Infinite Comp: Value Investors' Delight

What would a value investor ask from his picks (at the time of deciding whether to buy or not)?

1) UNDERVALUATION

He would want his picks to be undervalued- i.e market price to be much less than the value of the stock. For a 100 Rs value, he would want market price to be Rs 40-50 or less.

2) CATALYST
To bring market price to intrinsic value, there should be some catalyst (in the future) to trigger the change.
Just because its very difficult to tell when & how the catalyst will come, value investors practice diversification. And in absence of that catalyst, we will end only with Value Traps (cheap stocks which will remain forever cheap).

Let me explain with a live example- Lets say I buy an NBFC stock selling at Rs 27/- each. Now, the book value is Rs 140/- per share. The business is making Rs 9-10 EPS per year. So, from this knowledge, with a P/B of 0.2 & P/E of 3, the stock seems undervalued. What if I say two more things-
1) The business did a buyback 2 years back at Rs 133 per share.
2) The promoters have injected their own money into the business at Rs 45 per share recently.

So this satisfies my criteria 1- It is undervalued. I will easily value it at 60-70 Rs per share.
But for it to move to its true value, it will need a catalyst- Earnings jump/ Dividend/ Buyback/ More visibility.
Till then it will remain undervalued & the opportunity cost will hurt me.

What if a stock satisfies both the criteria- Undervaluation & a Visible Catalyst?
That will be the time to say ALL IN for a poker player, I guess.

Years ago, Prof Bakshi found a hugely undervalued stock which he loaded & then he became his own catalyst. I guess with catalyst in sight you can afford to do that- ALL IN !!!  

Here is an undervalued business which comes with its own catalyst- Infinite Comp Solutions

Why is it Undervalued?
At 120 Rs per share, the stock is selling at 4.2 times FY12 earnings. The business is asset light, generates enough free cash flows & management has given a 20% growth guidance for FY13. Insiders are buying the shares from the open market. 1Q13 results were good.
In nutshell, a 20% growing business having good ROCE is cheap at 4 PE.

Where is the Catalyst?
The catalyst is the Dividend. The management has clearly announced a policy of giving 30% of net profits to shareholders as dividends.

At an EPS of 33-34 Rs for FY13, that would be Rs 10 as dividend per share. The dividend yield works out to be a whopping 8.33%. {Remember the business is doing well, management is positive about the business, insiders are buying.}

If one can find 10-15 dividend yields of this quality, who needs a Fixed Deposit???

Risks- The company caters majorly to Telecom sector & US based clients. If clients' business faces a slowdown, Infinite will feel the heat. However, risks are overhyped at current price, in my view.

Fair Value- I would value it at around Rs 230-260 (Rs 33 EPS * 7-8 PE). Hence, I expect it to double in next 4-5 quarters.

Biases that may have affected my thought process- Endowment Bias, Confirmation Bias. So, please do your own due-diligence.

BHARTI AIRTEL- At 6 Year Low.....

The once darling of Indian Markets, Bharti Airtel seems to be on a steady decline. The company posted 10th straight quarterly drop in Profits. And the stock has crashed to a 6 year low.

Have we reached the bottom?

Let’s answer with the help of some borrowed wisdom........

"In a business selling a commodity type product, it's impossible to be a lot smarter than your dumbest competitor. " ------------ Buffett on Airlines

"Producers of relatively undifferentiated goods in capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage. As long as excess productive capacity exists, prices tend to reflect direct operating costs rather than capital employed." ----------- Buffett on Textiles

"In many industries, differentiation simply can’t be made meaningful. A few producers in such industries may consistently do well if they have a cost advantage that is both wide and sustainable. By definition such exceptions are few, and, in many industries, are non-existent. For the great majority of companies selling “commodity” products, a depressing equation of business economics prevails: persistent over-capacity without administered prices (or costs) equals poor profitability." ---------- Again on Textiles

So for a business to earn low returns, it needs (i) Undifferentiated Product (ii) Excess Capacity (iii) Low variable cost (for an additional customer) (iv) Low switching cost for customers.

So, where is Telecom in this? In my view, it satisfies all the above criteria & hence should earn low returns. Apart from that, it has the regulator, TRAI, which hurts the companies in whatever possible ways it can.

So, over the long term, there are going to be more losers than winners in Telecom Sector.

Now you may say- Airtel is the strongest. So it will definately be a winner (& not a loser).

But, there is no guarantee that there will be a few winners! What if all continue to earn below average returns?

So, Airtel is an AVOID in my view.

But there is a PRICE at which even the worst business becomes a great INVESTMENT.

Has Airtel reached that Price?

I Don't Know. And if you think that since price is 6 year low & hence its a good Investment now; then, I will say, Even you Don't Know.

FYI- Its still selling at 15+ PE.

Disclosure- No Plan to Invest. But there are some very good investors who are invested. So, I may be wrong also :-)

What, if Not Equities???

A lot of people don't like the idea of putting large sums of money into equities.
"Equities are risky" the saying goes.


Lets INVERT the situation & try to answer the question - "What then, if not equities?"

·       T he easiest option is Spend everything that you Earn. No Savings, no need to worry about where to put the savings. :-) But that's pretty much a stupid decision as you should have figured it already by now.

 ·       T he second choice is to "INVEST" in Savings/ Fixed Deposits & ensure "safety". However, there is one problem with this plan. It's not INVESTMENT, full stop.

      Buffett explains Investment in his 2011 letter as- " The transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date."

      Now since Fixed Deposits fail to meet inflation & hence are unable to provide more purchasing power to the user, they are not INVESTMENTS according to world's best investor.

  ·      The case is nearly similar for Corporate Bond Buyers. For extra 3-4% return over inflation, you     face the risk of default. You get no share in the upside, but have to pay heavily for the downside.

 ·      Next in line is GOLD. Again the same problem... Not an Invesment. Either Gold is an Insurance against things falling apart (govt printing more money/ defaulting) or its a Speculation wherein buyer is betting on price going up just because it has gone up in the past.

·      Next is REAL Estate. The good thing about this is that its productive. You buy a house, rent it out & live with the rentals. You buy a farmland, produce some goods, sell them & get Money (Purchasing Power) in return.

         However, NO Asset Class classifies itself as an Investment AT ANY PRICE. 

           If you look around currently, the rentals are maximum around 4-5% of house values. ( i.e for a property of 1 crore, the rents that you can get per year are around 5 lakhs only).

      So, to consider Real Estate as an Investment at Current Prices, you have to strongly believe that Rentals will keep going UP in the future (I am skeptical about that). Now Rentals can go Up only if Salaries go Up (else who will have the money to pay those rentals). Salaries will go Up only if Business Profits go Up (else who will have the money to pay those salaries). If Business Profits go Up, will equity prices go Down???

Have I left any major asset class?

P.S-

·      So if everything other than Equities is not touchable, where should I go?

·      Since equities are volatile, don't put the money that you need in next 5 years into equities.

·      NO Asset Class classifies itself as an Investment AT ANY PRICE applies to Equities also.So, look at Price before buying Blindly.

Be RATIONAL.

If you hear the above conversation, what would you say about the girl?
I would say- "She is not Rational." But there is nothing to laugh at. The financial equivalent of her is there in most (if not all) of us.

Charlie Munger was asked a few years ago to explain how he achieved his amazing success in the stock market. He thought for a second, and then replied simply: “I’m rational.”

Lets see five major irrational behaviour (complete list will take a book rather than a blog) that we tend to make in relational to stock markets-

(1) LOSS AVERSION BIAS- If we are given 50-50 chance of winning one dollar v/s losing one dollar, we tend not to play the game. Even if chances are made 75-25 in our favour, we tend to avoid the same. Even if magnitude is made in our favour (like two dollars for winning against one dollar for losing), we tend to not play. Reason- Pain of Losing is more (almost double) than Pleasure of Winning.
However, if we are asked to take a loss of 2 dollars v/s 25% chance of losing 10 dollars, we tend to take the risk. Same reason- 2 dollars loss hurts, while in second case, there is some Hope that we won't lose anything.

Equity Markets are volatile. We can suffer occasional losses. Because of loss aversion bias, we tend to avoid equity markets. Nominal but constant rate of 9% in FDs look much better than volatile rate of 15% in equities.

To avoid this- Look in Real Terms. FDs barely beat inflation while equities tend to (over the long run). What should you choose- Sure zero real return of FDs or possible high return from equities?

(2) AUTHORITY BIAS- Ok, fine. You decided to get into equities. But which one out of the thousands available?
You should buy the stocks recommended by the experts. After all, they are the experts. Right? WRONG.

Noble Winner Kahneman says- "

·         The acquisition of skills requires a Regular Environment, an Adequate Opportunity to Practise & Rapid & Unequivocal Feedback about the correctness of thoughts & actions."

In stock markets, the environment is far from Regular & Feedback takes a long long time. Hence, even after decades of experience, No genuine player (unless he is selling something) will claim himself to be an expert.

To avoid this- Don't take any advise (that you get from a so called expert) at face value.

(3) ZOOMING IN BIAS- So, you are not gonna take any expert advise either. Now what?
Look at the girl in the above picture again. She is concentrating on the pizza slice & not the whole pizza. She has Zoomed In too much & hence is facing the problem.

For being Rational, you should look at the Pizza (the whole business) rather then the individual piece of it (stock).
I have heard some people say this stock is too costly.. its selling at 1500 Rs. Some people (technical analysts) look at the price of each piece only. All these guys need to zoom out to see the complete picture.

To avoid this- Look at the business and its fundamentals rather than stock price movements.

(4) ANCHORING BIAS- So, you will analyse the whole business. When will you buy a stock? At 52 week low? At 3 year low? At lowest P/E? At lowest P/B? NO.
All these are Price Anchors which we tend to latch on to while buying a stock.
If you are buying/ holding/ selling a stock based on your buying price, you are falling for Anchoring Bias.

To be rational, you should buy when stock is selling at a sufficient discount to its value. Price is what you pay, Value is what you get.

(5) INSTANT GRATIFICATION- So what next after buying a stock below its intrinsic value.
Don't Sell it too soon. We tend to go for instant gratification with our stocks.

Let the price converge to value & till then Have patience. Patience is a Virtue.

If you hold on to your rationality when rationality is in such a scarcity, then you tend to have a big advantage in this game.
TRY TO BE RATIONAL (as far as possible) 


 

Diversify

If you try to give advise to any Tom, Dick or Harry about stock markets or investing; what you will get back is some borrowed wisdom from Buffett.
Why Buffett?
Because Buffett is all he knows or has heard about. Enters- Authority Bias, Halo Effect, Liking Bias and Vividity.

Actually this is a problem of our mind. It can't handle multiple things/ reasons/ situations/ persons in it.
More than one creates a Lollapalooza Effect {yes, again, my mind is back to Munger :)} with unpredictable outcomes which our mind dislikes. So, we tend to prefer one over many in most of the situations.

But if all we have is Buffett, we tend to overuse him & his wisdom.

So diversify. Diversify not just in what you buy but also whom you read.

Just because Buffett made more money than Templeton or Graham or Dorsey or Faber or Lynch or Taleb, that doesn't automatically mean that he is the most intelligent one also. Don't blindly fall for Outcome Bias.

Remember If all you have is a Hammer, everything looks like a Nail.

Investor's Portfolio League (IPL)

Lets imagine its IPL auction time. Also imagine you are given the responsibility to buy players from IPL auctions this time for a period of 3-5 years (Long Term hmmm...)

The players are categorised in four different classes-

(A) Proven Greats- These are the great players who have proved their worth in international & IPL matches over the years. The likes of Tendulkar, Hussey, Mallinga, Dhoni, Kallis, Gayle, Sehwag fall under this category. However, everyone knows their greatness & so they are available at 30 times their last year's points (calculated for each player based on runs scored, wickets taken & all other stuff).

(B) Probable Greats- These are the players which have done well in the past & seems to be having the necessary skill-set to succeed. However, they have a smaller & less enviable track record as compared to Category A & some of them may turn out to be a dud investment. The likes of Kohli, Rohit Sharma, Uthappa, Ashwin, Rahane fall under this category. Since, their greatness is debatable; they are available at 10 times their last year's points.

(C) Possible Greats- These are the players which have either fallen a a great deal from their past or have a very small track record of good performance and hence betting on them to deliver in the future is a risky bet. Fallen greats- Ganguly, VVS, Murali, Gibbs, Gilly. Small Track Record- Most of domestic Indian players. Because of the obvious risks involved; they are available at 3 times their last year's points.

(D) Costly Idiots- These are the players which got the attention of everyone recently due to 1-2 good performance but they lack the skills to succeed consistently. The likes of Ravindra Jadeja, Yusuf Pathan, Levi. But due to recency bias, they are selling at 30 times their annualised points.

So what's going to be your strategy?

Investing is kinda similar.
In Class A, we have Titan, HDFC, CRISIL, Page, Nestle, ITC selling at 25-40 times earnings.
In Class B, we have a lot of stocks like Mayur, Nesco, Eclerx selling at 8-12 times earnings and some of these will turn multibaggers.
In Class C, we have most of small & mid caps & some of these may turn multibaggers.
In Class D, we have a number of commodities selling at exorbitant valuations like RPower, RCom, Powergrid, Strides Arco & some of these will turn multibeggers.

Which one would you pick?
I find myself studying mostly in Class B & one or two lectures in Class C.
Also, the big aim is to avoid Class D & duds in Class C and Class B.
  

Chemplast Sanmar: As Interesting as it can Get

Being in company of logical and rational people makes life pretty boring!!!
We need some logically challenging, brain dead, System-1 dependent people to make life funny and interesting. (For details for System-1 and System-2 and their workings, Read this.

Delisting cases are a perfect example of this theory at work. Give the powers of delisting to rational and logical institutional investors (These guys are also not absolutely rational but are more rational than retail investors) and you will come across pretty boring cases of India Sec, UTV and Patni Comp delisting.

But, try giving the majority of powers to irrational retail investors, you will get Afla Laval and Chemplast Sanmar kinda interesting cases.

Lets talk about Chemplast only as the rest is Past. Promoters announced the intention of buying back 25% of outstanding shares some time back. Now after the tendering process, the discovered price has come out to be Rs 15 per share (All thanks to retail investors). Currently the stock is quoting at only Rs 7.3. So, there is a possibility of 100% gain if promoter group accepts the dicovered price.

Will the promoters accept this price?
I see that as a low probability event. Company is going through a tough time and has been making losses for past 3 years and has high debt also. Offer doc clearly highlights these points.
Though Sanmar group has a number of companies but financial numbers don't look convincing enough for going through the delisting at such a high price.

However, the stock has an all-time high of 22/-. So if promoters think that the business will improve, they should go through the delisting.

Lets see what happens. I am gonna watch only from the sidelines. 

Short Term Stock Pick- 531795

Some Unique Disclaimers first-

• Forgive me Warren for having holding period of some part of my portfolio as Less than Forever!!
• I love mid & small caps because of the inefficiencies that exist in these markets. Its tough to find similar inefficiencies in the large caps.  

So, here it goes............
Atul Auto is a 3-wheeler manufacturer. It submitted an important announcement to BSE regarding Q4 performance here. Company has sold 7457 vehicles in Q4, a 26% increase YoY. Lets do some analysis to see expected numbers for Q4.

	4Q11	1Q12	2Q12	3Q12	4Q12E
					Worst	Best	Expected
3-wheelers Sold	5927	5583	6794	7166	7457	7457	7457
q-on-q growth			21.7%	5.5%	4.1%
y-on-y growth					25.8%
Revenues (in Crs)	63.72	60.98	75.26	79.68	82.92	83.23	82.92
per unit (in lakhs)	1.08	1.09	1.11	1.11	1.11	1.12	1.11
increase			1.4%	0.4%	0.0%	0.4%	0%
Net Profit (in Crs)	1.88	3.29	5.06	3.09	2.45	5.60	3.22
Margin	3.0%	5.4%	6.7%	3.9%	3.0%	6.7%	3.9%
				YoY	31%	198%	71%
EPS	3.21	5.62	7.41	4.32	3.24	7.41	4.26
				YoY	1%	131%	33%

So, in short, I am expecting a 33% growth in EPS & 70% growth in net profit, which makes it a good short term opportunity. So, a 10%-15% jump after the results along with 3.5-4.5% dividend is a very likely scenario (Because 6 P/E stocks are expected to post drop in EPS and not growth).

FAQs 

• Market has ignored the good sales numbers announcement. Why will it react to good EPS announcement?

A- Its not certain that it will surely react. But, I believe, there are enough lazy participants who just make their decisions on YoY EPS growth & I am expecting them to react.

• In the worst case scenario, we are getting no growth in EPS. How likely is that possibility or even worse, a drop in EPS?

A- I see that as a less likely scenario.

• What if market crashes before the result or EPS is not that good or stock stays at same price even after the result?

A- In that case, you will end up holding a debt free company with a decent dividend yield having a top-line growth of 40% and available at 6 P/E. Not that bad as a long term pick either!!!!

HEADS I WIN, TAILS I DON'T LOSE!!!

Am I missing something?

RANDOM THOUGHTS

The BUDGET- So, finally, we have the Budget & all the analysis paralysis related to it.

How much impact it had on your investment portfolio?

If the answer to this question is MAJOR IMPACT, you are in trouble. Because, if subsidies/ duties/ bills/ service taxes can have a major impact on your investments; then, in all probability, it means your company is lacking Pricing Power; one of the most, if not the most, important attributes that a business must have to become a long term investment. (Minor Impacts are fine and Margin of Safety is supposed to take care of that.)
ITC is a good example in this case. It tends to underperform the market before the budget due to fear of increase in duties on cigarettes. But, even a simple historical analysis/ personal use of cigarettes can tell that ITC has Pricing Power & will be able to pass on any hike to its customers without having any effect on the demand.

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Talking of Pricing Power, comes an important question- What kind of companies have Pricing Power?
Out comes a quick response: Companies that provide some essential good/ service and they are the only providers will have the best Pricing Powers. In business jargons, it would be Inelastic Demand met by Monopolies. Right?

Not always. What better example of a business monopoly catering to Inelastic Demand than Indian Railways? :) Saw what happened after Rail Budget? Poor CEO (Mr. Trivedi) thought of verifying his business' Pricing Power but lost some Mamta in the process.

Coal India supplies more than 80% of required coal to the country & power plants that want coal only want coal.... Inelastic demand + Monopoly. Pricing Power? Again, No. They increased prices recently but again went back to earlier prices. The company's decision to go back on the recent price hike has angered a minority shareholder (UK based Hedge Fund). Helpless Minority Shareholders!!!!!

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Talking of Minority Shareholders, I had written some time back, that as a minority shareholder, you should love your stocks but after knowing Till When. OCCL answered Till When part too soon for my liking. How? This way..... I love you OCCL until You make a STUPID ACQUISITION. Details are here.
Basically, they are acquiring a loss making company having terrible business dynamics and high debt for 15 crs at a time when their own balance sheet is not that strong and is filled with capex driven debt.
Why? In M&A whenever in doubt, call it SYNERGY. (Man is Rationalizing Animal, afterall)

You, Me & IPO

2012 came with some good time for secondary markets. If secondary markets are doing good, primary markets also try to catch the action.... (Envy, Recency Bias, Social Proof)

So should I invest (or speculate) in primary markets i.e IPOs ?

Thinking in terms of probable outcomes should help....
1) IPO is Either Good or Bad... By Good IPO, I mean either good company at fair price or fair company at bargain price. You can get some indication of goodness or badness of a company through IPO grading. But always take that grade with a pinch of salt... (IPO grader gets money from the company he's grading... so Incentive Caused Bias comes into play)

2) Market will either apply or won't apply... Apply means 10-25-50-100 times over-subscription while don't apply means just full subscription or under-subscription.

Knowing this comes my decision... Apply or don't apply?

	Good IPO				Bad IPO
	Market applies	Market don't applies			Market applies	Market don't applies
I apply	Negligible GAIN	Huge GAIN		I apply	Negligible PAIN	Huge PAIN
I don’t apply	Look A Bit STUPID	Can buy after listing		I don’t apply	SAFE	SAFE

The above decision process is self-explanatory.
But it deals only with the magnitude... What about probabilities?

There is more probability of market applying to good IPOs and avoiding bad IPOs. So, there is much more chance of landing in green cells in the above shown decision process table...
And what's the probability of the next IPO to be Good?
Not too high either... Why would an informed seller leave too much on the table for an ignorant buyer?
So more probability of being in Table-2 than in Table-1.
So the most probable final outcome is going to be- APPLY- HUGE PAIN; DON'T APPLY- SAFE.

Where is MCX ?
Monopoly (82% market share), presence of economic moat, PE of 17-18 (on 2012 annualised E), high ROCE made it a Good IPO. 5/5 by CRISIL justifies this opinion. So, we end up in Table-1.
So, in all probability, Market had to apply. Market goes all-out & applies more than 25 times the desired quantity.
Result, If I applied- Negligible Gain or If I avoided- Looking a bit Stupid. Though 25 times over-subscription significantly decreases the magnitude of both the possible outcomes.

And by the way, is it a Good IPO?
Its a good company, and should get 25 PEs IMHO. But at normalised E. Due to recent run-up of gold and silver & muted equities, E looks on the higher side to me. If equities do well for 2-3 quarters relative to gold and silver OR something happens to China, Earnings may well correct for MCX.
That will be a good time to enter!!