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How to be a better investor – My approach

By Rohit Chauhan
In Investing Philosophy, Uncategorized
May 10, 2007
4 Min read
17 comments
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I posted the reply from warren buffett on the above question. The key takeaway from his reply is that one should read a lot and invest your own money based on your ‘own’ ideas and analysis.

I will touch upon my approach to improve myself as an investor in this post.

I have been reading various investment related books, articles and annual reports for some time now. However my approach to it was disorganized and did not have any pattern to it. However in the last 2 years I have developed a plan to read with specific goals in mind.

I look at reading with two key objectives

1. Find new ideas (which are profitable)
2. Develop mental models to become a better investor (read this article from charlie munger on mental models)

I have broken the second objective into the following topics (related to investing)

Finance – topics such as Balance sheet, income statement, various ratios, analysis of these statements etc
Accounting – understand various accounting concepts and standards
Valuation
Competitive advantage and strategy
Probability and analysis of risk
Study of business models
Economics – mainly micro economics
Investing – value investing
Options, derivates and other financial instruments

I have better knowledge in some these areas relative to other topics. For example I have not read much on options and derivatives till date. Somehow I get put off by all the math in it (although I am engineer by background 🙂 ).

So at the beginning of the year I try to assess myself on these areas and try to identify the specific areas on which I would focus. For ex: I am currently focussing on topic 4 – competitive advantage. I identify books for this topic and add it to the list of books I would be reading over the course of the year. I run through all the topics in this manner and try to come up with a tentative book list for the year. This is not a list set in stone. If I find a better book for the topic I am interested in, I end up replacing it with that book.

In addition to the above book list, I have also listed the industry groups I would be focussing on this year. Currently my focus is on pharma. I have shortlisted around 5-6 industry groups for the year (see my industry analysis spreadsheet here). To improve my knowledge in a particular industry (related to topic 6), I read up on the annual reports of some of the top few companies in the industry. In addition, I try to read up on industry reports if I can get access to them for free.

This industry group analysis activity helps me in increasing my circle of competence and also helps me in coming up with new investment idea. Finally as all knowledge in investing is cumulative, I can easily use this knowledge again later to come up with good investment ideas.

Finally I run valuation screens and if I can get some undervalued candidates, I read up on them. This is more haphazard as I may get candidates in industries which I have no prior knowledge. However it is a good starting point in those cases. If the candidate is in an industry in which I have done some prior study, then the analysis is faster.

The last step is – as they say on shampoo labels – rinse and repeat. That is I keep repeating the above process. Ofcourse the books, the topics and the industry groups keep changing, but the approach is the same. This approach has been helpful as it keeps me focussed on areas which i need to improve and also to enhance my circle of competence

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How to be a better investor – from Warren buffett and Charlie munger

By Rohit Chauhan
In Charlie munger, Investing Philosophy, Uncategorized, Warren buffett
May 7, 2007
2 Min read
Add comment
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Berkshire had their annual meeting on May 5th and 6th. During the Q&A session the following question was asked on how to become a better investor. I have read something similar from warren buffett earlier and could not resist posting the answer to the question again. The reply goes to the heart of becoming a better investor and I try to follow it in an effort to improve myself as an investor. Time will tell if I have been successful at it or not.

What is best way to a become better investor? Get an MBA, is it genetic, read more “Poor Charlie’s Almanac”?

WB: Read everything you can. In my own case, by the time I was 10, I read every book in the Omaha Public Library that had to do with investing, and many I read twice. You just have to fill up your mind with competing thoughts and then sort them out as to what makes sense over time. And once you’ve done that, you ought to jump in the water. The difference between investing on paper and in real money is like the difference in just reading a romance novel and…doing something else. The earlier you start the better in terms of reading. I read a book at 19 that formed my framework ever since. What I’m doing today at 76 is running things in the same thought pattern that I got from a book at 19. Read, and then on small scale do some of it yourself.

CM: Sandy Gottesman, runs a large and successful investment operation. Notice his employment practices. When someone comes in to interview with Sandy, no matter his hage, Sandy asks, “what do you own and why do you own it?” And if you haven’t been interested enough in the subject to know, you better go somewhere else.

WB: If you buy a farm, you’d say “I’m buying this because I expect it to produce 120 bushels per acre, etc…from your calculations, not based on what you saw on television that day or what a neighbor said. It should be the same thing with stock. Take a yellow pad, and say I’m going to buy GM for $18 billion, and here’s why. And if you cant write a good essay on the subject, you have no business buying one share.

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My approach to selecting equity based funds

By Rohit Chauhan
In Mutual funds, Uncategorized
May 5, 2007
3 Min read
24 comments
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My previous post was on my roller coaster ride with mutual funds. I have hopefully learnt from my mistakes and used this learning to develop an approach to selecting and investing in mutual funds. It is not an original or path breaking approach in itself. However it works well for me (based on my personal risk and return preferences).

My expectations from my mutual fund portfolio is around 3-4% extra returns over and above the market returns (including the index funds in the portfolio) net of expenses. I consider this level of additional returns to be quite fair considering the low amount of effort and time involved in managing a mutual fund portfolio.

I have now developed the following approach to select mutual funds. In addition, this is an evolving approach

1. Invest in diversified equity funds with a long history of performance. I typically do not invest in funds with less than 5 years of performance history. The fund should have outperformed the relevant index by 3-4% during the period (net of expenses)

2.Analyse the performance of the fund over one bull and one bear market cycle. This ensures that I am able to see how the fund performed during the bear market and what kind of risk the fund manager was taking during the bull market. There are a lot of fund managers who will ride the latest fad, gather assets and then when the fad passes, the fund would tank completely. I try to avoid such fly by night jokers.

3.Select funds which have beaten the market returns by 3-4 % per annum for the last 5 or more years. Why invest in a fund which cannot outperform the market over the long run and pay fees for that?
4.Check the expense ratios and turnover for the fund. Unfortunately most of the funds in India over charge and only a few have the performance to justify such steep charges. I agree on this with the comments on my earlier posts. I try to select a fund with the lowest expense ratio as far as possible.

5.Check the following additional parameters for a fund. (http://www.valueresearchonline.com/ is a good website for that. It gives a fund summary for most of the top mutual funds)
a.Total asset under management – Should be more than 500 crs.
b.Fund alpha – this indicates the level of outperformance of the fund based on the risk taken by the fund
c.Fund beta, sharpe ratio, standard deviation etc
d.Mutual fund manager profile – how long has the manager been with the fund. Is it a new manager and hence the past performance not indicative of the future performance?. I also try to read interviews of the manager if I can get access to it.

Based on the above broad selection criteria, I have ended up with around 4-5 funds most of the time. After investing with these funds, I tend to check the performance once or twice a year.

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Why invest in mutual funds if you can pick stocks

By Rohit Chauhan
In Mutual funds, Uncategorized
May 2, 2007
3 Min read
4 comments
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I got the following comment on my previous post and thought of putting my response to it in a post as I think it would help in putting my approach and thoughts on mutual fund investing in perspective.

“Low risk, low gain” is fundamental philosophy found true in every walk of life. I am surprised Why people like you, who can take risk after calculated move on the stock market, purchase mutual fund by paying hefty fee to suited gentlemen who musroom on CNBC and other TV channel giving alwyas buy advice in the time of Market going up and up? Find them when the market goes down……They will vanish.
Its my feeling that Mutual Fund is for those gullible masses who wants return on their capital but have no knowledge of stock market .Not like people like you, because why take risk on somebody feeling when you can take for yourself? That too by paying astronomical fee .

I do not agree with the above comment in entirety. True, there are several mutual funds which end up serving the asset management companies and their managers. A lot of these guys are just airheads who come on CNBC and other channels and spout useless drivel. Frankly I rarely watch these channels, they are at best a distraction and noise and just a form of entertainment. However, I would not sweep all the mutual funds with the same brush.

I consider mutual funds to be an important component of my portfolio in addition to stocks and other forms of investments. The reasons are as follows

– Low cost mutual funds with a good, consistent history are a good way of investing in the market and getting above market returns (the low cost and consistent history part is crucial). By selecting a mutual funds based on specific criteria (which I will post shortly), I can try to avoid the type of risks mentioned in the comment above.

– Mutual funds serve as a good benchmark for my portfolio. If my equity portfolio (stocks only) does not beat my mutual fund portfolio (net returns), then I am better off putting my money in well chosen mutual funds and not wasting time in picking stocks myself. In the end, investing is about the risk taken and the returns I get for it. I don’t define risk as volatility or loss of capital alone. Time spent on picking stock is also an investment for me and I see no reason to invest in stocks myself if my equity portfolio does not beat my mutual fund portfolio

– Mutual funds and ETF’s are also a quicker way of getting decent returns. I may not get the same returns as I would by picking stocks on my own, but I also end up spending considerably less time. This I say from experience.

I do not look at stock versus mutual fund investing. On the contrary for me it is stock and mutual fund investing.
Stock investing may give me higher returns, however I have to spend considerably more time on it. For every 10 stocks I analyse, I end up buying 1-2 stocks at best. Mutual funds may provide me lower returns, but I also end up spending much lesser time in selecting and tracking them on a regular basis. So in the end the returns I get compare fairly with the time and effort I spent on it. Investing for me is still a part time thing and not a profession (yet)

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