Every day our inbox is filled with investor’s question. It is very hard for me to reply each and everyone personally. But I will share my view on those stocks by posting them on Value Operations.

This week we witness plenty of information on macro economics and its future course. We expect GDP for 2013 to be below 8% and inflation is also expected in range of 6.5% – 7%. This information is enough for RBI not to cut and also not to expect cuts in interest rates in near future frequently.

Suddenly from pessimism of December 2011 we entered in the boom era of Jan 2012 and then getting those ideas busted in March 2012. So what is really happening with economy?

In December 2011 market was expecting companies to report low profits for third quarter or to slash their guidance for 2013. But market participants and analysts were taken back by the performance of many companies.

First quarter of 2012 also witnessed quantitative easing in Europe. Whenever quantitative easing takes place in any part of the world, we find lot of money around us. Quantitative easing is nothing else but printing money. Whether money is printed by US or Europe, it impacts all the economies of the world. Why? Because once that money comes into circulation, it finds its own destination. This is the reason we witnessed healthy liquidity in the market recently.

Investing is all about looking at the future prospects. As a fund manager my focus is always on stock specifics instead on macro economics. As a professional my job is to identify opportunities to invest in tough as well as pleasant macro economic environment. After considering macro economic information this week, I do not think 2012 -13 financial year will be any different economically to 2011-12. It won’t be that brutal as we witnessed earlier, but will be challenging.

I have made a habit of reading number of research reports in my day to day activity. In my experience I have always found analyst’s reports too optimistic in regards to future earnings. Many analysts’s while preparing future projections of financial statements also some times forget to consider equity raising and borrowings by companies who are in habit of raising and borrowing very frequently.

There is also a notion in market that business that has bright prospects for growth sought to be worth more than the one that don’t. I think earnings growth is not essential variable required every time. Some times growth – hurts where company’s return on equity is low. It will hurt rather than help shareholders.

Return on equity will help you understand the growth prospects of a company and whether or not that growth will be rewarding for shareholders.

So let’s look at the Voltas and its earnings expectation of Goldman to explain my point. Value Operations rate Voltas as B2 for quality and performance rating.








Rs 6.10

Rs 6.27

Rs 7.69

Rs 11.62

Rs 10.63


Rs 1

Rs 1.35

Rs 1.60

Rs 2

Rs 2

Retained E

Rs 5.10

Rs 4.92

Rs 6.09

Rs 9.62

Rs 8.63








Rs 103

Rs 86

Rs 82

Rs 166

Rs 84

We at Value Operations are expecting EPS for 2012 in range of Rs 4.40 – 4.50. Everyone knows the reason behind this plunge in its earnings. If we imagine that those one time losses didn’t took place then EPS for 2012 stands at Rs 9.59.

Now Goldman Sach came out with its reports asking investors to buy this stock and expects earnings to grow by 14% -18% more on Voltas consensus earnings. This triggered excellent rally in the stock price recently. We all know that in short term market will price anything but. In long run it is value of business that price chases.

The consensus earnings for Voltas are Rs 8.50 for 2013. If we add expectations of Goldman Sach then earnings for 2013 is to be expected in range of Rs 9.69 – Rs 10.03. So hang on to those expectations of Goldman for a while.

Let’s look at the performance for current year of Voltas. If we forget one time losses of 2012 and consider EPS for 2012 to be Rs 9.59, then as per Goldman we are expecting Earnings growth in range of 1% – 5%.

Now, if you look at the above table, in 2007 Voltas reported ROE of 58% and retained 84% (5.10/6.10)of their earnings back into their business. If Voltas want to maintain its return on equity then they will have to grow their earnings by 48% (84%*58%).

This calculation of 48% growth in its earnings is called as ‘implied growth rate’. The simple formula to calculate is to multiply percentage of retained earnings back in business by return on equity. Evaluating
earnings growth with its return on equity is a very helpful and beneficial tool to shareholders. No one was expecting Voltas will grow its earnings by 48% in the year 2008. A sluggish growth of 3% next year dented its profitability down from 58% to 41%.

If you look closely the table again then you will notice that Voltas earnings were growing consistently from 2007 to 2010. But if you look at the last two rows i.e. ROE and Intrinsic values then you will notice
big fluctuations. Have a look at the price chart below of Voltas and how values behaved during that time.

For any serious long term investors this business has not generated any value in last five years. Actually it has wiped out 22% of value from its 2007 standing.

Voltas has history of trading at healthy premium to its intrinsic value. But management had not created any real value for shareholders. Apart from your quantitative as well as quality analysis it is important to invest in the companies which are growing their values every year. Price follows the performance not the earnings growth of business. A volatile performance history makes investment in Voltas risky for us.

Lastly, coming back to ‘implied growth rate’, and analysing Goldman’s estimate, the actual return on equity including all the extraordinary losses for Voltas in 2012 will be in range of 8.5% -9%. We all know that extra ordinary expenses of last year are one of in nature and Voltas has potential to report its earnings in range of Rs 9.50 – Rs 9.75 EPS even before Goldman comes out with its expectations. Value Operations are expecting EPS for 2013 at Rs 9.83 (Almost in range of Goldman’s).

We don’t expect Voltas to give any dividends this year. If we factor in Rs 9.69 as EPS to calculate ROE for 2012 then it results as 21%. Now as per ‘implied growth rate’ theory, to maintain their profitability they will have to grow their earnings by 21%.Earnings growth rate in range of 1 -5% (As per Goldman) will dent its profitability and this will result into values diving for 2013.

Your views are most welcomed and happy to discuss if you have any issues to understand the concept of ‘implied growth rate’.

Have a good weekend.