Tuesday, May 26, 2015

Patience- Find stocks at your price-

(My piece that appeared in Deccan Chronicle on 26 April, 2015)

The stock markets have been on a roll for the last one year. From April 2014 to March 2015, the index delivered a splendid return of 27 per cent, once again rewarding people who have faith in equities and the patience to wait. Of course, over the last few months, the stock markets seem to be clutching at straws to hold on to the highs that have been reached.
Of course, everyone tells us that we should hang in there and not panic. My advise to people is to ignore the noise So long as we are invested in stocks of companies that are doing well, do not worry. Similarly, if we are in to the SIP mode of investments, do not waver. Do not try to time the market.
The last one year has also demonstrated the damage inflicted to wealth by investing in real estate or gold etc. Alas, both are unavoidable in the Indian context (House to own and stay and gold for the daughters’ wedding) unless one is so enlightened that we understand that it is cheaper to rent a house and gold is of no practical use and not the most profitable of long term investments.
Why do I say that it is cheaper to rent? Given today’s prices, I will use an example from a locality named Besant Nagar, Chennai. A premium location. The cost of a 3-BHK, around 2,000 sq ft, is approximately Rs 4 crores. It can be had on rent at around Rs 50,000 to Rs 65,000 per month, with an annual escalation of five per cent. Now, if we keep the Rs 4 crore in fixed deposit, we would get around Rs 32 to Rs 36 lakh a year or Rs 2.6 lakh to Rs 3 lakh a month! That is if we are buying the flat for full cash. If we are buying it with housing loan, the annual costs would be far higher. The rent would be under Rs 8 lakh a year. So by postponing your buying by one year, you add around Rs 25 lakh to your kitty, as opposed to buying. Figure it out. And there are enough rentals available.
It would make sense to buy when rentals go so high that it crosses six to seven per cent of the capital cost of a house. This is my take.
The flip side of this is that it does not make sense to ‘invest’ in a second home, given the poor yield on the asset, even if one factors in an’appreciation’ in the capital value.
One more aspect to wealth creation is to preserve a decent chunk of your assets in cash or near cash form, even if it means that inflation keeps biting in to it.
We need to preserve some liquidity so that we can take advantage of any panic selling, which makes quality stocks sell at mouth watering prices.
I see this happens once in five to seven years, but can never predict when. And it need not be market conditions alone. It could be stock specific. Like for instance, there is a slow down in growth of the automotive industry. I would like to keep an eye on the price of a stock like Bajaj Auto, Hero, Maruti etc. Should there be a big sell-off, I would like to own some. Surely, it is not as if the companies are headed for a closure. Once the industry bounces back, these will once again be in demand. I am happy to buy some things at my price. For this, I need to keep some money handy.
Similarly, I will use sharp rallies in stock prices which take some stock I own to a very high price. A price at which I am never going to buy it. So, I will sell maybe a part of my holdings, to cash in.
Today, the markets are “nervous” and is easily spooked. Given the illiquid nature of most of the stocks on our markets, there is always hope that some good high quality stock may tank because of some temporary reason. That is when we should be buying. When I buy like that, I never do all my purchases in one go. I buy maybe one third or one half and then wait for a fortnight or so and then buy the rest. Why I do this is to take advantage of the market behaviour and also to give myself time to kick the tyres once again.
The writer is an independent analyst and can be contacted at balakrishnanr @gmail.com



Most often, the dilemma we face is in understanding a company. We invest in a stock so that we get benefits or gains in two ways- One is from the dividend stream and the second is from a favourable change in the stock price. To make both happen, it is obvious that the company has to do well. Even if there is a slippage in performance, the dividend may still come to us, but we could be disappointed with a decline in stock price.
Temporarary declines in stock prices do happen. It is part of the volatility of stock prices and only the nerds on the TV channels can give reasons for a rise in price one day and a fall the very next day, and so on. Volatility has no explanation. One day there are more people feeling good about the company and drive up the prices. Another day, they are outnumbered by people who feel bad about the price and sell it. And these are most often not caused by any underlying change but by transient sentiments of buyers and sellers who throng the market place with changing views every nano second.
I like to look at most companies from two perspectives, with a view to deciding an approximate ‘value’:
THE FIRST is a ‘balance sheet’ view. This is useful in case of companies that are in business with no entry barriers, no significant technology changes over time and just economies of scale matter.  Most commodity companies would fall in to this category. For instance a Cement or a Steel company or even an automobile company. All of them have replicable plants and we can estimate a ‘replacement’ value for these kind of businesses. For instance, we could say that it costs around $130 per tonne (of installed capacity) to set up a cement plant.  Very unlikely that any one player has any significant advantage over the other, except for one growing faster and another growing slower. The time I would like to buy these companies is when the Enterprise Value (market capitalisation plus total debt minus cash ) per share is higher than the market price of the share. In other words, I am willing to give a fair value which would just be the replacement cost. I know that the product is cyclical and will rebound in the not to distant future. Thus, I will buy aggressively when there is a steep discount to the fair value as I estimate it. That is my ‘margin of safety’.  I am not bothered about the change in EPS etc since every player will be doing the same.  Balance Sheet based valuation is more useful to find stocks that are more short term opportunities than long term investment value.

THE SECOND is a ‘profit & loss’ view. Here, the company is asset light. Has turnover that is several times its fixed assets. Earns a superior ROE as compared to the Balance Sheet earning company. This company has brands, earns super normal margins and is one of the first three in the industry or segment. The company has built a ‘moat’ round itself by building market size, brand pull, scale economies etc over time, which will ensure its continued dominance in the near term. Here we will find companies predominantly in the FMCG, pharma space. These shares trade at several times the ‘book value’. However, their ROE is several times the commodity company. Most grow at healthy rates and the shares always trade at what we could term as ‘expensive’.  If we go by our above hypothesis for valuation, we will never own a single stock of this kind. Here, what I would do is to look at the average ROE over the last few years. And then relate it to the Book Value. If the ROE is 25%, then I do not mind paying three to four times book value. I would also use what is called as ‘historical P/E Band” ( the range of P/E at which the stock traded in the past ten years) and see the pattern. I am happier buying closer to the lower end of the P/E Bankd and selling at the higher end of the P/E Band. For instance, if I find out that HUL has historically traded in a band of 20 to 50 times EPS, I will buy the stock at closer to twenty rather than 50.
Of course there is another type of share which I cannot value. Companies in the emerging space that are allergic to profits and get valued higher if they lose higher moneys.