VALUE INVESTING Buying with a margin of safety
VALUE INVESTING § Buying with a “margin of safety” § Buying what we understand § Buying wealth creators (or potential wealth creators) § Buying sustainable businesses
WHAT IS “MARGIN OF SAFETY”? • Buying at a price – with a risk reward ratio greater than 3: 1. • at a discount of 40% to intrinsic worth.
WHAT IS “INSTRINSIC WORTH” AND HOW IS IT COMPUTED ? • Intrinsic worth is the statistical expected value of the discounted free cash flow values under three scenarios: Pessimistic, Neutral and Optimistic
WHAT ARE RISK REWARD RATIOS? Price bands which are based on a combination of - historical metrics - peer comparisons - dcf valuations - - Risk Reward Ratios are computed as a ratio of the probable upside to the probable downside at the current price - Price bands will change every year and even more frequently as a result of expectations based on real dynamics and to a lesser extent market dynamics (volatility)
Pharmaceutical Sector
Budget Moves • Raising foreign investment limit from $ 50 million to $ 100 million will help companies to expand their operations in various countries abroad. • Import duty of 35% on eight anti-cancer drugs to go, now there will be full exemption, apart from that drugs for other critical diseases will be fully exempted. • Anti-AIDS drugs to be fully exempted from excise duty. • Custom duty on Glucometers (used of diabetes) and test strips reduced from 25% to 10%. • Section 80 O not extended, implying the withdrawal of 50% exemption on royalties received from foreign enterprises. • 15% additional depreciation on capacity expansion by at least 25%. • Lowering of peak custom duty by 5% to 30%. • Removal of the distribution tax of 10% on companies and mutual funds on the dividends or income distributed by them. Income to be taxed in the hands of the recepient.
Impact • Anti-AIDS drugs manufacturers will benefit marginally due to exemption of excise duty. • Lowering of peak custom duty by 5% to 30% applies to the imports of pharmaceutical raw material/ packing material.
Name of Company Price Range Intrinsic Value Risk-Reward Ratio Ranbaxy 500 -1150 1045 0. 8 Dr. Reddy 675 -1700 1390 1. 9 Cipla 425 -1450 1340 0. 7 Pfizer 450 -1125 765 -68. 5 Novartis 150 -475 277 2. 4
FMCG
Budget Moves • • • Initiation of agricultural reforms. Restructuring of fertilizer, kerosene and LPG subsidy. Higher income households impacted in income tax rates and removal of some tax benefits. Reduction in peak import duty from 35% to 30%. Reduction in excise on cosmetics and toiletries (Skin cream, Shampoo, Deodorant, After Shave Preparations) from 32% to 16% Increase in excise duty on toothbrushes and footwear from 4% to 8% MRP based assessment extended to a few more categories such as sugar confectionary not containing cocoa and preparations of other sugar. Reduction in basic custom duty from 35% to 30%. The government has proposed an amendment of Milk and Milk products control order (MMPO) to remove restrictions on new milk processing capacity. Excise duty on Tea has been reduced from Rs 2 per kg to Rs 1 per kg. Custom duty on Coffee and Tea has been doubled to 100%
Impact • HLL and Tata Tea will benefit from reduction in excise duty and from increase in custom duty. • Colgate will be adversely impacted (8% of its sales comes from toothbrushes). • Since there is no change in excise duty in cigarettes, ITC will benefit from increase in volume (70% market share in the Indian cigarette market). • HLL will be amongst the largest beneficiaries as lower duties should enable price reduction and inturn spur penetration. • New items brought under MRP based assessment will negatively impact sugar confectionery manufacturers like Cadbury, Nestle & Parry’s.
Name of Company Price Range Intrinsic Value Risk-Reward Ratio HLL 185 -325 225 1. 09 Nestle 415 -720 820 2. 01 ITC 645 -1290 1260 6. 6 Smithkline 400 -700 Beecham Consumer 772 -38. 2 Colgate 200 -21. 6 150 -315
Banks
Budget Moves • Banks have been allowed to deduct 7. 3% of their total income against provisions made by them for bad and doubtful debts as against the earlier allowance of 5%. • Foreign banks have been permitted now to set up subsidiaries in India. • The government has proposed Asset Reconstruction Company (ARC) will develop a market for securitised loans. • The government has proposed full convertibility of deposit schemes for Non-Resident Indians. • Corporatization of IDBI. • Setting up of a mortgage credit guarantee scheme by the National Housing Bank (NHB) fully protecting lenders against default.
Impact • Inflow of funds from NRIs is likely to go up. • Banks are allowed to lower deposit rates without fear of flight of deposits. • Proposed ARC will benefit public sector banks and financial institutions. • Because of entry of MNCs foreign banks, there will be some merger and acquisitions and weak and small banks will cease to exist. • Small savings rates have been lowered by 50 basis points.
Name of Company Price Range (PR) Intrinsic Value (IV) Risk-Reward Ratio SBI 200 -400 245 1. 2 HDFC BANK 200 -500 350 3. 7 ICICI BANK 100 -250 216 5. 6 UTI BANK 40 -150 95 109
Information Technology
Budget Moves • The government has increased the maximum amount for overseas investment to US $ 100 million from US $ 50 million. • Custom duty on hardware inputs has been reduced to 5%. • The 100% deduction of export profits allowed under section 10 A and 10 B of income tax to 100% EOUs (Export Oriented Units) and units under FTZs (Free Trade Zones) has been restricted now to 90% deduction.
Impact • Software players will expand their network abroad due to increase in overseas investments limits. • Since 10% of the offshore profits will be taxed, is an unexpected negative for the sector.
Name of Company Price Range (PR) Intrinsic Value (IV) Risk-Reward Ratio Infosys Technologies 1000 -4000 2500 -0. 07 Wipro 375 -1750 1100 -0. 1 HCL Tech. 75 -350 215 0. 2
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