An Equity Investment Model

An Equity Investment Model for the Common Investor 1

Equity as an investment avenue  Equity is a legitimate investment avenue.  Equity is as legitimate an investment avenue as any other.  Equity is the best investment avenue for a common sensed and disciplined investor.  The problem is, equity can also be used for speculation. 2

Investment Versus Speculation  Investment: the purchase of an asset for the conservation of wealth and the increase of wealth, with the emphasis on the conservation of wealth. Speculation: the purchase of an asset for the conservation of wealth and the increase of wealth, with the emphasis on the increase of wealth. 3

Investment Versus Speculation  Short-term speculation Vs Long-term investment  100_____102_____104_____106_____124 1st Jan

31st Jan

28th Feb

31st Mar

31st Dec

 Senseless speculation Vs ‘Sensible speculation’ – short-term investment would be a good example of ‘sensible’ speculation, provided the investor can hold for the time horizon if necessary. 4

Investment Versus Speculation

“A trader reacts to price. An investor, to fundamentals.” Today, an investor is someone who reacts to the fundamentals of investment, rather than fundamentals of the stock market. 5

Doubling your money! “The safest way to double your money is to fold it over once, and put it in your pocket.” - Frank M Hubbard 6

The Folly of Speculation

“Ninety per cent of speculators lose. And the ten per cent who say they don’t, are liars.” 7

The Folly of Speculation “Markets reward investors and punish traders.” “Bear markets are when stocks are restored to their rightful owners.” - J P Morgan 8

John Pierpont Morgan (1837 – 1913)

9

Sir John Templeton I never ask if the market will go up or down next month. I know there is nobody who can tell me that. 10

Si r John Templ eton (b orn 19 12)

11

Mark Twain There are two times in a man’s life when he should not speculate: when he can’t afford to, and when he can. 12

Mark Twain  October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February. 13

Mark Tw ain (18 35 -191 0)

14

Sentiment Basic human irrationality Crowd behaviour Greed Vs fear syndrome Hype Over-reactions Mistakes

15

Sentiment Overconfidence Mistaking pure luck for expertise Using the stock market to fulfill the need to be entertained Mixing up the willingness to take risk with the capacity to take risk 16

Common Mistakes of Common Investors  They treat the stock market as a speculative avenue, not as an investment avenue.  They fall prey to market sentiment.  They indulge in short-termism, like asking for, and investing on tips and rumours.  Having made wrong decisions, they refuse to exit and cut their losses.  There is no plan, no discipline, no model and no strategy in their equity investment. 17

Why Equity? Government support for equity investment:  Dividends on equity shares are tax-free in the hands of the recipients even though there is a 14.025% dividend distribution tax payable by the companies.  Long-term Capital Gains Tax exempted on equity, although there is STT at 0.125% on all delivery based transactions.  Short-term Capital Gains pegged at 10.2% with STT. 18

Why Equity?  Exemption of all financial investments including equity from wealth tax  Holding period of equity & equity mutual funds for long-term capital gains eligibility is 1 year as opposed to 3 years for non financial assets  Abolition of stamp duty on demat purchases  Minimum market lot is 1, under the demat regime  Stock lending  Brokerages and demat charges are reasonable 19

Why Equity? The one reliable truth of equity investment is that in the long run, the market always goes up. The rate of growth of equity investments comfortably exceeds the rate of inflation. 20

Why Equity?  Equity and real estate are the only asset classes that have consistently delivered genuine wealth enhancement over the long run.  The long-term rate of return on equity investments is the total of the dividend yield and the long term rate of earnings growth.

21

Understanding the Stock Market  ‘Stock Market’, ‘Investment’  The stock market is a mirror of the economy.  The economy consists of major divisions like agriculture, industry and services and distinct sectors within each of these divisions.  The stock market reflects the current state of the economy and future expectations of economic performance. 22

Four ‘normal’ stock market scenarios  Weak current economy + pessimistic future economic outlook = prolonged stock market recession  Weak current economy + optimistic future economic outlook = beginning of a stock market boom. Volumes increase, stock prices stop declining 23

Four ‘normal’ stock market scenarios  Strong current economy + pessimistic future economic outlook = end of stock market boom with declining volumes and stock prices and often high volatility.  Strong current economy + optimistic future economic outlook = prolonged stock market boom. 24

Four ‘normal’ stock market scenarios – a quick recap  Bad current economy + bad future expectations = prolonged recession  Bad current economy + good future expectations = beginning of a boom  Good current economy + uncertain future expectations = beginning of a slump  Good current economy + good expectations = big, continuing boom 25

Therefore…..  Investing in the stock market is investing in the economy of the country.  No one can call himself/herself a stock market investor, unless he/she invests in the economy of the country.  Anyone doing anything else, is a mere punter. 26

Therefore…..  The world’s best writers on equity investment will always urge you to “buy the market.”  That is another way of saying, “Buy the economy or “Invest in the economy.”  In this era of globalisation, the time will not be far away when equity investment means investing in the global economy through the medium of equity. 27

An Equity Investment Model for the Common Investor 28

Introduction  Investment is a strategy.  Speculation is also a strategy.  Investment is a strategy based on the fundamental principles of investment.  Speculation is a strategy based mainly on greed and a get-rich-quick attitude.  The objective of a good investment strategy is to get above average returns at below average risk. 29

Six Rules and a Recommendation Six Rules: 1. Diversify across 10 to 20 major economic / industry sectors.  Select only the top blue chips from each sector.  Allocate equal amounts to each sector.  Reinvest dividends. 30

Six Rules.…..  Review the portfolio at least once in 3 months, making additional purchases upon a drop of 25% in the index from the date of investment and if need be, liquidating the portfolio wholly or partially when targeted returns are achieved.  The time horizon for equity investments is at least 5 years. 31

…..and a recommendation

Systematic investment is recommended, both for equity, as well as equity mutual funds. 32

Rules 1& 2: The Concept of Economic Impact  Diversify across 10 to 20 major economic / industry sectors.  Select only the top blue chips from each sector.  Why major sectors?  Why top blue chips? 33

Warren Buffett It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

34

Warren Edward Buffett

35

Rules 3 & 4  Allocate equal amounts to each sector. 4.Reinvest dividends. 36

Rule 5  Review the portfolio at least once in 3 months, making additional purchases upon a drop of 25% in the index from the date of investment and if need be, liquidating the portfolio wholly or partially when targeted returns are achieved.

37

Rule 5 – Quarterly Reviews Three portfolio performance scenarios: Under-performance Tracking Out-performance 38

Rule 6 – Equity Time Horizon The time horizon for equity investment is at least 5 years. “Be greedy, but be long-term greedy.” - Rakesh Jhunjhunwala 39

Rakesh Jhunjhunwala

40

Warren Buffett I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years. 41

Rule 6 & the recommendation  The time horizon for equity investment is at least 5 years.  The recommendation: Systematic investment is recommended, both for equity and equity mutual funds. 42

Three reliable facts of equity investment

Fact 1: In the long run, the market always goes up. 43

Actual Movement of the SENSEX

Source: Research of Sundaram Mutual Fund

46

Three reliable facts of equity investment Fact 2: In the long-run, the rate of growth of equity investments, comfortably exceeds the rate of inflation. 47

48

Cumulative annualised returns of different asset classes (1985 - 2006) Source: CLSA 17.9

Equity 11.3

G Sec Bank FD

10.4

Gold

7.2 (% Annualised returns)

6.8

Inflation 0

5

10

15

20 49

Three Reliable Facts of Equity Investment Fact 3: The long-term rate of return on stock market investments, is the total of the dividend yield and the long term rate of earnings growth. 50

A quick recap of the equity investment model 1. 2. 3. 4.

The Rules: Diversify across 10 to 20 major economic / industry sectors. Select only the top blue chips from each sector. Allocate equal amounts to each sector. Reinvest dividends.

51

A quick recap - The Rules 5. Review the portfolio at least once in 3 months, making additional purchases upon a drop of 25% in the index from the date of investment, and if need be, liquidating the portfolio wholly or partially when targeted returns are achieved. 6. The time horizon for equity investments is at least 5 years.

52

A quick recap – the recommendation

Systematic investment is recommended, both for equity, as well as equity mutual funds. 53

The Equity Model – based on PIP  The increase of wealth  Tax-efficient income  Liquidity  Safety  Diversification  Investment Time horizons  Systematic Investment  Reviews

54

Warren Buffett “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.” 55

Benjamin Graham “The defensive (or passive) investor

will place his chief emphasis on the avoidance of serious mistakes or losses. “His second aim will be freedom from effort, annoyance, and the need for making frequent decisions.” (‘The Intelligent Investor’) 56

Benjamin Graham

57

Warren Buffett There seems to be some perverse human characteristic that likes to make easy things difficult.

58

Warren Buffett

59

Albert Einstein “Everything should be made as simple as possible.” 60

Benjamin Graham Buy stocks like you buy groceries, not like you buy perfume. 61

Benjamin Graham

62

Testing the Model Portfolio of 15 sectors and 30 blue chip stocks. Two periods of 5 years each and one period of 4 years. Based on closing prices of stocks quoted on the BSE. 63

First Test: April 1992-1997  Why this period?  Bias against the portfolio:  Dividends ignored  Rights ignored  Investment made at the worst possible time, starting on the day the Harshad Mehta scam came to light. 64

Equity Portfolio Invested from April 1992 1997 No.

Sector

Company

No. of shares as on Apr 92

1

Paints & Chemicals

Asian Paints

24

BASF

19

Two Wheelers and Lubricants

Bajaj Auto

19

Castrol

8

Food and Dairy Products

Britannia

18

Nestle

25

Hospitality and Travel

Indian Hotels

24

Thomas Cook

9

Cement

Guj. Amb. Cement

19

L&T

29

2

3

4

5

Equity Portfolio Invested from April 1992 1997 No.

Sector

Company

No. of shares as on Apr 92

6

Aluminium & Steel

HINDALCO

14

TISCO

18

HLL

25

P&G

20

HDFC

4

ICICI

4

Indo-Gulf Fert

109

Tata Chemicals

28

ITC

12

Tata Tea

13

7

8

9

10

F.M.C.G.

Banking & Finance

Fertilizers & Chemicals

Agricultural Products

Equity Portfolio Invested from April 1992 1997 No.

Sector

Company

No. of shares as on Apr 92

11

Pharamaceuticals

Dr. Reddy’s Labs

25

Ranbaxy

19

TELCO

17

M&M

63

Tata Power

4

BSES

27

Ingersoll-Rand

13

Bharat Forge

24

Reliance

24

Grasim

16

12

13

14

15

Four-Wheelers

Power

Engineering & Forging

Diversified

Portfolio Performance 1992-1997 Basic Portfolio

With one additional investment

With 2 additional investments

Model Portfolio Gross Return

+ 21.35%

+ 53.66%

+ 61.76%

BSE Sensex Gross Return

- 19.45%

- 1.05%

+ 14.45%

Model Portfolio Annualised Return

+ 4.27%

+10.73%

+ 12.35%

BSE Sensex Annualised Return

- 3.89%

- 0.21%

+ 2.89%

68

Second Test: Jan 1998 – Jan 2003  Same bias  Screen Based Trading  Demat  Software boom and bust  Increased globalisation, regulation, liberalisation  Movement towards convertibility of the rupee

69

Second Test: Jan 1998 – Jan 2003  Indian multinationals, in software and pharma  Abolition of carry over or badla  Introduction of derivatives  ‘Ketan Parekh Scam’ of March 2001  Rolling settlements, T+3

70

No. Sector

Company

No. of shares as on 15-Jan-98

1

Asian Paints

34

Bharat Forge

149

Bajaj Auto

18

Castrol

14

2

3

4

5

Paints & Forging

Two Wheelers and Lubricants

Food and Dairy Products Britannia

25

Nestle

36

Hospitality and Travel

Indian Hotels

18

Thomas Cook

16

Cement

Guj. Amb. Cement

41

L&T

52

No. Sector

Company

No. of shares as on 15-Jan-98

6

HINDALCO

15

TISCO

80

HLL

8

Infosys

9

HDFC

4

SBI

42

Indo-Gulf Fert

294

Tata Chemicals

74

ITC

17

Tata Tea

25

7

8

9

10

Aluminium & Steel

F.M.C.G. & Software

Banking & Finance

Fertilizers & Chemicals

Agricultural Products

No. Sector

Company

No. of shares as on 15-Jan-98

11

Dr. Reddy’s Labs

30

Ranbaxy

14

TELCO

41

M&M

35

Tata Power

90

BSES

64

Ingersoll-Rand

24

ABB

20

Reliance

64

Wipro

20

12

13

14

15

Pharamaceuticals

Four-Wheelers

Power

Engineering & Forging

Diversified

Portfolio Performance 1998-2003 Basic Portfolio Model Portfolio Gross Return

+ 110.39%

BSE Sensex Gross Return

+ 0.24%

Model Portfolio Annualised Return

+ 22.08%

BSE Sensex Annualised Return

+ 0.05% 74

Third Test: Feb 2000 – Feb 2004  Why this period?  11-Feb-2000, BSE Sensex – 5933  Tech boom ended on 11-Feb-00  Ketan Parekh scam was in March 2001  25-Apr-2003, BSE Sensex – 2924  Stock market recession ended on 25-Apr-03  11-Feb-2004, BSE Sensex – 5949 75

No. 1 2 3 4 5

No. of shares Purchased on Sector Company 11-Feb-00 TISCO 720 Steel & Metals Hindalco 115 L&T 215 Cement Guj. Amb. Cement 317 Tata Power 1265 Power ABB 369 IOC 411 Petroproducts Castrol 298 Telco 602 Bajaj Auto 285 Automobiles

No.

Sector

6

Engineering

7 Pharmaceuticals Paints & 8 Chemicals 9

FMCG

10 Agro Industries

Company Ingersoll Rand Bharat Forge Ranbaxy Dr. Reddys Tata Chemicals Asian Paints HLL P&G ITC Tata Tea

No. of shares Purchased on 11-Feb-00 384 416 106 71 1913 219 42 149 103 185

No.

Sector Confectionery 11 & Food Banking & 12 Finance 13

Software Hospitality & 14 Travel 15

Diversified

Company Nestle Britannia SBI HDFC Infosys Wipro Thomas Cook Indian Hotels Grasim Reliance

No. of shares Purchased on 11-Feb-00 229 141 403 285 10 16 112 390 262 279

Performance (Year 2000) Date BSE Sensex Portfolio

11-May-00 -28.35% -24.78%

Date BSE Sensex Portfolio

13-Nov-00 -35.61% -28.13%

11-Aug-00 -29.34% -22.41%

79

Performance (Year 2001) Date BSE Sensex Portfolio

12-Feb-01 -25.74% -6.83%

11-May-01 -40.01% -22.73%

Date BSE Sensex Portfolio

13-Aug-01 -44.60% -23.87%

12-Nov-01 -47.85% -24.13% 80

Performance (Year 2002) Date BSE Sensex Portfolio

11-Feb-02 -40.76% -17.32%

13-May-02 -41.99% -13.84%

Date BSE Sensex Portfolio

12-Aug-02 -49.32% -19.19%

11-Nov-02 -50.31% -21.86% 81

Performance (Year 2003) Date BSE Sensex Portfolio

11-Feb-03 -45.04% -13.90%

12-May-03 -50.41% -10.62%

Date BSE Sensex Portfolio

11-Aug-03 -34.38% +20.96%

11-Nov-03 -15.22% +56.47% 82

Performance (Year 2004)

Date BSE Sensex Portfolio

11-Feb-04 -0.27% +86.11% 83

John C Bogle

Buy right, and hold tight. 85

Indices Versus Portfolios  An index is also a portfolio.  However, a narrow index is constructed to give a fair idea of how the stock market moves.  An narrow index is not constructed to enable an equity investor to invest well.  Therefore, always remember that the movements of indices and the movement of investment portfolios can differ vastly from each other. 86

Indices Versus Portfolios  A good stock market investor does not get fixated about movements of narrow indices.  A good stock market investor does not get obsessed with constantly benchmarking the performance of his portfolio.  A good stock market investor aims to mitigate risk and obtain inflation beating, wealth enhancing returns in the long run. 87

Equity risk and return  In equity, the uncertainty of return reduces with time.  In most other investment avenues, the uncertainty of returns increases with time.  Therefore, a proper time horizon is of vital importance in equity investment.  Systematic investment can help an equity investor cope better with uncertainty. 88

Returns with one additional investment: + 130.67% absolute, + 32.65% annualised

“Unless you can watch your stock holding decline by 50% without becoming panic stricken, you should not be in the stock market.” - Warren E Buffett 90

“Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell.” - Warren Buffett 91

Warren E Buffett “Lethargy, bordering on sloth, is the hallmark of our investing strategy.” (Sloth: indolence; extreme laziness; habitual disinclination to exertion. 92

“Always invest for the long term.” - Warren Buffett

93

“If you are not willing to own a share for ten years, then don’t own it for ten minutes.” - Warren Buffett 94

Warren Buffett

95

“History shows that time, not timing, is the key to investment success.” - Sir John Templeton 96

Sir John Marks Templeton

97

“Sell when they yell, Buy when they cry.”

98

“The stock market is a mechanism by which money is transferred from the impatient to the patient.” - Warren E Buffett 99

The Perils of Concentration In February 2000, most stock market “investors” were almost fully concentrated in either only software or “Telecom-MediaTechnology” stocks. This ‘sector’ was popularly called TMT or ICE (for Information technologyCommunications-Entertainment). 100

The Perils of Concentration  To show the folly of this type of concentrated investment, we picked a portfolio of 14 “TMT” or “ICE” stocks which were in the ‘A’ Group of the Bombay Stock Exchange on 11th February 2000.  We assumed an investment of Rs 30 lakhs equally distributed between these 14 stocks.The performance (or perhaps the nonperformance!) of this portfolio is as follows: 101

11-Feb-00 Name of Company Amount (Rs.) 1 2 3 4 5

Aptech Hexaware Digital Equipment Global Telesystems HCL Infotech Himachal Futuristic

11-Feb-04 Amount (Rs.)

211,633.25 NA 213,300.00 212,940.00

2,385.60 10,596.60 132,380.30 12,624.30

213,418.50 213,259.00

116,319.60 2,772.20

11-Feb-00 Name of Company Amount (Rs.) 6 7 8 9 10

Infosys MTNL NIIT Pentafour Software Satyam Computers

11-Feb-04 Amount (Rs.)

209,221.95 214,259.30 213,510.50 213,642.00

114,857.40 77,966.50 14,903.00 1,892.40

211,244.70

19,389.40

11-Feb-00 Name of Company Amount (Rs.) 11 12 13 14

Silverline Industries SSI Wipro ZEE Telefilms Total Portfolio

11-Feb-04 Amount (Rs.)

213,927.00

1,246.23

212,355.00 212,282.00 213,060.00 29,78,053.20

8,698.50 56,325.50 24,032.85 5,96,390.4

Never forget that… The movements of indices and the movements of investment portfolios can differ vastly from each other. 106

Never forget that… Portfolio returns are important, not the returns of individual stocks in the portfolio. 107

Never forget that…  Investment is a strategy.  Speculation is also a strategy.  Investment is a strategy based on the fundamental principles of investment.  Speculation is a strategy based mainly on greed and a get-rich-quick attitude.  The objective of a good investment strategy is to get above average returns at below average risk. 108

Old Chinese Proverb Fish see the bait, but not the hook; men see the profit, but not the peril. 109

Warren Buffett Risk comes from not knowing what you are doing. 110

“There are old pilots. And there are bold pilots. But there are no old, bold pilots!” 111

Warren Buffett “Its only when the tide goes out, you know who’s been swimming naked.” 112

Aldous Huxley Facts do not cease to exist, just because they are ignored. (Aldous Huxley was an English writer, essayist and philosopher, who later emigrated to the United States.) 113

Aldous Huxley

114

A lot of ‘bull’! Bull market: A random market movement, which causes an investor to mistake himself for a financial genius! Market correction: What happens the day after you buy stocks! 115

Sir John Templeton Bull markets are born on pessimism, grow on skepticism, peak on optimism and die on euphoria.

116

Sir John M Templeton

117

“Do not confuse brains with a bull market.” (Sign in a fund manager’s office) 118

Warren Buffett “The sillier the market’s behaviour, the greater the opportunity for the business-like investor. “ Follow Graham and you will profit from folly, rather than participate in it.” - From the preface to the fourth edition of ‘The Intelligent Investor’ by Benjamin Graham 119

The perils of concentration “The investor’s chief problem – and even his worst enemy – is likely to be himself.” - Benjamin Graham 120

“In the short run, the stock market is a voting machine, and in the long run it is a weighing machine.” - Benjamin Graham 121

Benjamin Graham

122

‘Risk’ in Equity  Maximum Sensex risk despite tech meltdown and Ketan Parekh scam was approximately 50%.  Maximum ‘model portfolio’ risk was approximately 30%.  Maximum risk during the 1992-97 period did not exceed 40%. 123

‘Risk’ in Equity Risks in equity investment may be considerably less than you fear. Risks in equity speculation can be greater than your wildest imagination. 124

Conclusion In a rising market, you do not need the advice of experts to make money. Any trash you buy will appreciate. In a falling market, the advice of the best experts will not prevent you from losing money. 125

Conclusion  What then is the role of an equity investment advisor?  To manage risk  To ensure that investors “buy the market”  To put in place investment strategies that deliver fair returns over a stipulated time horizon  Above all, to make investors comfortable with risk in ‘risky’ investments. 126

Conclusion – N J Yasaswy

“Safety first. Returns, later.” 127

N J Yasaswy

128

Conclusion – Warren Buffett

“The first rule of investment is, don’t lose. And the second rule is, don’t forget the first rule. And that’s all the rules there are.” 129

Conclusion – Warren Buffett

“We’ve long felt that the only value of stock forecasters is to make fortune tellers look good.” 130

Jesse Livermore (notable early 20th century stock trader)

Wall Street never changes. The pockets change, the suckers change, the stocks change, but Wall Street never changes because human nature never changes. 131

Jesse Livermore

132

Recommended Reading “Reminiscences of a Stock Operator”, 75 Anniversary Edition th

By Edwin Lefevre A book on the life and times of Jesse Lauriston Livermore Email: [email protected] 133

Conclusion “Wall Street people learn nothing, and forget everything.” - Benjamin Graham 134

Conclusion “It is not necessary to do extraordinary things, to get extraordinary results.” - Warren Buffett 135

Equity Vs Real Estate  Real Estate is one of the major sectors of the economy.  The availability of real estate is limited, but the demand for it is not.  Being one of the sectors of the economy, real estate oriented companies can easily be included in a well diversified equity portfolio.  But the reverse is not possible. 136

William J Bernstein

The concept of the “coward’s portfolio” 137

Five Simple Equity Investment Strategies, Using the Model Strategy 1: Simple diversified portfolio  Buy and hold a diversified portfolio, by purchasing at least Rs 20,000/- worth of shares in each of the companies numbered 1 to 30 in the list.  A portfolio of 60 stocks would be ideal. 138

“The time to invest in equity, is when you have the money. “History shows that time, and not timing, is the key to investment success.” - Sir John Templeton 139

Warren E Buffett “The stock market is a mechanism, by which money is transferred, from the impatient, to the patient.” 140

Strategy 2 – Systematic Investment  Invest at least Rs 10,000/- per month / once in two months / per quarter, in the companies numbered 1 to 60 in the list, at the rate of one company per investment interval.  Whatever investment amounts and intervals you choose, stick to them, because regularity is of vital importance.

141

Strategy 3 – Systematic Transfer Aggressive  Invest Rs 6 lakhs in a liquid avenue.  Buy Rs 10,000/- worth of stock of each company, at the rate of one stock per month.  Increase the frequency of purchases to one stock every 15 days, if the index falls more than 25% from the index on the date of your original investment.

142

Strategy 3 – Systematic Transfer Aggressive  The increased frequency is to be maintained only so long as the index remains at a level of 25% below the index on the date of your first purchase.  Variations …………….. 143

Strategy 4 – Systematic Transfer - Conservative  Invest Rs 12 lakhs in a liquid avenue.  Buy Rs 10,000/- worth of stock of each company at the rate of one stock per month.  Buy Rs 10,000/- worth of stock of each company, at the rate of one stock every 15 days, if the index falls more than 25% from the index on the date of your original investment.

144

Strategy 4 (contd.) – STP Conservative  Buy Rs 10,000/- worth of stock of each company, at the rate of one stock every week, if the index falls by 50% or more from the index on the date of your original investment.  The increased frequencies are to be maintained only so long as the index remains at or below the stipulated lower levels. 145

Strategy 4 (contd.) – STP Conservative The chances of danger to capital in this strategy are so remote as to be virtually non-existent, provided the liquid avenue returns at least 5% p.a. Variations………. 146

Strategy 5 – For those who long to ‘actively’ manage portfolios  Invest Rs 12 lakhs in a liquid avenue.  Buy Rs 10,000/- worth of stock of each company at the rate of one stock per month.  Buy Rs 10,000/- worth of stock of the next company, each time the index drops by 1% from the index on the date of your initial investment.  Note that these additional purchases may or may not be independent of, and in addition to, the regular monthly purchases.  The same strategy, with Rs 6 lakhs……. 147

Conversion of existing portfolios to the Equity Model  First, value the portfolio that you are intending to convert.  Second, divide the portfolio value by Rs 10,000/- or Rs 20,000/- to select the number of ‘model’ stocks you are going to pick.  Rs 20,000/- may be a reasonable amount to invest in each stock, by today’s standards. 148

Conversion of existing portfolios to the Equity Model  Third, pick the ‘model’ stocks that are already in your portfolio and calculate the number of ‘model’ stocks to be bought and sold.  Fourth, sell off ‘model’ stocks held in excess.  Fifth, sell off all ‘non-model’ stocks.  Finally, purchase the required number of ‘model’ stocks.

149

A Simple Tabular Aid to Portfolio Conversion Company 1. 2. 3. Company

Model stocks: Required Qty Existing Qty Qty to be +/-

Non-model stocks: Existing Qty Qty to be sold

1. 2. 3. 150

Booking profits “Our time horizons are for ever.” - Warren Buffett

 Profits in quality equity portfolios need never be booked.  A lifetime of steady investing will probably provide more than enough dividend income to comfortably take care of ordinary needs.

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Booking Profits  When dividends take care of normal expenditure, partial portfolio liquidation can be resorted to only to take care of substantial capital expenditure or unexpected expenditure.  A strategy of booking profits in order to migrate to lower risk equity investment avenues is okay.  However, profits must be booked only when reasonable profits are made. 152

Booking profits  Reasonable profits can be say, a doubling of the portfolio.  There is certainly no need to book profits before a portfolio doubles, otherwise the investor may get into a trading mentality.  Booking partial profits……….

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Churning  Frequent churning of an equity portfolio is an excellent way of making stockbrokers wealthy!  The stocks in our model portfolio are reviewed once or twice a year, and minimal changes may be made.  Churning to the extent required to realign your portfolio with the current model portfolio is okay.  However, even such minimal changes need to be made only once a year, at the most. 154

You and ‘Mr Market’  Fair estimates of the damage Mr Market can do to you:  In leveraged speculation, infinite damage  In concentrated non-leveraged speculation, 100%  In lump sum narrow index investing, 50%  In lump sum quality portfolio investing, 35%  In systematic investment strategies, 25%, 17% and 10% in 1, 2 and 3 years respectively  In 60 month systematic transfers, 10%  In 120 month systematic transfers, zero. 155

You and ‘Mr Market’ Sizing up ‘Mr Market’:  PE Ratios of the:  BSE-30: H-22 L-10 M-16  NSE-50: H-22 L-10 M-16  Capital Market-2000: H-20 L-09 M-14.5  Historic Boom-Recession periods since 1979  ‘Health’ of ‘Mr Market’ 156

Negotiating with ‘Mr Market’  Dividing a 50% fall from peak, into 4 quarters:  13,505 points (16th November 2006) divide by 2 = 6,753 points  So, if 13,505 was this boom’s peak, and if the next fall is going to be to the extent of 50%, the Sensex can fall down to 6,753 points.  13,505 minus 6,753 = 6,752. This 6,752 divided by 4 = four one-quarter segments of 1,688 points each. 157

Negotiating with ‘Mr Market’  The possible fall from 13,505 to 6,753 can be divided into four one-quarter segments of 1,688 Sensex points each, as follows:  13,505 – 11,817 : ‘Zero risk’ STPs recommended  11,817 – 10,129 : Five year STPs are okay  10,129 – 8,441 : Three year STPs are okay. Lump sum investments are okay for the risk tolerant.  8,441 – 6,753 : Lump sum investments may be actively considered. 158

Committing lump sums to ‘Mr Market’  13,505 – 11,817 : Not more than one-third of the amount reserved for equity investment  11,817 – 10,129 : Not more than half the amount reserved for equity investment  10,129 – 8,441 : Not more than half the amount reserved for equity investment, except if your risk tolerance is high.  8,441 – 6,753 : Full amount can be committed. 159

Benjamin Graham

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Daniel Kahneman The idea that any single individual without extra information or extra market power can beat the market is extraordinarily unlikely. Yet the market is full of people who think they can do it.

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Daniel Kahneman

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Anthony M Gallea, senior portfolio manager, Smith Barney

Investing is a strange business. It’s the only one we know of where the more expensive the products get, the more customers want to buy them. 163

Conclusion - Benjamin Graham’s Core Equity Principles

“A stock is not just a ticker symbol or an electronic blip; it is an ownership interest in an actual business, with an underlying value that does not depend on its share price.” 164

Conclusion - Benjamin Graham’s Core Equity Principles  Obvious prospects for physical growth in a business do not translate into obvious profits for investors.  The experts do not have dependable ways of selecting and concentrating on the most promising companies in the most promising industries. 165

Benjamin Graham’s Core Equity Principles “The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists.” 166

Benjamin Graham’s Core Equity Principles  “The future value of every investment is a function of its present price. The higher the price you pay, the lower your return will be.”  “No matter how careful you are, the one risk no investor can ever eliminate is the risk of being wrong.” 167

Benjamin Graham’s Core Equity Principles “The secret to your financial success is inside yourself. If you become a critical thinker who takes no Wall Street ‘fact’ on faith, and you invest with patient confidence, you can take steady advantage of even the worst bear markets.” 168

Benjamin Graham’s Core Equity Principles “By developing your discipline and courage, you can refuse to let other people’s mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave.” 169

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Conclusion “The ultimate objective of good investing, is to obtain above average returns, at below average risk.” 171

Conclusion “It is not necessary to do extraordinary things, to get extraordinary results.” - Warren Buffett

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Conclusion Investment is a marathon, not a hundred metre sprint. “Someone’s sitting in the shade today, because someone planted a tree a long time ago.” - Warren Buffett 173

Final evaluation of the Equity Investment Model  Strength 1: It is a proxy for ‘buying the market.’  Strength 2: Optimum diversification – approximately 20 sectors and 60 blue chip stocks  Strength 3: Virtually eliminates unsystematic risk 174

Final evaluation of the Equity Investment Model  Strength 4: Has never failed to outperform the popular indices during bear markets.  Strength 5: Beats mutual funds hollow on costs.  Strength 6: It is a ‘no-churn’ strategy, which is less expensive than a low or high churn strategy

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Final evaluation of the Equity Investment Model  Strength 7: Based on sound investment principles and risk management tools  Strength 8: Incorporates an element of real estate, the only other avenue of investment that has a long-term track record of beating inflation. 176

Final evaluation of the Equity Investment Model  Strength 9: Can incorporate exchange-traded real estate and bullion exchange traded mutual funds (ETFs).

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Final evaluation of the Equity Investment Model  Weakness 1: Large commitment of funds needed.  Weakness 2: Strategies like SIPs and STPs are not implemented automatically.  Weakness 3: Rebalancing strategies are difficult to carry out. 178

Final evaluation of the Equity Investment Model  Weakness 4: In SIP & STP strategies, you buy a stock each time, whereas in a mutual fund, you buy a portfolio each time.

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For the amateur investor…..  The best way to invest in equity, especially for a rookie investor with limited resources, is through a mutual fund asset allocation strategy like a systematic transfer plan.  Mutual fund investment is recommended not because it is superior to direct equity investment, but simply because mutual fund asset allocation strategies are automated.  Rebalancing strategies are also far easier in mutual fund investments. 180

Final evaluation of the Equity Investment Model  Owning a diversified portfolio of blue chip stocks is different from owning just units in diversified mutual funds.  Direct stock market investing has a certain charm.  For those who succumb to this charm, and have not yet found something better, this model could be a sound, low-cost method of investing directly in the stock market. 181

Warren Edward Buffett (born 1930)

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Warren Buffett  An investor who does not understand the economics of specific companies but wishes to be a long-term owner of American industry should periodically invest in an index fund.  In this way, the know-nothing investor can actually outperform most investment professionals.  Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb. 183

Burton G Malkiel (born 1932)

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Dr William J Bernstein

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Benjamin Graham (1894 – 1976)

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Benjamin Graham

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John C Bogle (born 1929)

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Sir John Templeton

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A N Shanbhag

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N J Yasaswy

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Sundar Sankaran

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Thank you! 193