What type of businesses will not make money ? Socialist businesses in a country.....My learnings

     

Over the years what I learned that not all the businesses make money.Let me say it differently,over the years what I learned and realized that some type of businesses will definitely not make money.

The soldiers in the economy

    Some businesses are like soldiers in the economy of a country ,which are the basic requirements of the country.These are the businesses over which other businesses in the country will flourish.So these soldier businesses are highly regulated and pricing power will never be granted to them.Because these are the basic requirements of the country and if pricing power is granted to these businesses ,then it will affect all the other businesses in the country.Some of the examples are

• Public Sector Undertakings (PSUs)
• Power Generation / Transmission / Distribution Companies
• Mining companies
• Railways
• Oil Marketing Companies etc.

Example

Power generating companies have entry barrier and not anybody can come and start generating power immediately.

Energy is highly essential. 

Not everybody can produce it.

    Then why the companies like NTPC,PGCIL etc do not make money for shareholders. Because even if they make highly essential products/services and  no body else can make them,still they don't have the right to fix the prices for their products / services that they provide.

    If the producer of the product do not have the right to fix the price for its products,then it will not make money.No matter even if it makes fighter aircrafts having alien technology, it will definitely not make money. These are like socialist businesses which are not allowed to make make money so that others can make money.   

     If pricing power is granted to the power generation companies ,then they can increase tariff and cost of production of  for FMCG,Automobile companies etc.will rise. So power tariff will be kept lower deliberately. 

Example

    Oil marketing companies like Indian Oil,BPCL etc are selling  petrol and diesel in losses and Reliance and Essar petrol pumps are avoiding selling  or selling less petrol and diesel so that that they can make less loss.

    Every country which is democratic in nature and do not have sufficient natural resources (like Land,Oil,Energy,food,minerals etc. )  to support its population is definitely a socialist country because it has a gap between need and availability of resources and the country need to distribute the resources as per the need of the people and not as per the wish of the people, which is a classic definition of socialist country. and if such country now allows you to make profits i.e.  if it supports capitalism now ,then there must be a set of businesses in that country which operate in the socialist rule and they are not allowed to make huge profits, so that other business can make profits and enjoy capitalism.

What I learned that ,category-A type of businesses are not allowed to make money so that category-B type of businesses can make money and  I need to stay out of such category-A type of business.... 

When Not To Buy

         Before buying any company, I must check my default check list.Apart from that even if all the check lists are satisfied,the most important thing I should not ignore is "valuation".Remember that a company may be a good one since last 15 years or it might remain excellent for next 20 years.But its stock price will not be good in between this time period, from a buyer's point of view.Stock prices oscillate in between cheap and expensive and I need to buy a good business in cheap or fair valuation.Sometime the stock price may not come to my calculated valuation and for years and I might have to sit with cash.It is okay if I sit with cash.But I need that margin of safety so that if the stock I purchased  do not rise ,then also I can sit with mental peace.A good purchase price provides me that mental peace.

 Scenario-1

            Often you might be hearing this in business news channels that a particular stock is corrected 40% from its 52 week high and looks attractive.

            If the business is not worth investing,then there is no point in calculating the valuation of the stock.It does not matter how much % the stock is corrected from its top.

            I just don't understand the logic behind it.

            TCS...no doubt ..it is a good company..... as on 19.07.2022...its stock price is Rs.3074/- and its all time high was Rs.4043/- .So,it means as on date the stock is corrected 32% from its all time high. Now TV channels are telling that TCS looks attractive.

give me a break....

            look at its  current market cap ...its 11.21 Lakh crore ....so at its all time high its market cap was 14.79 Lakh crore.

            Even if you buy TCS at current price ...if you think to make your money double in TCS ,then its market cap needs to be 22.42 Lakh crore.Lets say its earnings will justify its stock price ,then its current EPS (i.e. Earnings per share) i.e. Rs. 104 need to be doubled i.e. Rs.208. TCS has nearly 22% margin.So in order to make EPS double ,its revenue needs to be doubled i.e. from 1.95 lakh crore to 3.9 lakh crore.Lets say it will happen over next 5 years it means its revenue needs to be grown at 14% .But its revenue is growing at 5.71% since last 5 years.So if the whole IT industry will grow at 15% for next 5 years ,then it will cross India's GDP perhaps.Again what other IT companies will do ? TCS is not the only company in this planet.Perhaps it need to go to the Mars for getting projects.

            currently TCS is available at 30 PE multiple.Its growing at 5% and PE is at 30.It does not make sense.

                Two things can happen....

           1st... its stock price may stay there constant as it is for several years and gradually its earnings will increase slowly and justify its price.In this case you will not loose money in paper.But you will get -ve 6% yearly because in India inflation is  around 6% minimum.

            2nd....its stock price will collapse because market will not give 30 times premium to a 5% growth company.Lets say if it re-rates TCS to 15 PE multiple.So you will loose 50% of your money in paper.

                In both way you will loose money.

                Lets say we give premium to TCS ..since it can give whole EPS to shareholders ...still the 30 PE and target 22.42 Lakh crore market cap in next 5 years looks insane.

                I may be wrong...but I don't want to take that much risk to make my money double.

                Where we make the mistake is....we see the correction in stock price in isolation.

                But we need to see the following things in together

• Current market cap of the company
• Current Price to earning multiple.
• How much headroom is there for the market cap to go up (considering the profit growth).
• What % of the EPS, the company can give to shareholders as dividend without affecting its business.

Scenario-2

            Often we take the wrong reference point to evaluate the companies in different situations.I consider these as false indicators.Some of these examples are.

• Bank deposit interest rate during COVID pandemic is very low ..say 3.5%.So, if TATA Power is available at 4% dividend yield,then we should buy its stocks.PSUs are available at 5% dividend yield ,so we should buy them.These are all wrong metrics which seems right in extra ordinary situations.You need to ask yourself, that whether you want to own the businesses like TATA Power and PSUs.If not then it just does not matter in what dividend yield these stocks are available.If the business is an investment grade and headroom for multiple year growth is available and stock is available at 5% dividend yield and low PE ,then it makes a perfect buy.But you need to consider all the parameters together.Remember you invest in a business for growth in earnings not for dividend yield only.
• When interest rates are low,even the companies with 5%  earnings growth ,available at 40 PE will attract you.This is a perfect illusion, as you are taking only the interest rates as the bench mark for calculating the valuation and ignoring the inflation completely.As per simple economics, interest rates should beat inflation and at present in INDIA ,it is not beating the inflation.So ,your mind will tell you that its ok to buy the stock at 40 PE since interest rate is very low.Remember that ,what is important is the "sustainability of growth in the prices of your stocks " .This is the whole point for which you are investing in stocks and this can only be justified by growth in the earnings of the company.But if you are justifying the growth in stock prices due to low interest rates,then it is nothing else just a bubble.

        At present some of the good companies are available at insane PE & Market cap.

Example- TCS,Infosys,D-mart,TITAN etc....

 

My Check List for Buying a Company

1. Must not be a loss making company.
2. Must not be a PSU.
3. Must be able to remain profitable for next 15-20 years to come.
4. Must have zero or very low debt.
5. Must not be a capital intensive business.
6. Its Product and services must have competitive advantages i.e. 10x better than its competitors.
7. It must be very difficult to copy its business by any other company.
8. Value migration must not be happening or to going be happened in its business in next 10-15 years.
9. Technological or habitual disruption factor should not be there.
10. Customer loyalty must be there in the products/services offered by the firm (by force or choice )
11. Entry Barrier must be there in the business so that other companies can't take over its business or take its future business opportunities.
12. Pricing power must be there with the company for its products or services i.e. the company must have dominance over its customer,distributor,retailer
13. There must be sufficient head room to grow its business.
14. The company must have the ability to throw cash to the share holders (may be in a longer period of time)
15. Must be professionally run company.If it is 1st or 2nd generation company,then 1 or 2 family members of the promoter in the board is okay.
16. All the key positions in the company should not be held by family members.
17. The company should be such that ,any idiot can run it.
18. Management should be good at capital allocation.
19. Stock must be available at good valuation.
20. If FIIs/DIIs have less holding,then it is better.

  Its a learning process ...and will be refined over time.

What Not to Buy

     Before buying any stock ask the following question to yourself

• If the company is not profit making in the operation level,then I just through away the company from my list of thinking.I just don't want to even think to take their names.The Indian unicorns Zomato,Paytm,BYJU etc...etc...all are loss making companies as on date.
• People argue that these are cutting their losses day by day and will be profitable by 2-3 years.I don't buy stocks of the company which is supposed to post less loss.I am not interested in companies which can make profit in future.I am interested in those companies which are making profits and will make profits in future.
• I judge the  companies in its ability to remain profitable and not just only profitability.Check if the  company is profitable today ,and whether it will able to remain profitable for next 20 years.If you have doubt then simply discard the name.
• A loss making company means simply a no from my side.
• Do you really understand the business of the company or you are just buying because everyone else is buying that stock.
• If you understand the business,then is it wise to put money in that business  ?  Yes ,you must ask this question to yourself.I am telling you my choice I don't put my money in capital intensive businesses like Steel,Telecom,Automobile,Airlines,Energy companies etc.These companies need Rs.100 for running their business and earn Rs.10/- profit.Now even if they earn Rs.10 profit,they can't give you back this Rs.10 entirely.Because ,they will need money for running their business.Lets say they can give you back Rs.2/- as dividend.Check the dividend paid by these type of companies,you will understand what am I saying.Don't consider PSUs are exceptional ,just because they are paying good dividends.Look at their balance sheets.They are carrying huge debts.It just doesn't make any sense.Its like someone who takes blood from the blood bank every month in order to be alive, but donating blood to others.Its simple economics if you have debt ...pay the debt first...don't pay dividends.They just pay dividends because their boss needs money.
• Always judge the company by its ability to throw cash from its profits,to the shareholders as dividends.IT companies like TCS,Infosys etc. FMCG companies like ITC,HUL,Britannia,Marico etc can pay you almost all the profits as dividends.Because these companies are debt free and they do not need more capital for running their business. 
• Dividends are the only hard cash which an investor gets in his bank account.Ask yourself whether the company is paying dividends regularly.If yes,then the company must have very negligible debt.Because if debt is there,then there is no point in giving dividends to the shareholders. 
• If the company is not paying dividend,then ask yourself why is it not paying dividends? Remember that ,the very purpose of a company is to make money for its shareholders and the company creates it in terms of profit with hard cash.The only way it can reward its shareholders is by sharing profit with its shareholders by paying dividends and the capital appreciation in terms of rising stock price is a by product only and it is not in the control of the company.So,if a company is not paying dividend to its shareholders ,then it is like an unwritten promise to the shareholders that, dear shareholders I am not giving you the profits today,because I can use this money to make more profits for you in future.So,you have to check whether ,the company is actually retaining your profits for making more profits or it is just retaining it for its survival only.

• My No List

1. A loss making company.
2. Capital Intensive company (Infra,Energy,Telecom,Steel,Cement,Automobile etc.).
3. Public Sector Undertakings.
4. The Business I don't understand.

This is my learning ...and it will be refined over time ...because investing is an art......