What to expect from your investment portfolio?

In March 2020, the expected returns were high but not a lot of people invested. Now when the markets have zoomed, people expect that the run-up will continue. A lot of people have a misunderstanding of what to expect from the portfolio, also called expected return.

“The market’s not a very accommodating machine, it won’t provide high returns just because you need them” – Peter Bernstein

Rather than give a blanket perspective on what to expect from the portfolio, let’s look at the portfolio from three different perspectives.

1. Index-based investing

2. Large high growth and return companies

3. Small high growth and return companies

Index-based investing

An index is the basket of companies as defined by the index, say Nifty 50 is a basket of 50 companies, and the weight is based on the company's market capitalization.

One way to understand the expected return in an index is to look at earning yield.

Earning yield = Earning / Price

Here is the earning yield of NSE500. At the current time, earning yield of the index is around 4%. Recent low levels of earning yield were last seen in 1999/2000.

NSE 500 Earning yield

The average earning yield is around 5%, a 4% earning yield is not way off. However, a conscious investor may be wary of the current levels before allocating new capital.

“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” – Warren Buffet

Large high growth and return companies

These companies have been in existence for a long time with a high return on investments and high growth numbers. For example, Asian Paints, Page Industries, Nestle, etc. Although these companies are part of the index, their return profile is different.

The expected return of these set of companies is the expected return on its earnings.

‘Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return – even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive-looking price, you’ll end up with one hell of a result.’ – Charlie Munger

A bad quarter, negative macro trend, SEBI investigation, etc., maybe some avenues to buy these companies cheap. Otherwise, these companies trade at a premium. However, if these businesses are held for a long time, the expected return should be similar to its earnings growth, which is usually above 15% p.a.

Small high growth and return companies

Many small companies are leaders in their category. Identifying a good company at a reasonable price is critical. The share price of these companies fluctuates a lot, and so does the earnings.

These companies often have a high return on investment, but their growth trajectory is yet to be defined. Therefore, the path needs to be studied well by the investor, and the position is scaled up gradually.

These opportunities would often be available irrespective of what is happening in the market. However, evaluating them and keeping a watch on these opportunities is the key. One critical aspect is that management should not engage in non-core activities, i.e., the focus should be only on the core business.

So, if you are an index investor, the return expectation should be muted. However, if you invest in large-sized quality companies, the expected returns may be enhanced depending on the expected earnings growth. A small quality company is a path to becoming extremely wealthy but staying course and controlling your behavioural biases is the key.

Disclaimers

• Investment in securities market are subject to market risks. Read all the related documents carefully before investing.

• The securities quoted are for illustration only and are not recommendatory.

• Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

• Advisor: Ankur Kapur

• SEBI RIA No.: INA100001406

• BASL Member ID: BASL1337

Where to invest? Is it the best time or worst?

A company with a Price to Earning of 400 makes an IPO, and the media pours all forms of blessings. This is one of the indications that we are in an irrational zone.

Let’s simplify this understanding. Assume that you plan to buy a brass Buddha. Your online and offline research indicates the price to be around Rs 10,000. If a shop sells it for Rs 15,000, it is expensive. On the other hand, if the price is quoted at Rs 10500, you may still decide to purchase. You can just sense whether something is expensive or cheap when it is far from fair value.

Similarly, extreme market positions can be indicated. For example, March 2020 was in a cheap zone.

Where are we now?

Markets tend to move in oscillations. Understanding these oscillations is key to investing. Unfortunately, most investors and advisors do a shoddy job understanding this critical aspect of investing.

Almost 300 years back, the concept of credit came into being, and the world changed. Until then, the risk capital was limited to capital contribution by the entrepreneurs. These credit cycles have a significant impact on business cycles. In turn, business cycles will affect profits and stock prices.

Due to the Pandemic, interest rates were lowered down throughout the world, including India. This is primarily done to spur growth. However, lower interest rates bring in the problem of ‘inflation.’

Enough said, where are we now?

On one side, we have seen massive profit growth in the last few quarters and on the other hand rising inflation. As a result, central banks will have to increase interest rates to counter inflation. Last year, a fall in the interest rates caused the markets to grow, and now an increase will do the reverse. I don’t know when, but it may not be too far.

The number of IPOs in the market is a clear indication of euphoria. In almost any get-together, the conversations are about investing. Old and young people are discussing how to make quick money in the stock market.

It is time to apply caution.

How do we apply this caution?

Reflect on your long-term asset allocation and make necessary changes.

1. Equity mutual funds: AMFI has asked a lot of cricketers to promote mutual funds during the T20 world cup. This is not a time to be influenced by Sachin or Rohit. Allocate in equities gradually and do not invest in bulk.

2. Debt mutual funds: There may be rising pressure of increasing interest rates. This may cause the NAV of long-term debt funds to fall. Therefore, you should stick to short-term debt funds.

3. Gold: Gold is a good inflation hedge. 5-10% allocation may be excellent, but short-term pressure would continue.

4. Real estate: Real estate investment, as well as rental income, can be a good inflation hedge. In addition, REIT investments can be evaluated given that the economy is now opening and employees are returning to offices.

Now my favorite topic, investing in direct equity.

The first question is, why do you believe you have an edge investing in direct equity? Simply speaking, what makes you think you can pick a stock and the odds will favor you. But, of course, there is a difference between belief and wishful thinking!!

I find it quite amusing when 20-year-olds offer me advice on stock investing. The dopamine has flown way more than required :) Ghalib once said, ‘koi batlaye ki hum batlayen kya.’

Unless you can create a concentrated and contrarian portfolio of stocks, the probability of beating the market is minuscule.

A lot of investment professionals feel that they can beat the market. But, unfortunately, very few can consistently beat the market, and those who do will eventually make a lot of wealth.

The qualification has a minimal role; it is more a behavioral game. Stock Investing is a humbling career option and should be seen as a game of probabilities.

You should stick to areas where you think you have an edge. You can continue to increase your knowledge but always be aware of the edge. If you operate outside this boundary, you will be vulnerable to market forces. Last year, these forces helped, but now the same forces can crush.

The Law of Impermanence is the teaching that everything in material or relative existence is impermanent. That is, everything has a beginning, a middle, and, most definitively, an ending.

Nothing is forever.

Disclaimers

• Investment in securities market are subject to market risks. Read all the related documents carefully before investing.

• The securities quoted are for illustration only and are not recommendatory.

• Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

• Advisor: Ankur Kapur

• SEBI RIA No.: INA100001406

• BASL Member ID: BASL1337

How to pick quality stocks for long-term investing?

There are many ways to invest in the stock market. And each method has its merit and nuances. There is no reason anyone can claim one method as superior to others. However, you can’t be good in all forms of investing.

You can make money by investing in high-quality companies. However, you can also make money by identifying mispricing in low-quality cyclical companies. This article is focused on identifying high-quality companies that have had public information for at least ten years.

You can read the articles in a sequence to understand the process better. However, if read without a sequence, each article is complete in itself. At the outset, I would like to inform you that the purpose of these articles is to be relevant for finance and non-finance readers.

1. Myths of being a good stock investor

2. Shortlist high-quality businesses

3. Historical performance

4. Analyze financial statements

5. Accounting gimmicks

6. Identifying the ‘economic’ moat

7. Price for a high-quality business

8. Value based on assets

9. Cost of capital

10. Value of growth

11. Snowball

Disclaimers

• Investment in securities market are subject to market risks. Read all the related documents carefully before investing.

• The securities quoted are for illustration only and are not recommendatory.

• Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

• Advisor: Ankur Kapur

• SEBI RIA No.: INA100001406

• BASL Member ID: BASL1337