Archive for category Basic Posts

Ben Graham’s criteria, Greg Speicher’s investing ideas and Books list

a) Once in a while it is good to go back and read up what the Gurus have said. Especially Graham. Did I say ‘once in a while’? Scratch that. I think it should be all the time for value investors. Ben Graham in his last days proposed 10 criteria which he said ”seemed to be practically a foolproof way of getting results out of common stock investments with a minimum of work.”

Here are the 10 criteria that make up the new Ben Graham Formula.

1) An earnings-to-price yield at least twice the AAA bond yield.
2) A price-earnings ratio less than 40 percent of the highest price-earnings ratio the stock had over the past five years.
3) A dividend yield of at least two-thirds the AAA bond yield.
4) Stock price below two-thirds of tangible book value per share.
5) Stock price two-thirds net current asset value.
6) Total debt less than book value.
7) Current ratio greater than two.
8) Total debt less than twice “net current asset value.”
9) Earnings growth of prior ten years at least 7 percent on an annual basis.
10) Stability of growth of earnings in that no more than two declines of 5 percent or more in the prior 10 years.

Now, now – 10 criteria. ‘Too tough. I am already switching off and moving along my internet surfing exercise’, eh?. Hold on. Read on for a while. According to the Gurufocus article “The Investment Methods of Benjamin Graham”, the first five criteria in the new Graham formula were related to reward and the second five to mitigating risk of loss of capital. One needs to select a stock with at least one from the reward and one from the risk mitigation section. Very few if any stocks will pass all 10 critieria.

Interesting. This is getting slightly easier. Just (atleast) one from the top 5 and another one from the bottom 5. Very nice. If only some researcher/investor did some analysis to tell me which criteria should I pick in each category so that my investment becomes multi-fold?

Good news! Someone has already done it. (Ok, I will stop it. I am sounding like someone on the TV shopping network commercial). In a “Test of Ben Graham’s Stock selection Criteria,” Henry Oppenheimer studied whether or not a set of Ben Graham’s investing criteria actually worked. Oppenheimer discovered that two of the Ben Graham criteria, number 1 and number 6, produced exceptional returns. Oppenheimer found that the mean return during the time studied (1974-1981) was 38% vs. the S & P 500’s 14%. A remarkable out-performance.  He also found that using criteria 3 and 6 would have achieved mean annual return of  26%.

Nice. So, I’ll pick criteria 1, criteria 6, I will add my own criteria on return ratios and earnings growth etc., and ta-da, I have my list of stocks, no? Good thought process. Now think about – ‘what will happen if this list consists of only one stock?’, ‘what will happen if this list consists of 94 stocks?’. Would you invest in just one? Would you invest in 94? How would you segregate? Let me know your thought process.

Of course, Graham criteria was tested only on the US market and the results are dependent on the time period chosen. I am not aware of any such study done on the Indian markets though. If only some researcher/investor….. 🙂

b) Terrific list of 115 learnings, investing ideas and investment wisdom from the brilliant Greg Speicher (as always). A must read (and his blog is a must follow). Link here

c) I wanted to compile a list of good investment books I have read and a list I want to read this year in this post (I should probably make a tab to keep track). Please feel free to add to the list in the comments.

Already Read

i) The Intelligent Investor and Security Analysis – Ben Graham

ii) You can be a Stock Market Genius – Joel Greenblatt

iii) Common Stocks and Uncommon Profits – Phil Fisher

iv) One up on Wall Street – Peter Lynch

v) Stocks for the Long Run – Jeremy Siegel

vi) Margin of Safety – Seth Klarman

vii) Reminiscences of a stock operator – Edwin Lefevre

viii) Black Swan and Fooled by Randomness – Taleb

ix) Thinking, Fast and Sl0w – Daniel Kahnemann

x) Predictably Irrational – Dan Ariely

xi) Extraordinary popular delusions and madness of crowds

Want to read (in no particular order)

1) Essays of Warren Buffett – Lesssons for corporate america

2) The five rules for successful stock investing – Pat Dorsey

3) Influence by Robert Cialdini

4) In an uncertain world – Robert Rubin

5) Against the Gods – The remarkable story of risk

6) Seeking Wisdom by Peter Bevelin (Munger’s ideas explained)

7) Financial Shenanigans – Howard Schilit

8) Behavioral Finance and Wealth Management

9) It’s when you sell that counts – Don Cassidy

10) The Richest man in Babylon

11) Contrarian Investment Strategies – David Dreman

12) The Little book of value investing – Christopher Browne

13) Where are the customers’ yachts – Fred Schwed

14) A short history of Financial Euphoria – JK Galbriath


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Gazing into 2012 – Overvaluation or Undervaluation?

Now that everyone and his uncle are onto the predicting bandwagon in the New Year, I resolved to myself that I shall not let go this golden opportunity to pontificate and predict what might happen in 2012.

Then I said, scratch that. Let’s just see whether the broader market as a whole is undervalued or overvalued right now.

Before that, a review of basics. Over the long term, the broader market (Sensex/Nifty) will grow only at the rate of corporate profits. Corporate profits in turn grow at the rate of nominal GDP (real GDP+Inflation rate). I venture a guess (with a higher probability of being right) that Sensex/Nifty’s growth over the past 10-15 years has been commensurate with the growth in profits of their corporate constituents. Again, that is in the ‘long term’, not year-on-year. But we all want the answer to the question of ‘what about next year – where will the Sensex/Nifty go?’.

Now with this post in mind, and the current Nifty values (P/E: 16.79, P/B: 2.77, Div Yield 1.63), we can deduce that Nifty is in the Low Valuations category. Of course, no one knows how long it will take to move into the high valuations category (or get down to the Very Low valuations category), but in general, it is good sense to start dipping our toes in the broader market by buying the Nifty in parts.

All the above of course was a rehash of what we have spoken on this blog earlier. No new information in there.

In this post, I want to explore a hypothesis on the Sensex (Nifty comprises a broader market as a whole, yes. You can do this analysis for Nifty too).

Refer this post. The summary of that post was, if the Return on a stock (as defined by RoE/RoCE) was equal to the return on a post tax AAA bond yield, then that stock is said to be fairly valued at P/B=1.

For illustrative purposes, if a stock’s RoE = 20%, AAA bond yield is 10%, then the fair P/B would be RoE/AAA bond yield = 20/10 = 2. If the P/B of the stock is 4, then it is said to be over-valued and if it is 0.5, then it is said to be under-valued. (In my discussion with other investors, this seems to be broadly right except when there is pricing power, brand and scale involved).

So, what are the values for Sensex over the past 10 years? (I have taken the 10yr Govt. yield as a proxy for AAA bond yield)

Year RoE (%) Govt. yield(%) P/B Sensex
2000 16.90 11.00 3.50 5205
2001 16.10 11.70 3.00 4018
2002 17.20 8.00 2.30 3269
2003 18.00 6.00 2.20 3365
2004 21.50 5.00 3.30 6026
2005 24.30 6.50 3.70 6679
2006 23.50 7.00 4.40 9390
2007 25.40 7.50 5.20 13942
2008 23.30 7.74 6.50 20465
2009 18.80 5.35 2.50 9958
2010 16.30 7.58 4.10 17558
2011 17.60 8.00 3.70 20561
2012 (E) 18.20 8.40 3.14 15500

In the spirit of the illustration above, let’s divide RoE by the Govt. yield, and compare it to P/B.

Year RoE/Govt yield P/B Sensex
2000 1.54 3.50 5205
2001 1.38 3.00 4018
2002 2.15 2.30 3269
2003 3.00 2.20 3365
2004 4.30 3.30 6026
2005 3.74 3.70 6679
2006 3.36 4.40 9390
2007 3.39 5.20 13942
2008 3.01 6.50 20465
2009 3.51 2.50 9958
2010 2.15 4.10 17558
2011 2.20 3.70 20561
2012 (E) 2.17 3.14 15500

Over the past 10 years, data emerges which confirms our hypothesis. Whenever RoE/Govt yield was greater than the P/B, the Sensex rallied and whenever RoE/Govt. yield was lesser than P/B, the market tanked (as indicated in the initial years of this dataset) (except for the freak year of 2007-08, which as we all now know in hindsight was the peak of the bull market). Let’s plot a graph then (and due to my poor charting skills, I will have to divide RoE/Govt yield by P/B to arrive at a single figure, say x. If x is greater than 1, then the market is undervalued. If x is lesser than 1, the market is overvalued).


As per our hypothesis then, the Sensex at these levels is still overvalued. So, at what point does Sensex become undervalued? Assuming the Govt. yield remains around the 8.4-8.7 levels (and of course, I am trusting our corporates to be like a hawk on their profits and hence protect the RoE at these levels), the undervaluation in Sensex comes around the 10700-11500 range, which is around a 30% drop from these levels. Even if we give a little premium for the ‘India’ story (I don’t know if this is justified though), the Sensex becomes undervalued at 13000-13500.

And just so that we have some other data point to ensure our hypothesis is not way off, let’s see the 15 year averages for Sensex. The 15 year avg. P/E is 14.7, P/B is 2.6 and RoE is 18.8%. The current Sensex values are P/E 16.5, P/B 3.14 and RoE is 18.2%. This indicates that inspite of a similar RoE to the 15 year average, we are very much above the averages in P/E and P/B indicating overvaluation. Unless of course we ramp up the RoE dramatically in the current year and the next (which I see as a low probability scenario in the current conditions), the conclusion is the market is still overvalued.

Views/thoughts/counterpoints invited.

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Financial Statement readings and a Quick checklist

a) It never hurts to revert to basics (not once in a while, but all the time) and these blogposts from Jae Jun summarize what most of us want to know – how do we know whether the company has any durable competitive advantages? The more important question is, how can I know this easily rather than the tiresome activity of going through Annual Reports one by one (start with the ‘A’s as Warren Buffett said)  and find out firms which have unique licensing contracts (like Page Industries, Cravatex, Astral Polytechnik etc.) or are distribution kings (Asian Paints, ITC etc.). The easiest way is the quantitative way and Jae Jun takes us step by step through each of the financial statements. Must read.

i) Balance Sheet

ii) Income Statement

iii) Cash flow Statement

b) Before getting into the comprehensive checklist as stated above, I have a quick checklist to see whether I would like to further dig into the company.

i) Do I understand the industry that the company operates? (for example, I can’t understand the Oil industry for the world, and hence whenever I hear ‘check out HPCL, IOC, Chennai Petro, Panama Petro etc.’, I switch off my brain (actually, that’s my default state and it requires humungous efforts to turn it on)).

ii) Debt – I usually give a pass to companies with high debt. But what is ‘high’? Well, there are a couple of checks here. I would not analyze a company further if the debt ratio is greater than 25%. Secondly, I would check its peers in the same industry and look at their debt levels. If the comparitive debt is high, I drop analyzing the company.

iii) I am a big fan of the Du-Pont formula. In essence, Du-pont formula tries to arrive at Return on Capital Employed (RoCE) through a couple of factors. a) Capital Turnover b) Profit margins. The key is not to take a single year’s snapshot but to analyze atleast 5 years of data (10 years would be better, but ET and Moneycontrol have only 5 years of data and I am not rich enough to procure data from Religare) and check the average capital turnover and average profit margins. The best case scenario is increasing capital turnover (and hence becoming lesser capital intensive) and increasing profit margins (implying pricing power). I drop analysing the company if both are dropping continously for the past 3 years. Alternatively, I drop analyzing companies with RoCE less than 20% (Think of it this way: Let’s say I invest Rs. 10000 in a particular stock (my capital). Why would I be interested in this stock if the rate of return on this capital (and hence RoCE) is 10-12%? I can get that return by investing in a fixed deposit with almost no chance of a downside. Hence my hurdle rate is 20% – atleast double the fixed deposit rate – that doesn’t mean my rate of return on the invested stock WILL be 20%, rather I try to estimate the return to be as close to RoCE of the firm as possible – no guarantees though).

iv) Cash/Investments – What percentage of market cap is cash/investments? The reason being, higher the percentage of cash/investments in the market cap, lesser is the downside. However, this cash component requires further digging (say for example, whether investments are recoverable almost immediately or whether that percentage of cash is required as working capital due to the nature of the industry or whether there has been a recent sale of a unit of the company or whether they has been any equity offering etc.). Digging aside, just for a quick glance, this cash ratio helps immensely to weed out many companies.

v) Current ratio – If the current ratio is less than 1, the company might be operating on negative working capital. This requires further digging (sometimes customers might be paying in advance for product procurement like VST Industries, HLL, Colgate etc.) but for a quick pass, current ratio greater than 2 would be better.

vi) Cash generated from Operations – This one is from the Cash flow statement, and probably my most important figure. Check the cash flow from operations for the past 5 years. If its negative for the all the 5 years, ditch the company analysis (implication: they are losing money from their operations and are probably funding from equity/debt offerings). If I want to go one step further, I will calculate Cashflow Return on Invested capital (this is similar to RoCE, but is done with cashflow) (formula: Average cashflow from operations/Avg. Capital employed).

vii) Check whether earnings are real – Sometimes (remember Enron, Worldcom etc.) the reported earnings are not real. I perform a quick check (again, for the past 5 years) to see if the reported earnings are real. I check Operating profit against the difference between Cash generated from Operations and Depreciation (for the mathematically inclined Operating Profit ~ Cash generated from operations – Depreciation). If there is a wide difference year on year over the period of 5 yrs (or 10 yrs if you have the data), the reported earnings are not real and I stop the company analysis (Please don’t try to short the company – remember Keynes ‘the markets can be irrational longer than you can be solvent’).

viii) After all these 7 points, I’d like to see if the company is increasing its revenues year on year (for 5/10 yrs of data). Revenue being the first item on the P&L statement, there are very few avenues to manipulate this part (although, it still can be done), but as you go down the P&L, chances of manipulation increase dramatically. I am ok with a one or two year dip in revenue, but 3 continuous years of dropping revenue will screen this stock out of my radar.

These 8 points can seem like a lot of work, but believe me you when I say this – once you do this for about 5-10 companies diligently, this analysis wouldn’t take more than 15-30 minutes max after that for all other companies. There are lots of companies which pass all these 8 criteria and you need as much time as possible for further digging before investing. This quick checklist will only ensure that a) you don’t waste time digging into dud companies and b) you reduce chances of losing your money substantially (upside will come, as long as downside is taken care of).

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Nifty Strikes Back!

Well…the blogpost might not be as interesting as the title. I think I am getting influenced by Bollywood masala.

Anyway, I seem to have this strange obsession with Nifty valuations and how good an indicator it is of the broader market. Here are a couple of posts that I already posted on Nifty

a) Keeping you out of trouble

b) Nifty Valuation as an Investing Strategy

Continuing with this obsession, I have the following piece of data on Nifty –

FY Avg. P/E Avg P/B Avg Div Yield Avg. Nifty Avg Nifty EPS
2002 16.04 2.71 1.81 1050.14 65.76
2003 14.32 2.63 2.33 1198.90 83.79
2004 16.50 3.38 2.02 1731.97 107.76
2005 14.78 3.84 1.81 2217.50 149.95
2006 19.14 4.74 1.41 3308.95 172.87
2007 21.00 5.35 1.11 4485.71 213.25
2008 19.20 4.38 1.28 4449.63 232.00
2009 18.26 3.17 1.41 4013.83 219.09
2010 22.79 3.69 0.99 5417.43 237.59
2011 22.11 3.64 1.09 5749.54 260.31

With lot of talk on whether the market is overvalued or undervalued (‘experts’ swinging either way with reasons ranging from Japan earthquake to Anna Hazare’s impact on the Indian economy), I decided to let data speak for itself (mind you, 10 year data might not be statistically significant, but nevertheless). Here is the data on the Avg. Nifty Growth versus Avg. Nifty EPS growth.

FY Nifty growth (%) EPS Growth (%)
2003 14.17 27.41
2004 44.46 28.61
2005 28.03 39.15
2006 49.22 15.28
2007 35.56 23.36
2008 -0.80 8.79
2009 -9.79 -5.57
2010 34.97 8.44
2011 6.13 9.56

The data table doesn’t speak much, does it? Here is a graph to depict that data –


As the graph indicates, over a period of 10 years, Nifty growth followed EPS growth (as should be the case). For example, during the 2006-2007 phase, although EPS growth declined dramatically, Nifty refused to budge. The arrival of 2008 sparked panic and husha-busha happened.

As you can see for the current year, the EPS growth is only slightly ahead of Nifty growth indicating fair valuations. At current valuations, according to the graph, the Nifty is neither overvalued nor undervalued. So much for the noise on CNBC.

So, what are the stocks that we can invest based on this post? I have no clue.

So, what was the purpose of the post? Precisely not to trust market experts and let them swing you this way or that. Data will tell you everything you need to know, if you are willing to dig enough.

Excepting serious unforeseen circumstances (like crude shooting upto $200 and staying there for a while or another war or another calamity in India), we can expect normal growth in Corporate India results (approx. 10-12% y-o-y, assuming 8% GDP growth in real terms). Conclusion being, any serious correction from these levels (due to FIIs pulling out, unwinding of yen-carry trade or some such fantastico reasons) would result in Nifty getting undervalued and hence should be a time for accumulation of your favorite stocks.

Again, as this post suggests, once Nifty P/E goes below 20, risk-reward equation turns in your favor.

Disclaimer: This is not investing advice. It is just a rambling and an obsession I seem to have with Nifty. That is all.

P.S – I have updated the About section here. Feel free to add me on twitter.

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Delisting Norms and Plays

Sometimes, at the start of the day, you think you would write a blogpost about say X. And then, you end up writing about Y. This is exactly what happened to me today.

I was building up a blogpost (in my mind) about some of the stocks that I’d like to invest in, but only if they correct. However, reading this blogpost by Neeraj (btw, wonderful blog – must follow!) kinda moved me to write about Delisting.

Delisting, in very simple terms, is nothing but taking a firm private. That is, a particular firm (say, Gillette India for example) will buy back shares from all its public shareholders and delist (simply put, get out of) a particular stock market. That said, what are the different norms that guide delisting in the Indian Stock Market?

  • A company can be delisted only if the promoter hikes its stake to 90 per cent or acquires at least 50 per cent through a share purchase offer aimed at giving the shareholders an exit opportunity. For example, if a particular company, say 3M India, with existing promoter stake of 76% wants to delist, they need to buy back 14% from the market. Alternatively, since 24% is remaining with other shareholders, they need to repurchase atleast 12% from them to delist from the Indian Stock Market. (What happens to remaining 10% or 12% as the case may be? Well, they can tender their shares to 3M till one year from the end of repurchase at the repurchase price).
  • The offer price for delisting will be determined by calculating the average of the weekly high and low of the closing prices during the last twenty six weeks or two weeks preceding the date on which the recognized stock exchange are notified (whichever is higher). Previously, the rule was restricted to the last 26 weeks. However, minority shareholders are at a disadvantage if the promoter wants to delist when the market is about to pick up (or say, the current scenario, where the last 2 weeks avg. price is bound to be greater than the avg. of the last 26 weeks). This prices is usually the floor price (as in, the minimum price that can be offered to existing shareholders). The actual offer price for voluntary delisting will be done through a reverse book building process (a posh name for price discovery of a stock which depends on the demand levels for the stock at different price points). This will be equal to or greater than the floor price.
  • A company cannot be delisted unless three years have passed since the listing or any instruments convertible into shares are listed. For example, if there are any convertible debentures (or FCCBs), the company cannot delist.
  • The promoters need to dispatch the letter of offer to all public shareholders not later than 45 days from the date of announcement. Besides, the date of opening of the offer should not be less than 55 days from the public announcement and the offer should remain open for a minimum of three days and a maximum of five days.
  • Successful Exit Offer: A delisting process is said to successful in the following condition – Post offer, the Promoter holding should reach the higher of the following: 90% of total issued shares or  Pre offer promoter holding + 50% of the Offer Size. Otherwise the offer  shall be deemed to have failed. Back to the example of 3M India, the delisting process is said to successful if the promoter holding is 90% or 88% (in case 3M India acquires 0.5*24% of non-promoter outstanding shares).
  • In a special provision for small companies, the shares of a company with up to Rs 1 crore paid up capital could be delisted from all bourses, if shares have not been traded for one year. Besides, if a company has 300 or less public shareholders and the paid up value of these shares is not more than Rs 100 crore, the shares could be delisted.

Ok dude, enough with laws, norms and regulations. What are the companies that can delist?

Delisting is an expensive process. Therefore, it is reasonable to assume that only those companies with promoter holding greater than 80% would be wanting to delist (only 10% to buy). Here are the companies listed on the Indian stock market with promoter holding greater than 80%.


Promoter holding(%)

Astrazeneca Pharma


BOC India


Gillette India


Elantas Beck India


Kennametal India


Foseco India


Saint-Gobain Sekurit India


Fairfield Atlas


Atlas Copco


Tudor India


Ineos ABS (India)


SI Group-India


Honeywell Automation India


Blue Dart Express


Oracle Financial Ser Soft


Lotte India Corporation


Timken India


*Dilsa India also could come under this category. Neeraj’s post will explain that.

So, should I go and buy these out since they will delist at a higher price?

Not so soon.

Sebi rules are heavily loaded against the success of delisting offers since even a few key investors can block the deal if they do not approve of the exit price. There are two main challenges that companies wanting to delist face. The first is that there might not be sufficient response from investors for delisting as the price and the quantity of shares offered might not be acceptable to shareholders. Secondly, two-thirds of public shareholders need to give the management the go-ahead to delist.

Due to these reasons, the delisting of AstraZeneca Pharma and Goodyear India failed (and even Elantas Beck India, if I recollect). In AstraZeneca and Elantas Beck delisting, the floor price was way below the market price and the promoters rejected the price discovered by the reverse book building process. Delisting failed subsequently. The only two cases that I remember delisting being successful are Hindustan Inks and HSBC InvestDirect India.

(Here are the couple of posts where the wonderful Rohit Chauhan walks you through the Elantas Beck delisting (failed!) – Post 1, Post 2

Here are the couple of posts where the arbitrage guru, Ninad Kunder walks you through the HSBC InvestDirect delisting (successful!) – Post 1, Post 2)

Most of these businesses are extremely well run, with good revenue growth and capital ratios. Some of these stocks have run up in the last couple of weeks (I have no clue of the reason). Nobody knows when each of these companies will delist (if at all) and if the delisting will be successful. As is the case usually, for a concentrated portfolio, research each of these stocks thoroughly and invest in them according to your risk profile. For a diversified portfolio, you can buy small quantities of each of these stocks. They are good businesses anyway (and hence might not lose money). If a few of them delist, the portfolio will make a decent (not outsized) return.

P.S: BOC (India) had declared their intention to delist in Jan. The delisting failed. However, the stock has run up quite a lot. Any clue as to why all these stocks are running up (I mean, there is an alpha, compared to the broader market (Nifty))

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Types of Portfolios and Investors

In this blogspot, I’d first like to talk about the ever-confusing fight between the types of portfolios – concentrated vs diversified – and the type of portfolio you should maintain. I will then move on to explain three types of investor archetypes (analyst, trader and actuary). The objective, at the end of this blogpost is to evaluate where our portfolios stand and where we stand vis-à-vis these investor archetypes. How does that help, you ask? Well, knowing the type of investor you are will more or less drive you towards one or the other type of portfolio which has the highest probability to maximise your wealth.


Concentrated vs Diversified

A concentrated portfolio is a portfolio which has only a few stocks in it (not more than 10-15 stocks. Ideally, it is less than 10). The idea behind this kind of portfolio is that very few investing decisions need to taken, but the returns would be pheomenal. The biggest proponent of this type of portfolio is Warren Buffett. People seem to advise that concentrated portfolio is the portfolio to maximize wealth. My opinion would be, if you are not the type of investor who can dedicate a lot of time to study ‘Investing’, it is also the kind of portfolio which might lead to a lot of losses.

A diversified portfolio is a portfolio which has a lot of stocks in it (>15, more like 30. Walter Schloss, a famous value investor has over 100 stocks). The idea behind a diversified portfolio is that it protects your portfolio even if 4-5 stock investments go south, as they form a small percentage of your total portfolio. An index fund is one of the widely used diversified portfolio investments that you can have.


Analyst vs Trader vs Actuary

Each of these types of investors take an entirely different approach to the market, depending on his/her investment personality.

The Analyst: An investor who carefully thinks through all implications of an investment before putting even a single rupee behind a stock. This type of investor would pore through business valuations, business reports, cash flow statements, balance sheets etc. before taking a call whether to invest in a stock or not. Warren Buffett personifies this type of investor.

The Trader: An investor who invests/doesn’t invest depending on ‘feel of the market’. He trusts his gut feel and goes with the flow of the market, often spotting discrepancies which can make him profits. George Soros epitomizes this type of investor. Many investors also try to be ‘the trader’ getting in and out of markets, often with disastrous results. They don’t realize that there is a huge amount of education, discipline and competence to make money as a trader. The percentage of successful traders worldwide would ascertain to this fact.

The Actuary: Early in my investing career (which is not too long!), I thought there were only two types of investors – the analyst and the trader. However, Nassim Taleb’s book ‘Fooled by Randomness’ introduced me to this third type of investor – the actuary. This type of investor deals with probabilities, much like an insurance company. The Actuary investor is focused on the overall outcome rather than any single event. For example, the Actuary investor is willing to suffer hundreds of tiny losses while waiting for his next profitable trade which will repay his losses many times over. (Usually, this type of investor buys/sell a lot of severly-out-of-money calls/puts (which cost little) and in a significant event (like Lehman’s bankruptcy), this type of call/put (options) will have a lot of value, thereby covering all his prior loss-investments).

So, which type of investor are you? Are you none of these three? Well, Graham has an explanation.

Graham, in his investment classic ‘The Intelligent Investor’ clearly specified the differentiation between an ‘Enterprising Investor’ and a ‘Defensive Investor’ and hence the type of portfolio you need to maintain (concentrated vs diversified). An Enterprising investor is one  who can spend a lot of time studying ‘Investing’ (and not the one who is young and ‘100-your age into equities’ philosophy). On the other hand, if you can’t spend a lot of time studying investing, most investors would be better off investing into index funds (the summary of Graham’s definition of a Defensive Investor’).

Therefore, if you are an Enterprising investor, try to create a concentrated portfolio (you fall under ‘the Analyst’ category). Else, stick to a diversified portfolio (index funds or diversified equity funds). Very few us have the competence and knowledge to be successful at trading/actuary. If you do decide to go on the trader/actuary path, please realize that there is a lot more education, discipline and time required to be successful in either of these two disciplines than being an ‘Analyst’.

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Indian Stock Market: Keeping you out of trouble

As I was going through my archives of good articles on investing (value investing in particular), I came across this article by Prof. Bakshi which might throw a little insight into what we can expect in the markets at the current level.

Here’s the article –

The important excerpt –

Resolution 1: You will avoid equities when they become historically expensive
Recent research done by my firm shows just how dangerous it is to remain invested in an expensive market. Since NSE started, every time when Nifty’s Price/Earnings ratio exceeded 22, the average return from Indian equities over the subsequent three years became negative — see accompanying table.

Nifty’s PE          Three year returns%

Less than 14            152.10%
14 –16                      112.36.%
16 – 18                     79.14%
18 – 20                     51.18%
20 – 22                     21.18%
22 – 24                    -14.98%
24 – 26                    -32.92%
26 – 28                    -36.60%
28 – 30                    -40.17%

You can look up the current P/E multiple of Nifty from NSE’s website — see As I write this, I notice that Nifty’s current P/E multiple is 13.49 and while you read this, you may wonder why am I warning you about expensive bull markets now? The reason is simple. You won’t listen to my advice in a bull market.

Every bull market produces large profits for investors which gives them a high. This euphoric feeling is identical in biological terms to the feeling a cocaine addict gets after consuming a few grams
of the substance. (Brain scans of addicts minutes after they get a shot of cocaine, and those of stock market investors who just made a large sum of money are identical.)

It just feels so good that no addict ever wants to stop the feeling of euphoria. It is exactly at this time, when addicts become suggestible. They believe almost anything that will allow them to continue experiencing euphoria. Walter Bagehot, the famous British essayist once said, “All people are most credulous when they are most happy.” He was right. When the next bull market comes, you will find plenty of “experts” who will tell you to buy stocks and to remain invested, and to ignore lessons from history because “this time its different.” You must resolve today that you will ignore such advise. You will avoid investing, and remaining invested in equities when they become historically expensive.Remember this: History tells us that when markets fall, almost every stock falls too. Sure there are cheap things to buy in a bull market. They are traps. You will avoid them because you know that cheap things will become cheaper after a major market decline.

By ignoring the table and my advice, you will not prove Benjamin Disraeli right when he wrote:
“What we learn from history, is that we don’t learn from history.

So, what are our latest Nifty P/E figures?

Date P/E P/B Div Yield
04-Feb-2011 20.67 3.40 1.15

(If you haven’t gone through this post before, you should right away!)

There are about 7 companies in the Sensex (and quite a few in the Nifty) who are yet to declare their Q3 results, including companies like Tata motors, Unitech, Tata Steel, M&M among others. Let’s assume that all these companies churn out good numbers (just like all others have). On that assumption, we can safely estimate that Nifty at these levels (Nifty is at 5395 as of today) Nifty P/E is 20, or slightly below 20.

Synthesizing the two data points, what do we derive? Prof. Sanjay Bakshi’s firm’s calculations indicate that Nifty P/E at 18-20 levels have average three year returns at 51.18%. Nifty P/E is at 20 (or slightly below that)

Is there a further chance of correction from here? (If Nifty does indeed go to, let’s say 5100 from here, Nifty P/E will be around 18.5). I have absolutely no clue whether it is going to go down or going to go up. However, are the odds in making a decent (not outsized) return in our favor from these levels? A little more correction and I certainly think the odds tilt in our favor. Of course, I don’t advocate a lumpsum investment in these volatile times (If the market corrects after a lumpsum investment, recouping the loss is much tougher. Check out this wonderful video by Deepak Shenoy which illustrates the logic). A SIP (or an increased SIP if you already have one) would put the momentum behind your returns.

Disclaimer: The view is on the broader market and not on any particular stock. Again, please do your own research before investing.

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Indian Stock markets: Special Situations–A Starter Post

Everyone talks about Equity Investing, Debt Investing, Mutual Fund Investing and of course, No investing. But what about investing in Special situations? What exactly are these special situations?

This is a starter post where I try to compile some basics about Special Situations (am trying to learn more on these situations with virtual money and will compile as and when I have some learnings).

Special situations are usually (and mostly) one-off opportunities in the stock market. These situations tend to exploit the arbitrage opportunity between the current market price is versus a specific target price. Special situations arise because of the following reasons (not exhaustive) –

a) Takeover (Acquisitions)

b) Share Buyback

c) Rights/Bonus/Warrants issue

d) De-listing

The most recent examples of Special Situations are

a) iGate’s takeover offer of Patni – iGate wanted to acquire a 63% stake in Patni Computer. Due to some SEBI regulations and provisions, iGate has made a 20% mandatory open offer to buy Patni’s shares at Rs. 503.50 (there is a also a regulation for the floor price as explained below). The current market price of Patni as of today is Rs. 463. The Rs. 50 difference between the offer price and the current market price is due to certain risks as explained below.


b) Siemens AG International’s increase of stake in Siemens India – Siemens AG International wants to delist Siemens India. Delisting is a process where a particular stock will no longer trade in the market. Siemens International currently holds 55.18% in Siemens India and wants to increase its stake to 75% (increase of 19.82%). Siemens India was trading at Rs. 727/- per share before this deal was announced. However, the open offer to increase the stake was for Rs. 930/- per share. The current market price of Siemens India is Rs. 848 (again, the Rs. 100 difference is due to various risks outlined below).

Before we discuss risks, how does (for example) an acquirer determine the price? Well, the offer price doesn’t have any ceiling and the acquirer can offer as much money it thinks the target company is worth. However, there is a regulation for the floor price.

The price at which the tender offer must be made cannot be less than the maximum of two prices. Two of these prices pertain to the past. The minimum tender offer price has to be more than the maximum of:

i) the average stock price during 26 weeks before the announcement of the  acquisition and

ii) the average stock price during 2 weeks before the announcement of the  acquisition;

We move on to risks. For example, inspite of knowing the offer price is Rs. 503/- per share in case of Patni and Rs. 930/- in case of Siemens, why are the current prices of Patni and Siemens Rs. 463/ (a discount of Rs. 40) and Rs. 848 (a discount of Rs. 80/-) respectively.

Here, we take the help of Rohit Chauhan (and Ninad Kunder)’s explanation (I have modified their post slightly to make it more generic, instead of a specific example on which their post was based on) –

In any delisting opportunity, the same framework can broadly be applied across other special opportunities, there are 3 risk points in the transaction –

1) Time Risk
2) Price Risk
3) Deal Risk

Let me address each of these risks –

1) Time Risk

In any arbitrage opportunity even though the deal might go thru and at the price that we had defined, there could always be time delay involved in the deal which will shave off potential returns. This is especially true in the Indian context when there are court approvals required in certain special situation opportunities like mergers.

2) Price Risk

There were 2-3 ways to handle price risk in this transaction. This of course would be different for every transaction.

a) Valuation – Ascertain the fundamentals of the company and evaluate the fair (intrinsic value) of the company.

b) Ability / Inclination of the parent/acquiring company – How keen are the parents/acquiring company keen on completing increasing the stake/acquisition. (We can typically look at their Management’s history and get a pulse of their intentions vs action)

c) Expectation of market participants – What is the general opinion of the market participants. Specifically, can we look at any FIIs/MFs action on this stock/opportunity.

3) Deal Risk

Which brings us to the most imp variable in this transaction. Will this deal go through? How concentrated is the shareholding structure to make this deal a success? (a dispersed shareholding structure will lead to difficulties in securing a consensus)? What percentage would tender their offers? etc are some of the questions that need to be asked in Deal risk.

Prof. Sanjay Bakshi does talk about setting aside certain percentage of portfolio towards these Special Situations. In fact, he goes on to say (I can’t find the right post on his blog) that we need to be more aggressive in allocating funds to this portfolio when the market is overpriced, and value opportunities are few and far in between (times like now, I guess). Of course, we need to take into account the skill difference before being very aggressive on this portfolio 🙂 .

For investors who would like to take part in Special Situation opportunities, but can’t due to various other time commitments, there are Special Situation mutual funds that you might want to look at. Specifically,

a) Fidelity India Special Situations Fund

b) Birla Special Situations Fund

c) HSBC Unique Opportunities Fund and

d) ICICI Prudential Discovery Fund

The returns on these funds might not look very attractive during a bull market (where index and equity diversified funds might pound them), these might churn out better returns during the peak of the bull market and the bear markets than other funds (Of course, the usual disclaimer applies. Please do your own research before investing in any of these funds).

Update: As usual, Prof. Sanjay Bakshi explains different situations even more clearly (and this was way back in 1999) – Enjoy –

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Nifty BeES vs Index Funds–Analysis (including brokerage costs)

Nifty BeES was the first ETF (Exchange Traded Fund) in India. The investment objective of Nifty BeES is to provide investment returns that, before expenses, closely correspond to the total returns of securities as represented by the S&P CNX Nifty Index. Some of the features of Nifty BeES are –

a) One unit of Nifty BeES is approximately 1/10th of the S&P CNX Nifty Index

b) Nifty BeES is listed and traded on the NSE-Capital market segment and is settled in the rolling segment on T+2 basis

c) Nifty BeES can be settled only in electronic (demat) form.

For the ETF uninitiated, here is a brief note on Mutual Funds vs ETFs –

Here is a note on Nifty BeES itself –

The objective of this blogpost is to compare returns of Nifty BeES vs Index funds. Index funds can be based on Sensex or Nifty. For the purpose of this blogpost, Index funds mean Index funds based on Nifty.

About a year ago, I researched on the Internet quite extensively on the returns of SIPing in Nifty BeES versus Index funds. Conceptually, both are one and the same – that is, they invest in Nifty, which consist of the same set of 50 stocks. Ergo, the returns also have to be very similar, if not the same.

I was wrong.

Before I delve further, let me briefly introduce the concepts of Expense Ratio and Tracking Error.

Expense Ratio: Simply put, expense ratio is the cost associated with running a particular fund. It includes the management fee and operating expenses like the registrar and transfer agent fee, audit fee, custodian fee, marketing and distribution fee.  Usually, this cost is annualized and you would notice ‘Expense Ratio’ column somewhere way below in the Offer document. The NAV of each of the funds that we see in newspapers is after deducting this expense. Usually, expense ratios of equity funds are greater than debt funds.

Tracking Error: Simply put, Tracking error is the standard deviation of the returns differential between the fund and its benchmark. A fund that has a high tracking error is not expected to follow the benchmark closely and thereby might result in lower returns than the benchmark.

Coming back to our Nifty BeES vs Index funds argument, I present to you a table compiled by Ajay Shah (wonderful blog – must follow!) sometime back (slightly dated, July 2008. One Mint also compiled this data as recent as May 2010 and I don’t see much difference, do you?) –


Scheme Tracking error (%) Expenses (%)
Nifty BeES 0.19 0.5
Franklin India Index Fund – NSE Nifty Plan – Growth 0.42 1
Franklin India Index Tax Fund 0.58 1.5
UTI SUNDER 0.59 0.5
Tata Index Fund – Nifty Plan – Option A 0.63 1.5
UTI Nifty Fund – Growth 0.7 1.21
PRINCIPAL Index Fund – Growth 0.86 0.75
ICICI Prudential Index Fund 1.1 1.25
SBI Magnum Index Fund – Growth 1.26 1.5
Canara Robeco Nifty Index – Growth 1.45 ?
Birla Sun Life Index Fund – Growth 1.76 1.51
LIC MF Index Fund – Nifty Plan – Growth 1.99 1.5
HDFC Index Fund – Nifty Plan 2.55 1.5


We see that the index funds have a pretty significant tracking error compared to the Nifty BeES along with almost double (and sometimes triple) the expenses [double whammy – greater tracking error as well as more expenses!]

Based on the above data, it is pretty safe to conclude that if the objective is to mimic Nifty returns, your best bet would be to invest in Nifty BeES.

However, there is another nuance to this whole investing in Nifty BeES vs Index funds (and the point of this post – took too long, eh?). What about brokerage charges? Do they impact our returns? Especially when we SIP.

Mutual Funds have been forbidden (from August 2009, I think) to charge any entry loads on any of their funds. Almost all index funds do not have an entry load and have an exit load of 1% only if you exit the fund before 1 year of that investment. Technically, if you are a long term investor (say > 1 year) and are SIPing into an index fund, there is no expense other than the Expense ratio (which varies from 0.5%-1.5%).

SIPing into Nifty BeES however would involve brokerage charges. I use Sharekhan and they charge 0.25% on every purchase of Nifty BeES (or any other stock for that matter) and 0.25% on every sell. So, when you SIP, you are technically paying 0.25% every month, along with an expense ratio of 0.5% every year and 0.25% again when you sell.

How do the returns stand now? Let me illustrate with an example. We assume a simple scenario where there has been no growth in Nifty returns (or 15% growth. We assume there is zero tracking error). How would Nifty BeES vs Index funds stack up?

Period Nifty BeES Actual amount invested after brokerage of 0.25% Index funds Actual amount invested after entry load of 0%
1 10000 9975 10000 10000
2 10000 9975 10000 10000
3 10000 9975 10000 10000
4 10000 9975 10000 10000
5 10000 9975 10000 10000
6 10000 9975 10000 10000
7 10000 9975 10000 10000
8 10000 9975 10000 10000
9 10000 9975 10000 10000
10 10000 9975 10000 10000
11 10000 9975 10000 10000
12 10000 9975 10000 10000
Total Amount Invested   119700   120000
Expense ratio 0.50% 598.5 1% 1200
Brokerage on selling after 1 yr 0.25% 299.25 0% 0
Total returns   118802.25   118800
Difference in amount in returns between Nifty BeES and Index funds 2.25      


As you can see from the table, the difference is just Rs. 2.25/- on amount of Rs. 1,20,000. A miniscule percentage difference between investing in Nifty BeES and Index funds. Conclusion? The expense ratios of Index funds, although slightly larger is not directly comparable to the expense ratio of Nifty BeES.

However, Tracking error seems to be a huge problem and you see the difference in returns below for some funds which have been in the market for > 5 years (apart from tracking error, Index funds usually have 5% of their portfolio in cash to service redemptions and hence the returns might not exactly mimic Nifty and hence the difference in returns) –

Fund Name Launch Date Returns(%) Expense ratio (%)
Canara Robeco Nifty Index Oct-04 7.38 1
HDFC Index Nifty Jul-02 6.6 1
Nifty Benchmark ETS Dec-01 8.29 0.5


Therefore, investing in a Nifty ETF is much better (atleast for the additional 1-2% return) than any Index funds available in the market, even if you SIP it, brokerage costs included. I don’t see a reason why you need to invest in an Index fund.

A similar analysis can be done for Liquid BeES vs a Savings account –


Column1 Liquid BeES Savings A/C
Amount Invested 10000 10000
Avg. return over a 5 year period (from 5% 3.50%
Interest earned 500 350
Brokerage costs (buy and sell) 50 0
Total amount 10450 10350
Difference 100  


Investing in a Liquid BeES is much better than keeping your money idle in a Savings A/c (even after brokerage of buying and selling). Some brokerages don’t charge (Sharekhan does!) while you invest in Liquid BeES. Even better returns.

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Investing Strategy–Nifty Valuations

One of the most interesting strategies that I have come across is an investing strategy based on Nifty valuations. Valuations parameters we all understand – P/E, P/B and Dividend Yield.

I had read about investing strategy based on a single Nifty parameter, namely P/E. However, Momentum Signal had done a post a while ago (in Feb 2010) which included three parameters P/E, P/B and Div. Yield. I don’t see a reason why I need to repeat the entire analysis again except for linking to the relevant post  here –

Nifty Fundas –

The summary of that post is given below –


S&P Nifty Index P/E ratio P/B ratio Div Yield%
Extreme High Valuations 25 to 28 5.5 to 7.0 0.5 to 0.8
Very High Valuations 23 to 25 4.5 to 5.5 0.8 to 1.0
High Valuations 21 to 23 4.0 to 4.5 1.0 to 1.25
Long term Average 17.87 3.7 1.52
Low Valuations 15 to 17 3.0 to 3.5 1.75 to 2.0
Very Low Valuations 13 to 15 2.5 to 3.0 2.0 to 3.0
Extreme Low Valuations 11 to 13 2.0 to 2.5 3.0 to 3.5


The table (the blogpost is more illustrative with graphs) indicates when valuations might be rich and when valuations might be cheap depending on Nifty’s P/E, P/B and Div. Yield ratio.

Essentially, valuations are rich whenever Nifty P/E > 20 and/or Nifty P/B > 4 and/or Nifty Div. Yield% < 1.

So, what are the current figures based on some recent corrections in the market?

NSE data suggests (Nifty at 5654) –


Date P/E P/B Div Yield
14-Jan-2011 22.50 3.57 1.10


Correlating the data between the two tables, we derive that Nifty is richly valued in terms of P/E, not so much on P/B and very close to rich valuations on Dividend Yield.

My personal read into the situation, on a consolidated basis is that even after the recent correction, Nifty is richly valued and I would be wary of investing (except in few pockets) at current levels too.

When I hear analysts and CNBC talking about Sensex levels at 25k in 2011, 40k sometime in the future etc etc., I try to calculate what kind of earnings Corporate India needs to come up with to justify such levels of Sensex. The percentage increase is staggering (even considering Analyst’s speak of India’s GDP growth is 10% and will be 10% for the foreseeable future). Even if India’s GDP growth is at those levels, a EPS growth of 40% y-o-y is remote and hence Sensex at those levels in 2011/2012 look distant  (unless of course, the market goes really irrational like the 1999-2000 boom).

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