X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Will Warren Buffett invest here? - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • Jun 23, 2010

    Will Warren Buffett invest here?

    Warren Buffett is the world's most successful investor. He has an investment philosophy of his own. An investment/company fits Buffett's criteria only if:-

    • It has strong sustainable RoEs
    • Has consistent operating cash flow generating capability and
    • Low to minimal leverage

    Now, if one has followed Buffett's investment philosophy strictly then he/she might have overlooked the construction industry all together and never considered investing in it. The reason being - construction industry fails to meet Buffett's philosophy on all the three counts.

    In this article we explain the reasons why the Buffett's investment philosophy should not be followed as strictly - especially for the construction industry.

    Let us begin with the first criteria - sustainable RoEs. Numbers foretell the future. But it is important to understand that interpreting them right on the face of it can paint a different picture altogether. A higher RoE business is perceived to be better. But the construction industry is typically plagued with low double digit returns on capital and the reasons are obvious. Construction is a wafer thin margin business. The projects are created for social benefits - typically awarded by the government - and thus have a thin spread.

    It should be noted that over the last few years, construction companies have typically made huge investments in subsidiaries. These subsidiaries undertake BOT projects on behalf of the company. Investment in subsidiaries will not be generating incremental returns to shareholders at least in the near term as BOT projects require huge upfront construction cost (with back loaded returns spread over the concession period) and have long gestation period. This depresses the initial RoEs. Thus, viewing construction industry RoEs (ranging between 12-15%) in isolation does not reveal the true picture. Adjusting for investments in subsidiaries, construction companies typically generate RoEs in the range of 18-20%! Now, this is certainly commendable in an industry which does not have a very strong competitive advantage.

    Coming over to our second criterion on cash flow generating capability, construction is a working capital intensive industry and thus does not generate cash at the operating level. However, it should be noted that over the last few years, construction companies have advanced huge amount to subsidiaries in the form of loans & advances. This in effect exaggerated the working capital concerns. Adjusting for loans and advances the working capital cycle of the construction companies have improved - even if they have not managed to be operating cash positive. We do not expect the industry to be operating cash positive either but the point to be noted here is the exaggeration of concerns over cash flow due to capital mis-allocation.

    The last criterion relates to leverage. Construction companies are highly leveraged. However, it should be noted that debt is typically used to fund working capital requirements and is short term in nature. This is in sharp contrast to other industries where debt is used to fund capex requirements. Thus, when a construction company faces liquidity crunch during a downturn, it can tweak its working capital cycle by stretching creditor days. This should reduce its reliance on debt when liquidity is hard to come by.

    However, during similar crisis other companies in different industries are not as comfortably placed unless the capex they incurred via raising debt is generating profits immediately. If the capex was incurred in the initial stages and does not generate enough returns, the company might have to take more debt to fund its business operations. Thus, it might get trapped in the vicious debt cycle.

    Thus, what we try to convey over here is - Buffett's criterions give you a broader sense on investing in particular businesses. But the investor must be wise enough to understand the industry dynamics and apply the philosophy accordingly. Agreed that the construction industry falls well short of Warren Buffett's investment principles. But it does merit an attention provided the valuations are right and the management is visionary in nature. Of course, it goes without saying that companies in the sector deserve lower valuation multiples that those imparted to companies with limited cash needs and strong competitive advantages.

     

     

    Equitymaster requests your view! Post a comment on "Will Warren Buffett invest here?". Click here!

      
     

    More Views on News

    How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

    Jun 10, 2017

    Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

    How To Read Your Mutual Fund Account Statement Correctly (Outside View)

    Aug 17, 2017

    PersonalFN simplifies the mutual fund account statement for you.

    This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process) (The 5 Minute Wrapup)

    Aug 17, 2017

    A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.

    Which Gods Will Bring Down the US Empire? (Vivek Kaul's Diary)

    Aug 17, 2017

    Mr Trump is in the White House and the gods are in their heavens; what's not to like?

    Will They Haul Off Trump's Statue, Too? (Vivek Kaul's Diary)

    Aug 16, 2017

    All across the country, the old gods become devils. New, gluten-free gods take their places...

    More Views on News

    Most Popular

    Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

    Aug 7, 2017

    The data tells us quite a different story from the one the government is trying to project.

    Proxy Plays: A Smart Way to Bet on 'Off Limits' Companies(The 5 Minute Wrapup)

    Aug 4, 2017

    The small-cap space is full of small players that are clear proxies to great growth stories and Indian megatrends.

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

    Aug 7, 2017

    Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

    More
    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407
     

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms

    S&P BSE SENSEX


    Aug 17, 2017 (Close)

    MARKET STATS