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.

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.

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

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%.

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.