Cover Story

COUNT ON THE

Times have changed since Benjamin Graham wrote the Security Analysis but his principles can hold investors in good stead even now
N Mahalakshmi & Mohammed Ekramul Haque
t cannot be denied that the Great Depression of 1929 and the Wall Street crash that followed was perhaps the most humbling experience for investors at the time. Life was tough and there was no hope to clutch on to. After crushing losses, most stocks were available at ridiculously cheap prices over the next decade as the markets remained trapped in a bear grip. But as any stock expert will tell you today, behind every market disaster lurks opportunity if you just look hard enough. It was the same for Benjamin Graham, who, despite suffering heavy nancial losses himself, began a conscious campaign of snapping up stocks that suddenly became available at bargain prices. Graham strategy was simple: buy companies that he likened to cigar butts typically abandoned but still good for a puff or two. And you could pick them up for virtually nothing. Stocks quoting below their liquidation values after keeping a margin of

safety, allowing for any contraction in prices, were his key bets. His strategy soon started being talked about in the investing community. One man, in particular, was highly inuenced by Grahams strategy, and in tribute to his idol, bought shares in about a hundred such cheap companies. His faith soon paid off: in ve years, John Templeton whose name today is synonymous with value investing had multiplied his original investment several times, despite around 15 of those companies going bankrupt. The value investing philosophy propounded by Graham and practised vigorously by Sir John Templeton was eventually perfected into an investing technique that called on investors to buy stocks cheap so cheap that there was very little chance of the stock falling any further (thus avoiding any loss of capital). After Graham articulated his thoughts on the subject in the book Security Analysis in 1934, value investing

grabbed the attention of several professional investors, many of who have added their own perspectives over the following decades. Nevertheless, the basic essence of value investing has remained the same: buy cheap. It was a philosophy that was born in desperate times (the Depression years), and underwent a baptism by re as it was tested time and again over the next few years. So it wouldnt be wrong to wonder just a little bit whether those principles still work in todays times, given that the past few years have been exceptionally exuberant for the worlds major stock markets. Cut to January 2008. In sharp contrast to the crisis engulng the stock markets when Graham started out, the worlds economies Indias included were exuding condence like never before. Many experts claimed that Indian nancial markets were experiencing a secular bull run, not a cyclical upswing that would die down anytime soon.

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Cover Story
HOW WE DID THE BACK-TESTING
The universe Earnings yield portfolio: A portfolio of 30 stocks with the highest earnings yields, the minimum cut-off being double the bond rate for the respective year, from the BSE500 universe, excluding financials, with a debt-equity of less than 1. For years that threw up less that 30 stocks, we went with the available stocks. Net-nets & cash bargains: All listed companies with a trading history of more than 90 per cent excluding financials was taken as the universe. We calculated net-nets by deducting debt and current liabilities from current assets. The 30 or available stocks for the respective years with market-cap less than net currents were considered for the portfolio each year. Companies with cash and marketable securities less all external liabilities greater than the market-cap constituted the cash bargain portfolio for the respective years. Dogs of the Nifty: Top 10 stocks based on dividend yield at the end of every year. The returns We computed total returns (price appreciation plus dividend income) for the portfolio constituted every year and with a holding period of 1-10 years for the period 1998-2008. For dogs of the Nifty we tested results only for a two-year holding period. In the case of a stock getting delisted or stopped trading, we considered the stock to have lost 100 per cent in the year in which the stock disappeared from the portfolio. All data has been sourced from CMIE Prowess. Besides, stock prices were catapulting and there was what seemed like a never-ending ood of foreign money pouring in. For ve straight years till January this year, the Sensex proved the sceptics wrong at every level as it rapidly scaled new all-time highs, recovering almost immediately after every tumble. And investors continued to buy into stocks, whatever the price. Then, the inevitable happened. Global markets nosedived and over the next few months, continued to plunge as bits of bad news kept leaking out at a steady pace. Investors who had bought stocks at steep valuations now began to understand just how foolish their actions were, not to mention the speculators who had joined in for the free ride. Value investors had seen this coming all along. At a lecture in India on January 8, Bruce Greenwald, renowned nance professor at Columbia Business School, referred to stocks markets as being expensive. At the time, stocks were actually peaking out. Greenwald teaches the Graham and Dodd style of investing in the university Graham graduated from. Value investing is not about predicting when markets will hit their peaks. Graham (and todays value investors agree) emphasised the preservation of capital as the bedrock of investing. The beauty is, as Graham said, anything bought cheap will invariably go up in price, says Chetan Parikh, a successful Indian value investor and managing director of Mumbai-based Jeetay Investments. There is one difference though. What Graham considered bargains and what todays value investors consider as cheap (and we are not talking about growth-style investors who do not mind paying a high premium for stellar growth prospects) are separated by time.

CASH BARGAINS PORTFOLIO

Portfolio consists of stocks with cash and marketable securities greater than market cap
year 1 yr 2 yr Portfolio 1998 56.30 13.47 Sensex 1998 -17.00 7.82 Portfolio 1999 196.20 -25.04 Sensex 1999 40.05 2.87 Portfolio 2000 -45.69 -37.70 Sensex 2000 -24.44 -15.34 Portfolio 2001 -13.43 -3.30 Sensex 2001 -5.14 -8.29 Portfolio 2002 -2.98 39.67 Sensex 2002 -11.33 30.16 Portfolio 2003 66.00 109.10 Sensex 2003 91.06 44.20 Portfolio 2004 169.39 120.53 Sensex 2004 8.83 45.93 Portfolio 2005 76.22 40.86 Sensex 2005 95.67 50.13 Portfolio 2006 58.50 28.62 Sensex 2006 15.19 19.81 Portfolio 2007 53.67 Sensex 2007 18.82 Returns for 2007 portfolio until May 27, 2008 3 yr -45.88 -4.23 -15.97 0.12 -3.11 -14.03 31.75 17.13 73.51 22.62 105.99 59.64 92.65 34.87 61.42 41.10 4 yr -22.24 -4.46 -14.89 -2.87 6.55 4.97 53.64 15.00 86.98 37.82 69.22 47.14 49.22 32.23 5 yr -12.96 -5.88 4.01 11.20 19.24 5.73 66.82 27.90 76.96 32.96 55.70% 42.33 6 yr 2.03 5.91 24.82 10.80 19.65 17.15 63.88 25.69 84.35 31.53 7 yr 5.98 6.32 25.87 20.18 18.05 16.87 74.19 25.53 8 yr 15.41 14.75 21.03 19.55 29.14 17.81 9 yr 10.65 14.80 25.39 20.10 10 yr 8.68 15.74 Latest 8.42 14.78 26.24 18.92 28.81 16.56 77.32 23.83 84.91 29.30 57.67 39.09 51.58 28.88 66.43 35.96 56.86 14.92 37.15 18.82

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Outlook PROFIT 13 June 2008

The world has changed in many ways. And the way business is done has changed appreciably. In the past century, while industrialisation was still underway, manufacturing was the mainstay of business and companies were largely asset-heavy. Todays businesses are more service-led and asset-light. Even the landscapes for accounting practices, securities regulations and shareholding patterns are dramatically different. Grahams success was also in part because he had the luxury of buying businesses that were truly cigar butts because of the state of the economy at the time. Is Grahams philosophy still stay relevant in the changed times, (one of optimism, although recent data does point to a slowdown) compared with the gloom that the Father of Financial Analysis was witness to? Outlook Profit sought answers for this by relying two factors: data, because data does not lie; and people who have been unadulterated value investors. Before we disclose the results (please wait patiently being patient is the rst rule in value investing!), we present a quick look at Grahams various strategies.

THE PHILOSOPHY
Grahams investment radar mainly ashed stocks that could be classied as bargains based on earnings potential or asset values. The key earnings-based strategy that most lay investors can easily adopt involves buying stocks that offer a substantial earnings yield, typically, twice the prevailing bond rate. The earnings yield is the reverse of the price-earnings multiple. The logic is simple: if you view stocks as bonds that offer no growth but yield xed returns (consider prots as a proxy for interest earned) then the asset should be valued like a bond. If the earnings yield is twice the bond yield, it means that the asset actually promises to double the returns you could get from holding the bond. Given that the business is protable and will continue to be so, returns could be impressive as the yield in excess of the bond rate would provide an adequate margin of safety in the event of any capital erosion. Another earnings-based strategy is be to buy stocks that offer substantial dividend yield. Asset-based strategies of Graham revolve around buying stocks that are quoting either below their liquidation value (especially for businesses that do not have a future) or at a sub-

Sanjay Bakshi , CEO, Tactica Capital is a deep-value investor

stantial discount to the companys asset value (for businesses that boast good future prospects). Another set of bargains includes stocks of companies quoting below the value of marketable securities and cash on their books after deducting outstanding debt. The logic here is that the company can use its cash and securities to pay of its debt and other liabilities and still the shareholders would have something in their hand. At the heart of Grahams philosophy lies the ability to favour what is out of favour. Embrace the ugly, not the beautiful. Lift the disgraced and disregarded. And it works!

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PHOTOS: SANJIT KUNDU

Cover Story
ing the market temperature works beautifully as well. The proof of the pudding is in our study of stocks that were ultra-cheap in the past decade. Out of the 5,000-odd traded stocks at the peak of the IT bull run in 1999, 22 stocks were trading below their liquidation values (current assets minus current liabilities and debt). By contrast, when the markets plunged to their nadir in 2003, 132 stocks met these criteria. Nevertheless, some of the most successful value investors in the country believe that some changes to Grahams strategies may be required to make it more effective (although given that the back testing showed such good results, we wonder why?)

MISSING OUT ON GROWTH?

Focusing on the cheap stocks often means missing out on other opportunities. Why? Because the market is usually instantly enamoured by anything new that turns up in business until they nd reason to think otherwise Remember the dot-com boom? Companies were awarded sky-high valuations before it dawned on investors that many business models were simply unsustainable. However, the notion that you could be left behind if you dont pay the price for growth is not entirely baseless. If you buy stocks based strictly on traditional value investment principles, you will only play the arbitrage opportunity (the differential between the fair price and the market price) but the bigger opportunity in a country like ours lies in the future as the business grows, says K N Siva Subramanian, vice president at Franklin Templeton Mutual Fund. Hes considered one of the best fund managers of the past decade or so. For sure, adopting a Graham approach would have encouraged investors to pass over new, emerging businesses that have given outstanding returns on the bourses: Infosys Technologies, HDFC Bank, Pantaloon Retail; and Suzlon Energy to name just a few. None of these stocks would have qualied as value stocks in the Graham sense ever. But you would have built an equally stellar portfolio of stocks consisting of Bharti Televentures and State Bank of India (at one time available signicantly below book value); public-sector companies such as Bharat Earth Movers and BHEL and private-sector companies such as Areva T&D, Peninsular land, Gujarat NRE Coke, Mercator Lines, Aban Offshore and even Jai Corp. All of them have rewarded inves-

Chetan Parikh, MD, Jeetay Investments has been a committed value investor

8 Back-testing key Graham strategies reveal a stunning performance. The strategy of picking up stocks that have earnings yields that are twice as high as the bond yield proved to be spot-on for investors. Returns on such a portfolio beat the Sensex every time! Cash bargains and net-nets have worked with 70 per cent accuracy. (See table: Cash Bargains Portfolio)

8 Grahams way of gaug-

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Outlook PROFIT 13 June 2008

tors with handsome dividends and capital appreciation. Most of these names were ignored a few years ago either because business conditions were bad or the market simply shrugged them off because there were alternative opportunities that were more alluring. The market periodically gets into a phase of madness when there is a fascination for a few sectors and the others are completely forgotten, says E A Sundaram, a fomer fund manager with HDFC Mutual Fund who now manages funds for the Bilakhias. And its true: during the dot-com boom, remember how the old economy was forgotten? A year ago, software service companies had joined the ranks of fallen angels. A true Graham follower would, however, buy stocks precisely when there are no takers for them. And what about growth? Graham never believed in relying on the future, so he would not pay a penny for growth. The difference between Graham followers and the growth seekers is primarily that the former are risk averse (you can even call them miserly) and dont seek to pay a price for growth. Value investors want growth for free, says Sanjay Bakshi, professor at Gurgaons Management Development Institute. And by doing so, they could well make errors of omission but not of commission. He also runs

an investment rm called Tactica would have liked. If wishes were horses, that would have Capital, which specialises in deepbeen true! In todays circumstances, it value-investing . Other experts echo the sentiment. is not easy to nd stock that offer great Managing director of Motilal Oswal Se- growth prospects with the margin of safety embedded the curities Ramdeo Agarwal way Graham liked it. says an attractive purchase price is key to making monGraham strategy Most experts, however, believe trying to comey. The moment you pay was simple: bine a growth style and a price for growth, where buy companies the rather contrarian is the outperformance? that he likened value-style technique he asks. You are not dealdont mix very well. ing only with the company to cigar butts Still, the perception here, you are dealing with typically of value lies in the eyes the price of the stock. Peoabandoned but of the investor. The ple do not understand what still good for biggest contribution of role the price plays. Graham to the world The sceptics argue the a puff or two. of nance was three other side. The GraAnd you could words margin of safeham model is geared to pick them up ty and if you keep that nding cheap cigar butts, for virtually in mind while investbut many such compaing you will seldom go nies may have issues with nothing. Stocks awfully wrong, says their character itself, quoting below fund manager Sundasays Bharat Shah of ASK their liquidation ram. Raymond James who values after started out as a value investor but later changed track. THE CHALLENGES keeping a Cheapness can be an ilNevertheless, some margin of safety lusion. Just being cheap is strategies that were not good enough for me, it largely a product of has to be supported by capcircumstances that ital efciency and condence about prevailed during Grahams time are growth. While I like the cheapness that becoming less effective and riskier Graham would have liked, I would also propositions. Its easy to see the conlike quality of business that Fisher tentions.

EARNINGS YIELD PORTFOLIO

Portfolios with earnings yield more than double the bond rate with a maximum of 30 stocks
Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex CAGR Returns year 1 yr 2 yr 3 yr 4 yr 5 yr 1998 80.16 87.27 14.34 19.78 9.57 1998 -17.00 7.82 -4.23 -4.46 -5.88 1999 45.50 43.48 35.46 28.85 55.97 1999 40.05 2.87 0.12 -2.87 11.20 2000 39.06 49.09 36.37 70.69 82.05 2000 -24.44 -15.34 -14.03 4.97 5.73 2001 88.92 46.61 89.10 109.55 112.85 2001 -5.14 -8.29 17.13 15.00 27.90 2002 27.32 105.81 141.89 139.39 110.76 2002 -11.33 30.16 22.62 37.82 32.96 2003 268.56 217.40 173.73 127.78 112.65 2003 91.06 44.20 59.64 47.14 42.33 2004 289.12 220.77 134.53 118.07 2004 8.83 45.93 34.87 32.23 2005 434.52 172.21 110.90 2005 95.67 50.13 41.10 2006 119.92 79.41 2006 15.19 19.81 2007 33.56 2007 14.69 Note: 2007 based on latest sensex closing May 26, 2008 6 yr 27.44 5.91 69.76 10.80 91.31 17.15 95.99 25.69 105.14 31.53 7 yr 36.53 6.32 74.15 20.18 79.16 16.87 95.21 25.53 8 yr 48.24 14.75 65.24 19.55 75.19 17.81 9 yr 42.40 14.80 64.93 20.10 10 yr 42.47 15.74 Latest 43.82 14.78 67.84 18.92 78.79 16.56 100.3 23.83 109.9 29.30 118.7 39.09 125.5 28.88 110.9 35.96 95.68 14.92 33.56 14.69

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Cover Story
8 The concept of book value and
whether it reects the true worth of a company have undergone fundamental changes over time. Book value was one of the prime parameters Graham relied on since he preferred judging what was on the balance-sheet to looking at unquantiable parameters. In his time, companies were asset-heavy and it made sense to look at asset values. Not anymore. Today, the real value of several business lies not in the plant and machinery they own, but in more unquantiable factors. Take software services, for instance. In this industry, the real assets are the technically skilled people who walk in and out of the company gate every day; theyre not mentioned in the balance-sheet though. Similarly, the real value of consumer companies lies in their brands and distribution network, again not quantied in the statement of accounts. The balance-sheet does not capture the value of intangibles like brands, but they also have cash ows attached to them, points out Sundaram. tions. Indeed, some of the best-run companies in the world have a negative working capital -- consumer companies like Hindustan Unilever, Procter & Gamble and several others actually have been operated with negative working capital for quite some time now.

8 Some Graham strategies like cash

bargains work well in mature markets like the US because the shareholding pattern is diffused, so a nancial investor could identify situations and act in a fashion that compels management to unlock value. But in India, since promoters usually hold fairly large stakes and corporate raids are not that common, the probability of liquidation is rather slim and dilutes the case for unlocking value in such stocks. Besides, another risk with Grahams cheap stocks is that while you can buy a business at a lower price than what its worth, you can never tell whether it will add or subtract value. Templetons Subramanian quotes a classic example: when Warren Buffet bought Berkshire Hathaway, it was still a textiles company. And instead of continuing like that, Buffett used the cash to build a business that offered growth. While buying cash bargains may a rewarding proposition for an activist investor who can take the reins

8 Similarly, Grahams idea of looking

at net working capital requires rethinking as well. The whole idea of net-nets was to buy a company below its working capital because if the market did not give the company the valuation it deserved, the promoter could easily liquidate the company by realising the receivables and cash, pay off payables and debt and still take home some cash (by the way, were not even accounting for xed assets here). Obviously, Graham was looking at what was truly dirt cheap (cigar butts). He would have rejected companies with low net current assets outright. But, in todays world, high working capital is taken as a sign of a deteriorating competitive position. Higher receivables being built up; large discounts to customers; larger collection periods all these are actually signs of worsening business condi-

NET NET DROPOUTS

Companies that disappeared from the net-nets portfolio midway
year 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1 2 3 4 5 6 7 1 3 1 1 1 3 2 3 2 1 1 4 1 1 1 8 9 10 1

GRAHAMS NET NETS PORTFOLIO

Portfolio of top 30 stocks trading below their net current asset values
Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Year 1998 1998 1999 1999 2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 2007 1 yr 43.46 -17.00 220.43 40.05 -30.22 -24.44 29.67 -5.14 1.86 -11.33 91.19 91.06 151.46 8.83 54.25 95.67 16.94 15.19 31.938 18.82 2 yr 89.16 7.82 -1.32 2.87 -17.11 -15.34 17.11 -8.29 44.03 30.16 102.59 44.20 136.97 45.93 67.26 50.13 18.28 19.81 3 yr 4.77 -4.23 10.57 0.12 0.05 -14.03 56.62 17.13 70.12 22.62 84.42 59.64 93.67 34.87 81.85 41.10 4 yr 12.22 -4.46 5.55 -2.87 28.42 4.97 70.75 15.00 85.30 37.82 66.92 47.14 85.38 32.23 5 yr 7.40 -5.88 20.07 11.20 39.62 5.73 88.79 27.90 70.52 32.96 68.32 42.33 6 yr 15.22 5.91 28.07 10.80 51.37 17.15 67.24 25.69 72.13 31.53 7 yr 24.51 6.32 38.66 20.18 49.52 16.87 57.87 25.53 8 yr 28.30 14.75 31.08 19.55 49.91 17.81 9 yr 24.41 14.80 27.44 20.10 10 yr 22.24 15.74 Latest 23.64 14.78 28.29 18.92 52.94 16.56 58.26 23.83 74.76 29.30 68.78 39.09 89.21 28.88 93.37 35.96 28.83 14.92 34.809 14.69

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Outlook PROFIT 13 June 2008

of management and steer course differently, it may not be the same for regular stock investors who may not be in any position to inuence managements. An Indian example comes from the mid-cap segment of pharmaceutical stocks. Take the Indian subsidiary of Merck. Despite the fact that it has the equivalent of 30-40 per cent of its market capitalisation in cash, the stock price has shrivelled. In hindsight, its easy to gure out why the stock has underperformed: revenues havent grown as much and the balance-sheet has shrunk. So even as the company continues to add to its cash pile every year, the stock remains trapped in the doldrums.

8 Again, nding the right margin of

safety itself is a difcult proposition for strategies like cash bargains. Since these could involve long waiting periods, unless there is a trigger in sight, the opportunity cost of capital; the potential casualties in the portfolio (because Graham believed in diversication with less due diligence as opposed to the strategy of concentration with utmost due diligence that Buffett follows); and the fact that Graham never looked beyond fair-value situations (not letting prots run); the marValue gin of safetys has to investors are be considerably high. balance-sheet Finding such stocks analysts and in current circumstances poses a seriregular market ous challenge. analysts are

8 While Grahams strat-

P&L analysts.

egy is great in terms of capital protection, it focuses only on the arbitrage value between the margin of safety and the fair value of the stock (in fact, Graham would invariably sell the stock even before the fair value was achieved). By doing so, some present-day value investors say, you would lose out on the bigger value that is usually built into the growth of the company. Templetons Subramanian says that it makes a lot of sense to look at metrics such as dividend yields because growth opportunities in some segments may have exhausted but the situation may be entirely different for India, where growth in those segments may be just picking up.

Ramdeo Agarwal, MD, Motilal Oswal Securities believes in getting the purchase price right

ham framework to work is a purely capitalistic society with little controls. But some companies that are going cheap in the Indian markets today namely those in the oil, fertilisers and sugar business are those that have been hit because of government controls. These stocks look cheap, but its unlikely the situation will correct itself unless the government steps in.

8 The ideal environment for the Gra-

8 Again, one of the gripes against

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always cheap and they deserve to be so there are others that deserve superior valuations. A classic example, says Subramanian, is Infosys Technologies. Earlier on we made this mistake of trading Infosys for cheaper software companies. Only later did we realise that in some companies, the premium was because of the difference the management can make. It is not captured in current earnings but it can make a difference in the long haul.

PICKING WINNERS
Finding the catalyst: Buying cheap is a great idea but the biggest challenge in Graham-style investing is guring out the trigger that will unlock value in the stock. While a margin of safety is important, it is essential to look at the probability of getting that translated into returns. Sometimes, the catalysts could be growth itself, says professor Bakshi. If the stock trades at a multiple of four times or so, and earnings are still growing, your total returns could be very attractive since you can pocket a dividend yield, a price appreciation equal to the earnings growth and see a potential re-rating of the stock as well. In addition, a potential buy-back by a proactive management, special dividends, or open offers arising from potential take-over bids act as catalysts as well. Despite the deep value some holding companies harbour, there are few takers for such stocks simply because there are no obvious triggers in sight. But Bakshi says there is one way to play these stocks. The catalyst, he says, could potentially come in the form of a turn in the business of an underlying subsidiary. Usually, when business turns, the perceived value of the holding company improves and results in a fall in its discount to intrinsic worth. The perceived value in the company improves as a consequence. A case in point is Nalwa Sons. The stock was available at a 75 per cent discount to its intrinsic value but as group company JSW Steel (Nalwa holds 45 lakh shares) got rerated for the better, the discount contracted to 16 per cent of Nalwas intrinsic value. Experts say the way to view such companies is by taking a call on how the operating business of the subsidiary will fare in the long haul. For instance, if cement is expected to do well over the next ve years, it would make a lot of sense to put money in holding companies of cement enter-

K N Siva Subramanian VP, Franklin Templeton Mutual Fund, has an enviable long-term track record

Grahams strategy is that frequently the list of worthy buys is made up of obscure stocks on which there is little public information. The reported earnings are thus suspect and the chance of being duped, quite high. So following the rule always is never easy.

8And nally, there is an anti-thesis to Grahams philosophy. Pretty much like the fact that some companies are

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Outlook PROFIT 31 January 2008

DOGS OF THE NIFTY

Portfolio of top 10 dividend yield stocks
Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex Portfolio Sensex YEAR 1998 1998 1999 1999 2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 2007 1 yr -14.68 -17.00 145.80 40.05 10.53 -24.44 65.29 -5.14 4.64 -11.33 198.09 91.06 11.64 8.83 83.05 95.67 -4.25 15.19 32.65 18.82 2 yr 27.71 7.82 40.83 2.87 26.90 -15.34 33.08 -8.29 90.51 30.16 77.03 44.20 41.06 45.93 33.90 50.13 11.70 19.81 NA

prises. There are risks to such a strategy though. The lack of transparency in dealings between group companies and the vested interests of promoters can sometimes erode value in such stocks. Unless you know that the interests of the promoters are aligned with those of minority shareholders, there is no point in touching such stocks, says Templetons Subramanian. Then again, the famous law of averages or reversion to the mean could help a stock run the distance. Instances of over-reactions to one-off situations could be good Graham picks. But investors really need to be able to judge the situation correctly to make sure that what they think is a one-off really is just that. Take the recent forex losses by some companies, for instance. Buying bank stocks just because forex losses came in much lower than expected is denitely not a wise call. At this point in time, its still uncertain if the problem could strike again. It may not be a one-off situation as some experts are claiming. After all, as professor Bakshi rightly points out, there is never just one cockroach in the kitchen. Talking of out-of favour stocks, investors need to careful when theyre dealing with downturns. Again, the problem with some companies whose names pop up as good earnings yield candidates is that they

could run the risk of deterioration in folio requires going after little-known business. Candidates in the out-of-faor desired stocks. We all know what vour category now include commodkinds of stocks are thrown up on these ity companies which look incredibly screens, but it requires nerves of steel cheap but may be vulnerable to an and guts to buy these stocks. Why? earnings decline if the cycle turns for For one thing, you may not have heard the worse. One way to assess these about most of them. For another, most companies may be to look at average of these stocks will be drenched in pesearnings for the past ve years or more simism, so most investors will be reto remove the effect of cyclicality. luctant to invest in them. Professor Bakshi says one way to look Indeed, the reason value investing at cash bargains is to identify compais so difcult is because it may feel nies with fairly certain cash ows and completely foolish for a while. But not focus as much on abtrue value investors solute cash levels. Since are not worried about companies with regular If you buy stocks looking foolish as long cash ows will soon turn as theyre certain they based strictly into a treasure-chest of havent acted foolishly, on traditional cash, they could be viewed remarks Bakshi. value investment as cash bargains, he says. Yet impressions matThe problem with lookter to a large swathe principles, you ing at future cash ows, of investors. So even will only play as Graham also explained, if back-testing comes the arbitrage is that it requires a judgeup with sparkling reopportunity, ment of the future and sults, its still difcult those projections can diffor many to go ahead but the bigger fer from person to person. and take the plunge. opportunity in a Nevertheless, since stocks The reason value incountry like ours are now no longer availvesting is not popular is able at high discounts as in because people do not lies in the future Grahams time, we cant have the patience to go as the business ignore the value of future through these dull and grows. cash ows while looking at boring ideas, says Movaluations, says Bakshi. tilals Agarwal. While Grahams solution Another reason why for minimising the risk of bankruptmost investors get bludgeoned with cies and frauds was diversication, their stock picks is that they dont allooking at divergences in cash ows ways follow the rules and resort to gut and earnings in recent years (not just feel or judgement, which frequently quarters) can also be effective in spotgoes wrong. As humans, we do get ting the warning signs. Instead of carried away. A strict Graham stratlooking at accounts statements for just egy would involve selling stocks pea year, we should look at the aggregate riodically, in fact mechanically, adds picture for ve years, which will offer Agrawal. clues to the true picture, says Bakshi. Another fact that Graham followers Among companies that are capital inneed to accept is that they will rarely tensive, it is a worthwhile strategy to make extraordinary returns. On the search for those that have a high return other hand, they will rarely lose monon equity and low price-to-book value. ey. Its important to be comfortable As Motilals Agarwal puts it: Value inwith the fact that sometimes, they will vestors are balance-sheet analysts and miss new growth opportunities but regular market analysts are P&L ananot giving in to such temptations can lysts. Value investors buy assets cheap ensure a safer ride. and ahead of the market recognising True, there are those who have been a turnaround. Thus, instead of lookenormously successful by following only at operating and net margins, ing growth investing techniques. But it is perhaps smarter to look at longthese investors, it has to be acknowlterm returns ratios. With companies edged, are extraordinarily smart and operating in cyclical industries, stocks have learnt to be at the right place should be picked up when the industry at the right time. Very few ordinary is down in the dumps. investors can aspire to be successful that way. The relentless pressure of keeping up INTELLIGENT INVESTING with the Joneses and the need to boast It cannot be denied that Grahams about the latest stock picks at a party is strategy demands enormous psychowhat investors need to overcome to belogical strength and will-power. Thats come really successful investors. p because building a Graham-style port-

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13 June 2008 Outlook PROFIT