I have a lot of time on my hands these days ! With the market at the current levels, there is not much to buy. I am in the analysis/intellectual gymnastics mode these days, analyzing companies and thinking of odd ball stuff. In continuation of that spirit, I decided to write a post on the above topic. The advantage of a blog is that you can write anything you like. It’s a different issue if others would read it or just skip it.
This is a very contentious topic. I am not discussing about real estate as an investment. The post is only about a primary home – the home in which you are likely to stay.
I have also found myself in a minority of 1 when I discuss this topic with any friends or relatives. Lets try to look at the financial aspect of this topic first and then look at the non financial or emotional aspects of buying a house.
I can summarize a few ‘accepted’ financial truths in buying a house as follows
1. It is better to buy than rent. Money paid via rent is a sunk amount, whereas if one buys and pays an EMI, one is ‘investing’
2. A house always appreciates in the long term. As a result it is a smart decision to ‘invest’ in a house.
3. A house is a hard asset in comparison to financial assets which are just paper assets. So in the interest of diversification, one should buy a house.
Debunking some myths
The problem with accepted truths is that no one wants to think about them or question them. Everyone just accepts them as absolute truths such as ‘The sun rises in the east’. I have found it easier to discuss and argue about other topics about which people don’t think they know as much (such as stocks), in comparison to real estate, where everyone thinks they are a born guru just because they bought an apartment in the last 5 years which has appreciated by x%.
Let look at each point in detail now
Buy v/s rent
This is the most irritating argument I have heard on this topic. Everyone claims this as the truth, but I doubt if most would have actually done the calculations on a piece of paper ( I have !! yes, you cant get any more geeky than this :))
Let take an example and some cash flow numbers. Please don’t argue with me on exact numbers as they may vary a bit, but the overall conclusion will still hold. Let say you buy an apartment for 1000000 (10 lacs) for an easy round number.
A typical EMI for a 20 year loan @ 9-10%, would be in the range of 9000-10000 give or take. Additional costs of owning a house would be maintenance costs (repairs, painting etc), association fees and taxes. These are sunk cost which you need to spend to maintain the asset and no one will re-imburse you these cost when you sell the asset
EMI approximately = 11-12% of asset value. lets assume 5-6% of EMI is interest payment and rest goes to principal(varies during the tenure, but approximately 50% of the EMI is rent over the life of the loan)
Association Fees = 1% of value
Maintenance and upkeep = 1% or more
Taxes = 1% or more
Cost/ month of owning = EMI + maintenance cost + association fee + taxes
So total cash outflow = 5-6%+1+1+1= 8-9% of asset value (without tax benefit). If one consider 30% tax benefit then the number comes to 6-7% (you can do the math)
This component of your cash flow is not adding to the asset. Interest paid or association fees don’t add to the asset. Maintenance cost is equivalent to a depreciation expense. Only the principal paid adds to the equity.
If one rents a house, one would pay the rent (typically 5-6% of asset value) and association fees.
Rental cost/month = 5-6% +1% = 6-7% of asset value
Now you can play with the numbers as you like as I have not included some numbers such as utilities which are same whether you rent or buy. In addition we can get into all kinds of variations such as renting a room or doing something of such sort, but in the end if you buy a home just large enough to live, a lot of these variations may not be feasible.
The conclusion is this – The cash outflow on an owned asset which does not add to the asset (build equity by reducing the loan principal) is quite close the total rental and other associated cash flows of renting a house.
The difference in the numbers for rent v/s buy will vary by a bit if you modify some of the EMI and rental assumptions. However the real estate market is also reasonably efficient in the long run and these numbers tend to converge over a period of time (why ? ..thats a different post)
Real estate always appreciates in the long run
Says who ? can you claim it based on some data or are you just pulling that out of your ***** ? The long term (20-30yr) data for real estate across countries and time period has shown that real estate typically provides a 1-2% excess return over inflation.
Please don’t give me this type of example to prove your point
My ________ (fill uncle, nephew etc) bought this apartment/ land in a god forsaken place and then suddenly a new company came up and the real estate doubled overnight. It is the equivalent of saying that Infosys has gone up by 100 times in the last 20 years and hence all stocks should give that returns.
Finally long run does not mean, that if you buy an over priced asset, you will not lose money. If you don’t believe it please read about the investors in the US or in japan (in the 90s).
The key conclusion is this – If you overpay for an asset, you are toast !
House is a hard asset
That does not mean anything. If one can touch or feel a house, it does not mean that it is better than any other asset from a financial standpoint. An asset is attractive if it gives a high risk adjusted return, irrespective of its form.
For example – gold was always considered a hard asset and hence highly valued in India (not in other countries). In spite of this classification, gold returned close to nothing from 1970s till 2003. In the recent years, investors can now buy gold ETF and inspite of being a paper asset they have made good returns. The point is that the physical form of an asset does not change the characteristics of the investment. By the way, I am not justifying gold as an investment.
So should one not buy a house ?
No, the above analysis is not to arrive at that conclusion. On the contrary, one should buy a house, but for a very different set of reasons. I would say our parents got it right on this count. I would list the following reasons to buy a primary home
- Buying a home gives one peace of mind. It is a different feeling to live one’s own house and not in a rental one. It is a very satisfying experience. I cannot describe it, but those of you who own a house would know it.
- It is the smartest investment for a newly working professional. A lot of young people who starting working, get some cash in their bank accounts and get itchy with the cash. They go all around investing the cash in silly ways and end up losing money. In this respect, if they went and bought a house (within their means) it would be a sound investment and would also prevent them doing something foolish
- I now get into a slightly sensitive area – If the unfortunate occurs and the main earning member were to pass away, owning your own home makes a huge difference. I can tell that from my own experience.
Conclusion
I would say the primary reason for buying a home is that it provides a roof for your family and happiness and security. The accepted truths on financial aspects are delusions which people use to justify over spending on their house – buying more than they can afford.
Final question – have you heard of anyone who used to live in 3000 sqft house in a posh locality and when his house appreciated by 200%, decided to sell the house and went to live in a village in a 500 sqft hut ? Once you and your family gets used to a lifestyle, you will never want to downgrade it !!. So next time if you are getting giddy over the appreciation of your primary home, please think about what that means, if anything. (sorry for popping that bubble :) ).
Monday, January 11, 2010
Saturday, January 09, 2010
A reminder, an update and some links
A reminder
I have the following poll on the side bar and would encourage you to vote !
What do you expect to make from investing in stocks in the next 3-5 years ?
10-15% per annum
15-20% per annum
20-25% per annum
25-30% per annum
30%+ per annum
Update on donations
I am extremely happy to announce that around 45000 rs has already been donated by the readers of this blog. All the donors (except 2-3 towards the end) were provided with an investment idea - ESAB india. The recent donors (last 2-3 weeks) have not been provided with same idea it has already appreciated by 25% since then and is no longer as undervalued.
I still intend to keep my promise to them and hope they will be patient.
My heartfelt thanks to all the donors.
Some links
If you are new to the blog, you can subscribe to rss using this link or get an email update of the posts by entering your email under the subscribe button. Dont worry, i wont spam you unless you think my posts are spam itself :)
I have uploaded a template i use to analyse each company and some examples of the analysis - NIIT, LMW, Gujarat gas and other files at this location. You can join the valueinvestorindia google group and download these files.
I have the following poll on the side bar and would encourage you to vote !
What do you expect to make from investing in stocks in the next 3-5 years ?
10-15% per annum
15-20% per annum
20-25% per annum
25-30% per annum
30%+ per annum
Update on donations
I am extremely happy to announce that around 45000 rs has already been donated by the readers of this blog. All the donors (except 2-3 towards the end) were provided with an investment idea - ESAB india. The recent donors (last 2-3 weeks) have not been provided with same idea it has already appreciated by 25% since then and is no longer as undervalued.
I still intend to keep my promise to them and hope they will be patient.
My heartfelt thanks to all the donors.
Some links
If you are new to the blog, you can subscribe to rss using this link or get an email update of the posts by entering your email under the subscribe button. Dont worry, i wont spam you unless you think my posts are spam itself :)
I have uploaded a template i use to analyse each company and some examples of the analysis - NIIT, LMW, Gujarat gas and other files at this location. You can join the valueinvestorindia google group and download these files.
Sunday, January 03, 2010
Stocks Tips are not portfolio management
The standard service provided by most brokers, analysts and blogs is stock tips. The analyst typically analyses a company (often superficially) and after declaring it cheap, gives a price target. The brave ones may attach a time frame to the target too. There are several points missing in the above model for a typical investor
- How much of the stock should the investor buy?
- Should the investor buy a full position at the current price or build it over a period of time?
- What is the level of risk of the stock and how does it correlate with the stocks in the portfolio?
- Most importantly, when and under what conditions should the investor buy or sell the stock?
The analyst or the broker involved gets paid for recommending the stock and their responsibility stops at that point. None of the above points are considered when providing the service. In addition, there is sometimes no follow up and review of the stock on an ongoing basis which would help the investor decide whether he or she should buy, hold or sell the stock.
The above missing points in the standard model of the industry are provided at a high price via portfolio management services. I am not aware of the exact pricing, but have been told that it is generally around 2% of the portfolio and some percentage of the gains achieved by the portfolio manager.
This model is ofcourse stacked against the typical investor. The portfolio manager makes money irrespective of whether the investor makes a profit or not.
A decent portfolio management service should have the following features
Stock idea: The service should provide the stock idea with an estimate of fair value and a clear explanation of the risk involved in the stock. I don’t believe that a stock can have only an upside without a downside risk.
Position sizing: The service should provide a recommendation on the position size (amount of stock) and also provide regular inputs if the position has to be built over time.
Correlation risk: There is no diversification if one buy 3 cement and 2 telecom stocks in a portfolio. A lot of times the risk is not as obvious, but should be analyzed when recommending a stock and deciding on the position size
Regular update and sell recommendation: This is sorely missing from the current model. You will rarely find a sell recommendation from an analyst.
I am not aware if the above comprehensive service is available at a decent price. Most of the brokers provide stock tips or similar such recommendations with an eye on generating commissions through buy or sell action of the investor. As a result it is impossible for brokers and analyst to have their incentives aligned with yours.
An example
I discussed my portfolio in this post. I provided a listing of all the stocks in the portfolio with their 2009 gains and also an analysis of the idea in some cases. Does this list give an idea of the portfolio performance ? hardly. Some the ideas in the portfolio were analysed in 2006, some in 2007 and some in 2008. I don’t build a full position at the time of the analysis unless I think that the stock is extremely cheap and there is no point in waiting. The positions were built over the course of time as the stocks got cheaper or the fundamentals improved.
It is important to understand one point – A decision to buy need not be made at the time of analyzing the stock. One should analyse the stock and make a note of it (in my case I have a tracking spreadsheet). If the price drops below a certain threshold, one can start buying or increasing the position. If the price rises, well then move on to something else. It pays to do your homework in advance.
I typically analyse a stock and provide the readers with all the required information to make a decision. However there is still quite a bit of ongoing effort required to track the fundamentals and the price and make buy, hold or sell decisions. These decisions have to be made in context of one’s personal situation.
In my own case, I exited most of my positions in 2006-2007 time frame. I started buying a little bit in mid 2008. My main buying came during Oct 2008 – Jan 2008. As a result I did not hit the precise bottom of the market, which anyway has never been my goal. If the market keeps going up, I will keep exiting my overvalued positions slowly over this year. If however, the market crashes, and I can find undervalued ideas, I will start buying again.
I may have a long term view on stocks, but I am constantly evaluating my ideas on the four factors discussed about and making changes to the portfolio. A long term approach is not a brain dead approach.
The relevant returns
The relevant returns for any portfolio should be for the two year period 2008-2009. Most of the long term investors lost money in 2008 and made it back in 2009. If one has to evaluate the success or failure then one should look at the combined returns for these two years. In my case, I am more than pleased with my returns as I cleared my target by a wide margins (target being to beat the market by 5-8% per annum). I don’t expect to have a repeat performance in 2010.
Conclusion
Building a low risk portfolio and maintaining it, involves quite a bit of effort. If one is not ready to put the effort behind it, then a sensible option is to invest in mutual funds (inspite of all their drawbacks) or in index funds. Stock picks and tips will help you trade and have the thrill of jumping in and out of the market, but if you want to build your networth over a period of time, don’t expect these services to help you on that.
- How much of the stock should the investor buy?
- Should the investor buy a full position at the current price or build it over a period of time?
- What is the level of risk of the stock and how does it correlate with the stocks in the portfolio?
- Most importantly, when and under what conditions should the investor buy or sell the stock?
The analyst or the broker involved gets paid for recommending the stock and their responsibility stops at that point. None of the above points are considered when providing the service. In addition, there is sometimes no follow up and review of the stock on an ongoing basis which would help the investor decide whether he or she should buy, hold or sell the stock.
The above missing points in the standard model of the industry are provided at a high price via portfolio management services. I am not aware of the exact pricing, but have been told that it is generally around 2% of the portfolio and some percentage of the gains achieved by the portfolio manager.
This model is ofcourse stacked against the typical investor. The portfolio manager makes money irrespective of whether the investor makes a profit or not.
A decent portfolio management service should have the following features
Stock idea: The service should provide the stock idea with an estimate of fair value and a clear explanation of the risk involved in the stock. I don’t believe that a stock can have only an upside without a downside risk.
Position sizing: The service should provide a recommendation on the position size (amount of stock) and also provide regular inputs if the position has to be built over time.
Correlation risk: There is no diversification if one buy 3 cement and 2 telecom stocks in a portfolio. A lot of times the risk is not as obvious, but should be analyzed when recommending a stock and deciding on the position size
Regular update and sell recommendation: This is sorely missing from the current model. You will rarely find a sell recommendation from an analyst.
I am not aware if the above comprehensive service is available at a decent price. Most of the brokers provide stock tips or similar such recommendations with an eye on generating commissions through buy or sell action of the investor. As a result it is impossible for brokers and analyst to have their incentives aligned with yours.
An example
I discussed my portfolio in this post. I provided a listing of all the stocks in the portfolio with their 2009 gains and also an analysis of the idea in some cases. Does this list give an idea of the portfolio performance ? hardly. Some the ideas in the portfolio were analysed in 2006, some in 2007 and some in 2008. I don’t build a full position at the time of the analysis unless I think that the stock is extremely cheap and there is no point in waiting. The positions were built over the course of time as the stocks got cheaper or the fundamentals improved.
It is important to understand one point – A decision to buy need not be made at the time of analyzing the stock. One should analyse the stock and make a note of it (in my case I have a tracking spreadsheet). If the price drops below a certain threshold, one can start buying or increasing the position. If the price rises, well then move on to something else. It pays to do your homework in advance.
I typically analyse a stock and provide the readers with all the required information to make a decision. However there is still quite a bit of ongoing effort required to track the fundamentals and the price and make buy, hold or sell decisions. These decisions have to be made in context of one’s personal situation.
In my own case, I exited most of my positions in 2006-2007 time frame. I started buying a little bit in mid 2008. My main buying came during Oct 2008 – Jan 2008. As a result I did not hit the precise bottom of the market, which anyway has never been my goal. If the market keeps going up, I will keep exiting my overvalued positions slowly over this year. If however, the market crashes, and I can find undervalued ideas, I will start buying again.
I may have a long term view on stocks, but I am constantly evaluating my ideas on the four factors discussed about and making changes to the portfolio. A long term approach is not a brain dead approach.
The relevant returns
The relevant returns for any portfolio should be for the two year period 2008-2009. Most of the long term investors lost money in 2008 and made it back in 2009. If one has to evaluate the success or failure then one should look at the combined returns for these two years. In my case, I am more than pleased with my returns as I cleared my target by a wide margins (target being to beat the market by 5-8% per annum). I don’t expect to have a repeat performance in 2010.
Conclusion
Building a low risk portfolio and maintaining it, involves quite a bit of effort. If one is not ready to put the effort behind it, then a sensible option is to invest in mutual funds (inspite of all their drawbacks) or in index funds. Stock picks and tips will help you trade and have the thrill of jumping in and out of the market, but if you want to build your networth over a period of time, don’t expect these services to help you on that.
Thursday, December 31, 2009
Wishes for the new year
A happy new year to all the readers and thank you for reading and visiting my blog.
Wednesday, December 30, 2009
A poll
I have added a poll on the sidebar with the following question
What do you expect to make from investing in stocks in the next 3-5 years ?
10-15% per annum
15-20% per annum
20-25% per annum
25-30% per annum
30%+ per annum
The question is not what you wish, but what you think you will be able to make based on your past experience. The distinction is important as in my own case i would wish to make 100%+, have a private jet etc etc, but i will never make those kind of returns no matter how much i wish for it.
Why should i respond ?
Based on the survey i plan to publish a post with my personal views (who else's ..its my blog :) ) on what it would take to make the returns in each segment (10-15, 15-20% etc).
It should take not more than 10 sec to participate in the post and you can use the results to compare your expectations with others and see what it would take to get these returns.
What do you expect to make from investing in stocks in the next 3-5 years ?
10-15% per annum
15-20% per annum
20-25% per annum
25-30% per annum
30%+ per annum
The question is not what you wish, but what you think you will be able to make based on your past experience. The distinction is important as in my own case i would wish to make 100%+, have a private jet etc etc, but i will never make those kind of returns no matter how much i wish for it.
Why should i respond ?
Based on the survey i plan to publish a post with my personal views (who else's ..its my blog :) ) on what it would take to make the returns in each segment (10-15, 15-20% etc).
It should take not more than 10 sec to participate in the post and you can use the results to compare your expectations with others and see what it would take to get these returns.
Sunday, December 27, 2009
Annual portfolio review – 2009
I usually review my portfolio towards the end of the year and try to figure out what went right and where I goofed up. I disclosed my portfolio last year and the portfolio has remained more or less the same since then. I sold off some small positions such as India nippon, manugraph etc and have added to other ideas such as LMW, Ashok Leyland and other existing ideas, which I felt were cheap during the course of 2009. So how did it all turn out? well far better than I expected at the beginning of 2009. A summary of the results follows
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I have compared the returns on the stocks with the nifty (large cap) index and the midcap index as several holdings in my portfolio are mid caps and hence it would appropriate to compare them with the midcap index.
The reason for comparing with the index is straightforward. If one has to pick stocks, then the picks in aggregate (not necessarily each) have to do better than then index, otherwise one is better off buying the index via index funds and not wasting time and energy on picking stocks.
So what grade do it get ?
I have given myself a B for picking stocks and a B+ for having the patience and confidence in buying and holding the picks during the terrible drop in the markets. The stock picks are not phenomenal picks in themselves. It was very easy to find undervalued stocks during the Oct 2008 – Mar 2009, but difficult to buy and hold them. As an analogy with cricket, my picks are like singles and doubles, occasional fours and a very rare six. I am unlikely to lose my wicket on a reckless shot, but watching me play would kill one with boredom :)
Reviewing the picks
A few picks standout in the above list – namely Merck, CRISIL, Grindwell Norton and Honda siel. ESAB india and sulzer don't count as they are fairly recent picks. These picks have done poorer than the index and hence are worthy of deeper attention.
I have written about merck earlier here. I still feel it is undervalued and plan to hold on to it. The main reason for the underperformance is that the fundamentals of the company have not improved as expected over the years and hence the stock market has not given it a decent valuation.
CRISIL has performed as expected. The company was not as undervalued as some other stocks last year and hence the gain has not been as high. Grindwell Norton and Honda siel have not perform as well as some of the other companies and hence the stock performance has not been as good as the index.
A few other picks such India Nippon, Manugraph were clear goofups bought during the bull market and exiting them was a necessary decision. I don't expect to have a 100% success rate in picking stocks and it should still work out fine as long as my mistakes are smaller than my successes. For the time being, that has been so.
Is an annual review sensible
I have continuously harped on the need to have a long term view. Is it sensible to evaluate a portfolio on an annual basis ?
I personally think that any outperformance or underperformance over a year is usually a matter of luck. However it still does not mean that one should not evaluate the picks atleast once a year and see what worked and what didn't
Conclusion
My conclusions for the year has been as follows
- Majority of the returns for the year have happened as the market corrected the undervaluation of midcaps. This is unlikely to happen in 2010 as there are not as many undervalued stocks out there.
- It is important to understand the difference between a cyclical drop in demand and permanent change in industry dynamics. 2008-2009 was a cyclical drop for several industries such as auto. The same is however not true for telecom which is undergoing a structural change.
- It is important to bet big when the odds are in favor (price is low). It is also important to ignore the chatter in the media which is as best a distraction.
- I was lucky in 2009. I don't expect to be as lucky in 2010 and will have to work harder to get decent returns.
So whats next ?
I really don't have a crystal ball for 2010. I have no clue whether the market will go up or down. My approach has remained the same for the last 10 years and will be the same in 2010 – buy when the stock is undervalued and sell at intrinsic value or higher – market forecasts be dammed.
That said, I expect it to be more difficult to generate good returns in 2010 and beat the market.
Final note : The above listing is not entirely indicative of my returns as all the holdings are not equal weighted in the portfolio. Some holdings such as LMW and ashok Leyland have a higher wieghtage than the others.
As I read somewhere – its better to be lucky than smart. Well, 2009 was a very lucky year.
Tuesday, December 22, 2009
Some corrections to the previous post
The thing about a blog is that if you make an error in your analysis, especially a dumb one, it gets caught very quickly. I did not notice that HDFC floater LT has a 3% exit load. As a result, one of my conclusion in the previous post is invalid, if one is looking for parking short term funds. If however, the time horizon is more than 1.5 years, I think HDFC floater LT should turn out to be a decent option.
In addition to the options posted in my previous post, it was pointed out that flexible deposits and sweep-in are good options for short term funds. I agree with those comments completely. There may be a difference of +/- 1% point in terms of return between these various options, but unless you plan to invest 10 crores, I don’t think it will make a huge difference.
My personal preference when investing short term funds is for liquidity and safety of principal. Returns are important, but I will not compromise on the safety of my capital. A few percentage points is not worth the risk at all. I am a very conservative and risk averse investor in terms of debt and have always given high priority to the safety of principal.
Personal finance
This brings me to the next topic – personal finance. My own personal finance is split between equities, a little bit of debt instruments and cash. It is an idiosyncratic split reflecting my personal needs. I will definitely not recommend it to others who may have different goals than mine.
I don’t consider real estate (primary home) as an investment. I find it completely stupid to think of my primary home as an investment. If my home appreciates by 50%, what will do with it ? sell it and go live in a forest ? A home is an expense and responsibility. A second or third home or apartment can be called as an investment, but that’s a different story.
I consider insurance as simply that – insurance. So I have never bought a ULIP or a hybrid policy which are instruments of fleecing the common man. I have bought term insurance to cover my liabilities and to secure my family.
Keeping it simple
I prefer to keep my personal finance structure simple and manageable. I prefer to low to non-existent risk on my debt and other investments. The only risk I like to carry is the one for which I am paid – equity risk.
In addition to the options posted in my previous post, it was pointed out that flexible deposits and sweep-in are good options for short term funds. I agree with those comments completely. There may be a difference of +/- 1% point in terms of return between these various options, but unless you plan to invest 10 crores, I don’t think it will make a huge difference.
My personal preference when investing short term funds is for liquidity and safety of principal. Returns are important, but I will not compromise on the safety of my capital. A few percentage points is not worth the risk at all. I am a very conservative and risk averse investor in terms of debt and have always given high priority to the safety of principal.
Personal finance
This brings me to the next topic – personal finance. My own personal finance is split between equities, a little bit of debt instruments and cash. It is an idiosyncratic split reflecting my personal needs. I will definitely not recommend it to others who may have different goals than mine.
I don’t consider real estate (primary home) as an investment. I find it completely stupid to think of my primary home as an investment. If my home appreciates by 50%, what will do with it ? sell it and go live in a forest ? A home is an expense and responsibility. A second or third home or apartment can be called as an investment, but that’s a different story.
I consider insurance as simply that – insurance. So I have never bought a ULIP or a hybrid policy which are instruments of fleecing the common man. I have bought term insurance to cover my liabilities and to secure my family.
Keeping it simple
I prefer to keep my personal finance structure simple and manageable. I prefer to low to non-existent risk on my debt and other investments. The only risk I like to carry is the one for which I am paid – equity risk.
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