Nifty drops below 11000, what to do now?

Thank God, July has ended. We have just gone through the worst July in the Indian stocks markets in the past 17 years! This chart (courtesy Mint) conveys the extent of the carnage on Dalal Street in July.

The selling in the month of July was led primarily by Foreign Institutional Investors who were spooked by the budget proposal to increase the Income tax surcharge for the super rich. This was compounded by sluggish earnings for the June quarter suggesting a serious slowdown in the Indian economy. Notwithstanding the Indian Government’s target to achieve $5tn economy by 2024 there were very few investors who were willing to bet on the Indian stock markets in July. The simmering NBFC crisis and accusations of tax terrorism only worsened the situation. In short, we have moved from a situation of joy and ecstasy in May 2019 after the Modi victory to that of gloom and doom in July – in just two short months.

As an observer of the stock markets I have noticed a more disturbing trend in the past 12 to 18 months – specifically, the Nifty is no longer giving a true picture of the performance of the broader market. In other words, the broader market is significantly underperforming the Nifty over the past 12 to 18 months. In order to confirm this hunch I used the icTracker database and computed the returns of each stock over the past 12 months (including dividends, bonus, etc). I then grouped the returns in bands of 10% ranges and counted the numbers of stocks in each range. I did this for two sets – the Nifty and for all the stocks in the database. I then calculated the count as a percentage of the overall stocks in each set and plotted the results as line charts as shown in the chart below.

Here are my observations of this chart

• The line chart for the ‘Nifty’ is significantly shifted to the right of the line chart for ‘All’ stocks. This shift gives a visual picture of how much the Nifty stocks have outperformed the broader market
• I have put colored areas in the graph to make my point more clearly
• Green – Non Nifty Stocks that have outperformed the Nifty
• Yellow – Nifty stocks that have outperformed the broader market
• Red – Non Nifty stocks that have significantly underperformed the Nifty
• We can see that the size of the green area is significantly less than the combined Yellow and Red areas. This shows how much the Nifty has become disconnected with the broader market in the past 12 months alone.
• Consequent to my study above, I can safely conclude that in the past 12 months investors would find greater underperformance of their stock and Mutual Fund portfolios when compared to the Nifty as a benchmark

What to Do?
Steep market corrections instill a sense of fear no doubt, but also create an opportunity for investing more at lower levels. The right thing to do in such difficult times is to stick to the process – which in simple words means continue to invest as per your own risk profile. While doing this do keep in mind that the Nifty is no longer an indicator of the broader market. In any case the chart above shows that nearly 60% of the Nifty stocks gave negative returns in the past one year. Talk to your investment adviser so that he/she can choose fundamentally good stocks for your portfolio, whether from the Nifty or from outside the Nifty. If you can invest more at this time, you should. If not, just sit tight.

Value v/s Growth Investing

In the business world, the rearview mirror is always clearer than the windshield.

Warren Buffett

Successful stock market investors are often bracketed in one of two categories depending on their investment style i.e. Value Investor or Growth Investor. Both these styles can generate handsome returns for investors, yet they take diametrically different approaches to stock picking. Knowing the difference between these two styles is important in building an investment strategy and a diversified portfolio. So let us first understand the key differences between these two highly popular styles of investing, which I have tabulated below for ease of understanding

	Value	Growth
Focus	Distressed companies	Companies with growth potential
Type of Company	Well established	Young
Approach	Buy low, sell high	Buy high, sell higher
Timeframe	Long-term	Short-term
P/E ratio	Low	High
Investing basis	Ratio of current share price to intrinsic value	Inter-firm and industry-firm comparisons
Risks	Wrongly assessed value	Wrongly projected earnings
Tendency to outperform	During high GDP Growth and high inflation periods	During low GDP Growth and low inflation periods
Entry pricing	Undervalued	Fair to overvalued
Volatility	Less volatile than the broader market	More volatile than the broader market

Value investing is about finding diamonds in the rough. Value investors seek to invest in businesses that are trading at a price much lower than their intrinsic value. Hence such shares are available at a bargain. They bet that markets will discover the correct value of such shares over a period of time and the price will rise. The businesses underlying such stocks are established businesses with strong cash flows and a history of consistent dividend payouts. Hence even when the price of such stocks is not appreciating much, dividend distribution may still satisfy investor’s return appetite for a while. Such stocks can become undervalued for many reasons, such as if a promoter of the company is involved in a personal scandal or if the company is caught doing something unethical. Stocks markets generally punish the occurrence of such incidents by pushing down the stock price steeply. At this point value investors step in, betting that such incidents will soon fade from public memory and the stock price will be restored to its original value. Legends of investing including Benjamin Graham and his disciple Warren Buffett, have long championed the cause of value investing

Growth investors on the other hand seek to find stocks that have the potential to outperform either the overall markets or a specific sub-segment of the market for a period of time. Growth stocks are associated with high-quality businesses whose earnings are expected to continue growing at an above-average rate relative to the market. Such stocks are generally costlier compared to their intrinsic value, but investor expectations of continued growth keeps pushing their price even higher. Such businesses often re-invest their earnings into their own growth and hence do not generally pay dividends. Investors therefore look for capital appreciation in such stocks as the only means to justify their investing decision.

Which style is better?
The answer to this question depends on the investor’s own risk profile, investing time horizon and current state of the economy. Conservative to low risk investors will prefer value stocks over growth stocks. Passive investors with a long time horizon will also prefer value stocks over growth stocks. If the economy is growing steadily then value stocks may do better than growth stocks. On the contrary, investors with moderate to high risk profile will find resonance with growth stocks. Active investors with a short to medium term time horizon will find growth stocks attractive. Finally growth stocks will certainly find more favor with investors when the economic growth itself is low.

What to Do?
First of all assess and understand your own risk profile. This will give you a good idea of how you should be investing the stock markets. Secondly assess the current economic climate on just two parameters – GDP growth rate and inflation rate. This will tell you what type of stocks to invest in. As you do this keep in mind that it is difficult to determine exactly when economic shifts will occur. Therefore if you want to err on the side of profits, you should combine elements of both value and growth investing with occasional rebalancing of your portfolio. This approach will allow you to benefit from each strategy regardless of the prevailing economic climate. This is also the approach that we follow when we pick stocks for our Client’s portfolio using our icAdvisor service. Do browse the stocks from the icTracker database that are used for delivering this service and feel free to revert with queries, if any.

2017 - Letter to Clients

2017 has been a good year for Indian long term investors. The Nifty started the year at 8179 and ended it at 10,531, recording an impressive annual gain of 28.8% in the process. Equity remained the preferred asset class for investors this year, partly due to the continuing subdued mood in the real estate and bullion markets. 2017 has also been an impressive year for me and for all our Clients at Attainix Consulting. The average annual return of client portfolios under our advice clocked in at 53.6% this year. This is almost twice as much as the benchmark itself and is admirable by any yardstick. More importantly, all our client advised portfolios beat the benchmark Nifty by a significant margin. This is a matter of immense satisfaction for me, because it implies that our stock picking methodology generated healthy alpha (excess return above and beyond the benchmark) for the benefit of all our Clients, justifying our advisory fees! Further, it endorses our investment thesis that businesses with high degree of knowledge assets will always outperform the competition and continue to find favor with investors. The fact that we are the first and only firm that has quantified this investment thesis into programming logic that enables us to pick stocks free of human bias, only gives us an added edge!.

Which begs the question - what is the basis for our investment thesis anyway? Why do we believe in businesses with high Knowledge assets? And what are Knowledge assets? Why do businesses with high degree of Knowledge assets

have a competitive advantage in the marketplace? We will have to go back in time to answer these questions. Take a look at the graphic alongside. It shows that for the longest time in our history and until the turn of the last century agriculture was the main source of income for a majority of the population. Scale was achieved during this era simply by expanding into additional land. But land is a limited commodity and businesses had to find a way to get more from the land under their control. The invention of the steam engine and electricity enabled this need, ushering in the Industrial era. This era led to the creation of scale enabling businesses that achieved scale simply by replacing human and animal labor with machines. In this era the focus shifted from the production of agricultural produce to industrial products. This era lasted for the next 150 years or so which is when the Information era kicked in, with the invention of the computer. Just as machines in the Industrial era fastened the production of goods, computers in the Information era hastened the processing of Information. Thus in this era the focus shifted from the production of industrial goods to the processing of Information. Those businesses that could process Information quickly, efficiently and continuously were able to convert this information into Knowledge. And Knowledge is Power. This Knowledge gave such businesses a leg up over their rivals. It also gave them pricing power and enhanced their profitability beyond bounds. But it also attracted competitors who tried to replicate this process. Businesses that are able to encapsulate and institutionalize their information processing and knowledge generation process and shield it from their competitors have effectively developed an asset, which we classify as a Knowledge asset. Knowledge assets are intangible in nature – they are formed from a fluid combination of human knowledge and skills, business processes, databases, brands and supplier/customer relationships. Such is their beauty that Knowledge assets are hard to develop, maintain and replicate, but their impact is eminently visible and measurable! 

Having understood the nature of Knowledge assets, the only question left now is how do we discover such assets? That is where our icTracker software comes in – it calculates and reports the Knowledge assets (a.k.a. Intellectual Capital) of leading Indian and US businesses continuously. It provides us the basis for our simple three step stock picking process which, although described on our website, is worth repeating here.

STEP 1 – EVA check: We start by first checking whether the business is generating more money than its cost of capital. This is done by calculating the EVA (Economic Value Added) of the business. Ideally, we want to select businesses that have a positive EVA. The rationale for this check is that if the business is not able to generate at the least even its cost of capital, then it is actually eroding shareholder value. Alternately, if the business is generating more than its cost of capital, it will be in a position to fund its future expansion from internal resources, which will further decrease its cost of capital. Note that, this check will eliminate startup and fledgling businesses by design. It does not mean that such businesses are not good investments. It only means that these businesses have to prove their business model before they can be considered worthy of investing for retail investors.

STEP 2 – Knowledge assets check: This is the asset quality test. Here, we check whether the business is generating profits from traditional assets (such as land, building, machinery, cash) or from Knowledge assets. We look for businesses that have at least 50% of their total assets in the form of Knowledge assets. The rationale for this check is our belief that businesses that are generating profits from traditional assets will come under competitive pressure sooner or later, simply because such assets are not defensible. Anyone with sufficient cash can buy land and machinery. Knowledge assets on the other hand take years to build and develop and once in place, they provide sustainable competitive advantage to the business. In other words, such businesses develop a moat, which is difficult to surmount.

STEP 3 – Affordability check: In the above two steps, we have shortlisted businesses that are generating value through the use of Knowledge assets. As investors, these are highly desirable businesses because in all probability they will continue to generate sustainable profits for years to come. All that remains to do now is to find whether the stock underlying the business is affordable. For that we compare the market value of the stock to the intrinsic value of the business. Those stocks that have a low ratio of market value to intrinsic value are the ones that have not yet been recognized by the stock markets and hence worthy of our attention as investors.

This simple three step stock pricking process has not only proved its mettle during our back-testing but also provided above-benchmark returns to real Clients. Our icAdvisor service uses this exact stock picking process. In addition, when designing Client portfolios using the icAdvisor service we strive to reduce risk for our Clients by the following three actions: 

• Taking risk profile of the Client into consideration. This ensures that the stocks that we recommend match the risk taking ability of our Client. For instance, a Client who has low risk appetite and interested primarily in capital preservation will benefit from investing in established mature businesses that have a high dividend yield than from investing in emerging smaller sized businesses, which are considerably riskier.
• Selecting stocks from different sectors. This ensures that we do not put all our eggs in one basket. Rather, we divest the portfolio into multiple sectors, picking no more than one or two stocks from each sector. Sectoral impact on the portfolio, if any, is thus limited to the specific stock.
• Striving to build a perfectly diversified portfolio. All our Client portfolios are designed at the efficient frontier – it means that the quantum of each stock in the portfolio is such that it has minimum correlation with any other stock in the portfolio. This gives each stock the chance to perform independently of each other in the portfolio.

Despite all the above steps, sometimes one or two stocks in the portfolio fail to perform due to the vagaries of the market. This is the reason why we provide a free rebalance option in our icAdvisor service. Many of our Clients opted for the free rebalance this year and saw the benefit of doing so. Others chose to skip it because of satisfactory performance of their portfolios. Remember, even though the rebalance is free from our side, there is still a cost that you have to incur in terms of brokerage fees, transaction fees and government taxes.

In passing, I want to take this opportunity to thank you for putting your faith in our investment thesis and in our icAdvisor service for generating above average returns for your hard earned money. Your continued trust makes us stay committed to the vision encapsulated in our tagline – ‘Growth through Knowledge’. I believe that we can grow only when you see value in our service and growth in your own portfolios. I am available to address client queries at all times and am approachable via email or whatsapp. I am also open to feedback and suggestions and welcome you to provide the same. I also hope that if you have benefitted from our service, you will spread the word to your own friends, family and colleagues and have them share the benefit as well. 

Finally, let me wish you and your family a very happy and prosperous Happy New Year and hope that the relationship that we have built this year will continue to grow for many years to come!

Abhijit Talukdar
Founder, Attainix Consulting
SEBI Registered Investment Adviser

Invest in Stocks as per your risk profile

Risk comes from not knowing what you are doing.

Warren Buffet

Investing in the stock markets requires a study of stocks no doubt, but more importantly it requires an understanding of your own self – your expectations and objectives for investing in stock markets in the first place. Stock market investments are inherently risky and therefore the first thing to do is to understand your own attitude towards risk. Some questions that you need to ask yourself in this regard are:

• Your investment objectives – Capital preservation, Regular Income, Capital Appreciation, or a combination of these.
• The amount of time you are willing to stay invested in the markets and forget about the invested money
• Your inclination to learn more about the underlying business, the competition, the economic environment, etc.
• The frequency with which you tend to follow your stock investments – by the hour, daily, weekly, etc.
• Your mental make-up in the face of a steep market correction – ranging from sell and get out asap to buy more since stocks are much cheaper now

A professional investment adviser can understand your risk profile using a standard multi-choice questionnaire within minutes. This can range from conservative to balanced to very aggressive. At Attainix Consulting we use a five step risk profile classification and use that to advise Clients about the right stocks for their portfolio. This is not only in the best interest of the Client himself but it is also mandated by SEBI as the standard approach to be followed by all SEBI Registered Investment Advisers. This approach aligns the client’s expectations and investments objectives with his stock portfolio and thus minimizes the chances of future discontent.

Managing the risk of investing in stock markets has many elements, but the first step is to know your own attitude towards risk. As Warren Buffet likes to put it – Risk comes from NOT knowing what you are doing.