It has been a long time since I added anything new to this website. There was a reason for it – there was very little fundamentally new to add. For a value investor, life is quite simple. Buy value and diversify. And wait for market to catch up. That’s pretty much it.
However over the last few years there have been some concepts, ideas and notions that I am either convinced works or am convinced that they merit further attention.
As always, I don’t want to impose my stupidity on you. Think for yourself. Here are a bunch of such ideas:
1. Diversification reduces returns
This idea has been shot dead. The notion of diversification reducing returns is simply false. Diversification DOES NOT reduce returns. There ain’t any other way to put it. It increases the probability of good returns. If you want good returns, then diversify. If you want great returns, then diversify.
However, know the limitation of diversification as well. When is diversification not appropriate? When you are looking for a 2-5x bagger in a 1-2 year time frame.
It is as easy to put together a 50 stock portfolio as it is to put together a 10 stock portfolio. Why? Because when markets overreact they give plenty of opportunities across sectors and market caps. Generally when value is available, a bunch of value is available.
So how diversified can you get? That is your choice indeed. Choose diversification as per your comfort. I can easily build a diversified portfolio consisting of 50+ value stocks. Diversification also gives a good indication of market being overvalued. If I cannot find 50 stocks that I like at any time, it means the market is likely to be overvalued.
2. Asset allocation
Earlier I would get pretty excited about value stocks and would load up to the extent possible at first chance. I have now changed my strategy such that there is always reserve cash to buy when stocks fall further. I am convinced that a 50% – 50% allocation between stocks and cash/debt is wonderful starting point. Nothing new here. Benjamin Graham had mentioned this decades ago and like most things Graham said, they have stood the test of time.
3. Investing like Warren Buffet with help from Benjamin Graham
This idea is not for someone who wants to be an active investor. This is for someone who wants to do well following a good strategy while spending the least amount of time possible. Think for a minute about why Warrent Buffett is where he is? Is it because he can identify great companies? No. It is because he can value these companies correctly and snap them up at the right time. So let us say I am a dud at valuation. But I can nevertheless find companies that Warren Buffett may like.
It doesn’t take an IQ of 250 to figure out that these are great companies:
Asian Paints Ltd.
Britannia Industries Ltd.
Castrol India Ltd.
Colgate-Palmolive (India) Ltd.
Dabur India Ltd.
Glaxosmithkline Consumer Healthcare Ltd.
Godrej Consumer Products Ltd.
Nestle India Ltd.
Procter & Gamble Hygiene & Health Care Ltd.
I could add more to this list (say ITC, HUL etc.), but for now let us just stick with this list. These companies have the characteristics that Buffett looks for in a company before he buys it. High return on equity and competitive advantage. The only thing we are missing is the VALUATION at which the company/stock becomes a buy.
The idea here is to utilize the penchant of stock market to grossly overvalue/undervalue stocks and use it to our advantage. The idea is to do a classic 50-50 split between the stock and debt for these companies and rebalance when it reaches 45%-55% in either direction. Even if our starting point is not right, over a period of time, as the stock moves up and down in an erratic manner, we benefit by buying low and selling high.
4. Technical Analysis is Nonsense
Yes, I killed this idea. Coming for a self proclaimed value investor, this might be seem crazy. But I feel there is an element of truth in Technical Analysis.
Now before everyone starts abusing me, I am not talking about those vague slopes that one draws about in a chart.
I had always come across Technical Analysts that looked at a graph, drew some lines across and proclaimed “this is the upward channel” or something to that effect. This, to me, was unadulterated BS. The engineer in me went – just change the angle by a few degrees and the results would be drastically different. Everyone could draw the lines differently. TA seemed very much like astrology.
But what if there was a precise mathematical way to define variables, such that the results are always consistent (not right, mind you, just consistent). What if after doing such an analysis one comes to the conclusion that the results are much much better than be explained by randomness.
I stumbled upon these books:
Mechanical Trading Systems – Richard L. Weissman
Quantitative Trading Strategies – Lars Kestner
Way Of The Turtle – Curtis M. Faith
I analysed these concepts in the context of Indian stocks. I was surprised by the results. Now I can say with great amount of certainty that TA is not nonsense. That doesn’t mean that TA is way to go. But now I do not completely scoff at those who say I look only at technicals.
Ideas I am still experimenting with:
1. Using stop loss
For a value investor, stop loss is an anathema. I have not used stop loss so far. I have always averaged down – and with great success. But is that optimal? I am doing some research on this.
2. Combining Value and Momentum strategies
I am testing out some strategies that combine value and momentum concepts. Early days but seems like it is possible and a good idea to do that.
3. Money Management as an edge
Recently I became convinced that money management itself can be used as an edge. Is it possible that stock selection is grossly overrated? Can one use money management techniques, use a random entry on selected stocks or choose stocks at random and still make money with a sensible money management strategy?
I am exploring this idea …
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