pabrai, care ratings, and sell decisions

I am going to keep this post short. Care Ratings is trading at Rs.973.25 now. The low price was Rs.950.10 in November 2018 and the high price was Rs.1,430 in January 2018. So much has happened in during the year in the Indian markets too. 

I don't know why Mohnish Pabrai bought Repco Home Finance during April-September 2018, and I don't know why he sold much of the shares in November 2018 for loss. 

But then again I don't know why he bought Care Ratings. As of September 2018, the company had 29.461 m shares, and Pabrai funds owned 2.369 m shares (over 8%). 

Now I don't know why he sold shares in December 2018 for loss.

He sold 845 k shares at Rs.985.75 apparently for some loss on 20 December 2018. There are certain things in Pabrai's favor. He is a smart investor with historical returns behind him. He sounds good when he talks and writes; there aren't any stupid, irrational concepts that he brings in his philosophy. He is a long term investor, not bothered by short term events. And he is a huge Buffett and Munger fan.

So what made him sell Repco and Care Ratings in such a short time? I have noted earlier that he may have a better idea to deploy his capital. But then, there is another thing that I think may have triggered his sells at loss. Is that tax-loss harvesting? I am not too sure, but Pabrai is a smart investor. 

ny times business

New York Times was founded in 1851, and the company got listed as a publicly traded stock from 1969. The equity of the business is worth about $4 b today. In 2007, it was worth $3.8 b (high) and $2.3 b (low). In 2012 it hit some low times when the high market value was $1.6 b and low was $889 m. For the year 2011, it posted operating profits of $162 m and net loss of $40 m. There were several items of exceptional nature in that year probably. The broader point though is that there hasn't been much for its stockholders during the last decade.

Print media has been going through some tough, very tough times, and the digital media does not seem to be too promising as a viable business either. NY Times has been trying to transform itself onto digital platform, but the results are not interesting. The competitive advantages are lacking in media business in general.

In 2008, its advertisement revenues fell about 13%.

And by 2012, they were less than a million dollars.

For 2017, its latest reported financial year, the advertisement revenues were $558 m, but increase in subscription revenues have ensured total revenues stayed on course.

It had operating profits of $188 m, debt of $250 m, and the present value of its non-cancelable leases was  $47 m. It also had cash and non-operating assets of $735 m. The operating margins have improved over the years to about 10%. 

But the return on equity has not been encouraging: It was 21% in 2007; 17% in 2010; 26% in 2012; 10% in 2013. Other than for these years, the return on equity has been pretty dismal. If this has to continue, the business is not going to be a profitable venture for its shareholders. 

But then, who are its shareholders? The business is controlled by the Sulzberger family through a Trust. The company has two classes of shares: class A and class B.

While both classes share equally in profits, the voting power is controlled by the class B owners, and the family trust owns more than 90% of class B shares. That means any takeover threat is virtually eliminated. Over 50% of class A shares are owned by 6 investors: Vanguard, BlackRock and Darsana Capital own (8% each), Fairpointe Capital and Wellington Management (5% each), and Carlos Slim Helu owns over 16% of class A shares.

As far as the family trust is concerned, there is a case for retaining control for emotional and prestige reasons. But those 6 outside investors have some $2 b stuck in the business earning quite low on its equity. They may have their reasons, but it does not look fit for capitalists.

After a long time, total revenues grew year on year. 2017 saw over 7% increase in revenues, and the stock has hit $25. However, purely on pe terms, the price looks exorbitant. After denying dividends for 4 years from 2009 to 2012, they have been restored and increasing from the year 2013. The latest dividend per share is $0.16.

Free cash flows from business have not been great. NY Times generated some cash in 2012 and 2013 through sale of About group for $300 m and New England Media group for $70 m, and debt was brought down to $250 m.

At present, the equity is $900 m and non-operating capital is $735 m. Let us suppose that $250 m debt is fully paid off through sale of non-operating assets; there will be savings on finance costs. The business then will have $415 m operating assets and $485 m non-operating assets financed by $900 m equity. Now for the shareholders to make their investment business sense, the return on equity should be more than risk-free rate of return which is about 3%. Let's say the investors expect 8% return on their capital. The total return on equity should then be $72 m of which about $15 m (3%) will be provided by non-operating assets. The balance $57 m will have to be supplied by operating assets.; that is a return on operating capital of 14%.

It will not be easy to sustain 14% rate of return on capital for long though. A much better choice probably would be this: Excess capital which is deployed in non-operating assets may be used to pay additional dividends or buyback shares. Let's assume it will be used for dividends; so $485 m will be a windfall for the shareholders. Now the business will have only operating assets of $415 m financed entirely by equity. The expected rate of return is 8%. The business will have to generate only $33 m in profits; $24 m less profits will be relatively easier to make. Payout all profits after mandatory capital spends as dividends. Business will be mature, and valuing it will be simpler. Keep the story going as long as it is economically viable.

The outside investors will have to have faith that New York Times will be able to deliver their expected rate of return. The family trust is going to be probably fine since its objectives are different from class A share owners. 

market cap meltdown

I just thought of noting down the change in market caps of some of the largest companies in the US. Let's start with the market itself. The S&P-500 started the year with 2695.81. Here we have the google screen shot of the index.

On 7 December 2018, it was at 2633.08. Not that good. People are giving all sorts of reasons for the fall; but none of them are convincing, because it is the nature of the market to fall and rise, and rise and fall. Frequently, it forms sort of cycles that we call bulls and bears. There is no linear progression to be expected from markets or individual stocks. They don't have maturity values either. Stocks represent businesses; and businesses are perpetual, although they have their own life cycles based upon which they live their life, and often vanish. If we don't learn these lessons, we will have tough time dealing with volatility; and then, we will not be worthy of profits to be made from businesses. 

Look at Facebook:

25 July 2018 was the peak time for Facebook when it traded at $217.50 per share; and the market cap was over $625 b. But then it fell sharply on July 26, the next trading day, and closed with a market cap of $509 b. That was a near-19% crash. Was it due to the release of earning reports and expected growth rates? May be, but at $137.42, it is not looking good in terms of its past performance. Is it a good buy now? Time will tell. 

Apple is better:

Apple is comparatively better as the stock price now is near where it started the year. That it is far away from its trillion dollar valuation may be some consolation for those who try to compare intrinsic value with market price. That it is far too dependent upon one product, iPhone, that the overall growth may not be too high, and that it has too much cash may have implications on its financial and market performance in future. That Warren Buffett is the largest individual investor in Apple does not make it a buy. Cash flows, growth, and risk are the things that matter more than anything else. 

Alphabet has a full circle:

Alphabet stock was just above $1,000 in February and March 2018. In July, it reached $1,285.50 (more than $850 b market cap). As of now, it is back to about $1,000 from where it will begin again. 

Amazon makes an exception:

Amazon started the year with $1,189.01 per share. The latest price is $1,629.13. That's a 37% upside. The market cap touched $ trillion quite briefly on 4 September 2018, but closed the day lower. Compared to that the market cap now ($765 b) seems like a big fall. The thing is, stocks in general are moving down, aren't they?

We cannot leave Microsoft out of the equation, can we?

That old horse is still riding far and wide. That Apple is worth about $750 b and Microsoft is about $780 b tells us something. With windows and office as stable businesses, and cloud computing as its growth engine, the combo looks interesting. 

The fun is in the game
With 10-year treasuries yielding 2.85% and 1-year yielding 2.68%, investors are looking for a decent premium. A 5-point premium would lead to the expected returns of about 8%. That much, I reckon, markets and large-cap stocks should be able to give. For anything more than that, investors will have to look deep. Value is there in every market; it is easier to look at it in hindsight though.

As of now, it is much wiser to ignore the gyrations of the market and concentrate on the individual affairs. If you are an index investor, just continue the process. No worries. If you are a stock picker, look at the individual stock prices and their intrinsic values, and ignore the broader market index. More importantly for every sensible investor, ignore the experts and their stories. 

that fi cash

I have written about index investing many times, and I have written about how it is possible to make a reasonable amount of cash in order to claim financial independence. I have noted that making Rs.10 m in India should be relatively easy for anyone. Not many are privileged to be in that camp though. 

The purpose of this post is to assess how much cash is sufficient to sustain long term financial independence. There is the 4%-rule which says that: find out the current annual costs; multiply by 25; and that would be the cash required. This is how it is implemented: in the first year, withdraw 4% of the cash; for the second year, withdraw the first year number increased by the annual inflation rate; and so forth for the subsequent years.

Suppose that a family was able to accumulate Rs.5 m in financial assets at the beginning of 2000 and that the cash was invested in the Nifty-50 index. Assume that the family's annual costs at the time were Rs.125,000 and these will increase by annual inflation rate of 6% each year. That means for the year 2018, the annual costs will be about Rs.360,000. This is a very reasonable assumption for an ordinary family in India. Let us also assume that there will be no further investments.

As of 3 January 2000, the index was at 1592.20; and with Rs.5 m, about 3140 units could be bought; let's ignore transaction costs. On 1 January 2001, the index closed at 1254.30. The family will have to sell about 105 units for its annual costs of Rs.132,500 for the year. The remaining units on that day will be 3034, and the market value will be Rs.3.806 m. On 1 January 2018, the index was at 10435.55; annual costs are Rs.360,000; and units to be sold are about 35.

After the sale on 1 January 2018, the family will have 2016 units with a market value of Rs.21 m, a sizable number. All that the family did was: strived to make Rs.5 m as quick as possible, invested that in a diversified index, and had fun in life, doing what they liked to do. There is no pressure of working for someone else and meeting deadlines. No commuting time. Focus on things that mattered most and enjoyed that work. Leisurely meals. Lots of fun. If the person was age 40 at the time of financial independence, he or she would be worth Rs.21 m at age 58 which should be sufficient to lead a fun-filled life. I have not considered dividends that the index stocks payout. That should be yields of say, 1-2% as additional annual cash. 

The markets are not linear; and we have considered the exact moves of the market from 2000 to 2018. In fact, the index closed lower for (January) 2001, 2002, and 2003. Due to this, the market value reduced from Rs.5 m to Rs.3.043 m in January 2003. The family was not bothered by the PE; neither bear market, nor bull market. Heck, there weren't any more investments either. 

The only linear assumption was the inflation rate of 6%. We could tweak that here and there, but Rs.360,000 a year of annual costs are pretty reasonable in today's times for a typical family in a low-cost smaller town; it may be lower, but not higher. Why should this ordinary family be living in high-cost cities after financial independence when there are options for lower costs, better weather, and more leisure?

With that income, the taxes will be zero. Yes, we have ignored transactions costs; but I have made a bigger point: that it is not very difficult to be financially independent in India for anyone. For qualified professionals, it should be much easier, but even ordinary people can achieve it. The key is the behavior, not excuses. 

We have also ignored the asset allocation, investing fully in equities. But again, I wanted to make a bigger point, remember. A case could be made for the family to take up part-time work (that qualifies its criteria of fun) to meet just annual costs, and the annual realizations from equity (unit sales) are invested in bonds each year. Over the years, the family would be able to have reasonable amount in debt too. 

Even applying that 4%-rule - Rs.200,000 initial annual costs with Rs.5 m - the closing market value of investments will be Rs.14 m in January 2018. Good enough for that ordinary family. But I don't think, that typical family will have Rs.570,000 annual costs in today's times. Yet the point is made, isn't it?

If the family was able to accumulate Rs.10 m, instead of Rs.5 m, and had double the costs - Rs.250,000 in 2000 and Rs.720,000 in 2018 - the market value of investments would be Rs.42 m in January 2018. This is in fact possible for qualified professionals. Even initial year costs of Rs.420,000 which will be Rs.1.2 m in 2018, the market value would be Rs.26 m in January 2018.