What do Value Investors do differently

At Indiastockanalysis.com we employ Value Investing principles in the analysis and ratings of hundreds of shares traded on BSE and NSE. Analysis and ratings are done by  finance professional with more than 15 years experience of investing in Indian share markets.  Our goal is help you grow your financial wealth over long periods of time.

In this article we will examine what value investors do differently.

The one thing that separates the value investors from the rest of the players in the stock market is their ability to value the business objectively based on the available information. They are more oriented towards the value of the business. The price at which the underlying stock is quoting does not matter much to them except when comparing the value to the price when making a decision about whether or not to buy the stock.

They always have a margin of safety in their investments. Margin of Safety is what protects the value investors when the markets go down or the economy suffers due to macro-economic factors. They build margin of safety into their investments. This helps them to buy the stocks only when they are quoting below the actual value of the business. This ensures that they do not lose much when the tables turn.

They are very frugal (who spend less) by nature. They live below their means and do not make a show of their wealth. Personally, they are calmer and quieter people who amass huge amounts of wealth without the world getting any inkling of it.

Value investors are avid readers. They read a lot. If their investments are in a particular company, they read and know everything about the company so much so that they have more knowledge about the company than its directors themselves. They also read a lot of the trade journals, Industry magazines, product information and everything associated with the investments that they have made.

When they make a mistake, they book the loss and go for the next opportunity. Value investors do make mistakes. When COVID 19 happened, Warren Buffet the famous value investor sold most of his holdings in the Aviation sector. Most ordinary investors sit with their losses expecting the fortunes to turnaround in the companies that they invest in even though the facts are to the contrary. For example, the investors who lost heavily in Anil Ambani group of Reliance companies still hold on to their investments in the hope that those would recover whereas, based on the current circumstances, the chances are highly unlikely. Value investors do not do that. They swallow their pride, book the loss and move on to next best opportunity.

They are willing to wait patiently until the market provides the right price. They understand the importance of waiting patiently more than any other. If the price is not right, they will not commit anything. They make a profit at the time of buying itself as they pay a very low price for their investments. They buy mostly only when the stocks are on Sale such as in March 2020 (Covid Panic driven) when almost the whole market was available on discount.

They are okay to wait in cash and not fully invested if there are no better investment options available.

They generally do not sell their investments. If the business of the company is growing, their earnings are increasing year after year, then they would not sell their investments. They continue holding their investments almost indefinitely. They sell only when the reasons on the basis of which they bought the stock do not exist anymore, when the decline in the sales and profits of the company is permanent or when there is a better alternative available for their investible funds.

They are good with numbers and are able to make a lot of calculations about value and price instantly in their minds.

They are not active in the market. For them, inaction makes more profit than constant buying and selling at every point. They don’t follow the minute to minute price movements of their holdings and are okay even if the stock market is closed for the next two years so long as the business, they invested in does well.

They buy huge quantities of shares at aggressively lower prices (only when the whole market is on Sale) or when the business of the company is grossly undervalued or a temporary bad news which drives down the market price of a wonderful company to lowest levels.

How to determine the Right Price to Pay for any Stock (Cupid Limited as Example)

(The financials of CUPID Ltd (BSE Code 530843) are used as an example here. Cupid Ltd was one of the recommendations at Indiastockanalysis.com for the month of October 2020).

Cupid Ltd has a very stable business of predominantly producing male and female condoms besides other associated gels, sanitizers and creams. It exports them to several countries in the world. It has also applied for USFDA approval to market them in the USA. The company is debt free and has recently made a foray into production of medical test kits that would facilitate diagnosis of various ailments including Covid 19 symptoms. It is a very asset light company with a very clean balance sheet and generates substantial free cash flows every year.

In this article we will discuss how to determine the price that should be paid for any stock using the principles of Value investing. Most investors identify good investments but when it comes to paying the right price most of them are found lacking in this knowledge to arrive at the right price to pay. They buy good businesses at high prices.

The price that we pay determines how well our investments will perform.

At IndiaStockanalysis.com, we identify the price to pay for all the 3000+ stocks traded on BSE and NSE. We also take caution to exclude companies whose earnings are negative.

Earnings

Earnings made by the company is one of the most significant factors that influences the market price of any stock. A business that can grow its earnings significantly over a long period of time is viewed very favorably by the market. The market rewards the earnings generating capacity of the businesses.

Therefore, in arriving at the price to be paid, earnings is the most important factor and provides the starting point.

So, what is the meaning of Earnings for determining the right price to pay for any stock. We are interested in the earnings that remain after all expenses are met and which belong exclusively to the Equity Shareholders of the company.

Excerpt from Cupid Income statement from their Annual Report

The highlighted line from the income statement above is what we are interested in. It is portion of the profit that belongs exclusively to the equity shareholders of the company. We would like to invest in a company that grows this number year after year.

And we use the TTM earnings on a Consolidated level.

TTM stands for Trailing Twelve Months. For example, if we are analyzing the stock in the month of November 2020, the TTM EPS would be the

EPS of September 2020+ EPS of June 2020+ EPS of March 2020+ EPS of Dec 2019.

For Cupid Ltd, the TTM EPS as of November 2020 is Rs.25.23

EPS Growth rate

The growth rate of a company would tell us how well the company has been able to increase its Earnings per share in the last five years. We are interested in finding companies that have been able to grow their earnings consistently over several years. 

For Cupid Ltd, here are the numbers

The compounded EPS growth rate is therefore 20.16% 

Cupid Ltd has a very stable business of producing male and female condoms. It exports them to several countries in the world. It has also applied for USFDA approval to market them in the USA. The company is debt free and has recently made a foray into production of medical test kits that would facilitate diagnosis of various ailments including Covid 19 symptoms.

EPS after three years

The next step in the process is to estimate the earnings for at least next three years using the growth rate for the past five years. It is difficult to estimate which way the company would go after three years. For our analysis, three years is the long term. We can adjust this as we move forward.

Do not worry now about this estimate. We will apply a Margin of Safety (one of the most important principles of Value Investing) to the final price that we should be willing to pay for this stock.

SO the EPS of Cupid Ltd after three years in 2022-23 would be Rs.51.82.

This is nothing but the TTM EPS compounded at the rate of 20.16% for three years.

Market Price after three years

This will be the EPS after three years multiplied by the current Price Earnings multiple (PE) for the stock.  You can get the current PE multiple of the stock from the BSE website.

Current PE is 8.96.

Alternatively, we can also calculated the PE as the average of 52 week high and low prices divided by the TTM EPS in which case it would be ((295+115)/2) Divided by 25.23 which would be 8.12. However, we take the Current PE ratio.

Therefore, Market price of the Share after three years in March 2023 is likely to be 51.82 times 8.96 which is Rs. 464.

15% minimum expected return

 

As value investors, we would need at least 15% after tax return on our investments.

Now we estimate, how much should we pay now, so that at a compound rate of 15% per annum it becomes Rs.464 after three years.

At IndiaStockANalysis.com, we perform these calculations for all stocks traded on the BSE and NSE stock exchange so you don’t have to do it.

 

For Cupid Ltd, the Price that we should be willing to pay that would amount to 464 after three years is

464/1.15/1.15/1.15 which is Rs.305.

Rs.305 invested now grows to 464 @15% rate per annum.

Margin of Safety 

We should never pay a high price for any stock. So we will NOT pay Rs.305 for it.

This is the bottom line of all value investing principle. NEVER NEVER NEVER Overpay for any stock.

The above is a good estimate but it is an estimate nonetheless. The numbers that we expected might change over the years. Therefore, we want a good margin of safety of at least 40% should something go wrong with our estimates.

For class A group stocks, we have less margin of safety of 30%.

So, the price that we should be willing to pay is Rs.305 times 0.60 which is Rs.183.

Rs.183 is the maximum price that we should be willing to pay for this stock.

What next

But Cupid is now going at 225 as at the time of this writing. So, should you buy Cupid.

The answer is a resounding No. We should not be willing to pay anything more than 183 for that stock. When it comes to 183 or thereabouts, buy a huge quantity of shares in it – Buy a part of the business if you like their business. Make your research efforts pay.

Add this company to your watchlist and keep monitoring it until it reaches Rs.183 and when it gets there make a BIG investment and have the courage to hold it for next three years. This is how real wealth is created from the stock markets. Besides, you will also be rewarded with the dividends that this company pays over these years. Currently, Cupid pays a healthy dividend of around Rs.4.50 per share.

This courage to hold comes from conviction in our analysis.

Once you buy the shares, monitor the company like a Hawk. Read every announcement that it makes, pour over its quarterly results, Read the earnings call transcripts, Understand the quarterly financial statements and see the trends and decide whether the company still has all the characteristics intact that made it to the Buy list now. 

At Indiastockanalysis.com, we help you identify the Right Price to pay for all Profit making stocks that trade on the BSE and NSE. We also rate stocks based on several fundamental parameters. Cupid was the fifth best stock in our October 2020 recommendations.

Happy Investing.

Analysis of Caplin Point Labs

October 2020 Reco- Caplin Point Labs


Here is a snapshot of Caplin Point Labs and its rating and analysis

Out of the 3000+ companies analyzed for the month of October 2020, Caplin Point Laboratories has stood out as one of the buy recommendations based on our analysis and comprehensive rating system. We recommend 10 such stocks every month which excel on all identified parameters. These stocks can help create sizeable wealth if held for a minimum of three years at the least.

What follows below is an explanation of why this company was chosen for a “Buy” recommendation in the month of October 2020.

You can scroll all the way down to read the conclusion 🙂

About Caplin Point Labs

Caplin Point Laboratories Limited is possibly the only mid-sized company in India’s pharmaceutical sector to be engaged in the manufacture of APIs, finished formulations, research & development, clinical research, frontend generic presence in Latin America, brand marketing in Francophone Africa and a USFDAapproved injectable facility.

The Company’s asset-light marketing business model has helped generate the resources to build world-class infrastructure.

The Company’s debt-free and cash surplus situation positions it attractively to address the opportunities of the future.

Sales Growth Rating (10/10)

Sales have grown at a CAGR of around 38% in the last five years. The TTM (Trailing Twelve Months) sales as at the time of this recommendation was Rs.911 crores.

At IndiaStockAnalysis.com, we give a maximum rating of 10 for sales growth greater than 30% in the last 5 years. So this company got a rating of a perfect 10.

Net Profit growth rating (10/10)

The Net profit has grown at a CAGR of 52% over the last five years. The TTM net profit as at the time of this writing was Rs.219 Crores.

We give a high rating of 10 to companies where the net profit has been showing a steadily growing pattern over the years. Therefore, on this front, this company gets a full rating of 10.

Operating Profit Margin (OPM) rating (6/10)

The Operating profit margin of the company has been around 30 to 33% in the last five years. It gets a rating of 6 on this parameter. Operating profit represents earnings before finance charges, taxes , depreciation and Amortization. This explains how well the company has been able perform on an operational basis to maintain or grow its Gross profit margins.

Net Profit Margin Last Year and Latest quarter rating (6/10)

The Net profit is what is available to the shareholders of the company after all the expenses have been paid out. The higher the net profit margin the better it is for the shareholders. At IndiaStockAnalysis.com, we shortlist only those companies that have at least 8% as Net profit Margin. On this front, this company gets a rating of 6 out of 10. It has been maintaining a healthy net profit margin of over 20%.

Dividend Yield (2 /10).

Even though this company is cash rich and is debt-free, it is not known for paying generous dividends. The company has retained cash for expansion and acquisition purposes. In the year 2020-21 , it has paid a dividend of Rs.2.50 so far. However, one thing to note is that the dividend per share is showing an increasing trend (from Rs.1.50 in 2017 to Rs.2.50 in 2020-21).

Price to Earnings Rating (6/10)

Price to Earnings measure how expensive the company is when we compare its Earnings per share against its Market price. For this company, the PE ratio is around 17. Considering the fact that this company has been growing its Sales and Net profits at a considerable pace, on the PE ratio front, it gets a rating of 6. Companies with lower PE ratio get a higher rating.

Return on Equity for 5 and 3 years Rating (8/10)

Return on Equity measures how well the company is able to use its Equity resources to earn profits for the Shareholders. In order to get a good grip on the return on Equity we measure both Average return on Equity for 5 years and also for the last three years. The higher the return, the higher the rating. Caplin Point has a rating of 8 on this front.

Magic Formula (8/10)

Magic Formula is a concept popularized by Joel Greenblatt in his famous book The Little Book That Beats the Market. This is a combination of Earnings Yield and the Return on Capital Employed. In effect, this ratio tells us how well the company has been employing its capital (both Equity and Debt) to generate profits for the Shareholders.

On this front, it has a rating of 8 out of 10.

Debt to Equity (10/10)

At Indiastockanalysis.com, we do not favor companies that employ excessive amounts of debts (both long term and Short term) on their balance sheet. We give a very low rating to companies with High Debt to Equity. Caplin Point has no debt on its balance sheet. Therefore it gets a rating of 10 on 10.

Price to Book Value (2/10)

The market price to book value per share measures the Market price against the Intrinsic worth of the company. However, this is a traditional measure. Book value is not fully representative of the real realizible value of the assets/liabilities of a company. However, at Indiastockanalysis.com, we favor companies and highly rate the ones that have low Price to Book Value. On this front, Caplin point scores 2 out of 10.

 

Conclusion

So this stock of Caplin Point Laboratories has an overall Rating of 82 out of 100. It is no doubt a wonderful company. But is the price attractive enough to buy this.

At Indiastockanalysis.com, our objective is to identify wonderful companies and MORE IMPORTANTLY to recommend buying them at attractive prices.

So should you go and buy it. No. Not until you know what is right price that can be paid for it.

This is where most investors make mistakes. Most of them do not know what is the right price to pay for the stock.

But we will help you find this.

Caplin Point’s EPS as at the end of March 31, 2020 is Rs.26.13

Its Average rate of Return on equity has been around 35% in the last five years.

Assuming it can grow it at the same rate over the next three years (do not worry we will also add Margin of Safety and that should take care if our assumptions go wrong), its EPS in March 2023 would be

26.13 times 1.35 raised to 3 which is Rs.64.

The Current PE ratio for this company is 17.

At this PE, at the end of March 2023, this company will be quoting at 64 times 17 around Rs.1088.

If our objective is to earn 15% return for the next three years , we should be willing to pay nothing more than Rs.715 (that is the present value of Rs.1088 discounted at 15% for three years).

Lets add a Margin of Safety of 30% to this price, so we get a price of Rs.500.

Rs.500 is the right price to pay for this stock to earn a rate of 15% return at a margin of safety of 30%

Sales and Net profit growth

 

Sales Growth

The basic reason why a company exists is to market and sell a product or service and to make profit from out of those sales/services.

For example,

  • Bajaj Auto sells three wheelers and two wheelers
  • Infosys sells software services to its clients both within and outside India.
  • Bharat Petroleum makes most of its revenues and profits from sale of Petrol and Diesel.

From an investment perspective, we are interested in those companies that can increase their sales year after year and quarter after quarter. The trend should be an increasing one. Their business model and their product should not be an easily replicable one. The more the barriers to entry, the better it is for the company. The company itself should be in a position to increase the prices of its products without losing customers. This can happen only if the quality of the product/service offered by the company is world-class and Supreme.

As an investor, we should be in a position to understand the utility of the product/service a company sells and the business that the company is in. If we cannot explain in clear terms what their products/services are and how it benefits their customers, then we are better off by not investing in such companies.

Besides, we are on the lookout for the companies that develop products which can meet the needs of people not only within India but also elsewhere. A company that has both domestic and international presence would be an ideal investment choice for further analysis.

Therefore, sales growth is the most influential factor when analyzing companies listed on the stock market. The higher the sales growth, the better are the chances for the company to survive odds and bad economic situations.

At the same time, we are not interested in companies that spend heavily on Research and Development activities.

Sales can be Organic and Inorganic. Organic sales are revenues generated from the Core business of the company. Inorganic sales can be mostly from non-core activities such as investment income and from acquisition of companies in unrelated business.

At Indiastockanalysis.com, the Indian companies with Sales growth over the last five years of greater than 25% have a better rating than the other companies where the sales growth is, say, less than 5%. Our rating system identifies companies that can keep growing their sales numbers rapidly and at higher rates.

 

Net Profit Growth

Sales growth is of no use if the increase in sales do not result in an increase in profit. Besides, a rupee of sales should lead to higher rupees of profit. This is the net profit margin.

Increase in Net Profit is a result of two factors –

  • Curtailing costs and
  • Increasing the price of products or volume of products sold.

The companies that increase their net profits by cutting costs cannot sustain it over a long period of time. Net profit increase through cost cutting shouldn’t be seen as a good sign. While cutting costs is absolutely essential, but increase in net profits which do not show and which are not as a result of increase in sales should not be favored. This cannot continue for long as there is a limit to how much costs can be cut.

 

We are most interested in investing in companies which show a growing Sales and also net profit trends. Net profit is what is left out after meeting all costs including finance and Selling costs.

Net profit is a variable that can be affected by changes in cost structure, price and volume changes of the products or services that the companies sell.

At Indiastockanalysis.com, we rate companies based on how well the net profits have grown over the past five years. We focus more on companies that are not only able to increase their sales and net profit but also the net profit margins year after year and quarter after quarter.

 

Ratings are extremely important because unless we rate companies based on several factors, it would be difficult to identify the best companies from out of 3000+ companies traded on the Bombay Stock Exchange (BSE) and National Stock Exchanges (NSE)