Cash, cash everywhere, but not a Re to invest - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Cash, cash everywhere, but not a Re to invest 

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In this issue:
» Infosys to kick off the earnings season tomorrow
» Three Indian pharma majors probed by US Congress
» Fed official: US central bank should be patient in raising rates
» Blackstone Group has been on a property shopping spree
» ...and more!


00:00  Chart of the day
 
In the quarter ended June 2014, the cash pile up at Berkshire Hathaway stood at over US$ 55 bn. This is highest cash buildup seen by the company ever. It is believed that Warren Buffett likes to keep aside about half of the money for its core insurance business; as such, the balance figure of about US$ 23 bn is the deployable amount that has been getting piled up for a while now. As per reports, Berkshire Hathaway's existing holdings have been adding cash at the rate of US$ 1 bn a month. As such, it would be fair enough to assume that Buffett has not made any significant investments in the past two years.

In fact, this cash build up became quite a hot topic of debate with people taking this as a sign that market may be in for a crash. Considering that valuations of the US stock markets are amongst their highest 10% levels seen in the past century, finding attractive stock ideas would not be easy.

On the other hand, there are some who refute this argument on the basis that Buffett has the knack to identify bargains in every market situation and that he may be having a different strategy this time around.

Nevertheless, one thing is certain. Given his track record and capital allocation skills, shareholders of Berkshire Hathaway should not be very much concerned. Sooner or later, the cash would be put to work.

In fact it is this very reason why Buffett has not paid dividend in over four decades. He feels that it may not be the best strategy for investors, considering there would be other ways to create value.

Bringing this context to Indian markets, we came across an interesting article in the Outlook Business which provided a list of stocks that have built up huge amounts of cash on their books.

The chart below provides some of the details.

The largest cash hoarders are...
*- Adjusted RoE; # - Adjusted cash; EIL - Engineers India; BEL - Bharat Electronics;
HZNC - Hindustan Zinc; BCS - Bayer Cropscience; ACL - Ambuja Cement

The chart provides the names of thirteen companies with high cash balances. It also indicates the cash balance (adjusted for debt) as a percentage of market cap, the reported return on equity (RoE) and the adjusted RoE. The latter is calculated by dividing the core profits by the networth after subtracting the cash and cash equivalents.

In any case, the key point we would like to make here is that investors should not be so much concerned with the amount of cash on books but rather focus more on capital allocation skills of the management.

We are not indicating that holding cash more than what is required by the business is a good thing - as companies doing so over prolonged periods will not garner high valuations, as can be seen in the case of companies such as TCS and Infosys at the moment; nevertheless, the key concern for investors should not be whether their companies will be able to add to the already high return on capital. Rather, where and how the cash will be deployed are questions that investors should aim to find out. If managements of companies (which have capabilities to earn high RoEs) diversify into unrelated business or use cash for reasons such as lending out to parent companies or sister concerns, then investors should definitely be concerned.

What is your view on companies building up cash on their books? Let us know your comments or share your views in the Equitymaster Club.

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02:10
 
Infosys will kick off the earnings season tomorrow with its results for the quarter ended September 2014. It will mark an end of an era in many ways. Murthy and Kris Gopalakrishnan, the last two co-founders who are still on the board; will step down. All eyes and ears however, will be directed towards Vishal Sikka, the first non-founder CEO of Infosys who took charge on 01 August. He is expected to spell out his vision and strategy for the company. The company can be expected to maintain its full year revenue guidance of 7-9% in dollar terms. This will be in line with its conservative stance of providing guidance. Of more importance will be management's outlook for the future. Infosys has lagged behind its peers in terms of growth and margins. The company has also had to deal with high employee attrition. It will be up to Sikka and the new management team to revive the fortunes of the company.

02:45
 
The problems for Indian pharma companies seem to be exacerbating. Already, the players have been facing various challenges from US and Indian regulators. The recent pricing policy in India, the stringent USFDA norms and delays in approvals have squeezed the revenues and profitability of the various players. The list does not seem to end. Recently, another issue propped up, which can be another dampener for the pharma companies. It is believed that about 14 global pharma companies including three Indian pharma players viz Sun Pharma, Dr Reddy's and Cadila Healthcare have been probed by US congress over generic price hikes. And these are not small hikes. The US Congress has cited price hikes to the tune of 390-8200% across 10 products!

While price hikes are not new developments in the US market, the scope of increase seems to have amplified these days. Drug shortages, recalls, plant issues, amongst other give opportunity to the existing suppliers to take the advantage of low competition. However, the US Congress asking for the justifications for such a hike from pharma players is among the rare ones. Thus those pharma companies who will be able to give the valid reasons to take a price hike will be in a better position. However others may end up with problems given the fact that the US is trying to tackle the rising health costs. While it is still premature to take a call on the end result of this event, such developments will certainly offer more challenges for the pharma companies.

03:50
 
Can it be possible to analyse a firm's performance without looking at its profit numbers? Certainly not. It is indeed the profitability that helps us determine whether all the activities a firm is undertaking are valuable or not. It is from this perspective numerical information is so important. Numbers do a great job in condensing all the available information about any particular entity. They thus turn this information into something which at the same time can be both easily understandable and actionable. However, what if the numbers themselves are arrived at using the wrong means? Well, it would simply lead to wrong information being given out. And this ultimately leads to incorrect decision making.

Our key concern with respect to how the US Fed is going about interpreting the inflation figures is based on this very premise. One of the Fed officials recently commented that since inflation rates are well below the danger mark, the US central bank should be patient in raising rates. But as we argued, what if the inflation numbers themselves are arrived at using the wrong means? You see, the inflation fails to capture the rise in prices of financial assets and it is this area of the economy that's showing clear signs of overheating. And therefore, the longer the Fed takes in raising rates, the bigger the bubble will become and more terrible will be the consequences.

04:20
 
Seems like global PE major Blackstone Group has had a bargain in the Indian real estate market. In the last three years, wherein it went into an acquisition drive, the company acquired prime real estate assets in India worth Rs 54 bn or Rs 5,400 crores. This was the period when real estate market was shaky and developers were in dire need of money. Only time will tell whether Blackstone made a killing out of this pessimism or not. But the fact of the matter is that this acquisition drive has catapulted the company as a single largest commercial real estate owner in India. Its current portfolio corresponds to what DLF has. As such, many are amazed how the company built in such a strong portfolio within a span of 3 years.

Of course, it may have seen revival in commercial real estate as well. And would have had its pocket full. But the fact that it chose India, as a destination, is noteworthy. No doubt, the outsourcing boom will continue in India due to cheap labor. This will lead to ever increasing demand in office space. A new government may give growth a further fillip. Thus, things do look optimistic. However, vagaries of real estate market are location specific. And the demand/supply dynamics vary hugely. Hence, it would be interesting to see if Blackstone's bet really turns out to be fruitful or not.

04:50
 
In the meanwhile, the Indian stock markets firmed up further in the post noon trading session. At the time of writing, BSE-Sensex was trading higher by 373 points (1.4%). All the sectoral indices were trading in green led by banking and realty stocks. Most of the Asian stock markets were trading firm led by Hong Kong and Singapore. However the Japanese index was trading in the red. European markets have also opened the day on a strong note.

04:50  Today's investing mantra
"If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall." - Warren Buffett
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1 Responses to "Cash, cash everywhere, but not a Re to invest"

Rajeev Arora

Oct 9, 2014

Refer your chart on the biggest cash hoarders in today's 5 minute wrapup. Wonder why you never present your research or recommend BCS to investors even though it has the highest AROE with a proportionately smaller cash hoard. I had requested your views on BCS a couple of month back also but never saw a response.

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