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Performance

By Rohit Chauhan
In Uncategorized
August 21, 2009
3 Min read
7 comments
P

There is one key point missing in this blog – My portfolio details and performance. The omission is by design and there are several reasons behind it.

I have written in the past on my reluctance on sharing my portfolio in detail, especially the performance. I have disclosed my portfolio in the past (see here) and it has more or less remain unchanged since then.

There are several reasons for not sharing my performance. The key reason for not sharing the performance, is that a public display would put pressure on me and would in turn impact my investing decisions. Investing is tough enough and I don’t want to make it any more tough for me.

The second reason for not displaying the performance is that I want the readers to follow my posts based on the strength of the ideas I present and not the performance of my portfolio. The soundness of idea – sensible and rational value investing – does not change based on whether I perform well or badly as an investor. There are some investors who are far superior to me in performance and practise a similar approach. The performance of these investors is a reflection of their superior skills.

In addition to the above reason, I can choose to put any numbers as there is no independent audit of these numbers. I do not want to create a situation where the readers are always wondering whether the numbers on the blog are real or imagonary.

As you can see in the sidebar, I also publish my posts on moneyvidya.com. This association is non financial and i was contacted by the moneyvidya team in past to be a member of their core blogger team. I have posted my stock ideas on the website in the past few months and thought of sharing a snapshot of the portfolio performance.


A few caveats before you read too much into it.

– The above stocks do not represent my portfolio. They represent a few of my ideas which I decided to post on the website.
– The above is an equal wieghted portfolio of the picks which is not the case in my personal portfolio.
– The portfolio performance may not be a true reflection of my personal portflio in future as I do not have idea of how to take a stock off this model portfolio when I decide to sell it (maybe the moneyvidya team will clarify that for me)

So why publish this portfolio
A few key points stand out.

This dummy ( pun intended 🙂 ) portfolio has been in the top 10% for the last 10 months ( I don’t know how that is calculated though by the moneyvidya team). This in a way shows the validity of picking good stocks and holding on to them.

This dummy portfolio has beaten the index by around 20% during this period. This period is too short to reach a conclusion, but is interesting as typical value investors generally under perform bull market and out perform bear markets.

Finally, not matter what I try to claim, there is a certain amount of bragging involved too. The reason why the last few months have been more satisfying, is that I have been able to follow my convictions, ignore the doomsday predicitions and commit my personal capital to my ideas. That is more satisfying than the gains themselves. I expect this approach to work in the long term irrespective of short term market fluctuations.

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When to sell ?

By Rohit Chauhan
In Uncategorized
August 18, 2009
5 Min read
11 comments
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I recently received a comment from rajiv which is reproduced below

Rohit,
As a stock moves towards its intrinsic value, there is a temptation to exit a little before the final value is hit, especially if you have waited a long time for Mr. Market to come around.
I feel that as a value investor the sell decision is much tougher than the buy decision, because the buy decision usually comes with a big enough margin of safety. However, during the sale decision the market value may be stuck at Intrinsic Value minus 10%, making the investor quite jittery to sell.

I have been asked this question in a several different ways, but all essentially boil down to the point – when should one sell a stock ?

I agree with the point made by rajiv and several other readers – selling is more diffcult than buying. In addition, there is no clear cut formulae for selling. The process of selling is made even more diffcult by the various emotional and psychological factors involved in selling.

Emotional factors
Most the discussions and articles on investing rarely discuss emotions explicitly. I find that strange as anyone who has ever invested in the market can vouch for the emotional roller coaster. The rational aspect of selling is easy for a long term investor – sell when price crosses intrinsic value (or 10% below or above – take your pick of the number)

I have written on the above question earlier – see here. The is the rational way of deciding on when to sell.

Now this suggestion may have sounded irritating to some of you and rightly so. The reason this advice, though rational, does not sound great is due to the emotions involved in selling.

There are two situations in which one is selling – one has made great gains in the stock and wants to capture some of the gains. Selling at this point is driven by the fear of losing the gain, which is counterbalanced by the desire to hold on to a stock which has treated you well and also by the doubt that there may be more upside to it.

The other situation in which one sells a stock is when one has lost money on the stock and wants to get rid of that piece of !!@##. In this situation the decision is driven by disgust.

These emotions are quite powerful and not easy to manage

Ok, dude then what?
All these emotions are nothing new, right ? Even if you have felt these emotions earlier, it does not mean that you are managing them well.

A few of the readers and my friends have mentioned to me that I seem rational and cool headed. I wish !!. I am no different, atleast in most aspects. In case of investing, I have tried to manage my emotions as much as I can (manage and not master).

I maintain a spreadsheet of all my holding with the qty, intrinsic value estimate, current price and discount to the current price. At any point of time, when I am looking at my holding, I am looking at the instrinsic value and the discount to it. I ‘anchor’ myself to the instrinsic value. As a result if the stock is selling below the intrinsic value, I will continue to hold.

As the intrinsic value of the stock gets updated every quarter, I am not tied to a fixed value. If the business performs well, the intrinsic value goes up and so does the sell target. If the company performs badly, then the reverse happens.

So is this buy and hold ?
Buy and hold is most abused and misunderstood term (more on that in another post). My approach is not buy and hold, tops and bottom or any other term or title. The logic is simple – buy when something sells for less than intrinsic value, hold till it is below intrinsic value and sell when it is above it. Now if the intrinsic value grows faster than the price, I will continue to hold.

Where’s the catch ?
The catch is in getting the fundamentals and intrinsic value estimate wrong. If you get that wrong and refuse to change your opinion, then you are toast.

But you lose money when the market drops !!
Yes, that does happen. If the market drops, my portfolio will drop with the market. I have yet to figure out how to keep jumping in and out of stocks and still keep my sanity. There is so much chatter and noise in the market, that it is easy to go nuts. My way of keeping my sanity intact, has been to adopt the above approach.

Is this the best way ? no I will not claim that. However as I have a day job, I would rather lose a percentage points, than lose my job and maybe my sanity. Finally, I have yet to find another approach which relies on a sensible and consistent logic and not on the opinion of others.

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Johnson & Johnson – part II

By Rohit Chauhan
In Investment ideas, Uncategorized
August 11, 2009
4 Min read
17 comments
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Part II of the analysis

Competitive analysis
The main competitors for the company are the other big pharma companies and the generic firms such as Ranbaxy, Sun etc. We can apply Michael porter’s five factor model to evaluate the company
Barrier to entry – All the segments of the company enjoy substantial entry barriers. The pharma and medical devices have formidable barriers in the form of patents and sales and marketing network. In addition any new drug or device requires substantial R&D expenses and infrastructure. The consumer segment has barriers in the form of Brands and distribution network
Supplier power – Moderate to low in this industry. Suppliers are mainly providers of basic chemicals or contract manufacturers. The value is derived from the IPR of the drug and not from the manufacturing.
Buyer power – Low in consumer goods. However in case of Pharma and the devices segments, national programs such as Medicare have a strong leverage and with escalating cost will attempt to drive down prices.
Substitute product – none
Rivalry – There is intense rivalry in the industry from other pharma majors who are attempting to develop a similar drug and especially from the generics where the price and profits drop by as much as 90% over the course of a few years as soon as the drug comes off a patent. In addition, the generic companies are constantly trying to challenge the patents too.

Management quality checklist
– Management compensation: The company has almost 215 Million outstanding options which would result in 2% dilution. The options do not appear to be excessive.
– Capital allocation record: Fairly good. The management has maintained an ROE in excess of 25%, low debt and a dividend payout of almost 40%. In addition, the management has been engaged in acquiring other pharma companies to pull gaps in its drug pipeline and added to it too.
– Shareholder communication: The shareholder disclosure is good with clear explanation of the benefits assumptions and IP R&D (in process R&D) calculations from the acquisitions.
– Accounting practice: The overall accounting seems to be conservative. However there are some areas of concern. For example – the company has assumed long term returns on plan assets of 9%. I think that is aggressive and could result in additional charges over the years. The IP R&D (in process R&D) charges do not appear to be excessive.

Valuation
The company has approximately 12 Bn of cash flow and is selling at around 13 times earnings. The company has shown a profit growth of almost 15% per annum with high degree of consistency. At the same time the company has maintained a high level of ROE during this period too. One cannot assume such a high level of profit growth in the future as some part of this has come from the increase in net margins. However with a conservative assumption of 6-7% growth, discount rate of 8% and CAP period of 10 yrs, intrinsic value can be estimated to be between 80-85 (PE of around 20).

The current valuation assumes a growth of 0 or worse and gives no value to the competitive advantage of the company. The company is currently selling at a 5 year low and appears to undervalued by comparative and absolute standards.

Conclusion
The company has performed well in the past in terms of fundamental performance. The sales and profits have grown at a double digit rate. In addition the company has a healthy drug pipeline at various stages of approval which could help in replacing the blockbuster drugs going off patent. The medical devices and consumer division provide stability to the earnings and help in reducing the risks of the pharma division.
The management has been a rational allocator of capital which is visible via the high dividend payout, above average ROE and sensible acquisitions. The company appears 20-30% undervalued compared to the intrinsic value which in turn can be expected to grow at 7-10% in the future.

A new addition: I have created a pdf version of the analysis. Please feel free to download and share with others

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Investment idea – Johnson & Johnson (JNJ)

By Rohit Chauhan
In Investment ideas, Uncategorized
August 7, 2009
5 Min read
8 comments
I

About
Johnson and Johnson (JNJ) is a US based pharma and healthcare company. The company has three primary business segments – consumer products, pharmaceuticals and medical devices.

The company had a revenue of 63 billion USD in 2008. The Consumer segment includes a broad range of products used in the baby care, skin care, oral care, wound care and women’s health care fields, as well as nutritional and over-the-counter pharmaceutical products. The Pharmaceutical segment includes products in the following therapeutic areas: anti-infective, antipsychotic, cardiovascular, contraceptive, dermatology, gastrointestinal,hematology, immunology, neurology, oncology etc . The Medical Devices and Diagnostics segment includes a broad range of products such as Cordis’ circulatory disease management products; DePuy’s orthopaedic products; Ethicon’s surgical care products ; Ortho-Clinical Diagnostics’ professional diagnostic products and Vistakon’s disposable contact lenses.

The company operates globaly in a predominantly decentralised structure with over 118000 employees.

Financials
The consumer segment had a global sale of 16 Billion in 2008 with a 10.8% growth. The company also acquired the consumer healthcare business of pfizer in 2007. The consumer segment had an operating profit of 16.7%, an increase of 1% over 2007.

The pharma segment had a sale of 24.6 billion in 2008, a decrease of around 1.2% over 2007. This business saw an increase in operating profit from 26.3% to 31% mainly due to writedowns in 2007.

The medical devices segment had sales of 23.1 billion with an increase of 6.4% over 2007. The operating profit increased from 22.3% to 31.2% in 2008 partly due to some litigation settlements in 2008 and some restructuring charges in 2007.

The company has maintained a high level of R&D investment (around 10% of sales or higher) during this period. This efficiency of this investment is evident from the drug pipeline of the company which consists of around 18 drugs filed or approved and almost 25 in the stage III trails.

On an aggregate basis, the company has has a very steady performance in the last 10 years and more. The ROE has ranged between 26-30% during this period. This improvement has been driven by an improvement in net margins from around 15% to 20%. The various asset ratios such as working capital turns has improved from low teens to around 30. The fixed asset turns has improved during this period too.

The company has maintained a healthy cash flow during this period and has had a dividend payout of almost 40% during this period. The balance cash has been used to pay off the small amounts of debt, invest in assets and make targeted accquisitions.The company is a zero (net basis) debt company and has a cash flow rate in excess of 10 billion per annum.

Positives
JNJ has several key positives as a business and over other pharma companies
– The company derieves around 30-32% of its revenue and around 40-45% of operating profits from the pharma business segment. Although the company faces the risk of its top performing drugs going off patent, the company has a healthy pipeline to manage this risk
– The company has a medical devices division which does not face the generic or patent risk of the pharma division and is fairly profitable.
– The company has a consumer products division with strong brands and an extensive distribution network which act as a hedge to the other segments.
– The company has a deep moat in all its business segments and sustaniable competitive advantage.
– The company has a decentralised operating structure with 250 operating companies across 57 countries across the the globe.
– The company has strong balance sheet and consistent cash flows. The net profit and cash flow has grown at around 16% per annum for the last 10 years. In addition the company has improved its ROE and other asset rations

Risks
The company faces the following key risks
– Several key pharma brands (in excess of 1 bn sales) such as risperdal and Topamax have lost patent protection in the recent and will face drop in sales and profits due to generics. Success of new drugs is not a given and only a few drugs in the pipeline may replace these blockbusters. In addition, there may be short to medium term dip before the new drugs replace the loss in sales.
– The global slowdown is likely to impact the topline and bottom line growth for the next 2-3 years
– The US market accounts for almost 14 bn in sales for the pharma division and 10Bn in sales for the medical devices division. Although I have not been able to find the numbers. the profitability of these divisions in the US is fairly high. This may be at risk due to the health care reforms in the US.
– The recession in the developed markets which account for major part of the sales and profit could keep the topline and bottom line subdued for the next few years.
– The company faces litigation risks related to product marketing, pricing, product side effects and patent issues. These risks are detailed over 3 pages of the annual report and are not easily quantifiable. The company has accrued liabilities against these risk and has stated that these risks in aggregate will not have a material effect on the financials.

next post : competitive analysis, management quality, valuation and conclusion

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