March 3, 2012

The Dilemma

I have several dilemmas in life – such as should I eat jalebis and other good stuff or go to the gym? Sleep late or go to office? But as these dilemmas are of no concern to others, I will leave them for my own thoughts
The investing related dilemma I have always faced and more so during a market crash is this – Should I invest in the high quality companies whose price has dropped a bit or the low quality cyclicals where the price has collapsed completely. I have tried both and will try to present how my thinking has changed and where it stands today.
Let’s look at two specific examples – one of a high quality and other an average company. The high quality company is one of my long term holdings – CRISIL and the other company is Denso India, which I have long exited.
The chart below is of crisil
I wrote about  this company earlier in 2009 and have held the stock since then. As you can see the company and the stock has not disappointed and have done far better than what I expected at that time.
I have had an eye on crisil for quite some time and finally took the plunge in 2009. It is easy see that the company has an enormous competitive advantage due to government mandated status of a certified credit rating agency and brand. In addition the company requires minimal capital to grow (mainly office space and some computers). The company is thus like a toll bridge which does not require any capital expense.
The second example is of denso India. I wrote about the company here. The company was a cash bargain (stock price below cash on hand).
This is the chart for denso India
I was able to buy at an average price of around 40 and exited at around 85-90 bucks. In hindsight, it turned out to be good operation. However as you can see from the chart, the stock has been sliding since then as the performance of the company went south in 2011.
Where’s the dilemma?
Some of you may be thinking – what is the dilemma here? You made money in both, so both options are great. Case closed.
I don’t think that one should reach that conclusion here. In the case of crisil, the company has been able to increase its intrinsic value at a good pace and the stock price has followed suit. I had to make a one time decision to buy the stock and since then have just sat on that decision.
The case of Denso india is more complicated. The company appeared to be a complete bargain in 2009 and in comparison to crisil was much cheaper. At the same time, the company did not have much of competitive advantage. The trick was to buy the company when it was dirt cheap and get off the bandwagon when it was merely cheap.
This is a more complicated operation than it appears on the surface. One had to time the buy pretty well. If you had bought too early, say in mid 2008, the eventual gains would have been around 30-40%. In addition the sell decision also had to be timed correctly. If you sold in 2011, the gains would have been paltry. I  was unusually lucky in this case.
Thus in the short term,  gains are much higher in Denso type stocks. However one has to make more decisions and then also find a new idea to re-invest the capital. In the case of companies such as Crisil, once you have made a buy decision, you can just wait and watch the magic of compounding take effect
So what is a good option?
If you have tendency to constantly ‘do’ something and want some action, then denso type stocks are a good option. If however, you can live with a few percentage point lower returns with the benefit of much lower effort and headache, then Crisil type of stocks should be your target.
In my case, I do have this tendency to constantly do something. As a result, I am always looking for the next new and shiny stock for my personal portfolio to get that extra return. At the same time I manage my family’s portfolio too. In that portfolio,  I have made the decision to buy high quality , fairly priced stocks and let them compound. The returns could be a bit less, but the risk is much lower and the heartburn almost non-existent.
Following is my partial list of high quality ‘wish list’ stocks
HDFC bank, Titan industries, ITC, Marico, Hero motorcorp, HDFC limited and nestle india.
Time  for some jalebis now . Gym can wait J

24 comments:

Kishor Barhate said...

please do indicate when & @ what price u buy HDFC bank, Titan industries, ITC, Marico, Hero motorcorp, HDFC limited and nestle india .....

Dhwanil said...

Hi Rohit,

Interesting post. Don't you think that methodology for exiting both the stock would be roughly similar i.e. assessing discount in price as compared to approximate intrinsic value? In case of a cash bargain, the driving force for selection is pure value and business quality sufficient to ensure that it does not "burn cash". Hence, as the price rise and cash bargain cease to exit, one shall exit. However, I do agree that this strategy has its own downside and Ben Graham suggested to adopt this strategy as divesified portfolio instead of betting on single stock. So one has to adopt this strategy with pinch of salt!

Regarding your wish list, All of them are wonderful businesses. Wouldn't it take 2008 like crash to bring the stocks to a level where they are reasonably priced?

Lucky said...

Good post, as always. This is a dilemma faced by almost all investors.

The high quality companies seem to / tend to give lower returns over the short term. But if one considers the long term returns coupled with the lower cost oveheads of taxes and fees, they fare much better.

And the bonus is the peace of mind one gets by being invested in such a company.

We would, of course, want to know your estimate of the fair values of these esteemed companies.

Can L&T also belong to this list?

Anonymous said...

Hi Rohit,

Thanks for your post.

Personally, I like buying only quality companies for long term.

In India, at present my main concern being hefty premium attached to them-so even in medium term retun could be less than satisfactory.

comparing India FMCG valuations with international names make choice easy if one has access to international markets.

http://www.reuters.com/finance/stocks/financialHighlights?symbol=RBGPF.PK

stock like Reckitt with mighty brands and CAGR EPS long term growth rate of 15% is avaialable at PE of 14 and dividend yield of 3-4%.

In technology near monopoly Intel with long term growth rate 12-15% is available at PE of 11.2 and yield of 3.12!

http://www.reuters.com/finance/stocks/financialHighlights?symbol=INTC.O

These are same companies which traded at PE of 33 upwards at some point and hence underperformance for long time.

Looking at Nestle, Dabur, Marico reminds me the same. I love to invest in these companies but not at current valuation.

Valuing HDFC is difficult for me with all its divisions but it appears to be a sound coumpounder. Would you be kind enough to tell me whether it is fairly valued at current price?

Regards,

AShok

Anonymous said...

Great post as always. But why? Why do you think Crisil got this value, and not Icra?

RPost said...

Does the Value investor turning technical?

a value investor from germany said...

A dilemma every value investor faces!
I am still not sure if i am more comfortable with deep value stocks or with quality stocks. At the moment my portfolio is mixed with both.

Rohit Chauhan said...

Hi kishor
will provide that data in due course. at the same time times like dec 2011 or nov2008-mar 2009 are good times to pickup these stocks as everyone is scared at that time and these stocks are cheaper and safer too

rgds
rohit

Rohit Chauhan said...

Hi dhwanil
you raise very good points. you are right ..the basic approach is the same. at the same time cash bargins or the real cheap stuff has poor or very mediocore economics ...for example - 2nd and 3rd tier auto component suppliers, second tier chemical companies etc. in all these cases, the intrinsic value is not increasing at a good pace and in some cases it is stagnant

as a result one has to wait for the stars to align for the value to be realised. the longer it takes, more is the opportunity cost. in comparison in case of good business, the intrinsic value is increasing, so even if you wait the final gains are good

you will make decent returns even with graham style stocks, but the good money is made by investing in good business at reasonable or cheap prices.

Rohit Chauhan said...

hi lucky
yes ..the high quality stuff is good if one is a bit patient and it is a pleasent experience holding these companies. the cheap ones generally are with poor economics and horrible managements

L&T is also in the list, but it is more cyclical

rgds
rohit

Rohit Chauhan said...

hi ashok
are you in the US ? a lot of fantastic companies are available at unbelivable prices. Microsoft, pepsi, berkshire hathaway and the list goes on

most people take a simplistic approach. india = high growth = consumption stock = fMCG stocks ..so buy these stocks at any price

and US = low growth = dont buy anything

i personally will not by the so called consumption story stocks at these high valuations

rgds
rohit

Rohit Chauhan said...

Hi anon
have not looked at ICRA for some time. i simply picked CRISIL as it has the highest market share and also mulitple revenue streams

rgds
rohit

Rohit Chauhan said...

Hi Rpost
did not understand your comment ? what is technical in my analysis ? btw, i really dont know anything about technical analysis , so anything technical would only be by coincidence

rgds
rohit

Rohit Chauhan said...

Hi valueinvestor from germany
welcome to the blog. i am partly in the same boat too, but have been moving out of cheaper stuff for high quality stocks as valuations are cheap for the high quality stuff in india

rgds
rohit

Anil Kumar Tulsiram said...

Hi Rohit

Quite interesting blog. I would say that for companies like Crisil or any other growth company we need to know lot more about industry, management, competitive pressure, products etc compared to stock like Denso India, which are more like cash bargains or dirt cheap. On the basis of my personal experience the risk of loss is higher in growth companies compared to cash bargains or where value is substantially below book value. For eg People who had invested in companies like Vishal retail or Pantaloon retail might have to bear huge losses just because they fail to appreciate the risk of debt burden when the company was posting handsome growth.

Anonymous said...

Why would one exit CRISIL. Are you suggesting that it is fully valued. In which case returns should be in line with profit growth which in last 5 yrs is about 20%. IMHO this is a company with a solid management and is rewarding shareholders with 80-90% of profits as cash dividends. Given this why would one want to exit

Anonymous said...

Dear Sir,

lovely blog. I also have a blog over there in Germany regarding Value Investing. Check it out with Google Translate. I hope you will like it :
http://aktienanalyse-fundamental.blogspot.com/

but that is not the reason why i am here. I am here because i want to ask you how can i buy Indian stocks directly ? i asked 3 Indian Brokers. And they couldn´t help me. It sounded that as an foreigner, im German and live in Germany, i can´t open an account with an Indian broker ? is this right ? i never had an answer from this brokers :=(

http://mypursuitofperfection.wordpress.com/ said...

Thanks Rohit for educating us through these examples. I also like the fact that you continue to add to such list of high quality businesses.

Let's hope we come across an opportunity like 2008 again..:-)

Vic

Anonymous said...

Ministry of Finance India press release

IB

Rohit Chauhan said...

Hi anil
fully agree with you on your comment. valuation are always important, and i would not want to overpay not matter what the quality. that is where patience comes in

thats the reason why i have this wish list ...will only when the price is right

rgds
rohit

Rohit Chauhan said...

Hi anon
i did not say one should exit crisil ? i personally am still holding it ..atleast for the time being

rgds
rohit

Rohit Chauhan said...

Hi anon
welcome to my blog ...i did not realise i have readers from germany too :) .in that way value investing is universal.

saw your blog and can see that you have quite a popular blog

i think the indian government is looking at opening up the stock market to qualified foriegn investors soon... dont know the current status

i think one of the readers has left a link

rgds
rohit

Rohit Chauhan said...

Hi vic
good to see you here again. we had a repeat of 2008 in Q3 of 2011 ..isnt it , especially in financials. so i think this will keep hapening. just need to keep eyes open and a strong stomach :)

rgds
rohit

John said...

Hi Rohit,

I've followed your blog for a long time. This post is brilliant and spot-on.