True value of a share?

If you were to buy the entire company, how much will you pay?

If there are 10 lac shares of the company and each share is available @50/-, you can walk away with the company if you pay value of the entire 10 lac shares i.e. 500 lacs or 5 crore.

But if you don't know the share price or if you don't trust the share price or if the company is not a listed one, how much should you pay?

In such a case you need to find out the true value of the company by alternative methods.

One obvious way is to find out the net worth of the company.

Net worth = Assets - Liabilities = Net assets

But many a times this can give you very wrong picture.

For example, there is a decades-old super-famous Chane-bhaturewala shop on the mall road in Shimla.

It daily downs the shutter at 4 pm. Irrespective of how much stuff is prepared in the morning everything is sold out by around 4. (I must myself admit that they make damn tastiest Chane-bhature!)

If you were to buy out his business and go by the above formula of net worth, you may commit the mistake of offering him the cost of his shop minus whatsoever liabilities he has (by the way, he has none!)

He will fry you in his Bhatura vessel!!!

Why?

Because he daily sells Chana bhatura worth approx. 11000 and his shop's value in municipal corporation's accounts book is just 2 lacs! Putting the networth of this shop at just 2.33 lacs!

Therefore, as in this case, it may be grossly wrong to judge the value of a company by its net worth.

So, how do we find the fair value of a company?

Another way is the cash flow way!

This chana bhatura shop is generating an annual cashflow of 3years x 11000 per day x 365days days = 1 crore 20 lacs!

So according to a formula, the minimum price of his business (and not shop, mind you)
= (Potential profits for 3 years) + Assets and Inventories

Assuming a net profit margin of 50% in chana Bhatura, this gentleman's empire will be valued at

= 50% of 1crore20lacs + book value of shop

= 60 lacs + 2 lacs

=62 lacs

Now, would you be surprised if I told you that this gentleman's shrewd son is demanding 80 lacs as "pagri" from the potential buyers!

And would you be surprised if I told you that some businessmen are already willing to pay as much as 45 lacs! (The negotiation was going on till the writing of this article!)

But why is the son of the chana bhatura king asking for 80lacs and not 62lacs?

In his words "People come here in 'our' name!!! We have been serving mouth watering chana bhaturas since 60 years! we have a reputation and a pull value! We have a brand equity. 18 lacs is just for that. You can expand the business with that name!"

What if the potential buyer says

"We don't want to keep your name. Reduce the price now by 18 lacs" ?

And what if the equally-shrewd son of the bhatura-empire replied

"Ok, we will reduce the price by 18 lacs. But i hope you will not mind if we open another Chana bhatura shop in the neighbourhood in our name!!!"

-------------------

Now if I told you that this Chana bhaturawala floats 10,000 shares what will be the fair market value of each share?

= (Market value of the company as decided above i.e. 80 lacs) divided by (1000 shares)

= 800/- per share

-------------------

If this company was making software instead of chana Bhaturas and had a huge future value, that value would have been added to the share value!

-------------------

Now, what will be the value of this company if its current owners decide to start giving franchisees under their brand name in all Tier-II and tier-III cities along with their secret recipe !!!

Investing without tears!

Yesterday I met the grand old man of stock trading at a club in Shimla.

On finding him alone, I asked whether I could have a cup of coffee with him.

He obliged.

-------------------

"What are you doing these days?", he asked.

"I am itching to get into fundamental side of trading, Sir! Till now I was so focused on technicals that fundamental part got totally ignored. I am trying to make up for that!" I revealed frankly.

"So, how are you entering this sea of fundamentals!", he smiled!

"Well, I have got my hand on a few good books of stock fundamentals. I am burning my midnight oil to get the head and tail of balancesheets and Profit & Loss accounts and ratios....etc." I shared, albeit with a sigh of exhaustion.

He was listening quite attentively but didn't speak.

"It is a big big syllabi and I'm afraid I am already tired!" I admitted.

"But why are you getting into all this junk?" he said.

I was rather shocked at his question.

Everyone knew that this guy was a gem of an investor. His opinion about potential multi-baggers was famous in the Shimla circle.

"Sorry, I didn't get you!", I said.

"I am asking why are you mugging all this financial stuff?", he clarified.

"But why not, uncle!" I got involved!

"Afterall, how can I be a fundamentals-based investor without being a master of all this technical stuff?", I retorted.

"Look, Mr.Singh. You don't have to be an Chartered Accountant or M.Com or MBA (Finance) to be a good fundamental investor.

Rather, the more you entangle yourself in this jargon the more you will be vulnerable to being befooled by the army of financial special-effect experts of the corporate world.

You just can't think of beating them!", he explained.

"To be a good fundamental-investor you need to be good at psychology and common-sense!"
he continued.

"What!", I couldn't help reacting.

"Yes, you heard it right!", he calmed me down.

"All you need to focus on are these two things

1) The future of the business

2) The man behind the controls.

That's all I look for when I commit my money to a stock!"

"Sounds very interesting!" I was surely amused.

"So long as a budding Anand Mahindra or a Rattan Tata or a Sunil Mittal or a Kiran Majumdar or a Y.C.Deveshwar is at the helm of affairs....how can I be worried."

"When I am taking these names I don't mean I invest only in these bluechips or their new ventures.Rather, I have a big chunk of my investment portfolio into small caps and mid caps. And I must share that I regularly keep coming across tomorrow's Ratan Tatas and Anand Mahindras and Mittals..!"

"When I see common-sense business opportunities picked by able unstoppable men, I know I have found my investment opportunity!"

"So, all I am interested to know is

- what's the business opportunity

- who's heading, and

- what's in his head!

..............Period!

why should I bother about the fundamentals when I am sure "my" man-in-charge and his team is competent enough to manage it quite well for me?

His or her track record, the fire in their belly, passion in their body language, promise in their eyes............these all reveal it all!

If the fundamentals are not good, my man (or woman)-friday and his team will set it right for me.

Rather a situation where good team inherits a good business with marred fundamentals is a fantastic investing opportunity as the stock will be available at peanuts!!!

I know I can never be expert enough to be able to sniff-out the rat or cat in a cleverly dressed balancesheet, statements and ratios! So why bang my head into these?

Besides, what's the guarantee that a good balance sheet and P&L account will stay good?

Only a great team headed by a great leader can do that!

So, I should rather put my senses and energies to know about the guy (or guys) at the helm of affairs besides some common-sense gaze into the future of the business!

Once I am sure that the business potential is huge

Once I believe in the ability, integrity and intentions of the captain, I relax and let him and his team sufficient time to deliver results!!!

So, all I do to pick a stock for investment is

- look for emerging business opportunities

- read hell lot of interviews and anecdotes and stories about budding businessmen."

--------------

"I hope I have not bored you dear, you haven't finished your coffee!" he said.

I was awe-struck!

I just got rid of a mountain of books!!!

"No lollipop please!" (Understanding Balancesheet-II)

If you are an Investor

who is about to invest hard-earned money in a company

would you be interested in the lollipop talk of the company or its advertisers or agents?

or

would you be interested to know

* How much cash the company has? Is it too less? Why? Consequences? Is it too much? Why? Consequences?

* How much money it is due to receive including credit? Is it too high? Why? Consequences?

* How much bad loan it is carrying? Why? Consequences?

* How much inventory it is carrying? Why? Consequences? What is its Inventory Turnover (cost of goods sold divided by average inventory)? Why? Consequences?

* What is the cost of fixed assets (property,plant, equipment etc.) it has? Market value? Replacement Value? Implications? What portion can act as buffer for any contingency? Is the value of the fixed assets correctly assessed? Why? consequences?

* What are its short-term liabilities? Why? How much? Consequences? How manageable these are?

* What are its long-term liabilities? Why? How much? Consequences? How manageable these are?

* How manageable these are?

* Are these less than or more than the cash flows? Consequences? What is the companies Quick Ratio (current assets without inventory divided by current liabilities)? Consequences?

* Are these less than or more than the assets? Consequences?

* Are total assets of the company more or less than the total liabilities? Why? Consequences?

* What intangible assets (like patents, trademarks, copyrights, technology, processes, brands etc.) does the company have?

If you are interested in the answers to the above questions before you write the cheque, you are within your rights and wisdom.

Where to find all this info?

Balance Sheet!

Do you need a Accountant to understand it?

If you have a good one whose abilities you trust, then great!

Otherwise, it is easier than learning to ride a bicycle

provided you have fun playing with it!

Reading a balance sheet is like playing hide and seek! A treasure hunt game!

The real info is hidden somewhere there!

One of my friends doesn't solve crossword puzzles!

Instead, he amuses himself by reading one balance sheet with evening tea everyday!!

There are plenty available on the net!!!

"Dearest Papa!" (Understanding Balancesheet)

This is a letter by a daughter to her Business Tycoon father explaining why she was turning down her marriage engagement with the son of a top-shot business house.

-------------------------------------------------------

Dearest Papa,

This may come as a rude shock to you but I have decided to cancel my engagement with Kartik.

Papa, this is the question of my future.

You had said that I shall have a great future with this family, but when I had a closer look at their Balance Sheet I was shocked to find their true financial status and moral ethics.

I am sharing below my findings from the balance sheet so that you can understand what I am saying!

- short term receivables are very low

- too much of credit is being extended to the supply chain

- NPAs are high

- advance credit retail has been shown to jack up sales figures

- too less cash in hand (how are they managing the payments to suppliers etc.? Employees, Suppliers etc. must be highly dissatisfied!)

- in last year's balance sheet they had too much of cash-in-hand. This shows that either they had no idea of how to deploy the excess cash or they had no plans! All that excessive cash has evaporated from balance sheet this year without any meaningful asset creation this year!

- they are carrying too much of inventory. Their inventory turnover (=sale/avg.inventory) is too low. I am surprised at the inefficiency! They must be paying a lot of interest on this inventory pile! How can they be managing their lives efficiently?

- they have calculated their fixed assets (land holdings, plant, machinery etc.) at market value instead of at cost. they have given highly inflated figures for these not-meant-to-be-sold-till-distress assets. why have they done that? obviously, their actual financial position is not as healthy as they have made out to be - by inflating these non-current assets. Had they used genuine 'at cost' figures for these assets, their net assets would have nose-dived even further!

- they have huge current liabilities. how come they didn't manage their debt?

- their current liabilities are almost equal to their cash flows! As exposed by their quick ratio i.e. (current assets without inventory)/current liabilities, which is less than 1, how are they going to save their company from debt trap? they are likely to default soon on their interest payments. Even if they go for debt restructuring, this will result in decline in their credit-worthiness which will further make debt hard and costlier to come.

- the most shocking thing is that they have almost zero net assets! Their liabilities are almost equal to their assets!

- surprisingly, they have no intellectual property by way of any good brand, patents, trademarks, copyrights, technology, processes, etc.. They have no core strength!

- I have a strong feeling that they have a considerable hidden off-balancesheet debt due to some large capital expenditures

In light of my above findings from their balance sheet, I am really shaken at even the thought of marrying into that family of hollow financials and weak ethics!

I hope my darling papa understands me and allows me to snap this relationship.

Your loving daughter

Chiki