moat analysis framework

How to Check if a Moat Exist? (Moat Analysis Framework)

A quick Moat Analysis Framework for beginners: It is quite strange that a medieval defense strategy employed in the fortifications of forts in England has come to occupy such a central stage in value investing stock analysis.

Come to think of it, if you could picture England as a giant castle and The English Channel as the surrounding moat, you could quickly deduce that once England united the other nations on its island there would be few world powers who could launch massive territorial conquest on its shores especially since amphibious operations always tend to favour the defending side. (Perhaps this enabled them to  expand their empire since not much needed to be done on homeland security front).

As explained in our posts before, Moats are long-lasting competitive advantages a company might have owing to its business model that enable it to resist the onslaught of competition for a great number of years.

Also read: What is an Economic MOAT and Why it’s Worth Investigating?

The Evolution of Moat

In the period around 1950-1960, when great companies such as Walmart and Nike were still startups, the greatest struggle the entrepreneurs faced was the problem of securing a starting capital. Most of the times business in that time had to open a line of credit from banks but the problem was that the banks were highly regulated and only were willing to lend to those companies which had already established their operations and achieved some reasonable scale to their businesses. This gave an advantage to existing businesses since the system stifled the growth and emergence of new competitors.

Come the 70s, the world began to see the rise of venture capital and private equity firms namely Sequoia and Carlyle in the US. These companies were able to pool in money from investors and redirect them to fund the capital of emerging entrepreneurs of Silicon Valley and elsewhere.

In time (that is the last 4 decades), the high capital requirement as a barrier to entry has steadily eroded away and have enabled upstarts and disruptors to challenge incumbent businesses across different sectors.

The other trend (which will get even more relevant in the future) has been the evolution of technology at breakneck speed which has fundamentally brought down the cost of entry into many businesses at the cost of well-established firms.

Since companies face a greater risk to their business models now more than ever, it has become imperative for investors to select the companies with the most resilient business models for their portfolio. Only then it is possible for investors to generate steady returns without painful volatility.

The process of finding moats can be quite arduous and confusing for investors who are starting out, especially when a lot of companies seem to be running profitable operations for extended periods even without any apparent moat. Although moats often come in various forms and sizes, it may sometimes be very difficult to identify and to judge their quality for many companies. In such a scenario it helps to have a decision-making framework to act as a force multiplier in the investor’s toolkit.

Also read: SWOT Analysis for Stocks: A Simple Yet Effective Study Tool.

Moat Analysis Framework

The following moat analysis framework should provide a good starting point for our readers in their analysis. You may feel free to develop this into a more comprehensive and robust framework based on your experiences and understanding of different industrial sectors.

(Please note the framework was developed by Ensemble Capital, an asset management company in the US, it draws greatly from the experiences of the firm’s analysts and books including “The little book that builds wealth” by Pat Dorsey and The Investment Checklist by Michael Shearn)

moat analysis framework

(Source: Intrinsic Investing)

August 29, 2018 Investment Basics No comments yet
enterprise value and equity value examples

A Complete Guide on Enterprise Value and Equity Value.

Enterprise Value and Equity Value are two terms that have confused investors and sometimes professionals alike through the years. In this post, I shall try to clear some air on both the terms and help our readers figure out the one they need to use during their analysis of companies.

Here are the topics that we will cover in this post:

  1. Who are the different stakeholders in a firm?
  2. What is the level of risk associated with the level of ownership?
  3. What is Enterprise Value and Equity Value and how are they calculated?
  4. Enterprise Value and Equity Value Multiples
  5. Methods of analysis using Enterprise Value and Equity Value
  6. Closing thoughts

On a broad level, this will be long, but an easy read and we would really appreciate that our readers leave comments in case of any doubts.

1. Who are the different stakeholders in a firm?

To understand the concept of Enterprise Value and Equity Value, it would first be necessary to understand the different players in the capital markets and their claims on a company’s capital and income.

To understand this, picture a company like a big country with different religious and social groups with each group seeking to pursue their own interest but somehow still manage to operate under the common banner of a company.

These interest groups from the perspective of a company include those who have contributed capital to the firm. Since a company can generate capital from debt and equity the top-level classification of the mentioned interest groups comprises of Debt Holders and Equity Holders

Note that the two groups can be further divided into subgroups depending on the priorities of each subgroup.

Also read: Shareholding Pattern- Things that you need to know

2. What is the level of risk and return associated with the level of ownership?

In corporate finance, when an asset is sold the debt holders get a priority to the funds generated from the sale and then the different classes of equity holders.

Since debt holders normally take fixed payments at the regular periods regardless of the profit-generating capacity of a company, their position tends to be the one of minimum risk in the company’s capital structure.

The equity holders, on the other hand, get dividends only when the company makes a profit (in most cases) and also happen to pledge their money as owners of the firm without the promise of returns. This makes their position the riskiest within the capital structure.

The below infographic should summarise the relationship between capital and relevant risk and payments for different equity and debt holders.

Enterprise Value and Equity Value 1

3. What is Enterprise Value and Equity Value and how are they calculated?

Now to address the crux of this post, assume that a big financial investor wants to buy a company. Let us say he wants to get 100% control of the firm and also 100% of the earnings generated by the firm.

To achieve the first goal, he would just have to buy the stakes of equity holders of the firm, these equity holders could include the Minority Interest, the Preferred Shareholders, and the Common Shareholders. The money the buyer would have to expend to acquire the complete equity of all the above-mentioned groups is what is known as the Equity Value.

Now since the equity holders are of the picture, the buyer now turns his eyes towards the debt holders. To make the debt holders give up claims to the company’s earnings (in the form of interest and principal payments), our buyer would have to pay them cash equivalent to the debt they hold in the company. A lot of the times, the buyers use the cash and cash equivalents of the company they bought to pay off the debt outstanding on the balance sheet. In finance, the term used for the is called the Net Debt.

Net Debt = Total Debt – Cash and Cash Equivalents

And further, the formula for Enterprise value becomes

Enterprise value = Equity Value + Net Debt

Enterprise Value and Equity Value 2

Assuming the company has also got minority interest, preferred shareholders and affiliates/associates the formula gets modified as

Enterprise Value  = Equity Value + Preferred Shares + Minority Interests – Value of Associates + Net debt

4. What are the Enterprise Value and Equity Value multiples?

The key difference between Enterprise Value and Equity Value is the inclusion of the Net Debt figure in the calculation. So when we think of multiples only terms which have the payments related to debt (interest) should be included with Enterprise Value and the metrics devoid of debt payments (interest) should be included with Equity Value.

The following figure should give the summary of the financial statement components used with both Enterprise Value and Equity Value.

As mentioned earlier, please note in the income statement that all metrics which include interest is included with the Enterprise Value calculation.

Enterprise Value and Equity Value 3

The corresponding ratios are summarised in the following figure

Enterprise Value and Equity Value 4

5. Methods of analysis using Enterprise Value and Equity Value

The multiples of Enterprise Value and Equity Value can be used extensively in the valuation analysis of a company. The two methods of valuation that are commonly used are relative valuation and historical valuation.

The limitation of using the relative valuation method is that during the period of elevated valuations- during a bull market all our comparable companies may be trading at a premium, this may sometimes make our target company seem cheap when it is only less expensive.

Similarly, during periods of depressed valuations, our target company may look expensive compared to our comparables when it is actually only slightly less cheap.

Also read: Why Warren Buffet Suggests- ‘Price Is What You Pay, Value Is What You Get’?

6. Closing thoughts

Although a lot of retail investors do not use Enterprise Value multiples in their valuations to could be useful to do so since the resulting valuations are inclusive of the leverage the companies have employed in their business activities.

In case retail investors find the concept of Enterprise value confusing, it should not deter them from performing a good analysis of companies if they use other leverage evaluation methods in their research and analysis process.

We hope our readers continue to embrace an objective approach to their valuation processes while performing stringent quality checks on the stocks they invest in. Happy Investing.

August 27, 2018 Valuations No comments yet
Ways to Save for Your Retirement

3 Simple Steps to Save for Your Retirement.

3 Simple Steps to Save for Your Retirement:

What you earn, i.e. your income is centered, mostly, when it comes to “how much you actually need when you get retired”.  But, are you really sure that the math used here is all correct? I am not.

Suppose if you draw a hefty sum from where you work (monthly) but barely manage to save a dime out of it; would you retire rich? I guess not.

On the other hand, if you get to save even a 30% (roughly) of whatever that you earn in a month, you’d definitely be at a much better place than the former you, right? So, the math here needs to be shifted to “savings and expenditure” and not on the overall income.

You’d be surprised to know that still many are sticking to the former notions of 70% of the income but yes, there are loopholes:

  1. You wouldn’t want to get through an entirely miserable young age just to retire rich, would you? – That, sometimes, becomes the case when you try to save 70% of your income.
  2. You are certainly not including the notion of current taxes and increasing health expenses as and when you grow up.

Strategically, therefore, the 70% rule is a decorated bubble. The question is how much do you actually need in order to retire rich? Let’s answer this question carefully in this article.

3 Simple Steps to Save for Your Retirement:

1. When Should You Start Saving?

The best answer to this question would be: “as soon as possible”. You are 21, well and good! 31? It is still not too late to start. You can always jump start your emergency funds whenever you want to. However, being consistent is the only key.

The best part about starting early is the “power of compound interest” even on low proportions of monthly savings. You can save as less as 5000 INR a month and see a huge difference years later.

However, if you are in your 30s or 40s, don’t worry; cutting back on a couple of things would work well for you to get you a feasible retirement fund. As we mentioned, the power of compound interest on your savings, you need to take your picks on where you should invest your money.

Fixed Deposits, Mutual Funds, or SIP? Different people have different priorities based on their own risk-taking capabilities. Choose your own option!

Also read: What are Assets and Liabilities? A simple explanation.

2. Ask for a Raise:

If you are confused what does it have to do with your retirement savings fund, wait up? We have an answer for you: The net sum of income you earn in your first decade of working makes much more impact on your net total of emergency or retirement fund.

Asking for a raise would balance out the money going directly from your bank account to your savings account. In the best scenarios, you could use the raised amount to go into your retirement fund (fully or partially) which would act as an extra cash for you in future.

Research says that about 37% of the employees who get a significant raise annually are those who ask for it. So, the next time, don’t wait up until the annual records of employees are checked but ask for the raise whenever you feel necessary.

When should you ask for a raise?

Honestly, there’s no strict rule for the same. But if you are asking for the possible options then it could be one of those times whenever you have successfully completed a project or have brought a fruitful result for the business you are working for.

3. Does Fixed Deposit always Work?

According to traditional sayings, you should focus more on keeping your savings in a fixed deposit. These days, it is quite controversial to choose where to put all your stakes on?

The greatest advantage that a fixed deposit offers is that it can be unsealed quite easily in case of an emergency. When you choose any other option to put your money into savings, you don’t actually get this leverage. Moreover, you might have to pay an extra unnecessary sum in order to unseal your deposit in case of emergency. True.

However, the rate of interest provided on a fixed deposit is very, very low. In fact, it is incomparable to other means such as mutual funds. Viewing the other side of the coin, mutual funds investments can be quite risky. They are subject to the market risks and what not.

Also read: Where Should You Invest Your Money?

What is the best way to invest then?

Now, the correct way is to break your proportions into pieces and put them into different means such as fixed deposits, stocks, mutual funds, real estate etc. There is no compulsion or a set of predefined rules to govern the context of retirement savings.

The magic lies in the way how you balance your savings and lifestyle.

August 26, 2018 Personal Finance, Save money No comments yet
what is inflation

What is Inflation and Why you should care?

What is Inflation and Why you should care?

Our grandparents would like to reminisce about the days when they used to buy movie tickets for Rs 5-10. Nowadays it will cost you near Rs 200. In near future, it might be double. The simplest explanation for this increase in prices is- ‘Inflation’.

There have been a number of debates on the topic whether inflation is good or bad for an economy. However, before we discuss this complex question, first you need to understand what actually is inflation.

In this post, we are going to discuss what is inflation and why you should care about it. Here are the topics that we will cover today-

  1. What is Inflation?
  2. What causes Inflation?
  3. Effects of Inflation.
  4. An extreme case of Inflation
  5. Inflation in India.
  6. How is Inflation calculated?
  7. Bottom line

Overall, it’s going to be a very interesting post. Without wasting any further time, let’s get started.

1. What is Inflation?

Inflation is nothing but an increase in the general price of goods and services. It is measured as an annual percentage increase. Inflation can also be defined as the decline in the purchasing power of the currency. In general, a two percent increase in inflation shows a healthy economy.

inflation example

2. What Cause Inflation?

There are plenty of reasons which causes inflation, depending upon the location, type of economy, the status of government in terms of power and influence, and many other different factors. However, broadly here are the factors that are primarily responsible for causing inflation.

  • Problems with Supply

Inconsistency with growth in agriculture due to climate change or a natural disaster like flood, draught can hamper the supply to make the product. Inadequate growth of industry can also lead to less production of supply which ultimately leads to an increase in prices for manufacturing products. And hence price increases.

  • Problems with Demand

This is caused when an overall increase in demand for goods and services, which bids up their prices. It’s like too much money chasing too few goods. This usually occurs in rapidly growing economies. So, when there is more money circulation in the market that can cause inflation.

  • Problems with raw materials

Not all raw materials are produced in one country. In the era of globalization, we depend on many countries for the supply of raw material. So, if the prices of a commodity which we import from other parts of the world increases then it leads to an increase in the prices of the product that is made from it. For example- if the price of oil or corn increase that makes high prices of products that relies on that material.

  • Monetary Policies

In some case when central banks govern interest rates, then demand for services can either increase or decrease giving an invitation to Inflation.

3. What are the effects of Inflation?

Here are few of the major effects of Inflation in a country-

1. Cost-push inflation: High inflation can promote employees to demand rapid wage increases, to keep up with consumer prices. In this theory of inflation, rising wages fuel inflation. In a sense, inflation generates further inflationary expectations, which generate further inflation.

2. Hoarding: People buy durable and/or non-perishable commodities and other goods as stores of wealth, to avoid the losses expected from the declining purchasing power of money, creating shortages of the hoarded goods.

3. Social unrest and revolts: Inflation can lead to massive demonstrations and revolutions.

4. Hyperinflation: If inflation becomes too high, it can cause people to severely curtail their use of the currency, leading to an acceleration in the inflation rate. Hyperinflation can lead to the abandonment of the use of the country’s currency

5. Allocative efficiency: A change in the supply or demand for a goodwill normally cause its relative price to change, signaling the buyers and sellers that they should re-allocate resources in response to the new market conditions. But when prices are constantly changing due to inflation, some agents are slow to respond to them. This results in a loss of allocative efficiency.

6. Shoe leather cost: High inflation increases the opportunity cost of holding cash balances and can induce people to hold a greater portion of their assets in interest paying accounts. However, since cash is still needed to carry out transactions this means that more “trips to the bank” are necessary to make withdrawals, proverbially wearing out the “shoe leather” with each trip.

7. Menu costs: With high inflation, firms must change their prices often to keep up with economy-wide changes. Changing prices is itself a costly activity as it will lead to the need of printing new menus, or the extra time and effort needed to change prices constantly.

4. An Extreme case of Inflation-

In 2008, Zimbabwe had the second highest incidence of hyperinflation on record. The estimated inflation rate for Nov 2008 was 79,600,000,000%.

zimbabwe hyper inflation rate

The daily inflation rate of 98.0%. Roughly every day, prices would double. It was also a time of real hardship and poverty, with an unemployment rate of close to 80%.

Also read: #3 Best Ways To Save Money- That 90% People Are Not Using.

5. Inflation in India-

The situation in India has far been stable as far as the inflation rate is considered. Here is the inflation rate in India for the past few years:

Quick Note: The above statistic shows the inflation rate in India from 2012 to 2017, with projections up until 2022. The inflation rate is calculated using the price increase of a defined product basket. This product basket contains products and services, on which the average consumer spends money throughout the year. They include expenses for groceries, clothes, rent, power, telecommunications, recreational activities and raw materials (e.g. gas, oil), as well as federal fees and taxes. (Source: Statista)

6. How is Inflation calculated?

Part1: Finding Essential Inflation Information

1. Look up the average prices of the several products across a few years: – Inflation is calculated by comparing prices of standard goods across time.

2. Load the Consumer Price Index: – This is a breakdown, by month and year, of the changes in inflation based off of the averages mentioned in step 1. Any time the CPI is higher than the current month, it means there has been inflation. If it is lower, then there has been deflation. Inflation is calculated with the same formula in each country. Make sure the same currency is being used for all numbers in the calculation.

3. Choose the period of time for which inflation will be calculated: –Months, years, or decades can be used. 

Part 2 Calculating Inflation

1. Learn the Inflation Rate Formula. This formula is simple. The “top” find the difference in the CPI (rate of inflation), the bottom finds out what ratio of the total inflation that difference represents.

2. Plug the data into the formula. For example, imagine that we are calculating the inflation based on the price of bread between 2010 and 2012. Assume the price of bread in 2012 is $3.67 and the price of bread in 2010 is $3.25.

Inflation calculation 2

3. Simplify the problem through an order of operations. Solve for the difference in price, then divide it. Multiply the outcome by 100 to get a percentage. Here, the inflation rate is 11.4%

4. Know how to read inflation. This percentage means that, in current time, your money is worth about 11.4% less in today’s dollars than they were in 2010. In other words, most products cost on average, 11.4% more than they did in 2010. If the answer is a negative number then it is deflation, where a scarcity of cash makes money more valuable, not less, over time. Use the formula just as in case of a positive figure.

Also read: The Best Ever Solution to Save Money for Salaried Employees

7. Bottom line:

Most people complain about the fact that prices of the day-to-day products are increasing too fast. However, they ignore the part that their salaries are also increasing at a similar pace.

Moreover, a little inflation can be sometimes as dangerous as a high inflation. In other words, a modest inflation is always a good sign as it reflects the growing economy of the country. However, the problem arises when the inflation is rising too fast when compared to your wages.

August 24, 2018 Personal Finance No comments yet
How to use Treasury Stock Method to Calculate Diluted Share stocks

How to use Treasury Stock Method to Calculate Diluted Shares?

How to use the Treasury Stock Method to Calculate Diluted Shares?

Hi Investors. We earlier published an article detailing how dilution affects our ownership position in the company and how it affects the calculations for PE ratio and Earnings Yield ( 1/ PE). (You can read that article here: How Dilution Affects the Company’s Valuation?)

In this post, we will cover how employee stock options are converted into common stock and learn how to calculate the incremental contribution to a number of outstanding shares (NOSH). 

Here are the topics that we will discuss today:

  1. Why stock options?
  2. What is the common term associated with stock options?
  3. Main kinds of stock options given to employees and management?
  4. What is the treasury stock method and why is it called so?
  5. Closing thoughts – the good, the bad and the ugly

It’s going to a little lengthier post. However, it will definitely be worth reading if you want to learn the dilution basics. So, let’s get started.

1. Why stock options?

Companies are increasingly rewarding their employees using stock options this provides multiple benefits:

  1. It helps align the management actions in line with the interests of the shareholders or better said managers of a business become shareholders themselves and are rewarded when their decisions in the operating activities deliver value to the shareholders
  2. Employees and managers who are rewarded stock options get the twin benefit of capital appreciation of the stock in the market and also of the lower capital gains tax for investments held over the period of 1 year.

2. What are the common terms associated with stock options?

Although there are a lot of terms we may come across when we read about stock options, almost always it will suffice to know just the meaning and relevance of a handful of terms when assessing options. Some of the most relevant that we feel will be useful for our readers are as follows:

  • Issue date: this corresponds to the date on which the underlying stock option was issued to the holder
  • Exercise date: represents the date on which the holder of the stock gains the right to exercise the option
  • Exercise price: represents the minimum price required to be attained by the shares of the company before the options can be converted into common stocks
  • Vested and non-vested shares: When a stock option is owned by an individual and he/she retains the right to exercise them when they wish so, the option is said to be vested. Non-vested shares options, on the other hand, represent those which are still owned by the company and the transfer of ownership to the individual hasn’t occurred yet.
  • In-the-money / out-the-money: When the trading price of a stock above the exercise price of the option is then said to be the in-the-money option, while it is said to out-the-money when the share price is below the exercise price (and then rendering the exercising such options useless).

3. What are the main kinds of stock options given to employees and management?

In most annual reports investors may come across different types of stock options, the common ones are (but not limited to) ESOPs or employee stock options, Restricted Stock Units (RSUs), Performance Stock Units (PSUs).

Employee Stock Options (ESOPs)

In almost all cases these represent the options offered to individuals by companies as a part of their equity compensation plans. These are usually reported by companies with relevant details like issue date, exercise date, the and exercise price. The primary catch for the employees here is that their options do not become exercisable unless and until the stock price of the company trades above the mentioned exercise price

Restricted Stock Shares (RSSs)

These are awards that entitle individuals to ownership rights to a company’s stock. Normally, these are subject to restrictions with regard to the sale of the stock or option until they become vested. The vesting event is determined by minimum service or performance conditions set by the company for the employee. However, during the restricted period, the individuals may have voting rights and the right to the dividends owed to restricted shares.

Performance Stock Shares (PSSs)

Performance Stock Shares are restricted stock shares that vest upon the achievement of performance conditions specified by the company. These shares are generally subject to sale restrictions and/or risk of forfeiture until a specific performance measurement is satisfied. Performance measurements are set by your company. During the restricted period you may have voting rights and the right to dividends paid on the restricted shares, which may be paid to you in cash or may be reinvested in additional performance shares. Once vested, the performance shares are usually no longer subject to restriction.

Also read: #19 Most Important Financial Ratios for Investors

4. What is the treasury stock method and why is it called so?

The most commonly used method within the finance industry to calculate the net additional shares (from exercising the in-the-money options and warrants) is the treasury stock method (TSM).

Here, it is important to note that the TSM makes an assumption that the proceeds the company receives from in-the-money option exercises are subsequently used to repurchase common shares in the market. Repurchasing those shares turns them into shares held in the company’s treasury, hence the eponymous title.

Implementing the treasury stock method

The broad assumptions in the TSM are as follows. Firstly, it assumes that the options and warrants are exercised at the start of the reporting period and that a company uses the proceeds to purchase common shares at the average market price during the period. This is clearly implied within the TSM formula.

Treasury stock method formula:

Additional shares outstanding = Shares from exercise – repurchased shares

Additional shares outstanding -Treasury stock method

Example:

Imagine a scenario where a company has an outstanding total of in-the-money options and warrants for 15,000 shares. Assume that the exercise price of each of these options is around ₹400. The average market price of the stock, however, for the reporting period is ₹550.

Assuming all the options and warrants outstanding are exercised, the company will generate 15,000 x ₹400 = ₹60,000 in proceeds. Using these proceeds, the company can buy ₹6,000,000 / ₹550 = ~10909 shares at the average market price. Thus, the net increase in shares outstanding is 15,000 – 10,909 = 4,091 shares.

This can also be found by simply using the last formula provided above. The net increase in shares outstanding is 15,000 (1 – 400/550) = 4,091.

Also read: How to read financial statements of a company?

5.Closing thought:  The Good, The Bad and The Ugly

Although options can be a force used for good as described at the beginning of this post it is not always a very innocuous tool. Since almost always, options are more complicated than cash payments there arises a potential for companies to manipulative the rewarding scheme to incentivize the management too much (beyond what is considered acceptable) at the expense of the shareholders.

Another problem can sometimes arise when a firm holds options or convertible debt offerings in another publicly traded company, there have been cases in the stock market history where such firms have gained majority control in the publicly traded company and subsequently initiated multiple activist campaigns against the management and in extreme cases have ended up owning the company entirely (a lot of the times at the expense of minority shareholders).

An argument which is sometimes overseen but nonetheless is credible when understanding options are that options incentive management to undertake risky decisions. These could sometime come in the ugly form of management cutting corners to influence the stock prices in the short term so that the options they hold may become exercisable. It is also not uncommon to see situations where management undertakes short-term risks that may eventually outweigh long-term gains for the shareholders.

In view of the above scenarios, a retail investor when assessing companies should look at the state of the options and the rewarding schemes when studying the management of their target company. Normally the two main things an investor needs to look for to be able to make a reasonably informed judgment include the following:

  1. The period for the options are awarded: here longer is better, something more than 3 years should be considered as satisfactory
  2. The number of options which are awarded: make sure that excessive amounts in addition to the existing cash packages are not paid out to the management and employees unless deserved.

That’s all for this post. I hope it was useful to the readers. Happy Investing.

August 24, 2018 Valuations 1 comment
Is it the Right Time to Invest in Indian Share Market

Is it the Right Time to Invest in Indian Share Market?

Is it the right time to invest in Indian share market?

Yesterday, Sensex and nifty made its fresh lifetime highs. The Nifty managed to hit 11,500 for the first time ever, while the Sensex comfortably traded above 38,000-mark.

Those who have already invested in the market are enjoying the sweet ride. However, for the beginners- the situation is quite confusing. The big question for them is- Is it the right time to invest in Indian share market? Whether you should start investing in stocks now or should you wait. 

Sensex

In this post, we will answer the question of what is the right to invest in the Indian share market. Let’s get started.

Is it the right time to invest in Indian share market?

Is it the right time to invest in Indian share market?- This question has been asked again and again whenever the market makes a new high (or low). When the market is high, people would want to wait for some correction assuming that the indexes will fall in upcoming days. On the other hand, when it is low, people will expect that the market might go down further. So, in both the situation- people will are confused whether it is the right time to invest or not.

Nevertheless, bulls and bears are part of the market of the market. Even when the market moves sideways, people can argue that there’s not much happening in the market, and hence not a good idea to invest right now.

– Timing the market is really difficult. Especially, for the beginners.

Even for the seasoned investors, timing the market precisely and consistently is not possible. Buying at the lowermost price and selling at the topmost is an investing myth. You can only define a buying or selling zone, not the precise point.

buy low sell high

In short, you’ll never be able to find the best time to enter the stock market. The best approach here is to just get started. Maybe start small and increase your investment with time when the valuation is cheaper.

– Time in the market is more important than timing the market.

Time in the market is always more important than timing the market. Let’s assume that you’ve invested in a stock at Rs 150 and ten years later it appreciated to Rs 1,000. Here, it won’t matter much whether you bought that stock at Rs 120 or Rs 180 as long as the profits are decent. Because you stayed invested for a long time, the power of compounding worked in your favor. However, if you try to time the stock exactly at the bottom- it might be possible that you never invested in that stock at all.

– Invest in companies, not in the share market.

Until and unless you are investing in the index fund, it doesn’t matter much whether Sensex/nifty is high or low.

There are lots of good opportunities to invest outside the index. The market may be high/low, but there will be ample opportunities to invest in the individual stocks. It’s not necessary that all the stocks will be on their 52-week high during a bull market (or at 52-week low during their bear market). There are thousands of listed companies in the Indian stock market. Even during the bull market, you can find good companies at a reasonable price.

In short, focus on investing in companies, not the share market. If you keep looking for good companies, you’ll eventually find a few good ones. On the other hand, if you just follow the market- Sensex and Nifty– you will only keep looking for the answer to whether its the right time to invest in Indian share market or not.

– Follow the Rupee Cost Averaging Approach

As discussed earlier in this post, timing the market is really difficult. It is really burdensome to know the right time to invest in Indian share market and it is next to impossible to buy exactly at the bottom and sell at the top. If someone says he/she has been able to do it, they just got lucky.

An easier approach to follow here is rupee cost averaging. If the company is fundamentally strong and worth investing,  however, you are not sure whether the market will go high or correct, then just make a small position. Add more stocks every month when the price changes significantly.

For example, if you are planning to make an investment of Rs 20k, then do not invest all at once if the market is uncertain. The averaging approach suggests investing 20% of 20k i.e. Rs 4k right now. Add more stocks in the same proportion when the price goes down or up after a regular interval. Following the Rupee Cost Averaging approach will help you avoid the technicalities of timing the market exactly.

Conclusion:

“The best time to invest was yesterday, the next best time is today and the worst time is tomorrow.”

If you are trying to time the market based on the indices, then you might never be able to find the right time to invest in Indian share market. Instead, you should focus on the individual stocks. If you can find a good stock at a decent price, then buy it- no matter whether the indexes are high or low. Further, if you follow the individual stock, you can find good investments. If you follow the indexes, you will find just the numbers.

That’s all for this post. I hope it was useful to you. Happy Investing.

warren buffett quotes

August 22, 2018 Investment Basics 4 comments
Margin of Safety by Seth Klarman book review

Book Review: Margin of Safety by Seth Klarman

Hi Investors. In this post, we are going to discuss the book review of Margin of safety by Seth Klarman (Originally published in 1991).

About the Author:

Seth Andrew Klarman is an American billionaire investor and hedge fund manager.

He is a graduate of Cornell University and has a business degree from Harvard Business School. Klarman is the founder of The Baupost Group, a Boston-based private investment partnership, that focuses on making value-based investments in the US public markets (founded in 1982). 

In the recent decade, Warren Buffett and his lieutenant Charlie Munger have voiced their support for his investment style and even went on to state that Seth Klarman would be one of their asset managers of choice to manage their personal portfolios. 

Besides, Klarman is also a close follower of the investment philosophy of Benjamin Graham.

Book Review of Margin of safety by Seth Klarman:

margin of safety -seth klaarman

The Margin of Safety by Seth Klarman covers a broad spectrum from providing sound education on the psychology of investing as well as developing the quantitative and qualitative aspects of value investing. It is sometimes said to be the most important book available on value investing after The Intelligent Investor by Benjamin Graham.

The book primarily explores three broad themes for the investor:

  • Firstly the futility of the efficient model hypothesis and the practice of finance professionals of over-relying on their models and estimates.
  • Secondly, it focuses on the concept of risk and the central role it plays in investment success
  • And finally on valuation and market opportunities for the retail investors

Klarman encourages investors to always assess their investments only after first evaluating the risks associated with a particular opportunity and then and only then the potential returns.

In his eyes, the key to a successful track record in investing comes not by achieving higher than average returns but by achieving below than average losses.

This strategy has seemingly worked for him and his investment fund, they have achieved a 19% CAGR for every dollar invested in them (despite maintaining close to 20% cash position in their portfolio for most of the years)

“The avoidance of loss is the surest way to ensure a profitable outcome. Loss avoidance must be the cornerstone of your investment philosophy” – Seth Klarman

The book illustrates this concept through the example of 2 people, say A and B, who invested in the market over a period of 5 years.

Assume A generate returns of 12% for 4 years while B generated only 10%. In the 5th year, due to a market downturn, A’s portfolio witnessed a drop of 10% while B witness a drop of 5%. Because of this significant drop in the down year in A’s portfolio, B ends up having a higher portfolio return in comparison to A.

Also read:

In the book, Klarman espouses that the value investment philosophy is based on three timeless pillars:  a bottoms-up approach to selecting investments one stock at a time, absolute performance orientation that enables one to buy and hold irrespective of short-term relative non-performance and paying attention to the real risk of capital loss, not beta (volatility).

Further, in the book margin of safety by Seth Klarman, the author consistently stresses on the need to focus only on one’s own analysis and to discard the market noise when making an investment decision.

Klarman also discusses the difficulty involved in the art of valuing a business and recommends arriving at a conservative but imprecise range of business value based on 3 or 4 techniques: Net Present Value of Free Cash Flows, Liquidation or Breakup value, and Stock Market Value.

(His book provides practical examples of his philosophy, we encourage our readers to take time to go through his work to improve their knowledge and skill in valuation)

“It would be a serious mistake to think that all the facts that describe a particular investment are or could be known. Even if everything could be known about an investment, the complicating reality is that business values are not carved in stone. If you cannot be certain of value, after all, then how can you be certain that you are buying at a discount? The truth is that you cannot” – Seth Klarman

Klarman closes his masterpiece with tips for retail investors on finding opportunities in the market namely catalysts, market inefficiencies, and institutional constraints, as well as then going on to provide detailed evaluation methods for thrifts and bankruptcy situations.

Also read: 10 Must Read Books For Stock Market Investors.

Bottomline:

In our view, Margin of Safety by Seth Klarman is a must read for all investors of all levels, besides strengthening foundations on the value methodology it also provides insights into how a seasoned investor stays apart from the chaos of the market to generate stable returns. Happy Investing.

August 20, 2018 Books 3 comments
Introduction to business models Arbitrage and Retail

An Introduction to Business Models: Arbitrage and Retail.

Understanding business models – Arbitrage and retail:

Hi Investors. In this post, we will be discussing an arbitrage and how it is exploited in the retail industry. If you have previously analyzed any company in the market you would already know that among the different business models one of the easiest in terms of operation is the business of arbitrage and retail.

Today we shall go a level deeper into the analysis of a retail company and discuss one of its most important metrics and its significance. The topics we shall cover in the post are as follows:

  1. What is arbitrage?
  2. How do retailers use this strategy today?
  3. What metric should we use to analyze whether arbitrage is working out for a retailer?
  4. What is the SSS growth?
  5. How to identify the drivers behind retailers’ business model from SSS growth?
  6. How are business models changing in retail and how to modify our analysis?
  7. Conclusion

On the whole, this will be a long post- but we hope you find this very rewarding and is definitely worth reading. So let’s get rolling.

1. What is Arbitrage?

Arbitrage is a money-making strategy followed by traders since the very ancient times, even today it is sometimes thought to be an almost risk-free strategy. The aim of those traders in business was to profit from the difference in the pricing of goods between two regions or markets.

Let’s take the example of the famed Silk Road.

Traders and merchants used to travel from the Mediterranean, Persia and the Levant to Central Asia and China to buy silk and other products, then they used to travel all the way back to sell these goods in their home markets.

Silk route

Back then a commodity like silk was precious and luckily for all merchants, China had a complete monopoly over the production of Silk. This made them even more precious in some markets than the others. The markets farthest and wealthiest away from the production center became the areas where the silk trade was most lucrative just like ancient Egypt, the Roman Empire, Ottoman Empire etc.

2. How do retailers use this strategy today?

Modern retailers use the same strategy of arbitrage to generate profits (they buy products from manufacturers and wholesalers for lower prices and sell them to consumers at higher prices), but of course with some tweaks.

But since competition is high in the modern landscape, retailers often tweak their business models to gain an advantage over their peers.

3. What metric should we use to analyze whether arbitrage is working out for a retailer?

As we just mentioned, retailers tweak their business models to gain competitive advantage and a lot of the times many retailers follow the same strategies. This spells trouble for us as investors, how do we know which retailer is doing the right thing and who is failing to do so?

Luckily for us, there is a metric that can help us analyze just this question. The metric is called the Same-Store-Sales growth rate.

Also read: 14 Most Frequently Asked Stock Investing Questions by Beginners.

4. What is the SSS growth?

“Same-Store-Sales” as mentioned is one of the most important and useful metrics for retail companies. This metric also has other names such as “like-for-like” sales or “Comparable-Store-Sales” and “identical-store-sales”. The concept behind the metric is fairly straightforward: the metric represents the sales growth of stores which were present for more than a single financial year.

Let’s understand this through an example, assume that we operate a retail business with 10 stores spread across Maharashtra in 2016 and as part of our growth strategy we open two more stores in 2017. Let us also assume that our revenues increased by 10% during this period. This 10% growth could be broken down into the following two sub-parts

  1. Growth due to new stores opened in 2017
  2. Growth due to increased sales in existing stores at the beginning of 2017

The second sub-part: the growth from existing stores is what is represented by the SSS growth metric.

In an ideal world, we would want to make sure that our current stores are generating sales growth for many years once they are opened. This scenario will only happen only till the day our customers find value in our products and the SSS metric helps us deduce whether our business is continuing to deliver value to our customers.

5. How to identify the drivers behind retailers’ business model from SSS growth?

In economics, we all know the scenario of perfect competition. It is the market condition where every seller sells their products at the same price as their competitors and profits are marginal. Retail is a highly competitive business since anyone with a sufficient capital and basic knowledge of logistics can become set their own store up (remember the Kirana stores at the corner of your street?).

Retailers try to outdo their competitor by employing various strategies to create an intangible or a tangible value to their customers and deny or gain an advantage over their competitors.

The drivers behind SSS growth could be any combination of the following:

  1. Pricing of products: retailers try to achieve higher pricing power by creating intangible value to customers by selling branded products
  2. The volume of products sold: some retailers do not have much pricing power so they sell large quantities  at slightly discounted prices to make profits
  3. Net store productivity: retailers sometimes sell add-on products and accessories to boost the revenue per each sale that they have

Obviously, the most desirable and profitable route for a retailer would be to improve the pricing of products sold in their stores but most retailers would witness a drop in their volumes. But some company have created such strong brands that they can indefinitely increase their prices without facing a major drop in sales. Examples of these firms would be the sporting giant Adidas and the global luxury firms Tiffany and Gucci.

The second route is that of companies which focus exclusively on volumes, these are usually companies that have achieved economies of scale and can significantly underprice their competitors out of business. Because of their low pricing consumers flock to their stores for cheaper products. Examples of this type of retailers would be DMart, Amazon, Walmart etc.

(Please note here that economies of scale and brands that can charge a premium are significant economic moats for a retail and consumer companies)

The third most common route is to sell increase the products sold to a customer in a single transaction. It may be an auto-retailer who sells you a car and also an insurance scheme or maybe those leather covers on your seats. It could also be the restaurants that sell you the main course with starters and the side drink or even the furniture store from where you bought the table, the chair, and the table lamp.

6. How are business models changing in retail and how to modify our analysis?

With the advent of e-commerce retail players worldwide have witnessed dramatic headwinds in their operations and have begun to change their business models to adapt to the evolving business landscape. Increasingly retailers themselves are opening up their own e-commerce sites and selling products.

Eventually, as companies change so should our analysis techniques, in view of the above development, using the SSS metric along with the online/ e-commerce sales growth metrics to understand companies would better suit our goals.

Also read: What is an Economic MOAT and Why it’s Worth Investigating?

7. Conclusion

Retailers although reliant on arbitrage continue to adopt strategies to give an edge to their businesses. The SSS growth metric helps us identify whether the retailers are able to put theory into practice and also identify the factors driving their growth.

The SSS metric also helps us identify whether companies are able to develop credible economic moats. In companies which have both offline and online retail presence, it would be wise to incorporate online/e-commerce growth and value metrics along with SSS in our analyses. Happy investing!!

Also read: How To Select A Stock To Invest In Indian Stock Market For Consistent Returns?

August 19, 2018 Investment Basics No comments yet
14 Most Frequently Asked Stock Investing Questions by Beginners

14 Most Frequently Asked Stock Investing Questions by Beginners.

14 Most Frequently Asked Stock Investing Questions by Beginners: 

Hi there. Today is the day 30 of my ‘30 days, 30 posts’ challenge, where I’m writing one blog post daily for the 30 consecutive days. And hurray!! I did it.

I’m extremely glad that I took this challenge and was able to complete. But this is not the end, just the beginning. There are many many good investing posts that are going to be published on this blog in the upcoming days. So, stay tuned.

In this last blog of my 30 days series, I want to answer a few of the most frequently asked stock investing questions by beginners. This post will cover the general doubts of a number of newbies so that they can take the next step in their investing journey.

Most Frequently asked Stock Investing Questions by Beginners

1. I’ve bought a stock at Rs 200. Right now, it’s trading at Rs 160. What should I do next?

Sit back and relax. Patience is the key to successful investing. Most stocks won’t start moving upwards from the very next day since you bought it. It’s perfectly okay to see some dip in the stock price. Do not get emotional and give your stock time to perform. Getting emotional leads to poor investment decisions.

Anyways, in such cases- there are two important steps that you need to take next:

1. Validate your investment study

2. Make adjustment to your strategy.

First of all, try to validate the original thesis based on which you bought the stock. Read the current news and find out the reason why the stock is down. If the news is temporary or the stock is down just because of public psychology (people are fearful), then ignore the short-term fluctuations. Moreover, if your initial study is still standing strong, then consider buying more stocks. After all, you are getting that stock at a better-discounted price now.

On the other hand, if you find that your study was wrong or there is some new news that might affect the long-term performance of that stock (for example- new trade rule, change in government policy, change in management, demerger etc) then exit the stock. Reinvest that money in a better and stronger company.

Besides, your wealth creation strategy also governs your next steps. Here, you need to confirm whether your investment was with regard to capital appreciation or was it a dividend stock. If you bought the stock for capital appreciation, then you might need to do a thorough study and adjust your strategy. However, if it was a dividend stock and giving good dividends year-after-year, then price appreciation is not an issue for such stock. For a good dividend stock, a little price dip is not a good reason to sell. Unhealthy dividends are the reason to exit a dividend stock.

2. Where can I get the company’s financial report and other information?

There are three places where you can get the financial reports and other pieces of information of a company– 1) Company’s website, 2) Stock exchange website (NSE/BSE), and 3) Financial websites (like moneycontrol, investing, et market etc)

Besides, the best place to get all the important data related to a company is its website and annual report. This is because those reports and information are periodically scrutinized by independent auditors and SEBI.  On the other hand, financial websites may contain little error while collecting these financial data from the company.

3. How to find good companies as there are thousands of publicly listed companies in the Indian stock market?

An easier approach would be to use a stock screener. By using stock screeners, you can apply few filters (like PE ratio, debt to equity ratio, market cap etc) specific to the industry which you are investigating and get a list of limited stocks based on the criteria applied.

Quick Note: I’ve explained how to use stock screeners in details in my online course. Feel free to check it out here.

4. What is the appropriate amount of time to spend while researching stocks?

It depends whether you are trading or investing in stocks.

If you are trading in stocks then you do not need to spend a lot of time on fundamentals. Rather, here you should read charts, trends, patterns etc and get more involved in the day-to-day market activity. In addition, traders just work 5 days a week as the market is closed on the weekends. Hence, they can’t trade on Saturdays and Sundays.

On the other hand, while investing- you need to spend a lot more time studying stocks compared to trading. Here maybe you have to invest a couple of hours daily to study the company (even on weekends). Choosing stocks for long-term investment is not similar to choosing stocks for intraday. You need to do a rigorous study of the company, its management, financials, competitors etc.

Besides, the time required to research a stock also depends on your knowledge, your familiarity with the industry, your past experience with analysis, and visibility of the company (how easily the company’s information is available). With time and experience, stock research analysis becomes easier and effective.

5. Should I invest in upcoming IPO?

Frankly speaking, investing in IPOs is not very profitable. IPOs are the products of the bull market. They get public only when everything is good like people are optimistic, the economy is doing wonderful etc -in order to get good listing profits. The real test of a company is during the bear market (how they survive the bad economy and falling market)- which IPOs has not faced yet.

Nevertheless, few IPOs has given amazing returns to its shareholders in the past for long consistent years. If you are able to find such IPOs which are very promising (good business model, strong financials, efficient management and leader, decent valuation etc), then feel free to invest in them. However, in general, most IPOs are not worth investing.

6. My stock is down by 60%. How much further down can it can go?

Technically, it can go down 100% and the stock price may fall to zero. There are a number of stocks which has destroyed the wealth of the shareholders by over 90%. The most common example is Suzlon Energy. However, a 100% capital degradation is very unlikely- unless the company files a bankruptcy.

What to do in such case? If you find out that your study was wrong or the fundamentals/circumstances changed after you invested, there is no shame in accepting the truth. If you won’t accept it, then you are the only one who will be affected financially and mentally.  Just accept that it was a wrong investment and move to the next one.

7. Is investing in small caps more profitable than large caps?

Small caps companies have the caliber to grow faster compared to the large caps. There can be a number of hidden gems in the small-cap industry which might not have been discovered by the market yet. However, their true potential is still untested. On the other hand, large-cap companies have already proved their worth to the market.

Anyways, the quality of stock is more important than the size of the company. There are a number of large-cap companies which has consistently given good returns to its shareholders. Overall, investing in small caps can be more profitable than large caps if you’re investing in right stocks. 

8. I’ve invested in a stock at Rs 100 and it has given me a return of 58% last year. How long should I hold this stocks?

“Our  best investment period is forever” -Warren Buffett

Few of the best stock investors hold their winning stocks forever. For example- Warren Buffett bought made his first investment in the Coca-cola company in the late 1890s and he is still holding them.

You should keep your winners in your portfolio as long as possible. These stocks are the ones who will be driving your portfolio upwards. The strategy to build a strong portfolio is simple- ‘hold on to your winners and cut the losers’.

9. Should I use a stop loss on my investments?

This answer varies for traders and investors. If you are a trader, then yes!! Stop loss can help you prevent a lot of damage and you should definitely use it in your traders.

However, if you are a long-term investor, then using stop loss doesn’t make any sense. The stop loss might get triggered because of some unpredictable short-term market fluctuations and result in selling that stock. Further, as a long-term investor, you should consider buying more if the price goes down rather (than exiting the position).

10. Should I invest in stocks when the market is high?

Generally, the question that people ask is- ‘Should I invest in stocks when the market is falling?’ However, these past few months, the market is making new highs and that’s why this question has been modified a little.

Anyways, I’ll answer both the questions.

If the market is falling, then it’s the best time to buy. Imagine this scenario like a super sale on Amazon or Flipkart. On a big sale, what should you do? Buy more or just sit back because you are afraid of more discount in future. There’s a famous quote by Warren Buffett regarding this scenario

“Be fearful when others are greedy, and be greedy when others are fearful.”

On the other hand, if the market is high- then start making your watchlist of stocks. Keep an eagle eye on the stocks with good fundamentals. Anyhow, if you are able to find some good stocks and ready to invest, then avoid lump sum investment. Average out the stocks. This will reduce the chances of buying stocks at the high price.

11. What kind of stocks should I avoid?

You should avoid investing in stocks with low liquidity. There are a number of small-cap stocks where the prices may be continuously falling, but the investors are not able to sell that stock just because there are no buyers.  Avoid investing in companies with low liquidity.

Further, for the beginners- I would also advise avoiding investing in penny stocks. These companies are very risky and prone to different scams like pump and dump etc.

Also read: What are Penny stocks? And should you buy it?

12. How many stocks should I buy?

Your portfolio should not be over or under diversified. Do not invest all your money in a single stock as it increases the risk in your portfolio. Diversify your portfolio by purchasing multiple stocks from different industries.

In general, you should not buy more than 8-10 stocks as it becomes really difficult for a retail investor to monitor more stocks. Besides, over-diversification kills the profit.

Also read: How Many Stocks Should you own for a Diversified Portfolio?

13. How much returns can I expect from the market?

Your stock portfolio will always consist of multiple stocks. At any particular time, some stocks will perform excellently well, while some will not. Your portfolio returns will be the average of both.

During a good market, your portfolio can give you a return as high as 30-35% (the benchmark index nifty alone gave a return of over 26% last year (2017)). However, during a bad market- the returns can be as low as 2-5% (maybe even negative).

If you sum up everything, you can expect an annual return of 15-18%, depending on how good you were at picking stocks. Nevertheless, you can generate even better return if you are ready to put some hard work.

Warren Buffett, the greatest investor of all time, has got an annual return of 22.% for a period of last 5 decades. You can treat his returns as a benchmark.

14. Can I become a millionaire by investing in stocks?

Definitely. Many people have done this in the past and you can do it too. The stock market is popular for creating wealth for the intelligent investors.

However, this is not easy and it requires a lot of hard work. If you are hoping to make great money from stocks, then be ready to spend serious efforts and plenty of time researching companies.

Always remember the old proverb- ‘You will never know if you never try’. Most people don’t even get started investing in stocks just because they are too afraid. Dare to be different and be passionate enough to chase your dreams. The stock market is giving you an opportunity to create wealth if you are willing to take it. Happy Investing.

August 8, 2018 Investment Basics 2 comments
gambler's fallacy

What is Gambler’s Fallacy? [Investing Psychology]

What is Gambler’s Fallacy? Investing Psychology:

Statistics is always surrounded by two kinds of events – dependent and independent events. While the dependent event’s calculations are governed by different approaches such as the Naïve Bayes theorem and full joint distribution tables, the calculations involving independent events are quite easy to follow.

New technology and data mining techniques are all about using the past data in order to make the predictions true about the future. However, is this always true? Does the future data always depend upon its correlated past data? Even statisticians were not too sure of this.

Gambler’s Fallacy is one such proof which states that a human mind often interprets the outcomes of a future event judging by its corresponding past events even if the two are completely independent of each other.

Gambler’s Fallacy is inspired by the “failures of gamblers” due to their probabilistic illusions to make decisions in casino games. Also known as “Monte Carlo” fallacy, the gambler’s fallacy has been used a number of times for various conformances and inferences.

In this article, we are going to explain the basics of this fallacy and would also consider a few famous examples to understand the term and its context in a better way. Let’s start!

Also read: The First Golden Rule of Investing -Avoid Herd Mentality.

The Coin Toss Example

Gambler’s Fallacy can be very well explained with the help of a basic example involving a coin. For future reference, let’s suppose that the coin is fair with both sides (heads & tails) having an equal probability of landing on top.

Suppose a coin is flipped 10 times and the result of each event was “Heads”. What would you bet for the next coin flip?

Now, if a human bet on the outcome of the 11th flip of the coin to be “Tails” seeing the past events, there’s a 50% chance of him to fail. 

The above context does only imply a simple rule: The occurrence of an independent event is not dependent on the past events. In this example, the 11th flip of a coin would result in both heads and tails with a 50% chance of being associated with each one of them.

Therefore, the prediction of an event can’t be made seeing its past outcomes if the events are independent of each other.

Psychological Thinking & “The Gut Feeling”

Something which our brain is too good at is making inferences. A human brain is very quick at picking up things, assembling them, joining the pieces together, and making an inference. The probabilistic approach here is not always true, however.

A Human brain is just incredible at churning out new patterns and associations that it might create illusions. To put it in plain and simple words:

Our brain can deduce patterns that even don’t exist in reality.

That alone might cause problems and thus exist fallacies like “The Gambler’s fallacy”. In the coin toss example, our brain might work in two ways:

  1. It could think that on most of the coin flips, heads are turning up so, in the 11th flip, it might show a ‘head’ again. OR
  2. It could think that since most of the coin flips have shown “heads” on them, maybe it is going to show the “tails” now.

Both of them, however, are true BUT ONLY COLLECTIVELY.

In the coin toss example, the probability of the 11th flip showing “Heads” and “Tails” is equal and is exactly 50% for both of them.

Also read: Investing Psychology: Winner’s Curse

Gambler’s Fallacy and Investing:

You would think what do these both terms have to do with each other? However, you must know that it is a common practice in the investing domain as well. Investors tend to liquidate their positions (or their bet) over something which is long overdue – again, a classic example of the Gambler’s Fallacy.

For example, if a stock is continuously making new highs for the last 4 consecutive days, few may think that it will correct on the 5th day, so better to leave the position. On the other hand, the rest might argue that it will continue to rise because of the momentum.

An inaccurate understanding of basic terms related to probability can make one invest in wrong places. Now, I would like to ask you the same question again!

In the coin toss problem mentioned above, how much would you like to bet on heads or tails or both?

The correct answer would be to bet half of your money on heads and half of it on tails – pretty simple, right? Not because tails is overdue, not because heads are on a streak but because both of them are having an exactly equal probability of landing on top.

Also read: Get Rid of- Confirmation Bias For Good!

Summing up:

If you pay heed to the name of this fallacy; the gambler’s fallacy, you would relate it to a casino game. The co-relation is justified!

Most of the games in a casino or gambling games have sequences that are randomly generated and are statistically independent. Making a prediction on the outcomes of the events involving the sequence of these games isn’t easy and sadly can’t be derived from the mathematics of probability. Therefore, one would find it purely random and “lucky” to get a winning sequence – the Gambler’s Fallacy is rolling its dice in the background.

August 7, 2018 Investing Psychology, Investment Basics No comments yet
Bunty and Babli - A financial story of how Bunty lost Rs 1,29,94,044-min

Bunty and Babli: A financial story of how Bunty lost Rs 1,29,94,044!

Once upon a time, there lived two best friends- Bunty and Babli. Both were born in the same year, the same city, attended the same school and went to the same college. However, things changed when they started working.

Bunty was an impatient type guy who wanted to live his life king size and did care about his savings or future. He enjoyed spending every penny that he earned in different fancy things. On the other hand, Babli was patient and goal-oriented who cared for a secured long-term future.

And that’s why Babli begin investing at an age of 25 when she started getting her first paycheck. As she also enjoyed living a comfortable life, therefore, she only invested a small amount of Rs 3,000 per month in equities (stocks and mutual funds) with an expected return rate of 14% per annum. She advised Bunty to follow the same approach, but he ignored her saying that “what difference an investment of Rs 3,000 per month can make in our lives? I’ll start investing heavily when I have got a big amount to invest.”

When they both turned 40, Babli had built a corpus of Rs 18,28,561 on her portfolio. Realizing his mistake, Bunty decided to start investing from that year with double the amount invested by Babli i.e. Rs 6,000 per month to catch up with Babli. However, because of different responsibilities like Kid’s education, house loan etc, Babli couldn’t increase her investment amount. She continued the monthly investment of same Rs 3,000 per month.

Both Bunty and Babli continued earning an equal return of 14% on their investment in equities.

15 years later, on the 55th birthday, Babli had made a corpus of Rs 1,66,71,166 i.e. over Rs 1.66 Crores. On the other hand, Bunty had made just Rs 36,77,122 in his portfolio.

Please note here that both Bunty and Babli invested the same amount. Babli invested Rs 3,000 per month for 30 years i.e Rs 10,80,000. Bunty also invested the same amount i.e. Rs 6,000 for 15 years (=Rs 10,80,000).

In short, by waiting until an age of 40 to get started investing, Bunty’s portfolio was in loss of Rs 1,29,94,044 i.e. around 1.3 crores.

At 55, Babli retired and moved to live in a beach house. On the other hand. Bunty continued to work for the next few more years to save more money and later moved in with his children.

This is the power of compounding, my friend.

Bunty Bubli
Starting Age 40 25
Investing Each Year Rs 6,000 Rs 3,000
Annual Rate of Return 14% 14%
Total Invested amount Rs 10,80,000 Rs 10,80,000
Total Portfolio Value Rs 36,77,122 Rs 1,66,71,166

3k 30 yrs graph

Source: ClearTax SIP Calculator

Babli started investing 15 years sooner than Bunty, and over those 15 years, her money started to compound. As a matter of fact, Bunty has to continue to work 10 more years to make the same corpus as that of Babli (assuming that Babli stopped investing at 55 and took out all her money).

Quick Note: If you’re a beginner and want to learn how to invest in mutual funds the right way, check out this online course. 

Conclusion-

The sooner you start investing the better off you will be. Time is on your side so take advantage of it. Even by investing Rs 3,000 per month (just like Babli) you can reap big rewards in future.

Finally, here’s a famous quote by Albert Einstein regarding Power of compounding–

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

August 5, 2018 Earn More, Investment Basics 3 comments
pidilite industries

[Case Study] Pidilite Industries: A No-Brainer Stock

[Case Study] Pidilite Industries: A No-brainer stock

General Disclaimer: The stock discussed here is not a recommendation or advisory. This is a quick analysis and there might be much additional information that you need to refer to study the company completely. This case study is only for the educational purpose to teach the practical approach while investigating stocks. Besides, the past performance doesn’t guarantee the future returns. Please research the stock carefully before investing or take the help of a financial advisor.

Company Background:

Fevicol!! I bet you have heard or used this product multiple times in your life. There were many famous advertisements that used to run on our television during the 1990s. Here’s a video compilation (they’re really funny)-

Pidilite Industries is a popular consumer-centric company whose products you might have already frequently used- knowingly or unknowingly. They are the leaders in the adhesive industry and focuses on ease-of-use and value-for-money products.

Few of the popular products of Pidilite Industries are Fevicol Mr, Dr. Fixit, Fevikwik, M-seal, Fevistik, Hobby Ideas, Fevicryl etc.

pidilite industries products

The company started with a single factory that manufactured only one product, Fevicol in 1959. As of today, Pidilite has a diversified product portfolio from adhesives, sealants, waterproofing solutions and construction chemicals to arts & crafts, industrial resins, polymers and more.

As of 2017-18, Pidilite Industries’ top product portfolio consists of 55% in adhesive and sealants, 20% in construction and paint chemicals and 9% in art and craft materials.

pidilite industries products

Source: Pidilite Industries- Annual Report 2017-18

Financials of Pidilite Industries:

If we look at the financials, Pidilite is a financially strong company. Here’s the EPS and book value per share growth trend for the last 5 years (EPS has more than doubled in the last five years).

pidilite industries eps growth

(Quick Note: The financial data has been collected from Pidilite’s Annual report 2017-18)

Next, If we look at the profit before tax (PBT) and PBT as % of net sales (margin), both are showing a positive trend. PBT has also doubled itself in the last five years.

pidilite industries pbt

Further, Pidilite industries is a completely debt-free company for many years. Here’s the debt to equity ratio of Pidilite from 2013-14 to 2017-18.

pidilite industries debt to equity ratio

Besides, if we check the liquidity, we can find that Pidilite industries has high current assets compared to its current liabilities. As of 2017-18, its current ratio is 3 (Quick tip: Current ratio greater than 1 is considered decent)

pidilite industries current ratio

Pidilite Industries last 10 years financial performance-

If we look closely at the last 10 years financial performance of Pidilite industries, we can find a healthy growth trend in sales, operating profit, net profit, and dividends.

The sales and other income of Pidilite Industries has been growing at a compounded annual growth rate (CAGR) of 12.62% for the last 10 years. Besides, the net profit after tax is consistently growing at a splendid CAGR of 23.17% in the same time period. Here is a quick snapshot of the financial performance of Pidilite Industries for the last 10 years.

pidilite industries 10 years performance

Source: Pidilite Annual Report

Valuation: Pidilite Industries is currently trading at a consolidated PE of 57.36 which is a little high. This may be because of its high growth compared to its industry and competitors, that’s why people might be willing to purchase this stock at a premium.

You can learn more about the valuation of stocks on my online course here.

Dividends: Along with growth, Pidilite Industries has also been rewarding its shareholders with healthy dividends per share year-after-year. The company has been maintaining an excellent average dividend payout ratio of 34.74% for the last 5 years. Moreover, the significant point here is a steadily growing dividend over time.

Mar 18

Mar 17

Mar 16

Mar 15

Mar 14

Dividend / Share(Rs.)

6.00

4.75

4.15

2.90

2.70

Source: Moneycontrol

Competitors:

Pidilite is a dominant player in India’s adhesive industry with a market share of ~70% in its leading brand categories (Fevicol,) in the organized segment. Few of the competitors of Pidilite Industries are Tata Chemicals, BASF, BOC India etc.

Competitive advantage:

Here are few key competitive advantages of Pidilite Industries that helps it to remain profitable for the long-term:

  • Strong brand value.
  • Effective advertising and marketing (Fevicol ads have become a viral hit among the masses)
  • Market leaders in adhesives, sealants, polymer emulsions, hobby colors and construction chemicals in India.
  • Loyal customers- (Fevicol has become synonymous with adhesives)
  • Strong R&D center to cater growth and innovations.

Concerns:

Although Pidilite Industries has a strong competitive advantage, however, there are few concerns like over-dependence on Fevicol and M-seal (which alone account for over 50% of the total revenue of Pidilite). This eases the pressure on the sales of other brands and results in reduced investment in other businesses.

Past share performance:

There’s no doubt that Pidilite industries has performed well in that past few decades. And it clearly reflects in its share price. Pidilite has created a wealth of over 1,600% for its shareholders in the last 10 years. Here’s a comparison of Pidilite Industries returns vs BSE benchmark index SENSEX.

Source: TradingView

Bottomline:

From the above analysis, we can conclude that Pidilite Industries in a financially and fundamentally strong company with good ‘moat’ around it.

However, there are a few other aspects that we also need to check before making any investment decision like the company’s management, shareholding pattern, mutual funds holdings, future outlooks etc. For keeping this post simple, I’ve only included a limited study here. Nevertheless, I’ll discuss the remaining aspects in upcoming posts.

Anyways, I believe you would have got a good idea of how to study companies while researching and critical factors to check -through this short analysis.

Final tip- The company’s annual report is the best place to start investigating a stock. If you have noticed, most of the data in this post has been collected from the company’s report. In addition, these reports are more reliable than most financial websites as the company’s annual reports go through a strict scrutiny and audit by both independent auditors and SEBI. In short, start reading the annual reports of the companies.

That’s all for this post. I hope this post is useful to you.

And if you ready, take the #TradeBrainsChallenge- Invest Rs 5,000 in a month. #HappyInvesting.

August 3, 2018 Investment Basics, Stocks 4 comments
Invest Rs 5,000 in a Month Challenge

Invest Rs 5,000 in a Month Challenge.

Invest Rs 5,000 in a month challenge

Hi. This is the 1st day of August 2018. And today, I have decided to challenge all the beginners who are yet to start their journey in the Indian stock market. I challenge you to invest Rs 5,000 in a month.

I know, this might sound a little difficult. But in actual, it is not so. One month is a long time. And this time is enough for you to get started in the exciting world of stock market.

Further, do not worry. I’ll provide you a specific guide on how to invest your first Rs 5,000 in a month in this post.

Are you ready? Let’s get started!!

The goal of this challenge:

First of all, I would like to mention that the goal of this challenge is not to make you rich quickly or a stock market expert in a month. It takes years to reach that level. The goal of this challenge is to get you started.

Remember, the journey of a thousand miles starts with the first step.

No child starts directly running within days after they are born. First, they crawl, then comes baby steps, then imperfect walks and finally they are able to run. You have to also follow the same procedure. However, in order to do that, first, you need to get started.

You can only make good returns from your investments at some time in the future, if you start today.

Before you get started!!

No stupid investing in Penny stocks!!

Yes, I know! Penny stocks are the darlings of the newbie investors. The idea of investing in stocks worth less than Rs 10 in the stock market sounds appealing. You can buy as much as 500 quantities by investing Rs 5,000 if the share price of a company is Rs 10. However, these stocks are very risky and a majority of the population loses money while investing in these stocks.

Therefore, investing in penny stocks is not a good idea for the beginners. The basic rule for this challenge is to totally avoid investing in penny stocks.

Also read: What are Penny stocks? And should you buy it?

Only join if you’re serious to invest Rs 5,000 in the stock market this month!!

If you have any other commitments- let’s say you are giving some important exam, traveling the world or participating in the marriage of a close relative- then please do not join this challenge.

No one likes FAILING. Moreover, failing because you didn’t try enough is not worth it. Only participate in this challenge if you are wholeheartedly ready to invest Rs 5,000 in the stock market in a month.

Quick note: If you are a student and want to get started in the stock market, you can start with an amount of Rs 2,000. However, if you don’t even have this amount, then please do not start. In such case, first, you need to learn how to save!!

Set up your brokerage account.

I hope you already have opened your demat and trading account by now. If not, don’t worry. In the internet era, you can set up your brokerage account within hours.

If you are a beginner, I’ll recommend starting with discount brokers. These brokers will save you a lot of money as they charge minimal brokerage cost. You can always switch to another broker or open multiple demat accounts in future as there are no restrictions. However, for the beginners, I will recommend opening a brokerage account with discount brokers like Zerodha or 5Paisa.

If you need any help in getting started with the brokerage account, feel free to check out this site: Nifty brokers.

Set a time aside for research

One hour per day- not a big deal, right?

Keep this time for study and research. You can set aside this time either in the morning or after work- whichever suits you.

Quick note: If you are able to steal some extra hours during your lunch break or office time, then it will be considered as bonus time. Those time should not affect your regular research time. Stay disciplined to the time that you set aside for study/research.

Don’t expect to get fully prepared.

Perfection is the enemy of progress. Find me an investor who knew everything before he made his first investment. I bet, you can’t. Investment is a lifelong learning and there will be always more to learn. You are not supposed to learn everything before buying your first investment.

You will never be fully prepared. Just get started and keep improving on the journey.

Do not expect high returns

Again, the motive of this challenge is not to make you rich quick. Do not try to cross a 500-meter wide river in a month when you are just starting to learn how to swim.

With time and experience, you will get good returns on your investment. However, when you are just starting out, try to learn the fundamentals first.

Let’s start the challenge-

By now, you have would have a good idea of this challenge and its rules. However, what to do next? How to get started.

Don’t worry. I’ve planned out everything for you. Here’s are the exact steps to invest Rs 5,000 in a month.

#1. Start thinking about your favorite companies-

There may be hundreds of companies which you love -whose products and services you most frequently use.

Investing in the stock market is not like investing in Bitcoin, Ripple, Litecoin or any other cryptocurrency. Here, you already know the major companies as you have seen them since childhood.

Just look around and you won’t find it difficult to search for companies. From toothpaste, hair oil, edible oil, shampoo to cars, banks, shoes, clothes, petrol pumps etc, everything has a company behind it.

  • Automobiles → Tata Motors, Maruti, M&M, Bajaj Auto, Eicher etc
  • Banks → ICICI, Yes Bank, HDFC Bank, Axis Bank, SBI, IOB etc
  • Personal care —> ITC, Colgate India, P&G India, Dabur, etc
  • Shoes → Bata, Khadims, Shree leathers etc
  • Petroleum → HPCL, IOCL, BPCL, Oil India, ONGC etc…

large cap companies

large cap companies 3-min

You have grown up with the names of these companies. Why not study them and invest? Make a list of at least 30 companies which are your favorite.

#2. Be accountable

Do not ask for recommendations from your friends or advisors. Research yourself.

Maybe, you can have a casual talk regarding your favorite companies with your friends- if you know that they have a good knowledge of investing. But, do not get influenced.

This is your decision. No one cares more about your money and investments than you do. If you can’t make a decision to invest Rs 5,000 in a month today, how will you make decisions to invest lakhs in upcoming years? This challenge aims to make you accountable for your actions.

#3. Research. Research. And Research.

You do not need to be an expert to research the companies.

Just visit the website of any company and you’ll find tons of information there. All the products, services, vision, mission, team, management, future goals, latest announcements, financial reports, current happenings… everything is present on the website of the company. This is the best place to start your research.

For example, if you’re researching Hindustan Unilever (HUL)- go to their website and read everything that you can find about that company. Maybe you won’t understand many things. But do not let it stop you. One month is a long time to research and learn new things.

Further, google search your favorite companies. Use keywords like “Company name +..” founding year, founders, CEO, Board of directors, the latest news, results, competitors etc. This will help you to research the company from all the angles.

Overall, research everything about the company. Stalk it for a month and I bet you will know more about the company than most of the financial experts.

Also read: How To Select A Stock To Invest In Indian Stock Market For Consistent Returns?

#4. Select 2-3 companies that suit you the best

After the research part, you will be able to find a few good companies whom you believe are doing amazing and has a good future potential. Select 2 or 3 such companies to invest.

Further, do not select more than 3 companies. Rs 5,000 is not a big amount to invest. If you increase the number of companies, you’ll waste un-necessary time in researching. Keep the final list of the companies- SHORT!

#5. Finally, Invest

When you are done with your research and have made your final stock selection, make your commitment. Simply invest. Nowadays, using the online stockbrokers, you can buy stocks with a simple click.

As already said, the goal of this challenge is to get you started. Do not care about the returns. Just care about your research that you haven’t missed anything.

Bottomline:

One month is a good enough time to research a company. If you will use this time efficiently, you’ll learn a lot many things that will help you to make smart decisions in the future.

Further, making your first investment is very rewarding. You’ll never forget your first investment. (At least, I never did!!). Seeing all your hard work finally put to test is really an awesome feeling. In addition, even if you lose 20-30% in the market, it won’t hurt you financially. But this challenge will give you an experience of the lifetime.

ARE YOU READY FOR THE CHALLENGE?

start the challenge- invest 5k in a month

August 1, 2018 Challenge, Investment Basics 28 comments
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