How to be a better Investor part I

When you learn do drive a car there are some thing you have to know – like steering wheel, brake, clutch and how to use them. Why should investing be any different?

Having a firm grip on fundamentals will help you when in doubt. Let’s look at the following, one post at a time.

• Time value and Compound interest
• Asset allocation
• Industry dynamics
• Reading Financial Statements
• Valuation and Market capitalization

Time value of money
In an inflationary environment -Money is hand today is better than tommorow.Inflation as you know reduces the purchasing power of money. It’s happening all the time just that we tend to forget it and don’t adjust our returns for inflation. Some people buy gold as hedge against inflation, China is buying base metals.anyways.

There are lot of concepts and formulas to calculate the future and present value of money but I will spare you the punishment!


Compound Interest
Understanding compound interest is at the basis of understanding investing.
Let me ask you this - If I gave you the choice to buy Manhattan Island,NY for $24 would you do it ?
And a guy called Peter Minuit actually did just that. Sounds like a great deal! but the catch is that the year was 1626. Now suppose he had put this $24 bucks it in a saving account giving 8% compound interest - it would be worth $ 151 trillion today. That’s compound interest for you.

A company estimated to compounding its earnings by 21% over 10 yrs is better than a company doing the same@ 20% for 10 yrs. Simple huh!. Point to remember is -Effect of compounding is small for a small number of periods, but increases as the number of period increases.

Estimates cuts both ways though – at times the rate of growth can be fast so that the risks one take takes while buying the stock may not be risks at all if the growth forecasts are approximately correct. On the other hand if the rates are precisely wrong one can loose a lot of money – very quickly too.

As an investor you must look at what a company has done in the past because as in life, stocks need to be understood backwards but lived forward. You can use a scientific calculator or FVIV tables to make these compound interest calculations simple. One easy way is the rule of 70 or 72 (which ever is divisible)

Rule of 72
I use this approach to eliminate lot of investment candidates, you can use it too!

This is not accurate but handy tool to guesstimate – about how soon the money will be doubled. Let’s say Infosys declared an EPS of Rs 100 this year and expects to earn 200 in year 2018 - At what rate is it compounding?

The answer is 72 divided by 9(no of yrs to double) = 8% so if this is true I may be better of investing in savings accounts giving me 8% annually since its risk free. However the opposite is true if the company is able to do it in say 4 yrs (18%). Seems farley obvious but this is often forgotten by investors and institutions alike especially when they try to chase the latest fad.

I will discuss about asset allocation in the next post – although volumes of books have been written on each of these topics but you can better off from the completion by this knowledge, if you are still awake that is! 

What do you think, would love to know your thoughts.

Oil India - Should you apply ?

Oil India is coming out with an IPO to raise up to Rs 2,777 offering 2.4 crore equity shares. The price band is Rs 950-1,050.- should you apply ?

Business
The company is into E&P space and business model is similar to its bigger peer ONGC.
Company has primary assets in eastern India (assam, arunachal) and is more focused on being a onshore player rather than offshore. It has also selectively diversified across the oil and gas value chain by taking minority stakes in downstream businesses like refining, marketing and distribution. The oil gas mix is 60:40 compared to 90:10 for ONGC.

Financial and Valuation
Mcap = 20,333 crore to 22,470 crore
Mcap to sales =2.80 to 3.10
PE(based on FY09 EPS) = 9.13 to 10.07
PE (based on half yearly nos FY10) = 6.87 to 7.5
Cash on books = 6,100 crore
EV/2P = 3.6 to 4.1

Peer Comparison
OIL would trade at 3.6 to 4.1 x EV/2p which is at a discount to ONGC which is trading at 5.2x EV/2p. ONGC trades at 16 PE whereas OIL is at 10,the gap seems to be larger than justified.

Risks
1.E&P is the most risky business in the oil value chain however oil does not have a substitute till date and near future.
2. The price of crude is an unknown factor – if the price drops below $60 per barrel the business becomes nonviable (as told by ONGC chairman).
3. The subsidy policy of GOI is not yet clear and documented.Thus upside is capped until this policy continues.
4. Company is focused in one area – geographic risk.

Should you apply ?
Yes, I am convinced.The valuations are not cheap but not expensive either. Go for it at upper band, you may get modest listing gains but definitely it’s a business to be in for long term investors. We do not have many companies in this space and overtime GOI subsidy policy may be changed since oil bonds are not working out.The company is debt free and likely to have steady growth based on its reserves.

Six common mistakes

Photo:Nikhil Khade

Two golden rule of investing as told by Warren Buffet –
1. Don’t make mistakes
2. Don’t forget rule no1.

Let’s see some of the common mistakes -

1.Ask the wrong guy: More than half the people who give you advice on CNBC or similar channels are technical analyst. He is a guy who cares nothing about the stock but its price.Would you go to a doctor who gives the same medicine regardless of your ailment?

2.Regret - I wish I bought when Sensex was 7000 it’s moved up so I can’t buy now. Sensex is a small sample of few stocks.why would you not buy something which will have much more value than what the stock price is reflecting?

3.Lack of Patience – My stock are “stuck in a range”, let me buy something that “moves”. Would you be more comfortable about owning a asset which dances to the tunes of the market by the minute, does liquidity guarantee returns?

4.Book profits and don’t book losses: Oh I am great, my stock moved up,let me sell and “book profits”. Money is the same, it may be better to book losses elsewhere, if things are not going as planned. Once it’s clear that you are fighting a loosing battle would you keep rolling downhill?

5.Flavor of the season: DLF and Unitech must be great companies, they talk about them all the time, let me buy. Always be logical, don’t do something because of any other reason besides your conviction. Lots of folks get their head shaven in Thirupati, would you do just because they did it?

6.Blame the world: Everybody is ganging against me; “they” are the reason for my losses. If you don’t take responsibility for your actions, stocks are not a great place for you.

Always remember – we have a market because people disagree.

Update on Godrej Industries

I have written earlier about Godrej Industries,it has delivered 100% returns. As expected, recent development is that the company is planning to come out with an IPO for Godrej Properties (GPL).Preliminary news indicate that GPL will be valued at 6000 crore. The current valuation of Godrej Industries is about 4700 crore, which holds over 80% of GPL and multiple other businesses.
Whats the Idea ?
If you see Godrej Industries trade anywhere around Rs 120 to 130 mark, it’s a great buy, even on current levels (at Rs 145) it’s a good buy if you want to factor in the growth of GPL in couple of years.

Should you keep ridin'g the IT bus ?

photo:Nikhil Khade

Should you cash out ?
IT offshore companies have delivered about 50 to 80 % returns last couple of months. Particularly frontline IT stocks like TCS,Infosys have delivered good numbers and stocks have run up in a jiffy. The obvious question is -should you continue to ride or get off the IT bus?

Bullish case – IT is a play on global recovery as the markets are stabilizing the worst is behind us. As the economy improves more work will be offshored by companies looking to reduce cost. IT companies are zero or low debt and make for a good long term investment.

Bearish case – The recovery will be long and companies may not be able to deliver better results going forward. Customers will be demanding price reductions and volume pickup will be slow due to protracted global recovery. The stocks are already pricing in 20 to 30% growth so valuation look stretched.

So what’s the simple idea for you to make money?
The revenue growth delivered is in the range of 10 to 12% and profit growth is around 17 to 19%. Companies have delivered better majorly on basis of reducing expenses which if reduced beyond a threshold may have a negative impact.Althow i dont see that happening but the point is cost cannot be reduced beyond a limit.

At 20 to 22 times current year earnings the risk reward is in favor of bearish case, you may already be in final leg of the IT rally. The stocks may not sell off a lot but major part of stock price rise is over and done for 2009 I guess.Its prudent to look for better bargains rather than waiting for the stock to reach a particular price point.


You can use this rally to get out of these expensive frontline stocks into midcap trading at a discount. However the catch there is you need to be choosy here.( earnings are more volatile for these stocks). I would prefer to move into some financial or consumer oriented stocks at reasonable valuations.

What are your thoughts ? I would love to hear from you? !! lemme know