Coal India: The Next SJVN? 

Hello everyone, Rahul Shah here, trying to make investing accessible and profitable for the average investor.

Let us start today's session with a small quiz.

These are the historical financials of two companies between FY09 and FY13.

Where do you think you will invest your hard-earned money? Company A or Company P?

If you ask me, there are two kinds of investors.

Those who are more quality conscious and those who are more value conscious.

The quality conscious investor will reject company A for its poor historical performance. Its EPS is all over the place, it has high debt to equity ratio and it does not have a great average return on equity or ROE as it is popularly called.

Company P on the other hand, ticks all the boxes. Its EPS has almost quadrupled in a short span of five years, its average debt to equity is well below one and it has a very impressive return on equity (ROE) of 51%.

Therefore, the quality conscious investor will instantly take a liking for Company P and will reject Company A.

The value conscious investor on the other hand will ask for additional information. Most importantly, he will ask us to reveal the valuations.

Well, here's what the valuations of the two stocks looked like 10 years ago i.e. in September 2013.

Let us start with Company P first. Company P was trading at a PE multiple of almost 40x its previous 12-month earnings whereas its price to book value multiple was 21.4x

Company A on the other hand was trading at very attractive valuations. Its PE ratio was just 2.5x and its price to book value ratio was well below 1x.

You see, a PE multiple of almost 40x for Company P isn't all that bad given its historical growth rate and its extremely impressive return ratios. Therefore, a quality conscious investor would like to invest in company P if his investment horizon is for the long term.

On the other hand, despite its average fundamentals, the valuation of company A is very attractive. It is available at a PE of just 2.5x and a PBV of 0.3x. In other words, even if you assume it's fair value to be 1x price to book value, it is like buying a Rs 100 note at just Rs 30.

So, which of the two investors do you think made more money from their respective stocks. The value conscious investor who invested in company A or the quality conscious investor who invested in company P?

Well, a year later i.e. by September 2014, Company A was up a huge 307% whereas Company P was up almost 100%.

In other words, while Company A multiplied the investment of the value conscious investor by 4x, Company P almost doubled the investment of the quality conscious investor.

Over the short term i.e. over a 12-month period, Company A outperformed Company P by a big margin.

What about the long term though? What about 10-year investment horizon? Well, here, Company P has an edge over Company A. The quality conscious investor comes out ahead of the value conscious investor over a 10-year period.

Over a 10-year period, Company P has given an impressive 10x returns whereas Company A has multiplied investor money a little over 5x.

So, company P has given twice as much returns as Company A.

Now, let me not drag the suspense any further and reveal the names of the two stocks to you. Company A is none other than Arvind Ltd. Yes, one of the world's largest manufacturers of denim.

Company P is one of the hottest multibaggers of the past couple of decades, Page Industries.

Let me repeat that. Company A is Arvind Ltd and Company P is Page Industries.

It was Arvind Ltd that outperformed Page Industries over a 1-year period. And it was Page Industries that outperformed Arvind Ltd over a 10-year period.

Now, Arvind Ltd has also seen the demerger of a few businesses in the last decade. And if you consider the wealth that these demerged entities have created, then the gap between Page Industries and Arvind Ltd narrows down further.

However, there's no denying that Page Industries is qualitatively better than Arvind Ltd. Over the next 10 years, there is a strong chance that Page Industries will further increase the outperformance vis-a-vis Arvind Ltd.

But it is also true that when you buy a stock like Arvind Ltd at extremely attractive valuations then over the short term i.e. over a 1-2 year period, it can outperform a high quality stock like Page Industries.

I am sure you must have heard the famous Warren Buffett dictum that it is better to buy a good stock at a fair price than buy a fair stock at a good price.

I agree with Warren Buffett provided the investment horizon is 5-10 years. Over a short investment horizon, a fair stock like Arvind Ltd can outperform a good one like Page Industries provided it is available at a good price.

There is one more advantage of an attractively valued stock like Arvind Ltd and an investment horizon of 1-2 years.

You don't have to do an in-depth analysis of the company.

You see, an in-depth analysis is done to ensure that you are not making a mistake and that you don't incur a permanent loss on the stock.

And there are two ways of minimising your loss from a stock.

You take a look at the track record of the company, have a broad understanding of the business model, and ask for a big fat margin of safety in valuations.

Arvind Ltd's track record back in 2013 was average if not great and we knew that it was in the textiles business and had a long history and was also one of the world's largest manufacturers of denim. Lastly, the margin of safety was huge because the stock was available at a fraction of its book value.

I believe it was this basic requirement that was needed to earn those 50%-100% returns over a 1-2 year period. The company had a decent business model in place, and it was available at very attractive valuations.

However, when you are investing in a quality stock like Page Industries by paying a high PE multiple and having a long-term investment horizon then you need to undertake a more detailed analysis of the stock.

You need to figure out things like the company's expected profit growth over the long term, the company's market potential, the execution capabilities of its management, the strength and durability of its competitive advantages and most importantly, the valuation at which it will trade 10-years from now.

An analysis of this kind is not impossible, but it is time consuming and not that easy for sure. However, there is advantage of investing in a quality stock.

If you get the future right and if you are not paying a very high PE multiple, then you can make huge money from such stocks over the long term.

To be more specific, in stocks like Arvind Ltd or companies with similar fundamentals, you make the Surer money.

But in stocks like Page Industries you make the Big Money.

Put differently, the probability of making a profit is on the higher side in stocks like Arvind Ltd.

However, the magnitude of profits is likely to be much better in a stock like Page Industries.

Having said that, both the value-conscious investor as well as the quality-conscious investor can end up earning good long term returns if they stick to their respective philosophies and apply it well.

Now, let's take a look at the historical financials of another company.

Well, if you look at the average debt to equity ratio and the average ROE, it does look like a quality company. However, if you look at the trend in EPS, then you'd be a tad disappointed because barring FY23, the company has struggled to grow.

By the way, this company is none other than the PSU behemoth Coal India. Yes, it is India's largest coal producer.

Do you think it qualifies as an investment for a quality conscious guy and should be held for the long term or do you think it is meant more for a value conscious guy?

As far as I am concerned, considering its business model, its management, and its historical track record, it is meant more for a value conscious guy than a quality conscious one.

This means that not only is our investment horizon short, but we also want the stock to come with a big margin of safety.

As can be seen, the stock currently trades at a PE multiple of 6.4x its trailing twelve-month earnings, which is quite attractive to be honest.

I believe that anything below 10x is quite good, and Coal India does qualify on this parameter.

However, the multiple goes up to 9.3x if you take into account its average earnings over the last 5 years.

I took the average earnings just to be on the safer side as it is possible that its earnings in FY23 may not be sustainable and is one time in nature.

Thus, on its average 5-year earnings, the stock trades at a PE of 9.3x, which is also not bad as it is still below 10x.

I believe that this low multiple is one of the reasons that the stock has done well of late, going up around 20% in just one week.

However, can it continue its good run going forward? Can it give the value conscious investor a good return of 50%-100% over the next 1-2 years? Can it be the next SJVN, which has more than doubled in the last one year and where most of the gains have come in the last six months.

Well, I can't say for sure.

What I can say with a high degree of certainty that if you buy a group of 20 stocks with similar fundamentals and similar valuations then there is a strong chance the group may end up doing well over a 1-2 year period.

And then you may have to buy another group of 15-20 stocks with similar characteristics.

Thus, whether Coal India performs well doesn't matter. What matters is how the entire group does on an overall basis. And if history and logic is any indication, the end result may leave you positively surprised and happy.

That's all from me today. Happy Investing.