the bitcoin puzzle

Bitcoin is a cryptocurrency and worldwide payment system. It is the first decentralized digital currency as the system works without a central repository or a single administrator. Bitcoins are created as a reward for a process known as mining. I have not come up with this definition. 

Since it is accepted as a medium of exchange by a fair number of buyers and sellers of products and services, and is being considered as a store of value too, it is a type of currency. I am not too sure if it is a legal tender though. Who's backing bitcoins? Where's the promise to hold it as a valid medium of payment under the legal system for meeting financial obligations? Bitcoins are not issued by the government of any country. Sure, it is a type of digital currency, because it is not a physical currency. 

All major currencies are traded on the foreign currency exchanges. Bitcoins too are being traded on the digital currency exchanges. What's the big deal about it? That its price reached $10000 recently? Yeah, it is a big deal. 

From nowhere the price soars to $10000 within no time. It actually has become everyone's envy. If only one had bought it in April 2011 when it was priced $1, or in June 2013 when it was $100, or in November 2015 when it was $500, or when, heck, one could go on. Little does one realize that envy does not take us anywhere; it only puts us down. 

You can see the levels of greed and envy from bitcoin's price history. Yet, for those who are eternally greedy and envious, there's no need to be disheartened; the price of bitcoin is only going to go up, for $40000 price is very near as per this prediction. Volumes are going up, and prices are going up. Everyone is happy.

No, not everyone is happy; we just noted earlier that those who did not buy it are not happy. But they too can be happy if they bought at $10000 and are able to see $40000. Bitcoins are happiness quotients, aren't they?

I am not bothered by the surge in bitcoin prices. People trade in all sorts of things in life, from wood, shoes, and paintings to currencies, oil, gold, and other commodities. They trade in bonds and stocks too. These are the traders' paradise. Speculation is fine if people know that they are speculating. The tragedy though is that most do not know that they are speculating the prices of things they trade. They think that they are buying (or selling) something that has a fundamental value which is going to go up (or down). And this is a dangerous psyche; a recipe for disaster. 

Only assets that throwout cash can be valued. For instance, real properties, bonds, and stocks. Obviously then assets that do not bear cash flows cannot be valued. For instance, gold, silver, and currencies. They can be traded and priced. The price is then purely based upon demand and supply. And demand and supply are clearly based upon the traders' perceptions. They are not backed by the intrinsic characteristics of the underlying asset. For instance, prices of stocks are of course defined by the movements in demand and supply. But demand and supply are based upon the quality of the business behind the stock. That means, when the business does well, the prices go up, and vice versa. That is true on a scale of long periods of time. However, there is no such scale for assets that do not have any underlying (and cash flows). Their  prices move on whims of speculators. Nothing wrong, but nothing much for someone in the right mind, who wants to make money on a probabilistic note.

Now, bitcoins do not have any cash flows associated with them. There isn't any business or an asset behind it. In such cases, how do we know the intrinsic value of bitcoins? Well, we cannot. We are then dependent upon someone else's perception. One fool buys in the hope that there will be another fool to buy at a higher price. The second fool is in the hope to sell to another for profit. And it goes on...until there aren't any fools around to buy. This is when we say that the bubble has burst. The greater fool's theory is an interesting one, for it has been witnessed in the past many times, but lessons are never learned. There's also a reason for that. The early fools usually get away with substantial profits; and everyone wants to be the early fool during every bubble in the making. 

If one of the sharpest minds we have seen could not control greed and envy, how could lesser mortals make do with it?

I have been talked to in the past few months to buy into bitcoins. I resisted like I always do when it comes to speculation; I am no good at it. When you are likely to fret over things, you rather stay away. In fact, I am not even sure if bitcoin is able to sustain as a store of value for long; to that extent it might even fail the currency test.

If your neighbor is driving a fancier car, and you fret over it, there's something wrong with you. And if you chase the neighbor's car, there's seriously something wrong with you. The earlier you realize this, the happier you will be. 

What I know for sure is this: there is an easier route to riches, rather to being financially independent. That is to play the investing game, for long. You could do index investing, or you could do the business of investing. There's a choice. 

Let the bitcoins be. 

money managers, greedy or cheats

I don't like money managers, and I have made it clear more than once. They are the biggest shitheads for what they do. Consider this: asking for money from other people in the pretext of making them rich, is some kind of a sham. The motive is clearly to make themselves rich. And why would they do it? Perverted incentives, I reckon. This is true with all of them, who managed money for others by taking money from them. It is true with those, who continue to do that, and who intend to do it. I know that is harsh, but, I mean it. Their incentives are so misaligned that investors just do not understand it, or prefer to ignore it. 

Before we dwell into what these idiots engage in, let's find out why individual investors hand their cash to others. Investors are either too busy with their affairs that they don't get time to do it on their own, or they are ignorant about investing in general. That makes it easier for them to just pass it across to the so-called experts to do the job. That is understandable. Yet, there is a better way out for them; and this they do not understand. 

We invest because we want to retain, or rather increase our purchasing power in future. We need to be compensated for inflation. We need to be compensated for facing uncertainties of time. We need enough stash to take care of our future requirements. Among all available opportunities, equities have proven to be best suited to play this game. So we need to invest enough in equities in order to have enough in future. 

Here come money managers: mutual funds, hedge funds, alternative investment funds, and you-name-it funds. You have private portfolio managers. There are those, who manage money for only few groups of people. A number of small-time individual money managers have sprung up calling themselves (value, what else?) investors, who are capable of beating all others. Then there are some combinations of sort. What is common among them is that all of them seek money from others in the pretext of making them rich. Let's collectively call them money managers, although I prefer some other name.

There are two types of money managers: Those who generate excess returns consistently, and those who do not. Excess returns are possible when they beat the market returns over a long period of time. Not many are able to play this game well enough. By virtue of their doing, they are either greedy, or cheats. Yet, both types are frauds. Here's why:

The greedy

Let's take money managers, who are good at the game, and therefore, their operations are able to achieve consistent, superior returns over a long period. Their pitch is the precursor; that they promise to generate higher returns for investors. But if we invert, we get a different motive. These managers want to get rich quickly. These are the greedy breeds. Consider this: If someone is good at investing, the best one could do is to start one's own investment operations, which involves investing own money, and build wealth. Over a period of time, because of the superior investing skills, the investment returns would be superior, and consequently, wealth gets built. Getting rich is not going to be a problem for the person. I know so many of them, who mind their own affairs, and have gotten rich along the way. And I admire them more than others. But, our typical money manager will not do it because of greed. This manager knows that by promising superior returns to investors, there will be two advantages: One, asset management fees, irrespective of returns. Two, performance fees. This manager will get richer faster than he or she would have if other people's money was not sought. So the greed factor makes them tell others that they will make investors rich by earning superior returns; and thus seek money. Well, I give two hoots. 

The cheats

Then there are money managers, who are not capable of achieving consistent, superior returns over a long period. And they are the majority. Their pitch is the same: I will make you rich. However, they don't know how to play the game, and despite that, they get asset management fees, and some (non?) performance fees too. If investors don't call them cheats, what else do they want to name them? Investors should ask these men and women to get the heck out of their life. They are no better than mis-selling salespeople.

The ideal strategy

Now that we have dealt with both the types, what should investors do to stay in the equity game? They have two options:

The first is, if they know the game, like it, and have time to spend on it, they are better off playing the game themselves. Why give your money to others when you can invest yourself? Consistent, superior returns are more of a behavioral thing than of intellectual. Average intelligence, knowledge of accounting, time value of money, and basic statistics are all you need to do well if you have the right behavior.

The second option is for those, who cannot understand investments, or have no time and interest for it. These investors can easily invest their cash on a periodic basis in a diversified index fund. If they carry out such automatic investment operation for a long period of time, they will be assured of market returns, and also will be reasonably rich along the way. I mean rich enough to take care of their future financial requirements. Instead of worrying about purchasing power of money, they can continue to do what they are good at and enjoy life. Index investing will take care of the purchasing power, inflation, time value of money, and so forth.

Cavet emptor
In conclusion, if a money manager uses other people's money to invest, the manager is either greedy, or a cheat. Take your pick.

Also, it is always the caveat emptor that buyers need to be blamed first for choosing to buy without understanding consequences. There is always enough time to build wealth and resources to take care of our needs, but never enough to feed our greed. 

buffeted by buffett

Warren Buffett is a great buy. If he had not done what he has done, we would not have had the Warren Buffett we know. Sharp, witty, and an amazing storyteller. He is a cult. I have mentioned earlier as well that he has shaped my thought process in a major way, both in investing and in life in general. Needless to say again, I admire him a lot. 

Berkshire Hathaway has never paid out any dividends, nor has it bought back its stock so far. The reason: Buffett feels that he can allocate capital better than his fellow shareholders. And why not? History is with him. The strategy has worked superbly over many decades. Yet, now the time is different; he is working with truck loads of cash that he needs to allocate in a manner that returns higher than alternative opportunities. Admittedly by him, repetition of historical returns is getting way tougher. 

There is at least one investment that has not gone well with him in the past decade. Never mind that I don't like the product personally. Coke is all fizz and fuss; sugar and soda. And that's the reason I had a fourth question for him. In 2007, Berkshire had 200 m shares of Coke, representing 8.6% ownership, the market value of which was $12.274 b. In 2012, it had a 2:1 split, and Berkshire owned 400 m shares, representing 8.9% ownership, and worth $14.500 b. In 2016, the 9.3% ownership in Coke had a market value of $16.584 b. The increase in ownership was due to Coke's share buybacks, in which Berkshire never participated, Buffett being an all time fan of both Coke as a product and a business. 

Berkshire's investment in the stock had a high market value of $12.864 b and a low of $9.092 b in 2007. The values were $16.264 b and $13.316 b in 2012; and so far in 2017, the high value has been $18.972 b and the low has been $16.176 b. Berkshire neither bought, nor sold any Coke shares during the last decade. Therefore, the original 200 m shares have become 400 m post stock split. When we consider high values throughout, the return for the first five years from 2007 to 2012 was 4.80%. And for the next five years from 2012 to to date in 2017 has been less than 3.13%. The return over the last decade has been less than 4%. 

Now some math. If Buffett had sold the shares in 2007 at a high value of $12.864 b, and invested in Berkshire's (his own) alternative opportunities, the investment would have been much more than the current value of $18 b. If the opportunity cost of 10% is considered, the loss to Berkshire and its shareholders has been $15 b. When you madly fall in love with the stock, you have some serious consequences. 

What about the opportunity cost of his fellow shareholders? Surely, some or more of them would have dealt with the cash better than Buffett. Check out the S&P-500 just for comparison, and you will know. What next? Is he going to be in a denial mode all through? Hasn't Coke lost its mojo? It's a surprise, surprise that all-sugar-and-soda had its magic prevailing over the century; the stupidity of humans knows no bounds; remember, some of the smartest guys we know have extraordinary fondness for the can; and that's a debate for another day.

In May 2017, I did suggest to return cash back to the shareholders to mend themselves. Of course, Buffett is human, and is entitled to his share of mistakes. But would he listen now? Surely, you're joking, Mr...

hdfc bank, where can it go

HDFC bank's market value of equity was Rs.367 b in 2007; it was also available for Rs.198 b in the same year. Now, the whole bank is worth Rs.4750 b. That's a massive change in fortunes. And there is a reason for that. Earnings per share has increased from Rs.7.15 to Rs.59.52 during the period, even after accounting for dilution. Check this out: the number of common shares outstanding increased from 1.59 b to 2.56 b, adjusted for a 10:2 split in 2012. 

Market share has been steadily increasing. More importantly, the bank has been managed exceptionally well by Aditya Puri and his team. Book value per share increased more at the rate of 24.42% annually during the last decade. Mere increase in book value is meaningless if do not consider how good the book equity is. And that is measured by the quality of its advances, which were at Rs.5854 b, and  increased at 28.7% annually. Gross NPA was 1.05% in 2017, and net NPA was 0.33%. Including restructured loans, net NPA was 0.43%; that is phenomenal. Compare that to ICICI and Axis in the private sector, have a look at the entire public sector banks, and we will get the picture. Its equity capital is healthy too, with Tier 1 capital at 12.79% in 2017. 

The bank has excelled in other parameters as well. Its return on assets was 2.09% in 2017. Net interest margin was 4.30%. Average CASA ratio was 48%, which makes its cost of funds lower. Cost to income was 44.50%. Return on equity was 20.53%.

The story has been so good for the bank that its investors have really reaped rewards. The low base of a newly incorporated bank, and the advantages of a superior management have been clear. But where does it go from here? Is there anything left for the new investors to achieve superior returns?

The problem is that a good quality company always commands premium valuations. HDFC bank's price-to-book was 5.71 (high in 2007) and 3.08 (low). During 2008, 2009, and 2010, it was available at less than 3 (low). Even during 2014, 2015, and 2016, it was available at less than 3 (low). The high PB was never more than 5 during 2009-2016. I am measuring the ratio based upon latest annual historical numbers, rather than projected book numbers. Now the bank is selling at 5.18 times 2017 book equity. From March to September 2017, the book value has increased making it lower than 5 probably.

With the mess that has been around in the public sector banks regarding low quality book, their need for fresh equity is imminent. And, with the digital push from the government, it is reasonable to expect that the market share of public sector banks will gradually diminish, and private banks will gain. HDFC bank stands to gain from two counts: one, because of the sectoral changes shaping the economy, and two, top class reputation. 

HDFC bank will grow; but we do not know by how much. It will also command superior valuations compared to its peers; but again, we do not know how much. The bank's stock was trading at a high value of Rs.1454 during the year ended March 2017. In eight months time, it is quoting at Rs.1854 per share, a gain of more than 27%. 

Should we wait for the declines, or should we buy in bulk for the next decade? Or, should be accumulate on a periodic basis, averaging out the cost per share? My guess in terms of the strategy and results, is as good as anyone else's.