The Intelligent Investor – 5 – The Defensive Investor and Common Stocks

Posted on August 25, 2019 by Jimit Zaveri under Bibliophile: The Intelligent Investor

As we have seen to the previous articles of the same series that common stocks have the advantage to beat the inflation and given an income in the form of dividend and price appreciation. But we also have to keep in mind that common stocks become riskier if we bought it at a higher price. If we consider the period of the year 1929 then it has taken 25 years to break the market level of the year 1929. and we need to keep such a scenario in mind while making an investment decision. Such a scenario is more difficult and riskier compared to the bond investment. This scenario becomes difficult to survive if the focus does not have on the risk control.

The criterion for the selection of the stocks for the defensive investors are suggested by Mr. Graham

Investors have made a diversification between 10-30 stocks of the portfolio
Selected companies should be large, prominent, and conservatively financed.
Long track record of dividend payment.
Price multiple limits – multiple should not be higher than 25x of average earning of past seven years and multiple should not be higher than 20x of TTM earning. Such criterion removed growth stocks, popular stocks, etc.

Growth stocks to consider which has given a decent earning growth during the past period and also a similar growth will be sustained to the future also. As growth stocks have a long track record of the decent growth which will attract a speculative nature and increases a higher multiple. Such higher multiple can drop as earning growth fall, earning falls, etc. and that proves dangerous for the defensive investors.

One of the Air Cooler company of India

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As we can see that the company has posted the lowest growth in March-18 since the year 2010 and due to the lowest growth, P/E multiple of the company has fallen from around 89x to 32x.

After the selection of the common stocks to our portfolio, we need to keep track of the particular common stocks for checking whether the improvement of the business, financial or not.

Mr. Graham has also appreciated the systematic investment plan for the index fund which can be helpful to investors for the 20+ years.

We have seen to the last article of the same series that allocation of the capital between common stocks and bond depends on the individual situations. When a person needs money to run his family with no further income sources then he must deploy 75% fund to the bond. Also, investors should allocate fund as per their knowledge, experience, and temperament which is a fortune creator to the investment field.

People get confused for the risk with the fluctuation in the price of the particular common stocks. But we should take value rather than consider a market price of the particular common stock. If value, quality of value is getting deteriorate then it is a real risk for us. And also, if we have paid an excessive price for the common stock, then that invite a loss to our wealth. We need to buy common stock at a price which provides further growth to the future.

If we make a thorough analysis and keep the focus on the safety of capital then deploying money to the common stocks becomes as easy as we put money to the bonds. But when people have lost their money during the crisis, they do not believe that common stock investment also can be safe & help us to create wealth.

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Mr. Lynch has mentioned that we should buy common stock of those companies of which we are using a product or we understand the business. Also, he mentioned that though products of the company are successful and we all are using it, we need to study the financial statement of the company and estimating the value of the particular company. Majority of the people forget to do a later part and just put the focus on to the first part of the saying of Mr. Lynch.

One of the specialty foods with branded rice manufacturing company of India

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A company having a good brand for its products but its major fund gets stuck into the inventories and for that company requires to bring a borrowing. There are many examples where good products do not have rewarded as a good investment. So, there will be no alternative for hard work and analyzing financial statements.

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Disclosure – Companies mentioned in the article is just for an example & educational purpose. It is not a buy/sell/ hold recommendation.

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

The Intelligent Investor – 3 – A Century of Stock-Market History

Posted on August 4, 2019 by Jimit Zaveri under Bibliophile: The Intelligent Investor

We do not have data available for a century in the Indian stock market so that I have done a calculation with available data. All data are taken from BSE India and RBI site.

When we have seen a huge return into the past from the equities then it is not necessary to consider a similar kind of return into the future. Reality is that common stock prices related to the earnings and dividend from the particular companies or basket of companies. If the company fails to deliver earnings and dividend then it is obvious that the company will not deliver a similar return in the future.

This example shows that growth in earnings and dividend has an impact on the price of the companies and basket of companies (Indices). If earning/dividend growth contentiously falling or depressed during a time then prices of the securities also have an adverse impact. So that we can see that during the year range 2011-2019 or 2016-2019, SENSEX has increased more rapidly compared to the EPS growth. Now, either EPS to grow much rapidly or SENSEX has to fall. Or it can also happen that SENSEX can remain in the range till EPS growth does not match to the average return. For matching the average return, either EPS has to grow by 20-22% or SENSEX has to fall 22-25%. This study can provide a similar result with particular stocks.

When the difference between earning yield to bond yield and dividend yield to bond yield start getting lower than we can think that particular stock or basket of the stocks becoming overvalued. This is one of the effective indicators where we can see that when Earning yield / Bond yield has cross 0.67-0.70x then SENSEX has provided us an attractive investment opportunity and when Earning yield / Bond yield has gone below 0.67-0.70x then we need to decide to liquidate our position to the SENSEX in a phased manner.

The stock market does not become less risky just due to advancement to the prices of it. I have seen many people enter into the market or the particular stocks when the price of it starts increasing.

We have seen during the series of Mr. Howard Marks, The Most Important Things that if everyone thinks in the same way then that thinking getting discounted to the price and will not able to get similar kind of returns for the future.

Above mentioned parameter, we can check into the current scenario where real growth of the corporate earnings was not much and the stock market has performed due to the speculative growth. Everyone starts preferring equity as an asset class to invest due to the recent past return. Now, such a scenario is unfavorable for investors. Absent of earning growth does not attract higher valuation for a longer period.

Disclosure – Companies mentioned in the article is just for an example & educational purpose. It is not a buy/sell/ hold recommendation.

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

Investment versus Speculation: Results to Be Expected by the Intelligent Investor

Posted on June 29, 2019 by Jimit Zaveri under Bibliophile: The Intelligent Investor

From today, I am going to start a series on Book “The Intelligent Investor” under the Bibliophile category. Mr.Buffett has always mentioned that he keeps on reading this book every year. This book helps us with the developing an investment philosophy and also, help us to recognize ourselves as an investor or a speculator. I am grateful to the readers by which I am getting motivated to keep writing more and sharing more pearls of wisdom.

Mr.Graham has started the book with the definition of an investor which is very essential for us to understand to becoming a wise investor.

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Many of the people call themselves as an investor but they are not meeting criterion mentioned by Mr. Graham. If a person does not meet any of the criterion mentioned above then we need to consider him as a speculator rather consider as an investor. We have to check to introspect and need to check whether we are meeting above criterion or not. If not then we are doing speculation though we called ourselves as an investor. I have seen many of the people focuses on the adequate return but not meet up other two criteria, or they meet safety and return but not meet up with thorough analysis so that we need to consider those as a speculator, not an investor. People get more involves speculation because they get excitement into it and investing is a boring & lonely game. But over a longer period of time, excitement does not reward us. The stock market is not a place for getting excitement or thrill but it is a place where we need to stay calm, cool with a balance of emotion and balance of activities with hyper activities. When we do speculation, we get an immediate result but not happens the same with the investment. We can earn through making an investment in the long term only if we play this game with the rules.

People call themselves as an investor though they are just buying and selling shares at the stock exchange. They do meet the criteria of being an investor or not. Investor word commands a good reputation among the people so we feel the pride to call ourselves as an investor but rather to just get feeling, we need to work on logic and accept the reality. Though we perform a thorough analysis of investment opportunities or not, we consider ourselves as an investor but we need to understand that it is easy to call ourselves as an investor but it is difficult to act as an investor.

A thorough analysis of companies means we need to analyze the soundness of the company, long term survival of the business, pricing power with the company, etc.
Our major focus should be on capital protection. When we work on capital protection, we have already won half of the battle. I always emphasis on my philosophy which is “Return of Capital” is more important rather than “Return on Capital”.
We need to focus on adequate return rather than earning an extraordinary return. We run behind getting rich within a short period of time so that we desire to earn an extraordinary return.

People can do speculation also but many a time, speculation becomes dangerous –

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If we cannot stop ourselves from doing speculation then put some fund aside for making speculation and we never put the fund into the same account for making speculation and for making an investment. Also, we should not increase a fund to the speculation account just because the market has gone up or we have a good profit into it, but we should bring out the fund from it and transfer it to the investment account. 10% limit of our overall wealth is permissible for the speculative bets and we should not violate this rule. When our speculative account goes above 10% then those amounts need to shift to the investment account and if it goes below 10% then we should not transfer fund from investment account to speculative account.

Mr.Graham has advised to the defensive investors to keep their portfolio into the high-grade bond and into the common stocks. We should have a range of bond should be into the 25-75%, not less than 25%, and not more than 75%. Similar to the common stock also.

We need to make a selection of stocks and bond on the basis of inflation, interest rate, the future expected return from stocks, etc. Which can help us to earn above inflation return. As a defensive investor, we should make an investment to the company which has a good business with a strong track record of financial. We should avoid buying hot stocks which can be harmful to our wealth during the long term. Mr.Graham also has mentioned the concept of Systematic Investment Plan (SIP) for the defensive investors.

Mr.Graham has explained methods for aggressive investors such as 1) buying a security which is doing better than market average, and those not doing better which are candidate for short selling a security 2) Buying a companies which are expected to post a good earning or other favorable development expected 3) Buying a companies which have given a good earnings growth in the past and expected to deliver similar to the future or companies does not have a good past earning but expected to post a good earning to the future.

Here, uncertainty associated with the investment is human error and wrongly estimation of future or estimated future is already into the current market price. When we buy stocks on the basis of current year good result with the similar will happens to the next year then it is highly possible that other participants also think in the same manner.

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If we buy popular stocks on the street then we end up with the result what everyone else is expecting. We are not able to get above average return. We have other ways to make a return without taking a huge risk is a special situation such as a merger, demerger, buyback, liquidation, delisting, etc.

One of the bargains is given by Mr.Graham was Net of Current Asset (I.e. Working Capital) after adjusting all the liabilities. That means the stock price is well below working capital – all the liabilities. Here, we are not taking a plant and other fixed assets into consideration. Such issues consider as a bargain to its value.

One of the Indian air cooler company was available below the net of current asset

Company has a current asset of Rs.74.24 crore and total borrowing was Rs.29 crore so that the net of the current asset was Rs.46 crore, whereas Market Capitalization of the company was Rs.35 crore at the end of FY2009.

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Many of the investors do not take rest when odds are not in our favors. They keep on doing something though things are not into their favor. Such hyperactivity is also dangerous to the long term return of investors.

We have seen that many strategies and stories for the stock is getting popularized over a period of time and also erased as time get passes. We always need to focus that stocks only will perform well or poorly in the long run when business behind that stocks will do well or poorly. So that we need to focus on the performance of the business rather than focus on the different kind of strategy to becoming wealthy in the long run.

Disclosure – Companies mentioned in the article is just for an example purpose. It is not a buy/sell/ hold recommendation.

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

Benjamin Graham There Are No Iron-Clad Laws

Posted on January 26, 2019 by Jimit Zaveri under Bibliophile, Bibliophile: Big Mistakes

During my course at Flame University “Art of Investing with Neeraj Marathe”, Mr.Durgesh Shah Sir has suggested me to read a book which is “Big Mistakes”. So that I am hereby starting to write my learning from the book.

We make many mistakes in life and learn from those mistakes. We keep focus on does not repeat the same mistakes again and again.

My Guru always quotes that “If we focus on avoiding mistakes then we won half of the battle.” We always cannot keep on making mistakes and learning from it but also we can learn from others mistakes which we can avoid during our journey.

Learning from others mistakes and experience is the easiest way to learn and grow.

I am hereby starting my learning from mistakes made by well know investors. Upcoming series will be going to include learning from the book “Big Mistakes”. I am grateful to Michael Batnick – author of the book.

The first article of the series, I start with Mr. Benjamin Graham who is a father of a value investing. He has given a new direction to the investing field.

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Mr. Graham is a guru of Mr. Buffett and we cannot imagine investing field without Mr. Graham. Few biggest gift from Ben Graham to the investing field are Margin of safety, the difference between price & value, calculation of value to the business, etc.

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Many a time, we think that stocks fall ~40-50% from the high price, we should start trying to catch “falling knives” (Such terminology is widely used by so-called professionals). But we should focus on the value of the particular business rather focus on the high price and current price. During recent fall to the stock market, many of the people started picking stocks just because they fall much from the high price.

Indian companies examples

One of the media & Entertainment Company which is falling by ~51% from its high price but the company is making losses, negative CFO, management is taking a higher salary and also giving a loan to the subsidiary companies.

One of the companies which are into the DTH services and that company fall by ~79% from its high price. The company is making very little profit, very little FCF, huge debt, negative ROE% and where value can be still very less.

Such a fall in price does not make it attractive to buy which has very little or no value.

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The market always works in a pendulum and people generally forget the nature of the pendulum. The pendulum always moves towards both extreme directions.

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Whenever pendulum moves towards the bullish extreme, many of us forget that such situations will not stay forever. Many of us forget about the risk which involves during the bull phase. And start taking higher risk for generating higher returns; which invites a further huge amount of risk. At bullish sentiment, people generally buy assets at the highest valuations multiple and that invites the risk to the particular asset class. This scenario has a very high chance of getting damage to our wealth compared to generating a higher return.

Reverse to such scenario, whenever the pendulum moves towards extreme bearish phase, then generally people start recognizing the risk and start avoiding to invest in the particular asset class; which take out the risk from that particular asset class. Such a scenario is the appropriate time for capturing the opportunities because in such scenario we have very less chance to lose.

When people warmly accept any securities then the price will go far from the value and when people avoid or hate any securities then the security will fall in its value.

Mr. Graham has a strategy to purchase undervalued securities and shorted overvalued securities which have made him successful. Mr. Graham has started with $450000 and which he turns to be $2500000 in just three years.

During the last month of the year 1929, Dow Jones has started going down and Mr. Graham has started to cover his short positions and shifted to preferred stocks by considering prices are low. But the calculation of Mr. Graham went wrong and he lost 20% while Dow Jones down by 17%. After this Mr. Graham has considered that market has made the bottom and he used to leverage money to boost profit but again his calculation went wrong and he lost 50%. During the year 1929 to the year 1932, Mr. Graham has lost 70% of his money.

My learning

We should not take leverage to boost up our profits from the market, we cannot measure the madness of the market. I have implemented this learning from the mid time of my investment career and I have parked my money where I am convinced to park. I have never taken a leverage position rather I have to keep liquidity with my portfolio (I was holding ~73% liquidity in my portfolio during January – 2018 and currently having ~65% liquidity position). I have always focused on capital protection over the missing out of opportunity.

An example of one the biggest wealth creator company of the Indian stock market—

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