The Intelligent Investor – 10 – The Investor and His Advisers

Many of the immature investors seek advice from the investment advisers to improves their returns on investment.

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Immature investors have to be knowledgeable and experienced to pass an independent judgment for any of the investment opportunities communicated by others. Investors need to analyze the services provided to him by the consultant or advisers are of benefits to them or him, whether they are involved to generate commission/brokerage or true advice, etc. Intelligent investors look at the recommendation provided by reputed firms but they decide by themselves. So that we can have safety rather be sorry for the decision. It is always a question that should we manage our portfolio independently or should we seek for the help of others? It depends on to them how we have performed during the market cycle, better than the market or not, whether we can easily meet our financial goal or does we require to take help.

Before trusting any of the advisers, we need to make our due diligence and check whether any complaints, fine, a penalty against him or not. Before selecting an adviser, we need to ask a few questions –

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Answers of the above questions provide us clarity of selecting or rejecting an adviser. It is difficult to find a genuine adviser so that we also need to do due diligence from our side. I have experienced that no investment strategy outperforms in every period so that we should analyze the performance of the adviser over a market cycle, does adviser changing his process frequently? does he behave rationally with his investment or get emotionally trapped by market moods? We need to analyze all such aspects. And the most important aspect is to have an investment process and investment philosophy. If the adviser does not have it then we do not have to be in help of him.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

The Intelligent Investor – 9 – Investing in Investment Funds

For selecting whether to make an investment to the investment fund or not, we need to think for the answers of few questions such as getting better than average return (performance fund?), if not, then avoid fund which can give us a worse than average return and lastly, can we make choices between different types of funds or not.

General people who open a trading account, most probably engage in the speculations but such behavior is not common for the mutual fund investors. People also tend to select a fund that is growing fast.

Many times, due to the support of luck, few of the fund managers or investors stay in the right direction at the right time and they earn good returns but when such tide goes out, we can see the real skill of the particular manager or investor. It is also highest into the possibility that winning fund does not always remain winner due to –

If a fund has a good touch of the fund manager then every other fund house demands the same manager and they hunt to the manager at a higher pay scale also.

When a particular fund provides a good return then it will attract the investors. Due to the higher flow of the investors, managers have to put additional money into the stocks which he already owns. Such strategies lower down the returns. Sometimes, we can play a few risky strategies with small funds but the same is not suitable for the huge size fund.

As the fund grows bigger, the fund manager gets higher fees on it. So that reluctant to lose the higher fees and they started playing the game which everyone else is playing. If we see that top holding of the different funds then it will be more or less similar to each other. So, for protecting their higher fees, they do not focus on their ability to generate a superior return. They believe in getting wrong conventionally rather than unconventionally.

MFs

If we see then the majority of the funds having a similar stock as a top holding.

On the other view for good return from the fund when –

A fund manager is the biggest investor of the fund then his motive and motive of other investors will be the same and they work for generating a decent return.

Expenses of the fund are lower than definitely, the fund provides better performance.

Few fund managers do not focus on what others are buying but they focus on what looks good to them. They do not follow the herd and such strategies provide them decent return. Also, they do not get involved to do advertisements.

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When a fund manager feels that they will not able to generate a good return if the fund becomes huge then they close the door for the new investors which restricts the fund to get huge by the additional flow of new investors.

We should also focus on the few points which can help while the exit from the investment of the fund such as an unexpected change in the strategy, increase in the expenses, sudden huge volatility to the returns, etc.

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Few funds mentioned such a warning to the fund. I found PPFAS long term equity fund which has mentioned warning and to whom this fund is suitable and to whom it’s not.

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Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

The Intelligent Investor – 8 – The Investor and Market Fluctuations

When we have invested in the bonds then that will get little fluctuation to the market price. But when we have invested in the common stocks then it will have a wider fluctuation to the market price. So that we need to be ready financially and psychologically for upcoming fluctuation into our common stock investment. It is easy to advise for not doing a speculate but hard to follow it. Fluctuation and behavior of the market attract us to make a speculative decision. So, if we want to make a speculative decision then keep aside some amount of money as considering that we are going to lose it through speculation.

We need to take a benefit from the swing of the market pendulum rather than getting trapped into it. And we can take a benefit by way of timing to the market or through pricing.

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We cannot predict the direction of the market consistently and if we start predicting a direction then we end up as a speculator, not as an investor. People want to buy during the bear market where everyone else is selling and sell during the bull market where everyone else is buying. But people are tending to do the reverse, the majority of the people buy at high / during a bull market and sell at low / during a bear market.

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Similar has happened during the year 2017, people have seen a bull market from the year 2014 to 2017 and they started believing that this will never be going to end and stock prices keep on going higher and higher.

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1st, 2nd and 3rd point has been explained to the previous articles of the same series.

One of the optical and data networking products company

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IPO of the company came at Rs.257 so that MCap was ~Rs.2367cr which was at the EV/EBITDA of 14.09x in FY17 and stock price rose to ~Rs.437 in FY18 which was at EV/EBITDA of ~26.33x. The company has incurred losses in a few years and came to profit since FY2016.

One of the publication company

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The IPO of the company came at P/E of 33x and EV/EBITDA of 16.59x.

Day-to-day or month-on-month fluctuation to the market does not make investors richer or poorer. But what will happen for a longer period that will impact the wealth of investors. We need to keep distance ourselves from the crowd rather than go with the crowd. Also, we need to focus on emotional stability over an investment journey which helps us a lot. The normal investor gets trapped with greed as the market starts advances, but at the same time, intelligent investors booked a position of overpriced issues and parked those funds to bond, he will re-balance his portfolio.

Owning a common stock means we are a part-owner of the business, but due to the advancement of the stock market operation, investor’s mind gets diverted and they are getting more engaged towards the stock prices. They forget that stock price fluctuation should not be focused but they have to focus on the value of the businesses, quality of the businesses and progress of the businesses. Stock prices bring distance between business and us. If a person is making an investment for a longer period, but getting fluctuated as stock prices get fluctuate then he does not know for the emotionally stable and matured investors. Matured and intelligent investors do not focus on the price quotation every second but they focus on the underlying business. As businesses show successes it becomes popular among the people and it will command more premium, its mood swings with the market, etc.

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We need to focus on earning the power of the business with the asset value of the business. But we should avoid paying higher to the assets as well as to the earning, otherwise, we need to be stay affected through the market fluctuation.

One of the telecom company

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(Source – Thoughts on Thoughts blog)

The company looks very cheap based on the financial metrics and assets base, but if someone who does not have paid attention to the business of the company and earning the power of the business then—

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One of the gelatin company

The company has some uncertainty and raw material problems but having a stable business. The company was traded at ~Rs.66 cr of MCap with having investment + cash on the balance sheet was worth of ~Rs.70+ cr so that entire business was available at free due to uncertainty. The company has delivered a decent return with also deliver Rs.10/per share as a dividend.

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Few critics of value-based investing tell that such an approach does not work with the listed companies due to the ample amount of liquidity available. Such liquidity and stock market platform provide a daily opportunity to the participants to make changes to their holdings.

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Many a time, Mr. Market ready to pay overpriced for the business and sometimes, He is ignoring too few of the businesses. We need to stay away to getting trapped from the Mr. Market mood swings. Mr. Market also behaves like a human being because prices of it and the behavior of it direct through human involvement as a market participant. We need to control our emotions based on our experience and belief over a while. We should stop overpaying attention to the market.

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If we are doing a business then daily price fluctuations will not be going to disturb us and we do not make a change to our holdings. Price fluctuations only provide an opportunity to buy a business at a favorable price and sell when Mr. Market shows a higher price of the business.

The main distinction between speculators and investors is their attitude towards the market. A speculator is willing to make profits by way of market fluctuations whereas investors are willing to hold security at a suitable price and market fluctuations do not important for them. Market prices are just for our conviction so that taking benefits of it or to ignore it depends on us.

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Stocks or a bond, the Market price will remain to fluctuate over a longer-term period. Good company with good management gets recognition into the good market price and bad management will get bad market price recognition.

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Mr. Graham has explained the liquidity concepts which is suitable for the current scenario. The fund manager purchases few stocks for the portfolio, then the market starts moving upwards which attracts the investors to put more money. Now, due to the additional fund inflow, the fund manager has to buy a similar stock to the additional fund which brings stock prices to the dangerous level. Now, as the market falls, investors ask for the withdrawal of the fund and fund manager has sold out stocks to make the payment which leads to further fall to the stock prices. So here, they buy at high and sell at a low price. Our brain makes a pattern that similar has happened during the last time so it might be going to happens now also. And many times, our brain creates a pattern when there is not the availability of any pattern.

What we should need to do for the better than average return –

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Our behavior is most important to get an above-average return. By controlling ourselves, we can stop ourselves from becoming our enemy. When we have made any prediction and that proven right then we become addicted to own predictions.

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Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

The Intelligent Investor 7 Portfolio Policy for the Enterprising Investor: The Positive Side

Enterprising investors are willing to put more attention and efforts for generating a higher return.

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Generally, an intelligent investor buys and keep holding common stock when it has a cheapness and they sell a common stock when it becomes overpriced. After selling off the stock they transfer to the bond and wait till another opportunity of common stock available with the cheapness.

General Market Policy—Formula Timing

This is an approach of investing timing of the market. The market keeps on fluctuating and taking a benefit of those fluctuations to our favor adds additional value. It is very difficult to forecast the future market level for a consistent period. When we look back towards any situation then it looks easier to predict but when we are passing through the situation then it is very difficult to predict.

Growth-Stock Approach

Growth stocks are the companies which have shown a growth better than an average. The problem with such kind of companies is they have given good growth into the past and we have to assume that they will keep on doing the same into the future. But such kind of stocks selection needs huge careful attention from the investors. As the bigger companies start to grow at a slower pace compared to the smaller companies. But it is also a fact that if the company is a leader with the availability of competitive advantage in the market then it has a huge probability of growth. We need to careful with what we are paying for buying a growth. If we pay a sky-high price for the prevailing growth then also, we have to suffer through the company grows.

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If we have proven wrong with our assumption of future growth and also, we have paid a higher amount for the business, then it will be a dangerously affect to our wealth. Growth stocks can create our fortune or can spoil our fortune. If our assumption for the future growth proven right and also, we have bought the stock at a proper valuation then fortune into the growth stock can be created. Many times, the company has a temporary problem, then it will be available at a relatively cheaper valuation. When larger companies have adversity, they have a resource and brainpower to come out from the adversity and market responds quickly to such improvement to the larger company.

One of the two-wheeler company of India

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The company which has a negative cash conversion cycle, availability of float, market leader since many decades, traded at 10%+ of earning yield with higher return ratio, market participants having a fear of electric vehicle disruption.

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One of the MNC FMCG company of India

Company’s one of the flagship product got banned which contributes decent revenue to the company. Also, no other competitor gets success in the same product at the same level. Company has a higher return ratio, good brand over the globe, successful track record.

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Mr. Graham mentioned regarding a cyclical business

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We need to bought such businesses during the bad time at higher multiplier and need to sell it at a good time at a lower multiplier. During the bad time, the profitability of the company gets depressed which resulted in the higher multiple to the company and reversely, when time is good, profitability gets improvement which resulted in the lower multiple.

One of the sugar company

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When we want to get an above-average return into the investment, then our investment needs to be proper, sound enough to avoid risk and we need to adopt a policy which is different from most of the investors or speculators are using.

Bargain issues are those which are selling below its true worth. Now, for calculation of bargain – first, we need to forecast future earnings and giving it an appropriate multiple for arriving at a future market price. If the current market price seems lower than future market price then we can consider it as a bargain common stock. And second, where we need to focus more on the net realization of the asset value and net working capital (Working capital – all obligations) with the growth into the future earnings. Also, the current result is disappointing (future result can be improved) and unpopularity among the stock price creates a bargain opportunity. During a bear run, people do not focus on the companies which are not a leader, because they have a fear and belief that leader can provide safety. So that companies other than leaders will be available at a cheaper bargain price. We should focus that whether these companies can generate a fair return on invested capital or not and whether that generated return will be above the cost of capital or not. Such companies require a bull market, changes in policies, changes to the management, acquisition of smaller bargain companies by a larger one, etc. for reaching the fair valuation.

A special situation is also one of the ways to create a return on our investment. Special situations are different from the usual part of investing. Here, we need a different kind of process and different level of mentality compared to the usual one. This strategy includes demerger, merger, arbitrage, delisting, buyback, right issues, etc.

When we select to be an aggressive investor rather than a defensive investor then we require a thorough knowledge of businesses, how to value it etc. There is not a middle way between aggressive and defensive investment. And those who are involved in the middle way, they get a disappointment to the result due to the lack of requiring time and knowledge.

Disclosure – Companies mentioned in the article is just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

The Intelligent Investor – 6 – Portfolio Policy for the Enterprising Investor: Negative Approach

We have seen the defensive investors in the last article of the same series. Now, Mr. Graham has explained what not to do for the defensive as well as aggressive investors.

Mr. Graham has explained what not to do for aggressive investors such as –

Aggressive investors also have to start with deciding an allocation between common stocks and bonds. Also, they have to be ready with more analytical work compared to defensive investors. When second-grade bonds are available at the substantial discount to the principal value and also, having a prospect then it will be more attractive compared to high-grade bonds. Aggressive investors have to compare a discount available to the high-grade bonds and the second-grade bonds. We need not forget the rule of the safety of principal while investing in the bonds. We need to check the adequate cover to the interest charge on pre-tax earnings. If such cover is not available then we should avoid bonds though they having a higher yield.

Mr. Graham has mentioned regarding foreign bonds that we do not properly know the future of foreign bonds. If any troublesome times come then we do not have a legal means of enforcing claims. So, we should avoid such opportunities though we get interested rate benefits.

Day trading – Mr. Graham has mentioned that day trading is a weapon invented for committing financial suicide. Buying and selling a stock for a few hours also bringing down your profit. The more we trade; we keep less with us which also affects our long-term profitability. Luck can provide us a benefit for a few times, but for getting consistent benefits from trading, we require great attention. Someone who can’t hold on to stocks for more than a few months at a time is doomed to end up not as a victor but as a victim.

New issues – we need to be very careful before purchasing a new issue because the majority of the times new issues comes during favorable market conditions for the seller of the new issues which means not purely favorable to the buyers of the new issues.  Majority of the time, prices of new issues get collapsed. We have seen very few winners which have given a good return by investing in the IPOs such as Infosys, Wipro, Eicher Motors, etc. but there is a huge list of losers also.

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So that does not jump to the IPOs at higher valuations, lets company to work for justifying such a higher valuation.

Disclosure – Companies mentioned in the article is just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

The Intelligent Investor – 5 – The Defensive Investor and Common Stocks

As we have seen to the previous articles of the same series that common stocks have the advantage to beat the inflation and given an income in the form of dividend and price appreciation. But we also have to keep in mind that common stocks become riskier if we bought it at a higher price. If we consider the period of the year 1929 then it has taken 25 years to break the market level of the year 1929. and we need to keep such a scenario in mind while making an investment decision. Such a scenario is more difficult and riskier compared to the bond investment. This scenario becomes difficult to survive if the focus does not have on the risk control.

The criterion for the selection of the stocks for the defensive investors are suggested by Mr. Graham

  • Investors have made a diversification between 10-30 stocks of the portfolio
  • Selected companies should be large, prominent, and conservatively financed.
  • Long track record of dividend payment.
  • Price multiple limits – multiple should not be higher than 25x of average earning of past seven years and multiple should not be higher than 20x of TTM earning. Such criterion removed growth stocks, popular stocks, etc.

Growth stocks to consider which has given a decent earning growth during the past period and also a similar growth will be sustained to the future also. As growth stocks have a long track record of the decent growth which will attract a speculative nature and increases a higher multiple. Such higher multiple can drop as earning growth fall, earning falls, etc. and that proves dangerous for the defensive investors.

One of the Air Cooler company of India

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As we can see that the company has posted the lowest growth in March-18 since the year 2010 and due to the lowest growth, P/E multiple of the company has fallen from around 89x to 32x.

After the selection of the common stocks to our portfolio, we need to keep track of the particular common stocks for checking whether the improvement of the business, financial or not.

Mr. Graham has also appreciated the systematic investment plan for the index fund which can be helpful to investors for the 20+ years.

We have seen to the last article of the same series that allocation of the capital between common stocks and bond depends on the individual situations. When a person needs money to run his family with no further income sources then he must deploy 75% fund to the bond. Also, investors should allocate fund as per their knowledge, experience, and temperament which is a fortune creator to the investment field.

People get confused for the risk with the fluctuation in the price of the particular common stocks. But we should take value rather than consider a market price of the particular common stock. If value, quality of value is getting deteriorate then it is a real risk for us. And also, if we have paid an excessive price for the common stock, then that invite a loss to our wealth. We need to buy common stock at a price which provides further growth to the future.

If we make a thorough analysis and keep the focus on the safety of capital then deploying money to the common stocks becomes as easy as we put money to the bonds. But when people have lost their money during the crisis, they do not believe that common stock investment also can be safe & help us to create wealth.

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Mr. Lynch has mentioned that we should buy common stock of those companies of which we are using a product or we understand the business. Also, he mentioned that though products of the company are successful and we all are using it, we need to study the financial statement of the company and estimating the value of the particular company. Majority of the people forget to do a later part and just put the focus on to the first part of the saying of Mr. Lynch.

One of the specialty foods with branded rice manufacturing company of India

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A company having a good brand for its products but its major fund gets stuck into the inventories and for that company requires to bring a borrowing. There are many examples where good products do not have rewarded as a good investment. So, there will be no alternative for hard work and analyzing financial statements.

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Disclosure – Companies mentioned in the article is just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

The Intelligent Investor – 4 – General Portfolio Policy: The Defensive Investor

It is prevailing to the market that if we take a low risk then our return will be comparatively lower and we get a higher return with higher the risk. But actually, it is not always true. When we acquire a bargain situation with the proper margin of safety then we have a higher probability to get a higher return with the lower or controlled risk.

Mr. Graham has explained “Active” or “Enterprising” investor and “Passive” or “Defensive” investor –

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When we have time to spare, competitive thinking then we need to select the active investment strategy and when we cannot spare time on investment, do not keep on thinking about money then passive investment strategy is suitable for us. So that we have to select what works for us, which strategy is suitable to us rather what has worked in the market. If we cannot spend time researching the companies, what was going on to the business, etc then we should select a passive style of investing.

As we have seen in the review of the second chapter that defensive investors have an allocation to the bond as well as common stocks. And they makeshift from common stocks to the bond when they found a higher valuation of common stocks. As per Mr. Graham, If we have chosen to have a 50-50% allocation to the bond and the common stocks. So, at that time, if our stock allocation goes to 55% then sell off of additional 5% and transfer it to the bond and if common stocks allocation goes to 45% then bring 5% by selling off of bonds. This is one of the simple formulae for the defensive investor. Defensive investors have a strategy to fall less than the market during the worst time. And such a strategy can be helpful to them.

One of the other strategies is recommended by Mr. Graham –

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Example

If we have a dividend of Rs.720, SENSEX at 36000 and bond yield is 7% then we need to allocate 75% to the bond and 25% to the common stocks because 2/3rd of the 7% is 4.67% and we are currently getting a dividend yield of 2% on the SENSEX. Now, we need to wait for fall into the bond yield or reduction to the level of the SENSEX for increasing the allocation to the common stocks. It’s just a hypothetical example. The dividend yield in India has not reached at such a higher level, especially into the Index so that we can go for the earning yield.

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*Red indicates exit and green indicate entry

As we see that Mr. Graham indicator suggesting overvaluation in the SENSEX. And for getting it fair value -1) Risk-free rate has to fall, or 2) Earning has to increase (At least by 10%) or 3) SENSEX has to fall (At least by 10%). Rate cuts have given a positive boost to the market but if earning will not pick up then the market has to fall. If anyone has invested 100% into debt fund in the red zone and invested 100% into the green zone then the person has earned ~15% CAGR compared to ~11% CAGR of SENSEX.

When investors select the lower quality of the bond then return on it will get increase compared to the high-grade bond. We need to focus on to the buying a bond at the discount for getting a higher yield on it but with the same level of quality.

Defensive investors also can deploy fund to the FD, liquid fund, bond, preference shares, convertibles, etc.

For the allocation to the bond and stocks by defensive investors, an old theory which was prevailing to the market was deducting age from 100 and remaining amount consider as a % to invest in the stocks. That is if age is 28 years then 72% (100-28) of the net-worth will be into the stocks. But age should not be a factor in considering the risk-taking ability of any person. If someone at the age of 80 also well settled and having a good fund for spending his life then he can take more allocation stock also and does not just have to deploy 20% (100-80) to the stocks.

It is also possible that 20 years old person saving money for his further education, marriage in future, house, etc. So, he may not be able to deploy 80% (100-20) to the stocks. Allocation to the common stock or the bond depends on everyone’s risk-taking ability. We should not generalize certain allocation percentage for everyone.

This is what happens to the market and keeps on repeating in the future also.

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For allocating to the stocks and bond, we need to look at our life and situations where we require cash. We can ask a few questions to ourselves before making an allocation.

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We need to allocate to the bond and stocks, after considering all the above point. But as Mr. Graham mentioned that we need to make a minimum allocation of 25% to the maximum 75% the bond. When we make an allocation decision, then we need to change that allocation only while our situation at life changes. Not when the market starts moving upward. If we need a constant fixed amount of cash-flow to spend for the household expenses, covering the cost of living then bond only provides those cash flow rather to common stocks. We only can put 100% to the stocks if we have enough money to support our spending, survived during a bear market, we can able to buy more stocks to the bear market, we do not need to sell stocks for survival, we can invest for at least 20 years.

Disclosure – Companies mentioned in the article is just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

The Intelligent Investor – 3 – A Century of Stock-Market History

We do not have data available for a century in the Indian stock market so that I have done a calculation with available data. All data are taken from BSE India and RBI site.

When we have seen a huge return into the past from the equities then it is not necessary to consider a similar kind of return into the future. Reality is that common stock prices related to the earnings and dividend from the particular companies or basket of companies. If the company fails to deliver earnings and dividend then it is obvious that the company will not deliver a similar return in the future.

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This example shows that growth in earnings and dividend has an impact on the price of the companies and basket of companies (Indices). If earning/dividend growth contentiously falling or depressed during a time then prices of the securities also have an adverse impact. So that we can see that during the year range 2011-2019 or 2016-2019, SENSEX has increased more rapidly compared to the EPS growth. Now, either EPS to grow much rapidly or SENSEX has to fall. Or it can also happen that SENSEX can remain in the range till EPS growth does not match to the average return. For matching the average return, either EPS has to grow by 20-22% or SENSEX has to fall 22-25%. This study can provide a similar result with particular stocks.

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When the difference between earning yield to bond yield and dividend yield to bond yield start getting lower than we can think that particular stock or basket of the stocks becoming overvalued. This is one of the effective indicators where we can see that when Earning yield / Bond yield has cross 0.67-0.70x then SENSEX has provided us an attractive investment opportunity and when Earning yield / Bond yield has gone below 0.67-0.70x then we need to decide to liquidate our position to the SENSEX in a phased manner.

The stock market does not become less risky just due to advancement to the prices of it. I have seen many people enter into the market or the particular stocks when the price of it starts increasing.

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We have seen during the series of Mr. Howard Marks, The Most Important Things that if everyone thinks in the same way then that thinking getting discounted to the price and will not able to get similar kind of returns for the future.

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Above mentioned parameter, we can check into the current scenario where real growth of the corporate earnings was not much and the stock market has performed due to the speculative growth. Everyone starts preferring equity as an asset class to invest due to the recent past return. Now, such a scenario is unfavorable for investors. Absent of earning growth does not attract higher valuation for a longer period.

Disclosure – Companies mentioned in the article is just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

The Investor and Inflation

We all have some needs, some desire in life and we work for fulfilling those. But due to Inflation, our purchasing power get reduce which has always remained a serious question for all of us. We all working hard to beat inflation and enhance our purchasing power. We save, we invest money for our future life. The very popular story everywhere at the market prevailing is a common stock investment is a better tool to beat inflation compared to the bond investment. But is it true in all the situations? We know that every-time it is not true; many a time, good stocks do not give a good return compared to the bond. We need to focus on the valuation of the stock and yield available on the bond. It is very much possible that good stocks can be traded a valuation of the great stocks which can be harmful to us to beat the inflation by investing in it at such a valuation. And at such a valuation, investing into the bond becomes a better choice. Good business is not always a good investment.

Common stocks do not have an inheritance feature to always beat inflation. Yes, it is acceptable that stocks have delivered a good return compared to the bond in the past. But for the future, we need to look at the future of the growth of the economy, growth of the corporate earnings, etc.

If we see the growth of Japan then GDP grows at ~3% CAGR since the year 1981 and similarly their stock market also has given a return of 3% CAGR since the year 1981. Nikkei still is not able to break the higher level of the year 1989. So for growth of the investment return, underlying companies/economy also has to grow otherwise we are not able to earn by making an investment.

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When inflation keeps on rising then companies need to bring more capital for growing sales (as the purchasing power of the company reduces) at similar peace. Such a scenario creates difficulties for businesses to survive and grow further. When companies need additional capital to grow similar sales level, then return on incremental capital will reduce, also companies cannot able to put capital to the new projects as old projects require additional capital. This also can enhance a debt level or the external funding to run a business and that can hamper the profitability.

One of the communication company

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We can see that the capital employed of the company is growing at 16% CAGR and sales growing at 8% CAGR. This means for growing a similar business, the company need to make a twice of capital employed. So that company keeps on requiring external funding to grow the business. Here, we can see that company having a negative working capital cycle though the company needs to bring external funding to grow or maintain the business. There is much business which having such problems and those businesses require to have a huge capital to grow and to even maintain the business.

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Hyperinflation stop consumer to buy more and more goods as their purchasing power starts getting reduced. During such time, businesses do not rise a price to overcome the impact of the rising cost of raw material and other utilities. So that hyperinflation can hamper the earning, growth of the companies and which having an adverse impact on the annual investment return during those time period.

Many people make an investment to the gold, real estate, old paintings, old currencies, etc. for beating inflation but such a scenario does not seem to be practical even. Real estate is a hot investment for getting protection against inflation. But if we missed with a location, the price needs to pay, etc then we also do not protect ourselves against inflation by investing in the real estate.

We should not focus on the one and only basket by seeing the huge return in the past. We should focus on the different basket for making an investment. As we have experience in the near past that due to good return from the equities, people have started making an investment into the equities and market got a huge liquidity flow which has bring the market to the record high level. Similarly in the past for the real estate market.

Our investment success does not count by how much % of return, we have made through investment but how much we left after adjusting inflation is considerable. That means if we have earned 20% return on our investment and inflation is 8% then we need to consider our return is 12% after adjusting inflation. And if our investment is not able to generate a positive return after adjusting for the inflation at a longer period of time then that is of no use for us.

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Similar thing with the Indian economy, we also experienced a Current Account Deficit and we have to borrow money for supporting the economy. If the hyperinflationary situation starts prevailing to an economy then it will become difficult for the economy to grow further. We need to bring more fund to just maintain the existing state of living.

Disclosure – Companies mentioned in the article is just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

 

Investment versus Speculation: Results to Be Expected by the Intelligent Investor

From today, I am going to start a series on Book The Intelligent Investor under the Bibliophile category. Mr.Buffett has always mentioned that he keeps on reading this book every year. This book helps us with the developing an investment philosophy and also, help us to recognize ourselves as an investor or a speculator. I am grateful to the readers by which I am getting motivated to keep writing more and sharing more pearls of wisdom.

Mr.Graham has started the book with the definition of an investor which is very essential for us to understand to becoming a wise investor.

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Many of the people call themselves as an investor but they are not meeting criterion mentioned by Mr. Graham. If a person does not meet any of the criterion mentioned above then we need to consider him as a speculator rather consider as an investor. We have to check to introspect and need to check whether we are meeting above criterion or not. If not then we are doing speculation though we called ourselves as an investor. I have seen many of the people focuses on the adequate return but not meet up other two criteria, or they meet safety and return but not meet up with thorough analysis so that we need to consider those as a speculator, not an investor. People get more involves speculation because they get excitement into it and investing is a boring & lonely game. But over a longer period of time, excitement does not reward us. The stock market is not a place for getting excitement or thrill but it is a place where we need to stay calm, cool with a balance of emotion and balance of activities with hyper activities. When we do speculation, we get an immediate result but not happens the same with the investment. We can earn through making an investment in the long term only if we play this game with the rules.

People call themselves as an investor though they are just buying and selling shares at the stock exchange. They do meet the criteria of being an investor or not. Investor word commands a good reputation among the people so we feel the pride to call ourselves as an investor but rather to just get feeling, we need to work on logic and accept the reality. Though we perform a thorough analysis of investment opportunities or not, we consider ourselves as an investor but we need to understand that it is easy to call ourselves as an investor but it is difficult to act as an investor.

  • A thorough analysis of companies means we need to analyze the soundness of the company, long term survival of the business, pricing power with the company, etc.
  • Our major focus should be on capital protection. When we work on capital protection, we have already won half of the battle. I always emphasis on my philosophy which is “Return of Capital” is more important rather than “Return on Capital”.
  • We need to focus on adequate return rather than earning an extraordinary return. We run behind getting rich within a short period of time so that we desire to earn an extraordinary return.

People can do speculation also but many a time, speculation becomes dangerous –

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If we cannot stop ourselves from doing speculation then put some fund aside for making speculation and we never put the fund into the same account for making speculation and for making an investment. Also, we should not increase a fund to the speculation account just because the market has gone up or we have a good profit into it, but we should bring out the fund from it and transfer it to the investment account. 10% limit of our overall wealth is permissible for the speculative bets and we should not violate this rule. When our speculative account goes above 10% then those amounts need to shift to the investment account and if it goes below 10% then we should not transfer fund from investment account to speculative account.

Mr.Graham has advised to the defensive investors to keep their portfolio into the high-grade bond and into the common stocks. We should have a range of bond should be into the 25-75%, not less than 25%, and not more than 75%. Similar to the common stock also.

We need to make a selection of stocks and bond on the basis of inflation, interest rate, the future expected return from stocks, etc. Which can help us to earn above inflation return. As a defensive investor, we should make an investment to the company which has a good business with a strong track record of financial. We should avoid buying hot stocks which can be harmful to our wealth during the long term. Mr.Graham also has mentioned the concept of Systematic Investment Plan (SIP) for the defensive investors.

Mr.Graham has explained methods for aggressive investors such as 1) buying a security which is doing better than market average, and those not doing better which are candidate for short selling a security 2) Buying a companies which are expected to post a good earning or other favorable development expected 3) Buying a companies which have given a good earnings growth in the past and expected to deliver similar to the future or companies does not have a good past earning but expected to post a good earning to the future.

Here, uncertainty associated with the investment is human error and wrongly estimation of future or estimated future is already into the current market price. When we buy stocks on the basis of current year good result with the similar will happens to the next year then it is highly possible that other participants also think in the same manner.

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If we buy popular stocks on the street then we end up with the result what everyone else is expecting. We are not able to get above average return. We have other ways to make a return without taking a huge risk is a special situation such as a merger, demerger, buyback, liquidation, delisting, etc.

One of the bargains is given by Mr.Graham was Net of Current Asset (I.e. Working Capital) after adjusting all the liabilities. That means the stock price is well below working capital – all the liabilities. Here, we are not taking a plant and other fixed assets into consideration. Such issues consider as a bargain to its value.

One of the Indian air cooler company was available below the net of current asset

Company has a current asset of Rs.74.24 crore and total borrowing was Rs.29 crore so that the net of the current asset was Rs.46 crore, whereas Market Capitalization of the company was Rs.35 crore at the end of FY2009.

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Many of the investors do not take rest when odds are not in our favors. They keep on doing something though things are not into their favor. Such hyperactivity is also dangerous to the long term return of investors.

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We have seen that many strategies and stories for the stock is getting popularized over a period of time and also erased as time get passes. We always need to focus that stocks only will perform well or poorly in the long run when business behind that stocks will do well or poorly. So that we need to focus on the performance of the business rather than focus on the different kind of strategy to becoming wealthy in the long run.

Disclosure – Companies mentioned in the article is just for an example purpose. It is not a buy/sell/ hold recommendation.

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig