Tuesday, May 1, 2018

Just Looking at the Price is Not Investing - Warren Buffett

I present this article as a commentary on Warren Buffett's interview for CNBC TV titled, "Just Looking at the Price is Not Investing". I have also presented the embedded version of the video on YouTube.



Volatility and Fear in the Stock Markets

Buffett says that if you own an apartment you don't get price quotes every day or week. Suppose you bought an apartment at $20,000 and someone approaches you to buy it, you will not be tempted to sell it at $50,000. Similarly, you will not be worried too much if the price offered is $15,000. This because your apartment is your long-term investment. Therefore he asks you to take a close look at the business when you make an investment.

According to Buffett, the most important factor to you should consider while investing in a stock is the cash it is going to generate from today until judgement day (perpetuity). He adds that this cash flow is not going to change ten percent in two months time. (What Buffett did not say specifically in this interview is that if this cash flow is more than the cost of the investment (price of the stock) you should buy it).

Buffett says, continuing the conversation that anything can happen in the markets. In fact, there is no reason for the markets to remain always, he says. He adds that that is the reason people should not borrow to buy complex instruments (derivatives) that the Wallstreet offers. With these complex instruments, you could lose up to ninety percent of your money in an instant.  Buffett emphasises categorically that these activities amount to gambling and not investing.

Warren Buffett concludes this section of the interview by saying that when you are buying a stock you are buying a piece of the business. Therefore you should look closely at the business. He gives the example of buying a share of McDonald's. He says that when you are looking just at the price of something, you are not investing. Buffett gives the illustration of 'Bitcoin' or any other cryptocurrency you are not looking at an asset that produces anything.

Investing In Pieces of the Business as Against the Whole - Just Looking at the Price is Not Investing

The interviewer observes that Berkshire Hathaway was a net purchaser of stocks of listed companies in the year 2018. She asks whether it is because Warren Buffett could not find deals to buy whole businesses at a reasonable price.

Buffett replies, "You can buy small pieces of business for less than you can buy whole pieces of businesses. He continues, "You get a bargain as an investor compared to what I can get in terms of buying the whole business. Warren Buffett says that if people just think of stocks as pieces of businesses they will much better off than bothering about movements in prices. Buffett is true and it is a revelation for small investors like you and me.

We should understand, appreciate and feel good about buying a few stocks of wonderful companies like Coca-Cola, McDonald's in the US or 'Oil and Natural Gas Corporation' or 'The Great Eastern Shipping Co. Ltd'. When we buy these stocks we are in reality buying a small piece of these wonderful companies.

Just Looking at the Price is Not Investing: Interest Rates

The interviewer moves on to the subject of interest rates next. She says that despite good reports about jobs there is fear that interest rates are going go high. She says that the fear of interest rates firming up has created nervousness. And asks Buffett about his views on the interest rate environment.

Warren Buffet, to her question, elegantly defines the relationship between bonds, interest rates and stocks. He says that bonds have coupons attached to them on which the interest rate is already written. Whereas in the case of stocks the coupon is blank and the investor has to write the return the stocks are likely to provide.

He says that when the 30 years US Government bonds pay 3% per annum and stocks give a 10% return on tangible equity, which US companies always do, clearly the investment decision is in favour of stocks. When the 30 years US Government bond rate, which is the yardstick, exceeds 10% then the equation shifts towards bonds.

When the difference in yield between government bonds and stocks is vast, then the investors' concerns are unfounded.

Just Looking at the Price is Not Investing: Portfolio Mix of Stocks and Bonds

Finally, the interviewer asks Warren Buffett about oft advised portfolio mix of owning bonds and stocks for safety. Buffett replies that some people should not hold stocks at all. He says that some people are emotionally fit to own stocks. He says categorically that many people do dumb things like selling a stock when the price goes down. He points out that if you have bought your apartment for 20,000 dollars, you won't sell it if someone offers 15,000. Buffet emphasises that it is the same with stocks.

He has not answered the interviewers question completely though. Wise investors advise people to hold a certain percentage in bonds. Usually, the proportion of stocks and binds is 50:50. The advise that if the stock markets are depressed to increase the stocks portion to 70% and bonds 30%. When the markets are trading at very high levels the stocks shall be brought down to 30% and bonds shall be increased to 70%. This general advice is not entirely true.

Even when the markets are unreasonably high, you will be able to find a handful of excellent stocks, which are still available at a fair price. You should buy these stocks. It is perfectly all right to not to have a single bond in your portfolio. I have about 50% in fixed deposits with banks today. You may wonder why I don't follow my own advice. The reason for this is that in India the interest rates are quite high. They yield between 7 to 9%. On the contrary, the cash inflows to me as an investor in stocks, by way dividends, in many companies are a poor 2 to 4%. Therefore I own fixed deposits to maintain a healthy stream of passive income in the form of interest.

Conclusion

I conclude by saying that just looking at the price is not investing. When you have already invested in stocks of good companies after thorough research and at a fair value you should not bother about price fluctuations.

Saturday, April 21, 2018

Sunday, April 15, 2018

Stocks I Bought in April 2018


Every month immediately upon receipt of my paycheck I first make investments and then only start meeting expenses. This is the good habit I strictly follow and advise my readers. I also tell my audience the stocks I have invested in for the month. Continuing this tradition I present here the stocks I bought in April 2018. Of course, I analyse the stocks to check whether they are available in the market at a fair price. I make this assessment according to value-investing proved and time-tested principles.

Rules I set While Selecting the Stocks I Bought in April 2018

I have set the following rules such that besides being a member of our ‘Portfolio 2K15’, the stocks shall satisfy the four criteria prescribed below:
  1. The Price to Book Value (P2BV) Ratio shall be less than or equal to 1.50 times. This means we will allocate money to a stock under this rule only to those stocks that are available at a discount to the price to book value ratio of 1.50.
  2. The Price to Earnings (PE) Ratio shall be below 15.
  3. The product or combination of the first two numbers that is PE*P2BV shall be less than 22.50 (1.5*15)
  4. The Dividend Yield shall be more than 4.00%.

The total investable sum is taken as multiples of 20,000, that is Rs.20,000, 40,000 or 120,000 and so on, depending on the investible surplus available to you.

The basic unit of 20,000 is equally distributed among the four criteria at Rs.5,000 each.

The Summary of the Stocks I Bought in April 2018

Stocks I Bought in April 2018: Summary of Stocks Bought

Abbreviations Used:

Abbreviation:
Full Official Name
Formerly Known As
NHPC
NHPC Ltd/
National Hydro Electric Coporation Ltd.
PFC
Power Finance Corporation Ltd.
--
SJVN
SJVN Ltd.
Satluj Jal Vidyut Nigam Limited
NMDC
NMDC Ltd.
National Mineral Development Corporation Limited
NLC
NLC India Ltd.
Neyveli Lignite Corporation Limited
ONGC
Oil and Natural Gas Corporation Ltd.
--
NALCO
National Aluminum Ltd.
--
MOIL
MOIL Ltd.
Manganese Ore ( India) Limted
HZL
Hindustan Zinc Ltd.
--
OIL
Oil India Ltd.
--
GE SHIP
Great Eastern Shipping Company Ltd.
--
VEDANTA
Vedanta Ltd.
--
SCI
Shipping Corporation of India Ltd.
--

All the 14 stocks that figure in our ‘Portfolio 2K15‘ received an allocation under any one of the four criteria. However, As mentioned before I did not buy SCI because the company is still not making adequate profits. Its PE Ratio is very high and the company is not declaring any dividends. The only attraction is that the stock is selling at a hefty discount to its book value.

How the Stocks I Bought in April 2018 Fare under the Four Criteria

Stocks I Bought in April 2018: How the Stocks Fared under the Four Key Selection Criteria

The boxes in red indicate under which criterion the particular stock did not pass the hurdle or failed to qualify. What this means is that the stock did not get any allocation under that particular criterion. It does not mean that the stock was totally rejected. I made an exception to this rule only in the case of SCI. I did not buy the stock even though it earned allocations under two other criteria.

How the Stocks I Bought in April 2018 Fare under the Price to Book Value Ratio?


Stocks I Bought in April 2018: Selection Based on Price to Book Value Ratio Criterion

We can see that only two out of the 14 companies failed to qualify and get allocation under this criterion: NMDC and HZL.

Stocks I Bought in April 2018 Based On Price to Earnings Ratio Criterion

Now, let us examine the stocks under the important price to book value ratio criterion.

Stocks I Bought in April 2018: Stock Selection Based on Price to Earnings Ratio Criterion

PFC, GE Ship and SCI failed to cross the hurdle of a price to earnings ratio number of 15. All others qualified and got an allocation of money for investment.

Stocks I Bought in April 2018: The Combined PE x P2BV Ratios Criterion

The product of the price to earnings and price to book value ratios is also an important criterion. As per value investing principles, this number shall not be more than 22.5 (1.5 * 15). Let us see what stocks pass this test in April 2018.

Stocks I Bought in April 2018: Stock Selection Based on Combined Price to Earnings and Price to Book Value Ratios

Stocks I Bought in April 2018 Based on Dividend Yield Criterion


Stocks I Bought in April 2018: Stock Selection Based on Dividend Yield Crriterion

Five of the 14 stocks could not cross the hurdle. Rest got money allocated. Unfortunately, the laggards under this rule were ONGC, NALCO, MOIL, GE Ship and SCI.

Conclusion

To conclude I bought the first 13 stock appearing in the summary at the beginning of this post (first table image). Even though the table indicates that I bought 15 number of SCI shares, I stopped buying at the last moment while placing the order. I recommend that you may also buy the 13 stocks in the recommended numbers for each 20000 of your investment.
Happy investing!