May 21, 2017

No pizza today

I wrote the following note to my subscribers in response to two questions which are frequently asked by new prospects

a.     Please share your past performance
b.     How many stocks can I buy if I join your advisory today

The note below, seeks to answer the second question

Pizza versus investment advice
If you walk into a store or restaurant, you are handed the item or service as soon as you make the payment. Any delay or refusal to offer the said service is considered a breach of faith or fraud.

The above standard mode of exchange breaks down when we come to investment advice. The job of an investment advisor is to ensure that his or her clients make decisions which helps them in the long run (in achieving their financial goals). This can mean that the most sensible course of action often is do nothing and wait for the right opportunity to invest.

This is however not understood by the vast majority of investors who behave like a customer in a restaurant. A typical investor likes to be handed a menu card of stocks and would like to buy as many as possible even before the ink has dried on the cheque (metaphorically speaking). This expectation works if you order a pizza, but not when you are investing for the long run (5+ years).

The investment industry panders to this behavior and even encourages it. As much as one would like to blame the industry (and they have much to blame), the investor community is equally responsible for it. Stock markets are seen as a place to pat your ego (for recent high returns), indulge your gambling instinct or just entertain yourself.

In all my years, I have found very few who look at the stock market for what it really is – A place to invest your capital for the long term to earn returns above the rate of inflation and thus achieve your long term financial goals.

If you are in for the long haul, it makes sense to invest your hard earned money in the right company at the right price (price being very important). Often this happens, when everyone is running for the exit.

Walking the talk
It is easy to talk, but not easy to do the same thing unless your own money is on the line. My own funds, that of my partner kedar and our families is invested in the same fashion. Nothing focusses you on the risk, when your own money is on the line.

I get turned off when I read about fund managers and analysts who recommend a stock, but do not have skin in the game. It clearly means that they do not believe in what they say.

I made a conscious decision several years back that I will eat my own cooking and as a result, any loss in the portfolio is borne equally by me. In addition to this point, both me and kedar have made it a point to under-promise and hopefully deliver more. As result, inspite of a 100%+ rise in 2014, we decided to go low key as I knew that future results could be subdued for a period of time. I did not want to attract subscribers based on recent performance and disappoint them when I failed to meet their un-realistic expectations.

We continue to follow the same approach today. We will get excited when the market drops and go into hibernation when the market gets euphoric. The hibernation is limited only to activity and not to the effort of finding new ideas. We continue to build the pipeline, but the pizza will be served only when the time is right.

April 14, 2017

The Hangover from bull markets

A lot of people are celebrating these days and patting themselves on the back. We have a parade of investors touting their returns and claiming that 100% CAGR is for chumps. Multi-bagger could soon be a new name for kids :)

A bull market feels good and should be the best of times, right? How can one argue with that?
It feels great when your stocks are going up, making you richer by the day. You feel smart, on top of the world and in some moments can even see that retirement on the horizon when you stop working and live on the beach < insert additional fantasy as needed>

By my own estimates, I have lived through around 4 major and a couple more minor bull runs. It felt great during those periods as I  felt vindicated for sticking it out during the drops when everyone was rushing to the exits. It is only in hindsight, I have realized that bull market are dangerous in their own way and I was lucky to have survived the full cycle.
Let me explain

A confluence of factors
A typical bull market usually coincides with decent economic numbers when most companies are doing quite well. As a result, most participants become over optimistic and bid up the stocks of these companies. We thus have a confluence of factors – companies performing better than usual and being valued at higher multiples of peak earnings.

In addition to these factors, there are several psychological factors which come into play at this time. Let’s go over some of them
-           Social proof: At such times, you see people around you getting rich and more reckless the person, higher the returns. It is not easy on the psyche to watch your friends get rich , whereas you sit around doing nothing.
-           Scarcity: During bear markets, waiting helps. As the numbers are bad or getting worse, stock price for most companies stay stagnant at best. As a result, if you like to dig deep into a company, you have all the time in the world. No such luck during bull market. Any company with a half decent results gets bid up. As a result, you can either forgo an opportunity or buy the stock with lesser due diligence
-           Confirmation bias: A bull market gives a positive signal and makes you feel that you are doing something right. As a result, there is a tendency to ignore risks and not look for disconfirming evidence
-           Authority bias: If you switch on a channel, every other talking head and self-proclaimed guru on  TV is painting the vision of a glorious future where all of us would be rich. This makes you feel as the only idiot who does not get it

In effect there are multiple psychological and other factors, which conspire to get your guard down and ignore the risks
A bad hangover

I can recall the emotional roller coaster in the previous cycle, with the only difference that these cycles used to run over a period of 3-5 years. The years 2001-2003 (which is ancient for most investors) was a grinding and slow bear market.

It was the exact opposite of what we see now. I can remember buying companies selling for 5 times earnings, growing at 15-20% per annum and still going down in price. If you think these were low quality stocks, then that was not the case. I am talking of companies like Marico and pidilite which are the darlings of the quality school of investing now.
A new investor like me just could not understand why the market was behaving in this fashion.

The market started turning in 2003 and from there it took off for the next 5 years. A lot of my personal holdings went up multiple times (no one used the term multi-baggers as often then) and it was great to feel vindicated/ smart.

The problem with feeling smart was that is that you also feel invincible. The net impact of all these emotions is that I made a few picks, which were marginal at best.  These sub-par picks came back to bite me during the next downturn when they performed far worse than the overall markets.
A fight against instincts

The natural instinct for any investor is do the opposite of what should rationally be done.  When the markets are dropping due to poor fundamentals and bad sentiments, the tendency of most investors is to withdraw into a shell and wait for the sky to clear up.

This is usually the wrong action. Unless you believe that the world is going to end (in which case, stocks should not be your worry), it makes sense to buy attractively priced companies as markets usually have a tendency to extrapolate the recent trends into the future.
The same tendency is also visible during bull markets which leads investors to buy at the wrong price. The right action at such times would be to sell or do nothing, if the company is not overpriced. I personally think that one should go one step beyond – use this period to clean up your portfolio. If you hold some companies, which you are not as confident about, sell them down and increase the cash holding. A bull market is a good time to  swallow the bitter pill when the overall portfolio is doing well.

It is never easy
I wrote this a year back after the market dropped by 15% and this still holds true, except the circumstances have changed to a bull market.  Instead of courage to manage the fear, one needs the same courage to manage greed and euphoria.

It requires an equal amount of effort (or even more) to watch everyone around you make easy money, while you stick to your principles and refuse to take part in the madness.

Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

April 8, 2017

Letting go of easy money

I recently received an email and following is my reply

Hello Rohit,
Trust you are doing good.

I have a generic query regarding one of the stocks that has created a lot of buzz recently. Not sure, if you answer such Qs :)

Avenue Supermarkets (DMart) - This stock got listed at twice the IPO issue price. And, it is crossing new boundaries every week. There’s lot of positivity about this stock  (like next Infosys etc) and founder Mr Damani (value investor) in market and news.

Its very difficult to resist the temptation to grab this opportunity but not sure if this is the right time. So should we consider this opportunity or just ignore it as temporary heat in the air.

Kindly advise if possible.
let me share a couple of points on this :)
- i never invest in IPO (see here and here )
- i never chase hot trends in the stock markets
- i never buy momentum stocks, especially ones selling at high valuations
- i have never invested in retail companies as this is a very tough business.

i may be wrong here and this could be an exception to all my rules. maybe this stock will keep rising and people will make money. however i am fine with it ...i dont need to make money in all opportunities.

so my short answer is - i have no plans of considering or putting a single paise in such opportunities and am fine if others make money. as far as temptation is concerned ..i cant help you there :)

i hope i have shared my views clearly have to make your own decision. dont hold me responsible if the stock doubles :) ...i am fine with letting go of such opportunities

Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

February 20, 2017

Mental capital

This is a term I like to use to represent the time, and mental energy devoted to each position in my portfolio. I would also add mental stress to the equation.

I have realized that in a lot of cases the percentage of mental capital allocated to each position does not match with the allocation of financial capital. On the contrary, some of my top position have needed the least amount of mental energy on an ongoing basis and caused the least amount of stress. This has been mainly due to the quality of the business and management.
On the other hand, some of the smaller positions in my portfolio have resulted in a much higher allocation of mental capital and that could be also the reason why I never raised the size of these positions.

Not a mathematical exercise
Unlike the amount of financial capital, one cannot calculate the percentage of mental capital allocated to a position. However there are several pointers one can use to see if a particular company is taking a dis-proportionate amount of your mental energy
-           You are regularly surprised by the quarterly results
-           The management makes your stomach churn and causes you to worry about the safety of your capital
-           The industry is undergoing a substantial amount of change and you have no means of evaluating the economics of the business even for the short to medium term
-           You keep coming up with new reasons to hold on to your position, even after your original thesis has been invalidated. The word ‘hope’ keeps coming up in your thinking
-           You ‘worry’ about the position for any of the above or other reasons

The killer combination
If the financial and mental capital allocated to a position is too high, then we have a deadly combination. This is kind of an extreme situation can make you act irrationally and in the end be injurious to both your financial and mental health, if the position turns against you.

I have realized over time, unlike financial capital which can compound, mental capital is limited and does not increase much beyond a limit.  It is important to use it smartly both for your financial and mental health and finally for your quality of life.
A certain level of mental capital has to be invested when investing directly in stocks (instead of an index or mutual fund), but in some cases the level can go much beyond the amount of financial capital allocated to it. In such cases, I have usually found that selling down or completely exiting the position has freed up my mind to look for new ideas and devote more time to other stocks in the portfolio.

The tail (portfolio) should never wag the dog (your life).
Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.