Friday, October 26, 2012

Value Investing - Nucleus Software

Value Investing is all about buying stocks that are trading less than their intrinsic value or their actual worth. But finding such stocks is always difficult as the market prices in effectively most of the time. Market participants (People who matter the most) are aware of what is happening with companies in the market universe and they act swiftly to safeguard their investments based on the news flow. While finding such stocks are difficult, they do exist time to time as investors either fail to spot it or market is imperfect or something bad is happening that is known only to institutional investors and market participants who have insider information. I just found one and it appears to be an undervalued stock but I don't know if there is something that I am not aware. Anyways, it is a good exercise to discuss about it so that people will get to know what is "Value Investing".

Nucleus Software : (Rs.74.55 on 26 Oct 2012)

Nucleus Software Exports Limited provides software solutions to the Banking and Financial Services Industry. Very important details are briefly given below.

Market Capitalization : 241 Crores
Total Revenue in 2011 - 2012 FY : 282 Crores
Total Revenue in 2012-2013 (Q1 & Q2) : 145 Crores
Net Profit in Year Ended 2012 : 35 Crores
Net Profit in Q1 & Q2 2012 - 2013 : 22 Crores
Earning Per Share (EPS) in 2012 : Rs.10.9
Earnings Per Share (EPS) in Q1 & Q2 2012 - 2013 : Rs.6.91
PE Ratio based on 2012 EPS : 74.5/10.9 = 6.8 times

Looking at the 2012-2013 half year earnings, it appears that the stock is trading at less than 6 times the FY 2013 earnings. 

In essence this is a software product development and services company that generates close to 300 Crore rupees revenue and about 40 crores net profit. So given the small size of the company, one would argue market capitalization of 241 crores is fair and there is nothing irrational about it. That would be true until you look at the balance sheet. Lets look at it as well.

Note: All the numbers in this post have been taken from the Company Press Release for the September 2012 Quarterly Earnings and can be accessed by clicking the following link.

Balance Sheet Information

Equity & Liabilities

Consolidated Reserves and Surplus : 340 Crores
Liabilities (Including Short Term and Long Term) : 58 Crores
So Total Equities and Liabilities : 410 Crores


Non Current Assets : 76 Crores
Current Assets : 334 Crores
Total Assets : 410 Crores

Lets see the break up of Current Assets.

Current Investments (Mutual Funds or other liquid investments) : 116 Crore
Cash and Cash equivalents : 118 Crores
Trade Receivable : 59 Crores
Short Term Advances : 10 Crores
Other Current Assets : 28 Crores

Why I think this is Undervalued?

I don't know if you got it already.  If you have not, here are the reasons.
  • It is very rare for a service providing company trading less than the book value. But this company is trading less than the book value ( Rs. 74 Against the Book Value of Rs.96).
  • Considering the trade receivable of Rs. 59 crore, the debt is almost zero / negligible. 
  • But more importantly Cash and liquid investment is Rs.234 Crores ( Rs. 73 per share). In other words a company which has Rs.234 crore cash on hand is trading at a Market Capitalization of Rs.241 Crores.
So the stock is essentially trading at its cash value. Stock Price = Liquid Cash per share. 

What about the projects / deals that the company has on hand?
What about the products that the company has developed? 
What about the infrastructure? 
What about the people and their expertise?  
What about the decent net cash flow every year?

Its all free at the current market price and that's why I think it is undervalued. I searched extensively in the internet and it seems the company has a very good management and they apply good corporate governance practices. In fact this company was selected as one of the top five companies with good corporate governance practices in 2011. I know the growth has slowed down a bit and the latest quarterly revenue was less than estimates. But still considering the cash on hand and all other assets and expertise, this company is worth more than Rs.241 crores for sure. So I believe this company is undervalued. Hopefully there is nothing bad going on in the back ground that common man is not aware of. I would consider buying this stock around Rs.50 - 60 levels.

Kumaran Seenivasan


Saturday, September 8, 2012

"Undervalued" Stocks

The concept of "Undervalued" stocks is misinterpreted by many retail investors in my view (at least in my view) and I thought it can be a good discussion here. The idea to share my views on this came up after reading the post on "Opto Circuit" in the blog and also the comments that followed. Vishal has analyzed about this stock on his blog and the stock has come down since then. Many readers of his blog started hounding him for the fall which is very unfortunate. What impressed me the most is the comments section (I receive the comments to my email) where people took the stock analysis to another level. Readers have started dissecting each and every line on the financial statement of this company like never before. I have not seen investors analyzing each and every line item for any other company. Of course this is good, but one will not find even 2 stocks from Indian equity universe if  same level of analysis is done as in the case of Opto Circuit. No matter what great company and management it is, one can find some negatives in the financial statements or in the business or in the economic environment.

Many retail investors read books on Warren Buffet, Peter Lynch, John Templeton etc. and misinterpret the ideas in my view. One such misinterpretation is about "Undervalued" stocks. People think that great stocks without any issues both at the company level and at macro economic level are "Undervalued" sometimes because of market irrationality which is far from the truth. 

Lets assume a fictional company which has the following.
  • Great Business
  • Everything is innovation and no acquisition 
  • Top class management
  • Perfect corporate governance
  • Accurate financial statements in the way you expect them to be
  • Positive cash flow all the time
  • No goodwill in books
  • Pays 20 - 30% tax without using any legal deductions
  • Grows at 25% CAGR
  • Very good macro economic environment (Low inflation, low interest rate, high economic growth etc.)
  • Good political system
  • No regulatory issues
If a company has all of the above going for it, why would you think this will be "Undervalued"? Let me tell you how the price graph would be for this stock. It will look like a linear upward straight line. The closest stock I can think of is Apple inc which has several of the above points going for it and clearly does not satisfy all. In spite of that fact, look at the below graph which depicts the stock price appreciation for Apple Inc. If a company with few short comings can perform like this, then never ever imagine that a company with all the above points going for it would ever be "Undervalued".

If a company has all the above things, then it will never have to face the headwinds to be "Undervalued" by investors. Same thing applies to OPTO CIRCUIT. I am not at all saying this is a great stock to own. All I am saying here is that the analysis have to be rational. People expect this company to grow at a hot pace and expect them to show good profit but they also want the following (From the comments that I read in the post).

  • Company should have positive cash flows
  • Company should not make acquisitions
  • Company should not invest for the future but consolidate
  • There should be no goodwill on books
  • Company should pay more tax (Worries about tax payment)
  • Working capital position should be good
  • Debtor days should be way less than what it is now
  • Rating should be "A" from rating agencies
  • They should not delay the repayment of loan to the banks even for few days
  • Finally they also expect the price to be at Rs.130 and then they will buy !
Give me a break ! Why would such a company trade at that price? If all of these things are true, then the stock would be trading at Rs.330 and not 130.

Great investments are made when there is short term pain for a company and not when everything is good. If everything is good, then the market would already price it and your returns would be sub optimal. Do you think a stock is undervalued for no reason? Hell no. Something has to bother the market to undervalue a stock. For example, everything with the company is good but the economic environment is bad (Like 2009 where many good companies were available at great prices), or everything is good but the company market cap is small or everything good but the company does not have free cash flow as they invest for the future etc.

The reason "Undervalued" came into being is (in my view), the market irrationally punishes some stocks more than they deserve to be punished when companies associated with these stocks face short term headwinds. For example PSU Banks. Many of the PSU Banks are available at 0.5 times book value which is crazy. PSU Banks were trading at 1.5 - 2 times book value in 2010 and they were trading well above 1 times books value even few months ago. They definitely deserve to be punished because of the following.
  • Bad Macro economic environment (High inflation, high interest rate, High commodity prices etc)
  • Raising NPA's
  • No reforms, Corruption and unstable political environment
  • Declining growth 
  • Basel III Norms
  • Government involvement
If stock prices come down to 1 times or 0.9 times book value because of these reasons, then that would be a "rational" price and no one would term it as "Undervalued". But because of the inbuilt fear of losing the money among humans, people tend to over react and sell stocks at throw away prices to minimize the loss. Hence most of the PSU bank stocks are now trading well below 1 times book value which is more than what is "rational" or "Appropriate". So this is where the term "Undervalued" comes into play. You need to analyze the positives and negatives of these banks and if the stock prices have declined more than the "degree of negatives" then you can assume these stocks are "Undervalued" and have to decide whether to buy are not. That's where "Margin of  Safety" and "Risk - Reward" ratio terms come into play as well. If everything is good with the company, then no one will need margin of safety.

In essence, investors need to decide if the stock price is "rational" or "irrational" for the current situation of the company (Company situation as it is) and if the stock price is irrationally low even accounting for the short term headwinds and negatives, then that stock is "UNDERVALUED". Then there is an additional step to decide whether to buy the stock at that price or not for which one needs to look at the probability for the company to overcome the short term pain. If you expect there is a high probability for the company and management to overcome the current pain, then that is a reasonable BUY.

Kumaran Seenivasan


Monday, April 30, 2012

The Paradox of Being an Equity Investor

Friends, sorry for not posting any articles for a long time. As equity investors, we are all facing one of the most difficult economic climates around the world now. Recently I read two articles one discussing why there is going to be a global financial crisis and the other discussing why India will not have one. As investors we all want to make money in stock market and on the other side we also want to protect ourselves from a potential disaster. We are experiencing a paradoxical investment environment where investors who matter the most (FII’s and DII’s) are positive one day and become negative in no time though not without reasons. I will present some of the important points from those articles and relate how it can affect retail investors.

First Article: 22 Red Flags Indicating Serious Doom Is Coming For Global Financial Markets (Contributed By Michael T.Snyder)

One of my Investor friends shared this article with me and thanks to him. Important points from those articles are given below and my views are in the parenthesis.

• There are signs of trouble at major banks all over the planet. (Not really in India though. European Banks are in deep trouble and all the banking and financial institutions which have exposure to this region will be in trouble too. But terming this as “Global” financial crisis is little bit exaggerated when top Indian banks have shown above 30% growth in the recent quarter (ICICI, AXIS, HDFC AND YES BANK) while reducing the NPA level and Indian banks don’t have significant European business or connection.)

• The greatest global debt bubble in human history getting ready to burst, and when that happens the consequences are going to be absolutely horrific. (True if this happens. But how do we know this is going to happen for sure and when? There is risk in everything we do. We don’t know the bus we are boarding in has a good brake or not. Of course there are red flags about the safety of Government run buses, Indian railways or for that matter even Indian army. What are we doing about it? The same thing can be applied here too. By that I mean the investors who are planning to invest can wait for more clarity. But the investors, who have huge exposure already like me have only two options, ride out this journey or jump from the bus. We just can’t do things based on probability and if that’s the case FII’s might have already pulled out billions. Retail investors are in a catch 22 situation for sure.)

• According to CNN, the level of selling by insiders at corporations listed on the S&P 500 is the highest that it has been in almost a decade. (This is a warning for us. But sometimes when we are in fear we see tiger in a cat)

• Home prices in the United States have fallen for six months in a row and are now down 35 percent from the peak of the housing market. The last time that home prices in the U.S. were this low was back in 2002. (Not really. Florida is the worst affected market in the US and the home prices have increased in the last few months. Lot of people have changed jobs from my company which means there are opportunities out there.)

• It is now being projected that the Greek economy will shrink by another 5% this year and the budget deficit will be 7% of their GDP. (This can be true. If major economies of Europe does not support, Greece will even default.)

• Interest rates on Italian and Spanish sovereign debt are rapidly rising. (This is true. European nations as a whole are reaping the rewards for being reckless over a long period of time)

• Spain, Portuguese and Italy are in trouble and they might need bailout. (How funny? All these countries have become developed countries on borrowed money and now they are trying to protect their interests on bail outs. This is like a legal Ponzi scheme where you go on paying the debt through refinances. These countries also face huge unemployment.)

• Many experts are saying things could become bad again and there are dark clouds over the global economy. (Terrible thing to hear. But why were they projecting rosy things few months back?)

• A recent IMF report admitted that the current financial crisis could lead to the breakup of the Eurozone like Soviet Union. (We read this almost every day. What we don’t know is whether the governments are taking any action or not? Whether those actions will prevent the collapse or not? How bad the situation is? How much money involved? Can any expert answer?)

• A member of the European Parliament, Nigel Farage, stated in a recent interview that it is inevitable that some major banks in Europe will collapse. (Even though, Indian banks have no significant exposure, stock market might crash on FII selling if this happens. I shudder to think of that happening.)

• The IMF is projecting that Japan will have a debt to GDP ratio of 256 percent by next year.

• The 9 largest U.S. banks have a total of 228.72 trillion dollars of exposure to derivatives. That is approximately 3 times the size of the entire global economy. It is a financial bubble so immense in size that it is nearly impossible to fully comprehend how large it is. (If this happens, you and I will lose every penny but at the same time it might provide greatest opportunity that has ever existed.)

• The financial crisis of 2008 was just a warm up act for what is coming. The too big to fail banks are larger than ever, the governments of the western world are in far more debt than they were back then, and the entire global financial system is more unstable and more vulnerable than ever before. (Wow. So what’s in store for us? All you can do is to pray the god that nothing catastrophic happens in next few years.)

Second Article: Seven reasons why India’s economy won’t collapse as feared (Contributed By Jonathan Anderson)

• Credit bubble is not that bad. In terms of peak five-year increase in the overall domestic credit/GDP ratio across emerging market (EM) economies, India sits near the bottom of the pack, far removed from the "true-blue" credit bubble countries in eastern Europe. India is simply light-years away from the kind of numbers that normally point to trouble.

• The feared investment collapse does not exist. India does have a slowing economy, and real investment spending has shrunk. Still, India is investing between 30 per cent and 35 per cent of its GDP – the second highest investment ratio in the emerging universe, after China. No collapse in domestic savings either.

• Growth has not disappeared completely. If you look at the investment and production figures on a sequential rather than a y/y basis, you will find that levels have already recovered visibly over the past few months, even if we are not talking about a massive recovery here.

• Inflation is worse but it is on par with other emerging economies if you compare using GDP Deflator inflation. (GDP Deflator: nominal GDP divided by real GDP multiplied by 100).

• Cost of capital is not that alarming. While RBI has had to adjust reserve requirements to ensure continued liquidity in the system, that's about it. While short-term rates have been rising as a result of policy rate hikes, long term funding rates have been unchanged in the last couple of years.

• The myth about overseas borrowing by Indian corporates and repayment crunch is overdone.

• There was no rupee sell off last year. It was on par with other emerging economies.

What do we take home?

The truth is nobody knows exactly where we are heading and it will remain so no matter what. There are some true concerns and there are some exaggerated ones in these articles. To me it appears that the US is not really that bad for the time being considering the increase in home prices and reasonable job market. While India has so many macro issues because of government inaction and policy flip flops, she is still growing at a decent rate of 6.5%. If you consider banks are the back bone of an economy, then top private sector banks have shown more than 30% growth in the last quarter. Other sectors like Infrastructure, Power, Metals and gas are down in the dumps and it will stay there till government gets it act together. European Union is the major problem at this point of time and if it fails, then FII’s are going to flee Indian market (Not because of problems in India) and I can’t imagine the impact to retail investors.

Retail investors have not got any returns for the last 2 years. Only people who have invested in December 2011 lows might have made some money. If you are one of those guys who invested in 2010 and start of 2011, then you would be down by at least 20% and there are not many safe options at this point of time. But I have listed whatever options available and you just have to accept the reality and use these as a guideline according to your own situation.

• Remain invested and ride out the trouble if something bad happens.

• Keep good stocks and sell those that you don’t think worth having in your portfolio when there is a relief rally (if at all there is one) and restructure the portfolio by adding defensive stocks.

• If you are someone who can’t see the red, exit totally from the market when there is a relief rally and wait for the right opportunity to enter the market which means enter the market when there is no European union.

Relief rally a probability?

Warren Buffet says that we need to buy stocks when there is lot of pessimism and I do believe this is a market with lot of pessimism. Mid and small cap stocks offer cheap valuations even now. In that sense I do have the gut feeling that the (Though data and information supports otherwise) market might rally before something happens and that’s the risk that we need to live with.

Kumaran Seenivasan.



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