This is a quick scribble, since I'm in middle of many thoughts and writings and decision...and this is just an investment journal of what I'm thinking and going to do NEXT.
Here's the state of portfolio
- Have been adding few mutual funds to my portfolio, and have now concluded on this activity, except one last mutual fund SIP that needs to be started. My mutual fund allocation currently in my investment portfolio is 9%
- I've finally settled on fixed income securities - it'd be a combination of the following
a. Fixed deposits with healthy, stable banks, with deposits of up to Rs. 1 lac in each bank.
b. Floating rate debt funds. I've currently chosen SBI Magnum FRP - Savings Plus Bond Plan.
The current allocation of these fixed income (almost) securities in my portfolio is 12.94%, and I plan to increase it to about 20%, given the fact that I'm not planning to make any large equity investments in months to come, and there's quite some cash lying idle :)
- Cash and cash equivalent (in the form of liquid funds) currently stands quite high - at about 35%, and I plan to reallocate it into fixed income and equity mutual funds over next few weeks.
- The equities part of my portfolio is now structured into the following categories, mainly influenced by Dead Monk's portfolio. I must admit that most of the stocks were NOT bought originally with this thought, and it's a "re-allocation" I've done since I believe that most of the stocks in my portfolio are not bad businesses, and the fact that I want to remain invested in stocks.
a. High dividend healthy businesses - these are stocks that give a dividend yield of 4-5% or higher, and are healthy businesses (it's OK if there's industry wide slowdown or similar cyclical problems). I moved BHEL and MAZDA into this category, and current allocation here is 6.8%. I need to increase this, but I'll not buy stocks directly for few months now, when I want to focus on studies, and hence, to increase exposure here, I plan to move some cash into dividend plans of mutual funds
b. Stalwarts - this is influenced from Mr. Lynch, and I'll buy stable, large cap businesses that have been beaten down in market for some reason, and it is envisaged that the depression in stock prices is only temporary. Generally, these stocks may also provide good dividend. However, I don't intend to hold them for a very long time, but only expect 40 - 70% return when prices move up again, and this part of portfolio will have quite some churn. Currently, I hold BHARTI AIRTEL and INFOSYS in this category, amounting to 12.2%
c. Others - This includes speculative bets (stocks and derivatives), sidecar investments and all other types of stock investments. I had to move MCX into speculative category after NSEL fiasco, and this bucket now contains Piramal Enterprises apart from MCX, totaling to about 3% of my portfolio. I'll keep a strict upper limit of 10% on the speculative bets at all times, and these days, I'm thinking of trading in NIFTY options based on some highly trusted information sources :)
Hmm, so my portfolio is all right and not too skewed at present, except the actions identified above. So, let's now go back to work and resume studies, until 4 weeks later when I revisit my portfolio :)
Sunday, September 22, 2013
Wednesday, August 28, 2013
MCX India Ltd
Update (28th Aug 2013): Soon after I analyzed and posted, the world came to know about NSEL crisis. I suddenly realized I'm in 60%+ loss in the moderate positions I had accumulated in MCX, which I thought was undervalued at Rs. 800. Anyways, lot of emotions, reactions, etc. I've finally made my decision on what I'll do with it, but before that, here're some links which I want you to refer to:
========================================
June 24th, 2013: I analysed this stock in quite some details and posted my analysis on Safal Niveshak StockTalk. Enjoy reading.
- Discussion on SafalNiveshak Google Group
- Nice post by Prof. Bakshi and the discussion in comments section.
Hmm, so what I decided? Here's it:
- There're decent chances that FTIL group's demise is fast on its way, and sooner or later, they'll have to let go of their control on MCX
- The uncertainty is - how long it can take for this to happen
- When such a stake sale occurs, MCX may realize at least "fair valuation", and if my analysis if not grossly wrong, the stock price should come back to my initial buying price. Probably higher
- However, if we consider that as a reasonable probability event also, there's risk of losing all of the investment - if MCX stake sale doesn't occur and business loses trust, market share, and its sheen.
- Thinking in terms of probability, therefore, it DOES NOT make sense to invest more money into the business right now. The risk-reward ratio is not highly favorable to warrant the risk.
However, since there's good chance for a bounce back (and as I write this, the stock is now locked in upper 5% circuits for few sessions now, in the anticipation of some groups keen in buying FTIL's stake in MCX), I'll hold on to the investment and exit when the news of stake sale is out, or I find some other strong reason t quit this investment. However, I won't put in new money into this investment until I know that MCX is a "fresh" business, under a new, credible owner.
Goodbye :)
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June 24th, 2013: I analysed this stock in quite some details and posted my analysis on Safal Niveshak StockTalk. Enjoy reading.
Friday, August 23, 2013
The Final Decision
Here's a jot down of my thinking process and organizing those thoughts, after I slept over my last two posts on clearing confusions and focusing ..and I'm happy to have emerged stronger from the turmoil and have a clearer vision now :)
- Letters from Mr. Warren Buffet
- Mr. Charlie Munger's work on mental models
- Howard Marks's memos to investors
- Security Analysis by father of Value Investing, Mr. Ben Graham
1. Base rate of success of value investing in the long term, and timing the market along with study of business fundamentals - on this topic, I find and believe that base rate of long term investing success is quite good if time horizon is 15 to 20 years, as evident from below summary of few reads:
Immediate Actions, in this order
(0) Set the eventual goal of investing, write it down, and make sure you don't flip-flop - most important is to stick to the process and plan and not get worried by noises and intermediate results, which are anyways temporary...
1. Trim down PEL to a maximum of 5% of portfolio. This translates to selling about 40% of existing held shares in this counter. Then move this investment into speculative category.
[DONE]
2. Exit ARBL and IL&FS completely.
[DONE]
3. Start (small) SIP in PPFAS LTV fund.
[ONGOING]
4. Decide about MCX - whether to continue holding it as a high risk speculative bet in portfolio, or put sin money rather into Index Options trading (more as a portfolio hedge or trading only in strongly trending markets with clear stop losses and deep in-the-money options). Well, I feel more comfortable "avoiding options" due to the huge mental stress cost associated with them, at least as of now, and in that respect, MCX is easier. I'll therefore keep Index Options as a hedging instrument only, that too after assessing the risk-reward given I've liquidated some amount of stocks already. let that be a separate action below, in the next actions category. For MCX, I'll very slowly accumulate the stock whenever it is a bargain - need to look at latest audited balance sheets for the same, and that's an action now.
5. Analyze whether CARE needs to be exited immediately, or we have more to analyze it in further details.
6. Analyze what to do about capital goods stocks (BHEL, CG, MAZDA)
Next Action is to create a study plan, that'd comprise of:
(0) Can mutual fund SIPs (regular and continuous) be good enough for average returns, slightly better than fixed income? Further, invest (new money) directly into stocks only if you find a really great bet after very conservative and thorough analysis? As Mr. Buffet says, 2-3 great picks an year are more than enough...
(0->1) Goals and deadlines are for pure science work, which is somewhat true in office and engineering products. Investing is more of an art and hence it's futile to set goals and timelines. Be clear about it and set a wider goal accordingly, which should be to live a happier life. Outcomes which are out of your control should not worry you so much in future.
(...) I also need to revise lessons from Bhagvad Gita as it'll help me stick to my philosophy and strategy, and not get deviated by noises.
1. Technical analysis for long term investments and portfolio hedging using index options?
2. Portfolio allocation between value oriented investments, speculative bets (can you rely on others for this? are you competent emotionally for fast moving market timing based decisions? cost of mental stress?) and other investing methods (quantitative value investing purely based on numbers like Ben Graham's or Magic formula based screening or Prof. Bakshi's statistical bargains...).
3. The following readings for value investing / behavioral control, as I also mentioned in last post:
- Letters from Mr. Warren Buffet
- Mr. Charlie Munger's work on mental models
- Howard Marks's memos to investors
- Security Analysis by father of Value Investing, Mr. Ben Graham
- Prof. Bakshi's blog
- Pat Dorsy and Phil Fisher
- A few books on behavioral finance and history of market manias and crashes
4. Finally, maintain a regular portfolio review schedule - say every fortnight, and you don't want to spend too much time on this every week.
============================================================
Here're the notes based on brainstorming and taking final decisions:
This link shows how long has it taken for value oriented investments to recover in the past, and it is generally less than 5 years. Based on this "history", the decline that started in end of 2010 in Indian stocks (not the indices) should end by 2015 or earlier, and we should get good chances to exit investments in "not so great" businesses or not so great stocks in our portfolios at a decent if not great profit and re-balance portfolios sometime in 2016-2018. You need to stick blindly to buy and hold, but rather be vigilant of the business conditions and take decisions to sell stocks. Further, this study shows that base rate of success of a diversified portfolio with balanced allocation and held for over 20 years is quite high, and the key is NOT to time the market and staying invested. Finally, if you buy stocks very cheap, dividend yields tend to get higher and they more or less offset the cost of capital that's held in the investment. Hence, finding great value bargains with dividend yields approaching long term bond yields is an excellent opportunity to make great wealth.
The next question that relates to market timing is - What if I keep accumulating good quality stocks at good prices, but when it's time that I need money, we have a great depression? I'll just have one chance. On this, I read and found that:
This interview by Mr. Buffet tells us how staying invested in equities for long term generates superior returns - which is an increase in purchasing power of original invested money, post tax and costs, while ensuring sufficient safety of principal invested. Many other articles (like this) explain how timing the market is not so useful (yes there're exceptions, but probably the cost of stress and amount of time-investment is not so advantageous in terms of extra returns, even if they could be generated). Finally, we know the base rate of success of market timing is quite poor. We may still explore this subject of "Technical analysis for long term investments" in future as a part of study plan, but for now, we're incapable of performing this timing analysis on existing investment.
3. Whether to use PoE and quickly decide which stocks I can't hold for long enough, as an action from the last post. Not so sure, and rather the stock actions below are a better choice.
4. Stock actions (with the intention to minimize time resource allocation towards stock study, and re-allocate the same time more towards reading and learning):
a. Trim investment in PEL, mainly since I don't understand it very well, and sidecar investment can't be top holding in a value oriented long term portfolio. Considering it can still be a good investment, I'll trim it down to about 5% of my portfolio, and hold it as a special situation (where the capable manager in Mr. Piramal can revive the enterprise and generate superior returns, but this still has a level of speculative element as an investment and hence not a pure value play, and rather a turnaround story which may not do so)
b. Exit IL&FS and ARBL, as they'e anyways speculative bets not going to run away in a hurry and better would be to re-allocate these funds into mutual funds that I already hold (and they do have invested in these stocks). An action here (to get exposure to IL&FS indirectly) is to start a small SIP into PPFAS Long Term Value Mutual Fund, which may generate decent returns over long term (yes, there's a key man risk involved, and hence limiting exposure through a small SIP)
c. To conclude on what to do about capital goods stocks, MAZDA, CG and BHEL, I think I'm little worried about their long term future - they may not turn out to be great investments, but I think they'll generate good returns. The question is - since this is the industry I understand the best (engineering stocks), and they're ones in deep losses (except MCX), should I continue to hold or exit in the hope of timing the market and buying them when signs of recovery in capital goods industry are better, and even re-consider better bets like L&T? I don't yet know, and need to think on this with focus...
d. Rest of portfolio is MCX and CARE, of which I just moved MCX to speculative grade and hence I'll decide on that soon as a separate action, and CARE needs more analysis (if it's too hard to understand well) before any call can be taken. Regarding INFY and BHARTI (Bharti Airtel is probably a business more complex than I originally assumed, but since I understand it at a high level and believe that the worst is over for this sector and the business, I can afford to wait for some time to analyze this in deep, or move to the "out / too-hard" basket later on), I think I'll remain invested in these sound businesses - downside risk is quite limited in these, and I'll slowly perform more conservative analysis of these businesses and take a call accordingly, but no hurries to sell these two stocks right now.
Wednesday, August 07, 2013
Focus Dude, Focus...
Two days back, I cleared some deal of confusion in my mind, and I was trying to find some time to analyze how importance or dangerous is market timing for value investors, but even before I could read and assimilate that topic, a new doubt has emerged, and it's high time I write about it and try to clear it up as well. This came up from here, and the comments from Ajay in that post, and then some discussions at home, and further, Vishal's reply have given some direction to the thoughts.
So, the new doubt is - that I still have a long way to go; I need to read the following:
- Letters from Mr. Warren Buffet
- Mr. Charlie Munger's work on mental models
- Howard Marks's memos to investors
- Security Analysis by father of Value Investing, Mr. Ben Graham
- A few books on behavioral finance and history of market manias and crashes
All this needs a good deal of time, and more importantly, focus, and considering my day job, it's not so easy to get ample time. On top of that, my sizable investments into some "decent" stocks where I've not done detailed analysis and have committed few mistakes while building this portfolio keeps me slightly worried, at least so much that I spend a majority of time that I get on analysis of my portfolio and what should I do about it - forget about it, book profit in stocks that're in positive, cut losses or look for bottom fishing opportunities in stocks that've lost over 40% since I invested in them, thinking they were undervalued, or just liquidate everything and step aside (but slowly move money into mutual funds since I'm convinced I don't want to have too low an exposure in equities at any point in time).
So this time, it's a clear resource problem, more than anything. let us see how to resolve it. First, we write down scenarios, performing a sort of pre-mortem:
A. I spend (or waste) all of my time in analyzing stocks I already hold, and worry since I'm not able to take a clear decision whether to hold or sell them (it's far more difficult to control emotions when you see 50% losses in stocks you did not analyze well enough before buying). Since no actionable outputs emerge from such an analysis, it's definitely a waste of time
B. I analyze my existing portfolio and I'm able to decide on cutting some positions (either because I've strong reasons to believe that the business will deteriorate further in coming months and it'll reflect in the stock prices, or I believe that stock prices are a bit over-priced and there could be pain the medium term, in summary identifying stocks which I don't think can be held for next 5 years). If this can be done, it'd be a useful outcome of time spent. However, this would easily take over 2 months of my time if I can regularly analyze the stocks and underlying businesses, and I'm worried that in these two months, markets may move much lower leading to further losses to my portfolio
C. I spend couple of days, and try to use process of elimination, and find stocks where I've even a small doubt in holding for long term, while writing down my reasons on why I think so. Or, even those stocks where I believe there're strong reasons that they might under-perform for many months to come, even if they might be good bets for long term. Well, this might be a smart thing to do, but it has a risk of going grossly wrong about many points since it's effectively a short-cut. Let's come back to this point in a while.
D. I conclude that I've made few mistakes in picking stocks without detailed analysis, and I'm in general uncomfortable, and I'd better do by moving funds into mutual funds. However, I also weigh the fact that Vishal pointed about Icarus' Deception today, and decide to balance out investments in mutual funds and direct stocks, by remaining invested in the stocks where I feel there's good potential and I've not made a big mistake.
E. I don't do anything, and just decide how to NOT get de-focussed by looking at my stock portfolio, and only focus on reading. However, am I not trying to find just this "method" for so long now? To some extent, Vishal's post and then my introspection helped, but the realization that my analysis in many stocks is not that detailed and the worry about my portfolio being concentrated in sectors which may suffer for many months, possibly couple of years adds to the confusion.
Ok, having written in this post so far, one thought emerges - let me not look at every stock in my portfolio the same way, and rather write down about each of them, while recognizing that what's in profit today may not remain so, and what's down 60% may show a smart bounce back. So here's the list:
2. IL&FS
4. AMARA RAJA BATTERIES (ARBL)
5. PIRAMAL ENTERPRISES (PEL)
6. MAZDA LTD (MAZDA)
8. CROMPTON GREAVES (CG)
9. BHARTI AIRTEL (AIRTEL)
10. INFOSYS (INFY)
Now the interesting fact. The deeply analyzed stocks are either under-held (IL&FS), or in large losses (MCX). Then within moderately analyzed stocks, PEL is a side-car investment which may perform contra to the general market and I'm not much worried about this investment, and ARBL is only a negligible percentage of my portfolio. I'm neutral about holding MAZDA, a decent dividend yield being the only attractive reason, and CARE RATINGS is a confusion which I'll talk later about. Finally, the "not so well analyzed" stocks are popular large caps which earlier became out of favour when I picked them (INFY and AIRTEL) and the other two, CG and BHEL which comprise of more than 35% of my portfolio (by cost, but not by price) are reeling under an industry wide pressure (capital goods), which otherwise are decent businesses with a decent management quality.
Let me then eliminate stocks about which I'm not much worried:
a. PEL: A side-car investment, contra to market due to being a pharma company and in the hands of a solid management. However, since my exposure is large, I may consider trimming a bit and take some profits home if I decide to size down.
b. Negligible investments, so not much worry: IL&FS, ARBL
c. MAZDA is something I had been thinking for a while to trim down, so it should be an easy decision.
Now, the tougher ones:
d. INFY and AIRTEL are generating some handsome profits in my portfolio, and based on what I hear, these would keep going up in months and days to come, and while there're problems (and these businesses may again turn negative), there are some good positives that've emerged for both the businesses, and hence I'll be comfortable holding them for long term. The only point is that they're both 10% each in my current portfolio, and I'd find it easier to trim down if I've to sell other shares and trim down my exposure into direct stocks.
e. BHEL and CG, even though they're quite down, I still continue to remain positive about their long term future given the large need for India to grow it's energy infrastructure and tackling power shortage. However, there're challenges in the environment today which may keep this sector under pressure for many more months, and hence it may be prudent to trim exposure to these stocks and return back after a deeper analysis, and there's little risk of not being able to buy them at sufficient margin of safety even after 6 months.
f. CARE and MCX, well, toughest calls since I somehow feel positive about their long term prospects, but there're some short to medium term concerns that may take these stock prices further down, and I may loose as much as 90% of my investment into these two names. Further, both are associated with some form of "financial leverage" which is one big thing which makes me worried these days.
To summarize so far, I'm comfortable in:
1. Maintaining my small investment in ARBL and IL&FS
2. Trimming about 25-30% of my investment in PEL, BHARTI and INFY
3. Trimming down upto 50-60% in MAZDA, BHEL and CG
4. Not yet sure about what to do about CARE and MCX. Possibly buy more after further analysis since I still hold a positive view in the long term about these businesses.
Let's say I do this re-allocation. I bring down my exposure into direct stocks by about 30%, and even then, I'd have about 30% of my overall portfolio invested directly into stocks. Is it a comfortable level? Does it then allow me to not worry about these investments and focus on studying? Let me find that out, again by analyzing probabilities:
Scenario A: Leave portfolio as it is won't work - I've seen that now for last 3-6 months.
Scenario B: Trim down direct equity exposure as described above, and then leave those stocks there, and analyze them as I get time (while maintaining a regular study routine). This sounds more comfortable since it meets both goals - first to reduce exposure and hence risk of a wash-out (I still stand a chance to loose 30% of my portfolio, but that's a low probability event since these are still good quality businesses, maybe I'll lose 20-30% of direct equity portfolio, but not majority of it, and in such a more realistic worst case scenario also, I only loose 10% or lesser of my overall investments in equity, Mutual Funds and Debt); and second that I'm still decently invested in equity in case my worries of having picked wrong stocks by doing an incomplete analysis turns out to be wrong and some of them turn out to be multi-baggers in next 10-15 years. Finally, there's another indirect benefit, that I won't quit value investing, which could be a risk if I sell off all the direct stocks (and rely on good fund managers and not worry about learning some great knowledge about investing)
Scenario C: I say good-bye to all the individual stocks, and focus only on studies. But as I just said, there's a risk that I'll quit completely from value investing and my procrastination may rule and take me away from value investing and learning some great knowledge.
So, Scenario B seems to work the best. Let's now do a pre-mortem as final step - what can kill this plan? Let's see
- I still continue to worry about the remaining 30% of my money invested directly in stocks, and can't focus on studies. This is possible since if I assume I won't lose more than 30% of my equity portfolio over long term as a worst case, today I stand a chance to lose about 15% of my investments, and after this re-allocation, under the assumption that mutual funds won't lose any amount, I'd lose 10%. So the difference is only 5% of my current investments, but that's not a small amount. Let's see...
- I start moving funds from stock sale into mutual funds and then start worrying about mutual funds. Probably unlikely since I'd move funds gradually using SIP and then mutual funds can't lose a major part of capital, unless we're heading into a great depression for next 20 years! Again, a very low probability event.
- I don't worry about stocks, and I don't study also. Well that means I quit value investing anyways, but again a very low probability event given my strong and growing interest.
Phew, so much that I wrote. Let me now go and take rest, read this post 5-10 times again and then sleep over the idea, and finally act once I'm convinced about what I want to do :)
If not anything, it'll give me better clarity about my doubts and problems and a better way to pursue forward.
Wish me best of luck, bye bye :)
So, the new doubt is - that I still have a long way to go; I need to read the following:
- Letters from Mr. Warren Buffet
- Mr. Charlie Munger's work on mental models
- Howard Marks's memos to investors
- Security Analysis by father of Value Investing, Mr. Ben Graham
- A few books on behavioral finance and history of market manias and crashes
All this needs a good deal of time, and more importantly, focus, and considering my day job, it's not so easy to get ample time. On top of that, my sizable investments into some "decent" stocks where I've not done detailed analysis and have committed few mistakes while building this portfolio keeps me slightly worried, at least so much that I spend a majority of time that I get on analysis of my portfolio and what should I do about it - forget about it, book profit in stocks that're in positive, cut losses or look for bottom fishing opportunities in stocks that've lost over 40% since I invested in them, thinking they were undervalued, or just liquidate everything and step aside (but slowly move money into mutual funds since I'm convinced I don't want to have too low an exposure in equities at any point in time).
So this time, it's a clear resource problem, more than anything. let us see how to resolve it. First, we write down scenarios, performing a sort of pre-mortem:
A. I spend (or waste) all of my time in analyzing stocks I already hold, and worry since I'm not able to take a clear decision whether to hold or sell them (it's far more difficult to control emotions when you see 50% losses in stocks you did not analyze well enough before buying). Since no actionable outputs emerge from such an analysis, it's definitely a waste of time
B. I analyze my existing portfolio and I'm able to decide on cutting some positions (either because I've strong reasons to believe that the business will deteriorate further in coming months and it'll reflect in the stock prices, or I believe that stock prices are a bit over-priced and there could be pain the medium term, in summary identifying stocks which I don't think can be held for next 5 years). If this can be done, it'd be a useful outcome of time spent. However, this would easily take over 2 months of my time if I can regularly analyze the stocks and underlying businesses, and I'm worried that in these two months, markets may move much lower leading to further losses to my portfolio
C. I spend couple of days, and try to use process of elimination, and find stocks where I've even a small doubt in holding for long term, while writing down my reasons on why I think so. Or, even those stocks where I believe there're strong reasons that they might under-perform for many months to come, even if they might be good bets for long term. Well, this might be a smart thing to do, but it has a risk of going grossly wrong about many points since it's effectively a short-cut. Let's come back to this point in a while.
D. I conclude that I've made few mistakes in picking stocks without detailed analysis, and I'm in general uncomfortable, and I'd better do by moving funds into mutual funds. However, I also weigh the fact that Vishal pointed about Icarus' Deception today, and decide to balance out investments in mutual funds and direct stocks, by remaining invested in the stocks where I feel there's good potential and I've not made a big mistake.
E. I don't do anything, and just decide how to NOT get de-focussed by looking at my stock portfolio, and only focus on reading. However, am I not trying to find just this "method" for so long now? To some extent, Vishal's post and then my introspection helped, but the realization that my analysis in many stocks is not that detailed and the worry about my portfolio being concentrated in sectors which may suffer for many months, possibly couple of years adds to the confusion.
Ok, having written in this post so far, one thought emerges - let me not look at every stock in my portfolio the same way, and rather write down about each of them, while recognizing that what's in profit today may not remain so, and what's down 60% may show a smart bounce back. So here's the list:
Well analyzed Stocks
1. MCX2. IL&FS
Moderately Analyzed Stocks
3. CARE RATINGS (CARE)4. AMARA RAJA BATTERIES (ARBL)
5. PIRAMAL ENTERPRISES (PEL)
6. MAZDA LTD (MAZDA)
Not Analyzed So Well
7. BHEL8. CROMPTON GREAVES (CG)
9. BHARTI AIRTEL (AIRTEL)
10. INFOSYS (INFY)
Now the interesting fact. The deeply analyzed stocks are either under-held (IL&FS), or in large losses (MCX). Then within moderately analyzed stocks, PEL is a side-car investment which may perform contra to the general market and I'm not much worried about this investment, and ARBL is only a negligible percentage of my portfolio. I'm neutral about holding MAZDA, a decent dividend yield being the only attractive reason, and CARE RATINGS is a confusion which I'll talk later about. Finally, the "not so well analyzed" stocks are popular large caps which earlier became out of favour when I picked them (INFY and AIRTEL) and the other two, CG and BHEL which comprise of more than 35% of my portfolio (by cost, but not by price) are reeling under an industry wide pressure (capital goods), which otherwise are decent businesses with a decent management quality.
Let me then eliminate stocks about which I'm not much worried:
a. PEL: A side-car investment, contra to market due to being a pharma company and in the hands of a solid management. However, since my exposure is large, I may consider trimming a bit and take some profits home if I decide to size down.
b. Negligible investments, so not much worry: IL&FS, ARBL
c. MAZDA is something I had been thinking for a while to trim down, so it should be an easy decision.
Now, the tougher ones:
d. INFY and AIRTEL are generating some handsome profits in my portfolio, and based on what I hear, these would keep going up in months and days to come, and while there're problems (and these businesses may again turn negative), there are some good positives that've emerged for both the businesses, and hence I'll be comfortable holding them for long term. The only point is that they're both 10% each in my current portfolio, and I'd find it easier to trim down if I've to sell other shares and trim down my exposure into direct stocks.
e. BHEL and CG, even though they're quite down, I still continue to remain positive about their long term future given the large need for India to grow it's energy infrastructure and tackling power shortage. However, there're challenges in the environment today which may keep this sector under pressure for many more months, and hence it may be prudent to trim exposure to these stocks and return back after a deeper analysis, and there's little risk of not being able to buy them at sufficient margin of safety even after 6 months.
f. CARE and MCX, well, toughest calls since I somehow feel positive about their long term prospects, but there're some short to medium term concerns that may take these stock prices further down, and I may loose as much as 90% of my investment into these two names. Further, both are associated with some form of "financial leverage" which is one big thing which makes me worried these days.
To summarize so far, I'm comfortable in:
1. Maintaining my small investment in ARBL and IL&FS
2. Trimming about 25-30% of my investment in PEL, BHARTI and INFY
3. Trimming down upto 50-60% in MAZDA, BHEL and CG
4. Not yet sure about what to do about CARE and MCX. Possibly buy more after further analysis since I still hold a positive view in the long term about these businesses.
Let's say I do this re-allocation. I bring down my exposure into direct stocks by about 30%, and even then, I'd have about 30% of my overall portfolio invested directly into stocks. Is it a comfortable level? Does it then allow me to not worry about these investments and focus on studying? Let me find that out, again by analyzing probabilities:
Scenario A: Leave portfolio as it is won't work - I've seen that now for last 3-6 months.
Scenario B: Trim down direct equity exposure as described above, and then leave those stocks there, and analyze them as I get time (while maintaining a regular study routine). This sounds more comfortable since it meets both goals - first to reduce exposure and hence risk of a wash-out (I still stand a chance to loose 30% of my portfolio, but that's a low probability event since these are still good quality businesses, maybe I'll lose 20-30% of direct equity portfolio, but not majority of it, and in such a more realistic worst case scenario also, I only loose 10% or lesser of my overall investments in equity, Mutual Funds and Debt); and second that I'm still decently invested in equity in case my worries of having picked wrong stocks by doing an incomplete analysis turns out to be wrong and some of them turn out to be multi-baggers in next 10-15 years. Finally, there's another indirect benefit, that I won't quit value investing, which could be a risk if I sell off all the direct stocks (and rely on good fund managers and not worry about learning some great knowledge about investing)
Scenario C: I say good-bye to all the individual stocks, and focus only on studies. But as I just said, there's a risk that I'll quit completely from value investing and my procrastination may rule and take me away from value investing and learning some great knowledge.
So, Scenario B seems to work the best. Let's now do a pre-mortem as final step - what can kill this plan? Let's see
- I still continue to worry about the remaining 30% of my money invested directly in stocks, and can't focus on studies. This is possible since if I assume I won't lose more than 30% of my equity portfolio over long term as a worst case, today I stand a chance to lose about 15% of my investments, and after this re-allocation, under the assumption that mutual funds won't lose any amount, I'd lose 10%. So the difference is only 5% of my current investments, but that's not a small amount. Let's see...
- I start moving funds from stock sale into mutual funds and then start worrying about mutual funds. Probably unlikely since I'd move funds gradually using SIP and then mutual funds can't lose a major part of capital, unless we're heading into a great depression for next 20 years! Again, a very low probability event.
- I don't worry about stocks, and I don't study also. Well that means I quit value investing anyways, but again a very low probability event given my strong and growing interest.
Phew, so much that I wrote. Let me now go and take rest, read this post 5-10 times again and then sleep over the idea, and finally act once I'm convinced about what I want to do :)
If not anything, it'll give me better clarity about my doubts and problems and a better way to pursue forward.
Wish me best of luck, bye bye :)
Monday, August 05, 2013
Clearing the confusion
It's been a turmoil in my mind for last few weeks. I've heard a lot on how financial markets will do in coming future and how chances of a major crash in equities, commodities and real estate is going to follow us, and how cash will become the most sought out asset class (just opposite of what's the case today - easy liquidity is the buzzword today and no-one wants to keep cash with them, all of them want to "invest").
Well, that may very well turn out to be true. True that the mindless money printing can't go forever and liquidity worldwide will become tighter in months and years to come. Governments have to realize that they can't keep pumping and throwing cash like that and keep building their debt - this is NOT going to solve the problem of slowdown, it is only delaying the inevitable: world markets and economies are on steroids and this is NOT a healthy growth, any of which we see, and rather this is cancerous growth and must be curtailed at the earliest. You can't provide easy and cheap money to corporations and allow them to over-produce and foolish consumers to over consume. One day, this "bubble" has to bust and things will then revert to mean (which is healthy, organic growth, just about the right amount humans normally need). Of course, when reversion to mean occurs, it is always preceded by over-reactions and extending too far into opposite direction, simple law of physics that:
- either we slowly revert, without "overshooting" to the other side, i.e., over-damped systems, or
- revert in speed, and the faster the speed (which is generally true since everyone is taken aback by reversal and then there's panic and that causes a positive feedback to come in and speed up the reversal, till there's no more energy to continue reverting), larger the "overshoot" to the other side, i.e., under-damped systems.
OK, enough of macro-economics and physics. Let's get to the point. What is my confusion? Let me write down my worries:
a. Less than 5% chances that prices will fall by more than 90%
b. Upto 15% chances that prices will fall by up to 70-90%
c. 30-40% chances that prices will fall up to 60-70%
d. Good chances that prices will fall up to 50%
So, in summary, there's no reason for my worry "A" and confusion. Let's look at worry "C" before "B". Well, capitalism works on the basis of greed and fear, and the world has seen many such credit bubbles, and a very good summary of these bubbles is in this book, which I want to read for a long time. However, the summary is "The Rise of the Fallen" in literal sense :)
So long as we live in a capitalist world, we'll have to see such bubbles boom and bust, and we're probably facing the bust of an even bigger, possibly largest credit bubbles of all times, more so because of highly increased financial leverage across the world. But we can't be more worried about it. So long as we pick good businesses, they'll continue to perform well. Again it'd be a low probability event that businesses with healthy balance sheets, lots of cash in hand and large market shares will collapse easily. Yes there'll be pain, but as long as we continuously monitor their business performance, we can manage the risks associated in their investments. Hence, I'm convinced that my worry "C" is also unwarranted and it's futile to spend time and energy, not to forget stress due to something which is very low probability and simply out of my control.
Finally, what about my worry "B", which simply spells about market timing? This is an area I'm still exploring and trying to find answer to the next big question: "Have times changed such that market timing is now more important even for Value Investors?" Well, let that be the topic for my next post and I'll very soon come back on it.
Until then, may my little mind rest properly and go back to sleep every night peacefully and not with worry of what would happen to the world economy next morning. Enjoy the beautiful day :)
Well, that may very well turn out to be true. True that the mindless money printing can't go forever and liquidity worldwide will become tighter in months and years to come. Governments have to realize that they can't keep pumping and throwing cash like that and keep building their debt - this is NOT going to solve the problem of slowdown, it is only delaying the inevitable: world markets and economies are on steroids and this is NOT a healthy growth, any of which we see, and rather this is cancerous growth and must be curtailed at the earliest. You can't provide easy and cheap money to corporations and allow them to over-produce and foolish consumers to over consume. One day, this "bubble" has to bust and things will then revert to mean (which is healthy, organic growth, just about the right amount humans normally need). Of course, when reversion to mean occurs, it is always preceded by over-reactions and extending too far into opposite direction, simple law of physics that:
- either we slowly revert, without "overshooting" to the other side, i.e., over-damped systems, or
- revert in speed, and the faster the speed (which is generally true since everyone is taken aback by reversal and then there's panic and that causes a positive feedback to come in and speed up the reversal, till there's no more energy to continue reverting), larger the "overshoot" to the other side, i.e., under-damped systems.
OK, enough of macro-economics and physics. Let's get to the point. What is my confusion? Let me write down my worries:
A. Stocks prices and hence my current investments will sharply go down in next 1-2 years when we can see a major sell-off in all asset classes except currency.
B. If prices are going to crash, should we not just sit in cash and wait for the moment when things are much more cheaper and we know things are near the bottom?
C. What if we're on the verge of the mother of all great depressions and we may have several decades of slowdown and deflationary economies worldwide and we'll go back to pre-industrial-revolution times, and many people who're involved in jobs related to products and services that're NOT essential for a basic living, like an iPhone or a luxury car, will lose jobs, and agriculture will again become the most sought out profession?
I read this today morning and earlier during the weekend, Vishal send me this to read to relieve my concerns and confused state of mind. Well, very true that I was thinking of possibilities, without considering the probabilities. Now that I've recalled this very important rule of thinking in terms of probabilities, here's my assessment of what can happen and what are the chances that something will happen:1. What is the probability that stocks (good quality, in my portfolio and watchlist, and not sensex) will crash by over 90% in near future?
ANS: Low, I think here are the probabilities:a. Less than 5% chances that prices will fall by more than 90%
b. Upto 15% chances that prices will fall by up to 70-90%
c. 30-40% chances that prices will fall up to 60-70%
d. Good chances that prices will fall up to 50%
2. What is the maximum likelihood time period from now for which such "crashed" prices would remain?
ANS: I think depressed stock prices will remain here for next 2-3 years and this has a good probability of occurrence. However, chances that prices (and hence fundamental business performance) will remain deeply depressed for next 10 years is quite low, probably less than 5%.3. What is the probability that you'll sell majority of your portfolio in this period? Instead, what is the probability that this period will be your accumulation period since you'd not need the money from your portfolio?
ANS: NIL to very low, unless a financial crisis occurs. My job is a bond where risk of a major fall in income is quite low, and even if something dramatically wrong goes with my current employer, I've fair chances to get a new job. Hence, I won't need to liquidate major part of my portfolio in next 10 years, which is also my accumulation period. In fact, a good deal of chances are that I'll keep accumulating stocks (provided things remain normal) for next 15-20 years, and only sell over-priced stocks in my portfolio from time to time to balance it.So, in summary, there's no reason for my worry "A" and confusion. Let's look at worry "C" before "B". Well, capitalism works on the basis of greed and fear, and the world has seen many such credit bubbles, and a very good summary of these bubbles is in this book, which I want to read for a long time. However, the summary is "The Rise of the Fallen" in literal sense :)
So long as we live in a capitalist world, we'll have to see such bubbles boom and bust, and we're probably facing the bust of an even bigger, possibly largest credit bubbles of all times, more so because of highly increased financial leverage across the world. But we can't be more worried about it. So long as we pick good businesses, they'll continue to perform well. Again it'd be a low probability event that businesses with healthy balance sheets, lots of cash in hand and large market shares will collapse easily. Yes there'll be pain, but as long as we continuously monitor their business performance, we can manage the risks associated in their investments. Hence, I'm convinced that my worry "C" is also unwarranted and it's futile to spend time and energy, not to forget stress due to something which is very low probability and simply out of my control.
Finally, what about my worry "B", which simply spells about market timing? This is an area I'm still exploring and trying to find answer to the next big question: "Have times changed such that market timing is now more important even for Value Investors?" Well, let that be the topic for my next post and I'll very soon come back on it.
Until then, may my little mind rest properly and go back to sleep every night peacefully and not with worry of what would happen to the world economy next morning. Enjoy the beautiful day :)
Saturday, May 25, 2013
Speculation Watchlist
This will be a quick post; while I posted about asset allocation and need to increase equity investments, I've come across these few stocks where I believe a speculative bet will help generate some decent profits, and help me satisfy the urge of "gambling".
- IL&FS Investment Managers (IIML): I just concluded this morning that IIML is not a good enough investment for long term, but it might be a reasonable speculative bet, in small amount. I'll keep adding trickles of this stock to my portfolio - I don't see it running away in a hurry, but yes, if macro-economics improve, this stock may be an out-performer.
- Wockhardt Ltd: The stock has fallen from 2000 odd levels to 1200 levels in last 2 months, and is probably over-discounting the recent news of quality concerns with their medicines. It maybe a favorable bet, let's see if risk / reward is good enough. Looking at some numbers quickly, the company has generated an average annual revenue of Rs 4600 crores in last 3 years, and the sales is growing at about 18% annually. Further, the operating profit margin is growing from 24% to 36%. Assuming that the US import restrictions impact top-line by US$ 150 million (taking margin of 50% on what management says), this translates into a hit of Rs 750 crores to annual revenues. Assuming no revenue growth and current revenue level of average(5449 for last fiscal, 4600 as average for last 3 years) = ~Rs 5000 crores, and reducing Rs 750 crores, we get a revenue of Rs 4250 crores for next financial year. At a 30% OPM, this results in Rs 1275 crores of OPM. Now, looking at current numbers, Market Cap / Operating Profit has been around 10, and at current share price of Rs 1200, we get slightly smaller ratio. So, Rs 1200 per share is a reasonable price proxy to the share price before the import restriction, and if the company is able to regain FDI compliance (as management says they'll do it in next 3 months), the stock price can rebound back towards Rs 2000.
Considering the quick analysis above, I feel that the stock can be purchased below Rs 1200 for about 25-40% gains in next 3-6 months, and downside risk is very limited. As for margin of safety, we've taken higher hit on revenues, assumed no growth and a lower OPM, and that should be good enough to justify a small purchase in the stock, of course limited to less than 2-3% of my portfolio.
I'll add more speculative bets if they come, and till I don't hit upper limit of my speculative funds.
- IL&FS Investment Managers (IIML): I just concluded this morning that IIML is not a good enough investment for long term, but it might be a reasonable speculative bet, in small amount. I'll keep adding trickles of this stock to my portfolio - I don't see it running away in a hurry, but yes, if macro-economics improve, this stock may be an out-performer.
- Wockhardt Ltd: The stock has fallen from 2000 odd levels to 1200 levels in last 2 months, and is probably over-discounting the recent news of quality concerns with their medicines. It maybe a favorable bet, let's see if risk / reward is good enough. Looking at some numbers quickly, the company has generated an average annual revenue of Rs 4600 crores in last 3 years, and the sales is growing at about 18% annually. Further, the operating profit margin is growing from 24% to 36%. Assuming that the US import restrictions impact top-line by US$ 150 million (taking margin of 50% on what management says), this translates into a hit of Rs 750 crores to annual revenues. Assuming no revenue growth and current revenue level of average(5449 for last fiscal, 4600 as average for last 3 years) = ~Rs 5000 crores, and reducing Rs 750 crores, we get a revenue of Rs 4250 crores for next financial year. At a 30% OPM, this results in Rs 1275 crores of OPM. Now, looking at current numbers, Market Cap / Operating Profit has been around 10, and at current share price of Rs 1200, we get slightly smaller ratio. So, Rs 1200 per share is a reasonable price proxy to the share price before the import restriction, and if the company is able to regain FDI compliance (as management says they'll do it in next 3 months), the stock price can rebound back towards Rs 2000.
Considering the quick analysis above, I feel that the stock can be purchased below Rs 1200 for about 25-40% gains in next 3-6 months, and downside risk is very limited. As for margin of safety, we've taken higher hit on revenues, assumed no growth and a lower OPM, and that should be good enough to justify a small purchase in the stock, of course limited to less than 2-3% of my portfolio.
I'll add more speculative bets if they come, and till I don't hit upper limit of my speculative funds.
Friday, May 17, 2013
IL&FS Investment Managers - A new look
I had a look at this stock earlier, but quickly decided to stay away then. However, after I posted about asset allocation, I felt the need to have a high dividend yielding position, such that it provides cushion to my portfolio, and i found IL&FS investment managers as an interesting play.
Checkpoint 3: What kind of investment do you consider this business initially? Are you considering it as a long term story, or a medium term play (sorry, short term plays, i.e. for duration less than 3 months, are OUTSIDE the circle of value investors). Write down your initial thought in terms of [Peter Lynch] investment types - High Dividend Yielding, Stalwarts, Cyclical, Fast Grower, Turnaround story or an Asset Play?
a) Is management candid with shareholders? Have they done what they said in the past?
Looking at answers below on checkpoint 6, the management statements reflect that they're candid. They've acknowledged the challenges to business outlook and still tried to deliver the performance (we still want to validate their deep value investing belief, which we'll do towards the end, in checkpoint 7)
b) Does management act rationally?
Yes, they do. As we see below in checkpoint 6, they've invested heavily during the downturn when the valuations became more favorable and this is the most rational thing to do for a long term investor.
c) Do management acts imply integrity?
We've not found any signs of a behavior from management which highlights doubts about their integrity, but we'll keep a tab on this aspect as we analyze MD&A and specifics of investments made in details.
d) Does management demonstrate good capital allocation skills, or they're stuck in institutional imperative? Examples being prudent dividend declarations when no avenues for cash, buying back shares to reduce stock dilution etc.
e) Does senior executive compensation include company stock options, and is it designed to bring sense of loyalty and belief? Are "insiders buying" the stocks when their market price goes down? Is promoter holding a clean holding or shares are pledged to "manage cash"?
I'll go through the checklist that I recently created, and try to eliminate the stock. Let's see how far can this business stand in my screening :-)
Checkpoint 1: Is the business OUTSIDE your circle of competence [Charlie Munger]? Can you talk about it right after you're waked up from sleep? Do you understand the business well? Is it simple enough for an idiot to run [Peter Lynch]? Assume you're no better than an idiot!
IL&FS Investment Managers Ltd. (IIML) is a private equity fund focused in infrastructure and real estate funds. While I don't understand either of real estate or infrastructure (related to real estate) development, I understand the role of a PE fund, and I'll explain below on how I believe this company can be a good side-car investment, apart from providing healthy dividend yield. In this context, I'll focus more on analyzing the management's ability to sustain and grow the returns, more than understanding how the business operates.
Checkpoint 2: What is your main reason to look at this company? Write this down and once we analyze the business, we'll come back to see if our analysis is biased by this presumption [Anchoring bias, Charlie Munger]. If your reason is mainly a recent, sharp decline in share prices, try to find why so many people are selling, and if they know more than what you (prospective buyer) knows, or in other words, are you taking undue risk by investing into something with many unknowns?
Checkpoint 2: What is your main reason to look at this company? Write this down and once we analyze the business, we'll come back to see if our analysis is biased by this presumption [Anchoring bias, Charlie Munger]. If your reason is mainly a recent, sharp decline in share prices, try to find why so many people are selling, and if they know more than what you (prospective buyer) knows, or in other words, are you taking undue risk by investing into something with many unknowns?
I'm interested in IIML due to the following:
- Healthy dividend payout (above 40%), translating into 7% yield for current share price.
- Fund managers have delivered very good performance in the past. This belief, if true, can turn this stock as a very good side-car investment, similar to PEL that I hold today.
Checkpoint 3: What kind of investment do you consider this business initially? Are you considering it as a long term story, or a medium term play (sorry, short term plays, i.e. for duration less than 3 months, are OUTSIDE the circle of value investors). Write down your initial thought in terms of [Peter Lynch] investment types - High Dividend Yielding, Stalwarts, Cyclical, Fast Grower, Turnaround story or an Asset Play?
I consider IIML as the following investment type:
- High dividend yielding
- Asset Play, where value of assets is very good, and a positive catalyst is needed to unlock the value
- Side-car investment due to proven capability of the fund managers, based on past performance of the funds.
Next checkpoint is the most important point for this investment, as we're banking on management's abilities to drive the value creation for shareholder (me).
The following key financial numbers will support the arguments below:
The following key financial numbers will support the arguments below:
Checkpoint 4: A good management is essential to keep a "good business" good, and hence, we must identify whether
a) Is management candid with shareholders? Have they done what they said in the past?
Looking at answers below on checkpoint 6, the management statements reflect that they're candid. They've acknowledged the challenges to business outlook and still tried to deliver the performance (we still want to validate their deep value investing belief, which we'll do towards the end, in checkpoint 7)
Yes, they do. As we see below in checkpoint 6, they've invested heavily during the downturn when the valuations became more favorable and this is the most rational thing to do for a long term investor.
We've not found any signs of a behavior from management which highlights doubts about their integrity, but we'll keep a tab on this aspect as we analyze MD&A and specifics of investments made in details.
Management of IIML has indeed demonstrated good capital allocation skills. Here's the reasons in support of this statement:
- Maintained 30% (or higher) PAT margin %age, for last 7 financial years. This demonstrate good exit (divestment) criteria for investments that the PE fund group holds.
- Consistent ROE higher than 40% except in FY2005-06, when last 7 years are considered.
- Consistent ROE higher than 40% except in FY2005-06, when last 7 years are considered.
- Grown dividend %age consistently in the past, as they've surplus cash, beyond good investment opportunities. IIML has passed on most of the cash as dividends to shareholders, as evident from more than 70% dividend payout ratio of PAT in many fiscals.
- Cash flow from operations has been positive, but erratic compared with net profits. Analysis of Cash Flow statements will be performed in detail when analyzing financial health.
- Business has avoided debt for all of the financial years. Only liabilities are the deferred employee benefit payments.
- Business has avoided debt for all of the financial years. Only liabilities are the deferred employee benefit payments.
- The business has only dealt with share split, bonus issue apart from dividend payouts, but not exercised buy back option. This means that management wants to reward shareholders for long term shareholding with consistent cash flow in form of dividends, and do not want them to "trade upon buyback", despite that management might have felt that share price is beaten down to make it undervalued and lucrative for buyback to reduce equity dilution.
According to Annual Report FY2011-12, the salary of director is Rs. 2.62 crores. The non-executing directors are paid between Rs 20 lacs and Rs 4 lacs. According to P&L statement, the total expense on salaries and allowance for FY2011-12 is Rs 23.2 crores. Understandably, for a PE fund, most of the expenses are employee salaries and benefits, as also evident from P&L statements. Notably, director's compensation is ~10% of total employee compensation, and about 6% of PAT for the year. This is certainly not small, however, we should note that it is P/E fund, and hence such values are also not unreasonably high. Considering that the "team" manages an AUM of $3.2 billion (as of FY2011-12), the salaries for the "team" is Rs 232 million, which is 0.15% of AUM, which indicates a very low "management fees" if this company is treated as a mutual fund.
The company also has policy of ESOPs and encourages to provide performance based bonuses. In this case, director's compensation of Rs 2.62 crores includes Rs 1 crore as performance related pay.
As of 31st Mar 2013, directors of the company (7) hold 5.59% of publicly listed shares of the company, apart from the fact that promotors of the company (IL&FS Ltd) hold ~51% of the total outstanding shares. This means that both promotors and directors of the company believe in the company.
Additionally, Parag Parekh's investment firm (PPFAS Pvt. Ltd.) also acquired a sizable number of shares in 2012 end, and as recent as May 3rd, 2013, IL&FS Ltd. purchased additional 500000 shares from the market at an average price of Rs 21.56
Looking back at 2006, both promotors and employees have increased their %age shareholding.
All this indicates strong confidence of promoters and management in the future prospects of the company.
Overall, we believe that IIML has got a good management team.
Checkpoint 5: Does business possess a strong economic moat [Warren Buffet]? Check the following:
a) Do customers have a bargaining power that keeps an upper bound on prices and margin improvement is limited (cost cannot be lower than 0%)
b) Do suppliers have a bargaining power that keeps a lower bound on costs, such that margins are squeezed?
c) Risk of new entrants, who may play pricing wars and put pressure on pricing, i.e., does business have "earning power" like a brand value that allows it to maintain (or even increase) prices?
d) Is there an alternate product that poses a risk as a substitute to the product / service that business produces? Could it result in a permanent loss of revenue to the business?
e) Is the economic moat sustainable, or just due to luck?
Since IIML is a private equity firm, they generate money as commission to asset sale. Their customers are their clients who provide them with funds, and as a policy, they get a fix management fees of about 2%, and a "carry" of about 20% of profits if they're able to generate returns higher than "hurdle rate" which is about 12%. In this sense, the fund managers either get this "fixed" income or they don't accept funds, and then there's no customer pressure, i.e, they won't 'sell' at reduced profit margins.
Since there're no suppliers (actually clients provide the money supply, and in that sense clients are both suppliers and customers), there's no upside pressure on costs.
The competition are other funds who may snatch the "deal", but a mindless competition will be when acquirers pay insane prices for purchasing assets, or sell assets at lower profits. Both of these acts will reduce returns on investments. This has been the environment during last couple of years when there's liquidity crunch in PE investing, and it's getting difficult to sell assets at good profits. This is like a push and a "near ideal" economy where no P/E player has any moat - if you sell at profits you'd like, you may not be able to sell enough, it's like reducing revenues to maintain profit margins. The good part about IIML is that they chose to maintain profit margins, which keeps their 'carry' and provide them source of income, however, if they can't sell assets 'in time while maintaining hurdle rate', they'll eventually lose money. In this respect, "passing time and slowing asset sales" is a killer for IIML, and this indicates 'weak moat'
There's no alternate product I can think of, which poses a threat of replacement to IIML.
Finally, IIML has been able to maintain profit margins in the past, but we need a thorough, careful analysis on why they were able to do this, because they possess some special 'skills' or it was out of sheer luck? We do not yet know this answer, we'll need deeper study of what they could sell at good margins, and what they've not been able to sell profitably, and the times in which their asset sales were grand successful. We'll analyze this in checkpoints 6 and 7 where we assess risks to the business.
In summary, we believe that the business doesn't have a very strong economic moat.
Checkpoint 6: Since every business is essentially a system which takes in Cash and "is supposed to" generate more cash, such that the Return on Invested Capital (ROIC) is higher than Weighed Average Cost of Capital (WACC). Draw a "cash flow diagram" for the business explaining how it generates cash, and find out whether it has consistently been able to generate higher ROIC than WACC. Consider at least a period of last 5 years.
As mentioned above, here's how IIML makes money:
1. They approach prospective clients who believe in IIML's capability to generate returns that're acceptable to clients.
2. The agreement is, that if there's loss on investment, it is client's. IIML gets a minimum of ~2% as fund management fees on the total "Asset under management (AUM)', and if they make profits on investments greater than "hurdle rate", which is about 8-12%, they get 20% of the profits.
3. This is a "win-win" model for IIML, i.e., if they generate good returns, they get to keep 20% of the returns. If they screw up, they possibly lose the clients.
4. To increase revenues, IIML needs to attract more clients and more money, and to be able to do this,, they should deliver performance, consistently, as we're talking about some serious money.
b) Is operating cash flow poorer than profit (EBIT / EBITDA) on several occasions (consistently positive operating cash flow)?
c) How has working capital requirement changed over years? Is business generating cash faster than it needs (negative working capital)?
d) Is business generating good returns on capex, or it is burning precious cash in attempting to grow by capital spending (incremental return on capex)?
e) Is the debt on balance sheet concerning? Is most of operating cash leaking away in interest payments? Is business able to retire debt and gradually reduce interest burden? How long do you think will it take for the business to bring down debt to advantageous levels? Is dividend being regularly paid despite debt on the books? If so, is "Financial Leverage Index" > 1, indicating that return on investments is greater than cost of debt, and hence the leverage created due to debt is advantageous to the business, and it is good to pay dividends using generated cash, while keeping the debt at advantageous level.
The company also has policy of ESOPs and encourages to provide performance based bonuses. In this case, director's compensation of Rs 2.62 crores includes Rs 1 crore as performance related pay.
As of 31st Mar 2013, directors of the company (7) hold 5.59% of publicly listed shares of the company, apart from the fact that promotors of the company (IL&FS Ltd) hold ~51% of the total outstanding shares. This means that both promotors and directors of the company believe in the company.
Additionally, Parag Parekh's investment firm (PPFAS Pvt. Ltd.) also acquired a sizable number of shares in 2012 end, and as recent as May 3rd, 2013, IL&FS Ltd. purchased additional 500000 shares from the market at an average price of Rs 21.56
Looking back at 2006, both promotors and employees have increased their %age shareholding.
All this indicates strong confidence of promoters and management in the future prospects of the company.
Overall, we believe that IIML has got a good management team.
Checkpoint 5: Does business possess a strong economic moat [Warren Buffet]? Check the following:
a) Do customers have a bargaining power that keeps an upper bound on prices and margin improvement is limited (cost cannot be lower than 0%)
b) Do suppliers have a bargaining power that keeps a lower bound on costs, such that margins are squeezed?
c) Risk of new entrants, who may play pricing wars and put pressure on pricing, i.e., does business have "earning power" like a brand value that allows it to maintain (or even increase) prices?
d) Is there an alternate product that poses a risk as a substitute to the product / service that business produces? Could it result in a permanent loss of revenue to the business?
e) Is the economic moat sustainable, or just due to luck?
Since IIML is a private equity firm, they generate money as commission to asset sale. Their customers are their clients who provide them with funds, and as a policy, they get a fix management fees of about 2%, and a "carry" of about 20% of profits if they're able to generate returns higher than "hurdle rate" which is about 12%. In this sense, the fund managers either get this "fixed" income or they don't accept funds, and then there's no customer pressure, i.e, they won't 'sell' at reduced profit margins.
Since there're no suppliers (actually clients provide the money supply, and in that sense clients are both suppliers and customers), there's no upside pressure on costs.
The competition are other funds who may snatch the "deal", but a mindless competition will be when acquirers pay insane prices for purchasing assets, or sell assets at lower profits. Both of these acts will reduce returns on investments. This has been the environment during last couple of years when there's liquidity crunch in PE investing, and it's getting difficult to sell assets at good profits. This is like a push and a "near ideal" economy where no P/E player has any moat - if you sell at profits you'd like, you may not be able to sell enough, it's like reducing revenues to maintain profit margins. The good part about IIML is that they chose to maintain profit margins, which keeps their 'carry' and provide them source of income, however, if they can't sell assets 'in time while maintaining hurdle rate', they'll eventually lose money. In this respect, "passing time and slowing asset sales" is a killer for IIML, and this indicates 'weak moat'
There's no alternate product I can think of, which poses a threat of replacement to IIML.
Finally, IIML has been able to maintain profit margins in the past, but we need a thorough, careful analysis on why they were able to do this, because they possess some special 'skills' or it was out of sheer luck? We do not yet know this answer, we'll need deeper study of what they could sell at good margins, and what they've not been able to sell profitably, and the times in which their asset sales were grand successful. We'll analyze this in checkpoints 6 and 7 where we assess risks to the business.
In summary, we believe that the business doesn't have a very strong economic moat.
Checkpoint 6: Since every business is essentially a system which takes in Cash and "is supposed to" generate more cash, such that the Return on Invested Capital (ROIC) is higher than Weighed Average Cost of Capital (WACC). Draw a "cash flow diagram" for the business explaining how it generates cash, and find out whether it has consistently been able to generate higher ROIC than WACC. Consider at least a period of last 5 years.
As mentioned above, here's how IIML makes money:
1. They approach prospective clients who believe in IIML's capability to generate returns that're acceptable to clients.
2. The agreement is, that if there's loss on investment, it is client's. IIML gets a minimum of ~2% as fund management fees on the total "Asset under management (AUM)', and if they make profits on investments greater than "hurdle rate", which is about 8-12%, they get 20% of the profits.
3. This is a "win-win" model for IIML, i.e., if they generate good returns, they get to keep 20% of the returns. If they screw up, they possibly lose the clients.
4. To increase revenues, IIML needs to attract more clients and more money, and to be able to do this,, they should deliver performance, consistently, as we're talking about some serious money.
The only investment in IIML is into their fund managers and 'human capital", and hence their's is a very asset-lite model. Looking at financials as above, we find that the business is able to generate a healthy 40%+ ROE. This is a good number considering that the company doesn't need any 'new capital' for operations and their operating cash is obtained out of their revenues (since if no revenues, no performance pay to managers).
Checkpoint 5: Before we go further, we need to make sure that the financial health of the business is good. Answer these sub-points to find this out:
a) Is company sacrificing operating margins to grow revenue (lack of sustainable moat)? We want a business which is able to grow profits at least as fast as sales (maintain / grow operating profit margin).
a) Is company sacrificing operating margins to grow revenue (lack of sustainable moat)? We want a business which is able to grow profits at least as fast as sales (maintain / grow operating profit margin).
No, as we saw above, the business has maintained 30% PAT consistently, and while we need to read further (in checkoint 7) into "divestment policy", the financials show that IIML doesn't sacrifice profit margins to grow revenue.
b) Is operating cash flow poorer than profit (EBIT / EBITDA) on several occasions (consistently positive operating cash flow)?
We find that operating cash flow are erratic and do not match well with net profit. Looking at financial data table above, we see that CFO is always less than PAT, only in FY2008-09, FY2009-10 and FY2011-12, it matches well with PAT. Let us analyse why it is much lower in other years:
- In FY2010-11, there's an increase of over Rs 21 crores in trade receivables, which is about half the PAT. Additionally, the CFO reported for FY2010-11 in Annual Report for FY2011-12 is about Rs 11 crores lesser than reported in Annual Report for FY2010-11, which is because of difference in "change in current investments" and "interest income" between two reports. The breakup in schedule 5 tells that most of it is "other debt"
- In FY2007-08, both trade receivables and payables increased by almost the same amount, causing a net "decrease in cash inflow" of Rs 3 crores, but about Rs 14.5 crores was spent in making new "current investments". The breakup in schedule 5 tells that most of it is "other debt"
- In FY2006-07, there's an increase of over Rs 21 crores in trade receivables, which is more than the PAT. The breakup in schedule 5 tells that most of it is "other debt"
- In FY2005-06, major part of operating profit went into new advances and wasn't realized due to trade receivables. The breakup in schedule 5 tells that most of it is "other debt"
In summary, a significant part of operating profits being in form of "trade receivables" is the reason for smaller net operating cash inflow compared to net profits. Further, in all cases, most of increase in trade payable is recorded as 'other debt', and we need to find further details on what this consistent "other debt" is about?
- In FY2010-11, there's an increase of over Rs 21 crores in trade receivables, which is about half the PAT. Additionally, the CFO reported for FY2010-11 in Annual Report for FY2011-12 is about Rs 11 crores lesser than reported in Annual Report for FY2010-11, which is because of difference in "change in current investments" and "interest income" between two reports. The breakup in schedule 5 tells that most of it is "other debt"
- In FY2007-08, both trade receivables and payables increased by almost the same amount, causing a net "decrease in cash inflow" of Rs 3 crores, but about Rs 14.5 crores was spent in making new "current investments". The breakup in schedule 5 tells that most of it is "other debt"
- In FY2006-07, there's an increase of over Rs 21 crores in trade receivables, which is more than the PAT. The breakup in schedule 5 tells that most of it is "other debt"
- In FY2005-06, major part of operating profit went into new advances and wasn't realized due to trade receivables. The breakup in schedule 5 tells that most of it is "other debt"
In summary, a significant part of operating profits being in form of "trade receivables" is the reason for smaller net operating cash inflow compared to net profits. Further, in all cases, most of increase in trade payable is recorded as 'other debt', and we need to find further details on what this consistent "other debt" is about?
c) How has working capital requirement changed over years? Is business generating cash faster than it needs (negative working capital)?
Yes, working capital is always less than net profits, and in a sense, this indicates that business 'can generate' cash faster than it consumes. This however flows out as dividend payments.
d) Is business generating good returns on capex, or it is burning precious cash in attempting to grow by capital spending (incremental return on capex)?
Since business model is asset-lite, there're no large incremental capex, and capital spend increases proportional to revenue increase.
e) Is the debt on balance sheet concerning? Is most of operating cash leaking away in interest payments? Is business able to retire debt and gradually reduce interest burden? How long do you think will it take for the business to bring down debt to advantageous levels? Is dividend being regularly paid despite debt on the books? If so, is "Financial Leverage Index" > 1, indicating that return on investments is greater than cost of debt, and hence the leverage created due to debt is advantageous to the business, and it is good to pay dividends using generated cash, while keeping the debt at advantageous level.
The business requires very small capital for its operation, and hence it doesn't require any debt, nor has it taken, and there's no significant advantage in increasing debt to benefit from financial leverage.
Overall, we can say that the financial health of the business is decent.
Checkpoint 6: Stocks generally become value picks when they possess a healthy business with an able management, but suffering from a transient problem which drives the stock prices southwards. Is the business suffering from any such condition, and if so, why do you think this is not a permanent change (inflection point)? If you believe it is indeed an inflection point for the business, why do you think business is capable of turning it into an advantage [Andrew Grove]?
The share prices of IIML have been falling since end of 2010 and have dropped down by as much as 60% in last 2.5 years. This is possibly because of the stagnated growth in income and hence the profits. This clearly reflects the fact that company has found it difficult to increase divestment process.
Let us analyze "Chairman's Statement" section across FY2005-06 till date to see if management anticipated this "slowdown", and what have they planned and delivered so far.
- FY2005-06 shows positiveness and optimism that Indian growth has been due to entrepreneurs who have extended their reach beyond India, and PE funds have significantly contributed to this effect.
We still need to see if they really follow what they say, but their voice echos strong value investing principles - deep understanding (circle of competence), management capability (a bad manager can easily destroy an excellent business), minimize risk (don't go where you may die) and timely exit (sell when others are greedy)
- FY2008-09 statement looks at financial upheaval in retrospection, and how company managed to grow the AUM as planned, and they mention that quality and valuation of deals has improved due to slowdown. But this must be read with care - the valuation multiples have come down, and hence divestment generates lesser profits than before, while investments have better margin of safety / better growth potential. Finally, management believes that India will maintain growth rates as a new stable government comes, and investment environment stabilize going forward, at least at a moderate pace. However, there's first indication of growth / profit slowdown as seen in the commentary. Note the fact that management is being candid about dependence of business outlook on macroeconomic environment.
- FY2009-10 statement talks about the eventful decade, where downturn of 2008-09 created challenges and opportunities for PE funds. Specifically, the following text is noteworthy, indicating innovative, prudent and strong value oriented approach of the fund
- FY2010-11 was a tough year across the world, with signs of EU zone cracks appearing, high interest rates in India, etc, and here's what the CEO of the company has to say about fund's performance - they're able to grow AUM (and hence the revenue from management fees which they call annuity). Looking at the financial data table above, they've grown AUM very fast before the downturn, and AUM growth has moderated substantially, so much so that AUM is stagnant at $3.2 billion since FY2010-11. This remains a big risk to the future outlook, that it'd be exceedingly difficult to continue to grow AUM at a reasonable pace.
- FY2011-12 statement from chairman again mentions the impact of downturn in second half of 2011, and how PE fund raising is severely impacted. They also show how the business has still managed to continue investments and divestment in this backdrop
In essence, we see that the business is indeed at an inflection point - the growth is slowing, the environment is becoming tough with high competition, and outlook is gloomy considering that the world economy may remain subdued for many more years to come (leave aside spurs of growth which are highly inconsistent). It is now upto the business leaders of IIML to capitalize this inflection point to their advantage. How can they do it, what are they planning to do about it? Let us try to find these answers while analyzing MD&A sections of recent annual reports and answering next checkpoint about catalysts.
Checkpoint 7: Are there any negative catalysts foreseeable, that may impact the business prospects going forward, like a long term industry slowdown, increasing competition, or a regulatory change? On the other hand, what are the positive catalysts that'll bridge the gap between price and value?
The share prices of IIML have been falling since end of 2010 and have dropped down by as much as 60% in last 2.5 years. This is possibly because of the stagnated growth in income and hence the profits. This clearly reflects the fact that company has found it difficult to increase divestment process.
Let us analyze "Chairman's Statement" section across FY2005-06 till date to see if management anticipated this "slowdown", and what have they planned and delivered so far.
- FY2005-06 shows positiveness and optimism that Indian growth has been due to entrepreneurs who have extended their reach beyond India, and PE funds have significantly contributed to this effect.
Future strategic buyers find it reassuring to deal with a PE funded company, because they know that- FY2006-07 opens up with the following statement, boosting up optimism. They also indicate that capital availability is not a big problem now. However, quality human resources is highlighted as an emerging problem for sustaining long term growth of the company. Still no signs of concern about a potential slowdown or recession or difficulty in divestment.
governance and accounting will be up to standards. Institutional investors also attach significant value to PE
funded companies – this leads to a re-rating of the stock, thereby adding value to all stakeholders
The onward march continues. A trillion dollar economy, India’s future growth has been accepted as here to stay, rather than viewed as a passing phenomenon
In harnessing this growth, availability of capital is now largely being seen as an addressable issue. A positive investment climate ensures that an entrepreneur today has a variety of options for raising capital, as long as the matrix of past performance, reputation and project bankability measure up to the risk appetite of the investor- FY2007-08 statement mentions for the first time about the concerns of global turmoil and indicates that the smooth ride of past 4 years for India growth have seen first signs of problem, in terms of higher inflation, food crisis, depletion of investible funds globally. However, an important point in this statement is about "pro-active risk management" as a learning from the global problems. They indicate that IIML has developed such system of conservative yet productive risk management in their investments. Here's what they say:
We still need to see if they really follow what they say, but their voice echos strong value investing principles - deep understanding (circle of competence), management capability (a bad manager can easily destroy an excellent business), minimize risk (don't go where you may die) and timely exit (sell when others are greedy)
- FY2008-09 statement looks at financial upheaval in retrospection, and how company managed to grow the AUM as planned, and they mention that quality and valuation of deals has improved due to slowdown. But this must be read with care - the valuation multiples have come down, and hence divestment generates lesser profits than before, while investments have better margin of safety / better growth potential. Finally, management believes that India will maintain growth rates as a new stable government comes, and investment environment stabilize going forward, at least at a moderate pace. However, there's first indication of growth / profit slowdown as seen in the commentary. Note the fact that management is being candid about dependence of business outlook on macroeconomic environment.
- FY2009-10 statement talks about the eventful decade, where downturn of 2008-09 created challenges and opportunities for PE funds. Specifically, the following text is noteworthy, indicating innovative, prudent and strong value oriented approach of the fund
- FY2010-11 was a tough year across the world, with signs of EU zone cracks appearing, high interest rates in India, etc, and here's what the CEO of the company has to say about fund's performance - they're able to grow AUM (and hence the revenue from management fees which they call annuity). Looking at the financial data table above, they've grown AUM very fast before the downturn, and AUM growth has moderated substantially, so much so that AUM is stagnant at $3.2 billion since FY2010-11. This remains a big risk to the future outlook, that it'd be exceedingly difficult to continue to grow AUM at a reasonable pace.
- FY2011-12 statement from chairman again mentions the impact of downturn in second half of 2011, and how PE fund raising is severely impacted. They also show how the business has still managed to continue investments and divestment in this backdrop
In essence, we see that the business is indeed at an inflection point - the growth is slowing, the environment is becoming tough with high competition, and outlook is gloomy considering that the world economy may remain subdued for many more years to come (leave aside spurs of growth which are highly inconsistent). It is now upto the business leaders of IIML to capitalize this inflection point to their advantage. How can they do it, what are they planning to do about it? Let us try to find these answers while analyzing MD&A sections of recent annual reports and answering next checkpoint about catalysts.
Checkpoint 7: Are there any negative catalysts foreseeable, that may impact the business prospects going forward, like a long term industry slowdown, increasing competition, or a regulatory change? On the other hand, what are the positive catalysts that'll bridge the gap between price and value?
TBD
Risk Log: Based on analysis above, following are the risks to the future prospects of the business:
- Strong dependence of business performance on macroeconomic environment. If India doesn't grow like it did during 2004 - 2007, IIML may not be able to generate commendable returns as in the past.
- Since they're one of the largest PE funds in India, they might not have big scope to grow organically, mainly due to increased competition. (On the other hand, their large size may help them attract new capital if the PE investment environment regains the steam going forward)
- As performance is the key to maintain and grow AUM in this industry, inability to deliver good returns (timely divestment while maintaining profit margins) main negatively impact the future growth of both top-line and bottom-line for the business.
- IIML depends heavily on the performance of their fund managers, and if they can't deliver what they did in the past, the profits of the business can be severely hampered.
Stock Valuation
Even before we start 'calculations', based on risk log above, we must be conservative and assume:
- No growth, which means, we must assume constant 'free cash flow' going forward, and this constant can be taken as average FCF for last 3 years.
Quick valuation first. The business generates around Rs 400 million per year in cash flow from operations, and almost whole amount is free. Assuming no growth, a discount rate of 10% (risk free rate / base opportunity cost), we get a valuation of FCF, as of today at Rs 4 billion. The current market cap of the business is Rs. 437 crores, i.e., more than Rs. 4 billion. This means, there's no margin of safety in FCF valuations, contrary to the initial perception that the stock is probably available at very attractive valuations.
UPDATE as on 25th May 2013
I was 'away' for about a week, and I thought about IIML, and went through this "mirror test", to find any obvious reasons to drop the stock. I could not find strong reasons to either buy or ignore the stock - there're good deal of risks to the future growth / sustainability of AUM, and the past performance may not repeat. Incidentally, I also got to read about IIML's analysis here, and this adds to my belief that the risks of reduced profits from investments is quite high. On the other hand, if management can "maintain" the cash flow, there's a decent chance of 7% dividend yield from the stock. If things turn positive, it could be a black swan positive surprise and the stock can even generate capital appreciation.
In this context, there're large changes of negative catalysts over-weighing the possible positives, since the performance improvement for the business depends on macro-economic improvement, another boom in real estate (we didn't yet analyze, but a quick look at assets shows a large investment into real estate), and ability of management to generate returns as in the past - all of them happening will certainly be a positive black swan event. On the other hand, if any of these turns negative, it'll impact the business prospects, which will lead to reduced cash flow and dividend yield.
Hence, without further analysis of the stock, I tend to believe that the risk reward ratio is NOT favorable to hold this stock for long term. An annuity with 7% yield, but will a non-trivial downside risk, is not a Graham like pick, and definitely, the business moat doesn't warrant a strong conviction either. I'd therefore stay away from a long term relation with the stock. However, considering the potential for significant upside in the "best case scenario', this stock may be a potential addition to the "speculative" part of portfolio.
In summary of this "long post", this is certainly not a low risk, high dividend yielding stock as I originally started, but I'll keep IIML in the "sin stock watchlist" and add to the positions slowly, limiting a total exposure to less than 2% of the overall portfolio. Since I don't see the stock running away in near future, I'll wait for better opportunities before I start committing any serious money in the stock.
Risk Log: Based on analysis above, following are the risks to the future prospects of the business:
- Strong dependence of business performance on macroeconomic environment. If India doesn't grow like it did during 2004 - 2007, IIML may not be able to generate commendable returns as in the past.
- Since they're one of the largest PE funds in India, they might not have big scope to grow organically, mainly due to increased competition. (On the other hand, their large size may help them attract new capital if the PE investment environment regains the steam going forward)
- As performance is the key to maintain and grow AUM in this industry, inability to deliver good returns (timely divestment while maintaining profit margins) main negatively impact the future growth of both top-line and bottom-line for the business.
- IIML depends heavily on the performance of their fund managers, and if they can't deliver what they did in the past, the profits of the business can be severely hampered.
Stock Valuation
Even before we start 'calculations', based on risk log above, we must be conservative and assume:
- No growth, which means, we must assume constant 'free cash flow' going forward, and this constant can be taken as average FCF for last 3 years.
Quick valuation first. The business generates around Rs 400 million per year in cash flow from operations, and almost whole amount is free. Assuming no growth, a discount rate of 10% (risk free rate / base opportunity cost), we get a valuation of FCF, as of today at Rs 4 billion. The current market cap of the business is Rs. 437 crores, i.e., more than Rs. 4 billion. This means, there's no margin of safety in FCF valuations, contrary to the initial perception that the stock is probably available at very attractive valuations.
UPDATE as on 25th May 2013
I was 'away' for about a week, and I thought about IIML, and went through this "mirror test", to find any obvious reasons to drop the stock. I could not find strong reasons to either buy or ignore the stock - there're good deal of risks to the future growth / sustainability of AUM, and the past performance may not repeat. Incidentally, I also got to read about IIML's analysis here, and this adds to my belief that the risks of reduced profits from investments is quite high. On the other hand, if management can "maintain" the cash flow, there's a decent chance of 7% dividend yield from the stock. If things turn positive, it could be a black swan positive surprise and the stock can even generate capital appreciation.
In this context, there're large changes of negative catalysts over-weighing the possible positives, since the performance improvement for the business depends on macro-economic improvement, another boom in real estate (we didn't yet analyze, but a quick look at assets shows a large investment into real estate), and ability of management to generate returns as in the past - all of them happening will certainly be a positive black swan event. On the other hand, if any of these turns negative, it'll impact the business prospects, which will lead to reduced cash flow and dividend yield.
Hence, without further analysis of the stock, I tend to believe that the risk reward ratio is NOT favorable to hold this stock for long term. An annuity with 7% yield, but will a non-trivial downside risk, is not a Graham like pick, and definitely, the business moat doesn't warrant a strong conviction either. I'd therefore stay away from a long term relation with the stock. However, considering the potential for significant upside in the "best case scenario', this stock may be a potential addition to the "speculative" part of portfolio.
In summary of this "long post", this is certainly not a low risk, high dividend yielding stock as I originally started, but I'll keep IIML in the "sin stock watchlist" and add to the positions slowly, limiting a total exposure to less than 2% of the overall portfolio. Since I don't see the stock running away in near future, I'll wait for better opportunities before I start committing any serious money in the stock.
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