H1 CY09 - Surprise Party!!

Markets never deter to surprise us. JFM was the gloomiest and most beautiful quarter for Value Investors. This was a real market-panic never before seen in life, which amazed even veterans. The market was a buyer's market where one could have got anything at any asking-price. Cash was the real king. Then too many issues spooked the market - players felt that march quarter results would be worst than December quarter, credit lines had halted altogether, elections results were not supposed to be anything good and chances of hung Parliament were high. But markets have tendency to surprise us far more than we can assume.

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What did we do, when nothing was clear?
Once, a wise man asked a rich person - how did you get so rich? The person replied – I always keep a million here or there! And JFM was the time to use all the ammunition, while sticking to our system which said, be conservative, never over bet, don’t leverage too much.

In February, when things when really scary, we couldn’t have predicted how things were going to work out. But the message from the veteran value investors was – BUY. So investments were made in
(1) Cash rich companies, with no dependence on external credit, with zero debt status.
(2) Companies doing buybacks, with insiders buying and making use of the fire-sale market prices.
(3) Companies giving great dividend yield – in some cases as high as 10% assured, which was far superior to locking the money in the fixed deposit in the bank, post tax!
(4) Govt owned companies (In God, and Govt, we can trust in such times!).

We did not had any clue when growth would be back. But we were willing to wait for 1-2-3 yrs, when good companies, with good managements, paid us 8-12% tax free parking fees (dividends) for next 2-3 years.


Many investors, including Mutual fund houses, in the expectations of future downturn, were not willing to buy in JFM. The mistakes of 2008 were again repeated – “investors” who were unwilling to sell in Jan08, the same “investors” were unwilling to buy now!!

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Value Investing
Value investing offers a very conservative system of investing, as given by Ben Graham. It offers to invest in
• Very cheap securities – something selling at 50cents to a dollar
• Look for worst case – and try to get dividends for waiting.
• Buy companies which are not-too-big, where we have competitive ground-level-knowledge advantage, and less research is available from the street.
• Buying from punters, traders, not so knowledgeable investors,
• Buying from Financial Institutions (FIs) who cant hold smaller companies because of size,
• Buy from FIs, who have to forcibly get out of the market during falls, to beat the index daily – incentive caused bias.
• We are not required to be in the markets always. As Buffett says – wait for the fat pitch and strike when you want. We can sit comfortably on cash. Bernard Baruch, another great investor wrote in the book “My Own Story” that you must give rest to your soldiers!
• Our portfolios are non-indexed – and we are willing to unearth relatively unknown/ unloved/ under-owned names.

The overall result is a function of not only buying the right companies, but also managing the allocations. A good set of companies, with wrong allocation, will do no justice to the buying process. Allocation need to be managed within different companies, and between equity and cash.

PROTECTION OF CAPITAL to us means that our invested businesses shouldn’t go belly-up, or shouldn’t be under stress or dependent on the mercy of markets for capital. It shouldn’t happen that owners dilute the company at the cost of minority shareholder, because they went too aggressive when the markets were euphoric. For Ex - Unitech strained under debt, diluted the equity from 160c shares to 238c shares - at price between 38-85 bucks. This is good for company and promoters, but it dilutes the minority guys. Good for companies – as they got lifeline; Good for promoters – as they can still issue themselves warrants, or stock at lower price in a rising market and still enhance their stakes going forward. But minority shareholders lose their equity stake in the deal!!

For us protection means - good intelligent managements, which can add value without the mercy of external capital markets, and who are – most importantly fair to the minority shareholders. We want to grow the capital, but not at the risk of having “fun and excitement” from the markets and its corrupt deeds.

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Present Situation
Presently, Nifty is selling around 3.5x - not very cheap, but neither too expensive historically. The markets look expensive on PE basis selling at trailing 20-21x . However, so were they in 2002, when earnings collapsed and PE multiple remained high. When the earnings came back to the assets, the PE started looking cheap again!!

But the catch is the changing of constituents of Nifty. Exchanges move out the companies not doing well, with the companies which do well. Hence a inbuilt bias to see the eps-of-nifty high. For example – from 27 march 2009, Axis bank replaced Zee Entertainment. The idea is to keep healthier and flavor of the season in the index. Indeed, the exchanges are biased to see the growth in their own indices, which eventually overtime pushes up the EPS!!

The problems surrounding markets are not yet complete (but when are they?) Few companies - esp. real estate, has just been salvaged by new capital infusions. Few large companies are still sitting tight on debt and raising money. Interest rates have gone totally unpredictable, with the fear of inflation & increasing fiscal deficit– although the cheer leaders of the Govt dont accept that. The commodity prices can still shoot up again. The disinvestment program may face hurdles from employees of PSUs or other stakeholders. Threat of poor monsoon is also hanging on our head. World economy is still in woods. And more over, markets pendulum has swing too much to the other extreme, a bit too much too soon!!

On the positive side, presently, India is supposed to be a shinning star in dark global skies. World Bank recently showed bullishness by upgrading India's growth projections. (And smart people around say those World Bank projections are conservative!) Many industries are doing well, except for export units or those who have taken high debt in euphoric periods. With young and increasing population, the story of India's "demographic dividend" remains. The requirement for infrastructure (and capital) is huge in the country, and we haven’t even touched the tip of the iceberg yet. With world economy in doldrums, we think, India can be an oasis for return-thirsty investors!! But this has also started to reflect in the premiums of stock prices!!

The initiative of Govt to rope in people like Nandan Nilekani for Unique-ID project is commendable and shows the direction of change. This will give big boost to people living in rural areas and will help in sorting out complex problems like fertilizer subsidy or employment guarantee schemes.

The abolition of entry loads in mutual fund industry is another great feat achieved recently – good thing for the common investors of the country. Earlier the investors were “sold” the products which paid “advisors” or banks the highest commissions! Financial advisors used to churn and churn and churn, and bleed the investors – making them gain nothing out of their investments. Now at least, a common lay investor will know what he is buying and paying for!! Mahesh Vyas (of CMIE) recently wrote a wonderful article – Error of 2.25% commission - in Financial Express – which can be read from here

Re-election of the same political party for the second time in Parliament is definitely a positive for the country. They don’t have to waste time to rethink the old policies and can move forward quickly.

June quarter results have started flowing, and surprisingly they are looking good on face. A good reason for that is low commodity inventory accumulated by companies during JFM quarter. Also, another reason could be "re-stocking" the inventories, which were depleted in the last quarter. Banks are showing good credit growth, and loans off take has started picking up. Direct Taxes for the quarter look up and positive. However, I think next quarter would be a better guide of the industry conditions when low-cost inventories and restocking would be gone.

Soros’ Theory of Reflexivity has got a part to explain why companies showed good results and hence higher valuations. The new liquidity (QIBs) gave a lifeline to over-leveraged companies – especially real estate, which has helped them lower the pain of debt. The high stock prices of these companies - now fetching good value/share to the capital-raising-companies in turn, help improving the fundamentals - Only it needs to be seen is for how long will this party continue.

So far, so good for the businesses and real economy. However, valuations look a bit stretched, which is evident from crazy things happening in the market –
• Many companies are selling at or very close to all time high prices, historic high PEs and PBs.
• New companies are lining in the markets to raise capital
• Business houses have started talking about their grandiose plans to expand again. Acquisitions are back in action and animal spirits are high again.
• Fake trades are back on exchanges – read this article
• Small caps are seeing highlighted interest again
• Grey markets in Gujarat are active again

With such a bullish sentiment, it seems that words like "Fear", "Satyam", "Pyramid Saimira" are long forgotten again. Things are back to square-one - back to 2007 again!!