How to spot bargains – Graham Style
Ready to spot a bargain ?
To do that you have to play a game with me.
Imagine you have a choice to invest in one of the four companies below, What price you would be willing to pay for below companies ?
May be profit and sales data can’t be solely used to decide, to help you let me throw some more numbers at you
All four companies operate on decent margins also they are not commodity business as their margins are improving, While Company B is asset light but overall proxy pre-tax ROIC for all four companies is above ‘AAA’ bond yield. (In India pre-tax yield of an ‘AAA’ bond is about 9%). Also all four companies have negligible debt on their books. This is reflected in their ROE as their long term ROE is similar to last year proxy ROIC we calculated above.
As a rational investor who is not biased you would pay relatively more for A,B & C which have better ROIC/ROE compared to D.
What if I told you that Company B is selling 8 time of company C (in relative sense) you would say I must be kidding 🙂
Now let me make it more interesting – Remember, I told you that pre-tax yield on ‘AAA’ bond is India is about 9%, So a post-tax yield of ‘AAA’ bond is 6.3% assuming 30% tax rate.
2 companies out of 4 are earnings twice what a ‘AAA’ bond will fetch you at their current market price
Look at the table below
The final argument could be Company C and D have shady promoters, poor corporate governance, no brands and opportunity size to grow is Zero or declining.
Unfortunately none of its true. Time to uncover these companies
The four companies are
- A- Kajaria Ceramics
- B- Blue Dart
- C- MRF
- D- Apollo tyres
The moment we see those names, we will start rationalizing,
Of course I can pay 8 times (in relative sense) for Bluedart over MRF after all Bluedart is asset light business operating in an expanding ecommerce market like India
Of course I can pay 4 times (in relative sense) for Kajaria over Apollo tyres as Indians have huge unmet need for homes
To rationalize myself i think of these lines from Prof Bakshi
Buying into businesses where pre-tax earnings yield was in excess of twice of AAA bond yield, and the business had a strong balance sheet was one of the key methods of Graham for identifying a bargain security
To top it up,
I have created a very simple screen for you on screener to explore more companies like C & D.
Happy Investing and happy bargain hunting Graham style 😉
This is an educational post and not a recommendation to buy shares in any of the above companies. I have collated data from Money Control and Screener point out any errors if you find.