The fun of Wealth mangement!!

Hi Friends!!

Life has suddenly started resembling an adventure movie- with the startling pace at which things around us are changing everyday!! It’s not just the economic events which consume most of the space in media these days, but also other geopolitical events like US presidential elections; the MNS propaganda in Mumbai; blasts in Assam and violently fluctuating stock market movements everyday- volatility seems to be at an all-time high!!

Well, coming to the topic of this article, I have been spending some of my time in the past few days trying to figure out the manner in which I can best utilize the cash lying idle in my bank account. Everyone these days is talking about cash being the king; but cash lying idle in a savings bank account can’t even cover inflation. It’s my effort through this article to share some ways which I think can be useful in managing our wealth and making our cash work!!

Over the next few paragraphs, I have mentioned the different asset classes where our money can be invested; the importance of diversification; tax benefits on investment and an arbitrage opportunity which can fetch you a small (but risk-free) return. The ideal candidate I have in mind while writing this article is a salaried individual who falls in the highest income tax bracket; is yet unmarried and has a time horizon of at least 8-10 years to build a substantial portfolio.
How much cash must be there in my savings bank account?

• I know it is a feel-good-factor to have a lot of cash in our bank accounts- it gives a sense of accomplishment when we check our bank balance; but apart from that cash is the worst kind of asset class an investor can possibly think of!! This asset class; which earns a 3.5% p.a. pre-tax income (or 2.45% after-tax return) which Indian banks offer on savings account; has the potential to destroy our wealth in terms of purchasing power.
• But we can’t keep a zero cash balance in our account either- there are recurring monthly expenses, contingent unforeseen expenses, cash needed for infrequent trips, shopping and other purposes. I suggest a formula which can spare us the pain of determining the minimum liquid cash required.
• The formula is not to let more than 3 months of our recurring monthly expenses as liquid cash. The logic is simple, one month cash is what we need on a regular basis, and this can stretch to two months expenses if we have to travel, shop or have some other one-off requirement whereas three months is an extreme case when we need money for an unplanned or unforeseen event.
• Now considering a lavish personal monthly expenditure of 30% of the cash salary credited to our account; I think the maximum amount of liquid cash we need to keep in our savings account is close to one month of cash salary component (3*0.3*monthly cash salary). It’s better to enjoy the privilege of having 2-3 different bank accounts- when some of them have a good ATM network, some have good online and phone banking facilities and some may be willing to offer us value-added services.
• Now that we know what our “working capital requirement” is; we need to know how we can utilize our surplus cash.

Fixed Income investments- slow but steady way to enhance wealth

• There are different ways by which we can earn fixed return on our money- bank fixed deposits (FDs), Fixed maturity plans (FMPs), Public provident funds (PPFs) and corporate debt depending upon the conditions prevailing in the market.
• I think PPFs are evergreen fixed investment vehicles because they help us to save money for a longer time horizon (the minimum lock-in period is 7 years). Also, they help in saving tax (up to a maximum amount of Rs 70,000 is tax free under section 80c)
• FMPs are funds floated by asset management companies and mutual funds for a fixed time horizon- 1 month, 3 months, 6 months and so on and provide an indicative return on the investment close to the interest rate regime prevalent at that time. Although FMPs invest in debt instruments, the catch here is that they don’t guarantee a rate of return. But they carry an advantage in terms of tax savings- income from FMPs is subjected to dividend distribution tax (which is lesser than 30% income tax) and can also be adjusted for inflation index. Thus, FMPs are good investment vehicles for individuals looking to park their surplus cash.
• The next instrument is also the most common one- bank fixed deposits. I would like to recommend some good deals in FDs offered by the banks right now. Kotak Mahindra bank is offering a rate of 10% p.a. on a 10 year FD. It looks very ordinary, but I think it’s a good opportunity to lock in such a high rate of interest for 10 years – presently interest rates are high because of severe global liquidity issues but that may not be the case a few years from now. What differentiates this scheme from others is that there is no premature withdrawal penalty- in other words we get an option to earn 10% interest if interest rates are lower in the future. On the other hand, if interest rates go further up, we can redeem this money without any penalty and invest in the other high interest schemes. Similarly some banks are offering handsome rates of 10.5% on 390 days, 590 days and 890 days FD. The only disadvantage is the fully taxable status and the less flexible nature of most FDs.
• Now the difficult question- how much money shall I park in fixed income instruments? Well, there are no clear cut answers but it’s our endeavor to explore how we can best enhance our investments. I think 60% of our monthly cash surplus (monthly cash salary minus monthly recurring expenses) can be invested in fixed maturity instruments. And, out of the different options available PPFs can be used to the maximum limit (i.e. 70,000 annually), the remaining can be invested in FMPs, FDs and corporate debt according to the time horizon for which we don’t need the cash back for some other purpose. Corporate debts by some government bodies like NHAI have a favorable tax treatment but these schemes are not very frequently available.
• So, for an individual with a monthly cash income of Rs 50,000- the fixed income investment can be close to 21,000 per month after accounting for monthly expenditure of Rs 15,000 (60% of monthly surplus or 0.6*0.7*50,000). On an annual basis this comes out to be Rs. 2,52,000!!! After exhausting the tax free limit of 70,000 in PPFs we still have nearly Rs.1,82,000 for investment in other fixed income schemes. A prudent choice needs to be made between long term and short term schemes and also considering the tax benefits offered by FMPs.

Equities???- give me a break !!!

• We have a very short memory and try to recall only those instances which have happened in the recent past. Of course, the recent plight of stock markets across the world has made many individuals shy from investing in equities. But equity is still considered to be a lucrative asset class for wealth enhancement in the long term. This opportunity is compounded by the depressed prices prevalent right now and expected to remain subdued over the next few months, may be some years.
• Equities offer another opportunity in terms of favorable tax treatment (15% tax on gains if we sell off within a year and no tax beyond a year!!). Also, it probably is the only asset class which gives us so much choice and flexibility in terms of sector wise exposure, time horizon and dividends.
• Remember friends, we still have 40% of our monthly cash surplus available with us. Now, the amount of equity investment depends upon the risk appetite of an individual, I think the money which we direct towards equities must vary between 25-40% of our monthly cash surplus. This comes to Rs 8,750- Rs 14,000 (for a monthly salary of 50k) based on the opportunity offered by the market and our risk potential. On an annual basis, this turns out to be a substantial investment of Rs1,05,000 to 1,68,000!!!
• There are many ways by which we can invest in equities, but we need to choose the one which is the most optimum for us. Remember that we have exhausted just 70,000 from the limit of 1,00,000 on tax free income prescribed under section 80c. So, it’s a wise thing to invest at least 30,000 annually in tax free mutual funds. This provides us distinct advantages in terms of tax savings (not only on gain from investments but also on our regular income!!!), longer time horizon which spares us the pain of timing the markets and a substantial amount of savings (most tax saving MFs have a lock in of 3 years).
• Out of the remaining amount to be invested in equities (over and above tax-free MFs), it’s an individual’s call whether he/she wants to manage his/her own portfolio of stocks or wants to invest in MF with a particular theme or sector wise exposure. There are many mutual funds available to choose from; an individual can look at the past few years’ return history and the sector specific allocation of MFs to decide the ones he / she wants to invest in. Those who like to invest themselves need to be careful about diversifying their portfolios across value/growth stocks, large/mid cap stocks and diversification across sectors as well. Also, there must only be a few well researched picks in the portfolio because adding too many stocks can make monitoring difficult and can also cap the gains from the portfolio.

Alternative investments!!!

• Debt and equity investments are not sufficient investment vehicles if we consider a long time horizon of more than 10 years. We need exposure to some other asset classes as well which can help in diversifying our wealth and have a potential for generating superior returns in future.
• Two common asset classes in this category are Gold and Real estate. Its worth noting that these two asset categories offer a very good opportunity in terms of utility derived from investing in them. Gold is widely used as jewellery and real estate can provide utility either in terms of rental income or using the property for our own use (self-rented)
• Gold is usually considered a hedge against inflation and also the ultimate haven of safety. Now that we have just 0-15% of our monthly surplus left to invest, some of you might be wondering whether it’s still worth exploring the alternative asset classes!!! I would like to remind that there are other components of our salary which are not paid out by the employer on a monthly basis as cash. These include medical allowance, leave & travel allowance, annual bonus, on site allowance etc. This can be a significant amount for some of us. Alternative investments can be considered when we have satisfactorily invested in debt and equity, have a decent life style (don’t require to buy a major consumer durable for our day to day use anymore) and have adequately insured ourselves (both medical and life insurance!!)
• Real estate is an investment where timing plays a crucial role- more importantly because it’s a single bulky investment and a few percentage points can make a huge difference in absolute terms. Leverage can be used to invest in real estate. Buying a flat is more convenient by paying 25% upfront and the remaining 75% financed by a bank. This has a major advantage in terms of tax savings too. A total amount of Rs 1,50,000 annually as interest expense is tax-free under section 24. So it’s better to finance the house in such a manner to claim the maximum tax benefit!!!
• I would like to mention that the money required for real estate and gold is usually large and this can be made available from our earlier investments in debt and equity as and when we feel like booking profits or the need to buy gold or real estate arrives.

The ideal scenario

• The optimum scenario would be one where we have all the working assets at our disposal (the best consumer durables) and we still have a substantial cushion of earning assets which can help us maintain and enhance our lifestyle.
• A very important thing that must be kept in mind is to avoid over-exposure to any particular asset class. This is difficult to visualize when we start our investments because the amounts invested are not significant (especially on a monthly basis). But after a few years, the power of compounding starts playing its role and these assets start inflating. It’s very important that we don’t let our exposure to any particular asset class go beyond a comfortable level (as a proportion of our total wealth). This way we can hedge ourselves against unfavorable price movement in the particular asset class; in short reduce our risk.
• Partial profit booking and redemptions from inflated asset classes and channeling this money into other / sometimes more lucrative assets can be doubly rewarding.
• I think our exposure to a particular asset class must not be more than 25-30% of our total net worth (sum of all the assets we own minus the total liabilities we have to pay)

An arbitrage opportunity for salaried individuals!!

• A few employers have a policy of giving tax-free loans to their employees. This loan carries some tax liability in the sense that the interest calculated according to the market rate is added to the salary component which is taxed accordingly. Assuming an interest rate of 12% and tax slab of 30% this comes out to be less than 4% tax liability on the loan amount.
• If the funds loaned can be deployed in a risk free manner so that they earn a post tax return greater than 4% then we have an arbitrage opportunity to exploit.
• This is not difficult if we invest this money for equal to/less than 1 year in bank FD/ FMPs earning close to 10% p.a. Even after paying taxes we get a spread of 3.5% on FD (even more for an FMP!!). This is a small spread but why leave it when you can earn without any effort. Moreover, when the loan amount rises over a period of time, this small spread too can fetch handsome gains

Just a small recap after a lengthy article ....

• Liquid cash doesn’t earn returns; so maximum liquid cash must be 3 months of our monthly expenses; the surplus has to be “disposed off”.
• Fixed income investments- approximately 60% of monthly cash surplus spread across FDs / FMPs / PPF of different maturities depending upon interest rates and our cash requirement. Out of this 70,000 annual investment in PPFs is preferable.
• Equities – an exposure of 25-40% of monthly surplus is advisable. Out of this at least 30,000 annually in tax-free MFs, the remaining across value/growth, large cap/mid cap and sector wise diversified portfolio of stocks.
• After substantial insurance cover and consumer durables, investment in real estate and gold can be made for a long term wealth enhancement perspective. Timing and leverage are important because of the bulk amount required.
• Churning across asset classes and restriction of exposure to a single asset class can reduce our risk and enhance returns.

Guys, I hope you will benefit from some, if not all, of the points mentioned in this article. I wish I could have finished this topic in a comparatively shorter article but given the amount of detail this topic required; I was not able to do so. Moreover, there may be some more asset classes which could possibly have been worth mentioning here. Though, individuals have different risk and return objectives and we can’t apply a rigid set of rules for everyone, some amount of flexibility can be applied to the above mentioned logic to suit his / her condition. Wealth management, if followed in a disciplined manner, can work wonders for us. And it’s better that instead of “working for money” we make our “money work for us”.

I hope you will enjoy the process of managing your wealth and see it grow substantially by the time you grow old!!

Regards
Tanuj

(This article is a compilation of my academic, professional and personal knowledge in this field. Please feel free to comment and suggest changes you would like to see in my next articles. Also, in case of any doubts or further clarifications, don’t hesitate to contact me on my mail id- I would try my best to resolve them!!! )

The (in)famous Asset Bubbles ...

"I can calculate the motions of heavenly bodies, but not the madness of people”. Famous physicist Isaac Newton said these words after losing a part of his fortune speculating on the fortunes of a company’s stock. The last few weeks have presented before us events which we thought were impossible - in a span of 10 days the Wall Street & worldwide financial markets were devoid of names which had become a symbol of power & wealth. Fannie Mae & Freddie Mac- the government backed mortgage giants, Merrill Lynch & Lehman Brothers- two of the top 4 investment banks on Wall Street, American International Group- the giant insurance company & HBOS- UK's mortgage lender; all fell like a pack of cards in the current frenzy. This isn’t the first time an asset bubble has occurred & this won’t be the last one either. Human psychology would ensure that asset bubbles like these would crop up at times when we least expect them, although in different forms & magnitude.

I read a book during my NITIE days titled Psychology & Investing or something like Traders’ psychology which I don’t remember precisely. It gave a very crisp & simple description of the famous asset bubbles recorded in history. Unfortunately whatever information & knowledge we gather – majority of it is justified only in retrospect. I have tried to list these “(In) famous Asset Bubbles” in chronological order keeping in mind that I don’t get into too much detail

Tulip bulb Mania

• Generally considered the first recorded speculative bubble
• Place – Netherlands; the bubble reached its peak in February 1637.
• A species of tulip bulbs infected with a kind of virus & capable of growing beautiful tulips became so famous that they became a status symbol.
• Speculative traders start trading in tulip bulbs because of their growing popularity; futures contracts started for buying bulbs increasing their prices exponentially.
• An upward spiral on futures price kept on building without actually a single tulip being traded. Some tulips were traded for 12 acres of land & some for 2500 florins (equivalent to 16 years’ wage of a skilled laborer, phew!!)
• Many people got suddenly rich; but the process of buying contracts at higher & higher prices couldn’t last because no one was willing to purchase & take possession of real tulips at such high price.
• Finally when this realization set in; prices came crashing down by more than 90% from peak; many people & traders were stuck with tulips which were worth fraction of the money they paid for them. poor fellows :-(

South sea bubble

• Place- England; occurred in mid 1720
• The South Sea company was given exclusive rights to trade in the “South seas” which was the area surrounding South America & Mexico. The rights included sending one ship every year to trade goods & one to sell slaves.
• Short term government debt of 10m pounds was converted into stock of the company; more debt was later raised in exchange for equity. It is said that at one time the South Sea Company took more than half the national debt of Britain against exchange of shares.
• The business prospects of the company were presented in a very rosy manner. People thought it was an opportunity of a lifetime to invest in a company having exclusive rights to trade in South America.
• The share price of the company zoomed from 100 pounds to 1000 pounds in a few months!!! Many companies promising “bright future” came with stock offerings. Thousands of people subscribed for South Sea & other companies’ stocks even without having an idea what the “bright prospects” were.
• Realizing that the share price of the company was much more than the true value; some directors tried to secretly sell their shares. But once this news was out there was widespread panic to sell the company’s shares.
• Many people lost their lifetime savings in the company; many financiers & goldsmiths who financed them also went bankrupt. The share price tumbled from 1000 pounds (at peak) back to 100 pounds wiping out many people in the process.

The Great Depression

• This has been the longest & most severe financial crisis ever in developed world.
• Started in 1929 in USA & ended with the beginning of Second World War in 1939.
• Irrational exuberance in the stock markets led to many uneducated investors putting their money in stock markets. Some stock brokers & traders took advantage of this situation & started manipulating prices by trading shares at a high price between them. They made a lot of money & some of them got out at the right time.
• Markets crashed by 40% between Sept 1929 & October 1929 when prices reached unsustainable levels.
• During that time, the American economy had an excessive liquidity provided by cheap credit. This was available to both consumers as well as investors which kept the economy going till that time.
• Heavy market losses led to default on bank debts & created panic. Banks had to pay their depositors & couldn’t recover money from debtors. As many as 9,000 banks defaulted during the depression. Liquidity was wiped out & people lost faith in the banking system.
• Demand worsened & there was a complete lack of confidence; markets plummeted by 90% from 1929 to 1933. Industries got wiped out due to lack of demand & price deflation. Money supply was restricted because of the “Gold Standard” according to which more money could be issued only when there were substantial reserves of gold backing it.
• This situation spread to other trade partners of US; unemployment reached to 25-30% of total available work force. All asset prices remain subdued for years to come.
• The depression ended with the outbreak of Second World War when production & war spending doubled the GNP. Many new factories were set up to assist in war & economy was revived

The Asian currency crisis

• This crisis gripped the Asian “Tiger economies” of Thailand, Indonesia, South Korea, Philippines, Hong Kong & other south east Asian countries in July 1997.
• Like other asset bubbles this too started with blind confidence in the tiger economies after they grew at high rates of 8-12% in late 1980s & early 1990s.
• High interest rates attracted capital inflows into these countries leading to overheating of their economies; particularly the real estate sector where asset prices reached unsustainable levels.
• Foreign debt to GDP ratios went to as high as 180% leading to very high foreign currency risk exposure for these countries. When asset prices started cooling; foreign investors started taking money out of these markets leading to downward pressure on their currencies.
• The crisis triggered when Thailand announced to float the Baht (earlier, it was pegged against the dollar to make its exports feasible). This decision triggered panic among other surrounding economies whose currencies too were highly overvalued at that time. Floating the overvalued currency was equivalent to depreciating the currency which made foreign currency-denominated liabilities grow in domestic currency terms.
• IMF had to step in with a USD 40 billion bail out package to rescue these countries & preventing them from defaulting on their debt.

The Dotcom crash

• With the commercial use of internet in 1995; many new age entrepreneurs came with new companies to tap this high potential market
• Many entrepreneurs came up with fancy B-plans to exploit the new world of internet. But the fallacy was that all these ventures required a high market share to make profits & almost all of them had to bear operating losses in the start-up phase in the process of gaining market share.
• Low interest rates in 1998-99 led to huge investment in this sector, both by venture capitalists as well as through IPOs. In 1999, there were 457 IPOs; most of them internet & IT related & 117 doubled in price on the first day of trading. Similarly VCs were excited at the opportunity of investing in these companies without even assessing the feasibility of their business!!
• NASDAQ composite index doubled between March 1999 & March 2000 to reach 5,000 levels. But many interest rate hikes during that period & continuous losses & folding-up of operations by many of these companies led to panic among investors which led to massive sell-off in the technology companies.
• Total market cap of $5 trillions was erased in tech companies. Many investors went bankrupt because of this “grow big fast” syndrome & many of these companies seized operations. This crash also brought forward accounting scandals like those by World Com which overstated its profits by billions of dollars & filed the largest corporate bankruptcy in US history.

India too had its fair share of crashes

India was largely unaffected by the above bubbles; except the dotcom bubble which wiped out many internet & IT companies and led to a small recession in the economy particularly in the tech sector. There were two bubbles which are specific to the Indian markets and infamously known by the two individuals’ names who masterminded them- “Harshad Mehta” & “Ketan Parekh” scams- the latter is also known as K-10 scam referring to 10 shares in which Ketan Parekh used to operate. Both of them rigged up share prices with the help of huge money taken on debt (mostly illegally) from banks & other financial institutions. When their misdoings were revealed the share prices crashed. Both of them were convicted along with many public officials who colluded with them in these scams. The timing of Ketan Parekh scam was very close to the tech bubble.

But where is the Sub Prime Mess??

Does this one need anything to be written?? I am not writing anything about the Sub Prime because I think readers are fed up reading & listening about it. On top of it, many of them would have lost a substantial amount in the markets so they wouldn’t like it anyways. Moreover, the crisis isn’t over yet & only time can tell how nasty is it going to get with the signs of economic slowdown already visible

Conclusion

After knowing about the various asset bubbles we get to know that the cause of all of them has been exuberance & blind confidence that the price of these assets is never going to come down. A “herd behavior” leads to irrational rise in the market value of these assets & people forget the basic principle that price is what they pay & value is what they get. The bubble develops fast & encompasses many people who want to jump the money-making bandwagon.

Then suddenly some tragic event or bad news brings out the realization that the asset they’ve bought is highly overvalued. This sets in panic & prices fall faster than the pace at which they went up because no one wants to buy these expensive assets anymore. This doesn’t give room to anyone possessing these assets & the fall stops only when it reaches back to the level where it was before the bubble or sometimes even below it.

Thus we see that markets are classic example of place where human emotions of Greed, Fear & Hope interact with each other along with millions of people who try to out-smart each other. We can only hope for an efficient market where all assets trade at their intrinsic values; but that would be possible only when robots who can’t generate emotions are the only ones allowed to trade. Till then, asset bubbles would keep on appearing & crashing and prompting many like me to write an article on them.


Tanuj

(All the information used in writing this article has been taken from Wikipedia, Investopedia & few other websites)

Lakshmi Machine Works - a good buy in current market scenario

I recommend a BUY in Lakshmi machine Works with a medium to long term horizon. I believe the stock is oversold at current levels. Its trading at a P/E ratio of just 5.1 based on FY08 EPS (earnings per share) of Rs 196. I would like to mention that not very long ago this company was trading at 3500 levels & reached a peak of 4000 in January. Considering the low Price /Book value of 1.75 which means that even in case of liquidation the stock would be able to fetch a price of rs 612, I think its a reasonably safe bet.


About the company:

Founded in 1962, now one of the leading manufacturers of textile machinery in India. 3 businesses:-

1. Textile machinery division:

• Oldest biz of the company; revenue generated in FY08- Rs. 2007 crores or 91% of total revenues.


• 60% market share in the domestic Textile Spinning Machinery Industry; India's leading exporter of textile machinery.


• Out of India’s total installation of 39 mn spindles, a significant 24 mn spindles have been supplied by LMW.


• According to mkt estimates;demand for textile machinery looks strong for next 6 years- consolidated demand of 28.9 mn for new spindles & 28 mn for replacement of old spindles. This makes a total of appx. 55 mn spindles over the next 6 years.


• witnessed high growth in last 3 years from 1134 cr in FY05 to 2007cr in FY08

2. Machine tool division:

• Relatively new biz. manufactures CNC lathe machines, vertical & horizontal machine centres.


• Revenues of just Rs 125 cr in FY08 or 5.7% of total revenues; sluggish growth in past 3 years.


• This segment is dominated by German & other European manufacturers

3. Foundry division

• manufacture wind mill & engine parts


• this is a high competiton space


• major clients are GE, Siemens & Armstrong


• together the foundry & machine division account for less than 10% of total sales; management doesn't foresee high growth in this biz at least for the next 2 years.
  

Investment Rationale:

• very impressive performance by the company in the past 5 years- from FY03 to FY 08. A few statistics are: (1) 5-yr CAGR revenue of 34% (2) 5-yr CAGR operating profit of 48 % (3) 5-yr CAGR Net Profit of 56% from Rs 26 crores in FY03 to Rs 242 crores in FY08 (4) Net profit excluding other income & extraordinary income/(loss) has increased at a CAGR of 34% in last 4 years.

• High dividend payout - company has paid out an average 30% of net profits in past 4 years. The latest annual dividend was Rs 45 which translates to a dividend yield of appx. 4.5%

• The company's profitability has been very good - Return on Assets of 13%, Return on Equity of 32% & Return on capital employed of 26% in FY08. This statement can be more simply explained by considering that out of every100 Rs of Shareholder's equity in the company, it has generated a Net profit of Rs 32. Average gross profit margins in last 6 years have been 28% & avg profit margins before tax- 11%

• Well, all the above rationales attributed to the past performance of the company; but one factor which makes it a good buy is the debt-free status & high cash surplus. I have tried to calculate the net cash & fixed deposits of the company as a %age of its current m-cap. The reason for this is a buy back scenario bcos the current market price has reduced by 75% from its peak of 4100. The public shareholding of this company is very high-75% & one relief taking into account the present market scenario is that FIIs dont have a significant stake in this co :) Now, just imagine - LMW has readily dispensible cash of Rs 570 crores !!!!!!!! This turns out to be a whooping 46% of its current market cap (This figure is a bit out dated, as on 30th March, 2008: but I dont have the latest info with me) . This, I think is a very important point- even if the company doesn't decide to buy back its shares, it still has a good opportunity in terms of strengthening its equity portfolio in today's scenario wherein valuations seem reasonable.

• backward P/E based on FY08 earnings comes out to be 5.1 , this seems very cheap compared with the fact that LMW has historically traded at P/Es much higher than this. i have not done a Discounted cash Flow valuation for this company; but even if we take a conservative 10% growth in EPS in FY09 compared to the past 4 yrs CAGR of 34% , we get a PEG ratio of 0.46 !!! This makes it a very valuable pick- PEG ratio below 1 justifies the P/E of a stock with the growth which the company is able to command in future.

• Now some insight on operational front- the company spent around 350 crores last year as raw material expenses on Steel, Copper, Aluminium , pig iron & metal scrap. This turns out to be appx. 16% of its revenues last yr. With the melt down in commodity prices in recent past by as much as 25 - 30% we can hope that the company posts better margins in coming quarters. Another factor is rupee depreciation- the textile industry has been suffering bcos of the rupee appreciation for quite some time bcos a major portion of their production is exported. The rupee depreciation comes in as a good news for the textile sector & good news for textile sector means good news for LMW.

• Out of the totaled installed capacity of 39mn spindles in india- LMW commands 24 mn!! This presents a very good opportunity in terms of replacement demand which is estimated to be 8mn next year & a consolidated 28mn over the next 6 years.

• The company enjoys significant tax & export subisidies which have helped increase its margins in the past & would help in maintaining those healthy margins going ahead.

Investment risks:

• Now that I have made you aware of most of the positive reasons for investing in this stock- there are some risks that you all must consider before you go ahead & buy. One of the major risks is the cyclical aspect of textile industry- its not in a very good shape right now; has grown by 4% in the past year. Although some third party estimates talk of a high growth of 110bn USD by 2012 from almost 60bn levels- I dont have any reason to believe that it would double in 4 years. Subdued growth or degrowth in textiles would mean lesser capex with would mean less biz for Lakshmi Machine works.

• A high cash position may mean lack of profitable biz. alternatives for the company - the company may not have been able to find profitable avenues to invest. Although their capex on machinery & buildings have been almost close to their surplus (= PAT + Depreciation - Dividends) in the past 3 years; they have parked 530 crores in bank fixed deposits. One counter argument is that it turns into some 36 crore interest income after tax for the company.

• while going thru the equity investments of the company which were close to 86 crores valued at cost; I tried to mark it to market according to the current share price of each equity held. It turned out to be a loss of 35 crores :( no big deal considering the recent market turmoil & major loss in JSW steel shares (appx 50%). Well, when I considered a hypothetical scenario taking 75% of each equity's 52-week high (which would have been the scenario some 8 months bk) the results calculation showed a profit of 2 crores. This isn't a very significant negative bcos the company earns dividneds on its equity holdings.

Conclusion:

No equity investment comes without risk- but I view this stock to be a value stock with all the positives I have listed here. May be it can go down further from present levels due to negative sentiments but that would not be for a long time. The average trading volumes are low ; reflecting that this counter has gone unnoticed ( or under noticed) after its drastic fall. When sentiments improve (yes, thats the key !!) this one is the stock price to look forward to.

Analysis methodology & notes:

• no detailed DCF valuation; I have compiled an excel with past 5 years financial statements
• growth & major profit margins in past 5 years
• Reuters consensus estimate for FY09 EPS is 224 & consensus target price of 1930
• ICICI Direct consensus estimate for Fy09 EPS is 274
• qualitative & info on operations & details of financial statements from Annual report & company website
• All calculations are done at a share price of Rs 1000 which was the level close to which the stock was trading on 16th Sept'08

Material Disclosure:

The author of this article owns shares of Lakshmi Machine Works & looks forward to increase his holding by month end ; when his salary gets credited into his account :-)

I am open to any suggestions/ comments by you guys & regret for any formatting/editting errors due to my laziness in cross reading this article & my lack of expertise with MS tools.

Happy Investing !!

Tanuj Goyal