Guru Mantra 16- Competitive Advantage: Racing for Uniqueness (The Second Part)

Guru Mantra 1- Identify Commodity Type Companies

Since I left job one of my favourite is Airtel, how? Strange connections, I speak to my Guru almost everyday….on various topics. I used to do that earlier, these times I decide the agenda…direction meeting.

Taking a queue from old idea, “breakfast with senior management is not to have breakfast:)”.

About My Guru- Once again I refrain from disclosing his name to honour his privacy. My guru is a Mumbai based value investor having more than 35 years experience. By education he is a BE from IIT, Bombay and PGDBM from IIM, Ahmedabad. He worked for 5 years with erstwhile Lehman Brothers and Mitchell Madison Group before landing in Mumbai and plunged to value investing. Guruji has a created a envious wealth and knowledge all these years. On record and by heart he is inspired and taught by none other than Chandrakant Sampat.

I will try to send you all the Guru Mantra’s one by one. I am trying to package them one by one, they don’t relate to specifically value investing…can be economics, philosophy etc.

First lesson is to identify sick type of business:

I asked Guruji how can you call commodity type business as sickness! He said thats what it is and I won’t give a single rupee to them. The only way they should survive by government patronage, govt can collect taxes from me as a citizen nothing more.

Who are sick type: Few examples

  • Airlines
  • Producers of raw food stuffs (rice etc)
  • Steel producers
  • Gas and oil companies
  • Paper manufacturers
  • Automobile manufacturers

He says lets face it, would you bother to go by Indigo from Bangalore to Mumbai if you have other options at same time at same cost. I probed what if airlines like Vistatra who wants to lock in customer via loyalty programmes. He immediately replied you can’t have programmes without incurring profits and whats stopping others to launch such programme. If Indigo is not launching something we need to understand why!

In commodity type businesses the low cost producer wins. This is because low cost provider has larger profit margins which gives it more freedom to set prices at level that drive out the competition.

Relationship between revenue and inventory

Best situation is high inventory turnover with high profit margin. At moderate you can go for low inventory turnover and high profit or high inventory turnover with low margin. Look for the guys having low inventory turnover and low margins.


Low ROE indicates poor business economics created by commodity type of products and pricing. This is one subject we will come back later, without ROE value investing will not be possible.

Absence of brand name or loyalty

Don’t get confused with a retailer like a Big Bazar which creates a reputation with their name but they can’t make a profit unless they have high inventory turnover as low profit margins are attached to business.

Presence of multiple producers

If you find 7-8 names for something you known war has begun.

Organised Labour

Some industry like Sugar, Tea in India have organised labour for centuries. The moment there is a boom in business they make a beeline to snatch the profit away. On other hand Software in India have the nicest people who can work without increment over the years. You can see the healthy margin even during so called recession times (revenue may be flaking).

Over capacity in industry

Classic case of appetite management, when economic boom starts there will be a spurt in production and the moment scenario reverse it create a over capacity.

Erratic profits

Profits going up and down indicate poor economics behind the business.

Where profitability is almost entirely depends on management heroics

M S Banga of HLL is arguably one of the best CEO of India, Hindustan Lever has paraded the greatest CEO’s of country. As all of these companies need great people to squeeze assets, manage working capital, allocate finance efficiently more than other business.

Look out for business where dependent on intangible assets more than tangible assets. Remember great management is not great competitive advantage.

Short and sweet session, he left me with few questions:

  1. Why do low profit margin with low inventory creates poor profitability?
  2. Name a company which has erratic profit and sells a commodity type product?
  3. Which are commodity type business to stay away if you are exploiting the stock markets short sightedness?

I am not so sure whether this will help and benefit others, please flag me off.

Apologies in advance if I hit a wrong button!


Nice one keep it up.

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Great thread you started.

This is awesome service to investors like us…kudos to you for your good karma in selflessly sharing this wisdom. Really look forward to the other mantras!

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Guru Mantra 2- Spotting User Oligopoly

Disclaimer: this is a series of sessions between private individuals (almost 16 years now) which includes ideas from noted investors and their books. I do not personally claim ideas are exclusively mine. The intent of dissemination is to share and learn.

We picked up from where we left, I asked Guruji if you call commodity as sick company who’s healthy then. He immediately replied I would look for “mind oligopoly” but for now restrict our self to “User oligopoly’”. He promptly added, “Suvi” we must be shameless cloner from successful concepts rather reinventing wheel. Obviously it was reference to Buffet’s word consumer monopoly.

I am only interested in companies having great economic value and can stay healthy for long time. When Warren ventured out perhaps monopoly was order of the day, with population burgeoned by 10 times since then, if we get oligopoly we should be happy. Oligopoly is an economic situation where few firms are dominating. Key for us to differentiate the domination is voluntary or enforced on user.

Think about Amul butter, even if men exports themselves to moon still Indian will eat butter. Unless humans are replaced by robots who do not eat; butter is going to stay here. And imagine in a remote state like Nagaland where you don’t have anything other than Amul butter. However still oligopoly will go through cyclical ups and downs. But the economics behind products works as defensive mechanism, 1. there is a shut down point below which economics will over turn e.g. tires. You cant postpone the tire replacement forever. If you have to drive your car you have to replace tires. 2. once restart points starts people will rush to fulfill essential needs.

To find out this oligopolistic situation obviously we need to do some work ourselves. Multiple ways to find out or brain storm. It extends to as complex as mental models , inverse risk assessment or even Michael Porter’s five force theory. Fair point, I am not Harvard Student neither I am patronizing Charlie Munger. What other ways to start? Guruji said start where genius left their trail, none other than Warren Buffet;

Audit trail of Warren Buffett

  • is the company paying entire earnings as dividend? Zero net worth, surprised? Can be a very good fishing ground where temporary business calamities destroyed wealth temporarily.
  • can you recreate Amul by hiring their all managers in a single day? If no, then you know you are up for the game. Lots of guys have spend billions to attack HUL, still it stands strong there. Still some people identify themselves with Lux!
  • next is if tomorrow HUL gives me right to use brand name can I run the company? If you think you can run the business then you just cracked a pot. The rationale behind is business model is so simple anyone can come in and run the business “with Brand”.

To make my life easier, he said let’s ask these questions to ourselves:

Spotting a user oligopoly

Is there a brand name or service I am dependent on. No wonder products are easily identified and services are not. Go to Big Bazaar and Reliance Fresh and ask yourself, which are the brands without which Reliance Fresh can not survive? You would know the brand names, Gillette, Amul, Dabur and so on. Walk into a office reception and you will realize the news paper which you will find everywhere.

Finding a user oligopoly for services is not easy. Go for the places where services are build, operated and transferred by a similar mindset people. E.g. advertisements, Television networks etc.

Now lets not get confused if a business has a brand name and product working in its favour it’s a user oligopoly. How, lets trickle down few more questions.

Steady and upward earnings trend

If an user oligopoly have a bad management still company will suffer. Watch out for companies which shows slow but steady upward earnings growth over last ten years. This is where management is turning user oligopoly into share holder wealth creation. The big opportunity comes when stock market crashes, the economics for user oligopoly seldom changes.
Or there is a second chance when stock market is normal but one time problem happened with user oligopoly. Watch out for earnings , if there is a sharp decline, if there is a mild decline you roll up your sleeves for further analysis.

Organic funding

If a user oligopoly churns a lot of cash then it doesn’t require debt, isn’t it? Ability of asset is to produce earnings and wealth for share holders. Then we should have a user oligopoly which can pay debt out of its earnings. Check the earnings for company against debt it’s carrying, more than 2-3 year earning are the ones you should close down your lenses more. A caution is if debt is taken to acquire another company (e.g. Torrent Pharma) then watch out :

  • if a user oligopoly buys another user oligopoly then its marriage in heaven, both of them will do well.
  • If a user oligopoly buys a commodity type expect a mediocre result.
  • If a commodity type marries another commodity type then god save from disaster.

Return to Shareholders

Return on equity is a powerful equity this is why. Let’s say a company have asset 100, you borrowed 50 and put another 50 from your own pocket to fund the asset. This would mean 50 becomes equity, 50 becomes debt. If you earn 50 from asset and spend 30 to maintain earning then your profit becomes 20. This would indicate your return on equity would be 20/50 or 40%.
Now imagine multiple scenarios:

  • as a owner you are making 40% return against 8-10% pre tax earnings in a fixed deposit.
  • If the company invest that 20 profit back to business again, there is a chance of earning another 40% on that!
    We will touch upon the source or ROE the drivers later. For now high ROE is an indication management is making money from existing business but it can deploy retained earnings to make more money.

Indian companies as per old DSIJ (Dalal Street Journal) during 1990-2000 averaged around 12% ROE.

Enforced spending

If my retained earnings is forcibly used to spend for new products, research well boy I am in trouble when earnings go down. I would rather prefer buying other user oligopolies, or even invest in stock markets!

Hence let’s try to differentiate between making money, retaining and not spending is another thing. May be that’s why foreign salary figure doesn’t matter but how much effectively you can save becomes a decision making point.

Guruji continues, I found user oligopolies don’t have to replace their machinery so often. Take Chandrakant Sampat’s investment in Gillette, it was producing shaving tubes from same machine even after the machine book life expired.

If I make 100 a year and I am forced to replace my asset by spending 100….where I am making money. Can the business grow without infusing capital, you cant avoid completely….then one needs to draw a fine line. Guruji asked me to find a company which never have to replace assets? I don’t have an answer though I know breweries average life of assets are much higher than capital goods industry.

Check the asset spending with retained earnings to find out how much money is spend on replacing them. Increase in Gross block you can take it as asset spending. The problem with capital expenditure in cash flow statement includes both maintenance and growth capex. Lets talk about them some time else.

Knocking out owners

Guruji said if I am making money or lots of money I would never want the money to be shared with lots of people and that’s the tendency of any human being so does management. I will make sure I will send them off sooner, this is buying back your own shares.

Buying back own shares is one of capital allocation decisions where our Indian companies are really poor at. As the ownership base squeezed the earnings distribution becomes higher. Needless to discuss power of compounding, but try to compound with a lower base….it becomes a nigh uncatchable black hole. Hard to understand, here it is:

Earnings 1000 1200 1500
Shares 100 80 60
EPS 10 15 25.0

Earnings 1000 1200 1500
Shares 100 100 100
EPS 10 12 15.0

These are two different scene, where in first case management is able to buy shares….we can see number of shares by 3 reduced from 100 to 60. With same earnings level for both scenes the accretion to scene in EPS is buy 250% (EPS from 10 has become 25) against 150% for scene 2. If you take this with a scale over 10-15 years imagine you just replaced compounding machine with cryogenic engine!

But be watchful if company is destroying retained earnings e.g. buying shares of infra companies in India :slight_smile: (on a lighter side!)

What is inflation? I heard it somewhere!

Inflation is rising prices, so when inflation toor dal rises so does commodity. The increased cost creates overproduction result a drop in price in order to stimulate demand. This means cut back demand, reduce production cost till the time supply drop. There is always time gap between demand and supply cycles. Luckily user oligopolies doesn’t have to face this. Have you seen ITC getting bothered with increased taxes? From opening day of our constitution cigarettes are taxed incrementally every year. Still ITC is able to sell, cigarette smoking is a habit formation difficult to kick even with higher pricing.

The best way is to check at least 10 year’s price against generic bond yield rate. All your discounting factor should be basis expected minimum rate of return. Inflation, GDP, CPI are murkier than it looks!

Fine, will all the retained earnings will be ever respected by the bull standing on dalal street?

Over a long period fundamental growth catches up with earnings growth and this is why:

  • stock market is a place for company to access public capital to run day to day operations.
  • Stock market is a place for investor to share their journey with company in profits they make.
  • If stock market doesn’t recognize earnings, management will sit with tons of cash and will ultimately give you back via dividend ……not to worry!

You don’t trust my word….take top five companies from Nifty and plot a growth for 15 years:

One row EPS growth
Second row dividend growth
(first two row becomes fundamental growth)
Third row plot the market prices.

I will be surprised if the CAGR of fundamental growth doesn’t match with market growth. If not check the huge cash bounty with company….anytime it’s fallen fruit not even low hanging.

With my tryant of more than 1000 stocks I haven’t found more than 2-3% cases where market growth has gone astray with fundamental growth for a 15 year time map.

In next topic more hunting ground user oligopoly. This was back long time I seldom realized my Guru was building a platform for a word called “Competitive Advantage” or “the famous moat”.

Happy investing guys!


Thanks… this is great! Am sitting with my notepad making notes - feels like am back in school. :slight_smile:

Awesome Suvendu. Nice narration. I am eagerly waiting for your next post :smirk:

Such a wonderful post .really eye opener for a novice l like me.

Thanx suvi Ji.great effort

Guru Mantra 3- Sniffing User Oligopoly

Disclaimer: this is a series of sessions between private individuals (almost 16 years now) which includes ideas from noted investors and their books. I do not personally claim ideas are exclusively mine. The intent of dissemination is to share and learn.

The deafening noise of Dalal Street analysts, multiple pages of leading news paper can a create chord for symphony….but investing is an act of contrarian views fighting biases and prejudices. This is was a bad rainy evening back in 2008, Guruji quipped while sipping a single malt. Though I could co relate somewhat what he wants to say but never thought there will be a gruesome mental battle between sections of mind which investors like to call behavioral finance. I asked Guruji what is behavioral finance, he said let’s park the term, discuss and concrete what we been doing all these days!

Though I am a Chartered Accountant, I still remember his initial words in 2002, “ professional background is NOT an entry barrier for success or moving towards passion. You may not have a enormous portfolio like biggies of Dalal Street, still what you can bring to table is your own flame, unique style of investing…….self styled recipe but more importantly enduring."

I am not a Mumbaikar, often I travel there to Dalal Street….no work! I always realized during my journey to Dalal Street, although investment is part of process of globalization something unique is always happening. Go to “Dalal Street”- the symbol of financial epitome. Standing in busy lanes of Dalal Street I always feel the excitement in air. The Pav Bhaji stall in “Nasta Chai” to rumple papers on street or even anguish in eyes of an investor……truly a symbol of evangelism up-keeping spirit high and higher till the time you are standing six feet from edge and breath for ecstasy. The nostalgic sense culminates every evening when whole armory of hope, fear and greed get slowly and seductively packed off for the day….in combination with sea wind from South Nariman Point hitting your face reminds we will come back again tomorrow ……one more reason to survive ……we will not perish without fight……we can not be consumed by panic differences anymore!

Associate investment with positivity in life, not with money. Investment is more than money, it’s an identity……gives you an outlet to voice your opinion and expressions in uncertain economic environments. Investment is freedom….and together we are a global tribe. He said I will give you a price less tip…don’t think you are an investor….start calling yourself “Value Investor”……a term much more stronger, a passionate approach with millions of ideas on seedbed. Loads to talk about value investing later on!

The mining sniffer dog

Last time we spotted user oligopoly from various basic tenets of life be it standing at doors of grocery store or turning the pages from book of economics and finance.

Guruji said you must be a sniffer dog, and we want to be democratic dog who only barks but not bite. And a dog is best at sensing trouble, but have you wondered dog can sniff opportunity as well. I asked how, Guruji said elementary principle….it’s not dog character but our objective. If we use the dog to catch a thief it will do, but if you send him find out a mine he can do as well.

Taking forward the sniffing dog philosophy let’s sniff the best we can- but what? What causes a user oligopoly phenomenon? Why some business are able to charge higher margin than others? Make more profit than others? Stay more longer than others?

Voicing your mind

Build scenarios for your self, what I worked then is:

  • Say a brand like Colgate makes product like toothpaste which get consumed faster and I can’t imagine a shop which stores tooth paste without few packets of Colgate.
  • Some one else who repeatedly persuades to buy Colgate all the time.
  • Any one out there who provide repetitive service that people constantly need.
  • Local boys who become big and remain wants to be local and big.

Justify what mind says

These were my justifications then:

  • Reliance fresh makes profit by buying low and selling high. So it has to ensure that they buy as much as low possible. It gathers his product from many manufacturers like Colgate, HUL etc., hence it does have a choice of buying from many. But guess if there is only one manufacturer then Reliance Fresh has no choice but to pay whatever manufacturer asks. The price advantage shift to manufacturers. That would indicate higher profit and higher margin for manufacturers. Any guesses? Both HUL and Colgate enjoy this advantage, that is the precise reason we call oligopoly rather monopoly. Without both Reliance Fresh cant survive!
  • Now imagine Reliance Fresh, More, Big Bazaar all queuing up to buy Colgate and HUL. What would happen? Does manufacturer charge higher price to different retailers? No, its retailer who goes into a war zone and cut price directly and indirectly to destroy their own profit margins.
  • Now take another twist, when you go to any South Indian restaurant you don’t ask for idli prepared from HUL barter only. So manufacturer selling a product for further processing loose identity. Always? May be not……take a guess. Even if you close in to the same restaurant you may still ask for Nescafe!
  • Think about drug companies, if you have a headache and you got only one medicine disprin then neither your druggist nor you have no choice but to buy.
  • But there are some smart guys who use lots of generic manufacturers or products and build their own brand name. Specialty Food which manages Mainland China, Oh Calcutta etc. They don’t tell you whether their noodle was made of Ching or Prawns were purchased from Avanti feeds. You recognize them with Mainland China only!
  • Colgate will make sure they bombard your television set day and night with white teeth, skimpy babes….so that next time you go to Reliance Fresh you ask for Colgate only. Or perhaps your kid might intervene saying papa Colgate only……no choice. :slightly_smiling:

Can we spell out five companies having a brand and consumed immediately or quickly? Try for your self minus the examples I have given above, no Gillette either. :slightly_smiling:

Before Asian Games 1982, people in India were either reached through news paper or by sales man, door to door campaign to sell their products. Now all you need is a click, the messages zooms back to millions of user who have access to internet. Doesn’t matter where ever they are sitting. But the game is not changed, for manufacturer the battleground is still advertising, only the medium of advertising has changed.

Advertising is like addiction, once a manufacturer spend he cant come out so easily. Or else their competitors will barge in again. The moment one actress become old in Lux advertisement, another replaces!

Next guess about a service, which you use day in and out but not managed by those terrible unionized people. HR payroll service provider, we need to pay salary to all every month. You can put credit card guys who charge merchant and also charge you exorbitant money for default as well. And all they do is give you a plastic card with brown back (not there for Amex) and dingy card machine to merchant. And guess what those people who come to sell those cards barely educated either, you can hire and fire them as you need. No upgrading, no capex everything goes to bank’s pocket. Still none of these credit card business makes money, well our appraisal system is not fool hardy. That’s another cup of tea all together.

Lastly for now, the big boys of small town….roaring tigers in their den . PC Jeweler in Kolkata is nerve of city; they understand local taste so much ….its going to be humongous task to knock them off completely. PC Jeweler buys from small goldsmiths; bargain for cost and a lot of time pass on the cost to consumer. The stores are centrally located on leased land from Netaji’s time right opposite to his metro station also! Customer becomes happy with cheaper price, they keep coming back. And the same time PC Jeweler opens a new floor in same building with better furniture’s, one cold drink vending machine and charge premium for premium customer. :slightly_smiling:

Think about PC Jeweler’s competitor, the gigantic space in Bhawanipur is just crazy thinking to hire even now.

So moral of story as long as you marry, females wear jewelry, husband will use credit card, government will keep taxing, also husband will need hypertension medicines, hospitals charging all become a vicious cycle. Lots of money, for an extremely long time.

This was a chain of discussion we had in 2002, almost 14 years back (there were no Reliance Fresh…I replaced so that it look more refreshing). Simple logic and thinking……irony is I wonder sometime what I am thinking now after my hairs becoming grey….

  • what will happen if tyres are no more fitted by OEM (Original Equipment Manufacturer) but choice given to consumer through some online portal. No one will be bound to buy a TVS Tyre with a TVS bike…isn’t it?
  • What will happen to DTH when internet will drive all your need at one go.

These are not bad thought process….but I can request you something humbly……investing is simple….please don’t make it simpler……but kindly don’t make it complex so that it can not be implemented. How ….we will explore one by one.

Thanks once again for considering my views. I sincerely appreciate all your gestures shown in this board.

Happy Investing !


This is pure gold man ! Immensely thankful for sharing it all!.
Dont know your guruji, but you are my guruji here!:slightly_smiling:



Guru Mantra 4- The Soch (Thought) behind Financials

Arguably this is a long subject- Part I for now

Armored with a bit of business and user (who consumes services or products) knowledge always helps moving forward. Financial statements may be paradox but that’s the only way transactions are recorded and reported.

Guruji said let’s move to your fiefdom, financial reporting. What you feel about it? I felt proud for a while as accountant, I said what exactly you want me to explain? Financial reporting? Re-statements? Adjustments? Balance Sheet Reviews? US GAAP? He said hang on, all these term I don’t even know. Why are you embarrassing me? You just convince me what are different ways of looking at financials? I asked what do you mean by “different ways”?

This is what Guruji says, one-way is Seedhi (Straight), second is Tedhi (Reverse) and I am a Yeda (Contrarian here, Mumbai yeda stands for “dumb”). Fine, putting simply business drives accounting not vice a versa. Financial reporting or in short financials is consolidation, elimination and grouping of information so that it can be disseminated. Unless we understand business we will never understand economic view accounting or finance. The numbers appear in Balance Sheet and Profit & Loss is summation of a company’s state of affairs for a particular period and for a particular date (Balance Sheet-BS).
To understand a business you need to be novice, just like friend @romy messaged here, or even sense of acceptance like @vikskukreja said, even positive mind frame like @govindarajanv & @Aksnehru or @v4value , even @jainaj @Rounak . See we just listed so many wannabe Warren Buffett’s!

Let us a simulate a company before getting into a room called financials surrounded by confusing screens of compliance and accounting standards.

Recently I was analyzing a company called TVS Shrichakra, which makes tyres for 2 and 3 wheelers. It’s fresh in mind (otherwise called recency bias), I will walk you through to justify the concept before we land in a exclusive educational territory neither will help me or you to learn.

To understand a business and answer all Seedhi and Tedhi questions by a Yeda like me best way is inquisitiveness. Ahan, I wont ask you create compartments inside brain, I don’t have a brain in first place! Inquisitiveness means ask question….management consultant said for long time 5 W and one H.

What is 5W and 1H?

W1: Who did that?
W2: What happened?
W3: Where did it take place?
W4: When did it take place?
W5: Why did that happen?
H1: How did that happen?

Does this sound reasonable? Mckinsey added 2 more Ws to make it 7W…. that’s way too complex for me to understand. If you can please explore sometime.

Let us give an attempt to understand whether 5W and 1H can explain or help even in understanding financials.

The name of Company is TVS Shrichakra or even called TVS Tyres. Even before going to Google TVS is a famous group. TVS stands for T V Sundaram Iyengar .

He was born in 1877 and known as automobile pioneer. Hang on , no one will call anyone blindly as pioneer, must be something out there.
Mr TVS started a bus service in 1911 called as TV Sundaram Iyengar & Sons

1955 operated a number of buses and lorries under Southern Roadways limited. Then produced a gas plant, a factory for rubber retreading, Sundaram motors.

After Mr TVS expired what happened? Here is the balance story:

1978- TVS Motor
Middle 1980’s – TVS Shrichakra

Apart from this a host of other companies group boasts about, business accepts this is biggest business Automobile conglomerate in India.

First a possible list of “Seedhi Soch”, please keep on adding.

(all that are required to run the business)

Which all information we need?

  • Raw material
  • Other than raw material
  • People
  • Assets
  • Sales

Next another list of “Tedhi Soch”, please feel free to add:

(all that required for existence)

  • Imagine when TVS Shrichakra started; TVS Motor was in place already. The tyre factory started then had a pedigree of family known for automobiles in India, must have deputed it’s satraps including the family members from head quarter and other factories to build the factory.
  • Also I am sure by the time factory and plant is ready, operations would have taken its sweet time to settle down. It’s not a Formula 1 tyre fixing, 20 seconds…. boom and vroom.
  • Once it rolls out tyre, can we say customers standing outside a factory with gunny bags to collect tyres (with a chanting “here come tyres”:slight_smile:).We are sure some people would have gone miles and miles to consumer dealer and customer.
  • During last thirty years, people would have got disappointed with TVS Tyres, send them back to Tyre factory, company would have spend something to fix these defects.
  • Thirty years would have also seen ups and downs of economic cycle. TVS Tyres would have gone door-to-door, trumpet via Television, newspapers to tell people you need tyres and we are there with one Actor posing with a tyre.

Finally list of “Yeda Soch”, please feel free to add:

(all that required to be answered )

  • Do I need bank loan? Why and for what? Isn’t Mr. Iyengar supposing to billionaire?
  • Do I need multiple energy sources for running? Why and for what?
  • Am I giving lots of discounts to some one else to sell my tyres?
  • Am I paying excess money to employees? Is there a justification behind doing so?
  • Am I spending a lot of money to maintain my assets?
  • Am I spending on a lot on sophisticated software to run the business? Why so?
  • Am I able to increase the price as and when required, if not why so?
  • Is my cost of materials coming down? If not what’s the problem?

Don’t worry about completeness of questions, there is a long rope going forward. In case something gone amiss we have sufficient tool to captures information. What is idea behind these questions,….as we said we need a “information” from financials. Do they exist? Let’s check it out☺

Peeking into financials for answers

My suggestion use a copy of TVS Shrichakra Annual Report and please do a check for my answers below to ensure whether I am have improved from being a duffer.

Without even going further take the first category of “Seedhi Soch”, from 5W and 1H you will get only 1H from financials.

E.g. Raw Material- who supplies raw material? Why they supply raw material? What raw material got supplied? When did the raw material got supplied? Where did raw material got supplied? How much raw material got supplied?

Apart from last question (H) we wont get answer for anything else or may be partially. Now we understand the limitations of financials. Why this happens then, aren’t financials suppose to disclose everything:

Financial Reporting is a cluster of accounting transactions. An activity is initiated first, then processed, afterwards recorded which may or may not result an accounting transaction. In other words though organization captures a lot of data its not necessarily reported which we know. But the problem we need answers.

Think about this: I need to buy rubber as raw material for making tyres.

What would be the sequence of transactions? The bracketed ones is information published in financials.

Step 1: Identify a vendor (not available)
Step 2: Ascertain the requirements for purchase (not available)
Step 3: Decide a price to buy (not available)
Step 4: Place the order to vendor (not available)
Step 5: Receive raw material (partially, inventory is reported as aggregated- opening, consumption and closing—quantity is not mandatory disclosure from last year) ……Inventory DR Goods Received Not Invoiced (GRNI) CR------here we have accounting entry……
Step 6: Recognize the vendor in system (accounts or trade payables)……another accounting entry here……GRNI DR Vendor CR.
Step 7: Pay the vendor (inventory, consumption, payables)……last leg of entry……Vendor DR Bank CR.
Step 8: During a month end accruals is posted which is all those GRNI which are not recognized as vendor liability. Once next month kicks entry gets reversed.

(For non accountants DR is Debit and CR is Credit which is our trump card, if you Google it you will get lots of information may be not relevant for you).

Apart from this we do have inventory accounting to record inventory in, used and out. You can see accounting kicks off after deciding price, vendor, quantity etc which are significant for understanding our business.

Second category which is bit tedhi. We are saying Mr Iyer and his battery of people set up the plant, spent crores in convincing customer to buy. Where are these costs? Accountants will argue they are all written off during the year or amortised over a period of time. But as investor I need them, if one Mr. Vikas has to start another TVS he may not have Mr. Iyer, his battery of people, his commendable associate companies!

Finally the yeda man’s dream….bit dicey. The information is there and not there. For example simple ones bank loans would be there but again why may be absent.

What message we are getting finally, sufficient information may not be available to a decision as business owner. Get ready to scratch information from all other places available. In other words-

  • we have to refer to multiple places to obtain information.
  • The information recorded may not be suitable for my purpose e.g. writing off Mr Iyer’s initial expenses for his legendary skill set.
  • We may not get a lot of information and we should mentally prepared to handle them for our decision making.

Now one can say if we don’t get all these information then what is financials available to investor and how do we look at them.

A better organization ideally will have following accounting systems (simulation considering TVS, banks are different Animal, insurance is alien to this):

  • General ledger and financial accounting (record of accounting transactions captured from all processes, now transaction can come automatically or manually entered). Ultimately it leads to a Trial Balance, Profit & Loss Account and balance sheet.
  • Management accounting( this is the one we investors should be more interested, which has all sort of business analytics underlying transactions……e.g. sales per region, pricing of products and so on. Unfortunately not reported anywhere in world…we need to fight for ourselves).

Structure of Financial Statements

First few bloopers:

  • Revenue and Sales are same word , also called as top line
  • Profits, earnings and income are all same, we call them bottom line
  • Costs are money (people, operations) spent for making a product or services.
  • Sales order and purchase orders do not have impact (we saw above sequence of entry for purchase) on accounting.
  • Revenue and billing are different animal. Billing is what is billed to customers, revenue is what is recognized☺. That’s accounting, revenue is accounting recognition triggers basis the framework developed by Chartered Accountants . E.g. unless delivery takes place you cant recognize revenue. Though you can bill and collect money.
  • Profits are different from cash.
  • Expenses are different from costs.

We will cover each of these elements and much more with detail. I hope this will help non accountants if any who are not familiarize either. I am not familiar too, let us learn together.

At any point of time if you feel this is meaning less just put me to hook. I will change my direction. Also request you add all your own understanding, I will add back to my practice book.

Loads to talk about, this is just beginning. This is my practice book currently, let me know if you want to see anything else. Or even you add all subjects that is relevant for investing….only request with a sequence!

What all you can expect me to write after financials

Investment Philosophy (KYF- Know Yourself First)

Investment Philosophy (Personal Financial Planning)

Investment Philosophy- (Popularity may be illusion)

Investment Philosophy (CAP Plan- Capability Building, Active Investment Management, Portfolio Management)

The Value Investing

Building Nest (Portfolio seedbed)- allocation, comfort, security, entry and exit.

CBR1 – Competitive Advantage

CBR 1- The Competitive Strategy

CBR 2- Quality of Management- The Person

CBR 2- Quality of Management- Performance

CBR 3- Risk Management- Financials

CBR 3- Risk Management- Operational

CBR 3- Risk Management- Compliance

CBR 3- Risk Management- Strategy

CBR 4- Future Catalysts- Business

CBR 4- Future Catalysts- Management

CBR 4- Future Catalysts- Industry

CBR 4- Future Catalysts- Markets

CBR 5- Margin of Safety- Understanding Price

CBR 5- Margin of Safety- Psychological Valuation

CBR 5- Margin of Safety- Business Valuation

CBR 5- Margin of Safety- The Safety Net

CBR 6- Special Situation- Subsidiary

CBR 6- Special Situation- Merger and Acquisitions

CBR 6- Special Situation- Demerger

CBR 6- Special Situation- Wishful Thinking

  • CBR is Concentration Band Requirement (band is a section of business risk which needs to be managed within a portfolio).

Case Studies – Ten Companies (Sick- Commodity, Hot Guys-IT/Ecommerce, Cross Road- Auto, Evergreen- FMCG, No Choice-Pharma, Aspiration- Housing Finance, God father- Banks, Curiosity- Travel, Borrowed Conviction, Not So hot)

Establishing KPI for Portfolio Management- track portfolio

Opportunity Sourcing- Moat based

Opportunity Sourcing- Low Valuations

Opportunity Sourcing- Thematic

Opportunity Sourcing- Borrowed

The Behavioral Finance

The BUCK STOPS HERE (Philanthropy)

Unlearning- Sector Thinking


thank you for effort & time you putting here .
great work !
it will be nice if your cover this all concepts as per same sequence .
i m really eager to learn this concept
once again thank you

1 Like

Thanks again Suvi. Personally I would be most interested in learning on
"investment Philosophy (Personal Financial Planning"

Great work again, take a bow. I would love to learn on similar lines, as to how to dig for info and get more closer to management accounting. I agree 100%, that management accounting is what gives us inside (owner’s) view of business which is what we need to get under the skin. How to get info for building our own management accounting from reported numbers.
Vikas Kukreja

Thanks Suhas for kind words.

My practice book over the years do capture quite a few information I have captured earlier. Hence its becoming slightly easy in collating. Packaging, content withe examples…a bit of effort is required.
I must confess the reason for doing so:

  1. I am learning immensely, driving me back to check notes, check books and extrapolate the reasons.
  2. Till 5 days back I was not aware about ValuePickr (now you can understand why I am so incredibly stupid!). I was refreshing one of stock Premco Global and getting information from retail sources almost was becoming watertight. Then catch word “Premco Global” in Google get me into value pickr. The level of information was crisp, to the point.

I couldn’t believe my eyes at sharing of information by so much genuine souls out there. Every bit of information comes handy.

@Donald thank you for putting up such a valiant effort.

I will continue to contribute in my own little manner in educating, offloading what ever I learnt all these years.




@Suvi sir…Your mantras are a great help for us who are novice and have only miniscule knowledge about accounting.Articles are very thoughtful .Thanks a lot again for your help.


Guru Mantra 5- Understanding Financials

Part II of Financials

Power of Simplicity

Simplicity is most the sophisticated thing, friend of Guruji (investor of course) made a point to me over a discourse. This was a reference when I wanted to show a seedbed of ideas (or mental model what ever we call). He quipped why you make things maddeningly so unhelpful?

Simplicity is the ultimate sophistication – Leonardo Da Vinci.

One of major pillar of value investing is finding out a competitive advantage. Warren Buffett coined a word moat to look out for companies having unique product, unique service or a better-cost producer. But some one who has invented the broader word “Competitive Advantage” is none other than legendary Management Guru Michael Porter. And guess what, his landmark book “Competitive Strategy” provides a formula for sustainable growth. Yet no one use, but strangely it’s a very simple formula. Want to try?

Asset Turnover X After Tax Return on Sales X Asset/Debt X Debt/Equity X Fraction of earnings retained.

No one dares to ask Prof Porter whether it’s right or wrong. Even if it’s true still we will not follow it. We all have a habit of liking strong vocabulary and complex things.

But does simplicity creates knowledge and wealth? Of course yes, simplicity is adaptive, enduring and transmitting!

Accounting Principles

We can’t build a paper box without setting up few principles, accounting does have few. They run through every financials, these are basic rules and assumptions which decide the what, when and how to measure. The principles have serious impact on preparation of financials. Let us understand them:

First is accounting entity. Every company builds a chart of accounts (this is a list of accounts going to be used by company e.g. Trade payable –Number 10000, Raw Material- Number 20000). Accounting entities are different sections of business for which management need financials. For example ITC have Cigarette and FMCG. Both Cigarette and FMCG becomes accounting entity. Now trade payable will be linked to both accounting entity.

Second is going concern. Accounting by default believes unless there is an evidence otherwise every company life is for long time. Now no one can say this for sure but we need to assume. If you believe the company is sick (not commodity type, a company where net worth has eroded completely) auditor will point in their report (called as qualification).

Third is measurement, everything under the sun has to be quantified to be accounted. This has also become biggest pitfall for accounting as well. Unless we have agreed upon value we can’t record in financials. For example if a mine value can not be estimated it would be shown as either nil value or purchase price what ever is available which may not reflect true value.

Fourth is reporting currency, due to foreign operations every company deals with multiple foreign exchange rates e.g. US dollar, Euro, Yen etc. But Indian companies need to report only in Indian rupees as it will file financials with Indian authority.

Fifth is historical cost, meaning everything is recorded at original cost with no adjustment for inflation. Now take a land bought in Andheri back in 1955 at 1000 Rupees will still show as 1000 in 2016 even. This sometime understate asset value and depreciation grossly.

Sixth is materiality, this is basically relative importance of financials. We don’t have to break our head for 100-200 rupees. We will record big ticket items only when small ticket information are not available.

Seventh is** estimate**, assumptions and judgments, things change here as we move to unknown territory. What best you can do when we don’t have exact information and at the same time not much expected error will come. But estimates etc should be consistent across the years.

Eighth is consistency, now one year say 10000 is materiality next year 1 lac. Or tables or chairs are not assets, next year they become assets.

Ninth is conservative, we accountants are downward looking not because we wear specs. We don’t like to over value anything; hence we will recognize loss even at slight hint, wont record gain even with a big hint.

Tenth is periodicity, financials are prepared for a particular period. Say a financial year (Jan- Dec). Regulators enforce most of the time periodicity.

Last is substance over form, this means we want to book economic substance not what looks to our eyes. Long shot to claim☺.

There is something also called restatements, the moment we recognize mistakes we rectify and restate the financials. But it has a heavy implication for regulation, audits etc.

And pillar of all these is accrual accounting, this means recognize the moment you use the asset or liability rather waiting for payment. For example the moment your raw material is accepted vendor becomes liability and raw material cost is recognized. This time difference between actual usage and payment has resulted another statement Cash Flow Statement. This is the key reason why profits are not cash. Accrual concept includes matching principle, this means if you recognize revenue you cant say no to costs incurred. You have to record both. Allocation, lot of costs are not associated with a specific product e.g. though insurance is paid in full at beginning the expenses are recorded as they arise.

Who is making all these rules?

First foremost The Institute of Chartered Accountants makes all accounting standards for India. The institute is empowered by constitution through Companies Act. What you know them otherwise as CA or Chartered Accountants. Accounting standards are the rules, guidance to recognize asset, liabilities or any other item related to financials.

Next are Tax authorities, in few cases they don’t believe certain practices adopted by financial accountants. For example depreciation rates are different for tax purpose and other purpose. Many says tax accounting is more realistic. A fresh set up of books is not written, what happens we create another accounting entity for tax and pass the differences as adjustment entries to main financials.

Creative Accounting Practices

As we saw accounting principles are not straight forward, a good amount of estimation, fit for purpose application some times lead to creative accounting practices to suit management need. When creativity becomes manipulation with a mala fide intention fraud occurs. Fraud practice is popularly called as forensic. Forensic is a special subject, lot of people focus their career on this. Three famous books you can go through to understand. I will try to create a separate subject on this, I am not aware of forensic much!

Quality of Earnings by Thornton Glove

Financial Shenanigans by Howard Schilit

Creative Cash Flow reporting by Charles Mulford

But for basic foundation to analyze a stock, at least let us understand how accounting principles can be misused.

  • Concluding a going concern is estimating future. Auditors and management use a yardstick of net worth erosion (this means liabilities exceed assets). But negative net worth may not always be a bad factor e.g. this negative comes with a sharp provision entry for non collectability of receivables. We should be more worried about negative net worth with more interest bearing third party liabilities (debt from out siders).
  • Quantification or measurement is done is based on available information on a particular date. Now just because information is not available we can’t give a guarantee for accuracy of these measurement (for individual also its called as availability bias- park this behavioral finance).
  • Currency usage can lead to confusion as well, say fluctuations in foreign currency while buying an asset is charged off to P&L account. Earlier in India it was capitalized. Any of these application will create a understatement (lower profit than actual) of over statement (higher profit than actual) of profit.
  • Historical cost is one of biggest reason for not relying balance sheet valuation. As I said earlier assets like land, mines purchased long time back must have become a fortune over the years. Sometimes management does a revaluation of assets but again discretionary practice.
  • A decision towards estimates, judgments can have far reaching impact on financials. For example I was depreciating an asset over 5 years, suddenly changed to 10 years, this would mean my depreciation will come down by certain amount which will overstate the profit. Auditor does qualify in his report, then how many times people go back and normalize this for calculating net profit margin!

Indian Financial Accounting Structure

All of us are familiar with two things at least:

One is quarterly financial report submitted to stock exchange. But more importantly annual report, this is a package of many things (we will touch them sometime else) including financials of company. Schedule VI is the key format where company’s financials are presented and what you see in annual report as well.

But even before we take a stab at Schedule VI, we must understand underlying ethos of management behind financials i.e. otherwise called financial statement assertions (FSA). These are claims by management saying we are responsible for preparation of financial statements and they are appropriate. You may why do I believe so, here may be why:

Many ways you will find management talks about assertion. Let us not confused by these internet sites and blogs. There are only FIVE fundamental FSA, which are certified by COSO (the biggest body for accounting committee) and testified by Auditors (something called key controls for financial reporting under Sarbanes Oxley Act, Indian name is IFC or Internal Financial Control).

Five FSA tell us management believes and it is tested that:

  • All the transactions recorded are complete and nothing is missed out (Completeness).
  • Transaction has been recorded in right period i.e. 2015 transactions recorded in 2015 not 2016. (Existence or Occurrence)
  • The accounts are disclosed and presented in right place i.e. cash is suppose to be part of current assets , its not included within fixed assets. (Presentation and Disclosure)
  • Accounts and transactions are valued accurately, 100 purchase is shown as 100 not 200 (Valuation or Allocation).
  • Asset means I own, liability means I owe. My rights on asset or obligation for liabilities is fool proof and supported by evidence (Rights and Obligations)

Despite of management assurance there is no guarantee that management wont do any other things which you and me don’t want☺.

Now Schedule VI

In lay man’s word format of Balance Sheet, Profit & Loss Account, Cash Flow and associated items. Let us not get into individual elements, it wont help. Rather look at holistically to have a view, we have loads of chance again to look at individual items when we get into actual methods of stock analysis.

Balance Sheet

It tells us basically what I own (assets), what I owe (liabilities) and this is my worth (equity of net worth). Equity is the one we own as shareholder in any given company.

At any point of time assets will be equal to liabilities as for every debit there is a credit somewhere.

View balance sheet as a snapshot of history, a financial picture on a particular day when its written.

Balance sheet boasts mainly these items:


  • Assets are the one we got like cash in bank, inventory, machines, building- all of them.
  • Assets are also rights we have on monetary value, for example we can collect cash from customers if sold on credit.
  • Assets are valuable and must be quantified in reporting currency

What assets tell us further about their characteristics:

  • liquidity meaning can be sold easily like cash, investments etc.
  • productive e.g. plant and machinery.
  • Assets for sale e.g. inventory

Trade receivables is the obligation of a customer to pay whom we sold on credit.

In our Indian financials Assets are shown in order of safety i.e. first fixed asset followed by current asset. Where as in US you will find reverse, first liquid asset then fixed asset.

Current Assets

Are the ones which can be converted to cash within next 12 months. This includes cash, trade receivables, inventory etc.
Inventory includes raw material for to be used in manufacturing, finished goods to be sold, work in progress inventory, other spare parts and consumable which will be used for manufacturing.

Prepaid expenses are the ones where we have paid already in advance like insurance premiums, rent, deposits etc. This means we don’t have to pay in near future.

Cash is required to buy inventory which gets manufactured to become finished goods, once sold called receivables, on collection we get cash again! Cash is king and please always ultimate motto is to see cash.

There are few other categories of assets, we have enough opportunity to discuss in future.

Fixed costs are stated at cost value, they are used over again and again for making goods and produced. Cost means original purchase price. On balance sheet fixed cost is shown as original cost minus depreciation.

Depreciation is the decline in value of asset due to wear and tear and the passage of time.

Patent, copyright, software have a value but not tangible (cant touch or feel). These are valued by management according to various conventions bit complex for now.

Liabilities are categorized mainly:

  • to whom the money is owed
  • when the money is payable (current and long term liabilities)

Current liabilities are the one which needs to be paid within a year. Chief inclusions are accounts payable or trade payables owed to supplied. Accrued expenses owed to employee and other service providers, current debt owed to lenders, taxes owed to the government.

Working Capital

The amount of money left over once you subtract current liabilities from current assets. This is the money company has to work with to manage day to day operations.

  • every increase in current asset increase the working capital or every decrease in liability does same thing.

Shareholder equity

This has two component, one is capital i.e. the original amount we contributed as investment in company. Second is retained earnings which are earnings earned and retained but not paid as dividend. Retained earnings is critical component of value investing.

Now one may think capital is shown as 1,2, 5, 10 rupee per share but I pay 2000 to buy. Where is the rest money! Your share is capital and retained earnings, if you pay high you have to justify some reason why are you paying high.

I will cover Profit & Loss, Cash Flow next time and much more.

I have attached a Schedule VI for further understanding, please feel free to raise questions if any.

Now, without application theory is of very little use. All of us will disperse if these theories doesn’t create a wealth (money or knowledge), knowledge getting acknowledged by self becomes wealth.

I will take a live example and simulate , so that we keep on going with these mantras together to have a better view.

Here it is: the company name is International Travel House (ITH here onwards). Why I selected this, and what is there let us discuss in a separate thread or topic. As that would be stock specific information it will not be appropriate to club along investment learning. That will also keep me going, as I need to survive from investing as well. :relaxed:

Kindly note I don’t know even whether ITH is a good company or bad company. It’s a completely live simulation, please make it interactive. Allow all of us to learn from each other. As usual no buy or sell, nothing. Owning a stock is congregation of multiple decisions, ultimate outcome of which significantly vary from person to person. So when someone says buy or sell, its nothing more than entertainment, don’t fight….just take a bow and pass. All will be happy☺.

A stock analysis results:

  • certain positive points about business, industry and management, importantly the characteristics of element there.
  • Certain negative points on the same line as above.
  • Unanswered questions and points, of course same as above.

Happy investing tribes!Format_of_Financial_Statements_under_the_Revised_Schedule_VI.xlsx (311.7 KB)

This file I have collected from Google, not developed by me.


Guru Mantra 6- Case Study of International Travel House (The Battleground)

I must repeat again. No buy, sell and nothing. This is a live simulation and discourse around it. I even don’t know much about the company. Hence I am not even declaring this stock as hidden gems, opportunity etc. The idea behind simulation is to take you through Guru Mantras and apply them so it is easier for me and you to understand.

Why this company?
An opportunity for investment is sourced from several sources:

  • Financials indicating a moat
  • Low valuations at first sight
  • Thematic (secular trend, growth stories you are convinced at)
  • Borrowed (from web, advisors etc, where to borrow and not to)
    Opportunity sourcing needs good bit of understanding, better one take it up after doing few investment documentation. By that time one gets acquainted with nuances of investing world.
    To explain why I choose the company, I some time use a combination of Financials Moat and First Sight Low Valuations . What are they, will come to you in a while.

Circle of Competence
Before that one must understand whether a particular business falls under their Circle of Competence. How to do a circle of competence, just few days back I posted a topic in VP. Here is the link:

No one expects you to be master of a particular business. If you can do a mastery nothing like it. What is expected from an investor is:

  • Do you have a prior experience in such business either as employee, acquaintance or interest or even education?
  • Can you spend time in understanding business and allied stories?
    Quite subjective, isn’t it? The moment the preaching starts just like I am doing now, always ask the inverse questions:
  • My portfolio consists of Pharma, FMCG, and Financials. Just now we described the three biggest tenets of academics i.e. Engineering, Doctor and Accounting/Finance. Do you really understand such diverse characteristics?
  • Have I known or heard or customer, supplier, lender of business?
  • Have I seen the product, services or used?
  • Can I think like CEO of business?

We need to document the circle of competence, will come to you in a while, a cursor before that:

  • There is no “certified” words called as Large Cap, Mid Cap and Small Cap.
  • Emerging trends, potential multibaggers are either wish list or debate topics. Don’t mix them with circle of competence.
  • Good financials, a strong moat are characteristics of a business, not yours. So when someone says company have strong financials, you ignore ask yourself do I understand this business?
    Understanding circle of competence is a big step before you start. A brief reading of business is required before concluding. The sectors given on stock exchange may be too abstracts.

What I saw International Travel House (ITH)?

Revenue growth- it picked up during 2010 and 2011, otherwise a muted growth.
EPS Growth- flat for last two years, before that slumped to negative.
Free Cash Flow- somewhat stable barring couple of years.
Equity or Book Value Growth- started from 67 in 2007 went up all the way to 297 in 2013 before nose-diving to 159 in 2014 and stagnated at 176 in 2015.
Return on Invested Capital or ROIC- almost in the range of 13-15, except couple of unusual bump ups in 2011 and 2012.
Well what we just saw is confusing state of affairs, flat revenue and margin with a downward bias recently. Book value and free cash flow somewhat stable. ROIC is a number so far looks positive.
Is this the kind of number of I am looking for? Low hanging fruit? For me no, I would prefer 10% revenue, EPS, Free cash flow and book value growth at minimum. ROIC more than 10 are ok for me to start with. I rejected at first sight and closed the opportunity-sourcing file. What caught my next attention will come to you in a while.

You may ask, why these five things…. there are another twenty ratios. Why not them? This is my explanation:

ROIC- this is return a business makes on cash, which it invests in business every year. This means that portion of earnings reinvested to business. This indicates the confidence of management in business and how? I will only invest in my business only when I am confident of getting higher return than risk free rate i.e. say fixed deposit. Now lets not carried away, this is management confidence basis their past history. Future is uncertain other wise ITH wouldn’t have a reported flattish result. And ROIC doesn’t differentiate between borrowed money or owners money unlike ROE (Return on Equity) which tracks only equity or owners capital. If you have a consistent ROIC it gives some sort of indication that business is protected from constant price from competitors. I don’t want to see ROIC going down or at least stable…no sharp decline. If you look ITH they may not be super ROIC but it’s somehow ok type.

Sales or Revenue Growth- I would love to have a billing number than revenue. Remember you can still bill and collect money yet accountants do not allow you to recognize revenue because delivery is not made, work is not completed etc. Many of the times these are more academic reason than business necessity. Imagine you are collecting cash before delivery, ecommerce☺. Yeah, but icing on cake is when you own the product and freely pricing it.

EPS growth- how much business is profiting per share of ownership. The basic reason is the price of a stock is on expectations of current and future earning and that’s an undeniable truth. Though value investors will chop my head off if I say PE ratio is the one to rely!
Equity growth rate- now business earn money and spend in Bahamas in dine and wine. How would I know that? Equity is portion of my money or called as book value also. This means management has kept the money within business either investing within business or outside. Think about a scenario where earnings are growing but equity is not. What can happen, perhaps management need lots of money to maintain assets, spend in advertisement etc or blown that off in Bahamas.

Free cash flow growth- eventually this is the cash available from business. Free cash flow is Cash Flow from operations minus Capital expenditure. This would tell us whether profit also brought cash or just paper profits through creative accounting practices. Now there is a caution, free cash flow negative may not be bad always. A company at growing stage may have to spend tones of money in capital expenditure. Even the cash flow from operations include expenses like Research, Advertisement which is possibly using for creating a competitive advantage.

All five done, hopefully I could convince you.

As I said initially I booted this stock out of my file. Again it popped up during low valuations. What is the definition of low valuation? My apologies, PE ratio is just a psychological valuation for me….use when you just returned from a pub to brush up whether market is behaving same as fundamentally. Which they will never do in short run.

What is valuation based screening for me?

I use Graham and Dodd at purest form to dig the first hole. By spending X amount how much earnings Y I will get?
If I have to buy ITH today I have to spend 142 Cr that is the current market capitalization of company.
During last nine month ITH have made 11 Cr profit , if you full scope to 12 months it would around 15 Cr.
What does this mean? By spending 142 Cr, I can walk out with 15 Cr that gives a return of 10.56%. Sounds a small mark up on fixed cost, isn’t it? I mean one will say I get 9% in FD, even 11% in bond what’s the big deal? May be yes may be no, let us check out this same factor:
Cox and King appear to be the big daddy in listed space. Let us find out what Cox and King is up to:
It made 360 Cr profit in last nine months, say a full scope of 480 Cr and Market Cap is 2800 Cr, this is a whopping earnings yield of 17%. That to for a brand name.
Let’s find another one, Thomas Cook …another big daddy. Nine month profit 54 Cr, full scope 72 Cr. This is the earnings I will get if I pay 6836 Cr, which is market cap, a miniscule percentage of 1.12.
Another confusing story, I have one who is making lot earnings, another one who doesn’t and they are all big boys. Then I have this ITH, which is in middle. What should I do?

Here is my conclusion:

  • I didn’t see any one else other than this three survived business at least in listed space.
  • Earnings yield of 5% and more can be a case of price value mismatch. Simply because our index earning yield is 4-5%.

I am not very happy in selecting the stock but again not the best way to conclude.

Documenting the circle of competence
This is one step if I fail will simply pass the stock.
Question 1: What is the business category of company? What is my first reaction?
Consumer Cyclical Leisure, all about entertainment and travel. This something you and I do. May not be in same scale, I think can understand further.

Question 2: Did I look at the “about us “ section on web site? Can I explain they’re what are written without referring to other sources including Google?
ITH is travel and tourism service provider offers air ticketing, car rentals, inbound tourism and holiday packages. Plus official event management. Sounds super!
And this is an ITC Company☺.

Question 3: Did I check the products and services sold by the company? Have I seen them or known before? Can I write down 2-3 lines about each product and services?
All about services, when you hire car or go abroad you need these guys.
Business travel- requirement to execution, I have been part of such entourage. I am sure all of you.
Car rentals- taxi services.
Holiday package- complete package of fun, wine and dine.

Question 4: Who is buying the products or services and what is the usage? How does the product and services generate money in business?
Anyone of us, who wants to travel for need, for leisure.

Question 5: What is required to make these products and services? Have I seen them or known before? Can I explain in 2-3 lines about requirement?
We need chiefly people and infrastructure. For example we need a car and driver.
For holiday package we need network, people and technology.
This is kewl! I have see them and I have used ITH car hires in Gurgaon as well.

Question 6: Who (nature of) are the suppliers of the requirements as mentioned in question 5?
Suppliers are hotels, air line carrier, individual drivers. Long rope of value chain.

Question 7: Do I think the business or company is unethical at first go?
ITC is well trusted name in India, parent company is one of index company.

Question 8: Can I mention one more competitors for the company (which are listed)?

  1. Thomas Cook 2. Cox and Kings

Question 9: Do I think I will get right resources to analyze the company further? What is the edge of circle?
Plenty available, right from pricing, consumer preferences and trending. There may be a problem of plenty here.

Question 10: What all I need to move from CAN to CONFIDENT category?
None, confident category stock.

Conclusion: Confident category, I do understand the business…can document and maintain analysis on earnings, risk, operation, and finance.

The Initial Impression

Forming an initial impression is very important aspect , if you don’t feel good no point being associated with company. The problem is behavioral finance needs to practiced not read. How, write a small paragraph with your current understanding:

“When I check the key financials number somewhat I found stable or even flattish results. It didn’t not excite much. At valuation side apparently numbers do not meet the eye. Even two biggies earning yield behaving differently. Circle of competence is a positive, plenty of information available. Associate company of ITC add to the curiosity. I am sure it’s going to be fun reading about the company”.

Preparation for battle

All that is required a checklist which is flexible but no so flexible☺. This will ensure we don’t forget anything. Checklist doesn’t come easy, takes some time and study to build a mature checklist. What all I need before starting investment documentation, I can share with you:

  • Annual reports (10 years is good)
  • Links to major websites, forums etc.
  • Books and books (hard copy, kindle , pdf anything). Keep those books which are required for practice.
  • Conference call transcripts, all other BSE communications
  • Templates of investment documentation (we will go through sequentially)

What to avoid at this stage:

  • any analyst reports including buy and sell
  • price movements like DMA etc
  • getting overwhelmed by advertisement and name, fame etc (already we have one here ITC!)

Next step is information gathering, after covering financials and investment philosophy we will get into that. By that time I will collect the annual reports etc.

I sincerely hope I may be able persuade few people who will start believing in value investing or those master investors to encourage me more in value investing. Either way this will enlighten me!

Thank you so much for reading my rants.


Guru Mantra 7- Profit is NOT Cash

PL provides the most important health of a business that is profitability. Remember it does not tell you the financial health (a combination of income statement and balance sheet will tell us about financial health).

Please note PL doesn’t tell anything about cash either.

In other words PL is what is sold in a particular reporting period minus what is the cost to make these sales minus other expenses required for sales is equal to profit for the period.

Sales are recorded when company delivers the product or remit the services. Customer will have an obligation to pay and company will have a right to collect. When a company sends a bill company establish a right to collect but may be or not record sales. Simple reason sales is revenue which is recognized by accounting principle, and invoice is a contract note enforce a execution of negotiable instrument.

Costs are expenditure for raw materials, salary, overhead expenses, these are necessity when you a buy a products for inventory. When you ship the inventory, the total cost taken out for inventory and recorded as costs of goods sold. Cost will result lower bank balance and increase inventory values in balance sheet.

Gross margin is the amount left from sales after cost of goods sold is subtracted. It is also called gross profit, you can call the “manufacturing margin”. Helpful to analyze when a seller, manufacturer , buyer are all different people.

Expenses for selling, developing products or even general and administration aspects of the business. Few example would sales people salary, advertisement, legal feels, Research and development etc. Expenses reduces the income. Profit and income are same thing.

Operating expenses are those expenditures which company need to make income. E.g. sales and marketing, R&D, G&A. In US they called it SG&A, and in India very difficult to find easily. You need to calculated your own, so for same reason do not rely much the numbers published by various websites.

Operating income is gross profit minus operating expenses. Operating will exclude all other income like dividend received, interest etc.

Non operating income and expense are like paying interest on loan, receiving interest. They are not shown under revenue from operations.

Net profit is operating income minus non operating expenses plus non operating income.

We spoke about accrual accounting earlier , this means the timing between raising a bill and receiving cash differs and our financials is recorded on accrual basis.

Cash flow statement tracks the movement of cash through the business. Imagine your good old cheque book, where you use to write cheque number, money in and out. Cash flow is exactly the same.

Cash on hand at start of a period PLUS cash received MINUS cash spent EQUALS cash on hand at end.

Cash transactions all we know like paying salary, paying loan, purchasing goods. All these will reduce cash. On other hand we collect from customer, take loan which will increase cash.

Non cash transactions are those activities where there is no movement of cash. Like receiving goods or making goods (raw material and inventory), charging for depreciation.

Positive cash flow means company has more cash in end than beginning, negative means the reverse.

Cash comes to business either from operations (payment from customers etc) or financing (borrowing money, selling shares).

Cash goes out of the business when you spend for operations (buying raw material), financing (pay back loan, pay dividend), capital investments (buy shares, dividends, productive assets), paying income tax.

Cash from operations is the cash generated from day to day activities. This is a good measure of how well the enterprise is management operations.

However it’s just a element of cash flow.

Cash flow from investing activities is buying fixed assets, lending, investing. This indicates the usage of money generated from operations. If you take out fixed asset spend we call that as free cash flow which belongs to shareholders.

Now if you can not invest from operations you need to finance it somehow. That is called cash flow from financing activities like selling bonds, shares, paying back the loan taken earlier for financing, dividend payment. A company with negative free cash flow paying dividend is actually borrowing and paying you. Can be very dangerous.

Connecting Balance Sheet (BS), Profit & Loss (PL) and Cash Flow (CF)

The beauty of financials statements is New Delhi☺, snow fall in Shimla, Delhi becomes cold. Loo in Rajasthan, Delhi suffers. All financial statement items are connected to each other.

Let us understand these connections:

Just keep two things on mind: The flow of cash and flow of goods, services.

Remember the basic equation of accounting which is total assets is equal to total liabilities. So when you subtract anything from asset you need to either add into another asset or subtract from liability.

Net income (PL) is added to retained earnings in BS.

When sales is made on credit net sales is shown in PL, collectible amount becomes trade receivables on BS.

When sale is made product is moved from INVENTORY (BS) to Cost of goods sold in PL.

When a customer pays off money trade receivables reduced and in turn cash receipts increase the cash balance.

When a sale is entered in PL, net income is generated and added to retained earnings (general reserve) to BS.

Expenses when incurred and added to PL becomes trade payable on BS.

Expensed when paid reduces trade payables and reduce cash balance (both within BS).

There are lot more dots, suggest you start connecting and ask questions if any. Al lot of these we will cover during analysis of an investment.

The last piece for now, lets get into how did financials constructed:

Journals and ledgers: every event having a financial impact is known as financial accounting. Accounting summarize and track these events through journals and ledgers otherwise called “books”.

Ratio analysis: the relationship between the accounting number are established with the help of ratios. For example net profit to net sales tell us what is the ultimate margin we are getting. When we plot it over several years it tells us how we are doing, or check with competitors to know are we better off.

Common size statements: if we split PL to a common base i.e. say sale 100, cost of goods sold becomes 65, operating expenses 10, other expenses 10, net profit becomes 15. All in percentage, we can compare this year to year, this will give us a edge avoiding absolute number which can be distorted by a base effect. E.g. 100 to 120 is 20% rise, 1lac to 1.02 lac is 2%, if we read absolute number we may get carried away between 2 lac and 20. However both situations can be dangerous, we need to put our thinking hat on and on.

Not to worry, what type of common size statements or ratios are required…we have loads of time to analyze.

Thanks again for reading me out, I will touch base on investment philosophy next. Meanwhile you can go through financials and it’s good and bad to understands in detail from several sources available on net.