2004-2007
Inflation – 3-5%
Sensex – 300% up
Interest rates – around 7-8%
Salary hikes – 20% minimum
Real estate – 200% or more up
A few more years of this, and I could have retired. Ahh ..life was good !!. All I had to do was to buy a house, anywhere or pick a stock which I heard from my panwala or barber.
how I long for those times again 🙂
I want a new bubble !!!!!
I have posted on NIIT tech earlier here. I had done a quick back of the envelope calculation and uploaded the same in the google groups – see the file valuationtemplatev3NIITtemp.xls. I have been asked on the logic of the valuation via comments and emails. So here goes,
Following are the assumptions in the valuation
– Topline will grow by around 10% per annum for the next 2-3 years
– PBT margins will drop from 17% to around 10% in 2-3 years
– New tax rate will increase from around 15% to 25%
– Net margins will drop from the current 14.5 % to 7% due to the above factors.
I personally think, the above assumptions are very conservative. It is possible that the company can do worse than this, but based on current facts, I think that is a low probability.
So based on the above assumptions the net profit for 2010 is around 90 Crs. I have taken a multiplier of 14 and added the cash on books to arrive at a rough valuation of around 1550 Crs (I have also added the pending options to the share count).
To see what a PE of 14 means, please look at the spreadsheet quantitative calculation – worksheet ROC and PE. Look for the DCF calculation with ROC of 25% (approximate ROE for NIIT tech). A growth of 8% for 3-4 years gives a PE of 14. So I am talking of a growth of 7-8% in profits after 2010.
The valuation is dependent on the assumptions above. Ofcourse these assumptions are not set in stone. If the US market goes into a deep recession or the management does something very negative, then the netprofit could be lower than what I have assumed. If you believe that the market is pricing NIIT tech correctly, then your underlying assumption is that the company is going to fall off the cliff in the next 2-3 years (basically shutdown in the next 3-4 years).
Based on the past performance and this quarter’s result, I don’t see any reason to believe that. However I can and will change my mind if the future invalidates my assumptions. So as I have said before, please do not consider my analysis as a recommendation for the stock.
As an aside, I have received the maximum number of emails and comments on this stock. Its not too surprising as a lot of readers of this blog are from the IT industry and tend to invest more in IT stocks.
I received a list of companies to analyse based on my earlier post. In order to do a better analysis, I am trying to club all the stocks from the same industry. As there are several cement companies in the list, I decided to take a stab at the cement stocks first.
My earlier analysis of the cement industry is here and here. In addition I have analysed the industry and updated my analysis in the file business analysis in the google group. Please have a look under the column commodity – cement.
The cement industry is a cyclical commodity industry where the profit and return on capital is dependent on the demand cycle picture. From the mid 90’s to 2002-2003 period, there was an excess of supply and hence prices were depressed. Most companies had poor to non-existent profits and accordingly the stock prices suffered. Since 2003, the demand has increased rapidly and so have the prices. The profit margins are now in excess of 20% for some companies and ROE in excess of 40% for companies such as ambuja cements. I personally think these are fairly high returns for this industry and the best of the companies in the industry would earn around a max of 20% over a business cycle.
Valuation of cement companies should not be done on the basis of peak earnings alone. This holds true for most commodity companies. Case in point – sugar companies. In 2006-2007, these companies appeared cheap based on their peak earnings. However when the cycle turned downwards, the stock prices got wacked. The economics of the cement industry are not as bad (there is lesser government intervention), however the valuation approach should be similar to the sugar industry. One has to be careful in extrapolating the peak earnings and assuming that the stock is undervalued.
Due to the cyclicality and commodity nature of the industry, analysis and valuation of cement companies is more diffcult as one has to figure out where the industry stands in terms of the business cycle . High returns can be made if one can predict the key turnaround points in the business cycle.
Mysore cement –
This is an interesting company. The company was taken over by the heidelberg group and made a tender offer to buy shares from the public at 54 Rs/ share in 2006 . SEBI directed the group to set the price at 72.5 per share. This was recently overturned by SAT and the heidelberg group can now initiate a tender offer to buy the shares from the public at Rs54 per share.
In addition the company alloted 66.5 Million shares at Rs 54 per share in 2006 to the group. This capital was used to pay off the accumulated debts and wipe out the accumulated losses. The company has also become profitable from 2007 since the new management took over.
In addition a recent news, indicates that indorama cement would be merging with mysore cement taking the capacity to 2.8 Million tonnes. The company further plans to expand the capacity to 5.9 Million tonnes.
The financial look good, with the company solidly in the black, no debt and cash of almost 180 crs on the books. The impact of the new management can clearly be seen from the P&L account, balance sheet improvement and aggressive plans of the company to expand capacity through mergers and greenfield projects.
So if everything is so good, then one should go and buy the stock? I would hold on that before I can figure out the following
– Cement is a cyclical industry. Currently the industry is on an upswing and hence all cement companies are making good money. How will mysore cement fare when the cycle turns south (supply exceeds demand)
– What is the cost structure for mysore cement? Cost is critical in a commodity industry such as cement.
– Future plans of the management. Scale is important in the industry. Mysore cement is still at 2.8 Million tonnes and even after capacity expansion would still be one of the smaller companies
One interesting development is the tender offer. The stock is quoting at around 30 Rs and the tender offer should be around 54 Rs. The stock may be a good arbitrage opportunity, even if the long term prospects of the company needs a more thorough analysis.
Ambuja cements
Ambuja cements has been one of most profitable cement companies in india and has made money even during the downturns. They have the highest net profit margins in the industry at 30% and ROE of almost 40%. Net profit margins have grown from 10% to around 30% and the profit as a result has grown by 8 times in the last 5 years.
The company sells at around 560 Crs/ Million tons of capacity compared to say 170 Crs/ Million tons of capacity for Mysore cement. The difference is high and understandable as Ambuja cement is a well run company with huge capacity and a very efficient cost structure.
The company is currently selling at a PE of 7 based on last year’s net profit numbers. Based on normalised profit margins of around 12-15%, the company is selling at a PE of around 12-13. I would say the company is undervalued by 20-25% at best.
If you believe that the net margins are sustainable, consider the following fact : Net margins in 2003 and before were around 10% and have expanded to around 30% in the last 2 years.
Grasim, ACC, Ultratech etc
Grasim has a blend of cement, VSF and other businesses. The cement business seems to be doing well in line with industry. The other companies such as ACC and ultratech have also been performing well in the last 2-3 years. Most of the top cement companies now have margins in the range of 18-22%, ROE in excess of 30% and high profit growth rates in excess of 20-30%.
The valuations of these companies are fairly close. Most of these tier I companies are selling at 7-8 times profit in comparison to the smaller companies which are selling at 4-5 times or lesser.
I am reaching the following conclusions after looking at the complete sector
– The cement industry has enjoyed very high growth rates and great profits for the last few years. The profits margins are not sustainable. New capacity, cost pressure and competition are bound to drive the margins to long term averages of around 10-12% in the next few years
– Most of the companies appear undervalued in terms of the last 2 years profits. However on the basis of normalized profits they are selling at 12-13 times earnings. At best, these companies appear undervalued by 20-25%. There may be a bit of undervaluation, but not by a huge amount.
– Considering the level of undervaluation in some sectors such as pharma, IT etc and the better economics enjoyed by those industries compared to Cement, I am personally not too keen on investing in the cement sector. If I had to pick up one cement company to put my money in for the long term, I would prefer ambuja cement (if I had to that is !!)
I receive several comments and emails with questions which require a detailed response. Instead of replying through an email or a comment, I am posting my reply as I thought others may find the discussion useful
Question : Does the increase in inflation and interest rates, impact the intrinsic value calculation ? Would you not increase the discount rate and reduce the instrinsic value as the long term government bonds rates have increased?
My response : You can find my approach to calculating intrinsic value here. In addition my valuation template also has the format for calculating intrinsic value. You can download it from here.
As some of you would have noticed, the discount rate I use is around 12%. This is strictly not as per finance theory. The typical textbook way to calculate discount rates, is to use the CAPM model (use the cost of equity and debt to calculate the discount rate). I am however more influenced by buffett and munger and their way of looking at stocks. For me, the discount rate or hurdle rate is my opportunity cost.
What is opportunity cost ? It is the return I can normally get from other investment options (debt and equity included). So if I have to invest in a stock, the expected return should be more than my opportunity cost (with a margin of safety to compensate for the risk).
When the long term rates were around 10-12 % in early 2000, I had a hurdle rate of around 13-14%. However when the rates dropped to around 8-9%, I dropped the hurdle rate to 11-12%. If you believe that the long term rates are likely to stay around 10% or higher for quite some time, then it would make sense to increase the discount rate you are using. However in my case, I plan to hold the discount rate at 11-12% till I get a strong feel that the long term rates in india would be above 10% for quite some time to come. Even in that case I may bump up the discount rate by 1-2% at best.
The market is ofcourse adjusting the valuation due to rise in the inflation and interest rates by dropping the prices. However we cannot be sure if this rise in inflation is temporary (6-12 months) or we are in for long term inflation
From prashant
Wondering what you did with your mutual fund investment(I guess you hold diversified equity funds) during Dec 07 / Jan 08 when valuations were sky high? A friend of mine informed me in Dec, 07 that he is swapping all equity funds to debt / balance funds. I ignored the info and thought SIP would take care of any correction. At the peak, gains were around 60% on the total money invested (during SIP of 1-1/2 years – infact I invested extra money in MF during all corrections) and now around -8%.
Actually I was not tracking the market and was taking care of monthly SIP money only. Now looking at current situation, I think I missed the opportunity. I should have done the same as my friend did. Lesson Learned – at a very high cost!!!
My response :
I have done this swapping in and out, jumping up and down and sideways and all around in the past. So after all the jumping and hopping, I decided to do some analysis in 2007 to see how I would have done in the last 8-9 years if I had just done an SIP. Well to my utter surprise, my returns were only 1% better than what I would have got through a dumb SIP plan in a decent mutual fund. With expense loads factored in, I have fared worse than an SIP plan.
I have seen from my past experience when I tried to time mutual funds, I ended up second guessing myself. When the market tanked, I was out and still waiting to get in.Then finally the market resumed its upwards course, but I was still twidling my thumbs. So this jumping in and out over the last decade has costed me a lot.
So this is what I decided – find 4-5 decent mutual funds. I don’t mean the top 5 or top 3 funds which is diffcult to find in terms of future performance. You can find the top 5 funds for the last X years, but that is no assurance that those funds will do equally well in the next X years. So I look at the funds with long histories (more the better) and if they have beaten the market by 3-5%, I set an SIP in them.
Will this give me the highest possible returns ? No it would not. Will I have bragging rights that I was smart to recognize the market top and jump out at the right time ? No, I will not. But I think I will end up following a fairly intelligent investment policy and make good returns. In addition this frees up my time and energy to pursue other activities.
There are only a few times in the world of investing when you can be fairly sure. Most of my equity analysis has words like likely, could be etc. Equity investing is a probabilistic exercise. You can 60-70 or maybe 90% confident, but no one can say anything with a 100% confidence. There is no such thing as a sure gain.
That is however not the case with the downside. Sometimes you can be sure that you will lose, no matter what. For ex: if you jump from the 4th floor of a building …you get my hint.
With stock markets down, the tendency of a lot of investors would be to take refuge in fixed income instruments such as Bonds, FD etc. But are they really safe ?
Inflation is now at 11.5% and it could stay there for some time. The usual policy action is to raise the short term to slowdown the growth and also the inflation. Due to the poorly developed debt markets in india, RBI does not have the same leverage as other central bankers in developed countries such as the FED. As a result, the RBI will have to raise the short terms rates pretty high to influence inflation. This was the case in the mid 90’s when the RBI had to raise the rates to around 13% to damp the inflation.
The current returns on Bank FD’s is around 10% for 1 year duration. Similary fixed income debt funds are providing a return of around 8-9% before expenses. Net of expenses the returns would be 7-8%. So if you decide to invest in a long dated FD be prepared to lose at least 2-3% of principal by way of inflation.
In the year 2000-2003, interest rates came down from 10%+ to around 7-8%. As a result debt funds gave 15%+ returns during that time period. We could see that phase in reverse now. As short term rates rise, debt funds could give negative returns.
So what should one do ? If I have invest in fixed income debt, I would prefer short duration floating rate funds. See here , to understand what is duration.
I would generally look at the following points when selecting a short duration floating rate fund
– duration of the fund. Should be less than a year. See average maturity in the image at the top
– average credit rating should be AAA
– Known fund house
– Returns for the last 2-3 years should have atleast matched the category returns.
This is kind of investing is really a defensive one. The best outcome one can hope for is preservation of capital net of inflation.
update : 9-Jul
I did not expect a flood of emails and several comments on this post. It was my mistake in not specifiying a limit on the numbers companies per email or comment. As a result i have a list of around 300 companies now to analyse and growing 🙂
To make it manageable for me, i would request you to limit the number of companies to 2-3 per comment or email. You can select your top 2-3 companies and hopefully i would be able to cover the entire list in 2-3 posts.
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I get emails and sometimes comments asking for my opinion on stocks. I am thinking of doing, twice a month post, analysing all such stocks sent to me via emails or comments.
Please feel free to leave the stock names through either an email to my id – rohitc99@indiatimes.com or via a comment. I will consolidate the names over 2 weeks and post a quick analysis on each one of them.
However you have to keep in mind the following filter criteria I use to analyse stocks. Stocks which don’t meet these criteria are generally rejected by me without spending too much time on them.
1.Debt/ equity ratio <= 1
2.ROE over a 3-5 year period of more than 12%
3.No losses for more than 1 year in the last 5-7 years
4.Mcap of more than 20-30 Crs (can be relaxed)
5.No obvious fraud by the management in the past
6.PE not more than 40
If the fundamentals are poor, or valuations too high I tend to move on and not spent too much time on it. If like me, you need 10-15 stocks in the portfolio, there is no need to spend time in figuring out a difficult idea when there are easier ones available. A lot of times stocks may have good fundamentals and may be slightly undervalued. In such cases I tend to put the stock on a watch list and would follow it till it becomes undervalued (50% of intrinsic value).
Some of the stocks you may mention may land in such a bucket. It does’nt mean that I don’t find value in the stock, just that it is not cheap enough for me. So please leave names of stocks you want me to look at. If I get sufficient response, I will try to make it a regular effort on the blog.
In the previous post, I was asked to give an opinion on several stocks. I have fairly broad filters when selecting stocks. As a result I drop companies pretty quickly. Once they make through my filters, I spend quite a bit of time analysing and mulling over them. Frankly I don’t need more than 10-12 stocks to build a decent portfolio, so I don’t spend time on companies which don’t catch my attention, either due to the fundamentals or due to valuations
So here is my opionion on the stocks listed in the comments (please note the word opinion as I have really not done a detailed analysis on them)
Please note that for a stock to excite me, the fundamentals have to be good and the stock has to be fairly undervalued (selling at 50% of intrinsic value). So you may find that I am not too enthusiatic of some stocks if they don’t appear to be undervalued to me even if the fundamentals are good.
Following stocks are from mumbai jurno
Punj Lloyd – The net profits have grown by 30 times in the last 4 years. The company has a debt equity ratio of more than 1 which is on the higher side for my comfort. The market has recognized the rapid growth and inspite of the recent drop, the company is valued at 30 times its recent earnings. I personally will not invest in this stock for two reasons – I am not confident if the company can continue this level of growth and the valuation are on the higher side for me.
Voltas – I was invested in bluestar from 2003 to 2006 (see here). I exited blue star last year as I found the valuations to be on the higher side. The company has shown a high profit growth ( 5 times in last 5 years) and has a high ROE of almost 50%. The company has very low debt. Though the valuation (PE of around 20) is a bit on the higher side, I would personally put the company on my watch list and analyse it a bit further to make a decision.
Amararaja Batteries – This is the auto components industry. Overall I am not too excited by the economics of this industry. If the auto industry is under price pressure, it is bound to pass on those cost pressures to their suppliers. As a result auto component companies over a business cycle do not enjoy high profits. Most the companies in the industry do not have a high competitive advantage due buyer power, poor pricing strenght etc. I had analysed exide some time back, but never pulled the trigger. This is from memory – I think exide enjoys more than 50% market share in the industry. In such an industry a distant no.2 such as amaraja may not have very high pricing strength and may see its profits dip when the cycle turns downwards. So although the stock appears undervalued, I would be careful jumping into it. Looking into the rear view mirror (last year’s profit) may not be the smart thing to do in this stock. It is critical to figure out how the company will do going forward.
Venus Remedies – Company appears undervalued and has shown very high growth in the last few years. I would have to analyse if the growth is sustainable or not to make a decision.
Kamat Hotels – 2007 Debt equity ratio is 2:1, with the company carrying a debt of 270 Crs in 2007 (have not seen 2008 numbers). This debt is almost 10 times 2007 net profit numbers. This stock would fail to pass my fundamental filters and I generally end up passing on companies with this level of debt
ICSA (India) – This company like Punj lloyd and amaraja has shown phenomenal growth in the last 5 years. On a personal level such growth makes me nervous (although the market gets all excited by it). Before I touch this stock I would want to analyse the reason behind the growth and the sustainability of this growth. Basic numbers do not give the complete story. So I will need to research far more to make a decision on the company. A high growth in the last few years is good thing, but I would not extrapolate that growth blindly and buy the stock.
Axis Bank – Fundamentally a good bank. The P/B ratio is around 3 and the ROE has been dropping for the last few years. ROE is now at 12% which could be due to the additional capital raised by the bank. The bank is doing very well and growing rapidly too. I would personally track the stock, but the price is not cheap enough for me.
Yes Bank – This stock is current sweetheart of a lot of people. If I say something bad, some of you will beat me up 🙂 . The bank has good fundamentals. However at the current P/B of 4-5, the valuation is still too high for me.
From hardtoget
Alok – 2007 AR shows a debt of 3300 Crs (Debt equity ratio of 4). Unless 2008 is drastically different, this company is not for me. A debt equity ratio of more than 1 is generally a no go decision for me. I am not comfortable at all with such a high debt equity ratio, especially in cyclical industry
From vivek
Balmer Lawrie – I hold this stock. See analysis here
Berger Paints – I worked in asian paints and have seen how berger operates fairly closely. If there is one company other than asian paints which is aggressive and does a good job, it is berger. The company has a fantastic sales organisation. The fundamentals of the company are good and the valuation looks attractive too. If I was not as baised towards asian paints ( I hold this stock), I would invest in Berger paints.
Tata Tea – The company seems to have good fundamentals, good brands and decent valuation. I will be analysing the stock further.
Glaxo Consumer – I hold this stock. See analysis here
Castrol – The company has great brands, a good distribution network, very high ROE and great fundamentals. The valuation seems to be a bit on the higher side for me to pull the trigger. My key concerns are management quality and impact of oil pricing on the company’s profits. A few years back, I think the management tried to buy out the domestic shareholders at a low price. As a result I am not too comfortable with the management. In addition need to see if their margins will be impacted drastically by the oil price changes.
Hindustan Sanitaryware – Fundamentals look good, although the 2007 debt is a bit on the higher side. The valuations are quite attractive. I think the company is worth a closer look.
No, I have not been wishing that or whining about it. I have heard several of my friends wish that they had done that. Short of knowing the future, it would have been impossible to time the market that well.
I too have losses due to the market drop. However I am not dissapointed or wishing otherwise. It has nothing to do with being brave and more to do with being rational based on my approach.
This is how I construct my portfolio. I typically start buying at or below prices, which are 50% of conservatively calculated intrinsic value. Ofcourse at the peak in Jan, most my holdings had gone up (in some cases too fast) . However they were still trading at a discount to their intrinsic value. Hence I saw no reason to sell my stocks. However as they were above 50% discount levels, I was not doing any major buying too. As a result, after creating a small position in some stocks, I was doing nothing and just twidling thumbs.
Now with the market crash several of my holdings are below the 50% discount mark. There are quite a few new opportunities coming up too. So I have now started accumulating stocks which I had analysed in the past, but the price was not attractive enough.
So the point is this – If you felt the stocks in your portfolio in jan were not overvalued enough to be sold then, they should even more attractive now. If you did not sell then, thinking that they were not overpriced, you should buying more now. Ofcourse this assumes that the fundamentals have not deterioated suddenly.
If however you are pessimistic about the stock after a 30-40% drop, then you need to do some honest thinking. Either your analysis was wrong or the current pessimism is getting to you.
Update 29th – I missed an important point when i posted on 28th. The data for the index is non-stationary. What it means that the underlying composition of the index is not fixed and the various other parameters such as interest rates, inflation are changing too. As a result the index of 1995 is not the same as the index of 2008. One must be careful from drawing too many conclusions from the data. It is good to analyse the data and have a perspective, but dangerous to make invest decision based on it alone. It easy to say the index is overvalued if the PE is above 30 or undervalued if it drops below 10. However it is not easy to arrive at a firm conclusion if the PE is 15 or 18 or similar such levels.
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I am not planning to make any forecast on where the forecast will be in the next few month. However I have done some analysis on the sensex and nifty index and uploaded it in the google groups. You can check here to download the file Quantitative calculation 2008.xls and check the first worksheet – market valuation.
The numbers for june 2008 are computed for both the sensex and the nifty. A few observations
1. The current PE for the sensex is around 16.8 and 17.7 for nifty. By historical standard ( history is few years back, not a few months) it is not too low. Just about towards the upper end of the PE band
2. The Return on equity (earnings/book) is still pretty high by historical standard. In the 90’s the numbers were generally low in 14-19% range. The last 3-4 years were actually an exception. We had a confluence of positive factors. Low interest rates, high demand growth and high capacity utilization all resulted in high returns. Companies had also re-structured and so net margins and ROE have been high in the past few years. The business cycle may be turning, with interest rates and inflation creeping up. We could revert to an average ROE of 18% (still higher by historical standards)
3. The Earnings growth has been 20%+ in the last few years. This has slowed down to around 10-12% in the current year.
Lets do some scenario analysis. For sake of assumption lets look at some probable scenarios on factors which are based on fundamentals
Book value is around 3540. An ROE of 18% which looks like a fair no. (look at the data for the entire 90s till 2003. I am still assuming a higher number). So normalized earnings is around 640 Rs which is lower than the current number of 820. What this means the earnings growth could slow down over the next few years as ROE reverts to the historical numbers. It is important to remember that ROE, unlike PE is not driven by market pschology. So the historical numbers do count in case of ROE.
For PE looks at the years 96-98. Interest rates were high and market PE ranged between 14-17.
Now for a juicy forecast – lets say earnings grow to around 900 in 2 years (book value will have to grow by 20% per annum and returns will drop to around 18% for that, so it is not impossible) and the PE is around 16-18, we are looking at a range of 14500- 16500.
Keep in mind that the assumptions in arriving at these numbers are still optimistic. We are still assuming reasonable growth in book values, moderate drop in ROE and fairly decent multiples. If things turn out better then we could have another bull market. But if we revert to historical levels, even on some variables such as ROE or PE or growth, then even the current market level is not too low.
Ofcourse other than the data, everything else in this post is a hypothesis. So my guess is as good as yours.
For an analysis of the index 2.5 years back see here
06/27
some more observations from an outsider
– i have generally noticed that the younger crowd is more attracted to trading. that does not mean older people dont trade. just that if you talk to 100 young guys who are interested in stock market, a sizeable numbers would be into trading
– A lot of my friends who are into trading have a bias for action. There is the thrill of being right and knowing that pretty soon.
– there is more sense of company. you get to discuss about it with more people. value investing is pretty lonely. you buy ugly beaten down stocks. who wants to discuss companies no one has heard of ?
– media and the environment like brokers also encourage trading. no one will recommend buying a stock and sleeping on it for 5 years.
if you are a trader, please do not take this as a criticism of trading. These are just neutral observations (maybe incorrect) of an outsider. I may have bias against trading, but not a bias against people who do trading.
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I have noticed in general that the number of people interested in trading are far more than those interested in long term investing or value investing. For ex: there are far more blogs on trading than say value investing. There could be an overlap between the two groups too. I however have no aptitude for trading and it does not fit my temprament. I have said so in the past.
I can understand why there are more folks interested in trading. Trading does have an element of excitement. You get to do something quite often, whereas value investing or long term investing is as exciting as watching grass grow or paint dry. So this is my question – What are the average non – leveraged returns experienced by traders over a multi year period ..say 5-6 years (including a bull or bear market) ?
I agree there are several trading strategies and so to lump all of them under ‘trading’ is not smart. But at the risk of sounding dumb (which I am in terms of trading), I was curious to know what kind of returns do most people get ?