Saturday, December 31, 2005

Investing in India

The Indian economy is growing at a brisk pace in the 7-8% range. Though not in the same league as China in terms of growth rate, some consider India as having better prospects than China in the long term. The main reason for the optimism towards India is the presence of a democratic government for fifty+ years.

The situation in China is unpredictable and political uncertainty is not good for investing public. The faking/intellectual property theft problem that exists in China doesnt exist to the same extent in India. It is easier for western companies to set up subsidiaries in India. The legal system is similar to that of Britain/U.S and companies have recourse to a system that is independent of the government.

India also has a robust, well established stock market. The Bombay Stock Exchange located in Dalal Street was established in 1875 and is the oldest stock market in Asia. There are about 3500 stocks listed in the Bombay Stock Exchange. The overall market cap of the Indian Stock Exchange is estimated to be around 260 billion in 2005. The BSE is one of the worlds top five stock exchanges in terms of the number of transactions. Given the low liquidity of the overall market capitalization compared to the U.S stock market, the Indian stock market was susceptible for market manipulations. The S.E.C in the U.S has played a major role in playing the role of regulator and establishing market/trading rules. The absence of such an agency in India led to the market manipulation in the early nineties ( Harshad Mehta scandal ) and the later Ketan Parekh scandal. The Securities and Exchange Board of India ( SEBI ) was established in 1988 and was made an autonomous body in 1992 by the government of India after the Harshad Mehta scandal. The SEBI plays a watchdog and overseer of the market similar to S.E.C. Given the continued economic growth in India and the expected growth in capitalization, liquidity in the Indian Stock market, how should an investor based in the U.S invest in the Indian market?

Although the establishment of SEBI has put in place some rules in place, many stocks are still subject to manipulation. Given this, what are the best ways to invest in India?Some Indian companies are listed in the U.S market ( NYSE and NASDAQ ) and are available in dollar denominated securities, typically at a premium.

The companies listed in NYSE and NASDAQ are:

INFY - Infosys Technologies. INFY trades for about $60 in the Indian market and it trades for about $80 in the U.S market, a premium of about 25%.

SIFY - Sify Limited trading for $10

REDF - for $18

WIT - Wipro Limited trading for $12

HDB - HDFC Bank Limited trading for $51

IBN - ICICI Bank Lmtd trading for $29

VSL - Videsh Sanchar Nigam Limited for $17

MTE - Mahanagar Telephone Nigam Limited for $7

RDY - Doctor Reddy's Labs for $21

TTM - Tata Motors Limited trades for $14

PTI - Patni Computer Systems Ltd trades for $23

MT - Mittal Steel Company, NV trades for $26.33

One can buy these stocks directly or go through some mutual funds. The ones that invest exclusively in Indian mutual funds are IIF, IFN, ETGIX and MINDX.ETGIX is a newly started fund in 2005 and has an expense ratio of 2.77%.MINDX has a lower expense ratio that ETGIX with an expense ratio of 2%. There is a penalty of 2% for redemptions before ninety days.IIF Morgan Stanley India Investment fund has an expense ratio of 1.5% and has the morningstar 5 star rating.IFN India Fund Inc has an expense ratio of 1.6% and morning star 4 star rating.One can also get exposure to Indian market through the ETF EEM ( emerging market index fund ) which invests roughly about 5% of its assets in India.

A word of caution when investing in India. In 2005, Indian stock market has had a runup of nearly 45%. The valuations of many companies have gone up significantly. The growth in the service sector of the Indian economy is strongly correlated to the health of the U.S economy. In the service sector, the Indian market is significantly smaller compared to the world economy. The second factor affecting the Indian economy is monsoons. About 60% of Indian population is dependent on agriculture. Without a good rainy season between May and September, the crops and hence the spending power of large sections of population is severely affected. It is unlikely that the increases of last year are not likely to be repeated in the coming years. is a good resource for studying some of the trends and news from India.

Friday, December 30, 2005

Bank of America (BAC) Analysis

Bank of America (BAC) is a large capitalization stock with a market cap of about 185 billion dollars. BAC is an interesting stock to invest in as it has an increasing divident yield and low P/E. The popular theory in wall street is that the large cap stocks are undervalues compared to their peers in other sectors and are due for a run up. There is another wall street theory also doing the rounds - the international stocks have had huge runups and are due for a correction. This will cause some of the dollars invested in foreign stocks to come home. If these theories hold up, then the likelihood of increased share value in U.S large caps seems likely.

Let us take a look at the BAC financials. It has a dividend yield of 4.3%, P/E of 11 and a market cap of 185 billion dollars. The dividend yield is very attractive especially coming from a company with high credit rating. The 4.3% yield is the same as the ten year treasury note with the added benefit that the dividend yield has been growing at the rate of 11% per year. BAC has been paying out 42% of the earnings as dividends consistently.

Let us take the dividend discout model and run it on this stock. If we assume a dividend growth of 11% per year for the next ten years and a discount rate of 8% for cash we are investing, we get a price of $23/share. The second model is the one available in SmartMoney website. This one automatically fills out many of the factors for the stock once the ticker is entered. It gives the stock a value of 73.25 in five years. This gives the stock a compound growth rate of about 9%/year.

In addition to the models, looking at the most recent quarterly and annual reports will give a better insight into the cash flow and the business risk in various categories. Looking at the 10-Q from the September 05 quarter gives us some insights. BAC's revenues can be split into two main categories - interest income and non interest income.

The main component of the interest income is income from deposits. This component is dependent on the interest rates determined by the federal reserve. The impact on earnings because of the rising interest rates is not fully felt yet. We can start to see the increased impact on earnings in Q2 06. Now there is also the fear among many that the U.S economy is slowing down and will cause the federal reserve to reduce interest rates. The economist magazine ( ) has predicted U.S GDP to grow to about 16 trillion by end of 2010 from about 12.5 trillion from now. This gives a GDP growth rate of about 4% per year. Surely, some of the increase in GDP will come from increased exports because of higher growth in the rest of the world. Given the increased tightness in the labor markets and increasing salaries, a significant slow down in 2006 is unlikely. The likelihood of fed rates being a bit higher than what it is today is more likely. If the rates remain the same or go higher, it should translate to better earnings for BAC.

The main components of the non interest income category are service charges, investment and brokerage services, investment/brokerage services and credit card income. There is very little risk in this category and one can look for increased credit card income following the MBNA acquisition. The recent passing of the bankruptcy law bodes well for BAC and other credit card issuers. The good part of the income statement is that the exposure to mortgage banking income is limited. In case the interest rates cause a bursting of the housing bubble, BAC's exposure is limited.

The MBNA acquisition will increase the market cap of BAC and will also cause share dilution. BAC is paying approximately $5 billion in cash to MBNA share holders. In addition, BAC will issue 631 million shares to MBNA share holders. This will increase the outstanding shares to 4.65 billion.

BAC has been buying back shares aggressively. Year over year, the number of outstanding shares have decreased by about 50 million. This will help increase the earnings per share and also the dividends.

The only concern in the balance sheet is the slow growth in shareholder equity. Year over year, share holder equity has increased only by about 1.6%. This could be because of dividend payments and share buy backs. This is the only black spot on otherwise a solid balance sheet.

One can look for about 10-15% year over year earnings/dividend growth for the next year. MBNA acquisition should start adding to the earnings in six months to a year. In the short term, there will be charges related to the acquision as about 6000 employees are let go from the merger. It doesnt hurt that the company has A rating from all the major credit rating agencies. The high dividend yield with potential increase in stock price makes this stock attractive.

Wednesday, December 28, 2005

Gold, inflation and decrease in the value of currency

The recent run up in gold prices to above 500 U.S Dollars has caused a stir in the financial markets. Is the run up an indicator of stronger inflation in the coming year or is this a trend because of the strong growth in the emerging markets and transfer of petro dollars to Russia and middle east?Let us consider the first question - i.e., of inflation. Inflation is already running at multi year highs - the U.S I bond currently yields 6.83%.

Many companies are expected to pass on the increased costs to the consumers next year - Kimberly Clark has said that the tissue prices will be upped by 6% starting in January 06 as noted in the link below., the above price increases are already factored into the gold prices and the run up in November is the one that is posing the question - "is the runup in gold price a harbinger of greater inflation and stagflation?".

Economist wrote an article which basically debunked the theory of gold prices being the harginger of more inflation. The economist article compares and is able to correlate the increase in price of precious metals price to that of gold. of the reasons being touted for the increase in the price of gold is the gold ETFs GLD and IAU. Both these ETFs have low expense ratios and it is easy for investors to buy and sell gold like stocks through these ETFs. One doesnt have to go through the normal time consuming and expensive procedure to procure, secure and sell the precious metal. Investors have ploughed in about four billion dollars into these ETFs increasing the demand for gold bullion.

The recent article in supports this theory. The other reason for the strong demand for gold is the increase of wealth in emerging markets. As an example, in India the economy has been growing at a very fast clip ( 7-8% ) and is expected to keep growing that way for some years to come. The salaries have been growing even faster at the rate of 13-14% a year. This has resulted in a boom in all sorts of markets starting from the stock market to the use of consumer products such as cars. The trend is similar in other markets such as China, Russia and Brazil.

The only conundrum for this theory is that the stock prices of gold mining companies havent kept pace with the price of gold. The gold mining stocks GG, ABX, NEM and PDG havent kept pace with the price of gold. It is easy to conjecture that if the price of gold is to increase, the price of the gold mining stocks should also increase. The only reason this wouldnt happen is if the demand for gold is primarily from emerging markets. The currencies in emerging market countries are not freely convertible and it is not possible for individuals to buy the gold mining stocks. After all, gold is the real thing when compared to gold stocks.The International Monetary Fund (IMF) has published its forecast for next year's global growth at 4.2%.

The IMF forecast can be read here. though economic forecasting is a bit like fortune telling and it doesnt account for unexpected events such as terrorist attacks, natural disasters; there is significant momentum in the current cycle and it is unlikely that the U.S economic growth will slow down significantly in 2006. As I have published in the earlier blog on S&P 500, it is likely that the SP500 will do fine next year.We are seeing a global increase in wealth that is making more money chase the same goods. The demand from emerging markets will keep increasing. This has already shown itself in the increased demand for oil. Real estate is dearer all around the world now than was the case a few years back. The growth and demand from emerging markets will keep increasing.What is more likely is the growflation scenario - where we see growth and some inflation. It isnt going to matter what currency you own, everything is likely become dearer in the next couple of years. It is also likely that an average person's net worth will also increase significantly if the above scenario holds good.

Tuesday, December 27, 2005

Chesapeake Energy (CHK) Analysis

CHK or Chesapeake Energy has recently been in the news because of heavy insider buying. The CEO and COO have bought shares to the tune of $19 million dollars. Let us quickly look at the balance sheets to see how things look up for Chesapeake Energy and if the stock is a buy.

Chesapeake Energy is increasing the production of natural gas at the rate of about 5% per quarter. If oil and natural gas prices hold steady, this should lead to better revenues and profits. For the forth quarter of FY05, Chesapeake seems to be well positioned. From their third quarter earning report - it shoes that they have hedged 55% oil at 54.97/barrel and 77% of natural gas at 8.14/mcf. The fourth quarter of FY05 is now pretty much over and much of the debate is how the prices would hold up in the new year. It is unlikely that prices will drop below the hedged prices anytime soon inspite of the weather reports.

The revenues for Chesapeake Energy increased ~3% quarter over quarter from second to the third quarter of FY05. If this trend holds up, one may be looking at 10-15% growth in revenues for FY06. If the company is able to improve productions and the sales price remains the same or higher, one can expect some upside surprise in the stock.

The tempering factor for the stock are a couple of factors. First the volatility of energy prices, particularly natural gas prices. The second factor is the conversion of long term debt into common stock. The company has consistently issued common stock to take debt off from its balance sheet. The quarterly report shows that this trend will continue to improve the balance sheet. A cleaner balance sheet allows the company to borrow for infrastructue or growth needs more easily.

However, the trend to issue new stock must be balanced against the current market situation. At present the stock has done well although it is well off its 2005 peaks. Continued weakness in the stock will impede the management team from pursuing the policy of issuing stock to remove debt from the balance sheets.

Overall, this company has a strong growth track record and the management has focussed on execution. Management also believes that natural gas prices will continue to remain solid for the next five years. Management buying may be to maintain the percentage ownership of the company. Currently McClendon owns about 5.7% of the company and Ward owns about 3% of the company. The fourth quarter is definitely strong for CHK and if the gas prices hold up, FY06 will also be strong.

Monday, December 26, 2005

Investing in 2006

As 2005 is winding down, the questions in many investors minds is what are the places to invest in 2006? There are some publications that have dedicates some space to this question, including the recent business week article. In this segment, I will go through some predictions made about 2006 by some analysts.

I drove around my neighborhood this X'mas and found better lights and decoration compared to the past five years. Utility bills this winter are already significantly higher compared to the same period last year and this doesnt seem to have fazed our neighbors. Is it the home equity loans or is it better financial situation of households that is the reason for increased confidence? My bet is on the latter.

Almost all the economists expect a slow down in the U.S in 2006 especially in the second half. The reason for the slow down - the overextended U.S consumer. I dont see this to be an issue. Several of my friends are thinking of buying new cars in 2006, many are upgrades from one car per family to two cars per family. I went to a Honda car dealership myself and found the salesman charging two thousand dollars above MSRP for one of the models. The salesman was so confident he was telling me there are too many money'd people who are willing to pay a premium for the model.

Slow down in 2006 seems highly unlikely, it is more likely we will have increasing GDP for the next three years. The business cycle has hit an upturn and it will be a while before we hit a downturn.

Given this, what are the good stocks to buy? I like BRKA/BRKB as it is still trading very close to its liquidation value. The downside risk is minimal for this company. The earnings growth is comparable to the tech giant Microsoft and the investments are in the hands of some of the best people in the world. Compare this to Google - which has a liquidation value of about eight billion while the market cap is close to one hundred and thirty billion. There is also SEB which has a PE of eight and has seen an appreciation of about 50% this year. It still has a low market cap of about 2 billion. There is also PACCAR (PCAR) which is recommended by the Fools. ( ). PACCAR has a market cap of 12 billion dollar and a PE of about twelve. PCAR builds big trucks and has market presence all over the world. They have also increased their dividends consistently for the past forty years.

In the tech sector, one can speculate with Google, Yahoo!, Microsoft. There is also other e-commerce plays EBay and Amazon. None of these stocks are cheap with the probable exception of Microsoft. Here is a brief overview of the market cap, revenue growth and P/E of these companies.

Company Revenue Growth Market Cap P/E

Google 70% 130 billion 95
Yahoo! 30% 58 billion 38
Microsoft 7-10% 283 billion 22.5
EBay 10-15% 62 billion 62
Amazon 30% 20 billion 42

Of the lot, EBay looks the priciest for its growth followed by Google, Amazon and Yahoo!. Amazon's balance sheet doesnt look pretty with cash, cash equivalents and marketable securities declining year over year. The overall balance sheet looks better than last year and the growth is still good. Google's growth rate is going to decline slightly next year - as noted in an earlier blog, next year's growth is already priced into the stock. Microsoft's earnings are going to increase thanks largely to cost cutting. The revenues are expected to grow faster in FY2007 as more products are released. Yahoo! is also seeing slower growth and next year's growth is already priced into the stock. These stocks are mainly priced for their growth year over year rather than their balance sheets and growth seems to be slowing for almost all the companies with the exception of Microsoft.

One can go for individual stocks or one can also go for specific sectors like utilities, materials energy, emerging markets, foreign market indices etc. There are numerous ETFs that allow the investor to invest in any market of their choice at a reasonable cost. Two sites and provide good information on ETFs. There are also mutual funds from vanguard and fidelity that provide low cost alternatives to ETFs. The mutual funds are better than ETFs for investors that like to do periodic contributions. The trading cost must be balanced with the fund expenses. As an example, Vanguard charges a ten dollar fee to maintain an account that has less than ten thousand dollars worth of assets. More on ETFs and mutual funds in the next blog.

Thursday, December 22, 2005

Search wars - part II

There was this recent story about the AOL deal. Although Microsoft would have been stronger had it won the deal - Microsoft still won in this round. It made Google cough up some money and more importantly give up 300 million from its future revenue as credit for AOL.

This deal made Microsoft stock go down and Google stock go up. At first brush, it may appear as though Google won this round, in the long term, this may not matter as much. AOL's internet access business is in decline as more people migrate to broadband and its graphic intensive websites won't drive traffic to google. If Time Warner shares advertising in all of its web properties ( such as, etc. ) it would be a bigger win for Google.

As I mentioned in my prior post - Microsoft is a formidable competitor with oodles of cash- expect it to mount a strong challenge for the number two slot in the coming few years. The online ad revenue is going to total around fifty-five billion dollars by 2010 and Microsoft will definitely want a piece of this pie. Cnn published an article commenting on the deal -

Sunday, December 18, 2005

A tale of three stocks

In the internet search space there are two companies that can give Google a run for its money. They are Yahoo! (ticket YHOO) and Microsoft (ticket MSFT). Microsoft has invested heavily to improve its search offering and is adopting the look and feel of google in its windows live and office live webpages. Yahoo! has been one of the earliest internet companies and has also improved its search and other product offerings to compete better with google. In this segment, we analyze the three companies and look at the revenue trends and how should one invest for the coming six months to a year.

Let us first look at Google. In the most recent quarter( sept 05) - Google has revenues of 1.578 billion and up 14% from last quarter. It earned 529 million dollars. The google revenues are up 94% compared to last year. The run rate gives an estimate of about 70-80% growth for next year's revenues. Even if the stock price doesnt move much from where it is today - the P/E next year around this year would be 56. It is likely that Google earnings growth will slow down to 50-60% run rate at this time next year.

The second company in the mix is Yahoo! Yahoo has had a good run the last year but the rate of increase in revenues is slowing down. It is still growing quarter over quarter - the next year, the growth rate would be around 30-35% compared to this year. The Yahoo! stock price - it it doesnt move further will be around 29 at the upper end. The earnings rate for Yahoo! is also likely slow down further to about 15-20% in 2007. The quarterly revenues by Yahoo is 1.3 billion an increase of about 46% over last year.

The third company in the mix in Microsoft. Its MSN division is the third party to the race. The MSN revenues are down about 8% quarter over quarter and are slightly up at 1% year over year. Even though Microsoft has heavily invested in to search, the results are not showing up in the balance sheet. The quarterly earnings from the MSN division is stagnant around 580 million dollars per quarter.

What are the different things going in favor of different companies? Let us look at google, yahoo and microsoft and see how things look.

95% of google's revenue is through advertising and search. Google has moved quickly to monetize its mail program through advertising. The challenge for google in the upcoming years is to diversify more into other revenue streams before other companies start to copy its format and offer advertising. In the next couple of years, growth from search is likely go down a bit on a year over year basis.

Yahoo is already well diversified with different revenue streams such as providing marketing service to busisnesses, search and information for individual users and communication and consumer services. In the most recent quarter, Yahoo!'s retained earnings were 270 million dollars compared to Google's 550 million. While Yahoo! has upgraded its search and its e-mail service is good, it doesn't have Google's momentum. Also - Yahoo! is incurring higher costs to provide the various services it is providing compared to Gooogle.

Microsoft's MSN division is a distant third in the race. Accoriding to Microsoft's earning reports, the MSN division made 89 million dollars on revenues of 564 million in the most recent quarter. The MSN division is struggling as the revenues from dial up lines is drying up and its MSN portal site remains large and clunky. The MSN portal is more like AOL in many respects. The MSN search technology has improved significantly. The new windows live and office live offerings are a step in the right direction. Although Microsoft doesnt have momentum currently - it is a tough competitor and the next couple of years should show if it can reverse its current trend.

Given the trends - the pecking order is clear - it is Google, Yahoo! and Microsoft. It is unlikely the trend will change in the next three - six months. Google is richly priced for its potential and is likely to meet/beat the earning estimates in the next couple of quarters. Yahoo! likewise is richly priced for its growth which is likely slow down further the coming year. Microsoft is a wild card, it is unlikely Microsoft will give up in the search space irrespective of the results. Microsoft has done well when it has focussed in the past - it is likely to gain on Yahoo! and Google in the next couple of years. Although it is difficult to see Microsoft becoming the numero uno in the next couple of years - it is likely to give tough competition for the number two spot.