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ICICI bank news - some comments
2008-03-06 05:01:00
Deepak has posted on the current news around ICICI. See - ICICI's Disclosure See-Saws: Openly Making Fools Of UsFollowing is my comment . You can read the discussion and all the comments on his blogDeepak - Although it would be good to have more disclosure, it may be risky for a bank to do so also.In addition the changes in the loss estimates seem to be consistent with what is happening in the market. For derivatives, accounting requires that the losses of mark to market are passed through the P&L even if the contracts are held to maturity (see this year's berkshire hathaway AR for some discussion on this)So as the markets are deteriorating, the mark to market losses could increase and the bank will have to recognize them. This is also consistent with the banks claims that these are held to maturity and may not have losses (similar to a goverment bond portfolio where you may have mark to losses, but if you hold the bonds to maturity there may be no losses).I am not saying that...
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Allahabad bank – The risk materializes
2008-03-03 20:32:00
update : 03/04blog.rcfunds.com (referred to in the comment on this post) is also my website. I eventually plan to migrate this blog to that website. however my new website is still beta. I need to improve the look and feel of that website. As a result i have not publicized it, thinking no one will notice it. I guess i was wrong. Anyway, i will be posting my posts on both locations at the same time.I had written on Allahabad bank earlier. I mentioned the following as a key riskThe biggest risk for the bank is political interference. As the majority shareholder is our government, you can never be sure what hairbrained scheme they will come up with. In the past there have been loan melas, loan writeoff etc. This has reduced in the last few years, but you never know.Well, the risk has materialized. The FM has announced a loan waiver for small farmers to the tune of 60000 Crs. Forget about the fact that this money may never reach the farmers, a part of this money could come from PSU bank...
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GSK consumer products
2008-02-29 03:38:00
AboutGSK consumer is a 1300 Cr consumer goods company with well known brands such as Horlicks, Boost, Maltova, Crocin etc. The company is a part of the Glaxo smithkline group which specialises in pharma productsFinancialsThe company has done well for the last 5 years after a dip in performance in 2001-2002. The company topline dropped by 12% in 2002 and the bottomline by 33%. The company has since then recovered the topline growth to around 10% per annum and Net profit growth to around 12-15% CAGR.The RONW/ROCE have improved to 20%+ levels due to improvement in margins and Asset turns. The company has no debt and an approximate cash of 300 Crs.PositivesThe company has strong brands, well established distribution network and a high market share in its category (around 70%). In addition the company has cash of 300 Crs on its balance sheet.The management has been a rational allocator of capital. They have maintained a dividend payout of almost 35%. In addition the management executed...
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Reverse engineering the L&T stock price
2008-02-25 04:41:00
I got the following comment from abhishekHi Rohit,Using the same concept, dont u think L&T is a very expensive stock trading at PE of above 70.To sustain this PE, how much growth it must show in the future?Does this PE look sustainable?If no, could u please help us understand this calculation by using L&T as an example?Following is a very brief unpacking or analysis of the expectations embedded in the stock price. Is the stock undervalued?…that is your callCaution: I have done a quick analysis and hence there are a lot of assumptions (such as net profit = Free cash flow) and shortcuts. i have not done a detailed analysis as the company does not pass my initial selection criteriaThe stock sells at a PE of around 30 (assuming consolidated profits of around 3000 crs for the year. LY was 2250 Crs).The ROE is around 30%+ and Debt equity is around 1:1 based on 2007 Balance sheet.You can plug the following numbers in the spreadsheet – quantitative calculation – ROC and PE to ...
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Correction to the post : valuation – reverse engineering the stock price
2008-02-20 23:28:00
There was an error in the analysis of crisil in the post . I had looked at the standalone numbers only and not the consolidated numbers (as an anonymous reader has pointed out in the comments)So crisil may not be a good example of over valuation. I am not sure how undervalued the company is. It sells at a PE of 33 (approximate Net profit of 100 odd crs for 2007). I have analysed the company earlier here …and I have underestimated the competitive advantage of this company and its ability to keep increasing its instrinsic value.That said, if I were make my point in the post again, I would replace crisil with any of the Real estate companies or capital goods company which have a high performance hurdle to cross (due to their high PE) to deliver good returns to investors in the future.The post was however was not an analysis of CRISL. The key point is this – A good company may not be a good stock and vice versa (important word is ‘may’) . That depends on whether the stock price ...
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Some Interesting ideas
2008-02-15 00:07:00
I am analysing some of the following stocks in detail as these stock have passed my initial filtersConcorBalmer LawrieGSK Smithline consumerDisclosure – I have owned Concor and Balmer lawrie for the last few years and currently re-analysing the stocks. So my analysis could be biased. I would be posting the analysis soon.In addition Mid-caps and some value stocks have now become even cheaper. Some companies now sell for almost or slightly less than cash on the balance sheet. I am now finding quite a few ideas to work on and hoping that the cheap would get cheaper.In addition I am reading the following books and have found them to be good. I would definitely recommend reading both the booksMore than you know by Michael J. MauboussinMargin of safety by seth Klarman
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Using puts to reduce cost basis
2008-02-11 01:13:00
A thought experiment -Lets assume you find a stock which is undervalued and it is liquid (otherwise you may not get options on it). You buy the stock and would continue to buy if the price were to drop further (the critical point). In addition you sell puts for strike price say, 20% below the current price.If the price does not drop, you keep the premium and reduce your cost basis. If the price drops by more than 20%, the put gets exercised and you buy the stock (which you any way planned to do so).The key objections to this strategy could be· Does not work with illiquid, lesser known stocks which are more likely to be undervalued· if the price drops more than the strike price, say 30% then I am losing out on the additional 10% cost of the stock . In worst case scenario if I have mis-analysed the stock I could be in a lot of trouble as I may end up incurring huge losses in that scenario.· Someone has to be ready to buy these puts (puts should be saleable)Â...
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Futures, Options and hedging
2008-02-06 23:57:00
If your first thought is – Options and value investing …what a combination? You are not alone. You will rarely find discussions on options and derivatives in books and articles on value investing. But then just because most value investors don’t talk about options, does not mean one should not even try to understand them.That said, let me clarify – I am not an expert, heck not even a novice on options. I have read a few books on options and derivatives, bought a few here and there. However I am planning to read up more on options and understand them better – it would improve my understanding of probability.Most of the discussions I have seen on options is around the strike price. A lot of investors look at options as leveraged bets on the stock price. It goes like this – Lets assume I am bullish on L&T (who isn’t :) !).The current price is around 2500 (for argument sake). I expect it to rise by 20% in the next 6 months. So instead of investing 250000 and making 20%...
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Seesaw markets,my plans, a good book and market crisis
2008-02-01 18:23:00
The month of jan was a complete rollcoaster. Initially the market shotup, then crashed and now seems to go one step forward and one step backward.One could have made a killing shorting the market or by buying puts. I however did none of that. I personally need to do more homework in that area to venture into it. However I do see puts as a decent option to hedge the portfolio. The part I still need to work out is this -Most options expire worthless. The reason is that the options market is fairly efficient, definitely more than straight equity. So is it possible to buy puts over the long term, make money a few times only and still have a decent return after all the costs ?Some of my own holdings, some of which I have discussed (and some not), have declined below 50% of intrinsic value. Earlier I would get mixed feeling – pained by the decline and excited by the opportunity to buy more. Now I get more excited than pained. I however try to re-analyse the position and check if I have ...
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Valuation - some more thoughts
2008-01-29 00:30:00
I covered my approach to estimating the appropriate PE for a stock and reverse engineering the current valuations in the previous posts. This is ofcourse not the approach taken by analysts. The typical approach is to look at the past history and decide on the likely earnings (and not even free cash flow). If the analyst is optimisitic he slaps on a high PE and voila ..we have the price target. To support the argument, the analyst does a comparison with other companies in the sector and tries to justify the PE. So we may have an optimisitic earnings estimate and on top of that a high PE attached to it, which would amount to double counting.That is an incomplete approach. If the sector is in a bull run or has very high valuation then you are committing the same mistake twice. First assuming an optimistic estimate of earnings and then applying a high PE. Don’t believe me ? …well several IT companies sold for a PE of 100 in 2000 and real estate and capital goods companies sell for s...
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Valuation - reverse engineering the stock price
2008-01-23 17:31:00
I discussed my approach on evaluating PE ratios (see here). In addition based on the table shown in the previous post, we can work out the assumptions built into the stock price in terms of the ROC, CAP and growth rates. These variables can be compared with the actual and expected results of the company to decide if the stock is undervalued or not. Sounds easy in concept, and it is if you understand the company and the industry well. This approach is also called as expectations investing and I learnt about it in the book -.expectationsinvesting. I would recommend reading this book to understand DCF and the previous post better.The above approach is a very useful tool in analysing a company. Let me give two examples.Example A – CRISIL . This company sells for a PE of almost 60+. The embedded expectations areROC – 25% (current value)Profit growth ( Net profit = Free cash flow) – 18% p.a for last 6 yearsCAP – 20 yearsBasically the company needs to grow at 18% per annum for the ...
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Valuation - How to evaluate the PE ratio
2008-01-17 23:13:00
I had done a quick valuation exercise of MRO-TEK earlier (see here). I used a certain PE ratio in the post and said that I would explain my approach later. So here it goes …To understand my approach, you have to look at the file Quantitative calculation and worksheets – cap analysis and ROC and PE. You download this file from the google groups The worksheet ‘ROC and PE’ has DCF (discounted cash flow model) scenarios for various businesses such as Low growth, high ROC (return on capital ). For ex: Like Merck or high growth and high ROC like infosys etc.As you can see in excel screenshot, I have put a growth of around 10% in Free cash flow, ROC of 40% and calculated the Intrinsic value (or Net present value). The ratio of the NPV/current earnings gives a rough value of PE for the above assumptionsNow I have used various assumptions of growth, ROC etc and created the matrix below (CAP analysis worksheet in the same file) The above is for a matrix of ROC (return of capital = 15%...
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The black swan – unpredictability, futility of forecasting etc
2008-01-11 03:57:00
I have just finished this book. I wrote about this book earlier here. I have also read N N Taleb’s earlier book – fooled by randomness and liked it a lot.I will not be doing a detailed review of the book as that can be found on amazon and a lot of other website. I will however highlight some of the points, which struck me as important and how they impact me as an investor.One of the key points, which the author makes, is about the complexity of the real world and lack of predictability. For ex: No one predicted the rise and the importance of the internet. The Internet has become one of the major forces shaping our world. It can be termed as a positive black swan. As a result all complex systems such as the economy, financial markets, which get impacted by such black swans, cannot be predicted. But that does not stop analysts and all the talking heads on TV from making predictions (predictions for 2008 etc etc)Now one can argue that some prediction do come through. Well, you donâ...
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HPCL – a quick review
2008-01-06 05:24:00
I had written about HPCL earlier (see here). To recap, my main thesis was as follows.HPCL now sells at around 9000 crores. The EV is around 10000-11000 crores at best. The replacement value of the assets is around 25000-30000 crs. The company is selling at 25-30% of replacement value, which can reduce due to the following reasons1. The company is currently engaged in diversifying its revenue streams via various initiatives and reduce the impact of the pig headed policies of the government. These initiatives are lube marketing, Gas distribution and retail initiatives and oil trading and risk management. The market is currently not valuing any of these real options.2. The GRM and net refining margins are at their lowest. Going forward the worst case sceanrio is that they would remain at the same level. If that is the case, the bottom line should still improve as the various company intiatives take effect (see page 53 of Annual report)3. The 9 MMT refinery and expansion of Vizag refin...
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Reading the Book – The Black swan
2008-01-02 03:03:00
I am currently reading the book – The Black swan by N N Taleb. This is a great book on low probability, high impact events which are termed as black swans.I am still in the middle of this book. One key point which I came across is ‘confirmation bias’ on which the author has devoted a complete chapter.The basic idea behind confirmation bias is that once we make a decision, we tend to look for evidence to confirm it. As a result we tend to ignore any negative information which could refute our decision. As a corollary to this concept, any additional information is of no use as it would only re-inforce the decision and not add any more value to the decision making process.Like others, I am equally susceptible to this bias. My approach to reduce its impact is to write a single page thesis on an investment idea and sometimes post it on my blog. I try to gather negative information and also prefer to get negative feedback on my idea. That helps me in wieghing all negative informatio...
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Wish you all a happy new year
2007-12-31 17:29:00
Wish you all a very happy and prosperous new year. Thank you all for visiting and reading this blog.
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And I am out !
2007-12-28 18:58:00
For sake of disclosure, let me say that I have started exiting my position in MRO-TEK. The stock is almost at 95 and has shown an 80% rise in the last one month. It is now above my calculation of intrinsic value for the stock.I can see the thrill of momentum investing – instant gratification. In spite of the thrill, I am not planning on changing my approach which I understand well, and have become comfortable with, over the years. In general I have seen my picks rise and approach intrinsic value in 1-2 years. That allows me to analyse the company in detail and build a decent position. Sometime I have been able to even average down on the stock as the price went lower and I developed a better understanding of the company.A case like MRO-TEK is not really suited to my style of investing. Too soon, too fast. If the stock moves up very fast, I lose interest if it crosses my buy levels as I cannot complete the analysis and would hate to create a big position without understanding the c...

From Value to momentum – MRO TEK
2007-12-24 23:14:00
I generally select and buy stocks where the general enthusiam for them is very low. None of my picks shoot up after I have bought them and so when a few did in the last few months, it was a new experience for me.One such pick was MRO-TEK. I started looking at the Company a few weeks back when the stock was at around 52 per share. My analysis was as followsAboutThe company is primarily into end-to-end solutions and hardware/products-provider in data communications, data access and networking fields, offering a wide range of sophisticated LAN/WAN products.The company has a JV with RAD corporation and a few other technical collaborations. The company had a split of 30-70 of manufacturing v/s trading a few years back. In the recent years, the split has reversed to around 70-30 in terms of revenuePerformanceThe company has had very erratic performance. The projections which the company made at the time of the IPO in 2000, were never met (by a huge margin). Since then the performance has ...
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It was difficult NOT to do well
2007-12-17 05:57:00
2007 has been one of those years where it was difficult NOT to make money in the stock market. At the risk of offending, let me say even a monkey would have made money. Don’t get me wrong, if you have done well this year, it does not make you a monkey :) (by that measure I am a monkey too, not that I am complaining).The monkey term is more to randomly picking stocks than to a monkey IQ. This was one of those years where almost all types of stocks did well. If you avoided some of the sectors such as IT, everything else was in a bull market. From Aug to Oct the large caps did well and since then the Mid caps have caught fire. I have seen some of the stocks almost double in the last 1-2 months. When I wrote earlier, on midcaps in may there were a decent number of opportunities available. However the valuation gaps have started closing since then and the number of opportunities have come down (although there are still a few around).So whats in store for the next year? As if I know !! ...

Ashok leyland - Private market value
2007-12-13 01:16:00
I had written on Ashok leyland earlier.My valuation was as followsThe company sells at a PE of 12. The current EPS is around 3.3 per share. The company can be expected to grow at 10-12% over the next few years. In addition the company has some competitive advantage such as a known brand name (especially in the south), long operating history and experience in the market, rational management and a decent distrubution/ service network.The company can be valued at around 16-18 times PE and given an intrinsic value of around 60 Rs/ share.I recently got this email from VishnuI have been going through Eicher JV deal with VOLVO. It would be great if you can share your opinions.Story:Eicher is stepping down its Commercial Vehicle and Component business into a JV with VOLVO which is paying 275 million USD in CASH and 75 million USD in terms of VOLVO's truck distribution business in the JV.Valuations:Cash(VOLVO) is paying 1045 VOLVO India Truck dist...
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Maintenance capex calculation
2007-12-10 03:21:00
I discussed about maintenance capex and its relation with Free cash flow. To recapFree cash flow = Net earnings + depreciation – maintenance capexAnd free cash flow is the money the owner of business can take out or re-invest in the business.Maintenance capex however does not have a precise formulae. That does not mean you cannot calculate it. But as you can see, if valuation is based on free cash flow which itself is based on an imprecise measure such as maintenance capex, it cannot be precise in itself.Valuation depends on free cash flow, project growth rates , terminal value and the discount rates. All these are estimates and hence valuation is itself an estimate. That is the reason I find it assuming when analysts give reports where they give precise valuation targets and on top of that even the duration (next one year !!) when the target would be met.So, coming back to maintenance capex, how do I estimate it? let me warn you at the outset. My approach is self developed, impre...

maintenance capex and FCF
2007-12-03 21:53:00
I received the following question from sanjay shetty via email. I will try to answer the question and have also simplified it via several assumptionsYou mentioned you "use maintenance capex needed to support unit volumes or competitive position (maintenance capex)." I downloaded your Excel sheets couldn't figure out the basis for calculation of the same, especially as companies don't give break ups of maintenance capex. If you could explain would be great. Maybe my understanding is incorrect, however I feel that all Purchase of Fixed assets should be deducted from Free Cash Flow especially when the amount out there is a yearly spend by the company to grow it's business.Let me start with the following definition for free cash flow (paraphrased) as given by warren buffetFree cash flow = Net earnings + depreciation – maintenance capexNow you can take the above formulae as a given or debate whether it is correct. I think it is correct as free cash flow is basically discretionary ca...
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Grindwell norton and Free cash flow
2007-11-29 23:31:00
I received the following email from sanjay shetty and decided to post it as he has asked a very important question on valuation. I have done some work on it on my own and have put the results in the worksheet – Quantitative calculations.xlsYou can download is from here or use the download link in the side bar. Please see the tabs – Maintenance capex and FCF anal.My responses are in italics. There is a follow up question from sanjay on maintenance capex. I will post on it in detail shortly with an example. If you have looked at my valuation templates, you may have noticed that I use FCF based on maintenance capex for valuation purposesHi Rohit,I've been viewing your blog, after your comment on my blog (http://indiainvestor.wordpress.com).I had a few questions for you.What methodology are you using to value companies in India?DCF, comparitive or relative valuation, sum of parts etc. I try to value a company based on multiple approaches and also depending on the nature of the comp...
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Some interesting ideas
2007-11-28 02:36:00
I have been looking at the following two companies for the past few weeks. I have yet to make up my mind on them. I generally prefer to buy at 50% of conservatively calculated intrinsic value of the company. Both the companies trade at a discount to instrinsic value, but above the 50% mark.The companies areGrindwell nortonSRFMy personal notes on each companyGrindwell nortonGrindwell norton is in the business of abrasives and refractories. The industry is dominated by two player – Carborundum and grindwell norton. Grindwell has been doing fairly well for the past few years. It has an average ROC of 15%+ for the past few years. It has been able to maintain a NPM of 10%+. The average sales growth has been over 15% on an average and the NP growth in excess of 20%. The asset ratios have improved, especially the Wcap ratio and the profit margins have improved from 7-8% to 10-11%. The company enjoys reasonable competitive advantage due to R&D support by parent, strong sales force, de...
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Real estate valuation - Random thoughts
2007-11-23 02:55:00
I have been reading the book ‘Seeking wisdom – From darwin to munger’ which talks of various mental models and applying them to a problem to analyse it in detail.The book is itself inspired by charlie munger and his lecture on the same topic. I have attempted to apply some models to valuing and analysing real estate.The first post was valuing the real estate as a financial asset like stocks and bondsThe second post was trying to invert the problem.The third post was looking at psychological baises in valuation of real estate. I will follow up with more posts on the same topic with other models.I would like to add a personal approach for a first time buyer (buying for personal use)If you are buying a house to stay (not investment), the maximum value of the investment would be driven by two numbers – EMI and personal debt to equity.Let me explainSuppose I earn 40000 as net income. My current networth ( all stocks, bonds, cash etc) is 10 lacs (10 lacs = 1 million). To be on the...
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Real estate valuation - Psychological biases
2007-11-20 19:32:00
I think there are several psychological baises working in case of real estate. The first is incentive caused bais. Typically real estate is sold via brokers or by sales agents of the builder. They have an incentive to sell the property and typically earn a commision based on sale price. It is quite obvious that the broker or sales agent would be motivated to sell at as high price as possible. In addition it is likely that he will give you a bullish outlook for the property prices.The second strong bias is social- proof and deprival super reaction tendency. You see you friend buy a property and make easy money. At the same if you have not invested money and feel deprival super reaction tendency as everyone one else is making easy money.So these two tendencies work together and motivate us to look for a property. Combine this with the incentive caused bias where the broker is constantly trying to create a scarcity (he will tell you that he has a lot of buyers and even you don’t buy ...
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Real estate valuation - Inverting the problem
2007-11-18 23:36:00
As Charlie munger says, it is useful to invert a problem and think through. So let me try that and please bear with me on the mental acrobatics.In the last post, I developed the basic logic that real estate valuation depends on the rentals. Lets say you are looking at a property valued at say 50 lacs (5 million) . Now the reason to invest in this property is that you expect to make more than fixed income. Lets say you expect 15% p.a.So the property should be worth 1 Cr (10 million) in the next five years. Such a property to sell at 10 Million, should atleast yield a rent of 40000 Rs/ month (assuming a P/R of 20). For some one to pay a rent of 40000/month, that individual should be earning atleast 170000 rs / month pre-tax.How did I come up with number? assume a 30% tax rate and that a person would not prefer to spend more than 30% of his net income on rent in the long run. So we are talking of a person making 20-22 lacs per annum.I agree salaries in india are rising and will continu...
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Real estate valuation - I
2007-11-13 20:50:00
If like me you believe the basic definition that the intrinsic worth of an asset is the sum total of all the cash flows one would receive out of an asset from now onwards, then real estate could be analysed using the same approach as stocks or bonds.Using that logic, we can say that there are two components to the cash flow1. Rent which is equivalent of dividends2. Final sale price of the asset (real estate) which is the same as the sale price one would get from a stock or bondLike stocks, it is easy to get the value of rent (or dividend), but difficult to get the final selling price. In case of real estate the final selling price would depend on the state of real estate market, interest rate, economic activity of that area and location of the real estate. This is similar to stocks where the final selling price depends on a large number of factors, most of which cannot be predicted.Using the same analogy, if it is possible to value a stock roughly, if not with precision...
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Financial institutions and risk
2007-11-08 00:47:00
update: 09-Nov - A great post on the valuation of financial firms and the diffculty of doing so ...see hereI have written on banking earlier. You can find my analysis of allahabad bank here. Most of you must be aware of the subprime crisis. I discussed it briefly here.Banks and financial instutions by their very nature are highly leveraged organizations. So the risk of bankruptcy and losses is higher with banks. Citibank is one of the largest bank in the world and has seen its stock drop by 35% this year. The CEO has just resigned. You can read all about the crisis here.So what does citibank and the subprime crisis have to do with banking in india. Well a lot … Let me digress and tell you a short story.The year is 1996 or maybe 1997. I was starting to invest and saw an article on IFCI (I guess you must have already got the hint or must be thinking ….what a Bozo !). Well, the article said that IFCI is a good opportunity as it was near its 52 week low and had a dividend yield of a...
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A deep value stock
2007-11-06 18:56:00
Prof bakshi had posted a quiz to his students. You can find the answer to his question in the comments section. I have posted on the same company earlier.In addition you may find my response in the comments section too. There are several other answers from others in the comments section such as VST, wyeth, divyashakti granite etc. Some of the ideas sound pretty interesting and I would be looking at them closely.My suggestion – if you are interested in value investing, read prof bakshi’s posts ,articles and interviews. There is a lot you can learn from him.As an aside - i am reading a book : seeking wisdom - from darwin to munger. This book has been recommended by charlie munger himself. I dont remember the exact comment, but it seems he liked the book so much he bought a copy of this book for all his friends and relatives. He also said that if there are more books like this, he could bankrupt gifting them. I am not sure of the authenticity of the comment. But after reading 60 od...
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