Value: Intrinsic or Subjective

 

(Click here for old post on value investing)

Recently, a young student was discussing business valuation with me. The young fellow was quite intrigued by the business valuation models particularly DCF. He asked me about my preferred model for valuation and I told him that in my view these valuation models are good for having a theoretical viewpoint and conceptual framework but these are very primitive methods and not practical most of the time in the real world. So we need much better valuation theory/methods which can stand on its feet during the evaluation process.

I know many hardcore Value investing followers and once during our discussions one fellow asked (challenged) me if I could suggest a better fundamental valuation method to value the intrinsic value of a business/stock. But I asked him- whether things really have intrinsic value? We value Roses and consider grass to be inferior to roses but just keep humans aside and nothing is more valuable than the others. Things are just IS. So Roses are Red only for us. The valuation we do is not linked with the individuality of that thing (standalone value) but to the relevancy of that thing to us. Without humanity, roses and grass have same value but it is different when they are “valued”. So value is different from valuation. Leave aside human beings and all and everything has same value…objectively everything is equal. But a three dimensional human being can trade all the grain of the world for a glass of water when he is dying of thirst in Sahara desert….a human can kill thousand others for something as abstract as religious sentiments. Can we value the embedded value of a handful of wheat or a glass of water objectively? So value is intrinsic but valuation is subjective. Objective valuation may not even exist (at least for businesses/stocks).

Value is intrinsic but valuation is subjective

Every asset that generates cash flows has an intrinsic value.

Value investing postulates that prices will oscillate towards intrinsic value (one and only one) and so this intrinsic value is an objective value. I have seen many commentaries on value investing and seen many value analysts (like Buffet) criticizing efficient market theory (CAMP model) but at the fundamental level if we can see even value investing believes that price and value should coincide. But first of all, why there is a difference in market price of an asset and its value because theoretically market price and value of an asset should be equal? Value investing assigns irrational behavior (by market) as the reason for this difference. Value investing accuses market to be guided by temporal forces of greed, fear and its changing mood where it completely ignores the economic considerations related to that asset. So if we can see this irrational behavior is the backbone of value investing where they try to unearth hidden gems ignored by wisdom-less market.

So Value investing declares itself to be far superior to the other irrational players of the market and it feels that it is superior just because they try to calculate intrinsic value (though with large numbers of highly subjective assumptions). But this “irrational behavior” is a very weak rationale for the most fundamental part of the value investing since presumed foolishness of others can’t create something very fundamental related to most valuable aspect of human life- Valuation of assets. It is possible that during Covid lockdown in India from Mar-2020 one investor might have sold Laurus labs at 70 due to the fear of covid related unknown or another investor might have sold it in order to arrange money to help poor migrant labors. Can we say that their behavior is irrational just because they sold Laurus labs at 70 which later on touched 350? Were they foolish for the choices they have opted? No, definitely not.

Fear and optimism are the fundamental forces responsible for the direction of the economy. These are as abstract as something can be but still they have the powers to drive and motivate something as material as an economy. When people and entrepreneurs are hopeful and optimist they spend and invest which drives the overall growth of an economy. Major function of the governments is not micro managing productive resources and their allocation but to create an environment where people have the faith and optimism in the government policies and administration. Like, GST was a great financial engineering having the capability to transform and revolutionize the business models and supply chains in India but a Government can always make a mess of this by making unnecessary rules and large number of compliances which will only create confusions, increase the compliance costs, restricts the flow of Input credit…and this will hit the confidence of investors and industrialists hard and they may choose to invest in some other country or cancel their planned investments in India forever. So fear and optimism are not irrational behavior but are the driving forces responsible for growth and preservation in adversity.

It is a misconception that man, material, money and technology are the most important forces driving the economies. Actually economies are just like a big truck. But which part of the truck bears the maximum weight of the cargo/truck? I ask this question all the time and many time I get answers like axle, wheel etc. But this is not correct as it is the humble AIR in the tyres which bears the maximum weight. So, the most insignificant, subtle and least-physical part holds together the most significant. Similarly, Confidence of the people in the economy and the Government is the most important factor driving the investments and thus growth.

Role of Market in “Value” and “Price”

So what explain the difference in price and value? Actually I have always felt that the fallacy may be related to the role of the market. Contrary to the general perception, the role of the market is not to “find the Value” of an asset/stock/commodity but the role of the market is to “price’ these things as an intermediary of the forces of supply and demand. Price of wheat in the market in the year of short production is high and it is low when there is bumper production of wheat in the following year. The price of wheat is not determined by the market keeping in view the relative value (which is same) but as an outcome of demand supply forces. So, the value is perceived individually while the price is determined collectively by demand-supply forces. It is not the role of market to find the true “value” of an asset/commodity but only to “price” it which is impacted and directed by large numbers of complex and diversified variables. Hence, even when value investing finds that value and price are same; market is not doing anything to Value but it is just doing in which it is most efficient- to price.

And all of a sudden, we can feel that this “price” is more objectively arrived at than the “value”. Value investing use highly subjective assumptions like discount rate, growth rate, terminal value, no growth PE ratio etc. and so this makes intrinsic value highly subjective. For example, expected cash flows of an asset are subject to the wisdom/strategy/decision making of an able manager who manages to extract much more value out of an asset due to his wisdom and decision making. And that’s why valuation is subjective- there is no standalone value which accrues to an asset on its own. Value is created by able managers with wisdom and price is paid (and accepted) for this value subject to prevailing market and general economic conditions. Price is what we know and value is what we perceive.

In Real Life Valuation is Subjective

In real life things are also like that. Valuation is subjective- just take the recent case of coffee retail chain Café coffee day (CCD) which is on the verge of sale. Can we say that CCD has one and only one intrinsic value? No, because its value will accrue differently to each buyer. Tata coffee/Tata-Starbucks can extract big synergy by consolidating CCD with them and thus creating more value as compared to other buyers with unrelated business like Dabur or even Coca cola. But the likes of ITC who are trying hard for long time to build a branded FMCG business can see this as a big opportunity and will be ready to pay much higher price because they will be hopeful of creating more “value” than by spending the same money for promoting their other in-house brands. So whenever this will happen there will be a fierce fight for the control of CCD.

Let’s take the case of ITC. ITC has not performed that well in last 10 years or so. So how value investing would have valued ITC 10 years ago could have been very interesting. ITC was churning massive volumes of cash and it had grand plans for doing big in FMCG business. Value investing would have arrived at a very lucrative value keeping in view the past record (in creating a great FMCG brand in Aashirwad) and low cost of capital of ITC. But the most significant part in any business valuation is qualitative part (and impact of intangibles) which is not captured that well by value investing. Just like our traditional accounting which has no tools to evaluate intangible assets. But we all know that net worth in fact is the minimum value as businesses get maximum value from the intangibles like brands, technology, Patents, customer loyalty, information and data which are not assigned any value in the balance sheets by traditional accounting (not much even by Value investing).

So the story moves forward and ITC couldn’t create the value. First, it was not vry wise in allocating capital. It wasted it in hotel business which is highly capital intensive but low return business. In FMCG- apart from Aashirwad it failed miserably. It invested and focused on second standard products in crowded segments like Yippee, Sunfeast, Bingo which are forced choices...nowhere near Maggi, Lays etc. I don't think it could ever be a leader in any of these products...when Maggi was hit badly due to bad press it could not do anything even at that time. Actually Aashirwad was a great venture and I was thinking at that time that ITC would make a killing in Pulses/Spices with its Aashirwad brand but instead they focused on other low margin businesses like stationary/Hotels and other crowded FMCG products with very strong brands. The main reason for me to buy Tata chemicals (Before demerger of branded product business) was their foray into branded Pulses and Spices business and Tata has created a great brand in the last 5 years or so. Tata chemicals has really leveraged its supply chain and brand recall in creating niche products (Tata Sampann Brand). That’s why Tata chemicals is already giving almost three times returns (Including value of Tata consumer post-demerger).

It is very tough to create strong brands in FMCG sector which is already having strong brands. Inorganic growth via acquisitions should have been a much better strategy than building brands from the scratch. In today’s world it is very costly. So I feel a better way for ITC was to acquire a good company in FMCG with good brands like last year Zydus wellness did by picking Complan/Glucon-D and Horlicks was acquired by HUL. These are master steps; CEOs are paid for this. Sometimes I felt ITC should have sensed the opportunity in premium whisky in India and instead of investing capital and efforts in creating new brands in highly competitive FMCG sector related to snacks etc. It should have attempted at acquisitions preferably in liquor sector like Radico Khaitan (who once was looking for a partner). United spirits and UB were picked by Diageo and Heineken but investing 20000-25000 cr for buying these giant Indian brands in high entry barrier Indian liquor industry would have been a much better strategy for ITC and cash was never a problem for ITC. Liquor business is a much better extension of its cigarette business and ITC understands the dynamics of this complex regulated business in India much better than others and that’s why I think ITC could have created more value for United spirits and UB businesses than by the likes of Diageo and Heineken.

So the value is not created in a linear mathematical formula but by human wisdom and strategy which are not confined to any formula or any boundaries. Value is created and perceived subjectively.

Here I remember something- the divine lovers Laila Majnu!! You know Laila wasn't very beautiful but Majnu was a handsome guy. The king of the city liked him and he was very concerned to see Majnu dying for Laila, an ordinary girl. So he invited Majnu to his palace and offered him to pick any girl from his harem having the most beautiful girls of that time. But Majnu declined; king was shocked and asked, “but how can you decline these pretty girls for that ordinary girl Laila…she is nothing against these women?".

"Well, my dear King, to see the divine beauty of Laila...you need my Eyes", was the reply from Majnu.

(Every asset that generates cash flows has an intrinsic value so can we say that Money has an intrinsic value? I have asked this question to the young fellow as his next assignment)

(Views are personal. This post is taken from monthly Newsletter of this Blog. Reach me at oscillationss@yahoo.in)

Insurance and Reinsurance sector- Truth is Beyond Time and Space

Stocks covered in this study: GIC RE and Cholamandalam financial holdings Ltd

Dear all, this study is mainly about the dynamics and factors affecting and governing the growth of insurance sector and not about any particular insurance stock. I have tried to list out the factors affecting the functioning and growth of this one of the most complex sector. But insurance sector (General insurance in particular) is going to see the huge growth for next 10-15 years in India and I feel this is going to be one of the sectors to produce future multibaggers. The growth and performance we have seen in Indian insurance sector up to now is nothing compared to the massive growth lies ahead. So I have tried to find out the most relevant factors which are going to shape this sector in the future and which stocks are going to be the major beneficiaries is just a matter of time and space and we will continue to find out more such stocks opportunities. As of now, I have selected GIC RE and Cholamandalam financial holdings Ltd (CFHL).

This study I have shared with the subscribers of this blog some 10 days back but due to some reason could not share the same here and in the meantime CFHL has witnessed good buying and has already touched 540 from 430 at that time. So not wasting any further time, I have decided to share the same here. The study is detailed spanning 42 pages so it will take some time in reading and understanding due to the complexity of the subject. I have also tried to cover issues related to valuation of businesses especially of financial firms. The second part of this study will be released soon covering the detailed study of stocks like GIC Re and CFHL. The full version of this study is available for the subscribers of this blog so I am sharing some samples from this study report here. Those who are interested in getting the full report please contact at oscillationss@yahoo.in

Sample study:

 

CONTENTS
Paragraph	Description	Page no.
(A)	Insurance- Role and impact on business and economy	4
1	Risk management in insurance and law of large numbers
2	Law of large numbers is everywhere
3	Concentration risk and Reinsurance
(B)	Insurance is complex but Reinsurance is even more complex	10
1	Law of large numbers and correlated or concentrated risk events
2	Reinsurance to manage concentrated/correlated risks
(C)	Time for Reinsurance is yet to arrive in India	16
1	General Insurance has a long way to go in India
(D)	Reinsurance to play big role in India for the growth of specialty insurance	20
1	Cyber Insurance and Catastrophic Insurance- The big game for Reinsurance
(E)	Cyber Insurance-The next big thing in insurance and Reinsurance	23
1	Valuation of Intangibles- where traditional accounting is useless
2	Valuation of data, information, and intangibles- a must in today’s world
3	Valuing the data assets- The starting point of cyber insurance
(F)	Crop insurance and Aircraft insurance- other Reinsurance heavy sectors	31
(G)	Something about Float and Investment Income in Insurance business	32
1	How life insurance industry adds value
2	Solvency Ratio
(H)	Government role is crucial in catastrophe insurance and GIC Re will be a key player for India	36
1	Catastrophe Bonds
(I)	Individual valuation of GIC RE (CMP 127)	40
1	Valuation of financial sector business- Book Value multiple or Earnings Multiple
(J)	Cholamandalam Financial Holdings Ltd (CMP 430, Market Cap. 8100 cr)	43

One friend once told me that he was fortunate to be born into his present religion as his life could have been useless had he been born into some other religion. But I told him that he was not that fortunate because truth is beyond space and time. Truth is absolute, ever-existing and ever-lasting. It is not affected, directed and objectified/represented by variations in time and space. I told him that he would have felt the same had he been born into some other religion. However my friend argued that still he felt good about his religion. But I told him that I was not denying that (feel good) but that which can be affected so much by time and space can’t be the reality. It can be whatever it is but it is not the TRUTH. You aren’t/can’t be defined by these temporal and spatial phenomena. I have seen people having a feeling of greatness, ego and class because of money. But I always tell them (wherever I can) that this is not the reality because this reality is bound by time and space. They could have born into a poor family and they absolutely have no control over this.

This misconception engulfs every sphere of life and Stock market does the same mistake when it thinks that quarterly numbers (time) and issues (often temporary) affecting industry (space) are the truth. As it focuses on time and space so it misses the truth. It sees bad quarterly numbers and reshuffling of Industry as an end of the game. But restructuring, reallocation and consolidation in any industry are indispensible for long term growth and sustainability of the Industry. This restructuring takes care of the misallocation of the resources in the industry and so the same is corrected through reallocation and consolidation. It is not the sign of a disease but it is a much needed surgery to cut off the cancer. So, quarterly results are not the truth (may be bad due to industry or company specific issues)…Industry problems are not the truth.

Truth is something else. Consciousness is the truth as consciousness exits beyond time and space. Businesses/Firms have their own consciousness which has the ability to create a superior product with scale with high entry barriers. This consciousness can travel beyond time and space. Promoters/management is just one of the part of business consciousness which comprises technical capabilities, superior R&D abilities and focus, Networking effects, superior and vast supply chain etc. Businesses are not alive beings still we can feel they have their own consciousness…they have their own aura…employees feel it (different feeling with different employers), other stakeholders feel it. The legacy of a business, work culture, integrity and focus attract, nurture and develop like-minded people...just like the ones who have created the original legacy (Like Tata, I feel even when Ratan Tata is gone the legacy and style of Tatas will prevail and this shows that business consciousness is real and shape all and everything around it).

Brilliance is not the rarity but the opportunity and expression of it is. So Steve jobs, Gates and Ratan Tata are not the exceptions…they will keep coming. They will keep coming into Microsoft and Tata attracted by their business consciousness. Strong businesses are not one product wonders but they are because they create and develop a work culture (consciousness) which automates the generation of new ideas, innovation, expression and resilience. This is the real strength of a company…its soul…its most important asset. This is what makes companies to fight at the face of adversity and lead to their resurrection. A business becomes more resilient to outside threats (competition and existential) when it has technical expertise, high entry barriers due to business model and complex supply chain. A great warrior is not who can hit others hard with his power but he should have the will power to withstand the hard blows of opponents…only then he can win fights and be a great warrior. So, strong business model and technical expertise are not enough. A business has to be resilient…it should have the strength and will power to withstand tough periods…periods of droughts.

Future growth is extremely uncertain as it is impacted by thousands of variables…more so now because the world has become a big single market (and it may stay so). I don’t think it is possible to assess the impact of these vast numbers of variables into the distant future with a high degree of certainty and then assigning a value for this assessment (growth rate). This assessment or guesswork becomes increasingly difficult and complex for an emerging line of business or when there are structural shifts happening in an economy. But it is possible to assess the technical expertise, strength and resilience of a business. The chances of a traveller crossing a tough terrain are not determined by the risk of dangers which may come during the travel but more by his strength and resilience. He can defeat those dangers. So rather than focusing alone on assessing the future dangers (guesswork) the better approach is to assess the strength of the traveller. Same is also true for a business. Future growth is not determined by the external threats but by the capability of a business to fight of those threats.

But I have seen business analysts putting all efforts to declare a growth figure. I always wonder how they calculate the growth rates i.e. at CAGR of 15% or 20% because 90% of the times these estimates are wrong. But if I am a great analyst charging hefty fees then I have to give a figure otherwise I can’t claim to be a God…I need to demonstrate. I am not saying that all such efforts are futile and misdirected but that they should not be the sole basis for assessing the worthiness of a business. The value of a business should not be determined by these estimates. I always feel that the major portion of the value of a business is determined by the individual capability to fight and survive. Financial ratios are linear but consciousness (strategy) is multi-dimensional.

Last year I have written a detailed post on Homeschooling explaining the pain points of our education system. One school principal asked me that day what I think is the major limitation of our study books and teaching. I told him that our books lose the purpose when they declare, present and demonstrate that they know everything and what they know is unquestionable and absolute. I always feel that schools should not only teach what we know but also what we don’t know. Science books should also have strong focus on what we don’t know as of now. This will create more Einsteins…more children will feel interested and motivated. Similarly, I think we need to understand that we can’t assess thousands of variables projecting their future behavior in an excel sheet…rather than giving inconclusive and raw figures it is better to declare that this we can’t assess or can assess with lower degree of certainty.

GIC RE- Its recent business performance is not the TRUTH

 GIC RE has been hit badly in last one year and trading at extremely lower valuations. But the truth is completely different from its recent quarterly numbers. In the coming paragraphs we will try to capture the truth.

GIC Re is India’s biggest reinsurer with around 60% market share. Insurance business is one of the most complex businesses and reinsurance is even more complex. So no wonder people are trying to assess the fourth dimension with 3D tools.

Sample 1:

 Insurance- Role and impact on business and economy

Insurance is basically a process by which risk is spread among vast number of people across geographies. As I have shared earlier, future is extremely uncertain and there are existential threats for all whether for an individual or a business. So the focus was always on as to how to eliminate these existential risks. Insurance tried to fill this void with its innovative business model.

To understand the model, let’s assume a small town with some 1000 families. As there is a risk of untimely death due to accident or disease so every resident is worried about the safety and future of his family. The best way for him is to build an emergency fund for his family. As per his estimates, the fund he needs is Rs. 1 crore and so saves this much money. But this threat is for every family hence every family is focusing on saving around 50 lacs to 1 cr in order to ensure the safety of their families. This means that people will try to save 500-1000 cr in this small town and the same will be parked in safe instruments like FD. But the savings of this huge sum also means that people will spend less and take very less risk for staring new ventures. And this will certainly hit the growth of the town very badly and the question will come as to how they will save this much money in the presence of low economic growth. Interest rates will be low but still even at lower rates there won’t be much takers of credit as everybody has become risk averse.

But then, a smart guy comes into the town. He does his homework and finds that on an average every year some 10 people die of accidents. So he understands that there is no need for everyone to create emergency fund. In fact, he can create a fund sufficient to pay Rs. 50 lac to 1 crore to the family of each deceased fellow which will be around 5-10 cr and for that he can charge a small amount as premium from each family in the town. The premium he will decide based on his cost of capital, administration and other charges. So if everything goes according to his estimates (of 10 deaths) then he will make money from this business. Most importantly, people will be very happy to pay small annual insurance premium (say Rs. 20-30K) to safeguard the future of their families and avoiding the need to save huge money for emergency fund.

So we can see this arrangement is a win-win situation for everyone but most importantly this will ensure the good growth of the economy as a whole as people will feel comfortable to spend and to take risks for new ventures. So we can see the big role being played by Insurance for the growth of economy also not just ensuring the safety of the people alone.

But the major factor here is to cover large population under insurance because only then law of averages will come into play and this will further reduce the insurance premiums. Insurance is mainly about vast coverage because if in the small town in our example only 100 people opt for insurance then there are high chances that out of these hundred 7 people die of accident resulting in high claim payouts for insurance company which is not a viable model. So the expertise of Insurance firm here is to assess the mortality rate accurately and increase the insurance coverage to large number of population. Hence, Insurance is basically a risk management mechanism where the insured manage his risk by transferring the same to the Insurer while the Insurer manages his risk by accumulating/pooling the risks of similar large number of individuals.

Non-life insurance (General insurance) follows the similar model and just like the life insurance it has to assess the risk events accurately like motor accident rates, Fire and catastrophe risks. But the focus here also is to cover the large geographical area in order to spread the risks. Like in our small town case, effectively 1000 people are taking care of the families of 10 people expected to die of accidents in the current year because instead of each family taking care of themselves 1000 families are taking care by pooling money for an adequate fund. So the core competency of insurance business is to spread risk because the risks associated with different policies are not perfectly correlated so the total risk of a portfolio of policies is smaller than the sum of the policies’ risks- for example, 100 policies having insured value of 100 cr…now the risk of each policy is 1 cr but total risk of 100 policies is not 100 cr due to nonlinear correlation between all the policies.

Insurance is a unique business and a very complex one because unlike other businesses where they sell goods or services but in insurance they sell promises…a promise to indemnify the other in case risk/loss event happens in the future. So the indemnity event is also contingent upon the loss event happening in the future which may or may not happen. So, Insurance companies are required to keep adequate liquidity and capital to meet out their future obligations in the form of insurance claims. Insurance companies are required to maintain a solvency ratio of 150% in India (will touch this in the coming paragraphs).

 A strong and efficient insurance industry is vital for the growth of an economy because in the absence of insurance support businessmen won’t be able to take the risk of setting up new factories/projects. Take the case of a setting up of a power plant costing Rs. 5000 cr which is exposed to the natural catastrophic risks like earthquake, hurricanes or other risks like war and terrorist attacks. In the absence of strong and solvent Insurance industry it is not possible for any businessman to invest such a huge amount. Banks can’t provide credit to businesses in the absence of Insurance.....

Sample 2:

Concentration Risk and Reinsurance

This is what insurance business is all about and the most important strategic decision for any insurance company. The holy grail of Insurance business is to avoid concentration risk. This is the most important factor which affects the demand and profitability of insurance business however surprisingly there is not much information about this in any of the coverage reports on Insurance business. They only talk about regulatory and mass retail Motor insurance, health or fire which are required by law and are non-discretionary. But due to easy money there is high competition in these sectors.

The major risk for an insurance company is to have high number of claims as compared to expected claims upon which they have built and priced their insurance policies. Now this high claim risk can be due to two factors- first, their assessment was wrong and their data collection and analysis models were wrong or outdated; second they have accumulated/distributed insurance policies in such a way that it has concentrated the risk for them……..

Sample 3:

Insurance is complex but Reinsurance is even more complex

I have not seen a business as complex as Insurance where growth and demand dynamics are extremely difficult to assess. But I have seen people treating both insurance and Reinsurance on the similar lines…analysts predicts linear relationship between insurance and reinsurance business and growth in retail insurance will result in the same degree of growth in reinsurance. But this is not the case. Both have distinct demand and growth dynamics.

Once one analyst associated with large broker house was telling me that their analysis about reinsurance is that with the growth in Motor, health insurance in India more business will come to Reinsurers. But I told him that I did not feel the same and instead as far as I can see growth catalysts are very different for Reinsurers. Actually here things are very complex- risks associated with Motor and Health insurance are not co-related…means one car accident does not create the chances of another car accident. In other words, if one car insured by insurance company X gets into an accident in area A then it does not affect the possibility of another car accident in area B nor it creates a chain where another car accident may take place due to one car accident in area A…means each risk event is different and independent and does not even out the other risk event. Car accidents are not mutually occurring and each car accident is a mutually exclusive event and independent of other car accident unlike catastrophes like hurricane where one hurricane can do big damage in multiple and correlated risk events in a particular area and further you can’t pin point the area in advance……

Sample 4:

General Insurance has a long way to go in India

However, Indian general Insurance industry as of now is very backward and needs huge resources and innovation to start the new growth path. To have an assessment as to where India stands now, two ratios are used across the globe to measure the development of insurance industry. First is Insurance penetration which measure the development of insurance sector i.e. circulation rate of the insurance products in an economy and second one is Insurance density which is the ratio of total insurance premiums earned in a given year to the total population.

Insurance penetration rate is measured as the ratio of premium underwritten in a particular year to the GDP. India’s insurance penetration was 2.71% in 2001, when the world average was 7.83%. The same in 2016-17 was at 3.49% (2.72% Life and a mere .77% for non-life). The same now stands at 3.7% against global average of 6.8% which shows that we have too much to cover as of now.

But i don’t like this ratio much and don’t think that this ratio is expressing the status which is desired because:

(1) If we can see then this ratio attempts to show the relation between premiums and GDP. But I think the focus of Insurance is not on protecting GDP DIRECTLY.

(2) In fact, Insurance aims to protect the GDP generating assets not the GDP.  So I think the focus should be on to check how much of the income generating assets (Like factories/power plants) are insured.

(3) Also, insurance premiums are affected by competition and interest rate in an economy (because insurers can set low premiums to attract more business to invest the premiums in high interest generating assets like Bonds).

(4) So I feel instead of focusing on insurance premiums received in a year the better way is to focus on the value of income generating assets insured as a percentage of total income generating assets in an economy. I mean focus should be on sum insured not on premiums paid. For example, if an economy has Rs. 10 lac cr worth of assets then the penetration should be measured as how much of these assets have been insured not the premium paid for ensuring these…….

Sample 5:

Cyber Insurance-the next big thing in Insurance and Reinsurance

Data is God. As you all know I am a firm believer of this. And as things are changing in the structure, growth factors and catalysts of economies across the globe the same is going to be recognized by all the businesses and insurance providers. The world, economies and businesses as we know today are defined by one factor- DATA. Just see the top companies of the world- Google, Facebook, Alphabet, Apple, Amazon, Microsoft, UBER, Netflix, Linkedin. They are not our conventional companies selling physical goods but they are the ones selling information, digital goods and services. For these firms, Data is all and everything. Companies selling and dealing in physical goods are no longer the global giants. Goods are replaced by DATA.

This Data orientation of the businesses has fundamentally changed the risks associated with the businesses. Two-three decades ago, businesses were about investments in machines, plants, infrastructure and raw materials. Business meant physical assets but now is the time of intangible assets……

Sample 6:

Valuation of Intangibles- where traditional accounting is useless

Once I was sitting among the group of stock market enthusiastic and CAs when one passionate investor told me that my being a qualified CA helps me a lot in analyzing the stocks. But I disagreed with him. I have seen CAs considering themselves as depositories of accounting laws and fundamentals so they have a feeling that they can value stocks and businesses. But I usually tell them that this is not the case because stock analysis starts where traditional CA ends. In mergers and acquisitions, intangibles are accounted for some 70% of the business valuations with traditional assets in books accounting only for some 30%. The problem with the traditional accounting is that it has no tools to evaluate intangible assets. Our so called balance sheets comprise of just physical and financial assets and liabilities and accounting says that the difference of the assets and liabilities is the net worth which is the value of the business as per accounting. But we all know that net worth in fact is the minimum value as businesses get maximum value from the intangibles like brands, technology, Patents, customer loyalty, information and data which is not assigned any value in the balance sheets by traditional accounting. So we can feel the uselessness of our accounting systems. The uselessness of our accounting is more pronounced at present with the onslaught of digital economy as more and more resources are invested in the formation of digital and intangible assets…..

Sample 7:

But in the absence of capitalization of intangibles or valuation of Data assets in the balance sheets have rendered the books of accounts and return ratios meaningless in today’s world because as pointed out earlier it is very much possible (it happens always) that the revenue earned today is due to R&D expensed out 5 years ago so this revenue will distort the return ratios/metrics big time and investors/analysts will have a false interpretation of high return ratios when the fact is that the most of the related expenditure is charged off 5 years ago. Further, the timing of R&D expenditure may impact the results big time and people may arrive at wrong conclusions when the fact may be that in a particular year with lower profits the firm actually has invested much higher in R&D for a new breakthrough product. For instance, take the case of Pharma biggies like Gilead and Pfizer, aviation giants like Boeing planning a new aeroplane…all these new products require massive investments in R&D the benefit of which will be realized in the foreseeable future. So the books of accounts we are seeing and analyzing today (especially of a tech heavy and R&D heavy firms like Pharma) are just superficial. If you ask me, Indian analysts have very low expertise in recognizing and valuing intangibles (Biocon was never valued much in 2013-14 when it was spending big in R&D and I saw many analysts questioning its return ratios at that time. But I picked it at that time and it is now a 12 bagger). The main reason for this is that Indian companies are very backward in investing in R&D so in India these analysts have the liberty to ignore or deficient in valuing intangibles but still be regarded as great analysts…..

Sample 8:

How life insurance industry adds value

 If we can see, life insurance industry sells the true interest rate sensitive products or policies. Almost entire profits of a life insurance provider arise from the difference in the interest rates they are earning on their assets and the interest rates they have promised to their policyholders. So falling interest rates negatively affects the future value of its assets which it needs to payout its liabilities in the future which are at much higher interest rates. So this can result in the asset liability mismatch and even can threaten the insolvency of the insurance firms. That’s why prediction of long term interest rates is more relevant and imperative for life insurance firms than non-life firms.

So the most important thing for the life insurance firms is their ability to predict the behavior of interest rates over a period of 20-30 years…..

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your own Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post. Reach me at oscillationss@yahoo.in).

 

 

 

Value Investing- Fourth Dimensional Astral Body

Dear All, I am receiving regular queries about the next post as it is almost one and half month since my last post. Actually these days not being able to post as I am busy in some work so i will post as soon as i am free. Further, I have been receiving requests for a long time to start some initiative related to learning/education part of stock analysis and research. It is really heartening to see that these days people want to learn about the fundamental analysis. They are not that enthusiastic about short term trading as people these days are aware that real wealth in stock market is created over long term by investing in top quality stocks. But quite contrary to what appears on the surface stock market is the toughest place to earn money especially over a long period of time. Reason-stocks are affected by huge number of variables which are almost impossible to track to perfection like action by competition, risk of substitute products, global factors and variability (vs local demand), risk on future scale of operations/products (like thermal power), low entry barriers in the industry, scale of operations/market share, margin variability due to commodity nature of the products, government policies, Interest rates etc. And I have seen people trying too hard to comprehend and measure these variables (so many). However, ultimately all such exercises lead to an attempt to measure WEAK forces/factors of a stock (company) but i think Value investing starts from an attempt to FIND the point/points of strength.

Stock market does a big mistake when it tries to discount each and every news/issue in terms of earnings and stock price movement and it appears as stock price volatility is inherent or natural and it is affected even by the change in the direction of air. But there is something (in stock performance) which maintains its flow (upward/positive) even when all and everything about a stock appears negative. Sometimes I just find this similar to our body which is changing every moment but there is something in us which remains the same from our birth to death….just like the Linga-Sharira (Subtle/Astral body) of Indian Vedas. Vedic wisdom sees physical body as something which is in constant interaction with surroundings and changes form every moment but still something in us remains the same…throughout our life and we can feel it even with closed eyes. We can feel that all the changes in our gross physical bodies do not change the REAL We. Ling-Sharira is the real FORM- its aspect changes but it remains the SAME. Ling-Sharira is the form or base upon and around which physical body is created so Ling-Sharira pre-exists physical existence and will exist even after physical body is dead.

So most of the times stock analysis tries to measure the “Gross body” but the reality is the Ling-Sharira which remains the same and value investing is about finding this Ling-Sharira. I call this the fourth dimensional investing and fourth dimension is TIME. In our three dimensional world nothing is constant as every moment a thing is no longer what it was earlier. Me of today is different from me of yesterday or 20 years back but the difference is only in the aspect not the form…me of today appear different due to Time. But if i visualize my image from birth to now stretched out in time then I can see that something in me is still the same…this whole stretched out image is Ling-sharira in a four dimensional world. In a three dimensional world we only see or comprehend a part of this Ling-Sharira but that part is not whole. So in my analogy- Value investing is only about finding this Ling-Sharira/Astral body in every stock which never changes.

So coming back to stock analysis learning part- after thinking for a long period of time I have decided to venture into stock analysis education part. I have finalized most of the details of this venture. But still I want to know the views of all of my readers and any suggestions they can give before taking a final call. So if anybody is interested in being a part of this initiative then please contact me at oscillationss@yahoo.in.

NIIT Ltd- Disruption in Training

I am just putting a short note on NIIT as I think it may have a run very soon. So due to lack of time I am just touching some of the most relevant points and will share the detailed study at some other time. First time, I advised NIIT at this blog in 2015 at 39 (Click here) and now at 120 I think it is still a great buy. Off late, i am buying it regularly from 80 levels and picked last week at 100.

People still consider NIIT as an IT education firm offering IT courses and as Indians care more for certificates and degrees than authentic knowledge so no doubt this image of NIIT is a drag at least for the share price. NIIT is the one who turned millions of Indians into Techies in the 90’s when our Govt feared how they would survive with huge population. Our education system and universities were not capable of technical education to masses but the likes of NIIT and Aptech brought a big revolution in tech education in India. They designed and developed their own content for Indian market and managed their business with precision and professionalism and they were one of the big reasons that Indians tasted success in IT. But current avatar of NIIT is not about IT education. It has modified its approach at the right time. Our world now is changing very fast and skills are getting extremely specific. So degrees are no longer that important as skills are. That’s why IT/Tech education is moving online as more and more people are doing these online courses for developing a particular skill for a particular job which is not there in university degree as there the focus was more on theory and concepts. 

So, online tech education is disrupting the learning and education models. A great revolution is happening in tech education and the likes of Pluralsight, Lynda and Udacity are the new tech unicorn of the US with revenues around $100-150 million (700-1000 cr). But they have big daddy in the form of Skillsoft with revenues of around $ 500 m to $1 Billion. Cornerstone onDemand and Topyx are the other big names. These online tech education companies are mostly into B2C model even when they are having subscriptions from organizations. And these companies have changed the lives of many with their cheap education services…both of the content providers and students who can take up the courses and do something better with their life regardless of their current education and economic backgrounds. However, NIIT was also having a similar business under Element K and it sold of this business to Skillsoft in 2011 for some 500-600 cr. So it may look surprising that NIIT sold that high growth business. But I think that it was a wise decision because that enabled NIIT to cut its debt however most importantly there was a strategic decision at NIIT to leave that business to focus more on Managed Training Services business (MTS).

Managed/outsourcing Training Services- next big thing in corporate training and learning

There was and still is high competition in online tech education subscription based business model. But big corporations like Citi, Shell, Rio Tinto, GE, Toyota do not opt for these online portals. They need something more serious and concentrated and current trend is for outsourcing their training function to the experts in this field. For these large corporates, training is not core to their business but a necessity for improving the skills and productivity of their employees in today’s highly competitive landscape. So development, management and delivery of training is a big costly distraction for them. But for training management companies this is their core business and so they are highly skilled for this important task. HR department people are not skilled in knowing and understanding the complex training and learning needs of employees. In every HR meet, there is big noise around machine learning, Artificial intelligence, augmented reality etc. which are the current buzz words in the field of high end information technology but nobody is aware of how to implement these breakthrough technologies.

So now is the time to outsource complex training and learning task to the professionals. Further, some businesses with high regulatory and compliance requirements such as oil & Gas, Pharmaceuticals and banking have very complex training and learning requirements and they have no scope for any mistake in tight regulations as associated costs are very high like one mistake in complying with the requirement of keeping full records of data/tests for a drug may result in big losses in the form of cancellation of manufacturing license or recall of medicines from the markets. So there is scope for significant value addition by MTS professionals in the form of high quality training/learning and cost savings. And whenever a process can add create value for itself in the entire business chain then it has a viable high growth business model. US spends the most on training of its employees and now the trend for outsourcing the same is rising. India, as expected is still a very small market for MTS but the pace is going to increase in India because Indian employees are terribly short of training.

And I feel this is where NIIT has made a brave and visionary decision because NIIT had everything to support and motivate this business because of their 30 years’ experience in developing content and running a software development company (NIIT tech). And if we see the results; it prove that NIIT promoters were right in their vision. MTS is growing fast across globe and NIIT has some 40 clients globally with the likes of Shell, Citi, Riotinto, Nokia, ABB, Sanofi, GSK, Signify, Ebay, Skillsoft, Hitachi etc. In MTS, NIIT does everything from content development, technology services, delivery, selection of third party suppliers, consultancy etc. NIIT has managed to grow their MTS/CLG business from 85 cr in 2011 to 700 cr in 2020.

We have not yet counted the possible growth of India business in CLG. Indian employees are terribly under trained; our tech students are markedly not adequately trained in practical aspects. Earlier, Indian companies survived due to low competition but now we’ll see high investments in training from here on.

Its skill and careers business where it offers IT education has revenues of some 230 cr. As compared to India, NIIT is a big force in IT education in China and has achieved great results in training around half a million students in around 100 Chinese universities. In China, Job placement rate for students trained by NIIT is over 90 per cent. I feel with proper planning and renewed focus NIIT should do well in India again as now the focus on skill based digital education is growing in India and NIIT has one of the best content in IT education. Using training centers for IT education is a very costly choice and so not suited for all. But deep internet penetration is going to raise the demand for online IT courses in India.

Any acquisition in Tech/digital education space is the next big growth Catalyst

In mar-2019 NIIT sold its 23.5% holding in NIIT Tech for some 2100 cr. After paying taxes, buy back and dividends they have around 1200 cr in books as on Mar-2020 and this is where the real game will begin. I am sure that NIIT is going to do some big acquisition in the field of tech/digital education or MTS in the near time. Covid crisis may even help them in finding acquisitions targets at lower value now. Traditional education delivery models and corporate training models are going to see huge disruption in the near future and now is the right time to build the scale. That’s why I think the best way to use the proceeds from the stake sale is to build a new age business. Even the likes of Zee learn (kidzee) will be a great fit for NIIT. Its promoters already have one of India’s best IT education universities in Neemrana, Rajasthan (NIIT University).

It has 1200 cr cash in books and at CMP of 120 it is trading at a market value of 1700 cr so there is a huge valuation gap and margin of safety. Its EBITDA is around 100 cr on revenues of 900 cr and with further growth in revenues operating leverage is going to come into the picture. Its promoters have raised their stake from 31.5% last year to 35.3% this year. Also recently, MIT has picked 2% stake in NIIT and it already holds some 2% sake. Dividend yield of 8% is great and this is going to be stable in the future.

So it has some strong high growth catalysts in the future in its business- 1) big order wins in MTS business (right now orders for some 1700 cr in hand) 2) scaling up its IT education business 3) Any big acquisition in Tech/digital education field and I just feel that we are going to see all 3 happening very soon. But as much work is yet to be done in these 3 catalysts and from hereon it will get most of its value from future performance (cash in the books is almost discounted and future is uncertain as of now) so treat this one as risky option and invest only riskiest capital into it.

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post. Reach me at oscillationss@yahoo.in).