Should I invest in stocks now?

Well, this is the thought I’m trying to answer myself now-a-days, looking at the mirror every morning

First question: Why is the economy slowing down? Well, my one line answer to it – it’s the fear among people that’s slowing down the economy, rather than the virus itself. I’m not going to write about these things and “hows” and “whys” related to it (there are ample amount of media articles floating in the internet), but I’ll come straight to the point

Should I invest in stocks now? How should I invest?

In my opinion, this is the right time to review my investment portfolio and evaluate the stocks I always wanted to invest in

  1. I’ll choose stocks across sectors. Warren Buffet says, “One should never put all one’s eggs in one basket”. This is a golden rule now. I’ll read about the sector(s) before I invest in it. I should be able to gauge “Why would this sector do well?” I always choose that sector which is going to grow for the next 5 years. (i) Research reports, (ii) Analyst reports, (iii) investors say about the sector, (iv) what Mutual Fund Managers are investing in, etc. can be a good start to understand the chosen sector
  2. Large-cap stocks / blue chip companies across sectors are the ones for me now. I’ve been eyeing such stocks for a long time, but didn’t invest in them because they were expensive. Now is the time these stocks gives me the opportunity to earn profits
  3. If I’m fearful of losing money, I’d invest in staggered fashion. For example, if I want to invest INR 1,00,000 in a banking stock, for example, I’d invest in it in a equated installment, say INR 25,000, over a four-month period, or INR 12,500 every 15 days till I reach INR 1,00,000. In this way, I invest through the ups and downs of the stock market
  4. I keep a “sell” target before I buy a stock. I hold the stock for a period and book profits once it reaches its target price. I keep a variation of 15% in the absolute price
  5. I’d start small, if I’m new to an industry. To make a safe bet, I’ll capitalize on the expertise of a Mutual Fund Manager, who invest in my chosen sector, and see how the return came up for him/her in the last 5 years. I’ll, then, try my hands on the direct equity route
  6. I invest in a stock for at least 3 years. Equity is not for short-term investment (one year or less), nor is it for parking the money
  7. I do not borrow money from individuals or financial institution(s) to invest in stocks. While sophisticated investors do so, I recommend retail investors to stay away from such a strategy, even if there is substantial upside in stocks. I’d liquidate my term deposits and invests in stocks

In a nutshell, I’m holding cash to explore how the market volatility turns up. I know many Fund Managers who are waiting to see how low the stock markets go, so that they can buy good stocks at cheaper price. If you are a first time investor in direct equity, taking the expertise of a good fund manager, by investing through 100% equity mutual funds, is a great way to learn the fundamentals of equity investing and achieve long-term capital appreciation.

Warren Buffet says, “Fearful when others are greedy and greedy when others are fearful.” This is the time to realize this statement. Fingers crossed!


Why Oracle Should Buy Salesforce

CEOWith news, rumors, speculations floating around the potential acquisition in the cloud market, shareholders of are enjoying the surge in their share price, especially after Bloomberg reported that it could be a potential cloud computing acquisition target. With Salesforce market capitalization standing at $47 billion, its acquisition, if ever happens, will be one of the biggest in the technology industry. Such a deal, as per my view, can be financed only by a few Fortune 100 players, and when I say “few Fortune 100 players”, I’m referring to Microsoft, Oracle and IBM (not necessarily in this order of precedence).

In this article, I’m presenting my thoughts on “Why Oracle Should Buy Salesforce” and discuss some of the key points while the business leaders work on this deal with the Bankers. You may also want to read my previous articles on Information Technology Industry and Key Metrics here, where I highlighted the key parameters pertaining to this industry.

(1) Oracle aspires to go big in cloud computing

This is the very first thought that comes to my mind when I think of this deal. Since Oracle acquired Sun Microsystems for $7.4 billion on January 27, 2010 to compete with and beat IBM’s high-end systems and SAP applications, its cloud offerings, particularly Infrastructure-as-a-Service (IaaS), Platform-as-a-Service (PaaS) and Software-as-a-Service (SaaS) has enhanced. Salesforce acquisition will help Oracle:

  • uplift its cloud sales revenue from the current $2 billion to $5-6 billion
  • help improve its market share. According to Gartner, the combination would make Oracle the largest player in the CRM market
  • enhance its customer base, and
  • complete its SaaS Suite

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How do you capitalize an operating lease quickly?

To answer this question, let’s consider an example. Assume following is an annual statement of a public company. “At December 31, 2000, the Company was lessee at 7,000 restaurant locations through ground leases (the Company leases the land and the Company or franchisee owns the building) and at 6,000 restaurant locations through improved leases (the Company leases land and buildings). Lease terms for most restaurants are generally for 20 years and, in many cases, provide for rent escalations and renewal options, with certain leases providing purchase options. For most locations, the Company is obligated for the related occupancy costs including property taxes, insurance and maintenance. In addition, the Company is lessee under non-cancelable leases covering offices and vehicles. Future minimum payments required under existing operating leases with initial terms of one year or more are:

($ millions) Restaurant Total
2001 $748.3 $811.6
2002 735.3 790.4
2003 705.8 752.2
2004 676.2 715.1
2005 623.5 640.0
Thereafter 6,018.7 6,239.7
Total minimum payments $9,507.8 $9,967.3

Rent expense was (in millions): 2000–$886.4; 1999–$796.3; 1998–$723.0. These amounts included percent rents in excess of minimum rents (in millions): 2000–$133.0; 1999–$117.1; 1998–$116.7. “ To capitalize these operating leases, we need to discount the future lease payments to arrive at the present value (PV). Here are the steps:

  1. Cash flow for the FY2000 – 2005 are already given. So, we proceed to Step 2
  2. Divide the “Thereafter” amount ($6,240M) by FY2005 amount ($640M) to determine the number of years remaining, at FY05 level, for the lease payments.

 6,240/640 = 10 years remaining

Put $624M (=$6,240M/10) for the additional 10 years after the lease amount of FY2005 for the PV calculation.

  1. Consider its long-term borrowing rate (6%) to match the long-term assets.
  1. Calculate the Present Value(PV) of this cash flow.
Year Payment ($millions)
2000 886.4
2001 811.6
2002 790.4
2003 752.2
2004 715.1
2005 640.0
2006 624.0
2007 624.0
2008 624.0
2009 624.0
2010 624.0
2011 624.0
2012 624.0
2013 624.0
2014 624.0
2015 624.0
PV @6% 6,500.0

Now, let’s adjust the financial statements. Capitalizing operating leases does not affect net income; it just replaces the lease expense with interest expense and depreciation

  1. $6.5B is added to the ‘Long-term Asset’ of the Balance Sheet as “Assets Under Capitalized Leases”. A similar amount is also added to the ‘Liabilities’ as “Capitalized Lease Obligations”. Now, this represents as if the company had purchased the assets with borrowed money as of 1/1/2000.
  2. Reverse the existing entry ‘Lease Expense’ currently in the financials. The company paid $886.4M in FY2000.
  3. Calculate the PV of FY2000 interest payment.

$6.5B x 6% = $390M

Since the company paid $886.4M in FY2000, the difference amount of $496M (=$886.4M – $390M) is added to the depreciation, resulting in no change in the net income value.

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What percentage of valuation is usually in the terminal value?

It depends on how many years we are projecting. In a 5-years DCF, the terminal value (TV) would account for 70 – 80% of the business valuation, and in a 10-years DCF, about 50%.

Let’s take an example. Consider a firm that generates an after-tax operating profit of $100 million. With 25% return on capital (ROC), it reinvests 40% of its earnings back into the business, thereby generating an expected growth rate of 10% for the next 5 years:

Expected growth rate = 25% * 40% = 10%

After Year5, the growth rate is expected to drop to 5%, but ROC to stay at 10%. Terminal value is calculated as follows:

Expected operating income in Year6 = $100 million * (1.10)5 * (1.05) = $169.10 million

Expected reinvestment rate from Year5 = 5% / 25% = 20%

Terminal value in Year5

[$169.10 million * (1 – 0.2)] / (0.10 – 0.05) = $2,705.6 million

Present Value of firm

 (44 / 1.10) + (48.4 / 1.102) + (53.24 / 1.103) + (58.56 / 1.104) + (64.42 / 1.105) + ($2,705.6/1.105) = $1,900 million


$1,900 M / $2,705 M = 70.24%

You may also refer my article on Valuation: Asset Approach, Income Approach and Market Approach here.

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Where do I find company’s capital structure?

A company’s financial health is indicated by the balance sheet, and can be evaluated by 3 broad categories:

  1. Working Capital
  2. Asset Performance, and
  3. Capital Structure

Capital structure depicts a company’s debt and equity mix. A healthy proportion of equity and debt represents a healthy capital structure. Equity capital consists of Preferred Stock, Common Stock and Retained Earnings, which are summed up to form ‘Total Shareholder’s Equity’ in the Balance Sheet. Debt Capital generally comprises of short-term borrowings, long-term debt and current portion of the long-term debt. Equity capital is always costlier than the debt capital because the company shares its profit with the investors. The debt capital burdens the company with periodic interest payments, but the owners earn a tax rebate on the interest, with no profit sharing with the debt holders. But a highly leverage company can become a watchdog since the investors put restrictions to its activities. During economic downturn, if a competitive business is not able generate enough cash flows from its operations, it might have to file Chapter 11 Bankruptcy.

There is no magical debt levels defined. A company debt-to-equity ratio varies according to its stage of development, industry it operates in, and the lines of businesses it has. Analyst use various debt measuring ratios (debt-equity ratio, leverage ratio, EBITDA/interest, liquidity ratio, solvency ratio, to name a few) to analyze the financial health of the company. Various credit rating companies (like S&P, Moody’s, Fitch) evaluate a company’s ability to repay the principal along with the interest on debt obligations before awarding any rating. Capital Structure affects EPS (earnings per share) depending on whether it’s simple or complex. If the company has dilutive securities (complex capital structure), its diluted EPS is lower than the basic EPS; if it’s simple, then basic EPS equals diluted EPS.

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Management’s CapEx forecast: Where and how to find it?

Research reports are a good place. Else, we need to attend the investor meetings, presentations and conferences hosted by the company. We can try in MD&A section to get a hint (for example, a statement that says “$150M wind farm being built by 2020”), but generally, management does not disclose such information in a usable format (like public 10-K/Q reports) unless it’s a major project for them. There are some Oil and Gas and many utility companies that discloses such information. Oil and Gas highlights it as it impacts their production growth directly; it’s a big driver for them. Analysts need to see if Oil and Gas companies are generating enough FFO over CapEx needed to sustain or grow their production.

If I were to guess, I’d look at asset replacement based on the life of the existing assets and replacements values. And then, the cost of the expanded capacity they may highlight elsewhere. If they are forecasting a 15% growth on higher units, there will be a likely event of CapEx, assuming no under-utilization of capacities.

Common-size statement analysis to identify trends: We can also try to derive the capital expenditure by looking at the company’s historical financial statements (balance sheet, income statement and cash flow statement). Usually, companies in an industry spend in a proportion to their sales or EBITDA. If the sales are growing, using the same ratios (as in the past) can help derive the figure. Similarly, if the revenue / EBITDA estimates are flat, reducing the CapEx in proportion to the sales will help arriving at the estimate.

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