I wrote in the previous post that I have changed my portfolio design and split it into two categories. The first group is the core portfolio which contains the long term ideas where the intrinsic value is increasing and I feel strongly about the long term prospects.

The second group called the graham portfolio, named after the dean of value investing – benjamin graham, will contain the statistically cheap stocks. These stocks are cheap by various measures such as PE ratio, Mcap less than net current assets etc.

I received the following question from manish and thought of replying to via a post

Also I will be curious to know your strategies for these two portfolios. Will you be looking for a certain percentage of gain (say 50%) for Graham Style stocks and exit. I believe you will keep holding Core Portfolio forever (until business is intact).

The graham portfolio would be at best 20-25% of my total portfolio. The percentage is not fixed and will depend on the number of attractive ideas I can find.

I will not looking at a percentage gain to exit these stocks. For me the sell decision would be based on two factors – If the stock is selling at or 90% of intrinsic value I will sell the stock. In addition if the fundamentals deteriorate considerably or if the valuation gap does not close in 2-3 years, I may decide to bail out.

The holding period for the core portfolio could be longer as the intrinsic value of the companies is also growing. So unless the stock is grossly overpriced, I may continue holding a stock for some time.

Lesser analysis
In terms of analysis, I spend a considerable amount of time on the stocks in my core portfolio. However for the graham ideas, I am looking at cheap, obviously undervalued stocks and hence the extent of analysis would be less. I would be balancing the risk by diversifying more in the graham portfolio. The graham portfolio is an opportunistic reaction to the market crash.

An idea: HTMT Global
HTMT global is an IT/BPO company. Hinduja TMT (now called Hinduja ventures) demerged their IT/BPO business in 2006 and merged that into HTMT Global from Oct 2006.

Financials
HTMT global had a revenue of around 673 Crs in 2008 and a net profit of around 87.4 Crs. The company had a net profit margin on a consolidated basis of around 13% and an ROE of around 26% on invested capital. The total capital is around 823 Crs and a net cash of around 430 crs on the balance sheet (held in the subsidiary)

HTMT global on standalone basis (excluding subsidiaries) earned 367 Crs and a net profit of around 58.8 Crs. The company had a net margin of around 16% on a standalone basis. The lower margins on a consolidated basis is due to the Subsidiary ‘Affina’, which was turned around during the year.

Growth numbers are not representative as the demerger happened in the middle of 2007, however the company has been growing in excess of 30%.

Positives
The company is doing quite well and has been expanding the scope of its operation in terms of headcount, new clients etc. Athough the numbers are not comparable, the company has shown almost 50% growth per annum for the last 7 years (although from a small base – see pg 6 of annual report). The company has a cash of almost 470 crs (Q1 09) which has been earmarked for accquisitions and should add value to the company
The financials are quite good, with good free cash flow and a good dividend payout of almost 100%.

Finally the valuation is amazing. The company is being priced for less than cash on the books which means that the company worth more dead than alive

Negatives
Hindujas control this company and are not know for corporate governance. In addition the credit crunch and recession could hurt the company’s growth. However in the long term this should increase the offshoring.

Conclusion
Unless you believe that the company is worth less than cash, you cannot justify the valuations. One likely reason for the crash in price is the sell-offs by FII’s.

I am still looking for more negatives on the company, but cannot find any. One has to keep in mind that the stock price is assuming worse than bankruptcy. Personally, I am looking at this stock for my Graham portfolio.

Over the past few months I have modified my portfolio structure a bit. I have now divided my portfolio into two portions. The core portfolio, consists of companies where the intrinsic value is increasing and i have a higher level of confidence about the company. The other portion is more of a graham style portfolio. This consists of companies which are extremely cheap based on the various measures such as market cap less than cash on book, ultra low PE or market cap less than net current assets.

The core portfolio is a larger portion of my total portfolio and has companies, for which I have done a deeper and detailed analysis. The ‘graham’ portfolio on the other hand consists of the ‘cheap’ ideas. These companies may not score high on corporate governance or may not be a great businesses, but they are insanely cheap.

The idea behind this ‘cheap’ stock portfolio is to take advantage of the large number of opportunities, which are coming up in the market now. Ofcourse the number of stocks I plan to hold in the ‘graham’ styled portfolio could be between 15-20 or even higher versus 10-12 in the core portfolio.

So why this disclosure?
I will post on such cheap companies as time permits. I am planning to add them under the category of ‘graham’ type stocks – cheap stocks, but not necessarily great companies.

This type of value investing is also called cigar butt investing and it was developed in 1920s by the dean of value investing – Benjamin graham. This type of investing is low risk, involves quite a bit of diversification and works best during bear markets.

So please don’t be surprised if I post on ‘not so great, but cheap’ companies. One can get decent returns from such a portfolio, provided you have adequate diversification.

Is the stock undervalued?
I am getting several comments and emails asking whether so and so stock looks cheap. The odds of a stock being cheap these days are very high. If you pick 10 stocks randomly, I bet 5 will be cheap. However the question most of us should be asking is not whether the stock is cheap, but whether one understands the company well enough and will have the emotional fortitude to withstand another 20% drop in the stock price.

I have been getting several questions of this type

– what should be my buying strategy ?
– Should I buy immediately or wait for the bottom?
– Is the price of stock ABC good for buying or should I wait?

I have very simple approach and answer to all the above questions (from my perspective)

Step 1: understand the company well. Have confidence on your analysis
Step 2: Evaluate intrinsic value. Be realisitic in your evaluation. Be neither too pessimistic or too optimistic
Step 3: check price. If selling below intrinsic value (I personally prefer 50% below intrinsic value, you can choose your own number), buy. Otherwise do nothing
Step 4 : Every quarter analyse the results of the company and check if your assumptions are still valid. Recalculate intrinsic value if required.

Personally I decide on the position size and then invest around 40-50% of the full position if the price meets my criteria in step3. The rest of the buying is done in the next couple of months.

This approach cuts both ways. In a rising market, I am unable to build a full position. In a bear market, I am able to average down on price. However while I am doing this I am not looking at the overall market levels or trying bottom fishing. I personally think bottom fishing is a futile exercise and a 5-10% difference in the price will not matter in the long run. If it does, then one is cutting it real close

Do not invest
There is caveat to the above suggestion. If you do not understand the company well, cannot evaluate the intrinsic value or do not have confidence on your analysis, please don’t invest. A bull market is forgiving and you may make money inspite of poor analysis. However a bear market is brutal. If you analyse a company incorrectly or do not have the confidence, the market will not bail you out.

Finally, if you ask for the all time best strategy – Create an SIP (systematic investment plan) on the index for the next 15 years and don’t disturb it.

What I am looking at now?
The market is moving pretty fast these days. As a result I have been reviewing my holdings and looking at new companies. As I plan to keep the total number of holdings fixed (more on that later), I am comparing new ideas with the exisiting ones. A new idea has to be more attractive than an exisiting one, to get into the portfolio (and push out the less attractive stock)

Some companies I am looking at
Lakshmi machine works
Ingersoll rand
ICSA (later)
SKF bearing
HTMT global (cash bargain)
Denso india
Sonata software
Torrent software

The above list is not a recommendation list. It is just a list of stocks I am looking at and may or may not invest in any one of them. I will post on stocks which I find attractive when I complete the analysis and am able to write a post on it.