Saturday, April 26, 2014


Warren Buffett is truly a great teacher. He has simplified investing for everyone. Alas, we never learn. We read, get energised and then straight away shoot for something without thinking. Courtesy an internet forward, here is the essence of his approach

A checklist for the stock selector; the Warren Buffett criteria:

Is the business simple and understandable?

"An investor needs to do very few things right as long as he or she avoids big mistakes." Above-average returns are often produced by doing ordinary things exceptionally well.

Does the business have a consistent operating history?

Buffett's experience has been that the best returns are achieved by companies that have been producing the same product or service for several years.

Does the business have favourable long-term prospects?

Buffett sees the economic world as being divided into franchises and commodity businesses. He defines a franchise as a company providing a product or service that is

(1) needed or desired,

(2) has no close substitute, and

(3) is not regulated. Look for the franchise business.

Is the management rational with its capital?

A company that provides average or below-average investment returns but generates cash in excess of its needs has three options:

(1) It can ignore the problem and continue to reinvest at below average rates,

(2) it can buy growth, or

(3) it can return the money to shareholders. It is here that management will behave rationally or irrationally. In Buffett's mind, the only reasonable and responsible course is to return that money to shareholders by raising the dividend, or buying back shares.

Is management candid with the shareholders?

Buffett says, "What needs to be reported is data - whether GAAP, non-GAAP, or extra-GAAP - that helps the financially literate readers answer three key questions:

(1) Approximately how much is this company worth?

(2) What is the likelihood that it can meet its future obligations? and

(3) How good a job are its managers doing, given the hand they have been dealt?"

"The CEO who misleads others in public may eventually mislead himself in private." Does management resist the institutional imperative?

According to Buffett, the institutional imperative exists when "

(1) an institution resists any change in its current direction;

(2) just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds;

(3) any business craving of the leader, however foolish, will quickly be supported by detailed rate-of-return and strategic studies prepared by his troops; and

(4) the behaviour of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated."

Is the focus on Return On Equity?

"The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the consistent gains in earnings per share."

What is the rate of "owner earnings"?

Buffett prefers to modify the cash flow ratio to what he calls "owner earnings" - a company's net income plus depreciation, depletion and amortization, less the amount of capital expenditures and any additional working capital that might be needed. Owner earnings are not precise and calculating future capital expenditures requires rough estimates.

Is there a high profit margin?

In Buffett's experience, managers of high-cost operations continually add to overhead, whereas managers of low-cost operations are always finding ways to cut expenses. Berkshire Hathaway is a low-cost operation with after-tax overhead corporate expense of less than 1 percent of operating earnings, compared to other companies with similar earnings but 10 percent corporate expenses.

Has the company created at least one dollar of market value, for every dollar retained?

Buffett explains, "Within this gigantic (stock market) auction arena, it is our job to select a business with economic characteristics allowing each dollar of retained earnings to be translated into at least a dollar of market value." What is the value of the business?

Price is established by the stock market. Buffett tells us the value of a business is determined by the net cash flows expected to occur over the life of the business, discounted at an appropriate interest rate, and he uses the rate of the long-term U.S. government bond.

Can it be purchased at a significant discount to its value?

Having put a value on the business, Buffett then builds in a margin of safety and buys at prices far below their indicated value.

Monday, April 14, 2014

Downsizing our Capital Markets- A solution

SEBI is apparently going to set up a mechanism to ‘risk’ profile listed companies and financial intermediaries. ( Today, I see SEBI behaving like the anointed godfather of a child (the investing community). The only difference is that unlike a biological father, it will not do anything to regulate the playing field.

SEBI has to understand that the fault is not with the players but with itself. The primary fault lies with SEBI, for not checking who gets in to the playing eleven. The entry barriers to becoming a financial intermediary or to become a listed company are minimal. Instead of addressing this, SEBI is looking at the disease after it has become an epidemic.

For instance, does the Indian market size demand so many intermediaries who can meet all the compliance costs? Probably fifty to hundred brokers are more than enough given the market size. To keep it minimal, what SEBI has to do is to raise the bar. Say, insist on a minimum net worth of Rs.100 crore. Most of the small timers need to get out. All they do is indulge in proprietary trading and some dealings of a few cronies. There are even some who let out their terminal on hire to professional intraday punters.

The second thing is to reduce dramatically the number of listed companies. Today, barring a handful of companies, most are illiquid stocks, if we exclude the block deals and the institutional trades. In fact, like in the debt market, the institutional trades should go to a direct platform where buyers and sellers can bypass the broking system. And for listing, make it mandatory to have at least, say, around 50,000 shareholders, who each hold at least a few hundred shares. Put all the rest of the stocks in to the OTC category and for hand delivery. Our stock markets neither have the depth nor the breadth. I would say that more than ninetynine percent of the stocks in our market are illiquid and one cannot buy even a few crore worth without moving the price.

So, instead of confusing the investors further, SEBI should try and trim the playing field, however much it hurts the ego of the players and vested interests.

Sunday, April 13, 2014

The "ELITE" citizens of India- Ones who can shape India

(This is a review of a book "Revolution From Above" by Dipankar Gupta. Enjoyed the arguments. Thought provoking and if India and its politicians give you angst, READ this book. Ideally, BEFORE YOU VOTE.


Prof Dipankar Gupta spent over thirty years, teaching sociology and anthropology at JNU till 2009. He continues to be engaged with academics and has authored / edited nearly fifteen books. This book is a welcome and a very timely addition. There is a real dearth of high quality analyses of people who shaped or did not shape India from its independence to now. This book is a must read for those who want to figure out as to why India is stumbling and is clueless about the future.

Prof Gupta talks about revolution in a democracy. His convincingly argued view is that changes can be brought about only by ‘Citizen Elites’.

India of today is a result of shape given to it by very few ‘influencers’. Unfortunately, the positive impact stops with Gandhi and Nehru. After that, no one has taken charge of the destiny of India.

Prof Gupta takes the three ingredients of democracy- Liberty, Equality and Fraternity. India has somewhat succeeded in the first two, but Fraternity is totally absent or missing. This is a key point being made in this book. Essentially, Indians have never grouped together as one. There is a divide caused by religion, caste, language etc which has been exploited by the politicians to further their own cause. There are enough examples that give substance to this argument. Whether it is our old scriptures or the modern day politician, this divide has led to an economic divide also. So much that we all have a tendency to flock within a ‘peer’ group and create a differential opinion of others. For example, Prof Gupta validly says that a calamity that involves a high profile person is far more important than a tragedy that could be several times bigger, if it happens to an unknown Indian. Our media also has a role in this. No other democracy has so much of lack of ‘fraternity”. Prof Gupta strikes a chord with his arguments and sets us thinking. What will change this? This change has to come from an ‘elite’ leader. It was ‘elite’ leaders like Gandhi or Nehru that helped eradicate ‘untouchability’ or promote gender equality. These elite leaders were people who had no vested interest in what they helped achieve. They believed that bringing about this equality was important. Prof Gupta exposes how the politicians have used these ethnic divides to further drive a wedge between Indians and use divisiveness as a political weapon. Equality is brought about by making barriers vanish and not by creating fresh ones through reservations.

Alas, since the two mentioned leaders, there have been no ‘elite’ leaders thrown up in India. Prof Gupta has done a highly logical analysis of subsequent leaders, including the present PM, Manmohan Singh. Prof Gupta does not pull his punches. He is scathing of things mundane like the present PM, the uselessness of the Planning Commission (probably the best analyses of the Planning Commission has been done by Prof Gupta- For this alone, the book is a must read). The followers of Ayn Rand’s capitalistic ideals may have a different point of view when it comes to the issue of fraternity. But let us leave it aside as ‘utopian’ and that which ignores the facts.

Prof Gupta narrows down the focus areas to Healthcare and Education. He points out how Nehru let us down on both counts, in spite of setting up some stellar institutions like AIIMS or the IITs. For those who want to have a different perspective of Gandhi, Prof Gupta provides ample instances.

There are discussions on urbanisation, the contributions of the migrants to an urban city There is so much packed in to this small tome that the book deserves to be on one’s shelves at all times. There is also a debate on the importance and size of the ‘informal” sector that is such a large contributor to the GDP of India.

This book will surely make you think. There may not be anything new in terms of behaviour of the politicians, but the reasons for India being a lopsided democracy emerge. For a foreigner who wants to know India, I would include this book as a ‘must read’. And for the young and ‘elite’ Indian this book may provide the inspiration and help bring change. Get this book. A must have.

Saturday, April 5, 2014

Investment Analysis- Beyond the numbers


Over the years, I have come across different people using different recipes to churn out success in equity investing. Alas, none of us have found the correct recipe yet. And perhaps no one ever will. Whether you buy a share in HUL or buy one in ABC or XYZ, the returns are not guaranteed.

What we try to aim for is to minimise the riskiness in buying shares and hope that the market will reward us for our methods. We all think that the one method we have stumbled upon is fool proof and are happy when a couple of trades seem going right. However, it is a matter of time before we start searching for yet another strategy or method.

Yes, we can be reasonably good in our fundamental and financial analyses. For financial analyses to be right, we have to presume that there is no structured fraud. I agree that solid analyses can generally spot frauds, but not each and every one. I generally avoid PSU Banks simply because the accounting standards keep changing every year. So, analyses can also be a problem for many industries. The accounting standards have been becoming more and more opaque, in the name of transparency.

Assuming we did all we could and identified a stock; there are so many other factors that will decide its prices. For instance, if there is concentrated ownership with limited number of public shareholders (I could be describing over 99% of Indian companies here) prices will be extremely volatile. For example, if I take a company like CRISIL, it is very unlikely that I could buy more than a hundred shares at the last quoted price. Liquidity in most Indian stocks tends to be very poor. Thus, when somebody gives me a point to point return on a share, it means nothing.

I always emphasise that equity shares should not be the vehicle, if one wants to liquidate it on a fixed date or a predetermined period. This is because no one can forecast the market conditions. Even if the company you picked does exactly as you anticipate, there is no guarantee that the stock price will reflect that.

Then there are possibilities of the promoter having pledged his stock to borrow money. If he defaults, the stock price could go crashing as the lender sells the pledged share.

After detailed analyses, I like to prepare a checklist that looks something like this: i) Promoter holding- Less than 30%, I will not buy. Yes, I have made exceptions for an HDFC;

ii) Number of shareholders- Prefer 100,000 at least, but few companies meet this. Smaller number of shareholders means difficulty in executing trades at reported prices;

iii) Pledged shares- If promoter has pledged shares- surely a negative factor for me;

iv) Average daily traded volumes ; (try and exclude block deals where data available)

v) Actual delivery volumes as a part of total traded volumes- The relevant factor is the delivery volumes- If total delivery volumes in a month equal at least the total non promoter holding, it is a good sign. If not, another worry point;

vi) Do subsidiaries form a significant part of the total business? If yes, I like to get full accounts, do a double check and then take a call;

vii) What is the extent of investment/loans etc to subsidiaries and associates? If it exceeds 25% of the net worth of the company, I keep away. I have difficulty understanding reasons for keeping significant businesses in separate entities;

viii) Do promoters hold any direct or indirect stake in associates or subsidiaries other than through the entity under question? For instance, if a promoter family holds stake in a subsidiary or associate, I avoid such companies;

ix) Does the company have debt and keep resorting to buy backs? Obviously, it is an attempt to hike promoter stake as well as pump up share price.;

x) Does the company raise equity regularly through private placements etc? This is trouble, unless one is in banking business. I like companies that do not need to raise further capital;

xi) Does the company keep making ‘acquisitions’? Not a good sign as far as I am concerned. Acquisitions generally do not work and the acquisition costs often end up as a loss or a write off;

xii) Past regulatory offences by company or any Board member- a good place to check this out is and google search;

xiii) A glance at the independent directors is useful, though not a guarantee of anything;

xiv) Change of auditors needs to be examined- Generally an unhealthy sign for an established company.

Thus, it is important to understand that there are risks beyond the business and the balance sheet. An awareness of the entire framework is useful if you want to invest in direct equities. This list keeps expanding with time and learning.