Let’s do a thought experiment – Let’s say you are going on a multi-year cruise or journey around the world and need to invest your or your retired parent’s money. Let’s also assume that you want to ensure that the money is secure, but at the same time earns a decent rate of return (Which beats inflation).
Investments of this type should have the following characteristics
a. The portfolio of such investments should be reasonably secure – low probability of long term loss of capital, though temporary fluctuations are fine
b. Above average rate of return – The investments should beat the inflation and possibly earn a few percentage points above it, so that your family can withdraw a small portion of the capital without a reduction in principal
c. Low maintenance – should not require your family or you to run around, doing tons of paperwork or other tasks to manage it
Let’s invert the question and look at what will not be good options
a. Fixed deposit – Safe and low maintenance, but the rate of return barely beat inflation. As a result, if you use up the interest , the capital base will get eroded by inflation
b. Real estate – May be secure and give above average returns, but requires constant work (maintenance, repair, payment of taxes etc). In addition, you cannot really invest small amounts of money into it.
c. Gold – If you have been following me for sometime, you know my distaste for it. It is not an income producing asset and I cannot think of any family selling gold for meeting expenses – Remember the old Hindi films, where the family sells gold when it is in dire circumstances? We are too conditioned by those images.
I know you would have realized where I am going – equities!, but then not all types of equities. The above criteria eliminate some types of companies from the consideration set.
a. New companies with a short operating history – Sure, the company is going to be the next titan or ITC (fill in the name), but if the companies goes down the drain while you are away then your family is in trouble
b. Speculative companies – Loss making or penny stocks which have performed poorly in the past but have a very bright future.
c. Companies with poor management – I don’t want to hand over my money to a crooked management who could cheat me in my absence (remember we are away for a long period of time)
If you think through all these options, you will realize that you are left with a small list of companies which meet the following criteria
a. Durable competitive advantage – The company has done well in the past and you are assured that it will do well for a long period of time in your absence
b. Good management – You can trust the management to be good caretakers of your money in your absence
c. Reasonable prospects – The Company may not have phenomenal growth prospects, but should deliver above average growth.
If you put all these points together, I hope you can see a picture forming. We are talking of companies such as
Asian paints
HDFC ltd
HDFC bank
Crisil
ITC
Titan etc
HDFC ltd
HDFC bank
Crisil
ITC
Titan etc
A portfolio of such companies would be fairly safe as one is talking of good companies with above average economics and decent management. These companies may not be the next multi-bagger, but it is easy to see that they will give one a 15% or higher annualized return for a long period of time. Even if you consume 3-4 % of the return (via dividend or sale), your capital will still compound at 10-11%, which will take care of the corrosive effects of inflation.
If the above makes sense, then why am I not following it? Let me tell you why – The desire for higher returns! I think I can make higher returns than what I can get from these companies.
Please note the word – ‘Think’ and not would. Anyone who decides to invest on their own in all kinds of midcaps, small caps and other equity options is implicitly assuming that he or she can do better than these proven ‘blue chips’.
I am not saying that some people cannot do better, but I don’t think the lay investor who chases the current fad and hot tips, will do better than a basket of such companies. It is often smarter to make a sure 15% than chase the dream of 100% returns.
Hey Rohit, Good post. But there is another problem also. Other than Crisil which came down in 2008, none of the other companies have come in my range to buy… Iam still waiting :(… Even Crisil, I did not take a full position which now looks stupid …
With all respect to you, I sincerely differ. In investment field, whatever looks safe & sure, are never safe or sure. The names you are suggesting are big names today- can we remember the old stalwarts- Bombay Dyeing, Punjab Tractors, Hindustan Motors, DCL Polyster, National Organic… business environment too volatile for any company to survive long. Any passive investor who cannot follow a company on a regular basis must be invested in Index, and index only. More brave passive investor can choose mid cap or small cap index if available. Index perform well because on a regular basis they keep on eliminating failing companies and adding new successful companies. That is what investment is all about- adding successful companies and removing failing ones. If investor cannot do it, let it be done by stock exchange.
Really nice article.You should consider submission of your website to this directory for business blogs: http://business-fundas.com/top-business-blogs/ This is a blog by IIM faculty and alumni.
Haha!I like the wit (and the truth) in your post Rohit.Nicely put. most investors believe in 100% return or those magical (stupid) line in Hindi 'Mera pisa kab double hoga'.I think its human nature to try and break what is considered to be average. By trying to do that we end up not even making the average.Like Mr Graham mentions in his book 'Intelligent Investor' the stock market is like a casino and at the end of the day, the HOUSE always wins. Regards,Shantanu
Hi RohitI am a passive follower of your blog and really enjoy your posts. I disagree on than two things: First as someone else mentioned on the blog earlier, I think if one wants to be a passive investor, without botheration of watching over the company and doing the minimum task of atleast going through the annual report once a year and ensuring that the stocks are not trading at crazy valuation, one is better invested in index fund or a diversified equity mutual fund. Secondly I do not agree with the examples of the stock which you have given for instance Asian paints currently trading at 36x TTM PE similarly Crisil is trading at 30x TTM PE, Titan Industries at 35x TTM. These valuation leaves very little chance of error and if for any reason growth slows down because of company specific mis-steps or general economic slowdown, valuation can take a severe beating.
Asian paints PE multiple 38.00HDFC ltd PE multiple 27.65HDFC bank PE multiple 26.26Crisil PE multiple 32.75ITC PE multiple 32.70Titan etc PE multiple 34.78Do you think there is any justification why these blue chips should command such high PE ratios considering the fact now not much of growth left?I just wonder.. is it safe or actually risky because there high PE ratios are not backed by high growth expectation but by “market liking” towards them.And “Market liking” can not be taken for granted for forever.I observe how Power stocks once commanding these kind of high PE multiples just plummetedWould like to know your view point on above….Cheers..Neeraj
Hi karthikit is easy to blame yourself in hindsight 🙂 …but there are always some other ideas which one can pick upif not this girl then there are others :)rgdsrohit
Hi rajeshvery valid point and i dont disagree entirely. problem with index is that during bubbles one can get into all kinds of wrong investments. someone who invested in 2007 has still not made his money back.at the same time if one, does an SIP into the index it should work out.In my post, which is more metaphorical than real, i am talking of people who can analyse companies to a certain extent and invest. some companies you mention did go down in time, so you cannot always buy and forget. but some of the companies i refer have been for 20+ years and may remain around for some time to come.In addition, a basket approach will ensure that some companies may not do as well, but overall if you hold the best of 20 companies, i am sure you will do better than the indexrgdsrohit
Hi arpanthanks for the sugggestion…how does one submit the blog ?rgdsrohit
Hi shantanumaking 100% in one year is more exiciting even if in the long run the returns turn out to be ordinary …in comparison 15% does not look good in short run , but in 10-20 years will build a lot of wealthrgdsrohit
Hi anilMy post is more a metaphor …one needs to do some work …but in case of the blue chips you can ignore for a year or two and still survive easily.On valuations, i know where you are coming from. i have had that attitude for quite some time too 🙂 and not that i will invest that those valuations now, but think of it – if you think the company has great competitive advantage, has done well for 20+ years and has a long runway ahead of it, then even if the growth slows in the short term, all you may suffer is a some quotation loss, but will do well in the long runi would not worry too much of growth slowing down ..overtime most of these stalwarts will grow better than the economy and will grow into thier valuations and do well. you may make lower returns for 1-2 years , but that will normalize in 3-5 years. the bigger risk is change in the biz model and loss of competitive advanatge, that can kill the valuationsi will only be cautious if the valuations were in the extreme …at 50+ PE levels
Hi neerajI have followed your thought process for almost 10+ years and always sold off my positions when i thought the valuations were high in respect of the near term growth prospects. what i missed was that the company had great competitive advantage and would start growing again in time and go on to bigger hieghtsthese examples represt my biggest opportunity losses, far more than my actual lossespidilite, icici bank, asian pains, marico etc etci forced myself to reconsider this logic with crisil, and asian paints and found that in some cases the valuations run ahead of the prospects for a few years and you will get a few years or mediocore performace, but over 5+ years if the underlying growth is intact and business does well, then the overall returns are very goodplease look at the fundamental performance and price history of many of these blue chips for 10+ years and you will see my pointdoes not mean we have to jump blindly into these stocks, but it is worth thinking aboutrgdsrohit
Dear Rohit,Very true…am adding two more stocks to the above bluechip list.You have any comments… 1) GSK consumer 2) Page industriesRegards,Shanid.V.H
Interesting blog….always like reading about how people view investing in different countries. Personally big, blue chip stocks seem the most logical at the moment. In volatile markets, having a regular dividend is great….particular for people are are cautious an uneasy with things. Gold is not necessarily a great investment but has been a useful safe haven in the past…..keep up the good writing
Good write-up again Rohit. I am sure many investors fall in this category. How about TCIL or other such investing companies.
Hey Rohit,Just wanted to know that should a value investor give any importance to “market valuations” when he or she is putting money in a particular value stock?For example, Lets say a stock is trading at a PE of 2 and the market is trading at a PE of 22. Assuming that the stock has been analysed as a “value stock” using various parameters. But at the same time there is a significant risk of “market correction” as market PE is at 22. I am referring to a situation like January 2008 top of rhe market. Should we continue to put money even though the market is expensive? Or should we reduce the amount to be invested as the market goes up even though we might have a value stock in hand? Thanks.
I got over a similar mindblock by having a part of my portfolio into such co's right from the start. I buy more aggressively into them once the index/stocks fell 15-20%+ for any reason. Rest of my money is put into more active use. While I've got my share of multibaggers the overall results were not significantly better than the safe stocks. Guess my bargain hunting skills need more improvement 😉