Value Investing A presentation by Mr.

Sanjay
Bakshi
https://fundooprofessor.wordpress.com/2005/09/04/revisiting-oxford-book-club-talk-given-in-july-
2002/

Posted on by Sanjay Bakshi

Chetan Parikh: On behalf of Capital Ideas Online and Oxford Bookstore Id like to welcome all
of you this evening to a talk by a learned and skilled practitioner Mr. Sanjay Bakshi on value
investing. Thank you Sanjay for coming here.

When he was a 19-year-old student at University of Nebraska Warren Buffett read Benjamin
Grahams second great book The Intelligent Investor and said the experience was similar to
that of Paul on the road to Damascus. He saw the light. Buffett was so taken with Grahams
ideas that he offered to work for the Graham Newman Co. in 1950 for nothing. Graham turned
him down. Buffett later said He turned me down as overvalued. He took this value stuff very
seriously.

We have with us Sanjay Bakshi who takes value investing very seriously. Let me briefly
introduce Sanjay to you. Sanjay Bakshi is a professor of finance at Management Development
Institute, Gurgaon, where he teaches Security Analysis and Business Valuation to final year
MBA students. Sanjay is also CEO of Corporate Investment Research Pvt. Ltd., a New Delhi
based investment research company focusing on value investing. Sanjay obtained his
education from the Delhi public school, the Institute of Chartered Accountants of India of which
he is a fellow member and from the London School of Economics and Political Science, from
where he received the M.Sc in economics. Sanjay has 148 published articles to his credit in
various newspaper and periodicals including the Economic Times and the Intelligent Investor.
More details about Sanjay are available at his web site http://www.sanjbak.com.

Ladies and gentlemen, I present to you Sanjay Bakshi.

Sanjay Bakshi: Thank you. Well, you have an academic over here who is also a practitioner
and since we are in a bookstore, what I will try to do here today is to give you some idea
about what I think value investing is all about from an academic perspective and also how I
like to practice it in reality.

Value investing, I feel, is the most conservative way to invest your money. And I will
argue today that instead of focusing on how much money we can make in the stock
market, we should focus rather on how not to lose money in the stock market. And if
we start doing that, if we start becoming obsessive about not losing money in the stock market
we will automatically start making decisions which will help us to make money in the stock
market. So I am going to try to argue here that our focus should be, instead of on upside
potential, but on curtailment of downside risk and how to do that how I like to do that.

What is value investing?

Value investing is generally identified with as you all know low price/earnings ratios or are low
price/cash ratios, price/book value ratios, there are a number of ways in which people describe
what value investing is about even high dividend yields. Stocks that give you high dividend
returns, have low P/E. multiples, low P/B multiples are generally classified as value stocks.

But I have a little more to say on that because I think just by focusing on a low P/E a or a
low P/C or a P/B ratio or a high dividend yield ratio, you might not end up with what
I would classify as pure value stock.

Like I said value investing is about curtailment of risk, how not to lose money in the
market. Now when we are focusing on curtailment of risk, I am reminded of a famous
quotation by Will Rogers and he said that I am more concerned about the return of my money
than the return on my money. And I think that sounds quite interesting given the current
backdrop, whats happening around us through the last two or three years in the stock market.
People who were more concerned about the return on their money found that their money has
gone. And they have a big problem on their hands.

Value investing, like I said, is to be very very conservative in terms of not losing money, in
terms of curtailing your risk.

So what are the kind of things that one should look at it if one is obsessed about not losing
money in the market? What are the kind of things that would come to ones mind that you
dont want to lose money on a portfolio basis you might lose some money in stocks, but
overall on a portfolio basis you are making money whether the markets are down or they are
up over a long period of time. What are the kind of things that you would want to focus on?

I think a very good answer to that question, while buying stocks I will address what
happens when you sell stocks, later on is that one has to do both of the following things:

First, one has to buy stocks that are extremely cheap in relation to what the
company is really worth and I will try to give you some idea about what I feel is how
you should determine what is extremely cheap; and

Second, one has to diversify. On the second thing I dont think I need to elaborate much
but I just want to mention one thing and that is the role of diversification here is not to
guarantee that you wont have a loss in every stock that you buy and thats not possible for
any stock investor, as he is going to make mistakes. What diversification does offer you is
that on an overall portfolio basis you are going to make money. Very much like a good
insurance company does. The way they write insurance and that analogy has been borrowed
from Graham, from his book in Security Analysis, where he said that if you are a good
insurance company, then you want to assess the risk of writing insurance for each insurance
buyer. And supposing you are writing car insurance, then you want to make sure that the
people who are diving cars more dangerously are charged much higher premiums than people
who dont. Now while you sell insurance premium to make sure that the probability of a claim
when weighed against the premium taken from that person will offset the risk of loss. So, on
every policy you try to make sure that you are not going to lose money. But that always never
happens. You lose money in many policies because claims do come in and insurance premiums
are not really sufficient in comparison to the amount of losses that you have to pay out. But a
good insurance company then makes sure that amount of losses that you pay out are less than
the total premiums taken, which means that you have an underwriting profit, which is exactly
what Berkshire Hathaway has been doing for a long long time as you all know. And when they
do that, they make sure that they are pricing the policy correct. And they are making sure that
they are taking risks which are worth taking. Even though on a single policy they are willing to
lose money but overall they dont want to take large exposures, they dont end up losing
money overall. And I think thats the key and its very interesting lesson from the field of
insurance that can be applied to the field of investment.

Now, they are two more points that I want to say when I talk about things that are extremely
cheap and are pretty counterintuitive.

The first thing I want to say is that a good business and a good investment are two
very different things. And I dont want to confuse the two things. I often see this problem
when I talk to people who have an interest in the stock market, they tend to identify a good
business with a good investment. You know company has good long-term prospects and they
just buy it, regardless of what price it is quoting at. So, the first thing I would mention is that
good business and good investment are two very different things; and

Secondly and that is I think also counterintuitive is that it is not necessarily to

actually value a business to come to the conclusion that it is very cheap . And I think
that was one of the key lessons that Graham taught. He didnt teach how to value a business,
thats something that Warren Buffett does very well and there are a whole lot of investors who
do that very well. Instead Graham focused on how to ensure that what you are buying is very
cheap, which means you dont know the value is, but you do know that the value is much
higher than the price that you are paying. And then you diversify.

So, when you follow that approach, for example, you dont have to do management
interviews , you dont have to really worry about the industry prospects. Lot of fundamental
analysts that I meet, they are involved in writing research reports based on discounted cash
flow models, based on future projections of what they think that company is going to earn and
they come up with a value and then they say that this is the price and this is the value and
therefore the price is lower and therefore it is a buy. That is not the approach that Graham
used. He said that you dont need to value the business. Its too hard to value a business.
Anyway, it is not the job of an investor to value a business, thats the job of a
business valuer which is very different from the job of an investor. The job of an
investor, he felt, was to make sure that there is a big margin between the value that
you are receiving and the price that you are paying. And I am going to give you a flavor
of many things that are possible for security analysts to do to make sure that what you are
paying is far less than what you are receiving. And I think you will agree with me when I come
to that later.

A good business Vs. a good investment

First about the confusion between a good business and a good investment. We have all seen
what happens when people bought stocks of good companies at high prices and I dont have to
elaborate much on that because I think a lot of people got burned in that. Good businesses
which are still very good, but prices are down by 80 percent or more.

Good businesses like the good actresses, command very high prices. And price
changes everything. Graham mentioned in his book over and over again in both the
books, Intelligent Investor as well as Security Analysis, all the editions, that price changes
everything. So he would not hesitate in buying a mediocre business provided the price was
right, when it was too low. He said a high price can make a good business into a very
bad investment, whereas a low price can turn a mediocre business into a very sound
and profitable investment.

And I have been practicing this particular approach to invest money for eight years and I have
found that its actually quite applicable because although there is another approach
which is to focus on good businesses, good managements, and a great price, but you
dont always get all the things in the same combination. You may have good business,
you may have good management but price is almost always wrong. Whereas if you
compromise a little bit on the prospects and you compromise may be a little on management
quality, but you get a phenomenally low price, then that low price often offsets the
disadvantages that you think you have against the other approach. And if you can accept that,
then you can go on to developing various themes of value investing where you want to pay
very low price in relation to what you think the corporation is really worth. And, you really
dont need to know what the corporation is worth, in fact.

Let me just give you very quick example. Here are two companies

Company A Company B
Capital invested Rs 100 cr. Rs 100 cr.
Return on Capital 35% 10%
Price/Book 10x 0.20x
Market Cap Rs 1,000 cr. Rs 20 cr.
PAT Rs 35 cr. Rs 10 cr.
Price/Earnings 29x 2x
Dividend Payout 20% 20%
Dividend Rs 7 cr. Rs 2 cr.
Dividend Yield 0.7% 10%
Both companies have same amount of capital invested Rs. 100 crores. Return on capital
35 percent in A and a pretty mediocre 10 percent in B. A sells for 10 times book, B sells for 20
percent of book. Market Cap 1,000 crores for A and 20 crores for B. PAT 35 and 10. Price
to earnings 29 and 2. Dividend payout same in both the cases. Dividend actual payment
7 crores and 2 crores. Dividend yield 0.7 percent and 10 percent.

Now, one looks like a growth stock, the other looks like a value stock. Now, if you keep the
assumptions intact, if you assume that the future will be pretty much as what is been
displayed on this slide then obviously company A well turn out to be, not only a better
company, but also a better investment.

Company A is no doubt a better business than company B because it earns a higher return on
capital and has a rational dividend policy because it retains most of its earnings and so long as
the return on capital is high, this money will build up and like an internal compound machine
should eventually show up in increased market valuation.

Now, if the model assumptions hold, and if we assume that 5 years from now the same
assumptions apply, then over those five years A will produce a 175 percent return, while B will
return 95 percent. So A would have been not only a better business but also a better
investment.

But how sure are you that these assumptions will hold? That is the key thing here. What
history tells us how many companies are able to sustain that kind of growth which
is implicit in that kind of a return and low dividend payout ratio and how many
companies are able to sustain that kind of a high return on capital? I think they are
very very few.

So if we were to vary this model, if we were to make some changes in that model and if we
were to say for example that: (1) in year 5, As return on invested capital declines to 20
percent maybe due to competition, market saturation, managerial stupidity etc.; and (2) As
P/E multiple declines from 29x to 25x. And we also assume that in the year 5, Bs P/E
increases from 2x to 3x. And I will drop that assumption about Bs P/E multiple later. Lets see
what will happen if we were to make these assumptions.

And with these new more realistic and possible assumptions, I think youll find that A will
return 40 percent over five years and B will return 163 percent over the same period. So a
drop in return on capital in the year 5 results in a dramatic change in our earlier conclusion
that A is a better investment.

If we drop the assumption that Bs P/E multiple increases, if we assume that everything about
B remains unchanged, but we assume that As P/E has changed from 29x to 25x, even then B
will outperform A by a large margin by returning 95 percent as opposed to 40 percent for A.

And that is the power of value investing, when you pay low prices then you dont
need very good things to happen for you to have a good return . When you pay those
low prices, then even if some bad news comes out about the company, its already discounted,
the market ignores it. Whereas if any good news comes out, you have a jump, you have a
positive, skewed result. So you end up with P/E multiple going from 2 to 3 which is not
expensive by any means, but you can see what impact it has on the overall returns.

Like Buffett said and I quote Buffett is known as a renowned growth investor, not as a value
investor You pay a very high price in the stock market for a cheery consensus.

Value investing themes

Now, I want to spend some time with you giving you an idea of some of the value investing
themes that I like to identify myself with. I have used them and profited from them and I want
to share some of them with you. But I have to say here that there are many other themes
not just the three themes that I want to talk about and that some of them have been
discussed in the papers that I have circulated I think they would have been e-mailed out to
you and you will probably see them tomorrow in your mailboxes you will find that there are
many other themes than those that I will talk about today. But these three I found to be very
profitable for a fairly long period of time in India. These three themes are: (1) Cash bargains;
(2); Debt capacity bargains; and (3) Debt pay-down theme.

Cash bargains

Lets first look at cash bargains. Now this is one of my favorites because I have used it often
and I dont know why such a situation arises because its ridiculous if you really think about it.
A cash bargain arises when the market value of a company goes below the amount of
cash and other liquid assets in its possession, net of all current liabilities and debt. In
effect, the market is not giving any valuation to the fixed assets, to the inventories , and to the
receivables.

Now, if you were to walk into this fine book store and make an offer to the owner that, I want
to buy your store for the amount of the cash in the till plus the money that you have in the
bank or money market mutual funds, he will throw you out. But the stock market periodically
allows you to make such kind of offers.

And, there is nothing new in what I am saying over here because its all been laid out in the
Intelligent Investor, its all been there in the Security Analysis since the 1934 edition. Its just
that people dont look at these things.

Case No. 1: GESCO Corporation.

This company got demerged from GE shipping and it got quoted at a very low price, stock
price 11, cash in hand 12, no debt, book value of 54 bucks it got acquired by the Mahindras
eventually, giving an exit option to the shareholders at mere 50 rupees levels. That was
GESCO Corporation. One example of a cash bargain.

Case No. 2: Trent.

In August 2001, the stock price of this company was hovering at around Rs.60. Like Gesco,
this company too emerged from a restructuring operation. It used to be called Lakme. They
sold off the business to HLL, got a lot of cash, they paid off all the debt, the company was
sitting on a lot of cash, no debt and was trying to create a new retail business which they have
created over the last three or four years. And at that time in August 01, this company was
hovering in the market at Rs.60. It had a lot of cash on its balance sheet which was there for
everybody to see, it was an audited figure and the cash in the company was Rs.90 per share,
there was no debt and there was this business on top which has become profitable recently.
Earlier the business wasnt profitable, maybe the market thought that there is no future for
this business, they are going to dissipate the cash or whatever I dont know what the reason
is that the market was valuing it so low.

But I do know that these opportunities do periodically arise and when they do arise one should
take them. Because if you are a normal businessman, if you walk into a bookshop like that and
the owner gave you the store for less than the cash, you would take that opportunity. I think
you should do that in the stock market too.

Case No. 3: Madura Coats.

Again, like Trent, this company sold off some assets and ended up with a lot of cash. They sold
their Madura Garments division to Indian Rayon and the amount of cash that they got in that
sale, net of debt, turned out to be more than the market cap of the company, Because they
kept the cash for a long time and didnt announce what they are going to do with it, the
market became pretty disenchanted and the stock price went to about Rs.15 and I am not
telling you the lows the lows were 11 I am taking you about the time when I got involved
in this particular company, it was about Rs.15-16 and the cash in the company was Rs.26,
there was no debt, yes, there was problem in that business, yes, they had losses in that
business, but they were restructuring and eventually what happened was investors got two the
chances to exit. Once at Rs.27 when they did a buy back and now you know there is an offer
on the table to buy back shares at Rs.40.

The market tends to get obsessed with the bottom-line earnings and the earnings
per share and the P/E multiples that you want to apply to those earnings per share.
But in cash rich companies, cash hardly earns anything, it doesnt enter into the EPS
because hardly any earnings are coming down to the EPS, whereas the asset is still
there. So, this asset based approach is quite unpopular and obviously something
thats unpopular normally ends up creating some interesting opportunities in the
stock market.

Those are three examples I gave you and then there have been others. SSI, the company
which at one time was working at several I think tens of times of its current market
valuation when the market collapsed about an year back - and the price went below cash and
there was an opportunity to buy stock at below cash. Later on there have been fears about the
cash been dissipated away.

The point I am trying to say here as is this that the stock market often produces opportunities
for a person who is focusing on just this one theme of value investing and if you have this in
mind and you are always tracking what is happening to the balance sheet instead of whats
happening to the EPS numbers and what the financial projections. And when you do just that,
then you might end up getting some very good opportunities because markets are focusing on
EPS and P/E multiples whereas in this case from a businessmans point of view its ridiculous to
find a company selling for less than cash.

Debt capacity bargains

Now let us move to an even more interesting theme which I like to call the debt capacity
bargains and I find it very interesting because it has got an academic angle to it. And the
academic angle is this:
The value of a debt free company has to be substantially more than the amount of
debt it can comfortably service. Its a principle which was first laid out by Ben Graham in
Security Analysis and he wrote about it again and again in successive editions and he produced
examples in the annexure that this is a company, this is the valuations in the market, this is
the amount of debt that it can comfortably finance, it is a debt free company why are the
stockholders of this company valuing in this company at such a low price?

Id like to give an example of a person who is in financial trouble and he goes to a pawnshop
and tries to take a loan against his watch. The owner of the pawnshop when he gives out the
loan against the security of the watch, wants to make sure that the money he lends is a lot
less than the value of the watch. And thats exactly what happens when you go to any lender.
If you are a good lender, then and if you are lending money to a business, then you want to
make sure that the business to whom you are a lending money is worth a lot more than the
amount of money that you want to lend to that business. But the stock market doesnt always
think like that. Let me give you some examples.

Here is an unleveraged company A. Its got no debt. Its an all equity finance company. And it
has 5 years average profit before interest and taxes of say Rs. 100 crores per annum.

Let us say that A raises Rs. 250 crores by issuing 10 percent bonds and distributes the funds
to its shareholders as dividend, which means we are recapitalizing the firm. You are borrowing
money and giving it out as dividend. So the total capital in the company remains the same, its
just that the debt-equity ratio changes. Debt was zero, now it is there. Equity goes down, debt
has gone up. Total assets remain unchanged.

Now come to think of it, this company which was a PBIT of Rs. 100 crores is issuing bonds for
only Rs. 250 crores of 10 percent interest, which means the annual interest will be only Rs. 25
crores, which means the interest cover is if you look at it from the perspective of the income
statement four times, which means it is very safe from a bondholders viewpoint. This
means the bond fund managers will be pretty happy to give that kind of money to this
company against the security of its cash flow and assets. So thats the kind of money this
company can easily finance from its cash flow.

From where do the bond holders of this company derive their safety? Their safety comes from
the same PBIT number of Rs. 100 crores. Because if this number collapses their bonds are in
jeopardy. If this number remains big, the bonds are going to be serviced without a problem.
So the bonds are going to enjoy a high credit rating because the interest cover is 4. And these
bonds will have a market value of about 250 crores.

Then, what this principle that I have mentioned in the previous slide states is as follows:

The fair value of A before recap cannot be less than the amount of debt it can
comfortably service.
Its a very simple mathematical principle which often breaks down in the stock market,
providing very interesting opportunities which I will explain in a moment, but just think about
it you will have to agree with this, that unleveraged company As market cap cannot be less
than this debt part of the leveraged company A, because both these companies are essentially
the same companies. The total capital in the companies is the same. Debt is there in company
A recapitalized, it was not there in pre-recapitalized unleveraged company A. Thats the only
difference.

So all that this principle says that it is mathematical impossible for an unleveraged company A
to be less than the amount of debt that it can comfortably finance. And in this case we have
done the calculation. It is coming to about to Rs. 250 crores.

Then, supposing this unleveraged company A is less than Rs. 250 crores. Now you are going to
ask yourself a question, why is it less than Rs. 250 crores?

Because any bond investor, a rational bond investor a bond fund manager, for example, will
gladly subscribe to Rs. 250 crores bond issue of this company against security of only a part of
its assets.

If the bond market will value only a part of this company for Rs. 250 crores, then the value of
the entire company must be a lot more than Rs. 250 crores, because of the principles of
prudent lending requires that kind of lending practices.

If the stock market continues to put a low value on this unleveraged company A, then its board
of directors can magically create these own bonds by writing out these bonds and distribute
them to the stock holders which they can then sell for Rs 250 cr., and still leave them with
their equity ownership intact. Can they not?

Leverage can play an important role in aligning the interest of the stockholders with that of the
management, but thats beside the point. I am not arguing about that right now. I ignored the
tax factors and all those other things, what I am saying here is that you cant say that this
unleveraged company A will be less than the amount of the bonds that the bond investment
community will buy without hesitation of the same company. Let me explain. I will give you
more examples in a moment.

This concept of distribution was actually given by Graham in his book, Security Analysis, first
edition. He gave an example of a company called American Laundering Machinery and I think
you should all go and read that example if they have this book over here it will be very
interesting to see what he had to say. And he said that its ridiculous to think that the bond
market is willing to buy bonds of this company and give it Rs. 250 crores and the stock market
values this whole company for less than Rs. 250 crores, which has no debt in it. And if thats
the case then the solution of the problem has to be that the board of directors create these
bonds on a piece of paper and distribute them to the stockholders in proportion to the shares
they hold, in effect doing a leveraged recap, delivering to the stockholders of piece of paper
that has a market value of Rs. 250 crores and they still have got the original shares with them
which is also have a value. So you force the market to correct its mistake.

And I think some of the things that have happened in the U.S. are going to happen in India
pretty soon, because I think a company should act when they find their stocks are battered or
valued too low. And some of them might be doing that. I dont think that was the logic for the
bonus debentures issued by Hindustan Lever, but I think that might have been the logic
recently for Marico. If you read the report two days back they are planning to have a meeting
where they will consider distributing bonus preference shares to their stockholders. And there
have been others. Some years back if you remember NALCO did something like that. They
converted half their equity share capital into bonds and distributed them to the stockholders.
So this leveraged recapitalization could be a very useful way for companies to ensure
that the stock markets dont undervalue them. This particularly applies to a debt free
company because they can borrow money and distribute to stockholders and deliver them a
value sometimes more than the market cap prevailing before the leveraged recap.

Here is a quote from Ben Grahams Intelligent Investor which describes what I have just
explained:

There are instances where an equity share may be considered sound because it
enjoys a margin of safety as large as that of a good bond. This will occur, for
example, when a company has outstanding only equity shares that under depression
conditions are selling for less than the amount of the bonds that could safely be
issued against its property and earning power. In such instances the investor can
obtain the margin of safety associated with a bond with all the chances of large
income and principal appreciation inherent in an equity share.

And this is what he said in Security Analysis:

An equity share representing the entire business cannot be less safe and less
valuable than a bond having a claim to only a part that of.

And this is what one of the partners of Tweedy Browne, a company which follows Grahams
techniques of investment in the U.S. said:

Our research seeks to appraise the intrinsic value of a share by estimating its
acquisition value or by estimating the collateral value of its assets and/or cash flow.
We believe the process is related to credit analysis as we are seeking collateral net
worth in excess of the cost of our investment.

So, what in effect I am trying to say here is that when we are looking at debt free
companies or near debt free companies and there are plenty of those around we
should think of the stocks of such companies as stocks with bonds hidden inside
them and we can value the bond component as we know what price the bond market
will pay for those bonds. And if you can get the entire stock without the bond
component in it for less than the amount of the bond component, then you have got
yourself a bargain. Examples:

Example 1: Gujarat Mineral Development Corporation

Heres a company that generates tons of cash whose stock had been languishing at Rs. 30-40
levels, has recently gone up in the stock market. Market cap before the rise was Rs. 140 crores
and unutilized debt capacity was Rs. 260 crores. Which means that if you look at the numbers
and you do an analysis, you look at the cash flow statement and you look at the P&L account,
you can come to the conclusion that this company which is debt free and easily finance Rs. 260
crores of debt from its operations. But the stock market was giving you the entire company for
Rs. 140 crores. So you buy such companies and put them in your portfolio because this
satisfies this criteria of this theme stock price less than debt capacity in a debt free
company.

Example 2: Zodiac Clothing

Market cap Rs. 13 crores, I am talking about a year back. Unutilized debt capacity Rs. 15
crores. Again the assumptions are given at the bottom, the company had nine years average
PBIT of Rs. 7 crores. If you assume the interest cover of 4 and actually if you go to the bond
fund managers, if you go to the bank they would easily lend this company money on the basis
of and interest cover of 2 1/2 3. But I am talking about an interest cover of 4 here. Also, I
am assuming an interest rate of 12 percent. Today, this company can easily borrow money at 9
or 10 percent or even less, but I am assuming 12 percent. My assumptions are based on the
figures of that time, so I am giving you the prevailing interest rates at the that point in time.
So, you have a situation where a whole company is available for Rs.13 crores and it can
finance debt of Rs.15 crores. So its a buy. And you just buy it and put it in the portfolio. You
dont care what the analysts are saying, you dont care about how the industry is doing. You do
know that the cash flow of the company are likely to be volatile perhaps, but they will be able
to sustain, without problems a debt capacity of more than the market cap. And thats all that
you need to know. At least in the context of the value investing that I am talking about
Example 3: Blue Star Infotech

This company, which was de-merged from Blue Star, the air conditioning, had a market cap of
Rs. 30 crores but the unutilized debt capacity was Rs. 33 crores. Again a debt free company

Question: How much below cash should a stock trade before it becomes a buy?

Answer: What I am saying here is that you should buy companies that are selling
below cash. You dont have to buy them selling at 30 percent below cash or 50
percent. Below cash is good enough. They may go down further still, you can never know
how crazy stock market can be. So they can go down further still, which means you
have to continue buying, but you have to stop when you think you have reached the
exposure limits. You have to diversify. In that sense you are buying something
extremely cheap. Its hard to lose money there. And what history shows that these
stocks actually do tend to get valued up. Just think about it. When I talked about cash
bargains what did I mean? See, there is a concept of book value, what is book value? Fixed
assets plus current assets within current assets there is inventory, there is debtors, there is
cash and then current liabilities are reduced. And then there is debt on the liabilities side. Now
when you are talking about book value, you mean add up all the assets and deduct all the
liabilities including current liabilities and divide by the number of shares outstanding, that gives
you the book value. Now, cash value per share is a very small subset of that book value.

You know when some people say that a stock is selling for less than book value is a value
stock. But, I dont agree with that. When I say that stocks selling for less than a very small
subset of that book value (i.e. cash value) are value stocks is a very different thing to say.
Because in that book value you are eliminating fixed assets. In that book value you are
eliminating a substantial part of the current assets, which is the inventories and the
receivables. You are only counting the cash and the cash equivalents. And you are using that
small number on the assets side of the balance sheet and deducting the entire liabilities side.
And then you are comparing that number with the stock price or market cap and then you are
finding that the market cap is less than that number. I think you dont need to be more
conservative than that. So, in that sense I am saying you dont need to say that I want to buy
at 50 percent of cash. So you have already taken into account by saying that I dont want to
buy discount to book, you are buying discount to cash.

Question: How long one should hold on to such stocks?

Well, I dont know the average holding period but you get paid for waiting. I will tell you why.
What happens in these stocks is when you are looking at deep value stocks, you often
end up with high dividend yields also. So when you end up with a decent dividend yield of,
say, 10 percent, then you are being paid to wait. You can wait indefinitely because the cost
of waiting is not there. So if you combine this theme with a high dividend yield theme you
have got yourself a winning combination because you can then wait without feeling the pinch
of waiting. But to answer your question, what is the average holding period? I think average
holding period in this case would be no more than a year. I have looked at maybe about ten
below cash stocks in the last 8 or 10 years you dont find very many out there, in the sense
that what I am trying to say here is maybe more applicable for the individual investor and
more applicable for smaller pots of money and most certainly it is not applicable for the Birla
Mutual Fund because you cant put lots of money in these sort of stocks because of the amount
of the money that you manage. But my point is that if you buy for an individual investor, if
you just buy the shares and keep them in your portfolio, almost all your equity money is
invested in deep value shares. Now the only thing that can go wrong is if the whole country
tanks, which can happen.. After all you are investing in equities and the country goes down
and equities market goes down with it. But those are risks which I think are worth taking. At
least you will go down less than what the others go down. But the other point is that from my
experience I think no more than one year is the holding period.

Question: Can you explain theme 2 again?

Answer: This second theme, I think, is hugely interesting to me in the sense that I find it very
useful to look at a debt free company or a near debt free company from a bond holders
perspective than from a stockholders perspective. Because if I can get the whole company for
less than what a creditor will give this company on a conservative basis, I know I have got a
bargain. Now I dont have to argue with anybody with that, I just buy the stock and put it in
my portfolio and inevitably they it goes up at least till now I have not had a bad experience
in any of these situations. But I have to admit that you cant put large sums of money in these
sort of situations. But you can put fairly, you know small sums on maybe you know Rs.10-
15 crores is pretty much the maximum amount of money that you can put in these sort of
situations. So if you are managing lots of money, this is not going to work.

Debt pay down.

This is the third theme that I want to talk about and again the principle is very simple. Its an
academic principle, coming from corporate finance its very simple.

When a leveraged company selling for a very low P/E ratio starts paying down debt
from its cash flow and/or asset sales, then the value of the equity in that company
rises automatically and quite dramatically. Its a theme, its a value theme you are
already paying a low price of a highly leveraged company, so I am moving from one extreme
to the other. I am moving away from value investing in debt free companies (theme 2) to value
investing in highly leveraged companies (theme 3), which may be in financial trouble, which
are in a debt trap, which are on the verge of default, but have got their act together. They sell
off some businesses, they do some VRS, they restructure and they get the money to pay down
their debt. Now because this stock is already selling for a low P/E or P/C multiple when they
pay down debt, it will have a dramatic impact the sensitivity of the bottom line numbers to
debt pay down will be very very large. And it will happen an automatic impact on equity
valuations, eventually if not immediately reflected by the stock market.

And this is true even if the profit before interest remains unchanged. I am not looking at
growth in the top line, I am not looking at growth in margins. I am only looking at reduction in
the interest expense of a highly leveraged company, which should result in an increase in the
stock price, over time its that simple. You think of a company as a pizza. Now the pizzas
value is based on the cash flow before interest. Now that value should remain unchanged if
you believe in Modgiliani & Miller regardless of what the debt ratios are. Now as debt is being
paid down, equity is automatically going up, because the pizza remains the same. It doesnt
matter whether you think of it in terms of P/E multiple expanding because the company is
becoming less leveraged, and therefore less risky, or the way I like to think of it as a pizza.
When debt goes down, equity should automatically expand. And when you think about that
you come up with some very investing companies once in a while. But in these kind of
companies you got to be patient because debt pay down does not get immediately reflected in
increased equity value in the market as the market is pretty skeptical about it. Because
companies which have fallen on bad times, because of excessive debt did so because of
managerial mistakes. And markets are very skeptical about these companies coming out of the
problem they are in. So even though they are gradually paying down debt, markets may take
some time to realize or rather to acknowledge that there has been a major improvement in
debt pay down. So, the pizza is actually shrinking debt is going down, so the market value
of debt is coming down, but equity is not expanding in the market as quickly. Which I think for
value investors is actually an opportunity. Because if you have conviction in debt pay downs
happening gradually, then you can take advantage of that.

And I will very quickly put up to 3 slides I will give you three different examples.

One was the case of SRF, a company which fell on very bad times some five or six years ago
because they made a overpriced acquisition and financed it with short-term debt. But they got
their act together. They sold off a lot of businesses, they refinanced debt, they made asset
sales and paid down debt and they got lucky interest rates came down. And they didnt
make any other mistakes after that and they did a phenomenal acquisition, acquiring a plant
for virtually nothing the Dupont plant. And they have done a lot of good things and in the
process they have allocated capital well, they have been able to pay down debt and if you look
at the sequential interest expense over the last maybe 10 quarters, you will see every quarter,
the interest is down by Rs.1 1/2 or Rs.2 crore. So you think of it like that if Rs.2 crore
deduction in interest expense every quarter translates into say Rs. 10 crore of incremental
profit in a given year and you have a 6 1/2 crores shares outstanding, you have an incremental
EPS of Rs.2 2 1/2 and even if you give incremental EPS a multiplier of something like two or
three, you have a Rs.6 or 7 increase in stock price every year. And for a Rs. 20 share, thats a
phenomenal return to get. So in a sense this company is doing what you call in a reverse
LBO A company has leveraged itself up to the hilt and it is gradually lowering the debt. And
when it does that, the value of the equity has to automatically expand.
There are two other examples that I want to put up here. One is the case of Regency
Ceramics, again a company which has been in the limelight recently. The stock price has just
shot up but even at this price it looks cheap in relation to the profits that this company is
generating. But the more important thing is how this company will paid down debt in the
succeeding quarters. And you are able to visualize what is going to happen to the bottom line
numbers when they do that.

The third company which comes in this is again counterintuitive. It is Hindustan Motors of all
the companies. A company whose stock was selling at Rs. 5 at one time and again a highly
leveraged company, but they sold a division for a lot of money. They sold their Earth Moving
Division and retired high-cost debt.

In this theme what you need to do is to glance at the newspapers once in a while and look for
transactions where highly leveraged companies are selling off assets and you know that once
having learned the mistake of not having gone in that business in the first case and now
getting out of it, may be for lots of money, and they are not likely to make the mistake out of
diversifying, because that takes up more time. They will make that mistake maybe two years
from now when they are becoming more profitable but right now debt is at their door. They
have to pay off their creditors. And the moment they pay off their creditors, the value of the
equity goes up. And it goes up in two ways. You see the interest expense of highly leveraged
companies is already very high because its a risky company from the lenders perspective,
they charge a very high rate of interest. Now, when you are paying down debt, your interest
expense goes down for two reasons. One, the principal itself has gone down and second, as
you become more secure, you can refinance debt at lower rates. Combined with the situation
where interest rates are generally coming down in an economy, you have got a triple factor in
your favor.

But what, you may ask, about the management factor? You know, I am not at all happy about
the way Hindustan Motors has been managed over the last so many years, but it doesnt
matter. Thats the key thing. I know its very controversial what I am saying here because
almost any investor that I talk to emphasizes the management factor a lot. Whereas if you
read Grahams book carefully, he said I dont even want to know what the company
is doing, I dont even want to know who the manager is. I want to go by the
numbers. And I want to diversify a lot. So if I am wrong in some of them because I didnt
check out the management and I did a check out the prospects, if something went bad, its
OK, because I have so many other stocks in the portfolio which are so dirt cheap and they are
going to do well, its OK. So every insurance company doesnt do a check on your character,
but if you have a bad character, you can swindle an insurance company. But those are
acceptable risks which are taken care of with the principle of diversification.

Question in case of a company is burning a lot of cash in its main operations, then
what happens in this type of a situation?

Answer: Thats a useful point and I will actually you already said what I was going to say in
the next slide, which is that when you are going to look at cash bargains for example, when
you know there is a company with a lot of cash and has a business and that business is
burning cash, its losing money on the operating level, then you got to be little skeptical
because you are seeing that cash dwindling down. So if the company is going to dissipate the
cash away then the markets may perhaps be right in valuing the company at below cash. But if
a company is not dissipating away the cash or if it is having losses right now but you expect it
to turn around as was the case in the case of Trent initially they were having losses but they
have been able to increase their operations to a scale where they are now making money on
the operating level. So the cash which was helping them establish the business in the first
place is no longer required to funding the operating business. So those sort of bargains are
little different from a bargain where you just buy just because it is below cash without looking
at whether the other operations are loss making. So you have to look at that. I agree with you.

In terms of accounting, if you have to rely on the books, I think its hard to argue with cash. At
least in context of the first thing that I mentioned. Cash is cash. OK, maybe you got a crooked
auditor who tells you that the cash which is not cash, he is counting as cash in the balance
sheet. But I think again that is a risk that I am willing to take. See, we are talking about cash
bargains. What are the kind of thing you want to look at? When you are looking at the cash
bargains you are not concerned about the sales, you are not concerned about the profits, you
just want to make sure that the cash is there. The debts and other liabilities on the balance
sheet are obviously real. But if cash net of debt and other liabilities, is more than market cap
what else do you want to look for? You want to look at market share? Obviously not. You dont
want to look at management quantity, except when you think they are so crooked that there is
no way you are going to get the cash. And if you think you cannot get that cash, thats where
the market for corporate control comes in. As shareholding patterns become more
widely distributed, company with lots of cash and not a single large promoter will
become sitting ducks. They will get acquired. In fact the prospect they will get acquired
will insure that you dont find these bargains which stay bargains. So, you see its very
tremendous pressure on the management if the value of the company goes below cash. If the
promoters stake is low, he will try to do everything in his means to ensure that the market
value is well above that number. Because someone will acquire that company, liquidate it, fire
the management, take the cash and get all the fixed assets and other assets for free.

Common elements in three examples:

I have given you three examples of cash bargains. But there are peculiar reasons for those
examples. If you notice that three examples that have arisen Blue Star, GESCO, Trent all
three businesses have actually sold the businesses and they got into cash. And the very nature
of these businesses changed. And the market which was a hell-bent on thinking of those
businesses as if they were still a shipping company or something else, they ignore them, they
dont value them properly and thats where the opportunity arises. So, I think your point is well
taken that in the ordinary course you will not find a company sitting on so much cash, which is
more than market cap. Its normally happens when a business sells an asset or a business. A
land has been sold or something has been sold. And when that happens, initially the market
price actually goes up because thinks that there is going to be a huge dividend payout coming.
It happen in Max, it happened in Glaxo when they sold off their food division to Heinz. So
initially the market thinks that cash is coming in, they are going to make a special dividend
payout and the market price is so low, expected dividend is so low buy. But the dividend
doesnt always come. In Trent it didnt come. In GESCO it didnt come. In Blue Star it didnt
come. So markets get disappointed. Price slides down. Because markets, generally speaking,
dont like companies sitting on box of cash. Because you can keep a box of cash in your house,
what is a box of cash doing inside a balance sheet? It is only earning interest. So markets
dont put a good multiplier on that proportion of earnings which are coming from cash. And
that gets reflected in the total valuation.

Point relating to Takeover Code:

I am an opponent of the takeover code as such. Just for a moment visualize that there was no
takeover code, what will happen? These companies will get acquired very quickly. Which
means that market prices will not go down to those levels, so that they become takeover
targets. Because they are so easy to get acquired, promoters will not let them go to bargain
levels. Because they will be keeping awake at night. The takeover code, essentially, I think,
protects the promoters far more than helping the minority investors.

How I use these themes

Let me give you some practical insights on how I like to use these three value investing
themes. And then there are a whole lot of other themes, but I just want to restrict to these
three.

Theme 1 was if you get an opportunity to invest in a stock at less than cash value, then you
are, in effect, getting a chance to be a partner in the business at very favorable terms. It
doesnt matter how good on how bad the business is doing. You are getting in at the bottom.
But you have to be careful about cash operating losses. That was the point that was made
earlier.

According to theme 2, it makes sense to view debt free or near debt free companies from a
lenders perspective. Because in effect what you see is that inside every debt free stock is a
bond which bond fund managers will buy at a price. And if you can get the stock of this debt
free or near debt free company for less than what the bond investors would pay to buy the
bonds of this company, you have a bargain on your hands. Its unarguable. At least thats what
I think.

According to theme 3, buying stocks of leveraged companies at very low multiples of earnings
and cash flows when these companies are de-leveraging themselves, makes sense. But a
matter of caution here. I have not mentioned, but I should have that you need to diversify a
lot more in the theme No. 3 because they are inherently more risky because they happen to be
more highly leveraged. So dont put too much money in individual commitments, but you can
spread it across. And there are many such cases you can find. This process of reverse LBO
will be value creative for the stockholders even if the pretax earnings fail to grow.

The other thing I want to say about these themes is that the maximum percentage return
tends to come in theme 3. Because of the sensitivity of the bottom line profits to a reduction of
interest expense is a very high and even if the earnings multiplier goes up only slightly, the
effect is very large.

Now I try to answer the question how do you identify such stocks? And my answer is very
simple. You should have pre determined levels at which you will buy desirable stocks
at desirable prices. Let me give you an example of this company again its in simplified
example OK here is an executive summary taken from a (Table) database for the last 10
years of this company Himatsingka Seide. You can see that sales have been going on
continuously from Rs.26 crores in 93 to Rs.128 crores in 2001. Todays newspapers carry the
latest results and I have put those in. But I have not put the sales figures, I have only put the
net sales figures because that was given, but I have put the PBDIT, thats the number I wanted
to focus on. And I have put the PAT number. All these figures are in crores. Look at the stability
of the earnings of this company in the last 10 years. 12, 15, 23, 29, 32, 31, 41, 54, 60, 55.
Okay? Now, lets assume some very simple back of the envelope sort of calculations. Total
number of shares outstanding 1.9 crores. Current stock price Rs. 97. Market cap Rs.
185 crores. last five years average PBDIT Rs.49cr. Assume interest cover three times.
Assume interest expense that means if you assume interest cover of three times, that means
this company can comfortably have a 16 crore interest expense on it in the income statement.
Its a debt free company. Now assume an interest rate of 10 percent, it means this company
can put Rs. 163 crores as debt on its balance sheet. That is the debt component inside the
stock. But the stock has a market cap of Rs.185 crores. But the debt component is Rs. 163
crores. Its a cheap company but it doesnt satisfy the criteria of a dirt cheap company. Now
what does that mean? What is the required decline in market cap for it to fall in that criteria? If
the stock price falls to Rs.85 from Rs.97, this company will start selling for less than the
amount of bonds that it can comfortably finance in my opinion. Therefore it will come on my
radar screen and Id start buying the stock and the more at goes down, the more Id buy
because I am getting safer and safer at lower at lower prices.

Thats the way I would want to look at identification of such stocks for purchase. You can have
buy triggers in place, so you know that if the price of ITC comes to a certain point its a debt
free company you know at which price it will be a buy and thats one company with such a
solid cash flow in terms of predictability of it that lenders would gladly lend money to that
company at very low interest cover of as low as 2. So you have a different standard of credit
analysis for ITC than you would for maybe a high-tech company. You will insist on a higher
interest cover for a technology company then you would for a tobacco company. So you can
have these hypothetical interest coverage ratios, and you can pre calculate these buy signals
just like chartists have their buy signals, even fundamentalists can have their buy signals. So
you can have an idea at what price you are willing to buy ITC and what price you are willing to
buy at Colgate or other similar companies.

And the other thing you have to do is to exercise patience, which means you have to wait for
these stocks to come to you at your prices. You dont go after them. Rather, you wait for them
to come to you, on your terms. You just keep yourself ready to welcome them in your portfolio.
Because you are focusing on them. You are not focusing on what others are saying what that
the market is going to do. You are not focusing on watching the CNBC channel the whole day,
for example. You are not focusing on reading the stock markets ticker on a daily basis or being
in front of the brokers screen or anything like that. You are focusing on certain principles that
tell you that at this price, such-and-such stock is dirt cheap and I want to have it in my
portfolio.

I want to end by quoting Warren Buffett on the value of patience and he said this and he gave
an anthology of baseball. He said that:
They are no called strikes in this business. The pitcher stands there and throw the
ball at you, and if you are playing real baseball and its between the knees and the
shoulders, you either swing or get a strike called on you. If you get too many called
on you, you are out. In the securities business, you sit there and they throw U.S.
Steel at 25 and they throw General Motors at 68, and you dont have to swing at any
of them. They may be wonderful pitches to swing at, but if you dont know enough,
you dont have to swing. And you can sit there and watch thousands of pitches and
finally you get one night there, where you want it, something that you understand.
And thats when you swing.

Buffett used that quote in the context of betting big on things that he understands But I am
applying that marvelous quote in the context of what I have just said, which was that you
should wait for these things, you should be patient with them and once when you get them at
your price, you should act. Because these stocks are so cheap that they are no-brainers. Its a
mathematical principle which is being violated and wont be like that for long.

Conclusion

I think value investing is successful precisely because it is difficult to practice. What

I have said it is easy for you to understand, but I can tell you that is not easy to
practice.

I think it is successful because its unpopular and because it is based on

fundamentals and not stories that read about or hear or see on CNBC.

I think the value of value investing lies in its unpopularity and I think if value
investing became popular there wont be any value left in it.

Answer to question on the management factor and diversification:

What I want to say here that is no matter how careful you are, if the management is
absolutely fraudulent then there is nothing you can do about it.. Whether you are buying a
bargain, I mean you think you bought a Rs. 100 note for Rs. 20 but the note was fake. So
what do you do? But what I feel is that in general in general managements may be
somewhat dishonest but they are not fraudulent. Now there is a thin line between the
two. I think it is an acceptable risk to deal with businessmen who maybe slightly dishonest
because they carry with them a low low price which can offset the downside of a little
dishonesty on their part. But if you end up with a totally dishonest fellow, then no price is too
low for that fellow. I think that comes from experience I guess.

You see the way Graham handled that problem was by insisting on wide diversification. I think
it has not been accepted in India or in other parts of the world because people think that you
know they found as a good company, they want to put a lot of money in it. Because they get
greedy and they think this is going to double, triple, I want to put a lot of money in it. But
Graham said things can go wrong. They can go horribly wrong. But if you diversify very widely,
like if you have 60 stocks in your portfolio, then each stock will have less than 2 percent, if you
have spread the money evenly. Then in that sense you may go wrong on even maybe 20 of
them but if you are right on 40 of them your portfolio is going to go right. It is the same
principle of insurance. And out of the 20 stocks that did go wrong, it doesnt mean you lose all
the money in them. Thats not what I am meant by going wrong. What I meant was that if
your analysis was wrong because, for example, you based it on numbers which were not
correct , you can still take corrective action in getting out at a loss, maybe at a loss of maybe
even 30 percent of your original investment. But you havent lost all of it.
On Quality of Businesses and on the Sell Decision
See, none of the businesses that I have talked about today are so-called great businesses
with great potential, great managements in-place. But the prices were great .And
when you look at prices that are great then the investor has to truly not think very long-term.
He is thinking long-term in management of his portfolio, but he is not married to any of the
stocks in the portfolio. So, when he wants to sell, how does he decide when to sell a value
stock? And I think I have to say this- I learned this lesson from a great teacher I will tell you
about him later. What I learnt was in order to decide when to sell a stock is not by having a
value in your mind and saying that if it reaches that value, I will sell. Because you are not
trying to value stocks here. You are trying to buy cheap things. So when do you sell? When
it is no longer cheap. And when is it no longer cheap? When something else you find
is more cheap, far more cheap. So you keep on shifting your money out of stocks
which are no longer relatively cheap to stocks which are relatively very cheap. You
automatically have almost all your money invested in that part of the stock market which is
dirt cheap. And when you do that, your sell side decisions are taking care of automatically. So
you are not worried about the stock rising to some price that you have in mind at which you
will sell. So when I buy a stock at below cash, I may actually sell it not just when it crosses the
cash but I may sell it when it is still below cash because, maybe I have found another stock
which is relatively cheaper to switch into. Therefore, what I learnt is that instead of thinking
selling think switching.

Question: What to do when a value stock fails to rise?

Answer: Well, on a practical level they are two ways to handle that problem. One is to revisit
your assumption and to check out that you were right and have conviction that if you are right,
you are right. The market is wrong. Thats one. The other thing is that that you have to buy
more, but you cant buy enough you cant buy too much, sorry. You cant buy a quantity
which exposes you too much to that stock. So you think the value is much above the price.
The price is Rs.100, has come down to Rs.80 so you buy some more. But its come down to
Rs.50, you buy some more. But now you have reached the exposure limits that you had in
mind say 2 percent of your portfolio. You just forget about it. You dont sell it, of course not
so long as the assumptions were correct.

My experience has been that if I turn out to be wrong I got to know about it because I was
wrong in my assessment, not because something happened to the company afterwards. And
when that happens and you are proved that you are wrong you have got to sell and when you
sell its not at all relevant what is the price you paid. Because as they teach you in cost
accounting sunk costs are irrelevant. So what you paid for a share has got nothing to do
with whether you should sell it today are not.. Its all relative. And its a very important
principle which is that what you paid for a stock has got nothing to do with whether you should
at what price you should sell it for.

If you are sure about the sustainable dividend yield then waiting shouldnt be a problem even
though the market price is below your cost. If you are getting a current income return which is
commensurate with what you would have got if you sold this stock and put it into a bank, for
example, then you would have got some interest return, but here you are getting a dividend
return and you are sure that the cash generating ability of this company in the future years is
going to be more, much more than that dividend. So instead of interest cover which is the
correct ratio to look at from the perspective of a lender, in this case you are looking at the
dividend cover and dividend cover not from the accounting profits but from the cash flows,
from the cash flow statement. The cash flow of operations, net of capex, and working capital
changes and interest expense divided by dividend. Thats the number to focus on and if that
number is three or four and you know the industry is pretty stable in the sense that you dont
expect the earnings to collapse by 80 or 90 percent, which will wipe out dividend cover for you,
I think you are safe holding on to that stock.

On the interest rate cycle

At this point in time, its the theme No. 3 you got to be skeptical about. Because I think we are
at pretty much near the bottom of the interest rate cycle. And even if thats not the case its
not a risk worth taking in many cases. The point is, why to invest in a highly leveraged
company where the whole investment is dependent upon cut down in interest costs. The
principal is going down but if the interest rate goes up because of the change in market
interest rates, then you are back to square one. So you look at this theme when you see the
interest rates going down but not after they have gone down a lot. So you change your theme
as there are number of other themes that you can look at. You can develop your own themes.
But you got to develop themes which tell you in no uncertain terms that what you are buying is
cheap. But that doesnt guarantee you against a loss. Nothing can guarantee you against a
loss. There are no guarantees in this business. There are no guarantees in any business. You
can just try to do the best you can by having your money invested in things that you think are
really cheap and then hope that others will at one time find that they are too cheap too and
then they buy and the price goes up and that give you a chance to exit at a good price.
Alternatively you can hope for the development of and things are moving in that direction
a market for corporate control. Because when that happens, you have additional triggers which
come, additional catalysts which come to help you to exit from value stocks in the form of M&A
activity. Company A will buy company B because it is cheaper to buy than to make. Now if you
have a takeover code in place which makes it difficult to do that, it wont work. But if we
encourage M&A activity, you will often find that the companies whose stocks you buy as a deep
value investor, will tend to get acquired at multiples of your cost because some businessmen
who understand the valuation will be willing to acquire the business at a price which is at a
premium to prevailing market price, but at a discount to what they would spend to create that
business on their own. So its a win-win situation for everybody. The value investors who
bought it cheap, they get an exit at a large profit. And, the businessman who is buying this
company is getting it at a discount to what he would spend to create it from scratch.

Absence of deep value stocks as leading indicators

One thing which Graham said was there will be times when you will find no deep value stocks
like cash bargains and net current asset bargains (where he would buy stocks selling for less
than two-thirds of net working capital, net of debt) etc. He said this is a leading indicator for
you that the market has gone too high. He recommended that when you stop finding such
stocks, you should start thinking of asset allocation, which means you should reduce your
exposure to equities and go into cash. And thats I think a very interesting point because it
tells you how to allocate your capital also i.e. how much to put in equities and how much to
put in bonds and cash.

On Buffetts transformation
You have to go into the mystery of why Buffett did that. He loved doing what I am doing now
and what Graham did all his investing life. He just got too rich to do it anymore. Because if you
get too rich, you cant do these things anymore. Because for these things you are basically
looking at very illiquid situations. You are looking at stocks which nobody is looking at right
now. Which is why they are cheap. Because they are illiquid. So, he was doing these things
and he found that he could no longer find such opportunities where he could deploy substantial
amounts of capital. And he had too much money to play around with, so he evolved and he
went from bargains securities to good businesses with good management and a fair price
models. Which is something I dont know how many years I will take to reach, if at all, but I
am pretty happy to be doing what I am doing, because I think its one of the most
conservative ways to invest.

Mahesh: Ladies and gentlemen. I would like to take the opportunity to thank Mr. Bakshi and
present a small memento on behalf of Oxford Bookstore and Capitalideasonline.com

Sanjay Bakshi: Thank you for having me with you.

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