The current article in this series provides responses related to:
- Management analysis of companies
- Buying & accumulating criteria
- Chaman Lal Setia Exports Limited
Thank you Dr. Malik for the prompt reply. Really appreciate it. Kindly provide your inputs:
1. What kind of managerial remuneration is considered good?
In your management analysis section you mentioned 2-4% of profits is ideal. If it’s greater than 5 % of profits and is in the range of 10-12% then is it ok? For e.g. greenply management pays itself ~12% of profits. Would you be comfortable with such % of remuneration?
2. When a company shows someone as an independent director, but in reality they are not independent, then how would you see the management?
Would you see it as a red flag on management or just consider it as a kind of yellow flag? For e.g., greenply industries shows Sonali Dalal (AR 2016, page 82) as independent director. But she is also the director of greenlam. So for all practical purposes she is not independent. Similarly in the case of APM industries, Ram Ratan Bhagri is shown as independent directors (AR 2015 page 17). But Ram Bhagri was previously director of Faridabad paper mills in which Sanjay Rajgharia (son of R.K Rajgharia, director APM) is a director. So he is not truly independent.
What do you think of such managements? Would you be comfortable with investing with them?
3. What kind of remuneration is justified for independent directors?
For example in greenply industries the independent directors are getting a lot of commission (10 lacs each). I think higher pay for independent directors takes away their independence. They should be only paid a nominal sitting fees. Would like to know your views on the same.
4. Greenply industries is capitalizing loss on borrowing cost on account of fluctuation in foreign exchange (AR 2016, page 175, notes to fixed assets). Whereas century ply is charging it directly to earnings statement under Finance costs (AR 2016, page 187).
I think capitalizing this cost if a shenanigan since foreign exchange losses are operational losses. Please let me know your views on this.
5. I would like to know your views on the usage of revaluation reserve.
For e.g. APM revalued its fixed assets and created a revaluation reserve. Now due to this the depreciation has increased. So APM takes this depreciation amount (pertaining to increased fixed asset value) from its revaluation reserve and transfers it to depreciation account under P&L. This is to avoid reduction in earnings. This is permitted under accounting rules and many companies, including century ply, do this.
I personally think that they should not use revaluation reserve as a cookie jar. If they are revaluing the assets then they should bear the additional depreciation burden and charge them directly against earnings.
6. Some companies use W.D.V method of depreciation instead of S.L.M (like century ply and DHP India). I think using any of them is ok. Would like to know whether this is ok.
With thanks & regards,
Thanks for writing to me!
First of all, let me appreciate you for the hard work and the diligence that you have put in while analysing the companies. It’s my good luck that readers like you visit my website and provide their inputs.
Here are my views to your queries:
1) Opining on management remuneration is a very subjective arena. It has to be assessed on case to case basis. If a management has pulled the company from dire straits and revived it from deep losses into healthy profits, then I am ok with them taking the maximum salary permitted under the statue. However, a management that takes steep hikes while the business dwindles or stagnates, then I would wish to avoid it.
2 & 3) Independent directors: It’s again a subjective area. If it is a company specializing in a unique area where there is a dearth of professionals then you might find repeatedly same people on boards but still be ok with it. Whereas in a run of the mill business, such repetition might not be ok. Even otherwise, we have seen that independent directors are rarely able to safeguard minority shareholders.
E.g. In Satyam case, the merger of the software company Satyam with real estate & infra company Maytas was approved by a committee which had only independent directors and these directors were who’s who of corporate & academic world.
Therefore, most of the times, an investor’s only safeguard is to have a shareholder friendly majority shareholder.
On similar lines, the salary/commission of independent directors is immaterial if the majority shareholder is not concerned for minority shareholders.
4) Such losses are usually capitalized and added to the project cost under fixed assets, if they pertain to a specific project/s. otherwise, they are charged to P&L. Request you to first check whether we are comparing similar cases here and not apples with oranges. If the cases are similar, then the company that is charging it to P&L seems to be following conservative accounting practices and does score higher on investment criteria.
5) Similar to the above answer, a company that directly charges depreciation to reserves is following aggressive accounting than the one which does not. The conclusion is same as point no. 4 above. Another company that follows the practice highlighted by you is Emami Limited:
6) Because of reasons like 4, 5 & 6, I focus more on the cash flows than earnings. Especially on Free Cash Flows, which is post capex and takes care of capitalized part as well.
Keep up the good work. Hope these answers help you a bit in resolution of your queries.
Once you have analysing all the above areas, then I would definitely appreciate you for understanding the “Art” aspect of the stock investing.
All the best for your investing journey!
Read: When to sell a stock
You have mentioned criteria to Buy and Sell. What about Accumulate? When should an investor accumulate?
Say I buy a particular stock whose PE is 8 (and assuming other factors as elaborated by you are also good). 1 year later, say the PE is 15 while other factors continue to stay good. Should I accumulate more of the stock or not?
The reason I ask is, when we identify a stock, we may have only so much capital with us. A few months down the line, when we get more capital, should we reinvest in the stock already discovered or not? There are only so many good stocks in the market whereas capital availability happens numerous times over any reasonable time period.
I guess another way of asking is should the criteria for Buy and Accumulate be the same or not?
Thanks for writing to me and asking a very intuitive question!
Buy and Accumulate criteria:
I would advise to see 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 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 percentage of FCF, what should be the maximum P/E ratio that the investor pay 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 a altogether new stock.
I hope that the above argument is able to guide you into 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.
If you have any additional query on this topic, then please feel free to ask. It would be my pleasure to answer it.
All the best for your investing journey!
Dear Dr. Vijay,
Great discussion, comprehensive analysis and lots of food for thought. Here are my observations and questions.
- This is a very cheap stock given the growth it has shown. Companies with such growth is seen quoting at even 5-10 times its PE. How do I understand if I am being too choosy or not for this PE? Does the Cash Flow track record indicate long term growth rate would reduce to 8% kind? (Ref. PEG=1)
- The efficiency of Debt is increasing over the years (Sales/Debt, Net-Profit/Debt, D/E, Interest Cover) but the weakness in Cash Flow still is leading to increasing the absolute Debt. The 20-25% CAGR in Sales is aggravating that because it needs more stocking of rice. From stock market’s point of view, instead, should a company target to get a less aggressive Sales CAGR that Free Cash Flow can self-sustain? Where’s the trade-off in Market Capitalization terms?
- (A) With 15 crore Dividends, 20 crore Cash Flow, one way to look at the Plant CAPEX could be that the company managed 5 crore from internal accruals. For the rest it took on Debt. (ROCE >> CoC).
- (b) Loans by Promoters states “no risk of default on Principal as well as Interest”. With 15% returns in FY’14-15 and non-payment in FY’15-16 it may effectively feel like cumulative Preference Shares with a lazy arrangement – but kind of fair.
- (c) with 23-31000 T of production per year, average usage of 14 TPH plant capacity is still between 4.5-7.5 hours a day. Or is that already a bottleneck for Sales growth?
Thanks and regards.
Thanks for your feedback & appreciation! I am happy that you found the articles useful! Thanks for sharing your valuable inputs.
Let’s now address the queries raised by you:
1 &2) It is essential for any company to make free cash flows to survive and create value for shareholders in the long term. Otherwise, the company is a continuous cash drain, which consumes the entire cash that it generates from operations as well as additional cash from debt/equity. There have been many cases where companies perished as a result of debt funded growth:
Therefore, I always prefer to invest in companies which generate free cash flow. At some stage in future, the additional cash from debt &/or equity starts becoming unavailable and the whole business crumbles. In an extreme sense, it looks like a ponzi scheme.
3A) Loan by promoters should ideally be equity. I believe that a promoters should earn by way of dividends and if working as an executive, then as a way of salary. Any other format of taking cash from the company should be looked with caution. Here also the interest rate being paid to promoters is much higher than the market rate, which further deepens my belief that any form of promoter’s money in the company, other than equity should usually be seen with caution.
3b) Faisal has shared very good calculation of capacity utilization and future potential in the above article on Chaman Lal Setia Exports Limited. You may take guidance from his calculations.
Hope it answers your queries. If you have any other concern, then feel free to write as comments. I will be happy to provide my inputs.
All the best for your investing journey!
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- 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.