Equitymaster Agora Research Private Limited

Independent Investment Research

11 September, 2013

Pidilite Industries Page 1 of 11
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125
250
375
500
625
Oct-08 Mar-11 Sep-13
Pidilite Industries: Rs 327
BSE Midcap: Rs 95

Market data
Current price Rs 236 (BSE)
Market cap Rs 120,855 m
NSE symbol PIDILITIND
BSE code 500331
No of shares 512.6 m
Free float 29.9%
Face value 1.0
FY13 DPS (Rs) 2.6
52 week H/L Rs 303/189

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Rs 100 invested is now worth


Stock price performance
(as on 11th Sep 2013)
Pidilite Index*
Over 1 Yr 28.4% -11.1%
Over 3 Yrs 16.0% -11.6%
Over 5 Yrs 48.4% -1.7%
* BSE Midcap.
Return figures over 1year are compounded


Shareholding (Jun-13)
Category (%)
Promoters 70.1
FIIs 13.9
DIIs 5.4
Others 10.6
Total 100.0

Report prepared by
Equitymaster Agora Research
Private Limited
www.equitymaster.com
[email protected]
Pidilite Industries
Buy (Target price: Rs 320)
Investment Rationale
High growth and iconic brands override valuation concerns:
Over the long term, its hard for a stock to earn a much better return
that the business which underlies it earns. If the business earns six
percent on capital over forty years and you hold it for that forty years,
youre not going to make much different than a six percent return
even if you originally buy it at a huge discount. Conversely, if a
business earns eighteen percent on capital over twenty or thirty
years, even if you pay an expensive looking price, youll end up with
one hell of a result.
The above quote of Charlie Munger is by far the best on valuation. It
says that buying something cheap, ignoring the return generating
capability of the business may not yield the desired result. In other
words, if you buy something at 6x which yields only 8-10% kind of
ROEs in the long run you have fallen prey to value trap! However, at
the same time, buying businesses that are able to sustain their return
on capital can do wonders. Even though one pays what looks like a
slightly expensive looking price in the first place.
It is known that businesses with monopolistic market shares typically
earn higher returns. But once competition comes in, sustaining the
return ratios becomes a challenge. Companies which are able to do
that deserve premium valuations. Our Midcap Select for this
fortnight, Pidilite Industries Ltd (Pidilite), is one such company. It
has a relatively fast growing business that is resilient to economic
cyclicality.
We know for a fact that growth comes at a price. But when one is
paying a high multiple, he/she has to be reasonably sure about
future growth prospects. For once growth falters, valuations would
correct resulting into a loss.
Now let us see how Pidilite fares on the growth aspect. This will help
us understand the reason behind higher valuations of the stock. Over
the last 10 years, the companys topline has grown at a CAGR of
20.4%. At the same time, bottomline has grown at a CAGR of 22.2%.
During the same period, the average RoE of the company stood at
23%. So, in a nutshell, this is a business which has compounded at
20% YoY in the past with strong RoEs. However, whats
commendable is the stability in RoEs which have never fallen below
16% in the last 10 years! These characteristics deserve higher
valuations.
But what is the reason for such high growth and strong return ratios?
Also, is it sustainable in the future? Such questions would come into
the mind of many investors when they have to pay 25x (TTM PE) for
the stock.


11 September, 2013

Pidilite Industries Page 2 of 11
Well, the reason for such high growth in the
past has been iconic brands and very little
competition. It may be noted that Pidilite is one
of the leading manufacturers of adhesives,
sealants and specialty chemicals in India.
Notable brands of the company include Fevicol,
Fevikwik, Fevistik, M Seal and Dr Fixit. Its iconic
brand Fevicol has little competition and high
growth. Fevicol commands nearly 70% market
share in the white glue segment and is the
flagship product of the company. The consumer
and bazaar products segment of the company
which includes Fevicol, other sealants and art
materials contributes roughly 80% to the top
line. And it has been growing at a CAGR of
20.2% over the last 10 years, slowdown or no
slowdown! Also, this segments RoCE averaged
to about 81% over the last 10 years. These facts
present stability to both growth and return ratios.
Further, Pidilite runs strong advertising
campaigns. Thus, even if new entrants come in,
it would be very difficult for them to uproot
Pidilites share in a material way.
In short, Pidilite is a high growth story. The
company is also virtually debt free. Further,
iconic brands mean competition can do little
harm. Such businesses are rare and usually
command a premium.
Currently, the stock trades at 25x TTM earnings.
This is pretty much in line with what the stock
has traded over the last 5 years. Immunity to
slowdown and stability in return ratios are the
two reasons why Mr. Market accords a higher
multiple to it.
Considering the past trading history, future
growth prospects, clean balance sheet, iconic
brands and high visibility, we assign a multiple of
25x to the stock. Applying this to our estimated
FY16 EPS of Rs 12.7, we get a target of Rs
320 per share. This fetches a CAGR of 12.5%
and point to point return of 35%. We thus
recommend a BUY on the stock. However,
investors should make sure that no stock forms
more than 5% of their portfolio. They should also
have a look at the asset allocation guide
presented at the end of this research note.
Strong and long track record: Pidilites
Consumer and Bazaar Products (CBP) division
includes products such as adhesives, sealants,
construction/paints chemicals, art material and
others. This segment has grown at a good pace
of 20% YoY over the past decade ending FY13.
Its EBIT margins averaged to about 19% over
the past ten years, thereby indicating its high
margin profile. What is however an icing on the
cake are the returns that this business
generates! The return on capital of this segment
has averaged at 81% over the past 10 years. In
FY12 and FY13, the figures stood at 91% and
125% respectively. This business contributed to
nearly 80% of consolidated revenues over the
past three years, while contributing to about
87% of the total EBIT.
Majority of the balance is contributed by the
Industrial Products division. The performance
of this business segment is nowhere close to
that of the CBP segment. Over the past ten
years, the companys revenues grew at a
compounded pace of 14%. The divisions EBIT
margins averaged to about 3.7% over the past
ten years, while its return on capital stood at
36%.
What is the key differentiator is the customer
profile of these divisions. In the CPB segment, a
big factor is the many brands and the fact that
the company has near monopoly in selected
niche businesses it operates in. It has
essentially been able to create brand out of
commodity products. Thus, it may not be able to
command as much of a premium in the
Industrial Products division.
Nevertheless, a positive point is that the
company has been diverting a larger portion of
its capital expenditure towards the more
profitable business i.e. the CBP division every
year around 80% of total annual capex (69%
in FY13).
Coming to the cash flow details, Pidilite has
been cash flow positive for almost every year in
the past decade. The average operating cash
flow from operations stood at about Rs 2 bn
from FY02 to FY13. The average capital
expenditure stood at Rs 1.2 bn. As such the
company has been free cash flow positive. At
the end of FY13, the company had a short term
loans of about Rs 1.1 bn, while cash and cash
equivalents stood at over Rs 4.3 bn.
Strong brands complemented with a vast
distribution network: Being a company that
has been around for a long time, Pidilite has


11 September, 2013

Pidilite Industries Page 3 of 11

54%
50%
53%
55%
58%
60%
FY01 FY03 FY05 FY07 FY09 FY11 FY13
RMC (net; % of sales)
13-yr avg
RM costs: Not a long term concern
managed to build a strong distribution network,
which essentially reaches out to a vast
audience. It is believed that the company has a
strong dealer network of over 4,000+, through
which it reaches out to over 1,000,000 stores.
Investment Concerns
Stalled project blocking a portion of the
capital: In June 2007, Pidilite Industries
acquired plant and machinery, patents,
trademark and technology of a Synthetic
Elastomer (Polycholoroprene Rubber) plant. The
plant was located in Champaigner, France and
was owned by Polymeri Europa Elastomers,
France. The same was dismantled and shipped
to a Special Economic Zone (SEZ) in Dahej,
Gujarat. In FY08, the total capital investment
was estimated to be Rs 5.3 bn. The company
was also considering putting up a Caustic
Chlorine plant at the same location which would
have required an additional capex of about Rs 1
bn. This would be required for the manufacture
of Polycholoroprene.

However, the company put the project on hold in
FY12 as the commercial viability of the project
seemed to be in question. The situation
remained the same till FY13. Till now the
company has spent a total capex of over Rs 3.6
bn. Recently, Pidilite conveyed that it was
looking for a strategic partner for taking the
project ahead. Nevertheless, the future of this
project is uncertain. The total asset base of the
company stood at Rs 25.7 bn at the end of
FY13. As such, this project formed about 14% of
the total asset base. At the end of FY13, its
grossed fixed assets stood at Rs 12.8 bn (there
by forming 28.1% of GFA), while NFA stood at
Rs 10.7 bn (33.6%). The latter includes capital
work in progress (CWIP) of Rs 4.28 bn, which
includes the capital blocked in this project. In
fact, the same has been stuck in CWIP for over
three years now.

Foreign subsidiaries being a drag on the
bottomline: Pidilite has subsidiaries located in
various locations outside of India. These include
the USA, Brazil, UAE, Egypt, Thailand and
Bangladesh. While these have been operational
for a few years, they have been a drag on the
bottomline of the company. The overall losses in
these subsidiaries combined stood at Rs 440 m
as compared to Rs 254 m in FY12. The
expansion in losses was largely due to various
provisions (largest being an Rs 94 m impairment
in goodwill in Brazil) which totaled up to Rs 177
m. The total investment in overseas subsidiaries
stood at about Rs 2.6 bn.

As per the company, efforts are being made to
rationalize costs and improve profitability.
However, given the overall weakness and
uncertainty in the local markets, a meaningful
contribution to the companys overall profitability
in the short run seems difficult.

Currency risk: Pidilite faces currency risks
directly and indirectly. Directly, as it imports a
part of its raw material (RM) requirements.
Indirectly, because a significant part of its input
costs is derived from crude and hence linked to
crude prices. While some of the risk does get
offset by its subsidiaries in the form of a natural
hedge, input costs form nearly 55% of revenues,
of which the largest two contributors are
packaging material and vinyl acetate monomer.

As the company is able to pass on costs
(although with a lag) through the products it sells
in its consumer and bazaar products business
which contributes close to 80% of revenues, it
should not be a long term concern we believe.
However, the key challenge will remain doing so
in the industrial segment given the rising
competition and overall slowdown. The adjacent
chart displays the overall raw material costs as a
percentage of sales since FY01.



Tax evasion case: A leading business daily
recently reported that Pidilite has come under
the Income Tax scanner for alleged tax evasion.
There have been no news updates since then,
nor has the management clarified the same.
However, if the company is penalized for some
Source: Equitymaster



11 September, 2013

Pidilite Industries Page 4 of 11

wrongdoing in this case then it may impact the
profits in the near term.

Slowdown in volumes: Given the overall
slowdown in the economy, the FCMG sector
was being considered as the last man standing
in the wake of the recession. However, the
sector of late has started to see the impact of
the lowering discretionary spending. This we
believe is an area of concern for Pidilite and its
products in the short run.

Background
Pidilite Industries Ltd (Pidilite) is one of the leading
manufacturers of adhesives, sealants and specialty
chemicals in India. Notable brands of the company
include Fevicol, Fevikwik, Fevistik, M Seal and Dr
Fixit. It has manufacturing units located in the states
of Maharashtra, Gujarat, Himachal Pradesh and
Andhra Pradesh. Pidilite also has presence in
overseas markets. It has subsidiaries in US, Brazil,
Bangladesh, Thailand, Egypt and Dubai. Exports
contributed about 19% to the overall sales in FY13.
The business of the company is divided into 3
segments namely Consumer & Bazaar products,
Industrial products and Others. Consumer & Bazaar
products segment includes products like adhesives,
sealants, construction/paint chemicals etc. This
segment contributed 81% to the total revenues and
grew by 19% YoY in FY13. It is a high margin
segment with operating margins being in the region
of 20%. The Industrial Products segment includes
products like industrial resins, industrial adhesives
and organic pigments. Its share in the overall
business has been slowing over the years due to
slowdown in industrial activity. The Others segment
consists of vinyl acetate monomer (VAM) unit.
Considering that VAM prices are more favorable in
overseas market the company imports VAM. As
such, there is not much production happening at this
unit. However, Pidilite has started manufacturing
specialty acetates here. Profitability of this segment
has been under pressure over the last 3-4 years.
Industry Prospects
It is a well-known fact that the demand for consumer
products is a function of penetration (a factor of
rural, urban and population mix), affordability (a
factor of income and saving levels), and availability
(distribution) and consumption levels. While Pidilite
manufactures specialty chemicals the end product
being sold is ultimately classified as consumer non-
durable. The demand for end products, adhesives
and sealants, is typically dependent upon the
general economic activity and consumer spending.
For instance, the demand for the companys flagship
product, Fevicol, depends upon the discretionary
consumer spending (furniture etc). However, other
products like Fevistik, Fevikwik, M Seal etc happen
to be a part of regular consumer spend. The
demand for certain products like Dr Fixit (a water
proofing solution) depends upon the level of
construction activity. In short, the demand prospects
are more or less dependent upon discretionary as
well as non-discretionary spend of the Indian
consumer.
Further, the demand for industrial products like
industrial resins and adhesives is dependent upon
various industries like packaging, textiles, paints,
paper etc. Slowdown in these industries has
impacted the volume off take in the last few years.
As such, unless the end user industries get back on
track growth in the industrial segment will remain
under check.
Key management personnel
Mr. M. B. Parekh is the Chairman and Managing
Director of Pidilite Industries Ltd. He also serves as
the Managing Director of Vinyl Chemicals India Ltd.
He holds a Bachelor's Degree in Chemical
Engineering from UDCT and an M.S in Chemical
Engineering from University of Wisconsin, USA.

Risk Analysis
Note: See the ERM table on the page 7
In order to further improve our risk analysis of
companies we have come out with a revised risk
matrix. Our new risk matrix is broken down in to 4
sub heads namely industry risk, performance risk,
management risk and balance sheet risk. (For
details on break down please see the matrix at the
end of the report).
Regulatory risk: Some businesses are subject to
regulations by external government agencies. These
companies are subject to regulatory risk since they
do not have the liberty to operate in a free
environment. Excessive regulations can create
bureaucratic hassles and impede growth. Thus,
higher the regulation, higher is the risk for any
business. Considering Pidilite operates in a
regulatory free business environment we have
assigned a higher rating of 10 to the stock.


11 September, 2013

Pidilite Industries Page 5 of 11

Cyclicality risk: An industry cycle is characterized
by an upturn as well as downturn. Businesses
whose fortunes typically swing with industry cycles
are known as cyclical businesses. Cyclical
businesses do well during an industry upturn and
vice versa. On the other hand, there are some
businesses based on consumption stories that are
non-cyclical. These businesses are immune to
industry cycle changes and have less risk. In short, if
the business is cyclical higher is the risk. Given that
the FMCG sector is not a cyclical business, we
assign a low risk score of 9 to the company on this
parameter.
Competition risk: Every industry is characterized
by competition. However, some industries where
entry and exit barriers are typically low have higher
competition risk. Low barriers means more players
can enter into the industry there by intensifying
competition. Low product differentiation also
intensifies competition risk. Given the fact that
Pidilite is the market leader with very strong brands
and minimal competition in the sectors it is present
in especially the adhesive business segment - we
assign a score of 9 to the stock on this parameter.
Sales growth: Over the eight year period (actual
history of past 5 years and explicit forecast for the
next 3 years), the growth is estimated at a CAGR of
16.4%. We assign a medium risk rating of 5 to the
stock on this parameter.
Net profit growth: Over the five year period (actual
history of past 5 years and explicit forecast for the
next 3 years), we expect an adjusted net profit
CAGR of 18.5%. We assign a risk rating of 6 to the
stock on this parameter.
Operating margins: Operating margin is a
measurement of what proportion of a company's
revenue is left over after paying for variable costs of
production such as raw materials, wages, and sales
and marketing costs. A healthy operating margin is
required for a company to be able to pay for its fixed
costs, such as interest on debt. The higher the
margin, the better it is for the company as it indicates
its operating efficiency. The average operating
margins over the 8 year period (actual history of past
5 years and explicit forecast for the next 3 years)
stand at 15.8%. We assign a score of 5 on this
parameter.
Net margins: Net margin is a measurement of what
proportion of a company's revenue is left over after
paying for all the variable and fixed costs inclusive of
interest and depreciation charges. Net margin is the
final measure of profitability. It reflects the total
profits the company takes home. Higher the margin,
better it is for the company as it indicates better
pricing power and effective cost management. The
average net margins over the 8 year period (actual
history of past 5 years and explicit forecast for the
next 3 years) stand at 10.4%, which is on the lower
side. We thus assign a score of 4 on this parameter.
Return on net worth (RoNW): RoNW is an
important tool to assess a company's potential to be
a quality investment by determining how well the
management is able to allocate capital into its
operations for future growth. A RoNW of above 15%
is considered decent for companies that are in an
expansionary phase. The average RoNW over the 8
year period (actual history of past 5 years and
explicit forecast for the next 3 years) stands at
24.2%. We assign a score of 7 on this parameter.
Earnings quality: This measure helps us assess
the quality of earnings reported by the company. For
instance, some companies may follow aggressive
accounting practices and recognize revenues earlier
than warranted. Earlier recognition of revenues
boosts profits. However, at the same time they do
not generate sufficient operating cash flow (OCF).
This signifies debtors are not liquidated on time as
sales were booked in advance. Such companies
face working capital issues and their quality of
earnings is poor. We assess earnings quality by
dividing operating cash flow to net profits. Higher the
ratio better is the quality of earnings. The average
OCF/net profit ratio over the 8 year period (actual
history of past 5 years and explicit forecast for the
next 3 years) stands at 1.8x. We assign a score of
10 on this parameter.
Transparency: Transparency is the key to any
business. Transparency can be gauged by
assessing the past dealings of the company with
various vendors, the way it displays its financial
information and the frequency of management's
desire to communicate with external shareholders
whenever some unfortunate incident happens.
Transparent managements would get a higher
rating. We assign a score of 7 to the company on
this parameter.
Capital allocation: Apart from honesty, capital
allocation skills are equally important in assessing
management quality. There are many instances
where growth is given priority over returns on the
investment. This results in a company with larger
size but with poor returns. Management's are
enticed to increase the size since their
compensation is tied to the size of organization they
manage. Hence, capital allocation skills assume


11 September, 2013

Pidilite Industries Page 6 of 11

greater importance in gauging management quality.
Capital allocation skills are good when return ratios
depict resilience. In short, more stable/higher the
return ratios better the capital allocation skills.
Considering Pidilites return ratios have been at
higher levels notwithstanding the few issues
surrounding certain projects - we assign a score of 7
to the company.
Promoter pledging: Promoters typically pledge
their shares to take a loan which is generally infused
in the company. This exercise is generally resorted
to when all other sources of external liquidity dry out.
The risk with this strategy arises when share price
falls. This triggers margin calls. If management is
unable to provide some sort of a collateral to the
lending party from whom the money is borrowed that
party may sell the shares to recover its money. This
accentuates the share price fall. Hence, higher the
promoter pledging higher is the risk. With none of
the promoter equity being pledged we assign a low
risk rating of 10.
Debt to equity ratio: A highly leveraged business is
the first to get hit during times of economic
downturn, as companies have to consistently pay
interest costs, despite lower profitability. We believe
that a debt to equity ratio of greater than 1 is a high-
risk proposition. While Pidilite had taken on debt
around FY09, it has paid off the same. At the end of
FY13, the companys D/E Ratio stood at less than
0.1 times. Given Pidilites strong cash flows, we do
not expect its debt levels to rise from here on. As
such, we assign a score of 9.
Interest coverage ratio: It is used to determine how
comfortably a company is placed in terms of
payment of interest on outstanding debt. It is
calculated by dividing a company's earnings before
interest and taxes (EBIT) by its interest expense for
a given period. The lower the ratio, the greater are
the risks. Given the low debt levels of the company,
we assign a score of 9 on this parameter.
It may be noted that leverage, return generating
capability, earnings quality and management risk get
the highest weight in our matrix. Hence, scores
assigned to these factors influence the overall score.
Considering the above analysis, the total ranking
assigned to the company is 107. On a weighted
basis, it stands at 7.9. This makes the stock a
low-risk investment from a long-term
perspective. As such, we recommend investors
to BUY the stock at current levels.
Valuations
Pidilite has been able to grow its topline and
bottomline at a CAGR of 20.4% and 22.2% over the
last 10 years. Considering it has iconic brands,
market leadership and pricing power the company
can easily replicate the past growth cycle. Despite
that we have been conservative in our forecast and
expect sales and net profit to grow at a CAGR of
about 16% over the next 3 years. Further, we are
also confident that Pidilite will be able to sustain its
past return ratios considering that Consumer &
Bazaar Products segment (high RoCE business;
past 10 year RoCE stands at 81%) which is
relatively immune to slowdown contributes anywhere
between 80-90% to the overall EBIT of the
company. This means that slowdown in industrial
segment will not have a huge impact on the overall
return ratios of the company. Further, strong brands
like Fevicol and Dr Fixit enable easy recall
translating into higher growth.
Considering strong growth prospects, clean balance
sheet, iconic brands and high visibility the stock has
always traded at expensive valuations in the past.
Over the last 5 years Pidilite has traded at an
average TTM PE of about 24x. Taking into
consideration that the company is relatively immune
to slowdown and is one of the best defensive plays
in the consumer sector we assign a multiple of 25x
to the stock. Applying this multiple to our FY16 EPS
fetches us a target of Rs 320. This represents a
CAGR of 12.5% and a point to point return of 35%.
As such, we recommend a BUY on the stock.
However, investors should make sure that no stock
forms more than 5% of their portfolio. They should
also have a look at the asset allocation guide
presented at the end of this research note.
Valuations
(Rs m) FY13 FY14E FY15E FY16E
Net sales (Rs m) 36,812 43,045 49,876 57,500
PAT (Rs m) 4,069 4,648 5,521 6,526
No. of shares (m) 513 513 513 513
EPS (Rs) 7.9 9.1 10.8 12.7
Price to earnings (x) 29.7 26.0 21.9 18.5
Price to sales (x) 3.3 2.8 2.4 2.1
Price to book value (x) 7.3 6.2 5.2 4.3





11 September, 2013

Pidilite Industries Page 7 of 11

ERM
TM

Company Specific Parameters


Points
Riskiness (A)
Weightage (B)
Weighted
(A*B)
High - Medium - Low
Industry risk 1 2 3 4 5 6 7 8 9 10

Regulatory risk $ 10 5.0% 0.5
Cyclicality risk $ 9 5.0%
0.5
Competition risk $ 9 5.0%
0.5
Performance risk
Sales growth 5 5.0%
0.3
Net profit growth 6 5.0%
0.3
Operating margins 5 5.0%
0.3
Net margins 4 5.0%
0.2
RoIC / RoNW 7 10.0%
0.7
Earnings Quality (OCF/PAT) 10 10.0%
1.0
Management risk
Transparency $ 7 10.0%
0.7
Capital allocation $ 7 10.0%
0.7
Promoter pledging $ 10 10.0%
1.0
Balance Sheet risk
Debt to equity ratio 9 10.0%
0.9
Interest coverage ratio 9 5.0%
0.5
Final Rating# 107 7.9
*Excluding extraordinary gains
For qualitative factors, denoted by $ sign, lower the risk, higher the rating
For any risk parameter if the score is below or equal to 4 it indicates high risk. The risk score of these parameters is highlighted in red color.
For risk parameters where the score is above 4 riskiness is low. The risk score of such parameters is highlighted in grey.




11 September, 2013

Pidilite Industries Page 8 of 11

Financials at a glance


(Rs m) FY13 FY14E FY15E FY16E
Sales 36,812 43,045 49,876 57,500
Sales growth (%) 17.6% 16.9% 15.9% 15.3%
Operating profit 6,021 6,887 8,180 9,660
Operating profit margin (%) 16.4% 16.0% 16.4% 16.8%
Net profit 4,069 4,648 5,521 6,526
Net profit margin (%) 11.1% 10.8% 11.1% 11.3%

Balance Sheet
Current assets 11,824 14,703 19,087 24,583
Fixed assets 10,747 11,724 12,372 12,940
Others 3,181 3,181 3,181 3,181
Total Assets 25,752 29,608 34,640 40,704

Current liabilities 7,464 8,352 9,662 11,119
Net worth 16,515 19,484 23,206 27,812
Loan funds 1,112 1,112 1,112 1,112
Others 660 660 660 660
Total liabilities 25,752 29,608 34,640 40,704


11 September, 2013

Pidilite Industries Page 9 of 11

Where MidcapSelect Fits In...
We recommend that investors should decide their exposure to
equities, which is only one part of the overall investment portfolio, after
they have kept aside some cash. While we are no experts in wealth
management, we believe keeping aside some safe cash is absolutely
necessary. Not only will this cash take care of your liquidity needs, but
it will also come handy during market declines. Particularly when there
will be opportunities to pick up fundamentally strong stocks at cheap
valuations. For some of you this cash component could be 6 months of
usual monthly expenditure, for others 36 months. You need to decide
what amount works for you, and then set it aside. Maybe in a FD, or in
a pure liquid fund. Or maybe just cash at home!

Having decided what portion of your overall portfolio will be in equities, it is time to decide the allocation of stocks
within your equity portfolio.
As your experience will tell you, stock markets tend to be very volatile. And putting too much money in a single
stock or sector can be very risky. That is why we advise our subscribers to have a well-diversified equity portfolio
comprising the appropriate proportion of small cap, mid cap and large cap/ blue-chip stocks. Based on their
relative riskiness, we have created an asset allocation pyramid that can help you in deciding how much money
you should invest in a stock. However, it must be noted that the allocation levels could differ from person to
person depending on the risk appetite.
In our view, mid cap stocks represent moderate risk profile. Compared to small cap stocks, they are more resilient
to adverse market conditions. Moreover, they usually tend to have better liquidity as compared to small caps.
However, they are not as safe as large blue-chip stocks. We believe that mid cap stocks should comprise not
more than 30% of your total equity portfolio. This means that a single mid cap stock should not form
more than 4-5% of your portfolio. As such, even if your investment in a particular stock turns out to be a
disappointment, it will not derail your overall portfolio.

What does 'Closed Position' mean?
MidcapSelect recommendations are meant to meet the target prices within a time frame of three years. So when
the stock meets target price or completes the time frame we close the recommendation. However, since we
keep reviewing our assumptions and estimates for stock even in the interim, the view or target price on the stock
may warrant a change. This could be a revision upwards or downwards. In such cases, if the previous
recommendation on the stock is no longer valid we close that recommendation. So we essentially close
recommendations either by giving a Sell view or putting out a changed view.

How to read the returns calculations?
For positions that are not closed returns are calculated from date of recommendation till date.
For closed positions, there can be two types of calculations.
Assuming we initially gave a Buy on a stock with no subsequent recommendations on the same stock. In
that case the calculation is fairly simple. The returns shown in this case is simply the change in stock
price from the date of recommendation till the date on which the position was closed.

Now let us take a case where we initiated with a Buy (1st position) and subsequently came with another
recommendation (2nd position) on the same stock. Let us assume that the subsequent recommendation
was also a buy.


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In such cases, the return calculation depends on whether the 1st position is closed or not. If the first
position is closed before we reiterate buy then the return on the first position will be calculated as shown
previously.

However, if 1st position was not closed before we reiterated buy, then the return calculation is from the
earlier buy recommendation till the date on which the position was closed. Basically where we have
reiterated view on a stock we try to show cumulative returns. The same logic applies with Hold
recommendations as well.
Now let us look at Sell recommendations. There can be two situations here.
If there is no recommendation subsequent to the Sell recommendation we show maximum drop in stock
price from date of sell recommendation till date.
If the Sell recommendation is followed up by another recommendation, we show maximum drop in stock
price between the two recommendation dates.
Basically we have tried to cover all hypothetical instances in this note that may help you better understand the
return calculations and closed positions of our recommendations. If you have any query pertaining to it please do
write in to us for further clarifications.

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Equitymaster Agora Research Private Limited. All rights reserved.
Disclosure:
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financial situations, or needs of individual investors. Our investment recommendations are general in nature and available
electronically to all kind of investors irrespective of subscribers investment objectives and financial situation/risk profi le.
Before acting on any advice or recommendation in this document, investors should consider whether it is suitable for their
particular circumstances and, if necessary, seek professional advice. The price and value of the investments referred to in
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