divergence analysis toolkit

What Drives Stock Returns? (Divergence Analysis)

What Drives Stock Returns? (Divergence Analysis)

Two friends- Rajesh and Suresh, were returning home after a long and tiring day at work.

Rajesh, who happened to be an active investor in the market, turned to Suresh and exclaimed “Avanti Feeds share price has fallen down so much in the last 6 months, it destroyed all the gains it has generated in the last one year. How could this happen?”.

Suresh, a calm and a seasoned investor, who has seen multiple market cycle– listened patiently to Rajesh’s rants but kept reading his novel.

Perplexed by Suresh’s lack of response to his situation Rajesh asked “How can you remain so calm in this market, Suresh? Hasn’t the contagion affected the stocks in your portfolio too?”.

Seeing that he could no longer escape the onslaught Suresh replied– “Yes Rajesh, stocks in my portfolio have also been affected by the ongoing contagion… But I don’t bother much about that because I stayed away from the markets when it was reaching premium valuations. The contagion effect has had only a mild effect on my portfolio.”

*********

How many of us have been able to remain calm during the market volatility that we have witnessed in the last six months? Why is it so hard to remain stay put with our investments even when we had high conviction when we invested in them a couple of years ago? 

In fact, what causes the price of a stock to change so drastically? And what can we, as investors, do to prepare ourselves for it? This is exactly what we seek to address in today’s post.

We shall try to understand the various components of stock returns. How each divergence between the components can be used to gain a broader understanding of the market as well as the expectations placed on the script by other investors.

The topics for this post are as below:

  1. What are the components of stock returns?
  2. How do the different components affect the share price?
  3. Could the divergence be used to explain how the mood swings in the market? 
  4. What time period should be used for the divergence analysis?

This is going to a little longer post. But it will be worth reading. So, let’s get started.

Finding Stock Returns Using Divergence Analysis Toolkit:

1. What are the components of stock returns?

Everybody knows that the value of a company is driven by the underlying growth in its earnings.

But, the prices of a stock don’t just depend on the performance of the company. It also depends on the expectations of the investors and the underlying mood regarding the broader economy.

If we were to bring out an actual formula for stock price return for a company it would look something like this –>

Total Return =  Fundamental Return + Speculative Return + Dividend Return + Inflation in the Country

2. How do the different components affect the share price?

The dividend returns are a small component of the overall return achieved from a stock. If the company gives a very little or no dividend, then this component is literally doled out by the company.

The inflation return, however, happens to the black box. But, for growing economy like India, it suffices to take the inflation returns close to 5%.

Now, this brings us to the remaining two components of the equation. The Fundamental Return and the Speculative Return. From empirical evidence, it is has been broadly understood that close to 80 percent of stock returns occur just from these two components.

In a bull market, the speculative return goes over and above the fundamental return. While in the bear market the speculative return goes well below the fundamental return.

Let’s understand this from the example of Avanti Feeds. It was a hot stock in 2017, which means that it was basically a recipe for portfolio disaster.

avanti feeds share price

(Source: TradingView)

For simplicity of calculation let’s assume only the role played by fundamental and speculative return components in our equation.

Total Return =  Fundamental Return + Speculative Return

This equation could also be represented as,

Speculative Return = Total Return –  Fundamental Return

From financial and the stock price data we have created the following chart for our analysis:

Year* Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Aug-18
Stock Price (Rs) 49.5 102.5 131.8 239.2 732.6 426.9
Stock return (%) 0.0 106.9 28.7 81.4 206.3 -41.7
Profit (cr) 70.0 116.0 158.0 216.0 446.0 408.0
Fundamental Return (%) 0.0 65.7 36.2 36.7 106.5 -8.5
Speculative Return (%) 0.0 41.2 -7.5 44.7 99.8 -33.2

divergence analysis stock returns

*(Chart and table are scaled to show the returns starting from March 2014 and adjusted for stock splits and bonus issues. All financial data are shown on the preceding 12 months basis.)

From the above analysis, it becomes clear that whenever the overall stock returns exceed the fundamental returns produced by the company– the stock prices have seen a correction to the true levels denoted by the fundamentals.

3. Could the return divergence be used to explain how the mood swings in the market?

And is it really possible to time the market?

If the above analysis were to be repeated for every single company in the broader market indices, it could give a pretty good idea regarding the ebb and flow of investors’ money into and out of the market.

A possible combination of the PE multiples for the indices with the divergence analysis could be better used to indicate the overvalued/undervalued status of the market. And this may serve as a leading indicator for bull runs and market crashes.

Also read: Investment vs Speculation: What you need to know?

4. What time period should be used for the divergence analysis?

Since most market cycles last around 5-7 years, we at tradebrains, believe that it suffices to use 5-7 years of data for performing the divergence analysis.

But since a lot of stock splits and bonus issues take place in the markets every year, investors should account for these events in their analysis and use only price data that has been adjusted for these special events.

Closing Thoughts

The financial market, despite on a core level is powered by the fundamental returns generated by a company, it tends to fluctuate wildly from the fundamentals due to cycles of greed and fear that are chained to money investors put into the capital markets.

The divergence analysis can be used in this scenario to understand the cycles and be used as an indicator to make key capital allocation decisions on whether to keep away from the markets or build cash or sell your existing stock positions.

We hope you enjoyed this read, looking forward to your comments. Happy Investing.

September 28, 2018 Investment Basics 4 comments
Internal Rate of Return (IRR)

What is Internal Rate of Return (IRR)? And How Does it Works?

What is the Internal Rate of Return (IRR)? And How Does it Works?

Hi readers. A lot has been covered in our blog since inception, we have written articles ranging from the basics of financial statements to concepts of valuation. A reader who has followed our blog from the beginning should now be able to perform a detailed analysis of a company and arrive at a valuation for investment.

To our ever growing list of posts, today we shall add one that seeks to provide a method for calculating the rate of return of a portfolio. This method is called as Internal Rate of Return (IRR).

The IRR method to measure the portfolio performance has become a lot popular in recent days because of its effectiveness over CAGR measurements. That’s why you need to get acquainted with what actually is IRR and how to quickly calculate it.

The topics we shall read about in today’s post are as follows.

  1. What is the Internal Rate of Return (IRR)?
  2. How is IRR different from CAGR and how is it more useful?
  3. Application of IRR method of return calculation with an example.

It’s going to be a very informative post. So, let’s get started.

1. What is the Internal Rate of Return (IRR)?

Theoretically speaking, IRR is the rate at which the net cash flows (both inflow as well as outflow) from an investment would be equal to zero. Better said, it is the rate of return to be achieved by all the money invested to give back all the cash received.

2. How is IRR different from CAGR and how is it more useful for investors?

Although CAGR is a classic investment metric for calculating investment returns and makes a better representation of performance than average returns since it assumes the investment capital to be compounded over time.

But it makes a couple of assumptions which may hinder its practical use. Firstly, it assumes that the compounding process is a smooth one over time with steady returns being made every year. Secondly, it assumes that a portfolio incurs cashflow only two times during its lifetime. One at the very beginning when an investment is made and the second when the investment is sold and cash is returned to the investor.

In practice rarely do we come across such scenarios where an investment is made only once, most of us happen to make regular investments over time and hence the overall return may actually be different than what the CAGR method of calculation may usually project it to be.

In such cases of multiple or uneven investment periods and cash flows, the CAGR method of calculation becomes futile and using the Internal Rate of Return method would better serve the purpose. Mathematically, the IRR calculation is represented by the following expression.

Where P0, P1, . . . Pn equals the cash flows in periods 1, 2, . . . n, respectively; And, IRR equals the investment’s internal rate of return.

Also read: How to perform the Relative Valuation of stocks?

3. Application of IRR method of return calculation with an example.

Assume we bought a stock ₹3,00,000. Also, assume that we bought an additional ₹1,00,000 worth of stock one year later and another ₹50,000 in the two years later.

Let us make one more assumption that we hold the stock for 2 more years before selling the stock for a total cash return of ₹7,50,000

Here is how the IRR equation looks in this scenario:

Internal Rate of Return example

Mathematically speaking IRR cannot be computed analytically, but thanks to calculators and spreadsheets today this task can be done fairly easily.

Using the XIRR function in an excel we get the IRR for this scenario as 11.80%, which is the rate that makes the present value of the investment’s cash flows equal to zero.

If we were to calculate the CAGR for the example for an initial investment of ₹4,50,000 and final cash return of ₹7,50,000 over a period of 5 years we would get a but the incorrect return of 10.8%.

Quick Note: If you want to learn how to perform fundamental analysis of stocks from scratch, feel free to check out this online course- HOW TO PICK WINNING STOCKS. Enroll now and start your journey is the Indian stock market today!!

Closing thoughts

Although initially, the IRR method found applications in the capital budgeting projects of companies, recently it has become a favored method among investors to calculate the capital allocation efficiency of their portfolio.

We advise our readers to add this to their ever-growing investing toolkit. Happy Investing.

September 24, 2018 Valuations 1 comment
becoming warren buffett

Becoming Warren Buffett – 2017 HBO Documentary [Video]

Becoming Warren Buffett – 2017 HBO Documentary [Video]

Warren Buffett, also known as the ‘Oracle of Omaha’ is a popular name in the investing world.

He is an American business magnate, investor, speaker and philanthropist who serves as the chairman and CEO of Berkshire Hathaway. Warren Buffett is considered the greatest investor of all time. As of June 2018, he is the third richest person on the world with a net worth of over $88.5 billion. 

Warren Buffett was born on 30th August 1920, in Omaha, Nebraska. He made his first stock investment as an age of eleven. Later, he attended Columbia Business School as a graduate where he learned the philosophies of Value Investing through his mentor- Benjamin Graham, the father of value investing. In 1959, Warren Buffett created his Buffett Partnership after meeting Charlie Munger.

In 1962, Warren Buffett started buying stocks in a textile manufacturing firm called Berkshire Hathaway On May 10, 1965 Warren Buffett, through his investment partnership, took over the management and control of Berkshire Hathaway. Buffett’s partnership firm had accumulated about 49% of the shares of Berkshire.

As of today, Berkshire Hathaway is the third largest public company in the world, the ninth largest conglomerate by revenue and the largest financial services company by revenue in the world.

Becoming Warren Buffett – 2017 HBO Documentary

In 2017, HBO released a documentary on Becoming Warren Buffett, a co-production of HBO and Kunhardt Films; directed by Peter Kunhardt; produced by Teddy Kunhardt and George Kunhardt.

Here’s the video on how Warren Buffett became the greatest investor in the world –>

(Credits: Advexon TV)

Also read:

September 13, 2018 AceInvestors No comments yet
select right mutual funds

The Beginners Guide to Select Right Mutual Funds in 7 Easy Steps.

The Beginners Guide to Select Right Mutual Funds in 7 Easy Steps.

“But I don’t know anything regarding mutual funds…I’m interested to invest in mutual funds, but always confused where to begin?”, Rajat argued.

“That’s the beauty of investing in the mutual funds, Rajat. You do not need to be an expert or even a finance freak to start investing in mutual funds…

…there’s a professional fund manager who will manage your fund and will take all the critical decisions like which securities to buy or sell. Overall, your job as an investor is just to invest your money at the right fund. Rest everything will be taken care of by the fund manager and fund house.”, I explained to Rajat.

“Sounds good, so far? But how to find such funds which match my goals? There are hundreds of mutual fund in the Indian market…”, Rajat looked a little excited and cautious at the same time.

“Yes, there are hundreds of mutual funds in the market. However, there will only be a few good ones that will match your goals, risk appetite and has a good track record of consistent performance. Although it may take a little time to find such funds, once you find a good mutual fund, you can sit back and relax. Moreover, finding a winning mutual fund doesn’t take too long if you know the right approach…”, I was able to see a grin on Rajat’s face after listening to my answer.

*********

Hi Readers. One of the most frequently asked question by our blog readers is how to select right mutual funds to invest in.

Although mutual funds are managed by professional managers, however, not all funds perform are equally well. There are many funds who are not even able to beat the index. That’s why it’s really important for you to select right mutual funds that will fulfill your investment goals.

While researching the best mutual funds to invest, most beginners just look at the past performance. However, two equally other important factors to be checked before selecting any fund is whether the objective of the fund matches your investment goals and what are the different risks associated with the fund.

Moreover, mutual fund investing is a long-term relationship. Unlike the direct investment in stocks, where the people can switch the stocks fast, mutual funds are a long time period commitment. Most people stick with their funds for over 8-10 years. Therefore, it’s important that you choose a right fund and not get stuck with lagging ones which might result in you to lose both time and money.

In this post, we are sharing a beginners guide to select right mutual funds in seven easy steps. This guide will help you to perform exact step-by-step research to find winning mutual funds. Let’s get started.

A Beginners Guide to Select Right Mutual Funds in 7 Easy Steps

Here are the seven essential steps to select right mutual funds that will help you to meet your investment goals.

1. Read the Offer Document Carefully

One of the most comprehensive documents that every mutual fund provides is its offer document (also known as the prospectus). The first and probably the biggest step while choosing a mutual fund is to read the offer document carefully.

The offer document contains all the important details regarding the mutual fund like its objective, scheme type, past performance, details about the asset management company, classes of the underlying assets etc. (Quick note: If you are not familiar with these terms, check out this post regarding the must-know mutual fund terms). There is a strict instruction by SEBI regarding the filling of offer letter offered by the mutual funds- which you can find here.

In short, begin your research by reading the offer document of the mutual fund. Moreover, it’s not really difficult to understand these documents.

2. Match the objective of the fund with that of yours.

Every mutual fund has a specific objective. And based on the objective, they decide different factors like asset allocation (equity to bond weight), risks, dividend payouts, tax benefits, theme/sector focus etc.

You need to read the offer document of the fund and attentively identify whether the fund objectives meets your investment needs in terms of the above-mentioned factors. If the objectives are not relevant to you, then it might not be a good option to invest in those funds w.r.t. your investment goals.

3. Check Fees and Exit Loads

Mutual fund charges a fee for offering services and to meet different expenses like manager’s fee, operational & administration costs, advertisement costs etc. Generally, this expense ratio for an active fund can be as high as 2-2.5%. Further, some mutual funds may also charge you a fee up front when you invest (entry load), or a deferred sales charge when you sell your shares (exit load).

These pieces of information are present in the offer letter of a mutual fund. As a value investor, you should try to stay away from mutual funds with high fees and loads to avoid unnecessary costs.

Also read:

4. Evaluate the past performance of the fund

Although the past performance of a fund will not guarantee how well it will perform in the future, however, it will give you a rough idea about the returns and expectations. This is certainly an important factor which must be checked. Moreover, you should compare the funds’ past performance to the benchmark as it will give you a better idea of its actual performance.

You can easily find the information regarding the past performance of any fund vs the benchmark on the financial websites like ValueResearchOnline or moneycontrol. Further, focus on the long-term performance (3 years or greater) and compare it with its competitors and index.

5. Analyze portfolio and holdings

This may be a little tricky for those who have zero knowledge of investing. After all, even if you find out which companies that mutual fund is investing in, how will you understand whether the holdings are good or bad?

Nevertheless, analyzing the portfolio and holdings gives you a general idea about the securities in which the fund is investing. Here, the key point is to make sure that the fund is investing in the type of securities in which you are interested. For example- if you are optimistic about electric vehicles and want to invest a major proportion in the automobile sector, look for a mutual fund which has a high percentage of allocation in the automobile sector. Similarly, if you’re interested to invest in other sectors like energy, infrastructure, finance etc- then studying the portfolio will give you a good idea of whether the fund is right for you or not.

Anyways, there is also small trouble while analyzing the portfolio and holding. The portfolio/holdings can change from time to time as the manager may decide to buy or sell securities at their will in the future. Therefore, if you are not regularly reviewing the fund, the current allocation might be a little different from the time when you invested in the fund. That’s why you should always review your fund every six months or a year after purchasing to confirm that your requirements are still met by the fund.

6. Check the Credentials of the Fund Manager

The fund manager is probably the heart of any mutual fund. He/She is the one who will be making all the important buy/sell decisions on your behalf. Therefore, it’s important to find out more about the fund manager.

A manager with a long tenure may have done the job well and his/her credentials are tried out. On the other hand, the efficiency of a new manager might not have been tested yet. While researching mutual funds, check the tenure of the fund manager to find how long this fund manager is managing the fund.

Another important factor regarding the fund manager is to check which other funds he/she is managing. If the other funds are also doing equally good, then it is a good sign. On the other hand, if just one fund is performing well- while the other funds that he/she is managing are struggling, then it might be a fluff.

7. Check the size and credentials of the fund house

Although it’s not the biggest factor, however, as an intelligent investor- always invest in the fund which has already established a good track record. It’s important that the fund house has strong credentials because mutual funds investing is a prolonged relationship and you do not want to get involved with a troublesome fund house which might give you headaches in upcoming years.

Nevertheless, in a few scenarios, you may invest in comparatively newer plans or fund houses. For example, if there is an exciting new theme based fund house that meets your asset allocation plan, then feel free to invest a small amount in it and later increase the amount depending on the performance.

Quick Note: If you are new to investing and want to learn how to invest in mutual funds from scratch, check out this amazing online course: Investing in Mutual Funds- A Beginner’s course. Enroll in the course now to start your journey in the requisite world of investing today.

Bottomline

The procedure to select right mutual funds to invest requires a careful study of the fund. In this post, we have covered the seven critical factors that you need to check to select right mutual funds to invest.

Besides, you might have noticed that we didn’t talk about the ratings of the fund. This is because of the reason that the ratings vary from websites to the website. It’s quite rare that you’ll find the same fund listed in the top 10 suggested mutual funds on different financial websites. Which one to trust? Better make your own decisions. Anyways, if you’re really interested to check the ratings, then the CRISIL ratings may be a little helpful.

Here is the final tip- Do not rush with investing. There are hundreds of mutual funds in the Indian market. Take your time to analyze them and find out the one that best suits your goals.

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

September 12, 2018 Mutual Funds 5 comments
credit score

Credit Score – Everything You Need to Know!

Hello readers. Many a time, you might have heard that you should keep a high credit score. You should not default that EMI or else it will hurt your credit score.

An obvious question that may come to your mind is what actually is a credit score?  How are they measured? Moreover, why should you care whether your credit score is high?

Today, we shall be covering this hot topic in personal finance which we believe is central to addressing the financial health of any individual.

The topics we shall be covering are as follows:

  1. What is a credit score?
  2. Why is credit score important to you?
  3. How is credit score measured?
  4. Where can you get your credit report?
  5. How can you improve your score and how long does it take?

This is going to be a very interesting post, especially for the youngsters. Therefore, let’s get started.

1. What is a credit score?

Credit score is a metric used by banks and lenders to provide a comprehensive risk profile of a borrower. It is provided by four companies in India namely TransUnion CIBIL, Equifax, Experian and Highmark. The most popular agency of this being TransUnion CIBIL which provides the fabled CIBIL score.

The score is basically a reflection of your monetary habits derived from your transaction history upto three years which banks give these agencies periodically.

Also read:

2. Why is credit score important to you?

Credit-Score-Range

Every time you approach a bank for a loan or credit card, the bank tries to gauge the risk that comes along with your loan application. Gone are the days when your branch manager used to engage you in a long and mundane conversation asking about everything from your family background to your parents’ monthly pension before sanctioning the loan you asked for. Nowadays, they just send a mail to the credit agencies asking them for your credit score.

Upon receiving this request, the credit agencies aggregate your transaction data from multiple banks to ratify your profile into a scale of 300-900 to give a simple quantified data point for banks to make a judgment. After analyzing your score, the banks decide whether to accept or reject the application for the new credit card or loan, period.

The score bands used by banks for making an inference about your risk profile are as below

Credit score band Rating Comments
800-900 Excellent You have done great work on your score, make sure it doesn’t dip.
700-800 Good You most likely a couple of hiccups in your payments but that shouldn’t stop banks from rejecting your applications. You could improve your score through minor improvements
500-700 Average Although you may not be able to get loans immediately. You could improve your score within a matter of 2-3 months through planned action.
300-500 Poor You have several missed payments and defaults. Most banks would reject you right away.

Since a lot of things in life is unpredictable like the occurrence of disease or death of a family member, it would be beneficial to keep a healthy credit score so that one can always avail a line of credit when needed.

3. How is credit score measured?

The credit score may vary slightly due to the difference of calculation between each of the credit agencies but they more or less look at the same things to arrive at your score.

The following are the different parameters the credit agencies use to judge your score along with the weightage attributed to each of them.

Parameter Weightage
Credit History 30%
Credit Utilisation 25%
Credit Mix and Duration 25%
Other Factors 20%

Credit History: This is the most important factor in determining one’s credit score. The agencies look at one’s loan repayment data provided by the banks complete with the loan schedules, EMIs, late payments, and outstanding loans.

Credit Utilisation: This basically the percentage of loan one has outstanding to the total loan amount that can be availed. Ideally lower the loan one has outstanding the higher one’s score.

Credit mix and duration: The type of loan you avail also has a bearing on this aspect of one’s credit score, a higher amount of unsecured loan could lower credit score faster than an equivalent amount of secured loans. The reason for this being that secured loans are backed by property or any other asset that the bank can claim in case of default making it less risky than an unsecured loan.

Other factors: These include miscellaneous activities such as the number of hard inquiries made at the bank for loans and credit card applications. The banks often construe this as a sign of a person being under financial stress. This may have a negative impact on the credit score.

Also read: 10 Best Credit Cards in India [With Exploding Benefits]

4. How can you get your Credit Report?

As per the RBI directive in 2016, every customer is entitled to one free report from each of the credit agencies in a twelve month period. This means that you can get a total of four credit reports from all agencies together. We at Trade Brains advise that our readers avail this every quarter or at least semi-annually from different credit agencies.

You can avail your reports from the websites of the four credit agencies.  (TransUnion CIBIL, Equifax,  Experian, Highmark)

It is advisable that you don’t use a third-party website to obtain your credit reports since your confidential information could be stored by them.

5. How can you improve your score and how long does it take?

A seven-point roadmap to improving your score can be as shown below:

  1. Make all your EMI payments on time and close your outstanding debt as soon as possible
  2. Avoid making unnecessary credit limit extension or loan applications
  3. Reduce unsecured loans such as credit card loans and personal loans and pay them out as soon as possible
  4. Try to keep surplus cash in your accounts so that you can avoid the use of a credit card
  5. Keep checking your credit report for mistakes, if you spot them to take it up with your agency
  6. Avoid accepting settlements for your loans from banks even though your dues may be reduced significantly. The banks report this to credit agency which adversely affects your score
  7. Avoid being co-signee or a guarantor to friends or family who tend to habitually make late payments on their loans.

We believe that if you follow these steps, you should witness your score improve within the duration of three months to a year depending on your past scores.

Note: If you are yet to get a credit card, here is a quick link to check your eligibility and apply for credit cards online.

Bottom line

Credit Score is the most important metrics banks and financial institutions use to gauge your risk profile. It would be beneficial for an individual to maintain a high credit score so that they can avail a line of credit in times of need.

Although not easy, a credit score can always be improved through planned and disciplined action on the side of an individual. We at Trade Brains hope our readers make the best efforts to maintain a high credit score.

September 11, 2018 Credit Cards, Earn More, Personal Finance No comments yet
what are fang stocks

What are FANG stocks? And why are they so popular?

Originally coined by Jim Cramer of MSNBC, ‘FANG’ is a group of high performing technology stocks that includes Facebook, Amazon, Netflix, and Google (Alphabet).

While all these companies started as tiny startups just a couple of decades ago, they have rapidly grown into innovation engines and in the process have delivered stellar returns to investors.

Just to put the size of the FANG companies into perspective, as of September 7, 2018, the combined market capitalization of the four companies was USD 2.4 Trillion. This is greater than the market capitalization of all the 30 companies in the SENSEX (USD 2.2 Trillion) put together!

Nowadays, the FANG acronym has multiple versions. Some investors added Apple to the list to coin the term FAANG. Meanwhile, Goldman Sachs created their own acronym, removing Netflix and adding Microsoft to the mix, to form FAAMG, signifying the top 5 tech companies that have been the primary drivers of growth in the US stock market.

Regardless of what you call them, these technology companies have displayed unprecedented growth and have become darlings of investors across the world. Some key facts about the companies:

Facebook

  • Along with its own successful social media platform, Facebook owns Instagram, Whatsapp, and Facebook Messenger. All of these are globally recognized platforms with more than 1 billion users each.
  • Facebook makes the majority of its revenue from advertising. In fact, Facebook, along with Google, is a duopoly in digital advertising. Facebook captures almost 20% of the entire digital advertising spend in the US.
  • The Facebook stock recently lost USD 120 Billion in value primarily due to concerns over data privacy. Despite the stock price hit, Facebook continues to grow its revenue. At the end of 2Q 2018, the company’s revenue grew by 42% to USD 13.2 Billion.

Amazon

  • A global e-commerce player, Amazon recently crossed the coveted USD 1 Trillion market cap mark for the first time.
  • The company has captured 49.1% of the online retail market in the US and is set to post USD 258 Billion in retail revenue in 2018.
  • One of Amazon’s growth drivers is its cloud computing service called Amazon Web Services (AWS). AWS revenues grew by 42% year on year in 2Q 2018 to reach a revenue of more than USD 4 Billion.
  • It also has an internet advertisement business, which is expected to drive significant future growth and achieve USD 16 Billion revenue by 2021.

Also read:

Apple

  • Apple was the first company in the history of the stock market to hit a USD 1 Trillion market cap.
  • It has the market cornered for smartphones. Despite capturing only 18% of the smartphone volume, the iPhone captures about 87% of the profit margin of the entire smartphone industry. This is in stark contrast to Samsung, which captures only about 10% of the industry’s profit.
  • It also has a rapidly developing internet services business that grew at 31% year over year to deliver USD 9.5 Billion in revenue in Q2 2018. An incredible feat for a mature company.

Netflix

  • The first global TV provider and pioneer of the subscription model, Netflix has more than 130 million subscribers worldwide. This large subscription base allows it to spread development cost across its users and thus gain a cost advantage over its competitors.
  • Recently, concerns have been raised over the high debt the company is raising to fuel content development, and also around the increasing number of streaming competitors.
  • In the past several years, Netflix has almost always beaten investors’ growth expectations. However, the next phase of its growth is going to be challenging, it missed growth targets for Q2 2018.

Microsoft

  • Satya Nadella, the CEO of Microsoft, has done a tremendous job in navigating Microsoft through a post-Windows world.
  • Led by its cloud and AI practice, the company’s revenue surpassed USD 100 Billion for the first time, in the fiscal year 2018.
  • In its last earnings release, the company announced that its three core business units reported double-digit revenue growth, with Azure Cloud (its cloud services arm) leading the charge by posting 89% year over year revenue growth.

Google (trades under the name of Alphabet)

  • The leader in digital advertising, Google has captured 90.5% of the search market. Despite its massive size, Google’s revenue continues to grow rapidly.
  • In Q2 2018, revenue was up 26% year on year to reach USD 32.6 Billion.
  • The company enjoys a leadership in AI technologies, largely due to its massive user base and superb ability to capture and utilize big data to train state of the art machine learning models.

Clearly, the FANG/FAANG/FAAMG companies are on their way to revolutionizing how the world interacts with and benefits from technology! 

In order to become a part of this journey and to invest in these companies, visit Vested – It’s a platform that allows you to invest in US-listed companies like Facebook, Amazon, Google etc. in a cheap and simple way.

September 10, 2018 Market, Stocks 7 comments
how to measure your investment performance

How to Measure Your Investment Performance? The Right Way.

How to measure your investment performance? -The Right Way

Hello Readers. Honestly, we at Trade Brains love cricket!. We also happen to love following the latest records and comparing statistics of our favorite players. Which of our players are the most consistent? Who is more likely to score runs and how often? Who plays better against spinners? And who works best on a flat pitch?

Well, these are just some of the questions that we keep asking ourselves right?

This got us thinking, is there anyway, we as investors, could borrow from the sport and rate ourselves? And can we make ourselves as better investors through a defined process? After all, introspection is the best critic we have on our side right?

In this post, we will be covering the different metrics and techniques, we as investors, can use to measure our performance and hopefully identify and strengthen the weak spots in our investment process. An over the top view of the toolkit is as follows:

  1. Hit-rate
  2. Slugging rate
  3. Holding Periods
  4. Performance relative to the benchmark

Overall, this post will give the best ever solution to measure your investment performance. So, without wasting any further time, let’s get started.

How to Measure Your Investment Performance?

Here are the four best and easy metrics that you can use to measure your investment performance over the years in a right way.

1. Hit Rate

Broadly defined, hit rate is the percentage of profitable investments to the total number of attempted investments.

hit rate- How to Measure Your Investment Performance

The keyword in this metric is “attempted investments”. Many a time, retail investors do more harm than good to their portfolios by investing in stocks they do not understand in an attempt to diversify their portfolio. This approach could result in below market performance for the investors in the long run. A better approach would be to make infrequent but highly probably bets in the market.

This sentiment is also paraphrased by master investor Warren Buffett through one of his famous analogies comparing investment performance to playing baseball.

“What’s nice about investing is you don’t have to swing at pitches. You can watch pitches come in one inch above or one inch below your navel and you don’t have to swing. No umpire is going to call you out. You can wait for the pitch you want. In investing, just as in baseball, to put runs on the scoreboard one must watch the playing field, not the scoreboard. I’ve never swung at a ball while it’s still in the pitcher’s glove.”

 – Warren Buffett

Also read: Why You Should Invest Inside Your- Circle of Competence?

2. Slugging Rate

Quite simply this is a measure of how much you profit when you win and how much loss you incur when you don’t.

slugging rate -How to Measure Your Investment Performance

Logically, any investor who wishes to make positive returns will have to ensure that their gains outdo their losses. The more the outperformance of the gains the better the returns will be for the overall portfolio.

Also read:

3. Holding Period

Although most investors think they need not use this statistic to measure their performance, we at Trade Brains, believe otherwise.

Ideally, you as an investor would want to hold on to your winning picks and exit your losing stocks quickly. While, this doesn’t mean that you drop a stock just because it went down immediately after you bought the stock, a stock that drops 40-50% should be treated as a red flag and reviewed before taking a decision on whether to continue holding the stock or not.

4. Performance relative to the market benchmarks

Since most investors seek to beat the market over time, it would make sense to measure your portfolio’s performance against broader market indices such as NSE Nifty 50 or BSE Sensex.

The performance relative to the market indices can help you decide whether you need to increase your exposure to mutual funds or stop investing on your own entirely.

For a portfolio composed of predominantly large-cap stocks, it would make sense to compare the portfolio relative to large-cap indices (and similarly for mid-cap and small-caps).

But what if your portfolio had exposure to large, mid and small cap segments of the market?

Let us understand the method of evaluation through the following example.

Assume that an investor has 30% exposure to large-cap stocks, 30% to mid-cap and 40% to small-cap stocks.

The best method for evaluating such a scenario would be to take the weighted average returns of indices to measure one’s portfolio performance.

Market Segment Market Index 3-year return Portfolio exposure
Large Cap BSE Sensex 54.20% 30.0%
Mid Cap BSE Mid Cap 62.90% 30.0%
Small Cap BSE Small Cap 62.2% 40.0%

The weighted average returns of the indices for a similar market exposure as the portfolio will be given by the following expression-

Weighted Average returns for 3 Years = [(large cap exposure x large-cap index return) + (mid-cap exposure x mid-cap return) + (small-cap exposure x small-cap return)] x100

= [(30.0% x 54.20%) + (30.0 %x 62.90%) + (40.0% x 62.2%)] x 100

= [0.1626 +0.1887+0.2488]x100

= 60.01%

If the investor’s portfolio achieved returns greater than the 60.01% in three years (that would have been achieved by a similar exposure to the market benchmarks), then it is best for him to continue investing on his own. Otherwise, it would be better for the investor to allocate his capital to Index Funds with similar weighting or change his/her investing strategy.

Closing thoughts

The financial markets are fantastic yet dangerous places to grow your wealth over a lifetime. Any investor who wishes to play the game for the long term will have to continuously adapt their investing process to achieve the most optimum returns.

We hope our readers will add the above methods to their toolkit for measuring portfolio performance. Happy investing.

September 10, 2018 Investment Basics 1 comment
the law of small numbers cover

What is the Law of Small Numbers? Meaning, Examples & More.

What is the Law of Small Numbers? Meaning, Examples & More:

Often we don’t realize but the game of investment can be closely connected with hardcore psychology. You must have heard many people say: research before you invest.

While that is absolutely true, you must also know what to research for. While being on a searching spree, generally, you find many online (or offline?!) resources which tend to favor a kind more than the other. Enter, The Law of Small Numbers.

A data has multiple dimensions and each one of them is responsible for inferring the data in a different context. Statisticians tend to choose the attributes (read dimensions) very carefully. The choice of attributes is not random, of course. A couple of data mining techniques such as “Decision Tree Induction” can carry out specific attribute selection methods to take exact inference.

Coming back to the real context, “The Law of Small Numbers” is actually a law confirming fallacy. It says that the length of data is an important consideration for a data as the probability of it being relatable is directly correlated to the length of the data. Read more of this article to get to know about “The Law of Small Numbers”.

The Loophole in the Probabilistic Inference:

Imagine our whole world running on the rules of probability! However fancy it might seem, it is not actually possible otherwise you would be having a fair chance to everything, wouldn’t you? The point is that probabilistic results are always relative. You can neither expect nor confirm the extent of its reality.

The source of the data that you are picking for your hypothesis and inference is of great importance here. Rather than completely shifting your focus to what does a data infer, you might want to shift your focus to where the data has been picked from (and possibly how).

Random Sampling is one of the famous probabilistic sampling techniques which goes with a very basic rule: Each element has an equal and a fair chance of getting picked. Now, nothing in this world is absolutely defined by itself and so the fair & equal chance is quite a hypothesis.

Also read:

Causal Explanation/Causal Narrative:

A Causal Narrative is something which is derived from general human behavior. You must have not realized but we humans have always indulged in pulling out inferences from the pieces of information that are provided to us. The data, however, is not always full-proof.

To put it in clearer words, the data can be churned out as a result of random sampling which makes it even more difficult to put a word to the analysis done through its inferences. You must note that Random Sampling inferences are sometimes misinterpreted as the whole account of the data is not clear and was in fact collected randomly. Similarly, a causal explanation of a data which has been collected or sampled randomly does not always pull out exact inferences.

Why? – Because we are trying to infer a cause for something which has no cause (by its nature).

Hence, equal attention must be paid to the method which has been used for collecting the data.

Sparse Population & an Example:

In a famous statistical puzzle related to kidney cancer among the 3143 counties in the US, the data had two interesting (& confusing) inferences at the same time.

Inference 1: US Counties with the lowest rates of Kidney Cancer have the following attributes:

  • Mostly Rural
  • Sparsely Populated
  • Located in traditionally Republican states in the Midwest, the South, and the West.

Inference 2: US counties with the highest rates of Kidney Cancer have the following attributes:

  • Mostly Rural
  • Sparsely Populated
  • Located in traditionally Republican states in the Midwest, the South, and the West.

Now, how two exactly opposite (in nature) inferences can have exactly the same attributes?

The key attribute or factor here in this example is the sparse population of the data collected in the first place. In fact, a misinterpretation of the data source has been done because of the sparsely populated data as a small population (generated with a random chance) is inclined to show greater extremes in terms of deviations.

Let’s understand this context better in terms of another famous example:

Take an example where a jar of equal red and green marbles is placed and you need to pick 4 marbles out of the jar randomly. The possible outcomes noted are:

  • 2R/2G <- Actual Population Mean
  • 3R/1G or 3G/1R
  • 4G/4R <- extreme outcome (has 12.5% chance)

When the Sample sizes are increased and for example let’s say we’d be picking out 7 Marbles instead of 4 then the probability of extreme deviation (i.e. picking out 7 same colored marbles) is reduced to only 1.8%.

This result is in fact derived from the very famous law –  “The Law of Small Numbers”.

(Credits: Kevin deLaplante)

Conclusion

The law of small numbers explains the Judgmental bias which occurs when it is assumed that the characteristics of a sample population can be estimated from a small number of observations or sample data.

Therefore, while studying any survey, the length of data should be given an important consideration as the probability of it being relatable is directly correlated to the length of the sample.

September 9, 2018 Investing Psychology No comments yet
Does Investing take too long to build wealth trade brains

Does Investing take too long to build wealth?

Does Investing take too long to build wealth?

“… Even Warren Buffett build most of his fortune after an age of 50. Admit it, Kritesh. Investing takes too long to make money.” Gaurav asked wickedly.

“I’m not denying the fact that investing requires time to build wealth. Yes, it does take time. However, it doesn’t mean that it takes too long time.” I defended my argument.

“But what’s the point of getting rich if you are too old to use that money?“, Gaurav replied.

“You do not need to be in your 50s or 60s to build a massive wealth by investing. There are many investors who are able to gain financial freedom in their late 30s or early 40s just by investing intelligently. Here, how much time it takes to build wealth depends on how early you started and how intelligently you’re investing.”, I added.

I could notice that Gaurav was still not convinced. Therefore, I continued.

“…Moreover, now that you have started the topic of Warren Buffett, I would like to add that he did become a millionaire by the age of 30. Obviously, it took some time for him for becoming a billionaire and the richest man on the earth… However, being a millionaire in the early 1960s was a big deal. Besides, its a lot of money for most people who aims for a financially independent life.” I summed up.

warren buffett wealth growth

(Source: MarketWatch)

Gaurav seems to understand a little regarding what I’ve been trying to convey for the last fifteen minutes. However, our arguments generally never end within an hour. And hence, Gaurav was ready to fire his next question.

“…So you are saying that investing takes time to build wealth; but not too much time?” Gaurav asked with his witty sense of humor.

“All I’m saying is that for an intelligent investor- creating money doesn’t mean being wealthy in your 60s. One can achieve it a lot earlier. Obviously, value investing is not a get rich quick scheme. However, if you have made the right investments, you’ll start getting decent returns in next few years. Yes, it does take time, but the rewards are also great for those who are willing to be patient.”, finally, I had put my words to meaning.

*******

Does Investing take too long to build wealth?

As a value investor, I understand the importance of investing for the long term. When you invest for a longer time horizon, the power of compounding works in your favor. Moreover, if you have invested in the right companies which and it is giving good returns, it does not makes much sense to sell that stock just to keep the money in the bank account. Keeping the stock for the long term in your portfolio is the key to build wealth. But how long is relative to your goals.

Nevertheless, one should always remember that successful investing is a tricky business. It takes years of time to learn to invest intelligently in the stock market. Most people should not expect to make money investing over the short term. Besides, the majority of the good stocks takes at least 2–4 years to give amazing returns to their investors. Investing for six months is only good for making small profits, not wealth.

Also read: #21 Biggest Wealth Creator of 2017- Up to 1,450% return in a year

Earning from capital appreciation

Most stocks investors know this method to build wealth. Buy low and sell high. While investing in stocks, you can expect to make money through capital appreciation i.e capital gain when the share price rises. The profits can go as high as +1,000% (also known as ten-bagger stocks). However, even for the safest stock, there is no guarantee that the price will go higher in the short term.

Earning from dividends

Apart from capital appreciation, investors can also make income from the dividends. A healthy company distributes profits to its shareholders in the form of dividends. In most cases, the company partially distributes profits and keeps the rest for other purposes such as expansion, buying new assets, share buybacks etc. The dividends are distributed per share. If a company decides to give Rs 10 per share, and if the face value of the share is Rs 10, it is called a 100 percent dividend.

Anyways, an important point to learn here is that dividends grow over time for fundamentally strong companies. And if the dividends from the stocks are consistently increasing over the years, this means that the net income for the investors will also increase over time.

Also read: How To Make Money From Dividends -The Right Way?

Wealth creation over long-term

You might have heard the wealth creation stories of the common stocks like Wipro, Infosys, MRF etc. An investment of Rs 1,000 in these stocks in the early 1990s would have turned out to be worth over multiple crores in next 25–30 years.

Most people argue that no one can keep a stock for so long time frame. And I agree with their logic. Even, if I had invested in such stocks, there might be a few times in the time period of the last twenty-five years when I might have been tempted to sell those stocks and book profits. Overall, I agree with the logic that holding stocks for 25–30 years is a little difficult.

However, people ignore the second assumption that the investment in stocks was just Rs 1,000. This is something worthwhile discussing here. If I was an investor in those stocks, I would have definitely increased the investment amount with time. Investing just Rs 1,000 doesn’t make much sense if you already know its history of consistently making wealth over time. Any intelligent investor would have increased their investments in such stocks.

Therefore, while arguing the time period of investment for such wealth creators, also give a little attention to the investment amount. For simplicity, the analysts consider that people invested just Rs 1,000. However, as a matter of fact, most investors continuously increase their investment amount over time. And that’s why the total returns could be even higher than what mentioned. Even if you had not kept those stock for a long time frame, still the fact is that those stocks would have created a huge wealth for their investors.

Besides, you do not need to sell your stock to build wealth. As discussed above, you would have already made income from the dividends. And moreover, if the value of the stocks in your portfolio is increasing, your net worth will be increasing along with it.

Also read:

Conclusion

While holding stocks for the long term is the key to build massive wealth, however, it would be wrong to say that investing takes too long to build wealth. Even if you are investing for a decent time frame like 8–10 years, still the returns can be amazing.

Besides, if you do not need the money, it would be worthwhile to remain invested in that stock. There are only three reasons when you should sell any stock- 1)If the fundamentals of the stock changes, 2) When you find a better opportunity to invest, 3) When you really need to money. In all other cases, you should remain invested in stocks.

As Warren Buffett used to say- “Our favorite holding period is forever”.

September 4, 2018 Investment Basics 4 comments
robo advisors in india

A Quick Guide to Robo Advisors in India.

In the last few years, the financial market has noticed a strong rise in the robo advisors in India.  As a matter of fact, these Robo advisors have broken down the traditional barrier between financial services and the average investors.

For a very long time, an average investor cannot afford the advisory facilities of the high-fee Dalal street advisors. However, with the rise of robo advisors in India, these investors have a new alternative now.

In this post, we are going to discuss robo advisors in India. Here are the topics that we will cover today:

  1. What are Robo advisors?
  2. Benefits of Robo advisors
  3. Shortcomings of robo advisors
  4. Are all robo advisors in India same?
  5. Who should use a robo advisor?

In short, it’s going to be a very interesting post. Let’s get started.

1. What are Robo advisors?

In simple words, Robo advisors are online platforms that provide automated financial planning services based on the designed algorithms with minimum human interference. This is a method to automate asset allocation (and investments) of customers using computer algorithms.

Robo advisors are easy for goal setting and allocation for those who have no idea of where to begin.

Basically, robo advisors collect important pieces of information from clients like their financial situations, goals, preferences etc through a survey. And they use this data to offer financial advice or to automatically invest clients assets. (Please note that here the financial experts of the firm regularly monitor the market activity and underlying investment to keep the algorithm efficient.)

Robo advisors differ from the traditional financial advisors and do it yourself investors on various factors like cost, flexibility, time & research etc. Here is a simple comparison between traditional advisors, do it yourself investors and robo advisors.

Traditional Advisors Do it yourself Investors Robo Advisors
Cost High Low Medium
Feasibility Medium High Low
Minimum Investment High Low Low
Time & Research Low High Low

From the above table, you can notice that the robo advisors can be a good alternative to the traditional advisors.

One of the most popular robo advisor in united states is Betterment which was founded in 2008. A few of the popular robo advisor in India are Arthayantra, 5nence, Invezta, Scripbox etc.

Also read: 11 Key Difference Between Stock and Mutual Fund Investing

2. Benefits of using robo advisor.

The biggest benefit of robo advisors is that they deliver services directly to the customers.

Compared to the traditional advisors, robo advisors offer a low-cost alternative because these digital platforms similar services with a fraction of cost charged earlier by eliminating the human labor. Moreover, robo advisors are easily available and can provide a 24×7 support.

In terms of initial investment, you need a very little capital to get started with robo advisors in India. Same is not true in case of traditional advisors. For an average investor, the fees of the traditional advisors can cost a lot. They can easily charge as much as 20-30k for providing the advisory services of a year. Nevertheless, if you are investing a small amount (say less than one lakh), then even if you make a good return of 15% on your investments, still this profit will be gone in the annual advisory fee only.

That’s why most of the clients of the traditional investors are the people who are investing lakhs of rupees. In general, the top human advisors won’t take clients with less than Rs 10-15 lakhs of annual investments.

Also read: Why It’s Absolutely Okay To Not Have An Advisor?

3. Shortcomings of Robo Advisors:

The robo advisors in India are still in the evolutionary phase. And that’s why they still have a few shortcomings.

For example- Robo advisors lack emotions and empathy. As investments are also a subdomain of behavioral finance, there are still some doubts about the viability of Robo advisors.

Further, although they are good for beginners, still robo advisors are not effective for the advanced advisory services like complicated tax planning, real estate investment planning, multiple stage retirement planning etc.

And finally, Robo advisors are not trained/equipped to deal with an unexpected crisis or extraordinary situations like the economic crisis of 2008. Whether they can perform better or worse than the traditional advisors in such situations- is still not tested.

Also read: The Essential Guide to Index Fund Investing in India.

4. Are all Robo Advisors in India Same?

Now that you have learned about the basic meaning of the robo advisors, the next big question might be that- Are all these robo advisors the same.

The answer is ‘No’. All robo advisors are not the same in India. They have different algorithms and moreover, they differ in important factors like minimum investment, annual fees, asset allocation, account type, support, automation, tax planning etc.

If you are planning to use robo advisory, it’s important that you check these criteria and find out the best one that suits you.

Quick Note: If you are new to investing and want to learn how to invest in mutual funds, check out this amazing online course: Investing in Mutual Funds- A Beginner’s course. Enroll in the course now to start your journey in the requisite world of investing today.

5. Who should use a Robo Advisor in India?

The simple answer is that anyone can use Robo advisors in India.

However, the complicated question is whether they should or not? For the people who are investing lakhs of rupees, should they go with revolutionary robo advisors or choose the time-tested traditional advisors?

Although it might take years to find the right answer to the above question. However, there is no denying the fact that robo advisors in India are a good fit for people who are young, lacks investment experience and have a simple portfolio.

That’s all for this post. I hope it was helpful. Happy Investing.

September 1, 2018 Robo Advisory 5 comments
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