Market Timing Or Disciplined Investing – Which is More Sensible?

If you have read some of the older posts, you would have a fair idea about what Stable Investor is all about. And you will also understand that timing of stock markets is not what this website is interested in. And that is because for all practical purposes, it does not work!
A famous columnist once said,

“The market timer’s Hall of Fame is an empty room.” 

And the great stock picker Peter Lynch once remarked,

“I can’t recall ever once having seen the name a market timer on Forbes’ Annual List of Richest People.”
This clearly shows how successful (or unsuccessful) market timers have been. In an ideal world, an investor would have all relevant information and would know when to invest and when to get out of markets.
To explain these concepts, lets take a scenario, in which there are 3 investors – A, B and C. All three are ready to invest Rs 5000 every month from January 2000 onwards. But timings of their investments are different. 

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.
So where do A (Perfect Timer), B (Perfect Mistimer) & C (Indifferent Investor) stand at the end of 12 years?
Market Timing Make Money
This analysis shows that the difference between a Perfect Timer (A person who has all the insider information) and an Indifferent Investor (Does not care about intra-month fluctuations and has automated his investment process to invest at month ends) is of just 6%. Just 6%.

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.
So what does this analysis point to?

  • 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.


And wish you all a Merry Christmas to all the readers!
Stock Market & Christmas
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PE Ratio of Indian Markets – A Long Term Analysis

Price to Earnings ratio (P/E ratio) is a measure of price paid for a share relative to the profit earned by that share; i.e.


You can read more about P/E Ratios here & here.


They say that it is best to invest when valuations are low.

Sensex is currently (December 2011) trading at a P/E of 16.5. So is this the right time to invest? Is this what experts call a low valuation? We at Stable Investor have decided to answer these questions.

Analysis of Sensex’s last 12 years data (from 1stJan 1999 onwards) reveals a few interesting points –
  • 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!

(Caution – This statement is made on basis of historical data. Past performance is no guarantee of future performance.)

So after analyzing this interesting relationship between P/E Ratio and Returns, what does a Stable Investor do?
  • 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.
Update – You can check the latest PE-Ratio Analysis of Indian Markets in 2013 or 2012. For constant updates about Indian Markets’ PE, P/BV Ratios, please check the State of Indian Markets.

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Believe Us, You are not Warren Buffett!

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
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.
  • 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.

Warren Buffett had once said – My wealth has come from a combination of living in America, some lucky genes, and compound interest”. Out of these three, only compound interest, is under our control.

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.

Large cap Nifty Stocks available at deep discounts

On 25thNovember 2011, Nifty closed at 4710 – A level 26% lower than highs of 2007-2008 and 2011. So does it mean that all 50 stocks that make the index are following a similar trend?
Before answering this question, I would like you all to know that Nifty is made up of stocks of 50 companies representing 24 important sectors of Indian economy. All these stocks have different weights. And for all practical purposes, the index can be considered to be a good enough representative of stock markets.
NSE itself provides a lot of information about Nifty like Full list of constituents, calculation methodologies, etc. for retail investors.
I did some quick calculations to see how individual Nifty stocks were placed with respect to their 2007-2008 & 2011 highs –
Nifty Stocks 2008 2009 Lows
Nifty Stocks – Discounts to their 2008 & 2011 highs
As evident, shares of companies like RCom (Reliance Communications) are down 92% & 66% from their highs of 2008 & 2011. RCom, because of various negative reasons may not be the best stock to evaluate. But this small analysis also throws up some interesting insights about other large caps –
  • 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! 
So what should an average investor do after witnessing shares of mighty and blue chip companies fall like nine pins?
  • 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. 
  • 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.

200 Day Moving Averages (200DMA) Based Investments – 5 Years CAGR

In the previous post, I analyzed returns on investments based on 200DMA and how such investments performed over 3 year periods. This post is an extension of the thought with only change being the increase in evaluation period from 3 years to 5 years.
Just to remind everyone, 200DMA is calculated by taking the arithmetic mean of all values in consideration (Stock prices, index levels) in last 200 trading sessions (40 weeks). Before going forward, I would recommend that you get a basic understanding of how to calculate 200 Day Moving Average & how to calculate CAGR
You can easily find data for last 20 years on NSE’s or BSE’s website. Similar to that in previous post, a comparison of 5 years compounded annual growth rate (5Y-CAGR) was made against the index’s distance from 200DMA.
200 Day Moving Average Returns 5 Year
Correlation | Investing based on 200DMA & 5 Year Returns (CAGR)
The blue portion indicates index’s level (+/-) from its 200DMA. For example, in region marked P, index was trading at levels 20% lower than its 200DMA.
The red portion indicates returns over a 5 year period on CAGR basis.
A few interesting results that can be seen from the graph are –
  • 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.
Possible Deduction: Chances of your investments earning a positive return are more if you invest at times when index is trading at a discount of 20% or more to its 200DMA.

  • 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.
This 5-Year analysis and a similar 3 year analysis done previously reveal that if an investor is ready to invest in markets trading at large discounts to their 200DMAs, probability of earning positive returns over long terms is quite high.

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.

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200 Day Moving Averages Based Investments – 3 Year CAGR

200 Day Moving Average (or 200DMA) is a popular ‘weapon’ found in every technical analyst’s or a trader’s toolbox. And surprisingly, it is one of the very few technical analysis tools that are easily understood by those who don’t respect technical analysis, i.e. even a fundamental analyst understands the importance of 200DMA


How To Calculate 200DMA

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

To find out whether there is a correlation between Investing based on 200DMA and returns obtained over a period of 3 years, I analysed Nifty’s data of last 20 years.

A comparison between 3 year CAGR and index’s distance from its 200DMA was made.

200 Day Moving Average 3 Year Returns
Correlation | Investing based on 200DMA & 3 Year Returns (CAGR)
The red portion indicates index’s level (+/-) from its 200DMA. For example, in region marked P, index was trading at level which was 20% lower than its 200DMA. The green portion indicates returns over a 3 year period on CAGR basis.

A few observations from above graph are –
  • 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.
Possible Reason: Chances of your investments earning a negative return are more if you invest at times when index is trading at a premium of 20% or more to its 200DMA.
  • 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.
Possible Reason: Chances of your investments earning a positive return are more if you invest at times when index is trading at a discount of 20% or more to its 200DMA.
  • 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.
This small but interesting analysis shows that though 200DMA is generally used by traders, it can be a handy tool in hands of a long term investor as well. On broad levels, it actually helps investors understand the general direction of overall markets. 

It is therefore advisable that one should always have a look at a stock’s 200DMA before investing in it.

You can read a similar analysis where 5 year returns were investigated for having a correlation with investments based on moving averages.

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