Oil Prices

I'm getting increasingly sceptical of macro economic forecasts made by
leading economic insttitutions and economic journals. Six months ago
when oil prices crossed the comfort zone, all analysts had said that
if oil remains at these levels the world economy will go into
recession. Well six months are over and oil prices have continued
their northward run but the global economic health seems as good as ever.

This not only raises doubts on capabilities to make such predictions
but also coroborates views of Buffett regarding giving low priority to
macro economic factors. He says "When investing, we view ourselves as
business analysts - not as market analysts, not as macroeconomic
analysts, and not even as security analysts. "

These variables are very difficult to predict and investors are better
of by ignoring them unless they themselves are very sure of the their

Having said that I'm not concluding that the high oil prices will have
no impact but we have to take the predictions of the extent of impact
and time with a pinch of salt.

Posted:Apr 5, 2005

In a perfect economic system, the changes in relative strength of a
currency should not affect the relative strength of any other 2
currencies. However, we live in an imperfect world. The currencies of
various economies are market driven to a different extent.

For instance, Chinese Yuan is pegged to dollar. Indian rupee in partly
market driven and any major move is scuttled by RBI through open
market operations. In such a case if the dollar loses strength it will
not only affect the trade equation between India and US but it will
have impact on trade equation between India and any other country.

If rupee appreciates against dollar but Yuan doesn't then the Indian
export will become less competitive in compared to Chinese exports.
These countries compete in many areas and dollar devaluation can
affect the economies quite a bit.

More specific impacts of weakening dollar are listed below:
1. Company's who have raised debt through ECBs denominated in dollars
would gain because they have to pay back fewer amounts in rupees.
2. Companies with dollar denominated exports will suffer exchange
losses. Such losses can amount to large figures unless company
actively manages exchange risk.
3. Companies which are importing dollar denominated goods/raw material
like capital goods/crude etc will benefit from lower cost.
4. Companies competing against countries like china will suffer due to
relative appreciation of their currency against an inflexible/pegged
5. India's 130bn $ forex reserves would lose their sheen but you will
never see forex loss reported in any financial statement from india.
6. A huge and unsustainable reserve position may force government to
open up some restrictions on convertibility, foreign investment by
Indian companies etc. This will be a beneficial impact.

To summarize I'm more worried about appreciation against competing
Asian currencies than against dollar.

Posted:Feb 8, 2005

Strength of Currency

Understanding the interplay of exchange rates and economic implication
is a complex subject. I would try to explain the things in layman's
terms and would refer serious economics enthusiasts to books
referenced at the end of this message.

Lets imagine a world without currencies and trade based on bartering
of goods. Assume that A deal produces only spices and country B
produces only silk. Thus these two items become their currency for
trade. if the spices are highly sought after items then the economy of
country A would be able to import more goods by forgoing a little part
of their own produce, that is silk. The country would afford a large
buying power for their produce.

Implication 1: Strong currency is helpful to the economy.
All the countries during the periods of their economic superiority
have had strong currencies. The rise of Dollar along with US economy
and fall of Rouble along with the fall of Russia are 2 examples

Now let's assume that there is another country C which produces only
spices. To compete agaist each other to sell their spices both A and C
will have to keep the prices of their spices at reasonable level. If
the country C starts under pricing its spices the trade between
country A and B will suffer and the economy of Country A be affected.

Implication 2: A strengthening currency not helpful to the exports. If
exports drive substantial portion of the GDP, a A strengthening
currency is not helpful economy.

The strength of economy is not directly correlated with the fortunes
of the capital markets which represent only organized corporate
sector. In the countries like India where FII investment is a
significant driver in the investment decisions of market participants
the exchange rate movement matters. This acts through the "expectation
of change in the exchange rate" rather than change itself. If the FIIs
think that they can generate 10% rupee returns and expect rupee to
depreciate by 5% their dollar return becomes only 5% and they would
rather invest in US Govt. treasuries.

If the strong currency is associated with expectation of weakening you
would see large FII/FDI investment. If the exchange rate is expected
to be stable it will not be a significant matter rupee trades at 40/$
or at 50/$.

The more complicated impacts from exchange rates come in form of the
changes in interest rates and inflation. For instance, if the dollar
inflows cause a rupee to appreciate the RBI will have to buy Dollars
and release rupee in the economy. This would cause inflation and rise
in interest rates. To counter this the central banks follow
neutralization tactics like selling Govt. bonds to mop up additional
liquidity. I don't think that I can explain(or even i understand) this
aspect in a message.

None the less I can answer any specific queries you have in this
subject and feel free to post your views.

The General Theory of Employment, Interest, and Money, by Keynes

Wealth of Nations , by Adam Smith

Posted: Feb 8, 2005


Diverfification beyond a point is meaningless. For
sure you don't need to put all the eggs in one basket but if all the
baskets are under one roof which may fall any day then you don't
achieve anything out of your planning.

Sometime back I wrote a Note on Over-Diversification. Posting the same

To explain let us assume that the funds are invested in 20 best
opportunities available. Had the investment been concentrated to 10
best opportunities and the results turn out to be in sync with the
estimation, the gains from a portfolio of top 10 companies would be
far higher than the one with 20 companies. The risk in the latter
would be lower but not significantly less because a substantial
portion of risk comes from the risks inherent in economy and capital

I seek to achieve an adequate level of diversification to achieve
`Safety of Principal' and high returns. The mutual funds due to large
size can not deploy all their funds in 10 companies. The results is
over diversification and lower returns. For example as of June 30th,
2004 Morgan Stanley Growth Fund had invested in 46 listed, 7 unlisted
and 3 ADRS. The results were obvious. In the 10 years since inception
the NAV of the fund increased from 10.00 to Rs. 18.47. The fund has
paid dividends of 4 Rs during this10 year period.I believe that the
mathematical odds are stacked heavily against such over diversified
portfolio. The managers of the fund did make money for themselves with
1-1.25% management fee and annual administrative expense not exceeding 3%.

The discussion on asset allocation has led us to an important topic
of inflation. I feel that inflation deserves a more detailed analysis
because of the complicated ways in which it affects businesses. I'll
try to explain this in this message.

During inflationary period the currency loses value which cause all
the securities denominated in that currency lose value. In case of
long term debt the impact may be even higher because the central
banks resort to increase in interest rates to check the inflation
which depresses bond prices.

The real assets like properties, plants etc are less vulnerable to
inflation because their nominal values rise along with inflation.
However the impact is not straightforward and can be detrimental to
the business in many ways.


Let's enumerate the beneficial effects of inflation on business.
B1) Inflation tends to increase the prices of assets like real
estate, plant and machinery etc which directly adds to the nominal
value of existing stock of capital.
B2) The rising asset prices make affect the supply of new investments
because rise in supply price. For example the increase in steel
prices would mean higher cost of setting up a plant which may or may
not provide enough returns to justify cost. This increases the
competitiveness of existing asset base.
B3) The fall in the value of currency decreases the indebtedness of
the company. If a company has taken a loan of Rs. 500 crs, the fall
in the real value of rupee will mean that the company can pay back
with less amount of real currency.

Let's enumerate the detrimental effects of inflation on business
D1) Inflation affects the consumer demand because of increased cost
of living which may not be offset by a rise in monetary wages.
D2) Any increase in monetary wages due to inflation can lead to rise
in operating cost which is risky because monetary wages tend to be
sticky and may not decline as situations change.
D3) Inflation increases the working capital requirements to manage
the same level of output. This affects working capital intensive
businesses like retail in a big way. This effect was explained by
Buffett in his letters to shareholders during inflationary period of
early 80's.
D4) In a competitive environment the businesses may not be able to
pass costs to the consumers. For example biscuit manufactures in
India have not been able to increase prices since last 6 years even
though the input costs have risen by more than 505 in the same period.
D5) If Central banks raise the interest rates the valuations based on
discounted cash flow suffer due to rise in risk free rates.
D6) The destabilization of economic system due to high inflation
leads to rise in risk premium.
D7) Although the nominal values of assets like real estate, plant and
machinery rises with inflation, the values of other assets like
cash, investment by company in bonds etc decline. (related to B3)


The asset prices react in different ways to the rise in inflations.
1. The hard cash has permanent loss equivalent to the inflation rate
2. Bonds may be affected more due to compounded effects of high
maturity and rising in interest rates. However there is a twist to
this. If the interest rates have already moved higher with inflation
and fall along with subsequent fall in inflations bonds may provide
higher returns considering the risk involved.
3. Stocks are the least affected in general. However the prices do
not always rise with rising inflation. The inflationary period due to
oil shock, in late 70's and early 80's in US, is a testimony
to this.
Between 1964 and 1981, Dow Jones remained at the same level i.e 875
because the Fed raised interest rates from over 4% at year-end 1964
to more than 15% by late 1981. A seventeen year bond bought in 1964
would have given a return of 4%. Similar observations
can be noted by comparing the performance of Indian equities in early
90's and govt. securities.

Higher inflation is typically a characteristic of over heated economy
which is associated with surplus liquidity, investment boom and low
interest rates. In such cases the overriding optimism and shift to
equities often results in high stock prices. As the effects of
inflations may not be all in favor of the business such high prices
may prove to be a temporary phenomenon.

4. If the conditions of runway inflation the real value of bonds and
cash would be almost wiped out as happened after breakup of USSR with
inflation crossing 1000% per year.


A general conclusion can be derived that equities, bought at fair
prices, are the best bet when you expect higher inflation. If the
inflation has already moved high the low bond prices may be more
attractive choice as inflated stock prices. The investor is faced
with a difficult choice of slow erosion of real value through
investment in debt on one hand and prospect of decline in asset
prices from current highs on the other. Like all another financial
situations, he need deal inflationary conditions with caution and he
should base his actions on his knowledge and understanding of current

Posted: Dec 13,2004

Long term investing

So often you would read my messages about investing for long term.
Today when I was watching CNBC I got an interesting interpretation of
long term. A small investor said he invests only for long term. in
further questions he said that he invests with 1 year time frame in
mind. This interpretation of long term surprised me and I thoughts
let's clarify what I mean by long term so that the members of this
group are not confused about it.

Long term as I take it, is a time period which is required to take
business from the present state to a very different state in term of
progress of business. In case of new businesses its the gestation
period for the business where the reaches its normal level of
profitability on the initial investment.

In the corporate world the period may differ based on the
characteristics of the industry but the lowest time frame that can be
characterized as long term is 5 years.

For a typical business you can say 4 or more years as long term, 2-3
years as medium term and anything less than 2 years as short term. I
don't think that capital invested for less than an year timeframe in
mind falls under investment category and back that tax department for
taxing it.

I have delved upon the advantages of long term approach in countless
messages in last 3 years. Out portfolio LWB Special is an example of
what long term investing means. Hence in this message I would focus
on the cases where long term investing can go wrong.

When you invest for long term, the future of your invested capital
and retuns is tied up with the success of business. In short term you
can play around with undervalued stocks which revert to their mean
valuations and make money. However in long term the only determining
factor is the cash flows generated by the business during this period
and the potential at the fag end of your investing time frame.
Please note the second part clearly. Even though your business is
successful during the 5 years when you are holding the stocks but
when you need money the business in a temporary down phase, the
markets may not give you true price of the business. This is because
the investment communities, including high profile analysts are so
fascinated with quarterly numbers, the immediate past counts heavily
on stock prices. That leads us to the first implication.

Implication 1: When you invest for long term you have to manage your
investment and liquidity needs in such a way that you are never
forced to exit at unattractive prices under any circumstances.

Let's move on to the other aspect implied in the fact that the
success of your investment depends on success of your business. All
the businesses operate under inevitable economic laws. Among these
laws the one that can cause you greatest harm is law of diminishing
returns. Let's assume that you invest in a business that is generated
very high returns on capital. You pay a premium price to get a stake
in the business (the price of the stock). In the long run such high
returns attract competitors both the domestic and multinationals.
When the total capital invested in the business grows the returns
come down to more average levels. As an analogy you can see how your
speed diminishes the number of cars on the road grow. Another
important consequence is that your risk of accident increases.
Your business may still be generating sufficient returns above the
cost of capital, but the premium paid on such a business evaporates.
In such a case the price paid by you may turn out to be too high to
enable decent gains even when the business as such grows. There are
other changes and associated laws which can affect the profitability
of business including but not limited to, changes in interest rates,
regulation, taxation, technology, consumer preferences, currency
fluctuation, economic recession etc. This leads us to the second
implication of long term investing.

Implication 2: When you invest for long term you have to be aware
that the superior business returns can degrade to more average
levels. Hence before paying premium for such superior returns you
have to ensure that these are sustainable over the investment
timeframe. Conversely you can not reject the business yielding
average returns without proper analysis.

Let's move on to prices that you pay for the stake. As Buffett says
the investors drive using rear view mirror. When they analyze the
valuation of the stock they pay high importance to the immediate past
last 4 quarters. They use the past opportunistically to find a growth
rate for last 5 years and project it to next 10 years. The growth in
long term is at mercy of another empirical law. The law of reversion
to means. Most economic variables in a stable economic system revert
to their mean values. It is not possible for a company to grow at
rates higher than industry average for a long period. The same goes
for growth of a specific industry relative to the country's growth.
The investors and analysts try to sum up the situation in over
simplified parameters like P/E, RONW without analyzing properly the
quality and sustainability of the same. The newer terms like PEG are
what I term as mathematically flawed because PEG assumes linear
relationship between a growth rate and P/E attributable to that
growth. This leads us to the next implication.

Implication 3: The earnings and other profitability parameters of the
businesses are mean reverting. Over a long term a company with high
returns can return to average returns. A company with high growth can
return to a low growth or negative growth. Hence the valuations for
long term investments can not be based on variable of immediate past.
Averages of last 5 years may be better indicator then the current
earnings. The analytical ratios derived without proper context can do
you more harm then anything else.

Though the list of implication can go on and on, I would summarize
the message with the last but important point. As Graham said the
promoters and managements are closer to the assets than the
investors. There is a huge variety of ways, including some perfectly
legal ways, in which promoters and managements can serve their own
interest rather than the interest of small investors. If you invest
for long term with a company managed by crooks and promoted by
unethical promoters, your assets would be siphoned off. Its like
keeping a valuable locker room unlocked for too long. The
preferential allotments when the prices are low, stocks options, huge
salaries for directors, acquisitions of other companies owned by
promoters at high prices are some of the legal ways which can lead to
wiping out the networth accumulated over a long time period. This
leads us to the next implication of this message.

Implication 4: A typical business returns only a part of earnings as
dividends. The rest of the profits are reinvested in the business. If
the promoters or management follows unethical practices the investors
can not count upon the reinvested earnings as a return on their
investment. This implies that dividends are very important aspect
contrary to the currently popular belief that growing businesses
should not pay high dividends. It also means that the risk of assets
being siphoned off is not only high but incalculable and even
astronomically high returns can not compensate for this risk. Hence
the long term investments should be made only in those companies
which demonstrate high degree of accountability to general investors
and have high standards of corporate governance.

I would like to summarize the message with saying that the long term
investment by itself does not guarantee high returns, even though
it's the best investment strategy available to investors. If you are
investing for long term you should make a very careful selection of
your investments and pay a price only after completing an all
encompassing analysis of the characteristics of business.

Posted: Dec 2, 2004

Risk premium on housing loans

I want to draw attention of the equity analysts in the group to a
puzzling proximity in the housing lone rates and rates on govt. bonds.
As you all know the govt. bond are the safest form of fixed income
instruments and housing loans suffer from the risk of defaults.

Here follows a comparison of Govt bond rates and housing loan rates:
Loan rates for tenure to 5 years : 8.50%
5 year govt. bond rate : 6.81%
Risk premium charged : 1.69%

Loan rates for tenure to 5-15 years : 9.00%
15 year govt. bond rate : 7.52%
Risk premium charged : 1.48%

Loan rates for tenure to 15-20 years : 9.25%
5 year govt. bond rate : 7.80%
Risk premium charged : 1.45%


The risk premium ranges from 1.45% to 1.69%. Especially in short term
loans the figure seems low. For instance if 7.5% of the housing loans
default the banks/housing finance companies(HFCs) would get returns
less than the govt bonds. Any further rise in interest rates will
change the equation further.

Here I have not taken into account the selling and administrative
expenses incurred by banks on selling these loan products.It would be
interesting to gather data on whether the banks/HFCs are able to get
the promotion /selling/ administration expenses from the upfront fee
they charge apart from the interest. In personal loans it's quite
common to charge 2% upfront and I'm unable to get data about the
upfront fees in housing loans.

Thus every thing depends on what is the level of risk in housing loan.
The risk in any fixed income security is covered in 2 ways.
1) By securing loans with assets. This means that a bank/HFC should
give a loan worth less than the value of property. Considering high
prices of real estate the banks should keep adequate margin of safety
2) The income of the person purchasing loan product: The person
availing the loan should have an income sufficient to meet his
interest payments. In case of corporate customers income to interest
ratio (interest cover) of less than 3 is considered risky. In case of
individuals I thing that the interest coverage should be more than 5.
Another point to consider here is that the earning of a
company is net of all costs where the income of a person is gross.
While giving loans only the income is counted and any accounting of
expenses, though logical, is impractical.

On both these counts, I think, banks/HFCs are throwing caution to the
wind. In a competitive market where the employees have to meet their
targets such a result is not unnatural. I have read in the papers that
the banks are now giving loans up to 80-90% of the value of property.
They are giving loans to persons who have income barely twice the
interest payment.

RBI has also cautioned the banks in a measured way. The Monetary
policy contained the following statements
"The fast growing housing and consumer credit sectors also represent
some degree of higher penetration, but the quality of lending needs to
be ensured".... It is observed in the recent past that the growth of
housing and consumer credit has been very strong. As a temporary
counter cyclical measure, it is proposed to put in place, risk
containment measures and increase the risk weight from 50 per cent to
75 per cent in the case of housing loans and from 100 per cent to 125
per cent in the case of consumer credit including personal loans and
credit cards"

If such concerns are really valid and remain unaddressed, the retail
credit boom may well leave banks with similar amount of NPAs which
they accumulated on industrial credit boom in 90's.

Posted: Nov 27, 2004

Technical Analysis

I will admit that there was a time when I was chart gazer
too(1996-98). I never made money by it but I was so much interested
that I wrote an AI software called Autotrade. The hypothesis was that
if a technical trader can make money an optimzed software program can
make far more money due to quicker decisions. I set out to design this
money making machine. That software had 30 technical analysis signals
which used to act as Fund Managers and each had his weight in combined
decision. There was a controller who will change the weightage of the
signal based on past performance(there were promotions, demotions and
firings of fund manager!). I ran that program on the Sensex data for
last 10 years. The results were interesting.

The signals made huge money when there decisions were right and lost a
little bit on false signals. But overall the false signals far
outnumbered the right signals. The net result was that with the
highest level of optimization I was able to reach 8% gain per annum
level before brokerage. I was good enough for a financially dumb
program but I was not inclusing brokerage. As soon as I added
brokerage the returns were down to -4.78%.

I spent countless nights to improve the results. I separated leading
indicators from lagging indicator but there was simply no way to beat
the odds stacked against the technical trading.

I concluded the excercise by proving the anti thesis.

Those who still think that they can make money through charts can
purchase this software from me. It will cost you $11.5 in cash and all
your investment money in long run.

Posted: Nov 25,2004

(Investing?) in Real Estate

Personally, I do not consider real estate as an avenue for investment. It can
be satisfy your consumption needs or speculative needs but not
investment appetite.

Apart from the list of reason you have given here are some more.

1. It is impossible to judge the present value and expected growth of
real estate using any sort of analysis. There is simply no information
available to appraise the worth of a piece of real estate.

2. There is no information available to evaluate the risks associated
with the real estate investment. The legal problems as you mentioned
pose an incalculable risk. Hence it is not possible to use any
benchmark to ascertain margin of safety.

3. I perfectly agree that the returns are over hyped. People tell me
so often that the land prices in this or that locality have became 5
times in 2 years. Well..I tell them that I can give names of hundreds
of stocks which have become 5 times. What does it prove? The very fact
that the land prices have gone up may cause further gains to be
limited. People think that the land prices will go up and up because
there is limited supply and increasing demand. The same argument
applies to oil, minerals or any other limited resource.
For those who think that the real estate never goes down
you can compare the rates in Connaught place, one of the prime
locations in delhi, with the rates prevailing in 1995-96. The rates
fell have fallen 40% when the corporate started moving out to Noida
and Gurgaon.

As an avenue for consumption real estate does provide significant
advantage, specially in metro's. You can save a lot of taxes and high
rents in housing properties. The other reason is that the real estate
and housing is an asset with zero or negative depreciation. No other
asset appreciate in value even while you use it. If you buy a house
and are living in it the hazards of illegal occupations are minimal.
Even here you got to ensure that you don't pay artificially high
prices based on expected further growth and buy clear land titles and
stay away from controversial properties.

Posted: Nov 16, 2004

When to Sell

High price or high P/E should not be the only criteria for selling.
If you recollect 1 year ago Sterlite, Mahindra , ABB were selling at
P/E of above 40. We decided to stay and the earnings have increased
to such an extent that the same companies are quoting at P/E of less
than 12 even though the prices have advanced since then. The only
stock I sold in last 4 years was Bharti tele at 45 booking 50% gain
and you know what happened next.

I have the following rules for selling overvalued holdings though I
do override them in case to case basis.

1. When the future prospects of the company do not guareentee that
the p/e would be reduced to a more sensible figure(< 15).
2. When the prices are quoting at more than 30 times highest ever
earning of the company.
3. When the company is loosing its conpititive position which was
responsible for premium over general market.
4. When the company management/pronmotors shows any signs of
dishonest behavior in reporting financial results, in transactions
(preferential allotment, low priced ESOPs).
5. When the general economic scenario warrents lower multiples. In
this category would come rising long term interest rates, increase in
general tax rates.
6. When the industry is about to go through disruptive changess like
opening of markets in case of protected monopoly companies, increase
in taxes, restrictive regulation in industries like

In nutshell there are very few quantitaive criteria for selling and
its quite natural to make mistakes. However my guidelines in buying
and selling have a major difference.

In buying I'm conservative. That means I would rather miss an
opportunity for making gains if my analysis is either incomplete or
In selling I'm optimistic. I would rather hold the stock and suffer a
fall if my analysis is either incomplete or inconclusive.

To sum up, I prefer inaction if action is not warrented by the facts
and analysis.

Posted: Nov 8, 2004

Having read free e-text of this book by Lawrence A. Cunningham, I now
feel that the author did deserve the royalty for it and would
recommend that you buy a print. I did upload it to the files/books
section and if you don't have any moralistic pretensions you can read
it from there.

Coming back to the business(review!), I would say that the book is
well written. Lawrence A. Cunningham is known for his compilation of
Buffett's letters in form of the book "The Essays of Warren Buffett :
Lessons for Corporate America"

He makes no bones about his expertise as an investment guru. He writes
"I condense these ideas and insights in the spirit of a teacher and
professor, not an investment adviser". However as you read the book
you would notice that he himself has become a more trustworthy advisor
than most wall street high flyers. Knowledge is contagious!

To the person who has never read Graham and Buffett, the prospects of
hitting two birds with one arrow may seem exciting. This book, however
does not contain much about the nuances of the investment philosophies
of these legendary investors. It does contain snippets and intersting

The value proposition of the book comes from very good exposition on
the efficient market theory. He debunks this theory, staple diet of
business graduates, in a systematic manner. He raises valid
questionmaks on other theories, like Capital Asset pricing model and
Mordern portfolio theories, which again make most of the texts of MBA

The other exciting parts are the chaptors on corporate governance. The
book contains examples from real life describing the policies of good
companies and showing the loop holes exploited by the bad managers.

Overall the book is exciting, relevant to the present context and an
eye opener in some chaptors.

Posted: Oct 23, 2004

Investing is not the field for those who do
not have sufficient expertise to evaluate the company's prospects.
For the people who are learning the tricks of the trade, it is better
that they put their money in experienced hands.

However one should note that the historical performance may not be
the indicator of future performance. Even if the fund managers
invest randomly you would find top 10 funds giving superb returns.
Warren Buffett had explained this phenomenon in a characteristic
humor. I'm putting this excerpts here(full text in files/articles

"I would like you to imagine a national coin-flipping contest. Let's
assume we get 225 million Americans up tomorrow morning and we ask
them all to wager a dollar. They go out in the morning at sunrise,
and they all call the flip of a coin. If they call correctly, they
win a dollar from those who called wrong. Each day the losers drop
out, and on the subsequent day the stakes build as all previous
winnings are put on the line. After ten flips on ten mornings, there
will be approximately 220,000 people in the United States who have
correctly called ten flips in a row. They each will have won a little
over $1,000.

Now this group will probably start getting a little puffed up about
this, human nature being what it is. They may try to be modest, but
at cocktail parties they will occasionally admit to attractive
members of the opposite sex what their technique is, and what
marvelous insights they bring to the field of flipping.

Assuming that the winners are getting the appropriate rewards from
the losers, in another ten days we will have 215 people who have
successfully called their coin flips 20 times in a row and who, by
this exercise, each have turned one dollar into a little over $1
million. $225 million would have been lost, $225 million would have
been won.

By then, this group will really lose their heads. They will probably
write books on "How I turned a Dollar into a Million in Twenty Days
Working Thirty Seconds a Morning." Worse yet, they'll probably start
jetting around the country attending seminars on efficient coin-
flipping and tackling skeptical professors with, " If it can't be
done, why are there 215 of us?"

By then some business school professor will probably be rude enough
to bring up the fact that if 225 million orangutans had engaged in a
similar exercise, the results would be much the same - 215
egotistical orangutans with 20 straight winning flips"

The bottom line is that the new investors are still better off with
mutual funds but they should not blindly assume that past
performances would continue.

Posted:Oct 7, 2004

Investing is not the field for those who do
not have sufficient expertise to evaluate the company's prospects.
For the people who are learning the tricks of the trade, it is better
that they put their money in experienced hands.

However one should note that the historical performance may not be
the indicator of future performance. Even if the fund managers
invest randomly you would find top 10 funds giving superb returns.
Warren Buffett had explained this phenomenon in a characteristic
humor. I'm putting this excerpts here(full text in files/articles

"I would like you to imagine a national coin-flipping contest. Let's
assume we get 225 million Americans up tomorrow morning and we ask
them all to wager a dollar. They go out in the morning at sunrise,
and they all call the flip of a coin. If they call correctly, they
win a dollar from those who called wrong. Each day the losers drop
out, and on the subsequent day the stakes build as all previous
winnings are put on the line. After ten flips on ten mornings, there
will be approximately 220,000 people in the United States who have
correctly called ten flips in a row. They each will have won a little
over $1,000.

Now this group will probably start getting a little puffed up about
this, human nature being what it is. They may try to be modest, but
at cocktail parties they will occasionally admit to attractive
members of the opposite sex what their technique is, and what
marvelous insights they bring to the field of flipping.

Assuming that the winners are getting the appropriate rewards from
the losers, in another ten days we will have 215 people who have
successfully called their coin flips 20 times in a row and who, by
this exercise, each have turned one dollar into a little over $1
million. $225 million would have been lost, $225 million would have
been won.

By then, this group will really lose their heads. They will probably
write books on "How I turned a Dollar into a Million in Twenty Days
Working Thirty Seconds a Morning." Worse yet, they'll probably start
jetting around the country attending seminars on efficient coin-
flipping and tackling skeptical professors with, " If it can't be
done, why are there 215 of us?"

By then some business school professor will probably be rude enough
to bring up the fact that if 225 million orangutans had engaged in a
similar exercise, the results would be much the same - 215
egotistical orangutans with 20 straight winning flips"

The bottom line is that the new investors are still better off with
mutual funds but they should not blindly assume that past
performances would continue.

Posted:Oct 7, 2004

Around 4 years ago, while reading about investment philosophy of
Buffett, I chanced upon a quote from him saying that his style was 85%
Graham and 15% Fisher. I had been a avid reader of Graham by then but
I was hearing about Fisher for the first time. Couple of searches
later I got the details about this book called 'Common Stocks and
Uncommon Profits'. The book came highly recommended by famous investors.

When I read it I wasn't sure whether what Fisher said was at all
possible. He talks about the growth stocks where you buy and hold for
years seeing them grow 10 time..20 times. By that time I was into
buying undervalued companies at low price and selling them as soon as
they reverted to normal valuations. I liked his approach of analyzing
the company's business by meeting with customers, employees ,
suppliers rather than focusing on vague and volatile numbers from
annual reports. But I wasn't sure whether a individual investor can
achieve this.

On the second reading 4 year later, I found that my experience of last
4 years really back what Fisher had to say. I had realized that
investing in good businesses and holding for long term is a better
approach than buying stocks of troubled companies at dirt cheap
prices. The main reason for this change was that my earlier focus on
accounting numbers like EPS, P/E, ROE was proved wrong too many times.
I had bought many stocks just because their financials looked great
without bothering to know more about the company. The results of these
decisions were disastorous. On the other hand many of my investments
grew to 15 to 20 times their original value. When I did a detailed
study then I realized that al the successful decisions were those
where I had bought good businesses at attractive prices. I realized
that a good business ensures that the financials will look attractive
in long run but the financial figures which look attractive on first
glance do imply a good business.

I would rate this book the second most useful for the investors(the
first of course is 'Intelligent Investor' by Graham). The book
contains lot of useful tips about making your own investment strategy.
It exposes many myths small investors generally hold. It reminds the
investors that they are part owners of a business not a buyer of
lottery tickets. If one thinks that by number crunching he can know
about the characteristics and prospects of business, this book will
bring him closer to the hard reality.

Overall this book provides a very good reading with interesting real
life examples. Being free of investment jargons this book is easily
digestible to those who are new comers to the field of investing. I
recommend this book to all the investors.

When to Buy

Making a decision on purchase of a stock, which you have singled out
for investment based on your research, presents difficulties for most
investors. More often than not people try to time their purchases.
They want to buy the stock but hesitate to pay the current price. The
market analysts of CNBC add even more confusion by claiming that the
stock has gone too high and buy at correction.

My answer to the question is an emphatic NO. Market timing may have
worked in their case but it never worked in my 10 year investing
career. In the investment philosophy which I have developed, this
decision is very simple for me. When I evaluate the prospects of the
company I generally decide a price band for purchase, based on my
valuation. Please understand that the intrinsic value is not a pointed
value. Suppose a company has chances of 10-25% growth in next 10 years
with different probabilities. The intrinsic value calculated based on
10% growth will be vastly different from the once at 20% growth. So
all we can calculate is a price band where each point has associated

Thus when there are no specific values why do investors decide that
they will buy only when the stock falls 20% from current value. Most
people do this because they have no knowledge of valuation and they
think that market is efficiently pricing the stock. They think that if
the current price is correct and they are able to buy at 20% below
this they would make gains.

So what is the alternative? I can tell once which I follow (quite
successfully). I decide at which price band I'm comfortable and start
buying at that. I make periodic investments subsequently based on
renewed information about the company. For instance 4 years ago my
research showed that M&M is a company worthy of investment. Based on
different growth estimates the valuations suggested a price band of
400-600. I made the first investment of only Rs 15000 at Rs. 315. In
next 3 years I made 25 additional investments in M&M whenever it fell.
The last and the biggest investment I made was at Rs 52. My average
worked out to Rs 87 and current price of Rs 440 is almost 5 times
high. You could argue that if I had made all the investment at Rs 52
my gains would have been higher but these things work only in the
hindsight. You can never predict movement of stock prices in short
term and I know my limitations.

Please note here that the original investment at Rs 325 too has
provided me a gain of 40%. So I think that the best way is to start
with small investment and increase it as the .....Price falls....
No. As you get to know more about he company and are more comfortable
about its value in relation to current price.

Price in itself does not matter. In J&K bank I made similar series of
investments starting at Rs. 26 and continuing till Rs. 120 as the bank
grew in strength and profits.

Here is the bottom line. Start with small investment. Get to know more
about the company. Do a periodic review. Every time the decision has
to be made considering the current price in relation to its current

In case of M&M the prospects worsened(with tractor market degrowth)
but price fell even more sharply. That's why I invested more. In case
of J&K bank the price rose by 200% but the bank business and its value
in the eyes of the financial community grew more. So I made more
purchases at prices twice high as the initial one.

You can develop your own investment styles and take more risk by
commiting all your funds at once if you are dead sure about your
valuation. In my case though I'm dead sure about my valuation I'm
never sure about valuation of Mr. Market

Posted: Sep 5, 2004

In the cases where the debt is high relative to the size of operation
the proper method of valuation is Firm Valuation rather than Equity
valuation. In Firm valuation the total value of enterpise i.e. debt +
equity, is calculated based on earnings before interest. This value
can give equity valuation if you subtract the debt.

I would like to explain this using valuation of MALCO where I did a
mistake by using Equity Valuation method.

If you use Equity Valuation you would find that MALCO was quoting at
Rs 142 which means market cap of Rs. 320 Crs. MALCO had net profit of
Rs. 37.22 crs. on standalone basis. If you consolidate the profits of
its 7.18% stake in Sterlite it would have consolidate profit of around
65 crs. That's why I considered MALCO an undervalued stock and
ecommended a Buy.

If you do Firm Valuation then you would find that MALCO is not that
attractive afterall. This is because it has huge debt of 434 Crs. at
Debt/Equity ratio of 4.27.

In such cases the Firm valuation is better approach than Equity

At price of Rs 142
Equity Value = 320 Crs
Debt(06/2003)= 434 Crs.
Enterprise Value = Equity Value + Debt = 754 Crs.

If you remove the value of 7.18% Sterlite stake 262 Crs(@515) the
enterprise value of the MALCO core operations is still Rs 492 Crs.

FCFF(free cash flow to firm) =
EBIT (1-t) - (Cap Ex - Depreciation) - Change in Working Capital

Under no growth situation, assuming that the depreciation cancels out
Cap Expenditure and no changes to working capital the free cash flow
to firm for MALCO would be

EBIT 62.35
Tax rate = 15.23%
FCFF = 62.35*(1-0.15) = 52.84 Crs.

At Rs 142 the market was valuing the enterprise value of MALCO core
operations at Rs 492 Crs. Which means a EV/FCFF multiple of 9.30 which
is not underpriced for a commodity company.

The only catch is that I have used the debt value for the year 2003.
The debt must have come down as the interest charges for year 2004
were 8.99 Crs., compared to 16.06 Crs. Even that value will make it a
definite SELL at RS. 162.

More on Firm valuation

On choosing the right model

Posted: Sep 13 2004

Dividend yields that beat FDs

Very few of the investors realize the immense potential of regular
income from equity investments. If you choose your investments
carefully, it is not only possible to get some regular income from
investments but the dividends can beat the returns from fixed deposits.

Let me explain the essentials of the approach to achieve this result.
When an investor invests for the long term he would mostly focus on
the long term capital appreciation rather than the current income.
Also any good company will generally find a way to reinvest the
profits in the core business and distribute only 20-30% of profits to
the shareholders which may not amount to a good yield relative to FDs.
For this reason it is difficult to find good companies at fair prices
to get a good dividend yield while provide chance of capital

You see a real example open the LWB Special portfolio in a new window
by clicking link 'LWB Special Portfolio' in the home page. In the
second last column you would notice that dividend yields of the
companies at current market price are in the region of 2 to 3%, with
the average at 2.42%. So an investor in these stocks would be getting
2 to 3% dividend yield.

But those investors who bought the stocks when the model portfolio was
started are getting a dividend yield ranging from 2 to 16%. If you
take the average you would be surprised to know that these investors
(myself included) are earning 6.3% dividend yield on their original
investment. So these investors not only enjoy 160% gains in 2.7 years,
they are getting 6.3% returns on investment which is better than a
fixed deposit with a bank.

This example brings us to the main features of a portfolio with a view
to high income.
1. The portfolio should not be made just by viewing current dividend
yields. Many companies pay good dividends when sun shines but send no
cheque when dark clouds loom over the horizon. A consistent dividend
record plus the future growth would ensure that the dividends cheques
keep coming to your doors.

2. If the companies keeps giving good dividends but the investment
itself is under threat due to unrecoverable fall in prices the
dividends are of no use. So the investment decision should still be
based on capital preservation and growth.

3. Most companies retain their dividend percentages after bonus
issues. So the investors holding steadily growing can see higher
dividend yields in the future.

4. The dividend payout by a company not only depends on the profits
but also on the planned capital expenditure. A company which plans to
spend on new plants etc will not be able to pay good dividends. That
does not mean that this low dividend yield would continue forever.

5. Although a fixed income deposit carries the return of the principal
amount and a fixed yield in terms of money. This fixation is a double
edged sword. Although the fixed income deposits provide lower risk in
normal circumstances, these are subject to the threat of inflation. If
the value of money goes down the real value of your principal and the
real value of the interest go down. In a era of 6% inflation if you
hold 5.5% FD, the main danger is not that you are loosing 0.5% in real
terms but the fact that principal amount would be worth much less when
you get it back at the end of the term.

Equity investments are relatively safer under inflationary scenarios
because the value of assets and the prospective yields go up along
with the prices.

6. The interest on fixed deposits is subject to taxes (at source if
>2500) whereas the dividends are free in the hands of the investors.
This means a dividend yield o 4.-4.5% is preferable over FD of 5.5-6%

With these points in mind an enterprising investor can build a
portfolio which can give a decent income after 2-3 years have passed
while enjoying the benefits of capital gains.

Posted: Aug 27, 2004

Most investors find the complexities of valuation hard to deal with.
The issue becomes even more complicated in case of companies which
have large or numerous subsidiaries. As the financial results
published in newspapers generally show the standalone results the
investors often ignore the fact that it is the consolidated results
not the standalone result which should be taken into account while
valuing a company.

The subsidiaries can affect the financials in the following manner.
1. If a company has a subsidiary than it has same % share in its
assets as it has in the company's equity. The same holds good for
liabilities as well although the liability is limited to the extent of
parent company's exposure in the subsidiary.

2. Parent companies often give loans to the subsidiaries and to that
extent they are exposed to the risk of default as a creditor.

3. Parent companies get dividends by virtue of their stake and are
liable to get rewards if the worth of the subsidiary grows.

It is important to note here that the value of the investment in the
subsidiaries is shown at book value in the balance sheet of the parent
company. The actual value of the investment can be substantially

Also the income of the subsidiary is reflected only to the extent of
dividend and if the dividend payout ratio is low then the income of
the subsidiary is not correctly reflected.

Finally the business and the business prospects of the subsidiary can
be quite different from the parent and the earnings attributed to the
subsidiary can not be discounted at the same rate as the earnings of
the parent.

So if you trying to evaluate the worth of a company then it would be a
mistake to evaluate the financials of the parent on standalone basis.
The investors of Enron discovered this bit too late when the company
fooled not only general public but almost all the wall street analysts
by showing good standalone results whereas all its subsidiaries were
bleeding and had huge holes in their balance sheets.

In the Indian market this knowledge can be utilized by the value
investors to generate high returns. The model portfolio LWB Special
has 4 companies which have large and profitable subsidiaries.

Mahindra & Mahindra has a collection of many profit making
subsidiaries which add a substantial amount of profits to parent. The
most notable of these are MBT(57% stake), Mahindra Financial services,
Club Mahindra. These companies add 77 Crs profits to the figure of
348 Crs profit earned by Mahindra on standalone basis.

HDFC has 25% stake in the HDFC Bank which is reelected in the
valuation of HDFC.

Sterlite holds 51% in BALCO and 64% in Hindustan Zinc. These companies
add almost 400 Crs to the 198 Crs earned by Sterlite on standalone
basis. While swapping of Sterlite with MALCO I have used the equation
as MALCO holds 7.18% in Sterlite.

Micro Inks has a large subsidiary Micro Inks US which has turned
around recently. The markets never cared for the losses it made during
initial phases and nor did they account for the turnaround.

All these companies were included in the LWB Special portfolios
precisely because the market did not notice how much value was being
created by the subsidiaries behind the scene. The superb results of
these companies indicate how the value investor can utilize this
information to make smart decision.

Indian accounting laws mandate that the companies publish this
information in their annual report. This means that all this
information is available to the investor with eye for hidden value.

Posted: Aug 21, 2004

Closed ended mutual funds

Closed ended mutual funds provide exciting opportunity to make
handsome gains if you buy them at a discount.

A close-ended fund or scheme has a stipulated maturity period e.g. 5-7
years. The fund is open for subscription only during a

specified period at the time of launch of the scheme. Investors can
invest in the scheme at the time of the initial public

issue and thereafter they can buy or sell the units of the scheme on
the stock exchanges where the units are listed.

The market price of the listed closed ended fund generally trades at a
discount. The discount depends 4 variables.
1. Time left till redemption date : N years
2. Interest rates : y% per ammum
3. Expectated annualized returns : g% per ammum
4. Expected Dividends : d

For simplicity if you ignore variable 3 & 4 then the market price can
be calculated as follow.
Assume Market Price is P
NAV = P * [ (1+ 0.01* y) ^ N]
^ stands of power

As you know the NAV and price you can calculate what interest rate is
built into the prices.

For instance NAV of Morgan Stanley Growth Fund(MSGF) is Rs. 18.81 and
the market price is Rs. 13.85. As there are still 4.5

years left till date of redemption the prices are factoring in 7.04%
interest rate. In simpler terms if you buy MSGF today

and its NAV remains same on Feb 2009 then you would still get 7.04%
returns (- transaction costs ofcourse..)

However the factors which we ignored also play a significant role in
pricing of closed ended mutual fund. For instance in

2001-02 UTI crisis the UTIO mastershare was quoting at amazing 30%
discount to NAV with only 2 years left to the

redemption date. I kept accumulating this fund throught the crisis
days with significant transactions as given below.

25-Jul-01 Buy 3000 9.65
3-Oct-01 Buy 5000 6.6
22-Apr-02 Buy 5000 9.35
The average price comes to 8.36 and it now quotes at 17.25 after 2

At that time Sensex was quoting at 2700 -3000 range. As my
expectations were that in 2 years the market will be quoting

higher than these levels I knew that I stand to gain much more than
the discount at which I was buying. Let me explain this.

Assume a fund is quoting at pice 'P' and has NAV as 'NAV' and it given
returns of G% p.a. Let's assume the redemption date is

N years from today.

On redemption date NAV would be => NAV * [ (1 + 0.01* g) ^ N ]
=> NAV * (G^N) where G is (1 + 0.01* g)
You bought the fund at price P.
your returns is => [ NAV * (G^N) / P] ^ (1/N)
Now NAV/Price is the discount.

That means that your per annum returns gets boosted by a factor of
[NAV/Price] ^ (1/N).

The mastershare mutual fund gained cumulative 61% but my returns were
higher at 130% due to the discount of 30%. Please note

that the returns that I got were higher that simple addition of return
of mutual fun and discount (i.e. 130 > 61 + 30).

Thus if you are bullish on the market in general buying a closed ended
fund at discount gives extra returns and ensures lower losses in case
the markets go down. However it is very important to check the
portfolio of the fund, the management costs,exit loads and brokerages
before buying a closed ended fund.

For more information on closed ended mutual funds click the following

Title : A Brief Guide to Closed-End Funds

Posted: Aug 11, 2004


Buyback by a company definitely gives an indication that the
management thinks the company's stock is undervalued. However it can
not be sole criteria in deciding whether the stock is truly
undervalued. This is because most management has high sounding notions
about greatness of their companies and frequently go overboard in
their estimations of worth of the company. Also the buyback means that
the company does not have other avenues of deploying its cash in the
operating business. Still buyback can enhance return on networth and
EPS if the pricing of buyback is right.

There have been instances in india where the rogue managements have
used buybacks from open market to jackup the prices of their stocks.
One has to be careful to avoid such companies.

However the buyback defintly demands closer look on companies
financials. My experience with buyback has been very interesting. In
my case the buybacks were announced, most of the time, after I've
taken position on a stock. It did substantiate my views. For instance
I had when I had bough Sterlite it was quoting at half its book values
and 4 time its profits. Then Sterlite announced buyback of 25% shares
at 200. It later revised it to buyback 50% stock at 150. It was a very
smart move on part of Anil Agrawal(promotor) and very dumb move for
those who sold their stock to the company. The same stock now quotes
at 514*2(bonus). There were other inatances like Reliance,Britannia,

So investors can use buyback as a trigger to start investigating more
about the stock and only they would find that the company is realy
underpriced the investment should be done.

Posted: Aug 7, 2004

Investing Mistakes

Mistakes teach you more than success, if you are willing to learn.
When I started off in investing back in 94, still in
college, I was very sure that if I make mistake now I would lose
thousands of rupees but if I made mistakes 20 years later I would
lose in crores because my total investment would be higher.
There was one logical problem in this line of thinking. If I
made mistake today and again the same mistake 20 years later, making
mistakes won't help. So I started of documenting the mistakes,
whenever it became apparent, in my diaries. I also gave unique error
code to the mistake and wrote a 2 page description to each
Some critical points in this documentation were the
circumstances under which I took the wrong decision. Please note
nobody takes wrong decisions. No decision is apparently wrong at the
time when it is made. It's only the information we lack, or
misinterpretation of current information that proves your decision
wrong over time. You would also note that in hindsight it looks so
clear but unless you consider the circumstances under which the
mistakes were made, you are doomed to repeat the same mistakes.

The results have been good so far. As per my unaudited records I
have made 87 UNIQUE mistakes and lost a total of Rs 4.5 lacs in
these mistakes. (You know the kind of games mind plays while
justifying the past decisions..I may not have documented all, surely
I haven't accounted for mistakes involving opportunity loss).

Another thing that I've noted that the number of mistakes kept on
reducing as the years progressed. The earlier one were more related
to incorrect valuations but the mistakes of recent years have been
in estimating the intangibles like brand value, honesty of
management, correctness of financial figures etc.

Posted: Aug 5, 2004

Intrinsic value Vs. Book Value

Valuation of business is key to investing. When
you purchase a stock you are buying a piece of a
business which has certain economic value. But the price of
this piece of business namely market price of stock
,fluctuates around this value due to variation in demand and
supply. To quote Warren Buffet 'Price is what you pay, value
is what you get'. This means that unless you know
about valuation you can never be sure about what you
are getting for your dollar. The most important
concept in valuation of business is the intrinsic
value. In the long term buying stocks below their
intrinsic value is the most successful strategy. In my
effort to demystify equity investing I'm posting
excerpts from a letter of Warren Buffet where he has
explained this all important concept. Warren E. Buffet on Intrinsic value: Intrinsic value is an
all-important concept that offers the only logical approach to
evaluating the relative attractiveness of investments and
businesses. Intrinsic value can be defined simply: It is the
discounted value of the cash that can be taken out of a
business during its remaining life. The calculation of
intrinsic value, though, is not so simple. As our
definition suggests, intrinsic value is an estimate rather
than a precise figure, and it is additionally an
estimate that must be changed if interest rates move or
forecasts of future cash flows are revised. Two people
looking at the same set of facts, will almost inevitably
come up with at least slightly different intrinsic
value figures. You can gain some insight into the
differences between book value and intrinsic value by looking
at one form of investment, a college education.
Think of the education's cost as its "book value. " If
this cost is to be accurate, it should include the
earnings that were foregone by the student because he
chose college rather than a job. For this exercise,
we will ignore the important non-economic benefits
of an education and focus strictly on its economic
value. First, we must estimate the earnings that the
graduate will receive over his lifetime and subtract from
that figure an estimate of what he would have
earned had he lacked his education. That gives us an
excess earnings figure, which must then be discounted,
at an appropriate interest rate, back to graduation
day. The dollar result equals the intrinsic
economic value of the education. Some graduates will
find that the book value of their education exceeds
its intrinsic value, which means that whoever paid
for the education didn't get his money's worth. In
other cases, the intrinsic value of an education will
far exceed its book value, a result that proves
capital was wisely deployed. In all cases, what is clear
is that book value is meaningless as an indicator of
intrinsic value.

Posted: Mar 27, 2001

Graham's Mr. Market

Ben Graham, the guru of value investing , long
ago described the mental attitude toward market
fluctuations that is most conducive to investment success. He
said that you should imagine market quotations as
coming from a remarkably accommodating fellow named Mr.
Market who is your partner in a private business.
Without fail, Mr. Market appears daily and names a price
at which he will either buy your interest or sell
you his. Even though the business that the two
of you own may have economic characteristics that
are stable, Mr. Market's quotations will be anything
but. For, sad to say, the poor fellow has
incurable emotional problems. At times he feels euphoric
and can see only the favorable factors affecting the
business. When in that mood, he names a very high buy-sell
price because he fears that you will snap up his
interest and rob him of imminent gains. At other times
he is depressed and can see nothing but trouble
ahead for both the business and the world. On these
occasions he will name a very low price, since he is
terrified that you will unload your interest on him.
Mr. Market has another endearing characteristic: He
doesn't mind being ignored. If his quotation is
uninteresting to you today, he will be back with a new one
tomorrow. Transactions are strictly at your option. Under
these conditions, the more manic-depressive his
behavior, the better for you. But, like Cinderella at
the ball, you must heed one warning or everything
will turn into pumpkins and mice: Mr. Market is there
to serve you, not to guide you. It is his
pocketbook, not his wisdom, that you will find useful. If
he shows up some day in a particularly foolish mood,
you are free to either ignore him or to take
advantage of him, but it will be disastrous if you fall
under his influence. Indeed, if you aren't certain that
you understand and can value your business far better
than Mr. Market, you don't belong in the game. As they
say in poker, "If you've been in the game 30 minutes
and you don't know who the patsy is, you're the

This book is a jewel. However you need an eye for it. The book describes a unique approach to investing , surprisingly simple, sound yet unpopular. It also gives you reason why such an approach will not be popular. As for soundness of this approach just go to the appendices and read the article by Warren Buffet "Super-investors of Graham-Doddsville" .He has given an impressive list of people, disciples of Graham, all managing billions of dollars and earning consistent returns as high as 20%-30% for 20 years. The common thread among them is value investment philosophy, described elaborately in the Intelligent Investor. The book demarcates the line between investment and speculation. Graham describes how a stock of a sound company can become speculative at very high price and also, how a stock of relatively unpopular and average performing company can become a solid investment at low price. Graham describes 'Margin of Safety' as basic tenet of investing. With sheer force of knowledge and experience Graham dispels widespread myths (like you need to take high risk for high gains..) about stock valuations and gives a simple, effective approach, which can be used to generate satisfactory returns by an average investor. Graham's wit makes the book interesting despite seriousness of subject. “Buy stocks as you buy your grocery not as you buy perfumes" says he. People may ask how relevant the book is at present time? Well, sound strategies are timeless. If you go by the philosophy of value investing than you can apply this approach with minimum modifications even now 20 years later. If your doubts persist then check October 99 issue of fortune where Warren Buffet , legendary disciple of Graham, warned is clear words about high valuation prevailing at that time. People ignored the warning of 'the fogy old prof', at their own peril. New year chopped of 35% of NASDAQ. The highflying internet stocks lost as much as 90%. Still you may not like it. Value investing is not popular. Warren Buffet says, either you get hooked to it or you don't. There is no middle ground. Still you would benefit by reading this book in innumerable ways .At least you won't call yourself investors as you go on speculating.

Posted : Oct 30, 2000


Of Men and Mania

To study the inexplicable tendency of human beings to swing between euphoric to depressive bands of emotions is the realm of psychologist but investors will do well to analyze this behavior of mob of which they themselves make a part or at least are affected by it.

The meteoric rise and subsequent fall of tech stock is nothing but history repeating itself.Times change,people change,places change but throughout we can clearly see a link between man and
manias.This link may have its reasons in the way of working of our mind, in the deep recess
where emotions and thought are formed. Further exploration of which is out of scope of this article.However I would like to give here some glimpses of past so that we can learn from them.For those, who don't learn from history , are condemned to repeat it.

In the world of finance manias make rule rather than exceptions.The tulip mania of 17th century , when prices of a simple humble flower shot up through the roofs to the extent that a whole estate was not sufficient to purchase a small contingent of tulip.This flower became an object of obsession among the upper echelons of society ,not due to some miraculous powers or beauty, but just because it was difficult to get it.It was imported from far away countries and was
difficult to preserve.The prices kept rising and rising an along with it the appeal of tulip as status symbol.It was the costliest and consequently most sought after gift.Then the inevitable crash came.The tulip traders who had made millions in trading tulips became broke as tulip lost its
charm.To answer the query why the crash came,it would be sufficient to mention that as there was no reason for its rise, the crash needed no reasons. 

Then came the south sea bubble,the gold rush which are sufficient as a storyline of a 1000 page novel.To say in a line ,everyone who was capable,had some cash or land and had dreams(qualifies practically everybody rich and young) went in search of gold in the colonies of America and Africa.Its worthwhile to note that even if the expected amount of gold were found then also they were doomed as the price of gold would have crashed with increase in the

The last century had its own share of manias.The rise of rail road stocks in the beginning of last
century,that of auto stocks in 1920s ,of airline stocks in 1950s and the most recent,the rise of tech stocks in late 1990s. 

To give some examples from the home, the Harshed Mehta orchestrated boom, the rise of
Non Banking financial stocks in 1995 and the recent rise of software stocks are the manifestation of same tendency of human mind which makes them susceptible to maniacal behavior.

All such inexplicable movements in prices start due to some fundamental reasons. If the momentum is sustained for quite some time than that alone becomes reason for further rise. To explain this I would compare  greed and fear as accelerator and break for the price movement. When price moves upwards for quite some time the public starts getting news of people who have made themselves rich in a short period of time. The lost of opportunity pinches everybody. If the rally is sustained further than the fear of losing the chance to be a part of party overcomes the fear of loss. This is how the breaks start functioning as accelerator and the prices rise to astronomical proportions. However in real life a car without break can not go ahead indefinitely. 
A crash is due and it comes as surely as night after day. After the crash the panic grips the crowd and all of a sudden negative news start flowing from all sides. A crash of a fellow driver(read NASDAQ) forces up to check the speed and grope for breaks. The crash brings prices not only back to the intrinsic values but often brings them even lower.

The lesson we can learn from these are many.
1. If something rises well above its intrinsic price then there is no limit where it will end but that it will end is sure. However you can not go short if you see an stock quoting much above it's real value. If that price is not high enough, than even two times that price isn't.  

2. You can not buy something just after the crash when this return to their real prices as the momentum generally takes the prices to opposite extreme. Wait while sense returns to the sensex.

3. You can not time your entry and exit in such conditions as all forecasts are based on reason and this is by definition rare element at such times. That means even if you save yourself
from the irrationality of mob, to forecast on the basis of their rational behavior is foolish.

4. You can not afford to be overconfident about your abilities as everybody among the crowd is feeling in the same way. Like everybody thinks that he will be able to sell of quickly if a crash comes.

5. You can think of your actions as pretty reasonable but even the reason wears rosy colors in its eyes. All the public and media is euphoric at such times. The news, forecasts, analysis and even warnings wear same color at such times. And lastly you can not say that you will plan your
action when such a thing comes but it never tells you of its arrival till such day when you realize that you have brought Wipro at 9500, Zee at 2000 and have no option but to wait and curse your luck.

Reference: Charles Mackay's Extraordinary Popular Delusions and the Madness of Crowds John Kenneth Galbraith's The Great Crash, 1929 Charles Kindleberger's Manias, Panics, and Crashes

Posted: Dec 4, 2000

This article is an attempt to demarcate the line
between two widely used investment philosophies namely
value investing and growth investing. Both these styles
emphasize on getting maximum returns at manageable risk. The
difference ,however is in different perceptions about risk
involved with an investment. Value investing is buying assets at a cost less than their intrinsic worth. The intrinsic worth is measured as the current
market value of all tangible assets of the company. A more
conservative approach would recommend buying at a cost less
than the net current assets of the company (to get
fixed assets for free..).In reality this also means
that a stock qualifying for value investment will most
certainly be an unpopular stock which has lost its value
due to bleak short term prospects, lack of interest
or general apathy towards company. The value investor
is by definition a contrarian. He buys when everybody
sells. Growth investing means , putting your money in
the industries with best prospects. Though it sounds
very logical ,it may not be so. When everybody is so
sure about the bright prospects of the future of the
company the demand will push the price to such a high
level that its quite possible that the future growth is
already accounted for in the prices. The growth investor
relies on his timing skills to enter at a price where
there is some scope for profits. This is not so simple
as all are trying to beat each other by buying at
just right moment. The growth investor's domain is high
growth(..thus popular and high priced) stocks. Apart form the obvious differences there are some subtle
differences in these styles. Whereas the value approach
recommends to minimize risk by buying assets worth the
amount you pay for , the growth investor seeks safety in
the better prospects. The value investor relies in his
valuation skills whereas the growth investor relies on his
timing skills. The growth investor wants to get results
quickly but loses the certainty of profits as a
bargain. The value investor sacrifices the urge to get
quick results for certainty of the results. What does all this mean to a small investors. Though there
may be differences in opinion, value investing makes
an strong case for small investor. Predicting future
accurately is not everybody's ball game. Even an error of 20%
can make the difference between a profit and
crippling losses. The value investor does not need such an
skill. In Ben Graham's words he just need to be familiar
with high school mathematics. He does not need to take
quick decisions. He does not need to stay in touch with
market movements regularly as long as he has bought
scrips below there value. However, he needs a strict
discipline to avoid pitfalls of human emotions of getting
excessively euphoric of excessively depressed. He needs
patience and will power to go against the general trend.
Simple all these may sound but these qualities need to
be cultivated. Its not hard to understand why value
investing is not a popular style despite its superior
results . Investors are however free to choose their pick
as either of these is better than a haphazard way of
investing(which is the popular approach of most of the investors

Posted: Nov 27, 2000

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