Company Analysis – Here's How To Go About It!
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We at DSIJ have evolved a very unique way of analysing any particular company listed with the bourses. This technique has been sharpened over the past 29 years and has been perfected through a lot of trial and errors. In fact, our method of analysing companies/stocks has withstood some of the best and worst phases of the stock markets, albeit with some share of bad luck too. We have seen the bull rally of Harshad Mehta in 1991, the major crisis of Southeast Asian economies impacting the Indian stock market sentiment in 1995, the tech rally and its subsequent burst in 2000, and of course a major rally in 2007 and the aftermath of that. Each rally and fall has helped us to fine-tune our strategies to make it much better over a period of time.
There are several mantras that we believe in very religiously while analysing a company and through this piece of writing, we are revealing some of the best kept secrets of DSIJ. Please note that we keep updating these mantras as and when need arises to make the model more dynamic as there is no fixed and permanent solution to the ever-changing investment climate where new developments are the order of the day for the market investors. Also note that these mantras need to be applied in whole and not selectively to get the desired results.
Mantra 1:
No Company is Good or Bad
Does a good company give you good returns and a bad company yield bad capital appreciations? Most of you would answer in the affirmative. We strongly believe that there are no good companies or bad companies from investors’ point of view. Only their valuations are good or bad. Hence what is important from an investor’s perspective is that you understand whether the valuation that you are paying to buy a company’s share is right or not.
Let us explain the same through an example. In the year 2001 we came across two companies for analysis. The first one was Infosys and the other was Arvind Mills. Infosys scrip that time was available at Rs 715 (adjusted for bonus) and Arvind Mills was available at Rs 13. While Infosys was growing smartly with its best financial performance and disclosures with the added advantage of good management. On the other hand, Arvind Mills was a loss-making company operating in a sector that had been written off by most of the investors. Which one do you think would have given you more returns if you were still holding the same till November 2011? While most of you would think Infosys, the fact is that Arvind Mills would have yielded better returns.
The reason for this is that the market was more worried over Arvind Mills’ past problems than its better future and due to that the scrip was quoting at much below its intrinsic worth. Therefore it made sense to get the scrip despite the company reporting losses. Hence, it’s important that one understands what price one is paying to acquire a good company and if the price is not right, despite investing in good companies, your returns from the same would not be very exciting. There have been many ‘good’ companies in the last five or six years that have not provided good capital appreciations as the valuations were much higher than what they logically should have commanded, thus resulting in market underperformers.
Mantra 2:
Pay Premium for Good Management
Many a times you must have seen that some of the companies command a better premium over the other companies despite both having similar financial numbers. Why does it happen? It’s due to good quality management. Good management is like a brand and a brand always commands premium over non-branded goods. It’s like the premium one pays for branded readymade shirts over non-branded readymade shirts. We at DSIJ give a lot of weightage to promoters. Even if the company’s financials are good but the promoters’ track record is a shade doubtful, we will not recommend scrips to buy. Just to give an example: the Tele Data Software scrip in the past was available at a price earnings’ ratio of 1. Yet we gave the scrip a ‘sell’ signal as our comfort level with the management was not good.
No need to tell you that the scrip continued to underperform since our ‘sell’ recommendation despite it being available at cheap valuations. We also avoid companies having a tainted image like any of those involved in some kind of a scam. Our observations over almost three decades suggest that tainted promoters normally fail to generate good market returns for the investors.
Mantra 3:
Avoid ‘Hot’ Sectors
We at DSIJ believe that one should always look at sectors that are not much in vogue at the present moment but have great potential to offer towards capital appreciation in the future. Normally ‘hot’ sectors do not offer great capital appreciation if your timing is not right and in many cases this results in capital erosion. In the year 2000, we avoided recommending technology stocks and in fact in many cases we recommended ‘sell’ to our investors. In the recent past the hot sectors were realty and infra companies. Many of the investors parked their funds in these companies at their peak, assuming that they would make some quick gains but today most of the counters are quoting at huge discounts as compared to the 2008 levels. Our readers would vouch for the fact that in 2006 when the textile sector was down and out due to huge losses reported by it, we went ahead and recommended textile stocks as we could foresee great valuations. Let us remind you that these scrips provided handsome returns to investors.
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Mantra 4:
Understand the Business
When we invest in any scrip, we are not investing in a company. Rather it is the business of the company that we are investing in. So if the business is doing well the scrip will also reciprocate the performance on the bourses. Similarly, if the business idea fails, the scrip also fails to perform on the bourses. Hence one must understand what business the company is doing. If one does not understand this basic parameter, it is unlikely that one would make sound investment decisions. We at DSIJ spend a lot of time to understand what business a company is engaged in and the growth prospects, keeping in mind the national as well as the international scenarios.
Legendary investor Warren Buffet’s strategy states that it is important to understand the business, and if you do not understand, do not invest. Warren Buffet had never invested in information technology (IT) companies as he claimed that he did not understand the IT business. Of course he recently invested in IBM after gaining knowledge about the same. However, Buffett was quite happy to invest in Coca Cola which is in the business of selling soft drinks. It was an easy business to understand as also being scalable since Coca Cola is the most popular drink among the young and old alike. So it created great returns for Buffet.
Mantra 5:
Company’s Historical Performance and Ability to Sustain Different Economic Cycles
Warren Buffet has mentioned that longer the history of the company and management better it is for investors to take a call on such an organisation. According to him, the longer history of both indicates the ability of the company and its management to face the different economic cycles. We strongly believe in this philosophy too. According to us, at least the last five-year period is important as it provides a fair idea about the management’s capability. The annual report should be the prime source of information to judge the same. It will provide a good idea about the promoters of the company and also what the management had committed earlier and whether it has achieved the same or not. The same information is available in the director’s report and the management discussion analysis.
Looking at these reports one can find what they had promised in terms of business growth, expansion plans, capital expenditure, etc. We need to look at all the factors that they had mentioned and whether they have managed to achieve the same. If the management has been able to touch those benchmarks, it deserves high regard. However, constant failure to sticking to commitment takes away the scoring points. Infosys is one company whose management earned respect from investors as the company always surpassed the stated projected numbers.
On the other hand, Pyramid Saimira Theater’s promoters could not live up to the expectations. The company was in the business of acquiring and digitizing the single screen theatres. In 2009 it had ambitious plans to increase the number of single screen theatres to more than 2,000 from the level of 900. The whole expansion plan was to the tune of Rs 2,500 crore. But the company could not deliver and also allegedly got involved in a scam. The scrip was eventually suspended from the bourses.
Mantra 6:
Image of the Group Companies
We also need to take a look at the performance of the other companies from the same group or subsidiary companies. If they are involved in any scams or other such cases/legal issues, there should be a complete ‘NO’ for investing in those companies. One must see whether there has been any penal action by the SEBI or the stock exchanges taken action against any of the group companies of the promoters. Nowadays, with information available instantly (thanks to the internet), it is not difficult to dig out information about companies involved in scams and illegal activities. The market regulator SEBI (www.sebi.gov.in) and the stock exchange websites (www.bseindia.com and www.nseindia.com) also provide a good amount of exposure on the same.
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For example, companies like Ackruti City, Murli Industries and Brushman had witnessed an impact on the shares prices after the SEBI restrained the promoter groups from dealing in their shares on grounds of indulging in unfair trading practices. SEBI had exposed a nexus between these companies and some stockbrokers to manipulate the stocks and rig the share prices before the issuance of convertible bonds and private placements to institutional investors.
Mantra 7:
Companies Interaction with Analysts and Investors
Normally we give higher weightage to a company that interacts more often with the analysts and investors. This ensures that information about the company is updated and more relevant. Also many companies put the complete analysts’ presentations and transcript of the discussions on their website. This gives enough confidence about the management in terms of the fact that they want to remain transparent to the investing community.
Mantra 8:
Institutional Holdings
Usually the FIIs avoid companies with poor management. FIIs and domestic institutional investors like mutual funds and insurance companies are highly professional. They are considered to have better financial knowledge than the layman. Further, they have direct access to the management, as institutional investment means holding a good chunk of the shares. If the institutional holding is high then the thumb rule suggests that the company is good. So any buying and selling by the institutions should be followed and analysed. But here we prefer those companies where the number of institutional investors is more than rather just one or two. We would prefer a company where the institutional stake is at 15 per cent but the same is held by seven or eight investors rather than a company where the stake is at 20 per cent but held by two institutions only.
Mantra 9:
Debt Burden
Capital is an important part of the business and it is important to know how the company is arranging for the same, whether it is equity or debt. While investing one also needs to understand the debt burden on a company. If a company is debt-laden and is highly leveraged, the earnings’ growth gets impacted on account of higher interest outgo. So it is advisable to keep the debt at an optimum level. This level also depends on the industry the company is engaged in. For instance, an IT company will usually have zero debt but capital intensive industries like manufacturing will have higher debt amount. However, the debt/equity ratio of less than one is usually acceptable. One also needs to consider the debt service coverage ratio. The higher the ratio, the better it is.
For example, the ill-effects of higher leverage can be explained through the recent case of real estate companies. They have had higher debt on the balance-sheet and this has resulted in them not being able to service short-term debts. The impact of the same is clearly visible with the realty companies taking a huge beating on the bourses.
Mantra 10:
FCCB Conversion
Foreign currency convertible bond (FCCB) is one of the ways for the company management to raise capital. In layman language, it means that the company issues convertible bonds which can be converted into equity shares in a specified time (usually 18-24 months). The process is that the company will issue the convertible bonds which can be converted into shares at a pre-specified price.
At the time of this conversion if the conversion price is lower than the CMP, the bond-holders would prefer to convert the bonds into equity. This will result in equity dilution and will impact the earning per share (EPS) of the company. A major problem surfaces if the CMP is less than the conversion price. Here the company has to pay back the issuers along with interest charges. And as the payment is usually USD-dominated, any downward movement in rupee will severely impact the company’s financials. We at DSIJ look at the company’s FCCB issues that are pending for conversion and assess what impact any conversion or otherwise would have on the company.
For example, a recent case has been of JSW Steel which had issued FCCBs in 2007. With the CMP of JSW almost 40 per cent lower than the conversion price of Rs 953, it is unlikely that the investors will convert the bonds into equity shares at a higher price. Now JSW Steel has to pay around 142 per cent of the amount they had raised. The rising rupee has only worsened the scenario for them.
Mantra 11:
Promoters Pledging Shares
While comparatively a new concept for many individuals, this has been prevailing for quite some time. It is only recently that investors got impacted of the ill-effects of the same. The pledging of shares means that the promoters pledge their part of the shares with banks or financial institutions to raise capital. Usually it is done to raise capital for the business. The promoters keep the shares as collateral. There is one trigger point on the downside. If the same gets activated, the promoters either have to provide more collateral or the shares are sold in the open markets by the financers. This results in a huge fall in the share price on the bourses. There have been many such instances.
However, it is easier for investors to avoid the same as regulators have made it mandatory to announce the pledged shares in the quarterly results. So if the pledge is of a higher level, one should obviously be cautious while investing. For instance, many of the realty stocks in 2009 witnessed a sharp fall in the share prices as the pledged shares got triggered and were sold by the lenders in the markets. Rather, Ackruti City, which also had pledged the shares and was in the F&O, witnessed an erratic upward movement in one month. Although the scrip was then removed from the F&O list after its expiry, many had lost a good amount till then.
Mantra 12:
Auditors’ Comments
Auditors usually make comments in the annual report and hence auditor qualification should be read carefully. For example, there has been the case of the Global Trust Bank. Here the auditors have raised notes in the annual reports. The bank went bust and had to be amalgamated. Similarly, the United Western Bank faced some problems after their auditor’s qualification. Those who ignored this suffered losses.
We are providing herewith a sample check-list that every analyst has to follow before coming to any conclusions. Of course we interact with the management, competitors and agents of the company to understand the factual status whenever we are unable to get any response to our questions mentioned below. This check-list is only indicative and changes depending upon the need of the present economic and political scenario.
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Check-List for DSIJ Analyst
1) Company’s Business· What are the three main products of the company and its contribution to the total turnover?
| Product Name | FY2015 | FY2014 | FY2013 |
| A | Rs Crore (%) | Rs Crore (%) | Rs Crore (%) |
| B | Rs Crore (%) | Rs Crore (%) | Rs Crore (%) |
| C | Rs Crore (%) | Rs Crore (%) | Rs Crore (%) |
· What is the revenue of the company in terms of exports to total sales in the last three years?
| Product Name | FY2015 | FY2014 | FY2013 |
| A | Rs Crore (%) | Rs Crore (%) | Rs Crore (%) |
| B | Rs Crore (%) | Rs Crore (%) | Rs Crore (%) |
| C | Rs Crore (%) | Rs Crore (%) | Rs Crore (%) |
· In the domestic market where from does the company get a majority of its revenue? This is in terms of regions or state and it gives an idea about how states/regions can impact the revenue of the company. We have seen how SKS Microfinance took a huge beating due to its heavy focus on Andhra Pradesh.
· Who are the competitors for the company’s products?
· What has been the price movement of the products in the last one year? Illustrate with a graph and if not possible present the data in a table format.
· How easily can the products be imported?
· What has been the scenario in the domestic market for demand and supply?
· What has been the scenario in the international market for demand and supply?
· Is the company selling products under a brand name and if yes, how big is the brand (net of excise)?
1) Raw Materials
· What are the major raw materials of the company and its total cost to raw materials consumed?
| Raw Materials | FY2015 | FY2014 | FY2013 |
| A | Rs Crore (%) | Rs Crore (%) | Rs Crore (%) |
| B | Rs Crore (%) | Rs Crore (%) | Rs Crore (%) |
| C | Rs Crore (%) | Rs Crore (%) | Rs Crore (%) |
· What is the price outlook for each raw material? Give reasons with source of the information.
· Is it feasible to import raw materials?
· What is the present excise and custom duty on each of the raw materials?
· Is the excise modevatable?
· Who are the suppliers of these raw materials in the Indian market?
2) Future Expansion Plans
· Is there any expansion undertaken by the company? If yes, what is capacity expansion in each of the products with product-wise capex?
· When is the expansion likely to go on stream with product-wise details?
· What is the present capacity utilisation for each of the products?
· What is the present excise and custom duty structure for each of the products?
3) Financials
· How is the company growing in terms of topline as well as bottomline in the last three years?
| Particulars | FY2015 | FY2014 | FY2013 |
| Sales | Rs Crore (Growth %) | Rs Crore (Growth %) | Rs Crore (Growth %) |
| Other Income | Rs Crore (%) | Rs Crore (%) | Rs Crore (%) |
| Net Profit | Rs Crore (Growth %) | Rs Crore (Growth %) | Rs Crore (Growth %) |
· Is there any gross block addition in the last three years? Give last three years’ gross block numbers and balance-sheet size.
| Particulars | FY2015 | FY2014 | FY2013 |
| Gross Block | Rs Crore (Growth %) | Rs Crore (Growth %) | Rs Crore (Growth %) |
| Net Block | Rs Crore (%) | Rs Crore (%) | Rs Crore (%) |
| Balance-Sheet Size | Rs Crore (Growth %) | Rs Crore (Growth %) | Rs Crore (Growth %) |
· How has the company funded the gross block?
· What has been the cash flow for the company in the last three years and where it has been invested?
| Particulars | FY2015 | FY2014 | FY2013 |
| Cash Flow from Operations | Rs Crore | Rs Crore | Rs Crore |
| Total Debt | Rs Crore | Rs Crore | Rs Crore |
| Interest Cost | Rs Crore | Rs Crore | Rs Crore |
| Interest Coverage Ratio (PBIT/Interest) | Number of Times | Number of Times | Number of Times |
· What is the average cost of borrowings of the company?
· What is the present tax rate of the company?
| Particulars | FY2015 | FY2014 | FY2013 |
| Profit Before Tax | Rs Crore | Rs Crore | Rs Crore |
| Tax | Rs Crore | Rs Crore | Rs Crore |
| Net Profit | Rs Crore | Rs Crore | Rs Crore |
| Effective Tax Rate | % | % | % |
4) Dividend Payout Information
| Particulars | FY2015 | FY2014 | FY2013 |
| Face Value | Rs | Rs | Rs |
| EPS (Rs) | Rs | Rs | Rs |
| Dividend Per Share | Rs | Rs | Rs |
| Dividend Payout Ratio | % | % | % |
5) Valuation Matrix
| Particulars | | |
| Share Price | Rs | |
| EPS (Rs) | Rs | |
| P/E (x) | Times | |
| Market Cap to Sales | Times | |
|
| EV/EBIDTA | Times | |
| P/BV | Times | |
· When was the last bonus given by the company and its ratio?
· Is there any placement of equity/FCCB done by the company in the last 12 months?
· If yes, what is the price and number of equity shares placed?
· Give the last three quarters’ shareholding pattern.
| | Dec-15 | Sep-15 | Jun-15 |
| Promoters | | | |
| FIIs | | | |
| Institutional Investors | | | |
| PCB | | | |
| Public | | | |
| Total | | | |
| Number of Shareholders | | | |
· Give details of pledged shares by the promoters.
· Give the last five quarters’ financial performance.
| | Dec-15 | Sep -15 | Jun-15 | Mar-15 | Dec-14 |
| Sales | | | | | |
| Earnings Before Interest Depreciation and Tax | | | | | |
| PBT | | | | | |
| PAT | | | | | |
| Equity | | | | | |
· Location of the company’s factory.
· Does the company have excess land that is available for development?
· Give details of the top three companies of the same management.
| | Sales | Net Profit | Equity | EPS | P/E | Market Cap |
| Company A | | | | | | |
| Company B | | | | | | |
| Company C | | | | | | |