L'al·legoria, el somni i la visió

The current article in this series provides responses related to:

 Using tax payouts: from P&L or from CFO

 Preferred level of debt to equity ratio

 Margin of safety & preferred P/E levels

 Analyst/investor’s meetings or conference calls, listing on stock exchanges

 Sequence of reading annual reports

Query

While doing the tax analysis don't you think it's more accurate if we compare the actual tax paid (the figure in cash flow statement) as a percentage of PBT over the years rather than taking the tax paid figure from P&L.

A1: P&L and cash flow statement differ many times from each other on account of the timing of the receipt or payment of cash being different from the time when the revenue or expense become certain for recognition. This marks the basis of accrual based accounting. Like many other revenue and expense items, in the case of taxes as well, the timing of the tax being shown as payable in P&L and the tax being actually paid are different. Such instances give rise to deferred tax assets (DTA) & liabilities (DTL). If an investor wants to use cash flow statement based tax outflow instead of P&L tax expense, then she should use it for the entire 10-year history of the financial data, which is usually used in fundamental analysis.

This is because there might be years in the past where P&L tax expense was high and cash flow tax outflow was low. This would have led to the formation of DTL. In subsequent years, when the company paid the tax liability to income tax dept., it might be the case that in this year P&L tax expense might be lower than cash flow tax outflow. If the investor uses P&L tax expense for previous years and uses the cash flow based tax outflow for the recent year, then she would be over-estimating the tax liability by double counting a single tax liability. However, as an additional financial analysis parameter, it is advised that an investor should compare the total P&L tax expense for 10 years with the total tax outflow as per cash flow statement. Ideally, they should be similar to each other. In case, these two items are not similar, then the investor should analyse it in detail.

Query

Why do you think the Debt to Equity ratio should be less than 50%? If the company gets the long term loan on the cheapest rate, it would be beneficial for the company to finance its long-term projects.

Financing the projects with borrowed money than Equity is not expensive for the company?

A2: The stock investing approach along with the preferred investing parameters differ from one investor to another. A market is a place where different investors with different investing approaches meet, which results in a trade with two investors taking opposite decisions (buy & sell) with the same information available to them. I prefer to invest in companies, which have as low debt as possible, preferably debt free. An investor would appreciate that if the debt is taken, then a fixed liability of making interest and principal repayments falls upon the company, which needs to be met irrespective of the business/company performance. Many times, such liabilities lead to the companies selling their assets in tough times and in infrequent situations, companies face bankruptcy as well. Moreover, the probability of manipulating books to show good performance increases, when the company has debt on its books and it needs to meet the performance conditions stipulated by lenders. All these factors become almost irrelevant, though not non-existent, when a company does not have any debt on its books, which lends stability to the business approach as well as peace to the investor. However, as mentioned above, the investing approach is unique to each investor. Therefore, in case any investor believes that any company, despite having high debt, is being run by good management that would use the additional funds in a very good manner and this level of debt would not pose any risk to the company and the investors, then she may go ahead with her conviction.

Query

Read: 3 Simple Ways to Find Out Margin of Safety in a Stock. I find your articles very useful. Thank you for doing such a great job of contributing to the investor community. My query is relating to the Margin of Safety (MoS) principle, wherein it says that 'higher the difference between the Earnings Yield (EY) and

10 year G-sec Yield, higher is the margin of safety'. So, you advise the investors to buy stocks that have PE<10 with sound fundamentals. This was the case when you started writing the blog when the 10 year G-sec yield was around 8%. But in today's economic scenario in India where the 10 year G-sec yields have come down to ~6.23%, should an investor increase his PE parameter since a slightly higher PE parameter of say 'PE<12' while screening the prospective companies for detailed analysis would still offer a good margin of safety (as EY = 1/12 i.e. 8.33%) when compared to 10 years G-sec yield of ~6.23%.

Q 2

Read: Final Checklist for Stocks Analysis I have one doubt regarding PE to be below 10. G-sec yield, now, is around 6.24% based on which PE comes around 16. Should we not take PE<16 criteria as having sufficient margin of safety? Or am I missing something?

A: You are right that the benchmark P/E ratio for comparison/arriving at the margin of safety keeps on changing as per the interest rate scenario in the economy. In low-interest rate scenarios, the benchmark P/E ratio increases when compared to scenarios of high-interest rate. You may read more about my thoughts on the appropriate P/E ratio to be paid for stocks in the following article:

Query

One of my friends told me about you and introduced your site to me. I have just started reading your articles on analysis and Q&A articles, and getting a different perspective on Stock Market and Shares. I am not a big or full-time investor, very novice and till now I was not having any idea about value investing and also did not have any ownership feeling of any of the companies for which I bought stocks. Now I feel how important it is to have the ownership feeling on any of the companies whose stocks I am going to buy. Also got the importance of Fundamental Analysis that need to be done before buying stocks. After reading your articles I understood that how I had been misled all these days by market emotions, media and other sources. I am a very novice to the Stock Market, I have few basic questions on Stock Market.

It would be great if you could answer these queries or you can direct me to a right source where I could find the answers:

1) What will be discussed (or agenda) in the Analyst/Institutional Investors Meeting? And normally who are the participants of this meeting?

2) How often the Analyst/Institutional Investors meeting happens in a year

3) Can everyone have access to the Minutes or the Summary of the outcome of Institutional Investors meeting? If so, where can we get it?

4) Why some of the stocks are listed only on NSE or BSE.

5) What is the rationale or why companies prefer being listed in only one of the Stock Exchanges, not on both?

I will continue to read your articles whenever I find time. Also started reading the book: "Intelligent Investor"

A2: I am happy that you found the article useful. It's great that you are working towards doing your own stock analysis and also have started reading "Intelligent Investor". It is a great book and you will find it very helpful to develop the right attitude for a stock investor.

1. What will be discussed (or agenda) in the Analyst/Institutional Investors Meeting? And normally who are the participants of this meeting?

Analyst/institutional meetings usually focus on the results & business performance updates about the companies as well as all the latest developments about the company and their impacts on company's business. From the company, mainly CEO/Chairman, CFO, company secretary/investor relationship

person etc. i.e. key senior management personnel, are usual participants. However, many times the senior management also brings other key people like marketing head etc. to the Analyst meeting. From participants’ side, usually, the investment analysts from stock brokerage firms, mutual funds, institutional investors are the participants. However, individual investors like us also attend these meetings especially, when they are held by way of telephonic conference calls.

2. How often the Analyst/Institutional Investors meeting happens in a year

These meetings usually happen each quarter or whenever any major development related to the company, which is expected to have a material impact on the company, takes place.

3. Can everyone have access to the Minutes or the Summary of the outcome of Institutional Investors meeting? If so, where can we get it?

Analyst meetings/conference call minutes/transcripts are available on websites like researchbytes.com.

However, the minutes of the closed-door institutional investors meetings, which happen one on one between the company and potential investors are not disclosed in the public domain.

4. Why some of the stocks are listed only on NSE or BSE.

5. What is the rationale or why companies prefer being listed in only one of the Stock Exchanges, not on both?

BSE has much more companies listed on it than NSE. As a result, many companies are listed exclusively on BSE and there might be only a few companies, which are listed only on NSE. Reasons can be many:

A company might have got listed on BSE when NSE was not established (NSE was established in 1992.

And the might not have felt the need of getting an additional listing on NSE later on. Costs associated with listing on additional exchange might be a factor. However, now a days, many companies, which have been listed on BSE for many years are getting listed on NSE as well. Also, most of the new listings/IPO are listed on both NSE and BSE simultaneously, therefore, the trend of being listed only on one exchange seems to be on a decline.

Query

In what order do you recommend reading the ARs? The latest from older or older to the latest?

A3: An investor may read the latest annual report first to judge whether it is worth spending further time on the company. Once the investor has decided to analyse the company in depth, then it is advisable to read the annual reports starting from the last year and then keep reading the annual reports of later years on a sequential basis.

Q&A: Share Pledge, Revaluation Reserve, Meeting