Using leverage in a bull-market

In a bull market, a lot of people get enticed to use leverage to enhance their portfolio returns. Leverage comes in many forms, loans using existing stock as collateral, top-ups on home loans and using them to buy stocks, punting on stock futures etc. 

“Unquestionably, some people have become very rich through the use of borrowed money. However, that’s also been a way to get very poor. When leverage works, it magnifies your gains. Your spouse thinks you’re clever, and your neighbours get envious.

But leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices. And as well learned in third grade – and some relearned in 2008 – any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all too often produces zeroes, even when it is employed by very smart people.” - Warren Buffett, Berkshire Annual Report, 2010

In this context, let me recount the story of Rick Guerin - Buffett's contemporary and acknowledged by him as "Superinvestor of Grahamville". Guerin lost significantly and dropped out of the investment landscape after the steep crash of 1974 when he received margin calls because he was highly levered. He had to liquidate some of his best investments including Berkshire Hathaway stock. Today, everyone knows of Buffett and Munger but hardly anyone has heard of Guerin. (In fact, to be honest I was also not aware of Guerin's history before reading about it in one of Mohnish Pabrai's interviews).

As Buffett said in the quote above some people can become rich but in an alternate history (Taleb's definition) of events can become a pauper. So, keep away from leverage.

Don't Build Noah's Ark

We have been witnessing a very strong market sentiment that started with the run up to the general elections and then continued with the once-in-thirty-years win of a single majority by any political party in India. With a pro-reform mindset, the BJP government led by Narendra Modi has promised "acche din" to the people.

I have been bullish on the Indian market since last year and believe that this is just the beginning of a bull market in India. And it has a long way to go. I hear a lot of market players talking about steep corrections in the near future. As long as there is such healthy scepticism in the market, there is unlikely to be any major reversal. Also, intermediate corrections are healthy in a bull market and usually gives the opportunity to investors to get into good stocks of their choice.

A bull-market brings with its in-built  challenges for investors. Sell side analysts and brokerages start aggressively pushing their stock recommendations. Investors get such "multibagger ideas" daily in the inbox, whatsapp, facebook and other such groups & forums. Suddenly, "investment experts" come out of the woodwork and start making recommendations and touting up their "fantastic past records". And people get lured by the easy gains in the market and start "collecting" stocks. Their portfolio starts looking like what I call the Noah's Ark - having two of everything!! Stop. Think. And then only buy those companies which as an investor you are comfortable with; those stocks which are within your circle of competence.

And always remember sometimes the existing stocks in your portfolio and are as good (if not better) than the latest hot stock you are pursuing. So, focus on businesses, moderate return expectations (most errors occur when people try to chase incrementally higher returns) and cut out the noise.

Book Review - The Thoughtful Investor by Basant Maheswari

Over the last one month, other than the annual reports and other research reports, I have been busy reading two books, i) The Thoughtful Investor and ii) The Manual of Ideas. Today I am sharing my thoughts on the first one. I will post the review of the second book in a short while.

Firstly, The Thoughtful Investor is not a mere book on investment. It is more a description of an investment journey that the author Basant Maheshwari has undertaken. A lot of retail and HNI investors in India have probably visited the website/forum he started and moderates, theequitydesk.com, better known as TED amongst followers. 

The first thing that stands out is the exhaustive contents of the book. Very few things that a serious investor needs to thing about is left unaddressed in the book. It covers the psychological aspects of becoming a good investor, the pains of holding too long and the use and misuse of leverage. It gives a reasonable overview of fundamental analysis - though you will need to know the basics as that is not really covered here (and that is how it should be - this book is not really for beginners). It also has a very nice section on portfolio construction - a facet I have seen only very senior and serious investors focussing on, and something which is perhaps the most critical for overall returns than individual stock selection. The book ends with a checklist that can be picked up as-is or modified based on your individual experiences.

What is refreshing about the book is that it captures the passion of an equity investor through the struggles of making and losing money. There are very few good books on experiences of individual investors, specially Indian, and this is definitely one of them. 

The only improvement area for the book that I felt could have been better was the editing. There are quite a few typos and grammatical errors, which at times take away from the pleasure of reading a well-written book.

Every good book should provide atleast one takeaway. The main takeaway underlying theme that I felt coming out throughout was of making enough absolute returns to become financially free. I have heard a few folks complaining about the price of the book (it is priced at 999 rupees) and asking whether it is really worth that price. To me, if you are a serious investor investing in Indian equities, you should read the book, if for nothing else, than to just drill the key takeaway from the book in your heads. Being financially free is definitely worth much much more than the 999 rupees you pay.

Portfolio Update

Being a value investor is fun!! It gives one a leeway for being lazy and inactive while putting on a facade of being intellectually stimulated. 

The above is a disclaimer for delaying updating my portfolio at the end of July and doing it a month late :-)

The updated portfolio is on the Portfolio page of the blog.

The performance of the portfolio has been extremely satisfying to me. Luck does indeed catch up sometimes. For the first half of the year:
Portfolio - 89.3% 
Sensex - 21% 
HDFC Equity Fund - 40% 

HDFC Equity Fund is my benchmark mutal fund. My thesis is that if one can't perform better than a good fund over a period of time, then better invest in the fund and pursue other passions.

This time the returns were distributed and came from many of the portfolio stocks - Mayur contributed the most with a stellar rise, taking the price to an uncomfortable territory. Astral also has gone to a level which is making me uncomfortable, but not yet to the point of selling. Finolex Cables, Balkrishna, Ajanta, Alembic, PI Industries all contributed their fair share in the performance.

In the first half, I added Bajaj Finance, PTC India Financial Services, Kitex Garments and Selan Exploration and booked profits from Page & Atul Auto. 

I believe Bajaj Finance is on a very strong wicket and will do very well for a long period and is available at reasonable valuations (more I suspect due to the fact that they did not get a banking license). PTC Finance is also doing extremely well and has good visibility of earnings in the short and medium term though longer term is hazy. I need to do more due diligence on Kitex and Selan. 

Currently, I am relooking at some of my old favourites like Sintex, Shriram Transport and some others like Persistent Systems, Symphony Coolers to see if they fit into the portfolio.

In my opinion, we have just started a bull-market and we have a long, long way to go. So, good stock selection and portfolio weightage can give outsized returns even from these levels.

Happy Investing!

Stock Idea - Bajaj Finance

Bajaj Finance Ltd (BFL) (CMP - 2293, NSE:BAJFINANCE) is a financial lending company from the Rahul Bajaj group. The company is involved in multiple areas of lending in 3 verticals - retail (consumer), SME & Commercial with a split of 40:50:10 as of now. The company is looking to increase the commercial loan book to 20%.

The NBFC sector is growing consistently. Consumer finance is growing very fast. This is reflected in the growth of the company in the past as well as anecdotal experience at all consumer electronics stores and auto dealerships. With more and more consumption-driven culture and higher disposable incomes (specially in urban centers with double income families), consumer loans is likely to grow well for a very long period of time. Indian penetration of consumer loans / GDP is 11%, whereas it is 20% for China, 23% for Brazil, 54% for Germany and 99% for US. Even at the lower end of the spectrum, there is an opportunity to double the loan/GDP ratio.

In 2 wheeler finance, BFL has a 18% market share. It is the largest 2-wheeler lender in India focused on semi-urban & rural markets. Currently contributes to 30% of Bajaj Auto's 2 domestic wheeler sales. 

It has a 15% market share in consumer electronics finance in India and is the largest in India.

The market is very fragmented with other NBFCs and banks in the fray. BFL has a competitive advantage of being from the Bajaj group so will get a first shot at customers buying Bajaj 2-wheelers.

A lot of banks & NBFCs are in the space. Main competitor is HDFC Bank, followed by other NBFCs like Sundaram Finance, Shriram City Union etc. 

BFL has two major advantages - i) it is already entrenched in Bajaj Auto dealerships and gets an advantage in sourcing customers in the 2-wheeler business and ii) it is well entrenched in the large malls / electronic stores/chains for consumer electronics loans. It is not going to be easy to replicate the reach by others. 

• In FY2014, BFL’s total income was up 31% to 4,073 crore
• Profit before tax (PBT) increased by 25% to 1,091 crore
• Profit after tax (PAT) was up 22% to 719 crore
• BFL’s assets under management rose by 37% to 24,061 crore
• Loan deployment had risen by 34% to 26,024 crore. 
• Consumer lending grew by 36%
• Small and medium enterprise (SME) lending grew by 52%. 
• Commercial lending de–grew by 11% due to the company’s cautious stance on the precarious state of India’s infrastructure sector
• Capital adequacy as on 31 March 2014 was 19.14%, is well above the RBI norms
• BFL’s net NPAs were at 0.28% of total assets
• Present in 117 cities of India, BFL continued to be the largest consumer durables lender in country — and helped finance 15% of all consumer electronics sold in the year. 

The stock is available at a PE of 15 and a P/B of 2.7 which seems reasonable in an environment where all stocks have been bid up aggressively. BFL has good consistent profit growth of 87% over 5 years and a sales growth of 47% over the same duration, which has been rather difficult for the Indian economy. With any improvement in the economy and reduction of interest rates, BFL is well poised to outperform the industry and provide good growth over the longer term.

Note:- I am invested in the stock and thus have a vested interest. Please consult your financial advisor or do your own due diligence before investing.

Update on Finolex Cables

The Economic Times reports that the IT ministry is looking to connect 50,000 gram panchayats through non optical fiber network this year followed by 2L gram panchayats in next 2 years. 

Finolex Cables, which operates and is the leader in this space and which I have written about in my earlier posts (read them here and here) continues to do well. 

With an IT savvy PM, I expect the broadband rollout plan to be aggressively followed through. The power cable business is also likely to pickup once the industrial cycle picks up.

I continue to be bullish and hold my previous opinion of the price target of between 240-360 and a FY15 EPS target of 16-18.

CMP - 199.

End of the "hope rally". Focus back on fundamentals.

Last month, India may have witnessed a watershed moment in its history. The reason I say may, is because, only time will tell if it really was such a moment, or it was another great opportunity lost. Expectedly the markets rallied as the results poured in. All the common reasons were offered - Modi has a single majority so he can fix all the problems of the economy, India will push forward with its reform agenda, industrialization and fix governance.

So, the "easy" money based on the hope of "acche din" played out. During the hope rally, everything that a "India development" story went up - mining, power, infra, cement - almost everything. A lot of the PE re-rating for mid caps took place. It removed the glaring cheapness of most of the "good" midcaps. 

With the obvious cheap stocks now becoming well priced, we are back to the grind of making money on the fundamental basis. So, it is critical to focus back on individual companies and how they can perform and grow in the next few years. 

It is obvious that there are no easy answers (from Modi or anyone) of India's challenges. Inflation is stubbornly high and so are subsidies. Any reduction in subsidies (oil, LPG, fertilizers, rail fare etc) without a commensurate increase in efficiency is likely to increase inflation even higher. There is no magic wand that the PM has to fix the Indian economy. Once people start realizing that, markets are likely to correct or stagnate at the very least. And provide an opportunity for patient investors to buy into. The trick is to be prepared with a buy list and cash when (& if) that happens.