WHY YOU SHOULD KEEP A DIARY – Hindsight Bias

Posted on February 21, 2021 by Jimit Zaveri under Behavioral Finance

When we look back then past events look very obvious to us. But that was not as obvious as it looks now. People who know hindsight bias, also fall under the trap of it. So, the author has suggested us a way to handle it.

When we read any history book then feel that events that occurred were so obvious but living those moments are much difficult.

Business – If any businessman achieved success then he will look back in past and rate his probability of success much higher.

Investment – In 2007, everyone talks about the great growth potential of the economy and in 2017 also, post GST we will have a strong economy, we will post stronger economic growth. But when we look back to 2008 and recent GDP falls. It looks obvious to us.

So, when we have maintained records of our observations and decisions then we can track the quality of our decisions. We can look back on our decision and on what basis, we have taken a decision.

This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.

12 – ONCE A DARLING, NOW AN EVIL

Posted on August 16, 2020 by Jimit Zaveri under Once a darling, now an evil

The 12^th part of Series “Once a darling, now an evil”. This series is based on the companies which were once upon a time darling of the market and now, it has wiped out the majority of all those gains. I am trying to put some of the number-crunching facts by which we have identified ongoing issues in the companies and have saved our wealth.

I am starting this part with one of the company is in the business of global education company, with presence across the US, 40 counties in the UK, Pan India, Singapore, 9 countries in MEA, Hong Kong and 2 countries in the Caribbean which has an all-time high price of ~Rs.437 in 2008, ~Rs.338 in 2012 and now last traded price at Rs.1.77.

CoreEdu01

In the first instance this company having huge sales & PAT growth. Also, the narrative of the business seems good. But such growth and good narrative should not be a reason for investment.

So, we go deeper ….

CoreEdu02

Here, we can see that debtor day and inventory days are growing rapidly with fall in payable days which has to turn out a cash conversion cycle to positive from negative & growing rapidly. Assets utilization & return ratio are falling.

I would like to go further detail of it.

CoreEdu03

Here, we can see that CFO is lower than PAT with cumulative CFO of FY07-12 is Rs.779 cr whereas cumulative PAT is Rs.982 cr so that CCFO<CPAT which indicates that company has a working capital issue which we have seen in debtor days and inventory days also.

CoreEdu04

If we here look at the depreciation cover then initially it was higher but that is due to lower depreciation rate. Later on, that depreciation rate has become almost double. This has an impact on CFO.

CoreEdu05

We can see that the borrowing part is growing in overall sources of funds and on the other side the highest part is other assets.

Let’s go deeper into it one by one.

Here, we can see that company has software development is in inventories but similar inventories are not available with Infosys and TCS annual reports, even not in their initial years’ reports. The company is capitalizing inventories as well as few other expenses on the name of inventories which has boosted profits but has affected balance sheet and cash flow statement.

Journal entry of Inventory

Cost of goods sold expenses Dr

To Inventories

So when inventory gets sold costs are recognized into income statement but if you keep showing inventory not sold out then cost also gets understate which boosts profit artificially.

CoreEdu07

Here, we can see that company has intangible assets under development is Rs.529 cr in FY2012 and Rs.313 cr in FY11; Goodwill on Consolidation (arises due to investment in subsidiaries) Rs.118 cr in FY2012 and Rs.70 cr in FY11. These two items are 18% of the balance sheet. This is again a capitalization of expenses to balance sheet.

Journal entry of cost capitalization into assets

Assets Dr

To Cash

When we recognize assets created as expenses –

Expenses Dr

To Assets

So that cash keeps on reducing but borrowing keeps growing because there was just a capitalization of costs and not actual assets creation. This again boosts profits but when we look at the FCF then FCF always comes negative.

CoreEdu08

The company got an advance from group companies which increases the current liabilities part.

CoreEdu09

Here, the company has created provisions for fringe benefit taxes which a tax that an employer has to pay in lieu of the benefits that are given to his/her employees. A company has a pending to pay it means either company does not have enough money to pay it or they have created provision during the good time so that they can write back to boost profit.

Journal entries

When provision/liabilities get created

Profit & Loss A/C DR

To Provision/liabilities A/C

When the provision was written back

Provision/liabilities A/C DR

To Profit & Loss A/C

The company can boost profits whenever it requires to do.

CoreEdu10

The company has Rs.58 cr in the current account and Rs.37 cr of cheques on hand which is combined 60% of total cash and cash equivalents. Why does the company need to keep large funds into a current account where it does not get any interest?

In addition to all the above factors, the company has given a loan to related parties worth of Rs.116 cr in FY12, investment into subsidiaries worth of Rs.34 cr in FY12. We can see that company has put good efforts to hide many aspects but if we go into deeper, understand numbers, and read annual reports then it can visible to us.

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

This series contains learning from books –Financial Shenanigans Quality of Earnings The Financial Numbers Game Creative Cash Flow Reporting

Jesse Livermore Manage Your Risk

Posted on February 3, 2019 by Jimit Zaveri under Bibliophile, Bibliophile: Big Mistakes

We cannot make a rule of thumb for the investing world because there are lots of parameters which can affect the price of a business. If today some parameters driving prices of businesses then tomorrow there will be some another parameter which drives the prices of businesses.

We need to focus on to be on the right side. If we cannot short the overvalued businesses then also we can book the position of overvalued businesses, we hold into our portfolio.

When Mr. Livermore was learning about the market, he kept records of his trades to the journal. Keeps journal of our trades helps us to overcome many emotional biases and help us to stick with our predecided process. I am keeping a journal for my investment studies and decision since the last 2+ years which has helped me to build strong decisions.

In May 1901, Mr. Livermore has experienced first larger loss as a professional speculator. He put an order of short sale of US Steel and Santa Fe Railroad at $100 and $80 respectively before the market got opened. He had also taken leverage for this trade. But his US steel and Santa got executed at $85 and $65 respectively, it is a price where he intended to cover his position.

When we are engaged in the trading or into the investment, we need to spend the time to learn. We have to train ourselves as we get training in any other field. We cannot able to survive and win without getting thorough education, knowledge, experience, and temperament. If we are making an investment without spending time on above points then we have depends on the luck which we do not know that favor us or not. Rather being dependent on luck, we should work for developing our skills and temperament. If luck wants to favor us then it will add additional advantages to us.

He has a conviction on his position with the proper logic and he did not change his conviction into the worst period which has made him a rich man.

Many times, we get influenced by the other person or information overload (noise) which affect our decision. We should work on evolving our process but should not make a decision by just getting influenced by others. We should increase our position to the odds which are into our favors, not to the odds which are not into our favors. While we keep on accumulating our winners then we can have a huge probability to win. And when we keep on accumulating our losers then we can have a huge probability to lose.

We need to do our homework before making an investment, we cannot bet our money on the decision of others. If we see the past track record of so-called professionals then we can realize the importance of own homework.

Mr. Livermore had been cheated by people many times which also teach us that we should not trust others easily. We should work on what we know, not what others want us to do. If someone knows much then lets them take benefits. Because staying on the pitch is much important rather than getting wiped out. I have already implemented such learning into my investing career but still struggling with my personal life.

After the few snake and ladder game, Mr. Livermore has started to short from the year 1927 and the great recession of the year 1929 has created fortune of him.

The year 1932 was set for the bottom of Dow Jones but Mr. Livermore was on the wrong side. He had made the biggest mistake ever, he covers his shorts and goes for long on the top of the Dow Jones. After this failure, he declared bankruptcy for the second time.

One of the biggest lesson from Mr. Livermore –

We also need to prepare a list of “Don’ts” and which can be through our own experience or through the experience of others, such as learning from the mistakes of others.

He was also failed in his last attempts in the year 1939 and after that, he took his own life.

As Mr. Livermore quoted that there are a huge amount of mistakes available to the investing filed. We cannot avoid all of them but we can definitely avoid repeating those mistakes again and again.

The main lesson from the mistake of Mr. Livermore is to manage risk. He has not properly managed risk and he blows up. Investing itself as an uncertain and we cannot control our return, we cannot control uncertainty but we only can manage risk which is only into our hand. We need to construct our investment process in a way which can help us to manage risk and avoiding a few of the mistakes which can increase the probability of our winning. We need to work on the checklist, process, do’s and don’ts etc. I have work on the same and still making my checklist and process stronger which has to help me well.

Read for more detail: Big Mistakes: The Best Investors and Their Worst Investments by Michael Batnick