Thursday, February 23, 2012

Mr Market smells a rat

There is an interesting comment on Paulypilot's pub regarding EROS (Eros International) - a worldwide distributor of Indian films.It was entered as part of the NFSC competition. Earnings are expected to grow at double-digit rates over the next couple of years, and it trades on a PER of only 7.

CantEatValue responds as follows:
The story looks good, the profits look good and the potential looks even better.
 There's a "but":
I'm now going to argue that not everything is as rosy as it currently seems. ... If the accounting were to be more conservative and they expensed all this asset build up directly they'd have made no profit at all. ... the huge capex spends haven't even been all that successful in producing growth even with the generous accounting, with return on equity having dropped every year in the last five.
He elaborates, but you already get the idea where this going.

It seems to all fit a general pattern, too, along with the likes of GNG (Geong International), RCG (RCG Holdings), ACHL (Asian Citrus Holdings) and my new entrant, PTEC (Playtech).

What I notice is: less than a decade listing, it's India, increasing number of shares in issue (although EROS doesn't seem too bad), decreasing ROE, and low PER.

It's very interesting, isn't it, that EROS is on a PER of 7.2 with forecast earnings growth in double-digits. Why so low? It has a market cap of £272m, so it's hardly off everyone's radar. The more I look at blogs, read ADVFN (I'm not get paid to mention them, BTW), and Twitter, the more I doubt that there's such a thing as a company that's under the radar, anyway.

Mr Market is giving a clear signal that he doesn't like this one. I know we're not supposed to take investment advice from Mr Market, but still, I think he smells something fishy.

I think I know how this works, too: people see the growth and value characteristics, buy, become disappointed, and leave. The company "eats up" its pool of potential investors, leaving the share languishing.

It's also interesting to take a look at major shareholders. ACHL is a £443m company. It has as major shareholders Market Ahead Investments Ltd, Sunshine Hero Ltd, Wellington Management Comany LLP. Never heard of them. Now compare them with a company like CWK (Cranswick), which makes Jamie Oliver sausages, amongst other things. Alas, it doesn't actually use Jamie Oliver as one of its ingredients; that's just clever marketing. CWK has a market cap of £388m - a bit less than ACHL - and counts amongst its major shareholders Amvescap, Legal & General, Jupiter Asset Management.

See the difference? One has a list of major shareholders none of whom anyone as heard of, whilst the other, smaller, company is owned by a clutch of well-known insitutions. Makes you think, right?

Look at what the brokers say. EROS has 3 analysts, and all 3 rate it a "strong buy". CWK has 5 analysts, 1 of which has a strong buy (presumably the house broker), and 4 have a neutral. So why aren't the institutions investing in the larger, "better" company? My answer is: because the the institutions know that EROS is junk, whereas CWK has merit.

I'll tell you this straight ... if you were to offer £1000 of shares in any company that I have talked about in this post, with the proviso that I couldn't sell for 5 years, I would choose CWK. And by the way, CWK is trading on the biggest multiple.