My Investment Research And Value Investing

1:00 PM IST, Thursday, 20, October, 2011

The austerity bill won initial approval with a majority vote in parliament on Wednesday, and lawmakers now vote on the details. The measures include the suspension of 30,000 public servants on reduced pay and the suspension of collective labour contracts, and have angered even deputies from the governing Socialist party.

Today and coming few days will be very edgy for Greece and EU. France and Germany disagree over the ECB’s involvement in the plan, with France wanting the ECB to use its balance sheet to boost EFSF funds and for the EFSF to have a banking licence. Germany seems to favour the EFSF providing first loss guarantees to boost the funds. The French approach would increase the EFSF’s available funds, which overcomes one of the key weaknesses, but then it also increases the exposure of the guarantors and unless guarantees are increased the EFSF’s rating must be at risk due to the leverage.

Broad base market is down all over the world. US market has been down by 1 to 2%. European market has been trading low. Indian stock market is down by 1.83%.

UK inflation hit 5.2% in September 2011 the Office for National Statistics (ONS) revealed today.

More precisely Consumer Price Index (CPI) measure of inflation stands at 5.2% for September 2011. The CPI has never been higher but was also 5.2% in September 2008.

The Retail Price Index (RPI) measure of inflation stands at 5.6% in September 2011, the highest it has been for over 20 years. The ONS report that last time RPI annual inflation was higher was in June 1991 when it stood at 5.8%

Financial sector and global economic crisis has many moving parameters at the moment. Sometimes, even in single day you may see a lot of bad news spreading like forest fire and taking the stock market with it.

It is very difficult to make money in this kind of market. If you are a fickle kind of person. Stay in cash or at best invest in Gold or silver (real estate is already out of option.)

From my point of view, this is the condition where value investors thrive. Although, at the moment I am fully invested, but very soon I am ready to get out of all stock and will be waiting for the Greece to default. That would be the situation when Europe will go through gyrating series of event, which will change the world order.

9:43 AM, Monday, 17 October, 2011

 

It seems market is waiting for the result of TCS. Nifty has gained 10 points or less. All Intraday signal are showing that market will go up. US market as well as European market were closed with gains. Today Asian market is doing good. Lets see how much up Indian market will move….

8:01 AM, Monday, 17 October, 2011

Market today is expected to open with huge expectation from TCS scond quarter results. It is very much chances of getting what it hopes for. After a great results from Reliance Industries and Infosys, TCS is in good position to deliver good for market. There are some hiccups too in BFSI and Europe market but everything is calm at the moment. Earning is going to be the deciding factor in this week market.

Asian Markets are trading higher in the range of +1.05 to 1.95%. There is optimism in market for European crisis. And what it seems that the crisis has been delayed for sometime.

If everything go as per last week, Nifty is expected to touch the upper cap level of 5200. At that time it would be interesting to that the level will be breached or not. Meanwhile, big bull Rakesh Jhunjhunwala has been expecting market to be in the range of 4700 and 5200. He is too optimistic for this range to hold.

Meanwhile, experts has started talking about Greek default in near month(s). Daniel Hannan from Telegraph is putting his money for Greek debt defalt on 28 October, 2011 or in the subsequent weekend. As per him everything is in place. Private debt burden has been transferred to the public debt. Big fund houses and institutions has got out of the stocks. All 17 single currency nation is ready to bailout the banks. Greek is not able to achieve the required austerity measures. What is required is a just 2-3 days of quite period. And That may be from 28 October. Being 28 October, holiday in Greece and then further weekend and in some countries 1 November is holiday and so, that may be the best time. Lets see what will happen.

Some local and global news and information first:

1. Germany’s chancellor, Angela Merkel, led European Union critics of US and British attacks on their plans on Friday to resolve the sovereign debt and banking crises. Merkel criticised both Barack Obama and David Cameron for opposing EU proposals for a financial transaction levy, or Tobin tax, and demanding “big bang” solutions.

2. September inflation came in at an ugly 9.7%. The only relief was that the number was not uglier than expected. Economists note that the prices of non-food manufactured products have risen more modestly that they did in previous months. Nevertheless a rate hike in the next RBI policy meeting on October 25 seems imminent.

3. Occupy Wall Street movement has spread all over 80 countries from London to Madrid, South America to Austrlia.

4. RIL’s July-September quarter net profit rose 15.8% year-on-year, to Rs 5,703 crore. Net turnover for the quarter rose 35% to Rs 80,790 crore, better than the poll estimate of Rs 79,800 crore.

5. TCS will report its second quarter results. Street expert are expecting a Infosys type booster for market.

There will be lot of booster for stock market this week. TCS is expected to boost the market. Reliance Industries second quarter result has been above expectations.

Slovakia has approved the EFSF bailout fund. European market and US market is coming back in green. Rally may be expected to assume the course for sometime.

While back home, Bull market Rakesh Jhunjhunwala expect market to be in a range of 4700 to 5200. Jhunjhunwala do not expect market to break 4700. But to unleash the upper cap, India need more economic reform.

As per Daniel Hannan from Telegraph is putting his money for Greek debt defalt on 28 October, 2011 or in the subsequent weekend. As per him everything is in place. Private debt burden has been transferred to the public debt. Big fund houses and institutions has got out of the stocks. All 17 single currency nation is ready to bailout the banks. Greek is not able to achieve the required austerity measures. What is required is a just 2-3 days of quite period. And That may be from 28 October. Being 28 October, holiday in Greece and then further weekend and in some countries 1 November is holiday and so, that may be the best time. Lets see what will happen.

Personally feeling, Greece may not default this month. Whatever be the decision, it will be a political decision not a economic decision. EFSF is also not a economic fund. It has basically measured the willingness of 17 countries to bailout the weaker nation. But 14 days is not enough for all political entities to make up the mind.

Bank may not yet be ready for the contagion effect which may see after domino effect cause by Greek default.

But nobody know what is cooking up. One day you will sleep and when wake up, world will be a changed reality after Greek default. Although Greece has defaulted 5 times in past 100 years. But in those days, financial world not wired into such a mess. Greece default may have wiped some banks and companies not the entire financial system.

I had always suspected why a small country like Greece is so much important for whole Europe. But one wicket down and finance community will get them hit wicket.

Better to stay in cash or at best get ready to sell your stocks at first slip of market. You may not have the second guess. Keep cash ready to buy large and mid cap at rock bottom prices.

It is a finance people heaven.

This brings us to the third point, viz, the logical significance of this “subliquidating-value” phenomenon from the standpoint of the market, of the managements and of the stockholders. The whole issue may be summarized in the from of a basic principle, viz:

When a common stock sells persistently below its liquidating value, than either the price is too low or the company should be liquidated.

Two corollaries may be deduced from this principle:

Corollary I. Such a price should impel the stockholders to raise the question whether or not its is in their interest to continue the business.

Corollary II. Such a price should impel the management to take all proper steps to correct the obvious disparity between market quotation and intrinsic value, including a reconsideration of its own policies and a frank justification to the stockholders of its decision to continue the business.

The truth of the principle above stated should be self-evident. There can be no sound economic reason for a stock’s selling continuously below its liquidation value. If the company is not worth more as a going concern than in liquidation, it should be liquidated. If it is worth more as a going concern, then the stock should sell for more than its liquidating value. Hence, on either, a price below liquidating value is unjustifiable.

Twofold Application of Foregoing Principle. Stated in the form of a logical alternative, our principle invites a twofold application. Stocks selling below liquidation value are in many cases too cheap and so offer an attractive medium for purchase. We have thus a profitable field here for the technique of security analysis. But in many cases also the fact that an issue sells below liquidating value is a signal that mistaken policies are being followed and that therefore the management should take corrective action—-if not voluntarily, then under pressure from the stockholders. Let us consider these two lines of inquiry in order.

 

THE CURRENT-ASSET VALUE of a common stock is more likely to be an important figure than the book value, which includes the fixed assets.

Our discussion of this-point will develop the following theses:

1. The current assets value is generally a rough index of the liquidating value.
2. A large number of common stocks sell for less than their current assets value and there fore sell below the amount realizable in liquidation.
3. The phenomenon of many stocks selling persistently below their liquidating value is fundamentally illogical. It means that a serious error is being committed, either: (a ) in the judgment of the stock market, (b) in the policies of the company’s management, or (c) in the attitude of the stockholder toward their property.
   

Liquidating Value: By the liquidating value of an enterprise we mean the money that the owners could get out of it if they wanted to give it up. They might sell all or part of it to same one else, on a going-concern basis. Or else they might turn the various kind of assets into cash, in piecemeal fashion, talking whatever time is needed to obtain the best realization from each. Such liquidations are of everyday occurrence in the field of private business.

By contrast, however, they are very rare indeed in the field of publicity owned corporations. It is true that one company often sell out to another, usually at a price well above liquidating value also that insolvency will at times result in the piecemeal sale of the assets; but the voluntary withdrawal from an unprofitable business, accompanied by the careful liquidation of the assets, is an infinitely more frequent happening among private than among publicly owned concerns. This divergence is not without its cause and meaning, as we shall show later.

Prevalence of Stocks Selling below Liquidating Value. Our second point is that for some years past a considerable number of common stocks have been selling in the market well below their liquidating value. Naturally the percentage was largest during the depression. But even in the bull market of 1926-1929 instances of this kind were by no means rare. It will be noted that the striking case of Otis Company, presented in the last chapter, occurred during June 1929, at the very high of the boom. On the other hand, our Pepperell and White Motor illustrations were phenomena of the 1931-1933 collapse.

It seems to us that the most distinctive feature of the stock market of those three years was the large proportion of issues which sold below their liquidating value. Our computations indicate that over 40% of all the industrial companies listed on the New York Stock Exchange were quoted at some time in 1932 at less than their net current assets.

A considerable number actually sold for less than their cash-asset value, as in the case of White Motor. On reflection this must appear to be an extraordinary state of affairs. The typical American corporation was apparently worth more dead than alive. The owners of these great businesses could get more foe their interest by shutting up shop than by selling out on a going-concern basis.

In the recession of 1937-1938 this situation was repeated on a smaller scale. Available data indicate that 20.5% of the industrial companies listed on the New York Stock Exchange sold in early 1938 at less than their net-current asset value. (At the close of 1938, when the general price level was by no means abnormally low, a total of 54 companies out of 648 industrial studied sold foe less than their net current assets)

It is important to observe that these widespread discrepancies between price and current asset value are a comparatively recent development. In the server market depression of 1921 the proportion of industrial stocks in this class was quite small. Evidently the proportion of 1932 (and 1928) were the direct out-growth of the new-era doctrine which transferred all the tests of value to the income amount and completely ignored the balance sheet picture.

In consequence, a company without current earnings was regarded as having very little real value, and it was likely to sell in the market for the merest fraction of its realizable resources. Most of the sellers were not aware that they were disposing of their interest at far less than its scrap value. Many, however, who might have known the fact would have justified the low price on the ground that the liquidating value was of no practical importance, since the company had no intention of liquidating.

In calculating the assets available for the common stock, care must be taken to subtract preferred stock at its proper valuation. Ordinarily, this will be the par or stated value of the preferred stock as it appears in the balance sheet. But there is a growing number of cases in which preferred stock is carried in the balance sheet at arbitrary values far lower than the real liability attaching there to.

Island Creek Coal Company has a preferred stock of $1 par, which is entitled to annual dividends of $6 and to $120 per share in the event of dissolution. In 1939 the price of this issues ruled about 120. In the calculation of the assets value of Island Creek Coal common the preferred stock should be deducted not at $1 per share but at $100 per share, its “true” or “effective” par, or else at 120.

Capital Administration  Company, Ltd., an investment trust, has outstanding preferred stock entitled to $3 cumulative dividends and to $50 or $55 in liquidation, but its par value is $10. It has also a Class A stock entitled to $20 in liquidation plus $70 of the assets remaining and to 70% of the earnings paid out after preferred dividends, but the par valve of this issues is $1. Finally it has Class B stock, par 1 cent, entitled to the residue of earnings and assets. Obviously a balance sheet set up on the basis of par value is worse than meaningless in this case, and it must be corrected by the analyst somewhat as follows:

BALANCE SHEET DECEMBER 31,19xx

As published		As revised
Total assets (at cost)	$5,335,300	(at mkt.) $5,862,500
Payables and accruals	1,661,200	1,661,200
Preferred stock (at par $10)	434,000	(at 55*)   2,387,000
Class A stock (at par $1)	143,400	(at 20*)   2,868,000
Common stock (at par 1 cent)	2,400	1,043,600(d)
Surplus and reserves	3,094,300
Total liabilities	$5,335,300	$ 5,862,600

Coca-Cola Company has outstanding a no-par Class A stock entitled to preferential dividends of $3 per share, cumulative, and redeemable at 55. The company carries this issues is a liability at its “stated value” of $5 per share. But the true per value is clearly $50.

In all instances such as the above an “effective par value” must be set up for the preferred stock that will correspond properly to its dividend rate. A strong argument may be advanced in favor of valuing all preferred stocks on a uniform dividend basis, say 5%, unless callable at a lower figure.

This would mean that a $1,000,000 five per cent issues would be valued at $1,000,000, a $1,000,000 four per cent issues would be given an effective value of $800,000 and a $1,000,000 seven per cent no callable issues would be given an effective value of $1,400,000. But it is more convenient, of course, to use the par value, and in most cases the result will be sufficiently accurate. A simpler method, which would work well for most practical purpose, is to value preferred issues at par ( plus back dividends) or market, which ever higher.

The characteristics discussed in the preceding chapter are generally thought of by the public in connection with low-priced stocks. The majority of issues of the speculatively capitalized type do sell within the low-priced range.

The definition of “low-priced” must, of course, be somewhat arbitary. Price below $10 per share belong to this category beyond question; those above $20 are ordinary excluded; so that the dividing line would be set somewhere between $10 and $20.

Arithmetical Advantage of Low-priced Issues. Low-priced common stocks appear to possess an inherent arithmetical advantage arising from the fact they can advance so much more then they can decline. It is a commonplace of the securities market that an issues will rise more readily form 10 to 40 than form 100 to 400.

This fact is due in part in\to the preferences of the speculative public, which generally is much more partial to issues in the 10-to-40 range than to those selling above 100. but it is also true that in many cases low-priced common stocks give the owner the advantage of an interest in, or “call” upon, a relatively large enterprise at relatively small expense.

A statistical study of the relative price behavior of industrial stocks in various price groups was presented in the April 1936 issues of The Journal of business of The University of Chicago. The study was devoted to the period 1926-1935 and revealed a continuous superiority of diversified, low-priced issues over diversified, high-priced issues as speculative media. The following quotation from the study summarizes the result and conclusions reached by the author:

Unless there are serious uncompensated errors in the statistical work here presented, this investigation would seem to establish the existence of certain relationships between price level and price fluctuations which have hitherto gone unreported by students of stocks market phenomena. These relationships may be briefly stated as follows:

1. low-price stocks tend to fluctuate relatively more than high price stocks.
2. In a “bull” market the low-price stocks tend to go up relatively more than high price stocks, and they do not lose these superior gains in the recessions which follow. In other words, the downward movement of low priced stocks in less than proportional to their upward movement, when compared with the upward and downward movement of high-price stocks.

Continue from Part 3…..

For other plant and equipment, consulting engineers and industry experts can provide this information. Using these sources, the cost of adding aluminum fabricating capacity to existing plants could be estimated at about $1,000 per ton per year. Existing capacity was available to handle any foreseeable demand. the then earning of aluminum fabricators lead to market valuation which implied that their existing capacity was worth well in excess of $ 1,000 per ton per year. The result: a race to build new capacity to take advantage of the potential earning to be had in the fabricating business. This overexpansion resulted in falling earning and lower stock prices. Such companies provided to be unsatisfactory investments. You could have anticipated this developments only through a through analysis of the balance sheet.

Another area of difficulty that Graham and Dodd recognized was the valuation of intangible assets——profit portfolios, customer relationships, trained workers, brand recognition——many of which do not even appear on a firm’s balance sheet. But today available information some times allows these balance sheet items to be usefully estimated. Some of this information comes from financial statements. For example, the cost of replicating product portfolios, assuming these are not protected by patents, can be estimated using historical research an development data both from a company itself or other companies in its industry.

This analysis can be supplemented by expert information. Investment initiatives—-whether new products, new store openings, or brand launches —— are almost always based on detailed business planes. These plans identifies the costs of such initiatives with reasonable accuracy and the benefits more fancifully. Investors can use these data to estimate the cost of producing intangible assets. Industry managers with substantial experience will be able to estimate such costs.

More importantly, many intangible assets trade just like property. Cable franchises, clothing brands, new drug discoveries, store chains, and even music labels are bought by sophisticated buyers (usually larger companies) from  sophisticated sellers (usually smaller companies). The price paid in these private market transactions are presumably made with the alternative cost of internal development in mind. Thus, if a company like Liz Claibrone buys a brand that is similar to its own in-house brands for 50 cents per dollar of sets, then presumably this is reasonably close——-but lower than— the cost of reproducing its own brands. These private  market values are often used by sophisticated investors to price intangible assets.

Once a through analysis of assets and earning power values is complete, there are possible situations. The first is one in which the assets value of a company exceeds the value of its foreseeable earning. That tells you the assets are not being used to full advantage by management. Here, the critical factor for value investors is the prospects of some catalyst that will alter either the behavior or identity of current management. Graham and Dodd were aware of this although they ware not cognizant of the range of  interventions available to activist investors today.

A second possibility is that earnings power may exceed the assets value of a company. To maintain those superior profits, there needs to be some economics factors to perfect the firm from competition. Today, these factors are referred to us “moats,” franchises, barriers to entry, or competitive advantages. What they look like and how they can be assessed is an essential part of modern income statement analysis. However, even in this case where asset values are least relevant, they do provide useful information about the value a firm will retain if the factors erode in the future.

The third case in one in which the earning power and asset value of a firm are approximately equal. This is the circumstance that should hold with reasonable management and no special protections from competition. If qualitative judgments support such conclusions, then the asset value provides a critical check on the validity of earning projection. A through asset valuation then helps to provide a complete picture of what confidence on an appropriate margin of safely.

Beyond these specific uses of asset valuations in current practice, there is one final inescapable area in which assets values must be used. Firms often have some assets— most notably cash — that are superfluous to the operation of their basic business. Such assets do not usually contributed to operating earnings, but they may represent an important part of the intrinsic vale of a purchased security. The value of these assets must be added to any earnings-based value estimate (after appropriate subtraction of their interest income so as not to double count). Performing a comprehensive asset valuation ensures that they are not forgotten.

Continue from Part 2…….

The special importance that Graham and Dodd placed on balance sheet valuations remains on of their most important contributions to the idea of what constitutes s “though” analysis of intrinsic value. It is also, unfortunately, one of their most frequently overlooked contributions outside the relatively small community of value investors.

The reason that the balance sheet often ignored goes back to the times that produced Security Analysis. Back than, the economy and business were operating under severely  depressed conditions. As a result, Graham and Dodd went to balance sheet to determine liquidation values or, as a proxy for these, current assets minus all liabilities. the logic behind this predisposition was compelling and conservation. if a company could be bought at a price well below its liquidation value, that it seem unambiguously to be a bargain. Earning could pick up because of either an improvements in a firm’s industry environment (competition eases or demands recovers) or better management. If the earning improvement produced a market value above liquidation value, all well and good. On the other hand, if such positive earnings developments failed to materialize and if this happened before the liquidation value of the firm was significantly damaged, then the company could be liquidation and the proceeds distributed to its shareholders. In either case, the shareholders who bought below liquidation value would earn a “satisfactory return” on their investments.

The only risk of which, Graham and Dodd were well aware, was that management continue to operate the firm unprofitably and, in the process, dissipate the value of the assets. This, they advocated their own version of shareholders activism as a necessary complement to this kind of investing. As they wrote,

The choice of a common stock is a single act; its ownership is a continuing process. Certainly there is just as much reason to exercise care and judgment in being stockholders as in becoming a stockholder. It is a notorious fact, however, that the typical American stockholder is the must docile and apathetic animal in captivity. 

Taken as a whole, this approach was unimpeachable and, in its time, successful in practice. Since then the practice of buying below liquidation value has been undermined by two factor. First, the rapid rise in tax rates post-1940 has meant that strategies like this one, which have often involved realizing short-term gains over relatively short periods, have incurred high tax costs. Second, and more importantly, opportunities by stocks at price below liquidation value, which were abundant in the 1930s, have effectively disappeared in the long-term prosperity that has followed.

Relatively few industries in recent times have become economically nonviable and hence candidates for liquidation. This reality has been embodied in the general level of stock prices, with the result that Graham and Dodd’s much be loved “net nets” —— that is, companies selling below the value of their current assets less all liabilities—-are rare. And, net nets are available, their second requirement ——– namely, that management not be dissipating those assets at a rapid rate—— is seldom met.

However, the broader lessons that lead Graham and Dodd to focus on the balance sheet of firms continue to apply, with extensions that are much within the spirit of their original approach. First, it is now recognize that for economically viable firms, assets were out or become obsolete and have to be replaced. Thus, replacement value ——- the lowest possible cost of reproducing a firm’s net assets by the competitors who are best positioned to do it—— continues to serve the role that Graham and Dodd recognized.

If projected profit levels for a firm imply a return on assets well above the costs of capital, then competitors will be drawn in. That, in turn, will drive down profits and with them the value of the firm. Thus, earning power unsupported by assets values——- measured as reproduction values— will, absent special circumstances, always be at risk from erosion due to competition. Both “safety of principle”  and the promise of “ a satisfactory return”, therefore, require that “through” investors support their earnings projections with a careful assessment of the replacement value of a firm’s assets. Investors who do this will have and advantages over those who do not, and they should outperform these less through investors in the long run.

What appears to have deterred Graham and Dodd from considering the replacement value of  assets was the potential difficulty of calculating them. They choose the focus on the wealth of new financial information made available through the establishment of the Securities and Exchange Commission.  With today’s computers, that information can be obtained and digested almost instantaneously. Moreover, industry reports and trade publications, many of them available online, provide a wealth of information on assets values that was inconceivable to Graham and Dodd.

For, example, the cost estimate of adding to existing reserves of oil and gas are widely available, at lest forU.S.companies. So are estimates of recoverable deposits. As a result, investors today can calculate the values of resource companies; holding with the precision that was unattainable in the authors’ time. Physical property and equipment can also be valued with a higher degree of accuracy. For real estate, assessors with access to extensive transactions data can quickly and cheaply estimate the cost of purchasing  comparable properties.

 Continue in Part 4…..