The Valuation Game

Value is a magic word. 

Ears stand up. 

Where is value?

Big, big question. 

Medium term investors look for growth. 

Long-termers invariably look for value. 

How do you value a stock?

There are many ways to do that. 

Here, we are just going to talk about basics today.

For example, price divided by earnings allows us to compare Company A to Company B, irrespective of their pricing.

Why isn’t the price enough for such a comparison?

Meaning, why can’t you just compare the price of an Infosys to that of a Geometric and conclude whatever you have to conclude?

Nope. 

That would be like comparing an apple with an orange. 

Reason is, that the number of shares outstanding for each company are different. Thus, the value of anything per share is gotten by dividing the grand total of this anything-entity by the number of outstanding shares that the company has issued. For example, one talks of earnings per share in the markets. One divides the total earnings of a company by the total number of outstanding shares to arrive at earnings per share, or EPS. 

Now, we get investor perception and discovery into the game. How does the public perceive the prospects of the company? How high or low do they bid it? How much have they discovered it? Or not discovered it? This information is contained in the price. 

So, we take all this information contained in the price, and divide it by the earnings per share, and we arrive at the price to earnings ratio, or P/E, or just PE. 

Yeah, we now have a scale to judge the value of stocks. 

Is this scale flawed?

Yeah. 

A stock with a high PE could have massive discovery and investor confidence behind it, or, it could just have very low earnings. When the denominator of a fraction is low, the value of the fraction is “high”. You have to use your common-sense and see what is applying. 

A stock with a low PE could have low price, high earnings, or both. It could have a high price and high earnings.  The low PE could also just be a result of lack of discovery, reflected in a low price despite healthy earnings. Or, the low PE could be because of a low price due to rejection. What is applying? That’s for you to know. 

At best, the PE is ambiguous. Your senses have to be sharp. You have to dig deeper to gauge value. The PE alone is not enough. 

Now let’s add a technical consideration. One sees strong fundamental value in a company, let’s say. For whatever reason. How does one gauge discovery, rejection or what have you in one snapshot? Look at the 5-year chart of the stock, for heaven’s sake. 

You’ll see rejection, if it is there. You’ll understand when it is not rejection, because rejection goes with sell-offs. Lack of discovery means low volumes and less pumping up of the price despite strong fundamentals. You’ll see buying pressure in the chart. That’s smart money making the inroads. Selling pressure means rejection. You’ll be able to gauge all this from the chart. 

Here are some avenues to look for value :

 

– price divided by earnings per share,

– price divided by book-value per share,

– price divided by cash-flow per share,

– price divided by dividend-yield per share,

– in today’s world, accomplishment along with low-debt is a high-value commodity, so look for a low debt to equity ratio,

– look for high return on equity coupled with low debt – one wants a company that performs well without needing to borrow, that’s high value,

– absence of red-flags are high value, so you’re looking for the absence of factors like pledging by the promoters, creative accounting, flambuoyance, 

– you are looking for value in the 5-year chart, by gauging the chart-structure for lack of discovery in the face of strong fundamentals. 

 

We can go on, but then we won’t remain basic any more. Basically, look for margin of safety in any form. 

Yeah, you don’t buy a stock just like that for the long-term. There’s lots that goes with your purchase. Ample and diligent research is one thing. 

Patience to see the chart correct so that you have your proper valuations is another. 

Here’s wishing you both!

🙂

 

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Due Diligence Snapshot – IL&FS Investment Managers Ltd. (IIML) – Jan 14 2013

Price – Rs. 23.85 per share ; Market Cap – 499 Cr (small-cap, fell from being a mid-cap); Equity – 41.76 Cr; Face Value – Rs. 2.00; Pledging – Nil; Promoters – IL&FS; Key Persons – Dr. Archana Hingorani (CEO), Mr. Shahzad Dalal (vice-chairman) & Mr. Mark Silgardo (chief managing partner) – all three have vast experience in Finance; Field – Private Equity Fund managers in India (oldest), many joint venture partnerships; Average Volume – around 1 L+ per day on NSE.

Earnings Per Share (on a trailing 12 month basis) – 3.55

Price to Earnings Ratio (thus, also trailing) – 6.7 (no point comparing this to an industry average, since IIML has a unique business model)

Debt : Equity Ratio – 0.35 (five-year average is 0.1); Current Ratio – 1.05

Dividend Yield – 4.7% (!)

Price to Book Value Ratio – 2.1; Price to Cashflow – 5.1; Price to Sales – 2.2

Profit After Tax Margin – 32.85% (!); Return on Networth – 35.24% (!)

Share-holding Pattern of IL&FS Investment Managers – Promoters (50.3%), Public (39.2%), Institutions (4.9%), Non-Institutional Corporate Bodies (5.5%). [The exact shareholding pattern of IL&FS itself is as follows – LIC 25.94%, ORIX Corporation Japan 23.59%, Abu Dhabi Investment Authority 11.35%, HDFC 10.74%, CBI 8.53%, SBI 7.14%, IL&FS Employees Welfare Trust 10.92%, Others 1.79%].

Technicals – IIML peaked in Jan ’08 at about Rs. 59.50 (adjusted for split), bottomed in October of the same year at Rs. 13.60, then peaked twice, at Rs. 56.44 (Sep ’09) and Rs. 54.50 (Aug ’10) respectively, in quick succession, with a relatively small drop in between these two interim high pivots. By December ’11, the scrip had fallen to a low pivot of Rs. 23.30 upon the general opinion that the company wasn’t coming out with new product-offerings anytime soon. A counter rally then drove the scrip to Rs. 32, which is also its 52-week high. During the end of December ’12, the scrip made it’s 52-week low of Rs. 23. People seem to have woken up to the fact that a 52-week low has been made, and the scrip has risen about 4 odd percentage points since then, upon heavier volume.

Comments – Company’s product profile and portfolio is impressive. No new capital is required for business expansion. Income is made from fund management fees and profit-sharing above designated profit cut-offs. Lots of redemptions are due in ’15, and the company needs to get new funds in under management by then. If those redemptions are done under profits, it will increase company profits too. Parag Parikh discusses IIML as a “heads I win (possibly a lot), tails I lose (but not much)” kind of investment opportunity. His investment call came during the mayhem of ’09. The scrip is 42%+ above his recommended price currently. What a fantastic call given by Mr. Parikh. Well done, Sir! Professor Sanjay Bakshi feels that IIML has a unique business model, where business can keep on expanding with hardly any input required. He feels, “that at a price, the stock of this company would be akin to acquiring a free lottery ticket”. I opine that the price referred to is the current market price. Before and after Mr. Parikh’s call, the company has continued to deliver spectacular returns. The company’s management is savvy and experienced. They made profitable exit calls in ’07, and fresh investments were made in ’08 and ’09, during big sell-offs. Thus, the management got the timing right. That’s big. I have no doubt that they’ll get new funds in under management after ’15, alone on the basis of their track record. Yeah, there’s still deep value at current market price. Not as deep as during ’08, or ’09, but deep enough.

Buy? – Fundamentals are too good to be ignored. They speak for themselves, and I’m not going to use any more time commenting on the fundamentals. Technicals show that volumes are up over the last 3 weeks. People seem to be lapping the scrip up at this 52-week low, and the buying pressure has made it rise around 4% over the last 3 weeks. If one has decided to buy, one could buy now, preferably under Rs. 24. The scrip seems to be coming out of the lower part of the base built recently. There is support around Rs. 23 levels, so downside could be limited under normal market conditions.

Disclaimer and Disclosure – Opinions given here are mine only, unless otherwise explicitly stated . You are free to build your own view on the stock. I hold a miniscule stake in IIML. Data / material used has been compiled from motilaloswal.com, moneycontrol.com, equitymaster.com, valuepickr.com, safalniveshak.com and from the company websites of IIML & IL&FS. Technicals have been gauged using Advanced GET 9.1 EoD Dashboard Edition. I bear no responsibility for any resulting loss, should you choose to invest in IIML.

Can We Please Get This One Basic Thing Right? (Part III)

Yeah, we’re digging deeper.

How does an investor arrive at an investment decision?

It’s pretty obvious to us by now that traders and investors have their own rationales for entry and exit, and that these rationales are pretty much diametrically opposite to each other.

So, what’s the exact story here?

The seasoned investor will look at FUNDAMENTALS, and will exhibit PATIENCE before entering into an investment.

The versatile trader will look at TECHNICALS, and will NOT BE AFRAID of entry or exit, any time, any place. He or she will be in a hurry to cut a loss, and will allow a profit to blossom with patience.

What are fundamentals?

Well, fundamentals are vital pieces of information about a company. When one checks them out, one gets a fair idea about the valuation and the functioning of the company, and whether it would be a good idea to be part of the story or not.

A good portion of a company’s fundamental information is propagated in terms of key ratios, like the Price to Earnings Ratio, or the Debt to Equity Ratio, the Price to Book Value ratio, the Enterprise Value to EBITDA Ratio, the Price to Cash-flow Ratio, the Price to Sales ratio, etc. etc. etc.

What a ratio does for you is that in one shot, it delivers vital info to you about the company’s performance over the past one year. If it’s not a trailing ratio, but a projected one, then the info being given to you is a projection into the future.

What kind of a promotership / management does a company have? Are these people share-holder friendly, or are they crooks? Do they create value for their investors? Do they give decent dividend payouts? Do they like to borrow big, and not pay back on time? Do they juggle their finances, and tweak them around, to make them look good? Do they use company funds for their personal purposes? Researching the management is a paramount fundamental exercise.

Then, the company’s product profile needs to be looked into. The multibagger-seeking investor looks to avoid a cyclical product, like steel, or automobiles. For a long-term investment to pan out into a multibagger, the product of a company needs to have non-cyclical scalability.

After that, one needs to see if one is able to pick up stock of the particular company at a decent discount to its actual value. If not, then the investor earmarks the company as a prospective investment candidate, and waits for circumstances to allow him or her to pick up the stock at a discount.

There are number-crunching investors too, who use cash-flow, cash allocation and other balance-sheet details to gauge whether a coveted company with an expensive earnings multiple can still be picked up. For example, such growth-based investors would not have problems picking up a company like Tata Global Beverages at an earnings multiple of 28, because for them, Tata Global’s balance-sheet projects future earnings that will soon lessen the current multiple to below sector average, for example.

Value-based investors like to buy really cheap. Growth-based investors don’t mind spending an extra buck where they see growth. Value-based investors buy upon the prospect of growth. Growth-based investors buy upon actual growth.

The trader doesn’t bother with fundamentals. He or she wants a management to be flashy, with lots of media hype. That’s how the trader will get volatility. The scrips that the trader tracks will rise and fall big, and that’s sugar and honey for the trader, because he or she will trade them both ways, up and down. Most of the scrips that the trader tracks have lousy fundamentals. They’ve caught the public’s attention, and the masses have sprung upon them, causing them to generate large spikes and crashes. That’s exactly what the trader needs.

So, how does a trader track these scrips? Well, he or she uses charts. Specifically, price versus time charts. The trader doesn’t need to do much here. There’s no manual plotting involved. I mean, this is 2012, almost 2013, and we stand upon the shoulders of giants, if I’m allowed to borrow that quote. Market data is downloaded from the data-provider, via the internet and onto one’s computer, and one’s charting software uses the data to spit out charts. These charts can be modified to the nth degree, and transformed into that particular form which one finds convenient for viewing. Modern charting software is very versatile. What exactly is the trader looking for in these charts?

Technicals – the nitty-gritty that emerges upon close chart scrutiny.

How does price behave with regard to time?

What is the slope of a fall, or the gradient of a rise? What’s the momentum like?

What patterns are emerging?

How many people are latching on? What’s the volume like?

There are hundreds of chart-studies that can be performed on a chart. Some are named after their creators, like Bollinger bands. Others have a mathematical name, like stochastics. Names get sophisticated too, like Williams %R, Parabolic SAR and Andrew’s Pitchfork. There’s no end to chart  studies. One can look for and at Elliott Waves. Or, one can gauge a fall, using Fibonacci Retracement. One can use momentum to set targets. One can see where the public supports a stock, or where it supplies the stock, causing resistance. One can join points on a chart to form a trendline. The chart’s bars / candle-sticks will give an idea about existing volatility. Trading strategy can be formulated after studying these and many more factors.

Where do stops need to be set? Where does one enter? Exit? All these questions and more are answered after going through the technicals that a chart is exhibiting.

One needs to adhere to a couple of logical studies, and then move on. One shouldn’t get too caught up in the world of studies, since the scrip will still manage to behave in a peculiar fashion, despite all the studies in the world. If the markets were predictable, we’d all be millionaires.

How does the trader decide upon which scrips to trade? I mean, today’s exchanges have five to ten thousand scrips that quote.

Simple. Scans.

The trader has a set of scan criteria. He or she feeds these into the charting software, and starts the scan. Within five minutes, the software spits out fifty odd tradable scrips as per the scan criteria. The trader quickly goes through all fifty charts, and selects five to six scrips that he or she finds best to trade on a particular day. Within all of fifteen minutes, the trader has singled out his or her trading scrips.

Do you now see how different both games are?

I’m glad you do!

🙂

Due Diligence Snapshot + Technical Cross-Section — Ador Fontech Limited — Nov 27 2012

Price – Rs. 81.30 per share

Earnings Per Share projected on the basis of quarter ended Sep 30 2012 – Rs. 12.62

Price to Earnings Ratio (thus, also projected) – 6.44

Price to Book Value Ratio – the stock is selling at approximately 2 x book value currently

Debt : Equity Ratio – Nil

Current Ratio – 2.73

Profit After Tax Margin – 12.51%

Return on Networth – 32.54 %

Pledged Shares %age – Nil

Face Value – Rs. 2.00

Dividend Payout – 50% -150% of face-value.

Average Daily Volumes – around 5 – 6 k / day on BSE.

Product – Reclamation of alloys, fusion surfacing (preventive welding), spraying and environmental solutions.

Promoters – JB Advani & Company Pvt Ltd (of Advani-Oerlikon fame) + a group of other Sindhi business-people.

Share-holding Pattern – Promoters (35.4%), Public (58.9%), Institutions (2.0%), NICBs (3.7%).

Technicals (see chart below) – This is a very low volume scrip, so there could be slippage. The scrip has corrected from its June 2011 peak of Rs. 150.90 to a pivot of Rs. 73.25 within about one year. This low pivot lies bang in between the 50% and the 61.8% Fibonacci levels of correction on the weekly chart. Currently, the scrip is quoting at Rs. 81.30, just below the Fib. 50% level. Volumes are average, with one high volume peak every 7 odd trading days. The scrip is trading in a broad band between Rs. 73.25 and Rs. 93.90. Perhaps it is trying to establish a base.

Comments – Fundamentals are good, and the company’s corporate governance is considered clean. Market for the company’s niche is considered small, and people view that as a long-term growth concern. Technically, correction has taken place, and thus value shines out fundamentally. Debt is nil. Dividend is excellent. Projected PE is low, though P/BV is a bit high. Cushion is there, and profitability and returns are exemplary. Future investment would be required to keep niche-segment status alive.

Buy? – I like the theme – reclamation and preventive welding. Contrary to what others say, I feel the market is going to grow phenomenally, as earth and rare-earth metals become difficult to source, and need to be reclaimed. Valuations are excellent, governance is great, payouts are great too, and a technical buying level has presented itself. Yes, it’s a long-term buy right now. Remember, this is not a trade we are speaking about, so we are not going to talk in terms of a stop-loss. This is a long-term investment, and we’ve been speaking in terms of margin of safety, which I’m sure you’ve noticed. Also, while buying, one needs to show caution regarding slippage, which is invariably going to occur owing to the low-volume nature of the scrip.

Disclaimer and Disclosure – Opinions given here are mine only. You are free to build your own view on the stock. I have bought a miniscule stake in Ador Fontech today. Data given here has been compiled from motilaloswal.com, moneycontrol.com and equitymaster.com. Technicals have been gauged and shown using Metastock Professional version 9.1 by Equis International.