Long term investors are often in a dilemna if a stock they own runs up a lot. If they would not buy fresh stock at that price, should they sell? Here is a post by Sanjay Bakshi on the notion that for long-term investors in high-quality businesses, the rules for buying a stock and those for holding a stock are not the same.
Here is an extraordinary article on how to rationally evaluate the different returns that different asset classes obtain, and how to diversify away risk and volatility by constructing a portfolio. The conclusions are not great for someone seeking Alpha, as the author suggests that because diversification is extremely easy these days, and because there is a long history of markets, stock market valuations would rise to a point where the differential in return between stocks as an asset class and other asset classes like government bonds will narrow or disappear.
Here is a great post on different levels of investors, and how one can progress (if at all) from being a good investor to being a great investor, and from being a great investor to being a legend.
It has been almost a year and a half since I started equity investing seriously.
During this time, my portfolio of stocks and equity mutual funds has risen by more than 7 times. During this time, the amount of money I had in equity mutual funds has halved, while the amount of money invested in direct equity has tripled. On balance, the portfolio has gained around a 100% in a year and a half.
Obviously, one has made a lot of money. I almost have my first 10 bagger (MPS) in less than a year and a half. Several Stocks (PFS, Mayur, PI, Sintex,Shilpa, VST(since sold), IRB, Bharat Forge, Balkrishna, Kaveri,Polymedicure,Oriental Carbon, Munjal Auto, KRBL,CanFin Homes, Orient Cement, RS Software) have risen between 3 and 5 times. Several of my more recent purchases, like Ajanta, Indiabulls Housing Finance, Akzo Nobel, Kitex, GPPL, Amara Raja, Bayer Cropscience, Munjal Showa) have also shown terrific performance. Many of the stocks which I picked, and sold (because I thought they had run up too quickly, like Igarashi Motors, Kesar Terminals,GMM Pfaudler, SRF, Alkyl Amines Chemicals, and Avanti Feeds, went on to prove me spectacularly wrong, with me paying taxes to boot. So lots of hits.
Some quality companies, like Cummins, Grindwell Norton, Larsen, EClerx have given me great returns too. Private Banks,like ICICI and Federal Bank haven’t done badly, but in fact the PSU banks (at least in my portfolio) have done better.
What about misses? PSU banks have not done that well, but I would not call them misses. Clearly Metal Stocks, like SSLT, Tata Steel, Hindalco, NMDC, Hindustan Zinc were a miss. Most of these I purchased during September-October 2013. Given that, they have all risen around 50-70% from there. However, I have purchased NMDC, SSLT and Hindustan Zinc at prices higher than currently. Selan has given me good profits (because I sold at the right time), but I still hold some, and it has come right back to where I purchased it.
The two stocks that have the highest weightage in my portfolio IDFC and Oberoi Realty have clearly not performed as well as some of my best picks. Holding and Investment Companies (and I own Tata Investment, Bajaj Finserv and Bajaj Holdings, and if you can it call it that, EID Parry), and while these stocks have not done badly, they have hardly risen 300-4000%, even though they represented value when I purchased, and represent even more value today. I haven’t purchased Tata Investment or Bajaj Holdings lately, though I have recently purchased a whole lot, since it the only meaningful listed insurance play.
Another stock which has consistently disappointed this year has been Reliance. Another disappointment has been Bajaj Electric. A third has been Tata Global beverages. And finally NTPC has hardly moved, though it has fulfilled my investment goal of a 5% dividend and a 10% stock price rise annually. In such stocks, one has to pay the right price and one must clearly know one’s investment goals. I sincerely feel that stocks like SJVN and NTPC are necessary to have in one’s portfolio, since they insulate you from severe capital loss, and give steady returns. But one must buy them at the right price.
All in all, my crazily diversified portfolio has given returns better than most mutual funds. However, had I invested in only
i) ValuePickr Portfolio companies my returns would have been 2-3 times my current returns.
ii) Prudent Equity Stocks (Looking for deep value stocks, with poor business characteristics) would have lad my returns to at least twice what they are.
So I have not done that well
So what have been the learnings:
a) I stayed away from Stocks that had high PE’s. Which meant I have very little of the likes of Unilever, and Colgate and Gillette, and the ABB’s of the world. On balance, I think this was a good strategy. In face, I sold Colgate and bought Cummins, and Cummins has done much better. I think the high PE stocks are terrific businesses, but others think so too, and so they have not been spectacular purchases. On the other hand, quality businesses (or businesses with poor management quality but great structural tail winds) with low PE’s at the time of purchase (like BKT,Mayur, MPS or IRB, or Canfin or IBHL) gave spectacular returns.
b) Investment companies seem to be a no-no. As a wise young man told me once, these companies which merely are the promoters holding companies will rarely reward minority shareholders, because there is never value unlocking.
c) Commodity stocks will in general mirror commodity prices. So these stocks ought only to be bought after several months of an extreme price breakdown in that particular commodity, and that also, only if the company is not highly leveraged. Trying to catch a falling knife in these companies can injure one’s portfolio badly
d) Markets often give you spectacular mispricing. If one has courage in one’s conviction, one can exploit the mis pricing wonderfully.
e) High Leverage can be very toxic. Highly leveraged companies ought to be avoided in all circumstances, no matter what price the business is available at.
f) It is easy to fall in love with a stock.I think before one keeps purchasing, one needs to get the contra view. And one needs to consider the contra view seriously.
g) I am naturally slightly risk averse, and I have great curiosity. So I often buy for diversification, and I often buy because I just like some company’s financials, or because someone recommends it. But it is easy to buy a 150 stocks, much tougher to buy only 20. But it is much easier to manage 20. So one needs to make a real effort to cut down on the number of stocks one holds.
Questions
a) If one knows that some stock is likely to do better after a year, is it better to buy now, or wait for 9 months and then purchase. Obviously, if I know it, other market participants too know, and won’t the stock price run up before actual company performance? I have accumulated both IDFC and Oberoi Realty in this hope, that the stocks will do much better after a period. I also knew the negatives. In the case of IDFC the negatives were clear:
i) Infra finance was a dog. There is lack of demand for finance, existing accounts are struggling and the company had lent to gas based plants, which are just postponing their day of reckoning
ii) In the transition to becoming a bank, IDFC will increase costs. But the returns will come only a few months after the bank actually fructifies. Also, the company can’t increase its book too quickly, because otherwise it will have a hard time meeting priority sector targets.
iii)FII’s can’t buy IDFC stock, and FII’s are the main providers of liquidity.
Instead of IDFC, one could have easily bought a newer less mature Bank, like Yes, and made spectacular returns already.
In the case of Oberoi, the poor state of the Mumbai Real Estate Market is a clear negative. Presales are slow, the company is not able to lease its new tower, the new Worli tower has flats priced in the range of Rs. 25-30 crores each, and how can the company sell 250 of these? And finally, the slow pace of construction and launches. One could have easily bought a Bangalore play like Brigade.
Yet there are features of both companies which ought to lead to price recovery by the first quarter of 2015-16. But what if the overall market has tanked by then, or really risen up? One misses out on the run up in stocks which are already doing extremely well, and the opportunity cost is nothing to be sneezed at. Isn’t it better to be buying the stocks later, even if you don’t get very cheaply, but buying something that is rising now? Time will give me the answer to these questions.
The second question is what stocks to buy? How much should one trust the market? There are influential market gurus advocating that one buy’s stocks which have hit 52 week highs, not stocks which are at a loss. I buy those stocks which fall, not the ones which rise. It seems to me that if something is available cheaper (for eg in a sale) in real life, I rush out to buy. I don’t buy clothes when the prices are the highest. Why should it be different in Markets? But so far, in this market, in the last one and a half years, it seems to me that these gurus make sense. If I would have bought the same stocks which had given me more returns already, I would have had even better returns. Again, I have not followed their advice. Again, Time will tell how right the gurus are.
After long thought, I have decided to stop monthly updates on my investment performance, at least for a while.
There are many reasons for the same. Certainly one of the practical reasons is that I was spending way too much time on updating and refining my spreadsheets, neglecting more essential things. The other was that I was almost reviewing my performance on a minute to minute basis, and I think that that kind of obsessiveness results in too much activity on the stock markets. It is better not to know every minute what your performance is. The third reason is more nuanced. If indeed, I am a long term investor, why am I worried whether I have beaten the benchmarks daily, weekly, monthly or trimonthly. I should take a view on a stock at a particular price. If the price falls, I should buy more. Then I just need to review the performance every year, and try to beat the benchmarks every year. This is because my one and a half year’s intense experience has taught me that a) Markets often get it wrong in the short run and b) that momentum traders sometimes trade up a stock excessively, or sometimes punish a stock unreasonably. Momentum trading may be profitable for the people who practice it, but I cannot see myself trading solely on price, without any fundamental backing.
If markets do get it wrong in the short run, then why worry about performance in the short run. I should only worry about performance in the long run. And this is what I intend to achieve by not keeping on comparing myself to benchmarks.
There is no question that sometimes markets get it spectacularly wrong. While broad market performance is often sentiment and liquidity driven, individual stocks are sometimes completely misunderstood, and the market simply does not give them their due.
Within the broad market today, there are a number of stocks available at PE ratios of 30-50. There are several others available below 10. The large majority of midcap and large cap stocks are available with PE ratios between 10 and 30. Why this wide divergence between PE ratios of different businesses?
As I have understood it over the last year and a half or so, markets currently like companies which
a) Have Good Corporate Governance
b) Have steady growth, notwithstanding economic conditions. Usually, a necessary condition of this is economic pricing power through some kind of moat – brand power, distribution power, unique location or asset.
c) Are present in sectors markets like for the moment, because of the market’s reading of macro or microeconomic themes.
d) Have high Return of Equity and High Return on Incremental Capital Employed
e) Have Low Levels of Debt, which again allows them to come through economic cycles unscathed.
As a result of this, companies which are currently available at “high” prices (in my parlance, high PE ratios) are typically multinationals across the board (though especially those which own consumer brands, like Colgate), Pharmaceutical Stocks (like Sun Pharma), Indian Consumer Goods Stocks (like Marico and Emami) or Consumer Discretionary Goods Stocks (like Asian Paints). All these stocks share many of the above characteristics. The darling sectors of the markets are FMCG, Consumer Discretionary, and Pharmaceuticals. Autos and Auto Ancilliaries and Private Sector Banks are raring to join the party.
But it wasn’t always so. Rewind back to 2006. I wasn’t an active market participant at that time, but what I do remember is that HUL(which meets all the above criteria) languished for a long time in the first decade of the new millenium. And what was going at crazy valuations- DLF. DLF did have unique assets (Land) and did have good growth, and was present in a market sector which agreed with the market theme of the moment.
But on all the other parameters, Debt Levels, Corporate Governance, Return on Incremental Capital, DLF actually scored very low.
While DLF and HUL are probably only two examples, I think it is hard to argue on the broad thesis that stock prices run up first, and then broad thematic explanations are fashioned later to explain the stock run up.
One enduring theme is the notion of Economic Moats. Popularized by Buffett-Munger, and then expanded by Pat Dorsey, Economic Moats seem to deliver enduring returns over long periods of time. But even here, there can be a slow decay of moats over time, (witness Coco-Cola and Microsoft, as vivid recent examples), and thus for investing over the long run, investors need to focus on more than just economic moats-they need to be careful about the price they pay for stocks. If one pays too much for a stock, no matter how great the structural and human characteristics of the business, then you cannot expect that over the long term, you can make great returns on your investment.
This is particularly true when one confronts the kind of bull run we are in, and which may, hopefully, translate to being a multi year bull run. In September 2013, all stocks, save for some FMCG stocks, were available at prices which would have given great multi year returns, One did not need to be a stock market genius to acquire stocks at the prices they were available at then and then just wait till they would give you great returns over time. But as the bull run proceeds, I am quickly becoming sad. While I still have capital to deploy, I do not find prices very attractive any more. But the uncertainty is killing: On the one hand, if this is a multi year bull run, then it is best to purchase today, otherwise one might miss out on all the great gains that are likely to accrue. In the next post, where I discuss contrarian investing, I will also discuss how a great stock price itself propels companies forward. On the other hand, if it turns out to be a chimera, then one needs to be very careful about the price one is paying, and the kind of business one is paying a high price for. Otherwise, one needs to start worrying about capital preservation, rather than return on capital.
The time has not come yet, but I do see a time in the near future, where I just keep enjoying the run up in stock prices while doing absolutely nothing in the market other than staying invested. As far as I am concerned, I will not overpay for stocks beyond what their earning capacity is, plus a small speculative element where they may find avenues for growth in earnings beyond the obvious. So the only alternative is to wait for others to do so. Gauging value of stocks, and then sticking to that notion of value, is my investment style.
Update:
Here is a nice article by Dr. Vijay Malik, which talks about the same principle of not overpaying for stocks, but in a much more analytical way.
