How to Avoid Common Mistakes and Uncommon Losses

Here is the link of the video: https://www.youtube.com/watch?v=NUZ2MTJjvnU

Niteen Dharmawat is the speaker in CFA Society India’s program. He started Aurum Capital with his partner Jiten Parmar. They together have more than four decades of experience in equities and also in mentoring investors.

He starts with the discussion on timing the markets. He talks about investing in bear markets. He shares that he has never seen any instance when money is invested in bear markets and the money is lost. But people lose money when they invest in madness of bull market. He talks about compounding. The three components of compound interest are principal, return and time. Even if the principal is small but is invested over a longer tenure the amount could be very large. Investors focus on return and ignore time component. He takes a case study consisting two stocks – one having price of Rs.27 and another having price of Rs. 9785. He asked the attendees to choose between these two stocks and majority was with ‘A’ because they thought it was cheap so it is good. But the cheaper stock crashed in near future and the costly stock went up. He talks about another stock which had low of Rs.200 went up to Rs.2000 in a single year due to boom.

He talks about things which investors can do before putting in their money. Starting with creating an excel sheet, investors can write the buy price and the reason behind their investing, your expectations from this investment because people forget the reason behind their investment. Investors can also classify their portfolio using different scenarios. Further, he shares about annual reports. Often, investors are highly interested in Profit and Loss statement and ignore cash flow statement. But cash flow statement is very critical. Cash flow consist three components – investing, operating and financing. Cash flow from operations can be evaluated further because if company is selling goods and services and is receiving cash against it, it is recorded here. If a sale is on credit, then receivables are recorded and later when payments are done, cash is recognized. However, receivables are something where investors should focus because it may happen that companies are aggressively selling goods without collecting from customers. There may be some exceptions like banking /financing companies which sells cash through lending. Other things apart from CFO are checking interest expenses and comparing with net profit, checking promoter’s unpledged holding company (pledged stake should be considered as sold). It is difficult to manipulate CFO. CFO can be reported positive either by decreasing inventory or receivables or by increasing payables, but this not sustainable. Other things to be noticed are chairman or CEO’s statement or studying Management Discussion and Analysis report. In chairman’s report, first and last two paragraphs should be studied carefully. Management’s new plans to take business forward should be studied. If to the point information is not given and other numbers of industries are given then this can be a negative point because information about company is not provided. However, investors should look for result of operations, changes in financial condition etc.

Consolidated numbers should be considered instead of standalone. Other things to look in financial statements are net profit, sales, operating profit, cash flows, other income, main expenditure costs, inventory; capital work in progress etc.   

Other things to look at:

1. Salary of directors or any revision in the salary of directors or auditors, is the revision in salary in line with growth and profit numbers?
2. Who are the members of audit and salary committee
3. Composition of board of directors and number of independent directors.
4. Attendance of directors in board meeting
5. Independence auditor’s report
6. Shareholding Pattern

The 6 main components one should look while viewing the P&L account are:

1. Sales Trend
2. Operating performance
3. Interest Component
4. Depreciation
5. Tax Paid
6. Dividend Payout Ratio

The 3 main components one should look while viewing the Balance Sheet account are:

1. Equity Dilution
2. Share capital(Equity/Preference)
3. Borrowings(ST/LT) versus interest component from last quarter

The 5 main components one should look while viewing the Cash Flow Statement are:

1. CFO versus Net Income
2. Working Capital changes
3. Taxes paid
4. CFI Trend
5. CFF Trend

Mr. Niteen explains with the help of real life example how pledging of promoter affects the CFO and PAT of the company. He explains that the more the pledging done by the promoter, poorer the numbers would be.

On being asked how to decide whether to invest in a new upcoming company or not, given the absence of historical track record he says that, such stocks can be kept in your portfolio but with a very low stake.

The background of independent directors needs to be checked and it must be ensured that they have a decent educational background. Also, the information provided by the company can be cross checked to know how trust worthy the company is.

Mr. Niteen talks about various companies whose stock price almost came to zero because of insufficient cash flows, promoter pledging, Equity dilution and increasing debt.