Archive for the ‘Graham ideas’ Category.

 

Benjamin graham is considered as the dean of value investing. Warren buffet was graham’s student and considers him as his mentor. Buffett’s followed graham’s approach to value investing in the early part of his career. However later, he expanded on graham’s approach and started focussing on the quality of the business too.

Graham’s approach is basically picking stocks which are statistically cheap. What that means is that the stock is cheap based on various quantitative measures such as mcap being less than Net current assets, or the stock is selling for less than cash on books. The disadvantage of this approach is that you may end up buying some complete dogs which are cheap for a reason. The underlying business would be going downhill and so the value is just an illusion.

Graham understood this and he circumvented it by diversifying. So the key point in building a portfolio of cheap graham style stocks is to diversify the holding. It makes sense to hold 15-20 stocks at a time and to keep selling the stocks when they reach 80-90% of intrinsic value and to replace them with other cheap issues.

With the current drop, I can see more of such opportunities coming up. The last time I saw such an opportunity was in 2002-2003 time frame.

The initial filter criteria I am using is as follows
Mcap less than 500 crs
Debt / equity ratio less than 0.5
No loss in the preceeding 5-6 years
PE less than 7
ROE atleast 8-10%

I have been developing a list of such ideas and have loaded a list of possible ideas in google groups (stock screen graham). I have holdings in HTMT global, LMW and Denso india. I am still analysing the other stocks in the list and have yet to make up my mind on them.

The key point, and I repeat, is to hold a large portfolio of these stocks via diversification. Some will turn out to be clunkers, but on an aggregate the portfolio should do well.

Now you may have a valid counterpoint – why buy this stuff when there are good companies getting cheap by the day. That is true ..but if like me you also take a long time to analyse each company, then the  above mechanical approach is a quick way to assemble a decent portfolio. If you have the cash and the nerve (I could use a stronger word here 🙂 ) to invest when everyone is pessimistic, then the mechanical graham style of investing can be used to quickly assemble a decent portfolio while the opportunity lasts.

Please keep in mind that this list is just raw analysis and not a final list of stocks from which I plan to build my graham style portfolio. I will keep adding and dropping stocks and will upload the revised list when I do so.

 
 

I wrote in the previous post that I have changed my portfolio design and split it into two categories. The first group is the core portfolio which contains the long term ideas where the intrinsic value is increasing and I feel strongly about the long term prospects.
 
The second group called the graham portfolio, named after the dean of value investing – benjamin graham, will contain the statistically cheap stocks. These stocks are cheap by various measures such as PE ratio, Mcap less than net current assets etc.
 
I received the following question from manish and thought of replying to it via a post

Also I will be curious to know your strategies for these two portfolios. Will you be looking for a certain percentage of gain (say 50%) for Graham Style stocks and exit. I believe you will keep holding Core Portfolio forever (until business is intact).
 
The graham portfolio would be at best 20-25% of my total portfolio. The percentage is not fixed and will depend on the number of attractive ideas I can find.
 
I will not looking at a percentage gain to exit these stocks. For me the sell decision would be based on two factors – If the stock is selling at or 90% of intrinsic value I will sell the stock. In addition if the fundamentals deteriorate considerably or if the valuation gap does not close in 2-3 years, I may decide to bail out.
 
The holding period for the core portfolio could be longer as the intrinsic value of the companies is also growing. So unless the stock is grossly overpriced, I may continue holding a stock for some time.
 
Lesser analysis
In terms of analysis, I spend a considerable amount of time on the stocks in my core portfolio. However for the graham ideas, I am looking at cheap, obviously undervalued stocks and hence the extent of analysis would be less. I would be balancing the risk by diversifying more in the graham portfolio. The graham portfolio is an opportunistic reaction to the market crash.
 
An idea: HTMT Global
HTMT global is an IT/BPO company. Hinduja TMT (now called Hinduja ventures) demerged their IT/BPO business in 2006 and merged that into HTMT Global from Oct 2006.
 
Financials
HTMT global had a revenue of around 673 Crs in 2008 and a net profit of around 87.4 Crs. The company had a net profit margin on a consolidated basis of around 13% and an ROE of around 26% on invested capital. The total capital is around 823 Crs and a net cash of around 430 crs on the balance sheet (held in the subsidiary)
 
HTMT global on standalone basis (excluding subsidiaries) earned 367 Crs and a net profit of around 58.8 Crs. The company had a net margin of around 16% on a standalone basis. The lower margins on a consolidated basis is due to the Subsidiary ‘Affina’, which was turned around during the year.
 
Growth numbers are not representative as the demerger happened in the middle of 2007, however the company has been growing in excess of  30%.
 
Positives
The company is doing quite well and has been expanding the scope of its operation in terms of headcount, new clients etc. Athough the numbers are not comparable, the company has shown almost 50% growth per annum for the last 7 years (although from a small base – see pg 6 of annual report). The company has a cash of almost 470 crs (Q1 09) which has been earmarked for accquisitions and should add value to the company
The financials are quite good, with good free cash flow and a good dividend payout of almost 100%.
 
Finally the valuation is amazing. The company is being priced for less than cash on the books which means that the company worth more dead than alive
 
Negatives
Hindujas control this company and are not know for corporate governance. In addition the credit crunch and recession could hurt the company’s growth. However in the long term this should increase the offshoring.
 
Conclusion
Unless you believe that the company is worth less than cash, you cannot justify the valuations. One likely reason for the crash in price is the sell-offs by FII’s.
 
I am still looking for more negatives on the company, but cannot find any. One has to keep in mind that the stock price is assuming worse than bankruptcy. Personally, I am looking at this stock for my Graham portfolio.

 
 

Over the past few months I have modified my portfolio structure a bit. I have now divided my portfolio into two portions. The core portfolio, consists of companies where the intrinsic value is increasing and i have a higher level of confidence about the company. The other portion is more of a graham style portfolio. This consists of companies which are extremely cheap based on the various measures such as market cap less than cash on book, ultra low PE or market cap less than net current assets.

The core portfolio is a larger portion of my total portfolio and has companies, for which I have done a deeper and detailed analysis. The ‘graham‘ portfolio on the other hand consists of the ‘cheap’ ideas. These companies may not score high on corporate governance or may not be a great businesses, but they are insanely cheap.

The idea behind this ‘cheap’ stock portfolio is to take advantage of the large number of opportunities, which are coming up in the market now. Ofcourse the number of stocks I plan to hold in the ‘graham’ styled portfolio could be between 15-20 or even higher versus 10-12 in the core portfolio.

So why this disclosure?
I will post on such cheap companies as time permits. I am planning to add them under the category of ‘graham’ type stocks – cheap stocks, but not necessarily great companies.

This type of value investing is also called cigar butt investing and it was developed in 1920s by the dean of value investing – Benjamin graham. This type of investing is low risk, involves quite a bit of diversification and works best during bear markets.

So please don’t be surprised if I post on ‘not so great, but cheap’ companies. One can get decent returns from such a portfolio, provided you have adequate diversification.

Is the stock undervalued?
I am getting several comments and emails asking whether so and so stock looks cheap. The odds of a stock being cheap these days are very high. If you pick 10 stocks randomly, I bet 5 will be cheap. However the question most of us should be asking is not whether the stock is cheap, but whether one understands the company well enough and will have the emotional fortitude to withstand another 20% drop in the stock price.