Portfolio Yoga - Part 44

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.

Peak-and-Trough Analysis on Nifty 50

A adage in the market says that Stocks take an escalator up, and an elevator down and in this environment with Nifty falling like nine pins day in and day out, one actually wonders if it has taken the elevator or has actually fallen through the elevator shaft.

While till recently the mood of the market wasn’t bearish, the last time we saw a new high was way back on 3rd March and a month from now, we would have passed a year without being any closer to the same (unless of course the market decides to make up for all the mistakes in double time and make a new high before that).

But, historically what has been the duration of time spent between two highs and more importantly in light of the fact that we are now down 18.75% from the high point, what is the average draw-down one encounters.

When markets are hitting new highs, there is generally some amount of continuation and to avoid small number bias, I have reduced the number of highs to those that occur at least 1 month after a previous high. In other words, if markets hit a new high 3 times in the month, I ignore the 2nd and 3rd high and take for my calculation only the first.

But to calculate the draw-down and number of days spent, I use the 3rd high so as to ensure that only the draw down seen after the last high to the next high gets measured.

Web of Lies

From a very early age, one of the key leanings for most of us is the fact that lying can be beneficial when you are faced with the ignominy of accepting a fault which you would hopefully avoid accepting. Generally one starts lying to others, then slowly it transcends to family and finally we start lying to oneself – all in a attempt to prove that we were right.

It is said that every New Year, there is a spike in admissions to Health Clubs / Gyms, but over time, the interest wanes off and people just stop going. Of course, ask anyone and he has a plethora of options which he says is stopping him from going to the Gym and that he is really serious and hence the sign up. But dig a bit deeper and most of the flags raised are just issues one came up to convince oneself that while I am ready, its factors beyond me that is stopping me from being able to do what is needed.

Lying always has a cost and its visible everywhere. One such place is the stock market. Trading is a risky business proposition with a high mortality ratio, yet that doesn’t stop people from trying to excel out here.

Most of us know the importance of Stops and how its important to exit when we are wrong, but how many times have we skipped getting out in the hope that this is just a temporary phenomenon and like the last time around, markets are just trying to take my position before it starts its journey back to where it started from.

Yes, some times, stocks do bounce back from where we go stopped out and make it seem that only if we had not got out, we would have been a lot better. But most of the time, a stop actually means that our view was wrong and markets were right.

After all, there is no operator who works day and night with the sole intention of stealing your small position. He will not move the market X% just because you have placed a stop that he wants to trigger. But, hey, the excuse of operator taking out your stop is a good one since it ensures that if markets did crack later on, you can always say that I would have kept the stop just that stops are seen and taken out by the bigger traders / investors.

We are lied all the time elsewhere too. When a Pseudo Analyst says that Nifty will reach 5,000, he is basing on fact that people really have a short term memory and if it does’t work out, no one will be the wiser, but if it works, if it woks, Oh, God – that can make him a Hero for having called the same correctly.

When the Vastu guys says all your problems are due to the fact that your door faces West instead of East, he is just providing you with the excuse that seemingly makes everything else seem right.

When we do’t accept our wrongs, we are just prolonging the pain that comes with it. As a famous Quote by Benjamin Franklin goes
“For the want of a nail the shoe was lost,
For the want of a shoe the horse was lost,
For the want of a horse the rider was lost,
For the want of a rider the battle was lost,
For the want of a battle the kingdom was lost,
And all for the want of a horseshoe-nail.”

Have seen a lot of folks losing fortunes in market just because they didn’t adhere to their stops the one time that would have made all the difference.

Stop lying to yourself that your problems are not because of your decisions but factors outside your control and that alone can make a hell lot of difference to the way you trade and invest.

Keeping up with the Joneses

The last couple of years has been fabulous for a large variety of shares. While good shares (large cap) have appreciated a bit, it really has been the season of small caps with many of them showcasing (at their peaks), returns in excess of 1000%, this when the larger market had really gone anywhere.

Most investors are rational and know that they really cannot generate the kind of returns you can by investing in stocks where you really are clueless both about the company and the business it runs. But too many get swayed by the emotions and profits that such moves are accompanied with.

When everyone out there is showing how great their picks have been, its tough to stay calm and be a observer of things believing that normalcy is around the corner and this is just a short term phenomenon. On Twitter and WhatsApp, where I find a large amount of time, its Lake Wobegon affect all over. Everyone is happy to share how the stocks he has picked doubled / tripled (after which its only showcased as having returned some random number with a X suffixing it).

Some of these winners are genuine companies with a great business model that was left un-noticed for a long time but is now coming into the lens of the Institutional Investor. But then again, there are stocks which have gone 10 / 20X for no dime or reason and unless one has the ability to understand the difference, its easier to get into unworthy companies and the worthy turnaround ones, its easier to fall for the unworthy since they really make a lot of noise.

Much of the noise in retrospect is made by guys who picked it up early and are enjoying the returns. While its nice to have such ego boosts once in a while, since most of the time, one is clueless about how much (say as % of networth) he has really risked, it becomes a tale where your imagination is the key.

Digging a bit deeper, most of the time I find guys who claim big to be sellers of subscription based products. Its impressive as to how good they are in their ability to find great investments / trades for their clients and all that for a small fee.

Being a trader, one of the few record keeping trader I follow is @liveNiftyTrades who trades Nifty using a systematic trend following system. Recently, he changed the system and started from a scale of Zero after a year or more of under-performance in his old system.

Right off the bat, it seemed as if this system was designed for Glory as he racked up impressive gains in a very small amount of time. While I generally do not get affected by the profits generated by others, the kind of gains he logged in made me work on whether I was missing something (as my system was nowhere close to generating even 25% of the profits he had made).

But thanks to my mentor and saner thoughts, I was able to continue trading what suited me rather than try and devise a system that was not suitable both in terms of risk and time commitment it requires (shorter the time frame you trade, more the requirement to be in front of the system). Today as he closes his trading account (hopefully temporarily), I understand how fickle that thinking was. But when I look again at those who claimed the multi baggers, even with markets being down big time, I see no one accepting that they went wrong in a few stocks. Its as if, stocks that they were recommending (and many of which are now on the reverse path) are no more in the portfolio.

Instead, now I find a new set of guys who claim to have foreseen this fall and predicting a apocalyptic ending to it. Its their time in the Sun now and if you get swayed by their predictions, do remember that just like the setting of the sun, even this bear market will end – the only question that remains is how many remain to see the dawn of the next day.

Every bear market throws out weaker investors / traders who weren’t prepared for what the market dished out. But if you are able to survive one such market, the lessons learned will come handy for the rest of your life.

As a adage says “This too shall pass”.

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