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The current article in this series provides responses related to:

 Queries on analysis of Control Print Limited

 Use of credit rating reports in stocks analysis

 Reader’s (Naveen Kumar) inputs on detecting accounting frauds

 Other queries on balance sheet and stock selection

Q1: I am posting the following doubts 5 months after the post; I hope they will still be useful for newbies like me. While researching control print, I found that the promoters have issued themselves 3.75 lakh convertible warrants in 2013. The company does not have any debt. Why does management issues preferential warrants to itself:

 As part of compensation or for funding the company?

 Is it better than taking debt?

I see that over the last few years, that the total number of shares in issue has increased and the percentage of promoter has also increased. Is it in shareholder's interest when the number of shares increases without any bonus shares or splits?

A1: As different individuals have different risk appetite, similarly it is with the companies. Some seem to prefer debt when short of funds, others prefer equity. Issuing warrants to raise funds (equity) would depend upon the risk appetite of company. At end of the day, equity owners won't ask their money back in tough times. An existing investor in a company should be concerned about the exercise price of the warrants. If it allows the promoters to convert it into share at attractive terms, then it becomes a tool for promoters to benefit at the cost of public shareholders. Warrants are a form of stock option. If exercise price is sufficiently higher than current price considering the time after which warrants become convertible, then no concern for other shareholders. Equity dilution (increasing number of shares without split or bonus) is generally not perceived to be good by investors. However, I believe that it is a company's decision which also behaves like individuals do when it comes to raising debt or not.

Therefore, an investor should decide from case to case basis depending upon the terms of warrants/convertible securities and the purpose of equity dilution.

Q2: I was researching about the company Control Print Limited. I found that its credit rating by CRISIL was A3+ but it was suspended on November 2013. According to CRISIL FAQs, rating is suspended when disclosure level by the company is low. Is this a bad thing if a company does not have a credit rating? Also, when I look for credit rating in screener.in, many good, debt-free companies like Symphony Limited and DHP India Limited are not rated by any credit rating agency. Are such companies not looking for a credit rating because they do not need to raise debt any time soon in future?

A2: A company might stop getting rated by credit rating agencies when it has repaid all its debt, as annual rating has costs attached to it. Rating might be suspended by one agency when the borrower decides to shift to another agency, and then there might not be any problem with disclosure levels of the company.

Otherwise, there can be a real issue and a borrower going through a bad patch may stop rating fearing downgrades. All these are situations, which an investor has to judge.

Q3: Something which is rarely covered or discussed. Value investors generally give less weightage to credit agency reports and analysis, focusing more on annual reports and financial statements. However, this article clearly shows why credit rating reports cannot be ignored rather can be used to one’s advantage. I have couple of quick questions:

1. Do you think companies paying to get them evaluated by credit agency, will generally get its positives highlighted more than its negatives due to incentives bias (Whose bread I eat, His song I sing)? How do we put that in perspective? Similar thing happened in 2008-09 crises in US and since then credit agencies have lost bit of their trust in fair analysis.

2. Do you think, this information is in market (public) hence will immediately get reflected in price?

A3:

1) I do not know whether there has been any case where any company would have managed to get a favorable rating; however, I do not think that rating industry survives on earning money by giving positive ratings to borrowers. Credibility of rating agencies depends on their independence and more or less their outputs reflect it. However, this is not to vouch that every rating is right. An investor would have to take

her call in this matter. Anyway, I prefer to focus on the trend of rating movement rather than any particular rating.

2) I am not sure about what all factors the market price at any point of time, reflects. Market price movements defy all logic and I try not to have any opinion in this regard.

Q4: I have a similar but simpler rule of thumb: Over a period of years, a company should be able to increase book value at the same time reducing debt and if debt is already zero then dividends should be increasing.

This is probably not as deep as your formula but as a rule of thumb it removes a large number of companies, which would also be removed using your formula. In either case, the idea is the same - we want to find companies, which are generating enough cash that further capex is being internally funded and enough free cash flow (FCF) that shareholders are getting benefited.

A4: You are right that the rule of thumb described by you, does has the potential of segregating "good"

companies from a number of "not so good" companies.

Q5: I have a question regarding this blog, although I might find its solution later in your strategies mentioned but I thought it’s better to ask as I go along. You mentioned in the article: Book Review - The Intelligent Investor by Benjamin Graham. “Graham advises the defensive investor against buying growth stocks as they are usually overpriced and carry high risk. Risk in growth stocks arises not from the fear that such companies would de-grow in future, but from the risk that they might not grow as expected by markets. The book gives example of companies where profits grew 5% but the share price declined >20% because market had expected 10% growth.” Please mention if in case we find a good company according to the selection criteria and have a good profit, how will we know what the market have expected for the share and how can we be cautious of such measures when we already have found a very good company by fundamental analysis.

A5: Regarding your query: I do not know of any way to know for sure, what the market's expected growth rate from a company is. Most of the times, it is believed that market expects high P/E stocks to grow at fast pace. Or should be inverse this logic and say, the stocks which market expects to grow at fast pace, it assigns high P/E to them. Therefore, the logic can be extended that market expects low P/E stocks to grow at a very slow pace, however, if any investor can find a company among the low P/E stocks, which is fundamentally good and is able to grow at a fast pace, then she can earn good returns when market recognizes its potential and assigns it high P/E. Therefore, I would say that to allay the concerns highlighted by you, an investor should invest in fundamentally strong low P/E stocks.

Q6: I have a query with regards to this chapter. All the analysis that you have shown compare a company after 10-15 years of growth but by this time Mr. Market might have already assigned it its correct valuation. These companies might look really good at hindsight but the trick is finding good companies in early stages and believing that these companies are capable of such high valuations at later stage. How do we do this in industry/business analysis as there are no forecasts provided in the above analysis?

A6: It is not always true that Mr. Market assigns true valuation after 10 years of good performance.

Undervalued opportunities are always there in markets. An investor should keep looking. I, as an investor, get comfort only when a company has been around for long (say 10 years) and has proved that it can generate profits. I advise the same to other investors including reader of www.drvijaymalik.com. I believe that this approach would work for individual investors who work with limited capital, have limited risk appetite and can spend limited time for stock analysis. I say this because while investing in early phase/start companies, which venture capital or private equity funds do, the investors invest in a large number of companies expecting that a few of the bets would go right and cover the losses on those that did not go right. No one knows the future with certainty and institutional investors mitigate it by having a large portfolio with many investee companies. If an investor believes that she has the skill to analyse businesses in early phase and has the requisite risk appetite, then she should invest in companies with short history.

Q7: Few more additional things which can be added to the checklist could be:

1. Auditor disclosures/comments about non-recognizable income

2. Increase in other income to inflate profits (Capitalizing arbitration income whose outcomes are uncertain),

3. Promoter background, & frequent changes in key management persons (CFO, board of directors etc.),

4. Consistency in Tax rate (very difficult to analyze, request you to write about it sometime about various tax outgo),

5. Increase in Loans and Advances, corporate guarantee and contingent liabilities are few signs which should raise alarm about the authenticity of their result.

A7: I thank you on behalf of all the readers of www.drvijaymalik.com for your valuable inputs! I might write an article about corporate tax, however, it might take some time.

Q8: I want your view on 1 situation: If a company is expanding its business & growing at decent growth rate (>30%) and if the expansion depends on a combination of equity and debt instruments that include issue of fresh equity shares, non-convertible debentures (NCDs) and fixed deposits. Should we invest in such company where we know that equity dilution is going to happen?

A8: There is no one road to success. It depends on the risk appetite of the investor, which companies she should invest in. If an investor finds the business good enough and feels comfortable in investing the company with features described by you, then she can take the decision she feels convinced about. It cannot be said with certainty that the company described by you will not see rise in its stock price.

Q9: Is there a way to get receivable days in trailing twelve months (TTM) basis? Where can I get it?

A9: You can calculate it twice a year. Once at year end and another time after Sept quarter results, when trade receivables are disclosed in the summary balance sheet as part of results. You would have to do it manually for Sept data.