The Interview

The market is similar to an ocean, there is just too much information to assimilate, process and analyze, an investor needs to make sure he/she is on the right kind of a boat while traversing the rough ocean waters.

Recently, I was re-reading some of the very insightful interviews of reputed investors which Vishal (Safal Niveshak ) has been gracious enough to share with. This gave me an idea to conduct a small experiment

So my friend and I decided to conduct mock interviews of each other, to better understand our thought process, I have listed some of the questions we covered:

  • Why do you invest in the stock markets? Isn’t it too risky?
  • What stocks do you usually invest in?
  • Where do you find good investment ideas?
  • How do you decide which ideas to buy and which ones to let go?
  • What are your return expectations from the markets?
  • What???? Just 20% P.A, don’t you think you should be making more, at least wanting more?
  • What percentage of capital is allocated to each idea of your portfolio?
  • Do you buy into the full position at one go or in stages?
  • How do you decide when to add more to your existing holdings vs adding new positions?
  • When do you sell? What factors do you consider before selling?
  • Do you sell the entire holding together or in stages?
  • How do you handle your emotions when stocks you own are losing or appreciating in value ?
  • How do you develop conviction to hold on to stocks in spite of a huge up/down move?
  • What is your typical holding period?
  • Do you meet management of your portfolio companies?
  • What has been the worst performing stock idea for you?
  • How do you ensure downside protection, prevention of capital loss?
  • How do u handle and process the constant stream of information? How do you cut down the noise and clutter?

And so on…

To my utter disbelief I flunked this interview big time, I realized, I had no objective and concrete answers to most of the questions above.

This was a great learning experience, it forced me to think these questions through, I sat over the following weekend and wrote down the answers to each and every question, not only did I feel more confident but it made me more aware of my temperament and inherent personality as an investor.

The future is unknown and unpredictable, however managing risk is something we can control and influence, writing and documenting in detail, your entire investment philosophy and process can take you one step closer to that, it forces you to acknowledge the chinks in your armor and rectify the errors in your decision making process.

Go ahead, see if you can pass this interview, if not introspect. Repeat.

Check your premises

How is wealth created in the stock market? Whatever words you choose, at the bottom of it there are only two ways.

  1. Buy at X, Sell at Y ( X < Y, if you’re any good)
  2. Dividends

Now let’s dig a little deeper:

In point number 1, when we say X and Y we mean price.

In point number 2 we have dividends, typically in a decent portfolio the average dividend yield ( on current price ) is ~2-3% P.A, as an enterprising investor, your interest is in the former as is the focus of this post.

All of us have different styles, techniques, strategies we use and deploy to buy and sell prices of different companies, note, there is a difference between what we have learned and the true nature of things, we are not buying / selling the companies but their prices.

As I write this, Ratnamani Metals and Tubes is quoting at Rs. 572 / share, there are 2 participants, one is value investor. and the other is a technical analyst.

Both, buy (X) at the current price, let’s assume after a year price now is Rs. 700 / share, both sell(Y) and pocket the difference as profit.

These guys came from 2 completely different lines of thought, one analysed the company, its fundamentals and other such variables, the other analysed chart patterns, the result is the same, they both created identical quantum of wealth.

Mr. Market is like nature, it brings everyone to an even plane. No matter what your analysis is, you have to buy / sell price.

As an investor all you are really doing is betting on prices of different securities, this is at the heart of stock market investing.

Your sole focus as an investor must be just 1 thing,  find a way to make a killing when you’re on the right side of the bet, lose as little as possible when you’re on the wrong, do this consistently for a long time and you can’t help but become rich.

Hope this helped in some way!!

 

 

Greed is good?

 

Would you sell your house in exchange for a few flower bulbs? , No? If I had put this offer across 375 years back in Netherlands (Holland), you probably would.

For those who don’t know, I’m referring to Tulip mania”, one of the first economic bubbles in recorded history. Tulips were originally introduced to The Dutch by the Flemish botanist ~ Carolus Clusius in the late 16th century, It was unlike any other flower known to Europe at the time, it soon rose in popularity and became a status symbol among the rich and affluent.

It usually takes between 7-12 years for the seeds to grow into flowering bulbs, so you can imagine the scarcity in production in contrast to the prevailing demand.

Combined forces of their demand, rarity and time taken to grow these beautiful and exotic flowers caused prices to rise dramatically over a period between 1600’-1636’. This hike in prices was fueled by speculative trade, traders and merchants entered into formal futures contracts to buy and sell bulbs at the end of the season, what is more surprising is that neither party paid any margin money or mark-to-market margins, only a paltry deposit- “Wine money” prior to entering into a contract.

Things got out of hand when at its peak a single tulip bulb sold for more than 10 times the annual salary of a skilled craftsman, sometime around 1635, 40 bulbs were exchanged for 100,000 florins which equates to 2500 florins for a single bulb, For that amount  you could buy all of the following:

2 Lasts of wheat 448 f
4 Lasts of Rye 558 f
4 fat oxen 480 f
8 fat swine 240 f
12 fat sheep 120 f
2 hogshead of wine 70 f
4 tuns beer 32 f
2 tons butter 192 f
1000 lb. cheese 120 f
A Bed 100 f
A Suit of clothes 80 f
A Silver drinking cup 60 f
Total 2500 f

 

*Courtesy Wikipedia

By 1636, it wasn’t just the traders and merchants involved in this rampant speculation, the common masses  joined in too, so much so that people ignored their primary occupations and participated in Tulip trade. In the last few months leading to the subsequent crash of this irrational euphoria, the prices of tulip bulbs rose by close to 20 times.

Tulip trade reached its peak during the winter of 1636’-37 and had attention of the entire nation. February 1637, tulip bulb contract prices suddenly began to fall, and no deliveries were made to fulfill any of the contracts, this lead to free-fall in the prices of these bulbs, the market for “Tulips” evaporated overnight, there were simply no buyers for any contracts any more, only sellers. There was widespread panic and merchants turned to the government for help. Tauntingly, the Government announced that anybody could pay a 10 percent fee and void the contracts; the courts of law wouldn’t help either as they termed this activity as “Gambling” and declared that these contracts weren’t enforceable by law. This led to further fall in Tulip prices, any attempts to reach an agreeable solution failed and they couldn’t find any brakes to halt or even slow down this continued fall in prices.

The mania finally ended and People were left with flowers, worth a fortune just a few weeks back, now fetched a fraction of that amount. The Dutch economy was in recession for a few years following this event. The market values of various commodities was questioned, people were now fearful and more cautious than ever.

Think about it, Prices of these bulbs which took years to appreciate and rise in value were beaten down to almost nothing in just a few weeks.

At the crux of this incident lies a very basic human instinct and emotion ~ Greed. It’s a drug which you simply can’t afford to abuse.

 

* Primary source of facts and figures – Wikipedia. 

 

Keeping it simple!

 

Investing can be as simple or complicated as you make it to be. I’ ll share a personal example:

I used to be in awe and often get overwhelmed on reading these brilliant analyses of companies and concepts on various blogs across the internet, ” Wow how am I ever going to get so good” or ” I am going to start reading 6 hours a day, everyday (orders top 10 recommended books from Amazon)”.

After passing through a period of mindless reading and running about to various seminars ( which promised the fruit of identifying the next multi-baggers ) in the pursuit of gaining nirvana, I ended up with a 10 page framework and check list to analyse companies. I thought to myself ” Now, finally I am going to crank up those returns and become the best money manager ever”

This feeling did not last long, for 2 reasons:

  1. As I progressed, I realised that most of it was repetitive and as a result I had to think and write the same points over and over again and it took a really long time to finish researching a company
  2.  The framework itself was so vast, it was intimidating, most times as I sat down for research, to my surprise, I was bored rather quickly

On some introspection, I understood the following:

  1. Your only competition is yourself, focus on absolute returns
  2. Understand that knowledge grows gradually with time and experience
  3. Reading the wrong kind of stuff is very dangerous
  4. Reading too many books too soon will not add optimum value, it takes considerable time to absorb concepts and ideas of each book, relax there’s a lot of time, one book at a time, slowly
  5. If the idea is not appealing within the first 30 minutes of the time you spend understanding it, it probably never will be
  6. Luck plays a huge part in determining returns, it is often futile to know everything out there
  7. You are not really investing in the business itself but on the probability of the business doing well in future
  8. Your investing strategy must suit your temperament, different things work for different people, find what works for you
  9. There is no superior or inferior analysis, only returns

So what do I do?:

  1. I read about 1 book every other month(related to investing) and I am really choosy about what I read
  2. My investing framework is only 2 pages
  3. I usually complete my homework on the company within a couple of days max
  4. I try and know enough to understand if the business is going to do well 3-5 years out, My focus is generally on the larger picture
  5. I avoid crunching too many numbers, future is unknown, I’m good if I like the business model of the company and the people running it
  6. I allocate minimum capital at the start and keep adding and averaging up as and when I get more comfortable with the business and the management
  7. I follow very selected blogs of people I admire and which I believe can add good value to my investing life
  8. I don’t watch stock prices very often specially of companies I am invested in
  9. I often write down stuff rather than typing

The investing process has to be fun, engaging and most importantly simple!

Hope this has added some value to your investing journey!

Happy investing!

 

 

The other side of risk

Risk is often assumed to be “volatility” (measure of variation of price over a period of time), which is quite bizarre, ask any trader, for him / her it is bread and butter. 

Volatility in stock prices creates opportunity, your actions create risk.

So what is risk

One aspect of risk is loss of capital, so when we buy into something which has a high probability of faltering and going down we tend to take more risk ( think : buying IT stocks ’99, real estate and infra ’07 )

There is another aspect to risk which tends to get sidelined.

Picture this, there are ~5000 securities to choose from (India alone), As long term investors, we will typically hold ~20-25 ideas in the portfolio (beyond which diversification loses its significance).

We are betting on the fact that this small portfolio at any given point of time, comprising just 0.5% of the overall universe of stocks available will beat the market consistently over the long run (Only referring to long term, not the short term variations)

  While buying into an idea we are faced with two kinds of risks:

  1.     Loss of capital: Risk of downside from purchase price
  2.     Opportunity risk: Risk of under performance relative to better ideas

So let’s say, I bought Reliance Industries in the 1st week of January, 2009 at ~Rs.700, 1st week of January, 2015, price is ~Rs.930, so 6 year CAGR works out to be ~5%, my fixed deposit did better.

There is no loss of capital and I even got dividends, however it turned to be a poor investment decision, opportunity risk was very high (think: returns in Pharma, IT in the same periods)

Historical market returns have been ~16%, our portfolio has to beat this to justify the extra effort and risk.

We have to find ideas where the risk to capital and opportunity are low and consequently the probability of market beating returns higher.