What affects a business the most in long term?

After spending some three years in Stock Market and studying balance sheets of a lot of companies and also their profit and loss account of last ten years, I found that there are two things that affect profitability of a company the most:
1. The competition
2. The product/service offered by the company becoming obsolete

The first example is seen in most of the commodity companies. But some companies which are not in commodity can see the same fate as other commodity companies after some time. The example can be seen in Bharat Forge. For a very long period the company maintained its ROCE and keep growing at a good pace as can be seen in the financial results as below:

Year	Sales	Net Profit
2001	487.96	32.64
2002	434.45	22
2003	644.95	81.09
2004	851.14	124.9
2005	2001.375	201.088
2006	3085.013	250.542
2007	4275.213	290.588
2008	4751.57	301.523

Company had an ROCE of more than 25% till 2005. But things started deteriorating after that and now it stands less than 15%. ROCE clearly shows how competition is affecting the business. When you invest in a company for a long term, keep looking at the company's ROCE. If it starts deteriorating, get out of your long term investment.

The second example can be easily seen in some IT company e.g. Moser Bear. The results below shows that the company was making a good amount from its business till 2004.

Year	Sales	Net Profit
1995	33.8	4.2
1996	42.7	8.1
1997	60	10.6
1998	71.8	13.2
1999	101.3	20.4
2000	154.8	44.1
2001	383.92	137.65
2002	738.96	211.66
2003	1024.6	232.92
2004	1582.39	328.83
2005	1434.85	59.79
2006	1774.97	-6.4721
2007	2060.652	78.827
2008	2001.22	-79.259

What happened in 2005? The CD-ROM prices crashed from INR 30 to INR 8. Can you expect this in say HUL's Surf? or Nestle's Maggi? Never ever.

While investing, if people keep in mind these two factors, the investment operation will be very rewarding.

What a single stock can do to Sensex?

Looking at the weightage of stocks in Sensex at BSE, I conclude that
Reliance (13.65) > Ranbaxy + Tata Motors + Jaiprakash Associates + ACC + DLF + M&M + Hindalco + Grasim + Sterlite + Maruti + Wipro + Reliance Infrastructure + Tata Steel + Tata Power (13.28).

Thus if all these 14 stocks go up by 3% and Reliance goes down by 3%, the impact on Sensex is still negative. This is not the case with Nifty since Nifty considers Full market cap instead of Free Float. Full market cap of these 14 companies is 1.83 lakh Crore whereas that of Reliance is 1.69 lakh crore.

We got the first victim today

Just after two days of posting the names of companies which may have trouble paying their debt, we have got the first in Slowdown-hit Ispat defaults on loan repayment to UTI.

Indian Banks are in for a tough time - Part 2

Extending the article Indian Banks are in for a tough time, I am giving here the list of companies in BSE 500 which may face severe pressure going forward paying their debt:

Company	Sector	Debt
Alok Industries	Textiles	5767
Asahi India	Infrastructure	1391
Bhushan Steel	Steel	5718
Era Constructions	Infrastructure	1447
Essar Oil	Refinery	10015
GTL Infrastructure	Infrastructure	2475
Hotel Leela	Hotels	2035
Ispat Industries	Steel	7225
Jaiprakash Associates	Infrastructure	8234
Jet Airways	Airline	12015
Jindal Stainless	Steel	4290
Orchid Chemicals	Chemicals	1953
Strides Arcolab	Pharmaceuticals	1063
Unitech	Real Estate	8117
Varun Shipping	Shipping	2200

Let's see who defaults first. The list only includes companies with debt more than 1K Crore. Asahi India, Alok Industries, Era and Strides are repeated from BSE SMALL CAP.

Will blindly following Buffett help?

I would like to point out the difference of investing in US and India. Buffett's investment in two sectors - namely Publishing and Retail have been the most profitable. Buffett even remembers a missed opportunity - WalMart - in 1996 which caused a loss of profit of more than $10 Billion to Berkshire Hathaway. The Washington Post Company has been the investment of Buffett's life.

When I compared the performances of Indian publishing and retail companies, I feel the companies are not investment grade except few. Taking the retail first, Indiabulls Retails Services, Shopper's Stop made losses last quarter (Indiabulls Retails previously known as Pyramid Retail has never made profits) and Pantaloon Retail had an interest payment of 68 Cr compared to net profit of 36 Cr. Only Titan, Trent and Provogue are spared (of which Titan and Provogue are part of the famous R's portfolio). This may be due to high cost of Real Estate and high interest rates. In publishing ROCE's of Jagran Prakashan, Deccan Chronicle Holdings, HT Media and Infomedia are nothing to write home about. So if Buffett had been an Indian, he would have stayed away from these businesses.

The lesson is "Do Your Homework".

Indian Banks are in for a tough time

After the slowdown comes default. I am talking about lending of banks to corporates. I went through BSE SMALL CAP index companies to find out which of the companies are vulnerable and can default on their debts. Following is the list:

Company	Sector	Debt
Abhishek Industries	Textiles	1285.59
Alok Industries	Textiles	5767.31
Ankur Drugs	Phramaceuticals	618.14
Asahi India	Glass	1391.43
Bajaj Hindustan Sugar	Sugar	919.42
Era Infra	Infrastructure	1447.09
Piramal Glass	Glass	732.3
Rajasthan Spinning & Weaving Mills	Textiles	1064.41
Stride Arcolab	Pharmaceuticals	1062.77

I have included only those with debt more than 500 Cr. There are many with debts between 250 and 500 Cr. And also notice that these are small companies in BSE SMALL CAP and not in BSE 500. Similar examples will be found in BSE 500 too but might be lesser. The banks which would have lent to these companies will see their NPAs rise in the next one year. Most of them are from beaten down sectors like textiles, sugar and Infrastructure. I will keep track of these companies.

Graham would love this market

One of the criterion for choosing a company to invest in for Graham was that the price is below 2/3rd of the net working capital (cash or net worth + inventory - debt). I wasn't able to collect the inventory but just by looking at cash - debt, I found that out of 557 companies in BSE SMALL CAP index, 54 was meeting Graham criterion. Some of them are,

Company Name
Aftek
Ahmednagar Forgings
Andhra Petro
Avaya Global
Balasore Allyos
BLB
BSEL Infra
Carol Info
Consolidated Finvest
D-Link India
Dhanus Tech
G V Films
Ganesh Housing
Hexaware
Hinduja Ventures
HTMT Global
ITD Cementation
Jindal Photo
Jindal Polyfilm
Jindal Southwest Holdings
Jupitor Bioscience
Kernex Micro
Kolte Patil
Kothari Products
Krishna Lifestyle
Llyod Electric & Eng
Logix Micro
Lok Housing
Maharastra Scooters
Manaksia
Mascon Global
Megasoft
Micro Inks
Midday Multimedia
Nitco Tiles
Om Metal Infra
House of Pearl Fashion
Prajay Engineers
Prime Securities
Prithvi Info
Saregama India
Sasken Communication
SEAMAC
Silverline
Suraj Diamonds
Sujana Tower
Technocraft
Teledata
Triton Corp
Vaibhav Gems
Vakrangee Software
Vikas WSP
Vimta Labs
Zylog System

Some of these names like Aftek, Silverline, Teledata, are untouchables since they do not have a good history. But Lloyd Electric, Sasken, Vimta Labs, Vaibhav Gems, Micro Inks, Hexaware, Avaya Global, D-Link India were renowned names once. I haven't looked at these companies' P&L account to know whether the intrinsic value of the company is increasing or decreasing, but the running business of these companies is available for free.

Are stock markets efficient?

I would like to describe story of a company named Gulf Oil Corporation. The company had following consolidated profit/loss account in the last 5 years:

Year	Revenue	Profit
2004	415.51	22.62
2005	473.41	17.9
2006	507.25	15.59
2007	668.66	11.05
2008	838.16	36.77

At the height of 2003-2008 bull run in May 2006, the market capitalization of the company was around 3385 Cr, the same is around 231 Cr after a split of 5:1 and price correcting to INR 30. What the f**k? I don't know if any real estate is involved in this. The same is the case for MMTC. MMTC hardly had profits of around 200 Cr last year but its market capitalization was 2.84 lakh Cr (more than ONGC which earned profits of 20000 Cr last year) in November 2007. Even today it has a market cap of around 65000 Cr, this is more than ITC which earned 3200 Cr as profits last year. If the market has overpaid for these stocks on upside, it is bound to underpay for many other stocks on the downside. Be ready to buy those.

Something out of the box

There is gloom and doom everywhere. In this kind of time, I want to stick my neck out and say Sensex will touch 12500 (Nifty 3800) in the next 9 months, i.e. by July 2009.

Will history repeat - Part II ?

On May 22, 2008 I wrote an article about past Nifty levels with respect to its P/E (Will history repeat?). The fact is that I assumed that the bottom for the market would be reached in a span of 18 months but this correction came out to be much severe than anticipated. It has been only 10 months and the Nifty has reached a P/E of 13.15 on 19 October at a level of 3074.35, EPS being 233.79. If past is any indication and this quarter's earnings do not give much boost to Nifty EPS, than the bottom may come at around 2450-2535 at a P/E of 10.48/10.85. Past is just an indicator and history may be re-written, i.e. Nifty may go below P/E of 10 and reach 2000. Panic situation has started to appear on the faces of investors, brokers and analysts. People have started thanking God that they sold some stocks at 15-20K on Sensex. Everybody has started predicting new low levels for Sensex ranging from 7K to 8.5K. There is blood everywhere. I remember at this stage a statement made by Mr. Buffett in an interview with Forbes magazine in 1973 when Dow went to a P/E of 6-7. When asked how he feels right now, Buffett replied, "An oversexed guy in a whorehouse". Every value investor should feel the same right now in India.

Industrial Recession

Some days back when the IIP numbers for August 2008 came in at 1.1%, one of the economist in GOI (Government of India) said that it is an industrial recession. It seems that stock prices of Industrial Companies are reflecting that. See the table below:

Stock	Price	Earnings Last Year	P/E
Amara Raja	51	17	3
Ashapura Minechem	44	20	2.2
Asian Electronics	29	29	1
Bartronics	100	17	6
EMCO	51	11	5
Graphite India	36	9	4
HDIL	125	70	2
JK Lakshmi Cement	28	37	0.7
KEI Industries	20	7	3
Lakshmi Machine Works	640	200	3.2
Tata Steel	250	90	2.5

The list covers most of the industrial sectors from batteries to mining to steel to transformers to power cables to housing to cement to textiles. I am not saying this companies are worth buying at this point of time, some of them will go bankrupt in the next 2 years. I don't know which ones.

Strange things happen in stock markets

I created a portfolio of stocks which I think were good in December 2006 when the Sensex was at around 13500-14000 and Nifty was around 3700-4000. During December 2006 and October 2008, Most of the companies increased their profits except NALCO. NALCO's profit went down from 2006 December TTM (Trailing Twelve Months) of around 2000 Crore to 2008 October TTM of around 1700 Cr. The L&Ts, RILs, HDFCs, Bhartis and many others increased their profits by around 50% in these two years. Guess what happened to NALCO's stock price. It outperformed all the stocks till 16th October 2008. Which genius thought of this happening?

Where are those reckless mutual funds?

On May 29, I wrote about reckless investments by mutual funds. I am comparing the NAV of these mutual funds, then and now, with Sensex as well as BSE-500.

	Sensex	BSE-500	Tata Infra	Tata Indo Global
29-May	16316.26	6477.33	32.09	8.451
6-Oct	11801.7	4478.26	23.03	6.67
Gain/Loss	-27.67	-30.86	-28.23	-21.07

Most of the outperformance is attributed to cash holdings. Tata Indo Global is a new fund and they started investing with these kinds of stocks. I don't know what will happen to Indian investors!!!!!!!

Nifty P/E below 16 after a long time

As per NSE website, Nifty P/E is below 16 now after a long time. Last time it was below a P/E of 16 was on 12-Jun-2006, after the May 2006 Stocks meltdown. Before that Nifty P/E went below a P/E of 16 on 21-Nov-2005, after the October 2005 stocks carnage. Statistically, Nifty has remained below P/E of 16 for 38% of the time in the last 10 years (NSE provides data only upto 1-Jan-1999). So the odds are 3.8:6.2, i.e. if you buy nifty today, chances are that it will be above this level 62% of the time in the next ten years, provided the earnings do not go down. Let's see.

Market is right most of the time

I was wondering about a company named Prithvi Information Systems. The IPO came in Oct 2005 with a price band of 250-270. The company earned decent profit in years 2006, 2007 and 2008. Profit for FY2006 was 54 Cr, EPS 29 and in FY2007 was 90 Cr, EPS 50. Everything was fine till December 2007 but the stock market was not doing anything with the stock. The stock price was hovering between 250 - 400, with a P/E of 5-8 for an IT services company. But the latest result shows huge loss made by the company and the stock has plummeted below a price of 100. The company's revenues are more than 1000 Cr and the market cap is less than 250 Cr, that too for an IT services company, which generally boasts of market cap / sales ratio of more than 5. I am saying that the market is mostly right because if it is always right, as is the assumption of EMT (Efficient Market Theory), there wouldn't be value investors like
Warren Buffet and Seth Klarman. Hats off to the market.

ROCE

According to Warren Buffet, the best measure to gauge a company is to look at its ROCE - Return On Capital Employed. Unfortunately, ROCE's definition is Profit Before Interest & Tax / (Capital Employed=Total Assets - Current Liabilities). Thus it includes tax + interest. For a company having an ROCE of 20% with 30% of PBIT Tax rate and 3% of CE as Interest burden, PAT/Capital Employed will go down to 12%. He also mentions that you need to deduct interest and tax from ROCE to calculate how much return you get on your capital employed. This doesn't remain constant for a company throughout its life. Bharat forge had an ROCE in excess of 30% till 2005 but it fell to 16-18% after that. So constantly keep watching the ROCE of a company you have invested in. If it falls below 20%, it is a warning sign.

ICICI Bank NPAs rising alarmingly

The gross/net NPA for ICICI bank are rising alarmingly.

	ICICI Bank	Axis Bank	HDFC Bank
Sep 2007	2970.94	280.68	243.74
Dec 2007	3227.82	234.26	279.78
Mar 2008	3490.55	248.29	298.52
Jun 2008	4033.57	325.66	496.07

Till March, increase was 250 Crore every quarter, in the last quarter it was 550 Crore. The interest rates have actually started pinching only after June, when CRR and Repo rate were increased resulting in interest rates rising by 0.75% on Housing and Car Loans. May be we will see an increase of over 1000 Crore in Sep 2008 quarter. The figures for Axis Bank and HDFC Bank looks much better. The total non performing assets of HDFC Bank is being added every quarter in the balance sheet of ICICI Bank, this too after a big selling of NPAs to ARCIL (around 9000 Crore till 2006).

Many midcaps at prices of December 2003

I was recently looking at charts of some of the midcap companies and found that many of them were trading at a price level available in 2003 December when Sensex was at 6000. Here is the list:

Automotive Axles was at 300 today at 280
FDC was at 50 (100 before 1:1 bonus) today at 35
ZF Steering Gear was at 140 (280 before 1:1 bonus) today at 155

During these five years, the earnings of these companies have increased significantly (3x for Automotive Axles, 2x for FDC and 4x for ZF Steering Gear). Sensex EPS has also grown by around 3x and Sensex is at 14500 i.e. 2.42x. This shows what happens to small companies when investors lose interest from them. All these are debt free companies with significant dividend yield of more than 3%.

The secret of Sun Pharma

If you analyze the profit loss account of Sun Pharma, you will find that the company hardly pays 3-4% of its PBT(profit before tax) as Tax, while CIPLA, Cadila pays almost 20% of their PBTs as tax. The reason behind this low payout of income tax lies in one of its subsidiary partnership firm established in tax heaven of "British Virgin Island(BVI)". The rule of this island is that if a company makes 90% of its profit outside BVI, it only has to pay 1% income tax. Sun pharma does all its profitable business through this subsidiary, earns 1500 Cr worth of profits and pays meagre 2% as tax. I don't know if this should be considered good for shareholders or bad.

Sensex EPS Growth 0%?

When I posted on July 10, Sensex earnings was 807.78. Yesterday on 5th August at 14961.07, Sensex P/E is at 18.54 . Thus EPS turns out to be 806.96 less than what it was on July 10, i.e. June quarter results have lowered Sensex EPS instead of increasing it. The reason may be due to lower reported earnings by ICICI Bank, State Bank of India, ITC, ACC, Jaiprakash Associates, Mahindra & Mahindra, Maruti Suzuki, NTPC, Ranbaxy and Tata Motors. The pain has increased due to significant equity dilution by HDFC, HDFC Bank, Hindalco, ICICI Bank, Jaiprakash Associates, Reliance Infrastructure, State Bank of India and Tata Steel. As of 5 August 2008, these companies account for around 40% weightage in Sensex. The methodology of BSE site may be wrong.

Turbulent Times

It seems that we are going through turbulent times in stock market. There is no clear indication of where the Sensex and the overall market is going. Value companies are still not doing well (container corporation, britannia, cipla, ITC, etc...). Their profits are also not growing very fast (10%,10%,10%,-4% respectively for this quarter). The situation in market seems pretty similar to what was present at the end of 1969 in US when all the value investors went to Ben Graham to ask him that we are not finding any good stocks in market. Buffet even liquidated his partnership which invested in stocks because he was not finding good investment options.

Let one year pass and we will come to know what happens to Sensex and Nifty. Sensex/Nifty are still at a P/E of 18 while the earnings growth is just 12%. Will these two converge?

Stay away from buying Realty

I would like to tell everybody reading this blog to stay away from buying any real estate at least for the next three years. After reading Sabeer Bhatia building nanocity, I am convinced there is no juice left in IT and everybody is running behind real estate. Read this India's real estate boom coming to an end. These are the last buyers of real estate boom in India. Property prices corrected by 70% between 1996 and 2001. Will it correct by that much amount between 2007 and 2012?

What two i's have done to Britannia

I will talk about the impact of two i's, ITC and Inflation, on the profitability and price of share of Britannia. Following table shows the Operating Profit Margin and Net Profit Margine of Britannia over the last 8 years ( Operating Profit Margin = (Net Sales - Expenditure)/Net Sales, Net Profit Margin = Net Profit After Tax / Total Income) :

Year	Operating Profit Margin	Net Profit Margin
2001	8.6	5.2
2002	9.39	5.25
2003	11.36	7.46
2004	11.81	7.95
2005	11.58	8.92
2006	11.55	8.44
2007	5.77	4.58
2008	8.40	6.27

Figures for 2007 and 2008 are consolidated. If you see the more details at BSE you will find that the profits for 2003, 2004 and 2005 were helped by large other income mainly arising out of sale of securities. ITC started its operations from FY 2004. Inflation in wheat and edible oil prices started from FY07 onwards where government had to import wheat, edible oil prices shot up by 80% (my own experience when groundnut oil prices of Gemini shot up from INR 65 to INR 118). Sugar also had a short run but its prices came under control due to windfall harvest of cane. It seems than that profit margins of Britannia were unaffected by the entry of ITC (This is in contrast with HUL whose profits fell from 1800 Cr to 1200 Cr in 2004 due to entry of P&G in Indian Detergent market. P&G slashed prices of Tide by 40% and HUL had to follow suit. That kind of harakiri hasn't happened yet in Biscuits).

Till 2005, the Tax to PBT was around 30% which fell to 9% in 2007 and rose to 20% in 2008. I assume it will rise to 25% in future. The depreciation had remained constant at around 20-25 Cr which increased to 39 Cr in 2008. Interest burden is almost nil.

If we consider 2003-2006 to be exceptional years of high profits for Britannia, and 2007-2008 to be exceptional years of low profit margins, than still 9% OPM can be assumed for calculating long term profits, 1% for depreciation+interest and 25% of 8% = 2% for tax giving 9%-1%-2%=6% for Net Profit Margin only from operations, other income extra.

The sales growth of Britannia historically has been 14% (Sales increased from 100 Cr in 1983 to 2800 Cr in 2008).

Thus for the next 10 years, if we assume that the long term condition prevails, in 2018, the company should make INR 10000 Cr worth of sales and 600 Cr worth of net profits. Considering a conservative P/E of 15, the company should trade at a market cap of around 9000 Cr.

During these 10 years, company will generate profits of around INR 3300 Cr. Thus if we buy britannia today, we will get 3300 Cr in 10 years + 9000 Cr at the end. So in 2018 we would have got 12300 Cr. (I have not counted the profits of each year invested because 3300 Cr we will get in tranches from 2009-2018 170 Cr every year increasing by 14% a year).

Considering a risk free return of 8% on PPF, we are willing to pay INR 100 to government to get INR 216 in 2018. Thus we should give a market cap of at least INR 5695 Cr to Britannia at this point of time. But it is languishing at around 3200-3500 Cr in the current market, a margin of safety of 40%. For a big FMCG company like Britannia, this should be enough.

I would recommend STRONG BUY on Britannia today at INR 1350.

Future Sensex Candidates

BSE determines the candidates for Sensex based on free float average market capitalization of stock for 6-months. But it also looks at sectors. Based on BSE , it seems that top 17 are already in Sensex. Reliance Petroleum and Essar Oil have been skipped to take Tata Power and Sterlite into Sensex from 28 July. Stocks till Maruti Suzuki are in Sensex which has free float market cap of around 8000-8500 Cr. Axis Bank, Reliance Capital and IDFC from finance,
Sun Pharma from Pharmaceutical
Cairn and GAIL from Oil and Gas
Jindal Steel and Power from Metals/Power
might be the next candidates to enter Sensex. Stocks to go out will be Maruti Suzuki or Mahindra and Mahindra.

This shows that Auto is no longer a core sector in India's economy or is slowly going out just like GM and Ford went out in US. In pharma also the growth has slowed a lot. Just like Ambuja, ACC will also go out of Sensex within 2-3 years.

The companies which look promising to me over 10-15 year period to enter Sensex are Nestle and Asian Paints. Nestle was part of Sensex till 2003 and Asian Paints was in Nifty in mid nineties. The problem with Nestle is volumes. Otherwise I am sure it will replace HUL in the next 10-15 years.

Sensex will not cross previous highs till 2015

Everybody is talking about when the Sensex will bottom and when it will start its previous march towards new high. I want to differ and stick my neck out to say that Sensex will not cross its previous highs till 2015. I will put my own analysis. All the march quarter results for Sensex companies are out. The Sensex closed at 13,926.24 with P/E shown here 17.24. That makes an EPS of 807.78.

Sensex was trading at 3386.89 in 2003 June with an average P/E of 14.61. Thus EPS in June 2003 was 231.82. In the last 5 years Sensex earnings have gone up by almost 3.48 times i.e. 28.36% compounded annually. Some of these contributions were from cyclical commodity businesses like Cement (Ambuja Cement, ACC, Grasim), Metals (Tata Steel, Hindalco), Power/Infrastructure (BHEL, L&T, Rel Infra, NTPC, Jaiprakash Associates, DLF) and Oil and Gas (ONGC, RIL). Some of the earnings were from slowing sectors like Auto (Tata Motors, Maruti Suzuki, Mahindra & Mahindra), Pharma (Ranbaxy, Cipla), FMCG (HUL, ITC) and Tech (Infosys, Satyam, Wipro and TCS). The biggest contributions were from fast growing businesses of Finance (HDFC, ICICI, HDFC, SBI) and Telecom (Reliance Communications, BHARTI). Cipla and Ambuja Cements are going to be replaced by Sterlite and Tata Power.

What my gut feeling is that Cement, Metals, Auto and Infrastructure will see only 7% compounded annually increase in their profits in next 7 years till 2015 (equivalent to inflation).

Oil and Gas will increase their profits at 15%.

Pharma, Telecom, Financials and FMCG will be able to increase their profits by 12% for the next 7 years (counting equity dilution for financials).

IT will increase its profits by 15% till 2010 but then higher taxation and wage will erode their profit margins so they will also increase profits 7% compounded annually (equivalent to inflation).

Now if we consider the weight of these sectors in Sensex,
Auto (2.91), Cement (2.58), Metals (5.09) and Power/Infrastructure (15.7) makes 26.28%
Oil and Gas makes 19.37%
Pharma (2.57), Telecom (8.47), Financials (20.09) and FMCG (7.39) makes 38.52%
IT makes 15.83%

Now if Sensex's 26.28+15.83=42.11% grows at 7%, 19.37% grows at 15% and 38.52% grows at 12%, the whole Sensex will grow at 10.75% and achieve an EPS of 1650 in 2015. At 14 times 1650 comes 23104.

There are many ifs and buts here. Growth rate may be very very wrong. New comers to Sensex (Sterlite and Tata Power) may make huge jumps in profits due to increase in commodity prices or power reforms carried out by government, and so on.

Last time when Sensex touched 21207 on 8 January 2008, the market capitalization of the BSE was 75 lac crore. Indian economy is today at 44 lac crore and if it grows by 8% for the next 7 years, the economy will become 75 lac crore. Generally, stocks are fairly priced when GDP equals total market capitalization of stock exchanges.

Let's see.

Some Value Picks?

I would like to provide some interesting small/mid cap stock ideas in this post.

Stock	EPS	Dividend	Price	Business
Savita Chemicals	42	11.5	220	Transformer Oil
Automotive Axles	36	12.5	215	Truck Axles
Banco Products	6	1.4	29	Gaskets
Indraprastha Gas	12	4	110	CNG Distribution

I will review performance of these stocks every year.

Is TVS Motor Headed towards LML?

Some years back, LML shut its plants and became bankrupt. Looking at the financial results of TVS motor, it looks like it is also headed towards a similar fate. The company's fundamentals are quickly deteriorating. Company had a pretty good result in 2003 and the stock price touched a lifetime high of 113.69 (actually 1136.9 but it had announced a split 10:1). Then again in March 2006, a lot of hope took the stock to a lifetime high of 186.7. Today it is at INR 25. The book value of the stock is 34 but it has a debt of around INR 635 Cr which balances all the net worth. The lifetime low is INR 6.5. Let's see if it breaks it.

Should you invest in Mutual Funds?

I will give you an idea of underperformance of several mutual funds over the last two years compared to their benchmark indices. The NAV of the mutual funds have been taken on 20 June. Sensex was at 14571.29 and BSE500 was at 5747.63 on 20 June.

Scheme	Launch Date	Mutual Fund Return	Sensex Return	BSE 500 Return
UTI Contra Fund	22 March 2006	-0.016%	10905.2 33.62%	4355.5 31.96%
Reliance Equity Fund RP(G)	7 March 2006	24.7%	10735.36 35.73%	4286.73 34.08%
UTI Leadership Equity Fund	30 Jan 2006	25.2%	9919.89 46.89%	3982.17 44.33%
ICICI Pru Fusion Fund	27 Feb 2006		10282.09 41.71%	4113.14 39.74%
SBI Blue Chip Fund	20 Jan 2006	12.1%	9520.96 53.04%	3892.38 47.66%
Franklin India Smaller Companies Fund	14 Dec 2005	-0.013%	9241.76 57.67%	3745.57 53.45%
HDFC Long Term Equity Fund	27 Jan 2006	10%	9870.79 47.62%	4005.33 43.5%

The schemes cover from all the different mutual fund houses, ICICI, HDFC, Franklin, SBI and UTI. Nobody has been able to outperform the indices over the last 2 - 2.5 years. Is it a better idea then to invest in Index funds?

What can bear market do to stock prices

I want to highlight in this post the severity of bearish phase of 2001-2003 on the Indian stock market. I will explain with two examples.

The first one is CRISIL. The company had an earnings of around INR 16, 20.17, 20.84 and 15.59 in 1997, 1998, 1999 and 2000 respectively. The stock price reached a high of INR 825 in December 1999, that comes to be a P/E of 40. In the brutal IT bust, the stock price went down to 96, a P/E of less than 5 and it remained below 150 for the rest of 2001. Today it is trading at 3500. The consolidated earnings have increased to 117.8. In 7 years, the company made more earnings than what its market capitalization. A person who would have bought the stock at 200 at a P/E of 10 would have seen his capital eroded by 50% in 2001-2002.

The second one is Blue Star. The company had earnings of around INR 8.21, 8.62, 9.04 and 12.92 in 1997, 1998, 1999 and 2000 respectively. The stock price reached a high of INR 233 in January 2000, that comes to be a P/E of 20. In the bust, the stock price went down to 18.7, a P/E of less than 2 and it remained below 40 for the rest of 2001 and most of 2002. The company paid INR 4.5 and 5.5 as dividend in 2000 and 2001. In two years you would have got 50% of your capital back. Today after a 5:1 split, the stock is at 400. Company made 5 times profit this year than what its market capitalization was in 2001. A person who would have bought this stock at a P/E of 10 at a price of 100 would have seen his capital eroded by 80% in 2000-2001. Even Benjamin Graham and Warren Buffet would have got scared and sold these stocks.

Both this examples say only one thing:
Stop seeing the ticker on CNBC-TV18/NDTV-Profit/Zee Business. You may commit a mistake of selling a future Blue Star or CRISIL.

Those people who would like to compare these stocks with L&T, GMR and JP Associate today should see that even after the correction of 50%, they are not even below P/E of 30. JP associate at a price of 160 is trading at a P/E of 40 even after 70% correction from peak of 525. GMR at 100 is trading at a P/E of 80 even after correcting 60% from a peak of 250.

What happens when a stock lose investor interest

Benjamin Graham had seen a long history of US stock markets, almost 35 years, before he published the first version of Intelligent Investor. He had put a big emphasis on never paying more than 20 times last year's earnings for a company and 25 times average last seven years' earnings. This seemed to be a severe restriction for Indian markets since, excluding commodity companies like steel,cement,oil&gas etc., all the other companies in Sensex were trading much above a P/E of 20 after October 2005. That P/E has still not come down below 20 in June 2008, a period of almost 32 months. But if you see outside the Sensex, you will be able to find a lot of companies trading above a P/E of 20-25, now trading at a P/E of single digit. For example

Automotive Axles touched a P/E of 28.5 (at a price of 820) in March 2006 and now trading at a P/E of 7.6 (at a price of 275)
ZF Steering Gear touched a P/E of 19.9 (at a price of 900) in August 2005 and now trading at a P/E of 5.2 (at a price of 160 after 1:1 bonus)
Gateway Distriparks touched a P/E of 64 (at a price of 300) in November 2005 and now trading at a P/E of 11 (at a price of 92 after 1:4 bonus)

Automotive Axles pays dividend of INR 12.5 giving a yield of around 5%, ZF Steering Gear pays dividend of INR 8 again a yield of 5%, gateway distriparks pays dividend of INR 3 giving a yield of 3.25%.

These stocks were not a buy in 2005/2006 but I think today they are all worth taking a risk. There is a big question of oil prices looming large over auto and logistics industry. But it seems that it is priced into the stock prices. Remember that the companies have increased their profits by almost 30%(for automotive and zf) to 130% (for gateway) during this time frame. So it's not just the contraction in prices, it is also increase in profits that have brought down the valuations.

Reckless Investment by Mutual Funds

I want to show some deals by mutual funds that clearly targets reducing investor returns:

Fund Scheme	Stock	Price	EPS	P/E
Tata Indo Global Infrastructure Fund	Madhucon Projects	750	12	63.53
Tata Infrastructure Fund	GMR Infrastructure	220	1.1	200

Consider the deal by Tata Indo Global fund for Madhucon Projects. A company was bought with a P/E of 63.5. The company pays just INR 0.60 as dividend, a yield of less than 0.1%. The company's growth over the last 3 years has been impressive at 47% a year but even with that it will take 4 years for P/E to come down below 20. GMR also grew by 45% a year for the last 3 years. It will take 6 years for company's P/E to come down to 20. Madhucon has a profit of 50 crore with a market cap over 3000 crore. Even if after 4 years it earns more than 200 crore, it will be at par with IVRCL and Nagarjuna today. GMR after 6 years will have a profit of 1900 crore equivalent to what L&T has today. Do you think this will surely happen? There are so many ifs and buts.

Do you always have to buy stocks which are at such a high P/E when companies bigger than those are available at a lower P/E than their smaller rivals? IVRCL has a profit of around 300 crore (consolidated) and trading at market cap of 5000 crore. L&T has a profit of 2200 crore and trading at a market cap of 84K crore. Both are at much lower P/E than their smaller rivals. And putting Infrastructure in your scheme's name doesn't tell you that the stocks you buy should also have Infrastructure in their name.

Container Corporation, Asian Paints, Pidilite, Balmer Lawrie, Blue Star are also part of infrastructure trading at a much lower P/E than even the L&Ts and IVRCLs. Every bridge, building and house needs paint, adhesives and water proofing chemicals. Every mall will need an air conditioner. Every power plant needs coal transferred through container cargo. You can buy good infrastructure finance companies like SREI infra which was trading at a P/E of 4 till 2007. What we need is intelligence from Mutual Fund managers not stupidity.

Tale of a Textile Machinery Company

I will talk about Lakshmi Machine Works. The company had a lifetime high of 12350 (617.5 at today's price) in 1996. The company's price went down all the way to 525 (52.5 at today's price) which is an erosion of 91.5% from top. Then started a big rally and the stock touched a new lifetime high of 4250 in December 2006. The stock is langushing at around 1500 today a correction of 65% from top. Reliance Long Term equity fund bought the stock at 2925 in September 2007 and ICICI Prudential Life Insurance at 2045 in January 2008. Reliance has lost 50% of 66 crore and ICICI has lost 25% of 18.7 crore that it has invested. Now why has this happened? Let's see the profits of this company over the last years:

Year	Net Profit
1995	43.31
1996	42.96
1997	23.78
1998	25.9
1999	8.41
2000	21.92
2001	27.4
2002	14.71
2003	25.39
2004	60.22
2005	73.34
2006	148.07
2007	206.198
2008	242.3013

Anybody who has the record only till 1999 will feel that the company has shown degrowth in profits only in 1 year. But if you have a good record till 1990s, you can see that the average profits of the company has grown by just {(242.3013+206.198+148.07)/(42.96+23.78+25.9)}^0.1 = 20.47%. When Reliance bought the stock it was at a P/E of 20 and when ICICI bought it, it was at a P/E of 10. Now the stock is trading at a P/E of just 7. The company earns around INR 200 and pays INR 40 as dividend. The yield turns out to be 2.66%. Why so much under valuation?

Graham has put a lot of emphasis on earnings stability. If you see, the company's earnings went down from 43.31 in 1995 to 8.41 in 1999 which is an erosion of 80% of profits. So if the same situation arises again, the company will earn just 49 Cr and P/E will expand to 35 at current prices. Is this warranted? 1999 was an exceptional year preceded by Asian Financial Crisis in 1997 and the textile exports had gone down and the Indian economy was in doldrums. I don't know if the same will happen again. The rupee appreciation has already cost several lakh jobs in south India and a company with an order book of more than 5000 crore now has got cancellation for many orders. Just like how it has happened for airline companies after crude price rise. Let's see ahead what happens.

Paying too much for growth

Benjamin Graham while considering P/E, EPS etc. took an average of 3 years. To get an idea of growth of the company over the last 10 years, he will take average earnings of 3 years before 10 years and consider the earnings of last 3 years and then decide the growth rate. We will understand this with examples:
Take L&T, the biggest Engineering & Construction company in India and its net profit:

Year	Net Profit
1996	389
1997	411
1998	531
2006	1317.21
2007	2240.14
2008	2325.36

Thus average profit for 1996-1998 was 443.66 and average profit for 2006-2008 is 1960.9. Thus growth over ten years is 16% per annum while inflation rose at a rate of 6.36% during the time 1995-2005 (@ Inflation Index). The same company is commanding a market cap of 83K crore right now at bourses even after correcting 35% from its top of 130K crore. This is a P/E of 35.7 at the current price and 56 at the peak.

If you see, consolidated earnings growth was meagre 4% in the last year (standalone rose by 55% from 1403 to 2173 crore). Even if we assume it grows by 30% in year 2008-09 and 25% in 2009-2010 the P/E will still be 27 and 21 at the current price in 2010. And P/E will surely come down as the growth slows down, as already seen in IT companies.

Will History Repeat?

Looking at the recent correction in stock market, I started looking at historical data for benchmark indices to know how low the stocks could go. I was shocked to see the P/E ratios of indices during bear markets of 1999 and 2003.

The previous bull run of indian stock market started in November 1998 and peaked in Feb 2000 a bull run for around 15 months. The P/E range for this bull run was 11-28. The P/E ratio for Nifty was 10.58 at the start of bull run when Nifty was at 810.85 on 28-Nov-1998 and the bull run ended at a P/E ratio of 28.47 in February 2000 when Nifty peaked at 1756 on 11-Feb-2000.

If you analyze the data for the recent bull run between May 2003 and January 2008, a bull run of almost 57 months, also started with a P/E ratio of 10.84 for Nifty in May 2003 when Nifty was at 936 on 12-May-2003 and ended at a P/E ratio of 28.29 in January 2008 when Nifty was at 6272 on 9-Jan-2008.

After the last bull run the correction lasted for around 19 months and Nifty bottomed on 21-Sep-2001 at 854.2 when the P/E bottomed at 12.3. After that was a time based correction, i.e. Nifty earnings kept increasing but Nifty didn't see that much increase and so P/E contracted and bottomed at 10.84 on 12-May-2003 a time of around 20 months. Thus the total bear market lasted for around 39 months.

Nifty movement

Date	Nifty	P/E	Earnings
28-Nov-1998	810.85	10.58	76.64
11-Feb-2000	1756	28.47	61.68
21-Sep-2001	854.2	12.3	69.45
12-May-2003	936	10.84	86.35
9-Jan-2008	6272	28.29	221.7

The table shows that between 1998 and 2000, the Nifty EPS actually went down. This is in contrast with the current situation when the EPS has grown by 156%. If we assume that the history will repeat but earnings will continue to grow, then after 19 months we can say that at 21.88% earnings growth (which is what we have got over the last 57 months) the EPS of Nifty will be at 303.28. Multiplying this by the last P/E of 12.3, we get Nifty of 3730. This is still 25% below the current Nifty of 5025.

Are we headed for more pain? Two assumptions may change the scenario. Nifty EPS growth which has been only 11% yoy as per Nifty EPS Growth may make things worse since at 10% growth the EPS after 19 months will be 257.8. So at 12.3 P/E Nifty will be at 3171. The P/E may not go down as much as it did last time. It may remain at 15 or more this time due to EPS growth of 21% over the last 57 months. In that case the most optimistic scenario gives 303.28*15 = 4549 which was the recent bottom and the most pessimistic gives 257.8*15 = 3867. Let's see whether it goes to 3171 or remain 4549 in August 2009.

Amazing Performance by India Inc

Everybody is cribbing about slowdown of performance of India Inc. Forget about what large companies in Sensex are doing. Look at companies outside Sensex and you will be surprised to see that many of the companies have given their best performance ever in their history. For example

Company Name	Profit 07	Profit 08	% Change YOY
Pidilite	111.7	195E	74.6%
Asian Paints	281.03	409.18	45.6%
Blue Star	71.18	174.09	144.6%
Exide	155.21	250.33	61.3%
Marico	112.9	169.07	49.8%
Nestle	315.1	413.81	31.3%
CRISIL	61.43	83.6638	36.2%

These companies cover sectors ranging from chemicals to food to auto to finance. All these companies have what buffet says is "MOAT" i.e. a strong brand recall, monopoly/duopoly and a long term competitive advantage in my sense. I don't think the bull run of India Inc ends in 2008. This seems to be the beginning.

Speculating when you think you are investing

I want to put here the case of my own experience. The company in focus is one of the biggest pharmaceutical companies, CIPLA. The company has an envious record of ever increasing profits over the last 15 years.
1992 8.315
1993 10.361
1994 14.617
1995 24.82
1996 28.96
1997 70.75
1998 101.97
1999 114.95
2000 133.06
2001 179.07
2002 235.11
2003 247.74
2004 306.69
2005 409.61
2006 607.64
2007 ?
2008 ?

The company increased its profits by 73 times during the 14 year period 1992-2006 i.e 35.87% compounded annually. For 9 months ended 2007 the profits were 535.09 Cr compared to 409.31 Cr up 30.73% (Trailing Twelve Month-TTM profit of 725.86). If you see the profits than for any three consecutive years, the increase in profits were always more than 70%. I extrapolated the 2006 results to get the result for 2009, 1032 Cr. The stock at the start of 2007 was trading at Rs. 260 with a market cap of around 20K Cr. I bought the stock thinking that history will repeat itself. Did it really? The 2007 Q4 results had profit declining by 34% and full year profit came at just 668 Cr. The pain didn't end there. For 2008 the profits were just 700 Cr.
Now in 2009, the company has given guidance of just 12-15% growth which will result in profits of around 785-805 Cr off by 24% of my "speculated profits" and three consecutive year's growth between 2006-2009 will hardly be 30%. I doubt if the stock price will cross the market cap again before 2010. Even if they grow by 15% more in 2010, the profits will be just 925 Cr and P/E will still be above 20. Loss of 3 years of returns!!!!!!!!!!! The price is hovering around 170-230 range.

Emami

Emami is a midsize FMCG company in india. Company has brands like Navratna, Himani Boroplus, Himani Sona Chandi Chyavanprash etc... The company has earned following EPS for the last 7 years:
2002,2003 2004 2005 2006 2007 2008E
3.0,3.27,3.86,5.23,6.45,10.61,13E
Based on Graham's criteria of 25 times last 7 years earnings, the price comes to about 165 but 20 times last year earnings is at 260. The company has very small debt. It is one of the prominent and should be considered large for the FMCG industry. The recent market meltdown made the stock correct from 360 to 225 and seems cheap. It has grown fastest in terms of percentage net profit growth over the last 10 years (25% profit CAGR). 87% shareholding belongs to promoters. Pays Rs. 2 as dividends (excluding special dividend of Rs. 2 last year).