CAGR – A Parable

‘Hey! I made 3.2% on my investments last week,’ my friend came running to me all jubilant and brimming with pride.

 

‘That’s pretty good,’ I replied.

 

‘Pretty good! The sandwich I had this morning was pretty good. 3.2% in a week means 166.4% in a year. And that’s not even considering the compounding effect. My week was brilliant.’

 

‘That’s a very nice thought,’ I say. ‘However, that’s not how investments work. Or math works for that matter.’

 

‘Huh?’

 

‘Take a step back. How did your portfolio perform in the week before this one?’

 

‘Something like a negative 1%.’

 

‘So shouldn’t your projection for the next 52 weeks take at least the past 2 weeks into consideration? You know they say the best way to predict the future is to look to the past.’

 

‘So you’re saying that in the next year I’ll make only 3.2% - 1% = 2.2% per week? That’s still a pretty good year.’

 

‘That’s not what I’m saying. I’m saying that if you use CAGR to project in time periods ahead, you’re going to end up with very weird answers. CAGR is a tool for averaging the past, not projecting the future. When you have long time periods and you want to understand them, CAGR comes in handy. It tells you your average gain (or loss) every year which will take you to the same result. It’s basically the same concept as IRR, only in reverse.’

 

My friend looked confused. ‘So when mutual fund houses tell us that they made 80% annualized returns this quarter because they made 20% this quarter…’

 

‘They’re thinking you’ll be dumb enough to buy into that crap. Most reputed funds will not present annualized numbers to you unless the return period is over a year. For most major funds and analysts, daily, weekly, monthly, or quarterly returns are not annualized but only the nominal values are presented. If a fund were to present these numbers on a day when the market moved 1%, their monthly returns would be say 30% while the annual returns would be…’

 

‘365%! That’s insane!’

 

‘Precisely.’

Coal India - Graham Analysis

After going through Benjamin Graham’s “The Intelligent Investor” we wanted to try out the principles learnt on a real life company. Benjamin Graham has proposed some preliminary qualitative checks for the company, such as

• There should be a strong brand
• Business should be easy to understand
• Should be a near-monopoly
• Managers are realistic and have achieved past targets
• Belief in organic growth rather than mergers and acquisitions
• Low managerial remuneration and stock options

Coal India Limited seemed like the right company to take for the next stage of analysis. So we took the company through some of Graham’s basic checks

Current Ratio >= 2

Coal India has maintained a current ratio above 2 only in 1 of the last 5 years, and that was 5 years ago! So a poor start. Verdict – FAIL.

Long Term Debt <= Net Current Assets

Debt-Equity Ratio < 0.5

Coal India operates on very low debt levels. The total borrowings of the company stood at Rs. 2 kCr as of 31 Mar 2021. The total cash, cash equivalents and other bank balances stood over Rs. 28 kCr. The NCA were 18 times higher than the LTD. Verdict – PASS.

Again, the debt to equity ratio as of 31 Mar 2021 was at 0.06. Debt is not a problem for Coal India. Verdict – PASS.

PAT > 0 for the last 10 years

Dividend > 0 for last 20 years

Coal India has been consistently profitable for the last 10 years. Verdict – PASS.

Also, the Company has paid dividends for the last 10 years. Verdict – PASS.

3 year average EPS growth should be 33% over last 10 years

Graham does well for not depending on figures for a single year, which may be a rare year. Rather, Graham always asks you to focus on averages across large periods of times. Especially when he asks you to calculate growth. YoY growth is not as important as growth in 3 year or 5 year averages. In the case of Coal India, the 3 year average EPS growth over the last 10 years was 63% (logarithmic growth). Verdict – PASS.

PE Ratio < 15

Graham is mindful that some industries hold a high PE and some have a naturally low PE. However, according to him no industry should have a PE < 15. Coal India has held a PE < 15 for the last 2 years. Before that the PE stood higher for 3 years. Verdict – PASS.

NW <= MV <= 1.5 NW

Graham acknowledges that the market value should be higher than the book value, considering the future value of the operating assets. However, the PB should not be over 1.5 for any company lest they be overpriced. Here, Coal India’s market value is 2.6 times the book value. Verdict – NEUTRAL.

MV >= Net Current Assets

The market cap of Coal India stands at 2.5 times the Net Current Assets. Verdict – PASS.

Finance costs <= (1/5) PBT

Finance costs <= (1/2.9) PAT

The debt and consequently the finance costs of Coal India are low enough to easily pass this test. Verdict – PASS.

RoE > 20% in 10 years average

RoE > 15% every year for last 10 years

The average RoE has been 46% in the last 5 years and higher than 35% every year for the last 5 years. Verdict – PASS.

Promoter holding >= 20%

Government of India, the promoter of Coal India, holds 66% in the company. Verdict – PASS.

ICSR > 2

The interest coverage service ratio stands comfortably at 49 times and has never been less than 26 in the last 5 years. Verdict – PASS.

This is enough to spark an initial interest in Coal India. This is further increased when we look at the average PB ratio of the company for the last 5 years which is much higher than the present PB ratio for the company. That is in a highly optimistic market of early January 2021 where the indices are reaching new peaks every day.

Finally, the total assets of the company are Rs. 150 kCr. The provisions held by the company are of Rs. 60 kCr out of which Rs. 47 kCr consists of “Stripping Activity Adjustment”. This is a non-payable liability and is incurred as an expense over the regular course of business.

This shows that the company operates on a tight working capital but otherwise is technically and financially extremely sound and might be looking at great returns for its investors in the future.

Amnesty Scheme by the Calcutta Stock Exchange

Amnesty Scheme launched by the Calcutta Stock Exchange for the revocation of suspension of listed companies

Salient Features

• Applicable for listed companies suspended for less than 7 years
  
  
• Listing compliances reduced from last 12 quarters to last 4 quarters
  
  
• Interest reduced on outstanding listing fee from 18% on the outstanding amount to Rs. 5,000/- p.a. (plus GST) for the year of default
  
  
• Last date to apply: 7 Feb 2021

Standard process of revocation of suspension still available for companies suspended for over 7 years

Regards,

Amit Kumar Mishra

AVP, Intelligent Money Managers Pvt Ltd

Phone: +91 98360 44477

Email: amit@intelligentgroup.org.in

What is an ETF?

ETF or Exchange Traded Fund is quite simply a mutual fund that itself trades in an exchange.

Typically mutual funds invest in stocks or other assets, but they themselves do not trade in any stock exchange. After trading hours are finished a mutual fund's value is calculated based on the price of whatever stocks it held.

ETFs differ in the sense that they themselves are also traded on the exchange like other stocks and their value also keeps changing every instant the market is trading.

A popular reason for buying ETFs in place of mutual funds is the fact that an investor can keep a track of the ETF during market hours and when it touches a price that they like they can go ahead and buy it. Over the longer term ETFs can sometimes prove to be cheaper than mutual funds because typically they charge lesser annual fee and have no entry loads or exit loads. However because the method to buy ETFs is similar to stocks they do have a brokerage fee associated with them. This does not imply that you will make more money buying an ETF instead of mutual fund because that really depends on how much your mutual fund or ETF grows. This simply means it generally costs less to own an ETF than it would to own a mutual fund.

The philosophy of ETF is very similar to Index funds and it promotes diversifying risk by holding a bucket of stocks having a common feature and taking advantage of growth in that particular sector, region etc.

Warren Buffet – Businesses The Great, The Good and the Gruesome

A good business according to Buffet is one that has a long term competitive advantage in an industry where there is growth though there needs to be significant capital investment in order to finance the growth. The example that Buffet gives is FlightSafety. Buffet says that in this business the profits rose from $159 million in 1996 to $270 million in 2006 however the capital needed to make this happen has been an incremental investment of $509 million. While these are good earnings these are not what will make a business an extra ordinary business. This is the kind of business where if you want to earn more you will need to invest more.

Finally Buffet discusses the gruesome, which he describes as a business which grows rapidly and requires significant capital for that growth but doesn't earn as much money as would be required to justify growth. Buffet gives the example of the airline industry which has always required massive investment but has never really provided any returns to investors. This is primarily because in the airline business no company has been able to create a lasting competitive advantage for itself.

Buffet summarizes by saying that the great, good and gruesome investments are like three savings account where the great one pays you a extraordinarily high rate of interest which rises as the years rise, the good one pays an attractive rate of return which will be earned also on deposits that are added. The gruesome is one which pays an inadequate rate of interest and also makes requires an investor to keep adding money in order to make that low interest rate.