Rakesh Jhunjhunwala’s tips on how to find multibagger stocks

Rakesh Jhunjhunwala is the Mother Theresa  of the investment world because not only is this Living Legend eager to share his investment techniques with us, he is also happy to let us in on the most well guarded investment secret on how he made his billions .

But, Rakesh Jhunjhunwala, the wise sage that he is, is a man of few words. Rakesh Jhunjhunwala is reticent. When Rakesh Jhunjhunwala speaks, it is because he has something to say and not because he has to say something! So we scoured through hundreds of transcripts to decode Rakesh Jhunjhunwala‘s investment secrets. Now, we are proud to present our own version of Rakesh Jhunjhunwala‘s tips on how to find multibaggers.

Rakesh Jhunjhunwala‘s Tip No. 1: Don’t Look For Multi-baggers

Rakesh Jhunjhunwala‘s first investment mantra on how to find multibaggers is surprisingly different from what you would expect. Rakesh Jhunjhunwala says: "Don’t look for multibaggers. Don’t seek them at all. Let the multibaggers come to you!"

What is Rakesh Jhunjhunwala saying?

What Rakesh Jhunjhunwala is saying is: Don’t go out into the investment world saying "I only want to invest in potential multibaggers". Instead, Rakesh Jhunjhunwala, the Investment Guru,  says "Go back to the old-fashioned way of making investments designed by investment maestros Benjamin Graham, Peter Lynch and Warren Buffet". "If your homework is right and you have invested in fundamentally sound companies with good growth prospects, your investments will by themselves become multibaggers with the passage of time".

Sounds simple but Rakesh Jhunjhunwala is not content with giving abstract or theoretical advice because this great investment legend already knows that his disciples are a bunch of doubting Thomas and even his words of undeniable gospel will be met with stoic skepticism.

So, Rakesh Jhunjhunwala gives examples of what he means.

Rakesh Jhunjhunwala gives the example of BEML which several years ago was quoting at a pittance because it was regarded as a slothful government enterprise. No investor in his right mind wanted the shares of BEML at that time. But while other investors saw a sluggish government corporation, Rakesh Jhunjhunwala saw efficient management, a great product line-up and effeicient cash-flows. The result: Rakesh Jhunjhunwala got a bountiful; he got his multibagger.

One example is not enough to convince the cynical masses. So, Rakesh Jhunjhunwala gives another example – that of Bharat Electronics – which also was regarded as a Babu-wala company by other investors who couldn’t see what Rakesh Jhunjhunwala‘s discerning eye could. Another humble company turned into a multibagger by sheer passage of time!

Now you are convinced. But Rakesh Jhunjhunwala does not rest. He goes for the jugular. Now, Rakesh Jhunjhunwala gives a counter example.

What would an investor "looking" for a multibagger have bought in the heady days of 2000? The naive investor would have looked around and seen "spectacular" companies like Himachal Futuristic, Global Tele, Pentasoft soaring on the stock exchange, making new highs every day. So, the foolish investor would have tanked up on these shares thinking that these shares were his best bet to net a multi-bagger.

The result: You don’t need the great Rakesh Jhunjhunwala to spell that out for you.

So, now you know why Rakesh Jhunjhunwala says: "Don’t look for multibaggers!"

Yes, the point sinks in and you have understood but then you rub your eyes incredulously and ask "But what do I look for in a share?"

Rakesh Jhunjhunwala is not regarded as the greatest investor in India for nothing. He has a well-considered answer for that as well. And if you think about it, Rakesh Jhunjhuwala’s answer is made up of pure common sense.
 

'Rakesh Jhunjhunwala‘s Tip No. 2: Don’t Look for Profits; Look For Sources Of Profits

Rakesh Jhunjhunwala cautions that most investors obsess about the current sales and profits. They look at each quarter and focus obsessively on short-term profits. "That’s missing the wood for the trees" says Rakesh Jhunjhunwala.

Instead Rakesh Jhunjhunwala says "Look at the sources of Profits. What are the reasons that will give rise to Profits in the medium and long-term term".

Rakesh Jhunjhunwala drives home the point. "Look at the factors and circumstances that will create an opportunity for business in the sector".

Rakesh Jhunjhunwala gives the classic example of Infosys and Wipro. While the average Joe would have sat with his calculator analyzing Infosys’s & Wipro’s PE, ROE and nonsense like that, an astute investor in the 1990s would have realized that an internet revolution was coming in the next couple of years. He would have also realized that the off-shore business segment was booming and he would have tanked up on those shares.

Rakesh Jhunjhunwala gives another spectacular example: That of Praj Industries, a company engaged in manufacture of bio-ethanol fuel. When Praj Industries started out, nobody realized the massive demand that would arise for alternate fuels like ethanol. An investor would could have foreseen that would have had his multibagger. 
 

Rakesh Jhunjhunwala‘s Tip No. 3: Forget ‘Large Cap, Small Cap’ Nonsense – Look For Scalability Of Operations:

Rakesh Jhunjhunwala makes two very important points. First, the investing maestro expresses his contempt for the obsession that many analysts and investors have for the debate on whether large cap, mid cap or small cap stocks are better. "Forget all that and Look for Value" he thunders. "If there is value in Large Cap, buy it. If there is value in Small Cap, buy it. But don’t obsess on irrelevant matters", says Rakesh Jhunjhunwala, the one with infinite wisdom.

But Rakesh Jhunjhunwala makes his preference quite clear. He says that given a choice and all things remaining equal, a mid-cap or a small-cap is a preferred bet because the valuations will be low and they can scale it up quite quickly.
 

Rakesh Jhunjhunwala‘s Tip No. 4: Give it Time, Be Patient:

Rakesh Jhunjhunwala reiterates what the maha investment gurus like Benjamin Graham and Warren Buffet have been advising over the past several decades. Warren Buffet was plain in his advice "Our favourite holding period is Forever". Rakesh Jhunjhunwala gives the same advice: "Give your investments time to mature. Be Patient for the World to discover your gems". Rakesh Jhunjhunwala cites the examples of Crisil, Titan and Pantaloon Retail which he has held on for several years now and has absolutely no intention of divesting them any time soon.

When Rakesh Jhunjhunwala bought Lupin it was just another mid-cap pharma company starting out into the world of generic drugs. What Rakesh Jhunjhunwala saw was a good efficient management which knew its job, a debt-free status, a good product line up and a growing market. That’s all. Rakesh Jhunjhunwala bought and played the waiting game. When the market matured, Rakesh Jhunjhunwala raked in his billions.

Rakesh Jhunjhunwala also fondly talks about his investment in Karur Vysya Bank which he has held onto even after about 20 years since he bought them. He says that his paltry investment of Rs 2,000 is worth several crores today thanks to the patience and conviction that he showed.

Rakesh Jhunjhunwala is never tired of emphasizing that first you must always remember that you are buying a business and not just a little thing that bounces 2% around every now and then. When you buy that business, it must be of a very high quality, one that is capable of growing over time. Having done your hard work, you must wait for the market to do its work and reward you, says Rakesh Jhunjhunwala.
 

Rakesh Jhunjhunwala‘s Tip No. 5: Don’t get carried away by short-term aberrations:

Rakesh Jhunjhunwala cannot stop criticizing investors who are obsessed with short-term trends. Rakesh Jhunjhunwala emphasizes that he does not worry about quarterly results. If the results are bad in one quarter, he does not get perturbed. What Rakesh Jhunjhunwala is looking for is: Is there a trend? Are the quarterly results showing a trend and suggesting something or are they a mere aberration?

Rakesh Jhunjhunwala also cautions that one should not get carried away by short-term trends. He cites the oft-repeated example of 1999 when investors bought truck loads of Himachal Futuristic, Global Tele, Pentasoft while he used to buy Shipping Corporation and Bharat Electronics because he saw long-term value in them. The Oracle of Mumbai says “Never get carried away by aberrations, recognize and respect them but do remember that the market corrects its aberration though it takes time.”

Rakesh Jhunjhunwala then adds that if the market behaves irrational and punishes a stock for short-term aberration, that’s the time for you to jump in. Rakesh Jhunjhunwala cites the classic example of Titan Watches to buttress his theory. Rakesh Jhunjhunwala says that Titan suffered in a moment of crisis when it went into Europe and lost a lot of money. Rakesh Jhunjhunwala says he wasn’t perturbed because he knew that what is most important for Titan is India’s prosperity. Rakesh Jhunjhunwala envisaged the future and knew sub-consciously that Indians were going to buy far many watches and that the underlying business should be great. So, says Rakesh Jhunjhunwala, in a moment of crisis you can get great valuations and if you can envisage the future where the product could have great demand and great growth, you should use the opportunity to buy.
 

Rakesh Jhunjhunwala‘s Tip No. 6: Invest in a business that you can understand:

If you look at it hard enough, you will realize that Rakesh Jhunjhunwala‘s reluctance to buy Himachal Futuristic, Global Tele and Pentasoft even in their heydays and his preference to stick to Shipping Corporation, Bharat Electronics and the other tried and tested names reveals another great investment tip from the Prince of Dalal Street: Buy what you know. Do you understand the business enough to be able to know what will happen 10 or 20 years from today. With Shipping Corporation, you can because shipping of goods will continue to happen for our foreseeable future. But you can’t tell that with technology companies which may have a great product today but which may become obsolete in 5 years.
 

Rakesh Jhunjhunwala‘s Tip No. 7: Don’t worry about the macro stuff like fiscal deficit, inflation etc which are unknowable. Focus on what is knowable:

Another immensely practical tip from Rakesh Jhunjhunwala, India’s greatest investor, for us folk who keep obsessing about currency fluctuation rates, inflation, fiscal deficit, political turmoil is: “Don’t worry about things that you neither know about nor can do anything about. It’s not important. Instead focus your energies on what you can and should know well enough – the business of the company you are investing in“.
 

Rakesh Jhunjhunwala‘s Tip No. 8 : Don’t Try To Time The Market:

Rakesh Jhunjhunwala endorses the validity of investment advice that has been propounded time and again by the wizards of investment time and again. Never try to time the market because you can never find the bottom of the market. Instead if you are getting the stock cheap in terms of its intrinsic value and future prospects, buy it.

Here, one cannot resist referring to similar advice that Warren Buffet, the Emperor of Wall Street, gives. Warren Buffet points out that Coca-Cola made an IPO in 1919 when it issued shares at $ 40 each. A year later, the share was quoting at $19. You might think that’s a disaster because the share had lost 50% of its value in just one year. After that there was sugar rationing and the farmers were rebellious. Years later, the Great Depression and World War II happened, there were thermonuclear weapons and what not. He says you could always find a reason on why that was not the right to buy shares of Coca Cola. But if you had gone ahead and bought that one share for $40 and reinvested the dividends, your investment in Coca-Cola would be worth $5 Million today.

Rakesh Jhunjhunwala echoes the words of the Oracle of Omaha when he says that you must get right is the business. If you get that right, everything else falls into place. 
 

Rakesh Jhunjhunwala‘s Tip No. 9 : If it’s cheap, buy it- Don’t pass up something cheap today in the hope that it will get cheaper tomorrow:

Rakesh Jhunjhunwala says: If you see the opportunity today, GRAB IT! Many wonderful opportunities are lost to procrastination and then you rue your missed opportunities. Rakesh Jhunjhunwala says that it is not only important to identify the opportunity but then to be decisive and to act on it. Rakesh Jhunjhunwala cautions against getting stuck in a trap where you are perpetually seeking extra information to validate your idea.

In this, Rakesh Jhunjhunwala echoes the wisdom of Warren Buffet, the Oracle of Obama, who in the depths of the great stock-market depression of 2008 inspired investors by his clarion call "If you wait for robins, summer will be gone".  
 

Rakesh Jhunjhunwala‘s Tip No. 10 : Don’t buy stocks that have a fixed return:

Rakesh Jhunjhunwala‘s next tip seems to be a no-brainer but it is surprising how many investors overlook it. What is the point of buying shares in a company such as an electricity company where the return on investment cannot by law exceed a certain amount, asks Rakesh Jhunjhunwala. But, Rakesh Jhunjhunwala, emphasizes that this logic does not mean that electricity and utility companies should not form part of your portfolio because they offer an excellent defense mechanism to the vagaries of the stock market with the undemanding demand for their product and their predictable cash flows.
 

Rakesh Jhunjhunwala‘s Tip No. 11: Ride your winners!!

The one question on everybody’s mind is "When do I sell my multibagger?" Rakesh Jhunjhunwala answers with aplomb "Never".

One must be careful to understand what Rakesh Jhunjhunwala is saying here. What the Greatest Investor in India is saying is: "Don’t sell for the sake of selling because you can never say that the 10-bagger today will not become a 20-bagger tomorrow".

But, Rakesh Jhunjhunwala hastens to clarify that this does not mean that one will never sell a multibagger. He gives two situations when even he may sell his beloved multibagger. The first is when he is short of funds and he needs capital to invest in a stock that will give even better returns than what the existing one will give. And second, when the stock market has become so irrational that the perception of earnings and the P/E is unsustainable. Rakesh Jhunjhunwala gives the example of what happend in 2000 when euphoric investors laid bets that Infosys’ earnings would double every year for the next 10 years. Infosys’ P/E at the then current earnings was 100-150 times. So, says Rakesh Jhunjhunwala, when the expectation of earnings peaks and the P/E is unsustainable, that is the time to sell.
 

Rakesh Jhunjhunwala‘s Tip No. 12: Concentrate, concentrate & concentrate!!

There is a perpetual battle amongst investors on whether a diversified portfolio approach is better or a concentrated portfolio is better. (See Benefits of a concentrated portfolio).

Rakesh Jhunjhunwala is an unabashed proponent of the concentrated portfolio theory. But Rakesh Jhunjhunwala‘s theory must be carefully understood before being implemented in practice as it can otherwise lead to disaster.

Rakesh Jhunjhunwala emphasizes that one must venture into a concentrated portfolio only after one is sure that he has identified a share that will deliver superior returns to all the other chosen shares. The conviction must be extremely strong, says Rakesh Jhunjhunwala.

Rakesh Jhunjhunwala is not one to take risks lightly so must also be wary of the risks of a concentrated portfolio. In the recent past, we have seen so many excellent companies lose large portions of their market cap almost overnight. Some examples can be BP which was touted as the best buy in the oil space but which owing to the oil spill in the Gulf of Mexico is today regarded as a pariah. Other examples are RNRL which not only lost the battle in the Supreme Court with Reliance but then announced a disastrous merger with RPower which short-changes RNRL’s investors. Aban Offshore is another example which lost its’ Oil Rig Aban-Prince in the high seas and saw its market price plummet 25%. Yet another example is that of Satyam whose founder Ramalingam Raju was felicitated as the "Most Promising Businessman" by Earnst & Young. He later confessed that all profits shown in Satyam were bogus and that he and Maytas Infra had played a big fraud on the hapless investors.

So, while there are benefits to a concentrated portfolio, one must not be oblivious to its risks, cautions Rakesh Jhunjhunwala.

investing: f&o - Profit From Ups & Downs

A Simple Straddle

What is the strategy?

• (A) Buy call option at strike price of Rs 2,650 for a premium of Rs 60
• (B) Buy put option at strike price of Rs 2,650 for Rs 40
• Total premium expense (A+B)=C Rs 100

You will break even

• If the stock rises to Rs 2,750
• Or, if the stock falls to Rs 2,550

It turns profitable

• If price rises above Rs 2,750
• If price falls below Rs 2,550

You will lose some or all premium

• If the stock XYZ stays range-bound between Rs 2,550-2,750
• Or, if the stock stays put at Rs 2,650

***

Stock markets eagerly await important events such as the Budget or the results season. Often, these events also trigger significant volatility, especially if the event does not go by the market's expectations. Say, for instance, during the result season, if a company is expected to show a significant jump in profits, but instead shows no growth at all, the volatility in its stock suddenly spikes up and its price falls significantly.

Likewise, if the results of a company are above average, its stock will react sharply on the upside. Yet, investors can still profit from these extreme volatile situations.

There are option trading strategies which could help you earn profits from unpredictable markets. One such strategy is to buy a call and put option together at the same strike price and a common expiry date. This strategy works if the market moves sharply either way—up or down—and when investors don’t know which way the market is going to move. In this case, if the stock’s price moves up sharply, buyers can exercise the call option and if the stock falls, they can exercise the put option. This strategy is called a long straddle.

About options

Just to recap, a call option will give the option buyer the right to buy the stock at a specific price (strike price) on or before a future date, irrespective of the prevailing price on the future date. Thus, if the price has risen significantly over the strike price by the future date, you get to buy the stock at the strike price and benefit from the price difference. Similarly, a put option will give the option buyer the right to sell the stock at a strike price on or before a future date, irrespective of the price on the future date.

The cost

Let’s come back to our strategy of buying both put and call simultaneously (or the long straddle). You will incur a cost when you buy both a put and call option at the same time. Your expense is the total premium of both the call and the put option. For example, if the cost of the call is Rs 60 and the cost of the put is Rs 40, it takes your total premium cost to Rs 100.

The payoff

This strategy is profitable only if there’s a big movement in stock prices. Otherwise, you will not recover your premiums. For example, if you buy a put and call at the strike price of Rs 2,650 and the total cost of both the options is Rs 100, the stock will have to move by Rs 100 either on the upside or on the downside for the strategy to turn profitable (See A Simple Straddle). If the stock moves less than Rs 100 on either side, you will lose a part of your premiums. If the stock stays put at Rs 2,650, you will lose all your premium. Which is why it’s important to use this strategy during volatile times.

What to avoid

On NSE, the options on indices are of the European type—the options get exercised only at expiry. This makes it unviable to initiate straddles on indices as you would not be able to exercise the call or put options after the big price move. You could possibly sell the options, which is provided there are adequate volumes.

Word of caution

If the price doesn’t move sharply, you don’t profit. The two options bought could be sold off, though you might not be able to recover the entire amount of premium you spent on buying them.

You also need to remember that the decision to initiate a straddle should be complemented with adequate study of charts and technical analysis. Consult your broker’s research department before deciding on following such a strategy.

Strong Foundations

Why Buy

• Axis Bank High business growth, low cost of funds, expanding NIM, improving asset quality
• Bank of Baroda High growth in advances, best asset quality among PSU banks, high NPA provisioning, less volatile treasury income
• HDFC Bank Consistently high growth, lower net NPA percentage compared to its peers, higher provisioning of NPA, large CASA base, high NIM
• Punjab National Bank Low cost of funds, high yield on loans, maintains NIM in all conditions, higher NPA provisioning, less volatile bond portfolio
• Yes Bank Lowest NPA percentage among listed banks, high growth, healthy NIM in spite of low CASA base

***

The Indian banking industry, unlike its peers in the West, came out relatively unhurt from the global financial crisis. The stocks, however, did correct a bit on the concerns of rising non-performing assets (NPAs) and loan restructuring. But, with the fear subsiding and the economy getting back to the higher growth path, there is renewed interest in the sector. The reasoning behind this is, if India has to grow at over 8-9 per cent, companies will need funds for expansion. In the absence of a vibrant bond market, they will have to tap banking sources for funding their needs. Therefore, investors are looking at this sector as a proxy to the India growth story. So, if you are also eyeing gains from the India growth story through the banking sector, we tell you how to look at stocks in the banking sector, and profile five banks we like at this stage.

Parameters

Core business. The core business of a bank is to lend, so it’s important to see how the advances have grown in the past, at least in the last few quarters. Looking at the growth in the interest income will also give you a fair idea. But, remember, this only a necessary but not a sufficient condition. Says Rajiv Mehta, research analyst at IndiaInfoline: “If a bank is growing at, say, 5-10 per cent faster than the industry, we try to analyse how it manages its margins and asset quality.” There is a possibility that to gain market share the bank might be ignoring the quality of lending.

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Crests And Troughs

Although banking stocks fell along with the overall market as global crisis intensified, it has rebounded sharply and outpaced the overall market on prospects of economic recovery.

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Asset quality. In banking, asset quality is of prime importance and looking only at profitability is not enough. “It [profits] is not the right criterion to look for a good bank; you should rather look at the balance sheet,” says Arun Khurana, manager, banking sector fund at UTI MF. He uses the example of Vijaya Bank. For FY10, it reported a profit of Rs 502 crore, or Rs 240 crore higher than the previous year’s profit of Rs 262 crore. Thus, its profit almost grew by 92 per cent. But, at the same time, its net NPA also grew by Rs 289 crore. Khurana suggests that one should reduce net profit by increase in net NPA to get the real profit figure because the bank is not sure whether it will recover NPAs. Also, from September 2010, banks will have to provide for 70 per cent of gross NPA, which will dent profits significantly for banks not making sufficient provisioning at this stage.

Net interest margin (NIM). It is a measure of the bank’s profitability, and is calculated as net interest income (interest income minus interest expenses) divided by interest yielding assets. This checks the bank’s ability to price loans at higher rates, which is also function of bank’s ability to mobilise low cost deposits—current account and saving account (CASA). The higher the CASA ratio, the better it is. Also, as we are moving into higher rate scenario, CASA will become even more important. Says Vaibhav Agrawal, vice-president, research, at Angel Broking: “As interest rates go up, the banks with the highest CASA account will perform the best.”

Other income. There are two big components of other income: fee income and treasury income. Although growth in fee income can be predicted somewhat, treasury income is relatively volatile. It depends on the wider interest rates situation in the economy, and is also affected by various factors like the monetary policy and government borrowing. As banks in India are required to keep 25 per cent of their demand and time liability in government securities, the overall effects of bond price movement can only be managed a little.

The road ahead

Unanimous projections. The fiscal year 2010 wasn’t too good for the banking industry in terms of loan disbursal. It remained subdued for most of this period, even as growth in credit fell to single digits at the end of October 2009. But later, as economic activity picked up, credit growth accelerated to around 17 per cent at the end of the financial year. Analysts expect it to remain robust. The offtake is once again expected to come from the infrastructure space, which, after a lull, has started witnessing higher activity. “Banks have raised capital in the previous year. Further, the government’s decision to infuse capital into some banks would increase their limit for infrastructure lending,” says Rajrishi Singhal, head of research and policy, Dhanlaxmi Bank.

Treasury Tricks. When the RBI followed the policy of lower interest rates to bring growth on track, the yield on government bonds came down. As a result, banks made huge profits on bond portfolios. However, that trend has reversed now. The yields have risen significantly, with impacts already visible on banks’ result for the March 2009 quarter. Most banks have suffered losses on bond portfolios. Analysts believe that in the coming quarters, too, the bond yield will remain high and it would be difficult for banks to show treasury gains. But yields are not expected to harden too much from here on. Economists expect yields on 10-year government paper to move at most to 8.5 per cent from the current 7.8 per cent. So, major negative surprises can be ruled out. Also if the government raises the FII limit in G-secs, as reported by the financial media, greater demand will raise their prices, thereby restricting the rise in yield.

Maintaining Margins. The net interest margin rose in FY10. One of the causes behind this rise was the high proportion of low-cost CASA deposits in the overall deposit base. As rates on term deposits were low, it became less attractive, and the share of CASA increased.

However, as term deposit rates have started to rise again, banks will face difficulty in maintaining the CASA level, even as pressure might be compounded by the lag that exists in adjustment of lending and deposits rates. Suresh Ganapathy and Mudit Painuly of Macquarie Equities Research, say in a recent report: “The previous interest rate cycle was testimony to the hypothesis that lending rates, particularly in the case of Indian banks, react with a two or three quarter lag, compared to deposit rates. We expect this lag, coupled with an increase in savings rates, to exert pressure on margins in FY11.”

Banking Picks

Axis Bank. It posted another quarter and year of impressive numbers. March 2010 was the 22nd quarter in a row when the bank posted net profit growth in excess of 30 per cent. During the year, net profit went up by 39 per cent, while the net interest income was up 36 per cent, showing growth of 47 per cent in 5-year CAGR. Similarly, the fee income for the bank grew by 51 per cent CAGR over the five years ending FY 10. The bank continues to maintain good asset quality with net NPA at 0.36 per cent compared to 0.75 at the end of FY06. During the fourth quarter, advances for the bank grew by a healthy 28 per cent over the previous year, against the industry’s growth of just about 18 per cent. The cost of funds also declined to 4.54 per cent against 6.64 per cent in Q4FY11, which led to improved net interest margins of 4.09 per cent.

On 12-month trailing earnings, the stock is trading at 18.78 times. Given that is consistently growing at over 30 per cent, the stock does not look too expensive.

Bank of Baroda. Bank of Baroda, or BoB, is a preferred pick in the public sector. A higher concentration in industrialised states such as Maharashtra and Gujarat gives greater push to its business. In FY10, deposits grew 25.3 per cent over the previous year. The yearly growth in advances was lower than the previous year, but, at 22.2 per cent, it was still higher than the average for the banking industry. The asset quality remained high, with net NPA at 0.34 per cent of the net advances, which is the best among PSU banks. The bank maintains a strong balance sheet by provisioning 74.90 per cent of NPAs. Another positive aspect of this bank is the low volatility of its treasury income, unlike other PSU banks, as it categorises most securities as held-to-maturity, which are not marked-to-market as bond yield fluctuates.

Factoring better earning visibility and superior asset quality, at Rs 695, BoB’s share is trading 8.24 times its FY10 EPS.

HDFC Bank. HDFC Bank’s stock enjoys the highest premium among the large-cap banks. The reasons are obvious. It has consistently maintained a high growth rate without compromising on asset quality. Advances have grown by 39 per cent annually in the past three years. In spite of high growth, its asset quality is still one of the best in the industry, at net NPA around 0.3 per cent of net advances. The provisioning coverage is also high. Even though its provisioning policy is conservative (making larger provisions), the growth in profit is high and in the previous 42 quarters, it has maintained around 30 per cent annual growth in net profits. Because of high CASA deposit (around 50 per cent of the total deposits), the net interest margin of the bank is high and has helped it report high growth in net profit.

At a price-to-book value of four and PE of 29, the valuation may not rise, but growth in earnings would support the price rise.

Punjab National Bank. It is the most preferred choice among public sector banks. The differentiating factor is its ability to maintain high net interest margins. High CASA deposits in the overall deposit base helps it lower the cost of funds, while high lending to MSME (micro, small and medium enterprises) enable it price loans at higher rates. As a result, the NIM remains high.

Though there is a relatively higher risk related to restructured loan portfolios, the already high provisioning will ensure that the impact is minimal when the restructured loans turn bad. Another positive factor is that the value of the bank’s bond portfolio is less volatile as around 80 per cent of it is categorised as held-to-maturity, which is not marked-to-market.

At a price of Rs 1,017.05, PNB’s stock is trading 12 times FY10 EPS—a level attractive enough to ride on the bank’s growth.

Yes Bank. With the best asset quality and a strong growth rate, it is among analysts’ favourite stocks in the segment. At the end of the March 2010 quarter, the bank had a net NPA of just 0.06 per cent, while operating profits were up by 67.3 per cent compare to the same quarter last year. For the whole of FY10, the operating profit was up 63.6 per cent, while net interest income witnessed an upswing of 54.7 per cent. Interestingly, despite significant improvement in the CASA, Yes Bank's low cost deposits were at 10.5 per cent, much lower than large banks. Despite this, the bank had a net interest margin of 3.2 per cent, which is significantly better than most public sector banks.

Yes Bank has built its expertise in corporate banking and retail constitutes a very small part of its business. However, going forward, in the second phase of expansion (2010-15), it plans to accelerate its presence in commercial banking and aims to grow its balance sheet from the Rs 36,382 crore at present to Rs 1,50,000 crore. In terms of valuation, on a trailing 12-month basis, the stock is trading at 17 times.

Investors entering this stock are advised to take a long term earnings expansion play and not PE expansion.

Putting It The Right Way

		People need help for decisions that are difficult and rare, for which they don’t get prompt feedback and have trouble translating aspects of the situation into terms they can easily understand. The key point here is that for all their virtues, stockmarkets often give companies a strong incentive to cater to and profit from human frailties rather than to eradicate them, or minimise their effect. Major problems arise when people need to make decisions that test their capacity for self control. Daily and simple tasks, such as choosing the color of the shirt to wear, or choosing between brown and black shoes lack important self-control elements. Such issues are most likely to arise when the choices and their consequences are separated in time. At one extreme, there are investment goods, where the costs are immediate, but benefits are delayed. Exercising or flossing teeth fall in to this category. At the other extreme are the sinful goods which give immediate pleasure, but bring harsh consequences later. Smoking, alcohol and eating junk food are among them. Some things in life are easy to do, or cope with. If you are not a good chess player, a book can help you. We use spreadsheets and spellchecks to make our harder problems easier. But many problems in life are difficult and often there is no technology to solve them. We are more likely to need help in choosing the right investments rather than in buying bread.     We get feedback on the options we choose, not the ones we reject. Without feedback, there’s no learning     Even harder problems become easier with regular practice. The more one practices the more one becomes perfect, or at least better. This is what day traders think. However, life’s most important decisions don’t come with opportunities to practice. Most people choose a college once. Most people get married and have a spouse once, or maybe twice. Houses we buy once or twice in a lifetime. We get one chance to plan for our retirement and have few chances to make adjustments along the way. Generally, the higher the stakes, the less likely are we to get an opportunity to practice. This is especially true of money-related matters. Practice, however, also does not make us perfect if we lack good opportunities for learning. Learning is possible if one gets immediate feedback after one try. Say you are putting on the golf green. With 10 tries you would be pretty confident of getting the ball nearer the hole. But what if you were blindfolded and then told to putt? Since there is no feedback on what is happening, there is no learning. Moreover, we get feedback on options we choose and not on the options we reject. Instant gratification leads us to short-term trading and lack of feedback on long-term investing makes people shun it. Then again, in certain situations, it is particularly hard for people to make good decisions if they have trouble translating the choices into the experiences they will have. Would one choose a capital appreciation fund or a dynamic dividend fund? What the person really needs to know is how a particular choice affects his spending power later. This is something which even an expert backed by knowledge and computer software, will have trouble analysing. However, we have salesmen under the guise of investment experts selling such funds. This is also true of health and life covers in the market. Consider the insurance products in the market: benefits are delayed; the probability of having to make a claim are hard to analyse; and consumers are unable to get feedback on whether they are getting good returns, Mapping for what they are buying and what they are getting can be ambiguous. They have all the fraught features discussed above. And despite all this, insurance agents do roaring business. http://money.outlookindia.com/article.aspx?265558

Stable Lustre

Last fortnight, gold ETFs held their ground firmly even as stockmarkets and mutual funds took a hit

The Indian stockmarket corrected last fortnight on concerns that Greece-like problems could also affect other European economies. As a result, most equity funds in our coverage experienced a drag-down effect. Most of our core funds, however, held up well against this corrective trend. Among the equity large-cap (core) schemes under our coverage, HDFC Equity declined merely 3.53 per cent and Fidelity Equity fund saw a fall of 3.88 per cent as against the Sensex that slipped 6.54 per cent. In fact, all funds under our coverage managed to hold up their end in a bad market, declining less than 7 per cent. Even the mid- and small-cap funds under our coverage did relatively better than the BSE Midcap Index. On the debt side, there wasn’t too much action as yields were stable. But gold has been doing very well in the international and domestic markets. Likewise, gold ETFs, which track gold prices, have run up. Gold ETFs returned 3.20 per cent last fortnight.


OLM 50 is a list of our 50 mutual fund scheme recommendations, from among a thousand-plus schemes in the industry, that merit your attention. These schemes have made the cut after going through certain filters. OLM 50 is a guide for fresh investments only. Existing investors should keep reading our regular MF pages.

1. Less than five years old
2. NAV and returns for dividend plan only
3. Less than three years old
4. Gold ETFs give similar returns. No scheme has crossed three years
5. This is average one-year return for all schemes NR: Not rated Returns less than a year are absolute, else compounded annually Outlook Money’s rating for the three-year period as on March 2010-end NAV and Returns as on 25 May 2010

Source: Mutualfundsindia.com

Positives In Hard Times

A bear spread with calls can be initiated when you expect the price of A stock to decline moderately 

F&O Glossary

• In-the-money option In a call option, when the strike price of the contract is less than the prevailing spot market price of the underlying stock/index, it's an in-the-money option. It's the opposite in a put option.
• At-the-money options When an option contract is struck at a strike price which is equal to the prevailing market price of the underlying stock/index, it is referred to as an at-the-money option.
• Out-of-money options For call options, when the strike price of the contract is higher than the prevailing spot market price, it is a case of an out-of-money option. For put options, the opposite is true.

***

If you have a negative outlook for a stock, a bear spread with calls could be a useful strategy. It’s a limited risk, limited return strategy to be initiated when you expect the stock price to decline by a certain extent. Under this strategy, you buy and sell call options simultaneously—buy the call option at a higher strike price (usually-at-the-money) and sell a call option at a lower strike price.

Returns

You would incur a premium to buy the call option and earn a higher premium when you sell the lower strike price call option. This difference in premiums is the maximum return that could be earned from this strategy. You would earn such maximum return when, at expiry, the spot market price settles below the lower strike call (which has been sold). In this case, both the options will expire without being exercised and you would pocket the entire premium amount. Thus:

Maximum Profit = Net premium received
Maximum profit is attained when spot market price < or = lower strike call

Limited loss if price rises

If the spot market price settles above the higher strike call on the expiry date, the spread will yield you a loss restricted to the difference in the strike price between the two options, minus the net margin amount received when entering the position. In no case can there be a loss in excess of this, irrespective of how high the spot market price goes above the higher strike price.

Maximum loss = strike price of call bought-strike price of call sold-net premium received
Maximum loss occurs when spot market price > = strike price of call bought

When To Use Bear Call Spread

You should use a bear call spread when you expect a downward correction in the price of the underlying stock by a moderate extent. If you have strong conviction of the price declining substantially, you could take a more aggressive position, such as buying a naked put option, but it would involve higher risk if price rises against your anticipation instead of falling.

Advantages

If the stock price rises against your anticipation, even then the loss will be limited. The spread involves lower risk than simply buying a put option to support a bearish stand on the stock price.

Disadvantages

It limits your potential gains in the eventuality of a sharp decline in the price of the underlying stock.

The Reel Returns - film funds

Exploring one of india's most glamourous investment alternatives: film funds

What to bear in mind while investing in celluloid

1. Check if the film fund is registered
2. The fund's offer document should be specific about its investments
3. Check how the fund is being managed
4. Understand how the team selects films

The blockbuster 3 Idiots apparently made Rs 300 crore in less than three months. Regardless of what you thought of the movie, it sounds like a great investment. But can you benefit from it? For years, our benefit from films was limited to our experience as viewers. With the launch of film funds, however, films are now a real option for the Indian investor. Like mutual funds which invest in publicly listed stocks and private equity funds which fund privately listed firms, film funds provide growth capital to various kinds of films. Investors earn the return on film projects from ticket sales, merchandise, or satellite rights. Religare Vistaar and Cinema Venture Fund already have funds available and a number of others, including Nomad Film Fund and Midaas Film Fund are in the pipeline. What should you know about backing the next big blockbuster?

Do a basic hygiene check. First, check whether the film fund is registered with Sebi (typically as a venture capital fund). Next, check fund size. A fund that is too large will struggle to find attractive projects to invest in and be forced to make inferior investments. Film costs range from under Rs 1 crore to over Rs 50 crore for some of the largest films. Funds should typically have a size of Rs 100 crore-300 crore invested over 3-5 years. Note the fees of the fund. They should be in line with a portfolio management service (PMS) or private equity fund—management fee with profit sharing, where the profit-sharing component dominates.

Understand the mandate. Learning about what the film fund invests in is critical and, ideally, the fund’s offer document should be very specific about this. The fund should indicate the number of films it is planning to invest in to ensure that its bets are diversified across a number of films. Filmmaking has about 42 different revenue sources, from ticket sales to merchandise, and the fund’s investors should be able to benefit from all varieties of revenue. Finally, the film industry has always been considered a “murky” business. Understand what exactly your money is going to be financing, and how much of a film’s revenue will actually return to you.

Team and track record. Check how the fund is being managed. Funds will have a board of directors as well as an investment committee to select projects. These should comprise people with film production and financing experience. Be wary of a board filled with glamorous superstar names—skills in front of the camera don’t necessarily translate to expertise behind it. Understand the execution track record of the producers and financiers on the board—what films did they finance in the past, what was the budget, and what were the collections? If the fund is open ended, you can look at past investments.

Investment process. Understand how the team selects films. What is the screening process to approve funding for a film, and what are the criteria for providing funds? Films are notorious for delays, which can be costly to investors. What are the checks in place to ensure that films are made on time? Marketing and release are as important as making the film, and how involved the team get in this piece. Most importantly, many films fail because their budgets fail—how does the team ensure the budget stays in place?

If you portfolio is diversified beyond traditional asset classes—equities, debt, commodities, F&O, films and film funds may be a place to make a small bet. That said, you may want to get your feet wet by trying film production stocks first—UTV, Mukta Arts and Shree Ashtavinayak are some of the listed securities that will provide exposure to film and television. Once you have a little bit of comfort, hit the riskier waters of the silver screen.

Long-Term Power Surge

Power Finance Corporation (PFC)—a non-banking financial company focused solely on the funding needs of the power and related sectors—almost a year back, when it was at a level of Rs 200. Considering that PFC’s business has run in a stable manner in a difficult economic environment and it has future earnings visibility, at a price of Rs 276 today, the stock has gained 38 per cent in a year. We are re-recommending it as a long-term buy. 

Business performance. PFC is a Navratna public sector unit that finances power generation, transmission and distribution projects. It is also the nodal agency, selected by the government of India, to facilitate development of power projects with capacity of over 4,000 megawatts, also called ultra mega power projects or UMPP. Although PFC’s consulting business contributes little to its total income, it does give a diverse mix to the company’s product portfolio.

PFC’s business has grown at a healthy pace over time. The compounded annual growth rate (CAGR) of loan assets in last five years is 22 per cent. In FY10, PFC’s loan book expanded by 24 per cent, which is higher than overall growth in bank credit. The commendable part is that despite high loan growth, the asset quality is impeccable. The net non-performing asset is just Rs 6 crore, or 0.01 per cent of loan assets.

PFC faces competition in the lending business from banks, but the nature of its capital gives it advantage over them. First, banks face asset-liability management challenge in financing long-term power projects, as it uses short-term deposits to give long-term loans. On the other hand, PFC has the advantage of raising funds by issuing long-term bonds to fund long-term assets. Second, there is a cap on lending by banks to any sector, whereas there is no such restriction for PFC, giving it a free hand to meet large funding demand from the power sector.

Financial performance. Its five-year (FY05-FY10) CAGR of total income is 19 per cent. In FY10, company’s total income grew by over 22 per cent, while profit grew by 19.5 per cent. The net interest margin has moved to 4 per cent. Several factors help PFC maintain its margin. It raises a major portion of its debt at a fixed cost and has the flexibility to price its loans. Therefore, it is not impacted much by interest rate fluctuations. PFC’s credit rating, equivalent to sovereign debt rating, also helps it raise fund at low costs. Unlike many other PSUs, the company maintains a lean cost structure, which boosts its margin.

Investment rationale. India, being a power-deficient nation, will need huge investment in this sector. The government too realises this, and work on several ultra mega power projects (UMPPs) has already started. Even if capital becomes easily available, not all the investment in the power sector will be funded through equity. This is evidenced in the current debt-equity ratio of around 3:1 for an average power project. So, clearly, the demand for debt will exist and PFC is well positioned to take advantage of this opportunity. It also has an edge over banks.

Besides financing power projects directly, it has also started financing power companies’ purchase of raw materials. Another initiative is to finance power sector equipment manufacturers. Combined, these give visibility to PFC’s future earnings. Its track record in maintaining quality assets is another plus. Considering these, PFC’s stock at Rs 276, or 13.45 times FY10 earnings per share, is attractively priced and will be a long-term bet for you in the sector.

http://money.outlookindia.com/article.aspx?265548

Winners By A Margin

Though unable to beat their benchmark every year, some funds have done so convincingly over the long term.

 If you have ever invested in a mutual fund (MF) scheme, or even watched an advertisement for one carefully, chances are that you would've come across the disclaimer: Past performance is no guarantee of future results. And you would do better not to dismiss it as a mere statutory requirement. Few investments mention the inherent volatility as candidly as this eight-letter sentence. 

However, fallible as we are, most of us, consciously or unconsciously, resort to 'performance chasing'. As soon as we spot a hot fund or a fund that has sizeable exposure to a hot sector, we put our money on it, forgetting that lightning doesn't strike the same place twice. The result is that by the time we have made the investment the bull run is either already over, or in the deceleration mode. Plus, last year's champion might prove to be a dud this year, and vice-versa. In Fluctuating Fortunes, for example, take the year 2008. Few would have thought that previous years' champs would take such a nosedive. Almost every fund took a beating. Clearly, looking at the future is what matters.

Performance statistics

Every fund manager tries to outperform his respective benchmark index. However, if you look at the performance of all actively managed funds, few of them could outperform the widely tracked Sensex and Nifty on a 10-year basis. In fact, if you go by yearly returns, none of the funds could consistently outperform these two indices, not even the top 10 outperformers (see Fluctuating Fortunes).

When we looked at the performance of funds over 2000-2009, we found that the number of outperformers was more when the market did well. During the downturn, however, the number of underperformers exceeded that of outperformers. During the years 2000, 2001 and 2008, when the market gave negative returns, the number of underperformers was more. However, when the market returned a robust 76 per cent in 2009, more than 50 per cent of fund managers could not tap the opportunity, leading to underperformance.

Fund managers’ strategies

Usually, the fund manager of an actively managed fund exploits market opportunities by purchasing undervalued stocks or selling overvalued stocks. Either of these methods may be used alone or in combination. This way, fund managers check the market’s volatility and are able to deliver returns superior to that from the benchmark. Fund managers also use a variety of strategies to construct their portfolio, depending upon the fund’s mandate. Sometimes they purchase stocks that are temporarily out of favour with investors, or sell stocks at a discount to their intrinsic value, increasing the fund’s exposure to emerging sectors.

Why they fail

Fund mandate. This is a major limitation that fund managers face. In India, in order to be an equity fund, the equity exposure cannot be reduced to less than 65 per cent of the portfolio. This results in rising volatility and fund managers are not able to check volatility beyond a certain extent.

Poor investment decision. Poor investment decisions by fund managers could be the result of betting on sectors based on assumptions of their future growth, or buying into a stock at a wrong price at the wrong time. After all, it is not always possible to predict the unpredictable.

What you should do
Despite not being consistent performers on a yearly basis, there are several funds that have outperformed the benchmark indices by a wide margin over the long term. Investments in MFs are also supposed to be long-term. Therefore, we suggest that you don't jump at any fund just because it has done very well recently. Research thoroughly. And yes, keep reading Outlook Money. Every issue, we come up with OLM 50—our 50 choicest schemes across categories.

Stock basics - Profitability Ratios-I

Profitability ratios, as the name suggests, are a set of ratios that show how profitable a company’s business is. We measure them by calculating the profit that a firm makes on each rupee of sales or revenue it generates.

Commonly used ratios As there are different measures of profit (such as gross profit, operating profit and net profit), we can calculate one profitability ratio corresponding to each measure of profit. These ratios are gross profit margin (GPM), operating profit margin (OPM) and net profit margin (NPM).

Other indicators
Besides these commonly used ratios, there is another set of profitability ratios. These measure the profit earned by the company on each rupee of capital invested in it. These are return on capital, return on assets and return on equity. Here, however, we will discuss the first set of profitability ratios.
A Gross profit margin It is the ratio of gross profit (sales minus cost of sales) to sales. Consider a company with Rs 100 as sales and Rs 10 as cost of goods sold. The gross profit would be Rs 90
(Rs 100–Rs 10) and GPM would be 90 per cent (Rs 90/Rs 100). A higher GPM compared to others in the same industry indicates either or both of the two possibilities: higher realisation on each unit sold and the ability to source raw materials at a lower cost.

B Operating margin It shows the impact of operating cost on a company’s profitability, and is calculated as operating profit divided by sales. A high operating cost affects the OPM. In the above example, if the operating cost other than the cost of sales is Rs 50, the operating profit would be Rs 40 (Rs 90–Rs 50) and OPM would be 40 per cent. If OPM increases over time and GPM remains the same, it indicates improvement in operating efficiency.

C Net profit margin It shows how much a company saves after meeting all its expenses. So, an NPM of 20 per cent would mean that a company is able to save Rs 20 per Rs 100 sales after meeting all its expenses. If a company’s NPM increases over time and OPM remains the same, it indicates reduction in non-operating expenses such as taxes and the interest outgo.
Profitability ratios help you pick the best among various stocks. The higher the ratio, the better it is. However, ensure that the comparison is made among companies from the same sector as different industries have different levels of profitability.