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Multibagger stock ideas Multibagger stock ideas Document Transcript

  • Four Proven Approaches to Picking Multibagger Stocks February, 2010Index of Contents Preface 2 Approach I – Buying Stocks With Low Price in Relation to Earnings 4 Approach II – Buying Stocks With Low Price in Relation to Book Value 6 Approach III – Buying Stocks With Low Price in Relation to Liquidating Value 8 Approach IV – Buying Stocks Using Benjamin Graham’s Magic Multiple 10 A Universe of Stocks ‘On Sale’ 11© Equitymaster Agora Research Private Limited15, Khetan Bhavan. 198, J Tata Road, Churchgate, Mumbai - 20Tel: (022) 6143-4055 | Fax: (022) 2202-8550 | E-mail: info@equitymaster.comFour Proven Approaches to Picking Multibagger Stocks Page 1 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010PrefaceStock markets had a bumper 2009. And those who invested at the right time would be laughingtheir way to the banks. But what about those who missed the rally? They would certainly beitching to make up for lost time and invest right away.However, it may not be that easy anymore. The huge run up in stocks has done one harm. It hasmade valuations expensive and thus there are fewer stocks that are available at cheap valuationsthan what was the case in March 2009 when the current rally started.But why look for cheap stocks? Will any good stock not suffice? Certainly not!Buying stocks should not be different from buying things on sale in a supermarket or waiting forthe car companies to offer special incentives. The time to buy stocks is when they are on salei.e., selling cheap, and not when they are priced high because everyone wants to own them.The objective of this report is to validate this very fact – stocks selling cheap tend to give betterreturns over a long period as compared to those selling at expensive valuations, all thingsremaining same.As part of the analysis that went into preparing this report, we dug deeper into history andstudied whether the approach of buying cheaply valued stocks has delivered good returns overthe long run. For the purpose of our analysis, and to be in sync with the current times, we took atime in history when the broader stock markets were expensively valued as they seem to be as ofnow.The year we have used as our base is 2000 - when the dot-com bubble was in its prime and thebenchmark BSE-Sensex was trading at around 23 times earnings.And what has been the conclusion of our study?Less valued stocks, bought even when the markets were seemingly expensive like they were inthe year 2000, have performed brilliantly over the next ten years. Whether one bought stockstrading at low P/E, or low P/BV, or even low liquidation value (we will explain this in a bit), thereturns have been great.Four Proven Approaches to Picking Multibagger Stocks Page 2 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010Using this analysis as a backdrop, we have compiled some lists of stocks that pass these ‘lowpriced’ criterion as of now. You can treat this as a universe from which to find your next multi-bagger stocks.But just a word of warning here – these lists present just the universe of stocks that pass thesecriterion. One still needs to analyse a company’s past performance record, its managementcredibility, and future prospects before making the final buying decisions.We hope this report is of some help to you in your search for some brilliant long-terminvestment opportunities.Here’s to your long term financial well-being.Warm regards,Team EquitymasterFour Proven Approaches to Picking Multibagger Stocks Page 3 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010Approach I - Buying Stocks With Low Price in Relation toEarningsStocks bought at low price/earnings (P/E) ratios offer higher earnings yields than stocks boughtat higher P/E ratios. The earnings yield is the yield that shareholders would receive if all theearnings were paid out as a dividend.Investing in stocks that are priced low in relation to earnings includes investments in companieswhose earnings are expected to grow in the future. To paraphrase Warren Buffett, ‘value’ and‘growth’ are joined at the hip. A company priced low in relation to earnings, whose earnings areexpected to grow, is preferable to a similarly priced company whose earnings are not expectedto grow.The fact that buying low P/E stocks can get you better returns than stocks trading at high P/E isvalidated by the under-mentioned chart. It shows the average returns of stocks over the past 10years across different range of P/E multiples. Avg. return for stocks based on P/E 2,000 % Returns over 10 years From a universe of 206 of BSE-500 stocks that were listed 10 years back 1,500 1,000 500 0 <5 5 to 10 10 to 20 20 to 25 >25 P/E in January 2000 Data Source: CMIE Prowess Excludes banking & financial companies, and stocks with market capitalisation below Rs 10 bnAs the chart shows, stocks in the year 2000 with P/E multiples of less than 5 times, or eventhose with multiples of between 5 and 10 times, have generated the biggest returns over thefollowing ten years.Remember we are talking of a year when the dot-com bubble was at its peak, and so were Indianmarkets (BSE-Sensex) that were trading at a P/E of almost 23 times. Needless to say, returnsFour Proven Approaches to Picking Multibagger Stocks Page 4 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010from the Sensex since then till date has been just around 200% that will form part of thecategory that has generated the least return as per the above chart.But even if one had picked up low P/E stocks (P/E of less than 10 times) then, the returns tilldate would have been spectacular. As against this, those who picked up stocks with P/Emultiples of over 10 and 20 times have generated considerably lesser returns. The performanceof stocks trading at above 25 times has been poor to say the least.It must be noted that the analysis for this chart excludes small-cap companies, or those withmarket capitalisation of less than Rs 10 bn. This does away with the argument that the base forfastest growing stocks might have been lower. The analysis also excludes stocks of banking andfinancial companies, as P/E is not the right metric to assess their valuations. Price to book valueis, as we will study in the next chapter.Four Proven Approaches to Picking Multibagger Stocks Page 5 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010Approach II - Buying Stocks With Low Price in Relationto Book ValueApart from P/E, another ratio that is commonly used to value stocks is price to book value orP/BV. This is arrived at by dividing the market price of a share with the respective companysbook value per share. Book value is equal to the shareholders equity (share capital plus reservesand surplus). Book value can also be arrived at by subtracting current liabilities and debt fromtotal assets.Stocks priced at less than book value are purchased on the assumption that, in time, their marketprice will reflect at least their stated book value, i.e., what the company itself has paid for itsown assets. All things remaining constant, such stocks generate higher returns over the long runas compared to stocks that trade at higher P/BV ratios. Avg. return for stocks based on P/BV 2,000 % Returns over 10 years From a universe of 206 of BSE-500 stocks that were listed 10 years back 1,500 1,000 500 0 <1 1 to 1.5 1.5 to 2.0 2.0 to 3.0 >3.0 P/BV in January 2000 Data Source: CMIE Prowess Excludes stocks with market capitalisation below Rs 10 bnSee for instance the chart above. Stocks trading at P/BV of less than 1 time or even 1.5 times inthe year 2000 have far outperformed those that traded at a higher valuation (1.5 times andabove). Analysis for this chart also excludes companies with market capitalisation of less thanRs 10 bn.Four Proven Approaches to Picking Multibagger Stocks Page 6 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010Based on this analysis, it becomes clear that buying a basket of low P/BV stocks may get yououtstanding returns over the long term. But you may do even better if you can determine whichof the low P/BV stocks are worth purchasing and which are about to go bankrupt. Looking forcompanies with a good overall track record, and manageable to low debt among stocks tradingat discount to their book value can present great investment opportunities.Four Proven Approaches to Picking Multibagger Stocks Page 7 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010Approach III - Buying Stocks With Low Price in Relationto Liquidating ValueThe idea here is to buy stocks at a cost less than their net current asset value (NCAV), andthereby giving no value to the fixed assets. But why just current assets? Because it includesitems like cash and other assets that can be turned into cash within one year, such as accountsreceivable and inventory, and is therefore a good measure of a company’s worth if it were to beliquidated. This was a stock selection technique successfully employed by Benjamin Graham.Graham believed that stocks selling below NCAV were worth more dead than alive. He stated ifa stock was selling below liquidating value, either the price is too low or the company should beliquidated. He also states that stocks are ‘real’ bargains as per the NCAV method only if thesecompanies are in no danger of squandering these assets, and have formerly shown a largeearning power on the market price.The fact that the NCAV rule works cannot be doubted. But it is difficult to find stocks that sellat a discount to NCAV in bull markets. It was the case in 2000 as well. While there were severalstocks that were trading at low P/E and P/BV, but not many were trading at discount to theirrespective NCAV.As such, for our analysis, we have studied the premium on NCAV at which stocks from ouruniverse were trading at then. And the result is that - stocks that were trading at the lowestpremium to the NCAV (less than 5 times NCAV) in the year 2000 have returned the most in thesubsequent ten years. As compared to this, stocks trading at multiples of more than 5 timesNCAV have turned out a poor performance over these years.Four Proven Approaches to Picking Multibagger Stocks Page 8 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010 Avg. return for stocks based on MC/NCAV 3,000 % Returns over 10 years From a universe of 206 of BSE-500 stocks 2,250 that were listed 10 years back; Excludes bank stocks 1,500 750 0 <5 5 to 10 10 to 15 >15 MC/NCAV (Times) as in March 2000 MC-Market capitalisation, NCAV – Net current asset value; Data Source: CMIE Prowess Excludes banking & financial companies, and stocks with market capitalisation below Rs 10 bnFour Proven Approaches to Picking Multibagger Stocks Page 9 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010Approach IV - Buying Stocks Using Benjamin Graham’sMagic MultipleIf you are confused which of the first two ratios - P/E or P/BV - to use to determine whether astock is trading cheap, Benjamin Graham has a ‘magic’ formula to suggest!It is the multiple of a stock’s P/E and its P/BV.Graham has put an upper limit to the output of this ratio - 22.5. This he derived using amaximum P/E of 15 times, and maximum P/BV of 1.5 times - the highest multiples he wasready to pay for stocks.Our analysis shows that, on applying this multiple to our universe, stocks where the output ofP/E multiplied by P/BV was lower then 22.5, have generated more returns than those whoseoutput was greater than 22.5. Avg. return for stocks based on Grahams multiple 1,800 % Returns over 10 years 1,350 900 450 0 <10 10 to 22.5 >22.5 Grahams multiple as in January 2000 Data Source: CMIE Prowess Excludes banking & financial companies, and stocks with market capitalisation below Rs 10 bnFour Proven Approaches to Picking Multibagger Stocks Page 10 of 16
  • The Most Profitable Approach to Stock Picking February, 2010A Universe of Stocks ‘On Sale’After reading the above approaches to picking up cheap stocks, you must be wondering whetherthis can work in the current environment where stocks across the board are looking expensive.Before we dispel your doubts, remember that we have done the above analysis with the year2000 as a base - a year when the dot-com bubble was in its prime and the broader markets weretrading at expensive levels.Even now, when the Sensex is trading at around similar valuation levels, you can still find cheapstocks using all these four approaches. We will make your task easier by producing four lists ofstocks using all these methods.But we must warn you that all these lists present just the universe of stocks that pass thesecriterion. One still needs to analyse a company’s past performance record, its managementcredibility, and future prospects before making the final buying decisions.In short, it is important to do a proper homework before jumping on to opportunities that presentthem as having low P/E, low P/BV, low price as compared to liquidating value, and low as perGraham’s ‘magic’ multiple.These valuations criteria can just be considered as one of the important stepping-stones in yoursearch for multi-bagger stocks.But these are stones you would not want to trip over!So read the next four pages very carefully. You never know your next multi-bagger(s) could beout of these.Disclaimer: Stocks listed in the following four tables are just representative of the ideasand must not be treated as recommendations from EquitymasterFour Proven Approaches to Picking Multibagger Stocks Page 11 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010I. Stocks With Low Price in Relation to Earnings Company Name P/E Hindustan Petroleum Corpn. Ltd. 2.52 Bharat Petroleum Corpn. Ltd. 4.56 Gujarat State Fertilizers & Chemicals Ltd. 4.77 J K Cement Ltd. 5.07 Kesoram Industries Ltd. 5.39 S R F Ltd. 5.50 Indian Oil Corpn. Ltd. 5.71 Madras Cements Ltd. 5.83 Birla Corporation Ltd. 6.06 Strides Arcolab Ltd. 6.39 Electrosteel Castings Ltd. 6.70 Graphite India Ltd. 6.71 Binani Cement Ltd. 6.76 Great Eastern Shipping Co. Ltd. 7.16 Heidelberg Cement India Ltd. 7.35 Alok Industries Ltd. 7.37 Prism Cement Ltd. 7.42 Deepak Fertilisers & Petrochemicals Corpn. Ltd. 7.71 Gujarat Fluorochemicals Ltd. 7.71 Shree Cement Ltd. 7.97 Geodesic Ltd. 8.00 India Cements Ltd. 8.10 Rolta India Ltd. 8.11 Gitanjali Gems Ltd. 8.29 A B G Shipyard Ltd. 8.29 Gujarat Alkalies & Chemicals Ltd. 8.39 Nava Bharat Ventures Ltd. 8.45 Gujarat Narmada Valley Fertilizers Co. Ltd. 8.57 Monnet Ispat & Energy Ltd. 9.07 Dalmia Cement (Bharat) Ltd. 9.26 Excludes banking & financial companies, and stocks with market capitalisation below Rs 10 bnFour Proven Approaches to Picking Multibagger Stocks Page 12 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010II. Stocks With Low Price in Relation to Book Value Company Name P/BV Mahanagar Telephone Nigam Ltd. 0.47 Gitanjali Gems Ltd. 0.56 Essar Shipping Ports & Logistics Ltd. 0.71 Alok Industries Ltd. 0.74 Reliance Communications Ltd. 0.74 Videocon Industries Ltd. 0.78 Gujarat Alkalies & Chemicals Ltd. 0.82 D C M Shriram Consolidated Ltd. 0.83 Gujarat State Fertilizers & Chemicals Ltd. 0.87 Gujarat Narmada Valley Fertilizers Co. Ltd. 0.90 Moser Baer India Ltd. 0.91 Vijaya Bank 0.93 Great Eastern Shipping Co. Ltd. 0.93 Oriental Bank Of Commerce 0.93 Indian Overseas Bank 0.96 Syndicate Bank 0.97 Jammu & Kashmir Bank Ltd. 0.99 Uco Bank 1.00 Federal Bank Ltd. 1.00 Karnataka Bank Ltd. 1.03 Amtek Auto Ltd. 1.03 Indiabulls Financial Services Ltd. 1.03 Chennai Petroleum Corpn. Ltd. 1.05 Bajaj Auto Finance Ltd. 1.07 Bank Of Maharashtra 1.07 India Cements Ltd. 1.09 J K Cement Ltd. 1.11 Ballarpur Industries Ltd. 1.11 South Indian Bank Ltd. 1.11 Electrosteel Castings Ltd. 1.12 Excludes stocks with market capitalisation below Rs 10 bnFour Proven Approaches to Picking Multibagger Stocks Page 13 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010III. Stocks With Low Price in Relation to Liquidating Value Company Name MC/NCAV Gitanjali Gems Ltd. 0.7 Eicher Motors Ltd. 1.4 Omaxe Ltd. 1.4 I V R Prime Urban Developers Ltd. 1.4 Jai Corp Ltd. 1.8 Ingersoll-Rand (India) Ltd. 1.9 Puravankara Projects Ltd. 2.0 Mahindra Lifespace Developers Ltd. 2.0 Parsvnath Developers Ltd. 2.0 Redington (India) Ltd. 2.2 P T C India Ltd. 2.2 Indiabulls Real Estate Ltd. 2.3 U T V Software Communications Ltd. 2.3 Edelweiss Capital Ltd. 2.5 Zuari Industries Ltd. 2.5 Graphite India Ltd. 2.7 Maharashtra Seamless Ltd. 2.8 Electrosteel Castings Ltd. 2.9 I C I India Ltd. 3.0 Dredging Corpn. Of India Ltd. 3.2 Housing Development & Infrastructure Ltd. 3.3 S Kumars Nationwide Ltd. 3.3 Sobha Developers Ltd. 3.4 B E M L Ltd. 3.4 Peninsula Land Ltd. 3.4 Geodesic Ltd. 3.5 Anant Raj Inds. Ltd. 3.5 Shriram E P C Ltd. 3.8 Gujarat State Fertilizers & Chemicals Ltd. 4.1 Infotech Enterprises Ltd. 4.1 MC - Market capitalisation, NCAV - Net Current Asset Value; Excludes banking & financial cos., and stocks with market capitalisation below Rs 10 bnFour Proven Approaches to Picking Multibagger Stocks Page 14 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010IV. Stocks With Low Price in Relation to Graham’s Multiple Company Name Graham multiple Hindustan Petroleum Corpn. Ltd. 2.8 Gujarat State Fertilizers & Chemicals Ltd. 4.1 Gitanjali Gems Ltd. 4.6 Alok Industries Ltd. 5.5 J K Cement Ltd. 5.6 Kesoram Industries Ltd. 6.5 S R F Ltd. 6.5 Great Eastern Shipping Co. Ltd. 6.7 Gujarat Alkalies & Chemicals Ltd. 6.9 Electrosteel Castings Ltd. 7.5 Gujarat Narmada Valley Fertilizers Co. Ltd. 7.7 Bharat Petroleum Corpn. Ltd. 7.9 India Cements Ltd. 8.8 Indian Oil Corpn. Ltd. 9.2 Graphite India Ltd. 9.3 Deepak Fertilisers & Petrochemicals Corpn. Ltd. 9.4 D C M Shriram Consolidated Ltd. 9.8 Videocon Industries Ltd. 10.3 Birla Corporation Ltd. 11.2 Madras Cements Ltd. 11.3 Heidelberg Cement India Ltd. 11.5 Dalmia Cement (Bharat) Ltd. 11.6 Gujarat Fluorochemicals Ltd. 11.7 Monnet Ispat & Energy Ltd. 12.2 A B G Shipyard Ltd. 13.7 Prism Cement Ltd. 14.2 Geodesic Ltd. 15.1 Rolta India Ltd. 15.6 Zuari Industries Ltd. 15.8 Binani Cement Ltd. 15.8 Note: Data as on January 20, 2010; Click on the company name to get more information on the stock; Excludes banking & financial companies, and stocks with market capitalisation below Rs 10 bn; Source (for all tables): CMIE ProwessFour Proven Approaches to Picking Multibagger Stocks Page 15 of 16
  • Four Proven Approaches to Picking Multibagger Stocks February, 2010 To know more about how Equitymaster can help you earn extraordinary returns, call us at 1800- 209-3786 or Email us at info@equitymaster.com. We will be delighted to hear from you!DisclaimerThis booklet a) is for Private Circulation only and not for sale. b) is only for information purposes and Equitymaster Agora ResearchPrivate Ltd (Equitymaster) is not providing any professional/investment advice through it and Equitymaster disclaims warranty of anykind, whether express or implied, as to any matter/content contained in this booklet, including without limitation the implied warrantiesof merchantability and fitness for a particular purpose. Equitymaster will not be responsible for any loss or liability incurred by the user asa consequence of his taking any investment decisions based on the contents of this booklet. Use of this booklet is at the user’s own risk.The user must make his own investment decisions based on his specific investment objective and financial position and using suchindependent advisors as he believes necessary. Information contained in this Report is believed to be reliable but Equitymaster does notwarrant its completeness or accuracy.Four Proven Approaches to Picking Multibagger Stocks Page 16 of 16