taming the bull

What I write is nothing profound; but, usually, I find what most others write about investing just crap. So I read those just for fun and entertainment. I believe that it is always better to do your own research and then act based on it. Two advantages: one, you will gain knowledge along the way; two, you will learn to both appreciate research and luck, and accept your mistakes. Blame game is no good; learning lessons from mistakes is better. 

The markets are on a high, and many call it a bull market. And there is always a dilemma in dealing with it. To buy or not to is the question for genuine value seekers. They may find that it is becoming quite difficult to pick stocks in this market now. Price, based on the fundamentals, may look to be expensive. If you don't buy, and prices still go further, there is loss of profits; ouch, envy. If you buy despite your expectation that a correction is imminent and prices fall, you meet with realized losses; ouch, greed. The bulls too have their ways of dealing with investors. 

To tame the bull, you have to be tactical. There is a limit up to which you can be comfortable in placing buys for individual stocks. A better way of buying is through regular intervals: Buy only the broader index, not stocks, say, each month, either in fixed quantity or cash. Continue this program as long as you can, or at least until the bulls are tamed. 

The bull markets are also better suited for some betting, if you're keen, on the derivatives market; and a better way to do that is with the money separated from investments. It is both fun and exciting, and yeah, can be rewarding too, if carried out methodically; after all, there can be a method to one's madness.

Nifty hasn't got much to offer at these levels unless we have a surprise, surprise on the earnings growth. So it is advisable to show some restraint. For that to happen, though, you have to learn to deal with greed and envy first. Otherwise, it could be a greater fool's story, which left even one of the greatest minds in history dumbfounded and sort of starstruck.

fool, or a greater fool

As Nifty closed at 9316.85 today, I am reminded of someone's remark:

And there was a good reason why he said what he said. There are plenty of people who are calling targets for individual stocks and the index. One such is Sensex heading to 60000 in a few years. 

We have to remember that over the years, the productivity increases, GDP increases, corporate earnings increase, and therefore the market index increases. In January 1996, Nifty was at 908.01; it has marched forward despite political and economic issues; cross-border problems; droughts and floods; cold and heat waves; and so forth. We do not need anyone telling us that the index will increase in future; it will. 

That does not mean, however, that we need to start buying stocks overlooking the price. The single most important factor in deciding the rate of return on investments is the price. Therefore, it is always nice to have a good look at it before the purchase. People often do that while buying fridge and washing machine, or even groceries. For stocks, though, they pay what market asks. Well, the market is a maniac. We need to prove that we are not by not falling prey to its psyche. The more it appears to be sloppy, the more we need to be careful. The trick is to make money out of the market inefficiency, and not be part of it. 

As of now, the Nifty is not cheap. Nevertheless, for periodic buyers that does not matter because of price averaging. I have noted several times that for the long term index buyer the index levels do not matter at all, which is actually a very good strategy. Market returns are not going to be bad either. 

It is chasing excess returns that causes problems. Several individual stocks are currently trading at steep valuations. My search is on for gaps between value and price. Cash is a more rational decision at such situations. Ignoring comments like buy or you will miss the bus, etc. is wise. Most advisors will tell you to buy more when the prices are going up and high, and sell when they are down and low. 

As of now I cannot tell at which stage of the market we are in. Yet we can at least learn some lessons from the financial history; and I am reminded of one picture:

We need to ask ourselves at which stage of the market are we entering. Remember though that the final stage of a bull or even a bear market is always a greater fool's market; and fools have to often part with their cash. While we are not capable of measuring motions of heavenly bodies, we can at least try to stay away from the madness of people. Is that asking for too much? I would rather work towards making money out of their madness.

apple: 11 acquisitions, and no big deal

I noted earlier in 2014 how Apple can use its cash more productively. Although not much innovation has taken place at Apple, its market capitalization grew from $600 b in October 2012 to $765 b now. Never mind if it is not much of an appreciation for the investors. I also argued in February 2013 that with $140 b of excess cash, Apple had to do something. In late 2014, there was much talk of Apple being on sale, what with a market valuation of equity estimated to reach $1 trillion. In November 2015, Apple's market value reached $676 b; it had peaked to $750 b in 2015; and Apple had had a marvelous decade. In August 2016, we heard that Buffett had bought Apple stock, a news of the decades event. Recently in March 2017, I had wondered what Apple could do for its investors with a market capitalization of $744 b, 34% short of $1 trillion. I also expected that Apple could be a 7.50% returns business, which is actually not that bad in the present environment. 

Now we are back to Apple. At the current market price of its equity at $765 b, and a staggering cash hoard in excess of $250 b, Apple has become interesting; well, it has always been interesting. This story came up with some of the things that Apple can do with its cash. But then I thought of my version as I pleased. 

This time I would like to make it more interesting by moving to an emerging economy, which of course has the potential to provide higher returns even by the dollar terms. The most valued company in terms of market capitalization in India is either TCS or Reliance, each priced between $65-70 b. Compare that to just the amount of excess cash that Apple has; the perspective is evident. 

Apple has an enormous volume of fixed currency. Most of that is tottering outside of the US waiting to be repatriated once the tax laws are made favorable. This is not invested in any of its operating businesses. Consequently, Apple can use the cash as it pleases without hampering its business. The best use of excess cash is to return it back to the shareholders. It can be done through share buybacks if the stock price is much lower than its intrinsic value. If not, cash can be returned in the form of dividends. 

I wanted the post to be more interesting. Unsolicited as it may, I suggest acquisition of some wonderful businesses from India, which have the potential to become bigger through passage of time. The acquisitions are only a fiction as none of this is going to be allowed as per the laws. That does not stop imagination, though.

HDFC bank is a wonderful banking franchise, which has rewarded the investors handsomely during the past decade. Interestingly, it is still a growing business. 

State Bank of India has not been a performer; it rather has been a trading stock. Yet, it is a banking behemoth operating in some very interesting times.

Hindustan Unilever was struggling until 2011. Unilever offered to buyback shares at a price of Rs.600 in April 2013. The stock has been rolling since then.

Maruti Suzuki is the largest automobile business in India, and will likely continue to grow.

I strongly believe that both ICICI bank and Kotak Mahindra bank will grow at a decent rate in future. 

Asian Paints is the largest paints manufacturer in India, and has been an investor's delight for years.

Nestle has done very well in India, and probably will do well in future too.

I would be surprised if Asian Paints, Nestle, Dabur, and Marico do not do well in years to come. Just have a look at the chart. 

And there is Pidilite, an adhesives company, which has rewarded its investors big time.

There you go. If Apple acquires these eleven businesses at current prices, it should spend its entire excess cash, and yet be able to continue sale of iPhone, iPad, and Mac without any hitch. In fact, soon it might even generate cash, albeit in much smaller doses.

I would like to believe that over the years, these acquisitions will provide higher returns than Apple's core business unless of course Apple surprises me with innovation. 

news: of course it's fun

I have heard some investors boasting about how they don't read the news; they consider that it is quite cool to say that they shun it. They call it the noise, and go about giving reasons why it is uncool to actually read the news of the day. I reckon the chances are that they belong to this or that camp.

Well, I find them crazy; they could even be perverts obsessed with certain philosophies. Why do I care? Heck, I find it funny that since they have cultivated naive followers, they are able to exercise certain influence on them; and that is pretty bad. 

I don't understand why it is wrong to read the news; there are several newspapers that talk about various aspects of life, be it politics, business, sports, or even daily events. I religiously read topics of my interest every day. Shouldn't one be appraised of the events shaping our city, state, country, and our world? And the funniest part is that the same people who bash news items are the ones who choose to give their thoughts on them on their blogs and twitter accounts. If they don't like news, why do they mention about a particular news event? They do it because they don't preach what they do, a reason good enough to shun them rather than the news.

I almost find it fun to read news, whether from the newspapers, magazines, or generally from the Internet. It is another matter that I do not usually read opinions about stocks. I would rather read the source documents such as annual reports, etc. than hear someone giving any shit about a business. My stock picks are based on my own analysis, rather than someone else's thoughts. It is easier to blame or appreciate yourself than others for results of your actions. 

Opinions on any matter other than stocks, and I am game to hear. I think these people who propagate shunning news and making it a big deal are actually paranoid. I wish I could address all those simpletons who follow their favorites without some thinking. They got to wake up, and start pondering. And above all, they should start reading some news of the day.

The news stories spice up our life. I sometimes even read blogs of those clowns, and entertain myself. Howzat!

berkshire hathaway: return of cash

In July 2016, I noted that Berkshire Hathaway is a decent business that is not going to let its investors down, and yet it will also not be a market-beating investment. It is worth more than $400 b now, and sitting on a cash of over $85 b.

And it is its cash that is letting it down. Each quarter while the stash gets bigger, there aren't much avenues for its use. You cannot expect treasury returns on them forever; that would be an injustice to the shareholders. It's time now, probably, for Berkshire to consider the opportunity costs of its shareholders rather than its own. 

Berkshire has done very well in the past 5 years. 

As of May 2017, Berkshire stock has beaten both the Dow and S&P-500 by a decent margin. That's not the problem now though. As investors, we look at future rather than past. Quite naturally, we are interested in Berkshire's future returns.

Berkshire cannot sit on cash forever. Its operating businesses need far less cash for reinvestment than they throw out. Assuming that there are no further acquisitions, there seems to be an urgent need to return cash back to its shareholders. Even after allocating some cash for acquisitions, it is more rational to return cash than to keep in treasuries. 

The shareholders will have far better investment opportunities in the present environment than Berkshire for at least two reasons: Berkshire has grown too big such that its acquisition size has to be gigantic to make any meaningful return. Investment choices in marketable securities meeting both size and return criteria are rare; it would shake up the market prices. Opportunity costs of the individual shareholders are much higher. Therefore, cash in the hands of shareholders has much more value than in Berkshire's custody.  

Cash can be returned by way of either dividends or share buybacks. This is the single most important task in the hands of Berkshire; yet considering the towering brand of its two capital allocators, no one is brave enough to even talk about it. 

Let's allocate $10 b each to its two younger investment managers, Todd Combs and Ted Weschler. Let's keep $20 b in treasuries that is required for a good night's sleep for Buffett and Munger. That leaves Berkshire a one-time free cash of more than $45 b to give back to its shareholders. Each year, there will be free cash available to return based on an approved (significantly higher) payout ratio.

And return it must, in spite of its historical track record, and despite its iconic managers. We all have to appreciate that when facts change, we got to change our mind.

Who's going to show courage to inspire the bosses there?

nifty: what can it do for you

Nifty closed at 9217.95 on 24 April. Can investors continue to buy the market at this rate? If we are talking about periodic investments in the index itself over a very long period, my response is always yes. There is no need to play the timing game here, for we are never good at it. Periodic investment of a fixed sum usually takes care of pricing per unit, which tends to average out. This is a low risk investing strategy resulting in very close to market returns. 

Absolute investment in Nifty today is a different matter. That's 23.41 times earnings, and 3.52 times book equity. At least two factors affect investing in the index now: Earnings (actually cash flows) and market pricing at the time of exit. How much can earnings grow from here in the next 5, 10 or 20 years, and what pricing would it deserve at that time determine your return over the period. 

It is easy to remember that the higher the expected earnings growth, the higher the multiple accorded. Yet, there are other factors affecting this pricing. In fact, there are mainly three: cash flows, growth rate, and risk in cash flows. When expanded for instance: Higher payouts usually result in higher multiples. It is also true when the business earns a high return on capital. When interest rates are low, stocks are priced higher. High debt ratio brings down the multiple. Stable cash flows bring it up. Then there is the ubiquitous market bias. 

Instead of being part of the euphoria surrounding market, it is better to have a look at what has happened in the past, and think about what will trigger future. Usually, intrinsic valuation based on cash flows and growth rate is the best way to look at value. However, estimation errors are pretty significant there, so let's settle for what would be the implied rate of return. 

Over the last 10 years, Nifty earnings grew at an annual rate of 8.39%, and for the prior year it was 7.10%. As we can see in the chart above, the 5-year earnings growth during the last 10 years was between 6.05% (for the year 2016) and 11.77% (for 2014). In fact, for the preceding year, the growth rate was the lowest. Are they ready to rebound?

If I want to look at investing in Nifty for the next 5 years, I will have to estimate earnings for the year 2021. What is the reasonable rate of earnings growth in the present scenario? Of course, there is the India shining story, but what if it does not turnout as expected? We can use a range from say, 5% to 15%. Then we need an exit multiple for the earnings. I will use 15, 20 and 25. 

At 5% growth rate, I don't think investing is worthwhile even at a multiple of 25. Unless you consider that a post-tax return of 6.53% is difficult in alternative opportunities. Even when earnings grow at 15%, but index priced at 15 times earnings, the implied rate of return is less than ordinary. 

It is only when Nifty earnings grow at 10% in the next 5 years, and it gets a pricing of 25 times earnings, or grow at 15% and priced 20 times, the implied rate of return is close to 12%. Do we want it? Of course, there is an additional 1.25% dividends. When earnings grow at 15%, and the index is priced 25 times, the implied rate of return magically increases to 16.67%. This is definitely not bad considering available opportunities at the moment. 

Yet, the pricing multiple is subject to heavy bias. We are not sure of a higher multiple five years hence. At least that much risk is inherent in our expected returns. 

My thoughts are with the conservative investor who wishes to remain in the investing game, but does not want to take undue risks. We are thus back to, our favorite, index investing. Keep throwing cash beginning of each month to buy available units of the index. When done over 15 to 25 years, there should not be much reason to complain, provided our conservative investor has had fun doing things that are preferred in life. 

the conundrum of sell

Investors often consider that decision to buy a stock is the most difficult one. It is; when price and value gaps are to be analyzed. Yet, the decision to sell a stock becomes, probably, more difficult when dealing with human behavior. Investors sell (or don't sell) a stock due to various reasons, some right and some wrong. Let's cut to the chase, and come to the point. There are only four times when a long investor should sell a stock. 

The first is obvious: When you realize that you made a mistake in assessing value of the business; wrong earning power estimation or wrong growth rates. This is assuming the mistake is on over valuation. The quality of the business, after all, was not good enough compared to the price you paid. The second is a followup on the first one, and is more obvious: While your initial buy decision was correct because you found a reasonable gap between price and value, due factors not within your control, the quality of the business deteriorated over a period of time. This could happen because of poor management decisions on operations and/or capital allocation, or because of macro factors. For whatever reasons, the initial assessments of cash flows and growth rates are no longer acceptable. During both occasions, one would be at one's own peril if thumb-sucking is preferred to action.

There are at least two reasons for not selling here; this is when investors are not able to see the obvious: The first is when you don't realize the change in circumstances; i.e. you fail to assess the quality of the business compared to the price paid. The second happens when you are in excessive losses and therefore, hold on to your bias that things will improve; or even when you are in excessive profits and therefore, hold on to your bias that everything is alright. These are the real thumb-sucking situations. That is why behavior is of utmost importance in investing.

The fact is that whether you are in losses or profits is irrelevant. If market conditions are good, you would be lucky to get out of the stock at the first opportunity in profits. If you aren't lucky to see market optimism, it is also rational to sell the stock despite losses. In investing, we cannot leave entirely to the luck factor. A fair amount of analysis and thinking is required. The decision to sell is not easy mainly due to psychological factors.

The third time you should say time to sell is when you find a better investment opportunity. After all, investing is based on picking the best out of one's opportunity costs. If the stock that you bought has the potential to give you a return of say, 15%, and you find yet another stock, bond, or any other investment opportunity that has an expected return of say, 25%, it makes sense to sell one to make way for the other. The damage from inaction, though, is less here compared to the two reasons to sell noted earlier. The quality of the business has not deteriorated, its value has not changed significantly, and a relatively lower expected returns isn't troublesome. We need not be part of every investment opportunity.

The final time you should sell stocks is when there is emergency. Although you cannot invest short term cash in equities, sometimes one finds oneself in a situation where long term funds are to be liquidated for short term needs. These will be extraordinary times, and are therefore only rare.

There may be one more occasion when the investor may decide to sell. That is when you see that the gap between price and value has reduced significantly. Selling the stock is wiser especially when the business is not a high quality one having long term competitive advantages. Stocks of less than high quality businesses can be bought and sold more frequently purely based on price and value gaps. However, it is much wiser to hold on to the high quality businesses if the investor really wants to reap benefits of long term compounding. Wealth creation is always more imminent in a buy and hold strategy than in frequent trades.