Realty Stocks Overvalued?

I've not really been tracking IPOs much of late. The main reason for ignoring these is the fact that there is almost nothing on the table for long-term investors in IPOs today.

The lack of sufficient historical information coupled with some really eye-popping valuations thanks to the bull market make me jittery, to be honest. Also, the mammoth oversubscriptions in most of these imply that the average investor gets a miniscule allocation that is simply not worth the effort. Even if you were to sell at a handsome profit on the first trading day, the absolute value of your returns doesn't make it really worthwhile.

Among IPOs, the ones I am most leery about are realty companies, which are blessed by being at the intersection of both a stock market boom as as well as a property boom and hence these companies are cashing in big time. This article illustrates the issue beautifully.

Odds of Making Money in the Stock Market

I was surfing through some blogs and came across Value Investor India, a real gem of a blog that is not updated frequently but has some really good posts. It is based on value investing concepts and has some really good posts on arbitrage and industry overviews. Rohit, the author, has obviously gone deep into the internet to dig out some really good stuff, such as this arbitrage returns evaluator, which seems to be based on what I read in Buffetology (or maybe that's just how all arbitrage stock opportunities are evaluated).

Anyways, one post caught my attention, as it seems to be a pretty interesting way to look at timing the market. Basically, the concept is that you should take the current PE and be able to judge the odds of making money in the market based on how often the PE has been higher than this in the past. If today's PE is towards the higher end, then chances are you will lose money in the medium term.

The NSE, and perhaps even the BSE, site allows visitors to download historical index data (open, high, low, close, PE etc) into excel sheets. Now, once you have downloaded the data, it is fairly easy to count the number of times the PE has been higher than the current PE and divide by the total number of days in the historical period considered in order to get an idea of the probability of it being higher than today in future.

Example:
If today's PE is 18 and you see that over the past 1000 days the PE has been >18 50 times and <=18 950 times, then chances of you making money in the future are 5% and chances of losing money are 95%. So you might want to keep your money in the bank for now.

The obvious flaw in this approach is that as markets in India mature and growth slows down, future PEs might be generally lower than past PEs, thereby throwing your calculations out of the window. Further, since you are looking at an index PE, it would be wise to invest in an index fund on this basis. It might even be better than a passive SIP and yield better returns...

Why would this not work for individual stocks? Because individual stock PEs should not be anallyzed statistically as they are completely dependent on management and factors affecting the individual company. For a basket of stocks such as the index, the approach does provide a good rule of thumb.

If you have bought stock funds in a period when the odds were good of PEs rising in future, you'd probably have really done well, benefiting from the increased PE as well as rising earnings, a double benefit!

The example given in the post was that of the stock market crash during the UPA elections when apparently the odds were 10:1 of PEs rising afterwards - and of course the market soared over the next couple of years!

Anyone want to try this out and let us know today's odds?

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!

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.

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.

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

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

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.

Risks

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

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

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.

Investing in Stalwarts

According to Peter Lynch, stalwarts are large and established companies that have the ability to grow at a steady annual rate of 10-12%. I’d say the equivalent companies in India would show returns of about 15-18%, especially if bought at the right price. These are a very special group of stocks due to their ideal blend of growth potential and predictability and hence these stocks form the backbone of my stock portfolio – after all a growth rate of 18% would have these investments doubling every 4 years!

I believe ‘stalwart’ companies should have shown consistent and significant EPS and book value growth over the past 10-15 years. My method for finding a good purchase price for such companies is to calculate anticipated share price using 3 approaches and then take the lowest. To do this, the following are necessary:

Step 1
Calculate the average share price, EPS and book value growth rates over the past 10 years at least and then extrapolate these over the next 10 years (my expected holding period for stocks of stalwarts). In this manner I can find the expected share price, EPS and BV after 10 years.

Step 2
One can easily derive the stock price from these:
- Expected stock price using EPS = future EPS * lowest historical PE
- Expected stock price using BV = future BV * lowest historical return on net worth * lowest historical PE

Step 3
Take the lowest expected value from among these three methods and then work backwards to find the price at which the share should be bought in order to achieve the targeted returns

Step 4
Have the patience to wait for the target price to be reached.

What does this achieve? Well, for one you are confident of having taken the most conservative estimates for growth and can be fairly sure of meeting your targets, barring extenuating circumstances. At least there is little need to monitor these stocks’ performance on a daily basis. Further, there is a bit of a bonus, as dividends have not been considered in the above calculations.

Using these methods I was able to identify companies like Infosys and ITC as candidates for my portfolio and then had a bit of luck when the market crashed immediately after the elections and allowed me to buy both these companies at prices below my target price. These investments are currently doing well.