Q&A: Stock Selection, Margin of Safety, Cash Flow Statement & Others

Modified on July 2, 2018

The current article in this series provides responses related to:

  • Queries about stock selection process
  • Treatment of amortization by Emami Limited
  • Impact of recent changes in balance sheet presentation format on total debt calculation
  • Dilemma faced by mutual funds while investing and margin of safety for institutional investors
  • Clarifications on cash flow statement
  • Amount of time an investor should spend on stock analysis
  • Steps to reduce number of stock in one’s portfolio
  • Amount of capital needed to invest in stocks

 

Query

Dear Dr. Malik,

I have just started reading your blog and found very informative, precise, to the point and very practical in applications, I have few queries and would like you to shed some light on it.

  1. Do you find the concepts of multi-disciplinary thinking (mental models- Charlie Munger) usable in common investing ,if yes, how can they be utilized ,a case study will be appreciated.
  2. How can we discover some financial or non-financial factors that can seriously dent price of stock before any bad news hits them?
  3. Also how much is past data useful to determine the future of stock as things are unpredictable and any sudden hiccup can crash price of stock. Please mentions the parameters to include and exclude
  4. Finally, if u want to create a stock screener which parameter will you use and give priority to.

Thanks

Author’s Response:

Hi,

Thanks for your feedback & appreciation! I am happy that you found the articles useful!

1) I do not specifically use any multidisciplinary thinking in stock analysis. However, as most of the investors have multidisciplinary background: Science, Engineering, Commerce, Medicine etc. before they start investing in stock markets, it becomes indistinguishable that their prior education/experience would have some impact on their approach to stock investing. The same, if impacts my stock analysis, then it would be there. Else, I like to keep the stock investing simple and straight forward and have a checklist handy to assess whether any stock meets my criteria.

You may read about my framework for stock analysis here:

Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks

2) Discovering financial/non-financial factors impacting the companies in the portfolio is part of regular monitoring of the stocks in the portfolio. I have written about the steps an investor should use for monitoring stocks in her portfolio in the following article:

How to Monitor Stocks in Your Portfolio

3) I believe that past performance data is the most essential input to assess the quality of the business and the competence of the management of any company. These two factors, if found satisfactory, would tell an investor whether the company and its management would be able to face the unpredictable future by taking timely steps in the changing environment or not.

You may read about business analysis of a company in the following article:

How to do Business Analysis of a Company

You may read about management analysis of a company in the following article:

How to do Management Analysis of a Company

4) Stock screening parameters: As mentioned above, I use a checklist for stock analysis. Most of the parameters in the checklist are objective parameters which can be used as a filter in the stock screening software.

Final Checklist for Buying Stocks

Hope it clarifies your queries.

Regards,

Query

Analysis: Emami Limited (Emami, Himani and Zandu brands)

Dear Vijay,

Thanks a lot again for educating us.

I need to understand the treatment of amortization by Emami Limited with your help:

  1. Can you please help me understand how the amortization calculation is done? I am unable to link changes in reserves & surplus in balance sheet and changes in P&L statement for amortization?
  2. What is the advantage of this operation? If amortization amount is added back to profits, would it not have an implication on taxes paid out?

Thanks again!

Regards

Author’s Response:

Hi,

Thanks for your feedback & appreciation! I am happy that you found the articles useful!

1) Amortization is to goodwill/intangible assets what depreciation is to fixed assets/tangible assets. Emami has explained its amortization policy in its annual report. I advise you to read the annual report of Emami Limited to get further clarity on the policy it follows.

2) For linking amortization charge in P&L, changes in the reserves & surplus, advantages of transferring amount from reserves to P&L, I suggest that you prepare an excel file with calculation of P&L and balance sheet. You should try putting different values for the amortization charge, transfer from general reserve in the P&L and see its impact on profit before tax. You would come to know the impact it would have on the tax outgo in P&L.

This would be a good learning exercise for you.

All the best.

Regards,

Query

Hi Vijay,

I just want to clarify how total debt of a company is calculated from balance sheet?

I looked at your views on FIEM Industries Limited and got stuck at calculating total debt! It was mentioned 87cr total debt for yearend Mar-14 in article:

Analysis: FIEM Industries Limited

But when I looked at Balance Sheet at screener, I am not able to get – how you got 87cr as total debt for Mar-14?

Please clarify me – how I can calculate total debt of a company from balance sheet?

Author’s Response:

Hi,

Thanks for writing to me!

You would notice that the debt figures from March 2012 onwards are different from the ones mentioned in the article and the ones presented by screener now. The data presented in the article was taken from screener in June 2015.

In August 2015, the screener website has undergone a change and it has changed the way it presents/classifies the data on its website.

From 2012, the presentation of financial statements had undergone a change on account of change in Schedule VI. From August 2015, screener has updated its data presentation and has factored in the changes in presentation of financial statements from FY2012 onwards. Before August 2015, it seems to be calculating data as per its template which was prepared in the older format of annual reports.

The changed presentation of data by screener is the reason that you are not able to find debt data of March 2014 as ₹87cr.

It is advised that before taking any investment decision, an investor should check the financial figures from the annual report of the company as annual report is the most authentic sources of data.

Hope it clarifies your query!

Regards,

Query

Dear Sir,

It’s really a thankless job you’re doing. I read all your posts through reader.

Though mutual funds keep a portion as cash, they would normally be compelled to buy fresh shares whenever new funds are pumped in. And this often happens more in a bull market. So, how can they follow the valuation part of the shares?

Can they keep a margin-of-safety after a DCF or any other type of valuation?

Regards,

Author’s Response:

Hi,

Thanks for your feedback & appreciation! I am happy that you found the articles useful!

You are right that mutual funds usually face a peculiar dilemma. They get more money for investment, when the markets are going up and shares are becoming expensive every day. They get more redemption requests and have to sell shares in bear markets when shares are becoming cheaper every day. This situation leads to mutual funds buying stocks when they are becoming expensive and sell stocks when they are becoming cheap. In the end, this process hampers the returns the mutual funds can generate for investors.

This is precisely the reason, I believe that an individual investor who does not have to face such challenges, can do very well in markets. She is not answerable to anyone and can buy stocks when prices are down.

Regarding valuation part/margin of safety:

Valuation method does not have to depend on someone being a mutual fund manager or a retail investor. It is person dependent. Every investor has a personality and the valuation and stock selection methods varies from person to person. Some may like technical analysis, some like fundamental analysis. Some are growth investors, others are value investors and so on.

You should the following article about assessment of margin of safety for a company:

3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

Regards,

Query

Vijay,

Thank you for your comments.

I am having doubts with +ve & -ve numbers in CFO, CFI, and CFF as below –

# CFO:

  • -ve : ?
  • +ve: company generated cash from operations

 

# CFI:

  • -ve: company funding its expansion plans or investments by a mix of CFO & CFF
  • +ve: ?

 

# CFF:

  • -ve: company paid debt
  • +ve: company taken credit

Please clarify & correct me, if I am wrong in understanding.

Author’s Response:

Hi,

-ve CFO: company is not able to generate surplus cash from operations. Possible reasons: either company is making losses &/or cash is getting stuck in working capital.

+ve CFI: Company has liquidated its assets. Might be sale of fixed assets or investments like MF etc.

CFF can be -ve due to dividend payments and +ve due to equity dilution as well.

Regards,

Query

Hi Dr Malik,

  1. Typically how many hours of research do you do on a stock before deciding whether to add to your portfolio or not?
  2. Do you buy stocks in lump sum or staggered manner? If staggered, please can you explain your methodology?

Author’s Response:

Hi,

Thanks for writing to me!

1) It may take few seconds/minutes to a few hours to decide if I decide not to invest in a stock. However, it may take about a week while I analyse, get convinced and invest in a stock.

2) I prefer investing the entire surplus available at any time in a stock, when I find an attractive stock. It’s another story that I keep on buying it from my monthly savings until its valuation is within my buying range.

Hope it clarifies your queries.

Regards,

Query

Hello Vijay ji,

I need your help to reduce the number of stocks in my portfolio. At the moment there are more than 30 stocks. How I can reduce to 15 or 20?

Author’s Response:

Hi,

Thanks for writing to me!

You can use the guidelines and steps detailed in the article:

How many stock you should own in your portfolio

And

When to sell a stock

If you follow the different parameters highlighted for deciding about selling a stock from the portfolio, then you would be able to arrive at/zero in the stocks that you should exit so that you may remain with the desired number of stocks in your portfolio.

Hope it helps!

Regards,

Query

Analysis: Kaveri Seed Company Limited

Most of the positive features of this company was due to management’s efforts during the period of 3-5 years or before, while all the negative features are recent developments. Does it mean that the management has changed for bad and the company is in a declining mode?

Author’s Response:

Hi,

Assessment of management is very subjective just like assessment of one’s friends.

Therefore, it is advised that the investor takes due care while analysing the management of any company as it is the most important parameter of stock investment.

You may take further help from the following article on management analysis of a company:

How to do Management Analysis of a Company

All the best for your investing journey!

Regards,

Query

Hi Vijay ji, what about capital?

To be more successful should we need more capital? If we consider small capital, days of Rakesh Jhunjhunwala and Warren Buffett are over right?

Author’s Response:

Hi,

Days for hardworking investors are never over. Their days would get over only when the markets would cease to exit

Both Rakesh Jhunjhunwala and Warren Buffett started with small capital and worked hard to make it grow. In the same manner other investors, if work hard, can expect to grow their wealth over the years.

All the best for your investing journey!

Regards,

Follow up Query

Sir. If you suggest for capital, how much you say?

Author’s Response:

Hi,

There is no minimum or maximum limit on the capital that a stock market investor can start with.

I guess, the minimum capital is the minimum order size that the broker accepts, which is in the range of ₹500-1000/-, I guess.

Regards,

Query

Hi Vijay,

Thanks a lot for your view and guidance. Please help me to know, how to get below 3 parameters .I am not getting it from screener/balance sheet.

  1. Inventory turnover ratio
  2. Receivable days
  3. Market Capitalization (M-Cap) of last 10 yrs.

Thanks again in advance.

Regards,

Author’s Response:

Hi,

Thanks for writing to me! I am happy that you found the article useful.

You may find the calculation of ITR and Rec. days in the following article:

5 Simple Steps to Analyse Operating Performance of Companies

Gain in M-Cap of last 10 years is the change in market cap from 1st April 2005 to current date. Historical share price (adjusted for splits and bonuses) can be found at BSE, NSE websites.

Regards,

P.S.

 

DISCLAIMER

  • The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
  • I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
  • Currently, I do not own stocks of the companies mentioned above in my portfolio.

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