Introduction
Investors usually look for bargains in the street. Anything with the word, ‘free’ is really exciting. Is not it? Marketers play on this weakness of buyers and promote their products enticing the gullible public with inherently false, deceptive, and misleading advertisements. Is there a free lunch available in the stock market? If yes, how does one find the discarded cigar butts(beaten-down companies trading below a conservative assessment of their liquidation value) that cost a penny but will offer a kick in the belly? A few puffs that come with discarded cigar butts without spending a penny. The idea may look preposterous but, most investors fall into this trap with frustrating regularity. Let us look into this question more closely.
What is Cigar Butt Investing?
According to Warren Buffett, the Cigar Butt’s approach to investing is where you find a pathetic company available at a ridiculously low price that compels you to think there is one good puff left in it. The stub might be ugly and saggy but the bargain purchase would make the ‘puff all free’. You buy a company that is pushed to the wall and struggling to survive in a brutally competitive market. It is a ‘stretcher case’. But you think a final push in the prices happens (which you think is the free puff) that allows you to take one last puff and discard the stock, thereafter.
Easy to find cigar butts?
Can you find absurdly cheap stocks that are ignored, discounted, and discarded by almost all investors? If everyone has a deep-rooted hatred against a company, that must be for a valid reason. Promoters’ integrity might be in question. Books might have been cooked up. Revenue and profit figures might have been inflated. There could be multifarious reasons for a stock to be beaten like a dog in the street. Never is there one cockroach in the kitchen. As soon as one problem gets resolved, another may crop up as it happened in the case of stocks belonging to Anil Ambani. (Reliance Power lost 95 percent value; Reliance Capital lost 98 percent value; Reliance Communication lost 99 percent value and Reliance Infra lost 90 percent value and most of these are on the death bed as things stand now). Unless you examine the pros and cons carefully, the chances of getting it wrong are pretty high. Also, can the entire Market be wrong and you are the only intelligent guy to pick such cigar butts that can offer mouth-watering returns in a short span of time? Every company, these days, is subjected to close scrutiny from tech-savvy investors, analysts, fund managers, and bankers and there is very little chance of finding stocks that are dirt cheap—even in the short run.
How to identify cigar butts?
It’s a tough nut to crack. To cite specific examples, you think the scrip, PC Jewellers has fallen from Rs. 600 to Rs.100 and think there is deep value in it. You begin to buy. It falls further. You tend to average to cut down your losses. The stock sins to atrociously low levels—say to INR 20. Thereafter, the stock begins to consolidate for a painfully long time. It does not move at all and would lie there in a limited range between 20 and 25 for months together. You get frustrated and book your losses. To take a recent example, Paytm’s initial public offering price was INR 2150. Big FIIs and DIIs have participated in the IPO. Warren Buffett has picked up a stake some time back. Everything looks fine. After the IPO the stock tanks, when questions are raised against the Promoter’s capital allocation policies. The stock falls by 50 percent within a month. Then falls again and again. Nearly 75 percent of the stock’s value is gone within a short span of time. Is there deep value in the stock? If not, why the FIIs and DIIs are still holding the same? Why Warren Buffett has not taken a call? Does it sink further? How long will it lie in the dustbin? No one has answers to these nauseating questions.
Does this approach work at all?
There could be situations where a stock might get punished too harshly, whenever questions relating to corporate governance, promoters’ integrity, etc are raised. It can happen to even good companies due to wild fluctuations in currency, sudden accidents in a plant located in a different country, regulatory changes in domestic and international markets, etc. in such a scenario, analysts project a gloomy scenario, and investors tend to desert the stock in a hurry. The stocks in question might lose their sheen and value temporarily, offering a great investment opportunity. But you never know when the situation might turn positive. If one is patient enough to wait for painfully long periods of time—till the dust settles down—one can buy such stocks for enormous gains. In conclusion, one can certainly follow the voice of reason, as advised by Warren Buffett: “It is far better to buy a wonderful company at a FAIR PRICE than to buy a fair company at a wonderful price”
It works sometime but then one has to take call after meticulously analysing the stock. Take a case of Reliance Infra ,it was languishing between 12 to 30 last year. But then efforts of promoters in reviving the company has already started paying off. Promoters have reduced debt from 31000 Cr to 14000 Cr.in last five years.They had infused capital and subscribed to preference shares at Rs 62 per share . This has taken promoters holding from 4.9 % to approx 23%.They had recently won an arbitration award of 7200cr in SC against DMRC. Management had already clarified that this money will be used for further reduction of debt. The company is likely to be debt and default free on standalone basis very soon. The book value of stock is approx 430 plus. Stock has recently seen a high of 150 and now it’s consolidating around 115.
Reliance Infra might certainly fit the bill, but for the promoter’s whimsical and unethical actions spoil the party every now and then. Stocks like PTC merit investors’ attention since the fundamentals are very strong. With a book value of 175, EPS of 16, dividend yield of almost 10 percent, it is a gem of a stock that has taken the beating because of governance issues in a subsidiary company. The promoters of PTC --the four PSU gems–have excellent credentials. Once the stock comes out of the mess created by PTC Financial Services, the stock can double from the current levels. The same is the case with stocks like PFC & REC that have been punished for no apparent reason, other than the questions raised against their lending practices by analysts every now and then.
@VSPRAOO :-
The important point to consider is - why did the stock became a cigar butt in first place? There can be various factors at play and corporate governance is just one of them. Your opening post reflected only those cases and then reached the Buffett conclusion of buying quality stocks at reasonable prices. In fact, the 2 factors in this statement - QUALITY and REASONABLE price are equally, if not more, subjective than the cigar butt idea.
I have a few cigar butts examples that were cheap for a reason but then went on to become more than thr last puffs. Will share those in future posts in this thread to keep the discussion moving forward. For now, I request you to go thoroughly in VP posts to find those examples yourself. Others can pitch too.
The mentioned thread is a sort of summary of such examples.
Currently, in an overvalued, overheated market, i find deep value in PTC India. But for the governance issue in PFS, the stock should have gone past 120 or 130 mark comfortably. I also like Dilip Buildcon, which is on the recovery path. Mastek has been one of my old favorite stocks. Reliance Infra is the momentum play that has given good returns. All the picks that you mentioned in your post have given fantastic, mind-blowing returns. If you find any such gems in the current market also, please share.
Cigar butt investing is for truly courageous, or gamblers or the third category which is more likely to be successful. The category is of Peter Lynchs, Ramesh Damanis, Madhu Kelas. Not because they have the midas touch, but because they can actually visit the factories and grill the promoters. Bankers give them time. For ordinary investors only the balance sheets and profit and loss accounts are the tools of assessment.
Recently I have gone through the portfolios of some of the super rich, and have left wondering what they saw in a company-to me it looked like dead loss. But then I assume perhaps they know something I don’t. May be there is more to it in Panama Petro and K R Infra. But me? I will never put my hard-earned money on blind faith in some big investor.
I see in general and also on Quora that the penny shares have a mesmerising effect on a really small investor. He has wistfully heard the Ruchi Soya story, but having neither patience nor common sense enough to really analyse a story, he wonders if Yes Bank may be the next HDFC or whether Vodaphone is the doorway to the riches.
A turnaround company is a dream come true, but how many really find a Satyam?
Hi,
U are confusing Cigar Butt investing with Penny stocks here.
Penny stocks are low priced stocks where majority of businesses are low quality and have known governance problems. One is speculating here purely as a big trading move which might result in a one time pop gain( kinda pump-and-dump). Your assessment is correct here that retail investors should stay away from these cases.
Cigar Butt investing, on the other hand, is a form of value investing whr uncertainity surrounds immediate future earnings but the company has financial power in the form of assets, investments, resources etc. that vl help it survive and probably grow. The delta in expectations is the puff that value investors sniff and try to make gains from. Now few further points here :-
1.) Investments going bad - Some cigar butts do lose out as the expected earnings recovery doesn’t happen or happens with a bit delay
2.) Mgmt - Quite the reverse of what u stated, the expectations discounted in the price of Cigar Butts more than factors for bad mgmts. So as long as basic checks are done, retail investors are fine here. Meeting and assessing mgmts is optional.
E.g of few present past Cigar Butts - Newspaper cos - Jagran, D.B Corp., Godawari Power(when it started debt reduction), S. Chand in COVID, Repro India etc.
Disclosure :- Invested\Was invested in sm of the names mentioned
Cigar butt meaning those cogar where a last puff is remaining and you invest in them to get benefit of that last puff.
If these companies have potential to grow then they cant be called cigar butt companies.
Cigar butt companies are necessarily dying companies with last puff still stuck in them and they are getting almost free.
The butt and puff isn’t to be taken literally in the sense that only 1 puff chance is left and cos. are dying.
Who knows thr might be not one but more puffs thr once investors start smoking…
They are called Cigar butts bcoz they are priced for dying - selling at 1x or less multiples. I recommend reading Prof. Bakshi’s - From value to Glamor case study on SRF for more clarity on this.
Puff is that cos. survive and once they do, thr are few optionalities that materialize and eventually one puff becomes few more. Yes, quantitative value investors might sell once they hv had thr puffs
Exactly. This is the meaning I got from Making of an American Capitalist, and Snowball. The idea was a fad of Ben Graham, as far as I know. This also means a down on its knees company. Never fancied the idea.
From_value_to_glamor.docx (16.9 KB)
Attaching the doc here for reference. Go thru the SRF case here and see if that is(or not) the idea of Cigar butt.