PORTFOLIO MANAGEMENT STRATEGIES
in
STOCK INVESTMENT
PART III
In the last 2 Essays on this subject, we have summarized the basic principles, practices and strategies for PORTFOLIO MANAGEMENT and stock investing. Let us proceed further and examine the key concepts which are very popular with successful Stock Investors.
2 Concepts especially are very popular with stock Investors. (i) Value stocks and (ii) Growth stocks
VALUE STOCKS vs GROWTH STOCKS :-
Value stock picking arises from the basic concept that there is always a difference between the Price we pay for buying a stock and the intrinsic Value of the stock.
On the other hand Growth stocks are companies that are continuously growing at a fascinating rate and creating more value continuously in the company.
Value stocks possess more value compared to market price, based on past performance and past factors. If value already existing in the share is much more than the price, it is a value stock.
But, if a stock is fully priced right now, based on past performance and past factors, but the company is continuously expanding and creating more value due to such growth - it is called a Growth stock.
Many value stocks are also growth stocks and many Growth stocks are also value stocks. It is always ideal to choose VALUE + GROWTH STOCKS.
We know the market price we are paying for buying a company's stock/share. Let us say, the Face Value of a share is Rs.10 and the market price of the share is around Rs.80. These are easily known to everybody.
But, what is the intrinsic Value of the stock?
This is not so easily known and needs to be computed very carefully, before buying the stock. Suppose the Book Value of the stock is Rs.150. Ordinarily, we expect the Market price to be above the Book value. In this case, market price is Rs.80 but Book value is Rs.150. Usually, market price should have been above the book value of Rs.150 and not below Rs. 150. So, why is the market price below the Book Value?
This can be due to several valid reasons also. The Book value may consist largely of unused or underused Land and other assets which are not yielding any revenue. The revenue earned may be quite low compared to the book value of the assets with the company. If all assets are efficiently used, the revenue earned can go up significantly. In the hands of an unimaginative management, such efficient usage may not be happening.
Apart from comparing price with Book value, comparison is also made with the earnings per share. If the EPS has increased well but price has not increased, it may some times be due to slower market perception about the increasing value of the share compared to the price of the share. This is called PRICE EARNINGS RATIO.
What is the ideal Price to Book value ratio, and what is the ideal price to EPS ratio is difficult to tell. It depend on the market perception, the industry perception and so many other such factors.
SCENARIO.1 :
Typically, this is the case with many public sector undertakings. They have vast stretches of prime location land which they are unable to use and do not also let out or sell. Thus, the revenue earned by them on other, actually used assets may be paltry compared to their private sector competitors.
Many old private sector companies also possess such huge, unused and underused assets, thus yielding very little revenue compared to more efficient companies.
Therefore, the more efficient companies always command better price per share, as they are earning better revenue per share.
But, a hitherto, sleeping management wakes up and decides to put its assets to optimum use! We can see that the value undelying in the company's shares suddenly moves up in the eyes of the investor. Therefore, the price we pay for the shares will be less and the value we get will be more.
Scenario.2 :
There is a change in the Management and the New Management is perceived to be vastly superior to previous Management. Investors feel that a huge value now exists in the company's stock compared to its current price.
Scenario.3 :
Currently, the company is using about 50 percent of its installed capacity for producing its products. It can always expand its utilization to 70-80% also based on current assets. But, the Demand for its products is going up fast and it is now expected to improve on its capacity utilization to about 80% within a short time. Therefore, the value we get by buying the stock is much more than the price.
Scenario.4 :
A company was running in losses for last 2 years. But, the loss has been comping down every quarter. Many companies experience a positive turn around at some time or other, if they can sustain till that situation comes up. If we can be certain that the company can maintain the upward momentum and come out of loss making situations, Here also, there will be hidden value above the current market price.
Scenario.5 :
The company is manufacturing a niche product whose usage in the market is likely to go up very fast. Suppose, the company has a monopoly on the product. It is expected to expand capacities and cater to the growing demand. In such a case also, there will be huge hidden value in the market price of its share.
But, ordinarily, in pure VALUE INVESTING , already existing hidden value is taken into account and if this perceived hidden value is more than the price we pay, it is called VALUE INVESTING. in scenario.5, this can also be called Growth stock and Growth investing, as the value will arise due to expected future growth rather than already intrinsic value. Suppose, the company does not choose to avail rising demand due to any factors, but a competitor chooses to utilize the opportunity, we can say - there is no growth stock situation here. This has happened in Indian Markets several times.
Example : When Honda came up with Activa scooters, Bajaj also had the opportunity and Hero also had the opportunity. Hero availed but Bajaj did not. Honda became the No.1 scooter manufacturer. Hero is also doing well. But, Bajaj, failed to avail the huge opportunity.
SCENARIO.6 :
A company has come under a temporary cloud on some baseless rumours. Its price has fallen because of the baseless rumours. Sooner or later, investigations may prove that the rumours were baseless and that the company was in fact doing very well. So, a value investor goes on assessing the intrinsic worth of the share of the company and may go for buying the shares if he perceived the value to be more than the price.
I have given examples for Value investing and Growth Investing both.While Value and Growth are both important, the difference is - (i) value is - that which exists up to this moment and (ii) Growth is - that which is expected to be created from this moment.
There are products and services which have huge scope of growth. These companies will shine well in future. Their stocks will see huge growth. Investors in these companies will receive huge appreciation in the share price as time passes by. Therefore, Growth is an essential requirement to assess before we make a purchase of the stocks of a company.
As the economy is transforming and expanding fast, new opportunities are arising and new products and services are coming up with huge demand. An intelligent investor needs to assess the products and services of the future and locate efficient caterers for their demand. There lies the trick of value and growth stock investing.
MULTIBAGGERS :
What are Multibaggers? Multibaggers are those stocks whose market price rises beyond their purchase price by more than 100% in a short time of say 1 or 2 years maximum. Multibaggers are a direct offshoot or benefit arising from Value investing and growth investing.
Generally, new investors can be found asking others - please tell me some multuibaggers. I want to invest in them.
It is not correct to ask others. You must learn to do your research about the growth prospects of a company for the next 2 years at least and if you are satisfied, invest in them. Some of them will turn out to be multibaggers.
Normally, a return of 30% p.a. is a huge profit, compared to any other avenue of income. This is possible in stock investing with some care. Expecting 100% p.a. is GREED and not reasonable expectation.
But, some times, some stocks might give you such returns. Anything which gives you more than 30% return - has given you a fantastic return. The Best of companies in some sectors give just about 20% p.a., which is also definitely not bad at all.
In some years, due to political and other factors, returns can turn out to be either fantastic or Dismal. This too can happen. 2017 was generally a great year for stocks. Next 10 years can be reasonably good for stocks and you may reap good returns above 30% p.a. with some careful investing.
There are some other factors like (1) diversification (2) Power of compounding and so on - which are very fascinating. We will discuss them in a future post.
* * * WILL CONTINUE * * *
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