Balkrishna Industries – Nov 2014

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Dear Investor,

I’m quite proud of my Sept 2013 report on Balkrishna Industries. (link) We found this interesting Small Cap stock early. The share price was Rs 238. It had all the ingredients we look for in our investment research.

Small cap. Undervalued. Unknown. In the right sector. Good management.

We made this report public on this very website.

On 12 Nov 2014, this share touched Rs 855.

And we were staring at a 259% gain in a mere 14 months.

 

As usual, Mr Market threw in a googly.

On 13 Nov, Balkrishna came out with its Q2FY15 results. Next day, the share plunged by 16%. One day later it dropped further. A total of 29% wiped out in 2 days.

Investors are nervous about this firm. Perhaps even panicking. Naturally. Who likes to lose 30% of one’s investment in 3 days? So should one exit quickly? Or buy more of Balkrishna? Or just do nothing?

Subscribers of JainMatrix Investments aren’t worried. They’ve just got our follow up report on Balkrishna Industries. They know what to do.

 

JainMatrix Investments is today one of India’s best Equity advisory Investment Services in terms of quality of research, track record and reasonable costs.

JainMatrix Investments is the essential service for the Indian equity investor. 

 

Subscribe now to navigate the profitable but tricky Indian equity markets.

But hurry. There are just a few more subscriptions available. Join this select group of informed investors. 

 

This is an opportunity for you.

Punit Jain

Founder, JainMatrix Investments

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High Risk and High Return in Equity

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Here is a short article that re-examines the myth of High Risk and High Return in Equity.

What is Risk?

Risk defined by Investopedia is “The chance that an investment’s actual return will be different than expected. Risk includes the possibility of losing some or all of the original investment”.

One of the rules that is commonly believed is that ‘higher risk needs to be taken in order to earn higher returns’. This is intuitively obvious. The entrepreneur invests in a new business knowing that there is a probability of failure. The Venture Capitalist invests in a portfolio of businesses knowing that some may give him 30X returns and others may fail.

But lets review this in the context of Equity investments.

Asset Classes

In investing, this risk-return rule is true across asset classes. The following graphic Fig 1 illustrates the Risk and Return rankings across different asset classes. Fig 1.

JainMatrix Investments

Fig 1 – Asset Classes (click to enlarge) JainMatrix Investments

  1. Here we can see that Cash is the safest asset.
  2. FDs come next, as they are of fixed duration and fixed returns, guaranteed by a Bank.
  3. Next come Debt, Bonds, and Endowment Life insurance. Insurance of course is a very high gestation investment product.
  4. Debt and Bond MFs are products packaged by the Mutual Fund industry into Units.
  5. Gold and Gold ETFs are another investment option.
  6. Real estate may come next. It of course varies by location, and commercial/ residential.
  7. Equity ETFs and Equity MFs.
  8. Direct equity is the highest risk investment product. It also provides potentially the highest returns of these asset classes.

Note that these are strictly the author’s personal views of the most likely scenarios, and these may vary under different circumstances. The graphic Fig 1 is only a conceptual map, and indicates relative values.

Risk in Equity

Direct Equity as an asset class has two types of Risk:

  1. Systemic risk is applicable across all sectors. A significant political event, for example, could affect your entire equity portfolio. It is virtually impossible to protect yourself against this type of risk.
  2. Unsystematic risk is sometimes referred to as “specific risk”. This kind of risk affects a few of the assets. An example is news of a sudden strike by employees, that can only affect a specific stock. Diversification is the only way to protect yourself from unsystematic risk.

Even equity can be split into equity classes, where the risk profiles are different, see Fig 2. Speaking in general, Large Caps are most stable, and have lower risk, next are Mid-caps and next Small caps.

JainMatrix Investments, Equity Risk

Fig 2 – Equity Risk (click to enlarge) JainMatrix Investments

The Risk-Return Relationship

However, once we look at individual stocks for investing, higher risk may not give higher returns.

  1. The high performing firms in the stock exchange over longer periods are those that are more predictable in terms of growth, costs, investments, new projects and brand strength.
    • Example – HDFC Bank over the period of 2009-13 has given fairly predictable 30% YoY growth in profits. As a result investors gave it a superior valuation and it became the bank with the highest market capitalization, even though it was smaller than peers on other parameters.
  2. Sharp swings for a firm from profit to loss and the reverse too are not seen positively, especially if these happen unexpectedly.
  3. The ability of growth companies to execute on new initiatives is very important. Such firms need to launch in new markets, create new products or set up new manufacturing plants. Here the track record of such firms in these initiatives is important.
  4. Monopolies are seen as very positive situations for firms.
    • Example – ITC has for several decades dominated the Indian cigarette industry with 75-80% market share. This is a profitable and steady growth industry and so the ITC share has performed well over 10-15 years.
  5. Typically the fundamentals based approach to the stock market involves projecting financials for a company over 1-3 years, assigning target prices and identifying high potential investments.
  6. Warren Buffet has taken predictability to the extreme by investing in a bunch of consumer companies (Coca Cola, Procter & Gamble, Kraft Foods, Wal Mart, etc.) where these products are strong brands that are daily consumption habits and so growth is quite predictable over decades rather than years.

The Role of the Equity Researcher

It is the task of an equity researcher to identify, prioritize and assess the risks associated with an investment in a firm. Thus a good equity researcher is actually able to lower the ‘specific risk’ of making an investment, identify potential situations of a company’s future and increase the chance of profitable investments.

JainMatrix Investments approach to Investing

  1. The JainMatrix Investments approach to investing is to start with a top down approach to first identify the attractive sectors that are likely to outperform the next 1-3 year perspective.
  2. Next we drill down to the company level to analyse the fundamentals of firms and identify outstanding Large, Mid and Small cap firms. This research is published periodically.
  3. From this universe of good firms, a few are hand-picked and sorted into Model portfolios. By aligning the portfolios with their risk appetites, we help investors invest better.

Large Cap Model Portfolio

  • The objective of the LCMP is to outperform the Sensex and Nifty by 5-10%.
  • It consists of 7 large cap shares which are the current or future leaders from attractive sectors of the Indian economy.
  • This is a low risk portfolio.

Mid and Small Cap Model Portfolio

  • The objective of the MSCMP is to outperform the Mid and Small Cap indices by large margins.
  • It consists of 7 mid and small cap firms that are emerging out-performers from identified 3-5 high potential sectors.
  • This is a medium to high risk portfolio.

The performance of these portfolios over the last 20-21 months has been excellent –

JainMatrix Investments Model Portfolios

Fig 3 – JainMatrix Investments Model Portfolios

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The Rationale behind a SELL decision

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With the Indian markets pushing to new highs over the last 6 months, its time to ask a loaded, important, yet difficult question.

When should you SELL your stock?

I assume here that you are a long term investor. You are growing your equity portfolio from a minimum 3 year perspective and want to see it meet your big life goals.

Of late you would have looked at your nest egg with a glad eye. In the last 6 months, chances are you have been surprised at the excellent performance of these stocks. It is in these very happy times that you should note the importance of a Sell decision. After all it is very difficult to Time the Market. In stocks it is important to think contrarian. It makes more sense to decide for yourself on your sell decision, execute on it and be satisfied with it.

On a personal note, my favorite holding period for a stock is forever. This is a wisdom gained from the greats of investing. However there are some practical and real situations that we can face. The Indian market is more volatile than the ones the greats live in. These are the situations where you need to think of the Sell decision, and take a call. Here they are:

1. You need the Cash urgently 

The best of well laid out plans can get interrupted. It could be a medical condition. Or education admissions time. Or it could be a desired asset that has become available. Go ahead, and sell. You have earned the luxury of encashing your Demat balance.

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2. Maintain your asset allocation 

Asset classes are varied such as Direct Equity, equity mutual funds, debt/ bond mutual funds, Gold ETFs, real estate, fixed deposits, insurance and cash. You may in consultation with your ‘Investment Adviser’ have agreed to maintain your asset classes in a certain proportion. So when the time comes to re-allocate, its possible that selling of Equity is the call by the agreed formula. This is good, and can help you align your portfolio risk with your personal risk appetite and objectives.

3. Switch to a stronger share 

For a long term investment portfolio, your objective should be to enter into investments with a chosen set of stocks. Read up and track them. And always be on the lookout for a better investment idea. If one comes by and you are convinced, make a switch from a weaker stock to a stronger one. It could be from the same industry. Or even an industry change. You now have a stronger stock portfolio.

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4. Tax considerations 

In India any listed stock investment when sold at a profit after holding for one year constitutes a Long Term Capital Gain, which is not taxed. The one year period should be noted & considered before deciding to Sell.

Sophisticated investors may also consider the converse situation. A Short Term Capital (STC) Loss can be declared in case a loss is booked in an equity investment for a period less than one year. This can then be set off against a STC Gain, in the same year or (by carry forward) in the next few tax years. Speak to your Chartered Accountant before using this strategy.

5. Exceptional gains from a stock 

If you are invested for the long term in a number of stocks, you may be witness to a lot of stock specific activity that can be quite interesting. If your stock has recorded massive recent gains, which are difficult to justify on the basis of fundamentals, it may be time to book partial or even full gains in the stock. Things happen. Shares can appreciate suddenly and unexpectedly. This is a good problem to have. Greed may stop you from doing this. This is where good advice from your Equity Service can be useful.

(JainMatrix Investments is an Equity Service that tracks 3 portfolios for its subscribers, the Large Cap Portfolio 2014, the Mid Cap Portfolio 2014 and the Post Elections Investment Seven)

6. Business has deteriorated (but does not reflect yet in the price) 

You got some good equity research, assessed an opportunity and the risk, and decided that XYZ stock was a great investment. Six months later, something unexpected happened. Maybe one of your investment assumptions went wrong, or an industry specific regulation change, or such. And the future doesn’t look so good for XYZ now. Review the situation with inputs from your Equity Service. Bite the bullet. If justified, take the Sell call. Don’t get married to your stocks. You have to be solid yet nimble in your long term investment decisions. Get out quickly to minimize your losses.

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7. The share price has fallen sharply 

Markets, and shares, by nature are volatile. If the share you hold has seen a sharp fall in price recently, this needs to be analysed. If the fall is due to temporary reasons, like some bad publicity over a minor issue, a temporary technical correction or such reason, then it can be ignored. It may even be a good point to accumulate more shares. But if the reason for the fall is found to be due to a ‘fundamental’ deterioration, then again it may be time to exit.

8. The market changes direction for the worse 

Sometimes the market reaches an inflection point and changes direction. If it is positive like the recent elections schedule announcement then its good for your portfolio. But if it is negative then it may be time to exit, at least partially. This is a tough call to predict. Here again, you can review the situation with inputs from your Equity Service.

Having said all this, it is in the nature of stocks to see long periods of both under and over performance. The market is very very inefficient, and this gives good value and growth investors in India lots of opportunities.

The Converse, a few reasons why you should NOT Sell your stocks in these times:

  1. You can get 10 baggers only if you leave your high potential appreciating stocks alone and let them fly.
  2. If the Modi government delivers on their potential, promise and visibly bold approach, the party for Indian investors has just begun.
  3. For a long term investor, a short term correction of say 10% is not something to worry about. Markets move in a ripple or zig-zag fashion in the short term, but pan to the multi year view, and the Indian indices haven’t looked so bullish since 2004-05.
  4. Valuations for the Indian indicies are just above the average. If the investment cycle is kick starting again, aided by a Modi government, earnings will accelerate and valuations may stay just above average even if the Indices forge ahead sharply.
  5. Indian Retail, hurt by the dull period of 2008-12 and big damaging overpriced IPOs, is just about starting to join this market rally, if MF numbers are anything to go by. Picture abhi baki hai mere dost.

Overall Opinion

  • Stay positive.
  • Book partial gains in some stocks.
  • Temper future expectations from Indian Indices after the recent run up.
  • Watch for cues from the budget.

But as usual there are no easy answers.

Happy Investing,

Punit Jain, JainMatrix Investments

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Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an independent Financial Expert/Advisor. Either JM or its affiliates or its directors or its employees or its representatives or its clients or their relatives may have position(s), make market, act as principal or engage in transactions of securities of companies referred to in this report and they may have used the research material prior to publication. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com