Relativity

Einstien's famous theory of relativity states that "Measurements of various quantities are relative to the velocity of observers." Even though the theory is related to the field of physics, it is extremely relevant to the stock markets. The satisfaction and sense of achievement that a market participant derives from performance of his portfolio is relative to the performance of portfolios of other market participants. To a general investor, it does not matter whether he has done well in absolute terms, what matters more is how others have performed.

Sample this- last year my portfolio was up 110%  and I was so gung ho about it. I wrote this rather boastful article here. This year my portfolio returns have surpassed last years' returns in 8 months. But, I am not that excited this year. The reason being, last year I was not coming across people whose portfolios have done better than mine. This year every serious investor is claiming returns in triple digits. Even some of the mutual funds have given that kind of return.

Is 110% a bad return for 8 months? Of course not. Anyone should be extremely happy with that kind of performance. But then why I still believe that I have not done as well as I wanted to. I understand that there is theory of relativity that applies to stock markets as well. But that is just one part of the puzzle. The other part is even more interesting. Many stocks which were rejected as investment candidates by me are up by 300 to 400% YTD. I keep thinking that it was possible to construct a concentrated portfolio of following stocks to improve my performance by at least another 100%.

Stock	YTD Performance
Avanti Feeds	459.01%
Kitex Garments	309.92%
Granules India	307.51%
Symphony	227.64%
Shakti Pumps	218.62%
RS Software	211.86%
Acrysil India	204.88%

One would think that these stocks are picked on the basis of  "survivorship bias". But the truth is that I have considered all these stocks at some point of time in last one year and rejected all of them except RS Software for investment. These are very popular stocks among small investors and they exist in many portfolios. Actually, one can argue that these stocks were ignored because of "ownership bias" of existing stocks. Performance of "Ajanta Pharma" - up 70% for the year and "PI Industries"- up 80% for the year pales in comparison to these stocks. A "HCL Technologies" which is up by 35% for the year appears like an absolute dud.

Is this situation telling me something about the market conditions and an imminent market crash? I still believe that a significant market crash is far off as current PE of Sensex is only 18. Markets don't crash considerably from 18 PE. The other interesting fact is the growth of EPS of Sensex, which is more than 20% y-o-y for last 2 quarters. This is exactly what happened in 2003. The only difference being the Sensex PE, which was 11 then. Considering both these facts, it appears that a serious crash is far away.

If markets are not poised for a serious crash then the above discussion points me to a lacunae in my stock picking process. There are two clues about what can be improved. If one looks closely at the stocks mentioned above, all the stocks except for Symphony were trading at a single digit PE on trailing basis at the start of the year. Symphony itself was growing its profits by more than 200% per annum. These are probably two lead points that need to be kept in mind while selecting next set of stocks. If a stock matches these criteria, then it can be provided some leeway on management and business quality or on valuation front. That seems to be the only way to perform relatively better. Of course, one should not give so much leeway on quality front that instead of relative out performance one gets relative under performance. After all "Ati Sarvatr Varjayet".

Template for analyzing a stock story

There are many ways to analyze a stock story. But, at the core, one needs to pay attention to the following.

• Business model
• Sources and Quality of growth
• Risk/Bear Case
• Management
• Profitability 
• Financial Health 
• Valuation
• Moat
• Opportunity Size
  

Some of these are subjective, while others are more objective and they can be derived easily from financial statements. In any case, one needs to go through annual reports of many years to get these details right.  One should also be aware of the various happenings in the company and keep a track of all the news available about the company. One important aspect is not to miss any of these details while analyzing the stock story. For that, one needs to keep a template and try to fill it for every business that one is analyzing. The template listed below is the one that I use. It has been created based on Pat Dorsey's "The Five Rules for successful stock investing".

What does the company do aka Business

Sources of Growth

• Selling more goods or services?
• Raising prices?
• Selling new goods or services?
• Buying another company? 

Quality Of Growth 

• Is there a big difference between growth rate of net income, operating income and cash flow from operations? 
• What is the tax Rate? Has it changed recently? Why has it changed? 
• Are there one time gains? 
• What is the equity Dilution over a period of time?   

The Bear Case

• List all the potential negatives
• What could go wrong with my investment thesis?
• Why will someone sell this company?

Management 

• Does the management have a reputation of cheating minority shareholders?
•  Does the management have a political connection or involved in political deal making?
• Is management conservative in its guidance and projection or over aggressive?
• Has management been candid in telling about impending slowdown earlier? 
• How is management compensation relative to company profit? 
• Were executives given loans that were subsequently forgiven?
• Does the company rank and file get the stock options or it is given only to top management?
• What percent of company's equity is given as stock option every year?
• What percentage and kind of transactions are related party transactions?
• What is the attrition rate in the company?

Profitability

• ROE
• Free Cash Flow = Cash From Operations-Capital Expenditure

Financial Health

• D/E Ratio 
• Number of years of Net Profit(FCF) needed to pay off complete debt

Moat

• Does the company have superior technology or provides better features?
• Does the company have a trusted brand?
• Does the company run its operation far better than others(superior process)?  
• Does the company have locked in customers?
• Can the company lock out competitors by creating creating high entry barriers?
• How long will the moat last? Short, Long, Very Long?
• Does the industry generally have companies with high ROE or is the company unique? If industry itself has high ROE, Moat is more sustainable.

Valuation

• P/E
• PEG
• P/B
• P/S
• IV

Opportunity Size

• What is the overall size of opportunity? How long the company can continue growing with high rate?

What To Buy From "Common Stocks And Uncommon Profits"

"Common Stocks And Uncommon Profits" remains one of the best books ever written on stock market investing. It has a very important chapter on what stocks to buy. Ideas mentioned there would add to the arsenal of any serious investor. One can also add these to the investing checklist to make better choices in future. Below is a short summary for future reference:

a. Size of Opportunity - Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years? E.g., Large number of Indian homes do not have toilets. As the economic status of people improve, they will install more and more toilets at home. That represents a huge size of opportunity for a company like Cera Sanitaryware.

b. Innovation/Related Products - Does the management have a determination to continue to develop products or processes that will still further increase total sales potential when the growth potentials of currently attractive product lines have largely been exploited. E.g. Cera Sanitaryware is trying to enter related areas like Faucet ware, Mirrors, Tiles and Air Fresheners. If any of these areas click, they can substantially increase their sale.

c. Effectiveness of R&D - How effective are the company's research and development efforts in relation to its size? Ajanta Pharma is the best example of such effectiveness. Company puts a lot of money on research and the kind of products it is producing is helping them grow their businesses tremendously.

d. Sales Strength - Does the company have an above-average sales organization? This should be directly visible in the kind of sale growth the company is showing.

e. Profit Margin - Does the company have a worthwhile profit margin? this data can directly be tracked from profit and loss account.

f. Profit Margin Improvement - What is the company doing to maintain or improve profit margins? This can be traced by looking at profit and loss account for several years.

g. Labor Relations - Does the company have outstanding labor and personnel relations? New tools like glassdoor may help us in extracting this information.

h. Executive Relations - Does the company have outstanding executive relations? Glassdoor should help us in getting this information.

I. Depth of Management - Does the company have depth to its management?

J. Accounting Standard - How good are the company's cost analysis and accounting controls?

k. Leadership Position - Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

l. Long range outlook on profit - Does the company have a short range or long-range outlook in regards to profits?

m. Equity Dilution - In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders' benefit from this anticipated growth?

n. Candidness of Management - Does the management talk freely to investors about its affairs when things are going well but "calm up" when troubles and disappointments occur?

o. Candidness of Management - Does the company have a management of unquestionable integrity?

Himmat-e-Marda Toh Madad-e-Khuda

"Fortune favors the brave" is a popular saying. This proverb describes my stock market performance for the last year very aptly (though I prefer more rustic and local "Himmat-e-Marda toh Madad-e-Khuda"). After almost 10 years of active stock market investing, this year turned out to be the most fruitful for my investing career not only in terms of the percentage returns but also in terms of the absolute performance. I don't know any investor that have come close to my performance for the year. This year, I achieved returns in triple digits(110%).  It is important to note that these returns have come at a time when 110% of my net worth was invested in the markets. The importance of the last line increases in view of  an interesting tweet by venerable Samir Arora.

Interestingly, this tweet came exactly a day after I disclosed my portfolio performance on one of the equity forums while responding to a query. Is this too much of a co-incidence or the online equity world is really too small :). Anyways, we need to get back to the contributors of such a performance which is more important.

The biggest contributor to this performance has been the lesser number of mistakes made during the year. Actually, only one trade was a loss making trade this calendar year. AmaraRaja was purchased around 296-297 in Jan this year and it was sold around 260-270 in the march, causing a loss of close to 10-12%. The reason for selling at a loss was more pledging by the owners. I still don't consider selling this stock as a bad decision even though the share has bounced back to 325 levels. Staying with the stock would have given me a 20% return from the march time till now, but the opportunity cost would have been higher as my other picks have done much better.

Now with the bad news out of the window, let us discuss some brilliant decisions, which in hindsight appear almost divine.(P.S.- I was told by a friend that 2013 was my year because my birthday is on 13th).

a. Ajanta Pharma was suffering from taxation related issues at the start of the year. Most of the investors shunned the counter after receiving this news. My decision to stick with this scrip proved almost divine as the share went up by 250%  this year.

b. I was bullish on Bajaj Corp and have been buying this share from August 2012. I started buying this share from 165 levels and kept on buying till Feb 2013 when the price was almost 247. Towards the end of May 2013, the stock touched 275 levels for the first time and I sold all of the Bajaj Corp at that level. The decision hit the bulls eye as the stock never crossed that level and is trading currently at 214.

c. Last quarter Cera Sanitryware did not post good quarterly results. Its bottom line was almost flat. Many investors sold their shares seeing the results. I stuck with my position and Cera jumped from 550 to 700 in a quarter. Not a bad outcome for sticking with a company with bad results. Now, everybody and their cook are recommending this share.

d. My call on the Rupee that it will not fall below 65 turned out to be extremely correct (Please read the old blog for the thought process and analysis of the same here). From the stock market perspective, I switched from HCL Tech(exporter) to Astral(Importer) based on that call. Astral is up by 40% since then compared to a 20-25% jump in HCL Tech. Recently, I made a reentry into HCL Tech based on the better fortunes of USA and European economies and hoping to make money in that counter as well.

e. My firm belief on improvement in rural economy despite huge media outcry of sinking Indian economy fetched huge dividends with Kaveri Seeds up almost 40% and PI Industries up almost 90% for the year.

f. Some brilliant decisions were taken at the start of the calendar year 2013 to sell RS Software, Zensar Tech and PC Jwellers at a huge profit. These companies have struggled through out the year at best. RS Software has recovered itself to come closer to my sell price of 175 after an years' hiatus. PC Jwellers is in dumps and is trading at less than half of the price at which I sold it around a year back. The only decent performer is Zensar Tech which is trading 40% higher than my sell price. But most of the gains in this counter has been achieved in the last quarter only. This company has almost doubled in the last quarter and looks like a lot of froth is built into the price.

Now that this stupendous year is over, hoping to do good in current year as well. The ground is still fertile, but the terrain is becoming difficult with most of the under priced opportunities getting recognized by the market. These are the times when people tend to make stupid decisions and all the good performance of last year gets lost. Let us see how much I have learnt from my previous mistakes and can I avoid becoming dud this year after such a good run.

Happy New Year !!!

Disclaimer:
a. Above discussion is not an invitation to invest in the stocks mentioned.
b. One needs to put a lot of effort and energy to get buy/sell decisions right. Please do your own due diligence before making any investment decisions.
c. I sleep, eat, drink and watch only stock markets and hence I can exit or enter any stock in a jiffy and I may not inform anyone about my decisions before or after the trade.
d. The stocks mentioned above are small caps and they represent a minefield to navigate for any passive investor.

Quotes

There are only two mistakes one can make along the road to truth; not going all the way, and not starting.

- Gautam Buddha

You miss 100% of the shots you don't take

- Wayne Gretzky

The reasonable man adapts himself to the conditions that surround him. The unreasonable man adapts surrounding conditions to himself. All progress depends on the unreasonable man.

- George Bernard Shaw

Until one is committed there is hesitancy,

a chance to draw back, always ineffectiveness.

Concerning all acts of initiative and creation,

there is one elementary truth,

the ignorance of which

kills countless dreams and splendid plans.

That the moment one definitely commits oneself,

then providence moves too.

- Goethe

Talent develops itself in solitude; character in the 

stream of life

- Goethe

Consistency is the virtue of mules. 

- Amish Trivedi

Rupee, where to?

A news item caught my attention recently, which seem to have escaped all the mainstream media. It appears that last quarter, India might have turned into a current account surplus country from a current account deficit country. The biggest reason for Rupee's fall in recent times has been the huge current account deficit, which was threatening to go close to 5% of GDP. From there, moving to current account surplus will be quite a feat, which India seems to have achieved.

To start with, let us look at trade deficit numbers for various months of last quarter.

Sep 2013 - 6.7 billion USD

Aug 2013 - 10.9 billion USD

Jul 2013 - 12.27 billion USD

Total trade deficit for the quarter ~ 30 billion USD

Indian services have always been surplus in the range of 5-6 billion USD on a monthly basis. That gives us approximately 15-18 billion dollars from services export for the quarter. If we reduce this number, we get a deficit of about 12-15 billion USD.

India is the largest recipient of inward remittances. Indians staying abroad sent approx. 70 billion dollars to the home country last year. That gives us a rate of almost 17-18 billion USD quarterly. If we add that number to the deficit of 12-15 billion USD, we get a net positive number. So, looks like India has finally turned into a current account surplus country. The exports have also grown by double digits in percentage terms for all the three months. If this is sustained, the days of Rupee depreciation are over.

Corrigendum: The calculation above does not take into account outward remittances. Outward remittances are almost to the tune of 35-36 billion USD per annum. So, net inward remittances are approx. 36 billion USD p.a. or 3 billion USD p.m.. So, from the services export and net inward remittances, we get an amount of approximately 8.5 billion USD per month. That will give us a quarterly income of around 25 billion USD. That still leaves us with an current account deficit, but with a much smaller number of 5 billion USD. Even if this rate is retained for next 2 quarters, our current account deficit for the year will be less than 40 billion USD, out of which 20 billion will be done in the 1st quarter. and remaining 15-20 coming in the last 3 quarters. 40 billion USD is just 2% of Indian GDP of 2 Trillion, which is a far better number compared to the 5% that we had. And if the same rate continues in the next year, our current account deficit should be less than 20 billion USD or less than 1% of the GDP .

Rail Gaadi Rail Gaadi, Chhuk Chhuk Karti Rail Gaadi

Yesterday, I was discussing the status of railways in India and other countries with my friends. Apparently, European countries are way ahead in the cleanliness and beauty of railways. India is also chugging along and making some interesting changes in its railways. Here are some of the interesting things worth noting.

Shatabdi Trains

Shatabdi trains have much nicer looking coaches. They also have television sets in each coach(two of them for people sitting in opposite directions). Newspaper, dinner, breakfast and snacks are provided in the train, making it feel more like an airplane. These trains also run between metros (mostly just two stations) only, so people can't get inside the coaches anywhere. E.g., a Shatabdi starting from Bangalore stops directly in Chennai and nowhere else in between.

Double Decker
The thought of trains between Bangalore and Chennai reminded me of double-decker trains. It is a new experiment done to carry more passengers in the same number of coaches. I think a coach contained more than 120 passengers in a nice comfortable sitting position. Here is how they look from outside and inside.

Bio-Toilets
The ugliest thing about the Indian railways is the filth on the tracks that gets deposited through old age Hooper style toilets. This aspect of cleanliness is being addressed using bio-toilets. Bio-toilets emit only water on the tracks thus keeping the stations and railway lines clean. As of now, only 1400 coaches have been fitted with Bio-toilets, which would represent almost 1% of all the running coaches, but it is a step in the right direction and may enhance cleanliness substantially going forward if implemented in all the coaches. Here is one economic times article describing their current status.

Railways adds more bio-toilets

Freight corridors
In one of the letters to his shareholders, Warren Buffet talked about his huge investment in BNSF(Burlington Northern Santa Fe), one of the largest rail networks in the USA, and said that Rail transport is at least five times more fuel efficient than road transport. On top of that, rail freight can be carried on electricity, which is not possible with Road Transport. As electricity can be produced using different types of raw materials (Coal, Hydro, Wind, Solar, Nuclear etc.), one need not use Diesel or its derivative. Thus more usage of Rail Freight can save a lot of foreign exchange for a country like India, which has to import most of its petroleum requirements. Also, rail transport carried on electricity is much more environmentally friendly compared to the freight carried on the roads. Sadly, for last many years, India moved in the wrong direction. The percentage of freight carried by Road has gone up from 35% to 65% in last 30-35 years, while the freight carried by Rail has gone down from 65% to 30%. Slow movement of freight on rail tracks and pilferage of the transported goods is the main reasons behind this decline. As India needs to carry more and more passengers on its existing rail network, the time available for freight movement is going down substantially, thus causing delays in Rail freight movement, and making it commercially unviable for businesses. To solve this problem, Indian Railways have started implementing dedicated freight corridors for freight movement. The corridors are built roughly on the lines of Golden Quadrilateral and North-East South-West corridor put together. Essentially, there will be 6 corridors running like the following.

a. Mumbai (JNPT)- Delhi (Khurja,Dadri)
b. Ludhiana (Passing via Delhi/Khurja/Dadri)-Dankuni (Near Kolkata)
c. Kolkata- Chennai
d. Chennai-Mumbai
e. Kolkata-Mumbai
f. Delhi-Chennai

First four corridors represent the sides of the quadrilateral, while the last two are diagonals. Out of these six, first two are in some stages of implementation, while last 4 are still on paper and studies are being conducted on them. For the first two, a two-line specially dedicated freight corridor will be created in roughly 3300 km long route. Financing for both these have been secured(Japan as well as the World Bank), Land acquisition has been done for quite a large section and contracts have been awarded to players to build these. Good part is that the players who have got these awards are not Ambani types and may finish the project on time. Roughly one third of contract work has already been awarded for around 1000 Kms. Here is the link to the announcement.

Contract awarded for Freight Corridor

Jammu Udhampur Srinagar Baramulla Railway Link
Even though we keep talking about Kashmir to Kanyakumari and has even a hit song by that name, the Indian Railways do not connect Kashmir to Kanyakumari. The trains from the rest of the India could only go up to Jammu Tavi. A large project to connect Jammu Tavi to Srinagar and extending that link to Baramulla has been taken up. This involves various technical challenges like building World's highest railway structure (higher than the tip of the Eiffel tower) and making third largest tunnel in the Asia and so on. The work on this stretch is in Progress. Whenever it gets completed, it will be a marvel worth seeing. It also has high strategic importance as it will allow us to later connect Kargil/ Leh/ Laddakh with the railway line, thus providing us some equality with China, which has a railway link very close to the border. Please read more about this line at the following Wikipedia link.

Kashmir Railway

Railway lines of Strategic importance

Recently India announced a very ambitious plan to connect both Leh/Laddakh as well as the Arunachal / Tawang side of the Indian border with Railway line. Once completed, these will be both a strategic asset as well as tourist destinations of the country. But given the delays that we see in such initiatives, this may take quite some time. Read more about these in this article.

Indian Railway along the borders


Edit : 24th Jan 2014
While I was writing on the progresses made by Indian Railways, a new move was made by Railway ministry. They have constituted a new body to study and implement bullet trains across India. As this is currently at pre-feasibility study stage, there is not much talk about it, but it looks like Mumbai-Ahmadabad, Delhi-Amritsar, Delhi- Jaipur and Chennai-Bangalore routes are under consideration. The biggest problem will be financial viability as travelling by the train may cost more than airplane. Following are the two links about this project, with second one having more details.

http://www.hindustantimes.com/india-news/plans-to-run-bullet-trains--re-activated/article1-1140942.aspx
http://onrails.in/content/proposed-bullet-trainhigh-speed-rail-network-india.html