Right in the short term Wrong in the long?

Even the value investors face a dilemma when they find a stock whose intrinsic value is decreasing. Even though the investor buys with a margin of safety of 50%, i.e. a stock with an intrinsic value of INR 100 at a price of INR 50, the sentiment of the market plays a huge role in returns. If the sentiment does not change for two years and the intrinsic value decreases at a rate of 15% a year, after two years, the intrinsic value of the stock will be INR 72.25 and the margin of safety will decrease to 30.8% instead of 50% with which the investor started. Let me take an example of one of the company I was researching lately. The company is Dredging Corporation of India. The company at the end of FY2008 (FY2009 balance sheet is still not out) had a net current assets (NCA) of INR 663.6 Crore. In the October 2008 - March 2009 carnage, the stock price reached INR 200 (the low was INR 180) and stayed there enough for a value investor to buy it. The total market cap of the company at INR 200 was INR 560 Crore, less than its NCA. The company gave INR 15 as dividend in FY2008 and is debt-free. The company had generated free cash flows (FCF) of more than INR 150 Crore over the last five years, giving price / FCF of just 3.7. The market was clearly not valuing the company correctly. Then came the pop in stock markets and the share price reached a high of INR 650 with the market cap of INR 1820 Crore, 3.25 times that of the bottom.

Now comes the long term valuation. Even though the company is producing an FCF of INR 150 Crore over the last 5 years, the operating profit margin of the company is under pressure lately due to high hire charges of dredge. Following table summarizes the impact:

Year	Sales	Hire Charges	% of Sales	Operating Profit	% of Sales
2009	684.97	261.62	38.19%	-87.04	-12.7%
2008	705.32	125.64	17.81%	84.63	12%
2001	402	30.47	7.58%	151.93	37.8%

The operating profit margin has gone down from 37.8% in 2001 to -12.7% in 2009. This clearly is a company with decreasing intrinsic value. It's the INR 145 Crore other income that allowed the company to report profits at net level.

Even though a value investor didn't analyze all these facts and just bought the stock based on NCA, he would have got 150% returns in just six months, not a bad bet I guess.

Remember that Warren Buffet made most of his returns with this kind of investments in the early days but tilted more towards long term approach later.