December 6, 2017

How to Decide about existing portfolio stocks: Buy more/Hold/Sell, Promoters using funds of listed company to increase their stake, Low float due to promoters' indirect shareholding (Q&A)

www.drvijaymalik.com has a section dedicated to answering queries from readers: “Ask Your Queries”. Over time, many readers have asked their queries related to many aspects of stock analysis and sought clarifications about investing. I have responded to these queries as replies to their comments.

“Q&A” series is an attempt to share the queries & their responses, which have featured on “Ask Your Queries” section, with all the readers. The primary aim of this new feature is to share the knowledge with other readers of the website, who might have similar queries.

The current article in this series provides responses related to:
  • How to decide about existing stocks in the portfolio: buy more/hold/sell?
  • How to interpret the promoters’ usage of funds of a publicly listed company by the route of investments in promoters’ entities to increase their stake in the company?
  • Should one invest in companies with low float due to indirect promoters’ shareholding?

How to decide about existing stocks: buy more/hold/sell, promoters’ using of funds of company to increase their stake, companies with low float due to indirect promoters’ shareholding?


How to decide about existing stocks in the portfolio: buy more/hold/sell?


I wanted to understand how to value a stock which is already in your portfolio and it has reached slightly stretched valuation - I am referring to Kajaria Ceramics Limited (KCL).

If you want, then I can share the detailed thesis on KCL, but that would be more from a “Buy” perspective, which I don’t intend to do. The gist is:
  • It is the market leader. 
  • The tiles industry will continue to grow at a decent rate for next 3-4 years. 
  • It has good distribution. It is spending a good amount of money on branding (60+ cr consistently for last 3 yrs.), which is more than the PAT of some of its listed peers and branding is kind of reflected in good numbers (improving ROC, NPM etc.). 
  • It is launching new designs. But I am not weighing that in.

Everyone knows it and the market has provided a high valuation for it. Although, when compared to some of its peers (NITCO, Somany, Bell, orient, Asian Granito), KCL does stand out in terms of business quality and financial with good able management running it. Unless they do something wrong or any irrational competitor comes into the market, KCL should continue to do better than the average market growth.

Now, my question is: 
  • How should I value a stock, which I already hold in the portfolio and for which I am hopeful that business will continue to do well but I am not sure how much of that is already priced in?
  • Does it make sense for me to continue to own this business?
  • Should my valuation of business for buy and hold not be different?
  • How should I go about doing a valuation for this and similar stocks?

Mr. Bakshi’s example on Asian Paints (AP) does provide some insight but for every AP there might be thousands of failures as well.
  • What key things I should look to ensure that I am holding a high-quality business, which still has an upside potential from a 5-year perspective at current valuations?

I have a conflict in my mind. I have a feeling that KCL is a good business but is it the right investment at a current valuation to continue to hold for 3-5 years?

If you can share your experience or a post on this, then it will be great. If you have come across any great book on this please do let me know.

Looking forward to enhancing my learning.

Author’s Response:

Hi,

Thanks for writing to us!

The criteria for buying a new stock for the portfolio and holding a stock in the portfolio are different.

We would advise seeing each buy decision as a separate decision independent of what price the investor has paid for the stock in the past. The P/E ratio at which an investor should buy a stock depends upon the margin of safety in the stock price and in the business. I have elaborated on the margin of safety in the stock price and in the business in the following article:


If after the initial purchase, the interest rates have gone down, then the investor can think of purchasing the stock at a higher P/E ratio. 


If the self-sustainable growth rate (SSGR) of the company is very high than current sales growth rate and the capex needs are very low in comparison to the free cash flow being generated by the company, then the investor can think of paying a higher P/E to the stock. However, it is not objectively defined that at what level of SSGR in comparison to sales growth or at what level of Capex as a percentage of free cash flow (FCF), what should be the maximum P/E ratio that the investor pays for the stock. Nevertheless, let’s suppose that the investor decides that looking at the interest rates, SSGR, Capex/FCF levels that she would be willing to pay a P/E ratio of 14 for the company, then she can accumulate the stock up to P/E ratio of 14 irrespective of her initial purchase price P/E ratio.


Moreover, the fact of being invested in a company after doing analysis, brings in additional knowledge about the company, its products, its industry etc., which deepens the understanding of the investor about the company, therefore, an investor can think of paying a little higher P/E to the existing stocks of the portfolio for accumulation than adding an altogether new stock.

We hope that the above argument is able to guide you in the direction of deciding the maximum amount to pay for a stock while buying and accumulating. I understand that the answer is not giving you objective answers. However, it would definitely help to take a step in that direction, which is the "art" aspect of investing.

Moreover, we keep stocks in our portfolio until the fundamentals are intact or until any of the selling criteria is triggered. You may read about our thoughts on selling criteria here:


Hope it answers your queries.

All the best for your investing journey!

Regards

Dr. Vijay Malik

How to interpret the promoters’ usage of funds of a publicly listed company by way of investments in promoters’ entities to increase their stake in the company?



Dear Doctor,

Thanks for the detailed coverage.

Co-incidentally, I was also studying this company and found your note very helpful. For the time being, I will restrict myself to the shareholding issues.

The public owns ~60% of Dynemic Products Limited (DPL) which in turn owns 49.22% of Dynemic Holdings Pvt. Ltd (DHPL). Remaining shares of DHPL are held by promoters of DPL. So indirectly, the public owns 29.53% of DHPL. Quoting from the above article:
“assuming current (Sept 30, 2017) shareholding structure of promoters vs. public shareholders of about 40:60 in Dynemic Products Limited, the share of contribution of Dynemic Products Limited’s funds (49.22%) in DHPL can be bifurcated into promoters (19.69% = 49.22% * 40%) and public shareholders (29.53% = 49.22% * 60%).”
Now DHPL also owns 1.34% of DPL. Hence, the current stake of 1.34% of DHPL in DPL is essentially held as 0.40% by Public, 0.26% by DPL and 0.68% by promoters of DPL. Therefore Public ownership in DPL is essentially 60.4% and not ~60% as it looks on the face of it.

So while DHPL is classified as a promoter group, 29.53% of every rupee invested in DPL by DHPL belongs to the Public.
  • Are such cross holdings allowed?
  • Should the Public's holdings in DPL shown as full 60.4% or higher in case DHPL keeps on raising stake?

I could not get your interpretation of promoters' using public money to raise their stake. Whatever DHPL invests back in DPL, 29.53% of it is by the Public. So Public's stake also increases to the extent of 29.53%. Right?

I know I am missing something here. Please help me understand this better.

Thanks!

Author’s Response:

Hi,

Thanks for writing to us!

We request you to analyse the situation from the following aspect:

Suppose, in future, on any proposed resolution in the AGM of DPL, there is a dispute between the stand taken by promoters and public shareholders. Then, in whose favour the voting done by DHPL would be considered?


We would suggest that in case of further clarification, you may consult any CA or any lawyer/counsel who would be in a better position to clarify the applicable laws in this case.

All the best for your investing journey!

Regards

Dr. Vijay Malik

Should one invest in companies with low float due to indirect promoters’ shareholding?


Hello Mr. Vijay,

My query is about companies (mostly small caps), which have a very low float in the market. Although SEBI has a guideline which stipulates that promoters can only have a certain percentage maximum holding in listed companies, one comes across many firms where large portions (up to 95%) is held by promoters indirectly hence bringing the float to less than 5%.
  • Why do firms do this?
  • What is the advantage of staying listed for such firms?
  • Is it safe to purchase stocks of such companies from the point of view of a minority investor?

Thanks

Author’s Response:

Hi,

Thanks for writing to us!

We give more weight to management assessment than the float assessment. We believe that if an investor is not finding the management trustworthy, then she should avoid the stock altogether and on the contrary, if she has faith in the management, then she may take different views on the float.


All the best for your investing journey!

Regards,

Dr Vijay Malik

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DISCLAIMER


Registration Status with SEBI:

I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013

Details of Financial Interest in the Subject Company:

Currently, I do not own stocks of any of the companies discussed above