Wednesday, September 19, 2007

How buffet does it – by James Pardoe

a brief summary


o Ben graham says you don’t have to do extraordinary things to do get extraordinary results. Keep it simple.

o Give the kid a hammer n everything starts looking like a nail.

o Don’t own a stock that would cause you to panic and dump your shares if the price falls by 50%

o Think 10 yrs rather than 10 minutes, if you cant hold the stock for a decade, don’t buy it in the first place

o Investing is where you find a few great companies and sit on your ass

o Don’t be contrarian for the sake of it

o Better to hit singles n doubles regularly than to strike out swinging for the fences

o Make a list of your top companies n the max prices u will be willing to pay for them. Wait on the sidelines for opportunities

o Shun the ticker. Turn off the noise. Study the playing field n not the scoreboard. Ben graham says, “in the short run, mkt is a voting machine, but in the long run it is a weighting machine”

o Don’t swing at every pitch

o Mistakes of commission are worse than mistakes of omission
a) Omission – missing a multibagger – discipline in action
b) Commission – investing in losers – reflects breakdown of discipline

o Don’t get distracted by macro issues, focus on what you know ie the workings of the business

o Stay within ur circle of competence

o Volatility – Mr market’s dramatic mood swings creates opportunities .. look for those with significant margin of safety

o Be greedy when others r fearful; be fearful when others r greedy

o Read a lot

What to look for
o If you don’t understand a business don’t buy it

o Differentiate between a volatile stock and volatile business

o Mkt caps r a measure of co’s clout n borrowing power but cash in the door qtr after qtr matters more

o Look for companies with favourable long term prospects run by honest n competent mgt

o Look for a business that has been doing the same thing that it was doing a decade ago. Why
a) It had plenty of time to figure out how to get things right
b) Co. has likely found a niche

o Look for economic franchises – cos which provide products
a) Needed or desired
b) Not overly capital intensive
c) Seen by its customers to have no close substitutes
d) No price regulation

o Look for companies with moats – sustainable competitive advantages

o Look for absence of change..old economy ..boring n mundane businesses

o Concentrate – too much of a good thing is wonderful

o If you are on the right flower, stay there. Avoid the temptations of hyperactivity

o Evaluate the mgt
a) Frugal or spendthrift
b) Repurchases shares/ avoids dilution
c) Candid annual report
d) If the mgt claims to know the future, earnings projections n growth expectations – bad sign.If they hit the targets repeatedly – something is being manipulated

Saturday, September 01, 2007

DCF/Relative Valuation

Consistencies in DCF
• If we use real cash flows for forecasting (ie don’t build in inflation) we should use a real discount rate and not a nominal rate.
• If there is some source of other income like cash or marketable securities
a) Either build the annual income every year in your cash flow forecasts
b) Or deduct the total source of income after calculating enterprise value …logic being to acquire a company you need to pay EV but you also get the company’s cash which can be used to reduce your acquisition costs. Second method is preferable as it doesn’t involve forecasting such cash flows every year

Assumptions of Valuation methods
o DCF assumes mkt price may deviate from intrinsic value in short term but will get corrected over the long term
o Relative valuation assumes while individual companies might be mispriced the sector or the mkt as a whole is priced properly

Can a Firm be Undervalued and Over valued at the same time
If DCF shows a firm is overvalued however relative valuation suggests it is undervalued – the whole sector in fact might be overvalued and vice-versa. Eg. In March 2000, Amazon’s DCF value was $30, it traded at 70$ (overvalued), however still appeared cheaper on a relative basis compared to other internet companies.

• Damodaran on Valuation – Second Edition
• Job interviews :)

Saturday, August 18, 2007

Changing the incentive structure - KKR philosophy

KKR doesn’t like to have trouble sleeping at nights. They make sure that by making the mgt invest heavily in the business, so that the mgt has trouble sleeping in the night.

Something to ponder – ROE, ROCE

Through leverage the company takes on debt and can raise its ROE above its ROCE as long as ROCE is higher than the net cost of debt.

Wednesday, July 25, 2007

what is cheaper debt or equity

Please point out flaw in the argument below

Was discussing cost of equity vs cost of debt with a friend of mine with regards to BEML as to why it went for raising high cost equity when it can raise low cost debt considering it has negligible debt on its balancesheet

He raised an interesting point…(although the explanation is simplistic and has obvious flaws, I still think we can refresh our concepts)

Which was that practically cost of equity is nothing in today’s mkts
  • you raise money at premiums of > Rs 1000 (price band of Rs.1020 - Rs.1090 per equity share)
  • and what do you pay as a dividend is a measely 10 Rs dividend (optimistic scenario 100% div on Face value of 10 Rs which it has been paying for the past 2 yrs )
  • what about the other component of return ie capital appreciation … there is no outgo involved for firm
  • so cost for firm -> 10/1020 = ~1%
Consider debt:- you raise money@8 -9 %
  • so cost for firm is 8% (1-tax) = 5.6%

    so which is cheaper equity or debt ???
Equity Dividend 38.29 CR
Equity Dividend (%) 100.00
No of shares in issue – 3.68 cr (PRE FPO issue)

some replies recieved
view 1

If stock is over valued, equity is cheaperThe older shareholders benefit at the expense of the new onesIf the valuation is under valued, that means that the debt servicing capability of the business is much higher in relation to market accorded valuation, in that scenario debt is cheaper

view 2
Though i agree with the logical sense of the argument below, the key to all of this is which is more beneficial to the exisitng investor - that a company raises low cost debt or high cost equity. Eventually, the burden of the higher cost equity will reflect on RoEs and future growth rates of the company. A typical example of this is Gateway Ditriparks which underwent a huge equity raising exercise 2 years back and has been a laggard in the last 1 year

view 3
This is not wrong but ignores the fundamental fact that optimum dilution should be done at a time when company is close to have its valuations move upwards sharply, more so in case of project based company. Till such time, funding needs be better met by debt.