"Equity- Rocket Science" June 20th 2008.

"Equity- Rocket Science" June 20th 2008.
We all enjoy stories in which extraordinary things happen to ordinary people. An unemployed auto worker wins a 100 million lottery jackpot. A 75 year old mother of five and grandmother of 15 finally goes back to college to complete her degree. We take pleasure in both the situations, but the second case is more satisfying since the good news is not the result of luck, but the result of hard work and courage. We love to see virtue rewarded. In the world of equities folk often says Investing in a particular stock was lucky !, one should aware very well before Investing that stocks performance is luck or any science working behind the performance of the stock !. What this Equity science? Is it a rocket science to understand ? .Everybody wants know and try to understand the jargons and formulas of equity science to create multi bagger stories in their portfolios. In my regular interactions with investors , I found that Investors are curious to know more about the Fund Managers & Equity Strategist 's educational back ground , experience , AUM and earlier funds they were managed etc ., Some people asks this fund manager was from which B-School ?...IIMs , Harward or wharton ..? Because Investor belief is that , these Fund Managers & Equity strategist are well versed with the Equity science to manage and enhance their wealth more efficiently. And on other side of the coin i came across the investors who efficiently managing their funds with multi bagger stocks in their portfolio without having any professional qualification , to my surprise friends ! no other Fund Manager probably in the equity universe can match their returns generated over a period of time. If you are a firm believer investing in Equity is a science means you are RIGHT, but its more like common sense !.The top Fund Managers of 20th century Mr Warren Buffet from Berkshire Hathway ,Mr Peter Lynch - Fedelity , Mr John Templeton- Templeton Investments and my favorite Fund Manager Dr Mark Mobius are successful managing Billions of Dollars. Let me focus on few multi baggers , Rupees one lakh invested in 2002 in a company called Unitech would have been worth of 5.84 crores by April 2007 or 1.52 crores if it had been invested in Aban offshore. If somebody says I invests in stocks , in my opinion they are wrong , I invests in businesses rather than stocks , Investing in stocks involves identifying companies and shop for Quality , Value and Growth. I would like to analyse what are core ideas and analysis one required to be successful investor.
Management : Management is the life blood to the company , one needs to analyse the dynamism and quality of the Management , just observe the transition in the companies products and services , an edible oil processing company transformed as India's software services giant as WIPRO, A nylon polyester manufacturing company transformed as one of the worlds largest oil refining company with interest in various diversified businesses as RIL. we can observe a clear sheer Management brilliance in the both the companies . How effective is the management ,taking the advantage of changing economic environment and taking the company ahead with a great vision to capitalise the opportunities coming in the way is very important . ITC is the company transforming their outlook from a pure tobacco based company to a FMCG company. If the management is dynamic means it doesn't matter what type of industry and sector they operate , these managements excel in the art of creating value to the investors. Mr Laxmi Mittal known in the art resurrecting the sick steel plants to transform high margin yielding and profitable houses. where as steel as a sector cyclical in nature and bears less valuations in the market because of high gestation period , highly fragmented nature of industry throughout the world, and shortage of iron ore reserves . But Mr Mittal succeeded in the process of consolidating the industry and creating value to the share holders. The prime duty of the fund manager 's and investor is to feagure out these kind of Managements vying to transform to cash the opportunities and desperate to create the value to share holders. In the last three years of equity market from 2005 to 2008 markets are run up from 7,000 to the current levels , most of this happened because of unlocking value from the companies and de mergers . Some times internal disputes also surprises the share holders , tussle between Mr Ambani brothers given birth to R-com, RNRL , R-capital ventures . These are the times to the corporate India's managements to start creating value rather than unlocking values. While investing in a company one should look at the management traits how effectively manages the systematic and unsystematic risks is very important .
Price to Earnings ratio : A ratio everybody speaks and try to understand ,Price to earnings ratio is the key ratio to know How a stock is trading in the market in comparison with its earnings , we can derive this ratio by dividing current market price by number of outstanding share. feaguring out PE ratio is very easy by simple calculation but the crux and confusing portion to the investors is weather the current PE ratio justifies it price or not is vital. WIPRO which was trading in the band of 500 PE ratio during 2000. Capital goods as sector always enjoys high PE multiples . Historically Steel as a sector trades in low PE ratio. While tracking PE ratio one should keep in mind PE is more relating to the Earnings i.e P&L account , the current earnings growth will sustains or not one should keep in mind while assessing the PE ratio. Another way to get a peek into the future prospects of a company is by looking at its PEG or price-to-earnings-to-growth ratio. Anything under 1 is great, although staring at a 1.1 or 1.2 isn’t going to steer me away from a company. How does PEG work? Let’s say a company has a P/E of 12. And that company has projected annual earnings over the next five years of 12%per year. It would then have a 12:12 PEG ratio or a ratio of 1. If its projected growth rate is 15% per year instead of 12%, its PEG ratio would be less than 1. Fund Managers would die for such a ratio.
Price to Book value: A ratio used to compare a stock's market value to its book value , price-to-book (P/B). The “book” refers to net assets or assets minus liabilities. A P/B less than 1 either means you’re getting a great buy on the company or its assets are worth as much as shares Think about it. At a P/B of 1, the price per share you’re paying is the same as the value of the net assets per share. That means everything else you’re getting with the company is free. The business – and the profits it generates – IS FREE. The future growth of the company? Free too. A P/B of 1 or less is a phenomenal ratio. But anything less than 2 is still considered good. I like EBITDA (Earnings before Interest, Taxes,Depreciation, and Amortization) much better – and I believe EV (enterprise value) to EBITDA is a much better ratio than P/E.EV is simply the market capitalization of a company plus its cash minus its debt. It’s called “enterprise value” because that’s what you would pay for the company if it were up for sale. Investing in company is all about buying a growth at cheaper rate , there is no specific acid test to measure as we are buying at cheap or not . One more point i like from the thesis of Mr Warren buffet is Moats let me just brief about Wide Moats : How much distance can a company put between it and its competitors by being a technology, brand, or marketing leader? This is an easy concept to understand but a hard one to put it into practice .Ford and GM probably once thought their brand recognition gave them a wide and deep moat over their obscure Japanese competition like Honda (more known for motorcycles or lawnmowers than cars at that time).Wide moats creatse the efficiencies and high margin variation when compare with its peer group companies . Don't invest in a company for longterm where you can't understand their business model.
Ace fund manager Mr Peter Lynch rightly said " its futile to predict the economy and interest rates " .While investing there's always something to worry about in the market, one should shut out market noise and concentrate on company fundamentals, using a bottom - up approach. Invest for long run and pay little attention to short term market fluctuations. Equity science is not a rocket science to understand , One should develop a clear idea to understand Equity science to invest in stocks without scaring the market fads.