Millionaires portfolio – part 2

In October 2011 blog, I had recommended 5 stocks at the prices prevailing then -  all the five stocks (SBI, BHEL, Bajaj Auto, Esab Industries and Maharashtra seamless) are still hovering in the same range today and are still worth buying.

The methodology used for stock valuation is given in detail in my Sept 2010 blog - you can go back and look at it, if you wish. It is based on based on the historical earning per share growth rate (EPS CAGR) and the price earnings multiples (PE) for the company (over the past ten years) – using this past data, we can forecast the future stock prices beyond five years with a very high degree of certainty - especially for select companies that have an identifiable durable competitive advantage that cannot go away easily in the future decade.

Warren Buffet and Peter Lynch are known to follow these principles in stock picking - these are simple and straightforward methods and taught in MBA schools all over the world – the mistake that everyone makes is that they want quick results. For example mutual fund managers are measured by the investors based on their daily NAV - the fund manager has to make sure that he is giving at least as good returns as his competitors “on a daily basis” –he cannot think five years. Individual retail investors look at one year timelines for all investments as most of us have a tendency to slice our lives in yearly intervals. However, if we start looking at 5 years for equity, then there is a good chance of making good returns provided you follow some proven equity valuation and forecasting method.

So here are five more stocks that I recommend at the prices mentioned - all these stocks I have personally invested in the past 2 months and my analysis tells me that they will grow at 20% plus CAGR over 5 years:

1. COLGATE – all of us know this company - this stock is currently quoting at around 960 – I recommend this stock at even a price up to 1000 – the company has shown an EPS growth of 21.5% over the past 10 years. Looking at the performance of the company and the stock movements for the past few years - it is a good buy at this price and should give a 18-20% growth per annum over the next 5 years.
2. DABUR – this is another company known to all of us - this stock is currently quoting at around 97 – this company has shown an EPS growth rate of 24.7% in the past 10 years –at the current price of 97, it is expected to give a return of 18-20% per annum over the next 5 years – this surely is a buy at prices below 100.
3. Havells India – I am not sure if you know what they make –they are a large player in the industrial and residential electrical equipments space – they own well known brands like Sylvania, Crabtree and Standard – they make domestic appliances like irons, geysers, fans and motors , modular switches,  circuit protection components and cables and wires – the company has shown an EPS growth rate of 45% in the past 10 years – this stock is quoting at 434 now – if you get this at any price below 385 – buy it. Every stock goes up and down based on market sentiments and I do expect the stock to touch 385 at least once in the next 2 months.
4. TCS – TCS is a juggernaut that has enough momentum to take care of most external shocks – outsourcing and offshoring as a concept are here to stay and the more the pressures on the US and EU companies to cut costs, the more the opportunities for TCS – the company has shown better growth in EU this qtr than the US and the INR depreciation will make the company more profitable as it earns in USD and spends in INR – for the past 6 years, it has had an EPS growth rate of 26.65%  -I recommend this stock at any price till 1125 – currently it is quoting at 1067
5. Voltas – This company is quoting at 94 currently – I recommend this at any price till 100 – with a 10  year EPS growth rate of 38%, it surely is going to give a 5 year return of 20% plus.

 As always I want to put the rider that these are my recommendations -I have invested in these stocks in the prices mentioned above– it will do well for you to look at these stocks and read about these companies. After all it is your hard earned money – your risk and your reward.

As Peter Lynch puts it -“Spend at least as much time researching a stock as you would choosing a refrigerator."

Not that you chose a refrigerator every now and then :-)

Happy Investing.

Passive Income

Passive income as a concept is easy to understand – “it means getting a cash inflow every month without working for it” - passive income unlike active income does not depend on your effort –we all work for 8 hours or more a day - for 25 days a month and then we get a salary cheque – passive income comes every month without your working for it - a good example is rental income  - the rental cheque comes every month whether you are going to office or not.

Now imagine if your monthly living expense is Rs 50,000 and your monthly passive income is also Rs 50,000.

Wouldn’t that be an ideal situation? I am sure you’ll agree that this is a good situation to have.

So what does it take to reach this stage?

It takes a bit of planning, smart investing and about ten years of time in Indian conditions - that’s all.

Let me repeat this – In India, if you plan your finances well and invest smartly and keep at it for 10 years consistently – you will reach the stage where your passive income is equal to your monthly expenses.

There was this couple in their 40’s –they had invested smartly and bought a plot of land in a well known part of Delhi a decade earlier and over time, they had built a three floor residence. As the house was on a main road, they also built a few shops. By giving two of the floors and the shops on rent, they earned more than enough passive income to lead a comfortable life.  The story does not end there. The husband was an engineer and had a regular job - ever since this rental income started flowing in – his performance in the job shot up – he realised that he was stress free – he was more cheerful  - this was because, like most people, he was also fearful of a job loss and that created stress and performance issues which vanished once the rental income came and he was financially free.

Another friend had a great idea – he had worked for a few years in the US and had saved in USD – as he came back to India, he had savings of about 120 lacs in INR. He invested Rs 10 lacs in yearly FD @ 10%  which gave him an interest earning of 1 lac – and he figured out that after 12 months and 12 such FD’s he will get Rs 1 lac every month as interest which will easily meet his monthly expenses. All he needed was to reinvest the principle amount of Rs 10 lac every month in a FD @ 10% and use the interest earned.

How does that look?

Looks good?

Well not very good actually.

You see India has an inflation of about 8- 10% and this scheme of rotating FD’s means that his interest income will stay at Rs 1 lac per month for ever – over a few years, the purchasing power of this 1 lac would go down due to inflation and then he will need a higher passive income –or he will feel poorer.

We all know the salaries of our parents - in 1970s or 1980’s or 90’s  - the salaries in the 70’s were something like Rs 1000 per month –in the 80’s a good government job paid about Rs 2500 per month – in the 90’s a similar job came with a Rs 10,000 pay cheque – today the salaries are about Rs 40000 per month for a manager’s job – this increase is not because of living standards – it  is because of inflation.

Even government pensions are adjusted for inflation every now and then.

So in the long run, one needs to have a passive income that goes up at least as much as inflation – otherwise, we will become poorer over time.

Having enough passive income does not mean that you will retire early – it just means that you can chose to do what you want – you do not have to take up a job because of the salary – you can chose a job because you like the role. I teach as a visiting faculty and I left my high paying job – because I love to teach and because I can afford not to look at the salary difference between a corporate job and a teacher’s job –thanks to my passive income.

Now that we have understood the concept of passive income and would love to have it, you may be wondering whether it is possible.

The answer is that there are ways to achieve it – many people have achieved it – those who have achieved it may not talk about it openly– such people are all around you – just observe – you will generally find them less stressed, more cheerful, friendlier, and more helpful and generally they would contribute more than their fair share towards society.

In my forthcoming book, you will find ideas for passive income that will set you thinking. it will hopefully help you make a long term plan which will take you towards getting enough inflation proof passive income to meet your expenses through out your life.

My 2011 predictions revisited and where to invest in 2012

In retrospect 2011 was a tough year to predict – in Jan 2011, we were still talking of “green shoots” – now that’s a forgotten phrase. As of Jan 2011, the Europe crisis was in Portugal, Ireland, Greece and Spain – and it was largely under control. No one could have predicted the natural disasters in Japan and Thailand and no one, absolutely no one, could have foreseen the what happened in Tunisia, Egypt and Libya. The Anna Hazare phenomenon in India, the Occupy wall street protests in US, anti Putin protests in Moscow, anti economic policy protests Israel, Spain and London are all pointing to a global restlessness amongst the youth – there is an anger against governments and most governments are today less popular than they were in Jan 2011. All these were not foreseen 12 months back.

Having said that, my 2011 predictions were fairly correct –

• I had predicted a GDP growth slowing down – that happened.
• My prediction on rising interest rates through 2011 was fairly bang on target.
• I had wrongly predicted the markets to give positive returns – in reality, the Indian equity markets have given a minus 25% returns in 2011– so here I was wrong (as an excuse, I must say that almost every equity analyst from Citigroup to Credit Suisse to Morgan Stanley had predicted that equities would do reasonably well on 2011).
• I had predicted Gold to do well and I had recommended it all through the year – here I was correct – 2011 was, in fact, a “Golden year” – Gold gave a 30% return over the year.
• Real estate was another area where I had predicted that there will be not too much returns in 2011 -  but I had recommended it with a three year time frame- actual numbers are difficult to get – but NHB does a survey that you can see at http://www.nhb.org.in/Residex/Data&Graphs.php - the data here needs to be studied on the basis on the last four columns and you can see that there has been good appreciation (above 10%) in residential real estate prices in  Faridabad, Chennai, Pune, Bhopal, Mumbai & Delhi  and there has been low appreciation (below 10%) in residential real estate prices in Hyderabad, Patna, Ahmedabad, Jaipur, Lucknow, Surat, Kochi, Kolkata & Bangalore. So I believe here too I was fairly correct in my predictions.

So what will be the key themes for investing in 2012 for us in India?

I believe 2012 will be a tough year – the big picture is as follows:

• Indian economy will slow down a bit –reforms are the way out and our government will need to push through a few reforms if we need to be anywhere near an 8% growth
• Europe problems are expected  to dampen the markets for the first few months –I am optimistic that it will not result in a Lehman like crash – the Europeans will find a way out (even though a few countries like Greece and Italy will be bruised badly)
• The US economy will limp through a 1-2% growth in 2o12 (just like in 2011) – but in the absence of other alternatives, the US markets will be deemed as the safest place to be and US Dollar will be strong and the US Bond rates will be low
• Chinese economy too will slow down in 2012 ( it already has) –  and the challenge there would be growing their domestic consumption as currently 65% of Chinese GDP is export based.  
• And then are there are elections in US, France, Russia and a party leadership change in China in 2012 -so these will impact the government actions in the coming year.

So where do we invest?

If your investment is for one year timeframe –I am afraid, you do not have too many options – but if you are looking at three years and above, 2012 will offer you lots of opportunities - in fact there are great opportunities available right now.

The four big options that anyone has are – Investment in Debt, Equity, Commodities and Real estate.

Debt based investments in 2012 will be popular –low risk and inability to understand equity markets will drive people towards debt markets – Interest rates in India will go down gradually – starting Q2, I expect RBI to slowly reduce the interest rates – so you will find long term debt based funds which have debt issued in 2011 (when the rates were high) giving higher returns in 2012 as the interest rates go down. So here is the first opportunity for anyone who has a one or two year investment timeframe – invest now in Long term debt funds which have portfolio of 2011 debt –you can expect about 12% returns on these  – you can see some of the details of these funds at http://www.moneycontrol.com/mutual-funds/performance-tracker/returns/debt-long-term.html - as you can see, they have not been giving good returns till now as the interest rates have been going up – now I expect them to give better returns as the interest rates start to go down in 2012.

Equities will present long term opportunities in Q1 and Q2 of 2012– In fact even now, there are many equities that are priced attractively in the market – I have been investing in equities selectively since Q4 2011 and I recommend the same to anyone who has a 3 year plus time frame –as we all know, the value of a stock globally is determined by it’s earnings growth ( EPS growth) – but the price of the stock in India depends on the mood of FII’s  - right now the FII’s are net sellers in Indian markets and hence there are stocks that are good long term buys that are going cheap. I have listed out a few stocks in my blog in October and I will list out a few more stocks in my next note in Jan – but needless to say, these are opportunities with a three year time frame – so for those who are ready to invest for three years, you will get a 20% plus return per year by investing in these stocks.

When it comes to commodities – I do not track anything except Gold–so even though Indian markets for other commodities ( like grains) did perform well in 2011, I cannot comment on them. I believe Gold will not give more than 15% returns in 2012 in Indian rupees – It will beat Inflation in India – so it not unsafe – but there are better investment options in 2012 – so if you are investing now, Gold is not the place to invest –but if you have invested in Gold in 2011 or before – you can chose to rebalance your portfolio or chose to stay in Gold – you will not lose money.

Real estate will start showing signs of appreciation – but remember that  real estate is for those who have an investment time frame for 3 years plus– Investment in urban (not rural) areas is recommended – if you can buy a house or flat or urban land anywhere in India ( with a caveat that the location has to be an upcoming location and it has to be a legally clean asset) – you will make 15-20% asset return per annum. Real estate in fact is the safest bet as of now – as it is much easier to identify a good real estate opportunity than to identify a good equity opportunity and India’s urbanization story is still going strong even though the India growth story has dipped a bit.

So for 2012, I recommend

• for short term investors – Debt funds and
• for long term investors – Select equity and Urban real estate.

How to save tax (under section 80C)

This particular blog is for students who passed out of college in 2011 and are working for the first time – here, I would like to share the various tax saving options that you have and my recommendations as to how you can minimize your tax outflow.

You can invest up to Rs 1 lac and save on taxes under section 80C of the Income tax act. The amount invested under section 80c is directly deductible from your gross annual income for tax calculation purposes – what this means is that if your gross annual income is Rs 5 lacs and you invest Rs 1 lac under section 80c, your taxable salary goes down to Rs 4 lacs (on which you will need to pay the tax).

Now what are the various avenues for investment under section 80c?

The first avenue is Provident fund (PF). You already would be investing in PF through statutory deductions from your salary – your contribution to PF is tax deductible section 80c. Beyond this statutory PF deduction, you can also invest additional amounts in PF through voluntary PF (VPF) by instructing your payroll team to deduct additional amounts every month - this too is tax deductible under section 80c.  Currently PF investment gives you a return of  8.5% per annum. As you may know, PF accumulates throughout the working life and you get a lump sum once you retire. As you move from one company to another company, you move your PF money as well.

The second option that you have is the Public Provident fund (PPF) –for this you will need to open a PPF account in a bank (most banks offer PPF facility) – PPF currently gives you returns of 8.6% and this is tax free- the minimum you need to put is Rs 500 and the maximum amount you can invest is Rs 70,000 per annum. The PPF account has a term of 15 years and you need to invest for 15 years before you can close it and take the money out (there are ways to take money as loan before).

The third option that you have is Life insurance premiums and ULIP’s.  You can go through not just LIC - but any private insurer for this. I have always recommended that the only Life insurance that you must take is pure term insurance – any other life insurance policy (like endowments, ULIP’s, annuity /pension plans etc) are sub optimal investments with returns of around 6-7% over a long period.  I believe that insurance is mis-sold as an investment / tax saving avenue in India and we must only look at insurance as a risk mitigation tool. So insurance is not recommended for tax saving .

The fourth option that you have is Equity linked savings schemes ( ELSS) offered by mutual fund companies – these schemes have a lock in of three years. Data in moneycontrol.com tells me that the top ELSS schemes in India as per Crisil rating are Franklin India tax shield, Religare tax plan and Fidelity tax advantage – these schemes have given a return of appx minus 10% to -14% for one year, +4 to 5% annualized returns for two years and +25 to 27% annualized returns for three years. As equity investments are to be looked at for 3 years and above, these schemes have given good returns in that time frame. But as we all know, good past performance does not ensure good future performance.

The fifth option is five year bank or post office deposits – these are also covered under section 80c. The returns here are 7.5% to 8%.

Then there are rural electrification bonds and infrastructure bonds where you have a 3-5 year lock in –the interest earned in these schemes is appx 5-6% ( post tax).

There are other ways of investing under section 80c, that may not make sense to my students – for example, if you have a housing loan, then you can repay the principle and that would be deductible from taxable income under section 80c. Also, payment of tuition fees for upto two children in any Indian school, college or University would be deductible from taxable income under section 80c.

Having seen the most common options available,  for someone below 30 years of age and earning about 4-10 lacs  – I would recommend ELSS schemes or PPF beyond the PF that you are already investing.

The last issue that I want to address is the timing of these investments – we are now in December and we are deciding on these investments for the year 2011-12. This timing is sub optimal. We all know that the earlier we invest, the earlier the returns start accumulating and hence, I would recommend that for next year ( 2012-13) - you decide and invest as early as possible –  in April or May - or surely by June.

Investing in uncertain times

What does the future look like right now? Where do we invest? Where are the markets heading?

In Europe, US and in China, the governments are dithering from taking hard decisions – though for different reasons. These three regions combined represent 50% of the global GDP – and there are risks that Europe will simply implode or the US will sink back into a recession or China will have a hard landing. Decision makers in these countries have delayed the disaster so far by kicking the can down the road – but lately the can is getting bigger and heavier and the kicks are getting feebler – the risks of one of these regions stumbling is increasing by the day.

Europe has the biggest and most urgent problems. By getting new governments in Greece and Italy last month, the EU had once again kicked the can and delayed the D-day by a few weeks – but these were first baby steps towards solving problems that have been created over 2/3 decades of profligate spending -these are right steps but these are not the solutions to the problems they face. You cannot have the rich and the indebted EU nations under the same umbrella without the rich funding the indebted - It is like two brothers, one much richer than the other, staying in the same house - but being financially independent of each other- eventually the arrangement will unravel. In the last few days things have reached such a stage that you can’t kick the can any further. There are two scenarios possible –

• the Germans will change their minds and let the ECB print Euros at will and to underwrite sovereign debt; or
• the Eurozone will breakup

Till recently, I did not believe that the Eurozone will break up– but now I see that the scenario of Euro zone breaking up cannot be wished away - If that happens, how the markets will react cannot be judged –normally in such panic, equities could fall to levels like in 2008.

In US there are problems of slow growth and high fiscal deficit – the stimulus provided since 2008 in the form of bailing out of large financial institutions, keeping the interest rates low and the two rounds of quantitative easing have not revived the US economy. The US economy depends on consumer spending (70% of it’s GDP is consumer spending) and with high unemployment and households burdened with debt, the consumer spending is not expected to revive any time soon. As there is US presidential elections next year – one cannot expect any substantial economic measures till 2013 and hence the situation of uncertainty and slow growth will continue in the US at least till 2013.

China is a state managed capitalistic economy - of the 42 top Chinese companies in Forbes 500, 39 are state owned companies. It’s growth is dependent on keeping it’s exchange rate low and continue exporting to US, EU and Japan ( 2/3rdof their GDP is exports). The challenge there is to grow the domestic consumption. Increased government spending since 2008 in infrastructure has helped China pull itself out of slowdown till now – also they have enough cash and foreign reserves to postpone any crisis –however years of unbridled high growth seems to be catching up and there are signs of slowing down, higher inflation and financial stress in the system. Slowing down in china surely will have an effect globally, including India.

So the question that each one of us must answer is what should we do? I believe that equities will continue to be volatile for some more time – based on your own needs and ability to take risks, and the belief that India will be (compared to US and EU) a growth economy in the next decade

• If you are investing for 0-1 year - look at liquid funds - these give post tax returns of 7-8% and the liquid funds are almost as good as a savings bank account when it comes to liquidity - you can encash in 24 hours.
• If you are investing for 1-3 years- look at FMP's -these are better than FD's and will give you post tax returns of about 9%
• If you are investing for the long term (3 years and above) -look at fundamentally good stocks at the right prices is what you must aim for - I have suggested a few in my last blog - I will suggest a few more mid of December; and
• If you are investing for 5 years and above - look at urban real estate – every city in India has good locations/ properties where you will get good returns - the long term phenomenon of urbanisation will continue and urban real estate will go up in value –however as we all know, you need to have larger amounts for real estate and the investments are low on liquidity.

A millionaire’s portfolio - part 1

For the past 6-8 months I have been working on short-listing about 100 – 150 good companies – that have a great past and should have a great future. I now have 5 companies that I recommend that you can invest at the current levels. These stocks are expected to give 300% returns in 5 years – over time, I intend to amass about 20 such stocks and I intend to share my recommendations  to you through this blog.

These are companies that have:

1. an identifiable durable advantage
2. products or services that will not get obsolete in the next 2 decades
3. investment focus solely on it’s core business and does not look beyond into unrelated diversifications
4. a good EPS growth rate, a high return on Equity and a good return on capital employed in the past 10 years
5. produced more cash than it used in the past 10 years  -is cash rich and low on debt (preferably zero debt)
6. the ability to increase the prices of it’s products/service without losing market share

More details of the logic used can be seen in detail in my blog dated 29^th Sept 2010 called “Investing in equities  - part -2”.

Needless to say that this is what I teach in my Wealth management course in MBA and this is what I personally use for investing.

As we all know, the stock prices in India are dependent on the mood of FII’s – when the FII’s invest in our markets – the stock prices go up (beyond the normal PE multiples) – when they exit, the stock prices go down (below the normal PE multiples).

As of now, due to the global fears of a crash emanating from Europe, the markets are down (and I expect the markets to dip further). Due this, some of these stocks are at values that I believe are worth buying.

I have bought all these stocks recently and I intend to buy more of these stocks in the coming 4-6 weeks. So here are my recommendations and the current prices where I recommend that you enter:

1.       SBI – there has been bad news emanating from SBI ever since the new chairman took over a few months back – the stock has gone down as well – however, this bank is solid and has a great market reach in India and will surely perform well - At current market price of Rs. 1720 – this is surely a BUY recommendation – even if the price goes up to Rs. 1825 – this is a good buy.

2.       BHEL – again this is a great stock – the stock has not been performing well lately – but India’s power sector will grow tremendously and BHEL will be there supplying in the years to come – at the current price of Rs. 313 – this is a good buy.

3.       Bajaj Auto – when you look at the India’s motor bike market – Hero Motors is doing very well and is over priced. TVS is a laggard and is under priced. Bajaj has a good story, is doing well in India and has a good story in exports and is expected to grow faster than others – At the current prices of Rs. 1500, I believe it is starting to go above my buying price – I have been buying this lately and I still recommended it at this price.

4.       ESAB industries is a market leader in it’s field and has a very good past and a better future – this is a company that many will not notice – but I surely recommend that you invest in this stock – at the current price of Rs 515.

5.       Maharashtra seamless is another company not many people will notice – again a market leader in it’s market and has a very good story. I recommend that you invest in this stock at the current price of around Rs 345.

A few words of caution here –

·         Spread your investments across these stocks -do not invest in just one stock.

·         I do not know what will happen in the next 6 months to these stocks – but I am very confident that in 5 years these will give good returns – I expect 300%. These recommendations are for those who want to invest for 5 years or more -these are not for those who want to invest for periods less than 5 years.

·         You are investing - the reward is yours – the risk is also yours. But remember that I am also putting my money before I recommend it  - I am putting a minimum of 50K in each stock.

As and when other opportunities arise – I will share them – I do believe there will be opportunities in the next few months.

2011 predictions revisited – expect a rough ride in September 2011

If you thought August was tumultuous and volatile -get ready for September – it’s going to be a rough ride globally.

Nouriel Roubini, the economist who predicted the 2008 crash correctly, has said this week that "we are in a worse situation than we were in 2008” – He thinks that there is a 60% chance of a second recession (http://www.moneycontrol.com/news/fii-view/we-areworse-situation-than2008-roubini_582263.html)

World Bank President Robert Zoellick said on 3^rd Sept that “the world economy is stepping into a new danger zone" (http://www.moneycontrol.com/news/world-news/global-economydanger-zone-says-world-bank-chief_582370.html)’

Europe’s sovereign debt crisis will test the waters again in Sept. Greece is due for another round of International aid around 15^th of Sept. But before that aid is cleared, they will have to work with IMF/EU /ECB to show that they are implementing fiscal austerity measures agreed upon and they have only 10 days to do that.

Italy is also on the edge – they had promised to get their public finances in order and balance their budget by 2013 and now they are struggling politically to implement their promises. As the Italian politicians debate the austerity measures - there is a growing alarm in Europe over the credibility of the Italian govt’s ability to keep its promises.

US is also staring at a long period of low growth – US economy has slowed down last quarter - last week’s employment report which showed that US economy has not added any jobs in August –all this has increased investor fears that US may be headed for another recession.

President Obama is going to unveil proposals on Sept 8^th to create new jobs – but with political bickering between Democrats and Republicans -there is little hope for anything substantial in the short run.

There is a G7 Finance ministers and central banker’s meeting in France on Sept 15^th – they are supposed to discuss ways to reinvigorate global effort to support growth, jobs and financial stability – I do not believe it will have much impact in the short term.

There is a US Fed meeting scheduled for Sept 20-21^st  - it is expected to further discuss measures to support the US economy – but they too are not expected to announce another round of quantitative easing (QE3).

As these events unfold, I see investors being nervous –  FII's will pull out money from Indian markets –  sensex will be very volatile and may go below the 15750 levels it touched in August. This can open up opportunities for investing in equities if one looks at a 2 year plus horizon. Gold is expected to go further up due to this global nervousness – I am not recommending that one invests in Gold at these levels –But if you have already invested – you can look at further growth in your returns from Gold.

Overall just tighten your seatbelts and watch the events unfold.