Investing Gurus

 One sees many investing gurus, being talked about in glowing terms. One of them definitely is Warren Buffet.

Many of them have been giving a CAGR of  20% or more over the last so many years and one wonder's what is it that they possess that other ordinary investor do not possess.

My personal view is as follows:

a) One is their Patience. Their immense patience to wait out their convictions. They do research, study how the market will move and the demand and supply of the products they are investing in etc. All these in hindsight seems interesting and understandable, but was it at the time when they were investing. I can understand investing in a Coke or Gillette company thinking that people will continue to drink coke and men will continue to Shave and innovation and marketing to keep the products in shelf and attract. But things need not always be like this. Imagine someone investing in Nokia thinking mobile is the in thing and nothing can displace it. It went into oblivion for some time and space taken over by Apple and Samsung. Maybe not many would have thought these two will be such a success. Apple too went into a tailspin for some time before the brilliance of Steve jobs with ipod, iphone, ipad put it back on to the limelight. But in all of these investing gurus would have continued to remain invested and possibly bought some more.

b) Position Sizing- The second most important thing is they take large positions and accumulate over time. They get some close management information on how the things are working and where the business is leading. This is something you and I will not be privy to as our position is probably 100 or 200 shares or even 1000 shares while these investors have million shares. With position, they are able to get some information which others have to wait till it is public. One recent example is paytm bank and the RBI strictures. There is a rumour that many big ticket investors quit before the news came out as they were already aware of the goings on. And now they may pick it up at a lower price and thus control the number of shares which will help in future.

c) Conviction- Because of so many discussions with management of different companies, they get an idea of where the business is growing and what are the pitfalls. Our information is only when it is published and becomes a public document.  It can work both ways. Some business may say that there is a huge potential, which actually does not materialize, some may. Investing Gurus can afford to lose a Million to gain 10 million. Their diversified portfolio and position makes them lose less and gain more. Nobody can predict the future, but some can predict the direction of the future and these do. They also fail some time, but overall they are in the money. Harshad Mehta, the story goes, said that ACC Company equivalent will require huge capital to invest and nobody has that capital to build it. Thus his investment in that stock raised the ACC stock price to an extremely high value, but now it languishes as more players, either by takeover or new green field plant has come up increasing the capacity of cement many times.

d) And finally, the first few years of making millions is difficult, but once a large amount is made, multiplying it with a reasonable safety gives it a tremendous leverage that helps them in outperforming ordinary shareholders.

e) With their volume they can move the markets up or down and can through words and thoughts make other small investors follow through with their sayings and while not all practice this, many do.

So, what is the learning. Diversify a bit, increase position sizing in good companies (where you are convinced it will exist after 10 years also) and wait out long for the market to reach euphoric levels to cash out some of the investment if required. As you do this you will also learn more about the companies and markets which will help you invest wisely. Use screeners to get past 5-10 years data and see the trends and the P/E, ROCI, general trends of business in those areas to get a foothold in the market. Rolling returns are a better way to understand ongoing business.

Swimming and Investing

Swimming and Investing have much in common. If you do not know how to swim, you will be stuck in deep waters and with dreadful consequences. Similar is the investment pool. You will land in a big mess if you have not done your basic learnings.

Just before you jump into a pool, you need to wear a proper dress  in investing too you should have an expendable amount of money which you may lose but still not feel bad.

The next step in swimming  is testing the waters and remaining for some time in the shallow waters and kick around and see if you can float. Investing also requires you to read a lot and test a few of your hypothesis to see if it works or it fails and relearning them and trying to ensure you do not lose all your money at one go.

Then a few runs across the pool on the shallow side to see if you really picked up the basics in swimming. You may sometimes feel you are drowning, but since you are in shallow water, you can get back. Same way in investing, you can start with a few mutual funds and stocks and test the results of your hypothesis and even if you lose money you can still recover.

As you learn swimming and become better, you take more risks by going into the deeper side of the pool. In Investing, it is the  riskier shares or assets that you put your money in and the amount of money you put in ( position sizing).

If you have learnt your basics in a swimming pool, as you venture into the river or sea, you will notice that the pool now is not just a stable place, but has turbulence that is up and down. As you swim, you start picking up the up wave and float in the down wave. Investments journey is also like that over a long period of time. There are down periods where you invest slowly but surely in businesses you know will grow once the up periods come. And once the up periods come you will be rewarded substantially, which you may partly en cash and continue the ride or the swim.

 

Dakshinamurthy- A way to analyse stocks

 Dakshinamurthy- an invocation to learning is used here to analyze stocks. Of the various methods, this is one of the methods I have suggested to study stocks and my belief is that given the various parameters that are used in analyzing the stock, it is expected that most of the stocks analyzed this way will hold your investment ship steady for long. Like no one can predict future, there is no guarantee of these predictions going right as based on past data, but the past path that has been laid is a sign or indication that the future paths will also move in the right direction.

How to go about this analysis. 

I believe, a 5 year trend is neither too short or too long a period to analyse the stock. In an economic situation where every year changes, a look too far in the past may not provide the same perspective as a medium term analysis. Thus a 5 year trend is preferable.

 Second, the rating range is given. Rather than someone rate for you, it is better you rate to ensure consistency in the rating and as per your liking. Thus a high debt may be to your liking and may give a 6 or 7, while a person who shuns debt may give it 1 in case of high debt companies. Thus this analysis, rather than imposing someone's thought, tries to help you understand the business and rate it. This is an important learning as you gain confidence and convincing in a company you invest and can blame yourself and not others in the path of investing.

Third, I have provided a rough range as a guide and not fixed what should be the total at the end that gets you to a thresh hold that should make you comfortable in investing. This is because each individual is different and has to take his own responsibility/call to invest.

Fourth, I have below this formula given a brief of what each of this item means, which could guide you and make you learn in the art of investing.

 

				5 years trend
D	Debt	1-10		Zero debt 10, high debt 1
A	Asset Return	1-10		ROCE- @20%(10), less 1-9
K	Capital	1-10		Adequate funding/Promoter holding high/<10% 1, >70% 10
S	Sales Growth	1-10		Last 5 years Sales growth every year @10%10, else 1-9
H	Human Resources	1-10		Quality of HR/Attrition rate/Key mgt. change
I	interest coverage	1-10		EBIT/Interest
N	Networth	1-10		Reserves sufficient/P&L balances
A	Analysis-Ratio	1-10		OP Margin/GP Margin -growing-20%
M	Money-Cashflow	1-10		Consistent Free Cash flow
U	Understanding of business	1-10		What business/moat/future growth
R	Rate of Profit Growth	1-10		Last 5 years Profit growth every year @10%10, else 1-9. Rolling Returns growth
T	Type of Business	1-10		Nature of business-Steady (10), cyclical (5)
H	High/Low Trend of Share prices	1-10		Volatility / PE (<15,10) (>20,5)
Y	Yield of Dividend	1-10		Consistent Dividend trend, yields etc.

Assumed meaning of the terms used above
Remarks D Debt Higher debt involves higher risk A Asset Return Higher return shows better utilization of assets K Capital Higher Promoter holding shows promoters confidence S Sales Growth Shows Company's growing market. Demand H Human Resources Shows HR confidence in cpy. I interest coverage Debt taken and Interest is manageable. Higher cov better N Networth Build up of a fort for bad weather A Analysis-Ratio Butter of the Company. Likeability of product M Money-Cashflow Ability to remain afloat U Understanding of business Competition/Product uniqueness R Rate of Profit Growth Bottom line. Managing overhead costs. Rolling returns T Type of Business Ups and Downs H High/Low Trend of Share prices Market acceptability amongst brokers Y Yield of Dividend Payout. What Company is ready to pay out. Cap. Allocation
					Payout. What Company is ready to pay out. Cap. Allocation

TERM INSURANCE

Term Insurance-

Term Insurance is an oft repeated word you hear in any investment planning. What is Term insurance? Term insurance is a type of life insurance policy that provides coverage for a specified period of time and in the rare event a death happens, a death benefit amount is provided to the nominated member or heir (generally family member).

Key thing to note is that the person on whom Term insurance is taken is not the beneficiary. It is his family or heir whom he has nominated to receive the amount.

Since Term insurance per se is not very beneficial to Insurance companies, they generally club it with investment and have many variants like pension for life for the family, return of the amount after a certain years etc. What this effectively means  is insurance company takes extra money and probably invests @12-15% returns but gives you @3-4%  and thus makes money. ULIPs is one example of extra money being taken for life benefit.

So, what should one do? Should they take Term Insurance at all?

If you have a family and care for them or old parents with no source of support other than you or any such close relative who are all dependent on you providing them financial support, it is critical to take a Term Insurance. The reason being after you, who will take care of them and provide the basic necessities.

Thus a pure Term Insurance (i.e without any investment product attached to it) should be taken for a significantly large amount ( say, 15-20 times of your current annual income). This comes at a small cost (as young people in their 30's who take such insurance are expected to live at least beyond 60 and risk to insurance companies is small). Note that insurance companies work on probabilities and if risk is high, premium is high, low risk lower premium. This is based on the payouts in the happening of the event. Further, their payout risk decreases if the person commits suicide or such other clauses they put in fine print. 

Overall, the Term insurance is a standard product with a few clauses like self inflicted death not covered, but payout on death of the person taking the insurance is normally a given. Further, to protect the beneficiaries, these do not allow loans to be taken keeping it as a collateral.

Amongst the many reasons why a large amount is taken for Term Insurance are a)  in the event any incident of death happens, the family/beneficiary gets a significantly large amount for them to put in, say, FD and earn interest to keep themselves off the streets and b) since the risk for the insurance companies is small as it is a single event (death) and probability is less at a young age, the premium is also small for such a large amount.

Who all should take the Term Insurance.

a)  As mentioned above, if you have people to take care and are dependent on you providing them support you should take the Term Insurance. 

b) If you have take a large loan for a house to stay for your family and beneficiaries and EMIs are there, you should take the Term Insurance.

c) If you are in a business and significant debt, you should take both Term Insurance as well as Key Money Insurance (which your business entity pays) to meet your debts in the event of any untoward incident to you.

Please note that the payout will happen only on death and not on serious injury or disease you suffer. For that health insurance comes into play.

For how long should you take the Term Insurance

As I said earlier, the Term Insurance is cheaper to take when you are young. As you grow older the risk to Insurance Companies is larger and a higher premium is charged. Many Term Insurance plan comes with 10-25 years locked premium where if you join in your 30's you pay a small fixed premium every year till you are 40 or 55 years. Beyond 60's the risk of death increases and thus premium increases. But most people, by the time they reach 60's are financially secure and for some the older dependent parents are also no longer there and the financial risk is only for the immediate family member, primarily the wife, as children also would have by now taken a job after education etc. Best is to assess the financial situation after 60 and then go for a term insurance if required, but note that the premium would be higher.

To summarize, Term insurance, apart from health insurance, must be in any young person's investment portfolio and Term insurance can be kept till you reach a financial comfort zone where you feel paying this extra amount does not add any significant value to my support for my family or any liabilities clearance that I have. At 30's till 50's it is critical to have, beyond 60 it is a choice 

There is another insurance called the Key Man insurance and this is applicable for business where the insurance is taken on a key member of the business as in his absence the business could collapse or take a long time to recover.

 

CASTE

 Caste as a construct has been vilified by the west and milked dry by the Indian politicians for their vote banks.

Let me at the outset, make it clear that I believe in equality and do not discriminate against economic caste, religious caste, occupation caste or any other caste for that matter. 

My view of Caste in India arises more from the division and classification of work associated many years ago. It exists even today in this world in a different way, not just in India and I will come to that argument a bit later. Going back ages ago, a little smarter and knowledgeable guys became the brahmins who used their brains as the weapon, a more aggressive and fighting class became the warrior class, the smarter in terms of managing money became the business class and other classes depended on the work they did like a plumber, mason, cleaner etc. etc.

And in order to protect each one's hold in the group, they prevented intermingling of jobs amongst the groups and it was kept that way to prevent more supply than demand. At the lower end, since they were poorly paid for the manual work, they tried to ensure their child/children also picks up that task and the parampara (lineage continues) and provided a steady career, albeit a lower income. It ensured at least a skill was learned and a job could be obtained.

Since 1947, when we got independence and wanted to remove the caste system to ensure every citizen had a right to work where he pleases, we brought in the reservation system to uplift the lower strata of people to higher learning and income category. We thus have now had 75 years of reservations to uplift these people. Question to ask is "Has it really uplifted them or created a new caste (or class as we call these days) amongst the rich lower caste who ensured the reservation continues ad-infinitum. My belief is that for reservation to be truly effective, those who got reservation should be allowed only 2 generation of reservation and move on and give space to the next economically weaker section of the lower caste. One cannot continue to be rich and still take the benefit of reservation.

The second point on reservation is the quality of work. While the focus should be on primary and secondary education, lowering the standards, through reservations using a lower cutoff in marks, in colleges and critical areas of medicine, engineering causes immense damage to society. Not only Indians, would anyone in the world employ someone who did not study but breezed through college because of caste and lower marks passing was the order of the day. It is important to bring their education and financial levels to the top in such a way that they focus on the studies and be equal to those who got admission without reservation. Reservation cannot be a tool to pass through college without effort.

Coming back to my argument of the first para, where I said I will revisit. Everyone talks of caste system in India. Does it exist only in India. My belief is it exists all across the world  though subtly and stealthily done. The borders across nation is a caste system of discriminating people and casting them as belonging to X country or Y country. True caste less system will be like a Vasudeva Kutumbum- everyone stays together and does their job for the benefit of the world.

Again, would any of the richie rich marry off their children to a plumber or sweeper. They will look for a match that matches their financial strengths so that it is easier for the person to adapt. This is also a type of casteism which people will not talk. In many countries, they have adopted consanguineous marriages (at the cost of giving birth to impaired children) to keep their core class to themselves. This too is a casteism.

Again, would the sweeper or plumber or electrician be paid a high salary that enables him to live a good life and send his children to good schools and colleges. This is also casteism to keep them lowly paid and ensure work is done generation onwards by their families.

Maybe USA of the old times only had a true caste less society where people get paid as per the work they do and marry whom they please and caused by a huge migration and opportunity aplenty.

To conclude, casteism or whatever form it is called by, can be truly wiped out only in a borderless world, paid fairly well for all types of work (not just huge payouts for bankers, consultants, only), not much disparity in pays and human ability to work any type of jobs and given equal respect - be it an MD or a lowly worker.

It is only an Utopian dream to have a uniform society like above across the world and caste or what ever name it is called by  or even not called as such will continue so long as pay and work differentiation is there for jobs .

Valuation

 Valuation is the Buzz word for all finance guys in the financial market. But what is valuation. Valuation basically means what a company is worth now and likely to be in future.

While what a company is worth now can be obtained from its assets and liabilities in the balance sheet as well as how it has done in the past, valuing a company in the future is at best a shot in the dark. Why do I say that? Because nobody can predict the future. Future is so uncertain and has political, policy, regulatory, business impact, alternate business impact, competition and so many other variables to correctly predict the future.

When it is difficult to predict what is going to happen in the next minute (if it can be predicted, there will be zero accidents or disastrous events), how can one look at a crystal ball of the future many years hence.

Another non physical factor in a Valuation is a bias like if your job is to do a valuation for a client, you will try to match the figures of valuation that looks nice to the client, irrespective of what your model says. eg. If your model growth of sales is 5% and you value the company at $50 and client's expectation is $100, you tend to bump up the sales growth to 15% or 20%. This bias is evaluator bias as he wants to finish this deal with the client and earn a fat bonus for himself. How else does one explain a Paytm valued at 2000 Rs and crashes to 400 Rs or many such IPO companies.

Valuation also depends on the bias you carry because of the environment you live in. Eg ITC was poorly valued a few years back and even if somebody had valued  at that time, he would have valued at 150 Rs or 200 Rs. Now with the prices touching 600 Rs, if the same evaluator does the valuation he will do around Rs 550-600. This bias of going towards the market price valuation happens because you do not want to be proved wrong. If it goes down, you can always say, Everybody said so. You do not want to put your head out like the guy Michael Burry - on whom the movie The Big Short was made. He bet against the market in 2008, as his data showed him it was going to crash. Very few in the world can take such a contrarian call.

So, how do we value a company. My personal belief is the PE ratio should be reasonable (<20 or what is the average in the industry and much less than that. Eg Tech PEs are 60-80. I prefer valuing them at 30-40- even a 50% drop is bearable. Why do I do that? Tech is a very unpredictable beast. Anything can happen with in matter of days or months. Nokia is one eg, Netscape is another, Lotus 123 the pre excel pioneer, EVs of today and possibly AIs of the future. AIs can technically replace CAs, Lawyers, MBAs or knowledge based industry. MIT courses, for eg are available for free on You tube and so many other DIY courses for which once upon a time you paid huge amounts to learn.

I follow the following 5 pointed star valuation

a) PE at a reasonable rate (<20)

b) Sales Growth - 3-5 years - growing at 15-20% per year (Rolling returns)

c) Ebitda - 3-5 years - growing at 15-20% per year

d) ROCE- 3-5 years growing at 15% per year

e) ROI -3-5 years growing at 15% per year

If all the boxed at b) to e) get ticked and PE is <20, I multiply the EPS * PE to get the value of the company.

I do not say, I will be right all the time, but hopefully most of the time as stock prices are a function of many factors- momentum, shorting, margin calls, valuation bias and a lot more.