Balance Sheet Analysis. Significance of Book Value

 Practical Significance of Book Value: Book value of a common stock was originally the most important element in its financial exhibit. This idea has almost completely disappeared and book value has lost practically all its significance. This change arose because first, the value of the fixed assets, as stated, frequently bore no relationship to the actual cost and second, that in an even larger proportion of the cases these values bore no relationship to the figure at which they would be sold or the figure which would be justified by the earnings.

· In any particular case the message that the book value conveys may well prove to be inconsequential and unworthy of attention. But this testimony should be examined before it is rejected. Let the stock buyer, if he lays any claim to intelligence, at least be able to tell himself, first, what value he is actually setting on the business and, second, what he is actually getting for his money in terms of tangible resources.

· A business that sells at a premium to asset value does so because it earns a large return upon its capital; this large premium attracts competition, and, generally speaking, it is not likely to continue indefinitely. Conversely, in the case of a business selling at a large discount because of abnormally low earnings. The absence of new competition, the withdrawal of old competition from the field and other economic forces may tend eventually to improve the situation and restore a normal rate of profit on investment.

· Although this is orthodox economic theory, and undoubtedly valid in a broad sense, we doubt if it applies with sufficient certainty and celerity to make it useful as a governing factor in common stock selection. Under modern conditions the so called ―intangibles‖are every whit as real from a dollars and cents standpoint as are buildings and machinery. Earnings based on these intangibles may be even less vulnerable to competition than those which require only a cash investment in productive facilities. Furthermore, when conditions are favorable the enterprise with the relatively small capital investment is likely to show a more rapid rate of growth. Ordinarily it can expand its sales and profits at slight expense and therefore more rapidly and profitably for its stockholders than a business requiring a large plant investment per dollar of sales.

Therefore, it is not possible to lay down any rules on the subject of book value in relation to market price, except the strong recommendation already made that the purchaser know what he is doing on this score and be satisfied in his own mind that he is acting sensibly.

An Investing Principles Checklist

An Investing Principles Checklist

Risk – All investment evaluations should begin by measuring risk, especially reputational

􀂃 Incorporate an appropriate margin of safety

􀂃 Avoid dealing with people of questionable character

􀂃 Insist upon proper compensation for risk assumed

􀂃 Always beware of inflation and interest rate exposures

􀂃 Avoid big mistakes; shun permanent capital loss

Independence – “Only in fairy tales are emperors told they are naked”

􀂃 Objectivity and rationality require independence of thought

􀂃 Remember that just because other people agree or disagree with you doesn’t make you right or wrong – the only thing that matters is the correctness of your analysis and judgment

􀂃 Mimicking the herd invites regression to the mean (merely average performance)

Preparation – “The only way to win is to work, work, work, work, and hope to have a few insights”

􀂃 Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day

􀂃 More important than the will to win is the will to prepare

􀂃 Develop fluency in mental models from the major academic disciplines

􀂃 If you want to get smart, the question you have to keep asking is “why, why, why?”

Intellectual humility – Acknowledging what you don’t know is the dawning of wisdom

􀂃 Stay within a well-defined circle of competence

􀂃 Identify and reconcile disconfirming evidence

􀂃 Resist the craving for false precision, false certainties, etc.

􀂃 Above all, never fool yourself, and remember that you are the easiest person to fool

“Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things.”

Analytic rigor – Use of the scientific method and effective checklists minimizes errors and omissions

􀂃 Determine value apart from price; progress apart from activity; wealth apart from size

􀂃 It is better to remember the obvious than to grasp the esoteric

􀂃 Be a business analyst, not a market, macroeconomic, or security analyst

􀂃 Consider totality of risk and effect; look always at potential second order and higher level impacts

􀂃 Think forwards and backwards – Invert, always invert

Allocation – Proper allocation of capital is an investor’s number one job

􀂃 Remember that highest and best use is always measured by the next best use (opportunity cost)

􀂃 Good ideas are rare – when the odds are greatly in your favor, bet (allocate) heavily

􀂃 Don’t “fall in love” with an investment – be situation-dependent and opportunity-driven

Patience – Resist the natural human bias to act

􀂃 “Compound interest is the eighth wonder of the world” (Einstein); never interrupt it unnecessarily

􀂃 Avoid unnecessary transactional taxes and frictional costs; never take action for its own sake

􀂃 Be alert for the arrival of luck

􀂃 Enjoy the process along with the proceeds, because the process is where you live

Decisiveness – When proper circumstances present themselves, act with decisiveness and conviction

􀂃 Be fearful when others are greedy, and greedy when others are fearful

􀂃 Opportunity doesn’t come often, so seize it when it comes

􀂃 Opportunity meeting the prepared mind; that’s the game

Change – Live with change and accept unremovable complexity

􀂃 Recognize and adapt to the true nature of the world around you; don’t expect it to adapt to you

􀂃 Continually challenge and willingly amend your “best-loved ideas”

􀂃 Recognize reality even when you don’t like it – especially when you don’t like it

Focus – Keep things simple and remember what you set out to do

􀂃 Remember that reputation and integrity are your most valuable assets – and can be lost in a heartbeat

􀂃 Guard against the effects of hubris (arrogance) and boredom

􀂃 Don’t overlook the obvious by drowning in minutiae (the small details)

􀂃 Be careful to exclude unneeded information or slop: “A small leak can sink a great ship”

􀂃 Face your big troubles; don’t sweep them under the rug

In the end, it comes down to Charlie’s most basic guiding principles, his fundamental philosophy of life: Preparation. Discipline. Patience. Decisiveness.

Manappuram Finance returns more than 75% on your investment in less than 2 months

Dear Reader,

We suggested to buy Manappuram Finance on 21 Dec 2017 at 60 Rs and last week it climbed to 105 Rs resulting in gains of more than 75% only in less than 2 months.Recommendation here:

http://ankurjainraj.blogspot.in/2016/12/manappuram-finance-cheap-and-best-stock.html

In December stocks of micro finance and other sector specific stocks fell badly due to demonetization and everyone was predicting the end of the road for all of these companies in this sector.

(Read: http://www.livemint.com/Industry/CfB40Bu686ZaC6hk8isP7K/Cashdominated-microfinance-sector-reels-under-demonetizatio.html).

We had an entirely opposite view and recommended Manappuram Finance on 21 dec, 2016 at 60.2 Rs.It touched 105 last week.

The stock was available at very low valuations and was a great opportunity to add at lower levels.

In our last mail we clearly mentioned that 2017 will be the game changer for equity markets and will provide huge returns to investors. There are multiple reasons like GST rollout, shift from unorganized to organized sector, reduction in corporate tax, growth in developed countries. Don’t miss this opportunity to invest especially at a time when Indian stock market is at its inflection point. I repeat - this opportunity might not come again!!.

Budget 2017 has supported further economic growth by increased expenditure in infrastructure and reduction in income tax.

All the best.

Investing secrets -Part3

Secret #6: Identifying right set of stocks

The first step to master is to be able to recognize a great stock. As we have seen, they are not glitter stocks that have appeared on the front cover of an investment magazine or recommended by a popular share market commentator. Nor are they stocks that have a trader price pattern of breakouts, double bottoms, or candle-stick trend reversals.

The second is to know what to do when a great stock comes along.Buffett has said when everything meets your criteria of it being a great business at a fair price, then buy a “meaningful amount of the stock.” Of course, this means that you can only hold a small number of companies in your portfolio. The extreme exponent of only holding a small number of stocks was Phil Fisher. For Fisher, anything over six was too many.

The more stocks you hold, the more likely your returns will be average and the more time you will have to spend keeping track of the stocks in your portfolio. You also add considerable risk because you can’t study them properly.

The third step concerns knowledge and confidence. You need the knowledge to know approximately how often a great stock comes along. You won’t make the investors Hall of Fame if your criteria are set so high that you only get to swing every other decade. On the other hand, if they are set too low then, well, they are unlikely to give you the outcome that you desire.

Secret #7: Calculate how much money you will make, not whether the stock is undervalued or overvalued according to some academic model.

AS AN INVESTOR what is the right question to ask? Most ask whether the stock is undervalued or overvalued. The problem with this is that there is no way of properly determining whether a stock is, in fact, undervalued or overvalued.

There are various academic models for calculating what is called the intrinsic value of a stock. From my extensive experience of all these models, referred to as discount cash flow models, are fatally flawed. There are four areas that bring them down. They are theoretical, contradictory, unstable and untestable.

These problems are a rather technical to explain fully so I will only give the general ideas behind them. Just because some theoretical formula labels a stock as undervalued does not mean that you are going to make money from it. For example, perhaps the price will stay at that level. The models are contradictory since different values are obtained depending on which of the many variations of the models that you use.

They are unstable since insignificantly small changes in the input variables lead to changes of 100 percent or more in the intrinsic value. This means that in instead of the models being objective, they can lead to almost any output that is desired. And finally the models are impractical because they are untestable. Some of the input variables require verification over an infinite number of years. For example, forecasts of growth rates have to be made over not just five or ten years, but extending out forever.

This is precisely the criteria that Warren Buffett uses before making an investment. In the annual report of Berkshire Hathaway a few years ago he wrote, “Unless we see a very high probability of at least 10% pre-tax returns, we will sit on the sidelines.”

In other words, Buffett is focusing on expected return, not whether the company is undervalued or overvalued.

Of course, Buffett achieves a much higher return that this. The point is that he aims at a minimum level of 10 percent—his bottom line. By locking this in but leaving open the possibility for higher returns, he achieves his remarkable results.

Secret #8: Remove the weeds and water the flowers — not the other way around

FOR MANY IT is worse than having a tooth pulled to sell a stock for a price lower than what they paid for it. If you buy a stock for 20 Rs and it drops to 10 Rs, so long as you don’t sell, then it can be referred to as an unrealized loss. In this case you can say to your spouse, “Don’t worry, dear. It’s going to come back.”

Similarly, many can’t wait to sell as soon as they can see daylight between the purchase price and the current price. If the price has gone up be a few percentages, they want to sell and “lock in the profit”.

Peter Lynch and later Warren Buffett referred to this as watering the weeds and pulling up the flowers. They are examples of what I call investor diseases. The disease of holding on to your losers I call get-evenitis. The disease of selling winners I call consolidatus profitus.

Just how wide-spread these diseases are follows from a large-scale study carried out by Terrance Odean of the University of California in Davis. His study also showed just how expensive they are, being paid for in investors’ profits.

Reporting in the Journal of Finance, 1998, he found that people tended to trade out of winners into stocks that performed less well. In the opposite direction, the study showed that the losers in their portfolio tended to continue to underperform. It was really the case that once a loser, always a loser.

Overall he found that people would have been better to sell their losers and keep their winners. Instead, they did the opposite, namely keep their losers and sell their winners.

Suppose two simple changes were made: the investors sold their losers and held on to their winners. On average, the study showed that their average annual performance would have gone up by almost five percent per year.

The difference between the two strategies is even more marked when taxes are taken into account. When you claim a loss you are getting a tax rebate and so you want this as early as possible. In contrast, with a profit you are paying tax so you want to delay this as long as possible. But, as we just learned, the average investor tends to take profits early and losses late ending up on the wrong side of the taxman.

This gives us confirmation of secret number eight: Remove the weeds and water the flowers — not the other way around

Of course, this is an oversimplification. There are times when it is better to keep a stock when the price has gone down. In fact, it may well make sense to buy more. At other times, it is better to sell a stock after it has gone up. Each case has to be treated on its own merits.

This leads to the question. Just when should you sell? A large survey carried out by the Australian Stock Exchange showed that investors found it much harder to know when to sell than when to buy.

Similar results were found in a survey of nearly 300 investors that I carried out. Almost 50 percent said that they either regularly worry or constantly worry about when to sell their stocks.

The general rule which is full of common sense is: Sell only when you can be very confident that you can do significantly better with your money in another stock. The problem is to be able to determine when this is the case.

Secret #9: Become a conscious investor

THE FAMOUS GRAPHIC artist M.C. Escher said that “most of the time we are meekly sleepwalking on a treadmill.” In other words we are acting in an unconscious way and making little progress. This certainly applies to investing. Most of the time decisions are made based on either hope or wishful thinking or on abstract academic theories.

Fortunately investing is an area that responds well to becoming more conscious of what we are doing and why. “Risk comes from not knowing what you are doing,” Buffett said.

The whole direction of Conscious Investor is to place your investing, and hence your financial future, on a firm basis of sensible and knowledgeable investing.

Yet there is another part of being a conscious investor and this is to invest in companies with products and services that you support and believe in. When you become conscious of why you want to invest in a particular company, then risk can be substantially reduced. Investing this way helps to eliminate many of the unknowns whether psychological, emotional or material.

As those who have been to an annual meeting of Berkshire Hathaway will know, Buffett gets great pleasure from using and talking about the products and services of the companies that he invests in or owns.

When you do this investing becomes easier and more fun. You don’t have the worry of having your money tied up with enterprises that you know little about. Also you will become a more astute investor since you are picking up signals about the economics of companies long before they show up in its financial statements. 

Investing secrets -Part2

Secret #3: Scan thousands of stocks looking for screaming bargains

ONLY A HANDFUL of outsiders have been permitted to enter the inner sanctum of the Berkshire Hathaway offices in Kiewit Plaza, Omaha. When Chris Stavrou, the founder of the New York asset management firm, Stavrou Partners, visited the offices he reported seeing hundreds of file drawers full of reports on thousands of companies.

Two things stand out. Firstly, Buffett said that the reports were mainly annual and quarterly reports. In other words, material that is available to everyone. Secondly, he declares that he does not use a computer. Not even a calculator.

He is able to do without these standard aids since, as many people have attested, he has a prodigious memory. There are numerous examples of him being able to recall obscure facts about the companies that he has investigated, and their competitors, many years later. It seems that he has read, and memorized, a huge amount of the material in the filing cabinets.

This means that, when he is looking for quality investments satisfying his stringent criteria, he can scan through his own memory and couple the results with current prices. In the end, he is not looking for investments that are, with a little luck, likely to be slightly better than average. He wants them to be great investments by a large margin. “If (the investment) doesn’t scream at you,” he once said, “it’s too close.”

Few people have a memory to match Buffett’s. Even fewer have the resources to collect and index tens of thousands of documents on thousands of companies.

Secret #4: Calculate how well management is using the money they have

HOME BUYERS UNDERSTAND about equity. It is the value of the home less the amount owed to the bank. The same is true of a business. Its equity is the total assets minus all the liabilities. You can think of this as the money locked up in the business. It is a measure of how much money management has to run the business.

Another measure of the money available to management is the capital of the business. This is its equity plus the long-term debt of the company.

Clearly the success of any business is going to depend on how well management uses its equity and its capital. This is commonly measured by two ratios called return on equity and return on capital. Putting it simply, these are defined as the earnings of the company divided by equity and by capital. Their abbreviations are ROE and ROC.

Many companies consistently lose money year after year. So they do not even have an ROE or ROC. Others have very low values for these ratios. In other words, management is struggling to make a profitable use of what it has. Clearly, these are not the sort of companies that we should think of as quality investments. If management is only making a few percent on the money that it has, then over time this is all you can expect to make if you purchase shares in the company. After all, money can’t come from nowhere.

Every year, Warren Buffett writes in the annual report of Berkshire Hathaway that he is eager to hear about businesses that, amongst other things, are earning  “good returns on equity while employing little or no debt.” This means that ROE and ROC are essentially the same.

It makes sense. If you want a healthy return on any shares that you purchase, at the very least you need to select companies with management that is making a healthy return on the money that they have.

Secret #5: Stay away from “glitter” stocks

THERE ARE MANY thousands of stocks to choose from.Faced with these massive numbers and the associated deluge of information, investors get drawn to what I call glitter stocks. These are stocks that have some attention grabbing activity such as high trading volume, extreme movements in the price whether up or down, or when the stocks are in the news.

Even with the best of intentions, it is hard to look at these stocks in a clear and objective manner compared to the remaining stocks. Warren Buffett was so aware of this that he moved from New York back to his home town, Omaha, Nebraska. Regarding the benefits of living in Omaha, he said, “I think it’s a saner existence here. I used to feel, when I worked back in New York, that there were more stimuli just hitting me all the time… It may lead to crazy behavior after a while.” He ended by stating that it is much easier to think in Omaha.

A research study by Brad Barber and Terrence Odean of the University of California demonstrates very clearly the penalty to be paid by getting drawn into glitter stocks.

They found that, on average, individual investors tended to invest in glitter stocks more than professionals. Secondly, they found that by doing this they underperformed the market by anything from around 2.8 percent to 7.8 percent per annum.

Buffett has long understood this. For example, back in 1985 he said, “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”

Investing secrets -Part1

Most Admire Warren Buffett, But Few Try To Copy His Results.

Warren Buffett has been talking about his methods for decades — but few even make the attempt to understand what he is doing. “I have seen no trend toward value investing in the 35 years I’ve practised it,” Buffett declared some years back in the Chicago Tribune. “There seems to be some perverse human characteristic that likes to make easy things difficult.”

Most investors and fund managers are still caught in the impossible trap of trying to make quick money in the stock market. Preferably overnight.

Secret #1: Invest in quality businesses, not stock symbols

FOR MOST PEOPLE, investing in a stock is little more than watching the trail left by the stock symbol as its price wanders along some drunken path.

They know that the symbol is associated with a company while not being too sure what is expected of this company to ensure that its share price will rise. It is a case of let’s sit back and hope for the best.

Then there are others who deliberately do not want to know anything about the activities of the company. They want to study the “pure” movement of the stock price with the belief that they can use this information to make forecasts about the future movements of the price. Warren Buffett refers to this as trying to play bridge without looking at the cards.

It just makes no sense to ignore the fact that the stock symbol is attached to a company. And it makes no sense not to apply sound business principles to analyze these companies. The more we know about the company, then the more confident we can be about the price of the stock. Not on a day to day basis, but over time.

“When I buy a stock,” Warren Buffett said, “I think of it in terms of buying a whole company, just as if I were buying a store down the street.” If you were buying a store you would want to know all about it. What were its products? How consistent are the sales? Do they keep trying new products or do their products stay fairly constant? What competitors does the store have and what distinguishes it from them? What would be the most worrying thing about owning such a store?

This leads to the idea of looking for companies that have a strong and durable economic moat. Just as castles have moats to protect them from invaders, so companies can have economic moats to protect them from challenges of competitors and changes in consumer preferences. The moat can be made up of attributes such as brand name, geographical position or patents and licenses.

All these principles about purchasing businesses are equally applicable to purchasing shares. It becomes one of the most enjoyable parts of investing to look into the “business” aspects of any company that you are considering adding to your portfolio.

Secret #2: Don’t invest for ten minutes if you’re not prepared to invest for ten years

WHEN WE LOOK at the share price of a company we usually see a wildly fluctuating graph with mighty hills and plunging chasms.

For example, on the right is the graph of the daily closing prices of a company over ten years. It would be a brave person who could look at this graph and say what was going to happen in the next 24 hours, let alone the next 5 to 10 years. Yet this is a typical graph of the prices of a listed company.

But what about this graph? Because it is growing so consistently we would have a lot more confidence in making forecasts of what was going to take place in the future.

This graph is of the earnings per share of a company. If you were buying a company, this is just what you would want — a company whose earnings and sales go up like clockwork by 15 or 20 percent or more each year. It is no different when you invest in companies via the stock market.

Clearly it is an advantage to be able to find companies with such steady and strong growth in earnings.

When we locate such companies, we are well on the way to finding quality investments. Warren Buffett said a few years back, “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”

We must put together a portfolio of companies whose aggregate earnings march upwards over the years, and so will the portfolio’s market value.

In other words, as investors, we focus on the medium to long term business characteristics of companies. It is these that drive the share price.

Focusing on the short-term aspects of a company including both business and price fluctuations is foolish as Buffett has said. “Most of our large stock positions are going to be held for many years, and the scorecard on our investment decisions will be provided by business results over that period, not by prices on any given day.”

The exciting thing about value long-term investing is that time and time again,you 

outperform the market in the short term as well as in the long-term. If you own shares in a portfolio of great companies with sales and earnings moving upwards that you bought at sensible prices, then it often doesn’t take long to show up in the share price.

Only one stock is enough to create wealth.We have MANY!!

Here is the performance report of stocks that has been recommended by us:

• We Recommended ***a** Software on 3rd Oct,2016 at 151 Rs.It has given returns of 40% in just 3 months.
• Eicher motors bought at 4200 Rs and sold at 20100 Rs resulting in gains of 478% in 2 years.
• Can fin homes recommended at 380 rs and still holding at 1660 rs.
•  F**T** R** has doubled in 1.2 years.
•  Another software company was sold with gains of more than 200%.
•  A cooler making company has given hefty gains in last 5 years.
•  Our December 2016 recommendation is up 20% till now(in less than 2 weeks).
•  Mayur unicotter had risen 15 times while cera sanitaryware has risen 18 times and still a buy!!

To get such ideas , please drop a mail to: ankurjainraj@gmail.com