Common question in nearly every email I get is how to value any business. So let’s focus on high level approach on how to value a business. Also it’s time to evaluate the portfolios positions for three brother.

Firstly market is not always efficient and all the information about company does not disseminate   evenly, equitably or even quickly until someone responds to them rationally. Therefore share price cannot always reflect true value of the underlying business. As a value investors this provide us an opportunity to outsize our returns for our investors.

Warren Buffett once said that, ‘predicting rain doesn’t count, building ark does’. I am consciously building on this analogy through our Value Blog and trying my best to cast light on how to invest in equity market.

Let me give small example. Suppose you have an eye on a company, BHARTI SHIPYARD, you can see its share price has fallen down from Rs 175 to Rs 75. Should you buy now? What if you buy at Rs75 today and the share price falls to Rs 60? Let’s assume you decided to buy more. What if they decline more to Rs 50? Exactly, so when do you buy them?

You should only buy when you are 100% confident that this business is worth Rs 175, so what does it mean when you see share price of the same business at Rs 75 – then I would consider it opportunity, if you are confident of its value.

The challenging part of investing is not to identify good businesses but knowing when to buy them. let me give you an example, when FAG was trading around Rs 950 in December last year, we knew it was trading at approx 10% discount to our estimated intrinsic value for March 2012 year end. We also knew that its estimated value for March 2013 to be in range of Rs 1,350 -1,400.

We never expected that FAG Bearing price will go as far as Rs1,700 in span of 6 months, recently I know that when it went down to Rs 1,450 (15% down from highs), still not a cheap price to buy.

Let me leave you with to think on this insight shared by Bob Goldfarb of the Sequoia Fund remarked in 2004 in R Goldfarb, Sequoia Fund Shareholders meeting, New York, 2004:

Time is the friend of wonderful business, affording it the opportunity to reinvest incremental capital at favourable rates and increase the value of the enterprise. Over time, the price you paid for a terrific  company looks cheaper and cheaper. For the inferior business at the cheap price, time may turn out to be the fell destroyer.

I am also of belief that cheap price may not be good value for all the companies. Almost eight decades ago, Benjamin Graham began systematically evaluating companies and their shares at the time when people thought shares as a speculative alternative to bonds. Through his books, lectures, classes and fund management business he inspired many great investors, such as Christopher Browne and Warren Buffett.

The two most valuable legacies of Benjamin Graham for me were his Mr Market allegory and margin of safety concept. Many investors even today follows his ‘Net-Nets’ approach of investments. Even today Columbia University teach Net-Nets as the first step of valuation and present lecturers and stewards of Graham’s security analysis.

If I summarise his approach to measure value of a company, he purely looked and advocated to do quantitative analysis to find bargains. He would begin with current assets on the balance sheet of the company. These included the cash, the inventory and current debtors adjusted to reflect economic realities such as collect ability. These are the assets you can convert them into cash in short period of time.

From these assets he would subtract absolutely everything the company owed. If there was a positive number then he would divide that with number of shares on issue to get what he uses to call his ‘Net-Nets. And if a company share prices traded at less than two thirds of the net current asset figure, he would buy it.

He adopted this approach for many years and also his other students who continued in his tradition like Walter, Tom Knapp and Buffett. This approach had been indeed very successful for all of them but didn’t impress Buffett’s future business partner, Charlie Munger. Munger thought that a lot of Graham’s precepts were lunacy as they ignored what he believed to be relevant facts.

But then Buffett met Charlie, who suggested he focus on extraordinary businesses, particularly those with fewer tangible assets and higher return on equity. With Munger’s input Buffett did even better,
eventually becoming world’s richest man.

In the book of CJ Loomis, ‘The inside story of Warren Buffett’, Fortune, 11April 1988, he remarked:

Boy, if I’d listened only to Ben, would I ever be a lot poorer

After that for me it was important to own the extra ordinary businesses only and not to even bother thinking about ordinary ones. Also it is important that you do not overpay for the shares of even most extraordinary businesses. The price you pay for your shares will determine your returns. The lower the price you pay, the higher your returns, it is that simple.

Value operations quality and performance rating helps us to identify those extraordinary businesses and its intrinsic values chart helps us to wait for the right time to buy them and add in our portfolio.

This same approach has been advocated to one of our Delhi Brother and he is remarkably doing well in the field of investment business. We are tracking three different portfolios (of which two are on different brokerage recommendation) and are also tracking mutual fund returns from last 6 months to keep our point and analogy in front of all the serious long term investors.

Banglore Brothers portfolio as of 6th July 2012
is as follows:

Name

Price

Shares Bought

Price @ 6th July 12

Investment @ 6th
  July 2012

Axis Bank

Rs 806.75

124

Rs1,037

Rs 128,588

Syndicate Bank

Rs 68.50

1,448

Rs 109

Rs 157,832

Yes Bank

Rs 238.60

420

Rs 361

Rs 151,620

IDFC

Rs 91.75

1,090

Rs 142

Rs 154,780

Shriram Transport

Rs 419.40

238

Rs 557

Rs 132,566

L&T

Rs 995.10

100

Rs 1,405

Rs 140,500

Maruti Suzuki

Rs 920.05

109

Rs 1,215

Rs 132,435

Exide Industries

Rs105.05

952

Rs 136

Rs 129,472

BHEL

Rs 239

418

Rs 236

Rs 98,648

Guj state petronet

Rs77.85

1,285

Rs 72

Rs 92,520

Dividend received

 

Rs

Cash

Rs 6615.40

Total

Rs 1,325,566.40

Mumbai brother’s portfolio is as follows:

Name

Price

Shares Bought

Price @ 6th July
  12

Investments @ 6th
  July 12

ICICI Bank

Rs 684.60

146

Rs 935

Rs 136,510

Indusind Bank

Rs 225.35

444

Rs 344

Rs 152,736

HDFC

Rs 649.45

154

Rs 684

Rs 105,336

IDFC

Rs 91.75

1,092

Rs 142

Rs 155,064

IRB Infra

Rs 129.95

770

Rs 137

Rs 105,490

L&T

Rs 995.10

100

Rs 1,405

Rs 140,500

Bajaj Auto

Rs 1,592.80

63

Rs 1,539

Rs 96,957

Tata Motors

Rs 178.40

560

Rs 240

Rs 134,400

BHEL

Rs 239.00

418

Rs 236

Rs 98,648

Adani Ports

Rs 120.55

830

Rs 122

Rs 101,260

Dividends

Rs

Cash

Rs.7068.30

Total

Rs 1,233,969.30

Delhi Brothers portfolio is as follows:

Name

Price

Shares Bought

Price @ 6th July
  12

Total Investments

Fag Bearing

Rs 1,046.70

95

Rs 1,524

Rs 144,780

Gandhi Spl Tubes

Rs 124.95

800

Rs 140

Rs 112,000

LMW

Rs 1,477.95

68

Rs 1,707

Rs 116,076

Amar Raja

Rs 203

493

Rs 305

Rs 150,365

Swaraj Engines (26th
  March 12)

Rs383.05

261

Rs 449

Rs 117,189

Cash

Fixed term @

9%/anum

 

Rs 530,407.37

Dividends

 

 

 

Rs 0

Total

 

 

 

Rs 1,170,817.37

To summarise on all of the three brothers equity investments
is as follows:

NSE 50

14.67%

Banglore Brother

32.55%

Mumbai Brother

23.39%

Delhi Brother

28.14%

Same period top Mutual Funds return are as follows:

Overall Delhi brother’s return for the 6 months is 17.08% which compare to professionals and brokerage firms is good return as still Delhi Brothers portfolio is sitting on 45% cash!!

Happy investing!!!