May 20th, 2012
What is the most commonly heard refrain about the stock market these days?
My guess is that a lot of people now believe that the stock market is a nasty, volatile place where a serious investor cannot make any money. It is a place for gamblers, traders and at best for the short term investor. It is not the place where you invest your retirement money.
One cannot blame the common man for this view. The recent history of the stock market has only re-enforced the above viewpoint. The problem however is that recent history is a poor guide to the stock market or as a matter of fact for any asset returns.
Some historical numbers
Let’s look at some numbers.
The sensex went up roughly from 1300 levels in 1991 to 4000 in 2000. This gives us an average annual return in the 10-12% range. The sensex then rose from around 4000 to 20000 in the next ten years, returning around 17.5% per annum.
These returns are very impressive and also completely meaningless. These numbers hide more than they reveal. These numbers hide the fact the stock market returns are lumpy and do not come in smooth even intervals. None one made an even 17.5% per annum return during the period from Dec 2000 to Dec 2010.
Let’s break down this period as follows
Dec 2000 – Dec 2003: Index went from 3973 to 5838 (13 % per annum)
Dec 2003- Dec 2007: 5838 to 20286 (36% per annum!!)
Dec 2007 – Dec 2010: 20286 to 20509 (around 0.4% per annum)
As you can see, the returns have been lumpy and were concentrated in the 2003-2007 period.
How does the common investor behave?
Imagine an investor in 2007, who has always invested in fixed deposits, gold or real estate. He has been watching the stock market for the last 4 years and has seen the stock market rise by 300%. He is watching his friends and relatives get rich. At the same time, every time he or she visits the bank, the nice personal banker tries to push the hot mutual funds of the day by showing the fantastic returns of these funds for the last 3 years.
If you were looking at the data in 2007, it looked fantastic no matter how you sliced and diced it. The 1, 3, 5 and 10 or 20 year returns looked good.
So let’s say you got taken by the historical returns and went and bought a whole bunch of mutual funds and stocks. What happened after that?
Dec 2007 – Dec 2011: 20286 to 15454 (- 5% per annum for next 4 years)
Ouch!!!
What is the general perception now?
I have been reading quite a bit of the analysis that the stock market is a bad place to invest. Even if you are a long term investor and were invested for the last 3, 5 or 10 years, other asset classes such as fixed deposits would have beaten the stock market at a much lower risk.
I find this argument shallow and intellectually lazy.
The problem with this argument is that the person making this argument is doing data mining. He is slicing the data in such a way that it just proves his point and does not really highlight the main point about the markets
So what are the main points?
I would say there are several points worth remembering
- The stock market is a volatile place and returns come un-evenly. As you saw from the data above, past returns have not been smooth fixed deposit type returns, but lumped in short periods of time.
- Valuations matter! If you buy at high valuations (dec 2007) and sell at the time of low valuations (say Dec 2009), you will lose money. Period!
- The stock market is a risky place. There will be long periods of time where you will not make money or even loose money. At a point when everyone is pessimistic or has given up, the stock market has a tendency to turn and surprise everyone. The same holds true at market peaks too.
Other asset classes
Let’s look briefly at some other asset classes.
Gold (all prices in dollars per troy ounce)
1971- 1981: 40 – 460 (25% per annum)
1981 – 1991: 460 – 362 (-2 % per annum)
1991 – 2001: 362 – 271 (-3 % per annum)
2001 – 2011: 271 – 1571 (19% per annum)
As you can see from the above numbers, gold seems to have followed a similar trajectory. There have been periods of high returns, followed by long periods of dismal returns (40 year returns have been around 9.5% per annum)
I don’t even consider gold as an investment as it does not generate any cash flow and is merely an insurance against armageddon or end of the world scenario. But I think I am in the absolute minority, considering the fact that Indians are the largest buyers of gold and absolutely love this metal. So in the end, one cannot really put a price on love!!
I don’t have the numbers for real estate, but anecdotally real estate has displayed a similar pattern. The returns were poor from 1993 to around 2003. The major gains came from 2003 to around 2008 and now the real estate market has slowed down considerably.
You will definitely find examples, where someone purchased a piece of land outside the city and was able to get 10X his or her investment. However a single multi-bagger is not representative of an entire asset class. That’s like saying that as Hawkins cooker went up by around 1600% in the last 5 year, the entire stock market should also have done well.
The curse of past returns
I am not optimistic that the general, un-informed investor is going to change any time soon. The majority of investors are hard working, middle class people with busy lives. Investing and the stock market is the last thing on their mind. The time when the market does catch their attention, is when it has gone up considerably. As a result, most of the retail investors end up entering the market at precisely the wrong time.
Past returns are a good starting point to evaluate the long terms returns of an asset class. However these returns are not written in stone. The best approach to evaluate the likely (not guaranteed) returns one will make, is to calculate the expected returns at any point of time and make buy or sell decisions accordingly. The topic of expected returns is however a much more complex topic, and possibly one for a future post.
Categories: General thoughts
May 13th, 2012
I had written about this company in 2010 here and shared a detailed analysis with the members of my paid service in early 2011.
The company has performed quite well in 2012. The topline of the company has grown by around 25% and net profits by around 40%. The company has been able to improve its margins to around 10% levels. In addition the company has been adding capacity via new plants and should be able to grow at above average rates for the next few years.
I am including the analysis, I shared with my paid subscribers below. We are not buyers at current prices, but a 1300-1400 price range would a good point to buy the stock (if you like the company and want to create a position)
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About
Gujarat reclaim is a 200 Cr company in the business of reclaimed rubber. The company produces re-cycled rubber sheets for the tyre and non-tyre rubber goods industry.
The company currently has a capacity of around 61000 MT and holds a 45% market share in the industry. The company is thus the largest player in the industry and has increased its production from 2400 MT to around 45000 MT over time.
The company is also exporting around 70% of its production.
Financials
The company reported a topline of around 191 Crs in 2011 and a net profit of around 17.6 Crs. The company has a net margin of around 9-11% which mainly depends on the raw material prices (recycled rubber). The company has delivered a topline and net profit growth of around 30% in the last 9 years.
The company has been able to improve the asset turn ratio from around .98 to 1.7 in the current year.The company has been able to maintain an ROE in excess of 30% and at the same time been able to reduce its debt equity ratio from around 1.6 in 2002 to 0.6 in the current year.
The company has thus been able to deliver above average growth and at the same time been able to improve its balance sheet.
Positives
The company is one the largest companies in the business of recycled rubber. Re-cycled rubber sells at around 20-25% the price of natural rubber and thus is a cost effective substitution for it. Virgin rubber (new rubber) prices have doubled in the last four years and this has provided an added incentive to use recycled rubber.
Gujarat reclaim supplies to the major tyre companies and to other rubber users in India and abroad. The continuing high price of rubber (and petroleum) has increased the demand for the company.
The company also has a wide network to source used rubber (tyres etc) and thus is able to get its raw material at competitive prices. In addition the company has been expanding capacity at a regular pace and is now adding plants in new locations to tap new sources of used rubber.
Finally the company has been able to grow rapidly and improve the quality of its balance sheet at the same time.
Risks
The company exports almost 70% of its production to foreign markets. Any slowdown in US and Europe may hurt the company’s business in the short term. In the long run, this would however work in the company’s favor as the tyre manufacturers and other users of rubber will try to reduce raw material costs by increasing the usage of recycled rubber.
The company sources used rubber products like tyres to produce recycled rubber. Any increase in the cost of this crucial raw material (due to higher demand from other users) will impact the net margins of the company.
Management quality checklist
- Management compensation: The management salary is around 2% of net profits which seems to be reasonable
- Capital allocation record: The capital allocation performance has been satisfactory. The management has been re-investing the profits in the core business at reasonable rates of return.
- Shareholder communication: Adequate. The management provides the mandated information and disclosures, but does not go beyond that
- Accounting practice: As per norms
- Conflict of interest ? related party transactions: None which impacts the company or the minority shareholders
- Performance track record: Above average performance in the last 10 years
Valuation
The detailed valuation for various margin and topline scenario is provided in the analysis spreadsheet. At a mid point margin of around 9-10% and growth of 13% or higher, the fair value can be taken as around 2500. The current price assumes a margin of 8% or lower and a topline of around 8%. This appears to be far lower than what the company has achieved in the last 10 years.
conclusion
The company operates in a niche industry (recycled rubber) and is a major player in it. The industry is currently experiencing a tailwind due to high price of virgin rubber and increasing use of recycled rubber due to cost and environmental factors.
The company exports almost 70% of its production and has added capacity recently to meet the additional demand. The company has done well in the last 10 years and should be able to repeat the performance in absence of any major macro events.
The company seems undervalued at current prices.
Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please read disclaimer before making any decision.
Categories: Investment ideas
April 23rd, 2012
The key to superior returns from the market is to hold an accurate, but divergent view from the consensus.
How does this statement sound ? I made it up myself 
. This is something, an overpaid consultant would say to his or her client !!
Let me now put it in common English – If you want to make high returns, you need to think differently. If you follow the crowd, you will only make average returns.
I enjoy trying to question the consensus and see if I can hold and act on a divergent view. Here are some of my contrarian thoughts, most of which may turn out to be incorrect (the consensus would be right). Even if you do not agree with them, just give them a thought.
Now is the time to invest
India has been the toast of the world community for the last 5+ years. We have a young demographic, growing population and educated work force …blah blah blah. Almost everyone thought, that we could do no wrong (us included). As a result, the stock market took off in the last few years and the valuations reflected the optimism.
The view now is that India is fast turning into a basket case, where nothing can and will be done right. I personally think, that reality is somewhere in the middle. The optimism in the past was overdone and so has been the pessimism. The stock market valuations now reflect the pessimism and more.
I personally don’t like what is happening with our government, but I don’t let feelings influence my investing decisions which should be based on company specific facts and valuations.
Government PSU’s are not bad investments
My previous post on mining companies may have given you an impression that I hate these kinds of companies and would avoid any PSU. In addition, recent incidents such as the recent decision on gas pricing or the recent directive from the finance ministry to banks to cut interest rates, can only re-enforce this view point.
I am not dogmatic about these things – there are no hard and fast rules or likes and dislikes in investing. It is all about the quality of the company and more importantly the price. If the pessimism keeps increasing , the prices may become very attractive and I may end up investing even in PSU stocks.
Consumption stocks are over-rated
I know this statement is going to make some of you feel very uncomfortable and even annoyed !. At the same time, if you invest in a company based on some kind of simplistic ‘story’ , then you may be in for a negative surprise.
The stock market tends to get into these stories from time to time. It was the IT stocks in 2000, infrastructure and real estate in 2007-2008, Indian growth story from 2004-2010 and now the so called consumption stocks
The typical turn of events is quite standard – Some stocks do well. Investors start noticing the performance and start bidding up the price of these stocks.
A story is then woven around these stocks with a plausible reasoning behind it (India needs X amount of housing and hence real estate companies will do well). Any stock which can fit into the story, sees a rise in valuations (justified or not). Finally, the valuations run up too high or some part of the story is discredited and the stock price drops.
Will it happen this time? I don’t know. Let’s see how this story plays out.
US markets are a good place to invest
The conventional wisdom is that developed markets are a bad place to invest, due to all the macro –economic problems in these countries. As a result, large and established companies such as Microsoft are selling at throwaway valuations.
For example, Microsoft with an annual free cash flow of around 22 Billion dollar and excess cash of almost 58 Billion on its balance sheet, is selling for around 10-11 times earnings. This is for a company with a huge moat and expected growth of around 7-8% per annum. There are several such companies in the US and other markets available at very attractive valuations.
Will my contrarian thoughts turn out to be true? I don’t know, but I am betting some part of my money on these beliefs. At the prices i am getting, I don’t have to be 100% right to get a decent return on my investment.
Categories: General thoughts
