Lets say you have a portfolio of around 15 stocks, which I think is sufficient diversification for most of us. Now let’s say, you are one of those odd guys who for some inexplicable reason, believes in long term investing – that is buying high quality companies at decent prices and then holding the stock for the long term.
Let’s assume, for argument sake that the average holding period is around 3 years. In such a scenario, you are buying/ selling 5 stocks per year. Now let’s say, you are able to spend around 5-6 hrs each week on searching for decent ideas and are able to analyze 1-2 companies each week. At this rate, you can analyze 50-60 companies each year.
If you look at the above math, you need to smart or lucky around 10% of the time. I don’t consider that as a high threshold.
What wrong with the above logic?
For starters, the above reasoning assumes that you will be able to find attractive ideas on a regular basis – one every 2-3 months. As most of us who have been investing in the market for sometime know that, these things don’t work on such a smooth schedule. Investing ideas tend to come in clusters and in short periods of time – especially when the short term outlook is clouded.
The other assumption is that one will spend a 5-6 hours a week, diligently looking for stock ideas. Unfortunately, I don’t know of any shortcut to make money in the market. A lot of cheats claim to know ‘techniques’ to make money with minimal effort and are able to find enough fools to sell their techniques.
The logic actually works even better
The above logic works even better than what i claim in the post. Let’s say you are able to indentify some high quality companies such as a titan or crisil and make a purchase at decent valuations. Once you purchase such a company, I don’t see any reason to sell the stock unless the valuations go beyond all reason. In such a case, the portfolio turnover drops still further and the number of new ideas required each year is even lesser.
A 60-70% success rate of your ideas, where 3-4 ideas will either make no money or lose a bit for you is quite reasonable. At this success rate, one will still do well on an aggregate portfolio basis.
If you put it all together, I think one needs to pick a successful idea 5-10% of the time or around 1 in 10 ideas evaluated.
The only downside in the above approach is that you cannot share any exciting stories of your stock market coups with your buddies over a drink.
The comparison with trading
I genuinely believe that trading is much tougher game than long term investing. Even if one leaves aside what is required to be a successful trader, the basic math tends to work against you.
Even if you are a moderately active trader and buy/sell 10-15 stocks a year (1-2 per month), the success rate (no. of ideas invested/no. of ideas looked at) required is much higher than a long term investor. I think one has to be much smarter to be a successful trader than a successful long term investor.
Is that what you do?
Short answer to this question is – Yes. I typically evaluate 2-3 ideas each week in some depth and may end up picking just one idea every few months. In most of the cases, it is either some fundamental issue which turns me off or it may just be that the valuation is not attractive enough.
If the idea is good, but the price is not right, then it goes into my tracking list. I tend to review the tracking list once a month to see if Mr Market is offering some bargain on a decent idea.
April 25, 2011
April 18, 2011
Economics of the brokerage industry
I thought my previous post on the brokerage industry would receive minimal hits as it is quite a dry topic and has no entertainment value. However, I am glad that I have been proven wrong. Considering that a lot of users are interesting in reading such dry topics, I will continue to publish such analysis in the future.
I had given a brief overview of the industry in the previous post. I will try to analyze the economics of the industry in this post
The typical research report (at least the free ones) on industry analysis typically give pages and pages of past and current statistics, without attempting to look at the broader picture or overall dynamics of the industry.
Why is that important?
If one has to make a long term investment in a company, it is crucial to understand the long term economics and direction of the industry and the company in particular. The statistics and various parameters of the industry are just the starting point of the analysis.
Lets try to evaluate the brokerage industry
The brokerage industry is currently characterized by a large number of companies (private or unorganized). In effect it is a fragmented industry with a large number of participants.The industry thus has monopolistic competition (text book term) – a large number of firms selling a slightly differentiated product.
Let analyze the industry based on Michael porter’s five factor model
Barriers to entry
The industry now has a certain level of entry barriers. The primary brokerage firms need to have a certain scale and size as the business involves a high level of fixed costs in the form of technology platform, distribution network and back office operations. In addition brand recognition is also important to attract new customers.
A new entrant in addition to the above also needs a reasonable level of capital to fund the working capital requirements of the business (finance to customers, deposits with exchanges etc).
These scale requirements are increasing constantly and as a result a new entrant will require higher levels of investments in the future to enter the business. As pointed out by ansh in the comments, it is unlikely that we will see many new entrants in the industry. On the contrary, it is likely that the smaller players will exit by selling out or closing shop.
Supplier power – not relevant in most segments except investment banking, where employees control client relationships and hence have to be highly compensated
Buyer power – This is important in the institutional brokerage business which involves high volumes and low brokerage charges. The extent of buyer power is very low to non-existent in all kinds of retail segments
Substitute product – Not applicable
Rivalry determinant – This industry is now in a fairly high growth phase. However the brokerage industry is very cyclical and is impacted by the activity levels in the markets. During the downturns such as 2008-2009 period, the smaller players were squeezed out of the business. As a result there is a constant consolidation happening in the industry.
In summary the industry has moderate to low level of competitive advantage. There is low level of customer lockin and a customer will move his/her business if the brokerage rates are not competitive with the rest of industry. The only competitive advantage for the companies in this sector comes from size and scale which enables them to leverage their size to reduce average costs and thus make a profit on low brokerage margins.
Other points of analysis
In addition to the high fixed costs, the industry has very low marginal cost. As a result the cost of adding an additional customer is low and per transaction costs are limited. Due to this reason, we are seeing a constant pressure on the brokerage rates (similar to telecom which also has a very low marginal cost). This downward pressure on the brokerage rates has intensified the competition in the industry and is resulting in consolidation with the top players.
The basic brokerage business is now sometimes a loss leader to enable the brokerage firm to acquire customers and sell other products such as wealth management services, PMS or third party mutual funds. The agency business is thus a Iow margin, lower risk and a fairly predictable kind of business. This segment will provide adequate returns in the future for a company with scale.
The capital business involving financing is similar to a banking operation and is mainly a lending or a support business for the brokerage operation. This is a high risk and sometimes a high return business. It is easy to grow in this segment by taking large quantities of debt and then investing in high risk assets. However the risk of a black swan or plain old recession wiping out your business is very high.
Finally the treasury business is a trading operation driven by the skills of a select set of individuals. In the same manner business such as investment banking is also a very competitive business driven by key customer relationships. It is difficult to evaluate the competitive advantage in these businesses as it is driven by a few key employees, who can leave and thus take away your revenue streams and profits
I personally prefer low to moderate businesses with above average returns. In view of this preference, I am likely to reject high growth/ high risk businesses in the brokerage space and likely to focus on companies which are focused on the agency business.
I had given a brief overview of the industry in the previous post. I will try to analyze the economics of the industry in this post
The typical research report (at least the free ones) on industry analysis typically give pages and pages of past and current statistics, without attempting to look at the broader picture or overall dynamics of the industry.
Why is that important?
If one has to make a long term investment in a company, it is crucial to understand the long term economics and direction of the industry and the company in particular. The statistics and various parameters of the industry are just the starting point of the analysis.
Lets try to evaluate the brokerage industry
The brokerage industry is currently characterized by a large number of companies (private or unorganized). In effect it is a fragmented industry with a large number of participants.The industry thus has monopolistic competition (text book term) – a large number of firms selling a slightly differentiated product.
Let analyze the industry based on Michael porter’s five factor model
Barriers to entry
The industry now has a certain level of entry barriers. The primary brokerage firms need to have a certain scale and size as the business involves a high level of fixed costs in the form of technology platform, distribution network and back office operations. In addition brand recognition is also important to attract new customers.
A new entrant in addition to the above also needs a reasonable level of capital to fund the working capital requirements of the business (finance to customers, deposits with exchanges etc).
These scale requirements are increasing constantly and as a result a new entrant will require higher levels of investments in the future to enter the business. As pointed out by ansh in the comments, it is unlikely that we will see many new entrants in the industry. On the contrary, it is likely that the smaller players will exit by selling out or closing shop.
Supplier power – not relevant in most segments except investment banking, where employees control client relationships and hence have to be highly compensated
Buyer power – This is important in the institutional brokerage business which involves high volumes and low brokerage charges. The extent of buyer power is very low to non-existent in all kinds of retail segments
Substitute product – Not applicable
Rivalry determinant – This industry is now in a fairly high growth phase. However the brokerage industry is very cyclical and is impacted by the activity levels in the markets. During the downturns such as 2008-2009 period, the smaller players were squeezed out of the business. As a result there is a constant consolidation happening in the industry.
In summary the industry has moderate to low level of competitive advantage. There is low level of customer lockin and a customer will move his/her business if the brokerage rates are not competitive with the rest of industry. The only competitive advantage for the companies in this sector comes from size and scale which enables them to leverage their size to reduce average costs and thus make a profit on low brokerage margins.
Other points of analysis
In addition to the high fixed costs, the industry has very low marginal cost. As a result the cost of adding an additional customer is low and per transaction costs are limited. Due to this reason, we are seeing a constant pressure on the brokerage rates (similar to telecom which also has a very low marginal cost). This downward pressure on the brokerage rates has intensified the competition in the industry and is resulting in consolidation with the top players.
The basic brokerage business is now sometimes a loss leader to enable the brokerage firm to acquire customers and sell other products such as wealth management services, PMS or third party mutual funds. The agency business is thus a Iow margin, lower risk and a fairly predictable kind of business. This segment will provide adequate returns in the future for a company with scale.
The capital business involving financing is similar to a banking operation and is mainly a lending or a support business for the brokerage operation. This is a high risk and sometimes a high return business. It is easy to grow in this segment by taking large quantities of debt and then investing in high risk assets. However the risk of a black swan or plain old recession wiping out your business is very high.
Finally the treasury business is a trading operation driven by the skills of a select set of individuals. In the same manner business such as investment banking is also a very competitive business driven by key customer relationships. It is difficult to evaluate the competitive advantage in these businesses as it is driven by a few key employees, who can leave and thus take away your revenue streams and profits
I personally prefer low to moderate businesses with above average returns. In view of this preference, I am likely to reject high growth/ high risk businesses in the brokerage space and likely to focus on companies which are focused on the agency business.
April 11, 2011
Brokerage firms
I have started analyzing financial service companies such as Banks, brokerage firms, NBFC etc to find some attractive ideas in this industry. I think financial services as an industry is likely to do well as the Indian economy grows and the average level of income rises with it.
Globally, the financial services industry forms a much larger part of the economy (in some cases too large) than India and acts as the circulatory system of the economy.
The above insight is not unique and does not mean one should go out and purchase any bank or company in the financial services industry.
I have often been asked why I don’t invest or talk much about banks or financial services company. I don’t have any mind block against this sector. I have invested in Karur vyasa bank, ICICI bank and Allahabad bank in the past.
However, any company which works with a high leverage is not an easy decision. The risk management and capital allocation decisions of the management are very crucial. It is easy for the management to make stupid loans or follow risky trading strategies for a long time, before the whole thing blows up (remember Lehman brothers?). In addition, the management can easily cover up the asset quality and the investor will have no clue about it.
Any investment is a finally a bet on the management, but due to the high leverage it assumes a greater importance in the case of financial service companies.
As part of the above analysis, I have started looking at brokerage and capital market related companies. I wrote about geojit securities in an earlier post (see here). I am detailing some thoughts on this industry below. I will follow it up with an analysis of some of the companies in this space.
The business segments for brokerage/ financial services can split along two broad lines
Agency business – This business does not require high amounts of capital and is based on other assets such as distribution network, client relationship etc. It consists of the following sub-segments
Investment banking : This involves advisory and capital market services such as IPO transactions, FPOs, QIP and rights issues. In addition, this also involves other services such as Merger and acquisition advisory, real estate and infrastructure advisory and capital raising services such as debt syndication.
This business is characterized by high competition, low capital investment and the presence of several global companies such as Goldman sachs, Merrill lynch etc.
The key drivers for this business are client relationships and key personnel who have the experience and the network in the business.
Brokerage – Retail, institutional, Wealth management and third party distribution
The brokerage business involves several sub - segments such as retail brokerage services through online and sub-broker channels. Retail brokerage is a fairly fragmented business with a lot of brokers across the country.
The key drivers for this business are an extensive distribution network and a robust technology infrastructure to handle the online and back end processes of the business.
The institutional business uses the same technology infrastructure, but is driven more by client relationships and research capabilities.
Wealth management also uses the same capabilities – strong research capabilities, client/ customer relationships and technology infrastructure to provide various services to higher networth clients.
The third party distribution is a nice addon as it enables the company to earn additional fees from distributing third party products such as mutual funds and insurance etc by using the same assets.
Asset management – PMS, Mutual funds etc
This business involves private asset management – PMS, private equity and mutual funds. This business is a logical extension for brokerages as they can use their research capabilities, distribution infrastructure and client relationships to expand their AUM (asset under management).
The companies charge a certain percentage of the AUM and hence the key factor is to increase the assets being managed.
Capital business – This is a form of lending/ trading kind of business. This business requires large amounts of capital and is closer to traditional banking
Financing – This involves short term loans against equities, client funding for trading etc. Some of the brokerage companies are now expanding into new areas such as Housing finance etc.
This business involves a higher risk than the agency business as the company is assuming credit risk. However the overall risk is controlled by extending credit against some collateral (shares or real estate). This business was traditionally run by banks and other NBFCs. However in the recent past brokerage firms have taken the NBFC license and have started expanding aggressively into this area.
Treasury operations – This involves trading by the firm on its own account. In my view, this is the highest risk part of the company’s business. This is a basically a black box operation. One cannot figure out the level of risk the company is taking to generate the returns. On the upside the returns and profits are very high, however if the company makes the wrong bets, then it can bankrupt the company (as we saw during the financial crisis).
I have given a general overview of the business and some thoughts in the post. I have not quoted any figure or charts for the industry. You can find these numbers in the annual report of any of the brokerage firms.
I will briefly cover the economics of the industry and some companies in the sector in the subsequent posts
Globally, the financial services industry forms a much larger part of the economy (in some cases too large) than India and acts as the circulatory system of the economy.
The above insight is not unique and does not mean one should go out and purchase any bank or company in the financial services industry.
I have often been asked why I don’t invest or talk much about banks or financial services company. I don’t have any mind block against this sector. I have invested in Karur vyasa bank, ICICI bank and Allahabad bank in the past.
However, any company which works with a high leverage is not an easy decision. The risk management and capital allocation decisions of the management are very crucial. It is easy for the management to make stupid loans or follow risky trading strategies for a long time, before the whole thing blows up (remember Lehman brothers?). In addition, the management can easily cover up the asset quality and the investor will have no clue about it.
Any investment is a finally a bet on the management, but due to the high leverage it assumes a greater importance in the case of financial service companies.
As part of the above analysis, I have started looking at brokerage and capital market related companies. I wrote about geojit securities in an earlier post (see here). I am detailing some thoughts on this industry below. I will follow it up with an analysis of some of the companies in this space.
The business segments for brokerage/ financial services can split along two broad lines
Agency business – This business does not require high amounts of capital and is based on other assets such as distribution network, client relationship etc. It consists of the following sub-segments
Investment banking : This involves advisory and capital market services such as IPO transactions, FPOs, QIP and rights issues. In addition, this also involves other services such as Merger and acquisition advisory, real estate and infrastructure advisory and capital raising services such as debt syndication.
This business is characterized by high competition, low capital investment and the presence of several global companies such as Goldman sachs, Merrill lynch etc.
The key drivers for this business are client relationships and key personnel who have the experience and the network in the business.
Brokerage – Retail, institutional, Wealth management and third party distribution
The brokerage business involves several sub - segments such as retail brokerage services through online and sub-broker channels. Retail brokerage is a fairly fragmented business with a lot of brokers across the country.
The key drivers for this business are an extensive distribution network and a robust technology infrastructure to handle the online and back end processes of the business.
The institutional business uses the same technology infrastructure, but is driven more by client relationships and research capabilities.
Wealth management also uses the same capabilities – strong research capabilities, client/ customer relationships and technology infrastructure to provide various services to higher networth clients.
The third party distribution is a nice addon as it enables the company to earn additional fees from distributing third party products such as mutual funds and insurance etc by using the same assets.
Asset management – PMS, Mutual funds etc
This business involves private asset management – PMS, private equity and mutual funds. This business is a logical extension for brokerages as they can use their research capabilities, distribution infrastructure and client relationships to expand their AUM (asset under management).
The companies charge a certain percentage of the AUM and hence the key factor is to increase the assets being managed.
Capital business – This is a form of lending/ trading kind of business. This business requires large amounts of capital and is closer to traditional banking
Financing – This involves short term loans against equities, client funding for trading etc. Some of the brokerage companies are now expanding into new areas such as Housing finance etc.
This business involves a higher risk than the agency business as the company is assuming credit risk. However the overall risk is controlled by extending credit against some collateral (shares or real estate). This business was traditionally run by banks and other NBFCs. However in the recent past brokerage firms have taken the NBFC license and have started expanding aggressively into this area.
Treasury operations – This involves trading by the firm on its own account. In my view, this is the highest risk part of the company’s business. This is a basically a black box operation. One cannot figure out the level of risk the company is taking to generate the returns. On the upside the returns and profits are very high, however if the company makes the wrong bets, then it can bankrupt the company (as we saw during the financial crisis).
I have given a general overview of the business and some thoughts in the post. I have not quoted any figure or charts for the industry. You can find these numbers in the annual report of any of the brokerage firms.
I will briefly cover the economics of the industry and some companies in the sector in the subsequent posts
April 3, 2011
Where I steal my ideas from ?
First of all – yipeeeee !!! No I didn’t win the lottery, but India won the Cricket World cup. Wow, what a match ! it was thrilling and exciting to say the least.
Now, coming back to more mundane things, I am often asked – where do I find my investment ideas ?. I would say that I find my ideas via two methods – Find and borrow (or steal).
Finding ideas
I have a fairly low tech way of finding ideas. I have a simple spreadsheet in which are listed companies by PE, market cap, profit etc. I use the following screener to generate a list based on the following criteria
Criteria : PE greater than 15, ROE less than 12%, and debt/Equity ratio less than 1.2
Correction : PE less than 15, ROE greater than 12%
Once I have the initial list, I eliminate some companies based on following the criteria
- Any company with losses for more than 2 years, sales degrowth or management issues etc.
- Micro-cap finance/ retail/ commodity companies as these companies are too risky and one has to analyze a long list, before one can find a good idea.
The above step has its shortcomings such as filtering out turnaround situations, but one has to have some cut off to get a manageable list
Stealing ideas
I am no Albert Einstein or a physicist trying to come up with the theory of relativity. There is no Nobel prize for finding an original idea. The market will reward an idea if it is good, irrespective of the source.
So where do I steal my ideas from?
For starters from other fellow value investors such as
Ninad Kunder
Ayush mittal
Amit arora
Neeraj marathe
TIP blog
Prof bakshi’s blog
I usually read their blogs on a regular basis and if there is an idea posted by them, I will start investigating it further. These are smart investors and I would be stupid to ignore the ideas posted by them. These ideas have already been analyzed, so I know that they are very likely to be attractive.
I will not buy these stocks blindly, but it’s a good starting point for further analysis
Now, coming back to more mundane things, I am often asked – where do I find my investment ideas ?. I would say that I find my ideas via two methods – Find and borrow (or steal).
Finding ideas
I have a fairly low tech way of finding ideas. I have a simple spreadsheet in which are listed companies by PE, market cap, profit etc. I use the following screener to generate a list based on the following criteria
Criteria : PE greater than 15, ROE less than 12%, and debt/Equity ratio less than 1.2
Correction : PE less than 15, ROE greater than 12%
Once I have the initial list, I eliminate some companies based on following the criteria
- Any company with losses for more than 2 years, sales degrowth or management issues etc.
- Micro-cap finance/ retail/ commodity companies as these companies are too risky and one has to analyze a long list, before one can find a good idea.
The above step has its shortcomings such as filtering out turnaround situations, but one has to have some cut off to get a manageable list
Stealing ideas
I am no Albert Einstein or a physicist trying to come up with the theory of relativity. There is no Nobel prize for finding an original idea. The market will reward an idea if it is good, irrespective of the source.
So where do I steal my ideas from?
For starters from other fellow value investors such as
Ninad Kunder
Ayush mittal
Amit arora
Neeraj marathe
TIP blog
Prof bakshi’s blog
I usually read their blogs on a regular basis and if there is an idea posted by them, I will start investigating it further. These are smart investors and I would be stupid to ignore the ideas posted by them. These ideas have already been analyzed, so I know that they are very likely to be attractive.
I will not buy these stocks blindly, but it’s a good starting point for further analysis
In addition to the above sites, I also look at the follow general sites/ forums or magazines for any interesting ideas
- TED ( The equity desk)
- Moneylife
- Livemint and other papers
Now, if you were expecting me to be sitting in splendid solitude and contemplating about original stock ideas, you must be disappointed :) . Why should I only buy good idea which I find on my own, when there are other smart investors sharing their ideas freely ?
The only additional principle I follow is that if I steal – sorry borrow, an idea, I will recognize the source.
Accidental timing
- Moneylife
- Livemint and other papers
Now, if you were expecting me to be sitting in splendid solitude and contemplating about original stock ideas, you must be disappointed :) . Why should I only buy good idea which I find on my own, when there are other smart investors sharing their ideas freely ?
The only additional principle I follow is that if I steal – sorry borrow, an idea, I will recognize the source.
Accidental timing
I discussed about deccan chronicles and Geojit securities last week . These stocks have since then gone up by 5-10% in a week. Talk about accidental timing !.
Just as I have absolutely no hand in India’s world cup win, I also don’t have any ability in picking a stock just before a sharp upmove. In both cases, I have been a spectator. I have yet to invest a single rupee in these stocks – So much for my timing skills !!
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