AuthorRohit Chauhan

Wisdom of the crowds

By Rohit Chauhan
In Book review, Uncategorized
April 2, 2007
2 Min read
2 comments
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There is a new article by michael mauboussin on wisdom of the crowds (see here). There is also a book on the same topic which I read earlier (see here). Website of the book’s author here.
The key take-away for me from the article and book has been as follows

1. The crowd is usually smarter than an individual. This means that one should discount what the experts are saying (most of the times). One should not waste time in heeding to their forecasts. It makes sense to read the insights of investment masters or good investors. One can learn from that, but stay away from forecast (especially short term) by the so called experts. Most of the personal finance websites is full of this junk. I consider it mostly as noise

2. The crowd (market) is right most of the time. What that means is that the valuation of most of the companies is right. It is not always right, but most of the time it is right. As a result if I think that the stock is undervalued and a good buy, I try to analyse my assumptions in depth and check my variant perception in more detail to be sure that I have got it right and market is wrong on it. Almost 90-95 % of times I have found that the market is right and my edge is limted to 5-10 % of the cases.

3. Be humble – One should always have a growth mindset and learn from the market and others.

4. Even if individual investors are not extremely smart, the market as a whole is smarter than the smartest individuals ( see the article and book on how this is true)

5. There are a few situations (bubbles and crashes) when the diversity and collective wisdom breaks down. In such situations, it makes sense to diverge in your thinking from the market and not be swept by the euophoria or pessimism. For ex : the dotcom boom of 2000

I would recommend reading the article and the book as it would be a great addition to one’s mental models.

Disclosure : I have no financial interest in anyone buying ,borrrowing or stealing the book. Unlike stocks, I am always happy to recommend books as there is a limited downside to these recommendations

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How I am reacting to the interest rate tightening

By Rohit Chauhan
In General thoughts, Uncategorized
March 30, 2007
3 Min read
3 comments
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I got the following comment from ranjit and gave the response below

Hi Rohit,
Today RBI has increased repo & CRR again. Please can you give me your historical perspective on these high interest rates and also what would you do in such situations, would you move into FD’s for some time or would you stay invested fully.

hi ranjit
my personal experience with interest rates has been from 95 onwards when i saw the rates move to 15% and since then it has been a downwards movement.my stock market positions are not based entirely on interest rates (at least not in the past). if i find a compelling buy, i go ahead with it if the expected returns are good.since 2003 i have moved into floating rate funds and plan to continue . floating rate funds are more tax efficient than FD’s and far more liquid , although absolute returns are less

In addition I plan to do the following

1. continue with a laddered approach to fixed deposit investing. What I mean by laddered approach is that I would be investing in FD’s over the next few months across the most attractive maturities. Currently the 1yr+16 day duration seems to be most attractive to me (the 2yr + 16 days gives 0.25 % more , but is not attractive for the extra duration). In addition, I do not plan to put all my funds into FD’s as one go as I do not have an idea how interest rates will move in the next 6 months. I expect them to stay as is or harden a bit, but frankly your guess is as good as mine. So my fixed income investing will be spaced out over the next few months.

2. Continue with floating rate funds which are more tax efficient than FD’s and far more liquid. The absolute returns are low, but they can serve as a good place to park extra funds

3.The bar for the stock market investing is now higher. I generally use a discount rate of 11-13% . I do not plan to revise it.

4. FD’s and fixed income mutual funds have now started to become a viable alternative to investing in index funds. I am not too keen on the index till the index drops by another 20% or remains flat while earnings catch up.

5. Finally, bad time to take any kind of loans – housing or otherwise.

See here for an earlier post on the same topic

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You can be a stock market genius – Spin offs

By Rohit Chauhan
In Arbitrage, Book review, Uncategorized
March 28, 2007
3 Min read
7 comments
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The first topic in the book is Spin-offs. When a company decides to ‘spin-off’ a subsidiary or business, it may issue shares of the division being spun off to the existing shareholders. This spin-off may be 100% where in the parent company distributes its entire holding of the spun-off division to the exisiting shareholders based on the valuation of the division.

For ex: when reliance was split into the petrochemical, communication and other businesses, the shareholder were given shares in the spun off divisions based on the valuation of each business.

Spin-offs may partial where the parent wants the market to realize the value of the division and so by doing a partial spin off, the newly spun off company is now valued by the market independently. This enables the company to demonstrate the hidden value of its subsidiary and get a better valuation for the whole company.

In addition there are a few additional reason for spin-offs

a. The company wishes to spin-off a poorly performing division and improve the valuation of the parent company
b. In a regulated industry, by spinning off the regulated division, the parent can operate in a non regulated environment c. The company wishes to improve the valuation of the company by making the subsidiary an independent company with its own management and policies. This improves the valuation of the parent and the spun off company as both can now focus on their core businesses.

The reasons why spin-offs create an opportunity for the investor are listed below

a. The spun off division may be very small with a low market cap. As a result large instutional investors may not be interested in holding it due to various constraints. This creates a selling pressure and drives down the price.
b. The spun off division with its independent management can now focus on the business better and hence perform better in the future
c. The market may give a better valuation to the spunoff business depending on the nature of the industry in which it operates

update : 03/29

An additional approach to profit from spin offs is to look for situations where the company plans to conduct a rights issue instead of an outright spin-off of the subsidiary. In such cases the company is planning to ‘sell’ the division to its shareholders via a rights issue and raise some capital at the same time.

This modified and rare type of spinoff approach is profitable for the same reason as the usual spin off. In such cases large institutional investors may not subscribe to the offer due to illiquidity of the new issue. In addition if the spin off via rights is beneficial to the insiders , then it would make a lot of sense to subscribe to this spin off via rights purchased from the market or via direct purchase of the parent company’s stock.

An additional point repeated by the author several times in this section is that an investor should analyse closely the actions and motivations of the insiders during the spin off. Does the spin-off benefit the insiders ? do they have a stake on the upside ? Answers to these questions would help an investor make a good decision

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You can be a stock market genius – Introduction

By Rohit Chauhan
In Arbitrage, Book review, Uncategorized
March 26, 2007
1 Min read
3 comments
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I am currently re-reading the book by ‘Joel Greenblatt’. I will post my thoughts and key points which catch my eye. It is not a book summary or review. Look at it more as running notes on the book (based on memory).

– 8-9 stocks can help one diversify almost 80-90% of the non-market risk. With 20+ stocks the non-market risk reduces by almost 95 % (quoting from memory)
– don’t depend on broker recommendations. They are baised on buy side as they make commision if you buy stocks. Also as there are always more stocks to buy (for an investor) than to sell (one’s holding is limited in comparison to the total universe of available stocks), brokers are more interested in generating buy recommendations. Have seen the same in india. As a result I tend to look at sell recommendations more closely than buy recommendations.
– small cap and midcap is a fertile ground to find undervalued stocks as these stocks are neglected by brokers and also by large investors due to various size, legal and other types of restrictions.

I will keep posting more notes as I continue reading the book

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Indo nippon electricals a Value trap?

By Rohit Chauhan
In Company analysis, Investment ideas, Uncategorized
March 24, 2007
3 Min read
3 comments
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I got the following comment on my previous post on Indo nippon electricals

Hi Rohit,
In the absence of latest annual reports, it is difficult to evaluate this.

What is the catalyst that you have in mind which will unlock the value or force the reevaluation?

Earnings are not growing significantly where they would make the market to take notice. In the absence of takeover attempt, it might be a long time (years!) for market to re-evaluate the price.

Some months ago, I had made a purchase of Kothari products (pan parag fame). Its book value is more than the market cap. Tobacco business is a cash minting machine. That’s all the analysis I did at the time of purchase hoping that somehow market will recognise the Graham bargain.

However, later I noticed that the promoters own more than 80% of outstanding shares. There is no incentive for the current owners to reward shareholders. There is no way for a hostile takeover. Ergo, the value trap stays as is. I have moved on in due course – hopefully, wiser.

Best Regards,Ravi

I decided to post my thoughts on ravi’s comment. I have posted on value traps earlier here

i agree, value trap is always a concern in such situations. i have also invested in kothari products in the past (see post here) with a clear understanding that the underlying business was at best stagnant and the value unlocking would happen if the management did something about the cash. After holding the stock for more than a year (with a small gain), I realised that the management was not interested in any value enhancing measures. On the contrary there was a lot of apathy towards investors. The management had not bothered to update its website with the latest results and there was no way to access their annual report. As a result, I bailed out.

Indo nippon electrical has similar risks. However there are some key differences

1. The underlying business for Indo nippon is healthy and has a small amount of growth
2. The management has been pro-shareholder in the past and has given bonus shares and decent dividends in the past
3. The management has been very rational and efficient user of capital and has kept the return on capital fairly high.
4. They have updated their website with the latest annual and quarterly results

Value unlocking can happen via various actions on part of the management. In case of Indo nippon electricals I expect continued decent performance and passage of time to unlock the value.

However due to the concern of value trap, I have classified this idea as a graham idea. The key approach in such kind of investing is to invest in a group of such stocks (more than 10-15) where the entire group could do well, with some indivdual stocks performing well and some performing poorly. In contrast, focus investing which involves investing heavily in a select few stocks would not work in the above kind of idea. However with valuations being high, I am not able to find too many good ideas in which I can invest heavily.

see here a post on value traps and critical thinking titled ‘Value Delusions and Strategic Thinking’ by rick. he discusses about value traps and how to avoid them towards the end of his post.

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A graham idea

By Rohit Chauhan
In Investment ideas, Uncategorized
March 20, 2007
3 Min read
5 comments
A

I have come across a value stock – India nippon electricals limited. The investment thesis is as follows (my notes)

About (taken from their website)
INEL was incorporated in 1984 and converted into a joint venture in 1986 between Lucas Indian Service Ltd, a wholly-owned subsidiary of Lucas-TVS Ltd and Kokusan Denki Co. Ltd, Japan – a group company of Hitachi Japan, to manufacture Electronic Ignition Systems for two-wheelers, three wheelers and portable engines. Over the years the company has enlarged its customer base and now supplies to most of the manufacturers of two-wheelers, three wheelers and gensets. The Company’s net sales for the year ended March, 2006 was Rs.1678 Million (USD 37 Million). INEL makes the entire range of 2/3 wheelers, digital and analog ignition products.

Commencing its operation in Hosur (Tamil Nadu), over the years INEL has set up two more units one at Pondicherry and the other at Rewari (Haryana) to be nearer to customers and offer service such as just-in-time supplies and to improve response time for introduction of new products.

INEL’s product portfolio covers all custom-built ignition system parts for various applications for two wheelers, three wheelers or portable engines, offering Ignition System solutions to meet the needs of the whole range of OEM’s in the vehicle industry.

Currently, INEL’s range caters to two stroke / 4 stroke engine capacity of 30cc to 175cc. However, depending upon the needs of customers, INEL has acquired knowledge and capability to provide solutions for other applications also.
INEL specialises in offering ignition system solutions by design, development and manufacturing parts such as Flywheel Magneto, Digital / Analog CDI/TCI, Regulator/Rectifiers and Ignition Coils needed for application on various types of engines fitted on motorcycles, scooters, mopeds, 3 wheelers, portable gensets, lawn movers, wood saw cutters and other types of IC engines.

Financials
The company has grown from 122 Crs to around 168 Cr with a CAGR of around 7%. Net profits have grown by 17% in the same period (CAGR of around 3.5 %). Cash flow growth is higher due to low CAPEX needs and the evidence of cash and equivalents on the balance sheet of around 80 Crs. ROE has been consistently above 20%. The poor growth in topline and Net profit has been due to the pricing pressure from OEM and raw material increases in the last few years. Current year profits seems to be in the range of 20 Crs which would give a rough EPS of 25
In addition, the company has very low debt on the books and an investment portfolio of almost 77 Crs.

Positives
The company is a supplier to all the major 2 and 3 wheeler manufacturers in india (see here). In addition the management has been consistent and prudent in allocating capital and kept the Return on capital high, even when the margins were getting squeezed.

Risks
Further slowdown in 2/3 wheeler growth and additional pricing pressure due to metal price could hurt margins further. The company seems to be working on offsetting by developing new types of fuel injection systems and by exploring the export market

Valuation
At an EPS of 25 ( free cash flow being higher than that), the intrinsic value can be conservatively put at 350-400 Rs. This is low end of the valuation. If the company can grow the top line and maintain margins, then the valuation can be increased by 20-25%.

Open issues ( for me to explore – any inputs would be appreciated)
– long term growth prospects for the company
– Raw material pricing outlook for the company?
– Competitive scenario – any new competitors?
– How is the export plan working out?
– Plans for the cash on balance sheet?

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The power of mindset

By Rohit Chauhan
In General thoughts, Uncategorized
March 16, 2007
2 Min read
5 comments
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I came across this article on the blog galatime. It’s titled ‘The effort effect’. The article resonated strongly with me. I think the power of mindset mentioned in the article is extremely crucial if one is to become a good investor.

The growth mindset (see diagram here) mentioned in this article is crucial to become a good if not a great investor. In comparison a fixed mindset (which a lot of us see around us) leads to poor performance in the long run. The key points of the growth mindset in terms of challenges, obstacles, effort, criticism and success of others are extremely relevant for an investor. As an investor one has to learn how to deal with new challenges and obstacles (the market and businesses around us are constantly changing). Effort is crucial in terms of a desire to constantly learn and improve oneself. Self criticism and an honest one is crucial too. One should be able to accept mistakes and learn from them and then move on. Finally I look at the other successful investors and try to learn from them.

The attitude referred to in the article is relevant to us not only as investors, but is important in other walks of life too.

In addition I found another link on the same blog on the mark of greatness. I found a similar article on greatness in fortune some time back (see link). The article in fortune mentions the following
Reinforcing that no-free-lunch finding is vast evidence that even the most accomplished people need around ten years of hard work before becoming world-class, a pattern so well established researchers call it the ten-year rule.

I have read in some other articles that 10 year or 10,000 hours of work is essential to achieve proficiency in a field. All the above research encourages me to keep working hard on becoming a better investor. Even if I don’t become a great or super investor, if I keep working at it, I will defintely be a better investor. My definition of a good investor is one who can beat the market by 5-10% points over a ten year period. I have done that for the last 6 years. I definitely plan to continue working on extending this performance.

update : 03/23

see here for an earlier post on the same topic

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A relook at Indraprastha gas

By Rohit Chauhan
In Company analysis, Investment ideas, Uncategorized
March 13, 2007
3 Min read
Add comment
A

I received an analyst report on Indraprastha gas (see here) from uresh patel yesterday. The report has a sell rating.

Normally once one has made a decision and proclaimed it in public (via a post in my case), it is diffcult to accept information which goes against your conclusion. With that in mind, I have been trying to look at the report as objectively as possible and see if it refutes my assumptions.

On a broad basis the following points are made by the analyst for the sell recommendation

1. IGL has substantial margin risk as it is supplied gas on a subsidised basis. However the subsidized gas is 40% of the total supply. I have taken this scenario into account in my valuation and worked out the DCF calculations with the operating margins dropping from 40% to 32% by 2010 and net margins dropping to 14 %. Gujarat gas which is a similar company has net margins of around 11%, has a much larger commerical customer base and hence taking Gujarat gas a base case, I have assumed IGL will have a slightly better pricing power. So I agree with the analyst on the margin risk and impact on the net margins.

2. The analyst highlight risk to the topline due to competiton. I could not find any specific competitors who are planning to enter the delhi market. I could be wrong on that. In addition, IGL is planning to expand into noida and gurgaon. They are also exploring markets in haryana. These plans are very crucial for the company. If the company were sit tight and do nothing in terms of growth, then the topline will stagnate or even decline in face of competition. I find that hard to believe in case of IGL which has clearly stated aggressive plans in the PNG segment and new markets. In addition they have the cash to do so. So I am not sure why IGL will not have topline growth or choose not to do so. However any growth

3. Margin risks due to diesel pricing – The analyst have analysed the margin risk due to diesel prices falling from here. I have no opinion on this factor as I cannot predict what will happen to petroleum prices. This is a wild card and could hurt margins for some time. As a result I see this as a risk, but cannot evaluate it and predict it. In addition, the analyst case is based on the scenario that oil prices will drop in the future and hence that would reduce the discount and hurt margins. I am sure if anyone can predict that.

4. Regulatory risk – I missed this out completely. On reading the report, i think this could be a key risk going forward. One has to look at the petroleum sector and now cement to get a feel of it.

I think the key difference between my analysis and the one in this report is the difference in the expected topline growth. I have assumed a topline growth of greater than 10% due to the new initiatives. The analyst has assumed less than 10%. As a result my intrinsic value estimates are closer to 150-160. However if the growth comes lesser than 10%, then instrinsic value drops to 100-110. This is without even considering the regulatory risk. Any adverse development on that front could cut down the intrinsic value further

I would be analysing my assumptions further and would take a decision based on that.

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Increasing the circle of competence

By Rohit Chauhan
In Industry analysis, Uncategorized, Warren buffett
March 10, 2007
1 Min read
6 comments
I

The ‘circle of competence’ is a term coined by warren buffett. It roughly means companies, industries or businesses one knows well and can understand in depth to be able to analyse and predict the economics of the business for the next ten odd years.

In order to improve and increase the depth of my circle of competence, I have developed a business analysis worksheet which I have posted here again in the ‘My analysis worksheets’ section of the sidebar.

This worksheet is still work in progress. I would be uploading updated versions of it in the future.

Please feel free to download the worksheet, review and critique it, and send me any feedback on it. Please send me an email on valueinvestorindia@googlegroups.com

I would be uploading individual company analysis in the future too.

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A rejected idea – tube investments

By Rohit Chauhan
In Rejected investment ideas, Uncategorized
March 9, 2007
2 Min read
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A

Tube investments is an idea which passed through my initial filter. I initiated the next step of analysing the company’s annual report. The analysis summary is below

Summary

The company has several businesses such as cycles, precision steel tubes and other tube products, chains, metal forming and financial services.
The company has had good return on capital of 20%+. It has a net margin of 5-6% . Its debt equity ratio has been between 0.4 to 0.6. The company has shown low growth with the topline increasing by 50% in the last 5 years. The net profit has tripled in that period (net of one time gain on investments)
The company has a net investment on the balance sheet of 500 Cr (net of debt). If I knock off the investment value of 28 Rs per share, then the valuation comes to around 5 PE based on the current market price. The stock seems to be a compelling buy.

Reason for rejection

On analysing the consolidated balance sheet, I discovered that the company has an additional debt of 500 Crs on its books due to a JV. The company has converted Cholamandalam investment and finance co. (CIFCL) into a JV with DBS bank. As a result the JV debts is now on the books. The company has however not provided any details further on this event. I think the event is important enough for the company to provide more details and give an assesment on the risks.

The above reason may seem small, but the debt and corresponding risk changes the profile of the company. The D/E ratio is now 1.3:1 and the company has not even provided enough details of the new JV. As a result I have decided to give the company a pass for the time being.


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