Portfolio changes and some rejected ideas

I mentioned in my previous post on my change in approach. There are two key reasons, why I have made a change in my short term approach. The first reason is that most of the holdings in my portfolio have risen sharply and are now close to intrinsic value (which is true for almost every stock, so nothing surprising about it). As a result, I have the option of holding onto these companies and get a return commensurate with an increase in their fair value or replace these holdings with cheaper ones. The second reason is that there are not too many mouth watering ideas out there. There are a few decent opportunities, but nothing which would get me excited.

The net impact of above situation may result in the following approach for me, in terms of portfolio construction

• Sell some of the current holdings as they approach fair value
  
• Create new positions which are cheaper than the stocks i am exiting
  
• Higher diversification due to lack to truly attractive ideas selling at a high discount to fair value
  

In view of the above thought process, I recently initiated some stock filtering and level 1 analysis on a list of around 200 odd companies. I have written earlier on my filtering process (see here).The level 1 filtering for me is fairly quick and involves a quick review of the profit & loss, Balance sheet and cash flow statements. I typically spend 5-10 minutes on a company and if it does not catch my eye, then I move on to the next company on the list.

Placer mining

A valid criticism would be that this process is too superficial and crude and I could miss out on a gem. That would be a valid criticism, but that is a downside I am ready to accept. I look at this stage as mining for gold by the river (I think it is called placer mining). This typically involves collecting dirt and passing it through a series of filters, which get finer after each pass. Now as you are processing tons of rock and dirt, one cannot be too careful at the initial stage. Almost 80-90% of the time, the company may not be worth analyzing further at the initial stage, till the list has been whittled down to a manageable number.

The careful and indepth analysis happens at the final stage when it is time to pull the trigger on a few (hopefully) decent companies.

Some rejected companies

Let me give some example. It is possible that you hold the company as you have done in depth research. If that is the case, feel free to post a comment on them and i would be perfectly willing to change my opinion.

Kinetic motor company: The company has been incurring increasing losses in the last 5 years and the networth has turned negative

Compact disc india: Company has shown high growth, decent fundamentals. However rejected due to possible corporate governance issues

Temptation foods: Sudden increase in debt and equity in 2009. Company is into commodity trading, which is fairly risky

Sandur manganese & iron : Erratic performance with losses in current and some of the past few years.

EID parry: Sugar business with high degree of cyclicality. Current profits are high and hence the valuation appears low.

Lakshmi energy and foods: Negative free cash flow. Into commodity business, too high working capital with profit going into expanding the balance sheet.

Krone communications: Not performing well. Net profits dropped from 5 crs to 1 crs in the current year.

UB engineering: Negative networth, with business turning around in the last few years

Turnaround cases

One consistent theme in the above list are the turnaround cases, which I tend to avoid. Investing is turnaround is a fairly specialized, high risk and high return form of investing. There is decent chance of losing money in such cases, but a few of them can work out pretty well. However, I personally avoid such companies as I do not feel comfortable with such cases.