Whether we believe it or not, Bata is ingrained in indian Psyche. Now the question is whether the latest generation is going to adapt or not. How the competition is going to respond to it. The best thing is they have 235 acres and developing 25 acres with out any initial investment.
I also like these kind of companies because even though there is a global crisis, people still need to buy shoes and chappals. For Indian roads, we walk more and they worn out quickly. Can you belive we sell 1B shoes/chappals per year. It makes sense with 1B people. With 35% of the branded market share and 9% overall, this is a good thing for BATA. There are couple of huge tailwinds with, the percapita income is increasing and the economies of scale and power of branding will improve as they open up more stores. By they way, you should always use the broker report for information gathering but not necesarrrily decide based on their recommendation. I have also seen their turns have improved in the last three years. They are better utilizing their assets, inventory.
I have seen a lot Emerging Funds in US buy technology stocks in India. They forget if some headwinds are there in US, these businesses are getting affected. If they truly want to diversify they should invest in business which depends on the Indian population, percapita and GDP income/growth. Some times these concepts are simple but you only learn these lessons after a few scars
Read the detail report here
http://www.joindre.cmlinks.com/ResearchReport.aspx?Stype=1&Rtype=3&Ntype=5&id=1#
Saturday, January 9, 2010
Poker and Investing
As I am a poker fan and also into investing..Read this fantastic article from David Einhorn. He also talks about ROE which is very important asset heavy companies and not necessarily on asset light companies.
Thanks Value investing Congress and Manual of Ideas
http://manualofideas.com/files/blog/einhornspeech200611.pdf
Transcript of David Einhorn’s Speech
at the Value Investing Congress
Friday, November 10, 2006
When people ask me what I do for a living, I generally tell them “I run a hedge fund.” The majority give me a strange look, so I quickly add, “I am a money manager.” When the strange look persists, as it often does, I correct it to simply, “I’m an investor.” Everyone knows what that is.
When people ask me what I did on my summer vacation, I generally tell them “I played in the World Series of Poker.” Nobody gives me a strange look.
So I am at the World Series of Poker in Las Vegas and it is time for a break between rounds. A fellow comes up to me as says, “I am from CNBC and we’d like to interview you.” I ask, “About poker or investing?” The fellow looks at me like this is the strangest thing anyone has asked him in a long time; I realize he obviously picked me out due to my large chip stack or, according to my wife, due to my great looks. “About poker” he says as nicely as he can.
Today, I will discuss both. But for this group, who I bet all know what a hedge fund is, I will mostly discuss investing. Investing and poker require similar skills.
Different people approach poker different ways. Loose aggressive types play lots of hands – virtually any two cards – and try to win lots of small pots. They are the day traders of the poker tables. Others play any Ace or any King or any two high cards. They play too many hands, but don’t play them well. These folks can do fine for a while, but get outplayed after the flop by the loose aggressive types who eventually wear them down so that they wind up in a
1 of 11
desperate spot playing a decent hand against a strong hand for the remainder of their chips. I would compare them to long-only closet indexers who trade too much. Then there are the rocks. These folks sit around waiting for premium hands – high pocket pairs or an Ace, King. They fold and they fold and they fold. They are going to wait until they know they have a huge advantage. Then they bet as much as they can. It is very hard to beat a player like this. They can last a long time. Once people figure them out, nobody will play them when they do play. So they don’t get the chance to get enough chips in when they have a large advantage. Could this be what is becoming of Berkshire Hathaway?
I will tell you my poker style. It is close to the patient players waiting for a big advantage. I don’t play a lot of hands. But I don’t just wait for the perfect hand. They don’t come up often enough. I try to pick out one or two people at the table I want to play against or who I sense don’t want to play against me. When the situation feels right, I put in a big, aggressive raise with a marginal holding. It is very hard to describe how I know the “feel” and sometimes I get it completely wrong. But to do well in a poker tournament, you have to recognize a few non-traditional opportunities and you need to get people to sometimes fold the better hand. I think we invest similarly. By this I mean that most of our investing lines up nicely in the disciplined, traditional value camp – very low multiples of book value, revenues, earnings, etc., but occasionally we are opportunistic and invest in situations that are difficult to justify under traditional criteria but for one reason or another we believe to be better situations than they first appear.
People ask me “Is poker luck?” and “Is investing luck?”
The answer is, not at all. But sample sizes matter. On any given day a good investor or a good poker player can lose money. Any stock investment can turn out to be a loser no matter how large the
2 of 11
edge appears. Same for a poker hand. One poker tournament isn’t very different from a coin-flipping contest and neither is six months of investment results.
On that basis luck plays a role. But over time – over thousands of hands against a variety of players and over hundreds of investments in a variety of market environments – skill wins out.
My experience at the World Series of Poker was more like what can happen to a very lucky player in any given tournament. It sure was a blast. If I played a lot of poker, I know that over time the real pros would eat me alive. Personally, I think CNBC would be better served to ask me about investing. I think I have more to contribute in that area.
So let’s get to that. How many of you heard me last year? Now how many of you heard someone use the PEG ratio and kind of laughed to yourself when you heard it?
This year, I’d like to talk a bit about ROEs. One of the best investors around, Joel Greenblatt, has written a popular, charming and funny book about investing in great companies at low P/E multiples. To simplify an already simple book, great companies are generally measured as companies that can generate lots of profit without requiring a lot of capital. This means that they have high ROEs.
I recently met a smart hedge fund manager who has built a $10 billion fund around screening for companies with high ROEs and low P/E multiples for longs and low ROEs and high P/E multiples for shorts. The manager adds human analytical effort to confirm that the screened results are not anomalous accounting figures but instead generally confirm the performance of the business. This has been a successful approach.
3 of 11
My two cents on ROEs is that there are two types of businesses: there are capital intensive businesses and non-capital intensive business. Capital in this definition is both fixed assets and working capital. I define a capital intensive business as a business where the size of the business is limited by the amount of capital invested in it. In these businesses, growth requires another plant, a distribution center, a retail outlet or simply capital to fund growing accounts receivable or inventory. Examples include almost all traditional manufacturing companies, distribution companies, most financial institutions and retailers.
I define non-capital intensive businesses as businesses where growth is limited by things other than capital. Generally, this means intellectual capital or human resources. Examples of intellectual capital are in the pharmaceutical, computer software industries and even some consumer goods like Coke, which rely on brand equity rather than shareholders equity. For example, drug companies are generally limited by the composition of their patent portfolios rather than by their raw manufacturing capacity. Human resource companies are the ones known for the “business going up and down the elevator” every day. Most service companies qualify, including almost any company that sells labor whether it be nurses, construction workers or consultants.
I believe that it is irrelevant to worry about ROE or marginal return on capital in non-capital intensive businesses. If Coke or Pfizer had twice as many manufacturing plants, the incremental sales would be minimal. If Greenlight Capital – and here I mean the management company that receives the fees, and not the funds themselves – had twice as many computers and conference room tables we wouldn’t earn twice the fees…in fact, they probably wouldn’t increase at all.
When the capital doesn’t add to the returns, then ROE doesn’t matter. It follows from this that in non-capital intensive businesses
4 of 11
the price-to-book value ratio is irrelevant. The equity of the company in the form of intellectual property, human capital or brand equity is not reflected on the balance sheet. All that matters is how long, sustainable or even improvable the company’s competitive advantage is, whether it is intellectual property, human resources or market position.
For these companies the “reinvestment” question becomes what do they do with the cash. Do they return it to shareholders? Or do they do something worse with the cash? Think of all the beautiful non-capital intensive businesses that have either bought or entered capital intensive areas…mostly because their core business generated more profits than they knew what to do with.
A current example is the investment banks. Think about investment banking. It should be a wonderful non-capital intensive business. People go up the elevator and generate fees. Fees for corporate finance advice. Fees for raising capital. The top firms also benefit from their brand equity as companies actually measure their status by the perceived brand value of their financial advisors. They get still more fees for assisting buy-side customers to execute transactions in the capital markets and serving as custodians for their assets. None of this requires a lot of capital. From there, they can generate more revenue by facilitating customer orders, by committing some capital and by lending them money. So the investment banks become a bit more capital intensive. This has evolved.
Next the banks enter proprietary trading and investing – generally in everything from short-term trades in liquid securities to merchant banking or private equity efforts. All that cash flow from the great non-capital intensive businesses gets sucked into ever growing balance sheets. Before you know it, the investment banks are holding on-balance-sheet assets of 30x their equity in addition to tons of off-balance-sheet swaps and derivatives.
5 of 11
What does all this capital-intensive activity do? It drives down the ROEs. Sure the ROEs still seem good at around 15-20%. But when you consider that underneath all the capital intensive stuff is a wonderful non-capital intensive fee-generating business that should have an astronomical ROE, you see that all the proprietary investing and leverage isn’t adding much to shareholder returns here. The irony of this is that these are the companies that everyone else comes to in order to get advice on corporate finance and capital allocation.
Why did this happen? They say that the reason is to diversify the business to stabilize the results, as the fee streams are too volatile for the tastes of public investors. In my view that is a lot of value to destroy in order to stabilize results that are still pretty volatile.
I suspect a better explanation is the investment banks are run for their employees rather than their shareholders. They are run so that there is just enough shareholder return left so that shareholders don’t complain too loudly and a 15-20% ROE seems to be that level. Of course, the returns could be higher, but around 50% of the revenues go to employee compensation.
Given the risk taking nature of the incremental revenues and the fact that 50% of the revenues go to employee compensation, the investment banks are evolving into hedge funds with…how shall I put this?…above-market incentive compensation fee structures.
We have a company in our portfolio, New Century Financial (NEW), that turned a wonderful non-capital intensive business, the origination and sale of mortgages, and reinvested the cash flows into a mediocre capital intensive business of holding mortgage loans. Worse, they went into the capital markets to raise additional capital to focus on the capital intensive opportunity. I thought this was such a bad idea that I joined the Board with the goal of
6 of 11
unwinding this decision and to free the valuable service business from the investment business. It is too soon to discuss my progress.
One non-capital intensive business we like is Washington Group, which provides design, engineering, construction management, facilities and operations management, environmental remediation, and mining services. Most of Washington Group’s contracts are paid on a negotiated cost-plus basis. The plus is either a percentage of the costs or specific performance incentives or milestone payments.
For 2006, Washington Group is guiding to about $2.50 per share. For 2007, the guidance is $2.60-$2.92 per share. The “Street” has taken that guidance at face value and has declared the stock fully valued at $55.
To us, the shares seem less expensive. There is about $8 per share in cash and a tax NOL worth another $7 per share. Backing these out, the business value is about $40 a share.
We think that guidance is overly conservative. Washington Group’s end markets should experience large growth over the next few years. In 2006, Washington Group will grow backlog more than 16%. The estimates imply earnings growth of about the same percentage.
Until recently, Washington Group also participated in “Rip and Read” bidding for government infrastructure projects. Those projects are contracted based on sealed bids from contractors, all ripped open at the same time. The lowest bid wins the contract. This has not worked out very well for them.
When the customers on those contracts request changes or expansions, Washington Group incurs increased costs. 7 of 11
Washington Group will file a claim for the increased expense with the customer, and it is either paid out or litigated in a process that can take several years. Washington Group has historically recovered money on a good percentage of its claims.
Washington Group accounts for these loss-generating contracts with cost overruns by taking a charge for the expenses expected to be in excess of revenue going forward. Future revenue on the contract is recognized at a 0% EBIT margin. Claims are not recognized in earnings until the cash is received, no matter how far along in negotiations Washington Group and its customer are, or how reasonably claim recoveries can be estimated. In effect, Washington Group will have charges in early quarters, followed by quarters with revenue at 0% EBIT margin, and then later quarters with claims revenue at 100% margin. Washington Group does not include claims recoveries in its guidance.
Lately Washington Group has had three particularly difficult contracts with cost over-runs. This has resulted in repeated charges over the past few years. The 2006 guidance includes $32 million in pre-tax charges that have reduced earnings by about 60 cents per share.
There are other accepted ways to account for cost overruns on government contracts. The largest of these contracts, for which Washington Group has recognized $122 million of the losses, is done through a joint venture for which Washington Group has a 50% share. Washington Group’s publicly traded JV partner estimates $57 million of claims recoveries that it has recorded on its books as an offset to the losses. As I mentioned, Washington Group doesn’t book the recovery until it collects the cash.
I believe that a more reasonable estimate for 2007 starts with 2006, adds back the 60 cents of charges and grows the core business by 16%. That puts me at around $3.60 per share or about 11x
8 of 11
conservatively stated earnings that give no credit for claims recoveries. I do not believe this is a peak result. This seems pretty cheap for a non-capital intensive business with above average growth prospects and a history of using excess cash flow to buy back stock. For what it is worth, the peer group trades at 20x more aggressive earnings.
Coming back to my main theme. I believe it is very important to analyze ROE and marginal returns on capital…but only in capital intensive businesses. It may surprise you, but I prefer at the right price capital intensive businesses with low ROEs, where I think the ROE will improve, to high-, or at least medium-ROE businesses.
The problem with high ROEs in capital intensive businesses is that it is hard to sustain the ROEs. Here, high returns attract competition both from new entrants that come with new capital and existing competitors that try to see what the better performing competitor is doing to copy it. The new capital and the copycats often succeed in driving down the superior ROEs. Really bad things happen to earnings when a 25% ROE turns into a 10% ROE.
This is why I prefer the low ROEs. Great things happen to earnings when a 10% ROE becomes a 15% ROE. ROE can improve three ways: better asset turns, better margins and by adding financial leverage. I like to look for companies that can expand the ROEs in as many of these levers as possible.
This brings me to my second investment idea, which is, I hope, a good example of what I am talking about.
Arkema is a diversified generic and brand name chemicals company that was created in 2004 by the French oil & gas giant TOTAL following the reorganization of its chemicals portfolio. Arkema consists of three divisions: Chlorochemicals, which is a
9 of 11
mature and cyclical segment; Industrial Chemicals, which is growing and moderately cyclical, and Performance Products, that occupies high-value-added non-cyclical niches. Arkema’s products are used in automotive, electronics, hygiene & beauty, construction and chemical industries. Almost half of Arkema’s revenue comes from outside of Europe and about two-thirds of its employees and capital employed are located in Europe, primarily in France.
Arkema was spun off and started to trade in May 2006 on the Paris Stock Exchange under the ticker AKE FP. TOTAL management, more focused on its highly profitable oil and gas businesses, had under-managed the “non-core” Arkema segments that have generated margins considerably lower than its pure-play peers.
Arkema currently trades at €38 per share, which translates into a market cap of €2.3 billion and reflects a valuation of 1.2x book value, which was almost halved by a slew of write-downs and provisions in the three years preceding the spin-off. Arkema currently trades at 38% of revenue and 4.9x our estimate of 2006 EBITDA, representing an industry low multiple of a depressed EBITDA result, caused by an industry low 7.7% margin.
We like Arkema because it has a great opportunity to improve its ROE through improving asset turns, margins and, if it is inclined, by adding leverage.
Arkema was spun off with working capital of 23.6% of sales. Industry peers operate in the mid-teens. If Arkema can shrink this number to 17% over time it will free up cash in excess of €6 per share or alternatively, it could grow revenues by 39% without requiring working capital. Arkema should also be able to expand asset turns as it holds €220 million or almost €4 per share of construction projects that are not yet producing. As these come on line, Arkema will get the revenue and income benefits from these investments that have already been made.
10 of 11
Additionally, Arkema has a good opportunity to expand its margins, as Arkema’s recent “recurring” operating results had significant embedded undisclosed one-off costs depressing these results. The Industrial and Performance Chemicals divisions, Arkema’s two largest, which account for 75% of revenue and all of EBITDA, have had average margins over the last eight years that were significantly higher than recent levels. Arkema’s most comparable company, Degussa, has operating margins almost three times Arkema’s recent results.
We believe that just with the return of Arkema’s two largest divisions to their historical long-range profitability and a modest fixing of its troubled Chlorochemicals division, Arkema should be easily able to expand its EBITDA margin to 10% which would imply only 3.6x “reasonably achievable” EBITDA. After executing an authorized buy-back for 10% of its shares, such results would demonstrate €5 in EPS, implying a 7.6x P/E, and a 12% ROE. This is a dramatic improvement from what we think this year will be €2.50 in EPS and a 7.6% ROE. As I dream into the distant future of possibilities, if Arkema achieves Degussa’s margins, they would earn €8.60 per share, implying a 4.4x P/E, and a 20% ROE.
So I went back to the CNBC reporter and asked him to read my speech and summarize it with a title. He read it, thought long and hard, and came up with Winning Poker Strategies from an Investor. I looked at him in the same confused way he had looked at me back in Vegas. So I’ve come up with an alternative title for today’s talk: Financial Learnings for Make Benefit Glorious Wiseguys.
11 of 11
Thanks Value investing Congress and Manual of Ideas
http://manualofideas.com/files/blog/einhornspeech200611.pdf
Transcript of David Einhorn’s Speech
at the Value Investing Congress
Friday, November 10, 2006
When people ask me what I do for a living, I generally tell them “I run a hedge fund.” The majority give me a strange look, so I quickly add, “I am a money manager.” When the strange look persists, as it often does, I correct it to simply, “I’m an investor.” Everyone knows what that is.
When people ask me what I did on my summer vacation, I generally tell them “I played in the World Series of Poker.” Nobody gives me a strange look.
So I am at the World Series of Poker in Las Vegas and it is time for a break between rounds. A fellow comes up to me as says, “I am from CNBC and we’d like to interview you.” I ask, “About poker or investing?” The fellow looks at me like this is the strangest thing anyone has asked him in a long time; I realize he obviously picked me out due to my large chip stack or, according to my wife, due to my great looks. “About poker” he says as nicely as he can.
Today, I will discuss both. But for this group, who I bet all know what a hedge fund is, I will mostly discuss investing. Investing and poker require similar skills.
Different people approach poker different ways. Loose aggressive types play lots of hands – virtually any two cards – and try to win lots of small pots. They are the day traders of the poker tables. Others play any Ace or any King or any two high cards. They play too many hands, but don’t play them well. These folks can do fine for a while, but get outplayed after the flop by the loose aggressive types who eventually wear them down so that they wind up in a
1 of 11
desperate spot playing a decent hand against a strong hand for the remainder of their chips. I would compare them to long-only closet indexers who trade too much. Then there are the rocks. These folks sit around waiting for premium hands – high pocket pairs or an Ace, King. They fold and they fold and they fold. They are going to wait until they know they have a huge advantage. Then they bet as much as they can. It is very hard to beat a player like this. They can last a long time. Once people figure them out, nobody will play them when they do play. So they don’t get the chance to get enough chips in when they have a large advantage. Could this be what is becoming of Berkshire Hathaway?
I will tell you my poker style. It is close to the patient players waiting for a big advantage. I don’t play a lot of hands. But I don’t just wait for the perfect hand. They don’t come up often enough. I try to pick out one or two people at the table I want to play against or who I sense don’t want to play against me. When the situation feels right, I put in a big, aggressive raise with a marginal holding. It is very hard to describe how I know the “feel” and sometimes I get it completely wrong. But to do well in a poker tournament, you have to recognize a few non-traditional opportunities and you need to get people to sometimes fold the better hand. I think we invest similarly. By this I mean that most of our investing lines up nicely in the disciplined, traditional value camp – very low multiples of book value, revenues, earnings, etc., but occasionally we are opportunistic and invest in situations that are difficult to justify under traditional criteria but for one reason or another we believe to be better situations than they first appear.
People ask me “Is poker luck?” and “Is investing luck?”
The answer is, not at all. But sample sizes matter. On any given day a good investor or a good poker player can lose money. Any stock investment can turn out to be a loser no matter how large the
2 of 11
edge appears. Same for a poker hand. One poker tournament isn’t very different from a coin-flipping contest and neither is six months of investment results.
On that basis luck plays a role. But over time – over thousands of hands against a variety of players and over hundreds of investments in a variety of market environments – skill wins out.
My experience at the World Series of Poker was more like what can happen to a very lucky player in any given tournament. It sure was a blast. If I played a lot of poker, I know that over time the real pros would eat me alive. Personally, I think CNBC would be better served to ask me about investing. I think I have more to contribute in that area.
So let’s get to that. How many of you heard me last year? Now how many of you heard someone use the PEG ratio and kind of laughed to yourself when you heard it?
This year, I’d like to talk a bit about ROEs. One of the best investors around, Joel Greenblatt, has written a popular, charming and funny book about investing in great companies at low P/E multiples. To simplify an already simple book, great companies are generally measured as companies that can generate lots of profit without requiring a lot of capital. This means that they have high ROEs.
I recently met a smart hedge fund manager who has built a $10 billion fund around screening for companies with high ROEs and low P/E multiples for longs and low ROEs and high P/E multiples for shorts. The manager adds human analytical effort to confirm that the screened results are not anomalous accounting figures but instead generally confirm the performance of the business. This has been a successful approach.
3 of 11
My two cents on ROEs is that there are two types of businesses: there are capital intensive businesses and non-capital intensive business. Capital in this definition is both fixed assets and working capital. I define a capital intensive business as a business where the size of the business is limited by the amount of capital invested in it. In these businesses, growth requires another plant, a distribution center, a retail outlet or simply capital to fund growing accounts receivable or inventory. Examples include almost all traditional manufacturing companies, distribution companies, most financial institutions and retailers.
I define non-capital intensive businesses as businesses where growth is limited by things other than capital. Generally, this means intellectual capital or human resources. Examples of intellectual capital are in the pharmaceutical, computer software industries and even some consumer goods like Coke, which rely on brand equity rather than shareholders equity. For example, drug companies are generally limited by the composition of their patent portfolios rather than by their raw manufacturing capacity. Human resource companies are the ones known for the “business going up and down the elevator” every day. Most service companies qualify, including almost any company that sells labor whether it be nurses, construction workers or consultants.
I believe that it is irrelevant to worry about ROE or marginal return on capital in non-capital intensive businesses. If Coke or Pfizer had twice as many manufacturing plants, the incremental sales would be minimal. If Greenlight Capital – and here I mean the management company that receives the fees, and not the funds themselves – had twice as many computers and conference room tables we wouldn’t earn twice the fees…in fact, they probably wouldn’t increase at all.
When the capital doesn’t add to the returns, then ROE doesn’t matter. It follows from this that in non-capital intensive businesses
4 of 11
the price-to-book value ratio is irrelevant. The equity of the company in the form of intellectual property, human capital or brand equity is not reflected on the balance sheet. All that matters is how long, sustainable or even improvable the company’s competitive advantage is, whether it is intellectual property, human resources or market position.
For these companies the “reinvestment” question becomes what do they do with the cash. Do they return it to shareholders? Or do they do something worse with the cash? Think of all the beautiful non-capital intensive businesses that have either bought or entered capital intensive areas…mostly because their core business generated more profits than they knew what to do with.
A current example is the investment banks. Think about investment banking. It should be a wonderful non-capital intensive business. People go up the elevator and generate fees. Fees for corporate finance advice. Fees for raising capital. The top firms also benefit from their brand equity as companies actually measure their status by the perceived brand value of their financial advisors. They get still more fees for assisting buy-side customers to execute transactions in the capital markets and serving as custodians for their assets. None of this requires a lot of capital. From there, they can generate more revenue by facilitating customer orders, by committing some capital and by lending them money. So the investment banks become a bit more capital intensive. This has evolved.
Next the banks enter proprietary trading and investing – generally in everything from short-term trades in liquid securities to merchant banking or private equity efforts. All that cash flow from the great non-capital intensive businesses gets sucked into ever growing balance sheets. Before you know it, the investment banks are holding on-balance-sheet assets of 30x their equity in addition to tons of off-balance-sheet swaps and derivatives.
5 of 11
What does all this capital-intensive activity do? It drives down the ROEs. Sure the ROEs still seem good at around 15-20%. But when you consider that underneath all the capital intensive stuff is a wonderful non-capital intensive fee-generating business that should have an astronomical ROE, you see that all the proprietary investing and leverage isn’t adding much to shareholder returns here. The irony of this is that these are the companies that everyone else comes to in order to get advice on corporate finance and capital allocation.
Why did this happen? They say that the reason is to diversify the business to stabilize the results, as the fee streams are too volatile for the tastes of public investors. In my view that is a lot of value to destroy in order to stabilize results that are still pretty volatile.
I suspect a better explanation is the investment banks are run for their employees rather than their shareholders. They are run so that there is just enough shareholder return left so that shareholders don’t complain too loudly and a 15-20% ROE seems to be that level. Of course, the returns could be higher, but around 50% of the revenues go to employee compensation.
Given the risk taking nature of the incremental revenues and the fact that 50% of the revenues go to employee compensation, the investment banks are evolving into hedge funds with…how shall I put this?…above-market incentive compensation fee structures.
We have a company in our portfolio, New Century Financial (NEW), that turned a wonderful non-capital intensive business, the origination and sale of mortgages, and reinvested the cash flows into a mediocre capital intensive business of holding mortgage loans. Worse, they went into the capital markets to raise additional capital to focus on the capital intensive opportunity. I thought this was such a bad idea that I joined the Board with the goal of
6 of 11
unwinding this decision and to free the valuable service business from the investment business. It is too soon to discuss my progress.
One non-capital intensive business we like is Washington Group, which provides design, engineering, construction management, facilities and operations management, environmental remediation, and mining services. Most of Washington Group’s contracts are paid on a negotiated cost-plus basis. The plus is either a percentage of the costs or specific performance incentives or milestone payments.
For 2006, Washington Group is guiding to about $2.50 per share. For 2007, the guidance is $2.60-$2.92 per share. The “Street” has taken that guidance at face value and has declared the stock fully valued at $55.
To us, the shares seem less expensive. There is about $8 per share in cash and a tax NOL worth another $7 per share. Backing these out, the business value is about $40 a share.
We think that guidance is overly conservative. Washington Group’s end markets should experience large growth over the next few years. In 2006, Washington Group will grow backlog more than 16%. The estimates imply earnings growth of about the same percentage.
Until recently, Washington Group also participated in “Rip and Read” bidding for government infrastructure projects. Those projects are contracted based on sealed bids from contractors, all ripped open at the same time. The lowest bid wins the contract. This has not worked out very well for them.
When the customers on those contracts request changes or expansions, Washington Group incurs increased costs. 7 of 11
Washington Group will file a claim for the increased expense with the customer, and it is either paid out or litigated in a process that can take several years. Washington Group has historically recovered money on a good percentage of its claims.
Washington Group accounts for these loss-generating contracts with cost overruns by taking a charge for the expenses expected to be in excess of revenue going forward. Future revenue on the contract is recognized at a 0% EBIT margin. Claims are not recognized in earnings until the cash is received, no matter how far along in negotiations Washington Group and its customer are, or how reasonably claim recoveries can be estimated. In effect, Washington Group will have charges in early quarters, followed by quarters with revenue at 0% EBIT margin, and then later quarters with claims revenue at 100% margin. Washington Group does not include claims recoveries in its guidance.
Lately Washington Group has had three particularly difficult contracts with cost over-runs. This has resulted in repeated charges over the past few years. The 2006 guidance includes $32 million in pre-tax charges that have reduced earnings by about 60 cents per share.
There are other accepted ways to account for cost overruns on government contracts. The largest of these contracts, for which Washington Group has recognized $122 million of the losses, is done through a joint venture for which Washington Group has a 50% share. Washington Group’s publicly traded JV partner estimates $57 million of claims recoveries that it has recorded on its books as an offset to the losses. As I mentioned, Washington Group doesn’t book the recovery until it collects the cash.
I believe that a more reasonable estimate for 2007 starts with 2006, adds back the 60 cents of charges and grows the core business by 16%. That puts me at around $3.60 per share or about 11x
8 of 11
conservatively stated earnings that give no credit for claims recoveries. I do not believe this is a peak result. This seems pretty cheap for a non-capital intensive business with above average growth prospects and a history of using excess cash flow to buy back stock. For what it is worth, the peer group trades at 20x more aggressive earnings.
Coming back to my main theme. I believe it is very important to analyze ROE and marginal returns on capital…but only in capital intensive businesses. It may surprise you, but I prefer at the right price capital intensive businesses with low ROEs, where I think the ROE will improve, to high-, or at least medium-ROE businesses.
The problem with high ROEs in capital intensive businesses is that it is hard to sustain the ROEs. Here, high returns attract competition both from new entrants that come with new capital and existing competitors that try to see what the better performing competitor is doing to copy it. The new capital and the copycats often succeed in driving down the superior ROEs. Really bad things happen to earnings when a 25% ROE turns into a 10% ROE.
This is why I prefer the low ROEs. Great things happen to earnings when a 10% ROE becomes a 15% ROE. ROE can improve three ways: better asset turns, better margins and by adding financial leverage. I like to look for companies that can expand the ROEs in as many of these levers as possible.
This brings me to my second investment idea, which is, I hope, a good example of what I am talking about.
Arkema is a diversified generic and brand name chemicals company that was created in 2004 by the French oil & gas giant TOTAL following the reorganization of its chemicals portfolio. Arkema consists of three divisions: Chlorochemicals, which is a
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mature and cyclical segment; Industrial Chemicals, which is growing and moderately cyclical, and Performance Products, that occupies high-value-added non-cyclical niches. Arkema’s products are used in automotive, electronics, hygiene & beauty, construction and chemical industries. Almost half of Arkema’s revenue comes from outside of Europe and about two-thirds of its employees and capital employed are located in Europe, primarily in France.
Arkema was spun off and started to trade in May 2006 on the Paris Stock Exchange under the ticker AKE FP. TOTAL management, more focused on its highly profitable oil and gas businesses, had under-managed the “non-core” Arkema segments that have generated margins considerably lower than its pure-play peers.
Arkema currently trades at €38 per share, which translates into a market cap of €2.3 billion and reflects a valuation of 1.2x book value, which was almost halved by a slew of write-downs and provisions in the three years preceding the spin-off. Arkema currently trades at 38% of revenue and 4.9x our estimate of 2006 EBITDA, representing an industry low multiple of a depressed EBITDA result, caused by an industry low 7.7% margin.
We like Arkema because it has a great opportunity to improve its ROE through improving asset turns, margins and, if it is inclined, by adding leverage.
Arkema was spun off with working capital of 23.6% of sales. Industry peers operate in the mid-teens. If Arkema can shrink this number to 17% over time it will free up cash in excess of €6 per share or alternatively, it could grow revenues by 39% without requiring working capital. Arkema should also be able to expand asset turns as it holds €220 million or almost €4 per share of construction projects that are not yet producing. As these come on line, Arkema will get the revenue and income benefits from these investments that have already been made.
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Additionally, Arkema has a good opportunity to expand its margins, as Arkema’s recent “recurring” operating results had significant embedded undisclosed one-off costs depressing these results. The Industrial and Performance Chemicals divisions, Arkema’s two largest, which account for 75% of revenue and all of EBITDA, have had average margins over the last eight years that were significantly higher than recent levels. Arkema’s most comparable company, Degussa, has operating margins almost three times Arkema’s recent results.
We believe that just with the return of Arkema’s two largest divisions to their historical long-range profitability and a modest fixing of its troubled Chlorochemicals division, Arkema should be easily able to expand its EBITDA margin to 10% which would imply only 3.6x “reasonably achievable” EBITDA. After executing an authorized buy-back for 10% of its shares, such results would demonstrate €5 in EPS, implying a 7.6x P/E, and a 12% ROE. This is a dramatic improvement from what we think this year will be €2.50 in EPS and a 7.6% ROE. As I dream into the distant future of possibilities, if Arkema achieves Degussa’s margins, they would earn €8.60 per share, implying a 4.4x P/E, and a 20% ROE.
So I went back to the CNBC reporter and asked him to read my speech and summarize it with a title. He read it, thought long and hard, and came up with Winning Poker Strategies from an Investor. I looked at him in the same confused way he had looked at me back in Vegas. So I’ve come up with an alternative title for today’s talk: Financial Learnings for Make Benefit Glorious Wiseguys.
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Sunday, January 3, 2010
Interesting post about Nifty P/E
Even though the current P/E is like close to 22. Looks like in the short term Indian markets are reaching fairmarket value. This is not a perfect math. I am sure the earning are slightly depressed especially for the companies that are dependent on exports. The other way to see is I cannot find any bargains in the markets that easily. But if some has a time horizon of more than 3-5 yrs, then there are still some fantastic companies with strong moats.
Reat this good article from Indian Investor Blog
I talk about this often - typically, you want your Earnings Per Share (EPS) growth to, somehow, match the Price-to-Earnings ratio you're paying for the stock. This, at an index level, makes even more sense - a single company may be irrationally high priced or have very high P/E, but the index as a whole should demonstrate EPS Growth levels close to the P/E you pay.
Here's where it's continuing to not make sense. Following my April and August posts, the Nifty P/E continues to scale new levels, while EPS stagnates. continue reading here
Reat this good article from Indian Investor Blog
I talk about this often - typically, you want your Earnings Per Share (EPS) growth to, somehow, match the Price-to-Earnings ratio you're paying for the stock. This, at an index level, makes even more sense - a single company may be irrationally high priced or have very high P/E, but the index as a whole should demonstrate EPS Growth levels close to the P/E you pay.
Here's where it's continuing to not make sense. Following my April and August posts, the Nifty P/E continues to scale new levels, while EPS stagnates. continue reading here
Monday, December 14, 2009
This is really touching
Hermitage Capital's Tribute To Sergei Magnitsky
As we discussed serveral times before, Russia is corrupt and sad outcomes regularly happen. What follows is Bill Browder and Hermitage Capital's tribute to their murdered legal counsel, Sergei Magnitsky. We provide our full sympathy, as he seems like an honest, dedicated, professional patriot.
http://www.scribd.com/doc/24082102/Tribute-to-Magnitsky
Tribute to Magnitsky
As we discussed serveral times before, Russia is corrupt and sad outcomes regularly happen. What follows is Bill Browder and Hermitage Capital's tribute to their murdered legal counsel, Sergei Magnitsky. We provide our full sympathy, as he seems like an honest, dedicated, professional patriot.
http://www.scribd.com/doc/24082102/Tribute-to-Magnitsky
Tribute to Magnitsky
Friday, December 4, 2009
Good Analysis on Hanung Toys by Charu
Even though I am not sure whether there is enough moat is there or not. you do not have enough moat as long as it is compensated by really low p/e with good growth rates and good balance sheet.
Are you also fond of soft toys??? I am and I’m sure someone or the other you know also loves soft toys ;) Age is no bar when it comes to these cute cuddly toys. The smiles that flash across the face the moment you see them is just so beautiful.
Ever realized the company behind these wonderful smiles? Yes, I’m talking about HANUNG TOYS & TEXTILES LTD (HTTL), the company which produces the cuddly toys you buy from most of the popular stores. It is already present in over 3,000 stores, including chains such as Archies Gallery, Lifestyle, Shoppers' Stop and Pantaloons. It also has licensees for Walt Disney characters.
Set up in 1990, HANUNG TOYS & TEXTILES LTD (HTTL) proudly claims to be India’s largest Manufacturer and Exporter of Soft Toys Decorative Cushions & Children’s Room Furnishings.
In the initial formative years, company gained immensely from its technical tie-up/collaboration with South Korean company, Hanung Industrial Company Limited, as they helped in establishing well known Korean manufacturing practices and quality systems. After initial five years of collaboration, Hanung has since been independently operating its manufacturing
Please read the rest here
Thursday, December 3, 2009
Coattailing Great Investors - Mohnish Pabrai
I am huge fan of Mohnish Pabrai. He has an intriguing pick in IBKR (interactive brokers). It is very important to understand the logic of these investors and why they are investing in these companies. Even though he had his share of mistakes but overall he made some smart moves. A few lessons a lot of investors have learned is high leverage businesses can kill you in case of a black swan events and other thing we all need to learn the importance of sizing. Please read a few of his interviews and can provide some great insights. I also recommend his book Dhando Investor.
Thanks to DNA India.
Mohnish Pabrai currently manages Pabrai Investment Funds, which he founded in 1999. The fund has around half a billion dollars in assets under management. Pabrai went to the US in 1982 to do his undergrad in computer engineering. After that, he worked with Tellabs in Chicago. In 1990, he started his own company TransTech, an IT services/system integration business and ran that for around ten years, before starting Pabrai Investment Funds. He has written a book on investing, The Dhandho Investor: The Low-Risk Value Method to High Returns. Excerpts from an interview:
How did you get into investing business from information technology?
Around 1994 I heard about Warren Buffett for the first time accidentally. The first couple of biographies about him had just been published a year or two before that. I read those books and I was quite blown away by some data points that were coming out about him and the industry and so on. I didn't have any experience or even education in the investment business. But I was very intrigued by it.
I started to invest in the public equity markets using Buffett's model in 1994 and basically did extremely well, north of 70% a year, till about 1999. I was getting more and more interested in investment research and securities analysis and made a decision to leave my company. I brought in an outside CEO and decided that I would spend more time on investing and at the same time some friends of mine wanted me to manage their money for them. It started as a hobby in 1999 with about a million dollars from eight people. About a year later the business (TransTech) actually got sold, I wasn't running it anyway, but I was completely cashed out. And then I thought that let's make my hobby a real business, try to scale it up and get investors. We now manage about $500 million -- ten years later.
How did you narrow down on Warren Bufett and value investing?
Basically in 1994, when I read about Buffett, there were two things that stood out. One was that he had compounded money at a very high rate. If you are compounding at a high rate, even if you have a small amount of money -- let's say a million dollars -- in thirty years you could have a billion dollars. So the idea of compounding at a rate above the market rate is an extremely fine notion because it can lead to enormous wealth creation. That was the first thing.
The second thing was that the way Buffett was compounding money at a rate higher than the market was based on a core wisdom which he stood for. If you are physicist, whether you believe in gravity or not, it will always impact you. Just like there are laws of physics, laws of gravity, there are laws of investing.
I noticed in 1994 that the mutual fund business had two things: one, they did not follow the laws of investing, and two, their results were affected by the fact that they did not follow the laws of investing.
For example, a basic law of investing is that you make very few bets, you don't buy a hundred companies because you are not going to have an understanding of business. But if you look at mutual funds, that is not the way they operate.
So essentially, what you are saying is that investors should make fewer bets?
So you make few bets, you make big bets, infrequent bets and you only make bets when the odds are heavily in your favour. What I found very funny was that here is a guy (Buffett) who is telling you very much the approach to investing he follows, and this is like Newton telling you the laws of physics. The second thing is that the investment industry does not care about these laws, and their results reflect it.
The third conclusion I came to is, I said, OK, if what I am saying is right, what it means is that a person like myself, who has no experience in this industry, could come in and apply Buffett's rules and do better than all these managers running all these funds. So I said, well, that hypothesis means nothing until you test it out. I had an asset sale take place of a part of my business in 1994, and I had about million dollars in cash, sitting with me for which I did not have any need for.
I decided I am going to take this million and put this on a twenty or thirty-year compounding engine. I was about 30 years old, I wanted to see if by the age of sixty I had my billion dollars. I started playing this thirty-year game in 1994, and basically I found that first of all, it was very enjoyable and second, that it's been fifteen years now and the original hypothesis I had is absolutely correct -- which is that the industry doesn't get it, they still haven't changed their ways, and there results reflect that.
What are the factors you look at before deciding to invest in a company? Can you give us an example?
The first thing you got to look at is, "I am not buying a stock, but I am buying a business." And you only buy the business if you were willing to buy the entire business if you had money for it. So, for example, if Reliance Industries has a market cap of $100 billion and you had a $300 billion, the question you would ask yourself is, would I buy the entire business for a $100 billion?
The first thing is that you are not buying pieces of paper, but you are buying an entire business. The second is that you ask yourself, do I understand the business? Do I truly understand how it will work, how it makes money, how will it do in the future?
Then the third thing is, if Reliance produces$3 billion a year cash flow and it trades for $100 billion, I have no intention of buying it at 33 times cash flow. It is like I have no interest in putting money in an account that pays 3% interest.
So I love Reliance, maybe, if the fair value of business is 15 times cash flow, which is $45 billion. And since I am cheapskate, I don't want to buy it for more than half its fair value, so I just say to myself, that if it goes below $20 billion in value -- or one-fifth the current price -- then I will look at it again. In fact, that is the way to look at the Indian Sensex. You take all the Reliances, the Wipros and Infosyses of the world, chop their price by four, and that's your entry price.
What has been your most successful stockpick till date?
You know that's a very funny question. The most successful company I ever invested in is Satyam. I invested in 1995, and I was completely out by 2000. When I invested the stock was at Rs 40, and Satyam's earnings at that time were about at Rs 12 a share, so you were buying a business for three-and-a-half times earnings. And the more interesting thing for me was that property the company had in Hyderabad exceeded the market capitalisation as it was carried at a value that was bought a long time ago.
The only reason I knew about Satyam was because I was in the IT services space. These guys had actually visited us to see if they could do business together. And I had been pretty impressed by the way the business operated and the people I had met.
I looked at it from my investment point of view after was amazed that such a business could trade at such a price. So I invested in Satyam. In 2000, it was trading at Rs 7,000, that is about a 150 times the price I bought it at. This was in the days before demat, and actually when I bought the stock with an account through Kotak that I had in Mumbai, I was given physical delivery of these shares that looked like tattered pieces of paper that were falling apart.
Satyam from less than a PE of 3 to more than PE of 100. I just said I am out of it because now I owned a bubble stock even though I did not buy it at bubble price. I sold my entire position within 5% of the peak. Within six months it had dropped from Rs 7,000 to Rs 1,000, and continued on the sidelines for a while. That was the best deal that I ever made.
I also happened to read somewhere that you wear shorts to work and do not as a matter of habit short stocks?
Well, I am wearing shorts right now ... the math for for shorting is really bad. When you are long on a stock, as it goes down in price, the position is going against you and it becomes a smaller portion of your portfolio. In shorting, it is the other way around: if the short goes against you, it is going to become a larger position of your portfolio. When you short a stock, your loss potential is infinite; the maximum you can gain is double your value. So why will you take a bet where the maximum upside is a double and the maximum downside bankruptcy?
Also, any time you short a stock, you are hooked to a (stock price) quote machine for life support because you have to watch what is happening all the time. Many a times, when I am travelling in India, it could be several days when I don't have a quote for any positions that I hold. So I don't want to be a in a situation where I have an umbilical cord linked to some quote machine ... and blood pressure going up and down.
Do you have investments in emerging markets like India and China or do you stick to the stocks in the US market?
I would say that most times a very large portion of our portfolio has a lot of exposure to the global market. I have (shares in) several companies in Canada. I own (shares in) one Chinese company and an Egyptian company, I don't own any Indian companies right now, but I use to own Satyam. Also Pabrai Funds use to own Dr Reddy's.
You have said in the past that investment ideas come to you by reading a lot...
An investor should think of himself as a gentleman of leisure. Don't think that you are in some profession. You just think that you are a person who is focused on enjoying and living life well. If you focus on yourself as a gentleman of leisure what is going to happen is that you do not feel any compelling reason to act. It has been several months since I have bought any new stock. And that is not a problem because we went through a period in December when we bought ten stocks. The first thing is that we are in a profession were you don't pay for activity, you get paid for being right. So there should be no compelling reason to act. Basically, the thing you do is you take out the reason to act.
The second thing you do is you focus on acquiring worldly wisdom. I read an enormous amount of stuff and relate to what different investment managers who I respect are saying. So, at times, things become no-brainers.
In the fourth quarter of last year, when everything was going to hell, one part of the market that went to extreme hell was commodity-related stocks. Commodity-related stocks absolutely got crushed. 95% down. 90% down. And if you simply keep in mind that you look at the growth rates of India and China, you can get an insight.
Through our foundation Dakshina I spend a good amount of time in rural India. I can see nuances about India, that most people would not see. You can see that the pressure on the few commodities in the earth's crust is tremendous.
China has severe problems with fresh water and you really have big problems with agriculture with those type of water issues. When you have growth rates of 7-8%, people will want to eat the best. Generally it is proven that protein consumption climbs very high when economies do well. It is absolutely a given that 10 years from now the amount of agriculture and protein needed will be much higher from today. And getting there will not be easy.
So the thing is there are certain businesses that serve as toll bridges in that space. For example, one toll bridge is if you look at Latin America. It has a lot of land and it is flooded with fresh water rivers. South America can basically take that land and convert it into producing corn and soybean or whatever and export the hell out of it to China. And that is exactly what will end up happening. Latin American agricultural companies with large land holdings today are not excessively priced, they are very cheap. But there is absolutely no way for India and China to satisfy the consumption demand that is coming without going to Latin America. So we will just own the toll bridges and wait.
How much of Warren Buffett's success can be attributed to his investment prowess and how much to the fact that he is Warren Bufett?
Well the thing is you could have invested even after Buffett had invested and you could have made six times the money out of it.
In fact there are a couple of professors in Ohio, who studied any stock that Warren Buffett bought, if you bought on the last day of the month, when it was public that he owned that stock, and you sold it after it was public that he had started selling it, you would have generated north of 20% annual rate of return.
I would say that we will never see another Warren Buffett. Just like we will never see any Albert Einstein or another Mahatma Gandhi. Buffett is a very unique individual. His skillsets outside of investment are phenomenal but they get dwarfed by his investing skills. The main thing that makes Warren Buffett Warren Buffett is that he is a learning machine who has worked really hard for, let's us say seventy years, and is continuously learning every day.
So the thing is if you want to be like Buffett, there is no short cut. First of all, you have to be deeply interested in investing and you have to be very willing spending tens of hours, hundreds of hours, reading the minutiae. There is a very famous value investor called Seth Klarman. He is into horse racing. And his famous horse is called Read the Footnotes
http://www.dnaindia.com/money/interview_we-will-never-see-another-warren-buffett_1301088-all
http://www.investorguide.com/mohnish-pabrai.cgi
http://alexbossert.blogspot.com/2008/04/mohnish-pabrai-interview.html
http://www.bloomberg.com/apps/news?pid=20670001&sid=aLNGqNqAv_Js
http://www.grahamanddoddsville.net/wordpress/Files/BLArticles/An%20Interview%20with%20Mohnish%20Pabrai%20-%20Graham%20and%20Doddsville%20-%20Fall%202008.pdf
Thanks to DNA India.
Mohnish Pabrai currently manages Pabrai Investment Funds, which he founded in 1999. The fund has around half a billion dollars in assets under management. Pabrai went to the US in 1982 to do his undergrad in computer engineering. After that, he worked with Tellabs in Chicago. In 1990, he started his own company TransTech, an IT services/system integration business and ran that for around ten years, before starting Pabrai Investment Funds. He has written a book on investing, The Dhandho Investor: The Low-Risk Value Method to High Returns. Excerpts from an interview:
How did you get into investing business from information technology?
Around 1994 I heard about Warren Buffett for the first time accidentally. The first couple of biographies about him had just been published a year or two before that. I read those books and I was quite blown away by some data points that were coming out about him and the industry and so on. I didn't have any experience or even education in the investment business. But I was very intrigued by it.
I started to invest in the public equity markets using Buffett's model in 1994 and basically did extremely well, north of 70% a year, till about 1999. I was getting more and more interested in investment research and securities analysis and made a decision to leave my company. I brought in an outside CEO and decided that I would spend more time on investing and at the same time some friends of mine wanted me to manage their money for them. It started as a hobby in 1999 with about a million dollars from eight people. About a year later the business (TransTech) actually got sold, I wasn't running it anyway, but I was completely cashed out. And then I thought that let's make my hobby a real business, try to scale it up and get investors. We now manage about $500 million -- ten years later.
How did you narrow down on Warren Bufett and value investing?
Basically in 1994, when I read about Buffett, there were two things that stood out. One was that he had compounded money at a very high rate. If you are compounding at a high rate, even if you have a small amount of money -- let's say a million dollars -- in thirty years you could have a billion dollars. So the idea of compounding at a rate above the market rate is an extremely fine notion because it can lead to enormous wealth creation. That was the first thing.
The second thing was that the way Buffett was compounding money at a rate higher than the market was based on a core wisdom which he stood for. If you are physicist, whether you believe in gravity or not, it will always impact you. Just like there are laws of physics, laws of gravity, there are laws of investing.
I noticed in 1994 that the mutual fund business had two things: one, they did not follow the laws of investing, and two, their results were affected by the fact that they did not follow the laws of investing.
For example, a basic law of investing is that you make very few bets, you don't buy a hundred companies because you are not going to have an understanding of business. But if you look at mutual funds, that is not the way they operate.
So essentially, what you are saying is that investors should make fewer bets?
So you make few bets, you make big bets, infrequent bets and you only make bets when the odds are heavily in your favour. What I found very funny was that here is a guy (Buffett) who is telling you very much the approach to investing he follows, and this is like Newton telling you the laws of physics. The second thing is that the investment industry does not care about these laws, and their results reflect it.
The third conclusion I came to is, I said, OK, if what I am saying is right, what it means is that a person like myself, who has no experience in this industry, could come in and apply Buffett's rules and do better than all these managers running all these funds. So I said, well, that hypothesis means nothing until you test it out. I had an asset sale take place of a part of my business in 1994, and I had about million dollars in cash, sitting with me for which I did not have any need for.
I decided I am going to take this million and put this on a twenty or thirty-year compounding engine. I was about 30 years old, I wanted to see if by the age of sixty I had my billion dollars. I started playing this thirty-year game in 1994, and basically I found that first of all, it was very enjoyable and second, that it's been fifteen years now and the original hypothesis I had is absolutely correct -- which is that the industry doesn't get it, they still haven't changed their ways, and there results reflect that.
What are the factors you look at before deciding to invest in a company? Can you give us an example?
The first thing you got to look at is, "I am not buying a stock, but I am buying a business." And you only buy the business if you were willing to buy the entire business if you had money for it. So, for example, if Reliance Industries has a market cap of $100 billion and you had a $300 billion, the question you would ask yourself is, would I buy the entire business for a $100 billion?
The first thing is that you are not buying pieces of paper, but you are buying an entire business. The second is that you ask yourself, do I understand the business? Do I truly understand how it will work, how it makes money, how will it do in the future?
Then the third thing is, if Reliance produces$3 billion a year cash flow and it trades for $100 billion, I have no intention of buying it at 33 times cash flow. It is like I have no interest in putting money in an account that pays 3% interest.
So I love Reliance, maybe, if the fair value of business is 15 times cash flow, which is $45 billion. And since I am cheapskate, I don't want to buy it for more than half its fair value, so I just say to myself, that if it goes below $20 billion in value -- or one-fifth the current price -- then I will look at it again. In fact, that is the way to look at the Indian Sensex. You take all the Reliances, the Wipros and Infosyses of the world, chop their price by four, and that's your entry price.
What has been your most successful stockpick till date?
You know that's a very funny question. The most successful company I ever invested in is Satyam. I invested in 1995, and I was completely out by 2000. When I invested the stock was at Rs 40, and Satyam's earnings at that time were about at Rs 12 a share, so you were buying a business for three-and-a-half times earnings. And the more interesting thing for me was that property the company had in Hyderabad exceeded the market capitalisation as it was carried at a value that was bought a long time ago.
The only reason I knew about Satyam was because I was in the IT services space. These guys had actually visited us to see if they could do business together. And I had been pretty impressed by the way the business operated and the people I had met.
I looked at it from my investment point of view after was amazed that such a business could trade at such a price. So I invested in Satyam. In 2000, it was trading at Rs 7,000, that is about a 150 times the price I bought it at. This was in the days before demat, and actually when I bought the stock with an account through Kotak that I had in Mumbai, I was given physical delivery of these shares that looked like tattered pieces of paper that were falling apart.
Satyam from less than a PE of 3 to more than PE of 100. I just said I am out of it because now I owned a bubble stock even though I did not buy it at bubble price. I sold my entire position within 5% of the peak. Within six months it had dropped from Rs 7,000 to Rs 1,000, and continued on the sidelines for a while. That was the best deal that I ever made.
I also happened to read somewhere that you wear shorts to work and do not as a matter of habit short stocks?
Well, I am wearing shorts right now ... the math for for shorting is really bad. When you are long on a stock, as it goes down in price, the position is going against you and it becomes a smaller portion of your portfolio. In shorting, it is the other way around: if the short goes against you, it is going to become a larger position of your portfolio. When you short a stock, your loss potential is infinite; the maximum you can gain is double your value. So why will you take a bet where the maximum upside is a double and the maximum downside bankruptcy?
Also, any time you short a stock, you are hooked to a (stock price) quote machine for life support because you have to watch what is happening all the time. Many a times, when I am travelling in India, it could be several days when I don't have a quote for any positions that I hold. So I don't want to be a in a situation where I have an umbilical cord linked to some quote machine ... and blood pressure going up and down.
Do you have investments in emerging markets like India and China or do you stick to the stocks in the US market?
I would say that most times a very large portion of our portfolio has a lot of exposure to the global market. I have (shares in) several companies in Canada. I own (shares in) one Chinese company and an Egyptian company, I don't own any Indian companies right now, but I use to own Satyam. Also Pabrai Funds use to own Dr Reddy's.
You have said in the past that investment ideas come to you by reading a lot...
An investor should think of himself as a gentleman of leisure. Don't think that you are in some profession. You just think that you are a person who is focused on enjoying and living life well. If you focus on yourself as a gentleman of leisure what is going to happen is that you do not feel any compelling reason to act. It has been several months since I have bought any new stock. And that is not a problem because we went through a period in December when we bought ten stocks. The first thing is that we are in a profession were you don't pay for activity, you get paid for being right. So there should be no compelling reason to act. Basically, the thing you do is you take out the reason to act.
The second thing you do is you focus on acquiring worldly wisdom. I read an enormous amount of stuff and relate to what different investment managers who I respect are saying. So, at times, things become no-brainers.
In the fourth quarter of last year, when everything was going to hell, one part of the market that went to extreme hell was commodity-related stocks. Commodity-related stocks absolutely got crushed. 95% down. 90% down. And if you simply keep in mind that you look at the growth rates of India and China, you can get an insight.
Through our foundation Dakshina I spend a good amount of time in rural India. I can see nuances about India, that most people would not see. You can see that the pressure on the few commodities in the earth's crust is tremendous.
China has severe problems with fresh water and you really have big problems with agriculture with those type of water issues. When you have growth rates of 7-8%, people will want to eat the best. Generally it is proven that protein consumption climbs very high when economies do well. It is absolutely a given that 10 years from now the amount of agriculture and protein needed will be much higher from today. And getting there will not be easy.
So the thing is there are certain businesses that serve as toll bridges in that space. For example, one toll bridge is if you look at Latin America. It has a lot of land and it is flooded with fresh water rivers. South America can basically take that land and convert it into producing corn and soybean or whatever and export the hell out of it to China. And that is exactly what will end up happening. Latin American agricultural companies with large land holdings today are not excessively priced, they are very cheap. But there is absolutely no way for India and China to satisfy the consumption demand that is coming without going to Latin America. So we will just own the toll bridges and wait.
How much of Warren Buffett's success can be attributed to his investment prowess and how much to the fact that he is Warren Bufett?
Well the thing is you could have invested even after Buffett had invested and you could have made six times the money out of it.
In fact there are a couple of professors in Ohio, who studied any stock that Warren Buffett bought, if you bought on the last day of the month, when it was public that he owned that stock, and you sold it after it was public that he had started selling it, you would have generated north of 20% annual rate of return.
I would say that we will never see another Warren Buffett. Just like we will never see any Albert Einstein or another Mahatma Gandhi. Buffett is a very unique individual. His skillsets outside of investment are phenomenal but they get dwarfed by his investing skills. The main thing that makes Warren Buffett Warren Buffett is that he is a learning machine who has worked really hard for, let's us say seventy years, and is continuously learning every day.
So the thing is if you want to be like Buffett, there is no short cut. First of all, you have to be deeply interested in investing and you have to be very willing spending tens of hours, hundreds of hours, reading the minutiae. There is a very famous value investor called Seth Klarman. He is into horse racing. And his famous horse is called Read the Footnotes
http://www.dnaindia.com/money/interview_we-will-never-see-another-warren-buffett_1301088-all
http://www.investorguide.com/mohnish-pabrai.cgi
http://alexbossert.blogspot.com/2008/04/mohnish-pabrai-interview.html
http://www.bloomberg.com/apps/news?pid=20670001&sid=aLNGqNqAv_Js
http://www.grahamanddoddsville.net/wordpress/Files/BLArticles/An%20Interview%20with%20Mohnish%20Pabrai%20-%20Graham%20and%20Doddsville%20-%20Fall%202008.pdf
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