market cap meltdown

I just thought of noting down the change in market caps of some of the largest companies in the US. Let's start with the market itself. The S&P-500 started the year with 2695.81. Here we have the google screen shot of the index.

On 7 December 2018, it was at 2633.08. Not that good. People are giving all sorts of reasons for the fall; but none of them are convincing, because it is the nature of the market to fall and rise, and rise and fall. Frequently, it forms sort of cycles that we call bulls and bears. There is no linear progression to be expected from markets or individual stocks. They don't have maturity values either. Stocks represent businesses; and businesses are perpetual, although they have their own life cycles based upon which they live their life, and often vanish. If we don't learn these lessons, we will have tough time dealing with volatility; and then, we will not be worthy of profits to be made from businesses. 

Look at Facebook:

25 July 2018 was the peak time for Facebook when it traded at $217.50 per share; and the market cap was over $625 b. But then it fell sharply on July 26, the next trading day, and closed with a market cap of $509 b. That was a near-19% crash. Was it due to the release of earning reports and expected growth rates? May be, but at $137.42, it is not looking good in terms of its past performance. Is it a good buy now? Time will tell. 

Apple is better:

Apple is comparatively better as the stock price now is near where it started the year. That it is far away from its trillion dollar valuation may be some consolation for those who try to compare intrinsic value with market price. That it is far too dependent upon one product, iPhone, that the overall growth may not be too high, and that it has too much cash may have implications on its financial and market performance in future. That Warren Buffett is the largest individual investor in Apple does not make it a buy. Cash flows, growth, and risk are the things that matter more than anything else. 

Alphabet has a full circle:

Alphabet stock was just above $1,000 in February and March 2018. In July, it reached $1,285.50 (more than $850 b market cap). As of now, it is back to about $1,000 from where it will begin again. 

Amazon makes an exception:

Amazon started the year with $1,189.01 per share. The latest price is $1,629.13. That's a 37% upside. The market cap touched $ trillion quite briefly on 4 September 2018, but closed the day lower. Compared to that the market cap now ($765 b) seems like a big fall. The thing is, stocks in general are moving down, aren't they?

We cannot leave Microsoft out of the equation, can we?

That old horse is still riding far and wide. That Apple is worth about $750 b and Microsoft is about $780 b tells us something. With windows and office as stable businesses, and cloud computing as its growth engine, the combo looks interesting. 

The fun is in the game
With 10-year treasuries yielding 2.85% and 1-year yielding 2.68%, investors are looking for a decent premium. A 5-point premium would lead to the expected returns of about 8%. That much, I reckon, markets and large-cap stocks should be able to give. For anything more than that, investors will have to look deep. Value is there in every market; it is easier to look at it in hindsight though.

As of now, it is much wiser to ignore the gyrations of the market and concentrate on the individual affairs. If you are an index investor, just continue the process. No worries. If you are a stock picker, look at the individual stock prices and their intrinsic values, and ignore the broader market index. More importantly for every sensible investor, ignore the experts and their stories. 

that fi cash

I have written about index investing many times, and I have written about how it is possible to make a reasonable amount of cash in order to claim financial independence. I have noted that making Rs.10 m in India should be relatively easy for anyone. Not many are privileged to be in that camp though. 

The purpose of this post is to assess how much cash is sufficient to sustain long term financial independence. There is the 4%-rule which says that: find out the current annual costs; multiply by 25; and that would be the cash required. This is how it is implemented: in the first year, withdraw 4% of the cash; for the second year, withdraw the first year number increased by the annual inflation rate; and so forth for the subsequent years.

Suppose that a family was able to accumulate Rs.5 m in financial assets at the beginning of 2000 and that the cash was invested in the Nifty-50 index. Assume that the family's annual costs at the time were Rs.125,000 and these will increase by annual inflation rate of 6% each year. That means for the year 2018, the annual costs will be about Rs.360,000. This is a very reasonable assumption for an ordinary family in India. Let us also assume that there will be no further investments.

As of 3 January 2000, the index was at 1592.20; and with Rs.5 m, about 3140 units could be bought; let's ignore transaction costs. On 1 January 2001, the index closed at 1254.30. The family will have to sell about 105 units for its annual costs of Rs.132,500 for the year. The remaining units on that day will be 3034, and the market value will be Rs.3.806 m. On 1 January 2018, the index was at 10435.55; annual costs are Rs.360,000; and units to be sold are about 35.

After the sale on 1 January 2018, the family will have 2016 units with a market value of Rs.21 m, a sizable number. All that the family did was: strived to make Rs.5 m as quick as possible, invested that in a diversified index, and had fun in life, doing what they liked to do. There is no pressure of working for someone else and meeting deadlines. No commuting time. Focus on things that mattered most and enjoyed that work. Leisurely meals. Lots of fun. If the person was age 40 at the time of financial independence, he or she would be worth Rs.21 m at age 58 which should be sufficient to lead a fun-filled life. I have not considered dividends that the index stocks payout. That should be yields of say, 1-2% as additional annual cash. 

The markets are not linear; and we have considered the exact moves of the market from 2000 to 2018. In fact, the index closed lower for (January) 2001, 2002, and 2003. Due to this, the market value reduced from Rs.5 m to Rs.3.043 m in January 2003. The family was not bothered by the PE; neither bear market, nor bull market. Heck, there weren't any more investments either. 

The only linear assumption was the inflation rate of 6%. We could tweak that here and there, but Rs.360,000 a year of annual costs are pretty reasonable in today's times for a typical family in a low-cost smaller town; it may be lower, but not higher. Why should this ordinary family be living in high-cost cities after financial independence when there are options for lower costs, better weather, and more leisure?

With that income, the taxes will be zero. Yes, we have ignored transactions costs; but I have made a bigger point: that it is not very difficult to be financially independent in India for anyone. For qualified professionals, it should be much easier, but even ordinary people can achieve it. The key is the behavior, not excuses. 

We have also ignored the asset allocation, investing fully in equities. But again, I wanted to make a bigger point, remember. A case could be made for the family to take up part-time work (that qualifies its criteria of fun) to meet just annual costs, and the annual realizations from equity (unit sales) are invested in bonds each year. Over the years, the family would be able to have reasonable amount in debt too. 

Even applying that 4%-rule - Rs.200,000 initial annual costs with Rs.5 m - the closing market value of investments will be Rs.14 m in January 2018. Good enough for that ordinary family. But I don't think, that typical family will have Rs.570,000 annual costs in today's times. Yet the point is made, isn't it?

If the family was able to accumulate Rs.10 m, instead of Rs.5 m, and had double the costs - Rs.250,000 in 2000 and Rs.720,000 in 2018 - the market value of investments would be Rs.42 m in January 2018. This is in fact possible for qualified professionals. Even initial year costs of Rs.420,000 which will be Rs.1.2 m in 2018, the market value would be Rs.26 m in January 2018.

pabrai, repco, and sell decisions

Mohnish Pabrai is a great guy, and I have immense respect for him. But, I don't make my investment decisions based upon his - or anyone else's - actions. I would like to hold myself responsible for my deeds. Sure, I will hear those I admire, and Mohnish is one of them. 

I don't know why he bought Repco Home Finance during April-September 2018. There must have been good reasons to buy. 

As per this report, his fund bought 3,719,265 shares during April-June 2018 quarter. 

During that period, the lowest quoted price was Rs.540.90, and the highest price was Rs.642.40. 

The fund made more purchases of the stock during the next quarter ended September 2018.

During July-September 2018, the lowest price was Rs.425 which was only at the end of September 2018, and the highest price was Rs.624.95. 

As of September 2018, the total number of shares held by the fund was 3,909,699. 

We don't know yet whether there were additional buys during October and November 2018. However, what we know now is that the fund sold some shares on 29 November 2018 at a price way below cost. 

BSE:

NSE:

A total of 948,535 shares have been sold. And again, I don't know why he sold the stock. There must have been good reasons to sell. 

It is fine to sell a stock only when our initial analysis turns out to be incorrect; or when the company's fundamental situation deteriorates subsequently for whatever reasons; or when we find a better buy. 

I don't know what the reasons are for the fund to sell the stock within such a short period of time. The stock has not even made profits yet for the fund. There must be something we don't know. Is there a much better opportunity for the fund to not only recoup the losses on Repco, but also likely make higher profits? Hmm...

In investing, these things happen, and we have to move on. 

yes bank, market, and rating

Yes Bank is taking its toll; rather its investors are. It is becoming too much, or it's not? In September, the RBI said, weak compliance, weak governance, and wrong asset classification. The CEO had to step down without extension of tenure. 

It was enough for the stock to plunge. On 28 September, the stock was staring at Rs.165 per share. Things seemed to be better in October and November as the stock was trading at around Rs.200, not moving much. October's high was Rs.248.90; and low was Rs.180.70. November's high was Rs.227.90. But then...

Some of the board members resigned later in November. The stock closed below Rs.200 for the first time in the month on 16 November. Here's the snapshot of the skin in the game that the board exhibits (as of March 2018).

Not all directors own shares in the bank, and those who own have insignificant number of shares.  This is not new to only Yes Bank; most of the companies in India have board members and even executive officers who do not own meaningful number of shares. I find that surprising, but want to keep the story for another day.

Whereas look at the volume of shares owned by the CEO and the CFO. I wouldn't conclude that they will act against the interest of their fellow shareholders. I don't know the inside story; but the RBI's remarks regarding corporate governance are serious, and should be taken seriously. There is time to repair the damage caused, and that should be the new CEO's top priority.

On 26 November, it was reported that the CEO, who is also one of the promoters, had raised money from two mutual funds through his associate firms by keeping his stake in Yes Bank as some sort of a guarantee. It was interpreted by the market as shares pledged, but not reported. This perception was bad enough for the stock, and it closed the day at Rs.187.90.

On 27 November, Moody's downgraded Yes Bank's ratings citing corporate governance and growth concerns. The stock had to react; Rs.182.65. On 28 November, Rs.162.10. And today, 29 November, it quoted as low as Rs.146.75, but closed at Rs.160.45. The trading volume was 292 m shares. I don't have any respect for the rating agencies, but the truth is that it becomes difficult for the downgraded business to raise cash on favorable terms; the cost of borrowing goes up. 

The two promoters must have felt it too. Let's do some math. Rana Kapoor, including Yes Capital and Morgan Credits, owns 245.875 m (10.65%) shares in the bank, and Madhu Kapur, including Mags Finvest, owns 213.987 m shares (9.27%). 

Based on the 20 August 2018 price of Rs.404, the market value of Rana Kapoor's shares was Rs.99.333 b ($1.419 b); and Madhu Kapur's was Rs.86.450 b ($1.235 b). As of 29 November, the respective market values are Rs.39.450 b ($563.580 m) and Rs.34.334 b ($490.489 m). It is still a lot of wealth. But, when the stock price falls 60% from its high, the value of shares goes down with it. Yet, it is important to remember that these are only paper losses until they are realized through transaction. 

Is the reaction from market an overreaction of some sort? While time will tell us about it, I guess, there are a lot of people out there on the media and social media giving enlightened opinions about how a badly managed business is a bad investment. Well, when the stock was going up, these naysayers were probably talking about some other stock. Never mind, it is the business of people to talk about other people. 

Every business has a price. A good business has a price, and a bad one has another. I am not too sure at the moment whether Yes Bank is a bad business. Yet, at the price it is quoting now, probably there is some value to be claimed by patient investors. Didn't I say something like that in early October too?

kotak bank stake conundrum

Kotak Bank has been a well run bank among the private banks of India. With gross npa of 1.94% and net npa of 0.73%, its track record has been extraordinary. The net margins are over 4%; business is growing. And the market is willing to pay the price for its equity. At current prices, it doesn't come cheap in excess of 4 times September 2018 adjusted book value. 

Yet I reckon, if it grows at 15% in the next 3 years and market allots a pb of 3.50, the investor will have about 8.50% annualized return. Is that enough, is a question for the investor as of now. 

However, with the RBI asking the promoters to reduce their stake from 30% (current) to 20% by December which we see likely not happening by the time, there are chances that the stock prices might get lower. Time will tell whether they will become attractive enough to meet the investor's opportunity costs.

This article presents options available to the promoters well; however, I don't think this will leave investors on edge. Investing isn't a short term game; so they should relax and take it easy. If they believe in the capabilities of the promoter manager, they should be fine.

At the moment though, the promoters have the following options to keep the regulator happy, unless the RBI accepts the current status of Rs.5 b perpetual non-cumulative preferred shares.

The promoters have the option of selling 191 m shares or issuing 477 m fresh shares in order to meet the RBI's directive. I am assuming that fresh issue will have to take place at discounted prices. With the first option, the promoters will have challenge of dealing with some Rs.224 b cash; they will not only have to pay taxes on it, but also will have to check out the alternative investment opportunities. If fresh shares are issued, the bank will get about Rs.530 b in cash which can be useful in meeting its growth targets. But then, Kotak bank has a Tier 1 capital ratio of 17.04%; so it already has enough cash for its growth requirements. 

It is an uneasy conundrum for the promoters for sure. To keep able promoters' stake high enough is a good idea so that investors benefit from aligned objectives. Whether 30% or 20% is a good stake, will have to be dealt with independently. Yet, the RBI cannot have a separative guideline for one bank and another for other banks. 

Kotak bank stock had a high price of Rs.1,417 in July 2018. I find that even at current prices which are much lower, it is not cheap. But then investing is a waiting game, isn't it?

index investing

Whenever I am asked for advice on investing, I recommend the broader index. I never suggest individual stocks to anyone. For the most, picking stocks is more of arrogance than of skill. Everyone is up to beating the index. But the truth is that majority of investment managers, forget individuals, fail to trump it. A simple, low cost S&P-500 is all one needs to move towards financial independence. Alas, stocks never cease to excite people. That's a behavioral problem, isn't it?

While S&P-500 is what I suggest, there are total market index funds too. Let's check out the index offerings from Vanguard. All information is taken from the Vanguard website.

The S&P-500 investment comes in 3 variants: ETF, Admiral shares, and Investor shares. All invest in the S&P-500 stocks representing 500 of the largest US companies. Consequently, they track the index returns. 10 largest holdings make up approximately 23% of the fund's total net assets. The net assets value of the fund is $459.3 b. The expense ratio is 0.04% for ETF and Admiral, and 0.14% for the Investor. Here's a quick summary of these funds.

The total market investment also comes in 3 variants: ETF, Admiral shares, and Investor shares. All invest in the CRSP US total market stocks representing the large, medium, small, and even micro-cap US companies. Consequently, they track the CRSP US total market index returns. 10 largest holdings make up approximately 19% of the fund's total net assets. The net assets value of the fund is $756.6 b. The expense ratio is 0.04% for ETF and Admiral, and 0.14% for the Investor. Here's a quick summary of these funds.

While it really does not matter which index is chosen, my preference is S&P-500. Many prefer the total market because smaller companies have the tendency to become big and give superior returns. It is true, but, my advice is to stick to the large businesses than bet on small and micro. The S&P-500 makes up a large portion of the total market anyway.

What is imperative is to choose an index, and then stick to it for a very long time. Throw the money each month irrespective of the market levels. And this is the best part of the index investing: pe ratios or pb ratios don't matter; implied equity premiums don't matter; whether the market is overpriced or underpriced is irrelevant for the investor. As the investing horizon gets longer, the risk in expected returns gets lower. With this you will be able to beat a majority of the investment managers in the country. 

Invest in the index, and move on with life. Do what you enjoy instead of fretting over expected returns. The index will take care of your financial needs. Isn't that cool?

Yet, there aren't many who pick this strategy or after picking it have the discipline to stick to it. That's altogether a different story.

suze orman gets it wrong, twice

Suze Orman, the personal finance guru and self-proclaimed queen of needs vs wants, gets it wrong about how much money you need to not to work rest of your life. In fact, she gets it wrong twice, first here, and then here. I am not taking anything away from what she has achieved; she has done herself well with net worth of $30 m as reported by the wikipedia. It was very nice of her that she even supported her mother and took care of her. More power to Suze. 

Yet, in her podcast with Paula Pant on 1 October 2018, Suze surprised me for not knowing the concept behind FIRE (financially independent, retire early), but still had her comments reserved for it: I hate it, I hate it, and I hate it. Sure Suze, you can hate it, but you need to know it before you hate it. And on 13 October 2018, she wrote a post on Linkedin where she noted that she was given bad information about FIRE. Well, we could ask her, by who? Never mind. 

In the podcast, Suze goes on about how wrong FIRE is about finance and work. She says, it is not possible to live well if you do not have $5 m or $10 m. She also mentions that the retirement age for people should be 70, not any earlier. According to her, $2 m is nothing but pennies. Never mind that the US median household income for 2017 was $60,336. How many people can afford to spend $2 m on their family medical needs (which Suze did)? 

First, there must be others who have spent more than $2 m; but they are exceptions, rather than the norm; they are some very rich people. Second, more important, you need not, and even Suze did not have to, spend $2 m on medical costs. That is because such needs are to be taken care of by insurance. If you think that you need high insurance, take one by paying higher premiums. There are people who think that a much lower insurance is enough. For them, basic, standard insurance will be just fine. For every calamity you think you might face, you are entitled to, and should, take an insurance. Accumulating cash just to deal with it is both unnecessary and unwise. 

The same goes about the size of financial assets. Who are we to generalize and say that $5 m, $10 m, or more is required before one can retire? To each his or her own. If Suze requires $30 m before she can afford not to work for money anymore, great for her. If Spendy thinks she requires $100 m, more power to her. On the other hand, if Frugally's idea of enough is $1 m, we cannot much argue against that either, can we? 

The key is that the financial assets will have to be reasonably sufficient compared to the person's sustainable annual costs. If a family's annual costs are $20,000, having $1 m in financial assets covers a period of 50 years assuming zero real rate of return. I can safely say that it is enough. I can also see that while Suze may not be able to live on $20,000, someone else might live on that quite happily. Wouldn't it be wrong on anybody else to pass a judgment on that? 

The same can be said about having $40,000 costs and $1 m assets. People who are aware of basic math and some knowledge of finance should be fine with this situation. This is how it should work: In the normal times, the family will spend $40,000 in annual costs adjusted for inflation; in down markets though, the family will learn to bring down the annual costs; substantially down if required. You see how a flexible family can adjust, yet live happily if it wants to. Suze will not understand it, forget appreciating it. She even missed that these people's math is based upon compounding over a long period of time. But I don't blame her because she has much more money; it is difficult to think different in such a situation. 

Yet Bill Gates, the richest man at the time, said, beyond a million dollars, it's the same hamburger. He may have said it in 2011 (or I don't know when), but the hidden meaning from it holds good all the time: That you do not need a fortune to live well. What you do need is the right mindset. If you lack it, we cannot help it. 

Don't get me wrong; it is great to have $10 m or much more. But like everything, it has a price tag: How many hours of work, especially that is not enjoyable, will one have to spend in order to get it? For instance, if one is able to get that number at age 60, after 40 years of selling time, what good will that $10 m or $100 m do to him or her? Heck, the precious time is already lost; that's a huge opportunity cost. If that person is fine with $1 m at age 40, what's wrong with it? In fact, here's what is good with it: That person can spend rest of the life in doing things that are fun. Who cares if that does not bring more cash? Doesn't it bring more gratification and pleasure? 

Suze implies that $200,000 to $400,000 is what one requires annually to live. I am not sure how many will be able to afford that even after 40 years of labor. Then there is this statistics that tells us the number of millionaires in the US. Their definition of millionaires: households with at least $1 m in investible assets, excluding primary residence. As per the report, there were more than 11 m millionaire households in the US in 2017. That means we have about 115 m households that are not millionaires. Of course, the concentration of wealth in the hands of high net worth households is disproportionate. So what should these 115 m households should do, go after $10 m, or fun and happiness?

The question to ask is: After basic needs can be taken care of by the cash that you have, will you be happy working just for the sake of more money or on things that really make you happy in life? The endgame is actually about happiness, not cash. If someone likes photography, not coding, what good that extra cash from coding do? That person will be happier in life, and therefore more successful in life - (happiness is success) - with photography. That is basic commonsense, but not many are capable of pursuing it.  

In her Linkedin post, Suze acknowledges that not working in a place that is not enjoyable is a good idea. But then she says that one has to look for another place so that it can bring money. For her, having 25 times costs and retiring at 40 without working is too risky which will not work for 50 or 60 year period. 

The thing is that these FIRE people are a bunch of smart people. They know the math, finance, and logic behind their choice. In fact, the RE is actually a misnomer; retire early is not retire from work altogether; it is retire from unwanted, not enjoyable work; it is a choice to retire from working for money; there is no obligation at all. None of these people have the idea of sitting idle in life. They want to do work that is both meaningful and fun for them; and they want to keep doing this for the rest of their life; there is no retirement from this work. If this work brings money great; if it doesn't it is fine. But mostly, there is some money coming in that contributes to their bills. Some even like the idea of taking up part time work just for bills, and use rest of the time for fun. There are too many possibilities; but sucking thumbs is not one of them. 

Basically, the FIRE people are frugal which gives them immense power and option to adjust their lifestyle according to the needs of the time. Spending $2 m on medical costs is not one of them; they will buy insurance for it. They know that oatmeal and rice-n-beans isn't a bad deal if combined with fun-filled day's work. Being financially independent is a very powerful idea. They have time for leisurely meals, for healthy meals that cost less, for workout, for work that they like, for good sleep, and for all the fun in their life. If they chased many millions of dollars instead, they wouldn't be able to do any of this. They are more likely to be happier than others, although I agree that happiness is relative and elusive. 

May be it should not be called FIRE, but FIFA (financially independent, fun all time).