“Singing in the Lifeboat” – A book review

(If I had never met with Ian Bain, I do not think I would have read this book. It was my good fortune to have met Ian. Apart from being a fabulous host, he is also a great story teller. Ian has had a fabulous life- Moving from town to town and school to school in Scotland, not finishing his school, working for a newspaper at 15 and then a sailor, a smuggler, a sub editor , an entrepreneur and then treading the path spiritual. All this in one lifetime! I will wait for more stories from Ian)

Ian Bain has given us a glimpse in to his Life. From a disturbed childhood, lack of ‘formal’ education to becoming a sailor, a journalist, a successful public relations entrepreneur … his life is anything but ordinary.

Living for the day, Ian moves from country to country, job to job, has his battles with the bottle and finally finds peace in his spiritual pursuit.

The book is fast paced. Makes you want to know what happens next to Ian before you can put the book down.

The writing is easy, and Ian succeeds in putting a smile on the reader’s face even as you go along the most turbulent of his life phases.

A truly remarkable journey in a single life. Not many of us are privileged to have so much excitement and learning.

The title is very apt. Ian moves from one potential shipwreck to another all the while, without losing his charm or cheer. If I change the timelines of history, I will say that Robert Bruce was inspired by Ian.

I am sure Ian must have had his days of gloom, but as I read the book, they disappear among the words and the turning of the pages.

Ian’s editorial skills are imprinted across the book. He wants to make sure that the reader is not burdened with any boredom. He has succeeded. I finished the book in two sessions.

In this book, are hidden many more books. Ian’s time line spans a period that has seen remarkable changes. And Ian has been in ‘happening’ places all along. As a reader, I would love to have Ian tell me stories of Dubai in 80s, of ocean voyages, of his bootlegging booze to Bombay, the Simla he saw that was frozen in time, the America that he experienced. He is a story teller nonpareil. He makes fishing sound interesting even to a vegetarian like me.

I am fortunate enough to have met Ian. Ian and Sharadha are wonderful people and hosts that did not make us feel like guests. And Leela, another wonderful host at their place.

Ian and Sharadha’s tryst with spirituality and healing tops off the book. Even here, it is ‘giving’ and doing good. Good at heart and at hearth, I wish them forever years of happiness and togetherness.

I am waiting for his next book on Baba, the real Slumdog… And then on Leela… And then on….

Go get a copy of the book. You will not regret it.

This is where you could get one:

 

https://www.amazon.in/Singing-Lifeboat-Ian-Bain/dp/1906852421/ref=sr_1_1?ie=UTF8&qid=1531909910&sr=8-1&keywords=singing+in+the+lifeboat

 

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Of Index Funds and ETFs— Some thoughts

(This appears in today’s edition/s of Deccan Chronicle)

(http://epaper.deccanchronicle.com/articledetailpage.aspx?id=11142075 )

 

 Globally, it is tough for mutual funds to beat the performance of broad indices. Yes, there would be a handful that beat the index, but looking at the rearview mirror, picking them up, can be hazardous.

In India, our Index is not the best representative of the market. If we take the current market, over 40% of our index weight comes from one sector- Banking & Finance!.

This is what our NIFTY looked like a few days ago:

nifty july18

(Source: https://www.nseindia.com/content/indices/ind_nifty50.pdf)

 One sector keeps pulling the broad indices. And individual stocks’ weights also can distort the picture. Every fund manager would be overweight or underweight each of them according to his judgement and expectations. However, collectively, all the investors move the stocks different to what rational expectations are. In addition, a fund will not limit its portfolio to stocks out of an index (unless it is an index fund). As I am writing this, the NIFTY is headed towards an all time high driven by stock prices of some private banks. A mutual fund manager would use his discretion and some may be of the view that the private bank stocks are expensive and put money in some other place where they find value. They cannot be chasing momentum.

A mutual fund manager tries to pick value, growth and future performance. In the early days in India, you could beat the indices easily as the index had a lot of companies that were boring or dying companies. And a lot of undiscovered opportunities were waiting. Today, the index has become packed with high momentum stocks and the chances of new discoveries has reduced due to the number of investors as well as the easy availability of information. In addition, the promoters are aware of the wealth creation abilities of the stock markets and are always eager to spread their story.  All this makes it difficult for a mutual fund manager to keep constantly beating the indices.

It is said that globally less than five percent of mutual funds beat the broad indices. This will happen in India also.

This makes a strong case for ‘passive’ investing through index funds. You know what you are in for. You could either do a SIP or keep making lump sum purchases when you have money. Personally, I would recommend a SIP process and when we do get some extra moneys, try for some direct equity if so inclined.

The exchanges keep revamping their indices to keep adding the big names and trim the ones that do not deliver. In a sense a passive fund management is happening behind the scenes. If you look at the Sensex of just 30 stocks ( the BSE Sensex was created sometime in 1980-81 with 1978 as the base year). Stocks that were in the Sensex include names like ACC Ltd, Bombay Dyeing, Premier Automobiles (defunct), Nirlon Ltd, Centure Textiles, Proctor & Gamble, Mukand Ltd, Tata Chemicals etc… Thus, the Sensex itself keeps evolving and tries to include companies that are becoming bigger and excluding companies that do not keep pace. And including a company or dropping a company from an Index has its own consequences. Many global funds are happy with passive tracking and will mimic the index. All index funds will sell the stocks that go out of an index and buy the new entrant.

Thus, the broad indices, while they will have their excesses either way ( I seriously doubt if the index will ever be at a perfectly fair valuation ever… Everyone’s perception is different and funds flows in to markets are a big determinant of the indices) are a fairly good way to participate in the stock markets. .

And we will have two choices- Either use an Exchange Traded Fund (ETF) or an “Index Fund” floated by a Mutual Fund. Personally, I would pick an ETF for the simple reason that costs are lower than in an Index Fund. The procedure for buying and selling is different. ETFs are bought and sold like stocks. So it will call for an action on your part to make a buy. You could easily set up a SIP with your broker on most online platforms for stock trading.

If I do not have the time and the skills for direct equities, I would suggest the ETF route. You can have ETFs for all indices. It is a matter of time.

 

 

 

Retirement Simplified

(This is from my Moneylife article published in the issue dated 28-09-2006) A primer on planning early for your retirement.

 

Here is a simple strategy to retire wealthy. The hard part is following it

Today, with starting incomes being fairly handsome, it is possible to have a nice nest egg when you are 50. You can retire early if you choose to, do something on your own or chase your dreams, provided you plan early. All you have to do is to take a fixed amount every month and put it away for a definite time horizon. Do not put away such a large amount that you will be tempted to use it before the time period is over. Save small amounts every month as a discipline. Think of this money as money that you would have spent at a restaurant. Let this minimum not change.

As your income rises, use the extra money to save for other things that you aspire. Even if you can save Rs 2000 every month from the time you are 25 till you reach 50 and assuming a minimal return of 10% a year, you will have over Rs 26 lakh at the age of 50! The amount you have invested is Rs 6 lakh (300 monthly installments of Rs 2000 each). Hindsight is a great thing. As I grow older, I realise that I should have started planning my savings and investments this way, much earlier in life.

Now, comes the question where to invest. I am a great believer in equities. If we believe that, on an average, our GDP will grow even at a rate of 7% over the next few decades, corporate profitability in nominal terms would increase by over 12-14% each year. Ultimately, this would get reflected in share prices. Of course, there would be terrible years in between, but since you would be buying every month, you will finally emerge as a winner. Investing in equities also addresses the taxation angle, assuming that capital gains would remain tax-free. What stocks to select? Assuming that this savings is the minimal amount we put away, the basic objective is to prevent erosion of wealth. I have three choices to recommend, the first one being my preferred one:

1. Choose an Exchange Traded Fund (ETF). ETF represents an index and indices typically include the largest companies that have a track record and reasonable survival prospects. Each ETF unit comprises all the stocks in the index it represents, in the same weight. More importantly, it takes away the decision-making aspect of which stock to omit and which to choose as the ETF automatically adjusts for changes in index components. The transaction costs are minimal and can be bought or sold like a stock. Pricing is real time. The one caveat is to avoid sector based ETFs and stick to a general index like Nifty or Sensex.

2. The second and inferior option is to choose a mutual fund scheme. Transaction costs are higher and the fund is vulnerable to the fund managers’ decisions. There is no guarantee that over a long period, a mutual fund scheme would outperform the index. Globally, it has not happened and there is no reason to believe that it will happen in India.

3. The third alternative is to invest directly in equities. You have to follow a strategy of investing once a year on a fixed date. Limit yourself to a few stocks (not more than 10), but you would have to do a lot of homework about choosing the 10 best and sticking to them over time, subject to periodic reviews. I would choose large established companies that I expect would be in business at least for the next 10 years. Having chosen them, I would divide my money equally among the 10, eliminating any personal bias.
This strategy may sound simplistic and unexciting but believe me, it is remarkably effective.

Keeping eyes open in the stock markets….

 

(This appears in today’s Deccan Chronicle . Buying opportunities are best when there is some fear and pessimism. Interesting times, though I cannot forecast the waiting period. Typically, commodity stocks take a long time after peaking, to bounce back. First they have to crack hard then stagnate before the next round of optimism takes them up. )

 

The market is a great teacher.  There is a list doing the rounds on the social media. It shows the percentage of loss in share price from their highs. Many of the popular stocks have lost between thirty and sixty percent of their price.

These are mostly small cap and mid cap stocks. They climb up rapidly and drop down as easily. Your state of mind depends on when you got in. And when they are first ‘discovered’ they are in short supply. Someone has slowly accumulated the free float and then it keeps shooting up as the only persons who show interest in the stock are ‘buyers’. So, on its journey after discovery, “Upper Circuits” are the norm. The second lesson is that exit from these stocks is an art. You have to sell when there is optimism and people are screaming to buy it. When the tide turns, and everyone is a seller, there is obviously no buyer. These small stocks have a few thousand shareholders at best and there is no institutional interest. So, when everyone is a seller, the “Lower” circuits come in to play. Thus, your timing of entry and exit are both critical. Even mutual fund managers have not got it right. Their fear is that they accumulate large volumes and when they come to sell, it won’t get absorbed.

 

Very often, the decline in the mid caps also is a signal of the end of a commodity cycle. Those magnificent doubling of profits / sales every year or Q on Q secular growth etc are at some stage going to halt. Once the trend peaks, the next step is for earnings to decline, till many players go in to the red. This is a normal cycle. Each time there is an upturn, there is a new story and each one thinks “this time, it is really different”. Six months ago, no one would even have thought about any price actually going down, forget losing twenty to sixty percent.

 

And have the prices come to desperately attractive levels? My view is, NO. Nothing has become cheap. Most cases, very expensive has come down to expensive. And even that may not hold good as earnings will very likely show smaller numbers.

 

For a change, the FII money seems to be trickling out. However, the strong domestic inflows have been kind of holding on so far. While the bigger indices have not shown much decline, the smaller ones have lost considerably.  Clearly shows that the smaller company space is losing steam.

Let us flip the coin. Is it time to buy? What if the stock price has gone below its ‘fair’ value as we estimate? For example, we discovered that a mid cap stock “XVL” has historically (last 10 years) traded in a Price to Book range of 1.2 to 4 times. So, if it comes to near 1.2 times or below, should we be buying? Logic says, we should buy. The only caveat is that we cannot look for a quick return. For that, apart from business cycle, investor moods have to change. That time frame is generally unpredictable. Looking at the commodity cycles, perhaps the best is behind. Results will get weaker. New capacities are being planned by those companies that can find the money. Interest rates are on the way up.

 

So buying now may be fine as far as price goes. However, given the circumstances, your wait could be long. And it is likely that when the sector or company revives and investment climate improves, the returns could be exponential. The important thing is to make sure that the company we have identified will hang in there and do business as we expect it to. It is better to be frugal and not take 100% of our planned exposure right away. You could get more juicy opportunities. However, if you make a list of five or ten small companies which you like, you can keep a checklist and slowly put money in to them in instalments. Do not chase every stock. Do not say ‘yes’ to the first opportunity that comes your way. If we understand business cycles in a commodity, it helps. Dig data from the past and see how much time gets spent at the bottom of a price chart.

The other caveat is not to be anchored to recent highs and lows but to stick to a process and method. Do not violate that. There are companies that lost 70% between 2008 and 2009. And from there lost another seventy.

 

 

 

 

 

Stock markets- Holiday Season

(This is my column in Deccan Chronicle today.  http://epaper.deccanchronicle.com/articledetailpage.aspx?id=10910014 .

Hope is eternal. It is difficult to admit that stocks can get ‘de-rated’ . Specially, when we are holding it. Many of us might have caught on to the momentum very late. And the whiplash would have caught us off guard. I do believe that there is further pain in the markets. It is best to understand the risks rather than getting tuned off from the markets. Maybe it is time for a long wait??)

THE TRADE TURNS…

Over the last year or two, some stocks ran up ten times or more in price. In the last couple of months, many have corrected by thirty percent or more. So, to those with a short-term memory, these stocks look attractive. Should one buy or avoid?

Commodity companies have had a spectacular year, thanks to China. Is this sustainable? I do not know. I have generally used a very passive approach to commodity stocks. I have used the Balance sheet as my basis to buy rather than the Profit & Loss account. This approach keeps me out of mischief of having to estimate profits. I fully believe that commodities will not go out of fashion in a hurry (when they vanish, they do completely- Remember there used to be a metal called “TIN” which was replaced by Aluminum?). However, they do go through cycles of boom and gloom. And it is safe to buy when no one wants it rather than when everyone is out to buy them.

Thus, I am happy to wait out for the next round of neglect that these stocks will be subjected to. It may even take five years. Who knows? But one thing I know is that at current levels, I am playing with uncertainties and probabilities, with no margin of safety.

What I will have to be alert for is ‘value’. Neglect sets in rapidly. Some companies can go below the balance sheet valuation. When the next cycle turns up, these stocks will give returns. The uncertainty here is the timing. The wait can be very long. Or very short. Depends on the flow of funds. Corporate results are unlikely to turn around in a hurry. So, once again, patience is the key. Patience and watchfulness.

One way to keep track of these companies is to take ten-year averages of ROCE or of EBITDA margins. The recent years will show these numbers at the upper end. The time to buy them would be when they are at the lower end of the ten-year averages. Here, I am avoiding the conventional PE ratios. It is very likely that when it is a good time to buy, the PE could be extraordinarily high, since the earnings will be very poor to negative.

One big possibility is that we would be still hanging on to many of these commodity stocks even now. Our minds are anchored to our ‘buying’ prices and there is a reluctance to convert the ‘paper’ losses to actual losses. That may not be a good thing. Surely, there is more pain ahead for most of the commodity sector stock prices. Even now, there are many brokerage reports telling us to ‘buy’ or ‘accumulate’ such stocks. Suddenly, we are discovering that early quarter profits were due to inputs being from old inventory and that new prices are beginning to cut in to margins. When all commodity prices are going up, did we wonder why input costs were not going up in tandem? Now as quarterly results start getting announced, the ‘growth’ in profits seem to be mellowing down as opposed to ‘bellowing’ advertisements and talks in the media a few quarters ago. We are hearing talk like “This quarter has been a subdued one, but we expect the full year to be better..” or words that indicate less confidence in future trends.

No management is going to come and warn the public that they are headed for hard times. It is up to us to read the ‘tea leaves’.

Does it mean that we exit small companies, commodity companies and put our money in to ‘large’ companies? It all depends on whether there is a compulsion to keep remaining invested 24X7 in to stocks. Staying in cash sometimes is also a good option. Global undercurrents are not very conducive to continuing funds flow in to our markets. The US increasing interest rates means that more money will be headed in to US rather than emerging markets. Interest rates in India never came down as was widely believed. And on the contrary, it has started to move up. Increasing interest rates would mean that some of the moneys that chase equities will now chase debt. One is because of returns and the second is because of a perception that rising interest rates are bad for corporate profits, unless you are a bank.

So, if you have made money and have cashed out by and large, good for you. However, if you were late on to the band wagon and are staring at losses, it is still not too late to get out. What will happen is that you will have a long a painful wait and may not make anything. Given your injuries, your wait may be just till prices recover to your ‘anchor’ price of buying. This happens every time the cycle turns. At that point, will you treat it as a ‘new’ trade ? Or will you just blow a big breath of relief, sell the stock and put the money in to a FD? Being the victim of timing is not new. Learning from it is the key.

 

 

 

 

 

 

Coffee-can quality- Some thoughts

(This was published in Deccan Chronicle. A few pointers on building a ‘coffee can’ portfolio. )

 

I mention this terminology “High Quality” stocks quite often, in my writings. Some people have asked me whether I could be specific in defining or explaining what a “High Quality” (HQ) stock is.

Let me put across some characteristics of HQ stocks, as I imagine them to be.

 

  1. Longevity with Pricing Power

In this era of technological change, life cycles of companies are shortening. So what it means to find HQ is a tough task. Many years ago, we used to talk of NOKIA as a HQ stock. We thought it would last forever. Or Kodak (do not know how many of this generation even know the brand name ‘kodak’). Even a mighty company like General Electric has metamorphosed.

At the same time, we have companies like Unilever, P&G, Gillette, Cummins, 3M etc which seem to keep going on and on. They are in the same space and remain leaders in their industry. This leadership also brings with it a distinct edge in profitability. They are typically very profitable. Shareholder returns are the consistently high. A company like Colgate India or HUL has enjoyed 100% return on equity in many years. However, I like to put a number of 25 as the required ROE, consistently, over ten years at least. Maybe in financial services or banking it is not likely that such high ROE can be seen, because there is nothing special in what one bank offers vis a vis another. Banks will be lucky to earn over 15% ROE consistently.

These companies deliver products or services of a quality that is demanded by the buyers, thereby enabling the companies to enjoy the power of pricing.  These companies always pass on their cost increases. They constantly increase their profitability by lowering costs and maximizing revenue. Examples of this are companies in FMCG space, Page Industries, Asian Paints, Eicher, Hero Motors, Bajaj etc.

2.Low to zero debt

HQ companies will have no debt at all.  In five to ten years, these companies would become debt free. Their profitability is high, working capital management is good and typically, their cash conversion cycles are low. From buying raw materials to the point of selling and collecting their money, these companies have high efficiencies and do not keep throwing more and more money behind working capital. Thus, we will not find companies in infrastructure, real estate, manufacture of heavy capital goods, ship builders etc with these HQ attributes. These companies have a very long cash cycle and their profitability is generally not commensurate with the risks they take. Have a look at the companies in Wind Power, Solar power etc. They rarely have five to ten good years in a row. They run in to debt crises sooner or later. And to grow sales, they need more money.

3.Tax paying

HQ companies will be generally paying tax at the marginal tax rates. This is because these companies have high Asset Turnover (a rupee of fixed asset generates many rupees of turnover in a year, unlike a ship builder or a infrastructure company) and do not make investments simply to save tax. We see many promoters spend on unnecessary capital expenditure simply to lower tax.

4.Dividend paying

All good companies should be paying dividend to shareholders. This is because of two reasons. One- cash is not needed by the business. And the second and more important reason is that keeping extra cash in bank simply lowers profitability. The business may earn 25% ROE and money in the bank will earn less than five percent post tax. We expect promoter/management to run a business and not to run a treasury.

5.Capital Allocation

HQ companies will pay out dividends. They remain focused on what they do. They will not simply diversify because there is cash. As a shareholder, when you invest , say, in a two wheeler company, you do not want the management to get in to real estate. Many promoters have used cash in the books to invest in stock markets. These are poor quality companies. IF promoters want to indulge in all this nonsense spends, they should buy out all the shareholders and do what they want. So long as even one share is held by the public, they should not be doing this.

If we take a short list of companies with the highest ROEs, with a cut off of, say, 25%, we may not get more than 300 companies. And there will be not a single company from the financial sector or the banks. Banks in a country like India get high valuation because of growth. The best bank enjoys ROEs under 20%. And many of them get their higher ROE not from core banking, but from other activities. So, it is difficult for me to put this sector in to a HQ label. Yes, I like HDFC or HDFC Bank or Kotak or Cholamandalam. They are well managed and probably the most profitable in their business. And with every other good attribute. However, they will not make it to the list because they fall short on my ROE expectation. The main reason why we invest is to ensure that the invested money earns the best possible return. We are not biased towards any one kind of business. We are looking at ‘sustainable’ growth with high ROE.

 

 

 

Integrity? What does it have to do with Shares?

(This was published in the Deccan Chronicle. Some editions on 29/4/18 and some on 30/4/18.  http://epaper.deccanchronicle.com/articledetailpage.aspx?id=10567284 )

Management quality is a function of ethics and governance. Someone asked me how important are these two attributes? If we go by ‘equity research’ reports, it has absolutely no importance. No report comments on the quality of the management, preferring to be diplomatic or practical, since most sell side firms need some business in banking or equities to come their way. Equity research as a function has never made money on its own. It is like the appendix in the human body.

Of course, it comes in to play when we want to acquire a company or take a significant stake in a company. Then we will all perhaps spend a lot of time figuring out who the owner is and what are his strengths and weaknesses. Sometimes, I see large institutional investors taking significant stakes in companies where the management quality is known to be suspect. I can only infer that it is perhaps a reflection on the quality of the investor also. Institutional investors are managed by people who get salaries and bonuses and they are not investing their own money. Most of us seem to think that it will not impact the investment.

We think that by the time the bad qualities come to the fore, we would have cashed out our gains. Or we think that with so many other investors, we are not alone. We always seek for this comfort that we are not alone.

Governance and ethics of the highest standards are something that exist only in seminars and books. When it comes to money, there are shades of grey everywhere. The one thing working in favour of the investors is that most often, the businessman is also interested in maintaining  a perennially north bound share price and hence our interests are aligned. In the old days, when salaries of directors were restricted to a few thousands, there we no ESOPs or ‘preferential allotments’ or ‘warrants’, the story was different. Also, the interest rates used to be high and our markets were small. Stocks never got such fancy valuations as what exist today. So, the promoter found it useful to take money away and leave just enough for the shareholders. Today, with the fancy valuations the stock markets give, the promoter finds that keeping a rupee inside the company adds substantially to his wealth. And the promoter can take his multi-crore salaries, dilute when the price is right, issue warrants to himself when the timing is good etc. There are so many indulgences that have become legal now. Thus, the promoter has less reasons to skim off.  A higher EPS translates in to significant wealth, given the benevolent secondary markets.

Of course, no one is immune to a structured fraud. That can happen to catch the best of investors unaware. Satyam Computers was one. Of course, the investors got lucky there since there was a motivated attempt to rescue the company in order to bail out a select few. However, I do not see the same things happening in a Gitanjali Gems.

However, one way to keep ourselves safe is to avoid companies with high debt, unusual amounts of cash in hand combined with low dividend payouts, continuous raising of capital, constant mergers and acquisitions, having hundreds of subsidiaries, having too many ‘associate companies’ (associate companies are where there is no disclosure, since there are external persons who are co-owners) etc. Avoid in general companies where ‘revenues’ are based on some funny accounting or on ‘certification’ by management rather than plainly visible ones. Have a look at the schedule of Fixed Assets (nowadays referred to as ‘non-current assets) and look at what is happening there. Is there too much of fictitious assets like Goodwill? Is too much invested in real estate? Too much goodwill? All of these are just warning signs and call for deeper probe rather than just ignoring or accepting. Many edifices are built of papier-mâché. Kicking the tyres by going through the schedules of accounts for a few years will be a good habit to keep.

Other thing that has helped me is to have a binary classification for valuation- companies that have brands or consumer products to be valued on basis of revenue. Companies that deal in commodities etc to be valued by Balance Sheet. In essence, I find out what the company can make and how much of assets are needed. Then compare it with the “ENTERPRISE VALUE” (enterprise value is the sum of market capitalization PLUS debt) .  That helps me to buy when the industry is doing badly and sell when it is doing well.  Of course, the approach is simplistic, but a great start point.

Management integrity always pays off handsomely over time. If you are taking chances, taking it knowingly. And be prepared for surprises. There is no early warning signal as to when a fraud will be exposed. .

p.s. A good analyst can always smell the cockroaches. No investor has patience to listen to someone ranting about it

 

 

 

Independent Directors?? Fortis/ICICI

(This appeared in the Deccan Chronicle of 15-4-18 and 16-4-18.  What is happening at Fortis or ICICI has thrown the spotlight on the “independent” directors. My view is that it is easier to believe in Santa Claus than in the ‘independence’ of independent directors)

In an earlier article, I had talked about the importance of Management Quality. When I buy a share, I become a co-owner of the business. The share price will over time, behave as the business behaves which in turn is dependent on the management. Thus, my fortunes are hitched to what the promoter-manager does. Often, the promoters/managers do things that benefit themselves exclusively and the other shareholders suffer. The suffering can be of two kinds-  A reduced return which may still be good (and thus overlooked by all) or a disaster in the making where the promoter-manager takes the cake and leaves the others with crumbs.

The person/s in charge of the affairs have a fiduciary responsibility to every shareholder. Every act should have an equal impact on ALL the shareholders. When it hurts one at the cost of the other, we can say that governance has failed ant TRUST betrayed. It is truly a criminal breach of trust when the shareholder is diddled out of money by the person/s at the helm.

In today’s corporate world, CEOs are extremely well paid, with incentives linked to performance. CEO pay has to be decided upon by “independent” director. However, thus far, the ‘independent’ directors have excelled by their silence rather than speech. Not just any one company, but every company you come across.

How much can be blame the “independent” directors? In general, the independent director is chosen by the promoter. There is no way someone will pick up a person who will every speak up against the promoter. And today, the ‘independent’ directors are paid well, given a lot of free perquisites etc which are significant incentives. And by speaking up, there is a very high probability that no other company will like to have you on Board. This is common sense. So most often, the ‘independents’ keep quiet or prefer not to speak up. Unless of course they see that the risk of not speaking could make them an accomplice.

Let us understand one thing. An ‘independent’ can only know what the CEO or the promoter chooses to tell him. Other than statutory accounts, he is not privy to much. Some decisions which require a board resolution will be known. Day to day spending and/or revenues or decision making is hidden from them. So, an ‘independent’ director need not know most of what goes on. It is time we gave up the ghost that ‘independent’ directors are guarding the investors. Nothing can be farthest from the reality on the ground.

However, there are situations when these honourable gentlemen have a role to play. Let us take the case of Fortis Healthcare Ltd. Here is a company, with the promoter having lost all his stake by pledging and no clear owner visible. Add to that some dents to reputation that this industry will give to every player. In such a situation, they are the guardians. They should guide and advice the shareholders about various options available. Instead, they just acceded to the first offer for acquisition that came about. They should have found out what are other options and advised what is best for the shareholders. Their role should not extend to decision making. The decision making should be by the shareholders. The independent directors cannot do what they have done in this case. In case of M&A or other offers, they should firstly find out what other offers are possible. They should have engaged an investment banker to get counter offers. Once that was done, they should have evaluated the offer, negotiated the best terms and then put it to the shareholders for approval, with their recommendations and reasons.

What is disturbing is the goings on in the so called ‘professionally managed’ banks that are neither PSUs nor privately owned. Here, the professional management and the board have a duty to be beyond reproach. Banking is a business of Trust. If there is any deal involving a ‘related’ person, it should NOT be done at all, rather than depend on the lame excuse that there was ‘full disclosure’ and there was ‘no conflict of interest’. The independent directors have clearly let down the shareholders by keeping quiet about it. As is said, “Caesar’s wife must be above suspicion”.

Regulations or rules cannot bring about corporate governance. If there are harsh punishments on independent directors, surely no one would want to be in that position. Maybe it is best to do away with the concept of ‘independent’ directors. That way, there will be no illusion of governance. Even with independent directors, capital allocation decisions are always the prerogative of the promoter director and the independent director can only nod. Often, capital allocation decisions are a fait accompli by the time it reaches the Board rooms. So let us be on our guard. It pays to be skeptical. You cannot be disappointed.

Some additional thoughts;

Any independent director, at best, can help preserve a modicum of governance. He cannot be expected to know the business and is dependent on what the CEO/promoter tells him. However, in cases like Fortis, they should have played a better role than they did.

 

 

 

How do I lose less money this year in the markets?

(This appears in today’s Deccan Chronicle http://epaper.deccanchronicle.com/articledetailpage.aspx?id=10369714)

Essentially a review of past misdeeds and a resolve to not make the same mistakes this year.  The turn of a new calendar is an opportunity to revisit some good and not so good habits in investing)

STOCK TA(L)KING

Bad loans, frauds in listed companies, weak markets, interest rate volatility, bankruptcy proceedings, corporate deals and a full plateful on the political debate arena. All seem to strike at the same time. So many distractions. As the financial year closes and new tax rules are about to set in, it is time to tick the boxes again. I do not know how your year has been (not that a financial year matters in the investment journey), but what chatter I can hear on the social media, it looks like a lot of inventory that is under water, is waiting in many investor accounts.

This is as good a time as any to reflect on the actions we did. We had at some point agreed that we will be ‘disciplined’ investors. Discipline was with reference to our yardsticks for buying, our objectives for buying and our processes for stock selection. If we re-examine our ‘mistakes’ we will probably see that we let our optimism get the better of us and bypassed our set processes or violated our discipline. Too much noise and stories of riches being made had an impact on our thought processes.

What this will do is to scare us off the market. We will be frozen. While the index may have fallen ten percent, there will be many stocks which have fallen twenty to fifty percent. Not all of them may be good buys, but there could be some opportunities. So, the thing to do is not to keep away from the markets, but to take a piece of paper and write down our rules for investing/ trading. I make a distinction between the two. Investments consist of High Quality stocks that will not be sold, unless the entire story changes and not just one quarter mishap. Trading will be stocks we pick up, where the quality of earnings is not the best and would probably offer some cyclical/seasonal plays. Here, the price of the trades is important. Taking money off the table is important. Stop-losses are extremely important. You will see that many mistakes are still in the portfolio because we did not have the heart to be strict about our stop-loss rules.

I also see that there is a lot of corporate action, insolvency proceedings etc which can throw some trade opportunities. 2019 being an election year, and one with no proper budget, there is greater stability in government policies. Tax rules have changed, which makes the investor almost indifferent to long term or short term from a taxation perspective.

Thus, the task ahead of us is very simple.  Let us divide it in to two parts:

INVESTMENT opportunities in High Quality stocks can be done, if the price is right. In a market correction, there will be some extremes, which offer a great opportunity for buying. Sticking to High Quality will protect you from getting washed out. It is important that the core portfolio be built with High Quality stocks.

TRADING is for those with a penchant for trading. Those with a compulsion to do something. At an aggregate level, this portfolio is almost certain to give a lower return than the INVESTMENT portfolio over an extended period. Here, the way to preserve capital / reduce losses is to stick to ‘stop-loss’ discipline. Treat each trade as a unique event. Focus has to be on prices. Do not fall in to a trap of keeping the stock for long and increasing your exposure to it by ‘averaging’ on dips etc. Do not forget why you do this.

As a ‘trader’ you often do not do any study of the company. Many could be on impulse or on the basis of ‘following’ someone. You do not have any reason as to why it should succeed. That is the reason a stop-loss rule helps.  Just as you have a stop-loss rule, it is important to have a ‘book-profits’ rule. Do not violate that. The third element you may like to include is to have a ‘time-limit’ for a single trade. These three elements will keep you going for a longer time and ensure that you do not run away from markets for good.

Stock prices are dependent on a lot of things. Value is an important thing and when there is an over-valuation, we are in reality just ‘trading’ the trend. Ensure that you are not ‘anchored’ to past ‘high-lows’ of the trade you make. That is a sure way to end on the losing side. It is best to remain focused on the ‘now’ in your trading portfolio.

 

 

 

Big Name Stock or Small Company? A tip please…

(This appears in yesterday/today editions of Deccan Chronicle. http://epaper.deccanchronicle.com/articledetailpage.aspx?id=10269023

Most of us who want to buy stocks for the first time want that unknown small company which will make our ten thousand in to a crore… What are the odds? Read on…

I come across many requests for ‘tips’ or ‘recommendations’ for investing in shares. There are two categories of people who just ask. One is the type who have not invested in direct equities. The other ones are the seasoned ones, who are in search of new ideas. Let us leave aside the second category for now.

The first timers are interesting. Many of them have heard stories, read the news and are generally up to date with most headline financial news. Some of them keep trying their luck at applying for IPOs and when they do manage to hit the button, sell it on listing. If they have made a gain, they are happy. If the stock shoots up after they sold, then the story is never told.

Many of them walk up to me and ask me to give them a couple of names for investing for the ‘long term’. Naturally, it has to be such that the price should only go up. And since they think I am an ‘expert’, the stock should do far better than the market. They are conditioned to think that only penny stocks or low-priced stocks can be the recommendations.

I tell them that if they are making a beginning, they should start off with well known names like HDFC, HDFC Bank, Kotak, Cummins, Bajaj Auto, Hero, Nestle, Levers etc. Their response is that “oh, that is too well known, you should be able to tell me of a small stock that will grow”.

If you are a first timer, you should stick to well-known names. Pick a product that is familiar to you. Your daily use tells you which companies are popular and touch your life regularly. These may be well known, but they are also good and safe havens for your wealth. Most of them deliver excellent returns and you are unlikely to do worse than the market, over time. Of course, if you could pick a basket of five to ten names you like, I would urge that you do a SIP in those stocks for ten years. You can keep increasing the allocation to SIP as your income grows. This kind of a portfolio will create a solid bundle of wealth for you.

If I give you an unknown or lesser known name, it is only a ‘potential’ that is being given to you. In today’s world, there are more number of analysts per stock than there are investors. Everyone with a computer and internet seems to be talking shares, earnings, multi-baggers. The flows in to equity have never been so strong and it can only go up from here. Discovering new ideas is an extremely tough ask and the risks are very high. The best money can be made only if you spot a company that will go on to become one of the top three or four in any industry.  Here, there is a lot of luck also involved. You would have been lucky to pick a Symphony instead of a Maharaja or a Hotline. There is always an element of luck in picking. And the one who you think has made 100 X from some stock, must have put his moneys in to different stocks. His winners get talked about. No one talks about the ones that did not make the grade.

You have to first secure your wealth with solid assets where preservation of capital is needed. Smaller names can be picked up with money that you can afford to lose without batting an eyelid. And to make big returns, it is not enough if you put some Rs.10,000 rupees in to an idea. You have to commit significant amounts to make real wealth. Here, do not forget your compound arithmetic.  Let us say, that the stock market gives us an ‘average’ return of 15%. Suddenly we read that HDFC gave a compound return of 29% over 27 years.  Do you realise the significance of this? Let me give you a small table with 30 year returns…

Let the ‘power’ of compounding sink in. Cut this out and stick it on a wall. If you put aside a sum of a lakh of rupees and just forget it for thirty years, this is what it would be, at the end of the thirty year period, at different rates of return:

 

Annual Maturity 
Return  (Rs Lakh)
A B
6% 5.42
10% 15.86
15% 57.58
20% 197.81
25% 646.23
30% 2015.38

When the return increases from 10 to 15 percent, the final value is nearly four times. Thus if a quality company grows its profits at around 15 to 20 percent per annum, it is reasonable to expect that the share prices will also do likewise. Thus, when you have reasonably good comfort in well-known names, what would you choose?

When there is a simple solution, why do we complicate things?