Myopic Markets

Benjamin Graham has always emphasized on normalized earnings since there are many one time expenses/income reported by companies which needs to be adjusted to know the true earning power of the company. But markets may remain myopic and look at only the reported numbers. I will provide two examples of this situation:

The first example is that of a pharmaceutical company, Unichem Laboratories. The company has always been a very well managed company. Due to improvement in employee productivity, many companies allowed employees to opt for VRS during 1995-1997. This added some one time expense for companies. Unichem also allowed some employees to opt for VRS and incurred an expense of INR 9.08 Crore in 1997 and INR 11.13 Crore in 1998. The EPS of the company was thus INR 8.16 instead of INR 20.93 for 1997 and INR 9.41 instead of INR 22.21 for 1998. The facts were clearly mentioned in the annual report and annual results of the company. EPS for 1996 was INR 15.31 thus EPS declined by almost 40%. The company's share price declined from INR 270 to INR 84.75 between March 1996 and February 1998. This made a P/E of 9 on reported earnings but a P/E of only 4 on actual normalized earnings. What happened next when the market realized this mistake? When the company reported EPS of INR 23.65 and INR 36 for years 1999 and 2000 respectively, the investors became overly optimistic and share price went up to INR 780 in February 2000, a P/E of 21.67, nine times the original price in two years.

The second example is that of an FMCG company, Britannia Industries. The company reported a one time income of INR 120.2 Crore in FY2000 so the total profits came in at INR 203.2 Crore, with EPS of INR 72.5. The share price went up to INR 1809 in September 1999 while the actual profits were only INR 83 Crore with an EPS of INR 29.65. Thus, even though P/E looked like 25, the P/E on normalized earnings was more like 61. Even today after ten years, the share price is below 1999 high.

Conclusion? Wear specs!!!!

How Government Policies affect companies?

There is already a well known example of Oil Marketing Companies in the Indian Stock Market. But these companies are majority government owned and so the impact of government policies on these companies can be understood. But even companies not owned by Government can have a major impact of policy changes. Let's take an example of cooker makers. There are two main organized cooker makers in India, Hawkins and TTK Prestige. The following shows their profits and share prices during the last thirteen years.

	Hawkins		Prestige
Year	Profits	Share Price	Profits	Share Price
1997	4.7	55.5	8.39	45.5
1998	NA	46	5.08	25.75
1999	4.01	37.3	9.33	45.5
2000	3.6146	28.1	3.64	30.75
2001	1.868	30.1	1.55	16.8
2002	-2.06	24.25	0.7	14.5
2003	-6.91	18.15	-11.47	6.65
2004	0.798	16.45	0.21	13.35
2005	3.11	51.4	3.81	46.4
2006	4.027	71.05	7.11	150.75
2007	7.494	83.1	11.77	122.7
2008	11.261	153.3	20.67	116.05
2009	19.116	162.2	22.38	90.8

The two durations of government policy changes are marked with bold. What was that change? The change was very simple. The Central Excise Duty on cookers was increased from 8% to 16% from 1st April 2000. The results of these companies started deteriorating from that year itself as the profits went down by 50% or more. The companies started making losses in 2002-2003 and the government woke up. The duties were again revised from 16% to 8% from 1st April 2003. The companies started making profits from the first year itself and see the results of the last year.

The share prices too declined along with profits during 2000-2003 by around 40% to 70%. Hawkins skipped dividend only in 2003 while TTK skipped for three years of 2002-2004. The investors who bore the pain of heavy losses and no income of dividend have been rewarded handsomely as the prices are up by more than 35-50 times (not percent) today.

F***ing Ba***rds

I am talking about BSE. I have maintained my own excel sheet of BSE500 and BSE SMALL CAP indices where I keep every company's book value, its debt, its profits and sales of last 20 years, etc... I have a practice of visiting their SMALL CAP and BSE 500 scrip watch page, copying the daily quotes, pasting them in an excel and copying the price column and pasting it to my own maintained excel sheet every day. But these guys keep changing the order of the scrip every day. Sometimes RIL is represented as Reliance Industries, sometimes Reliance Inds and sometimes RIL. When I paste the newly ordered prices into my excel sheet, price of Reliance Power appears against RIL and price of RIL against Reliance Infrastructure. Can somebody please lay off these guys at BSE and hire some professionals?

India Inc is not deleveraging at all

World over the private sector is reducing its debt but in India, the party is still not over. Companies, especially small by size, are continuing their debt binge. Even the banks are lending without strict lending norms as can be seen in case of many companies.

The total outstanding debt of 473 BSE SMALL CAP Index companies stood at approximately INR 1,68,000 Crore at the end of FY09. This only includes debt of standalone non-financial entity. BSE SMALL CAP index's total market cap is just INR 3,22,680 Crore, with P/E of 17.68 and P/B of 2.13. This indicates that net profits of BSE SMALL CAP index would be around INR 18,250 Crore (and lower if we exclude financials) and Book value around INR 1,51,500 Crore (and lower if we exclude financials). Thus the total outstanding debt is even more than the book value (or net worth or shareholders' equity) giving debt/equity of 1.1 (higher if financials are excluded). Since the interest rates are low right now and the profitability of many companies is above average, the companies have been able to bear their interest burden. Reverse the two and the situation will become completely different. If interest rates increase and operating margins contract, the outcome will be nothing but horrible. Even with the current scenario, it will take more than nine years for companies to pay their debt completely. The only thing difficult to predict is the timing. The real punishment will be to the banks since their assets will deteriorate.

Compare this to companies belonging to BSE 500 index. The total outstanding debt of 500 BSE 500 Index companies stood at approximately INR 7,68,000 Crore at the end of FY09, excluding that of financials, 4.5 times that of BSE SMALL CAP index companies. The total market cap of BSE 500 is at INR 55,00,000 Crore, i.e. 17 times that of BSE SMALL CAP index. The P/E of 21.16 and P/B of 3.79 gives net profits at INR 2,60,225 Crore and book value of INR 14,57,102 Crore. Thus total outstanding debt is much less than the book value, with debt/equity at 0.53. It will take just three years of profits to pay the debt completely.

This puts BSE500 companies in much stronger position than that of BSE SMALL CAP. This is just a conclusion based on average. The individual companies may vary. Also notice the fact that some companies like, 3i Infotech, Alok Industries are present in both the indices. This is just to highlight the fact that investing in small companies is riskier than that of larger ones. Even when it comes to restructure debt, the banks would provide favourable terms to big companies compared to smaller.

Mismanagement of money?

I was looking at the list of companies trading at a market cap below the money they raised during their IPOs in the last five years provided in previous two articles, and found one of them, named Precision Pipes and Profiles, interesting. The company till March 2007 had investments of only INR 0.72 Crore, on their balance sheet which subsequently increased to INR 56.86 Crore at the end of March 2008 and declined to 21.24 Crore in March 2009. This made me curious and led me to read their annual reports of FY2008 and FY2009. I found that the company heavily invested in equity mutual fund schemes during April 2007 - March 2008. Some of the schemes were liquid, FMP schemes and were sold off during April 2008 - March 2009 but equity schemes still remained in the investments and that too at a very steep decline in NAVs.

Scheme	Units 2008	Value 2008	Units 2009	Value 2009	Value Today
Birla Special Situation Fund	9388753	80413731	9388753	48314523	86977407
Birla Sunlife Industries Fund	90113	3173975	90113	1647271	2706093
Fidelity Equity Fund	26715	429822	26715	289834	784111
HDFC Infrastructure Fund	2000000	18708000	2000000	10364000	21782000
JM Basic Fund	53860	1071603	198320	1238506	3572139
Kotak 30	61285	1918655
LICMF Equity Fund	44540	393953	44540	253927	1092031
LICMF Infrastructure Fund	5400000	50079600	5400000	30493800	49680000
Reliance Growth Fund	73730	3735910	69457	2041755	3661495
Reliance Natural Resources Fund	2962962	28511111
Tata Infrastructure Fund	203307	4586314	151163	1935036	4875006
AIG World Gold Fund			1955990	17545232	24404887

The value today for the investments mentioned in the annual report of 2009 stands at
INR 199535169 which is still below the actual invested amount of INR 205188460. The company clearly mismanaged money. At the end of March 2009 itself, the market value of schemes was 45% lower than the invested amount. Thanks to rise in stock market over the last 10 months, the market value of this schemes today is just 2.8% lower than the invested amount. But we don't know if the company has already sold them or not. Let's wait for the next annual report.

Some Thoughts on IPOs - Part 2

This is an extension to the first part of this post. Here are the ones excluded from yesterday's post:

Company	IPO time	Offered Equity	Times Subscribed	Raised Money	Market Cap Today
First Winner Industries	June 2008	31.02%	1.14	68.75 Crore	33 Crore
Niraj Cement Structurals	May 2008	31.42%	1.07	61.75 Crore	54 Crore
Sita Shree Food	March 2008	47.65%	2.41	31.5 Crore	20 Crore
Tulsi Extrusions	February 2008	45.62%	1.83	48.45 Crore	35 Crore
Bang overseas	January 2008	27%	1.13	72.45 Crore	68 Crore
Cords Cable	January 2008	27%	4.63	41.65 Crore	46 Crore
Porwal Auto	December 2007	33.11%	1	37.5 Crore	15.5 Crore
Precision Pipes	December 2007	35.71%	10.59	75 Crore	91 Crore
Kaushalya Infrastructure	November 2007	40.93%	5.884	51 Crore	39 Crore
Renaissance Jewellery	November 2007	37.99%	2.75	79.86 Crore	92 Crore
Dhanus Technologies	September 2007	21.37%	28.29	113.13 Crore	58 Crore
Magnum Ventures	August 2007	46.92%	2.75	52.92 Crore	33 Crore
Alpa Laboratories	July 2007	44.06%	0.945	64.6 Crore	25 Crore
Roman Tarmat	June 2007	25%	29.26	50.75 Crore	59 Crore
Vishal Retail	June 2007	16.85%	76.12	110 Crore	150 Crore
Nelcast	June 2007	25%	7	95.26 Crore	102.5 Crore
Decolight Ceramics	May 2007	42.98%	1.7	43.45 Crore	18.5 Crore
Asahi Songwon	May 2007	30.33%	2.12	33.5 Crore	36 Crore
Abhishek Mills	February 2007	29.27%	1.24	41 Crore	43 Crore

The total money raised by all these companies comes to about INR 3500 Crore. The market value of the same shares today is less than INR 900 Crore, 25% of original investment even after 4 years in some cases. Not just the fractional ownership, the whole companies can be bought today for less than INR 2900 Crore. This surely is just one side of the coin. There were some good issues too, like Educomp, ICRA, etc... which have given decent returns to investors but the risk was not worth taking.

Some thoughts on IPOs

This post is to highlight the fact how investors are fooled into investing in IPOs. The basic idea of the post is to show that some of the companies coming up with IPOs in the last 5 years raised more money in their IPOs than their total market cap today. Please have a look at the table:

Company	IPO time	Offered Equity	Times Subscribed	Raised Money	Market Cap Today
Raj Television	February 2007	27.5%	2.36	91.7 Crore	78 Crore
AMD Metplast	February 2007	42.16%	4.88	76.25 Crore	56 Crore
Oriental Trimex	February 2007	64.5	0.95	48 Crore	22 Crore
Evinix Accessories	February 2007	32.71%	3.4	42 Crore	35 Crore
Broadcast Initiatives	February 2007	44.27%	2.36	102.6 Crore	36.5 Crore
Indus Fila	February 2007	25%	1.34	82.35 Crore	50 Crore
Euro Ceramics	February 2007	32.87%	2.86	92.75 Crore	71 Crore
Transwarranty Finance	February 2007	42.86%	1.52	31.2 Crore	19 Crore
Cinemax India	February 2007	31.86%	41.86	138.26 Crore	160 Crore
House of Pearl	February 2007	33.52%	3.67	362.83 Crore	172 Crore
XL Telecom	December 2006	26.07%	8.1	59.35 Crore	80 Crore
Ruchira Papers	November 2006	45.57%	2.53	28.5 Crore	19.5 Crore
Blue Bird	November 2006	25.07%	4.82	92.14 Crore	100 Crore
Global Vectra Helicorp	October 2006	25%	3.53	64.75 Crore	60 Crore
Hov Services	September 2006	32.3%	2.51	81 Crore	89 Crore
Lokesh Machines	May 2006	25.47%	19.37	42 Crore	52 Crore
R Systems	March 2006	32.57%	3.36	110.21 Crore	105 Crore
Uttam Sugar	March 2006	15.53%	4.63	136 Crore	156 Crore
Nitco Tiles	March 2006	44.9%	4.51	184.8 Crore	162 Crore
Nitin Spinners	January 2006	57.14%	16.51	49 Crore	29.5 Crore
Celebrity Fashions	December 2005	25.5%	23.6	81 Crore	35 Crore
Kernex Microsystems	December 2005	34.85%	22.95	99 Crore	105 Crore
Prithvi Information	December 2005	25.17%	15.27	135 Crore	116 Crore
SPL Industries	July 2005	31.03%	28.26	63 Crore	30 Crore

The list is so long my finger pains and I am not including more.

Investors bought fraction of a company at a price and today the whole company is available at a fraction of that price, after two-three years. I don't believe in Efficient Market Hypothesis, so I do believe some of the companies listed above and also some which have not been included are real bargain today. I would see if I find some bargains and list in the next post.

Is dubai the next bear stearns?

I am just trying to compare current crisis with one in the past. Bear Stearns had to borrow from Fed on March 15, 2008. JP Morgan then bid for Bear Stearns at USD 2 and finally agreed to pay USD 10 on March 28. There was a kind of panic in investors across the world for few days. The Sensex too declined from 16371.29 on March 29, 2008 to 15343.12 on April 4, 2008. There was a big rally after that to 17490.9 till May 5, 2008. And everybody knows what happened after that.

Some Statistics

Looking at the way market is heating up, I would like to provide how odds stack up against investors at current valuations. In the data available for Nifty from January 1, 1999 till 1st Dec 2008 (yes, this is 2008, since I don't know what returns Nifty gives from 2nd December 2009 onwards), the following observations can be made:

• There are 721 days out of 2485 total days when Nifty settled above a P/E of 20. The next one year returns from Nifty averaged -8.5%, lowest -56.8%, highest 65.7% and median -14.5%.
• There are 222 days when Nifty settled below a dividend yield of 1%. The next one year returns averaged -25.6%, lowest -56.8%, highest 26.4% and median -21.0%.
• There are 1438 days when Nifty settled above P/B of 3.5. The next one year returns averaged 8.18%, lowest -56.8%, highest 89.95% and median 6.76%.
  

These statistics show that except P/B, other statistics do not favour investments in Nifty at these levels.