Category Archives: Fundamentals Of Investing

Right price quality.

“Quality always comes at a price”. This often repeated argument about mid-caps is suddenly looking a bit wobbly. The reason is that the price has got too stretched for comfort. Several stocks that once enjoyed disproportionate fame and following have lost a third of their peak value. Slowly, the list of correcting stocks is growing. The list of rapidly correcting stocks would grow much faster but for the Indian public’s irrationality. Retail investors are putting all their monies in mid-caps. This only means that we are committing the same old mistake of concentrating bets in one space. In 2008, it was infrastructure. We can’t have smaller companies trading at higher valuations than bigger peers. Yet, that is the irony of our markets. This is the perfect setting for volatility to rise.  Any pressure on performance or failure to meet expectations will get a brutal response from the markets. This makes the notional gains made by investors who selectively played only mid-caps very vulnerable. The drastic fall in large caps only make them relatively even more attractive than the mid-caps in relative terms. The stage is set for a more balanced approach to equity investing. We will see valuations converge over time. The latecomers to the midcap party will see the temperament get badly tested. Caution is the watchword on mid-caps. If we don’t exercise it now, our conviction will be badly tested later. Better wisdom must prevail on our approach to quality stocks. Wealth creation should be approached with greater balance.

“Volatility is a symptom that people have no idea of the underlying value.” – Jeremy Grantham

The return of Equity

The week that was has served an important pointer. The story certainly got tough for the risk averse investor. The fall in inflation triggered a sharp fall in bond yields. This effectively closed the option of investing in bonds as most of the gains already seem to be in the price. Gold is continuously getting sold off by global ETF’s. The returns from debt are clearly set to drop making it extremely difficult for investors. The hunt for returns is only set to get tougher as returns drop in debt, gold and real estate. The sharp uptick in equity is possibly a pointer that smart money has begun its move into equity. We have clearly reached a point where betting against the economic recovery will not work. Asset choices clearly are set to change.

If you are not willing to risk the unusual, you will have to settle for the ordinary. -Jim Rohn.

Invest speak:

Most of the time, investors are betting for or against the economy. If we think the economy will do well, equity finds favour. Investors choose to take on economic risk over the shelter of a safe haven. When the prospects of the economy are bleak, we move our investments into safe havens. Debt is the first among safe havens. Weak economic prospects often lead to gold becoming the default choice as we tend to have less faith even in debt. Real estate is often a preferred choice when investors believe that it is safer to speculate on capital appreciation rather than bet on return yields. An economic recovery will see capital shift from safe havens back into the economy. Lower returns from safe havens tend to force investors to take on risk. The savvy investors anticipate this and make the shift to risk ahead of others.

Equity is set to return better. Ignore it at your own peril.

Freeze your strategy now

The favorite pastime that most investors indulge in – index gazing. Investors spend months watching one number for that elusive signal. Often, years pass by simply watching the Index and staying gloriously inactive. The idea of one number guiding decision making is irresistible to the investor who is struggling to simplify decision making. Investors find it compulsive to rely solely on the index to guide their decisions. But, numbers don’t tell the whole story and the index is no exception. For instance, index composition is transitory and the number certainly fails to explain changes in its composition. It also fails to explain how corporate actions of a few companies can distort the big picture. The power that one number wields over the mind space of the entire community can be both fascinating and frustrating to the analytical lot. For example, in an index of fifty stocks, six stocks make up for most of the movement it makes. In recent weeks, the index surged and investors clammed up after concluding it was expensive. The buyback of HUL coupled with the continued over valuation of ITC, HDFC, HDFC BANK, TCS and RIL distorted the index significantly. Outside of these six stocks, the index multiple is closer to its historic lows. But, the index tells a different story.

The twin killers of success are impatience and greed. ~ Jim Rohn.

Invest speak:

The current account deficits of the world’s fastest growing economy and the world’s second fastest growing economy presents a tale of contrasts. China has a huge surplus as it exports significantly more than it imports. India, on the other hand, is generating a huge deficit with little emphasis on changing course. Being a hugely surplus generator gave China the leeway to merrily shop for global commodities in a way that no nation has in recent history. China went berserk buying huge inventories of different commodities. The prices went into a tizzy as the China bull wrecked the global commodity shop. But, China may well reverse gears realizing that it can’t buy too much more. This will send the global commodity markets back into a phase of price tumult. Commodity prices hold the key to India’s economic recovery.

Time to freeze both debt and equity strategies.

Crash your fears

Quick Edit:

‘The beast isn’t tamed yet’. The RBI governor said this in his own, long, pedantic style. The beast clearly is inflation. The markets didn’t get what it wanted. Rates wouldn’t go down too fast, too soon. Hardly surprising, isn’t it? The central bank makes decisions based on empirical evidence. It needs to have the right numbers before it in order to take hard decisions. But, the business of the stock market is very different from that of the central bank. The stock market works on the basis of expectations. Smart investors make decisions expecting things to get better. When the evidence shows up in the numbers all the smart people would have bought stocks. Markets can never work on evidence. Central banks can work only on hard evidence. The trouble starts when stock investors look to central bankers for market direction and the government looks at the central banker to make that leap of faith. Making that leap of faith is the stock investor’s job. When the beast is finally tamed, the genie will be out of the bottle and out of your reach.

The wall of fear is virtual. Crash it in your mind.

Invest speak:

Inflation is a statistic that is generated year on year. We measure the growth in prices over the trailing twelve months. Simply put, it helps us measure rising costs. When the prices in the previous year (base prices) were higher and present year prices haven’t grown too much, inflation tends to fall. We are stepping into a phase when the base prices will be high and prices will not grow too fast. If the prices stop rising as fast as they did last year, that itself will bring inflation down over the next four quarters. Interest rates are usually kept high to dissuade people from consuming more. Lower rates would result in higher consumption .When inflation is already high it is not possible to drop interest rates. Rates will drop only after inflation reduces. The waiting period cannot be shortened. It will have to play out over time.

Believe in the economy now. Evidence will follow.

Cracking the investment puzzle

2008 made most of us risk averse. So, we thought the best way to steer clear from high risk was to stay off Equity. The investment options were limited to debt , gold and realty. Most investors went for a mix of the three. The strategy worked very well till gold came apart. Now, debt is set to give lesser returns. That leaves property as the last man standing.’ Will property fall ?’ If it falls, our investments of the past five years may well turn futile. But, the question should actually be ‘what if ?’.

Here is the ithought view. Investing should be done with the ‘what if ‘ question always taking precedence over the ‘ will there be a crash ? ‘ question. A crash will always happen if we overdo things. That is the plain truth. As investors , we must learn how to keep the damage minimal.  We must learn how a crisis works and how we must work in a crisis. Predicting a crisis is less important than preparing for one.
The important thing in investing is to be able to respond to a crisis. Why is it so important ? The reason is simple. When there is a crisis and we are in a position to respond, we turn the crisis into an opportunity. How do we achieve that ? We achieve that by actually assuming that things can go wrong. And, preparing for it.
Investors hate hearing that things can go wrong. Imagine the advisor telling us things can go wrong when you are about to invest ! So most advisors say only the right things. As an investor , one must learn to hear bad news. The ability to take the bad news first will turn us into better investors. The good news will anyway find us. We must learn to find the bad news.
When we devised an investment process for ithought , we were in a dilemma. How do we tell people the bad news and yet make them
invest ?Painting a rosy picture wasn’t an option. But, starting with a dirty picture wasn’t easy either ? That didn’t stop us from trying. So, we boldly did some straight talking.
We gave the bad news first and then explained how the good news will start flowing. Here too, investors are often in a hurry. ‘Why is my portfolio down now ?’. This question almost always makes its appearance when things are at their worst. ‘ I could have as well invested in a deposit.’ is another oft-heard reaction.
Here, the investor in us needs to be prepared. By asking questions in panic , we are only showing how unprepared we are. If we are prepared for the worst, we would respond by turning that into an opportunity. The ‘what if things turn worse ? ‘ approach always helps us take our investing to the next level. When the world panics, we will be ready to act. In panic, others will certainly freeze when they are unprepared. Just then, we will act decisively having prepared well for that moment.
An advisor’s  job is to prepare investors for that moment. Willing investors will be better prepared. The reluctant warriors will lag behind. But, preparation is clearly a journey.  So, how should you journey now ?
Prepare for debt investments turning unattractive. Prepare for a property meltdown. And, slowly start believing in the economic recovery.
Performance of asset classes is always by rotation.  Yesterday’s performers like gold are today’s laggards. Today’s performers could be tomorrow’s laggards. The laggard of today will deliver returns tomorrow.
Stop predicting. Prepare . Tomorrow’s prosperity lies ahead near us.

Stitch it together in time

Quick edit:

The newspapers of yore and the newspapers of the present offer readers a very different experience. The typical reader would recall reading the headlines , moving onto the local news or other interesting pages in sports , business or entertainment. Today’s newspaper starts with the full page realty ads, followed by more of the same with relief from the gold jewelers ads. The headlines follow this ad splash and then one quickly returns  to the daily advertorial pages on gold and realty. The poor reader has to actually strive to read between the lines and make the distinction between news and advertisements. The story of every bubble starts on the front pages of newspapers and ends when the first page returns to the business of reporting news headlines. The newspaper is a great barometer of economic trends and the story is not in the news it carries. The story lies in the news it fails to carry. The untold story  fails to report real housing demand, unsold inventory, poor rental demand, high monthly maintenance costs, delayed project delivery, high resale of unoccupied apartments, high cost borrowings on real estate projects ,heightened solvency risk among developers and falling demand for homes. Instead, you see ads staring at you from every other page selling you Suburban Utopia. The first page will take some time to return to reporting the headline news. Till then, it is bubble time for the print media.

Skepticism negates objectivity. Skeptics rarely spot the best investment ideas.

Invest speak:

Debt investing works best when the investor plays the cycle right. When interest rates start rising, investors gradually move money into debt  instruments that give stable returns. When interest rates peak, investors lock money into long term debt and stabilize their long term returns. It is when interest rates start falling that investors struggle to find solutions. Falling rates is an advanced sign of a rising economy. Investors who are principally debt-oriented need to take cues from these signs and re-balance their investing. After all, the best way to raise returns in a rising economy is to bet on it. The way to bet on a rising economy is to buy equity in small increments. While your investment portfolio can principally be debt driven, taking on a limited equity exposure will clearly compensate the drop in interest rates. Logically, one must bet on the beneficiaries of falling interest rates. Equity holders gain when interest rates fall. Becoming equity holders now will greatly help debt investors generate stable returns. The important thing one must remember is to limit equity exposure to a ceiling and gradually raise your exposure till it reaches that limit. The time to begin re-balancing is now.

Buy steadily now. Avoid chasing the missed bus later.

When Havens fall !

Free fall Friday it was. And, how? A day when safe havens crumbled like they never really were safe. Infosys, gold and silver as a threesome make for odd company. But, they send out a message which investors can ill afford to ignore. Safe havens are safe only at a price. If the price is stretched, then the elastic expansion will reverse at the slightest panic. The flight of capital out of safe havens is the story of 2013. We saw this coming and for a good reason. Investors were over paying for safety on the one hand and undervaluing risk on the other. Today, Risk looks cheaper than safety and far more attractive. It makes better sense to gradually step out and buy risk rather than hide in safety. That is a signal you must take note of.

Safe havens are also price sensitive. Safety is never a given.

Invest speak:

The markets have clearly been treating private players and PSU’s differently in recent years. Despite stable earnings, good dividend payout and decent business visibility, PSU’s have clearly lacked market recognition and trade at a substantial discount to private players. The prospect of disinvestment has also contributed to the weak valuations of PSU’s. PSU’s which once traded at premium valuations now trade at discount valuations when they announce an offer for sale. Investors must remember that PSU’s have been growing through the most difficult economic times, with very little equity dilution. The promoter selling stakes will increase liquidity temporarily. Once the markets absorb this liquidity, PSU stocks will reflect business fundamentals and prices will once again recover.

Risk looks attractive. Buy it judiciously.

Strategise & Structure

Quick edit:

A new high or a new low are not mere benchmarks. They are milestones around which investors reinvent their expectations. A new high catalyses over exuberance and breeds optimists by the dozens. A new low triggers more converts to the pessimists’ camp. Gold hit a 10 month low this week and global optimism around the metal are clearly ebbing. But, India has her own behavioural asymmetry when it comes to gold. Investors actually believe that one can never lose money in gold. They don’t calculate or compare returns from gold with the relatively risk free benchmark which is their overwhelming favorite – The Fixed Deposit.  But, they always bring up the comparison between the FD & equity. 2013 seems headed for significant under-performance by gold vis-a-vis the FD. Like the proverbial ostrich ,domestic investors have been buying gold  regardless of the price or its trending returns. The pain will sink in only when things get worse.  The more informed investors have lapped up huge volumes of structured gold products like ETF’s and are sitting on losses that may only widen. Unlike the fall in equity, the fall in gold will create wider pain.

                  The memory of people in the stock market is very short.

Invest speak:

In equity investing,ordinariness comes with good reason. Investing on the basis of past performance ends up with very ordinary outcomes.  Or, the outcome could be even worse. To make your investing out of the ordinary, you need to rise above the past and the present. Investing is all about the future. To bet on the future isn’t really easy. You need to read economic prospects right.When economies are in a phase of turbulence, it often becomes a leap of faith.Yet, that is what investors should learn to make. When will a leap of faith work? When valuations are modest, growth is returning and investment appetite runs low. The markets seem headed into such a phase. Being in the state of mind to make that leap is what investors must focus upon now. But, how can an investor translate his faith into actions? This bothers investors no end. Should it be a quantum leap or, will small increments work? That depends on your risk appetite. Lower risk appetite is best served by investing in small increments in a consistent manner.

         Time to put strategy above tactics and look at the long-term opportunity.  

Don’t predict. Prepare.

Quick edit:

Short on guts, long on fear. This seems to be the mood of the markets. Delving deeper into the investor mood tells us that the major worries are elections and poor macro fundamentals. When the mood is despondent, the market response can only reflect the mood. This explains the capitulation in prices of stocks of companies whose books have high borrowings and heightened business uncertainty. Fear and uncertainty combine dangerously and almost always lead to a mindless sell-off.  The past few weeks have been a sell-off season of sorts.  The leveraged stocks have hit prices as low as 10% of their all-time highs of 2008. Obviously, prices don’t always go to zero. The damage remaining to happen will probably happen very quickly. The markets will slowly move on. One only needs to sense the mood a little ahead of it.

Few things go to zero.- Howard Marks.

Invest speak:

Investors mostly believe that wealth is created through better performance of financial instruments. Therefore, when instruments fail to deliver, investors take the easy way of blaming the instrument. Faulting the manager is another common response. Investors mostly overlook the behavioral aspects. Wealth creation has become an increasingly behavioral phenomenon in recent years. Behavior plays a greater role in deciding wealth outcomes and assets are acting as vehicles driven by investor behavior. Investor behavior in recent years has been greatly prejudiced by volatility. Investors mostly head towards assets where volatility is positively distorting prices. If the prices go down, they simply press the exit button. Clearly, there is a serious need for investors to behaviorally alter their response to volatility. Volatility cuts both ways. Investor behavior must realign to sidestep volatility rather than to swing with its ways. The bet has to clearly move beyond volatility.

Time to stop predicting markets. Start preparing your investments.

Invest for the long haul

Quick edit:

An equity portfolio is like a garden. There always will be times like spring when it will shed most of what it has. That doesn’t stop it from reaching full bloom a short while later. Experiences tell you that the strain of shedding always leads to a search for relief. A walk in the garden in spring will see the gardeners working actively, cleaning up, tending to the weaker plants, applying manure, watering and doing so many little acts of caring. Investing and gardening have a lot in common. Yet, investors often overlook the need to tend to investments. They mostly look at them only when it is bloom time or harvest season. Many even tend to them at that hour. As if miracles happen overnight? The time to tend is when there is strain. This is a simple truth. But, investors either don’t understand gardening or are poor believers in the act of tending at the right time and waiting. It clearly is spring in the Indian stock market. The discerning investors are busy gardening their portfolios. They are tending to them, with utmost care and giving them all that they need. The busy ones find the right gardeners and leave them to do the job. There is a time for everything. The one who understands this stands to see the best bloom in his garden. Happy investors are also those who know the art of gardening. They know when its spring. Their gardens are working overtime now. There will be a full bloom someday soon.

When investment ideas are aplenty, the method matters in making the right choices.

Invest speak:

When costs rise, they exert severe pressure on corporate profits. The earnings (EPS) tend to be pressured across the board and investors tend to believe that valuations are stretched. While earnings outlook may look weak, the quality of earnings is actually better. Companies actively respond to the cost pressures through cost cutting, productivity improvement and business transformation. Normally, these moves tend to bring benefits into the bottom line with a time lag. Importantly, when the overall outlook improves, the hard measures always deliver handsomely to earnings. We seem to be in a phase when these tough measures are being taken continuously.  Markets tend to take cognizance of future benefits much before they kick in. All the market needs are a few early indicators for evidence. The coming quarters will see the evidence trickle in.

Invest for the long haul. Run it like a marathon.