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COUNT ON THE
Times have changed since Benjamin Graham wrote the Security Analysis but
his principles can hold investors in good stead even now
N Mahalakshmi & Mohammed Ekramul Haque
I
t cannot be denied that the Great safety’, allowing for any contraction in grabbed the attention of several pro-
Depression of 1929 and the Wall prices, were his key bets. fessional investors, many of who have
Street crash that followed was per- His strategy soon started being talk- added their own perspectives over the
haps the most humbling experi- ed about in the investing community. following decades. Nevertheless, the
ence for investors at the time. Life was One man, in particular, was highly in- basic essence of value investing has
tough and there was no hope to clutch fluenced by Graham’s strategy, and remained the same: buy cheap.
on to. After crushing losses, most in tribute to his ‘idol’, bought shares It was a philosophy that was born
stocks were available at ridiculously in about a hundred such cheap com- in desperate times (the Depression
cheap prices over the next decade as panies. His faith soon paid off: in five years), and underwent a baptism by
the markets remained trapped in a years, John Templeton – whose name fire as it was tested time and again over
bear grip. today is synonymous with value the next few years.
But as any stock expert will tell you investing – had multiplied his So it wouldn’t be wrong to wonder
today, behind every market disaster original investment several times, just a little bit whether those princi-
lurks opportunity – if you just look despite around 15 of those companies ples still work in today’s times, given
hard enough. It was the same for Ben- going bankrupt. that the past few years have been ex-
jamin Graham, who, despite suffering The value investing philosophy pro- ceptionally exuberant for the world’s
heavy financial losses himself, began pounded by Graham and practised major stock markets.
a conscious campaign of snapping up vigorously by Sir John Templeton was Cut to January 2008. In sharp con-
stocks that suddenly became available eventually perfected into an investing trast to the crisis engulfing the stock
at bargain prices. technique that called on investors to markets when Graham started out, the
Graham’ strategy was simple: buy buy stocks cheap – so cheap that there world’s economies – India’s included
companies that he likened to cigar was very little chance of the stock fall- – were exuding confidence like never
butts – typically abandoned but still ing any further (thus avoiding any loss before. Many experts claimed that In-
good for a puff or two. And you could of capital). dian financial markets were experi-
pick them up for virtually nothing. After Graham articulated his encing a secular bull run, not a cyclical
Stocks quoting below their liquida- thoughts on the subject in the book Se- upswing that would die down anytime
tion values after keeping a ‘margin of curity Analysis in 1934, value investing soon.
41
13 June 2008 Outlook PROFIT
Cover Story
as bits of bad news kept leaking out
HOW WE DID THE BACK-TESTING at a steady pace. Investors who had
The universe bought stocks at steep valuations now
began to understand just how foolish
Earnings yield portfolio: A portfolio of 30 stocks with the highest earnings yields, the
their actions were, not to mention the
minimum cut-off being double the bond rate for the respective year, from the BSE- speculators who had joined in for the
500 universe, excluding financials, with a debt-equity of less than 1. For years that free ride.
threw up less that 30 stocks, we went with the available stocks. Value investors had seen this coming
all along. At a lecture in India on Janu-
Net-nets & cash bargains: All listed companies with a trading history of more than 90
ary 8, Bruce Greenwald, renowned fi-
per cent excluding financials was taken as the universe. We calculated net-nets by nance professor at Columbia Business
deducting debt and current liabilities from current assets. The 30 or available stocks School, referred to stocks markets as
for the respective years with market-cap less than net currents were considered ‘being expensive’. At the time, stocks
were actually peaking out. Greenwald
for the portfolio each year. Companies with cash and marketable securities less teaches the ‘Graham and Dodd’ style
all external liabilities greater than the market-cap constituted the cash bargain of investing in the university Graham
portfolio for the respective years. graduated from.
Dogs of the Nifty: Top 10 stocks based on dividend yield at the end of every year. Value investing is not about predict-
ing when markets will hit their peaks.
The returns Graham (and today’s value investors
We computed total returns (price appreciation plus dividend income) for the agree) emphasised the preservation
portfolio constituted every year and with a holding period of 1-10 years for the of capital as the bedrock of investing.
period 1998-2008. For dogs of the Nifty we tested results only for a two-year holding “The beauty is, as Graham said, any-
thing bought cheap will invariably go
period. In the case of a stock getting delisted or stopped trading, we considered the up in price,” says Chetan Parikh, a
stock to have lost 100 per cent in the year in which the stock disappeared from the successful Indian value investor and
portfolio. All data has been sourced from CMIE Prowess. managing director of Mumbai-based
Jeetay Investments.
There is one difference though.
Besides, stock prices were catapult- covering almost immediately after What Graham considered bargains
ing and there was what seemed like a every tumble. and what today’s value investors con-
never-ending flood of foreign money And investors continued to buy into sider as cheap (and we are not talking
pouring in. For five straight years till stocks, whatever the price. about growth-style investors who do
January this year, the Sensex proved Then, the inevitable happened. Glob- not mind paying a high premium for
the sceptics wrong at every level as it al markets nosedived and over the stellar growth prospects) are separated
rapidly scaled new all-time highs, re- next few months, continued to plunge by time.
CASH BARGAINS PORTFOLIO
Portfolio consists of stocks with cash and marketable securities greater than market cap
year 1 yr 2 yr 3 yr 4 yr 5 yr 6 yr 7 yr 8 yr 9 yr 10 yr Latest
Portfolio 1998 56.30 13.47 -45.88 -22.24 -12.96 2.03 5.98 15.41 10.65 8.68 8.42
Sensex 1998 -17.00 7.82 -4.23 -4.46 -5.88 5.91 6.32 14.75 14.80 15.74 14.78
Portfolio 1999 196.20 -25.04 -15.97 -14.89 4.01 24.82 25.87 21.03 25.39 26.24
Sensex 1999 40.05 2.87 0.12 -2.87 11.20 10.80 20.18 19.55 20.10 18.92
Portfolio 2000 -45.69 -37.70 -3.11 6.55 19.24 19.65 18.05 29.14 28.81
Sensex 2000 -24.44 -15.34 -14.03 4.97 5.73 17.15 16.87 17.81 16.56
Portfolio 2001 -13.43 -3.30 31.75 53.64 66.82 63.88 74.19 77.32
Sensex 2001 -5.14 -8.29 17.13 15.00 27.90 25.69 25.53 23.83
Portfolio 2002 -2.98 39.67 73.51 86.98 76.96 84.35 84.91
Sensex 2002 -11.33 30.16 22.62 37.82 32.96 31.53 29.30
Portfolio 2003 66.00 109.10 105.99 69.22 55.70% 57.67
Sensex 2003 91.06 44.20 59.64 47.14 42.33 39.09
Portfolio 2004 169.39 120.53 92.65 49.22 51.58
Sensex 2004 8.83 45.93 34.87 32.23 28.88
Portfolio 2005 76.22 40.86 61.42 66.43
Sensex 2005 95.67 50.13 41.10 35.96
Portfolio 2006 58.50 28.62 56.86
Sensex 2006 15.19 19.81 14.92
Portfolio 2007 53.67 37.15
Sensex 2007 18.82 18.82
Returns for 2007 portfolio until May 27, 2008
42
Outlook PROFIT 13 June 2008
The world has changed in many
ways. And the way business is done
has changed appreciably. In the past
century, while industrialisation was
still underway, manufacturing was the
mainstay of business and companies
were largely asset-heavy.
Today’s businesses are more ser-
vice-led and asset-light. Even the
landscapes for accounting practices,
securities regulations and sharehold-
ing patterns are dramatically differ-
ent. Graham’s success was also in part
because he had the luxury of buying
businesses that were truly ‘cigar butts’
because of the state of the economy at
the time.
Is Graham’s philosophy still stay rel-
evant in the changed times, (one of
optimism, although recent data does
point to a slowdown) compared with
the gloom that the Father of Financial
Analysis was witness to? Outlook Prof-
it sought answers for this by relying
two factors: data, because data does
not lie; and people who have been un-
adulterated value investors.
Before we disclose the results
(please wait patiently – being patient
is the first rule in value investing!), we
present a quick look at Graham’s
various strategies.
THE PHILOSOPHY
Graham’s investment radar mainly
flashed stocks that could be classified
as bargains based on earnings poten-
tial or asset values.
The key earnings-based strategy that
most lay investors can easily adopt in-
volves buying stocks that offer a sub-
stantial earnings yield, typically, twice
the prevailing bond rate.
The earnings yield is the reverse of
the price-earnings multiple. The logic
is simple: if you view stocks as bonds Sanjay Bakshi , CEO,
that offer no growth but yield fixed re- Tactica Capital is a deep-value investor
turns (consider profits as a proxy for in-
terest earned) then the asset should be
valued like a bond. If the earnings yield
is twice the bond yield, it means that stantial discount to the company’s as-
the asset actually promises to double set value (for businesses that boast
the returns you could get from hold- good future prospects).
ing the bond. Given that the business Another set of bargains includes
is profitable and will continue to be stocks of companies quoting below
so, returns could be impressive as the the value of marketable securities
yield in excess of the bond rate would and cash on their books after deduct-
provide an adequate margin of safe- ing outstanding debt. The logic here is
ty in the event of any capital erosion. that the company can use its cash and
Another earnings-based strategy is be securities to pay of its debt and other
to buy stocks that offer substantial liabilities and still the shareholders
dividend yield. would have something in their hand.
Asset-based strategies of Graham At the heart of Graham’s philosophy
revolve around buying stocks that lies the ability to favour what is out of
are quoting either below their liquida- favour. Embrace the ugly, not the beau-
tion value (especially for businesses tiful. Lift the disgraced and disregard-
that do not have a future) or at a sub- ed. And it works!
43
PHOTOS: SANJIT KUNDU
Cover Story
ing the market temperature works
beautifully as well. The proof of the
pudding is in our study of stocks that
were ultra-cheap in the past decade.
Out of the 5,000-odd traded stocks at
the peak of the IT bull run in 1999, 22
stocks were trading below their liq-
uidation values (current assets mi-
nus current liabilities and debt). By
contrast, when the markets plunged
to their nadir in 2003, 132 stocks met
these criteria.
Nevertheless, some of the most suc-
cessful value investors in the coun-
try believe that some changes to
Graham’s strategies may be required
to make it more effective (although
given that the back testing showed
such good results, we wonder why?)
MISSING OUT ON GROWTH?
Focusing on the cheap stocks often
means missing out on other opportuni-
ties. Why? Because the market is usu-
ally instantly enamoured by anything
new that turns up in business until
they find reason to think otherwise
Remember the dot-com boom? Com-
panies were awarded sky-high valu-
ations before it dawned on investors
that many business models were sim-
ply unsustainable.
However, the notion that you
could be left behind if you don’t pay
the price for growth is not entirely
baseless. “If you buy stocks based
strictly on traditional value invest-
ment principles, you will only play the
arbitrage opportunity (the differential
between the fair price and the market
price) but the bigger opportunity in a
country like ours lies in the future as
the business grows,” says K N Siva
Subramanian, vice president at Frank-
lin Templeton Mutual Fund. He’s con-
sidered one of the best fund managers
Chetan Parikh, of the past decade or so.
MD, Jeetay Investments has been a For sure, adopting a Graham approach
committed value investor would have encouraged investors to
pass over new, emerging businesses
that have given outstanding returns
on the bourses: Infosys Technologies,
8 Back-testing key Graham strate- HDFC Bank, Pantaloon Retail; and Su-
gies reveal a stunning performance. zlon Energy to name just a few. None
The strategy of picking up stocks of these stocks would have qualified as
that have earnings yields that value stocks in the Graham sense ever.
are twice as high as the bond But you would have built an equally
yield proved to be spot-on stellar portfolio of stocks consisting of
for investors. Returns on Bharti Televentures and State Bank
such a portfolio beat the of India (at one time available signifi-
Sensex every time! Cash cantly below book value); public-sec-
bargains and net-nets have tor companies such as Bharat Earth
worked with 70 per cent Movers and BHEL and private-sector
accuracy. (See table: Cash companies such as Areva T&D, Penin-
Bargains Portfolio) sular land, Gujarat NRE Coke, Merca-
tor Lines, Aban Offshore and even Jai
8 Graham’s way of gaug- Corp. All of them have rewarded inves-
44
Outlook PROFIT 13 June 2008
tors with handsome dividends and cap- an investment firm called Tactica would have liked.”
ital appreciation. Capital, which specialises in deep- If wishes were horses, that would have
Most of these names were ignored a value-investing . been true! In today’s circumstances, it
few years ago either because business Other experts echo the sentiment. is not easy to find stock that offer great
conditions were bad or the market sim- Managing director of Motilal Oswal Se- growth prospects with the margin of
ply shrugged them off because there curities Ramdeo Agarwal safety embedded the
were alternative opportunities that says an attractive purchase way Graham liked it.
were more alluring. price is key to making mon- Graham’ strategy Most experts, however,
“The market periodically gets into a ey. “The moment you pay was simple: believe trying to com-
phase of madness when there is a fas- a price for growth, where bine a growth style and
cination for a few sectors and the oth- is the outperformance?”
buy companies the rather contrarian
ers are completely forgotten,” says E A he asks. “You are not deal- that he likened value-style technique
Sundaram, a fomer fund manager with ing only with the company to cigar butts don’t mix very well.
HDFC Mutual Fund who now manages here, you are dealing with – typically Still, the perception
funds for the Bilakhias. And it’s true: the price of the stock. Peo- of value lies in the eyes
during the dot-com boom, remember ple do not understand what abandoned but of the investor. “The
how the old economy was forgotten? A role the price plays.” still good for biggest contribution of
year ago, software service companies The sceptics argue the a puff or two. Graham to the world
had joined the ranks of fallen angels. A other side. “The Gra- And you could of finance was three
true Graham follower would, however, ham model is geared to words – margin of safe-
buy stocks precisely when there are no finding cheap cigar butts, pick them up ty – and if you keep that
takers for them. but many such compa- for virtually in mind while invest-
And what about growth? Graham nies may have issues with nothing. Stocks ing you will seldom go
never believed in relying on the future, their character itself,” quoting below awfully wrong,” says
so he would not pay a penny for growth. says Bharat Shah of ASK fund manager Sunda-
The difference between Graham fol- Raymond James who their liquidation ram.
lowers and the growth seekers is pri- started out as a value inves- values after
marily that the former are risk averse tor but later changed track. keeping a THE CHALLENGES
(you can even call them miserly) and “Cheapness can be an il-
don’t seek to pay a price for growth. lusion. Just being cheap is
Nevertheless,
‘margin of safety’ strategies that some were
“Value investors want growth not good enough for me, it largely a product of
for free,” says Sanjay Bakshi, profes- has to be supported by cap- circumstances that
sor at Gurgaon’s Management Devel- ital efficiency and confidence about prevailed during Graham’s time are
opment Institute. “And by doing so, growth. While I like the cheapness that becoming less effective and riskier
they could well make errors of omission Graham would have liked, I would also propositions. It’s easy to see the con-
but not of commission.” He also runs like quality of business that Fisher tentions.
EARNINGS YIELD PORTFOLIO
Portfolios with earnings yield more than double the bond rate with a maximum of 30 stocks
year 1 yr 2 yr 3 yr 4 yr 5 yr 6 yr 7 yr 8 yr 9 yr 10 yr Latest
Portfolio 1998 80.16 87.27 14.34 19.78 9.57 27.44 36.53 48.24 42.40 42.47 43.82
Sensex 1998 -17.00 7.82 -4.23 -4.46 -5.88 5.91 6.32 14.75 14.80 15.74 14.78
Portfolio 1999 45.50 43.48 35.46 28.85 55.97 69.76 74.15 65.24 64.93 67.84
Sensex 1999 40.05 2.87 0.12 -2.87 11.20 10.80 20.18 19.55 20.10 18.92
Portfolio 2000 39.06 49.09 36.37 70.69 82.05 91.31 79.16 75.19 78.79
Sensex 2000 -24.44 -15.34 -14.03 4.97 5.73 17.15 16.87 17.81 16.56
Portfolio 2001 88.92 46.61 89.10 109.55 112.85 95.99 95.21 100.3
Sensex 2001 -5.14 -8.29 17.13 15.00 27.90 25.69 25.53 23.83
Portfolio 2002 27.32 105.81 141.89 139.39 110.76 105.14 109.9
Sensex 2002 -11.33 30.16 22.62 37.82 32.96 31.53 29.30
Portfolio 2003 268.56 217.40 173.73 127.78 112.65 118.7
Sensex 2003 91.06 44.20 59.64 47.14 42.33 39.09
Portfolio 2004 289.12 220.77 134.53 118.07 125.5
Sensex 2004 8.83 45.93 34.87 32.23 28.88
Portfolio 2005 434.52 172.21 110.90 110.9
Sensex 2005 95.67 50.13 41.10 35.96
Portfolio 2006 119.92 79.41 95.68
Sensex 2006 15.19 19.81 14.92
Portfolio 2007 33.56 33.56
Sensex 2007 14.69 14.69
CAGR Returns Note: 2007 based on latest sensex closing May 26, 2008
45
13 June 2008 Outlook PROFIT
Cover Story
8 The concept of book value and in and out of the company gate ev- tions. Indeed, some of the best-run
whether it reflects the true worth ery day; they’re not mentioned in the companies in the world have a neg-
of a company have undergone fun- balance-sheet though. ative working capital -- consumer
damental changes over time. Book Similarly, the real value of consum- companies like Hindustan Unilever,
value was one of the prime pa- er companies lies in their brands Procter & Gamble and several oth-
rameters Graham relied on since and distribution network, again not ers actually have been operated with
he preferred judging what was on quantified in the statement of ac- negative working capital for quite
the balance-sheet to looking at un- counts. “The balance-sheet does some time now.
quantifiable parameters. In his time, not capture the value of intangibles
companies were asset-heavy and it like brands, but they also have cash 8 Some Graham strategies like cash
made sense to look at asset values. flows attached to them,” points out bargains work well in mature mar-
Not anymore. Today, the real value Sundaram. kets like the US because the share-
of several business lies not in the holding pattern is diffused, so a
plant and machinery they own, but 8 Similarly, Graham’s idea of looking financial investor could identify situ-
in more unquantifiable factors. Take at net working capital requires re- ations and act in a fashion that com-
software services, for instance. In thinking as well. The whole idea of pels management to unlock value.
this industry, the real assets are the net-nets was to buy a company be- But in India, since promoters usual-
technically skilled people who walk low its working capital because if the ly hold fairly large stakes and corpo-
market did not give the company the rate raids are not that common, the
valuation it deserved, the promoter probability of liquidation is rather
NET NET DROPOUTS could easily liquidate the company slim and dilutes the case for unlock-
Companies that disappeared from the by realising the receivables and cash, ing value in such stocks.
net-nets portfolio midway pay off payables and debt – and still Besides, another risk with Graham’s
year 1 2 3 4 5 6 7 8 9 10 take home some cash (by the way, cheap stocks is that while you can
we’re not even accounting for fixed buy a business at a lower price than
1998 1 3 1 1 1 assets here). Obviously, Graham was what it’s worth, you can never tell
1999 1 3 looking at what was truly dirt cheap whether it will add or subtract value.
2000 2 3 (cigar butts). Templeton’s Subramanian quotes a
2001 2 1 He would have rejected companies classic example: when Warren Buf-
with low net current assets outright. fet bought Berkshire Hathaway, it
2002 1
But, in today’s world, high working was still a textiles company. And in-
2003 4 1 capital is taken as a sign of a deterio- stead of continuing like that, Buffett
2004 1 rating competitive position. Higher used the cash to build a business that
2005 1 receivables being built up; large dis- offered growth.
2006 counts to customers; larger collec- While buying cash bargains may a
tion periods – all these are actually rewarding proposition for an activ-
2007 signs of worsening business condi- ist investor who can take the reins
GRAHAM’S NET NETS PORTFOLIO
Portfolio of top 30 stocks trading below their net current asset values
Year 1 yr 2 yr 3 yr 4 yr 5 yr 6 yr 7 yr 8 yr 9 yr 10 yr Latest
Portfolio 1998 43.46 89.16 4.77 12.22 7.40 15.22 24.51 28.30 24.41 22.24 23.64
Sensex 1998 -17.00 7.82 -4.23 -4.46 -5.88 5.91 6.32 14.75 14.80 15.74 14.78
Portfolio 1999 220.43 -1.32 10.57 5.55 20.07 28.07 38.66 31.08 27.44 28.29
Sensex 1999 40.05 2.87 0.12 -2.87 11.20 10.80 20.18 19.55 20.10 18.92
Portfolio 2000 -30.22 -17.11 0.05 28.42 39.62 51.37 49.52 49.91 52.94
Sensex 2000 -24.44 -15.34 -14.03 4.97 5.73 17.15 16.87 17.81 16.56
Portfolio 2001 29.67 17.11 56.62 70.75 88.79 67.24 57.87 58.26
Sensex 2001 -5.14 -8.29 17.13 15.00 27.90 25.69 25.53 23.83
Portfolio 2002 1.86 44.03 70.12 85.30 70.52 72.13 74.76
Sensex 2002 -11.33 30.16 22.62 37.82 32.96 31.53 29.30
Portfolio 2003 91.19 102.59 84.42 66.92 68.32 68.78
Sensex 2003 91.06 44.20 59.64 47.14 42.33 39.09
Portfolio 2004 151.46 136.97 93.67 85.38 89.21
Sensex 2004 8.83 45.93 34.87 32.23 28.88
Portfolio 2005 54.25 67.26 81.85 93.37
Sensex 2005 95.67 50.13 41.10 35.96
Portfolio 2006 16.94 18.28 28.83
Sensex 2006 15.19 19.81 14.92
Portfolio 2007 31.938 34.809
Sensex 2007 18.82 14.69
8
46
Outlook PROFIT 13 June 2008
of management and steer course
differently, it may not be the same
for regular stock investors who
may not be in any position to
influence managements.
An Indian example comes from the
mid-cap segment of pharmaceutical
stocks. Take the Indian subsidiary
of Merck. Despite the fact that it has
the equivalent of 30-40 per cent of
its market capitalisation in cash, the
stock price has shrivelled.
In hindsight, it’s easy to figure out
why the stock has underperformed:
revenues haven’t grown as much
and the balance-sheet has shrunk.
So even as the company continues
to add to its cash pile every year,
the stock remains trapped in
the doldrums.
8 Again, finding the right margin of
safety itself is a difficult proposi-
tion for strategies like cash bargains.
Since these could involve long wait-
ing periods, unless there is a trigger
in sight, the opportunity cost of cap-
ital; the potential casualties in the
portfolio (because Graham believed
in diversification with less due dili-
gence as opposed to the strategy of
concentration with utmost due dili-
gence that Buffett follows); and the
fact that Graham never looked be-
yond fair-value situ-
ations (not letting
‘profits run’); the mar- “Value
gin of safety’s has to investors are
be considerably high.
Finding such stocks
balance-sheet
in current circum- analysts and
stances poses a seri- regular market
ous challenge. analysts are
8 While Graham’s strat- P&L analysts. “
egy is great in terms
of capital protection,
it focuses only on the arbitrage val-
ue between the margin of safety Ramdeo Agarwal,
and the fair value of the stock (in MD, Motilal Oswal Securities believes
fact, Graham would invariably sell in getting the purchase price right
the stock even before the fair value
was achieved). By doing so, some
present-day value investors say, you
would lose out on the bigger value ham framework to work is a purely
that is usually built into the growth capitalistic society with little con-
of the company. Templeton’s Sub- trols. But some companies that are
ramanian says that it makes a lot of going cheap in the Indian markets
sense to look at metrics such as divi- today namely those in the oil, fer-
dend yields because growth oppor- tilisers and sugar business are
tunities in some segments may have those that have been hit because
exhausted but the situation may be of government controls. These
entirely different for India, where stocks look cheap, but it’s unlike-
growth in those segments may be ly the situation will correct itself
just picking up. unless the government steps in.
8 The ideal environment for the Gra- 8 Again, one of the gripes against
47
Cover Story
always cheap – and they deserve to
be so – there are others that deserve
superior valuations. A classic exam-
ple, says Subramanian, is Infosys
Technologies. “Earlier on we made
this mistake of trading Infosys for
cheaper software companies. Only
later did we realise that in some
companies, the premium was be-
cause of the difference the manage-
ment can make. It is not captured in
current earnings but it can make a
difference in the long haul.”
PICKING WINNERS
Finding the catalyst: Buying cheap is
a great idea but the biggest challenge
in Graham-style investing is figuring
out the trigger that will unlock value
in the stock. While a margin of safety
is important, it is essential to look at
the probability of getting that trans-
lated into returns. “Sometimes, the
catalysts could be growth itself,” says
professor Bakshi. If the stock trades
at a multiple of four times or so, and
earnings are still growing, your total
returns could be very attractive since
you can pocket a dividend yield, a price
appreciation equal to the earnings
growth and see a potential re-rating of
the stock as well. In addition, a poten-
tial buy-back by a proactive manage-
ment, special dividends, or open offers
arising from potential take-over bids
act as catalysts as well.
Despite the deep value some hold-
ing companies harbour, there are
few takers for such stocks simply be-
cause there are no obvious triggers
in sight. But Bakshi says there is one
way to play these stocks. The cata-
lyst, he says, could potentially come
in the form of a turn in the business
of an underlying subsidiary. Usually,
when business turns, the perceived
K N Siva Subramanian value of the holding company im-
VP, Franklin Templeton Mutual Fund, has an proves and results in a fall in its dis-
enviable long-term track record count to intrinsic worth. The perceived
value in the company improves as
a consequence.
A case in point is Nalwa Sons.
Graham’s strategy is that frequently The stock was available at a 75 per
the list of worthy buys is made up of cent discount to its intrinsic value
obscure stocks on which there is lit- but as group company JSW Steel
tle public information. The reported (Nalwa holds 45 lakh shares) got re-
earnings are thus suspect and the rated for the better, the discount
chance of being duped, quite high. contracted to 16 per cent of Nalwa’s
So following the rule always is never intrinsic value.
easy. Experts say the way to view such
companies is by taking a call on how
8And finally, there is the operating business of the subsid-
an anti-thesis to Gra- iary will fare in the long haul. For in-
ham’s philosophy. stance, if cement is expected to do
Pretty much like well over the next five years, it would
the fact that some make a lot of sense to put money in
companies are holding companies of cement enter-
48
Outlook PROFIT 31 January 2008
DOGS OF THE NIFTY could run the risk of deterioration in folio requires going after little-known
Portfolio of top 10 dividend yield stocks business. Candidates in the out-of-fa- or desired stocks. We all know what
vour category now include commod- kinds of stocks are thrown up on these
YEAR 1 yr 2 yr
ity companies which look incredibly screens, but it requires nerves of steel
Portfolio 1998 -14.68 27.71 cheap but may be vulnerable to an and guts to buy these stocks. Why?
Sensex 1998 -17.00 7.82 earnings decline if the cycle turns for For one thing, you may not have heard
Portfolio 1999 145.80 40.83 the worse. One way to assess these about most of them. For another, most
companies may be to look at average of these stocks will be drenched in pes-
Sensex 1999 40.05 2.87
earnings for the past five years or more simism, so most investors will be re-
Portfolio 2000 10.53 26.90 to remove the effect of cyclicality. luctant to invest in them.
Sensex 2000 -24.44 -15.34 Professor Bakshi says one way to look Indeed, the reason value investing
Portfolio 2001 65.29 33.08 at cash bargains is to identify compa- is so difficult is because it may feel
Sensex 2001 -5.14 -8.29 nies with fairly certain cash flows and completely foolish for a while. “But
not focus as much on ab- true value investors
Portfolio 2002 4.64 90.51 solute cash levels. Since are not worried about
Sensex 2002 -11.33 30.16 companies with regular “If you buy stocks looking foolish as long
Portfolio 2003 198.09 77.03 cash flows will soon turn based strictly as they’re certain they
Sensex 2003 91.06 44.20 into a treasure-chest of haven’t acted foolishly,”
cash, they could be viewed on traditional remarks Bakshi.
Portfolio 2004 11.64 41.06 value investment
as cash bargains, he says. Yet impressions mat-
Sensex 2004 8.83 45.93 The problem with look- principles, you ter to a large swathe
Portfolio 2005 83.05 33.90 ing at future cash flows, of investors. So even
as Graham also explained,
will only play if back-testing comes
Sensex 2005 95.67 50.13
is that it requires a judge- the arbitrage up with sparkling re-
Portfolio 2006 -4.25 11.70
ment of the future and opportunity, sults, it’s still difficult
Sensex 2006 15.19 19.81 those projections can dif- for many to go ahead
but the bigger
Portfolio 2007 32.65 NA fer from person to person. and take the plunge.
Sensex 2007 18.82 Nevertheless, since stocks
opportunity in a “The reason value in-
are now no longer avail- country like ours vesting is not popular is
able at high discounts as in lies in the future because people do not
prises. There are risks to such a strat- Graham’s time, “we can’t as the business have the patience to go
egy though. The lack of transparency ignore the value of future through these dull and
in dealings between group companies cash flows while looking at grows.” boring ideas,” says Mo-
and the vested interests of promoters valuations,” says Bakshi. tilal’s Agarwal.
can sometimes erode value in such While Graham’s solution Another reason why
stocks. for minimising the risk of bankrupt- most investors get bludgeoned with
“Unless you know that the inter- cies and frauds was diversification, their stock picks is that they don’t al-
ests of the promoters are aligned with looking at divergences in cash flows ways follow the rules and resort to gut
those of minority shareholders, there is and earnings in recent years (not just feel or judgement, which frequently
no point in touching such stocks,” says quarters) can also be effective in spot- goes wrong. “As humans, we do get
Templeton’s Subramanian. ting the warning signs. “Instead of carried away. A strict Graham strat-
Then again, the famous law of aver- looking at accounts statements for just egy would involve selling stocks pe-
ages or ‘reversion to the mean’ could a year, we should look at the aggregate riodically, in fact mechanically,” adds
help a stock run the distance. Instanc- picture for five years, which will offer Agrawal.
es of over-reactions to one-off situa- clues to the true picture,” says Bakshi. Another fact that Graham followers
tions could be good Graham picks. Among companies that are capital in- need to accept is that they will rarely
But investors really need to be able to tensive, it is a worthwhile strategy to make extraordinary returns. On the
judge the situation correctly to make search for those that have a high return other hand, they will rarely lose mon-
sure that what they think is a one-off on equity and low price-to-book value. ey. It’s important to be comfortable
really is just that. As Motilal’s Agarwal puts it: “Value in- with the fact that sometimes, they will
Take the recent forex losses by some vestors are balance-sheet analysts and miss new growth opportunities – but
companies, for instance. Buying bank regular market analysts are P&L ana- not giving in to such temptations can
stocks just because forex losses came lysts. Value investors buy assets cheap ensure a safer ride.
in much lower than expected is defi- and ahead of the market recognising True, there are those who have been
nitely not a wise call. At this point in a turnaround.” Thus, instead of look- enormously successful by follow-
time, it’s still uncertain if the prob- ing only at operating and net margins, ing growth investing techniques. But
lem could strike again. It may not be it is perhaps smarter to look at long- these investors, it has to be acknowl-
a one-off situation as some experts are term returns ratios. With companies edged, are extraordinarily smart and
claiming. After all, as professor Bakshi operating in cyclical industries, stocks have learnt to be at the right place
rightly points out, there is never just should be picked up when the industry at the right time. Very few ordinary
one cockroach in the kitchen. is down in the dumps. investors can aspire to be successful
Talking of out-of favour stocks, in- that way.
vestors need to careful when they’re INTELLIGENT INVESTING The relentless pressure of keeping up
dealing with downturns. It cannot be denied that Graham’s with the Joneses and the need to boast
Again, the problem with some com- strategy demands enormous psycho- about the latest stock picks at a party is
panies whose names pop up as good logical strength and will-power. That’s what investors need to overcome to be-
earnings yield candidates is that they because building a Graham-style port- come really successful investors. p
49
13 June 2008 Outlook PROFIT
