a) I am experimenting with the approach stated below (which I am pretty sure I’ve read somewhere but can’t recollect where). Let me know your views.
The interest rate offered on a AAA bond in India is around 9.75% (SBI AAA, issued in Feb 2011). Now that we have all that interest increase jazz, let’s assume that if any firm would issue a AAA bond today, the interest rate would be around 10.7%. Post-tax, the return would be 7.5%.
Imagine there is some company somewhere in the Indian stock market which delivers around 30% post tax return. That is, its Return on Capital Employed is 30%. Since this company has utilised the capital 4 times better than a AAA bond (4*7.5), it should ideally command a price 4 times the price of a AAA bond.
Post-tax return of AAA bond = 7.5%
Post-tax return on some company = 30% (4 times AAA)
Therefore, the fair value of this company will be around 4 times P/B.
I usually don’t invest in companies with RoCE < 20%. For experimental purposes, I am trying to find companies with RoCE >= 30% with P/B < 4. Since a company can deliver very high returns in any single year, I have taken an average (rather, a median) over the past 7 years (10 yrs would be even better,but I don’t have the data). Extra caution has been exercised to list out only those companies where there has been a continous increase in Book value per share. (Devesh did point to me that this would work only for non-cyclical companies. Also, credit to Moneysights and Valuepickr for the data and tools provided). Here’s a initial list – Thoughts are invited.
|S.No||Company||CMP||Median RoCE 7 yrs||Current P/B||Fair Value P/B|
Of the above list, I like Sesa Goa, NESCO, Goodyear, DISA and Bharat Bijlee. Sesa Goa especially seems highly undervalued according to this parameter (economic conditions, shipping downturn and all that – but is this entry price alright?).
b) This one is for momentum investors. And maybe I am the last person in the universe to realize this trick. Whenever a company declares a stock split or a bonus issue, the share price rises considerably (in cases I have seen, atleast by 20%). So maybe there is a theme here (or probably I am plagued by availability bias – not sure yet). Buy stock of any company (not any company literally – some basic checks on revenue, EPS, RoCE etc. are required) which declares a stock split or bonus (If you think about it, it doesn’t matter whether the company’s face value is Rs. 10/- or Rs. 5/- (2:1 split or bonus) or Rs. 2/- (5:1 split or bonus). The company earnings are not going to change. The only change would be increased liquidity in the market which has nothing to do with the company (but this is after the split, and not before the split) and yet the stock price shoots up. Maybe irrationality. Maybe its a corporate signal that dividends/earnings are going to increase in the future (how?).) No idea. Titan Industries, HDFC Bank are some of the prime examples. Alternately, NESCO share price rose on the split announcement and fell considerably once the split announcement got cancelled.
c) Wonderful read from Prof. Sanjay Bakshi, written way back in 1997 –
Name some companies in the current environment which fall in this ‘relatively unpopular large company’?
Disc: Invested in NESCO. Kindly do your due diligence before investing in any of these companies and all that.