Coal India: IPO analysis

Coal India has come up with the biggest ever IPO in the Indian Stock market history. Government, however, is being greedy these days and further offers of PowerGrid, Shipping Corp. of India, ONGC, IOC are coming. It is interesting to understand where is the money in the market for these issues. Anyway coming back to Coal India.

Summary:

As per research by CRISIL, CIL is world largest coal producer and largest reserve holder. India is world's third largest coal producer and consumer. CIL met close to 82% of coal demand in India; In India power generated from coal was 52% of total power (FY2009). Apart from power generation, coal is heavily used in cement and steel plants.


Negatives:

1. Coal India is a holding company and its results and profitability is dependent upon  its subsidiaries.
2. GOI is selling its stock. Gains from this offer will not be part of Coal India company.
3. The current state of transportation available will not help even if Coal India could increase its production. 
4. Coal India may (and probably will) face problems in land acquisitions. It also has mandate to share 26% of its profits with the affected people.
5. India is a power hungry country; still many NGOs have been working relentlessly against such power plants, and their efforts may result in Coal India's loss.Greenpeace is already on to this link.
6. Estimation of coal reserves is pretty much subjective process and could be incorrect.
7. Coal India sells its coal below international price (although coal has been deregulated since 2000)
8. Much of its assets are located in politically unstable areas.
9. Finding further coal fields has risks of not finding, not enough coal finding, and not finding a good grade coal.
10. Illegal mining.

Positives:

1. Largest coal producer and largest reserve holder. Apart from this, there is enough unmet demand in India.
2. Strong and stable financial track record.
3. Has started ERP implementation. For company of such a scale, ERP implementation will pay dividends in long term.
4. Focused on increasing resources by venturing into outside India.

Castrol India: A little analysis on dividend

To start with I have calculated Castrol India's dividend yield from last 10 years dividend data on the basis of current stock price. Now I will try to fit a regression line (using TREND function from MS Excel) and find out from which year I will start beating the risk free return of 7.5% of FDs.

My aim from this analysis is to understand if Castrol India will be a good investment choice for my dividend portfolio at current price.

So what is my conclusion?

I will wait for Castrol India a bit. I think I should achieve my dividend target of > 7.5% way before 2020.

Five good equity diversified funds for analysis

All the numbers have been picked up from valueresearchonline.com

So what is my conclusion today?
ICICI Prudential has historically performed better than the other three 5 star funds.
SBI Magnm contra was a good fund, but it is sliding down slightly
Reliance growth is a good fund but has high volatility

How to choose a good mutual fund

One line answer: select any 5 star or 4 star fund from www.valueresearchonline.com.

Long answer: look at the track record of various mutual funds, monitor how have they performed over the period of time and how the performance has been lately. Check out couple of ratios and bingo!

Let's take HDFC Top 200 (this is my personal favourite fund) : (All these screen shots are from valueresearchonline.com)

I have highlighted the important aspects:

1. It is 5 star fund
2. Its return grade is high and risk grade is below average
3. Trailing returns for 1 year is 32%, for 3 years (compounded annually) is 17.30 (due to 2008-09), for 5 years it is 26.67 (stupendous) and from launch it has been 26.71 (fantastically stupendous).

Now if we go to Performance tab the scene is as following:

This image has couple of important points. Fund returns with respect to category return, with respect to Nifty and with respect to Sensex.

There are other ratios:

1. R-Squared ratio: is the statistical measure of how well an approximation (regression) line matches with the real data points. It is an analysis of the deviation from the benchmark. For equity funds, the benchmark is Nifty or Sensex. This ratio varies from 0 to 1. 0 says there is no correlation while 1 says there is 100% correlation. This mutual fund's R Squared is .96, which means it is closely tied to the fluctuations/returns in the Sensex.
2. Alpha ratio: tells how better a security has been against the bench mark. Alpha of 9.41 says that this mutual fund has been outperforming the benchmark Sensex by 9.41%.
3. Beta ratio: talks about the volatility of a security as compared to the benchmark. If the beta value is more than 1, the NAV of that fund will fluctuate more than the benchmark. If the beta is 1, it will go along with Sensex. If the beta value is less than 1, it means the security is not much volatile and safe. This fund comes into this category.
4. Standard deviation: is another measure of volatility in the fund. It is calculated on the historical annual rate of return data. It is a measure of how the funds performance deviates from the average performance over a period. A low standard deviation is better. This fund apparantly has it little higher side, but this is due the recession (and jump back after that) effect.
5. Sharpe ratio: is one of the most important ratios for risk analysis of a fund. This ratio also throws light on the fact that the fund's performance was just a fluke or due to a smart fund manager. Sharpe ratio gives a sense of returns from a fund over the risk less return per unit of risk. Risk here is the standard deviation. The higher Sharpe ratio, the better it is. But it all alone doesn't guarantee any information. It is calculated as ((expected return - risk free return)/standard deviation). If the standard deviation is very low (for liquid funds) the Sharpe ratio could come very high but that doesn't guarantee higher returns.

Other tabs are self explanatory and can be easily understood.
In the next post I shall provide a list of 2010's good equity mutual funds and their ratio analysis.

So what is my conclusion here?
Always look at the risk side of your investments. Don't distribute your hard earned money to agents.

Disclaimer: I am not advocating anyone to buy HDFC Top 200. This is my personal faviourite mutual fund. I have selected it based on my risk profile and objectives from investing.

Understanding a company's financial strength

A company generates following reports annually.

1. Balance sheet (on 31st March)
2. Income statement
3. Statement of cash flow

These three documents are the only tool with common investor to assess the company's financial strengths. (I am certainly not discounting insiders :-)

Lets understand these concepts via mind maps:
Balance Sheet

Income Statement

Statement of Cash Flow
Statement of cash flow is the most important document. If the company is unable to keep positive cash from operations, still it is able to show net earnings, it could be a sign of window dressing.

Highest NAV plans!!! A guarantee or another financial alchemy?

First thing first, does highest NAV mean highest ROI? Nope, they say that it is the highest of whatever they can manage to attain. It is very unlikely that with such a guarantee in place, they can provide even bench mark returns.

Let’s have a close look at how a possible highest NAV plan will work. They use Dynamic Hedging and Constant Proportion Portfolio Insurance. Although I don't fully understand these concepts, we actually don't need to digest this financial alchemy. Let's try to figure out how a common man would manage such plans.

Rule1#: If you have to provide some guarantee, you will have to charge some money for that. That money has to be taken from the fund value.
Rule2#: Stock market can never be guaranteed anything. It may crash anyway. So fund managers will have a pressure to minimize their risk and keep money in debt instruments and fixed deposits.
Rule3#: Since the lock in period is pretty big, 7-10 years, some amount of market risk can be adjusted here and there.

Let’s assume that the average interest on a secure debt instrument will be 7%. For the sake of simplicity I am assuming that the fund administration charges and other charges are 0.

Suppose the current NAV (and total fund value) is Rs 100. The fund manager wisely allocates the money in stock market, and after 1 year it gives 20% returns. The total NAV is Rs 120. Now the fund manager has the obligation to pay at least Rs 120 after 9 years. Now fund manager cannot take the risk of putting everything in stock market as it doesn't come with the guarantee. The debt product gives the guarantee. So the fund manager will have to pass a portion of total fund value to debt product to assure Rs. 120.

X*(1.07) ^9 = 120 gives X as ~ 65.

So the fund manager will allocate Rs 65 to some debt product and 120-65 to equity market again.

Let’s say after another year, the market resulted in good returns, and Rs 55 invested in the market sees another 20% jump. Now the total fund value becomes 65*1.07 + 55*1.2 ~ 146. Now the fund manager has the obligation to pay at least 146 Rs after 8 years. To provide this fund manager will need to solve this equation.

65*(1.07) ^9 + Y*(1.07)^8 = 146

This gives Y ~ 11.

Now fund manager will allocate additional Rs 11 to debt market, and put rest 44 in the equity market.

Let’s assume this process continues and after 6th year you have assured sum as Rs 180. By that time the equity component will be almost negligible and even if the market is highly volatile, it will not affect the fund value.

So absolute returns after 7 years will be 80%. (This is another gimmick, they will immediately say, sir which bank assures 80% returns and YES THEY DO SAY SO). If we calculate the effective rate of annual return it will come around ~8.7%. Which is marginally better than an FD (if we include the tax saving, it may be a bit better) but do we really want ~9% from the equity market for next 7 years period? Even the balanced mutual fund will give much more than 12% for this time frame. The few best MFs in my view have given more than 25% over the period of 15 years.

Pictorial representation of what I wrote will be like this.

So what is my conclusion today?

Whenever someone is guaranteeing something, please ask...what is the cost of guarantee? Are you into charity? :-)

ULIP and MF: A comparison from my portfolio

I think I was lucky that I chose a good ULIP (an oxymoron? ) SBI ULIPII. Around the same time I invested in a Tax Saving MF SBI Magnum Tax gain (G). After 4 years, lets see what is the actual absolute profit in both the investments.

I started my ULIP in April 2007 for 30000 annual premium (paid annually). I lie into the tax slab of 30%; rebate is given to me (for whole 30000) monthly at the very start of the financial year. I will use discount rate of 9% (assumed average inflation rate) to discount the time value of money back and forth.

Now I will do the similar calculation for my SIP in SBI Magnux Tax gain.

The difference is clear between the two. It doesn't look a lot since my choice of fund was not good. Had I chosen the HDFC tax saver, the current profit for the ELSS MF would have been much more than Rs 1,25,000

So what is my conclusion today:

Avoid ULIPS as much as you can and invest wisely in an MF which has a good track record.

How to know if you are being trapped into mis-selling

I think the various agents have mastered the art, the science and what not of miss-selling. Still a few key sentences can be observed and you should be alarmed of the miss-selling.

1. Sir, see this policy has give 100% returns. If you dig down, he will explore the papers and show you the absolute 100% returns since 2005. Well 100% return in 5 years doesn't make it much more than 15% returns (compounded annually). Although 15% annual is a good return, but it is not that 100%, of which you are being lured.
2. Sir, see this wonderful policy is the money maker! It has returned 60% in one year. Well if you look little deep, he has data from sensex at 8000 to sensex at 18000. Any mutual fund has given much more than 80% during this period.
3. Sir, there is a guaranteed bonus of 180%. Here you have to really understand and read between the line. Your agent will stop at 180% nonsense. If you are smart you will ask, 180% of what? total sum? Then the agent will sheepishly say, no sir of the annual premium. You then have to ask, ok when? As I buy the policy? The agent sweats a bit and says, no sir after 15 years. Suppose you take a policy of 10000 annual premium, you are being lured for 10000 additional bonus after 15 year. With the average 10% inflation, the NPV of that 10000 in today's term will be ~2400. So is it worth?
4. Sir, this is the wonderful time to invest in this mutual fund. Its NAV is only Rs 10. Why to invest in Rs 400 NAV mutual fund. Here you will get a big number of units. Well any sane person after a minute of inspection will understand the folly of the statement. Present NAV doesn't matter at all and secondly one should always wait to see the performance of the fund. Why be the guinea pig?
5. Sir, you wont believe us! This is the highest NAV plan. You know the market position currently, it is so low, market has to increase 10 times (as if he really plays the market). Just imaging, if you invest 10 Lakhs today, we are guarantying you 1 crore after 10 years. Well can you give it in the writing? No sir, but you see it is highest NAV plan, so there is guarantee anyway. It is guaranteed by IRDA as well. But the foolish agent doesn't tell me the guarantee of NAV going up!!! What if NAV increases well for first 3-5 years and then stops (actually thats how all highest NAV plans will work). Is there any respite?
6. Sir, this is unique ULIP plan and the most important point is that you can withdraw your money after 3 years. Someone bitten once like me can understand that the deductions in the ULIPS (old) are highest for the first 3 years. What indirectly he is suggesting is to pay him commission from your pocket and forget it.

Jai ho! The art and science of miss-selling is still being taught at the premier institutes of wealth creation.