Investor A invests at lowest index level during the month (i.e. A has all the information);
Investor B invests at highest index level during the month (i.e. B mistimes the market every month!);
Investor C is indifferent to news flow and invests at month-end closing prices. Each one them has invested a total of Rs 7,20,000 in 144 months.
That is, if you are ready to invest in a disciplined manner for long term, having information and timing does not matter much. Even an indifferent person can make money by investing dispassionately.
- It should be understood that there is no point in trying to time the market. Though it has been tried by millions of people and people have made money and have become millionaires, the fact remains that it is neither easy nor feasible for a average investors like us.
- Timing is possible. But only for those who are part of the inner circle – people who have insider information.
- There is a difference between information and wisdom. An investor should be vary of all information being bombarded at him and one needs to be wise enough to filter out the noise.
- As a regular retail investor, it makes sense to keep on investing in a disciplined manner. The reason being that there is not much to lose (6% – Refer to above example) if an investor decides to ditch time-the-markets approach.
- But if you still think that its easy to time the markets, then its better if you stick with shares of companies which are robust and have withstood the test of economic cycles. And there is nothing better if you can buy shares of such Large Caps which are available at Huge Discounts)
And wish you all a Merry Christmas to all the readers!
- Over any rolling period of 5 years in last 12 years, Sensex has not given negative returns! So if you are ready to stay invested (in this case, in an Indian Index Fund) for a period of 5 years, you won’t lose money.
- Returns earned during last 12 years, when segregated on basis of P/E ratios are –
|Returns (Over 3 & 5 years) & P/E Ratios|
This clearly indicates that at current P/E of 16.5, we have a chance of earning more than 15% per annum for next 3-5 years!
- Stable Investor is now in a better position to respond to people’s view that it is better to invest in markets of lower multiples (P/E). Our analysis clearly shows that if investor invests in markets of lower multiples, probability of earning high returns is very high.
- P/E Ratios are still relevant for judging overall valuations of markets, if not individual stocks.
- It is advisable to invest when markets are trading in early teens (i.e. 13<P/E<16). It has also been seen that Indian markets tend to stay between P/E Multiples of 12 and 24 (Read Indian Markets PE 12 to 24 for details)
- P/E Ratio is a beautiful indicator of market’s overall valuation. But before making any buy or sell decisions, an investor should also look at a lot of other information/data.
Oracle of Omaha, Warren Buffett has been in news lately for tipping his son Howard Buffett to be the new chairman of Berkshire Hathaway (source). By profession, Howard is a farmer. Company’s investment strategy would still be governed by the CEO and Board of Directors. But Warren Buffett’s son would serve as a Custodian of Company values rather than take part in regular day to day affairs.
So what makes Warren Buffett so special? On very first page of his famous and revered Annual Letters to Shareholders (2011, 2012), it is mentioned that from 1965-2010 (a period of 45 years), Berkshire has had a CAGR of 20.2% i.e. your money doubles every 4 years!
Can average investors like you and me, who don’t know so many things beat that performance?
Can we earn 20% year on year for decades? I doubt that.
|You are not Warren Buffett. Period.|
Such superlative performance can have have the effect that average investors try to become the next Warren Buffett. But in doing so, they would be making a grave mistake. That’s because-
- Most profits made by Berkshire come from owning entire companies, which an average investor is incapable of doing.
- Though Buffett gives independence to individual companies’ management, he always keeps a tab on them to see that they don’t deviate from Berkshire’s simple but sacred principles. As far as an average investor is concerned, he doesn’t even meet any member of the company’s management.
- Buffett owns the perfect business of insurance. This is equivalent of having a constant source of interest-free loans given to buy shares of other companies. Now who among us can boast of ownership of such a business?
- Inspite of being famous for having a holding period of forever, Buffett occasionally sells stocks. Unlike us, he doesn’t require money for his basic needs. He sells when he does not see value in his investments or wants to fund more lucrative investments.
- Unlike average investors, he has access to loads of insider information and has an army of people who can do comprehensive number crunching for him. This augments his investment decision making process.
- For him, return of capital is more important than return on capital. But this statement requires a lot of discipline and will-power to be put in practice. An average investor is attracted by prospects of high returns from risky companies. He is ‘absolutely’ not ready to do his due diligence and find a few large and stable stocks trading at discount to their real values. Day traders use various tools like 200 Day Moving Averages for earning a quick buck. But they forget that they can also use these 200 Day Moving Averages to help them in investing for long term.
- Buffett is a fast and voracious reader. We can’t imagine an average investor to read Forbes, Wall Street Journal, Financial Times, New York Times, USA Today and Omaha World-Herald every single day of the year, decade after decade. (For Indian Investors, replace above names with Indian financial newspapers and publications). Even if a person does read a few good publications, the question arises whether he will he be able to utilize and interpret this information to his advantage?
- An average investor does not get deals which are skewed heavily in his favor. Buffett got one hell of a deal from Goldman Sachs, where he was earning $500 million every year for doing simply nothing!!! And when Goldman Sachs decided to redeem the preferred stocks, Warren was the unhappiest person in the world as any normal person would hate to lose a free cash flow of $500 Million an year. Very recently, he entered solar energy via Topaz. An interesting article shows once again that why and how he lands up such delicious deals.
Though compounding has a peculiar problem, it still works for those who are patient enough.
So an average investor should focus more on buying good stocks and allowing compounding to show its magic. But instead, what he does is that he is constatnly on a lookout for stock tips and is looking to find the next multibagger. As a sensible investor, one should be prepared for opportunities which markets throws up every now and then. And when that opportunity comes, be prepared to take advantage of them.
|Nifty Stocks – Discounts to their 2008 & 2011 highs|
- SAIL– A major steel player is down 72% & 68% from its 2008 & 2011 highs.
- Sterlite Industries – According to a few, another ‘Reliance’ in making, is down 68% & 58%
- Tata Steel is down 64% and 50%
- BHEL is down 54% & 50%
- Reliance Industries – Bellwether of Indian stock markets, sitting on a cash pile of more than 16 Billion Dollars, generating cash of around a Billion Dollar every quarter is down a staggering 54% from its 2008 highs and 35% from its 2011 highs!
- Long term investors should understand that though index is down around 25%, good individual stocks like Reliance Industries, Tata Steel, SAIL & State Bank of India are down more than 60%. And these are not small or mid caps; these are full-fledged large caps!
- This analysis does not suggest that there won’t be any further fall in these scrips.
- One of the most important points to note here is that there may be several other stocks which might be trading at larger discounts. But, during crisis, it is advisable to look for sustainability of business rather than growth prospects of business. There is no point buying a cheaper growth stock when it may not even exist after the crisis is over.
- It makes sense for long term investors to continue with their SIPs in good mutual funds or index funds. Also investor should start selectively buying these large cap stocks, which score high on sustainability parameter and have visibility in revenues/profits.
|Correlation | Investing based on 200DMA & 5 Year Returns (CAGR)|
- In regions marked P, Q, R, S, & T, the index was trading 20% lower than its 200DMA. And as red graph in these regions indicates, returns have always been in positive territory.
- Please note that it is assumed that investor is investing in index as a whole. A similar graph drawn for individual stocks may show different patterns and would depend on businesscycles of the sector.
- Region A (i.e. Year 2000-2004) is a possible outlier in this analysis. During this period, India was in long term secular bull market and as evident from the graph, relation between 5Y-CAGR and distance of index from its 200DMA is not evident. Returns continue to be positive even though Distance from 200DMA continuously switches between positive and negative territories.
Though 200DMA is generally considered as a tool to be used by traders, it can very well be a potent tool in the hands of a long term investor who wants to time his entries in the market.
200DMA is calculated by taking arithmetic mean of all values in consideration (Stock prices, index levels) in last 200 trading sessions (40 weeks). 200DMA is generally used to assess long term trends. Another tool regularly used by traders to assess short term trends is 50DMA. Generally, a stock trading above its 200-day moving average is said to be in an uptrend and is being accumulated; one below it is in a downtrend and is being sold. (Learn how to calculate CAGR)
200DMA & 3 Year Returns
A comparison between 3 year CAGR and index’s distance from its 200DMA was made.
|Correlation | Investing based on 200DMA & 3 Year Returns (CAGR)|
- Regions marked A, B, C, D & E had Nifty trading at level 20% (+) above its 200DMA. And as green graph shows, returns obtained in all 5 regions have been negative. As of now, discussion on region F is being left out intentionally.
- In regions marked P, Q, R, S and T, Nifty has been trading at level 20% (-) below its 200DMA. And as green graph shows, returns obtained in all 5 regions have been positive.
- It is assumed here that investor is investing in index as a whole using an index fund or something similar. Similar graph drawn for individual stocks may show different results depending on sector’s business cycles.
- Region F (i.e. Year 2000-2004) is an outlier in this analysis as during this period, India was in long term secular bull market and as evident from graph, relation between 3Y-CAGR and distance of index from its 200DMA is not evident. Returns continue to be positive even though distance from 200DMA oscillates between positive and negative.