Asset Allocation

While I'm working on the revised checklist, I also thought that I should get my portfolio asset allocation right. In this short post, I try to pen down what would be my asset allocation strategy.

Since my human capital is "bond type', as I strongly believe that my job is reasonably secure, I must keep a large portion of my investments into stocks / equities. Hence, I plan to keep the following allocation

NOTE: I do not consider real estate as an investment right now, and hence I'll NOT count it in this allocation. Also, cash investments like providend funds are also kept aside from this asset allocation.

1) Set aside sufficient money for daily expenses, committed annual expenses and emergencies, maintained in savings bank account, apart from some money (encashable in 2-3 days) in liquid fund. This part of money is NOT for investment.

2) Remaining available funds are for long term investing and limited speculation. This is partitioned as

- At least 10% in fixed maturity bonds and balanced fund. I do not choose bank fixed deposits as I believe that the post tax return on these are disadvantageous and do not compensate positively for inflation. I plan to keep this part of investment in HDFC Prudence Fund, as it is a good balanced mutual fund and has performed well during deep market corrections.

- Up to 15% in commodity investments like GOLD and others.

- At least 60% in equity investments, most of which would be direct stock investments, while a small portion (mostly through SIP route) into healthy equity mutual funds. As I wrote earlier, these investments will be directed into the following mutual funds. Note that mutual fund investments will be increased only when there're little chances to directly invest into stocks.

Large Cap focussed

- Franklin India Bluechip Fund
- HDFC Top 200 Fund

Small / Mid cap focused

- DSP Blackrock Small & Mid-cap fund

- SBI emerging businesses fund

- Franklin India Prima Fund

Amongst the direct equity investments, the following allocation looks reasonable on the diversification and balancing front:

- At least 10% in High Divident Yielding (3-5% or higher dividend yield) stocks. These stocks will provide cushion to the equity portfolio. Some of the potential stocks in this category of watchlist are: 

• IL&FS Investment Managers (~7% dividend yield at CMP)

- Up to 30% in large, stable businesses (stalwarts) from which I expect to generate 30-50% return in not more than 2-3 years. I believe that these businesses are decent but would not be suited for a very long term investments, and when they fall due to some transient problems, they can be picked up for decent returns. Some of these in my portfolio / watchlist are

• Infosys
• Possibly BHEL & Crompton Greaves, but these two would also fit into the next category

- Up to 5% in speculative bets / sin stocks. These will help fulfill the human desire to speculate, and also occasionally make some money. But again, here too, the main driving principle will be to protect the capital. Here, I'll take help from my brother who studies and practices technical analysis, or bet on some stocks where I feel risk / reward ratio is highly favourable.

- Remaining investments into Turnaround and long term stories. By turnaround, I mean businesses which are sufferring some structural problems right now (like an evolving industry or the business is transforming), but the long term prospects look good and I have the conviction to hold them for a long period of time, expecting to generate multi-bagger returns. Some of the investments in this category are:

• Piramal Enterprises
• Bharti Airtel
• CARE ratings
• MCX India
• Amara Raja Batteries
• Possibly BHEL & Crompton Greaves, but there's confusion as they also fit the above category, and my conviction is NOT very strong enough to hold them for more than 5 years (as I believe that very long term return may be below average returns)
• Mazda, but since this is a small cap, I need to build that conviction again through a deeper analysis.

I'll now work towards reviewing my existing holding and re-allocating based on benefiting from opportunities and maintaining a reasonable asset allocation.


UPDATE as on 25th May 2013
Here're the charts showing my current asset allocation

As can be seen from charts above, my current portfolio is heavily inclined towards "retirement investments", and I need to balance the same. Here's what I need to do:

1. Need to infuse new capital, as I can't reduce Provident Fund and re-allocate it into other investments
2. Need to increase investments in the following asset classes
- Stalwarts (medium term horizon)
- All forms of mutual funds, including a dividend plan which would generate regular income
- Withdrawable bonds, like Fixed Deposits. This is to ensure we always have liquid funds for emergency needs, and which can be withdrawn within couple of days. It may so be the case that I'll maintain a minimum investment in liquid debt fund and not go for a separate investment, but considering the size of my current portfolio, I need to infuse new capital for any new investments, and the current size of HDFC Cash Management Fund only covers for "withdrawable bonds' category.

Checklist

After a lot of business at work, I'm now back with trying to set a regular routine, and before I go ahead an start analyzing the stocks I listed in my last post, I must write down the checklist - my checklist based on my latest learning. I did make a "huge" checklist last year, but over time, I've realized:

- The bigger the checklist, the bigger the resistance to adhere to it
- It is very important to bring together ideas (mental models) from different people and perspectives into the checklist to make us think in different dimensions. While this doesn't eliminate the risk of "black swans (unknowns) [Nasim Taleb]", it does help to reduce it.

- We tend to flow away into details when we solve a problem, and we 'forget' the big picture and the original problem we were solving - the same happened with my old checklist, it grew too big and I forgot the first reason why I needed a checklist!

The first reason we need checklist is to make sure we don't forget - and we don't go where we can die. Instead, I kept making a checklist which had so many items, without the focus on the main objective. Hence, I derive the following new checklist, with the main objective in mind - "don't go where you may die"...and yes, I'm getting more and more influenced by what Mr. Munger has said, and I'm reading and planning to read more of what the legendary investor has written, especially on behavioral finance.

So, we start, and once again, keep the following in front of mind:

- Don't go where you may die

- Invert, always invert, for there can be infinite ways to prove something, but only one exception is needed to disprove, hence the "process of elimination" or Inverting the problem is a more efficient way, and no wonder why science has used it for such a long time, successfully

Most importantly, the checkpoints are eliminating - if you can't provide a very convincing answer to move to next checkpoint, you should probably let go the stock and look for others :)

And before we start eliminating based on checklist, let us write down the following two point - our "initial perspective" about the business / stock:

• What is your main reason to look at this company? Write this down and once we analyze the business, we'll come back to see if our analysis is biased by this presumption [Anchoring bias, Charlie Munger]. If your reason is mainly a recent, sharp decline in share prices, try to find why so many people are selling, and if they know more than what you (prospective buyer) knows, or in other words, are you taking undue risk by investing into something with many unknowns?

• What kind of investment do you consider this business initially? Are you considering it as a long term story, or a medium term play (sorry, short term plays, i.e. for duration less than 3 months, are OUTSIDE the circle of value investors). Write down your initial thought in terms of [Peter Lynch] investment types - High Dividend Yielding, Stalwarts, Cyclical, Fast Grower, Turnaround story or an Asset Play?

TBD: Where do we add checks about finding scuttlebutt [Philip Fisher], behavioral biases, checks about black swans (really possible?). Pre-mortem?

Checkpoint 1: Is the business OUTSIDE your circle of competence [Charlie Munger]? Can you talk about it right after you're waked up from sleep? Do you understand the business well? Is it simple enough for an idiot to run [Peter Lynch]? Assume you're no better than an idiot!

Next, we try to eliminate the business based on management quality, for, a good manager may not be able to turn a bad business into a good one, but a bad manager can certainly damage a great business, irreversibly, and hence we must be very careful of the management.

Checkpoint 2: A good management is essential to keep a "good business" good, and hence, we must identify whether
a) Is management candid with shareholders? Have they done what they said in the past?
b) Does management act rationally?
c) Do management acts imply integrity?
d) Does management demonstrate good capital allocation skills, or they're stuck in institutional imperative? Examples being prudent dividend declarations when no avenues for cash, buying back shares to reduce stock dilution etc.
e) Does senior executive compensation include company stock options, and is it designed to bring sense of loyalty and belief? Are "insiders buying" the stocks when their market price goes down? Is promoter holding a clean holding or shares are pledged to "manage cash"?

Checkpoint 3: Does business possess a strong economic moat [Warren Buffet]? Check the following:
a) Do customers have a bargaining power that keeps an upper bound on prices and margin improvement is limited (cost cannot be lower than 0%)
b) Do suppliers have a bargaining power that keeps a lower bound on costs, such that margins are squeezed?
c) Risk of new entrants, who may play pricing wars and put pressure on pricing, i.e., does business have "earning power" like a brand value that allows it to maintain (or even increase) prices?
d) Is there an alternate product that poses a risk as a substitute to the product / service that business produces? Could it result in a permanent loss of revenue to the business?
e) Is the economic moat sustainable, or just due to luck?

Checkpoint 4: Since every business is essentially a system which takes in Cash and "is supposed to" generate more cash, such that the Return on Invested Capital (ROIC) is higher than Weighed Average Cost of Capital (WACC). Draw a "cash flow diagram" for the business explaining how it generates cash, and find out whether it has consistently been able to generate higher ROIC than WACC. Consider at least a period of last 5 years.


Checkpoint 5: Before we go further, we need to make sure that the financial health of the business is good. Answer these sub-points to find this out:

a) Is company sacrificing operating margins to grow revenue (lack of sustainable moat)? We want a business which is able to grow profits at least as fast as sales (maintain / grow operating profit margin).
b) Is operating cash flow poorer than profit (EBIT / EBITDA) on several occasions (consistently positive operating cash flow)?
c) How has working capital requirement changed over years? Is business generating cash faster than it needs (negative working capital)?
d) Is business generating good returns on capex, or it is burning precious cash in attempting to grow by capital spending (incremental return on capex)?
e) Is the debt on balance sheet concerning? Is most of operating cash leaking away in interest payments? Is business able to retire debt and gradually reduce interest burden? How long do you think will it take for the business to bring down debt to advantageous levels? Is dividend being regularly paid despite debt on the books? If so, is "Financial Leverage Index" > 1, indicating that return on investments is greater than cost of debt, and hence the leverage created due to debt is advantageous to the business, and it is good to pay dividends using generated cash, while keeping the debt at advantageous level.


Checkpoint 6: Stocks generally become value picks when they possess a healthy business with an able management, but suffering from a transient problem which drives the stock prices southwards. Is the business suffering from any such condition, and if so, why do you think this is not a permanent change (inflection point)? If you believe it is indeed an inflection point for the business, why do you think business is capable of turning it into an advantage [Andrew Grove]?

Checkpoint 7: Are there any negative catalysts foreseeable, that may impact the business prospects going forward, like a long term industry slowdown, increasing competition, or a regulatory change? On the other hand, what are the positive catalysts that'll bridge the gap between price and value?

At this point, you'd have either closed down, or successfully written down your understanding about the points above, and find that the business is healthy enough to pursue the analysis further. Before going further and performing a more detailed analysis, let us write down the expectation

Refer to a different post on guidelines for TBD stock valuation.

Risk Log: This is a concept used in large engineering projects. It is a way to write down risks involved in the project, and how to mitigate each of them. Borrowing this concept to investing, it'd make sense to create a risk log after having analyzed the points above, so that we know how much risk is involved in this investment, and are we going to get compensated enough for taking this risk [Charlie Munger]?

Stock Valuation: Do you expect the transient problem to go away / last for a small time, say a few months, and the temporary depression in stock can be used to make a small investment and benefit from it, i.e., do you consider this a stalwart [Peter Lynch]? If so, perform a "relative valuation" and find the "right buying price". If you've chosen this stock as any other form of valuation play (live a high dividend yielding stock), other than a long term holding, write down here and explain what is the right buying price, and why do you believe that you have adequate Margin of safety to justify this medium term investment's risk is well calculated.

However, if you still hold your "initial view" and plan to hold the stock for long term, perform a more detailed absolute and relative valuation and take sufficient margin of safety to address the concerns pointed out above in business analysis.

Opportunity Cost: Before taking the final decision, make sure that you're not overlooking the opportunity cost in this investment - can you allocate money elsewhere and get better returns with better margin of safety?

Final Decision: Does "initial view" still hold true? Is our analysis above somehow biased by those presumptions? After your analysis indicates that you should buy this stock, perform the following:
a) Keep the stock under "watch" for a week, and DO NOT buy or sell.
b) Post on blog and seek critical feedback. Seek contrary opinions, dis-confirming evidences, and try to find what you do not know [Charlie Munger].
c) At the end of the week, if your conviction in the business and stock's prospects is intact or stronger, go and BUY :-)

Analysis List

Over last few days, thoughts have changed, and I've come back to "analysis mode". Few discussions lead to the conclusion that just reading doesn't work - it works, but doesn't help you tame your emotions and biases.

Hence, now that I'm beginning to resume a regular "study plan", I plan to add a regular analysis work assignments as well to make it more lively and practical. Hence, here's my shortlisted stocks that I want to analyze in next few weeks. This list also includes stocks I already own - with the intent to re-allocate funds by selling off "weakest' holdings and buying better ones - only after a detailed analysis and "patience test of 2 weeks". So, here's the list, in order of my interest:

1. Amara Raja Batteries: I wrote about it earlier on the blog, and have always found it interesting, but need to justify whether it is really expensive or not. This is where I'll learn about Charlie Munger's principles and try to apply to AMARARAJA...

2. MCX: Again, similar to AMARARAJA, I like the story, it is beaten down recently and available around all time low, and below IPO price, but need to do a thorough analysis if the price is good enough to justify buying...

3. CROMPGREAV and BHEL: Top holdings in my portfolio, and still beaten down and around multi-year lows. Need to analyze if it makes sense to add more capital into these names.

4. MOIL: I like the story, and it has not moves anywhere - keeps oscillating...I stand at minor losses, but need to perform a reality check - while Manganese ore prices will increase, can I really bank upon it and hold on to MOIL? Do I understand this company and industry good enough - or should I move funds across, to say SAIL to benefit directly when steel prices rise, or just exit commodity stocks altogether...

5. BHARTIARTL: Again, like the "long term" story, but could it be too early to enter? Can it fall in price further due to mid term concerns? Need a reality check again...whether to exit or keep accumulating for long term...

6. Piramal Enterprises: They've decided to sell stake in Vodafone - on track with what they said when they bought it - but what do they do with the cash? Are they eyeing some big acquisition? Probably something like Novartis India stake? Need to think...hold or book profits?

7. Infosys & CARERATINGS: Just perform regular review. Any better opportunity? Just try to find if it is one of the worst of my holdings today? Most likely not, but need an unbiased analysis...

8. MAZDA: Could it generate acceptable returns in long term, or makes sense to re-invest? Think...

9. Bajaj Auto & Tata Motors & TVS Motors: Auto companies? Think about them - are they available at deep discounts?

10. IL&FS Investments: Probably too complicated to understand, but can I learn from Charlie to deviate a bit from circle of competence and still make some great investment decisions? Similar to what holds true for MOIL...but need careful thoughts...

11. Goodricke Group, Kirloskar Pneumatic, Swaraj Engines, KPIT Cummins, NIIT Technologies, Persistent Systems, Solar Industries India: These are filtered based on some "healthy business" parameters, but no "story" yet for them, to analyze and see if any of them is a great deal, compared to rest of the stocks for which I have some story...

Finally, to remind myself that this blog is currently also my investment journal, and I must write down my thoughts as well action plan before I do anything - will try to be more regular and post even my thoughts as micro-posts as I resume the daily studying routine...

Let the journey begin...

Slight change in "plan"

UPDATE as on 26th Mar 2013: I met Vishal Khandelwal, the chief Tribesman of Safal Niveshal on the evening of the day I originally wrote this post. Earlier in the day, he commented and cautioned about uncertainty in how PPFAS mutual fund would perform. We later had a great discussion about the current times and what should be the most favourable investment strategy, and here's further refinement to the plan below

Keep liquidity to benefit very good chances Mr. Market will give us in weeks and months to come. Even though the index is closer to the peak made recently than the bottom made in end of 2011, a large number of stocks of healthy businesses are at their several year lows again. This is interesting. While there's a risk that the stocks can fall further below, but now they're available at much favorable terms than before, and hence it makes sense to keep liquidity and "slowly and carefully catch the falling knife", small trickles at a time and keep accumulating good businesses.

I've a few funds that I don't want to continue, and they're nearly at break-even, and at the end of Financial year, it makes sense to lower the tax liabilities by selling off these investments. This will provide some liquidity, apart from the capital freed up in earlier planned mutual fund SIPs as I wrote below.

Also, regarding PPFAS mutual fund, I'll first try it by putting in a small amount rather than commit to SIPs right away in the NFO, and then see how they perform for next 2-3 years.

All this means that now I have about 70% of my planned monthly savings free for stock accumulation, not to mention the surplus cash inflow every month due to salary hike that'll come on its way very soon :-)

Vishal also suggested to keep the "cash in a liquid fund" so as to further reduce tax liability and still have enough liquidity to pay for stock purchases. HDFC Cash Management Fund is a very low cost (0.2% for direct investors) fund that can help generate decent post tax returns and give the desired liquidity. However, note that one must keep some pure cash liquidity in a savings account for day to day and emergency needs.

The next step now is to now re-analyze the stocks I hold in my portfolio and any new opportunities (here I differ from my earlier statement, but this means that I'm willing to churn the holdings to bring in better ones - where I have much higher conviction to hold and benefit in the long run). I've realized that simply reading doesn't work - it's probably not fun, and I somehow can't learn without hands-on. I know this is not funny, but as long as I can patiently invest, and not get impulsive and start "trading" and write before buying, this will work for me.

P.S: I completed sale of PNB and redirected 75% of the proceeds to buy CARERATINGS and remaining I put into BHEL and CROMPGREAV which were at better price now. Further on, any fresh capital infusion into the portfolio will follow a "write up" on why I'm doing it with clear justification.

Happy Investing and good luck to you and me for the accumulation period!
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Soon after I wrote my plan couple of weeks back, I came across "Parag Parekh's entry into Mutual Funds", and I found about their plan to launch "PPFAS Long Term Value Fund". I'm excited to know that an able value investor is going to lead a value oriented mutual fund, probably for the first time in India. It's principles align well with what a value investor thinks.

Accordingly, I'm making slight change in the mutual fund investment plan. Instead of diversifying into 5 equity based mutual funds through SIP route, I now plan to route major funds into PPFAS mutual fund when it is launched, and I've started SIPs into HDFC Top 200 Fund and SBI Emerging businesses fund. I wanted to get some exposure to very good skills of Franklin Templeton mutual fund, but now I don't have a choice - or I have a much better choice :-)

Also, considering a renewed confidence in value investing based on the learning that "it takes only a few weeks for stocks to outperform even after a prolonged period of underperformance", I'll start analyzing my existing investments, starting with the one which has maximum portfolio exposure, and address re-allocation. This means, that I'll analyze business again in light of latest developments and financial reports, and revise the right purchase price range, and if stock falls to this range and I've surplus funds (after setting aside for SIPs), I'll make incremental investments in most favourable holdings (the ones available at greatest discount to my "right purchase price", not necessarily the one in which I'm making maximum loss (I'll not try to blindly average and bring cost down - I'll try to make right capital allocation)

I'll also need to take a decision soon about another large investment - into real estate, and how to manage continuing investing in equity. More on that after some time...

Swap PNB with CARE Ratings

Update as on 23rd March 2013

I've completed the swapping. I sold all of my holding in PNB at around Rs 793 (average), and bought CARERATING at around Rs 810 for 75% of the sale proceeds. I'll keep rest of funds and now analyze which would make the best sense to route this amount to - CARERATING or some other existing holding (potential candidates being MAZDA, CROMPGREAV, BHEL, BHARTIARTL and MOIL)

=================================================================

In my last post, I mentioned the following about these two stocks:

8. CARE Ratings: I subscribed and was allotted 20 shares in the IPO. Since I believe in long term prospects of the industry and the business, I decided to hold on and NOT book 25% profit which came on the listing day. I'm even willing to make more investments in this stock when I have surplus cash and that price is low (the stock has fallen closer to the IPO price in recent weeks), however, any fresh investment after careful incremental analysis only.'

9. Punjab National Bank: This is a pure valuation play - buy known banks when trading at significant discount to their book value to insure against "unknowns" in balance sheet. However, I've committed mistake of not selling this stock when the intermittent re-rating occurs. This stock confuses me - whether to keep it as a short term (3 - 6 months) investment and exploit mis-pricing, or hold it for long term considering PNB's status. I don't think the business is great, especially since it's a PSU bank with command from government which often deteriorates asset quality, and it'd probably be better to be conservative and sell it upon the next rally in stock (and when P/BV comes above 1)

Looking at current price movements, PNB is around book value and there's no clarity on how far can it go. We've seen strong resistance around 900 - 925 range from which it has fallen. Moreover, the very recent sting operation report on private sector banks can keep banking sector in general depressed if not falling, and we're not sure how long can it take PNB to reach back ~920 range from current level of 800.

On the other hand, despite good results and dividend payment, CARE has come closer to IPO offer price, probably on account of profit booking. Although I analyzed it to be reasonably priced at Rs. 750 during IPO, paying slightly higher for a healthy business is not a very bad idea, especially when we're re-allocating capital from a riskier bet to safer, long term story.

I'll start selling PNB and converting the proceeds into buying CARE stocks, maybe in 3 or 4 tranches, since there's a news event (RBI policy) around, and market seems to be at a short term inflection point.

After this action, my portfolio will have no short / medium term bets, and all the stocks are long term holdings.

Latest Portfolio and plan ahead

UPDATE on 13th Mar 2013

One of my facebook friends read this and posted the following comment:

"You seem to have diversified too much! You hold 7 mutual funds, index fund, gold fund, bank deposits and 9 companies apart from 'sin' money?! Surely too much right?"

Here's my response to the question on too much diversification:

1. I have 5 equity mutual funds, 3 into small / mid caps and 2 into large cap. This is to reduce risk of "key man". Moreover, when I'm going into study phase, I'd prefer to invest primarily into mutual funds and almost no investments directly into equity.

2. Debt funds are primarily a place for parking incremental gains, and not fresh capital. I believe this is better than holding these gains as pure cash, and when I liquidate stocks, the macro environment may not be right to make fresh investments into equity or other main stream funds.

3. Investment in GOLD is for "traditional purposes"

4. Finally, NIFTYBEES is the last resort when I don't have clarity and conviction to invest money in any other vehicle, and I just want to ride along the index.
In any case, not all of these will be present in my portfolio at all times. As I gain more confidence from learning and the fact that I can invest directly in stocks, I'll reduce exposure to mutual funds. Regarding 9 stocks, I think 10 is more or less the maximum number of stocks an individual can follow diligently. Yes, 9 is close to this upper limit, but this 9 is mix of my decisions and their changes over last 1 year, and I'm OK to reduce this, but honour 10 as upper limit at all times.

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I'm back from a long break, and time now to catch up on value investing studies and practice. This one's a quick dump down of plan ahead.

Stay with no more fresh investments directly into stocks, unless justified with strong reasons. Any fresh investible cash to be added to mutual funds. Here's the list of mutual funds (equal contribution, which gives 60% into small / mid caps and 40% into large caps) I've selected:

Large Cap focussed

- Franklin India Bluechip Fund
- HDFC Top 200 Fund

Small / Mid cap focused

- DSP Blackrock Small & Mid-cap fund

- SBI emerging businesses fund

- Franklin India Prima Fund

Balanced / Debt focused

Depending on macro-economic outlook and its understanding (through interest rate cycle and equity market P/E cycle, apart from global financial situation), any surplus funds when there're no good options for main-stream equity investments, will be distributed in one of the following, depending on relative valuations:

- Bank Fixed Deposits

- Gold through GOLDBEES ETF

- Index fund through NIFTYBEES ETF (only if there're reasons NOT to add one time into mutual funds, such as when amount of cash is too small to invest equally in all mutual funds)

- HDFC Prudence Fund, as a balanced investment in equity and debt

- ICICI Pru Gilt Investment Fund Growth Option, as a debt oriented investment vehicle

Apart from these choices of investment vehicles for fresh capital, I've also categorized the direct stock investments that I hold currently into three classes:

Long Term Stock Investments

These are investments where I believe that the potential unlocking will take at least 3 to 5 years, such that I expect a return of at least 50% (3 years) to 100% (5 years), assuming a hurdle rate of 15%, and the following holds true

- I believe in the "story"

- The business quality is good and I expect business to grow in value over long term

- I've performed a thorough qualitative analysis to justify investing in this company, and I've performed a reasonable valuation analysis to NOT have bought the stock at expensive valuations.

Right now, the following are such stocks in my portfolio, although I may not have performed an in depth analysis for all of them.

Infrastructure & Natural Resources

I believe that India will grow and infrastructure still needs to play a big role. I've bought these stocks at reasonable if not cheap valuations, and when infrastructure spending rebounds, these businesses will see improvements in earnings and the depressed stock prices will see upwards re-rating. When this happens, I'll have a re-look to analyse if it makes sense to continue to hold these stocks or book profit and channelize elsewhere

1. Crompton Greaves

2. BHEL

3. MOIL

Telecom and IT

These are backbone of Indian economy, and the new generation services growth is linked to these industries. Moreover, the following two businesses have been the leaders, and they still hold potential to continue to remain so. Bharti with its hold on telecom spectrum and market position, and Infosys with a conservative management and a lot of free cash, will slowly grow and regain their "leader status" in the stock market when the next peak of bull market comes. That'll be the time to revisit them and see if to hold them further or not

4. Bharti Airtel

5. Infosys

Medicine / Healthcare

No doubts that healthcare industry will grow real big as Indian population gets older and has cash to afford quality health care when they retire. Since I've written about this company on my blog, so no further here :-)

6. Piramal Enterprise Ltd

Manufacturing (Small cap stock)

This is a small company which I believe has good potential to continue to grow and it has able management to not destroy the good balance sheet position like others. It's my sole "Lynch type" holding, but I'll remain conservative to evaluate it continuously and make fresh investments in this company only at reasonable valuations.

7. Mazda Ltd.

Financial Services

No doubts this industry plays a big role in Indian economy today, and has the largest weightage on indices as well. I've chosen the following two stocks, but with doubts about PNB, as mentioned below

8. CARE Ratings: I subscribed and was allotted 20 shares in the IPO. Since I believe in long term prospects of the industry and the business, I decided to hold on and NOT book 25% profit which came on the listing day. I'm even willing to make more investments in this stock when I have surplus cash and that price is low (the stock has fallen closer to the IPO price in recent weeks), however, any fresh investment after careful incremental analysis only.'

P.S: I also hold a tracking position (1 share) in Hindustan Unilever (HUL). Its a great business, but probably still too expensive below 450. I need time to find the right valuation method and good purchase price and start accumulating this evergreen stock as it falls when money moves into cyclicals. Such stocks like FMCG / Pharma need to be picked up slowly like an SIP in Mutual Funds, since you never know when they again become market darlings, and finding a floor for them is very difficult. Another reason to buy this stock individually is since none of the mutual funds I selected above hold HUL, and I simply love the business (through scuttlebutts, of course :-))

Short Term Plays / Sin Money

These are investments where I see an opportunity with reasonable margin of safety to exploit market mis-pricing to my profit. Examples include, but not limited to:

- BFSI stocks: Buy when available at good discount to book value, and sell when revert to mean (P/BV > 1)

- Beaten down stocks: Carnage in market causing some stock to be beaten down sharply, and I have strong reasons to believe that the stock can rebound at least 15-20% in 3-6 months.

Since the risk is high, I'd want higher returns from such investments - at least 20-30% in the investment horizon, if I don't see reasons that this will happen, I'd rather stay away.

Moreover, I'll limit to 15-20% of my portfolio in such stocks to avoid major erosion of capital in case these "bets" go wrong. This doesn't mean I'll always invest in such stocks, and I'll be happy to park surplus funds in mutual funds if I can't find such opportunities.

Some examples where I recently benefited, although only 3% of my portfolio holding was in such stocks. All four below were beaten down for various reasons and I believed they'll bounce back in months to come.

Unitech: Bought around 30 on 29-Nov-2012 and sold around 39 on 18-Jan-2013

Moserbaer: Bought around 5.8 and sold at 6.95 in less than 2 months

Spicejet: Bought a little expensive at 45 but sold at minor profit at ~49

Suzlon: Committed mistake to not sell at 25%+ profits, but managed to exit at some profits

9. Punjab National Bank: This is a pure valuation play - buy known banks when trading at significant discount to their book value to insure against "unknowns" in balance sheet. However, I've committed mistake of not selling this stock when the intermittent re-rating occurs. This stock confuses me - whether to keep it as a short term (3 - 6 months) investment and exploit mis-pricing, or hold it for long term considering PNB's status. I don't think the business is great, especially since it's a PSU bank with command from government which often deteriorates asset quality, and it'd probably be better to be conservative and sell it upon the next rally in stock (and when P/BV comes above 1)

Going forward, I'll stick to this plan and focus on studying, and post when I learn something new :-)

Happy Investing, and drive safely as the speed is increasing ;-)

CARE IPO Analysis

While I'd normally just let go most IPOs, but I somehow feel the urge to analyze this company. And since it's an IPO, I'll be extra cautious to analyse this, hence, start with Charlie Munger's way of 'always invert'...

Invert the question "why should you invest in CARE IPO" that so many "analysts" have answered on Friday (just google CARE IPO and you'll find) to:

WHY SHOULD YOU NOT INVEST IN CARE IPO

- It's an IPO which is a means to exit the investment for existing early shareholders like SBI, IDBI etc. If these 'professional' institutions are selling, why should you buy?

- None of IPO proceeds will go to the business, and hence IPO doesn't bring any fundamental improvement to the business

(BTW, same was the case for MCX IPO few months back)

- There's likelihood that after an initial jump, the stock price comes down and is available at cheaper price after a couple of months

- Equity markets have run up quite a lot since June 2012, and they might be around the top and might either decline or stay at current levels for a long time from now, and in such sentiments, the IPO stocks might not do very well and can easily come down to more favourable levels.

- I do not understand the business of CARE and it's industry dynamics very well, and hence my analysis of businss might be grossly wrong.

- All the brokerage coverage of this IPO can be 'mis-guided' and brokerages, as almost always, might have vested interests in promoting the IPO

- Owing to the fact that CARE is a rating agency, SEBI has exempted the rating of CARE IPO, possibly since sharing internal financial information to competition can be detrimental to CARE. This means that there's no standard rating for this IPO, and hence the risk of incorrect valuation prevails.

So, we analyze the risk that, even if the business has good fundamentals, the stock may be overpriced in IPO and there's chance of buying it at better levels post IPO. Let us, however, not be conclusive and go ahead to analyze the stock, since there's no strong reason right now to indicate weak business. Here's the next step to do a qualitative analysis of the business.

QUALITATIVE BUSINESS STRENGTH

What does the company do?

Credit Analysis and Research Ltd, CARE Ratings Ltd. was established in 1993 and since then, it has grown as the second largest Indian credit rating agency after CRISIL.

CARE ratings has experience in rating:

- Debt Instruments
- Bank loans
- IPOs
- Insurance companies' capacity to pay claims
- Mutual Funds
- Recovery
- Corporate Governance, etc...

CARE has a subsidiary, CARE Research, which provides research reports and custom research on a multitude of industries like Banking, Retail, Automobiles, Infrastructure, Textiles, etc.

What is outlook for credit rating industry in India?

With the introduction of BASEL III system in India, the business volume for rating agencies is going to grow further, since regulation norms are getting stricter and require more financial transactions and credit instruments to be formally rated. Moreover, in my opinion and understanding, the reputation of rating industry plays a big role in getting deals through quickly, since for example, a positive rating by CARE or CRISIL will weigh more positively on a credit instrument like a debt restructuring, than any unknown rating agency. In this respect, CARE and CRISIL will benefit from regulatory reforms in credit markets and they can leverage their positions to grow their top-lines  while maintaining healthy profits margins that they currently enjoy.

Having said that, there's certainly a threat from international competitors like S&P, Moody's etc. If the landscape changes and these big companies expand in India, it can be a risk of margin erosion for CARE.

Also, from a shorter term (1-3 years) standpoint, as interest rates come down, more investments will be made and hence volumes of business rating will increase, which is a positive development. However, it'll also mean that restructuring business will take hit since more businesses will be able to service their current debts and requirements for further restructuring will reduce. Overall, it'll depend on concentration of business for CARE on how declining interest rates will impact their revenues and profits. However, as per RHP, CARE mentions that increasing interest rates negatively impact their business, and hence, if interest rates turn southwards from here on, as is very likely given the current macroeconomic situation and RBI indications, next 12-24 months can be good for CARE business.

Where is the business of CARE concentrated, and is there any concern due to this concentration?

As mentioned in RHP, more than 85% of revenue for CARE is generated from rating of debt instruments. While CARE is trying to diversify into other areas of ratings, it may turn out to be diworsification and waste of precious cash. On the other hand, over-concentration in debt instruments can be detrimental to the business health in case the general debt instrument transactions are to reduce in volume going forward due to various reasons.

On the other hand, given the stability in debt instrument transactions and the fact that they'll grow as macroeconomic situation improves, concentration can be helpful for CARE.

How does CARE stand in credit rating Industry?

CARE is now the second largest rating industry in India, after CRISIL and while latest data is not available, CARE roughly controls about 20-25% market share today.

Does CARE has a strong business moat?

CARE does have at least a moderate business moat owing to the following:

- Established position and experience of 20 years gives them a reputation and CARE (and CRISIL) ratings are valued well by investors. This means more clients go to CARE and CRISIL and hence both these companies enjoy "barrier to competition" due to loyalty of their brand names. This of course, also means that CARE might lose business to CRISIL on similar grounds, but CARE can grow (and has shown to grow as we'll see shortly) its business by capturing market share from smaller players, and hence enjoys the benefit from "high switching cost", since a client doesn't benefit from switching away from CARE to a smaller player as investors won't like this (an example is large drop in share prices of OPTO CIRCUIT when they decided to change their rating agency; while they're switching to CRISIL, the fact that they're changing rating agency brings questions to investor minds). This factor can help CARE ratings to maintain and grow their revenue, while maintaining profit margins.

- "Operational efficiency" of centralized back-end operations in Ahmadabad. This helps reduce costs of duplicate database, reliance on third party data services and inaccurate information. Use of integrated information interface ("i3 interface") by analysts also help improve operational efficiency. This helps keep "costs low" and hence better profit margins.

SWOT Analysis for CARE Business

Strengths

- Established position and experience of 20 years

- Strong management with rich experience from banking industry (IDBI roots)

Weaknesses

- Over-concentration in debt instruments

Opportunities

- Leverage current position and capitalize the growing market (due to better macroeconomics and Basel III norms, etc)

Threats

- Diversification efforts fail and erode capital

- Competition from foreign players like S&P (via CRISIL) and alike.

- "IRB Approach" by banks can damage revenue avenues, as highlighted by the company in RHP risks section.

- Inability to recover annual surveillance fees

- Corporate governance issues can severely damage the reputation of company and can impact the revenues and margins negatively.

- Growth rate can reduce going forward due to larger base and stiff competition can dent profit margins

- Acquisitions may not work out so well

- Regulatory changes can impact business negatively. This document highlights some areas where regulatory changes can hamper the business for rating agencies.

- Delay in regulatory approvals can impact business negatively

- Pending litigation against senior management or company, if decided against the company can severely impact the reputation and hence the business for CARE

Financial History and Summary

According to RHP, the following are salient points for last 5 years of financial performance:

- Very low levels of debt / equity, standing at 0.02 as of latest balance sheet

- Growth of 20%+ in net worth over last 5 years

- PAT growth of 44% over last 5 years and sales growth of 41% in the same period (profit growing faster than sales)

- Consistent positive cash flow from operations

- Regular dividend payment since last 18 years, growing during last 5 years from 45% in 2008 to 100% in 2012. At upper band of IPO price (Rs 750), this is a dividend yield of at least 1%

- Return on Net Worth / ROE of more than 25% in last 5 years

Stock Valuation

By now, we find that the business is healthy, growing, and despite risks from competition and regulation, this is still a very good business justifying efforts to do some quantitative valuation.

Some useful numbers:

- Upper band price: Rs 750 per share

- Current book value: Rs 137 per share

- Current Net Worth: Rs 427 crores

- Current EPS: Rs 37 per share

- Current P/E ratio: 20.27

PEG based valuation

Since this is a fast growing, healthy business, let us first value it using PEG ratio, which comes out to be 0.5 considering ~40% PAT growth. This is very good for such a healthy business that generates 25%+ ROE with zero debt and consistent positive cash flow.

DCF based valuation

Performing 3 different DCF, assuming discount rate of 12%:

- 20% growth for next 5 years and 2% thereafter, fair value is Rs 762 per share, very close to offer price

- 30% growth for next 5 years and 2% thereafter, fair value is Rs 1090 per share, which is more reasonable considering 44%+ CAGR of profits in the past

- A very conservative DCF with 15% PAT growth for next 7 years and no growth thereafter gives a fair value of Rs 660 per share

This tells us that using DCF, CARE IPO is reasonably prices at upper band, if not available at a deep discount.

Relative Valuation

CRISIL and ICRA trade at P/E multiples of 40 and 25 respectively, and hence, CARE IPO is again under-priced at Rs 750 and a P/E multiple of 20. This again supports healthy price for the share.

Summary

While we've used very simple valuation methods, considering the health of business, it is not unreasonable to say that the CARE IPO is fairly priced at Rs 750. It may not be a deep value bargain, but market revaluations can easily take the share price to at least Rs 1000 such that it trades at 30x, more comparable to what CRISIL enjoys. Even a conservative estimate can be about 25% return from the IPO in next one year.

Yes, there're risks, but the risk to reward ratio is favorable to investors. Let us now see how the institutional buyers subscribe to the IPO, and accordingly we can take a call on Tuesday morning to subscribe, depending on liquidity. But at the least, it'd do no harm to subscribe to one lot (20 shares) at upper band price.