Tuesday, February 23, 2010

Mutual Fund Mistakes

I have already talked about reckless investment practices of mutual fund here and here. One more example I got to know when I was analyzing a company named Shanthi Gears.

HDFC Mutual Fund holds a very large stake in this company through various mutual fund schemes. If you look at the block deals of the company, HDFC Long Term Equity Fund bought the shares at INR 78.5 on 26 April 2006. HDFC Prudence Fund bought the shares at INR 61.5 on 21 June 2006. This was a boom time for auto/capital goods industry. The stock price peaked in January 2008 at INR 115 and bottomed in March 2009 at INR 25. As can be seen today, the company's share price is hovering around INR 37 after three years and nine months.

How can the investment be analyzed from a value investor's perspective? The book value of the company at the end of the year ending March 2006 was just INR 11.9. Thus both the mutual fund bought the stock at more than 5 times book value. The company's EPS in year ending March 2006 was at INR 3.56. Thus both mutual fund paid P/E of more than 17. If you follow Ben Graham and take average EPS of last five years, it was around INR 1.88. Thus the stock at INR 61.5 was trading at 32.7 times and at INR 78.5 was trading at 41.75 times five years' average earnings. Company paid only INR 1 dividend in year ending March 2006. Thus dividend yield on the share price was not more than 1.63%. What is the situation today? The company's TTM (Trailing Twelve Month) revenue and profits are almost similar to what it was in year ending March 2006. The book value has increased to INR 24.75 at the end of March 2009. The last five year's average EPS is INR 4.2. TTM EPS is around INR 3.1. At the current price of INR 37, the P/E is around 12, a reduction of 40% from the P/E at which mutual funds bought, and P/E of five year average EPS is 9, a reduction of 75% from what mutual fund paid. The price/book is 1.5, one third of what mutual fund got. Dividend yield on the last year's dividend payout is 3.25%, twice what the mutual funds were getting.

The mutual fund schemes today are holding more shares in their schemes then mentioned in the block deal, so there is a possibility that they either bought more shares at higher or, if the mutual fund investor is fortunate, lower prices. So their average buying price is different from what is mentioned in the block deals. But once you overpaid for a stock, even averaging doesn't help.
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