Making a quick buck in the market ..??

(Some thoughts on the trades in the marketplace.  This appeared in Deccan Chronicle on 11th Sept 2017 )

(The long term trend is always valid till change. So far, the mood is good and everyone is searching for ‘buy’ ideas. Money is pouring in.. Some observations ..)

Stocks in our markets seem to move by rotation. Sharp traders who spot the trends early, make money.  When a wave of money moves in to or out of any sector, there can be a whiplash on the ‘investors’ who board the train late.

Till a year ago, pharmaceutical companies were prized investments and were quoting at crazy levels. Then the skeletons started to tumble out and the prices crashed. So someone might think that there is an overreaction and buy the fall. However, this may not work out well. For one, the industry woes do not seem to be over. And secondly, how are these companies going to regain the markets and pricing power that has been lost? It is going to be a long haul. And one could wait for a very long time before the sector finds favour again. One important thing that people could overlook is valuations. Even after the fall in prices, the valuation has merely come down from exorbitant to expensive. There is still no margin of safety. Thus, by buying now, you may be able to make some smart trading gains if your timing is right, but it is unlikely that you will make supernormal returns in quick time.

Similarly, look at stocks in metals. Many of the fallen stocks are now finding favour and there is a run up in prices. Whether it is Tata Steel or Vedanta, the prices have rallied sharply. Maybe there is some more steam left in the sector as the benefit of rising metal prices start reflecting on the bottom lines. However, we always run the risk that the juice in these stocks have already been extracted by the first movers and after the sharp moves on think volumes, prices can get sluggish. Unless there is concentrated buying, prices will not go up. And at every rise, some early entrant will be offering fresh supply as he pockets his gains. I am not an expert on commodity prices, but have seen this cycle play itself often. The stock prices peak much before the underlying commodity price. When everyone starts to notice and talk about the sector, the time to look at other things is around.

Microfinance, Housing finance are two other sectors that are in favour. Valuations are very aggressive and prices are now hyper sensitive to bad news or ‘disappointments’ in results or magnitude of problem loans. Yes, there is a big shift that has happened when growth moved from PSU Banks to private banks and private players. However, this will taper off and growth will slow down to reasonable levels. This will mean that stock prices will either slide or stagnate for a long time, before earnings catch up with stock prices.

With so much money flowing in to the markets, it is difficult to spot undervalued stocks. Thus, there is a rush towards the ‘out of favour’ sectors. If you are lucky enough to catch the trend early, you make some quick money. The later you get in, the worse your chances. Smart money moves in to these sectors long before research reports get published. They make the big money on these cyclical moves and the investors who follow the noise can end up even losing money.

Most of these stocks that are ‘out of favour’ will have one common characteristic. Poor ROCE, lumpy and jerky profit numbers and high leverage. They are unlikely to fit in to a long term investment list and should be seen as trading opportunities, if one is so inclined. Discipline in trading will certainly help. Do not get carried away and place disproportionate bets.

This market does not offer much comfort in terms of valuation. However, given the strong funds flow and the fair economic conditions, the poor earnings are not impacting investment sentiment. While we see the broad indices of the stock market stuck in a zone, the mid cap space is seeing a lot of churn. Mid cap indices which had fallen sharply have pulled back as sharply. The valuation matrices are still not tempting, but there are many investors who probably have the ‘left out’ feeling.

Know the risks at this level. If you are in diversified mutual funds, there is less to fear. And if you are in SIP mode, do not bother. These are interesting times. Globally, the world is on an edge, politically and economically. Growth numbers are getting smaller. However, there is surfeit of money.  Personally, I am happy to keep away from the stocks. I do not have a ‘compulsion’ to invest.

 

 

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Stocks- Confidence in earnings & valuation

(Some thoughts on valuation with specific reference to predictability of earnings.. Faith in what we are sure about.. Appears in the Deccan Chronicle of yesterday/today)

VALUATION AND EARNINGS PREDICTABILITY

Valuing stocks is often a subjective exercise. We all have our ‘objective’ yardsticks, which could be related to PE, EPS, Book Value, ROCE, ROE or any other matrix or a combination thereof.  Even there, there is always a final element of ‘subjectivity’.  We often fail to find a good reason and then simply say that a similar company trades at so many times earnings, and therefore this company deserves better. Very often I have seen research reports give precise price targets as if they are a holy grail.

 

Common sense says that if we use a multiple, say Price to Earnings (PE) as one indicator, there should be some rationale. A company can have a high PE or low PE. It does not necessarily mean that the company with a low PE is undervalued or vice versa. All quantitative measures have an element of subjectivity when it comes to valuation.

 

One thing I like to look at is the ‘predictability’ of earnings of a company. I do not refer to the precise numbers, but to whether I can predict that under normal conditions, the company will keep making money. For instance, if I take a company like HUL or Marico, I know that their products will continue to sell with reasonable margins and there is a high level of predictability about their earnings.  This, to me, is important. On the other hand, if I take a company like L&T, a lot depends on the stage of completion, the revenue recognition methods etc. Similarly, a construction company will always have work in progress. A completed contract is when the earnings can truly be recognized. However, some of their contracts will cross the financial year end and some work is still left before revenue can be recognized. However, they use something called ‘stage of completion’ and recognize some revenue and profits. To me, this is not high quality. Nor is it ‘predictable’. For instance, we know that in the year 2016-17, Bajaj Auto sold “X” no of two and three wheelers and made “Y” rupees. In 2017-18, I am sure that they will do the same or better both on the volume and on the profits.  This company has highly predictable earnings stream.

 

I am willing to pay a higher multiple for a more predictable stream of revenue as compared to ‘probable’ or not so certain streams of revenue. A rupee earned by Bajaj Auto is valued higher than a rupee earned by L&T. In Bajaj Auto, the future is less volatile. So, one is willing to pay a higher ‘valuation’ – whether it is in terms of P/E multiple or P/B etc. It may be also incidental that Bajaj Auto earns a Return on Equity that is immensely superior to L&T.

 

Industries that have poor predictability of income include commodities, engineering, construction etc.  They also could have ‘lumpiness’ in earnings.

 

One of the most ‘predictable’ industries should be banking and finance. However, while one can forecast numerical growth in lending, interest rates etc, the element of risk in lending vitiates the industry valuation. So we look for comfort in history. By now the market believes that HDFC Bank or Kotak Mahindra are great at managing loan recoveries and also have good lending practices. So, these banks command a premium in terms of measures like Price to Book or Price Earnings. On the other end of the spectrum, we have the PSU Banks, where the only predictability seems to be the recurrence of NPAs.

 

Commodity sector also has very low predictability of earnings. They go through business cycles with price movements of commodities swinging to extremes. Thus, this sector valuation is the most tricky. If we take a ten year average earnings cycle, we probably get a better fix on the ‘average’ profitability. Price swings are huge.

 

However, our markets are young and tiny. We have too much money chasing stocks and there is not enough depth or breadth in the market. So, we probably have no valuation rules except those decided by flow of funds rather than any yardstick. We tend to swing between extremes of optimism and pessimism. And our optimism is often based on who is buying, the recent price moves etc rather than any genuine exercise at studying the P&L, Balance Sheet and the management.

 

However, the earnings predictability is certainly anchored in to a lot of valuation, if we look at stocks in the FMCG or consumer spend sectors or in growing B 2 B spaces. If we want to look for big winners, we should try and evaluate:

  1. Will the products or service sell profitably?
  2. Can the company pass on cost increases?
  • Will the demand grow in line with the economy?
  1. Is the cash flow and profits in line with each other?
  2. Is the ROE / ROCE attractive?

 

If the answer is yes to all the above and the stock commands a low PE or low Price to Book, it is worth digging deeper. Sooner or later, the market will recognize this and give it a greater valuation.

 

 

 

 

INFOSYS- Some thoughts

 

There are far greater minds than mine which are focused on finding a way out of the current impasse at Infosys. However, given that Infosys is an icon that is an essential part of the Indian landscape, the mind is restless. In many ways, Infosys has been a trend setter and a role model for many. NRN and his team launched a million dreams. Infosys became the flag bearer of India in the IT world. Here are some random thoughts…

It would be nice if the likes of NRN, Nandan, Mohandas Pai get together to form a Promoter Council which lays down the path for Infosys for the next two decades or so. It will take some time to become a blueprint and must involve active participation of five key persons at Infosys. These five should be those who have at least ten years of service left and have been with the company since early 2000s.

From these five, the Promoter Council can identify TWO future leaders. And in one year or so, the PC can make one of them the CEO.

Till such time, one of the Promoters can be the CEO, but the clear path should be laid down.

Once the 20 year road map is put down, the CEO should be having his council of five, which will put up the three year, two year, one year and half year operating plans.

The Promoter Council should not be the Board of Directors, but should be interacting with them regularly.

The tricky issue is whether the Promoter Council has stakes enough to do what it can do for as long as it does. Given who they are, perhaps their owning a stake is not so important. The Board of Directors can be the ones to take a call, in consultation with the CEO and his team. In two years, hopefully the Promoter Council can just be a sounding board, with strategies and plans being done by internal council.

A transition to a professional firm is not so easy. Especially with a CEO who is a stranger to the operating team. The CEO has to be from within. That is the failure of the promoters, who did not groom one from within.

Of Tata Motors- bad debts and analyst estimates

Tata Motors ‘financing’ arm has always been a problem child. This story

http://www.business-standard.com/article/companies/why-tata-motors-credit-practice-is-under-attack-117082300305_1.html

just keeps reappearing in time, with larger numbers.  In the old days, good credit used to go to the external NBFCs, whether it was the trucks or the construction equipment that was being sold by the company.

Rate was never an issue. When Tata Finance was created as a separate company that would absorb the sales pressures of Tata Motors, it ran in to a different problem and had to be closed down. However, financing arm in most auto companies play a large role.

It can be good business if sales do not drive credit. In theory, every dealer is supposed to informally back the borrower, but in practice, the selling pressure on the auto companies are so large that prudence is left behind.

Companies like Bajaj Finance were created to meet the sales demand, but evolved in to successful finance companies, with good risk management systems.  Tata Motors seems to be particularly unlucky or incompetent in managing credit risk. In the article that I have linked, the author compares Ashok Leyland and Tata Motors for the ‘receivables’. Ashok Leyland has an independent finance arm so the numbers will not be comparable.

As an auto analyst, if one is tracking Tata Motors, the finance company risk is equally large and creates big holes in the P&L. However, we can conveniently treat is as ‘unusual items’ and hide our error. What the analyst has to realise is that when the unusual keeps recurring like clockwork, it ceases to be unusual.

 

IPO- The promoter takes all

(This was a piece written in 2008 )

IPO’s and the merchant bankers- Takeaway for investors

Quotes from a newspaper:

“regulator’s inspection showed that the details of the promoters as mentioned in the IPO document were different from the one filed with the Reserve Bank of India.

 

, the merchant banker had not even verified the plant and machinery of the companies, the issues of which they had managed

 

one IPO, the regulator found out that the post-issue capital of the company was higher than its authorised capital —“

Above are some “omissions & commissions” by merchant bankers whilst managing IPO’s, according to a press report. The report also says that the regulator is likely to impose penalties on the merchant bankers concerned.

IPO business is funny business. Every issuer wants to sell shares at the highest possible price. Obviously, once an issuer short lists a few merchant bankers, then the actual choice would be made on who would offer the highest price. In any IPO, the fee is large. It could be a lowly 1% to as high as 5%. For an issuer, the total expenses can be in the range of 7 to 11% of the issue. Naturally, a 10% higher pricing means that the issue expenses are covered.

IPO’s, under the book building route can only proliferate in a bull market. In general, most IPO’s tend to be overpriced. All IPO pricing is based on some rosy picture of the future, so it is but natural that at least half of them will fail to live up to promises.

Once an IPO goes under water, the IPO investor feels cheated. Once many go, the noise levels increase. Investor forums start shouting and ask for action against lead managers etc.,

Firstly, no investor is forced by anyone to invest. He makes a conscious choice. He is being misled by the noise surrounding an IPO. He has no access to the prospectus or has no expertise to understand the same. So, he goes by his broker/friend/media views and plonks his money. Most investors I know want to keep flipping each IPO on allotment and move on to the next. One group just keeps piling up the IPO allotments. Over time, they sell where they see gains and hold on to the ones under water. In many cases, the reasons for holding on are psychological. Further, in each issue, the amounts involved are small (though it all adds up to a tidy sum) so there is a tendency to hang on. Over time, some of them become worthless and move on to the “vanishing companies” list.

What about the lead manager? To my mind, the lead manager/s should be punished only if there are compliance issues. If there are mis-statements, suppression of facts (which any due diligence should have thrown up) or any other act/omission which could have materially altered the story, then they should be punished. Here, the punishment should be severe and not nominal. I would say that suspending all the business of the entity for six months to a year plus a financial penalty which is at least four to five times the total fees involved in the issue should be levied. The penalty should hurt. A few lakhs does not make a difference to most merchant banks. Suspension of activities (all business done by the entity/group) in capital markets is a must. Only then would it hurt.

There would be instances where the lead manager is taken for a ride by the company. Such cases would be complex in nature. For instance, one of the cases cited above relates to the company filing some return with the RBI. It is very unlikely that the merchant banker would be able to verify this and to my knowledge, would not fall in the check list for due diligence. However, non-existence of plant and machinery is something that is amazing. So is the case of the authorised capital not being adequate. These are elementary errors and the punishment should be very severe. In fact, taking away the capital markets business licence would be a fit action in these cases. When a merchant banker takes on an IPO mandate, his responsibilities are huge. He may not have all the expertise himself, so he has to hire the right people to help him in this. On pricing, it is what the traffic can bear, so no issues with them. I would not blame a merchant banker on this. If he does this frequently, the market place would judge him over time.

Pricing is something we all like to hold the merchant banker responsible for. If an issue lists at a huge premium, then the issuer has lost. Similarly, if the issue lists at a discount, the investors get hurt. There is no answer to this. The merchant banker gets paid by the issuer. Naturally, his first loyalty lies there. As far as the investor is concerned, he has to take his call. There is no point in saying that if institutional investors put in money, they would have done their homework. World-over, there is an unholy nexus between institutional investors and merchant bankers (who also are brokers). The institutional investor can move more quickly, he has access to much more information than the retail investor would have.

The retail investor is all alone in this. The IPO grading system has been discussed in our magazine. Whilst it is a useful tool, it gives no help on pricing. This brings home the lesson that equity investments are fraught with risk. IPO investing is perhaps more risky than a secondary market investment. In the secondary market, you would have access to more information, research and price history. Further, in most IPO’s one has no idea about the management quality and capabilities. You may end up with a multi-bagger or end up with tissue paper. It is best to be cautious. In IPO’s, the advantage is typically with the issuer. He comes in at a time and price convenient to him. It need not coincide with what is good for an investor.

One issue relates to pricing disclosure. Whilst giving the mandate to a merchant banker, all issuers insist on a “price range” at which the merchant banker can place the shares. Without this, no issuer will give a mandate. However, the public get to know of a price only when the issue is about to open. All offer documents have a blank in the price disclosure. I understand that pricing can change, in tune with market conditions. However, why not give the indicative price band whilst filing the red herring or the draft prospectus with SEBI? This would give time to analysts to give their views on the issue. Today, most analysts do not get time to do this efficiently, because the price band fixation and the issue opening happens with a gap of a few days. This is something for the regulator to consider. Let the issuer be free to fix a totally different price when actually opening the issue. By giving the indicative price range up front, it would help the investor to take a better view and lead to more analysis and information to the potential investor.

The funny thing is that we all get introspective and rational when the markets are down. When a bull market resumes, all of us forget our lessons and plunge headlong in to putting our money back in to the markets, hoping to make a quick killing. By and large, IPO’s do give an opportunity to make money, depending on whose greed is greater at a point in time. In a bull market, the issuer takes advantage of the investor greed. In a bear market, unless the issuer is desperate, he waits it out.

 

August 23, 2008.

 

MIDCAPS- The story of emerging microcaps..

(this is published in Today’s editions of Deccan Chronicle. The hot favourite of the markets is the mid cap segment.)

EMERGING MUDCAPS

If you are the person who is a keen investor in small and mid cap stocks,  be aware that you are entering a twilight zone. The mid cap stocks drama is nearing completion of another cycle, notwithstanding the money that is pouring in to the markets.

As this bull run started, somewhere around 2014, the mid cap space looked interesting.  Smart investors jumped in early. Valuations for mid caps, that were at discount to large caps, shot up higher and higher. Earnings growth seemed to exist only in the mid cap space. As earnings expectations were met, the next round of forecasting jumped even higher, prompting push in prices higher and higher.

Currently, the BSE mid cap index trades at a thirty times earnings and the small cap index at a healthier 74 times earnings. Of course, the BSE Sensex is at a measly 24 times earnings. Let us see how the indices behaved post the change in government:

 

(BSE INDICES)  SENSEX    MIDCAP    SMALL CAP
   
Apr-14  22,418  7,323  7,490
   
Dec-14 23%  27,499 42%  10,373 48%  11,087
   
Jun-15 24%  27,781 46%  10,680 48%  11,075
   
Dec-15 17%  26,118 52%  11,143 58%  11,837
   
Jun-16 20%  27,000 60%  11,717 58%  11,801
   
Dec-16 19%  26,626 64%  12,031 61%  12,046
   
Jun-17 38%  30,922 100%  14,644 106%  15,411
   
LATEST 42%  31,798 107%  15,157 109%  15,635
             

 

(These are month end closing indices of the BSE for the Sensex, Midcap Index and the Small Cap index )

These are amazing returns and for those who stayed invested, the journey must have been exciting. However, there are many who keep buying and selling and it is very unlikely that the returns would have been so much if measured for their money, over this period. Yes, one may have had great returns if there was concentrated investing in one or two stocks that multiplied many times, in this bull run.

However, it does look clear that the party is about to slow down dramatically, if not end. And the latecomers are the ones who will take longest to recover from the hangover.  As I am writing this (10th August, 2017) the markets seem worried. Of course, as an investor, I have to keep awake at these times. If there is some irrational correction AND I can spot some value buying WITH margin of safety, I am ready. I think that time where we can get ‘margin of safety’ is still to come.

The worst hit will be those who joined the bandwagon late. The sweet spot in the last three years seem to have been the first calendar half of 2017. In other words, if you joined the party by end December 2016, you probably had a good ride. The indices hide individual stock movements and thus the story would be different for different investors. If you are in pharma and IT, you probably are staring at losses whereas if you are in to cyclicals like steel, you had a good ride.

However, none of these periods offered ANY margin of safety to the investor. We had to bank on crowd behaviour and money flows.

For those in the mid cap stocks, my advise would be to stick to high quality stocks (those with ROEs in excess of twenty percent) and exit the rest, even if it means a loss. Very often, when the exits get crowded, no one gets out. So, I would opt for a conservative approach, cashing out on the speculatives and the ‘hope’ driven small companies.  The cash can be useful in the days to come.

Once a sector gets impacted, many people try to buy the stocks on decline. It is not a good strategy, always. Just look at the pharmaceutical sector. The stream of bad news has brought down the prices, but still the multiples are nowhere close to giving the buyer any margin of safety. So, if you just look at the High/Low and keep buying stocks, it is unlikely to work in this bull market. Pharma stocks have just become ‘expensive’ from being ‘very expensive’. Prices are still not related to earnings and are driven by hopes that are getting dashed as events unfold.

Cash is king in these markets. And there is no need to rush in at the sign of first correction. I am not referring to any levels in the indices, but keep your eye on the ‘margin of safety’. Buying closer to that is what will give you better investment returns. Being conservative at this juncture, will ensure that you are around in the markets for a long time.  I am sure that one investor named Warren Buffet must not have even averaged three buys in a year. He spends all his waking time on the stock markets and buys and sells far lesser number of stocks than we do, by spending a few hours in a week.  And he has not done too badly.

 

(http://epaper.deccanchronicle.com/articledetailpage.aspx?id=8778359  )

 

 

The lament of a Senior Citizen

(This came to me as a ‘forward’. It makes great sense and is a genuine plaint. A senior citizen has no hope that someone is looking out for him. As jobs get scarcer and medicines become stronger, we are condemned to longer and longer lives. And the rulers, do not seem to care enough. What is particularly telling is the comment that the legislators have the right to fix their own pay, so they are not worried at all.)

A Senior citizen posted the following on the facebook page of PM Mr. Narendra Modi and sent an email to FM Mr. Arun Jaitley. For information of all my friends.

Respected Prime Minister Shri Narendra Modi ji,
Respected Finance Minister Shri Arun Jaitely ji,

First of all I extend my sincere thanks in anticipation that you will spare a few minutes of your valuable time to read and take suitable action in the matter.

I am a senior citizen and on 01.08.2012, I put Rs 40 lakhs in a nationalized Bank for 5 years. I was being paid an amount of Rs. 35,352/- every month (of course subject to income tax) enabling me to lead a worry free life financially. Now on maturity I have reinvested the amount in the same Bank and I will be paid Rs. 26,489/-; a shortfall of Rs. 8863/- i.e. 25% over the previous return, per month. Can you please advise me from where I should make good the loss or sacrifice consumption of medicines or atta or dals or vegetables or fruit or milk or what?

Practically your government after taking over in 2014 has done nothing for senior citizens. No additional facilities extended but withdrawal of what existed in 2014. No commodity or provision item is available at the price of 2014. Yes you have been able to bring down the figures of inflation and indices but not the actual prices. Every off and on the prices of some essential daily use items go rocket high like dals, chana/besan, salt, onion and now the tomatoes. At that time we cannot even dare see those items.

I know you have political and the theoretical replies for these issues like interest on deposits and advances in banks depend on demand and supply. The prices of daily use items vary with seasons being agricultural products. But the straight upward shoot of prices cannot be justified by these reasons. If the government wants to provide cheaper credits to the trades and industries, it should not be at the cost of depositors. Banks are sitting over volcanoes of NPAs and all good money is being diverted for bad money. On the other hand banks have exponentially increased service charges on anything and every thing.

In desperation we look for investments in equity or mutual funds. There also over scrupulous elements outsmart us and hardly give us any returns. Your NPS scheme is of no use to us at this stage.

But is it not the duty of the government to enable the senior citizens to lead a respectable life who have spent their golden years in serving various organizations and finally the nation? Government cannot see the other way. I am at a loss to understand from where this deficit of 25% be met.

It may not be appropriate for me to question lije this but i am compelled to. Is any of the minister/MP/MLA is ready to cut his salary and allowances by this percentage? If not, then why the public especially the senior citizens?
Perhaps it is because that, like you, we do not have the power to fix our own salaries, allowances and perqs and getting everything for full year, for sessions of total of 3 months and that too attending sessions at their sweet will. When the matter of increasing your salaries comes, you pass the same just in 2 minutes with no discussion, with all heads together be it from ruling or opposition benches. For this increase, you totally over look the cost to the exchequer, deficit, economics and any other factor.

The government had started a scheme for deposits of senior citizens and the rate was 9.20% but In July, 14 it was reduced to 8.3%; the amount limited to Rs 15 lakhs. This is totally unjustified. The rate should be a minimum of 12% and the amount limit should be equal to what a person gets as terminal benefits. The government should ensure financial respectability to the senior citizens to walk with their heads straight.

I am sure you will understand the plight of the people whose good part of expenses comes from the interest of their savings of life time.
Sorry if I have offended you in any way.
Thanks and Regards

D. P. Bhateja 2246 sector 48C Chandigarh
Mobile : 9417819504

GST- Reason to Invest in India

(This appears in the Deccan Chronicle of yesterday/today in various editions. GST transition has been smooth, contrary to the noise around it. There are problems, but the opportunities it throws up are big.  The fiscal reforms that have kicked in are primarily aimed at ensuring a high level of information control and management by the government. Irrespective of our criticism, the moves have a positive spin on the corporate sector as well as on the fiscal situation)

GST is now a reality. I doubt if there are any direct winners or losers merely due to a lower or higher rate of effective taxation. There will be a transition period of eighteen to twenty-four months till the dust settles. These are yet early days. Numbers will not tell us the story for some more time.  The panic situation to clear inventory that was produced before June 30th,  seems to have been a blessing in disguise for many. Inventory has been cleared and cash freed. There will be some inventory losses as well as some inventory write offs. A cleansing, so as to say.

 

Gradually, as the dust settles, there will be good tidings for the organized sector. The entire GST system levels the playing field. This means that the unorganized sector will not have any price advantage. Advantages of scale will be a competitive advantage, as it ought to be. The largest companies will be the biggest winners. Further, companies in sectors that face competition from unorganized players, will also gain. I can see textile industry regrouping. As will automobile ancillaries. The organized sector will insist on buying inputs only from registered players in order to get their GST credits. Logically, this means that the smaller players will be forced in to registration and paying GST.

 

In the initial phase, a lot of companies will be shy of passing on the full extent of the inputs credit as they deal with a new system. In about a year or so, as the system stabilizes, there will be further competition based on this fact. So, in the short term, some consumer products could face some price hikes, but will level off over time. Consequently, we may see some consumer companies report a spike in short term earnings over the next couple of quarters, but it would level off.

 

One thing to remember is that a broad increase or decrease that is universal, is unlikely to change the demand supply equation in an industry. For instance, increase in the effective service tax rate from fourteen to eighteen will not reduce the total services being provided. Similarly, an across the board reduction in automobile prices is unlikely to dramatically increase the sale of automobiles.

 

The BIG question is whether GST will result in a better compliance and consequently a higher collection of expenditure taxes. My answer is YES. Firstly, the service tax hike is a huge boost to the collection. And the compliance net will spread wider.  The key thing to see is whether there will be a spin off on the government finances. I would think that there would be a consolidation of our finances leading to lower deficit. Now, the government could share some of the spoils by way of lower income tax rates.

 

Lower income tax rates is something that ‘appears’ more tangible and real. Even if it gets taken away by higher taxes on expenditure, the human mind always reacts more positively to a higher cash in hand. This illusion helps build confidence in the system and also the economy.

 

GST is probably the single biggest fiscal reform that India is seeing. Yes, we can always moan about the absence of a single rate and procedural issues, but after one year, the results will be on the ground for all. Just one factor of Octroi being abolished helps boost our economy, as goods move faster and efficiency improves.

 

Let us not look at GST in isolation. Demonetisation was also an important step in the whole process. This administration is extremely focused on data integration. Demonetisation, Aadhaar, GST are all pieces of a jigsaw which will complete the data integration. As every transaction becomes traceable and linkable, tax compliances would improve. Ultimately good compliance would help in lowering the effective tax rates. How the administration redistributes the gains is something that only time will tell.

 

Over the next two years, I can see corporate India becoming big beneficiaries of the GST system. Market leaders stand to benefit as scale becomes an important component. Compliance costs are unlikely to be high on a recurring basis, though there would be high transition costs. However, transition costs are unlikely to break the backs of any of the companies.

 

It is important to close our ears to the noise and look at each of the moves by this administration for its impact. The power of the information age is being harnessed to benefit government as well as business. Only those who have gained by evading compliance will be losers in this game.

 

As an investor, I think that we are headed for good times. Focus on quality, size and potential. Overall, one can expect better efficiency of capital. To use a much-abused phrase, “opportunities are always there”. We all need some luck to back the right horses.

 

R Balakrishnan

 

 

 

MARGIN OF SAFETY- (A rude WTF reminder)

(This appears in some editions of Deccan Chronicle today and in some, will appear tomorrow. Stock markets give us a rush of blood at some times and some times suffocate us. Logic and reasons are strange in the market)

If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you’d need. If you’re driving a truck across a bridge that says it holds 10,000 pounds and you’ve got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay; but if it’s over the Grand Canyon, you may feel you want a little larger margin of safety…

Warren Buffett

Stock markets make us human beings behave in strange ways. When things are quiet and stocks are inexpensive, we do not enter the arena. Once things warm up and there is a lot of noise, including anecdotal evidences of fortunes being made by others, we start looking at it. Finally, we succumb. Either though a SIP route (if we convince ourselves that we cannot manage the risks associated with stock picking) or a brave plunge in to the markets, all by ourselves, with friendly tips from media and experts.

 

Most of us go through our lives without bothering to understand ‘valuation’. And given that over time, stock prices tend to rise, we attribute our investment performance to our skills and ‘information’ network. And when the performance of what we pick happens to be disastrous, we attribute it to lousy experts.

 

We all have different interpretations of “Value”. To some, it is price. They look at historical highs/lows and seek their comfort. Some look at P/E multiples and buy it. Some look at P/E relative to growth. Some look at the overall market mood and are happy to look at ‘relative’ P/E multiples. Some are happy to chase what they read or hear that some ‘ace’ investor is buying. Sometimes it is ‘story’ based buying. Like we suddenly get bullish on ‘solar’ power or ‘electric fuel’ or ‘retail’ or ‘banking’ etc. Or we have stories like PSU companies going to be managed better. Of course there may be more theories and strategies. However, unless one spends a lot of time in understanding business and financials, you are leaving your investment to chance and luck.

 

You should make attempts to improve your odds.  One thing we should understand is that we are buying in to future expectations on a company, stock, or economy. Buying the past is the most common thing that everyone does. Even when choosing a mutual fund to invest, we are happy to go by ‘independent’ ranking that is purely based on past performance.

 

At each stage, when we buy a stock, we are buying in to ‘prospective’ returns. And that means one has to buy at valuations that give us a level of comfort. Stock prices never move according to our expectations. It rarely gives you the ‘speed’ of price movement that you want. Sometimes, even the direction can go wrong. After all, there are thousands of people out there forming a view on a stock, every moment. When you are buying or selling, you are in effect not just impacted by a price but also by expectations.  The prime assumption that one makes is that sooner or later, price will reflect the quality of a company with respect to its earnings and business.

 

I would urge all of you to read or re-read the chapter on “margin of safety” in the book “Intelligent Investor” by Benjamin Graham. Essentially, it is buying a business at a price that is lower than what it is worth. Yes, we all think times have changed.

 

Everyone tells me that I will never be able to buy stocks, given my conservative approach. I will miss out on stocks and be stranded with bank deposits and liquid funds. There is so much money flowing in to the markets that downside is ruled out. Everyone wants to buy Indian stocks. Reforms are happening at rapid pace. We are growing rapidly. Banks are getting cleaned up. Transparency in governance. Aadhaar has helped eliminate so much of waste. Oil prices are low. Inflation is low. And GST will multiply the profitability. Low oil prices across the globe. Fastest growing economy in the world.

I prefer to not change my thinking or rules for valuation. Everything will obey the law of gravity. Excesses happen at both ends. I am happy at one end and unhappy at another. Why should I voluntarily choose unhappiness?

 

I am not going just by the stock market indices. Given that we have a market with over 450 companies that deliver a ROCE of over 15% on an annualized basis, there are enough companies to invest. However, when I scan each of them under a lens, I do not seem to find a ‘margin of safety’ anywhere. One has to have an exaggerated view of future performance and also pray that nothing will go wrong, in order to make even a 15% annualized return. Yes, there is tremendous volatility and there are huge price swings that will lure us to quick returns. However, given growth, interest rates, inflation and valuation, I will be happy to sit this one out. I will be happy to watch the action around me, keeping an eye on any opportunity that will come when the crowd becomes quiet. Sometimes, it pays to hunt alone.

 

 

 

 

Dilip Pendse, RIP

To those who did not know him, he was in a financial scam involving Tata Finance.

I first met Dilip in 1984, when he was working in a secretarial function in one of the Tata Companies, perhaps Indian Hotels. He helped me and my friends with a lot of introductions within the group and help us win some business. With Dilip, it was business first. He was fiercely loyal to his employers. I doubt if that loyalty every wavered, till two days ago.

During all the times we knew, he never asked us for anything in return. He was happy to see his friends get business on merit. Yes, probably we got some preference because he pushed, but never did he let us do a second best deal.

I lost active touch with him somewhere in the early nineties. I have followed the stories, with scepticism and grief. Grief because a man who devoted his entire life to one employer, was soon hounded by the same employer.

Dilip takes with him many secrets to the grave. Secrets that would hurt some people, who are possibly relieved at his unfortunate end.  Maybe he will be in a story telling mood when we meet him on the other side. He may have done something wrong and reckless. But I doubt he did it for any personal gains. Those who knew him and his lifestyle, will vouch for that.

Whatever he was, he remains, to me, a good man and a good friend.  It is unfortunate that he ended his life in despair and fear. Surely, the Gods above owe some answers for treating him the way they did.

There may be stories and debates about his alleged wrongs. I am happy to ignore them and say a prayer for his soul. Dilip, RIP.