Sensex to touch 50,000 in 7 years says Morgan Stanley

Morgan Stanley said that sensex could touch 50,000 mark in seven years from current levels , if the assumptions made are optimistic.

“One way of looking at market valuations is to find out the number of years it could take the market to reach a certain level. In our base case, using our residual income model, the BSE sensex (used as a market proxy) could take about nine years to breach 50,000 from its current level.
If the assumptions are made optimistic, the period to 50K shrinks to seven years,” analysts Ridham Desai and Sheela Rathi said on Thursday . Source : Economic Times

A Graham style deep value stock portfolio

Benjamin Graham is considered as the dean of value investing. Warren buffet was graham’s student and considers him as his mentor. Buffett’s followed graham’s approach to value investing in the early part of his career. However later, he expanded on graham’s approach and started focussing on the quality of the business too.

Graham’s approach is basically picking stocks which are statistically cheap. What that means is that the stock is cheap based on various quantitative measures such as mcap being less than Net current assets, or the stock is selling for less than cash on books. The disadvantage of this approach is that you may end up buying some complete dogs which are cheap for a reason. The underlying business would be going downhill and so the value is just an illusion.

Graham understood this and he circumvented it by diversifying. So the key point in building a portfolio of cheap graham style stocks is to diversify the holding. It makes sense to hold 15-20 stocks at a time and to keep selling the stocks when they reach 80-90% of intrinsic value and to replace them with other cheap issues.

With the current drop, I can see more of such opportunities coming up. The last time such an opportunity was come in 2002-2003 time frame.

The initial filter criteria I am using is as follows

Mcap less than 500 crs

Debt / equity ratio less than 0.5

No loss in the preceeding 5-6 years

PE less than 7

ROE atleast 8-10%

The key point, and I repeat, is to hold a large portfolio of these stocks via diversification. Some will turn out to be clunkers, but on an aggregate the portfolio should do well.

Now you may have a valid counterpoint – why buy this stuff when there are good companies getting cheap by the day. That is true ..but if like me you also take a long time to analyse each company, then the above mechanical approach is a quick way to assemble a decent portfolio. If you have the cash and the nerve (I could use a stronger word here :) ) to invest when everyone is pessimistic, then the mechanical graham style of investing can be used to quickly assemble a decent portfolio while the opportunity lasts.

Wisdom of the crowds

There is a new article by michael mauboussin on wisdom of the crowds (see here). There is also a book on the same topic which I read earlier (see here). Website of the book’s author here.

The key take-away for me from the article and book has been as follows :-

1. The crowd is usually smarter than an individual. This means that one should discount what the experts are saying (most of the times). One should not waste time in heeding to their forecasts. It makes sense to read the insights of investment masters or good investors. One can learn from that, but stay away from forecast (especially short term) by the so called experts. Most of the personal finance websites is full of this junk. I consider it mostly as noise

2. The crowd (market) is right most of the time. What that means is that the valuation of most of the companies is right. It is not always right, but most of the time it is right. As a result if I think that the stock is undervalued and a good buy, I try to analyse my assumptions in depth and be sure that I have got it right and market is wrong on it. Almost 90-95 % of times I have found that the market is right and my edge is limted to 5-10 % of the cases.

3. Be humble – One should always have a growth mindset and learn from the market and others.

4. Even if individual investors are not extremely smart, the market as a whole is smarter than the smartest individuals ( see the article and book on how this is true)

5. There are a few situations (bubbles and crashes) when the diversity and collective wisdom breaks down. In such situations, it makes sense to diverge in your thinking from the market and not be swept by the euophoria or pessimism. For ex : the dotcom boom of 2000I would recommend reading the article and the book as it would be a great addition to one’s mental models.

Disclosure : I have no financial interest in anyone buying ,borrrowing or stealing the book. Unlike stocks, I am always happy to recommend books as there is a limited downside to these recommendations.

Stock Selection Approach - Fundamentally

I follow a simple approach to stock selection.

The first step involves using a stock filter (see links in the side bar under useful links). I typically use a simple filter criteria of PE<15,> 10-12%, Debt to equity of less than 0.7 and a market cap of greater than 100 Cr.

In addition to the above source, I add to the initial list based on recommendations on other blogs, analyst reports etc. The next stage involves doing a quick analysis of the company’s statements such as Profit and loss, balance sheet, financial ratios etc. I end up eliminating almost 70-80 % of the stocks in the original list. The reasons can range from low PE due to one time gains in the previous year (and normalized PE being high) to lack of transparency in the annual report.

I am fairly ruthless in eliminating companies at the above stage. If I am not comfortable with the economics of the business, or find that the level of disclosure is inadequate, I tend to give the stock a pass. I have ended up passing over stocks which have done well later, however I prefer the risk of omission than commission.

Once the numbers check out and I have the necessary AR and other documents, I initiate a deeper analysis. I have a detailed excel document and checklist which I use to analyse the company in terms of competitive position and competitive advantage etc. As a last step I do a 3 scenario DCF analysis ( optimistic, pessimistic and base case scenario) and a relative valuation exercise.

If at the end of the above exercise , the company checks out in terms of the qualitative analysis and the stock price is 60% of Intrinsic value, I initiate a buy on the stock. However I tend not to buy in one shot. I tend to buy in 5-6 orders spaced by a few weeks each. This allows any excitement or irrational attitude towards the stock to cool down. I also try to look at my notes again with a fresh mind and reanalyze my assumptions.

The above takes atleast 4-6 weeks of time. However the above analysis does not involve any peter lynch style study of the company’s products at stores or talking to customers or suppliers.

Trader or Investor ...who should i be ?

Trader or Investor ...who should i be ?
Let me see .....
Trader:-
-> read the papers every day
-> watch cnbc full day for each development
-> sit in front of the trading screen watching the price ticker
-> try to see which party may get elected ( depend on the exit poll ??!!!)
-> have the courage to watch the market fall by 500+ points ( and go nearly bankrupt)
-> then watch the market go up by 200+ points ( and wonder what will happen next)
-> have the courage to lose big money or the courage to bet big
-> has a strong stomach for this kind of swings

Investor:-
-> read annual report at leisure
-> analyse the company and industry over a long term
-> make a piddly 20 % p.a but not lose more that 5 %
-> less blood pressure
-> more time to watch other channels other than cnbc ( maybe discovery ??)

guess i am not cut out to be a trader .... dont have courage to bet big / lose big , like to sleep peacefully at night , politicians make my life miserable enough ...dont want them bankrupt me ...naah ...not for a lazy guy like me...

Latest Equity Portfolio of Rakesh Jhunjhunwala as on 21 Jul 09

Latest Equity Portfolio of Rakesh Jhunjhunwala with value as on 21 Jul 09

Titan Industries............ 3566756 shares............Rs 442 cr

Lupin Ltd........................3018835 shares............Rs 271 cr

CRISIL........................... 550000 shares..............Rs 189 cr
Aptech Ltd.................... 4200000 shares.............Rs 69 cr
NCC.................................1490000 shares.............Rs 20 cr
Bilcare Ltd..................... 2022500 shares.............Rs 77 cr
Praj Ind.......................... 15726624 shares............Rs 135 cr

Punj Lloyd...................... 5040000 shares............Rs 117 cr
Karur Vysya bank.........1968724 shares...............Rs 57 cr
Pantaloon Retail.............000000 shares...........Sold in Jun 09 Qtr
Geojit...............................18000000 shares............Rs 72 cr
Agrotech Foods..............2003259 shares...............Rs 31 cr
Viceroy Hotel..................4750000 shares...............Rs 14 cr
Prime Focus....................882500 shares..................Rs 15 cr
Infomedia 18...................1506062 shares................Rs 12 cr
Provogue.........................19,00,000 shares..............Rs 9 cr
Rallis india.......................5,00,088 shares................Rs 37 cr
Autoline Ind....................1251233 shares................ Rs 9 cr
Geometric Ltd................4515000 shares................Rs 14 cr
Zen Technologies............9,00,000 shares.............. Rs 12 cr
Ion Exchange...................6,50,000 shares...............Rs 6.5 cr
Kajaria............................. 1,502,642 shares............. Rs 6 cr
JB Chemicals...................1,251,650 shares...............Rs 5.3 cr
Indage Vintners..............5,00,000 shares................Rs 3.2 cr
Mid-Day...........................2,250,000 shares..............Rs 3.6 cr
Dwarikesh Sugars...........4,50,000 shares................Rs 3.46 cr
Hindustan Oil...................2,585,643 shares..............Rs 35 cr
Alphageo...........................125,000 shares.................Rs 2 cr
Rishi Laser........................380,000 shares................Rs 1.2 cr
Vadilal................................2,00,000 shares...............Rs 0.86 cr