My article at Yahoo: Good Stock. Bad Stock.
Tata Steel showed some gutsy results in the last few quarters, with phenomenal year-on-year growth in their net profits. As western economies have recovered (ever so slightly) the Corus acquisition has helped them in scaling up.
But, the impact of such results for investors has been less than stellar. When Tata Steel announced the Corus acquisition in early-2007, it decided to finance that acquisition through a rights issue and compulsorily convertible preference shares (CCPS), sold to existing investors. The Rights issue allowed an investor with 5 shares to buy one more at Rs. 300 per share. The CCPS was priced at Rs. 100 per share, convertible in 2009 at 6 CCPS to one equity shares, valuing the equity share at Rs. 600 then.
This sounded cheap! The stock price in November to December 2007 — the dates of the rights issue – was between Rs. 800 and 900, much higher than any of the rights or convertible prices. In fact, just the rights issue would have taken your purchase price to the Rs. 750 levels. And the CCPS at 600 looked juicy.
At this price the company was an absolute steal, pun unintended, for investors in November 2007.
Fast forward to today. The Tata Steel share quotes at Rs. 640 and you have had three dividends in between, adding up to Rs. 40. In total, you would have got Rs. 680 — still 10% lower than the purchase price more than three years ago. Not accounting for inflation.
This gets the investor very unhappy — such a big acquisition, and yet, the stock price is dead? Bad stock.
Financially, results have shown an expansion. The company went from making 4,177 crores in the year ended March 2007 to now, when it has made 4,800 crores of profit in just the first nine months. At the current rate it will make more than 6,000 crores for the year as profit, which gets all the more attractive as you realize that the company has had two loss making years (2008-09 and 2009-10) in between.
Now we’re thinking: Okay, maybe it was the recession. Good stock.
But before you rush to buy, consider that the earnings per share (EPS), a prime consideration for how much juice you are getting out of the fantastic results, isn’t that attractive.
We have a nine-month EPS of Rs. 51 today, which you can extrapolate to Rs. 70 for the full year. This is still lower than the EPS of Rs. 73 in March 2007, meaning — massive profit growth may not necessarily mean growth for you. It’s like starting with four apples and four people, and then getting two more apples but having to share everything with 5 more people; you’re still getting a bad deal.
We’re back to: Bad stock.
But then, markets haven’t done anyone justice — the Sensex was between 18,000 and 19,000 then, and it remains that much today. Effectively, on a scorecard starting end-2007, nearly nothing has gone up. A key competitor, Steel Authority of India Limited (SAIL) is down 35% from that time.
Hey, wait. Competitors: Jindal Steel and another player in the metals space have outperformed Tatasteel!
We could go on and on. But the story contains important lessons for investors.
Stock performance is relative. A stock could have great financial results, but the other companies in the space could have done better. Even if it produced great results, it could have diluted equity so much that it hurts every existing shareholder. You would have done well to pick some of the other players, perhaps; after all, what you want to do is beat the market, not match it.
Specifically, those who care about relative performance are those that manage money. When your performance is judged on how well you put money to use, you had better put it to the best use possible. Basically, they need to choose, or be left behind. In a market that is up 50%, you don’t want to be the 40% guy.
But what matters to many of us is absolute performance. You and I don’t care about relative performance. We don’t feel happy that if the market is down 15%, we are down only 10%.We care about our portfolio growing, and growing faster than inflation, which is currently a positive figure.
Data can be twisted. What you are told is often not the whole picture. Even what I’ve mentioned about Tata Steel is incomplete — there are some “losses” that they have not accounted for because certain accounting rules allow them to, there is so much steel capacity in China that will flood India if their economy slows down, the cost of coking coal has just gone up substantially this year due to floods in Australia (which hurts Tata Steel’s competitors), and so on. If you’re going to analyze companies for investing, data of all sorts should be of interest; and because you can’t devote so much time to so many companies, it’s best to keep only a few investments in your portfolio.
Luckily, this is not the end of the investing era; most of us have a longer way to travel, and will keep investing. The important point is to learn our lessons and move on.
It’s not important for it to grow every year; we all understand that stocks will have periods of underperformance, and then periods of outperformance. In three years, stocks are a few percentage points below their 2008 peaks, but so what? The recovery will be stronger, you might think.
But what if, like the US, we have a 10 year period of nothingness? Or, like Japan, which was an investor magnet in the late 90s, slip to even below the all time highs? Or, again like the US between 1966 and 1982, flirt with a historical high a few times just to reverse back into seriously negative territory? The last example has an uncanny similarity with where we are in India today — a very high rate of inflation, potentially rising oil prices and high gold prices. What broke the back of inflation then was drastic interest rate hikes by the Federal Reserve, resulting in two back-to-back recessions. Will we go the same way?
It’s always different this time, of course. And it’s always the same. Happy stock picking!
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