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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What’s the Frequency, Flipkart?

Hmmm, a zero-profit company…

In fact, a loss making company…

Do you get the logic?

People are probably seeing an Amazon.com in the making.

Amazon exists in a highly infrastructure-laden country with systems.

Can we say the same about us?

As of now – no.

Are we on the trajectory?

Sometimes yes, sometimes no. It’s been five steps forward and then three back till now.

What’s all the hype about?

Institutions want to make money during the ride.

Whether the ride culminates into an Amazon.com is irrelevant for institutions.

Public opinion acknowledges the ride.

That’s enough for institutions.

They’ll ride to a height and exit, irrespective of any MAT or what have you.

While exiting, they’ll hive off the hot potato to pig-investors in the secondary market, post IPO.

Hopefully, a valuation is calculable by then. Even the PE ratio needs earnings to spit out a valuation. No earnings means no divisor, and anything divided by zero is not defined.

Keep your wits about you. Follow performance. Follow earnings. Follow bearable debt. If you see all three, a sound management will already be in place. Then, look for value. Lastly, seek a technical entry.

Don’t follow hype blindly.

Cheers! 🙂

A Secret Ingredient for Equity-People

Racking your brain about how to make Equity work?

Don’t.

Two words work here. 

Be passive. 

Learn to sit. 

Let’s say you’ve gotten all your basics right.

Company is great. Management is sound. Multiple is low. Debt is nil. Model looks promising. Yield is note-worthy. Technicals allow entry, blah blah blah…

Then what?

Yeah, be still. Learn to sit. 

What are the prequisites for sitting?

You need to not need the stash you’ve put in, at least for a long while. 

You also need to get your investment out of your primary focus. 

For that, your day needs to be full…of other main-frame activities. 

Make Equity a bonus for yourself, not a main-course. That’s how it’ll work for you. That’s the secret ingredient. 

How to… … is stated above.

Why to? Aha.

For it to work, fine, but why the sleeping partner approach?

Human capital needs time to show results. 

That’s why you’re in Equity, right, for human capital? The rest is ordinary stuff, but human capital is irreplaceable. Human capital works around inflation. One doesn’t need to say anything more. 

You’ve got your work all cut out.

Get going, what are you waiting for? 

What’s your Answer to Dictatorial Legislature?

Cyprus almost bust…

Money from savings accounts being used to pay off debt…

Five European nations going down the same road…

US economy managing to function for now, but without any security moat (they’ve used up all their moats)…

Our own fiscal deficit at dangerous levels…

Scams in every dustbin…

Mid- & small-caps have already bled badly…

Let’s not even talk about micro-caps…

Large-caps have just started to fall big…

Just how far could this go?

Let’s just say that it’s not inconceivable to think… that this could go far.

Large-caps have a long way to fall. I’m not saying they will fall. All I’m saying is that the safety nets are way below.

I see one big, big net at PE 9, and another large one at PE 12. Getting to either will mean bloodshed.

Inflation figures are not helping.

In a last-ditch attempt to get reelected, the government recently announced a budget for which it’ll need to borrow through its nose.

Oops, I forgot, it doesn’t have a nose.

The whole world is aware about work-culture ground-truths in India.

Things are out of control, and this could go far, unless a miracle occurs and Mr. Modi gets elected. Before such an eventuality, though, things could go far.

When large-caps fall, everything else falls further.

How prepared are you?

Hats off to those with zero exposure.

Those with exposure have hopefully bought with large margins of safety.

Those who are bleeding need a plan B.

In fact, a plan B should have been formulated during good times.

Anyways, how prepared is one for a Cyprus-scenario, where dictatorial last-minute legislature allows the government to whack money from savings accounts?

In future, you might need to find a solution for loose cash in savings accounts. It needs to be kept in a form where government doesn’t have access to it.

As of now, what’s serving the purpose is an online mutual fund platform, through which loose cash can be moved and parked into liquid mutual fund schemes. For government to exercise full control over mutual fund money, it’ll probably need to be more than a bankruptcy scenario.

That’s just for now. Adaptability is the name of the game. It’s always good to be aware of one’s plans B, C & D.

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.

Stock-Picking for Dummies – Welcome to the Triangle of Safety

Growth is not uniform – it is hap-hazard.

We need to accept this anomaly. It is a signature of the times we live in.

Growth happens in spurts, at unexpected times, in unexpected sectors.

What our economic studies do is that they pinpoint a large area where growth is happening. That’s all.

Inside that area – you got it – growth is hap-hazard.

To take advantage of growth, one can do many things. One such activity is to pick stocks.

For some, stock-picking is a science. For others. it is an art. Another part of the stock-picking population believes that it is a combination of both. There are people who write PhD theses on the subject, or even reference manuals. One can delve into the subject, and take it to the nth-level. On the other hand, one can (safely) approach the subject casually, using just one indicator (for example the price to earnings ratio [PE]) to pick stocks. Question is, how do we approach this topic in a safe cum lucrative manner in today’s times, especially when we are newbies, or dummies?

Before we plunge into the stock-picking formula for dummies that I’m just about to delineate, let me clarify that it’s absolutely normal to be a dummy at some stage and some field in life. There is nothing humiliating about it. Albert Einstein wasn’t at his Nobel-winning best in his early schooldays. It is rumoured that he lost a large chunk of his 1921 Nobel Prize money in the crash of ’29. Abraham Lincoln had huge problems getting elected, and lost several elections before finally becoming president of the US. Did Bill Gates complete college? Did Sachin Tendulkar finish school? Weren’t some of Steve Jobs’ other launches total losses? What about Sir Issac Newton? Didn’t I read somewhere that he lost really big in the markets, and subsequently prohibited anyone from mentioning the markets in his presence? On a personal note, I flunked a Physical Chemistry exam in college, and if you read some of my initial posts at Traderji.com, when I’d just entered the markets, you would realize what a dummy I was at investing. At that stage, I even thought that the National Stock Exchange was in Delhi!

Thing is, people – we don’t have to remain dummies. The human brain is the most sophisticated super-computer known to mankind. All of us are easily able to rise above the dummy stage in topics of our choice.

Enough said. If you’ve identified yourself as a dummy stock-picker, read on. Even if you are not a dummy stock-picker, please still read on. Words can be very powerful. You don’t know which word, phrase or sentence might trigger off what kind of catharsis inside of you. So please, read on.

We are going to take three vital pieces of information about a stock, and are going to imagine that these three pieces of information form a triangle. We are going to call this triangle the triangle of safety. At all given times, we want to remain inside this triangle. When we are inside the triangle, we can consider ourselves (relatively) safe. The moment we find ourselves outside the triangle, we are going to try and get back in. If we can’t, then the picked stock needs to go. Once it exits our portfolio, we look for another stock that functions from within the triangle of safety.

The first vital stat that we are going to work with is – you guessed it – the ubiquitous price to earnings ratio, or the PE ratio. If we’re buying into a stock, the PE ratio needs to be well under the sector average. Period. Let’s say that we’ve bought into a stock, and after a while the price increases, or the earnings decrease. Both these events will cause the PE ratio to rise, perhaps to a level where it is then above sector average. We are now positioned outside of our triangle of safety with regards to the stock. We’re happy with a price rise, because that gives us a profit. What we won’t be happy with is an earnings decrease. Earnings now need to increase to lower the PE ratio to well below sector average, and back into the triangle. If this doesn’t happen for a few quarters, we get rid of the stock, because it is delaying its entry back into our safety zone. We are not comfortable outside of our safety zone for too long, and we thus boot the stock out of our portfolio.

The second vital stat that we are going to work with is the debt to equity ratio (DER). We want to pick stocks that are poised to take maximum advantage of growth, whenever it happens. If a company’s debt is manageable, then interest payouts don’t wipe off a chunk of the profits, and the same profits can get directly translated into earnings per share. We want to pick companies that are able to keep their total debt at a manageable level, so that whenever growth occurs, the company is able to benefit from it fully. We would like the DER to be smaller than 1.0. Personally, I like to pick stocks where it is smaller than 0.5. In the bargain, I do lose out on some outperformers, since they have a higher DER than the level I maximally want to see in a stock. You can decide for yourself whether you want to function closer to 0.5 or to 1.0. Sometimes, we pick a stock, and all goes well for a while, and then suddenly the management decides to borrow big. The DER shoots up to outside of our triangle of safety. What is the management saying? By when are they going to repay their debt? Is it a matter of 4 to 6 quarters? Can you wait outside your safety zone for that long? If you can, then you need to see the DER most definitely decreasing after the stipulated period. If it doesn’t, for example because the company’s gone in for a debt-restructuring, then we can no longer bear to exist outside our triangle of safety any more, and we boot the stock out of our portfolio. If, on the other hand, the management stays true to its word, and manages to reduce the DER to below 1.0 (or 0.5) within the stipulated period, simultaneously pushing us back into our safety zone, well, then, we remain invested in the stock, provided that our two other vital stats are inside the triangle too.

The third vital stat that we are going to work with is the dividend yield (DY). We want to pick companies that pay out a dividend yield that is more than 2% per annum. Willingness to share substantial profits with the shareholder – that is a trait we want to see in the management we’re buying into. Let’s say we’ve picked a stock, and that in the first year the management pays out 3% per annum as dividend. In the second year, we are surprised to see no dividends coming our way, and the financial year ends with the stock yielding a paltry 0.5% as dividend. Well, then, we give the stock another year to get its DY back to 2% plus. If it does, putting us back into our triangle of safety, we stay invested, provided the other two vital stats are also positioned inside our safety zone. If the DY is not getting back to above 2%, we need to seriously have a look as to why the management is sharing less profits with the shareholders. If we don’t see excessive value being created for the shareholder in lieu of the missing dividend payout, we need to exit the stock, because we are getting uncomfortable outside our safety zone.

When we go about picking a stock for the long term as newbies, we want to buy into managements that are benevolent and shareholder-friendly, and perhaps a little risk-averse / conservative too. Managements that like to play on their own money practise this conservatism we are looking for. Let’s say that the company we are invested in hits a heavy growth phase. If there’s no debt to service, then it’ll grow much more than if there is debt to service. Do you see what’s happening here? Our vital stat number 2 is automatically making us buy into risk-averse managements heading companies that are poised to take maximum advantage of growth, whenever it occurs. We are also automatically buying into managements with largesse. Our third vital stat is ensuring that. This stat insinuates, that if the management creates extra value, a proportional extra value will be shared with the shareholder. That is exactly the kind of management we want – benevolent and shareholder-friendly. Our first vital stat ensures that we pick up the company at a time when others are ignoring the value at hand. Discovery has not happened yet, and when it does, the share price shall zoom. We are getting in well before discovery happens, because we buy when the PE is well below sector average.

Another point you need to take away from all this is the automation of our stop-loss. When we are outside our safety zone, our eyes are peeled. We are looking for signs that will confirm to us that we are poised to re-enter our triangle of safety. If these signs are not coming for a time-frame that is not bearable, we sell the stock. If we’ve sold at a loss, then this is an automatic stop-loss mechanism. Also, please note, that no matter how much profit we are making in a stock – if the stock still manages to stay within our triangle of safety, we don’t sell it. Thus, our system allows us to even capture multibaggers – safely. One more thing – we don’t need to bother with targets here either. If our heavily in-the-money stock doesn’t come back into our safety zone within our stipulated and bearable time-frame, we book full profits in that stock.

PHEW!

There we have it – the triangle of safety – a connection of the dots between our troika PE…DER…DY.

As you move beyond the dummy stage, you can discard this simplistic formula, and use something that suits your level of evolution in the field.

Till then, your triangle of safety will keep you safe. You might even make good money.

PE details are available in financial newspapers. DER and DY can be found on all leading equity websites, for all stocks that are listed.

Here’s wishing you peaceful and lucrative investing in 2013 and always!

Be safe! Money will follow! 🙂

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!

🙂