Commentary | Portfolio Yoga

Coattail investing

The world has become a smaller place thanks to technology which these day enables everyone access to quality information nearly at real time, something which in the older days played a great part in returns generated by professional investors / fund managers. In other words, it has become a great equalizer of sorts.

Twitter / Facebook / Whatsapp / Slack among other tools have become tools of collaboration and discussion resulting in better disbursal of knowledge and ideas. But what is also brings to the table is blind belief’s in some one elses ideas / trades and trying to follow them in the hope of easy money (easy give the fact that one doesn’t need to spend a lot of time doing the leg work himself).

When markets are good, these trading strategies / ideas are lauded as the next best thing, but markets being cycles are prone to excesses on either side and when things go wrong, its amazing how fast everyone is quick to blame the one guy who propogated the idea and hence is the person to blame for all the misery.

Following big investors / traders seems a nice idea if your intention is to pick up on the thesis behind their picks, but if its just the picks you are more concerned about, its just a matter of time before you will be sorely disappointed and will have parted with more money than you bargained for.

2015 seemed one such year when a strongly recommended and fancied stock (which manufactures pressure cookers) took a severe beating. Every one, whether he had a position or not, decided that the blame was to be laid at the door of the guy who felt it was a good pick with even suggestions that he was actually selling himself quitely while suggesting that other stay on.

2016 has started with a fancied textile company which is facing a rout similar to one the previous company faced. Unless the company turns out to be a complete fraud, the stock will stop falling and normalcy will return. But those who picked up the stock at much higher levels may need to wait for months or even years before they can get back to their high water mark.

At the beginning of last year, a famous analyst came up with a prediction for Nifty that suggested that 2015 will be the big year (in terms of returns) and while that call came nowhere close to being true, the said Analyst is still very much renowned and continues to be one of the talking heads at business channel. So much for accuracy of forecasts.

Profits and Losses are part and parcel of trading / investing. But if you are investing based on some one’s (paid or free) view, the risk quotient goes up even higher since you have no clue regardless of what happens and taking action is tougher especially when its not going the way one would have wished it would.

I see advisers regularly advising investors to invest only what they are willing to lose while at the same time claiming that only investing in equity can provide one with above inflation returns and its not prudent to invest into other asset classes for history has shown (not in India) that Equities beat others by a long yard.

The very term of being willing to lose means that you cannot risk enough to make a difference to your lifestyle should your selections work great. But if you risk more than what you are willing and do end up on the losing side, you will be faulted for risking too much. Heads I win, Tail you lose.

Warren Buffett has in the past talked about distinguishing between temporary draw-down and permanent loss of capital. When you invest in a ETF / Mutual fund, the risk is generally of the temporary draw-down nature. No matter how worse it looks, the probability is that it shall eventually recover (unless the country goes to dogs, but if that happens, you will have a lot more to worry than the value of your investments) while investing in stocks can result in serious and permanent loss of capital if you aren’t able to exit even as the stock continues to slide down on the slope of hope.

When you follow other people’s trades, you are in affect hoping that the other guy (the guy you are following) is not actually lost but knows the way. But it still doesn’t allow you to risk the kind of capital that will make a big win, a win worthy enough to retire upon. In one of my past blogs, I have written about my 1000 bagger – a kind of return that is very rare and yet, the fact that I risked so little has meant that even that amount I stand to gain should I sell now is too negligible. Forget about retiring, I cannot even go on a dream holiday and yet I have a 1000 bagger.

This year is my 20th year in markets and yet as far as I can remember, I know more people in markets whose biggest wins have come from Business / Real Estate than their wins in market. In fact for many of whom I know, what they risk even today is a small percentage of their total net-worth and this alone ensures that even if everything they touch goes to dust, they can still lead a comfortable life.

Coattail-ing is a interesting strategy only if you have complete knowledge of the guy you are trying to copy. Else, where he will be risking 0.01% of his money, you could end up risking 25% or more of yours. A loss won’t affect him anyways while a loss for you will wipe out a significant amount of your capital.

Social Media provides a interesting platform to learn from but if you were to try and use it as a short cut, you run the risk of getting caught in the middle of a forest with no clue as to where to go next as the light dims away.

What will you do, What will you do

The toughest thing in markets is to action when things aren’t going the way one hoped it will be. When markets are going up, the biggest worry for most investors and traders is that they haven’t loaded up enough to benefit from the rise and when it starts to fall, and when it starts to fall – man, most of them are caught up in the “Deer in the Headlights” syndrome – fixed feet unable to decide whether I should even move a damm muscle.

When markets plummeted 600 points (Nifty) in a matter of days, anyone caught on the wrong foot would have had it tougher by the day to take corrective action. Much of this can be ascribed to the “Sunk Cost Bias” that affects every one of us. After seeing a 400 point loss, would you consider cutting the position or sitting tight or worse, adding in the hope that a small recovery shall make good all the losses suffered till then?

The advantage for guys who use charts is that they provide you with clues on what may happen if a support or resistance gets broken (can be a many a time a major inflection point). When a stock or a Index breaks below what is known as a major support zone, you know that the probability of a rise now looks even dimmer and the best way to handle the situation is to either take a hedge or better, exit the position and wait for a new Signal.

Its much tougher for fundamental investors who have piled into a share to take evasive action since their signals aren’t like the one of technicians. You don’t get the company to make a announcement every time their stock tanks nor can you expect earnings reports to be updated after a major rise in the company’s share price.

Lets use a real life example – Kitex. This is a stock, that is as far as I know, that most value / fundamental investors have fallen in love with. Great business, nice earnings and hopefully a great future. The stock for a long time did not disappoint them either as it surged from trading in single and low double digits to something that was traded in 4 digit numbers.

All that changed when the company came out with its first quarter results for 2015 on 21st July. The company’s results were not what analysts had expected and given the premium valuations, it was natural to see a slump in the price of the stock. For a trader who uses charts, this would have been a clear exit signal as it broke through several support zones without as much as pausing.

When a stock price pierces several Resistance / Support zones, one indication is that the buying / selling is too strong and hence all the selling / buying that would have happened at those zones were not enough to change the situation.

The stock then continued to decline as it gutted away the gains that were accumulated in the previous months before it stopped at 575. But why 575 and the reason is that this was the place from where it had taken off in April. To add to that, this was also the breakout zone (once failed) which made the level even more of a worthwhile candidate to risk buying at.

Either way, it did work as the stock through much of the fall – but did it reverse course completely – of course, not. The price did not even catch up to the price at which it opened after the bad results. The slide that has taken place from there was not as sharp as earlier though we did fall and this time, even the old support wasn’t good enough.

But unless a stock moves into All time Low zones, there will be areas of support and for Kitex, there is a glimmer of hope at the levels between 422 and 437. That tiny gap which wasn’t filled is the next best hope. When I started writing this, was inside that very area. I even tweeted the chart showcasing the gap (Chart below).

As of now, the stock has bounced off from that zone, but will that hold? I don’t know and I honestly won’t care. But the fact is that for some one who looks at charts to trade, this is a area which provides a good risk reward opportunity. If it works, well and good, else one takes a small loss and exits in the hope that there will be another potential trade somewhere ahead.

Technicals is not about catching those bottoms or selling at the tops. Its all about listening to markets and going with the flow – no one has survived by trying to swim against the tide, not even John Paulson who if reports have to be believed has been forced to pledge his personal properties to ensure that he can remain in the trade (that for the time is wrong). He got it right in 2007 / 08, but will he be second time lucky?

What will you do, What will you do if your stock breaks that major support

Sell Sell Sell

What will you do, What will you do if your stock cruises past that major resistance

Buy Buy Buy.

What will you do, What will you do if your stock doesn’t behave as you expected

Run Run Run

for there is always another trade around the corner waiting for you.

New age Gold Diggers

In the mid 18th Century, California experienced what is now known as the California Gold Rush. People converged from near and far to try and get rich quick. While the initial diggers made some money, the late arrivals barely eked out a living, let alone get rich. A allegory that is used to describe those who made money says that those who sold Shovels made more money that those who actually dug for the Gold.

While the stock markets aren’t a place for the easy money kind, it does attract investors who hope to make a killing buying stocks that are peddled by advisers with the promise of it being the next big thing. Investors subscribe to websites that claim to tell you what big investors are Buying / Selling and how by just following them, you too can make a fortune.

When mid and small caps were booming, we had big fund managers come on TV claiming to have bought what they claimed was stocks which were very under valued and were ripe for a revaluation. Momentum sellers showcased how their portfolio’s were able to buy only the best of the lot and profit from the rally we were seeing.

Its amusing (though having fallen myself more than once into such traps) as to how we believe that the experts who come on TV are there to educate the public rather than trying to ensure growth of their own services. Fund mangers have found TV to be the best medium to broadcast their views and become popular and more the popularity, higher their assets under management.

Advisers come on TV in the hope that you not just hear their views, but visit their website and subscribe to their products – products designed to make you a better investor / trader / Macro Analyst or whomever you want to be. The idea is that all you need to do is pay a few shillings and glorious days are here.

Of course given the fact that failure rate in markets are so high, most experience disappointment about losing more money than they bargained for and try to exit as quickly as possible. But the world being a large place, that place is occupied by the next sucker hoping to not do the wrongs did by the one who lost. But guess what, probability is that he too ends up in the same place as the earlier – maybe in a different way.

I have had the good fortune of being able to meet / interact / learn from quite a number of guys and guess what, none of these have anytime to run subscription services, let alone spend majority of the time shuttling between various television channels giving gyan to one and all.

These days, everything is for sale but none come without any assurance of profit. Tip sellers want you to risk real money first to pay them and next to invest on those stocks that they recommend. But ask about reversing the process and they want some sort of guarantee that you shall pay if it works.

At least in the Mutual fund space this seems to be changing with the arrival of new age distributors who provide you with the ability invest directly and who are willing to get paid for their advise only if they beat predetermined benchmarks. While we still do not have websites like Collective2, I do hope that we shall see something of that nature in a matter of time as investors and traders want more than just assurances of the stock picker really knowing his stuff.

But till that time happens, you are better off taking every claim with a bag of Salt and spend your hard earned money on things that are worthwhile (Books for instance) than fall prey to buying the latest shovels from the friendly guy next door.

Promoters and Lifestyles

While Indian stock markets are said to be on the largest (in terms of listed securities) exchanges of the world, when it comes to Mergers & Acquisitions, especially of publicly listed firms, we really pale to a non significant ranking. And if you were to search for hostile acquisitions, there is very little of that happening on Indian markets. The last famous hostile battle was to try and takeover GT Offshore.

“Taking over a company (in India) has become even more difficult … every time if one has to waste years in court, it’s not worth it (a take-over bid),” said Lord Paul who attempted some high profile takeovers in 1982. While he exited in profit, the fact that he had to take the companies to court to get his shares registered says a lot about the pain quotient in taking over publicly listed firms.

The fact that its tough to acquire companies has made promoters to worry less about the risk of being thrown out even if they run the company to ground trying to boost their ego even if they don’t own 51% of the company. And if you own 51% or 74%, you can treat the company as your own piggy bank with none to bother.

Motor Cars are a depreciating asset and hence when you buy them personally, you suffer the depreciation. But what if the same could be routed out via your company. You get the same car while the company pays off the cost of acquiring and sets if off against its balance sheet.

Now, companies are free to spend the money the way they want but when promoters start to use them for their personal needs, one really wonders where the line ends between the company’s real needs and the promoters own needs.

If I own 100% of my company, I can do as I please since end of the day, its my own money at stake. But what if I run a publicly listed firm where at least 25% (SEBI minimum) of shareholding is held by the public. Treat them with the contempt they deserve to have trusted me in the first place?

A long time ago, a flashy promoter bought a private jet for his personal use using funds from a US listed (where he owned a majority stake I believe) firm. All hell got raised and he was forced to act. The promoter therefore simply sold off the plane to his Indian firm (where again, being listed was not 100% his own) and that matter died a natural death.

Media tags promoters with tags like Visionary or frauds / charlatans. Most of the time, its based on outcomes rather than the process itself. If a promoter takes enormous risks and succeeds, he is a Visionary, if he fails, it was because he was either stupid or there is more to it than visible to the eye.

The idea for this particular post came from friend Anand Mohan who runs equitybulls.com. (A disclaimer though, he also holds a stake in the company and hence can be treated as being interested). He posted a pic of the depreciation table of a small listed company. The company as on date has a market cap of 6.65 Crores and a Enterprise Value of 8.16 Crores. Promoters hold 74.43% of the company shares.

In the Financial Year 2014 – 15, they had a Profit after Interest but before Depreciation of 1.13 Crores. But then there is the depreciation which came to 94 Lakhs which literally ate away all that the company made that year. So, the question is, what kind of assets does the company hold that ensures that all it earns is literally wasted away in depreciation.

Here is the Fixed Assets statement. Apologies for the low quality of the pic, but it seems that the company has in order to save money, stitched up pictures taken from what seems like a low end camera.

The biggest number out here is for Plants and Machinery which is acceptable given that Plants and Machinery constitute the very basis for the company’s existence. Second biggest item though is Motor Car. The total amount invested into Motor Cars before this year was 2.16 Crores and this year they seems to have added 38.46 Lakhs worth more.

In other words, 23.50% of the company’s depreciation is due to Motor Cars which most likely are for personal usage rather than being for running the business of the firm. While 38 Lakhs in itself may not appear big, do consider that the Net Profit of the firm comes to just 8.89 Lakhs for the whole financial year. In other words, they spend around 4x what the company made.

Of course, this is one such company and I am sure that there are dime a dozen companies where the promoters milk the company in every way possible.

A famous quote of Warren Buffet is

“When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.”

Most investors unfortunately get sidelined by the management even in outstanding business as promoters lifestyle requirements takes a more prominent place. Since hostile take overs cannot even be effected, there is no exit route other than to give up on the company’s shares since its rare as they say “A leopard can’t change its spots”.

Debt and Investor returns

Growth is rarely possible without some amount of debt, at least at the initial stage if not later. But while some companies try to pay of their debt as soon as situation becomes better and internal accruals can fund their needs, some promoters get addicted to cheap debt and many a time end up destroying what was build over decades, even generations.

While the advise generally is to invest in good companies which have very little (or better Zero debt), the question I am asking here, is what is the difference in returns. To get to the bottom of that question, I did a small test.

I selected the top 50 (based on Friday’s Market Cap) Debt free companies and selected the top 50 companies with the largest debt. Since Banks / NBFC companies cannot go without debt, I excluded such financial firms from my test. The test though suffers from Survivor bias since all the data is from Friday and any company that has got delisted from exchanges due to Debt goes scot-free as such.

The first chart is of the returns generated by investing 10,000 into each company shares (since this is more of a theoretical exercise, fractional shares were allowed to be bought).

While one would expect Zero Debt companies to beat High Debt companies, the picture above seems to indicate that while Zero Debt companies would have beaten High Debt (though both end in losses, remember our total investment was 5,00,000.00) if you had invested 1 year back, on the shorter term, the High Debt companies have given stronger returns if the same was done just a month back. A Quarter back, it was more or less a draw.

What does the above data show? To me, it suggests the importance of timing regardless of the kind of company you are investing in. Now, lets explore this idea and use a much bigger data set (in terms of look back time). Instead of the max period being 1 year, how about we see how this would have worked over 3 / 5 and 7 years.

There is a issue here though – some companies were not even trading 5 / 7 years ago. To make the comparison uniform, I have assumed that they generated Zero returns (i.e., capital remained the same at the end of the period).

While high debt companies may have given some amount of competition on shorter time frames, on longer time frames, its beaten black and blue. Of course, do note that one will need to make a more detailed test since 7 years back, some of today’s high debt companies may actually have had low or even Zero (looking at the list I doubt, but better to be wary than accept facts blindly).

Hot Money and Mutual Funds

Why do people invest in Mutual Funds vs say Directly investing in the stock market?

One reason is that Mutual fund offers a diversification that may not be easy to achieve by a lay investor with limited funds.

A bigger reason, reason number two is that there is hope that the fund manager knows better about companies and their future prospects and will not make ill advised investments that go bust when the sentiment changes.

A question that was bothering me recently was the role played by mutual funds in bubbles. A bubble literally sucks everyone and its only later one realizes the absurd valuations that one was paying for those whereas the same is seen as rational during the course of such a bubble.

In the 2000, as Infotech stocks zoomed breaking barriers upon barriers, I remember quite a few funds getting launched (Sector funds) with focus on investing in the hot info-tech companies. How many were launched and how many are still present till date?

In 2007 we saw a lot of funds launching Infra focused funds since this time Real Estate and Infra were the hot sectors everyone was looking up at. Every time a real estate company acquired land, it notched up gains as it was seen as a major moat (land bank). Once again, how many funds remain active today (a observation made by some one a long time back was how many a Infra had big investments in sectors such as Banking making its comparison with the Infra index totally unreliable).

In recent time, this role has been played by Mid and Small caps as they notched up enormous gains and while the large cap Nifty 50 topped out in quarter ending March 2015, the Mid Cap Index closed at its highest level in December 2015 (lag of 9 months).

A rise in itself doesn’t mean anything since undervalued stocks can rise greatly to catch up with what the market believes as its fair value. So, let me once more present to you the Mid Cap Index Price Earnings ratio which I had posted in my previous post

At the end of 2015, valuations were the highest we have ever seen and came very close to touching the 3rd Standard Deviation. Mid and Small caps are more easily prone to move from under-valued to over-valued due to lack of liquidity and the frenzy making it seem like many of these will transform themselves to become large cap over time.

But liquidity is a two bladed sword. When the swords turns around, it literally can slice through portfolio’s like a hot knife through butter.

The above chart is a Quarterly chart of Nifty Midcap 100 Index. As can be seen, after the rise in 2009 / 10, the Index had more or less flattened out till the next leg started from the quarter starting 1st October 2013. From its close in September 2013 to end of December 2015, the Index rose a incredible 91.50%.

So, how did the Assets under Management of funds change in the period. Here is a pic depicting the same

Above is data compiled using data from AMFI India and selecting funds which had MidCap in their names. AUM above is in Lakhs of Rupees.

From End of September 2013 to End December, Assets under Management increased by 316% while number of funds increased by nearly 50%.

The question now is, how much of this flow of money pushed the valuations of Mid Cap stocks to levels it had never seen earlier. And the bigger question now is, how much of this will stay as historical evidence points out that future returns from times of high valuations are really poor (in a post earlier, I have posted data of future returns you can expect if you invest at different Price Earning ranges (for Nifty)).

Mid and Small Cap funds have given excellent returns over the last year and a half, but the question you need to ask is

Does it make sense to continue to be invested in such funds given the evidence above.

Do note that I may be totally wrong and the Small and Mid Cap rally can continue unabated, all I am offering you (with apologies to Morpheus) is data, nothing more.

Buying Cheap or Buying Early

A couple of days ago, I read a blog post by a Distributor of Mutual funds showcasing the difference of what FII’s are doing and what DII’s are doing (in terms of buy / sell) since the beginning of this year. As has been the case most of the time (and even historically), most of the time, DII’s do opposite of FII’s. So, in months where FII’s are buying, there is a high probability that the sellers are DII’s and vice-versa.

In fact, since April 2007 to Dec 2015 (105 months), only in 29% of the months have both been on the same side (16 Months when Buying and 15 Months when Selling). The writer of the blog using the data of the recent past hypothesizes that Mutual Funds are “essentially bargain hunting; probably buying quality stocks at low valuations.”. In other words, the author seems to believe that FII’s are selling cheap (Idiots probably) while the funds are lapping them up (Intelligent folks, eh?).

Before we go further, lets first check what FII’s and DII’s were doing as the market tumbled in 2008. Yes, its true that we did recover from that fall (and unless the world is going to end), probability is very high that we shall recover from every fall given enough time, but if you were a investor during those times, its tough not to remember that many funds actually lost way more than what the Indices lost.

So, while its true that they eventually recovered and made it up, any investor who invested or was invested fully during those months had a wait a very long time before he could see the NAV’s he saw before the crash.

The above picture depicts the amount of selling and buying by FII’s and DII’s from Novemeber 07 – March 08. As can be seen, other than in December 2008 when both ended up being buyers, in all the other months, FII’s continued to dump which was picked up by the DII’s even as Nifty tumbled from 6350+ to a low of 2252 in October (a loss of nearly 64% at the bottom).

The next question is, are we expensive. If you are a reader of this blog, you will know that while I have many a time said that we weren’t extremely expensive, we aren’t cheap either. That was based on my reading of the PE ratio (I know, I know, its not accurate to depict the future given the changes it frequently goes through and is hence a broad indicator) of the Nifty 50.

The last year and half has been more about Mid and Small Cap than the Large Cap. While I have no data, I wonder if like in 2000 when IT funds were all the craze and in 2007 when Infrastructure funds were able to accumulate a lot of assets, this time I wonder if Mid Cap funds have got a pretty large amount of inflow given the strong 1 year returns most of them were able to generate.

Lets hence first look at the PE chart of Nifty MidCap 100

Nifty Mid Cap 100 Price Earnings ratio at the start of the year was at a all time high – a high well above the one we saw in 2008 and even after the current fall, it has just come back to its 2 Standard Deviation. Now, valuation in itself doesn’t mean anything. After all, high growth companies command a very high PE and still provide returns to investors (Example: Page / Eicher in the last few years). But are companies in the Nifty MidCap 100 Index growing at 25%+ is the question one needs to definitely ask.

Because if they are not growing, the future returns (even in the best case scenario) are pretty bleak. So, before we move to Nifty 50 PE chart, would you consider the above to be Cheap / Distress Selling??

Compared to the Nifty Mid Cap 100 PE chart, this is a bit more pleasing to the eye. We haven’t touched any of the peaks that we touched in previous rallies and in that sense, its good. But as I have emphasized earlier, we aren’t cheap even today. In fact, unless you believe there has been a lot of good things that happened since the coming of Modi, why should a investor pay anything more than what he paid earlier?

The reason to utilize charts is because we are clueless when it comes to the future. But historical insights give us a clue on what could be expected of the future (all being nothing more than probability).

In one of my earlier posts, I commented that just sipping month on month without accounting for market valuations will get you average returns. There are times you should buy more and times you should actually sell. Buying all the time is good for everyone other than your own finances as average returns means that you need to invest more to achieve a return which could have been achieved with just a little tune up in terms of how much to be invested at current juncture.

Investing all the time helps the distributor get his commission, but is he really hand holding you and informing you about the risks of investing (even in SIP) at high levels and investing the same amount when markets are historically cheap?

Caveat Emptor should be how you look when investing since bad advise / investments can take away many years of toil.

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