The Intelligent Investor – 19 – Shareholders and Managements: Dividend Policy

Posted on December 22, 2019 by Jimit Zaveri under Bibliophile: The Intelligent Investor

When a question about the questionable management getting asked the shareholders then –

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It is always a debatable situation for paying a high dividend or reinvesting profits into the business.

One of the finance company which paying out lower dividend but reinvesting to the business

Bajaj Finance

One of the capital goods company which pays out a decent dividend

Greaves Cotton

If the company does not require to make a reinvestment of profit and no further huge growth opportunity then the company should pay out a higher dividend. But if a company does not pay out a dividend or pay with a lower payout then market price can be seeming to be lower to the fair value.

Another point is when the financial position of the company is not favorable then the company should work on paying out debt and other obligations first rather pay a dividend.

One of the steel company of India

TATA Steel

In theory, we have learned that equity shareholders are the owners of the company but in practice, such things do not go to happens. As a minority shareholder, we need to follow the recommendations given by the management. We cannot go against them.

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There can be two types of problems, we found among the management. First, they are not able to run the business efficiently and second, they do not work in the favor of minority shareholders, they make decisions that help them & create their personal wealth. We need to thoroughly read annual reports, footnotes, corporate announcements, etc. for understanding the efficiency and shareholder-friendly behavior of the management.

For checking the efficiency of the company, we need to compare the company with its peers in terms of profitability, size, growth, competitive advantage, etc. If the company is doing better than peers consistently for a longer period of time, then we can say that management can able to run the company more efficiently.

For checking the shareholder friendliness of the management, we need to check compensation, stock ownership, related party transactions, etc.

Though We are owning a 100000, 1000 or 1 share of the company, if we do not read an annual report of the company and company has gone for a toss then we need to only blame ourselves.

The stock repurchase is considered a good strategy, the dividend comes with tax obligation but buyback is tax-free and also improves financial of the company. But in reality, the company issues ESOP to the executives as a performance bonus and that will end up with the dilution of the equity. Many times, buyback is done for counteracting such dilution. Also, stock buyback is done at the overvaluation or at the undervaluation is matters a lot.

SIMPLE IS BETTER – ISSUE -13 – BUYBACK

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

The Intelligent Investor – 18 – A Comparison of Eight Pairs of Companies

Posted on December 15, 2019 by Jimit Zaveri under Bibliophile: The Intelligent Investor

We should take care when company deliver their promises but actually traded at more than their promises. Companies that have to deliver a higher sale, earnings growth then they will be available at higher multiple. But we should distinguish between higher and reasonable multiples. Stocks which does not have underlying soundness then those will become speculative and riskier.

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When sales growth keeps coming people ignore the underlying quality of business and financial. As the company grows, its growth becomes slower otherwise the company will eat up the entire world. As growth gets slower, multiple also gets lower. We need to understand that we cannot provide similar multiple to the same company at every phase of the company. Higher quality growth commands a higher multiple but as growth slows down, multiple for the same business gets lower down.

One of the air-cooler manufacturing company of India

Symphony

Symphony1

We can see that as growth slowdown in the FY2018 and 2019 then P/E multiple of the company has fallen down rapidly.

Comparison of Real Estate VS Pharma VS FMCG

RE PH FMCG

We can see that in the Jan-2008 Real estate companies (Just two companies) MCap was ~4x of 10 pharma companies and ~2x of 10 FMCG companies. Pharma and FMCG companies have posted growth and real estate companies are not able to grow at the same peace. In addition, real estate companies were traded at sky-high valuations which resulted in an average return of ~-91% whereas Pharma (*not taken from high mcap) and FMCG has posted average return of ~963% and 1109% respectively.

If we look at the fall in price too low of 2008 then also pharma and FMCG have outperformed real estate.

RE PH FMCG1

If we see the quality companies i.e. pharma and FMCG then those fall less than the entire market fall, Nifty fell by 50%+ in the year 2008.

In the Short term, any stocks win the popularity of the market but in the long-term earnings matters. If we see that fancy business has does not perform in the long term but boring business such as FMCG has outperformed in the long term.

If we look at the P/E multiple of DLF and Unitech then that was 36.69x and 82.22x in high of the year 2008 and that fall to 4.67x and 4.21x respectively. Whereas Lupin, Sun Pharma, HUL, ITC, and Nestle was traded at P/E of 13.54x, 17.91x, 26.23x, 29.34x, 26.90x and fall to 12.50x, 17.52x, 26.71x, 22.28x, 24.80x respectively.

Market panic provides us with an opportunity to enter into such business which helps us to get more returns. If we have bought the above-mentioned pharma and FMCG companies at a high of the year 2008 and then bought again at low of the year 2008 then-current average return of pharma and FMCG has been increased by ~347% and 137% respectively.

For the current scenario, if we see HUL MCap vs 10 Pharma companies then HUL has a 24% higher MCap from pharma 10 companies.

This analysis is given by many of the investors and fund managers but if we look at the return ratios then average RONW% & ROCE% of top 25 pharma companies is ~20% and average RONW% & ROCE% of top 10 pharma companies is ~16% whereas RONW% & ROCE% for the HUL is 80% and 90% respectively.

Pharma VS HUL

So, if we look at the growth and profitability of the top 10 pharma and HUL then does not has a wide difference but asset quality is far good for HUL compared to the top 10 pharma which must need to look. This comparison is not similar to real estate and pharma and FMCG whereas real estate has poor asset quality compared to the pharma and FMCG but here HUL has a better asset quality. If pharma has a huge earning growth compared to the HUL with 15-20% of return ratios then we can look into it. If we look at the ~73 listed FMCG then those companies do not have similar asset quality then they do not have a similar kind of valuation but those have, they command.

Closed watch also shows real-time sometimes in a day that does not mean, we consider that watch as a good watch.

If we compared sugar companies’ vs tea & coffee companies then it can be a good comparison where sugar companies are available more than double in MCap.

Sugar VS Tea & Coffee

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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

The Intelligent Investor – 13 – A Comparison of Four Listed Companies

Posted on November 10, 2019 by Jimit Zaveri under Bibliophile: The Intelligent Investor

When we have decided to make an investment then we need to perform an analysis work so that we do not be stuck with the wrong investment avenues or at the wrong time. For making an analysis, we must need to focus on a few points.

Profitability – how the company performs? Return on invested capital, margins, growth in sales-profits, earning per book value, etc. If the profitability of the company gets hampered then we need to check whether it is permanent or temporary.

Stability – earning of the company decline in any of the years from the past ten years? Do the earnings of the company get fluctuations? Does a company involve in a seasonal or cyclical business?

Growth – companies with higher growth command for the high multiples and lower growth with low multiples. The growth of the company can help us to grow our wealth also. The growth provides an opportunity for the company to use capital appropriately.

Financial position – liquidity ratio, the position of a balance sheet, debt, preference share, etc. Tree does not grow in the sky. If financials are not strong then the business will not be surviving for a longer period. So that we need to put emphasis on the financial. How does a company utilizing assets? Company is capital intensive or asset-light? Working capital intensive or negative cash conversion cycle?

Also, we need to check what the company is doing with the capital generated. What is the capital allocation decisions of the management? Long dividend track record, increment into the dividend, buyback, buyback at higher than intrinsic value or lower than intrinsic value and if a company requires fund for growth then reinvest profits for growth rather pay dividend or buyback.

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

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.

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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

15707167094

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