Tuesday, November 22, 2005


  1. Shai Dardashti on Grahamian Value, a really good blog on value investing and one of the most comprehensive such resources I've seen on the Net. Highly recommended for people who follow Buffet, Graham and other fundamental analysts of their ilk.
  2. Value Stock Plus, which belies its name by spending a fair amount of time on global trends and movements of economies around the world, kind of like a CNN for the blogosphere! Check out the interesting comments on the Indian economy in this post and this one
I'd also take this opportunity to thank everyone who commented in response to my last post. Do keep coming back!

Monday, November 14, 2005

Looking Back

My interest in stocks - actually in investing in general - began early last year, when I read 'Rich Dad, Poor Dad' and was inspired enough to sit up and take some interest in my finances, open demat and trading accounts, set up mutual fund SIPs and begin to take an active interest in the stock market.

Beginner's Luck

I was lucky in chancing upon some really good books on fundamental analysis and value investing which I could use to work out an initial stock-picking strategy. Far too many people I think get into day-trading and market timing, approaches that are not suitable for everyone, especially for salaried types like me who don't have the time, guts or funds to get into such short term plays.

I was even luckier to get into the market just before the major crash at the time of the 2004 elections. I saw many of my holdings go into the red but I didn't have enough in the game to panic. Instead, I took the opportunity to add to my holdings, based on some conservative target prices I had worked out by applying various ideas I had got from my readings. The research took time and a great deal of number crunching, but it was worth it.

Lessons Learned

It's now been about 18 months since my first stock purchase and the markets have swung all over the place, from around 5,500 to 4,500 to 8,800 to 7,500 and now back to around 8,500. During this period, a patient and savvy investor would have had several opportunities to buy good companies at decent prices and make money.

I was neither as patient, nor as savvy or alert as I should have been through this period but I think I've made a decent start and would like to share a few of the things I've learnt and validated so far:

  1. Have a target purchase price based on some sound reasoning: This is the biggest lesson I have had so far and I am yet to learn it fully! Based on a study of your target company, you must have an idea of how much you're willing to pay. Don't get swayed by the market. I have applied this sporadically and been rewarded handsomely each time. Conversely I have screwed up several times by not working out the price properly before jumping in
  2. Have a target sale price and / or some sensible offloading criteria: Again this is based on a study of why the company is attractive and when it will not longer be worth holding. I have not suffered significant losses selling late but I have sometimes given up sizeable gains by selling too early
  3. Have confidence in your analysis: Flying in the face of popular opinion is surprisingly difficult to do but remember that if you've done a good job of the research your opinion is at least as valid as everyone else's! The corollary to this is that you must check and cross-check any calculations you are doing, especially if you are using Excel as it is very easy to screw up one formula and end up bankrupt!
  4. Be patient: That stock you have your heart set on will sooner or later come down to a reasonable valuation. Wait for your target purchase price to be reached before making a move. It could take a long time but it's better to have cash and do nothing than to jump the gun and have nothing!
  5. Evaluate the management: Your company is only as good as its management and share prices will in the long run reflect this factor. I try to judge management by comparing their forecasts and stated plans and strategies from old annual reports with actual achievements as evidenced in subsequent years. This might not be good enough, though.
  6. Hold on to a good thing: Why churn your investments if they are doing well? I like steady companies like ITC and Cipla that hold out the promise of slowly, but surely gaining ground year after year.
  7. Don't be too cautious: Putting in a tiny amount is going to yield nothing worthwhile so, if you are betting on a stock, make sure the potential gains are worth the effort
  8. Don't sweat the small stuff: Don't get hung up on making another rupee. Too often we have a stock making profits at, say, Rs. 119 and we hold out for it to reach 120, only to see it fall to 110 before we have to sell in panic.

My Portfolio as a Basis for These Lessons

Lesson 1: A conservative target price yields good results

  • Purchased Hero Honda in May 04 - currently at 76% profit
  • Purchased SBI in July 04 - currently at 105% profit
  • Purchased ITC in May 04 - currently at 122% profit
  • Purchased Infosys in April - currently at 86% profit
  • Purchased Cipla in May 04 - currently at 60% profit
  • Purchased Wockhardt in May 04 - currently at 58% profit
  • Purchased iFlex in April 04 @ 510 - sold recently at about 90% profit

All these were bought at or near target prices I determined through Excel-based analysis

The price for not following this lesson? I bought Thomas Cook a few months back at 550, after which it dropped to 500 and has never come up to 550 again. I'm sure I will make money in the medium term, but it could have been better...

Lesson 2: Have a target sale price

My best example is iFlex, which I sold at 977 immediately before it dropped to below 900. I believe it was a good move as the PE is too high and future prospects uncertain.

I've screwed up on Patni, which at a 20% profit in a matter of a few months. If I had thought it through, I might still have been holding it at a profit of almost 100%! Even worse was my purchase of Nestle at 575 and subsequent loss-making sale at about 560 (when I got worried by its steady decline). The stock is currently over 900!

Lesson 3: Have confidence in your analysis

I passed up City Union Bank when it was at 32 just because some bankers told me it was no good even though my analysis was screaming out for me to buy it. It is currently at 95, a three-fold increase in less than a year. Worse still, I finally bought it at 85 but realised my mistake and sold it at a small loss.

On the other hand, I've had two spectacular successes - a 60% gain in 6 months on the obscure Indian Hume Pipe Company (I've sold it) and a whopping one-year 500% increase in Torrent Cables, another unknown company (I still hold it).

Lesson 4: Be patient

After scaling the rarified heights of 500 and 600 last year, Biocon finally came down to about 400, when I was finally able to buy it after tracking it for months. The stock is currently over 500.

Lesson 5: Evaluate the management

My Biocon purchase was based almost entirely on the management quality and ability to deliver on its promises. I also bought Bharti Tele a few months back, again mostly on the strength of its management (and a recent dip in price that brought it into the BUY zone), and it is already up 70%!

Lesson 6: Hold on to a good thing

I'm still holding almost all the stocks I bought in last year's crash. They've rewarded me handsomely and look set to keep on delivering the goods for years to come

Lesson 7: Don't be too cautious

I invested way too little in many of my small-cap stocks and repented when they turned out to be spectacular successes - notable example again is Torrent Cables where I could kick myself for not putting in more

Lesson 8: Don't sweat the small stuff

I've not been guilty of this, thankfully, but know several people who've had horror stories of this sort.

I hope this was useful. Do write in with your thoughts.

Happy investing!

Tuesday, November 08, 2005

'Winning On Wall Street'

I recently stumbled across this book by Martin Zweig, a mutual fund manager who was quite well-known and respected in the '80s and '90s. It is simply amazing, especially for people like me who focus on fundamentals and have little or no idea on technical investing.

The most interesting aspect of 'Winning on Wall Street' is that, based on research into the long history of the Dow, Zweig outlines a set of parameters as well as a complete forecasting model that he used to forecast the onset of bull and bear markets on a consistent basis!

Imagine that - wouldn't you like to be able to tell when an upsurge is an aberration and when it is actually the start of something big and so get into the market early? Or when a small dip might be leading to a major market decline?

The only issue is that the model is based on the Dow and hence the triggers might not work for the Sensex / Nifty, though the parameters (like interest rates etc.) are universal. It needs someone to work out the values at which the Indian markets make their moves, which might not be possible as the Sensex data goes back only 20 years.

Would be worth a try, though. Even better would be marrying such an India-specific 'Zweig' forecasting model with a working stock-picking model based on fundamental analysis in order to get truly spectacular results.

The key takeaways for me are the list of parameters to consider when evaluating market moves and the relationships between them as proposed in the model.

The book is a little academic in nature, but simply written and definitely very high up in the list of investing books to read.

Note: For a list of other good books, please check out my previous post on the subject

Tuesday, October 25, 2005

Help Me Fight 'Comment Spam'

I just spent 45 minutes deleting spam comments from various posts on the blog and am really PISSED! So far I'd kept the comments free for all, hoping that it would encourage all you guys to share your views with the minimum of fuss and bother.

Unfortunately, spam comments are outnumbering genuine ones by at least 5 to 1 and so I'm having to disallow anonymous comments. I hope all you guys out there will understand and take the time to create a blogger ID so you can continue to contribute to this blog. On my part, I hope this step reduces the spam to a more manageable level so I can devote more attention to writing.

Thanks for your support and do come back soon!

Tuesday, October 11, 2005

Companies I'd Love to Own - 1

For a follower of Warren Buffet, I’ve been quite remiss in my attention to great companies. It’s time I focused more on the brand names and businesses I’d be proud to own rather than chasing every company that looks undervalued and diffusing the gains on my portfolio.

Buying only on value and / or clear future promise is a philosophy that has paid off very well so far, getting me into great businesses like ITC, Infosys, SBI and Bharti at prices that seem throwaway by today’s standards. I’ve made at least 60% on these on an annualized basis, not bad by any standards!

In line with this strategy, I plan to maintain a watch-list of my favourite companies, starting today. Today’s post contains a few of the more obvious ones and I will keep adding companies to the list over subsequent posts. These may not be undervalued right now – in fact almost all would be priced quite high in today’s market – but there’s bound to be a time in future when I can pick them up on ‘sale’.

And, when that happens, I’ll be there. Will you?

Today’s List

I bet you recognize all of these companies, making them a great way to start a list of 'Great Companies to Own'

  1. Jet Airways
  2. Blue Star
  3. Hero Honda
  4. Bajaj Auto
  5. Maruti Udyog
  6. State Bank of India
  7. Punjab National Bank
  8. ICICI Bank
  9. HDFC Bank
  10. Kotak Mahindra Bank
  11. United Breweries
  12. ITC
  13. Infosys
  14. TCS
  15. Wipro
  16. Blue Dart
  17. Sintex
  18. Britannia
  19. HLL
  20. Asahi India
  21. Apollo Hospitals
  22. Hotel Leela Ventures
  23. Mirza Tanners
  24. CRISIL
  25. Trent
  26. Pantaloon Retail
  27. Dabur
  28. Marico
  29. Gillette India
  30. Cipla
  31. Wockhardt
  32. Ranbaxy
  33. Bharti Televentures
  34. Biocon

Do write in with your suggestions on companies big and small that might belong to this list. They must have something that gives them a strong, sustainable advantage in their market. Usually this is a brand name but it could be anything - a captive market, a niche area of expertise that others cannot get into, an early mover advantage in a potentially lucrative market...

Will wait for your comments. See you next time.

Friday, September 30, 2005

IPO - Suzlon Energy

Suzlon is by far the largest wind-energy provider in India, a lucrative and under-served market for renewable energy. It is also the sixth largest such company in the world.

What I Like

  • The company holds a strong and sustainable position in a growing market where barriers to competition (need for an impeccable track record and significant capital to bid for projects) are high. Further, India is a potentially huge market for wind energy and there’s plenty of room to grow domestically. And petroleum prices are shooting through the roof, making renewable energy even more attractive
  • Suzlon has captured 3.9% of the global market this year, which is much better than the 1.9% it has of the cumulative installations till date. This means it is actually increasing its share of the pie, a very encouraging sign
  • Further, the company has demonstrated sales and profits growth of 54% and 47% respectively on a cumulative basis for the past 4 years, which compares quite well with the issue PE range of about 29-34

What I don't Like

  • The EBITDA / EV margin is in the range of 11%-13% for the issue price band, which, unfortunately is a bit low for a relatively high-risk business. Wish the company had been able to bring it up to at least 15%
  • The company has re-stated its numbers due to changes in its accounting policies. The cumulative effect of these changes has been to increase the profits for the last year by Rs. 204 mn leading to an EPS increase of about 66p, which is significant. While the accounting changes are probably all right, I’m sure the fact that they led to increases in profit was a big factor in approving these changes. Sneaky!
  • The Price to Book ratio for Suzlon is around 12, whereas the same is in the range of 3-10 for its peer group companies. A P/B ratio of 12 is very high and would be an immediate disqualification for conservative investors
  • Being sixth (with a tiny market share of about 1.6%) in a relatively small global market means Suzlon will have to really work at its strategy in order to grow faster than the market and move into the big league. The top player in this market has twenty-two times it market share and even the 5th largest has five times the market share of Suzlon.

In Summary

Apply if you like ‘growth’ stocks that with potentially significant upside (though at a high risk) – and even then go for the lower end of the band. Those willing to hold it for many years will definitely reap huge benefits - after all the market will really explode when the cost of wind energy comes close to that of fossil fuels.

Don’t touch it if you are risk-averse or if you have a short horizon.

Friday, September 23, 2005

Value Pick - The Coming of Zicom

I first stumbled across this company (www.zicom.com) when I was surfing the net for home security solutions. And I was instantly hooked!

Well Worth Watching

This tiny concern has a lot going for it, investment-wise.

  • It's in a niche sector and getting to a dominant status with growing brand recognition and appeal
  • A slew of products and partnerships catering to the security needs of organizations
  • An impresive and growing client list
  • A recent product cum service offering targeted towards home users, priced attractively on a monthly payment model
  • Improving financials - better margins, better ROCE / RONW, fairly low debt (rising, but that is to be expected with a growing company)

I believe it has ample room to grow given the focus and attention that Indian corporations are now giving to security.

I also expect the home user offering to be simply lapped up by the well-to-do. At a couple of thousand a month, even I can afford it and it comes with the 'cool' factor that's likely to appeal to the upwardly-mobile, urban male. Wait for a few years and watch the home security market explode!

A Tad Over-Priced

It's difficult to price this company, just as it is with all small-caps. There isn't a sufficiently long track record to base one's opinions on unlike with, say, an ITC. However, we can take a guess.

Today's price (even after the Sensex fall yesterday) is about Rs. 150, which implies a PE ratio of 22.5, approximately in line with historical earnings growth. This is a little too high for my liking, though the good news is that quarter-on-quarter growth seems to be over 30% and RONW is nice and healthy.

Ideally, I'd have liked to buy the stock at Rs. 125-130, though I must confess that when I first saw it at that level I wanted it below Rs. 100! Just shows you what we value investors are like - never happy!

I expect Zicom to reach at least Rs. 165 around April next year. Hence, in my opinion, it is an OK buy at Rs. 150 and a great deal at Rs. 125. Hold it for longer and the story should get better once the company attains some scale and gets noticed by the fund houses.

So set your limit orders, sit back and enjoy.

Current Market Price: Rs. 150

Tuesday, September 06, 2005

iFlex - A Good Time To Sell

I sold my iFlex shares yesterday.

The company has rewarded me well - I especially enjoyed the run-up in the price after the Oracle news - but it seems to me that it has gone too far ahead of its real value for one to hold on any longer.

Valuation Seems High

  • PE stands at around 35 but the company has only grown at about 23% CAGR over the past 5 years. Average PE over the past 5 years has been around 25
  • EPS growth has slowed down over the past couple of years
  • RONW has consistently fallen from about 35% in 2002 to around 18% now, a huge drop, especially given the fact that book value has not really been growing very fast either
  • Oracle's open offer (based on their assessment of the company's value) is much below current market price

Prospects Not Clear

  • iFlex has so far been a leading player in universal banking software, which is usually purchased by mid-tier banks. Given the company's phenomenal success over the past few years, it has actually covered large parts of its traditional market in Middle-East and Africa. In order to grow it now needs to look at the US and Europe, which are much more competitive markets and have several established, dominant banking systems players
  • The company has shown greater growth in the services space than in products, making it more of a mainstream IT player and bringing it in direct competition with the Wipros, Infys, TCSes and Satyams of the world
  • The ability of iFlex to move into large banking solutions through the good offices of Oracle might be a little over-rated as Oracle works closely with many of the other leading banking software vendors as well

The way forward for iFlex is fraught with a lot of uncertainity and it seems more prudent to sell at what seems to be a high and wait for iFlex's strategy to become clearer over the next year or so.

Current Market Price: Rs. 970

Monday, September 05, 2005

Value Pick - Torrent Cables

Hello world! Like the proverbial bad penny, I’ve turned up again – and just when you thought it was safe to venture into the blogosphere! Sorry for not writing these past few weeks but I’ve been a bit preoccupied with shifting hearth and home overseas. Hope you weren’t feeling too lost without my insights into the stock market ;-)

Anyway, here I am with another long-term recco. This time it’s a small cap company, Torrent Cables.

I bought this stock almost exactly a year back, when it was quoting at Rs. 50 and it has rewarded me handsomely, appreciating about 5 times since then. And the story is not yet over, methinks.

A Turnaround Story

Torrent Cables is part of the USD 550 mn Torrent group of companies and a sister concern of the better-known Torrent Pharma. It is in the power cables space and, as of 2001, it was struggling to keep itself afloat. Things reached such a state that it was referred to the BIFR (Board of Industrial and Financial Reconstruction) in 2001, where it was financially overhauled over two years.

Torrent Cables emerged in 2003 a leaner, fitter entity and there’s been no looking back since then.

Remarkable Improvement in the Numbers

  • EPS has grown from 4.16 in 2002 to 19.88 in 2005 – an increase of almost 5 times in 3 years, yielding a CAGR of about 68% year on year
  • Book value has grown from –0.08 in 2002 to 46.48 in 2005. It has actually doubled in the last year itself
  • The company has declared a dividend for the first time in 5 years this year (only 2 rupees per share but that indicates management confidence in sustainable earnings and also that the company has better ways to invest the remaining profits)
  • Operating profit margins have improved from 17.43% in 2002 to 21.51% in 2005
  • Net profit margins have improved from 5.91% to 10.96%
  • RONW has improved from 20.39% (already quite good) to a whopping 43.61%
  • Best of all, debt-equity ratio has declined from 2.07 (high debt) to 0.08. This is also reflected in the interest cover, which now stands at a very healthy 26.20

Why is it Still A Good Buy?

  • Torrent Cables is in a business related to the infrastructure sector, which itself makes it worth a look. It has a long and pretty impressive client list, as can be seen on the company web site
  • Financials have been steadily improving (as can be seen from the above discussion)
  • The stock is currently trading at a PE of about 12, which gives it a PE to growth (PEG) ratio of 0.2 indicating under-valuation relative to its growth rate
  • Torrent Cables seems undervalued when compared to its peers as well – Universal Cables is at a PE of about 70 and some of the others are actually loss-making
  • It has shown a quarter-on-quarter growth rate of about 35% in EPS for the quarter ended June 30, 2005
  • Mutual funds and FIs have so far not been significant shareholders in the company, probably because of the really low market cap of this company, which made it an unattractive institutional buy till now. Only in the past 3-4 months have a couple of funds invested in it to the extent of about 7% of the company, indicating that the stock is now on the mid-cap fund radar. Once the market cap increases a bit more (from the current 120-odd crores to about 150-200 crores), I expect more institutional interest and hence a significant revaluation of the stock upwards.

If the stock PE is revalued higher to at least 15 (seems reasonable based on past and expected growth rates) and the earnings grow by about 30% as seems to be indicated, we can expect the stock price to go up by at least 40-50% over the next year, which is quite attractive.


Downside seems limited as the company is showing impressive growth and the PE is low. Financial ratios are attractive and, even if they may not improve significantly beyond this point, amply justify the investment. A note of caution for Graham-style, ultra-conservative investors - the price to book value is very high at about 5.

The risk is probably more on the market side. If the Sensex loses steam, midcap stocks in general will see a sharp slide in prices. This should, however, make Torrent Cables even more attractive in the long run.

Current Market Price: Rs. 246

Wednesday, July 20, 2005

IPO Analysis for Fun and Profit

Hi all! I’m back after a brief vacation and in keeping with my philosophy of writing for the thinking investor, here is my long-overdue note on IPO analysis.

[Note for people who think the title is nerdy: Make the profit and you’ll get my drift]

What follows is a list of things I look for when evaluating an IPO. These are, of course, generic and there are usually industry- and company-specific idiosyncrasies in each IPO that must be evaluated on a case-by-case basis.

The good news is that it doesn’t take too long to cover all the ground. On an average, it takes me no more than two or three hours to do the research (a fast internet connection is an asset) and make up my mind about an IPO.

Is that good enough? Possibly not, but then my track record is perhaps better than average and it’s tough to find more time than that anyway!

Part I: Screening (10 mins)

  • Already Listed: Beware if a company is already listed. Chances are that it is trading at a huge premium to the offer price band at the time of the IPO and you’re tempted to make easy money. Going by recent history in many such offers (Punjab National Bank, Jindal Polyfilms) the prices are likely to come down close to IPO levels and you’ll make little or no listing gains. Invest only if you really like the business and even then it might be a good idea to wait till after the IPO and pick up shares straight from the market.
  • Prior Experience: Experience of similar IPOs in the past should serve as a good guide to investing in any fresh issue
  • Industry: Are you comfortable with the industry the company is in or do you feel it has bleak / unpredictable / cyclical prospects over the long term. Know what you’re getting into
  • Market Cap Post Issue: Does the post-issue market cap ‘look’ reasonable or does it look like a grossly inflated figure e.g. Google has a market cap higher than McDonald’s, which, even given Google’s potential for stunning growth, seems a little out of whack
  • Demand: Check out the NSE-BSE demand graph on the NSE website, especially on the last day. This will indicate the extent of oversubscription. Most investors seeking to make quick profits would apply for highly oversubscribed issues but I tend to favour the less popular ones as chances of getting a decent allotment there are better.

Part II: Googling! (1 hour)

  • The Company Website: Look for their products and services, financials (if available), geographic spread, client list, history, management profiles, press releases, partnerships and client testimonials. If you’re really lucky, you’ll find downloadable documents / presentations related to the business and the industry on the company website. Read these carefully and no points for guessing that such transparency is a sign of good, professional management
  • News Items: Check out news items (try Google News) on the company, preferably going back at least 2-3 years. These will give you a feel about the company, its management and its overall direction as well as its recent achievements and level of visibility. One often also finds out things (usually bad things like lawsuits and squabbles between promoters) that are under-stated in the prospectus but quite important from an investor’s perspective.
  • Analyst Reports / Informed Opinions: Right from Sharekhan and Moneycontrol down to blogs like the celebrated one you're reading right now – there’s a wealth of opinion on the net. Get as many perspectives as you can.
  • Industry and Peer Group: Which other companies are engaged in similar lines of business? How are they doing? What are the general trends (growth, innovation) in the industry?
  • What People Are Saying: Check out the bulletin boards on Moneycontrol. They’re always buzzing with activity, though only about a tenth of the posts are of any use. You’ll might find a nugget or two there.

Part III: The Prospectus – Softer Aspects (30 mins)

You’ll find offer prospectuses (prospectii?) on the SEBI website. It could be filed as a draft, ‘red herring’ or final offer document. I have no clue as to the differences between these but I guess they are pretty much the same.

  • Risk Factors: These are outlined right at the beginning and again in the middle of the document. Several of these are of the ‘filler’ type but tread carefully – there might be a couple lurking about that could really rock the boat if they were to come about. Examples of these are sizeable lawsuits (ERA Constructions), chances of a major industry downturn in the near future, over-dependence on a single or small group of clients / suppliers etc. There is often a discussion of management’s viewpoint on some of the ghastlier ones and they are worth taking note of
  • Business Overview: There is usually a 2-3 page discussion of the industry structure and trends as well as key growth factors. This is worth reading to get an idea about the industry and to identify the company’s special niche (one hopes it has one!). As a bonus, knowledge gleaned from one prospectus can be used in IPO / stock analysis in the same or related industries
  • Objects of the Issue: The proceeds of the issue should be used entirely in value-enhancing, business-related purposes. Anything else – like Emami using 17% of the proceeds to build a plush head-office – is a strict no-no. Use of proceeds for working capital is also not a very encouraging sign
  • Track Record: The company must have a decent track record. Investing in brand-new companies (like YES Bank) is a huge risk in my book. If you must go for such issues thoroughly check out the management and the company’s strategy, because that is the sum total of what you’re paying for
  • Promoter and Management Profiles: Ideally the senior management should have long years of experience in the industry and be professionals unrelated to the promoters. Companies where the leadership roster reads like a family tree are best avoided
  • Promoter Holdings Post Issue: Should be high enough to keep them interested in the business but not so high as to smother professional management completely. Something like 40-60% sounds about right.

Part IV: The Prospectus – Financials and Hard Numbers (1 hour)

  • Check on Diluted Financials: Remember to check that all per-share data has been calculated on a diluted basis i.e. on the increased number of shares outstanding following the issue
  • Growth Rate: What is the cumulative growth rate of overall sales, net profit, and operating profit of the company over time (at least three years of data would be provided in the prospectus). What is the average year-on-year growth rate? Is it steady and increasing or showing signs of unpredictability, with wide deviations from the average growth rate?
  • PE Ratio: Is it reasonable compared to its peers (a peer-wise comparison is often provided in the prospectus)? Ideally the PE Ratio should be lower than the average growth rate and also at a discount to peer values
  • Return on Equity / Return on Net Worth: Is the ROE figure comparable or higher than its peers? Is it growing over time? I’d ideally like companies with ROE over 20% and growing
  • Debt / Equity Ratio and Interest Cover: Is the debt / equity ratio low (for the industry) and consistently falling over time? Does it compare favourably with its peers? Is the interest cover high (preferably over 5) and consistently rising?
  • Price to Book Value: To be a bargain, the price should be below the book value (price to book ratio of less than 1) but that is a utopian dream in a fresh issue. Anything that seems about right for the industry should be fine. Growth stocks (like IT, Pharma, Biotech) usually have prices waaaay beyond the book value.
  • EBITDA / Enterprise Value: This ratio determines the return on investment for someone acquiring or buying into the company (like us!) and works well for growth companies like small IT players and capital-intensive enterprises like airlines and telecom. I’d ideally look for something greater than 10%
  • Unusual Spurts and Dips in Financials: Look for suspiciously high profits in the last year or sudden increases in personnel / raw material costs. These may be genuine but one should know the reasons for the same.
  • Large Bonus Issues / Stock Grants in Recent Years: These only benefit the promoters and leave less on the table for investors like you and me
  • Notes to Accounts: Often neglected, this is the place to look for financial jugglery if you can make sense of it. If not, trust in God (and the management) not to hand you a mini Enron!

Part V: Informed Sources (10 mins)

  • Friends in the Company: Company employees are usually a good source of down-to-earth information that cuts through the hype. The flipside of course is that most insiders usually paint an overly pessimistic or optimistic picture based on a relatively narrow view
  • Industry Insiders: People in the industry usually have some idea of the main players and especially about their competitors. Such people are a good source of unbiased, though sketchy, information

Do write and let me know whether you found this useful.
Till next time, adios amigos!

Tuesday, June 28, 2005

IPO - ERA Constructions

I'm definitely not going in for ERA Constructions. Looks like a major risk for at best moderate returns. Read on...


I'm sure litigation is a way of life in the construction sector but even a brief look at the number and seriousness of the cases pending against ERA (check the prospectus) should make any would-be investor tread warily.

Most of the cases are such that an adverse ruling could lead to the arrest of the promoters / senior management.

A couple of biggies:

  • Indian Oil has claimed damages to the extent of Rs 4.44 crores + 18% interest. The proceedings have been completed and a decision is awaited. As per the prospectus, the arbitrator "may award the entire amount along with interest and costs" in favour of Indian Oil. Yet it seems no provision has been made at all in the financial statements. This despite the fact that an award of this magnitude would almost wipe out the entire FY 05 profit of the company
  • A counter-claim by the PWD (Public Works Department) in an arbitration case works out to Rs 1.54 crores, for which again no provision has been made

As per the prospectus, the company has not acknowledged claims amounting to Rs. 6.5 crores as debts as in the opinion of the management, these claims are frivolous.

Inadequate provisioning as indicated above has led to a healthy-looking balance sheet but it looks to me like an axe waiting to fall!

Poor Record on Regulatory Compliance

SEBI has served notice on the company for regulatory violations (probably poor financial reporting) in the period 1998 to 2002 and the company is paying a penalty of 1.75 lakhs to SEBI for the same. I fact, ERA Constructions has even waived its right to a hearing, thereby making it evident that it has no defence.

Or perhaps it was in such a hurry to push through the IPO that it wanted to get such matters out of the way, hmm...?

Inadequate Track Record of Promoters

Of the three promoters, only one (Mr. HS Bharana) has experience in the field. The others have little / no experience or knowledge of the business. Imagine what would happen if HS were to be booked even for a short while in connection with any one of the myriad cases against the company and its promoters!

Unusual Accounting Policies

Investments are stated at the cost of acquisition. Provisions for diminution in the value of investments are made only if such decline is other than temporary in management's opinion. Usually investments are stated at cost or market value, whichever is lower.

No Great Shakes Expected on Long-Term Returns

The issue is not significantly under-priced compared to its peer group, implying that any major gains would need to come from earnings growth. As evident from the discussions on litigation above, the earnings themselves are a little suspect.

In a nutshell, the investment is not worth the risk.

Wednesday, June 22, 2005

IPOs - Nectar Lifesciences

I know I was supposed to post my thoughts on IPO analysis but today’s the opening day for the Nectar Lifesciences IPO and the company looks like a good buy so thought I'd take a rain-check on preaching for today...

The Business

Nectar Lifesciences is a pharma company engaged primarily in API (Active Pharmaceutical Ingredient, the chemicals that actually have medicinal value in any tablet, syrup or powder we consume) manufacturing. It focuses on manufacturing Cephalosporin and Semi-Synthetic Penicillin (SSP), both of which are anti-bacterials and has manufacturing facilities in India as well as Sri Lanka.

It currently supplies to several Indian pharma firms including Ranbaxy, Aristo Pharma, Alkem, Ind Chemie and Biochem.

What Makes the Issue Interesting?

Reasonable Growth Prospects

  • SSPs seem to be in a de-growth phase and demand seems to be slackening. However, the accelerating growth of Cephalosporins more than makes up for it. Bulk drugs (APIs) have shown a growth of almost 20% year on year for the past decade. One of the objects of the issue is to increase production capacity to take advantage of rapid growth in this segment and Nectar Lifesciences is well-placed to grow in line with this trend.
  • Cephalosporins are the fastest-growing category in the Indian anti-infective segment, with a CAGR Of over 15%. Globally, too, they figure in the top 10 drug classes. Nectar Lifesciences manufactures 10 out of 15 types of Cephalosporins used in India
  • There’s been limited impact of the new patent regime on the company’s business, primarily due to their focus on off-patent drugs

Sound Objectives for Deploying IPO Proceeds

The IPO proceeds are being routed to high-growth and business-critical areas, namely:

  • Setting up a formulation plant, which will enable the company to forward-integrate into manufacture of capsules, tablets etc. and move up the value chain from being a supplier of bulk drugs
  • Increasing production capacity of Cephalosporins to take advantage of high growth in this segment. Current capacity utilization is around 90%
  • Improved R&D and quality control facilities. The quality control facilities will help the company obtain US FDA approval, which will significantly improve the company’s business prospects, especially in regulated markets like the US and Europe
  • Movement into non-antibiotic segment for greater breadth in the company’s product portfolio

Sound Financials

  • Sales and profits have increased at a compounded rate of 15% and 38% respectively from 2000 to 2005
  • RONW has been steadily increasing from 21% in 2000 to 31% in 2005
  • Profit margin has grown from 4 % in 2000 to about 10 % today
  • Debt-equity ratio has fallen marginally from 1.54 in 2000 to 1.34 today, though total debt has increased (not very worrying for a growth business, especially since interest payments are still quite low compared to revenues and operating profits)
  • EBITDA / EV (a good measure for capital intensive and growth businesses) is at about 9.6%, which implies that an investor in the operations of the business could expect an ROI of about 10%

Low Single-Client Exposure

The company exports to about 40 countries and its top 5 customers account for only about 17% of its revenues.

External Validation of Business Model

The company has a venture capital fund (Swisstec) among its shareholders.

High Promoter Holding

Post-issue, the promoter holding will stand at about 65%, which will ensure that the promoters have sufficient ‘skin in the game’ to ensure good governance and management.

Some Areas of Concern

Pricing Pressures

APIs are an ingredient in branded drugs and hence are susceptible to pricing pressures and price volatility. Further, the company’s main focus is on the Indian market, where leading pharma players have not been doing as well as in the past and drug prices are being brought under regulatory control. If big-name players find their margins being squeezed, they will almost certainly look at re-negotiating contracts with their suppliers


Pharma, by and large, seems to be the kind of industry where scale is an important factor. Bigger companies can spend more on marketing, distribution and R&D than smaller ones, thereby making it that much more difficult for the smaller players to survive. Companies like Nectar Lifesciences need to find a niche or fall by the way-side.

Export Slow-Down

Exports as a percentage of sales has actually been falling (primarily due to lack of demand for SSPs) whereas it is rising for most Indian pharma companies

Tax Penalty

A tax –related penalty of Rs. 2 million looks likely to be imposed. It won’t have a major impact on profits, but will probably depress the share price for a while. Lawsuits and related payouts are always dampeners on stock prices

Few Big-Name Clients

The company does not seem to have any really large Indian clients except Ranbaxy, even though most of the drug majors market medicines that require Cephalosporin.


It is in direct competition with Aurobindo Pharma, Lupin and Orchid Chemicals, all of which are well-established players in the market.

Price Attractiveness

One thing I did not like in the prospectus was the use of pre-IPO numbers in calculating EPS and PE. This gives a pretty distorted picture of the price attractiveness. I’ve used post-issue share numbers below.

Post-issue, the number of shares outstanding will be approximately 14.9 million. This implies that the ’05 EPS post-issue will be about Rs. 15 per share. The book value (BV) will be about Rs 48.38.

The shares have been priced in the range of Rs 200 – 240, which yields a PE range of 13.3 - 16 and a P/BV range of 4.1 – 5.0. To give some perspective, its peers are valued in a PE range of 22-45 and P/BV range of 2.0-4.7.

For a company that’s been growing profits at about 38% compounded over the past 5 years this seems quite attractive, especially given the company’s growth plans and strategy. It would be worth buying even at the top end of the band.

Saturday, June 18, 2005

IPOs - My Track Record

There’s plenty happening in the primary market nowadays. With the stock markets on a general up-trend (or is it a bull run, hmm?) plenty of companies are cashing in by way of IPOs, or Initial Public Offerings. And the public, by and large, are lapping them up! With every IPO over-subscribed by several times, the appetite of the average small investor for new issues seems to be insatiable. Wonder where the money’s coming from!

Being part of the herd of small investors, I’m often in a dilemma as to which issue to subscribe to. This is especially acute at times like now when there is more than one issue (Yes Bank, Provogue, Jindal Poly-Films) hitting the market at around the same time. How does one decide which one to give a miss?

In this, and the following couple of posts, I’d like to outline my decision-making process and invite comments on the same. To be honest, I’ve had a mixed bag of results on this count and would be happy to receive guidance that could help me spot the winners more often.

A Brief Note for Visitors From Outside India

IPOs in India are available to all investors, including financial institutions, high net-worth individuals as well as small investors. IPOs and fresh market issues normally follow the book-building process, which is kind of like an auction of the company’s shares.

My Track Record

The following are the IPOs / fresh issues I’ve considered and the approximate results to date. Since I’m a long-term investor, I do not look for listing gains. For an idea of how various IPOs fared on the first day of listing take a look here.

I’ve given the company name and industry followed by my call on the issue and the performance of the scrip till date.

  • Biocon, Biotechnology (subscribed but did not get allotment) – up about 40% since issue in March 2004
  • NDTV, Media (did not subscribe) – up about 200% since issue in April 2004
  • Dredging Corporation, Dredging (subscribed) – up about 24% since issue in May 2004
  • ONGC, Petroleum (subscribed) – up about 30% since issue in May 2004
  • Bharti Shipyards, Shipbuilding (subscribed but did not get allotment) – up over 100% since issue in June 2004
  • TCS, IT (subscribed but did not get allotment) – up about 50% since issue in August 2004
  • Indiabulls Financial, Financial Services (did not subscribe) - up about 720% since issue in September 2004
  • Deccan Chronicle, Media (did not subscribe) – up about 22% since issue in November 2004
  • NTPC, Power (did not subscribe) – up about 34% since issue in November, 2004
  • Indoco Remedies, Pharmaceuticals (did not subscribe) – up about 20% since issue in November, 2004
  • Emami, Cosmetics (did not subscribe) – up about 7% since issue in February 2005
  • Jet Airways, Airlines (did not subscribe) – up about 13% since issue in February 2005
  • Punjab National Bank (did not subscribe) – up about 1% since issue in March 2005
  • Gateway Distriparks, Shipping (subscribed) – up about 100% since issue in March 2005
  • Shringar Cinema, Entertainment (did not subscribe) – up about 1% since issue in March 2005
  • Jaiprakash Hydro, Power (did not subscribe) – down about 12.5% since issue in March 2005
  • India Infoline, Financial Services (did not subscribe) – up about 12% since issue in April 2005
  • Allsec Technologies, IT (did not subscribe) – up about 14% since issue in April 2005
  • Gokaldas Exports, Export (did not subscribe) – up about 50% since issue in April 2005
  • 3i Infotech, IT (did not subscribe) – down about 7% since issue in April 2005
  • Cybermedia, Media (did not subscribe) – up about 150% since issue in May 2005
  • Shoppers Stop, Retail (did not subscribe) – not listed yet
  • Jindal Poly-Films, Packaging (did not subscribe) – not listed yet
  • Provogue, Apparel (did not subscribe) – not listed yet
  • YES Bank, Banking (offer open currently)

In order of annualized performance, the IPOs may be ranked as below (the ones in bold were my picks):

  • Cybermedia : +1200%
  • Indiabulls Financial : +960%
  • Gateway Distriparks : +400%
  • Gokaldas Exports : +300%
  • NDTV : +170%
  • Bharti Shipyards : +100%
  • Indiainfoline : +72%
  • Allsec Technologies : +67%
  • TCS : +60%
  • NTPC : +58%
  • Jet Airways : +39%
  • Deccan Chronicle : +38%
  • Indoco Remedies : +34%
  • Biocon : +32%
  • ONGC : +28%
  • Dredging Corporation : +22%
  • Emami : +21%
  • Punjab National Bank : +4%
  • Shringar Cinema : +4%
  • 3i Infotech : -42%
  • Jaiprakash Hydro : -50%

There were some other issues as well but I cannot remember them right now. The above gives a good idea, though. As you can see, I’ve done reasonably well in avoiding the laggards but have not been able to consistently spot the real winners.

OK, got to go now. Will write in soon with Part 1 of my IPO Analysis ‘techniques’.

Na IPO porein… Heh, heh.

Little Tamil pun. Couldn’t resist. :-)

Wednesday, June 15, 2005

An Aside

I recently received a mail from Vibhu urging me to list my favourite books on the site.

Given the nature of this blog, it seemed to me that I should focus on investing related books rather than a general reading list. That's of course not to say that I have this single-minded focus on reading management tomes. I do read serious, high-brow classics like Asterix, Tintin, Dilbert, Red Riding Hood... but then there's probably a different and better forum for holding forth on those!

The following are (in order of preference) on my list of 'highly recommended' books for investors like me:

  1. One Up on Wall Street by Peter Lynch - excellent teachings on finding small and mid-cap winners. You can read an excellent synopsis of the book and Lynch's teachings here
  2. Buffetology and The New Buffetology by Mary Buffet - Buffet's modus operandi, mainly oriented towards finding large-cap stocks at a good price
  3. Rich Dad, Poor Dad - the book that inspired me to think about my finances and set me firmly on the path to a comfortable and early retirement (hope springs eternal...)
  4. The Intelligent Investor by Benjamin Graham - quite a tome, but this is by the guru of value investing and eminently worth a read

These four books are enough to help any small investor do well in stocks, provided he / she is willing to devote time and effort towards understanding and applying the lessons in these books to their hard-earned money.

Sunday, June 12, 2005

Mutual Funds - Make Your Own Unit-Linked Insurance

Much is written and said nowadays about unit-linked insurance, which is touted as one of the best savings schemes for the retail investor, especially one with some appetite for risk.

Unit-linked insurance plans are essentially bundled savings offerings that combine the risk cover of insurance with stock market-linked returns of a mutual fund. These schemes are likely to generate superior long-term returns to the traditional endowment policy while allowing the individual to retain the tax benefits available on insurance – a win-win situation. As with any market-linked instrument there is a modicum of risk attached but over the long term that insurance policies are (or should be) held, the chances of loss are negligible.

There is a catch, however. Unit-linked insurance plans are always offered against funds managed by the insurance provider, which might not be among the better-performing options available in the market. Therefore, while you would be better off than if you invested in an endowment policy, the returns could have been higher. And the power of compounding is such that over the twenty-year period of the average insurance policy, a difference of even one percent could mark quite a significant increase in the size of your nest egg.

Do-It Yourself

Ideally, we’d like to have our insurance linked to the returns of the market-leading mutual fund and there is a way to achieve this. The solution lies in term assurance.

Term assurance is a no-frills insurance that covers risk, full stop. There are no returns – even your principal will not come back. However, the premium payments are really low, much lower than with the savings-oriented insurance schemes, and the same tax benefits are applicable. Such a pure-risk insurance plan offers us the ability to manufacture our own ‘unit-linked’ insurance, but this time with any fund of our choice.

A Step-by-Step Guide

  • First decide on the amount of insurance you want to take on a unit-linked scheme and calculate the premium you’d need to pay
  • Then figure out the term assurance premium of an equivalent amount. This would be significantly lower. Take out a term assurance policy for that amount.
  • With the money you have left over – and this is where the beauty of the scheme lies - set up a Systematic Investment Plan (check out my previous post on SIPs here) in any fund of your choice. You’d generally prefer a market-leading diversified equity fund with a long and successful track record, like Franklin Bluechip.
  • If your policy and SIP renewal period is the same (usually annually) then you need to take little extra effort over what you’d have done for a standard unit-linked insurance
  • Sit back and relax – you’re almost certainly going to save more than with any unit-linked insurance scheme

Caveat Emptor!

Thanks to my wife for pointing this out:

Before you rush off to put this idea into action, remember that tax benefits would be available only on the insurance allocation, not on the mutual fund investment. Hence the plan might not hold as much charm for those who purchase insurance for tax benefits alone.

Friday, May 06, 2005

Value Pick - Betting on Biocon

What Would You Say to the Following?

  • Despite growing at a blistering pace of over 200% the year before, company X grows its net profit by another 42%
  • PAT margins, already among the best in the sector (at 25%), have improved to 26%
  • Every one of its businesses is profitable and growing
  • The company is cash flow positive and generates enough to comfortably manage its operations and have some left over to fund acquisitions as well
  • Company X possesses a patent on an innovative fermentation process, one of the core capabilities required for the business
  • The company has recently launched human recombinant insulin into the market, one of only four companies worldwide that has been able to do so
  • X is recognized globally in the field of statins, the world’s single-largest drug segment with a market size estimated at USD 23 bn globally
  • The management team is extremely capable and experienced and almost all have been with the company for over a decade. Attrition levels at the company are a mere 1%, well below industry average
  • The company has a research pipeline extending well into the next 5-10 years, beginning with lower-risk generics and moving on to high-risk, higher-value products
  • Entry barriers into most of the company’s businesses are high, demanding sophisticated technology and regulatory clearances
  • It has a clear vision, has delivered on every promise made to investors over the past few years and is poised to become a globally-recognized biotech and pharma major

Do You See A Dog? Or a Star??

The company is Biocon (www.biocon.com).

Debuting on the Indian exchanges in April 2004 at an impressive 52% premium (closing the day at Rs. 483) over the offer price, the stock is currently languishing in the early 400’s. The only explanation could be the general weakness of the market and perhaps lower-than-expected earnings, both of which have combined to make this a great buy!

At a PEG (Price / Earnings to Growth) ratio of around 0.5, the stock is almost certainly undervalued, even though its EV / EBITDA is quite high (around 12-14). Considering that it’s a growth business in a ‘hot’ industry, this state of affairs can only last as long as the overall market correction. Once the sensex swings the other way, this stock is poised to take off like a rocket!

Over the long term, given a couple of good breaks on new molecules / drugs, Biocon has the potential to really make it big. And, touchwood, if any of its products should become a blockbuster, the sky is the limit!

Have confidence.

Current Market Price: Rs. 395

Wednesday, April 27, 2005

Real Estate - A Strategy for Apartment Purchase?

For some months now, I’ve been in the market to purchase a good apartment. Unfortunately, I find I’m not alone! Thousands of others have had the same thought – apparently at the same time – and, armed with cheap home loans, they’re driving up prices way beyond control.

Unfortunately, not only is a flat a major investment, it is illiquid and the price at any point is quite subjective. There are few, if any, guidelines to determine the value of a property accurately.

A Strategy for Purchase

Now, if you’re like me, you’d have taken a loan for the purchase, probably up to 90% of the value of the apartment. The remainder plus the registration amount would be financed through available cash and perhaps a personal loan as well.

In this scenario, there are two components to the investment we’re making – principal repayment (which is basically installment payments against the value of the apartment) and interest (which is the amount we are spending in addition to the value of the apartment). Since the principal is merely a payment for the property, we don’t have an issue with it – we got a flat and we’re paying off against it. The problem is with the interest, which is an additional, fairly substantial, amount that we will have to fork out over time. This is the part we need to take care of.

The plan I have is to ensure that the rent for the apartment takes care of the interest component (home loan + personal loan if any) at least. This way, I’m merely paying for the value of the property, which is not an issue.

The other problem is the down payment that we’ve made from our own cash resources. Given a choice we would like the cash to earn interest. Let’s assume that for a low-risk investment similar to property, we would want returns of 10-12%. The expectation would then be that the apartment being purchased must has enough scope to appreciate by an amount that would make such returns possible.

Thus, in summary:

  • Principal payment (home loan + personal loan) gets set off against value of the house
  • Interest component (home loan + personal loan) should be matched by the rent
  • Capital appreciation in the value of the property should be at least enough to translate into 10-12% returns from the down payment made with our own cash

An an example, let's take an apartment of value 50 lakhs, of which the home loan is for 45 lakhs. Let's assume registration amount is 5 lakhs. The down payment required is therefore 10 lakhs, of which the buyer intends to take a personal loan of 5 lakhs and fund the rest himself. The interest component of all the loans works out to about Rs. 25,000-27,000, which needs to be covered by the rent. Further, the apartment must appreciate by at least Rs. 50,000 per annum to generate returns of 10% on the 5 lakhs paid by the buyer. This implies that the apartment should show capital appreciation of 1% per annum at a minimum.

If the buyer had been able to fund the entire down payment himself, the rent requirement would have been lower at about Rs. 18,000 and the capital appreciation required would have been 1 lakh per annum, or about 2%.

Monday, March 14, 2005

IPO - Gateway Distriparks

The Gateway Distriparks offer hasn’t quite generated the frenzy that generally characterizes Indian IPOs. Oversubscribed by 6-7 times overall, the retail segment has seen remarkably little action, remaining undersubscribed up till the close of the offer. Perhaps the fact that Punjab National Bank and Emami were also available at the same time had something to do with the lack of enthusiasm…

What Makes Gateway Distriparks Interesting?

The following points indicate the company is a good buy:

It's a mid-cap company with significant presence in a growing industry

The company is in the logistics industry, dealing mainly with packaging of goods into containers and storage of incoming and outgoing goods in company-owned facilities. They have a significant presence in major shipping hubs like Mumbai and Vizag, with plans to acquire a facility in Chennai. They also have a presence in Gurgaon, thereby catering to road transport. The company plans to expand its presence geographically as well as in different transport sectors.

The offer proceeds are to be used for business expansion and other strategic purposes

GDL aims to use the proceeds to retire high-cost debt, acquire a facility in Chennai and improve its facilities in Mumbai and Gurgaon, all of whicih will lead to profit growth in the medium term.

GDL has displayed strong revenue and profit growth over the past five years

The company has shown a CAGR of 55% in revenues, with no year recording less than 20% growth. Costs have shown a more gradual increase, leading to excellent profit growth.

RONW and ROCE have been consistenly improving over the past few years

RONW has improved from about 8.3% to 23.5% over the past 3 years and ROCE from 4% to 19% over the same period.

Debt components have been steadily declining

Overall debt to equity and interest liabilities have been falling over the past 5 years and current interest coverage is at comfortable levels, suggesting that the company will at least not go under on account of debts!

There's evidence of improving business efficiency and movement up the value chain

The primary income streams are rental for goods storage and service charges for packaging and handling. While both have been on the rise, the share of rentals in the overall revenue has fallen, indicating the company has been able to command premium rates for services, indicating a move up the value chain. Further, reducing dependence on rentals also reduces the need to constantly acquire storage facilities involving high capital investments.

Price Attractiveness

At the offer price band of Rs 60 – Rs 72, the PE Ratio (using diluted EPS) is between 24 and 28, which is a tad high for a company that’s growing at an average of 30% year on year. However the overall business is attractive enough to buy at the price, especially at the lower end of the band.

Sunday, February 13, 2005

Real Estate - Investing in Property

The first (and last) bit of investing advice most of our parents gave us – save, save, save and buy a house as soon as you can. You can never go wrong in real estate!

And it does seem like a good proposition. Just ask the people who’ve made millions from their ancestral properties or those who’ve recently made a killing in Bangalore or Gurgaon!

For many of us, buying a flat or a property is a big deal in every way. It is likely to be one of the biggest investments we ever make, it has a lot of sentiment attached to it and it does give a sense of fulfillment - I have a house, ergo I’ve arrived in life! Plus there’s the expectation of the property appreciating many times in value over time.

But is this expectation justified? Is real estate really an investment that defies the basic risk-return principle, yielding high returns for relatively low risk?

Consider This

Property purchases are fraught with uncertainty. For one, we never know what the ‘fair’ value of a property is. There are all kinds of intangibles determining the price, there is little or no flow of information and of course there are the buyer’s own biases involved as well. Further, during times of rapid expansion, ‘hot’ areas tend to appreciate to stratospheric levels (like parts of Gurgaon today) and there is rather inevitably a correction. Property prices, contrary to popular opinion, do not always tend northwards.

Further, as with any investment, one should consider the cost of funds and ongoing maintenance. In this context, we have tax breaks to consider, differing interest rates for loans, different payment schemes, stamp duties, property taxes, ongoing maintenance costs, brokerage…

In the following discussion, I propose to treat real estate as just another asset class in my portfolio and hence determine whether it compares favorably with other instruments. Of course, an underlying assumption here is that the purchase is purely for investment and not for personal use. In the latter case, just buy the best location you can afford - preferably in an area you’re comfortable with - and then forget it. Who cares what happens to the price? Your kids maybe, not you!

Some Basic Assumptions

In this discussion, I’ll focus on purchasing a house / apartment, not land. Land purchases, by their very nature, are speculative and the returns indeterminate. One buys land in the hope that it will appreciate in value but there’s no indication of what the appreciation might be.

In the case of an apartment, however, there is a clearly defined rental income that one can expect and I hope to use this as the primary basis for evaluating whether a property is a worthwhile investment or not.

Other assumptions (I’ve tried to take the worst case scenario) -

  • The apartment costs Rs 10 lakhs, inclusive of stamp duty
  • The property is bought on a 20-year loan @ 8.5% fixed interest rate working out to an EMI of Rs 900 per lakh or Rs 9,000 for the whole. I assume there’s no initial down payment required
  • Inflation over 20 years will average at about 5% per annum. A higher inflation will be more beneficial by reducing the real interest rate on the loan
  • The tax benefit on interest paid for housing loans does not exist.
  • The rental yield on the property is about 4% per annum (about average for most cities in India, except Gurgaon, where the yield is higher), which works out to about Rs. 3,300 per month. This increases at par with inflation (usually the rental increases are higher)
  • Ongoing maintenance costs plus applicable taxes are about Rs. 12,000 per annum (or about Rs. 1,000 per month), appreciating in line with inflation
  • Tax on rental income is at 30%
  • Post-tax returns on a low-risk bond are 6% per annum

For the above scenario, one could consider the property investment in two ways:

  • As a pure investment: In this case, the buyer’s mindset would be of an investor looking to allocate his capital between various assets. The purchase of an apartment is incidental and the focus is on return on total investment
  • As a mandatory purchase: In this case, the apartment price itself is above scrutiny and the focus is on determining whether the additional costs (interest, maintenance etc) are worthwhile in terms of returns.

Real Estate as a Pure Investment

The investor would only purchase an apartment if the returns (capital appreciation + post-tax rental income are comparable with other low-risk assets like bonds. Hence, the investor would consider the total cost to be the sum of the NPV of the total repayment over 20 years and the NPV of maintenance costs. This would be compared with the NPV of the rental income and the returns expected from a bond of similar cost in order to determine the capital appreciation required from the apartment.

In our example:

  • NPV of loan repayment over 20 years = Rs. 13,45,920 (Rs. 1,08,000 per annum discounted at 5% rate of inflation)
  • NPV of maintenance costs over 20 years = Rs. 2,40,000 (Rs. 12,000 per annum, rising in line with inflation)
  • NPV of post-tax rental income over 20 years = Rs. 4,80,000 (Rs. 24,000 per annum post-tax over 20 years, rising in line with inflation)

Total investment in today’s prices = Rs. 13,45,920 + Rs. 2,40,000 = Rs. 15,85,920

Value of similarly-priced 6% bond over the same 20-year period = Rs. 50,86,250

In order to be an equally good investment, the ten lakh rupee property must appreciate to Rs. 46,06,250 (since the rental income is about Rs. 4,80,000) i.e. it must grow at a cumulative rate of 8.37% per annum.

One should purchase the apartment only if the expectation is for the property to grow at this aggressive rate year after year.

Real Estate as a Mandatory Purchase

The mandatory purchaser would not focus on the cost of the property, assuming that the price is a fair one. The only concern here would be to ensure that the extra cost of maintenance and interest is met by the rental income and the gain in apartment value so that the there is no loss incurred in the purchase.

In our example:

  • NPV of interest repayment over 20 years = Rs. 7,47,730 (Rs. 60,000 interest payment per annum discounted at 5% rate of inflation)
  • NPV of maintenance costs over 20 years = Rs. 2,40,000 (Rs. 12,000 per annum, rising in line with inflation)
  • NPV of post-tax rental income over 20 years = Rs. 4,80,000 (Rs. 24,000 per annum post-tax over 20 years, rising in line with inflation)

Total investment in today’s prices = Rs. 9,87,730
Value of similarly-priced 6% bond over the same 20-year period = Rs. 31,67,790

In order to be an equally good investment, the ten lakh rupee property must appreciate to Rs. 26,87,790 (since the rental income is about Rs. 4,80,000) i.e. it must grow at a cumulative rate of 5.34% per annum.

One should purchase the apartment only if the expectation is for the property to keep pace with inflation year after year, a not unreasonable requirement.

Final Thoughts

The above analysis does not really throw up anything new other than the idea that real estate, as a pure investment, seems to be rather speculative. It’s not the sure-fire winner that people would have one believe. The best bet is probably to purchase apartments on the outskirts of growing metro cities or in B-category towns with the potential to scale up fast. It might even be a better idea to just buy land.

Buying an apartment for security and the feel-good factor seems to be a better motive. It’s also probably a good idea for people who currently stay in rented accommodation. Even apartments in mature parts of large cities should at the very least keep pace with inflation.

Returns could be juiced up a bit by holding for short period of time and selling out on substantial jumps in value, obtaining tax benefits on interest repayment, finding an apartment with a high and growing rental yield and perhaps reinvesting the rental income into interest-bearing investments.

Monday, January 24, 2005

When Does One Sell?

‘You hold on to stocks like they’re your babies and then sell when they are at their lowest!’ says my wife, making a point. Sound familiar?

A lot’s happened in the past month – the stock market bull run turned into a bit of a dream run, with stocks rising to dizzying heights. We saw record highs that even a year back few would have predicted. And I saw my investments generate over 50% in unrealized returns – man was I good!!

The key word in the fairy tale above of course is ‘unrealized’ returns – that's about the only realization I've had in the past month. It’s been only a few weeks since the record highs and the market index has fallen by around 10% or so, wiping out a lot of those gains. Stocks that had gotten ahead of their valuations have returned to more reasonable levels (though not to bargain prices by any stretch of imagination). Thankfully, I’m still profitable, though of course at a more modest level.

But why, oh why, didn’t I sell?

Kind of makes one wonder, doesn't it? Is a buy-and-hold strategy really a good idea? And if it is, how long should one hold? And when should one sell?

Is a Buy-and-Hold Strategy a Good Idea?

I think it is, at least for me. Look at the benefits – lower tax, less worry and no need to time the market except in a broad sense. On the down side, one tends to fall in love with one’s buys and live in a world of paper profits and ‘unrealized’ gains as I’ve just figured out. That, however, needs a mind-set change and acceptance of selling as an important aspect of investing. A bit of discipline (and a sharp jolt like the current downslide) should help sort it out. Not a problem, really.

When Should One Sell?

As with the choice of investment approach, there seems to be no single ‘best’ method for determining the selling strategy. Here are three options that have stuck in my mind and may be used as appropriate:

  • In a rising market, set stop-losses at levels below the normal stock price fluctuation so they get triggered in case of unusual dips in the price. This has the advantage of being a mechanical method and hence creates discipline. The downside of course is that the stop-loss levels should be reviewed periodically (perhaps even daily) to ensure that they are relevant to the current stock price. Further, this approach will also lead to short-term corrections inadvertently triggering off the sale of a stock that should actually have been held for longer
  • Peter Lynch’s investing approach is to find companies whose stocks have a good reason to grow manifold in the near future and then wait for the market to catch on. Hence the selling strategy would be to do so once the story has been fully played out, as per the investor’s opinion. The advantage of this approach is that it looks at the long term potential rather than at short-term price movements. The disadvantage of course is that the investor might be wrong in his / her assessment of the company or that the market may not bid the stock up in the near future. In the meantime the investor would hold on, accumulating losses in the hope of a turnaround.
  • Another approach is to sell the stock when it reaches a price such that reinvesting the proceeds in a low-risk investment would still allow the investor to meet his / her financial goals. This is actually an intriguing idea – I think this is Warren Buffet’s - and it’s worth dwelling on this further.

Sell High and Re-Invest in Low-Risk Instruments

Let’s say you have invested Rs. 1,000 today in the hope of turning it into Rs. 10,000 in 10 years (you’re target returns are 25% compounded per annum). Now suppose after two years there is a major bull run and the stock reaches Rs. 5,000. Based on this philosophy, the investor could sell it and invest the proceeds (Rs. 5,000) into a low-risk bond at 8% let’s say. At the end of 10 years, the investor would have made approximately Rs. 9,500 with almost negligible risk.

This way, the investor meets his goals in the most efficient way by taking advantage of a bull run to jump-start the process. A capital idea (again no pun intended!), but would one be able to do this? Would it not take fabulous amounts of forbearance to sell a stock that’s doing well and put it into the boring ‘slow and steady’ bond that will get you to your goals but will not help you get rich quick? Would it not cause pangs of regret when the same stock scales even greater heights immediately after you sell? And what if it hits Rs. 10,000 when you’ve sold at 5,000 to take the scenic route to your destination? Whoa, that’s a killer!!

And do I hear you ask what I would do? I’d go for the rational and disciplined approach of selling high and investing in bonds, of course.

Or perhaps leave just a wee little bit in the stock just in case…

Actually, let me just wait till the next bull-run to find out.