Thank God or May Be Thank the Judges

Thanks to the Delhi High Court Judges for putting sense back in to the Government which seemed to have slipped its way on condoms.

As per the following news report, the High Court of Delhi has revoked the Government's move to cap condom prices. Hip, hip, Hooray !

Bonus Shares - Careful when you sell !

ZERO tax has been the biggest advantage of long term equity investing in India. This particular advantage makes investing in any other asset class fall pale by comparison.

Shareholders in India get an exemption from paying tax on long term capital gains [gains on stocks held for more than 12 months] and pay short term capital gains [gains on stocks held for less than 12 months] at a rate of 15%, provided the stocks have been sold on a recognised stock exchange in India and STT has been paid on such transactions.

This post deals with the tax treatment of new shares issued through stock splits and bonus issues. One needs to understand the difference between the two and be careful at the time of selling to avoid any kind of tax tangle.

In recent times, a host of companies have split the face value of the shares, some have issued bonus shares to their shareholders and some companies have done both : a stock split and a bonus. Both these tools enhance liquidity of the shares in the market and provide the shareholders an option to partially exit their positions. At the same time, these actions come with certain disadvantages like: unnecessary hype around the bonus issue and gullible investors falling for the lure of  it. The net advantages of issuing bonus shares and share splits is debatable. Here, I will restrict myself to the tax treatment only.

Let's see what happens in the case of a stock split. In case of a stock split, the face value of the share is split into a lower value. For example, a share of face value of Rs 10 could be split into shares with face value of Rs 5 each or any other lower face value till Re 1. As per SEBI guidelines, the lowest face value that companies in India can have for their shares is Re1.
 

In case of a stock split, the original shares and the new shares issued by the company are considered to be acquired at the same time. Only the acquisition price of the shares [both original and new] reduces proportionately. Say for example, a share [Face value Rs 10] was bought on Jan 1' 2014 for Rs 100 per share. The company announces a stock split in the ratio 1:1 on March 1, 2015. Now,  a shareholder would have 2 shares in his account for every single share that he or she purchased. On March 1, 2015 the acquisition cost of the shares would be considered to be Rs 50 per share for the 2 shares. Lets assume that the price in the market post split is Rs 70 per share. While selling, the capital gains on both the shares would be considered long term capital gains and hence would be exempt from any tax since the holding period would have been more than 12 months.

Let's consider the same example for a bonus issue.

In case of a bonus issue, the original shares and the new shares issued by the company are treated differently under the taxation rules. Say for example, a share was bought on Jan 1' 2014 for Rs 100 per share. The company announces a bonus in the ratio 1:1 on March 1, 2015. Now,  a shareholder would have 2 shares in his account for every single share that he or she purchased. On March 1, 2015 the acquisition cost of the shares would be considered to be Rs 100 for the old share and Zero for the new bonus share. Lets assume that the price in the market post bonus is Rs 70 per share. On selling, the capital gains on the old share would be considered as long term capital gains and hence would be exempt from tax. But for the new shares issued as bonus, the acquisition date would be March 1, 2015 and the acquisition price would be Zero. If one happens to sell the new bonus share within 12 months of the acquisition date i.e. March 1, 2015 : the short term capital gains would apply on the entire selling price of Rs 70 since the bonus shares are considered to  have been acquired at zero cost.

If you enjoy the advantage of exemption from long term capital gains tax , have companies in your portfolio which have announced bonus issues and you are sitting on large capital gains: be careful while selling or you may find yourself tied in tax knots.

Reference :  http://tinyurl.com/qd3oweh

The Spill Over Effect !

Disclaimer : This post is not a stock recommendation. This post only demonstrates that value investing like common cold is infectious and spreads quickly in the family.

I am sure in any family where there's a value investor, there would be similar stories. 

Here's mine :

Please meet my son Aditya ; 8 years old. He picks up on what I read and what I talk. He also accompanies me a few times that I visit a company showroom , a construction site or a walk in the market where I can gather a feel about the products, brands and their competitors.

Some months back, I was reading up on Ashiana Housing Limited and see what he drew in his drawing class in the school.

Ashiana Town, Bhiwadi

 

And Bajaj Auto Limited...Bajaj Pulsar and Bajaj Discover !

When to Sell And When not to ?

Should I sell ? 

This question has been baffling me for quite some weeks now. The valuations of the stocks I hold looked fair a few months back, they looked stretched a few weeks back and they look super stretched now. To find an answer to this question, I searched for what great investors have written about this. After reading and thinking about this, I feel that what Philip Fisher wrote in 1957 in his book "Common Stocks and Uncommon Profits" is by far the best treatise written on this topic. Reading and careful re-readings of  Chapter 6 [When to sell and When not to?] in that book helped me crystallize my thoughts and clarified a lot of doubts in my mind. For my own benefit and the benefit of the readers, I thought of putting up the excerpts of that chapter in a post. What more ? I borrowed the title of the chapter as well. I couldn't think of a better title !

The following is an excerpt from the book.

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Start

 

I believe there are three reasons, and three reasons only, for the sale of any common stock which has been originally selected according to the investment principles already discussed in the book. 

1. The first of these reasons should be obvious to anyone. This is when a mistake has been made in the original purchase and it becomes increasingly clear that the factual background of the particular company is, by a significant margin, less favourable than originally believed.
2. Second reason. Sales should always be made of the stock of a company which, because of changes resulting from the passage of time, no longer qualifies in regard to fifteen points [reasons why you bought the stock in the first place] outlined earlier to the same degree it qualified at the time of purchase.When companies deteriorate in this way they usually do so for one of two reasons. Either there has been a deterioration of management, or the company no longer has the prospect of increasing the markets for its products in the way it formerly did. When any of these things happen the affected stock should be sold at once, regardless of how good the general market may look or how big the capital gains tax may be. Similarly, it sometimes happens that after growing spectacularly for many years, a company will reach a stage where the growth prospects of its markets are exhausted. From this time on, it will only do about as well as industry as a whole. It will progress at about the same rate as the national economy does. Hence, if after years of being experts in a young and growing industry, times change and the company has pretty well exhausted the growth prospects of its market, its shares have deteriorated in an important way from the standards outlined while buying the stock. Such a stock should then be sold.
3. The third reason why a stock might be sold seldom arises, and should be acted upon only if an investor is very sure of his ground. It arises from the fact that opportunities for attractive investment are extremely hard to find. A word of caution may not be amiss, however, in regard to too readily selling a common stock in the hope of switching these funds into a still better one. There is always the risk that some major element in the picture has been misjudged. If this happens, the investment probably will not turn out nearly as well as anticipated. Therefore, before selling a rather satisfactory holding in order to get a still better one, there is need of the greatest care in trying to apprise accurately all elements of the situation.   

 End of excerpt

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In all 3 reasons, Fisher has not talked about valuation. So, in essence EVALUATION of the business before VALUATION of the business. The same thing we do while buying should be considered while selling. Sounds very crisp and clear.

We should be asking questions to ourselves about the companies we own before considering selling the stocks.

Is the competitive advantage of the business better than before ? Any deterioration in the bargaining power of the business ? How are the growth prospects ? Any foolish diversification attempted by the management ? Can the business continue to scale up and deploy large amounts of capital at attractive rates of return ? Change in the competitive landscape ?  Is it a better, larger and a stronger company now than when I bought the stock?  If the answers to these questions are largely in favour of the company in question, we know that the company is on the right track.

Now comes valuation. One reason which usually becomes predominant in our minds is about the stocks becoming overpriced. This is what Fisher wrote about stocks of good companies being overpriced, temporarily.

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Start

Another line of reasoning so often used to cause well-intentioned but unsophisticated investors to miss huge future profits is the argument that an outstanding stock has become overpriced and therefor should be sold. What is more logical than this ? If a stock is overpriced, why not sell it rather than keep it?

Before reaching hasty conclusions, let us look a little bit below the surface. Just what is overpriced ? What are we trying to accomplish? Any really good stock will sell and should sell at a higher ratio to current earnings than a stock with a stable rather than an expanding earning power. After all, this probability of participating  in continued growth is obviously worth something. When we say that the stock is overpriced, we may mean that it is selling at an even higher ratio in relation to this expected earning power than we believe it should be. All of this is trying to measure something with a greater degree of preciseness than is possible. The investor cannot pinpoint just how much per share a particular company will earn two years from now or whether a sizable increase in average earnings is likely to occur a few years from now. Under these circumstances, how can anyone say with even moderate precision just what is overpriced for an outstanding company with an unusually rapid growth rate ? If the growth rate is so good that in another ten years the company might well have quadrupled, is it really of such great concern whether at the moment the stock might or might not be 35 percent overpriced ? 

That which really matters is not to disturb a position that is going to be worth a great deal more later. If for a while the stock loses, say 35 percent of its current market quotation, is this really such a serious matter? Again, isn't the maintaining of our position rather than the possibility of temporarily losing a small part of our capital gain the matter which is really important ?

Perhaps the thoughts behind this chapter might be put into a single sentence: If the job has been correctly done when a common stock is purchased, the time to sell it is- almost never.

End

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 Well, I am not sure of myself of not selling a stock ever but I am sure that with the Fisher's frame work in mind, atleast for some of my stocks, the time to sell it will not be now.

Book Recommendation : Pathbreakers

I like reading interviews and a read a lot of them. I find interviews extremely engaging as they are short, crisp and have a conversational style. Provided the questions asked are good, an interview allows the interviewer & the reader to navigate the mind of the interviewee. 

One of the best series of interviews that I have read was carried out a few years back by Ms. Sucheta Dalal and Mr. Debashis Basu in their magazine Money Life. They had interviewed achievers from diverse fields : like Geet Sethi [Sports], Rajiv Bajaj; K V Kamath, Aditya Puri, Sanjiv Bhikchandani [ Business], Dr R A Mashelkar ; Dr Vijay Bhatkar [Scientists], Meeran Borwankar; R C Sinha [Civil Servants] and many many more.

The interviews encapsulate the determination of a  civil servant who wanted to save the citizens of Aurangabad from a famine [ R C Sinha]. About a business leader who rebuilt his whole company from scratch after being a leader in the industry for decades [Rajiv Bajaj]. About a sports person who was so focused on his sport that the only things that mattered in his life were a billiards table and a cycle that took him to the billiards club [ Geet Sethi].

One of the most inspiring, thought provoking and captivating interviews. Money Life did a good job and compiled all the interviews in the form of a book [2 parts] and appropriately titled them : Pathbreakers.  I strongly recommend that one should read both the parts. They carry a lifetime of wisdom in them.

 [The magazine is offering a 50% discount on the price of the books. In today's times when most of the things are selling above or close to their fair values, these books carry immense value for money.]

Hawkins Cookers Limited- My journey as an Investor

The first time I came across Hawkins Cookers Limited was in 2006. The stock was selling at 90 and the dividend was Rs 5 per share. Dividend yield was close to 5.5%.
I casually looked at it and left it at that. No particular reason : I just sucked my thumb.The stock didn't wait for me and moved up.

In 2009, a friend of mine : Vibhu Natrajan mentioned Hawkins to me when I met him in Chennai. The stock was quoting at 250 then. My mind became closed to that idea because the stock had already gone up almost 3 times since I first saw it. I had been deprived of the profits which I could have earned : Classic Deprival Super Reaction. I felt bad about  the missed opportunity and decided to not look at the stock. Also, I did not had any clue about the quality of Hawkins or the process to judge the quality of a business per se. I missed Hawkins again.

In 2010, Prof. Sanjay Bakshi and Priyank Sanghavi co-authored an investment note on Hawkins Cookers explaining very well the quality of the business and the management. The stock was quoting at 650 by that time [2.5 times up from 250]. I understood the quality of the business a bit and I liked the management as well. But I was not very sure about the process to gauge the intrinsic value of the business. By the crude methods of EV/ EBITDA  and Mkt Cap/ PBDT, the stock seemed expensive. I didn't buy.

In 2011, Hawkins Cooker announced a dividend of Rs 40 per share. The price around that time was Rs1000 per share. The dividend yield became 4%. Being moderately convinced about the business and the management and stock again with a 4% yield [The Ben Graham in me woke up], I invested a small part of my portfolio in Hawkins. Within a year, the stock was quoting at 1700 while the company experienced twin problems of a stay on production by the Punjab Pollution Control Board and a workers strike in the Jaunpur factory. Feeling unsure about the capability of the company to tide over these crises, I sold my shares at Rs 1700.

In early 2014, I did a thorough work on Hawkins Cookers. After diving deep into the workings of the business, I emerged fully convinced about the quality of the business , the quality of the management [Both were of gold standard in my view] and the unmatched capability of the company to weather any crisis which might come its way. My intrinsic value estimate was around 1600 per share [based on DCF] while the price hovered around 2000 per share. Being used to buying businesses with a margin of safety, I found myself in a difficult position to take such a close call. I again decided not to buy.

As of today : Sep 27th, 2014, the stock is quoting at 3000 . In the last 8 years, the stock has moved up from Rs 90 to Rs 3000 excluding the dividends. And there were multiple opportunities during this time to become a stockholder of this wonderful company. Not buying the stock was a missed opportunity. There were wide gaps in my evaluation of businesses, their managements, the valuations and most importantly my own behavioral biases.

The whole objective of this exercise was to look back, chronicle a particular stock which will help me figure out the gaps in my understanding of businesses and my biases. I am confident that I will be able to plug those gaps by reading, learning, observing and practicing. As investors and students, we should look back at our investments, our mistakes and continue to improve the process.

 

As Charlie Munger says : "Investing is the only thing which you become better at as you grow old."
________________________________________________________

I read the latest annual report of Hawkins , the chairman's speech delivered at the AGM and the checked out the latest results.

How is the business ?  

It is one hell of a business. Only 2 organised players in the market [duopoly] , low bargaining power of customers and suppliers, no threat of imports, low threat of new entrants, very strong brand equity in the market, low threat of substitutes. ROCE / ROE of around 80%, low capex requirements and high dividend pay out ratio. Strong tailwinds of nuclear families, higher penetration and a move towards premium products. Volume growth of around 12-13% for the last few years and an annual average price hike of 3-4%. Owing to these factors, it is easy to conclude that the top line and the earnings of the business will continue to increase for  a long time to come.

How is the management?

Fantastic. Absolutely ethical, honest and focused on the business. Very difficult to find such managements . As mentioned in the note earlier, the management is of gold standard. Chairman's speeches delivered at the AGM are again gems of their own kind. I think they should be read by every student of business and otherwise. They are available on the website of Hawkins Cookers Limited. www.hawkinscookers.com

What about the price ?

This is where I am stuck again. My current intrinsic value estimate of the business is close to Rs 2000 per share. The current price is Rs 3000. I like the business, I admire the management but paying a high price for the business would be a mistake. Almost 235 years ago, in this letter Ben Franklin advised : "Don't give too much for the whistle". I agree with Mr. Franklin and have decided to wait for the right price.

Tail piece : The timing and the prices mentioned in the note might be slightly out of place. 8 years is a long time and memories fade. And it will be too much of an effort to go back and check out for the exact timeline and prices.

This is not an investment advice to buy or sell shares of Hawkins Cookers Limited.