2008 and 2009

As I had posted before, I had gone substantially into cash and was making selective investments.  I used this last year to re-organize my investment structure with a view to expand in the years to come.  As a result, I am starting a new performance series with 15-Jan-2008 as my new start date.  Initially, during the transitional period, the series is a combination of multiple portfolios which get December 2009.  This transitional period was very convenient due to the portfolio weighing requiring mostly transfer of cash, rather than securities across portfolios.

During the 11.5 months till end of Dec 08, Nifty went from 6206.8 to 3033.45 losing more than 51%.  Then for the next 12 months, it went to 5201.05 gaining 71%.  Overall, it went down 16%. (Percentage returns are not additive - they are multiplicative; so it is (1+-.51) = 0.49 x (1+.71) = 1.71).

It had been a great two years instructive of lessons in weighing your portfolio, giving it the right preference between cash and stocks.  As a result, the difference in return has been a whopping 185% for a period of 23.5 months, essentially meaning that if you had passively invested in an index fund on Jan 15, 2008, you would be sitting on a loss of about 16%, while my portfolio would have returned 185%.  This is more true if you include dividends, the over performance actually becomes 191%.

Here's the interesting factoid about that 185% over-performance, half of that gap was made in May 09, when the market jumped and almost all the stocks hit the upper filter after the results of the elections came out.  Now that is a lesson, against trying to time the market.
In absolute terms, I fully invested by March 2009 and stayed that way till May 2009 when I went to 80% invested and again to 95% invested till October 2009.  End of December, I am about 2/3 invested.  The 2/3 may be overstating it, since I am expecting to receive some additional funds into the portfolio by the last week of January, which would bring it down to 40%.  So effectively, I am 60% in cash.

My process has been pretty simple so far - I time entry and exit based on individual stock valuation; disregarding the overall market sentiments.  A few cases attesting to the point , which I had written about earlier.

Patience has been a true virtue in this rough and tumble road, since I show a quotational loss of upto a third during some months.  This drop came to my attention just now, when I was collecting the data to post.  I usually disregard short-term quotational losses and am focused on entry to exit returns, rather than period to period returns.  After-all, longer the period of measuring, less volatile the returns will look.

Two Companies in Transportation

Company 1:
Average of last six years' Return on Networth is around 31%

Book Value: 7,764 Million
Last Fiscal PAT:  2,267
Last Traded Market Cap: 8,546 (High)

P/BV ~ 1.1
P/E ~ 4
which means your real return is around 28%, if you invest at this price.

Company 2:
Average of last six years' Return on Networth is around 23%
Book Value Per Share: 37,317 Million
Last Fiscal PAT:  7,791
Last Traded Market Cap: 148,850 (High)

P/BV ~ 4
P/E ~ 19
which means real return is around 6%, if you invest at this price

Both are in very predictable industries, which can be seen from their gross and operating profit margin trends and the future outlook is not so similar.  The company 1 has been growing their volumes at around 30% in the last 10 years and company 2 at lower double digits, posting the first drop in volumes in the last year.

Trying to guess which these two are?  It is Concor - company 1 is Concor in Oct 2001 and company 2 is the same Concor in Oct 2009.

The outcomes are definitely going to be contrary on investing on these two dates.

A few steals this year

I was on the look-out for a boring business this March. That's how I found Today's Writing Products Ltd. Their main product is Today's pens. In this internet age, pens are highly unglamorous products. Back when I was still writing most of the time with a pen (and occasionally with a pencil), Today's and Reynolds were the big names.  It was a pure book value play trading well below book, when I looked at it in March 09.  I closed this fast trade in May for a 70% profit.

They say, lightning never strikes twice.  Fortunately, it did with GIPCL. I posted about it earlier in 2007.  It happened again in 2009, this time a 60% return in 4-5 months.  Same conditions held as in the 2007 posting, when I bought it.

Then there was Tata Steel - it was just there for the taking.  Even if the company performs as well as it did in 2003 without any contribution from Corus, it would have given a sweet dividend yield.  I booked (a little early, as is the case with almost every other investment) the gain at 50-60% gain in two months.  The 2% CCPS would have given a better return - my broker didn't have permission for trade in that instrument.

And Corporation Bank, one of the best capitalised and performing banks was beaten down so hard that it gave a good return as well.

There are two more that are still playing out.

Structural Developments in India

While the financial world has been going crazy in the past couple of years, India has been taking steps further develop the country's economy.

The New Pension Scheme which was applicable to Government employees starting 2004 is now open to public. The unique feature of this scheme is it allows investment into equity indices. It also has life cycle type investing plans as the default option. (inspired by Thaler and Sunstein's Nudge - may be?). And it is open to Non-residents as well, as long as they are citizens.

The other has been the recently proposed new Tax Code with a discussion paper. The current Income Tax Act, 1961 structurally looks like the apocryphal camel creation story. It is a mish-mash of various amendments, political concessions and such. The new code de-jargonises the Act and rationalises the structure. There is also an attempt to move towards a EET (Exempt-Exempt-Taxed) concept for savings. The concept is that contributions and earnings on the contributions are exempt and the withdrawals are taxed - very similar to the Traditional IRA in the US. This has been a step-by-step progress made since 2006 and the New Pension scheme becomes part of this step. There is also an attempt to bring stability to taxation rates. According to the current practice, a tax rate has to be notified every year in the Finance Bill during the Budget Speech which become the Finance Act. The tax rates become part of the new Tax Code. Changes to rates will presumably become a legislative amendment. These are just a couple of structural changes.

Where are we now?

It has been an interesting time to live as an investment professional since July 2007. "Unprecedented" is an adjective/adverb that was thrown about most of the last year or so - whether it was referring to the market seize-up or to responses to the seizures.

First, a quick recap of the events. Debt fueled growth; asset values stop growing; debt becomes a real "liability"; asset values drop from forced sales and fear of forced sales; Superman (read, government) stops this train-wreck from happening. The last part of this comic book is yet to play-out completely - will the villain (inflation, to name one) come back stronger than before from under the debris or is it a new-new-new world (new world was post industrial revolution, new-new world was after Netscape went public like Michael Lewis says)? My sense is that we are in the eye of the storm. There may be more to come; it is too hard to say. I'll leave predictions about the future events to astrologers and followers of Nostradamus.

Whichever way you look at the recent past, the times have been exciting. It is somewhat like being a student of geopolitics in 1989-92. Poland's independence, consequential effect on the map of the Baltics and the nearby region, Fall of Berlin wall, End of cold war, First Persian Gulf War (remember those greenish night vision images from CNN). Similarly, there are a lot of changes in the financial cartography - no Investment Banks today - one under receivership, two forced to be merged and two converted to banks. Policies are taking a U-turn - earlier everyone wanted to privatize every business in every country; now it is about government taking equity stake in auto, banks, insurance companies. Mostly self-governance vs. government intervention. Read this letter of resignation

Where do we stand in India? There have not been any major mess-ups. I am not forgetting Satyam fiasco - that is part of any downturn. Like Buffett wrote "It's only when the tide goes out that you know who is swimming naked". Every downturn in the stock market of the past had its casualties - caused by fraud or otherwise - be it Global Trust Bank from the fall out of IT crash or Ketan Parekh or Harshad Mehta. Here's an extract from The Great Crash (1929) by J.K.Galbraith and decide for yourself how different things are:-

"Weeks, months or years may elapse between the commission of the crime "(of embezzlement) "and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in - or more precisely not in - the country's businesses and banks. This inventory - it should perhaps be called the bezzle - amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances, the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks."

Systemically, India is in a great shape. The government didn't have to bail out anybody, yet. Domestic demand is much better and there are more opportunities for an individual than there ever was before in India.

The other fallout of this downtrend will be a reduction in the number of people watching the stock markets - the engineer can focus on building and innovating, rather than watching the ticker move up and down on a screen; the doctor can provide more attention to his patients' charts and not be perturbed about what Infy or Sify's chart was doing and the surgeon can watch the life line of his patient on the OR table without wondering about where the Sensex or Nifty's line is. The problem with boom times is everyone regardless of whether they know about markets or not and regardless of whether they know or do not know that they don't know is an expert about stocks. As an adviser on money matters, I am no longer (at least not anytime soon) going to face a rhetorical question of "if the market is overvalued, why is (fill in the name of the stock) rising?". It is hard for reason to penetrate our thick skulls, when the near term experience is to the contrary. As every Grahamite knows, it is a fact of the markets that it is there to serve you and not to instruct you about valuations.

Where do we go from here? Over the long term (long-term is not 1-2 years for me),

1. India is in a great shape. There is no dearth of great companies to invest in.
2. Stocks are still the best investment for the long term and
3. Compounding of returns still does its magic.

Investing consistently is the mantra. And, watch out for those once in a life-time (based on past few years life-time should be in mouse years) opportunity that occurs every once in a while to buy those great companies at a bargain price.

Wesco Financial Corp - 2009 Meeting Notes

I am posting my notes (in pdf) from Charlie Munger's Wesco (WSC) meeting last month. Good reading.

Berkshire Hathaway Shareholder Meeting Notes

I attended the Berkshire Hathaway Meeting this year as well. Here is a link to my quick notes from the meeting (pdf) grouped by topic and with some background reference to the questions
I have also included notes from others and other coverage at the end. Feel free to distribute it.

Berkshire Letter 2008

The Berkshire Hathaway Inc.'s 2008 letter (pdf) is out. The unusual point is that Buffett posted a decline in book value for the second time in the last 40+ years and still out-performed the S&P by 27 percent.

On the face of it, things look bad for Berkshire. However, reading through the letter and report I am happy to note the swing in book value comes mostly from derivative losses which can go either way in a given year. Buffett's discussion on the state of Manufactured Homes market and Black-Scholes Formula are a must-read.

Will this present a buying opportunity for BRK? Here are some quick excerpts from the letter:-
_______________________________________________________________
On Derivatives and Mutual Dependence in Markets
"Derivatives contracts, in contrast, often go unsettled for years, or even decades, with counterparties building up huge claims against each other. “Paper” assets and liabilities – often hard to quantify – become important parts of financial statements though these items will not be validated for many years. Additionally, a frightening web of mutual dependence develops among huge financial institutions. Receivables and payables by the billions become concentrated in the hands of a few large dealers who are apt to be highly-leveraged in other ways as well. Participants seeking to dodge troubles face the same problem as someone seeking to avoid venereal disease: It’s not just whom you sleep with, but also whom they are sleeping with."
Pricing Risk
"The investment world has gone from underpricing risk to overpricing it. This change has not been minor; the pendulum has covered an extraordinary arc. A few years ago, it would have seemed unthinkable that yields like today’s could have been obtained on good-grade municipal or corporate bonds even while risk-free governments offered near-zero returns on short-term bonds and no better than a pittance on long-terms. When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost
equally extraordinary."
Inflation
"...even though that wonderful cash is earning close to nothing and will surely find its purchasing power eroded over time."
"This debilitating spiral has spurred our government to take massive action. In poker terms, the Treasury and the Fed have gone “all in.” Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation. Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political
challenge. They won’t leave willingly."
On Investing
" Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier. Beware the investment activity that produces applause; the great moves are usually greeted by yawns. "
"Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols. Our advice: Beware of geeks bearing formulas."

On Housing Crisis
"Indeed, the stupefying losses in mortgage-related securities came in large part because of flawed, history-based models used by salesmen, rating agencies and investors. These parties looked at loss experience over periods when home prices rose only moderately and speculation in houses was negligible. They then made this experience a yardstick for evaluating future losses. They blissfully ignored the fact that house prices had recently skyrocketed, loan practices had deteriorated and many buyers had opted for houses they couldn’t afford.
In short, universe “past” and universe “current” had very different characteristics. But lenders, government and media largely failed to recognize this all-important fact."

"Commentary about the current housing crisis often ignores the crucial fact that most foreclosures do not occur because a house is worth less than its mortgage (so-called “upside-down” loans). Rather, foreclosures take place because borrowers can’t pay the monthly payment that they agreed to pay. Homeowners who have made a meaningful down-payment – derived from savings and not from other borrowing – seldom walk away from a primary residence simply because its value today is less than the mortgage. Instead, they walk when they can’t make the monthly payments.
Home ownership is a wonderful thing. My family and I have enjoyed my present home for 50 years, with more to come. But enjoyment and utility should be the primary motives for purchase, not profit or refi possibilities. And the home purchased ought to fit the income of the purchaser.
The present housing debacle should teach home buyers, lenders, brokers and government some simple lessons that will ensure stability in the future. Home purchases should involve an honest-to-God down payment of at least 10% and monthly payments that can be comfortably handled by the borrower’s income. That income should be carefully verified.
Putting people into homes, though a desirable goal, shouldn’t be our country’s primary objective.
Keeping them in their homes should be the ambition."
____________________________________________________________________

I am also glad to see the format change for asking questions. Last year was one of the worst meetings regarding the quality of questions asked by shareholders.

The Year that was!!!!!

For most people I know, 2008 would be the year when reality (not the sector) bit and chewed off most of their savings.

As I look back on my investment activities, I had started to take a closer look at valuations as early as Mar 2007, when I started the sells on most of my investments. I re-invested in July 07 and was almost completely back in cash by Jan 2008.
Here's a short-recount of my investing history. I started investing this portfolio in April 2001, with my peak capital outlay being in May 2003. After that month, I have not invested any funds from outside the portfolio - all new purchases were funded by either sales or dividends. If you had invested in Nifty, during that time and till Dec 08, you would have made an annual return of 12%. My portfolio, not including dividends, made 24% for me. Over this period, I have over-performed by 130%.

After Jan 2008, I have made some very selective underpriced investments for short-term and made some quick money. In the periods from Oct-Dec, I have bought some very under-priced securities - one of which is a typical Graham play, trading at less than its net-net. You could buy this particular security at a value at a discount to its Net Current Asset less Long term liabilities per share. This means that you are getting the Fixed Assets free of cost.

These type of short-term opportunities are worth looking for only if you have the patience and the capital for it. Other than these purchases and some special situations from late 2007 that are still developing, I am entirely out of the market in India as of December.

So much for status updates.

I think of this situation as an opportunity, following the maxim to be greedy, when others are fearful.

Assuming someone invested Dec 31 of every year since 1991, here's how the return would look like. If you invest for a period longer than three years, unless you are investing right at the height of the market, you will make decent returns.

It is like Overs 16-35 in a One-day cricket match. These middle overs are for patient batsmen. Runs flow in ones and twos and occasional fours and sixes. The main goal is to to avoid errors of commission and lose wicket during these times. Likewise, my main goal for these middle overs (not talking of my age - but market conditions in general) is to patiently invest with the aim of not losing capital. I would look for Ones and Twos in the form of dividend yields with an occasional Four or a Six when Mr.Market throws me that sweet loose ball. Oh and be sure, they will come.

As someone who is looking to buy securities in the next few years, I want the market to remain under-priced for as long as it can. I am not looking towards market prices for affirmation that I have made right investments. It would be like asking your barber whether you need a haircut.

My approach doesn't change overall. I will be looking for under-priced securities in businesses that I can understand and that are not vulnerable to change, run by good management team. I would be perfectly satisfied if I managed to earn about 4-5% above the return of G-Secs such as the National Savings Certificate (8% plus 4-5%).

Besides, long-term prospects for India are only starting to get better. A look at some of the mass market products is enough to give you an indication. Movies, for instance. Slumdog Millionaire winning Golden Globe for AR Rahman is a portend for things to come in the next 20 years or so. Short-term political and geo-political uncertainity is throwing up a lot of investing opportunities.