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July 7, 2008

6 Min read

In the previous post, I was asked to give an opinion on several stocks. I have fairly broad filters when selecting stocks. As a result I drop companies pretty quickly. Once they make through my filters, I spend quite a bit of time analysing and mulling over them. Frankly I don’t need more than 10-12 stocks to build a decent portfolio, so I don’t spend time on companies which don’t catch my attention, either due to the fundamentals or due to valuations

So here is my opionion on the stocks listed in the comments (please note the word opinion as I have really not done a detailed analysis on them)

Please note that for a stock to excite me, the fundamentals have to be good and the stock has to be fairly undervalued (selling at 50% of intrinsic value). So you may find that I am not too enthusiatic of some stocks if they don’t appear to be undervalued to me even if the fundamentals are good.

Following stocks are from mumbai jurno

Punj Lloyd – The net profits have grown by 30 times in the last 4 years. The company has a debt equity ratio of more than 1 which is on the higher side for my comfort. The market has recognized the rapid growth and inspite of the recent drop, the company is valued at 30 times its recent earnings. I personally will not invest in this stock for two reasons – I am not confident if the company can continue this level of growth and the valuation are on the higher side for me.

Voltas – I was invested in bluestar from 2003 to 2006 (see here). I exited blue star last year as I found the valuations to be on the higher side. The company has shown a high profit growth ( 5 times in last 5 years) and has a high ROE of almost 50%. The company has very low debt. Though the valuation (PE of around 20) is a bit on the higher side, I would personally put the company on my watch list and analyse it a bit further to make a decision.

Amararaja Batteries – This is the auto components industry. Overall I am not too excited by the economics of this industry. If the auto industry is under price pressure, it is bound to pass on those cost pressures to their suppliers. As a result auto component companies over a business cycle do not enjoy high profits. Most the companies in the industry do not have a high competitive advantage due buyer power, poor pricing strenght etc. I had analysed exide some time back, but never pulled the trigger. This is from memory – I think exide enjoys more than 50% market share in the industry. In such an industry a distant no.2 such as amaraja may not have very high pricing strength and may see its profits dip when the cycle turns downwards. So although the stock appears undervalued, I would be careful jumping into it. Looking into the rear view mirror (last year’s profit) may not be the smart thing to do in this stock. It is critical to figure out how the company will do going forward.

Venus Remedies – Company appears undervalued and has shown very high growth in the last few years. I would have to analyse if the growth is sustainable or not to make a decision.
Kamat Hotels – 2007 Debt equity ratio is 2:1, with the company carrying a debt of 270 Crs in 2007 (have not seen 2008 numbers). This debt is almost 10 times 2007 net profit numbers. This stock would fail to pass my fundamental filters and I generally end up passing on companies with this level of debt

ICSA (India) – This company like Punj lloyd and amaraja has shown phenomenal growth in the last 5 years. On a personal level such growth makes me nervous (although the market gets all excited by it). Before I touch this stock I would want to analyse the reason behind the growth and the sustainability of this growth. Basic numbers do not give the complete story. So I will need to research far more to make a decision on the company. A high growth in the last few years is good thing, but I would not extrapolate that growth blindly and buy the stock.

Axis Bank – Fundamentally a good bank. The P/B ratio is around 3 and the ROE has been dropping for the last few years. ROE is now at 12% which could be due to the additional capital raised by the bank. The bank is doing very well and growing rapidly too. I would personally track the stock, but the price is not cheap enough for me.

Yes Bank – This stock is current sweetheart of a lot of people. If I say something bad, some of you will beat me up 🙂 . The bank has good fundamentals. However at the current P/B of 4-5, the valuation is still too high for me.

From hardtoget

Alok – 2007 AR shows a debt of 3300 Crs (Debt equity ratio of 4). Unless 2008 is drastically different, this company is not for me. A debt equity ratio of more than 1 is generally a no go decision for me. I am not comfortable at all with such a high debt equity ratio, especially in cyclical industry

From vivek

Balmer Lawrie – I hold this stock. See analysis here

Berger Paints – I worked in asian paints and have seen how berger operates fairly closely. If there is one company other than asian paints which is aggressive and does a good job, it is berger. The company has a fantastic sales organisation. The fundamentals of the company are good and the valuation looks attractive too. If I was not as baised towards asian paints ( I hold this stock), I would invest in Berger paints.

Tata Tea – The company seems to have good fundamentals, good brands and decent valuation. I will be analysing the stock further.

Glaxo Consumer – I hold this stock. See analysis here

Castrol – The company has great brands, a good distribution network, very high ROE and great fundamentals. The valuation seems to be a bit on the higher side for me to pull the trigger. My key concerns are management quality and impact of oil pricing on the company’s profits. A few years back, I think the management tried to buy out the domestic shareholders at a low price. As a result I am not too comfortable with the management. In addition need to see if their margins will be impacted drastically by the oil price changes.

Hindustan Sanitaryware – Fundamentals look good, although the 2007 debt is a bit on the higher side. The valuations are quite attractive. I think the company is worth a closer look.

Read on 9 comments

Wish I sold off my entire portfolio in Jan !!

By Rohit Chauhan

In Uncategorized

July 2, 2008

2 Min read

15 comments

No, I have not been wishing that or whining about it. I have heard several of my friends wish that they had done that. Short of knowing the future, it would have been impossible to time the market that well.

I too have losses due to the market drop. However I am not dissapointed or wishing otherwise. It has nothing to do with being brave and more to do with being rational based on my approach.

This is how I construct my portfolio. I typically start buying at or below prices, which are 50% of conservatively calculated intrinsic value. Ofcourse at the peak in Jan, most my holdings had gone up (in some cases too fast) . However they were still trading at a discount to their intrinsic value. Hence I saw no reason to sell my stocks. However as they were above 50% discount levels, I was not doing any major buying too. As a result, after creating a small position in some stocks, I was doing nothing and just twidling thumbs.

Now with the market crash several of my holdings are below the 50% discount mark. There are quite a few new opportunities coming up too. So I have now started accumulating stocks which I had analysed in the past, but the price was not attractive enough.

So the point is this – If you felt the stocks in your portfolio in jan were not overvalued enough to be sold then, they should even more attractive now. If you did not sell then, thinking that they were not overpriced, you should buying more now. Ofcourse this assumes that the fundamentals have not deterioated suddenly.

If however you are pessimistic about the stock after a 30-40% drop, then you need to do some honest thinking. Either your analysis was wrong or the current pessimism is getting to you.

Read on 15 comments

Where does the index stand ?

By Rohit Chauhan

In Market analysis, Uncategorized

June 27, 2008

4 Min read

7 comments

Update 29th – I missed an important point when i posted on 28th. The data for the index is non-stationary. What it means that the underlying composition of the index is not fixed and the various other parameters such as interest rates, inflation are changing too. As a result the index of 1995 is not the same as the index of 2008. One must be careful from drawing too many conclusions from the data. It is good to analyse the data and have a perspective, but dangerous to make invest decision based on it alone. It easy to say the index is overvalued if the PE is above 30 or undervalued if it drops below 10. However it is not easy to arrive at a firm conclusion if the PE is 15 or 18 or similar such levels.

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I am not planning to make any forecast on where the forecast will be in the next few month. However I have done some analysis on the sensex and nifty index and uploaded it in the google groups. You can check here to download the file Quantitative calculation 2008.xls and check the first worksheet – market valuation.

The numbers for june 2008 are computed for both the sensex and the nifty. A few observations

1. The current PE for the sensex is around 16.8 and 17.7 for nifty. By historical standard ( history is few years back, not a few months) it is not too low. Just about towards the upper end of the PE band

2. The Return on equity (earnings/book) is still pretty high by historical standard. In the 90’s the numbers were generally low in 14-19% range. The last 3-4 years were actually an exception. We had a confluence of positive factors. Low interest rates, high demand growth and high capacity utilization all resulted in high returns. Companies had also re-structured and so net margins and ROE have been high in the past few years. The business cycle may be turning, with interest rates and inflation creeping up. We could revert to an average ROE of 18% (still higher by historical standards)

3. The Earnings growth has been 20%+ in the last few years. This has slowed down to around 10-12% in the current year.

Lets do some scenario analysis. For sake of assumption lets look at some probable scenarios on factors which are based on fundamentals

Book value is around 3540. An ROE of 18% which looks like a fair no. (look at the data for the entire 90s till 2003. I am still assuming a higher number). So normalized earnings is around 640 Rs which is lower than the current number of 820. What this means the earnings growth could slow down over the next few years as ROE reverts to the historical numbers. It is important to remember that ROE, unlike PE is not driven by market pschology. So the historical numbers do count in case of ROE.

For PE looks at the years 96-98. Interest rates were high and market PE ranged between 14-17.

Now for a juicy forecast – lets say earnings grow to around 900 in 2 years (book value will have to grow by 20% per annum and returns will drop to around 18% for that, so it is not impossible) and the PE is around 16-18, we are looking at a range of 14500- 16500.

Keep in mind that the assumptions in arriving at these numbers are still optimistic. We are still assuming reasonable growth in book values, moderate drop in ROE and fairly decent multiples. If things turn out better then we could have another bull market. But if we revert to historical levels, even on some variables such as ROE or PE or growth, then even the current market level is not too low.

Ofcourse other than the data, everything else in this post is a hypothesis. So my guess is as good as yours.

For an analysis of the index 2.5 years back see here

Read on 7 comments

A question on trading

By Rohit Chauhan

In Non-equity assets, Uncategorized, Views on news

June 25, 2008

2 Min read

11 comments

06/27

some more observations from an outsider

– i have generally noticed that the younger crowd is more attracted to trading. that does not mean older people dont trade. just that if you talk to 100 young guys who are interested in stock market, a sizeable numbers would be into trading
– A lot of my friends who are into trading have a bias for action. There is the thrill of being right and knowing that pretty soon.
– there is more sense of company. you get to discuss about it with more people. value investing is pretty lonely. you buy ugly beaten down stocks. who wants to discuss companies no one has heard of ?
– media and the environment like brokers also encourage trading. no one will recommend buying a stock and sleeping on it for 5 years.

if you are a trader, please do not take this as a criticism of trading. These are just neutral observations (maybe incorrect) of an outsider. I may have bias against trading, but not a bias against people who do trading.
————————————————————————————————
I have noticed in general that the number of people interested in trading are far more than those interested in long term investing or value investing. For ex: there are far more blogs on trading than say value investing. There could be an overlap between the two groups too. I however have no aptitude for trading and it does not fit my temprament. I have said so in the past.

I can understand why there are more folks interested in trading. Trading does have an element of excitement. You get to do something quite often, whereas value investing or long term investing is as exciting as watching grass grow or paint dry. So this is my question – What are the average non – leveraged returns experienced by traders over a multi year period ..say 5-6 years (including a bull or bear market) ?

I agree there are several trading strategies and so to lump all of them under ‘trading’ is not smart. But at the risk of sounding dumb (which I am in terms of trading), I was curious to know what kind of returns do most people get ?

Read on 11 comments

Old flames and Old affairs

By Rohit Chauhan

In General thoughts, Uncategorized

June 22, 2008

2 Min read

6 comments

I have had love affairs with Gujarat gas, concor, asian paints, Blue star etc in the past. The original thesis when investing in these stocks played out and the final results were far better than what I had expected.
Then like all affairs, it was time to part. A few of these stocks got overvalued and I moved on.

Now unlike old girlfriends, there is no harm in revisiting these old relationships from time to time. You know the company, its management well and if you held it for a long time, then you would have become comfortable with the business too. So I tend to track these old flames regularly and if I find them to be attractive again, I will go ahead and invest again in them.

They key point when investing in the same stocks again is to avoid becoming emotional with these stocks which have treated you well in the past. It is important to analyse these companies as if you are analysing a new stock and check the price value relationship. If there is a substaintial gap, then I am fairly comfortable re-investing again.

Case in point : Gujarat gas. I sold off this stock by end of 2006 thinking that the stock was overvalued, after having held the stock for 3 years. Then last year on checking the fundamentals, I realised some of the risk in terms of gas pricing had been handled pretty well by the company. In addition the company has expanded its area of operations further and is doing very well. With the current spike in fuel prices, I think the company should do well for the next few years.

So no harm in revisiting these old flames from time to time and re-starting the old relationships again. Ofcourse I mean stocks and not girlfriends 🙂 . Now this is one post my wife should not read (she hardly reads them anyway, so I am safe I guess).

Read on 6 comments

Inflation and debt

By Rohit Chauhan

In Uncategorized, Views on news

June 17, 2008

2 Min read

5 comments

I have been reviewing the results of some companies and a few points are standing out

– raw material cost, over heads and labor costs are now increasing faster than sales
– Net margins are stable or coming down. Profit growth has slowed
– Debt may start getting repriced soon. As a result interest costs could start increasing

Maybe this is not news. However the above has the following implications

– valuations for the market and several companies is still based on the low inflation, high growth and high ROE environment of 2002-2007. If we have stagflation (high inflation and low growth), we could see prices drop sharply.
– Some companies in response to high growth, have taken on large amounts of debt. If we have stagflation, these companies could get hit very badly. The stock price for such companies could plunge sharply.
– In contrast companies with strong competitive advantage and low debt can maintain margins due to pricing power of their products and low interest costs. Such companies may see lower impact to their stock price.

I am not predicting a long period of high inflation and low growth and cannot be sure if we will see drop in stock prices. History (mid 1990’s) gives us a clue. During mid 90’s in response to high inflation, RBI hiked the interest rates to around 15% and we had a period of low growth from 1997-1999. Stock market returns were also poor during this period.

Does it mean that we should sell our stocks and wait for the clouds to clear. I would say no. The future is never crystal clear. It never was and never will be. What we can, however be sure is that good companies, with strong sustianable competitive advantage, will do well in inflationary and recessionary times.

What such times gives us is low prices due to the pesimissm. These low prices can be used to invest in good companies at attractive prices to build a good portfolio. However this is not easy and not for the faint hearted. If the inflation drops and the growth picks up quickly , then the returns could be good in the short term. However if economic situation takes time to turnaround, then be prepared to wait for a long time for the returns to materialize.

Read on 5 comments

What is hot today ?

By Rohit Chauhan

In Uncategorized

June 14, 2008

2 Min read

3 comments

I wrote about ‘rear view mirror investing’ in my previous post. What it essentially means is buying yesterday’s winners. As a far as long term investing is concerned, you will rarely make money buying yesterday’s winners. If like me, you believe that value investing is the way to go, then the focus has to be on companies and sectors which are currently out of fashion.

Lets try to invert – What is hot today. Let me think aloud and put a quick list below

Oil
Gold
Other Commodities like wheat, corn, metals etc
Energy companies (out of india ofcourse)
Real estate – In india it is a sure thing to make money and get rich 🙂

If you thought that this kind of investing was limited to investors, think again. Seasoned businessmen are prone to similar biases. Think telecom in US in 1998-2000 when companies invested huge sums of money in building capacity and then went bankrupt when the demand never materialized.

The same may be happening in real estate ..see this article and this. Maybe this is just a blip. But when real estate price (per sqft) starts becoming costlier than US, singapore, UK etc there is something funny happening.

So why do most people do it ? two reasons i can think of
– social proof : if everyone else is doing and making money, it must be right and i must do it too.
– laziness : If you imitate others, you dont have to think and take responsibility for your own decisions

Like driving, if you invest looking into the rear view mirror, then be prepared to get hurt (hopefully not badly).

The above may work for traders, momentum players etc. That is however not my area of competence and so you have to evaluate the above statement in light of long term investing.

Read on 3 comments

Rear view mirror investing

By Rohit Chauhan

In Investment process, Uncategorized

June 11, 2008

3 Min read

7 comments

Was reading this article – mutual fund NAVs take the plunge. The following caught my eye

“The high erosion in the NAVs is the outcome of heavy concentration by mutual fund industry in sectors like banking, real estate, capital goods, engineering, cement and construction which were going great guns in 2007, but have eroded sharply this year. Most schemes had comfortably ignored sectors like pharma, FMCG and IT, which have started to perform now. So, the funds that failed to tap in these opportunities then are paying a heavy price today.”

The above statement gives me such a feeling of deja-vu. History repeats itself in the stock market, again and again. I saw the same thing happen in 2000 with IT. Most of the mutual funds piled into the IT sector, right before the crash. The same seems to have happened now.

Ofcourse it takes courage of conviction to go against the crowd. It is not rocket science to figure out that a company selling at 70 times earnings could be overvalued. But then most of the fund managers, wanting to keep their jobs are more worried about their quarterly performance than doing well in the long run.

For those who say that the small investor is at a disadvantage v/s the pros, I would say it is complete hogwash. All other factors aside, as a small investor I am personally not forced to invest in the current hot stocks. At the cost of looking like a moron in the short run, I can afford to pickup undervalued scrips which will give me good long term returns. That advantage alone is more than all other advantages the big boys have such as more research, access to management etc.

This rear view approach is however not limited to the big boys alone. Unfortunately a lot of small investors do the same. However if they lose money, they end up blaming everyone except themselves.

I am guilty of doing the same thing in the past. However the sensible thing I did was to blame myself completely for the losses. It is not that I mindlessly go against the crowd ( I wont cross the road with a red signal when everyone else is standing on the sidewalk for the sake of going against the crowd 🙂 ).

If am looking at a company, I need to convince myself why the market is undervaluing the company and what is my variant perception. For stocks which favored by everyone else, I have generally found that the market is either too optimistic or is valuing them fairly and hence it is unlikely that I will make good returns.

Read on 7 comments

Inflation and portfolio strategy

By Rohit Chauhan

In Portfolio management, Uncategorized

June 8, 2008

3 Min read

9 comments

With inflation at 9% or higher (depending on the numbers you believe), it may be too late to profit from the increase, but it makes sense to re-construct your portfolio to reduce the impact.

My plan, which I detail in this post, is a mix of reading and personal experiences. Ofcourse everyone has a unique situation, so my approach may not be valid for everyone. However some points may be of use to most of you.

1. Equity is one of the best hedges against inflation. Long term returns are definitely 12% + (I don’t think 40% is the norm unlike the last few years). If one can find and invest in good companies, one’s with strong competitive advantage and pricing power, then I think the returns will definitely be more than inflation. Ofcourse in the short run one can lose money, so equity is not hedge against inflation in short term.

2. Debt is usually a component of one’s portfolio. In period of rising inflation it makes sense to invest in floating rate funds. That way one is hedged against inflation and may get a return of 1-2% above inflation. However with the current lose monetary policy and low interest rates, the real returns from such funds may be negative. It is likely that the benchmark rates will be raised in response to the inflation. In such a scenario, floating rate funds may give returns slightly above inflation.

3. Avoid long term FD’s and such commitments. If you invest for 5 years at say 8%, and if inflation crosses 9-10%, then you are losing money. One option can be to break the deposit and re-invest, but there is generally a penalty and loss associated with it.

4. Real estate is good hedge especially if funded by a fixed rate loan. In hindsight 2003-2004 was a great time to invest in real estate. Interest rates were low, everyone thought inflation was gone and real estate seemed to be priced reasonably. However I am not sure how good real estate is now as an investment option in general.

5. Be good at your job/ profession etc . Now this is a non-financial advise, but in the end for most of us the biggest asset is our skills. I think constantly upgrading skills and doing well in our professions is one of the best hedges against inflation. If you are one of the top performers, you will earn more via better increments or higher profits from your business. So I think investing in yourself is one of best hedges against inflation.

Now a lot of people will say gold, metals etc. I personally have no interest in those options. The long term data in most of these options show that the returns track inflation. So in absence of some special understanding of these alternative asset classes, I prefer to avoid them. I think there is enough for me to do in equity and debt than to worry about all this other stuff.

Finally, I mentioned profit from inflation ..is that possible ? if you can fund a long term asset such as real estate with a fixed debt (when rates are low) then during inflationary periods the rental rises with the inflation whereas debt is fixed. So equity in the asset is rising faster than inflation.

Also if you can roughly estimate when inflation is peaking, an investment in long duration debt (such 10 year bonds or mutuals) will give good returns when inflation slows (due to repricing of bonds). This happened to investors during the 2000-2003 time frame.

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Analysis – Bharat Electronic limited (BEL)

By Rohit Chauhan

In Investment ideas, Uncategorized

June 3, 2008

4 Min read

6 comments

About
Bharat Electronics Limited (BEL) is the largest defense equipment company in India catering to Defense services electronic requirement. BEL enjoys near monopoly status in supplying high-tech defense products like radars, sonars, communication equipment, electronic warfare equipment to the armed forces. Other division manufacturing civilian products supplies communication equipment to the telecom industry, voting machines etc.

The defence sector contributed to 76% of the revenue and the rest was from the civilian sector.

The company has a government mandated near monopoly for the defence sector business. In addition foreign vendors as a part of localization are required to source from BEL

Financials

The company has shown considerable improvement in financial performance. Topline has grown by 10% p.a for the last 5 years. The net profit has however grown by almost 20% p.a during the same period.

The higher bottom line growth has been driven by an increase in net margins from 10% to around 17% in 2008. Total Asset ratios have improved from around 8.2 to around 9.2 in 2007. The Wcap is negative or zero and the inventory turns have also improved 2.1 to 3.3. Only the recievables ratio has dropped from 3.1 to 2.5 in 2007.

The management seems to be aware of this and in 2007 has indicated that this was mainly due to incomplete projects and should improve in the current year.

The company is a cash rich company with cash net of debt of around 2200 Crs which could improve further in the current year.

The ROE seems to be steady, however net of cash it has been improving and the Return on incremental invested capital has gone up a lot.

Positives
The financials have improved substanially in the last 5 years. The net margins and Return on capital has gone up. The company has considerable cash on books. In addition the company spends almost 3-4% on R&D.
The company has introduced almost 25 products and systems in 2007. The company plans to continue this pace of new products in the future too.
The company has an order book of almost 90000 million in 2007 which is equivalent to 3 years of revenue at the curent rate.
The company will also benefit from the mandatory offset clause where in foreign vendors have to procure some portion of the contract from BEL.

Risks
The margins have gone up from 10% to around 17% in the current year driven by Raw material cost reduction. I am not sure how sustainable this improvement is. The long term average is still around 10-12 % and the current rise could be temporary.
The defence spending dropped around 1996-1998 time period and the net profits were low during that period. It looks unlikely that the government would drop defence spending now, however the risk remains.
Competition is very low in the defence sector, however the other segments do have some competition.

Competitive analysis
BEL is one of those rare companies which have very substantial competitive advantages. These advantages are government mandated and I find it diffcult to see how these will go away. Across the world there is a preference for domestic companies for defence contracts, more so in india.

Valuation
With an assumption of current growth and margins, the Intrinsic value comes to around 2100 Rs/ share. However a senstivity analysis of margins and topline gives the following numbers
Topline – 10%, margin – 10-12 % (long term average): 1650
Topline – 14%, margin – 10-12% : 2200
Topline –14%, margin – 17% : 3300

The central point for the intrinsic value seems to be around 2000-2200.

Conclusion
The company seems to be trading at 30-40% discount to instrinsic value. This is however not a sexy company. This is a company with substantial competitive advantages and will continue to be very profitable. However I don’t expect the market to suddenly discover this company and give a higher valuation. Most likely one can expect decent returns in the long run.

Read on 6 comments

Rapid fire analysis of multiple stocks

Wish I sold off my entire portfolio in Jan !!

Where does the index stand ?

A question on trading

Old flames and Old affairs

Inflation and debt

What is hot today ?

Rear view mirror investing

Inflation and portfolio strategy

Analysis – Bharat Electronic limited (BEL)

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