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Cover Story 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
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