September 8, 2008

Replying to a comment, a correction and misc thoughts

I got the following comment recently

If I take u back to 1994, how would u have spotted Infosys. The only way one could spot it could be through the market opportunity, good results and good management.or u may enlighten if there was any other way. So it could have been a kind of recurring deposit wherein one wud have seen good results and put money in that company every quarter.

I agree there could have been companies where the growth wud have stopped, but then its like finding out 20 horses in a race of 5000 and then slowly and steadily identifying the best horse through results only. When I say results I mean higher EPS also and not just a company like Teledata or any other which diluted its equity too.

Thats what big companies like GE, Tatas do. Hire gud people and then thru performance weed out the non performers.

Agreed that Educomp is richly valued or investing in Infosys in 2000 wud have been burning fingers. What I am saying is that implmenting the value investing approach with growth companies.Take micro technologies for instance. It has been growing at CAGR of >50% for last 4 years. It has a book value of 206 approx. It trades at 220. EPS of around 50. Almost no debt. Mcap of <250>60% CAGR for last few years.

These companies are not richly valued at all.Thru Value Investing combined with Growth, I could see huge returns. Unfortunately I did not put a lot for money. e.g Rajesh Exports in a single year increased its sales from 200 to 2200 crore somewhere around 2003. That time the stock did not appreciate and had excellent value(128 book value, eps around 40, Price around 150. It gave 25 times returns since then), That was the time to enter and make huge money. and I did but with a small amount as I was learning then.

Following is my response :

Hi anonymous
There is a book, The gorrila game, which talks about an approach on how to invest in tech companies.

Approach is similar to the one you mention the whole basket ..and then follow the results of each. sell the poor performers and invest the cash into the good performers. That could have been a way to make money in infosys.

However it would have been diffcult to have the foresight in 1994 that infosys would do so well.even employees working in infosys did not recognise that (employees who were given options then thought the options were worthless).

I think growth is compatible with valueinvesting. Growth in the end, is a variable in the valuation process. As long as your are paying less than the growth implied intrinsic value, you will do well. So microtechnologies and Geodesic may fall in that bucket. They maybe insanely undervalued due to the excellent prospects. I have however not looked at these companies and hence cannot comment. However I would definitely look at them now.

Regarding your experience with rajesh exports, I can understand what happened as I have gone through similar experiences several times – namely how do you know beforehand that you are right on a company. I think as one gains experience, one learns to identify and benefit from such opporunities.

A correction
In the valuation of several companies I have used the following formulae to check the valuation

Mcap – cash on hand = Net Mcap
Net Mcap / Net profit = effective PE.

There is an error in the above approach. Typically the above cash earns 8-10% as part of the other income. The net profit should be adjusted with this non core income to arrive at the effective PE, otherwise you end up double counting the cash.

The error, lucklily has not changed most of the valuations I have done, but it is an error all the same and has a bigger impact if the cash as a % of market cap (mcap) is high. It is such an obvious error, but I have missed it till now. Well, better late than never.

A quote

I saw this quote from
Keynes (A famous economist)

When the facts change, I change my mind. What do you do, sir?

Reply to a criticism during the Great Depression of having changed his position on monetary policy, as quoted in Lost Prophets: An Insider's History of the Modern Eonomists (1994) by Alfred L. Malabre, p. 220

This quote is very apt in investing. One analyses companies based on present facts and a set of assumptions. Valuation is finally an exercise of projecting the future. By being conservative, you can reduce the possiblity of an error. However when facts change dramatically, I am reminded of the above quote and find it prudent to change my mind – nothing wrong with that. Even a 60-70% success rate in picking stocks (being right 6-7 times out of 10) can give very good results in the long run.

Misc thoughts
I am reading through the Annual reports of several companies which I follow. I will be posting my analysis on the same. The market seems to be going one step forward and one step back. There are
problems developing in the US and the markets may start weakening in the US. In india, inflation seems to be high and somehow the policy response has still not been strong enough. I think the RBI thinks that this inflation is temporary and it will cool on its own.

I hope they are right for everyone’s sake. If however they are wrong and they forced to hike the rates further to kill inflation, then we could have nasty times ahead of us in the market.


Anonymous said...

Hi Rohit
I am referring and understanding various formulas which are used to calculate Discounted Cash Flows, Intrinsic Value of a stock. I came across
This guy has illustrated Grahams Formula for calculating Intrinsic Value. What do you think how best fit is the formula for Indian Stocks? do you think it's useful? The result of this formula is same with Discounted Cash flow method, what is your observation?

Kind regards

VISHNU said...


Growth is good only when it comes from internal accruals and not by diluting equity or applying debt. Plus Growth should be valued in co-ordination with ROE.

"Take a paper company that on average has produced a 6% return on equity through its history, and take Microsoft,which has produced a 50% return on its equity through its history. One unit of growth or one percent of growth at Microsoft is worth way more than one percent of growth in a paper company" Richard Pzena

Sometimes Market agrees that a particular company as Growth company only if they come with high PE, not if it comes with Low PE. For example , Hawkins Cooker is not recognized as growth company, though it increased its profit from 1 cr to 11 Cr in 5 years.

Sometimes there is value even in High PE / High Book Value as the company profit/prospect explodes.
Walmart/Microsoft are good examples. but I dont have any good strategies to find such companies..Even if you find such companies, I will not be having confidence to put 50% of networth in such companies. (I dont buy a single share if I dont have confidence to put 50% of my networth)


sam said...

Hi Rohit,

I came through a business called" OPTO CIRCUITS INDIA LTD". It seems that it has a tremendous growth potential, have analyzed last 8 years data the growth rate is superb, ROE is excellent and growing, no debt, and virtually no competitor. Check its fundamentals and let me know what your analysis says.

Samesh Patel

Rohit Chauhan said...

am i reading this right ? micro technologies issued 24 lac warrants to promoters in Feb 2008 at around 250 ? that is 25% of current equity
in addition there is FCCB related dilution too ?

Neeraj said...

Hi Rohit,
On ur formula of 'net market-cap', which u calculate as mkt cap-cash..
dont u think this is an incorrect approach as far as value investing goes? i mean, as a value investor, u shud always look for maximum possible margin of safety. that means, u shud value stocks as cheaply as possible, and if these stocks become available even on the cheap valuations, u shud buy them, right?
now when u r deducting cash from mkt cap, the resultant PE wud be less. arnt u being an optimist rather than a pessimist? arnt u awarding higher valuations to companies? arnt u missing on the margin of safety here?
even in case of cash rich companies, i wud propose that they be valued as if they had no cash. and if the price drifts down, and they seem attractive evn if they had no cash, they shud be bought (and bought HUGE)... the cash wud b the margin of safety...
cheers man..

Rohit Chauhan said...

Hi ani
i have not seen the formulae. however dcf is the most fundamental approach in calculating intrinsic value. however the assumptions which go into the calculation more important than the formulae itself

vishnu - growth is just component of intrinsic value. ROE and competitive advantage period (how long the excess return can maintained) is equally or more important. however almost universally i have seen investors getting infatuated with growth. sustainability of ROE and growth is very important in this high growth companies

sam - i will have a look at the company and let u know my views


Rohit Chauhan said...

Hi neeraj
My approach is to look at the core operating income (net of the income from excess cash) and use this operating income to arrive at the valuation (via DCF and other approaches). the resulting value is then added to the cash (excess) to arrive at the final number for the intrinsic value.

if the current price is 50% or less than the above number, then i will make the purchase. so my margin of safety is in buying at a discount from the intrinsic value.

in the correction mentioned in the post, i have corrected the way i measure intrinsic value.

effective PE (net of cash) is just one way to look at the current valuations


Anonymous said...

Hi Rohit
Tata Invewstment Corp has declared Right Issue as following
You are here : Moneycontrol » Markets » Corporate Announcements - Tata Investment Corporation
Tata Investment Corporation

Published on Thu, Sep 04 at 10:34,
Source : BSE
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Tata Investment Corporation Ltd has informed BSE that September 17, 2008 has been fixed as the Record date for the purpose of Right Issue. - Instrument - Zero Coupon Convertible Bond (ZCCB) with detachable warrant. - Right Ratio - 1 ZCCB with detachable warrant for 5 Equity Shares held on the Record Date. - Conversion - Each ZCCB will have three parts - Part 'A' of Rs 300 would be compulsorily converted into 1 equity share of Rs 10 at a price of Rs 300 per share on August 01, 2009. Part 'B' of Rs 350 would be compulsorily converted into 1 equity share of Rs 10 at a price of Rs 350 per share within 18 months from the date of allotment. Part 'C' will be a detachable warrant which will entitle the holder to purchase one equity share at a price of Rs 400 per share during the month of April, 2011.

The Price is already 10% down today, why there is such a downfall in price? How to evaluate this offer? BV is 245 and cmp is 440, it's attractive.

Is it worth to buy this scrip on declines?