Value Investing in India
I have often wondered as to what is the best way to invest in the stock markets:
- Should one buy undervalued stocks and then hold, maybe for years (Value Investing); or
- Should one buy stocks that are trending up and then sell as soon as the desired short-term return is achieved and then move on to the next big idea (Trading mentality).
As they say, the proof of the pudding is in the eating. Warren Buffett has become the richest man (before he donated a substantial part of his fortunes to the Bill and Melinda Gates Foundation) following the principles of Value Investing, as enshrined in the Security Analysis, written first in 1934 by his gurus at University – Benjamin Graham and David L Dodd. Why then are there so few followers of this time tested technique. As mentioned by Glenn H Greenberg (a Value Investor) in the Introduction to Part V of the Security Analysis (Sixth Edition), the answer lies in three human traits:
1. Aversion to boredom
I once asked a banker friend as to why did he invest directly in the markets, when he advised most of his clients to go the mutual fund route. The answer to that was, “While mutual funds are passive and boring, stock market investing really gets my adrenaline flowing high.”
Value Investing can be boring and cumbersome. Careful research takes time and seldom results in a clear case for buying a large position. It is tedious to review company after company, only to find that most are neither really special nor greatly undervalued. It is equally tedious to hold shares in a good company for an extended period. My “smart” friends often ask me as to why I did not sell when the market was trending up and then buy back the same share once it went down. Wish I were “GOD” !!
It is my firm belief that momentum traders only end up making their broker and their doctor rich. The broker earns high brokerage fees, through substantial rounds of trading. The doctor of course makes her money once the momentum trader is struck by a heart stroke.
On the contrary, Value Investing has led to high returns on a consistent basis. The stock of Bharti Airtel, debut at 55 in 2001, went all the way down to 21, but then rose from the ashes to touch a high of about 1200, (22 times return all in 7 years time). And this is not a one-off. Most of us know that PSU stocks, such as ONGC, IOC used to trade in double digits during the 90s. Only if we had the courage, patience and the sense and conviction to pick up these stocks trading at such low valuations!!
Not satisfied. Check out some of the investments made by the legendary Oracle of Omaha (Warren Buffett):
a. Multiplied his investment in Coca-Cola 15 times in around 21 years.
b. Multiplied his investment in Washington Post 81 times in around 36 years.
In the words of Graham and Dodd, “Obviously it requires strength of character in order to think and act in opposite fashion from the crowd and also patience to wait for opportunities that may be spaced years apart.”
2. Tendency for emotions to overwhelm reason
Greed (in times of irrational exuberance) and fear (during times of a market bust) often tend to shroud one’s ability to make rational decisions. 2008 and 2009 were the best examples of this statement. We bought when we should have sold and sold when we should have bought. How often have we felt mighty intelligent when the latest stock that we purchased has doubled in price and we end up buying more. Or, conversely, how dumb have we felt, when the last stock that we purchased has halved in value. (Wonder why anybody would not want to buy more of anything that is now available at half the price?) Part of the problem lies in the fact that the stock price is quoted 61/2 hours a day, 5 times a week and 52 weeks a year and the tendency toalways act. We of course do not want to be seen as lazy fools. Besides, when we do not tend to value our private businesses so regularly, then why value shares, which are nothing but part ownership in a business, so often.
Greenberg holds the hedge fund culture for the building up of excessive greed. Investors in these funds are usually sold on the premise of exceptionally high returns, being absolutely oblivious of the risks being taken. This was amply evident in the crash that we experienced in 2008. Besides, hedge funds tend to move in and move out of investments with alarming speeds. Thus, timing is of essence. If you get the timing wrong, it can lead to very high losses. On the other hand, investing is concerned with thorough investigation of an investment idea. Greenberg states a hilarious anecdote about hedge fund managers in the Security Analysis, “I once attended the US Open and sat near two hedge fund managers whom I did not know. They were talking shop during the match, and much to my surprise, their discussion focused exclusively on assets under management and fees. I kept waiting for them to mention an investment idea, but it never happened.”
I have often been bamboozled (with due regard, that word has been borrowed from the lexicon of Navjot Singh Siddhu, a cricketer of yesteryears) as to how most of us are so fixated with return, with complete disregard to the risk involved. Surely, smuggling from across the border could make me rich overnight, but then it also involves extreme amounts of risk.
Again to borrow from Greenberg, “With so much information available, there is a tendency to act too quickly to buy and sell in haste, and to substitute the views of others for the hard work necessary to come to one’s conclusions. (To quote the legendary Indian investor, Rakesh Jhunjhunwala, “One cannot make money based on borrowed knowledge”) Perhaps this is why so many market participants can be described only as “traders” and “speculators”, unafraid of using debt to turbocharge returns. This method requires frequent profitable trades, after transaction costs (in terms of high brokerage costs), and incurs far higher taxes than the long-term investor pays.” Mind you, if one sold shares after holding them for a period of more than a year, the gains are tax free in India. On the other hand, a trader would have to pay tax at the normal marginal rate. This in itself could lead to a return differential of about 20 – 30 %.
Trading mentality leads to heavy emotional wear and tear and lets the market ups and downs run our life. A friend once told me that market performance could be judged based on the crowd at the samosa stall outside the stock exchange. Besides, one would rather enjoy quality family time, which becomes impossible if one is tracking a flock of trading positions about which one has little conviction.
Warren Buffett once said, “The stock market is not a weighing machine, but a voting machine.” And the markets just voted in 2008.
The author, Gautam Khandelwal, is a financial markets/taxation expert and CEO of Prithemius Consulting. He can be contacted at firstname.lastname@example.org