Not all investors are equally good and it’s often one single investment decision that starts a good investor on the journey to becoming a legendary investor. In the case of Warren Buffet, it was his decision to invest in Walt Disney and American Express, for George Soros, it was his decision to short the British Pound. Similarly, in the case of India’s very own Rakesh Jhunjhunwala, it was his decision to make a substantial investment in a then poorly-performing stock called Titan Company Limited in 2002-2003.
Fast forward to 2021, Rakesh Jhunjhunwala and Associates hold approximately 5.1% stake in Titan, which is currently worth approximately Rs. 11,000 crores. Sure he has made other lucrative investments too, but none of them have eclipsed this one investment. So how did he identify that Titan, a poor performer at the time, would become a multi-bagger later on? And more importantly, are there any strategies or calculations that we can do to help us pick a multi-bagger stock ourselves?
In this blog, we will take a closer look at Titan Company Limited to figure out how value investing techniques might have helped Rakesh Jhunjhunwala identify the stock as a potential future multi-bagger. This way, you will be better placed to figure out how you can pick undervalued stocks.
Details of the Business Environment for Titan in 2002-2003
In 2001 and 2002, Titan Industries Limited was facing a number of internal and external challenges. Internally, a dispute between the company management and the Employees’ Union had resulted in a lockout of the company’s key factory at Hosur. This had led to a reduction in revenues and profitability for the company.
A number of unfavourable external factors such as increase in the price of raw materials especially gold, greater competition and low demand had also dented the profitability of the company. This decline in profitability is clear when you compare the profit after tax and dividend data from the Titan P&L Statement for FY 2000-2001, FY 2001-02 and FY 2002-03 as shown below:
|Financial Year||FY 2000-2001||FY 2001-2002||FY 2002-2003|
|Profit After Tax (Rs. crore)||23.48||13.09||6.21|
|Equity Dividend (%)||26%||15%||10%|
year period and dividend payouts by the company had also been substantially reduced. The various difficulties facing Titan during that period are also evident from a market decline in other key metrics like return on capital employed as shown below:
|Operating Return on Capital Employed||9.8%||9.7%||9.2%|
|Return on Capital Employed (EBIT)||11.3%||9.7%||7.8%|
|Return on Net Worth (PAT)||11.4%||6.4%||2.4%|
As this long list of the company’s difficulties and poor performance became public knowledge, the share price of Titan, dropped to an 8 year low of Rs. 29. What’s more, there seemed to be little sign of a possible recovery in the near future.
Rakesh Jhunjhunwala started purchasing stocks of Titan around this time at low prices ranging from Rs. 30 to Rs. 35 per share. So the obvious question here is what did he see in this beaten-down stock that others did not? A closer look at the sales numbers of different product categories answers this partly as shown below:
|Sales By Product Category of Titan Industries (FY 2000-01 to FY 2002-03)|
|FY 2000-01||FY 2001-02||FY 2002-03|
|Time Products (Rs. crore)||495||457 (-8%)||453 (-1%)|
|Jewellery (Rs. crore)||203||267 (+31%)||345 (+29%)|
|Total||698||724 (+4%)||798 (+10%)|
As you can see even during the difficult years of 2001-2003, the company’s jewellery business had grown 30%. The company’s jewellery brand, Tanishq had opened 52 stores across the country and had introduced a number of innovative schemes to boost customer interest and retention. In fact, the Titan management was actively pursuing a strategy that could make the jewellery segment its main business in the coming years.
Additionally, during this same period, Titan had also introduced a number of schemes designed to save costs and grow the company’s profits in the coming years. These included:
- Implementing VRS (voluntary retirement scheme) for 600 employees
- Restructuring of the company’s European operations
- Introducing projects to help reduce working capital requirement
While these were steps in the right direction for the future of the company, Rakesh Jhunjhunwala might also have noticed some additional information in Titan’s annual report for FY 2002-03.
A Closer Look at the Financials of Titan Industries
Now, in the previous section it was clear that Titan’s profits had dropped significantly within a few short years. However, judging the long-term potential of a company based on only its recent performance might be the wrong approach. To better understand why that might be the case, let’s take a closer look at Titan’s P&L statement data for FY 2001, 2002 and 2003:
|Profit and Loss Statement of Titan Industries (FY 2001 to FY 2003)|
|FY 2001||FY 2002||FY 2003|
|Cash Operating Profit||36.84||41.44||38.39|
|Add: Other Income (One-Off)||9.66||—||7.71|
|Less: Other Expenses (One-Off)||—||—||5.18|
|Less: Provision Against Losses||—||—||10.00|
|Less: Taxes (Current Year)||2.09||5.07||3.57|
So the key reason for the company’s marked decline in profitability is a provision against losses of Rs. 10 crore that the company had made in FY 2003. This amount was actually set aside to restructure the company’s operations in Europe.
Additionally, the operating profit of the company has actually been maintained in a narrow band of between approximately Rs. 16 crore to Rs. 18 crore during the FY 2001- FY 2003 period. This indicates that Titan Industries operations and revenues are quite stable even though the Net Profit numbers might indicate otherwise.
Now a value investor would definitely notice this and consider Titan to be a financially stable business and Rakesh Jhunjhunwala might have arrived at the same conclusion on observing this. But a better way to confirm whether Titan is a good business to invest in using this data is to use to Net Current Asset Value method originally developed by Benjamin Graham.
How to Use Net Current Asset Value to Pick Value Stocks
Benjamin Graham, the father of Value Investing, was the first to introduce the concept of net current asset value in the 1930s. It is calculated using 4 key data points from a company’s balance sheet:
- Net Current Assets of the company
- Amount of preference share capital
- The Long-term Debt of the Company
- The total number of outstanding Equity shares
Net Current Assets Per Share of Titan
This is the difference between the current assets and current liabilities of a company. A current asset is any item that can be converted to cash within a period of 12 months. Examples of current assets are finished goods, raw materials, cash on hand, etc. Similarly any short-term financial obligations of a company such as loan repayments, dividend payouts, etc. are considered as the current liabilities of a company.
In the case of Titan, the company’s net current assets were valued at Rs. 396 crore as of 31 March 2003. This meant that if Titan had ceased operations on that date, it would have been able to liquidate Rs. 396 crore of assets within 12 months after paying off its current liabilities. Additionally, on the same date, the number of outstanding Titan shares was 4.22 crore. So, using the formula:
Net Current Assets per Share = (Total Current Assets – Total Current Liabilities) / Total Outstanding Shares,
The net current assets per share of Titan was Rs. 93.84 on 31 March 2003. On the same date, the closing price of Titan stock on that day was Rs. 50.
This indicates that at the end of FY 2002-2003, the liquidation value of Titan’s net current assets was almost double the company’s market capitalization. As a result of this difference, investors were assured of a significant margin of safety which is one of the key rules of value investing.
Now, the formula to calculate net current asset value (NCAV) of a stock is like this:
NCAV = [(Net current assets – Preference share capital) – Long Term Debt] / Total Equity Shares
Using the data from Titan’s balance sheet for the year ending 31 March 2003, we get the following data:
Net Current Assets = Rs. 396 crore
Preference Share Capital = Rs. 40 crore
Long Term Debt = Rs. 467 crore
Number of Equity shares = 4.22 crore
So, Titan’s NCAV for 31 March 2003 = (-)Rs. 26.30
Now, it is obvious that this NCAV formula of Benjamin Graham is based on a very conservative model. So, it might seem that Titan is not a value stock one should invest in. One reason for this is that when Graham developed this stock selection technique in 1930s and 1940s, companies were significantly more conservative in their borrowings therefore, their net current asset would have been significantly higher than their market cap or debt.
So, it is necessary to tweak Graham’s model a bit by assuming this:
Amount Required to Buy a Company = Debt + Market Capitalization
Here, we have assumed that to purchase a company, you will not only need to buy all its outstanding shares but also pay off all its outstanding debts.
Using this assumption, the revised formula we can use would look like this:
Easily Accessible Money By the Company / Amount To Buy Entire Company = (Net Current Assets – Preference Share Capital) / (Market Capitalization + Debt)
Using the data from Titan’s balance sheet for 31 March 2003, this ratio comes to 53%. This represents the liquid assets of Titan at the end of FY 2003.
You should keep in mind this ratio does not take into account any long-term assets like the company’s physical assets eg. land, future earnings, long-term investments, cash flows, growth prospects, etc. Taking those long-term assets into account, the 31 March 2003 share price of Rs. 50 per share would definitely be an attractive entry point for a value investor.
Now, neither the NCAV data nor the modified ratio method can be taken in isolation to determine whether a stock is a suitable value investment. These should be treated as one of many signals that can indicate if it is the correct time to enter or exit a stock.
So, what exactly would Rakesh Jhunjhunwala have seen when he looked at Titan as a company to invest in during the FY2001 to FY2003 period. There were quite a few positive indicators for the stock such as:
- Low share price hence available at a reasonable value
- A company with sustained increase in revenue for the past 15 years
- Established brand name with a track record of profitability
- Track record of providing high return on Equity prior to FY 2001
But there were also a few notable concerns that he would have considered:
- Consecutive 2 years of poor profit numbers
- Ongoing factory lockout that could impact future profits
- Low profit margins of around 3-4%
- Low return on capital employed
But beyond this short list of pros and cons, there are also some key lessons that one can learn from the analysis of Titan Industries in 2001-2003.
Lesson 1: To be a good value investor one needs to understand the different components that are included in a financial statement. For instance, even though the financial statements of Titan showed a dramatic decline in year on year net profit between FY2001 and FY2003, the operating profits of the company were relatively stable during the same period.
Lesson 2: The impact of internal or external factors on stock price might be temporary. For example, after the Hosur factory lockout occurred in February 2003, Titan stock prices dropped by 22% within a couple of months. But after the lockout ended with an agreement between the management and the Union, the factory reopened, production was back on track and the stock price recovered rapidly. So, the correction in stock prices due to the lockout would have offered an excellent investment opportunity for value investors seeking a bargain.
Lesson 3: Using tools such as NCAV can help investors identify a value stock that can give exceptional returns when the market value of the stock moves closer to its intrinsic value.
After all, value investors are bargain hunters who seek out reasonable valuations and invest in stock whose current price does not accurately represent the value of the company.