Mind of an Analyst

Manish Chokhani September 2004 1

The Mind of a Business Analyst

Applied Lessons for Investment Bankers and Research Analysts

ENAM Securities 2August 2004

AgendaComponents of an average recommendation

What requires to be validated

First Principles of Financial Analysis

Valuation Principles

Valuation Shortcuts and Market Cycles

Business Analysis – Circle of Competence Approach

Macro Economic, Political and Social Factors

Buyer Characteristics and Compulsions

Slotting the Recommendation

Recap the Valuation


An Average Recommendation Here are the financials

Past two years, next two yearsCurrent business trajectory is goodThis is the P/E , this is the EPS or something similarly cheap sounding

Here are some comparable valuations Local, regional, global

Occasionally:Chance to buy a good business…Unique Promoter …Great Shareholders/ Funds/Pvt Equity… Backing it

So Buy It


What Needs to be Validated?Validity of business financials

Forecast ValidityKey Business DriversAny hidden liabilities/ subsidiaries / etcBusiness CompetitivenessMacro factors at playAppropriate Valuation Tool

Relative validityWhat else is attractiveDecompose by Country / Sector / Mktcap / Promoter

What is driving the deal?Why the deal?Why Now?Who is the intermediary?Whats in it for me?


Understand the Business DriversVOLUME

Most loved Consumer focussed UVG stories: eg CellPhones, Retail, Hosing Loans, Media or large addressable markets globally like ITand pharma (buzz on BPO, Textiles…)

PRICEMost loved Pricing Power stories: Brands, OligopoliesExcitable Commodity swings: Cement, Metals…

EFFICIENCYIMPROVING ASSET UTILISATION

Usually Cyclicals – Autos, Engineering due to operating leverage

IMPROVING COST STRUCTURE/ ECONOMIES OF TECHNOLOGYUsually Engineering, PSUs, Conglomerates…

RESTRUCTURINGCatalysts such as Privatisation, M&A, Divestitures, Buybacks…


Case Studies

Lets Examine Sustainable Valuations forCement

Autos

IT

Pharma

FMCG

Use 5 key measures that define peak valuations…Sales / G Block

W Cap / Sales

Sustainable or desirable OPM%

Capex requirements

Volume Growth Assumptions

Help us to decide what we lay out and what we get back…


Now Lets Attempt a DCF


Markets continuously discount all of the above…

Value multiple- Predictable- Sustainable- Scaleable

Use Bond YieldReciprocal (100/8)=12.5xas benchmark

Val

ue

Time

ROE : 25%

ROE : 15%

8% Bonds

Cash

P/E=20x

P/E=12x

P/E=12x


“Virility” Symbols (Towers, diversification/ M&A)Bad qlty of IPOsCapex > near-future reqmentsInterest rates spike. Huge Credit expansionRetail euphoriaShock/ Leaders in trouble

Understand Market Cycles – I

Ignored, stagnant Cheap valuationsNegative press

Severe Undervaluation

Important commodities take off (Steel, Gold, etc.)Catalyst/ Regulatory (eg Privatisation, LT Cap gains exemption)Easy Liquidity

Undervaluation

Capex/ IPO/ Credit cycle revivesAsset & Cost inflationTourism/ Media attention“Themes” emerge, New Valuation “Paradigms”

Fair to Over valuation

Bubble

Sharp fall followed by pull back

“Left outers” jump in

Leadership narrows

Correction

Bear Phase

Bust

Symptoms of each hump deceptively similar -- It is the QUALITY which differs:

Eg high quality IPOs & Capex at “Reasonable”Valuation stage vs flood of bad IPOs & far-out-Capexat Bubble stage


Resulting in a Swing in Valuation Approaches

• Payback• EV/EBIDTA• P/E• DCF

• Technical Charts• Reflexivity• PE/G• Option Value

MomentumGARPValue

• Dividend Yield• Price/BV• Replacement Cost

BEAR MARKET BULL MARKET BUBBLE MARKET


Valuation Measures – CASH FLOW IS THE ONLY REALITY

DCF helps to make assumptions explicit;gives a good RANGEUse probability – don’t fudge the discount rate!Factor in uncertainties and risksTerminal Value is the key – Is all the value residing there?Wider the Optimistic-Pessimistic range – lower the valuation!

P/e = d/e / (k-g)P =d/(k-g)

d = dividend per sharek = shareholder return expectationk = i + r + rp (inflation+real int+risk premium)g = growth in dividend per share

Hence Importance of payouts and cash flows for better valuation

Close approximation of P/E to ROE

Other Methods are all variants for validationEVA – Economic Value Added - Excess return over WACC quantified EVA = ROIC – (IC x WACC) CFROI – Another smart way to do a DCF


MARGIN OF SAFETY

Cash flow v/s Bond Valuations

Growth prospects

Gap between Perception and Reality

Knowledge v/s Popularity

Limited downside/ lots of upside


UNDERSTAND “GOOD BUSINESSES”

THE CIRCLE OF COMPETENCE APPROACH


BUSINESSES APPRAISALThink long and hard about cycles

Life cycles

Business cycles

Think about sustainability and sources of advantage

Think about external pressures on profitability

Where does this business fit on a profitability distribution?

The financial litmus tests

Think about management and the majority partner


Think of Cycles!Nature is cyclical, not linear!

Life Cycles

Business Cycles / Boom-Bust

Seasonality

Innovation / Schumpeter

Market Cycles


LIFE CYCLE ANALYSIS

TIMETIME

SALE

SSA

LES

SOFTWARESOFTWARE

JUTEJUTE


BUSINESS CYCLES

INTERMEDIATESINTERMEDIATES

FMCG, SERVICESFMCG, SERVICES

CAPITAL GOODSCAPITAL GOODS

CONSUMER DURABLESCONSUMER DURABLES


COMMODITYCOMMODITY

EMERGING/EMERGING/SMALL SCALESMALL SCALE

SPECIALISED/SPECIALISED/OLIGOPOLIESOLIGOPOLIES

MONOPOLY/MONOPOLY/CONSUMER FRANCHISECONSUMER FRANCHISE

SUSTABILITY OF ADVANTAGESUSTABILITY OF ADVANTAGE

MANYMANY

HIGHHIGHLOWLOWFEWFEW

SOU

RC

ES O

F A

DVA

NTA

GE

SOU

RC

ES O

F A

DVA

NTA

GE

BOSTON CONSULTING GROUP MATRIX


PORTER’S 5 FORCE ANALYSIS

SUBSTITUTE PRODUCTSSUBSTITUTE PRODUCTS

NEW ENTRANTS/ IMPORTSNEW ENTRANTS/ IMPORTS

SUPPLIERSSUPPLIERS BUYERSBUYERSINTRA INDUSTRYINTRA INDUSTRYRIVALRYRIVALRY


PROFITABILITY DISTRIBUTION

ROIROI

BANKBANK

RATERATE


THE FINANCIAL LITMUSSuperior BUSINESSES

Low asset requirementsLow credit / inventoryMany clients/ economic goodwillDefensible marginsPricing power ( inflation + )Sustainable growthFree cash flows

Most other businessesCapital intensiveWorking capital intensiveWant premium valuation, do not deserve itLikely to be cyclical valuations and themes


Now lets talk Micro Focus

Costs

Capital Efficiency

People Issues

“Slack”


Costs

Are you aware of implications of:

Inappropriate Amortisation

R&D

Technology

Marketing Requirements

Training ; Leadership!

UNIT COSTS/ measures


0

25

50

75

100

Cost of ProducingCement

EnergyConsumption

(Units/ton)

CoalConsumption

(kg/ton)

1998 2003

(%)

050

100150200250

RMC (tons per tonof Steel)

EnergyConsumption(GCAL/TCS)

LabourProductivity

(tons/Man years)

1997 2003

(%)

Corporates have re-engineered costs

1998 2004

Cost of Producing Cement (Rs/tonne) 1,200 900

Energy Consumption (Units/tonne) 110 90

Coal Consumption (kg/tonne) 200 130

Source: ENAM Research

1997 2004

RMC (tons per ton of Steel produced) 4.3 3.1

Energy Consumption (GCAL/TCS) 8.7 7.2

Labour Productivity (tons/Man years) 119 264


Cost cutting in Cement Industry

Cost cutting by TISCO2004

2004


0

100

200

300

400

1995 20030

3

6

9

12

Revenue (LHS) Labour Force (LHS)Revenue/Person (RHS)

(%) (Rs.m)

Corporates have right-sized

Company Staff shed Period (Yrs) % of Labour Force

BHEL 20,000 7 30Tata Motors 10,000 5 29Mahindra & Mahindra 6,500 5 34Bajaj Auto 7,800 6 37Tisco 30,000 8 40ACC 6,000 8 38

Right-sizing across sectors


Restructuring by Top 10 Corporates

1995 2003

Revenue (Rs bn) 900 2,750

Labour Force (nos) 420,000 335,000

Revenue/Person (Rs m) 2.1 8.2


Capital Efficiency

Are you well focussed on:

Asset Turns: Gross Block, Working Capital?

Lean Assets: Owned v/s Rented

Flexible Structures: Outsourcing

Impact of M&A, Restructuring?

People…


Efficiency Saved India Inc.

Peak Rate of Custom Duty (%)

0

40

80

120

160

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Working Capital / Sales (%)

4

6

8

10

12

1996 1997 1998 1999 2000 2001 2002 2003

-5

0

5

10

15

20

25

1996 1997 1998 1999 2000 2001 2002 2003

Gro

wth

(%)

Cap Emp Borrowing GFA

-40

-20

0

20

40

60

80

1996 1997 1998 1999 2000 2001 2002 2003

Gro

wth

(%)

Sales PBIT PBT

Source: CMIE


Industry consolidation helped profitability

Market share (%)

Sector 1997 2004

Aluminium Top 3 players 77 100

Tyre Top 5 players 72 85

Cement Top 5 groups 32 61

Paper Top 5 players 32 38

Petrochemicals Top player 45 70

Media No. of players Multiple 3 large

Telecom No. of players Multiple 4 large



People Issues

How is the company managed?

Lifetime Employment?

How does it Hire? Train? Retain? Fire?

How does it build skills? LEADERS?

Are they Commandos? Soldiers? Mercenaries?

Succession Plans?

Empowerment?


Focus on Micro, Company specific factors

How is Product or Service Quality?Germany/Japan/China v/s India, v/s competition

How is Cost & Capital Efficiency?Frugality as a mindset v/s “professionally managed”

What are their Value Systems?Sugar in the milk

How is their Service to the Customer?The “goodwill” earned


Watch Out for Hidden BombsConflict of Interest Structures

Pvt Businesses

Inter Party relationships

Split Ownerships

Loans & Advances

Off balance Sheet Libailities

Unfunded Pensions

Litigations

Family Settlements

… and many more creative reasons why CAVEAT EMPTOR


CHOOSING “BUSINESS PARTNERS”Integrity / track record

Ability (not just lucky)

Understanding of key issues

Ambition tempered by reality

Commonality of objectives

Orientation towards minority


MACRO FACTORS TO BEAR IN MIND


Do you have Macro Pointers in Mind?

Do you have a point of view about:

Politics as it affects the business

Economics as it affects the business

Demographic Trends

What are Capital Markets Signalling?

Each powerful trend can have disruptive or tidal wave effects on any business


Politics

Geo Politics affects addressable markets, terms of trade, cost of doing business…

Effect of SAFTA, ASEAN, WTO/GATT

Risk Premium/Opportunity of Pakistan

Emerging US-India axis ; NAM, ML

Opportunities in “emerging” economies

Outcry against/trends favouring outsourcing


Outsourcing to India : Brewing Trouble

Company Outsourcing for

IT ServicesInfosys Goldman Sachs, Aetna, Northwestern Mutual, Am Ex, DHL, VerizonTata Consultancy GE, Honda, UBS, HSBCWipro Transco, HP- Compacq, Nortel, General Motors, Cisco, Sony

ITESMphasis BFL Citi Group, Acenture, Auto Zone, Capital OneSpectramind Dell, American Express, Capital One

PharmaceuticalsCipla Ivax, Watson Pharma, Eon LabsShashun Chemicals Eli Lily, GSK PharmaLupin Laboratories Apotex, APP, Watson Pharma

EngineeringBharat Forge Meritor, Caterpillar, Toyota, Ford, FAW (China)Tata Motors RoverMoser Baer Imation, BASFEssel Propack P&G, Unilever, Colgate


Increasing FDI reflects “openness”

Early entrants

Cost Savings(Production Hubs)

GE, Citi IT, State Farm Amex, Bank AmIBM, HP

Research Services Texas Instruments, GE

Recent entrants

JP Morgan, HSBC, PrudentialAccenture, CGE&YDelphiTeva

Microsoft, Sun, IntelGSK, Pfizer, Eli LilyCOVANCE

Likely entrants

BPOs in throngsDeloitte Consulting

Generic Pharma Cos

A number of CROs

Domestic Market Opportunity

Coke, PepsiFord, HyundaiLG, SamsungLafargePort of Singapore, P&OMorgan Stanley, Templeton

McDonalds, Pizza HutHonda, ToyotaNokiaMichelinDubai Port, MaerskHSBC MF, Duestche MF Fidelity MF, ABN MF



Confident Indians going globalLarge Groups

Tata -Tetley, Daewoo , Rover tie-upRIL - FLAG undersea cable,Trevira (Polyester firm in Germany)Birlas - AV Cell (Canada), Copper mines (Aus), Carbon Black (China) etcSterlite - Copper Mines in Australia, Listing on LSEONGC - Stake in: Sakhalin oil fields (Russia), GNOOC oil fields (Sudan)

Auto PartsSundaram Fasteners - Gear casting business of Dana Spicer (UK), Plant in ChinaBharat Forge – Dana Corp Forging business (UK), Forging business of CDP (Germany)

PharmaWochardt-Esparma (Germany)Ranbaxy- RPG Aventis (France)Dr. Reddy’s - Meridian Healthcare (UK),Trigenesis Therapeutics (USA)Cadila – French operations of Alpharma (USA)

IT Wipro - Nervewire, Utilities consulting division of AMS (USA)HCL Tech - BT’s call centre (Ireland)

OthersAsian Paints - Berger International (Singapore)Essel Propack - Propack Holdings (Switzerland),Arista Tubes (UK)Moser Baer - Mmore International (Holland)Atlas Cycle, Ajanta Clocks - Plants in China


Macro Economic Indicators

Global and local economic cycles

Capital costs

Interest rates, Currency rates, Inflation

Cost pressures: RMC, Tarriffs, etc

Social Costs / development

Competition is a given


Eg: Complete Reversal in IndiaForex reserves

Re. depreciation

Interest rates

External debt

External debt

Forex reserves

Source: RBI, CMIE

Interest rates & Re. depreciation

-6-30369

1215

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Jul

-04

1011121314151617

Rupee/ US$ (LHS) Prime Lending Rate (RHS)

(%) (%)

0

20

40

60

80

100

96-97 97-98 98-99 99-00 00-01 2-Jan 3-Feb 0̀3-04Foreign Exchange Reserves as % of external debtExternal Debt (% of GDP)

(%)

-40

-20

0

20

40

60

94-9

5

95-9

6

96-9

7

97-9

8

98-9

9

99-0

0

00-0

1

01-

02

02-

03

03-

04

0

20

40

60

80

100

120

Trade Balance (LHS) Invisibles (LHS)Capital Receipts (LHS) Total Reserve (RHS)

(US$ bn) (US$ bn)


Soft interest rate bias nearing an end..

Forex reserves at a peak

Source: Blloomberg, RBI, CMIE

Inflation making a comeback?Room to grow advances vs investments

Investment Deposit Ratio

35

40

45

50

Jan-

99

Jul-9

9

Jan-

00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Rupee volatility on the cards

-6-303

69

1215

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Jul

-04

10111213

14151617


(%) (%)

0

3

6

9

12

15

Jan-

95Ju

l-95

Jan-

96Ju

l-96

Jan-

97Ju

l-97

Jan-

98Ju

l-98

Jan-

99Ju

l-99

Jan-

00Ju

l-00

Jan-

01Ju

l-01

Jan-

02Ju

l-02

Jan-

03Ju

l-03

Jan-

04Ju

l-04

(%)

0

20,000

40,000

60,000

80,000

100,000

120,000

93-9

4

94-9

5

95-9

6

96-9

7

97-9

8

98-9

9

99-0

0

00-0

1

01-

02

02-

03

03-

04

(US$m)


Understand Market Cycles – II


US Interest Rates through cycles


Rising commodity prices reflect USD weakness

Non-ferrous Metals AluminiumAluminium Primary OP SPTLondon Metals Exchange Index

All CommoditiesCRB All Commodity Index

Source: Bloomberg

GoldGold AM Fix Prices

Steel MB HR Steel Prices

AluminaEurope Alumina Spot Price

250

300

350

400

450

Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04

(USD/ troy ounce)

200

220

240

260

280

300

320


250

350

450

550


1,000

1,200

1,400

1,600

1,800

2,000


(USD)

1,000

1,200

1,400

1,600

1,800

2,000


100

200

300

400

500


(USD)


Consumption trends across Asia


Government P&L A/c AS IT REALLY IS

Deficit of 5-6% of GDP misleading! Receipts only 11%

Centre’s P&L (2004-05E)

Source: Government of India Interim Budget, ENAM Research

Particulars % of GDP

Total Receipts 11-- Revenue Receipts 10

-- Capital Receipts 1

Total Expenditure 15-- Interest 4

-- Defence & Subsidies 4

-- Transfer to States 3

-- Infrastructure & Capital Expenditure 1

-- Administrative, etc. 3

Deficit 4

Total debt (Internal + External) 64


States have joined the party!

Source: RBI

Aggregate fiscal deficit of states

0

200

400

600

800

1,000

1,200

1,400

FY91

FY92

FY93

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

E

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

Fiscal Deficit (LHS) % of GDP (RHS)

(Rs.bn) (%)

Power subsidies (% of state fiscal deficit)

State (%)Madhya Pradesh 74

Andhra Pradesh 51

Gujarat 65

Karnataka 65

Maharashtra 28

Tamil Nadu 40

Source: World Bank


Profligate Governments…weaken us allCrowds out private sector

Upward pressure on interest rates

Rupee depreciation

Making us “poorer”, costlier, less competitive> poorer!

40%

50%

60%

70%

80%

1980

-81

1982

-83

1984

-85

1986

-87

1988

-89

1990

-91

1992

-93

1994

-95

1996

-97

1998

-99

2000

-01

2002

-03

RE

Debt/GDP

Total Central & State debt as a percentage of GDP

Source: RBI


Demographics

Income Shifts

Age Group Shifts

Social Shifts


Affordability has risen dramatically


Falling prices and low interest rates have made products easily affordable

1994 2003 Increase in affordability (x)

Housing (Ratio of Hsng Price/Annual Inc.) (x) 6 3 2.0

Housing EMI (Rs.) 1,690 1,250 1.410-year repayment / Rs.100,000 / month

Cost of (in Rs.)21" Color TV 18,000 11,000 1.6Washing Machine 18,000 13,000 1.4Refrigerator (165 Ltr) 12,000 8,000 1.5Cordless Telephone 4,000 2,500 1.6Cellular Phone 25,000 4,000 6.3

All this has led to a boom in retail lending and consumption


Wealth effect adds to consumer power

-6-303

69

1215

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Jul

-04

10111213

14151617


(%) (%)

Market Cap gain = $75bn

Strong rupee and low interest rates

Gold: 20,000 tonnes = $100bn gain

250

300

350

400

450

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

(USD/troy ounce)

2,000

3,000

4,000

5,000

6,000

7,000

2002 2003 2004Source: Bloomberg


1001000

20003000

4000>5000

1998

2003

20070

100

200

300

400

500

600

Popu

latio

n (m

)

Annual income (US$)

1998 2003 2007

Income demographics = Secular consumption growth

Cars: 1998 - 3m, 2003 - 6m, 2007 - 9m

Home Mortgage Outstanding: 1998 – Rs145bn, 2003 – Rs478bn, 2007 – Rs1367bn

Cellular Subscriber: 1998 - 1mn, 2003 - 14m, 2007 - 95m

Tax Payers: 1998 - 10mn, 2003 - 40m, 2007 - 80m


Volumes Value

Two Wheelers 12% 20%

Cars 13% 20%CAGR (1994 – 2003)

Value growth far exceeds volume growth

TV: 1998 - 70m, 2003 -98m, 2007 - 130m

2 Wheelers: 1998 - 28m, 2003 - 46m, 2007 - 80m

Cable TV Sub.: 1998 - 25m, 2003 - 48mn, 2007 - 80m

Basic Telephone: 1998 – 22m, 2003 – 44m, 2007 - 65m


Consumers are under-leveraged

2%

17%

34%

54%

75%

53%

0

100

200

300

400

500

600

700

800

India Thailand Malaysia Taiwan Korea USA0%

10%

20%

30%

40%

50%

60%

70%

80%

Total consumer loans outstanding Consumer loans outstanding / GDP (%)

(USD bn)

Source: ICICI Bank


Age profile points to secular growth in demand

Increasing consuming/producing age group

0

400

800

1,200

2001 2013

0 to 19 20 to 34 35 to 60 & above

Total 1,012.4m

Total 1,211.6m

Overall growth 19.7%

Growth 34.4%

The rising consumer class246.8m 331.6m

Source: Census 1991

World Age Population Projected To Decline


BRICs : The growth engine of the world

Source: Goldman Sachs BRICs Report


Caveats

Leadership!

Macro economic stability

Infrastructure and Institutions

Openness

Education (and Health)


Political Contradictions reflect Social flux

Muslim League

CPM CONGRESS

National Conference

BJP

RJDBSPSPDMK

NCPJDSamta party

Telgu DesamAIADMKBJD

Shiv Sena


Capital Markets

Be aware of shifts

In sectors

In Leadership

In Valuations?

Where we are in the cycle?


Flat markets cloud sectoral shifts!

Sectors (% of Nifty)

Source: CMIE

Share of corporate profit / GDP Share of sector profit % v/s Share of market cap

Should always be at the back of the mind !

1998 1999 2000 2001 2002 2003 (July) 2004

Banking 8 6 5 7 8 10 12

Commodities 42 32 22 23 25 34 37

Cyclicals 19 15 8 7 9 9 15

FMCG 19 27 16 19 21 15 9

Pharma 4 5 7 6 8 7 6

TMT 8 15 43 38 29 25 21

Total 100 100 100 100 100 100 100


Similarly, be aware of relative country valuations

P/E (x) Interest RoE (%) EPS Growth (%)2002 2003 2004 rates (%) 2002 2003 2004 2002 2003 2004

China 15 14 13 NA 12 14 15 14 11 6

India 18 15 13 4.5 18 21 24 34 13 16* Indonesia 8 9 8 9.0 27 25 27 53 (7) 10

Korea 11 12 9 3.9 15 14 18 (5) (7) 33

Malaysia 20 16 15 3.1 10 12 13 14 20 9

Phillipines 26 17 13 7.8 6 9 11 (23) 50 30

Singapore 25 18 16 0.8 7 9 10 (19) 37 12

Taiwan 43 20 15 1.1 5 11 15 (9) 124 29

Thailand 16 12 11 1.3 16 21 23 86 35 9

Source: The Economist, Citi group. * Currently witnessing upgradation and growth to be sustained in 2005

High and Stable RoE (EVA +ve), Size and Scalability, Variety and Growth


Churn in Top 20 reflects underlying reality shifts

Source CMIE

Note: Names in red indicate exits, in blue indicate new entrants

1998 As ofJune2004Company Name Mkt Cap (Rs. bn) Company Name Mkt Cap (Rs. bn)

Oil & Natural Gas Corpn. Ltd. 402 Oil & Natural Gas Corpn. Ltd. 927Hindustan Lever Ltd. 278 Reliance Industries Ltd. 625Indian Oil Corpn. Ltd. 272 Indian Oil Corpn. Ltd. 464Mahanagar Telephone Nigam Ltd 163 Infosys Technologies Ltd. 354Reliance Industries Ltd. 158 Wipro Ltd 354I T C Ltd. 153 Hindustan Lever Ltd. 286State Bank Of India 129 Bharti Tele-Ventures Ltd. 278Hindustan Petroleum Corpn. Ltd. 110 State Bank Of India 253G A I L (India) Ltd. 106 I T C Ltd. 222Bharat Heavy Electricals Ltd. 86 I C I C I Bank Ltd 194Tata Motors Ltd. 77 Ranbaxy Laboratories Ltd 187Bajaj Auto Ltd 73 Housing Development Finance Corpn. Ltd 151Bharat Petroleum Corpn. Ltd. 63 G A I L (India) Ltd. 144Industrial Development Bank of India 63 Tata Motors Ltd. 141Hindalco Industries 56 Bharat Petroleum Corpn. Ltd. 131Larsen & Toubro 51 Steel Authority Of India Ltd. 122Tata Iron & Steel Co. Ltd. 50 Hindustan Petroleum Corpn. Ltd. 121Castrol India 46 Maruti Udyog Ltd 119Steel Authority Of India Ltd. 43 Bharat Heavy Electricals Ltd. 113National Aluminium Co 39 Tata Iron & Steel Co. Ltd. 110

Total Market Cap 2,418 Total Market Cap 5,270


… and the Index hides more than it shows!

0

5,000

10,000

15,000

20,000

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Infosys Wipro Satyam

0

400

800

1,200

1,600

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Ranbaxy Dr Reddy'sCipla Sun Pharma

0200400600800

1,0001,200

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

HDFC HDFC Bank

0

2,000

4,000

6,000

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Zee Hero Honda

IT Pharmaceuticals Banking Media & Auto

020406080

100120140160180200

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

1,5002,0002,5003,0003,5004,0004,5005,0005,5006,0006,500

Indexed Sensex (LHS) Sensex (RHS)

All Figures indexed 100= price in 1994


Always disaggregate the market

Note : Companies may change characteristics over time!

Global Outsourcers

ITPharmaceuticalsEngineering

Global Commodities

OilMetals

Domestic Demographics

FMCGAutoBanking

Emerging Business

TelecomMediaRetail

Sustainability of Advantage

Sour

ces

of A

dvan

tage

HighLow

Low

Many


PSS companies outperform markets over time!Infosys Vs Sensex HDFC Vs Sensex

HLL Vs Sensex MICO Vs Sensex

RIL Vs Sensex

0

100

200

300

400

500

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Reliance Industries (LHS) Sensex (RHS)

0

10,000

20,000

30,000

40,000

50,000

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Infosys Sensex (RHS)

0

100

200

300

400

500

600

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

HDFC Sensex (RHS)

0

100

200

300

400

500

600

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

HLL Sensex (RHS)

0

100

200

300

400

500

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

MICO Sensex (RHS)


Multibaggers of the last 10 years

Price as on 14/7/94 Price on 15/7/04 CAGR (%)

Satyam Computers 3 326 62

Infosys Technologies 13 1443 60

Wipro 6 525 56

Sun Pharmaceuticals 21 351 33

Hero Honda 33 460 30

Cipla 41 231 19

Ranbaxy 214 976 16

Zee Telefilms 30 126 15

HDFC 161 550 13

Dr Reddy's 248 749 12

Source: Bloomberg; Adjusted for bonuses and stock splits; NIFTY constituents only


Multibaggers since 9/11 : The REAL BSE-30!

Company Price as on Price on CAGR15/7/04 11/9/01 (%)

Oriental Bank 240 34 92

Mahindra & Mahindra 476 68 91

SAIL 33 5 87

Tata Motors 407 75 76

ONGC 654 136 69

Shipping Corp Of India Ltd 117 24 68

Tata Iron & Steel Co Ltd 327 84 57

BHEL 527 135 57

IPCL 157 40 57

Grasim 952 274 51

GAIL 182 53 51

Reliance Energy 571 176 48

ABB 730 225 48

Bajaj Auto 841 266 47

Tata Chemicals Limited 121 39 45

Company Price as on Price on CAGR15/7/04 11/9/01 (%)

National Aluminium Co Ltd 139 48 43

HPCL 288 111 38

Tata Tea 386 150 37

Hero Honda 460 183 36

Tata Power 254 101 36

Sun Pharma 351 141 35

Ranbaxy 976 415 33

ICICI Bank 238 103 32

SBI Bank 431 187 32

Glaxo 603 282 29

Indian Hotels 370 175 28

BPCL 314 159 26

Satyam Computers 326 175 23

ACC 232 128 22

Gujarat Ambuja 275 155 21

Source: Bloomberg; Adjusted for bonuses and stock splits; NIFTY constituents only


AOL, Time Warner merger – A lesson to remember

0

20

40

60

80

10019

96

1997

1998

1999

2000

2001

2002

2003

2004

Announcement of Merger

Stock Price of Time Warner: now AOL Time Warner

(US$)


Lets Summarise TILL THIS POINT

Value is created through an interplay of:

Macro Trends

Micro Focus

Subtler Nuances

Business Leaders must constantly be on top of these ; good leaders and investors continuously value these.

Real winners understand this and play to create enduring value.

May run out of luck, never out of wisdom !


NOW: BUYER BEHAVIOUR


Understand Fund Manager Behaviour!Approaches to Portfolio Construction

Top Down v/s Bottom Up

Value v/s Growth

Think of Where we are in the Market Cycle!

Client RequirementsMatch Needs, Requirements and Abilities

Your OWN Portfolio?


Top Down

Bottom Up

MomentumValue Growth

Elements of Valuation


KYC and Thyself!

Asset Allocation

Country Allocation

Sector Allocation

Large Cap

SmallCap

Pvt. Banks / Pension Funds / Macro Funds/ Fund of Funds

Regional Funds

Country Funds/ Mutual Funds

HNW / PMS / Absolute Return Funds/ “Hedge” Funds

Relative

Absolute


Key Success Factors : Match Your Pitch!

Pvt. Bankers / Pension Funds / Macro Funds

Regional Funds

Country Funds

AbsoluteReturnFunds

• Institutional Marketing• Deployment of Large Pools• Capital Preservation

• Marketing Scale & Scope• Economist

• Fund Manager• Technician

• Stock Picker

CAPITALUBS, GAMGSIC, ADIA

PICTETJANUSGMOLLYOD GEORGE

HSBC, , CIBC, JFICICI, HDFC, UTI

SLOANEABERDEENARISAIGEMICOPPENHEIMER


Decomposing Approaches

SectorCountryAsset Class

Top Down

• Equities• Bonds• Currencies• Property• Commodities

– Oil– Precious metals– Natural Resources

• Developed Markets• Emerging Markets• Regional markets

• FMCG• Pharma• Services• TMT• Manufacturing• Cyclicals


Category 1980 1990 199930 Largest 9 15 46Remaining 9 14 23S&P 500 9 15 30

Valuation – MegaCap bias


Some Lessons from HistoryJapan V/s UK in 1944

Korea V/s India in 1950

Singapore!

Hero Honda V/s Kinetic Honda

Bharti V/s IDEA

Infosys V/s HCL

HDFC Bank V/s SBI

There is NO trade-off between Top- Down and Bottom up


Valuation Approaches based on Sentiment Swings

• Illiquid

• Misunderstood

• Hated/Uncovered

• Appraised value

• Institutional Favorites

• UVG Stories

• Imagine it!

• DCF or Option value

• Max Volume

• News Flow

• Volatile

• Technicals

Value Growth Momentum

In Reality, there is no distinction. Growth and Momentum are LongTerm/Short Term Value catalysts


Think Client Management WHO is the CLIENT?

WHAT does he want from you?

HOW are you shaping his expectations & mindset?

WHY should he stick to you?

“Most clients would rather have their fund manager fail conventionally than succeed unconventionally.”

— Marc Faber


Decompose | Decompose | Decompose

Sectors Large Cap Medium Cap Small Cap TotalFMCGPharmaBanksITTelecomMediaEnggAutosCommoditiesTotal


SUMMARYUNDERSTAND YOURSELF OBJECTIVELY

Everybody is not Schumacher or Tendulkar: TAKE HELP, BE SELF AWARE

UNDERSTAND THE INVESTMENT LANDSCAPEA grip of Macro, Micro, Accounting and Street Smartness is REQUIRED

UNDERSTAND THE UNDERLYING INVESTMENT What will make it tick or explode?

UNDERSTAND THE MARKET PARTICIPANTSWho are you playing against and how does he play?

FOLLOW BASIC PRINCIPLES AND STICK TO THEM!

BE HAPPY!


How is your Portfolio Tilted?

BUILD A CONSCIOUS LIFESTYLE !

WORK COLLEAGUES

PROFESSIONAL COLLEGUES

OWN INTERESTS

FAMILY

CLIENT TIME


HEAVEN AND HELL

AMERICAN SALARY

ENGLISH HOME

GERMAN CAR

CHINESE FOOD

INDIAN WIFE

AMERICAN WIFE

ENGLISH CAR

GERMAN FOOD

CHINESE HOME

INDIAN SALARY

YOUR REAL WEALTH = YOUR HAPPINESS = YOUR STATE OF YOUR REAL WEALTH = YOUR HAPPINESS = YOUR STATE OF MIND = WITHIN YOUMIND = WITHIN YOU

Mind of an Analyst

Documents

Transcript of Mind of an Analyst