October 25, 2010

On the previous post and some additional thoughts

I recently made a discovery – The higher the market goes, the more I get a lot of intellectual thoughts. This is exactly reverse of a lot other people who seem to be finding a lot of good ideas to invest in the market. Well I guess I may have to work a bit harder to find something good …sheesh why isn’t it easy to make money in the market :) ?

All IT stocks overvalued?
I was not precise enough in my
previous post. I think some of the large cap IT stocks are fairly valued, if not overvalued and hence there is no margin of safety. That is they are priced for perfection.

The same may not be true for several midcaps, though I think one cannot make a general statement. As I have written in the past, general statement such as ‘market is overvalued or undervalued’ are meaningless and the same holds true for IT stocks too. So let me be more precise – companies like Infosys, Wipro and TCS seem fairly valued.

In case of Mid –cap IT companies like NIIT tech, patni or hexaware it is not as clear, atleast to me.

I typically value stocks using 3 different approaches at the same time. The first approach is the discounted cash flow – try to estimate the future cash flow (or earnings) and then discount them to arrive at a net present value. The second approach is to look at past valuations of the company and compare with the current valuation. The third approach is to look at the relative valuation of the company with others in the same sector.

I try to evaluate a stock on all the three approaches and see if they are pointing in the same direction. A stock may appear undervalued in terms of the DCF value and with reference to other companies in the sector, but appear fairly valued compared with its past valuations.

Now such a situation, which is currently present in case of Mid-cap IT and some cement companies, definitely throws up a key question for me – Why should the market value the mid-cap IT companies at a higher level in the future than it has done in the past ?

A typical case where the market values a company at a higher levels than in the past is when the growth or return on capital of the company has increased and the market now thinks that the company has a much better future and prices it accordingly.

In case of mid-cap IT companies and various other mid-caps, I am grappling with the same question – what is it that I know which the market has not considered, that would cause it to value it more in the future. In some cases it is easy to figure that out, but I am not able to figure it out in case of IT companies.

Hence my statement – Some IT-midcaps may be undervalued depending on your point of view. My point of view is that i can’t think of any unrecognized factors which may cause the market to re-price these companies upwards.

On the contrary I can only think of negative factors, several of which are not yet priced into these stocks. You may have a better insight on factors which may cause the market to value these companies higher and so both us are correct from our respective points of view.

The problem with stock tips
Moving on the next general thought – stock tips. Regular readers to this blog know that I am totally against stock tips. Other than the reason that I think that most of the stock tips are given by the unethical to the unsuspecting, I also believe that such tips do not help in the long run.

It is easy to take stock tips and follow them in a bull market. Even a dart throwing monkey can come up with some profitable ideas (unfortunately I am not as smart as this monkey during bull runs :)) and it would not difficult to follow them. How many of us will have the courage to hold on to such stock tips when the market drops or add to such positions? I cannot speak for others, but I definitely cannot blindly follow others when the market is in a free fall.

The only way one can follow stock tips or such a person is to understand that person’s underlying approach and then have some amount of blind faith on the skills of such a person. So the next time you decide to follow someone else stock picks, remember that you are putting some amount of blind faith in that person, which will be tested when the market drops (which it will sooner or later).

How to get decent return these days?
One of the readers asked me a question on the previous post – how do I make decent return these days when a lot of stocks appear overvalued and fixed income options don’t give much returns?

I don’t have an easy answer – if I had one, don’t you think I would be using it?

The first option is to keep analyzing stocks everyday (as I am doing) and hope that you may hit a few good ideas in due course of time. If you can find a few such ideas, you will have to have the courage to buy such stocks, knowing fully well that such stocks could drop if the market were to drop suddenly.

The other option is to do nothing and sit tight. This option is not easy too as you will have to watch your friends make easy money while you sit like a dumb dodo, doing nothing.

Either of the options are not easy – in one you face the risk of losing money (atleast in the short term) if the market drops and in the other you are foregoing easy money. You have to choose your poison.

19 comments:

rajsmusings said...

Nice post!

Tempted to go with the second option - sit tight. Not only it saves the trouble of trying to find needle in the haystack but also conserves the precious cash in the account which surely will be worth it when the market decides to get into reverse gear. I guess till that time if the cash earn even 6-7% interest in bank a/c we should be more than happy.

Regards
Raja

Sachin Purohit said...

Regards the last question, I have been analyzing companies everyday as suggested by you and have put just about 1/3 or half the amount I would have wanted to commit to such scrips. The rest I would buy only after the markets drop considerably. Till then, all the idle cash have been moved to Short-term Floating Rate plan. These days, there is no entry or exit load on them.

Of the scrips I analyzed, I liked Swaraj Engines on Cash Flow basis. Can you check this company, how does it look to you? Though it appears pricier now on DCF basis.

Lucky said...

Very well said. The margin of safety is totally absent nowadays - in the market in general and in the IT companies in particular.

Infy, TCS and many more of these companies are very well run and should remain profitable for years to come. However, if anything goes wrong, in the short term or medium term, one is not sure if the same valutation will be applied to them as is the case now.

I have chose my poison. I am not confident enough to buy at this level of overall optimism. So sitting on the fence :-)

PS: Some fresh / add-on position in Balmer Lawrie (thanks to you) and Praj Industries & Visaka Industries (thanks to TIPGuy) are the only exceptions.

PPS: What about the paid service?

rayhaan said...

hi rohit , i dnt have any thesis as such. All i know is that united distilleries has bought the promoters stake (of 54% of the co.) @ rs.101 and wants a further 20% @rs101 and will acquire it thru an open offer (from 10 nov ~29nov) and the cmp is rs83. I'm really new to arbitrage, are there any other factors that i shud consider?

Indrajeet Singh said...

Dear Rohit

Have been reader of your blog for sometime. I was surprised to know that you even bother to analyse companies like Hexaware. With such dubious promoter management (with proven track record!!), there can be no value assigned to such companies.
I feel no margin of safety is enough for such cases.

sandy said...

hey rayhaan,

check out this site http://tacticacapital.blogspot.com/

Bala said...

I started investing just 3 months back. But as a cautious businessman I spent 4 months prior to that reading on stuff and I am very grateful to your blog for a lot of useful inputs. My investing strategy is not to buy and sell and follow random tips etc. I think like a businessman, study the business and ask myself if this company can give me 15% - 18% annual returns over the long run. In this mad rally I managed to find some stocks which I feel are good long term value and every month I buy only these stocks. My stocks are ABC bearings, Balmer Lawrie, CCCL, Graphite India,Lloyd Electric and Tulip Telecom. I think they are still undervalued in this mad bull market too. In fact my portfolio has appreciated only 3-4% in 3 months as against various indices. But I am very clear that in 5 years these stocks will double (minimum) by basic performance and not by market sentiment.

I think your thoughts on ignoring the index or IT companies being overvalued are all spot on. I dont know why you try to justify your posts :) - you are very wise as is!

Thanks
Balaji Shankar

Anonymous said...

Hi Rohit

Is it possible to download dcf worksheet for asian paints?

regards

Anonymous said...

Hi Rohit,
If either large or midcap IT companies cater more to the needs of the domestic market instead of focusing only on business abroad, doesn't the future look bright for them? Seen from that lens, what is your opinion on Mindtree which has won the UID contract?

Anonymous said...

Hello,

Happy to find your blog.

Regarding IT companies, after reading Graham, Lynch and friends I would not touch any of them. They are too volatile and too easily replaceable. In such a growing economy as India, why not keep an eye for retailers or other boring businesses? They might not be as sexy as IT, yet we can understand their internals and make a judgment.

Roy

rayhaan said...

@sandy -thx 4 introducing me 2 dat blog , wish i'd read it b4,especially considering dat i understand zilch bout dat biz and i find it a bit scary at a d /e of 3. @bala-its nice 2 c dat u've started ur investing journey in graham and doddsville.dnt give up .and yeah thx 4 d stock ideas esp graphite india. Do try and have a luk at net - net situations like teesta agro if u have the orientation. Luck
P.s. Hopefully rohit will respond 2 us soon if he's alive or well and will reprimand us 4 making a messageboard out of dis blogpost.....Lol!

Rohit Chauhan said...

Hi raja
keeping cash around is definitely the safer option ..but requires a lot of patience if the bull run continues for a long time

rgds
rohit

Rohit Chauhan said...

Hi sachin
i am following a fair similar startegy ..i am going in with a part position and will add to it if the price is right

will look at swaraj engines and post

rgds
rohit

Rohit Chauhan said...

Hi lucky
yes the large IT companies are likely to do well in the long run ..same cannot be said about the stock ...as you rightly pointed out ...there is no margin of safety

i have been adding to balmer lawrie in dribs and drabs too. have not looked at other companies closely ..if i remember visaka is into construction material ?

rgds
rohit

Rohit Chauhan said...

Hi rayhaan
in case of an open offer you also need to see how much is the public shareholding and the buyback % ...if 20% is needed and 46% is public shareholding..then acceptance would be less than 50% ..so you may have to sell the rest of the position at a loss

in such a case the current price may be right as the market could be factoring the loss from current levels once the buyback closes

rgds
rohit

Rohit Chauhan said...

Hi indrajeet
analysing companies is a different point from buying their stock ..i think one should keep an open mind in analysing companies ..ofcourse if the management cannot be trusted then one should move on

i have looked at a lot of companies in the past and not bought it for various reasons ..including the management. in case of hexaware i have looked at it only briefly and never bought into it ..frankly i dont know enough about the management as i never dug too deep into it

rgds
rohit

Rohit Chauhan said...

Hi balaji
you give me more credit than i deserve :)

anyway ..i think anyone who invests as a businessman think is bound to do well ..i think warren buffett and benjamin graham have said it that investing is most intelligent when it is business like

on some of the stock you mention ..i had looked at graphite india and almost pulled the trigger but it was not cheap enough for me. may be soon

on you holding not beating the market ..i think it happens to most of us. in the long run it works out if you are patient and sensible

rgds
rohit

Rohit Chauhan said...

hi anon
sorry i dont have a DCF worksheet for asian paints

never did a dcf ..i used to work with the company and the value was obvious when i bought it ..i bought in 2000 at a PE of 15 and felt the company was very cheap then

the company done even better since then

rgds
rohit

Rohit Chauhan said...

Hi rayhaan
:) ..you are definitely persistent. and i am fully alive and kicking

on teesta agro ..will definitely look now as you have mentioned it several time ..there must something in it :)

feel free to connect with others via the blog , have no issues with that as long as you dont end up cursing someone

rgds
rohit