Wednesday, September 30, 2015

How Important Is "Timing" The Market?

How Important Is "Timing" The Market?
We have read from many investment text books that equity markets can deliver superior returns than any other asset class when stayed invested for a long term, say five years. In fact, may of us would have even witnessed the same in their investment portfolios.
The chart below plots the value of S&P 500 index from January 1950.
During the period, there were 16,537 trading days (as per daily index data). Out of this, we have a total of 15,279 five year periods. Let us now look at how much returns the S&P 500 delivered over these five year periods.
As we can see, the S&P 500 has delivered positive returns in over 81% of the observations. It has delivered negative returns in only around 19% of the observations.
There is another important data point to look at. Comparing the average returns, the quantum of negative returns (-2.26%) is much lower than the quantum of positive returns (12.59%).
Let us now go one level further. The number of observations where the average returns were more than 10% was 7,095 which is 46.44% of the observations. The average returns above 10% was 18.16%.
Thus, based on these historical data, we can infer that had one invested on any day of the market (S&P 500), the probability of not losing money is as high as 81.25%. It reiterates Mr.Warren Buffet's famous quote. "Time in the market is more important than Timing the market".
While I try to emphasize on the importance of "time in" the markets, I would also like to elucidate certain key points one has to keep in mind while investing in the markets.
  • Always stick to your lane. Assess your risk profile thoroughly and take only those investments that suit your risk-return profile.
  • Practically, no one can time the markets perfectly. If you keep waiting to invest at the bottom-most point, you might end up missing the bus again and again.
  • Invest in equities with a long term perspective - ideally 5 years. Historical data has shown that the chances of making positive returns over a 5-year investment horizon is as high as 81.25%.
  • Keep reviewing your investments periodically.
Disclosure: This analysis and views expressed in this document do not have any connection with my company and pertain only to my individual analysis. Please note that past performance does not guarantee future performance. Please contact your investment advisor for advice specific to your portfolio.

Friday, September 11, 2015

Ashok Leyland - Standing Out of its Peers, But a Long Road Ahead

Over the last five years, Ashok Leyland's stock  has underperformed BSE Auto Index as well as the CNX Nifty Index. The chart plotting the stock movements in comparison with Tata Motors, CNX Nifty Index and BSE Auto Index is shown below.

                                            (Rebased to 100)

An industry that has been languishing

Ashok Leyland is the second largest company in the commercial vehicles space in India. It has a market share of around 29%, next to Tata Motors which holds more than 50% market share. The commercial vehicles industry has been languishing, especially since 2012.

The primary reasons for this weakness are

  • Weak demand from end-users
  • Significant delay in economic recovery and pick up in growth
  • High interest rates - This has resulted in many buyers of commercial vehicles defer their purchases
The positive sentiments in the Indian equity markets were boosted since the later half of 2013 when Shri Narendra Modi was announced the prime ministerial candidate. The markets rallied sharply as we witnessed the historic win of BJP in the 2014 general elections by a thumping majority.

This was on the hopes of faster economic recovery and development.
However, growth was not as fast as expected. The government's failure in passing the two key bills - The Land Bill and the GST Bills led to negative reaction in the Indian equity markets. These are two important bills to spur investment and manufacturing activity in the Government's Make in India campaign. And, commercial vehicles industry is highly dependent on the manufacturing sector.

What next?

Let us have a look at the monthly sales growth for commercial vehicles pertaining to the three main players - Ashok Leyland, Tata Motors and Mahindra & Mahindra (M&M).

As we can clearly see, the recovery at Ashok Leyland in terms of sales has been far better than the industry and the peers (Tata Motors and M&M). The Society of Indian Automobile Manufacturers (SIAM) expect the commercial vehicles industry to grow by 6-8% in FY 16. However, I feel that this industry will grow in a much faster pace on the backdrop of government's policies and actions focused towards growth & development, increase in manufacturing activity and revival in economic growth. 

Growth with Improving Efficiency

After reporting an operating loss in FY 14, the company has come back to profits in FY 15. The company has reduced its debt significantly, with the debt-to-equity ratio falling sharply from 1.01 to 0.55 (Calculated using book values, after adjustments). Normalising the cash flows, a net capex of 57.75% of EBIT (1-T) and a Non-cash Working Capital of 3.94% of Revenues is expected to continue for the next 10 years for which high growth is assumed. 

However, the current Return on Capital (ROC) of 4.17% is significantly lower than the cost of capital which works out to 7.10%. I expect that during this high growth period of 10 years, Ashok Leyland's return on its new investments will move at least half way towards the global average ROC of 12.77%. This, combined with expected efficiency in ongoing investments is expected to produce a growth of 15.6% during the next 10 years, before the company enters into a consolidation and stable phase. The passage of the GST bill and the gradual reduction in corporate tax rates (as announced in the Budget 2015) will also contribute the the efficiency growth.


I have valued the company using a Free Cash Flow to the Firm (FCFF) method. Notes to my valuation is given below and the excel file containing my valuation is attached herewith.

Here is a breakup of the valuation.

The value per share works out to Rs.74.14. The current market price is Rs.87.55. Based on this valuation, it appears that the stock is overvalued by 18%.

Key Notes to the Valuation
  • 10-year GSec Yield minus country default spread is taken as the risk-free rate.
  • Cost of Capital:
    • Implied Equity Risk Premium, combined with a bottom-up beta is used for the cost of equity. 
    • Market value of debt to equity is used for weightages
    • Cost of debt is calculated using the risk-free rate and a synthetic spread
  • Financial Statements
    • R&D Expenses have been capitalised and amortised over a period of 5 years
    • Other Income has been removed from operating revenues
    • Financial statements are normalised using the last five years' data to find out reinvestment rate and return on capital
  • FCFF Valuation with a 10 year high growth period is used
  • Terminal value is calculated using risk-free rate as stable growth rate
  • Cash is kept out of the cash flow valuation and added to the firm value separately.
  • Cross holdings are accounted separately. 

Friday, April 3, 2015

My View On Income Funds

This is my first blog post of this new financial year, or rather, 2015 itself. In this post, I would like to share my views on Income Funds. Of late, I have been speaking to many of my peers and experts in the industry understanding their strategies and views on markets. Almost everyone is bullish on long term duration funds which I am not comfortable with.

There have already been two rate cuts this quarter – one in January and one in March. Both these rate cuts came in as surprises as they were not announced during the scheduled monetary policy reviews.

These rate cuts have mainly been on the backdrop of an easing inflation scenario.

CPI Inflation increases, WPI Inflation drops further

As per the latest data, the WPI inflation fell to -2.06% in Feb 2015 compared to -0.39% in the previous month. The Consumer Price Index (CPI) came in at 5.37% in Feb 2015, compared to 5.19% in the previous month. While one index declined, the other rose. I believe that this is mainly because of the different baskets of goods they track.

Data Source: RBI,

However, the RBI continues to focus on the CPI and as per the agreement signed by the RBI and the Government of India last month, the RBI will aim at an inflation target of 6% in January 2016 and 4% in 2016-17 and the following years.

An update on Income Funds

Over the last one year, the 10-year GSec yield has fallen from over 9% to 7.79%.

As per data on 10th March 2015, medium term funds have delivered 11.84% returns and long term & dynamic funds have delivered 15.88% returns over the last one year. Assuming 30% income tax on gains, these translate to post-tax returns of 8.29% and 11.12% respectively. The yields are much higher than the post-tax yields on fixed deposits (FD) offered by reputed institutions.

Let us now have a look at how consistently these funds have performed.

 Data source: Data as on 10th March 2015. Green colour denotes top quartile performance and red colour denotes bottom quartile performance.

As we can see from both these charts, we can hardly find consistent performers across time periods. Funds that have delivered top quartile returns in the long term have delivered only average or bottom quartile returns in the short term. Similarly, funds that have delivered top quartile returns in the short term have delivered only average or bottom quartile returns in the long term. In short, these income funds have failed to deliver consistent returns across time periods.

I attribute this lack of consistency largely to the inability of fund houses to effectively manage duration as yields change dynamically. This lack of consistency adds a lot of confusion in investment decision making process, especially while the direction of interest rates is uncertain.

My Take

The RBI has already cut 50 bps in the repo rate during Q4 FY15 in response to a sharp decline in CPI inflation from above 8% levels seen in last year.

I now believe that the RBI will be looking at more data before taking action on policy rates.

The recent unseasonal rains in various parts of India and the fuel price increase of 28th Feb 2015 could have an impact on food prices, thereby increasing inflation. 

Though the US Fed came out with a dovish statement regarding rate hikes in the recent FOMC meeting, the interest rates in the US are expected to rise late this year. Rate hikes in the US can result in outflow of funds from emerging markets – both equity and debt.  An outflow from debt markets can lead to a downward pressure in bond prices which could affect the interest rates.

Thus, though interest rates are expected to come down in the long run, the debt yields can be highly volatile in the short term.

Investors who have entered into income funds with a view of making absolute returns can book profits now. They can move to accrual based funds with a holding tenure of 3 years. I would prefer 3 year Fixed Maturity Plans (FMPs) and Hybrid funds with a capital protection oriented structure. These funds have a potential to deliver 1.5 – 2% more than fixed deposits (post taxes).

Please do share your views on the same.
Happy Investing.

Please Note:
Schemes from reputed AMCs which have sizable AUM alone are considered for this analysis.

Mutual Funds investments are subject to market risks. Please read the offer document carefully before investing. The views presented in this blog post are my personal views and not of my company. This post does not solicit the sale of any mutual fund scheme. 

Saturday, November 23, 2013

[Mutual Funds]: Direct Plans are like the Wholesale Markets

With the direct plans coming into the mutual funds industry, many distributors have winessed a sudden drop in their Assets Under Management (AUM) as many institutional investors switched their funds to direct plans.

The expenses in Direct Plans are far lesser than those in Regular Plans because there is no distributor involved. So, no brokerage is paid out from the fund's NAV. This leads to superior performance of Direct Plans compared to Regular Plans.

Ok. Is it really worth?
How many of us go to the wholesale markets to buy our regular supplies? And if we do, how how often do we go? I am sure none of us would be going to a wholesale market every month to buy our supplies. Why don't we? Because...
a) It is time-consuming.
b) Most wholesale shops are concentrated in a single area of the city/town and might be very far from where you stay.
c) Transportation might be a challenge.
d) We will have to buy mostly in bulk to save more cost.

So, we stick to the supermarket or departmental store which is close by to buy our supplies. And, we know that the retailer earns a margin by selling for more than the wholesale price.

Direct Plans in mutual funds are also something similar to the wholesale markets. Since there is no distributor involved in it, the investor would have to select the scheme by himself. He will have to
a) Decide by himself on what buy & when to buy.
b) Procure the application form either through internet or by contacting the AMC directly.
c) Submit the filled application form by himself.
d) Request and get the account statements by himself as and when required.

And the lack of standardisation in the mutual funds industry makes it extremely challenging for an investor to do all these by himself.

Though the returns in direct plans would be superior to those of regular plans, I feel that it is worth to pay a distributor than going through all these hassles.

Happy Investing...!!

Saturday, August 3, 2013

High P/E Stocks are like Dosas in the Malls...!!

Consider a small restaurant in the city. What would be the cost of a Dosa? Let us assume it would be around Rs.20-30. The restaurant manages to make around 20-25% profit margin on each dosa, after deducting all costs.

Now, let us consider the same dosa sold at a food court in a swanky mall. The cost of each Dosa would be around Rs.80-100 (almost 200% higher). The restaurant manages to make only the same 20-25% profit margin.

So, why both make the same margins in spite of the huge difference in the pricing?
It is simple. The costs involved are much higher in the food court and hence, he charges more than what the small restaurant charges.

So, is this justified? I feel, yes...!! People are aware of this huge price difference in the dosa, but still you can see the malls crowded all the time, especially on weekends. The food courts never run out of business. They are making good volumes in spite of the premium pricing. My point is, people are willing to pay this premium price for the dosa at the mall.

This is similar to some of the high P/E stocks, especially in the FMCG sector.
They have always remained expensive in terms of Price to Earnings ratio. Does that mean that people investing in these companies do not make money?
Ok, here is a small analysis.

The markets have seen both bull and bear phases over the last ten years.
I have tried to compare the yearly returns (for the past 10 years + 2013) of 12 top listed FMCG companies with those of the Sensex.

Let me share with you my observations based on this analysis.
  • The highest return delivered by Sensex was 81.03% - in 2009. This year was quite positive for the markets as the Sensex recovered from the historic fall to 8,000 points. But, this 81.03% was not even in the top quartile when compared to the FMCG stocks. 3 out of these 12 companies delivered more than 100% returns in the same year.
  • The lowest return delivered by the Sensex was -52.45% - in 2008. During the same year, FMCG stocks were more resilitent to the fall, with the lowest return of -47.35%, generated by Gillette India Ltd.
  • As you can see in the chart, the FMCG companies on an average have delivered more number of top-quartile returns than the Sensex, less number of bottom-quartile returns than the Sensex.
This analysis reveals that in spite of the high P/Es, FMCG stocks have been resilient to falls and have delivered superior returns during bull markets.

Investors are willing to pay a premium for such stocks, like those willing to pay for the expensive dosas at the malls. Apart from superior performance, these companies have delivered consistent ROEs, Margins and Growth.

So, I believe that the high P/Es in such companies are justified...!!

Please share with me your views, folks.

Sunday, July 7, 2013

Always Stick to your Lane

While driving, sticking to your lane is very important. If you switch lanes very often without even looking at the other vehicles, you would definitely meet with an accident and will not reach your destination.

Equity investments are quite similar. Many investors invest in equities for long-term. But, if they hear or read about some bad news in the market, they immediately sell off their positions not even understanding the long-term impact of their decision.

Investors also take short-term trading calls based on cues from their friends, media and even their own intuition. This can be witnessed during the quarterly earnings season. People look for trading opportunities without understanding the risk involved in the trade and forgetting their long-term investment goals.

It is mostly triggered by the regret-aversion bias in investors. When they see their friends taking short-term bets, they are also tempted to take the same bets because they do not want to regret the opportunity loss, though they are oblivious to the risks involved. Most of them have this "Follow the Herd" attitute while investing. They forget their long-term objectives and keep switching between different trading opportunities. They actually end up losing money in their short-term risky bets, burn their fingers get stuck in the middle of their investment journey, thereby not reaching their destination.

Doesn't this sound very similar to switching lanes while driving?
  • First of all, one has to know where he has to reach (Financial Objectives).
  • He should then decide which route to take (Asset Classes).
  • Having decided these two, he should know which lane to take depends on their vehicle and speed (Investment Strategy in the chosen asset classes).
  • Having chosen his lane, maintain the speed and always remember to stick to his lane (Avoid Jumping Investment Strategies). Switching lanes would result in fatal accidents.
  • If you follow the above rules, I'm sure you would reach your destination (Financial Objectives).
Always Stick to your Lane, folks.

Happy Investing...!!

Saturday, July 6, 2013

(5 + 2) > (6 + 1)

What can be worse than working on a Saturday?

I always envy my friends who do not work on Saturdays. It is the most unproductive day of the week. The weekend-mood sets in on Friday evening itself. So, how can one actually be productive on a saturday?

My mum, in fact is fed up with working saturdays. You know why? She feels bored to prepare and pack my lunch on a Saturday...!!

An individual works his ass out from Monday to Friday. And after that, he is expected to work on a Saturday too...!! Doesn't he deserve at least those two days of rest?

I think most of the folks (including me) working on Saturdays just come to office to warm their chairs for attendance. What output can he produce when he is in such a mindset? He actually becomes tired and frustrated just by coming to office on a Saturday.

As a result, he gets no time to spend with his family and friends. Oh, you have Sundays...!! The poor guy has one day to rest. Is he actually going to spend that one day with family and friends? He would actually be sleeping the whole day.

Jack works for five days a week, spends time with his family and friends on Saturdays and takes rest on Sundays. Jill works for six days a week, doesn't know whether to spend time with family and friends on Sundays or to take rest, ends up doing neither of these fully.

Who do you think would be in a better frame of mind to come back to work on Monday? Of course, it is Jack...!!

I strongly feel an individual deserves two days of rest after five days of hard work.
By the way, I am writing this blog on a Saturday, sitting in office. You can imagine how productive I would be... :)

5 + 2 will always be greater than 6 + 1...!!