Mastering The Market Cycle – 02- THE NATURE OF CYCLES

Posted on January 12, 2020 by Jimit Zaveri under Bibliophile: Mastering The Market Cycle

Cycle changes for the different time period, details, extent but it will be ups and downs forever which changes the investment environment & behavior.

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There are cycle moves in an identical phase such as a low to the middle point, middle point to a higher point, higher point to middle point with correction, middle point to lower point and then again to the middle to a new high. It is not necessary that the cycle starts from the low and ends at high or at again low, but it can start with any point and end up at any point.

Actually, the cycle never starts nor ends. We need to know why this upswing starts, where we are into the cycle, are we near the end of up/downturn, etc. Such answers need to be sought for the better judgment of the cycle.

Details of every cycle can change such as speed, time, reason, duration, etc. but cycle repeats.

Mr. Marks has quoted a story that blind persons touch the different parts of the elephant and make a story based on that touched part. Mr. Marks has explained that we are also similar to them, we also do not try to put things together and make a judgment. We must remember past events and keep in mind the cyclical nature of things. We also keep on thinking that the bull/bear run will continue forever but we need to focus on the previous cycles and understand the cycle that no phase-in cycle remains forever.

Cyclical development into one area also affects the other area of the cycle. That is if growth in an economy starts going down then the central bank will also work on reducing interest rates which involves a different cycle.

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We must have to understand that cycles are interconnected and one affects others, others affect another. We can study individual cycles for the analysis purpose but for the conclusion, we need to combine all together. Without putting everything together, we cannot reach a conclusion that where we stand at the cycle.

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We have seen that it takes time when we pump air into the balloon but it takes very little when air goes out from the balloon. Similarly, asset booms take time to occur but the majority of the time bust happens very rapidly.

Every boom and bust having a similar lesson that excessive optimism is a dangerous thing; that risk aversion is an essential ingredient for the market to be safe; that overly generous capital markets ultimately lead to unwise financing, and thus to danger for participants.

Generally, we do not learn lessons from past mistakes and doing the same things with the expectation of different results. This is never going to happen. Every time when asset prices start moving towards the bubble territory then people start running to take the asset with the missing feeling. And similarly, when asset prices are near to bust then all running away from the asset. This is a common and repeatedly occurred event. And every time, people keep believing that it’s different this time. But it’s never different but yes the majority of people are different in the different cycles which make them a force to think that it’s different this time. Those who have survived during the different cycles must know that every cycle having the same characteristics and it will always be going to occur.

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

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

Mastering The Market Cycle – 01 – WHY STUDY CYCLES?

Posted on January 5, 2020 by Jimit Zaveri under Bibliophile: Mastering The Market Cycle

After the completion of the Bibliophile series on the book “The Intelligent Investors” by Mr. Benjamin Graham; I am hereby starting a series on the book “Mastering Market Cycle” by Mr. Howard Marks. I have already completed bibliophile series on his first book – “The Most Important Things”. He is one of the investors to whom I admire and learn about the cycle and always get to protect my wealth while nobody thinks about it.

As the cycle getting change, our odds also start getting change. It is mainly depending on our position to the cycle at where we stand to the cycle. If we are standing in a favorable position then we can increase our bets and reap the benefits of the cycle. Similarly, in unfavorable situations, we can protect ourselves from unfavorable changes in the cycle. If we are standing at unfavorable situations then we can adjust our position.

If we have the same information as others have and we analyze as similar to them then we cannot outperform the mass. Consistently outperform the mass is already a difficult task to perform.

Mr. Buffett has mentioned regarding the desirable piece of information – it has to be important, and it has to be knowable. Macro definitely affects the market so knowing it helps. But for consistently outperforming through knowing macro is difficult.

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When we are constructing the portfolio then we generally look at the difference between price and value. Also, we bought the company which has the highest value I. E. Company available at a discount to its value.

So, does it not look at the quality of the company?

Yes, it is right that for successful investing, we need to identify the company which understates the value proposition. Higher the upside, we can take a position accordingly. But if we adjust our position as per the upcoming market storm then it can be more profitable and can add further value to our investment journey. This estimation of the upcoming market situation helps us with the decision making to remain aggressive or to be defensive in our portfolio. We only make an aggressive /defensive decision when we know the investment environment and where we stand in a cycle. When we get investment opportunity at cheaper, discounts to value then we should be aggressive and when getting expensive, then we should be defensive.

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Similar we can do for the midcap and small-cap universe. And prepare ourselves from an upcoming cyclone.

We all talk about the risk but what actually risk mean? It can be loss of capital, academic says the risk is volatility in the price of assets. So, Mr. Marks has explained the types of risks in a good manner.

Opportunity loss, this is a missing out a potential gain, our investment has underperformed compared to what we missed and things do not happen the way we want it.

Risk means the occurrence of more things than we have predicted. If we know what is going to happen then there will be no uncertainty or not any risk. And if things are certain then we also get certain returns such as bank deposits. We cannot surely know the outcome of the events but we can assume the probability of the occurrence of the events. We assume the probability of the events that does not mean that we know the occurrence of the events. Anyone event can occur out of the many events. When we do not know the occurrence of the events, then we do not have an edge and we have to stay depended on luck. When we have the knowledge of the occurrence of the events then we have an edge and winning probability will increase with lower down losing probability.

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Superior investors are attentive to cycles and they capture the cycle for reaping profits.

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When a cycle is in our favor, we can earn good profits by taking benefits of it and visa Versa, when the cycle does not favorable to us then we can protect ourselves for loss of capital.

When cycle at extreme of Greed then we have to protect ourselves from capital loss. There will be a higher chance of incurring losses rather than earning profits.

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If we look at the P/E of Midcap and Small Cap index during the year 2017-18 then on the closing basis it was 37.22x and 86.19x respectively and high P/E of both during the same period was ~47x and ~114x respectively. At such valuation, we are not ready to buy a few growing large caps but having a huge hope of getting a return at such high valuation and transformation of small-cap as a future large cap. So that such a scenario is for protecting capital rather than chasing high returns. I had parked ~73% of my portfolio in the liquid fund during the same period which has helped me to survive in such cyclone. We need to focus on the cycle, pendulum where it is moving and where we stand in the cycle.

When in a similar cycle economy, corporate profits and prospects remain the same but pessimism among the participants provides an excellent opportunity to make an investment, increase our position to be more aggressive. And when the economy, corporate profits, and prospects remain the same but having a huge optimism among the participants then we should adjust our position as a defensive investor.

When our position in the cycle changes, our odds also get change and if we do not change our investment accordingly then we miss the opportunity to enhance return or protect capital.

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

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

The Intelligent Investor – 12 – Things to Consider About Per-Share Earnings

Posted on November 3, 2019 by Jimit Zaveri under Bibliophile: The Intelligent Investor

Many of the companies having smart enough management who know that analysts and the majority of investors focus on the bottom line so that they also emphasize the boosts earning at any means. Manipulating earnings for the few years can reward them a better way by offloading their stakes. Thus, we require to study earnings quality by putting a huge emphasis.

I have a different series under the “Simple is Better” category which covers tricks to identify earning manipulation.

Management of companies can be hungry for getting recognition which makes them involved in the playing with the earnings. We should not focus on the short-term earnings or one year earning for deciding for investment purpose otherwise we can be stuck into the trap. We need to focus on the footnotes for understanding properly for onetime earnings. Whether such earning will be going to recurring or one time? We also can perform an adjustment to the one time earning and need to check that still stock available at cheaper multiple or not. Does the company involve the frequent selling off assets for boosting profits? Does Company has change revenue recognition policy, change other accounting policy? Does the Company involve accounting shenanigans? When things available at dirt cheap then first need to check it thoroughly that why such cheapness is available with the stock. Cheapness is attractive always but the reason behind cheapness is an important factor.

One of the exchanges

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The company got other income due to stake sell into the subsidiary company which has boost earning by ~3x and due to such one-time earning P/E multiple has fallen drastically. And, this fallen P/E multiple misguide investors and attract them to make a mistake.

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We have to remove the effect of one time gain in the normal business and need to take an average of the 10 year or entire cycle for elements temporary and extreme profitability effects.

One of the automobile company has a reverse of the provision made during a slowdown time

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If businesses into the cyclical nature then it is advisable to take an average of past seven to ten years or a business cycle earning average for nullifying the effects of ups and downs into the earnings due to changes into the cycle. If we focus on the earning at the best cycle then we can attract to buy and end up with the losses or has to wait till the next good time of the cycle. Reversely, when we focus on the worst cycle then we avoid the opportunity and we end up with the opportunity miss.

Example of the cyclical company regarding buying at top of the cycle which resulted in losses and the bottom of the cycle resulted in a profit

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We are habituated to buy at the lower P/E and sell at the higher P/E but the same is not applicable in the cyclical industry. We have to buy company during the bad cycle which has depressed earnings that shows higher P/E and need to sell during the good cycle which has good earning that has depressed P/E. So, if we buy at the lower P/E then we end up with losses though P/E will be increased. Also, higher-earning is temporary and as the cycle turns out then earnings will disappear.

We can start reading an annual report from the backside so that some facts which the company wants to hide in the last section which comes first to us. Always read footnotes, focus more on learning about financial reporting.

Disclosure – Companies mentioned in the article are 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 7 Portfolio Policy for the Enterprising Investor: The Positive Side

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

Enterprising investors are willing to put more attention and efforts for generating a higher return.

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Generally, an intelligent investor buys and keep holding common stock when it has a cheapness and they sell a common stock when it becomes overpriced. After selling off the stock they transfer to the bond and wait till another opportunity of common stock available with the cheapness.

General Market Policy—Formula Timing

This is an approach of investing timing of the market. The market keeps on fluctuating and taking a benefit of those fluctuations to our favor adds additional value. It is very difficult to forecast the future market level for a consistent period. When we look back towards any situation then it looks easier to predict but when we are passing through the situation then it is very difficult to predict.

Growth-Stock Approach

Growth stocks are the companies which have shown a growth better than an average. The problem with such kind of companies is they have given good growth into the past and we have to assume that they will keep on doing the same into the future. But such kind of stocks selection needs huge careful attention from the investors. As the bigger companies start to grow at a slower pace compared to the smaller companies. But it is also a fact that if the company is a leader with the availability of competitive advantage in the market then it has a huge probability of growth. We need to careful with what we are paying for buying a growth. If we pay a sky-high price for the prevailing growth then also, we have to suffer through the company grows.

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If we have proven wrong with our assumption of future growth and also, we have paid a higher amount for the business, then it will be a dangerously affect to our wealth. Growth stocks can create our fortune or can spoil our fortune. If our assumption for the future growth proven right and also, we have bought the stock at a proper valuation then fortune into the growth stock can be created. Many times, the company has a temporary problem, then it will be available at a relatively cheaper valuation. When larger companies have adversity, they have a resource and brainpower to come out from the adversity and market responds quickly to such improvement to the larger company.

One of the two-wheeler company of India

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The company which has a negative cash conversion cycle, availability of float, market leader since many decades, traded at 10%+ of earning yield with higher return ratio, market participants having a fear of electric vehicle disruption.

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One of the MNC FMCG company of India

Company’s one of the flagship product got banned which contributes decent revenue to the company. Also, no other competitor gets success in the same product at the same level. Company has a higher return ratio, good brand over the globe, successful track record.

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Mr. Graham mentioned regarding a cyclical business –

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We need to bought such businesses during the bad time at higher multiplier and need to sell it at a good time at a lower multiplier. During the bad time, the profitability of the company gets depressed which resulted in the higher multiple to the company and reversely, when time is good, profitability gets improvement which resulted in the lower multiple.

One of the sugar company

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When we want to get an above-average return into the investment, then our investment needs to be proper, sound enough to avoid risk and we need to adopt a policy which is different from most of the investors or speculators are using.

Bargain issues are those which are selling below its true worth. Now, for calculation of bargain – first, we need to forecast future earnings and giving it an appropriate multiple for arriving at a future market price. If the current market price seems lower than future market price then we can consider it as a bargain common stock. And second, where we need to focus more on the net realization of the asset value and net working capital (Working capital – all obligations) with the growth into the future earnings. Also, the current result is disappointing (future result can be improved) and unpopularity among the stock price creates a bargain opportunity. During a bear run, people do not focus on the companies which are not a leader, because they have a fear and belief that leader can provide safety. So that companies other than leaders will be available at a cheaper bargain price. We should focus that whether these companies can generate a fair return on invested capital or not and whether that generated return will be above the cost of capital or not. Such companies require a bull market, changes in policies, changes to the management, acquisition of smaller bargain companies by a larger one, etc. for reaching the fair valuation.

A special situation is also one of the ways to create a return on our investment. Special situations are different from the usual part of investing. Here, we need a different kind of process and different level of mentality compared to the usual one. This strategy includes demerger, merger, arbitrage, delisting, buyback, right issues, etc.

When we select to be an aggressive investor rather than a defensive investor then we require a thorough knowledge of businesses, how to value it etc. There is not a middle way between aggressive and defensive investment. And those who are involved in the middle way, they get a disappointment to the result due to the lack of requiring time and knowledge.

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