dividend investing

There are a lot people who think that investing for dividends is great. They work hard, very hard, to accumulate the investment corpus enough for them to live on dividends for rest of their life. 

There’re at least two problems with it. The first is that dividends are just one of the components of the total return. The other, often the major portion, is capital gains. 

Generally, dividend paying firms do not have much growth left in them; and high-growth firms generally do not pay out any dividends because all internal profits are ploughed back into the business to generate growth. For high growth firms, increase in market price reflects capital gains which will be quite high too.

So this obsession with dividends is laughable. More so because even for people who need cash, they can sell some portion of their portfolio as capital gains. There may be times when market price may not be the best to sell, but investing in stocks is that game. For fixed income, it’s better to stick to fixed currency investments.

The second is that considering dividend yield based on cost (past purchases) isn't a great idea. It's the opportunity cost on current market price what matters. 

There’s another problem too. Somehow these people like to grind all their life only to live on a teeny portion of their wealth; dividends. They’ll be glad to leave their wealth for someone else to enjoy. Freakish, perverse, or masochist, how do we define them?

Try telling this to dividend buyers...

the twenty percent return strategy

The (so-called) value investors have dug a hole for themselves when they talk about margin of safety and bash (higher) discount rate in dealing with risk in cash flows.

They like to discount cash flows at 10%, bring down the present value by 40% as margin of safety, and then expect the stock to give them 20% return.

In fact, I have seen some of them discount earnings, rather than cash flows.

They also have the habit of beating round the bush so much. Can't put across their point without some bullshitting. 

not investing

What is value investing? It means nothing, or nobody knows what it means. In fact, it is nonsense. 

If you acknowledge value investing, well... If you criticize value investing, well… Heck, if you write about value investing, well... People think that low PE/PB stocks are value investing. It’s fool’s paradise to assume that. 

Academicians come out with stories that bring down the very premise of value investing. And the self-proclaimed value investors have their stories that always uphold their virtues. The truth is that both stories have a lot to catch up. 

Because, there’s no such thing as value investing. The definition of investing was laid down by the great BG long back. It doesn’t have value or growth attributed to it. There’re 3 key components to investing: Thorough analysis, safety of principal, and expectation of adequate return. So it’s either investing, or it isn’t. 

Stocks represent businesses behind them. To be a good investor, you need to understand the business first. You need to know the difference between price and intrinsic value. 

Price changes all the time, and therefore the multiples change too. Because prices change to weird levels, and thus create a wide enough gap between price and value, there’s scope for investing. If this ain’t so, it ain’t investing: It is something else: can be speculation or trading, or anything…

Academicians have a constant itch to talk and write, and even concoct theories. They come up with stories about almost anything, and put up for display. Their job is done.  

Finance is commonsense, in that there’s not much difference between personal finance and corporate finance. Coming out with Greek letters and complex theories don’t make good financial decisions. They make good looking books. Good financial decisions make good financial decisions. 

A business is formed to make money. If it’s viable, it’ll make money. As it makes money, it grows. And it doesn’t happen over a quarter, or a year. It takes time; it’s a long process. In the meantime, people price it based on their theories. Most often, these theories are crap; therefore, investors get opportunities to invest, and make money. 

Investing is neither value investing, nor growth investing, nor momentum investing, or any other. Investing is just investing. 

CAPM is crap; and so is the margin of safety in the sense that some people view it. Cost of capital used in finance to discount cash flows is also stupid because that is supposed to be a theoretical business valuation. What investors want is make money, not theory; and for that their own opportunity cost is a better discount rate. 

Starting a new business is a waiting game. Making it expand, and grow its cash flows is a waiting game. Making business profits is a waiting game. And for the same reason, investing is a waiting game. 

Cash flows are powerful indicators. Focus on them. It is very much possible to earn excess returns (beat the index) if you know how to estimate cash flows, know your opportunity cost, and you’ve the behavioral acumen to play the waiting game. If not, no worries; invest in the index. 

Individual investors are neither answerable to the marginal investors of the business, nor to the academic finance. 

Don’t listen to self-proclaimed value investors; and don’t listen to the academicians. Most people, most of the time are better off not listening to other people’s opinions.

things burry cannot explain too well

Recently, Michael Burry made a comment which the investors seem have taken too seriously. The story is short, but has made the news big.

Burry rose to fame after he made loads of money predicting the crash of the housing bubble in 2008. He was made more famous by Michael Lewis through his book, the big short. So yeah, he is a great guy. 

But that does not mean whatever he says has to be sacrosanct. He makes mistakes too. In the story, he saying that index investing is proving to be bad. In fact, so bad that he is likening it to the subprime CDOs. 

I am not sure whether I have to feel sorry for him, or for those who believe him. There is one thing I have found short in the investors' mind: that they don't have their own conviction. That's a behavioral debt which often becomes too expensive. 

Well, Burry is saying that index investing is bad, because it does not support market price discovery. Because when too much cash chases the index, prices of all stocks - good, bad, and ugly - will shoot up. Because investors buy without any regard for the price and value of stocks. Because the index comprises of far too many small, bad businesses whose stocks do not have liquidity, and yet are priced high. And he says the crash will be ugly. 

Then he goes on to compare index investing with the synthetic asset-backed CDOs. Here I am not sure whether he is actually comparing the bubble to the bubble, or the index investing itself to the CDOs. If he did the latter, his blunder is more prominent, for the CDOs are based on disproportionate leverage, and the index stocks are not that much. So that aspect is never comparable. But let's give the benefit of doubt to Burry, and believe that he just said about the bubble, like any other bubble. 

Now coming back to his concerns regarding the bubble in the index investing, we all know that the economy and markets are like a cycle. They go up and down all the time. There are times when the prices shoot up so much that they have to eventually fall, and yet other times, the other way is true. When taken to extreme, the bubbles have to eventually lead to price fall, and the busts, price rise. And they always do. 

Also, the free market mechanism comes into play all the time. Let's suppose that the bubble crashes badly. When the prices of the index stocks go up disproportionately compared to their fundamentals, the crash is bound to happen. Remember the dot-com bust. After the crash, the good stocks represented by high quality businesses become cheap compared to their intrinsic value, and the bad stocks represented by poor quality businesses may remain somewhat expensive. The investors will shun the index and buy good quality stocks, and may even short poor quality stocks. The index will then eventually move towards becoming fairly priced, making the case for index investing. 

Let's assume that the index investors, after the crash, sell their index stocks and buy good stocks which became cheaper. After the continual demand, prices of good stocks will go higher, and value of the index will correct. Now we have the case for index investing again. Because of this free market mechanism, even those index investors, who do not sell after the index bubble and crash, will also benefit by staying put on the index investing.

In fact, that is the essence of index investing: to keep going during both good times and bad times, pushing the average price of index units lower, and getting a reasonable market return. I can even say that a good index investor can achieve a return slightly higher than the market by increasing buys during bad times. But that's another story.

The hedgers, speculators, and short-sellers are always alert in a free market, and they take advantage of all arbitrage opportunities ensuring that the price and value of stocks and, therefore, the index are never too far off, for too long.

I am surprised Burry missed this point big time. We should be asking him where else to put money if not the index. The treasuries and high quality corporate bonds yield much lower. Junk bonds are not an option for the real investors. We have two choices then: Pick the stocks, or go to the index. 

Picking stocks is not for everybody. It requires time, interest, skill, and behavior. Index investing is for everyone who cannot be a stock picker, for the investor is assured of the market returns. 

For someone who has at least a decade of investing ahead, index makes the perfect choice. Once the horizon becomes shorter, asset allocation will have to come into play. A right mix of the treasuries, high quality bonds, and the index should take care of the investor's cash requirements for the rest of life.

The fun part is that we are not even close to all-passive investing. There is huge money actively and continually chasing stocks all the time, and I believe that as much as we know of the human behavior, we have a very long way to go against it. The fear, greed, and envy will ensure that active investing will stay for a long time, and index investing will continue to give market returns for those who find it satisfactory.

It is far better to use common sense and wisdom than borrowed conviction. Life and investing then will be rewarding.

microsoft and a trillion

Microsoft Corporation share closed the day at $127.13 with a total market capitalization just shy of a trillion dollars. The entire equity of the firm was worth $245 b some time in 2008. The growth has been both phenomenal and unprecedented because of the products it was dealing with and sheer size.

Revenues in 2008 were $60 b, and comprised the following.

In 2018 as revenues nearly doubled, the segments have changed.

The intelligent cloud has been the savior for Microsoft which experimented with many things using cash flows from Office and Windows. The elusive growth has been restored at least for sometime. Operating profits and (pretax) free cash flows to firm were $35 b in 2018. The growth in pretax fcff was 8.5% and 12.4% during the last 5 and 10 years respectively. Pretty decent given Microsoft's size of operations.

There were at least 2 major acquisitions in the past decade. Skype was bought at $8.6 in October 2011, and LinkedIn for $27 b in December 2016. Taxes in 2018 were exceptional; Microsoft is capable of $25 b aftertax fcff each year. Is 40x fcff a fair price for Microsoft? I am not sure. Apple is making nearly twice free cash flows, and yet is priced similar to Microsoft. But then Apple is banking on just one product, iPhone. Microsoft has a better product mix; Office and Windows generate steady free cash flows.

Even with a 10% growth for the next 5 years, and then moving towards a steady growth state in year 10, Microsoft may not give 10% return. If you are going to be ok with that, you might as well be ok with the S&P-500 with a far lower risk.

Microsoft has done well, and it is likely to do well in terms of its business and operations. But the stock is also not coming cheap.

Let's see again the numbers coming up for the year ending June 2019.

axis and yes bank q4

Both Axis bank and Yes bank reported their financial year results, and here's the story. Axis reported Rs.50 b profits for the year, and Yes had Rs.17 b profits. 

Yes also had losses of Rs.15 b for the latest quarter weighing in heavy provisions. While people are fretting over those losses, they don't get that when an investment turns sour, it just can't be called sweet; taste it to know it. Postponing provisioning for non-performing assets doesn't make sense even when the regulator or laws allow it; that will be stupid. On that front, Yes bank has probably done the right thing. 

Yes bank's book value is Rs.116 per share, while that of Axis is Rs.263 per share. With these numbers, their stocks are trading 2x and 2.8x respectively. But that is not the way to look at it. They have more NPAs, including stressed assets, that are not yet provided for. Including them in book value will inflate equity. Adjusting for full provisions on estimated NPAs, the stocks are trading 2.68x (Yes) and 3.43x (Axis).

Both banks have decent regulatory capital ratios: Axis (12.7%) and Yes (11.3%) in Tier 1 capital. Loan book is growing for both banks. Axis has better CASA (44%) compared to Yes (33%). Axis also has lower cost of funds (5.69) and Yes (6.5%), and slightly better net interest margins (3.44%) compared to Yes (3.2%).

Yet considering the current stock price, for a return of 13-15% in the next 3 years, Axis will have to grow 20% and Yes, 15%. Of course there will be people who will shoot for Axis in terms of higher growth and better book. At its current price though, Yes bank could give a return of 8% with a 10% growth rate. This is based on the reported gross NPAs and stressed assets; any hidden NPAs should bring the book equity and returns lower.

There is also a good chance that the Yes bank stock will be hit hard in the next trading sessions, and that should give opportunities for better returns. Axis bank is also likely to do well, but its stock price as of now is a little on the higher side. 

tesla q1 2019

Tesla reported its q1 numbers, and are we in for a surprise, or we aren't? That question depends upon whether we are a Tesla bull or bear. Vehicle deliveries fell short, and apparently had to be shifted to q2. The company still stands by its guidance of 360-400 k vehicles in 2019 representing a 50% plus increase over 2018. With Gigafactory China coming up, the target is 500 k vehicle deliveries. 

There was a significant reduction in revenues compared to the previous quarter. Tesla had operating losses of $521 m, and interest charges were $157 m. Cash loss from operating activities were $639 m, and over $300 m capital expenditures meant negative free cash flows of nearly a billion dollars. Tesla also repaid over $500 m of debt. Because of these, closing cash position was $2.6 b compared to the opening position of $4.2 b. The company has a debt of $12 b, and in addition, also had operating leases which are in effect a form of debt. 

The management has a guidance of capital expenditure of $2-2.5 b in 2019. So we should expect the company to make cash flows of at least that amount just to breakeven.

To justify the market value of nearly $50 b - never mind the fall post results - Tesla should do a lot more than what it has in the past.