THE REAL ESTATE CYCLE – 11 – MASTERING THE MARKET CYCLE

We have seen the financial cycle in the post of the credit cycle. Similarly, Real Estate also follows the same cycle as all the financial cycles follow, except one that real estate having a higher lead time to development takes place. Generally, real estate projects take a huge time to get constructed to get commercializes.

When the economy is bad at that time credit will be unavailable for the construction work and when time is a good credit will available easily. This impact on the real estate cycle. Better economic time causes an increase in demand and bad economic conditions led to a fall in the demand. Due to the higher lead time, supply & demand mismatch takes place which causes the rise in the rent and the sale price.

When projects got halted due to the credit unavailability then these situations invite a bust in the Segment. That will cause a fall in the price of buildings. Investors can get land less than what developers have invested in. Also, here, lead time reduces as approval got finalised in good time. It hurts to the projects of which construction started in the boom period.

When there is a demand for home and financing options available, builders decide to build a home and all builders decide the same which creates a surplus of home. Also, due to long lead time, demand gets soften then builders left out with the inventories which he has to sell at lower than the expected value. But the reverse of it, when the economy is slow, availability of finance is low and pile-ups of unsold inventories so that builders stop building a new home. This helps to slowly getting sold out of inventories. Now, when the economy revives again, at that time supply will be lower than the demand which brings prices to the upper level. So that building a home during the slowdown is a better way to reap profits.

People tending that real estate investment beat the inflation (same for common stocks) but we need to understand that if the price which we pay are too high then it will not beat inflation and in result, it will beat us.

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If we have bought real estate during a high price growth then we have to wait a little more while price growth has been slowing and many of the area it has been degrowth. So that not all price purchased of real estate result into the wealth creation.

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: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

The Intelligent Investor – 18 – A Comparison of Eight Pairs of Companies

We should take care when company deliver their promises but actually traded at more than their promises.  Companies that have to deliver a higher sale, earnings growth then they will be available at higher multiple. But we should distinguish between higher and reasonable multiples. Stocks which does not have underlying soundness then those will become speculative and riskier.

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When sales growth keeps coming people ignore the underlying quality of business and financial. As the company grows, its growth becomes slower otherwise the company will eat up the entire world. As growth gets slower, multiple also gets lower. We need to understand that we cannot provide similar multiple to the same company at every phase of the company. Higher quality growth commands a higher multiple but as growth slows down, multiple for the same business gets lower down.

One of the air-cooler manufacturing company of India

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We can see that as growth slowdown in the FY2018 and 2019 then P/E multiple of the company has fallen down rapidly.

Comparison of Real Estate VS Pharma VS FMCG

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We can see that in the Jan-2008 Real estate companies (Just two companies) MCap was ~4x of 10 pharma companies and ~2x of 10 FMCG companies. Pharma and FMCG companies have posted growth and real estate companies are not able to grow at the same peace. In addition, real estate companies were traded at sky-high valuations which resulted in an average return of ~-91% whereas Pharma (*not taken from high mcap) and FMCG has posted average return of ~963% and 1109% respectively.

If we look at the fall in price too low of 2008 then also pharma and FMCG have outperformed real estate.

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If we see the quality companies i.e. pharma and FMCG then those fall less than the entire market fall, Nifty fell by 50%+ in the year 2008.

In the Short term, any stocks win the popularity of the market but in the long-term earnings matters. If we see that fancy business has does not perform in the long term but boring business such as FMCG has outperformed in the long term.

If we look at the P/E multiple of DLF and Unitech then that was 36.69x and 82.22x in high of the year 2008 and that fall to 4.67x and 4.21x respectively. Whereas Lupin, Sun Pharma, HUL, ITC, and Nestle was traded at P/E of 13.54x, 17.91x, 26.23x, 29.34x, 26.90x and fall to 12.50x, 17.52x, 26.71x, 22.28x, 24.80x respectively.

Market panic provides us with an opportunity to enter into such business which helps us to get more returns. If we have bought the above-mentioned pharma and FMCG companies at a high of the year 2008 and then bought again at low of the year 2008 then-current average return of pharma and FMCG has been increased by ~347% and 137% respectively.

For the current scenario, if we see HUL MCap vs 10 Pharma companies then HUL has a 24% higher MCap from pharma 10 companies.

Pharma VS FMCG

This analysis is given by many of the investors and fund managers but if we look at the return ratios then average RONW% & ROCE% of top 25 pharma companies is ~20% and average RONW% & ROCE% of top 10 pharma companies is ~16% whereas RONW% & ROCE% for the HUL is 80% and 90% respectively.

Pharma VS HUL

So, if we look at the growth and profitability of the top 10 pharma and HUL then does not has a wide difference but asset quality is far good for HUL compared to the top 10 pharma which must need to look. This comparison is not similar to real estate and pharma and FMCG whereas real estate has poor asset quality compared to the pharma and FMCG but here HUL has a better asset quality. If pharma has a huge earning growth compared to the HUL with 15-20% of return ratios then we can look into it. If we look at the ~73 listed FMCG then those companies do not have similar asset quality then they do not have a similar kind of valuation but those have, they command.

Closed watch also shows real-time sometimes in a day that does not mean, we consider that watch as a good watch.

If we compared sugar companies’ vs tea & coffee companies then it can be a good comparison where sugar companies are available more than double in MCap.

Sugar VS Tea & Coffee

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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

BIBLIOPHILE THE MOST IMPORTANT THING BY HOWARD MARKS

One of the books which have influenced me and my investment journey is “The Most Important Thing by Howard Marks”. This book teaches us the most important thing which we need to develop for becoming a wise investor.

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“The Most Important Thing” has many concepts which can help us to our investment journey. I have posted articles on the book. Now, I have compiled different articles into the one file for the ease of reading.

For, All in One Article click – BIBLIOPHILE THE MOST IMPORTANT THING BY HOWARD MARKS

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “Combating Negative Influences”

In this article, I am going to discuss regarding the psychological factors which affect our decisions negatively.

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Market many times provide us an opportunities to earn superior performance through inefficiencies, mispricing, misperception, mistakes of other people.

But the question is why such opportunities come? What makes us different from other people? Why mistakes do occurs?

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We need to analyze data and reach the conclusion. In investing errors occurs not due to analytical factors but errors mainly come from psychological factors.

Let’s look at the few psychological elements which affecting the investment decisions.

First emotion is GREED – Desire for money.

Most of us are making an investment for making more money. If we don’t care about the making more money than we are not going to make an investment.
And also there is nothing wrong with trying to make money. The market and economy run because of our desire to make money. But we should remain careful with a transformation of desire towards greed.

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Real estate

Real estate sector in India in the year 2007-08 creates a bubble and huge jump in the optimism by everyone. Such situation resulted under the sharp fall in the value of the sector.

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Due to an impact of greed, people hope that their strategies help them to produce higher returns without taking higher risk for forever. And due to this hope, many times people hold highly priced securities with expectations of more appreciation can be possible. Many times such expectations went wrong and prove that expectations were unrealistic and people have ignored the risk.

Opposite of Greed is FEAR. As similar to the greed, excess fear is also harmful to the investors. Excess of fear stops us from taking a constructive decision while actually, we require taking such decisions. Due to fear, many a time we cannot able to make a good investment and also lose the opportunity.

The third factor is PEOPLE’S TENDENCY TO DISMISS LOGIC.
Generally, it happens that people stop using logical thinking and they start doing work with an irrational mindset. Many a time, we are not ready to accept logical reasoning for the situations and work as per unrealistic scenario. We do not apply what we have learned in the past but get easily deviate from those learning.

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When market or a particular strategy starts generating higher returns for a while, then we started believing that it will continuously generate such returns without an involvement of risk.

Howard Marks called such situations as “Silver bullet”, the Holy Grail.

But is it really same strategy keeps on generating higher returns without risk?

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As Warren Buffett mentioned, when prices started rising then it affects to the reasoning power of the people. It led to mania and situations of mania results towards the bubble.

The fourth factor is THE TENDENCY TO CONFORM TO THE VIEW OF THE HERD RATHER THAN RESIST.

Many a time, we started Believing to the crowd and starts to take an action as per the crowd behavior. Though behavior of the crowd is harmful and dangerous to us.

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The fifth factor is ENVY. Envy comes into the picture when we are comparing ourselves with others. And envy works as a negative force which affects our decisions.

When we see that our investment is growing then we remain happy. But the time we start comparing our investment returns with investment returns of others then we become sad. Now, envy starts showing its color and we make decisions which we may not take or which may be harmful to the financial health.

It is very difficult to see the higher growth of other compared to our growth.

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The sixth factor is EGO. Ego gets satisfaction while we generated higher returns compared to others. And we are keeps on evaluating our return in the short term. While we should focus on the longer horizon returns rather than keeps on tracking returns in the short term and also try to get out of the trap of ego. Ego can be harmful to the financial health. We keep on demonstrates that how much we know much compared to others rather than focusing on how much we know and how much we do not know.

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The seventh factor is the CAPITULATION. It means investors give up towards the situations while economic and psychological pressure becomes irresistible.

Many a time, overpriced assets become more overpriced, and underpriced assets become more and cheaper. This scenario affects to the psychology of investors and repetitions of such situations inspired investors to give up towards the situations and make investment decisions without using logical reasoning.

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When few or all the factors combined then it affects to the investor’s decision making and that affects the market. This resulted in the mistakes and those can be expensive for our financial health.

Psychology in IPO is funny. When our friend is applying to IPO and we asked for the business then he doesn’t know about the business. But he is applying for getting good returns. And he continuously getting higher returns and such higher returns earned by our friend attracts us to make an investment into the IPO. And such situations keep on repeating & more people get involved into the IPOs.

IPOs

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Read for more detail: The Most Important Thing Illuminated by Howard Marks