In this post I am posting only my reasoning for acquiring brokers stocks without specifically going into too much detail on Motial Oswal. Will post a short comment later, specifically on Motial Oswal.
Itas true that various investors acquire same stocks for totally different reason. I had invested in couple of broker stocks like Geojit BNP Paribas, and Motilal Oswal, Emkay Global (Emkay is totally a different story now after they got hit badly in flash crash and would not recommend any fresh position for now) couple of months back. I acquired these stocks based on what Martin Whitman of Third avenue Fund (You can download his newsletter from here (http://www.thirdavenuefunds.com/ta/) has mentioned while acquiring stocks of companies directly impacted by housing crisis. Lets see how his reasoning can be applied to brokers:
Let’s see what these principle are and how can we apply the same to Indian brokerage companies._(Mentioned it italics principles laid down by Martin _and my comments below I normal font)
First the bad side of these investments:
1)The stock market pricing for these equity issues is chaotic. There is no way Fund management is able to pick a bottom for securities prices, or a near bottom. - this is quite evident from the stock prices wherein stock prices of most of these companies are down more than 80%.
)- This is indeed the case for most of the brokers stocks wherein their share prices have fallen by more than half or more. Going forward its quite likely that share prices can test new low in case of any uncertainty (decline of more than 25-30% would not surprise me)
2_) Fund management has no good idea of how deep the crisis will become, or how long it will last. Our best guess is two to four years._
)- Its difficult to say when the sustainable rally will begin. Currently there are lot of high impact low probable events hanging around both domestic and international.
Second, the good side of these investments:
1)_In each instance, Third Avenue Value Fund (TAVF) is acquiring common stocks at meaningful discounts from readily ascertainable NAVs.__For each of these companies, a normalized Return on Equity (equity equals book value) (aROEa) ranges from 8% to 14%. Assuming a 10% ROE sometime in the future, and no further dramatic deterioration in book value during the interim, probably a realistic assumption; and current pricing at 40% of book value, Third Avenue would be paying only four times future normalized earning_power.
- At one point on time stocks of Geojit BNP Pribas and Motilal Oswal were trading at or very near to their book value and Emkay Global steep discount to book value (more than 50%). Brokerage rates have definitely have hit bottom or close to bottom. Assuming that going forward brokers can earn ROE of 10-12%. Going by high asset turnover ratio or in other words low capex requirement, which these businesses enjoy, conservatively they should be able to earn atleast 15% ROE (Motial Oswal asset turnover declined after they invested in buying their corporate office) So if you acquire these stocks at or near book value, you can acquire these stocks at a normalised PE multiple of 6-7x.
2)Each common stock acquired, is acquired in a company which enjoys a strong financial position.
)- Both Geojit BNP and Motilal Oswal have zero net debt as on Mar 2012. Their business is not at all capital intensive and having burned their fingers in rapid expansion during 2006-08, I do not think any of the brokers will expand their branch network aggressively.
Now, even if it takes upto 5 years for broking stocks to recover its profitability, they should atleast double from these levels. This imply minimum CAGR of 15%, with likely possibility of much higher return.
Disc: My opinion can be biased, I have positions in the stock discussed above.
