Saturday, November 25, 2006
Markets continued to defy gravity this week and moved into higher territory for the fifth week in a row. While the BSE benchmark ‘Sensex’ edged higher by 2%, gains in Nifty were a tad higher at 2.5% for the week ended November 24, 2006.
The week’s proceedings started on a rather dispirited note on Monday, as markets seemed to take a leaf out of the previous week’s close. The Sensex tumbled by as much as 200 points within the first couple of hours. While it continued to stay rangebound throughout the day, it recovered miraculously in the final hour to shed all its losses and close at breakeven levels. However, there were no such worries over the next two days as led by gains in heavyweights, bulls literally went on a rampage and the Sensex edged higher by a mind numbing 275 points. Considering the levels the indices are at, the gain of such a magnitude is indeed staggering. After a mild profit booking on Thursday, indices resumed their northbound journey on Friday and recouped most of the gains it had pared the day before.
As far as the institutional activity on the bourses was concerned, FIIs were net buyers this week to the tune of nearly Rs 31.6 bn. Domestic mutual funds, on the other hand, turned out to be net sellers to the tune of Rs 3.4 bn.
As far as sectoral indices are concerned, this week it was the turn of the BSE IT index to emerge as the frontrunner as it closed higher by 4%, comfortably above the rest of the pack. Sector majors like Wipro and Satyam played pivotal rules in propping up the IT index as they ended higher 8% and 7% respectively for the week. With valuations among other heavyweights looking rather stretched, relatively safer havens like software stocks seem to be once again propping up on the radar of investors.
Among other indices, the midcap and small cap indices gained 2.8% and 2.6% respectively. As large caps are looking rather expensive, investors seem to be moving towards mid cap and small cap stocks in a view to further improve upon their investment results. However, one need to keep in mind that the high returns on these stocks are directly proportional to the higher risks involved. Hence, caution needs to be exercised to that extent.
As per a leading business daily, the dispute between Reliance Industries (RIL) and power generation major NTPC, over the supply of natural gas to the Kawas and Gandhar power projects may be resolved, as the two companies are working out a limited liability formula to cover the eventuality of non-supply of gas or NTPC not buying the gas it contracted for. RIL was to supply 132 trillion British thermal units (BTU) of gas to NTPC's 2,600 MW expansion plans for the Kawas and Gandhar power plants at a price of US$ 2.97 per MMBTU for 17 years. Reliance is proposing a fresh price discovery after every 2 to 3 years, reflecting market trends. The new price of gas would then be US$ 4.3 per MMBTU. However, it needs to be noted that power companies cannot afford to pay energy cost above US$ 4 per MMBTU, which is likely to make the power generation cost uneconomical. NTPC stock emerged as the highest gainer on the Sensex for the week by notching up gains of 8%.
In what could be termed as another landmark event in the Indian stock market history. dotcom major, Info Edge made its debut on the bourses during the week, and what an opening it was! The stock opened with 41% gains over its offer price of Rs 320 and went on to make the opening day's high of Rs 624. It finally closed the week at Rs 583, a rise on nearly 82% over the offer price. As a matter of fact, Info Edge is a leading provider of online recruitment and matrimonial classifieds and related services in India, and owns brands like 'Naukri.com' and Jeevansathi.com'.
Engineering major Siemens earlier this week gained a huge 11% in just one trading day as it won a huge Rs 36 bn order from a Qatar based company. However, the stock closed 1% lower for the week as its FY06 results although buoyant, fell short on expectations, thus sparking a sell off. Consolidated revenues and net profits grew by 64% YoY and 27% YoY respectively. This strong performance was specifically aided by traction in the company's power and telecom divisions. The company board has recommended a dividend of Rs 3.8 per share for the fiscal (dividend yield of 0.3%).
Despite the satisfactory performance of India Inc. and positive news emanating with respect to organic and inorganic growth across sectors, there is no yardstick that seems to justify the current level of valuations. At the current levels, markets have more than factored in the growth prospects of India Inc. from a medium term perspective. Nevertheless, a bottom up approach, longer investment tenure and selective stock picking with cognizance of one’s risk profile will stand investors in good stead. Happy investing!
The following recommendation is based on price as on Friday, 24th November 2006.
BUY: Honda Siel Power at Rs 167
Now full details:
BUY : Honda Siel Power at Rs 167
BSE Code : 522064
NSE Symbol: HONDAPOWER
Market Lot: 1
A 67% subsidiary of Honda, Japan, Honda Power is a leading player in portable generator sets. Through higher indigenisation, cost control and better market grip due to upturn in demand and reduced competition due to stricter compliance norms, the company is set to substantially improve its profitability. With more than half of its high book value of Rs 150 parked in bank deposits, the company can give a very liberal dividend and/or go for buyback.
Actual EPS for March 2005 : Rs 7.9
Actual EPS for March 2006 : Rs 10.2
Projected EPS for March 2007: Rs 16.3
: The number of malls India is expected to have by 2007, up from a mere 30 in 2003
per cent: The share of Mumbai, Delhi, Chennai, Kolkata, Bangalore and Hyderabad in India's total organised retail market
million (Rs 5.85 crore): The amount for which TCS has acquired TCS Management, a privately-owned consulting company in Australia
per cent: The contribution of India's urban population to government revenues
(Rs 22.5 lakh): The permissible overseas remittance limit for resident Indians per financial year, up from $25,000
billion (Rs 14,400 crore): The increased limit for FII investments in government securities, up from $2 billion (Rs 9,000 crore)
billion (Rs 2,16,000 crore): What financial systems reforms, and further economic liberalisation, can add every year to India's gross domestic product
crore: The amount the three-day bandh by traders in the Capital (Oct. 30-Nov. 1, 2006) is estimated to have cost the exchequer
crore: The total assets under management of the domestic MF industry as on September 30, 2006
per cent: Projected growth of technology spending by SMEs in India in 2007, the highest in the Asia-Pacific region
million-plus: Total number of websites on the internet, according to a survey by the internet research firm Netcraft
million litres: The estimated use of ethanol in India in 2006
: India's current annual urban per capita income
lakh cases: The current size of the domestic wine market in India. Over the next 5 years, this is likely to grow to 28 lakh cases to be Precise
Nicholas Piramal India
Cluster: Apple Green
Price target: Rs325
Current market price: Rs235
CRAMS to power revenues
- Several products of Nicholas Piramal India Ltd (NPIL) are amongst the top brands across various therapeutic segments. With its focus on building brands rather than merely launching new products and initiatives to expand and improve the productivity of its field force, NPIL expects to outgrow the domestic market in the coming years.
- With six contract-manufacturing deals under its belt, NPIL expects the custom manufacturing business to be its growth driver in the coming years. The company expects revenues of Rs60 crore in FY2007E and of Rs140 crore in FY2008E from this business.
- Acquired in December 2005, Avecia Pharmaceutical, UK has healthy gross margins but it is making losses due to its high fixed costs. NPIL is currently in the process of integrating Avecia into its operations and is undertaking several initiatives to derive cost synergies from Avecia. With these initiatives NPIL believes that Avecia will break even by the end of FY2007 and start contributing positively from FY2008.
- NPIL recently acquired one of Pfizer's facilities at Morpeth, UK. The Morpeth facility is currently being integrated with NPIL, following which NPIL plans to scale up production at the unit to make use of the idle capacity. The Morpeth unit current has EBIDTA margin of around 15.5% and is currently earnings accretive for NPIL. With a ramp-up in revenues, the management believes Morpeth's margins would improve with the increased operating leverage.
- With the Baddi facility going on stream, the increased operating leverage derived from the higher capacity utilisation at the Morpeth plant and the shift of manufacturing of the inhalation anaesthetics to India, NPIl expects its margins to improve significantly in the future.
- To account for the delay in the ramp-up of NPIL's contract-manufacturing business, the contribution from the recently acquired the Morpeth facility and the improved scenario in the domestic market, we are revising our revenue and earnings estimates for FY2007 and FY2008. Our revised earnings estimates stand at Rs10.7 per share for FY2007 and Rs16 per share for FY2008. At the current market price of Rs235, NPIL is discounting its FY2008 estimated earnings by 14.7x. Considering the strong revenue flows and enhanced profitability picture expected for the coming years, we maintain our Buy recommendation on the stock, with a price target of Rs325.
Aditya Birla Nuvo
Cluster: Apple Green
Price target: Rs1,280
Current market price: Rs1,100
A right(s) Idea
- Aditya Birla Nuvo (ABN) yesterday announced the ratio and the price of its proposed rights issue. The company plans to raise close to Rs780.0 crore through the rights issue.
- It will issue two equity shares for every 17 equity shares held. The pricing of the ssue is attractive as it is at a 28% discount to the stock's current market price of Rs1,100.
- Over the last one month the stock has run up by over 20% and breached our price target of Rs1,031.
- In view of the fact that ABN's leverage after the rights issue will come down to more comfortable levels and the continued stellar performance of the growth business, we are revising our estimates and price target for the stock.
- We continue to like ABN's strategy of having twin motors of value creation: the value business and the growth business. We believe that the cash flow from the value business is being invested profitably in growth areas, creating good value for the shareholders. We are revising our price target to Rs1,280 due to the higher valuation that we believe the telecom business ought to enjoy. In fact, the telecom and insurance businesses together contribute 78% of the old price target or roughly Rs1,018. This implies that the investor is getting all the value businesses, the business process outsourcing (BPO) and the garment business for zilch.
Price target: Under review
Current market price: Rs1,105
- Leading banks caught in IPO scam: In order to penalise errant banks caught in the initial public offering (IPO) scam as well as to avoid such defaults in future, the Reserve Bank of India (RBI) had decided against granting fresh branch licences to the banks unless it was convinced that the processes and checks were in place.
- New branch licences a positive development for HDFC Bank: The RBI has granted HDFC Bank the permission to set up new branches and automated teller machines (ATMs). The bank's current network comprises 535 branches and 1,323 ATMs as on September 30, 2006. Though the exact number of new branches and ATM licences granted to the bank are not yet known, we expect the same to be in the range of 18-20% of its existing network.
- Branch licences remain crucial to sustain margins: Although HDFC Bank didn't face any significant pressure on its NIM due to the denial of new branch licences by the apex bank, yet going forward the absence of new branches and ATMs could have had a material impact.
- Business mix and asset growth maintained: HDFC Bank is predominantly a retail bank with 70% of its business mix generated through retail banking. Branch presence is crucial to execute retail banking and hence banks need to open new branches in potentially untapped areas to generate new business.
- Permission to open new demat accounts a positive: HDFC Bank is a major player in the capital market related business areas, be it loan against shares or demat facility and advisory services. The bank has a very high component of fee income in its total income and the SEBI's recent permission to open new demat accounts would help the bank to improve its fee income.
- Valuation: The RBI's permission to set up new branches and SEBI's consent to open new demat accounts are positive developments for the bank. Based on the current market price of Rs1,105 the stock trades at 23.1x FY2008E earnings per share (EPS), 9.4x FY2008E pre-provisioning profit (PPP) and 4.7x FY2008E book value. Currently the price target for the bank is under review.
Siemens has announced its fourth quarter and full year results for the financial year ended September 30, 2006. The company's consolidated sales grew by a strong 65.8% to Rs6,032 crore from Rs3,638 crore last year. The consolidated profits however grew at a lower rate of 26.4% to Rs392 crore from Rs310 crore last year. The profit growth was lower largely because of a high raw material cost, the investments done in the year in new ventures (such as transformers) and the subdued performance of its subsidiaries, Siemens Information Systems Ltd (SISL) and Siemens Public communication Networks Pvt Ltd (SPCNL).
Ray Kurzweil, an inventor and new hedge fund manager, is describing the future of stock-picking, and it isn’t human.
“Artificial intelligence is becoming so deeply integrated into our economic ecostructure that some day computers will exceed human intelligence,” Mr. Kurzweil tells a room of investors who oversee enormous pools of capital. “Machines can observe billions of market transactions to see patterns we could never see.”
The listeners, attendees of a conference sponsored earlier this month by the Capital Group Companies, are slightly skeptical. Some have heard that Mr. Kurzweil, 58, who takes more than 150 vitamins and supplements a day, believes people will eventually live forever. Others know he has said that in 2045, man and machine will achieve “singularity,” and humans will hold their breath for hours thanks to nanomachines in our bloodstreams.
But some are aware that a former Microsoft executive and chairman of the Nasdaq stock market, Michael W. Brown, is an investor in Mr. Kurzweil’s new hedge fund, FatKat, and that Bill Gates once described him as “the best person I know at predicting the future of artificial intelligence.”
More important, many of them have seen Mr. Kurzweil’s ideas used by stock speculators. So, they want to learn more about his brave, new world.
“These ideas are the future,” said David Atkinson, a private investor who attended another lecture later that day by Mr. Kurzweil. “I’m not really sure I understand them, but they’re making some folks rich.”
Complicated stock picking methods are nothing new. For decades, Wall Street firms and hedge funds like D. E. Shaw have snapped up math and engineering Ph.D.s and assigned them to find hidden market patterns. When these analysts discover subtle relationships, like similarities in the price movements of Microsoft and I.B.M., investors seek profits by buying one stock and selling the other when their prices diverge, betting historical patterns will eventually push them back into synchronicity.
Today, such methods have achieved a widespread use unimaginable just five years ago. The Internet has put almost every data source within easy reach. New software programs, like the Apama Algorithmic Trading Platform, have made it possible for day traders to build complicated trading algorithms almost as easily as they drag an icon across a digital desktop.
“Five years ago it would have taken $500,000 and 12 people to do what today takes a few computers and co-workers,” said Louis Morgan, managing director of HG Trading, a three-person hedge fund in Wisconsin. “I’m executing 1,500 to 2,000 trades a day and monitoring 1,500 pairs of stocks. My software can automatically execute a trade within 20 milliseconds — five times faster than it would take for my finger to hit the buy button.”
Studies estimate that a third of all stock trades in the United States were driven by automatic algorithms last year, contributing to an explosion in stock market activity. Between 1995 and 2005, the average daily volume of shares traded on the New York Stock Exchange increased to 1.6 billion from 346 million.
But in recent years, as algorithms and traditional quantitative techniques have multiplied, their successes have slowed.
“Now it’s an arms race,” said Andrew Lo, director of the Massachusetts Institute of Technology’s Laboratory for Financial Engineering. “Everyone is building more sophisticated algorithms, and the more competition exists, the smaller the profits.”
So investment firms have increasingly begun exploring mathematics’ furthest edges and turning to people like Mr. Kurzweil, who became an expert in pattern recognition building a reading machine for the blind.
For years, computer scientists had tried to help machines perform mundane tasks like reading printed words or telling faces apart. With algorithms similar to those used by stock pickers, programmers created millions of rules designed to tell an “A” from an “a.” But no machine could read a page of text as well as the average child.
So Mr. Kurzweil and others took a different tack: instead of creating sequential rules to instruct a computer to read, they thought, why not create thousands of random rules and let the computer figure out what works?
The result was nonlinear decision making processes more akin to how a brain operates. So-called “neural networks” and “genetic algorithms” have become common in higher-level computer science. Neural networks permit computers to create new rules and automatically change underlying assumptions by experimenting with thousands of random sequences and processes. Genetic algorithms encourage software to “evolve” by letting different rules compete, and combining the most successful outcomes.
Wall Street has rushed to mimic the techniques. Because arbitrage opportunities disappear so quickly now, neural networks have emerged that can consider thousands of scenarios at once. It is unlikely, for instance, that Microsoft will begin selling ice-cream or I.B.M. will declare bankruptcy, but a nonlinear system can consider such possibilities, and thousands of others, without overtaxing computers that must be ready to react in milliseconds.
“Most software fails in pattern recognition because there aren’t enough sequential rules in the world to teach a computer to discern between two faces, or to find almost imperceptible relationships between stocks,” said Orhan Karaali, a computer scientist and director at Advanced Investment Partners, a $1.7 billion hedge fund. “But a machine that can generate complicated rules a person would never have thought of, and that can learn from past mistakes is a powerful tool.”
Last year, the funds using Mr. Karaali’s model returned in excess of 20 percent by using nonlinear techniques, according to his company. Whereas older methods of stock analysis rely on certain assumptions — for instance, that market volatility always reverts to the mean — Mr. Karaali’s model calculates probabilities and generates assumptions on the fly, and might predict that during a panic, investors will sell Microsoft but, for seemingly irrational reasons, hold onto I.B.M.
“Only an elite group of people are using these ideas, but a lot of people are thinking about them,” said Stacy Williams, director of quantitative strategies at HSBC Global Markets. HSBC is working with Cambridge University in using models based on how viruses spread to forecast foreign currency markets.
“The downside with these systems is their black box-ness,” Mr. Williams said. “Traders have intuitive senses of how the world works. But with these systems you pour in a bunch of numbers, and something comes out the other end, and it’s not always intuitive or clear why the black box latched onto certain data or relationships.”
Such qualms, however, have not stopped Wall Street from scouring university doctoral programs or listening to people like Mr. Kurzweil.
In the pursuit of previously undetectable patterns, hedge funds are racing to quantify things — like newspaper headlines — that were previously immune from number-crunching.
Both Dow Jones Newswires and Reuters have transformed decades of news archives into numerical data for use in designing and testing algorithmic systems. The companies are beginning to structure news so it can be absorbed by quantitative models within milliseconds of release.
Moreover, companies like Progress Software are working with news agencies to create computer programs that instantly translate news — for example, a headline regarding Microsoft’s earnings — into data. M.I.T. is examining, among other things, evaluating companies by seeing how many positive versus negative words are used in a newspaper article.
Software in development could potentially respond automatically to almost anything; changes in weather forecasts on television news, shifting analyst sentiments or what a particular movie critic said about the new blockbuster.
“Right now, everyone basically has access to the same data,” said John Bates, a Progress Software executive. “To get an edge, we want to give investors the ability to immediately turn news into numbers. We want to automate what before required human analysis.”
But as these new techniques proliferate, some worry that promotion is outpacing reality. These techniques may be better for marketing than stock picking.
“Investment firms fall over themselves advertising their latest, most esoteric systems,” said Mr. Lo of M.I.T., who was asked by a $20 billion pension fund to design a neural network. He declined after discovering the investors had no real idea how such networks work.
“There are some pretty substantial misconceptions about what these things can and cannot do,” he said. “As with any black box, if you don’t know why it works, you won’t realize when it’s stopped working. Even a broken watch is right twice a day.”