Interpreting Negative Working Capital Companies, Are Buying & Holding Criteria Different

Modified on July 13, 2018

The current article in this series provides responses related to:

  • How to interpret companies with negative working capital?
  • Why would a company with SSGR less than sales growth be debt free?
  • Is increase in the market cap being less than retained earnings a red flag?
  • How to calculate operating profit?
  • Are buying and holding criteria different?

How to interpret companies with negative working capital?

Hi Dr. Vijay

  1. Negative working capital is usually considered not favourable as the current liabilities being higher than current assets is not a good sign.

But, at times, we have also read that negative working capital is good too. For example, if the cash conversion cycle is negative then your inflow of funds are more and faster than the outflow of funds and hence may result in the negative working capital. Is my understanding correct?

How to analyse negative working capital and find which situations are good and which situations are bad?

  1. When the overall markets are richly valued or frothy, and if you find good companies at fair or undervaluation, then from where do you draw the conviction to invest in them? Because I often get confused and wait for the overall market to also correct along with these companies so that I can invest at much lower valuation 🙂

Is this approach correct?

Author’s Response:

Hi,

Thanks for writing to us.

1) If the negative working capital is on account of liquidity crunch and not on account of higher bargaining power over vendors/suppliers, then there would be other signs of financial stress in the company like burgeoning debt, delay in project execution, debt servicing requirements being more than CFO etc.

Advised reading: How to do Financial Analysis of Companies

2) The conviction to invest is usually drawn from the process of stock analysis and selection. You may read more about our stock selection process and the steps to arrive at the price to pay for any stock in the following article:

3 Principles to Decide the Investable P/E Ratio of Stocks

If any stock is able to score successfully on all our parameters including the valuation, then we invest in it regardless of the market/Nifty/Sensex valuations.

We are able to elaborate/clarify the approach that we follow. We do not have any opinion on the approach being followed by other investors including your approach.

Hope it answers your queries.

All the best for your investing journey!

Regards

Dr. Vijay Malik

Is increase in the market cap being less than retained earnings a red flag?

Dear Dr.

You have told that increase in market cap should be more than the retained earnings for 10-year data. Suppose any stock became undervalued due to any reason, its increase in MCap may go down than the retained earnings. What should we do in this case?

Please guide. 

Author’s Response:

Hi,

Thanks for writing to us!

Currently, we do not keep the parameter of cumulative retained earnings for 10 years being more than the increase in market cap over 10 years as filtering criteria. If all the other parameters are excellent, then it may be a sign of undervalued opportunity.

All the best for your investing journey!

Regards

Dr. Vijay Malik

 

How to calculate operating profit?

First Read: NOCIL Research Report

Hats off to you for the analysis and also giving your work to the public. Makes a learner’s life so much better.

Sir, I would like to know how you calculated the operating profit for the latest financial year (March 2017). The revenue for NOCIL was 742 crores. (From operations, excluding other income). Expenses are around 600 crores. Profit before tax is 150 crores.

Operating profit (EBIT): I added back the finance cost of 2.22 crores so I got the operating profit of 153 crores. But your worksheet shows an EBIT of 159 crores. So I would like to know where I am going wrong. What other expenses are u excluding?

Thanks in advance.

Author’s Response:

Hi,

Thanks for writing to us! We are happy that you found the article useful.

We calculate the operating profit from the data provided by Screener by factoring in the following expenses from the sales income/operating revenue:

  • Raw Material Cost
  • Change in Inventory
  • Power and Fuel
  • Other Mfr. Exp
  • Employee Cost
  • Selling and admin
  • Other Expenses

To reconcile these items in the screener export to excel data sheet with the annual report, we request you to refer to the following article:

Read: How to Use Screener.in “Export to Excel” Tool

Reference to this article and using the Screener data will help you.

All the best for your investing journey!

Regards

Dr. Vijay Malik

 

Are buying and holding criteria different?

Dear Dr.

You have told that we should invest in low PE ratio good business to get the benefit of earnings and PE expansion and keep holding the stock until the business get worse.

My doubt is:

  1. Can we invest in the stocks which are in early phase of PE expansion, means whose PE ratio is ~15?
  2. Why we focus on margin of safety only while investing, why not during the holding period?

Please clarify.

Author’s Response:

Hi,

Thanks for writing to us!

1) We should decide about investing in any stock after assessing it from all the perspectives like financial, business, management and valuation. Only looking at valuation would be taking a myopic view.

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

In case, an investor is satisfied with all the fundamental aspects of any company and is ok with paying the price at which it is available in the market, then she may choose to invest her money.

2) We keep the buying and holding criteria different. Once we buy a stock in our portfolio, then we usually hold it until the fundamentals are intact and in fact, add more until the price is in our buying range.

Read: 3 Principles to Decide the Investable P/E Ratio of Stocks

All the best for your investing journey!

Regards

Dr. Vijay Malik

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.

"Peaceful Investing": My Stock Investing Approach

“Peaceful Investing” approach is the result of my more than a decade of experience in equity markets. This approach helped me invest even when I had a full-time corporate job and could not spare a lot of time for stock analysis. During my investing journey, I have faced all the common challenges of the investors, the biggest one being “scarcity of time”. “Peaceful Investing” approach keeps in mind that an investor will have limited amount of time to spare for stock investing. 

The objective of “Peaceful Investing” approach is the selection of such stocks, where once an investor has put in her money, then she may sleep peacefully. Therefore, if later on, the stock prices rise, then the investor is happy as she is now wealthier. On the contrary, if the stock prices fall, even then the investor is happy as she can now buy more quantity of the selected fundamentally good stocks.

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