Author: Sanjeel Kothari

I am currently pursuing FinBridge program from Finnacle Investment Academy, Surat. I have cleared Investment Foundation exam by CFA. I want to become an Equity Research Analyst.

Summary of “Should the RBI print money to revive the economy?”

Here is the link to the article https://www.newslaundry.com/amp/story/2020%2F05%2F08%2Fshould-the-rbi-print-money-to-revive-the-economy-its-not-as-simple-as-it-sounds?__twitter_impression=true

Due to Covid 19, government imposed lockdown in whole country due to which almost all businesses were shut down. Due to this government’s income in the form of GST declined. Foreign trade was also impacted due to which government’s income in the form of customs and other duties also declined. State government’s source of income – sales tax/ VAT on petrol and diesel – took a hit as consumption of fuel declined. Also there were no real estate transactions which means no stamp duty and as alcohol shops were also closed no taxes were collected from their too.

In such crisis times, every person share their views on how to revive economy and all have one answer – RBI will print money from thin air and will give it to government for spending. But there’s a catch here. What looks easy doesn’t mean it is easy.

There are few points which need to be taken care of. They are –

  • The money which the government is printing and distributing is just fiat money i.e. it is not backed by any commodity. Just because government says that it is money people believe and accept this as money. One more reason people accept this fiat money is that they know others will accept it (Example – ‘A’ use this money because he knows that ‘B’ will accept it and ‘B’ accept it because he know ‘C’ will accept it).  Government too create demand of fiat money by accepting taxes in home currency. The problem also lies in taxes. In India, if government reduce tax evasion then this will ensure in more demand of rupee.
  • Another point is that if government will infuse money into economy to create demand then it will lead to inflation. Because more money will be chasing the same quantum of goods. But according to survey done by RBI on capacity utilization it was found that one-third capacity is lying unused. So manufacturing companies can increase production without affecting prices (inflation).
  • Now here comes an interesting point. RBI prints money and buy government bonds. Government spends this money through which it reaches many people. These people spend this money further in buying goods/services. Through this the money reaches to corporates and they deposit it in bank accounts. Then the banks park the excess money with RBI at lower rate (if bank buy government bonds they earn 6% interest but parking with RBI in reverse repo window yields 3.75% return, according to latest rate). This also leads to lower tax collection from banks as they earn less.
  • Creating money and infusing it into economy can also lead to depreciation of economy. Foreign investors will take an exit which will lead to more demand for other currency and selling pressure on rupee will lead to a rise in exchange rates. Also, currencies of countries like United States, United Kingdom etc. have global demand. So they can print money without damaging exchange rates.

Hence there are challenges in taking this step. But at the end it’s the call of government to take decision on it.

Summary of Article on “Asset-Liability Management”

Here is the link to the article https://twitter.com/FinsenseG/status/1259705804661256193?s=19

In this article, the concept of ALM is explained.

What is ALM?

Simple, ALM is the management of assets and liabilities. For banks, assets are the loan given to customers and liabilities are the deposit made by the customers or money raised by debt instruments like NCD’s or bonds etc.

What is a mismatch?

When banks have excess of either deposits or liabilities in a single time frame, it is mismatch. Example – A bank has deposits for 5 years but it gives loan for 20 years.  After 5 years when depositors will demand money then bank would not be in a position to pay it back and thus it will default.

Banks have to group all their assets and liabilities (according to time frame) and need to show it in balance sheet.

Some techniques used by banks for management of assets and liabilities –

  1. Gap Analysis – Interest rate risk on RSA (Risk Sensitive Assets) and RSL (Risk Sensitive Liabilities) are assessed using this method. RSA and RSL are floating rate loans or deposits or any instrument with premature mature and withdrawal option.
  2. Duration Analysis – Duration analysis is done to asses risk of interest rate fluctuation. Higher the maturity of instruments, higher is the chance of change in interest rate.
  3. Scenario Analysis – In this method, various scenarios are created to check how ALM can be affected in future. Scenarios can be like rise in interest rate, decline in interest rates etc.

Thus ALM is an important concept when it comes to risk management. Investors gain confidence if ALM is good. It can be checked in annual reports of banks/ NBFC’s.

Summary of article “Nifty 50 is a Different India”

Here is the link to the article http://www.nooreshtech.co.in/2020/05/nifty50-is-a-different-india-economy-not-equal-to-nifty50.html?utm_source=feedburner&utm_medium=twitter&utm_campaign=Feed%3A+TechnicalViewByNooresh+%28Technical+view+by+Nooresh+on+Sensex%2FStocks%2FCommodities%29

In this article, it is shown that how some sector or top companies dominate indices like NIFTY 50. That’s why NIFTY 50 cannot be considered as the indicator of Indian economy.

Top 7 companies together make 52.1% of NIFTY 50.

Two companies together make 30% (reliance Industries – 11.54% and HDFC and HDFC Bank – 18.63%).

BSE’s (Bombay Stock Exchange) market capitalization is Rs. 1,23,83,500 crore. Out of this, top 30 companies together make 51.5% and there are more than 2000 companies on BSE.

Main problem is that financials are dominating index whereas sectors like metals, construction, cement etc. which are biggest driver of growth and jobs in economy doesn’t have much weightage.

So Nifty should not be considered as an indicator of Indian economy because it can convey a different story.

Summary of article “What have we learned here”

Here is the link to the article https://www.collaborativefund.com/blog/what-have-we-learned-here/

In this article, few things are shared which we learnt during this pandemic

First thing is about business which have low margins. As lockdown was imposed and businesses were shut down, many businesses which were operating on thin margins faced bankruptcy.

Second point which is discussed here is about lowest-paid workers which consists of food delivery, truck drivers, farmers, grocery store clerks etc. these people got less respect but are most important during this pandemic situation.

Size of business collapse and magnitude of stimulus are important stories. As the economy is facing huge unemployment government is supporting it by providing stimulus.

A calamity is a good time for investment strategy to prove itself. Words like ‘recession proof’ will now not be used as people have seen that this kind of pandemic doesn’t leave anyone i.e. the affect is seen on everyone.

If someone does forecasting and people have stake in it then they want certainty too.

Whatever happens to economy people will take it by saying that it was obvious. If GDP falls then people will say it was obvious because there was high unemployment. If a vaccine is discovered then people will say it was obvious we can’t live with this whole life. One or the other day the vaccine was to be discovered.

Leverage is danger. The cost of leverage is not only interest but also your ability to have good cash flows in future when debt matures or interest payment is due.

When people suffer from something unexpected, their views changes i.e. they adopt views which they used to refuse earlier.

Things can go beyond imagination and adaption can be bigger than considered. Take lockdown for example. Two months ago it was hard to digest that businesses needs to be closed.

The most important learning is no one can predict future. Things can change in the way you never imagined.

Summary of Neelkanth Mishra’s Article

Here is the link to the article https://twitter.com/neelkanthmishra/status/1257836711670804481?s=08

In this article Neelkanth Mishra, co-head of APAC strategy and India Strategist for Credit Suisse, is talking about impact of Covid 19 on income of people, companies and government.

He starts with talking about the situation of Covid 19 in India. He says that Covid 19 will remain with us for a long time until a vaccine is not discovered. This means that many small workers will be impacted due to no income.

He explains impact on demand by giving two examples, first of electricity generation that how the generation was allowed in first lockdown but as the demand fell, generation and distribution companies suffered. Second example he gives is of fuel retailing. As the demand for fuel fell it not only impacted fuel retailing companies but also refineries.

He then talks about various researches done in past few days which show impact of income loss. It showed that Rs. 8.5 trillion will be the loss but he states that impact of other lockdowns and the long fight with Covid 19 is not fully reflected so we should assume the loss to be around Rs. 10 trillion.

Who should bear the losses?

Income in an economy is split between individuals, corporations and government. On corporations, he says that fixed costs like rent, salaries, interest etc. will not be deferred so their share in losses would be higher. Government too would loss more than normal because of loss of taxes, spending on healthcare, providing food for poor people etc.

For individuals he said that their point was beyond debate. The loss would be more if corporations fail to make money because these firms pay taxes, create employment, and consume too. As the business will suffer, unemployment will increase which will lead to further loss for government (as these workforce pay taxes too), also firms will stop consumption. There will be risk on financial sector also because if there will be income loss then NPA’s will increase.

Instead of government coming when all these losses have occurred, it will be good if government takes action now.

Book Summary of “The Five Rules for Successful Stock Investing”

Note – This summary is till chapter 6 only.

Chapter 1: The Five Rules for Successful Stock Investing

Investors should have a investing framework i.e. investment philosophy. One should stick to his philosophy. Even Warren Buffet in Berkshire Hathaway’s AGM tells same thing every year of being invested for longer time. If you have done your homework well then you can do well in markets.

Five rules recommended by author are –

  1. Do your homework – Many investors don’t have knowledge about the company they are investing in. It is good if homework is done because at the end it is your money which is at risk. Here homework means reading company’s annual reports, going through past financial statements in short doing research on company. Doing this can help you uncover facts about companies and you can make your investment decision.
  2. Find economic moats – Economic moat refers a firm’s competitive advantage. In a competitive economy there are always people who eat away the profits of big businesses. If a firm has an economic moat, it can keep earning higher profits for a longer time and thus making a superior investment for longer tenure.
  3. Have a margin of safety – Margin of safety means having a difference between the price the market is asking and the price you want to pay. It plays as a cushion if there are losses in future. Size of margin depends upon firm i.e. volatile firms require higher margin and vice versa. Valuation plays an important role.
  4. Hold for the long haul – Buying a stock should be considered as an asset. You hold your asset for a long tenure so should be your stock – hold for a long tenure. Frequently trading stock will lead to higher expenses such as commission, taxes etc.
  5. Know when to sell – In short term many factors drive stock’s price. It can be attractive or less attractive due to share performance in short term. There are some questions which can help you TO decide whether to sell the stock or not. These questions are – have the fundamentals deteriorated?  Do you make a mistake? Has the stock risen too far above its intrinsic value? Is there something better you can do with the money? Do you have too much in one stock?

So these five steps are just a summary of what an investor need to do and further will be discussed later.

Chapter – 2 Seven Mistakes to Avoid

While investing, the investor must know how to avoid the common mistakes, otherwise these portfolios returns wouldn’t be something that cheer him up. The Seven Mistakes which usually the investors make and which must be avoided are:

  1. Swinging for the fences
  2. Believing that it’s different this time
  3. Falling in love with products
  4. Panicking when the market is down
  5. Trying to time the market
  6. Ignoring Valuation
  7. Relying on earnings for the whole story
  • Swinging for the fences – One of the mistakes which investors often make is to load their portfolio with risky stocks. Such stocks may prove to be a disaster for any investor. It’s a very difficult job to assess the Startups and predict which startup is going to be the next big thing in Stock Markets. This is because it is difficult to foresee the future of the firm which is just starting out. Numbers prove that small growth stocks are the worst returning equity category over the long term. In fact between 1997 and 2002, 8% (Nearly 2200) firms on the NASDAQ were delisted each year.
  • Believing that it’s different this time – It is foolishness in a market to think that “It’s Different this time”. An investor has to be a student of markets history to understand how the future events would pan out. For example, in 2001 the energy stocks were booming and many analysts had high hopes for these stocks until the economy slowed hurting demand and new plants coming in and thus driving up the supply as a result the energy stocks tanked 50% to 60% followed by the Enron Debacle which sealed their fate.
  • Falling in love with products – It is not just a product which drives the stock price of a company it’s the entire business of the company which controls the stock price. Thus even if the product of the company is attractive, it is equally important for factors like profit margin, competition and the company’s moat to support the product to drive the stock up.
  • Panicking when the market is down – It is generally being seen that assets are cheap when everyone is avoiding them. Stocks are generally attractive when no one really wants to buy them. For example, a study by morning star revealed that those fund categories which attracted the most money were the ones which were outperformed by those funds which experienced the strongest outflows. You will do better as an investor if you seek out bargain in parts of the market that everyone else had forsaken, rather than buying the popular stocks.
  • Trying to time the market – Market timing is one of the myths of investing. There is no strategy that can consistently tell you when to be in the market and when to be out of it. A study by Financial Analyst Journal compared the buy and holds and market timing strategy between 1926 and 1999. It concluded that the market timing strategies produced a greater return than simply buying and holding. However there are limitations to these studies:
    • The benefit of compounding has been ignored as each year has been seen as a discrete period.
    • The market in and out strategy has a high risk of not being in the market for anyone looking to build wealth over a long period of time.
    • There are no funds which have been consistently able to time the market based on the signals generated by a quantitative model.
  • Ignoring Valuation – The only reason you should buy a stock is that you think the business is worth more than it’s selling for and because you think another person will pay you more for the shares a few months down the line.  The best way to mitigate your investment risk is to pay careful attention to valuation. Buying a stock on the expectation of positive news is asking for trouble.
  • Relying on earnings for the whole story – The importance of cash flow is more than that of earnings. The Cash Flow Statement is very helpful in providing insights into the true health of a business and a lot of blowups can be predicted through this statement. For example, if operating cash flow is stagnating even if earnings grow it’s likely that something is rotten.

Chapter 3: Economic Moats

Businesses which earn good profits attract a lot of competition in future. Economic moat is a characteristic by which companies can remain the same profitable or they can safeguard their profit.

Four steps to analyze company’s economic moat:

  1. Check historical profitability of firm.
  2. Assess the sources of firm’s profit.
  3. Estimate company’s competitive advantage period
  4. Analyze industry’s competitive structure
  1. Checking historical profitability – we look for companies which are earning in excess of its cost of capital. To analyze this, there are few questions which can be helpful
    • Analyzing free cash flow of the company – Free cash flow is CFO minus capital expenditure. It essentially tells that how much cash is left after doing capex. Then free cash flow should be divided with revenue (sales) which will tell the proportion of each dollar which is converted in excess profit. Strong free cash flow is good sign of a company having economic moat.
    • Analyzing firm’s net margin – Net profit margin is how much profit the firm is earning on per dollar sale. Higher the margin better is the company doing.
    • Analyzing return on equity (ROE) – ROE is how much profit the firm is earning per dollar of shareholder’s equity. Posting consistent ROE for a longer period of time can be a sign of company having economic moat.
    • Analyzing return on asset (ROA) – ROA shows how a company is translating its assets into profits.  

These factors, if studied for longer time horizon, can be helpful in finding a company with good economic moat.

  1. Building an economic moat – We should check why company is earning higher profits than peers. In every business there are competitors who are ready to eat away the profit. Company can build competitive advantage in five ways :
    • Real product differentiation – If a firm has a product which customers prefer over all peer brands then this can be a economic moat. Good knowledge of inner working of industries can help gain competitive advantage.
    • Perceived product differentiation – A firm with better products create a brand for itself. For a good brand consumers are ready to pay more. This helps in separating valuable brands. If a brand is actually making money then only it can be considered as economic moat because there are some brands which were unable to generate returns.
    • Driving costs down – If a product is offered at a low price then consumers are attracted towards this product. For this the firm has to drive down their costs. It can become a strong source of competitive advantage.
    • Locking in customers – If customers are locked in by putting higher switching costs then it can be a wide economic moat. Switching costs is not in terms of money but is time. A customer will least prefer to buy a brand and then learn how to use it.
    • Locking out competitors – If firms are able to lock out competitors it can result in years of strong profits. If licenses or other government exclusivity is obtained then competitors can be locked out easily. A strong network of customers can be more effective tool of locking out competitor.
  2. How long will economic moat last – Estimating how long will an economic moat will be there for company is difficult but even if you come to an estimate it will be helpful because some firms post good profits in short term but their economic moat doesn’t last longer.
  3. Industry Analysis – By analyzing firm’s sales and earnings growth rate, we can come out with a conclusion that whether the industry is growing or shrinking. It needs to be done on few companies and not one or two.

Chapter 4: The Language of Investing

  • The Basics

An investor is always interested in three statements namely, the Balance Sheet, the Income Statement and the Cash Flow Statement.

The Annual Report, 10-k and 10-Q are the detailed set of financial information that the companies file with SEC. These are the sources to extract the three statements.

The Balance Sheet tells you how the company owns relative to what it owes at a specific point in time.

The Income Statement tells how much the company made or lost in accounting profits during a financial year.

The Statement of Cash Flows records all the cash coming in and going out of the company.

  • The Income Statement and the Cash Flow Statement tell different stories about a business as they are constructed using different set of rules.
  •  The Income Statement strives to match revenues and expenses whereas cash flow statement, regardless of the timing of the action, cares only about the cash that goes in and out of the door.

Chapter 5: Financial Statements Explained

Financial statements are the foundation for analyzing companies.

Balance Sheet –

This statement shows the equity and liability i.e. what company owns and what company owes. The asset side consist of current assets and non-current assets.

Current assets consist of assets which will be used in current fiscal year like Cash and cash equivalents (very short term investments like money market funds etc.), inventories, account receivables etc. Some useful information which can be found from this side is whether the inventory is increasing or decreasing, whether company is aggressively selling goods on credit etc.

Non-current assets consist of PP&E (Property, Plant and Equipment), Non-tangible assets like goodwill, investments (done in shares of other companies or purchased bond of other companies).

Liability side consists of current liabilities and non-current liabilities.

Current liabilities are those which the company has to pay within a period of 1-year. It includes account payables, short term borrowings etc. If the firm has huge amount of debt which needs to be paid in one year and it is huge as compared to asset then this can be a red flag.

Non-current liabilities are those which need to be paid after 1-year or from next fiscal year. Long term debt and retained earnings are the important things that can convey some message for investors.

Income Statement –

This statement shows how much company is making or losing. It consists of revenue, cost of goods sold (from these two we calculate gross profit), operating expenses (such as marketing, salaries, research and development etc.). Operating expenses or SG&A (Selling, General and Administrative Expenses) when is taken as a percentage of revenue can depict how a company is on cost basis (cost effective or efficient). Other components are depreciation, one-time (non-recurring) charges/gains, operating income, interest income/expenses, taxes and finally net income. One time charges and taxes need to be analyzed properly as they may convict some useful information.

While analyzing EPS more focus should be given on diluted shares because it can affect shareholder’s stake in the company.

Cash Flow Statement –

This is the most important statement. It tells the net cash earned by business either through operating activity, financing activity or through investing activity.

Cash flow from operating activity is the most important because it shows how much cash has the business generated through its core business. Changes in working capital can cause huge difference in net income and operating cash flow.

Cash flow from investing activity involves the income/expenses done by business either on the company itself (which is known as Capex) or is invested in bonds or shares of other companies. Money left after doing capex is free cash flow.

Cash flow from financing activities deals with transactions done with company’s owners or creditors like paying dividends, issuing/buying back shares, and issuing/repaying debt. This numbers are important to analyze because they show from where is the cash coming (either through issuing shares or bonds) or where the cash is going (buyback or repayment of debt).

Thus analyzing these three statements will guide investor to analyze the whole company.

Chapter – 6 Analyzing a Company — The Basics

The process of analyzing a company can be broken down into five areas:

  1. Growth

Strong growth more often tempts investors than anything else. However, it has been seen that strong earnings growth is not very persistent over a series of years i.e. high earnings growth in the past doesn’t necessarily leads to high earnings growth in the future. It is always critical to investigate the sources of the company’s growth rate along with the quality of the growth. High quality growth means selling more goods and entering into new markets whereas low quality is generated by cost cutting or accounting tricks.

  • The Four Sources:

Sales growth arises from one of the four areas:

  • Selling more goods & services – The easiest way to grow is to sell more products than your competitors and steal market share from them.
  • Raising prices – Raising prices can also be a great way to boost top lines, although it takes a strong brand or a captive market to be able to do it successfully for long period of time.
  • Selling new goods & services – If there is not much more market share to be taken or your customers are very price sensitive, you can expand your market by selling products that you hadn’t sold before.
  • Buying another company – Another source of sales growth is acquisitions of other companies. The historical track record for acquisitions is mixed. The reason for this can be that the firms have to acquire bigger and bigger firms to keep growing at the same rate or simply that buying other companies takes time and money. The goal of this type of analysis is simply to know why a company is growing; it will help in predicting the source of growth in the future and the opportunities that the company can tap.
  1. Profitability

The real key to separating break companies from average one is to ascertain the amount of profits which the company is generating relative to the amount of money invested in business. By measuring the return that the company has achieved through its investment process, we know how good they are at efficiently transforming capital into profits. Higher the return, the more attractive the business will be.

  • Return on Assets – The two components of return on assets are net margin and asset turnover.

Net margin is equal to net income divide by sales and asset turnover is equal to sales upon assets.

Net margin * Asset turnover = Return on Assets

ROA helps us understand that there are two routes to excellent operational profitability:

  • High prices for your products
  • Turning over your assets quickly – ROA isn’t enough because many firms are at least partially financed with debt which needs to be taken into accounting.
  • Return on Equity – Return on Equity is an efficient measure of company’s profitability because it measures how good the company is at earning a decent return on the shareholders money.

Return on Equity = return on assets * financial leverage = net margin *asset turnover *financial leverage

Financial Leverage is a measure of how much debt a company carries, relative to its shareholders equity.

There are two caveats while using ROE to evaluate firms:

  • Banks always have enormous financial leverage ratios that look high relative to a non bank.
  • The second caveat concerns firms with ROE that are too good to be true. It may occur due to buyback of a company’s share, companies that have spun off from parent firms, etc because their equity base is depressed.
  • Return on Invested Capital – Return on invested capital adjusts some peculiarities of ROA and ROE. It puts debt and equity financing on an equal putting. It removes all the debt related distortion that can make highly leverage companies look profitable when using ROE. It uses operating profit after taxes but before interest expenses.
  1. Financial Health

After figuring out a company’s growth and profitability, we need to look at the financial health. The bottom line above financial health is that company increases its debt; it increases its fixed cost as a percentage of total cost.

The key matrixes when assessing a company’s financial health are:

  • Debt to equity Ratio
  • Times Interest earned
  • Current and Quick Ratios
  1. The Bear Case

Constructing a bear case involves listing of all the potential negatives, from the most obvious to the least likely. It acts as a great reference point when you decide to buy the stock. It will help you know in advance what kinds of trouble to watch for so that better decisions can be made.

Having investigated the negatives you will have the confidence to hang on to the stock even during rough patches.

Economic Profit Analysis

In the last post we calculated the opportunity cost for business that came around 12%.
Now by taking that opportunity cost as Cost of Capital we have calculated RoCE for companies of cement sector and by that RoCE we calculated which firm is earning in excess of cost of capital.
Here, attached is the excel file where analysis and all calculation is done.
By doing this activity we can filter good and bad companies up to some extent.
Note – Data used was acquired from different sources.

industry-company-roce-1Download