October 10, 2011

Stock for the long run

I am married to some stocks, which in these times of hyperactive trading, is quite shocking to a lot of people.
I have held some of these stocks for five to ten years. I have discussed most these companies on my blog in the past. A partial list follows
  1. Balmer lawrie – Held since early 2005: compounded return of around 26% per annum including dividends. You can read the analysis here, here and here
  2. Asian paints – Held since 2001: Compounded return around 31% per annum including dividends. You can read the analysis here and here
  3. Gujarat gas – Held since early 2005: Compounded return of around 38% per annum including dividends. You can read the analysis here and here
  4. Crisil – Held since late 2008: Compounded return of around 42% per annum including dividends.  You can read the analysis here and here
  5. Lakshmi machine works – Held since late 2008: Compounded return of around 50% per annum including dividends. You can read the analysis here and here.
Buy and hold philosophy?
The most common reaction to such an approach is to call it the buy and hold philosophy. I personally don’t follow any dogma in investing. At the time of investing in any stock, my approach is to buy stock in a company which has a sustainable competitive advantage (ability to maintain above average return on capital over a long period) and at a discount to fair value. I will hold the stock as long as the company continues to do well (maintains its competitive advantage) and is not too overpriced.
As you would notice in my approach above, there are no quantitative measures. Competitive advantage, though a well defined concept, is fuzzy in practice and not clear cut always. In addition, though some analysts like to give a specific number for fair value, it is usually an approximate number. As a result overvaluation also depends on your specific point of view (what you think about the company’s future prospects).
Due to the above subjectivity, I do not have a specific holding period in mind when I take a position in a stock. I generally evaluate the performance of the company annually, update the fair value and will hold till the market price does not exceed this fair value by 20-30%.
The above approach has led to a holding period of 5-10 yrs in case of some stocks.
Do I ever sell?
I will not hold the stock of a company, no matter how I feel about it, if I think the stock is overpriced. For example, I have reduced my position in asian paints in the last 2 years as the stock became overpriced.
I have exited Gujarat gas in the past when I thought it was overpriced and re-entered the stock when I felt it was undervalued again.
So in way, it is truly not a marriage, but more of a long term steady relationship :)
Why do most investors hold for shorter periods?
I have a theory or hypothesis on this. There is some research to support this theory too. Let me call this the ‘macho effect’. Most men, me included, want to look macho or ‘manly’ in almost all the activities they do. This testorone display is useful in a lot of activities (though one can doubt that too), but it is completely disastrous as far as investing is concerned.
What is the macho effect?  Simply put, most men think that they are highly skilled in investing and the way to show it off is to aim for the highest possible returns.  Any returns less than 40% per annum is for sissies. So in order to get these super high returns, they trade in and out of stocks and in the end are not even able to match market returns. The means becomes more important than the end itself.
If you don’t agree with my hypothesis, try discussing about a stock which can give you 20% per annum for the next 5 years with a high probability. Most of the guys will dismiss such a stock as useless and point to you a hot idea which can double in 3 months.
The same research (Barber and Odean (2000) study), also points out that women are much better investors than men. I think that would be true if they were more involved in the financial decisions of the family.
What are the downsides of long term holdings?
One downside is that such ideas will not make you look smart in front of your friends. These ideas will also not satisfy that ‘macho’ urge in you :). If you really have that itch to scratch, keep around 10% of your portfolio for entertainment.
In addition, it is not always possible to know such ideas in advance. Some stocks develop into long term holdings as the company in question continues to perform well and as a result there is no reason to sell the stock. One can only look for good quality companies and hope that they will continue to perform well into the future.
How should one buy?
In times of market distress, several high quality companies are available at cheap valuation. One can look at creating a position in these stocks at such times. The advantage of buying the stock on the cheap is that one gets a double kicker – one from the reversion of the valuations to more normalized levels and the other from a steady increase in fair value of the stock.
I am quite comfortable with stocks listed in the post. In addition, I will add to them if the market continues to drop and they get cheaper.There are no guarantees that each of these companies will continue to do well, but as a group I would expect them to do well. Of course one has to be careful about the valuations at which you buy any stock.


Neeraj Marathe said...

Really good post Rohit..in continuation of the same topic, may i suggest that u write something about portfolio allocation? I mean, what would have been the situation, if u had put in lets say, only 2% of your portfolio in Asian Paints or just 5% of your portfolio in LMW?
Good analysis and conviction needs to be supported by a material size of position. Your thoughts on the same would be very welcome, i feel..

Lucky said...

Good post as always. Short term heroism leads to long term losses.

Started with A - B, C, D and E look very costly. Would be good to have your range of fair values also indicated.

Anonymous said...

LMW has dropped since your last post. Would you still recommend it? It under 2000

ravi said...

hi rohit ...great article again...ur blog is superb...
cud u please send me the complete article of prof bakshi on value investing (10 value themes) u gt frm one of subscriber of capitalideas...u gt in jun 07..
my email id is : laveen10@gmail.com

Anonymous said...

Gem of a post Rohit.

Another great aspect of long term holding, is the dividend yield. Your yield keeps increasing provided the company is increasing the payout (which it normally does).

Do you reinvest the dividends in the same company given good entry level valuations? or ?


Anonymous said...

Again a great post Rohit.

Congratulations on fantastic returns.

Personally, I wish to adopt similar stratragy for investing. (started my learning in Nov '10 and has not made any meaningful investment yet)

One comment I wish to make if I may, mark to market returns indicate market's current appraisal of a company which is dynamic and could prove illusionary at another point in the future.

Just interested to know, as Buffett suggested do you calculate earning yield of your long term holdings as a yardstick of performance as well?

I also like your stratragy of reducing overpriced stocks.

just looked at Asian paints. from '95 it's profit has increased around 15-16% CAGR(paint industry was in slowdown from 97-00)

Earnings yield: at current consolidated trailing PE of around 35(If you remember can you please tell us roughly what was the PE at purchase), current yield is 2.8%. If one anticipate conservative 15% CAGR for next 10 years, average yield would be 7% at end of 10 years. (lesser than risk free debt instruments giving post tax 8.5% return)

valuing it as a bond: with ROE around 40% if one buy it five times book value than retun would be around 8% comparable with risk free debt investment and then one can anticipate 15% CAGR in book value so return would be 15%. However it is trading around 15 times book value!

So, in either case to get 15% return CAGR price has to come down significantly(50-66%).

Market is assigning 35 PE to hightly profitable last few years. In slowdown years after an macro event if margins are compressed and bottomline static, market coule re-appraise and assign PE of 20-22 and future mark to market returns could come down.

Mathematically it probably makes sense to me to sell at this counter at this opportunity and move into another attractive opportunity or debt instrument awaiting reasonable valuations.

I understand my calculations are probably elementary, so welcome any further comments on that for my learning.



Rohit Chauhan said...

Hi neeraj
good to have you here :)

these picks were definitely not more than 5-8% my portfolio size ..if they were, i would have retired by now :)

in hindight, i should have allocated more to high quality ideas. i plan to do that going forward ...so if a gujarat gas or crisil were to become undervalued i will add to the position and take it up. however i am still not comfortable with any position being more than 10%

you can say that my positon size has been smaller than my conviction in the past , but now i have started getting more aggresive , relatively speaking with my top ideas


Rohit Chauhan said...

Hi lucky
balmer lawrie and LMW are not expensive ..others maybe. i would add to these two companies if i was not already at a full position size.

Rohit Chauhan said...

my fair value for LMW is around 3600 ..so i would add to it only if it drops below 1800. the fair value number is ofcourse subjective and not a precise number


Rohit Chauhan said...

Hi ravi
sorry i dont have a copy of that article now with me ..been a long time since then


Rohit Chauhan said...

Hi rahul
i really dont bucket dividends separetly ..it goes into the same pool of uninvested cash. if at that time one of the long term holdings is cheap, i will buy it and if something else is available then the money goes to that.
so its a case of opportunity cost


Vikas said...

Hi Rohit,
I am a recent silent follower of your blog.
Just wanted to share few videos.

came across few excellent thought provoking and hilarious videos of Prof.Vaidyanathan.

Giving below 2 links



A must watch.
It gives true picture of Indian Economy from an Indian Economist and not some foreigner.


plus.ly/Suhail said...

Vikas those links were great.

For those who haven't watched it:

The first link in particular is very informative sprinkled with light-hearted rumour all around :)

The second one is the first of 4-part series. Awesome.