“What are you looking at?” my wife asked while staring at me.
“N-n-nothing dear!” I said. “I was just reading on a company.”
“All you guys are the same!” she said while rushing out of the room without even giving me a chance to explain.
“I knew this would happen!” I said to myself while turning back to that website of…Lovable Lingerie Ltd. (LLL).
I was looking at this company after a long-time reader of The Safal Niveshak Post, Nitin Shetty, asked me how he should go about researching this company and whether this could be the “next Page Industries” (the company behind the “Jockey” brand of innerwear in India).
“This is my first step in analyzing the company and valuable suggestions would be appreciated,” Nitin wrote to me.
I feel great whenever a reader asks me how he or she should start researching a particular company. This is not because I feel proud to be in a position to give my suggestions…but because someone is taking the pains to do the hard work to make his/her money work better for him/her.
99% of investors don’t fall in this “I-will-do-the-hard-work” category, thus it feels good to interact with the 1% who take this road less travelled. So Nitin, congratulations as you seem to be on the right track to become an independent, successful investor. 🙂
Anyways, LLL’s comparison with Page Industries Ltd. (PIL) is valid on one, and just one, count – and that is that both these companies are in the branded innerwear market. While PIL largely serves the men’s innerwear market (though it also has products for women), LLL has presence only in a woman’s wardrobe.
Now, before I even start analyzing LLL, I must first get over a bias, which in this case is known as the “Next Page Industries bias”. And this bias comes when I see this chart.
Data Source: Ace Equity
Here’s a stock that has multiplied by more than 7x in the last five years, and has left the broader markets way behind.
7x in five years is an amazing rate of return any investor would love to earn, and this is what creates the bias – “What if LLL is the next PIL?”
Or at least, investors start imagining returns from another stock that they have seen a “similar” stock earn in the past.
This isn’t an unusual way of thinking because, by nature, we try to create patterns where none exist…and especially when it comes to stock markets.
So the starting point for many people while analyzing stocks isn’t whether, “Let me find out whether XYZ is a good company,” but “Can XYZ be the next ABC?”
And this is where the first big mistake in stock analysis is committed. It’s same as thinking that if Salman Khan is a crowd puller, so will be Arbaaz Khan or Sohail Khan. After all, all of them carry the same genes. But that isn’t true you see. One can be a star (for any reason) and the others, who carry the same genes, can be disasters.
So the lesson here is – Whenever you encounter a case like LLL, begin your analysis looking at the company or its stock independent of any other company or stock that it resembles.
This is because no two businesses are the same. While they might appear same in many senses (which is also true of LLL and PIL), there are many points of differences as well.
Here is a table that showcases the difference in the businesses of LLL and PIL. These are just some parameters you can use to identify how two “similar” businesses you are researching could be different.
Data Source: Ace Equity, Safal Niveshak Research
So, as you see from the table above, both PIL and LLL are two completely different animals – with different competitive scenario, buyer behaviour, product segments, and financial performance.
Such a comparison should remove the bias that the business you are about to research (LLL in this case) could be like another business that “sounds similar”, but in reality is entirely different.
Like there isn’t the “next Infosys”, there isn’t the “next PIL”, and knowing this is the first step before you even start analyzing a company that you like on the face of it (like LLL in this case).
Here are the next few steps you need to use in your analysis…
Step #1: Analyze the industry
Understand how competitive the women innerwear industry is, what drives demand and supply, and where do the future opportunities and challenges lie.
For instance, Nitin also mentioned in his email that the female to male ratio in India is increasing over the years and now it stands at 940:1000.
This is one important number that hints towards the opportunity that lies ahead for LLL. Greater woman population can lead to greater demand for the company’s products. While this might not be the case, but it definitely hints at something.
You can get such statistics when you keep your eyes and ears open, and read the available information on the industry. Often, the annual report of a company itself gives a good enough overview of the industry, along with its future growth outlook.
Simultaneously reading the annual reports of two or three competitors (if there are competitors) should give a clearer picture.
Step #2: Analyze the company (and its business model)
After studying about the industry, the next step is to focus on the company’s strengths and weaknesses.
The strengths of a company are often reflected in things such as its brand identity, products, customers and suppliers. You can learn about a company’s business model from its annual report.
For instance, LLL’s FY11 annual report clearly mentions the threat of low brand loyalty and fluctuations in raw material availability and prices as key risks.
Source: LLL’s FY11 Annual Report
By the way, LLL’s annual report also touches upon the factors that influence the choice of a woman consumer, which is so important in analyzing this company.
Source: LLL’s FY11 Annual Report
You won’t come to know of such things if you don’t read a company’s annual reports.
Step #3: Analyze the financials (and learn to read between the lines)
Understanding the financial strength of a company is the most crucial step in analyzing a stock. This is because if you don’t understand the financials, you cannot actually think like an analyst.
Often, numbers lying in the financial statements speak louder than the glossy words of an annual report (like we saw in the case of Temptation Foods the other day).
I have identified some key financial numbers for LLL in the table above, which paints a reasonably good picture for the company. These are some key numbers that you must use while analyzing any company.
Step #4: Study the management quality
Peter Lynch once said, “Go for a business that any idiot can run – because sooner or later, any idiot probably is going to run it.” What Lynch meant here is that you must always invest in simple businesses (which LLL seems to be).
But it’s equally important to understand the management quality. While it is the quality of the business that will drive your long term investment returns, it is the management that will drive the business’s quality.
One quick way to study the management quality is by seeing how it has driven the company in the past. And you can know that by the company’s past financial performance, especially through numbers like “debt to equity ratio” and “return on equity”.
Step #5: Calculate the intrinsic value (valuations)
Sensible investing is always about the price that you pay for a given value of the business. You can easily know the price the business is quoting at (that’s the stock price).
The difficult (and more important) part is calculating the intrinsic value (IV) of that stock.
I’ve explained several key methods of calculating IV in all the StockTalk research reports I’ve done so far, so you can use them for calculating LLL’s IV, if you’re keen to research the company.
Step #6: Understand signals from your stomach (the gut feel)
This step is one that will separate you from all the data and numbers, and let you listen to what your inner self is hinting at.
Sometimes, and you must have noticed this for sure, even after doing a thorough analysis on something you are looking to buy (like a television, laptop, or timeshare holidays), your gut tells you that something might not be right with your decision to buy that stuff.
But you realise this in actuality only after you buy it, and then you curse yourself for not having listened to your gut feeling.
This is also true for investing. Again, as Peter Lynch says, “In many ways, the key organ for investing is the stomach, not the brain.”
So even after you’ve found that based on your analysis, LLL is a worthy investment candidate, wait for a week (I sometime wait 2-3 weeks) and let your stomach tell you whether you would be comfortable owing the stock or not.
Believe me, you might sometimes be surprised with the answers.
The bottom line
The ultimate goal of every investor is to make a profit. However, as the saying goes, not all roads lead to Rome.
So, never blindly accept your first impression of a stock and never ever get biased that a given stock can be the “next something”.
What do you say? Do you follow a set of steps while analyzing stocks before investing in them? If yes, it will be great if you can share with others in the Comments below.
If not, do you think the steps I enumerated above make some sense?
(By the way, Nitin must be disappointed with me as I did not answer – “Whether LLL could be the next PIL?” – and have instead pushed him on the longer way to seek for himself ;-))