Cover Story
COUNT ON THE
Times have changed since Benjamin Graham wrote the Security Analysis but
his principles can hold investors in good stead even now
N Mahalakshmi & Mohammed Ekramul Haque
I
t cannot be denied that the Great
Depression of 1929 and the Wall
Street crash that followed was per-
haps the most humbling experi-
ence for investors at the time. Life was
tough and there was no hope to clutch
on to. After crushing losses, most
stocks were available at ridiculously
cheap prices over the next decade as
the markets remained trapped in a
bear grip.
But as any stock expert will tell you
today, behind every market disaster
lurks opportunity – if you just look
hard enough. It was the same for Ben-
jamin Graham, who, despite suffering
heavy financial losses himself, began
a conscious campaign of snapping up
stocks that suddenly became available
at bargain prices.
Graham’ strategy was simple: buy
companies that he likened to cigar
butts – typically abandoned but still
good for a puff or two. And you could
pick them up for virtually nothing.
Stocks quoting below their liquida-
tion values after keeping a ‘margin of
safety’, allowing for any contraction in
prices, were his key bets.
His strategy soon started being talk-
ed about in the investing community.
One man, in particular, was highly in-
fluenced by Graham’s strategy, and
in tribute to his ‘idol’, bought shares
in about a hundred such cheap com-
panies. His faith soon paid off: in five
years, John Templeton – whose name
today is synonymous with value
investing – had multiplied his
original investment several times,
despite around 15 of those companies
going bankrupt.
The value investing philosophy pro-
pounded by Graham and practised
vigorously by Sir John Templeton was
eventually perfected into an investing
technique that called on investors to
buy stocks cheap – so cheap that there
was very little chance of the stock fall-
ing any further (thus avoiding any loss
of capital).
After Graham articulated his
thoughts on the subject in the book Se-
curity Analysis in 1934, value investing
grabbed the attention of several pro-
fessional investors, many of who have
added their own perspectives over the
following decades. Nevertheless, the
basic essence of value investing has
remained the same: buy cheap.
It was a philosophy that was born
in desperate times (the Depression
years), and underwent a baptism by
fire as it was tested time and again over
the next few years.
So it wouldn’t be wrong to wonder
just a little bit whether those princi-
ples still work in today’s times, given
that the past few years have been ex-
ceptionally exuberant for the world’s
major stock markets.
Cut to January 2008. In sharp con-
trast to the crisis engulfing the stock
markets when Graham started out, the
world’s economies – India’s included
– were exuding confidence like never
before. Many experts claimed that In-
dian financial markets were experi-
encing a secular bull run, not a cyclical
upswing that would die down anytime
soon.
41
13 June 2008 Outlook PROFIT
 Cover Story
as bits of bad news kept leaking out The world has changed in many
HOW WE DID THE BACK-TESTING at a steady pace. Investors who had ways. And the way business is done
The universe bought stocks at steep valuations now has changed appreciably. In the past
began to understand just how foolish century, while industrialisation was
Earnings yield portfolio: A portfolio of 30 stocks with the highest earnings yields, the
their actions were, not to mention the still underway, manufacturing was the
minimum cut-off being double the bond rate for the respective year, from the BSE- speculators who had joined in for the mainstay of business and companies
500 universe, excluding financials, with a debt-equity of less than 1. For years that free ride. were largely asset-heavy.
threw up less that 30 stocks, we went with the available stocks. Value investors had seen this coming Today’s businesses are more ser-
all along. At a lecture in India on Janu- vice-led and asset-light. Even the
Net-nets & cash bargains: All listed companies with a trading history of more than 90
ary 8, Bruce Greenwald, renowned fi- landscapes for accounting practices,
per cent excluding financials was taken as the universe. We calculated net-nets by nance professor at Columbia Business securities regulations and sharehold-
deducting debt and current liabilities from current assets. The 30 or available stocks School, referred to stocks markets as ing patterns are dramatically differ-
for the respective years with market-cap less than net currents were considered ‘being expensive’. At the time, stocks ent. Graham’s success was also in part
were actually peaking out. Greenwald because he had the luxury of buying
for the portfolio each year. Companies with cash and marketable securities less teaches the ‘Graham and Dodd’ style businesses that were truly ‘cigar butts’
all external liabilities greater than the market-cap constituted the cash bargain of investing in the university Graham because of the state of the economy at
portfolio for the respective years. graduated from. the time.
Dogs of the Nifty: Top 10 stocks based on dividend yield at the end of every year. Value investing is not about predict- Is Graham’s philosophy still stay rel-
ing when markets will hit their peaks. evant in the changed times, (one of
The returns Graham (and today’s value investors optimism, although recent data does
We computed total returns (price appreciation plus dividend income) for the agree) emphasised the preservation point to a slowdown) compared with
portfolio constituted every year and with a holding period of 1-10 years for the of capital as the bedrock of investing. the gloom that the Father of Financial
period 1998-2008. For dogs of the Nifty we tested results only for a two-year holding “The beauty is, as Graham said, any- Analysis was witness to? Outlook Prof-
thing bought cheap will invariably go it sought answers for this by relying
period. In the case of a stock getting delisted or stopped trading, we considered the up in price,” says Chetan Parikh, a two factors: data, because data does
stock to have lost 100 per cent in the year in which the stock disappeared from the successful Indian value investor and not lie; and people who have been un-
portfolio. All data has been sourced from CMIE Prowess. managing director of Mumbai-based adulterated value investors.
Jeetay Investments. Before we disclose the results
There is one difference though. (please wait patiently – being patient
Besides, stock prices were catapult- covering almost immediately after What Graham considered bargains is the first rule in value investing!), we
ing and there was what seemed like a every tumble. and what today’s value investors con- present a quick look at Graham’s
never-ending flood of foreign money And investors continued to buy into sider as cheap (and we are not talking various strategies.
pouring in. For five straight years till stocks, whatever the price. about growth-style investors who do
January this year, the Sensex proved Then, the inevitable happened. Glob- not mind paying a high premium for THE PHILOSOPHY
the sceptics wrong at every level as it al markets nosedived and over the stellar growth prospects) are separated Graham’s investment radar mainly
rapidly scaled new all-time highs, re- next few months, continued to plunge by time. flashed stocks that could be classified
as bargains based on earnings poten-
CASH BARGAINS PORTFOLIO tial or asset values.
The key earnings-based strategy that
Portfolio consists of stocks with cash and marketable securities greater than market cap most lay investors can easily adopt in-
year 1 yr 2 yr 3 yr 4 yr 5 yr 6 yr 7 yr 8 yr 9 yr 10 yr Latest volves buying stocks that offer a sub-
Portfolio 1998 56.30 13.47 -45.88 -22.24 -12.96 2.03 5.98 15.41 10.65 8.68 8.42 stantial earnings yield, typically, twice
the prevailing bond rate.
Sensex 1998 -17.00 7.82 -4.23 -4.46 -5.88 5.91 6.32 14.75 14.80 15.74 14.78
The earnings yield is the reverse of
Portfolio 1999 196.20 -25.04 -15.97 -14.89 4.01 24.82 25.87 21.03 25.39 26.24 the price-earnings multiple. The logic
Sensex 1999 40.05 2.87 0.12 -2.87 11.20 10.80 20.18 19.55 20.10 18.92 is simple: if you view stocks as bonds Sanjay Bakshi , CEO,
that offer no growth but yield fixed re- Tactica Capital is a deep-value investor
Portfolio 2000 -45.69 -37.70 -3.11 6.55 19.24 19.65 18.05 29.14 28.81
Sensex 2000 -24.44 -15.34 -14.03 4.97 5.73 17.15 16.87 17.81 16.56
turns (consider profits as a proxy for in-
terest earned) then the asset should be
Portfolio 2001 -13.43 -3.30 31.75 53.64 66.82 63.88 74.19 77.32 valued like a bond. If the earnings yield
Sensex 2001 -5.14 -8.29 17.13 15.00 27.90 25.69 25.53 23.83 is twice the bond yield, it means that stantial discount to the company’s as-
Portfolio 2002 -2.98 39.67 73.51 86.98 76.96 84.35 84.91 the asset actually promises to double set value (for businesses that boast
Sensex 2002 -11.33 30.16 22.62 37.82 32.96 31.53 29.30 the returns you could get from hold- good future prospects).
ing the bond. Given that the business Another set of bargains includes
Portfolio 2003 66.00 109.10 105.99 69.22 55.70% 57.67
is profitable and will continue to be stocks of companies quoting below
Sensex 2003 91.06 44.20 59.64 47.14 42.33 39.09 so, returns could be impressive as the the value of marketable securities
Portfolio 2004 169.39 120.53 92.65 49.22 51.58 yield in excess of the bond rate would and cash on their books after deduct-
Sensex 2004 8.83 45.93 34.87 32.23 28.88 provide an adequate margin of safe- ing outstanding debt. The logic here is
ty in the event of any capital erosion. that the company can use its cash and
Portfolio 2005 76.22 40.86 61.42 66.43
Another earnings-based strategy is be securities to pay of its debt and other
Sensex 2005 95.67 50.13 41.10 35.96 to buy stocks that offer substantial liabilities and still the shareholders
Portfolio 2006 58.50 28.62 56.86 dividend yield. would have something in their hand.
Sensex 2006 15.19 19.81 14.92 Asset-based strategies of Graham At the heart of Graham’s philosophy
Portfolio 2007 53.67 37.15 revolve around buying stocks that lies the ability to favour what is out of
are quoting either below their liquida- favour. Embrace the ugly, not the beau-
Sensex 2007 18.82 18.82 tion value (especially for businesses tiful. Lift the disgraced and disregard-
Returns for 2007 portfolio until May 27, 2008 that do not have a future) or at a sub- ed. And it works!

42 43
PHOTOS: SANJIT KUNDU
Outlook PROFIT 13 June 2008
 Cover Story
as bits of bad news kept leaking out The world has changed in many
HOW WE DID THE BACK-TESTING at a steady pace. Investors who had ways. And the way business is done
The universe bought stocks at steep valuations now has changed appreciably. In the past
began to understand just how foolish century, while industrialisation was
Earnings yield portfolio: A portfolio of 30 stocks with the highest earnings yields, the
their actions were, not to mention the still underway, manufacturing was the
minimum cut-off being double the bond rate for the respective year, from the BSE- speculators who had joined in for the mainstay of business and companies
500 universe, excluding financials, with a debt-equity of less than 1. For years that free ride. were largely asset-heavy.
threw up less that 30 stocks, we went with the available stocks. Value investors had seen this coming Today’s businesses are more ser-
all along. At a lecture in India on Janu- vice-led and asset-light. Even the
Net-nets & cash bargains: All listed companies with a trading history of more than 90
ary 8, Bruce Greenwald, renowned fi- landscapes for accounting practices,
per cent excluding financials was taken as the universe. We calculated net-nets by nance professor at Columbia Business securities regulations and sharehold-
deducting debt and current liabilities from current assets. The 30 or available stocks School, referred to stocks markets as ing patterns are dramatically differ-
for the respective years with market-cap less than net currents were considered ‘being expensive’. At the time, stocks ent. Graham’s success was also in part
were actually peaking out. Greenwald because he had the luxury of buying
for the portfolio each year. Companies with cash and marketable securities less teaches the ‘Graham and Dodd’ style businesses that were truly ‘cigar butts’
all external liabilities greater than the market-cap constituted the cash bargain of investing in the university Graham because of the state of the economy at
portfolio for the respective years. graduated from. the time.
Dogs of the Nifty: Top 10 stocks based on dividend yield at the end of every year. Value investing is not about predict- Is Graham’s philosophy still stay rel-
ing when markets will hit their peaks. evant in the changed times, (one of
The returns Graham (and today’s value investors optimism, although recent data does
We computed total returns (price appreciation plus dividend income) for the agree) emphasised the preservation point to a slowdown) compared with
portfolio constituted every year and with a holding period of 1-10 years for the of capital as the bedrock of investing. the gloom that the Father of Financial
period 1998-2008. For dogs of the Nifty we tested results only for a two-year holding “The beauty is, as Graham said, any- Analysis was witness to? Outlook Prof-
thing bought cheap will invariably go it sought answers for this by relying
period. In the case of a stock getting delisted or stopped trading, we considered the up in price,” says Chetan Parikh, a two factors: data, because data does
stock to have lost 100 per cent in the year in which the stock disappeared from the successful Indian value investor and not lie; and people who have been un-
portfolio. All data has been sourced from CMIE Prowess. managing director of Mumbai-based adulterated value investors.
Jeetay Investments. Before we disclose the results
There is one difference though. (please wait patiently – being patient
Besides, stock prices were catapult- covering almost immediately after What Graham considered bargains is the first rule in value investing!), we
ing and there was what seemed like a every tumble. and what today’s value investors con- present a quick look at Graham’s
never-ending flood of foreign money And investors continued to buy into sider as cheap (and we are not talking various strategies.
pouring in. For five straight years till stocks, whatever the price. about growth-style investors who do
January this year, the Sensex proved Then, the inevitable happened. Glob- not mind paying a high premium for THE PHILOSOPHY
the sceptics wrong at every level as it al markets nosedived and over the stellar growth prospects) are separated Graham’s investment radar mainly
rapidly scaled new all-time highs, re- next few months, continued to plunge by time. flashed stocks that could be classified
as bargains based on earnings poten-
CASH BARGAINS PORTFOLIO tial or asset values.
The key earnings-based strategy that
Portfolio consists of stocks with cash and marketable securities greater than market cap most lay investors can easily adopt in-
year 1 yr 2 yr 3 yr 4 yr 5 yr 6 yr 7 yr 8 yr 9 yr 10 yr Latest volves buying stocks that offer a sub-
Portfolio 1998 56.30 13.47 -45.88 -22.24 -12.96 2.03 5.98 15.41 10.65 8.68 8.42 stantial earnings yield, typically, twice
the prevailing bond rate.
Sensex 1998 -17.00 7.82 -4.23 -4.46 -5.88 5.91 6.32 14.75 14.80 15.74 14.78
The earnings yield is the reverse of
Portfolio 1999 196.20 -25.04 -15.97 -14.89 4.01 24.82 25.87 21.03 25.39 26.24 the price-earnings multiple. The logic
Sensex 1999 40.05 2.87 0.12 -2.87 11.20 10.80 20.18 19.55 20.10 18.92 is simple: if you view stocks as bonds Sanjay Bakshi , CEO,
that offer no growth but yield fixed re- Tactica Capital is a deep-value investor
Portfolio 2000 -45.69 -37.70 -3.11 6.55 19.24 19.65 18.05 29.14 28.81
Sensex 2000 -24.44 -15.34 -14.03 4.97 5.73 17.15 16.87 17.81 16.56
turns (consider profits as a proxy for in-
terest earned) then the asset should be
Portfolio 2001 -13.43 -3.30 31.75 53.64 66.82 63.88 74.19 77.32 valued like a bond. If the earnings yield
Sensex 2001 -5.14 -8.29 17.13 15.00 27.90 25.69 25.53 23.83 is twice the bond yield, it means that stantial discount to the company’s as-
Portfolio 2002 -2.98 39.67 73.51 86.98 76.96 84.35 84.91 the asset actually promises to double set value (for businesses that boast
Sensex 2002 -11.33 30.16 22.62 37.82 32.96 31.53 29.30 the returns you could get from hold- good future prospects).
ing the bond. Given that the business Another set of bargains includes
Portfolio 2003 66.00 109.10 105.99 69.22 55.70% 57.67
is profitable and will continue to be stocks of companies quoting below
Sensex 2003 91.06 44.20 59.64 47.14 42.33 39.09 so, returns could be impressive as the the value of marketable securities
Portfolio 2004 169.39 120.53 92.65 49.22 51.58 yield in excess of the bond rate would and cash on their books after deduct-
Sensex 2004 8.83 45.93 34.87 32.23 28.88 provide an adequate margin of safe- ing outstanding debt. The logic here is
ty in the event of any capital erosion. that the company can use its cash and
Portfolio 2005 76.22 40.86 61.42 66.43
Another earnings-based strategy is be securities to pay of its debt and other
Sensex 2005 95.67 50.13 41.10 35.96 to buy stocks that offer substantial liabilities and still the shareholders
Portfolio 2006 58.50 28.62 56.86 dividend yield. would have something in their hand.
Sensex 2006 15.19 19.81 14.92 Asset-based strategies of Graham At the heart of Graham’s philosophy
Portfolio 2007 53.67 37.15 revolve around buying stocks that lies the ability to favour what is out of
are quoting either below their liquida- favour. Embrace the ugly, not the beau-
Sensex 2007 18.82 18.82 tion value (especially for businesses tiful. Lift the disgraced and disregard-
Returns for 2007 portfolio until May 27, 2008 that do not have a future) or at a sub- ed. And it works!

42 43
PHOTOS: SANJIT KUNDU
Outlook PROFIT 13 June 2008
 Cover Story
ing the market temperature works tors with handsome dividends and cap- an investment firm called Tactica would have liked.”
beautifully as well. The proof of the ital appreciation. Capital, which specialises in deep- If wishes were horses, that would have
pudding is in our study of stocks that Most of these names were ignored a value-investing . been true! In today’s circumstances, it
were ultra-cheap in the past decade. few years ago either because business Other experts echo the sentiment. is not easy to find stock that offer great
Out of the 5,000-odd traded stocks at conditions were bad or the market sim- Managing director of Motilal Oswal Se- growth prospects with the margin of
the peak of the IT bull run in 1999, 22 ply shrugged them off because there curities Ramdeo Agarwal safety embedded the
stocks were trading below their liq- were alternative opportunities that says an attractive purchase way Graham liked it.
uidation values (current assets mi- were more alluring. price is key to making mon- Graham’ strategy Most experts, however,
nus current liabilities and debt). By “The market periodically gets into a ey. “The moment you pay was simple: believe trying to com-
contrast, when the markets plunged phase of madness when there is a fas- a price for growth, where bine a growth style and
to their nadir in 2003, 132 stocks met cination for a few sectors and the oth- is the outperformance?”
buy companies the rather contrarian
these criteria. ers are completely forgotten,” says E A he asks. “You are not deal- that he likened value-style technique
Nevertheless, some of the most suc- Sundaram, a fomer fund manager with ing only with the company to cigar butts don’t mix very well.
cessful value investors in the coun- HDFC Mutual Fund who now manages here, you are dealing with – typically Still, the perception
try believe that some changes to funds for the Bilakhias. And it’s true: the price of the stock. Peo- of value lies in the eyes
Graham’s strategies may be required during the dot-com boom, remember ple do not understand what abandoned but of the investor. “The
to make it more effective (although how the old economy was forgotten? A role the price plays.” still good for biggest contribution of
given that the back testing showed year ago, software service companies The sceptics argue the a puff or two. Graham to the world
such good results, we wonder why?) had joined the ranks of fallen angels. A other side. “The Gra- And you could of finance was three
true Graham follower would, however, ham model is geared to words – margin of safe-
MISSING OUT ON GROWTH? buy stocks precisely when there are no finding cheap cigar butts, pick them up ty – and if you keep that
Focusing on the cheap stocks often takers for them. but many such compa- for virtually in mind while invest-
means missing out on other opportuni- And what about growth? Graham nies may have issues with nothing. Stocks ing you will seldom go
ties. Why? Because the market is usu- never believed in relying on the future, their character itself,” quoting below awfully wrong,” says
ally instantly enamoured by anything so he would not pay a penny for growth. says Bharat Shah of ASK fund manager Sunda-
new that turns up in business until The difference between Graham fol- Raymond James who their liquidation ram.
they find reason to think otherwise lowers and the growth seekers is pri- started out as a value inves- values after
Remember the dot-com boom? Com- marily that the former are risk averse tor but later changed track. keeping a THE CHALLENGES
panies were awarded sky-high valu- (you can even call them miserly) and “Cheapness can be an il- Nevertheless, some
ations before it dawned on investors don’t seek to pay a price for growth. lusion. Just being cheap is
‘margin of safety’ strategies that were
that many business models were sim- “Value investors want growth not good enough for me, it largely a product of
ply unsustainable. for free,” says Sanjay Bakshi, profes- has to be supported by cap- circumstances that
However, the notion that you sor at Gurgaon’s Management Devel- ital efficiency and confidence about prevailed during Graham’s time are
could be left behind if you don’t pay opment Institute. “And by doing so, growth. While I like the cheapness that becoming less effective and riskier
the price for growth is not entirely they could well make errors of omission Graham would have liked, I would also propositions. It’s easy to see the con-
baseless. “If you buy stocks based but not of commission.” He also runs like quality of business that Fisher tentions.
strictly on traditional value invest-
ment principles, you will only play the EARNINGS YIELD PORTFOLIO
arbitrage opportunity (the differential
between the fair price and the market Portfolios with earnings yield more than double the bond rate with a maximum of 30 stocks
price) but the bigger opportunity in a year 1 yr 2 yr 3 yr 4 yr 5 yr 6 yr 7 yr 8 yr 9 yr 10 yr Latest
country like ours lies in the future as Portfolio 1998 80.16 87.27 14.34 19.78 9.57 27.44 36.53 48.24 42.40 42.47 43.82
the business grows,” says K N Siva Sensex 1998 -17.00 7.82 -4.23 -4.46 -5.88 5.91 6.32 14.75 14.80 15.74 14.78
Subramanian, vice president at Frank-
lin Templeton Mutual Fund. He’s con- Portfolio 1999 45.50 43.48 35.46 28.85 55.97 69.76 74.15 65.24 64.93 67.84
sidered one of the best fund managers Sensex 1999 40.05 2.87 0.12 -2.87 11.20 10.80 20.18 19.55 20.10 18.92
Chetan Parikh, of the past decade or so. Portfolio 2000 39.06 49.09 36.37 70.69 82.05 91.31 79.16 75.19 78.79
MD, Jeetay Investments has been a For sure, adopting a Graham approach Sensex 2000 -24.44 -15.34 -14.03 4.97 5.73 17.15 16.87 17.81 16.56
committed value investor would have encouraged investors to
Portfolio 2001 88.92 46.61 89.10 109.55 112.85 95.99 95.21 100.3
pass over new, emerging businesses
that have given outstanding returns Sensex 2001 -5.14 -8.29 17.13 15.00 27.90 25.69 25.53 23.83
on the bourses: Infosys Technologies, Portfolio 2002 27.32 105.81 141.89 139.39 110.76 105.14 109.9
8 Back-testing key Graham strate- HDFC Bank, Pantaloon Retail; and Su- Sensex 2002 -11.33 30.16 22.62 37.82 32.96 31.53 29.30
gies reveal a stunning performance. zlon Energy to name just a few. None Portfolio 2003 268.56 217.40 173.73 127.78 112.65 118.7
The strategy of picking up stocks of these stocks would have qualified as
that have earnings yields that value stocks in the Graham sense ever. Sensex 2003 91.06 44.20 59.64 47.14 42.33 39.09
are twice as high as the bond But you would have built an equally Portfolio 2004 289.12 220.77 134.53 118.07 125.5
yield proved to be spot-on stellar portfolio of stocks consisting of Sensex 2004 8.83 45.93 34.87 32.23 28.88
for investors. Returns on Bharti Televentures and State Bank Portfolio 2005 434.52 172.21 110.90 110.9
such a portfolio beat the of India (at one time available signifi-
Sensex 2005 95.67 50.13 41.10 35.96
Sensex every time! Cash cantly below book value); public-sec-
bargains and net-nets have tor companies such as Bharat Earth Portfolio 2006 119.92 79.41 95.68
worked with 70 per cent Movers and BHEL and private-sector Sensex 2006 15.19 19.81 14.92
accuracy. (See table: Cash companies such as Areva T&D, Penin- Portfolio 2007 33.56 33.56
Bargains Portfolio) sular land, Gujarat NRE Coke, Merca-
Sensex 2007 14.69 14.69
tor Lines, Aban Offshore and even Jai
8 Graham’s way of gaug- Corp. All of them have rewarded inves- CAGR Returns Note: 2007 based on latest sensex closing May 26, 2008

44 45
Outlook PROFIT 13 June 2008 13 June 2008 Outlook PROFIT
 Cover Story
ing the market temperature works tors with handsome dividends and cap- an investment firm called Tactica would have liked.”
beautifully as well. The proof of the ital appreciation. Capital, which specialises in deep- If wishes were horses, that would have
pudding is in our study of stocks that Most of these names were ignored a value-investing . been true! In today’s circumstances, it
were ultra-cheap in the past decade. few years ago either because business Other experts echo the sentiment. is not easy to find stock that offer great
Out of the 5,000-odd traded stocks at conditions were bad or the market sim- Managing director of Motilal Oswal Se- growth prospects with the margin of
the peak of the IT bull run in 1999, 22 ply shrugged them off because there curities Ramdeo Agarwal safety embedded the
stocks were trading below their liq- were alternative opportunities that says an attractive purchase way Graham liked it.
uidation values (current assets mi- were more alluring. price is key to making mon- Graham’ strategy Most experts, however,
nus current liabilities and debt). By “The market periodically gets into a ey. “The moment you pay was simple: believe trying to com-
contrast, when the markets plunged phase of madness when there is a fas- a price for growth, where bine a growth style and
to their nadir in 2003, 132 stocks met cination for a few sectors and the oth- is the outperformance?”
buy companies the rather contrarian
these criteria. ers are completely forgotten,” says E A he asks. “You are not deal- that he likened value-style technique
Nevertheless, some of the most suc- Sundaram, a fomer fund manager with ing only with the company to cigar butts don’t mix very well.
cessful value investors in the coun- HDFC Mutual Fund who now manages here, you are dealing with – typically Still, the perception
try believe that some changes to funds for the Bilakhias. And it’s true: the price of the stock. Peo- of value lies in the eyes
Graham’s strategies may be required during the dot-com boom, remember ple do not understand what abandoned but of the investor. “The
to make it more effective (although how the old economy was forgotten? A role the price plays.” still good for biggest contribution of
given that the back testing showed year ago, software service companies The sceptics argue the a puff or two. Graham to the world
such good results, we wonder why?) had joined the ranks of fallen angels. A other side. “The Gra- And you could of finance was three
true Graham follower would, however, ham model is geared to words – margin of safe-
MISSING OUT ON GROWTH? buy stocks precisely when there are no finding cheap cigar butts, pick them up ty – and if you keep that
Focusing on the cheap stocks often takers for them. but many such compa- for virtually in mind while invest-
means missing out on other opportuni- And what about growth? Graham nies may have issues with nothing. Stocks ing you will seldom go
ties. Why? Because the market is usu- never believed in relying on the future, their character itself,” quoting below awfully wrong,” says
ally instantly enamoured by anything so he would not pay a penny for growth. says Bharat Shah of ASK fund manager Sunda-
new that turns up in business until The difference between Graham fol- Raymond James who their liquidation ram.
they find reason to think otherwise lowers and the growth seekers is pri- started out as a value inves- values after
Remember the dot-com boom? Com- marily that the former are risk averse tor but later changed track. keeping a THE CHALLENGES
panies were awarded sky-high valu- (you can even call them miserly) and “Cheapness can be an il- Nevertheless, some
ations before it dawned on investors don’t seek to pay a price for growth. lusion. Just being cheap is
‘margin of safety’ strategies that were
that many business models were sim- “Value investors want growth not good enough for me, it largely a product of
ply unsustainable. for free,” says Sanjay Bakshi, profes- has to be supported by cap- circumstances that
However, the notion that you sor at Gurgaon’s Management Devel- ital efficiency and confidence about prevailed during Graham’s time are
could be left behind if you don’t pay opment Institute. “And by doing so, growth. While I like the cheapness that becoming less effective and riskier
the price for growth is not entirely they could well make errors of omission Graham would have liked, I would also propositions. It’s easy to see the con-
baseless. “If you buy stocks based but not of commission.” He also runs like quality of business that Fisher tentions.
strictly on traditional value invest-
ment principles, you will only play the EARNINGS YIELD PORTFOLIO
arbitrage opportunity (the differential
between the fair price and the market Portfolios with earnings yield more than double the bond rate with a maximum of 30 stocks
price) but the bigger opportunity in a year 1 yr 2 yr 3 yr 4 yr 5 yr 6 yr 7 yr 8 yr 9 yr 10 yr Latest
country like ours lies in the future as Portfolio 1998 80.16 87.27 14.34 19.78 9.57 27.44 36.53 48.24 42.40 42.47 43.82
the business grows,” says K N Siva Sensex 1998 -17.00 7.82 -4.23 -4.46 -5.88 5.91 6.32 14.75 14.80 15.74 14.78
Subramanian, vice president at Frank-
lin Templeton Mutual Fund. He’s con- Portfolio 1999 45.50 43.48 35.46 28.85 55.97 69.76 74.15 65.24 64.93 67.84
sidered one of the best fund managers Sensex 1999 40.05 2.87 0.12 -2.87 11.20 10.80 20.18 19.55 20.10 18.92
Chetan Parikh, of the past decade or so. Portfolio 2000 39.06 49.09 36.37 70.69 82.05 91.31 79.16 75.19 78.79
MD, Jeetay Investments has been a For sure, adopting a Graham approach Sensex 2000 -24.44 -15.34 -14.03 4.97 5.73 17.15 16.87 17.81 16.56
committed value investor would have encouraged investors to
Portfolio 2001 88.92 46.61 89.10 109.55 112.85 95.99 95.21 100.3
pass over new, emerging businesses
that have given outstanding returns Sensex 2001 -5.14 -8.29 17.13 15.00 27.90 25.69 25.53 23.83
on the bourses: Infosys Technologies, Portfolio 2002 27.32 105.81 141.89 139.39 110.76 105.14 109.9
8 Back-testing key Graham strate- HDFC Bank, Pantaloon Retail; and Su- Sensex 2002 -11.33 30.16 22.62 37.82 32.96 31.53 29.30
gies reveal a stunning performance. zlon Energy to name just a few. None Portfolio 2003 268.56 217.40 173.73 127.78 112.65 118.7
The strategy of picking up stocks of these stocks would have qualified as
that have earnings yields that value stocks in the Graham sense ever. Sensex 2003 91.06 44.20 59.64 47.14 42.33 39.09
are twice as high as the bond But you would have built an equally Portfolio 2004 289.12 220.77 134.53 118.07 125.5
yield proved to be spot-on stellar portfolio of stocks consisting of Sensex 2004 8.83 45.93 34.87 32.23 28.88
for investors. Returns on Bharti Televentures and State Bank Portfolio 2005 434.52 172.21 110.90 110.9
such a portfolio beat the of India (at one time available signifi-
Sensex 2005 95.67 50.13 41.10 35.96
Sensex every time! Cash cantly below book value); public-sec-
bargains and net-nets have tor companies such as Bharat Earth Portfolio 2006 119.92 79.41 95.68
worked with 70 per cent Movers and BHEL and private-sector Sensex 2006 15.19 19.81 14.92
accuracy. (See table: Cash companies such as Areva T&D, Penin- Portfolio 2007 33.56 33.56
Bargains Portfolio) sular land, Gujarat NRE Coke, Merca-
Sensex 2007 14.69 14.69
tor Lines, Aban Offshore and even Jai
8 Graham’s way of gaug- Corp. All of them have rewarded inves- CAGR Returns Note: 2007 based on latest sensex closing May 26, 2008

44 45
Outlook PROFIT 13 June 2008 13 June 2008 Outlook PROFIT
 Cover Story
8 The concept of book value and in and out of the company gate ev- tions. Indeed, some of the best-run of management and steer course
whether it reflects the true worth ery day; they’re not mentioned in the companies in the world have a neg- differently, it may not be the same
of a company have undergone fun- balance-sheet though. ative working capital -- consumer for regular stock investors who
damental changes over time. Book Similarly, the real value of consum- companies like Hindustan Unilever, may not be in any position to
value was one of the prime pa- er companies lies in their brands Procter & Gamble and several oth- influence managements.
rameters Graham relied on since and distribution network, again not ers actually have been operated with An Indian example comes from the
he preferred judging what was on quantified in the statement of ac- negative working capital for quite mid-cap segment of pharmaceutical
the balance-sheet to looking at un- counts. “The balance-sheet does some time now. stocks. Take the Indian subsidiary
quantifiable parameters. In his time, not capture the value of intangibles of Merck. Despite the fact that it has
companies were asset-heavy and it like brands, but they also have cash 8 Some Graham strategies like cash the equivalent of 30-40 per cent of
made sense to look at asset values. flows attached to them,” points out bargains work well in mature mar- its market capitalisation in cash, the
Not anymore. Today, the real value Sundaram. kets like the US because the share- stock price has shrivelled.
of several business lies not in the holding pattern is diffused, so a In hindsight, it’s easy to figure out
plant and machinery they own, but 8 Similarly, Graham’s idea of looking financial investor could identify situ- why the stock has underperformed:
in more unquantifiable factors. Take at net working capital requires re- ations and act in a fashion that com- revenues haven’t grown as much
software services, for instance. In thinking as well. The whole idea of pels management to unlock value. and the balance-sheet has shrunk.
this industry, the real assets are the net-nets was to buy a company be- But in India, since promoters usual- So even as the company continues
technically skilled people who walk low its working capital because if the ly hold fairly large stakes and corpo- to add to its cash pile every year,
market did not give the company the rate raids are not that common, the the stock remains trapped in
valuation it deserved, the promoter probability of liquidation is rather the doldrums.
NET NET DROPOUTS could easily liquidate the company slim and dilutes the case for unlock-
Companies that disappeared from the by realising the receivables and cash, ing value in such stocks. 8 Again, finding the right margin of
net-nets portfolio midway pay off payables and debt – and still Besides, another risk with Graham’s safety itself is a difficult proposi-
year 1 2 3 4 5 6 7 8 9 10 take home some cash (by the way, cheap stocks is that while you can tion for strategies like cash bargains.
we’re not even accounting for fixed buy a business at a lower price than Since these could involve long wait-
1998 1 3 1 1 1 assets here). Obviously, Graham was what it’s worth, you can never tell ing periods, unless there is a trigger
1999 1 3 looking at what was truly dirt cheap whether it will add or subtract value. in sight, the opportunity cost of cap-
2000 2 3 (cigar butts). Templeton’s Subramanian quotes a ital; the potential casualties in the
2001 2 1 He would have rejected companies classic example: when Warren Buf- portfolio (because Graham believed
with low net current assets outright. fet bought Berkshire Hathaway, it in diversification with less due dili-
2002 1
But, in today’s world, high working was still a textiles company. And in- gence as opposed to the strategy of
2003 4 1 capital is taken as a sign of a deterio- stead of continuing like that, Buffett concentration with utmost due dili-
2004 1 rating competitive position. Higher used the cash to build a business that gence that Buffett follows); and the
2005 1 receivables being built up; large dis- offered growth. fact that Graham never looked be-
2006 counts to customers; larger collec- While buying cash bargains may a yond fair-value situ-
tion periods – all these are actually rewarding proposition for an activ- ations (not letting
2007 signs of worsening business condi- ist investor who can take the reins ‘profits run’); the mar- “Value
gin of safety’s has to investors are
be considerably high.
GRAHAM’S NET NETS PORTFOLIO Finding such stocks
balance-sheet
Portfolio of top 30 stocks trading below their net current asset values in current circum- analysts and
Year 1 yr 2 yr 3 yr 4 yr 5 yr 6 yr 7 yr 8 yr 9 yr 10 yr Latest stances poses a seri- regular market
Portfolio 1998 43.46 89.16 4.77 12.22 7.40 15.22 24.51 28.30 24.41 22.24 23.64 ous challenge. analysts are
Sensex 1998 -17.00 7.82 -4.23 -4.46 -5.88 5.91 6.32 14.75 14.80 15.74 14.78
8 While Graham’s strat- P&L analysts. “
Portfolio 1999 220.43 -1.32 10.57 5.55 20.07 28.07 38.66 31.08 27.44 28.29 egy is great in terms
Sensex 1999 40.05 2.87 0.12 -2.87 11.20 10.80 20.18 19.55 20.10 18.92 of capital protection,
Portfolio 2000 -30.22 -17.11 0.05 28.42 39.62 51.37 49.52 49.91 52.94 it focuses only on the arbitrage val-
Sensex 2000 -24.44 -15.34 -14.03 4.97 5.73 17.15 16.87 17.81 16.56 ue between the margin of safety Ramdeo Agarwal,
and the fair value of the stock (in MD, Motilal Oswal Securities believes
Portfolio 2001 29.67 17.11 56.62 70.75 88.79 67.24 57.87 58.26 fact, Graham would invariably sell in getting the purchase price right
Sensex 2001 -5.14 -8.29 17.13 15.00 27.90 25.69 25.53 23.83 the stock even before the fair value
Portfolio 2002 1.86 44.03 70.12 85.30 70.52 72.13 74.76 was achieved). By doing so, some
Sensex 2002 -11.33 30.16 22.62 37.82 32.96 31.53 29.30 present-day value investors say, you
would lose out on the bigger value ham framework to work is a purely
Portfolio 2003 91.19 102.59 84.42 66.92 68.32 68.78
that is usually built into the growth capitalistic society with little con-
Sensex 2003 91.06 44.20 59.64 47.14 42.33 39.09 of the company. Templeton’s Sub- trols. But some companies that are
Portfolio 2004 151.46 136.97 93.67 85.38 89.21 ramanian says that it makes a lot of going cheap in the Indian markets
Sensex 2004 8.83 45.93 34.87 32.23 28.88 sense to look at metrics such as divi- today namely those in the oil, fer-
Portfolio 2005 54.25 67.26 81.85 93.37
dend yields because growth oppor- tilisers and sugar business are
tunities in some segments may have those that have been hit because
Sensex 2005 95.67 50.13 41.10 35.96 exhausted but the situation may be of government controls. These
Portfolio 2006 16.94 18.28 28.83 entirely different for India, where stocks look cheap, but it’s unlike-
Sensex 2006 15.19 19.81 14.92 growth in those segments may be ly the situation will correct itself
Portfolio 2007 31.938 34.809 just picking up. unless the government steps in.
Sensex 2007 18.82 14.69
8 The ideal environment for the Gra- 8 Again, one of the gripes against
46
8 47
Outlook PROFIT 13 June 2008
 Cover Story
8 The concept of book value and in and out of the company gate ev- tions. Indeed, some of the best-run of management and steer course
whether it reflects the true worth ery day; they’re not mentioned in the companies in the world have a neg- differently, it may not be the same
of a company have undergone fun- balance-sheet though. ative working capital -- consumer for regular stock investors who
damental changes over time. Book Similarly, the real value of consum- companies like Hindustan Unilever, may not be in any position to
value was one of the prime pa- er companies lies in their brands Procter & Gamble and several oth- influence managements.
rameters Graham relied on since and distribution network, again not ers actually have been operated with An Indian example comes from the
he preferred judging what was on quantified in the statement of ac- negative working capital for quite mid-cap segment of pharmaceutical
the balance-sheet to looking at un- counts. “The balance-sheet does some time now. stocks. Take the Indian subsidiary
quantifiable parameters. In his time, not capture the value of intangibles of Merck. Despite the fact that it has
companies were asset-heavy and it like brands, but they also have cash 8 Some Graham strategies like cash the equivalent of 30-40 per cent of
made sense to look at asset values. flows attached to them,” points out bargains work well in mature mar- its market capitalisation in cash, the
Not anymore. Today, the real value Sundaram. kets like the US because the share- stock price has shrivelled.
of several business lies not in the holding pattern is diffused, so a In hindsight, it’s easy to figure out
plant and machinery they own, but 8 Similarly, Graham’s idea of looking financial investor could identify situ- why the stock has underperformed:
in more unquantifiable factors. Take at net working capital requires re- ations and act in a fashion that com- revenues haven’t grown as much
software services, for instance. In thinking as well. The whole idea of pels management to unlock value. and the balance-sheet has shrunk.
this industry, the real assets are the net-nets was to buy a company be- But in India, since promoters usual- So even as the company continues
technically skilled people who walk low its working capital because if the ly hold fairly large stakes and corpo- to add to its cash pile every year,
market did not give the company the rate raids are not that common, the the stock remains trapped in
valuation it deserved, the promoter probability of liquidation is rather the doldrums.
NET NET DROPOUTS could easily liquidate the company slim and dilutes the case for unlock-
Companies that disappeared from the by realising the receivables and cash, ing value in such stocks. 8 Again, finding the right margin of
net-nets portfolio midway pay off payables and debt – and still Besides, another risk with Graham’s safety itself is a difficult proposi-
year 1 2 3 4 5 6 7 8 9 10 take home some cash (by the way, cheap stocks is that while you can tion for strategies like cash bargains.
we’re not even accounting for fixed buy a business at a lower price than Since these could involve long wait-
1998 1 3 1 1 1 assets here). Obviously, Graham was what it’s worth, you can never tell ing periods, unless there is a trigger
1999 1 3 looking at what was truly dirt cheap whether it will add or subtract value. in sight, the opportunity cost of cap-
2000 2 3 (cigar butts). Templeton’s Subramanian quotes a ital; the potential casualties in the
2001 2 1 He would have rejected companies classic example: when Warren Buf- portfolio (because Graham believed
with low net current assets outright. fet bought Berkshire Hathaway, it in diversification with less due dili-
2002 1
But, in today’s world, high working was still a textiles company. And in- gence as opposed to the strategy of
2003 4 1 capital is taken as a sign of a deterio- stead of continuing like that, Buffett concentration with utmost due dili-
2004 1 rating competitive position. Higher used the cash to build a business that gence that Buffett follows); and the
2005 1 receivables being built up; large dis- offered growth. fact that Graham never looked be-
2006 counts to customers; larger collec- While buying cash bargains may a yond fair-value situ-
tion periods – all these are actually rewarding proposition for an activ- ations (not letting
2007 signs of worsening business condi- ist investor who can take the reins ‘profits run’); the mar- “Value
gin of safety’s has to investors are
be considerably high.
GRAHAM’S NET NETS PORTFOLIO Finding such stocks
balance-sheet
Portfolio of top 30 stocks trading below their net current asset values in current circum- analysts and
Year 1 yr 2 yr 3 yr 4 yr 5 yr 6 yr 7 yr 8 yr 9 yr 10 yr Latest stances poses a seri- regular market
Portfolio 1998 43.46 89.16 4.77 12.22 7.40 15.22 24.51 28.30 24.41 22.24 23.64 ous challenge. analysts are
Sensex 1998 -17.00 7.82 -4.23 -4.46 -5.88 5.91 6.32 14.75 14.80 15.74 14.78
8 While Graham’s strat- P&L analysts. “
Portfolio 1999 220.43 -1.32 10.57 5.55 20.07 28.07 38.66 31.08 27.44 28.29 egy is great in terms
Sensex 1999 40.05 2.87 0.12 -2.87 11.20 10.80 20.18 19.55 20.10 18.92 of capital protection,
Portfolio 2000 -30.22 -17.11 0.05 28.42 39.62 51.37 49.52 49.91 52.94 it focuses only on the arbitrage val-
Sensex 2000 -24.44 -15.34 -14.03 4.97 5.73 17.15 16.87 17.81 16.56 ue between the margin of safety Ramdeo Agarwal,
and the fair value of the stock (in MD, Motilal Oswal Securities believes
Portfolio 2001 29.67 17.11 56.62 70.75 88.79 67.24 57.87 58.26 fact, Graham would invariably sell in getting the purchase price right
Sensex 2001 -5.14 -8.29 17.13 15.00 27.90 25.69 25.53 23.83 the stock even before the fair value
Portfolio 2002 1.86 44.03 70.12 85.30 70.52 72.13 74.76 was achieved). By doing so, some
Sensex 2002 -11.33 30.16 22.62 37.82 32.96 31.53 29.30 present-day value investors say, you
would lose out on the bigger value ham framework to work is a purely
Portfolio 2003 91.19 102.59 84.42 66.92 68.32 68.78
that is usually built into the growth capitalistic society with little con-
Sensex 2003 91.06 44.20 59.64 47.14 42.33 39.09 of the company. Templeton’s Sub- trols. But some companies that are
Portfolio 2004 151.46 136.97 93.67 85.38 89.21 ramanian says that it makes a lot of going cheap in the Indian markets
Sensex 2004 8.83 45.93 34.87 32.23 28.88 sense to look at metrics such as divi- today namely those in the oil, fer-
Portfolio 2005 54.25 67.26 81.85 93.37
dend yields because growth oppor- tilisers and sugar business are
tunities in some segments may have those that have been hit because
Sensex 2005 95.67 50.13 41.10 35.96 exhausted but the situation may be of government controls. These
Portfolio 2006 16.94 18.28 28.83 entirely different for India, where stocks look cheap, but it’s unlike-
Sensex 2006 15.19 19.81 14.92 growth in those segments may be ly the situation will correct itself
Portfolio 2007 31.938 34.809 just picking up. unless the government steps in.
Sensex 2007 18.82 14.69
8 The ideal environment for the Gra- 8 Again, one of the gripes against
46
8 47
Outlook PROFIT 13 June 2008
 Cover Story
K N Siva Subramanian
VP, Franklin Templeton Mutual Fund, has an
enviable long-term track record
Graham’s strategy is that frequently
the list of worthy buys is made up of
obscure stocks on which there is lit-
tle public information. The reported
earnings are thus suspect and the
chance of being duped, quite high.
So following the rule always is never
easy.
8And finally, there is
an anti-thesis to Gra-
ham’s philosophy.
Pretty much like
the fact that some
companies are
48
Outlook PROFIT 31 January 2008
always cheap – and they deserve to
be so – there are others that deserve
superior valuations. A classic exam-
ple, says Subramanian, is Infosys
Technologies. “Earlier on we made
this mistake of trading Infosys for
cheaper software companies. Only
later did we realise that in some
companies, the premium was be-
cause of the difference the manage-
ment can make. It is not captured in
current earnings but it can make a
difference in the long haul.”
PICKING WINNERS
Finding the catalyst: Buying cheap is
a great idea but the biggest challenge
in Graham-style investing is figuring
out the trigger that will unlock value
in the stock. While a margin of safety
is important, it is essential to look at
the probability of getting that trans-
lated into returns. “Sometimes, the
catalysts could be growth itself,” says
professor Bakshi. If the stock trades
at a multiple of four times or so, and
earnings are still growing, your total
returns could be very attractive since
you can pocket a dividend yield, a price
appreciation equal to the earnings
growth and see a potential re-rating of
the stock as well. In addition, a poten-
tial buy-back by a proactive manage-
ment, special dividends, or open offers
arising from potential take-over bids
act as catalysts as well.
Despite the deep value some hold-
ing companies harbour, there are
few takers for such stocks simply be-
cause there are no obvious triggers
in sight. But Bakshi says there is one
way to play these stocks. The cata-
lyst, he says, could potentially come
in the form of a turn in the business
of an underlying subsidiary. Usually,
when business turns, the perceived
value of the holding company im-
proves and results in a fall in its dis-
count to intrinsic worth. The perceived
value in the company improves as
a consequence.
A case in point is Nalwa Sons.
The stock was available at a 75 per
cent discount to its intrinsic value
but as group company JSW Steel
(Nalwa holds 45 lakh shares) got re-
rated for the better, the discount
contracted to 16 per cent of Nalwa’s
intrinsic value.
Experts say the way to view such
companies is by taking a call on how
the operating business of the subsid-
iary will fare in the long haul. For in-
stance, if cement is expected to do
well over the next five years, it would
make a lot of sense to put money in
holding companies of cement enter-
DOGS OF THE NIFTY could run the risk of deterioration in folio requires going after little-known
Portfolio of top 10 dividend yield stocks business. Candidates in the out-of-fa- or desired stocks. We all know what
vour category now include commod- kinds of stocks are thrown up on these
YEAR 1 yr 2 yr
ity companies which look incredibly screens, but it requires nerves of steel
Portfolio 1998 -14.68 27.71 cheap but may be vulnerable to an and guts to buy these stocks. Why?
Sensex 1998 -17.00 7.82 earnings decline if the cycle turns for For one thing, you may not have heard
Portfolio 1999 145.80 40.83 the worse. One way to assess these about most of them. For another, most
companies may be to look at average of these stocks will be drenched in pes-
Sensex 1999 40.05 2.87
earnings for the past five years or more simism, so most investors will be re-
Portfolio 2000 10.53 26.90 to remove the effect of cyclicality. luctant to invest in them.
Sensex 2000 -24.44 -15.34 Professor Bakshi says one way to look Indeed, the reason value investing
Portfolio 2001 65.29 33.08 at cash bargains is to identify compa- is so difficult is because it may feel
Sensex 2001 -5.14 -8.29 nies with fairly certain cash flows and completely foolish for a while. “But
not focus as much on ab- true value investors
Portfolio 2002 4.64 90.51 solute cash levels. Since are not worried about
Sensex 2002 -11.33 30.16 companies with regular “If you buy stocks looking foolish as long
Portfolio 2003 198.09 77.03 cash flows will soon turn based strictly as they’re certain they
Sensex 2003 91.06 44.20 into a treasure-chest of haven’t acted foolishly,”
cash, they could be viewed on traditional remarks Bakshi.
Portfolio 2004 11.64 41.06 value investment
as cash bargains, he says. Yet impressions mat-
Sensex 2004 8.83 45.93
The problem with look- principles, you ter to a large swathe
Portfolio 2005 83.05 33.90 ing at future cash flows, of investors. So even
as Graham also explained,
will only play if back-testing comes
Sensex 2005 95.67 50.13
is that it requires a judge- the arbitrage up with sparkling re-
Portfolio 2006 -4.25 11.70
ment of the future and opportunity, sults, it’s still difficult
Sensex 2006 15.19 19.81 those projections can dif- for many to go ahead
but the bigger
Portfolio 2007 32.65 NA fer from person to person. and take the plunge.
Sensex 2007 18.82 Nevertheless, since stocks
opportunity in a “The reason value in-
are now no longer avail- country like ours vesting is not popular is
able at high discounts as in lies in the future because people do not
prises. There are risks to such a strat- Graham’s time, “we can’t as the business have the patience to go
egy though. The lack of transparency ignore the value of future through these dull and
in dealings between group companies cash flows while looking at grows.” boring ideas,” says Mo-
and the vested interests of promoters valuations,” says Bakshi. tilal’s Agarwal.
can sometimes erode value in such While Graham’s solution Another reason why
stocks. for minimising the risk of bankrupt- most investors get bludgeoned with
“Unless you know that the inter- cies and frauds was diversification, their stock picks is that they don’t al-
ests of the promoters are aligned with looking at divergences in cash flows ways follow the rules and resort to gut
those of minority shareholders, there is and earnings in recent years (not just feel or judgement, which frequently
no point in touching such stocks,” says quarters) can also be effective in spot- goes wrong. “As humans, we do get
Templeton’s Subramanian. ting the warning signs. “Instead of carried away. A strict Graham strat-
Then again, the famous law of aver- looking at accounts statements for just egy would involve selling stocks pe-
ages or ‘reversion to the mean’ could a year, we should look at the aggregate riodically, in fact mechanically,” adds
help a stock run the distance. Instanc- picture for five years, which will offer Agrawal.
es of over-reactions to one-off situa- clues to the true picture,” says Bakshi. Another fact that Graham followers
tions could be good Graham picks. Among companies that are capital in- need to accept is that they will rarely
But investors really need to be able to tensive, it is a worthwhile strategy to make extraordinary returns. On the
judge the situation correctly to make search for those that have a high return other hand, they will rarely lose mon-
sure that what they think is a one-off on equity and low price-to-book value. ey. It’s important to be comfortable
really is just that. As Motilal’s Agarwal puts it: “Value in- with the fact that sometimes, they will
Take the recent forex losses by some vestors are balance-sheet analysts and miss new growth opportunities – but
companies, for instance. Buying bank regular market analysts are P&L ana- not giving in to such temptations can
stocks just because forex losses came lysts. Value investors buy assets cheap ensure a safer ride.
in much lower than expected is defi- and ahead of the market recognising True, there are those who have been
nitely not a wise call. At this point in a turnaround.” Thus, instead of look- enormously successful by follow-
time, it’s still uncertain if the prob- ing only at operating and net margins, ing growth investing techniques. But
lem could strike again. It may not be it is perhaps smarter to look at long- these investors, it has to be acknowl-
a one-off situation as some experts are term returns ratios. With companies edged, are extraordinarily smart and
claiming. After all, as professor Bakshi operating in cyclical industries, stocks have learnt to be at the right place
rightly points out, there is never just should be picked up when the industry at the right time. Very few ordinary
one cockroach in the kitchen. is down in the dumps. investors can aspire to be successful
Talking of out-of favour stocks, in- that way.
vestors need to careful when they’re INTELLIGENT INVESTING The relentless pressure of keeping up
dealing with downturns. It cannot be denied that Graham’s with the Joneses and the need to boast
Again, the problem with some com- strategy demands enormous psycho- about the latest stock picks at a party is
panies whose names pop up as good logical strength and will-power. That’s what investors need to overcome to be-
earnings yield candidates is that they because building a Graham-style port- come really successful investors. p
49
13 June 2008 Outlook PROFIT
 Cover Story
K N Siva Subramanian
VP, Franklin Templeton Mutual Fund, has an
enviable long-term track record
Graham’s strategy is that frequently
the list of worthy buys is made up of
obscure stocks on which there is lit-
tle public information. The reported
earnings are thus suspect and the
chance of being duped, quite high.
So following the rule always is never
easy.
8And finally, there is
an anti-thesis to Gra-
ham’s philosophy.
Pretty much like
the fact that some
companies are
48
Outlook PROFIT 31 January 2008
always cheap – and they deserve to
be so – there are others that deserve
superior valuations. A classic exam-
ple, says Subramanian, is Infosys
Technologies. “Earlier on we made
this mistake of trading Infosys for
cheaper software companies. Only
later did we realise that in some
companies, the premium was be-
cause of the difference the manage-
ment can make. It is not captured in
current earnings but it can make a
difference in the long haul.”
PICKING WINNERS
Finding the catalyst: Buying cheap is
a great idea but the biggest challenge
in Graham-style investing is figuring
out the trigger that will unlock value
in the stock. While a margin of safety
is important, it is essential to look at
the probability of getting that trans-
lated into returns. “Sometimes, the
catalysts could be growth itself,” says
professor Bakshi. If the stock trades
at a multiple of four times or so, and
earnings are still growing, your total
returns could be very attractive since
you can pocket a dividend yield, a price
appreciation equal to the earnings
growth and see a potential re-rating of
the stock as well. In addition, a poten-
tial buy-back by a proactive manage-
ment, special dividends, or open offers
arising from potential take-over bids
act as catalysts as well.
Despite the deep value some hold-
ing companies harbour, there are
few takers for such stocks simply be-
cause there are no obvious triggers
in sight. But Bakshi says there is one
way to play these stocks. The cata-
lyst, he says, could potentially come
in the form of a turn in the business
of an underlying subsidiary. Usually,
when business turns, the perceived
value of the holding company im-
proves and results in a fall in its dis-
count to intrinsic worth. The perceived
value in the company improves as
a consequence.
A case in point is Nalwa Sons.
The stock was available at a 75 per
cent discount to its intrinsic value
but as group company JSW Steel
(Nalwa holds 45 lakh shares) got re-
rated for the better, the discount
contracted to 16 per cent of Nalwa’s
intrinsic value.
Experts say the way to view such
companies is by taking a call on how
the operating business of the subsid-
iary will fare in the long haul. For in-
stance, if cement is expected to do
well over the next five years, it would
make a lot of sense to put money in
holding companies of cement enter-
DOGS OF THE NIFTY could run the risk of deterioration in folio requires going after little-known
Portfolio of top 10 dividend yield stocks business. Candidates in the out-of-fa- or desired stocks. We all know what
vour category now include commod- kinds of stocks are thrown up on these
YEAR 1 yr 2 yr
ity companies which look incredibly screens, but it requires nerves of steel
Portfolio 1998 -14.68 27.71 cheap but may be vulnerable to an and guts to buy these stocks. Why?
Sensex 1998 -17.00 7.82 earnings decline if the cycle turns for For one thing, you may not have heard
Portfolio 1999 145.80 40.83 the worse. One way to assess these about most of them. For another, most
companies may be to look at average of these stocks will be drenched in pes-
Sensex 1999 40.05 2.87
earnings for the past five years or more simism, so most investors will be re-
Portfolio 2000 10.53 26.90 to remove the effect of cyclicality. luctant to invest in them.
Sensex 2000 -24.44 -15.34 Professor Bakshi says one way to look Indeed, the reason value investing
Portfolio 2001 65.29 33.08 at cash bargains is to identify compa- is so difficult is because it may feel
Sensex 2001 -5.14 -8.29 nies with fairly certain cash flows and completely foolish for a while. “But
not focus as much on ab- true value investors
Portfolio 2002 4.64 90.51 solute cash levels. Since are not worried about
Sensex 2002 -11.33 30.16 companies with regular “If you buy stocks looking foolish as long
Portfolio 2003 198.09 77.03 cash flows will soon turn based strictly as they’re certain they
Sensex 2003 91.06 44.20 into a treasure-chest of haven’t acted foolishly,”
cash, they could be viewed on traditional remarks Bakshi.
Portfolio 2004 11.64 41.06 value investment
as cash bargains, he says. Yet impressions mat-
Sensex 2004 8.83 45.93
The problem with look- principles, you ter to a large swathe
Portfolio 2005 83.05 33.90 ing at future cash flows, of investors. So even
as Graham also explained,
will only play if back-testing comes
Sensex 2005 95.67 50.13
is that it requires a judge- the arbitrage up with sparkling re-
Portfolio 2006 -4.25 11.70
ment of the future and opportunity, sults, it’s still difficult
Sensex 2006 15.19 19.81 those projections can dif- for many to go ahead
but the bigger
Portfolio 2007 32.65 NA fer from person to person. and take the plunge.
Sensex 2007 18.82 Nevertheless, since stocks
opportunity in a “The reason value in-
are now no longer avail- country like ours vesting is not popular is
able at high discounts as in lies in the future because people do not
prises. There are risks to such a strat- Graham’s time, “we can’t as the business have the patience to go
egy though. The lack of transparency ignore the value of future through these dull and
in dealings between group companies cash flows while looking at grows.” boring ideas,” says Mo-
and the vested interests of promoters valuations,” says Bakshi. tilal’s Agarwal.
can sometimes erode value in such While Graham’s solution Another reason why
stocks. for minimising the risk of bankrupt- most investors get bludgeoned with
“Unless you know that the inter- cies and frauds was diversification, their stock picks is that they don’t al-
ests of the promoters are aligned with looking at divergences in cash flows ways follow the rules and resort to gut
those of minority shareholders, there is and earnings in recent years (not just feel or judgement, which frequently
no point in touching such stocks,” says quarters) can also be effective in spot- goes wrong. “As humans, we do get
Templeton’s Subramanian. ting the warning signs. “Instead of carried away. A strict Graham strat-
Then again, the famous law of aver- looking at accounts statements for just egy would involve selling stocks pe-
ages or ‘reversion to the mean’ could a year, we should look at the aggregate riodically, in fact mechanically,” adds
help a stock run the distance. Instanc- picture for five years, which will offer Agrawal.
es of over-reactions to one-off situa- clues to the true picture,” says Bakshi. Another fact that Graham followers
tions could be good Graham picks. Among companies that are capital in- need to accept is that they will rarely
But investors really need to be able to tensive, it is a worthwhile strategy to make extraordinary returns. On the
judge the situation correctly to make search for those that have a high return other hand, they will rarely lose mon-
sure that what they think is a one-off on equity and low price-to-book value. ey. It’s important to be comfortable
really is just that. As Motilal’s Agarwal puts it: “Value in- with the fact that sometimes, they will
Take the recent forex losses by some vestors are balance-sheet analysts and miss new growth opportunities – but
companies, for instance. Buying bank regular market analysts are P&L ana- not giving in to such temptations can
stocks just because forex losses came lysts. Value investors buy assets cheap ensure a safer ride.
in much lower than expected is defi- and ahead of the market recognising True, there are those who have been
nitely not a wise call. At this point in a turnaround.” Thus, instead of look- enormously successful by follow-
time, it’s still uncertain if the prob- ing only at operating and net margins, ing growth investing techniques. But
lem could strike again. It may not be it is perhaps smarter to look at long- these investors, it has to be acknowl-
a one-off situation as some experts are term returns ratios. With companies edged, are extraordinarily smart and
claiming. After all, as professor Bakshi operating in cyclical industries, stocks have learnt to be at the right place
rightly points out, there is never just should be picked up when the industry at the right time. Very few ordinary
one cockroach in the kitchen. is down in the dumps. investors can aspire to be successful
Talking of out-of favour stocks, in- that way.
vestors need to careful when they’re INTELLIGENT INVESTING The relentless pressure of keeping up
dealing with downturns. It cannot be denied that Graham’s with the Joneses and the need to boast
Again, the problem with some com- strategy demands enormous psycho- about the latest stock picks at a party is
panies whose names pop up as good logical strength and will-power. That’s what investors need to overcome to be-
earnings yield candidates is that they because building a Graham-style port- come really successful investors. p
49
13 June 2008 Outlook PROFIT