My Simple Investment Framework !

Since last two days i was thinking about how to get extraordinary investment return by investing in stock market though i must admit that like most other investors i also always wanted extraordinary investment return for myself. My thought also went into various popular investment theories and how some investors become extraordinarily successful, some make meaningful return  while most other fail miserably in this pursuit. I would like to emphasis here that by its very nature share market in itself is not wealth creator but merely an exchange and gateway of wealth distributor and share prices fluctuates on short terms based on demand/supply and in long term based on future business performance of  any particular script. It is difficult to predict both of them in any scientific ways and with high degree of  accuracy and reliability by using any specific formula, methodologies or analytics which is used or followed by large number of investors or market players.


My simple investment framework and rules:
(1)Maximum number of stocks in protofolio should not exceed 10. Dont invest more than 25% of protofolio value or less than 5% of protofolio value in a single stock.
(2)Except banking and financial services sector, promoters holding should be atleast 40 %. No past history of promoters share pledging or equity dilution except due to bonus or employee stock option.
(3)Scalable and simple business model with distinguished product and service offerings
(4)Price of stock/market cap, Maximum 5 times book value or sales turnover and 18 times last one year earnings and 15 times operating cashflow
(5)PEG ratio of atleast 1 and debt-equity ratio of less than 0.5 (also no past history of high debt-equity ratio of more than 0.5).
(6)No fresh investment in stocks if sensex or nifty PE  exceeds 18.
(7)Sale stocks equivalent to protofolio cost  if sensex/nifty PE exceeds 25.
(8)Fully invested if sensex/nifty PE moves below 12 (can take additional loan of upto 50% of profolio value for further investment) else hold atleast 20% of  protofolio value in cash.
(9)Once invested hold the individual stocks for atleast 2 years unless it falls by 20% of buying price in rising or normal market conditions.
(10)Wait for atleast three months before buying a good stocks which is making new lows. Don't sell a stock which is making new highs.
(11)Wait for atleast 3 months before introducing a new stock or exiting a holding stock in protofolio. Always give preference to current holding stocks for more investments over introducing new stocks in the protofolio.
(12) Give special empathasis on quality of earnings, quality of product/services and quality of management/promoters  before selecting a stock for protofolio.
(13) Without considering current stock price, arrive at fair price range for buying a stock and strictly stick with those price range for buying. Consider atleast 20 % margin of safety in  fixing fair price range.
(14)Review in month of november  every year each stocks in the protofolio by studying and analysing their annual and quaterly results and conference call, investor presentation and other independent websites and research reports. Sale the stock if result is not satisfactory for continously two years or their is declining trend  in margin or sales growth or promoters holdings  or increasing trends in debt level  from previous years (for past atleast 5 years).

(15) All criteria should be strictly followed pointwise before making any stock investment. Immediately sale those stocks which violates any of these criteria even after purchase and facts come into light/known which violates any of these criteria. Date of full compliance of criteria is 30/11/2013.

Lessons For Indian Investors From Investing Failures Of Warren Buffet !

We learn wisdom from failure much more than from success – Samual Smiles

My primary objective behind writing this article is to help retail and common investors make their own financial decisions and learn from investing failures of one of the all time greatest investor in financial market history, Warren Buffet. As per Forbes 2010 list of world richest individuals , Warren Buffet (with net worth of  $47 billion ) and George Soros (with net worth of $13 billion ) are perhaps only individuals among top 50 (It is also interesting to know six indian among them whose combined net worth of $ 113 billion is almost about 10 % of  India GDP of  $1.31 trillion though all of them earned or inherited most of their fortunes through business other than financial market) to earn their fortune almost entirely by exploiting the inefficiencies of global financial markets though their style of exploitation may be slightly different. It may not be entirely coincidental that both of them are almost same age (79 years) and USA citizens (More about it on some other article).

Warren Buffet is definitely among  most talked and written about financial personalities in recent memory ( his holding company Berkshire Hathaway Inc annual report among most widely read annual report by global investment community)  and perhaps in entire human history but contrary to popular believe major chunk of his fortunes created through purchase of businesses rather than stocks. Most part his stock buying is substantial (with holdings of more than 10 %  of the company in question which allowed him to participate in financial and other strategic decision of the company) and during period when most of those companies are going through temporary period of crisis (which allowed him to extract better investment deal from companies with assured return substantially higher than generally available to common stock investors through dividend payments)   Also stage of American economy and financial market during major part of his investing career  has profound effect on his investing success. Perhaps what differentiates most of investors (including me) from Warren Buffet  apart from his financial acumen is his simplicity of thought, patient, preservenss, emotional intelligence, foresight, ability to learn from past mistakes and wisdom of others like Graham, ability to adopt his investment style as per changing realities of financial market and for most part commit money only to businesses which falls within his areas of competence. Also like most of financial investors during his investing career of over five decades, his financial investment decisions has turned out failure as many times as its turn out successful though successful one is most widely reported, followed, liked and believed by  most of investing community.

Warren Buffet and some of his most successful investments

To support my above assertion let us looks at some of  his most successful security investment decisions which are in his holding company portfolio for many years.

  

Table 1.1: Some of Berkshire Hathaway most successful investments

(Source: Berkshire annual report 2000, 2005, 2007, 2009)

(All Data is normalized to cost price as appear in 2000 annual report to enable multi year comparison to take care of buys and sales during period in question)

Company	Percentage of Company Owned	Cost of Purchase (in millions $ as in 2000 annual report)	Market Value (in millions $)
			2000*	2005	2007	2009
American Express Company	12.2	1470	8329	7802	7887	6143
The Coco -Cola Company	8.4	1299	12188	8062	12274	11400
The Gillette Company (Latter P & G Company after acquisition of Gillette)	3	600	3468	3694	4339	2355
The Washington Post Company	18	11	1066	1322	1367	NA
Wells Fargo & Company	5.7	319	3067	692	437	389
Others		6703	9501	Not Relevant	Not Relevant	Not Relevant
Total Common Stocks		10402	37691	30475	19875	17725

*: Mention increase in market value from time of buy. Some of buys like Washington Post happened in 1970’s while some other like Coca-Cola, Gillette happens in mid 80’s & early 90’s.

As can be seen from table 1.1 above most of his very successful and multi-bagger investments of 1970’s and 80’s and early 90’s like washington post,  coca-cola, gillette , wells fargo, american express from 2000 onwards has not shown any significant appreciation(actually almost all of them  has suffered significant decline in value in last 10 years). Also cost of common stocks investment for Berkshire  in year 2000 was around $ 10.4 billion which has increased to around $ 15.94 billion in 2005, $ 39.25 billion in 2007 and around $ 34.6 billion in 2009, so significant new money was invested in stock holdings during  2005 and 2009 (more than $ 20 billion) which was not generated through gain in securities and profit bookings but free float cash available from his holding companies reinsurance and other cash flow generating businesses which subsequently turn out to be one of the most difficult period for security investment in American history and consequently may be not a wise investment decision in hinder sight.

Indian investor can draw following lessons from above discussion:

Lesson # 1: No company even with high quality management, products and services can successfully grows its business and market share  over  many decades continuously and at some point of time it is likely to decline or hit upper limits of its growth potential. So common investors should never wed for life to a particular share investment and analyze the size and future growth potential of the business before making their potential investment decisions.

Lesson # 2: It is highly unlikely for any investor to make a living out of security market investment because there is hardly anybody able to do that successfully by depending on such activities alone (including Warren Buffet). However working in financial industry as professional is altogether a different ball game. So involve yourself in real business activities which contribute to growth of Indian economy and not rely on speculation as way of living because in long run it is not likely to succeed.

Lesson # 3: Stages of Indian economy and security market has important bearing on investment success and considering current economy scenarios and market condition it is not likely that  in next decade Indian investors as a class can able to generate and preserve value of their investments (after adjusting for inflation) like they did in last decade (during 2000-10)  so diversify your investments significantly in other financial instruments including debt and commodities.

Lesson # 4: Nobody can  time the market entry/exit successfully most of the times even with insiders information on state of economy in general, so focusing on business fundamentals of companies may be more worthwhile than trying to time the market.

Beating the market and Warren Buffet

 S & P 500 index is one of the most popular index used in USA market to benchmark investment return and success (Like sensex and nifty used in Indian market) and in first page of Berkshire annual report Warren Buffet lists comparisons of his annual returns w.r.to S & P 500 index from 1965 onwards. As per this report S & P index has grown with CAGR (Compound Annual Growth Rate) of 9.3 % while investment in Berkshire share has grown with CAGR of 20.3 % (This should not be confused with return of its security investment only  and includes profit from its various businesses as well. Rs 1 invested in Berkshire in 1965 should have grown to Rs 4340 in 2009 while with index it should have grown to 54 during the period ). To put this figure in prospective for Indian investors, Wipro (a leading Indian IT Service company) has grown with CAGR of around 18 % and Tata group has grown with CAGR of around 13 % during the same period. There is no doubt that Berkshire returns during the period is spectacular to say the least however between 1999 to 2009, Berkshire has grown with CAGR of 7.58 % only, which is less than long term  S & P index average CAGR of 9.3 %. Also most of the gain of Berkshire has come from  avoiding steep decline in value of its portfolio during bear markets of 2002 and 2008 and not from major gain during bull period of 2003 – 07 (in comparison to S & P index). Actually Buffet portfolio has gained by 10 % in 2002 (while S & P was declined by 22.1 %) and in 2008 declined by 9.6 % (in comparison to S & P decline of whopping 37 %).

Lesson # 5: It is almost impossible to beat the market over long period of time and even Buffet find it difficult to achieve this feat. So for most investors investing in Index funds may be best choice over long term. Also yearly returns of portfolios may be small but compounding over long period of time is what causes actual creation of wealth.  To put this in prospective if every human in year 1600 had foresight to invest only Rs 1 and should have grown that amount to CAGR of only 5 % (by passing to their next generations off course) that amount should have more than 48 crore in 2010 and no person in the world should have been poor today. This also tells us how difficult it is to pass even small amount of wealth through generations or grow the money consistently over long period of time(This can be good advise for our politicians , businessman, bureaucrats and greedy promoters who indulge in corruption at the expense of country and common investors in false hope of amassing wealth for their future generations)

Warren Buffet and some of his most unsuccessful investments

Warren Buffet investment record is spectacular however like most of investors many of his investments after purchases have turned into failures.

Table 1.2: Some of Berkshire Hathaway most unsuccessful investments

Company	Year of Purchase	Cost of Purchase (in millions $ )	Market Value at time of exit (in millions $)	Remarks
Salomon Inc	1988-90	700	1700	Salomon Inc is among leading investment companies of wall street in 1970s and 1980s became came close to bankrupty in early 1990’s and latter acquired by Citigroup in 1998
General Re	1998	22000	Not Available but definitely significantly less than its acquisition cost of 22 billion $. May be currently valued around 10-12 billion $ only.	After Buffet buy by paying 22 billion $ its business has continuously declined from premium collected of 8.6 billion $ in 2000 to 5.7 billion $ in 2009. During whole this period this acquisition is mostly in loss with combined loss of around 5.7 billion $.
NetJets	1998	725	Still hold by Berkshire	NetJets is in aeroplane leasing business and still owned by Berkshire but in last 10 years it has not able to achieve expected profit and during 2009 posted a loss of 700 million $.
Pier 1 Imports	2004	150	30 (Started selling in 2005)	Pier 1 is a furniture retailer. Buffet bought this stock at price of 20 $ in 2004 and by 2007 this stock was quoting at less than 5 $ per share
ConocoPhilips	2006-07	2741	1926	ConocoPhilips is a oil producing company. Buffet has started investing when oil prices are close to its peak of around 140 $ per barrel which dropped to around 35 $ in 2008. So also Its share price has dropped in value by more than half after Buffet buy and he eventually started selling it from second half of 2008.
Freddie Mac	1996	333	3170 (selled in 2000)	Buffet has existed from this company in 2000 however in 2008 this housing finance giant was in brink of bankruptcy and was bailed out only with huge federal package to avoid it.

Contrary to the popular believe Buffet investment decisions has also turned out in major failures fortunately for him most of his mistakes came  in latter period and at the beginning of his investing career.  Buffet has relatively dream run of investment success during 1980 -95 which is incidentally also one of the best period for American financial market and economic growth. Also in last decades his portfolio churning ratio is quite high and he has existed many of his investments within relatively short period of time and not able to hold it for long term as many of us like to believe.

Lesson # 6: Never invest in commodities or commodities related stocks like mining, metal, oil etc close to peak of economic cycle or when they are available at close to peak of their historical valuations otherwise it may lead to major loss in your investment value (like ConocoPhillips for Buffet)

Lesson # 7: While investing base your investment decisions on your analysis and understanding of business fundamentals of the company and don’t loose heart if some of your investment turn out to be bad and be quick to recognize and exit such investment at earliest favorable opportunity.

To conclude financial market is a very complex and futuristic system whose predictions based on past history for investment purpose always carry some amount of risk and Indian investors should make their investment decision in financial market based on his/her risk profile and by  analyzing &  learning from past mistakes of investment gurus like Warren Buffet.