Value-Stock-Plus

For some strange reason, a few technology companies across the world manage to rustle up exuberance that borders on the irrational. And then, the stock markets, pregnant with hope, propel prices through the sky. Dig a little deeper, and what emerges is a story of, well, hype. Closer home, Geodesic Information Systems, a stock market darling, fits the bill.

Touted as one among a handful of next generation IT product companies, Geodesic was started in 1999 by four young entrepreneurs—Pankaj Kumar, Kiran Kulkarni, Mahesh Murthy and Prashant Mulekar. Geodesic made headlines when it announced the launch of Mundu, an instant messenger that allows the user to chat across different services at the same time. So if you’re chatting on Yahoo, Mundu messenger allows you to simultaneously access MSN, Google, Indiatimes and Rediff.

The excitement this software generated rubbed off on the firm’s stock price. Coupled with the right kind of noises the company made, the stock price rose by over 175% in the year up to November 2005. A Rs 2 paid-up share of the company trades at over Rs 225 on the stock exchanges. Interest in the company is so high that foreign investors now own more than half of it.

Many more want a piece of it. In November last year, prompted by requests from clients, foreign broking firm CLSA decided to take a close look at the stock’s fundamentals. The 11-page CLSA report, a copy of which is in TOI’s possession, wasn’t very flattering.

For one, Geodesic had very high cash and equivalents—Rs 41 crore—surely a sign of robust health. The six-year-old fledgling had net profits of Rs 18 crore on sales of Rs 40 crore for 2004-05.

When CLSA looked closer, it was stumped. Apparently, 83% of the cash in hand were cheques in hand. Mind you, it isn’t quite the same as cash in the bank. That was just Rs 6.3 crore and investments accounted for Rs 4.7 crore. In fact, investments had dwindled from the previous year’s level of Rs 12 crore, a reflection on the firm’s poor treasury operations considering the way equities and mutual funds have performed.

Geodesic’s management has an explanation: they claim the money was deployed in various i n t e r- c o r p o r at e deposits and mutual fund schemes that were withdrawn at the end of the year. So the redemption payments were shown as cheques in hand. “Also the company received payments from some clients, which for their cash management purposes, were issued to Geodesic towards the year-end. All these cheques have been encashed immediately and paid to creditors with the balance invested in mutual funds,’’ it said.

Yet the company did have a few large creditors waiting. Sundry creditors had jumped to Rs 12.1 crore (77% of expenditure) from a mere Rs 32 lakh in the previous year. That was pretty high for a company which spends mostly on salary, conveyance and software development, CLSA thought. Geodesic’s explanation: the rise was partly because of payments due for capital expenditure and also some implementation services.

The broking firm also found it odd that employees’ salaries, on average at Rs 30,000, was rather low by industry standards. That employees were compensated by stock options didn’t find too many takers at CLSA. How then, did Geodesic manage to keep its attrition rate low at 2-3%, the broking firm asked?

On its part, Geodesic argued that after including ESOPs (employee stock options), the average salary works out to about Rs 90,000 per month, which helped them attract and retain talent. However, CLSA has pointed out, if ESOPs expense were to be considered at Rs 60,000 per employee, then Geodesic’s reported profit would be lower by Rs 6 crore or 30%.

Consider the math: at current prices, the total gain per employee is Rs 100 per option and a cumulative gain of Rs 6 crore to the employees (as mentioned by the company) from options of 2004-05, CLSA said.

However, it says, in earlier years such gains would not have boosted employees profits as the share was trading as low as Rs 20-30 apiece. “FY03 and FY04 were critical years for product development at Geodesic as its Mundu messenger platform was being developed and perfected,’’ the report said.

At the same time, Geodesic appeared to be quite liberal with accounting for software development expenses of Rs 2.8 crore for Mundu and Rs 2.3 crore for Hamarashop Retail Kiosk in the year. It merely capitalised them. Criticising the practice, CLSA said, “…even though allowed by accounting law, it is not a conservative accounting policy to capitalise developmental expenditure in our view.’’ The report also quotes Geodesic as saying that the company earned Rs 1 crore per annum from Indiatimes for its Mundu messenger. Sources at Indiatimes told TOI that the company paid much less than that claimed by Geodesic. When contacted, the company said that as a policy it does not comment on individual clients.

The broking firm also found it odd that promoters should sell their holdings in a company that held tremendous promise. Over the last four years, promoters’ holding have more than halved to 25%. Even in absolute numbers, the holdings have reduced from about 2.4 crore shares to about 1.5 crore shares, despite a 1:1 bonus issue in February last year.

Source: EM

In making an investment decision, apart from returns, there is one more very important factor that weighs heavy on investors’ minds – risk. Simply defined, it is the uncertainty of happening/non-happening of a certain event(s) that is likely to affect future returns.

A risk is generally attributed to external factors that create disturbance in the existing scheme of things. Some of these external factors are geo-political uncertainties (elections, terrorist attacks and wars), financial crisis and economic downturn. However, what stockbuyers generally fail to understand is that, apart from these external factors, there is one very big ‘risk-factor’ that is very inherent (or internal) to them. This internal risk is that of ‘indiscipline’.

By indiscipline, we mean that stockbuyers tend to forget the basic scruples of safe and sound investing, as they are then lured by the high probability of earning ‘a big bang for their buck’. These times when everything around seems promising and that the stock markets are rising incessantly (as happened in the most of 2003), discipline generally gives way to chaos. And this leads to even the best of investors putting their money into the worst of stocks believing that their invested company is the ‘next big thing’. Ironically, as just these very times when stockbuyers need to stick to the fundamentals of sound investing, they seem to forget these (the fundamentals).

This is where the ‘behavioral’ aspect of investing gains importance. And this is the time when a stockbuyer, before making the next investment (say investment ‘X’) should look into a mirror, and ask certain strict questions to himself. First, he needs to ask whether he understands his investment ‘X’ as well as he thinks he does. This would include:

• asking whether the investor has enough experience of similar kind in the past. This is like, when an investor is thinking of investing in say, Tisco, he should ascertain what has been his previous experience with the company;

• asking what has been other people’s track record in the past in making a similar kind of investment;

• ascertaining how much returns should his investment ‘X’ generate for him to break-even after his taxes and cost of making the investment. This would make clear the price that he would be ready to pay for the value of the investment ‘X’.

Secondly, the stockbuyer needs to ask himself as to what would be his reaction in case his ‘correct’ analysis about investment ‘X’ goes wrong. This would then involve:

• asking whether he has adequately allocated his assets (into equity, debt, insurance) to tide over losses from his investment ‘X’;

• asking whether he has a track record of controlled behaviour (i.e. acknowledging that he made a mistake) or else he would be a part of the overall chaos when things go wrong;

• asking whether he is relying on a well-calculated approach and what is his tolerance level of risk. He could find out his tolerance level by studying his past losses.

Now, while the answer to the first question (i.e. whether the stockbuyer understands his investment ‘X’ as well as he thinks he does) would be indicative of the ‘confidence’ level of the stockbuyer, the answer to the second (i.e. what would be his reaction in case his ‘correct’ analysis about investment ‘X’ goes wrong) would speak about the ‘consequences’ in times his investment decision goes wrong. If the stock buyer has clear answers for all the abovementioned questions, he would only make his larger task (of making investment ‘X’) easier. Thus, before you (as an investor with a long-term horizon of 2 to 3 years) invest, make sure that you have pragmatically ascertained your probability of being right and as to how would you react to the consequences of being wrong. Always, look at the downside before the upside. And always, look into the mirror before investing!

The author is a regular writer on stock market related issues. He is an eminent Chartered Accountant. He invites comments at tsrawal@gmail.com

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Lighten up for this rollercoasterThe best time to invest is when you have money.

This is because history suggests it is not timing which matters, it is time. — John Templeton

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