Equities- How long is the night?

(This appears in today’s Deccan Chronicle. Some thoughts on the markets. When valuation theories run out of steam even on the way down, what do we do? Buy? Or wait? Interesting times..)

FUDGET – Nothing to do with Budget 2019

(This is not an analysis of the Budget- These are random thoughts about the Fudget. Why is it in this form? It is nothing that a budget in a corporate board room would be about. As I was listening to the talk yesterday, scribbled some views…)

Fudge. Budget. Fudget. That is what all government budgets are. Bureaucracy is clever enough to make sure that the number-work is good and there is now enough things that are pushed outside the budget, to hide problems. We do not even bother about accounting propriety. Revenue and capital is all mixed up. We sell family jewels to meet living expenses.  We sell the assets that belong to future generations, to fund some grandiose scheme.


I have stopped reading budget documents. Today, I heard most of the budget speech. The first part took so long that it stuck me that by the time the second part comes, most of us just want it be done and over with. The first part was an enumeration of schemes and plots that the government has done in the past. Strictly, I do not want all these in the budget. A budget is an estimate of receipts and payments. It should not be a narration of past achievements. You can put it as an annexure to the budget document and focus on how you will raise money, where you will spend, why you will spend etc.  And then come down to brass tacks. How much are you short by and how will you meet. And do you have a plan B? What will happen when there is a revenue shortfall? And do you want to give us a quarterly break down of broad numbers and then give us a report about where we stand.

Today, there were a few things that stood out:

  1. The first budget is the ONLY one where big changes in policies can be made. Missed the bus by making this a pure plus/minus game;
  2. The attempt to curb corruption of the Income Tax officials is welcome. Personally, I would have also added severe punishment (confiscation of all property etc plus a minimum jail term of 25 years or so) for those accepting and giving bribes;
  3. There is no intent to let go of the PSU Banks. In fact another 70,000 crores is being thrown away;
  4. Worried when there is mention of reincarnation of Term Lending Institutions;
  5. Amused to hear the intent to set up an Aircraft financing business;
  6. NHB being stripped of regulatory powers over HFCs is very good;
  7. RBI being given additional responsibility is scary- They have failed in every role given to them thus far;
  8. Why this sudden love for NBFCs? Another scam in the making?
  9. Why this pathetic increasing surcharge on the uber rich?
  10. Nothing for the middle class;
  11. Another cess on petrol. Will there be a separate accounting for that?
  12. Good moves on affordable housing;
  13. The government seems to be moving towards extreme left, with room for a limited number of friends;
  14. Gold smuggling will increase ;
  15. Single brand retail – Welcome liberalization. Might as well make it multi brand;
  16. Angel tax is not eliminated- Just one more level approval needed;
  17. Aadhaar is here to stay. Ego and compulsion win over common sense and fairness;
  18. Farmer can forget doubling of income. Only way it will happen in the time frame as promised is by folding the currency note in to two;
  19. Borrowing in foreign currency is never a good idea, unless you can raise perpetual debt;
  20. Debt servicing takes away so much of our revenues;
  21. We are talking about elections for Centre and State together. It is time to think of a budget for Centre and States consolidated;
  22. Some discussion on revenue share with states and centre;
  23. Government expenditure needs a discussion. Why? Why so much? Why it never reduces?
  24. Government manpower plans needs to be seen. How will we reduce wasteful headcount?
  25. A note on pension liability for the future that is being built up;
  26. The push to Electric Vehicles is good. Also make it time bound. A calibration based on time- For example, a zero GST in year one and two and then increasing gradually. Give the early movers the most;
  27. APMC is still hanging in there. No action to help the farmer from farm to shelf. That is where the room to improve farmer income lies.;
  28. No government ever addresses incentives for farmer to increase farm productivity;
  29. We are not able to see an actual vs budget. Like companies give audited accounts, government should present it within three months of year end- Line by line ;
  30. We are moving towards protectionism. The whole world is being pushed and what it means is that each nation is shrinking its GDP;
  31. Once again talks of export incentives. Give incentives only for increase beyond actual achievements of last year;
  32. Why should budget mention rubbish like introduction of new coins etc?
  33. Why should the Finance Minister be constantly praising the Prime Minister?
  34. Was the budget finalized in the PMO?
  35. Plugging the tax loophole on the buyback of shares was good.
  36. Why does the budget document have to mention changes in regulation for HFC etc? These are things that do not have to wait for the budget. SEBI, RBI etc should not be part of an annual budget.

I am sure a lot of us have different thoughts. Till the path breaking VP Singh budget under Rajiv Gandhi, the only thing we wondered was the quantum of hike in excise or customs duties and tax rates. Now, the focus has shifted to silly things in capital markets. Why should it matter if public holding is 25% or 35%? If the market thinks that increased free float will crash the market, it is very amusing.

In terms of quality of ideas, this budget is very poor. And seeking to increase taxes on the Uber rich is not a great thing to do. Clearly smacks of the policies of Indira Gandhi.

The PM has made a grand statement about our economy becoming a five trillion dollar one in some time. Big deal. Simple arithmetic. As my friend commented,  the politician wants to take credit even for compound arithmetic. And this BS line became the theme song of this budget. It tells me that there is no thought to pull this economy out of its slumber. Jobless growth?

Valuation- Established, Large Companies

This article was published in Moneylife Magazine.  Some thoughts about the valuations of large cap companies. Basic thoughts are that we have to study trends in them. What is happening to the profitability of dominating players. What happens is that trends in profitability can be good indicators over a period of time. Often when we find that old P/Es do not come back, the answer will often lie in a secular decline in ROCE/ROE.


How To Pick Large-cap Stocks

I have always tried to segregate investment in equities into two categories. The first one is to buy into established companies with a long history. I know that I am unlikely to find spectacular returns; but I still hope to get better than index returns, provided I can buy the scrip at the ‘right time’. The second category is to buy young companies with the potential to grow exponentially from where they are when we get in. In a sense, it is akin to venture capital investing, because not every bet will pay off. The hope is to pick as judiciously as possible and hang on to them for many years. Let me talk about the first category. The old and the boring ones, so to say. I will start with a bunch of companies from the Nifty 50 and put down some numbers:
The table above needs some explanation. These are established companies with longish history and are very likely to continue to be in business for the next decade or more. Thus, the single important metric to evaluate them will be the amount of money they can make as profits each year. Their growth is not going to be spectacular and the 10-year averages are more likely to hold over the next 10 years or probably get weaker as the base effect takes its toll. Thus, RoE (return on equity) is an excellent tool to measure how good they are. The RoE could swing in a good year or a bad year; but is unlikely to shift to a different plane altogether. Generally, over time, RoE will tend to remain in a very narrow range for mature businesses.
I have done some slicing of the 10-year numbers. I have chosen four time periods to see what is happening to the key metrics. I start with the latest 10 years’ data. Then, I chose the latest five out of the 10, the latest three and then, finally, the latest 12-month period also known as trailing twelve months (TTM). These are large companies and, by and large, their top-lines would have some correlation to economic growth. The table below helps me to:
i) Find out the trend in sales, profits and RoE. If TTM is lower than the latest three which is lower than the latest five which is lower than the latest 10, then there is a declining trend and vice versa;
ii) Use the trend to figure out which companies in the Nifty 50 will outperform or underperform the index, by using the first two columns ( average P/E and P/BV) in conjunction with the findings above;
iii) Use the trend to add or reduce the portfolio.
To give an example, in the grid below, based solely on numbers, some of the oil companies look very attractively priced. They are trading below their historic averages in terms of P/E (price-to-earnings ratio) and P/BV (price-to-book-value ratio). The basic premise is that they will continue to maintain their historic RoE. There is a probable distortion here because oil price deregulation is a recent phenomenon and, hence, the future should look better as do the more recent numbers. Thus, if government policies do not get any more restrictive than they are today, it is very likely that this bunch of stocks will deliver better returns than the overall index, given their attractiveness. Of course, fundamentally, one could point out to a number of reasons why one should,  or should not,  invest in a stock. I am referring to a visible pattern in the numbers that make decision-making simpler. If I extend the same analysis to the entire Nifty basket, I get some very interesting observations. For the sake of curiosity, I will list  a few:
I) Bosch Ltd has a 10-year average RoE of 17%, with progressively lower recent numbers, trades at nearly 50 times earnings, has an average top-line growth of 10.4%, with the recent five years’ being 5.6% and recent three years’ being 6%. What this means is that growth in real terms has probably not happened or the company has lost its pricing power (if volumes have grown);
II) Bajaj Auto Ltd has a 10-year average RoE of 38.2%; but, in the latest five years and three years, RoE is dramatically down to 28.7% and 25.3%, respectively. Clearly, there is increasing competition in the industry. The other auto companies have a similar trend; but Eicher Ltd has delivered increasing returns to its shareholders. Its 10-year average is 26.2%; but the RoE, over the latest five years, is over 32% and that over three years is 36%.
These are purely quantitative trends. At some point, market memories fade and prices catch up with performance. The numbers of the large software companies are a clear revelation. There is slowing growth, slowing profitability and worsening RoE. Thus, their ‘average’ valuations and current valuations reveal a story of deterioration. I am not advocating this approach for all companies. It is merely another tool to help make a decision when it comes to established companies. When you spot a statistical opportunity, do not jump in blindly. Use it as a starting point. Fundamental analysis cannot be replaced. Quantitative analysis can only be a decision support system rather than a stand-alone method for investing.

Of investing in Banks & NBFCs

The Finance & Banking sector stocks have become the F&B of India’s investing theme. Every move in the economy is tagged with this sector. This sector can create demand, put growth on steroids or lead us in to a slowdown. And being money, it is the subject of influence by the politician, the regulators and the managers/owners. And when the going is good, the weak ones thrive on mismatches in funding. And there is frequent repair costs in the banks owned by ONE promoter (the government of India) which leads to boom and gloom in the universe. Some thoughts, in today’s Deccan Chronicle

Warren Buffett on AUDIT committee

This is a must read- Each sentence is worthy of reading again and again.


6.2 Warren Buffett on the Challenge of the Audit Committee

Often called the “Oracle of Omaha,” Warren Buffett, the largest shareholder and CEO of Berkshire Hathaway, is well known for his adherence to the value investing philosophy, his conservatism when it comes to issues of governance and accounting, and for his personal frugality, despite his immense wealth. On the subject of a board’s audit committee, he writes,Buffett, annual letter to Berkshire Hathaway shareholders (2002).

Audit committees can’t audit. Only a company’s outside auditor can determine whether the earnings that a management purports to have made are suspect. Reforms that ignore this reality and that instead focus on the structure and charter of the audit committee will accomplish little.

As we’ve discussed, far too many managers have fudged their company’s numbers in recent years, using both accounting and operational techniques that are typically legal but that nevertheless materially mislead investors. Frequently, auditors knew about these deceptions. Too often, however, they remained silent. The key job of the audit committee is simply to get the auditors to divulge what they know.

To do this job, the committee must make sure that the auditors worry more about misleading its members than about offending management. In recent years, auditors have not felt that way. They have instead generally viewed the CEO, rather than the shareholders or directors, as their client. That has been a natural result of day-to-day working relationships and also of the auditors’ understanding that, no matter what the book says, the CEO and CFO pay their fees and determine whether they are retained for both auditing and other work. The rules that have been recently instituted won’t materially change this reality. What will break this cozy relationship is audit committees unequivocally putting auditors on the spot, making them understand they will become liable for major monetary penalties if they don’t come forth with what they know or suspect.

In my opinion, audit committees can accomplish this goal by asking four questions of auditors, the answers to which should be recorded and reported to shareholders. These questions are:

  1. If the auditor were solely responsible for preparation of the company’s financial statements, would they have in any way been prepared differently from the manner selected by management? This question should cover both material and nonmaterial differences. If the auditor would have done something differently, both management’s argument and the auditor’s response should be disclosed. The audit committee should then evaluate the facts.
  2. If the auditor were an investor, would he have received—in plain English—the information essential to his understanding the company’s financial performance during the reporting period?
  3. Is the company following the same internal audit procedure that would be followed if the auditor himself were CEO? If not, what are the differences and why?
  4. Is the auditor aware of any actions—either accounting or operational—that have had the purpose and effect of moving revenues or expenses from one reporting period to another?

If the audit committee asks these questions, its composition—the focus of most reforms—is of minor importance. In addition, the procedure will save time and expense. When auditors are put on the spot, they will do their duty. If they are not put on the spot… well, we have seen the results of that.

(from  https://saylordotorg.github.io/text_corporate-governance/s08-02-warren-buffett-on-the-challeng.html )

What do I do? My Bond Fund NAV has dipped sharply due to DHFL…


While we can debate endlessly on credit risk and the role of the mutual funds, let me address a simple issue- What if I am an investor in one of the funds that has knocked off the NAV?

What does it mean for the investor who is still in the scheme? Logically, the write off could have been for 75% of the investment in the defaulted paper. If we exit immediately, we get the lower NAV.

What happens when the bond pays off after a delay of a week or a month or a year? In that case, the fund house would ensure that everyone who redeemed after the write back gets their fair share. That is logical and should happen. Staying on or redeeming should make no difference.

Of course, the lucky ones are those who redeemed their money till two days ago, where they probably got the higher NAV.

If the fund had already sold of the paper at a loss, the NAV would reflect the loss. As an investor, you have probably suffered some loss.


Thus, as an investor, wait or exit should not matter.  The only issue will be in case of FMPs, where you would have to stay on till the end, unless there is a provision for early redemption.