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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
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
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.…..
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
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
Equity 17.9
G Sec 11.3
Bank FD 10.4
Gold 7.2
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
The Rules:
1. Diversify across 10 to 20 major
economic / industry sectors.
2. Select only the top blue chips from
each sector.
3. Allocate equal amounts to each
sector.
4. 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?
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
Nestle 36
L&T 52
No. Sector Company No. of shares as on
15-Jan-98
6 Aluminium & Steel HINDALCO 15
TISCO 80
Infosys 9
SBI 42
Tata Chemicals 74
Tata Tea 25
No. Sector Company No. of shares as on
15-Jan-98
11 Pharamaceuticals Dr. Reddy’s Labs 30
Ranbaxy 14
12 Four-Wheelers TELCO 41
M&M 35
BSES 64
ABB 20
15 Diversified Reliance 64
Wipro 20
Portfolio Performance 1998-2003
Basic Portfolio
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. of shares
Purchased on
No. Sector Company 11-Feb-00
TISCO 720
1 Steel & Metals Hindalco 115
L&T 215
2 Cement Guj. Amb. Cement 317
Tata Power 1265
3 Power ABB 369
IOC 411
4 Petroproducts Castrol 298
Telco 602
5 Automobiles Bajaj Auto 285
No. of shares
Purchased on
No. Sector Company 11-Feb-00
Ingersoll Rand 384
6 Engineering Bharat Forge 416
Ranbaxy 106
7 Pharmaceuticals Dr. Reddys 71
Paints & Tata Chemicals 1913
8 Chemicals Asian Paints 219
HLL 42
9 FMCG P&G 149
ITC 103
10 Agro Industries Tata Tea 185
No. of shares
Purchased on
No. Sector Company 11-Feb-00
Confectionery Nestle 229
11 & Food Britannia 141
Banking & SBI 403
12 Finance HDFC 285
Infosys 10
13 Software Wipro 16
Hospitality & Thomas Cook 112
14 Travel Indian Hotels 390
Grasim 262
15 Diversified Reliance 279
Performance (Year 2000)
Date 13-Nov-00
BSE Sensex -35.61%
Portfolio -28.13%
79
Performance (Year 2001)
Date 12-Feb-01 11-May-01
BSE Sensex -25.74% -40.01%
Portfolio -6.83% -22.73%
Date 11-Feb-04
BSE Sensex -0.27%
Portfolio +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.”
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-Media-
Technology” stocks. This ‘sector’
was popularly called TMT or ICE
(for Information technology-
Communications-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 non-
performance!) of this portfolio is as follows:
101
11-Feb-00 11-Feb-04
Name of Company Amount (Rs.) Amount (Rs.)
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.”
- 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
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: investments_sac@yahoo.com
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.”
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
Model stocks:
Company Required Qty Existing Qty Qty to be +/-
1.
2.
3.
Non-model stocks:
Company 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. 151
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……….
153
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
160
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. 161
Daniel Kahneman
162
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
172
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 175
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).
177
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.
179
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)
182
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)
184
Dr William J Bernstein
185
Benjamin Graham (1894 – 1976)
186
Benjamin Graham
187
John C Bogle (born 1929)
188
Sir John Templeton
189
A N Shanbhag
190
N J Yasaswy
191
Sundar Sankaran
192
Thank you!
193