REFERÈNCIES BIBLIOGRÀFIQUES

The current article in this series provides responses related to:

 How to find out whether a company is capitalizing its interest cost and not showing it as interest expense in the P&L statement

 How should an investor approach contingent liabilities

 How to calculate capex and in turn free cash flow (FCF) for any company

 Standalone or consolidated financials: which ones the investor should analyse?

 Clarifications about analysing well-known vs unknown companies

 Clarification about considering minimum NPM of 8% as a stock filtering criteria

 Impact of El Nino and INR depreciation on profitability of spinning firms

 Roadmap for a beginner investor to learn stock investing

 What are Operators’ Stock and should a retail investor be worried about them

 The best book to learn stock investing

 Understanding how the profits get stuck in the working capital and do not always lead to cash flow from operations

Q1: I made a mistake in adding the PAT for 10 years. You have gone a step further in evaluating the operating performance of the company. It makes the picture clearer. I believe that all manufacturing companies, currently, are riddled with these issues of Asset Turnover Ratio. Also in the current market phase of high cost of debt, further makes the sales growth trajectory by way of raising debt futile, considering the capital nature of most manufacturing companies. But most manufacturing companies are saddled with this issue and making investments in such companies become harder. Doesn't this speak a lot about the general business environment in the country, not just the country but the competitive nature of industries around the world? Fact is that most of the industries are working with commodities, which are cyclical in nature by way of their demand vs the price. When the demand rises the commodity prices rise and hit the bottom-line of the companies but this fact is usually disregarded as in such times the growth in sales leads to profits growth. When the demand

cools down the commodity prices fall resulting in poor sales performance of the company but better margins due to lower cost of goods sold. This improved profitability due to lower commodity prices could be hampered if the specific company is a supplier to an original equipment manufacturer (OEM) as the OEM would suck the benefit of cooling raw material prices out of the supplier in any possible way. This impacts most of the auto ancillary companies like Munjal Auto Industries Limited and Motherson Sumi Systems Limited. Perhaps this is a general comment. My specific questions are the following:

1) Why would a company raise debt and hide it in the Capital Work in Progress (CWIP) and not pay the interest on debt and thereby reduce its taxes:

 I believe that one reason could to show to the investors that the company has strong Net Profit Margin (NPM), which otherwise would look terrible. Is that correct?

 Also how can the company not pay interest on the debt raised or is it possible by deferring the interest liability for the gestation period of the new projects.

2) How do you get the data for the receivable days and Inventory Turnover?

I exported the data from screener and in the balance sheet column found the data on debtor days and inventory turnover. However, that data is different in your sheet as compared to what is in the exported file. I have read your article "Simple Steps To Analyze Operating Performance Of Companies" where you have given the underlying principles, but I need to understand how you calculate the same from the excel sheet if what I am referring to above, is different from your method of investigating.

A1: Bottom-up investing is all about analysing individual companies which are performing well despite challenging economic scenario. Commodity cycles>>fluctuating profitability might be true for most of the companies, but then, an investor has a choice of ignoring most of these companies and keep searching until she finds a company which she likes. There are thousands of companies in the listed universe. It is advised to keep searching until the investor is satisfied. Debt is not hidden in CWIP. Debt details are be there in balance sheet in the liabilities section (Non-Current Liabilities and Current Liabilities). It is the interest cost that is added to CWIP and not deducted from sales while calculating net profits. It is legal as per accounting standards. Only thing is that an investor should know that 3,500cr debt would never have₹ only 25 cr of interest cost. Actual interest paid in a year, which should be about 350cr considering 10%₹ ₹ rate of interest. Total amount of interest paid by a company would be visible in cash flow statement under cash flow from financing (CFF). Banks would never defer interest payments. It has to be paid monthly, irrespective of whether you show it in P&L or CWIP. The article mentioned by you on analysing operating performance of companies, clearly states the formula for calculation of receivables days. All the data needed is in the screener excel. I suggest you to try again. You may take help of google to read some other articles to understand receivables days better.

Q2: I would like to know how the contingent liability is seen by the market. I mean what is contingent liability and does it affect the price of the stock? Also, Sir, I would like to analyse a company based on the Free Cash Flow (FCF) it is generating over 10 yr. period time. I mean each yr. how much FCF it is generating. How can we find the free cash flow of a company from Screener?

A2: It depends on what kind of contingent liability it is:

 Corporate guarantees given on behalf of subsidiaries should definitely be considered as debt.

 Performance guarantees given as part of contracts are normal part of business and are ok.

Therefore, there no one way to deal with all contingent liabilities. You may calculate capex by following formula:

 NFA = Net fixed assets

 CWIP= Capital work in progress

 Dep= Depreciation

 Capex = capital expenditure

(NFA+CWIP) at Year end = (NFA+CWIP) at start of year - Dep+Capex Therefore,

Capex = (NFA+CWIP) at year end - (NFA+CWIP) at start of year + Dep You can calculate free cash flow (FCF) for any company as:

FCF = CFO - Capex

Q3: I have a question related to analyzing a company which is diversified like Balmer Lawrie & Company Limited. Basically, my query is about analysing Balmer Lawrie & Company Limited at standalone &

consolidated basis or both. As I have seen that many a times a stock gets effected by a bad consolidated result although the standalone results are really good.

A3: Consolidated financials carry more weightage as they represent the combined results of all the assets/investments of a company whether in the plants & machinery on its own books or through its subsidiaries/JVs etc.

Q4: I have a few queries:

1. I see that the market cap in the excel output of a particular company does not match the market cap stated on other websites like edelweiss. One reason I can think of is that they are of different time periods. However the values are far different. Is it because of the free float vs actual market capitalization?

2. Secondly, I see that you have created a portfolio of small and mid-cap companies, which are excellent companies for the purpose of investment. Also you do not worry too much about these companies on account of the stock markets. I assume that your view would be to stay invested for the period of more than 5 years because even with excellent results of the company the stock may not come into the notice of institutional investors which restricts the gains due to the sentiments associated in the market.

On the contrary companies that are darlings of the stock markets also to a large extent create value for the shareholders. You have not given any method for making assessments of these companies for long periods of investments. Please share your views for companies of such nature.

A4: Ideally the market cap figure would mention whether it is free float or total market cap. If it’s not mentioned, then you have to judge it yourself by spending some more time analysing it. I focus on companies below 500 cr. market cap. There is no single road to success and companies in various other₹ segments would also make wealth for investors. However, every investor frames her favourite style of investing.

I would like to delineate a belief that I hold about investing: "There is no one path to success in stock market investing. Investors have made money in markets by following high P/E growth investing, low P/E value investing, and mix of both, arbitrage, technical investing, large cap investing, mid/small cap investing and many other such approaches. Therefore, I believe that there is no single standard path to succeed/make money in markets. The path an investor should follow is the one she is convinced with and feels comfortable with."

Readers are right when they mention that good business may not be available at low P/E ratios (a P/E<10). An investor is free to invest in businesses with high P/E, if she is comfortable. However, I believe in investing fundamentally sound companies, which are yet to be recognized by the markets. I believe that such companies are present in the markets. Such opportunities might not be aplenty; however, I believe that an investor does not need to find dozens of good companies. My experience in markets says that one company a year is enough. Nevertheless, there is no one path to success in markets and therefore, if an investor believes in investing high P/E companies, which are valued fairly, then she should invest in such companies without any second thoughts. Investing methods are personal choice.

Q5: I have a query:

 Why do you take the minimum net profit margin (NPM) rate as 8%?

 I mean why you consider 8%.

 Does it have any correlation with 15% sales growth?

 Why is minimum NPM rate almost half of minimum sales growth rate?

 Why is there big gap?

 Does such gap exists in all industries?

A5: There is no correlation. These are the levels that I like in the companies in which I feel like investing.

An investor should have her own criteria for selecting stocks. Depending on her preference, I suggest that the investor should tweak these parameters to the levels that she feels good.

Q6:

I read your article on Analysis: APM Industries Limited and Nitin Spinners Limited

Since 83% of the products are cotton textiles and they depend upon cotton yarn, which is an agricultural product and as El Nino is predicted, cotton yarn prices may go up substantially. If it happens, then NPM might be hit badly in 2016. And INR is depreciating and at 63.5 per US dollar (as of now), this may₹ compensate for the losses due to the increase in the price of raw materials as 68% out the output is exported. Present capacity of 77,616 spindles and 2,936 rotors for cotton yarn with installed manufacturing capacity of 22,650 TPA and 3,900 TPA of knitted fabrics. After expansion spindle count will reach 150,096 and the manufacturing capacity will be 37,800 TPA of cotton yarn and 8,600 TPA of knitted fabrics. As the manufacturing capacity would be almost doubled, how these two factors would affect the profitability? Need your inputs on this Dr.

A6: If the cotton price hike and rupee depreciation predicted by you actually happens in the proportion assumed by you, then they might nullify each other. And if alongside it, the capacity doubles and assuming the company is able to sell its entire production, then the profitability would increase slightly due to economies of scale. However, there are many ifs & buts in your assumptions and my explanation.

Reality in all probability would be different.

Q7: I am a 19 years old investor jumping between technical and fundamental analysis. I have now settled at fundamental analysis as I believe that the stocks are pieces of great businesses, which I cannot own just like a piece of paper to trade back & forth. I also know that everybody has their own style of investing. Some follow growth investing, others follow value investing. Some are seasoned investors whereas other are just pure speculators. At this Moment, I truly want to be a long term value + growth investor as time is on my side. I am determined to be a complete value investor and currently, reading the book “Security Analysis”. Sir, the only help I want is to get a detailed path for a 19 year old so that I do not make wrong decisions. I want some kind of roadmap towards investing for the rest of my life. I am sorry for the long query.

A7: It’s great that you have started thinking about investing at an early age. You are right that time is on your side. I would suggest that you read books written by great investors. You should have the faith in equity markets and no doubt that you would be able to make good wealth.

Q8: While analyzing some small cap companies, I am frequently coming across a word in some forums

-"Operator Stock".

 What it mean to a retail value investor?

 How a retail investor can identify the trap?

Your detailed view will be highly helpful.

A8: "Operator stock" is usually referred to the stock whose price is manipulated by different people. Small cap stocks have low market cap and operators need very low money to influence its price. E.g. to increase the price to double for a 20cr. market cap company, an operator needs much less money than₹ a 2.5 lakh cr market cap company. As a fundamental long term investor, I do not worry about operators₹ being active in a stock, until the time I am convinced that company has a good business and is improving

its operating performance. Once you buy a stock, the holding or selling decision are rarely decided by market price of stock. Operators may come and go. If the company is good, then an investor should hold on to the stock irrespective of short term price movements.

Q9: Which is the best book to understand the financial statement analysis and stock valuation for a beginner who has no background in accounting and finance?

A9: The Intelligent Investor by Benjamin Graham is the best book.

Q10: I have gone through a lot of topics that you have covered here in the blog including some of the companies’ analysis. There is one parameter that I am not able to understand. It is about the analysis that you do on the cash flows in which you infer whether the company is able to collect its profit in cash or not. Can you please cover this topic in a post with the details like using a hypothetical example? I don’t understand:

 How a company can survive if it’s not collecting it profit in cash, although it is showing that in profits?

 How it’s related to receivables?

A10: I would suggest that you should read the cash flow statement in the annual report of any company, which would show step by step calculation of CFO from PAT/PBT. The calculation would clearly show how the profits get stuck in working capital. It would be a good learning exercise for you. In case after reading the cash flow calculation, you have any query, then I would be happy to provide my inputs for its resolution.

Q&A: South Indian Bank, Nucleus Software, Gold ETF &

Others

The current article in this series provides responses related to:

 A reader’s (Hari Balaji) views about South Indian Bank Limited

 A reader’s (Sridhar Govardhanan) views about Nucleus Software Exports Limited

 Use of enterprise value in stock valuation

 Clarifications about gold exchange traded funds (Gold ETFs)

 Clarifications about P/E ratio, PEG ratio and Margin of Safety

 Sources for finding production & capacity utilization information for a company

 Finding opportunities in existing stocks in an investor’s existing portfolio first.

 Reasons for not analysing stocks of banking & financial services on the website

 Reasons for analysing financial performance for 10 years while doing stock selection

 Clarification about demerger of companies

Q1: I have been following your blog for quite some time and I find it extremely educative. Your work is nothing short of being service to society by creating awareness. Based on you framework, I have analyzed the stock South Indian Bank Limited. Please find below my investment rationale.

 Stock is trading at 0.89 times its book value

 South Indian Bank Limited has good consistent profit growth of 21.21% over 5 years

 It has a compounded annual sales growth of 25.35% over a period of 10 years

 It been consistently paying dividend of over 15 percent in the past 10 years

 It has consistently been improving its EPS

 South Indian Bank Limited has been maintaining a decent Operating margin of a little over 15%

on an average

 No negative news about promoters or about the South Indian Bank Limited

 The bank has been consistently gr owing its fee bases income. (Other income)

 At the current market price of 24.25, it’s available at a PE of 8.80 which provides decent margin ₹ of safety

 South Indian Bank Limited operates in an industry which has a strong entry barrier

 South Indian Bank Limited has been maintaining non-performing assets (NPA) at below industry average

 South Indian Bank Limited has a very strong regional presence in Kerala

 The company has a positive cash flow from operations, the cumulative net profits for the past 5 years is 1,937 crores, whereas the CFO for the same period is 6,066 crores₹ ₹

Please let me know your opinion.

A1: If I see the points highlighted by you about South Indian Bank, it looks great. However, analysis of Banks/financial institutions involves many other factors like asset liability mismatch, sources & breakup of funding profile, capital adequacy ratio & its breakup, NPA movements and other weak credit parameters, borrower wise concentration analysis, which are not readily available in the data sources like screener.

Therefore, due to lack of ready availability of pertinent data, I am not able to provide any opinion about SIB.

Q2: I am presenting my views on Nucleus Software Exports Limited. I would be happy to hear your views on my analysis and about your view of future prospects of Nucleus Software Exports Limited.

 Sales Growth was in an increasing trend from 2005-2008. Negative growth was observed during 2008-2011. Nucleus Software Exports Limited started to pick growth around 2013 and has been increasing since then. Sales growth in the last quarter was good

 OPM is also in an increasing trend for last 3 Yr., fluctuating between 15%-20% between (2012-2015).

 NPM is between 17% in last 3Yr.

 Tax % is fluctuating no-line with corporate tax slab.

 D/E is 0, which is really great.

 Debtor days have been reduced from 113 to 43 days. Good sign.

 Dividend payout is constantly good. Recently announced a 5/Share dividend.₹

 Stock is in the process of getting re-rated. Recently, it has had a run-up of prices, which has pushed P/E from 10 to 15.

 Its products are doing very good in global markets. Nucleus Software Exports Limited has showing promising growth.

With its specialization of lending & transaction banking products, Nucleus Software Exports Limited can

With its specialization of lending & transaction banking products, Nucleus Software Exports Limited can