Annual Report

The most scary part of value investing is reading and understanding the Annual Financial report or shareholder’s letter.

I mean how can I make sense out of this ~200 page document. I have never done any finance course didn’t understand a thing about most of the terms used here. Now don’t expect next para to be “When I really started reading a financial report it was really easy”. Of-course it is not so easy to grab at first. You have to spent sometime on reading about the terms (mostly wikipedia is enough). Go through a few blogs or videos about how to skim Annual report. Do not go into lot of detail just a few videos/blogs and you are good to go. Select a company you really like in the field you understand.

For example say you understand IT or Infra anything if nothing suits you just select a known FMCG company. Go through the latest Annual report don’t read everything start from Chairman’s letter read the parts which interests you skip the part which you do not know. Try to go through the boring tables of Balance sheet and Cash flow. It doesn’t matter whether you understand everything or now just go through them.

This exercise will give you some idea about how company is run what kind of challenges the company is facing. What future prospect they have. Are they facing any cash crunch? Is the management able to handle the growth? How much salary management team is drawing? This is correct for any listed company in India you can actually know the exact renumeration a big shot guy/gal is receiving from the company.

After going through some of the terms from balance-sheet and reading through couple of annual reports of companies. I got addicted at least for a week or so and whenever I got any time I was skimming through some annual report.

Let us go into little bit of detail now. What exactly do I read in an Annual report:

  1. The most interesting and easy part is reading the chairman’s letter this is directed toward investor stating how the company they have invested into is doing. What future goals the company has in mind. This can be just data for some company or may be just filled with high short terms from MBA/finance without making iota of sense.
  2. Depending upon company or the field the company is working in you may read about Director’s letterIndependent Auditor’s report, Management renumeration(Salary), Advertising effort etc. But all this if it seems interesting to you. You really don’t have to do this. If it interests you you can even read the CSR(=Corporate Social Responsibilities).
  3. Balance sheet In some other blog post I will cover how to go about it right now I am kind of also learning.
  4. Cash flow statement. You know cash is really important even to run a small coffee shop. You gotta have milk, coffee beans/powder, equipments etc (the establishment cost, raw materials), you need to pay yourself/employees. There are so many small/large things. I just mean to say that cash is really important so you have to make sure that company has surplus cash to run the business even through bad times right because you never know(actually no one knows). The company which can sustain the bad time are the one who emerges to be leader because at bad times competitors may go for a toll.
  5. 5 year/10 year performance

Basically there are couple of things which you want to be sure of

  1. Futuristic thinking: Are they thinking futuristic? sometime they just want to make fast cash or may just have 1-2-3 years in target. If you read that for our factories power was a big expenditure so we installed Solar panel, Windmills thumbs up (That is huge investment in the business may be thinking about long term).
  2. Capable Management: How good the management is? How capable they are? Can they handle good/bad days?  What are the management credentials like degree B.Tech, Masters, BE, MBA (credentials of management team) even if there is no degree then you need to check other hints which will make sure the capability of the management.

These will make you in sync with the actual Vision and mission statements of the company not the one you write in the section of mission statement/Vision but the actual ground reality.

3. Cash: Do the company have surplus cash to take and decisions? Think in long term. Invest in research/future growth. Or is the company cutting it’s expenditure all around is it facing ash crunch?

4. Is current price a bargain? Next is making sure you are not paying a lot for the business. This is just like knowing that a company is really great but at this time the price is not worth buying at. You don’t buy something very pricey when their are other similar things which are really cheap. You also know that there will be Diwali/Christmas sale sometime in future. You don’t know dates though.

This part is somewhat tricky and there can be multiple ways to judge this. Everyone has their own formula to calculate the bargain price. It will depend upon what you feel is comfortable for you. In beginning you are not sure actually what is comfortable as this will come with practice. You can read about P/E ratio, Book value, Debt earning ratio etc. You can make your formula based on what return you are expecting then use company’s earnings (profit) and past couple of years growth, you can weigh on market cap which is nothing but combined value of all shares. You can check on company’s all asset (-liabilities).  How much Debt the company has.

But before you start on all this first thing you have to make sure that do you want to invest in this area/company? You should not just take the annual report read it verify all and invest. You need to be comfortable about companies business first. Like you may not be comfortable in investing in a print media company right now (just a thought).

Explanation of Some Financial Terms

In cash flow these are some of the terms which are new to me:

  1. Operational activities (OA): The day to day core business earnings or loss like sales, advertising, raw materials etc. I mean as the name suggest this is almost clear
  2. Investing activities (IA): This term was new for me but again as the name suggest it is actually the same. Company also invest like in land, factories/plant they can even invest in Fixed deposit or some other shares/equities of an startup etc. Purchase or Sale of an asset (assets can be land, building, equipment, marketable securities, etc.). Payments related to mergers and acquisition.
  3. Financing activities (FA): This is where the paying interest to the debt company has borrowed comes in. They can also do some corporate borrowing via some contract for short term cash. This also include dividend payouts. Buyouts of companies own share. This always looks very good to investors as this directly impacts the the share value(it goes up). As the shares in the market will denote higher percentage value of the company.

Cash flow has inflow(good), outflow (huh) means the same as name suggest.

Depreciation, Amortization: Very important to understand how Financial report works. If the company is buying a huge land or establishing a new factory or buying equities in another company in a given time this means a huge investment. May be many folds more than what company’s profit will be this year. So the balance sheet will go for a toll in this scenario. Even when the company is going to reap the benefit of this investment in coming years may be for lifetime. For this reason we have Amortization which means that this kind of huge investment will have a time period defined over which the expenditure will be added to balance sheet.

Then we have Depreciation which means that if you have car which you are using/or not using doesn’t matter the value of that car will go down to zero at some point in time. May be if you keep it long it may go up as antique but you got my point. This is called depreciation again this is also predefined for each kind of equipment how much the value will depreciate over time.

Asset: I get confuse about this asset and debt but I got a simple example to understand this. Let us say you have bought a house of value 50x for which you got loan of 40x(debt) and 10x you paid. Now you have an asset worth 50x of which debt is 40x but remember the asset is 50x so you need to subtract the debt from asset to get a clear picture.

I don’t know about this one so read on wiki Deferred tax  Somehow you don’t pay tax and defer it for later for what earnings in what scenario does it imply I do not have to pay interest on the tax ?  I don’t know read !! 🙂

Pidilite Industries

I started my investing with some blue chip Indian companies because that is the way to go. Just do initial analysis and buy when there is a dip you will rarely be very wrong because there are so many large investors involved and also because they already have good market share good and many number of clients. They have branding power etc.

Anyway this company was one of the first I chose to invest into but eventually this is turning out to be a quick profit and exit. Not a value investing but anyway good way to learn. My initial thoughts when I just started with my trading account was. The company has good hold on Indian market and according to Annual report they have good hold in foreign markets also. I am sure about India though didn’t do lot of research for out of India presence and their branding power their.

So first impression was Fevicol, Fevi stik, Fevi kwik, M-seal, Dr-Fxit OMG.. so good.. and their advertisement campaign are such a game changer. Known to all Indian used in daily life. It is like synonym to adhesive (Fevicol, Fevi kwik), and sealant(m-seal). They have branding power returning and happy customer base. Carpenters can’t suggest you anything other than Fevicol and you don’t even know the alternative. These products will be there even 5-6 years down the line. If you read the Annual report all this will be strengthen like how they have planned the future and how they are advertising with Indian mentality in mind which will keep their brand as selling point. Management salary okay their shares in company is not changing they believe in themselves :).

Cash flow: Company has good amount of cash decreased their debt a lot.

Hardware stores in India is recognized by these brand’s product. All this can simply tell you some very important things like: 1. Capable Management 2. Branding power and Pricing capability 3. They are not going out of business soon

Now let us come to some numbers

Market Cap. ₹ 30,206.83 Cr.

Current Price ₹ 589.20 

Book Value ₹ 64.10 

P/E : 35.89 

Dividend Yield: 0.70%

Net profit: 755.55

Total asset : 3,928.79 cr

OMG this was expected but not this much seems very costly on first look let us do more digging. You can tell somewhat by book value and P/E.

Above figures are actual figures in near about past from the day this post is published.

Now my calculation part and what I see keeping my margin of safety

Profit Growth:  20%

Sales Growth: 13%

Return on Equity: 26%

These are my figures please do not get confuse.

Anyhow the company has huge growth I want my money to also grow like this The company has brand and future so seems secure.

But there is just one catch the company share is really costly in my calculation. In my calculation the price of stock came out to be two times. I have some investment in the company still which I will sell soon sell (not a good way to present myself stating that company is costly and I have made a wrong choice but still not selling). Anyway I have just started and learning and this is blue chip for me so no problem.

Final Verdict: No

Disclaimer
I am very new to value investing and this is me taking random notes just for myself. Please don’t base any of your decision on these write-ups. That will be foolish.

Asian Paints

Another blue chip company with huge branding. Although in some respect the branding is not at same level as pidilite where a common man doesn’t know the competitors at all. Also it is not something which everyone one will be very specific about. You can select Nerolac, Deluxe etc in place of asian paints. Although this is true for pidilite also.

Most of the thing which is true for pidilite is true here also. Asian paints has lot of presence outside India also. Company has lot of cash good advertising campaigns capable management. If you read annual report it looks very authentic and futuristic.

Market Cap.: ₹ 85,469.32 Cr.

Current Price: ₹ 891.05

Book Value: ₹ 69.36

Stock P/E: 43.17

Dividend Yield: 0.84%

net profit: ₹ 494 Cr.

By above figures only it seems like Costly stock.

growth: 18%

Final Verdict: Nope

Disclaimer
I am very new to value investing and this is me taking random notes just for myself. Please don’t base any of your decision on these write-ups. That will be foolish.

Ambika Cotton Mills

While analyzing a company we have to consider about many factors. For initial filtering you do not have to do a lot of thinking couple of figures from balance sheet or shareholder letter etc will turn you off.

What I mean to say is you need to have some criteria for selecting a company and deciding to invest into. A good term will be Checklist. (Atul Gawande – Checklist Manifesto) is a great book to read.

If a company started to satisfy all your criteria then comes the next set of challenges which are open and depends on how much effort you want to make into finalizing the company.

For me I have though of keeping some buckets of investment.

  1. Blue chip bucket: So there are less researched blue chip companies in one bucket for quick cash if need be.
  2. growth bucket: Then I have high researched companies which may have some risk but there is a huge gain side. Basically you really don’t need all your companies to perform superb to make a huge return on your portfolio. In this bucket even if 25-30% companies will make it what I have expected that will make my returns good. But to make it 25% successful I have to lot of research.

Ambika cotton mills seems a promising company. It is doing buy back currently which is really great. I have already made a position in the company some time back. Growth wise there is not a huge benefit and also I have less knowledge about what the companies clients are.

Market Cap.  ₹ 599.90 Cr.

current price 1,000

book value: 616 (good )

P/E: 12 (very nice)

Dividend 1.47%

Net profit: 44 cr in 2016,  51 in 2015, 48 in 2014,  31cr in 2013, so assume 44 cr

% growth 1.47% from dividend +  12% growth (not a lot)

India inflation is 7-8% so this is not very good return from investment but average types ..

When calculating growth on my investment I also check inflation into account. So in first step you need to decide upon what exactly you want with your money. For me it is different for different bucket. Some you want as cash, some you want to be in FD etc.. So best thing is make buckets of money and see what is best option for each bucket.

Ambika Cotton Mills has great management that is 100% sure. Just skim through  shareholder letter and you will know tally it with balance sheet to make sure. For each checklist I have some marks assigned and there is some passing marks (minimum required ) and huge mark in one checklist tends to compensate other given that passing marks are crossed. So for management Ambika has performed really well. Company has plenty of cash (they are doing buyback). Good investing of surplus money.

One thing I am not sure of is market, who are the customer for the company. I don’t think it has pricing power or brand. There are so many great competitors in India in cotton industry. Also the share price is not very cheap. You can buy on dips for stable investment but not much to expect is what I think.

Textiles industry provides second-largest direct and non-direct employment (after agriculture) in India. The industry relies heavily on government support for its survival and government has a special loan scheme (Technology Upgradation Fund Scheme – TUFS) for this particular sector. All the companies in this sector have huge debt on their balance sheet. The companies in this sector keep on diluting their equity to service their debts. No wonder the industry has hardly managed a PE of double digits and have never really participated in any bull market.

Some links:
https://aceinvestortrader.wordpress.com/2014/11/30/ambika-cotton-mills-ltd-spinning-towards-glory/

http://www.drvijaymalik.com/2015/02/equity-research-ambika-cotton-mills.html

 

My Checklists:

  1. Management: Capable, Great, Thinking in long term
  2. Good business, nothing going to change in Cotton industry for long
  3. Not okay with the past growth prospect
  4. Copy paste: Suggested by great investors
  5. Valuation:  Growth wise okay but Discounted cash flow wise not good.
  6. Current price
  7. Not much growth

Final Verdict: Good for stable growth bucket

Disclaimer
I am very new to value investing and this is me taking random notes just for myself. Please don’t base any of your decision on these write-ups. That will be foolish.