CategoryGeneral thoughts

Scenario: I bought a stock for Rs 50. My intrinsic value estimate was Rs 100. The stock quickly doubled and then some more. It quotes at Rs 125 now. What should I do?

The most common response I read and have also heard from friends is this – Sell half your holding and recover your investment. What you leave behind is your profit. Let it be in the market as can afford to play around with it.

I have myself engaged in the above logic. However I find this logic completely faulty. My ‘investment’ now is not Rs 50. It is Rs 125. That is the money I have now with me. I can sell the stock completely and choose to invest the money in another security or maybe just buy a Flat screen TV or whatever I fancy 🙂

The above is a case of anchoring bias. We tend to anchor our thinking to the purchase price of the stock. The purchase price is history. The current price is what matters

Lets take another case

I buy a stock for Rs 50. My intrinsic value estimate is Rs 100. The stock drops to 40. I investigate and realise that I have made an error and the intrinsic value is actually 35 only. What should I do?

The price of 50 now has no meaning. The stock has dropped and is still quoting above the intrinsic value. A rational response would be to take a loss and move on. Before I sound any more preachy, let me tell you I have been guilty of the same thought process. I bought SSI at Rs 1900 and rode it right to Rs 100.

Personally, I think the most rational approach is to constantly evaluate the stock price with your conservative estimate of intrinsic value. If the stock sells for more than intrinsic value , sell or else hold. Nothing else matters! not the price paid for the stock or the current level of the market.

I read somewhere that all of us have a set of underlying assumptions based on which we create a model of the world. This model involves all aspects of life, but I will restrict myself of investing.

I am aware of a few assumptions on which my investing style or philosophy is based. These assumptions are not universal truths or applicable to others. Its just that I have developed these assumptions over a period of time. Some may be valid and some not. I constantly test these assumptions against my performance and try to discard those that work against my long term performance.

So here goes my list

1. Value investing is an extremely productive approach to investing for my circumstance. I have a regular job, a family and can devote only a limited time to investing. So for me value investing and an as an extension, buy and hold makes sense.
2. Trading is time consuming, too stressful and not a game in which I can or want to excel. In addition, I have a mental block against trading (which must quite obvious). I am currently reading a great book on trading – Way of the turtle (on which I will post next) to learn more about it. My initial reaction – Trading is not for the faint hearted, is a tougher (especially emotionally) way to make money and definitely not a part time activity.
3. Investment advice especially from analysts and financial website is baised and not worth following. Blogs are a different matter as the bloggers do not have a hidden agenda.
4. It is impossible to predict the markets in the short run. Don’t waste energy on that. Time is better spent in learning other aspects of investing
5. One can get better at investing if one is ready to put the effort into it.
6. Avoid options, derivatives and other avenues such as gold as there are enough opportunities in equities. No point in spreading my self thin. Knowing a little bit of equity, a little bit of commodities and gold will not get me superior returns. Focus on one area and do well in that.
7. Avoid stocks with high PE unless I am very very certain of the business prospects. Avoid stocks above a PE of 20 in most of the circumstances.
8. Avoid IPOs (see my logic here)
9. Investing in not an intrinsic talent usually. There are a few exceptions to it like warren buffett. I can learn to be a better investor.

I am a buy and hold investor. This has been gospel for me in the past. I guess if you follow warren buffett as much as I do, you end up following his philosophy completely. However over the past 1 year I am trying to expand beyond this approach. I would still prefer to buy and hold stocks for which the instrinsic value is increasing rapidly. However I have started looking seriously at a few more approaches such graham type deep value investing, special situations and also looking at how momentum may be combined with value investing . My core philosophy is still value investing, however I am trying to expand the scope.

Only when the tide goes out do you discover who’s been swimming naked – warren buffett

It is diffcult to avoid reading on the subprime mess in the US. I have an oversimplified explaination –
‘Losses being incurred by individual and institutions for overpaying for financial assets like CDO, MBS (mortage backed security) and other debt due to greed (for higher yields), ignorance (not knowing what was behind these assets) and overconfidence (too much faith on models)’. So what we are seeing is repricing (or correct pricing ?) of these assets.

Well for a much better understanding on what is happening and what may happen in the months to follow , read this article on fortune.

In a nutshell the opinion is that this bubble will take some time to unwind, there could be volatility in the markets due to that and there could be steep losses for some.

I think india is not going to be affected much directly. However we could see second order effects. With a liquidity crunch, it is quite possible that the excess liquidity which is driving our stock and real estate markets may dry up. This could cause some volatility and short term drops. How much and when ? …who knows. I think the equity markets are already reacting and there maybe be some anecdotal evidence of the same happening in the real estate market too.

If, like me, you have also been tracking some stocks or have surplus cash to invest , the next few months may provide a few good opportunities. For ex: the auto sector, oil and gas and several mid-cap, microcaps are now selling at much lower prices and could soon be great bragains.

The most common cause of low prices is pessimism. We want to do business in such an environment, not because we like pessimism, but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer – warren buffett

I typically write posts beforehand and publish them later. The following was written around the 15th of July.

Over the last 7-8 years of investing I have outperformed the index by around 8-9% per annum. This has been mainly with a buy and hold type of investing and without any leverage, options or any other type of investments. However I have underperformed the index several times. I have underperformed around 2 out of 8 years of investing. If I reduce the time horizon, the number of times I would have underperformed the index will be even higher, maybe 30-40 % of time if I consider monthly buckets.

There is no fun in lagging behind the index. As I put it in another post, the benchmark I follow is the BSE index. My entry into active investing was also perfect. I started actively and seriously investing around dec 1999, right around the peak and promptly saw my portfolio cut by 25% in a years time.

I remember reading charlie munger and warren buffett say that temprament and ability to take losses without going nuts is crucial to investing. Most of us will have losses over our investing lifetime (diffcult for most to believe now as the indian market has been in a bull run from 2003).

I am still pained when I lag the index or when my stock goes down by 5-10%. However the advantage I have now is that I have experienced it several times and am able to be rational about it. When I was new to investing it was diffcult for me figure whether the market was being irrational or if I was missing something and my analysis was at fault.

For example I invested in concor in 2002 at around 250 –300 Rs/ share. The stock promptly dropped to around 180-190 Rs/ share. This company has a big competitive advantage to the point of a monoploy in container transport, high return on capital and was selling at around 5 times earnings then. When the stock dropped, I was not able to understand the reason behind it. I could see nothing wrong with the stock even after analysing it again. So I kept faith on my analysis and held on to the stock. The stock sells at around 2400 now. It is easy to look smart or stupid in retrospect, but I was not a 100% sure then.

The difference now is that I have more faith on my analysis and have more experience (and scars !!). I still get pained by losses, but am able to keep my emotions better under control.

01-August

I did not realise that I would be seeing the market crash so soon. Earlier I would read and try to check for the reasons behind the crash. Now, I usually don’t bother. The main reason is that my guess is as good as anyone else’s which in the end is a guess. However not bothering to find the reason does not mean ignoring the market crash. On the contrary, stocks which were cheap earlier are now cheaper and some stocks are getting more interesting. So if the price drops further, I see a good opportunity to pick up a few stocks or increase my investments in a few exisiting ones. Ofcourse the assumption here is that the underlying analysis is correct and nothing has changed from a fundamental standpoint.

The above viewpoint is ofcourse not conventional wisdom and is painful to execute especially when your holdings have already dipped below cost.

I started blogging in 2004 and had a blog on sify ( see here)

I was just browsing through my old blog to see what i had written then and see how my thinking has changed since then. I came accross this post which i had written then (more in jest than anything else). This was the time i think the market had just crashed.

Wednesday, May, 19th, 2004
trader or investor …who should i be ?
Let me see …..

trader
-> read the papers every day
-> watch cnbc full day for each development
-> sit in front of the trading screen watching the price ticker
-> try to see which party may get elected ( depend on the exit poll ??!!!)
-> have the courage to watch the market fall by 500+ points ( and go nearly bankrupt)
-> then watch the market go up by 200+ points ( and wonder what will happen next)
-> have the courage to lose big money or the courage to bet big
-> has a strong stomach for this kind of swings

investor
-> read annual report at leisure
-> analyse the company and industry over a long term
-> make a piddly 20 % p.a but not lose more that 5 %
-> less blood pressure
-> more time to watch other channels other than cnbc ( maybe discovery ??)

guess i am not cut out to be a trader …. dont have courage to bet big / lose big , like to sleep peacefully at night , politicians make my life miserable enough …dont want them bankrupt me …naah …not for a lazy guy like me

Prem sagar had a poll running on his blog for the best indian financial blogger and published the results recently.

Good to know that there at least 30 folks who find the blog worth reading 🙂