Yogesh's blue chip 10 Portfolio

(Yogesh Sane) #265

My buy range is when price falls below fair value. Its that simple. the difficult part is finding fair value. My valuation model is described here. I use it extensively to get an estimate of fair value. Calculation depends on how well one understands the business so everyone will have a different notion of fair value.

Fair value is dynamic. It depends on earnings, risk premium, interest rates, growth rates, news flow etc. There is always something that will change every day. Some events will have larger impact than others. On an average, I think these stocks are still overvalued so a 20% drop from here will be a good low-risk entry point. It does not mean I expect these stocks to drop 20% from here. It only means if a stock 20% from these levels, risk of loss of capital will be low buying at that price. A stock gets into this list if I am willing (and able) to buy more of a stock if it drops 20% due to valuation reason. If a stock will appear overvalued even after a 20% drop then its too overvalued to be shortlisted.

If you have track shrimp prices, who’s selling stake, custom duties, production in China etc (factors that companies themselves cannot control), then it means stocks are priced to perfection and investors are on the edge of their seat. Investing in such a situation mean expected return will be average (approximately 10-12% for a basket of stocks). Investors weren’t worried about these factors when stocks were selling at single digit PE ratios few years ago.

IMO, buying right company is more important that paying the right price as long as you are not paying an exorbitantly high price. I think its not too difficult to tell if the price is too high. you don’t need a complex valuation model for that.

(Yogesh Sane) #266

Tracking management quality is difficult. Numbers tell you half the story. But since this is an important aspect of investing so can’t ignore it. I use following criteria / numbers.

  1. Return on equity - Efficient management will generate an ROE of 20% or more consistently. Less than 15% is low and more than 25% is excellent. A high but falling ROE is worse than a low but rising ROE.
  2. Leverage - Management should be able to generate good ROE without using too much leverage. A high leverage means that returns are coming at the cost of increased risk that has not materialized yet. Less than 2 is good for non-financial companies. It is also important to see if leverage is by choice or by compulsion. If a company is generating free cashflow, then it has a choice of repaying debt, reinvest in gross block or pay dividend/buyback shares. All three will benefit shareholders. It it chooses to keep the debt and has enough stable cashflow to service it, then its not a problem. If the company has debt because its cashflow is too low, then its a red flag. In this case, at least ratio of gross block to debt should be rising as that would mean at least some growth is coming from internal accruals so over time debt will not explode. Stable cashflow and high margin is must for highly leveraged companies.
  3. Return on assets - This is the return that management has generated before financial leverage kicks in. double digit ROA is good (for non-financial companies). More than 20% is great.
  4. Gross Margin - A high gross margin means company is adding value. Low margin generally leads to low ROA and high leverage. more than 50% is great. Less than 30% is too low.
  5. Cashflow - A good management should be able to convert sales into cash else it will get into debt trap. Efficient working capital management is important (receivable days, inventory days) to maintain cashflow. Cash profits should be close to PAT on a rolling 3 year basis.
  6. Information disclosure - Management should clearly disclose important operational metrics (capacity, production, order book, disbursements etc) at least annually preferably in annual reports. If I have to dig out the information from conf call transcripts, press releases etc, then it is difficult to build conviction. Companies that do not disclose this information are generally more volatile than those that disclose it. Companies often talk a lot about macro factors but fail to give vital information about their own companies. Too many glossy pages in annual reports or too many slides in IR presentation is a distraction and a red flag to me. It does not take more than 4-5 pages to communicate performance of a company.
  7. Money coming out of the company - A good management will not hoard cash. It will pay taxes, dividends, buyback shares, repay debt etc. If the company is only taking in cash but it is not coming out then its a red flag to me.
  8. Executive compensation. - This should not be too high but should not be too low as well. For really small companies this tends to be an issue as absolute compensation appears to be a high % of PAT. If there is a lot of gap in compensation of promoter directors and other senior managers, then company is likely to be a one man show. Growth in compensation should be in sync with growth in dividends. Exercise price of ESOP should be close to market price on issue date.
  9. Growth in dividends - Typically dividends should grow at the rate of PAT.
  10. Debt and liquid investments together on the balance sheet is a concern to me unless there is enough justification for it.
  11. Persistently low PE, PB ratios is a red flag to me. Markets can be noisy in short term but in long term it figures out management quality pretty well. If a company is trading at a deep discount for a number of years then earnings are not driving the stock but management quality is. I prefer to stay away unless there is a good reason for it.
  12. Credit rating, cost of debt and accounts payable should be within normal ranges. If the company is rated then it should be at least BBB. Cost of debt should be not too high, 8-12% is normal range. Anything more means creditors are considering the company to be risky. Accounts payable is a good indicator. If vendors are not offering credit, it reflects badly on management as these are first in line in a liquidation.
  13. Assets in emerging markets or tax havens - Unless a company is a predominantly in export oriented industry (IT, Pharma etc) having lot of fixed assets in poor countries in Asia or Africa is a red flag to me especially if it is a small company. Having a sales, office, customer service center, warehouse etc is fine but having manufacturing facilities or other fixed assets in countries with capital controls is a red flag to me. There are many good companies with overseas assets so this is not a general rule but too many times I have seen these overseas fixed assets is nothing more than a money laundering / siphoning schemes.
  14. Common pursuits - This is another difficult to find issue. If promoter or its immediate family has a similar line of business as the listed company, there can be conflict of interests.
  15. Complex corporate structure is also a no-no especially when company is small and has only few lines of business. If majority of business is coming from subsidiaries, its not good. I prefer majority business to come from parent company. companies that disclose consolidated statement only annually when a large business comes from subsidiaries is a re flag. Construction companies are a good example. they have subsidiaries that are loss making with heavy debt that operate projects on a BOT basis but information about these subs is disclosed only annually.

these are just few points at the top my my head. Often the visual screener I explained here will help me spot a pattern of a good or bad company. No company will meet all the criteria above but its the combination of several factors that ring a bell.

(saurabhshares) #267

Yogesh, Thanks a lot for your response. It was quite helpful. regards, Saurabh

(Bheeshma Sanghani, PhD) #268

Amongst the others outlined, this one is a good point as there are several cos that have this tendency to hoard cash for years without paying out or doing buybacks. This often points to a business which has run of out opportunites and this directly impacts the valuation in a negative way. Several IT cos which otherwise have good margins are very stingy with cash and non cash distributions. Not only IT, newspapers, tyres, auto etc all have such cos

(rskothari) #269

@Yogesh_s any change in exclusive blue chip Portfolio. What is its structure as of now (Enterprising and Defensive)
Thank you for sharing generously.

(Bikram11206178) #270

@Yogesh_s Regarding Nitin Spinners ,Can you please explain why they have a huge d/e ratio ? are you comfortable with the their high debt ?

(Yogesh Sane) #271

Low maintenance portfolio is re balanced annually towards end of the year so no changes since the last update in Dec 2017.

Textile companies are leveraged as return on assets is low. they also get interest rate subsidy from government so they borrow just to take advantage of that and pass on the benefits to customers so leverage is high across the industry while return on assets is low.

A high leverage is OK if cashflow is good enough to service it. Also most of the leverage is used to build fixed assets and not to fund working capital. Ratio of fixed assets to debt is rising which means at least some of the fixed assets are funded with internal accrual. This is an indication that cash flow is large enough to service debt, fund working capital and part of capex. Cost of debt for Nitin is 6% and expected to remain low due to subsidy. I also look at interest cover to see if leverage is helping or hurting equity. A rising interest cover means leverage is helping. Anything more than 5 is acceptable. Return on capital is also higher than weighted average cost of capital so there is some value added. And finally they raised some equity earlier this year to bring down the leverage.

(Bikram11206178) #272

@Yogesh_s Thanks a lot for your response . one more query regarding beekay steel , Why did you like Beekay steel over prakash industries and sunflag ?? .I think both beekay and prakash industries ROE and ROCE are same , Beekay steel has more debt than prakash industries and inventory days for prakash industries is less. Leverage ratio is also high for Beekay steel .
Thanks in advance :slight_smile:

(Yogesh Sane) #273

Prakash Industries and Sunflag are integrated steel producers while Beekay Steel is just a rolling mill. Risk-Reward characteristics of these companies is different because they will benefit differently at different stages of steel cycle.
Beekay’s ROE will be high for FY 18 as its utilization has improved in FY 18 and expected to remain elevated for FY 19 as well given traction in steel demand.

Disc: Invested in Beekay Steel.


Wasn’t Bhushan Steel also rolling mill. Do they really have high RoE biz model or it something special about Beekay

(adeepsandhu) #275

Bhushan Steel has rolling mills for rolling HR & CR Coils. It’s is a different ball game all together when compared to Beekay steel who are rolling primarily TMT Bars & Sections.

I would not be too bullish on Beekay Steel on fundamental basis as the product line which they are in is very competitive and lack of Moat in this business.

Disclosure: Not invested. Not Interested.

(Yogesh Sane) #276

Bhushan Steel is an integrated steel plant so it has a rolling mill among other things.

(Yogesh Sane) #277

Caution: This post is heavy on statistics

Yesterday when Sensex hit new high while mid and small cap stocks remained in bear territory, I began to wonder if this is the first time such a thing has happened and what can be possible reasons behind it. Besides the reasons listed in my earlier post, I decided to use number crunching to see if there is any explanation.

Movement in stock indexes can be broadly explained by two factors, trend and shock. We know that stocks go up over long term and over the last 25 years Sensex has gone up at a CAGR of 12%. That’s the trend growth. But the journey hasn’t been in a straight line because market was hit with a series of shocks which caused Sensex to trade way below or way above the trend line. Over time, these shocks recede and market returns to trend level only to get hit with another set of shocks.

As investors we are interested in knowing if the market has gone too far away from trend as a result of these shocks. In other words, we are not interested in the trend growth (as it is predictable) but the shocks as these are unpredictable.

I used a statistical technique called Trend Stationary Time Series analysis to remove the trend component in Sensex so that the residual will represent purely the shock component. I then calculated the ratio of actual Sensex value and trend value to know the effect of shocks. I performed the same analysis for Small-Cap index. Chart below shows Actual / Trend lines for these two indices.

Source: BSE

A value of 1.22 means that Sensex is trading 22% above (+ve shocks has pushed the Sensex above trend) trend while a value of 0.6 means Sensex is trading 40% below the trend line due to -ve shocks.

As you can see in the chart above, Small-Cap index is significantly more volatile than Sensex. At the peak of 2008 bull market, it reached as high as 170% above trend. In 2013, the small cap index reached about 40% below trend almost as much as the trough reached in 2008 crisis. No wonder there were bargains in small cap stocks in 2012-13.

Sensex on the other hand has seen volatility drop by a huge margin since the 2008 crisis. Prior to that, index used to trade way above or way below trend, but in last 7 years, Sensex reached 22% above trend only once at the peak of 2014-15 Modi rally. Other than that is trending close to trend value i.e. neither going too much above the trend nor going too below trend.

In 2017, the euphoria in small and mid cap stocks pushed the small cap index (and Midcap index) to as high as 26% above trend while Sensex was trading withing +/- 5% of trend. Only time Smallcap index traded this high above trend was prior to 2011 when economic stimulus caused stocks to rebound from crisis low. As the euphoria receded, small caps went down in 2018 and now trading close to long term trend value. Since Sensex was always trading close to trend value in 2017 and 2018, there was no fall in Sensex.

Only other time, a similar move happened was towards the end of 2010 when small caps began to crack while Sensex was trending up. Although at that time both indices were way above the trend value so in 2011, both went down together. While Sensex stabilized around the trend line, momentum and liquidity squeeze carried the smallcaps further down to crisis level.

On the other hand, in 2015, Sensex went down more than small and mid cap stocks as large caps that were pushed higher in Modi rally returned to trend levels while mid and small caps were already trading trend level as they had barely recovered from 2013 liquidity squeeze.

Some of the factors that were at play (Fed taper, current account deficit, FII running away, rupee crashing) in 2013 are also at play in 2018. However momentum is not as strong so we may not see 2013 like valuations in 2018. even if we do get to that level, 2013 turned out to be a great time to pick small and mid caps and 2018 might as well.

(Arun S G) #278

Excellent dissection ! Are you using Matlab or equivalent for computation?

(A. King) #279

Story of company in 40 Charts - Is this a google sheet?
Would you consider sharing ?
If already shared, please advise.

(Nitin ) #280

Thanks for such a useful information…

(Yogesh Sane) #281

I used Excel for this analysis but Matlab will be easy as it has a builtin Detrend function.

(Yogesh Sane) #282

It is not a Google Sheet. I use desktop version of Excel. I can’t share it as I can’t share the data from the corporate database. It is a single user licence. Almost the same data can be downloaded from Screener into Excel.

(roy) #283

Hi Yogesh,

I really like this idea. I’ve been contemplating stopping my Mutual Fund SIPs and simply investing in a Nifty100 ETF. However, it’s always bothered me that buying a NIFTY ETF would force me to invest in companies Iwouldn’t touch otherwise. (Yes, MFs have the same problem).

I’ve now decided to start a smallcase (on Zerodha), selecting 20 companies from the Nifty 100 using a simiar logic to yours. There are a couple of questions I had:

  1. When you started we had no LTCGs. With the 10% LTCG tax have you changed your strategy of bootstrapping the portfolio every year?
  2. Although, I’d probably be creating a smalling and SIPing in it, which month do you bootstrap your portfolio?


(Alok Bhola) #284

I have always believed that large cap investing cannot give you outsized returns. Hence, when I recently came across this thread, I became curious to find out the actual returns earned by this strategy vs returns from Nifty and Large Cap MFs.

I compared the returns earned by the two model portolios of this thread with corresponding Nifty and Large Cap MF Returns. As the exact portfolio buy dates have not been provided, I assumed 31-Aug-2016 as the purchase date for the portfolio mentioned in the first thread and 31-Aug-2017 as the purchase (rebalancing) date for the portfolio mentioned in thread no 94.

Hence, the comparison period is from 31-Aug-2016 to 13-Jul-2018. The returns are total returns over the period (not annualized), excluding dividends. Following are the results:

Portfolio Return: 10%;
Nifty Return: 25%;
MF Large Cap: Average about 23% (Range from 12% to 35%).

Off course, the comparison period (slightly less than 2 years) is not adequate for arriving at any hard conclusions but the results have cemented my existing belief that MFs are the best way to invest in stock markets for people who neither have the inclination not time to analyze and invest directly in stocks.

Among the various MF Categories, Mid and Small Caps have outperformed Large Caps over long periods. For eg, over the 15-yr period ending 31-Dec-2017, while Mid & Small Cap MFs have multiplied the initial investment 30-fold, Large & Mid Cap MFs have only multiplied 19-fold. Pure Large Caps have done even worse.