"Floats" and Investing : Brainstorming

Most of  the investing knowledge I have acquired is through reading books, articles, case studies, etc. and I believe this is the best possible way to make oneself better at investing.

But, one more way which I found way more effective, is through discussion with your peer group. This provides you with different solution to a similar problem and thus acts as pseudo multi-disciplinary approach advocated by Charlie Munger. In one of his article, Munger mentioned that how he and buffet discuss their ideas on a regular basis.

Recently, I was discussing about the investing strategies with one of my friend where he mentioned about the presence of "float" ( please refer article by Prof. Bakshi), as reflected by "Advance from Customers" in the current liabilities, to be one of the good indicator of sound business model. He was absolutely right on his part, because a business where customers are ready to provide advance, the business reflects strong holding in the industry as compared to its peer. Very few companies are able to do that.

I gave that idea more time by brain storming over it, and I came to conclusion that though the presence of "float" is reflection of good business model, but it also poses a risk. The "float" should be considered as an advantage only when one is sure about the credibility of management. My reasoning for same is that the Float  represent short term capital which will used by the business during its business cycle. Over a period of years, when numerous business cycles are completed, this float becomes a permanent kind of free cash available and if the management is not a good allocator of capital, they might invest the same in long term assets (for expansion, M&A etc.). This will pose a heavy risk when the business will be tested by tough times.

I understand that similar thing happened with Kingfisher airlines, whereby they collected the ticket revenue from the passengers upfront (thus generated float) but didn't paid their creditors(viz., oil companies), but rather utilized the same  to pay its long term liabilities, in effect deployed the float to long term use. And as we all are aware, Kingfisher has eroded precious capital of several investors .

So, its better to look at a positive aspect from several view points before banking upon it to support the investing decision.

Views Invited

--
Tony stark

What type of Investor are you :Quantitative or Qualitative ?

Time and again, we hear/read that investment in companies with heavy "moat" are key to successful investing career. Investing in a couple of them at right price will ensure that you can spend your life after retirement at a beach (or any place, you think is better !) with a chilled beer in your hand.

But if finding the sustainable "moat" had been so easy, then nobody would have cared and sought it so vigorously. And the reason why finding "moats" is not easy is that one has to look beyond raw numbers to ascertain whether a business have a sustainable "moat". Good Numbers (Ratios, quarter on quarter results) can only provide support  to the view of moat's existence and in itself can't assure moat existence. So, its one's own business sense, which can help him ascertaining it. As mentioned by Mr. Buffett " I am good businessman, coz I am a good investor, and , I am a good investor, coz I am a good business man".

So, to be an outstanding investor (which in my case is the one who beats the average on a regular basis) one needs to have an uncanny ability to judge the business on qualitative aspects such as :

1) Management : Managers like Ajay Piramal, Sunil Bharti Mittal, Ratan Tata, Steve Jobs etc. at helm in itself are a moat to business as they have phenomenal capital allocation ability)

2) Products : Products such as Colgate, Coca-Cola, Cadbury's, Surf, Google,  which have itself become the face of the industry and are always first to strike our mind when we think of that industry)

3) Barriers to Entry :Where entrance in the industry is restricted by number of factors such as Government's restriction, Intellectual Constraints, High Capital Outlay, Monopolistic or Duopolisitc industry dynamics (For e.g. Motorcycle industry in India, where still a large chunk of market share is captured by 2 player namely Bajaj Auto and Hero Motrocycles)

4) Economies of Scale (Where the organisation such as "Walmart" grow to such a level that they get the power to squeeze supplier's or buyer's to the possible extent and add muscle to their top line, bottom line, middle line, side line, and every line available in this universe)

5) Other's :  Other Qualitative aspects which can be judged only by seasoned qualitative investor's or one with outstanding business sense.

As you can see, judging a company on qualitative aspect is not that easy as it seems while reading Mr. Buffett's letter, Philip Fisher's material. One needs to go and check for the data in terittories such as customers, suppliers, competitors, management meetings etc. and then make decision based on the information, which can be really difficult for passive investors. Often, while judging the company qualitatively, one experiences behavioural biases (you knew, that it will be coming !!) which are the one of the most threatening enemy for an investor. These behavioural biases are results of the decision making on something "Unknown & Unknowable" , in other words, which can't be judged with absolute correctness.

So, with all this gyaan, do I mean to say that we can't be a good investor if we are not good at analysing the qualitative aspect. No, as there is another ideology for investors like you and me: Quantitative approach.

Ben Grahams - Net Net, Debt capacity Bargains, Special situation investring and Joel Greenblatt's Magic formula are few out of those quantitative approaches which have outperformed the averages satisfactorily over a period of time. As rightly said by Mr.Buffet "buying extremely cheap, will ensure that even a mediocre selling price will result in outstanding result". And a testament to these techniques is the fact, that Mr. Buffet in itself started its own business partnership with these quantitative approached and later on graduated to "Qualitative" approach. He also asserts that he is "85% Ben Graham, and 15% Fisher".

So, to conclude, find your own calling, as to whether you are a "Qualitative" investor or a "Quantitative" investor ? Venture out in Market as per your own "Circle of Competence".  So, be assured, that even with quantitative approach and disciplined attitude in market, you'll be able to spend you post retirement life at beach (Whether Bondi Beach or Calangute beach, will depend on your own discipline !!!)

--

Cheers !
Tony Stark
(CEO - Stark Capital)

Solar Power Plants : Can we term them as "Toll Bridge" functional equivalent ??

"In an inflationary world, a toll bridge would be a great thing to own because you've laid out the capital cost. You built it in old dollars and you don't have to keep replacing it"

-Warren E. Buffet

Above words are one of those excellent peice of advice, which Mr. Buffet has imparted to the fellow investors for better understanding of his business evaluation process. Though simple, but these words have profound meaning.

In Oct 2012, Prof. Sanjay Bakshi also posted a thought provoking on the functional equivalent of "Toll Bridge". In this post, I'll make an attempt to evaluate Solar Energy project from the "Toll Bridge Equivalent" perspective

Statutory Warning :

(a) The analysis might be suffering from "Confirmation bias" . Reader's discretion is expected.

(b) Since I am looking this analysis from the goggles of a "toll bridge" equivalent , so I might be lacking on variety of mental tool requisite for unbiased analysis. In words of Mr. Munger, " I am a man with hammer, and every thing to me look likes a nail"

Analysis :

Solar Energy project is a long term project whereby an entity setups solar panel today and generates electricity for future year (say 25- 30 years). So, going by the sacred words of Mr. Buffet , a solar panel's capital cost is laid down initially and the benefits are reaped in future years without any future incremental cost. In other words we built it in "old dollars" and we "don't haved to keep replacing it". So, prima facie it seems like a decent business model like a toll bridge, but unlike toll it has got several competition like non -conventional energy sources such as Wind based power plants, Hydro electric power plants. So we cant say that this business model has got a wide "moat". Though it has got some "moat" attached to it but it will converge within few years.

Now, coming to Prof. Bakshi's post on Functional equivalent for "Toll Bridge", the broad parameters laid out are as follows:

1. Pay the Toll
2. Mind of the user
3. Movement
4. Traffic
5. Gateway

Point wise analysis is as under :

1. Pay the Toll: Since electricity is one of the basic need for mankind and with the fact that still approx 60% of India is deprived of electricity, and rapid industrialisation has led to huge gap in demand-supply figures. So, in order to keep the country's growth momentum intact, the electricity demand will sustain and for the purpose Government is signing long term Power Purchase Agreement with the solar power project at high rate (As per Gujarat Solar Policy 2009, its Rs. 15/- for first 12 years and then Rs. 5/- for future years). So, Government is paying the toll to get access to the electricity. One can also sell the power through 3rd party sales, to enjoy the benefits of increase in revenue on y-o-y basis. 1^st point "Check".
2. Mind of the user: With this term " mind of the user" , professor meant that the product must not have any alternative. So, in a solar project, the underlying product is electricity and as we all would agree, there is no alternative to electricity. We cant imagine this world today without electricity. So , I guess, 2^nd Point "Check"
3. Movement : In a solar project, there is continuous movement of electricity or more specifically Electrons ( pardon me if I am wrong, and blame my commerce background for it) from solar panels to Grid and then to the end user. Also, since there are no viable technology available which can ensure the storage of power at large scale, so this makes the movement inevitable. Whatever energy generated, has to be transmitted. I agree that there are transmission losses, but still majority of current has movement. So, 3^rd point "check".
4. Traffic : As discussed above, since there is no viable source of large electricity storage, all the electric current has to be transmitted. So, therotically , there is no reduction in traffic movement as such over the period. There can be a fluctuation in Capacity Utillization but still it will generate electricity for atleast 10 hours a day generating healthy traffic of electric current over its useful life of say 30 years. So, 4^th point "Check"
5. Gateway : Gateway can be referred to as the junction point where two important ends meet. In effect, it is the passage which charges you to move from one point to other. Though I can't term solar project directly as a gateway like that of Internet, telecom companies or Power Dis-com, but indirectly it act as the reverse gateway between the buyer's demand for electricity and the suppliers urge to generate income. In order to source the electricity, the government is paying additional tarriff to solar projects for a considerable time frame. So, its upto one's own discretion whether to say, 5^th point "Check".

Other Aspects : Though prima facie, Solar project seems a good business model, but it has its own share of cons as well. Some of which i can think readily are :

• I guess the plant load factor in monsoon season should be less as compared to the normal scenario, hence reduced traffic/ movement in monsoon season.
• With involvement of Government, the project is subject to political risk. For states like gujarat where the government is stable and pro-active (personal view) , solar industry will be a good bet, but for other states (i won't name them) the tarrifs can change and dent the revenue for good
• Asset intensive industry. As per the latest information available to me, the cost per MW is somewhere near Rs. 8 Cr, which is on a higher side in comparison to its contemporaries.

Views invited.

--

Tony Stark

(CEO – Stark Capital)

(Note : The author has no intention to copy the ideas of other blogs/websites. If the person metioned above minds mentioning their name on this blog, author is ready to do so. Special thanks to Prof. Bakshi for his post)

Wishing you a very happy new Year !!

First and Foremost, wishing you a very happy new year !

May this 2013 brings peace and wealth to you in abundance!!

Year 2012 turned out to be good year for equity investor with market rising by 25% or so. Euphoria has again started to build up, with brokerage houses have already started projecting Sensex at 25000 in the coming year. With support of numbers such as historical P/E range of sensex, P/BV etc., brokerage houses are selling the idea of sensex trading at slight cheap valuation.
I still wonder, that if these guys are so apt at valuing the market or a stock, why are they not betting their pants out and make a killing on street.

As far as I am concerned, I am as clueless as you are about the market direction.But considering the global scenario, and Indian market outperforming majority of its contemporaries, the valuations has soared and finding value opportunties will be tougher unless market corrects itself.

With IPO of CARE and PC Jewellers performing fairly, there can be couple more of IPO in the coming season from the companies who are waiting for the right time to raise funds. I wish investors excercise due care before investing and don't get any behaviourial bias from the profits of CARE and PC Jewellers.

I believe, that these times, when opportunities are tough to find, provide good opportunity to re read the golden words of Mr. Buffett, Mr. Munger, Prof. Bakshi etc. and act cautiously, as this euphoria often culminates behavioural biases while analysing and can lead to disaster.

For me, its time to go basics and control my emotions(Lure) to invest. Though I might miss the market rally, but I still want to stick to old school values and search heard for undervalued securities.

Keep Investing !!


--
Tony Stark
(CEO - Stark Capital)

Probability and Investing : A dynamic duo !!

 

I believe "Probability" is one of the most sensible mathematical techniques after "Compound Interest" formula. If one has a good command over these two, and simultaneously apply them while investing, once can do wonders and is bound to become wealthy in long term. To support my views, I have examples of some great investors who are applying both the principles while investing and they are not only rich but extremely wealthy. List of such investing extraordinaire includes WARREN BUFFET, Mohnish Parbai etc.

Charlie Munger, in one of his speech highlighted the way Warren buffet thinks. He mentioned that Warren buffet is so much rational in thinking that he uses Decision tree Analysis in almost every decision making. Similarly, Mohnish parbai too in his book "Dhandho investor" has mentioned about probability as one of the effective tool and suggested "Kelly Criterion" for portfolio construction.

Why Probability Works ??

In my sense, Probability is such a powerful tool, coz it reduces the effect of uncertain event on the decison's outcome. The reason for it might be, that it incorporates the possibility of unfavourable events before hand and hence normalise the decision, making it future proof to a great extent.

In investing paralance,we can take it as "margin of safety" of decision making. If we see the underlying effect of "margin of safety", it is meant to reduce the effect of uncertain event of future that can have effect on stock price. As, one cannot ascertain the future unfavaourable event correctly, incorporating "Margin of safety" in an investing decision is suggested over and over again by each and every Value investor ranging from Father of Value investing "Ben Graham" to Warren buffet, Charlie Munger to Walter Schloss, Seth Klarman (Even wrote a whole book on the topic) to Mohnish Parbai.

Probability and Investing : Application of thoughts

We usually start our investing through our hard earned money and after finding a next possible mulitbagger, we are inclined to bet on it heavily. But, a scrip will be multibagger in future and we as investor, can't and never will be able to ascertain future correctly. So, making an investing decision based on the optimism that everything will turn out as presumed, will be nothing short of utter foolishness.

So, this is where we can plug in probability and take its advantage in portfolio construction. One such method is "Kelly Criterion" as highlighted by Mr. Mohinsh Parbai in "Dhandho Investor". The Kelly Criterion formula is simple :

Capital to be committed : Probability of winning – (Probability of losing / Edge)

                              (where, Edge = Win ratio i.e. Winning Amount/ losing amount)

 

The other probability method to be deployed is "Margin of Safety".

Example :

Suppose you analysed the stock with CMP of Rs.120 and its near its 52 Week Low (Rs. 118/-). Now as per your analysis, the stock price may go upto 130/- on account of some triggers (say some value accretive product launch, some buy back indications from management etc.).

As per kelly criterion, the weightage of this scrip in your portfolio should be ascertained as under :

Probability of Winning : Say 60 %

Hence, Probability of Losing : 1- 60% = 40%

Expected Win Amount = Rs. 10/- (130 -120)

Expected Loss Amount = Rs. 5/- (120-115)

Hence Edge = 2

Kelly Criterion = .6 – (0.4/2) = 0.4 i.e. 40 %

Hence as per Kelly's Criterion, one can bet upto 40% of its capital on this particular investing bet.

Conclusion:

As rightly mentioned by Prof. Sanjay Bakshi "A chain is as strong as its weakest link", one should apply the mathematical models with due caution and only after acquiring proper knowledge. As half knowledge is extremely dangerous,especially for investing decisions,

So, wish u a happy new year and all the luck for your future investing decisions.

--

Tony Stark

CEO- Stark Capital

Fluidomat limited | BSE : 522017

Name : Fluidomat Limited

M.Cap : Rs. 27 Cr || CMP : Rs. 55.10/-

ABOUT THE COMPANY :

The company manufactures Fluidic coupling, having its application in varied industries ranging from Thermal Power Plants, Cement Plants, Coal, Lignite & Ore Mining, Chemical, Fertilizer, Paper & Oil Extraction, Steel Plants, Copper, Zinc & Aluminum Plants, Harbour handling, an other miscellaneous Indsutries

LIST OF CUSTOMERS :

a) Plant & Machinery Manufacturers :

ABB, BHEL, Braithwaite, Burn Standard, CIMMCO, Chemical Construction, DEMACH, DCIPS, ELECON, EPIL, FFE, Fuller KCP, Flakt, Flender, HEC, HDOL, HSML, INDURE, Krupp, Kirloskar, Kraft Engg., L&T, MAMC, MBE, Metso, MECON, Naveen, Oilex, Penwalt, Promac, Reitz, Sayaji Iron, Techpro,Thermax, TLT, TRF, Walchandnagar Industries, Warman etc.

b) Approvals from the Consultants :

Fluidomat Fluid Couplings are approved by all leading industries and consultants in the country. The consultants include ACC, BHEL, Birla Tech Services, DCPL, Desin, HOWE India, Holtech, Jacobs, MECON, MN Dastur, NTPC, Tata Consultants,Tata Projects, Samsung, Doosan (Korea), Hyundai (Korea), Alstom (France), Sulzer (Germany) etc.

KEY FINANCIAL FIGURES :

BUSINESS MOAT :

The company manufactures fluid coupling, which is one of the key components in Industries. Hence the future of the company is dependent on Infrastructure sector and growth plans of other industries. Globally, only limited numbers of companies are in the manufacturing of fluidic coupling, making it a niche market.(Source : Balance sheet)

The company is manufacturing the products since 1971 on the basis of its own engineered products and it also has an in house Non Ferrous and Cast Iron Foundries for producing high quality intricate castings required for Fluid Couplings. In a way, the compnay has undertaken backward integration and thus enjoying the low cost benefit, which is evident from the improving Operating profit Margins (OPM) and Return on Equity (ROE). Moreover, despite of the fact that the customers being the big brand organisations, the company has been able to pass on its increasing cost of raw material, with sales price per unit increasing from Rs. 61116.79/- in FY 2005-06 to 97865.10/- in FY 2010-11.

A point to be noted is that the company went into Debt Restructuring in 2002-03, and has successfully came out of it in 2009-10. The testament to the above fact are the figures posted by the compnay on an year-on-year basis. And it seems like the company learned the lesson from restructuring and has not raised any debt after repayment of restructured debt from its internal accruals. Currently the company is debt free and has only working capital limits with Central Bank of India

As per the website, the company also has orders from likes of Adani Power Plant, Mundra Port, BHEL etc . There is a need to dwell more on this front.

RISK AND CONCERN :

1. There has been no major increase in capacity in recent times. Instead the company is over utillising its capacity.In year FY 08-09 and 2010-11, the company was able to produce 1704 and 1776 units respectively with installed capacity being only 1500 units. This leads to over utillisation of the capacity by 20-25%. If the product is having so much demand, why the management is not augmenting the capacity ?

2. The future of the company is dependent on the Infrastructure and other allied sectors which in turn depends on the spending activities of government. Considering the current scenario and India's slowing economy, the growth aspect needs to be reconsider

3. Being a small cap scrip, not much data available about the management. Though the management seems to be investor friendly considering the fact that the company has started distributing dividends from last 2 years and also the capital allocation has been good (indicated by improving ROE), but still lot needs to be find out rather than just relying on numbers.

4. The Auditor is not a recognised entity and the details in balance sheet (such as MD&A) are not up to the mark. Management is not sharing much details about the industry and the company in MD&A. Also, details of order book are mentioned in Balance sheet on a regular basis.

5. The Revenue Recognition policy of the company is a bit aggressive, as it recognises the revenue at the point of dispatch of goods. Though, I am not a good judge of accounting policies, but considering the AS-9 for revenue recognition, the revenue should be recognised when all the material risk are transferred to the buyer. In this case, company is recognising revenue at dispatch itself, even when the risk related to sales are not transferred in favour of buyer. Need to check further on the accouting policy

6. The compnay purchased a flat in Leelam Vatika, Indore in FY 2007-08 for Rs.16.20 lacs. The purpose stated was for stay of Executives of compnay. However, the same is removed from the the list of assets in FY 2008-09. The loss on sale of fixed assets is shown at Rs. 61,000/-, which I believe doesn't reflect the transaction of the property. The only deduction I am able to make out of this transaction is that the promoter used the company's money to buy the property for self.

7. No details of R&D mentioned in Balance sheet, which makes me skeptical of the future growth prospects. Since,the company is in a high tech sector, R&D is the key to prolonged success.

8. No details of Order book mentioned in the current year. As per the balance sheet of 2010-11, the pending order book was Rs. 31.73 Cr, but no mention of the same in current year. This restricts the revenue visibility.
9. The analysis mentioned above might be suffering from the various behaviourial bias such as "confirmation bias", "Self- deception bias" "Selective thinking bias". Such biases can distort the analysis and reduce the effectiveness.

VALUATION :

Valuation as per Debt Capacity Valuation : Rs.46.31/-

Valuation as per EPV Valuation : Rs. 42.10/-

Valuation as per Relative Valuation : Rs. 56.39/-

Valuation as per 12M P/E Fwd : Rs. 58.93/-

Average Valuation : Rs. 50.93

Considering the current market price of Rs. 55/-, the stock seems to be fairly valued and the position can be initiated at levels of around Rs. Rs. 50/-. Though this stock doesn't seem to be turning multibagger, but can give decent return in coming years. So stay tuned for further action.

Views and discussions invited !!

--

Tony Stark

CEO - Stark Capital LLP

Usual Startup Post !!

To keep it short and succinct, this is yet another blog from a novice and utterly confused value investor !!

Reason for starting : Get some of my confusion solved through mutual discussion (Expectation of some comments on posts !!)

What to expect : Lots of confused thoughts, which might be camoflouged as Stock Analysis based on value Investing principle. Please carry on at your own risk.

What not to expect : Some “TIPS” on stocks, next “CRISIL” or “Infosys”, some good gyaan on “Value Investing”, some high fundaa valuation methods, and last but not the least any technical anlaysis gyaan (like Resistance / Support etc.) … but let me assure you that nothing of sort will be available going ahead, as yours truly is no where close to such esoteric knowledge.

Statutory Warning : All the post on this blog are wierd thoughts and imagination of author and it has no relation what so ever with the life and death, profit and loss, or any sort of mishappening of any follower. Readers are requested to enjoy the posts merely for fun and in no way the post should be taken seriously !! 

Lastly, I don’t recommend any of the stock on this blog, and recommend self reliance to readers in investing process.