December 22, 2008

A Graham style deep value stock portfolio

Benjamin graham is considered as the dean of value investing. Warren buffet was graham’s student and considers him as his mentor. Buffett’s followed graham’s approach to value investing in the early part of his career. However later, he expanded on graham’s approach and started focussing on the quality of the business too.

Graham’s approach is basically picking stocks which are statistically cheap. What that means is that the stock is cheap based on various quantitative measures such as mcap being less than Net current assets, or the stock is selling for less than cash on books. The disadvantage of this approach is that you may end up buying some complete dogs which are cheap for a reason. The underlying business would be going downhill and so the value is just an illusion.

Graham understood this and he circumvented it by diversifying. So the key point in building a portfolio of cheap graham style stocks is to diversify the holding. It makes sense to hold 15-20 stocks at a time and to keep selling the stocks when they reach 80-90% of intrinsic value and to replace them with other cheap issues.

With the current drop, I can see more of such opportunities coming up. The last time I saw such an opportunity was in 2002-2003 time frame.

The initial filter criteria I am using is as follows

Mcap less than 500 crs
Debt / equity ratio less than 0.5
No loss in the preceeding 5-6 years
PE less than 7
ROE atleast 8-10%

I have been developing a list of such ideas and have loaded a list of possible ideas in google groups (
stock screen graham). I have holdings in HTMT global, LMW and Denso india. I am still analysing the other stocks in the list and have yet to make up my mind on them.

The key point, and I repeat, is to hold a large portfolio of these stocks via diversification. Some will turn out to be clunkers, but on an aggregate the portfolio should do well.

Now you may have a valid counterpoint – why buy this stuff when there are good companies getting cheap by the day. That is true ..but if like me you also take a long time to analyse each company, then the above mechanical approach is a quick way to assemble a decent portfolio. If you have the cash and the nerve (I could use a stronger word here :) ) to invest when everyone is pessimistic, then the mechanical graham style of investing can be used to quickly assemble a decent portfolio while the opportunity lasts.

Please keep in mind that this list is just raw analysis and not a final list of stocks from which I plan to build my graham style portfolio. I will keep adding and dropping stocks and will upload the revised list when I do so.

25 comments:

VISHNU said...

Hi,

All of my picks are concentrated on Cash bargains. I dont know why you kept 500 crs Market Cap as limit..But if you search below 500 Cr..You can find some more bargains..

MRO-TEK is one such case.it was trading at 40 Cr.. (Stating Since you are familiar with this)

I found 6-7 Cash bargains..I am continue adding my cash into these position..

Regards
Vishnu

Anonymous said...

How do you build the list? Are there any sites that allow one to apply the filters you have stated above?

Rohit Chauhan said...

Hi vishnu
my filter is less than 500 cr Mcap ..and not 500 or above.
however i am avoiding microcaps .below maybe 20-30Crs. such companies are too small for my comfort.
can you share your list of cash bargains ?

regards
rohit

Anonymous said...

hi rohit..
ever looked at thermax? super premium business with amazing cash on books, going real cheap..
regards
neeraj

Anonymous said...

rohit..LMW may not necessarily be a cash bargain.Graham clearly says that for cash bargains one should consider the free cash in the balance sheet. if you net out the cash against the advances received from customers the number may look less interesting...Cash in LMW is just future sale. Others like Engg.India, BEL etc. have similar problems

Rohit Chauhan said...

hi
your are correct LMW is not a cash bargain. it is a graham style cheap stock.

i would not net cash out. although cash is advance sale, it is part of the cash flow for the company and adds to its value. most companies consume cash when they grow. LMW, guj gas, HLL can generate cash from growth. that makes FCF more than the earnings which is a good thing.

neeraj - will look at thermax

regards
rohit

Vic said...

Hi Rohit,

Thanks for the update on Graham Style portfolio.

Vikas

Anonymous said...

Hi Rohit,
I agree with Neeraj. Thermax would be excellent Buy on or below 160
What say?

thanks
Ani

kaizenbudhi said...

Where is Vakrangee, Micro technologies, Venus Remedies in the list?

Anonymous said...

Rohit/Ani,
i have studied thermax to a decent extent. i have also talked with few people in the company, some customers and suppliers of thermax. (not for any insider info or anythn)..i wont mind sharing details if any of you are interested/are studying the company.
regards
neeraj
research.neeraj@gmail.com

Rohit Chauhan said...

hi neeraj/ ani
had a look at thermax. it looks undervalued based on the current numbers. however i do not know how sustainable the current earnings are ..need to get a better understanding on that. sustainability and growth of earnings will be key .

neeraj - can you please share the details

Rohit Chauhan said...

kaizenbudhi
yes these companies should be on the list. i use the icici direct database and did the filtering 1-2 months back ..so not sure why they fell outds

rohit

Rohit Chauhan said...

kaizenbudhi - venus remedies has fairly high debt and will not come in my list due to my filter condition on debt

rohit

Anonymous said...

Hi Neeraj
Please share the details with me also

regards
Ani
aniruddhakul@gmail.com

Neeraj said...

I don’t think there would be any doubts about the business or the management of the company. So I wont dwell on that too much.
The recent foray into the boilers segment is a big big positive as per me. (B&W agreement)
Thermax has grown at over 40% CAGR over the last 5 years. The power sector has been its major business area, but the company has intelligently diversified into other areas such as boilers and environment related areas to derisk their business model. The recent 8.2 bn order win in the boiler segment is a big positive as per me. With the slowdown in the industry, I do not think that the company will be able to sustain the huge growth momentum growing forward. I conservatively estimate growth to be 15% going forward.
The order book of the company stood in excess of 4000 crores (133% FY08 revenues). After talking with various people (since I am also based in Pune), it has come to light that some orders from Indian clients have been cancelled. Projects like those of Bhushan steel and another orissa based steel company have been scrapped. Some sectors which were hit a lot have scrapped expansion plans. A total of 22 orders from Indian clients are on hold, out of which only 6 could be cancelled. Rest would start soon. There is no impact on overseas orders. Overall, I do not think there is a BIG hit on its business.
The financials of the company are also in great shape. Negative working capital, no debt on books and a decent order book are good positives. On the P&L side too, it’s a decent picture. Operating profit margin of 13-15% and excellent ROCE and RONW give me comfort.
The valuations are extremely mouthwatering. Thermax is currently reading at 5-year low valuations. The PE range has been 18-60 times trailing in the last 5 years. We have a company here, which I expect to grow @ at least 15%, trading at 7 and 8 times trailing PE. I find that extremely attractive and gives me some MOS.
In short I see a company, with sustainable competitive advantage and excellent management, in an area of business which has decent growth visibility. The MOS is there, and although I would prefer it cheaper, I have started buying…small and slow. I hold thermax, bought recently, and will add more on declines. Something like 150 or lower would be great I think. So I would request everyone to sell thermax and bring the price down, so that I can buy!! Hehe…
For better knowledge on the company, do download the concall transcripts here.. http://www.thermaxindia.com/v2/InvestorPage.asp?levelno=0&pageno=1&objectid=22

Hope I was of a bit of help…
regards
neeraj

Vic said...

Neeraj,

Thanks for the detailed analysis.

How can one determine that the orders on hold or got cancelled won't have much impact? How did you quanitify this part?

Vikas

Rohit Chauhan said...

Hi neeraj

great analysis. now let me play the devil's advocate ..look at the results during the last downturn (1999-2002). the net profits went down for all capital goods companies. companies like BHEL sold for 5 times depressed earnings. why do you think the current downturn will not be as bad for thermax and is thermax any different from what it was then ?

regards
rohit

Anonymous said...

Hi Rohit
I was looking at your spreadsheet of Graham style stocks. I am surprised that you have not included Voith Paper & Fabrics in your selection. Is there any specific reason? Snapshot as following
MCap 35 Cr
Cash 83 Cr
No debt
Divd Yld 5%
Book Value 190
CMP 80

I think you might have excluded it on the basis of RONW as it's 5 yrs avg around 10

regards
Ani

Rohit Chauhan said...

hi ani
had a look at voith. it should be there in the spreadsheet.
RONW does not look the like the reason for excluding it.

either i was half asleep or drunk when i was preparing the spreadsheet. that seems to be the only explaination i can think of :)

regards
rohit

Anonymous said...

Yes, Venus should not be in the list.
One more thing Rohit --> You must also keep some criteria of growth in Sales and profit in the criteria.
Kaizenbudhi

Chinmay said...

Thermax had a loss in 2001. The company's margins are susceptible to economic activity

Anonymous said...

hi rohit,

Have you updated this list since first publication?

Thanks
Prashant

Anonymous said...

Hi Rohit,

Nice to read your blog. What are your opinions about Phillips carbon black, India Glycol? PCB (part of RPG group)has a 41% share in carbon black and IG makes ethylene oxide from natural sources unlike other companies. EPS growth over past 5 years has been good for both. For both of them, D/E ratio now in the regions of 1.2 and they are good dividend payers...
Please mail me your opinion(s) at queries.my [AT] gmail [DOT] com, as well as posting on the blog for others' benefit.

Thanks
Srini

PS: BTW, I read your (maybe older) list of companies on TED and I liked what I saw :-) namely - Manugraph and Cheviot.

One question on Calcutta based companies (excluding biggies like ITC): because of the lack of work culture and predominance of red flag culture, isn't it a bit risky buying their shares thinking that they will do well? PCB is based at Calcutta as well and your reply to the above question would be an answer for PCB as well. My relative was president of GKW and he said that the unions were horrible to say the least...

Rohit Chauhan said...

Hi srini
i have not checked philips carbon black or indian glycol. however considering the overall valuation of the market, i would not be surprised of they are undervalued.
I would personally not give too much wieghtage if a company is based out of calcutta. what one has to look at is whether the major operations of the company are put of West bengal and how the labor/employee relationship is. look at employee productivity (revenue or profit per employee ) and compare with other competitiors to be sure.

as far as manugraph and cheviot are concerned, these are smaller holding for me. manugraph is quite small and i have never gone beyond a very initial position due to lack of clarity of the business.
cheviot is a cash bargain and hence part of my graham style portfolio. they however do not form my core holdings

regards
rohit

Rohit Chauhan said...

hi srini
my own father had worked with unions and i have dealth with unions a bit. i dont have anything good to say about them.
i would rather remain unemployed than have a job where unions are involved ..as i will any die quickly from heart problems and stress :)

however as an investor, we can be more objective. if the company has worked with unions for a long time, then it is just an added cost of doing business

regards
rohit