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Searching for investment candidates – IV

By Rohit Chauhan
In Investment ideas, Uncategorized
June 26, 2007
2 Min read
3 comments
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A few more investment ideas which have passed through the initial filters.

Alembic – A mid cap pharma company. Revenues have gone up from 550 Crs to around 750-800 Crs for the current year. Net profits in the same period has gone up from 30 odd crs to 80-82 Crs. The margins have doubled in the same period, however the ROE continues to around 20% due deterioration in inventory and fixed asset turns. The valuation at around 7-8 times PE looks interesting. Definitely worth further investigation.

Infomedia – The company is valued at around 20 times normalized earnings. The bottomline has been more or less stagnant. The reason for looking at the stock was it has appeared in rakesh jhunjhunwala’s portfolio recently. However I cannot see the value in it (and also I am not as smart as the big man to be able to see the value, so need to study the company more)

Gruh finance – A subsidiary of HDFC and selling at almost 6-7 times the latest quarter earnings. Seems to be a well managed company and worth a closer look. Diffcult to conclude from looking at the numbers alone in case of an HFC. However the company is defintely worth a closer look.

update : 06/26
Had a look at gruh finance again. It is selling at around 20 times annual earnings and 3 times book value. At this price the stock may not be over-valued, but does not look like a bargain too. A good company to track and wait for the valuations to come down a bit

Manugraph and VST – I will be posting detailed analysis for these companies in later posts.

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Margin of safety and banks

By Rohit Chauhan
In Industry analysis, Investment ideas, Uncategorized
June 21, 2007
5 Min read
5 comments
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I recieved an email from Rohit shah. I am posting the email and my reply to his question below

Hi Rohit,

When you have some time, I request you to elaborate on ‘Margin of Safety’ principle as propounded by Ben Graham and strongly followed by Warren Buffett. What constitues margin of safety and how does one gauge it?

To give an example, I am trying to apply Margin of Safety principle on my Yes Bank investment in the below way.

My average cost of 115 Vs. CMP 150+. Last 200 Days avg. is 144.

40 Branches now
Target
100 by Mar 08
250 by Mar 2010.
(I am applying a 20% discount here as they don’t have good track record on Branch Expansion)

Currently the valuations are running ahead of performance, as Adj. PBV is around same as HDFC, ICICI & UTI Bank though the Branch expansion, higher retail portfolio and higher CASA % will help to improve NIM which is around 2.5/2.7% per last q results.

In 2010 Banking will start getting de-regulated. Yes Bank is positioned as an attractive takeover target due to (1) A greenfield bank with a knowledge driven banking approach (2) Zero levels of Net NPA.

Is this a right way? Are there any other criterias? Need your help with generic thoughts on this, per your convenience.

(I know Buffett perhaps wan’t invest in Banking businesses as Capital requirement of 12/13 % means just 1/8 of advances turning bad can have v significant impact. I however like the business model being perpetual in nature + due to my work experience, I have partial eligibility for ‘Circle of Competence’ principle)

Cheers
Rohit (Shah)

Hi rohit

Good to hear from a fellow value investor. The concept of margin of safety is actually very simple, but takes a lifetime of learning to apply effectively.

The concept is that one should buy a security at a discount to its conservatively calculated instrinsic value

The key words in the definition are ‘conservatively calculated instrinsic value’. There are multiple ways of calculating intrinsic value with DCF being a key one. Other ways would be to use relative valuation techniques or any other valuation approach which suits you.

The other key word is ‘conservatively’. In the end any price can be justified via a DCF if one makes aggressive assumptions in terms of growth and duration of the growth. So a prudent approach is to analyse the company which is in your ‘circle of competence’, be realistic about the growth and duration of growth assumption and use a probabilistic approach (please see the valuation spreadsheets which I have loaded on my website)

Banks unfortunately do not fall easily in the DCF approach (I have expressed my thoughts on banks on my blog earlier here and here and here).

Frankly I have not analysed ‘Yes’ bank till date. It is a new bank and should definitely grow. However the business risks are higher and I would not value it similar to HDFC bank which has a much longer operating history. At the same time I do not have a background in the banking industry and do not know how good the ‘Yes’ bank management is. However if you personally have an insight into the management quality, then it may be worth the bet.

Frankly my own analysis of banks is that by the very nature of the business, management quality is far more important in case of banks than any other business and as you pointed out, a management error can easily wipe out the bank . Also with a high leverage, even a few errors can be fatal especially for a new bank. So in the case of ‘Yes’ bank I would assume that the margin of safety will reside in the quality of the management and their ability to achieve the stated growth plans (profitably). I would personally not look at the option of the bank being a takeover candidate in the future. That may turn out to be icing on the cake, but I would not use it as a key valuation factor.

Additional thoughts

1. I look for additional margin of safety in case of banks. The biggest unknown for me is the quality of loans by a bank. NPA’s represent only a partial picture and usually a goes up with a lag if the loan quality is bad. Banks like ICICI bank and others have agressively expanded their retail loan portfolio in the past few years. Are they provisioning adequately? I am not sure but I think the bad debt risk in the retail segment is being under reserved by most banks

2. Management quality make a lot of difference in case of banks. I think by the basic nature of the business, competivitive advantages are weak and high returns are made by those banks which have good management. Bad or over aggressive management can sink a bank very quickly

update : 21st see this article on rising bad loans in retail

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What a waste !!

By Rohit Chauhan
In Notable value investors, Uncategorized
June 17, 2007
2 Min read
6 comments
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Rakesh jhunjhunwala is an eminent investor. He is one of the indian investors I follow closely. Recently I found the following interview

I typically read all his interview very closely. He is both an exceptional trader and investor. One of his key approaches to investing is to understand the business model of a company, identify the underlying trend and buy meaninful portions of the company (invest heavily). His investments in praj industries and Titan have been based on this approach.

There several other facets to his investing. He is also an exceptional trader. If you have followed rakesh closely and have of an idea of this brilliant investor, the interview above strikes as completely stupid. The interviewer keeps asking the man about where the market is headed, whether the market will go up or down. Now even an investor like warren buffett has stated that it is a foolish endavour to predict the market in the short term and in the interview rakesh seems to saying something on similar lines. He seems to have an opionion on which he trades, but even he cannot predict. His approach seems to be to trade opportunistically. At the same time he has a deep knowledge of various businesses, their business models and invests based on that knowledge.

Instead of trying to help the reader/ viewer to get behind rakesh’s thinking, the entire interview is about predicting the market. What a waste !!

In addition to rakesh jhunjhunwala, I follow these indian ‘super-investors’ closely

a. Chandrakant sampath
b. Rakesh damani (I may not have got his name right)
c. Chetan parekh (his website capitalideasonline.com is a must read)
d. Prof. Sanjay bakshi

I make it a point to read their interviews and listen to their views closely. I may not blindly follow them, but there is a lot to learn from these brilliant investors.

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Searching for investment candidates – III

By Rohit Chauhan
In Investment ideas, Uncategorized
June 15, 2007
3 Min read
2 comments
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In continutation of my previous posts (see here and here), I am posting a very rough analysis of a few more rejected and ‘in-process’ ideas. Again a disclaimer – I am not promoting or justifying any of these stocks. These stock may be injurious to your networth if you are looking for quick profits (if they come, no credit for me on that). With that out of the way, a few more ideas follow

No Go bucket

Motherson sumi systems – The company is priced at a PE of 25. Unlikely that the stock is undervalued. Just had a quick look at the financials and have no reason to believe that the stock could be undervalued.

Electrosteel – The company is into DI pipes and has a PE of around 7-8. The performance has been cyclical. The net profit reached a peak of 97 Crs in 2002-2003 and this performance was repeated only last year with a net profit of 108 Crs. The company raised capital via a GDR issue and has backward integrated into sponge iron. The economics of the business are ok and the performance has been a bit cyclical. The stock may be a bit undervalued, but I am not sure if the discount is more than 20-30% and hence I am not too excited by the stock. The company seems to be fine and the stock a bit undervalued, but I think there are better opportunities in the market.

Go bucket

Savita chemicals – A midcap chemicals company. Topline has grown from 250 crs to almost 700 odd crores. Netprofit in the same period has climbed from 11 crs to around 38 Crs. The company has a low debt on the balance sheet. The margins have held steady at 5% and the ROE is 20%+. The company may make a profit of 40-42 crs this year. At a market cap of around 350Crs the company seems to have a reasonable valuation of 7-8.

MRO-TEK – A small cap company into computer hardware. The topline has grown from 90 Crs to around 150 Crs and the net profit from 7 to around 17.5 Crs. This year could be lower at around 9-10 Crs. Net of cash the company seems to have a valuation of around 7-8. The margins have flucutated between 4-10% and the ROE has also fluctuated between 7-25 %. Cannot make up my mind on this stock. Will need to analyse further. However overall the stock does not look too exciting.

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The Gut feel test of investing

By Rohit Chauhan
In Investing Philosophy, Uncategorized
June 12, 2007
3 Min read
7 comments
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The gut feel test may sound totally illogical and irrational, but I have used it several times. I have posted my investment approach earlier here. As I wrote, I run various filters and do a 1-2 hour check on the basic financials of the company. That is followed by reading the Management discussion and analysis.

If the numbers do not look ok, I tend to give the idea a pass. There are no set rules for the numbers to look ok. Let me list a few cases

1. In case of aftek the acqusition of promoter held companies was a red flag for me. Clear case of conflict of interest
2. In case of Dr reddy’s and other pharma companies the valuation of the company seems to be high and I do not have the skills to evaluate the success or failure of ANDA filings
3. In case of JSW holding, more than 60-70% of the value is due to JSW steel. I do not have a specific insight into the steel business. As I could not evaluate whether JSW steel is fairly valued or undervalued, I decided to give JSW holdings a pass.
4. In 2004-2005, I felt bharat forge was fairly valued and could not project with confidence if the performance would continue. Hence gave the company a pass. Clearly a mistake, but a rational and acceptable one.
5. Indraprastha gas limited – Gas is available at a subsidy. Future margins may drop and hence the current price seems to be reflecting that. So no undervaluation although the stock appears to be so by past measures.

A lot of times, I have analysed the company and towards the end a few points keep nagging me. If I cannot evaluate those critical issues with confidence, I tend to give the stock a pass. The risk of this approach is that I tend to miss out on several good opportunities. I however do not agonize over it if the reason was related to my circle of competence, wherein I do not have the necessary knowledge to evaluate the company well.

In a few cases however, the level of undervaluation may be so great that I have a large margin of safety. In such as cases even if I have a few issues with the company, the downside risk is low and the risk reward equation seems to be fine. In such cases I may buy the stock and hold it till the undervaluation dissapears.

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A few general points

By Rohit Chauhan
In General thoughts, Uncategorized
June 9, 2007
2 Min read
4 comments
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I have recieved Prof Bakshi’s interview via email. However i have yet to write to him and get his approval to forward the interview. In the meantime i have recieved a huge number of requests for forwarding the interview. I will try to email to all who have requested it (if prof bakshi is fine with it) , but please bear with me as the number of requests is huge.

I also recieve personal emails several times. I have attempted to answer them but i am not able to do justice to all of them due to personal time constraints. Hope those of you who do not hear me, will understand that i am time constrained and hence may not be able to reply some times. Leaving a comment would be a good idea in such a case. Some other reader on the blog may be able to respond to your query equally well.

Finally if you wish to subscribe to the blog via email , please enter your email id above the blog archives. You will recieve an email update whenever i post a new post.

Please feel free to leave a comment on how to improve the blog further and make it more useful.

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Searching for investment candidates – II

By Rohit Chauhan
In Investment ideas, Uncategorized
June 8, 2007
2 Min read
1 comment
S

I have posted earlier a list of investment candidates which had passed through my investment filters. After doing a quick 20-30 min analysis, I slotted these ideas into the ‘Go’ bucket which are good for further analysis and into the ‘No-go’ bucket which are the rejected ideas.

A few more ideas in each bucket follows –

No Go bucket

Pricol – An auto ancillary midcap company. Topline has grown by 50% in the last 5 years and net profit has doubled in the same time. ROE is firmly above 20% and the valuation seems to be cheap at a PE of around 7-8. However the company has a high debt of almost 230 crores (DE ratio is more than 1 ) and the cash flow is poor too. Debtors have gone up by 400% and inventory has doubled too. The quality of earnings seem to be poor. I would this company a pass for the time being.

Navneet publications – A publishing company. The topline and bottomline has been stagnant for quite some time. The balance sheet does not look too good with inventories up 4 fold in the same period. The ROE and other numbers such as margins and debt equity ratio seem to be fine. However the free cash flows seem to be poor and the performance is erratic. Although the company seems to have some competitive advantage, the performance in the past has not been very good. Would give this company a pass.

Go bucket

Sarla polyester – A small cap company into textile processing. The turnover has grown from 30 Crs to 88 Crs in 2006. The netprofit has gone up to almost 11 Crs and this year could be almost 13-14 Crs. The company has a very low debt of 8-9 crs on books and a high ROE of 20%+. The valuations are fairly low at a PE of 6-7. Definitely worth a closer look

Investment and precision casting – A small cap casting and forging company. The net revenue has tripled in the last 5 years and the net profit has also tripled in the same period. Net margins have held steady at 15% and the ROE is 20%+. The company has a low debt partly offset by cash balance. The current year profit seems to be flat at 8 Crs and the valuation seem reasonable at 10 times current year earnings. Worth a closer look.

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Searching for investment candidates – I

By Rohit Chauhan
In Investment ideas, Rejected investment ideas, Uncategorized
June 4, 2007
3 Min read
1 comment
S

Recently I shortlisted a few stocks which passed through the basic filters and did a quick 15-20 min analysis to sort them into two buckets – the ‘go bucket’ and ‘No go bucket’. The ‘no go bucket’ are the rejected stocks on which I will not be spending any more time for further analysis. I may have rejected some stocks which may turn out to be good ideas later, but I prefer the sin of ommision than commision. The ‘Go bucket’ has stocks which have to go through more detailed analysis before I commit money to them.

No Go bucket

Torrent pharma – A profitable pharma company into bulk drugs and formulations. Growing well and has a clean balancesheet. Have not looked into detail, but the valuation seems to be around 15-16 times latest earnings. Have scanned the financials very briefly and cannot find anything wrong. However it is in the No go bucket as the valuations are not too cheap. May come back later after I run out of ideas.

Diamines and chemicals – This is a very small company with turnover of 20-25 Crs and Net profit in the current year of 6-7 Crs. It sells for a market cap of 35 Crs and so it seems to be very cheap at a PE of around 6. The company had a negative networth till 2003 and seems to have turn around since then. Has a high Debt equity ratio of almost 0.7. Although looks cheap, I am not comfortable due to the small size of the company and inconsistent operating history. No further analysis on this company.


Go bucket

Poly medicure – A health care company into health care disposables. Currently growing in double digits with this years topline likely to be around 80-85 Crs and net profit to be between 7-8 Crs. The ROE is 20% plus range and the entire company is selling at around 75 Crs, with a PE of around 8. Had a brief look at their website and was unimpressed. No annual report or financial available on the company website. Worth further investigation for the time being

Ultramarine and pigments – A small company into dyes and pigments with an annual turnover of around 60-70 Crs which has been stagnant for the last 4-5 years. Net profits have zoomed from 4 Cr to almost 18 Crs (expected) for the current year. Capital invested in the business has come down in the meantime with investments on the balance sheet of around 25 Crs (FY 2005) and low debt of around 5 Crs. Capital requirements in the business seem to be low and hence the business seems to have good free cash flow and a return on invested capital of almost 50%. Definitely worth a closer look.

next post : i would be listing more ideas in both the buckets

ps : Please see my disclaimer. I would not want anyone to lose money based on my analysis

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A must read interview by prof bakshi

By Rohit Chauhan
In Notable value investors, Uncategorized
June 1, 2007
2 Min read
31 comments
A

I admire prof. Bakshi, have read all his articles and read his blog regularly. He is a great teacher and it would have been great if I had been his student. I found this interview on capital ideas online. Unfortunately only part of the interview is available and the rest is available only to subscribers.

I would recommend reading the interview. On reading the section under cash bargains, I was almost nodding my head in agreement. I have posted a few cash bargains like novartis, cheviot company and merck earlier. I plan to re-read security analysis by benjamin graham and further expand the scope of my search for investment ideas.

In addition, my own thinking has started expanding to include graham type situations more. The reason is that buffett type companies are diffcult to find and require a lot of indepth understanding of the business to make a meaningful investment. Looking back at my stock screens, I realise that I left a lot of bargains on the table because they were mediocore businesses. These businesses were selling below intrinsic value and although the intrinsic value did not expand, a convergence of the current price with intrinsic value yielded good results.

A move to expand into graham type stocks has increased the number of my investment ideas. However this type of investing means a higher portfolio turnover and a constant search for cheap stocks as one may not be able to buy a great company at a decent price and enjoy the benefits of an increase in the instrinsic value.

This does not mean that I am not looking for the buffett type good companies. It is just that I am trying to let go of my mental blocks to other types of companies and other types of investing. Who knows I may overcome my aversion to trading too 🙂

A request – If any one reading this post has access to the full interview, I would request you to email me the link or the interview itself (id : rohitc99@indiatimes.com)

update : 4th june : i have recieved the complete interview by email. thanks to sajeesh mathew for that. It is a great interview and i learnt a lot from it. I will have to confirm with sajeesh and prof bakshi if it fine to email the interview to others. I would definitely not be posting it

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