Learning Fundamentals

Yesterday I had an opportunity to interact with a fundamental investor who have picked Bharti Airtel @ Rs 20, Pantaloon Retail @ Rs 7 and loads of similar scripts and is still holding on to them or have booked profits once they have multiplied at least 15-20 times its initial price. There are many things which he told me is good to see/check before investing in any stock and I thought to share some with you people also.

The first thing which is important in this troubled environment is to go for stocks with high dividend yield and a good payout ratio. This protects the downside risk from the stock. For example if we buy Rs 200 stock with a 5% dividend yield and when the markets are tanking that same stock at Rs 100 (or around the same range) becomes a 10% yielding stock. Thus offering a return better than a FD and hence protects the further downside in the stock.

The next rule is to ignore a loss making company because in that case neither the DCF nor the PE valuation process can be used. But still if one gets tempted to buy the company because of a belief that it will turn around and generate returns then the best metric to use is its market cap. To use market cap is to check whether or not it makes sense to buy the company X at a particular market cap given its revenue, production capacity, ..., etc.

To check whether or not a company's Return on capital employed (ROCE) is high or not. By high he meant at least 30%. ROCE is the actual return a company generates with the money we invest in its stock. To also check what drives a company's ROE, whether its the high leverage or the asset turnover or the net profit margin. This is because during the last bull run most of the ROE expansion by companies was because of higher leverage and they are only the ones in big trouble presently.

He also mentioned that presently its good to invest in companies where the P/E have collapsed but earnings have remained almost stable, because these will be the companies which will perform on the bourses when the market recovers. Moreover companies which currently are not operating at 100% capacity utilization but around 60-70% will tend to benefit more when the demand recovers as they will be ready to supply more as compared to companies which are presently utilizing 100% of their capacity (because capex for new capacity will be time consuming)

He mentioned a 30-5-5 rule, which is any stock with at least 30% ROCE , 5%dividend yield and a P/E of 5 is a good investment and has a potential of becoming a multibagger.

There are many more which I would be sharing in my later posts. Till then wait and watch whether or not Nifty breaks 3500 or this euphemistic bubble bursts.

Google for Market Forecast...?

Blue: Stocks, Red: Bonds

Data on Internet searches can help predict certain kinds of economic statistics before they become available. This is one latest view by Hal Varian, a professor of economics at the University of California,

Berkeley who also happens to be Google’s chief economist. He says that fluctuations in the frequency with which people search for certain words or phrases online can improve the accuracy of the econometric models used for prediction.

These data are available through a site called Google Trends, which allows anyone to download an index of the aggregate volume of searches for particular terms or categories. We can use the data for searches of real estate agents to predict the number for housing sales or using data on searches for trucks and SUVs to predict the monthly sales of motor vehicles, etc.

It can also be used to track the sentiments indicator. Over the last few months the word recession is dominates the list of most searched words and the total searches for the word 'stocks' has being underperformed the total searches for the word 'bonds' in the last few months.

Thus it makes good sense for one to form a list of words that signals recovery/doom and form a composite index of searches on Google and use that as an indicator to track the markets. I am working on the same and may be my next blog would have the same 'Google Sentiment Index'.

Waiting For d next Bubble

There’s a remarkable lifting of mood in the world’s investment markets. A week ago, this was part of the G20’s achievements spin, some good Data releases by US but that connection has been stretched as far as it goes. Just as the markets were unwilling to ignore any bit if bad news till some time back, they are now willing to ignore all bad news and look only on the brighter side.

China's GDP at almost 2 decades low, UBS reporting over $1.5 bn loss and laying of 8000 employees, Infoys posting poor results along with even dismal guidance... But the markets are closing higher and higher...

The basics of this theory are simple—a huge amount of liquidity is being poured into the global monetary system and sooner or later, some of it is going to find its way into Indian assets and it has. So the bubble is being built up. The realisation that from now on the stock prices will only head in one direction and that is up is slowly setting in.

CNBC have started asking questions that is it a bear market rally or a beginning of the next bull market...? Hence I believe that slowly this bubble will burst leaving behind even more pain as the retail investors are euphemestically joining this bandwagon..

Thus the best strategy should be to cover the longs or build fresh short positions but not to gape at the index levels believing it to go high and be folled again by the institutions.

The number Game

Ask your self a very simple question... If the stock price of a company rises from Rs 1 and becomes 2, what is the percentage increase...? and if the price rises from Rs 100 and becomes 101, then again its a Rs 1 rise but what is the percentage increase this time...?  

I think all of you must have got it right.. Its 100% in the former case and 1% in the later.  But most of us misunderstand this simple logic tend to over react to the rise in stock prices of US financial services firm. 

Yesterday I saw Citigroup 30% up, Wells Fargo by over 25% and same with over top banks and financial institutions. So the DJIA was up by a good 3%. But is this something to cherish. Citigroup has risen by some mere 30-40 cents and same is the case with most of the others.  But still they are more than 90% down from their highs.. The reason of this rise as Bloomberg says is because of a better than expected result of Wells Fargo (that was mainly on account of some restructuring).

So in reality nothing great has happened. Its again the same euphemistic phase the stocks are entering. Reliance Industrial Infra has rallied by over 165% in last 4 trading sessions, Tata steel up by over 55% in 1 month (earnings growth would never be even 20% of this). The market pundits are saying Nifty to reach 4100/4500,...

I would again say as earlier that numbers are sometimes very miss leading and so there is nothing to get excited about the US financials rally and be over cautious. As Mr. Buffet says that "Be Greedy when others are fearful and fearful when others are greedy" and over the last few weeks the market has became a place of greediness and everybody is of the mood that the worst is finally over... 

A IIP figure of -1.5%, a almost negative inflation which is leading us towards a different and difficult to fight macroeconomic problem (liquidity trap: see my earlier blog for details)

So as per contrarian view I believe the worst is far from being over.. the party will begin once the 4Q results start coming in form 15th of April... The real use of numbers will come then...

PPB Vs Greediness

Over the last few weeks the global equity markets have rallied by over a whooping 30%. This was mainly on account of some decent data releases from US, Obama’s plan to purchase the toxic asset, a weakening dollar (leading to a rise in the commodity prices) and the expectation of the G-20 meet.

The Indian stock markets too have broken the past resistance levels and the Nifty is trading well above 3150. I had already stated in my blog earlier that this pre election rally is going to continue for sometime since those politicians need money for campaign.

However we can not be euphemistic once again and start saying that the index will rise to 4100 or 4500 or … (even higher levels). The stocks we have invested in at around 25-2700 index have rallied more than 35-40% and hence I believe that it’s a good time to go for partial profit booking (PPB). Likes of Tata Steel, Hindalco, DLF, etc have risen by over 40% and I see no harm in partially booking the profits at the current levels.

The biggest problem in retail investors is their market psychology. They are the ones who are least reluctant to sell once the markets are going up, with expectations of further return and tend to hold on to their investments and always sell when the value erosion has already taken place. In India the risk free rate of investment is around 7% p.a. and if my investment has given a return of over 30% in few weeks time, it makes much sense to book the profits.

There is one very simple way to book partial profits. Lets assume you bought 100 shares of company X at Rs 50/share, total investment amounting to Rs 5000. After two weeks time the market price of the share is Rs 75/ share and you are making a profit of Rs 2500 (50% profit). So in order to book the partial profit you can sell only 33 shares of company X, retaining the other 67. (Here 37 = 2500 profit / current price per share). Thus your profit is in your pocket and the initial investment of Rs 5000 is still intact. This will ensure that if the price goes up to Rs 100, you don’t miss that opportunity and if the market goes down from here your investment would not fall too much in value as the case could have being.

Thus start doing PPB instead of being over greedy. As the pic says that the choice is between booking super normal profits or more super normal profits

GM Bankruptcy can lead to next round of fall

President Obama is saying that a quick, negotiated bankruptcy is the most likely way for General Motors to restructure and become a competitive automaker and he is also prepared to let go bankrupt and be sold off if it can form an alliance with Fiat.

I think this move is a better one than providing tax payers hard earned money to save these ailing companies. On one hand this sudden bankruptcy announcement by the auto majors could trigger a fresh round of selling in the global financial markets (as in Lehmans, Bear Sterns case in the past) but on the other hand it would lead to a long term competitive markets (since it would be a lesson for other companies in US and at the world level too).

For Indian markets the bad news is that the total IT outsourcing deal by the US auto sector is around Rs 5000 cr and any such move could lead to huge amount of losses for the Indian IT sector, specially TCS. The news is also negative for the Indian auto ancillary sector which depend heavily on US exports.

Thus apart form the news (it it actually happens) that world's one of the top auto companies is filing for bankruptcy, there is a strong linkage for the Indian stock markets and could bring the index down. Hence, any long positions should be taken care cautiously.