I am continuously talking about dividends and how I am building my income portfolio around that philosophy. Dividend investing is one of the investing strategies among many other different styles of investing and trading strategies. In addition, I am a believer in two sides of a coin, I am a believer of black, while, and gray, and I am a believer in negative and positives.

Keeping with this, I am not dumb to believe that dividend investing is an ultimate panacea of all investing strategies. Anything that we do in our lives has two sides and we manage it in our own ways. Similarly dividend investing also has its dark side and unfortunately, it is often the focus in many discussions. We need to remove some of the myths associated with it and understand how it can be managed. Following is my attempt to bust some these myths associated with dividends.

(1) Dividends are viewed as very small. Very low dividend yield (of the order of 1% to 3%) is often cited as being the main reason. It is said that these low yields do not even match the savings accounts interest rate of 7%.

Dividend yield is “dividends paid per share” divided by “stock price”. Now, if the stock price is over valued, dividend yield is bound to be low. If the stock is priced in excess of 20 PE ratio, dividends tend to be lower than 2%. That does not necessarily mean that dividends have low yield. Stock price is governed by the market sentiment; it does not have any fundamental basis. If you choose to only look at high flyer stocks of the day, then you are bound to feel yields are less. This is addressed by investing in stocks whose dividend yields are based on fair value and earnings of the company. And not based on stock price on any given day, given week, or given year.

In addition, dividend investing is not about present yield. It is about what future yield (i.e. Yield on Cost) you will end up with. Does this bust the myth?

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The current rally has added 48% to the SENSEX relative to February 2009 low of 8160 points. Is this the start of next Bull Run? The market players and traders will make you believe it is in fact the start of next Bull Run. Any rational investor will ask himself one question, what has happened since February 2009 that justifies this rally. Has the global economy turned around? Has the Indian economy turned around? Has the earning of companies turned around? Or the general question can be has it even stabilized to say it is turned around? Some may argue that equity markets are leading indicators and hence things have changed for better.

The real economy across different countries and India has showed continued sign of slowing down. The US economy contracted by approximately 6% last quarter, European economy shows no sign of stopping the slide, and Japan has been in 18 year downward spiral. In addition, the export oriented economy of emerging markets continues to slow down. Russia is in tatters, Brazil is hit by reduce material demand, and Indian companies are looking ways to maintain profitability. China is attempting to spend its way out of this slow down.

In addition, I looked into the latest quarterly earnings of the 30 Indian corporations that are included in the SENSEX. (more…)

You could read the earlier parts on ratio analysis here and here.This post discusses the profitability and valuation ratios.

Profitability Ratios

The profitability ratios try to associate the amount of profits generated with the amount of resources used. These ratios measure the economic efficiency of the firm,

a) Return on assets

This is one of the most effective measures of resource utilization. This is defined as

Return on assets (ROA) = Net Operating profit after taxes/ average assets

The Operating profit is found by removing from the net profit other nonrecurring incomes. Since the operating profit includes, interest expenses as well the return on assets ratio will not be partial to the capital structure of the company.

b) Return on invested capital

This ratio measures the efficiency of the firm to generate income from all assets that are committed for longer periods of time. The ratio is calculated as

Return on invested capital (ROIC) = Net income (modified)/ (Total assets-Current assets)

As in the above case, to make this ratio independent of the capital structure of the firm the after tax interest expense given by Interest expense *(1-tax rate) is added back to the net income.

c) Return on equity

This is a measure of income generated to the stock holders on their investments. This is usually calculated as

Return on Equity (ROE) = Net income/Average stock holders’ equity

d) Net profit margin

This ratio measures the percentage of contribution to net income from each rupee of sales. It is calculated as

Net profit margin = Net Income/Net sales.

One should understand that a high profit margin does not necessarily imply a good performance. One should judiciously use this metric along with other ratios such as return on assets (ROA). For example a firm with very high profit margin, but a low return on assets might not be generating high value to the stockholders.

Valuation Ratios

a) Price to Earnings ratio (PE ratio)

This ratio measures how much investor is willing to pay for each rupee of earnings generated by the firm. One of the most commonly used valuation ratio, it is calculated as

PE ratio = Market price of the share/ Earnings per share

The Earnings per share used in the denominator is usually the forecasted earnings for the next year. This ratio being simple to calculate is widely used by the investors. Companies that are growing rapidly and are thought to have higher potential for future growth usually trade at higher PE ratios. A variation of the ratio called PEG ratio is also commonly used to value growth companies. It is calculated by dividing the PE ratio of the firm with its earnings growth rate. A PEG ratio of one usually indicates a fair pricing for the stock.

b) Price to Book value ratio (P/B ratio)

The book value of a company could be thought of as the amount the shareholders of the company receive if the company gets liquidated. This ratio is calculated as

P/B ratio= Market price of the share/Book value per share

As with PE ratio generally, lower the P/B ratio more the value for investors. ‘Value Investors’ traditionally look out for companies that are trading at a discount to their book value. But investors should be careful enough to use the P/B ratio along with other metrics. Most often stocks that are trading at a low P/B ratio are just ‘bad companies’.

c) EV/EBITDA

This ratio termed as the enterprise multiple, is often preferred over the PE ratio by analysts. The main reason for that being this ratio is neutral to the capital structure of the company. The Enterprise value of the firm might be thought of as the amount required to be paid if you are going to acquire the company today as valued by the markets. It’s calculated as

Enterprise value = Market capitalization of the stock + Long term debts –Cash and equivalents held

EBITDA = Earnings before interest, depreciation and taxes

Enterprise multiple = Enterprise value/EBITDA

As with PE ratio it’s common to use the EV/EBITDA ratio with forecasted earnings.

In the next part we will talk about some common mistakes to be avoided when using ratio analysis for investment decisions.

The first post in this series of articles explaining the basic of ratio analysis covered Liquidity and Leverage ratios, it is available here . This post covers Activity ratios which indicate how efficiently the various assets and current liabilities of the organization are being used .The focus is usually on three areas; inventory, accounts receivables and accounts payable.

a) Asset turnover ratio

Asset turnover ratio measures the effectiveness of the organization in utilizing the assets of the organization. It’s defined as

Asset turnover ratio= Net sales/ Total Assets

Various sectors will be having different asset structures, hence it make no sense to compare the asset turnover ratios across industries.

b) Inventory turnover ratio

This ratio measures the number of times a firm sells its inventory in a year. It’s defined as

Inventory turnover ratio = Cost of goods sold/Average inventory over the year

The average inventory during the year is usually calculated by adding together the beginning and ending inventories during the year and dividing it by 2.This ratio also indicates how liquid an asset is inventory of the company. A low value of this ratio indicates that the inventory is an illiquid asset. A higher value for this ratio indicates that the threat of inventory obsolescence will be quite lesser for the firm. The inventory turnover ratio could be used to find out the days inventory the firm is holding.

Days inventory = 365/ Inventory turnover

c) Account receivables turnover ratio

This ratio calculates the number of times a firm collects the average account receivables each year. It’s calculated by

A/R turnover ratio = Net sales/Average accounts receivables

This ratio will be larger for firms that have a larger portion of their sales as cash sales. An approximate indication about the number of days that elapses between sales and receipt of payments from customers could be got from calculating the Days receivables

Days receivables = 365/ Account receivables turnover ratio

A higher days receivables may indicate poor collection efforts by the firm, the firms’ key customers in financial distress or delayed payments by customers.

d) Account payables turnover ratio

This ratio calculates the number of times a firm pays the average account payables each year. It’s calculated as

Account payables turnover ratio= Cost of goods sold/Average accounts payable

Days payables = 365/Account payables turnover ratio

e) Cash cycle

A related efficiency measure is the cash cycle. This could be thought of as the number of days taken to get back the cash once the firm has used cash. It’s calculated by

Cash cycle = Days account receivables+ Days inventory –Days account payables

An efficient firm will try to have a cash cycle as small as possible. Needless to say, cash cycle varies across industries. Most FMCG firms have a cash cycle close to zero or sometimes even negative. This means that they are able to run their day to day operations on the supplier’s money.

Rakesh Junjunwala rightly defined the stocks markets as “Markets are like women always demanding, unpredictable and volatile.” No one know whats next. For an instance take it - Does any one knows when this recession is going to end ? No, no can say it accurately, one can just predict but as all know that the future is uncertain.
But what one can do is spot out some value stocks in this badly beaten markets and think of long term investment in them. But a question comes here that which company to invest in?
The answer to the above question is invest in the company in which you have faith and confidence and more over of which you are aware of.

Here are few easy steps to identify Multibagger stocks.

1. Go for a company which gives regular dividend. Dividend paying stocks mostly lie in A group category.
2. Preferably go for a Mid cap stock which in future can become a large cap. Mid cap stock have a greater chance to move upwards and that to fast. Preferable a stock whose market cap is less than 1000 Crores.
3. Go for a stock in a particular sector which is in boom.
4. Look out for the companies financial. In this check out the companies profit f last 4-5 years and check it out that it is increasing every year. One can also check out EPS of the company.
5. Check out whats running these days, Say for example there is a invention of a new technology which will be in demand in a near future. An excellent example is invention of 3G. Even TATA Nano can be taken in consideration as it is only one of its kind being the cheapest car in the world.
6. Check out for a companies order value. There are various companies which have a good amount of orders for future which are of great importance to a company.
7. One can also look out for a company which has good amount of land / property. Unitech had a lot of lad which can in the eyesight by end of 2005. An investment of Rs 40,000 then would be worth over 1 crore by the end of 2007.
8. Last and not the least be confident in your stock.

Few don’t s in selecting a multibagger stock.

1. Don’t select a Penny Stock.
2. Don’t loose hope in your company.
3. Don’t depend on others , do your own research.

Happy Investing.
Post originally written by Chirag Jethmalani on www.Squamble.Com

This is the first post in a three part series which will introduce one of the core methods of fundamental analysis; ratio analysis.

Ratio analysis is one of the most powerful tools available to help interpret financial statements and better understand the strength or weakness of the underlying business. Financial ratios can let the investor know about the financial condition of the organization, the efficiency of its operations, the profitability of the company, the ranking of the company among its peers and the perception of the company in financial markets.

Although ratio analysis is quite a powerful tool, relying solely on financial ratios to arrive at investing decisions can be dangerous. This series of posts will explain how to calculate the key ratios from the financial statements of the company and explain what these ratios can tell you about the business in question.

This post will introduce you to Liquidity ratios and Leverage Ratios. The second post will cover Activity Ratios. The third in the series will look at Profitability and Valuation Ratios. This three part series will be followed up with a post explaining some common mistakes that are to be avoided when using ratio analysis.  

So here we go…

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About
Balmer lawrie is a diversified government owned company. It has the following diverse businesses
-        Industrial packaging: Drums, barrels etc
-        Logistics infrastructure and services
-        Travels and tours
-        Greases and lubes
-        Tea
-        Others

The company is a profitable PSU and a zero debt company and now has surplus cash on its books.

Financials
The financial performance of the company has been improving steadily from an ROE of 12% in 2004 to almost 24%+ in 2008. The Topline for the company (includin JV and Subs) has grown from around 1100 to 1788 in 2008 giving a CAGR of 10%. The bottomline has improved from 31 Crs to 99 Crs in the same time period indicating an improvement of profitability.

Positives
The topline has grown by 10%, however the netprofit for the company has almost tripled in the same time period. The company has now become a zero debt company (including JV and subs) now, with surplus cash on its books

In addition the company management realizes the importance of allocating capital . They have indicated that they are looking at exiting low profitability businesses like tea and invest in the more profitable ones. This is also visibile from the improvement in profits over the topline.

In addition the excess cash has been used to reduce the debt too.

Risks
Everything said and done, this is still a PSU. So there is always a risk that the government may do something stupid. However in the recent past the profitable PSU’s are being allowed to operate with autonomy (barring the Oil PSU’s). Still a risk exists.

Almost 60% of the profits come from the logistics and infrastructure serivces division. So any drop in profitability of this division could impact the company strongly.

Management quality
The PSU label seems to indicate that the management quality is poor. I think that would be as wrong as saying the MNC label indicating good management. Each company and its management should be evaluated based on their own merit.

Management compensation - Being a PSU, the compensation is a bit too low.

Capital allocation record - The management has had a good and sensible record of capital allocation. They ROE has been increasing steadily over the years due to the management focus on better performing PSU such as tour & travels, logistics and divestment of the poor performing businesses such as Tea (in UK), projects etc. In addition the management has reduced debt and also increased dividends.

Shareholder communication - Fairly decent. The management has regularly discussed the strenghts and weaknesses of each SBU, plans for each of the businesses and have been transparent on the downside risk of each business (may be a bit to pessimistic)

Accounting practise - Good. I don’t see any aggressive accounting.

Conflict of interest - None from the management. However the majority shareholder is the government. Till date there has been no interference.

Valuation
The company sells for around 3-4 times the cash flow for 2008-2009. With an ROE of 20%+, and a moderate 10% net profit growth, the instrinsic value seems to be around 1500 Crs or higher for the whole company.

An alternative approach to valuing the company would be to value each division individually as some have great economics such as the logsitics division and some horrible such as the Tea division.

Conclusion
The company seems to be selling at greater than 50% discount to instrinsic value. It seems to carry a  PSU discount to its valuation too.

disclaimer : I have a holding in the stock

This is about Satyam Saga. Most of the articles and comments I have read in business media focus on tangibles like revenue, profits, number of customers, etc. So in today’s post I am discussing my view of Satyam Saga. My focus is more on the intangible issues that are hidden and may not visible to common investor.

I would like begin with commending the authorities who made this transition smooth, swift, and without much ado. The use of word authorities here is a proxy for industry association, company law board, ministry officials, and other unknown institutions. I believe if this situation had prolonged and quick decisions were not made, Satyam would have went for a toss, and it would have had a negative impact on Indian outsourcing business. The short term implications would have been far reaching somewhat similar to Lehman Brothers.

One company is Tech Mahindra (TM). The other one is not Satyam. My personal viewpoint about Satyam is that it does not have wide moat in the supply chain. It operates on a business model which uses labor arbitrage as its USP. It is relatively easy and manageable for customers to shift the vendor and still not have any significant impact on their operations. I do not have any intention to offend Satyam folks. However, one has to be pragmatic and take into account how their customer base (i.e. international companies across the developed world) views them as a company. It is viewed as Wal-Mart of software outsourcing industry. The second company I would like to include here is Larsen and Toubro (LnT). (more…)

When some one says Long term investment the first thing to come in mind is Patience.
Do you know an investment of Rs. 10,000 in Wipro in 1979 would be worth more than 200 Cr. today. Believe it or not but this is the fact.
So all of you all may be searching for another Wipro. But no one knows which company will be Wipro.

A PPT On Long term Investments - Click Here to Check out the PPT

How to analyse the stocks for long term ? - My Six Sigmas.

1. Check the market cap. Select a company preferably in a market cap of 3 figures. Less the market cap the more is the advancement oppurtunities.
2. Look for an upcoming sector. eg . Telecom and Pharma. An example is China Mobile worlds largest mobile company. Every body needs a cell phone. Telecom is sure to rock.
3. Look for resources Example - Land. Look for companies which have good amount of property. As most money made is in Property and Development.
4. Increasing profits in balance sheet on year over year basis. A tip check for PAT.
5. Future Order value. Example LNT is one good stock.
6. Be Confident in your Scrip.

Post published by Chirag Jethmalani on www.Squamble.Com

My investing philosophy involves investing in high quality dividend paying companies at a fair value. I am willing to wait for more than 10 years. So many times I have been questioned on this investing approach and believe it or not, I just smile and move on. Not because I cannot respond, but because I am confident that I will have the last laugh. As an example, you may read one of my earlier posts on yield on cost.

Indian companies are not alone in paying dividends to its shareholders. Dividends are paid to common shareholders by corporations across the world, in different economies, different markets, and variety of industry segments. The characteristics of common shareholder dividends are not same. There are differences with respect to yield, frequency, how dividends are perceived, quality, and growth rates. In addition, for an international investor, effect of currency fluctuations is an added risk.

Today I am presenting the dividends yields and growth rates in three different parts of the world. It would very difficult (if not impossible) to either screen or identify every dividend paying companies in these markets. Therefore, I am using individual index and their yield to look at trends in any given market. While there may be varied arguments about quality and validity of such comparison, I still believe it is a good start to understand any given market and its policies vis-à-vis common shareholder dividends. (more…)

A statement that you can’t spend profits, might surprise you! Individuals might think that this is a very odd statement and perhaps incorrect. It is a correct statement and should be made as an investing proverb to be used by any type of investor. Let me present my case.

Companies make profit by selling or exchange of their products or services. At a very basic fundamental level, this can be done by making those products or services at lower associated cost (or expenses). In the end, what we all want is to somehow convert those profits into cash so that we can spend it. Some might argue that this is just semantics of words. I say, it is not! If that were the case than how can we explain the fact that many times companies report profits that are more than cash flow from operations? Take a pause and think for a moment. How can we have more profit when we are not getting that much of cash transactions? In one of my earlier post Cash Flow is Important Financial Statement, I discussed how cash flow is what ultimately drives the value of any given business. (more…)

Trend Analysis

The whole reason for any business to exist is to generate sales revenue and make more profits. At a minimum, the parameters listed below should have continuously increasing trends. All the data below is based on last 8 years 2000 to 2008.

• Revenue: Increasing trend with average growth of 24% (SDev. 9%).
• Earnings per share: Increasing trend with average growth of 24% (SDev. 16%).
• Net cash flow from operations: Overall, the net cash flow from operations has an increasing trend. However, the net cash flow is consistently less than reported net profit. I would like to understand (if possible) how company is showing continued profit is when its cash inflows are always lower.
• Profit/Loss from operations: Looking at standalone profit only, the corporation is showing consistently increasing profits from its operations.
• Reported net profit: Increasing trend.
• Gross margins: Sustainable gross margin, averaging 19.5% (with a very narrow standard deviation of 1.36%). Purely on numbers alone, this may seem very good. However, I would like to understand how company is able to maintain such a tight control on its profitability.
• Operating margins: Sustainable operating margin, averaging 22.2% (SDev. 1.20). Again, I would like to understand the narrow standard deviation.

  

Cipla Trend Analysis

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