March 14, 2011

Cleaning up the Zoo

My portfolio is now a certified zoo. Although the bulk of my portfolio is in the top 10 holdings, I still hold several stocks which are not as attractive. I initiated a clean up few months back, but it is not as easy as i thought it would be.

How did I get here?
I have always had this problem to a certain extent – call it the teenager syndrome :) - I fall in love with a different girl every month. The problem is that although I fall in love with new girls, sorry stocks, I have refused to let go of the old flames.

Some old flames are worth holding. Companies like asian paints, crisil and Gujarat gas are part of my core portfolio now. They may become overvalued from time to time, but they have phenomenal business models and great competitive advantages. These companies, if bought at the right price, are likely to give great returns over a period of 10 yrs.

The same is not true of several other stocks in my portfolio such as bharat electronics, Honda siel power products or novartis. These are companies with decent economics and fair management. It is just that they are not as attractive, both from a valuation and future performance perspective – call them mediocre stocks (though decent businesses).

I have been too slow in realizing that these stocks, at current prices, will not give great returns going forward.

So what should one do?
The most rational approach would be to sell the stock when it is selling at fair value or when a stock with superior risk reward characteristics is available.

I have usually been able to do that fairly well when the stock is very close to fair value or if I think the economics of the business are no longer attractive (or I have simply made a mistake in understanding it). I have been slow in making a decision on stocks which land in a grey zone. These are stocks selling at a moderate discount to fair value and have average prospects.

An example
Let me illustrate with an example – Bharat electronics. I purchased BEL in 2008-2009 time frame at an average cost of around 850 and have been able to get 100%+ returns in 3 years including dividends.

These returns though decent, are not earth shattering. They are in line with the returns I expected from the company when I invested in it. This company has a near monopoly in the Indian defence market and should keep doing reasonably well in the future.

I personally think that the stock is around 15-20% undervalued and is unlikely to give not more than 12-15% returns per annum over the next few years. These are decent returns, but unlikely to get your heart racing.

The key to such stocks is hold them till the undervaluation corrects itself and then be able to dispassionately analyze the stock and exit , if there are better opportunities available

If you know, why not sell it?
Good question – call it the endowment bias or inertia, but I have been slow to react. It has also been partly due to the issue of opportunity cost.

For most part of 2010 and 2011, I have not invested more than 50% of my net assets with the rest being in cash as I have not found attractive enough opportunities. In such a scenario, a moderately underpriced BEL seems to be a better choice than holding cash. The downside of such a thought process is that soon the portfolio becomes a zoo and one’s mental space (list of stocks being tracked) becomes too crowded.

So whats the plan?
Sell – though it’s not easy to sell and hold cash. In addition, one also faces the risk of regret if the stock which was sold recently, has a run-up after that. Who said investing was easy?

In the end, however to keep my sanity intact and manage a reasonable list of stocks, I plan to bite the bullet and sell these kind of stocks.


Lucky said...

Talking of zoos, you should come to mine :-) You will find ~30 animals there, some of them on their deathbeds e.g. Suzlon / Reliance Comminucations. (I hope the companies will not vanish but I will have made a huge loss anyway).

Good to know that you follow a core portfolio approach too. I always belived that there should be some such stocks which are not sold irrespecitve of the CMP. Of course the tougher task is to find 5-7 such stocks.

Asian Paints are CRISIL are definitely two such stocks. Not so sure about Gujrat Gas. I guess BEL is also one of them. Of course you must be having better reasons of your own.

KD said...

Of course, people who are regular in investment process (not those who invests regularly :)) create their own ZOO each time they get opportunity like Q4 2008-H1 2009. It happened to me and I lost on some profits due to my inertia to sell such animals...after reading your blog on your selling IT stocks, I was wondering about Infosys. I had bought it sometime in early 2000 and its oldest stock in my portfolio now. Let me think it over on such stocks!!!

Raja said...

Do you think ITC can be in the group of Asian Paints, CRISL etc...

Anonymous said...

Hi Rohit - This is on your Oil India blog:

1) You have mentioned Oil India takes 33% subsidy burden and the rest borne by downstream companies. What about ongc which takes chunk of the brunt too?
2) How do you rate ongc compared to oil india? I guess ongc is a great stock as well.

rit said...

Hi Rohit,

I'm glad at least now you realised that BEL is not such a great stock. Never mind, if this realisation has set in little late though. Well, 3 years back a much simpler story like Tata motors would have given far better returns.

Rayhaan said...

Hey rohit, just went through d crisil post,i guess dats 1 stock worth getting married to. Q1.any ideas on how 2 profit from the japanese debacle,i mean there are some pretty INTERESTING situations out there...there are some crazy cheap japanese insurance stocks(who wont lose a cent due 2 d payout)..are there any japanese stocks listed here worthy of investigation? Q2.wot r ur views on buying co.s trading below n.a.v like bnk capital(mkt cap-30 crore,holds shares of cesc worth 90 crore,see ayush's blog 4 details) or maybe holding co.'s (bengal and assam co.,c 4stocks . Com)...u know sort of like buying close ended mutual funds at a discount...wot r d possible risks here? P.s do share if u find anything interesting in d empire or bio green industries situation.

vinayak said...

what is your opinion about L&T and RCOM ? can L&T join the core group ? also can RCOM become a value pick ?
please share your views.


Rohit Chauhan said...

Hi lucky
we all have our share of dead animals ..part of the game :)

BEL is not bad holding..just that there better opportunities in the market now


Rohit Chauhan said...

true ...periods like 2008-2009 are times when the portfolio expands. i am now looking at focussing the portfolio again. sometimes the good has to be let go to be replaced by the better


Rohit Chauhan said...

Hi raja
ITC is close ...almost in the group. the only thing which has put me off is that the management has taken cash from a cash generator - cigarettes and put it into dogs like finance, hotels, papers etc


Rohit Chauhan said...

Hi anon
I reviewed ONGC while looking at OIL india. ONGC definitely has a bigger scale and can expand / buy overseas assets . however it faces the same risks as OIL. so i will end up staying away from ONGC for the same reasons


Rohit Chauhan said...

Hi rit
no BEL is a good company and can give decent returns ...its just that there are better ideas out there now. over a three year period it has given decent returns for the risk assumed. if you expect 50% returns, then BEL is not the stock to pick

tata motors was not a simple story ..definitely not 3 years back. they had JLR accquisition which was a mess. if the world economy had not stabilized they would have more trouble. tata motors looks simple due to hindsight bias. BEL had lower risks even then and has correspondingly given lower returns


Rohit Chauhan said...

hi rayhaan
i dont have idea of japanese companies ...on some of the companies you mention ..they may be good, have not looked at them and some are too risky for me


Rohit Chauhan said...

yes L&T can be a core pick. RCOM - i will not touch it with a 10 feet pole. i saw it in 2008 and decided never to look at it again. they have atrocious accounting and governance is bad


anurag said...

Wish you and your family a very happy holi


karthik said...

Hey Rohit,

Is there any way we can invest in Japan or Bangladesh. Both look like a good investment scenario.