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Peter Lynch: Making Money by Investing in “Fast Growers”

“The investor of today does not profit from yesterday’s growth.” Warren Buffett

Most of us have relatives who like to fashion themselves as ‘stock-gurus’, with their stories revolving around how they ‘could have been’ millionaires now, if only they had held their nerves. The stock that comes up frequently in these conversations is Infosys. If you had invested Rs. 9,500 to buy 100 shares of Infosys in the IPO (that went undersubscribed in 1993), 51,200 shares (adjusted for bonus issues) worth sum of Rs. 5,46,30,000 would be in your kitty.

Infy has given CAGR returns of whopping 48.2% to investors during last 22 years. Infosys got listed in June 1993 at price of Rs. 145 per share and investment of Rs. 9,500 in June 1993 is valued at 5 crores and 46 lakhs today. But, is Infosys still the key to riches? As often repeated, past performance is no guarantee of future results. So, how does one find out the next ‘Infy’?

A Fast Grower is a small yet aggressive & nimble firm, which grows roughly at 20-25% a year. This is an investment category which can give investors a return of 10 to as much as 200 times the investment made by them. No doubt, it remains a favourite of Peter Lynch!

In 1950s, the Utility & Power Sector were the fast growers with twice the growth rates to that of the US GDP. As people got more power-hungry gadgets for themselves, the power bills ran through the roof & the power sector surged with booming demand. Post the Oil Shock in 70’s, cost of power generation became high with power tariffs going up; people learnt to conserve electricity. Demand, thus, fell and power sector witnessed a slowdown. Prior to it, similar decline was observed in the Steel Sector & Railroads. First, it was the Automobile Sector, and then the Steel, followed by Chemicals & Power Utility & now the IT Sector is showing signs of slowing down. Every time, people thought, rally in the fast growers of the age would never end, but it did end, with people losing money as well as their jobs. Those who thought differently like Walter Chrysler (founder of Chrysler Corporation), who took a pay cut and left the railroads to build new cars in the turn of the last century, became the next millionaires.

Three phases involved in their life cycles, are:

1. The Start-Up Phase: Majority of the companies either burn up all the cash or run out of ideas by the end of this phase. Maximum casualties have been observed here, making it one of the riskiest phases. However, maximum returns can be made from them, if one enters near the end of this phase.

2. Rapid Expansion Phase: The Company’s core proposition has worked now, with the strategy being replicated by expansion of product/service portfolio or consumer touch points.

3. Mature Phase: Growth slows down, either due to high debt or low cash, owing to the massive expansion witnessed in early stage. Fall in demand or legal restrictions might also contribute to faltering growth.

The trick is to track, which phase the organization is in, at the moment. If the firm is in late start-up phase with possibility of moving to rapid expansion phase, buy the stock when it is still cheap. Once firm’s earnings start falling with its products witnessing poor demand, it’s time to bid goodbye to the stock.

The key parameters involved in Peter Lynch’s ‘two minute drill’ are:

1. P/E Ratio: avoid stocks with excessively high P/E

2. Debt/Equity Ratio: should be low

3. Net Cash per Share: should be high

4. Dividend & Payout Ratio: should be adequate

5. Inventory levels: lower the better

Stay away from companies which are being actively tracked, followed & invested in by large institutional investors. News about buy back of shares or internal stakeholders increasing their stakes should be construed as positive.

Checks specific to Fast Growers:

1. The star product forms a majority of the company’s business.

2. Company’s success in more than one places to prove that expansion will work.

3. Still opportunity for penetration.

4. Stock is selling at its P/E ratio or near the growth rate.

5. Expansion is speeding up Or stable

One must judiciously walk the tightrope between the unquestioning belief that made the stock to be held for so long and the fear of the end from nose-diving prices due to a one-off bad year. The key is to always keep revisiting the story & ask some pertinent questions like ‘What would really keep them growing?’, ‘What is their next offering? or ‘Are their products & services still in vogue?’ It is here, that one must track the point of time when the phase 2 of the firm’s expansion comes to an end. This is usually the dead-end for organizations as success is difficult to be replicated. Unless, innovation happens, downfall is imminent & thus, an exit is necessary. P/E of these stocks is drummed up to unrealistically high levels by the madness of crowd towards the end. One must keep one’s eyes & ears open to signs, which mark the end of the road for these fast growers. A great case in point is Polaroid which had its P/E bid up to 50, only to be rendered obsolete later by new technologies.

A sure shot sign of a decline is a company which is everywhere! Such a company would simply find no place to expand any further. Sooner, rather than later, such a company would see its ‘Manhattans’ of earnings reduced to ‘plateaus’ of little or no growth, simply because no space is left to expand further.

1.The quarterly sales decline for existing stores.

2. New stores opening, though results are disappointing: weakening demand, over supply.

3. High level of attrition at the top level.

4. Company pitching heavily to institutional investors talking about what Peter Lynch calls ‘diversification’.

5. Stock trading at a P/E of 30 or more, when most optimistic estimates of earning growth are lower than 15-20%, thus, unable to justify the high price.

Fast Growers, which pay, are ephemeral & one misses them more often than not. It is a High Risk & High Gain Category of Stocks. One must remember along the classic risk & return principle, that when one loses, one loses big! So, if you are in the quest for magnificent returns, a Fast Grower can be your bet provided you know when to bid Goodbye!

If you feel its difficult for you to identify Fast Growers stocks at early stage, you can subscribe to our Hidden Gems and Value Picks subscription services. We put best of our efforts to identify companies having potential to give exponential returns in medium to long term. Its our mission to ensure that you reap the best returns on your investment, our objective is not only to grow your investments at a healthy rate but also to protect your capital during market downturns.

 
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Posted by on January 9, 2016 in stock market

 

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Ambit puts Infy in the dock over governance

A new report has raised serious questions on the corporate governance standards at Infosys, saying board independence at India’s second-largest information technology (IT) services firm might be the weakest among Tier-I entities.
The report, published by brokerage firm Ambit Capital Research, also says the promoters hold disproportionately high board representation with respect to their total shareholding in the Bangalore-based company.
“While N R Narayana Murthy, S D Shibulal and S Gopalakrishnan together hold around 10 per cent in the company, they represent 23 per cent of the voting rights on the board. With the highest promoter representation and the lowest proportion of independent directors, Infosys’ board independence appears to be the weakest among Tier-I firms,” Ankur Rudra and Nitin Jain said in the report.

 

The report, titled ‘The underbelly of Indian IT – the ugly, the bad and not so good’ hasn’t spared a few other IT companies, either. While it categorised the accounting and corporate governance standards at Geodesic, Educomp Solutions and Financial Technologies (FT) as ‘ugly’, these at Rolta India and MCX have been categorised as ‘bad’. Tech Mahindra/Satyam, Infosys and KPIT Technologies have been classified as ‘not so good’.

“While some of these companies (such as FT, Educomp and Geodesic) are already understood by the market for what they are, others (such as Rolta, MCX, Infosys, Tech Mahindra and KPIT) are yet to be discounted appropriately by investors,” it said.

When contacted, Infosys said it did not want to comment on the report. While FT also declined comment, Tech Mahindra said the company had not seen the report and so was unable to respond. A senior Educomp official said: “We completely reject the opinion put out in this report, that too on an accounting practice the company discontinued a little more than two years ago. We will go through this report and take necessary action against what seems to be an ill-researched and motivated piece to mislead investors.”

A spokesperson for Rolta India said Ambit’s was not the correct assessment. “We have revalued all assets and, in fact, adopted a more conservative policy,” he said. Emails sent to other companies had not elicited any response till the time of going to press.

While talking about Infosys, the report says the company has been regarded as a paradigm of corporate governance in India ever since its initial public offering in 1993. “While this image has earned Infosys goodwill from investors, clients and employees, there are signs these high corporate governance standards are fraying. Murthy’s entry into Infosys in an executive capacity (even after the firm’s well-articulated policy of executives retiring at the age of 60), bringing with him his son as an executive assistant, higher promoter representation at the board and peculiar guidance pattern resulting in high volatility in share price – none of this gels with Infosys’ image of a leader in corporate governance,” it adds.

Infosys co-founder Murthy returned to the company as executive chairman in June last year, junking his retirement after what he claimed was a crisis call made to him by the board. This, he said, was done to seek his help in bailing out the company, which was steadily losing its lustre. However, he joined the company with a pre-condition to bring his Harvard-educated son, Rohan Murty, as his executive assistant. This was accommodated by the board.

The Ambit report says the entry of Murthy, as well as his son, amounts to breach of corporate policies. “Infosys has historically followed a well-articulated policy of executive retirement at the age of 60, with Murthy himself being a strong proponent of the policy. Similarly, all the founders have time and again mentioned about not letting a family manage the business. More surprising was Rohan Murty’s entry into Infosys as the senior Murthy’s executive assistant.”

Infosys is known for introducing some of the global best corporate governance practices, including giving quarterly (it has discontinued the practice now) and annual revenue growth guidance, among other things. The Ambit report, however, says Infosys has lately been following a peculiar guidance pattern, which is leading to extreme volatility. “There has been a pattern in Infosys’ guidance and outlook over the past three years. It sets a lower expectation in the fourth quarter of a year and overdelivers in the following quarters, causing extreme share price volatility,” it notes.

“Indeed, Infosys has repeated this pattern yet again by indicating on March 12 that it will settle at the lower end of the guidance for 2013-14 and giving a weaker outlook for the first half of 2014-15,” it adds.

In 2012, brokerage CLSA had written an open letter to Infosys voicing investors’ concerns.

BANGALORE: Infosys, once the gold standard for corporate governance in India, now finds itself in a list of companies that a leading brokerage firm categorizes as the ‘Underbelly of Indian IT’.

The firm, Ambit Capital, notes several developments in recent times that have lowered governance standards at Infosys, and says the market is yet to discount these appropriately.

Two of those developments have been noted by many in the past few months. These include co-founder N R Narayana Murthy’s return to the helm as executive chairman last June “despite the firm’s well-articulated policy of executives retiring at the age of 60 years”.

 

“More surprising was (son) Rohan Murty’s entry into Infosys as NRN’s executive assistant. Whilst this is a position of power, but not of control, the manner in which Rohan Murty was brought in raised eyebrows to put it mildly,” Ankur Rudra and Nitin Jain of Ambit Capital said in the report. “All founders have time and again mentioned about not letting family manage the business,” the report noted.

Ambit then goes on to note two other discomforting developments. Infosys promoters’ representation on the board is now significantly higher relative to their shareholding in the company. The three promoters who are also board members — N R Narayana Murthy, S D Shibulal and Kris Gopalakrishanan — collectively hold 10% stake in the company and they represent 23% of the voting rights on the board.

TCS has a promoter shareholding of 73.9%, while the promoter representation on the board is 9.1%. Azim Premji promoted Wipro has promoter holding of 73.5% and a promoter representation of 7.7%.

“With the highest promoter representation and the lowest proportion of independent directors on the board, Infosys’ board independence appears to be weakest among the tier-1 firms,” the report says. The $8 billion IT company has 13 board members, including 7 independent directors.

However, this could change next year, when Shibulal and Gopalakrishnan retire. Murthy has said the company would effect changes to its board in the next 12 months. Shriram Subramanian, founder of corporate governance research firm InGovern Research Services, also notes that promoter representation is a tricky thing. “They wield a higher degree of influence and control in decision-making. In the case of TCS, 5 out of 11 are non-independent directors and they may influence decisions,” he said.

Ambit also notes that the pattern in Infosys’ revenue guidance over the last three years has caused extreme volatility in the share price.

Ambit’s report categorizes companies as ugly (Geodesic, Educomp, Financial Technologies), bad (Rolta, MCX) and the not so good (Tech Mahindra, Infosys, KPIT Technologies).

The report said that Indian IT firms have used a variety of tricks to window dress their accounts, ranging from recognizing cashless revenues (Geodesic), recognizing seemingly non-existent revenues (Geodesic, Rolta and MCX), accelerated revenue recognition (Educomp), margin management (Geodesic, Rolta and KPIT), inflated balance sheet (Rolta), cash flow management (Rolta and Geodesic), and sugar-coating accounts (Tech Mahindra).

 
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Posted by on March 28, 2014 in Uncategorized

 

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