- In this issue:
- » A Fabulous Company Whose Stock Went Nowhere for Seventeen Years
- » HUDCO's IPO Does Well, What Do We Make Out of This?
- » ...and more!
India's IT companies will reportedly layoff thousands. If the change in the H1B visa rules weren't enough, the layoffs should attract them enough bad publicity.
Add to that a disappointing performance in recent quarters...
As you may expect, I get loads of mails from investors worried sick about losing money in 'bad' tech stocks.
If you are one of them, pay attention...
Remember Buffett's rule number one and two rules for investors? The ones about never losing money...?
Most investors don't follow these rules even if they remember them. That's because they fail to differentiate between good companies and bad stocks. And between bad companies and good stocks.
Most investors perceive blue chips as good companies. No brainers. Businesses with long histories and reasonably good financials. There is a blind faith that these businesses could never lose money. So even when steep valuations cause a good business to become a bad stock, there is no reluctance to buy.
Think of Infosys in March 2000. The PE over 100x made it a bad stock. The virtues of the business remained intact. But anyone who bought Infosys in March 2000 didn't make money for the next six years. A case of good investment, bad stock.
Also, nothing hurts a stock price as much as bad publicity. No one bothers to dig deeper into the underlying fundamentals. Most investors just rush in to sell. In many cases, 'bad businesses' end up becoming good stocks for the long term.
Think of Tata Motors in 2008. The rumored bankruptcy after the acquisition of Jaguar Land Rover brought the stock to lifetime lows. No doubt, the financial performance was unencouraging. The business was bordering on bad. But anyone who dug deeper, like we did, knew that it was a great stock.
Of course, given a choice, we would like to buy great companies with great managers at a great price. But greatness on all fronts is hard to find!
Valuation genius Ashwath Damodaran (featured in our ebook The Super Investors of India) suggests we settle for a more pragmatic end game.
At a great price, buy a company in a bad business run by indifferent managers. At the wrong price, avoid even superstar companies.
On his blog, Damodaran even helped us with what he calls his buy-sell template:
|Company's Business||Company's Managers||Company Pricing||Investment Decision|
|Good (Strong competitive advantages, Growing market)||Good (Optimize investment, financing, dividend decisions)||Good|
(Price < Value)
|Good (Strong competitive advantages, Growing market)||Bad (Sub-optimal investment, financing, dividend decisions)||Good|
(Price < Value)
|Buy & hope for management change|
|Bad (No competitive advantages, Stagnant or shrinking market)||Good (Optimize investment, financing, dividend decisions)||Good|
(Price < Value)
|Buy & hope that management does not change|
|Bad (No competitive advantages, Stagnant or shrinking market)||Bad (Sub-optimal investment, financing, dividend decisions)||Good|
(Price < Value)
|Buy, hope for management change & pray company survives|
|Good (Strong competitive advantages, Growing market)||Good (Optimize investment, financing, dividend decisions)||Bad|
(Price > Value)
|Admire, but don't buy|
|Good (Strong competitive advantages, Growing market)||Bad (Sub-optimal investment, financing, dividend decisions)||Bad|
(Price > Value)
|Wait for management change|
|Bad (No competitive advantages, Stagnant or shrinking market)||Good (Optimize investment, financing, dividend decisions)||Bad|
(Price > Value)
|Bad (No competitive advantages, Stagnant or shrinking market)||Bad (Sub-optimal investment, financing, dividend decisions)||Bad|
(Price > Value)
Source: Ashwath Damodaran's blog Musing on Markets
Looking this template in mind, what do you think of the so-called 'bad' tech stocks? Are all Indian IT companies suffering bad publicity - emphatic sells?
Damodaran's template makes a strong case to take a closer look at management and valuations.
We urge you to do so before rushing to sell IT stocks.
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02:30 Chart of the Day
Talking about good companies being bad stocks, how about a company with such a record: Not even close to a loss in the last twenty-six years, and some outstanding return on equity (ROE) numbers.
If you were co-owner in such a company at the turn of the century in the year 2000, you could have barely hoped for a better performance from it over the next seventeen years.
Moreover, let me tell you, this is no small company. There are few people in the world that don't use its products.
So here's the question for you. How do you think this company's stock has performed over these last seventeen years? Good? Great? Fabulous?
Today's chart of the day has the answer.
A Fabulous Company Whose Stock Went Nowhere for Seventeen Years
Yup, that's right. The stock of this company has gone pretty much nowhere over the last seventeen long years. In fact, only late last year did its stock finally crossed the level it had touched way back in 1999. Phew!
I'm talking about none other than the third-largest company in the world by market cap - Microsoft Corporation.
So, what explains the strange saga of the Microsoft stock?
The world's greatest investor, Warren Buffett, offers us a clue:
- Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid.
And yes indeed. In the overexcited markets of 1999, the stock of Microsoft was in seventh-heaven. It had touched a high price to earnings (PE) of almost 80 times.
The result is that it has taken the company seventeen long years to work out the hangover of that stock market party, despite a great performance in terms of sheer profitability.
What do I make of this? It is ironic, yes. But surprising? Not at all. Buffett is right. Time and again, over optimism about a company or sector takes stock prices to ludicrous levels. And in most cases, even if the company turns in a very respectable performance over the next many years, it could have a hard time living up to such hyped-up stock prices.
The only defense investors have to avoid getting stuck in such situations is to be intensely price-focused while buying stocks. Frugality is always the best policy.
Reports suggest that government owned Housing and Urban Development Corp. Ltd (HUDCO) saw its initial public offering (IPO) subscribed almost 80 times by the time its offering closed yesterday.
Despite this IPO seeing such good demand, we had our reservations. You see, at the upper end of the price band, HUDCO's valuations (requires subscription) appear modest at price-to- book value (adjusted) of 1.5 times.
However, the biggest concern for us was its gross bad loans ratio. Even though profits have expanded in the last four years, margins have slipped below 20% in the latest nine months for the first time in the last five years. Further fixed rate borrowing constitutes 98.27% of HUDCO's borrowings whereas it has lent 79.75% of its loans to borrowers at floating rate of interest which is a very serious mismatch in a falling interest rate scenario.
We did not reckon the offer price provided sufficient margin of safety to subscribers. The fact that the offer did so well was more a sign of optimistic markets rather than the quality of the offering, we believe.
Christopher Wood of CLSA believes that the bank reforms make India the best equity story in emerging markets. Honestly, we believe a lot will depend on how the reforms will be executed by the central bank. And whether the reforms put in place better lending practices for big ticket corporate loans. Given the stagnancy in bank credit currently, our view on the bank reforms is far from being as optimistic as Wood's.
Madhu wrote an interesting piece to ResearchPro subscribers on this - Why Banks Need to Pass the Bad Loan Smokescreen Test? (requires subscription).
The Indian stock markets were trading marginally lower at the time writing. Stocks of companies in the consumption and private sector banking space which have declared disappointing set of FY17 numbers were being put on the block. At the time of writing, the BSE-Sensex was trading lower by around 27 points. Gains were largely seen in auto and pharma stocks.
04:56 Investment Mantra of the Day
"Price is what you pay. Value is what you get." - Warren Buffett
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