Investing Basics - Feel free to ask the most basic questions


#606

The dividend income will be recognised by a company when it’s entitlement is established i.e. after approval of final dividend in the AGM. In case of interim dividend on its approval by the Board. I want to know if a subsidiary company declares interim dividend, how it is treated in the accounts of holding company in its standalone financials and in consolidated financials. In the consolidated accounts the earnings of the subsidiary will be consolidated and in the standalone the dividend is taken. Does it not amount to accounting the earnings twice. Can somebody please clarify.


(Dinesh Sairam) #607
  1. You can look at industry P/E, P/B and then try to compare it with the company’s ratios. But they’re ultimately just rule-of-thumb. They can only help so much.
  2. No. I don’t see why you should. If there’s an extraordinary dividend paid, it will reduce the P/B by a lot momentarily. But if the dividends are being paid regularly, then it shouldn’t cause that much of a difference. However, if the company is paying a very high rate of dividends when compared to the industry, then yes, it probably would cause problems in comparison.
  3. RoE is Earnings divided by Equity Employed. P/E and P/B determine how much the market is paying per unit of Earnings and Equity. So, high RoE stocks tend to have higher P/E and P/B. Once again, these are all just rule-of-thumb.

A Subsidiary’s Dividends do not form part of the company’s P&L. The usual practice is to create a receivable (Ex: Dividend Receivable) in the B/S against Retained Earnings once the Dividend is approved. As soon as the Dividend is received, the receivables account (Ex: Dividend Receivable) is cancelled against actual dividends transferred from the subsidiary.

Vice versa, the subsidiary will also deal with dividends within the B/S itself (Creating a ‘Dividends Accured’ account against Retained Earnings and then writing it off once the Dividend is paid).


(Dinesh Sairam) #608

There are largely 3 valuation methods:

1. Intrinsic Valuation: This method values a company at the sum of the present values of all the free cash flows a company is likely to produce from now to kingdom come. The most famous tools here are the DCF and DDM. VP has threads on both: DCF thread, DDM thread. These models require you to understand the company’s business. the industry’s economics, in an attempt to convert the understanding to projecting a future for the company (So, a well-informed story for the company, supported by numbers grounded in reality). The biggest risk here, is of course, model risk.

2. Multiples/Relative Valuation: Probably the most used and also the most abused valuation model. Ratios like P/E, P/B and P/CF are compared either to the company’s own history or the industry. From there, an ‘Exit P/E, P/B, P/CF’ etc are decided. Then all it takes is a projection of the company’s Earnings, Book Value or Operating Cash Flow. Then, multiplying the former by the latter will provide you with a value. You can see how easy this is to do, but also easy to misuse to fit one’s own whims and fancies. So, this is a double-edged sword. I think someone posted a very simple Multiples valuation excel file somewhere. I forget who. If someone remembers, do help out.

3. Sum of Parts / Liquidation Value: Least used, but possibly the most accurate. The company is valued at how much it would be sold for if it shut down tomorrow. The problem is, it requires a lot of expertise to determine how much each asset of the company is worth. More feasible for manufacturing companies than service companies. I can’t think of any cons in this model, because this is just very close to reality.

There’s no ‘value investing’ or ‘growth investing’ or ‘quality investing’ or ‘momentum investing’, there’s just investing, which is a search for value. What you’re asking for is whether one can predict if a company can create wealth during a specific period and destroy wealth during a specific period. With very few exceptions (Like Commodity companies, whose fortunes are highly linked to one or two factors), it’s impossible to do this.

As a side note, Warren Buffet said that a company which can survive periods of severe inflation is probably a great company. That is to say, the company can pass on the additional costs imposed on it to the customers and live to see another day.


#609

Thank you for the clarification.
It may not make a difference to total cash flow,: but,
Suppose X has 850000 shares (85%) in Y.
Y declared Rs.25 per share dividend for 2017-18.
Which was approved in AGM in Aug 2018.
Y also declared interim dividend of Rs.50 per share in August 2018.
Company X would be accounting the dividend income as other income in Q2 FY 2019.
Company X does not publish the consolidated financials in quarterly accounts.
At the end of the year 2018-19, if the EPS of company Y is RS.100, that would be accounted by X in consolidated accounts and part of the same EPS would be in standalone financials as other income.
I have this doubt in relation to a listed company.


(Dinesh Sairam) #610

Sorry, I misread your question earlier. I have edited my answer now. Hope it makes sense.

  1. Usually denoted as ‘Advances’ or such in the Assets side of a bank’s B/S.
  2. If you mean teh CASA Ratio, it’s ‘Current + Savings Account Deposits / Total Balances’ with the bank. A more likely example is, if the bank holds Rs. 100 in Deposits and Rs. 45 worth of it is in the form of Current and Savings Accounts, then the CASA Ratio would be 45%

(mvc7799) #611

Thanks @dineshssairam :slight_smile: it means the more CASA ratio tells us that there is huge retail presence for a bank and the funds are available for cheap right ?


(Dinesh Sairam) #612

Yes, that’s the likely conclusion. However, a better way is to just look at the evolution of NIM.


(AtulD) #614

@dineshssairam

Why are you calling this as double-edged sword?

If the company has a consistent growth (Net Profit/EBDT) but the current price is low compared to the average P/E (may be due to market sentiments) then is this not a good technique of valuation?

But surely, it will not be useful for new companies as they dont have the history.

Can you also help to understand, when to sell the stocks? I know the answer of this single line question is not that easy but can you suggest some books or share your experience which is easy to understand?

Thanks.


(Dinesh Sairam) #615

That’s the fallacy. Historic growth is not representative of future growth. And P/E is just rule-of-thumb as I keep reiterating. Using these two to value a company doesn’t sit well with me. But you would probably be happy to know that even Charlie Munger uses this method (But he does have a lot of insights into the business world than a typical investor).

But Warren Buffet still uses a DCF (Although he doesn’t need a spreadsheet to do that… he does it in his head). Even when Munger uses the simpler method, he invests his money with Li Lu, who again uses a DCF/DDM kind of method.

In conclusion, I would say, you can use the Multiples method if you have a lot of business insights. It gets dangerous when you use it because you think it’s simple or if you want to manipulate the numbers to fit your narrative (After all, manipulating 1-2 inputs is easier than justifying a whole set).


(sambandham82) #616

My interpretation is that If there is not much change in NPA and net profit and it’s growth, then P/E is more appropriate like in case of HDFC bank. Else, P/B is used like in case of J&K bank.

RoE= PB/PE. Did u mean this relation or anything else?


(AtulD) #617

@sambandham82 Thanks.

I just want to understand, In case of financial firms can one make an entry by only looking at P/B if the firm have consistent/increasing RoE and low NPA and low P/B compared to historical avg and/or its peers?

Is this the good approach to make an entry or @dineshssairam you are only suggesting to use DCF and ignore these?


(Dinesh Sairam) #618

I think any of these methods are fine, as long as you can justify every step of the way. I mentioned that Charlie Munger uses a Multiples Valuation method. But look at how he does it. Here’s an excerpt from his 1996 speech titled “Practical Thought on Practical Thought”:

We can guess reasonably that by 2034, there will be about eight billion beverage consumers in the world. … Each consumer is composed mostly of water and must ingest about sixty-four ounces of water per day. This is eight, eight-ounce servings. Thus, if our new beverage and other imitative beverages in our market, can flavor and otherwise improve only 25% of ingested water worldwide, and we can occupy half of the new world market, we can sell 2.92 trillion eight ounce servings in 2034. And if we can then net four cents per serving, we will earn $117 billion. This will be enough, if our business is still growing at a good rate, to make it easily worth $2 trillion.

He’s essentially doing a Multiples Valuation of Coco-Cola. But observe how we tries to justify the numbers.

I personally think a DCF is the least inefficient Valuation model. But if someone is valuing a company like Mr. Munger, I’ll be impressed.

However, many times, I see people using random multiples pulled out of thin air, aimed at calculating a value they already have in mind or justifying a purchase. That kind of reasoning doesn’t sit well with me.


(AtulD) #619

Thanks. I got your point.

The only problem in calculating the future value through DCF is it requires some experience which is difficult for a beginner.


(sumit680) #621

Hii folks…i just finished the book common stocks and uncommon profits…many of my perceptions about value investing got replaced with new concepts…i have created a checklist which summarizes the contents of the books…The aim of this list is to form a checklist for identifying the companies with long term growth prospects –

  • The long term Sales Curve
    • This will include finding the opportunity size in the market.
    • It is important to identify the consumer behaviour and needs by reading various reports.
  • The importance of research
    • The research activities may seem as risky endeavours. However it is the research efficiency which will bring new product lines in the market which will sustain the growth.
    • We need to identify the product pipeline of the company.
    • The current poor profit margins due to deep investment in research and sales promotion are the investment by the company for the future growth of the company
    • The aim of research needs be a product for which a market is readily available, already established marketing system is able to handle it and it should generate healthy profit margins.
  • Marketing and distribution strength
    • Marketing capabilities of the company by means of advertisement, brand recognition, partnerships need to be identified
    • Strength of the distribution channels for better customer reach
  • Training activities being sponsored by the company
    • Companies with long term view form the institutes catering to their specific needs.
    • Training is required not only for the research activities but also in sales and marketing.
    • These centres of excellence may open another line of products for the company.
  • Cost cutting methods being incorporated by the management
    • The modern technology should be used for cost cutting
    • The profit per employee should increase gradually
  • Human resource development
    • What is the view and emphasis of the management on human resource development
    • The turnover ratio of labour
    • The reviews by the employees of the working environment in the company
    • The gradual increase in the wages
    • The training of human resources being promoted by the company or not.
    • Productivity index of the company should improve gradually
  • The level of team work in the top management
    • While the family business are safer till the time original founder is active in the business, for consideration of the same to invest for longer duration needs a management depth.
    • No monopoly will survive the situation.
    • Does the directive style of command exist.
  • Patents
    • Type of patents
    • What kind of moat these patents provide to the company
    • Constant leadership in innovation is the key moat
  • Is the company friendly to minority share holders
    • What is its view on equity dilution
    • This point requires further scrutiny on favourable environment to minority shareholders
    • Does the management speaks freely of the expected and current difficulties
    • Payrolls of the relatives to the management needs to be checked
    • The issue of common stocks should be scrutinised regularly
  • High valuations
    • High valuations to a stock are recognition of the intrinsic qualities of the company which will derive the stable earnings expected from it…if the company is able to maintain those intrinsic qualities it will keep commanding the higher valuation as in future also they may maintain the same expectations of the growth.
    • However, in between there may come periods of slow growth and that time these stocks will tumble sharply due to failure in meeting the high expectations…such opportunities can be termed as buying times…
    • What is more important is to scrutinise such intermittent failures by interacting with the management and find their plans for future growth…find their future outlook
  • Is the company lowest cost producer in the industry
    • This factor is important in determining the ability of the company to survive the difficult times when the costs increase to a painful level…indigo is the lowest cost operator among the airline…spicejet is 18% costlier than indigo…
  • Marketing strength of the company
    • Is it able to understand the changing behaviour of the consumers in advance.
    • Is it able to sense the new needs of the consumers and highlight these requirements to convince these consumers to buy such products. Is it able to stay ahead of the curve.
    • Is there any training facility established by the company for imparting adequate marketing skills to its salesperson.
    • Is it able to balance the cost on marketing with the desired profit margins…new customers should not be gained on the cost of profit margins.
  • Budgeting and accounting within the company
    • They should be able to pin point the excessive cost generation
    • They should be able to keep a track of inventory and receivables…both on a higher scale should be avoided
  • Salary structure of the top management
    • The difference between the salaries of the no.1 person and no.2 and no.3 reveals the domination of no.1 person
    • Such a company will lack cohesion in the team and may not be able to survive as larger organisation.
  • What is the current appraisal of the industry by the financial community
    • This will decide the valuation part for that company
    • Appraisal of the market as a whole
    • Appraisal of the sector as a whole
    • Appraisal of the company in specific
    • What is the current belief system of the community about the stock
    • Is company capable enough to maintain the strong reputation among the community.
  • What are the long range plans of the management…is the management able to make long range plans

(mvc7799) #622

@dineshssairam can you please give any source to understand banking balance sheet. will refer and learn some basics
Bit hesitated to ask bit by bit


(Dinesh Sairam) #623

Investopedia itself does a wonderful job:

I don’t think there’s a specific book that explains a bank’s financials alone. But you could try getting any textbook on the topic Assets, Liabilities and Treasury Management.


(Manojlion) #624

For understanding valuation of Banks,please check out this video.I found it very useful


(AtulD) #625

ICRA on 21Sep has updated the ratings of YESBANK from Positive to Stable after the RBI’s decision.

Is it good to rely on the ICRA/CRISIL reports before buying the stock to analyse the quality of the company?


(Susindar) #626

I think they have downgraded to stable as positive means the rating is on track to be moved to a higher rating (AAA in this case). If it is stable, then it has to become positive before moving to a higher rating.


(AtulD) #627

Thanks for the reply. Just to understand -

YESBANK is still a good script to buy if we consider the ratings irrespective of RBI’s decision and the market behaviour?