Investing in Equities -part 2

I will share with 14 questions that we need to ask before we invest in any share – these questions describe the way Warren Buffet analyses companies – these questions are not mine – it is from a very popular book called Buffetology by Mary Buffet – she had access to Buffett’s thought process as she was his daughter in law for 12 years and she has described his philosophy of investing in the book - I have tried to follow it since 2003 and it has given me good results. 

I will also take the example of CRISIL to discuss the issues raised in these questions. As a starting point, I have uploaded the Balance sheet and the P&L statement of Crisil of the past 10 years along with some calulations – it is available in  http://www.slideshare.net/sgrajasekharan/crisil-data . Before you go ahead with my questions, it is suggested that you look at this data of Crisil. The presentation made in this session is also available for download in http://www.slideshare.net/sgrajasekharan/wealth-management-session-3.

So here are questions that we need to ask:

Q1 – Does the company have an identifiable durable competitive advantage?

The company must have product /service offerings that is somehow unique and difficult to reproduce – strong brands, entry barriers (like telecom licensing in India) or technology leadership (like patents in Pharma industry) are good examples of identifiable durable competitive advantage. Normally companies in this category would have strong upward trend in earnings ( Crisil’s Net profits have consistently increased over the last 10 years) – these companies normally are cash rich and do not need excessive debt ( Crisil has zero debts for the past 10 years) and a high return on shareholder’s equity (Crisil’s average ROE for the past 10 years is 23%).

The answer for CRISL is a YES – it is a well respected brand, a market leader and a pioneer in this industry in India and it’s financials also show that it has a durable competitive advantage

Q2 – Do you understand how the company’s business model works?

Before investing in even a single stock – you will need to figure out the industry dynamics – the key areas where the target company is strong vis a vis it’s competitors –and what is required for the company to survive in the next two decades.

Crisil’s business is based on it’s internal processes and templates that has been perfected over the years, on it’s ability to attract and retain talent and it’s good track record.  So the answer to this question is also YES.

Q3 -What is the chance that the product /service/business model would be obsolete in the next 20 years?

Will there be a market for this product /service 20 years from now and will the company be able to manage the changes that can happen in technology, consumer preferences etc.

Crisil’s product /service offerings will be required after 20 years as well – rating is an expert’s job and one cannot automate it fully and there will always be investment opportunities that need to be rated. So the answer to this question is also YES.

Q4 - Does the company allocate capital exclusively in the realm of expertise?

Does the company sticks to what is knows best and does not invests in completely new businesses. What has been the track record in this area in the last 10 years.

Crisil has not had any unrelated diversifications in the past 10 years and it is allocating capital to it’s realms of expertise. Here too we will give a Yes answer

Q5 - What has been the company’s EPS history and growth rate?

Earnings per share is a very good starting point to see the financial performance. The company that we will short list for investing should have a consistently good record of growth of EPS over the past 10 years – erratic EPS growths and dips will disqualify the company from our shortlist.

Crisil has had a good growth of EPS from Rs 20.83 per share in 2000 to Rs 208 per share in 2009. There has been two years where there were dips in the EPS  - one of them 2001 is not a minor dip  - but we also know that in 2001 there was a global slowdown post the Ecommerce bust in the US markets . So the answer to this question is also YES.

Q6 - Is the company consistently earning high Return on equity?

Return on Equity = Reported Net profit / Net worth

The company must show a consistently high ROE over the past ten years – In India, an average ROE above 20% would qualify as a high ROE.

Crisil’s average ROE for the past 10 years is 23% and hence the answer to this question is also YES.

Q7 - Is the company consistently earning high Return on total capital employed (ROCE) ?

Return on total capital employed = Reported Net profit / (Net worth + secured loans+ unsecured loans)

Like in the last question, the company must show a consistently high ROE over the past ten years – we need to compare the ROCE with it’s peers in the industry.

Crisil has no debts and hence it’s average ROCE for the past 10 years is a very high 23% and hence the answer to this question is also YES.

Q8 - Is the company conservatively financed?

This question again looks at the debt coverage for the company – companies that we want to shortlist and invest must have strong cash flows and hence would be cash rich and would not have requirements for large long term debts.

Crisil has no debts and hence the answer to this question is also YES.

Q9 - Has the company been buying back its shares?

Cash rich companies have the option of reinvesting their earnings within the company by buying back it’s shares – if there is a history of share buyback, then there is a good chance that the company is financially strong.

Crisil does not have a history of buyback – in fact it has increased it’s number of shares from 62 lac shares to 72.25 lac shares in the period 2000 to 2010. However, we will progress forward with our shortlisting despite a NO as an answer.

Q10 - Is the company free to adjust prices to inflation?

Companies with sustainable competitive advantage would be able to increase the prices to inflation without the risk of losing significant volume of sale –this means that the profitability of the company will not be eroded overtime by inflation.

Crisil, we believe, can increase it’s prices and hence the answer to this question is also YES.

 Q11 – The company should not need to constantly reinvest in capital?

Retained earnings must first go toward maintaining current operations at competitive levels, so the lower the amount needed to maintain current operations, the better.

Crisil does not really need too much of reinvestment to keep it’s operation running. Hence the answer is again a Yes.

Till now Crisil has passed all the filters – just take any company of your choice and try answering these questions – you will be surprised with the discovery that very well known companies would not pass these filters. Only after the company passes these 11 questions with a Yes answer, does it qualify for our investment.  Once it is qualified, then we need to look at whether the current price in the market is right to enter or not. That will be covered in the last three questions.

 I would share the last three questions in a day or two – through those questions, we will qualify the current share price as low or high and also forecast the future share price ten years from now - that will ultimately decide at what price the share is a good buy.

Investing in Equities -part 1

In this session, I would like to share with you the basic strategies that Warren Buffet has followed over the past five decades.

Warren started out early in life - as a school kid, he made money selling lemonades and having a news paper route. At the age of 14, with his earnings, he bought 40 acres of land and rented it out. In college, he studied Value investing under Benjamin Graham –the father of value investing. Value investing denotes an approach where investors pick up stocks at rock bottom prices.  He went into stock broking after college and by the age of thirty, he was a millionaire. He started Buffet associates in 1962 - over time bought a dying textile mill called Berkshire Hathaway. Using the cash generated from the mill, he slowly invested in other companies – overtime these investments overshadowed the textile operation and in 1985, he shut down the textile business altogether. His investments have given a CAGR of 20% plus between 1964 and 2009 and today, he is the third richest person in the 2010 Forbes list with a net worth of USD 47 Billion.

The basic investment philosophy of Warren can be described in the following Buffet quotes:

·         Rule No.1: Never lose money.   Rule No.2: Never forget rule No.1.

·         You don't need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.

·         All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies.

·         If a business does well, the stock eventually follows.

·         The best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago.

·         Time is the friend of the wonderful company, the enemy of the mediocre.

·         Never invest in a business you cannot understand.

·         Risk comes from not knowing what you're doing.

·         Wide diversification is only required when investors do not understand what they are doing.

·         Diversification may preserve wealth, but concentration builds wealth.

·         What we learn from history is that people don't learn from history.

Warren believes that any equity investor should view the company in the same way as any business person buying up the whole company –focussing on its cash generating potential in the future   – overtime the company that has a superior cash generating potential would give a good value appreciation of the stock.

Warren identifies excellent businesses and then sets out to acquire the shares of the business if the price is right.  Once invested, he holds the investment for long term until the business loses its attractiveness or until a more attractive alternative investment becomes available.

In this session, I describe 14 questions that one must ask before investing in any company. I also take an example of CRISIL to explain these questions – at the end of these 14 questions, we will arrive at two ways of projecting the stock price of CRISIL in 2020 – and this would then give us the 10 year CAGR if you invested in CRISIL today – I also share results of the same calculation on CRISIL done in 2003 and see what the results looked like today.

For details of these 14 questions, you will need to wait for a few more days. Patience is one of the halmark of good investors :-)

Introduction to Mutual funds

Here is a real life case – the name has been changed though.

My presentation for this session can be downloaded from http://www.slideshare.net/sgrajasekharan/wealth-management-session-2

Rashmi had finished her MBA in 2008  – lived in Bangalore with her friends –– was employed in a mid tier IT services firm – had a saving of about 20 K per month. She had come to me for advice regarding investments - this was in Aug 2009. She had looked at options like recurring deposits, fixed deposits, and post office schemes. She knew investment in equity was a high risk / high returns option - was not sure where to start.

Post discussing her needs the following points emerged:

1.       She must not use the Fixed deposit, Recurring deposit or Post office schemes as the returns from these schemes just match the inflation levels in India.

2.       She must not buy specific stocks directly as she is not got enough hands on knowledge in stock markets.

3.       She must look at a time frame of at least 3 years for any investment – in fact the longer the better.

4.       She must start immediately as she had not done anything on these lines since she started earning one year back.

5.       We decided that it was a good time to invest in mutual funds that had equity investments – it would give her

a.       the returns that equity investments gave with a lower risk vis a vis direct equity investment as the MF’s were diversified.

b.      access to professionals who managed the funds at a cost that was miniscule

c.       the flexibility to invest every month through Systematic investment plans if she wanted

d.      there was transparency on the value, as the Net Asset Values of the MF’s were calculated daily for the open ended funds

e.      she had the freedom to exit anytime after paying the exit load

f.        she had many choices as to which MF to invest in.

Deciding on which MF to invest in was the next step – the key factors that we took into consideration was

·         the past performance of the fund, even though we knew that the past performance does not guarantee future performance

·         the ratings for the MF - we got it from http://www.moneycontrol.com/mutualfundindia/ and http://valueresearchonline.com/

·         look at the background of the fund manager and see how successful he has been

·         look at the offer documents of the MF and see the detailed investment objectives

·         look at the size of corpus that the fund is managing –the larger the better

Based on these parameters, Rashmi invested in two equity funds through the SIP route – where the money is transferred every month from her bank account automatically.

Today, in Sept 2010, she is glad that she took these steps as her investment has appreciated by over 30%  in the past 12 months.

 She intends to continue with this SIP for the next two years and as of now she is educating herself on the other investment options available in India.

This case sums up what we discussed in the class -although in a different format - for more information - you can download the ppt -the url is shared early in the blog.

Overview of Financial planning and Wealth management

Hello students - This week onwards, for the next ten weeks, we will explore the various facets of wealth management - remember that Wealth management is for managing your own wealth - aimed at making you financially independent - where one does not need to work to maintain your lifestyle - as we go through the classes every week, my blog also will follow with one update every week.


My plan to cover Wealth management in the next ten sessions is as follows:

Session 1 - Overview of financial planning and Wealth management

Session 2 and 3 - Equity, Debt and Mutual funds

Session 4 -Insurance, Derivatives and Bullion

Session 5 -Real Estate, Private Equity and Venture capital

Session 6 -Macro Economics

Session 7 -Tax planning, Retirement planning and Estate planning

Session 8 - Wealth management industry in India

Session 9 and Session 10 - executive interaction and Wrap up

The first session aims at making you realize that each of us, irrespective of our backgrounds, can become financially independent - all that we need to do is create a personal long term financial cash flow plan and a focus on getting good % returns on our savings.

My presentation and the excel sheet that I use for this session can be downloaded from

http://www.slideshare.net/sgrajasekharan/wealth-management-session-1

http://www.slideshare.net/sgrajasekharan/financial-planning-template

Robert Kiyosaki in his book “Rich dad, Poor Dad” has defined Assets as any item that produces an income and Liabilities as any item that produces an expense. In order to reach financial independence, you need to amass assets and keep liabilities to the minimum possible. For example -a car for personal use and a house where you stay will be classified as a liability as it creates a cash outflow - and the same car used as a taxi or a the same house given for a rental will be classified as an asset as it creates a cash inflow.

You need to invest in more and more assets, which over time will create bigger and bigger cash inflows - and over time, this cash inflow from assets will take care of your living expenses and you will be financially independent.

Each one of us have three areas where we must focus in order to become financially independent:

Salary - our cash Inflow

Expenses - our cash outflow

Savings - the net of cash Inflows minus outflows

As future professionals, most of you will be focused on the salary - being aware of what you make in your job, what your peers are making in their jobs and as most professionals, we believe that for reaching financial independence, you need to get a high salary. That’s not fully true.

Then there are people amongst you, who will go one step further and have a reasonably accurate measure of what the expenses are - hence know what the net savings would be - the belief is that controlling expenses and having a good salary will make you financially independent -that too is not fully true.

Both these are reasonable approaches - but not good enough to ensure financial independence - the only sure shot way to reach financial independence is to focus on the % returns from your savings - focus on investing in areas where you get better % returns. For example a Fixed deposit that gives 8% returns is not good enough as inflation in India is also 8% (also interest in FD is taxed) - so FD is not an investment that will take you to financial independence but most of us do not see FD in this way as it is a safe (and if I may add - lazy) place to park our savings.

So a clear focus on savings and the % return is needed to reach financial independence - We must have our money working hard for us - so that we do not have to work hard and have time to do things that we always wanted to do.

In this session, we have jointly prepared a 50 year (long term) cash flow plan - for a young MBA who will be shortly married - we have made some reasonable assumptions of their income, expenses, life time expenses (things like children’s education, parent’s health, holidays etc), inflation and returns from investments. This data is given in the excel sheet and anyone can customize this sheet and make a personal financial plan.

I urge each one of you to make a personal financial plan - make reasonable assumptions as you see fit - and over the next few years, revise the plan regularly - and you will be on your way to reach financial independence. The earlier we start, the faster we will reach this stage - hence it makes sense to start it now - even though you are not earning as of now.

In the next few sessions, we will address the various options that we have in India for investments. If we can be smart and get about 25-30% returns on our investment (at this stage of life -when you are starting your careers) - you will reach financial independence in about 12 -15 years.

I know many people, who have been able to achieve this. And we will jointly explore the various options available for us as we go through this exciting journey of Wealth management.

I want you to realize that it is not necessary to do extraordinary things to get extraordinary results - you just need to plan well and be focused and consistent over time.

My objectives of blogging and views on Wealth management

The objective of starting this blog is to help my MBA students with additional content to get a better perspective of the subjects discussed. This trimester, I am teaching two courses, Wealth management and Entrepreneurship, in Christ University Institute of Management in Bangalore. Through this blog, I intend to share my views and contents on these two subjects.


Let me start with Wealth management.

I believe wealth management is not just for MBA finance students –every graduate must go through the basics of wealth management. After all each one of us should know how to manage our own wealth. As one progresses in life and career, one will earn and save – with the expectation of India’s economy growing at 8% and above for the coming decade – everyone will do well financially in the years to come - and in that context, everyone needs to have a long term plan for achieving what I call “financial independence” – a stage where one does not need to work to earn a living – a stage when the money saved and invested gives you enough returns to fund your lifestyle. Once you reach this stage of financial independence, you can be free to follow your dreams.

There are many ways of doing this – and wealth management will expose you to the various ways this can be achieved. This course is a journey where you will learn about various asset classes where you can invest -you will learn the role of insurance in wealth management - we will discuss retirement planning and estate planning - plus we will discuss the wealth management industry in India and what is required to succeed if you want to make this your career. Through this course, you will also realise that the earlier you start in this journey, the better it will be for you. As you learn to manage your own wealth – you would be better equipped to manage other’s wealth too. Then you are truly a wealth manager.

Warren Buffet had once said “Wall street is the only place that people ride to in a Rolls Royce to get advice from those who take a subway”. It is similar here in India – many young wealth managers in India do not practice wealth management in their personal lives - and that is what we need to change.

Looking around, I do not see much activity in this space addressed at the common man –there are courses for specialists – but for a common man there is not much training available – there is one company called Finshiksha (http://finshiksha.com/) that is starting to do some good work in creating awareness for wealth management for the common man in India.

My course is intended to help you become financially independent early in life – I will help you to make a long term (30 year) financial plan for yourself - I believe that if you can manage your own wealth, then you will be truly qualified to become a professional wealth manager – if that’s what you want to do in life.