AuthorRohit Chauhan

My experience with Equity mutual funds

By Rohit Chauhan
In Mutual funds, Uncategorized
May 1, 2007
5 Min read
8 comments
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As I write this post, I have been investing in mutual funds for over 8-9 years. This is a post to show the experiences I have had with mutual funds and learnings from my mistakes and sucesses. So it is not a showpiece of my brilliance or of my stupidities (of which you will find more of in the narrative). It is just a gist of my experience and learnings

1999-2000: Time of confidence and on top of the world

It is mid 1999. I had already dabbled a bit in mutual funds. I had invested a small amount in UTI-Mplus 91 in 1995 at a discount to NAV (it was a closed ended fund then). The discount had closed and I had made over 20% per annum and was feeling more confident of investing in mutual funds. Also I had moved out of Unit 64 scheme in 1998 after I had read a few adverse reports about it and managed to avoid the losses.

So here I am in 1999, feeling confident and having a little bit of cash in my pocket. Towards the end of 1999 (right a the start of the bull run) I started investing in mutual funds (yes, got the timing right!)

This was my list of mutual funds at that time
Alliance new millennium fund
Alliance buy india fund
DSP meryll lynch opportunities fund
Kotak MNC fund
Kothari pioneer fund balanced and Internet opportunities fund
Prudential ICICI tech fund
Alliance 95 fund
Franklin index fund

So I was heavily invested in IT funds. Considering that I was in mutual funds and spread across several of them, I incorrectly assumed that I had diversified the risk.

2001-2002: What was I thinking ?!!

The tech carnage started in mid 2000 and several of my funds lost 80-90% of the value. The saving grace were the non IT funds. But those funds lost more than the index as they were also heavily wieghted in IT. So the herd mentality affects everyone at the same time.

Although it was easy to blame the mutual funds and their aggressive marketing (they advertised 100% gains for 3 month periods), I realised it was my greed and faulty logic which was the reason for my losses.

I had been reading buffett and other value investors since 1998 and was a firm believer in value investing, but allowed myself to be carried away by euphoria and greed.

By the end of 2002, my mutual fund portfolio was down 25% and I had already exited from several tech funds and moved into diversified funds.

My fund summary by the end of 2002 was as follows
Alliance new millennium fund
Alliance equity fund
DSP meryll lynch opp fund
Zurich equity (now HDFC equity)
Prudential ICICI tech fund
Alliance 95 fund
Franklin index fund
Pioneer ITI index fund

So as you can see, I had started moving out of tech funds and into index funds.

A few learnings

– avoid sector funds. If you want to invest in a sector, find some good stocks in that sector. Sector funds don’t diversify risk, only concentrate them
– A good portion of funds should be kept in low cost index funds. You are garunteed market returns in the case of index funds.
– Diversified equity funds are the best option as these funds allow the mutual fund manager the maximum flexibility, unlike the sector fund where the manager and the investor are stuck in the same sector even when the sector is sinking.

2002-2004: Fixing the portfolio

With the above learnings in mind, I took my losses and moved into diversified equity funds. I chose funds which had demonstrated long term outperformance.

My portfolio looked like this by 2004.

Alliance equity fund
Reliance vision
DSP meryll
Franklin templeton – Blue chip growth and Dividend
Templeton india growth fund
Prudential ICICI growth (switch from tech fund)
HDFC equity
Rest was index funds and Nifty BEES.

My portfolio by this time reflected the following approach

– reduce the number of funds in the portfolio. More funds do not provide diversification, they just reduce the reduce the return without reducing the risk
– Select funds with low expenses and a long term performance history
– Prefer diversified equity funds over sector and promotional funds (like an MNC fund or similar idea based funds).

2004-2007: Doing nothing (and reaping the rewards)

During this period my fundamental approach did not change drastically. I have kind of fine tuned a few aspects of my mutual fund approach, but the broad approach has remained the same and has worked quite well

A few changes during this period have been

– reduction of the number of mutual funds and consolidation into fewer high quality funds
– Regular investing through a Systematic investment plan, barring when I feel the market is extremely high
– Limit the total number of mutual funds to 4-5 at best and re-invest additional money in the same funds.

The net result of the above journey from the year 2000 to 2007 has been a net performance of around 23% per annum , which would be around 5-6% more than the market returns.

Next post : My approach to selecting mutual funds

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Fixed income investing

By Rohit Chauhan
In Investment process, Mutual funds, Uncategorized
April 27, 2007
4 Min read
8 comments
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My blog and most of my posts refer to equity investments. I have once in a while posted on real estate. However fixed income investments are a fair percentage of my portfolio. The reason I don’t post much on fixed income investments is because there is not much I can do to generate extra returns in proportion to the time and effort I will have to spend on it.

The fixed income options available to me are

– Bank FD : this is almost a no brainer and the most passive form of investmtent. However I don’t chase returns blindly. I typically hold deposits in only the Top banks and avoid the second tier banks and co-operatives. The extra 1-2% return is not worth the risk. In addition, I tend to look at the capital adequacy ratio (CAR) and the NPA levels of the bank, before going ahead with the FD. The name or reputation of the bank alone is not sufficient. Typically the CAR levels of the bank should be above 8-9 % (TIER I) and NPA levels below 1-2 %.

– Company bonds : The next avenue for fixed income investing is company bonds. I have invested in company bonds and FD’s in the past when the interest rates were higher and it was possible for me to process the paperwork. However since 2000, partly due to the amount of paperwork involved then (there was no Demat for bonds) and due to the easy of investing in mutual funds , I stopped looking at company bonds and FD’s. Also due to the high profile failure of some of the companies and the losses incurred by the bondholders, I kind of lost interest in company FD’s and bonds. The key factors to look at when investing in such instruments is the interest coverage ratio ( PBIT/ Interest expense ) which should atleast be 4, Debt equity ratio for the company ( < 0.5 if possible) and debt rating by the rating agencies such as Crisil (invest in AAA or AA+ only).

– Mutual funds – fixed income: This is my favored avenue during a falling rate scenario and I tend to invest with well know mutual fund houses such as franklin templeton, DSP etc. At the time of investing in a debt mutual fund, I tend to look at the following factors
o Asset under management – avoid investing in funds with low level of asset as the expense ratios could be high.
o Fund expense – lower the better. Although the indian mutual fund industry typically gouges its customers and charges too high compared to the returns.
o Duration of fund – This is the average duration of the fund. A fund with longer duration will rise or fall more when interest rates change
o Fund rating – 80-90% of the fund holding should be in p1+ or AAA / AA+ securities.
o Long term performance of the fund versus the benchmark

– Mutual funds – floating rate funds : This is my favored approach in a rising rate scenario. In addition to all the factors for the fixed income mutual funds, I also tend to favor floaters with shorter duration.

– Post office : Nothing much to analyse in this option other than it was an attractive option a few years back when the Post office offered better rates than available in the market. Currently the 8-9% per annum for the 6 year duration is not attractive enough.

– FMP (fixed maturity plan) : I have just heard about it and have yet to understand about this investment option.

Finally in terms of tax effectiveness, debt based mutual funds are the most efficient as they are subject to long term tax rate after 1 year.

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You can be a stock market genius – Recaps, stub stocks,warrants and options

By Rohit Chauhan
In Arbitrage, Book review, Uncategorized
April 24, 2007
3 Min read
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The final section of the book starts with recaps. Under a recap, a company may decide to buy back stock from the investor via cash, bond or through preferred stock. Thus the proptional ownership of the investor remains the same. However the company doing the recap is able to create value for the investor. For example, a company is trading at 200 Rs per share. The company earns 20 Rs per share (post-tax). The company returns Rs 150 to the shareholder by raising debt. Post the recap, the company has say Rs 15 of interest expense. As a result the post tax earnings are now are Rs 11 share (assuming 40% tax rate). Even if the company continues to sell at 8 times earning, the net gain for the shareholder is now Rs 38.

The stock after the recap is called as a stub and an investor can benefit from buying such stub stocks after the announcement of the recap. The reason for this is that the stub is a leveraged position on the stock. As the company has high amount of debt, the equity value is depressed due to high leverage. As the company pays off debt, the earnings grow rapidy. Also the multiple could expand at the same time due to reduction in the risk. As a result a small improvement in the debt level can result in a large improvement of the stock price.

Recaps are rare (and even rarer in the indian markets). As stubs via re-caps are rare, the same result can be achieved through LEAPS (Long term equity anticipation security). Leaps are a form of long term call options on the company. They are a leverage call on the medium to long term performance of the company. For sake of an example, lets assume that the stock price of company is Rs 88 / share. The company is highly leveraged and I feel that the company should do well in the next 1-2 years. I could (theortically speaking) buy a LEAP at 50 Rs/ share. If the company does well and the stock goes to 150 Rs/ share in two years, my gain would be 300%. The downside is that if the stock goes below the strike price, then I lose my money completely. LEAPS are thus a leveraged bet on the performance of a company. However, I think the indian market does not have LEAP securities yet.

Warrants provide an alternative route to put in a leveraged bet on the performance of the company. Warrants however have an advantage that their duration is much longer than options and LEAPS. The book has specific examples on recaps and all the other specific arbitrage options like spin-offs, arbitrage, and merger securities.

For all the previous posts on the book
Introduction
Bankruptcy and restructuring
Arbitrage and merger securities
Spin-offs

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Company analysis worksheet and valuation template

By Rohit Chauhan
In Company analysis, Uncategorized
April 20, 2007
1 Min read
2 comments
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I have received several requests for my company level valuation template. Instead of responding individually to each of the request, I am posting it in the ‘My analysis worksheet section’ (see here)

The company level analysis worksheet is still a work in progress and I will keep uploading updated versions in the future. I use this worksheet as I detailed it here in an earlier post, for a detailed analysis of a company once it has passed through the basic filters.

I am also uploading the worksheet which I created for gujarat gas limited in 2003 (see here). I have since then, bought and liquidated my holding. I will upload more of such worksheets in the future.

In addition, I am also posting a quantitative worksheet. This worksheet has some quantitative analysis of the relationship between PE, ROC and Competitive advantage period. It has a similar analysis of the relationship between FCF (free cash flow), ROE and depreciation (see here)

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You can be a stock market genius – Bankruptcy and restructuring

By Rohit Chauhan
In Arbitrage, Book review, Uncategorized
April 19, 2007
3 Min read
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The next section of the book deals with how to profit from bankruptcy and restructuring. As in the other parts of the book, the author again emphasizes the point that an investor should ‘pick his spots’ within the bankruptcy arena.

It is rarely a good idea to purchase the stock in a company which has recently filed for bankruptcy. As the stock holders have the lowest claim when a company files for bankruptcy, usually they end up getting very little or almost nothing at the end of the bankruptcy proceedings.

One way to make money off bankruptcy is to invest in the debt securities of such a company which may be selling at 20-30 % of the face value. However this is a very specialized field which is best left to experts who specialize in this field.

The best way to profit from bankruptcy is to invest in the new common stock of the company which is issued after the completion of the bankruptcy proceedings. Since the stock is issued to the current creditors like banks or suppliers, they are rarely interested in holding the stock due to which there is a selling pressure after the new common stock is issued. This creates a situation similar to spinoffs. However it is critical that the investor analyses the company in detail before buying the common stock as random purchase of such stocks that have recently emerged from bankruptcy will rarely result in superior long term performance. There are several reasons for it. One reason is that most companies that have gone through bankruptcy were in diffcult or unattractive businesses to begin with and shedding debt obligations does not change the basic economics of the business ( think airlines). However if the investor does reasonable due diligence, then he would be able to find a few attractive opportunities which the underlying economics of the business is healthy.

The next area of opportunity is corporate re-structuring. If there is a major re-structuring of a company where a major division is spun off or if a losing business is sold off then such an event can create a profitable opportunity. After spinning off the weaker or money losing division, the resulting company is more profitable and focussed and may be given a higher multiple by the market. In addition the re-structuring can create a more focussed and efficient enterprise which may perform better in the future. Investing in the company after the re-structuring is over can be a profitable option.

Previous post on arbitrage
Previous post on spin-offs

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Why I avoid IPO’s

By Rohit Chauhan
In General thoughts
April 14, 2007
3 Min read
10 comments
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I have a very irrational reason (yes it is not a typo) for not investing in IPOs. My thinking is like this (A hypothetical tale)

I have a house and wish to sell it. Also I have a decent cash balance and I am no hurry to sell the house. I will sell the house if I can get a good price for it. Looking around I realise that my neighbour has just sold his house at a fantastic price. That tempts me into start looking for buyers and I approach a few brokers to test the market. The brokers are extremely bullish and tell me that this is a good time to sell and the market is hot !. I get all excited and invite a few brokers to come over and look at the house. A few brokers come over and have a look at the house. On inspecting the house, they notice a few problems in the house. The west side wall seems to be weak and roof needs repairing. They ask me to repair the roof and paint the walls so that the these ‘defects’ can be hidden. I go ahead and start the repairs and meanwhile the brokers are looking for buyers.

The broker meets the buyers and tells them that they have a great house on the market. The price for houses in that area have increased by 50% in the recent past and this house is a great deal. The buyer, all excited by the likely appreciation, comes over, looks at the house and agrees to buy it. A somewhat weak roof and wall goes un-noticed because the house is a great ‘investment’. Why bother checking!!

So the deal gets done and everyone is happy. I get a good price, the broker his commission and buyer gets the dream of price appreciation and hopes of profits in the future.

One year later, the RBI in all its wisdom raises the interest rates. The housing market starts slowing. Buyers are now more discerning. They are not buying to invest, but to stay. A house with a weak roof and wall is not a good place to stay. The buyer is finding it difficult to sell the house and has EMI to pay on top of that. Dejectedly he sells the house at a loss and resolves never to get sucked into such a scheme.

Ok, I am not an evil scheming guy 🙂

So now replace me with company, broker with merchant banker, buyer with investor and house with a company and you would get the point.

If I have only X no. of hours in a week to analyse stocks, why waste time looking for needles in an IPO haystack when I can find them more easily in the rest of the market (with full knowledge of all the problems and leaky roof !!)

 

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Comments on the Post of Cheviot company

By Rohit Chauhan
In Company analysis, Investment ideas, Uncategorized
April 12, 2007
4 Min read
2 comments
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I received a few comments on my analysis of Cheviot company. Thought of posting it on the blog as they add to the analysis of the company.

Prem Sagar said…
Rohit,
Do you know what the mgmt intends to do with the huge investment portion?
from their last 5 yrs, I see no huge capex and I dont think the mgmt has any plans to invest huge sums into the same business to increase sales or to enter into new avenues to explore new possibilities. So as of now, the investment portion is just sitting on their books without any plan for it, but merely compounding it.
do you think they would do better if they disburse a part of it to shareholders or buy their own shares back?and the industry itself is struck severly by strikes and I can see several instances of strikes for this co alone. and the whole industry doesnt look enticing.
Assuming that the investments are discounted, would you be willing to buy such a co at 2 times?
4/11/2007 12:25:00 AM

Rohit Chauhan said…
Hi prem
very valid concerns. as far as strikes are concerned, i would not be too worried as the company has been able to manage the financial impact of such strikes in the past. unless the company has some very serious labor issues in the future which shuts down the plants for a very long time, i dont think these labor issues should harm the long term economics of the company
the capex needs of the company are low and hence i expect the cash to increase. i have seen no evidence of the management wasting the cash till date. they have given a bonus, decent dividends and seem to be accumulating cash. need to see how the cash gets used. buyback is unlikely as the no. of shares is low (0.45 crs).
cheviot is a graham play and a portfolio of such companies should do well ..although individually a few of them may do badly
4/11/2007 04:06:00 PM

khali_pili_lafda said…
Hi Rohit,
First off great effort on this blog. My observations on Cheviot are below.
1. Jute prices are on the decline on a global scale and may exert pressure on profit margins for Cheviot over the next few years given that export orientation of company has increased.
2. Historically the P/E has always been below 6. Cannot figure out why the markets are unwilling to give Cheviot credit for performance.
3. Company has a lot of cash on hand (Rs543M) with only 4.5M shares outstanding. May be diversifying into Tea – read this online? Saw a spike in Capex in 2003.
4. Labor issues have already been highlighted by you but given that Cheviot operates in West Bengal, labor laws and strikes can be particularly harmful and unpredictable.
5. With only 4.5M shares outstanding – it raises a liquidity red flag since trading may be controlled by a select syndicate. On Apr 12th only 485 shares changed hands although Mkt cap is over 100 crores.
Niraj
4/12/2007 02:35:00 PM

Rohit Chauhan said…
Hi niraj
great comments.my thoughts on the points raised by you
1. i also noticed that jute prices (raw material) is decreasing. i think that is a plus for the company as it improves the net margins for the company (the company sells valued added jute products)
2. i think the historical PE is low because of the various factors in your and prem’s comment. small cap, illiquid stock in an unglamorous industry with labor issues
3. i am not sure that the company has diversified into tea. the 2003 increase in gross asset was a revaluation which was reversed in 2004. i checked this in annual report. the capex for last 5 years has been roughly equal to the depreciation
4.agree with you. however i feel that labor does not represent a threat to the long term economics of the company. it can cause short profits to suffer. although a serious labor trouble could impact my assumption. frankly it would be difficult to evaluate this risk objectively
5. this could be the reason for the low valuation

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Priced for bankruptcy – Cheviot company

By Rohit Chauhan
In Company analysis, Investment ideas, Uncategorized
April 10, 2007
3 Min read
12 comments
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I am currently analysing Cheviot company (for company website see here).

The valuation is as follows

No. of shares outstanding – 0.45 Cr
Price per share – 228
Mcap – 103 Cr
Investment/ cash on book – 63 (last year)+ 10 Crs (this year) = 73 Crs
Net value = 103-73 = 30 Crs
Current year expected NP = 23 Crs

The company seems to be priced for 1-2 years earnings. The market seems to valuing the company with a horizon of 1-2 years and expects the company to be out of business after that !!.

Background

Cheviot company is a West bengal based company into the manufacture and sale of Jute based products. Almost 70% of the sale is export and the rest is domestic (Page 6 of Annual report).

The company has been in business for more than 100 years and is currently the most profitable in its industry (the jute industry as a whole is sick and incurring losses). The company has two manufacturing units, one at Budge budge and the other at Falta. The unit at Budge budge is having some labor trouble which may impact the Topline for the company.

Financials

The company has had a ROC of almost 20%+ for the last few years (if one excludes cash). The company has been consistently profitable and has good free cash flows ( equal to net profits).

In addition, although the volumes have come down, the company has moved up the value chain and has been able to improve realization for the end product (Raw material cost as % of Sales has been coming down over the years). The topline has increase with a CAGR of 6% for the last five years whereas the Net profit has increased by 15% CAGR over the same period.

The company has almost 73 Crs cash on book which has been invested in mutual funds and other liquid investment.

Risk
The indian government has made jute the mandatory packaging material for food grains and sugar to support the industry. In addition the government also provides marketing assistance for the export market which is received as a credit. Thus the industry is surviving based on this support from the government.
The company currently has labor unrest in one of its units which may impact the short term profitability. In addition, this industry is marked by labor issues and strikes.

Conclusion
In my view, the strike could impact the topline for a quarter or two, but it is not a long term risk. In addition, the company has been concentrating on the export market and as a result could continue to do well.

The market is currently discounting all the above issues and more and pricing the company for bankruptcy, which does not seem probable.

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A bi-polar market

By Rohit Chauhan
In Market analysis, Uncategorized
April 8, 2007
1 Min read
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I typically do not invest based on the market cap of companies. Though I have a cutoff of 100 crs for market cap when filtering for investment ideas, I do not give it anymore importance than that.

I have been reading a few articles that the midcap sector of the market seems to be performing poorly as compared to the index. As I hold several midcap stocks in my portfolio, I decided to check the validity of this view.

I checked on the performance of the midcap index and compared it with the nse nifty. Since april, the midcap index been in a bear market and has dropped by around 2-3% whereas the nse nifty is up 7-8 % (see under statistics section of the nse india website)

In addition, my stock filters seem to be turning up a few good ideas in the midcap space.

The above thought does not mean that I am planning to rush out and buy midcap stocks indiscriminately. However the small cap and midcap space is now a good place to look for new ideas

You can find are recent post on market breadth here on galatime.com

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You can be a stock market genius – arbitrage and merger securities

By Rohit Chauhan
In Arbitrage, Book review, Uncategorized
April 5, 2007
3 Min read
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The next topic in the book is on arbitrage and merger securities. Risk arbitrage is the purchase of stock in a business that is subject to an announced merger or takeover.

Risk arbitrage involves two kinds of risk. The first risk is event risk. The deal or merger may not go through due to various problems such regulatory issues, financial problems, unforseen events.

The second nature of risk is the timing risk. For ex: A company A announces the buyout of another company B. Company B trades at 200. The buyout offer is at a premium of 20%. As a result of the announcement, the stock rises to 230. This is still below the deal price of 240 and give rise to an arbitrage of 10 per share (4.3%). Now the time take for the deal to play out will have a big impact on the eventual returns. If the deal takes 2 months, the returns are 25%+. However if the deal takes a year, then the return falls to around 4% which is below the risk free rate.

Finally the area of risk arbitrage is now fairly competitive and the typical returns have come down over the years. As a result the risk/ reward equation is not compelling in several situations and hence the author advises that non-professional investors should stay away from this area of arbitrage

The next sub-topic is on merger securities. These are securities such as warrants, bonds, shares etc which are issued by the acquirer to pay for an acquisition. These securities, issued during the merger, may not really be desired by the large investors for various reasons (similar to the spin-offs). The reason could be the restrictions on the institutional investor such as a stock fund may not be allowed to hold bond securities issued during a merger. In addition some securities such as warrants may not be large enough for the large investors to get interested. Finally due to the various reasons, these securities are sold off without regard to the investment merits. As a result these securities can be purchased below their intrinsic value

Thus merger securities are similar to spin-offs and an investor who is able to do a certain amount of analysis and due-diligence may be able to profit from both the special events.

My thoughts : I have seen a few merger and acquisition announcements in the past. However these coporate events are not as frequent in the Indian market as compared to other foreign markets. Also the pricing in quite a few of these merger announcements is fairly efficient and these is little opportunity for a small investor to earn a good return (without leverage). However it is still a good area to investigate if one is interested in extra returns. A word of caution though – aribitrage of any kind requires continous effort and may not be too truly appropriate for a part time investor.

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