A deep value portfolio - critiques invited!

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First time poster on VP, but long time lurker/reader/fan. I feel like my portfolio style emphasizes valuation and consists mostly of companies trading cheap, but having re-rating potential on consistent earning performance.

Hinduja Global Solutions - 20% (low P/E, high growth in healthcare in US, demographic tailwinds)

Sunteck Reality - 14% (low P/E P/BV, Promotor Buying, Ajay Piramal stake, high quality execution)

Sintex - 8% (P/E rerating after demerger of plastic business, KKR efficiency in plastics)

Jindal Poly - 6.5% (absurdly low PE both cyclical/adjusted, high volume growth and execution)

Inox Wind - 6.5% (debt/WC overhang due to high growth, PE rerating inbound with 25%+ growth)

Eldeco Housing - 5.5% (~3x trailing P/E, consistent dividends with dividend growth so real earnings)

Vivimed Labs - 5.5% (transformation from spec. chem to API to generic pharma, P/E rating change)

Infinite Computer - 5% (undervalued with consistent buybacks multiplying returns, great underlying business)

Gujrat Heavy Chemical Limited - 5% - (see VP)

Llyod Engineering - 4% - (cheap, proxy to consumption story though retained OEM business)

I also hold the following positions:

Short Page Industries (64x+ P/E, all possible positives priced in, any negative may lead to re-rating)

Short Divis Laboratories PUT options APR (taking advantage of Mr. Marketā€™s fears on Divis Lab)

Iā€™d appreciate any criticism, suggestions or questions.

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2

Only problem with owning deep value company vs those that is under change is that holding period for deep value may be too much and even though underlying buisness is doing good market wonā€™t rerate the stock due to some correct or wrong idea about the stock.

For example 1 year back I calculated that even though there is low growth and limited products infinite computer is worth 400+ but trading at 220. So I bought a lot of it and waited and waited but nothing happened , finally sold and bought stocks that were undergoing some changes which caused the market to rerate the stock much more faster.

But the problem is the companies undergoing changes are very few and those might be priced with narrow margin of safety.

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3

Deep value require deep patience. If you can carry that behavioral aspect you will be the winner. It is easier to preach than to practice.

I like Sunteck Realty out of the pack. I am not covering other stocks.

All the best.

Cheers,
Amit

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Agreed with you 100%, which is why I try to identify possible triggers for a re-rating. To give you an example of a trigger for infinite global, is that the company is buying back shares at 6x P/E. What this means is instead of owning Rs. 100 of bonds (that give an Other Income in form of interest of say ~Rs. 10/100), the company buys back Rs. 16 of earnings per Rs. 100 earned, thus allowing the company to reinvest money at a 16+% RoI. Hence I believe that the large buybacks done by the company (~15% of market cap) if done regularly can increase EPS by ~15% CAGR, and with a top line growing at another 20%, we can see some absurd 30+% growth., in EPS every year, so even in absence of P/E rating I feel stock is a great buy.

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Agreed with you. I have been holding some stocks for a long time with huge Opportunity Cost (e.g. Sintex since 2014, HGS since 2015), but it has paid off in the form of some large winners (HGS, Sunteck, Sintex, Jindal Poly etc.)

Thanks for your comments!

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If you read the books by Ken Fischer, he makes a very valid point (backed by data)ā€¦that the value investing strategy performs well in tough times while growth / momentum strategy performs well in a bull market.

So before deciding on particular stock selections, what is your overall view of the market and the indian economy? And how well is your portfolio aligned with that macro view?

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I try not to take a view of the market, but yes, I generally hold better quality companies during the start/mid bull market and gradually sell off as valuations increase. I am more of a bottom up stock picker, so I donā€™t mind shorting some stocks in F&O too in order to isolate myself from broad market trends (beta)

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Keynes said it aptly decades ago- ā€œThe Market Can Remain Irrational Longer Than You Can Remain Solventā€

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9

The good thing about buying stocks without margin is that you donā€™t have any risk of insolvency. As for the short on Page, its a risk iā€™m willing to take, and Iā€™ve adequately kept margin reserves.

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Obvious concerns would be the Page short. We would agree that stock is quite highly priced but business is still healthy and consistently giving healthy growth. Generally big short traders look to short businesses which are fundamentally flawed and overvalued and typically are saddled with bad balance sheets (high debt etc.). These are triggers for big corrections over time. Well run businesses worst case may just be re-rating to PE 30 but if business continues to grow it may not give you much returns on the downside.

Scott Fearon in ā€œDead Companies Walkingā€ ( a really good read) writes he like to short companies which he sees going bankrupt in 1-2 years so that he will not even have to cover his short.

Again this is my personal POV and I am not an experienced short trader anyway. But I just see much lower upside vs. downside risk on this trade

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Regarding the Hinduja and Infinite Computer, though valuation looks enticing, my understanding is the underlying business going through major changes.

Healthcare BPO is booming but there is the significant investment the clients are making on process automation also. Hence not guaranteed that the Hinduja/Infinite might see stellar growth for rerating.

Would like to be corrected on this like with the robotic process automation, the Indian healthcare BPO will benefit?

Now with underlying business uncertainties, is the price cheap enough to hold on?

Donā€™t hold positions in any of the stocks.

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Thanks for the insight. I agree with you on that an ideal short would be a ā€œdead company walkingā€ (will read the book), but as far as Page Industries goes, its a valuation short. The near term trigger I see for the stock lies in its shareholding structure. I believe Pageā€™s insane valuations as a result of retail investors chasing a good stock too far because of its low float. When the institutional money starts selling Page due to the limited potential upside, theyā€™ll find few buyers for such a large chunk of stock at that price. As Porinju puts it, "Page is over-priced unless govt makes it compulsory to wear 2 underwears, like superman :slight_smile: ". I expect PE funds that invested at Page at under Rs. 1,000/Share to exit in the near term, which can lead to a rerating. A re-rating from the insane ~64x trailing PE it is currently trading at to a more sane ~30x multiple would lead to a profit of nearly ~70%+ with rebalancing (for constant exposure). This low downside risk (if Page trades at an astronomical 80x P/E) is one that Iā€™m willing to take

source:

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Absolutely. I think whats interesting in the case of HGS is that they are constantly moving up the value chain, and their automated process outsourcing division is showing huge growth (Colibrium has doubled revenues since its acquisition by HGS). HGS aims to move its existing low margin BPO business into a low cost high margin automated outsourcing business.

As far as Infinite goes, the space of outsourcing is growing at a huge pace for them, and I trust the management outlook on the future.

Both HGS and Infinite are priced accordingly to no growth in the next 5 years, so I view any growth as having delivered more value than the measly ~3/4x multiple I paid for these companies.

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@sarangg

Good list mate!!

My two cents, given we have a few holdings in common and a few i studied!!

While investing in value portfolio, i prefer to have companies with some trigger in near term (like in a year or two; something to bring it to notice and possibly revert to fair valuation). I feel it necessary or otherwise these stocks may just keep on languishing. Example, Sintex with demerger news in September and textile story even older; but nobody bothered and now so many brokerages are coming out with buy on Sintex and value unlocking from demerger :slight_smile: !!!

commenting below on some i am familiar with:

HGS: I like, good revenue growth. Profitability stuck because of Canadian operations, BPO acquisitions etc etc. Less likely to be disrupted from the Trump/ Visa/ IT issue, given they have aggressive hiring plans in Canada. Good dividend and cash flow history; i continue to hold from lower levels of c.450/ share.

Jindal poly: Well if your thought is low PE; note that it has historically traded at low levels only. If PE expansion didnā€™t happen in last few years, when duds were flying like rocket; what makes you think it might happen in next year?

Sintex: we discussed above.

Inox: Be cautious; its a value play, but their product quality & future lineup is not that good as Suzlon. This might just result in market share shifting to Suzlon (actually a trend is already visible). I am invested in Suzlon; but if you want to avoid debt, might have a look at proxy- Sanghvi.

Eldeco: I have bought a home from them in Lucknow, big setup coming up. They have a good reputation in that area; but i think that is not visible in numbers and possibly because the group operates through multiple entities. So projects might not be coming in this one.

Short positions:
Page: Agree with your point on valuation of Page; but in downturn quality stocks fall way less than mid or small caps and in uptrend, nobody goes down. This might be an under-performer for a while and thats how, might reach fair value; rather than dropping like a bomb.
Also, depends on how you built up this position; if yours is a relative bet, lets say to NIFTY (Buy nifty and short page), you might have to rollover next few quarters and answer margin calls, before Santa Claus answers your call. But Outright short, i am not sure how great that idea is, good luck!!

Divis: Mr Market is fearfull, but at times comes back with vengeance. Example, wellspun, where i made some good money, buying after the Egyptian issue. on Divis, some of their products are exempted from import Alerts, their CRAMS business to continue. Maybe the impact on valuation front is overdone; although not an expert, and so not buying here (for now)!! But any move (either up or down) would be a sharp one, around June quarter results, as the impact will get clearer. Also, i think their other unit is yet to be visited by FDA; keep your fingers crossed, if that happens sooner, you might get lucky.

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Hi Narender ,
I like to know what are the products that suzlon will offer but Inox wind wonā€™t when it comes to WTGā€™s?Or are you referring to some different product line , can you please share some more information ?

My understanding is that in the current situation where size of market pie has increased both have managed to acheived growth and managed to grab a bigger piece of the pie . Suzlons grabbed a much bigger share than Inox wind ? Sure! But Inox is also growing because overall market is growing rapidly

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Suzlonā€™s latest S111 2.1 MW turbines for example are unique and have a better PLF and so more efficient. Considering Wind is now competing with Solar, innovation is very important and Suzlon is better invested on this front than INOX Wind.

Disc: Invested in Suzlon from 13 levels.

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For me its a psuedo-relative short, since I hold long positions in stocks, I expect around market return from them, and hence in good times I can offset these losses.

As far Divis goes, I am not shorting Divis Lab, in fact, I am shorting put options on Divis Lab because I believe it is a great buy if it fell more, but I donā€™t mind missing the price appreciation because of the high premium on options.

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I think the idea of value investing is against shorting. I will explain how: one of the basic principles of value investing is that the mean reversion would take place - which means the investor following the principle of value investing knows that what will happen but not when it will happen. This is okay with holding of long positions with excess cash one does not need in the foreseeable future so that even if for a long or short time, the ā€˜whatā€™ call goes wrong - one is never a forced seller and hence one is never someone who acts against the very fundamental principles of value investing (buying low and selling high) by being a forced seller.

However, by taking short positions, you canā€™t call your positions as part of ā€˜deep valueā€™ since deep value by definition is one extreme of value investing. This is because in your shorts you can be a forced buyer (what if Page doubles in next two months) and you have exposed yourself to potentially unlimited liability which can happen anytime - markets may be irrational and their irrationality can increase multifold. This, in my opinion, is against the principles of value investing. I am also not aware of any short positions that Graham (father of value investing) ever took.

On a separate note: I would suggest avoiding putting too much importance to too media friendly investors like Porunju. I think that the best of the investors are rarely so marketing savvy and media friendly as this guy is.

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First of all, agreed on listening to Porinju - I am definitely not the biggest fan, but I donā€™t have to be a fan to completely agree with him on his quote from my own research.

Secondly, while I broadly agree with your points, I try to set aside enough cash to cover any M2M loses I could incur on the position, and to that effect, I can currently cover my short to a ~20% upside, and can mobilize cash for a 100% upside. The real question to consider then, is what are the odds of Page going to a 120x P/E for what is essentially a branded widgets firm. To this extent, I think that if Page doubles (market irrationality), I expect my portfolio to atleast double if not triple, and hence because of the inter-correlation between Pageā€™s returns and my Portfolio returns, I donā€™t feel like I am taking an outsized amount of risk.

I agree with you on the main points - clearly, having to cover a short opened at 60x at 120x is undesierable, but you ignore the correlation between losses on Page, and gains on my other portfolio. Its more of a midcap hedge than a ā€˜pureā€™ short, but at the same time, I think it has a high positive expected value.

In summary, I expect my position in Page to have a significant and positive impact on my realized sharpe ratio, due to its volatility smoothing effects day to day.

BTW: Page futures have been trading in backwardation for a long while, indicating large F&O shorting action. I expect any upmove in Page to be capped by such shorts, now that Page is in F&O

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I also used the recent correction/volatility to rebalance my portfolio.

NSE:HGS 20.1%
NSE:PENINLAND 17.5%
NSE:INFINITE 15.5%
NSE:INOXWIND 8.8%
NSE:LLOYDELENG 7.9%
NSE:UJJIVAN 6.1%
NSE:VIVIMEDLAB 5.8%
NSE:SUNTECK 5.5%
NSE:GTLINFRA 3.7%
NSE:PURVA 2.7%
NSE:MTEDUCARE 1.2%
NSE:AUROPHARMA 0.7%
NSE:PAGEIND -17.6%