November 17, 2006

Value Traps

I think every value investor dreads a value trap which is basically a company, which seems cheap by historical standards and the gap between the price and the supposed intrinsic value does not close.

I found the following very useful comment from bill miller (he is a very famous money manager in the US whose fund has beaten the index for a straight 15 years)

"You never know for certain, but the nature of value traps is, they tend to have certain characteristics. Typically, one is that the valuation of the business or the industry is lower than its historical norms. The company or business normally has a fairly long history, so the historical normal valuations provide a lot of comfort. Therefore, when you get down toward the lower end of these valuations, value people find them attractive. The trap comes in when there's a secular change, where the fundamental economics of the business are changing or the industry is changing, and the market is slowly incorporating that into the stock price. So that would be the case over the last several years with newspapers. They are a good example of where historical valuation metrics aren't working."

The complete article is here

In addition found the following interesting quote from warren buffett

“Margin of Safety is the untapped pricing power in a business.”


Prem Sagar said...

talking abt cheap stocks.. I would like to know ur view on these.
Hi Rohit,
Just thought this might be of use to u.
1. Control print is a co thats got a low PE of around 6. Its printer business has intense competition and hence the low PE, but the fact is its consumables business is growing and the mgmt is focussing on it more and more and the dependence on printer business is lowering every quarter. BUt the mkt still treats it as a printer co. This co produces products that print the price, manufacture dates,etc on bottles, packages..with retail growing they seem pretty ok
and they are debt free almost.
2. Aarti industries: a co whose results have been very poor for the last 2 qtrs and is beaten down very much. Quoting at less than book value, dividend consistent and recent div was around 6.6% on todays price of 30Rs. PE of less than 5. And except last 2 qtrs, the co had grown at 22%CAGR in 5 yrs. and its a mkt leader in several products. And though its dependent on benzene and hence crude, its product mixture is so diverse that its not dependent on any specific industry. One grey area is the high debt and hence the high interests which have gone up significantly. But I see value in this. I believe even if the next few qtrs are bad, the price of Rs 30 factors it in.

What do you think of these contrarian picks?

And I am sure you know Aftek infosys. But it really perplexes me how a stock can be depressed for so long. K10 influence had murdered this co.. but would you think of having this co in ur folio?

What do you think of these 2 contrarian picks?

Prem Sagar said...

Oops it got jumbled at the start.

Rohit said...

will have a look at the stocks and let you know my views on the company


Prem Sagar said...

Hi Rohit,
More on Aarti:
This co had got USFDA approvals recently and had started manufacturing APIs. And I am not sure if the margins on these were low to bring down profits. And interest hikes have hurt this co and its trying to issue some FCCBs and raise cash to pay off a part of the loan.
And the higher margin (relatively) agro chem sales should have been poor I guess, possibly.

But this is a co that is
1. cost conscious and efficient, trying to put each by-product to some use.
2. has global capacities and scale
3. has been relatively investor friendly
4. The ROE has been good, but with a higher leverage of more than 1 D/E!

What puzzles me is the sudden fall in profits for teh last 2 qtrs esp with simultaneous API production.. or is it bcos of a lower Agro chem offtake.. not sure and I am not able to find out why.

Looking at the history of the co, its domestic leadership and global scale, I feel this is cheaply valued. With a 3 yr period, I find this to be a potential multibagger, not bcos of its future potential(which looks ok), but bcos of the sudden depressed sentiment around it.

Prem Sagar said...

And one more thing is everytime I see Aftek infosys, I find tremendous value in it and a huge margin of safety.. but its been like that for ages.

Ketan parekh scare still keeps this stock away from most. But the valuations are so compelling..and it is intriguing how an IT co with good OPM, growth, potential could be so cheaply valued!!

Do you have a view on it?

Shankar said...

Hi Prem,

Aftek has had me perplexed aswell. Possible scenarios can be -
1. Share buyback (there's enough cash and internal accruals for that)
2. Takeover candidate by any of the top 4 firms
3. Private equity or leveraged buy-out by promoters (& further de-listing of the company)
4. Heavy dividend payout to the shareholders
5. More acquisitions abroad using the available cash 9this would be an expensive proposition as equity markets in EU and Americas are on a high)

Warm Rgds

Rohit Chauhan said...

i have started looking at aftek as well. i am not been able to find anything negative on the stock. need to dig deeper.
typically for a tainted stock, it takes a long time for the market to change is opinion. however i have had picks which have taken 1-2 years to turnaround, but once it happens , you get really good returns.
aftek on the face of it seems to be selling at 1-2 times earnings even after the equity dilution due to warrants and stock options.
the stock is definitely worth a close look