Monday, May 4, 2009

Finance vs Cricket

I’m a diehard fan of Chennai Super Kings. Right from the day this team was selected and Dhoni was announced as the captain I have been following my team very passionately. I had a passion for cricket during my younger days, following every match of India.Cheering every run scored and every wicket taken..But that child like enthusiasm was somehow lost in the recent years.Thanks to the boring matches all round the year. But this new format of the game: IPL has brought that enthusiasm back in me and I have enjoyed every victory of Chennai.

I thought it would be an interesting experiment to explain some of the finance concepts through my teams IPL players …Don’t know how it’ll shape up…You have to comment on it !!

Suresh Raina: Once you see a company or a business idea, the way they operate you immediately get a feeling that this organization is going to be the next money spinner. You would not have even seen it earning revenues, but you still believe that this company and its model will definitely succeed .Hence it’ll be operating at a high P/E (Price/Earnings ratio). P/E ratio is nothing but the hype surrounding the company.It is the belief that the particular organization has the potential to earn in the future. So it trades at a very high price compared relative to its current earnings. Take the case of Educomp when it issued IPO in the market few years back it traded at a P/E of 440!!(Once reason being low equity exposure, but more because of the belief that it has good earnings potential)..Similarly Raina is a high P/E player. As soon as he came into the international scene ,there was so much hype surrounding him and I remember him hitting two cover drives and he was immediately praised to be the next Tendulkar…(I now wonder how much would Tendulkars P/E would have been when he first came into the international arena at the age of 18!!)

Mathew Hayden: Investing in Mathew Hayden is like investing in a high paying equity at a low risk (Now doesn’t this defy the logic of Risk return model where basically high returns come with high risk!!).When he comes on to bat the opponent is terrified. He creates the sense of terror in the bowler and he is one among the few players who has a high average at a very high strike rate(current IPL series strike rate of 160+ and an average of 40+) ..This in finance terms is like companies having a very high Sales figure and yet is able to maintain that profit margin levels. I have seen many companies which compromise on their profitability when they increase their sales (nothing wrong with them, as that is the way of doing the business. The reason being the working capital requirement like your Receivables turnover and your bad debts starts increasing with increasing sales)..But there are also some companies like Microsoft, Google which never compromises on its profitability because of being the leader in the market, because of the innovations they bring into the market. These are the stocks which you’ll always strive to have in your portfolio irrespective of their price (who cares about valuation here…Wish Damodaran does not read these lines J )

Dhoni: The Glamour Quotient…These are the kind of stocks which I would say fetches a high EV/EBIDTA ratio. EV is enterprise value (which is nothing but the market value of debt plus market value of the equity) and EBIDTA (Earnings before interest depreciation tax and amortization).Again as I explained for the P/E ratio this kind of stocks trade at a high value because of the perception.When Dhoni made his international appearance he made it with a bang, two big 150+ knocks and that coupled with his being cool as a captain :20-20 world cup victory , victory in Australia , Newzealand , has risen his market value…So both the market value of equity and market value of debt(yield being very low : Don’t we observe it in the current series , with hardly any runs coming from his bat compared to the money paid for him) is very high. So in simple terms these are mostly stocks with good potential but more or less overvalued and correction can happen anytime in the near future.

Joginder Sharma: These are what I call as junk bonds (not in the literal sense though…Junk bonds by definition will yield very high returns but at a abnormally high risk…But Jogi is a case where there is high risk and low return…Now Markowitz will have a tough time explaining this logic!!) ..But these stocks gets listed into the market somehow (SEBI regulations require the companies to have consistently performed in the last three years with good bottom line before being listed) . But there are some companies which make it just because of the backing of the parent company (One example being RP). If I see such a stock without the parent company backing it up it would be just another junk company (I know it hurts telling RP to be a junk , but will a company with zero sales figure trade at such a price in the market during the listing ).Jogi is one such player who deserves not even a Ranji berth , but plays for the Indian 20-20 side just because he can li** the a** of Dhoni . Such stocks never can perform consistently in the market and you’ll be a big loser if you go on to hold such stocks for a long time

Albie Morkel and Jacob Oram: These stocks are always fancied in the market since their product portfolio is diversified .Hence even in a recessionary scenario such stocks can survive one way or the other. These are companies which have revenues from different business segment (in the balance sheet you can observe the revenue from the segments). But being into variety of activities somehow makes the critiques point “the core competency agenda against them”. I would love to test these players similar to the Modigliani Millers theorem of “Dividends really don’t matter”...MM proposed that irrespective of whether companies provide dividend or not, value of the company does not change. Similarly I would argue that irrespective of whether he is an all-rounder or a batsman or a bowler his value does not change.Just like when MM argues that giving dividend reduces the current price of a share, I would argue that being an all rounder reduces your potential in batting and bowling as well. Hence the value of the player remains the same. But there are also critiques who argue that dividends are a strong signal to the market. (So when a player claims himself to be an all-rounder, be ready to differentiate between a Kapil Dev, Imran Khan and Ajith Agarkar)

Jakati : I started writing this article on 2nd May and due to infrastructure problem I could not post it then ..But couple of days later when I’m about to post this I cannot do it without the inclusion of this guy who has picked up 8 wickets from 2 matches and has turned a star bowler for Chennai . These are companies which have rapid turnaround in their performances and don’t give an average investor an opportunity to cash in on the opportunity. For example observe the graph of some of the Lloyd group of companies which was relatively an unknown stock initially and when it started rising it was a sharp rise that it never gave an average investor to benefit. There are some companies which have huge debts on their balance sheet and their profits will be more than eaten away by the interest component that they have to pay ..All the profitability ratios and the interest coverage ratio would have looked bad for that company .. But there could be some quarter or an year when they would have gradually wiped off their debt and they’ll start rising their heads above the water.Once they rise their heads above the water there’ll be people who can observe it quick and fast and purchase those shares to benefit (No sooner will the stock be perfectly placed on the Security market line)..Look out for such stocks and hold some of them in your portfolio as it is like a lottery(low cost) , the probability to achieving a turnaround might be very low , but once they achieve it , then it’ll be a great bonanza for the investors..

Hope you enjoyed reading this article…

No comments:

Post a Comment