Stock picker in me: Point of loss (when loss happens?)

Once I bought dart game for my son to play at home. It was bit expensive. As soon as we were at home we started playing. It broke within one hour. My wife was not happy and she said we wasted our money. I said loss did not happen now, it happened when we bought it. The time I paid for it, I had already discounted the value of dart game to zero but my wife felt loss only when it was broken. In this situation I was fine with it but my wife was not.

I am a conservative person I discount my losses well ahead or let’s say I provision for them immediately. I understand that same logic cannot be applied to all the things we buy for example we cannot bear or provide for loss of our real estate (home) investment, and big ticket items (jewellery, home furniture etc.).

For me loss happens at point of making payment. I feel that’s how we should assess our investments as well. You should do all the due diligence before making investments/payments. We should not feel loss is happening after the price of your investment dropped or when thing you bought broke. If you are able to sell your investment as soon as you realize your mistake you are only recouping your loss.

So for example, let’s assume stock you bought fell 20% from your buy price. You revisit the thesis of buying the stock and you find that you made a mistake. You should not think that your loss is 20%, you should assume your loss is currently 100% if you sell it you can recover 80% back. If you fail to follow this you are likely to have more losers in your portfolios, which will overall be drag on the portfolio.

Retirement corpus quadrant – Achieve, protect and sustain

This is the highest risk quadrant. By this time you would have achieved what you aimed for and that’s where the risk lies.  Long-time ahead can expose you to various uncertain highs and lows. Health and unexpected emotional shocks can put your maths for a toss.

From this quadrant going back to first two quadrants is very difficult. Hence before reaching this quadrant you need to ensure you reassess your corpus requirement.

Few other things you need to make sure before come to this quadrant is take steps to protect and sustain. Some simple tips are adequate insurance, adequate diversity, and adequate assessment of income vs. expenses.

Cockroach in my pants

One day while working in my office I felt certain movement near my calf muscles. I ignored for a second, but again it started moving and it was very creepy. I shivered and ran to the toilet. I took off my pants and saw a cockroach falling from it. I was totally shocked and could not believe it. Cockroach would have climbed from dustbin under my desk to my pants.

I am so much impacted by this incident that till today if there is any minor movement around my legs I get nervous. Sometimes it might be just my trouser touching me but I now have heightened sense of any movement.  First thing comes in my mind is cockroach. Now this happens to me many a times. Sometimes I just stop to understand if this not the same creepy movement.

One incident changed my awareness, senses and causes needless worry. How many of you felt such things in your life. Phone not vibrating but feels like vibrating? I am 100% sure that no one felt vibrations until phones came in their life.

How many of us become very sensitive to such incidents. If you lost money in the stock market, it is likely that you start avoiding it. Some people become extremely worried about taking flights after some flight mishaps.  We start expecting less probabilistic scenarios to be a norm. This has completely negative impact on our sound judgment. Pants were always touching my legs it never bothered me one creepy cockroach in my pants once in 39 years of my life now makes my whole pants a cockroach.

Retirement corpus quadrant – Invest and reassess

This is the area where over 95% of people do not have expertise or influence. Don’t worry the positive thing about it that you don’t need to spend your time here. Even the experts’ results do not change much irrespective of time investments. In fact in this quadrant time investments may result in negative outcomes.

Simple tip from me is spend negligible time in this quadrant. Invest in exchange traded funds which are cheap and broadly replicate market returns. Things you should focus on is commitment for long-term, consistency and focus on first two quadrants (earn and save more).

Reassess your corpus requirements on every 3 to 5 years. Rebalance your asset allocation reflecting your progress on corpus. If you estimate that you need more than seven years to build corpus then you can allocate slightly more to stocks otherwise bonds.

Retirement corpus quadrant – Save

This step cannot happen without first quadrant and retirement (early) cannot happen if you miss this quadrant.  This is simple but not easy and most important of the all the quadrant.

If you find it difficult, start with tracking your expenses. A consistent tracking of expenses for few weeks would give an overview of expenses. I suggest downloading certain apps for tracking. Most of the apps would link to your SMS and automatically recognize the expenses done through digital/card forms.

Once you become aware of your expense start making budget. Allocate budget for each type of expense category (groceries, shopping, travel, entertainment, health etc.). Target to cut down budgeted expenses by 5% initially and keep tight control (incremental decreases) every month.

Next step is to pluck the low hanging fruits. Keeping in mind that it’s simple but not easy; first simple and relatively big impact item is cutting on eating out.

Retirement corpus quadrant – Earn

This is the starting point. However, I am not just talking about your day job or business. I am also talking about how you can increase your earnings. About 7/8 years ago I encouraged my wife to work. Last year I started this blog and hoping I can earn something from it in the next few years.

There are various ways one can improve his/her earnings. Coaching, consulting, writing etc. are some of the side hustles one can do. You can also think of adding certain skills to become more valuable in your workplace.

The control on this quadrant is not very high but also not very low. If you invest time to improve your earnings it will likely to have positive impact for the quadrant. You can use your judgment and skills to get disproportionate results in your favour and downside is somewhat limited.

Retirement corpus quadrant

You don’t want these in your life, but they are part of life and in hindsight you like them

Guessed what it is? Let me provide little more build up on this. You are facing this right from your childhood; this is given or created by your friends, relatives, colleagues, boss/manager, sometimes strangers and enemies. And above all these may be sometimes self-created or imagined (while actually they might not exist). They change, come in different sizes and duration.

They are challenges. When we are going through them we don’t want them to be part of our life, however, there is no way they disappear permanently from our life. However, when we are through with them they give us some learning and make us stronger so we like them in hindsight.

I have gone through various challenges in my life. I would give one recent example. I set up a team of 40+ people over the last 3 years in my company. I did not do well with my first hire; I had to face escalations almost every day. First six months were hell for me. However, after first six months passed, I learnt dealing with people and I refined my hiring skills as well. Post this I never faced any people issues.

It could have been very easy to blame the tough situation and put all the blame on other party. However, I took a different approach and looked at myself and asked few questions.

1. How could I have handled these challenges/situations differently?
2. What are the areas where I faced these challenges?
3. What can I do to improve in these areas?
4. If I am not able to figure it out all by myself, can I rope in a third (neutral) party to assess the situation and he or she can counsel me?

List down key action items arising from above questions and implement them to ensure these situations/challenges so they do not re-occur. So these are questions I am going to ask next time whenever if face challenges. Are you ready for your challenges?

Assessing management and corporate governance

This is the trickiest part for an individual investor to understand. Understanding people is generally a difficult task. For management assessment I have generally followed the below checklist:

1. Long history of company (minimum 20 years)
2. Management has done what they said in the past (go through conference call transcripts, management interviews, annual report)
3. Sound financial policy
   1. Capital allocation where potential ROE/ROA is high
   2. Low debt and focus on reducing debt before paying dividends
   3. Capex and dividend from internal accruals rather than borrowing
   4. Management highlighting importance of profitable growth rather than just achieving scale
4. How management puts across its business? (some examples: we know that BSE is an exchange but Mr. Ashish Chauhan, MD of BSE, says they are in the business of compliance. Paytm, not listed, they were very open to agree that they can’t make money in wallet business. Bajaj Finance: pulled out from banking license race and decided to remain a NBFC. Somewhere Bajaj Finance management also said they are in the business of risk not lending.
5. Unique business strategy, actions against popular trends: follow everything company does, see if you find something unique (examples: Bajaj Finance tie ups at every point where you do your small, mid to large sized budget shopping, Kotak Mahindra decided to own 100% of insurance, Bajaj Finserv did not allow additional stake in its insurance company’s stake to go to its foreign partner, Edelweiss allows its different businesses to be led by several individuals/leaders rather than Just Mr. Rashesh Shah leading the business)
6. History of value unlocking (Birla management with AB Nuvo, can they repeat with AB Capital which houses lot of businesses, Grasim is other one where they can unlock value for investors. Borosil Glass, new management got rid of lot of real estate which was keeping the ROEs suppressed, demerger of business to allow investors to own clean businesses without any inter-linkages, listing on NSE. IIFL Holdings allowed investors to own individual businesses)
7. Low or no pledged shares
8. Focus on long-term
9. No related party transactions (We found Kwality, the dairy company, attractive at price of 44 in around 2014/15, but remained away from it due to related party transactions, it went to 160 in 2017/18 but ultimately came back below 40. I also remained away from Borosil Glass but as I noted new management is inclined to clean up all legacy issues I jumped in made decent money despite buying it at higher prices)
10. Compensation of CEO/Chairman and senior management is adequate. More the variable portion (linked to company’s performance) better it is
11. Auditors notes to understand if there is any grey area
12. Board composition – majority of board should be independent
13. Visibility on usage of excess cash (I exited tree house at 340 just because I did not see management talking about how they will use the money they raised in QIP)
14. Accounting gimmicks: hiding the P&L expenses in balance sheet through capitalization, high and increasing receivables,
15. Financial reporting: timely and granular financial reporting

Above listed items are not exhaustive. It will help you more if you also understand company’s business and industry otherwise it could be easy for management to fool you.

TIP: Exit at smoke rather than waiting for things to flare up.

Disclaimer: I am not a certified analyst. Any stock named here should not be construed as a buy/sell recommendation.

Stock picker in me: Notional losses

In my previous blog I talked about notional gains, I am taking more critical topic bit late. Mr. Buffet has outlined 2 rules: Never lose money 2. Don’t forget rule no. 1. How is it possible to never lose money? Did Mr. Buffet never lose money? Do all successful investors never lose money?

If you are able to restrict your notional losses either by selling stocks or these losses reverting to gains within short period of time (ideally within 12 to 18 months), you are most likely to be a successful investor. Restrict the damage. I ask few questions:

1. Is this a temporary loss due to external factors?
2. There is no change in business fundamentals and story continues to be in line with your assumptions.
3. Company has negligible leverage.
4. Promoters are clean and their ownership remains as is? No pledging of shares

If answer to all of the above is yes/true, you can continue the course cautiously. I will always be cautious in losing cases. Let the price prove you are right rather than telling that price is wrong. Do not be brave to add at every fall.