CategoryGeneral thoughts

I have recieved Prof Bakshi’s interview via email. However i have yet to write to him and get his approval to forward the interview. In the meantime i have recieved a huge number of requests for forwarding the interview. I will try to email to all who have requested it (if prof bakshi is fine with it) , but please bear with me as the number of requests is huge.

I also recieve personal emails several times. I have attempted to answer them but i am not able to do justice to all of them due to personal time constraints. Hope those of you who do not hear me, will understand that i am time constrained and hence may not be able to reply some times. Leaving a comment would be a good idea in such a case. Some other reader on the blog may be able to respond to your query equally well.

Finally if you wish to subscribe to the blog via email , please enter your email id above the blog archives. You will recieve an email update whenever i post a new post.

Please feel free to leave a comment on how to improve the blog further and make it more useful.

I got the following comment from ranjit and gave the response below

Hi Rohit,
Today RBI has increased repo & CRR again. Please can you give me your historical perspective on these high interest rates and also what would you do in such situations, would you move into FD’s for some time or would you stay invested fully.

hi ranjit
my personal experience with interest rates has been from 95 onwards when i saw the rates move to 15% and since then it has been a downwards movement.my stock market positions are not based entirely on interest rates (at least not in the past). if i find a compelling buy, i go ahead with it if the expected returns are good.since 2003 i have moved into floating rate funds and plan to continue . floating rate funds are more tax efficient than FD’s and far more liquid , although absolute returns are less

In addition I plan to do the following

1. continue with a laddered approach to fixed deposit investing. What I mean by laddered approach is that I would be investing in FD’s over the next few months across the most attractive maturities. Currently the 1yr+16 day duration seems to be most attractive to me (the 2yr + 16 days gives 0.25 % more , but is not attractive for the extra duration). In addition, I do not plan to put all my funds into FD’s as one go as I do not have an idea how interest rates will move in the next 6 months. I expect them to stay as is or harden a bit, but frankly your guess is as good as mine. So my fixed income investing will be spaced out over the next few months.

2. Continue with floating rate funds which are more tax efficient than FD’s and far more liquid. The absolute returns are low, but they can serve as a good place to park extra funds

3.The bar for the stock market investing is now higher. I generally use a discount rate of 11-13% . I do not plan to revise it.

4. FD’s and fixed income mutual funds have now started to become a viable alternative to investing in index funds. I am not too keen on the index till the index drops by another 20% or remains flat while earnings catch up.

5. Finally, bad time to take any kind of loans – housing or otherwise.

See here for an earlier post on the same topic

I came across this article on the blog galatime. It’s titled ‘The effort effect’. The article resonated strongly with me. I think the power of mindset mentioned in the article is extremely crucial if one is to become a good investor.

The growth mindset (see diagram here) mentioned in this article is crucial to become a good if not a great investor. In comparison a fixed mindset (which a lot of us see around us) leads to poor performance in the long run. The key points of the growth mindset in terms of challenges, obstacles, effort, criticism and success of others are extremely relevant for an investor. As an investor one has to learn how to deal with new challenges and obstacles (the market and businesses around us are constantly changing). Effort is crucial in terms of a desire to constantly learn and improve oneself. Self criticism and an honest one is crucial too. One should be able to accept mistakes and learn from them and then move on. Finally I look at the other successful investors and try to learn from them.

The attitude referred to in the article is relevant to us not only as investors, but is important in other walks of life too.

In addition I found another link on the same blog on the mark of greatness. I found a similar article on greatness in fortune some time back (see link). The article in fortune mentions the following
Reinforcing that no-free-lunch finding is vast evidence that even the most accomplished people need around ten years of hard work before becoming world-class, a pattern so well established researchers call it the ten-year rule.

I have read in some other articles that 10 year or 10,000 hours of work is essential to achieve proficiency in a field. All the above research encourages me to keep working hard on becoming a better investor. Even if I don’t become a great or super investor, if I keep working at it, I will defintely be a better investor. My definition of a good investor is one who can beat the market by 5-10% points over a ten year period. I have done that for the last 6 years. I definitely plan to continue working on extending this performance.

update : 03/23

see here for an earlier post on the same topic

The RBI has just raised the CRR by another .5 %. This with inflation at 6.5%, although I feel this inflation is understated as the government’s basket of goods really not reflect an average middle class’s consumption profile. Rentals, education and health care alone are inflating in double digits.

I have never had any specific views on interest rates or inflation. I try not to base my investment plans on any predictions of inflation or interest rates. However that does not mean I don’t to react to it. In the past I have taken the following actions

In 2000-2001, I invested in fixed income debt funds. As the rates fell, the appreciation in these funds was substantial.

In 2003 when the interest rates were at an all time low, I moved my fixed income investments into floating rate funds and went long on by housing debt (see my thoughts on it here)

With rates hovering in 9-10 %, I have started looking at the option of moving out of floating rate funds into fixed income debt funds of average maturity (4-6 years duration). I have not made up my mind yet on it. I may wait for a couple of months more as I feel that the interest rates may rise a bit further. I am not sure about it and do not have specific views on it, but would wait and watch and react opportunistically to it.

As far as the stock market is concerned, I have been finding a few interesting opportunities such as indraprastha gas which I will explore further in a future post.

Additional comments – 15-Feb

Found this article on GEF (morgan stanley ‘s global economic forum)

http://www.morganstanley.com/views/gef/archive/2007/20070214-Wed.html#anchor4403

Following comments are worth noting

Excess liquidity conditions in late 2003 and 2004 resulted in banks searching for yield and charging negligible risk premiums for loan assets with inherently higher risks. Just about 12 months ago, banks were making little distinction between pricing credit risk for various types of loan assets. Almost all loans were being priced in a very narrow range of around 7.5-8%, which was very similar to the 10-year bond yields then. Indeed, banks’ lending behavior implied that the risk of lending to a low-income-bracket borrower (for whom there is little credit history available) for the purchase of a two-wheeler was not meaningfully different from the risk of investing in government bonds.

If the past two months’ average credit growth of 30% and deposit growth of 22.5% are maintained, the banking sector SLR ratio will reach its maximum limit of 25% by March 2007.

I have been noticing in the past few weeks that interest rates have started hardening. I do not have the exact figures, but it seems that the rates for housing loans have started approaching double digits now.

I wrote a post on interest rates a year back (see here). Back in 2003-2004 the rates were at an all time low (as low as 7.5% fixed and 7.25 % variable). However everyone looking at the immediate past, were prediciting further drops (what else would explain almost everyone’s preference for variable rate loans?). I almost got into an argument with the loan officer in getting a fixed rate loan (the loan officer kept telling me that I was making a big mistake).

My logic in working out a rough pricing level for loans was detailed here. General extremes in valuations, whether stock or interest rates are easier to spot (although I cannot predict them). However I do not know if the rates are high now, will rise or fall in the future. What I feel strongly is that any rate lower than 8% is good and should be locked in via a fixed rate loan.

There are a few new conventional ideas now prevalent such as

– real estate is great investment at any price and will rise 20-30 % per annum due to the extreme shortage of real estate in india (for better idea of real estate bubbles, read about the 90’s real estate bubble in japan)
– Indian economy has entered a new era and stocks are worth more now. Every drop in the market as a result presents a new opportunity to buy

I don’t claim that I know any better on the above two new convential ideas in vogue currently. I am however unwilling to pay for the bright and shiny new future in these investment classes (stocks and real estate)

1991-1992: Harshad mehta boom
Story: Liberalisation

1994 – IPO boom

1999-2000: IT stock boom

2003 – ? : The india story .

‘India will grow at above average rates ( > 6 %) for the next few years and more. India has the requisite demographics, savings rate and the right condition for growth’

The underlying idea behind each boom was true and maybe sound. But typically the idea got carried too far. I am reminded of this quote from benjamin graham (paraphrased)

‘ It is not the bad idea which does you in, it is the good idea carried too far’

So you have a boom in the stock market, the commodities market, gold market, real estate market. Read somewhere that property in mumbai is more expensive than manhattan !!

Maybe it is ‘different’ this time …who knows ?

I am reminded of the following statement from warren buffett

The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large dosesof effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities – that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.

— warren buffett , letter to shareholders 2000

So maybe there are people who are smart to know when the market will turn. I don’t think I can do that. Better to hold back or if the froth in the market increases, start selling.

another indicator of the bull market – in any party or evening out with friends and family, i keep hearing of the fantastic real estate, IPO or stock tips which should not be missed. prefer to keep my mouth shut in such groups. Who wants to listen to a party pooper ! surprising bit is that no one talked about stocks in 2002-2003 .

Is it that software stocks are undervalued relative to the market? Will they outperform going forward? In our view, the risk-return matrix of investing in software stocks currently is equally poised.
On a relative basis, assuming a 15% CAGR growth in earnings of the BSE Sensex companies, the benchmark index is trading at a price to earnings multiple of around 14 times FY08 earnings. As compared to the same, the top five software majors, on an average, are trading at 19 times our estimated FY08 earnings. This is a 28% premium to the benchmark index. Considering the fact that earnings growth of the top three software companies i.e. Infosys, Wipro and TCS is likely to around 25% CAGR in the next three years (66% higher than Sensex earnings growth), we believe that the premium is justified

From: BSE IT: Has it tracked fundamentals

Question: Company A has a PE of 10, expected growth of 10 % for next 10 years and a ROE of 5 %. Company B has a PE of 15, expected growth of 8 % for the same period and an ROE of 20 %. Which company is cheap?

IT companies have a return on capital which is far in excess of 25%. However the key point in justifying the current valuations would be whether this level of growth and ROE hold? and that is where issues such as competivitive advantage of the indian IT service companies, their ability to contain costs, rupee – dollar rates etc comes in. So basically the answer to the question posed in the above article is not as obvious as the writer is suggesting (at least to me)

I typically avoid reading broker reports and their recommendations. The analysis is typically very shallow, incomplete
and hardly covers any of the key aspects in valuing the company. And worse is the tendency to compare apples and oranges, which in this case is to compare BSE sensex (which includes banks, commodity companies etc ) with an IT services company.

Answer to my question: Company A is a value destroyer and would need capital to grow at 10 % for next 10 years. So I would not pay more than 4-5 PE for the company.