Where does your stock derive value from? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Where does your stock derive value from? 

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In this issue:
» GAAR draft guidelines still not clear enough
» Rogers' views on why investment in commodities hold merit
» China's reform focused growth unlike India's
» Why Indian economy is getting 'dieselised'...
» ...and more!

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"We now have eight subsidiaries that would each be included in the Fortune 500 were they stand-alone companies. 492 more to go." - Warren Buffett

We are not big fans of complicated business structures. Especially ones having too many subsidiaries and associate companies. But we appreciate the above words of the legendry value investor more now than ever before. Subsidiaries of Indian companies earlier used to be just marketing arms or resource procurement arms. But they are no longer so. Most of them are thriving business entities in their own right. Albeit not all. However, some are so important to the parent that the fortunes of the subsidiary can make or break the parent entity's future.

A profitable subsidiary with a robust business model can be immensely value accretive to the parent. For one, it can offer generous dividend payouts to the parent. Thus it can strengthen the latter's cash flows. Take the case of Tata Consultancy Services (TCS) for instance, which recently pocketed 1860% dividend from its American subsidiary. Secondly, the parent company's stock can unlock a lot of value from the subsidiary's valuations. Several Indian conglomerates are valued by analysts on the basis of sum-of-the parts valuation. This is to ensure that investors do not miss out on the fortunes of important subsidiaries. However, not every subsidiary is a potential money spinner. In fact some can be a huge drag on the parent entity. The parent not just loses profits but also valuations due to the subsidiary's miserable performance. Too many innocuous subsidiaries can also make the parent's company's business model complex. And complex business models with blurred long term visibility hardly attract investors.

It therefore goes without saying that investors need to be extremely cautious while investing in companies with large subsidiaries. Without getting carried away by lofty valuations assigned to them, it is important to reckon the risks to the business. The purpose of the subsidiaries, their accounting norms and effective management are also important indicators. They speak volumes about the parent company's management quality and corporate governance.

Thus if you own stocks that derive substantial value from subsidiaries, it would be worthwhile to judge the latter's performance as well. After all, hidden value in subsidiaries can be a value investor's delight.

Do you think it is important to study the subsidiaries of the companies before investing in them? Share your comments comments with us or post your views on our Facebook page / Google+ page.

01:20  Chart of the day
With rising coal prices and delayed payments from state electricity boards (SEBs), Indian power utility majors are in a state of flux. Strained cash flows and unviability of projects based on power purchase agreements (PPAs) have necessitated revision of power tariffs. However, data from the Central Electricity Regulatory Commission (CERC) shows that Indian households and corporate already pay much higher power tariffs than their counterparts in the US and China on purchasing power parity (PPP) basis. Hence higher tariffs will mean additional cost burden on Indian consumers.

Data source: CERC, SERC (China), US EIA

The Union Budget for the year had proposed several measures to try and increase foreign investors to invest in India. But it also proposed one big thing that scared FIIs (Foreign Institutional Investors). This proposal was that of GAAR or General Anti Avoidance Rule. The Rule was proposed with the intention of preventing investors from routing money through the tax havens to avoid payment of taxes. Naturally like any individual, FIIs were also unhappy at the prospect of paying more tax. Fortunately like most other ambiguous rules and proposals, GAAR too was deferred to another date. But in a new development the Finance Ministry has proposed a monetary limit on invoking GAAR. Though the ministry has not disclosed the amount of this limit, it has proposed the same in its draft guidelines for GAAR. So all deals over this limit would fall under the purview of GAAR. Also this would be applicable only on those FIIs who choose to take the benefit of double tax avoidance treaties. As such the statement in itself is neither good nor bad. Unless there is more clarity on how GAAR would be invoked there would be no point in reacting to the same. More importantly till there is more clarity on when GAAR would be invoked again there would be no point in reacting to the same.

Where is the global economy headed? Which assets should investors hold during such times? We thought it would be interesting to hear what renowned commodity guru Jim Rogers has to say. Starting with Europe, he thinks Eurozone policymakers are doing nothing to solve the debt problem. They are only postponing the crisis to get past the next election. On the currency front, he has taken up large positions in the Swiss franc and the Japanese yen. Though he owns the US dollar as well, he doesn't believe in its long term fundamentals. The main reason for holding it is the crisis in Europe, which tends to give the illusion of safety in the greenback. Rogers is most bullish on commodities, silver being his favourite at the moment. He argues that the supply of commodities has been in decline for more than 20 years. Major oil fields are on decline. Also, not many new mines are being opened up. And given that major central banks across the globe are on a money printing binge, it would be rewarding to hold real assets. We think there is indeed some merit in Rogers' views.

The biggest indicator of the strength of a country is the health of its financial system. American banks took risky bets on the US subprime market and subsequently went bust. European banks are also exposed to declining economies, debt heavy governments and have a thin capital cushion. Thus there is no respite there. So in light of global uncertainty, how are our Indian counterparts doing?

The Reserve Bank of India (RBI) is concerned over the deteriorating asset quality of banks and slowing credit and deposit growth. The gloomy economic outlook and global headwinds may also lead to further bad assets. So far power, airlines etc have led to large scale defaults. Steel, textiles, construction firms are also under stress. However, the Reserve Bank of India (RBI) concurs that the financial system is still resilient to withstand shocks. Indian banks maintain a number of statutory and reserve requirements. Banks maintain 24% of their deposits in government bonds and other approved securities as reserves. Plus they hold 4.75% of their deposits in cash reserves. Most banks are also adequately capitalized post infusions from the Centre and LIC. While this adds to comfort, we cannot rule out more stress on the non-performing assets (NPA) front, which will in turn dampen profitability.

Amidst the current slowdown growth rates across economies have stagnated. Even China, the second largest economy, is bearing the brunt of the slowdown. The manufacturing activity in the nation has slowed over the last 8 months. However, unlike India, China has plans to restore growth via reforms. The country plans to expand the financing available to banks by allowing them to raise funds from overseas markets. Permitting banks to issue preference shares is also under consideration. This will inject liquidity into the economy as banks will have more money to lend. However, previously such rounds of monetary easing had led to excessive speculation in real estate and stock prices. Thus, infusing liquidity to revive growth has its own disadvantages. Also, China's ability to provide fiscal stimulus for revival is limited. That's due to the huge amount of debt the country has piled up from deficit financing. So, with traditional policy tools appearing to be futile, reforms is the only way to revive growth. And it remains to be seen what steps the government takes in that regards.

'Dieselisation' of economy has become a hot topic these days. The Government sometime back decided to hike Petrol prices by Rs 7.5 per litre and left diesel untouched. However, extending subsidies to diesel that is burnt over four times than petrol hardly addresses the fiscal concerns especially at times when rupee is in a free fall. Instead, with its half baked reforms, the Government has ended up incentivizing inefficient trends in fuel consumption. No wonder diesel is being highly preferred by car-owners. Ironically, a four wheeler owner is now taking free ride at the expense of a two wheeler owner who still uses petrol. It's not just the petrol cars that are going off radar. The diesel is fast replacing other industrial fuels as well. The subsidy on diesel is making its way to those who are least deserving. It's high time the Government recognizes this and does something to curb the distortions in transportation fuels. However, any such reform is likely to be put on the backburner at least until the Presidential elections are over.

Taking cues from their peers across Asia, the indices in Indian stock markets made a firm up move into the positive territory backed by investor interest in heavyweights in auto, commodity and power sectors. The positive sentiments seem to be primarily based on hopes of rate cut by the RBI. At the time of writing, the BSE Sensex was trading 388 points above the dotted line. The indices in most other Asian markets closed higher in today's trade. Those in Europe have also opened in the positive.

04:50  Today's investing mantra
"For some reason, people take their cues from price action rather than from values. What doesn't work is when you start doing things that you don't understand or because they worked last week for somebody else. The dumbest reason in the world to buy a stock is because it's going up." - Warren Buffett

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    Equitymaster requests your view! Post a comment on "Where does your stock derive value from?". Click here!

    4 Responses to "Where does your stock derive value from?"


    Jul 2, 2012

    we are dragging to disaster only with corrupt politicians where central bank reserve bank of India is tempering with exchange rates and no implementation of full convertibility when they play games with public money and tax payers money



    Jul 2, 2012

    Drop interest rates fast!
    There was No need to raise rates 13 times when there never was any demand pull inflation in the economy. The RBI is clueless as to monetary policy.
    The only reason investors are fleeing India is because industrial growth is now zero, due to sky high interest rates!
    Drop rates by 200 basis points immediately and watch how the rupee strengthens, inflation expectations and behavior abate and GDP starts picking up - faster GDP growth (say 10%) solves everything, including reducing prices.

    Like (2)

    J Thomas

    Jun 29, 2012

    I judge a company by its consolidated results, not the standalone.

    Like (2)


    Jun 29, 2012

    i didn't find answer to title...

    Like (2)
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