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

3 points about NHPC IPO- should you apply ?

NHPC is coming out with an IPO of 15% of its share capital (167 crores) at a price band of Rs 30 to 36. One third of issue proceeds will go to the government (about 2000 core) and rest to the company (4000 core). ICRA has rated the issue as “average”, 3 marks out of 5.

You either have to play this for listing gains or for a long term horizon(at least 4 yrs).While the issue looks expensive but may have some listing gains for a couple of days due to trading interest– market conditions permitting. This issue is more expensive than recently concluded Adani power(coal based power generation)

#1 Company’s Business
NHPC has 13 hydroelectric power stations operational (making power from water) with total installed capacity of 5,175MW. The company is engaged in the construction of 11 projects with installed capacity of 4,622 megawatts. Thus if all goes well the company will have about 10,000 MW capacity by 2012. Seven projects have been identified to receive the benefits from this IPO.

While during the project planning itself the company gets into contracts with its customers these contracts are called Power purchase agreements (“PPA”).In the current year the company sold power at price of Rs 2.03 per unit and the company & its subsidiary generated about 17,000 MU in total..Being a PSU, i dont think they
can raise prices easily.


#2 Valuation
Market Cap basis
1. Market cap = 40,225 crore (upper band) to 33,546 (lower band)
Mcap/ mw (2009) = 7.77 to 6.48.
Mcap/ mw (2012) = 4.0 to 3.35 – if all goes as planned.
2. PE based on 2009 EPS = 36.7 to 30.61

I dont have enough info to do a "Sum of parts" valuation.However if the company is able to generate 17,000 mu from 5175 mw @ Rs 2. We can do guesstimation on the sales once 10,000 mw is achieved.

Peer group valuation
The only other major player in exactly the same space is JP Hydro which is trading at about 30 PE but they seem to operating a project of 300 MW.NTPC is at about 22 to 23 and Tata power about 30 PE( as on 01-aug-09). All these players have mcap/mw of about 3 or less. Having said that,the operating margins may be slightly better for NHPC and it is insulated from fluctuation in coal prices.

#3 Risks
1. The gestation period in hydro power projects is much longer since there is need to acquire land , get clearances and then construct the plant etc. Thus its may be more risky compared to coal based plants.

2. Unavailability of water and lack of rainfall may impact the output.

So whats the simple idea? - Should you apply ?
If you are risk averse investor avoid the issue at this price.Although the barrier to entry are high,the business is capital intensive and company may need to dilute equity periodically. If you want to play the trading bounce and have guts - go for it, but do exit once you get the bounce.

3 Points to understand ETF

#1 Why you should care about ETF’s
Investors expect mutual fund mangers to outperform the markets since they are paying them for it.However in the recent crash most MF did worse than the index and when the markets picked up steam most MF managers were holding huge amount of cash.

So you may ask- is paying money to loose money a smart thing to do?
Let’s look at an alternative Mr. ETF. ETF allows us to diversify into a basket of multiple stocks and yet trade just like a single stock. ETFs trade at prices that closely match their underlying assets, so for example a Gold ETF like “GoldBees” is based on domestic gold prices similarly another one based on prices of basket of index stocks - "NiftyBees" or bank stocks etc.

#2 How does ETF compare with an diversified mutual fund ?

Mutual funds are not listed on the exchanges. When you purchase shares in an open-ended mutual fund, new shares are created . However ETF are traded between investors, you can do everything with an ETF unit which you can with a stock. example- market order,stop-loss and write put or call options.

Mutual funds are actively managed- frequent buying and selling by fund manger whereas ETF’s are passive investment. If the index changes then the ETF fund manager sells the security which has been moved out of the index and buys the one which has been included. Which basically means you will be paying less taxes and fees for ETF,
Although you will pay a brokerage commission and STT (for securities ETF) to buy or sell them.

Its better to buy stock ETF when markets are trading at lower PE something like 12 to 14.5 is good.If you are planning to do a SIP (systematic investment plan) then a good mutual fund may turnout to be a better than investing in an ETF. Basically the point is buying ETF as an SIP does not appeal to me.

ETF are easier to trade and can be bought at current NAV where as mutual funds are always bought at previous days closing NAV.

Need to maintain a DEMAT account to buy ETF, don’t need one for mutual fund.

#3 What about Gold ETF ?

Gold ETF are a good idea, its a way to own gold in electronic form traded on the exchange. You don’t have to worry about storing, purity and chase multiple jewelers to find the best price to buy / sell.
Gold ETF are based on corresponding movement between gold prices. Tax wise also it makes sense - STT is not charged for since GOLD is not “securities”. Long-term capital gains tax is applicable after 12 months from the date of purchase where as its three years in the case of physical gold. Also, unlike physical gold, investments in Gold ETFs are exempt from wealth tax.

So whats the simple idea?-So should I buy an ETF?
Multiple options are available in the market so do your research before making a firm decision.

If you cant beat Mr. Market.. join him

I am not sure, how many market pundits predicted that markets will rise 60% in such a short time.In Jan 2008, when markets hit 21k, we heard predictions like 30k or 40k but we all know what happened.

My point is that its very very hard to predict the market. A lot of self styled "experts" try to make predictions, even if they do get it right its impossible to be consistently right. I would not like to give my hard earned money to these guys.It has also been proven over the years, that even the best fund managers under perform the index over long term.

Given the above problem, how can we benefit from this -why not choose a strategy whict at least guarantees you returns which mirrors markets returns.

Index funds and ETF allow you to do just that.Refer this link for differences. Will discuss more about ETF in next post.

Analysis Godrej Industries

I have been analysing and buying godrej industries.You can download the number analysis here.The company is a kind of holding company for multiple business that godrej operates. The businesses include from agro retailing to soaps, hair dyes to food and beverage,home insecticides to industrial surfactants.

The rationale for investing is the furure market for Affordable Housing.This business is going to have great economics in downturn -construction costs have come down, steel, cement prices are down, plan costs and mortgage rates are down and people have disposable income.Government is also planning for some policy action - this will act as tailwind. Management seems to have woken up and is doing a buy back worth 100 crore.


Good Businesses
Godrej Properties (GPL) GIL holds 80.3 % in GPL.
The most attractive piece of this conglomerate is Godrej properties. GPL has been focusing on its developing residential townships and commercial in tier 1&2 cities like Mumbai, Pune,Kolkata , Hyderabad ,Chandigarh,Chennai and Kochi. In any development, it does not allow land price to exceed 30 per cent of the selling price of the developed property (the average is only about 10 per cent). This protects the company from fluctuations in land prices.

Management is increasing capital allocation and focus to GPL and hopes to be one of the prime player in this fast growing space. Godrej Properties' land reserves currently stands at 78.87 million square feet as of May 15, 2008, it has completed a total of 19 projects consisting 13 residential and six commercial projects, aggregating to approximately 3.62 million square feet of area.

A company called Godrej & Boyce also owns about 3000 acres of prime land in Mumbai, they will lease the land to GIL and GPL will develop it. This land bank can be conservatively valued at 40,000 to 50,000 crore (@ Rs 3500 per sq feet). GPL will have rights to develop this land ,this will give steady revenues and margin of safety to GIL stock since it owns more that 80% of GPL.

GPL is also going to come with an IPO, considering the land under development the issue expected to value the company at about 3000 to 4000 crore.

Godrej agrovet
GIL holds 75.2 % in Agrovet
Agrovet is into Animal Feed,Integrated Poultry and Retail business. These are high ROCE business with a huge potential. Current turnover is about 1500 crore.Agrovet also has 100 acres in bangalore which can be roughtly valued at 100 to 150 crore.

Godrej hershey
GIL holds 43% in Godrej hershey
This business too will have great market as india is becoming a younger country and confectionery is at a nascent stage.Godrej has a jv with hershey to manufacture and distribute confectionery, snacks and beverages across India.Company acquired a 100% stake in Nutrine Confectionery Company Private Limited, the largest player in the Indian confectionery market. The acquisition gives an ownership of the Nutrine brand. Current turnover is about 400 crore.

Godrej Saralee
GIL holds 20% in Godrej Saralee
Is into home insectiside, hair care and aerosols business - "Good Night", "HIT" , "Brylcreem" and "Ambipur" are leading brands.Current turnover is about 800 crore and its high ROCE business.

Godrej Consumer
GIL holds 21.6% in Godrej Consumer.FMCG business has brands like "Cinthol","Fairglow" and "Ezee".Soaps depends on veg oils and competes with HUL they seems to be screwing up.


Bad businesses and Negatives
The oil and chemical business is not good it eats up capital and is basically a commodity business. The structure of the company is complex and leads to unallocation expenses which impact value.It becomes difficult to value the company because the change in stake across so previous results are not easily comparable. Such multiple business companies always trade at a discount to fair value

Analysis - Federal Bank

I did an analysis on federal bank of India after FY09 results . You can download from here, @Rs 230 to 240 i found it to be trading at least about 30 to 35% below being reasonably valued.

Positives
A private sector bank trading at a discount to BV,PE =8,Div=40%.CRAR-tier 1 is healthy at 17.42 % and provision coverage is one of the best.Good NIM @ 4.28 and steady NII.Low Gross and Net NPA at 2.63% and 0.3% respectively.Bank is growing its business in gulf - source of deposits for kerala.Has over 600 branches and growing, it helps to have a good network.


Negatives
The bank did a 1:1 rights issue about 16 to 18 months back @ rs 240. RONW in short term may not grow very fast due to this excess equity.RONW is expected to be in range of 13 to 14% for next year or so.Tax as a % of profit is increasing.

Other private banks like ICICI and HDFC are trading at PE's in range of 20'es and two times p/b. I am more comfortable with Fedral banks valuation it does not seem to be a sexy stock.I own the stock.

Lessons from Graham

As an investor we have do focus on few things and do them correctly. Learning from experts like Ben Graham and Warren buffet is one of the "must do"- here are a few points from Ben Graham which i try to remind myself every morning

Investment is most intelligent when its most business like

1. Know your business -Know what you are doing, know the value of securities.

2.Do not let anyone else run your business - decide what has to be done with your money.

3. Do not enter a business unless reliable calculation shows that you will make money.Base your decision on arithmetic not optimism.

4. Have courage on your knowledge and intelligence.Act on your judgement.Courage becomes supreme virtue once judgement is at hand.

5. The secret of being being financially independent is inside yourself.
If you become a critical thinker and let not the noise of the market drive your opinion you can take advantage of even the worst bear markets. Make your own discipline and let not mood swings of people drive your financial future

6. You are neither right or wrong because people agree with you.
To be a investor you should be a believer in better tomorrow - stocks are not about the past