The 20 most important decisions of your life...
(Apr 7, 2015)
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In this issue:
» Does Volatility=Risk?
» Insider-outsiders could be a good choice in a management transition!
» Will 2015 be a big year for IPOs?
» ...and more!
"I am extremely disappointed. Since the last two months there are very few recommendations that are actionable..." one of you, who is also a subscriber, wrote to us recently.
Such emails from 'disappointed subscribers' are the norm rather than an exception for us. Especially in months when markets are buoyant. Incidentally, as the frenzy of buying stocks goes up in buoyant markets, our inclination to recommend buys gets lower. And we find your frustration of not being able to act, when everyone else is, very understandable. Just that the frustration could be turned into an emotion of solace if you think of your investing activity very differently.
Think of the last 5 times you decided to invest in a stock. And think of the last 5 times you took the most important decisions in your life. When you decided on your course in college, your first job, the person you got married to, the purchase of your first house and so on. Were the investing and life decisions taken very differently? And if yes, your investing decisions may never yield you the desired results unless you treat them like the most important decisions of your life.
Should you buy stocks based on the RBI's policy decision today to not cut rates? Should you buy them based on the latest quarterly result performance? Or whether the latest news article or expert comment on television should suffice to influence your decision Whenever such questions haunt you, there is a simple solution. Think of your 20 ticket punch card!
What exactly are we referring to?
Well, Warren Buffett has often said, "I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches - representing all the investments that you got to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at all. Under those rules, you'd really think carefully about what you did, and you'd be forced to load up on what you'd really thought about. So you'd do so much better."
Therefore your decision on buying a stock should be as important as taking the most important decisions of your life, which cannot be altered. And when you do that, you will know that as long as you do not commit too many blunders, your expectations will be met. In buying stocks your blunders could range from choosing the wrong company to buying a right company for the wrong reason to buying a right company at the wrong price. By keeping away from such blunders, you will protect yourself from the downside risks. And rest assured the upside will take care of itself!
By not recommending you to act when the risk of committing blunders are too high, we can nudge you to be patient and think harder about your investing decisions. But ultimately the decision is up to you to decide how many blunders you can afford to commit in your 20 ticket punch card.
How often do your treat your investing and life decisions very differently? Let us know your comments or share your views in the Equitymaster Club.
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Another reason why you may not be thinking through your investing decisions in the right perspective is because of your perception of risk. Unfortunately every time you read the newspapers, listen to business channels or even attend a business school lecture, all you get to know is that Volatility = Risk. The truth cannot be further from this! It is true that the performance of your investments in stock markets will always be more volatile than the performance of your investments in say bonds or fixed deposits. But the returns too are commensurate. So every time you see volatility as a risk and pay a premium for investing when there is less volatility, your investments will cost you more than they should.
This lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong! Volatility is far from synonymous with risk. So when you look back at the years when market sentiments were extremely volatile, you will see that the opportunities to invest in the safest stocks at the best valuations were the maximum. Years like 2009 and 2013 when the market volatility offered the most opportune investing options come every once in a while. And you should make the most of times like these to take your most important investing decisions. At other times stay away from the blunders.
Buffett's views on market volatility are no doubt strong and clear. However, his views on management integrity is if anything, even stronger. Time and again, we at Equitymaster have cautioned investors against placing their trust in managements with questionable integrity. Long term investors in Indian markets are well aware of the losses one can suffer due to the poor choices made by managements against the interests of shareholders. A large part of the problem of management integrity in India is rooted in the structure of family owned business.
Thus it came as a welcome news when the promoters of Pidilite Industries announced the company's leadership transition. Once completed, none of the family members will hold any operational roles in the firm. However, the new managing director, Mr. Bharat Puri, won't be a complete outsider either. Shareholders will derive comfort from the fact that he has been an independent director on the board since 2008. Thus he can be thought of as an 'insider-outsider'. We believe such a transition is certainly shareholder friendly. Hopefully, more family owned businesses will follow in the footsteps of Pidilite's management.
Long time readers will be aware of our caution in recommending IPOs. Our warnings on some of the recent issues were appreciated by our subscribers. As the Sensex surged past the 21,000 mark in early 2014, we were sure that astute promoters would line up with their public issues sooner rather than later. Sure enough, 2015 promises to be a big year for fund raising and IPOs will take center stage yet again. However, as we have stated before, promoters are interested in squeezing out the maximum funds from the capital markets with least possible dilution of their stakes. This is only possible if the issue is priced at sky high valuations.
Investors buying into such pricey issues are putting their money at considerable risk. This has now been proven by a recent study done by a proxy advisory firm and reported in The Mint. The study has found that out of the 394 issues between FY04 and FY15, 42% were trading below the offer price! What's worse, the average return of 164 issues that are in the green is lower than the post-tax returns from fixed deposits. Studies such as these prove what we already know, most IPOs should be avoided by retail investors.
Will the IPO market reive in FY16?
Meanwhile, the Indian stock markets have witnessed a volatile trading session today as the RBI made no change to the benchmark lending rates in the Monetary Policy review today. The BSE-Sensex was trading down 92 points (0.25%) at the time of writing. Banking stocks were leading the losers. The midcap and small cap indices were outperforming with gains between 0.5 and 1.0%. European indices have also opened on a positive note.
"I think you have to learn that there's a company behind every stock, and that there's only one real reason why stocks go up. Companies go from doing poorly to doing well or small companies grow to large companies." - Peter Lynch
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|This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee.
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