Three Small Caps Stocks – Not for my Long Term Buy and Hold

1035790_pick_up_drop_off_onlyWhat do you do when stock market, and hence all stocks, are trading at a much higher price than you would be willing to pay? If you are like any other value investor or like me, then you would continue your reading and prepare your watch list. On many occasions, you would like the stock but unfortunately they are trading at a premium for pulling the buy trigger. In early December, I had shortlisted five small cap stocks for further reading. Few readers namely, arunsg, Young@market, Rutwik, Aditya, anonymous, and two more in emails presented their comments on the list. Just looking at these comments, Aegis Logistics and Numeric Power Systems seem to be preferred companies.


I completed my analysis and presented a discussion about Aegis Logistics Limited. I also liked Graphite India Limited (will present my discussion shortly). I initiated starter positions in both of these companies. So now the question is what about remaining three companies?

Banco Products (I) Limited, (BANCOINDIA): It is supplier of engine cooling components and engine sealing gaskets to the automotive and industrial engines. Its products include radiators, intercoolers, oil-coolers and many different types of engine gaskets.

  • Most of the time for last eight years, its operating cash has been continuously less than its reported net profit.
  • It also seems to have quite a bit of debt, which generally has been more than its cash flow.
  • Although the company pays consistent dividends, they are more of less flat. There is no growth in dividends.
  • This company does not meet my portfolio criteria. I will not be buying shares of Banco Products.


Indraprastha Medical Corporation Limited, (INDRAMEDCO): It is a Delhi-based healthcare company which operates through Indraprastha Apollo Hospital. It is the largest corporate hospital in India. In my view, Indraprastha is a pioneer in corporatization of healthcare services.

  • Although Indraprastha pays dividends, it has a very low payout factor. I do not like this.
  • It has margins in single digits and has pretty much flat cash flows.
  • For healthcare sector exposure, I would prefer Parma company instead of a hospital.
  • I do not plan on buying shares of Indraprastha.


Numeric Power Systems Limited, (NUMERICPW): It provides power continuity and clean power through its total power management solutions. The product portfolio includes uninterrupted power supply (UPS) systems, servo stabilizers, isolation transformers, inverters, DC power, custom-built power conditioners, power quality management products, active harmonic conditioners, and AC-DC converters.

  • It has a very good positioning in UPS (and power management) solution market place.
  • It has a very low level of debt.
  • Overall, it has a growing EPS in last few years.
  • I do not like very low dividend payout factor and low margins.
  • I do not like that it has consistently higher net profits than its operating cash flow.
  • I also find a lack of information. The website does not provide annual reports; there is no comment or any speeches from company executives. I just could not figure out what the company wants to do or what direction it is heading.
  • I spent quite a bit of time trying to figure out why I should buy shares in this company. Numeric Power does not demonstrate characteristics that I am looking for i.e. growth in dividends, communication, and operating cash flow. So I will not be buying shares for this company.


I would like to point that all three of these companies viz., Banco, Indraprastha, Numeric Power, may be good companies which would continue to grow in future. Furthermore, they could even turn out to be a multi bagger. However, it is not necessary to go and buy everything that is good. As individuals, sometimes, we have to make a call based on objectives. To be successful as an investor, we have to decide which one would be best for your risk appetite.

Questions, comments, kudos, and brickbats, all are welcome. Any thoughts?

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20 Responses to “Three Small Caps Stocks – Not for my Long Term Buy and Hold”

  1. Saif says:

    Hello Sir,
    I was trying to understand the differences btw various profit margins used.
    Gross Profit : It is the difference btw the sales(revenues) and cost of raw materials ,before any other deductions.
    Net Profit : It is gross profit minus the other expenses,such as advertising,employee salaries,interest,taxes..
    Is this correct.What would then be the difference between Operating Profit and Gross/Net Profit.Is operating profit and EBITDA same?

    Thanks

    • TIP Guy says:

      Hello Saif,

      I will get back to you.

      Happy New Year and Best Wishes,

    • TIP Guy says:

      Hello Saif,

      Operating profit is not equal to EBITDA
      Operating profit is equal to EBIT.

      The link below should help you understand the gross/operating/net. http://en.wikipedia.org/wiki/Net_profit

      Please note, going into this level of details will mess your head up and result in confusion. It will not help you make a decision.

      Instead, I suggest focus of trends and relativeness. For example…

      – The T, D, A is different of different industries so I will confuse you a hell lot.
      – Understand whether you want to invest in a company with single digit margins vs. double digit margins.
      – Look for significant variations in these parameters, either relative to each other or in absolute terms. Look for consistency, stability and/or improving trends.
      – Put those numbers in the context of competitors or industry itself.
      – An IT company with 25% margins does not necessarily mean it is better than an auto company with only 12% margins.
      – If a company has been having 12% margins, then suddenly its AR or somebody else say margins will likely to grow 20% in next few years. That’s a red single. Either it could be taking debt or something does not jive…..

      Hope this helps!

  2. Yogesh Tiwari says:

    I went through company financials of BANCO.

    Operating income has been steadily in uptrend..Good observation.

    Debt though it has increased over years..but it has been paying back a lot of it too.

    Debt to equity has lowered too. and so has longterm debt.

    Dividend payout hasnt been inline with sharing profit

    More Net PBT than Net Cash from Operation..I m not sure how does this impact?

    Kindly explain. This ‘d really help me understand how we should look at company financials.

    Regards
    Yogesh Tiwari

    • TIP Guy says:

      Hello Yogesh,

      Think for a moment, how can somebody make more profit, when it does not have cash flow? It is possible once or twice, but if becomes a norm, then hmmmm….

      Quite a few folks do not understand the importance of cash. I will write a simple post explaining this.

      Best Wishes,

  3. Aditya says:

    Hi
    I regularly follow your blog and it’s nice to see good updates.
    The market penetration is more aggressive for pharma companies compared to hospital and I would pick a pharma stock for even the best hospital stock.
    Coming to Banco, the PBT has been increasing continously for the past 6 quarters and hence the net profit too. The %age holding by public is almost constant over the past 6 quarters. Also the EPS for this quarter end could be around 4.1 as per my understanding and I would consider this a good buy considering the coming budget.

    • TIP Guy says:

      Hello Aditya,

      I am not disagreeing with you.

      However, probably you did understand my rationale with reference to my portfolio objective.

      And I am looking at the standalone company, because I my goal does not end at the coming budget or this quarter. I am looking far beyond that.

      Good to know that your views are similar to mine on hospital stock.

      Happy New Year to you and Best Wishes for 2010.

      Thanks for stopping by.

  4. TIP,
    Wish you a very happy new year ahead.
    I am curious to know how your portfolio has done in the past year. post some facts if possible.

    Regarding Indraprastha medicla, I do not agree with your views.
    1) for net profit margin, Hospital stocks are like that only. compare any stock you will get 1 digit NPM.
    2) Indraprastha has a decent dividend yield if got early last month. for me dividend payout ratio is less important than divd yield. Next year Rs. 1.75 is expected. which is around 4.54% of my cost Rs. 33. If you see in the past, they haven’t cut down any dividends, but rising more & more.
    3) Govt has 26% stake in Indraprastha. So if pric eis appreciated, it can be a decent disinvestment candidate or takeover candidate.
    Above are main factors i am bullish on Indra. expecting Rs.1.75 as dividend & some price appreciation will give decent returns in just 6-8 months.

    regards
    MIP

    • TIP Guy says:

      Hello MIP,

      Haven’t seen your for long time. I hope everything is good at your end. Happy New Year and Best Wishes for 2010.

      Shortly, I will post my portfolio update. I haven’t had time to take stock of it yet.

      We do not have to agree on the analysis, right? Having said that, I would not disagree with you on the data points you have mentioned.

      If you use these same numbers from the perspective of my portfolio objective, then you will find they are actually weak points.

      (1) Using dividends as a decision factor and 6-8months time period? it does not jive. Dividends are paid once a year. the volatility may (or will) wash your dividends. I think 2001 had a dividend cut.

      (2) if a company pays more than 50% of its earnings as dividends, then it has less for growth, or may have to take debt. OR company has decided to go for very slow growth.

      (3)Personally, I cannot justify myself to buy a stock for a company whose business model has single digit margins. At least not for a growth oriented economy.

      (4) Plus, my objective is beyond 6-8 months.

      Thanks,

  5. Aditya says:

    Tip Guy,
    Even I didn’t mean to end at the coming budget. Since, we have the budget is near future, I strongly believe that this company might bag new orders on its books as the budget allocation for is expected to increase.
    Pls point me how I am wrong.

    • TIP Guy says:

      Hello Aditya,

      I did not say your thought process is wrong. I did mention, “I am not disagreeing with you”.

      the difference is between your objectives and mine. I presented my analysis w.r.t. to my objectives which i have discussed many times.

      I am not sure what you are looking for while buying a stock. I just could not find (or I could not understand) how national budget is related to Banco getting orders? And how it will affect my returns. What’s the logic?

      let me help explain the analogy…….
      my blog has some revenue. I expect (in future) to get more advertising order. Would you buy a few stocks on my blog (assuming if it were a company?).
      Probably not, right!

      I am attempting to help explain the difference.

      Best Wishes,

  6. TIP
    Thanks for your clarifications. I totally agree that nobody will be on the same page, same line in investing. Just i wanted to say that Indraprastha is not that bad.:) As i may be biased as I hold that.
    The last year gone was as per my expectations. I managed to hit my goals.

    I have posted my portfolio review here http://myincomeportfolio.blogspot.com/

    Your comments are welcome

    regards
    MIP

    • TIP Guy says:

      Hello MIP,

      I looked at your update.

      First, I commend your ability to get 30% return on borrowed money. Honestly, I don’t have a gumption to trade/invest on margin. I will lose my sleep.

      Second, couple of questions
      (1) How did you balance principle paid in the year? did it come out of profits or your working salary?

      (2) How does this compare to the index returns? I understand that it is just one year, even then, would it have made sense to just invest everything in NIFTYBeES? it gave approx 60% return in 2009. I know it will balance out over x number of future years, or it was one of those good years, etc. In short, how does it compare with index return? Do you use that as a baseline, or it does not matter as long as you are in green (since it is borrowed money?).

      I want to understand your thought process.

      Best Wishes,
      TIP Guy

  7. arunsg says:

    A hospital company getting new “orders” due to budget? 😉 I hope the budget is not going to be so bad as to cause much sickness ! 😀

    Cheers,
    Arun

  8. TIP Guy
    1) When i picked up my stocks in Dec08-Mar09, I did not know that index would return such blockbuster returns. That time everybody used to hate index for it’s lackluster returns. Remember Mar09 lows?
    2) Principle goes from my Salary. It has to because i claim tax rebate on Principle & Interest. It will take some time to recover principle also from profits.
    3) I am trying to keep my thought process simple. My invested capital should fetch me the amount equal to the amount i am paying to the bank over 20 yrs.
    4) I feel myself lucky that i got 30% returns. but I completely ignore Index returns for comparison purpose. I try to compare my returns over rate of borrowing. i.e. 6-7% in my case. I am happy with couple of points above tan interest rate. My investment horizon would be equal to my loan tenure. I intend to build equal amount slowly & steadily.

    Kind regards
    MIP

    • TIP Guy says:

      Hello MIP,

      Thanks. I understand your method and your rationale. However, I am still trying to figure out the reason you have adopted the such a process.

      Objective is to have few percentage points above your borrowing rate of 10.75%, in your post you mentioned 2 to 3% above it. Let us say 4%. So your objective is to have 15% (rounding it off).

      Now NIFTY index has given 15 to 18% returns over last 10 to 12 years. Even if you blindly invest on few fixed time intervals. This is not even optimization the index buying process.

      So after all those borrowing money and churning, you are only getting (or targeting) few single digit returns?

      If you put your own money, you will get 15% return all for yourself. And you don’t even have to stress out about churning? you just buy index ETF!

      Am I thinking incorrectly?

      Best Wishes,

  9. “If you put your own money, you will get 15% return all for yourself. And you don’t even have to stress out about churning? you just buy index ETF!…”

    The problem is “I Don’t Have that much of Money”.
    I look at the matter different way. Lets say Mr. A has 200k cash! he has two choices.
    Choice 1
    1) Buy a Maruti with that cash.
    2) Take a personal Loan for Investment.

    Choice 2
    1) Take a car loan
    2) Invest own Cash.

    Most of the people choose option 2, they don’t understand that once they have paid complete loan for car, the underlying asset is worthless. Why people are happy to take a loan for worthless things? Is leveraging bad at all?
    Understand that those extra 4% i am getting on the money which i do not own. That is the main difference.

    MIP

    Watch Deepak fertilizers. cmp 110 I found it a value play at 100..

    • TIP Guy says:

      Hello MIP,

      I see now where you coming from. 4% from a capital which you do not own.

      BTW: in my school of thought both choices that you mentioned is bad 😉

      Still, if I were in your situation, with 129K in my kitty, I would use this capital to chase 15% (instead of 4% using leverage).

      But two people are never same. In the end its all about making money and there are many different ways.

      Thanks if was a good discussion.

      Best Wishes,

  10. saif says:

    sir..any clarification for my basic doubt above :-)..Happy new year to you also

  11. Saif says:

    Thanks sir..i will think more about what you have said and get back.

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