Value Investing in India


Director, Banyan Tree Advisors

June 9, 2013

Value Investing, as a sub-set of investing, is considered to be the process by which an investor buys into an stock at a price which is at a reasonable discount to its intrinsic value, with the assumption the discount will reduce over time. Assume the intrinsic value of a stock is 100, and the current stock price is 70, then the value investor buys into the stock at 70, with the belief the stock price will converge towards intrinsic value over time. There are a few relevant factors to take into account before one chooses to initiate the investment.

a. Intrinsic value and the discount to intrinsic value at which the stock is currently traded
b. Expected time for the stock price to converge to intrinsic value
c. Will intrinsic value grow during this time
d. Inflation rate and opportunity cost of investing in the markets
In several developed markets, where the economy is expected to grow at about 3% per annum and a 1% annual rate of inflation rate, if I get a stock with intrinsic value of 100 at a current price of 70, I will jump at it. Whereas in India, with the nominal GDP (Rupee value of GDP has been averaging a 15% pa growth over several years) growing at 15% per annum and with inflation at 8%, the above questions become far more relevant. To illustrate the point, let us take the following examples.

1. Scenario 1 : The company has an intrinsic value of 100, but intrinsic value is falling at about 10% per annum and current stock price is say 40. This may sound absurd, but one sees such situations very often, mostly in hindsight. For example, MTNL had a net worth of about Rs 10,000 cr in FY2004, cash balance of nearly Rs 5,000 cr, annual profit of over Rs 1000 cr and a market cap of about Rs 10,000 cr. Eight years later, its market cap is down 85%, larges losses and net worth has fallen sharply. There are several examples of such situation. Buying such situations, when intrinsic value is at 100, current market price at say 40, but intrinsic value falling, requires a very short time period for value realization. Else, the investor is better off giving the investment a skip.

2. Scenario 2 : The company has an intrinsic value of 100, intrinsic value is growing at about 5% and current stock price is close to say 60. I have had reasonable experience is getting caught in such situations. The upside from 60 to 100 looks great, but for each year of delay in realizing the value, the investor loses about 3% against inflation. More importantly, the market’s intrinsic value is growing at close to the nominal GDP growth rate of 15%, and the investor loses 10% each year (15% market intrinsic value growth less 5% growth in intrinsic value of the stock) from an opportunity cost basis. I have seen stocks where the value realization has taken 5 years, and in the mean time, though the investor made a return ahead of inflation, has lost out on an opportunity cost basis.

3. Scenario 3 : Intrinsic value of 100, growing at about 10%, which is ahead of inflation, but less then market intrinsic value growth. Stock price is about 75. Such situations are much safer than the above two scenarios, where the investor who aims for absolute return will definitely make a return ahead of inflation. The investor is also getting paid for each year of wait to get value realized. On the other hand, not enough on an opportunity cost basis.

4. Scenario 4 : Intrinsic value of 100, growing at about 18%, stock price is about 85.
The good thing in such situations is that the company’s intrinsic value is growing above nominal GDP growth and the market wide intrinsic value growth. The investor gets to participate in the intrinsic value growth, and at the same time benefit from the market price discount to intrinsic value. On the other hand, such stocks would never be available at valuation that look cheap on an absolute basis.

The above variations in value investing in really not that relevant in many developed markets where the nominal GDP growth and inflation are relatively low. Whereas in India, with a reasonably high nominal GDP growth and inflation, analysing your value investing opportunity in this framework can have a reasonable impact on your decision itself.