- Wealth PMS (50L+)
We had written a post at the beginning of last year on the Magic Formula and had created two portfolios with companies having market capitlization of greater than Rs 1,000 Cr and companies falling in the Rs 500 – 1,000 Cr market cap category. Based on the best combined ranking, each portfolio had twenty stocks. We had provided a detailed write up explaining the Magic Formula and the process to shortlist the stocks here. We would highly recommend to go through this post, which should be a refresher to understand the concept of Magic Formula.
In this post we will see how have the portfolios performed since we shortlisted them and run the screen again to shortlist stocks for 2019.
Let us get straight away into looking at the performance of the portfolios.
Below is the performance of the portfolio in the greater than Rs 1,000 Cr market capitilizaton category.
For illustration purposes we assume that investments of Rs 10,000 were made in each stock, total investments will amount to Rs 2,00,000 for this portfolio. How has this portfolio fared in the last year? let us see below
One can see that it hasn’t been a pleasant experience investing in the above portfolio. The markets also haven’t had a great year. The Nifty Midcap 100 in this period has fallen by 23% and the Nifty Smallcap 100 by 39%. One is seeing a absolute loss of 38% in the above portfolio, for Rs 2,00,000 invested in January last year, one is able to realize Rs 1,24,127 on 26.2.19.
We also want to reiterate the importance of having a basic understanding of the businesses, financials and level of valuations of the final list of stocks screened before committing any investments.
For instance, we had highlighted about HMVL in our previous post. The company still has huge cash and investments on its books. Dividends in this case also haven’t increased. In this case it is best to avoid making investments in such companies. In the case of 8K Miles there have been corporate governance issues, in our view however lucrative the business if there are any corporate governance issues it is best to avoid such companies. 8K Miles is the biggest loser in the above list, it lost 88% of the invested value. Other companies that saw heavy draw-downs were Hubtown, Tirumala Chemicals and IGPL.
Infosys declared a 1:1 bonus issue in September,2018. Tirumala Chemicals had a stock split from Rs 10/FV to Re 1/FV in August,2018. We have adjusted the buying prices above to reflect these corporate actions.
In the case of Geometric, the business has been transferred to HCL Technologies. As per the share swap agreement, every 43 shares of Geometric would be entitled for 10 shares of HCL Technologies. In addition, one listed redeemable preference share of 3DPLM software solutions limited of Rs 68 will be issued for every one share held in Geometric. These preference shares carry a dividend of 7%. As per the share swap agreement for the 38 shares held, one is entitled to 9 shares of HCL Technologies. We also assume that the 38 preference shares are sold once they have been allotted, realizing an amount of Rs 2,584.
Dividends, brokerage and other charges haven’t been taken into consideration while arriving at the above figures.
Below is the performance of the portfolio in the Rs 500 – 1,000 Cr market cap category.
The drawdown for this portfolio was 49%. Sum of Rs 2,00,000 would fetch Rs 1,01,562 ON 26.2.19. Stocks which saw the highest drawdowns were ILFS engineering, vivimed labs, alphageo and allsec technologies. Stocks in this category have seen heavier beating due to their small cap nature. These stocks have taken the most hit in the past year.
Kellton technologies declared a bonus in Feburary last year.
In the case of Talwalkars there was a demerger in which the gym business was transferred to Talwalkars lifestyle. There was confusion on the names and we had written about it here. There is talwalkars better value fitness and talwalkers healthclubs listed on the exchanges. Shareholders of Talwalkars better value fitness got 1 share for every one share held in talwalkars healthclubs as part of the scheme of arrangement.
We ran similar screen that we did last year –
In addition we screened for companies in both the portfolios for earning yield greater than 7.5%. However in the case of companies greater than 1,000 Cr the return on invested capital (ROIC) was 20%, while for those in the 500 – 1,000 Cr segment it was 18%.
Below is the query that we ran on screener.in for Portfolio 1 (>1,000 Cr market cap)
Before we share our findings, we would like to highlight that financial services companies, cyclical companies – mining, metals and steel players were removed from the ranking process. Another way to look at this is that every company in a way is in a cycle, it is for the investors to identify where a particular company is currently placed in the cycle, in other words have fair understanding of the big picture. We have removed the obvious cyclical companies and financial services firms from the list.
The screen generated a total of 202 stocks. We segregated companies by industry and below is the list of the top five industries.
Highest number of companies – 30 were generated from the financial services segment. They formed 15% of the total stocks generated. However the financial services companies were not ranked. Some of the companies in the other segment include – BSE, Quick Heal and Nesco. The screen also generated companies in the electrodes and graphite space – HEG and Graphite, we decided to remove them from the ranking process given the latest run up in stock prices and cyclical nature of the indsutry in which they operate.
We ranked the remaining companies and shortlisted the top 20 companies based in the lowest combined ranking. For instance Hero Motocorp generates 173% ROIC and is ranked 3rd on this matrix, its earning yield is 10% and it gets a ranking of 89 on this front. The combined ranking of Hero Motocorp is 92 (3+89), this however does not fall in the top twenty companies. It is the 24th company in the list. For understanding how the combined ranking process works, we would highly recommend to read our earlier post on Magic Formula.
Below is the list of the top 20 stocks
There a total of 6 companies or 30% of the portfolio is from the chemical space. Indian Oil Corporation (IOCL) and Hindustan Petroleum (HPCL) both find a place in the top 20 list. The screen also generated Bharat Petroleum (BPCL), however it had a combined ranking of 124 and was 52nd company in the list.
There were a total of 84 stocks generated. The top 5 industries on the basis of weightage are
One third or 29 companies were from the five industries highlighted in the above table. Observations from both the portfolios are
Below is the list of the top 20 stocks based on the lowest combined rankings
There are 3 companies from the chemicals space, 2 each from the auto ancillaries, infrastructure, media & entertainment and printing & stationary segments.
We would again like to highlight the importance of having a fair bit of understanding on the business before investing in the above companies. For instance Hindustan Media (HMVL) appears in the above list, this stock had also appeared in our last year list. Company has cash and investments on its books greater than the market cap and hasn’t shared this cash with its shareholders. It is best advised to avoid such companies. Kitex garments is another example, which faces certain corporate governance issues and should be best avoided. The next two companies if we were to exclude the above companies are Jay Bharat Maruti and Nuclues Software. The updated portfolio is shown below
One observation after running this year’s screen is the number of stocks that each of the portfolios have generated. Portfolio 1 generated 202 stocks this year as compared to 73 stocks in the previous year, portfolio 2 on the other hand had 84 stocks this year as compared to 28 stocks last year. The markets haven’t had a great 2018 and increase in the number of stocks is an indication of that. The current situation provides opportunity to add quality names to their portfolios. The magic formula can be a starting point for the same. We will review and see how the above portfolios have fared in 2020.
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Note: This is not portfolio advice. Consider this a very risky portfolio and proceed at your own risk. At Capitalmind Premium the reason we have a portfolio is to demonstrate our commitment to our analysis, and we track it closely. It is not meant to be a recommendation for anyone in particular, primarily because we don’t know your risk profile.
Holdings: Analyst and family do own some of the positions listed above. Please assume we are biased.