Budget 2016, some views

As it sometimes happens at this time of the year, I'm writing this before the Union Budget for 2016-17 is presented by the finance minister, Arun Jaitley. I'm not going to stick my neck out and make predictions about the Budget. In any case, I'm not one of the commentators who are in the predictions business. However, all I'll say is that based on the news that has been floating around, equity investors are probably going to be quite disappointed if there is any fiddling with the long-term capital gains tax.

However, I don't think we should bother much about things of this kind. They are important and would certainly determine your eventual returns, but they are actually much lower down the rung in terms of importance than the actual choice of investments. The stocks you invest in are a far greater determinant of what returns you get out of investments. If you make wrong investments, then believe me, it's not going to be of much comfort that you could have paid less tax on the profits, had you made profits.

There was a time, years ago, when a Budget could make or break a company. Entire industries could be made more or less competitive depending on some duty or regulatory change. Some companies were much better than others at influencing the whole process. For years, friends in the media would pore over the Budget documents, looking for the 'Reliance clauses', since Reliance Industries' reputation for being able to manage such things was legendary. A leading business magazine used to do an entire feature projecting the actual rupee impact on the profitability of hundreds of companies. Or maybe they still do; I haven't really paid attention. But, generally speaking, those days are long gone.

Actually, investing by double-guessing the Budget, or by double-guessing any event was never a good idea. A few days ago, I was watching a talk by Udayan Mukherjee, a famous business TV anchor who for better part of a decade had practically come to symbolise this whole approach to stock investing. Every morning, as the markets opened, he would be there, live on CNBC-TV18, giving a running commentary on every tick of the indices. It was breathless stuff, resembling more the radio cricket commentary of earlier years rather than anything to do with investing. However, he is a changed man now. He said in this talk that only two things matter in investing: the quality of management and the valuation at which you buy a stock. Everything else is irrelevant.

It would be hard to disagree with this piece of wisdom. Of course, the list is small, so it's more about what is relevant than what is irrelevant. So if one agrees with this kind of a view, does it mean that everything else is irrelevant, including all the pages of data and analysis that we present to you?

Not quite. Saying that only quality management and valuation matter is a good rhetorical point but not a recipe for investing. It's like the old joke. A novice investor asks an old-timer, 'How do you make money in the market?' The wise man answers, 'Nothing could be simpler: buy low, sell high.' The beginner asks, 'How can I learn to do that?' Comes the response, 'Ahhhh... that takes a lifetime.'

Similarly, what is quality management? What is the right valuation? Discovering these takes a lot of work, experience and cool-headed analysis. What it doesn't is watching events like the Union Budget. The Budget (hopefully) contains a lot that will eventually enable growth, but it shouldn't be a reliable guide for what stocks will do well and what will do badly in the short term.

Ask your money to work & earn money for you !!!

I have put my money on a job to earn money for me.

It had been lazing around in my bank account for quite some time. It would just sit there, not doing much, if anything at all. Minutes would turn into hours, hours would turn into days, days into weeks, weeks into months, and the only time my money would even move an inch was when I would try to withdraw it. The rest of the time, I would sit comfortably on its backside without a care in the world. Eventually, what happened was that my money got too comfortable with the easy lifestyle that the bank account provided. It was then that I realized that I had to get it to do something useful.

I also realized that it wasn't in my interest to allow my money to be lethargic. They're right when they say that one has to try and get the best out of all of one's assets. I don't know exactly who 'they' are, but whoever 'they' are, 'they' are right about this--whatever asset you have, you have to put it to use if you want to get wealthier. And money is definitely such an asset. I couldn't afford to let it loaf around idly in the bank account. It had to get it out in the real world, it had to work, it had to be productive.

So, what I did was I pulled the money out of the bank account. Understandably, it was reluctant to come out of its comfort zone. It was apprehensive about how it would fare in the world outside. It wasn't sure if it would be able to meet my expectations. But I consoled it. I told my money that I would put it to work in a place where it would know what to do. I would get it a job that would be right down its alley, something it would be comfortable with.

Having built up my money's confidence, I put it to work in mutual funds. I got it jobs in a couple of mutual funds of different types, where it would be exposed to different types of market environments and challenges. And to its credit, it has been doing pretty well. My money has settled into a productive way of life. Now, my money works hard to earn more money. Every day, like the rest of us, it goes to work and tries its best to grow in value.

And I must say, I'm very happy to see my money be so productive. Getting it work in the right kind of mutual funds has definitely been better that seeing it sit around purposelessly in the bank account. It's something I recommend you do with your money as well. Put your idle money to work in mutual funds or other investment avenues and see how great it feels to see it grow.

Stock picking, investing principles!

Never mind the vision and mission statement of a company, the raison d'etre of an enterprise is to compound the shareholder's capital at a reasonable rate. Do that and survive, or fail and die.

An equity investor should understand that when buying a stock, she is not buying an entry into her stock account but a piece of a company. Efforts should be made to understand the company and its prospects for the future. But how do you understand whether a business is successful or not in its endeavors?

As a shareholder, the company in which you invest should be able to compound your capital at a healthy rate. To ensure this, the business should operate in an industry where it feels it has an edge over competitors in order to extract a reasonable return for every rupee of shareholder money it puts to work.

The first aspect an investor should then look at when selecting a stock is the attractiveness of the business. This would involve the various competitive edges the company has such as brand, technology, distribution, and so on. There is one more important aspect that needs to be considered-sustainability of this edge.

India has witnessed reforms since the early 1990s. In the initial phase, India opened up its manufacturing sector and this unleashed global competition on Indian companies. When we compare the end of 90s with the beginning of that decade, we would realise that many manufacturing companies did not survive. Even though many had huge advantages, most of those advantages were good only in a closed economy and could not survive the global onslaught. Today, the domestic services sector, which has been protected to a large extent from global competition, is being opened up. One would assume that if you are investing in a company operating in this space, you would need to be sure that the company's competitive edge would survive in a more open, global environment.

The second aspect of evaluation would be how high the business compounds the capital it employs. Clearly, if one wants high levels of compounding, then it is better to have a small base. The higher the capital employed, the more difficult it is to produce returns sufficient to justify the employment of such a high amount of capital. A good business would be one which can employ low amounts of capital, for it is easy to compound smaller sums of money.

There are various measures used to evaluate this aspect. One such measure is ROCE (return on capital employed). This measure is a reasonable one if the debt levels are low. If debt is a significant component of funding, then as an equity holder, the risk of significant economic losses is high. One should remember that as an equity holder, one gets paid last and hence, if there are more mouths to feed before dividends are paid, the higher is the chance that the leftovers will not be sufficient to take care of the equity holder's appetite.

Metrics such as EBITDA (earnings before interest, taxes, depreciation and amortisation) are dangerously inaccurate. Sawing off the profit and loss statement needs to be undertaken with discretion. One wonders which right minded businessman will accept that his fixed assets are "cashless". Yet there is no dearth of reports which state that "depreciation" is not a cash expense. I wonder how exactly peddlers of such a theory expect a business to invest in plant and machinery. Strangely, it also ignores interest cost, which is fine if the evaluator is a lender but not if she is the owner.

Another metric used to show attractiveness of a business is "growth rate". Higher growth rates can mask basic business problems for a while but will rarely be able to reverse the basic economics of business. Warren Buffett frequently points out to the two great inventions of the 20th century-air travel and automobiles-which grew phenomenally but were a disaster to the providers of capital to these industries.

An example here would illustrate the uselessness of the above two metrics. There is one investment which any one can make easily. It has 100% EBITDA margins and one can generate as high a growth rate of earnings as one desires. Yet, it probably will not even beat inflation! This investment is a bank deposit.

Since, margins did not consider the capital employed, it had no use in judging the attractiveness of the "investment". And one can easily increase the amount one earns from a bank deposit by increasing the amount of principal that is deposited. It is fairly common to find such businesses that keep increasing the capital employed to produce growth rates even though the return per unit equity capital is low.

Surely, great economics in a business is not possible if it is not run by competent individuals. And hence, evaluation of management is critical for ensuring the continuation of favourable economics. A good manager would be one who keeps enhancing the competitive edge of the business and would also simultaneously respect the equity holders and reward them appropriately.

What we have gained in 2015

SCRIP	Price on       1-1-2015	Price as on 31-12-2015	GAIN	%AGE gain
ENTERTAINMENT NETWORK	529.55	778.35	248.8	47
EVEREADY IND	179.55	301.35	121.8	68
CENTURY PLYBOARDS	160.3	169.50	9.2	6
GRANULES	83.19	148.80	65.61	79
LLOYD ELECTRIC	122.25	300.55	178.3	146
NUCLEUS SOFTWARE	201.6	258.10	56.5	28
R S SOFTWARE	299.98	144.25	-155.73	-52
SUVEN LIFE SCIENCES	211.95	265.75	53.8	25
T V TODAY NETWORK	216.4	336.00	119.6	55
CHOLAMANDALAM FINANCE	473	641.85	168.85	36
ZICOM SECURITY	188.35	132.60	-55.75	-30
BAJAJ FINSERVE	1431.2	1987.9	556.7	39
overall gain	in year 2015			37.34%
Whereas Sensex has given minus 5% returns in 2015

What we have gained since last Diwali

SCRIP	PURCHASE PRICE	Price as on 11-10-2015	GAIN	%AGE gain
ENTERTAINMENT NETWORK	410	639.80	229.8	56
EVEREADY IND	110	278.00	168	153
CENTURY PLYBOARDS	183	180.50	-2.5	-1
GRANULES	76	148.00	72	95
LLOYD ELECTRIC	180	267.00	87	48
NUCLEUS SOFTWARE	223	234.00	11	5
R S SOFTWARE	283	122.70	-160.3	-57
SUVEN LIFE SCIENCES	122	274.20	152.2	125
T V TODAY NETWORK	170	249.10	79.1	47
CHOLAMANDALAM FINANCE	610	622.00	12	2
ZICOM SECURITY	173	134.40	-38.6	-22
BAJAJ FINSERVE	1450	1950	500	34
overall gain	from last diwali to this diwali			40.35%