Today, I am responding to generic questions about treating a holding companies like a mutual fund scheme. The point here is, not to say, my approach is the only right way. Right or wrong depends upon the context. It depends upon your objective. So without much ado, here I go….
……holding company having ‘Strategic stake Vs Financial Stake’ and treating(valuing) each of them differently simply because strategic stake may never get sold/realized. Do you factor in this difference in to your fair value calculation ? If yes, how ? The how part of the question is because as per my knowledge there is no such breakup provided in the AR
I do not differentiate between strategic stake vs. financial stake. No, I am not questioning the categorization into two types. This is because, in the context of my objectives, it does not make any difference both ways. In calculating my fair valuation, I use a set of matrices that are oriented towards cash flow to me. This cash flow to me is not standalone dividends (a misunderstanding!). This cash flows includes dividends and potential capital appreciation upon selling. How do I determine that? I answer lies in my process for calculating fair value range. I take into account:
- Future cash flow, to determine what would I get out of it, measuring DCF (uses dividends and selling price)
- Dividend history (not just payment, but growth and consistency), measuring dividend yield
- Historical pricing, to determine what premium market assigns to its earning, measuring average PE,
- Generally accepted valuation point, measuring PE of 12.
- Graham Number, another generally accepted valuation point, measures book value (although it is my desire to use tangible book value, I have not done it yet).
Let us take an example. I am assuming, before you try to determine fair price, you will make sure that qualitatively, it is a good company. Next question is; what is fair price to buy? In case of strategic holdings, value will never be realized. But in such cases, the dividend cash flow should provide you your value. It is hard for me to believe, that good promoter group will have strategic holding just for the heck of it. In the end, what matters is returns, the difference is ‘how’. If stake is destined to be never sold, my expectation is it should have some mechanism to realize value for promoter group. If it is indeed a bad holding company, then it is likely to get reflected in fair price. The DCF could be low, historical pricing could be low, PE12 would be low, etc. In case of financial holdings only, I expect it to be similar, i.e. It will likely get reflected on fair price. Higher DCF with higher dividends, higher historical price, PE12 is high, etc. So you see, it does not have a way to differentiate between them. But the process will filter out what is fair range for me. Again, this comes after qualitatively I agree it is good holding company.
There is a school of thought which wants to treat holding company like TIC as a MF scheme (and the best one at that, because because it’s CMP is less than it’s last stated NAV). What’s your view on that?
I consider TICL as a standalone investment company and not similar to MF scheme. The difference lies in its structure. The difference lies in the way it conducts its operations. In general, MFs manage funds on behalf of individual investors and they get paid for it. The charter of MFs are, typically, to do transactions in equity/derivative/commodity exchanges. Fund management makes money by (a) management fees; and (b) bonus on performance. Investors, like you or me, make money on capital appreciation and/or dividends. The performance risk is entirely borne by individual investors. On long term, yeah, a crap management will suffer, but that time frame is pretty long.
On the other end, TICL is a incorporated company (not a scheme or collective fund). Its job is not to take money for retail or individual investors. TICL is a subsidiary of the Tata Sons. Meaning, Tata Sons provided the initial paid up capital to create TICL – a company. TICL is now in the business of making money (from its assets – which is money). It does not take money from you or me to invest in equities. So, as an investment company, how does TCIL make money? Over the years, it has been able to generate and grow sizable amount of assets. TCIL makes money as follows:
- TICL holds 32% stake in TATA Asset Management Company (TATA AMC manages TATA mutual funds). AMC is the asset manager. Note: you are now on the other side, being AMC you are now on fund manager’s side (not on retail investor side). In short, buying shares of TCIL puts you in fund manager’s team, where people pay you fees to manage their money. While buying units of mutual funds, puts you in retail investor team, where you pay fees to MF to manage it for you. TCIL gets dividend income from this AMC. It owns this AMC business.
- TICL from its own financial assets invests in diversified portfolio of quoted or unquoted securities of companies (including TATA companies). It gets dividend and profit from buying/selling. My understanding is unquoted securities are not available to MFs (please correct me if I am wrong).
- TICL from its own financial assets invests in mutual funds and bonds. It gets dividend and profit from buying/selling.
- TICL from its own financial assets invests in venture capital funds. It profits from selling stakes. MFs are not likely to invest in venture funds. It may have partial ownership in a business.
TICL does not have to depend upon retails investors to pump up its asset base. It does it like any other company, use its capital to grow and generate earnings. That is why in my TICL stock analysis I said, I would like to model my personal portfolio like TICL. Fundamentally, it is different than MF. That’s why I think it is apples to oranges comparison.
Can an individual who wants to invest in MF just take into account the published NAV value of a holding company like TIC and buy it with the thought process that he is getting it cheaper based on CMP ?
I discussed above the fundamental difference between TICL and MF. I consider TICL as a company. I determine fair valuation as discussed above, which I believe captures what I am looking for (independent of whether it is a holding company or company) . I compare CMP with this fair valuation. So question of comparing CMP against NAV does not arise. Let us take some examples. TICL has NAV of 700+. So what? What do I get out of this NAV? Will market ever price it at NAV? I do not know.
Having said that, just because I do not use it, does not mean it is wrong to compare CMP with NAV for buying. It is possible that, NAV is applicable to some other type of objectives. For example, in a traditional value based investing, it would make sense to use tangible book value or NAV. And then experience and understanding of domain will teach you that in case of holding companies, the market valuations are typically half of this tangible book value or NAV.
If am not wrong NAV in case of companies like TIC is calculated as per the market value of the investments (except for the unlisted investments, which is calculated as per independent valuations) it holds where as in case of Berkshire it’s calculated on the basis of book value. Is this correct ? What’s your view on the same ?
Reiterating again, you have look at this in a some type of context. Berkshire makes money by dividends and increasing value of business. BRK does not depend upon continuous buying/selling on equity markets. BRK likes to call itself invested in businesses. After sometime, when value grows, it may or may not sell depend upon future prospects. So it makes sense for BRK to use book value because it own business. TICL makes money by dividends and profit on buying/selling equities. It gets dividend from equity portfolio and unquoted businesses (like AMC). Most of its unquoted investments are like businesses. As you mentioned TICL uses combination of market value and independent valuations. TICL uses market value for all quoted investments and independent valuations, which I am sure is somehow related to book value, for all unquoted investments. So to say TICL uses only market value is a tad incorrect. The earnings contribution from unquoted investments is higher than 50%.
There is no valuation method that is absolutely correct in all circumstances. Each method has its own pros and cons. I consider valuation methods as different set of tools in your toolbox. You have to determine what fits in and use the one that gets your job done. Had TICL been purely a mutual fund type of operations, then yes, considering it as a mutual fund would make sense. But TICL is little more than mutual fund.
501301, holding company, tata investment corporation, TATAINVEST