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It is never easy

May 28, 2016

7 Min read

The following note was sent out to our advisoryclients in February. This was in response to the jitters, some of them were experiencing after a 15% drop in the market. I think this is valid in all kinds of markets including the optimistic one we have now.
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I am not feeling any better knowing that the model portfolio is down less than the overall indices. I increased the cash holding a bit in the last few months and avoided the momentum stocks in the later part of 2015. Inspite of these defensive measures, the portfolio is getting hit and it is not pleasant to see losses every day.

At the end of 2014, after a 100%+ rise, I had written the following

It is easy to feel smug and complacent after a 100%+ rise in the portfolio. However it is precisely at this stage that the risks are the highest. The various companies in our portfolio are performing quite well in terms of business performance (topline and profit growth). In addition, we exited a few companies where I felt that the performance depended more on the macro than the company specific condition such as the management or the target market

In effect my effort has been to reduce the business risk of our portfolio. This however does not mean we do not face a price or a quotation risk. If the stock market drops by 20% (just an example, I don’t know what will happen), then our portfolio will get impacted too.

If your time horizon is less than 3 years and you cannot bear a 15%+ drop in the portfolio, then you need to take action when the times are good (such as now) and not after the market drops due to some macro factor.

In my case, I consider my equity investments with 3-5 year perspective (or more) and will continue to hold the positions through any future volatility.

I did not know when a drop in the markets will happen, but was sure that it would occur as that is the nature of markets – greed and fear. We had a period of greed in 2014 and 2015, which has now turned to fear.

A repeat of history
The recent events and volatility we are seeing, is not new and has occurred from time to time. The reasons have been different, but the end result is the same – fear and rush to the exits.

At times like these, no one is looking at the company and its fundamentals. The selling is often driven by panic and a desire to reduce the pain.

My own portfolio is invested exactly the same as the model portfolio and hence it is not a theoretical loss for me. I have seen this happen several times, and still feel the same level of pain. Experience does not change the reaction to such losses.

The only difference is that I try to ignore the pain and focus on the individual companies, their business and the intrinsic value. That helps me in maintaining some level of rationality.

I have been asked by some on how bad this can get? I don’t know and anyone who claims otherwise is lying. It could get worse and it will not be easy to hold on to our positions when everyone around us is panicking and selling.

How to handle the volatility
Let me share how I am looking at the current situation (as I have done in the past)

Do not shorten your time horizon
Let’s say (and I hope that is the case), that you have invested your capital with a 2-3 year time horizon. As long as the market is rising, everyone is a long term investor. It is times like now that this belief is tested. There is no dial which increases or reduces the time horizon at an aggregate level. One needs to look at each holding and decide if you will be comfortable holding that position for the next couple of years.

I have been doing that for all the positions in the model portfolio and have exited some, where my level of confidence was not high . As the market crashes and causes some level of business risks, it is important to have a decent understanding of the companies in the portfolio.

We have held most of the companies in the model portfolio for atleast one or more years and have seen them go through their ups and down. I think most of these companies would be able to survive and manage the risks

Position size and diversification
I have often been asked about position size and the level of diversification one should have in the portfolio. I have a much simpler approach – size it to a point where you can sleep well. If the size of a position or the level of diversification causes you lose sleep, then it is too high.

The above is a very subjective point and varies from person to person. One way to think about it is to look at how much of your net worth is in equities and are you comfortable with it? Can you bear a 20%+ drop in your portfolio without losing your cool?

Look at the intrinsic value
I have always emphasized the important of intrinsic value and its growth for a company. One should always focus on that number. As a long as that number is stable or increasing, then one should stop worrying about the stock price.

Do not fixate on the turn
Another common feature at a time like this is the tendency of investors to call the bottom of the market. This is a toxic way of managing the portfolio. It leads to a focus on the short term and disappointment if the turn does not happen.

My approach during such times in the past has been to add to my positions slowly over time as they became cheaper (subject to size limits) and not expect to make a killing in the short term.

There is no pill for courage
The final point I have to make is that there is no magic pill for courage. There is a reason why equities have high returns – Volatility and risk.

My effort is to reduce the level of risk (of permanent loss of capital) in the portfolio. I have not tried to reduce volatility actively. Courage and ability to ignore the volatility comes down to temperament and that cannot be supplied by anyone.

To summarize
– Think long term and focus on the portfolio with a 2-3 year time horizon. This means you should not be investing any money which is needed in less than 3-5 years.
– Ensure that the position size for each stock and the overall diversification lets you sleep soundly at night
– Focus on intrinsic value and performance of each company
– Do not try to time the market (now or any other time)
– Avoid listening to forecaster, pundits and other doom and gloom guys. It will weaken your resolve
– If you manage to hold your nerves and plan to invest, stagger it over time. I am planning to do the same.

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Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

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Not everything that counts, can be counted

By Rohit Chauhan

In Investment process, Portfolio management, Uncategorized

December 18, 2015

17 Min read

11 comments

In an earlierpost, I wrote about the two types of risks faced by an investor – risks faced by all investors irrespective of the nature of the investment and business risks associated with a particular investment.

In this post, I will try to describe a variety of business risks and how I use it via a checklists to further evaluate a business. The list I present below is by no means comprehensive (as I am not writing an academic paper) and just represent the ones I have faced in the past or can think of as I write this post.

Advance warning – this is a long post even if it is not comprehensive and there is no silver bullet or blue/red pill at the end to make investing easier.

Regulatory risk [earning excess returns from favorable regulations]
If a company is able to make above average profits due to a favorable regulation, then it is exposed to this risk. For example, think of a banking license or the right to supply natural gas to a specific geography such as Delhi in the case of indraprastha gas.

In these cases, the company has a pseudo monopoly due to a favorable regulatory position. If the terms of the regulation changes, the company could find that the economics of the business has worsened or worse, it no longer has a viable business at all.

There are a lot of examples of this kind of risk. For example, PNGRB – the gas regulator announced in april 2012 that they had the authority to fix gas prices and asked IGL to drop its price by 50%+. The company lost more than 50% of its value after the day of the announcement and since then has recovered most of it, after the supreme court overturned the decision. In spite of the favorable response, an investor in this stock has done worse than the index during the same time period.

The same story has played out for several companies in the mining space after the Supreme court order banning iron ore mining due to the illegal mining problem in some states. This kind of risk is critical in the case of telecom, power, finance and other heavily regulated industries.

The key point is this – If the business model of a company depends on specific regulations, then the company is always exposed to this kind of risk. . The company could be doing well for a long time and then suddenly the regulator or the government can change its mind and put the entire business at risk.

I have noticed that the market is usually sanguine about this risk and it is generally not priced in. However if the risk materializes, the reaction is swift and brutal. The only way to mitigate this risk is either to avoid such companies altogether or hope and pray that the regulator/ government does not change its mind on the key regulation.

Reputation risk [earning excess returns based on reputation/ brands ]
This is a key risk in those businesses which depend on the reputation of a brand or a company. If the company earns an above average profit due to a favorable image or brand position, then it is very important for the company to safeguard the brand.

In the event that there is some incident where the brand image is impacted, the management should react swiftly and prevent further damage to it.

Case in point – Maggi from nestle. Irrespective of the merits of the case, the response of the company to the whole lead content issue and subsequent recall was appalling. The issue surfaced in April and the company finally responded in June when the issue blew up in the media. This is a 1.2 Bn dollar brand and the management did not react to the situation till it finally got out of hand. Net result – The company lost close 20% of its market cap in the aftermath.

This risk is critical when the company you invest makes money based on the power of its brand and trust. The only way to mitigate this risk is to have a management which reacts promptly if it sees a risk to the reputation of the company or its brands.

Management risk [Poor quality management]
This is a risk commonly understood, accepted but least followed by a lot of investors. If you talk to someone who has been investing in the markets for a period of time, they will agree that it is important to invest only with a high quality management.

Lets first define what is high quality which I like to think of on two parameters

Capital allocation and distribution – does the management allocate capital at high rate of return in the business and distribute the excess to shareholders via dividends?

Ethical behavior towards all stakeholders – Does the management behave ethically or treat other stake holders (such as customers, employees, shareholders etc) in a manner they would like to be treated if the roles were reversed?

The first parameter is quite objective in a nature and can easily be verified by looking at the return on capital of the business over an entire business cycle. It is amazing to find that people end up investing with managements which have consistently destroyed wealth (several airlines come to mind). I understand that at a certain price, even a value destroying business can give good returns, but a majority of the investors end up buying such companies at the peak of a cycle when the profitability seems to be high (but is just a mirage)

The second factor is far more difficult to evaluate and needs careful study of the management’s actions over time. Again it is not easy to define the right behavior in several cases such as high compensation or bending regulations to gain an undue advantage in business.

Even if we leave aside some of the fuzzy stuff, it is quite easy in a lot of cases to just reject a company if several red flags pop up. In the end, my own experience has been that if you ignore this risk, it eventually catches up. A particular investment with unethical and incompetent management may not go south, but over time the law of averages work and the overall result will be poor.

The only way to mitigate this risk to avoid such companies and management. It will prevent a lot of anxiety, heartburn and sleepless nights

Customer concentration risk [All eggs in one or few baskets]
This risk arises when a company derives a large percentage of its revenue from a handful of customers. Although this is an easy to understand risk, it not necessarily as easy to evaluate.

For example, is it better for IT and other service companies to focus on their top customers who provide 80% of their revenue instead of spreading themselves thin? I don’t have an answer to this question.

There is one crucial factor to consider when thinking of this risk – Customer lock-in. If a customer is locked in with a company and cannot easily switch then it makes sense to devote enough resource to maintain this competitive advantage.

However if a customer can easily switch suppliers based on price, then customer concentration will kill a business. A company fighting price based competition and earning its revenue from a limited set of customers is never going to earn profits above its cost of capital and is likely to remain locked in a low return business.

This risk turns up in surprising places. China as a country is the largest consumer of most commodities such as steel. So when this ‘customer’ slowed, the price of the product collapsed and has hurt all suppliers in the product category. It does not matter if as a steel company you don’t supply to the Chinese market. Once the no.1 customer in the steel industry (accounting for 50%+ of global demand) slowed, everyone in the industry was going to get hurt.

There is no easy way to mitigate this risk and it requires a case to case decision. One needs to be aware of the level of concentration for the company and check if the management is focused on either reducing the concentration or has such as hold on the key customers, that it will not be exposed to price based competition.

Competitive risk
The easiest way to think about this risk is to count the number of companies in an industry and tabulate their market share. If you find just one company and that company has a 100% share, then you have found a monopoly with no competitive risk.

At the other extreme if you start listing the companies and end up with a long list of firms with each company having a tiny share of the market, then you are looking at an industry with high competition and poor returns.

I have generally used a simple thumb rule to evaluate this risk. If the top 3-5 companies account for 60%+ of an industry and most of them earn over 15% return on capital, then the competitive intensity within the industry is low. On the other hand, if I have to spend over a week finding all the companies in an industry and if the top 10 companies account for less than 50% share (assuming I can even get this number), then it is very likely I have stumbled into an industry with high levels of competition and poor profitability.

For example – most consumer brands have limited numbers of companies and high profitability. On the other hand, industries such as cement, textiles etc are the other end of the spectrum with a large number of companies and poor profitability.

As an investor, you can manage this risk by first diversifying across industries so that a sudden worsening of the economics in a particular industry will not sink the entire portfolio. The second way to manage this risk is to study each company and its competitive position in detail so that you are atleast aware of the risks and do not get blindsided by it. Finally, as an investor one is paid to understand and manage this risk.

Change or obsolescence risk
This risk is especially relevant in fast moving industries where the underlying technologies are going through a lot of change. Think of telecommunications – this is a fast paced industry which needs a lot of investment, but at the same time the underlying technology keeps changing rapidly (see my post herea long time back on the same topic).

We have seen the technology go from 2G to 3G to 4G to who knows what ( 5G is already being tested in labs and can do 1 gbps ). There is wifi, satellite or balloon internet and all sorts of communication tech coming up. Is it easy to predict what will be the shape of this industry in 2020? Doing a DCF analysis and putting a terminal multiple on the valuation of a telecom or similar company is sheer insanity.

The way to mitigate this risk is to have a very deep understanding of the particular industry, monitor the changes closely and not overpay for the stock. However if you do not have any specialized understanding of such an industry, it is best to stay away – discretion is often the better part of valor in investing

Commodity risk
This is the case where the price of a specific commodity drives the profitability of the business. This is obvious in the case of industries such as steel, metal, oil etc.

It was not so obvious in some other cases, till the commodity price dropped and hurt the industry badly. Take the example of jewelry/ gold loan companies.

These companies became the darling of the markets in the 2010-2012 period when the price of gold was going through the roof. A lot of these companies got a double boost from rising demand (due to rising gold prices) and from an increase in the value of their inventory.

Once the tide turned, some of these companies have struggled to remain profitable.

A similar story has played out in the agri space for seed companies (where the price of commodities have dropped) or mining firms.

One way to mitigate this risk is to evaluate a company over the entire business cycle and see if the company is merely the beneficiary of a lucky tailwind from rising commodity prices or will do well inspite of the commodity prices.

Capital structure risk
A company having a high debt equity ratio is generally a riskier company. What is ignored sometimes when evaluating this risk are the hidden liabilities which are the equivalent of debt, even though they do not appear as such on the balance sheet.

Take the example of tata steel and its pension liabilities or airplane lease and other fixed costs in case of airlines, which are a form of quasi debt.

The deadly combination is when some other form of business risk hits a highly indebted company. In such cases, the end result is often bankruptcy (atleast for the minority shareholders in india, promoters have no such risks)

How do you mitigate this risk? Learn to read the balance sheet carefully and understand all forms of fixed obligations which cannot be reduced even if the revenue goes down. Try to answer the question – How long will the company survive if its revenue dropped by 20%.

Valuation risk/ growth risk
This not a risk of the business risk. If you pay for the growth and it does not happen, then you are in trouble. An example which comes to mind is Hawkins cooker. A lot of investors continued to give high valuations to the company even when the growth slowed.

However once reality hit the market, the reaction was swift and sudden. As much as investors curse the management after such an event, I do not blame them for it. One can fault the management on not doing its best to deliver the highest possible growth, but then if growth is not visible, nothing stops an investor from exiting the stock for better opportunities.

There are several other companies (Which I will not name) which seem to be in a similar place – low growth, but high valuations. If we are lucky the drop in the multiple would be slow and gradual unless the growth picks up and justifies the valuations.

How do you mitigate this risk – simple, don’t follow the herd and think for yourself. If you don’t understand why a company sells for a high valuation, move on. Investing is not an exam paper where you have to answer all the questions to pass!

How to think about risks
Are you still reading? congrats !! you are true fan of this blog and also like to read boring stuff on investing J

It is easy to go on and on about risks and there are books on each type of risk. I cannot do justice to all of them in a single post. As an investor one has to evaluate all of these risk and more for each investment idea and identify which ones are the most critical.

Let me give an example – I used to hold Noida toll bridge company earlier in my portfolio . As I started thinking of the risks associated with the company, there were two key ones I was able to identify

– Reinvestment risk: The company had been generating a good level of free cash flow, but had no opportunity to re-invest it. A company which cannot re-invest its cash flows is equivalent to a long dated bond and will get valued as such. Hence in this case, once the company reached its steady state cash flow, the future returns were likely to follow the growth in cash flow which was expected to be in the range of 6-8%.
– Regulatory risk: The Noida toll bridge is a BOT project with an assured 20% return during the operation period (around 30 years). On top of that if the company did not make these returns in any year, the company could just carry forward the shortfall to the subsequent years. This meant that by 2011-12 the company had close 2000 Crs+ of shortfall on its books. The ground reality was that the Noida authority had refused to raise the tolls even by the level of inflation and every time they did, there were protests and dharnas. So the chance of realizing this shortfall was low.

The key point in the above idea was that the upside was limited and there was a regulatory risk which if it materialized, could completely destroy the investment thesis. So in a stroke of brilliance, after having held the stock for 2+ years and with a minimal gain, I decided to wise up and exited the company.

In July 2015, the management announced that company was re-writing the contract which would now end by 2031 and its likely the company will not be able to recover the prior shortfall. The stock dropped promptly as the market had assumed that company would be able to make up some part of this shortfall by an extension in the lease term or land development rights.

The above case is instructive of a variety of business risks. A lot of business risks are fuzzy and grey and one cannot put a precise number behind it. In addition, these risks do not materialize for a long time. However if one does materialize, the stock market is quite efficient in resetting the valuations promptly.

As an investor, you can ignore business risks at your own peril.

No mathematical precision
You would have noticed that I have not used any greek letters or volatility measures till now to measure the business risk. It should be quite obvious that these academic measures do not represent the risks for a company.

Think of the example of Noida toll bridge – did the past volatility of the company give any indication of the regulatory risk faced by the company?

The best one can do is to be aware and analyze these risks on an ongoing basis. If you are being compensated to bear this risk (in the form of expected returns), then you continue to hold the stock. If the returns are inadequate or if you think the downside from the risk will be too severe, then the best option is to sell and move on

My current approach to evaluating the risk is usually as follows

–       I have a checklist of all the above risks and use it to evaluate which of these risks are relevant for the company I am analyzing.
–       I try to dig deeper into the critical risks for the company and understand what are the key drivers and how it could hurt the company and its valuation
–       My job as an investor is to evaluate the upside from the bull case of the company versus the downside from all the risks facing the company. If the downside risk seems too high, I will just move on to the next idea.

One final point – if this sounds complicated and difficult to implement, let me assure you – it is and will always be. The upside is that with an increase in competition for investment returns, this may still be an area where a hardworking and diligent investor will continue to have an edge over others.

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A catalogue of risk

By Rohit Chauhan

In Uncategorized

September 26, 2015

9 Min read

5 comments

Beta – This is the term used by academics to represent risk. In other words, for them volatility is equal to risk. This definition of risk makes sense, if one is a short term trader, but is completely useless for an investor.

I have never used beta or any such silly measures to evaluate risk and as an individual investor could not care less for an academic definition of risk.

In my view risk is multifaceted, fuzzy and grey and it cannot be boiled down to a single number. It is not even possible to minimize all forms of risk at the same time – for example you can minimize the risk of a quotational loss on your portfolio by increasing the cash component, but that increases the risk of missing out on the gains if the market moves upwards.

In a set of posts, i am going to list some of the risks which come to my mind. I will try to explain these risks and give some example too. In the end, I will share a framework which I use to think and make investment decisions. As always, if you are expecting a magic formulae at the end, you will be disappointed.

I am going to break down an investor’s risk in two sections – Risks faced by investor independent of the company/ stock and the business related risks of a specific investment. This post will cover the risks faced by all investors, irrespective of the type of investments.

Stage of life/ Age risk

This is a widely understood form of risk – As one grows older and approaches retirement, the capacity to bear risk reduces. As a 25 year old, one can afford to lose a large portion of one’s portfolio and can still recover from it as one has a long working life ahead. I personally managed to lose almost 25% of my portfolio in my 20s and although it hurt emotionally, it did not make much of a dent on my long term networth.

I personal think that all kinds of experimentation and trial and error should be done by an investor as early in their working life as possible. However once you cross late 30s or 40s, it is important to focus on risk reduction and avoid losing a large portion of your portfolio (small losses are however inevitable in equity investing)

The duration / cash flow needs

This is usually but not always related to the age of an investor. A younger investor can afford to take a very long term view of his or her investments and think in terms of multiple decades. An investor in his or her late 50s however has several cash flow needs on the horizon such as education for children and hence needs to design the portfolio accordingly. As a result, any capital which is needed in the next 5 years, should not be invested in equities. If you do so, you are exposing yourself to the risk that the market would drop at the time when this invested cash is needed, turning a temporary loss to a permanent one.

The interesting point is that this advantage is usually wasted by the younger investors. I have rarely seen investor in their 20s who are patient and long term oriented. At this stage in life, one usually feels invincible and smart. On top of that if you have graduated from some of the top colleges in the country, you close to 100% sure that you will beat the market in your sleep.

A majority of such over confident guys (and they are mostly guys) get their back side kicked and blame everyone else for their failure. A few however are sensible enough to realize their stupidity and work to fix it over time.

Emotional/ Attitude risk

This is a rarely discussed risk. Let me explain what I mean by this – One can call this temperament or maturity. There are some people who have temperamentally more suited to the stock market as they are calm, humble and eager to learn. In addition these people do not get swept by greed or fear. As a result such people are able to do fairly well over the long term.

On the other hand, you will often find people who are eager to invest in equities but are impatient and bring a level of arrogance to the stock market. They seem to believe that the stock market owes them high returns. As a result a lot of them assume that all they need to do is to buy some random stock touted by a talking head on TV and the money will start rolling in.

This attitude is however not specific to any age or gender, though I have seen it mostly in men. Women either stay away from financial decisions or if they are forced to manage it, are far more sensible as they realize their limitations.

Lack of knowledge + arrogance + greed/ fear is guaranteed recipe for disaster.

Knowledge risk

This is a risk a majority of investors in india face due to the huge amount of misinformation and misguidance by the financial services industry.

A lot of investors have been exposed to the traditional forms of investments such as fixed deposits or gold/ real estate. They are however approached by banks/ brokers and other financial agents from time to time on mutual funds, stocks or insurance and I have personally found that majority of this advice is toxic (see my post here on ULIPs).

The only way to manage this risk is to educate yourself on the basics and never to listen blindly to your friendly broker/ agent whose interest is in the commissions and often not your financial well being.

Inflation/ Cost of living risk

Quite self explanatory, but a very under-appreciated risk. A lot of people assume that if they invest in fixed income options, they have taken care of their investment needs. My own parents were guilty of this mistake in the past.

This risk unfortunately is a very slow and stealthy form of risk where one thinks that his money is growing, but in reality one is falling behind in terms of buying power. This risk comes to bite you at absolutely the wrong time – retirement. At that time, you realize that the nestegg is not sufficient to take care of a lot of your needs. In such cases, in absence of a social safety net, one either has to continue working or depends on others to make ends meet.

I see a lot of educated and young people in my own family ignore this risk to their peril.

Leverage risk

Leverage risk is commonly understood as the leverage taken by an investor in his portfolio. I prefer to expand this further and consider all forms of non –investing leverage too. For example, if you have a big home loan and other forms of leverage in the form of personal and car loans, then your flexibility as an investor is greatly reduced.

Lets say an individual earns around 10 lacs per year and has around 50 lacs as various forms of loans. This individual is paying around 50% of his earnings as debt repayment. If this individual has around 10-15 lacs as savings, can he or she really afford to invest in a highly volatile small cap fund ? If this was the financial profile of an individual in 2008, he or she would have panicked and sold all their stocks at the bottom.

I have personally looked at leverage in the above manner and worked to ensure that my total debt to networth never exceeds 30-40%. This ensures that my debt servicing is within control and any fluctuations in the stock market, will not force me to liquidate my positions to manage this debt.

Professional risk

I have never seen this risk discussed, but I think it influences your investing behavior a lot. If you have a full time profession (job or a business) which will put food on the table irrespective of how the stock market behaves, it is bound to impact your risk appetite.

A stable well paying job allows one to take a long term view and invest without worrying about the market volatility. On the other extreme if your monthly expenses depend directly on the stock markets – either from capital gains or through employment as a financial intermediary, then your risk appetite is greatly reduced.

A combination of risk

It may appear that several of the risks I have pointed out are overlapping in nature. I would agree with that and my post is not provide an exhaustive and non overlapping list of risks faced by an investor. The idea is to look at some risks which are faced by an investor, outside of the specific investment itself.

A lot of times, it is the combination of risks which become financially fatal for an individual. Lets say an individual does not save enough early in his or her career, and due to the inflation risk realizes later in life that his nest egg is not going to be sufficient. In absence of sufficient knowledge about various forms of investments, this investor under the influence of a unscrupulous broker may make wrong investment choices. Such an investor can get hurt very badly during a market downturn. I think I may have described the unfortunate situation for a lot of senior citizens.

I have tried to cover risks which are independent of the type of instrument chosen for investing. I think these risks play an important role in determining the nature of one’s investments and the kind of returns one can make. In the next post, I will discuss about the various forms business risks one needs to keep in mind when investing in equities.

I still stand by my post below on managing non – investing risks

http://valueinvestorindia.blogspot.com/2014/04/shortest-investment-book.html

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Emotions and investing

By Rohit Chauhan

In behavioral finance, Uncategorized

January 6, 2015

10 Min read

17 comments

We are all supposed to be perfectly rational, supercomputers that can do a discounted cash flow analysis on every investment idea we come across. If this is not enough, we are also supposed to be able to compare all investment options at the same time, before making a decision.

This is what most ivory tower professors would have us believe (except one ). Ofcourse this does a lot of disservice to a budding investor, who feels stupid when he or she lets emotions creep into the decision process.

I have invested for around 15 years now and in the countless investors I have followed, I have yet to come across anyone who comes close to this mythical investor. For the ordinary investor like me, I find it far more useful to acknowledge my irrationality and learn to work with it. Although there are no universal rules to managing emotions when investing, let me share my experiences as some would definitely be instructive.

Let’s start with a list of some commonly felt emotions and their impact –

Fear

Think back to August – Oct 2013. Rupee dropped close to 71 to a dollar. Current account deficit was around 5% and at the risk of expanding further. The Indian government led by congress was in a state of paralysis. The net effect – The stock market dropped close to 10%. The same story had occurred in 2003, 2008-09 and 2011.

Inspite of the economy and market coming back after a few years in the past, a majority of the commentators and investors decided to stay away from the market. This is even more surprising considering the fact that Mid caps and small caps were selling at 5-6 year lows and some highly profitable and growing companies were available at decent valuations.

My thinking: It is not that I am immune to fear and pessimism. I felt equal depressed about the state of affairs and angry with the government. However, during such times I go by my sense of history (past record of the stock market) and valuations. If the company is doing well and available at decent valuations, I will buy the stock without worrying about when I will be proven right. How does it matter if the stock doubles in one year or the end of year three?

Greed

I don’t have to go far on this one. Look around now – after almost five years, the small investor is now coming back. We have mutual funds advertising the last one year results and people are now getting excited about equity after a 55% rise from the bottom.

This is a very predictable pattern. Gold increased by 19% CAGR from 2001-2011 and everyone was bullish about gold.

Indians, with a perennial love for gold, found one more reason to buy it and anything associated with gold such as jewelry companies got swept up in the same euphoria.

Gold is down 25% now and so are gold related companies. As far as I know, I am not seeing analysts recommending gold or gold related companies now

So the emotion of greed is obvious – once we see others make money, it is easy to be envious and follow the crowd. The result is predictable too – The last people to join the herd also lose the most money.

My thinking: I have a standard thumb rule. Do not buy something which almost everyone is recommending. If I do buy into something which is the current flavor of the market, I try to move slowly into it so that I don’t lose much if the tide turns. In addition to that, I won’t buy something I don’t understand. For example – I was never able to understand what the true free cash flow for most gold companies is (except titan industries), considering all their profits are generally eaten up by inventory. As a result, I just stayed away from them.

Love and security

Now this is not an emotion, one associates with money and investing. I did not consider it relevant for a long time, but as I think about gold and real estate, I can see the role of these two key emotions

I first realized the importance of love and security as an investment criteria when my mother tried to convince me to buy gold to secure the future of the family. I tried to explain that equities give a better return, but soon realized that there was no way I could convince her. Of course, she decided to take matters in her own hands – she went and bought some gold for the family and said that that was her way of providing security to the family 🙂

The effect of emotional attachment is very high with gold – When it goes up, people justify its purchase based on the price rise. If it goes down, the justification changes to it being undervalued or being a hedge against catastrophe or any other reason you can think of.

If you still don’t agree with me – go to your spouse or any other member of you family and suggest the following: Please hand me your gold, I will sell it and invest it in a higher return instrument. In X number of years from now, you can buy more gold than what you have now. I have tried it and I am scared to use the two words ‘gold and sell’ again in the same sentence 🙂

Flaunting

If you think, love and security alone explains the fascination for gold – think again. I always found it irrational to buy gold or even real estate (beyond your housing need) if all that you are looking for is high returns.

This thinking changed when my family and in-laws felt that I had finally arrived in life when I bought my own flat with a big loan and essentially signed my life to the housing finance company (read EMI!). I never got any praise for buying an asian paints or any other long term compounder , whereas the flat was a concrete evidence (no pun intended) that I was doing something right in life

There is a tangible quality to both gold and real estate. You can see it, feel it and even flaunt it . In the past one could look and touch the stock certificates, but now with demat accounts what are you going to show others?

Imagine this fictious dialogue

Mom to her friend: My son has finally arrived in life! he bought a 1000 sqft flat in XYZ location. We are going to grah pravesh (house warming). Why don’t you join us?

Versus

Mom to friend: My son bought 1000 shares of asian paints. Let me show you his demat account! you know this company has a sustainable ……… will this dialogue ever happen!!

It’s the same with gold. Your wife or mother can wear the gold and in a lot of cases this serves to signal that the family or husband/ son is wealthy. So gold and real estate actually help in feeling secure or in displaying wealth. It is incidental that they earn some return too.

These emotions sometimes creep into stocks too. At the height of a bubble, investors want to invest in the hottest companies so that they can show their friends and colleagues how smart they are.

My thinking: In my own case, I have usually not felt the need to flaunt (or so I believe). At the same time, I try hard to avoid envy, which causes one to do stupid things such as chase the latest investment fad or buy stuff to show off.

There are only a two exceptions to the above rule in my case – The first one is that the emotional value of your own home is high, so it don’t look at it as a financial decision, but something which makes my family feel secure. The second one is that when my wife wants to buy jewelry I look at it as an expense to keep her happy

The driver

Volatility in prices is not an emotion in itself, but a driver of a lot of emotions we have been talking about. When stock prices crash, we can see that investors are overcome by fear, despair and in some cases complete disgust to the point of avoiding equities forever.

On the contrary if prices rise rapidly the reverse happens – we see greed and euphoria. These feelings are common to all investments, but as the volatility is high in stocks compared to other options, these emotions are amplified in the stock market.

I personally think that one of the reasons investors make higher returns in stocks compared to other options on average, is due to the higher volatility which tends to put off a lot of people. Investing in stocks is tough emotionally, no matter how long one does it. You go through periods of sickening drops and exhilarating spikes and it never gets easier, emotionally.

Take your pick

So it comes down to what one is looking for in their investments. If you want to flaunt your wealth or to feel warm and fuzzy, then go for real estate and gold. The returns could be good, if you have specialized skills in these asset classes, but then that is a different ball game.

If you want complete peace of mind – invest in Fixed deposits and sleep well. There is no harm in that!

If you are ready for a few sleepless nights, stomach churning drops in your networth (even if temporary) or sudden euphoric rise, and have nerves of steel to handle all of these emotions, then you will be rewarded with higher returns over the long term. That is equity investing

This brings me to a final anecdote –

I was discussing about expected returns of various types of assets such as real estate and stocks with a friend. I mentioned that one should expect anywhere between 15-18% from the stock market in the long run. To this, my friend replied that he ‘wanted’ nothing less than 20% per annum.

I asked my friend on why he ‘wanted’ these returns? Ofcourse he had no reason for it. It was just something he thought should be the case!

My reply was that like my kids, if you are wishing for something as they wish during Christmas from santaclaus, you should not hold yourself back. Why stop at 20%, why not ask for 100% – maybe your wish will come true!

We are still good friends, but don’t talk about investments any longer :). This is the final emotion a lot of uninformed investors suffer from – Hope

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Scared ? Worried ?

By Rohit Chauhan

In Uncategorized, Views on news

December 16, 2014

2 Min read

3 comments

Oil down 50%+, Ruble crashing. Rupee on its way down and maybe the stock market too !

Worried about your stocks ?

Take a deep breath and ask these questions (I ask some of them and a lot of times the answers I get make me see my mistake)

Are you retiring next year ? If yes, why the hell is that money in the stock market!

Do you understand the business and have confidence in the long term performance of the company ? If not, why did you invest in the first place?

Do you lose sleep from the volatility and quotational loss of your portfolio ? If yes, why are you not in just fixed deposits?

Do you have good health, another source of income and don’t need the money in the next few years ? If yes, then stop watching the financial news and go back to some more productive activities?

As I said in the previous post, I have a consulting service to provide a list of very productive activities to people who watch too much Financial news ! Call me for a free consultation 🙂

If you think this is new – read this, this and this. This is almost an annual or a once in two year affair. For the some of you who were wishing for bad times, be careful what you wish for! you may finally get it, so better be ready for it.

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Facing despair

By Rohit Chauhan

In General thoughts

July 31, 2013

4 Min read

5 comments

I was planning to continue on the previous post – ‘Failure to sell’ , but decided to write on a different topic as I have been receiving quite a few emails – full of despair and frustration.

A lot of young investors, who came of age in the early 2000s, entered the workforce when the economy was booming. If you passed out from a half decent college, you could get a decent job with a good starting salary.

As the economy was growing at 8%+, it was common for employees to be given 15% salary hikes (people quit in disgust if the raise was less than that) and the high performers got promoted every other year. In addition, flush with cash, some of the same people invested in the stock market or real estate and saw their net worth double in a few years.

You did not have to work too hard to do well

We are not entitled to be rich

I am going to ruffle a few feathers, but let me still say it – We had a dream run from 2003-2008 and now it is over. The days of 20% salary hikes and 30% stock returns are gone (at least for now) for the masses.

If you are really good at your job or in investing, you may get above average raises or returns, but that is not going to be the norm for everyone

If you entered the workforce in 80s or 90s, you may have seen tough times yourself (or maybe your family did). The reason why the current slowdown feels horrible is because our expectations are high now. Don’t get me wrong – I am equally angry with the government for running the economy to the ground.

Keep grinding

I faced a similar market from 2000-2003, when the market dropped by around 50% over a three year period. At the market bottom in April 2003, capital goods companies like BHEL, Blue star were selling at 5 times earnings. The current market darlings like Asian paints (15 times PE), Marico (around 5-7 times PE) and other consumption stocks were selling a very low PEs too.

At the risk of getting philosophical, I can think of the following things to do this time around

– Assess your risk tolerance: If you have trouble sleeping in the night after seeing your portfolio drop by 10-15% , you should reduce your level of equity holdings. My thumb rule – will I be able to sleep well if my portfolio dropped by 40%+ ?

– Clean out the trash: Now is a good time to clear up junk from the portfolio. A bear market and 40% loss on weaker ideas concentrates your mind. One should evaluate each position closely, sell the weaker ones and redeploy the cash in the better ideas.

– Have faith: There is no data or logical argument which can make you hold on to your stocks or add money to it. You need to trust that the markets will recover in time and so will your portfolio.

It is easy for people to say that they want to think independently and stand apart from the crowd. Now that that we have a blood on the streets and no end in sight, you will know whether you can truly do that.

At the risk of looking foolish, I plan to keep adding to my positions.

Edit : I have a day job to support my family. I will not starve even if my portfolio goes to 0. I would not do the same thing if I was living off my savings.

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The Dilemma

By Rohit Chauhan

In Investing Philosophy, Uncategorized

March 3, 2012

4 Min read

24 comments

I have several dilemmas in life – such as should I eat jalebis and other good stuff or go to the gym? Sleep late or go to office? But as these dilemmas are of no concern to others, I will leave them for my own thoughts

The investing related dilemma I have always faced and more so during a market crash is this – Should I invest in the high quality companies whose price has dropped a bit or the low quality cyclicals where the price has collapsed completely. I have tried both and will try to present how my thinking has changed and where it stands today.

Let’s look at two specific examples – one of a high quality and other an average company. The high quality company is one of my long term holdings – CRISIL and the other company is Denso India, which I have long exited.

The chart below is of crisil

I wrote about this company earlier in 2009 and have held the stock since then. As you can see the company and the stock has not disappointed and have done far better than what I expected at that time.

I have had an eye on crisil for quite some time and finally took the plunge in 2009. It is easy see that the company has an enormous competitive advantage due to government mandated status of a certified credit rating agency and brand. In addition the company requires minimal capital to grow (mainly office space and some computers). The company is thus like a toll bridge which does not require any capital expense.

The second example is of denso India. I wrote about the company here. The company was a cash bargain (stock price below cash on hand).

This is the chart for denso India

I was able to buy at an average price of around 40 and exited at around 85-90 bucks. In hindsight, it turned out to be good operation. However as you can see from the chart, the stock has been sliding since then as the performance of the company went south in 2011.

Where’s the dilemma?

Some of you may be thinking – what is the dilemma here? You made money in both, so both options are great. Case closed.

I don’t think that one should reach that conclusion here. In the case of crisil, the company has been able to increase its intrinsic value at a good pace and the stock price has followed suit. I had to make a one time decision to buy the stock and since then have just sat on that decision.

The case of Denso india is more complicated. The company appeared to be a complete bargain in 2009 and in comparison to crisil was much cheaper. At the same time, the company did not have much of competitive advantage. The trick was to buy the company when it was dirt cheap and get off the bandwagon when it was merely cheap.

This is a more complicated operation than it appears on the surface. One had to time the buy pretty well. If you had bought too early, say in mid 2008, the eventual gains would have been around 30-40%. In addition the sell decision also had to be timed correctly. If you sold in 2011, the gains would have been paltry. I was unusually lucky in this case.

Thus in the short term, gains are much higher in Denso type stocks. However one has to make more decisions and then also find a new idea to re-invest the capital. In the case of companies such as Crisil, once you have made a buy decision, you can just wait and watch the magic of compounding take effect

So what is a good option?

If you have tendency to constantly ‘do’ something and want some action, then denso type stocks are a good option. If however, you can live with a few percentage point lower returns with the benefit of much lower effort and headache, then Crisil type of stocks should be your target.

In my case, I do have this tendency to constantly do something. As a result, I am always looking for the next new and shiny stock for my personal portfolio to get that extra return. At the same time I manage my family’s portfolio too. In that portfolio, I have made the decision to buy high quality , fairly priced stocks and let them compound. The returns could be a bit less, but the risk is much lower and the heartburn almost non-existent.

Following is my partial list of high quality ‘wish list’ stocks

HDFC bank, Titan industries, ITC, Marico, Hero motorcorp, HDFC limited and nestle india.

Time for some jalebis now . Gym can wait J

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Continued analysis – Hyderabad industries

By Rohit Chauhan

In Company analysis, Uncategorized

November 30, 2010

8 Min read

14 comments

Statutory warning – Long post detailing further analysis of the company. Can knock you off to sleep – please be seated while reading 🙂

I described my process of analyzing two companies from the sector – construction material, in an earlier post. At the end the analysis, the only conclusion I reached was that the companies were still attractive enough to continue my analysis and invest more time in them.

I had a look at visaka industries and for non quantitative reasons have decided not to go further with it. The main reason is management. I am not comfortable with the open ended risk of the investment in the power plants at a cost of 5000 crs. I do not have clarity on it and hence in view of a risk which I cannot evaluate, I decided not to pursue the analysis any further.

We can debate back and forth on this, but my personal approach is to look at it as a binary decision. If I am not comfortable with the risk, I tend to quickly move on. There is no point in doing some fancy calculations here. I may have missed quite a few opportunities in the past, but this approach has also helped me avoiding risks which I don’t understand. I would rather commit the error of omission than the error of commission.

Hyderabad industries
I have initiated a deeper analysis of Hyderabad industries now. The performance of the company has been good, but unspectacular in the last few years. Ofcourse one cannot expect spectacular performance in a commodity and mature industry such as building construction material.

The company re-structured in 2004 and has since then been doing fine. The company has been able to maintain a net margin in the range of 6-9%, ROE in excess of 15% , a top line growth of around 10% and a bottom line growth in excess of 15%. It is important not to take 2009 as a representative year in making these calculation, as margins were far above average in that year and these margins are already trending down in the current year.

Rough cut valuations
Once I am comfortable with the fundamentals of the company, my next step is generally to do a very rough cut, fundamentals based and price based valuation (see page – other valuations in my valuation template).

The reason for a two fold check is to quickly see if the fair value of the stock is below the current price and then to compare the current valuations (current PE) with the valuations in the past (around last 10 years). The past history of the valuations allows me to look at how the market has valued this company in the last 10 years. In addition, when you compare these valuations with the fundamental performance, you tend to get a lot of insights into how the market looked at this company in the past (more on it in the next few paragraphs)

The normal earnings of the company can be taken as around 40-50 Crs over a business cycle. So one can very roughly value the company at around 400-550 crs.

The last ten years of valuation shows the company’s PE has ranged between a low of 4 and a high of 10-12 (ignoring the extreme low valuations of 2008-2009 when everything crashed). These valuation levels have to be compared with the earnings of the company which have been very volatile.

It is obvious that the company saw rapid price increase in 2004-2006 when its fundamentals improved and saw a PE of around 10 times peak earnings. After 2006, the margins started dropping due to higher capacity and so did the stock. The stock price did not recover till late 2009 when the fundamentals started improving again.

The current valuations and price may appear as bargain based on the recent history, but looking back a few years, it does not look like a no-brainer.

A 20% price drop from here could make it a very compelling buy.

Question – what if the price runs up and I miss the opportunity?

Response – Well that’s the risk of being patient. I would prefer the price to come to me, rather than chase it. If not this company, then there are 5000 other companies to look at !

Checklist analysis
At this stage, even if I am not completely bowled over by the price, I will perform a checklist analysis on the company. I have listed various checks on the accounting, business model, management factors in my valuation template, which I run though to find any specific red flags.

Some of the key highlights of the checklist review
– Company has around 35 Crs of contingent liabilities (taxes etc). This translates to around 6 months of annual profits. Nuisance, but not too much to worry about
– The company has a foreign exchange risk due to import of asbestos which accounts for around 50% of total raw material costs.
– No specific accounting red flags

Competitor/ industry analysis
The next step for me usually is to analyse the industry and competition and see where the company stands viz-a-viz other companies. This industry is partly fragmented, but the top 4 players account for almost 65% of the market share.

The top four players are
Hyderabad industries
Visaka industries
Ramco industries
Everest industries

On checking the fundamental performance of all these companies, it seems that their average ROE is in the range of 13-20% range. The debt varies from 0.4 (for visaka) to .75 for ramco industries. Sales for the top 4 companies have grown by an excess of 20% and bottom line by around 10-15% range. These are not exact numbers, but they paint a decent picture of the industry.

Some key takeaways are
– The ROE for the industry over a business cycle is around 13-15%
– The topline for the industry is growing (as expected), however competition has ensured that profits have not grown as fast
– The net margins for the industry are in the range of 6-7%.
– No specific company has a breakaway performance from the rest of group, yet Hyderabad industries and Visaka seem to have slightly better performance and low debt levels
– Small amount of industry consolidation seem to be happening as the top players are growing faster than the market.

In summary, the industry leader – Hyderabad industry is only slightly better than the other competitors and seem to selling at cheaper levels.

Multiple model analysis
I have borrowed this approach from Charlie munger, who has stated that one should apply various mental models from multiple disciplines to improve decision making. For example – economic models of demand and supply, psychological models etc.

A few key takeaways for Hyderabad industries
– The demand and supply elasticity for the industry is high. In plain English that means that any drop in demand will cause commensurate drop in price which is bad for profitability
– Competitive advantage in the industry is weak and limited to brands, distribution network and to sourcing from the production side.
– Management seems to be rational and has disposed off weak businesses in the past.

Inverting the problem
What will cause one to lose money on this idea? I always ask myself this question to find disconfirming evidence. I can think of two points
– Demand supply situation worsens with new capacity. This would cause price to drop and a lowering of profitability. 2009 profitability was much higher than average and reversion to mean will not be good for the stock
– Industry is cyclical and hence net profit and stock price may trend downwards in the subsequent months (capacity addition or surplus capacity is available)

Final conclusion
I could go on and on in terms of further analysis, but in interest of keeping the post to a reasonable size, let me summarize my thinking till now

The sector seems to have above average profitability over a business cycle. In the recent past, the margins and hence profitability were above average and hence the stocks in this sector appear very cheap.

It is important to value stocks in this sector based on normalized profits and make a decision based on that value. The past few years of data shows an average margin of around 6-7% for most companies – except for extreme demand collapse or shortage conditions. In view of this, Hyderabad industries seems to have fair value in the range of 500-550 Crs for the company. At current price, it is at a discount of around 40% to fair value.

I do not have a position in this stock and will continue to analyse further and may or may not take a position. The above analysis was for illustrative purpose only and if needed, to put you to sleep 🙂 …sweet dreams !

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A personal experiment

By Rohit Chauhan

In Uncategorized

June 20, 2010

5 Min read

25 comments

I was recently talking to a friend and he made an interesting comment after looking at my blog.

‘Why do you target beating the market by 2-5%, when you can make 80-90% per annum by trading? I recently started trading and have been making almost 7-8% per month. You should do that too!’

I have heard this comment from a lot of people in the past. The only common feature is that such people trade for a few months, make good returns and extrapolate it to annual returns. Ofcourse, the very same people after losing money in the market make a hasty retreat and are never heard of again.

The quants
I am currently reading a book – The quants. It is quite an entertaining book, though I doubt there is anything to learn from it. The book is about various kinds of traders who use mathematical models and high power computers to trade in the market. It talks about a few hyper successful traders at various firms such Goldman sachs, Morgan Stanley, deutsche bank and hedge funds such as renaissance technologies and citadel investment group.

Some of these trader/ investors were pioneers in their fields, the best of the best and achieved in excess of 30% annual returns over 10 years or more. The best returns were posted by renaissance technologies, which seems to have posted annual returns of around 40% over 2 decades.

The point of the above commentary is this – If you can make 30-40% annual returns for a few years and prove it, there are people who will be ready to handover millions to you to manage. You will be rich and can retire soon. If you can make 40% or more, then you will be considered a god and there is will be books written about you – think of George soros and others.

If you think you can make 70-80% per annum for the next 10 years, then you are day dreaming. If you think you can make these kinds of returns, as my friend suggested while working in a full time job, you should meet a psychiatrist and get a mental health check done.

I think the chance of 1 crore rupees dropping on someone from the sky while walking on the road is higher than making 70-80% per annum for the next 10 years. A 75% return for ten years will give you 269 times you starting capital and 73000 times your capital in 20 years.

A personal experiment
Let me come back to title of my post. If you are new to the blog, let me say it outright – I am biased against short term trading. I do not believe it is the right approach for me. It may work for others, but not for me.

I have said this more out of a general belief and not based on any specific experience, atleast till now.

So, this time around I tried an experiment. I decided to experiment with trading in the last few months. I bought some stocks for day trading, did some momentum buys and sell and did some news based trading too.

At the end of the experiment, I tabulated my results and found that I had made around 18% on my capital in around 3 months. The maximum loss was around 6% and the highest gain on a single position was 11%. The average holding period ranged from 2-3 days to around 15 days.

A success?
If I annualize, then the returns come to around 72%. Should I declare it a success and start trading actively?

I do not term the experience as a success and do not plan to trade ever again. Let me tell you why.

I typically check my long term positions once in a month or a quarter. My broker is one unhappy guy as I have very few orders in a month and my account is generally a sleepy account.

The above experiment seems to be a success only in terms of the returns. What is not obvious is the effort and the pain behind it. I found myself scouring the internet and bse website for news and tips. In addition, I found myself checking the stock price several times in a day. There was definite change in my thought process as I found myself more anxious, stressed and reacting more and more to daily news.

I realized that my short term approach started infecting my long term though process too. I started looking at my long term holding frequently and started getting more anxious about them. One fine morning, I just plugged the plug and stopped all the trading. Life is good now and back to normal 🙂

A typical experience?
So does it mean long term investors should not trade? No, it only means that I should not trade because I do not have the temperament to do it.

The point of the post it this – One should invest based on one’s own temperament. Some people like fast paced action and the adrenaline rush, so trading may the right approach for them. I prefer a slower and more sedate approach where I will analyze a company for a long time and then slowly build my position. Now if that nets me lower returns, then so be it! Atleast I will sleep well at night and not check stock prices continuously during the day.

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What’s on my mind – Apr 2010

By Rohit Chauhan

In Uncategorized

April 25, 2010

5 Min read

15 comments

I wrote a similar post on miscellaneous topics in Feb. I am able to use these posts to ramble on several disconnected topics which in themselves may not warrant a post.

Facor alloys
I recently analyzed this stock here. As luck would have it, Arcelor mittal – the LN mittal company seems to be in talks with the management to acquire a stake in a sister company – Ferro alloys corp (I received a comment on the same recently)

The management of the company controls three companies – Ferro alloys corp, Facor alloys and Facor steel. Ferro alloys corp owns and controls the Chrome mines. Facor alloys, also controlled by the same management has been able to access these mines and is in the business of manufacturing chrome alloys.

Chrome alloys are used in the manufacture of Steel and thus these talks on stake acquisition make sense as they would represent backward integration by acerlor mittal. These talks may or may not be successful, but the market has already responded by increasing the price by 10% for Facor alloys.

The stake accquistion seems plausible and could be a good trigger to exit the position. However I would not base my decision on this criteria alone. One should be convinced that the stock is undervalued and these kinds of events would only unlock the value

Sulzer india
I wrote about sulzer here. I have since then exited the position completely. I was able to get a 45% gain in 6 months. I am definitely pleased with the outcome. However this was sheer luck and nothing more. If I assume that I have the skill to make 90% returns per annum, then I can plan my retirement in the next 2-3 years.

Psychology of investing
I received two comments, which touched upon the issue of how can one manage emotions in the market ? If one has invested a sizable amount of savings in the market how does one handle the market swings ?

I personally think that the intellectual part of investing – learning the basics and the fundamentals of stock analysis etc is not too difficult. Any smart person should be able to cover a decent ground in 2-3 years. The most difficult part is handling the emotional roller coaster of the stock market. That takes a lifetime and sometimes even a lifetime is not enough.

I think some people assume that one is born with the temperament to handle these emotional swings . I do not agree with that. There is definitely some level of temperament involved, however one can train oneself to become better at it.

During my early days of investing, I would get happy and greedy when the market went up and anxious when my stocks dropped. I went through considerable self –doubt too. I was always asking myself – do I really know what I am doing?

However if one focuses on learnings from mistakes, then over time the self doubt reduces. I still feel good when my stocks do well or unhappy when they drop, but I do not base my decisions on how I feel. The only antidote to these emotional swings is to learn continuously and know what you are doing.

At the same time, if you feel anxious and are losing sleep when the market drops by a few percentage point, then it is a clear indication that you have taken on way more risk than you can bear. The reasonable course of action in such a situation is to reduce the amount of money in equities and increase the allocation in debt.

Ask yourself a question now – are you feeling bullish these days? if yes, then you are thinking like all others. The time to be bullish was Jan-Mar 2009. I am not bullish or pessimistic these days, but I am definitely cautious.

Responding to emails
I have been slow in responding to personal emails. If you have written to me and have not heard from me, my apologies. I read all the emails I receive, though my responses are delayed sometimes.
If however you have written to me asking for my opinion on a stock, I would prefer if you did some homework at your end and shared your analysis with me. I would then be able to provide a better response to you.

Overall portfolio plan
I am now adopting a slightly different approach in making sell v/s hold decision. I am now asking this question – If this stock drops by 20-30%, will I add to it or do nothing. If the answer is ‘do nothing, then the stock is a good candidate to sell.

I have exited my position in VST and would be doing so in case of some other stocks as the gap between the price and fair value reduces further. The issue is not if the stock is good or not, but whether there are better ideas in the market. Holding an average idea may not result in a direct loss, but there is always an opportunity loss if the stock does not rise as much.

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It is never easy

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Scared ? Worried ?

Facing despair

The Dilemma

Continued analysis – Hyderabad industries

A personal experiment

What’s on my mind – Apr 2010

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