You should take owner earnings and divide it by market cap to get the yield they are talking about. The simple way is to use FCF instead and calculate the yield - FCF/Market cap. In my experience if you find FCF yield of 10%+ then that is worth investigating as an opportunity. In the depth of recession or when the good company is hit by some temp adversity you do find such opportunities. Dividend yield is very poor measure to assess the returns. FCF (or owner’s earnings) is better measure. This is the cash that is available to distribute to owners, if the management decides, without impacting ‘current levels’ of sales.
If the PSB stocks are trading below stated book value then it is because that book value is not sustainable or trustworthy. If non performing assets are high then that loss is covered from the net worth (book value) of that finance company. If the market suspects increasing NPAs and hence future erosion of the net-worth then the stock will trade below networth/book value. It doesn’t matter if the EPS growth is high or low in that case.
For finance businesses these things are very critical:
- Quality of assets and credit/lending standards- as depicted by NPAs, Asset-Liability management etc.
- Adequate Profitability - ROA and ROE (which is derivative of cost of funds and ROA)
- Earnings growth- this should be the last one and least important in three. Single minded focus on earnings growth can get you in trouble in finance stocks. Conservative & cautious management is preferred over the growth at any cost kind approach.
Not that if the ROE is low then the equity is diluted to fund the growth of disbursements. But some equity dilution is expected to fund the growth in finance companies. It is not bad per se.
I talked about their way of calculating Owner’s Earnings. Owners Earnings and FCF are different. Please go in depth and then answer.
I am also talking the same. I urge you to read it very carefully and also understand owner’s earning concept as espoused by these guys, warren buffet and Grrenwald etc. They all talk the same though in different words -
"We calculate a business’s worth using a methodology known as the “owner earnings yield.” This is defined as
owner earnings—or excess cash earnings—divided by enterprise value. To arrive at owner earnings, we begin with pre-tax operating income, remove non-operating sources of income (e.g., gain on sale of assets and amortized pension gains), adjust for the difference between depreciation and true maintenance spending, and charge the income statement for options granted, inflated pension assumptions, etc. "
It is the money the owner can take out, if he wants to, after taking care of routine maintenance capex.
The calculation starts with operating profit. You add back book depreciation amount and then subtract the maintenance capex. This is the amount that is needed to maintain the production volume at current level. Then subtract tax calculated based on statutory rate etc. They also do other adjustments for one off profits, costs etc to get more normalized figure. The attempt is to gauge the normalized figure that can be maintained for some time. Looks like they calculate at enterprise level and hence divide by EV to account for debt.
Also for your information… if you take trouble to do such calculations you will find that the owner’s earning earning figure comes close to FCF often calculated as Net cash from Operations - Capex. Often times this is quick and rough way to calculate this figure. Again depending on whether OCF contains interest or not …you are either dealing at enterprise level or equity level.
The Davis guys try to find opportunities where this Owner earning/EV yield is at least twice that of 10 year risk free govt bond rate. Not at all easy and not available all the time. But don’t make blanket statement that such opportunities are not available from time to time.
I am presenting a contra view in this discussion. Negative on Banks & HFCs and positive on Credit rating & Insurance companies.
Mr R Balakrishnan has written a very good article in Moneylife on “Valuing Bank Stocks”. He argues that the private sector banks are probably overvalued and public sector banks impossible to value. His basic thesis is that given the low ROEs from the banking sector (the best bank gets about 20% ROE), we are paying way too much for banks where the asset quality is presumably good. PSBs suffer because if the true bad debt recognition happens, there may not be any earnings left to compute ROE. Other stalwarts like Ramesh Damani and Porinju Veliyath also have a negative view on banking sector.
But that is not the only reason. IMHO, the economy is yet to turn the corner, the ground level situation is not good - people are not committing new investments, coupled with worsening bank balance sheets because of recognition of NPAs ……… I believe all the banks have so called bad/restructured loans in their books. Once it is classified as NPA (of course, not all of it…), the provisioning increases, denting the Net Profit. This process has begun (albeit after the deadline set by RBI Governor), which will continue for several quarters. I feel banking sector will undergo some pain in the near term.
HFCs : As I have written earlier in Hitesh bhai’s thread, I continue to get negative inputs from friends based in HFCs regarding new mortgage business. Several thousand apartments are lying unsold and the realty sector is in bad shape. However, Balance transfer business continues at brisk pace which ensures that HFCs and banks fighting with each other for lower rates thereby driving NIMs down.
Credit rating companies : The Kingfisher fiasco has raised a question mark on banks’ ability to asses / appraise the loan proposals. IMHO, there will be an ever increased demand for customer ratings by recognized rating agencies. To the best of my knowledge, some of the well run pvt banks have internal rating process by their Credit/Risk Depts. Not sure about the same with PSBs. So I see an opportunity here for increased business for rating companies. Not to mention the low capital requirement, excellent ROEs, good dividend track record and good FCF they generate.
Insurance companies : There is only one pure play listed insurance company as of now and I am positive on the long term potential of this sector because of under penetration in Life Insurance and increasing awareness about Health Insurance (because of rising healthcare expenses).
So, the consensus view is that the banks & especially PSU bank’s loan book is in trouble. And there is no way of knowing how bad the situation is.
IMHO this is precisely the opportunity that @Donald was alluding to when he started this thread.
Because of this common thinking - call it consensus/analyst view - the bank stocks are beaten down. The question now is, amongst these are there any bargains to be had - some stock/s beaten down well below the intrinsic value? Can we research/analyze these - separate the wheat from the chaff?
Analyzing a banking business is beyond my current level of expertise. Are there any experts on this forum that perhaps can chime in with their thoughts on the direction one should take to tackle this problem? I am willing to put in the effort.
P.S. The article you mention is behind a paywall…if possible can you please post a copy somewhere that I can read.
Thanks Donald and others for this discussion.
My take is slightly different. I think because of the high levels of leverage involved in the BFSI sector, this is an extra risky area to take educated bets on - simply because of the elevated level of leverage, the management / owner quality because all the more important. And it’s not just the quality, but also the intent / incentive structure etc, where these decisions can pull down the entire financial institution.
So, while yes, financial institutions can be great compounding machines (The story about getting your daughter married with HDFC shares), one needs to be extra careful with these companies because of the very high dependence on management quality.
The power of compunding is not grasped in high growth buinesses, specially when equity raise happens at high P/B levels. Human mind/nature can not intuitively grasp it.
For instance SKS looks optically expensive at 25P/E buit given the growth just one year out FY17 P/E is 18 as per my estimate. Even adjusted for normalized tax FY18 P/E would be 24x. Satin Credit FY17 P/E would be a mere 13x. This is for a super high growth business with a high ROE!
There is no activity on this thread for more than 540 days.
I thought let me rejuvenate with a new title.
Post Demonetisation and GST formalisation of economy with a new scope for AMC & Insurances has started.
As these are low working capital, high ROE and ROCE businesses there is a huge scope for this industry.
A discussion on this topic is felt necessary.
Presently the MF industry is receiving 15-20% financial savings.
Previously this figure was less than 12%.
Sipping culture has increased.
Will this result in tsunami? If yes who will be the gainers?
Members can share their inputs.
There are multiple reasons why more and more saving money is moving to equities via AMC. So yes, they seem to be in a sweet spot. I am not sure if this is a usual phenomenon as economies mature. Lending rates decrease and so do deposit interest rates. And more savings start to move into markets. If it does then surely AMCs/brokerages and platforms like BSE/NSE/CDSL kinds are up for a good time.
That said, a market fall and sustained downfall can flight of capital out of the equity. Right now, We are witnessing a transition may be.
Whats the take on GIC Re going tobe listed in next week.?
GIC Re will be a major beneficiary of crop reinsurance scheme of Modi govt and will continue till 2019 n beyond.
Just wanted to understand on why LIC accounted for over 50% of the bids fro GIC Re.What are they fore-seeing that they are investing 7k-8k crore where market response is tepid for this IPO.
My logic is LIC have to follow instructions from finance ministry to support PSUs