Every few years we start talking about the fads of investing and then when hard times hit the financial market people are talking about Benjamin Graham, Warren Buffett, David Dreman and other value investors. These names keep appearing till such time when the market gets roaring and unidirectional, like 1999 or 2007-08, and just about when everyone starts talking of their investment methods and styles are declared dead until the next fall, i.e. 2000 or 2008, when the names of these legendary investors are again the talking point among investors.
Although often a lot of space is used to write about value investing and these experts are talked about but few have taken to understand the philosophy of value investing and why there are so many sub-style within them like deep value investing, contrarian, market-cap based, geography based, accounting value based style, etc.
In this issue we explore every aspect of value investing and also what the differences in various sub-style. We also talk about a less known but great value investor – John Neff. Based on his screen we also share with you 10 stocks and bring to you the perspective of experts on each of them.
Value investing is perhaps the most talked about investing philosophy on the planet.
“All investing is value investing. What is investing if not the attempt to buy something for less than what it’s worth?” says Sanjay Bakshi, Adjunct Professor at Management Development Institute (MDI), Gurgaon. He further explains, “Overpaying for an asset can make you money if you can find a greater fool to buy it from you at an even higher price and that works for a while but it cannot work indefinitely as the supply of greater fools is not infinite.”
Sankaran Naren, CIO, ICICI Prudential AMC says, “The culture of value buying is already prevalent in India, with Indian consumers buying various products in attractive sales and discount offers; with this analogy, value investing could be understood as a style of investing in equities when they are cheap and holding the investments till they become reasonably valued.”
In an article titled 'The Superinvestors of Graham-and-Doddsville' published in the Fall, 1984 issue of Hermes, Columbia Business School magazine, Warren Buffett had written, “The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market”
Atul Kumar, Head - Equity Funds at Quantum Mutual Fund says, “Value Investing as per (Benjamin) Graham’s definition was to buy a stock for something that is just equivalent to its net working capital. Today you do not have such opportunities in because with time investors are becoming more savvy and sophisticated.” That doesn’t mean that value investing is dead, it has just evolved.
Value Vs Growth investing
Some people differentiate between growth investing and value investing. Bakshi opines, “Warren Buffett demolished the distinction on growth and value long ago when he said growth is just a component of value, sometimes negative, and sometimes positive. Averaged out, growth in the airline industry has hurt investors while growth in the chocolate business has made investors rich.”
Raamdeo Agrawal, Joint Managing Director, MotilalOswal is also of the opinion that value investing is what everyone practices if they are investing because the idea of investing is to make money and to do that one has to buy at a price less than what they expect it to be. He says, “Investing is broadly classified as value and growth but I don’t believe they are separate. No one can buy into a business if it is not growing.”
Different shades of Value investing
Buffett in his article had given examples of the different disciples of Benjamin Graham and how all were following value investing and out-performing the markets, and they were able to achieve this with different stock picks, this reflected as they had very few overlapping stocks. Thus, indicating that there can be many different sub-style within the value investment philosophy.
Similarly, even in India, value investors have developed their own style of investing. Bakshi of MDI says, “I am a moat investor.” ‘Moat’ is a term Warren Buffett uses to illustrate the idea of a competitive advantage which is sustainable because of strong entry barriers. He says, “Profitable and scalable businesses with moats which are run by honest and competent managers can compound capital at high rates for a long time. This combination of longevity and compound interest are the key ingredients of successful value investing I know about.”
“My approach is to buy a stock where I pay less than fair value for its current business in order to have a higher margin of safety. This ensures that I get the growth as an additional bonus,” says Agarwal of MotilalOswal.
Parag Parikh, Director of Parag Parikh Financial Advisory Services (PPFAS) says, “We prefer to own businesses that keep doing well over a long period of time. We buy them when we notice that the market is not fully appreciating the opportunity / capability. If the business keeps doing well and delivers as per our expectations and the opportunity to continue its momentum exists, there is no reason to sell it.” Adding a note of caution he adds, “Occasionally the market does give too much importance to the future prospects of any industry and ends up over-valuing it that may be a time to sell.”
Multi-level approach can also be used by value investors. “At Quantum we look at companies which are trading at lower valuations in terms of price-to-earnings, price-to-book, or other such metrics depending upon the sector. One important thing that we look at is if there will be events which will help in value unlocking. Only when there are earnings trigger or valuation triggers only then will the valuation be unlocked,” says Atul Kumar, Head of Equities at Quantum AMC.
Vinay Khattar, Head of Research, Edelweiss explains his stock picking strategy as, “We try to focus on stocks which are out of favour with the market or with valuations are below their intrinsic worth, as expectations for earnings growth are very muted. In this context, even a small change in earnings growth expectations can result in fairly good stock returns even as the downside is protected. We also believe that margin of safety exists in stocks that are trading at fair value but the visibility of future earnings is high given the huge opportunity size in their respective businesses.”
Or you can create your own rules based on some rationale. "I keep value investing as operating assets that generate acceptable economic growth rate of returns. Acceptable economic growth rate is the opportunity cost to the shareholder for investing in the equity of that company," says Phani Sekhar, Fund Manager-PMS at Angel Broking.
Among mutual funds, there are 13 funds that Morning Star, a mutual fund research company, classifies as funds’ following value investment strategy. But their performance is also different and so are majority of the names in their portfolios. Even if one sees the portfolios’ of the previous month the unique stocks would be more that 60% of the portfolio.
The table below can be reduced by taking only 4-5 funds with the longest history
|
Group/ Investment
|
Morningstar
Category
|
Inception
Date
|
2011
|
2012
|
2013
|
2014*
|
|
Templeton
India Growth Gr
|
Large-Cap
|
10-09-1996
|
-29.57
|
35.90
|
-0.60
|
18.98
|
|
Birla Sun
Life Dividend Yield Plus Gr
|
Small/Mid-Cap
|
26-02-2003
|
-18.81
|
29.39
|
-3.00
|
22.24
|
|
Principal
Dividend Yield
|
Small/Mid-Cap
|
15-10-2004
|
-26.84
|
41.94
|
-5.30
|
20.65
|
|
Tata
Dividend Yield A
|
Large-Cap
|
22-11-2004
|
-16.93
|
27.29
|
6.10
|
15.81
|
|
ICICI Pru
Value Discovery
|
Small/Mid-Cap
|
16-08-2004
|
-23.73
|
46.01
|
8.31
|
32.95
|
|
BNP
Paribas Dividend Yield
|
Large-Cap
|
15-09-2005
|
-17.00
|
32.90
|
5.56
|
19.33
|
|
ING
Dividend Yield
|
Large-Cap
|
24-10-2005
|
-16.87
|
25.02
|
1.64
|
19.81
|
|
UTI
Dividend Yield
|
Large-Cap
|
11-04-2005
|
-17.54
|
22.37
|
0.20
|
17.29
|
|
Quantum
L/T Equity
|
Large-Cap
|
13-03-2006
|
-20.16
|
31.21
|
9.16
|
19.23
|
|
Templeton
India Equity Inc
|
Large-Cap
|
18-05-2006
|
-23.66
|
36.12
|
3.72
|
13.93
|
|
L&T
India Value Gr
|
Large-Cap
|
08-01-2010
|
-27.09
|
39.81
|
6.64
|
30.81
|
|
NIFTY
|
|
|
|
|
|
|
|
SENSEX
|
|
|
|
|
|
|
|
PPFAS Long Term Value & ICICI PruDiv Yield
Equity were launched only in 2013.
*Returns between 01/01/2014 to 31/05/2014
|
||||||
Margin of safety
Explaining the art of value investing Benjamin Graham, the father of value investing, wrote in Chapter 20 of The Intelligent Investor that if he were to explain sound investing in three words then all he would say is ‘margin of safety.’ This naturally leads to the question, what is ‘margin of safety’?
In simplest words margin of safety is difference between the actual or expected value of the asset against the price at which you buy the asset. For example if you think that the value of a share is Rs 100 and you purchase the share (price paid) at Rs 60, then your margin of safety is Rs 40.
Khattar says, “We believe margin of safety is the most important concept in value investing. Margin of safety is paying less than fair value of the company which protects the downside of money invested as even if something goes wrong in the company investor’s capital is protected.”
Parikh of PPFAS says, “Margin of safety is very important, it protects us from our errors in judgement.” Adding a word of caution he says, “But it is also very difficult to calculate precisely when we are dealing with long holding periods because the business can evolve in ways we may not have expected. Margin of safety must be coupled with being aware about the developments in the industry.”
What investing style is suitable in this market in India?
Vikas Gupta, Executive Vice President, Arthveda Fund Management says, “A long-only, reasonably diversified across Indian and developed market equities, primarily exposed to ultra-large caps with some exposure to mid-and small-caps. Focused on high quality at cheap valuations.”
Naren says that despite India being perceived as growth market, value investing has a good scope of success. “Our experience with the value investing model over the last decade has been very favourable, except in 2007 when the markets were significantly high in a narrow range of stocks. Therefore, we believe that value investing requires an investment horizon of 3-5 years in order to bear fruit,” says Naren.
Parikh says, “In India we do not have corporate raiders and hostile takeovers. Further in Indian companies, usually the promoter family controls a large portion of equity and it is difficult to impose any change or to safeguard minority shareholders.” Given this scenario Parikh advises that one should guard against Value Traps.
Value Traps would be companies where the stock is statistically cheap but rather than the stock price moving up to the intrinsic value, the intrinsic value would come down to the stock price! This can happen on account of bad capital allocation, mis-appropriation of funds, bad M&A activity and so on.
John Neff
John Neff is not a name that people would recognise as easily as Warren Buffett. Yet, within the financial community, Neff is a name that most have at least heard of.
He had steered the Vanguard Windsor Fund from June of 1964 to December of 1995. During these 31 years his fund management skills generated a compound annual growth rate of 13.7% annually versus 10.6% for the S&P 500. Simply put investors putting in their money with Neff would have earned twice the amount had they invested in S&P 500 during his tenure.
Naren of ICICI Prudential AMC says, “John Neff has a contrarian style of investing.” He opines that the global liquidity environment through quantitative easing has made it difficult to make use of these styles in the near term. “However, a year back, the styles recommended by David Dreman and John Neff enabled us to consider launching a series of close-ended value funds,” says Naren.
Based on his book ‘John Neff on Investing’ and various commentaries on his methodology, we created a screening criteria, keeping in mind the Indian market, in which we have selected 10 stocks.
Methodology
Price-Earnings Ratio (PE) >= 40% of market average & =< 60% of market average
EPS >=7%
Sales Growth >= 70% of EPS Growth or at least >7% of EPS Growth
Free Cash Flow >0
EPS Growth: Q1>Q5, and Q2>Q6, and Q3>Q7, and Q4>Q8
P.S. This is the submission draft. The actual story had appeared in August issue of Money Today. You can read the final version. Click here or copy paste the given below link - http://businesstoday.intoday.in/story/investment-lessons-from-warren-buffett-others-and-top-stocks/1/208504.html
The stock recommendation is outdated from that perspective.
Tata Consultancy Services (TCS): The company has been adding new services and capabilities over the past several years, to penetrate deeper into the clients’ IT budgets. It has guided for a better growth rate in 2014-15 as compared to 2013-14. This is despite a very high base and strong growth in 2013-14.
Dipen Shah, head, private client group research, Kotak Securities says, “We expect revenues in rupees terms to grow at a CAGR of 13% and net profit to grow at a CAGR of 12% over the next two years.”
According to market experts, efficient sales engine and a very effective delivery organisation are the differentiators for TCS, which sets it apart. The company also has had a stable management team, which has allowed continuity in strategy and performance.
For the further movement of TCS shares, Shah of Kotak says, “A lot would depend on the movement of the rupee, though. A sharp appreciation over the next two years may limit gains for the sector as a whole. If the rupee remains at around the current levels, the stock may give annualised returns of between 10-12% over the next 24 months. In the short term, the stock may remain ranged after its recent up-move.”
MothersonSumi (MSSL): MothersonSumi is a leading global tier-1 auto ancillary company, it has been a remarkable and consistent value creator for its shareholders. It is interesting to note that an investment in 100 shares in the initial public offerings of MSSL in 1993 has grown to 11,389 shares and the IPO investment value of Rs 2,500 (100 shares @ Rs 25), has grown more than 1,000 times over 20 years implying a annualised growth of 40%.
Vishal Jajoo, senior research analyst, PCG, Nirmal Bang Securities says, “The stock has already generated multi-fold return for its shareholders. The same trend is expected to continue going forward as well and we expect the earnings to get reflected in the share price going forward. We have a target of Rs 580 over the next 24 months.”
The company currently generates nearly 85% of its consolidated revenues from India and Europe, however, these two geographies account for just 25% of the global 75 million car market. Management’s recent comments indicate that the next target geography for them is United States and China which would mean that their target market would treble to 75% of the global car market.
Return on capital employed (RoCE) which is estimated around 28% in 2013-14 an increase of 1400 basis points YoY aided by sharp improvement in core operating margins at the key subsidiaries SMP & SMR and higher asset sweating. Going forward, the management guided for an RoCE of 40%. Jajoo of Nirmal Bang Securities believes that the company is well on track to achieve the target. RoCE measures the profitability and the efficiency of the company with which its capital is employed.
HDFC Bank: The share price of the company appreciated around 116% to Rs 823.10 in the past four years till July 1. HDFC Bank’s stock performance becomes stellar when seen in the context of the rather mediocre performance of the banking industry during this period. During the period, the BSE Bankex jumped 65% to 17,558.
V K Vijayakumar, investment strategist, Geojit BNP Paribas Financial Services says, “The reasons for this robust performance are the consistent industry beating performance of the bank and particularly the quality of its earnings.”
The strengths of the bank are its enviable track record, excellent management, consistent industry beating performance, ability to manage difficult times and above all the quality of its earnings reflected in the lowest non-performing assets (NPA) in the industry.
The bank has been registering healthy profit figures year on year. It booked net profit of Rs 5,167 crore, 6,726 crore and Rs 8,478 crore in the past three financial year from 2011-12. Vijayakumar says, “Profit growth of 26 to 30 % CAGR can be expected from the bank during the next 3 years.”
From the stock market perspective the major negative is that HDFC Bank looks expensive. With a PE of around 23 and Price to Book Value of 4.6, the stock is expensive. On July 3, industry PE was at 17.58. However, Vijayakumar is looking bullish on HDFC Bank. He says, “It would be realistic to expect around 35 % appreciation in the share price in the next 24 months. With economic growth recovery and credit expansion there is no reason why the bank cannot get back to its old 30 % quarter-on-quarter profit growth.”
IPCA Laboratories: During July 2010 to June 2014, the company has consistently improved its operating performance, aiding the company to post return on equity (ROE) in excess of 25%.
Sarabjit Kour Nangra, vice president research, Angel Broking says, “Due to strong growth and the healthy ROE’s the stock posted a robust return in the past four years.” The share price of the company jumped 203.60% from Rs 286 on 1 July 2010 to Rs 868.45 on 1 July 2014.
In 2013-2014, out of overall anti-malarial business of over Rs 430 crore, IPCA Laboratories did more than Rs 170 crore kind of business under the AMFm programme. That programme is now being modified by the global fund under the programme called pool procurement and the tender was for pool procurement kind of programmes and this tender was almost for around Rs 1,000 crore. Overall, as a value of this and under this tender IPCA Laboratories have been awarded around 30% of the business, which will last for two years now.
The company’s strength lies in the domestic formulation business, where now company has 50% of its business from chronic segment, which aided the company post growth higher than the Industry. On the weakness side, exports being now at higher portion of sales, exchange fluctuations impact the financial performance of the company.
For the year ended March 2014, the company posted net profit of Rs 477.37 crore, up 44% against Rs 331.39 crore in the previous financial year. Nangra of Angel Broking says, “We expect the company to post a net profit and revenue CAGR of 20% during the next three years. As a result, the shares of the company can give minimum 15% annualised return to investors in the next 24 months.”
Gruh Finance: The company, a subsidiary of HDFC, is a housing finance company recognised by National Housing Board (NHB). It offers loans to individuals for purchase, construction, repairs, renovation of dwelling units. Gruh also offers loan to the self employed segment where in formal income proofs are not available.
Silky Jain, research analyst at Nirmal Bang Securities says, “The stellar performance demonstrated by the company on all parameters be it loan growth (without leading to equity dilution), profitability, maintaining asset quality leading to significantly healthy return ratios or timely rewarding the shareholders with dividend are some of the reasons due to which Gruh Finance has generated strong returns in the past 4 years.”
The company has recently ventured into loan against property and it is also focusing on starting operations in the state of Bihar and Jharkand.
It has stable and experienced management along with 61% stake in the company is held by HDFC. Gruh Finance has been the pioneer at financing India’s non-urban housing landscape in Gujarat and Maharashtra (76% of its portfolio). GDP of Gujarat and Maharashtra is higher than the Indian GDP on a whole which is an added advantage.
Jain of Nirmal Bang Securities is bullish on the further share price movement of the company. She says, “We believe that despite the stock is trading on significantly higher multiples, it will continue to remain an outperformer considering the steady track record of the company in delivering numbers. We expect the stock to generate healthy and consistent returns (15-20%) every year in the same way as its parent HDFC has been delivering.”
Emami: The company is a Kolkata based FMCG company founded in 1974 and a home grown multi-national company. Its objective is to make people healthy and beautiful naturally – by blending their Ayurvedic lineage with modern sciences. They strive to enter the niche market segments and target the rural and semi urban areas, which currently are the drivers of growth. Some of the major brands of the company are Boroplus, Fair and Handsome, Navratna, Zandu, Fast Relief. Brands like Boroplus, Fair & Handsome and Navratna are leaders in their respective markets.
According to experts, customer loyalty, capable management and presence in niche and high growing segments are the major strengths of Emami.
The share price of the company increased over 95% to Rs 510.65 in the past four years till July 1. Aditya Bapat, research analyst institutional desk, GEPL Capital believes that the acquisition of Zandu in 2008 and healthy margin growth helped the company to deliver lucrative return to investors in the past four years.
The company is planning to launch new products in the male grooming segment like soaps, shaving creams, deodorants, hair gels and after shave lotions as a part of its long term plan in an endeavor to become a billion dollar company. Already in June 2014, the company has forayed into women hygiene space by acquiring a sanitary napkin brand ‘She Comfort’.
At market price of Rs 543.40 on July 4, Emami was trading at PE ratio of 30.97 against its industry average of 36.09. Bapat of GEPL Capital is positive on the company. He says, “Emami can touch Rs 667 in the next few quarters.”
Abbott India: The company is one of the major Pharma MNCs in India. It is a debt free with no long term and short term borrowings. Net profit of the company jumped 21.14% to Rs 38.40 crore in the quarter ended March 2014 against Rs 31.70 crore during the corresponding quarter a year ago. Net sales jumped 17.72% to Rs 478.55 crore in the quarter ended March 2014 against Rs 406.52 crore during the same quarter last year.
For the full year, net profit rose 37.15% to Rs 198.45 crore in the year ended March 2014 as against Rs 144.70 crore during the previous year ended December 2012. The share price of the company surged 95.84% in the past four years till July 1.
Sudip Bandyopadhyay, president, Destimoney Securities says, “Out of the Pharma pack, the MNC pharma companies have always been performing well, predominantly driven by corporate action and mergers and acquisitions. Abbott India also went up on the back of such corporate action and generally favourable trend for the pharma industry. By and large, we expect pharma, as a sector, to continue to perform over the next few years as well. We expect over 20% return from Abbott India over the next two years.”
Phoenix Mills: Over the last few years the company performance has improved significantly both in terms of revenue growth and profitability. This has come at a time when most of the real estate companies have reported subdued performance. This is attributed to the string business model followed by the company.
The company has lined up retail, residential and office projects for development in multiple cities. Around 3 million square feet (msf) of mall space is expected to be operational in tier-2/3 cities over the next 18 months. A luxury residential project for 0.35 msf was recently launched in Pune and has witnessed good demand.
DK Aggarwal, chairman and managing director, SMC Investments and Advisors says, “The key strength of the company is its diversified business model. It has business operations into different segments of real estate sector including, hospitality, retail mall and commercial developments across various geographies in domestic market. Also the company has been operating cash-flow positive, thanks to its lease income.”
Phoenix Mills has been a regular dividend payer. Consolidated cash and cash equivalents as of 2013-14 is Rs 140.30 crore. Also, the company has huge debt in its books as a result the interest outgo is also very high. As on March 2014, the total debt of the company stood at Rs 3,084 crore.
Housing Development Finance Corporation (HDFC): HDFC has delivered net profit CAGR of nearly 20% in the past four years which has led to faster accretion in book value (almost double from Rs 92 in 2008-09 to Rs 180 in 2013-14) which helped stock returns of over 100% since July 2009. On July 7 this year, it was trading at Rs 1017.50.
DilipBhat, joint managing director and PriteshBumb, research analyst, banking, PrabhudasLilladher says, “Market gives a lot of premium to any business which has reasonable growth, visibility and stability. This was more pronounced in the last 4 years when market rewarded such companies. We expect HDFC to register annualised net profit and revenue growth of 17% and 18%, respectively, in the next 3 years.”
The company has started focusing more on Tier 3 and Tier 4 cities to capture growth as currently it has been focusing on Metros and Tier-I cities, which has been the driver of loan growth till now.
According to market experts, prudent management with high standards of integrity and transparency is the foremost strength of the company. This is coupled with strong business model with a strong franchise which is difficult to replicate, stable asset quality and superior return ratios compared with its peers.
Bhat and Bumb of PrabhudasLilladher are bullish on the company. They say, “As economy revives and optimism returns, we expect core mortgage business to lead the growth. Also, a lot of clarity is expected on increase in FDI in insurance business, where HDFC will be able to unlock value and reduce further capital commitment. We expect an annualized return of 18-20% in the next 24 months from HDFC.”
Havells India: Havells India is electrical and power distribution equipment manufacturer with products ranging from industrial and domestic circuit protection switchgear, cables and wires, motors, water heaters, fans, power capacitors, CFL lamps, luminaires for domestic, commercial and industrial applications and modular switches covering the entire gamut of household, commercial and industrial electrical needs.
The share price of the company jumped over 275% in the past four years to Rs 1171.25 on July 1.
Amol Rao, analyst (industrials), Anand Rathi Institutional Research says, “Steady growth in revenues, strong operating profitability, healthy return ratios and excellent cash flows are reasons for good performance of stock.”
Company is trawling deeper for opportunities. Expansion of dealer network in tier 2 and 3 cities and introduction of products for customers in these markets are noteworthy developments.
Rao says, “Havells could witness revenue and operating profit growth of 17-20% over the next 2 years in Indian operations. However, international operations to be sedate with focus on profitability.”
According to a research report of Motilal Oswal Securities, earnings per share of the company will increase from Rs 43.4 in 2013-14 to Rs 48.4 and Rs 56.1 in 2014-15 and 2015-16, respectively.
ELEMENT OPTIONS – Quotes
"It's not always easy to do what's not popular, but that's where you make your money. Buy stocks that look bad to less careful investors and hang on until their real value is recognized."
- John Neff
"I've never bought a stock unless, in my view, it was on sale."
- John Neff
"Successful stocks don't tell you when to sell. When you feel like bragging, it's probably time to sell."
- John Neff
According to us, value investing is embodied very well in Buffett's two rules of investing:
Rule 1--Don’t lose capital;
Rule 2--Don’t forget Rule 1.
- Vikas Gupta, Executive Vice President, Arthveda Fund Management
Investing in growth stock is like riding on a tiger as lot of expectation are built in price. If growth falters due to one or other reason downside is not protected.
- Vinay Khattar, Head of Research, Edelweiss
ELEMENT OPTIONS – Advice for investors
If someone always likes to buy during end of season sales, they might be more comfortable towards buying deep value (statistically cheap) price target triggered opportunities. Follow Benjamin Graham
If someone who is comfortable with buying quality stuff and does not mind paying a bit more and holding on, they might only look for great businesses with a long term story. Follow Warren Buffett
If you are someone who only likes to take contrarian calls then follow David Dreman
ELEMENT OPTIONS – Building a portfolio
What affects value investing performances? A difference in any one of the three steps will lead to difference in performance.
Step 1: Selection strategy: Which universe does one focus on?
Is it based on capitalisation, geography, or sectors etc
Source of ideas, screening methodologies etc.
Step 2: Valuation strategy: How sophisticated a valuation technique one uses?
Step 3: Portfolio strategy: How diversified is the portfolio, what is mis-valuation threshold for buying and selling i.e. buy only when the price is undervalued by 50% and sell when it is overvalued by 25%, hedging strategy, if any, portfolio turnover, tax sensitivity
