Stock Valauation Blunders

A concept that can help avert stock valuation blunders! source:equitymaster BHEL, India's largest manufacturer of power and infrastructure equipment in the public sector, is up some 75% in the last 8 odd months. But this is hardly any solace for us. We recommended the stock around 40% higher from the current price. In other words, it is down some 30 odd percent from the time we recommended it. Clearly, this one has not worked in our favour. What has helped us enormously though is the lessons that we've learnt from this and other similar recommendations. If we were to put it in couple of words, valuing a stock correctly is all about finding the 'right valuation anchor' we believe. When we recommended BHEL, we valued the company using the price to earnings method. In other words, the earnings of the company was our anchor for valuation. Similarly, there are other anchors like the book value of the company, EBITDA, dividends and in fact even the growth in earnings has been used as an anchor courtesy the famous PEG ratio. Now, what do you think is the most ideal valuation anchor for all the companies? Well, there is no one size fits all approach to this we reckon. It all boils down to reliability. Say for example if the company has been paying dividends for decades and the same has also been growing for many years, then there' no harm valuing the company on its dividend yield. Also, if the company has been generating growing or steady stream of earnings, then perhaps the PE approach is the right approach to valuing a company. And if the earnings are not reliable and move around a lot like say for a cyclical company, then perhaps the price to book value approach is the right approach we reckon. The error that we made with respect to BHEL we reckon is that we valued the company hoping that some sort of growth in earnings will take place. And hence valued the stock based on a PE ratio. We could have been better off may be taking the medium term earnings volatility seriously and wait out the bad times. Or if we had to still make a valuation, a price to book value approach would have been far more reliable and more objective in this case. You see, a lot of people think that their valuation of a company should fall around the same ball park as to what the markets are valuing it. But this is a wrong way to approach things we believe. What is most important is finding a valuation anchor that's quite dependable and arrived at after looking at the past history of the company. If one's valuation using such method falls short of the current market price, so be it. One can always go on to another company or wait till the price falls well below our intrinsic value calculations of the company. Let us see how we can use this method to value PSU banks. Banks being business models of different kind, have to be valued from a price to book value perspective because historically that's proved to be the most reliable valuation metric. But the problem is there are a lot of bad assets lurking in the balance sheets of most PSU banks and we don't quite know how much more pain is to come. Consequently, while the valuations based on dividend yields look quite mouth-watering, we know, that's not quite the valuation anchor to use. As a result, it is much better to wait out till some more clarity emerges rather than taking the plunge. Use this method of 'valuation anchors' across different industries and we believe you'll see a huge difference in your understanding of valuation matters. Do make it a point to screen companies through these valuation anchors in our Stock Screener from time to time. Recent Articles

SUUTI selloff proceeds rightfully belong to Unit Trust investors. JAGO GRAHAK JAGO

The Government of India is set to make a killing from the assets that it bought for a pittance from investors in US64 and other guaranteed schemes of the old UTI

By Dhirendra Kumar | Jan 13, 2014

Last week, there was a news item in this newspaper detailing how the government is planning to sell off the equity holdings in SU-UTI to help control the fiscal deficit. According to the report, sale of SU-UTI's holdings in companies like Axis Bank, ITC, Larsen & Toubroand others could bring in as much as Rs 47,000 crore within this fiscal year. In effect, this will be the final bonanza that the Government of India out of robbing the original investors of the Unit Scheme 64 and the guaranteed return products of the original Unit Trust of India.

For those who've forgotten the SUUTI story, this is a 'Special Undertaking - Unit Trust of India' that was formed in 2003 out of assets held by the schemes of the old Unit Trust that had to be rescued by the government, which were US64 and the guaranteed Monthly Income Plans.

This rescue meant that the the government took over the assets and made the investors an offer they couldn't refuse, in the sense of the movie 'Godfather'. Unit-holders were given the choice of either taking Rs 10 per unit or taking up five year tax-free bonds from which they would earn 6.75 per cent a year, effectively a total gain of Rs 38 for every hundred rupees invested. Even though the government managed to present it as a rescue, eventually the deal turned out to be a pretty sorry one for the investors and a good one for the government.

Those investors--most of them financially conservative small investors (aam aadmis, so to speak)--lost out because over the years, the government mismanaged the Unit Trust of India. Whether out of incompetence or malfeasance or the usual combination of both, this scheme was run to the ground and its assets were of a far lower value in 2003 than the Unit Trust was pretending.

However, the government did pretty well out of the assets it bought from those investors at what turned out to be a bargain basement price. First, in order to wash its hands off UTI, it sold it off for Rs 2000 crore to four public sector entities, Bank of Baroda, Life Insurance Corporation, State Bank of India and Punjab National Bank. Now, it will manage to get tens of thousands of crores out of assets that rightfully belong to those investors. By the way, these four also did pretty well for themselves by selling part of their stake to the American AMC T. Rowe Price.

The government supposedly mounted this rescue and gave the poor investors something. However, the fact that the investors lost out was not their fault. These weren't people who invested in some shady ponzi scheme. They trusted the Government of India and invested in that magnificent institution called the Unit Trust of India. Effectively, the government ran UTI to the ground, bought back the assets of its victims for a pittance by offering them a Hobson's choice, and is now ready to make a killing by selling off those assets when the equity markets are much higher.

The only fair conclusion of this story would be that the government should now wind up the SUUTI by selling its assets and then return the proceeds to the original investors. It can deduct whatever it paid on those bonds, but the profits on schemes' holdings rightfully belong to the investors who suffered so much because of the government. Of course, there's no chance of that actually happening because this is a taking kind of government and not a giving kind. When worthies like Mr P Chidambaram and Mr Raghuram Rajan next deliver one of their frequent scoldings to the Indian saver for not trusting financial assets, perhaps they should ponder the shabby treatment of the investors.

I only wish we had the kind of legal framework whereby the investors could have gotten together and filed a class action suit against the government. Or perhaps they should just call Mr Kejriwal's hotline.

That Foreign institutional investors (FIIs) are interested in Indian stocks is not something new. The fact that their stakes in large Indian companies have increased over the past few quarters is something that proves this point. On the other hand, the actions taken by domestic institutional investors (DIIs) are quite the opposite. In the year till date, their net outflows stood at over Rs 732 bn. As per the Business Standard, this is probably the highest sold by such institutions in about 9 years; data prior to 2004 is not available. The earlier record was about Rs 570 bn in 2012. On the other hand, the net inflow by FIIs stood at Rs 1 trillion during the year. This is their third highest figure of such inflows reported in a year. 

One may argue that redemption pressures, which may have led to a situation of net outflows by DIIs, must be taken into consideration here. Not to forget the outperformance of other asset classes, coupled with profit booking (with the BSE-Sensex touching its highest levels recently) as reasons for investors pulling their money out of stocks. 

We believe this should ideally be the situation that investors should be taking when the markets seem overheated. Sure, the markets have touched new highs, but does that mean they are expensive? 

Warren Buffett is of the belief that the best single measure for gauging the attractiveness of stocks in an economy is the 'total market capitalisation to GDP ratio'. The lower it is the, more attractive the stocks are in that market. The higher it is, the more expensive they are. 

If one were to view valuations by this parameter, stocks look anything but expensive at the moment. At the end of FY08, the figure stood at about 106%, which indicated an overheated situation. Post the market decline, the figure fell close to 55% levels at the end of FY09. Going by the chart below, valuations picked up quickly thereafter. However, in recent years the ratio has moved lower. As of a couple of days ago, India's market cap to GDP ratio stood at about 64%, which is pretty much close to its thirteen year average. 

Going by this parameter, stocks are not expensive

* As of December 23, 2013; It may be noted that the business daily has estimated the FY14 nominal GDP growth rate to be 12% (5% growth + 7% inflation).

What does this suggest? A short answer would be that one can consider investing in stocks at the moment. 

But when one views valuations of the different indices, it paints a slightly different picture - for the blue chips mainly that is! The BSE-Sensex trades at a multiple of about 17.8 times its trailing twelve month earnings, which is slightly above its long term average. Comparing this to the BSE-500 index, which comprises of the large cap companies in India, valuations are lower at about 15 times. Now, considering that the bluest of blue chip companies form a significant portion of this list of 500 companies - in terms of market capitalisation - it would be fair to assume that the collective valuation for the balance large cap companies would be much lower. 

Also, if one looks at the smaller companies, i.e. stocks forming part of the BSE-Midcap and BSE-Small cap indices, they seem all the more attractive. Given the volatile earnings reported by them in the past few quarters, looking at these companies on a P/E basis may show a distorted picture. But when seen on a price to book value basis, stocks forming part of these indices collectively seem attractive. The price to book values of the BSE-Midcap and BSE-Smallcap indices stand at about 0.67 and 1 times respectively. These are much lower than their long term averages and attractive when gauged in isolation as well. 

Considering the last five year period was one of the most challenging phases for companies, it would be relatively easy to identify the ones that have done well or those that have done much better than their peers. Investors would do well to identify such companies for investment opportunities, especially considering that the markets are not seemingly expensive at the moment. 

The 'Greatness' Conundrum

The 'Greatness' Conundrum

Only 10% or so of the BSE 500 companies are able to stick to the 'greatness' framework over a 5-6 year period...

By Saurabh Mukherjea | Apr 26, 2013

Indian companies find it very hard to generate shareholder returns – over the last 20 years, 80 per cent of Indian companies have not been able to deliver real returns (i.e. returns better than the rate of inflation) to their shareholders. However, given that the country has grown at around 15 per cent per annum (in nominal terms) over this period, this means that the remaining 20 per cent of companies have delivered very significant real returns. So, how does one systematically identify these magical 20 per cent of companies? That was the homework exercise my colleague Gaurav Mehta and I set ourselves two years ago.
Our research lead us to the "greatness" framework i.e., a way of identifying companies which grow their businesses over long periods of time in a consistent and calibrated manner. What these "great" companies do is very easy to describe – they invest systematically in their businesses, turn investment into revenues, revenues into profits, profits into cashflows and cashflows into further investment. The good news is that because the country is growing at roughly 15 per cent per annum, the "great" companies are able to grow their toplines, bottomlines and assets at around 25 per cent per annum. High school maths tells us that if a company grows at 25 per cent per annum, it becomes a 10-bagger in 10 years (even without any P/E re-rating).
The fact that only 10 per cent or so of the BSE 500 companies are able to stick to the "greatness" framework over a 5-6 year period does not surprise us – the negative political, social and economic influences prevalent in the country make consistent and calibrated development difficult for any Indian institution in almost any facet of Indian life.
What does surprise us though is that very few large cap stocks are able to stick to the "greatness" framework – the only Nifty stocks in our 40-stock "greatness" portfolio for CY13 are ITC, Asian Paints and Lupin. So why is this? Why is it that the vast majority of the biggest companies in the country are not able to grow in a consistent and calibrated manner? This is a question which we are currently investigating. Answering this question is important as it could explain one of the other conundrums that had puzzled us – why is it that every 10 years the Nifty "churns" by around 45-50 per cent, a much higher ratio than other major developed and developing markets.
My current thinking is that large and successful Indian companies tend to hit at least one of the following roadblocks which brings them to a juddering halt:
1. Over the last decade India has created a dozen or so autonomous regulators. Whenever a sector becomes very large and very profitable, someone in Delhi decides that it is time to do some rent-seeking by setting up a regulator. Once created, the regulator seeks to lower the profitability of the sector. Classic example, our beleaguered telecom sector.
2. India has become a relatively open and competitive economy. Access to capital for local companies has become more democratic with the creation of a large Private Equity sector and with FDI norms being relentlessly eased, foreign capital is now able to enter relatively easily. So when entrepreneurs, Indian or foreign, see a large and profitable sector with juicy operating margins and RoCEs, they decide to join the party and thus disrupt the profitability of the incumbents. Classic example, our two wheeler sector which is currently being disrupted by Honda.
3. Indian companies, for all their claims to be relying on "professional management", are still overwhelmingly dominated by and run by promoter families. These families are only human and once they decide to grow beyond the core business and the core territory that they know so well, they struggle. Expansion into new countries or new sectors by Indian companies are rarely successful. The finite nature of the promoter's skill set puts a natural cap therefore on how far an Indian company can go. Classic example: plenty – so it would be unfair to single any one company out.
So, how does one beat this trap? Look for Indian companies operating in niches which: (a) are unlikely to invite regulation or foreign competition; (b) have natural barriers to entry based on brand, distribution or technology; and (c) create a natural incentive to invest steadily (the need into expand a new region). Examples: TTK Prestige, Bata, Whirlpool, Jagran Prakashan, Asian Paints, Carborundum, Cummins India and Balkrishna Industries.

TERM PLAN- SELECTION MADE EASY

Below table shows you the comparison of various term plans available in the market from different insurers.

Sr.No.	Company Name	Policy Name	Mode	Entry Age	Minimum Term	Maximum Term	Maximum Maturity Age	Premium
1	Aegon Religare	iTerm	Online	18-65	5	40	75	7,753
2	Aviva	i-Life	Online	18-55	10	35	70	8,058
3	SBI	eShield	Online	18-65	5	30	70	9,135
4	HDFC	Click 2 Protect	Online	18-55	10	30	65	10,112
5	Kotak	e-Term	Online	18-65	5	30	70	10,140
6	Bajaj	iSecure	Online	18-65	10	30	70	10,955
7	ICICI	iCare	Online	18-65	5	30	75	12,360
8	Birla SL	Protector Plus	Offline	18-65	5	30	75	14,045
9	Max Life	Platinum Protect	Offline	18-60	10	30	75	18,090
10	LIC	Amulya Jeevan - 1	Offline	18-60	5	35	70	25,700

Note: Premium mentioned in the above table is for a 30 years Non Smoker individual for a Sum Assured of 1 crores for 20 years.

Above table shows Term plans available in 2 different modes i.e. Online and Offline.

Online Term plans are directly from the life insurance company, wherein an insurance agent is not involved in the process thus resulting in low premium for you. Offline Term plans are bought through an insurance agent, the premiums you pay for indemnifying risk to life is high when compared to online term plans.

From the above table it is clear that any person of the age of 18 years can buy a term plan while maximum entry age is 65 years for most of the companies in a term plan. Minimum tenure for most term insurance plans is 5 years, while the maximum tenure is 30 years. Only in case of Aegon Religare iTerm the maximum tenure is 40 years. Term plans can cover you upto a maximum age of 75 years depending upon the insurance company you choose but most insurers cover you upto a minimum of 70 years of age.

In the above table we have ranked life insurance companies from the lowest to highest premium for a term plan. Aegon Religare provides the cheapest term plan being an Online Term plan, while LIC has the highest premium for an offline term plan. There is a huge difference between the lowest and highest premium term plan of approximately Rs. 17,000. The main reason for such a huge difference is:

• Insurance agent's commission;
• Increasing competition in the life insurance industry;
• Difference in life insurance companies' actuarial assumption rate;
• Past claim settlement experience; and
• Credit worthiness of life insurance companies.

LIC being the most trustworthy and with the highest claim settlement ratio of all the life insurance companies charges higher premium for its term plans.

So, which is the best Term plan in the market?

Well, the best term plan depends upon your requirement i.e. at what age you are opting for it and till what age you require it and the premium you are willing to pay for the term plan. Online Term plan can save your premium amount and also provide you the convenience of buying a life insurance policy but you should always check on claim settlement ratio of the insurance company from which you are buying the term plan, since it is the most important factor in deciding which policy to go for. You should also disclose your true health history while filling up the proposal form so that insurance company cannot reject claim on the ground of past health history.

Source:personal FN

When you get I T notice, Donot scare but reply

With the Income-Tax department on a drive to increase compliance, notices are being sent to individuals for old dues, which will now be adjusted against pending refunds.

Of course, anyone who gets a notice starts panicking. But for all you know, your returns may have been picked for random scrutiny.

Importantly, don't ignore the notice. Non-compliance with the notice could lead to a penalty of Rs 10,000, apart from the tax and interest penalty. Provide all the documents to the assessing officer (AO) and things might get resolved.

Before you meet the AO, check for details like the permanent account number (PAN) in the notice. Sometimes, the name or address might be incorrect but the income-tax department identifies you through the PAN.

"Identify the reason for being served a notice. Typically, under section 143(1D), individuals get demand notices for discrepancy in the returns. At other times, it could be for mismatch in tax deducted at source (TDS) or income amount," says Vaibhav Sankla, director of Pune-based tax consultancy H&R Block.

If there is a refund claim and the case is selected for scrutiny under section 143(2), then the return may not be granted. Section 143(2) enables the AO to make a regular assessment after a detailed enquiry. Otherwise, an intimation under section 143 (1) is the proof of return processed as submitted.

Then, check the validity of the notice. Under section 143(3), a scrutiny notice has to be served in six months from the end of the financial year in which the return was filed. But, a notice under section 148 can also reopen five-six year old cases if the AO has enough reasons for it.

After collating all the information/documents, prepare a cover letter (make two copies) listing all the documents provided.

Ask for an acknowledgement on the copy of the letter. Preserve this as evidence of the documents given. In case of a notice under Section 143(2), where the details required are not specified, collate basic information, like bank statements, major expenses, income and loan details, say chartered accountants.

Such notices have the officer in-charge's details like name, designation, signature, office address and, most importantly, income tax ward/circle number. Now that such notices come electronically, it must have the Document Identification Number, available on each communication by the tax authorities.

Do remember to make copies of the demand notice, in case you lose it. Or, scan and store the document. The envelope that carries the notice is an important evidence and should be preserved. It has the Speed Post number and establishes when the notice was posted and served to you. This helps when you receive the notice late and can't respond within the validity period.

Chartered accountants suggest seeking professional help to better understand the demand in the notice and supporting it with proper documents. In case you have to appear before the AO, a professional can help you better prepare your responses.

Why pension products may not help you plan your retirement well

Many of us engage in an economic activity to make a living. And with competition around we often work hard and try to give the best within our means to our family in times where inflation monster haunts us. But while we do all it takes to keep our family happy, prudent financial planning can bring in solace in our endeavour to give best to our children and even save for the golden years of retirement. Mind you, many misconceive ad-hoc investing with prudent financial planning and often think they are on the right path to meet life goals. But let's apprise you that investing along with planning is rather a serious activity and often boring, as against the excitement depicted by the market intermediaries (i.e. agent / brokers / distributors / relationship managers), glamorous business channels and friends.

Today, while all of us want to have a cosy retirement life ahead the onus of indeed making it cosy ahead (during the golden years) is on us as investors. There are host of investment avenues available to plan for retirement, but it is imperative that your investment portfolio intended to achieve you goal of retirement, to have the right mix of asset classes and investment options therein. Annuity in the form of pension which takes care of our cash flows during retirement is something very much desire; but it imperative to plan for the same wisely and not get lured to inappropriate products, merely getting carried away by the exuberance created by the market.


In a market condition that seems to be uncertain, you need to follow the right investment approach.

Ideally all your investment moves should be demarcated by in-depth knowledge.

We have often seen investors getting hooked on pension plans offered by insurance companies, in their objective of planning for their golden years. It is noteworthy that earlier, until the new guidelines on pension products issued by Insurance Regulatory and Development Authority (IRDA) came into effect, guaranteed returns were not offered to policyholders. But now by the virtue of new guidelines from IRDA, a number of life insurance companies are planning to launch pension products that will now offer capital guarantee - where you as the insured will at least get back the total premium paid.

Life Insurance Corporation, HDFC Life Insurance, Birla Sun Life Insurance and ICICI Prudential Life Insurance have already launched pension products while few others including Bajaj Allianz Life Insurance and Aegon Religare Life Insurance are mulling options.

But should you invest in these pension products?
Well we are of the view that, in the process of planning for your retirement it imperative to undertake a holistic exercise considering your:

• age;
• income:
• expenses;
• risk appetite
• existing assets;
• existing liabilities;
• intermediate goals (which you are catering to viz. children's education and their marriage) and
• nearness to goals

Taking into account the aforementioned along with the inflation factor (which haunts most of us and has eroding effect on our savings) would help you plan for your retirement prudently by having in place the right asset mix in your portfolio and investment avenues therein. But you need to act early, and not procrastinate executing the plan - as that may not help make your retirement life cosy. Moreover you got to refrain from digging into your retirement corpus, unless you absolutely need to (where your contingency funds are drained out).

The pension products from insurance companies, while they provide an annuity they do not help you optimally structure your retirement planning. The aforementioned new product launches are taking place since life insurers offering pension products withdrew them last year following IRDA's guidelines relating to pension plans that said all unit-linked pension plans (in which a part of fund is invested in stocks or bonds) should specify assured benefits on pension plans, applicable on death, surrender or maturity. So, there's no point merely getting swayed by the tall claims and sales pitch of your insurance agent. Instead it is imperative to have structured, intelligent financial plan in place for your retirement which can ensure smooth and cosy retired life ahead.