The New Financial Plan

I'm writing after a long time - it's been nearly two years! While a lot has changed in my personal front, I'm happy about one thing - I'm confident and proud to say that I'm a more patient, lazy and stable investor - my portfolio turnover rate has come down significantly and I don't get "into action" when markets get volatile - like they're these days.

OK - I won't write a lot, but just some thoughts and recent realizations, and how they're shaping my portfolio and future investment strategy - and of course, this is also my way to journal the decisions I take so that I can come back and learn from mistakes I may be doing now :)

Here we go!

1) My time is very precious, and perhaps for good, I'd spend little time I get from unavoidable things to spend with my little baby - it is more satisfying than the feeling of identifying a good investment opportunity.

2) Instead of spending time, I'd spend a small amount as fees for professional investment management - OK, I'm not talking about any hi-fi stuff - all I mean is that I'll invest in equities by means of Mutual Fund SIPs and no more direct stocks, unless I'm comfortable analyzing businesses and get sufficient time to do so. In fact, if I get time, I'll spend that to read good books first and not on business analysis. I realize that there's a long way for me to go in terms of learning and reading about Value Investing and putting those ideas into practice.

3) Unless someone very well knows fixed income investing, they should forget Fixed Deposits or Debt Funds or direct Bonds as a mode of investment with an aim for income generation. At the best, in any economy, fixed deposits from banks can act as capital preservation - they don't really generate any income - after we account for the very important concept of Inflation.

4) I was earlier invested in 6-7 different mutual funds, but I realized it was unnecessary and I've now trimmed them to just 4 - with clear focus and rationale, as I list below

• Franklin Templeton Prima Plus Fund for Large Cap allocation - this is to provide a stable core for my equity portfolio. I chose this based on Morningstar rating
• HDFC Midcap Opportunities Fund & ICICI Prudential Value Discovery Fund for aggressive growth orientation for the portfolio - given my risk capacity, I can afford to have a healthy proportion of mid-caps - of course, quality mid-caps and this approach should generate good long term return for my portfolio - my expectation is 12% or higher annual return on the overall equity portfolio in next 15 to 20 years
• Even though it is a relatively new fund, I've strong respect and trust in Mr. Parag Parekh's skill and inheritance and I hope PPFAS fund house will deliver to its promises in next 10 to 15 years. This is the fourth and final fund in my portfolio

5) I still hold a small amount of direct stocks I purchased in 2013 - they're sitting at decent profits, but I believe in those stocks and I'm trying to monitor them and if need arises, I'll exit them in coming months, but so far, inaction prevails here.

6) I believe individual investors like me should utilize the Morningstar's Instant XRAY feature more and more and analyze portfolio once in 3 to 6 months using this superb tool. This doesn't take a lot of time but provides useful insight. I used it to rebalance my portfolio - I realized I was more large cap focussed when my aim was to be mid-cap heavy and hence I've reallocated part of large cap funds into mid cap funds. Perhaps the timing may not be right, but in the long run, such timing won't matter as long as fund selection is right and I continue to systematically invest and not bet lumpsum money at any point in time.

Finally, on fixed income - I suggest that everyone should very carefully analyze their need for emergency fund, surplus for unplanned expenses and surplus cash for potential investment opportunities in future, and simply keep this money in an avenue which provides very good safety of capital and a post-tax return that is at least as high as current inflation rate - this would be a simple yet prudent strategy to manage liquid part of one's portfolio. No need to worry about 60--40 or 75-25 rules - make sure you have a good cushion of liquidity before you commit to equity investments - after all - long term investing requires that we don't need to and don't urge to withdraw from our equity corpus when we earn via our jobs - for me, it is still a period of at least 25 years and I'm proud and confident that I've a good plan in place to develop and maintain a healthy equity portfolio and a cushion of liquidity and insurance as my financial plan. I'm being honest to not expect more than 12% growth rate on equity portion and to match inflation on liquid portion of this portfolio - as a final check, I tried to calculate my retirement capital that I expect to generate from such a portfolio and I'm happy it'd be large enough to provide me a monthly income post-retirement (through a Monthly Income Plan) whose Net Present Value is 4 times my current expenses - this income without having to draw any amount from the retirement corpus at all.

Thanks for reading through, but as a statuary disclaimer, please do not copy this plan as-is - use your mind and mold these guidelines to suit your individual requirements and situation. I'm thankful and pleased if you like this post and do plan to take away some of the things :)

Till then, Bye and I'll try to write soon - even if I'm inactive as far as financial plan and investment actions are concerned :)

Happy Investing!

Monthly Portfolio Review - September 2013

This is a quick scribble, since I'm in middle of many thoughts and writings and decision...and this is just an investment journal of what I'm thinking and going to do NEXT.

Here's the state of portfolio

- Have been adding few mutual funds to my portfolio, and have now concluded on this activity, except one last mutual fund SIP that needs to be started. My mutual fund allocation currently in my investment portfolio is 9%

- I've finally settled on fixed income securities - it'd be a combination of the following
    a. Fixed deposits with healthy, stable banks, with deposits of up to Rs. 1 lac in each bank.
    b. Floating rate debt funds. I've currently chosen SBI Magnum FRP - Savings Plus Bond Plan.

The current allocation of these fixed income (almost) securities in my portfolio is 12.94%, and I plan to increase it to about 20%, given the fact that I'm not planning to make any large equity investments in months to come, and there's quite some cash lying idle :)

- Cash and cash equivalent (in the form of liquid funds) currently stands quite high - at about 35%, and I plan to reallocate it into fixed income and equity mutual funds over next few weeks.

- The equities part of my portfolio is now structured into the following categories, mainly influenced by Dead Monk's portfolio. I must admit that most of the stocks were NOT bought originally with this thought, and it's a "re-allocation" I've done since I believe that most of the stocks in my portfolio are not bad businesses, and the fact that I want to remain invested in stocks.

    a. High dividend healthy businesses - these are stocks that give a dividend yield of 4-5% or higher, and are healthy businesses (it's OK if there's industry wide slowdown or similar cyclical problems). I moved BHEL and MAZDA into this category, and current allocation here is 6.8%. I need to increase this, but I'll not buy stocks directly for few months now, when I want to focus on studies, and hence, to increase exposure here, I plan to move some cash into dividend plans of mutual funds

    b. Stalwarts - this is influenced from Mr. Lynch, and I'll buy stable, large cap businesses that have been beaten down in market for some reason, and it is envisaged that the depression in stock prices is only temporary. Generally, these stocks may also provide good dividend. However, I don't intend to hold them for a very long time, but only expect 40 - 70% return when prices move up again, and this part of portfolio will have quite some churn. Currently, I hold BHARTI AIRTEL and INFOSYS in this category, amounting to 12.2%

    c. Others - This includes speculative bets (stocks and derivatives), sidecar investments and all other types of stock investments. I had to move MCX into speculative category after NSEL fiasco, and this bucket now contains Piramal Enterprises apart from MCX, totaling to about 3% of my portfolio. I'll keep a strict upper limit of 10% on the speculative bets at all times, and these days, I'm thinking of trading in NIFTY options based on some highly trusted information sources :)

Hmm, so my portfolio is all right and not too skewed at present, except the actions identified above. So, let's now go back to work and resume studies, until 4 weeks later when I revisit my portfolio :)

MCX India Ltd

Update (28th Aug 2013): Soon after I analyzed and posted, the world came to know about NSEL crisis. I suddenly realized I'm in 60%+ loss in the moderate positions I had accumulated in MCX, which I thought was undervalued at Rs. 800. Anyways, lot of emotions, reactions, etc. I've finally made my decision on what I'll do with it, but before that, here're some links which I want you to refer to:

• Discussion on SafalNiveshak Google Group
• Nice post by Prof. Bakshi and the discussion in comments section.

Hmm, so what I decided? Here's it:

• There're decent chances that FTIL group's demise is fast on its way, and sooner or later, they'll have to let go of their control on MCX
• The uncertainty is - how long it can take for this to happen
• When such a stake sale occurs, MCX may realize at least "fair valuation", and if my analysis if not grossly wrong, the stock price should come back to my initial buying price. Probably higher
• However, if we consider that as a reasonable probability event also, there's risk of losing all of the investment - if MCX stake sale doesn't occur and business loses trust, market share, and its sheen.
• Thinking in terms of probability, therefore, it DOES NOT make sense to invest more money into the business right now. The risk-reward ratio is not highly favorable to warrant the risk.

However, since there's good chance for a bounce back (and as I write this, the stock is now locked in upper 5% circuits for few sessions now, in the anticipation of some groups keen in buying FTIL's stake in MCX), I'll hold on to the investment and exit when the news of stake sale is out, or I find some other strong reason t quit this investment. However, I won't put in new money into this investment until I know that MCX is a "fresh" business, under a new, credible owner.

Goodbye :)

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June 24th, 2013: I analysed this stock in quite some details and posted my analysis on Safal Niveshak StockTalk. Enjoy reading.

The Final Decision

Here's a jot down of my thinking process and organizing those thoughts, after I slept over my last two posts on clearing confusions and focusing ..and I'm happy to have emerged stronger from the turmoil and have a clearer vision now :)

Immediate Actions, in this order

(0) Set the eventual goal of investing, write it down, and make sure you don't flip-flop - most important is to stick to the process and plan and not get worried by noises and intermediate results, which are anyways temporary...

1. Trim down PEL to a maximum of 5% of portfolio. This translates to selling about 40% of existing held shares in this counter. Then move this investment into speculative category.

[DONE]

2. Exit ARBL and IL&FS completely.

[DONE]

3. Start (small) SIP in PPFAS LTV fund.

[ONGOING]

4. Decide about MCX - whether to continue holding it as a high risk speculative bet in portfolio, or put sin money rather into Index Options trading (more as a portfolio hedge or trading only in strongly trending markets with clear stop losses and deep in-the-money options). Well, I feel more comfortable "avoiding options" due to the huge mental stress cost associated with them, at least as of now, and in that respect, MCX is easier. I'll therefore keep Index Options as a hedging instrument only, that too after assessing the risk-reward given I've liquidated some amount of stocks already. let that be a separate action below, in the next actions category. For MCX, I'll very slowly accumulate the stock whenever it is a bargain - need to look at latest audited balance sheets for the same, and that's an action now.

5. Analyze whether CARE needs to be exited immediately, or we have more to analyze it in further details.

6. Analyze what to do about capital goods stocks (BHEL, CG, MAZDA)

Next Action is to create a study plan, that'd comprise of:

(0) Can mutual fund SIPs (regular and continuous) be good enough for average returns, slightly better than fixed income? Further, invest (new money) directly into stocks only if you find a really great bet after very conservative and thorough analysis? As Mr. Buffet says, 2-3 great picks an year are more than enough...

(0->1) Goals and deadlines are for pure science work, which is somewhat true in office and engineering products. Investing is more of an art and hence it's futile to set goals and timelines. Be clear about it and set a wider goal accordingly, which should be to live a happier life. Outcomes which are out of your control should not worry you so much in future.

(...) I also need to revise lessons from Bhagvad Gita as it'll help me stick to my philosophy and strategy, and not get deviated by noises.

1. Technical analysis for long term investments and portfolio hedging using index options?

2. Portfolio allocation between value oriented investments, speculative bets (can you rely on others for this? are you competent emotionally for fast moving market timing based decisions? cost of mental stress?) and other investing methods (quantitative value investing purely based on numbers like Ben Graham's or Magic formula based screening or Prof. Bakshi's statistical bargains...).

3. The following readings for value investing / behavioral control, as I also mentioned in last post:

- Letters from Mr. Warren Buffet
- Mr. Charlie Munger's work on mental models
- Howard Marks's memos to investors
- Security Analysis by father of Value Investing, Mr. Ben Graham

- Prof. Bakshi's blog

- Pat Dorsy and Phil Fisher

- A few books on behavioral finance and history of market manias and crashes

4. Finally, maintain a regular portfolio review schedule - say every fortnight, and you don't want to spend too much time on this every week.

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Here're the notes based on brainstorming and taking final decisions:

1. Base rate of success of value investing in the long term, and timing the market along with study of business fundamentals - on this topic, I find and believe that base rate of long term investing success is quite good if time horizon is 15 to 20 years, as evident from below summary of few reads:

This link shows how long has it taken for value oriented investments to recover in the past, and it is generally less than 5 years. Based on this "history", the decline that started in end of 2010 in Indian stocks (not the indices) should end by 2015 or earlier, and we should get good chances to exit investments in "not so great" businesses or not so great stocks in our portfolios at a decent if not great profit and re-balance portfolios sometime in 2016-2018. You need to stick blindly to buy and hold, but rather be vigilant of the business conditions and take decisions to sell stocks. Further, this study shows that base rate of success of a diversified portfolio with balanced allocation and held for over 20 years is quite high, and the key is NOT to time the market and staying invested. Finally, if you buy stocks very cheap, dividend yields tend to get higher and they more or less offset the cost of capital that's held in the investment. Hence, finding great value bargains with dividend yields approaching long term bond yields is an excellent opportunity to make great wealth.

The next question that relates to market timing is - What if I keep accumulating good quality stocks at good prices, but when it's time that I need money, we have a great depression? I'll just have one chance. On this, I read and found that:

This interview by Mr. Buffet tells us how staying invested in equities for long term generates superior returns - which is an increase in purchasing power of original invested money, post tax and costs, while ensuring sufficient safety of principal invested. Many other articles (like this) explain how timing the market is not so useful (yes there're exceptions, but probably the cost of stress and amount of time-investment is not so advantageous in terms of extra returns, even if they could be generated). Finally, we know the base rate of success of market timing is quite poor. We may still explore this subject of "Technical analysis for long term investments" in future as a part of study plan, but for now, we're incapable of performing this timing analysis on existing investment.

3. Whether to use PoE and quickly decide which stocks I can't hold for long enough, as an action from the last post. Not so sure, and rather the stock actions below are a better choice.

4. Stock actions (with the intention to minimize time resource allocation towards stock study, and re-allocate the same time more towards reading and learning):

  a. Trim investment in PEL, mainly since I don't understand it very well, and sidecar investment can't be top holding in a value oriented long term portfolio. Considering it can still be a good investment, I'll trim it down to about 5% of my portfolio, and hold it as a special situation (where the capable manager in Mr. Piramal can revive the enterprise and generate superior returns, but this still has a level of speculative element as an investment and hence not a pure value play, and rather a turnaround story which may not do so)

  b. Exit IL&FS and ARBL, as they'e anyways speculative bets not going to run away in a hurry and better would be to re-allocate these funds into mutual funds that I already hold (and they do have invested in these stocks). An action here (to get exposure to IL&FS indirectly) is to start a small SIP into PPFAS Long Term Value Mutual Fund, which may generate decent returns over long term (yes, there's a key man risk involved, and hence limiting exposure through a small SIP)

  c. To conclude on what to do about capital goods stocks, MAZDA, CG and BHEL, I think I'm little worried about their long term future - they may not turn out to be great investments, but I think they'll generate good returns. The question is - since this is the industry I understand the best (engineering stocks), and they're ones in deep losses (except MCX), should I continue to hold or exit in the hope of timing the market and buying them when signs of recovery in capital goods industry are better, and even re-consider better bets like L&T? I don't yet know, and need to think on this with focus...

  d. Rest of portfolio is MCX and CARE, of which I just moved MCX to speculative grade and hence I'll decide on that soon as a separate action, and CARE needs more analysis (if it's too hard to understand well) before any call can be taken. Regarding INFY and BHARTI (Bharti Airtel is probably a business more complex than I originally assumed, but since I understand it at a high level and believe that the worst is over for this sector and the business, I can afford to wait for some time to analyze this in deep, or move to the "out / too-hard" basket later on), I think I'll remain invested in these sound businesses - downside risk is quite limited in these, and I'll slowly perform more conservative analysis of these businesses and take a call accordingly, but no hurries to sell these two stocks right now.

Focus Dude, Focus...

Two days back, I cleared some deal of confusion in my mind, and I was trying to find some time to analyze how importance or dangerous is market timing for value investors, but even before I could read and assimilate that topic, a new doubt has emerged, and it's high time I write about it and try to clear it up as well. This came up from here, and the comments from Ajay in that post, and then some discussions at home, and further, Vishal's reply have given some direction to the thoughts.

So, the new doubt is - that I still have a long way to go; I need to read the following:

- Letters from Mr. Warren Buffet
- Mr. Charlie Munger's work on mental models
- Howard Marks's memos to investors
- Security Analysis by father of Value Investing, Mr. Ben Graham
- A few books on behavioral finance and history of market manias and crashes

All this needs a good deal of time, and more importantly, focus, and considering my day job, it's not so easy to get ample time. On top of that, my sizable investments into some "decent" stocks where I've not done detailed analysis and have committed few mistakes while building this portfolio keeps me slightly worried, at least so much that I spend a majority of time that I get on analysis of my portfolio and what should I do about it - forget about it, book profit in stocks that're in positive, cut losses or look for bottom fishing opportunities in stocks that've lost over 40% since I invested in them, thinking they were undervalued, or just liquidate everything and step aside (but slowly move money into mutual funds since I'm convinced I don't want to have too low an exposure in equities at any point in time).

So this time, it's a clear resource problem, more than anything. let us see how to resolve it. First, we write down scenarios, performing a sort of pre-mortem:

A. I spend (or waste) all of my time in analyzing stocks I already hold, and worry since I'm not able to take a clear decision whether to hold or sell them (it's far more difficult to control emotions when you see 50% losses in stocks you did not analyze well enough before buying). Since no actionable outputs emerge from such an analysis, it's definitely a waste of time

B. I analyze my existing portfolio and I'm able to decide on cutting some positions (either because I've strong reasons to believe that the business will deteriorate further in coming months and it'll reflect in the stock prices, or I believe that stock prices are a bit over-priced and there could be pain the medium term, in summary identifying stocks which I don't think can be held for next 5 years). If this can be done, it'd be a useful outcome of time spent. However, this would easily take over 2 months of my time if I can regularly analyze the stocks and underlying businesses, and I'm worried that in these two months, markets may move much lower leading to further losses to my portfolio

C. I spend couple of days, and try to use process of elimination, and find stocks where I've even a small doubt in holding for long term, while writing down my reasons on why I think so. Or, even those stocks where I believe there're strong reasons that they might under-perform for many months to come, even if they might be good bets for long term. Well, this might be a smart thing to do, but it has a risk of going grossly wrong about many points since it's effectively a short-cut. Let's come back to this point in a while.

D. I conclude that I've made few mistakes in picking stocks without detailed analysis, and I'm in general uncomfortable, and I'd better do by moving funds into mutual funds. However, I also weigh the fact that Vishal pointed about Icarus' Deception today, and decide to balance out investments in mutual funds and direct stocks, by remaining invested in the stocks where I feel there's good potential and I've not made a big mistake.

E. I don't do anything, and just decide how to NOT get de-focussed by looking at my stock portfolio, and only focus on reading. However, am I not trying to find just this "method" for so long now? To some extent, Vishal's post and then my introspection helped, but the realization that my analysis in many stocks is not that detailed and the worry about my portfolio being concentrated in sectors which may suffer for many months, possibly couple of years adds to the confusion.

Ok, having written in this post so far, one thought emerges - let me not look at every stock in my portfolio the same way, and rather write down about each of them, while recognizing that what's in profit today may not remain so, and what's down 60% may show a smart bounce back. So here's the list:

Well analyzed Stocks

1. MCX
2. IL&FS

Moderately Analyzed Stocks

3. CARE RATINGS (CARE)
4. AMARA RAJA BATTERIES (ARBL)
5. PIRAMAL ENTERPRISES (PEL)
6. MAZDA LTD (MAZDA)

Not Analyzed So Well

7. BHEL
8. CROMPTON GREAVES (CG)
9. BHARTI AIRTEL (AIRTEL)
10. INFOSYS (INFY)

Now the interesting fact. The deeply analyzed stocks are either under-held (IL&FS), or in large losses (MCX). Then within moderately analyzed stocks, PEL is a side-car investment which may perform contra to the general market and I'm not much worried about this investment, and ARBL is only a negligible percentage of my portfolio. I'm neutral about holding MAZDA, a decent dividend yield being the only attractive reason, and CARE RATINGS is a confusion which I'll talk later about. Finally, the "not so well analyzed" stocks are popular large caps which earlier became out of favour when I picked them (INFY and AIRTEL) and the other two, CG and BHEL which comprise of more than 35% of my portfolio (by cost, but not by price) are reeling under an industry wide pressure (capital goods), which otherwise are decent businesses with a decent management quality.

Let me then eliminate stocks about which I'm not much worried:

a. PEL: A side-car investment, contra to market due to being a pharma company and in the hands of a solid management. However, since my exposure is large, I may consider trimming a bit and take some profits home if I decide to size down.

b. Negligible investments, so not much worry: IL&FS, ARBL

c. MAZDA is something I had been thinking for a while to trim down, so it should be an easy decision.

Now, the tougher ones:

d. INFY and AIRTEL are generating some handsome profits in my portfolio, and based on what I hear, these would keep going up in months and days to come, and while there're problems (and these businesses may again turn negative), there are some good positives that've emerged for both the businesses, and hence I'll be comfortable holding them for long term. The only point is that they're both 10% each in my current portfolio, and I'd find it easier to trim down if I've to sell other shares and trim down my exposure into direct stocks.

e. BHEL and CG, even though they're quite down, I still continue to remain positive about their long term future given the large need for India to grow it's energy infrastructure and tackling power shortage. However, there're challenges in the environment today which may keep this sector under pressure for many more months, and hence it may be prudent to trim exposure to these stocks and return back after a deeper analysis, and there's little risk of not being able to buy them at sufficient margin of safety even after 6 months.

f. CARE and MCX, well, toughest calls since I somehow feel positive about their long term prospects, but there're some short to medium term concerns that may take these stock prices further down, and I may loose as much as 90% of my investment into these two names. Further, both are associated with some form of "financial leverage" which is one big thing which makes me worried these days.

To summarize so far, I'm comfortable in:

1. Maintaining my small investment in ARBL and IL&FS
2. Trimming about 25-30% of my investment in PEL, BHARTI and INFY
3. Trimming down upto 50-60% in MAZDA, BHEL and CG
4. Not yet sure about what to do about CARE and MCX. Possibly buy more after further analysis since I still hold a positive view in the long term about these businesses.

Let's say I do this re-allocation. I bring down my exposure into direct stocks by about 30%, and even then, I'd have about 30% of my overall portfolio invested directly into stocks. Is it a comfortable level? Does it then allow me to not worry about these investments and focus on studying? Let me find that out, again by analyzing probabilities:

Scenario A: Leave portfolio as it is won't work - I've seen that now for last 3-6 months.

Scenario B: Trim down direct equity exposure as described above, and then leave those stocks there, and analyze them as I get time (while maintaining a regular study routine). This sounds more comfortable since it meets both goals - first to reduce exposure and hence risk of a wash-out (I still stand a chance to loose 30% of my portfolio, but that's a low probability event since these are still good quality businesses, maybe I'll lose 20-30% of direct equity portfolio, but not majority of it, and in such a more realistic worst case scenario also, I only loose 10% or lesser of my overall investments in equity, Mutual Funds and Debt); and second that I'm still decently invested in equity in case my worries of having picked wrong stocks by doing an incomplete analysis turns out to be wrong and some of them turn out to be multi-baggers in next 10-15 years. Finally, there's another indirect benefit, that I won't quit value investing, which could be a risk if I sell off all the direct stocks (and rely on good fund managers and not worry about learning some great knowledge about investing)

Scenario C: I say good-bye to all the individual stocks, and focus only on studies. But as I just said, there's a risk that I'll quit completely from value investing and my procrastination may rule and take me away from value investing and learning some great knowledge.

So, Scenario B seems to work the best. Let's now do a pre-mortem as final step - what can kill this plan? Let's see

- I still continue to worry about the remaining 30% of my money invested directly in stocks, and can't focus on studies. This is possible since if I assume I won't lose more than 30% of my equity portfolio over long term as a worst case, today I stand a chance to lose about 15% of my investments, and after this re-allocation, under the assumption that mutual funds won't lose any amount, I'd lose 10%. So the difference is only 5% of my current investments, but that's not a small amount. Let's see...
- I start moving funds from stock sale into mutual funds and then start worrying about mutual funds. Probably unlikely since I'd move funds gradually using SIP and then mutual funds can't lose a major part of capital, unless we're heading into a great depression for next 20 years! Again, a very low probability event.
- I don't worry about stocks, and I don't study also. Well that means I quit value investing anyways, but again a very low probability event given my strong and growing interest.

Phew, so much that I wrote. Let me now go and take rest, read this post 5-10 times again and then sleep over the idea, and finally act once I'm convinced about what I want to do :)

If not anything, it'll give me better clarity about my doubts and problems and a better way to pursue forward.

Wish me best of luck, bye bye :)

Clearing the confusion

It's been a turmoil in my mind for last few weeks. I've heard a lot on how financial markets will do in coming future and how chances of a major crash in equities, commodities and real estate is going to follow us, and how cash will become the most sought out asset class (just opposite of what's the case today - easy liquidity is the buzzword today and no-one wants to keep cash with them, all of them want to "invest").

Well, that may very well turn out to be true. True that the mindless money printing can't go forever and liquidity worldwide will become tighter in months and years to come. Governments have to realize that they can't keep pumping and throwing cash like that and keep building their debt - this is NOT going to solve the problem of slowdown, it is only delaying the inevitable: world markets and economies are on steroids and this is NOT a healthy growth, any of which we see, and rather this is cancerous growth and must be curtailed at the earliest. You can't provide easy and cheap money to corporations and allow them to over-produce and foolish consumers to over consume. One day, this "bubble" has to bust and things will then revert to mean (which is healthy, organic growth, just about the right amount humans normally need). Of course, when reversion to mean occurs, it is always preceded by over-reactions and extending too far into opposite direction, simple law of physics that:

- either we slowly revert, without "overshooting" to the other side, i.e., over-damped systems, or
- revert in speed, and the faster the speed (which is generally true since everyone is taken aback by reversal and then there's panic and that causes a positive feedback to come in and speed up the reversal, till there's no more energy to continue reverting), larger the "overshoot" to the other side, i.e., under-damped systems.

OK, enough of macro-economics and physics. Let's get to the point. What is my confusion? Let me write down my worries:

A. Stocks prices and hence my current investments will sharply go down in next 1-2 years when we can see a major sell-off in all asset classes except currency.

B. If prices are going to crash, should we not just sit in cash and wait for the moment when things are much more cheaper and we know things are near the bottom?

C. What if we're on the verge of the mother of all great depressions and we may have several decades of slowdown and deflationary economies worldwide and we'll go back to pre-industrial-revolution times, and many people who're involved in jobs related to products and services that're NOT essential for a basic living, like an iPhone or a luxury car, will lose jobs, and agriculture will again become the most sought out profession?

I read this today morning and earlier during the weekend, Vishal send me this to read to relieve my concerns and confused state of mind. Well, very true that I was thinking of possibilities, without considering the probabilities. Now that I've recalled this very important rule of thinking in terms of probabilities, here's my assessment of what can happen and what are the chances that something will happen:

1. What is the probability that stocks (good quality, in my portfolio and watchlist, and not sensex) will crash by over 90% in near future?

ANS: Low, I think here are the probabilities:

a. Less than 5% chances that prices will fall by more than 90%
b. Upto 15% chances that prices will fall by up to 70-90%
c. 30-40% chances that prices will fall up to 60-70%
d. Good chances that prices will fall up to 50%

2. What is the maximum likelihood time period from now for which such "crashed" prices would remain?

ANS: I think depressed stock prices will remain here for next 2-3 years and this has a good probability of occurrence. However, chances that prices (and hence fundamental business performance) will remain deeply depressed for next 10 years is quite low, probably less than 5%.

3. What is the probability that you'll sell majority of your portfolio in this period? Instead, what is the probability that this period will be your accumulation period since you'd not need the money from your portfolio?

ANS: NIL to very low, unless a financial crisis occurs. My job is a bond where risk of a major fall in income is quite low, and even if something dramatically wrong goes with my current employer, I've fair chances to get a new job. Hence, I won't need to liquidate major part of my portfolio in next 10 years, which is also my accumulation period. In fact, a good deal of chances are that I'll keep accumulating stocks (provided things remain normal) for next 15-20 years, and only sell over-priced stocks in my portfolio from time to time to balance it.

So, in summary, there's no reason for my worry "A" and confusion. Let's look at worry "C" before "B". Well, capitalism works on the basis of greed and fear, and the world has seen many such credit bubbles, and a very good summary of these bubbles is in this book, which I want to read for a long time. However, the summary is "The Rise of the Fallen" in literal sense :)

So long as we live in a capitalist world, we'll have to see such bubbles boom and bust, and we're probably facing the bust of an even bigger, possibly largest credit bubbles of all times, more so because of highly increased financial leverage across the world. But we can't be more worried about it. So long as we pick good businesses, they'll continue to perform well. Again it'd be a low probability event that businesses with healthy balance sheets, lots of cash in hand and large market shares will collapse easily. Yes there'll be pain, but as long as we continuously monitor their business performance, we can manage the risks associated in their investments. Hence, I'm convinced that my worry "C" is also unwarranted and it's futile to spend time and energy, not to forget stress due to something which is very low probability and simply out of my control.

Finally, what about my worry "B", which simply spells about market timing? This is an area I'm still exploring and trying to find answer to the next big question: "Have times changed such that market timing is now more important even for Value Investors?" Well, let that be the topic for my next post and I'll very soon come back on it.

Until then, may my little mind rest properly and go back to sleep every night peacefully and not with worry of what would happen to the world economy next morning. Enjoy the beautiful day :)

Speculation Watchlist

This will be a quick post; while I posted about asset allocation and need to increase equity investments, I've come across these few stocks where I believe a speculative bet will help generate some decent profits, and help me satisfy the urge of "gambling".

- IL&FS Investment Managers (IIML): I just concluded this morning that IIML is not a good enough investment for long term, but it might be a reasonable speculative bet, in small amount. I'll keep adding trickles of this stock to my portfolio - I don't see it running away in a hurry, but yes, if macro-economics improve, this stock may be an out-performer.

- Wockhardt Ltd: The stock has fallen from 2000 odd levels to 1200 levels in last 2 months, and is probably over-discounting the recent news of quality concerns with their medicines. It maybe a favorable bet, let's see if risk / reward is good enough. Looking at some numbers quickly, the company has generated an average annual revenue of Rs 4600 crores in last 3 years, and the sales is growing at about 18% annually. Further, the operating profit margin is growing from 24% to 36%. Assuming that the US import restrictions impact top-line by US$ 150 million (taking margin of 50% on what management says), this translates into a hit of Rs 750 crores to annual revenues. Assuming no revenue growth and current revenue level of average(5449 for last fiscal, 4600 as average for last 3 years) = ~Rs 5000 crores, and reducing Rs 750 crores, we get a revenue of Rs 4250 crores for next financial year. At a 30% OPM, this results in Rs 1275 crores of OPM. Now, looking at current numbers, Market Cap / Operating Profit has been around 10, and at current share price of Rs 1200, we get slightly smaller ratio. So, Rs 1200 per share is a reasonable price proxy to the share price before the import restriction, and if the company is able to regain FDI compliance (as management says they'll do it in next 3 months), the stock price can rebound back towards Rs 2000.

Considering the quick analysis above, I feel that the stock can be purchased below Rs 1200 for about 25-40% gains in next 3-6 months, and downside risk is very limited. As for margin of safety, we've taken higher hit on revenues, assumed no growth and a lower OPM, and that should be good enough to justify a small purchase in the stock, of course limited to less than 2-3% of my portfolio.

I'll add more speculative bets if they come, and till I don't hit upper limit of my speculative funds.