I recently read the news on suspending AS11 accounting standards for the next 2 years in view of the dramatic changes in international markets. In the last one year, the rupee has suddenly depreciated from 40s level to 50s declining by more than 20% during this period. Most of the companies were caught by surprise as they did not expect the rupee to depreciate so sharply and hence are facing MTM (mark to market) losses for the current year.
AS11 is a standard for recognizing impact of forex changes on the company’s accounts. I have the discussed impact of forex changes in my discussion of NIIT tech. I have said the following in the past
The current quarter results show a bottom line drop of around 50%, mainly due to forex losses. I do not consider them as core losses (just as forex gains are not permanent gains). I have seen a lot of people get all worked up about forex losses, which does not make sense to me.
Unless the company is speculating on forex (via non effective hedges), I think the forex gains and losses should even out over the period of few years and hence one should be concentrating on the core profits to value the company.
As an example look at the results of the airlines such as southwest (in the US). Southwest airlines has been consistently profitable for the last 20+ years. They have had 2-3 quarters of hedging related losses due to oil price volatility. Do you think they have a problem in their core operations?
So if I have considered these losses to be temporary, akin to a bad bet, then why am I not applauding this temporary suspension of the standards?
The reason is simple – I want my companies to give me the true picture. Don’t fudge, whitewash or hide information from me (as an investor). Please tell me the whole truth and leave it to me to judge the impact of it. As investors we are smart enough (as a group) to judge the impact of forex changes on the long term economics of the companies and don’t need the companies to whitewash this information for me.
Now that we are in the territory of fantasy accounting, I have a few more proposals
- Ignore cost increases of raw material when they become too high. When steel prices increase sharply, all auto and other companies should be allowed to ignore price increases
- Ignore manpower costs and salary hikes. Allow all IT companies to ignore salary hikes in excess of 5%.
- Ignore depreciation after a huge capex. Whenever the company puts up a new plant or makes a big accquisition, allow it to ignore depreciation and amortization expenses
I could go on and on. The above change is self serving and will only muddy up the numbers. It allows the companies to present the numbers in a good light and ignore reality. Is it a given that the rupee will appreciate to 40s level in 2 years and all will be great in the fantasy land?
I personally don’t care what companies report by suspending AR 11 for 2 years. I will personally adjust the numbers of the companies I have invested in or plan to, based on the forex changes.
I really wish I had this flexibility when I was studying !! I would have asked the examiners to ignore all the question I got wrong and I would have always got 100% in all my exams :) . Life would have been good !!
Tuesday, March 31, 2009
Fantasy accounting
I recently read the news on suspending AS11 accounting standards for the next 2 years in view of the dramatic changes in international markets. In the last one year, the rupee has suddenly depreciated from 40s level to 50s declining by more than 20% during this period. Most of the companies were caught by surprise as they did not expect the rupee to depreciate so sharply and hence are facing MTM (mark to market) losses for the current year.
AS11 is a standard for recognizing impact of forex changes on the company’s accounts. I have the discussed impact of forex changes in my discussion of NIIT tech. I have said the following in the past
The current quarter results show a bottom line drop of around 50%, mainly due to forex losses. I do not consider them as core losses (just as forex gains are not permanent gains). I have seen a lot of people get all worked up about forex losses, which does not make sense to me.
Unless the company is speculating on forex (via non effective hedges), I think the forex gains and losses should even out over the period of few years and hence one should be concentrating on the core profits to value the company.
As an example look at the results of the airlines such as southwest (in the US). Southwest airlines has been consistently profitable for the last 20+ years. They have had 2-3 quarters of hedging related losses due to oil price volatility. Do you think they have a problem in their core operations?
So if I have considered these losses to be temporary, akin to a bad bet, then why am I not applauding this temporary suspension of the standards?
The reason is simple – I want my companies to give me the true picture. Don’t fudge, whitewash or hide information from me (as an investor). Please tell me the whole truth and leave it to me to judge the impact of it. As investors we are smart enough (as a group) to judge the impact of forex changes on the long term economics of the companies and don’t need the companies to whitewash this information for me.
Now that we are in the territory of fantasy accounting, I have a few more proposals
- Ignore cost increases of raw material when they become too high. When steel prices increase sharply, all auto and other companies should be allowed to ignore price increases
- Ignore manpower costs and salary hikes. Allow all IT companies to ignore salary hikes in excess of 5%.
- Ignore depreciation after a huge capex. Whenever the company puts up a new plant or makes a big accquisition, allow it to ignore depreciation and amortization expenses
I could go on and on. The above change is self serving and will only muddy up the numbers. It allows the companies to present the numbers in a good light and ignore reality. Is it a given that the rupee will appreciate to 40s level in 2 years and all will be great in the fantasy land?
I personally don’t care what companies report by suspending AR 11 for 2 years. I will personally adjust the numbers of the companies I have invested in or plan to, based on the forex changes.
I really wish I had this flexibility when I was studying !! I would have asked the examiners to ignore all the question I got wrong and I would have always got 100% in all my exams :) . Life would have been good !!
AS11 is a standard for recognizing impact of forex changes on the company’s accounts. I have the discussed impact of forex changes in my discussion of NIIT tech. I have said the following in the past
The current quarter results show a bottom line drop of around 50%, mainly due to forex losses. I do not consider them as core losses (just as forex gains are not permanent gains). I have seen a lot of people get all worked up about forex losses, which does not make sense to me.
Unless the company is speculating on forex (via non effective hedges), I think the forex gains and losses should even out over the period of few years and hence one should be concentrating on the core profits to value the company.
As an example look at the results of the airlines such as southwest (in the US). Southwest airlines has been consistently profitable for the last 20+ years. They have had 2-3 quarters of hedging related losses due to oil price volatility. Do you think they have a problem in their core operations?
So if I have considered these losses to be temporary, akin to a bad bet, then why am I not applauding this temporary suspension of the standards?
The reason is simple – I want my companies to give me the true picture. Don’t fudge, whitewash or hide information from me (as an investor). Please tell me the whole truth and leave it to me to judge the impact of it. As investors we are smart enough (as a group) to judge the impact of forex changes on the long term economics of the companies and don’t need the companies to whitewash this information for me.
Now that we are in the territory of fantasy accounting, I have a few more proposals
- Ignore cost increases of raw material when they become too high. When steel prices increase sharply, all auto and other companies should be allowed to ignore price increases
- Ignore manpower costs and salary hikes. Allow all IT companies to ignore salary hikes in excess of 5%.
- Ignore depreciation after a huge capex. Whenever the company puts up a new plant or makes a big accquisition, allow it to ignore depreciation and amortization expenses
I could go on and on. The above change is self serving and will only muddy up the numbers. It allows the companies to present the numbers in a good light and ignore reality. Is it a given that the rupee will appreciate to 40s level in 2 years and all will be great in the fantasy land?
I personally don’t care what companies report by suspending AR 11 for 2 years. I will personally adjust the numbers of the companies I have invested in or plan to, based on the forex changes.
I really wish I had this flexibility when I was studying !! I would have asked the examiners to ignore all the question I got wrong and I would have always got 100% in all my exams :) . Life would have been good !!
Thursday, March 26, 2009
Getting cheated
I am mad ! very very mad. See this news item on novartis india.
Novartis AG has announced an open offer for Rs 351 per share with the aim of taking their shareholding to 90%. Although they have not stated any plans for delisting, I think once the shareholding reaches 90%, delisting norms could kick in and the rest of the shareholders will be forced to exit the company.
Why am I mad ? See my analysis of novartis here. My conservative estimate of the intrinsic value is around 600-650 (company has a cash of almost 150 rs/ share). Look at it this way – Net of cash, the buy back offer is valuing the company at 800 crs. This is for a company making almost 100 Crs of profit on a capital base of around 30-40 Crs !!
Another view point – The buyback offer will cost the company around 440 Crs. The company has cash and equivalents of around 435 Crs as of december 2008. So the Parent company will be able to increase its holding to 90% without spending a penny from their pocket !!
Should I feel cheated ? May be not. I have known this modus operandi for some time. A lot of MNC’s have cheated their minority shareholders this way. The steps are as follows
- Allow the performance of the company to stagnate for a few years by avoiding product launches and anything else which enhances value
- Hold all the surplus cash during this time period.
- Wait for a bear market to drive your price down to very low levels.
- Announce an open offer at premium to current price, utilising the cash holding
- Try to mask this operation as a shareholder friendly operation by pointing out that the price is at premium to the current price (which is way below intrinsic value).
I have known and written the above earlier on my blog. I have however chosen to ignore my own advice though and would now be paying for it. At the current price, net of dividends, I have made modest returns. However that is not the point – The point is being treated fairly by the management of your company.
Another case - Ingersoll rand : They have announced their intention of coming out with an open offer too. I am not holding my breath on that as they have tried a similar tatic in the past, but were not successful in completing the buyback.
Lesson for me : Management matters more than i would like to accept. A good business with bad management will translate to poor returns.
What next ?
I am going to wait and watch how this open offer will play out. However even if the minority shareholders reject it, don’t expect the management to change or mend their ways. They will continue to ignore the minority shareholder, give poor dividends and will continue to accumulate cash. The best startegy in such a case would be to exit the stock and deploy the capital somewhere else.
Novartis AG has announced an open offer for Rs 351 per share with the aim of taking their shareholding to 90%. Although they have not stated any plans for delisting, I think once the shareholding reaches 90%, delisting norms could kick in and the rest of the shareholders will be forced to exit the company.
Why am I mad ? See my analysis of novartis here. My conservative estimate of the intrinsic value is around 600-650 (company has a cash of almost 150 rs/ share). Look at it this way – Net of cash, the buy back offer is valuing the company at 800 crs. This is for a company making almost 100 Crs of profit on a capital base of around 30-40 Crs !!
Another view point – The buyback offer will cost the company around 440 Crs. The company has cash and equivalents of around 435 Crs as of december 2008. So the Parent company will be able to increase its holding to 90% without spending a penny from their pocket !!
Should I feel cheated ? May be not. I have known this modus operandi for some time. A lot of MNC’s have cheated their minority shareholders this way. The steps are as follows
- Allow the performance of the company to stagnate for a few years by avoiding product launches and anything else which enhances value
- Hold all the surplus cash during this time period.
- Wait for a bear market to drive your price down to very low levels.
- Announce an open offer at premium to current price, utilising the cash holding
- Try to mask this operation as a shareholder friendly operation by pointing out that the price is at premium to the current price (which is way below intrinsic value).
I have known and written the above earlier on my blog. I have however chosen to ignore my own advice though and would now be paying for it. At the current price, net of dividends, I have made modest returns. However that is not the point – The point is being treated fairly by the management of your company.
Another case - Ingersoll rand : They have announced their intention of coming out with an open offer too. I am not holding my breath on that as they have tried a similar tatic in the past, but were not successful in completing the buyback.
Lesson for me : Management matters more than i would like to accept. A good business with bad management will translate to poor returns.
What next ?
I am going to wait and watch how this open offer will play out. However even if the minority shareholders reject it, don’t expect the management to change or mend their ways. They will continue to ignore the minority shareholder, give poor dividends and will continue to accumulate cash. The best startegy in such a case would be to exit the stock and deploy the capital somewhere else.
Getting cheated
I am mad ! very very mad. See this news item on novartis india.
Novartis AG has announced an open offer for Rs 351 per share with the aim of taking their shareholding to 90%. Although they have not stated any plans for delisting, I think once the shareholding reaches 90%, delisting norms could kick in and the rest of the shareholders will be forced to exit the company.
Why am I mad ? See my analysis of novartis here. My conservative estimate of the intrinsic value is around 600-650 (company has a cash of almost 150 rs/ share). Look at it this way – Net of cash, the buy back offer is valuing the company at 800 crs. This is for a company making almost 100 Crs of profit on a capital base of around 30-40 Crs !!
Another view point – The buyback offer will cost the company around 440 Crs. The company has cash and equivalents of around 435 Crs as of december 2008. So the Parent company will be able to increase its holding to 90% without spending a penny from their pocket !!
Should I feel cheated ? May be not. I have known this modus operandi for some time. A lot of MNC’s have cheated their minority shareholders this way. The steps are as follows
- Allow the performance of the company to stagnate for a few years by avoiding product launches and anything else which enhances value
- Hold all the surplus cash during this time period.
- Wait for a bear market to drive your price down to very low levels.
- Announce an open offer at premium to current price, utilising the cash holding
- Try to mask this operation as a shareholder friendly operation by pointing out that the price is at premium to the current price (which is way below intrinsic value).
I have known and written the above earlier on my blog. I have however chosen to ignore my own advice though and would now be paying for it. At the current price, net of dividends, I have made modest returns. However that is not the point – The point is being treated fairly by the management of your company.
Another case - Ingersoll rand : They have announced their intention of coming out with an open offer too. I am not holding my breath on that as they have tried a similar tatic in the past, but were not successful in completing the buyback.
Lesson for me : Management matters more than i would like to accept. A good business with bad management will translate to poor returns.
What next ?
I am going to wait and watch how this open offer will play out. However even if the minority shareholders reject it, don’t expect the management to change or mend their ways. They will continue to ignore the minority shareholder, give poor dividends and will continue to accumulate cash. The best startegy in such a case would be to exit the stock and deploy the capital somewhere else.
Novartis AG has announced an open offer for Rs 351 per share with the aim of taking their shareholding to 90%. Although they have not stated any plans for delisting, I think once the shareholding reaches 90%, delisting norms could kick in and the rest of the shareholders will be forced to exit the company.
Why am I mad ? See my analysis of novartis here. My conservative estimate of the intrinsic value is around 600-650 (company has a cash of almost 150 rs/ share). Look at it this way – Net of cash, the buy back offer is valuing the company at 800 crs. This is for a company making almost 100 Crs of profit on a capital base of around 30-40 Crs !!
Another view point – The buyback offer will cost the company around 440 Crs. The company has cash and equivalents of around 435 Crs as of december 2008. So the Parent company will be able to increase its holding to 90% without spending a penny from their pocket !!
Should I feel cheated ? May be not. I have known this modus operandi for some time. A lot of MNC’s have cheated their minority shareholders this way. The steps are as follows
- Allow the performance of the company to stagnate for a few years by avoiding product launches and anything else which enhances value
- Hold all the surplus cash during this time period.
- Wait for a bear market to drive your price down to very low levels.
- Announce an open offer at premium to current price, utilising the cash holding
- Try to mask this operation as a shareholder friendly operation by pointing out that the price is at premium to the current price (which is way below intrinsic value).
I have known and written the above earlier on my blog. I have however chosen to ignore my own advice though and would now be paying for it. At the current price, net of dividends, I have made modest returns. However that is not the point – The point is being treated fairly by the management of your company.
Another case - Ingersoll rand : They have announced their intention of coming out with an open offer too. I am not holding my breath on that as they have tried a similar tatic in the past, but were not successful in completing the buyback.
Lesson for me : Management matters more than i would like to accept. A good business with bad management will translate to poor returns.
What next ?
I am going to wait and watch how this open offer will play out. However even if the minority shareholders reject it, don’t expect the management to change or mend their ways. They will continue to ignore the minority shareholder, give poor dividends and will continue to accumulate cash. The best startegy in such a case would be to exit the stock and deploy the capital somewhere else.
Monday, March 23, 2009
A few thoughts on other instruments
I received the following comment from Raj. I am posting my response via a post. Please feel free to share your comments
Hi Rohit/Everybody,
Can we include below mentioned financial instruments in personal finance and short comments (how easy they are for new investors, who should dabble with them, pros/cons) on them:
A) Commodities
B) Gold
C) Debt instruments
D) Derivatives (options etc.)
Commodities – An easy one for me. I have zilch idea about it. Due to my mindset (value investing, looking at intrinsic value etc), I have not been able to figure out a way to invest rationally in commodities. It does not mean commodities are bad or anything. I just find them outside my scope of competence and would not recommend a new investor to dabble big time in commodities.
Gold – A subset of the above. However I am baised against gold and am a contrarian on gold. The reason for all this excitement on gold is more due to the price run up in the recent past. Look at this chart . Over the past 20+ years, gold has barely doubled giving a return of 3.5% per annum with the entire return coming over the past 5 years. Unless you have some special insight into the demand supply scenario of gold over the next few years, I would not invest in gold based on what others are saying.
Debt instruments – my thoughts on the same here
Derivatives – A short cut to ruin if you don’t know what you are doing. I have personally started looking at these instruments and am currently in the learning phase. I am currently reading and investing in these instruments in a very small way. The idea for me is to test and learn over the next few years before I increase my commitment. This is same approach I adopted when I started investing a decade ago – learn and invest small so that early mistakes are not fatal to your networth and self confidence.
I personally consider derivatives, complex and not an easy way to make money. The upside may be high, but at the same time the risk is high (due to the inherent leverage in these instruments) especially if you are new to investing and have just started out.
Hi Rohit/Everybody,
Can we include below mentioned financial instruments in personal finance and short comments (how easy they are for new investors, who should dabble with them, pros/cons) on them:
A) Commodities
B) Gold
C) Debt instruments
D) Derivatives (options etc.)
Commodities – An easy one for me. I have zilch idea about it. Due to my mindset (value investing, looking at intrinsic value etc), I have not been able to figure out a way to invest rationally in commodities. It does not mean commodities are bad or anything. I just find them outside my scope of competence and would not recommend a new investor to dabble big time in commodities.
Gold – A subset of the above. However I am baised against gold and am a contrarian on gold. The reason for all this excitement on gold is more due to the price run up in the recent past. Look at this chart . Over the past 20+ years, gold has barely doubled giving a return of 3.5% per annum with the entire return coming over the past 5 years. Unless you have some special insight into the demand supply scenario of gold over the next few years, I would not invest in gold based on what others are saying.
Debt instruments – my thoughts on the same here
Derivatives – A short cut to ruin if you don’t know what you are doing. I have personally started looking at these instruments and am currently in the learning phase. I am currently reading and investing in these instruments in a very small way. The idea for me is to test and learn over the next few years before I increase my commitment. This is same approach I adopted when I started investing a decade ago – learn and invest small so that early mistakes are not fatal to your networth and self confidence.
I personally consider derivatives, complex and not an easy way to make money. The upside may be high, but at the same time the risk is high (due to the inherent leverage in these instruments) especially if you are new to investing and have just started out.
A few thoughts on other instruments
I received the following comment from Raj. I am posting my response via a post. Please feel free to share your comments
Hi Rohit/Everybody,
Can we include below mentioned financial instruments in personal finance and short comments (how easy they are for new investors, who should dabble with them, pros/cons) on them:
A) Commodities
B) Gold
C) Debt instruments
D) Derivatives (options etc.)
Commodities – An easy one for me. I have zilch idea about it. Due to my mindset (value investing, looking at intrinsic value etc), I have not been able to figure out a way to invest rationally in commodities. It does not mean commodities are bad or anything. I just find them outside my scope of competence and would not recommend a new investor to dabble big time in commodities.
Gold – A subset of the above. However I am baised against gold and am a contrarian on gold. The reason for all this excitement on gold is more due to the price run up in the recent past. Look at this chart . Over the past 20+ years, gold has barely doubled giving a return of 3.5% per annum with the entire return coming over the past 5 years. Unless you have some special insight into the demand supply scenario of gold over the next few years, I would not invest in gold based on what others are saying.
Debt instruments – my thoughts on the same here
Derivatives – A short cut to ruin if you don’t know what you are doing. I have personally started looking at these instruments and am currently in the learning phase. I am currently reading and investing in these instruments in a very small way. The idea for me is to test and learn over the next few years before I increase my commitment. This is same approach I adopted when I started investing a decade ago – learn and invest small so that early mistakes are not fatal to your networth and self confidence.
I personally consider derivatives, complex and not an easy way to make money. The upside may be high, but at the same time the risk is high (due to the inherent leverage in these instruments) especially if you are new to investing and have just started out.
Hi Rohit/Everybody,
Can we include below mentioned financial instruments in personal finance and short comments (how easy they are for new investors, who should dabble with them, pros/cons) on them:
A) Commodities
B) Gold
C) Debt instruments
D) Derivatives (options etc.)
Commodities – An easy one for me. I have zilch idea about it. Due to my mindset (value investing, looking at intrinsic value etc), I have not been able to figure out a way to invest rationally in commodities. It does not mean commodities are bad or anything. I just find them outside my scope of competence and would not recommend a new investor to dabble big time in commodities.
Gold – A subset of the above. However I am baised against gold and am a contrarian on gold. The reason for all this excitement on gold is more due to the price run up in the recent past. Look at this chart . Over the past 20+ years, gold has barely doubled giving a return of 3.5% per annum with the entire return coming over the past 5 years. Unless you have some special insight into the demand supply scenario of gold over the next few years, I would not invest in gold based on what others are saying.
Debt instruments – my thoughts on the same here
Derivatives – A short cut to ruin if you don’t know what you are doing. I have personally started looking at these instruments and am currently in the learning phase. I am currently reading and investing in these instruments in a very small way. The idea for me is to test and learn over the next few years before I increase my commitment. This is same approach I adopted when I started investing a decade ago – learn and invest small so that early mistakes are not fatal to your networth and self confidence.
I personally consider derivatives, complex and not an easy way to make money. The upside may be high, but at the same time the risk is high (due to the inherent leverage in these instruments) especially if you are new to investing and have just started out.
Friday, March 20, 2009
Evaluating various personal finance schemes
I typically don’t write much on personal finance. The key reason is that it does not hold much interest for me and does not challenge me. After you have spent 1-2 years reading on investing, evaluating a scheme is quick and easy. In addition, there are a lot of other blogs and magazines which do a better job of explaining personal finance for the lay investor.
Let me a list a few criteria I use to arrive at a decision on any personal finance instrument
- What has been the performance of the instrument in the past? If this is a new instrument of scheme avoid
- Has the instrument or scheme out performed a benchmark? If it is related to equity, has it outperformed the index for the last 3-5 years. If not, avoid
- What are the costs involved ? what is the expense ratio, sales load, exit loads etc. The total of all costs should not exceed 2% (typical of most open ended mututal funds which in itself is too high). If the expenses per annum exceed 2%, avoid
- What is the lock in period ? I typically avoid products with lockin periods. Product with high lockin periods do not necessarily perform better than open ended product. They just tie your money up and you can lose flexibility if the performance is poor
- What is the kind paperwork involved ? can I do it online ? I personally hate paperwork and have no interest in running to the bank to fill up forms and fill up paperwork every year.
I finally don’t care what is pedigree of the fund house or whether the fund or instrument is from a reputed bank or AMC. In addition I don’t care if the name sounds good or the sales person is a cute looking girl. I will open up my wallet only if the instrument meets my criterias listed above.
Finally you can see this post where I have listed how I select equity based funds. As you can see, it is not complicated to decide on a personal finance instrument. Most of the times, I don’t bother to look for one and tend to buy mutual funds, stocks or ETFs online directly.
Let me a list a few criteria I use to arrive at a decision on any personal finance instrument
- What has been the performance of the instrument in the past? If this is a new instrument of scheme avoid
- Has the instrument or scheme out performed a benchmark? If it is related to equity, has it outperformed the index for the last 3-5 years. If not, avoid
- What are the costs involved ? what is the expense ratio, sales load, exit loads etc. The total of all costs should not exceed 2% (typical of most open ended mututal funds which in itself is too high). If the expenses per annum exceed 2%, avoid
- What is the lock in period ? I typically avoid products with lockin periods. Product with high lockin periods do not necessarily perform better than open ended product. They just tie your money up and you can lose flexibility if the performance is poor
- What is the kind paperwork involved ? can I do it online ? I personally hate paperwork and have no interest in running to the bank to fill up forms and fill up paperwork every year.
I finally don’t care what is pedigree of the fund house or whether the fund or instrument is from a reputed bank or AMC. In addition I don’t care if the name sounds good or the sales person is a cute looking girl. I will open up my wallet only if the instrument meets my criterias listed above.
Finally you can see this post where I have listed how I select equity based funds. As you can see, it is not complicated to decide on a personal finance instrument. Most of the times, I don’t bother to look for one and tend to buy mutual funds, stocks or ETFs online directly.
Evaluating various personal finance schemes
I typically don’t write much on personal finance. The key reason is that it does not hold much interest for me and does not challenge me. After you have spent 1-2 years reading on investing, evaluating a scheme is quick and easy. In addition, there are a lot of other blogs and magazines which do a better job of explaining personal finance for the lay investor.
Let me a list a few criteria I use to arrive at a decision on any personal finance instrument
- What has been the performance of the instrument in the past? If this is a new instrument of scheme avoid
- Has the instrument or scheme out performed a benchmark? If it is related to equity, has it outperformed the index for the last 3-5 years. If not, avoid
- What are the costs involved ? what is the expense ratio, sales load, exit loads etc. The total of all costs should not exceed 2% (typical of most open ended mututal funds which in itself is too high). If the expenses per annum exceed 2%, avoid
- What is the lock in period ? I typically avoid products with lockin periods. Product with high lockin periods do not necessarily perform better than open ended product. They just tie your money up and you can lose flexibility if the performance is poor
- What is the kind paperwork involved ? can I do it online ? I personally hate paperwork and have no interest in running to the bank to fill up forms and fill up paperwork every year.
I finally don’t care what is pedigree of the fund house or whether the fund or instrument is from a reputed bank or AMC. In addition I don’t care if the name sounds good or the sales person is a cute looking girl. I will open up my wallet only if the instrument meets my criterias listed above.
Finally you can see this post where I have listed how I select equity based funds. As you can see, it is not complicated to decide on a personal finance instrument. Most of the times, I don’t bother to look for one and tend to buy mutual funds, stocks or ETFs online directly.
Let me a list a few criteria I use to arrive at a decision on any personal finance instrument
- What has been the performance of the instrument in the past? If this is a new instrument of scheme avoid
- Has the instrument or scheme out performed a benchmark? If it is related to equity, has it outperformed the index for the last 3-5 years. If not, avoid
- What are the costs involved ? what is the expense ratio, sales load, exit loads etc. The total of all costs should not exceed 2% (typical of most open ended mututal funds which in itself is too high). If the expenses per annum exceed 2%, avoid
- What is the lock in period ? I typically avoid products with lockin periods. Product with high lockin periods do not necessarily perform better than open ended product. They just tie your money up and you can lose flexibility if the performance is poor
- What is the kind paperwork involved ? can I do it online ? I personally hate paperwork and have no interest in running to the bank to fill up forms and fill up paperwork every year.
I finally don’t care what is pedigree of the fund house or whether the fund or instrument is from a reputed bank or AMC. In addition I don’t care if the name sounds good or the sales person is a cute looking girl. I will open up my wallet only if the instrument meets my criterias listed above.
Finally you can see this post where I have listed how I select equity based funds. As you can see, it is not complicated to decide on a personal finance instrument. Most of the times, I don’t bother to look for one and tend to buy mutual funds, stocks or ETFs online directly.
Tuesday, March 17, 2009
Why unit linked plans are a bad idea ?
I recently visited icici and HDFC bank for some personal work and some of the sales folks at these branches went into a sales pitch, pushing their respective unit linked plans. These unit linked plans are a combination of an Insurance policy and mutual funds. The key highlights of these plans are
Highlights
- An annual ‘premium’ payment towards the plan for around 15 years.
- An option to pick from a range of 100% equity to 100% debt plans
- If the primary holder passes away, the nominee get the insurance amount in addition to the accumulated value of the mutual fund component (varies by plan)
- A max total insurance cover of around 12.5 lacs even if the annual premium exceeds 2.5 lacs
- 40% premium charge in year 1, 30% charge in year 2 and 2% thereafter.
- A plethora of other charges some of which are not very clear unless you dig further such as mortality charge, admin charge etc
- A 1.25% fund management charge
Now these sales folks are well intentioned and all that. But frankly my initial feeling was that anything this complicated and convoluted cannot be very good. Lets look at some math
For ex : I invest 2.5 lacs per annum for 15 years in a 100% equity option. So around 1.75lacs are deducted in year 1 and 2 combined and around 5000 rs per annum thereafter. The rest would be invested in a mutual fund of choice.
The insurance component
Lets look at the insurance component first. A pure risk policy (which is what the above is) is currently priced at around 4000-6000 p.a premium for a duration of 15 years. So clearly the insurance component is overpriced.
There is a bumper component which is paid at the end of the policy term which equates 70-80% of the premium. If you look at it in another way, this equals the 70% you pay upfront at the start of the policy.
So in a nutshell, the company is taking 70-80% of the annual premium from you and holding it interest free for 15 years. At an interest rate of around 9% per annum that is 3.6 times your annual premium !!
The 2% annual deduction would get you a similar pure risk policy with all the attendant benefits including tax deductions.
Mutual fund component
Lets look at the mutual funds component – Nothing special here. The company is taking 60% of your premium in yr 1, 70% in year 2 and 90% in yr 3 and onwards and investing it on your behalf for 15 years. At the end of 15 years, you redeem based on the NAV then.
What are the negatives here ?
– For starters my money could be locked for 15 years – a big negative if the performance turns out to be poor.
– The brochures, which I have seen show very average performance for all the concerned funds (most of them, barely beating the index before charges and actually underperforming the index after the fund management fees).
– A plethora of charges I noted earlier, get deducted from the mutual fund component. There is not much clarity in the brochures on the quantum of total charges, but I don’t expect it be less than 1% of the total (maybe more).
Conclusion
A pretty bad investment option. The insurance component is way overpriced !!. The mutual fund component has nothing special in it and has a load of charges attached to it, which will reduce your returns substantially in the long run. I will not be surprised if the banks are getting a hefty commission or good fee from these kind of plans.
My initial feel was that anything this convuluted and complex is a nice way for the bank or AMC to make good money off the fees and leave the investor with poor returns
Recommendations
Buy a low cost pure risk policy for the insurance cover. These policies do not pay anything if you survive ( A happy outcome !! as I have survived) and have a very low premium. For the mutual fund component invest in a low cost index fund or ETF or a decent mutual fund (if you can find one).
Finally, buy something nice for yourself or your spouse/friend with the money you save and send me a gift for saving you this money (just kidding !).
Highlights
- An annual ‘premium’ payment towards the plan for around 15 years.
- An option to pick from a range of 100% equity to 100% debt plans
- If the primary holder passes away, the nominee get the insurance amount in addition to the accumulated value of the mutual fund component (varies by plan)
- A max total insurance cover of around 12.5 lacs even if the annual premium exceeds 2.5 lacs
- 40% premium charge in year 1, 30% charge in year 2 and 2% thereafter.
- A plethora of other charges some of which are not very clear unless you dig further such as mortality charge, admin charge etc
- A 1.25% fund management charge
Now these sales folks are well intentioned and all that. But frankly my initial feeling was that anything this complicated and convoluted cannot be very good. Lets look at some math
For ex : I invest 2.5 lacs per annum for 15 years in a 100% equity option. So around 1.75lacs are deducted in year 1 and 2 combined and around 5000 rs per annum thereafter. The rest would be invested in a mutual fund of choice.
The insurance component
Lets look at the insurance component first. A pure risk policy (which is what the above is) is currently priced at around 4000-6000 p.a premium for a duration of 15 years. So clearly the insurance component is overpriced.
There is a bumper component which is paid at the end of the policy term which equates 70-80% of the premium. If you look at it in another way, this equals the 70% you pay upfront at the start of the policy.
So in a nutshell, the company is taking 70-80% of the annual premium from you and holding it interest free for 15 years. At an interest rate of around 9% per annum that is 3.6 times your annual premium !!
The 2% annual deduction would get you a similar pure risk policy with all the attendant benefits including tax deductions.
Mutual fund component
Lets look at the mutual funds component – Nothing special here. The company is taking 60% of your premium in yr 1, 70% in year 2 and 90% in yr 3 and onwards and investing it on your behalf for 15 years. At the end of 15 years, you redeem based on the NAV then.
What are the negatives here ?
– For starters my money could be locked for 15 years – a big negative if the performance turns out to be poor.
– The brochures, which I have seen show very average performance for all the concerned funds (most of them, barely beating the index before charges and actually underperforming the index after the fund management fees).
– A plethora of charges I noted earlier, get deducted from the mutual fund component. There is not much clarity in the brochures on the quantum of total charges, but I don’t expect it be less than 1% of the total (maybe more).
Conclusion
A pretty bad investment option. The insurance component is way overpriced !!. The mutual fund component has nothing special in it and has a load of charges attached to it, which will reduce your returns substantially in the long run. I will not be surprised if the banks are getting a hefty commission or good fee from these kind of plans.
My initial feel was that anything this convuluted and complex is a nice way for the bank or AMC to make good money off the fees and leave the investor with poor returns
Recommendations
Buy a low cost pure risk policy for the insurance cover. These policies do not pay anything if you survive ( A happy outcome !! as I have survived) and have a very low premium. For the mutual fund component invest in a low cost index fund or ETF or a decent mutual fund (if you can find one).
Finally, buy something nice for yourself or your spouse/friend with the money you save and send me a gift for saving you this money (just kidding !).
Why unit linked plans are a bad idea ?
I recently visited icici and HDFC bank for some personal work and some of the sales folks at these branches went into a sales pitch, pushing their respective unit linked plans. These unit linked plans are a combination of an Insurance policy and mutual funds. The key highlights of these plans are
Highlights
- An annual ‘premium’ payment towards the plan for around 15 years.
- An option to pick from a range of 100% equity to 100% debt plans
- If the primary holder passes away, the nominee get the insurance amount in addition to the accumulated value of the mutual fund component (varies by plan)
- A max total insurance cover of around 12.5 lacs even if the annual premium exceeds 2.5 lacs
- 40% premium charge in year 1, 30% charge in year 2 and 2% thereafter.
- A plethora of other charges some of which are not very clear unless you dig further such as mortality charge, admin charge etc
- A 1.25% fund management charge
Now these sales folks are well intentioned and all that. But frankly my initial feeling was that anything this complicated and convoluted cannot be very good. Lets look at some math
For ex : I invest 2.5 lacs per annum for 15 years in a 100% equity option. So around 1.75lacs are deducted in year 1 and 2 combined and around 5000 rs per annum thereafter. The rest would be invested in a mutual fund of choice.
The insurance component
Lets look at the insurance component first. A pure risk policy (which is what the above is) is currently priced at around 4000-6000 p.a premium for a duration of 15 years. So clearly the insurance component is overpriced.
There is a bumper component which is paid at the end of the policy term which equates 70-80% of the premium. If you look at it in another way, this equals the 70% you pay upfront at the start of the policy.
So in a nutshell, the company is taking 70-80% of the annual premium from you and holding it interest free for 15 years. At an interest rate of around 9% per annum that is 3.6 times your annual premium !!
The 2% annual deduction would get you a similar pure risk policy with all the attendant benefits including tax deductions.
Mutual fund component
Lets look at the mutual funds component – Nothing special here. The company is taking 60% of your premium in yr 1, 70% in year 2 and 90% in yr 3 and onwards and investing it on your behalf for 15 years. At the end of 15 years, you redeem based on the NAV then.
What are the negatives here ?
– For starters my money could be locked for 15 years – a big negative if the performance turns out to be poor.
– The brochures, which I have seen show very average performance for all the concerned funds (most of them, barely beating the index before charges and actually underperforming the index after the fund management fees).
– A plethora of charges I noted earlier, get deducted from the mutual fund component. There is not much clarity in the brochures on the quantum of total charges, but I don’t expect it be less than 1% of the total (maybe more).
Conclusion
A pretty bad investment option. The insurance component is way overpriced !!. The mutual fund component has nothing special in it and has a load of charges attached to it, which will reduce your returns substantially in the long run. I will not be surprised if the banks are getting a hefty commission or good fee from these kind of plans.
My initial feel was that anything this convuluted and complex is a nice way for the bank or AMC to make good money off the fees and leave the investor with poor returns
Recommendations
Buy a low cost pure risk policy for the insurance cover. These policies do not pay anything if you survive ( A happy outcome !! as I have survived) and have a very low premium. For the mutual fund component invest in a low cost index fund or ETF or a decent mutual fund (if you can find one).
Finally, buy something nice for yourself or your spouse/friend with the money you save and send me a gift for saving you this money (just kidding !).
Highlights
- An annual ‘premium’ payment towards the plan for around 15 years.
- An option to pick from a range of 100% equity to 100% debt plans
- If the primary holder passes away, the nominee get the insurance amount in addition to the accumulated value of the mutual fund component (varies by plan)
- A max total insurance cover of around 12.5 lacs even if the annual premium exceeds 2.5 lacs
- 40% premium charge in year 1, 30% charge in year 2 and 2% thereafter.
- A plethora of other charges some of which are not very clear unless you dig further such as mortality charge, admin charge etc
- A 1.25% fund management charge
Now these sales folks are well intentioned and all that. But frankly my initial feeling was that anything this complicated and convoluted cannot be very good. Lets look at some math
For ex : I invest 2.5 lacs per annum for 15 years in a 100% equity option. So around 1.75lacs are deducted in year 1 and 2 combined and around 5000 rs per annum thereafter. The rest would be invested in a mutual fund of choice.
The insurance component
Lets look at the insurance component first. A pure risk policy (which is what the above is) is currently priced at around 4000-6000 p.a premium for a duration of 15 years. So clearly the insurance component is overpriced.
There is a bumper component which is paid at the end of the policy term which equates 70-80% of the premium. If you look at it in another way, this equals the 70% you pay upfront at the start of the policy.
So in a nutshell, the company is taking 70-80% of the annual premium from you and holding it interest free for 15 years. At an interest rate of around 9% per annum that is 3.6 times your annual premium !!
The 2% annual deduction would get you a similar pure risk policy with all the attendant benefits including tax deductions.
Mutual fund component
Lets look at the mutual funds component – Nothing special here. The company is taking 60% of your premium in yr 1, 70% in year 2 and 90% in yr 3 and onwards and investing it on your behalf for 15 years. At the end of 15 years, you redeem based on the NAV then.
What are the negatives here ?
– For starters my money could be locked for 15 years – a big negative if the performance turns out to be poor.
– The brochures, which I have seen show very average performance for all the concerned funds (most of them, barely beating the index before charges and actually underperforming the index after the fund management fees).
– A plethora of charges I noted earlier, get deducted from the mutual fund component. There is not much clarity in the brochures on the quantum of total charges, but I don’t expect it be less than 1% of the total (maybe more).
Conclusion
A pretty bad investment option. The insurance component is way overpriced !!. The mutual fund component has nothing special in it and has a load of charges attached to it, which will reduce your returns substantially in the long run. I will not be surprised if the banks are getting a hefty commission or good fee from these kind of plans.
My initial feel was that anything this convuluted and complex is a nice way for the bank or AMC to make good money off the fees and leave the investor with poor returns
Recommendations
Buy a low cost pure risk policy for the insurance cover. These policies do not pay anything if you survive ( A happy outcome !! as I have survived) and have a very low premium. For the mutual fund component invest in a low cost index fund or ETF or a decent mutual fund (if you can find one).
Finally, buy something nice for yourself or your spouse/friend with the money you save and send me a gift for saving you this money (just kidding !).
Tuesday, March 10, 2009
Letter to shareholders from Warren buffett – Some thoughts
Warren buffett as most of you must be aware is considered as one of the foremost investors. He is the chairman of Berkshire Hathaway and publishes an annual letter to shareholders which is a must read for any aspiring or seasoned value investor. You can access his letters here. The 2008 letters was published more than a week ago and I downloaded it the moment it was posted and read through it immediately (yes I am a complete fan !).
Some thoughts –
The options bet
One of most discussed topic about buffett is the options bet he has taken. The argument goes like this – Buffett has claimed that derivatives are a weapon of financial mass destruction and yet he has gone ahead and invested in the same instruments. He is being irresponsible and has doomed his company by this bet
Those who write the above are highlighting two points of their own ignorance
- Derivatives are dangerous for those who don’t know what they are doing. This is similar to giving a knife in the hands of a child. I don’t think any journalist, no matter how anti – buffett would consider him to be a novice investor. He has clearly spelled out what kind of bet he has taken in the letter and what are the risks associated with these instruments.
Following is the comment by buffett on the same above point in a recent CNBC interview
JOE: Those are derivatives. You don't like derivatives, but you used them in that case, right?
BUFFETT: I--well, we've used derivatives for many, many years. I don't think derivatives are evil, per se, I think they are dangerous. I've always said they're dangerous. I said they were financial weapons of mass destruction. But uranium is dangerous, and I just went through a nuclear electric plant about two weeks ago. Cars are dangerous.
JOE: Yeah
BUFFETT: But I mean, every American wants to have one. You know, the--a lot of things can be dangerous, but generally we regulate how they're used. I mean, there was a--there was some guard up there with a machine gun on me, you know, when I was at the nuclear plant the other day. So we use lots of things daily that are dangerous, but we generally pay some attention to how they're used.
- They are getting confused between the possible and the probable. Let me explain – It is possible I will become a billonaire in the next 10 years and will have a personal jet . The probability of that happening is 0.0000001%. Buffett’s option bet stands to lose 37 billion dollars if the 4 indices on which he has written the puts go to zero. Let me tell you this – If these four main markets go to 0 in the next 10-15 years, money would be least of our worries. I for one be forced to work on a farm or forage for food as the markets as we know would not exist.
When I first read of these puts, my thought process was that these were akin to an insurance contract based on a long term event with the premium paid upfront (similar for CAT insurance written by Berkshire hathaway). Buffett has explained it in a similar manner in detail in the annual report. I would recommend you to read the explaination in detail.
In addition, the option bet is equivalent to taking a long term loan where the interest rate of the loan can vary depending on the final payout.
Drop in profits
Most of headlines are screaming a major drop in profits. Buffett in clear, uncertain language has written that the profits of his company are very lumpy and will vary depending on the sale of investments. In certain years, buffett sells off overvalued investments and those gains are realised in the net profit. In the subsequent years, in absence of any such gain the year on year comparison looks bad (look at page 28 of the annual report and the explainatory note at the bottom)
The company’s operating business had a approximate cash flow of 9 bn. However various write offs and other change has result in a drop in the quarter’s net profit. The bad economy has definitely affected the company, but the results are not as bad as they appear on the face of it.
Mea culpa
Buffett has admitted to two mistakes - his timing on purchasing Conco phillips and two irish banks. I have been reading and following buffett over a decade and have seen his mistakes to be sometime more profitable than most of the successes of other people. In any case, these could be genuine mistakes and could cost Berkshire 1-2 % of their networth in the worst case scenario.
Looking closely
If you look closely at the results and compare across the years, you will see that the insurance subs and utilities are doing well. Float continue to increase at a steady rate with cost of the float being below zero (which is more important than premium growth) . Both these subs which form a major portion of Berkshire’s business have actually done well compared to the overall economic environment.
The other business are doing quite fine considering the horrible economic environment (see pg 61 of the 2008 annual report)
But the price has dropped ?
Yes the price has dropped and the CDS spreads have widened. Do you always believe the market to be right and the price to be aribiter of value ? Well then we are speaking different language. The markets are often but not always right.
Berkshire CDS spreads are at record levels signalling liquidity or credit issues. To validate that, look at the balance sheet of the company and you will find that the company has 25 billion of cash and equivalents (after all the investment which buffett has done last year). Do you really think a company with 11Bn+ operating cash flow and huge cash reserves will go bankrupt ?
Buffett fan ?
You can rightly accuse me of being a Buffett fan. However to that name, please add the names of Seth klarman, Phil fischer, Charlie munger, Marty whitman, Bill miller, eddie lampart, Rakesh jhunjhunwala and Chandrakant sampat.
I am follower of all great value investors and try to use every opportunity to learn from them. I have never blindly followed their picks or tried to imitate any of these investors, but I always try to learn from each one of them, even if they have been wrong a few times.
Let me ask you this – If you wanted to learn how to play cricket or golf or tennis, would you learn it from sachin tendulkar or Tiger woods or Roger federer (if they were ready to teach someone) ? Sure these players make mistakes and lose matches, but does that take away the fact that these players are the one of the greatest sportsmen in their fields?
It is easy for armchair players or armchair investors to critize from the comfort of their seats, especially after the event with a 20/20 hindsight. Majority of the criticism I have read about buffett and the other investors lacks rigrious detail and analysis and is usually along the lines – The stock price has dropped and hence he is doing something wrong !!.
Some thoughts –
The options bet
One of most discussed topic about buffett is the options bet he has taken. The argument goes like this – Buffett has claimed that derivatives are a weapon of financial mass destruction and yet he has gone ahead and invested in the same instruments. He is being irresponsible and has doomed his company by this bet
Those who write the above are highlighting two points of their own ignorance
- Derivatives are dangerous for those who don’t know what they are doing. This is similar to giving a knife in the hands of a child. I don’t think any journalist, no matter how anti – buffett would consider him to be a novice investor. He has clearly spelled out what kind of bet he has taken in the letter and what are the risks associated with these instruments.
Following is the comment by buffett on the same above point in a recent CNBC interview
JOE: Those are derivatives. You don't like derivatives, but you used them in that case, right?
BUFFETT: I--well, we've used derivatives for many, many years. I don't think derivatives are evil, per se, I think they are dangerous. I've always said they're dangerous. I said they were financial weapons of mass destruction. But uranium is dangerous, and I just went through a nuclear electric plant about two weeks ago. Cars are dangerous.
JOE: Yeah
BUFFETT: But I mean, every American wants to have one. You know, the--a lot of things can be dangerous, but generally we regulate how they're used. I mean, there was a--there was some guard up there with a machine gun on me, you know, when I was at the nuclear plant the other day. So we use lots of things daily that are dangerous, but we generally pay some attention to how they're used.
- They are getting confused between the possible and the probable. Let me explain – It is possible I will become a billonaire in the next 10 years and will have a personal jet . The probability of that happening is 0.0000001%. Buffett’s option bet stands to lose 37 billion dollars if the 4 indices on which he has written the puts go to zero. Let me tell you this – If these four main markets go to 0 in the next 10-15 years, money would be least of our worries. I for one be forced to work on a farm or forage for food as the markets as we know would not exist.
When I first read of these puts, my thought process was that these were akin to an insurance contract based on a long term event with the premium paid upfront (similar for CAT insurance written by Berkshire hathaway). Buffett has explained it in a similar manner in detail in the annual report. I would recommend you to read the explaination in detail.
In addition, the option bet is equivalent to taking a long term loan where the interest rate of the loan can vary depending on the final payout.
Drop in profits
Most of headlines are screaming a major drop in profits. Buffett in clear, uncertain language has written that the profits of his company are very lumpy and will vary depending on the sale of investments. In certain years, buffett sells off overvalued investments and those gains are realised in the net profit. In the subsequent years, in absence of any such gain the year on year comparison looks bad (look at page 28 of the annual report and the explainatory note at the bottom)
The company’s operating business had a approximate cash flow of 9 bn. However various write offs and other change has result in a drop in the quarter’s net profit. The bad economy has definitely affected the company, but the results are not as bad as they appear on the face of it.
Mea culpa
Buffett has admitted to two mistakes - his timing on purchasing Conco phillips and two irish banks. I have been reading and following buffett over a decade and have seen his mistakes to be sometime more profitable than most of the successes of other people. In any case, these could be genuine mistakes and could cost Berkshire 1-2 % of their networth in the worst case scenario.
Looking closely
If you look closely at the results and compare across the years, you will see that the insurance subs and utilities are doing well. Float continue to increase at a steady rate with cost of the float being below zero (which is more important than premium growth) . Both these subs which form a major portion of Berkshire’s business have actually done well compared to the overall economic environment.
The other business are doing quite fine considering the horrible economic environment (see pg 61 of the 2008 annual report)
But the price has dropped ?
Yes the price has dropped and the CDS spreads have widened. Do you always believe the market to be right and the price to be aribiter of value ? Well then we are speaking different language. The markets are often but not always right.
Berkshire CDS spreads are at record levels signalling liquidity or credit issues. To validate that, look at the balance sheet of the company and you will find that the company has 25 billion of cash and equivalents (after all the investment which buffett has done last year). Do you really think a company with 11Bn+ operating cash flow and huge cash reserves will go bankrupt ?
Buffett fan ?
You can rightly accuse me of being a Buffett fan. However to that name, please add the names of Seth klarman, Phil fischer, Charlie munger, Marty whitman, Bill miller, eddie lampart, Rakesh jhunjhunwala and Chandrakant sampat.
I am follower of all great value investors and try to use every opportunity to learn from them. I have never blindly followed their picks or tried to imitate any of these investors, but I always try to learn from each one of them, even if they have been wrong a few times.
Let me ask you this – If you wanted to learn how to play cricket or golf or tennis, would you learn it from sachin tendulkar or Tiger woods or Roger federer (if they were ready to teach someone) ? Sure these players make mistakes and lose matches, but does that take away the fact that these players are the one of the greatest sportsmen in their fields?
It is easy for armchair players or armchair investors to critize from the comfort of their seats, especially after the event with a 20/20 hindsight. Majority of the criticism I have read about buffett and the other investors lacks rigrious detail and analysis and is usually along the lines – The stock price has dropped and hence he is doing something wrong !!.
Letter to shareholders from Warren buffett – Some thoughts
Warren buffett as most of you must be aware is considered as one of the foremost investors. He is the chairman of Berkshire Hathaway and publishes an annual letter to shareholders which is a must read for any aspiring or seasoned value investor. You can access his letters here. The 2008 letters was published more than a week ago and I downloaded it the moment it was posted and read through it immediately (yes I am a complete fan !).
Some thoughts –
The options bet
One of most discussed topic about buffett is the options bet he has taken. The argument goes like this – Buffett has claimed that derivatives are a weapon of financial mass destruction and yet he has gone ahead and invested in the same instruments. He is being irresponsible and has doomed his company by this bet
Those who write the above are highlighting two points of their own ignorance
- Derivatives are dangerous for those who don’t know what they are doing. This is similar to giving a knife in the hands of a child. I don’t think any journalist, no matter how anti – buffett would consider him to be a novice investor. He has clearly spelled out what kind of bet he has taken in the letter and what are the risks associated with these instruments.
Following is the comment by buffett on the same above point in a recent CNBC interview
JOE: Those are derivatives. You don't like derivatives, but you used them in that case, right?
BUFFETT: I--well, we've used derivatives for many, many years. I don't think derivatives are evil, per se, I think they are dangerous. I've always said they're dangerous. I said they were financial weapons of mass destruction. But uranium is dangerous, and I just went through a nuclear electric plant about two weeks ago. Cars are dangerous.
JOE: Yeah
BUFFETT: But I mean, every American wants to have one. You know, the--a lot of things can be dangerous, but generally we regulate how they're used. I mean, there was a--there was some guard up there with a machine gun on me, you know, when I was at the nuclear plant the other day. So we use lots of things daily that are dangerous, but we generally pay some attention to how they're used.
- They are getting confused between the possible and the probable. Let me explain – It is possible I will become a billonaire in the next 10 years and will have a personal jet . The probability of that happening is 0.0000001%. Buffett’s option bet stands to lose 37 billion dollars if the 4 indices on which he has written the puts go to zero. Let me tell you this – If these four main markets go to 0 in the next 10-15 years, money would be least of our worries. I for one be forced to work on a farm or forage for food as the markets as we know would not exist.
When I first read of these puts, my thought process was that these were akin to an insurance contract based on a long term event with the premium paid upfront (similar for CAT insurance written by Berkshire hathaway). Buffett has explained it in a similar manner in detail in the annual report. I would recommend you to read the explaination in detail.
In addition, the option bet is equivalent to taking a long term loan where the interest rate of the loan can vary depending on the final payout.
Drop in profits
Most of headlines are screaming a major drop in profits. Buffett in clear, uncertain language has written that the profits of his company are very lumpy and will vary depending on the sale of investments. In certain years, buffett sells off overvalued investments and those gains are realised in the net profit. In the subsequent years, in absence of any such gain the year on year comparison looks bad (look at page 28 of the annual report and the explainatory note at the bottom)
The company’s operating business had a approximate cash flow of 9 bn. However various write offs and other change has result in a drop in the quarter’s net profit. The bad economy has definitely affected the company, but the results are not as bad as they appear on the face of it.
Mea culpa
Buffett has admitted to two mistakes - his timing on purchasing Conco phillips and two irish banks. I have been reading and following buffett over a decade and have seen his mistakes to be sometime more profitable than most of the successes of other people. In any case, these could be genuine mistakes and could cost Berkshire 1-2 % of their networth in the worst case scenario.
Looking closely
If you look closely at the results and compare across the years, you will see that the insurance subs and utilities are doing well. Float continue to increase at a steady rate with cost of the float being below zero (which is more important than premium growth) . Both these subs which form a major portion of Berkshire’s business have actually done well compared to the overall economic environment.
The other business are doing quite fine considering the horrible economic environment (see pg 61 of the 2008 annual report)
But the price has dropped ?
Yes the price has dropped and the CDS spreads have widened. Do you always believe the market to be right and the price to be aribiter of value ? Well then we are speaking different language. The markets are often but not always right.
Berkshire CDS spreads are at record levels signalling liquidity or credit issues. To validate that, look at the balance sheet of the company and you will find that the company has 25 billion of cash and equivalents (after all the investment which buffett has done last year). Do you really think a company with 11Bn+ operating cash flow and huge cash reserves will go bankrupt ?
Buffett fan ?
You can rightly accuse me of being a Buffett fan. However to that name, please add the names of Seth klarman, Phil fischer, Charlie munger, Marty whitman, Bill miller, eddie lampart, Rakesh jhunjhunwala and Chandrakant sampat.
I am follower of all great value investors and try to use every opportunity to learn from them. I have never blindly followed their picks or tried to imitate any of these investors, but I always try to learn from each one of them, even if they have been wrong a few times.
Let me ask you this – If you wanted to learn how to play cricket or golf or tennis, would you learn it from sachin tendulkar or Tiger woods or Roger federer (if they were ready to teach someone) ? Sure these players make mistakes and lose matches, but does that take away the fact that these players are the one of the greatest sportsmen in their fields?
It is easy for armchair players or armchair investors to critize from the comfort of their seats, especially after the event with a 20/20 hindsight. Majority of the criticism I have read about buffett and the other investors lacks rigrious detail and analysis and is usually along the lines – The stock price has dropped and hence he is doing something wrong !!.
Some thoughts –
The options bet
One of most discussed topic about buffett is the options bet he has taken. The argument goes like this – Buffett has claimed that derivatives are a weapon of financial mass destruction and yet he has gone ahead and invested in the same instruments. He is being irresponsible and has doomed his company by this bet
Those who write the above are highlighting two points of their own ignorance
- Derivatives are dangerous for those who don’t know what they are doing. This is similar to giving a knife in the hands of a child. I don’t think any journalist, no matter how anti – buffett would consider him to be a novice investor. He has clearly spelled out what kind of bet he has taken in the letter and what are the risks associated with these instruments.
Following is the comment by buffett on the same above point in a recent CNBC interview
JOE: Those are derivatives. You don't like derivatives, but you used them in that case, right?
BUFFETT: I--well, we've used derivatives for many, many years. I don't think derivatives are evil, per se, I think they are dangerous. I've always said they're dangerous. I said they were financial weapons of mass destruction. But uranium is dangerous, and I just went through a nuclear electric plant about two weeks ago. Cars are dangerous.
JOE: Yeah
BUFFETT: But I mean, every American wants to have one. You know, the--a lot of things can be dangerous, but generally we regulate how they're used. I mean, there was a--there was some guard up there with a machine gun on me, you know, when I was at the nuclear plant the other day. So we use lots of things daily that are dangerous, but we generally pay some attention to how they're used.
- They are getting confused between the possible and the probable. Let me explain – It is possible I will become a billonaire in the next 10 years and will have a personal jet . The probability of that happening is 0.0000001%. Buffett’s option bet stands to lose 37 billion dollars if the 4 indices on which he has written the puts go to zero. Let me tell you this – If these four main markets go to 0 in the next 10-15 years, money would be least of our worries. I for one be forced to work on a farm or forage for food as the markets as we know would not exist.
When I first read of these puts, my thought process was that these were akin to an insurance contract based on a long term event with the premium paid upfront (similar for CAT insurance written by Berkshire hathaway). Buffett has explained it in a similar manner in detail in the annual report. I would recommend you to read the explaination in detail.
In addition, the option bet is equivalent to taking a long term loan where the interest rate of the loan can vary depending on the final payout.
Drop in profits
Most of headlines are screaming a major drop in profits. Buffett in clear, uncertain language has written that the profits of his company are very lumpy and will vary depending on the sale of investments. In certain years, buffett sells off overvalued investments and those gains are realised in the net profit. In the subsequent years, in absence of any such gain the year on year comparison looks bad (look at page 28 of the annual report and the explainatory note at the bottom)
The company’s operating business had a approximate cash flow of 9 bn. However various write offs and other change has result in a drop in the quarter’s net profit. The bad economy has definitely affected the company, but the results are not as bad as they appear on the face of it.
Mea culpa
Buffett has admitted to two mistakes - his timing on purchasing Conco phillips and two irish banks. I have been reading and following buffett over a decade and have seen his mistakes to be sometime more profitable than most of the successes of other people. In any case, these could be genuine mistakes and could cost Berkshire 1-2 % of their networth in the worst case scenario.
Looking closely
If you look closely at the results and compare across the years, you will see that the insurance subs and utilities are doing well. Float continue to increase at a steady rate with cost of the float being below zero (which is more important than premium growth) . Both these subs which form a major portion of Berkshire’s business have actually done well compared to the overall economic environment.
The other business are doing quite fine considering the horrible economic environment (see pg 61 of the 2008 annual report)
But the price has dropped ?
Yes the price has dropped and the CDS spreads have widened. Do you always believe the market to be right and the price to be aribiter of value ? Well then we are speaking different language. The markets are often but not always right.
Berkshire CDS spreads are at record levels signalling liquidity or credit issues. To validate that, look at the balance sheet of the company and you will find that the company has 25 billion of cash and equivalents (after all the investment which buffett has done last year). Do you really think a company with 11Bn+ operating cash flow and huge cash reserves will go bankrupt ?
Buffett fan ?
You can rightly accuse me of being a Buffett fan. However to that name, please add the names of Seth klarman, Phil fischer, Charlie munger, Marty whitman, Bill miller, eddie lampart, Rakesh jhunjhunwala and Chandrakant sampat.
I am follower of all great value investors and try to use every opportunity to learn from them. I have never blindly followed their picks or tried to imitate any of these investors, but I always try to learn from each one of them, even if they have been wrong a few times.
Let me ask you this – If you wanted to learn how to play cricket or golf or tennis, would you learn it from sachin tendulkar or Tiger woods or Roger federer (if they were ready to teach someone) ? Sure these players make mistakes and lose matches, but does that take away the fact that these players are the one of the greatest sportsmen in their fields?
It is easy for armchair players or armchair investors to critize from the comfort of their seats, especially after the event with a 20/20 hindsight. Majority of the criticism I have read about buffett and the other investors lacks rigrious detail and analysis and is usually along the lines – The stock price has dropped and hence he is doing something wrong !!.
Monday, March 02, 2009
How we decide
I recently came across a book – How we decide ? This is a book about decision making and how humans make decisions under various circumstances. Although this book is not on some best seller list or by a very well known author, I found the book good and learned quite a bit from it.
Let me list some of my key learning’s from the book
- The rational brain - prefrontal cortex is involved in rational decision making and can evaluate only a limited number of variables and data elements at a time. However our emotional brain, the amygdala and other parts are the hidden supercomputers of the brain. They are able to process more pieces of information and can do so much faster. The reason is evolution. When facing an immediate danger, such as a tiger, the emotional brain had to process the information quickly and cause a fight or flight response. There was no time to sit and think in such a situation.
- The standard model of decision-making has been the rationality based model. Emotions are considered bad for decision making and corrupt our thinking process. That however is not true. Emotions can and do lead us astray, but they are crucial to decision making. The emotional brain and the rational brain are constantly communicating with each other and help us in arriving at our decisions.
- The decision process is a not a smooth process involving the rational brain alone. It is actually an argument where the emotional brain and rational brain go back and forth and based on the situation a final decision is reached.
- The learning process of the brain has a big emotional component. The dopamine system is involved in this process. Whenever we commit a mistake, the dopamine levels drop in the brain and we ‘feel’ bad about it. The emotional centers of the brain encode this memory and use it for later decision making.
- Emotions mislead us several situations. For example, the normal response to price drops in the market is fear and panic. The typical response of most of the investors is to exit the market to avoid the pain and fear. However this is often an incorrect response. A rational and calm response would be to look at the individual stocks and evaluate the expected value at the given price. A decision should then been taken based on this number, than based on emotions.
Some key learning’s for investors (my conclusions)
- Stock market investing is all about decision making under uncertainty. As investors, we can never have complete and full information. Perfect information is a myth. No one can ever know all there is to know about a company, much less an industry or the market.
- A perfectly rational investor is an incorrect model. The above book and several other books I have been reading, point out that the best investors are able to combine rational thinking with their emotions.
- Emotions are formed based on repeated experiences in a particular field. These emotions are referred to by several terms – intuition, gut feel etc. As one develops experience, the learning’s are encoded in the brain as emotions or intuitions. However one should not rely on emotions when starting out as an investor. At that time, one does not have enough experience and the emotions have not developed fully. However as one gains experience, one should learn to trust one’s instincts or at least be mindful of them.
I have personally faced this several times. When analyzing a company, all the numbers will look fine and the company looks undervalued. However some stray facts or a few points will keep troubling me. In most of the instance, where I have ignored such feelings, I have regretted later.
- Smart investing is a mix of rational thinking combined with emotional learning. As one matures as an investor, one should learn to tune in to emotions and gut feel and try to at least understand what they are telling us. You will rarely see investors talk about gut feel or emotions. They are considered too soft or not macho enough!. That is however foolish. The human brain does not work that way. Decision making is a mix of rational thought and emotions. Ignoring emotions means using only a limited power of your brain.
- Novel problems require thinking and should not be based on emotions. When analyzing a new company or business model, do not rely on emotions alone. One should think rationally and assemble all facts before making a decision.
- Embrace uncertainty – It is amazing the level of confidence most people have on their investment. Analysts writing about a company, will provide you projections for the next 3-5 years. Sometimes these projections are not even round numbers (like sales would 1244 crs in FY2010). What crap !. Nothing is absolutely certain in the stock market. There are only varying levels of certainty. To simplify it, I look at low (20-30% probability), medium (around 50%) or high level of probability (around 70-80%) for any specific scenario. In addition, I always believe in developing multiple scenarios when trying to come up with an intrinsic value number. As a result you would have noticed that my estimates are generally in a range and not a fixed number
- Entertain competing hypothesis – One should always be open to counter arguments to one’s investment idea. That allows one to accept contradictory information and weigh it properly. I try to constantly look for points, which go against my investment idea though i am not sure how successful I am at it.
- Finally think about thinking. One should constantly analyze one’s decision making and thinking process. You should be able to look at your thought process objectively and look at ways of improving it ( read this process v/s outcome article by Michael J. Mauboussin ). This blog is my approach of doing it, though in a public fashion. In addition, I always write down my investment thesis when I am looking at an idea and also how I feel about it (though I don’t publish it as they are my private thoughts).
I would strongly recommend you to read this book. It is a very good book and has several crucial points on how the human mind works and how one can improve his or her decision making.
Let me list some of my key learning’s from the book
- The rational brain - prefrontal cortex is involved in rational decision making and can evaluate only a limited number of variables and data elements at a time. However our emotional brain, the amygdala and other parts are the hidden supercomputers of the brain. They are able to process more pieces of information and can do so much faster. The reason is evolution. When facing an immediate danger, such as a tiger, the emotional brain had to process the information quickly and cause a fight or flight response. There was no time to sit and think in such a situation.
- The standard model of decision-making has been the rationality based model. Emotions are considered bad for decision making and corrupt our thinking process. That however is not true. Emotions can and do lead us astray, but they are crucial to decision making. The emotional brain and the rational brain are constantly communicating with each other and help us in arriving at our decisions.
- The decision process is a not a smooth process involving the rational brain alone. It is actually an argument where the emotional brain and rational brain go back and forth and based on the situation a final decision is reached.
- The learning process of the brain has a big emotional component. The dopamine system is involved in this process. Whenever we commit a mistake, the dopamine levels drop in the brain and we ‘feel’ bad about it. The emotional centers of the brain encode this memory and use it for later decision making.
- Emotions mislead us several situations. For example, the normal response to price drops in the market is fear and panic. The typical response of most of the investors is to exit the market to avoid the pain and fear. However this is often an incorrect response. A rational and calm response would be to look at the individual stocks and evaluate the expected value at the given price. A decision should then been taken based on this number, than based on emotions.
Some key learning’s for investors (my conclusions)
- Stock market investing is all about decision making under uncertainty. As investors, we can never have complete and full information. Perfect information is a myth. No one can ever know all there is to know about a company, much less an industry or the market.
- A perfectly rational investor is an incorrect model. The above book and several other books I have been reading, point out that the best investors are able to combine rational thinking with their emotions.
- Emotions are formed based on repeated experiences in a particular field. These emotions are referred to by several terms – intuition, gut feel etc. As one develops experience, the learning’s are encoded in the brain as emotions or intuitions. However one should not rely on emotions when starting out as an investor. At that time, one does not have enough experience and the emotions have not developed fully. However as one gains experience, one should learn to trust one’s instincts or at least be mindful of them.
I have personally faced this several times. When analyzing a company, all the numbers will look fine and the company looks undervalued. However some stray facts or a few points will keep troubling me. In most of the instance, where I have ignored such feelings, I have regretted later.
- Smart investing is a mix of rational thinking combined with emotional learning. As one matures as an investor, one should learn to tune in to emotions and gut feel and try to at least understand what they are telling us. You will rarely see investors talk about gut feel or emotions. They are considered too soft or not macho enough!. That is however foolish. The human brain does not work that way. Decision making is a mix of rational thought and emotions. Ignoring emotions means using only a limited power of your brain.
- Novel problems require thinking and should not be based on emotions. When analyzing a new company or business model, do not rely on emotions alone. One should think rationally and assemble all facts before making a decision.
- Embrace uncertainty – It is amazing the level of confidence most people have on their investment. Analysts writing about a company, will provide you projections for the next 3-5 years. Sometimes these projections are not even round numbers (like sales would 1244 crs in FY2010). What crap !. Nothing is absolutely certain in the stock market. There are only varying levels of certainty. To simplify it, I look at low (20-30% probability), medium (around 50%) or high level of probability (around 70-80%) for any specific scenario. In addition, I always believe in developing multiple scenarios when trying to come up with an intrinsic value number. As a result you would have noticed that my estimates are generally in a range and not a fixed number
- Entertain competing hypothesis – One should always be open to counter arguments to one’s investment idea. That allows one to accept contradictory information and weigh it properly. I try to constantly look for points, which go against my investment idea though i am not sure how successful I am at it.
- Finally think about thinking. One should constantly analyze one’s decision making and thinking process. You should be able to look at your thought process objectively and look at ways of improving it ( read this process v/s outcome article by Michael J. Mauboussin ). This blog is my approach of doing it, though in a public fashion. In addition, I always write down my investment thesis when I am looking at an idea and also how I feel about it (though I don’t publish it as they are my private thoughts).
I would strongly recommend you to read this book. It is a very good book and has several crucial points on how the human mind works and how one can improve his or her decision making.
How we decide
I recently came across a book – How we decide ? This is a book about decision making and how humans make decisions under various circumstances. Although this book is not on some best seller list or by a very well known author, I found the book good and learned quite a bit from it.
Let me list some of my key learning’s from the book
- The rational brain - prefrontal cortex is involved in rational decision making and can evaluate only a limited number of variables and data elements at a time. However our emotional brain, the amygdala and other parts are the hidden supercomputers of the brain. They are able to process more pieces of information and can do so much faster. The reason is evolution. When facing an immediate danger, such as a tiger, the emotional brain had to process the information quickly and cause a fight or flight response. There was no time to sit and think in such a situation.
- The standard model of decision-making has been the rationality based model. Emotions are considered bad for decision making and corrupt our thinking process. That however is not true. Emotions can and do lead us astray, but they are crucial to decision making. The emotional brain and the rational brain are constantly communicating with each other and help us in arriving at our decisions.
- The decision process is a not a smooth process involving the rational brain alone. It is actually an argument where the emotional brain and rational brain go back and forth and based on the situation a final decision is reached.
- The learning process of the brain has a big emotional component. The dopamine system is involved in this process. Whenever we commit a mistake, the dopamine levels drop in the brain and we ‘feel’ bad about it. The emotional centers of the brain encode this memory and use it for later decision making.
- Emotions mislead us several situations. For example, the normal response to price drops in the market is fear and panic. The typical response of most of the investors is to exit the market to avoid the pain and fear. However this is often an incorrect response. A rational and calm response would be to look at the individual stocks and evaluate the expected value at the given price. A decision should then been taken based on this number, than based on emotions.
Some key learning’s for investors (my conclusions)
- Stock market investing is all about decision making under uncertainty. As investors, we can never have complete and full information. Perfect information is a myth. No one can ever know all there is to know about a company, much less an industry or the market.
- A perfectly rational investor is an incorrect model. The above book and several other books I have been reading, point out that the best investors are able to combine rational thinking with their emotions.
- Emotions are formed based on repeated experiences in a particular field. These emotions are referred to by several terms – intuition, gut feel etc. As one develops experience, the learning’s are encoded in the brain as emotions or intuitions. However one should not rely on emotions when starting out as an investor. At that time, one does not have enough experience and the emotions have not developed fully. However as one gains experience, one should learn to trust one’s instincts or at least be mindful of them.
I have personally faced this several times. When analyzing a company, all the numbers will look fine and the company looks undervalued. However some stray facts or a few points will keep troubling me. In most of the instance, where I have ignored such feelings, I have regretted later.
- Smart investing is a mix of rational thinking combined with emotional learning. As one matures as an investor, one should learn to tune in to emotions and gut feel and try to at least understand what they are telling us. You will rarely see investors talk about gut feel or emotions. They are considered too soft or not macho enough!. That is however foolish. The human brain does not work that way. Decision making is a mix of rational thought and emotions. Ignoring emotions means using only a limited power of your brain.
- Novel problems require thinking and should not be based on emotions. When analyzing a new company or business model, do not rely on emotions alone. One should think rationally and assemble all facts before making a decision.
- Embrace uncertainty – It is amazing the level of confidence most people have on their investment. Analysts writing about a company, will provide you projections for the next 3-5 years. Sometimes these projections are not even round numbers (like sales would 1244 crs in FY2010). What crap !. Nothing is absolutely certain in the stock market. There are only varying levels of certainty. To simplify it, I look at low (20-30% probability), medium (around 50%) or high level of probability (around 70-80%) for any specific scenario. In addition, I always believe in developing multiple scenarios when trying to come up with an intrinsic value number. As a result you would have noticed that my estimates are generally in a range and not a fixed number
- Entertain competing hypothesis – One should always be open to counter arguments to one’s investment idea. That allows one to accept contradictory information and weigh it properly. I try to constantly look for points, which go against my investment idea though i am not sure how successful I am at it.
- Finally think about thinking. One should constantly analyze one’s decision making and thinking process. You should be able to look at your thought process objectively and look at ways of improving it ( read this process v/s outcome article by Michael J. Mauboussin ). This blog is my approach of doing it, though in a public fashion. In addition, I always write down my investment thesis when I am looking at an idea and also how I feel about it (though I don’t publish it as they are my private thoughts).
I would strongly recommend you to read this book. It is a very good book and has several crucial points on how the human mind works and how one can improve his or her decision making.
Let me list some of my key learning’s from the book
- The rational brain - prefrontal cortex is involved in rational decision making and can evaluate only a limited number of variables and data elements at a time. However our emotional brain, the amygdala and other parts are the hidden supercomputers of the brain. They are able to process more pieces of information and can do so much faster. The reason is evolution. When facing an immediate danger, such as a tiger, the emotional brain had to process the information quickly and cause a fight or flight response. There was no time to sit and think in such a situation.
- The standard model of decision-making has been the rationality based model. Emotions are considered bad for decision making and corrupt our thinking process. That however is not true. Emotions can and do lead us astray, but they are crucial to decision making. The emotional brain and the rational brain are constantly communicating with each other and help us in arriving at our decisions.
- The decision process is a not a smooth process involving the rational brain alone. It is actually an argument where the emotional brain and rational brain go back and forth and based on the situation a final decision is reached.
- The learning process of the brain has a big emotional component. The dopamine system is involved in this process. Whenever we commit a mistake, the dopamine levels drop in the brain and we ‘feel’ bad about it. The emotional centers of the brain encode this memory and use it for later decision making.
- Emotions mislead us several situations. For example, the normal response to price drops in the market is fear and panic. The typical response of most of the investors is to exit the market to avoid the pain and fear. However this is often an incorrect response. A rational and calm response would be to look at the individual stocks and evaluate the expected value at the given price. A decision should then been taken based on this number, than based on emotions.
Some key learning’s for investors (my conclusions)
- Stock market investing is all about decision making under uncertainty. As investors, we can never have complete and full information. Perfect information is a myth. No one can ever know all there is to know about a company, much less an industry or the market.
- A perfectly rational investor is an incorrect model. The above book and several other books I have been reading, point out that the best investors are able to combine rational thinking with their emotions.
- Emotions are formed based on repeated experiences in a particular field. These emotions are referred to by several terms – intuition, gut feel etc. As one develops experience, the learning’s are encoded in the brain as emotions or intuitions. However one should not rely on emotions when starting out as an investor. At that time, one does not have enough experience and the emotions have not developed fully. However as one gains experience, one should learn to trust one’s instincts or at least be mindful of them.
I have personally faced this several times. When analyzing a company, all the numbers will look fine and the company looks undervalued. However some stray facts or a few points will keep troubling me. In most of the instance, where I have ignored such feelings, I have regretted later.
- Smart investing is a mix of rational thinking combined with emotional learning. As one matures as an investor, one should learn to tune in to emotions and gut feel and try to at least understand what they are telling us. You will rarely see investors talk about gut feel or emotions. They are considered too soft or not macho enough!. That is however foolish. The human brain does not work that way. Decision making is a mix of rational thought and emotions. Ignoring emotions means using only a limited power of your brain.
- Novel problems require thinking and should not be based on emotions. When analyzing a new company or business model, do not rely on emotions alone. One should think rationally and assemble all facts before making a decision.
- Embrace uncertainty – It is amazing the level of confidence most people have on their investment. Analysts writing about a company, will provide you projections for the next 3-5 years. Sometimes these projections are not even round numbers (like sales would 1244 crs in FY2010). What crap !. Nothing is absolutely certain in the stock market. There are only varying levels of certainty. To simplify it, I look at low (20-30% probability), medium (around 50%) or high level of probability (around 70-80%) for any specific scenario. In addition, I always believe in developing multiple scenarios when trying to come up with an intrinsic value number. As a result you would have noticed that my estimates are generally in a range and not a fixed number
- Entertain competing hypothesis – One should always be open to counter arguments to one’s investment idea. That allows one to accept contradictory information and weigh it properly. I try to constantly look for points, which go against my investment idea though i am not sure how successful I am at it.
- Finally think about thinking. One should constantly analyze one’s decision making and thinking process. You should be able to look at your thought process objectively and look at ways of improving it ( read this process v/s outcome article by Michael J. Mauboussin ). This blog is my approach of doing it, though in a public fashion. In addition, I always write down my investment thesis when I am looking at an idea and also how I feel about it (though I don’t publish it as they are my private thoughts).
I would strongly recommend you to read this book. It is a very good book and has several crucial points on how the human mind works and how one can improve his or her decision making.
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