Before we get into the WB’s principles, we must first understand the stock market context we are in. In the year 2003, the BSE index was at 3,000. The next 5 years were the magical era in Indian markets. The BSE index rose 7 times in these 5 years to hit around 21,000. In these years, pretty much anything one touched in the markets turned into Gold. This was also the era of an accelerated rise of the Indian middle class and penetration of the internet among the masses. Hundreds of thousands of online demat accounts were created and there was increased participation by the masses in the stock markets. Most of the people started trading in markets for the first time during these years. Unfortunately, what many people still haven’t realized is that this period was more of an aberration. Markets usually DO NOT rise 7 times in 5 years, especially markets like India that have already had the kind of run that we have had. This abnormal period unfortunately over-pampered and even spoilt large sections of investors who got used to expecting 30-40 % annual returns in the market year after year. It is like how Infosys started as a small cap stock and its share price rose by 100% year after year. It then became a mid-cap and then a large-cap stock and now, growing at 100% year on year is not just improbable but pretty much impossible. There is nothing wrong with Infosys, infact it is a much better and more established company today. But market returns will now be more ‘normal’ than ‘irrational’. We must realize that the Indian stock market too, is now entering a similar phase.
Given this context, I feel it would be prudent to now aim for 18-20% annual returns and be satisfied if we can get it. I am not an expert at WB’s principles but my understanding of the basic crux is this. Do not expect irrational returns in the market. Such expectations cause us to make wrong moves and invest in penny stocks or unfamiliar stocks for short term trading gains. If you have to put your hard earned money in the market, you must carefully select companies which have a good and consistent year on year track record in a simple to understand and sustainable business. This is because simple businesses tend to remain evergreen as against complex ones that tend to get replaced by more efficient business models. An example of this was WB’s decision to invest in Coke and Gillette in the sixties. He has held on to these investments ever since and even increased his exposure. Needless to say, he has made a killing. Coke was just a simple syrup company but WB saw its consistent track record, simple business model and potential to continue its growth. Once you shortlist your companies in this way, always try to make an entry at a steal deal. This is because the nature of markets is such that though the stock price tends to oscillate around the intrinsic value of the company, there are times when the price falls much below the intrinsic value because of unjustified reasons. For instance, a calamity or disaster or even a sentimental reaction to news can lead to a sudden and steep but temporary drop in prices which are unjustified. This makes the valuation of the stock extremely cheap and is the right time to make your entry. There are several indicators that give an idea of how cheap or expensive a stock is. Some examples are P/E ratios, Price to Book ratios compared to industry average ratios and so on. We need to compare these indicators with historic values to get a good picture of current standing.
Once the entry is made, we must remember that we need to be in for the long term. WB seems to have always been against short term trading. If you are convinced about the business model of your company and its management, you need to have patience. Returns will come. An example was when around the year 2000, dot com stocks were booming. WB apparently didn’t invest in them inspite of the huge returns because he just did not understand their business. If anybody was laughing at WB for not riding the dot com wave, they would have been silenced by what happened next. Come 2001, the dot com stocks started crashing. Some crashed by 80-90%, thus more than nullifying all the gains they made in the past. Just shows the importance of having a long term view.
To conclude, stock market investing is not about having prescience or heavenly foresight. It’s just about having practical and reasonable expectations and building a balanced portfolio of good quality stocks/MF’s/instruments.
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4 comments:
Very well covered and summarized WB's principle of stock investments.
- do not allow your principle amount to erode and go for a modest and realistic return on a consistent basis year on year.
Thanks! and of course to add to what you said, leave the rest to the power of compounding...
Hi Vivian,
great to read your blog here. Wanted to draw your attention to just couple of things will be interested in what you think abt these -
1. You see the problem with valuation is you never know when its cheap for ex if a stk was quating at PE of 14 a week back and now its at PE = 8 will you buy it - cant say may be the market is rerating the stock, you see thats the problem. You think Infy is cheap now, it used to trade at PE of 35 in 2007 its below 30 now is it cheap how do we know ... the stock is getting rerated every quarter.
2. There is one problem with investing in India and that is vast information asymmetry. You know all promoters are operators/traders you never know when you will be hit by some negative information. You knwo this is one of the reasons single stk option market is nt taking of in India.
Let me know what you think abt these.
Hi Neeraj,
Thanks for your comments. You have raised some very valid points. Please see my responses below:
1. While I understand we can never know when a stock is cheap purely on the basis of PE ratios, we can get a reasonably good starting point to reflect upon if the PE ratio drops. The next thing to note is if drop is due to some negative news that genuinely impacts bottomline or is it due to circumstances not in our control. eg. Infy is going through turmoil and getting re-rated, so I would stay away from investing in this stock although PE ratio has fallen as there is a genuine problem. However, imagine if the PE had fallen due to a bomb blast somewhere or a natural calamity having a negative temporary sentimental impact. In that case, I would have certainly bought the stock if it was on my shortlist since, the reason is temporary and has nothing to do with the company.
2. Yes, there is major information asymmetry in India. We have seen the DB Realties and Satyams crash overnight. Which is why I like to play it safe in terms of balancing my investment portfolio. See my latest post on 'How to build a balanced portfolio'. Try to keep your equity exposure to about 50% and be open to other instruments like Gold and Debt. if you are really the adventurous types, you may even set aside some percentage for F&O, short term trading etc. But make sure you keep an upper limit to it.
Hope this answers your questions.
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