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

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

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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.

Pharma VS FMCG

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

Quality Investing can be a Contrarian Investing….

I am going to write something different which is not easily acceptable to our investment society. But if we analyze it thoroughly then we can understand it and able to accept the reality.

So before going forward with the core discussion, let me start with some basic concepts.

Let me first mention what is contrarian investing?

 “Contrarian Investing is an investment strategy that is characterized by purchasing and selling in contrast to the prevailing sentiment of the time.” – Wikipedia

“Contrarian investing is the ideology in which an investor attempts to make profits by making his decision against the popular understanding but only when the conventional wisdom appears to be wrong.” – Trade Brains

After reading the above definition, we can come to know that contrarian means going against the herd. If we perform a task that is not performed by anyone then we fall into the category of contrarian person.

When it comes to an investment then What people usually do as a contrarian investing decision?

People run a list of 52 week low, the stock price has fallen a lot, low in valuation, companies having some problems & not with good financial but available as penny stock prices, etc. These things the majority of people are doing. I was in interaction with many of the clients and all those seek an investment idea with all the mentioned criteria earlier. In addition, they seek investment ideas where stock prices are below Rs. 5, 10 or maximum Rs. 100

A common myth in the market is catching a falling knife, turnaround, beaten-down stocks, etc. work as a contrarian. But if we check ground reality then the majority of people focus on those factors so if all want to do the same then how it can remain contrarian.

In addition, people average quality when stock prices start falling, the majority like to average at lower and booking profit when stock prices going upwards territory. They don’t have guts to book losses. Thus, lastly, they remain with the losers as they have booked out winners.

So, if the majority are performing in the same way then how it can be a contrarian investing?

I have taken a few examples of the companies which are having lower quality and prices have fallen. And as prices have fallen people have started accumulating those stocks. I have taken the last 10 shareholding patterns for reaching to a conclusion. All these people who have tried to catch a falling knife, those all have ended up with the losses.

Low Quality Public

We can see that people have to keep on buying as prices have fallen, book value bargain, try to catch a falling knife, averaging lower, etc.

So, what can be a contrarian investing?

When I asked people to invest in XYZ company and stock prices trading near 52 weeks high then people tell me that it’s already run up, give me something which has not run.

Also, stock prices are above Rs. 1000, 5000, etc. then they fearful and ask for a penny.

Means buying stocks which are traded at 52 weeks high then people tend to stay away from it. In addition, when stock has moved upward and things have improved with it then we never have to hesitate by averaging upward. We need to book losses if things are not happening as per our assumptions and keep running profitable ideas.

“Cut the losers and stay with the winners” – it’s the only formula of staying with a portfolio of winners.

So, these all can be a contrarian where the majority of people don’t focus.

Mr. Nooresh Merani has twitted a few days back –

NooreshEJUfFtgU4AALLTc

Similarly, I have taken a few examples of the companies which are having a decent quality and prices keep on rising. And as prices keep on raising people have started booking profit in those stocks. I have taken the last 10 shareholding patterns for reaching to a conclusion. All these people who have to try to sell out their positions, all have ended up with the regrets.

High Quality Public.jpg

We can see that people don’t like to average upward when companies having a quality, they run for booking profits when the stock price has moved up rather keep holding a winner. So that what the majority are not doing that only can provide us with an above-average return.

It is not always one asset class; one investment style remains contrarian forever. As particular assets or investment styles generating above-average returns then that will attract more and more participants which convert contrarian style to general style or asset class. When equity becomes popular among the participants then it having a good probability of underperformance compared assets class which is relatively lower popular. So that we require to shift from asset class as it moves in the pendulum of unpopular to highly popular.

This is the only concept of contrarian investment that teaches us. But the majority of investors have taken this in a different way. And they try to hunt for the lower value, falling knife, etc. Yes, this can be a contrarian investment style but we have to compare that when the majority of the people interested in such situations then that will not remain contrarian any longer.

The majority of the time, investors avoid higher value, quality, keep upward-moving stocks and that can be a contrarian investment strategy for us till people not getting attracted to such quality companies.

So that there is not a single investment style or asset class which remains contrarian forever. It will be unpopular and will moves to popular and then again once in a while return to the unpopular. We have to identify it and that helps us to create and protect our wealth.

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

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “FINDING BARGAINS”

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In all the previous articles of the series, I discussed buying a cheaper assets / Investment. But buying cheap does not mean that we should go and buy anything which seems cheaper.

We need to prepare a list of investment ideas which are matches with our criteria, matches with our risk tolerance capabilities and exclude which are not matching with our criteria. There are not each and every idea which are compatible with our risk appetite, we need to work on the ideas which fall under our circle of competence. We get many ideas which can be good but not compatible with our criterion then we need to stay away from it.

Before eating a food, we need to know which kind of food we really like to eat. We do not like each and every food so as similar to it, we need to prepare a list of ideas which match with our criterion.

If we are managing the fund of others, then not only our risk appetite but also risk appetite of clients, we need to focus.

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The second step is to select an investment idea from the prepared list; which is suitable for the potential returns and risk ratio, value for the money scenario.

After getting the list of the foods which we like then we need to work on the place from where we get a food with requiring quality, where we get food as per our spending, etc. we generally do not prefer to visit the place where food is not available as per our taste and preference.

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If we pay high valuation for the any of the assets then it is logical that our potential returns will be kept on reducing and might be chances of occurrence of loss starts increasing. We made an investment for generating returns and enhancing returns.

We buy food for fulfilling our hunger not for exhibiting of our food dish with expensive food. We sometimes eat expensive food, not on a daily basis. As not only expensive foods can able to fulfill our hunger similar to that not only good and quality investment can able to provide us returns.

We need to focus on the bargain through which we can able to generate a potentially higher returns with minimizing risk.

Sugar IT

As I quoted an example of a good fundamental IT & Pharma company with cheap sugar company.

We can see that if we have bought the comparatively lower fundamentally good stock at a cheap price than this stock has generated a higher return compared to the good fundamental stocks in last 5 years.

Good food means we get a satisfaction & fulfill our hunger from eating that food, and that never matter how much expensive or cheap it is.

In general buying good assets mean, the assets provide us high potential returns relative to lower risk and also has a low price relative to the value of an asset.

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Mr. Howard Marks mentioned that while popularity is high towards stocks and people hates bonds, also many institutions shifting from bond to stocks; such situations provide a bargain for the bonds.

When the time change and people seek for more safety relative to the price appreciation then they start recognizing the potential of bonds.

Generally, people start recognizing the potential of the assets while the price of an assets starts appreciating. But people who have identified assets earlier, those can produce above-average returns.

When the restaurant is crowded then only people recognize the popularity of a restaurant. We make a decision by seeing how much-crowded restaurant is. If no one at a restaurant then we generally not prefers to visit by assuming that particular restaurant provides a low-quality food. Similarly with stocks, when everyone is buying particular stocks then we also run for buying those stocks with assuming high quality with high return. We do not check anything and follow the crowd.

We should try to make an investment into the underpriced assets rather than fairly priced. Fairly priced assets just provide fair returns with risk involvement. So that we should focus on underpriced assets with risk involvement for generating above-average returns.

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Bargain only available while perception is worse compared to the reality towards the asset. If everyone feels good and want to own that assets, then that asset will not be available at a bargain more.

When everyone cannot able to see the potential of the asset then we need to check the reason for unloved of the asset. Unloved assets can be available at the bargain if people hate it more than it should be.

If nobody is loved to the asset then nobody holding it So that demand for the asset will increase when people can able to see the potential of the asset. If our assumption has proven wrong and nobody is holding an asset or people unloved an asset then we might get limited downside or get the least loss from our investment.

When nobody to go for visiting a particular restaurant then we get foods at cheap cost with the proper quality for maintaining its customer.

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Read for more detail: The Most Important Thing Illuminated by Howard Marks

 

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