Tag Archives: Business

The Investor and Inflation

Posted on by under Bibliophile: The Intelligent Investor

We all have some needs, some desire in life and we work for fulfilling those. But due to Inflation, our purchasing power get reduce which has always remained a serious question for all of us. We all working hard to beat inflation and enhance our purchasing power. We save, we invest money for our future life. The very popular story everywhere at the market prevailing is a common stock investment is a better tool to beat inflation compared to the bond investment. But is it true in all the situations? We know that every-time it is not true; many a time, good stocks do not give a good return compared to the bond. We need to focus on the valuation of the stock and yield available on the bond. It is very much possible that good stocks can be traded a valuation of the great stocks which can be harmful to us to beat the inflation by investing in it at such a valuation. And at such a valuation, investing into the bond becomes a better choice. Good business is not always a good investment.

Common stocks do not have an inheritance feature to always beat inflation. Yes, it is acceptable that stocks have delivered a good return compared to the bond in the past. But for the future, we need to look at the future of the growth of the economy, growth of the corporate earnings, etc.

If we see the growth of Japan then GDP grows at ~3% CAGR since the year 1981 and similarly their stock market also has given a return of 3% CAGR since the year 1981. Nikkei still is not able to break the higher level of the year 1989. So for growth of the investment return, underlying companies/economy also has to grow otherwise we are not able to earn by making an investment.

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When inflation keeps on rising then companies need to bring more capital for growing sales (as the purchasing power of the company reduces) at similar peace. Such a scenario creates difficulties for businesses to survive and grow further. When companies need additional capital to grow similar sales level, then return on incremental capital will reduce, also companies cannot able to put capital to the new projects as old projects require additional capital. This also can enhance a debt level or the external funding to run a business and that can hamper the profitability.

One of the communication company

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We can see that the capital employed of the company is growing at 16% CAGR and sales growing at 8% CAGR. This means for growing a similar business, the company need to make a twice of capital employed. So that company keeps on requiring external funding to grow the business. Here, we can see that company having a negative working capital cycle though the company needs to bring external funding to grow or maintain the business. There is much business which having such problems and those businesses require to have a huge capital to grow and to even maintain the business.

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Hyperinflation stop consumer to buy more and more goods as their purchasing power starts getting reduced. During such time, businesses do not rise a price to overcome the impact of the rising cost of raw material and other utilities. So that hyperinflation can hamper the earning, growth of the companies and which having an adverse impact on the annual investment return during those time period.

Many people make an investment to the gold, real estate, old paintings, old currencies, etc. for beating inflation but such a scenario does not seem to be practical even. Real estate is a hot investment for getting protection against inflation. But if we missed with a location, the price needs to pay, etc then we also do not protect ourselves against inflation by investing in the real estate.

We should not focus on the one and only basket by seeing the huge return in the past. We should focus on the different basket for making an investment. As we have experience in the near past that due to good return from the equities, people have started making an investment into the equities and market got a huge liquidity flow which has bring the market to the record high level. Similarly in the past for the real estate market.

Our investment success does not count by how much % of return, we have made through investment but how much we left after adjusting inflation is considerable. That means if we have earned 20% return on our investment and inflation is 8% then we need to consider our return is 12% after adjusting inflation. And if our investment is not able to generate a positive return after adjusting for the inflation at a longer period of time then that is of no use for us.

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Similar thing with the Indian economy, we also experienced a Current Account Deficit and we have to borrow money for supporting the economy. If the hyperinflationary situation starts prevailing to an economy then it will become difficult for the economy to grow further. We need to bring more fund to just maintain the existing state of living.

Disclosure – Companies mentioned in the article is just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

 

SIMPLE IS BETTER – ISSUE -16 – NUMBERS TELLS YOU EVERYTHING

Posted on by under Simple is Better

We have seen that equity investment has provided decent returns to those who have made an investment into a decent business with having decent management. I have also explained a similar concept to my articles of Pat Dorsey and Kite Flying regarding business + management combination.

Accounting is a language of business, we need to understand it well so that we can make communication with numbers.

I will try to explain all manipulation in a simple manner into the upcoming issues of the same series.

Entire series of “Numbers tells you everything” is based on the books –

I have tried to cover up concepts available with the above books.

For Detail Issue, Click here —> SIMPLE IS BETTER – ISSUE -16 – NUMBERS TELLS YOU EVERYTHING

BIBLIOPHILE: WARREN BUFFETT’S LETTER 1957 – 2017

Posted on by under Bibliophile, E-BOOK

Mr.Buffett has taught us – 

Never count on making a good sale. Have a purchase price be so attractive that even a mediocre sale gives good results. The better sales will be the frosting on the cake.

Our business is making excellent purchases – not making extraordinary sales.

Mr. Buffett believes that big money can be made by making investment decisions based on qualitative factors whereas sure money can be made by making investment decisions based on quantitative factors. And hence, on the basis of this; he considers himself as a quantitatively focused investor.

The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share.

Business must have two characteristics: (1) an ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume, and (2) an ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital.

Many a time, management only focuses on the increasing future Earning Per Share (EPS) by sacrificing the strength of the balance sheet. But they forget that if the balance sheet does not remain strong for a longer period of time then business is going to have a tough time into the future.

Accounting numbers, of course, are the language of business and as such are of enormous help to anyone evaluating the worth of a business and tracking its progress. Charlie and I would be lost without these numbers: they invariably are the starting point for us in evaluating our own businesses and those of others. Managers and owners need to remember, however, that accounting is but an aid to business thinking, never a substitute for it.

“What we learn from history is that we do not learn from history.”

Any company’s level of profitability is determined by three items: (1) what its assets earn; (2) what its liabilities cost; and (3) its utilization of “leverage” – that is, the degree to which its assets are funded by liabilities rather than by equity. Great companies = Float + Investment + Cash with higher return ratio

If the choice is between a questionable business at a comfortable price or a comfortable business at a questionable price, we much prefer the latter. What really gets our attention, however, is a comfortable business at a comfortable price.

Buy commodity, sell brand has long been a formula for business success.

Capital-intensive business, look for PBT / interest cost rather EBITDA / interest cost.

When we are fearful with our investment decisions then we focus on the each and every aspects which can result in the erosion of the capital.

Mr.Buffett has taught us many concepts and wisdom which is essential to us while making an investment decision. I am hereby compiling all my learning from the letters of Mr.Warren Buffett. Also an evolution of Mr.Buffett from bargain to quality businesses.

For all in one learning from Mr.Warren Buffett’s Letters, Click here –>  BIBLIOPHILE WARREN BUFFETT’S LETTER 1957-2017

What can be a probable return from SENSEX in coming 10 years?

Posted on by under You, Me and Business

I have written on this topic is due to current market fall and fear into the mind of an investor. We are seeing many uncertainties hindering the growth of the economy, rising crude oil prices, commodity prices, fiscal deficit, banks NPA, government expenditure, rising interest rate, the success of GST, structural changes into the economy. All such events will impact the growth of business positively or negatively. If we try to put all such events into different scenarios then we can come to know what can be a probable return from SENSEX in coming 10 years.

For the calculation of probable return, I have taken a formula which is given by John P. Hussman. John P. Hussman is the U.S.A stock market analyst and owner of the hedge fund.

Formula –

Annualized Return (%) = (1+g)(future PE or P/BV / current PE or P/BV)^(1/T) – 1 + dividend yield (current PE or P/BV / future PE or P/BV + 1) / 2

G = Business earning growth,       P/E = Price to Earnings ratio,          P/BV = Price to Book Value ratio

Return of our investment is based on –

Business Earning Growth – Our investment return will grow if particular business earning will grow. Investment return is directly related with the earning of a business. If business survives for the longer period of time with generating the higher return on invested capital with earnings growth then we will able to earn a decent return from particular business.

Dividends – Dividends comes from the earning of the company. If a company distributes dividends to shareholders with growing earnings, the dividend is an additional return for the shareholders with the appreciation of business value. As per Mr.Buffett, if the company does not have a reinvesting opportunity available or business does not able to generate a higher return than the cost of capital then management should distribute earnings in form of dividends.

Changes in the valuation – the Stock price of the particular business is also affected by the changes in the valuation such as changes into the P/E, P/BV, P/S (Price to Sales) or Market Cap to Sales, etc.

Assumptions –

  • Dividend yield (%) is assumed to be 0.50% to 1.00%.
  • Business Earning Growth (%) is assumed 3.50% (a rate, which is half of the current GDP growth), 7% (current GDP growth rate) and 14% (twice of current GDP growth rate). Assuming average earnings growth of various businesses comprises SENSEX.
  • Future P/E taken as 19x (Historical average of last 20 years since the year 1998), 21x (10% premium on historical average P/E) and 23x (20% premium on historical average P/E).
  • Future P/BV taken as 3.29x (Historical average of last 20 years since the year 1998), 3.62x (10% premium on historical average P/BV) and 3.95x (20% premium on historical average P/BV).

SENSEX

We can use a similar kind of valuation matrix for the particular business itself. Here, I have also shown valuation calculation of an air cooler manufacturing company of India, I have calculated as I was at the year 2012 and what can be a probable return from particular business till the year 2022.

Stock 1

If we consider actual business performance then sales of the company have been grown by 17% CAGR since the year 2012 to the year 2018. But the stock price has been increased to Rs.2209 (high price and the current price is Rs.967) from Rs.130. This entire return is come to the stock only because of valuation multiple expansion such as P/E, P/BV, EV/EBITDA etc. Similar period has P/E increased to 85x (high P/E and current P/E is 46x) from 23.63x and P/BV increased to 33x (high P/BV and current P/BV is 11x) from 5.84x.

Disclosure – I am not using this valuation matrix in my investment journey till now. This is only one of the valuation matrix and we need to use a different appropriate valuation matrix for reaching to a value range.

Learn matrix from –

http://hussmanfunds.com/wmc/wmc050222.htm

https://www.gurufocus.com/stock-market-valuations.php