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Stock for the long run

By Rohit Chauhan
In Uncategorized
October 10, 2011
5 Min read
13 comments
S
I am married to some stocks, which in these times of hyperactive trading, is quite shocking to a lot of people.
I have held some of these stocks for five to ten years. I have discussed most these companies on my blog in the past. A partial list follows
  1. Balmer lawrie – Held since early 2005: compounded return of around 26% per annum including dividends. You can read the analysis here, here and here
  2. Asian paints – Held since 2001: Compounded return around 31% per annum including dividends. You can read the analysis here and here
  3. Gujarat gas – Held since early 2005: Compounded return of around 38% per annum including dividends. You can read the analysis here and here
  4. Crisil – Held since late 2008: Compounded return of around 42% per annum including dividends.  You can read the analysis here and here
  5. Lakshmi machine works – Held since late 2008: Compounded return of around 50% per annum including dividends. You can read the analysis here and here.
Buy and hold philosophy?
The most common reaction to such an approach is to call it the buy and hold philosophy. I personally don’t follow any dogma in investing. At the time of investing in any stock, my approach is to buy stock in a company which has a sustainable competitive advantage (ability to maintain above average return on capital over a long period) and at a discount to fair value. I will hold the stock as long as the company continues to do well (maintains its competitive advantage) and is not too overpriced.
As you would notice in my approach above, there are no quantitative measures. Competitive advantage, though a well defined concept, is fuzzy in practice and not clear cut always. In addition, though some analysts like to give a specific number for fair value, it is usually an approximate number. As a result overvaluation also depends on your specific point of view (what you think about the company’s future prospects).
Due to the above subjectivity, I do not have a specific holding period in mind when I take a position in a stock. I generally evaluate the performance of the company annually, update the fair value and will hold till the market price does not exceed this fair value by 20-30%.
The above approach has led to a holding period of 5-10 yrs in case of some stocks.
Do I ever sell?
I will not hold the stock of a company, no matter how I feel about it, if I think the stock is overpriced. For example, I have reduced my position in asian paints in the last 2 years as the stock became overpriced.
I have exited Gujarat gas in the past when I thought it was overpriced and re-entered the stock when I felt it was undervalued again.
So in way, it is truly not a marriage, but more of a long term steady relationship 🙂
Why do most investors hold for shorter periods?
I have a theory or hypothesis on this. There is some research to support this theory too. Let me call this the ‘macho effect’. Most men, me included, want to look macho or ‘manly’ in almost all the activities they do. This testorone display is useful in a lot of activities (though one can doubt that too), but it is completely disastrous as far as investing is concerned.
What is the macho effect?  Simply put, most men think that they are highly skilled in investing and the way to show it off is to aim for the highest possible returns.  Any returns less than 40% per annum is for sissies. So in order to get these super high returns, they trade in and out of stocks and in the end are not even able to match market returns. The means becomes more important than the end itself.
If you don’t agree with my hypothesis, try discussing about a stock which can give you 20% per annum for the next 5 years with a high probability. Most of the guys will dismiss such a stock as useless and point to you a hot idea which can double in 3 months.
The same research (Barber and Odean (2000) study), also points out that women are much better investors than men. I think that would be true if they were more involved in the financial decisions of the family.
What are the downsides of long term holdings?
One downside is that such ideas will not make you look smart in front of your friends. These ideas will also not satisfy that ‘macho’ urge in you 🙂. If you really have that itch to scratch, keep around 10% of your portfolio for entertainment.
In addition, it is not always possible to know such ideas in advance. Some stocks develop into long term holdings as the company in question continues to perform well and as a result there is no reason to sell the stock. One can only look for good quality companies and hope that they will continue to perform well into the future.
How should one buy?
In times of market distress, several high quality companies are available at cheap valuation. One can look at creating a position in these stocks at such times. The advantage of buying the stock on the cheap is that one gets a double kicker – one from the reversion of the valuations to more normalized levels and the other from a steady increase in fair value of the stock.
I am quite comfortable with stocks listed in the post. In addition, I will add to them if the market continues to drop and they get cheaper.There are no guarantees that each of these companies will continue to do well, but as a group I would expect them to do well. Of course one has to be careful about the valuations at which you buy any stock.
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Fasten your seatbelts

By Rohit Chauhan
In Uncategorized
September 25, 2011
6 Min read
14 comments
F
A swing of 1% up or down is a decent move in the stock market during normal times. In the US and European markets a 3%+ swing is now becoming the norm. If you have been looking at these markets, you will realize that the volatility of these markets has gone up.
The European debt crisis and other issues are causing a surge in the volatility . The Indian market, though not yet impacted to the same extent, is beginning to feel the effects. It is easy to feel dizzy and disoriented by such large daily swings.
The most common reaction to such swings is to look for explanations and the common source for it is usually the news channels. We have the talking heads trying to make sense of it on a daily basis and giving us one silly reason after another after each up or down in the market.
What if there is no explanation
It is quite likely that we do not have any specific reason to explain these wild swings on a daily basis. Almost everyone in the market is equally confused and just reacting to the news flow on a day by day basis.
One option for all of us have is to ignore the daily chatter and get on with our daily lives. I am trying to follow this option. It is not easy, but I am definitely trying hard to ignore the noise as it is easy to get overwhelmed by it and do something silly as a result
Head in the sand?
Does that mean one buries his or her head in the sand and just ignores what is happening around us. I don’t think that’s a smart option either. The line between keeping your eyes open and getting swamped by the noise is however very fine
There are a few scenarios which look more probable every day. It is now an accepted fact that Greece is close to bankruptcy (if not already so) and sooner or later will have to restructure its debt in some shape or form.
It is difficult to figure out the chain of events that will follow from this event.
Will this lead to defaults in other European countries and consequent failure of banks? Will this be a repeat of 2008 and more? There are many opinions, each supported by its own logic and each sounding as plausible as the other
My thought process
I will not add more noise to the mix. My thoughts are good as anyone’ else’s or maybe worse as I don’t have any special macroeconomic skills.  As I cannot forecast what is going to happen, the prudent approach is to position myself for the possible storm.
The usual recommendation is to go into cash, hunker down and avoid all equities  till it all sorts out. If  you have been reading this blog for sometime, you know I will hardly recommend that and will not follow that course of action J
I actually have a very simple plan which I can break it down into a few points
–          Keep 25-30% or more cash as part of the portfolio to take advantage of a collapse in the market, if it happens. Ofcourse the market could rise and my returns could suffer.
–          Keep analyzing companies and identify some attractive ideas before hand. If the market drops, these companies could be available at cheap prices and I need to only pull the trigger. Ofcourse one needs ample amounts of courage at such times
–          Keep 6-9 months surplus cash in form of expenses at hand. If there is a contagion and a loss of job, the last thing one should do is to liquidate your investments to pay the bills.
–          Have some popcorn and coca cola ready for the entertainment on CNBC and other channels – need to have a sense of humor during such dark times !
Isn’t it déjà vu ?
It is tempting to think that this is a repeat of 2008 again. The market could collapse and the brave would go riding in with their cash. They may have to wait for 6-9 months and then we would see a sudden turnaround as we saw in 2009.  It may turn out that way and then maybe not !
As the saying goes – History does not repeat, but rhymes. We may have a similar crash, but it also quite likely the rebound may not be as quick. The last time around, the central banks and governments released a flood of liquidity which did the trick. This time around  the lenders of last resort – the governments are themselves the problem. There is no superman around this time to save the day. As an equity investor one needs to be prepared for the long haul.
One thing which will not change is the reaction of people around us. A lot of people will be shell-shocked and scared. One advantage of writing for 6 odd years is that I can go back to my earlier posts and look at the comments and see the thought process of a lot of people.
You may find some of these posts interesting. Do read the comments (some may be yours too) to see how we looked at the crisis as it was unfolding
Time to get busy – this was after the Lehman bros collapse and markets started dropping. I started getting excited way before the bottom (as always)
Buying in bear market –As I spoke about buying into the bear market, a lot of people and their friends were advising otherwise. See – nothing changes !
Analysis: Lakshmi machine works – this is one of my favorite posts. The company sold for close to cash during this period. This is the no.1 textile machinery manufacturer in India. I just could not see this company going bankrupt. Still, a lot of people had doubts. I still hold the stock and will add if the stock drops 15% from current levels ( stock tip J)
My portfolio details in 2008 – Needless to say it got hammered during the drop as I kept buying.
Don’t catch a falling knife – As prices dropped, everyone felt that it was dangerous to invest till the bottom was reached. There is no bell when the bottom is reached. One knows about the bottom only in hindsight. Another similar post here on NIIT.
Hoping for a quick rebound and Bear market to end soon –  These posts were meant to be jokes, when I predicted that the bear market will end by April 22nd 2009. Interestingly it did rebound in April – though I was off by a few days. If I have such a flash of inspiration this time too, I will let all of you know when this bear market will end J
Are you feeling excited – With perfect hindsight, March 2009 turned out to be the bottom.
It was quite a rollercoaster ride then and i expect it be a similar one, this time around too.
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Analysis: Maharastra seamless – conclusion

By Rohit Chauhan
In Company analysis
September 17, 2011
5 Min read
4 comments
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I wrote about maharastra seamless a few weeks back. The initial part of the analysis is here. The rest of the analysis follows

Competitive analysis

There are several companies in the steel tubes and pipes space. Some of the key companies in this space are Welspun corp, PSL, APL Apollo tubes etc.

Welspun corp is one the biggest companies in this space with a total capacity of around 1.5 MMT (3 times Maharastra seamless) which is slated to rise to around 2 MMT. The company is into LSAW, MSAW (higher dia pipes), ERW and seamless pipes. The company has maintained its ROE numbers at around the 20% levels. The company has also maintained its net margin levels at around 6-8% levels which is much lesser than MSL (at around 9-10%).

PSL is one of the largest HSAW pipe makers with a installed capacity of around 1.8 MMT. The company is expanding capacity by 75000 MT in 2012. The company also has a presence in the middle east (UAE) and US.  The company has maintained an ROE of around 15% with a net margin of around 3% in the last few years. The company however has a high debt equity ratio of around 1.6.

MSL seems to have better financials than the other companies in the same sector. The company has an operating margin which is higher than the other companies in the sector by atleast 4-5% which has led to a better ROC and higher cash flows. This higher operating margin seems to be the result of better pricing and lower overheads.

Management quality checklist

  • Management compensation: Management compensation seems to be reasonable. The MD made less than 0.5% of net profit in 2011 which is on the lower side for promoter led companies
  • Capital allocation record: The capital allocation record is a mixed bag. The company has consistently maintained a high gross margin on its product and thus been able to generate a high return on capital and good cash flows. These cash flows have been used to pay off debt and is also being used for capacity expansion (horizontal and vertical). At the same time the company raised money through an FCCB offer in 2005, which was not utilized by the company. I would give some benefit of doubt to the company on this point as they have been trying to expand into a billet plant (Which is the RM for ERW pipes) and have not been able to make progress due to land acquisition issues.
  • Shareholder communication: Seems adequate. The management provides adequate information about the business and has quarterly presentations about the same on its website. In addition the company conducts quarterly conference calls and shares the transcripts on its website
  • Accounting practice: Seems adequate and in line with the standards. Nothing stands out
  • Conflict of interest: There were no related party transactions which seem to be out of line. However the management has lent out around 177 Crs to a company (highlighted by the auditors) in 2011 which is a point of concern.

Valuation

The company sells at around 7-8 times  core earnings. One needs to exclude the impact of excess cash and non –core income (income from deposits and other sources) to arrive at the core earnings which were around 300 Crs last year. A normalized margin of around 14 % (rough average of last 5-6 years excluding impact of non core icome) gives an approximate net profit of around 270-290 Crs.

If  you exclude the excess cash on the books, the company is selling at around 7-8 times earnings.

The other companies in the same sector sell at around the same valuation. If one considers that maharastra seamless has superior financials, then one can make a case for a premium. The company is also selling on the lower side of its historical valuations, which has ranged between 5 to 20 times earnings.

In summary the company appears to be undervalued on various measures. At the same time, I still have doubts on the sustainability of the margins. In view of the capacity expansion in the industry and higher level of competition (due to dumping from china), it is quite likely the margins would trend downwards.

Conclusion

This is an industry with a limited number of players in india and with low levels of competitive advantage. The main competitive advantage comes from economies of scale and client relationships (takes time to become an approved supplier for the major O&G companies). In addition, there is a lot of competition from the Chinese companies in the same space and this has led to price pressure in india.

At the same time, the user companies of oil and gas, power utilities and water supplies are growing and is likely to result in robust demand over the medium and long term. We thus have two opposing trends (growth in topline and pressure on margins) and it is difficult (for me) to understand how this will impact profits eventually.

I have the company on a watch list for the time being and 10% drop in the price would be a good point for me to start a small position.

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On being patient

By Rohit Chauhan
In Uncategorized
September 12, 2011
5 Min read
12 comments
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One of the most common advice on investing is to be patient. I read this early on and always wondered what it meant? In my early days of investing, I thought I was missing something profound and did not get what the writer had to say. Overtime I have come to realize that a lot of people, who write that investors should be patient, are completely clueless about it themselves.  
What does being patient mean? Should I wait 1 day, 1month, 1 year or 10 years before I buy or sell the stock?
Does it mean I should be patient for the results? Is 1 year being patient enough?
There is no universal definition
I personally think that there is no universal definition of patience. This is something, one has to figure out for oneself. It depends on your investing philosophy, temperament and goals. 
A day trader is being patient when he waits for more than a couple of hours, whereas for an investor like me that is the blink of an eye. There is nothing wrong with what the day trader is doing as it works for him.
I would say that being patient has two components – time one should be able wait before buying a stock and the second piece is the time before selling the stock or getting the expected returns.
Patience in buying
Why should one wait before pulling the trigger ? If you are a long term investor and the company has a bright future, then should you not just buy the stock as a small difference in valuation will work itself out over the long term.
The above statement would be true if you knew the future of the company perfectly. As most of us don’t know the future precisely, it makes sense to have a margin of safety built into the purchase price. There are no hard and fast rules here, but I generally prefer to buy a stock at a 50% discount to fair value. If I have a high level of conviction, then I may drop the discount a bit , but I will never buy it close to fair value.
A lot of times, the company may be selling at or above its fair value. The future would be bright and everyone one and his milkman would be buying the stock. In such times, it makes sense to wait .
As it usually happens, something in the environment changes such as a slowdown in the industry and the market will abandon the stock. It is during such times that one has to have the courage of his or her convictions to buy the stock. The wait is sometimes short, but usually is long, often extending into years
Patience in selling
Let’s say you have been patient in buying the stock. Once you have purchased the stock, you want the stock to rise rapidly to validate your brilliance. I don’t know about you, but I get this urge all the time. However the world does not owe me anything ! If the industry is going through some short term pain, then it likely to take time for things to work out and the stock to realize its fair value.
I have found that 2-3 years is a good time for things to work out and if the market still does not see the light, then there is a strong possibility that you are wrong in your assessment.
So have you perfected it ?
The tone of the post would suggest that I am the perfect investor, who is supremely patient and is able to buy and sell with complete rationality. I wish I was!
I go through the same emotions as everyone else. If I find an attractive idea, I have to really hold myself back from rushing into it. To satisfy this urge, I create a small position and ensure that the itch is scratched.
I think I am far more patient on the sell side. This is usually a plus, but it has been curse too. I have been patient to the point of being stubborn in changing my view of the company. I have often persisted with a company for far too long and ignored the lack of performance. This flaw has usually resulted in an opportunity loss (where my capital was tied up in a low return idea).
How about now ?
So we come to point of the current market situation. In view of the high inflation, issues in Europe, US debt, corruption, my dog’s constipation (ok I don’t have a dog !) and all other issues, does it not make sense to be patient ?
As one of my friends was saying the other day – should you not wait till all this uncertainty clears up ? If you have been reading my blog for sometime, you know my answer  – The future is never clear !!! It is clear only in hindsight. I personally do not believe on waiting for a specific level of the market, before buying specific stocks.
I am being patient on the price of specific stocks. I am currently 30-35% in cash and tracking and analyzing companies everyday. If the price falls below my target price, I start buying the stock.
If the market crashes for some reason and I get a lot of bargains, then I will get aggressive. If nothing happens, I will keep waiting and hopefully be patient.
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