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Bankruptcy risk analysis

By Rohit Chauhan
In General thoughts
January 14, 2024
2 Min read
B

It was the later part of March 2020 and I was really worried about the tail risks to our portfolio. I started getting worried about Covid in late feb/early march and wrote the following posts on it

Battening down the hatches

Tailrisks

And the key post in the series: Economic sudden stop in which I wrote the following

What is an economic sudden stop – It is when most economics activities for a location come to a sudden stop due to a financial or natural disaster. In most cases such sudden stops are local such as due to a flood or an earthquake.

Global sudden stops are extremely rare and have happened only during the great depression in 1930s and 2008. Even during wars, we do not have such a situation.

The current crises has the potential of an economic sudden stop (and may have started). I have been thinking of this risk (which I have been referred to as a Tail risk). Over the weekend, I drew the following crude picture to illustrate my hypothesis (please excuse my drawing)

In view of this risk, I decided to analyze all my positions for bankruptcy risk. I wanted to assess how long the companies in my portfolio would survive, if there was complete stoppage of business (revenue = 0)

I am attaching the analysis below. Please note all companies in the note are for educational purpose only. Also we don’t hold these stocks now.

Bankruptchy risk analysis

Read on

Real estate cycles

By Rohit Chauhan
In Industry analysis
December 10, 2023
3 Min read
R

I am sharing an edited note, we published to subscribers recently. A few points to keep in mind as you read this note.

  • I have a terrible track record in forecasting business cycles.
  • I got the real estate cycle wrong the last time when we added to the sector in early 2017.

That said, I am stubbornly persistent. Even if I got it wrong the first time, it does not mean I will not try again.

I wanted to start the update for this quarter with some broad comments for the sector and how it is influencing our decisions for this basket. I am looking at the real estate basket versus individual companies, in the same manner as financial services/banks.

The real estate sector is a longer duration cyclical sector like infra in comparison to the financial sector. The real estate cycle is around 8-10 years from peak to peak versus 2-3 years for financials. Again, this is not an empirically proved number, just an observation.

The Indian real estate sector went through a longer down cycle this time due to some additional events namely Demonetization in 2016, Credit down cycle in 2018 and then covid in 2020. At the same time, demand for real estate is usually steady over the long term. There are sub cycles of extra demand from investors, but over the long run demand is tied to household formation, migration, and replacement of old stock.

We had an overinvestment phase from 2003-2010 which peaked around 2011. Since then, we have had a bear market for 11 years during which the excess inventory was absorbed. I had originally estimated that the cycle would turn in 2017 but got the timing wrong (by only 6 years!)

We are seeing an upcycle now. Keep in mind that this cycle will not be a linear one. We could have intermediate downcycles within this secular uptrend. This trend is now visible across the sector as follows.

  1. All real estate companies are now reporting high double digit pre-sales. This will translate to higher reported sales in the next 2-3 years.
  2. There is a trend towards higher priced housing. Increasing pre-capita income level is driving this trend.
  3. Regulatory and other changes mean that the organized sector is capturing incremental demand. This means industry consolidation, better pricing, and higher ROC in the long run.

My gut feel (Which can be wrong) is that we are in the initial phase of this cycle, and it can continue for 3 years or more. At the same time, there will be periodic corrections as we go along.

Our investment in this sector is based on the above thesis. We are spreading our bets so that we can benefit from the tailwinds without being 100% right at the company level. We may swap positions based on the relative performance of the companies in the sector

Read on

Managing risk without timing the market

By Rohit Chauhan
In Investment process
December 1, 2023
4 Min read
M

We posted the following to our subscribers recently. Thought of sharing it with a wider audience

There was a question from one of the subscribers to which we responded via email. we wanted to share the communication with all of you. We have slightly edited the conversation and added to it

Question:  

I am fully invested into the model portfolio stocks currently, will I get any panic alert to liquidate portfolio and raise cash and wait for a dip again. Is that how your investing style works or I stay put and be invested at all times. Asking this as, most stocks are trading at all time highs. Is it possible to buy cheap and sell high!?

Our response

We think the underlying question is about timing the market and if we cannot time it, then what will be our course of action? Will we sell in panic to raise cash or just stay put and live through the rollercoaster ride

For starters, we cannot predict the stock market and so can no one else. We have spent 25 years looking at all kinds of systems and approaches and there is none which can predict the market. Some approaches can alert you to the possibility, but there is no fool proof system. If one exists, it is unlikely the practioner will ever share it.

The second part of the question is about a sudden crash and panic selling in response to it. The only scenario where everything just collapses and requires us to liquidate the full portfolio is if a major global catastrophe occurs. Unfortunately, no one can predict or prepare for it.

We have never seen a market where everything collapses suddenly. The worst case was covid which took close to a month to play out.

So how should we navigate this risk if we cannot predict.

We have a defined process to manage risk at the portfolio level and at the risk of repetition, let’s go over it again.

  1. Being diversified: We have 20+ positions in our portfolio with no position exceeding 7% and sector allocation capped below 15%. A collapse in a stock or a sector will hurt us, but not wipe us out
  2. Avoid leverage in the portfolio including F&O: No one can force us to sell
  3. Have sufficient cash: This is not part of our advisory, but 101 of personal finance which all of you should practice. Have proper equity allocation based on your age, and risk tolerance and enough cash to cover personal expenses for 6 months
  4. Stop loss on all positions: This acts as a circuit breaker at the stock and portfolio level. If the stop loss is hit for a stock due to company, sector or market related reason we will exit from a risk management standpoint. We will cap our losses and look for reasons at a later point. These stop losses are reviewed monthly and in advance so that we don’t have to make decisions in the heat of the moment

Our approach is to buy and hold each position till either of these conditions are met.

  • Stock becomes extremely overvalued, and we decide to cut position size to manage risk.
  • Company level issues occur and causes me to lose confidence.
  • Stop loss gets hit for obvious or unknown reasons.
  • A better idea comes along.

In summary we have a process laid out to manage risk level in the portfolio via diversification, position size and finally stop loss so that we don’t have to predict what will happen. As we cannot predict, our only option is to react to what is happening and if a dire situation occurs, we will do what needs to be done

Read on

Beating the market is not supposed to be easy

By Rohit Chauhan
In General thoughts
November 16, 2023
4 Min read
B

“It’s not supposed to be easy. Anyone who finds it easy is stupid.” – Charlie munger

Investing is very easy when you are investing in a bull market. If you are ‘unlucky’ to begin investing in a bull market, you start dreaming of being the next Rakesh Jhunjhunwala or Warren Buffett

I used the word unlucky on purpose because every new investor who starts investing in such  periods gets a rude awakening in the next bear market

Bull market stories

A common theme during such periods are stories we hear from people who are striking it rich at such times

US covid Tech boom

“Buy quality at any price”

“Chor bane mor”

Secular growth of financial services

Perpetual growth in Infrastructure

The last one was in fashion in 2006-07 when a lot of current investors were not around

What happens at such times is that investors fit a story to the price action and think of it as a law of physics. These stories gain prominence as more investors get sucked into it. Eventually the trend runs its course and a lot of investors are left holding the bag when it eventually turns

Beating the market appears deceptively easy

Can you think of any activity in life which pays well, is competitive in nature and easy all time ? Is it easy to be a doctor, architect, actor, chef ?

Investing seems to be the only field where a lot of people get fooled into thinking that its easy. The reasons are not complex to understand

  • For starters this is a probabilistic field with returns accruing in spurts. A 15% CAGR over 10 years is not spread evenly over this period. Its more like +25%, +10%, -15%, + 18% and so on. Anyone who invests during a bull market thinks of it as normal and tends to extrapolate it
  • During such bull run making money appears to be easy. Just buy whatever is in fashion and it works. No need for any kind of risk management
  • Its easy to trade and getting easier by the day. Open an account in a few days and start trading in F&O. A thousand rupees is enough to get started. There are no qualifications or gate keepers to stop you

Performance over the cycle

Anyone can be a bull market genius. The true measure of performance is over multiple cycles which include several bear markets

Most investors get washed out after a bear market, never to return back. The few who stick around, dig deeper and learn the craft of investing. Even so, this does not assure you of above average performance

The reason for it is that the basis of out-performance changes over time. What worked in early 2000 does not work now. As I look back on my old posts up until 2013/14, it was easy to buy good quality small and midcap companies at cheap prices to make multi-bagger returns. That game is over now

In the same manner, quality at any price worked in the 2015-18 period, or loss making tech companies were the go to place in 2020. A lot of investors tend to stick with the old theme even when the paradigm has shifted

Beware of the snake oil salesmen

If you want to do well over the long run, you have to overcome your natural biases which trip most investors. One has to un-learn and relearn every 3-5 years as the paradigm shifts. If you miss one, then be prepared to live through a period of under performance till you adapt to the new one

That’s the reason why a lot of successful long term investors have said: Trading or active investing is a tough way to make easy money

I can vouch for that. I have worked in the corporate world and invested actively at the same time. I can tell you that making a living from the stock market is much more difficult than a full time job.

So anytime someone tries to tell you that beating the market is easy over the long run, keep these points in mind

  • They are trying to sell you something which is not worth buying
  • They are lying on purpose
  • They are incompetent and a bull market wonder
Read on

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