Dark clouds on the economic horizon

Let me make a confession. The last few years I have not read a single pre-budget article nor watched any pre-budget shows on TV. I have shied away from these as I have seen that the budget has been hyped up by the TRP/ratings hungry media into something which it is not. So, inevitably the budget disappoints and after a couple of days people forget about it completely.

This time looking at the macro economic scenario after the budget, I see two dark clouds on the horizon. The first is the huge market borrowing planned by the central government to the tune of 5.8 lakh crore. The second is the rupee depreciation.

The net impact of the huge government borrowing would mean that the interest rate is unlikely to come down in the near term. Even if it does, it will not be more than 0.5% to maximum of 1.0%. It will also make corporate borrowing more difficult and may push more and more companies towards ECB (external commercial borrowing). Both of this is likely to be a major dampener for corporate earnings growth.

FII net inflows into India in 2012 has been $7.16 billion as per SEBI. To put that in perspective, the FII net outflow in 2011 was $358 million. However, in the euphoria of such large doses of FII liquidity, an important point is being missed. The fact is that even with this huge inflow, the rupee has not appreciated at all. In fact, it continues to hover around the Rs 50 mark with respect to the US dollar. This means if the FII inflows weaken, the rupee can take another dive towards the 55-57 to the dollar mark.

Macro economic forecasting is a fool's endeavour and I engage only to amuse myself :-) Sometimes, though it can give some insights into the headwinds and tailwinds of the economy. At this time, I am a little bit more skeptical than six months back on the immediate economic future. I think I will have to relook at those stocks which have high FCCB/ECB borrowings and maybe shed some weight there. Good buying opportunities may be there in export oriented companies.

Portfolio Query: What to do with my portfolio?

A reader sent a query on an older post "My Rules for Investing":

Great Post!!.

A generic query. Even after repeated warnings a lot of us have bought a few stocks based on TV channel/CNBC/Guru's tips etc..which results in
a) Too many stocks in portfolio around 35
b) Some are down around 25% & unfortunately i have no investment thesis & hence no plan on what to do with them.

What can be plan of action here, should i sell them at a loss, build a thesis and then accordingly hold or sell the stock or finally keep them in cold storage and hope that after 3 years they have appreciated :) 

Here is my response. I am putting it up here so that others who may have a similar predicament, can benefit and if anyone has a better idea, can share it with me :-)

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Firstly, stop listening to all "gurus" on TV for your financial health :-) If they knew which stock would do well, they would reverse mortgage their houses and buy those stocks :-)

For your current holdings, the only option you have is to build conviction. Here is a quick and dirty process that you can follow:-

1. Take one or two stocks a day and go through their financial numbers and basic business (what it does)
2. Check on debt levels
3. Check if company pays regular dividends
4. Check if sales and profits are either constant or growing over the last 5 years (atleast) - the growth need not be every year but on a average 3 out of 5 years there should be reasonable growth.
5. Check the RoE & ROCE. Take a real hard look if they are below 15%
6. Check if there is +ve operational cash flow for atleast last 3 out of 5 years

If you do this, it wont take more than 30-60 mins each and you will get a much better idea of each company. Do this for every company in your portfolio. If you find ones which you do not understand or the numbers don't look good at all, just go ahead and sell. Those where you are not sure, dig a bit deeper.
Also, remember once you have a set of companies that you like and understand, it may be a better bet to keep buying into those than always looking for stocks not in your portfolio.

"I measure any new purchase against what I like least in portfolio now and unless it meets the  test, I'll just buy more of something in the portfolio." -- Warren Buffet

Guru Speak: Warren Buffet's 3 hour talk on CNBC

CNBC Transcript Ask Warren Buffett February 27 2012

Why it is nearly impossible to be as good as Warren Buffet

 I got this speech by Mark Sellers on the internet. Absolutely fabulous and a must-read.Sellers 24102004

Concentration or diversification - For a midcap or smallcap portfolio

I was talking to a friend. Like me he invests typically in midcap and smallcap stocks. The interesting fact he mentioned was that invests only in 4-5 stocks at a time. That is, he has about 20-25% in each stock of his portfolio. His argument was that Buffet and Munger continue to advocate high concentration in stocks and also followed their own advice and had a large concentrated portfolio. I think he is taking on unnecessary wipeout risk.

My friend is like me, a purely small retail investor and makes investment decisions based on publicly available information with no recourse to management. I agree that Buffet and Munger advice a concentrated portfolio, but only if you understand the businesses very well. For a purely external investor it is very difficult to understand a small or mid sized business so well that they can bet a very large portion of their networth on it. Also, it is important to understand that for mid and small cap investing it is likely that some of your picks will go wrong. And when it happens stock prices can go down 80-90%. It is important to diversify adequately to ensure that you don't get wiped out when, inevitably, some of your picks go bad. I think it is important to have around 10-15 stocks in your portfolio and preferably not all from the same industry sector!

Walter Schloss passes away: His learnings remain

Superinvestor Walter Schloss passed away earlier this week. He was 95. From 1955 to 2002, by Schloss’s estimate, his investments returned 16 percent annually after fees, compared with 10 percent for the S&P 500.

Here are the golden rules as espoused by him.

1. Price is the most important factor to use in relation to value

2. Try to establish the value of the company. Remember that a share of stock represents a part of a business and is not just a piece of paper.

3. Use book value as a starting point to try and establish the value of the enterprise. Be sure that debt does not equal 100% of the equity. (Capital and surplus for the common stock).

4. Have patience. Stocks don’t go up immediately.

5. Don’t buy on tips or for a quick move. Let the professionals do that, if they can. Don’t sell on bad news.

6. Don’t be afraid to be a loner but be sure that you are correct in your judgment. You can’t be 100% certain but try to look for the weaknesses in your thinking. Buy on a scale down and sell on a scale up.

7. Have the courage of your convictions once you have made a decision.

8. Have a philosophy of investment and try to follow it. The above is a way that I’ve found successful.

9. Don’t be in too much of a hurry to sell. If the stock reaches a price that you think is a fair one, then you can sell but often because a stock goes up say 50%, people say sell it and button up your profit. Before selling try to re-evaluate the company again and see where the stock sells in relation to its book value. Be aware of the level of the stock market. Are yields low and P-E rations high. If the stock market historically high. Are people very optimistic etc?

10. When buying a stock, I find it helpful to buy near the low of the past few years. A stock may go as high as 125 and then decline to 60 and you think it attractive. 3 yeas before the stock sold at 20 which shows that there is some vulnerability in it.

11. Try to buy assets at a discount than to buy earnings. Earning can change dramatically in a short time. Usually assets change slowly. One has to know much more about a company if one buys earnings.

12. Listen to suggestions from people you respect. This doesn’t mean you have to accept them. Remember it’s your money and generally it is harder to keep money than to make it. Once you lose a lot of money, it is hard to make it back.

13. Try not to let your emotions affect your judgment. Fear and greed are probably the worst emotions to have in connection with purchase and sale of stocks.

14. Remember the work compounding. For example, if you can make 12% a year and reinvest the money back, you will double your money in 6 yrs, taxes excluded. Remember the rule of 72. Your rate of return into 72 will tell you the number of years to double your money.

15. Prefer stock over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.

16. Be careful of leverage. It can go against you. 

Model Thinking: Online Course

“The better decision maker has at his/her disposal repertoires of possible actions; checklists of things to think about before he acts; and he has mechanisms in his mind to evoke these, and bring these to his conscious attention when the situations for decision arise.” (Herbert Simon, Nobel Laureate)


I recently came across an online class for Model Thinking.  I have started on it and it is very good. You can sign up for the class at the following website: http://www.modelthinking-class.org/

The class will last for ten weeks ending the last week of April. It will be covering two topics per week. Each topic will consist of a series of lectures with some embedded questions to make sure we are understanding the material as well as required and supplementary readings. Every week, starting in week two there will be a quiz. The quiz questions will vary in difficulty from basic competency questions to more challenging numerical calculations.

As you are probably aware, model thinking is critical to a serious investor's success. Without having the right (and enough number of) models in your head, it is not possible to analyze different businesses.

Need for mental models from Charlie Munger:
What is elementary, worldly wisdom? Well, the first rule is that you can't really know anything if you just remember isolated facts and try and bang 'em back. If the facts don't hang together on a latticework of theory, you don't have them in a usable form. 

You've got to have models in your head. And you've got to array your experience—both vicarious and direct—on this latticework of models. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and in life. You've got to hang experience on a latticework of models in your head.

What are the models? Well, the first rule is that you've got to have multiple models—because if you just have one or two that you're using, the nature of human psychology is such that you'll torture reality so that it fits your models, or at least you'll think it does. You become the equivalent of a chiropractor who, of course, is the great boob in medicine.