Don’t just do something, stand there!

Johann Sebastian Bach, the great German composer and musician, once said

“I was obliged to be industrious. Whoever is equally industrious will succeed equally well.”

Johann Sebastian Bach

Bach was a prolific artist. He composed more than a 1,000 original pieces, over a 40 year period. In fact, he kept composing music right up to his death, in 1750 AD. I don’t know of many musicians today who can boast of such a feat.

Even though popular perception has it that when producing creative work, one cannot substitute quantity for quality, I have read in a number of places that authors, musician, painters work diligently everyday….  many a time working at the same time & place… almost like going to office daily. They all acknowledge the fact that a stroke of genius doesn’t happen by accident but by purposeful work. In this regard, Bach was no different. He had a very regimented approach to composing his music, diligently spending time each day doing what he loved most. He knew he had to put in the hours to compete with contemporary composers such as Vivaldi, Telemann & Handel. And above all else, he was German, so, peristent work came naturally to him.

As kids, I am sure that each one of us has been told the Aesop’s fable of “The Grasshopper and the Ant”…. about how the industrious Ant gathered food for the winter while the lazy Grasshopper whiled away the summer only to die of starvation in the winter. This was supposed to teach us that doing something was somehow better than doing nothing.

I am sure that this advice of being industrious is applicable to most aspects of life but for one, Investing. Nifty 50, over the past week has had a few vicious sessions, falling from a peak of ~10,150 to ~9,730 which represents a fall of almost 5% in the space of a couple of sessions.

The fall has been much worse for the Nifty Next 50, Midcap and Smallcap indices. When there is so much volatility, especially on the downside, there is a tremendous urge to do something. Behavioral finance has taught us that the pain we feel when $1 is lost is only offset by $2 of gains. This is called “loss aversion”. So, per unit, loss hurts more than the happiness gain gives. Thus, many a time, people tend to panic when they see a ⇓ or a red number in their portfolio. They feel the urge to do something to stem the loss. Typically, they end up selling. Is this the right strategy?

Empirical studies have clearly proven that one cannot time the market…. So, when you sell something, you never know if the trend will reverse the next day or the next year. And when it does reverse, you don’t know whether to buy again or wait… fearing another correction. This is a slippery slope…. timing the market never has worked. If it had, you would see billionaire technical analysts whose sole business it is to time the market.

Jack Bolge, one of my heroes, had this to say when he was asked what an individual investor had to do when the Dow Jones Industrial Index had suffered a few brutal sessions of selling.

“Don’t just do something, stand there!”

Applied to Investing, this is Jack’s take on the famous American adage “Don’t just stand there, do something!”

Watch the full video by clicking below…. don’t miss it….. absolute 100% gold.

https://finance.yahoo.com/video/individual-investors-stay-course-bogle-180600539.html?format=embed

Dragging one’s feet might not be a bad strategy in investing. The only people who make money when we keep “doing something” are the brokers. So, sloth, one of the 7 deadly sins, is not at all bad when it comes to investing. All one has to do is to ignore the temporary losses as if nothing has happened. This is easier said than done though.

I am going to do absolutely nothing if the Nifty 50 falls another 10% or 20% or 30%. I am going to keep investing as long as I have cash coming in. I have developed a thick skin when it comes to losses. Knowing the history of the financial markets, I know for sure that I will be rewarded handsomely for doing nothing. Contrary to what Bach said, equally industrious investors won’t succeed equally well. Perhaps Investing is the only place where you get paid better when you do nothing.

So, the next time the market goes bonkers, and you have an urge to do something… Remember Jack Bogle’s immortal words, “Don’t just do something, stand there!”

 

Read the disclaimer here.

 

 

Investment Nirvana!

The Reserve Bank of India recently identified HDFC Bank as a Systemically Important Bank. The two other banks which are on the list are State Bank of India (SBI) and ICICI Bank. If you would like to read more about this, click here.

HDFC Bank by far has been one of the best run large banks in India. It has one of the lowest Non Performing Assets (NPA) ratios, which has enabled it to profitably grow its loan book, which in turn has enabled it to become the largest bank in India by Market Capitalization. Indeed it has come a long way since its incorporation in 1994. Nerdy fact: the first branch in Sandoz House, Worli, Mumbai was inaugurated by the then Union Finance Minister, Dr. Manmohan Singh. Below are some pictures from that occasion…

HDFC Bank has become a main stay of most Mutual Fund portfolios, be it large cap funds, growth funds, value funds, financial sector funds or income funds. There are a lot of analysts covering this bank and most of these analysts have a very favorable view of the company. HDFC Bank has an excellent management team and are quite customer-centric, at least much more so than other big banks. I can personally vouch for this as a customer of HDFC Bank and some of its competitors. It is also a consistent dividend payer. All of these positive points have meant that HDFC Bank has a very high level of both domestic institutional and foreign institutional ownership. This wouldn’t come as a surprise as most Mutual Funds have HDFC Bank in their portfolios.

Let’s now look at how the stock has performed over the past 5 years. I have chosen 5 years arbitrarily. I am assuming that most investors would say 5 years would be the minimum window to qualify as a long term holding. The stock has given a return of ~200% in this period, roughly tripling in price from around Rs. 600 to Rs. 1,800. This works out to a annual compounded rate of ~25%. Clearly, anyone owing HDFC Bank during this period would have done extremely well for himself.

Picture this scenario in your mind. Assume that you have come into some money and are wanting to invest it. Looking at the fantastic rate of returns HDFC Bank has delivered and all the other positives associated with that bank, would you invest a huge chunk of your money in it? What are the questions you would ask?

If  I were you, I would ask the following 3 simple questions

1. Are the returns likely to continue in the future?
2. How have the shares of other companies performed during the same period?
3. Is this investment likely to increase or decrease my portfolio risk?

Given all the positives of HDFC Bank, let’s for a moment assume that the answer to question number 1 is a “yes”. Given the past rate or returns, HDFC Bank has out performed quite a few scrips in the Nifty 50 index. So, let’s give it a good score on question 2 as well. Now, coming to the most important question, if I would like to allot a substantial amount of my money to HDFC Bank, it will definitely increase my portfolio risk. There are simply too many things which can go wrong with a company, both due to internal or external factors….for example, business model disruption, fraud, lack of speed due to size, economic downturn etc.

There are 2 types of risks associated with each investment, systemic risk and idiosyncratic risk. One cannot get away from systemic risks … it affects all investments (ex. economic downturn, monsoon failure) but one can diversify away the idiosyncratic risk associated with individual investments (ex. fraud in a company, bad management, business model disruption). If you held the shares of many companies, the impact of fraud in one company wouldn’t dent your portfolio as much as if you held shares only in that company.

Now that I have sold you in on the benefits of diversification, the question we need to answer is “Can I generate similar returns as HDFC Bank, at a much lower risk?” The answer to this question is “yes, you can.” What if I told you that you could have gotten similar returns not holding shares of 1 company but 50 companies? Isn’t this Investing Nirvana?… diversification with comparable returns but at tremendously lower risk. Isn’t this what investors crave for?

There is an index called Nifty Next 50, which used to be called Nifty Junior index until recently. Nifty Next 50 is, as the name says, the next 50 companies which couldn’t make it to the Nifty 50 index. Look at the performance of Nifty Next 50 vs HDFC Bank over the past 5 years

As you can see the performance has been pretty close. In fact, Nifty Next 50 has outperformed HDFC Bank during most of the past 5 years except for the spurt HDFC Bank has had in the past 6 months.

Nifty Next 50 is tracked by an Index ETF called Reliance ETF Junior BeES, which is managed by Reliance Mutual Fund. The performance plot you see above is that of HDFC Bank vs. Junor BeES. There is another ETF which tracks Nifty Next 50, the SBI – ETF Nifty Next 50 fund. More about index funds and ETFs in another post.

Isn’t it strictly better to have 50 companies in your portfolio and attain the same returns as just having one company, while tremendously reducing your risk? All it takes to attain Investment Nirvana is to be an intelligent investor who is aware of the various investment vehicles. I pity people who blindly extrapolate past returns into the future without any sort of analysis. I would bet my house that the past performance of an index can be better extrapolated than the past performance of an individual company. This is so because the index is cushioned by many companies. One company’s under performance can be compensated by another company’s out performance. This isn’t possible if you only hold stock of one company.

In a future post, I will compare how Nifty Next 50 performed compared to the individual components of Nifty 50. Hopefully this should convince you to start investing in indexes rather than individual names. So, go ahead, attain Investment Nirvana by diversifying into the right types of investment vehicles.

Until next time, stay safe….

Read the disclaimer here.

Investing in Fools Gold

What would you do if I gave you a 10 Kg lump of this stuff?

Did you say you will jump around with joy while deciding which car to purchase next? May I recommend the Lamborghini Gallardo?

The Gallardo is Lamborghini’s best selling model. It is a 5 Liter, 10 Cylinder, 6 Speed beast, capable of doing 300 km/h. Did you know that the name Gallardo comes from a famous breed of bulls used for bull fighting?

Before you let your imagination go too far…. let me bring you back to reality. What if I told you that you wouldn’t be able to afford even the wheel of this car let alone the whole car. Yes, the lump of “gold” is not really gold. Pyrite, or Fools Gold, as it is known, has, over the years, fooled a lot of prospectors looking for real gold.

History is replete with a lot of smart and famous people such as Sir Martin Frobisher, Jacques Cartier, Captains John Smith and Christopher Newport who have been fooled by fools gold. Read more about it here… The famous saying “Not all that glitters is gold” owes its origins to the humble Pyrite, or Fools Gold.

“Not all that glitters is gold” is as much valid in the investment domain as it is outside of it. I have, over the years, made many investment mistakes which have come back to bite me in the arse. They were a “sure thing” when I invested in them… but they never made a penny for me. I think investments are about learning from ones own and others’ mistakes and not making them in the future. I have no shame in admitting them and will never commit them in the future.

I have been investing in common stock ever since 2002, and intelligently since 2008. I draw a clear distinction between just investing and intelligent investing. By intelligent investing I mean that all investments one makes should be backed by a sound foundation which has been proven empirically to stand the test of time. Once such a foundation has been adopted, one should stick to it through thick and thin. I would categorize all other forms of investing as speculation. So, technically, between 2002 and 2008 I was speculating, while I was under the illusion that I was investing intelligently. Let me give you an example of one of the speculative blunders I committed… Hopefully this will be instructional to my readers in terms of showing them how not to build an investment thesis.

I took my first flight in 2003. I still remember it as if it were yesterday. It was an Indian Airlines flight to Singapore. Had to be there on work … and yes, Indian Airlines did have a flight from Bangalore to Singapore during that period. It was a wonderful new means of transportation. I told myself that who wouldn’t want to travel by air… It was fast, safe and more comfortable than train travel. It was the hay day of low cost carriers in India. Air Deccan ruled the roost. So, when the IPO of Air Deccan came out in 2006, I couldn’t have been happier. I thought that I could make a tidy sum of money. I told myself that none of the Air Deccan flights seemed to go empty and hence they must be making good money. Moreover, the civil aviation industry in India was growing by leaps and bounds. The IPO price band was Rs. 146 – 175. I blindly subscribed to the IPO without even giving a cursory glance at the Draft Red Herring Prospectus (DRHP) or the company’s Balance Sheet and P&L Statement. As is the norm in India, to no ones surprise, the IPO got oversubscribed and share allotment happened at Rs. 148. I couldn’t have been happier at that time to own a piece of the burgeoning Indian aviation industry. In fact I went on to subscribe to the IPOs of Jet Airways and Kingfisher Airlines. The rest, as you know, is history. Kingfisher Airlines acquired Air Deccan and all the Air Deccan shares were converted to shares of Kingfisher Airlines. I eventually sold out of my position in 2008 at around Rs. 23. The Kingfisher Airlines stock is now trading at around Re. 1 mark.

What a tremendous loss of capital. Warren Buffet famously said

“There are only two rules to successful investing

Rule No. 1: Never Lose Money.

Rule No. 2: Never Forget Rule No. 1.”

If you are curious, my Jet Airways bet went down the shitter too. It went from an IPO price of Rs. 1,300 to a paltry Rs. 450 in 2008, when I exited that position. In fact the current price is around Rs. 400-500. So, if you bought the shares in 2008 and looked at it almost a decade later in 2017, you would have made no returns. All it has given is loads of volatility and constant downward movement. Thanks to the drop in Aviation Turbine Fuel prices, the company is managing to churn a meager operating profit of late.

Sir. Richard Branson once said “If you want to be a Millionaire, start with a billion dollars and launch a new airline”. The Aviation industry is perhaps the only industry which has cumulatively lost more wealth than created it. Was I wrong in investing in Airlines? Unequivocally Yes! I didn’t understand the cost structure of the industry or the heavily levered balance sheets of the Indian aviation companies. All I knew was that people would love travelling by air and thus, my thesis was, airline companies would do well. Guess what, true to my initial uninformed thesis, air travel in India has increased tremendously.

But the profits and thus the stocks of aviation companies have had exactly the opposite trajectory. Customer boom didn’t translate into company profits or investment gains.

Don’t be fooled by such investments. They will turn out to be fools gold. I was licking my wounds for a long time. Are these the only mistakes I have made? Of course not. I have made many others, but none have been loss making and this costly. They have made money, but much lesser money than if I had just bought the damn index without applying much mind. There is a lot of fools gold out there in the markets masquerading as real 24 karat gold. I don’t know what to call companies like Tesla or “currencies” like Bitcoin. Tesla at one point in time (mid 2017) was the most valuable auto company in the US, this with not a cent of profit to show for. Don’t get me wrong, the cars Tesla makes might be awesome and electric cars might be the cars of the future. But however good a company is, at a certain price it becomes a bad investment. Companies having very little to no earnings and commanding stratospheric valuation are nothing but fools gold to me. The sheen will come off once the surface is scratched.

It is always best, as I have already said, to have an empirically tested investment thesis and follow it through thick and thin rather than falling for hearsay or the next sure thing as per your own intuition. Don’t ever take stock tips from the so called experts on business networks without doing your homework and seeing how it fits your investment thesis. There are a lot of cocktail party investment advisers who will sell you fools gold assuring you that it is the real thing. Believe me, if you took the time to find real investment gold, with time, the Lamborghini Gallardo will be well within your reach. Wroom… Wroom….

Read the disclaimer here.