d-mart, goldman, and idiots

Goldman Sachs, recently, recommended Avenue Supermarts as a buy and set its target at Rs.1,586; it currently trades at Rs.1,086 per share. That's an upside of 46%; want it? 

The stock was priced at Rs.299 per share when it was offered for public listing in March 2017; but the euphoria was evident as it closed the day at Rs.641.60. Well, the exuberance has not evaporated, yet. 

At the time of the offering, the company was priced at Rs.187 b. At the listing date, it was priced at Rs.400 b. As of now, the market price of the company is Rs.678 b. And now, Goldman is pricing it at Rs.990 b ($15 b). 

When EBIT grows 13 times, and EPS grows 30% annually over 10 years, magic happens. Euphoria combines with exuberance. 

Let's do the math. EPS for the year ended March 2017 was Rs.7.67. I don't buy the shit about weighted average number of shares, and Rs.8.48 EPS as reported in the financial statements; those are as per the accounting standards. 

When EPS grows 30% over the decade, it will be Rs.105.75 in 2027. So, if we expect 12% return on investment, the stock has to trade 32 times its earnings in 2027 as compared to 141 times now. But who wants 12%? Let's ask for 15%; for that, the stock should trade at 42 times. For 20% expected return, the multiple rises to more than 63 times. For 18%, it is 54 times. We are nearly there; in a decade, the stock will have to trade at 54 to 63 times its then earnings in order for the investor to earn a decent return. 

It's a simple math; but where's the catch? Retail is a tough business. We have seen in the past how Walmart killed other retailers, and how the current times are so testing for its own business. Online retailing, and ecommerce are set to takeover in future. Can d-mart survive it? Nobody can tell now, but with some rationality, one can say that over 50 times earnings is too much to ask from a retail business. 

D-mart reinvested Rs.20 b in the last three years. If it has to keep pace with its growth estimates, reinvestment has to continue. When stories about the Indian demography, consumption, low base, high growth and so forth are told, the growth story has to be matched with the reinvestment story. During the last six years, the company has not had positive free cash flows to the firm; in fact, it had a cumulative negative FCFF of Rs.12 b during the period. Is that a surprise? If you want to open stores, you got to put the cash back. And if you fall short of internal cash earnings, you got to look outside for cash; and if that happens for too long, it is not going to be good. 

So how do we value d-mart based on its cash flows? As of March 2017, d-mart had Rs.19 b cash and Rs.15 b debt. Let's assume its after-tax EBIT (March 2017) is free cash flows; wishful thinking, but hold on. Some more wishful thinking: Let's say FCFF grows 30% annually over the next decade; and let's assume that it would reach to Rs.75 b in 2027. We will then have to value it based on an expected rate of return. 

If we use these high cash flows over the decade, and then apply a perpetual growth rate set equal to the stable growth rate, and discount them at 15% rate of return, we get a value of Rs.314 b for the entire equity. At 18%, it is Rs.217 b; and at 20%, Rs.177 b. 

Instead of using the perpetual growth route, if we apply a multiple to the 2027 free cash flows, we get a value of Rs.400 b for the equity when expected rate of return is 15%. At 18%, it is Rs.318 b; and at 20%, Rs.275 b.

Now compare the values to the Goldman's value of Rs.990 b. Also remember that we have had a fair dose of wishful thinking. We have plucked cash flows from nowhere. We have assumed high growth rates in cash flows for a long time. These two assumptions are quite powerful, and quite exuberant. And I have not even considered dilution through options, for d-mart has some options outstanding.

Will they all hold? I mean, come on...

But then again...if the stock can trade at 141 times earnings now, it can also trade at that multiple ten years later. So there is a strong case for the stock to trade close to Rs.15,000 per share in 2027. How about that? All the stupid men and women, hurry up, the stock is a screaming buy now...

value investors, india

I don't like value investors, and I have made it clear. I don't like money managers too, and I have made it much clear. There are self-proclaimed value investor communities in India, and do I have to say more about how much I loathe them?

There are groups of course, and each has sort of a leader, whom the members look up to and say, awesome every time the leader spits out something whether spoken or written. They tell stories, write blogs, and thus attract naive men and women. And then they find ways to make money for themselves by asking money from the naive to manage or through conducting teaching sessions, or something else. 

They talk about teaching investing to the public, and their own portfolio is created through mutual funds. Oh yeah, some of them are so sloppy about their work that they discount earnings. Can't tell the difference between EBIT and EBITDA; don't understand that depreciation is a genuine expense. 

Many of them are SEBI registered investment advisors. Man...if you are good at investing, can't you stick to your philosophy and invest your own cash, and be an honorable person? Do you have to use someone else's money to pay your bills? Some of those, who don't invite cash for investment, charge fees for their gibberish. Man...can't you just be honest about the fact that you ain't no good for the investment game, and therefore need cash to pay your bills?

Man...you discount earnings? whatever happened to depreciation, capital spending, and working capital requirements? You guys talk about CAPM and its evils, yet, use higher discount rates for riskier cash flows. You harp about margin of safety, and yet, implicitly use a method to protect your follies in estimating cash flows, which is another way to say that cash flows are riskier. 

You make a living out of Graham, Buffett, and Munger, and some lesser mortals. Some shame guys, before you tell stories to idiots, who are incapable of knowing that they can earn market returns very easily without any efforts. 

I admire those, who use their own money to invest, or even borrow to invest, which means two things: one, they are confident about their skills, and two, they have skin in the game; they eat their own cooking. And there is the third, they are confident of paying their bills through their investing skills, not through fees generated from either managing money or teaching lessons. 

Twitter has made the game much easier to play. It's a pity that the public is stupid enough to be gamed. 

earnings growth, expected return

Nifty tanked 157 points yesterday, which is a 1.56% fall from the previous day. This happened after some time, and especially when people did not expect it. The market euphoria seems to be there still, although the index trades close to 26 times earnings now. 

What people do not understand is that there is a business behind every stock, and therefore, the index is nothing but a giant conglomerate comprising of 50 or more businesses. We cannot view the prices in isolation, for if we did, we will have esoteric numbers, which otherwise will be difficult to explain. 

A better way is to think about what we can expect from the current prices. If we expect Nifty to give us an annual return of say, 12% in the next 5 years, we will have to think about two numbers: earnings at year 5 and a multiple to apply at the time. Let's use a multiple of 20, which itself is not pessimistic, and 5 years from now the expected Nifty will be about 17500. So far so good. The catch, however, is that to achieve that the earnings will have to grow at 18% annually over the period. Is that doable? Yes, of course; but I always like to think in probabilistic terms. So how likely is that to happen? Well, a lot of things will have to fall in place before that can happen. It's been quite long since Nifty clocked that kind of earnings growth; very long. 

That is for Nifty. How about individual stocks? If the index can give a return of 12%, we would like returns from stocks to be at least say, 15%. Let's stick to that. The Nifty-50 stocks have been trading at different multiples, mostly unsustainable over longer period. If we can normalize the multiples, and then check how much earnings will have to grow to achieve our expected return of 15%, it should make sense. 

So here's the story for the 50 stocks within Nifty.

The blue line shows the current PE of each stock; and the red one shows our expected, a little more reasonable multiple. I have been careful not to assign a too low multiple. So I believe that the expected growth rate is on the lower side, rather than higher. Let's take for instance, Eicher Motors, which is trading at a PE of 50, and I have assigned an expected PE of 30. We can see how much the blue line is off the red line. 

When I analyze stocks, I pick all numbers from the reports published by the company. However, here for this exercise, I have relied on the external sources to pick current earnings and multiples. To the extent that it might have errors, the numbers could be unreliable. Yet, I believe that this should give us a fair idea about whether the growth in earnings is probable. Although book multiples are better suited for the financial stocks, we get the idea for them too.

Now we move to the expected growth in earnings:

As we can see, most of the companies will have to grow their earnings by more than 20% annually over the next 5 years in order for us to give a return of 15%, based upon our expected multiples. ACC, for instance, will have to grow at 47% annually; and Cipla, 37%. I have ignored Tata Steel, which has negative earnings, and the multiple did not make sense. Still, Tata Steel stock price will have to move from 654 to 1316 to give us our expected return. How likely is that? Or how likely is that these Nifty companies will be able to grow their earnings as pointed out by the chart? Will Zee Entertainment be able to grow its earnings by 24% annually?

PE multiples are also based upon the fundamentals of the business, which is driven by the cash flows, growth, and risk in those cash flows. The higher the operating and financial leverage, the higher the risk, and the lower the multiple. The more consistent the cash flows, the higher the multiple. But there is a limit to the multiple assigned because it is mostly dependent upon the growth in earnings and cash flows. The earlier we get it, the easier it becomes for us to check the market. 

If we are too quick to assign future prices to the stocks at present times, naturally we will have to tone down our expected return, which is what has happened now. Blame it on the guys on the street.