General thoughts Archives - Page 5 of 10

October 25, 2015

12 Min read

I recently tweeted the following

This tweet was prompted by the debate – online, and sometime offline between the different approaches to value investing. These debates appear like religious arguments with each side claiming their god is the superior one.

I have never quite understood the point of these debates. There is obviously no single way of making money in the stock market. There are short term traders, buy and hold guys, debt specialists and all kinds of people in-between. Each approach has its strengths and weaknesses and no one can claim that a specific approach is inherently superior to the other, unless they are equally proficient in both.

I have come to realize that the most important factor to long term success is to understand which approach suits your temperament.

The value of learning
Some of you who have followed me on my blog, would have noticed that I try not be a dogmatic about any specific style. I have tried multiple approaches and continue to do so. I do have a dominant style which suits my temperament – buy decent quality companies and hold them for the long run, but I have tried deep value, arbitrage, options and all other types of investing.

Most of my experiments have been failures (see here and here) from a monetary perspective, but they have deepened my understanding on what works and does not work for me.

A valid question would be – why bother? Why not find an approach which works for you and then just stick with it (and maybe even publicly defend it as your faith 🙂 )

Let’s consider an analogy – let’s say you are a sculptor who likes to make figures using wood, stone and other materials. Let’s assume you are exceptionally good at making stone sculptures, but not so great on wood. You go to an exhibition and see some great wood figures and happen to meet the artist. The artist tells you about his techniques and the tools he uses. Assuming you want to get better on wood, will you start laughing at this artist and belittle his tools?

In a similar fashion if you are a deep value investor, what should be your reaction to the success of investors who buy and hold seemingly overvalued stocks?

Durable success

I know what the first objection is to this line of thinking – The success of these investors is just dumb luck. These guys are not really practicing value investing, but a form of momentum investing. It is just that the momentum has lasted for 5 years in some of these cases, and sooner or later this bubble would burst.

My counter point – sure that is possible, but what if this bubble has lasted for 10-15 years in some cases. Will you still just wave away these anomalies and label them as flukes?

I prefer to take a different approach. There is no religious debate to this in my mind – if something has worked for 3+ years in the stock market, then it is worthy of investigation. A lot of bubbles and temporary fads usually get washed out in 2-3 years and so 3 years is good cutoff point.

Why not 5 years? Well now we are moving from the physical to the meta-physical 🙂 and debating the nature of reality.

So what can one learn from this oddity where some companies manage to sell for seemingly high valuations for a very long time.

New business model or value capture
I think the first point to look for is whether there is a change occurring in the business model/ design, wherein due to changing customer needs and priorities, a new type of design is now more suited to meet them more profitably.

I would recommend reading the book – value migration, which goes over this concept in quite a bit of detail. The main point is that changing customer needs and priorities cause a change in the business design best suited to meet them. Companies which can identify and develop a business model to meet this new reality are able to accrue a lot of value for their shareholders.

For example, a rise in the income levels has caused the retail consumer to now value quality, brand image and convenience in addition to the price. As a result, companies which can meet this new set of needs have been able to create a lot of value.

It is easy to see this phenomenon around us – Bathroom fittings, automotive batteries, garments etc. Some of these products were commodities in the past, sold largely based on price. However increasing consumer purchasing power has meant that the priorities have shifted beyond price. Companies which have been able to adapt their business model to deliver on these new priorities of brand, quality and convenience in addition to price have delivered exceptional returns

Example: Cera sanitary ware, Amara raja batteries, Astral polytechnic etc

Opportunity size with durability

It is not sufficient to be able to meet the changing needs of the consumer, better than the competition. For starters, the opportunity size should be large so that the company can grow for a long time to come.

This is a major advantage of the Indian markets over almost all other foreign markets. Even niches in India have a market size running to millions of consumers and hence a company which can build a good business model can easily grow for years to come.

An additional point to keep in mind is the need for the company to develop a durable competitive advantage. Let’s take the case of the telecom industry in the early 2000s. The need for communication and mobile telephony was recognized by a few companies such as Airtel in the late 90s and these companies moved in quickly to satisfy the needs.

The market size was in the 100s of millions and most of the telecom companies were able to scale rapidly. However the edge or competitive advantage turned out to be transitory and as a result after a few years of high profitability, we soon had a lot of price based competition. As a result by 2007-08, most companies were losing money and did not create (actually destroyed) wealth.

In such cases seemingly overvalued companies were truly overvalued.

Kings of their domain

A productive area for finding multibaggers is in the microcap space, where the company operates in a niche and is growing rapidly as its business model is uniquely suited for that niche. In addition, the niche is large enough for the company to grow for a long time, yet not so big that it attracts large companies initially.

There are a few examples which come to my mind – Think of air coolers a few years back (symphony), CPVC pipes (Astral poly) or various niches in pharma and information technology.

A small company develops a unique set of skills for this specific segment and is able to dominate and grow within the segment for a long time. In addition as the niche is quite small, it does not attract much competition till it reaches a certain size.

However by the time the niche is big enough to catch the attention of larger companies in the overall space, it is too late as the specific company has established a dominant competitive position and cannot be dislodged.

A lot of these companies appear to be overpriced after they have started growing, but this ignores the possibility of above average growth and a dominant position for the company.

Capacity to suffer

This is a term used by Thomas Russo (see talk here) to describe companies which are capable and willing to make investments in the business for the long term, even though it penalizes the profits in the short term.

In most cases, due to market pressures, companies are not willing to hurt short term profitability to build the business for the long term and hence the few companies which are willing to do so, appear to be overvalued due to depressed profits.

Look at the example of Bajaj corp (an old holding which I have since exited). The company acquired no-marks brand in 2013 and started deducting the brand value on their P&L account. In reality the brand value is actually going up as the company continues to spend heavily on advertising (17% of sales) and hence the profits are understated.

The market did not like this short term penalty and punished the stock in 2013. The stock price has since recovered and we have a company which appears to overvalued due to the high investments in the business.

Platform Business
This is good note on what is a platform business

I do not have an example in the Indian markets, but will try to explain this using the example of a well know US company. Its 2004 and a well-known company called google decides to launch its IPO at a then PE of around 65. A cursory look shows the company to be grossly overvalued and as a result most of the value investors tend to give it a pass.

The company has since then delivered a return of around 26% p.a and I am sure this qualifies as a great return. So why did a company which appeared so overvalued turn out to be a 10 bagger.

My own understanding is that this result came about from multiple factors. To begin with, the company operates in a winner take all kind of a market where the no.1 company tends to dominate and capture almost all of its value. Once google had a 60%+ market share, the network effects kicked in and the company just kept getting more dominant in the search space.

Once this base was built, the company extended it to other platforms such as mobile where the next leg of growth has kicked in. These type of companies also have a very low marginal cost of production and hence any growth beyond a threshold, drops straight to the bottom line.

This however does not explain fully the reason behind its success – We have a management which in the words of Prof Bakshi in this note – are intelligent fanatics and also have the capacity to suffer (as referenced by Thomas Russo). As a result they have continuously invested in long term ideas (called as moonshots) even if it meant losses in the near term. You tube, android etc which are now bearing fruit were drains at one point of time.

Such companies have been referred as platform companies and usually appear highly overvalued in the early stages of growth. Another similar company seems to be Facebook.

A point of caution – For every successful platform company, there are atleast 10 pretenders which destroy value. So it is not easy to identify such companies ex-ante (atleast for me)

Rate of change matters
Let me introduce a new concept – business clock speed which I read here. This is the rate at which a business is changing. For example the rate of change in the social media business is high and conversely there are business such as paints or undergarments where the rate of change is low.

I think it is quite obvious that businesses with low rate of change can create a durable competitive advantage for the long term and hence a seemingly high price turns out to be cheap.

On the contrary very few high change businesses (google, Facebook being a few exceptions) turn out to justify their sky high valuations.It is difficult to establish a strong competitive position in an industry where the basis of competition keeps changing every few years – Just look at IBM which has had to re-invent itself almost every decade to stay in business and grow its value. For every IBM, there is DEC or Sun microsystems which did not make it.

It is quite rare

It is important to understand at this point that it is quite rare to find overvalued companies, which in hindsight turn out to be undervalued. A lot of overvalued companies, actually turn out to be just that and so it is important for a value minded investor to be cautious about such companies.

In addition it is not easy to identify such companies upfront (there are no simple screens for it) and one has to think deeply to develop the right insights to buy and hold such companies.

So why study ?
As I stated in the beginning of this note – If you want to be a successful investor, it is important to have as many mental models in your head. Investing in a cheap, low valuation companies is one such mental model. However this does not mean one should just wave away any company which is selling at a high price.

The advantage of understanding the drivers of success is that the next time when you are evaluating a company, it makes sense to check if this company fits into any of these models? One can ask some of these questions

–           Is the company overvalued simply because the management is investing in the business for the long term which has suppressed the near term profits?
–           Is the company developing a new business model which meets the changing requirements of the consumer much better than competition
–           Does the company have a durable advantage and a large opportunity space (the case for a lot of FMCG companies in India)
–           Does the company have network effects or is it a platform company run by an intelligent fanatic?
–           Has the company identified and developed a unique business model for a niche which it will dominate for a long time?

My post above does not cover all possible reasons why a seemingly overvalued company, will turn out to be cheap. There is no standard formulae or screen which will give you the answers. One has to study the company and the industry deeply to develop any useful insights (as fuzzy as they may be).

Inspite of the odds, if however if you do manage to get it right, it would be stupid to sell the company based on a PE ratio which appears higher than normal.
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Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

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Active patience

By Rohit Chauhan

In General thoughts, Uncategorized

November 26, 2014

5 Min read

28 comments

I think the next 2-3 years are not going to be easy, just because we are in a bull market. A few of you who decided to invest when India was supposedly going down the drain, must be feeling good about it. It is fine to feel good about it, but one should not get carried away by it.

More noise
In a bear market, as we had in the last 3-4 years, almost no one spoke about the stock market except as a place to avoid. Unless you turned on one of the financial news channels, it was easy to avoid any talk about it.

The advantage of this comparative silence was that you could think investing without too much distraction. The situation has changed quite a bit in the last few months. We now have friends, colleagues and relatives, all getting excited about the market. If like me, your acquaintances know that you invest in the stock market, I am sure you must get badgered with tips for the top ten hot stocks which will double in 21 days – small caps especially.

In my case you can imagine the disappointment – recommending people to invest in 2013 when no one wanted to, and being cautious now when everyone and his dog thinks we are at the start of a multi-year bull run.

Feeling envy
It is easy to feel envy when you see others do better during such times. The media adds fuel to the fire by publishing the list of stocks which have gone by 50 or 100 times in the last 4-5 years. Ofcourse, they were silent when these stocks were starting the journey.

In addition, you now have friends and other investors boasting how they doubled their money in the last six months, by buying the hottest idea.

One can abandon his or her approach and start chasing such stocks which have worked well for others in the past. From personal experience, I can tell you that this never works out (atleast for me).

Unnecessary churn
As the market touches new high, I think some people get itchy to sell stocks which have given high returns and recycle them into new positions, which ‘appear’ to be cheap.

I am looking for new ideas too, but will not do it for the sake of ‘doing something’, unless I think it will add to the overall returns. If this means doing nothing for long periods of time – so be it.

Let me explain further – I currently have around 19-20 positions in my portfolio. I am constantly looking for new ideas. As I am close to fully invested, I will have to sell an existing idea, incur the brokerage and taxes (if any) and then buy the new position. The implication of this decision is that I expect this new idea which has been analyzed for a few weeks, will do better than an existing company which I have analyzed and followed for more than a year.

There are people who are smart enough to do this consistently – I am not one of them. I do not want to take these decisions lightly. If the time horizon is 2-3 years and more in my case, it is really important that I take a little more time to think through this decision.

Being patient is never easy
I have found bull markets to be far more difficult to handle than other times. For starters, it involves doing nothing for long stretches of time, when stocks are going up and you are missing out on easy money ( that the easy money is lost in the end is a different matter).

Let me ask a few rhetorical questions (which I keep asking myself too) – is it really important to have all the hottest stocks in your portfolio? Is it really necessary or even possible to have the highest possible returns at all times, if a lower rate of return at much lesser risk will meet your goals ? Is this investing or just showing off?

The main challenge we will face in the coming months and years is to keep our heads amidst the euphoria. It is very easy to get carried away and starting buying marginal companies showing profit and stock price momentum – I have done that a bit in the past and it has always come back to bite me.

Let me suggest a few activities to keep you busy while waiting for the right opportunity
–          Watch TV soaps, especially the family dramas. They have a lot of twist and turns too (or so I have heard)
–          Take up body building or weights. You will have chiseled body if the bull market turns out to be a 10 year one J
–          Go for long walks and walk a little more every day. If this a long bull market, you may be walking the whole day
–          If you are single, go to parties and have fun. If you have been investing in the past and not partying, shame on you anyway – what a waste of youth!

For those of you who like me, cannot do any of the above – keep faith and hope. This too will pass. The skies will turn dark again, and they will be gloom and doom. You will get your chance then J

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Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

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Shortest investment book

By Rohit Chauhan

In General thoughts, Uncategorized

April 19, 2014

1 Min read

20 comments

1.    Save atleast 20% of what you earn

2.    Buy a term life insurance policy such that the policy value = 30-50 times annual expenses (add health insurance to this if required)

3.    Park 10-20% of savings annually in liquid deposits (Emergency fund or for down payment on a house)

4.    Invest 60-80 % of savings via SIP in an index fund or a basket of diversified mutual funds like HDFC equity.

The above is enough for 90% of the people to retire comfortably at the end of a 40 year working life. Anything beyond this just commentary !

So there you go – no need to listen to any broker , read this blog or any investing book J.

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Facing despair

By Rohit Chauhan

In General thoughts

July 31, 2013

4 Min read

5 comments

I was planning to continue on the previous post – ‘Failure to sell’ , but decided to write on a different topic as I have been receiving quite a few emails – full of despair and frustration.

A lot of young investors, who came of age in the early 2000s, entered the workforce when the economy was booming. If you passed out from a half decent college, you could get a decent job with a good starting salary.

As the economy was growing at 8%+, it was common for employees to be given 15% salary hikes (people quit in disgust if the raise was less than that) and the high performers got promoted every other year. In addition, flush with cash, some of the same people invested in the stock market or real estate and saw their net worth double in a few years.

You did not have to work too hard to do well

We are not entitled to be rich

I am going to ruffle a few feathers, but let me still say it – We had a dream run from 2003-2008 and now it is over. The days of 20% salary hikes and 30% stock returns are gone (at least for now) for the masses.

If you are really good at your job or in investing, you may get above average raises or returns, but that is not going to be the norm for everyone

If you entered the workforce in 80s or 90s, you may have seen tough times yourself (or maybe your family did). The reason why the current slowdown feels horrible is because our expectations are high now. Don’t get me wrong – I am equally angry with the government for running the economy to the ground.

Keep grinding

I faced a similar market from 2000-2003, when the market dropped by around 50% over a three year period. At the market bottom in April 2003, capital goods companies like BHEL, Blue star were selling at 5 times earnings. The current market darlings like Asian paints (15 times PE), Marico (around 5-7 times PE) and other consumption stocks were selling a very low PEs too.

At the risk of getting philosophical, I can think of the following things to do this time around

– Assess your risk tolerance: If you have trouble sleeping in the night after seeing your portfolio drop by 10-15% , you should reduce your level of equity holdings. My thumb rule – will I be able to sleep well if my portfolio dropped by 40%+ ?

– Clean out the trash: Now is a good time to clear up junk from the portfolio. A bear market and 40% loss on weaker ideas concentrates your mind. One should evaluate each position closely, sell the weaker ones and redeploy the cash in the better ideas.

– Have faith: There is no data or logical argument which can make you hold on to your stocks or add money to it. You need to trust that the markets will recover in time and so will your portfolio.

It is easy for people to say that they want to think independently and stand apart from the crowd. Now that that we have a blood on the streets and no end in sight, you will know whether you can truly do that.

At the risk of looking foolish, I plan to keep adding to my positions.

Edit : I have a day job to support my family. I will not starve even if my portfolio goes to 0. I would not do the same thing if I was living off my savings.

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Searching the debris

By Rohit Chauhan

In General thoughts, Uncategorized

April 8, 2013

4 Min read

10 comments

There are two numbers I want to highlight

-13% and -15%

This is the drop in the CNX midcap and CNX small cap index since the start of the year. If these numbers look troubling, they don’t even represent the vertical drop in some stocks. I wrote about some such stocks in this post and now that seems to have become a daily affair with some stock just dropping like a stone.

I have to be honest about one thing – I have never seen such bungee jumping in the Indian markets. In the good old days, the market took its own sweet time to react to any fundamental or corporate governance issue and as a result an investor had a lot of time to get off the train wreck.

No such luck these days!!
If the company you own comes out with slightly disappointing numbers or if there is whiff of a corporate governance issue, the punishment is brutal.

The good news

It would take real optimist to look for any good in this. I am in that camp.

If you are looking closely at the carnage, you may have noticed that companies with a weak business model or poor corporate governance are getting punished severely. At the risk of sounding insensitive, I would say that is the way markets should work. A properly functioning market should reward companies with sound business models and good managements and punish the wealth destroyers.

In case you think I am being insensitive to the plight of a lot of small shareholders, let me tell you that I have suffered for my poor decisions in the past and some of my current holdings have got impacted too. The market is not a good place to discover yourself.

Digging through the rubble
A lot of investors, if there any left, are shell shocked with this sudden turn of events. The most common advice is to wait for the uncertainty to resolved. The reality is that the future is never certain – it is just that investors sometimes get optimistic and pay for the illusion of certainty.

One can choose to either wait for the fog of uncertainty to clear up or better yet have the courage to start digging through the debris to see if there are some gems lying around.

The first point to keep in mind is to avoid anchoring to the pre-crash prices. A stock is not cheap just because the price has dropped by 90% – look at Deccan chronicle holdings. A large drop in the stock price is a good starting point, but not a sufficient condition for a bargain

The second point to keep in mind is to look closely at the fundamentals of the company. Is the company highly leveraged and with a weak business model? In addition, it is important to avoid companies with corporate governance issues.

The final point is regarding one’s own emotions and conviction. Once you have identified a good idea and believe that the market is being irrational in beating it down, it will require a lot of emotional fortitude to hold onto the stock. One is likely to get a daily dose of negativity via falling stock prices and bad news or reports about the company. It is unlikely that a company with a beaten down price is enjoying great growth and high expectations from the market. One needs to do his or her homework that the current downturn is a passing phase and the stock will give above average returns over the next 2-3 year time frame.
I am currently looking at some of the following companies. This is just a preliminary list and I may or may invest in any idea

BHEL
Infinite computer s ltd
Manapuram finance
FAG bearings
Whirlpool India
Eros international
Tata motors
Canfin homes – thanks to ayush mittal.

I am sure some of you would have rolled your eyes on reading this list. Well, I have never been the one to buy popular stocks anyway. I am usually fishing in areas where you will not find most investors.

A roller coaster ride since 2007 and negative returns since then in comparison to double digit returns in gold and real estate means that if you tell someone that you are investing equities, they think you need to be assigned to a mental institution. It is not easy to be any equity investor these days. However if you look past the gloom, then the current downturn is a decent time to pick good stocks.

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Taking advantage of quarterly results

By Rohit Chauhan

In General thoughts, Investing Philosophy, Uncategorized

February 7, 2013

4 Min read

6 comments

We are deep into the quarterly result season and most of the channels and papers are talking about the X% growth or drop in the profits of companies. It almost feels like a fashion parade J
A few years back, the stock market reaction to quarterly numbers was not too high and stocks would rarely move by a few percentage points. Now a days, it is quite common to see a 5-10% swing in the stock price, based on whether the company has beaten or fallen short of expectations. Most of the times, the expectation is around the net profit with minimal analysis beyond the reported numbers.
If you can keep your emotions in check and look beyond the headlines, you can make some sensible investments during such emotional reactions

Homework

For starters, one needs to have done his or her homework before hand. You have to constantly look for new ideas and analyze them in detail on a regular basis. A lot of times, the company could be performing well, but priced for perfection (high valuations).
In other cases, the company could be going through a cyclical downturn and the stock price would be reflecting the near term bleak prospects (though the long term could still be good)
In all such cases, one should do a detailed analysis before hand and have a trigger price in mind. If you are lucky, a excessive reaction to the result could give you an opportunity to act.

Digging through the results

Once the annual / quarterly results are announced, it is important to analyze the results in detail and look beyond the obvious numbers.
For starters, look at the lead indicators. For example, in case of banks and financial institutions, disbursements / approvals start rising before the topline and profits pick up. If you keep a track of this indicator and see it rising, it is a good indicator that the performance of the company is likely to turn around soon.
If the price is right and the lead indicators point in the right direction, it may make sense to start a new position in the stock.

Have a sense of the business cycle

In addition to the obvious indicators, one needs to have sense of the business cycle too. You don’t have to predict the exact timing of the turn, but a general sense will help. This is relevant for the cyclical industries such as capital goods or materials (cement, steel etc) and banking too.
The quarterly results could give you a sense of the drop from peak to trough (drop from the peak profit levels) and can be used as a rough guide to plan your purchase.

Read /listen to the conference call
The conference call is unique source of information which is not available through any other channel. One should read the transcript or better yet, listen to the conference to gauge the thought process of the management and the direction of the business.
All the above suggestions may sound fuzzy to you and do not provide a clear buy signal at any point of time. The problem is that by the time the signals are clear and loud, it obvious to everyone that the company is doing well and the price starts reflecting the same.

If one wants to generate above average returns, then it is crucial to keep your emotions in check and look for the faint signal in all the noise. One needs to look at the results holistically and digest both the quantitative and qualitative information to arrive at a conclusion (which often means doing nothing). It is not as difficult as it sounds, but requires a different mindset and practice to have some success at it.

Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

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Trading on noise

By Rohit Chauhan

In General thoughts, Investing Philosophy, Uncategorized

December 27, 2012

4 Min read

6 comments

Mid-caps and small cap stocks have an average standard deviation of around 18-20% per annum. The implication of this factoid is that these stocks can drop or rise by 15%+ over a year for no fundamental reason at all.

Anecdotally most of us have seen a drop or rise in the stock price by 15% or more within a quarter, even in absence of any stock specific news. One can say that the stock price in such cases is being driven by noise.

What is noise?

In layman’s term, noise is variation without any underlying cause. In other words, the probability of the upside or downside is around 50%, which is the equivalent of a coin toss (random event). So if you expect a 15% variation due to noise, the probability of increase or decrease is the same with the expected value being zero ( expected value = 0.5*upside+0.5*downside)

Trading on noise

If your trading or investing strategy involves a 15-18% upside on the current price within a year, it is quite likely that the stock price may rise for no reason other than random fluctuations. In such a scenario, you may end up making money for no specific reason – though you may think that it was the result of your accurate analysis.

The risk of making money in such a way is that one ends up with the wrong conclusions, even though the real cause of success was sheer luck (for further understanding of this phenomenon , you should read the book – fooled by randomness).

In addition to a faulty understanding, the long term returns can turn out to be sub par as the expected value for a series of such trades is essentially zero (upside and downside being equally likely).

Financial news is all noise

I am sure most of you have watched the financial news channels. Almost 90% of the time is spent on explaining the fluctuations during the day, which for the predominant part is just noise. Ofcourse you will get some information or insight if you spent the entire day watching this circus, but it is like chewing a ton of grass to get a litre of milk.

There are far more efficient and easier ways to get the required information – annual reports or magazine articles being some of them. One should watch these channels for entertainment and not for information.

Noise trading quite pervasive

If you think that trading or investing on noise is a rare occurrence, you may be mistaken. I am sure most of you would have seen analyst reports or talking heads recommend some stock with a 10-15% upside in the short to medium term.

If the random fluctuation of stocks is 15% or more, then some of the recommendations will achieve this upside for no reason at all. The unsophisticated investor would erroneously consider the analyst to be skilled at picking stocks and may start following such people or worse, even pay for such advise.

How to see through such tricks?

I will suggest a simple set of rules to ignore analysts and their stock picks if the following is true

– A price target with a 15-20% upside within the year

– A success rate of 55% or less in terms of success rate (preferably over a year)

– Completely confident and sure of the picks (no allowance or probability of error)

Now, you may be thinking that the above is an unrealistic and harsh set of expectations. Let me ask you this – In your job or business, does your boss or customer give you a raise or money for being wrong more than 50% of the times?

As far as I know, if someone goofed up 20% of the times or more, he or she will be out of a job or business. Why should the expectations from an analyst be any lower?

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2013 market predictions

By Rohit Chauhan

In General thoughts, Uncategorized

November 22, 2012

3 Min read

24 comments

We are approaching the year end and soon the experts will start coming out with their predictions for next year. As there is a lot of competition to be the first one, I decided to get ahead in the line by kicking it off in November itself

So here goes
1.    Barring any macro-economic shocks and if sensex earnings exceed 15%, the stock market should be up next year. If however we have a crisis in Europe or we get an oil shock then the index could even touch 10000 levels.

2.    Gold could be up by 10%, if we get a major recession in US due to the fiscal cliff and it could surprise us on the upside if it coincides with the further instability in Greece and Spain. Over the long term, the macro-economic and supply-demand drivers point to a continued increase in gold prices.

3.    Capital good stocks in India could surprise on the upside if the current momentum on the reforms continue. One needs to focus on high quality names in the sector

4.    The consumption story continues to play out and high quality names should outperform the market in 2013, barring any sudden depreciation of the rupee. Demand from consumption centers, such as India and China largely seem to be on a firm footing

5.    The real estate market will continue to face headwinds of high interest rates in the initial part of the year, but if RBI starts cutting rates in the second half, we could see higher activity in certain pockets of the market

6.    Rohit Chauhan will become the smartest and richest investor in the Indian stock markets. President Obama and other world leaders will seek his counsel on how to fix the developed economies J

Did I get you? Do you realize how absurd these predictions are?

There is a consistent pattern in all these predictions. They are not predicting anything and are simply stating that a market will go up if all conditions are right, otherwise it will go down (if the conditions go bad). This is similar to what you would hear from an astrologer if you were to ask him about your future.

One more point – I did not make up all these predictions. I just googled some sites and cut and paste what I found for 2012 (yes for the current year !!).

If you really feel the urge to get some predictions for 2013 on the cheap, please email me and send me 10 Rs. I know a guy on the street with a parrot, who for 10 bucks , will ask his bird to pick a card and will use the card to tell you the future. The parrot is a better fortune teller (50% accuracy), is crisp and short (no beating round the bush) and much cheaper.

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If facts change, do you change your mind?

By Rohit Chauhan

In behavioral finance, General thoughts, Uncategorized

July 19, 2012

3 Min read

12 comments

I have often ‘preached’ on this blog – when facts change, one should consider them rationally and change one’s mind if required. Well, as always, it is easier to preach than practice.

Let me tell you a recent story.

I spoke very briefly about a company in this post. The company was Ricoh (I) ltd. You can download my detailed analysis of the company here.

So after doing this detailed analysis in late 2010, I built a decent position at an average price of around 35-37 Rs/ share. The company continued to perform poorly (as I expected) as it had done an acquisition and was also investing heavily into sales and marketing.

The topline grew by 40%, but the net profit dropped from around 15 Crs to a loss of 5 Crs in 2012. The price continued to stagnate in the range of 37-40 rs during this period.

I have been consolidating my portfolio and weeding out the weaker ideas for the last 2 years. As a result, I exited Ricoh in the feb-march time frame. I think it was a rational thing to do based on the information I had as of March 2012.

The change

The company declared the Q4 2011 results in April and reported the following

Q4 sales growth, YOY – 60%
Net profit growth, YOY – 73% (12 Crs profit in Q4 versus 11 crs loss in Q3)

The price action can be seen below

As you can see, the market did not react immediately to the turnaround in the performance and there was a 1-2 month window for an intelligent investor to digest this information and purchase the stock.

So that proves my level of intelligence J

The explanation
It is easy to call the decision, stupid and move on. The true reason for my failure to capitalize on the change in performance (which I was expecting) is due to a behavioral bias.

The bias is called the commitment and consistency bias. In simple words, once one makes a decision, the tendency is to ‘commit’ to the decision and be consistent with it. This results in ignoring positive information as in the above case or holding on to a losing position (inspite of consistent negative news) and hoping that the price will rise in the future.

Not a one off case
The above incident was not a one off in my case. I have made the same mistake twice earlier – in the case of VST industries and Mayur uniquoters. I sold the stocks and then saw the fundamental performance improve, after the sale. Instead to getting back into the stocks (as I already knew about the companies), I just ignored them and lost out on pretty decent gains.

I have become alert to this bias now and am paying more attention to sudden turning points in the performance of the stocks I hold or have held in the past.

It is better to look foolish (in my own eyes), than miss out on a good idea

Added note – The above example does not mean Ricoh India is a good buy and should be purchased at the current price. It is quite possible that the performance may regress and so would the stock price. The example is only for illustrative purposes.

Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please read disclaimer towards the end of blog.

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A speculative bet

By Rohit Chauhan

In General thoughts, Uncategorized

July 5, 2012

4 Min read

7 comments

An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative – Benjamin graham, father of modern security analysis and value investing.

Some background

I had written about globus spirits earlier – read here. The stock price has since dropped by around 10% versus the index, which has essentially been flat during this period.

So what happened during this period ? Well, the company declared the Q4 results and the market reacted negatively to the drop in operating margins from around 16.8% to around 13%. The company closed the year with a 40% growth in topline and a measly growth of 2.5% in net profits.

This drop in net margins was mainly due to an expansion in the capacity to 84Mn litres and additional new capacity of 40 Mn litres which should come online in the middle of next year. This additional capacity has caused an increase in manufacturing expenses (initial startup costs) and higher interest expenses (due to higher debt to add the capacity). These costs in combination have depressed the operating margins.

So what is my bet ?

I think that the drop in the operating margins is temporary due to the new capacity which is being added in the current and next year. As the new plant stabilizes, the extra costs should reduce and with the extra topline , we should see an improvement in the margins.

In addition, a decent portion of the additional capacity has been booked by USL for the franchise IMFL bottling (outsourced production) which should help in boosting the bottom line. The management is targeting a 15% operating margin for the next year.

The management has also indicated that they would be able to grow the topline by 20% or more in 2013 (which appears doable based on past results). If we put all of this together, the company should be able to increase the operating profits from around 73 crs to 100 Crs, with net profits in excess of 55 crs in 2013 (interest costs should also reduce due to a planned reduction in debt)

The company is current selling for around 5 times the current year’s depressed earnings of around 40 crs. The company is thus selling at historically low valuation too (past valuations have generally been in excess of 7-8 times earnings).

In addition, all the other companies in the sector sell for 10+ times earnings, inspite of having much lower ROE and higher debts.

So why is it speculative?

Have I built a good case that the company is really undervalued – from absolute, historical and comparative valuation perspective? I think I have done that. At the same time I am still calling it speculative …why is that ?

Please look at the definition in the beginning of the post – An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.

The key word in the above definition for our example is promise. I am not confident about the above analysis and think it is a 50-50 proposition. I am still concerned that the industry has extremely poor economics and it is generally quite difficult for a single company to buck the trend of an entire industry.

Speculation is subjective

The key point is that a stock can be both a speculation or an investment at the same time and that depends on the investor himself. If you know what you are doing, then it is an investment, otherwise it is a speculation.

The danger is not speculating, but in confusing a speculation as an investment and betting heavily on it.

I am personally not very sure if the above thesis will play out and hence have committed a very small amount of money to it. In effect, this position is just to scratch an itch and not meaningful. If it turns out well, I will brag about it on the blog, otherwise you will not hear a peep on it 🙂

Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please read disclaimer towards the end of blog.

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CategoryGeneral thoughts

The value of ‘overvalued’ stocks

Active patience

Shortest investment book

Facing despair

Searching the debris

Taking advantage of quarterly results

Trading on noise

2013 market predictions

If facts change, do you change your mind?

A speculative bet

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