Mr Parag Parikh is considered one of the top value investors in India. His firm PPFAS has a blog in which Mr Jayanth Pai is active. I have enjoyed it and have subscribed to it through an RSS feed. The following is an interesting piece from one of his recent entries.
https://www.ppfas.com/pdf-docs/research/week-reports/2010/wr311210.pdf
https://www.ppfas.net/blog/2010/12/31/ten-commandments-of-investing-for-the-decades-ahead/
In keeping with the festive spirit, I thought of donning the garb of Moses and impart a light-hearted version of God’s ten commandments to investors with a disclaimer that “We do not intend to hurt the sentiments of speculators or day-traders. Resemblance to any person or financial advisor living or dead is purely coincidental”…..
1.You shall have no God other than Warren Buffett: He is truly a living God in the world of investing. It is difficult to hold a candle to him. Hence believe only in Him and ignore the myriad pretenders to his throne.
2. You shall not worship the trading terminal: The terminal is not your temple. Make it your slave. It will always try to tempt you to over-trade. Do not fall for its (and your broker’s) wiles.
3. You shall not take the name of “Investing” in vain: Do not undertake speculative trades and convert them into “long term investments” merely because they are underwater….
4. Remember the Sabbath day: Do not think about stocks on Sunday. Sunday is meant to be enjoyed with your family and not to be spent with CNBC and the Economic Times.
5. Honour your mentors: Do not forget the critical role that they have played in moulding you as an investor when you entered the stockmarket. Treat them with reverence.
6. You shall not murder: By this I mean murdering the definitions of long term investing by treating a day, week or month as “long term”. Think in terms of “years”…..
7. You shall not commit adultery: By this I loosely mean, do not overdiversify your portfolio. Too many stocks is akin to too many mistresses. It is difficult to maintain all of them.
8. You shall not steal: This applies more to agents and advisors. You shall not steal investors’ money by rendering false, biased or unduly optimistic advice. Investors beware….
9. You shall not bear false witness: Do not blindly act and induce others to act on the views and “tips” given by members of the financial media, market experts, technical analysts etc. Doing so will be akin to bearing false testimony to events you never saw.
10. You shall not covet your neighbour’s stocks: Never purchase a stock merely because your neighbour has made money in it. The stock and the timing of the purchase may be completely incongruous with your financial and psychological profile. Being envious of your neighbour will not help you in any manner.
As Charlie Munger once noted “Envy is a really stupid sin because it’s the only one you could never possibly have any fun at. There’s a lot of pain and no fun.”
Have a happy and profitable decade ahead…..
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Reading list
The original post I wanted to make.
I have a reasonably good collection of books on value investing (Read some and many are pending). However thought will compile the list in a single post.
Investment Analysis:
Security Analysis by Benjamin Graham
Intelligent Investor by Benjamin Graham
Beating the street by Peter Lynch
One up on Wall street by Peter Lynch
Common Stocks And Uncommon Profits by Philip Fisher
Value Investing and Behavioural Finance by Parag Parikh
You Can Be A Stock Market Genius by Joel Greenblatt
The Five Rules For Successful Stock Investing: Morningstar’s Guide To Building Wealth And Winning In The Market by Pat Dorsey
Warren Buffett and the Interpretation of Financial Statements by Mary Buffett and David Clark
Buffettology by Mary Buffett and David Clark
Margin of Safety by Seth Klarman
Cash Return on Capital Invested: Ten Years of Investment Analysis with the CROCI Economic Profit Model by Pascal Costantini
Value Investing: From Graham to Buffett and Beyond by Bruce Greenwald
Distressed Debt Analysis: Strategies for Speculative Investors by Stephen Moyer
Financial Statements - Nitty Gritties:
Financial Shenanigans by Schilit
How to Read a Financial Report: Wringing Vital Signs Out of the Numbers by John Tracy
Hidden Financial Risk: Understanding Off Balance Sheet Accounting by Edward Ketz
Financial Fine Print: Uncovering a Company’s True Value by Michelle Leder
Biographies/Business history:
The Great Crash 1929 by JK Galbraith
Manias, Panics, And Crashes: A History Of Financial Crises- by Charles Kindleberger and Robert Aliber
Extraordinary Popular Delusions and The Madness of Crowds by Charles MacKay
The Big Short by Michael Lewis
When Genius Failed by Roger Lowenstein
Too Big To Fail by Andrew Ross Sorkin
Barbarians at the Gate
Buffett: The Making Of An American Capitalist by Roger Lowenstein
The Snowball
General Books:
Fault Lines by Raghuram Rajan
More Money Than God by Sebastian Mallaby
The Art Of Choosing by Sheena Iyengar
The Checklist Manifesto by Atul Gawande
The Ten Commandments For Business Failure by Donald Keough
Competitive Advantage by Michael Porter
Competitive Strategy by Michael Porter
The Black Swan by Taleb
Fooled by Randomness by Taleb
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Online Book stores
I have been using Flipkart for purchasing books. They give reasonable discounts ranging from 10 to 30% on most books (and as most readers of this blog would like discounts on anything, would suggest one to give it a try).
I actually started writing this post to mention some books I have read or bought on investing. But just as I started writing, I wondered where Landmark and Crossword would end up if Flipkart becomes India’s Amazon.
I know many of my friends who go to Landmark or Crossword to just browse books and eventually order from Flipkart, especially those who purchase books regularly. This inspired me to check how the scenario in US had panned out. Barnes and Noble is the largest book retailer with physical stores and Amazon is largest online book retailer.
Barnes and Noble has returned 1.33% to shareholders in the last 17 years (Not annualized, Net!!). It looks like the book business as a whole has not been value accretive to shareholders.
Amazon, on the other hand has just returned 100 times (10000%) returns in roughly similar period.
This killed it:
“As of May 1, 2010, B&N operated 1,357 bookstores in 50 states, 637 bookstores on college campuses, and one a Web eCommerce sites, which includes the development of digital content products and software.”
Though the reasons are fairly obvious, when it is put in terms of hard coded return figures (1.33% vs 10000%) for investors, it kind of drives home the point on disruptive competition.
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Prof JRV has a good post on some of the books he has enjoyed on financial history..
http://www.iimahd.ernet.in/~jrvarma/blog/index.cgi/Y2010/financial-history-book.html
and some books on the recent crisis.
http://www.iimahd.ernet.in/~jrvarma/blog/index.cgi/Y2010/crisis-related-books.html
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It took me quite some time doing this, but is useful to take a printout (double sided please!) and read through. I have read them in parts and not continuously. This should give some continuity of thought. It would be interesting to understand how he evolved over years. I consider this to be the Bhagavad Gita equivalent for Business.
(Please click File -> Download original to download the PDF)
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Accounting Earnings
There are many times when we get attracted to companies with fast growth in reported sales and earnings. And when such companies also generate high ROAs and ROEs and are available at single digit P/Es (with no debt and reasonable cash in Balance sheet) it is a potential multi bagger in waiting.
The figures for the company I am talking about is as follows:
This company is available at a market cap of 400 crores and has no debt. It operates in the attractive pharma industry. It has grown at a CAGR of 40% in last 4 years (excluding 2006 low base year) and has earned wonderful returns on its asset base.
However, before we invest in this company, to get a better picture, one has to look at the cash flow statement which is as follows.
As we can see, the cash flow figures present a stark contrast to the earnings figures. The company made PBT of 128 crores in last 5 years but just made 25 crores in CFO. Please note that we are not talking about Free cash flow but Cash from operations.
This does not automatically mean that the company is cooking its books. There can be businesses with very high working capital requirements which ensure that no CFO remains post working capital investments.
It is prudent to understand the key working capital ratios in such cases to understand what is happening. The figures for that are as follows:
Cash conversion cycle = Receivable days + Inventory days – Payable days. The lower it is the better it is for a company. This effectively measures “how long does it take a company to convert its product to cash”.
As we can see the company’s receivable days shot up and is at 120-140 days now. Its inventory days, which is the number of days of inventory stored, is also very high. But the payable days, i.e. the time taken to pay its suppliers has been coming down.
So effectively the company has not been able to collect money from its customers for 120-140 days, it also is storing inventory for 140-150 days and pays its suppliers within 80-100 days. Definitely not a great picture.
Usually such companies resort to earnings management like recognizing revenues much in advance than the actual sales occurs. This is to show fast growth.
A check is to understand “how much cash the company actually collected from customers” and “how much did it actually pay suppliers”.
Cash collected from customers = Revenues – Increase in A/R
Cash paid to suppliers = COGS + Increase in Inventory – Increase in accounts payable
This should be compared to Revenues and revenue growth should more or less match cash growth. Else it may mean that the company is potentially managing earnings.
As we can see from this, in 2006-08 period the company collected far less cash from its customers compared to 2008-10 period. The company may potentially have been more aggressive in recognizing revenues. If we look at COGS though, the company has paid more to its suppliers than what is recognized as COGS. The company may have potentially been more aggressive in not recognizing expenses.
It is possible that this may be a perfectly valid company with clean books. But one must observe the CF statement and BS statement and not just the IC statement since they may potentially tell a very different picture, as it was in this case. The key is to understand the “why’s” if at all one still wants to invest in this company. Because, at the end of the day, cash is king.
The company is Bliss GVS Pharma and has been recommended by ET this Saturday to be among the fastest growing fundamentally sound companies.
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Portfolio Summary 1.0
I am happy with the performance of most of these companies in my portfolio. I intend to sell Gujarat Reclaim and Patels Airtemp once they reach their intrinsic value which I feel is around Rs 140-160 for Patels Airtemp and ~2000 Rs for Gujarat Reclaim. Gujarat Reclaim was a borrowed idea from www.dalaal-street.com.
I am reasonably confident that Vinati Organics, Astral Polylinks, Cera Sanitaryware and Omnitech Infosolutions should be able to increase their intrinsic value by 15-20% yoy over a 3 year time period. I unfortunately could not increase my position size in 3/4 of these companies since the prices shot up in August. I have a full position only in Vinati Organics now. Let us see how they end up performing.
According to me, Peninsula Land seems to be a good company which has been punished due to the public’s distaste towards real estate. I am -15% on it!! I intend to hold it for sometime and see how the company performs (not the stock).
“Others” is Noida Toll Bridge which I invested in after reading Prof Bakshi’s analysis. Intend to hold it till it comes close to intrinsic value.
I exited Ador Fontech fully at ~285-290 Rs from the ~20o Rs at which I bought it. My estimate of intrinsic value was 300-320 Rs.
I had bought Esab India at 540 at a PE of ~11 but ended up tripling my position at 590 Rs to which it had shot up very soon. I tripled my position hoping the run would continue. It finally went to 575 Rs and I had to exit. Its fair value was 575-600 Rs then. Learnt the first lesson of “Do not speculate”. 
Present: I am unable to find many obvious bargains in the present market conditions. Getting a monthly salary increases the pressure to invest regularly since the savings pretty soon becomes large and sits idle at 3.5% returns. There are two things which I plan to do:
-> Create larger investment positions than what I have been doing (I regret taking smaller positions in many of my investments!)
-> Search for ideas not based on the money in bank but based on whether ideas exist! Simple, but not easy. All of us know that the pressure to invest will lead to mediocre returns in the long run. 3.5% return is better than -ve returns!!
Long list of companies which I want to look at:
J Kumar Infra Projects
Nava Bharat Ventures
WimPlast
Banco
Balkrishna
Dhanuka Agritech
Recommendations from other value investors:
FDC (valueinvestorindia)
Pondy Oxide (www.dalaal-street.com)
Are there any corporate governance issues in the list of companies which I am planning to look at? Or anything good amongst those? Any other interesting ideas?
PS: The nice screenshot of portfolio allocation is from the software MProfit recommended by tipblog.in
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Buffet’s letter from 1986
The appendix to this letter has some wonderful discussion from Buffet on accounting fallacies and valuations.
http://www.berkshirehathaway.com/letters/1986.html
(Appendix is towards the end of the letter, ‘
Purchase-Price Accounting Adjustments and the “Cash Flow” Fallacy’
)
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Starter positions
I have created starter positions in the following 3 companies. A minor analysis.
Cera Sanitaryware: Many stock publications club the sanitaryware segment into the “Ceramics” space however these two categories have different economics and are not comparable. Some different segments related to the “Ceramics” segment are:
Sanitaryware : CERA, HSIL, Parryware
Bath fittings: CERA, HSIL, Jaquar
Ceramic Tiles/Vitrified tiles: Kajaria, Somany, NITCO, Asian Tiles
Wellness segment: Steam cubicles, Massage bath tubs, Equipped panels, etc.: CERA, Kajaria
There are multiple listed ceramics companies but only 2 sanitaryware companies. Though there may be considerable overlap (like Hindware/HSIL is active in both bath fittings and sanitaryware) between these various segments. But not much of an overlap between sanitaryware/bath fittings and ceramics players.
If one sees the performance of the 2 segments separately, one can see that the ceramics as a segment has very bad economics and this trend can be seen across years.
But Cera and HSIL seem to have better economics and though hindware has a better brand name, cera seems undervalued in traditional measures. I believe there are multiple sanitaryware players in the market but most seem to be concentrating on the premium segment. Cera has maintained a clear value proposition of “value for money” and at the same time launched premium products under a different brand game. They have increased their revenues 3.5 times and profits 8 times in the last 5 years. Cera has maintained a RONW of 20-25% and a D/E ratio of 0.6 to 0.8. Though they do not need debt, they seem to be comfortable with debt on their balance sheet and this increases the RONW. It is available at a P/E ratio of 7.5 now.
Peninsula Land: Real estate stocks are out of favour now and I find a few names appearing in my screens. Ashiana Housing and Marathon next gen realty are the other two names which appear on my screen. I was not comfortable with the cash flow characteristics of the other two. Peninsula, though having negative CFO for last 2 years, had +ve CFO for considerable period before that. They operate across commercial, residential and retail space. They target premium consumers and have increased revenues from 250 crores to 750 crores in the last 5 years. Their average profits for last 5 years is 180 crores. Their profit margins have oscillated between 25 to 40%. I am not entirely comfortable with the company and plan to do more analysis. However it is valued at 1900 crores, has 650 crores cash and 450 crores debt, effectively giving an enterprise value of 1700 crores. Its normalized P/E is around 10 though actual P/E is 6.xx. However, P/E ratios should not be used much while valuing real estate companies since their land banks are a more important measure of their value rather than the earnings.
Omnitech Infosolutions: This company operates in the remote infra management space which has other players like allied digital solutions and glodyne technoserve. They basically provide offsite infra support for firms which have computers. These companies also act as disaster recovery centres. Hence established brand names charge a premium. Disaster recovery is an important component of risk minimization of companies and hence companies would prefer to pay a premium to a more reliable service provider. Allied has grown its revenues from 45 crores to 350 crore+ in last 5 years whereas Omnitech has grown its revenues from 45 crores to 200 crores in last 5 years. Their profit margins have been between 15 to 20%. RONW has been between 20 and 40% and D/E ratios are less than 0.5. Omnitech has increased profits 5 times in 4 years and Allied 7 times in 4 years. These obviously are due to low base effect. However the interesting aspect is the equity dilution these companies have done. Corresponding EPS growth has been 2.5 times and 1.7 times, a far cry from the PAT growth. However the company which is profitably growing at 30%+ with healthy profit margins and ROE’s is available at a P/E of 6.xx.
These companies look “cheap” from traditional metrics however the tougher job is to find why they are cheap!! Has the market ignored them or is it a case of ”do not touch”, only more research can tell.
I have created starter positions in these companies. Would hopefully provide a detailed study on these sometime. Any opinions on these 3 companies?
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There are different types of investment opportunities one comes across. I have tried formalizing this into many different categories for clarity of thought.
1. Stable Companies with no significant competitive advantage but decent fundamentals quoting at a significant discount to its intrinsic value:
In these companies, I try to buy at a discount and sell it once the value comes close to the intrinsic value. I would prefer buying at 50-60% of intrinsic value and start selling at 85-90% of intrinsic value. One cannot tell with confidence whether these companies can increase their intrinsic values at a CAGR of 15-20%. Hence it is better to sell such positions once they reach intrinsic value. Some companies which comes to my mind in which I have invested are: Ador Fontech, Patels Airtemp, Jet King Infotrain. I have started reducing my holdings in both Ador Fontech and JetKing after a fast run-up in prices.
2. Stable Companies with significant competitive advantages but quoting at a significant discount to its intrinsic value:
This is a wonderful combination. The reason being I would not necessarily like to sell the position even if it reaches intrinsic value on conservative estimates. This would stem from the fact that one would believe the company would be able to grow the intrinsic value at a rate faster than the general market and at a rate higher than what I could get out of any other investment. I would be willing to accept a less than “opportunity cost return (i.e. return I can generate by selling this holding and investing in Type 1 opportunity)” since it comes at a significantly lower risk of losing money. Buffet loves such investments, especially at a later stage of his career (post 1980), since it becomes difficult to keep shuffling positions when your fund size is very large. These investments may generate lower return than what may be generated by actively shuffling your portfolio with mispriced securities. CRISIL, Nestle, Asian Paints, CCI are some examples of such investments. I have not got an opportunity to invest in such companies yet. Such conditions are in fact very rare in my opinion.
3. Companies with no significant competitive advantage, at least at earlier stage, but growing at a very fast pace of 30%+ yoy due to industry dynamics
This is usually the space growth investors operate. The company may look expensive on usual value investors parameters like PE and usually one will not make money from PE expansion since such companies may have high PEs already but still will make money from earnings expansion at a very fast rate. It is difficult to nail the intrinsic value in such companies since it is difficult to predict how fast they will grow in future and with what kind of fundamentals they will end up with. The interesting aspect is these companies may not have any competitive advantage to begin with but “may” build it on over a period of time. There are four types of cases which can happen:
a. The company grows, matures and ends up with significant competitive advantage: Infosys, Google
b. The company grows, matures but does not seem to have significant competitive advantage, at least as of now: Bharti Airtel
c. The company grows, matures, but ends up with no competitive advantage and ends up in an industry with bad economics: Dish TV
d. The company fails or is close to failure from an investment standpoint: Subiksha, Vishal retail, Suzlon
It is important in growth investments to figure out what is happening to the industry dynamics very closely. Things are changing pretty fast here. One can make money during various stages of such investments however one should remember that the value is very closely tied to the future.
The best way to play this is to combine value investing concepts with such investments. One should be sensible not to pay crazy PEs (PRIL/Educomp) for such investments. I would be vary of any economic normalized PE above 20 and 15-20 is the maximum range I would be willing to operate. I have not made any investment in this though JetKing I hoped would turn out to be something like this.
4. Turnarounds:
These can be good investments if one figures out that some change is happening in the company for the good. There is usually some catalyst. Symphony is an example. There was some restructuring due to bad debts and the company paid off most of its debts, emerged debt free and has been able to grow fast in 1-2 years. Conventional valuation parameters wont help one much in such cases.
Every investment depends on how the future plays out and one cannot escape from that. However futures of certain companies/certain investments/certain situations are more certain than others. Risk, I would say, is not the volatility of stock prices, but on how the future may pan out.
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