Equity Investment - Learning

“Never invest in a business you cannot understand.” - Warren Buffett

Experience is a bad teacher as it gives the test before lessons. I have invested last year amid the SENSEX meltdown (Portfolio in Aug 2020) and (My Investment Universe). The wealth was created in the bear market (60% upsurge). I have tried to document personal decisions and convictions from the experience in the equity market. Any stock market is driven by herd mentality and kept afloat by confidence. The system is inherently a closed-feedback loop. Hence, sharing experiences matters.

My investment philosophy is really simple: invest in great businesses. My diligence is also focused on finding the sources of the competitive advantages of these companies, their track record of dealing with technological disruptions, and the wisdom of their capital allocation decisions.

Lessons

1. The long-term target is to own 10 to 20 stocks in the portfolio. I have trimmed down the portfolio from 34 to 21 stocks. No individual stocks make up over 15% of my portfolio. Good business with a moat is the primary focus of investment thesis and then cheap valuation.

2. I have purchased only 70 shares of Adani Gas during April 2020. Adani Gas has a massive debt since it is in the expansion phase. The stock skyrocketed to 10X. Too fast growth is always suspicious and always sucks the money out of the retail investors! Hence, I am sitting on the onetime decision and pondering over the investment thesis.

3. I couldn't understand the digital transformation wave in the IT industry last year. I sold Sonata Software and TCS during their surge in July 2020. Wrong move. Platform-based business models will pave the way forward for the future. Digital Revenue share is an important parameter in the digital transformation story to be tracked for the retail investors. The unicorn will emerge in the sectors that are underserved in terms of technology. The larger risk lies at the other end: giving up on a good business in pursuit of a perfect one.

4. ITC: Genuinely undervalued or value trap? I assume it's a value trap. I am not investing in Ciggarate and Liquor stocks. Hence, exited from ITC shares.

5. Don't risk on the back of borrowed conviction. I invested in Borosil Ltd under the assumption of the vaccine story. I was caught in the sucker rally and suffered the loss after the bounce fizzled out. Borrowed conviction ends up with misplaced confidence in flawed methods, throwing our judgment into a downward spiral.

6. I took an exit from the FMCG sectors. There is tremendous growth in the private labels and penetration has been achieved in the urban and rural market. FMCG companies have longevity about them but they are also reporting a decline in volume growth and focusing on value growth. I had purchased Nestle and Britannia at the peak of the valuation last year. Yet, I have exited from them because of a change in the investment thesis. 

7. Businesses shouldn't be much prone to regulatory changes and if that happens we must read their impact on the business. Understanding the business is the most important aspect of investing. I invested in City Union Bank without an understanding of the banking sector. The financial loss eventually happens even when the market was under-recovery. Any financial institution that has SMEs as lenders suffer during a major recession due to market consolidation. I didn't apply this insight despite knowing the economics behind that I suffered from the ‘optimism bias’ and overestimate my likelihood of experiencing good events and underestimate the likelihood of things going bad. I took an exit from CUB stock with minor losses. The important thing is to keep your winners & sell your losers.

8. I have a fair share of miscalculated entry and exit time. Data overload creates exaggerations in sentiments and patience gives away. I took an exit from Pfizer too early without guessing 2nd wave. Not reacting to the first piece of information that hits you is an asset and a highly undervalued one. A more complete picture, better information, and newer perspectives emerge with time, and holding one’s horses can end up being very profitable. I had exited from Vinati Organics, Info Edge, ITC, and Ashok Leyland too early with no gain despite buying them at a low valuation. 

9. CDMO and CRMAS are going to be such a big investment opportunity for India in the next decade. Investors have now the opportunity to take a long-term position in Pharma and Biotechnology sector innovators. I have allocated 30-35% of the capital in the sector. 

10. There is a huge boom happening in the Chemical sector but it is outside my circle of competence, Hence, I am not invested in them. The circle of competence can be expanded gradually by learning from people that have different interests and also are into investing.

A website like Screener helped in understanding numbers. Thanks to Sajal Kapoor for insightful tweets, SOIC- School of Intrinsic Compounding for astounding good business analysis, IIC Alpha Series (Free Videos of sectoral analysis), Saplings Capital for undervalued tweets, and Marcellus PMS for sharing the investment thesis in the large caps. The emphasis on reading annual reports and earnings call transcript brings CCCF (conceptual clarity, contextual familiarity). The most important lesson is - never knowingly misguide someone and block off a few hours each week in your calendar for relevant reading. Whilst there will be difficulties along the way, but wealth can only be created with patience in equity markets. Patience is backed by your conviction & your conviction (Allocation)is backed up by your understanding of the business. 

Personal Finance - Insurance, Debt and Pension

This post is in the continuity of the personal-finance series where earlier blog post: Personal Finance - Investment was published in May 2020.

RBI published a very important ‘Indian Household Finance Survey’ in August 2017. The report highlighted that:

• The average Indian household holds 84% of its wealth in real estate and other physical goods, 11% in gold, and the residual 5% in financial assets. A disproportionately high share of wealth allocated to physical (i.e. non-financial) assets, such as gold. 
• Under-investment in long-term insurance and pension products. Households can move up between 0.4 pp (percentage points) and 1.6 pp by taking on insurance to avoid the burden of emergency credit associated with medical costs
• Disproportionally large reliance on unsecured debt, mostly from non-institutional sources (e.g. moneylenders).

The need to finance adequate consumption during retirement is a huge issue, and when combined with the low penetration of insurance, households appear vulnerable to adverse shocks later in life. Even the middle class doesn’t even recognize how bad public healthcare and costly private healthcare is for the bulk of the Indian population.

The basic rule for personal finance is - "Keep Insurance and Investments separate." The financial services industry is one black hole for retail consumers.The mischievous cross-selling at private financial institutions on the supply side, and consumers' lack of financial education on the demand-side compounds the problem to a great extent. 

Which financial products you need? Most people just need five simple products in life. Fixed Deposit as a Liquid Fund, Index fund, Home Loan, Term & Health insurance. All of the investments commences only after sufficiently covering oneself with sufficient Health, Life insurance cover, and liquidity to manage at least 6 months of living cost. For any financial product, keep a basic checklist: What is my investment? When?  If yes, put numbers and dates. When does the return start to come in? Is the amount guaranteed in writing? What amounts are expected and on what dates?  Is the return based on an assumption? What is that assumption?

Few insights can be used while taking decisions for pension and insurance.

1. Do NOT buy a bundled life insurance policy. Reasons: Poor life cover, Poor returns, and Heavy losses in case of withdrawal. Pensioners and new parents are the most vulnerable targets for the agents. Look for a Term Insurance with optimum cover i.e. 200 times monthly expense.

2. It is never too early to start saving for retirement. National Pension Scheme can be used to close this gap at the microscale. Under the scheme, The government of India contributed INR1,000 per year to each account, for individuals that contributed themselves between INR1,000 and 12,000 per annum. Equity investments are already discussed in the previous post on personal finance.

3.The medical inflation rate in India is around 15-20 % annually which is much above the general inflation level. This means that a single hospitalization can exhaust the lifelong savings! More can be read here. Summary:

• Take Health Insurance
• Reveal the right information and never hesitate to go for a medical test.
• Avoid Third-Party Administrator and Copay clause while exploring health insurance plans.

4. Settling a debt must be the first priority. To debtors, creditors are like dictators. Always look for a lower interest rate and cut back big expenses.

5. Plan a Budget: When there is difficulty in managing the finance, a budget should be used as a tool for the allocation of the money according to the priorities both in good and bad times.

6. Emergency Fund: A family must have 3-6 months worth of living expenses stowed away in an immediately accessible bank account.

In a recent webinar with Monika Halan, an authority on personal finance in India, three questions were discussed in detail. How big should one’s retirement pot be at the age of 40, 50 & 60? How does one asset allocate one’s retirement across various physical and financial assets? How should one think about life insurance and health insurance in the context of his/her own long term savings plan? She told them in a concise manner that can be viewed on youtube. I will recommend the readers to read the book "Let's Talk Money" and weekly columns of Ms. Uma Shashikant to plan personal finance more carefully.

Personal Finance - Investment

As reading and writing are essential to participating in society, a person has to be financially literate today to plan for the future. This is essential without indulging deep into technical and jargon-filled financial concepts. The ability to save and the power of compounding is not quickly understood by many people. Investment can be done in various asset classes like equities through mutual funds and stocks, Bonds through mutual funds, Gold, P2P crowd-lending, National Saving Certificate, Public Provident Fund, Fixed Deposits through Banks, NBFC (HDFC Ltd.), Post Office, Real Estate and Currency.

I have started my career in the shadow of the 2008 financial crisis and have been at the receiving ends of the global recession of 2020 due to Covid-19. Both catastrophes have revealed that we could all benefit from a clearer understanding of how markets work. Let us look at the 2007-2010 period for the fall and rise of Sensex. The meltdown in the global financial system proved to be the best time for a stock investment and by March 2009 began the greatest rally seen in equities seen this century.

Companies having good corporate governance and sustainable long-term growth across market cycles recovered from the 2008 crisis. Investment and saving for future shocks take discipline that even middle-income class struggle with. I am hereby sharing the insights before investment:

Checklist for Investment:

1. Systematic Investments (SIPs) are just a methodology to invest, not a winning formula. They are the best means to accumulate. Worst Performing Mutual Funds will deliver poor returns despite the method of investment. And the reality is that not all these investments will generate the expected returns.

2. Don't be a compulsive asset class investors. E.g. a person who loves equity will keep on investing in equity no matter the results. If returns on assets (short or long term) are unconvincing, then there is no point sticking to it. Yet, it is advisable to have a portfolio with different asset classes instead of any single asset class.

3. Get-rich-quick and guaranteed-upside schemes are incubated daily. Investment isn't a poker game! Please do avoid investment in schemes promoted by online marketing companies (Speakasia) and multi-level marketing company (QNET). Whilst investing is not the same as human life, for most people, risk of losing their hard-earned savings can be no less tragic. The moral seems to be that any approach to money-making in the stock market which can be easily described and followed by a lot of people is by its term too simple and too easy to last.

4. IPO is always released in the seller's market with a lot of buzzes and probably have overpriced valuation. Business is not a popularity contest. Avoid hype around a company that didn't even have a basic business model in place. And investment bankers to wealth managers to the media are paid to create hype.

5. Most of the high yield bonds are junk bonds. A combination of macro liquidity and market illiquidity is a time bomb. It always leads only to volatile flash crashes and sudden changes in bond yields and stock prices.

6. The mutual fund market is flooded with multiple schemes: real estate, infrastructure, pharma, technology, close-ended, mid-cap, small-cap, multi-cap, growth, value, and so on. Please do check the last 5 years' performance, exit load factor, and locking period before investment. The investment can be done through direct and distributor in mutual funds.

7. One must find a sound advisor to lay down goals according to their priority and lay emphasis on life goals such as marriage, kids, higher education, and retirement. The fees charged by the advisor should be from you rather than trail end commission from the companies.

8. Public Provident Fund (PPF) is among the best long term investment schemes available in the market. It offers tax-free benefits with an initial lock-in period of 15 years.

Demystifying Stock Investment:

1. Trading is not the same as Investing and its speculation for the majority of the people. Trading is beneficial for the broker by service fee and government through GST. Investing isn't about beating others at their game, it's about controlling yourself at your own game. The right investing process and the ability to hold on for the long term is the way to wealth creation. Not chasing fancies.

2. An individual should own between 10 to 20 stocks as this is an adequate number and avoid excessive diversification. The number can be based on the capital, risk profile, and investment objective. The financial risk lies mostly within ourselves with our habit of feeling restless or relishing a complicated intellectual challenge.

3. We all now know how prominent public and private sector banks in India fudged their NPA figures for years on end until the RBI’s Asset Quality Review forced them to come clean. The same problem exists with several companies exposing them to accounting risk. Most accounting frauds usually come to light when the stock market is tanking and the access to capital starts drying up. Hence, companies with clean management are of paramount importance for investment.

4. A sustainable competitive advantage is a mantra for a successful business. The company’s competitive advantage is the reason for domination in its industry and generates returns much higher than its cost of capital. The sustainability of the competitive advantage enables the company to maintain its dominance and free cash generation ability for long periods. Read about Nestle.

5. Nifty index is not a good representative index. The over-representation of the capital heavy sectors like Power, Construction, Metals, Telecom, Real Estate, and Oil in the Nifty is a key reason for its sluggish performance. The sluggishness of the Nifty makes it relatively easy for reasonably competent PMS managers to outperform the index and unjustifiably claim the presence of skill.

6. Never buy a stock for dividend income alone. Company management and business must be solid and its stock price must be reasonable. If a stock is good 3 months earlier with solid underlying business, it's good now also.

7. Gambling is inherent in human nature. Speculating stock (assumed multi-bagger) should not be more than five percent of the total investment money. Never succumb to the certainty that any industry (eg IT) will outgrow others in the future.

8. There are two methods of investment in the stock market either: dollar cost averaging or buying an undervalued share and simply buying shares of premium companies in a bear market.

10. Don't invest in the sectors in which there is too much government interference (aviation sector). Better to invest in US stock exchange (S&P 500 and NASDEQ) through index funds.

“Invest in businesses that buy commodities and sell brands” is a powerful idea for long-term investing propagated by Warren Buffet. For geeks who want to test this idea, I will share the process (found on the internet )of assessing a stock into a checklist (step 1: check accounting quality; step 2: check the consistency of ROCE generation and revenue growth over the past 15 years; step 3: read the last 15 years of annual reports to assess capital allocation; step 4: assess sustainable competitive advantages, etc)

Footnote: Those have read with patience can get list of companies to invest compiled with limited knowledge.