EquityMidas

Subscriber Update - May '22

Dear Subscriber,

Welcome to the fourth issue of Equity Midas Capital’s Subscriber Update.

May 31, 2022 marked the closure of our FY2021-22 recommendations. On this day, we issued SELL recommendation for all the BUY recommendations issued last year, except those stocks that have been shortlisted this year again.

An equal-weighted portfolio of our FY2021-22 FEAST recommendations yielded 8.6% returns including dividends. While the returns did manage to beat the benchmark index returns marginally, they are not per our expectations. We will try to analyze the reasons of this underperformance in the letter.

Q4-IY2021-22 (IY = Investment Year, Q4 = Mar 2022 – May 2022) saw the world grapple with the effects of Russia-Ukraine war. High commodity inflation has forced governments and central banks take corrective action. Our portfolio was hit negatively by such an action, more on this later. Supply chain issues are further adding to the inflationary troubles for global companies. This is being reflected in the stock markets which saw steep corrections in April-May 2022 and as we write this letter in the second week of June, the fall seems to have accelerated.

While the setup is negative globally, I personally see this as an excellent opportunity for Indian companies. China +1 policy is gaining ground and India can fit in the role of +1 perfectly. Consumption has not yet shown signs of a slowdown and capex cycle is not yet showing any slowdown. Ultratech’s 12,886 crore capex plan is one such example.

The strong export sectors for India (IT, Pharma, Chemicals) can continue to do well even in this difficult environment. Companies in the agri sector are also expected to do better considering strong focus on food security.

Portfolio Performance - FY2021-22

As on May 31, 2022, average holding period of our recommendations completed 1 year. We also had the FY2022-23 recommendations shortlisted.  This meant that we issued SELL for FY2021-22 recommendations and BUY recommendation for FY2022-23 shortlisted stocks. All except 2 stocks recommended in FY2021-22 have been recommended a SELL. These 2 stocks were shortlisted for the FY2022-23 recommendations.

In aggregate the FEAST recommendations delivered 8.6% returns. The returns are lower than our expectations but exactly in-line with the EVM tenets. EVM states that stock returns follow the difference between the operating performance of the company and the expectations of the market. In the 34 recommended stocks, only 11 companies were able to meet or beat the EVM derived expectations. These 11 companies delivered an average of 46.6% returns. The other 23 stocks which were not able to deliver the expected returns delivered -9.5% returns.

MET EXPECTATIONS NUMBER OF COMPANIES AVERAGE RETURNS
N 23.00 -9.51
Y 11.00 46.61
Realised Returns, As On May 31, 2022 (before fees & taxes, including dividends) 
PORTFOLIONUMBER OF STOCKSTOTAL RETURNS (%) Incl DividendsBENCHMARKBENCHMARK RETURNS (%)AVG HOLDING PERIOD
FOCUS (LARGE & MID CAP)98.85NIFTY 2007.221 YEAR
FEAST (ALL CAP)348.64NIFTY 5007.231 YEAR


The graphs below show the daily performance of Focus and Feast in comparison with their respecting benchmarks.

Key Observations

  • Despite the many factors that impact market returns, the operating performance stands-out as the most critical factor.
  • Though the EVM tenet is correct, the difficulty lies in identifying companies that will meet or beat the expectations next year. The model clearly did not do a good job in this aspect.
  • Even if we are able to avoid the blunders (Quadrant 1 companies), the returns would have been close to 20%.
  • Small caps form the majority of both Quadrant 1 and Quadrant 4. Large/mid caps give the stability, but small caps have the potential to make or break the portfolio returns.
  • We have made improvements in the model so as to avoid stocks which may have shown excellent operating performance due to external factors and which may not be reproduced.
  • We had this situation in FY2021-22 portfolio when Covid induced performance was extrapolated by the model.
  • Both Focus and Feast were impacted due to the export duty on metals announced by the government a couple of weeks prior to our planned SELL. This had a significant impact o @5% on the portfolio returns.
  • The drop from 28% returns around April end to 8.6% returns by the time we rebalance the portfolio has raised a lot of questions on why we could not have given the SELL call earlier.
  • In fact, the FY2022-23 BUY recommendations are down 8% as we publish this letter and the same question has been raised, why did we not delay our recommendations if the market sentiment was this bad. We have answered this in the “Investor Queries” section below.

Operating Performance Analysis - EVM View

As we did in the previous edition of our letter, we have distributed the portfolio companies based on the expectations achieved for the year.

In a typical year, anything above 90% of expected performance is meeting the expectations. This is when we can say that the model shortlisted the companies correctly. We were inclined to give the benefit of Covid in the operating numbers to the companies, but decided against it.

So to review the performance of the companies we created four quadrants.

Quadrant 1 – Poor Performance (< 60% of expected performance achieved)

Quadrant 2 – Adequate Performance (60% to 75% of expected performance achieved)

Quadrant 3 – Good Performance (75%-90% of expected performance achieved)

Quadrant 4 – Excellent Performance (>90% of expected performance achieved)

Based on this grouping here is how we see the results:
QUADRANT COUNT OF COMPANIES RETURNS
1 8 -25.91
2 7 -5.59
3 8 3.46
4 11 46.61
Grand Total 34 8.65
As seen from the table above, returns generated by companies in Quadrant 3 and Quadrant 4 are much better as compared to companies in Quadrant 1 and 2. Higher the ability of the model to identify the companies that can meet or beat the expectations, better will our recommendations perform. This though is the hardest activity as well. Anything to do with forecasting for the future is basically a guess. We, instead, determine these companies by their track record. This avoids us to make any predictions on the future or make any judgment calls. Thru out the year, this theme has been consistent. Operating performance over the expectations has a significant effect on the market returns.
Here is the detailed data of the company performance:
QUADRANT
TRANCHE
MARKET_CAP_CLASS
COMPANY
EXPECTATIONS ACHIEVED
RETURNS
NSE SYMBOL
BSE CODE
MET EXPECTATIONS
PE RATIO
1JunSMALL CAPThe Grob Tea Company Ltd.8.83-35.46GROBTEAN24.80
1JunSMALL CAPNucleus Software Exports Ltd.14.99-40.1NUCLEUS531209N27.10
1JunSMALL CAPThangamayil Jewellery Ltd.29.2525.69THANGAMAYL533158N36.20
1JunSMALL CAPAuro Laboratories Ltd.31.53-47.28530233N19.20
1JunSMALL CAPKanchi Karpooram Ltd.36.27-42.42538896N8.40
1MaySMALL CAPMangalam Organics Ltd.43-26.68MANORG514418N9.30
1JunSMALL CAPRefex Industries Ltd.49.17-19.02REFEX532884N7.10
1MaySMALL CAPHIL Ltd.59.83-21.99HIL509675N15.30
2MaySMALL CAPPermanent Magnets Ltd.60.861.74PERMAGNET504132N13.90
2AprSMALL CAPShree Digvijay Cement Company Ltd.62.54-4.55SHREDIGCEM502180N16.40
2AprSMALL CAPTata Metaliks Ltd.65.01-30.93TATAMETALI513434N10.60
2MaySMALL CAPAssociated Alcohols & Breweries Ltd.69.191.33ASALCBR507526N12.90
2JunSMALL CAPBajaj Healthcare Ltd.69.57-23.77BAJAJHCARE539872N12.00
2MayLARGE\MID CAPChambal Fertilisers and Chemicals Ltd.71.2929.49CHAMBLFERT500085N9.70
2MayLARGE\MID CAPIpca Laboratories Ltd.73.54-12.43IPCALAB524494N25.90
3MaySMALL CAPHigh Energy Batteries (India) Ltd.78.5936.02504176N13.60
3AprLARGE\MID CAPBajaj Finance Ltd.79.3811.74BAJFINANCE500034N52.40
3MayLARGE\MID CAPShree Cement Ltd.83.05-19.42SHREECEM500387N34.20
3MayLARGE\MID CAPPI Industries Ltd.83.085.68PIIND523642N49.60
3MayLARGE\MID CAPUltratech Cement Ltd.85.16-8.77ULTRACEMCO532538N23.90
3MayLARGE\MID CAPAlkem Laboratories Ltd.86.966.52ALKEM539523N22.70
3JunLARGE\MID CAPMuthoot Finance Ltd.87.55-21.5MUTHOOTFIN533398N11.60
3MaySMALL CAPAction Construction Equipment Ltd.88.5917.4ACE532762N22.50
4JunSMALL CAPLA TIM Metal & Industries Ltd.91.2469.96505693Y8.20
4MaySMALL CAPDolat Investments Ltd.97.8712.41DOLATALGO505526Y8.10
4AprSMALL CAPBhansali Engineering Polymers Ltd.97.98-26BEPL500052Y5.40
4MaySMALL CAPKNR Constructions Ltd.101.3618.46KNRCON532942Y20.70
4AprSMALL CAPK.P.R. Mill Ltd.103.52128.14KPRMILL532889Y25.70
4MayLARGE\MID CAPSRF Ltd.107.2689.71SRF503806Y38.70
4MaySMALL CAPKirloskar Ferrous Industries Ltd.112.83-3.32KIRLFER500245Y7.70
4JunSMALL CAPBCL Industries Ltd.113.3235.48BCLIND524332Y10.20
4MaySMALL CAPGujarat Ambuja Exports Ltd.114.77101.01GAEL524226Y16.20
4MaySMALL CAPGodawari Power And Ispat Ltd.131.4924.67GPIL532734Y3.00
4JunSMALL CAPSandur Manganese & Iron Ores Ltd.192.2862.18504918Y4.20

Investor Queries

Q1. Why could we not give our SELL recommendations earlier or delay the BUY recommendations based on market situation?
Ans: Giving any recommendations (either BUY or SELL) needs to comply with the model. EVM is run every year and when we have the next years recommendations we give out the SELL recommendations for the current stocks.
We generate our recommendations based on a mathematical model. This model runs when we have the annual results data. Hence the May end schedule to release our recommendations. Since we do this every year, in a way we are re-balancing our recommendations. We cannot time the market. We believe in staying in the market as long as possible albeit with the right stocks, hence the rebalancing every year. Market levels or patterns do not play a role in our stock selection or recommendation schedule.
Having said this, all our subscribers should talk to their investment advisors to determine the timing and the capital allocation of their investments.
The only method to provide a pre-mature SELL call will need to be based on some kind analysis that predicts a further fall in the market price for that recommendations. We are aware that technical analysis has these capabilities but that is not something we have enough knowledge about.
Further, what we experienced in May 2022, is not expected to repeat every year. So we are not convinced that early exit calls are the solution, but that is something we will pursue this year. More on this in the “Chef’s Corner” section below.

Q2. What should an investor do when the market is falling so much, so fast?
Ans: Before we comment on this topic, please read our thoughts on building an ideal equity portfolio. Also note that we are a registered Research Analyst. We cannot recommend any capital allocation or give any financial advice. The answer below represents our approach to market corrections.
Market corrections are an opportunity but it certainly is not a department store sale. What worries us when market crashes is the loss in the notional value of our investments and we tend to mis-read this opportunity as an threat. There is fear that any new investment will also fall in value thus adding to the already loss making positions.
So, what if we invest more and the market continues to fall? We like to work it back from the worst possible scenario. Lets try and find the bottom of the market as they say. For the current EPS of 850 Rs. and assuming the 2008 lowest PE of 12 (source: https://nifty-pe-ratio.com), we reach a figure of 10200 for NIFTY50. So this is the worst case scenario. Nifty50 as on date is close to 15000. This means we have another 33% downside possible. There is no point in fearing anything beyond 10K for the reason that the numbers we have assumed are from the worst financial crisis of the century. Having said that, the 10,200 number will change if the EPS numbers change. Note that this bottom calculation will change person to person. My assessment of the current market condition will never match any other individual.
Once we have defined a bottom, let us work out the possibility of such a scenario happening. Lower the Nifty 50, lower the possibility. 
If we divide the 5000 point drop in to 10 tranches to get 10 opportunities to invest. Based on your analysis of your investment advisor’s analysis, decide what amount you are comfortable to invest in each of the tranche. Typically the amounts should increase as NIFTY falls. This is because investing at 14500 has a downside risk of 4500 (@30%) point and investing at 12000 has a downside risk of 2000 point (16-17%). So as the risk of downside decreases, your investment amounts can increase.
Why not exit all the positions and be in cash? The problem with this approach is that you are trying to predict the market or time the market. If you are good at this there is no problem at all. For those who are not comfortable to time the market, we can at least ensure that the opportunity to buy at lower levels is not lost. 
Also, we believe that one should exit stocks either when they need the money or have a better alternative investment opportunity. If the opportunity presents itself when the market has corrected, do take that opportunity (after consulting with your investment advisor).
Now that we know we can or should invest more when the market falls, what should we buy? 
Going back to our idea of an ideal portfolio, we believe that one invests in equity either to build wealth, generate income or expecting a bounty thru some risky bets. Market corrections are great to load on your wealth builder & bounty hunter stocks. 
Income generators are typically bought on some advice and you should refer to the advisor on what should be the next steps on those stocks.

Current Affairs

This quarter was spent on marketing efforts and publishing this years recommendations. No progress was made on any other activities. We will continue the efforts on these activities this quarter.

 

Chef's Corner - Technical Analysis

The sudden drop in the returns this May has meant that technical analysis is now an important subject area for me. 

I do not intend to use technical analysis for stock selection, but will look at TA to help determine exits. The idea is that if a TA signal confirms a breakdown in the stock price pattern in the last 2 months of the planned holding period, can we use this for early exit to reduce our losses.

I am not sure I am on the right track but TA has certainly helped a few of my fellow investors reduce the draw-down on their portfolios during these volatile periods. Will be very happy to hear your thoughts on this aspect as well.

 Premature exits have not been tested in the model yet. I have not been a believer of Technical Analysis but I do understand that TA is a tool that helps understand the psychology of the market participants. Does TA have a place in EVM? If yes, how can it be used and when will take a lot of my time this year.
 
Thank you & Regards,
Ashish Arole
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.