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Subscriber Update - Nov 2022

Dear Subscriber,

 

Welcome to the sixth issue of Equity Midas Capital’s Subscriber Update. This letter marks the second quarterly review of the IY2022-23 (IY = Investment Year, 31 May 2022 to 31 May 2023) recommendations.

 

 

Overall, the second quarter(Sep-Nov) passed off without any major surprises. While the geo-political tensions continued, fortunately, the inflation flare-up stabilized causing the central banks to slow down on the interest rate hikes. As discussed in our earlier updates, interest rates have a crippling impact on stock valuations.  Central banks need to respond to higher inflation by raising interest rates which in-turn impacts stock market returns.  

 

With stability in interest rates, stock markets re-focus on company performance. This quarter, performance of the stocks had a very high correlation with the company operating performance. Corporate results were also in-line or slightly better than the analyst estimates. Here is a link to an external report that will give some more information: https://www.sharekhan.com/MediaGalary/newsletter/Specialreport.pdf

 

Stock markets are people. Human nature, hence, is the biggest driver of stock price volatility. When there are urgent matters to take care of (like macro conditions, inflation, interest rates, war, pandemic) the important aspects (long term company operating performance) take a back seat. Whether the urgent matters impact the underlying company’s business is often ignored. Long term gets muddied by short term and stock prices become volatile.

 

Fortunately, this quarter was a quite quarter. Hoping that the situation continues.

 

Stock Performance Analysis

Out-performance of Focus (large & mid cap stocks) continued over Feast (large, mid, small & micro cap stocks) this quarter. I believe that this out-performance is here to stay till the market gets convinced about future stability. As long as future looks unstable (due to war, inflation, covid), markets will prefer the stability of large and mid caps over small & micro caps.

 

 

As on end of Nov 2022, an equal-weighted portfolio of our 2022-23 FEAST recommendations (in other words the average returns for our FEAST recommendations) has yielded 16.8% capital returns i.e. without dividends. FOUCS recommendations have yielded 21.8% capital returns in this period. 

 

 

Both the portfolios have performed better than their benchmark indices. The overall returns are within the expected range considering the underlying company performances.

 

 

Lets see how we got here: 

 

Key Observations

  • From the lows of the year, both feast and focus recommendations have performed good.
  • Within the small & micro cap universe, the tradition of couple of stocks pulling the up the average returns continues.
  • Companies that did not do well operational in Q1, failed to perform in Q2 as well. 

Operating Performance Analysis - EVM View

Please refer the  EVM Guidelines for Operating Performance Classification to understand how we group the companies based on their quarterly operational performance. Based on the guidelines above here is how this quarter has panned out:
QUADRANT
NUMBER OF COMPANIES
AVERAGE RETURNS
EXPECTATIONS ACHIEVED
13-26.91%<=40
21-3.99%>40 & <45
3420.65%>45 & < 50
4736.34%>50
The correlation is immediately visible. Companies that have met or beaten the expected operating performance have delivered much better returns. Our success as quantitative analyst truly depends on our ability to identify companies that can beat the expected operating performance.

Here is the detailed data of the company performance:

QUADRANT
TRANCHE
MARKET_CAP_CLASS
COMPANY
EXPECTATIONS ACHIEVED (%)
RETURNS (%)
PE RATIO
5 YR MEDIAN PE
1MaySMALL/MICRO CAPSharda Cropchem Ltd.15.11-42.611.921.1
1JuneSMALL/MICRO CAPGujarat Ambuja Exports Ltd.25.85-32.0112.027.9
1JulySMALL/MICRO CAPTransport Corporation Of India Ltd.27.2-6.1316.99.6
2AugustLARGE/MID CAPSRF Ltd.44.6-3.9931.917.1
3SeptemberLARGE/MID CAPTimken India Ltd.45.4744.9961.18.7
3OctoberLARGE/MID CAPSun Pharmaceutical Industries Ltd.46.1721.5561.224.0
3NovemberLARGE/MID CAPCipla Ltd.47.5314.7735.96.5
3DecemberLARGE/MID CAPUPL Ltd.48.881.314.88.7
4JanuarySMALL/MICRO CAPFineotex Chemical Ltd.51.8776.547.215.9
4FebruaryLARGE/MID CAPITC Ltd.56.4125.6224.439.0
4MarchSMALL/MICRO CAPApcotex Industries Ltd.57.01-19.8221.321.9
4AprilSMALL/MICRO CAPKama Holdings Ltd.57.715.57.043.1
4MayLARGE/MID CAPSolar Industries India Ltd.60.664856.945.1
4JuneSMALL/MICRO CAPNitta Gelatin India Ltd.62.57100.1612.016.0
4JulySMALL/MICRO CAPE.I.D. – Parry (India) Ltd.65.338.4110.217.1

Investor Queries

Q1. A few stocks from your previous year recommendations like Permanent Magnets and Refex are doing very well. Why did you recommend a SELL in such stocks?

Ans: This is something that every investor dreads of. What if the stock goes up after we sell? If we review our previous year portfolio, some stocks that we sold are doing very well.


A simple answer to the question is that both those stocks were not filtered by the model this year. We do not study individual companies using fundamental or technical analysis. The quantitative model looks at companies like a black box, a financial black box and relies on how the market values the company rather than doing any kind of valuation excercise.


We recommend a holding period of one year and as re BUY recommendations are identified, we recommend a SELL on all previous year holdings. All stocks bought previous year are recommended a SELL by on the day we recommend BUY of our next years stocks. Some stocks so reappear (like SRF this year), but that is only because the quantitative model filtered it for this year. The entire portfolio is re-balanced every year.


As on Nov 30, if we would have held on to the entire 2021-22 portfolio, the incremental returns (from May 31, 2021) would have been close to 7%. The 2022-23 portfolio in the same time frame, has delivered close to 22% returns (including dividends). The point is that the re-balancing process is very important to ensure that we are invested in the group of stocks every year.




Q2. There is a buy-back announced by Kama Holdings, should we participate? Similarly there is rights issue planned for Nitta Gelatin, do we participate in that?

Ans: None of these corporate actions have been tested by us when we tested the model. So by default, we recommend not participating in buy-backs. 


Rights issue is a different ball-game. Last year, GPIL declared a rights issue at 10Rs when the stock was priced at above 2000Rs in the market. In such situations we have not option but to participate in the rights issue. If we do not, the market value of our holdings (of GPIL) would have declined by 2/3rd. The cost out-go of participation would have have any impact on the overall capital allocation either. Such situations are rare but vital.


Rest assured, if such corporate actions have a direct impact on our portfolio returns, we will provide you with the possible scenarios and our recommendations.

Current Affairs

We redesigned the website this quarter. Websites performance was not up to the mark and its design was bulky. We did try a set of new designed but reverted back to the original concept since we felt it was the right way to share the quantitative concepts and the EVM model details with the reader.

 

We also had to more or less rewrite the entire code to match the new data source. This also allows us to retest our model and catch any bugs. Thus far, nothing new and the test results match our prior testing. This effort is expected to continue in the next quarter as well.

 

The demand driven model is going well, but no concrete progress worth reporting.

 

 

 

 

Thank you & Regards,
Ashish Arole
SEBI Registered Research Analyst
Equity Midas Capital
equitymidas.com
 
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Research Analyst Role

We are SEBI registered Research Analyst and not Investment Advisors. This means our expertise lies in researching and analysing stocks and giving our views/recommendations on those stocks. In our case, we publish them as recommendations.

 

An Investment Adviser on the other hand, works with you to plan your overall finances after understanding your financial goals. The advice offered by an Investment Adviser is personalised as against our recommendations which do not change based on individual financial situation/goals. Simply put, our recommendations are not personalised advice; it is the output of our research.

Unlike a PMS or a Mutual Fund, we are not involved in the actual trading of stocks. The actual buying and selling of the portfolio stocks is done by the subscriber himself/herself using their own trading and demat accounts.

Our service to subscribers is limited to giving access to the recommendations.

Value Investing

Investing is simple, buy low, sell high & make profit.  The core focus of investing, hence, has always been to identify stocks valued lower than their intrinsic value.

Any financial asset can be valued based on the expected returns (earnings, cash flow, dividends, etc.) in the future. These future returns when discounted at the expected rate of return (also called as discount rate)  yield us present value (or the intrinsic value) of the asset. Consider every company as a returns yielding machine. If you can forecast the expected returns, you can determine the present value. If the present value is higher than the market value, it is valued low and is a candidate for buying.

Value Investing is always a contrarian approach. Many great investors including Warren Buffett, Charlie Munger, Benjamín Graham, Peter Lynch, have their own interpretations of value investing but all of them have this trait in common. Value Investing is a game of patience, once you make your move, you have to trust the market to correct its mistake and re-value the stock to its appropriate level.

Even when the company maintains or betters it performance subsequently, it might take a few weeks to few years for the market to revalue the company. However, once you find such a company, which you bought at a relatively low price and which continues to deliver on its operational performance, you probably never need to sell such a wonderful asset! While value investing is perfectly correct in theory, its implementation in practice is much more complicated.

Predicting the future is no mean game. Even the people managing and running the business won’t be able to make correct predictions. The solution is Margin Of Safety.  Margin of Safety gives you the leeway to be wrong on the predictions but yet be right on making gains.

Rating Rationale

  • Our BUY Recommendations are the output of our proprietary quantitative model, Expectations Value Model (EVM). EVM combines financial performance, market expectations, and quantitative assessments to determine stock recommendations. To know more about the model, please visit: https://equitymidas.com/philosophy/
  • We divide the stocks in two sets viz. Large & Mid Caps and Small Caps. Top 6 companies as determined by EVM,from each sets, are given as our recommendations.
  • EVM can only be run after the annual results are declared i.e. on last day of May every year. Our BUY recommendations are hence released typically on 31st May (except when 31st May is a weekend/holiday)
  • When the next set of BUY recommendations are available, we simultaneously give SELL recommendations for the previous year’s BUY recommendations. In other words, we re-balance the recommendations once a year. Essentially, SELL recommendations only mean that the next set of BUY recommendations have been identified.
  • These are key tenets of EVM:
    1. Operational performance of the companies should be rewarded by the market, historically.
    2.  Market expectations are within the reach of the company for the next year.
    3. Company is fundamentally sound with good interest coverage.
    4. Rank the company based on valuations and probability of meeting the expectations.
  • Since EVM is run every year, the typical holding period for our recommendations is 1 year but few stocks may re-appear in our next year’s BUY recommendations.
  • We do not have any price targets.
Rating/Recommendation
Interpretation
BUYStocks identified by EVM with potential to deliver good returns (as a group) over the next twelve months. Total expected return includes dividend yields.

DO NOTE:
EVM being a quantitaitve model, has been backtested for the set of recommendations it genrates and not for performance of individual stock. Potentially, the variation in returns of individual stocks can be very high. We do not have target prices of target returns for our recommendations.
SELLHolding period of 1 year has been completed and new set of opportunities have been identified by EVM.

EVM Guidelines for Operating Performance Classification

EVM states that the market performance of any stock is closely correlated to the underlying company’s expected operating performance. Every quarter we analyse the operating performance of the recommended stocks against the expectations calculated by EVM.

 

We rank the recommendations based on the operating performance and group them in 4 quadrants based on expectations achieved in that quarter. Here is how we group them:

 

 

QUADRANT CLASSIFICATION PER EXPECTATIONS ACHIEVED (%) EVERY QUARTER
Quarter 1Quarter 2Quarter 3Quarter 4
Quadrant 1<=20<=40<=60<=80
Quadrant 2>20 & <22.5>40 & <45>60 & <67.5>80 & <90
Quadrant 3>22.5 & < 25>45 & < 50>67.5 & < 75>90 & < 100
Quadrant 4>25>50>75>100

According to EVM, the group meeting the expectations for that quarter should deliver better than market returns.