VALUE INVESTING AND TWO VALUE PICKS

Value Investing as a term,  has its genesis in the teachings of Benjamin  Graham and David Dodd who taught  at Columbia Business School in 1928 and subsequently developed the “value investment” paradigm in their 1934 classic, “Security Analysis”, one of the must read books on my list, for any  investor who wants to jump into the deep end of stock market investing. Although value investing has taken many forms, in simpler terms it implies buying a rupiah for aath aannas.

For readers who may not be familiar with the term of aannas. A rupee has 100 paise and in old times 6 paise was equivalent to one aanna.  It is an older version of VFM (value for money) buying. The Indian housewife or home maker is the best value buyer. She buys a Kg of tomatoes from the vegetable vendor after a hard bargain, checks every tomato for its ripeness, firmness and texture. And then she also gets some free green chillies and fresh coriander along with it. In stock markets, it implies buying securities whose shares appear underpriced through fundamental analysis.

The poster boy of value investing has been Warren Buffet, the Berkshire Hathaway chairman and an astute value investor. In India, Sanjay Bakshi (Tactica Capital Management) , Chetan Parikh (Jeetay Investments) and Parag Parikh(PPFAS) are the best value investors, I am aware of. They have their own investment firms and outfits and they manage their own money except for Parag Parikh who does portfolio management for investors with Rs 25,00,000 or above as per SEBI guidelines and is planning to launch a mutual fund next year.

The main premise of value investment is buying stocks at less than their intrinsic value. The discount of the market price to the intrinsic value is what Benjamin Graham called the “margin of safety”. Value investing hinges on the capacity of an individual to have discipline and patience. Qualities which have more to do with EQ rather than IQ.

Benjamin Graham’s has always proposed looking at the past record and not the future estimates. Facts are for real, projections are fiction. He advises investors to normalize the last five years data of net profits/EPS, dividend payouts, cash flows, debt etc. What it says is, “Total up the EPS of last five years, divide by five and now judge the PE multiple based on this EPS and not on just last year’s EPS”. Graham’s criteria of value investing are listed below:-

• Debt-Equity Ratio has to be < 1. (I personally prefer companies with zero debt.)
• P/E of the stock has to be less than the inverse of the yield on AAA Corporate Bonds. The current yield on AAA corporate bonds in India is about 10.5%. So, calculate the EPS/Price ratio. It should be greater than 10.5%.
• P/E of the stock should be less than 40% of the normalised PE over the last 5 years.
• Dividend Yield > Two-Thirds of the AAA Corporate Bond Yield.
• The company should have an uninterrupted dividend record for last 20 years.
• Price < Two-Thirds of Book Value
• Price < Two-Thirds of Net Current Assets
• Current Assets > Twice Current Liabilities
• Debt < Twice Net Current Assets
• Historical CAGR of EPS (over last 10 years) > 7%
• Not more than two years of negative earnings over the previous ten years.
• Price/Book Value < =1.
• Check out what is the company doing with the profits? Good companies invariably do three things with the profits earned:  invest more in the business so as to increase profits/distribute the profit to share holders/hold cash in liquid investments to acquire another business and integrate and consolidate existing business. If the company is not doing any of these three, it is best avoided. And this is indicated by a healthy Operating Cash Flow.

My personal start point of evaluating a stock starts with the market capitalization. It tells me what is the whole business worth? For example, if I have Rs 221 cr, I can buy a company called National Peroxide (as I write, the stock is selling for Rs 372.50). Were I to buy this whole business would it be worth it? When I get answer to that question as a minimum 85% Yes on my evaluation parameters. I go and buy the stock. But before that I do go through the lengthy and cumbersome process of taking out the annual reports, reading the financials, sifting through the chaff etc, etc.

Two value buys as per my analysis at prices of 08 June 2012 closing are PIRAMAL HEALTHCARE (Rs 431) and  NATIONAL PEROXIDE (Rs375). I can give my reasons individually for both companies in the form of an analyst report but I will keep it for another blog. Meanwhile if you have the patience and discipline to not get swayed when others are panicking, then buy these stocks and leave them for at least five years for good returns.

Disclaimer: I hold Piramal Healthcare in my personal Portfolio.