It was autumn, and the Red Indians on the remote reservation asked their New Chief if the winter was going to be cold or mild. Since he was a Red Indian chief in a modern society, he couldn't tell what the weather was going to be.
Nevertheless, to be on the safe side, he replied to his Tribe that the winter was indeed going to be cold and that the members of the village should collect wood to be prepared. But also being a practical leader, after several days he got an idea. He went to the phone booth, called the National Weather Service and asked 'Is the coming winter going to be cold?' 'It looks like this winter is going to be quite cold indeed,' the meteorologist at the weather service responded. So the Chief went back to his people and told them to collect even more wood.
A week later, he called the National Weather Service again. 'Is it Going to be a very cold winter?' 'Yes,' the man at National Weather Service again replied, 'It's definitely going to be a very cold winter. '
The Chief again went back to his people and ordered them to collect every scrap of wood they could find. Two weeks later, he called the National Weather Service again. 'Are you absolutely sure that the winter is going to be very cold?'
'Absolutely' , the man replied. 'It's going to be one of the coldest winters ever. '
'How can you be so sure?' the Chief asked.
The weatherman replied, 'The Red Indians are collecting wood like Crazy.'
This is how stock markets work !!!
Tuesday, November 04, 2008
Sunday, November 02, 2008
GE Shipping
This is truly a value business which could be bought at a bargain at rs 138. With dividend around 15 rs and earnings at 80 rs. Its a diamond for a value investor. With it buyback of share it is amazing to see the equity base reducing. This is a rare phenomenon and very share holder friendly.
Buyback
Sep 8, 2008
Cover Story: Buyback
Check the agenda
Buyback is increasingly resorted to boost the stock price. But it also means that the company does not have any growth plans
Buyback is a reverse of issue of shares by a company. The company offers to take back its shares owned by the investors at a specified price. The price can be binding or optional to the investors. Buybacks have increased this year due to the decline in markets from all-time high. A depressed market is a ripe time for promoters to mop up shares at low prices without using personal funds.
There are many reasons why companies choose to buy back shares. Investors should study the reasons behind the company’s buyback strategy before tendering their shares. If companies have huge cash reserves with not many new profitable projects to invest, buyback is a way to reward investors. However, companies in emerging markets like India have growth opportunities. So this logic does not apply.
Many companies use buyback to show better financial ratios. Thus, return on assets (ROA) actually increases with the reduction in assets, and return on equity (ROE) rises as there is less outstanding equity. The earning per share (EPS) and the P/E ratio looks better after the buyback on reduced capital even though the earning may not improve. As investors scrutinise EPS and P/E before investing, the favorable ratios could boost the stock.
Some companies buy back stock to contain the dilution in promoter holding and EPS from the employee stock option plans (ESOPs). Any such exercise leads to increase in outstanding shares and drop in prices. This also gives scope for takeover bids as the share of promoters reduces.
Buyback is another strategy to maintain the share price in a bear run. By buying shares at a price higher than the prevailing market price, the company signals that its share valuation should be higher, thus stemming the fall. The stock repurchase program reaffirms the confidence the company has in its long-term growth and profitability, and demonstrates its commitment to enhance shareholder value by rewarding investors.
Buyback also has certain negative implications. Buyback sends signals that the market capitalisation of the shares has scope to improve and, thus, leads to speculative activities.
Second, the promoters’ holding increases subsequent to the capital reduction with the use of company funds. This is a setback for investors who stay put in the company, particularly in the growth sectors. A reduced capital decreases the borrowing power. If buyback is resorted to by incremental borrowings, the increased cost of capital proves to be detrimental to the company’s health. The financial flexibility of the company is curbed, consequently restricting the developmental process and may even prove fatal in contingencies, which cannot be ruled out in a business.
Buyback also prevents the company from raising equity capital for the next two years. This could impact the company’s growth process as it may not be able to use opportunities that may arise in the following two years for diversification, modernisation or expansion.
There are certain checks and balances investors must apply before participating in a buyback. Companies generally tend to buy back shares at a higher premium over the market price if they feel that their shares are under-priced. This decision to buy back often leads to increase in the share price. Investors should look at the share price movement immediately before the buyback. If there has been a significant rise, the assumption is that the promoters have been up to some manipulations.
Companies with huge debts are unlikely to have free cash. So investors should check the debt-to-equity ratio of the company. Companies that have just come to the capital markets to raise money are unlikely to be good candidates for buyback. When the management has passed special resolutions, with a lot of publicity, empowering the board to decide on the buyback date, there is scope for suspicion.
If investors feel the share price is undervalued, refrain from tendering the shares, as the company buying back the shares is indirectly conveying that its shares are undervalued. Despite strong fundamentals, the shares of a few companies are highly volatile and exhibit wild oscillation in prices. If investors want to play it safe and avoid volatility, selling out would be a better option. Decide to sell the scrip when the market price is equivalent to the highest in the offer band.
When a company announces a buyback, it is usually perceived by the market as a positive, which often causes the share price to shoot up. In one sense, this is good for shareholders because the dividend payout per share rises. On the other hand, it is an acknowledgement that the management can think of nothing better to do with company’s money than buy back its own shares. If a stock is undervalued and a buyback truly represents the best possible investment for a company, the buyback — and its effects — can be viewed as a positive sign for shareholders.
Watch out if a company is merely using buyback to prop up ratios to provide short-term relief to an ailing stock price or to get out from excessive dilution. The reward to the shareholders should be equitable and without discrimination and there should be no protection to one class or group of shareholders at the cost of other.
Buyback has provided MNCs the option to convert their Indian ventures into whollyowned subsidiaries, delist their shares and take complete control over their Indian ventures, and make decisions that could be detrimental to the interest of minority investors.
BOX
Three routes to buy back
Tender offer, bookbuilding or open market purchases
Companies can buy back shares in three ways. First, the shareholders are presented with a tender offer where they have the option to submit a portion or all of their shares within a certain time period at a price usually higher than the current market value. This premium compensates investors for tendering their shares rather than holding on to them. Another variety of this is the Dutch auction, in which the company states a range of prices at which it is willing to buy and accepts the bids. It buys at the lowest price at which it can mop the desired number of shares.
The second way is the book-building process. The third method is buying shares from the open market over the long term subject to various regulatory guidelines.
In the first two methods, promoters can participate in the buyback by tendering their shares. But they cannot in the third process.
To value the buyback price, companies use the weighted average closing price (averaging the price obtained by assigning proportionate weightge to the price based on volume) for a period immediately before the buyback announcement. Based on the trend and value, the buyback price is decided.
The company, thereafter, sends investors a tender/offer form. The decision to accept or forgo the offer lies with the investor. Shareholders accepting the offer have to fill up the form and enclose the documents asked for by the company.
Investors can even make an application on plain paper stating their folio number, name, address, number of shares held, share certificate number, distinctive numbers, number of shares tendered together with the original share certificate. These can be tendered at the collection centres mentioned in the public announcement. It is required to send intimation to the tenderers within 15 days from the closure of the offer. Acceptance from any investor is on a proportionate basis irrespective of the number of shares tendered. It is required to send consideration or the share certificate within 21 days from the closure of the buyback offer.
There are certain regulations imposed on companies going for buyback. A special resolution has to be passed in a general meeting of the shareholders for buyback up to 25% of the total paid-up capital and free reserves. A company may buy back its shares without shareholders’ resolution to the extent of 10% of its paid-up equity capital and reserves. A declaration of solvency has to be filed with Sebi and the registrar of companies. The shares bought back should be extinguished and physically destroyed.
The company should not make any further issue of securities within two years, except bonus and conversion of warrants. The ratio of the debt owed by the company should not be more than twice the capital and its free reserves after such buyback.
There should not be any default in repayments of debt. A company which is in default of payment of deposits, redemption of debentures or preference shares or repayment of a term loan to any financial institution is prohibited from undertaking a buyback exercise.
A company cannot buy back its shares or other specified securities out of the proceeds of an earlier issue of the same kind of shares or specified securities.
The buyback should also be in accordance with the Sebi guidelines which include daily advertisements, disclosure of purchases daily, declaration by promoters of the upfront pre- and post buy-back holding to prevent manipulation. Also, the company cannot participate in the buy-back through any subsidiary company or investment companies.
In the queue
Companies approving their buyack plans since 1 April 2008
Company, Sector, BB Price(Rs), BB Apprv Date, Aggr Amount (Rs cr), Cash Reserve, Market Price 29-Aug-08, Chg(%) Since Apprv*, Pre-BB Promoter Stake(%)
HEG Electrode-Graphite 350 19-Aug-08 48.5 317.87 239.2 -9.62 51.44
FDC Pharma 40 12-Aug-08 35.85 354.99 33.5 -2.9 63.98
Gateway Distriparks Miscellaneous 110 25-Jul-08 64 532.31 90.8 6.64 41.14
TV Today Network Entert / Electr media 115 31-Jul-08 29.3 225.54 95.3 -9.41 55.68
Jindal Poly Films Packaging 350 14-Jul-08 150 758.78 260.2 9.3 55.2
TTK HealthCare Pharma 120 25-Jul-08 11.06 44.39 96.5 3.6 62.64
DLF Realty 600 10-Jul-08 1100 346.92 493.3 7.63 88.16
Abbott India Pharma 630 09-Jul-08 50.24 216.55 560.9 4.73 65.14
Surana Telecom Telephone-cables 50 22-Apr-08 6 54.88 27.75 -25.7 54.66
Sasken Commu Tech software 260 19-Apr-08 40 394.31 138.8 -3.58 26.44
JB Chemicals &Phar Pharma 70 08-Apr-08 29.52 446.32 43.8 -18.05 55.46
SRF Textiles 160 25-Apr-08 70 844.58 132.9 -4.42 42.12
Note
BB-Buyback. ##Cash reserves as on buyback approval date. Reserves excluding revaluation reserves of latest financial year considered. * Change % since approval date
Cover Story: Buyback
Check the agenda
Buyback is increasingly resorted to boost the stock price. But it also means that the company does not have any growth plans
Buyback is a reverse of issue of shares by a company. The company offers to take back its shares owned by the investors at a specified price. The price can be binding or optional to the investors. Buybacks have increased this year due to the decline in markets from all-time high. A depressed market is a ripe time for promoters to mop up shares at low prices without using personal funds.
There are many reasons why companies choose to buy back shares. Investors should study the reasons behind the company’s buyback strategy before tendering their shares. If companies have huge cash reserves with not many new profitable projects to invest, buyback is a way to reward investors. However, companies in emerging markets like India have growth opportunities. So this logic does not apply.
Many companies use buyback to show better financial ratios. Thus, return on assets (ROA) actually increases with the reduction in assets, and return on equity (ROE) rises as there is less outstanding equity. The earning per share (EPS) and the P/E ratio looks better after the buyback on reduced capital even though the earning may not improve. As investors scrutinise EPS and P/E before investing, the favorable ratios could boost the stock.
Some companies buy back stock to contain the dilution in promoter holding and EPS from the employee stock option plans (ESOPs). Any such exercise leads to increase in outstanding shares and drop in prices. This also gives scope for takeover bids as the share of promoters reduces.
Buyback is another strategy to maintain the share price in a bear run. By buying shares at a price higher than the prevailing market price, the company signals that its share valuation should be higher, thus stemming the fall. The stock repurchase program reaffirms the confidence the company has in its long-term growth and profitability, and demonstrates its commitment to enhance shareholder value by rewarding investors.
Buyback also has certain negative implications. Buyback sends signals that the market capitalisation of the shares has scope to improve and, thus, leads to speculative activities.
Second, the promoters’ holding increases subsequent to the capital reduction with the use of company funds. This is a setback for investors who stay put in the company, particularly in the growth sectors. A reduced capital decreases the borrowing power. If buyback is resorted to by incremental borrowings, the increased cost of capital proves to be detrimental to the company’s health. The financial flexibility of the company is curbed, consequently restricting the developmental process and may even prove fatal in contingencies, which cannot be ruled out in a business.
Buyback also prevents the company from raising equity capital for the next two years. This could impact the company’s growth process as it may not be able to use opportunities that may arise in the following two years for diversification, modernisation or expansion.
There are certain checks and balances investors must apply before participating in a buyback. Companies generally tend to buy back shares at a higher premium over the market price if they feel that their shares are under-priced. This decision to buy back often leads to increase in the share price. Investors should look at the share price movement immediately before the buyback. If there has been a significant rise, the assumption is that the promoters have been up to some manipulations.
Companies with huge debts are unlikely to have free cash. So investors should check the debt-to-equity ratio of the company. Companies that have just come to the capital markets to raise money are unlikely to be good candidates for buyback. When the management has passed special resolutions, with a lot of publicity, empowering the board to decide on the buyback date, there is scope for suspicion.
If investors feel the share price is undervalued, refrain from tendering the shares, as the company buying back the shares is indirectly conveying that its shares are undervalued. Despite strong fundamentals, the shares of a few companies are highly volatile and exhibit wild oscillation in prices. If investors want to play it safe and avoid volatility, selling out would be a better option. Decide to sell the scrip when the market price is equivalent to the highest in the offer band.
When a company announces a buyback, it is usually perceived by the market as a positive, which often causes the share price to shoot up. In one sense, this is good for shareholders because the dividend payout per share rises. On the other hand, it is an acknowledgement that the management can think of nothing better to do with company’s money than buy back its own shares. If a stock is undervalued and a buyback truly represents the best possible investment for a company, the buyback — and its effects — can be viewed as a positive sign for shareholders.
Watch out if a company is merely using buyback to prop up ratios to provide short-term relief to an ailing stock price or to get out from excessive dilution. The reward to the shareholders should be equitable and without discrimination and there should be no protection to one class or group of shareholders at the cost of other.
Buyback has provided MNCs the option to convert their Indian ventures into whollyowned subsidiaries, delist their shares and take complete control over their Indian ventures, and make decisions that could be detrimental to the interest of minority investors.
BOX
Three routes to buy back
Tender offer, bookbuilding or open market purchases
Companies can buy back shares in three ways. First, the shareholders are presented with a tender offer where they have the option to submit a portion or all of their shares within a certain time period at a price usually higher than the current market value. This premium compensates investors for tendering their shares rather than holding on to them. Another variety of this is the Dutch auction, in which the company states a range of prices at which it is willing to buy and accepts the bids. It buys at the lowest price at which it can mop the desired number of shares.
The second way is the book-building process. The third method is buying shares from the open market over the long term subject to various regulatory guidelines.
In the first two methods, promoters can participate in the buyback by tendering their shares. But they cannot in the third process.
To value the buyback price, companies use the weighted average closing price (averaging the price obtained by assigning proportionate weightge to the price based on volume) for a period immediately before the buyback announcement. Based on the trend and value, the buyback price is decided.
The company, thereafter, sends investors a tender/offer form. The decision to accept or forgo the offer lies with the investor. Shareholders accepting the offer have to fill up the form and enclose the documents asked for by the company.
Investors can even make an application on plain paper stating their folio number, name, address, number of shares held, share certificate number, distinctive numbers, number of shares tendered together with the original share certificate. These can be tendered at the collection centres mentioned in the public announcement. It is required to send intimation to the tenderers within 15 days from the closure of the offer. Acceptance from any investor is on a proportionate basis irrespective of the number of shares tendered. It is required to send consideration or the share certificate within 21 days from the closure of the buyback offer.
There are certain regulations imposed on companies going for buyback. A special resolution has to be passed in a general meeting of the shareholders for buyback up to 25% of the total paid-up capital and free reserves. A company may buy back its shares without shareholders’ resolution to the extent of 10% of its paid-up equity capital and reserves. A declaration of solvency has to be filed with Sebi and the registrar of companies. The shares bought back should be extinguished and physically destroyed.
The company should not make any further issue of securities within two years, except bonus and conversion of warrants. The ratio of the debt owed by the company should not be more than twice the capital and its free reserves after such buyback.
There should not be any default in repayments of debt. A company which is in default of payment of deposits, redemption of debentures or preference shares or repayment of a term loan to any financial institution is prohibited from undertaking a buyback exercise.
A company cannot buy back its shares or other specified securities out of the proceeds of an earlier issue of the same kind of shares or specified securities.
The buyback should also be in accordance with the Sebi guidelines which include daily advertisements, disclosure of purchases daily, declaration by promoters of the upfront pre- and post buy-back holding to prevent manipulation. Also, the company cannot participate in the buy-back through any subsidiary company or investment companies.
In the queue
Companies approving their buyack plans since 1 April 2008
Company, Sector, BB Price(Rs), BB Apprv Date, Aggr Amount (Rs cr), Cash Reserve, Market Price 29-Aug-08, Chg(%) Since Apprv*, Pre-BB Promoter Stake(%)
HEG Electrode-Graphite 350 19-Aug-08 48.5 317.87 239.2 -9.62 51.44
FDC Pharma 40 12-Aug-08 35.85 354.99 33.5 -2.9 63.98
Gateway Distriparks Miscellaneous 110 25-Jul-08 64 532.31 90.8 6.64 41.14
TV Today Network Entert / Electr media 115 31-Jul-08 29.3 225.54 95.3 -9.41 55.68
Jindal Poly Films Packaging 350 14-Jul-08 150 758.78 260.2 9.3 55.2
TTK HealthCare Pharma 120 25-Jul-08 11.06 44.39 96.5 3.6 62.64
DLF Realty 600 10-Jul-08 1100 346.92 493.3 7.63 88.16
Abbott India Pharma 630 09-Jul-08 50.24 216.55 560.9 4.73 65.14
Surana Telecom Telephone-cables 50 22-Apr-08 6 54.88 27.75 -25.7 54.66
Sasken Commu Tech software 260 19-Apr-08 40 394.31 138.8 -3.58 26.44
JB Chemicals &Phar Pharma 70 08-Apr-08 29.52 446.32 43.8 -18.05 55.46
SRF Textiles 160 25-Apr-08 70 844.58 132.9 -4.42 42.12
Note
BB-Buyback. ##Cash reserves as on buyback approval date. Reserves excluding revaluation reserves of latest financial year considered. * Change % since approval date
Saturday, November 01, 2008
Financial Technologies Ltd
Story of Jignesh shah , its promoter.
This company is a player in transaction market. Its products are means to the end and not the end itself. That is no matter people gain or loose money while buying or selling equites, commodities or bullion, FTIL is going to have a commission amount from the transaction made. That is a toll bridge kind of revenue model which would also need less capital expenditure.
The price of Rs 515, dividend of rs 20 and earnings of rs 148 is okay but if the price falls around rs 250- 350 would be a bargain price for this company.
Indian public holding in FT is only 7 %. So there is no scope for
promoters to buy any of the stock. Promoters buying is a good indicator
but not the sole indicator.
The company has two streams of income : 1) license and transaction fee on
its products 2) periodic stake sale in subsidiaries that it has
incubated.
Incubating and stake sale in subsidiaries is a Venture Capital model and
earnings are lumpy. Just as GE Shipping considers profit on sale of ships
as regular income, stake sale in subsidiaries is also regular income for
FT.
When analysing "Other Income" we have to see whether it is regular income or
extraordinary.
FY 08 results included part stake sales in MCX. But, even discounting
that, the previous few years had CAGR of 90 %.
Q-2 FY09 has no stake sales. There is rapid growth in license and
transaction fee income. MCX has increased its market share.
The value of the stake in MCX and other unlisted subsidiaries is listed
at cost in the balance sheet. The market value is much higher.
FY07 EPS was Rs 20. Due to the high profits in FY08, the dividend payout
was Rs 20, equal to the entire EPS of the previous year. The company has
enough free cash to continue paying Rs 20 dividends.
The price of FT is volatile due to the small floating stock.
This company is a player in transaction market. Its products are means to the end and not the end itself. That is no matter people gain or loose money while buying or selling equites, commodities or bullion, FTIL is going to have a commission amount from the transaction made. That is a toll bridge kind of revenue model which would also need less capital expenditure.
The price of Rs 515, dividend of rs 20 and earnings of rs 148 is okay but if the price falls around rs 250- 350 would be a bargain price for this company.
Indian public holding in FT is only 7 %. So there is no scope for
promoters to buy any of the stock. Promoters buying is a good indicator
but not the sole indicator.
The company has two streams of income : 1) license and transaction fee on
its products 2) periodic stake sale in subsidiaries that it has
incubated.
Incubating and stake sale in subsidiaries is a Venture Capital model and
earnings are lumpy. Just as GE Shipping considers profit on sale of ships
as regular income, stake sale in subsidiaries is also regular income for
FT.
When analysing "Other Income" we have to see whether it is regular income or
extraordinary.
FY 08 results included part stake sales in MCX. But, even discounting
that, the previous few years had CAGR of 90 %.
Q-2 FY09 has no stake sales. There is rapid growth in license and
transaction fee income. MCX has increased its market share.
The value of the stake in MCX and other unlisted subsidiaries is listed
at cost in the balance sheet. The market value is much higher.
FY07 EPS was Rs 20. Due to the high profits in FY08, the dividend payout
was Rs 20, equal to the entire EPS of the previous year. The company has
enough free cash to continue paying Rs 20 dividends.
The price of FT is volatile due to the small floating stock.
Friday, October 31, 2008
GNFC
I believe GNFC has competitive advantage which is sustainable.
The EPS growth which I analysed is predictable.
http://www.nseindia.com/marketinfo/companyinfo/eod/announcements.jsp?symbol=GNFC
Main activities are to produce and distribute chemicals, fertilizers, IT solutions, and electronic goods.The Fertilizers Co. of Gujarat Narmada Valley has a Urea plant which is the world's single largest stream plant and also an Ammonia plant which too is one of the largest in the world.
The various fertilizers manufactured by the Gujarat Narmada Valley Fertilizers Co. are:
Urea
Single Super Phosphate
Ammonium Sulphate
Muriate of Potash
Di-ammonium Phosphate
Calcium Ammonium Nitrate
The various chemicals manufactured by the Gujarat Narmada Valley Fertilizers Co. are:
Acetic Acid
Methanol
Formic Acid
Ammonium Nitrate
Calcium Carbonate
Methyl Formate
The advantage of fertilizer company is that
"though the price of fertilizer is 1/5th that of the global market, the goverment compensates the fertilizer companies by providing subsidy for the difference in the actual price and the price paid by the farmers. The farmer community is a major votebank that the political parties will hesitate to loose by displeasing them"
This is a advantage to the fertilizer industry as a whole.
The key issue is to find whether this advantage is durable. Another issue will be that when all the players in the industry gains then which are the companies which is going to benfit from it the most.
Source: http://www.scribd.com/doc/5061434/Indian-Fertilizer-Sector
Further the impact of NPS stage III policy according to ICRA is favourable to few companies like GNFC, NFL, GSFC and DCM Sriram Consolidated Ltd. View 9th page of http://www.icra.in/Files/PDF/ArticleFiles/2007-March-StageIIIUreaPolicy.PDF
Futher GNFC and NFL gain because of
1. full reimbursement of Tax inputs.
Notes:
Few years back the a company resolution was proposed to use 30% of the profits for charitable use. To a shareholder this is like another tax on income and an unfriendly attitude in play. The protection of the moat being a state owned company thus becomes a double edged sword for the shareholder. Though this proposal was defeated, the threat exists.
The lack of sustained leadership at the top management can be seen by the change of leaders. This is like a ship changing its captain during its voyage frequently.
The EPS growth which I analysed is predictable.
http://www.nseindia.com/marketinfo/companyinfo/eod/announcements.jsp?symbol=GNFC
Main activities are to produce and distribute chemicals, fertilizers, IT solutions, and electronic goods.The Fertilizers Co. of Gujarat Narmada Valley has a Urea plant which is the world's single largest stream plant and also an Ammonia plant which too is one of the largest in the world.
The various fertilizers manufactured by the Gujarat Narmada Valley Fertilizers Co. are:
Urea
Single Super Phosphate
Ammonium Sulphate
Muriate of Potash
Di-ammonium Phosphate
Calcium Ammonium Nitrate
The various chemicals manufactured by the Gujarat Narmada Valley Fertilizers Co. are:
Acetic Acid
Methanol
Formic Acid
Ammonium Nitrate
Calcium Carbonate
Methyl Formate
The advantage of fertilizer company is that
"though the price of fertilizer is 1/5th that of the global market, the goverment compensates the fertilizer companies by providing subsidy for the difference in the actual price and the price paid by the farmers. The farmer community is a major votebank that the political parties will hesitate to loose by displeasing them"
This is a advantage to the fertilizer industry as a whole.
The key issue is to find whether this advantage is durable. Another issue will be that when all the players in the industry gains then which are the companies which is going to benfit from it the most.
Source: http://www.scribd.com/doc/5061434/Indian-Fertilizer-Sector
Further the impact of NPS stage III policy according to ICRA is favourable to few companies like GNFC, NFL, GSFC and DCM Sriram Consolidated Ltd. View 9th page of http://www.icra.in/Files/PDF/ArticleFiles/2007-March-StageIIIUreaPolicy.PDF
Futher GNFC and NFL gain because of
1. full reimbursement of Tax inputs.
Notes:
Few years back the a company resolution was proposed to use 30% of the profits for charitable use. To a shareholder this is like another tax on income and an unfriendly attitude in play. The protection of the moat being a state owned company thus becomes a double edged sword for the shareholder. Though this proposal was defeated, the threat exists.
The lack of sustained leadership at the top management can be seen by the change of leaders. This is like a ship changing its captain during its voyage frequently.
Tuesday, October 28, 2008
COLGATE-PALMOLIVE (INDIA) LIMITED
Colgate Palmolive is the leading provider of scientifically proven oral care products at various price points. Products include toothpastes, topotpowder and toothbrushes under the "colgate" brand.
These have become the daily part of oral hygiene and therapeutic oral care in India
Under the "Pamolive" brand it has personal care products like shaving creams, lotions, face creams, baby powder and talcum powder etc.
Colgate brand has competitive advantage which is sustainable.
Inventory turnover is 19.9 for yoy 2008. EPS growth (5 year) rate is above 17 percent for yoy 2008.
Dividend for yoy 2008 is 13 rs for 1 re share.
The working capital for a turnover of 1553 cr is 7.59 cr and the net current asset is -104.68cr. The company is zero debt.
http://www.fourstocks.com/stocks/colpal/company_info/IncomeStat
These have become the daily part of oral hygiene and therapeutic oral care in India
Under the "Pamolive" brand it has personal care products like shaving creams, lotions, face creams, baby powder and talcum powder etc.
Colgate brand has competitive advantage which is sustainable.
Inventory turnover is 19.9 for yoy 2008. EPS growth (5 year) rate is above 17 percent for yoy 2008.
Dividend for yoy 2008 is 13 rs for 1 re share.
The working capital for a turnover of 1553 cr is 7.59 cr and the net current asset is -104.68cr. The company is zero debt.
http://www.fourstocks.com/stocks/colpal/company_info/IncomeStat
Monday, October 27, 2008
Bharat Electronics Limited (BEL)
About
Bharat Electronics Limited (BEL) is the largest defense equipment company in India catering to Defense services electronic requirement. BEL enjoys near monopoly status in supplying high-tech defense products like radars, sonars, communication equipment, electronic warfare equipment to the armed forces. Other division manufacturing civilian products supplies communication equipment to the telecom industry, voting machines etc.
The defence sector contributed to 76% of the revenue and the rest was from the civilian sector.
The company has a government mandated near monopoly for the defence sector business. In addition foreign vendors as a part of localization are required to source from BEL
Competitive analysis
BEL is one of those rare companies which have very substantial competitive advantages. These advantages are government mandated and I find it diffcult to see how these will go away. Across the world there is a preference for domestic companies for defence contracts, more so in india
Bharat Electronics Limited (BEL) is the largest defense equipment company in India catering to Defense services electronic requirement. BEL enjoys near monopoly status in supplying high-tech defense products like radars, sonars, communication equipment, electronic warfare equipment to the armed forces. Other division manufacturing civilian products supplies communication equipment to the telecom industry, voting machines etc.
The defence sector contributed to 76% of the revenue and the rest was from the civilian sector.
The company has a government mandated near monopoly for the defence sector business. In addition foreign vendors as a part of localization are required to source from BEL
Competitive analysis
BEL is one of those rare companies which have very substantial competitive advantages. These advantages are government mandated and I find it diffcult to see how these will go away. Across the world there is a preference for domestic companies for defence contracts, more so in india
Monday, January 14, 2008
Early Investor
Let's compare two friends – Sonia and Peter. Sonia starts saving Rs750 per year from the time she is 15. After 15 years, she stops investing money to her nest egg.
On the other hand, Peter starts investing Rs5,000 per year when he is 30 and continues investing this amount every year till he is 60.
If both earn 15% post-tax return per annum on their investments, who will have more wealth when they retire at age 60?
Sonia. Her Rs750 annual savings between age 15 and 30 will aggregate to Rs27.7 lakhs by age 60, whereas, Peter’s Rs5,000 annual savings between age 30 and 60 will aggregate Rs25 lakhs.
Both will have built up meaningful wealth (compared to their investments). BUT for Sonia to build her wealth, the difference in the annual investment amount and the fewer number of years required for making investments, highlight the importance of starting to invest early.
To summarise, the power of compounding is the single most important reason for you to start investing right now. Remember, every day that your money is invested, is a day that your money is working for you.
On the other hand, Peter starts investing Rs5,000 per year when he is 30 and continues investing this amount every year till he is 60.
If both earn 15% post-tax return per annum on their investments, who will have more wealth when they retire at age 60?
Sonia. Her Rs750 annual savings between age 15 and 30 will aggregate to Rs27.7 lakhs by age 60, whereas, Peter’s Rs5,000 annual savings between age 30 and 60 will aggregate Rs25 lakhs.
Both will have built up meaningful wealth (compared to their investments). BUT for Sonia to build her wealth, the difference in the annual investment amount and the fewer number of years required for making investments, highlight the importance of starting to invest early.
To summarise, the power of compounding is the single most important reason for you to start investing right now. Remember, every day that your money is invested, is a day that your money is working for you.
Saturday, January 12, 2008
Ratios II
PROFITABILITY RATIOS
If you decide to set up a business, the most important thing for you to know is the return you would earn on your investment. Say, you decide to invest Rs 15,000 in a business–Rs 10,000 from your own pocket and Rs 5,000 using borrowed funds. The two figures you should look at to gauge its viability are your profits after meeting all operational expenses (termed return on capital employed) and profits after meeting expenses and paying the interest on the loan (termed return on equity).
If you pay an annual interest of 12 per cent on the loan and your business generates a return on capital employed of 14 per cent, it earns more than the cost of debt–and is therefore a profitable proposition; if it earns less, it’s a losing proposition. Also, if your return on owned funds was less than 12 per cent, it wouldn’t be a sound investment, as you could get at least 12 per cent by lending out your money. Before buying a company’s stock, evaluate its business on these two counts–no point investing in a losing business.
Return on capital employed (RoCE).
The RoCE is a measure of the efficiency with which a company uses its funds. It’s also a useful tool for lenders to gauge a company’s ability to service its debt obligations. Mathematically, the RoCE is the profits generated from operations divided by the capital employed (normally, taken as the average of the past two years so as to smoothen the effect of a mid-year increase or decrease in equity or loans) in the business.
RoCE=Profit before interest, depreciation and taxes÷(equity+reserves+debt)
As a rule of thumb, a company’s RoCE should exceed the interest rate it pays on its borrowed funds. Obviously, the higher a company’s RoCE, the more profitable it is. Having said that, RoCEs vary across sectors. For instance, steel is a more capital-intensive business than FMCG (it requires more funds to support operations), and it is only to be expected that Hindustan Lever will have a higher RoCE than Tisco. Hence, always compare a company’s RoCE with that of its peers. Also look at its RoCE over the preceding three to five years. Look for consistency, especially the ability to maintain profitability during downturns in the sector.
Return on equity (RoE). The RoE is a measure of the returns generated on shareholder funds.
RoE=Net profit÷(equity+reserves)
Companies that generate high returns on shareholder’s equity have the ability to pay their shareholders handsomely and create incremental assets on each rupee invested. The RoE is also an indicator of financial strength–companies with high RoE are more likely to generate incremental cash to fund capital expenses and are better placed to raise debt at fine rates. As in the case of RoCE, to draw meaningful inferences from a company’s RoE, compare it with that of its peers and over time.
OPERATIONAL RATIOS
Next, you need to evaluate a company’s operational efficiencies–how well it manages various aspects of its operations. Here, we focus on three key ratios that shed light on three important areas of a company’s business.
Inventory turnover ratio.
Inventories are the sum total of finished goods, raw materials, stores and spares that a company holds at any point in time to ensure continuity in production and sales. The inventory turnover ratio indicates what proportion of sales are held as inventories.
Inventory turnover ratio=Sales÷Avg inventory
The average inventory is worked out by taking the average of inventories for two consecutive years, which is available in the balance sheet. A more understandable concept is the inventory turnover period–the number of days it takes the company to turn over its inventory.
Inventory turnover period=Number of days in a year (365)÷Inventory turnover ratio
So, if the inventory turnover ratio is 3, the inventory turnover period is 122 days (365/3). This shows the company sold its inventory 3 times in a year and, on an average, it took 122 days to sell that stock.
Broadly speaking, a lower inventory turnover period is positive, as it means faster liquidation of inventory–and therefore, lower working capital requirement. The less money a company has tied up in inventory, the more money it has to spend on other operational activities.
Inventory holdings vary across sectors, and need to be viewed in conjunction with the nature of the business. Hence, while comparing inventory management of two companies in the same sector is fair, inter-sector comparisons are not. Between two companies in a sector, the one turning over its inventories faster is managing its inventories better or is able to sell its products more easily. Also look at a company’s inventory management over a period of time. A pronounced decrease (or increase) in a company’s inventory turnover period would indicate an improvement (or deterioration) in its inventory management.
Debtors turnover ratio.
This ratio indicates how quickly a company is realising payments from customers. If a company is slow to convert receivables into cash, it indicates that the company is resorting increasingly to credit sales or that it is having a problem with recoveries. The company’s liquidity could be impaired and it may need to borrow more funds to meet its working capital needs.
The debtors ratio calculations are similar to the inventory ratio calculations.
· Debtors turnover ratio=Sales÷Average debtors
· Debtors turnover period=Number of days in a year (365)÷Debtors turnover ratio
If the debtors turnover ratio is 4, the debtors turnover period would be 91 days (365/4). This means that, on an average, the company takes 91 days to realise its payments.
Compare a company’s debtors turnover period with other companies in the same sector and over time. This will show which companies are managing their credit better and getting money in faster on their sales. This is a crucial edge to have because money that is not tied up in accounts receivable is money that can be used to grow the business.
Be wary of companies whose debtors turnover period exceeds that of its competitors by a big margin and whose debtors position is showing a rising trend. Such companies are probably overstating current sales by pushing stock to their distributors. This was, in fact, the case with many tractor companies in mid-2001. Around 100,000 tractors were lying unsold with dealers then, which is abnormally high given that around 260,000 tractors are sold annually. In other words, tractor companies had recorded these sales in their books, but there was a question mark over when this money would actually come into the company’s coffers.
Current ratio.
The current ratio shows how much liquidity a company has to meet its trade obligations. This ratio is calculated by dividing the company’s current assets (assets that can be easily converted into cash) by its current liabilities (short-term debts). Both figures are available in the balance sheet.
Current ratio=Current assets÷Current liabilities
As a general rule, a current ratio of 2:1 is considered comfortable, as it provides an adequate margin of safety for the company to meet its operating cash needs. A low current ratio suggests a company might need to raise funds from other sources (raise debt or issue fresh equity) to meet obligations. On the other hand, a high current ratio suggests that a company is hoarding assets instead of using them to grow the business–not the worst thing in the world, but potentially something that could impact long-term returns. Always check a company’s current ratio against that of its competitors. Certain industries have their own norms on current ratios.
VALUATION TOOLS
If you’re convinced a company is on a sound wicket, there’s only one decision left to make: at what price is the stock a good buy? A good company is not always a good investment; it’s a good investment only when its share price offers appreciation potential. These four valuation tools help you find the right price.
Price-to-earnings (PE) ratio. This is the most commonly used–and abused–valuation tool. It shows how many times a company’s earnings are discounted for by the market.
PE ratio=Share price÷Earnings per share
Since the market values companies on their future prospects, not past performance, the historic PE (based on the latest declared EPS) presents an inaccurate picture. Instead, use the forward PE–current market price divided by expected EPS for the coming years–to project the future value of a stock, and decide at what price it merits investment. Say, a company whose stock has traditionally traded in a PE band of 10 to 15 expects its EPS to increase from Rs 10 for the financial year ended March 2002 to Rs 15 in the year ending March 2003. Given the stock’s historic PE band, the stock should trade between Rs 150 and Rs 225 in a year’s time. If the stock is currently at Rs 100, you’re looking at a potential return of 50-125 per cent in a year.
But what PE should a stock get? Two good benchmarks to use are the stock’s historical PE band (the high and low PE it has got over the years) and the PE of its peers. While a stock’s historical PE band is a good benchmark to apply for future valuations, keep an eye out for developments that necessitate a re-rating of the stock–upward (giving it a higher PE) or downward (giving it a lower PE). On the positive side, these could take the nature of increased visibility in earnings for a pharma company from new drug launches, or, more generally speaking, a restructuring that makes the company more focussed and efficient. On the negative side, these could be a perceived decline in business prospects and lower growth.
Discounted cash flows (DCF).
The most comprehensive valuation method, it involves forecasting a company’s future cash flows and discounting them at your desired rate of return from the stock to today’s value.
DCF value=Cash flow Year 1/d+cash flow Year 2/d +...+cash flow Year n+residual value/d
where n=time period; d=(1+r/100)y; r=rate of return desired; y=year
While doing a DCF analysis, be careful about the four assumptions you make:
· Cash flows: Ideally, one should use free cash flows. But since this is a complex calculation, we advise you to use net cash from operating activities generated by the company in the latest year as the base. This figure is available in the cash flow statement in the annual report. Then, you need to make realistic projections of the rate at which you expect the company to grow, and work out the cash flows for the coming years.
· Discount rate: This is the return you desire from the stock. But again, keep it realistic. A 15 per cent annual return from equity is almost twice the risk-free rate of return, and a reasonable benchmark to go with given the risk involved.
· Number of years: Theoretically, you should do a DCF valuation based on the life expectancy of the business or the expected payback period from the business (by when you would like to recover your investment and desired rate of return). If you are unsure on both counts, use an evaluation period of five to 10 years.
· Residual value: Most businesses last for more than just 5 to 10 years (the time period indicated above), and you need to assign a value to the residual life of the business. The simplistic thing to do is to add the company’s present net worth (asset value) to the cash flows in the last year of your calculation.
After running the numbers on an Excel sheet, you’ll get a figure of how much net cash the company’s shareholders will earn from the business during the period under study. From this discounted value, current debt (an outflow) is deducted. The figure derived is divided by the company’s equity to arrive at the fair present value per share of the company. If this DCF price exceeds the current price of the stock, buy; if it’s less, sell.
Price-to-book value (P/BV) ratio.
The P/BV ratio illustrates how adequately or inadequately the share price of a
company reflects the shareholders’ share of assets in the business (total assets minus external liabilities).
P/BV ratio=Share price÷Book value per share
Theoretically, a P/BV of below 1 indicates that the shareholders’ interest in the company is undervalued–if all its assets were to be sold and the proceeds distributed to shareholders proportionately, each shareholder would get back more than the current price of the share. Therefore, there’s a case for the share price to rise.
In reality, though, assets are not easy to sell, more so at book value. A company is said to be an asset play when the difference between its share price and book value is significant and its assets can be sold easily at or above book value. This tool is best used for companies that could be targeted for a takeover or where there is a possibility of liquidation of these assets.
The P/BV ratio is relevant for companies in commodity-based businesses that have significant tangible assets like factories and depots. But don’t apply it to companies in sectors such as FMCG and pharma, which have brands or other intangible assets such as patent rights that are not reflected in their books.
Enterprise value-to-operating profit ratio.
This is another indicator of how attractive a company is to buyers. Unlike the P/BV ratio, which looks at the company purely as an asset play, this places emphasis on the company’s earning potential and how this is valued.
Enterprise value-to-op. profit ratio=(Mkt. cap+debt —liquid assets)÷Operating profit
From the perspective of a buyer, the cost of acquiring a company (the enterprise value, or EV) is the market value of its stock (market capitalisation) plus debt (which he’s likely to take on) minus cash and liquid assets (over which he has control, post-acquisition). This enterprise value now needs to be looked at in relation to the operating profit (or the profit before interest, depreciation and tax, or PBIDT) generated by the company. Depreciation is not accounted for, as it is a book provision. Likewise for interest, which is the cost attributable to borrowed capital (already accounted for in the acquisition cost).
The lower the EV/PBIDT ratio, the more attractive the valuation. So, a company with an enterprise value of Rs 1,000 crore and generating an operating profit of Rs 500 crore (EV/PBIDT of 2) is more attractive than a company available for Rs 1,500 crore and earning an operating profit of Rs 600 crore (EV/EBITDA of 2.5). A comparison with peers on this parameter can direct you towards the undervalued business.
If you decide to set up a business, the most important thing for you to know is the return you would earn on your investment. Say, you decide to invest Rs 15,000 in a business–Rs 10,000 from your own pocket and Rs 5,000 using borrowed funds. The two figures you should look at to gauge its viability are your profits after meeting all operational expenses (termed return on capital employed) and profits after meeting expenses and paying the interest on the loan (termed return on equity).
If you pay an annual interest of 12 per cent on the loan and your business generates a return on capital employed of 14 per cent, it earns more than the cost of debt–and is therefore a profitable proposition; if it earns less, it’s a losing proposition. Also, if your return on owned funds was less than 12 per cent, it wouldn’t be a sound investment, as you could get at least 12 per cent by lending out your money. Before buying a company’s stock, evaluate its business on these two counts–no point investing in a losing business.
Return on capital employed (RoCE).
The RoCE is a measure of the efficiency with which a company uses its funds. It’s also a useful tool for lenders to gauge a company’s ability to service its debt obligations. Mathematically, the RoCE is the profits generated from operations divided by the capital employed (normally, taken as the average of the past two years so as to smoothen the effect of a mid-year increase or decrease in equity or loans) in the business.
RoCE=Profit before interest, depreciation and taxes÷(equity+reserves+debt)
As a rule of thumb, a company’s RoCE should exceed the interest rate it pays on its borrowed funds. Obviously, the higher a company’s RoCE, the more profitable it is. Having said that, RoCEs vary across sectors. For instance, steel is a more capital-intensive business than FMCG (it requires more funds to support operations), and it is only to be expected that Hindustan Lever will have a higher RoCE than Tisco. Hence, always compare a company’s RoCE with that of its peers. Also look at its RoCE over the preceding three to five years. Look for consistency, especially the ability to maintain profitability during downturns in the sector.
Return on equity (RoE). The RoE is a measure of the returns generated on shareholder funds.
RoE=Net profit÷(equity+reserves)
Companies that generate high returns on shareholder’s equity have the ability to pay their shareholders handsomely and create incremental assets on each rupee invested. The RoE is also an indicator of financial strength–companies with high RoE are more likely to generate incremental cash to fund capital expenses and are better placed to raise debt at fine rates. As in the case of RoCE, to draw meaningful inferences from a company’s RoE, compare it with that of its peers and over time.
OPERATIONAL RATIOS
Next, you need to evaluate a company’s operational efficiencies–how well it manages various aspects of its operations. Here, we focus on three key ratios that shed light on three important areas of a company’s business.
Inventory turnover ratio.
Inventories are the sum total of finished goods, raw materials, stores and spares that a company holds at any point in time to ensure continuity in production and sales. The inventory turnover ratio indicates what proportion of sales are held as inventories.
Inventory turnover ratio=Sales÷Avg inventory
The average inventory is worked out by taking the average of inventories for two consecutive years, which is available in the balance sheet. A more understandable concept is the inventory turnover period–the number of days it takes the company to turn over its inventory.
Inventory turnover period=Number of days in a year (365)÷Inventory turnover ratio
So, if the inventory turnover ratio is 3, the inventory turnover period is 122 days (365/3). This shows the company sold its inventory 3 times in a year and, on an average, it took 122 days to sell that stock.
Broadly speaking, a lower inventory turnover period is positive, as it means faster liquidation of inventory–and therefore, lower working capital requirement. The less money a company has tied up in inventory, the more money it has to spend on other operational activities.
Inventory holdings vary across sectors, and need to be viewed in conjunction with the nature of the business. Hence, while comparing inventory management of two companies in the same sector is fair, inter-sector comparisons are not. Between two companies in a sector, the one turning over its inventories faster is managing its inventories better or is able to sell its products more easily. Also look at a company’s inventory management over a period of time. A pronounced decrease (or increase) in a company’s inventory turnover period would indicate an improvement (or deterioration) in its inventory management.
Debtors turnover ratio.
This ratio indicates how quickly a company is realising payments from customers. If a company is slow to convert receivables into cash, it indicates that the company is resorting increasingly to credit sales or that it is having a problem with recoveries. The company’s liquidity could be impaired and it may need to borrow more funds to meet its working capital needs.
The debtors ratio calculations are similar to the inventory ratio calculations.
· Debtors turnover ratio=Sales÷Average debtors
· Debtors turnover period=Number of days in a year (365)÷Debtors turnover ratio
If the debtors turnover ratio is 4, the debtors turnover period would be 91 days (365/4). This means that, on an average, the company takes 91 days to realise its payments.
Compare a company’s debtors turnover period with other companies in the same sector and over time. This will show which companies are managing their credit better and getting money in faster on their sales. This is a crucial edge to have because money that is not tied up in accounts receivable is money that can be used to grow the business.
Be wary of companies whose debtors turnover period exceeds that of its competitors by a big margin and whose debtors position is showing a rising trend. Such companies are probably overstating current sales by pushing stock to their distributors. This was, in fact, the case with many tractor companies in mid-2001. Around 100,000 tractors were lying unsold with dealers then, which is abnormally high given that around 260,000 tractors are sold annually. In other words, tractor companies had recorded these sales in their books, but there was a question mark over when this money would actually come into the company’s coffers.
Current ratio.
The current ratio shows how much liquidity a company has to meet its trade obligations. This ratio is calculated by dividing the company’s current assets (assets that can be easily converted into cash) by its current liabilities (short-term debts). Both figures are available in the balance sheet.
Current ratio=Current assets÷Current liabilities
As a general rule, a current ratio of 2:1 is considered comfortable, as it provides an adequate margin of safety for the company to meet its operating cash needs. A low current ratio suggests a company might need to raise funds from other sources (raise debt or issue fresh equity) to meet obligations. On the other hand, a high current ratio suggests that a company is hoarding assets instead of using them to grow the business–not the worst thing in the world, but potentially something that could impact long-term returns. Always check a company’s current ratio against that of its competitors. Certain industries have their own norms on current ratios.
VALUATION TOOLS
If you’re convinced a company is on a sound wicket, there’s only one decision left to make: at what price is the stock a good buy? A good company is not always a good investment; it’s a good investment only when its share price offers appreciation potential. These four valuation tools help you find the right price.
Price-to-earnings (PE) ratio. This is the most commonly used–and abused–valuation tool. It shows how many times a company’s earnings are discounted for by the market.
PE ratio=Share price÷Earnings per share
Since the market values companies on their future prospects, not past performance, the historic PE (based on the latest declared EPS) presents an inaccurate picture. Instead, use the forward PE–current market price divided by expected EPS for the coming years–to project the future value of a stock, and decide at what price it merits investment. Say, a company whose stock has traditionally traded in a PE band of 10 to 15 expects its EPS to increase from Rs 10 for the financial year ended March 2002 to Rs 15 in the year ending March 2003. Given the stock’s historic PE band, the stock should trade between Rs 150 and Rs 225 in a year’s time. If the stock is currently at Rs 100, you’re looking at a potential return of 50-125 per cent in a year.
But what PE should a stock get? Two good benchmarks to use are the stock’s historical PE band (the high and low PE it has got over the years) and the PE of its peers. While a stock’s historical PE band is a good benchmark to apply for future valuations, keep an eye out for developments that necessitate a re-rating of the stock–upward (giving it a higher PE) or downward (giving it a lower PE). On the positive side, these could take the nature of increased visibility in earnings for a pharma company from new drug launches, or, more generally speaking, a restructuring that makes the company more focussed and efficient. On the negative side, these could be a perceived decline in business prospects and lower growth.
Discounted cash flows (DCF).
The most comprehensive valuation method, it involves forecasting a company’s future cash flows and discounting them at your desired rate of return from the stock to today’s value.
DCF value=Cash flow Year 1/d+cash flow Year 2/d +...+cash flow Year n+residual value/d
where n=time period; d=(1+r/100)y; r=rate of return desired; y=year
While doing a DCF analysis, be careful about the four assumptions you make:
· Cash flows: Ideally, one should use free cash flows. But since this is a complex calculation, we advise you to use net cash from operating activities generated by the company in the latest year as the base. This figure is available in the cash flow statement in the annual report. Then, you need to make realistic projections of the rate at which you expect the company to grow, and work out the cash flows for the coming years.
· Discount rate: This is the return you desire from the stock. But again, keep it realistic. A 15 per cent annual return from equity is almost twice the risk-free rate of return, and a reasonable benchmark to go with given the risk involved.
· Number of years: Theoretically, you should do a DCF valuation based on the life expectancy of the business or the expected payback period from the business (by when you would like to recover your investment and desired rate of return). If you are unsure on both counts, use an evaluation period of five to 10 years.
· Residual value: Most businesses last for more than just 5 to 10 years (the time period indicated above), and you need to assign a value to the residual life of the business. The simplistic thing to do is to add the company’s present net worth (asset value) to the cash flows in the last year of your calculation.
After running the numbers on an Excel sheet, you’ll get a figure of how much net cash the company’s shareholders will earn from the business during the period under study. From this discounted value, current debt (an outflow) is deducted. The figure derived is divided by the company’s equity to arrive at the fair present value per share of the company. If this DCF price exceeds the current price of the stock, buy; if it’s less, sell.
Price-to-book value (P/BV) ratio.
The P/BV ratio illustrates how adequately or inadequately the share price of a
company reflects the shareholders’ share of assets in the business (total assets minus external liabilities).
P/BV ratio=Share price÷Book value per share
Theoretically, a P/BV of below 1 indicates that the shareholders’ interest in the company is undervalued–if all its assets were to be sold and the proceeds distributed to shareholders proportionately, each shareholder would get back more than the current price of the share. Therefore, there’s a case for the share price to rise.
In reality, though, assets are not easy to sell, more so at book value. A company is said to be an asset play when the difference between its share price and book value is significant and its assets can be sold easily at or above book value. This tool is best used for companies that could be targeted for a takeover or where there is a possibility of liquidation of these assets.
The P/BV ratio is relevant for companies in commodity-based businesses that have significant tangible assets like factories and depots. But don’t apply it to companies in sectors such as FMCG and pharma, which have brands or other intangible assets such as patent rights that are not reflected in their books.
Enterprise value-to-operating profit ratio.
This is another indicator of how attractive a company is to buyers. Unlike the P/BV ratio, which looks at the company purely as an asset play, this places emphasis on the company’s earning potential and how this is valued.
Enterprise value-to-op. profit ratio=(Mkt. cap+debt —liquid assets)÷Operating profit
From the perspective of a buyer, the cost of acquiring a company (the enterprise value, or EV) is the market value of its stock (market capitalisation) plus debt (which he’s likely to take on) minus cash and liquid assets (over which he has control, post-acquisition). This enterprise value now needs to be looked at in relation to the operating profit (or the profit before interest, depreciation and tax, or PBIDT) generated by the company. Depreciation is not accounted for, as it is a book provision. Likewise for interest, which is the cost attributable to borrowed capital (already accounted for in the acquisition cost).
The lower the EV/PBIDT ratio, the more attractive the valuation. So, a company with an enterprise value of Rs 1,000 crore and generating an operating profit of Rs 500 crore (EV/PBIDT of 2) is more attractive than a company available for Rs 1,500 crore and earning an operating profit of Rs 600 crore (EV/EBITDA of 2.5). A comparison with peers on this parameter can direct you towards the undervalued business.
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