When to sell your stock?

What others are doing means nothing.

Warren Buffett

As a long term investor in the stock markets, researching stocks and buying the ones that meet your investment criteria is often only half the story. The other half is about knowing when to sell your stocks, book your profits (or losses) and reinvest the proceeds. And although the majority of long term investors struggle with the second half, the process for both of them is surprisingly similar. Yet, investors cling on to their holdings, even when selling them and reinvesting the proceeds into other promising opportunities which are staring them in the face clearly make more sense. There is a psychological aspect to this.

First of all, no investor wants to accept that he/she was wrong by booking losses. This emotion comes into play for loss making holdings. In such cases patiently waiting on loss making holdings becomes the default strategy. I am not saying here this is wrong. This strategy may be advocated when the original reasons for making the investment are still valid and all that is needed is a patient wait for a change of technical momentum in the stock. In such cases, waiting for the market to recover and in fact even buying more at lower levels makes eminent sense. In other words, patiently waiting on your loss making holdings makes sense when the underlying business remains fundamentally strong and has a sustainable competitive advantage in the marketplace. 

Secondly, in the case when the holding is in a profit position, investors are averse to closing their position and booking their profit in the fear that they may lose out on further future gains. This may not be entirely the wrong thing to do either. This approach is advocated only when the original reasons for making the investment are still valid and no other better opportunity is visible on the horizon.

Here are some questions that will help you determine if and when to sell your stock holding.

1. Do you need the money? If you need the money to cover an unforeseen expense then the choice is clear - you have to sell your position. This is the easiest decision for selling your stock.
2. Have the latest quarterly results been in line with expectations? After the announcement of the latest quarterly results, does the stock still meet your original investment criteria? If so, hold it. If not sell it and re-invest the proceeds in the next best available opportunity. 
3. Has there been a recent event that makes a material impact on the business? Has the company admitted publicly to accounting fraud? Has any promoter of the company got involved in scandal that affects the company’s image and its brand? These types of material events are rare but they still occur once in a while. As an investor, when you don’t know the extent of the unknown, it is best to exit your position if you can. Bad news is highly viral and can depreciate the stock’s value so quickly that you may not be in a position to sell your holding at all, because of lack of buyers.
4. Are there better opportunities out there? The business world is a competitive place. Existing businesses who are leaders in their space have to fight hard every day to retain their place. Despite this other upstart businesses are born everyday who either challenge the leaders in existing categories or establish a whole new category altogether. Smart Investors should always be on the lookout for such upstarts and invest in them when they are still affordable, at the cost of selling some of their current holdings. 

What to Do?

One thing is clear – in today’s day and age long term investors cannot afford to buy and hold any more. This strategy does not work very well in the Internet age any more, where upstart businesses challenge existing leaders every day. What is required instead is periodic monitoring of your portfolio and constant scouting for better opportunities. If you have the time, inclination and aptitude for doing this on your own, by all means go ahead take the challenge and prepare yourself to do this task on your own. If not, consider engaging the services of a SEBI Registered Investment Adviser (RIA) who can perform this activity on your behalf.

The 4 Ps of personal financial planning

Someone's sitting in the shade today because someone planted a tree a long time ago.

Warren Buffet

Personal financial planning is a very important aspect of every individual’s personal life. Simply put, it is just the process of developing a roadmap for your financial well being – now, tomorrow and well into the future. When it is done well enough, it helps you in achieving your goals and your dreams, but more importantly it helps you navigate life’s ups and downs by overcoming the financial barriers that are an inevitable part of everyone’s life journey. This aspect of personal financial planning is rarely visible in public though. What is starkly visible however - mostly amongst your friends, neighbors and families - are the financial difficulties that arise in their lives due to lack of adequate financial planning and the discipline to stick to the plan in cases where a plan may even exist. These are the people who due to their own laziness or indiscipline or both land themselves in financial quicksand and then cover themselves with debt of all kinds - credit cards, personal loans, business loans, overdrafts and even loans from friends and families - to try and get out of it. If such people are lucky to have the benefit of good financial advice they do come out of their financial distress over a period of time. Else they continue sinking deeper into the financial hole which they have dug for themselves with each passing day.

The irony is that personal financial planning is not a difficult process at all. It is very easy and to make it even simpler to remember and etched into your memory I have codified it into a pyramid named the “The 4 Ps of personal financial planning” as shown below.

Provision: This is the first P of personal financial planning and is at the bottom of the pyramid. It is mostly applicable in your early years when you are young and preparing for a career although it can be applied all throughout your lifetime. It calls for making an investment in yourself i.e. educating yourself with the knowledge and the skills that will enable you to make your mark in society. It is equivalent to planting a seed that will grow into a tree someday. This is the stage in your life when you are in the red, when you have no personal wealth unless you are blessed with an inheritance. Hence the best thing to do at this stage is to build large provisions of knowledge and skills that will enable you get a job and earn an income. As you increase your knowledge and skills and grow in your career your income will grow and after providing for your expenses it will enable you to start building a nest egg, which will be the start of your wealth creation process.

Prevention: The second P of personal financial planning lays emphasis on preventing any illness that may come in the way of your ability to earn regular income. In this phase you invest in your health and hence you need to focus on best health practices – such as a healthy diet and regular exercise – but also supplement it with a good health insurance plan just in case some illness were to afflict you, god forbid. A good health plan not only pays for the cost of your hospital stay but also gives you cash for out of pocket expenses when you are ill. Most importantly it ensures that for a small fixed amount every year, your growing nest egg is prevented from being dented by a significantly large medical bill. 

Protection: The third P of personal financial planning is applicable when you have got married and started planning for a family. At this phase in your life you find that you have dependents, whose financial well being depends on you. This creates an additional financial obligation on you but most people do not realize it and those that do are inevitably late. Financial wizards have created a solution for this problem too and it is called life insurance. In this phase you invest in your peace of mind which ensures that for a small amount every year your life remains protected and that in the event of your untimely demise your dependents can continue to enjoy the financial well being that you had planned for them. Life Insurance products are often sold bundled together with investment plans in the name of endowment policies, ULIPs, etc. It is a best practice to always separate insurance from investments so that each product can work for you for the specific purpose for which it is designed. 

Profusion: The final P of personal financial planning is the one that focuses on multiplying your nest egg. In this stage you invest for your future. The future is not only uncertain but it is paved with ups and downs. The future also holds the key to your goals, your aspirations and your dreams. Realizing this fact early on in life will compel you to plan for the future by investing your nest egg in such a way such that your goals may be achieved without undue stress on your finances. There are multiple investment products available for multiplying your nest egg, ranging from fixed income products such as fixed deposits and bonds to equity products such as stocks, futures and options. Mutual funds are a convenient way of investing in these products since they not only reduce the ticket size abut also provide useful combinations of these products bundled together in a single fund. 

What to Do

If you have incorporated one or more of the above elements into your personal financial plan, you are already ahead of your peers. If not, it is better late than never that you start as soon as possible. Assess where you stand today and then if you need help, engage the services of a Registered Investment Adviser (RIA) to help you navigate the complex world of investments and select the ones that are best suited for realizing your financial goals. Your Investment Adviser will understand your financial goals, assess your risk profile, calculate the optimal asset allocation mix for your needs and then create a financial plan for you that is aligned with your needs. A regular review of this plan with your adviser will ensure that you stay on top of the financial markets and in control of your own financial dreams!

Happy Investing.

How to find businesses with wide moats

I was a chartist. I loved all that stuff. I had charts coming out my ears. Then, all of a sudden a fellow explains to me that you don't need all that, just buy something for less than it's worth.

Warren Buffet

In the investing world, “moat” is a term that has been popularized by the legendary investor Warren Buffet to mean the amount of competitive advantage that a business enjoys in the marketplace over the competition. Moats create entry barriers for the competition and enable the business to harvest uninterrupted profit from its products and services. Therefore moats are a very desirable attribute for investors, when screening for investment opportunities. If they exist at all, moats can be either wide moats or narrow moats. Obviously wide moats are preferred over narrow moats, not only because of the extent of competitive advantage that they provide to the business but also because such an advantage may even be sustainable in the long run. Businesses with wide moats are therefore the ones that long term investors want to ‘Buy and forget’. In the Indian context, such investments fall in the category known as ‘Buy right, sit tight”.

Wide moats in a business may exist for a number of reasons. Some of these include strong brand, widespread distribution network, loyal customer base, low cost of operations, etc. Whatever be the reason for the wide moat, the search for the source for it always ends in an intangible asset – i.e. an asset that is not present or reported on the balance sheet of the business. Isn’t this strange – the one asset that gives the business a wide moat and hence a lasting competitive advantage does not even make it to the company balance sheet and hence never ever reported to investors. This is the single biggest reason why screening for businesses with wide moats is a task fraught with danger, because the person doing the screening may have to rely on hearsay and assumptions rather than hard facts. Unless of course there was a way to measure the intangible assets of the business and value it in monetary terms, in the first place!

This is where the icTracker comes in. We developed this software explicitly to address this very problem i.e. to measure the intangible assets of the business from the company’s reported financials and value it in monetary terms. Next we developed a ratio called the Knowledge Basis – which is just the ratio of the Intangible Assets over the Total assets of the business. Note that Total assets equal the Intangible Assets as calculated plus the physical and financial assets which are reported on the Balance sheet of the Business. The Knowledge Basis then becomes a simple measure for checking if the business has a wide moat. As a thumb rule we consider that a Knowledge Basis greater than 50% means that the business has a wide moat, else it has a narrow moat. The icTracker software has therefore quantified the calculation of wide moat and made it objective, thus making screening of stocks easier and more importantly, reliable. Our icAdvisor service in fact uses the icTracker database when designing and rebalancing client portfolios.

What to Do

When making investment decisions for your stock portfolio, always ensure that the underlying business has a wide moat. But that is the easy part – the difficult part is staying on top. Moats can disappear very quickly if a new competitor takes over the market for instance using a superior moat. Hence it is very important to check the moat of the business every quarter to ensure that the competitive advantage it enjoyed earlier is still in place. It is well and good if you have the time and passion for doing this yourself. If not, you should approach a SEBI Registered Investment Adviser to help you with this process.

SEBI bans upfront commissions to Mutual Fund distributors

Honesty is a very expensive gift. Don’t expect it from cheap people.

Warren Buffet

Last month SEBI asked Mutual Fund Asset Management companies (AMCs) to stop paying upfront commissions to distributors and instead adopt a full trail model of commission in all their schemes. This is a very admirable move by SEBI, to the large discomfort of a lot of distributors who had made a practice of earning extra income by churning their client’s portfolios frequently. Such upfront commissions were in the range of 1 to 1.5 percent and hence very lucrative to distributors. Each churn earned them an upfront commission from the AMC at the cost of the beleaguered client who was left to wonder why her MF investments were not delivering the expected returns.

This move by SEBI is the latest in a series of moves by the regulator in order to bring greater transparency to the Indian Mutual Fund industry for the benefit of retail investors. Some of these include:

• Removal of entry loads in all schemes of all funds
• Introduction of Direct plans in all schemes of all funds
• Capping of maximum Total expense Ratios
• Tapering of Total Expense Ratios by Assets under Management
• Mandatory disclosure of expense ratios by mutual funds for all schemes
• Mandatory disclosure of any and all changes in expense ratios to existing investors
• Standardization in the naming of mutual fund schemes to prevent confusion
• Mandating fund houses to use TRI (Total Return Index) v/s PRI (Price Return Index) for benchmarking performance of funds
• Introduction of the ‘riskometer’ – a five point scale from low to high – to enable investors better understand the risk associated with the fund.

The point of all this is to understand that the regulator is taking proactive steps and making changes to the investing framework to protect the interests of the small investor. Yet none of it will succeed if investors themselves choose to remain uninformed or uneducated about the benefit of these moves. Many a mutual fund investor has become so used to the prevailing system of investing via mutual fund distributors that they are averse to take advantage of the new framework even when it is in their own interest.

What to do

The simplest thing to do is to switch over from regular plans to direct plans of the same fund. The difference in expense ratio between a regular fund and a direct fund of the same scheme can be up to 1.0%, and when this difference is compounded say over the next 10 years, it can mean an additional return of more than 9%! In other words, if you have Rs 10 lakhs invested in a regular plan today, you can earn an additional 208,000 over the next 10 years just by moving to the Direct plan now (assuming a 8% return on the fund in the regular plan).

But hold on, just making a blind switch is not in your best interest, if only because it will lock you in for the next one year (remember exit loads). So if you are convinced about the need to make the switch you will be better off contacting a SEBI RIA to go over your financial plan and link your investment plan to your financial goals. Working in your best interest, your advisor will also recommend the best funds appropriate for your level of risk tolerance. And then suggest you to make the switch in a structured and tax efficient manner.

Why deal with a SEBI-RIA only?

When you combine ignorance and leverage, you get some pretty interesting results.

Warren Buffet

The investing community in India has witnessed a history of mis-selling of financial products. A recent example of this was the rampant selling of ULIP plans by private insurance companies and their agents prior to 2010. That round of mis-selling ULIPs was encouraged primarily by upfront commissions of more than 60% of first year premiums to the agents. Although this situation was corrected by the IRDA (the insurance regulator) in 2010 by tightening selling rules and introducing disclosures, the damage was already done by then as was discovered by a host of ULIP investors who found that they had been sold nothing but false promises!

SEBI (the capital markets regulator) got into the act in 2013 and introduced the concept of SEBI Registered Investment Advisers as part of the Investment Advisers Regulations 2013. SEBI also warned the general investing public to only deal with SEBI RIAs going forward. The press release in this regard is shown below.

Why deal with a SEBI RIA 

There are several good reasons for engaging the services of a SEBI–RIA for your financial planning and wealth management needs. The primary advantage for the client is that she is dealing with an investment adviser rather than an investment (product) seller. This distinction generates the following benefits:

• No conflict – Since the SEBI RIA charges fees directly from the client, he is free of conflict with product manufacturers and acts in the best interest of the client. He is also accountable to the client for this reason
• Certified – SEBI RIAs have to go through a stringent process prior to registration with SEBI. This includes passing the relevant NISM series X-A and X-B exams - which have negative marking - as well as demonstrating proof of adequate qualifications, capital and infrastructure. Moreover SEBI RIAs have to renew their qualifications every three years by clearing the NISM CPE exams in order to retain their SEBI registration. 
• Customized Advice – SEBI RIAs are required to tailor their advice to match the risk profile of the client. This guideline ensures that they do not dispense a one-size-fit-all solution to all clients.

What to do

It is amply clear that seeking financial advice from a SEBI-RIA is in the best interest of the investor. Astute investors should therefore first verify the credentials of their financial adviser from the SEBI website and thereafter compare their services and fees with other advisers. Investors should select an adviser who is not only qualified and registered but also credible and available. 

Our stock advisory service based on the icTracker software not only picks quality stocks but also designs an efficient portfolio based on the investor’s risk profile. No wonder it is able to deliver consistent outperformance over the years. Check our backtesting results to see how our model portfolio has outperformed every major index handsomely in the past 10 years!