The difficult job of assessing governments

Assessing the performance of an employee is not the most difficult job (caveats exist!!!) in the world despite the subjective judgments involved. Nevertheless, I find that in Bangladesh (and possibly the world) top management and HR often fails in awarding the good performers and penalizing the bad ones. Rather, either nepotism wins or employees are promoted by ‘socialism’ which usually means that age determines position and rank.

When we extend the challenge to analyzing companies, it becomes slightly more difficult. However, it’s still quite doable by using a number or relative (benchmarking against key competitors) and absolute (Total shareholder returns, RoIC, Profit growth etc) metrics.

The toughest of these all is assessing the performance of a government in my view. The challenges actually start from the very basic level as we are still not sure if GDP growth is the single best indicator of economic progress. On top of that consider that, calculation methodologies and data collection ability also differs greatly between countries. Morten Jerven has done some great work on GDP calculation of African economies that highlights this challenge.

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The start of the third year

Thanks to Linkedin, I got to know that the Asif Khan Blog has just passed two years. It has been a rewarding two years. Writing these posts helped me clear up my own concepts. Additionally seeing people from all around the world read and subscribe to the blog gives me extra confidence.

One of the goals for 2016 that I have is to write better quality and more well researched posts. This will make the posts longer (which is against the conventional wisdom cited by social media experts) but for the type of content I write, they are ideal. On the flip side, as work and other activities take away more and more time the number of posts will surely come down.

As a new years gift to readers I bring link to a talk show “Weathtrack” which I recently stumbled upon. It was love at first sight (or in my case love at first listen as I use my podcast app to listen to these episodes). Here are two great episodes that I listened to recently. Coincidentally both the guests have worked in the First Eagle Fund.

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Damodaran on country and currency risk

I was reading Aswath Damodaran’s blog and much to my surprise found a series of posts on country risk. A lot of the material he talks about overlaps with my last post on currency risk and risk free rate. I did not however find confirmation of what I suggested for currencies which are ‘highly’ overvalued (my suggestion for a global investor was to adjust the fair value estimates, for assumption of a large currency depreciation which is not captured by the risk free rate).

Nevertheless, I think all 4 blog posts are relevant readings for equity investors. Here they are.

  1. Groundhog day in Greece, Hijinks in Brazil and Market Chaos in China: Pictures of Global Risk – Part I
  2. Valuing Country Risk: Pictures of Global Risk – Part II
  3. Pricing Country Risk: Pictures of Global Risk – Part III
  4. Decoding Currency Risk: Pictures of Global Risk РPart IV

While the posts become quite technical and makes it clear to the reader that a lot of what we do is subjective one key advice from Damodaran is very important. That is consistency in our cash flow assumptions and discount rate assumptions. If our discount rate implies inflation rate of 5% and cash flow assumes inflation rate of 2% we have a mismatch and our valuation could well undervalue the company. The reverse can also happen where we are using a high terminal growth rate number and a low discount rate.

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Does risk free rate compensate for currency risk in equity valuation?

The risk free rate is one of the basic inputs used for company valuation. I have done a bit of thinking on the risk free rate because it poses a number of practical challenges faced by analysts.

For example, when risk free rates are extremely high or extremely low (e.g. government bond yields are fairly low across South Asia at the moment) do we take the current yield or a historical average? If we take an average will it be a 3 year or a 5 year average? In fairly volatile times, the answers to these questions can have pretty large implication for stock valuation.

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A visionary ecosystem

Microfinance is not innovative. Many will be understandably aghast at such a statement. The origins of microfinance is of a hapless yet determined economist, Muhammad Yunus, attempting to sell the novel idea that the poor can be creditworthy, a notion that was shunned by virtually all the banks existent in the late 1970s. Banks could not imagine loaning to those without collateral. It was simply too big a risk. This is precisely what is not innovative about microfinance. It was just another example of a loan to a customer. It is not like a bond, which is also a loan, as bonds are transferable securities; nor is it like a derivative, whose value depends on another financial asset.

Instead, what makes microfinance unique, though not innovative, is its success depends on monitoring and mentoring. Without observation or the support required to set up small enterprises, the likelihood is that the poor, in general, would fail to pay back their loans. This is not an indictment on the poor, far from it. Rather it is to say that the presence of an overseer and an enabler can lead to ideal outcomes.Hardly a novel insight, it is not only a characteristic of microfinance; we see the importance of mentors in other industries, particularly venture capital and private equity industries.

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How to value ‘brand value’ during company valuation?

‘How would you incorporate our brand value in our company valuation?’ A friend of mine was recently asked this question by a corporate professional. It is a pretty interesting question when you think of it. Let me start the answer with the definition of ‘brand equity’ according to wikipedia.

Brand equity is a phrase used in the marketing industry which describes the value of having a well-known brand name, based on the idea that the owner of a well-known brand name can generate more money from products with that brand name than from products with a less well known name, as consumers believe that a product with a well-known name is better than products with less well-known names.”

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Dealing with earnings season

With companies having started to report quarterly earnings we are back in the ‘earnings season’. This is a fairly hectic time for equity analysts on both the buy and sell side. It is quite common for sell side analysts to cover 15-20 stocks while their buy side counterparts can look at a higher number. The trade-off is however in the fact that the sell side analyst needs to look at numbers at more depth and then also perform the task of client communication. Nevertheless, the bottom line is that its a hectic time for all.

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Getting back to fitness

After a few years of not paying attention to my body I found myself in the worst physical shape I have ever been. I am 5 feet 10.5 inch tall and weigh around 81 kg. The problem was my body fat which I roughly calculated to be 23%. Most importantly I had a pretty bloated stomach.

Now my two previous experience with working out proved that I usually cannot sustain it. The greatest length I continued working out was for 6 months or so. Also, in both those occasions I was trying to gain both weight and muscle mass while this time I have no target of gaining weight. I just need to get my body fat % down to reasonable levels (numerically and aesthetically).

Its been a few months I have started my attempt to get fitter. Initially it started with just walking and light jogging. I then started some body-weight exercises like push-ups, chin-ups, dips etc. More recently I have added some weight training (3 day upper lower split). In addition to these I have started the following things.

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Cost deflation and profitability

In a world where commodity prices are under pressure companies with imported raw materials see interesting benefits. Consumer good companies which need flour, sugar, soyabean oil etc are one such example. Other examples are companies which use some sort of oil derivative that includes paints, lubricants etc. The decline in cost in the short term usually leads to margin expansion and higher profitability.

This is where we need to be a bit careful. The short term increase in margins may or may not sustain depending on competitive situation. In a highly competitive sector like cement (particularly when there is overcapacity in the sector), benefits of declining raw material prices can vanish quite rapidly as companies are forced to pass on the benefits to the customers. On the other hand, in a sector with concentrated large companies with strong brand value, companies can delay price cuts for a long time.

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