Happy New Year 2006
Dear Visitors, I wish all of you a Happy New Year & Happy Emotionless Investing!
Investing is most intelligent when it is most businesslike - Benjamin Graham (1894-1976)
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Friday, December 30, 2005
Crazy Market Is Tough to Beat
by Jonathan Clements in Wall Street Journal
It's one of the great investment contradictions. Yes, stock investors do all kinds of goofy things. No, beating the market isn't easy. On the face of it, this seems absurd. If some folks behave irrationally, others should be able to make money at their expense. Yet, as is patently clear from the long-run market-lagging performance of most stock-mutual funds, it is awfully difficult to beat the market. This isn't just an issue of how to manage money. It is also a raging debate among finance professors. For years, the prevailing academic wisdom was that the stock market was highly efficient, with prices set by rational investors.
But lately, that notion has come under assault from behavioralists, who argue that market movements aren't adequately explained by traditional economic models. No doubt about it, irrationality is on display everywhere.
Why do investors trade so much? All that buying and selling can't be rationally justified. Why do companies bother splitting their stocks, say, two for one? All it means is that shareholders now have twice as many shares, each with a 50% smaller claim on the company's earnings. Why do companies pay dividends? From the standpoint of taxes, it makes far more sense to buy back stock. Yet shares often rise after a company announces a dividend increase.
"It doesn't look to me like markets behave as if investors are rational," says Richard Thaler, an economics professor at the University of Chicago. "Everybody agrees that there are some irrational investors out there," Mr. Thaler says. "The controversial question is whether they set prices. The behavioralist line is that they do some of the time. The efficient-market line is that prices are set by rational traders." Not all behavioral quirks hurt market efficiency. Many investors, for instance, are excessively self-confident. This shows up in investors' ill-advised tendency to trade too much and to bet heavily on a limited number of stocks. But it also manifests itself in the huge effort made to find undervalued stocks, says Mark Rubinstein. "I concede that investors are overconfident," Mr. Rubinstein says. "But what this means is that active managers spend too much on research. It makes the markets too efficient. It's like a gold mine where most of the gold has already been taken out.
Occasionally, you'll find some, which will egg you on. But it's just not cost-effective to keep mining." Mr. Thaler says the validity of behavioral economics doesn't hinge on being able to beat the market. "It could be that stock prices were wildly irrational, but unpredictable," he says. "If so, it wouldn't be possible to make money." Indeed, even if you buy the behavioralist argument that the markets aren't entirely efficient -- and the evidence is compelling -- that doesn't mean you should try to beat the market. No matter where investors stand on the academic debate, they "should behave as if markets are efficient," argues William Sharpe, a finance professor at Stanford University and a 1990 winner of the Nobel Memorial Prize in Economic Science.
Consider the 1987 stock-market crash, when the Dow Jones Industrial Average plunged 22.6% in a single day. It stands out as a glaring example of irrational behavior on a grand scale. But that doesn't mean you can predict the next bear market, says Meir Statman, a finance professor at Santa Clara University. "The market may be crazy," he says. "But that doesn't mean you can beat it." After all, if the overall market is a tad screwy, the blame lies with us, the market's participants. "Individuals make mistakes," says Hersh Shefrin, also a finance professor at Santa Clara University. "Markets aggregate those mistakes. But in the aggregation, the errors become smaller than those made by individuals. As a result, if you set out to try to beat the market, you're more likely to fail than to succeed," after figuring in investment costs.
Even Mr. Thaler, who has turned his hand to money management, readily concedes that beating the market isn't easy. "The academic dispute doesn't translate into very big differences in advice for individual investors," he says. "The efficient-market guy says it's impossible for the individual investor to make money. The behavioralist will look at the data and say most individual investors don't make money. So they would both give the same advice, which is to buy and hold."
The bottom line? The behavioralists may offer some slim hope to the market's stock jockeys. But in the end, it still makes a ton of sense to settle for average market results, by purchasing index funds.
Random Readings
Click on the link to read the full story
"You need discipline, patience, and courage. You must have a willingness to lose, but a strong desire to win." - Gary Biefeldt
Thursday, December 29, 2005
Stephen Roach on India's future
"I think it is premature to crack out the champagne and celebrate the dawn of the new Asian century," says Morgan Stanley, MD, Stephen Roach. But at the same time he explains, "India is a market, a story, a country, an economy and they (investors) need to take it seriously."
Click here for the whole story
Random Readings
Click on the link to read the full story
'Buy' on Infotech Ent: ICICI Sec
'Neutral' on Arvind: SSKI
Foreign investments spur growth of stock market
SAIL favours mega merger of steel PSUs — `A single entity is the need of the hour'
Analysts` corner: Timex Watches
Stock watch: K M Sugar Mills
Banks 2005: Benchmarking global standards...
Market valuations stretched: Gryffon Investment Advisors
Open offer season
It’s the capital gain, not dividend, stupid!
Of wealth creators & markets - must read!
"In horse racing, people generally don't like to bet on a great horse at short odds. Instead they under-bet the best horse and over-bet the worst. The same is true for the stock market." - William Ziemba
Wednesday, December 28, 2005
Long Term Investing = Contrarian Investing?
Economists muse about just why it is that stock markets around the world are subject to fits of "irrational exuberance" and "excessive pessimism." Why don't rational and informed investors take more steps to bet heavily on fundamentals and against the enthusiasms of the uninformed crowd? The past decade gives us two reasons. First--if we had correctly identified long-run fundamentals a decade ago--betting on fundamentals for the long term is overwhelmingly risky: lots of good news can happen over a decade, enough to bankrupt an even slightly leveraged bear when stocks look high; and lots of bad news can happen over a decade enough to bankrupt an even slightly leveraged bull when stocks look low. Thus even in extreme situations--like the peak of the dot-com bubble in late 1999 and early 2000--it is very difficult for even those who believe they know what fundamentals are to make large long-run bets on them. And it is even more difficult for those who claim they know what long-run fundamental values are and want to make large long-run contrarian bets to convince others to trust them with their money.
As J.P. Morgan said when asked to predict what stocks would do: "They will fluctuate."
Perhaps this is how it should be: if it were easy to pierce the veils of time and ignorance and to assess long-run fundamental values with a high degree of confidence, it would be easy and safe to make large contrarian long-run bets on fundamentals. In this case the smart money would smooth out the enthusiasms--positive and negative--of the overenthusiastic crowd. And stocks would fluctuate less. And there wouldn't be teasing evidence at the edge of statistical significance of large-scale deviations of stock market prices from fundamental values.
Source: Bigpicture blog
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Random Readings
Click on the link to read the full story
Markets: The writing is on the wall!
End of bull run or long-term bet?
Analysts` corner: Hero Honda
Stock watch: Mahindra Ugine
Vivek Paul set to ink deal with Sharekhan
Momentum in auto ancillaries: Morgan Stanley
Brics initiates buy on Petronet
Indian equities expensive: ML
Country funds hot now: Durham
For Finance St, 2005 has been a year to remember
Operators run rings round the Sensex
Reliance demerger: You ain’t seen anything yet - a good read!
How GDP is estimated in India
The incredible power of compounding - a good read too!
"In the short run, the market is a voting machine but in the long run it is a weighing machine." - Benjamin Graham
Tuesday, December 27, 2005
The Little Essay That Beats the Market
By Joel Greenblatt
I love movies. I hate reading movie reviews. That's because I don't like people telling me what to think, plus most reviews merely summarize the plot and give away the ending. That kind of ruins things for me.
Nevertheless, my plan is to ruin things for you. Luckily, we're not talking about a movie. We're talking about stock market investing. I'm going to tell you what to think, summarize the basic idea and end with a "magic formula" that can make you a better stock market investor.
So, what should you think? If you want to be a successful stock market investor, you should think about buying pieces of "good" businesses at "bargain" prices. Yes, that sounds simple, but if you actually could find a good business at a bargain price, wouldn't it make sense to buy it? Doesn't that sound like an investment strategy that should work!
The only problem is figuring out what's a "good" business? Well, a "good" business is a business that can earn a high return on capital. What's that? It's a pretty simple concept really.
Say you own a store. In my recent book, The Little Book That Beats the Market, we used the example of a gum store (yes, a store that sells only gum--don't ask!). Anyway, say that store costs $400,000 to build (including inventory, store displays, etc) and last year that store earned $200,000. This works out to a 50% yearly return ($200,000 divided by $400,000) on the initial cost of opening a gum store. This result is often referred to as a 50 percent return on capital. Without knowing much else, earning $200,000 each year from a store that costs $400,000 to build, sounds like a pretty good business.
But what if we compared that to another kind of store, say a store that sells only Broccoli (we called that store, Just Broccoli, for obvious reasons). What if it also costs $400,000 to open a Just Broccoli store? But what if that store only earned $10,000 last year? Earning $10,000 a year from a store that costs $400,000 to build works out to a one-year return of only 2.5 percent, or a 2.5 percent return on capital.
So here's the tough question. Which sounds better--a business that earns a 50% return on capital or one that earns a 2.5% return on capital? Of course, the answer is obvious. You would rather own a business that earns a high return on capital than one that earns a low return on capital.
So, now we know what "good" is--a business that earns a high return on capital. But what's cheap? In the book, we defined cheap as a business with a high earnings yield. What's that? Take two businesses, one earned $300,000 last year, one earned $100,000. Both are for sale for $1 million. If we buy the first, we get an earnings yield of 30% ($300,000 in earnings divided by the $1 million purchase price). The second has an earnings yield of 10% ($100,000 in earnings divided by the $1 million purchase price).
Which is cheaper? All other things being equal, the company that earns more relative to the price we're paying is cheaper than the one that earns less. In other words, getting a 30% earnings yield is better than a 10% earnings yield--a high earnings yield is better than a low one.
And that's it. Now you know the "magic formula"! What do I mean? Well, in the book we show that if you just stick to buying "good" companies (those with a high return on capital) but you buy them only when they are available at bargain prices (when they have a high earnings yield), you can more than double the market's average annual return. And you can do it with very low risk.
Having trouble believing that it's that easy? Well, how about this? A study we conducted over the last 17 years shows that holding a portfolio of stocks with the best combination of a high earnings yield and a high return on capital produced over 30% annual returns vs. just 12% for the overall market during the same period (see Table 1).
Note: The "market average" return is an equally weighted index of our 3500 stock universe. Each stock in the index contributes equally to the return. The S&P 500 index is a market weighted index of 500 large stocks. Larger stocks (those with the highest market capitalizations) are counted more heavily than smaller stocks.
Over 17 years, earning 30% a year means $11,000 would have turned into over $1 million! Not bad.
But what if we made it even easier for people to follow the magic formula? What if we created a free website--magicformulainvesting.com--that made finding "magic formula" stocks completely automatic? Would that convince you to try it yourself?
Actually, maybe not. With me being such a blabbermouth, if everyone "knows" the "magic formula" maybe it will stop working? After all, how can any strategy keep working if everyone follows it?
Well, here's the answer. The great thing about the "magic formula" is that it isn't that great! It doesn't work all the time. That's right. Over long periods of time, it's true, the results are amazing. But...there are still 1, 2 and even 3 years periods when the formula doesn't work at all! Most people just don't have the patience or the discipline to stick it out during those tough periods. After a year or two of following a strategy that underperforms the market, most people simply give up!
That means for the "magic formula" to work for you, you must "believe" that the formula makes sense and that it will continue to work over the long term--even if it hasn't worked for months or even years. For that, you'll have to understand why the magic formula makes sense. You'll have to continue to believe that it still makes sense even when friends, experts, the news media, and Mr. Market indicate otherwise. That's tough to do! Unfortunately, to really "believe", I mean really, truly "believe", you'll have to be convinced that buying above average companies at below average prices actually makes sense. I believe it does. I hope you "believe" too.
If you do, I know you'll become a more successful investor. But darn if I didn't just give away the ending.
Source: John Mauldin Newsletter
Note: The "market average" return is an equally weighted index of our 3500 stock universe. Each stock in the index contributes equally to the return. The S&P 500 index is a market weighted index of 500 large stocks. Larger stocks (those with the highest market capitalizations) are counted more heavily than smaller stocks.
Over 17 years, earning 30% a year means $11,000 would have turned into over $1 million! Not bad.
But what if we made it even easier for people to follow the magic formula? What if we created a free website--magicformulainvesting.com--that made finding "magic formula" stocks completely automatic? Would that convince you to try it yourself?
Actually, maybe not. With me being such a blabbermouth, if everyone "knows" the "magic formula" maybe it will stop working? After all, how can any strategy keep working if everyone follows it?
Well, here's the answer. The great thing about the "magic formula" is that it isn't that great! It doesn't work all the time. That's right. Over long periods of time, it's true, the results are amazing. But...there are still 1, 2 and even 3 years periods when the formula doesn't work at all! Most people just don't have the patience or the discipline to stick it out during those tough periods. After a year or two of following a strategy that underperforms the market, most people simply give up!
That means for the "magic formula" to work for you, you must "believe" that the formula makes sense and that it will continue to work over the long term--even if it hasn't worked for months or even years. For that, you'll have to understand why the magic formula makes sense. You'll have to continue to believe that it still makes sense even when friends, experts, the news media, and Mr. Market indicate otherwise. That's tough to do! Unfortunately, to really "believe", I mean really, truly "believe", you'll have to be convinced that buying above average companies at below average prices actually makes sense. I believe it does. I hope you "believe" too.
If you do, I know you'll become a more successful investor. But darn if I didn't just give away the ending.
Source: John Mauldin Newsletter Random Readings
Click on the link to read the full story Indian banks to weather storm in volatile 2006 Convenios is the next big retail story Equity allocation in your investment portfolio ‘India is comprehensible to long-term investors’ Analysts' Corner: Everest Kanto Stock watch: Himatsingka Seide What's So Big About a Speculator? - good one! Dos and Don'ts for investors Brics maintains 'buy' on RIL Buy on Rain Calcining: Anand Rathi ML maintains 'buy' on Jet Airways "There are two requirements for success in Wall Street. One, you have to think correctly; and secondly, you have to think independently." - Ben Graham
Monday, December 26, 2005
Random Readings
Click on the link to read the full story
IPO scam...SEBI needs to act quickly
Group of investors acquire over 5 cr shares of Reliance - huh!
Poor governance can stop the bulls
Don't mistake activity for achievement.
Chart Book 2005
| $10 billion FII inflows, Corporate profits at 5 per cent of GDP, 87 companies in the billion dollar club, Sensex at a life-time high, M-cap at $500 billion. |
| Click here for Chart Book 2005 (2.5mb .pdf file) |
Stockmarkets: New Year, New Thoughts!
Source: Equitymaster.com
As we enter the fifty-second week of 2005, the final one for this year, and when the Indian markets are nearly at their all time highs, there's one phrase that reminds us of the situation prevailing around. It goes like this - "Human nature is human nature and human nature would continue to remain human nature till human nature remains human nature." - (Late) Nani Palkhivala. Now, one would ask why this quote on a website dedicated to equities. Well, this phrase, when used in context of equity investing, holds true to a very high extent.
History is replete with examples when greed and fear (key ingredients of human nature) have taken over discipline, resulting into windfall gains and, of course, 'windfall' losses for investors. And more sadly, small investors are the biggest losers in these phases of indiscipline (recollect the year 2000 stock market boom and bust, or in case of those with short memory, May 17 2004. While greed results into bulls taking the centre-stage and leading markets towards nauseatingly high levels, fear brings them back to ground zero. And small investors suffer in both these situations.
As we are about to enter the year 2006, the second last year of the tenth five-year plan, Indian equity markets are at their all-time highs. While such a situation brings in factors that cause the 'greed' element to rear its face, investors need to practice utmost caution and not give in to temptations that rising markets like these bring with them. This calls for high levels of 'discipline' and, in these times, this should be like a resolution for the New Year.
Now, while making a New Year resolution is quite easy, practicing the same is otherwise. And when that resolution demands high levels of discipline, the task becomes all the more burdensome. First of all, most of us generally fail to make reasonable resolution(s), and that is the major reason why most of us fail to keep the one(s) we make! Sure, all New Year resolutions do not make it past the 2nd of January, but wisdom would be in believing that this year is going to be 'different'. Right? Happy New Year!
Sunday, December 25, 2005
Random Readings
Click on the link to read the full story
Fertilisers: High yield to maturity Overseas offerings: The capital Nirvana `Inflation, interest rates driving gold' Lessons from Yes Bank IPO scam
New features of stock market surge
"Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid." - Warren Buffett
Leveraging India Inc's investments
There may be value for patient investors from exposures in select companies with sizeable investments. The ones that make the cut are Tata Investment Corporation, Parry Agro, Ramco Industries, Maharasthra Scooters, Zuari Industries, Rane Holdings, Atul, Indian Oil, Eicher and SRF Polymers. Click Here for the complete article.
Saturday, December 24, 2005
Random Readings
Click on the link to read the full story Analyts' Corner: Rajasthan Spinning: Capacity addition boosts Sensex: Crystal gazing In Focus: Carbon credits Asian steel prices to stabilise 2006 Investment Checklist Stock watch: VisualSoft Tech Analyts' Corner: Nagarjuna Const: higher RoE BSEL Infrastructure Realty Ltd. from ICICI Just how big is China’s economy? Insight: Rediff’s second coming; ICICI Bank slips "Some say opportunity knocks only once. That is simply not true. Opportunity knocks all the time, but you have to be ready for it." - Louis L'Amour
Theme-based investing: A perspective
Source: Equitymaster.com
The markets continue to hit all-time highs, even as, at every rise, 'market experts' advise caution! As more and more FIIs buy into the India story, wanting to get a piece of the action, valuations keep on moving higher and higher. Consequently, finding value in stocks is becoming increasingly difficult. The large cap stocks seem richly valued at current levels (barring a select few) and it appears that most of the growth in the medium-term has been factored in.
In such heady times, where idea generation becomes more and more scarce and difficult, theme-based investing can make things a little easier for investors. In simple terms, theme-based investing means identifying a particular 'theme' in the country that is likely to become a strong growth story going forward, due to reasons such as increasing demand, favourable policy environment, nascent market to be tapped, and so on.
Examples of theme-based investing abound in the history of the Indian stock markets. Liberalisation, privatization, information technology, commodities and infrastructure are examples of major themes, based upon which the markets rallied in the past, of course, with the help of the FIIs.
This time around, it is the 'emerging markets' theme that has played out and continues to do so. This has actually been the major theme based upon which FIIs have poured in massive sums of money into the Indian stock markets and, for that matter, other emerging markets globally, like Taiwan and Korea. Of course, it must be noted that while this example is from the point of the view of the FIIs, on a retail basis, the theme could be sector specific.
Thus, one needs to first pick the theme that one likes and that one feels can deliver good growth over the medium to long term and then, of course, do the requisite stock picking. We believe that 2 themes have a strong chance of playing out over the next few years - 'domestic consumption' and 'outsourcing'.
Domestic consumption Given India's burgeoning middle class population, favourable demographics and increasing affluence, we believe that sectors that are focused on domestic-led consumption could benefit in future. Sectors that are expected to do well range from FMCG, two-wheelers, consumer durables, tractors, telecom, PCs and retailing. In fact, the rural market is highly untapped and this is undoubtedly where the future growth of India Inc. needs to come from if the country is to reach the next trajectory of growth.
To substantiate this with an example, in the telecom sector, India's cellular teledensity is just around 6.5% to 7%. Therefore, there is significant scope for growth. However, if we break this up between rural and urban areas, urban India's cellular teledensity is 32%, while that of rural India is just 1%! Thus, we believe that it is in the rural markets where the next phase of growth needs to come from, if India is to grow in a sustainable manner over the longer term.
Outsourcing India's attractiveness as an outsourcing destination is only too well known. Just ask techies in the US, UK and Europe! India's pre-eminent position in IT-BPO outsourcing is due to factors such as low labour costs, highly skilled engineering and management talent, enabling policy environment, mastery of the art of global delivery and execution excellence. Therefore, global Fortune 1000 companies and beyond are really looking very seriously at India for outsourcing/offshoring their work.
But while India's software exports story has been known for many years now, we believe that the time has come for India to stand up and be counted as a viable manufacturing destination as well. Of course, we need to ensure that we stick to our strengths. China has strengths in mass manufacturing, while India can carve a niche in higher-end products and design and development of products. Auto ancillaries, pharma and textiles are 3 major areas that have the potential to grow at an impressive pace in future and replicate the success of the software industry.
However... It must be noted that identifying a theme is easier said than done. Markets latch on to 'the next big thing' very quickly and very soon, the theme plays out. Investors must have the foresight to be able to identify themes. But then, the next step is equally important, if not, more so - that of stock picking. Investors in technology stocks were on the right track when they picked the theme (the fact that it turned out to be a huge bubble is another matter). But then, investors who went for stocks like Pentamedia Graphics and DSQ Software would have ended up losing most of their investments. This is because these kind of companies did not have stable and robust business models, unlike Infosys or Wipro, which is why they are still languishing at low stock prices.
The main point here is that, while theme-based investing is undoubtedly a good way to make money, one must first of all have the ability to spot a theme first that is likely to give good returns over a long period of time and then choose the right stocks that will benefit from this. If not, then relying on a good fund manager or research house would be the appropriate thing to do.
Are the bulls tired?
Source: Equitymaster.com
Considering this week’s behaviour, the one question that comes to mind is, are the bulls tired or is it just a temporary phase as they pause for breath before resuming their journey? Well, while we do not make any directional calls for the markets for the near-term, even if we were doing so, at the current juncture, we would have refrained from making any directional call. In fact, anybody who claims he can, is probably betting big on luck to support his call, as nobody knows what FIIs are going to do in the next week or month. However, what we can definitely say is that though investing at the current levels is froth with risks, as we find the markets to be fairly valued for the next 1 year at least, in the long-term, there are no second thoughts on the direction of the Indian stockmarkets. Though intense volatility could mark the market movements over the next few quarters, the long-term India story remains intact.
Thus, at the current juncture, the one good way to invest would be to invest in small quantities at pre-determined regular intervals in fundamentally sound stocks with some value still left in them. We know that investment ideas at the current levels are difficult to come by, but a little bit of hard work and extra research could help you recognise a few of them. This type of investing pattern would not only help an investor to be a part of the rally (if it continues), it would also protect him/her from over-exposing to equities at the current historic high levels and would thus protect him/her from getting severely hurt in the case of a correction. Moreover, even if a correction comes by, the investor would not have to worry on account of his fundamentally safe investments. Happy and safe investing!
Thursday, December 22, 2005
Interview of Mark Mobius
Where is investing guru Mark Mobius looking next? President of Templeton-Emerging Markets, Mark Mobius is regarded as the Indiana Jones of the industry. His home is a hotel room, he commutes by jet, his religion is his work. When Mobius talks, people usually listen in pindrop silence. Click here for the whole interview.
What's good enough for Buffett will do for us!
by David McEvan
"The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizeable declines nor become excited by sizeable advances. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored. He should never buy a stock because it has gone up or sell one because it has gone down. He would not be far wrong if this motto read more simply: Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop."
This is easy to forget. Unless you need to sell shares to raise cash in the next few weeks, it is not relevant what their price is. Far more important is the financial strength and management quality of the company. A good company will always survive and sometimes even prosper during the inevitable ups and downs of the economy.
Those who do not need to raise cash in the short term should keep in mind the good times that will inevitably return, while taking solace in the dividends good companies churn out year after year. Here is a passage from another book, The Warren Buffett Portfolio, by Robert Hagstrom.
"If we were to ask Buffett what he considers an ideal holding period, he would answer, `Forever' – so long as the company continues to generate above-average economics and management allocates the earnings of the company in a rational manner.
" `Inactivity strikes us as intelligent behaviour,' he explains. `Neither we nor most business managers would dream of feverishly trading highly profitable subsidiaries because a small move in the Federal Reserve's discount rate was predicted or because some Wall Street pundit has reversed his views on the market.' Why, then, should we behave differently with our minority positions in wonderful businesses?"
That is a key point – good investors buy businesses, not shares. All businesses have very profitable years and not so profitable years. The key number to the long-term investor is the return on their capital – shareholders' funds. If a company is generating a return that is better than other investment options such as cash, bonds or property then the investor should be happy to let the money sit there and grow.
Return on capital has nothing to do with the share price on any given day. Instead, it is a measure of how much is earned and poured back into the business – the real formula for success that share prices often fail to depict. It is measured by taking net profit as reported, and dividing that by shareholders' funds as shown in the balance sheet. Buffett has said if that ratio ends up being 15 per cent or higher, you have a real growth investment.
The share price is not that important. Your target should be to find good companies with reliable earnings that generate a return on equity of 15 per cent or more – without the weak balance sheet that can distort that number.
Random Readings
Click on the link to read the full story
"Those who do not study are only cattle dressed up in men's clothes." - John Pierpont Morgan
Wednesday, December 21, 2005
Better safe than sorry!
I read this small piece of information in one of the articles which I found very interesting:
"Investors were irrationally exuberant during the bubble years of 2000. And that's exactly why the shrewd market players today should be feeling confident. Look at it this way, "Six years ago we could do no wrong, and everything was possible in the world. Today everything seems exceedingly challenging. We were wrong six years ago. And I think we could very well be wrong today." In Stock Market, it most often pays not to follow the leader. No one wants to hear that. It's almost irresistible to believe that after all we investors have endured -- the hellish bear market, the recession, the scandals -- we've emerged from the crucible sadder but wiser, finally willing to face the truth about stock values. But it isn't so. The amazing reality is that we haven't learned our lesson even yet."
Though the above quotes are mainly related to US Markets, in Indian context, it may not be that relevant. But as an intelligent investor, with Sensex currently at 9000+ levels, utmost caution must be excercised while investing at these levels.
Here, a famous quote by Warren Buffett comes to my mind:
" Be fearful when others are greedy and greedy only when others are fearful."
So, let us better be safe than sorry!
More comments are welcome
Random Readings
Click on the link to read the full story
Indian organised retail to triple by 2010 - report
Foreigners own 30% of India Inc
Soaring input costs hang heavy on battery stocks underperform Sensex
The Compass: Wipro: A Logical move & Steel Prices
Analysts` corner: Petronet LNG
Stock watch: MTNL
All investors are Liars by John Allen Paulow
One pound of learning requires ten pounds of common sense to apply it.
Markets: Do stocks and cars have any relation?
Source: Equitymaster.com
Yes, because whenever an investor buys a stock, he is interested in how fast will it move up or reach the target price, and a similar situation arises when one buys a car - the buyer is only interested in how fast (in seconds) will the needle on the speedometer hit the 60 km/h mark, as it is the yardstick for measuring a car's performance. In both cases, the more time it takes, the lower is the rating given, be it a car or a stock. Also, in both these situations, the individual clearly misses out one vital thing.
In case of a crash or emergency, be it the stockmarkets or the road, how fast will the stock go down, and in case of a car, the buyer is not interested in knowing how much time will it take for his vehicle to come to a standstill, basically from 60 to 0 km/h.
One can also relate the stock markets to a traffic signal on the road. Aware as everyone is, there are 3 lights - red, yellow and green. In mid-2003, the markets were in the green mode, as we were entering the bull phase and if an investor put his hand in any stock, he soon realised that it doubled within a year. Then, as the markets gained momentum and reached new highs, we entered the yellow signal, wherein investors only with a high risk appetite could invest, as the upside seemed way less then the downside risk, and a similar situation happens on the road, as drivers who are cautious stop with the yellow light, while less cautious ones jump the signal, indicating their risk-taking ability (in case of cars, facing the cop). However, when the signal turns red, its time for everyone to stop, like in the stock markets, when they are overheated, its at least time for retail investors to take the back seat.
We had recently conducted a poll on our website, asking our viewers, that in the current bull run, in which segment had they made money, was it large, mid or small cap. The outcome was quite stiff - 50% said that they made money in small cap stocks, 24% made money in mid-cap, while the rest made in large cap stocks. With this outcome, we are sure that the passion for mid and small cap stocks amongst investors is not yet over and that they yet see potential in them.
Even we agree that opportunities exist everywhere, at every level for large cap stocks and even for select, fundamentally strong mid-cap stocks. But if one takes the trouble to go back in history, mid-cap stocks have been the first ones to be gunned down in case of any correction. But, as we wrote in the first paragraph of this article, people do not bother to check how fast is the downward run going to be in case of an event or correction.
Thus in conclusion, we do not say who is right or wrong, but ultimately, everything melts down to justifying valuations. Today, an institution might be ready to give a stock a P/E multiple of 20x its forward earnings, while a retail investor will be comfortable only with 15x its earnings going forward for the same period. Who in this case should we say is right? The thumb rule says that if a company's profits are growing at 15% YoY for a consistent period, it can be given a P/E multiple of 15x and if 20% then 20x and so on and so forth. However, one must keep in mind that there are other factors, like economy scenario, sector outlook and so on that also need to be clubbed in while projecting, and then arriving at a suitable valuation.
Tuesday, December 20, 2005
Random Readings
Click on the link to read the full story
Ranbaxy: Courting trouble & Welspun India
Patience is one of the rarest things on Dalal Street, which is why if you have it, you'll outperform those who don't.
The puzzle of ‘home bias’ in investing
by Shivaji Das/DNA Money
'Home bias' is a persistent and major puzzle in international finance. Studies have discovered that foreign equities account for a small proportion of investor's portfolio's in developed nations.
This is clearly puzzling since it seems that investors are shying away from chances to diversify their risk. However, a step in the unravelling of this puzzle has been offered from the field of neuroscience.
In a paper published in last week's Science, researchers led by Ming Hsu and Meghana Bhatt from California Institute of Technology, Pasadena, give us some idea of how the brain behaves when faced with risky choices—choices where the probabilities are clearly known such as investing in local stocks and ambiguous choices where the lack of information 'seems' to disallow one from having an idea of the odds.
The difference between risk and ambiguity is shown easily enough.
For example, imagine you have two decks of 100 cards each. The first deck has 50 blue cards and 50 red cards, while the second deck has the same two colours but in an unknown distribution. A card is picked randomly from both the decks.
Would you bet on the colour of the card from first deck or the second? The first deck signifies risk - you know the probabilities, the second deck signifies ambiguity - it may be possible that all the cards in that deck are of the same colour. Studies have found that people are far more willing to bet on risky outcomes than on ambiguous ones.
However, in the view of subjective probability theory, on which a lot of current risk aversion theories are based, there is no reason to choose the first deck over the other and therefore it should not affect your decision.
Why? Because as long as you are unbiased against the two options — red or blue — you are equally likely to say either, whatever the distribution of the colour in the pack. Hence, even if all the cards are of the same colour, you still only have a 50% chance of betting correctly. In the study, scientists monitored the brains of several volunteers who were given various decisional tasks to do. They found that when faced with an ambiguous choice and shortly before any choice was made, the emotional areas of the brain would become very active.
Moreover, the part of the brain that anticipates reward would become less active. It seemed that in the face of ambiguous choices, the heart was telling the individual what to do and at the same time the brain was bracing itself for a loss. This could be a possible explanation for the 'home bias': though logic dictates that we should be unbiased - that we should not distinguish between the two decks, in normal circumstances, we cannot help but act the way we do. Standard theories do not take into account that a person's brain behaves differently in the face of risk and ambiguity. "There is much more to risk aversion than decreasing marginal utility," explained Bhatt.
The study also found that people having lesions in the emotional areas of the brain in question (the amygdala and the orbitofrontal cortex) treat risky and ambiguous cases as the same and thus their abnormal behaviour is ironically consistent with subjective expected utility theory. Explaining the practical consequence of her work, Bhatt said, "The reluctance to hold foreign stocks amounts to a sacrifice in annual percentage return of one to two per cent per year, according to one estimate. Assuming an average unbiased return of 7%, a person with home bias who invests a lump sum at age 25 will end up with only half as much money at age 65 as an unbiased investor. It is nearly impossible to tease apart theories offered to explain home bias using field data alone. Our approach has the potential to differentiate among the possible explanations."
Mind over matter
Research paper shows how brains behave when confronted by risky choices
Though logic dictates that we should be unbiased, we're hardly so
When faced with ambiguous choices, emotions get the upper hand
Monday, December 19, 2005
Are There Experts in Investing?
Experts and Markets
Overall, the evidence suggests there is little benefit to expertise . . . Surprisingly, I could find no studies that showed an important advantage for expertise. - J. Scott Armstrong, The Seer-Sucker Theory: The Value of Experts in Forecasting
Given that the stock market is a probabilistic, high-degree-of-freedom domain and the poor aggregate performance of active investment managers, there seems little reason to look for investing experts. However, a handful of distinguished investors have established excellent long-term records, which holds hope for expertise in investing.Economist Burt Malkiel says it this way:
While it is abundantly clear that the pros do not consistently beat the averages, I must admit that there are exceptions to the rule of the efficient market. Well, a few. While the preponderance of statistical evidence supports the view that market efficiency is high, some gremlins are lurking about that harry the efficient-market theory and make it impossible for anyone to state that the theory is conclusively demonstrated.
Since we don’t yet understand all the issues around expertise and have yet to study successful investors in great detail, our conclusion that there are expert investors is tentative. However, it does not appear expert-investor skill sets are transferable.
Here are some of the characteristics expert investors share:
• Successful investors put in plenty of deliberate practice.
In investing, this generally means lots of time reading, often across diverse fields. For example, the highly-regarded head of GEICO’s
investments, Lou Simpson, says, “I’d say I try to read at least five to eight hours per day. I read a lot of different things . . .” Berkshire Hathaway’s Charlie Munger makes the point more emphatically, “In my whole life, I have known no wise people (over a broad subject matter area) who didn't read all the time—none, zero. You'd be amazed at how much
• Great investors conceptualize problems differently than other investors.
As a group, these experts go beyond the near-term obvious issues, can identify relevant principles because of their experience, and see meaningful trends. These investors don’t succeed by accessing better information; they succeed by using the information differently than others. As an illustration, star investor and Sears Holdings chairman Eddie Lampert carefully studied Warren Buffett’s past investments to understand the logic. By reading annual reports in years preceding Buffett deals, Lampert sought to reverse engineer Buffett’s thought process. In a Business Week article, Lampert noted, "Putting myself in his shoes at that time, could I understand why he made the investments? That was part of my learning process."
• Long-term investment success requires mental flexibility.
Just as markets constantly evolve, so too must investors. Further, expert investors possess the second type of flexibility—an ability to
recognize when their easily-accessible mental models no longer apply. This recognition requires a return to basic principles to think carefully about a topic.
Bill Miller’s investment-process evolution is a good case:
The [conventional value investing] approach that had been so successful for us . . . had serious shortcomings when the economy peaked and began to head down. I decided to see if the academic literature offered any insights into how we might improve our investment process. After reviewing the data . . . it became clear that the conventional wisdom about value investing was wrong. Our experience in the late 1980’s and the changes we implemented in our process allowed us to sidestep that [performance] pothole in the late 1990s.
• Not pattern recognition but process recognition.
As scientist Norman Johnson notes, in complex systems an expert can create a mental simulation, fueled by diverse information. An idea or
problem solution emerges from the simulation, leaving the expert unable to explain how he or she arrived at the solution. 23 A colleague’s description of legendary hedge fund manager George
Soros makes this point:
[
The research on expertise is ambiguous on how much of expertise we can attribute to innate characteristics versus deliberate practice. For example, Ericsson and Smith report, “the research approach of accounting for outstanding and superior performance in terms of general inherited characteristics has largely been unsuccessful in identifying strong and replicable relations.” 25 Our view, in contrast, is there is clearly a hard-wired element to investing success. That most investors with outstanding long-term records share a similar personality profile supports this view.
Summary
Some skepticism about the value of experts is clearly warranted. An expert’s ability to solve a problem appears largely dependent on the problem type. Computers tend to solve simple problems better, and cheaper, than experts, while collectives outperform experts for complex problems.
Till the dividends come home
by Haresh Soneji/ Economic Times
The dividend yield ratio is computed by dividing the annual dividend per share with the current stock price of the company. So, if the annual dividend yield is around 10%, it means that you get Rs 10 on every Rs 100 you spend buying the stock.
This implies that as the stock price rises, its dividend yield declines and the same stands true the other way round too. So, at this point in time, as share prices seem to be moving largely up, dividend yield is on its way down.
In a falling market, however, shares of dividend-paying companies become attractive in terms of dividend yield. These stocks are likely to outperform the market when things don’t look great in the equity market. And the good news is that a surprising number of companies in India have been consistent dividend payers even through in times when equity markets are bearish.
So, a small retail investor with a low risk profile can enter into companies with a high dividend yield ratio. Small retail investors, who are primarily long-term players, value high dividend yields. These investors bite this bait as nothing could be a more credible way of knowing a company’s position than to see it give dividend cheques to shareholders. In India, the dividend yield of leading stocks has fallen over the past three years because of the continued bull run.
Dividend yield, per se, is not a useful investment tool. At best, it could help identify a set of stocks from which one could pick and choose. So, buying into a company based purely on the dividend yield ratio may be futile. Strong cash flows are the key. The ideal dividend payer is a company in a net cash position operating a business that does not need a lot of capital reinvestment.
While profits can be cooked up, sales vouchers fudged, dividend cheques have to be paid. No wonder, the 100-year quote of John D Rockefeller, one of America’s richest men, echoes the sentiment even today. He said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”
Also, taking a call on whether to buy or not depends much on the investment horizon as it is about the nature of business and the company’s business model. But, picking a good dividend stock isn’t only about the yield. Investors need to take into account the growth prospects of the business, the overall investment environment and the potential movements of the share price. The ideal combination is a stock that pays dividends and is also seen as a growth play.
During uncertain economic times, steady payers can rise rapidly in price, trimming dividend yields. Investors typically seek shelter in utilities, for example, in a bear market.
The most consistent dividend payers, despite being historically stable companies, are still subject to the vagaries of the market, especially if they operate in volatile economies. They are not nearly as risk-free as bank deposits. The prudent approach is to construct a diversified portfolio, with dividend payers at the core and growth stocks, bonds and cash deposits at the periphery.
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Understanding financial statements-III
Saturday, December 17, 2005
Random Readings
Click on the link to read the full story Beware Of Too Much Diversification 'Herd mentality of FIIs can destabilise markets'
Re overvalued 7.6%, says RBI
Bharati Shipyard: Sailing smooth
Thomas Cook & Midcaps
Paying for infrastructure
Looking at 2006 - India: Borrowing from the Future - by Morgan Stanley
Open, free markets are antithesis of violence: Greenspan
Shimmering metal(Aluminium) & Thomas Cook
Lasting Bubbles
Source: Morgan Stanley
Even though the current business cycle is old, the policy environment is still stimulative. US interest rates have yet to reach the neutral zone. The euro zone’s real interest rate is still near zero. Japan has not begun to tighten. As a result, global money supply remains ahead of GDP growth.
Globalization of manufacturing has allowed the major central banks to maintain stimulus. The price elasticity of the global supply curve has increased sharply due to the entry of China and other emerging economies into the global supply chain. Hence, inflation reacts much more slowly in response to money supply than before.
Instead, the excessive money supply has flowed into asset markets, which has stimulated demand by inflating asset prices. In that regard, the globalization of capital flows has played a vital role. The rise of the hedge fund industry has fundamentally changed how risks are priced. As this industry is compensated on annual performance, the future is increasingly irrelevant to risk pricing. The low risk premium everywhere has made borrowing much easier than before.
The easier borrowing terms have led to a global property boom that is at the heart of demand creation. In the US, consumption demand depends on borrowing against rising property prices. In China, investment demand depends on property construction and hence high property prices.
We estimate that the global asset bubble, mainly in property, may amount to US$15 trillion, which would make it the biggest bubble in history. However, players in the global financial markets are not scared, as there is a belief that the central banks will not burst the bubble. Hence risk premiums are kept low, sustaining the bubble. There is a self-reinforcing relationship between the central banks and hedge funds, which is sustaining global GDP growth despite the existence of imbalances and structural fragilities.
Risks
Bubbles burst when they are least expected to. In 1990, the bookstores in the US were full of books on Japan’s different but more effective economic model. In 1996, the World Bank had just come out with a study on the ‘East Asian Miracle’. In 2000, several large funds threw away their long-held skepticism on the tech story and bought NASDAQ. History is full of examples of those who thought bubbles would last forever.
The current bubble, just as previous ones, will burst unexpectedly, in our view. As long as inflation remains low, the central banks are unlikely to burst it by tightening. Considering the extent of overcapacity in China, it is difficult to imagine that inflation will get out hand. Hence, we would expect the burst to be triggered by a shock, probably due to internal fragilities in emerging economies.
China and India, the two countries at the centre of the current bubble, look the most vulnerable. China has invested its export income unproductively, creating overcapacity and empty buildings. China’s investment demand is based on excessive optimism about the future. ‘Build first and they will come’ has been taken to the extreme. History tells us that such optimism often turns suddenly to pessimism. Should this happen, asset prices could fall precipitously, leading to a demand crash.
India depends on capital inflow to fund its consumption-led growth, like a poorer version of the US. However, the optimism felt towards an emerging economy can be fickle. As US interest rates rise and the optimism becomes more expensive to maintain, sentiment could turn quickly, leading to devaluation and rising real interest rates. We see India as a candidate to experience the kind of capital flight that hit Southeast Asia in 1996.
While we expect moderate deceleration in the coming year, it is important for investors to mind the risks. When sentiment towards China or India turns negative, we think investors should rapidly decrease the beta in their portfolios.
‘Believe’ is okay. ‘Be prepared to run’ is vital.
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