The recent spate of stock buybacks

When stock can be bought below a business's value it is probably the best use of cash.

Warren Buffet

The Indian capital markets have seen a spate of stock buyback announcements in recent months, and that too from businesses of all sizes and industries. Here is a summary of some of the recent buyback announcements:

Company	Announcement date	Buyback price	CMP	Premium%	Buyback size (Rs cr)
Infosys	11-Jan-19	800	727.9	9.9	8260
IOC	13-Dec-18	149	137.35	8.5	4435
ONGC	21-Dec-18	159	141.05	12.7	4022
NHPC	14-Nov-18	28	24.45	14.5	2615.6
Bosch	10-Dec-18	21000	18171.95	15.6	2159
Oil India	19-Nov-18	215	170.3	26.2	1085.7
Mphasis	27-Nov-18	1350	972.8	38.8	988.3
HEG	26-Nov-18	5500	1980.3	177.7	750
Tata Investment Corp	16-Nov-18	1000	822.1	21.6	450
SKF India	4-Dec-18	2100	1920.05	9.4	399
Natco Pharma	5-Nov-18	1000	665.95	50.2	250
Persistent Systems	28-Jan-19	750	583.4	28.6	225
Triveni Turbine	1-Nov-18	150	106.35	41.0	150
Indian Energy Exchange	20-Dec-18	185	158.35	16.8	69

In a buyback, a firm purchases its shares from existing shareholders, usually at a price higher than the prevailing market price. Buybacks are a more efficient way of returning money to shareholders compared to issuing dividends, since the firm avoids the burden of dividend distribution tax (DDT). A buyback announcement is a strong statement of belief by the firm’s management that the market is undervaluing the shares of the company. The management backs up this belief by using the firm’s money to buy back shares from the existing shareholders at a predetermined price (which it considers as the fair value), thus reducing the number of outstanding shares available. This boosts the earnings per share and consequently the price of the share as well.

Of late we are witnessing a phenomenon where an increasing number of companies are choosing to announce buybacks. This indicates general fatigue in the market for correctly valuing shares of the firm. Moreover, the above table shows that the price of the share continues to lag behind the buyback price by a significant amount despite the buyback announcement. Although the data presented here is from the last quarter of 2018, this trend has been witnessed throughout 2018 and is nothing sort of an anomaly. The management of the firm has the best view of the business and competitive landscape and if they think that buying back their own shares is the best use of cash then that belief deserves nothing but support.

What to Do

A buyback announcement presents investors with an opportunity to exit their investments at the buyback price in a depressed market, of the kind that we are witnessing now. Hence in such times investors should always subscribe to the buyback to the fullest extent possible. The buyback ratio is calculated differently for different categories of investors and it determines the percentage of shares in an investors holding that qualify for the buyback. After subscribing to the buyback to the maximum extent possible, investors should hold on to the balance shares until the market price reaches the buyback price, which is an event destined to happen sooner than later.

How to find businesses with wide moats

I was a chartist. I loved all that stuff. I had charts coming out my ears. Then, all of a sudden a fellow explains to me that you don't need all that, just buy something for less than it's worth.

Warren Buffet

In the investing world, “moat” is a term that has been popularized by the legendary investor Warren Buffet to mean the amount of competitive advantage that a business enjoys in the marketplace over the competition. Moats create entry barriers for the competition and enable the business to harvest uninterrupted profit from its products and services. Therefore moats are a very desirable attribute for investors, when screening for investment opportunities. If they exist at all, moats can be either wide moats or narrow moats. Obviously wide moats are preferred over narrow moats, not only because of the extent of competitive advantage that they provide to the business but also because such an advantage may even be sustainable in the long run. Businesses with wide moats are therefore the ones that long term investors want to ‘Buy and forget’. In the Indian context, such investments fall in the category known as ‘Buy right, sit tight”.

Wide moats in a business may exist for a number of reasons. Some of these include strong brand, widespread distribution network, loyal customer base, low cost of operations, etc. Whatever be the reason for the wide moat, the search for the source for it always ends in an intangible asset – i.e. an asset that is not present or reported on the balance sheet of the business. Isn’t this strange – the one asset that gives the business a wide moat and hence a lasting competitive advantage does not even make it to the company balance sheet and hence never ever reported to investors. This is the single biggest reason why screening for businesses with wide moats is a task fraught with danger, because the person doing the screening may have to rely on hearsay and assumptions rather than hard facts. Unless of course there was a way to measure the intangible assets of the business and value it in monetary terms, in the first place!

This is where the icTracker comes in. We developed this software explicitly to address this very problem i.e. to measure the intangible assets of the business from the company’s reported financials and value it in monetary terms. Next we developed a ratio called the Knowledge Basis – which is just the ratio of the Intangible Assets over the Total assets of the business. Note that Total assets equal the Intangible Assets as calculated plus the physical and financial assets which are reported on the Balance sheet of the Business. The Knowledge Basis then becomes a simple measure for checking if the business has a wide moat. As a thumb rule we consider that a Knowledge Basis greater than 50% means that the business has a wide moat, else it has a narrow moat. The icTracker software has therefore quantified the calculation of wide moat and made it objective, thus making screening of stocks easier and more importantly, reliable. Our icAdvisor service in fact uses the icTracker database when designing and rebalancing client portfolios.

What to Do

When making investment decisions for your stock portfolio, always ensure that the underlying business has a wide moat. But that is the easy part – the difficult part is staying on top. Moats can disappear very quickly if a new competitor takes over the market for instance using a superior moat. Hence it is very important to check the moat of the business every quarter to ensure that the competitive advantage it enjoyed earlier is still in place. It is well and good if you have the time and passion for doing this yourself. If not, you should approach a SEBI Registered Investment Adviser to help you with this process.

2018 - Letter to Clients

After the stellar run of the stock markets in 2017, 2018 turned out to be somewhat of a damp squib for Indian investors. Here is how the year panned out for various asset classes during the year.

The Nifty started the year at 10,533 and ended it at 10,863 – giving a meager return of 3.14% in the process.  But at least it gave positive returns. The Nifty Midcap 100 and Nifty Smallcap 100 on the other hand did much worse, giving deep negative returns during the year. In comparison, the average annual return of client portfolios under our advice clocked in at 2.29% this year. Considering that our client folios are made up of a mix of Largecap, Midcap and smallcap stocks depending on the client’s risk profile, this performance was very satisfactory. Inflation was at 4.7% during the year which meant that only the relatively safe asset classes beat inflation during 2018 – none of the equity classes did so, as shown by the table above. 2018 was therefore the year of safety - but more importantly it was also the year of volatility. There were three major trends in the stock markets during the year – two on the downside and one on the upside. The quantum and duration of these trends were as follows:

This can be seen visually in the daily chart of the Nifty during 2018 below.

Although volatility is a basic attribute of the stock markets, high volatility of this kind spooks retail investors and scars them for life. As for our part, we saw the first downtrend coming in early Jan and advised our clients to sell major portions of their portfolio and sit on cash at that time. We got them back in the market after April when the results of the quarter started coming in. This action benefitted all our Clients. However, we missed catching the next downtrend which started in early September, primarily because it was not a systemic downtrend – rather it was based on fears about risk in the NBFC space triggered by default of IL&FS – a leading lender to the infrastructure sector. The extent and impact of such sector specific risks are always difficult to assess but the markets always take a safe route by first pushing prices down and then analyzing the impact. Since none of our Client folios had investments in the NBFC space we considered it prudent not to react to this kind of downtrend but rather ride it out. In hindsight we can say now that this approach did not do too badly for our Clients.

On the economic front, the year was characterized by high crude oil prices (which moderated towards the year end), inflation fears, fiscal slippages and systemic liquidity concerns. State elections in five major states during the year also made the market nervous. SIP inflows into equity mutual funds continued at an increasing pace reaching a run rate of billion dollars a month by the end of the year, despite high selling by foreign investors. These flows found their way mostly into largecap stocks leading to their stability at the expense of midcap and smallcap stocks.

What can be look forward to in 2019? For one, the Indian economy continues to be the fastest growing economy in the world growing at a rate of 7.2%. It is poised to become the fifth largest economy in the world this year overtaking the UK in the process. The central elections are due in May 2019 and this will be a time when we can expect some nervousness and volatility in the markets. If the elections throw up a majority Government, then the markets will settle down and could even start a rally. If on the other hand the elections throw up a fragmented mandate then we could be in for a long phase of consolidation. At this point the best thing to do therefore is to stay invested. Investing is a long term game and those who stock to their convictions during difficult times get rewarded by the stock markets ultimately.

At the end of such a difficult year, it is well worth the time to take a moment and review the fundamentals of long term investing. We enumerate them here for quick reference:

1. Asset allocation – Diversify your financial assets across Debt, Equity, Real Estate, gold, etc. depending on your risk profile and age. In the current scenario, real estate and gold are no longer sources of capital appreciation. Hence these assets should be used to satisfy consumption needs only. It means that your assets should be spread only across Debt and Equity. One simple rule of thumb to do this quickly is to subtract your age from 100. The number you get should be the percentage of your assets that you should allocate to equity - the rest should be allocated to Debt.
2. Financial planning - Identify your financial goals and classify them by time horizon – short term, medium term and long term. Use Debt assets to achieve short term goals, mix of Debt and Equity assets to achieve medium term goals and Equity assets for achieving long term goals. This will be the basis of your financial plan.
3. Reviewing your plan - Review your financial plan yourself or with your advisor at least once a year and make adjustments depending on the prevailing situation.
4. Invest right - When it comes to equity, invest in the right businesses and then give markets time to give you returns. This calls for patience in the face of volatility. Speak to your financial advisor whenever you are in doubt and need a second opinion.

Finally, I want to inform all my Clients that during the year we made optimization improvements to our stock picking algorithm based on observations and our own backtesting. These improvements will ensure that we pick long term winners that have a high probability of returning generating alpha for our Clients. Having said that I have to add that there is always scope for further improvements in our stock picking and monitoring process and with the help of the active support of our Clients we will keep working diligently on such improvements. I also want to thank all my Clients whose active support and trust in us got recognized by Silicon India magazine in their 2018 ‘Consultant of the Year’ award to us.

In passing, I want to take this opportunity to thank you for putting your faith in our investment thesis and in our icAdvisor service with your hard earned money. Your continued trust makes us stay committed to the vision encapsulated in our tagline – ‘Growth through Knowledge’. I believe that we can grow only when you see value in our service and growth in your own portfolios. I am available to address client queries at all times and am approachable via email or whatsapp. I am also open to feedback and suggestions and welcome you to provide the same. I also hope that if you have benefitted from our service, you will spread the word to your own friends, family and colleagues and have them share the benefit as well. 

Finally, let me wish you and your family a very happy and prosperous Happy New Year and hope that our relationship will continue to grow for many years to come!

Abhijit Talukdar

Founder, Attainix Consulting

SEBI Registered Investment Adviser