Archive for category Investing Learnings

Learnings from Recent History

‘Recent History’ – an oxymoron, as history is typically measured in decades if not more.

However, given that most PMS funds, hedge funds and all kinds of investors proclaiming their vision and CAGR all over the place by choosing a very convenient 2009-2011 start dates/years to calculate their CAGR, I think ‘recent history’ would serve as a good reminder for all of us that mortality (in investing, as in life) is a good idea to revisit now and then.

Take a look at this snapshot and spend some time reading through the image:

IMG-20151006-WA0002

An emerging STAR fund. Or you can call it by any other name. Portfolio as of Jan 2008. The name of ICICI is not even relevant here, as most mid-cap and small cap funds (and other funds masquerading as value funds) ended up in a similar fate in the great crash of 2008.

Look at the holdings of this fund in detail and ponder. Ponder for a moment, and especially on these lines:

a) The holdings in the portfolio were THE emerging names – with ‘quality’, ‘management integrity’, ‘scale of opportunity’ written all over them – back in 2008. Like we have many names now. With all three adjectives being attached to many of the names.

b) Access to Investing wisdom is not new (already available in 2008). Even the fund managers of ICICI STAR fund had access to a lot of investing books and Buffett’s letters.

c) Scuttlebutt is not new. Fund managers have had access to managements for as long as one can remember.

d) Access to networking is not new. Fund managers have always been widely networked. Only that networking has got more democratic because of technology (and especially whatsapp). Previously, there might have been panics in bursts. These days, there is a panic every day because of costless distribution of any written word.

d) Asset heavy businesses got massacred. Oh, well. We “know” about this now – we never invest in asset heavy businesses, right? Wait till the replacement cost bull market takes over.

d) Asset light businesses also got massacred. Either because the management turned out to be fraud or their industry turned out to be irrelevant.

e) What you don’t see in the snapshot is the price multiples one might have paid for those businesses. Given that ‘infra’ was all the rage back then, the P/E multiples were also high, pretty much with similar explanations that we are attributing to some sectors these days.

There are many more points to ponder just by looking at this image, which is basically a snapshot of the investing theme/rage back then.

Now ponder:

i) Why do you think your portfolio of 2015 is not like the STAR fund portfolio of ICICI of 2008?

ii) What makes you ultra-confident (dare I say, cocky)? [I pretty much assume all of us are going to say ‘nope’ to i) above]

iii) What are the steps one might want to take/plug your learnings to not repeat i) and ii) above? [Hint: Whatsapp/Investing forums is definitely not the answer]

George Bernard Shaw made an epic statement when he said – “We learn from history that we learn nothing from history”. The history of markets is replete with same mistakes repeated over and over again, each time with a different twist (mostly unimaginable/black swan).

Given the proliferation and access to information, let us atleast attempt to learn from history this time? I started with an oxymoron, and I think I ended with one 🙂

P.S: Post inspired by a conversation with a friend who chooses to be anonymous, but is bloody brilliant.

P.P.S: If you think ICICI STAR fund didn’t really tickle your senses, and you are craving for more, here is a more elaborate chart on an assortment of businesses – more varieties than you can find in a Walmart store – quality, scale of opportunity, management integrity, vision, mission, goal, rags-to-riches, first generation promoter – choose your poison – and the current market value is not even 1/10th of what it was.

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Go for the Million!

If you already have a million dollars or more, this blogpost is not for you.

For all others, I’ll cut the bullshit and get to the chase. I am just mighty pissed off.

When you have less than a million dollars –

Please don’t listen to any or all the Gurus who are propagating 16% CAGR, 18% CAGR, 20% CAGR. You know the usual spiel. Say, you have 5 Lakh rupees. Gurus recommend that you should be happy be 18% CAGR or 20% CAGR and over a long period of time (40 years), you would be so rich, that even the rich would be ashamed.

Bullshit.

For all those studies, where you read that if you had invested in quality at any price, and just held on to them for a long period of time (40 years), you would have made enough money to be proud of yourself.

Bullshit.

You really want to know what they DON’T tell you.

By the time you are rich, you will be OLD. You will be very old. Your kids and grand kids, of course, would really appreciate all your journey, effort and all the good things that you have done for them. You will just die as a rich man without all the good things before it. That’s just a tragedy.

Since the readers of this blog are reasonably well versed with numbers, let me illustrate it with numbers.

Let me get the first and the easiest thing out of the way without the numbers. People keep doing these fancy calculations in excel about how much their salary is growing to grow, how health expenses will increase, plug in a sexy inflation number and try to arrive at a figure which they think will be enough for retirement.

Let me solve that for you. You need a million dollars (ex-Mumbai). Unless you want to live the luxurious life of Vijay Mallya ,(well, if you were Mallya, you wouldn’t do all these calculations), a million dollars would let you live and eventually die peacefully.

Ok, now for the numbers bit.

Let’s say you start investing at the age of 27 (well, how better it would be if you could start investing at the age of 15, but try convincing your teenage son or a fresh graduate not to spend on the latest smartphone and you’ll know what I mean). You start with Rs. 5 lakh (You can plug in any arbitary number).

Let’s say you manage to do 18% CAGR over a long period, say 40 years. Do you know how much money you would have by the time you are 67? 37 cr 51 lakh.

Whoa. That’s a lot of amount you say. Definitely it is.

But what would you do with so much amount at 67? You would be old, frail and not really ready to say travel widely or eat whatever you want or whatever shaukh (sic) you have.

Ok. So, how much money would you have by the time you are 57? 7 cr 16 lakh. Did you observe the difference?

Ok. So, how much money would you have by the time you are still fit, healthy and want to do what you want – say at the age of 47? 1 cr 37 lakh.

Did you see the difference? Did you really observe the beauty of compounding? You would not dream to live a reasonably luxurious life, traveling where you want, doing what you want to do with 1 cr 37 lakh.

And that’s my problem with folks preaching ‘my target is 18% cagr because the Gurus said it’, ‘I am ok with 16-20% cagr, but I don’t yet have a million dollars’.

Nobody, or rather, from whatever I have read spells out clearly on this intricate relationship between CAGR and Age. You can be rich, but you are already old.

I would rather die with 10 cr, in the process doing what I want than die with 37 cr to make my children and grand children happy.

And that brings me to my real point.

You should really not be aiming anything less than 35-40% CAGR if you are not already a millionaire. It just sucks not to aim for it.

Why did I say 35-40% at a minimum? That’s because, you can make 100x your money in 15 years with a 36% CAGR. Your 5 lakh will become 5 cr in 15 years (if you start at 27, by the time you are 42 – you are reasonably rich and an almost millionaire). This is not something that I picked up from the now famous 100-to-1 book. That never spoke of age. In fact, he talks very long time frames.

Is this the bull market in me speaking? Definitely. But why not? Look, unless you are outrageously lucky with a stock or timing the depth of a bear market, your BIG returns are going to come only in a bull market. Again, numbers. If a Rs. 20 has to become Rs. 100, you need a 400% return. That same Rs. 100 to come back to Rs. 20 requires just a 80% drop. So, you absolutely need to make killer returns in the bull market to survive the bear market.

People will try to dissaude you by quoting process will get corrupted, people will indulge in speculative stocks etc. My question is – what’s a corrupt process? Just because there is a wave of high quality, high management integrity bull market this time, everybody is on this bandwagon of the right process etc. It’s almost as if investing was just born in 2009.

And speculation. I don’t think speculation is going to net you 35-40% CAGR for 15 years. I have not met anybody yet doing this.

Is this easy? It’s obviously not meant to be easy. Just because you have some internet forums and whatsapp groups these days doesn’t mean investing is easy. There is a lot of hard work, there is a lot of luck and there is a lot of position sizing science involved before you make that million dollars. As Munger says, ‘It’s not meant to be easy. If you think it is easy, you are stupid’.

And speaking of Munger (which, in these days of the current bull market, seem to encapsulate all other Gurus), here’s what he had to say in Snowball – remember, when he was young –

munger

So, for all those people who keep saying 18-20% CAGR, you are either already a millionaire or you are just bullshitting. Aim higher. Work harder. Enjoy the process of investing. And actually enjoy life at the right age. There is no fun in dying rich. And there is a tragedy in dying really rich without having enjoyed or doing what you really wanted to do.

Go for 35-40% CAGR (atleast). Become a millionaire. Live comfortably.

P.S – Cynical folks may obviously point out that 5 lakh is only a starting capital and people will add as and when they grow in life. You know, if people were so disciplined in investing, we’d have a lot more people active in 10 year and 15 year SIPs.

P.P.S – Other folks might point out CAGR is not important but how much, as a % of your networth, is more important to overall gains. Absolutely agree. Convince your friend in a bear market to put 90% of his networth in equities. % of networth is very important, but even with smaller sums of money (and I do think Rs. 5 lakh is a smaller amount of money these days, with freshers from IIMs earning Rs.20 lakh), CAGR at the right levels covers a lot of ground.

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Intense Learning…

Earlier this week, I had the privilege to be a part of an intense, immersive and absolutely enlightening investor conference in Goa. It was an invite-only and unfortunately, I am not at liberty to disclose either the names of participants in the conference, nor the name/theme. Participants were amazing. It was such an intensely collaborative conference that the time spent on the beach in 2.5 days of the conference was about 2.5 hours 🙂 But Goa, being the place it is, relaxes you completely in those 2.5 hours.

Anyway, enough about the background. I think I do have the liberty to compile a list of learning that I had from this conference. This is more like a list that I wrote down on paper, so there might have been a zillion other things that I missed. Papers get lost but Internet is forever (or something like that) and hence this attempt:

1) Owner’s View: Look at every business from the owner’s standpoint. What motivates the owner? What are 1 or 2 key factors that the owner  understands that bring value to the business? How will the owner react in adverse conditions? That’s absolutely critical to value the business. (Book recommendation for this point: “Creating Shareholder Value”)

2) Crossing the Chasm. An excellent mental model to think about businesses, especially emerging businesses. There are two critical strategies for listed markets based on this mental model. a) Initially, follow a basket strategy in an emerging theme (bowling alley phase) and b) More critically (and this was the key learning), the leader usually gets a disproportionate share of the market and hence move capital from basket strategy to the leader once data/analysis points to who would be a leader.

3) Invest in Leaders: Try investing in large, proven and addressable markets (companies trying to create a market usually face a lot of headwinds and probably will not be successful). A further refinement would be to always invest in leaders in pull-based (demand) businesses.

4) What’s the DNA?: Understand the company’s DNA. Look for greatness DNA. The strengths and weaknesses of promoter/owner/leadership gets amplified in the company (and thereby earnings).

5) Write it down: Try and write down core investment thesis before investing in any stock (or selling a stock, for that matter). This would serve as a record to check against reality.

6) Sell a bit: Sell a bit of your most favorite/loved stock and check if the love holds (selling will trigger rationality in a much loved stock in your portfolio). Especially, sell a bit if numbers get disappointing to get rational.

7) Growth, growth, growth: The weightage for growth (usually, sales and then profits) in the Indian stock markets is 50%.

8) What’s your insight?: Decent opportunity size, difficult to dislodge and high predictability are critical factors for any business and in all markets (bull and bear). What requires more effort, insight and is more important to returns is the evaluation of a visible gap between performance and perception (especially, in bullish times like these).

9) Successful patterns: Some of the successful patterns in the Indian stock market have been Growth + Deep undervaluation, Operating leverage + reducing debt, maiden dividend, industries with a reform tailwind, demand businesses + oligopoly and small equity + illiquidity

10) Leverage Darwin: Buy shares (in tracking quantity) of all businesses that you like. Else, it’s usually ‘out of sight, out of mind’. And Darwin theory will force you to forget those stocks even though you seem to be hearing good news (since you don’t even own a share)

11) Read, Read, Read: I found that most good investors in that forum read, at a minimum, 500 annual reports a year (may not be 500 different companies; may be 5-7 annual reports of every company that one likes). And as Munger says, it adds up over a lifetime.

 12) Psychological Denial: One of the bigger mistakes that bright investors usually make is psychological denial. It’s not that they fail to recognize that the business is deteriorating. It is that they don’t act upon it. There would be plenty of time to recognize deterioration of a business and act upon it (sell). But psychological denial comes into play and these bright investors are left holding the bag.

13) Are you screwed yet?: If you are not screwed by the markets in 2 years (consecutively), then watch out. Screwing is just round the corner (not just a bull to bear, but due to transition from confidence to overconfidence, mistakes are bound to happen)

14) Don’t take the lollipop: Many a bright investor with wonderful track records for 5, 7, 10 years get lulled by the market and their analysis. Market, at some point in time, gives a wonderful, sweet (but dangerously poisonous) lollipop which these investors partook and then got rogered. Sometimes, they don’t recover financially and worse, are broken in confidence too. The key always is to be watchful.

15) My observation/contribution in the conference: Be absolutely obsessive about working capital (and detailed components). Working capital is a leading indicator of competitive advantage. If working capital (days) is increasing for all businesses in your portfolio, either you have a shitty portfolio or the economy is going in a tailspin.

P.S: As I mentioned earlier, these are the ones that I wrote down (the essence as such. Detailed discussions on these points obviously were a killer). Such was the intensity of the conference and discussions that there were a zillion other things which I couldn’t/didn’t note down. My biggest takeaway from this conference was the humility and down-to-earth behavior of these brilliant investors who have seen the ups and downs of the market for more than 10-15 years and also have made a lot of money still looking to learn, still looking to share and in general, being absolutely stellar. Lot to learn. And as Frost lingers on, ‘miles to go before I sleep, miles to go before I sleep’.

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Welcome 2015!

After what seems to be a fabulous year for the stock markets in the hope of ‘acche din’, we seem to be headed for a confusing year in 2015. More on that later.

Massive year for the stock markets. I am yet to come across any person in my circle of investors who have not made atleast a 100%+ gain on their portfolio. The extreme I have heard is a 600%+ gain. Multiple nuances to these claims obviously. Suffice it to say that all the hard work on investing in 2011, 2012 and 2013 paid off in 2014 in my personal portfolio too with 300%+ gain (and obviously, the CAGR will automatically get bumped up). Let’s see how it goes from here.

More than the monetary gains, which are no doubt important, I have made some highly knowledgeable, highly networked and yet very humble friends in the bargain and I immensely thank God for this blessing. Markets and studying about Markets have taught me way more than I could ever imagine – useful stuff not just for Markets but in personal and corporate life. The role of luck is hugely understated in every success is one of my most important learning. Stellar stuff in finance, behavior, management, logic, probability, luck, black swans – I mean, the range of thought processes that I was exposed to, thanks to friends, well-wishers and various social networks, has made life that much more richer (and more unsure of?). They say that Ignorance has the highest courage and the more you know about something, the more you realize you know less about that something. I guess that’s true across all aspects of life, including markets. And also perhaps the reason why older folks are more circumspect than the young folks about any decision they make/take.

Since multiple blogs have been talking about successes, I want to go a bit contrarian. What I want to do in this post is not to talk about successes, which obviously involve luck too, but talk about failures. Failures in thought processes than any price action per se (as it was very difficult to lose money in the 2014 bull market even with a faulty thought process).

As the Prof says, there are two types of mistakes – mistakes of omission and mistakes of commission. I committed both types of mistakes in this year. My selfish effort in documenting these mistakes on the blog is to publicly put pressure on myself to minimize these mistakes to re-occur again (and a bear market is very unforgiving).

Mistake of Omission: This is a easier form of mistake, as opportunity cost doesn’t get reflected in numbers or CAGRs. But opportunity cost is a cost and it needs to be accounted for. So, in this year, I missed two stocks – Symphony and Eicher Motors.

Of course, it’s easier to say that in Bull markets all stocks go up, so what if you missed a couple of them? The point is, there was a flaw in the thought process which led me to not invest in any of the two.

Symphony – It’s a little strange as to how much time I spent studying this stock, business, management, listening to their concalls, doing localized scuttlebutt etc. The price was around Rs.325. My logic of not buying this stock hinged on two reasons –

a) Historically, the management of Symphony was known to give very aggressive targets that they were not able to fulfill. Classic case of overpromising and under-delivering.

b) The Sales growth year on year (unless you took the low of 2009 and calculated CAGR) was not encouraging at all. In all stocks I invest, I try to check the historical sales growth and see if the management had the capability to ramp up sales and if there was a temporary industry/global issue. Symphony sales growth was left wanting. \

And then, the Prof also wrote a great blogpost on Symphony and its business. Q2FY14 results came in very well. I bought a token position of 1% at around Rs.370 post Q2 results. However, I was not convinced that Symphony was a stock I wanted to invest (I am usually a concentrated investor, with no more than 7-9 bets). Inspite of all these good indicators, I sold out the stock at Rs.450 and moved on to something else.

You may call it price anchoring. You may call it wrong judgment of business. Or maybe – and this might be my learning –  I underestimated the market’s power of re-rating a stock with an asset-light model, good dividends and a demonstrated quarter-on-quarter sales growth for two consecutive quarters. I really should have bought a chunk post Q2FY14 results. But I didn’t.

Of course, I never expected the stock to go from a 20 PE to a 60 PE to the current price of Rs.2000. But, at a bare minimum, I missed a 3-4 bagger from Rs.370 levels in a easy to understand asset-light business with high dividend payouts coming up the curve on sales growth.

Similar mistake of omission occurred on Eicher Motors. Saw it at Rs.1000. Never expected the RE division to contribute so heavily. Was always thinking that CV division is the one that will turn around Eicher. Totally under-estimated Siddharth Lal’s vision, inspite of seeing a rapid increase in Royal Enfield’s on the roads. The learning – Reading all those Peter Lynch’s books over and over again came to nought. Absolute zero understanding and implementation of Lynch’s statements and thereby losing out on a massive gain (my view has always been, if you can’t implement even such simple things, why read at all?). Of course, never expected this to go to 85 PE. Even at 40PE, I missed a 4-8 bagger from Rs.1000-2000 levels. At current levels, the margin of safety seems quite less, although every analyst and his friends think this is a Rs. 1 lakh stock price business as the CV business is also turning around. If it does go to Rs.1L, I’ll probably write another mistake of a mistake, a meta-mistake blogpost 🙂

Mistake of Commission: A more grave mistake, and probably a bear market would have destroyed my CAGR. I got out unscathed, with some decent returns, but the thought process was pretty sub-standard.

So, I bought this auto-component stock owned by a private equity player as I thought it was highly undervalued at Rs.110 bucks and kept buying till Rs. 120. Nothing wrong with that. But greed overtook me. What I did, since I didn’t have any surplus cash, I sold out most of a artificial leather company, a cpvc company and a three-wheeler company for buying this stock. The thought process was – I will sell these three -> invest in the auto-component story as I saw private equity triggers coming through -> once it becomes fairly valued, I will sell that –> get back into these stories yet again.

The reason why I called such a thought process pedestrian is because I was betting on a series of probabilities rather than a decision or two. I was selling three very good compounding stories, which had given me stellar returns to buy a stock which was only undervalued but not really as great as those three stories with a hope of getting back into those three stories. I was basically trying to time the market, as I thought those three stories were fairly/over valued and this one was undervalued. I got out once I realized the gravity of this mistake (and thanks to the bull market, sold out at Rs.160 in about 2-3 months I think).

The learning, really was, and I keep repeating this to myself over and over – is to never sell a longer term story for a shorter term story. Sell a longer term story for another longer term story. Once in a while, like in 2014, you escape unscathed (with decent returns for a bad process). But in a bear market, such mistakes are going to cost me a lot.

Anyway, those were my mistakes. I may have committed more, but I have probably not yet realized them 🙂

Back to the initial statement about confusing state of affairs in 2015. The markets seem fairly to over valued depending on who you ask. Nobody in the market is saying that markets are undervalued at this point in time. There are a lot of discussions (maybe more than necessary), across all channels of communication, about raising cash to prepare for a crash.

This blogpost should hopefully clarify matters – http://calculatedwagers.blogspot.com/2015/01/when-to-sell-and-when-not-to.html

But my personal view on cash is this – Given that Nifty is not over-valued by traditional means (TTM PE < 24-25 PE) and given most stocks in my portfolio are fairly to slightly over-valued, there is no hurry to get into cash. Cash gets built over time. Of course, there might be minor crashes (10-15%), but that’s the nature of equity markets and you probably shouldn’t be in the markets if you are not ready for such corrections. My view is either be in 0% cash (and expect these minor corrections, and if the businesses you have bought are good, there is only going to be a temporary loss) or be in 30-40-50% cash (which is really like preparing for a crash). Having a 10% cash for example, is only satisfiying the psychological urge to assume you are in control than help you in any sort of corrections. Past corrections in this bull market have led me to believe that quality is not going to correct much – so a 10% cash may not really help in minor corrections. In major corrections, everything’s going to fall and a 10% is no respite.

Disclosure: I am not a financial analyst nor a research analyst. All posts on this blog are only for my documentation and educational purposes. Please contact your financial adviser before taking any decisions.

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This time is different…

Hola and long time no see on this blog. Apologies for not posting regularly (of course, I doubt anyone in the world noticed). Caught between work, investing and a bull market, things have been quite busy.

All right then. With SEBI rules and all that, I will obviously not even venture into mentioning any stock names, much less recommend them anymore on this blog. And given that I post so infrequently, I again doubt my recommendations (if I had any) would have been taken seriously by anybody.

But I do want to point out some unique things that are happening in this market and especially focus on some tidbits of conversation around this bull market:

1) Everybody wants to quit their job and get into full-time investing: With people making 2x, 3x of their portfolios in the last 1 year, a very common theme has emerged – that of quitting job and doing full time investing. Sounds very sexy. Sounds very carefree. Nobody to report to. No more appraisals. No more HR mails. Pure meritocracy (and no bicker politics) in the sense that Market will reward you if your reasoning is right and punish if the reasoning is wrong. Very liberating. The idea in itself is so magnetic, that it can leave best of the folks high and dry. I am highly tempted to do this too, no doubt. I don’t think it’s a bad step if a) you know that you have enough assets and income to back you even if your portfolio tanks 50% from here b) you have a fair idea of what to do in your spare time as investing in general is very boring and would require only short bursts of massive activity (unlike trading) and c) you are actually passionate about investing and learning its million nuances than just being attracted to the idea of not having to report to anybody/hierarchy.

2) 80% of story in 20% of time: Since our memories weigh the recent events more highly, this quote will be attributed to Basant sir, but I can assure you that many senior and legendary investors have said the same thing. I have massive respect for Basant sir (and the education he provides constantly) along with other legendary investors but this is precisely the wrong time (start or middle of a raging bull market) for such utterances. People remember quotes and not entire interviews and thought process. What is 20% of time? What is 80% of story? How much time should I spend so that the 20% of time is actually useful to learn 80% of story? My read is that legendary investors have sifted through so many stories, so many stocks, been through multiple cycles that they have various heuristics to understand which story may run well and which story may not (and still be only 60% right). Investors who are on the learning curve, in my opinion (and that includes me), need to spend as much time as it takes to know everything about a stock as possible. They need to have an illusion of control, atleast thinking that they know everything about a stock before clicking the ‘Buy’ button. When they have sifted through enough stories, and been through one bull-bear-sideway market cycle is probably when they would know and really understand the meaning of ‘80% of story in 20% of time’. Till then, using such statements to justify a thesis would be a recipe for disaster.

3)  This is a stock picker’s market: This is an all-time favorite. I really don’t know what the statement means as it is used in every type of market (bull/bear/sideways). I had already shot off a warning on twitter for anyone who wants to use such statements. For the sake of brevity, will avoid repeating that threat.

4) Is it 2005 or 2007: This thought has been running through many investors’ heads (including mine, evidenced by my twitter thread). Stocks have been moving up so fast that everybody has started estimating FY17 and FY18 earnings. Portfolios have moved up 2x, 3x or more depending on the stocks and portfolio allocations you have done. People are scared if there would be a massive correction from here and equally excited about another massive run from here to say 35000 on the Sensex. Which one is it then? 2005? or 2007? Or does it matter at all that even in massive bull runs, there are routine corrections of 20% in due course. Or that your CAGR will be quite healthy even if you don’t score big over the next 3 years?

2013 2014 2015 2016 2017 2018 CAGR
100 125 250 275 302.5 332.75 27%

Above is an illustration of any investor who started with Rs.100 in 2013 and ended up with Rs.250 by end of this year. Even if this investor takes this money and puts it in a fixed deposit giving 10% returns (well, take 7% in case you are tax-sensitive), 3 years down the line, with a risk of zero capital loss, he/she is going to end up with a healthy 27% CAGR. Legendary investors will tell you that a 27% CAGR is an absolutely great number to have. What they may not ask you of course, for the risk of sounding rude, is how much of your net worth was in equities before you put it in fixed deposits. We all know the math. We all seem to know the trick. But what do we do?

Bah, who cares about data. Is it like 2005 so that I can buy more? Or is it like 2007 that I need to sell? Tell me that first.

5) The fallacy of selling 20% below the top: Which brings me to my next and favorite topic. Nobody wants to leave the party that is going on. Value investors are very famous and take great pride in laughing at the stupid statement of former executive of Citibank saying “”As long as the music is playing, you’ve got to get up and dance.” We laugh and laugh at that stupidity. We quote Buffett. We quote Munger. Why, these days, we have become more exotic and even quote Daniel Kahneman and his super book ‘Thinking, Fast and Slow’. But almost no-one wants to exit the party. These days, the hypothesis is even better. These days, investors say that ‘let the market reach the top and then correct…we’ll all get out 15%-20% from the top’. Let me explain this fallacy through a famous picture:

image

That’s the chart of the IT bubble – starting from 1996, all the way till 2001. All those investors who say ‘let the market reach the top and then correct……’, would they want to get out at all the points marked ‘Red’ in color? How would they know in advance? Conversely, in reality, wouldn’t most investors get out at all the points marked ‘Green’ in color? Not really. Every investor worth his salt wants to get out at the point marked in ‘Orange’. How many can do it? I seriously doubt if it would be in high single digits.

Then again, the lure and the logic is too irresistible. Combine fallacious logic with your neighbor (rather, twitter/whatsapp friends) making more money than you everyday – and you have got a dynamite waiting to blow up. We all want to dance till the last minutes, irrespective of how many times we read Buffett pleading ‘the clock has no hands’.

6) Impact of social-investing: Post the 2008 crisis, a new kind of animal took shape in the world and seems to have impacted the markets in a big way. The animal of crowd-sourced investing/social investing/forum investing/whatsapp investing. This has been a massive boon for all investors to connect themselves to superb investors across the country. I have personally benefitted, both monetarily and otherwise by picking brains and discussing stocks and worldly wisdom with some super investors and have learnt quite a lot. If one has already networked in the wave, it would hold him in good stead in the future too. Given recent SEBI rules (to circle back and tie in to the first paragraph of the post), unless clarifications come, there are hardly going to be any stock recommendations in blogs and forums henceforth. Given that most investors have caught onto the mantra of “‘scope of opportunity + management quality’ is enough to understand and invest in a story” (never mind that each parameter in the equation itself is a universe), how would the investors cope with no recommendations would be fascinating to see. In fact, I think that ‘scope of opportunity’ has been defined so widely that maybe sometimes even promoters are shocked and surprised at how wide we have defined ‘scope of opportunity’. The investor seems to say ‘aapko pata nahi aapki company scope ki taaakat’. There might be some Ph.D down the line, maybe in 2025, who would probably write a book on how SEBI rules had far reaching impacts on how investors in the millenial age behaved in the Vision 2020 age.

Prashanth has a wonderful post on investing and social media. Read, if you haven’t already.

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Goodbye 2013!

So, it’s that day of the year where everybody looks at the year gone by – some with happiness, some with wistfulness and some others with a tinge of sadness. Nevertheless, everyone except for the greatest of cynics look forward to the new year with hope, enthusiasm and happiness.

So, here’s wishing all of you a fantastic happy new year 2014!

From an investing standpoint, I wanted to jot down some notes for posterity –

a) Performance: At the beginning of this year, I started deploying most of my capital towards equities. Right now, except for emergency funds (and gold and real estate of the old), most of it is in equities. Maybe it’s a sign that the market top is here and it’s all downhill from here 🙂 My portfolio’s return over the past 5 years is now 30.4% CAGR, helped massively by some decent investments I have made over the last year. 25% of my portfolio has been invested in HDFC Bank and that has returned 0% over the past 1 year. If I remove the best performing stock in my portfolio (which gives a slight indication of whether the portfolio is robust enough, and that you weren’t just ‘lucky’), the returns fall to about 22% CAGR. 8% CAGR difference is massive if you consider a long enough timeline – but for now, the portfolio seems robust enough, although there is a long way to go in terms of a perfect portfolio.

b) HDFC Bank: As I said above, it constitutes 25% of the entire portfolio and has returned 0% over the past 1 year.  I have an idea of what to do with most of the stocks in my portfolio except this one. This is probably the bluest of the blue chips and has been with me for the longest time (esops) and has compounded extremely well. I do understand (and have read) that the stocks don’t know you own them and you need to be un-emotional about stocks etc., but this one is slightly special. Many a time, I have come mighty close to selling a portion (or all of it) to invest in other opportunities, but have held myself back so far. Other good friends of mine have suggested to take the option of LAS (loan against securities) against this. Somehow, I am slightly averse to leverage. Anyway, this stock has been my biggest dilemma of 2013. Behavioral science is that much more tougher to implement when one stock is a runaway success.

c) Friends: To begin with, they were just acquaintances who used to interact regularly on investing forums like valuepickr and whatsapp groups. Slowly, over many conversations, and on everything under the sun, this year has been amazing in terms of getting to-gether with like-minded friends and learning a lot from them. It is my belief that incremental CAGR will come, not just by reading and working on your own but also consulting with like-minded friends who can teach you a lot about investing much faster and point out behavioral flaws in the nicest manner. This easily has been my biggest benefit of 2013 and hope to continue in 2014 and beyond.

d) Mistakes of Omission: Well, I would not call them mistakes because I had consciously avoided them after reading up  on their businesses. These businesses have gone on to becomes doublers in about 6 months or less. One of the changes that I have noticed over the past year is that I no longer feel the need to ‘catch-up’ or ‘missing out’ on a stock. Stocks like PI Industries, Acrysil, MPS etc. have doubled in the last 6 months. I had read about them but didn’t invest in them. The reasons are many – I either didn’t understand the business completely or didn’t like the management or didn’t understand the competitive landscape well and hence didn’t invest in them. I maintain a 7-10 stock portfolio most of the time and I can’t afford not understanding a business/not understanding the triggers for growth/not able to track more details on the company. I am not really too worried about mistakes of omission (and I honestly think nobody should unless their capital is massive).

e) Mistakes of Commission: This one gets my goat. Thankfully, there have not been too many of them this year. However, I did lose 0.5% of my portfolio capital on one single stock – CP labs this year. In fact, I sold the stock at a 20% loss and the stock has promptly moved up 50% from the time I sold – talk about wonderful timing 🙂 This stock had all the wonderful influences of psychology while buying it and also while selling it. A story for another day perhaps. Other than that, lost tiny bits of money on APW President delisting and Cravatex (I kick myself for this investment – as it was on a whim, a bias for action than anything else). The takeaway for me from this year is to not invest on a whim and not get taken by the influences of psychology. Both are of course extremely tough to do, but that’s the challenge, ain’t it?

f) Unsatisfactory Profits: This is a strange case where I made some good profits, but am still unhappy to have take then decision to buy (and then sell). The stock case in point is Avanti Feeds. I saw massive value when the stock declared its Q1 results this year and bought quite a bit in my portfolio (at around Rs.170). The price kept increasing from then on, but I was on tenterhooks all the time – especially because there were so many variables to track. Inspite of all the assurances from various forums, I was really not comfortable holding the stock and tracking the stock on a daily basis (can’t do because of my day job). So, I sold – in the range of Rs.240-Rs.265. Decent profits but not satisfactory. I really want to get into a system of investing in stocks with not too many variables in 2014 and beyond, especially the ones that don’t keep me on tenterhooks every day.

g) Special Situations: As you would have noticed over the past year, I have not written about special situations on this blog (or actually, written on hardly anything at all). I have stopped analyzing them for multitude of reasons – a) I have realized that they are very intellectually stimulating but not very monetarily stimulating, considering effort vs return b) They don’t end up giving me the comfort of compounding and am exposed to reinvestment risks c) Too much competition chasing too few special situations, resulting in hardly any arbitrage. I may invest in special situations in the future, but they are going to be very few in number.

Hope to blog more in 2014. And wish you a very happy and prosperous new year.

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Numbers don’t lie!

Today was a very humbling experience. I did a mammoth exercise of plugging in all numbers since the time I have been investing (6 years). This included stocks, debt (this is a combo of debt mutual funds+cash – not loans), equity mutual funds, one ULIP (yes, I had one ULIP). I didn’t consider PF. Over the past 6 years, my CAGR is 18.2% as of today’s closing prices. And here I was, thinking that I was doing 30-35%.

A few facts upfront, before I dive into details:

i) My broad portfolio as of today is 39% in Stocks, 23% in Debt and 39% in Real Estate. The real estate consists of my home back in my hometown. Technically, it is an asset (I have already paid off the entire loan) but my parents live there and I don’t think I’d be selling the house ever (unless, a massive black swan strikes).

ii) I have not included Gold in the portfolio calculations. Gold is an asset, inflation hedge etc., but we Indians never sell Gold unless and until it’s an emergency. So, again, technically, it is an asset but not really. If I include Gold in the total assets ratio, it’d be 34:20:34:12 (S:D:R:G).

iii) In general, I have tried investing as carefully as possible (one of the prime reasons being, if I fail, I don’t have a inter-generational wealth to back me and pick me up again). This also included taking max. term insurance to protect my family from black swan.

iv) Although I am invested in stocks since 2007, active investing was only since the last couple of years. Before that, it was a combination of pure luck for gains, and pure speculation for losses. The last couple of years have been pretty good in terms of % gains, but not very high in absolute numbers.

Alright, that story done, let me dive into a few details.

a) Let me put the 18% CAGR in perspective. 18% handily beats all ‘Large&Midcap’ and ‘Midcap&Smallcap’ funds. However, my target has always been atleast 25% (else, not worth the effort). My aim is to hit 25% p.a on average till I hit atleast a 8-figure number on the Stock+Debt portfolio. So, 18% did come as a big bummer. Here I was, thinking I could easily beat the markets, value the business, discuss and argue cogently with hallowed investors and then there was this number that stared me in the face (I double checked the numbers, just to ensure I have not under-performed, willingly).

b) The last 2 years of active investing has been pretty good, but so has the record of the midcap/smallcap market in the past 2 years. If I eliminate the first 4 years of my passive investing, the last 2 years CAGR came to about 40% p.a. This again, is due to a combination of extreme luck (forums like valuepickr/theequitydesk in no small measure), effort (constant lurking on wonderful blogs like I mentioned before) and a bit of reading (which helped me avoid the dumbest mistakes). However, since there were a host of factors like paying off my home loan, wedding expenses (oh my!) etc., the lack of sufficient capital led to not much of absolute capital appreciation. I hope I can sustain this luck and learning for a long time so that my capital grows too.

c) Drilling down to the details. HDFC Bank is a clear winner, not much in % terms (it’s like 5x in 6 years) but I put in a quite a lot of capital. In fact, I would boil this down to luck too. I accrued ESOPs since I worked for HDFC Bank, and I bought all ESOPs that got accrued when I left the Bank (split-adjusted price of Rs.125/-). In fact, I had taken a personal loan to buy all the options. Thankfully, Mr. Puri is carrying the Bank along well. A combination of extreme luck (working for the bank and hence ESOPs) and monstrous stupidity (taking a personal loan to buy stocks) – but it is now an anchor stock and has served me well. Too bad, I didn’t buy this one yet again in the 2009 bear market.

d)  Out of the 38% in stocks, 10% of it is in a venture. When I mean, venture, I mean an unlisted company. There is this very good friend of mine who had an aeronautical spare parts company. He was committed to his company and grew it by leaps and bounds. He then got an opportunity to tie-up with a major company and asked me if I’d invest. I knew this guy to be honest&committed, he was putting in a lot of his personal stake, and the major company also put in 50% of the total capital. I saw a large scope of opportunity and committed management and invested 10% of the stock capital in it last year. Thankfully, it is going well. Of course, if and when the company goes for an IPO, I am committed to write a glowing IPO note to pump the stock :). Let’s see how far this goes. Yet again, outlier event, extreme luck of having him as a friend, and he asking me if I’d be interested in investing.

e) In the last 2 years of active investing, forums, blogs and books galore. Inspite of major undervaluations in very good stocks shared by one and sundry, I had the heart to commit major capital to only two stocks – Mayur Uniquoters and Atul Auto. Of course, I have exposures to Astral Poly, Kaveri Seed, Muthoot Capital, PEL etc., but even if they go 3x, at the current capital allocation level, they are not going to make much of a difference to overall wealth. Inspite of multiple people urging me that ‘Pharma’ was simple, it was simply my laziness and lack of interest that I didn’t dig through the story of Ajanta Pharma/Unichem etc. Ajanta Pharma, in hindsight of course, was a major miss. This 40% p.a return in 2 years, I would admit, involved a lot of effort, apart from luck. Effort in reading up valuepickr/theequitydesk every day and see if I can invest in a stock or not.

f) In essence, if you remove my top 4 stocks – HDFC Bank, Venture investment, Mayur Uniquoters and Atul Auto, my portfolio % returns is okish, but the absolute capital is very meager. It is surprising how Buffett’s rule (top 25% stocks make most returns) is discrimination-less even for an amateur investor like me.

g) Of course, contrary to Buffett’s rule, I have made far more than 20 purchases (20 punch-holes). And in most of them, the returns are less and some are even negative. I should have just stuck to buying more of the success stocks rather than diversifying into many and multiple.

h) As I was doing the analysis all of today afternoon (I had to pull out 6 years worth of reports etc.), the experience was very taxing and liberating at the same time. I understood some of the mistakes I made, some of the portfolio allocation decisions I took, portfolio sizing problems that I encountered and will encounter in the future etc. So to say, it was a meditative experience. Till, I hit the ‘Enter’ button on the XIRR formula. After that, everything came crashing to the ground, which is currently leading me to deep questioning and introspection. I don’t know what will come out of it though.

Not sure if this post helped you in any way. Not sure if 3 facts and 8 ramblings made the post long and/or boring. The key takeaway though is I needed extreme luck and constant lurking on different forums to make any of my gains 🙂

I look forward to interactions with any senior investors reading this – a) Were you in this situation before? b) How do you go about correcting flaws in thinking/approach? and any other tips/tricks to help me survive and grow in the market.   

P.S: If you are a novice/amateur investor, and haven’t done the exercise of pooling in all the stock&debt portfolio at one place (I recommend Google finance, simply for the reason that excel sheets tend to get lost in nested-nested-nested folders with the same names), please do so. I can assure you, even if the XIRR value is not too exciting, the very fact of putting down those numbers is tremendously educative.

DISCLOSURE: The stocks that I mentioned or referred ARE NOT be taken as recommendations for a Buy or a Sell. Please do your own due diligence before investing.

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Random thoughts…

It’s been close to 2 years since I started this blog. A 2 year anniversary gives me the permission to distribute some learnings and hence a few random thoughts I’ve learnt over these couple of years –

a) The curse of ‘value investor’: The term ‘value investor’ is a burden. In fact, I think it’s a burden to be categorized into any one particular type of investing theme. Almost everybody in the world is trying to buy stocks cheap in the hope of selling it at a higher price (even a speculator thinks he is buying Rs. 1 worth of stuff for Rs. 0.90 in the hope that the market will eventually correct itself in the next 1 hour; a growth investor thinks a 60x P/E stock is worth it etc). Ben Graham himself called it a ‘mystery’ when he deposed in one of the Congressional sessions when asked what exactly causes an undervalued stock to reach its intrinsic value. Some others call it the Invisible Hand which corrects all prices. The axiom of ‘Markets are voting machines in the short term and weighing machines in the long term’ is said by all and sundry. And so is ‘Heads I win, tails I don’t lose much’. At times, I feel I don’t understand any of this stuff. And in other times, I feel that these axioms are too simple to encapsulate the complexity of investing. However, all the above afflicts almost every type of investor – value, growth, GARP etc. However, only one curse hits the ‘value investor’ very hard. It is the perennial search for the undiscovered stock. Nobody wants to hear the same old stocks anymore; stocks which have been wealth creators and probably will create wealth for a long time to come. ‘Value investors’ want their next kick in some unknown stock (or a stock that is not widely known). We sort of believe, after we have read ‘Intelligent Investor’ again and again (too much for our own good) that we have to discover an undiscovered stock (rather, we presume an undiscovered stock = inefficient market and hence larger chances of mispricing). We are like the addicts who screen for stocks for various parameters and miss gems just because they are widely known and we assume an efficient market in the stocks that are widely known. The faster I get out of this affliction, the better it is for me.

b) Concentration vs Diversification: This is a perennial question asked in many forums – which one is better? The real question underlying this seemingly innocent question is actually ‘which methodology would make me the maximum return in the minimum amount of time, without losing a paisa’? The answer, obviously varies from person to person and is entirely subjective. In my view, I think it is dependent on so many factors. I will just elaborate on what worked for me.

I have realized off late that I don’t have the skill to monitor and keep track of a lot of stocks (Ayush, Safir and a lot others have this skill as an instinct). In fact, I have fallen in the trap of spreading my little time available (outside of my day job) into researching every new stock that is quoted on twitter/other forums. In fact, not only have I spent time on these ideas most of which are outside my circle of competence, but have also made the cardinal mistake of investing in them. Now, given that I have been lucky to find guys like Ayush, Safir, Hitesh, Devesh writing about these different stocks, I haven’t lost money on them, but I haven’t gained much either in absolute terms. Let me explain. To quote a psychological term, I suffered from deprival super reaction syndrome. When these guys tweeted about certain stocks (let’s say pharma for instance, of which I am only learning baby steps now), I had found that over a period of time that these ideas made money (by and large). So, whenever these guys tweeted/wrote about some stock, I invested 1-3% of my portfolio in these ideas (given that these are usually outside my circle of competence, I can’t get myself to invest more) and made money – Nitta gelatine, Unichem, Ajanta, Smartlink being some of them. However given my limited time and resources, I couldn’t keep track of events, tweets, qtrly results etc. of all these stocks (and maybe I couldn’t understand even if I looked at all of these). Although the end result turned out alright, the process is clearly wrong.

On the other hand, stocks which I understood, which I researched and which I put in 10-20% of my money are clearly outperforming and wealth creating. HDFC Bank (my alma mater, and I had put in the greater part of my networth into this stock back in 2007), Cera (which I wrote on this blog long ago), Mayur (valuepickr’s choice, and the undervaluation and the business screamed at me), Astral, Atul Auto (this was a cinch), Oriental Carbon (to Ayush’s credit) are some of the examples.

The experience has taught me that a concentrated portfolio with 6-8 stocks have worked much better for me than spreading my bets across many different stocks. Of course, if I encounter a black swan event in any of these stocks, that’s when the chicken will come to roost, but I think given that I give a very high weightage to management integrity before it becomes a substantial part of my portfolio and I don’t play with F&O, the chances of a wipe-out are low and I hedge it off by not allowing more the 10-20% allocation for any stock.

So, net-net, identify where your strengths are, how your past experience has been, how much time/ability you have to analyze many stocks and then bet accordingly than listening to anybody’s opinion on concentrated vs diversified question.

c) Price anchoring: The fallout, of course, of a concentrated portfolio is that you will be subject to the extreme bias of price anchoring. For example, I saw Mayur at Rs.150/- (adjusted for bonus), bought quite a bit and then it went to Rs.230/- and then bought a little more. Now, given that the market was recognizing the undervaluation, and it was still undervalued at Rs.230/- levels, ideally I should have bought more and more (subject to my limit for the stock). But I didn’t. I fell into the trap of ‘let it come down, and I will buy more’. Today, it is at Rs.460/- and counting and although I don’t see a huge undervaluation from these levels, if it goes to say Rs.700/- in 1 year’s time, I am sure to experience hindsight loss aversion. The same thing got repeated in Astral (bought it first at Rs.130/-, bought some more at Rs.160/- and then stopped buying and now it has doubled) and Cera, and Atul Auto etc. I am slowly coming out of this bias (believe me, it’s been a very difficult process because you encounter a thought of – if the market falls rapidly from the elevated levels that I bought the stock, then what?) and I am slowly buying Atul Auto now (also, when you are trying to get out of this bias, you will keep hearing of the BSE small/midcap index overvalued, QE3 not having much effect, reforms not taking shape leading to a market sell-off etc. which makes this process excruciatingly difficult and you’d just want to hold cash and do nothing). Doing nothing is great, holding cash is great too if and only if your mentality allows you to invest all of this cash when the world is going down rapidly. For example, Charlie Munger held money in Treasuries for about 10 years and when the moment was right, invested 70% of net worth into one stock, Wells Fargo. You just got to decide(within yourself, not as a justification to others/in some forum) if you possess the same mentality.

d) Bailing out vs Doubling down: This has been one question which I loved playing around with. When do you bail out of a stock and when do you double down on a stock (in other terms, average down) when there has been a savage fall in the price. Let me state some recent examples.

SKS Microfinance, initially invested by Narayan Murthy (at Rs.300/- level) as venture capital and then IPOed at Rs.980 levels shot up to Rs.1400/- levels very quickly. Most forums claimed that it would be a great buy at Rs.700/- levels. One forum also claimed that it would be a blind buy at Rs.300/- levels, if and when it came down. And crashing down it did (allegations of fraud). From the highs of Rs.1400/-, it crashed to Rs.60/- levels (CMP: Rs.112/-). Nobody squeaked of buying this stock when it was crashing from Rs.1400/- to Rs.700/- to Rs.300/- and then to Rs.60/-. Everybody wanted the picture to be clear before they invested. Of course, we all forget from time to time that if the picture was clear enough, the market wouldn’t price SKS Micro at Rs.60/- levels.

Manappuram Finance, the premier gold loan provider, touched an all time high of Rs.95/- in Nov 2010. People started buying this as a proxy to multiple things (rising gold loan prices, rural growth proxy, network effects, rising acceptance of gold loans etc). It came crashing down to Rs.20/- levels as recent as June 2012. So, do you bail out or do you average down? In my mind, I have one criteria for further evaluation. Was there a fraud or not? If there was no fraud (or fraud allegation), I am perfectly willing to double down (rather average down). In this case, there was a RBI objection, there was a large investor bailing out, there were promoter pledged shares being sold etc., but there was no allegation of a fraud. A perfect case for further evaluation to average down (as usual, this is just the starting point to check on intrinsic value and buy cheap shares). If it was fraud, then treat as sunk cost and just bail.

In recent examples, IRB Infra was another which fell to Rs.100/- levels, moved up to Rs.150/- quite quickly (and now at Rs.120/- due to another allegation of a crime). Ajanta Pharma which quite a few in the forums that I am part of are invested, is facing some kind of tax evasion problem. Although the prices haven’t crashed yet, it’d be good to monitor and evaluate whether your reasoning tells you to bail or average down.  (When I say ‘double down’, I am not talking of doubling down blindly and get into gambler’s fallacy – that would lead to disaster).

e) Special Situations: I look at my blog search feeds and it delights me that most people land up on this blog because of special situation analysis, although I have hardly put up any actionable special situation which can lead to a profit. Evaluating Special Situations personally is very satisfying compared to let’s say stock analysis since there are so many parameters to consider and secondly, it helps in sharpening the stock analysis scenarios. Some of my friends have suggested that I start a paid special situations newsletter (actionable ideas) for a nominal cost. I am considering it actively, and would like to know your views in the comments section if that is something you’d like.

Disclosure: The stocks mentioned in the post are only for educational purposes and not a recommendation for buy/sell. Please do your own due diligence before investing in any of the stocks mentioned in the post.

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Special Situation – Open Offer Analysis – Brescon Advisors & Holdings

These guys were also known as Brescon Corporate Advisors till a few months ago (just in case you’d like to check on brokerage reports of the past – if there are any).

I will evaluate this special situation combining the principles/questions outlined by the Prof in this post (which, needless to say, is a must read for anyone who wants to do risk arb and the complexity is getting complexier and complexier 🙂 ) along with the analysis I had done for Tata Sponge Iron/Tinplate company in my previous post.

This open offer was brought to my notice by my friend Ashish Kila today morning. Also, at today’s closing CMP, there is no trade that can be done in this open offer on a profitable basis. This post is only for analysis (which reminds me, I need to come up with a mindmap kind of thing for open offers after the Prof’s complete post on the risk arb problem).

Anyway, Nusarwar Merchants Pvt. Ltd. (NMPL) has come up with an open offer to buy 26% of Brescon at a price of Rs. 123/-. Today’s current CMP is Rs. 113/-. The genesis of this offer was a 33.75% buyout from certain sellers (looks like a part of the promoter group, also called ‘persons acting in concert’ in the latest AR) in Brescon on 29/Sep/2012 and hence this open offer is a triggered offer. Here’s the link to the open offer.

Let’s go through the Prof’s questions to analyze this then (and given that all regulatory approvals are through and the chances of any regulatory surprises are close to nil, the relevant template would be template #2).

a) What’s the expected return of this operation?

Ans. The current CMP is Rs. 113/-. The offer price is Rs. 123/-. Payment would be done by Dec 25th, 2012 according to the schedule (2 months from current date). Since 33.75% has been acquired, theoretically, 66.25% can tender. Theoretical acceptance ratio would be 26/66.25 = 39.24% (approx to 39%). Let’s say I buy 100 shares and I expect the price after the open offer closes to be Rs. 100/-.

Investment = Rs. 113 * 100 = Rs,11,300/-

39 shares would be accepted at Rs.123/-. 39*123 = Rs. 4797 (Rs. 390/- would be the gain, on which 30% marginal tax would be applied since STT wouldn’t be applicable while tendering, but I’ll ignore this for now)

Remaining 61 shares would be sold at Rs.100/-. 61*100 = Rs. 6100/-.(a loss of Rs.793/- can be used to offset short term capital gains, if any)

Total return = 6100+4797 = Rs. 10897/-

That is, Investment > Total return, resulting in a loss, assuming a theoretical acceptance ratio.

b) Should you look at fundamentals of the target company? Why or why not?

We should certainly look at the fundamentals of the company since there is a chance that we can acquire shares of a good company at a very low cost. However, in case of Brescon, after looking at the fundamentals over the last 2-3 years and this slump sale arrangement (where they sold Brescon Corporate advisory business to their own subsidiary company on a slump sale basis citing some convoluted logic, read Item No. 3 on Page 6 of that arrangement for starters), I am not too comfortable in acquiring shares of this company for the long term.

c) What is the likely acceptance ratio i.e. how many of your shares are likely to get accepted under the offer (theoretical vs. practical) and what key factors will govern that ratio?

The theoretical acceptance ratio is 39% as stated in a). The practical acceptance ratio might be different. Given that only one part of the promoter group has sold out, the remaining promoter group has approx. 24% of the shareholding. Since this looks like a voluntary sellout by one part of the promoter group, the rest of the promoter group may not participate in the open offer. However, the chances of the promoter participating is non-zero. The retail shareholding is close to 20%. On a historical basis, not all retail investors have tendered for various reasons. Let’s assume 5% brain dead investors then. Let’s look at the two different scenarios then (am assuming the rest will tender)

S.No Scenario Acceptance ratio Possibility Probability
1 Promoter group doesn’t tender; 5% brain dead investors 71% Highly likely 70%
2 Promoter group tenders; 5% brain dead investors 43% Probably not 30%

A few calculations summarized in the table below –

No of shares 100
CMP 113
Offer Price 123
Investment 11300
Price post open offer 100
Gain if  
Acceptance ratio 71% 333
Acceptance ratio 43% -311
Expected value per share based on probabilities above 1.40
Gain% on expected value on an annualized basis 7.50%

Therefore, we’ll have a gain of 7.5% on an annualized basis without considering the effect of taxes, service tax, cess etc. This is poorer than the return if we invest the same money in a liquid plus mutual fund for 2 months. Hence, this opportunity is a pass.

d) How can you use the “inversion” (invert, always invert) trick to estimate market’s assessment of the acceptance ratio?

Ans. Let’s assume that the market cost of capital is 12%. That is, 2% for 2 months of money.

CMP is Rs. 113/-. At the end of 2 months, at the market cost of capital, the money should have been Rs.115.26. We can find the market’s expected acceptance ratio by

Rs. 115.26 = Offer price * Accepted shares + Remaining shares * Resultant share price after open offer.

Plugging in the values,

Rs. 115.26 = 123*x+(1-x)*100 and solving for x, we get an acceptance ratio of 66.34%. That is, the market is pricing to almost close to the best case scenario (refer table above) where the rest of the promoter group doesn’t tender and there are 5% brain dead investors. This is clearly very optimistic and hence the chances of a substantial upside is close to nil.

e) Should you borrow money to do this operation? Should you have done it in Template 1? Why or why not?

Ans. With the expected value of 7.5% p.a, and being a retail investor, I cannot borrow at less than 12%, if not more. This clearly is a losing operation for me. Hence, I wouldn’t borrow for executing this operation.

Segways:

a) There is certainly a price at which this operation can deliver a lot of value. Between now and 11 December 2012, if the market price of Brescon falls below say Rs. 100/-, this operation will have a quite a bit of value. It is not profitable just right now.

b) I have not considered the scalper syndrome scenario where you buy at Rs. 113/- and say if the market shoots up and if the price goes to Rs.118/- by end of next week, you can make some returns in quick time. However, then I would be speculating than evaluating.

Disclosure: No position in this open offer. This post is only for analysis and not for investment purposes.

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Interesting Corporate Actions – PVR Ltd and TV18

There have been a few interesting corporate actions over the past 2 months. I will elaborate a couple of them here.

a) PVR Ltd – The first one is from PVR Ltd. (of PVR Cinemas fame). I observed this strange set of events way back in August and yesterday’s Devesh’s tweet on the event was the final push required to write this blogpost.

In summary, PVR Ltd. did a buyback in 2011 (in the May-Oct timeframe) and now sold shares (in the Aug-Oct timeframe). You’d wonder if PVR was in the entertainment business or financial engineering business. On the whole, it seems to be value-accretive to PVR, but this buy-sell stuff in the space of 1 year is a little unsettling.

The details.

PVR in June 2011 announced a buyback of shares not exceeding Rs. 26.21 cr representing 9.99% of the company (as an aside, a buyback greater than 10% requires a EGM and hence most companies don’t do it), with the max. share price of Rs. 140/-. 10% of 27,149,372 shares (total equity) represented 2,714,937 as per audited Balance Sheet at March 31, 2011. The Company proposed to buy-back a minimum of 562,000 Equity Shares.

Anyway, cut to the chase, as per this September 2011 notice, PVR had bought back 1,388,328 shares utilizing Rs. 15.82 cr (excluding brokerage and taxes) and that was the end of the buyback (that is approx. 5.1% equity was bought back at an average price of Rs.114/-). As an aside, the book value (net of debt) of PVR Ltd. as of March 2011 was Rs.126.12 cr. That is, 12.55% of book was used to buy approx 5% of equity back – not a great buyback by any standard, but not extremely poor either.

Anyhow, that was history. Cut back to the present. Aug 2012. This news item indicates that a private equity player called L Capital wanted to buy 10% of PVR’s equity at a price of Rs. 200/- (a 7.5% premium on the then market price Rs.186/-). This translated to 28.85 lakh shares (well, there were just 2.595 cr shares after the buyback and then PVR issued a some fresh shares (0.3 cr shares) to L Eco (at Rs.200/-) leading to equity dilution and hence now the equity is actually 2.85 cr shares). With this sale, PVR gets Rs. 57.7 cr for further expansion.  (There is a small bit on further Rs.50 cr investment from L Capital into PVR Leisure, a PVR subsidiary (and PVR will eventually have only a 35-40% stake in this business), but that is not pertinent to this discussion).

So, net-net,

PVR bought back 13.88 lakh shares for Rs. 15.82 cr in Sep 2011.

PVR sold 28.85 lakh shares for Rs. 57.7 cr in Sep 2012.

Is it value-accretive to PVR? Certainly. Even if you consider that the 13.88 lakh shares which were bought back were sold, the firm netted a gain of 75% within one year without considering the extra benefits of the network of a private equity player, the extra investment into the PVR subsidiary etc. Also, the debt has not increased due to the equity sale, so hurrah!

But should PVR indulge in this buying and selling of equity frequently? The jury is still out on that one.

b) TV18 – This Network18 group has always fascinated me. Not like a Page Industries fascinating, but fascinating with their ingenious financial engineering capability.

This time, the Network18 media group decided on the rights issue part of engineering. Of course, all and sundry do know about the Reliance-Raghav Bahl-ETV-Network18-TV18 story and complications, so I will not get into it (please to google, if you are not aware of it – the twists and turns will put the movie ‘Race’ to shame).

I will analyze this TV18 rights issue as an ‘expert’. That is, I will try to exactly explain why the stock moved from the lows of 20 to the highs of 30 today. (Actually, to be fair to ‘experts’, I am cheating. I had done this analysis much before and only blogging about it today). I have had no positions nor will I ever have positions with the Network18 media group. Their skill in shortchanging minority shareholders is unparalleled and since I have a day job, I can’t monitor their schemes daily.

Anyway, here’s the analysis I had done once the rights issue was declared –

The rights issue size of TV18 is Rs. 2700 cr. For every 11 shares held, 41 shares will be issued on a rights basis, each share costing Rs. 20/-. CMP of TV18 Rs. 22/-. If I had 100 shares today (as total equity), post-rights issue, I will have 500 shares for the company. But since the equity is coming through at close to market price, major correction may not happen. In fact, there might be upsides (unless of course, the management dreams up something else). The management of Network18 stock will garner money through its own rights issue and invest in TV18 rights issue. Therefore, the chances of higher allotment are very low (and since the rights price is very close to market price, why would I want to go for a higher allotment?)

The stated intention of the management is that total debt of TV18 would be re-paid and remaining amount would be used to fund the acquisition of ETV channels. The possible increase in revenue due to acquisition of ETV channels aside, this debt repayment has very interesting ramifications on the EPS of TV18.

Consider the P&L statement for the year ending March 31, 2012 (I am looking at standalone results. The consolidated results are much worse, and they are losing money at an operating level). The EBITDA of the company is Rs. 97.42 cr. The interest payment is Rs. 93.48 cr. That is, 96% of the money generated is funding the interest costs. What would happen if the interest costs vanished, since the debt would be extinguished? Let’s do a small financial exercise –

Assume revenue doesn’t increase (which is a pessimistic assumption, since ETV channels are going to earn some revenue). So, EBITDA, say will be around Rs. 97 cr. Now, there are no interest costs to service since the debt has been extinguished, utilizing the funds from the rights issue. Depreciation of Rs. 25 cr. Therefore, PBT is Rs. 72 cr. Due to accumulated losses over the past 6 years (yeah, they have been losing money in all six except the year ending 2012), taxes would be zero. Profit would be Rs. 72 cr.

Now, the equity base currently is 34 cr shares. March 2012 profit is Rs. 9 cr. That is Rs. 0.26 per share. The equity base will increase by 135 cr shares, taking the total equity base to 169 cr shares.

Therefore, technically (forget the interest of June 2012 quarter for a moment), the EPS would be Rs. 72 cr/169 cr =  Rs. 0.42 per share, an increase of 63% in EPS, without any increase in revenue. Of course, now we consider June 2012 interest and Sep 2012 interest (sum approx to Rs. 58 cr). That would bring down the EPS to Rs. 0.09/-, but that’s only in the short term.

If the tailwind of digitization works (Safir Anand’s pet topic) and ETV revenues flow through, at the very least, TV18 is going to earn a decent profit, maybe equivalent to March 2012 profit, but with zero debt. A stronger balance sheet ideally should propel this stock to greater heights. Even considering consolidated results, if the management pays off the entire debt as claimed, I think TV18 will generate a decent profit at the end of FY13. However, I am not buying. Too many ifs and buts.

P.S: If you are on twitter and not following Devesh  (@_devesh_) and Safir (@safiranand), you are missing on interesting conversations. Go, follow!

Disclosure: I have no positions in PVR and TV18 (or Network18). This is not investing advice. This post is only for analysis purposes and not a buy/sell recommendation.

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