WHAT CAN BE A PROBABLE BOTTOM OF INDIAN STOCK MARKET?

Posted on March 28, 2020 by Jimit Zaveri under Investment Philosophy

We have seen a sharp fall in the market these days. Now, everyone has a question that what can be a probable bottom? where we should start buying? Bottom of the market already made? Should we buy or will we have missed out this opportunity? Yes, Nifty has reached to the fair value zone but pendulum never stayed at the middle zone it will go extreme to both the direction. So, we have seen upside extreme and now have to see downside extreme move.

Before starting answering the above questions, here, I am requesting you to read my old article which I had posted on 4^th August 2019. In that article, I mentioned regarding market fall. Please first go through that article because the current article is a continuation of that article.

THE INTELLIGENT INVESTOR – 3 – A CENTURY OF STOCK-MARKET HISTORY

Now, if we analyze current fall then we can say that Indian corporate and GDP has witnessed a limited growth in the past. Also, Covid-19 virus has disrupted the entire world economy. Majority of the economy has started giving a revival package but if we look at the speed of the spreading of Covid-19 and death of the people then it is very painful for us as well as the economy.

Our PM has announced with the 21 days lockdown to fight against the Covid-19. We have taken this step well in advance so that we can able to control the situation, because if the situation will go out of control then we do not have a proper infrastructure for citizens to cure.

I have taken a few data from HDFC Bank India growth outlook 2020, cost of lockdown.

By looking at the above data and havoc of Covid-19 in the world, it is essential to go for the not only lockdown but to declare an emergency in India. Now, let’s go to the economic impact of this mayhem. People can oppose that government of the majority of the economy has started announcing a revival package. But We have to think that it’s not a financial crisis where you pump liquidity into the system and things will start recovering. It’s taking the lives of people so what will change after the liquidity get infused. People try to save life rather use those liquidities. So, disruption can take time to revive. If this problem can worsen it will be led to a financial crisis which is still pending to come. It’s just my thoughts, don’t know what can happen but this thing looking worse than any financial crisis.

If the normal situation has come where growth remains subdued then the market can remain in range but here this difficult situation can hamper the earning badly. we have to understand that our states of India are equivalent of the many of the country where corona has done huge damage. Here, the world economy gets hamper, trade around the world hamper, supply chain get disturbs, corporates have to fund fixed cost, they only can manage variable cost through the lockdown.

Many of the articles and reports indicating towards global recession and as intense as the recession of 1929. I don’t know that will happen or not but I only can pray that such will not happen because it will take many further issues with many of the lives. Let’s not getting into the debate and do some number crunching which is always my favourite.

Current, Nifty EPS is ~Rs.444 so proceed with the calculation based on that. I am assuming current EPS will remain same for FY20 and all degrowth will account in FY21 and FY22 (if the situation will not come to the control then FY22 will also go for a toss).

I have taken the bank rate as an SBI FD rate after the rate cut.

Now, if we look at the earnings yield to bond yield ratio then it has reached at the 1.03x in the current period. If we take same EPS and take that ratio to the worst happen during the 2008 – financial crisis then it was 1.11x so nifty level come to the 8000 but Covid-19 will going to hamper earning growth and might be a new level of earning yield to bond yield ratio can come, which I have taken a range of 1.25 to 1.50 with a different scenario.

If things will be in control in coming few days then might be 5% degrowth can be possible and then market also maybe get stable at the old worst level of earning yield to bond yield ratio – 1.11x to 1.25x. But if things will get more worst then now and continue with coming 1-2 months then 10% degrowth in earning can be expected. I have made a study in S&P500 of USA and in that market earning yield to bond yield ratio has reached around 3x in worst level which I am not considering as of now. If we see that then past falls in the market have accounted for ~50% fall from the top so that that will also come to ~6215 level.

Now, another point is that earnings growth always essential for generating returns in the market. So that market can be remaining in the range till no sign comes for earning growth revival because, on the hope of earnings growth, the market has already run a lot.

I have posted an article on WHAT CAN BE A PROBABLE RETURN FROM SENSEX IN COMING 10 YEARS? a way back and where I have taken SENSEX level after 10 years on worst earning growth of 3.50% came at 43547 on P/E and 57678 on P/BV based. So, if earning growth cannot revive then the market can remain in range for a longer period. But from the current base, we can have a good chance of making a return in the range of 4-7% CAGR in the index overcoming 10 years. Tax cut reform will also aid in earning growth coming forward. We only have to pray that situation will not worsen from here and for that we have to stay at home, stay safe and fight against Corona.

#Stayhomestaysafe #Stayhomesavelives #Fightagainstcorona

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

The Intelligent Investor – 11 – Security Analysis for the Lay Investor: General Approach

Posted on October 27, 2019 by Jimit Zaveri under Bibliophile: The Intelligent Investor

A security analyst has to deal with the past, the present and the future of any security issues. The analyst works on the understanding of businesses, financial strength, strong & weak points, possible risk, future earning power under the various scenario, etc. after all works, he decides whether to invest in the given security or not. We do not always rely on past performance, but for selecting the growth stocks, we need to value a future earning power and growth rate. Additionally, we should not forget the past performance given by the businesses for making a mathematical calculation of valuations. When we forecast for the longer future horizon then it will become the involvement of more errors.

Bond analysis

We need to focus on the safety, quality of the bond issue. And our prime criterion should be several times interest charges have been covered by the earnings currently. Cover on the average earnings of previous years and cover on the poorest earning year. As preferred stock dividend is not tax-deductible so that we need to check cover on PBT to interest charges + 2x of preferred dividend.

With the above points, we need to check the size of the company, (debt + preference stock)/equity ratio and property value. Now, if bonds passed through the stringent test and survived into the past performance then it has a higher probability to survive into the future. If the bond does not meet such criterion then it must be avoided though it offers a 2-3x yield compared to the risk-free rate.

Common stock analysis

Valuation of common stock needs to perform for deciding whether a common stock is attractive to purchase or not.

II C11 01

This means estimating future earnings and then multiplying it with the multiples. Multiple decided as the 1/expected earning yield. For example – if I expected to get 6% earning yield then my multiple would be 1/6% so multiple will be 16.67x. Different people provide different multiples and estimate different earnings which tends to a different price target for them. Why one company available at 10x of earning and other at 20x of earning? Do we pay rightly or paying overdue to a rosy picture? These all questions getting answered by the following factors –

Long term prospects – we cannot able to know that what will be going to happens in the longer future but then also, we try to estimate for the far future. This estimation creates a different multiple for the same stock. Also, need to check that whether the company is a serial acquirer or they make an investment to own company? If serial acquirer then what is the track record of previous acquisitions? Whether the company able to generate enough cash from operating a business or has to rely on other people’s money? Whether diversified customer base or rely on one single customer?

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Does the company spend money on research & development, developing new products though they have a successful product? (R&D as a % of sales) and also how much company is spending on selling and marketing? (Selling & marketing, distribution spending as a % of sales)

One of the Pharma company of India

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A company having R&D and Selling spending combined account for ~16.73% of sales. Such spending improves the longevity of earnings. Sales and profit of the company have grown by CAGR of 17% and 26% respectively during FY12-19.

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Management – we know that management plays an important role in the development of the business. And many a time, given weight to the management leads to overvaluation or undervaluation to the stock. If any business is continuously successful for a longer period then it will be considered as having good management. Does management has fulfilled promised made by them? How they behave while meet failure – they admit failure or pass responsibility to the economy, uncertainty, weak demand, etc.? Look at their behavior during the best period. Does senior management involve the frequent buying and selling of shares? Does management involve to direct the market speculation through announcement? Does the financial statement of the company is transparent?

All the above points provide a study of qualitative aspects of the management part. If we focus on the above points then we can avoid the management who is not shareholder-friendly.

Financial strength and capital structure – one company has an excess of cash on the balance sheet and another one has a bank loan + preference shares + bonds then we should consider the first one good compared to the second one though both have the same revenue, EPS, etc. Good business does not frequently require huge cash to run a business and they generate a good sum of money.

I am not quoting any example over here; I have already explained the same in Warren Buffett’s 2007 letter article. And many businesses pass and fail from the above parameters.

Dividend – consistent dividend payment is one of the criteria for judging the quality of the company. Defensive investors will focus on the consistency of the dividend payments. We also have to check that the company paying dividends out of free cash flow or from borrowings.

One of the steel manufacturing company

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There are few companies which are into the expansion phase then also paying out dividend by taking a debt and equity dilution rather retain cash for expansion. In such cases, we should not focus on the dividend. Also, if the company can grow with generating a good return ratio then we should prefer to retain cash for expansion purposes rather than the distribution of dividends.

One of the retail company

The company has good growth and over some time, the company has started generating a decent return ratio. Here, the company does not require to distribute dividends and retain cash for expansion of the business which the company is doing with zero dividend payout.

If the company does not have a growth opportunity and does not require to bring external funding to run a business then it is preferable to distribute earning as a dividend.

Dividend policy – how much company is distributing profit as a dividend, higher the dividend distribution higher the valuation the company gets. Here, we need to see that whether dividend serves the purpose of shareholders or retaining profits for future expansion serves the purpose. The company should buy back the shares when it available cheap, not when it traded at high/overpriced.

The capitalization rate for growth stocks

Value = Current Earnings * (8.5 + 2 * Expected annual growth rate)

*Expected annual growth rate would be considered as growth for upcoming seven to ten years

Industry Analysis

For making an analysis of any security, we need to check the industry growth, position of the particular company within industry, how industry will grow and earn profits, what was the past of the industry, what is present state and what will be the future state of the industry, what will be the new product and process.

For calculating the value of the company, we need to check how the company has performed into the past and what are the factors which can change the future performance of the company. Calculate valuation on the past performance and list down the factors which make changes to the valuation based on past performance. Also, mention points that can change the future performance of the company.

Disclosure – Companies mentioned in the article are 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

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

Posted on November 11, 2018 by Jimit Zaveri 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