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Buy and hold investing

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The idea of buy and hold was popularized in the US by warren buffett, the guru of value investing (and if you have realized, my intellectual guru too).

The idea behind buy and hold has been that one should buy the stocks of the really good companies and hold them for the long term (sometimes over decades) without concerning ourselves with the short term swings in the stock market.

A myth on buy and hold
A few commentators project buy and hold investing as a form of investing requiring no thinking and analysis. All one needs to do is to go ahead and buy an Infosys or a levers or titan at any valuations and just hold onto it. One does not even need to check on the performance of the company, even briefly, on an annual basis.

These commentators point out to investors who made an investment in a levers or Infosys years ago , just sat on their positions and are now comfortably rich. This is survivorship bias. For every levers or Infosys, there is a company which went bust or went nowhere.

Buy and hold is not brainless investing!!

It requires work, even if there is no activity (read – trading). It may sound easy, but it is not. By the way, why should earning a decent amount of money, while sitting on one’s a**, be easy for everyone?

Why are there no such recommendations?
You may wonder, why one cannot find such recommendations from brokers or analysts. Why don’t they indentify such companies and recommend it to investors?

Let me take a personal example. As far back as 2000, inspite of being a novice, I had a decent amount of conviction that asian paints was a good company (as I had worked with them). I invested a decent sum at that point of time in the stock.

Now lets assume you are my client. Let’s say in 2000, I recommend this stock and you pay me a commission.

You come back next year and we have this conversation

You : So Rohit, what should I do with asian paints?
Me : Nothing. The company’s doing well. Just hold on to it. By the way, you will be getting a bill for my recommendation next month
You (thinking) : What ??!! this dude did nothing for me this year and is charging me. I am not coming back

So I assume you get the point why brokers and tipsters cannot make a living by giving out such buy and hold ideas which can make you rich.

Please note that the advisor is still doing work. He or she has to keep analyzing the company and track how it is doing. The only difference is that as long as the company keeps doing well, there is no need to trade the stock.

The unfortunate reality is that most investors believe some activity is needed to make money and on top of that if an advisor is to be paid, he or she should be ‘doing’ something.

Is it relevant now?
I feel like a dinosaur these days, especially when talking to my friends. The holding time spans range from a few months to a year. If I point out to long term stock ideas, the same friends are quick to point out the fantastic returns they have been able to make in the last 6 months on midcaps and microcaps.

Why wait for the long term when one can get instant gratification 🙂

The problem with a short term approach, disconnected from an underlying philosophy, is that it works till the going is good. If the market turns south, then the same investors would lose their shirt and all their undergarments and would start singing the buy and hold tune.

An investing philosophy should be based on fundamentals and not on the current fads of the market.

How to practice buy and hold?
I personally do not believe in going and buying a stock blindly and then holding on to it forever (hoping it will do well). I think one should be able to identify on the basis of a reasonable amount of analysis and experience a list of good, long term ideas.

What should be the characteristics of such companies?

A decent operating history – The company should have been in the business over 10 years with an above average record of performance.

Sustainable competitive advantage – The company should have a strong competitive position in the industry so it can sustain its above average performance in the long run

Decent to attractive industry with minimal change – It is important to avoid industries with a lot of change (ex: telecom) or currently in a decline (example – jute). In addition, commodity type industries are also not a great place to find such ideas, though one cannot rule it out.

The hit by truck test – If the unfortunate happens, can you leave the stock untouched in your account as an asset for your family?

The key is to identify a list of such attractive ideas and invest a small amount of money in it (if the valuation are not too high). Once you do that, you need to start following the company and the industry on a regular basis. In time, over a few years, you will become more and more comfortable with the long term prospects of the company.

The idea is not keep adding money as you become more confident of the long term prospects of the company (long term being more than 5 years). One needs to be patient and should let the opportunity come to you. When the market drops due to some short term concern, it is time to add a meaningful amount of money to some of these ideas.

The above approach is not easy. It requires effort and patience. However if you can build a portfolio of 4-5 such companies, you are set for life.

I have been able to identify a few such companies over the last few years. The notable ones are asian paints, Crisil and maybe a Gujarat gas. These names are not set in stone, but are fairly good ones for me.

I am planning to look at new ideas such as titan, HDFC bank, ITC etc and start following them closely. The next time a market crash happens, I plan to load up on these stocks, as I did on Crisil in 2008.

Some portfolio changes

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A few of you may have noticed updates on my portfolio page. I don’t update this page on a real time basis, but it roughly reflects my current positions except for one stock.

I have been reviewing the Q2 numbers of most of my positions and have been satisfied with the performance of most of the companies. The results have come as expected in most of the cases. However there were a few surprises. Let me give a brief rundown on some of the changes in my portfolio and the quarterly results

The reductions
As I wrote in some of the
previous posts, I have more or less exited most of the IT stocks such as NIIT tech, Patni computers and Infosys. Infosys performed better this quarter, growing in double digits. However I personally feel the stock is fairly priced and have exited the stock completely.

NIIT tech came out with decent numbers after a long time – mainly due to their BSF order. In addition they have been able to reduce the impact of their hedge positions. As a result the hedge related losses have reduced and the company posted decent results. I personally think the stock may be undervalued by around 20% at best. However I have reduced my position substantially.

In addition I have sold off Concor completely as I think the company is now fairly valued. I have been reducing the position for the last few years. This is a very interesting position for me. I bought this stock in 2003 when the company was selling at a PE of 5. I had been investing for a few years and could not figure out why the stock was so cheap when it was doing so well.

I created a position inspite of all the doubts. In hindsight I was too timid.

I have also started reducing ashok Leyland as I think the stock is now approaching fair value. The company is doing extremely well and firing on all cylinders. I remember looking at this stock at 11-15 levels and wondering how it could not be cheap?

I closed out my position in mayor uniquoters as I feel it is fully priced and my position was too small to begin with anyway. I have also been reducing my position in clariant chemicals as it is now close to fair value

Finally, I have started reducing one of my largest positions – Lakshmi machine works. The company is doing well, but is now close to fair value.

In case of all the above stocks, it is not divorce, but a temporary separation. If the price drops or the valuation becomes attractive, I will buy again.

The additions
This is a small section. I have been adding to my positions in Balmer lawrie, hinduja global, Patel airtemp, Ricoh india and FDC. The additions have happened over the last few months. However I have been a net seller than a buyer. The only major buying has been for Diwali 🙂

The disappointments
BEL (bharat electronic limited) had a fairly poor quarter where their topline and bottom line dropped by double digits. I am however not too disturbed as they have quite a bit of a monopoly in the defence business and the revenue is not evenly distributed in each quarter (due to projects nature of the business).

I was also disappointed after I read the annual report of facor alloys. The company has passed several special resolutions to invest to the tune of 300+ crs in other sister firms, which are expanding into power and other businesses. I get fairly mad with this kind of diversifications. Needless to say, I plan to exit the stock in time irrespective of what happens to the business or the stock.

I had written about mangalam cement recently. As I was not confident enough, I never bought the stock. I was quite surprised to see a sudden 90%+ drop in the bottom line for the second quarter. This was a learning for me – companies with high operating leverage can see huge spikes in their bottom line. The fundamentals of the company are still intact, except that I would like to buy the stock at a time of extreme pessimism

Response rate
A few of you may be disappointed with my response time to emails and comments. Unfortunately like others, I also have a limited time and hence cannot devote more than a few hours a week on responding to comments and emails.

I will definitely read and respond to your email, but would ask you to be patient with me on that count.

A happy Diwali to all the readers

On the previous post and some additional thoughts

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I recently made a discovery – The higher the market goes, the more I get a lot of intellectual thoughts. This is exactly reverse of a lot other people who seem to be finding a lot of good ideas to invest in the market. Well I guess I may have to work a bit harder to find something good …sheesh why isn’t it easy to make money in the market 🙂 ?

All IT stocks overvalued?
I was not precise enough in my
previous post. I think some of the large cap IT stocks are fairly valued, if not overvalued and hence there is no margin of safety. That is they are priced for perfection.

The same may not be true for several midcaps, though I think one cannot make a general statement. As I have written in the past, general statement such as ‘market is overvalued or undervalued’ are meaningless and the same holds true for IT stocks too. So let me be more precise – companies like Infosys, Wipro and TCS seem fairly valued.

In case of Mid –cap IT companies like NIIT tech, patni or hexaware it is not as clear, atleast to me.

I typically value stocks using 3 different approaches at the same time. The first approach is the discounted cash flow – try to estimate the future cash flow (or earnings) and then discount them to arrive at a net present value. The second approach is to look at past valuations of the company and compare with the current valuation. The third approach is to look at the relative valuation of the company with others in the same sector.

I try to evaluate a stock on all the three approaches and see if they are pointing in the same direction. A stock may appear undervalued in terms of the DCF value and with reference to other companies in the sector, but appear fairly valued compared with its past valuations.

Now such a situation, which is currently present in case of Mid-cap IT and some cement companies, definitely throws up a key question for me – Why should the market value the mid-cap IT companies at a higher level in the future than it has done in the past ?

A typical case where the market values a company at a higher levels than in the past is when the growth or return on capital of the company has increased and the market now thinks that the company has a much better future and prices it accordingly.

In case of mid-cap IT companies and various other mid-caps, I am grappling with the same question – what is it that I know which the market has not considered, that would cause it to value it more in the future. In some cases it is easy to figure that out, but I am not able to figure it out in case of IT companies.

Hence my statement – Some IT-midcaps may be undervalued depending on your point of view. My point of view is that i can’t think of any unrecognized factors which may cause the market to re-price these companies upwards.

On the contrary I can only think of negative factors, several of which are not yet priced into these stocks. You may have a better insight on factors which may cause the market to value these companies higher and so both us are correct from our respective points of view.

The problem with stock tips
Moving on the next general thought – stock tips. Regular readers to this blog know that I am totally against stock tips. Other than the reason that I think that most of the stock tips are given by the unethical to the unsuspecting, I also believe that such tips do not help in the long run.

It is easy to take stock tips and follow them in a bull market. Even a dart throwing monkey can come up with some profitable ideas (unfortunately I am not as smart as this monkey during bull runs :)) and it would not difficult to follow them. How many of us will have the courage to hold on to such stock tips when the market drops or add to such positions? I cannot speak for others, but I definitely cannot blindly follow others when the market is in a free fall.

The only way one can follow stock tips or such a person is to understand that person’s underlying approach and then have some amount of blind faith on the skills of such a person. So the next time you decide to follow someone else stock picks, remember that you are putting some amount of blind faith in that person, which will be tested when the market drops (which it will sooner or later).

How to get decent return these days?
One of the readers asked me a question on the previous post – how do I make decent return these days when a lot of stocks appear overvalued and fixed income options don’t give much returns?

I don’t have an easy answer – if I had one, don’t you think I would be using it?

The first option is to keep analyzing stocks everyday (as I am doing) and hope that you may hit a few good ideas in due course of time. If you can find a few such ideas, you will have to have the courage to buy such stocks, knowing fully well that such stocks could drop if the market were to drop suddenly.

The other option is to do nothing and sit tight. This option is not easy too as you will have to watch your friends make easy money while you sit like a dumb dodo, doing nothing.

Either of the options are not easy – in one you face the risk of losing money (atleast in the short term) if the market drops and in the other you are foregoing easy money. You have to choose your poison.

A bear case on IT companies

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It’s not that I have always been a bear on IT companies. I have held NIIT tech, Patni computers and Infosys are various times over the last 5-6 years.

You can see my analysis of NIIT tech
here and patni here.

The main reason for my bearishness is simply ‘valuations’. Mid cap companies like NIIT tech or patni and maybe a few others could be slightly undervalued (depending on your point of view), but I find it difficult to see the undervaluation in large caps such as Infosys which are selling over 30 times their current earnings.

A lot of the IT companies are priced for perfection which as we have seen never happens in reality. In the alternative universe of brokers and tipsters, the time to buy IT stocks was in 2000 and now and to sell was in 2008. We do not know how things will turn out in the future, but can clearly say from hindsight that 2000 was the time to sell and 2008 was a decent time to buy.

The advantage (or disadvantage) of having a blog for more than 5+ years is that all your past thoughts and statements are online and can be referred back at any time. In 2008, I felt that IT stocks, especially midcaps were extremely undervalued (some selling for PE of 2 or 3) and hence were a bargain. It was not a macro point of view, but based purely in valuations (you can read the post on it here)

Getting the timing wrong
My decision to start buying into some of the IT midcaps was based on valuations and a belief that the underlying economics of the IT service space was still attractive and the companies would continue to be profitable in the long run.

I had no clue that 2008 and 2009 would be such a disaster ( if I knew, I would have bought put options and retired by now 🙂 ). So clearly, in hindsight the best time to buy was 2009.

However one cannot make investment decision based on hindsight and so mere mortal like me (unlike some of the forecasting gurus ) have to base their decision on current valuations and expectations of reasonable business conditions in the future.

Still no idea of the future
As I have still do not have any special powers of knowing the future, my current view on IT stocks is centered on valuations and some of the long term headwinds faced by the industry such as
– Dollar depreciation : when and by how much …who knows, but more than likely to happen
– Increased costs : If you are an employed with an IT company, a point to remember is that everytime you get a good raise in salary, it comes from the bottom line (no there is no santaclaus paying for your salary)
– Intense competition: From other IT companies which is likely to drive down returns in the long run
– Host of other factors: regulation, slow growth in developed markets etc etc

The point is that the current valuations do not reflect these risks. Ofcourse you can make a point that current valuations for a lot of companies do not reflect the risk – but that is whole different story.

So what to do ?
Nothing much – sell if you think the stocks are overvalued and yes, be prepared to look like a fool if the stocks keep zooming up after you have sold. I have done that for most of my IT stocks and I am fully ready to look like a complete fool.

Review – Lakshmi machine works

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I had written about Lakshmi machine works earlier here. I would recommend reading the earlier post, especially the comments. The post and comments were right in the middle of the financial crisis. The stock was quoting in the 500-600 range and went down to the low 400 range in the subsequent weeks. At that price, the company was selling for slightly over cash on the books and the market was assuming that the company would go bankrupt soon.

I distinctly remember the comments and a few emails I received on this idea. The general theme was as follows
– The near term outlook for the company is horrible. As a result one should wait till the outlook is clear and then buy the stock.
– The company is barely making any profits and could be in financial trouble if the textile business shrinks further.
– The stock market gurus and pundits are advocating caution and I would prefer to wait (close to the first point).

My logic at that point can be summarized as follows
– The near term outlook was terrible and hence the stock was available at a bargain. Stock don’t sell at throw away prices if the near term outlook is great. The key point to analyse was how the company will do in the long run – that is after the downturn is over
– The company had a 60% market share in the industry and is one of the dominant players in india. They had a very strong balance sheet and good management. The company had a much higher probability of surviving than the other smaller players. On the contrary, I would say that a recession wipes out the weaker players and the stronger ones gain market share and strength due to lesser competition.
– If you listen to gurus and pundits, and don’t do your own thinking then you are likely to be in trouble anyway.

The post of LMW received a big number of hits and I think a lot of people found the company attractive.

I bet you would be thinking that I am busy patting my back !. I am not. In hindsight (which is 20/20), I think I was not aggressive enough and did not commit enough capital to the idea. I was personally quite confident of this company and a few others and still bought very cautiously. The caution had more to do with my extreme risk aversion and less with a specific idea. Anyway, I am working on that.

Let’s look at how the company performed in the last 2 years
– The topline of the company collapsed by 50% in the last 2 years
– The bottomline of the company came down by 60%+
– The return on capital has dropped, but is still at 50%+ levels (excluding surplus cash)
– Fixed asset turns dropped from around 4.1 to 2.5
– The company is still working capital negative (operations generate working capital instead of consuming it)
– Net margins have dropped from 10%+ to around 8% range (excluding other income)
– Net cash on the books (excluding customer advances) increased from 250 crs to 520 crs and total cash from 670 crs to around 830 Crs.
– The management has indicated plans to develop some land in Coimbatore (a real estate venture). This is a bit of a bouncer !

So what grade do we give the company ? I would say A and no I am not out of my mind.

In case of LMW one has to distinguish between the factors which cannot be controlled by the management (external environment and demand) and which can be controlled (their own cost structure and profitability).

The topline and bottom line dropped as expected (which is why the stock was selling for 500 and discounting this performance). However the management did a decent job of controlling the costs and still managed to generate profits during the downturn. There are very few companies which can remain profitable in face of a 50% drop in topline with a profit margin in the 10% range.

Where do we go from here?
The stock is now selling at around 2400. The company has announced a buyback to use up the extra cash, which is a good sign though not a great timing. The current price is partly discounting the expected good performance of the company.

If you assume a net margin of around 8-9% and topline growth of 10%, then the fair value can assumed to be around 2900-3100 range. The stock is slightly cheap, but not a bargain at current levels.

Annual review 2010 – Balmer lawrie ltd

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Balmer lawrie is a decent size holding for me and hence I make it a point to review the annual performance in detail. The annual report for the company was published recently and I have been looking at it. Following are my thoughts on the performance of the company –

I have written about the company
here earlier. The company has been doing fairly well and the management has been moving the company in the right direction. The changes are not obvious from the overall results, but if one analyses the individual businesses of the company, the picture turns out to be much better.

Let me list some statistics (for last 6 years) of each of the SBU of the company and then give my thoughts on it
Industrial packaging (steel drums/ barrels etc) – Revenue growth per annum: 14%, Profit growth: 29%, Average ROCE: 18%+
Greases and lubes – Revenue growth per annum: 19%, Profit growth: 26%, Average ROCE: 15%+
Logistics (the largest division in terms of bottom line) – Revenue growth per annum: 8%, Profit growth: 19%, Average ROCE: 150%+
Tours and travels – Revenue growth per annum: 11%, Profit growth: 14%, Average ROCE: 30%+
Others (tea, leather chemicals etc) – Revenue growth per annum: -5%, Profit growth: negative, Average ROCE: negative
Overall company – Revenue growth per annum: 11%, Profit growth: 30%+, ROCE: 25%+

A few key points stand out
– The management is moving the company out of the unprofitable lines and investing into profitable businesses. They could move faster, but I still appreciate the performance as they are operating in a PSU environment with unionized labor.
– The management has improved the Return on capital for the good businesses too in the last 5-6 years. For example – logistics, travel etc have seen improvement in capital returns
– The management has paid off all the debt and has surplus cash of almost 300 crs on the balance sheet
– The management has raised dividend rapidly in the last 5 years and the current dividend is almost 4% of the CMP.

I personally think that the management has done a fairly good job of delivering good performance in tough business segments.

A few more points –
– The company has a few JVs (joint ventures) also. One of the JV (TSL) had a fraud and misreported the results for the last few years . As a result Balmer lawrie has prudently written off the investment in the JV. This has depressed the company’s profit for the year.
– The company is investing in the logistics business by opening new CFS. In addition the company has exited most of its unprofitable tea business in UK and hopefully will do so in india too.

The company should be able to make a net profit in the range of 130-140 crores for the year (including JVs). I think a conservative estimate of fair value for the company is around 1300 Rs/ share.

Perception driven investing
There is a lot of perception driven investing in the market. A lot of investors, including me, make decisions based on certain pre-conceived notions. A few of these notions are true, but some are just assumptions which have never been validated.
– PSUs do not make good investments: The assumption is that the PSU label means a poorly run government company which is always losing money. This is however always not true . There are several profitable and well run PSU such as Concor, BHEL etc.
– MNC are attractive investment: The assumption is that the MNC subsidiaries are run by well educated and professional managers. Hence they are good investments. The reality is that these companies are fairly well run, but not for the benefit of the minority shareholders. There have been a lot of instances where the top management has stiffed the minority shareholder to benefit the parent company
– Small and mid caps are risky: All stocks are risky if you don’t know what you are doing. Even walking in the house is risky, if you close your eyes when doing so.
– Rohit is smart, handsome and good looking: This is not a perception, but absolute truth 🙂 even if no one including my wife refuse to agree with it.


Balmer lawrie has suffered from a PSU discount and has always sold below fair value. At the same time it has given 35%+ returns per annum (including dividends) to shareholders who have been diligent enough to evaluate the company beyond the labels and patient to hold on to it for the long term.

I think it is important to check one’s assumptions and perceptions before making a decision. You may be surprised by what you find – that is other than the last point about me, which I can assure you is not a perception but absolute reality 🙂

Ignore the index – clearing some confusion

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As expected, my previous post got a lot of good comments and emails questioning my logic (and sanity 🙂 ) . Most of the comments highlighted a lot of valid points against my assertion, that one should ignore the index when investing directly in stocks. I can bet a lot of you must have rolled your eyes when you saw the title and read the post 🙂

The main reason why my previous post may have appeared rash is that I did not explore all the nuances of investing, while ignoring the index. Let me start by highlighting some assumptions behind the previous post

– My key assumption behind the previous post was that the investor is investing for the long term and would not be bothered by short term fluctuations of the market or the stock price.
– The investor is a reasonably informed and diligent investor (a do it yourself kind of person)
– The investor has done his or her homework or analysis and has sound reason for believing that the stock is undervalued. In other words, the investor has evaluated the business well and believes that the company will do well in the long run (increase its intrinsic value).
– The investor is looking at building wealth in the long run and would be satisfied with above average returns (couple of percentage points above the index in the long run) and not looking at beating the index every quarter or year.

Let’s explore further by what is meant by investing while ignoring the index –

Sound fundamental analysis
The first requirement for this type of approach is that the individual has analyzed the company in detail and has good reason, backed by experience, to believe that the company will do well and the stock is also undervalued.

It is common to find undervalued and cheap stock during bear markets and market panics. It is however not a fact written in stone that one cannot find cheap stocks during bull markets and overpriced one’s during bear markets (hint – look at bharti airtel’s performance since Jan 2009 during which period the index has almost doubled).

When I suggested that one should ignore the index when investing in individual stocks, I did not mean that one should stop thinking and buy a stock which does not offer a good margin of safety. My assertion is that the process of evaluating a company and deciding if it is undervalued or not is not linked to the index levels.

A stock is undervalued if the current price is well below the conservatively calculated fair value of the company (which depends on the future performance of the company). This undervaluation or overvaluation does not depend on whether the index is overpriced or if it is raining in Timbuktu.

What if the market drops?
If you believe that company is selling below the fair value and you have confidence in the long term performance of the company, why does it matter if the market and the stock price drops after you have bought? Is it a tragedy that you bought a stock at a 50% discount to fair value and the stock went to 60% discount before eventually reaching fair value and giving you a 100% return in the process?

Is your approach to buy at the very bottom and sell at the absolute top ?

The problem with most of the investors is that they look at the short term price performance to validate their analysis. If you have that mindset, then it is very difficult to hold a stock for the long term as almost every other company which has given good long term returns has had short term spells of absolutely disastrous price performance.

The sole validation of your analysis should be the fundamental performance of the underlying business. If the company does well, the stock price will follow in due course of time. In the short run, the stock price will be influenced by market sentiments, news, liquidity and god knows what other factors. In the long run (usually 2-3 yrs), the price does catch up with value.

If on the other hand, the underlying business performance starts going south, then the best course of action is to sell and cut your losses (easier said than done). You will lose money in such a company even if the index goes up.

Buying the stock cheaper
The other argument I read repeatedly is that the stock price will come down when the market drops and an investor should be patient to wait for such opportunities.

I am all for being opportunistic and keeping some cash on hand to take advantage of such opportunities. I did not recommend that one should be fully invested during bull runs and not have some cash around if an opportunity presents itself. Asset allocation depends on several factors (age, target allocation % etc) and should be made based on your personal preferences.

Let’s say you do have ample cash and have to make a decision on a specific stock. If however you think that the market is too high and would like to wait for the market to drop to pick the stock cheap, then how do you know if the market will drop in 1, 3 or 8 months. In addition, can you be assured that the company will not keep doing well during this period and even if the market drops, the price may never drop to the current levels?

Finally, if you are confident that the market is going to drop soon (based on some logic or intuition), then are you buying index puts to benefit from it? If the market drops as you thought, then you will make money on your puts and also be able to buy the stock cheap !!!

Should you invest blindly during bull runs
I actually got accused of saying this in the previous post ! I personally don’t recall making this statement. Ignoring the index does not mean that you become blind to the valuation of individual stocks and start investing like a monkey.

It is true that stocks are usually overvalued when the market is in a bull run. Usually does not mean always and all the time.

My suggestion is this – disconnect the process of analyzing the stock and deciding whether it is undervalued or overvalued from the level of the market, GDP growth projection and other macro factors. One should focus on the specific factors which will drive the performance of the company and based on this assessment, decide if the stock is undervalued or overvalued.

If it is undervalued start buying! If you think the market will drop, then buy slowly and add to your position when the price drops. If you are wrong, then you would have missed a good opportunity. ofcourse all of this is easy to say and tough to execute.

The most cherished assumption
The market level seems to be one of the most fundamental drivers of buy/ sell decisions for most investors. I personally think it is worth evaluating this assumption and not dismissing it without thinking about it. You can always test it with a single stock or a very small amount of your capital and see if the assumption holds up.

The downside of this test is that you could lose a small amount of your money, but the upside is that it could open up a completely new way of thinking about the market and investing.

Ignore the index

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I regularly try to understand the assumptions which drive my portfolio decisions, which in turn have a major impact on the long term returns . There is a fancy term for this process – meta congnition or ‘thinking about thinking’.

I have realized (and will continue to discover) that I have made sub-optimal decisions in the past due to various assumptions. One of the most damaging assumptions has been this – One should buy stocks when the market is low and sell when the market is high.

This assumption and way of thinking is more or less a stupid way of investing in the markets. I have engaged in it in the past and have paid a heavy price in terms of opportunity cost

Reason behind this thinking
I think the main reason behind this thinking is due the negative effect of all the media chatter and noise. The commentators on various financial channels are paid by the volume and not by intelligence. If a financial commentator recommended a great stock or great idea and then asked you check back after one year, do you think they will remain in business?

As a result of this bais (towards unnecessary activity), the media and a lot investors have to discuss about something. Now, you can’t discuss about the fundamental performance of stocks every day ..isnt it ? so what better topic to discuss than market levels and price action of various stocks?

Does the market level even matter ?
The first question I am asked after someone comes to know that I invest regularly is – do you think the market is high or low and should they wait for a particular level before they starting putting money into the market ?

What do you people mean by the market level ?

The market level is usually the index which in turn is a weighted average of a fixed number of stocks (for example nifty is an average of 50 stocks). So the notion is that the market is overvalued or undervalued at some number at a particular point in time.

The problem with this question is the market level is immaterial if you want to buy individual stocks. If the stock you want to buy is overpriced, then a low market does not matter and vice versa.

The only case where the market level would matter is if you plan to invest a large sum of money into the index.

How has this assumption hurt me?
I have engaged in this convoluted thinking in the past. As a result, I have slackened during bull runs assuming that most of the stocks would be overpriced. The reality is that even during bull runs there are stocks which are undervalued, but it takes more effort to dig them out.

I abandonded this thinking two years back and have started looking for good ideas irrespective of the market level. If the stock is underpriced, I will create a position in the stock irrespective of the market levels. If the market drops and the stock drops too, then all the better as I am able to add to my position further at a lower price.

A real example
One can have several counter points to the above thought process
– Should one not wait for the markets to drop so that you can buy the stock even cheaper?
– Will the stock appreciate if the market drops and remains at lower levels for extended periods of time?

To the first point – if you can see the future (know if the market will drop in the future), then either you are a gifted person or completely delusional. If you are gifted, then use your talents to do something big or world changing.
One cannot invest based on hindsight and we have to make decisions based on what we know now (the stock is cheap or not based on current facts!)

On the second point – The long term returns of a stock is dependent on the level of undervaluation and fundamental performance of a company and not entirely on the market level. As an example, in early 2008, mid cap IT stocks were among the most ignored group. The future was not bright for them.

I wrote about IT stocks (NIIT tech in particular) in Q2 of 2008 and felt that the market was over discounting the future. Interestingly the future turned out to be worse than anyone imagined. Inspite of that, these companies survived and have done fine.

The market has since then corrected the undervaluation and these stocks have doubled during this period whereas the index (aka market level) has been more or less flat.

Focus on the important and knowable
As warren buffett has said, an investor should focus on the important (fundamental performance of a company) and the knowable (current performance and not future market levels). The rest is noise and a smart approach is to ignore it.

The secret of high portfolio returns

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There is none.

If you were expecting me to share some magic key to super high returns, you must be disappointed. It is amazing that there is an entire segment of the financial industry which is into selling all kinds of special ways of making very high returns with minimal risk and absolutely no effort. I will not blame the seller alone for selling
snake oil. They would not be able to sell this garbage, if there was no demand for it.

If one leaves aside the clueless and the greedy, the rest of the investors still live under several myths. Let’s look at some of the prevailing myths

Finding a multi-bagger is key to high returns
The number one aspiration of a lot of investors is to find the elusive multi-bagger or better yet a ten bagger. If one can find and invest in a multi-bagger, then he or she is all set for life.
I don’t deny the thrill of investing in a multi-bagger. However unless one has a focused portfolio (with 3-5 stocks), a multi-bagger will not make a huge difference to the overall returns.

The problem with focusing on multi-baggers is that one loses sight of the main objective (getting good portfolio returns) and ends up confusing the means with the end. A lot of times a mindless focus on multi-baggers blinds one to good opportunities, where one can make good returns (30-40%) in a decent period of time.

In addition to the above problem, new investors become susceptible to fly by night operators and other shady services which promise multi-baggers and quick returns.

Finally multi-baggers are the result of a good investing process, patience of holding the stock over a long period of time and ample luck.

Leverage
I have heard from some readers that they have considerable leverage in their portfolio and it has helped them to get high returns.

I am personally against leverage. High leverage is enjoyable when the going is good and one is making high returns, but it can kill your financial well being when things go wrong. The whole 2008-2009 financial disaster was a lesson in excess leverage, both by individuals and financial institution.

John maynard Keynes said it best – The markets can remain irrational longer than you can remain solvent.

Inside information
The other common myth I have heard is that the markets are completely rigged and the only way to get high returns is to have access to insider information.

That may be true. It is quite possible that there are several shady operators in the market who try to manipulate the market and have been able to make a killing as a result.

It is however incorrect to blame the market operators alone for the losses of the small investor. A lot of time, cheats and con artist are able to take advantage of others due to their greed and fear. This is not limited to stock markets alone and one has heard of such stories in lots of other cases, especially if money is involved.

Super high intellect
The other common myth is that one is born with some kind of ‘finance’ gene. Such super talented investors can make money effortlessly and are destined for greatness. This myth is not limited to finance alone and extends to a lot of other areas such sports and education.

This is an topic is of great interest for me and I have read a lot on it (as I consider myself to have no inborn talent for investing).

The question is this – Is extreme skill, such as being a great investor or great sportsman the result of an inborn talent or something which one can develop over a lifetime?

There are a lot of great books on this topic – talent is overrated and mindset. My personal conclusion for whatever it is worth is this – Extreme skill is the result of a lot of focus and hard work over a long period of time.

There are lot more myths and I could go on and on. The key question is what drives high returns?

The key points which I think drives portfolio returns are quite simple and can be listed in a couple of points

1.Continuous learning with the aim of constant improvement
2.Intellectual humility to learn from one’s mistakes
3.Hard work and intense focus

I don’t have any research to back the above points and state them from my personal experience and what I have read of other super-investors and top performers.

It is true that talent plays a part in one’s success, but intense focus and hard work drives eventual success far more than talent alone. I don’t think there is any great investor out there who has also not worked extremely hard over a long period of time to achieve that level of success. There is nothing natural in picking a good stock.

The counter point to the above statement can be – Do you think that working hard will make you a warren buffett or rakesh jhunjhunwala ?

I think this statement or thought misses the point. I may not become a warren buffett (highly unlikely), but working hard and focusing on this skill over a long period of time will definitely make me a much better and hopefully successful investor.

Borrowed Idea – Gujarat reclaimed rubber products

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A disclosure first – This is a completely borrowed idea. I originally saw this idea on Ayush’s blog and started investigating it on my own. I had some discussions with him on the phone and liked the story behind the company.

The idea is a borrowed one, though hopefully the thinking is not (Ofcourse if the idea succeeds it would become my original idea as i would conveniently forget the source in due time 🙂 ). I personally have no qualms of borrowing ideas from other smart investors like ayush (would highly recommend following his blog), though I will provide due to attribution to the original idea if I post about it.

I will not repeat some of the analysis here as ayush has done a great job of it. You can find the analysis here. Let me add some additional thoughts to the analysis

Competitive analysis
The Company has been able to sustain a fairly high growth and profitability for the last 8-10 years. The company currently enjoys a 35%+ market share in its business niche which is characterized by a large number of players from the unorganized sector.

The company has been expanding rapidly and is now enjoying the benefits of scale in production and sales. The Working capital turns have been going up steadily over the years which is an indication of the operating leverage (Fixed asset turns have not increased as much due to constant capacity addition). The company is now one of the largest company in its sector and is now exporting almost 57% of its total turnover. An effective sales and marketing organization is required to develop and sustain an export business as it requires a close relationships with the OEMs (tyre manufacturers and other users of rubber)

The competitive intensity from any large players is likely to low as this is not a big and attractive segment for any big player. The company enjoys a substantial competitive advantage over smaller player due to economies of scale, customer relationships, strong sourcing network (for waste rubber) and ability to invest in research.

Risk
The main threat is low cost import of tyres from china which can hurt the OEMs directly and Gujarat reclaim indirectly. In addition this is a very competitive industry with a lot of competitors and it is unlikely the company can earn very high profits for a long time.
The price of rubber also plays an important part in the profitability. As the price of virgin rubber has increased, the substitution by reclaimed rubber has gone up too. The substitution effect may slow down once the price of rubber starts dropping.

Competition
The company does not seem to have any major listed competitors, though there seem to be a lot of
smaller competitors. A company like Indag rubber is not really a direct competitor even though they operate in the tyre industry. Gujarat reclaim provides cheap substitution of a raw material used in tyres, whereas indag provides a substitute for the end product – tyres itself (via re-treading).

Valuation
The fair value of the company can be estimated to be between 1700-2000 with an assumption of 8-9% net margins and growth in the range of 10-11 %. The company is selling at a decent discount to fair value and would be quite attractive if the price drops below 800.

Disclosure: I have a position in the stock. Please read disclaimer at end of the blog.

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