Sonata Software : A value buy or a value trap?

Sonata software was founded in the year 1986. The company is in the business of providing IT consulting and software services.

Financials
The average ROCE of the company on consolidated basis over the last five years is 26%. On a consolidated basis, the company has debt of INR 30.76 crore while the net current assets stood at INR 246.95 crore. The cash flow of the company over the last five years has been positive. The turnover of the company has risen from INR 511 crore in FY06 to INR 1411 crore in FY11, i.e. 22.52% compounded annually. The profit after tax of the company has risen from INR 28 crore in FY06 to INR 86 crore in FY11, i.e. 25.16% compounded annually. The company's total income declined in FY10 to INR 1393 crore from INR 1602 crore in FY09. The profit after tax of the company never declined in the last seven years.

Promoters
The promoter holding of the company has decreased from 45.35% in September 2006 to 43.29% in September 2011. Also the promoters have pledged a part of their holding. This is a big negative for the company.

Mutual Fund Holding
Some of the UTI schemes hold this company.

Valuations
The book value of the company on consolidated basis is INR 38.7. So at the current market price of INR 23, the company is trading below its book value. The current market capitalization of INR 241.87 crore is just a tad above the (net current assets - debt) of INR 216.21 crore. As per my understanding, this company is a value trap unless it gets acquired and the investors get an open offer.




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Blue Star : A fallen hero

In the past, I have written a lot of praise about Blue Star, ranging from how management utilized buy-back effectively in 2002-2003 to reduce equity capital, how high dividend-yielding low-debt companies turn out to be good investment when Blue-Star price went up from INR 30 to 1700, and how to find next Blue-Star.

Two months back I was discussing the balance sheet of Blue Star for the year FY11 with one of my colleagues. The company had increased its net current assets from INR 297.16 Crore to INR 668.49 Crore, i.e. an increase of INR 371.33 Crore, i.e. 125%. The company's debt to equity ratio suddenly went up from almost 0 to 0.72, and anything above 0.5 for industrial companies is considered bad as per Benjamin Graham. Even in the years 2000-2001, it had hovered around 0.55, i.e. near Graham's cut-off. Even the June 2011 quarter results show that the interest payment of INR 7 Crore was more than 25% of PBDIT (Profit before Depreciation, Interest and Tax) of INR 27.65 Crore. The alarm bells had already started ringing about the company's financials and I told my friend that Indian manufacturing sector seems to be under heavy stress.

Here comes the latest results and the company's interest payment suddenly went up to INR 30 Crore, that is more than twice its PBDIT of INR 14.59 Crore and the company has shown losses.

This set of events show how good balance sheet analysis enables a person to move their money out of a particular scrip at the right time. Hats off to Benjamin Graham.

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How right/wrong I was?

I write this blog and express my views not just on individual companies and their share prices but also overall market. Over the last one and a half year, I had observed on several occasions that Mr Market was either very enthusiastic or very depressed about a particular security or about general enthusiasm in top level companies that are part of Sensex/Nifty. How have I fared in my opinions? Following table summarises my opinion and today's outcome:

Date	Company/Sector/Market	Price Then	My View	Price Now
April 26, 2010	Mcnally Bharat Engineering	370	Negative	110
May 5, 2010	Deepak Parekh (Sensex)	17087	Negative	15792
May 7, 2010	Banking Sector	10505 (Sensex 16769)	Negative	9961 (Sensex 15792)
July 22, 2010	FMCG	3204.37	Negative	3819
September 3, 2010	Sensex	18221	Negative	15792

I also showed positive views on some of the small cap stocks like Indo Borax, Elegant Marbles, Small Caps. Although these companies haven't been multibagger but they have outperformed Sensex over the period they were recommended to now. Except FMCG sector, most of my calls were right in the above table. On the banking sector, I had put underperform rating for the next five years, but over the time period, it has done better than the Sensex it seems. Let's see if I come out winning my call or not.

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Voith Paper Fabrics: A value investment?

Voith Paper Fabrics was incorporated in the year 1968.

Financials
The average ROCE of the company over the last five years has been 15.978% with average operating profit margin of 27.12%. The operating profit margin of around 22% in the last two years was the lowest in the last eleven years. The average net profit margin was 14.52% for the last five years which is much higher than most of the companies in India. The company is debt free with net current assets worth INR 70.93 crore out of which INR 52 crore are just in fixed deposits. The asset turnover ratio of the company decreased from 1.30 in FY01 to 1.15 in FY06 to 0.88 in FY10. The company always had a positive cash-flows over the last ten years but the average in the last five years is lower than what it was between FY01 to FY05.

The average total income of the company has risen from INR 35.59 crore betwen 2000-2002 to INR 50.50 crore between 2008-2010, i.e 4.47% compounded annually. The average net income has also risen to INR 7.49 crore in 2008-2010 from INR 4.63 crore in 2000-2002, i.e. 6.2% compounded annually. The company had one down year in profits in FY08 when the profits declined by 33%. Revenues too declined in FY08 by 10%. 

Promoters
The company is a subsidiary company of a German company with promoter holding at 74.04%. The dividend payout ratio of the company has decreased from 30% in FY01 to less than 20% in FY10.

Mutual Fund Holding
No mutual fund schemes hold this share.

Valuations

The book value of the company is INR 217 and so at the current market price of INR 215, the company is trading just near its book value. If the net current assets of INR 71 crore is removed from the market capitalization, the company's market capitalization of INR 23 crore is less than 30% of what it earned in operating cash flow over the last ten years. The valuations are compelling to buy.

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VTM - A Ben Graham value play?

VTM Ltd's history dates back to 1946.

Financials
The average ROCE of the company over the last five years was 4.614% which is way below the average for BSE500 companies with average operating profit margins of 12.25% and net profit margins of 2.894%, most of the gap going into depreciation. There is a big surge in all these ratios in FY11 most probably due to high cotton prices. The company increased its fixed asset investment from INR 47.56 crore to INR 59.78 crore. The company is virtually debt free with net current assets + investments of INR 46.57 crore while debt at INR 6.23 crore. The company's asset turnover ratio declined from 1.3 to 0.61 between 2004 and 2010 but it went up in the last year to around 1.0. The company's average total income hasn't risen much over the last seven years. It was at INR 110 crore in 2004-05 and is still the same on an average even though the capital investment has gone up from INR 84 crore to somewhere around INR 140 crore. This shows that the business is very capital intensive (remember Warren Buffett's Berkshire Hathway?). If revenues do not increase, how would the profits go up? The profits are almost stagnant or may be declining due to high depreciation of fixed assets investment.

Promoters
The promoters hold around 75% in the company and dividend payout is on an average 50%.

Mutual Fund Holding
None of the mutual funds hold this stock since the company is very small and floating stock is also small.

Valuations
The company's book value is INR 227.47. At the current market price of INR 105, the company is trading almost near its net current assets - debt of INR 40.6 crore. The business is not very good. So I will wait for a higher margin of safety.





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Is Unichem Laboratories cheap?

The promoter of the company, Prakash Mody is heavily buying shares of the company from the open market. See the table below:

Date	Shares Bought	Amount	Average Price
8 Aug	7389	1090247	147
9 Aug	30983	4529405	146
10 Aug	9592	1397938	145
11 Aug	26209	3744218	142
12 Aug	14257	2094638	146
16 Aug	175946	25772570	146
17 Aug	3395	494256	145
18 Aug	5160	762878	147
22 Aug	14572	2091826	143
23 Aug	22580	3199009	142
24 Aug	6282	885110	142
25 Aug	1476	210933	143
26 Aug	2447	352137	144
29 Aug	4169	599724	144
30 Aug	15784	2243806	142
2 Sep	3000	426441	142
5 Sep	226882	32403021	143
Total	570123	82298157	144.35

His stake in the company has gone up from 11.61% to 12.24%. The company's operating profit margin over the last two quarters has been around 14-15%, which is lowest till 2002. Net profit margin of around 8.25% is also the lowest in the last ten years. But even at the current price of INR 144, the company trades at 2 times book and 15 times earnings. The (net current assets + investments) stands at INR 30 per share. The earnings are obviously depressed due to margin pressure, but the high P/E is still not justified. Even though the promoters are showing a lot of confidence in the company, I would wait for price to correct to at least INR 100 to enter the scrip. I already have some bought in 2009 at the split adjusted price of INR 60.

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Eimco Elecon - A Ben Graham value play

The eimco elecon engineering company was incorporated in 1974 as a joint venture between ELECON group and the indian public.

Financials
The average ROCE of the company over the last five years is 15.728% with average operating profit margin of 18.984%. The margins were highest in the years between 2007 and 2009 and in years 2000 and 2001. Net profit margin too were highest in years 2008, 2000 and 2001, in low double digits. The margins have shrinked to 7.2% in 2011 which is lowest in the last 13 years. This shows that the business is under severe margin pressure but still the margins are much higher than the average for all the companies in India. The company is debt free with (net current assets + investments) worth INR 114.05 crore. The assets turnover ratio of the company decreased from 1.81 to 1.06 between 2002 and 2006 but the same has improved again to 2.00 in FY2011. The company had negative cash-flow in FY2009 but the average operating cash-flow over the last five years is equal to the net-profit reported by the company. So the company is providing proper depreciation and not over-reporting the profits.

The company's average total income has risen from INR 72.98 crore between FY00-FY02 to INR 167.49 crore between FY09-FY11, i.e. 9.67% compounded annually. The net profits during the same time has risen from INR 8.653 crore in FY00-FY02 to INR 13.81 crore, i.e. 5.33% compounded annually. The company had three down years in profits over the last ten years, FY03 down by 45.27%, FY06 down by 5.83% and FY10 down by 16%. The revenues declined in two consecutive years in FY06 by 7.24% and in FY07 by 3%.

Promoters
The company is a family owned business and promoters hold 74.05% of the shares as of June 2011. The promoters increased their stake from 73.17% in the quarter ending December 2008. Dividend payout ratio of the company is 20% of the net profit which is less but is fine.


Mutual Fund Holding
As of June 2011, only HDFC growth fund holds this shares and that too bought at INR 216 in 2007 and INR 300 in 2006.


Valuations
The company's book value is INR 242 so the company at the CMP of INR 185 is trading below book-value as well as below its net current assets of INR 113 crore. The trailing twelve months EPS is INR 21.9 so the P/E comes at 8.45. I would recommend a buy on this company.


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Sensex Nifty EPS after FY11 results

It seems all the results are out and the Sensex EPS as of 6 June stands at 18420.11/19.58=940.76. The Nifty EPS stands at 5532.05/20.43=270.78. This compares with 828.5 on 27 May 2010 for Sensex, i.e. an increase of 13.55% YoY and 239.4 for Nifty, i.e. 13.1% increase YoY.

Sensex EPS drops after SBI results

I had tried to give an early indication of Sensex EPS for the year 2011 in an earlier post. I had assumed that since around 46% of the companies; that are part of the Sensex; had announced results that increased EPS by 12.6% YoY, there will be some more gains in EPS when all the companies finish reporting their results. Today SBI announced their horrible results for the year ended March 2011 and the Sensex EPS; which was prevailing at somewhere around 933 (18345.03/19.66) yesterday; dropped to 924 (18137.35/19.63) today. Nifty still does not seem to be reflecting it. This result was before the interest rate hikes of 25 bps of January 2011 and 50 bps of May 2011 since the bad loans take at least 90 days/three months to come into banks' books. God help those analysts predicting an EPS of 1200 or more for FY12 (1100 for FY11 by Rakesh J, 1070 for FY11 by Motilal Oswal, 1250 for FY12 by Raamdeo, 1345 by UBS and 1100 for FY11 and 1250 for FY12 by Credit Suisse). Those who are finding PSU banks cheap on P/B or P/E basis need to rethink about the correctness of the results being published by UBI, Bank of Baroda, PNB, Canara Bank, IOB, Indian Bank, Allahabad Bank, Central Bank of India and Andhra Bank. I had already written about a coming banking crisis in India in September 2010 and I still stick to it.

Is this the end of MSFT?

This is the first time I am posting on a company not listed in India. I am talking about Microsoft. This post is inspired by Microsoft's buyout of Skype for $8.5 billions. Many of the big companies that are favourite of speculators get to a point where their dominance is threatened by creative destruction that is the core of capitalism. Microsoft has dominated tech industry for more than thirty years now. But over the last ten years, the growth of internet has just shaken the ground below this bellwether company. The company has meager presence in this area and is struggling to build products that make its presence felt on internet. The last time the company was this desperate was in 1997-98 which resulted into buyout of Hotmail at exorbitant price of $400 million in January 1998. I don't have the data for the revenue and profitability of this acquisition over the last fourteen years, but Microsoft share price did get a boost from $15 to $25 in a span of just eight months. The price today is still hovering at $25 and change after almost thirteen years.

Even the current internet division in Microsoft is bleeding with heavy losses with annualized loss number to the tune of $3B(billions with a B). The PC sales declined annualized 4% in the last quarter although the notebook sales increased and with the prevalence of virtual machines, operating system sales may not match one-to-one with hardware sales since many virtual machines can run on a single hardware server.

I am working in technology sector and not in Microsoft so my opinion may be biased. So take this with a pinch of salt. There is a famous call from Bill Gates on Kodak in 1991 when its share price was hovering around $30. When asked about Kodak, Bill Gates said, "Kodak is toast". The share price did go up to $90 and today going for $2 and change. Will he say the same thing for Microsoft today?

How great companies outperform index over time?

Many a times so called analysts mark companies in FMCG and Pharma sectors as defensive. But if we look at the returns generated by these companies over long term, they are many a times much better than the returns generated from index. Today, I will describe two good companies from FMCG sector which have shown the same kind of characteristics over the last 10 years. The first is Nestle and the other one is Glaxosmithkline Consumer Healthcare. If you look at the returns generated by these companies over the last ten years, they can be summarized as shown in the following table:

* Average price

Company	Price 2002-03	Price 2007	Price 2011
Sensex	3000	18000	19000
Nestle	500	1100	3500
Glaxo Consumer	250	550	2200

You can see that during the bull market till 2007, both the companies underperfomed the Sensex by a hugh margin but after 3 more years, they are now outperforming the index. The Sensex generated returns of more than 40% compounded annually between 2002-03 and 2007 and many of the stocks like L&T, Reliance and BHEL went up by more than 25 to 50 times. The returns generated from both these stocks were of the order of 15-20% at best during those times. But the situation has changed over the last three years, all the stocks that generated great returns earlier are still trading 30-40% below their 2007 peak while these companies multiplied their returns and generated more than 40% returns compounded annually during the last three and a half years while the Sensex hasn't moved much. It is just in hindsight that somebody would have bought L&T and Reliance in 2003, sold them in 2007 and bought Nestle and Glaxo from that money. But buying good companies at great prices never turns out to be a bad deal.
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Where will Sensex EPS be after FY11 results?

Following table shows the list of companies that have already announced their FY11 results along with their weightage in Sensex as of May 3, 2011.

Company	Weightage
Reliance	11.45
Infosys	9.58
ICICI Bank	8.29
HDFC Bank	5.61
TCS	4.5
Wipro	1.81
Jindal Steel	1.8
Sterlite	1.79
Maruti	1.24

In total, 46.07% of the companies have announced their results so far and the Sensex value and P/E stands at 18534.69 and 19.87 respectively resulting into an EPS of 932.8. This compares with Sensex EPS of 828.5 on May 27, 2010. Thus, the Sensex EPS has increased by 12.6% over the last one year with 54% of the results still pending to be released, this at a time when the nominal economy is growing at a rate of 20%+ with 8% real GDP and 12% inflation. Not a pretty picture!!!

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Is TCS really doing better than Infosys?

The financial media is ripe with the articles of praise for TCS and Infosys seems to have lost its glory over the last one year. See the headlines below:

• TCS takes over Infosys (livemint)
• TCS Infosys treading different paths (livemint)
• TCS topples Infosys as the most valued IT company (trak)
• TCS tops Infosys (DNA)

Most of the analysts are not looking at the results of companies with sharp eyes. See the following table:
* 9 months FY11

Year	Infosys			TCS
	PBT	Tax	Tax/PBT	PBT	Tax	Tax/PBT
2007	4249	386	9.08	4876.59	663.96	13.61
2008	5344	685	12.82	5812.33	786.31	13.53
2009	6907	919	13.31	6095.37	838.95	13.76
2010	7899	1681	21.28	8197.61	1196.97	14.60
2011	9313	2490	26.74	7812.19*	1367.08*	17.5

If we forget about the quarterly movements of revenues then over the last 6 years, Infosys consolidated revenue increased from 7129.65 Crore in FY05 to 27501 Crore in FY11. During the same time TCS revenue increased from 9748.47 Crore in FY05 to estimated around 37000 Crore in FY11, not much difference between the two in terms of growth.

The annual report of Infosys clearly provides details about the expiry of tax exemption due to Software Technology Park(STP) scheme of government of India. There were five big centers (Bangalore, Pune, Mysore, Hyderabad, and Chandigarh) whose tax exemption expired in 2009 and there are three more (Chennai, Bhubaneshwar and Mangalore) whose exemption expired in 2010 and so the effective tax rate for Infosys has increased from 13.31% to 26.74% over the last two years. If the tax rate had remained the same, Infosys EPS this year would have been higher by INR 20. Due to new SEZ policy of government, the tax rate may again go down a bit due to lower MAT rates on SEZ and Infosys annual report does mention five centers whose tax exemption expires after 2020. On the other hand, TCS annual report does not give any information about this but STP is going to expire in March 2011 so TCS' tax ratio is likely to move higher in the next year which not a single analyst seems to be talking about right now.

Yes; the operating profit margin of TCS has caught up with that of Infosys over the last two years but I doubt they can do better than Infosys going forward. Let's see.

Being too far ahead of your time is indistinguishable from being wrong
 - Howard Marks

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An humble investor

I was reading the transcript of Warren Buffett's interview with Financial Crisis Inquiry Commission and the following quote made me feel humble:

I can tell you it’s very hard to change. I was at Solomon (laughs) and it, the nature of Wall Street is that overall it makes a lot of money relative to the number of people involved, relative to the IQ of the people involved and relative to the energy expended.They work hard, they’re bright, but they aren’t, they don’t work that much harder or that much brighter than somebody that, you know, is building a dam someplace, you know, or a whole lot of other jobs. But in a market system it pays off very, very big, you know. And it, in effect, you know, boxing pays off very big now compared to what it did when the only auditorium we had was 25,000 seats at Madison Square Garden and now you’ve cable television so you can put a couple of, you know, lightweights who you’ll never of again, you know, on pay per view and they’ll get millions for it now. Market systems produce strange results and Wall Street, in general, the capital markets are so big, there’s so much money, taking a small percentage results in a huge amount of money per capita in terms of the people that work in it. And they’re not inclined to give it up.

I have never heard a doctor saying that what he is doing is not harder then what a person working as a garbage collector is doing. A lawyer will never be able to accept what he is doing is not harder than what a cook is doing. An architect would never be able to convince himself ever that what he is doing is not harder than what a barber is doing.

Here is a man who has been working in the investment industry for more than 55 years and he thinks people in his field are not doing work harder than what a man building a dam is. Kudos to his humility and modesty.

I would suggest you read the whole transcript.

Statement of lifetime

Following is a statement from K V Kamath, one of the most respectable and experienced banker in India

We can't afford to raise interest rates any more.

The statement was said in an interview with economic times on 10 October 2010.

I have a tendency to keep statements of famous individuals in my blog noted down with the date when I feel the person is saying this due to his vested interest and I strongly disagree with his statement. As per my own understanding, the US Treasury yields bottomed (and not topped) in the second week of October. The lending rates in India has gone up by more than 150 basis points (1.5%) since this statement and I think there is more to come.

Earlier, I already noted down one of the statement from Mr Deepak Parekh of HDFC on May 5, 2010. Some of these statements might become famous along with the person just like the famous statement from Irving Fisher before the great depression

Stock prices have reached what looks like a permanently high plateau.

Are insiders fool?

Generally when the Sensex/Nifty trades at more than 20 times earnings, the insider buying to selling ratio remains very low. But when a stock become cheap, promoters buy shares of their own company, both to provide confidence as well as increase their stake in the company at a bargain prices. I had seen this happening a lot between October 2008 - May 2009. Banco Products, Sarla Performance Fibers, Precision Pipes & Profiles Company, Asahi Songwon, ZF Steering Gear and many other companies' promoters bought heavily to increase their holding in their companies. All these companies have generated extraordinary gains since the bottom in March 2009. Banco Products has gone up from INR 15 to INR 70, Sarla Peformance from INR 30 to INR 115 today, Precision Pipes from INR 35 to INR 100 today, Asahi Songwon from INR 13 to INR 68 today and ZF Steering has gone up from INR 100 to INR 295 today. Contradictory to general perception, even at this Sensex/Nifty levels, some of the promoters who were not able to increase their holdings at rock bottom prices in March 2009 have bought shares in their own company between September 2010 and February 2011 and their shares are available today below their own buying price. Some of the examples are given below in the table:

Company	No of Shares Bought (% Equity)	Average Price	Current Price
Dynemic Products	92563 (0.817%)	22.88	22.8
Wimplast	65547 (1.09%)	193.15	160
Ador Welding	23117 (0.17%)	164-201	167
Garware Wall Ropes	23718 (0.1%)	74.17	58
Patels Airtemp	33703 (0.665%)	NA	69

There might be more companies than what have been mentioned here. BSE/NSE does not provide a clean interface to easily find out the way to get insider buy/sell information. This clearly shows that there is a large gap in terms of valuation between Sensex/Nifty and small cap companies. When big companies are trading at 25-40 times earnings, the promoters of small-cap companies are not finding any takers. Some of the selling pressure is coming due to large institutional investor (read LIC) liquidating their stake in a company (read Garware Wall). Promoters may be trying to provide a floor to that.

I don’t think man should have to learn easy lessons in such a hard fashion. You should be able to learn not to pee on an electrified fence without actually trying it. - Charlie Munger

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Are good days going to come back again?

Here is a snippet of the article in economic times dated 30 March 2001 with my own emphasis highlighted in bold letters:

While the market may have belied the hopes of investors looking for capital appreciation, the sharp downturn in prices has raised the dividend yield for many companies. With the annual results fast approaching, dividend income from companies may prove to be a source of steady income for investors.
Consider the case of Blue Star, for instance. The company has been paying dividend consistently for the last three years. With the dividend declared last year at Rs 5 per share and the current market price at Rs 30, the dividend yield works out to as high as 16.5 per cent. Even if the company pays Rs 3.5 as dividend this year, the dividend yield still stands at 11.5 per cent, which is tax-free.
This is not all. There are many others like Kirloskar Oil, VIP Industries, GNFC, Tat Finance, Wellwin Industries and Bank of Punjab, which have a consistent dividend-paying record over the years and an attractive dividend yield of 10 to 13 per cent based on their current prices. In some cases like Pentamedia, Paper products and Avanti Feeds, there has also been a gradual increase in their dividend pay-out over the years.
Of all the 4,000 plus companies listed on the BSE, there are around 775 profit-making firms, which have a consistent dividend paying track record for the last three years. While some companies have a very low dividend yield, others run the risk of not being able to repeat their past performance. In a detailed study, ET tried to identify companies which may provide attractive dividend yields, assuming they maintain their past dividend paying record. Taking a cut-off for the dividend yield at 10 per cent or more, based on the dividend paid last year, and by including only those companies with a positive net profit growth in the trailing 12-month period, compared to the previous year, the list was pruned to just 80.
Since liquidity is of paramount importance, only those companies were selected which had an average daily volume of atleast 500 shares and market cap above Rs 10 crores. In many cases, the volumes have dried up in the current market scenario.
The final list had around 20 companies. Ashok Leyland Finance is at the top with a dividend yield of 16.7 per cent, followed by Blue Star with 16.5 per cent and Garware Wall Ropes with 16.1 per cent. It is the tax-free nature of dividends which make share attractive, compared with the falling interest rates on other fixed income instruments. Also, with the finance minister reducing the tax on the dividend paid out by companies from 20 to 10 per cent in the current Budget, it is possible that some corporates may even increase their dividend pay-out.
The only risk involved in dividend pay-out on shares is that of a capital loss. This is because there is a time lag between the dividend declaration date and the actual payment date, which could be as much as three months. Capital could thus erode in the intervening period. Also, in some cases, the volumes are quite low, due to which there remains a risk of not being able to exit.

Returns Flight

Company	FY '00 Div (%)	FY '99 Div (%)	FY '98 Div (%)	TTM NP Chg (%)	Latest Price (Rs)	Div Yield (%)
Ashok Leyland Fin	40	40	50	39	24.0	16.7
Blue Star	50	35	35	10	30.4	16.5
Garware-Wall Ropes	20	20	18	17	12.4	16.1
Goetze (India)	25	20	40	9	18.3	13.7
Wellwin	25	25	22.5	55	19.5	12.8
VIP	25	25	25	35	19.8	12.6
Pentamedia	120	70	55	1	95.7	12.5
Avanti Feeds	35	25	18	37	29.1	12.0
Lakshmi Auto	25	30	30	23	21.0	11.9
Advani Oerlikon	15	25	25	130	13.2	11.4
City Union Bank	25	20	25	7	22.2	11.3
Varun Shipping	14	14	21	1	12.5	11.2
GNFC	25	22	22	4	22.4	11.2
Tata Sponge Iron	20	10	18	100	18.0	11.1
Bajaj Auto Fin	30	25	2	4	27.8	10.8
Kirloskar Oil	35	35	35	49	32.6	10.8
Tata Finance	45	40	40	12	42.0	10.7
Bank of Punjab	15	14	14	46	14.6	10.3
Tata Yokogawa	32.5	32.5	30	23	31.9	10.2

TTM - Trailing 12 months, NP-Net Profits

Not every company in this list turn out to be a good investment. Blue star share price multiplied from INR 30 to INR 1700 today (5:1 split with price of INR 340 today) and Advani Oerlikon (Ador Welding) going up from INR 13 to INR 170 today but Varun Shipping is still languishing at INR 30.  I would like to remind investors that at the bottom in March 2009, many small cap companies were available at similar valuations, IMPAL @ 120 giving dividend of INR 12 yielding 10%, Garware Wall Ropes @ 25 giving dividend of 2.5 yielding 10% and many more such companies.

Is Mr Market going to give this kind of opportunity again in 2011?

Smart doesn't always equal rational.

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Why book value matters?

Most of the value investor understands the importance of book value in determining the intrinsic value of a company. Book value represents the hard assets including its inventory, fixed assets minus depreciation and its cash/receivables minus all the liabilities like provisions, accounts payable etc...Ben Graham suggests not to pay much higher than book value while buying shares of a company.

If this criterion is strictly followed, there might be some set of companies that an investor may not be able to invest in ever. These companies include FMCG firms like Nestle, HUL and GSK Consumer since they distribute most of their earnings as dividends and so the book value of the company does not increase much. These companies also work sometimes on negative working capital so their book value will be very less compared to their earning power and so their intrinsic value can only be calculated based on their earning power.

But in bull markets, like the one we are in, investor enthusiasm stops differentiation between these companies and average small/mid cap companies. See the following table for the examples:

* 2006 numbers
Company	Book Value March 2005	EPS March 2005	Share Price September 2005	P/B September 2005	P/E September 2005	Book Value March 2010	TTM EPS	Share Price Today	P/B Today	P/E today
Ador Welding	63.36	19.95	260	4.1	13	108.45	21.22	170	1.57	8
GMM Pfaudler	36.39	5.21	116.94	3.21	22.45	62.9	8.07	94	1.5	11.65
GM Breweries	25.63*	14.3*	117*	4.57*	8.18*	60.12	17.73	101.8	1.69	5.74
India Nippon	122.4	22.86	286.5	2.34	12.53	187.17	30.95	242	1.29	7.82
Gateway Distriparks	62.39*	7.88*	131.4*	2.1*	16.67*	61.91	7.4	120	1.94	16.22
TV Today	35.58	2.83	96.15	2.7	33.97	52.56	-7.17	62	1.18	NA
Voith Paper	141.15	17.22	200	1.42	11.61	217.81	21.44	200	0.92	9.33

Most of the companies were purely trading at that time based on their earning power and the importance of book value was completely ignored by Mr Market. After more than five years, they are trading at prices lower than what they were trading at in 2005. The loss is not even compensated from dividends since capital erosion is far more than the cash received by an investor from dividends. The story may not end here. In the bear market of 2001-2002, these vary companies were trading at a steep discount to their book value and the same may happen when the next bear market comes. This doesn't mean the investor should shy from buying these names since the loss would be a notional loss unlike the loss that has happened over the last five years which is real.

The typical experience of the speculator is one of temporary profit and ultimate loss. - Benjamin Graham

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Sensex Nifty preliminary EPS after Q3FY11

While there are some companies, like Tata Steel, Tata Motors, M&M and Unitech still left to announce their Q3FY11 numbers, the preliminary EPS for Sensex and Nifty can still be calculated. Sensex ended at 18008.15 with a P/E of 19.78 which gives Sensex EPS of 910.42. The Nifty ended at 5395.75 with a P/E of 20.67 which gives Nifty EPS of 261.05. This compares with Sensex EPS of 876.36 and Nifty EPS of 250.62 at the end of Q2FY11 and Sensex EPS of 806.81 and Nifty EPS of 232.5 at the end of Q3FY10.Thus Sensex EPS has grown by 12.84% compared to last year while Nifty EPS has grown by 12.28%. This too in a year when the whole economy grew by more than 20% in nominal (inflation 12% + real 8%) terms. Now try to think how the EPS would grow to 1250 in five quarters, i.e. 28.86% compounded annually? If it cannot, then ask samir arora why he thinks Sensex is trading at 14.5-15 times FY12 earnings?

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Have some investment opportunities started emerging?

With a correction of more than 10% in NSE Nifty over the last two months from a high of 6338 on 5 November 2010 to 5624 on 17 January 2011 and more than 20% in BSE SMALL CAP index from a high of 11168 on 10 November 2010 to 8860 on 17 January 2011, there are fair amount of chances that some investment opportunities will really be available. There is a big contradiction between the two set of companies since some large caps are still trading at a P/E multiple of 30-50 while some small caps are available just near their book value with a P/E of 4-10. Following is the list of some of those small caps:

Company	Current Market Price	Market Cap	TTM Profits	TTM P/E	Average Profits of last five years	P/E of five year average EPS
Ador Welding	184	250	28.85	8.67	30.6	9.4
Asahi Songwon	74	91	15.99	5.69	7.5	12.14
Eldeco Housing	153	30	9.22	3.25	5.9	5.07
GM Breweries	106	99.2	16.59	5.98	9.14	10.85
Gandhi Special Tubes	120	177	25.92	6.84	17.82	9.93
Premco Global	25	7.7	1.53	5.03	0.88	8.75
WimPlast	170	102	17.1	5.96	6.306	16.17
Dynemic Products	25	28.32	7.02	4.04	2.75	10.31
Plastiblends	170	110	13.66	8.05	12.77	8.61

And there are many more like Natural Capsules @51, Medicaps @65, Eimco Elecon @270, Garware Wall Ropes @72, VTM @160, Mac Charles @ 230, Mazda @ 110, SI Paper @ 47. Most of the companies I have mentioned have been profit-making companies and some are consistently giving dividends over the last 15 years and still Mr market is quite depressed about their future. None of these are burdened with high debt that may affect their future profitability and existence. Are they really value traps?

Special Situation in APW President Systems

APW President Systems informed the exchanges on 7 January that Schneider Electric has acquired 55% shareholding in APW President Systems from promoters at a share price of INR 195. SEBI rules require an open offer of 20% to the minority shareholders. The announcement of the offer has been done and the specified date is February 4, 2011. Dates of opening and closing the offer are 2 March 2011 and 21 March 2011 respectively. The share price is currently hovering around INR 182. Let's analyze the payout of this special situation.

The promoters hold 71.3% (4312501) shares in the company while the general public holds 28.7% (1735499) shares. The open offer is for 1209600 shares, i.e. the acceptance ratio will be 69.7%. If an investor buys 100 shares of APW President Systems at INR 182 today, the total investment would be INR 18,200. If 70 shares get accepted in open offer at INR 195, he gets 13,650 back.

How banks made money while investors lost - in India

There has been a lot of bashing of banks in the United States over the last three years when the US taxpayer saved banks while the employees of the banks made billions in bonuses. There wasn't a lot of bashing on banks in India though and in November 2010 the bank index climbed to all time high. Sadly though, there were companies and their investors who got punished (I wanted to use a different word but was afraid of getting sued) by a lot of private banks between 2007-2009. Here are two examples that I would like to provide:

Sundaram Brake Linings

The company had a turnover of INR 189 Crore in FY07 and was earning a decent ROCE above 20% till 2007. When the financial markets froze in 2008, the derivative contracts the company had entered into with the help of Axis Bank and Yes Bank backfired. The banks started asking for losses on derivatives but the company refused to pay up and went for suits in Madras high court against both the banks. The banks won the case and now the company has to pay a total sum of 109.48 Crores. Did you read that figure? The company's total profits between 2001-2007 was INR 61.79 Crore. Even if we assume that the company will keep its earning power and will make double the profits between 2008-2015 (prices in India double every 10 years), the company will have to pay almost 90% of its profits in these years as compensation of losses on derivative contracts. The company has already paid these banks over the last three years and the total liability has come down to INR 84.12 Crores in the latest quarter.

HimatSingka Seide

The company had a turnover of INR 174.164 Crore on standalone basis in FY07 and was making above 20% ROCE if the fixed deposits were removed from capital employed. The company had a total derivative MTM loss of USD 41.5 million, i.e. INR 166.5 Crore. The company totally had to write off INR 68.213 Crore in FY09 and FY10. This is more than the net profit of FY07.

Indo Borax - A Ben Graham value play

I was looking at the list of companies trading below their book value and came across Indo Borax Chemicals. The company's share is trading at INR 81. The company has equity worth INR 3.481 Crore of 34,81,000 shares of face value INR 10. This translates into a market capitalization of INR 28.2 Crore.

Negatives:

1. The company started paying dividend only in 2007.
2. Dividend yield at current price is just 1.875%. 
3. The company diversified in infrastructure and construction business by creating a subsidiary as mentioned in announcement dated 7 December 2009. The promoters hold 40% in the subsidiary and the company owns 60%. Good luck for corporate governance.
4. The tax/PBT was very high last year when company paid INR 3.31 Crore worth of tax on INR 7.938 Crore worth of PBT, i.e. a tax rate of 41.7%. Tax/PBT was less around 33% between 2006 and 2008.
5. I sent an email to the company to provide annual report to see the details about "Loans and Advances" which have risen from INR 7.94 Crore in FY09 to INR 22.82 Crore in FY10. Most probably they have been given to the new infrastructure subsidiary and I consider this as big negative.