Value Investing for Layman – Part 1

(http://JTtime.blogspot.com)

ValueValue pick, valuation gaps, fundamental analysis, etc. So many words for finding investment stocks.
Many times I hear people saying that company is fundamentally strong, or good ratios. But if I ask u what
should be good for you if you wanna buy shares for earning??? Of course its stock for which there is potential
to rise. Stocks for which value is not yet realized. Such stocks where people are not yet buying aggressively to
take it to new highs or rather stagnant and range bound for long time or in downtrend. I call them sleeping
tigers. I have the habit of finding such stocks which are not yet in focus but soon it will be in news or people will
buy in madness.

People are scared about fundamental analysis as they think they are poor in understanding balance sheet,
income statement, etc. But layman can adopt basic things to identify their own value picks without much
knowing finance terms. One can easily understand what is net profit, operating profit margin, sales, etc. This
much basics are okay. First let us understand basics terms in this session required for analysis. Then in next
session, we will switch to method of finding stocks for investment.

Brush up on basic Sales related terms:

Don't consider sell of scraps, or income from rent/lease to the company or even income from investments.
Sales consider revenue from core business for which the company is established. Rest just comes under other
incomes. So beware when company posting huge profit but major portion is other income. Example as follows

Suzlon

Just check June 2015 quarter results

Sales - 2605.81

Expenses - 2415.46

operating profit - 227.62

so operating profit margin (OPM) comes out to

227.62 divide by 2605.81 multiplied by 100 equals 8.74%

layman generally have the habit of calculating profit divide by cost/expense. but let me clarify here that profit
divide by cost is return on investment or profit percentage. to calculate profit margin, we need to check how
much margin is there for company of sales value, that's why checking OPM is important.
But if you check net profit, it is shown as 1047.41 because net profit also includes 1329.83.

Suzlon’s return to profitability in the quarter ended June 30, 2015, is attributed to a windfall gain of about
INR 13.14 billion related to its disposal of German sector player Senvion to Centerbridge Partners LP.
The Indian group noted that the particular transaction was completed at the end of April 2015, which
means that its consolidated financial results for Q1 fiscal 2015/16 are not comparable with the prior period
presented.

so if we deduct other income from net profit to remove the effect of windfall gains, we get net loss. But
market actually cheered this huge net profit after this result was out without even noticing this other
income concept and many retail investors might have got trapped by buying it at higher price and waiting
for that price to come again.

Sales is steady but net profit showed huge growth. Reason was other income. Common people tend to see net
profits growth directly and specially when they have stock in study in their portfolio. It makes person biased and
they see only positive things. But we should be cautious enough as other income surge is not good sign as its
not sustainable. It generally implies windfall gains. Our main focus should be how much company is earning
with its core business which is showed only in sales heading.

OPM also called as operating profit margin denotes how efficiently company is working. To know what
percentage OPM is good , we should have idea of business. You may also see OPM more than 100% which is
practically impossible. But its just accounting method. Here a person should just focus on how company is
earning money and what is ideal OPM. It may happen that other companies in that industry are having more
OPM and stock under study is having less OPM then our stock under study is not good. It may be improving its
profit margin quarter on quarter, maybe company is in expansion mode or any constructive reason. One can
take efforts to find the reason. Thumb rule is don't just stick to numbers on financial statements. Try to built
story as what company might be doing and how company might be utilizing its resources. It doesn't need big
shot finance knowledge. A person can just select stock of the industry he understands better. And check
whatever company has published on financial statements is in sync with what information is available to
you???

Bottom line is select the stock from the business a person understands better. Try to built the company story
with available numbers. How to use this will be explained in further write ups. 2 most important technical that I
would like to elaborate here are PE and EPS

PE and EPS at glance

EPS is earnings per share. It indicates how much a company is earning for shareholders. Like 10 EPS is
company is earning 10 Rs for each share after paying all expenses and taxes. Even dividend issued will reduce
EPS as its an outflow for the company and that much amount has already been realised to the shareholders.
Its like earlier it was 10 EPS. Means company should pay 10 Rs to each shareholders per share. But it pays
only 1 Rs as dividend and retains 9 Rs for business. So revised EPS should be 9. This should actually reduce
the stock price as EPS is considered in final stock value. So whenever you focus on financial statement, focus
on EPS growth rather than net profit. And observe reason for EPS growth if its because of core sales or other
income.

Next very common term being discussed is PE. You may find many people discussing low PE stocks. There
are few amateurs who always focus low PE stocks as undervalued stocks. But remember, Nifty with 22 PE was
recently said to be overbought. Same Nifty at 22 PE was said to be oversold just 4 months back. So PE is
actually a matter of perception of investors to be considered overbought or oversold. PE is simply price per
earnings

It simply means how much price you are ready to pay to earn 1 Rs in that company. Like 20 PE indicates, an
investor is paying 20 Rs to earn just 1 Rs from that company. It may look strange but its a fact. Why should we
pay higher price to earn lower money. So basically it just denotes expectations. Expectations that company
earning 1 Rs today will earn 20 Rs in future. It is only the expectations of the people from the company that
makes stocks move up and down. Technical analysis call this demand and supply. If stock is expected to earn
more in future then it will be in demand and price will surge. Bear in mind that EPS remains constant unless
company has declared fresh results. Once results are out, new EPS will be considered and that should factor in
stock price. One may think this as a simple trading opportunity. But experienced traders might have observed
that results are mostly factored in stock price before it is out. Or many cases when results are outstanding,
stock locks in upper ciruict with no sellers or vice versa with bad results. So nothing comes easy

People always compare company PE with industry PE or with PE of other companies. And many layman
considers it as valuation gap for investment. But one should bear in mind that people should consider PE only
as future expectations of earnings. Let me give 1 classic example

Experienced investors might have seen rally of kitex. It quadrupled ( 250 to 1000) within just 1 year. Kitex was
trading around 20 PE when it was 250. In that case, kitex should have been considered fairly priced. But still it
made excellent rally in a year to make it 4 digits stock. Suddenly what could have happened that even with 20
PE, kitex rallied to give 300% returns. If one goes through company presentations or google few analyst
coverage or report then it can be found that Kitex has planned for expanding its capacity to double their sales
with just 20% increase in cost. Now doubling the sales means doubling the earnings. But without much
increase in cost means improvement in profitability thereby more than triple increase in net profits. So this
statement from management increased its earnings expectations, which ultimately reflected in stock price. But
today financial statements indicates sales are not doubled but 70-80% surge in 2 years with increase on OPM
from 20% to approx 34%. It means management really took efforts in increasing their sales while making sure
not to increase their cost proportionately. But couldnt achieve their target as promised. So even if for a layman,
results are consistently good, it is not as per expectations for which, stock price took rally from 200 levels to 4
digits. And stock price fall which is now trading below 700 Rs. Many people are curius about stock price
behaviour after results. Its difficult for layman to understand that why stock fall inspite of good results and why
stock surged inspite of bad results. So they should just keep in mind that company performance is already
discounted. So again bottom line is that stock price is the factor of expectations which is indicated by PE. So
many investors have basic question like why few stocks are trading at high PE or few trading at low PE. So i
guess they might have got answer.

Kitex is a past story. Now its obvious to know that readers are curious to know upcoming story. Its simple now.
Just keep surfing through management commetries on their company performance. And also test the credibility
of management commitments from their past performance. If you feel that management does what they says
and they have made bullish statement on their growth then grab it for long term. 1 stock that I can suggest will
be Vakrangee. I am personally invested in Vakrangee long back when it was trading at 132. I grabbed it
because promoters are increasing there stakes and it was sleeping tiger since long. Management had set their
vision upto 2020 and are aggressively approaching to complete their targets on time. recent announcement of
strategic alliance in Ricoh India will improve their network and help vakrangee to achieve sales growth of 30-
35% CAGR for next 5 years. Those who want to understand importance of 30-35% CAGR, they should divide
72 by 30 to see in how much time frame will the sales double.

72/30=2.4

Means sales will double in max 2 years 5 months as per company expectations.

Now thinking about cost??? Of course doubling the sales requires expense to be proportional. But let's
understand vakrangee business model. If you open their website, you will see invitation of franchise and
amazon advert on top(vakrangee also have strategic tie up with amazon). Right now vakrangee is aggressively
focussing on selling franchise. For franchise they are asking franchise owner to invest and vakrangee will give
all back office support. For these support, vakrangee will get 20% share of the revenue earned by franchise.
Now back office already exists. Infrastructure is already set up. Apparently Vakrangee don't need to put up
additional cost for these revenue growth. Rather more the franchise, more will be the cash inflow without
marginally increasing the cost. Sounds like kitex situation??? Kitex vision was just for for 1-2 year and
vakrangees vision is for 5 years. Do your own research before investing and reading these numbers.

A glance at CAGR

CAGR stands for compounded annual growth rate. Means 100 Rs invested today at 10% CAGR will increase
as follows

1st year 110

2nd year 121 (10% increase over 110)

3rd year 133.1 (10% increase over 121)

4th year 146.41(10% increase over 133.1)

5th Year 161.051(10% increase over 146.41)

6th Year 177.1561(10% increase over 161.051)

7th Year 194.87(10% increase over 177.1561)

and so on.

Now its easy for us to understand that, with simple interest, money doubles in 10 years with 10% rate. but it
takes only 7 years and few days to double with 10% CAGR. Now applying formula of 72.
72 divide by 10 equals 7.2.

so, instead of calculating, when our money will get double with defined rate, we can directly find out dividing 72
by our expected CAGR. That's the magic of compounding and number 72.

Finally combining EPS and PE

EPS multiplied by PE gives current market stock price.

EPS X PE = CMP

As discussed before, EPS will be constant till fresh EPS out with results and PE changes according to stock
price.

Hope I am able to explain basic points with investing point of view. This terms may not be new to investors
traders or even layman who never traded. But my aim was to make readers think same term with respect to
value investing. This session was just introduction to the basics of terms. In next part, will introduce you one
method by which you can select which stocks to select for investment.

I call them sleeping tigers