Jigger Pokery at the NSEL, Murder on the Orient Express etc

The NSEL scam is funny. No one seems to be interested in finding out where the money went. The promoter has drawn out a schedule of repayment which is like a pregnancy to delivery routine stretching over ten months. The brokers are busy pointing fingers at Jignesh Shah so that the investors conveniently forget their role of luring the victim. The brokers now hide the fact as to who did the KYC on the names that are borrowers. Or each one of them fronts for Jignesh Shah? No one wants to know or say.

The brokers & Jignesh Shah, in a bid to soften government response, pay off 'small' investors. And how? By Jignesh Shah, dipping in to the wallet of Financial Technologies WITHOUT legal sanction!! Jignesh Shah is a class act!! His contacts have ensured that the government still has not touched him, looks on to his charade of appointing 'independent' Officer on Special Duty, "Forensic Audit" and what not. But it seems to be working. Government has still kept him outside bars and the Economic Offences Wing still deliberating perhaps about whether there is a crime happened or not.

Wonderful example of corporate governance. Promoter picks pockets of one company clean. Then picks pockets of another company to give 'loan' to the other, which can NEVER be repaid. The other co shareholders don't even get a thank you letter from the promoter for this robbery by the promoter. And brokers, who took investors on a guaranteed return trip, now point fingers. Who gave the funny limits to NK Proteins? It seems that sons-in-law command the nation. The Chairman / directors of the NSEL just walk out, having partaken of whatever fees and other gains they could.

And no one is interested in tracing where the money went to. It should have been less than one working day's task to find out where the money went. Now Grant Thornton will do its 'forensic' audit. Who will foot the bill?

The brokers, the directors and the government all look like characters out of Agatha Christie's "Murder on the Orient Express". A murder has happened. A body is there. And all the killers get away scot free.

A Disciplined Approach to equities

An earlier piece that has appeared in Moneylife EQUITIES – A DISCIPLINED APPROACH When it comes to equities, each of us has a different experience, though we are perhaps all in the same “market”. Dig deeper and you will find that each of our journeys are separate, originate at different times, we take different vehicles and yet all of us seem unhappy with the “market”. Is there some safe way to be in the market with the objective of creating long term wealth? More often than not, the disillusionment is solely on account of a lack of thought behind the reasons for being in the market. Yes, all of us want to double our money each day. But do we sit back and think about the probabilities or possibilities? Take a look at the data below: Jan1-2012 to date- Sensex 20%, midcap 14%, small cap 0 2013 to date- Sensex -4%, midcap -18%, small cap -25% The above table is interesting. You can go back in time and check for whatever periods. The takeaway is that smaller stocks need a tougher skill set. One other thing has happened, which has not been documented. If one were to form a bucket of stocks with high ROE, businesses that are solid and have been around for a few decades, a different story comes through. Since the panic of 2008, when the broad markets fell, there has been a rush in to these stocks (for example, HUL, ITC, Nestle, Asian Paints, etc). Even in a falling market these stocks have trended higher. At the same time, some of the mid cap stocks are below what they were quoting when the Sensex was below 10,000. Thus, there is a huge difference in one’s experience of the stock markets even in same time frames. We all know that timing makes a difference. Yes, stock selection also matters. But this safe haven story seems to be a development of the last five years. This also means that these great stocks are priced to perfection and leave no room for disappointments. Yes, the street may tolerate one weak quarter, but a perceived slowdown or drop in expected profitability will lead to a severe de-rating of these stocks. The levels at which they are priced, limits the upside potential. Yes, they are great stocks to have in one’s portfolio, but the risk one runs is of prices stagnating in that portfolio. Let me tell you what a basket of five high quality stocks have delivered over the last ten years: Time Cummins HUL HDFC ITC Nestle Total Sensex Bank RD 1 year (7) 17 9 14 5 8 6 4 2 yrs (2) 38 15 34 9 19 11 9 3 yrs (4) 62 19 53 19 30 9 13 4 yrs 14 78 29 82 39 49 12 18 5 yrs 49 91 51 116 76 77 25 23 10 yrs 177 157 207 321 312 233 91 53 ( Absolute return in percentage terms, NOT COMPOUNDED) start date is June 2003/ In the above table, I have assumed that each month, on the first business day, we put up to a maximum of Rs.5,000 in each stock. Actual amounts would be slightly below 5,000/- to avoid buying fractions. Thus, maximum commitment of Rs.25,000 per day. Against each stock, the time wise returns are indicated. “Total” refers to the total returns from all the five stocks together. 1% brokerage on stocks is considered. In effect I am doing a SIP of 5,000 per month in five stocks, 25,000 per month in the index and a like amount in a bank recurring deposit, monthly compounded at 8% p.a. The above basket is a matter of choice and returns will vary widely based on what stocks one chooses. Clearly, the start and end period would make a difference. To make a basket of your own, just pause and think about which five or ten businesses you would like to own. That can help you prepare a list. Financial analysis can come later. I am using this table for a limited illustration. My point is that a basket of good quality stocks will beat the sensex returns comfortably. The risk of choosing just one stock is high, and hence I have chosen a bundle of five stocks. To me, it is also a function of discipline in investing. What is also evident from the table above is that if we look at the ten year window, the latest five have not provided great returns. And whilst a bundle of handpicked stocks have beaten the index in each year, the index has even lagged the bank recurring deposit investment over the latest three and four year periods. Of the stocks chosen above, I would have had difficulty in ranking one over the other even five or ten years ago. Same would be the predicament if I were to look five or ten years in to the future. My reasonable expectation is that in the next five or ten years, these companies would still be around and the businesses would continue to be great. This basket need not be the ‘perfect’ basket and five is not the only number. This kind of a basket may not give you great returns or multi baggers, but can provide you with a healthy equity portfolio that goes to create wealth. Mutual funds in India have so far done a decent job in equities. Nearly half of them have beaten the index. However, as the size of the funds increase, this will become more and more difficult, given the illiquid nature of our market. There are hardly 200 stocks with a market capitalisation of more than Rs.5000 crores. In essence, our entire market is a mid cap or micro cap market. So, any large fund will tend to mimic the bigger indices more and more. At best they will be overweight or underweight on a few stocks. So, investing in mid caps pays off when the size is small. A fund like HDFC Top 200 is a great example. Its great performance in the early days made money pour in. Today it has bloated to nearly Rs.12,000 crore! Finding 200 stocks to deploy the money is not easy. Now the performance is slipping badly. The fund should have closed out at around 2000 crores or so to sustain performance. So as the mutual fund industry grows in size, it would find it harder and harder to match indices. It would be a good exercise to go back to all your equity investment decisions and analyse them. Often, disappointment is the result of inadequate time and thought given at that point. I firmly believe that equities are a valuable investment vehicle. So, think hard. Equity investment is not a short cut to multiplying your money. First try and create a corpus through a long term plan. Then, take what risks you want, with money that is really surplus and where the loss is not going to hurt you. The chance for big rewards will always be with big risks. You may buy ten penny stocks and maybe if you are lucky one will become a big winner. The key to success in equities is your ability and willingness to acknowledge and accept the risks attached to it.

The Financial Planner- Get to Know one- Do your homework in advance

We do not shy away from paying our doctor (where we do not even worry or wonder about the fee he is going to charge, whether the medicines he has prescribed are the best or if there are other alternative medicines at a lower or higher cost and efficacy available) when it comes to a health issue. However, when it comes to our wealth issue, our attitudes are very different. Same is the case for many of the services we use, whether it is a plumber or an electrician or the mobile repair fellow. However, when it comes to our wealth, we do not think about engaging a professional. Maybe, we have suffered losses on our investments as we thoughtlessly bought products without asking all the questions and tried to fit a square peg in a round hole. As a result, we have developed a generic mistrust of financial advisors. Of course some of the advisors are also to blame, as they pushed products that gave them the highest commission, without considering its suitability for you. To my mind, most of us lack in financial literacy. We simply get carried away by anecdotal evidence or advice which we do not question. To me, a financial planner or an advisor has a key role to play in assisting us with our money. However, the important thing to note is that his task should be confined to taking our present financial condition and explaining the risk in each of the product he advises us of. It should start with an assessment of where we are currently. Often, I have seen people reluctant to share financial information with advisors. This is akin to not telling a doctor about your medical history. The first requirement is that before you go to a financial advisor write down everything about what you have and what you owe. This has to be the starting point. The next step is obviously to write down what you make every month and how much you could put aside every month for the future. Also try and visualise what big expenditures (college admission, marriage, car, house or whatever you think are going to be big and non routine expenditures that you can anticipate). Now you are ready to talk to a financial planner. Now you have two sets of planned expenditure- those that are unavoidable and those that depend on how much you can save. In life, often our large expenditures have to be tailored to meet what we have. We may desire a three bedroom apartment, but what we could afford could be smaller. Once you decide to go to a financial planner, the first approach should be to evaluate what is clearly possible with your savings. This would obviously vary. If you already own a loan free home, a vehicle and other comforts, your only concern could be your children and your retirement needs. So each problem is unique. The first answer I would seek from a financial planner is to ask him: i) If I take zero risk with my money, what would be the outcome with my savings? After five years, ten years or twenty years? Obviously, the instruments available would include things like my provident fund, PPF, bank deposits etc. This would be my first line of defence.; ii) How much of my money can be spared to invest in riskier assets like shares, real estate etc? iii) What instruments are available for me? iv) For each instrument, I want to know the risk – Who is going to repay? When? and what are the price risks? Can I liquidate when I want and if so, what are the consequences? Do not be shy of asking as many questions as you can. Once I get these basics, then it is up to me to choose an appropriate mix of risk. If I already have all the basics paid for (house, car, children’s education etc) then I can take higher risk. If not, I have to opt for a lower risk. The important thing is to understand that you should NOT push the financial advisor saying that this is what I need at different points in my life and give me a plan to get there, with what I can spare. If your needs are more than what your savings can provide, then he will be pushed in to a corner and give you instruments that are highly risky and you will end up in a mess. It is best to fit needs to what we have. That is the only way to peaceful sleep.

If you are so profitable, where is the cash?

(This appears in the latest issue of Moneylife, the personal finance magazine) KICKING THE TYRES- LOOKING AT EARNINGS QUALITY Stock picking theories are many. Right from ratio analyses, industry analyses we have technical analyses and astrology. The average investor survives only because of luck. He has generally no clue about what he is buying or selling. His long term investments or holdings are often an outcome of a short term trade he initiated. He simply hates to sell below the price at which he bought. Well, let us keep all the analysts to one side. To me, the quality of management is perhaps the single most important factor after a cursory financials and business analysis. Ultimately, when we buy a share, we are becoming a part owner of the business that is run by someone. We are dependent on him to deliver a bang for our buck. However good a business or industry be, it cannot be better than the man at the helm. Often, I come across some incredible set of headline numbers and everyone talking great things about the company. Often, it happens in businesses that are fundamentally weak. The first disconnect for me is when a company stands out in a weak business. That is the first red flag. Then we start going deep in to the numbers and basic analyses throws out a con game. Of course, no one is immune to a structured fraud (like Satyam was), but most inconsistencies show themselves early- Bartronics Ltd, Opto Circuits, KS Oils, etc. So what do I look for in terms of numbers or inconsistencies? I will try and list out a few pointers and hope that some of the readers may benefit by it. The first test is to see whether a company has got any ‘free’ cash flow. For example, there is Profits After Tax. To this one can add depreciation. That is the first level of free cash flow generated by a business. However, this is only the surface. To reach this level of profits, I also like to see what happened to the working capital needs over two balance sheets. For example, the level of debtors has increased. This means cash is locked up there. Similarly, inventory could have gone up. And cash flow gets a boost by getting some credit on purchases. So, to the Cash Flow after taxes but before depreciation, we have to add or subtract the changes in working capital. Hopefully, this number is still positive. From this, I also like to knock off things like increase in loans and advances and a normal level of capital expenditure that is required. Let us assume that the depreciation is probably the amount needed to be reinvested in to maintaining its fixed assets. In such case, the FCF is really PAT +/- Changes in working capital +/- changes in loans and advances. This FCF is available to pay dividends. Now, in many companies, you will find that for years on end, FCF is negative. Obviously a Ponzi is on. In a case like Opto, the FCF was also diluted or negated by the buyout of new businesses on a continuous basis. In 15 years, the company bought 35 businesses!!. Obviously it needed cash. Already, the FCF was negative. So, it frequently raised capital. In one sense, dividends were paid out of fresh capital raised!! There are many other pointers- Does the company have too many subsidiaries in which a lot of money has been lent or invested? If so, do these associate or subsidiary companies pay market rates of interest? Why does the company have associates (businesses where others have a stake) ? To me, the presence of many associates and subsidiaries is a big red flag. Then I have to sit down with the subsidiary accounts (which mean writing to the company and then getting them) and see where the cash is going. I try and see ‘transactions with related parties’. The higher the value, the more suspect the numbers. I also like to see companies with no debt. When they have debt and it keeps increasing, I worry. I have seen companies where the borrowings increase by more than the sales numbers. Surely a great sign of trouble. Taxation is a great give away. If a company pays less than marginal tax, there is a very high probability that the profits are inflated. Similarly, depreciation is something I like to see. When depreciation rates are very low, I worry. I also like to see addition of vehicles etc. Just to get a feel of how much of personal expenditures get dumped on the company. Of course, a corporate jet is a big sign of a rip off and I try and stay far away from such managements who do not like other mortal means of transport. I also like to do some back of the envelope checks. Often I find companies understate their borrowings. For this have a look at cash and bank balances. When a company has borrowings as well as huge cash, something is wrong. Also check the interest outgo and try to relate it to the borrowings. One thing I like to do is to compare ratios and numbers with competition. If the numbers are way off either way, then I smell trouble. One company I was analysing was in to technologically advanced products. In one place they boasted about the total number of employees. Taking that and relating it to the total wage bill, I found that the average annual pay was under Rs.10,000 per month for those highly skilled persons. Each line in the accounts tells a story. Ideally one should look at ten to fifteen years of numbers if possible. Of course, there are things like Board of directors etc, which I ignore. In reality, there are no independent directors. Most are cronies of promoters and simply there to enjoy the perks of holiday homes and the commissions they get. So the Board tells us nothing. Board compensation also does not matter much, except a few of the directors now seem to be blatant about pocketing a few crores per year as compensation for self, spouse and children. Dividend payout is something I pay attention to. The higher the dividend payout, the greater is my belief on the cash flows. A low dividend payout is a flag. After Satyam, one is not sure even about balances in banks and mutual funds as reported in the balance sheets. I also tend to ignore asset values of land and property. Often, I have seen that the gains of these rarely accrue to the minority shareholder. Best to buy a predictable business where one is comfortable with the past. I am also sceptical about companies where the inventory and receivables keep going up disproportionately. Often, they are indicators of companies trying to show higher level of sales and profits than what is. Whilst investing, it pays to be cautious and sceptical. At worst we may miss an opportunity. But at least it will help us stay away from rotten apples.

Telengana - Andhra- Dividing People- Advantage Congress- Disadvantage People

So many issues- Doubt whether the Telengana people are going to be happy. Or the other half. Things that cannot be shared would include Tirupati temple, Hyderabad, water, food etc. People from Telengana who have properties and businesses in the other half would be targeted. Realignment in property prices is one small thing. Everything from State Transport, Infra, Police personnel will have to be divided. And a monetary payout from the Centre would have to come to the new state. One more High Court. One more Sales Tax regime. The list is endless. Positive possibility? Telengana with its own CM can develop better. If they can find the resources, which all seem to be with the other side. Till the dust settles down, expect riots and uneasy peace (if army steps in). Not a happy development at all. But suppose the Congress had to use this easy and divisive thing to get a few MPs in to its fold.

The Hindu Rate of Growth Is Back

The RBI did not do anything. A quiet 'state of the nation' address. Not surprising, given that it has the unpleasant task of having been told to keep the rupee below sixty to a dollar. The only answer was to squeeze the liquidity so tight that in the short run, forget dollar, the demand for everything calmed down. Will the rupee stay around or below sixty for some time? Unlikely, given that we continue to import beyond our ability to pay. We are paying for imports with borrowed currencies. How long can this go on? Fundamentally when we are revenue deficit in foreign exchange terms on a permanent basis, we have to either reduce imports, hike exports or attract long term capital that will find a home in India. Obviously that cannot be through the portfolio route. It has to be by letting foreigners engage in business in India. For that, we need infrastructure. Even that is not a big thing if our policies were stable and friendly. The number of permits and permissions, the number of bureaucrats to meet and then the capricious policies et al do not exactly welcome foreign business to set up base here. The other reason why manufacturing cannot move to India is because of the poor work ethic and the absence of a speedy and effective legal redress system. We have some laws, but apart from overhaul, they also need to be timely. With this situation, the economic growth also takes a hit. Capital expenditure in India is not happening. Demand is booming at the consumer end thanks to easy loans and a high wage services sector. With supply refusing to go up, the outcome is a combination of stagflation and higher current account deficits. The thing is that we are also seeing a slowdown in job creation. The situation now is not good at all. Maybe even consumer spending will be throttled by runaway prices. Once that happens, we will be back to five and four percent growth. But no, let us hope that the politicians do not screw it up so badly. But the last four to five years are putting spokes in every wheel of our growth story. Let us wait for interest rates to cool off. In the meanwhile, let us watch the Direct Cash Transfers. In all this economic problems, if Telengana happens, there is going to be more mess. Truly, Darkness At Noon

DO U REALLY NEED YR CHILD TO BE INSURED? THEN WHY BUY CHILD INSURANCE?

(Insurance companies con you with 'child' insurance etc. The premise behind their con is that should your child die before he or she grows up, you need a payout in money terms. Are you dependant on your child for your daily living? Or is it that you want to provide for the child's need in future?) Most of the adult fraternity goes numb in the mind when it comes to the future of their children. We often become easy meat for the insurance company that sells ‘Children’s Plans”. Sentiment and emotions overcome reason and we get taken for a ride. Someone hawks a plan that says that it will provide for education of your children, marriage etc and also provide an insurance cover for them. Pause. Think. What do you need for your children? Obviously, you need enough money to provide for their education and maybe for their marriage also. Can you quantify it now? How can one quantify needs that are twenty years or ten years in to the future? Do your children need insurance on their lives now? Why pay for it now? Let us say the unspoken happens, is it a financial disaster for you? So, why waste money on insuring their lives? What we need is a savings plan. And savings plans cannot be provided efficiently by any insurance company. The insurance company invests your money in bonds or stocks or some such combination. From this they will deduct their costs and selling commissions (which are way higher than in any other instrument) and give you the balance. And if you are suckered for insurance, that money will also be lost to you. So why go for that? Simply for an emotional pull that was utterly irrational? If you put the same amount in to a recurring deposit with a bank, you will have a higher corpus. Even a liquid fund will give you a better post tax return. And you do NOT have to spend on your children’s life insurance now. So get smart. Children’s Plans being hawked are simply inefficient and result in a poor return for your money. Instead start an investment plan. And since you want to be sure about having the money without any loss of principal at the time it is needed, you have to eschew equity. If you are planning to save for your child’s college fees or something, the best way is to go about putting money aside either in a liquid fund or in a recurring deposit with a bank in the child’s name. Yes, you will get a return that would be seven or eight percent. Putting money in to bonds may not be good as there would be interest payouts and no increase in maturity value. Shares are ruled out because you cannot predict either the price or the market conditions when you need the money. Yes, the next question is how much to save? The unknown here is the amount needed for education. Education expenses are a matter of luck, the marks your child gets and the kind of college one gets in to. The amounts can vary from a meagre amount of under a lakh of rupees a year for college to a few lakhs a year. In addition there could be capitation fees if you are unlucky. The only thing predictable and possible is for you to decide on an amount that you can spare regularly to be put aside for this purpose. Of course if you are well off and earning well, you are not bothered too much about it. One mistake to be avoided is to try and stretch returns on your investments simply because your calculator tells you that there is a gap between what your savings will amount to and the amount you need at the hour of need. Someone will then tell you- Over the long run, equities will give fifteen percent, so why not put some money there? Wait a moment.. What if the market is bad at that time? I might even lose some principal. Take a piece of paper and write down the needs and the means over the time frame you have in mind. The only way out is to keep your dreams and needs within your means. If you forget this, then you will take so much risk with your money that you will find it difficult even to make ends meet. It is possible that some aspirations may have to be toned down. Get smart with your money. Do not be outsmarted by insurance salesmen and dream sellers. R. Balakrishnan