June 25, 2009

Some interesting questions

I received an email from Thirunarayanan with some interesting questions and have decided to publish my answers to his email.

1. You said that your goal is to beat the stock market by 5-8%. How did you arrive at this lower and higher end ? And why is that important ?

The market on an average has given 13-14% per annum over the long term, maybe even more. In case of most of the value investors - ones with public record- i have seen an outperformance of around 2-3%. The greatest of them all - warren buffett beat the market by around 13%. So i have taken a goal which is not as ambititous as buffett, but more ambititous than the average. Also as i do this part time, i dont think it would be easy for me to exceed 8% above market - which translates to around 20-23% per annum over the long run (5+ years).

The above goal is important, for the reason that the time and effort should justify the rewards. i can easily match the index or maybe beat it by 1-2% via index or mutual funds. So i should cross the high water mark of 1-2% to justify this effort, else i am better off investing in index and mutual funds - which i do now too. I have been lucky to have exceeded my goal till date.

2. You also mentioned that you wanted to beat the stock market on 3 year rolling cycle. How did you arrive at that number ? And what is the significance of this number ?

The reason of having a 3 yr rolling period is that a yearly or lesser number is too short to confirm if i am beating the market or not. Over 1 year or less, luck plays an important role and one cannot be sure if the performance is due to skill. However as the time period increases, the element of luck reduces and skill plays a bigger role in the returns. The reason for keeping it 3 years is that it long enough to eliminate substantial a component of luck, but not so long that i dont get feedback for a long time on whether i am truly beating the market or not.

There are ofcourse no hard and fast rules on the above parameters and i have set them to my own specific case.

3. I am assuming that you are publishing your whole portfolio and your thought process in your blog. What are the chances of someone coat-tailing? What are your chances of seeing some competition and see a rise in the share price because of your publication ? Either you will share forever or there may be a time when you will have to stop revealing a lot (because of competition or lack of time to blog)

I have no issues people coat tailing me, although i dont think that is a problem yet. i am not yet so famous or considered a super investor that people will blindly follow me. in addition, my picks usually have a bad short term outlook.

So it is unlikely someone will just buy what i discuss and see immediate benefit.My approach on the blog is to share my learnings and analysis, but i dont give tips. So an individual is left to make his decision, which is not easy if you are just following someone blindly. Also considering i am small investor and followed by others like me, it is very unlikely that any stock i discuss will have a price run up after i discuss about it. if that starts happening ..then i have arrived in life :).

On continuing to share my ideas i dont know how long this will continue. i dont see it stopping in the next couple of years ..however i do have plans to start private investment partnerships. When i do so, i will have look at the constraints such an arrangement will have. However that is still a few years away.


Padmanabhan said...

//The greatest of them all - warren buffett beat the market by around 13%.

WB beat US market by 13%. How can you use that as a benchmark for investing in Indian markets. If WB were investing in Japanese market (growing at 1% may be) would he still beat it by 13%?

sumi said...

Dear Rohit,
Thanks for giving your readers such extensive answers. I think once I feel I have read and learned a sufficient amount it would be nice for me to set some aims like this. As of now investing is still very hap hazard and the discipline of beating the market by a certain percentage is something as an aspiring value investor I will aim to do.

Rohit Chauhan said...

Hi padmanabhan
the margin of outperforming the market doesnt change whether its us or indian markets. maybe it could be easier in indian market if you believe that the indian markets are more ineffecient and hence easier to beat.
however there are no clear indications to the contrary.
no one can know if he could beat the japanese or any other market by x%. the point of using buffett as the benchmark is that it is not easy to beat the market by more than 10% over long periods of time (> 10 years). one or two years of outperformance can be due to luck.
a 10%+ outperformance in india market would mean a compounded returns of 25% or higher.
if someone has done that for 5+ years, then that person is a good investor and could possibly invest professional and become very rich.
finally if you have a unreasonably high goal, you may take high risks and regret later

Rohit Chauhan said...

Hi sumi
the aim or benchmark to beat the market is a subjective and personal exercise.
it should be realistic and commensurate with the effort and risk one is ready to bear.
i may have a dream to earn 100% per year and beat the market by 90% every year.
If i set that kind of goal, i am deluding myself and may lose money big time

Avadhut said...

Hi Rohit,
I went through your LMW DCF sheet. you have taken PBDIT and deducted OPEX and CAPEX. One question, should we not deduct Interest from PBDIT first and then charge Tax on it as Interest is tax-free?
We can add Interest after that.
Second question is Capex and Capex(maint). Can we take these two capex( I assume,first one is growth Capex)amount (or%)together?

RK said...

good to see you have a set goal and is working towards it. maybe setting a goal, whatever it may be, is the most important thing for any new investors to do. Can you also share the returns you have had so far?


Rohit Chauhan said...

Hi avadhut
most of companies i invest have low debt. in case of LMW has interest income and hence there interest being paid on the tax.
however interest works to reduce the tax outflow. so i would prefer to take out interest (in the spread i am calculating NOPAT = pbdit+d+i).
the above is not really accurate, as one should take the impact of tax on interest income also, so i may be adding extra tax here.
on the capex, fcf is calculated using maintenance capex. definition of free cash flow is the cash left over from business if the business can sustain itself at current levels of unit volumes. so maintenance capex is used.
growth capex actually adds value if done above cost of capital. so if you deduct the growth capex, you will underestimate the value.

Rohit Chauhan said...

i have made returns of around 26% per annum and have beaten the market by around 11-12% over the last 9 years. ofcourse the results are not uniform, sometimes they have been above this level and sometimes i have trailed the market. the current year seems to be shaping at the same levels of around 10% in excess of the market returns