IS 1 CRORE ENOUGH TO RETIRE ON?

As more and more people are thinking of taking an early retirement, being sick of the hassles of participating in a never ending rat race, it automatically begs the question " what can be a sufficient corpus for retirement?" In this post I've tried to examine the feasibility of a couple with two kids retiring on their grand savings of Rs.1 crore.

Certain assumptions have been made in order to simplify matters. These are

1. Using a mix of debt and equity, the investor can earn a steady 12 % per annum after taxes over his life span.
   
2. Inflation grows at a steady 7 % per annum.
   
3. Monthly living expenses are Rs.75,000 at present.
   

From the above assumptions the investor will generate Rs.12 Lakhs in the first year and spend Rs.9 Lakhs. He will reinvest the balance 3 Lakhs at the same 12 %. Considering inflation and reinvestment of surpluses the situation at various time periods will look somewhat like this:

Year, Corpus Rs. (Crore), Annual Expenses Rs. (Lakhs)

Year 1, 1.03, 9.00

Year 5, 1.11, 11.02

Year 10, 1.05, 16.52

Year 12, 0.94, 18.90

Year 15, 0.59, 23.14

Year 18, Negative, 28.33

As we see from the above working, the investor would start eating into his capital from the 12^th year and from there on his capital would rapidly get eroded. Under the above conditions 1 crore would not be sufficient to last for even 20 years of retirement.

The result would be somewhat different if the figures in the assumption are tweaked somewhat, but what I would like to highlight is the corrosive effect of inflation on savings and its potential to destroy value without our realising it.

VALUE INVESTING - BASICS

Value investing is an important tool in the arsenal of a fundamental investor. In simple terms it means buying a stock for much less than what an investor thinks it is worth. But how does a value investor decide the worth of the company under study? Given below is an explanation of some basic parameters to decide whether a business is undervalued or not. They are

1. PE ratio. This is the ratio of the market price of a stock to its earnings per share. It also the number of years the business will take to realise earnings equivalent to the current market price based on current earnings. For instance a business having a PE ratio of 10 would take 10 years before its earnings behind one share equals the market price of one share. This, of course, assumes that the company will keep on earning the same amount of profits every year. PE ratio, therefore indicates how expensive a company is based on current earnings. This is a useful indicator to compare companies in a similar line of business. Lower the PE ratio, cheaper is the stock. Naturally, PE comparisons cannot be carried out across industries, because some industries are given higher PE ratios due to their business dynamics.
2. Market Capitalisation. The market cap of a business is the number of shares outstanding multiplied by the price of each share. In short the market cap denotes the notional cost of buying the entire shares of the company. This parameter is useful in judging the relative attractiveness of a business as compared to other businesses in similar lines based on what value the market has assigned that business by way of market cap. For example a business in the consumer durable sector may be valued at significantly lower market cap than another consumer durable company. This would make it a value buy based on market capitalisation. For more on how to value a business based on market cap refer here.
3. Book Value. Book value is value of assets of the company behind every share. It represents the valuation of the stock based on its underlying assets rather than its earnings. If the market price of a stock is quoting at or below its book value, it means that the market does not think that the prospects of that company are bright and often indicates that the company that has become insolvent. However if the market price is below book value due to factors of a temporary nature, then this fact can be looked at by investors as a value proposition and can be used to buy into the stock with a holding perspective till the negative factors turn around.
4. Dividends. A value investor uses the dividend payouts as an important factor to determine undervaluation in a stock. If the dividend yield of a stock (i.e. the dividend per share divided by the market price) is high it indicates a higher degree of safety in times of adverse market conditions. Also important is to see what proportion of its earnings a company pays out in the form of dividends. For more on use of dividend yields referhere
5. Net current assets. Net current assets (NCA) are current assets minus current liabilities. If a business has high net current assets and the markets are assigning it a market cap near or below its NCA, it indicates a high degree of undervaluation. According to Benjamin Graham, the pioneer of value investing, investors cannot often go wrong in buying a business valued at or below NCA.

   The above are basic factors used by value investors in determining the relative underperformance of a stock. Of course, an investor also needs to go into the reasons as to why the market is giving a significantly lower valuation to a stock or an entire industry and whether it is justified in doing so before taking an investment decision.

   
   

CONTRARIAN INVESTING

Contrarian investing pays if you are a patient investor. We have numerous examples of how stocks which are out of favour with investors, but are fundamentally sound, have given handsome returns once the reasons behind their underperformance ease off.

Consider capital goods stocks in 2003. Stocks like BEML, BHEL, L&T and many others were available at a fraction of today’s prices. Investors’ who had the foresight and vision to invest in such stocks at that point would be having 15, 20 or even 100 baggers on their hands. The logic behind investing in such companies would have been that they were high quality companies backed by good managements and having solid assets on their books. They had pedigree, market standing and years of experience. It was simply a case for investing and simply waiting for the investment cycle to turn around.

And what did investors do? I know people who got tired of holding on to such stocks and sold off only to see markets reviving and stocks reaching the stratosphere. My argument is that for earning the highest returns, an investor needs to identify stocks which have been hammered to their lows, analyzing whether such low valuations are justified given the history, management quality, nature of the business, quality of assets, size of the business and future prospects. Then if the investor is convinced that the business is not going to disappear any time soon and simply awaits a change in the business cycle to see better days, go ahead and invest in it. Market volatility may yet take the stock price lower, but one should have conviction that the buy is backed by solid reasoning and not panic. Rather the fall could be used to buy more.

All evidence points to the fact that the world’s best and richest investors like Warren Buffet, Charlie Munger, Mohnish Pabrai, Rakesh Jhunjhunwala etc. have this philosophy at the core of their investment strategy. Each may his own variations on stock selection and valuation matrices, but the core strategy remains buy low and sell high. Contrarian investing is the only way you can follow this strategy. This strategy need not be applied only to a particular industry or stock, but to asset classes or markets as a whole. As described in a previous post, right now income and Gilt funds seem to be logical examples of contra investment as applied to debt investments.

SLOWDOWN IN COMMODITIES

Are we seeing the beginning of the end of the great commodity run? I feel that, though it is premature to write off commodities, they are certainly headed for a major fall. The reasons are not far to see;

A slowdown in the global economy is imminent. We are already seeing the signs in America and Europe. A demand drop poses a major threat to commodity prices, since demand has been a major driver of growth. The Chinese have contributed to the demand by their massive infrastructure build up for the Olympics. This is compounded by the fact that China has put on temporary freeze, all polluting industries like metals, chemicals, plastics. A significant cool off in demand is expected as the preparations for the Olympics near completion, coupled by increase in supplies once Chinese industries resume production.

The demand destruction could result in a major fall in commodity prices. Already crude oil has fallen about 18 % from its highs. A similar trend is seen in some non Ferrous metals, data for which is given below:

The data below gives the Commodity, Price on 2nd Jan 08, Year High and Price on 26th July,08.

Aluminium 2365 3291 2936
Copper 6665 9000 8258
Lead 2579 3459 2180
Nickel 26500 33250 19005
Zinc 2383 2825 1891
All prices are on London Metal Exchange, in US $ and per tonne.

Steel and plastics are still going strong and prices are buoyant in these items.
If commodities correct even moderately from current levels, it augurs well for Indian stocks, because we have witnessed a strong sales growth for the companies who have come out with results till now. Margins are under some pressure due to rise in input costs. If commodity prices come down, it could bring some cheer to the bottom lines of companies.

INVEST IN SAFE STOCKS

In the present market scenario, with volatility being the order of the day, I believe investors should stick to safe stocks with solid managements behind them. Even though some sectors have been beaten badly, investors would do well to not look at how much a stock has fallen from its highs, to base their investment decisions on.

It is important to differentiate between stocks and sectors where the losses are justified because something is basically wrong with their business models and those where the present drubbing is due to some temporary factors which are likely to ease out with time. Fundamentally sound stocks offer an incredible opportunity to buy at bargain basement levels and simply wait for fundamentals to reassert themselves.

In my opinion, there are enough indications for the real estate sector to be de rated by the markets. The main reason of course being that, the valuations of these stocks were NAV based. The NAV being the value of the land holdings of the company translated into potential for development. Since the companies decided their own NAV’s, this factor was open to various interpretations. Now with real estate prices crashing, the NAV has come down, though the extent of the fall is debatable. Again deals are not happening on the ground. Some sale is made at an inflated price and this is used as a benchmark to justify valuations of similar properties. The fact that the deal holds only a notional value is conveniently ignored.

Since most of the real estate companies listed on the stock exchanges are recent entrants, there are no parameters to judge their track records. In the absence of historical data by which to evaluate them, such stocks pose a significant risk on the downside. Though their prices may look extremely attractive when compared with the highs achieved by them, investors would do well to remember that a lot of tech companies fell to 10 % of their top valuations following the 2000 dot com bust.

A marked contrast are the PSU banks, many of them having decades of history and giving great dividend yields, now available for less than book value. I believe the reasons for the drubbing they have received are temporary in nature, as discussed in a detailed previous post on PSU bank stocks here.

Investors in this market need to have the conviction in the stocks they own, so as to ensure that they do not panic in case of a sudden fall. Hence they would do well to invest in businesses which have stood the test of time and which can be valued using simple and conventional methods.

THEORY OF REFLEXIVITY

The theory of Reflexivity propounded by George Soros, seeks to demonstrate that financial markets cannot discount the future correctly because, in certain cases, the behaviour of financial markets affect the so called fundamentals which they are supposed to reflect. It implies that financial markets do not merely discount the future; they help to shape it.

Therefore reflexivity is a self fulfilling prophecy which occurs when markets react to the expectations of its participants. A feedback loop occurs, wherein prices are driven by perceptions and the movement of prices help to reinforce expectations.

Consider the example of the Indian stock markets after its all time high in January, 2008. Once the markets started falling from its highs, investors, particularly FII' withdrew from the markets in large numbers. This caused stock prices to fall further. The fall in prices led to a perception among investors that markets were overheated. This in turn led to further selling in the markets, thus creating a feedback loop, where the prices were affected by investors' negative perceptions, which were in turn reinforced by falling market prices.

This selling and absence of fresh inflows by FII' led to the Rupee weakening against the Dollar, which resulted in inflation rising and interest rates going up. As a consequence, profitability of companies, which was projected to grow at 20 % on an average, started slowing down. Though not the only reason for slowing growth numbers, this example serves to illustrate how markets can influence fundamentals.

Soros contends that, "such boom/bust sequences do not arise very often, but when they do, they can be very disruptive, exactly because they affect the fundamentals of the economy." Conventional market theory acknowledges that all the available information is built into prices and current markets correctly discount the future. Soros thinks that this interpretation of the way markets operate is severely distorted . He works on the principle that whenever he takes a position, he does not automatically presume that the markets are wrong, but allows for the fact that he himself could be wrong on his call.

This article relies heavily on a speech made by George Soros on April 26, 1994 to the MIT Department of Economics World Economy Laboratory Conference Washington, D.C.

WHERE DO WE GO FROM HERE

With crude showing signs of cooling off, stock markets look poised for a rebound. It also depends on the vote of confidence scheduled for the 22nd and the inflation figures. In my opinion it’s a good time for long term investors with a time horizon of 2 years and above to go on a shopping spree.

Oil, which has been a major drag on the markets is projected to react to $100 to $110/bbl in the next six months. The reasons are slowing demand for gasoline in the US, the relatively lower growth in GDP projected by India and China and the comments of the King of Saudi Arabia seeking lower oil prices. If oil prices fall as expected, this would provide a huge boost to economies like India and consequently their stock markets. Since higher oil prices are already factored into current market levels, any positive news could act as a trigger.

On the political front, the exit of the left parties should act as a pleasant surprise for stock markets, only if the government survives the vote of confidence. In such a scenario, the Government would be free to aggressively push reforms in insurance and banking sectors. Moreover the disinvestment process of PSU’s would get a huge boost, bringing quality new issues to primary markets and increasing the depth and liquidity of our markets in addition to improving sentiment among battered investors. Also opening of the insurance sector would bring a flood of FDI into the economy, thereby strengthening the Rupee.

Inflation poses a huge risk to the markets, but again most of the bad news is built into prices. Though inflation is not expected to fall off any time soon, it is after six months that the higher base effect will kick in. Since, in India inflation is measured on a YOY basis, we are getting inflation figures compared with last year’s figures. Inflation was quite low at this time last year hence we are seeing disproportionately higher inflation growth figures. Also by this time we will see some of the measures taken by RBI to curb inflation take effect. Another positive would be the normal monsoon, at least till now, which would bring down the prices of food articles.

A caveat here is that any of the above scenarios not happening could act as a dampener. But in my view, current prices hold value for investors willing to wait it out and having the capacity to bear some potential pain in return for longer term capital growth.

IN DEFENSE OF FUND MANAGERS

There has been a lot of mutual fund bashing going on recently, with investors upset that fund managers have not been able to protect investors in the current downside. I am also guilty of criticizing these guys in a previous post. Everyone wants a scapegoat when things go wrong. But I now think we ought to take a relook at what went wrong with the decisions that fund managers made and were they entirely responsible for not saving investors from the terrible erosion in values that has taken place. I would not go so far as to say that there was nothing they could have done to protect investors, but given the circumstances it was extremely difficult to act any other way.

It has been said that funds did not take profits at higher levels. I think that, even though funds did book profits, by mandate an equity fund has to have a majority of its corpus in equity. Being in another asset class is not a call for a fund manager to take. When investors have given him the money to deploy in shares it means that they have studied the implications of having a portion of their assets invested in equity, with the associated risks. If investors had indeed wanted fund managers to periodically rebalance their portfolios, they should have invested in the various asset allocator mutual fund options in the markets or, opted for the dividend payout option. Let's face it, it was our greed that got us to invest in pure equity funds and not sell the units at higher levels.

Another point people make is that fund values have fallen more than the benchmark indices, which is quite true. But one has to realise that however diversified a fund might be, it's portfolio is still quite concentrated when one compares it to its benchmark index. The concentration may not be in the number of scrips held, they may be quite diversified but a large percentage of the fund's assets are concentrated in a few top holdings. Generally a large cap fund has about 45 to 50 % of its holdings in 10 stocks. This is exactly what enables an actively managed fund to outperform the indices when they go up. It is but natural that the converse should be expected to hold true on the way down. If the past 5 year track record of the top funds is compared with that of the indices, we find that the funds have hugely outperformed.

A criticism that I have also made in the past is that the fund managers were invested heavily in flavour of the month stocks like infrastructure and real estate. But as investors, our investment psyche is such that we generally look at how well funds have done over a 1 year period. We then invest in last year's better performers. In doing so, we do not allow fund managers to take a longer term call. If investors focussed on 3-5 years returns, I feel fund managers would be emboldened to avoid hot stocks which are overpriced and concentrate on value instead. Whichever way one looks at it, a fund has to have assets under management, to stay in the business. Assets can only be garnered by showing fantastic returns in the short term.

I have recently seen the concept of SIP' being attacked as not being a suitable investment strategy. I would like to differ on this. ICICI Prudential Growth Plan, not one of the top ranked funds, has given SIP returns of 18.57 % over a 3 year period and 29.60 % over a 5 year period. I have deliberately not included a top performing fund, in order to give readers an idea of the average fund returns. Returns are as on 31.05.08. Anyway, the best method of judging a SIP is when the markets have recovered after being down for a while. This is where the benefits of Rupee cost averaging works out. If the markets have fallen precipitously as they have done recently, investors do not get time to accumulate enough units at lower levels. The error in estimating the efficacy of this strategy is compounded when the lowest NAV' are used for calculating the returns. In my view SIP is an extremely efficient and simple way to create wealth in stock markets. If an investor sticks to his SIP plan, I am sure that when markets recover, he would be amply rewarded for his discipline and persistence.

The above does not in any way absolve fund managers from their duties as guardians of public wealth, but we, as investors, need to realise that they are after all human and are subject to the same failings as we are. They have done an admirable job in the past in beating market returns and can be expected to do so in future, if we allow them some leeway and time to get their act together again.

LESSONS FROM JAN 08

What percentage of the Indian investor population regrets not getting out at 21000? My guess would be 95 %. Even long term investors are shocked to see the value erosion in their portfolios now. Some of them are even thinking of cashing out, while they still have some profits left on the table. Panic is slowly creeping into the markets as stock values are rapidly eroded.

Looking back it seems that we all got too greedy. But aren't we doing the exact opposite right now by becoming too fearful? We felt that markets would never come down and miscellaneous analysts were egging us on by outdoing each other in predicting higher sensex levels. Some of us were afraid to sell thinking that we would miss out on the gains of tomorrow. The exact reverse is happening at the present moment. When so-called support levels are breached, analysts predict still lower levels. We are afraid that if we buy a stock today, tomorrow it will be available 5 % cheaper.

I am not saying we are at the bottom. I don't profess to know what the bottom is and am not interested in guessing. But I do know that valuations are attractive, just as they were stretched in January. Just like various theories were bandied about to justify high valuations, doomsday scenarios are being painted now.

One cannot sell at the exact top or buy at the bottom. We can take a call based on reasoned past and present indicators and a likely future scenario. Had someone taken a valuation call in December 07 and sold out at 18000, he would have seemed foolish initially as markets rallied another 12 % or so. But in hindsight his actions would have looked extremely wise. Similarly a purchase now might look foolhardy, but it is certain to pay off handsomely in the next 12 months. We need to learn lessons that history teaches us, if we are to profit from the folly of others.

GARP INVESTING

GARP (Growth At a Reasonable Price) investing is an offshoot of the growth investing principles propounded by Philip Fisher and T Rowe Price. It involves identifying rapidly growing companies that are available for low PE multiples. If an investor gets it right, this strategy could yield multi baggers in due course of time because of two factors. One, the growth of the company and its per share earnings would increase over a period. Two, because it shows sustained growth over many years, its price to earnings ratio would get rerated.

One of the leading practitioners of this investment style, Peter Lynch, often looked at businesses which manufactured products that he liked and used. An aspect of his investment style involved going to shopping malls with his family to check out the brands that were doing the best sales. Then he would research the companies that owned these brands and come up with options for investment.

An important aspect of GARP investing is the PEG ratio. This is the ratio of the PE multiple of the company to its average growth rate in EPS over a period of 3-5 years. For small companies that are growing rapidly, a PEG of 1 is considered suitable for investment in the Indian context. Here rapid growth rates are seen in a variety of businesses and an investor can find many companies quoting at PEG of 1 and below. Are all these companies good buys on the basis of GARP? To determine that, an investor needs to look at the sustainability of that growth. For example a company growing at 25 % per annum for the past three years and quoting at a PE ratio of 15 may be a buying candidate if an investor can satisfy himself that the business can sustain growth rates of at least 15% if not 25 % over the next few years.

How does an investor ascertain that? Therein lies the art element in investing. He looks at the business prospects of the industry in which the company is operating, the brands it owns, how well its products are doing in the markets, its loyalty among buyers, service track record, capacity additions it has planned and the quality of its management.

A risk in employing GARP investing is that high growth and low PE businesses are available mostly in the small and midcap space. By nature these companies do not have the staying power to overcome prolonged adverse market cycles. This risk can be mitigated to an extent by selecting companies which have been around for some length of time and have demonstrated their ability to weather difficult conditions. Large cap companies can be considered buying opportunities at a PEG of 1.25.

Let's try and apply this methodology to the BSE Sensex. The Sensex is expected to deliver earnings of 970 for FY 08-09. In the past the Sensex earnings have been growing at 25 % per annum. Since a slowdown is expected due to inflation, crude prices and other factors, let us assume that the Sensex will grow at 15 % in future. Since India is among the top five markets in terms of market cap in Asia, it is analogous to a large cap company. Therefore, it deserves a PEG of 1.25.

Price/Earnings/Growth = 1.25

Price (Sensex) = 1.25 x Growth x Earnings
= 1.25 x 15 x 970
= 18180
So, when various analysts say that India at a PE of 17 is expensive compared to other emerging countries, they fail to take the growth rates into account. PEG normalises the PE ratios by adjusting for growth.
Brazil's GDP growth rates for the past 6 years are given below:
2003 1 %
2004 -0.2 %
2005 5.1 %
2006 2.3 %
2007 3.7 %
2008 4.5 %
Average GDP growth over 6 years = 2.73 %
The PE ratio of Bovespa was 16.8 as on 31.05.08.
Brazil being a commodity driven economy, these growth rates are in an era of high commodity prices. Even in such conditions adverse to it India has clocked a GDP growth of 8 % over 6 years. What would happen if commodity prices were to correct, as is widely expected? Therein lies the genesis of my arguments that long term investors should buy Indian stocks at present levels.

WHAT ANALYSTS PREDICT & WHAT ACTUALLY HAPPENS

I would like to highlight an interesting post on rediff where three different analysts employing different prediction methods predict their levels for the sensex in the coming year. The predictions were made on Jan 7 2008. They went something like this:

1. Milind Karandikar - using Neowave theory - Sensex between 27000 to 39000 in the 1st half of 2008,

2.Devangshu Datta - using technical analysis - Nifty between 6600 to 7000 in six to eight months with a bottom of 5600 to 6100. Really?

3.Mukul Pal - using Elliott wave - Sensex not extending beyond 24000 in 2008. The closest of the lot, but still wrong by a long long way.

I would like to ask these gentlemen their views in the present context, but they have chosen to not display their respective e-mail id. They would probably be bearish now, taking refuge in some jargon or some hedging terms which they have been careful to qualify their projections with. Readers may judge the value of the predictions for themselves by reading the article here.Its very easy and popular to simply extrapolate the current trend and on that basis come up with fancy figures. The real test of an analyst is if he can go against the mood on the street AND end up being right. In that respect I admire people like Gul Tekchandani and Ramesh Damani who had the conviction to go against the popular mood and point out the risks, when markets were at their peaks. Some like Morgan Stanley have been screaming from the roof tops about overvaluations since the index was at 8000 and are delighted that their call has been proved right finally with the index at 21000! Some call, guys. Even a stopped clock is right twice in a day.

PASSIVE WEALTH CREATION

It is an established fact that over the long run, equities as an asset class outperform all other alternative asset classes including real estate. A RBI report on Currency and Finance, 1997-98 revealed the following returns over a 20 year period compounded annually:

Inflation    :     9.19 %

Gold        :    7.62 %

Bank FD'    :    9.19 %

Co. FD'        : 14.47 %

Equities        : 20.15 %
 

It shows that equities have spectacularly outperformed all other assets. I suspect that the difference would get even more pronounced if we were to conduct a similar study today.
 

It is clear that our choice of investments have to give us returns that beat inflation. A recent study revealed that only 2 % of savings in India are invested in equities. So, why are we Indians so averse to equity as an asset class? The reasons, perhaps, lie in the setbacks that Indian investors have received in 1992 and 2000. That apart, stock markets were regarded to be manipulated by operators and promoters had a reputation for unethical practices. Maybe investors who had burned their fingers were justified in having such beliefs.
 

But one cannot get away from the fact that our approach to investing in equities lacks discipline and is sporadic, with an overwhelming bias towards flavour of the month stocks. When stocks are down, we refuse to even consider them as investment options and when they go up, we chase prices which have already gone up substantially. This might work as a trading strategy, but is eminently ill suited to long term investing. The error is compounded when we go for trading, but fail to book losses and convert out trades to 'long term investments'.
 

A simple method for genuine long term investors to build wealth, would be to invest regularly in units of Index funds or Exchange traded funds (ETF') such as Nifty BeES. This strategy might not give you an adrenaline rush, but has some advantages which you might consider:

1. You invest in an index which is almost sure to go up in the long term, unlike some stocks which may simply disappear.
   
2. You invest regularly, in equal amounts every month, so that when markets are down you acquire more units and when markets are up you get less units, but the value of units already acquired in your account goes up.
   
3. You attain automatic diversification, thus avoiding the temptation to get into hot stocks.
   
4. You benefit from the growth in the economy, without any significant effort in stock selection or rebalancing.
   
5. Indices routinely weed out stocks which are no longer relevant and replace them with new stocks. You gain from shifting business trends.
   
6. You capture the long term effects of compounding, since your gains are embedded in the upward movement of the indices.
   
7. Since you hold for the long term, you do't have to pay any taxes, which increases the compounding effect.
   

 

You could do even better with actively managed funds, which have managed to outperform the indices, especially in the Indian context, but this comes with a dose of higher volatility.

 

ARE BUSINESS CHANNELS ON TV RELEVANT TO INVESTORS

When the Sensex was at 21,000, how many experts on the business channels were advising investors to sell? I can remember only one, Gul Tekchandani. All the others were busy predicting index levels from 24,000 to 30,000 to come up. Remember the reasons they were quoting to make you buy? Insurance companies have X 1000 crores to invest. Mutual funds have mopped up so many thousand crores. All this money was just waiting to enter the markets and promising to take it to new highs.

Fast forward to the situation now. When markets are about to hit 2008 lows, these same guys are advising you to sell, because the markets are headed still lower. Nice, easy way to make money guys, buy at 21,000 and sell at 15,000.

Another thing that bugs me about business analysts is that they give you all kinds of jargon in the hope that you believe that they know what they are talking about. This one is my favourite. An investor asks the analyst that he has bought a stock which is now showing losses. Should he hold or sell? The analyst advises him as follows " ABC stock has support at X levels, if it breaks the next support is at Y and if that breaks too, then it has long term support at Z". What does that tell the poor guy who has lost some money and hopes to get some quality advice about what he should do next. Come on guys. There is some real hard earned money here, not some paper trading game.

Then again the way these analysts encourage day trading is a real shame. They give out all kinds of daily calls, knowing fully well that day trading is a losers' game even for people with deep pockets, leave alone small investors. The poor guy watching TV sees a person with impressive sounding credentials, spewing out even more impressive jargon, giving him a tip. He does not realise that the tip is going out to a million more viewers like him, at the same time. So what is the value of that tip?

Truth be told, business channels are nothing but entertainment to the vast majority of investors out there. They are the new "Saas Bahu" soaps. Only they are infinitely more dangerous. At least you don't lose money watching soaps. Investors need to realise that there is no substitute for hard work to succeed in the markets. Tips don't work. Sure, you may make money a couple of times acting on tips, but eventually it is certain that you will lose.

Select whatever method you believe is the best for you. It could be fundamental, technical, growth, value, dividend yield, whatever. Study it well and only then invest your hard earned money. You may still make losses, but you know that you have done your best. As in all things, there is an element of luck involved in investing and perhaps this time luck was not on your side.

 

 

 

 

WHY STOCK MARKETS ARE NOT SPOOKED BY OIL

The single biggest factor influencing the global economy today are surging oil prices. Oil has risen from $ 20/bbl in 2002 to $ 130/bbl now. However this may not affect markets negatively and may in fact even be a bullish signal for stock markets going ahead.

The main reason touted for rising oil prices is the increasing demand for the commodity from growing economies. Therefore the very fact that oil prices are increasing means that the growth drivers are still intact. This is a very significant indicator for the future and it may be one of the reasons why, in spite of a surge in oil prices stock markets around the world are stable.

The second reason for the spiraling prices is the speculative element. Now if oil prices show some volatility on the downside, it could make the oil bulls run for cover. In turn this could trigger a sharper fall in prices intensified by speculators rushing to cover long positions.

The long term reason why oil cannot sustain current prices is that there are huge oil reserves in the form of oil shale, estimated at 2.6 trillion bbl. The only problem is that shale oil requires a different technology to convert into petroleum and new refineries have to be built. The cost of converting shale oil is estimated at $ 35/bbl. Now, as long as oil was in the $ 50/bbl range, this was a problem as it could slip back to less than $ 35 and render these refineries unviable. But at current prices investing in these technologies makes eminent sense and many companies are rushing to set up new plants.

Alternative technologies like wind power, solar power, nuclear energy are likely to get advanced as oil sustains its high prices. Also clean technologies being developed will ensure that demand for oil stops growing even though economies maintain their pace of growth.

When we combine all the above factors, it can be seen that oil is in a bubble zone presently. Whether the bubble goes on to assume larger proportions or deflates shortly remains to be seen. But deflate it will and stock markets across the world are picking up this signal well in advance, as markets have a habit of doing. This is the reason behind their surprising resilience.

REMEMBER THE PAST

Do you remember the stock markets in 2002? The whole world was recovering from the aftermath of the September 2001 attacks. Amidst all the gloom and doom, everyone and his uncle were advising you to sell stocks and get into good old fixed deposits. In fact people were talking as if markets would never rise again and any fresh investments made would fall even further. Further? Think about it now. In 2002, BSE Sensex was at 3200 levels. True, it may have gone down by a couple of hundred points more, but with the benefit of hindsight, just think how ridiculous that advise was.

So do not panic. Treat market falls as your friend. Remember the advise of Warren Buffet who said “ If you are in the market for buying apples and the price of apples were to suddenly fall, would you be happy or sad?” Think about buying stocks as you would about buying businesses. The same solid business that was available at Rs.500 a share barely 6 months ago is now being priced by the market at Rs.300 a share. Consider this. Everything about the business remains the same. Its growth rates, business prospects, quality of management – everything. Only you are getting it 40 % cheaper. In a few days it may fall another 10%. So what? It still remains a great business. If you can, buy more.

Remember, in spite of what the pessimists tell you India is still growing at 8%. Very few economies in the world can match that. Wages are increasing across categories. Millions of people are crossing over to middle class status every year. People are buying new homes, new cars and what not.

Do not let experts tell you that oil is at $ 132/bbl, so we must slow down. We may, but again we may not. We did not slow down when it went from $ 20/bbl to $ 130/bbl. And who knows, oil may come back to $80 levels before soon. These are the same experts who predicted that Indian IT companies would face rough weather because the Dollar had fallen against the Rupee and would fall still further to Rs.35 to the Dollar. And Infosys gained nearly 40 % in this period.

Therefore act with courage. Courage is not the absence of fear. Courage is the ability to act, to move ahead even when you are afraid. After you buy, even if markets fall further, remember the past. Markets have to recover at some point of time. And when they do so you will not only recoup your losses but overall your gains will far exceed interest earned on some stupid fixed deposit. Only remember to invest in quality. Do not buy simply because a stock has fallen sharply from its highs.

Don’t you think India will be a major economic power in the next 10 years? So make the most of that opportunity. Your chance is NOW.

LOOK AT THE BIG PICTURE

When markets are down and everyone from television analysts to the man on the street are painting a doomsday scenario, it makes sense to step back and take a look at the larger picture.

Since its inception in 1979 has moved from a base of 100 to around 17,000 at present. The compounded annual growth rate works out to 19% p.a. It has been a roller coaster ride, as anyone who has been in the markets long enough will attest. Along the way many investors have been wiped out, many new investors have entered and old ones have given up on stock markets as a den of thieves and manipulators. (The word “investor” is used in the generic sense and includes both long and short term investors, day traders and speculators). But the ones who have made money are those that have stayed invested through market ups and downs.

So what lessons does history teach us:

1. In the long run stocks of superior companies have outperformed any other alternate investments.
2. Stocks bought without researching and analyzing the rationale behind the investment are almost certain to eventually lose money.
3. Concentration on any one sector should be avoided at all costs. Moderate diversification is the key to long term success in the markets.
4. Remaining invested in the markets is more important than timing the markets in the case of long term investors with clearly defined goals.
5. Compounding in the long run makes wealth grow exponentially.
6. Do not borrow to invest.
7. Invest in the markets what you are likely to not need for the next 3 years.

Although it is extremely difficult to keep your head when everyone else around you is losing theirs in a sharp market downturn, we have enough evidence to prove that is where investors have made the most money.

A good strategy would be to pick 5-6 good stocks, market leaders across various industries or diversified mutual funds and invest a fixed amount of money every month in purchasing shares or units. In a market downtrend this means buying shares of great companies at reasonable prices. The advantage of picking solid companies being that their very size and stability gives you the conviction to hold patiently and even buy more during volatile times.

The big picture tells us that in spite of major upheavals and calamities that have occurred in the past, stock markets have always bounced back and rewarded investors who have held on through the pain. Therefore learn from history and grow rich.

A 100 % EQUITY PORTFOLIO FOR RETIREMENT

Conventional logic has it that as people approach retirement, their asset allocation should move away from equity and into debt. For instance most financial advisors recommend that a portfolio of 70 % equity and 30 % debt should be rebalanced towards 40 % equity and 60 % debt as retirement approaches.

Take the case of a retired person with Rs.3000000 in savings and having a monthly expenditure of Rs.20000. If he puts the entire corpus into debt, currently at 8 % interest for Government schemes such as PPF, NSC and Post office deposits, he stands to make 240000 per annum, just about enough to see him through. But with inflation at 8 %, the purchasing power of Rs.240000 at the end of 5 years becomes Rs.158000. And this is considering the Government published inflation figures which are much lower than the real figures, as any shopper will testify. At some point our retired common man will be forced to eat into his capital if he is to maintain his original standard of living. Except among the very rich, ones standard of living cannot be preserved or increased without exposure to stocks.

Naturally how much you can invest in stocks depends on how soon you need the money. But consider a hypothetical Rs.1000000 invested in 3 ways for 10 years.
100 % invested in bonds.
50 % in bonds and 50 % in stocks.
100 % invested in stocks.
Assume bonds give 8 % per annum and stocks give an appreciation of 14 % per annum
(Historically in India the Sensex has appreciated 18 % per annum compounded annually since inception). Dividends accruing from stocks are ignored.

In case 1 at the end of 10 years the investor gets back his Rs.1000000 plus Rs.1160000 as interest. A total of Rs.2160000. In case 2 he ends up with a portfolio of Rs.2930000 and in case 3 his portfolio of stocks is worth Rs.3700000.

Now consider a case where the same principal of Rs.1000000 is invested and the investor requires a regular annual withdrawal of Rs.80000 for his expenses. If he invests the entire amount in 8 % bonds , at the end of 10 years he will be left only with his capital in hand even considering no inflation. On the other hand if he invests in a 100 % stock portfolio he could, after withdrawing the same Rs.80000 every year be left with Rs.2160000.

Agreed that stocks do not move up 14 % every year, year after year. So assume that the day after he invests the markets fall by 30 % and thereafter increase by 14 % every year. Even in this scenario, a principal of Rs.1000000 with a withdrawal rate of Rs.80000 per annum ends up with Rs.1050000 at the end of 10 years. This excludes dividends, and if a 1.5 % compounded dividend yield is considered, the returns would go up to Rs.1210000. This still beats buying the 8 % bond.

Investments in high dividend yield stocks would provide still better returns. Instead of a 1.5 % dividend yield, if an investor sets up a portfolio of stocks yielding 3 % dividend yield and growing at 14 % p.a. ( e.g. Many PSU banks and Fertilizer stocks are available in this range) for 10 years, with 30 % of his capital wiped out initially and a withdrawal rate of Rs.80000 per annum, he ends up with Rs.1392000.

Therefore investors would do well to relook at blind asset allocation formulae and instead question their utility against a 100 % stock portfolio.