How to value a stock? The complex game of mind and accounting

There is too much focus to today. As in there is great interest to what is happening now as opposed to how things are going to shape tomorrow. Infosys results is the case in point. Why so much of interest in going into this one bad result?  Are we missing out the bigger picture and log terms prospects of the business?  While I am not specifically sure about the particular stock or the business, one thing is sure as a pattern, stocks go down a lot but they will go up a lot more – if the future prospects of the business is positive. Is the company in a high growth business? Is the total income increasing continuously? Is the EPS growing aggressively? Is the Profit after Tax growing? What is the ROE?  How much intangible value is acceptable? Often a stock sell off is never because of investors who have answered these questions.

How to value a stock? Accurate valuation is difficult. One can look at the above factors, dividend track record, its place in the industry as size matters, governance, institutional holding.

Is it a good time? One can achieve this methodically by stock diversification and time diversification.

Entry price and exit price band can be evaluated by finding the intrinsic value of the stock or a discounted cash flow analysis.

Then of course one has to understand the economics of the business. There is a very huge sector of trades, hotel, restaurants, transports which are non-corporate. There is a huge opportunity to corporatize these sectors in the next decade or two. Investing in these sectors can lead to huge wealth creation. Any business will have a life-cycle of growth and after that it can stall and fall apart. The stock market generally moves up because the old and aging businesses are replaced by faster, newer and innovative companies. The innovators and disruptors have growth ahead of them and we must be invested in them. The needs of people are few but wants are many. The successful companies cater to the wants of people through their brands and marketing.

Learn how the stock market really works, the dangers, the opportunities, common mistakes and how to overcome them, the mental attitude to succeed in stock market. Register for a free learning session and discovery into the modern investing at research@learnivest.in

 

When do you decide ?

Repetitive decision making takes its toll on the decisions. The energy levels and time of day when you make decisions also impact the quality of analysis. Researcher Jonathan Levav analysed 1112 parole hearings assigned to 8 judges. The Judge's pace of decision making was grueling with 6 minutes to make a decision. The impact of the study is interesting for the investing world, the chance of a parole being released was as high as 65% in the mornings and after breaks and dropped to near zero at the end of the day, when the will power and energy was sapped. He concluded that we revert to default decision making when the process is repetitive and will power is low.

In the investing world, a person who is regularly taking decision & analyzing the volume of information or reversing his previous inferences will suffer the same behavioral obstacle. Mind is a monkey whose priority keeps changing with times. A learned investor has to chain the urge to change the opinion every once in a while. Give time for businesses to perform once you have made a decision based on wise counsel.

The story on this Stock was based on this principle. Avoid too many decisions or doubts. As you can see form charts the stock did not give good returns for 3 years between 2011 and 2014. Since the decision basis to invest in the stock captured in the Blog written 5 years ago did not change, there was no need to revisit or make new decision. In the period from 2014 to 2016 the stock gave 400% returns. 

We tend to revisit the stocks that we hold if they do not give paper returns in a few months if not week. We must resist this temptation to look at the stock price and continue to look at the fundamentals of the business. Lets move from being Stock investors to business investors.

By investing in such sound businesses, the risk and downside is reduced, when you manage risk, it manages the returns. 

Read more about this here 

Future of the Stock

A Value Stock is the one which trades at a discount to its intrinsic value. The intrinsic value can be found out through future cashflows or dividends or by using a discounted cash flow analysis. such stocks exhibits high dividend yields and lower price to earnings ratio. The intrinsic value of a stock is based on the future prospects and predictability of earnings. Many of us look at the past earning and history of performance but this in my opinion can lead to a trap. Business landscape today is changing so radically, the past formula of success is being re-written. Technology, changing demographics play a crucial role is such unprecedented change. So the value of the company is based on the future earnings and performance which should be the new reference. Recently we sold most of our holdings in a FMCG company that we held for almost 4 years. The earnings had not only deteriorated in the past few quarters but we see a huge dilution of demand. This company had grown at rapid pace for the past several years and likely to see slackened future earnings prospect, a good enough reason to sell the stock. In the portfolio, we have replaced with a Finance company that we believe should offer future prospects.

How does one predict the future? Some businesses especially technology firms believe you create a future by disrupting the present. Visionary business leaders have the magic eye to see what is changing and adapting their business models to take advantage of such changes. With such changes we will see value migration that will result in huge uptake of demand. A well known example is the how the nuclear family lifestyles has created demand for cookers. More nuclear families meant more cookers. TTK Prestige was able to take advantage of this change is lifestyle by launching products that looked and felt better. But companies like Hawkins failed to take full advantage of such changes.

The opportunity is the same for the market, but the management that has an eye for how the markets will change are the ones that will succeed.

In the Banking industry HDFC bank has proven how they could anticipate and manage change better than others. But Change is constant and so will have to be the management to keep ahead of change.

On a side note, Lupin drew some negative attention correcting by a whopping 40% in 6 months. Do we see value in it at 1300? 

Check this Video to see how they are managing the change 

Make the most of it !

The best investments are done during times of uncertainty and tough conditions. Market overreacts to good news and bad news. They respond more strongly than what is appropriate. That's why when Modi took over almost 20 months ago, it touched an all time high with out any change in business fundamentals. Today it is overreacting to many negative cues on global as well as domestic fronts. These are cycles and while we can't predict accurately when the direction will change, one thing is sure. In the long run, markets will behave rationally. The broader markets have come down by about 20% from its peak without considering long-term market prospects.

Some of our best companies whose stocks we hold, have also corrected significantly making them juicer. It requires a clear mind void of confusion and one that appreciates 'business like investing' to identify the opportunity. The same market that behaves in an irrational manner will be rationale in the long run, the ones who understand this will profit immensely. Again this cant be borrowed belief, it has come from ones own experiences and analysis. 

We have seen world-wars, Lehman crisis, terrorist attacks, but we are doing well. That's the nature of the world and business. As the RBI governor rightly summed it up, The Stock Plunge is a market problem, Not Economy's. We must differentiate between market sentiments and business fundamentals.

Invest when times are tough and there is no better time than today. We need to be mentally prepared to do this as we normally get swept in the emotional turbulence. You can start by looking at recent looser, stocks that have been battered between 20% to 50%. Make a list of stocks that you wanted to own but found them expensive in the past, they might have become reasonably cheap. Make the exercise objective and attach no emotion to this. The Sale is on

For help and a list of stocks that we wanted to own and are on sale please email research@learninvest.in

Trends and Off Trends

Microfinance, Real-estate, Hospitality and Publishing are now not really in the trend. But these provide reasonable margin of safety on stocks of some good companies. A microfinance glut and government apathy turned this into a spoilt broth, but there are opportunities lurking here with companies that have grown at 60% CAGR and long lived for 25 years with legacy. The sectors such as real-estate too have some good beginners with ethical practices that can grow very big in the coming years. This is time when we can invest in these companies as the sectors are out of fashion and hence beaten down stocks provide a good degree of margin with limited downsides. These stocks are quoting at reasonable valuations at current prices of of  360 and 1300 respectively. They are likely to grow and create wealth for the contra-investors.

Same with new trends that will become main stay. When Infosys leveraged on the trend of services outsourcing, it was a new trend that made wealth. Today the world of  Big Data and cloud will turn to become mainstay in the years to come as many enterprises adopt them for their business. There are 2 companies that have very unique positioning in the market today and will likely get bought out or grow organically. We look at the size of the opportunity here, how big is this adoption going to change the quantum of revenue and earnings. Mere growth is not sufficient, this growth should bring more economic value to the investor. Economic value is created when the return on capital is more than the cost of the capital, while the company continues to grow. So we need growth with economic value being added.

As a long term patient investor, you need to continuously water plants while cutting of the weeds.Our economy is on the upswing if you ignore the immediate issues at hand. Our duty as investor is to look for great businesses run by capable management of integrity and with execution skills that result in consistent and profitable growth. The business that have longevity, predictable performance, large opportunity size.

To know of the stocks discussed, please mail us at research@learninvest.in

Check blog The Money Making Machine