Tuesday, May 1, 2012

Go for it- Direct equities are best

( A different version appeared in the Asian Age/Deccan Chronicle)
  Focused investing- Single Stock SIPs In the recent past, we have been flooded with articles that compare the returns on various types or forms of investment. There were also some ridiculous debates which went on to argue that fixed deposits gave a better return than equities. Of course, we can compare everything from returns on gold, sugar, US dollar or mutual funds. Of course, no one has still dissected the actual returns on a ULIP to an investor (perhaps because it is not worth mentioning).
 At the same time, each one of us knows of someone who has a pile of shares in some company that has given great returns. Either the person was lucky enough to have bought his shares before the markets were discovered (say, prior to 1994 or so) or has so much money that he has a high level of holdings in a lot of stocks. And of course, we only know of the winners. The losers are buried out of conversation.
I am sure that most of us dream of having sufficiently large number of stocks in a few high quality companies. For example, I would love to own a basket of shares in companies like ITC, HUL, HDFC, Colgate, Glaxo, Nestle etc.
 However, each time I look at the price, it either looks expensive or I am not able to muster enough money to buy enough. So, let us get down to building a dream portfolio of stocks that will help us to create serious wealth. I am not talking about buying some share at ten rupees and seeing it go to ten thousand. Of course, I would love to own something like that, but there are no recipes for this. What I aim instead, is to build a core portfolio of direct equities that will at some point be worth a small fortune.
 Today, I cannot imagine serious wealth being created through a mutual fund route. As each fund keeps getting larger, the funds are perforce mimicking each other. One is the herd mentality and second is the shape and size of our markets. When a fund is over a few thousand crores, it is not possible to merely buy a couple of crores worth of stocks in a few companies. Even if they were to make spectacular returns, there is unlikely to be a serious impact on the overall fund. So, mutual funds are forced to buy and hold stocks that are within the universe of, say, BSE 200 or NIFTY. This is to ensure that they can buy and sell decent quantities at short notice and at prices not too different from the quoted prices. For example, you would be able to buy RIL or Tata Steel to within five or ten paise of the prices on the screen, whereas, if you want to buy something like, say, MICO, there would be significant difference in the actual bid and offer prices. And, the fund manager may not be able to buy the quantity he wants for his fund.
 I must mention that the strategy I am suggesting is for the real long haul and is fraught with risks. Venture on this path only if you have already accumulated some money and have money to spare for the route I suggest. I would firstly see how much money I can spare every month, after meeting all my usual investment commitments etc., I will only use that portion of my monthly income that can be put away for the next generation or for twenty years or so. Let us say, this amount is around Rs.20,000 per month. I would now pick up two to four high quality stocks and buy them in equal proportions.
 Let us say, I choose four stocks. Then, I would allocate Rs.5,000 to each stock. I would, on the first (or any other day suitable to you) trading day of every month, buy the four stocks. My outlay on any one stock will not exceed Rs.5,000 and the total will thus stay within Rs.20,000, which is the amount I think I can put away. I will buy each month, for the next ten to twenty years. In each year, I have 12 buying dates. Thus, over a twenty year period, I would have 240 buying dates. I would be able to accumulate a fair number of stocks in four companies I have chosen. I would be buying through good times, bad times, bull markets and bear markets. So, in a bad market, I may get more number of shares and in a bull market, I would get lesser number of shares. The prices would surely average out over time.
 The important thing here is to pick up the right stocks. I do not have any magic for this, but I would make a list of some conditions that my ‘buying’ list companies should meet with. It would include:
 i) A good track record of at least ten to fifteen years;
ii) Never more than two years of losses;
 iii) Non controversial family ownership;
 iv) Return on shareholders’ money (PAT/Networth) in excess of 20%;
 v) Low to zero debt;
 vi) Consistently dividend paying company;
vii) Commonsense view that the company will be around in the next two to three decades at least;
viii) Good management reputation and no past ghosts;
 ix) No visible family issues ; and
x) No regular visits to the capital markets.
You can add your own filters. The ultimate idea is that you end up with a list of one, two or more companies that will let you sleep peacefully, under most normal circumstances. Surprises are still possible, but if you spend some time, it should not be difficult to make a short list. I am NOT asking you to do a valuation exercise. Simply a selection exercise.
Just to do a random check, I ran the numbers on the ITC stock. I ran the exercise from April 2000 and ran it for 145 instalments (up to April 2012). The results were very interesting. I assumed a maximum monthly investment of around Rs.5,600. After 145 months, I ended up with 16594 shares, at a total cost of Rs.7,78,866/- and a resultant market value on April 1st 2012 of Rs.37.69 lakh, giving a return of over 22% p.a.!!
Lucky? Perhaps yes, in choosing this stock. I am sure that the results would have been in this range for a few more companies like HDFC, Nestle, Colgate, Indian Shaving Products, Aventis, Maruti, L&T etc., Only when we start to think about companies for the next two to three decades, do we see the universe of equities suddenly shrinking to a handful. I must caution you that this route has its risks, but once you are covered for your basic needs and look to wealth creation, this would work well. You have to be extremely unlucky to pick long term losers. If you have to follow just two or three companies, you will find yourself reading more about the company and the industry. Take the first step slowly. But, once you start, do not miss a single instalment of buying for at least ten to twelve years. And do not get in to the temptation of increasing and decreasing your lot sizes. Leave that to the professionals.
R. Balakrishnan (balakrishnanr@gmail.com) April 27th, 2012

5 comments:

MangoMan said...

Hi Bala,

I found this columns of yours very interesting as an individual investor.
I have been thinking along similar lines. Though the challenge as you mentioned, remains in finding the companies which will be around for next 20-30 years and hopefully grow at a pace healthier than the GDP growth rate + inflation.

Regards
MangoMan

MangoMan said...

Hi Bala,

I found this columns of yours very interesting as an individual investor.
I have been thinking along similar lines. Though the challenge as you mentioned, remains in finding the companies which will be around for next 20-30 years and hopefully grow at a pace healthier than the GDP growth rate + inflation.

Regards
MangoMan

Unknown said...

suffers from hindsight bias and survivorship bias. In the year 2000 which are the companies that you would have chosen? Would it have been say Century and Bombay Dyeing? Even in the Tata Group other than say Ta Mo, others would not have done so well - and TCS would not have been listed. I am LESS (FAR LESS) confident of doing it going forward..even though I have done it in the past :-)

Frustrations Amalgamated said...

It would be unfair to put yourself in my place- I am known to be conservative and more important, the names you mention, would all fail the ROE test. In those days, it is the MNCs and perhaps someone like INFY would have shown up. Simply take the highest average ROE over last ten years and then make a shortlist- And see if we understand the business- ITC, NO cyclical business would enter this list logically.
But you make a very valid point. So the entry in to the list holds key to winning or losing.

Frustrations Amalgamated said...

Maybe in view of the comments here, I will try and identify a dozen companies over the next week and put it up for a debate.
Thanks for all the feedback- Helps me learn