Investment buckets

I have been discussing my investment objectives in my various posts. Here in this post I am going to jot down a high level plan to meet my investment goals.

I have divided my total savings into four chunks majorly.

1> Bond Fund Chunk: This contains 30% of my total investment. I keep this fund in safe heaven such as AAA rating FDs, NSCs and PPF (yes I consider PPF a very good investment vehicle). In this bit of my investment planning, I am allocating money for my short term needs such as my education etc. I am happy with 8%-9% growth in this investment chunk.

2> Opportunity Fund: This is the most liquid part of my income portfolio and never exceeds 10% cap. I keep it in my savings account and use it to take advantage of news based sentiments. ICICI buying BOR, petrol prices etc. Since I am not a regular follower of complex news items, this part of the portfolio remains cash most of the time.

3> Medium to Long term Equity fund: This contains 30% of my investment capacity. I allocate this capital for various equity linked avenues. A part in Mutual Funds and a part in stocks. Here I choose companies which have good management and have wonderful business concept/moat and are to grow for sure. I consider Moser Baer, ABCIL in such category.

4> Dividend chunk fund: This consists my rest 30% investment chunk. Here in this part of the portfolio I would rather invest in a company that gives good dividends. My aim from this pocket of investment is to have capital appreciation and maintain a regular flow of income in terms of dividends.

Having said all this, I shall deliberate more on what to vehicle to choose for each investment chunk in further posts.

The Intelligent Investor: The Bible

Had reread the bible the first day of Diwali vacation. Cannot agree more with 'the Graham'; the basic principles he laid 50-60 years ago are so true even today.

I have extracted following main points from the book.

1. Beware of companies which are always interested in other people's money. They can be easily noticed by their acts of continuously diluting equity, issuing warrants, issuing convertible debentures (convertible bonds are double edged sword, Graham says. Companies management it betting on the fact that stock prices will always go up and people will eventually convert their bonds to stocks. This expectation gives them incentive to do financial alchemy to ensure that stock prices some how carry on going up. But we all know this is not sustainable).
2. Beware of companies' which have taken more loan than the cash they can generate. Take example of Rei Agro. They pay close to 340 crore as interest payment on the debt and generate net profit 150 crore. Are they sustainable? I don't think so.
3. Always look into the net profit and operating cash flow. Net profit should never be more than the operating cash flow. If a company continuously show such relation, beware!
4. A combination of high entry cost and good margin makes the company out smart the competition easily. TTK Prestige is an example from my kitty. No road side company can breach the brand Prestige easily.

Coal India: IPO analysis

Coal India has come up with the biggest ever IPO in the Indian Stock market history. Government, however, is being greedy these days and further offers of PowerGrid, Shipping Corp. of India, ONGC, IOC are coming. It is interesting to understand where is the money in the market for these issues. Anyway coming back to Coal India.

Summary:

As per research by CRISIL, CIL is world largest coal producer and largest reserve holder. India is world's third largest coal producer and consumer. CIL met close to 82% of coal demand in India; In India power generated from coal was 52% of total power (FY2009). Apart from power generation, coal is heavily used in cement and steel plants.


Negatives:

1. Coal India is a holding company and its results and profitability is dependent upon  its subsidiaries.
2. GOI is selling its stock. Gains from this offer will not be part of Coal India company.
3. The current state of transportation available will not help even if Coal India could increase its production. 
4. Coal India may (and probably will) face problems in land acquisitions. It also has mandate to share 26% of its profits with the affected people.
5. India is a power hungry country; still many NGOs have been working relentlessly against such power plants, and their efforts may result in Coal India's loss.Greenpeace is already on to this link.
6. Estimation of coal reserves is pretty much subjective process and could be incorrect.
7. Coal India sells its coal below international price (although coal has been deregulated since 2000)
8. Much of its assets are located in politically unstable areas.
9. Finding further coal fields has risks of not finding, not enough coal finding, and not finding a good grade coal.
10. Illegal mining.

Positives:

1. Largest coal producer and largest reserve holder. Apart from this, there is enough unmet demand in India.
2. Strong and stable financial track record.
3. Has started ERP implementation. For company of such a scale, ERP implementation will pay dividends in long term.
4. Focused on increasing resources by venturing into outside India.

Castrol India: A little analysis on dividend

To start with I have calculated Castrol India's dividend yield from last 10 years dividend data on the basis of current stock price. Now I will try to fit a regression line (using TREND function from MS Excel) and find out from which year I will start beating the risk free return of 7.5% of FDs.

My aim from this analysis is to understand if Castrol India will be a good investment choice for my dividend portfolio at current price.

So what is my conclusion?

I will wait for Castrol India a bit. I think I should achieve my dividend target of > 7.5% way before 2020.

Five good equity diversified funds for analysis

All the numbers have been picked up from valueresearchonline.com

So what is my conclusion today?
ICICI Prudential has historically performed better than the other three 5 star funds.
SBI Magnm contra was a good fund, but it is sliding down slightly
Reliance growth is a good fund but has high volatility

How to choose a good mutual fund

One line answer: select any 5 star or 4 star fund from www.valueresearchonline.com.

Long answer: look at the track record of various mutual funds, monitor how have they performed over the period of time and how the performance has been lately. Check out couple of ratios and bingo!

Let's take HDFC Top 200 (this is my personal favourite fund) : (All these screen shots are from valueresearchonline.com)

I have highlighted the important aspects:

1. It is 5 star fund
2. Its return grade is high and risk grade is below average
3. Trailing returns for 1 year is 32%, for 3 years (compounded annually) is 17.30 (due to 2008-09), for 5 years it is 26.67 (stupendous) and from launch it has been 26.71 (fantastically stupendous).

Now if we go to Performance tab the scene is as following:

This image has couple of important points. Fund returns with respect to category return, with respect to Nifty and with respect to Sensex.

There are other ratios:

1. R-Squared ratio: is the statistical measure of how well an approximation (regression) line matches with the real data points. It is an analysis of the deviation from the benchmark. For equity funds, the benchmark is Nifty or Sensex. This ratio varies from 0 to 1. 0 says there is no correlation while 1 says there is 100% correlation. This mutual fund's R Squared is .96, which means it is closely tied to the fluctuations/returns in the Sensex.
2. Alpha ratio: tells how better a security has been against the bench mark. Alpha of 9.41 says that this mutual fund has been outperforming the benchmark Sensex by 9.41%.
3. Beta ratio: talks about the volatility of a security as compared to the benchmark. If the beta value is more than 1, the NAV of that fund will fluctuate more than the benchmark. If the beta is 1, it will go along with Sensex. If the beta value is less than 1, it means the security is not much volatile and safe. This fund comes into this category.
4. Standard deviation: is another measure of volatility in the fund. It is calculated on the historical annual rate of return data. It is a measure of how the funds performance deviates from the average performance over a period. A low standard deviation is better. This fund apparantly has it little higher side, but this is due the recession (and jump back after that) effect.
5. Sharpe ratio: is one of the most important ratios for risk analysis of a fund. This ratio also throws light on the fact that the fund's performance was just a fluke or due to a smart fund manager. Sharpe ratio gives a sense of returns from a fund over the risk less return per unit of risk. Risk here is the standard deviation. The higher Sharpe ratio, the better it is. But it all alone doesn't guarantee any information. It is calculated as ((expected return - risk free return)/standard deviation). If the standard deviation is very low (for liquid funds) the Sharpe ratio could come very high but that doesn't guarantee higher returns.

Other tabs are self explanatory and can be easily understood.
In the next post I shall provide a list of 2010's good equity mutual funds and their ratio analysis.

So what is my conclusion here?
Always look at the risk side of your investments. Don't distribute your hard earned money to agents.

Disclaimer: I am not advocating anyone to buy HDFC Top 200. This is my personal faviourite mutual fund. I have selected it based on my risk profile and objectives from investing.

Understanding a company's financial strength

A company generates following reports annually.

1. Balance sheet (on 31st March)
2. Income statement
3. Statement of cash flow

These three documents are the only tool with common investor to assess the company's financial strengths. (I am certainly not discounting insiders :-)

Lets understand these concepts via mind maps:
Balance Sheet

Income Statement

Statement of Cash Flow
Statement of cash flow is the most important document. If the company is unable to keep positive cash from operations, still it is able to show net earnings, it could be a sign of window dressing.

Highest NAV plans!!! A guarantee or another financial alchemy?

First thing first, does highest NAV mean highest ROI? Nope, they say that it is the highest of whatever they can manage to attain. It is very unlikely that with such a guarantee in place, they can provide even bench mark returns.

Let’s have a close look at how a possible highest NAV plan will work. They use Dynamic Hedging and Constant Proportion Portfolio Insurance. Although I don't fully understand these concepts, we actually don't need to digest this financial alchemy. Let's try to figure out how a common man would manage such plans.

Rule1#: If you have to provide some guarantee, you will have to charge some money for that. That money has to be taken from the fund value.
Rule2#: Stock market can never be guaranteed anything. It may crash anyway. So fund managers will have a pressure to minimize their risk and keep money in debt instruments and fixed deposits.
Rule3#: Since the lock in period is pretty big, 7-10 years, some amount of market risk can be adjusted here and there.

Let’s assume that the average interest on a secure debt instrument will be 7%. For the sake of simplicity I am assuming that the fund administration charges and other charges are 0.

Suppose the current NAV (and total fund value) is Rs 100. The fund manager wisely allocates the money in stock market, and after 1 year it gives 20% returns. The total NAV is Rs 120. Now the fund manager has the obligation to pay at least Rs 120 after 9 years. Now fund manager cannot take the risk of putting everything in stock market as it doesn't come with the guarantee. The debt product gives the guarantee. So the fund manager will have to pass a portion of total fund value to debt product to assure Rs. 120.

X*(1.07) ^9 = 120 gives X as ~ 65.

So the fund manager will allocate Rs 65 to some debt product and 120-65 to equity market again.

Let’s say after another year, the market resulted in good returns, and Rs 55 invested in the market sees another 20% jump. Now the total fund value becomes 65*1.07 + 55*1.2 ~ 146. Now the fund manager has the obligation to pay at least 146 Rs after 8 years. To provide this fund manager will need to solve this equation.

65*(1.07) ^9 + Y*(1.07)^8 = 146

This gives Y ~ 11.

Now fund manager will allocate additional Rs 11 to debt market, and put rest 44 in the equity market.

Let’s assume this process continues and after 6th year you have assured sum as Rs 180. By that time the equity component will be almost negligible and even if the market is highly volatile, it will not affect the fund value.

So absolute returns after 7 years will be 80%. (This is another gimmick, they will immediately say, sir which bank assures 80% returns and YES THEY DO SAY SO). If we calculate the effective rate of annual return it will come around ~8.7%. Which is marginally better than an FD (if we include the tax saving, it may be a bit better) but do we really want ~9% from the equity market for next 7 years period? Even the balanced mutual fund will give much more than 12% for this time frame. The few best MFs in my view have given more than 25% over the period of 15 years.

Pictorial representation of what I wrote will be like this.

So what is my conclusion today?

Whenever someone is guaranteeing something, please ask...what is the cost of guarantee? Are you into charity? :-)

ULIP and MF: A comparison from my portfolio

I think I was lucky that I chose a good ULIP (an oxymoron? ) SBI ULIPII. Around the same time I invested in a Tax Saving MF SBI Magnum Tax gain (G). After 4 years, lets see what is the actual absolute profit in both the investments.

I started my ULIP in April 2007 for 30000 annual premium (paid annually). I lie into the tax slab of 30%; rebate is given to me (for whole 30000) monthly at the very start of the financial year. I will use discount rate of 9% (assumed average inflation rate) to discount the time value of money back and forth.

Now I will do the similar calculation for my SIP in SBI Magnux Tax gain.

The difference is clear between the two. It doesn't look a lot since my choice of fund was not good. Had I chosen the HDFC tax saver, the current profit for the ELSS MF would have been much more than Rs 1,25,000

So what is my conclusion today:

Avoid ULIPS as much as you can and invest wisely in an MF which has a good track record.

How to know if you are being trapped into mis-selling

I think the various agents have mastered the art, the science and what not of miss-selling. Still a few key sentences can be observed and you should be alarmed of the miss-selling.

1. Sir, see this policy has give 100% returns. If you dig down, he will explore the papers and show you the absolute 100% returns since 2005. Well 100% return in 5 years doesn't make it much more than 15% returns (compounded annually). Although 15% annual is a good return, but it is not that 100%, of which you are being lured.
2. Sir, see this wonderful policy is the money maker! It has returned 60% in one year. Well if you look little deep, he has data from sensex at 8000 to sensex at 18000. Any mutual fund has given much more than 80% during this period.
3. Sir, there is a guaranteed bonus of 180%. Here you have to really understand and read between the line. Your agent will stop at 180% nonsense. If you are smart you will ask, 180% of what? total sum? Then the agent will sheepishly say, no sir of the annual premium. You then have to ask, ok when? As I buy the policy? The agent sweats a bit and says, no sir after 15 years. Suppose you take a policy of 10000 annual premium, you are being lured for 10000 additional bonus after 15 year. With the average 10% inflation, the NPV of that 10000 in today's term will be ~2400. So is it worth?
4. Sir, this is the wonderful time to invest in this mutual fund. Its NAV is only Rs 10. Why to invest in Rs 400 NAV mutual fund. Here you will get a big number of units. Well any sane person after a minute of inspection will understand the folly of the statement. Present NAV doesn't matter at all and secondly one should always wait to see the performance of the fund. Why be the guinea pig?
5. Sir, you wont believe us! This is the highest NAV plan. You know the market position currently, it is so low, market has to increase 10 times (as if he really plays the market). Just imaging, if you invest 10 Lakhs today, we are guarantying you 1 crore after 10 years. Well can you give it in the writing? No sir, but you see it is highest NAV plan, so there is guarantee anyway. It is guaranteed by IRDA as well. But the foolish agent doesn't tell me the guarantee of NAV going up!!! What if NAV increases well for first 3-5 years and then stops (actually thats how all highest NAV plans will work). Is there any respite?
6. Sir, this is unique ULIP plan and the most important point is that you can withdraw your money after 3 years. Someone bitten once like me can understand that the deductions in the ULIPS (old) are highest for the first 3 years. What indirectly he is suggesting is to pay him commission from your pocket and forget it.

Jai ho! The art and science of miss-selling is still being taught at the premier institutes of wealth creation.

My ULIP agent: Many many thanks to you

Flash back to January 2007. I had joined a new company, got good package and had a good sum returned from previous company. By the end of Jan it was raining tax savings schemes and alike instruments all around. I was asked to provide my tax saving stuff and alas I had nothing. Suddenly one fine day the God himself decided to meet me in the form of an ULIP agent. He offered me a product too lucrative to be ignored. I thought one should listen when opportunity knows. I wholeheartedly poured in 70K as the annual premium for the sum assured 7 lakhs. The God said, you look so healthy, nothing will happen to you, thus 7 lakh is more then sufficient for the insurance cover. I happily agreed, after all he was personal finance God.

Fast forward to Jan 2008; The stock market was euphoric and the wisest man inside me chose the "Growth" option in the ULIP, I was too happy to blab about my investment mantra and intelligent decisions. To boast about it I logged into the my savior ULIP web page and hit the 'fund value'. The whole world rolled in front of my eyes. While even my 'kam wali bai' had earned a lot in the stock market during that period, my safe fund showed me my fund value a little more than 30K. I thought to bash at the agent, who conveniently cut the phone. I then rang to the respective insurance company, who enlightened me with the fine details I didn't bother to read previously.

My policy had a funny deduction structure.

1. From the first premium 65% will be deducted as administration charges plus agent commission.(Oh God!)
2. Mortality charges
3. Some other management charges1%
4. 10% service tax and 2% education tax (close to 10.2%)
5. Some 2.75% annual charges

I was amazed at the scene of such a wonderful looting scheme and thought to cancel it. I then was enlightened about the surrender charges and I realized that I would have to pay more to surrender it :-) 

This was the mistake part of my investment life. I thanked my investment agent to teach me a wonderful lesson. I realized the importance of reading the fine print and more importantly, understanding the personal finance. That event left me a much more learned and motivated person.

Many many thanks Mr Agent!!!

P.S I still pat my back for not felling for this. The first year charges are 100%.

Stock selection methodology

Having served the role of project manager for a few projects, I like to present everything as a WBS. So here is my long promised my WBS for stock selection. It still needs a PERT chart analysis. Stay tuned...

A few dividend stocks I am looking into

I am looking into these three dividend paying stocks. The current filter criterion is dividend and nothing else. If this screen test passes I shall look into other matrices.
The graphic above tells the dividend paid as percent. This can help us analyze the dividend trend, stability and deviation (I use standard deviation to measure deviation).

I make a dividend portfolio which will give me a stable income after a few years, I am much interested in stable (if not increasing trend). I will put "Andhra Sugar" off based on this criterion. Having left with Castrol & Valson, it is imperative to understand yield part of the dividend. I will use today's prices to calculate the dividend yield. This will help me understand the trend.

Valson has been giving consistent dividends of more than 8%, it is much more than any A grade bond and FD provides today. At this stage I will place this stock in my to further screening criterion.
A closer look as Castrol dividend yield chart reveals that is has picked up an increasing trend. The financial health of the company is good and the brand image is good. I have multiple reasons to believe that it will yield 8+ % in coming 5 years. This should go to my dividend portfolio for sure.

My equity portfolio allocation

This is the state of my current portfolio. In spite of heavy rebalancing it is still tilted towards oil & gas sector. Any government policy change can decide the direction of my portfolio.

This metric is based on the current capital allocation. The another metric I follow for rebalancing is dividend income. I dont want my dividend income to be tilted on any side otherwise the stability factor goes away.

My current asset allocation

Since quite some time I have been working a lot on my asset allocation. Asset allocation is one way of reducing the risk possibility.

I strongly believe that bonds and debts should be much more than 30% in once portfolio for that provides a solid foundation.

Bharti Airtel : Express your self

I am a great fan of good management. In fact this is my one of the stock screening criterion. Two days back I was reading an article in hindubusinessline.com. The article was about another great personality I admire. I admire him because he talks of future.

....There are 600 million phone users in India whereas the country has only 55 million bank account holders. The way towards financial inclusion — getting the unbanked into the net — is through the mobile money route, feels Sam Pitroda, tech evangelist and currently advisor to the Prime Minister on public information infrastructure and innovations.

In his new book, The March of Mobile Money, co-authored with Mehul Desai, CEO of C-Sam Inc, a company that Pitroda founded, the two discuss the disruptive nature of mobile money technology....

Just after reading this article, there was a flash in my mind. What if the competition mired mobile companies enter into mobile money. Then I thought, who else but great Sunil Mittal can take such a step. Wish I could have asked for something else as what I wished came true. Bharti Airtel has got the license for mobile payment. Is he fond of creating bule oceans?

I am happy about my continued long position on Bharti Airtel. I have been acquiring it since 280 levels. I am very long on good managements.

Dividend Investing

I am a big fan of dividend based investing. I have learned and incorporated this methodology of investing after burning my hands in 2008 crash ;-) and reading tipblog. I simply adore this guy.

Anyway coming to the point of investing. I have become great follower of dividend based investing for these few reasons.

1. Dividends provide a steady stream of income: Dividends work as additional source of income on which you can count on (provided your stock selection was good). It is largely different from the movement of the stock prices in the market. During FY09-10 my dividend income was Rs 11,004 (tax free). Secondly a consistent stream of income is always better than money once at a time.
   
2. Dividend stocks prices mostly go up: In my investment experience I have seen that dividend paying companies are always relied upon by many investors and gradually the stock prices go up. In fact I used dividend yield as one screening criterion for stock selection. My recent dividend investment was Tata Steel. I started acquiring it from 475 levels up to 500. My average dividend yield is close to 4%. Since then I have seen a steady rise in the stock price. Currently it has crossed 600 level.
   
3. Dividends increase: Generally big and mature companies become dividend paying companies. We may not see meteoric capital appreciation in such stocks (and truly speaking dividend investing is not much about capital appreciation). Smaller companies need more capital to grow thus cannot afford to pay dividends (and taxes). Big organizations earn lots of profit, thus can afford to share in spite of having growth plans. I generally like companies having 20%-30% dividend payout factor. In my stock selection I have seen that dividends have increased (in rupee value) consistently. I firmly believe that 4% dividend yield will become at least 8% in next 5-8 years. And if India has to grow, interest rates will have to come down in near future. Which security will give me 8% (and increasing) rate of returns after 10 years?
   
4. Dividends have benefit of SIP: Why SIP is good? It is good because if promotes rupee cost averaging. What to do with dividends? In my view dividends should be reinvested as the stock price comes down. This will help increase the portfolio value and with the effect of compounded interest, my retirement will be peaceful.

My recent dividend stock picks: Tata Steel, Titan Industries, IDBI bank

How much insurance cover do I need

If we ask a typical agent, they come up with the magical figure of 10 times of annual income. I was also advised this almost an year ago. The logic they probably have is that a person with X income would easily be able to pay "X/some number" amount of premium easily. At least I don't subscribe to this logic.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Consider Mr X: A typical Indian family man
He is married
30 years
Has a home loan for which monthly installment is 35k
Has a car for which installment is 10k a month
Has dependent parents, non working wife and a one year old girl child
Earns 10 L PA (take home after taxes)
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

As per our bright insurance adviser, he should take cover of worth 1 crore.

Suppose Mr X is dead now and his family gets 1 crore. As per current standard of living the monthly expenses would come around 10-15k. Lets take 10k for simplicity of calculation.
Total amount needed monthly 35 + 10 + 10 = 55k
Lets assume that Mr X's family will keep 1 crore in some FDs (considering the 0 risk tolerance) which will safely beat inflation (a big assumption). With 55k as monthly expense, 1 crore would barely last for 15 years. ( I have assumed that car loan will always continue, it will not make much difference int the final conclusion)

This amount doesn't include cost of sudden medical emergencies (which are very likely due to old parents and young child). It doesn't include the cost of education which is going to be very high as time passe and this amount certainly doesn't include the cost of marriage of his girl child.
If we include these factors, the insurance amount should be increased by at least 50 lakhs.
But no adviser will suggest you because they are not trained to do so.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Now lets take Mr Y, a typical software professional
He is married
30 years
Doesn't have a home loan, his parents have one for him
Has a car for which installment is 10k a month
Has dependent parents
A working wife and a one year old girl child
Earns 10 L PA (take home after taxes)
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Suppose Mr Y is dead now and his family gets 1 crore. As per current standard of living the monthly expenses would come around 10-15k. Lets take 10k for simplicity of calculation.
Total amount needed monthly 10 + 10 = 20k
Lets assume that Mr X's family will keep 1 crore in some FDs and Equity mutual funds (considering there is one earning member, thus some risk can be taken) .
Lets assume 50L is invested in FD (and MIP) and rest is invested in Equity MF (assume 15% CAGR very safe assumption) .With 20k as monthly expense (in this case car loan will actually stop much before), invested 1 crore would last for more than 70 years. And if invested properly, it will last for even more.
Mr Y's wife's earning will easily take care of his daughter's future cash flow needs.

With the help of these two examples, we can easily establish that the magic figure 10 doesn't make any sense. Cover amount should be estimated individual's risk profile and current financial condition.

Term plan and unawareness all around

What do we think when we think of life insurance? I guess endowment plans!!!
This is what one of LIC agents told a couple of days back.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Manish Sir,
XXX is the best policy.Its features are:
Tax Bft:Deduction u/s80C of Income Tax Act,1961.
Period Covered:For first 20 years(with premium)
After that upto Age of 70 years
(without premium)
Premium: According to Age
Bonus : Rs. 6000 p.a.
Addl. Incentive : Rs. 20,000 after 20 years
Accidental Death : Double the policy amount.
If you take Rs. 1 lakh policy you will get Rs. 2,40,000 after 20 years (if you don\'t die).
If death takes place your legal heirs will get Rs.1,00,000 more then the due amount.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

I calculated premium for sum assured 100,000 for 20 years tenure for me. It comes around Rs. 5660. So if I "invest" 5660 yearly, I will get a tax benefit and my family will get 100,000 or 240,000 depending upon the situation.

Give me a break! My life if worth 240,000? What would my dependents do with 240,000? After all life insurance is a way to protect my from financial loss in future if I don't survive.

How much protection is needed can be roughly estimated; but for the sake of fun, lets take it 10,00,000. For me the premium comes whooping 55,000 per year. Is it really worth?

I guess the 20,000 bonus and 6000 bonus part can be easily ignored. It is just a marketing gimmick.

If we look at historical performance of any endowment policy, none has given more than 6-7% returns compounded annually. If we take the best case scenario of 7% and pay 5660 per year, what I get in the end is 5660*(1+0.07)^20+5660*(1+0.07)^19....5660*(1+0.07)+ which comes around 2,48,276. This is what I get in the end if I survive; If I lose my life in between my family would be showered with 1-2 lakhs and nothing more. This return doesn't not even beat inflation and the insurance amount doesn't cover anything. It wont last even 6 months for my dependents.

By now I have established that endowment policies are not suitable for me. I understand 2,48,000 will not have any meaning after 20 years; So let me think about a plan that doesn't give me anything if I survive but gives a good protection in my absence. Take any term plan for example. I am taking icici's iprotect for illustration purpose.

Sum assured (50,00,000) (this is what my family gets if I die)
Policy term (30 years) (till I am 60) (makes sense, I am sure I will not have any dependents after 60)
Premium only 5600!!!

We dont need to be a finance guru to understand the difference between 100,000 and 50,00,000. The only problem is that I don't get anything if I survive. I lose 1,50,000 over the period of 30 years in this case.

disclaimer: I am not saying that endowment policy is bad and term plan is good. I am not also marketing ICICI's iprotect plan. My only concern is think before you buy!!!

New DTC, a relief for investors

I was very tempted to write about DTC and its implications on normal salaried employees as well as on stock investors but by the time I decide a new draft of DTC was presented. Admittedly, I was little lazy but better late than never. I assume the latest version of DTC in its current form is quite stable and may not need a big change henceforth. In any case it will be applicable from April, 2012, there is still a lot of time to not to think about it.

Affect on investors:
As per one of its clause, the short term capital gain tax will be applicable only on the 50% of the profit thus in effect the tax will be 5%, 10% or 15% dependent upon individual's take home. This move will attract lower income people to come and join the spree of stocks :-)
The long term capital gain tax, as it currently is at 0%, has been not touched in the revised DTC. This is a refresher. SIP investors were literally worried on the prospects of their life time savings being taxed at the time they need the money at the most.

But such things are not in our control and I believe we should not worry at all about them. Whatever comes will be applicable for all, so in effect it will make little less difference.

By the way, does anyone smell a trader's, broker's & mutual funds' lobby?

Interest rates and their effect on stock market

Every now and then we hear about RBI planning to raise interest rates to tame inflation. How does interest rate tame inflation may be little complex if we go into the detail but from a broader perspective a token raise in interest rate tightens the money supply in the market. Now there will be lesser money and the same amount of goods available (in the short run) in the market. The buying power of money increases. This is valid for a short run only. On long runs, producers find ways to tackle; they will either decrease the production or will move to some other rewarding business. Both the steps will bring up the prices.

But how does interest rate affect stock market? For businesses interest rate is the cost of money or funding. If rates increase, they will have to pay more for the money. This will (again short run) bring down corporations margin, thus free cash flow, thus the net profit per share. Since the cash generating power of corporations comes down, the price people would want to pay for the stocks will be less. The market in general comes down.

Rich dad! An example

My favourite book Rich Dad, Poor Dad says "poor dad pays taxes while rich dad coins legal ways to avoid them". The recent change in RIL's holdings glorifies the statement.
Mukesh Ambani restructures his holding in RIL

RIL: Should I accumulate or wait?

Reliance Industries has come down to 980 level. How long should I wait before I pounce on it to see a wonderful retirement :-). Well RIL is not a good dividend paying company as far as my dividend calculations go, so such expectations are unfounded. And due to some whim of mind, I already have RIL at very high price, it will take ages for it to break even (since I am sure of good returns, I am holding on to it).

But lets deliberate on RIL a bit. It has been dropping since 1080 levels and has done absolutely nothing for an year. The probable reason that market is currently punishing RIL--in spite of good results--is that they have created a lot many liabilities and they still need a lot of capital to fund their future acquisitions. Their current spate of buyouts in the US Shale gas field is a risky business anyway. Well to fund their needs, RIL is selling its treasury stocks to LIC @ 950. This is what the investors are more angry at. No one likes thy neighbor getting richer without sharing the profit. I am sure RIL stock will tumble to 960 levels before coming into senses. Even at those levels (15-16 PE), a big company like RIL will be a good buy opportunity for long term.

Let's look at the brighter side of RIL. What is the internet penetration in India? Close to 7%-8%, so if we believe the India will shine someday story--I do believe, not because I am a patriot but because it is my gut feeling--at least internet will be ubiquitous. Who has 4G licenses? Bharti & RIL (I own both). RIL is sitting on the largest gas reserves and RIL has biggest reach in the policy making. They are just waiting for a trigger to start their dysfunctional petrol pumps.

So I am accumulating, are you?

Tata Steel: What should I do now.

Before I go ahead, let me declare that Tata Steel has a comfortable place in my dividend, thus long term, portfolio. I have explained my expectations from a dividend portfolio here. Currently I am sitting on a handsome capital gain with respect to Tata Steel. Now the question is what should I be doing today? Today Tata Steel is going to declare its first quarter results and one doesn't need to be a genius to know that results will be bad. Reason! None of the steel companies have reported profit in the current result season and it is a commodity business, Tata Steel may not do much different. I am sure I will lose 5%-10% in terms of capital reduction today.

Given that this stock is for my long term portfolio, I am not willing to trade my long term vision for 5%-10% change. I will slightly add up my positions. Rationale? If input costs shoot up, these companies will no longer be doing charity, they will increase the price to adjust and Tata Steel being the most respected and the largest will have a cake walk.

Since I thoroughly believe that it will give me double benefit ( good dividend & good capital appreciation) adding up when the prices come down will give me good dividend yield and good capital appreciation.

Update:13/08/2010
Results were as expected. Not very good. I stuck to what I said, I was jumping with joy when people sold it to me at 500.

The most powerful thing in finance

They say is it compound interest. Yes they are right but the other most important powerful thing is time. Sometimes all you have to do is 'do nothing' to make your money grow.

Lets take an example for a 20 years scenario. Lets assume that we invest Rs 10,000 a month in a modest recurring bank account giving interest rate of 8% compounded monthly. What should be the sum after 10 years? 18,50,000 by saving 12,00,000. Not so impressive! But after 20 years it would be 59,00,000 by saving just 24,00,000.

Lets take interest rates of 12%. After 10 years resultant sum would be 23,33,000 by saving 12,00,000. Good! But just imaging the 20 years time frame; the sum would be whooping 1,00,00,000.

Could you guess your savings if you could manage 15% for 20 years? It will be 1,51,00,000.

Now just for fun, lets imagine it is 30% for 20 years. 10,000 monthly savings will lead to unimaginable 15,32,50,000.

This is power of time and compound interest.

Are these numbers unrealistic? Not much! We have couple of mutual funds which have give more than 30% CAGR for more than 10 years.

Had I started my investments in any such mutual funds, I could have retired in the age of 30 by now!

But it needs patience and trust. Do we have anymore of it in Indian market?

Bajaj Corp : IPO

I missed this IPO. I am not much an IPO fan at the same time I like to keep an eye on bargains.
I feel that this IPO was worth my opportunity fund risk. Lets see why!

Good:

• Brand test: What image comes to mind when someone whispers 'hair oil'. Dabur Or Parachute Or Bajaj Almond drop? Well I see there is a big tie here but how many will know that Marico manufactures Parachute. Anyway both the names are justified; Bajaj has little more than 50% market share of hair oil market.
  
• Product test: Bajaj is mostly into hair oils. It has other notorious but almost extinct product "Kala Dant manjan'. Hair care products majorly need a prestige in the market and that's what Bajaj Corp already has.
• Management test: I haven't dug much about the management but I trust Bajaj is a good management.
• Financial status test: During FY10 topline grew by 35% and similar was the trend in bottom line. Companies profit margin is at 25%, which is quite good as compare to Dabur or Marico. Bajaj Corp has wisely chosen its manufacture units in tax free zones. It will enjoy no excise duty for 10 years and no income tax for 5 years from 2009. After this period too it will enjoy good concession. (A good way to achieve margin for an FMCG company). Company's balance sheet is quite strong and it has enough cash to fund future growth.
  

Bad:

• Only one category: Bajaj corp has leadership in only on category of the product. In fact it has only one product to offer. If suddenly any other company does something better and cheap, the whole company will have to bear the brunt.

Valuation:

On the lower side at 630, it is valued at 21.3 PE and on the higher side at 660, it is valued at 22.3 PE. While its direct competitor are trading at 27 (Marico) & 31 (Dabur). Since Bajaj is a good brand name, it is quite likely that this will easily trade at 27 to 31 PE. In any case there is a small upside expected when the IPO opens.

Infrastrure Bonds and Tax saving:

If some creditable institution gives me a guarantee for returns--which even if matches with the inflation rate--on my investment, I simply adore it. The simple reason for my rejoice is guarantee! For there is no guarantee on equity market. A simple spur of bad events may take me back to 80% loss portfolio and I may have to wait till eternity to recover my loss.

Currently I am looking forward to invest a good chunk of my cash fund into bond market. I am considering NSCs, FD & Infrastructure bonds as my options.

In the revised DTC, infrastructure bonds have been added as a new tax saving instrument. These bonds can be issued by LIC, IFCI, IDFC and any other non banking infrastructure financial institution. Rate of return offered is not yet known.

Let's objectively analyze these bonds and their effective yield assuming that they will offer not more than 8%.

Suppose I have invest 10,000 for 5 years (lock-in period) on March 31st (for simplicity). With the revised tax slabs, I shall be saving 1000 in the first year itself. So my effective lock in money will be 9000. After 5 years with the compound interest, 9000 will be 10000*(1.08)^5 ~ 15000. If we take 9000 into account the actual interest benefit we get will be {(15000/9000)^1/5 } - 1 } *100 ~ 10.3 %.

Lets see what would be the interest for NSCs. 10,000 invested for 6 years. After 6 years it will mature to 16010 (8% annual but compounded half yearly). Effective rate of interest would be 10.08%. With NSC we will not get 'additional tax saving benefit'

In the same line tax saver FD with and interest rate of 8 % will effectively fetch 10.3%.

Clearly infrastructure bonds have additional benefit. So what are you going to do?

ABCIL

I have discussed ABCIL here. I initiated a small position in it that day and kept on accumulating whenever it went down.

My fair value calculation for this stock then was somewhere at 130-150. I knowingly kept it on little low side as ABCIL is into commodity business where margins are always skimpy.

First quarter results have been stable. There has been a marginal increment in profit (but the input cost has gone up) and dividend of 15% (Rs 1.5 per share). As I mentioned previously, this stock is not part of my dividend portfolio. I still have it in a small quantity and expect a hefty capital appreciation before I sell it.

In the current scenario, where I don't see much to change, I would like to remain invested in ABCIL. I will start planning my exit if people are ready to buy it at 150 from me.

My Investment chunks

I have been discussing my investment objectives in my various posts. Here in this post I am going to jot down a high level plan to meet my investment goals.

I have divided my total savings into four chunks majorly.

1> Bond Fund Chunk: This contains 30% of my total investment. I keep this fund in safe heaven such as AAA rating FDs, NSCs and PPF (yes I consider PPF a very good investment vehicle). In this bit of my investment planning, I am allocating money for my short term needs such as my education etc. I am happy with 8%-9% growth in this investment chunk.

2> Opportunity Fund: This is the most liquid part of my income portfolio and never exceeds 10% cap. I keep it in my savings account and use it to take advantage of news based sentiments. ICICI buying BOR, petrol prices etc. Since I am not a regular follower of complex news items, this part of the portfolio remains cash most of the time.

3> Medium to Long term Equity fund: This contains 30% of my investment capacity. I allocate this capital for various equity linked avenues. A part in Mutual Funds and a part in stocks. Here I choose companies which have good management and have wonderful business concept/moat and are to grow for sure. I consider Moser Baer, ABCIL in such category.

4> Dividend chunk fund: This consists my rest 30% investment chunk. Here in this part of the portfolio I would rather invest in a company that gives good dividends. My aim from this pocket of investment is to have capital appreciation and maintain a regular flow of income in terms of dividends.

Having said all this, I shall deliberate more on what to vehicle to choose for each investment chunk in further posts.

Should I invest in commodities?

Since I started investing, I have kept myself away from commodity investment. I even remained aloof from precious metals. Not that these things shouldn't be part of one's portfolio,in fact gold has given consistently good returns for a few years. It is time to tell if such a run will continue.

But should such things be part of a long term portfolio of an investor like me? Taking stock of macro economic policies, understanding currency movements and making sense of other political decisions could be a matter of luck, which may not work most of the time.

Takes take a few examples:
1> Investing in wheat:
Monsoon was wonderful, wheat production was good thus prices are supposed to fall in near future. We sell our stock either at marginal profit or little loss. Suddenly news breaks out about a drought in Russia and wheat prices starts mounting. In the hope of wonderful returns we enter into wheat again. Next day government out of their whim reduces the import duty on the dream commodity. Price tumble!

2> Investing in Gold:
Stock market is crashing! Gold is the only rehab now. Gold price jump with joy and investor in the hope to mint more money keep the precious metal pump. Dollar is another paper gold that people like and acts as a substitute to gold and gold is sold in international market in Dollars. Indian government has artificially kept rupee so low to support export & IT industry (lobby). But with the FDI & FII pouring in, we cannot keep our currency so low for every. INR will appreciate against dollar some day and effective gold prices will appear coming down.
This is not a future prediction. It is just my analysis of gold prices from an Indian investor perspective.
Clearly, with such a huge uncertainty ahead, I cannot consider gold a safe bet for my long term portfolio. It may be my one of the few investment mistakes; let it be, but I will stick to my investment objectives at least.

Long term investing: A thought

Long term investors like me have always been confused about

1. How many stocks should be there in the portfolio?
2. What should be the real investment objective? Clarity of goals and objectives!
3. How to diversify? Is there an ideal diversification?
4. When to sell!

I will try to take each point one by one and elaborate on them. My observation and comments are according to my risk acceptance and my investment objectives. Please always be sure of your investment objectives before investing.

• How many stocks should be there in the portfolio? How many marbles can we hold well such that none slips or falls if the wind blows awry? It is as simple as that. One should have only those many stocks in hand, which one can easily keep watch on and monitor the progress. When we buy a stock we buy a part of business and become partial owner. And we must think like an owner then! But of a little different type. Since we generally don't get the majority share we cannot influence the business decisions but if the business is not going well we can make a safe exit and deploy the same capital somewhere else.
• What should be the real investment objective? Clarity of goals and objectives! If you are full time investor and your monthly expenses are from stock market, you may not like my investment methodology. However, many of us would be having a secure stream of regular income and we would be interested in deploying some capital for our future planning. What is an investment objective? Saving and raising fund for a car? Saving funds for our own house? Long term or short term? What I believe is that clarity of investment objectives is must before one should start investing. For my short term investment objectives I keep the money in savings accounts & Fixed Deposits and for my long term objectives I keep them in equity. Not that this is the ideal scenario and has some guarantee but this is what I evaluated as per my risk appetite and long term investment objectives.
• How to diversify? Is there an ideal diversification? Why should we even be thinking about diversification? The answer is simple. If I could find a business that always keeps increasing, I would deploy all my cash in it and will never sell it. But as we all know it is almost impossible to find such a business. Many factors such as input cost, policies and competition. And some business (and management) go up and some come down. But does this mean we should figure out a perfect business and deploy our cash in those companies, which are into such business. This may work out but why stick to only one business when there are aplenty to choose from? Some may shine today and some may shine tomorrow (as I feel alternative energy business will glitter more than gold someday and I am long on Moser Baer & Suzlon). (Suzlon is in fact my contra investment). Equity diversification is good; that's what all sane fund managers do. But remember what happened in 2008. Market tanked and so did all mutual funds and any equity portfolio. Even gold was not glittering then. But the worse part was in such times when your saving took a huge beating, your job was in danger too. Many people lost jobs and savings and everything! What didn't evaporate then was old friend Fixed deposit and other bonds. I laughed when I saw my equity port folio down by 80% and my bond portfolio up and growing at 8 CAGR. Little late in 2008 even gold started glittering but the equity kept silent. So what the lesson has been? There is no ideal diversification, but diversification is must and bonds provide ideal cushion when in need.
• When to sell! This is one of the most difficult aspect of value investing. Finding the right entry point is difficult but taking profit and leaving a stock is much a difficult task. Why? We all are greedy! When a stock goes well beyond our calculated MRP we become greedy and let it go. When stock suddenly tanks as we buy it, we tend to wait to recover the loss. I remember when I entered into L&T a couple of days back, I calculated its top end price close to 1900 INR. L & T rose much faster and well beyond 1900 but the greed took over and I increased my target to 2000. The result is that today the stock is trading below 1800 and I still couldn't sell it.

With all this I conclude my today's post. If time permits I shall elaborate on my stock analysis process.

What am I doing now?

I have a couple of friend who trade almost everyday (and read it sound, they trade). Every other day I am asked the question, what to buy today? I have been opening up with my suggestions which mostly no one likes as they are much interested in high volume, euphoric scrips, which give instant returns. However, I being a patient investor could never understand the logic behind euphoric scrips, which inherently distribute the money. Some make profit and some make loss. It is mere a redistribution akin to gambling.

Well the short answer to the question is that I am sitting tight, holding cash in my hand and looking for bargains (almost impossible to do so in the current scenario). In the mean time if I find any of my investment reaching their max price, I am slowly rid of them.

On the other hand I am increasing my allocations in some of the already help scrips.

Day trade and technical analysis!!!

Since the day I had a dmat account, my phone has been flooded with ready to zoom stock ideas. Once in a while when I dabble with the remote control of my TV set and stumble some channels oozing with investment ideas. To my surprise they talk about day trading and classify this act as investment. I humbly respect their views but I don't agree at all with the technical analysis.

Technical analysis says one should starts buying when prices are rising and sell if prices are coming down. Stock market is rife with case studies of failed fund managers who tried to time the market. Secondly, investment is all about thinking and planning for the long term. At least I, as a value investor, don't understand the daily watch on stock prices.

Current status of the portfolio

A good news for my portfolio. Since last three months I have started working on my portfolio actively. Around three months ago when the market was hovering around 18k, portfolio was at 12% loss. Today again market is hovering around 18k and my portfolio loss has come down to 2.5%. Certainly a good improvement within three months of rigorous portfolio churning.

Currently my portfolio consists three types of investments.

Bonds (NSCs, RDs, FDs and debt MF)
Equity MFs
Equities

During the last three months phase I have partially reduced my loss making equity investments and placed into better valued stocks, FDs & MFs. Over all churning has been close to Rs 100,000.

Recent allocations:
NHPC
SJVN
Bharti Airtel (Somehow I liken Sunil Mittal to Steve Jobs)
IOC (Before it shot up :-))
RIL
Alok Industries
Moser Baer
Tata Steel

Key learnings have been

1. Bonds provide a stable foundation; never underestimate them
2. If we have entered into a bad scrip. Evaluate the possibility of exiting or averaging equally. Don't blindly average.
3. Dividends are important. ( If India has to grow, eventually interest rates will come down to 4% to 5%. Lets assume that the time frame for such change is 10 years. If I invest in a good dividend paying stock with dividend yield of 3% and annual dividend appreciation of 10%, my dividend yield after 10 years would be ~8%. This returns would be apart from the capital appreciation I enjoy after 10 years.)
4. Commodity exposure is important ( I am still evaluating the possibility of adding this in my portfolio. As stated previously, I probably take much more time than required in analyzing investments. But then there is no fast way to make money I suppose. )
5. Buy good business (I am long on solar energy)
   
6. Seek investor friendly good management. ( I am long on Tata * )
7. Always keep a small portion of fund available for arbitrage opportunity. This activity should never be a part of long term wealth building portfolio.
   

With this update I conclude my today's post. I shall be putting more about my investment process and the way I value stocks in a matter of days.

RIL: Is it an opportunity now?

Reliance Industries has long been in passive mode. I have been watching this stock since 980 level. I did not buy it then for it has invested in very risky assets. Telecom business, Shale gas in the US and what not. Shale gas by the way is very difficult to extract and a slight mismanagement would bring RIL to shambles. The US will not take 26 years to declare useless verdicts.

Still recent deregulation on fuels will directly benefit RIL. It has had many dysfunctional petrol pumps for now. Unless prices have been deregulated, RIL would never use its petrol pumps. From this perspective I see RIL is at a bargain prince currently.

Disclosure: I have a small exposure in RIL

ABCIL : Why is it so undervalued?

I have been observing this particular stock ABCIL since quite some time. While most of the companies in to the chemical industry hover at 10-20 PE, ABCIL has been at 3-4 PE for quite sometime.

Positives and negatives about the company:

1. It is Aditya Birla group company. I have no qualms about its management.
2. Topline growth has been okay since 2005. 2005-2006 3%, 2006-2007 28%, 2007-2008 21%,2008-2009 17%, 2009-2010 10% with standard deviation 9
   
3. Net profit has seen ups and downs. 2005-2006 -1%, 2006-2007 29%, 2007-2008 45%,2008-2009 -6%, 2009-2010 31% with standard deviation of 22.
4. Book value as been increasing considerably.
   
5. EPS has not shown consistent up turn. 2005-2006 0%, 2006-2007 29%, 2007-2008 46%,2008-2009 -6%, 2009-2010 31% with standard deviation 22
6. Cash flow has not been increasing, this is alarming for me.
   

More to come...

Disclaimer: I have started a very small position in this stock. It will be my benefit if you invest in it.