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 –

II C19 01

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.

II C19 02

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 – 17 – Four Extremely Instructive Case Histories

Posted on December 8, 2019 by Jimit Zaveri under Bibliophile: The Intelligent Investor

Mr. Graham has mentioned a few points which need to be check for any of the companies in which we are planning to make an investment. And if the company having such points then should avoid it is a better choice.

The company not paying income tax through earning profits. We must have doubts about the earning of the company if the company continuously not paying income tax. We need to check whether the company has any tax benefits or not. If the company has any tax benefits then we need to check where such benefits are going to expire and need to adjust tax benefits for our calculation of future estimation of profitability / per-share earnings.
Overpriced giant companies. Giant companies are those which have shown decent growth in the past and gaining market share. Thus, such companies have won the trust of the investors and available at a higher valuation. We need to understand that not always a great company can be a great investment. Also, we need to stay away if the company available at an extreme higher valuation. One of the current giant IT companies was traded on 200+ of P/Ex during the IT bubble and after that company has posted sales & profitability growth of 30%+ but the stock has given return ~7-8% CAGR during that period.
Interest coverage is less than 5x. If the company cannot able to generate pre interest profit 5x higher than the interest amount then any unforeseen circumstances can affect the profitability of the company.
The company involves frequent mergers and acquisitions. Frequent merger and acquisition turn a simple financial statement into a complex which becomes much difficult to understand. In addition, the company can hide many things through mergers and acquisitions which becomes difficult to identify.
Merger and acquisition are huge in size compare with the size of the company and also, funded through huge debt. Such M&A can create trouble for the company if not played well. The majority of such M&A has failed badly. One of the steel company which has done an acquisition of the company which is huge in size by taking a huge debt.
Here, we can see that the company has faced a hugely difficult to get survived. Also, the company has to take a huge debt + equity issuance.
Acquisition of the company at a higher valuation. When one company has acquired another company at higher valuation then it will consider as a capital misallocation and it will take time to cover the extra value which the company has paid. If the company has paid a huge premium + balance sheet also not stronger than it can be troublesome.
Frequent merger and acquisitions. This will create trouble for an investor to understand financial statements. In addition, the company can hide many things under such frequent M&A and can boost up revenue and profitability in a fraudulent way.
Deferred debt expense which is greater than entire shareholders fund
Amortization of deferred debt expense
The company has a debenture that is traded at a huge discount then also, the company buying warrant.
Increasing debt in more peace compared with the revenue
We need to deduct preferred stock payment, debenture payment from available cash & investment of the company to reach the conclusion regarding available cash & investment for the common stockholders.
Checking a liquidity position of the company
Expansion strategy, if expansion is huge enough that it has a higher probability to get fail, the profitability of the company can wipe out. And if such a huge expansion funded through external fund then can be the hero or zero kinds of situation arise.
One of the chemical company of India has announced a huge expansion plan which is a hero or zero kinds of plan
Here, we can see that the company can able to grow its revenue and profitability after the huge Capex which has helped the company to get survived very well.
The company owning huge preferred, warrants and convertibles then need to check such companies with more patience or should avoid it.
Changes into the method of arriving at the pension
Changes into the depreciation rates
Stock trading at Extreme cheapness. When things available at cheaper valuation then we need to be cautious and ask to question & try to find out the reason for cheap valuation.
Avoid hot stocks and hot fancy businesses
An initial public offering of shares in a basically worthless company. IPOs of the company which are not good in the balance sheet and just coming up with an IPO due to fancy in a sector or in the market.
Inspection from SEBI or other regulatory authorities. When we come across such news then we need to study carefully with that company.
Few more things to avoid – MY LEARNING FROM MY MISTAKES
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

WARREN BUFFETT’S LETTER – 1992

Posted on September 8, 2018 by Jimit Zaveri under Bibliophile

WB Letter 1992

Mr. Buffett has written that they own a collection of business which is exceptional and also a run by an exceptional manager which has resulted in the higher returns.

Nowadays I have experience that everyone is becoming a market expert and providing their view on the short-term direction of the market. For such people, Mr. Buffett has given a good quote –

WB 1992 01

The Salomon Interlude

In 1991, Salomon Brothers caught for bond trading scandal and Mr. Buffett has performed as a chairman of Salomon for the ten months to resolve a problem at Saloman. At Salomon, they have been submitting false bids in an attempt to purchase more Treasury bonds than permitted by one buyer during the period between December 1990 and May 1991.

Five authorities – the SEC, the Federal Reserve Bank of New York, the U.S. Treasury, the U.S. Attorney for the Southern District of New York, and the Antitrust Division of the Department of Justice – had important concerns about Salomon.

Acquisitions

Many acquisition-hungry managers made an acquisition with the hope that they will transform business which will provide them with a good opportunity to earn. When a manager gets failed, they learn a lesson but shareholders pay fees for selecting them as an investment candidate. Mr. Buffett has accepted that during his earlier career, he also has made an acquisition but he able to achieve success due to cheapness into acquisitions and some of the acquisition got failed also. And due to such mistakes to get a failure, he revised his strategy to make an investment.

TATA Steel 01

TATA Steel 02

WB 1992 02

Berkshire has made an investment into the Central States Indemnity which is an insurance company provides an insurance to the credit-card holders who are unable themselves to pay because they have become disabled or unemployed.

H.H.Brown, a Subsidiary of a Berkshire has made an acquisition of Lowell Shoe Company which is into the manufacturing of the shoes for nurses, and other kinds of shoes as well.

Mr. Buffett has initial thought of purchase General Dynamics for the tendering stocks to the buyback and earns a small profit in short term. But Mr. Buffett began to study the company and he found that Bill Anders, CEO of the company has performed a decent job to run a business. Mr. Buffett has dropped the idea of buyback opportunity and decided to become a long-term investor of the company.

Investing strategy of Berkshire has been little change and also Mr. Buffett has made some compromise on the price to purchase a business’s due to market condition and their increased size.

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Now, how to know an attractive price? Mr. Buffett has explained that we look attractive price with the framework of value or a growth investor – what we consider to ourselves. He explained that growth is always a component of the calculation of the value of any company. He mentioned that people using value investing term everywhere with the paying higher price then calculated the value in the hope that someone pays higher to purchase an asset from them. But such activities do not consider as an investment, it is a speculation.

People consider value investing where attribute such as low Price – to – Earnings ratio, low Price to Book Value ratio or high dividend yield or combination from mentioned and not consider value investing where reverse attributes are available. Many a time, business growth also tell us little about the value but it is also true that often growth has a positive impact on the value. We have to analyze that whether a business can able to generate a good return on the incremental invested capital or business generating a low return on incremental capital. Former one provides the benefit of growth to the investors and latter one hurts to the investment.

Ex – Value Trap

Taken from Thoughts on Thoughts blog

The company looks very cheap on the basis of the financial metrics, but if someone who does not have paid attention to the business of the company then—

MTNL Chart

An investor has lost his capital also. So, that in value investing also, we cannot escape from the future. (For detail article, Kindly visit – http://neerajmarathe.blogspot.in/2010/04/mtnl-value-trap.html)

Value Trap – One of the educational providing company which fall under the criteria of value investing –

Jetking

The company is not able to generate good growth in sales and in the profitability but investment and cash have grown well. Also currently the company is available below cash + investment which fall under the criteria of the value investing. But what about the growth into the business or on the survival of the business. Will be cash & investment remain with the company in the future? Lower sales, higher expenses, lower profitability and for last 3 years the company has stopped paying a dividend. Should we consider such investment as value investing or value trap?

Ex – Growth at the low return on capital companies

The company which is generating a good sales growth but they is not able to generate a higher return on capital they employed then those companies require to take debt or dilute an equity (in-short they need external funding). Investors in such companies will face difficult to create wealth or sustain wealth.

High growth with low return

We can see that companies having a higher sales growth but cannot able to generate a higher return on capital then they require to bring external finance to fund the growth. The growth of such companies will extend for the long period but investors face difficult to create wealth.

High growth with low return chart

Ex – Growth at the higher return on capital companies

Reverse to above if company having a good growth with having a higher return on employed capital then company does not require to bring external financing (if they having a borrowing or a dilution of capital then the size of it is very small in proportion) to fund the growth of a company and also investors of such a company can create a good wealth.

High growth with high return

High growth with high return c 1

Ex – Higher growth but no value

If we just focus on the growth of the company and not on the quality of the growth then we need to lose our capital also.

High growth but no value

A company having good growth but does it have a quality of growth?

High growth but no value C 2

More dangerous balance-sheet quality after FY2010 –

High growth but no value 1

Every time does not value investing or growth investing provides a better investment opportunity but a rational combination of the both can be good investment opportunities.

Mr. Buffett has explained valuation matrix given by Mr. John Burr Williams which is determined by the cash inflows and outflows – discounted at an appropriate interest rate – that can be expected to occur during the remaining life of the asset. He has given matrix which similarly uses for bond and stocks. But bond involves fixed future cash inflow in-terms of coupon received by us and in equities such coupon is not fixed, we cannot say with surety about future cash inflow and outflow for business. Cash inflow and outflow into equities are highly dependence on the nature of a business, quality of management. For overcoming such problem Mr. Buffett uses two rules at Berkshire –

WB 1992 04

WB 1992 05

According to Mr. Buffett, new issue market is controlling by the stockholders and institution; also new issues come during favorable market conditions and we need to pay a higher multiple. Here, we are not going to get any bargain whereas in the secondary market, many a time, we get x value business at the 1/2x.

Warren Buffett’s Letters 1957 – 2012