Coffee can investing

 List of Abbreviations

AIF           Alternate Investment Fund 

AMFI        Association of Mutual Funds in India

AUM        Assets Under Management 

B2B          Business to Business

BSE          Bombay Stock Exchange

B2C          Business to Consumer

BPs          Basis Points 

CAGR      Compounded Annual Growth Rate

CCP         Coffee Can Portfolio

CFI           Cash Flow from Investing 

CFO         Cash Flow from Operations

CWIP.       Capital Work In-Progress

DCF.        Discounted Cash Flow

EBIDTA   Earnings before Interest Depreciation Tax and Amortization

EBIT        Earnings before Interest and Tax

EMI          Equated Monthly Instalment

ETF           Exchange Traded Fund 

F&O          Futures & Options

FD             Fixed Deposits

GDP.         Gross Domestic Product 

IMF           International Monetary Fund

InvIT.         Infrastructure Investment Trust

M&A.         Mergers & Acquisitions

MF             Mutual Fund

MTM         Mark to Market

NCD          Non-Convertible Debentures 

NCR          National Capital Region

NDA          National Democratic Alliance

NOI            Non-Operating Income

NSE           National Stock Exchange

P/B multiple        Price-Book Value Multiple

P/E Multiple.       Price-Earnings Multiple

PAT            Profit After Tax

PBIT           Profit before Interest and Tax

PEG ratio              P/E divided by expected earnings growth of a stock.

PMS            Portfolio Management Service

REIT            Real Estate Investment Trust 

ROA             Return on Assets

ROCE           Return on Capital Employed

ROE            Return on Equity

SEBI          Securities & Exchange Board of India

SPV           Special Purpose Vehicle 

TSR           Total Shareholder Returns

ULIP.          Unit Linked Insurance Plan 

YTM          Yield to Maturity.

COFFEE CAN INVESTING

All of us need to set aside some money for a rainy day, I strongly believe it should be done by investing in Government bonds and conservatively managed liquid funds.

The best time to plant a tree was the 20 years ago. The second best time is now.

The key was to quantify everything since reality is different from perception. (The first thing is to quantify one's net worth.)

Stock appreciate when one least expects them to. And they do not appreciate evenly.

Seven basic investment mistakes most of us make:

(i) No clear investment plan.

(ii) Trading too much, to often.

(iii) Lack of diversification.

(iv) High commission and fees.

(v) Chasing short term returns.

(vi) Timing the market.

(vii) Ignoring inflation and taxes.

Ch.2

An investment in knowledge pays the best interest.

He isn't a smart investor who let his emotions get the best of him and swayed by the irrationality of the crowd.

Successful equity investing largely hinges around answering two simple questions: 

(Q) Which stocks should I buy? 

---> a) A business we understand;

b) Favourable long-term economics; 

c) able and trustworthy management;

d) a sensible price tag;

e) A truly great business must have an enduring "moat" that protects excellent returns on invested capital;

f) Long-term competitive advantage in a stable industry is what we seek in a business.

AND

(Q) For how long should I hold the stocks I bought?

---> When we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds.

Unless a stock reaches an absurd valuation or if something fundamental has changed in the business environment for that company or something critical has changed in the company's growth outlook, we prefer not to sell stocks that we own. Our view is that there are a limited number of companies in India where everything lines up... good business, capable and ethical management, you have access to the management: such combinations do not come that often.

COFFEE CAN PORTFOLIO

We will limit our search to companies with a MINIMUM MARKET CAPITALISATION of Rs 100 CRORE, then, we look for companies that over the preceding decade have GROWN SALES EACH YEAR BY AT LEAST 10 PER CENT alongside generating RETURN ON CAPITAL EMPLOYED (pre-tax) of at LEAST 15 PER CENT.

(It is important to note that we are not looking for companies that have grown sales over a ten-year period at a compounded annualized rate of at least 10 per cent. Instead we are looking for companies which have grown sales every single year for ten consecutive years by at least 10 per cent.)

For banking stocks.

ROE of 15%

Loan growth of 15%

historical data suggests the Coffee Can Portfolio offers more than a 95 per cent probability of generating a positive return as long as investors hold the portfolio for at least three years. If held for at least five years, there is more than 95 per cent probability of generating a return greater than 9 per cent.

When it comes to investing in stock markets, greatness is defined as "the ability of a company to grow whilst sustaining its moats over long period of time"

"If the business earns 6 per cent on capital over forty years and you hold it for those forty years, you're not going to make much different than a six percent return even if you originally buy it at a huge discount. Conversely, if a business earns 18 per cent on capital over twenty or thirty years, even if you pay an expensive looking price, you'll end up with one hell of a result."

Earnings is the biggest driver of stock market returns in the long run.

Having established earnings as the biggest driver of share prices, the next question to be answered is: What drives earnings growth? Intuitively, one might imagine that 'earnings growth' is an independent metric -- the more products or services can sell, the more revenues you book and the more profits you deliver!

Rather than considering earnings growth as an independent metric by itself, it is more useful to see earnings growth to be an outcome of two independent parameters---growth in Capital Employed in a business and the firm's ability to generate a certain Return on the Capital Employed (ROCE). As a result, 'earnings growth' can be achieved either by growing capital employed whilst maintaining ROCE, or by growing ROCE through enhanced operating efficiencies whilst maintaining the firm's capital employed.

Here are four compelling factors that go against churn in a portfolio composed of great companies.

(i) Higher probability of profits over long period of time.

(ii) Power of compounding.

(iii) Neutralizing the negatives of 'noise'.

(iv) Transaction cost.

Starting-period valuations have very little impact on long-medium run investment returns in India.

The Coffee Can Portfolio is skewed towards specific themes by design.

(i) More B2C than B2B

(ii) More structural rather than cyclical.

(iii) Avoiding companies that borrow lots of money to grow.

As discussed in the preceding pages, a Coffee Can Portfolio constructed today needs to be invested equally in all the stocks mentioned in this list. This portfolio should be left untouched for the next ten years regardless of how well or badly it does in a short-term period within this ten-year holding period.

Ch 3

Beware of little expenses. A small leak will sink a great ship.

There are primarily three types of expenses that the investor, knowingly or unknowingly, pays for:

(i) Transaction fees

(ii) Annual fees

(iii) Hidden fees

Expenses compound too.

In the case of mutual funds, the service is the 'outperformance' that the fund manager is able to generate for you. Note that our focus is on outperformance and not just the performance of the fund.

The developed markets in the US and Europe are nearly there after over two centuries of evolution. As a result, in these markets, actively managed funds have no edge over index ETFs

Ch.4

Real estate is a uniquely dangerous asset class for investors for the following reason:

(i) Investment size

(ii) Liquidity

(iii) Transaction cost.

(iv) Non standard asset: An ounce of 24-carat gold will appreciate at the same pace in your hand as it will in the hands of another investor. An Infosys stock will give you the same appreciation as it will to anybody else who holds it. However, real estate is very non-standard. It varies across macro markets (like Mumbai versus Delhi), micro markets (Bandra versus Lower Parel) and even across streets and neighbourhoods. This makes it a very unpredictable asset class and returns are driven as much by luck as by thought out investment decisions.

Ch.5

'At the end of the day, small business success should just be a way station on your way to large business success.'

Small cap has outperform large cap in 5year CAGR. 

Over the past eight years (2009 to 2017), the BSE small-cap index has beaten the BSE 100 by 4.6 per cent per annum.

The scope for generating superior long term investment returns is significantly greater with small caps (relative to large-caps), the need for professional help is disproportionately greater than is the case with large-caps.

The probability of a positive return from BSE Sensex over the past thirty years (1987-2017) has risen exponentially as we increase the holding period from one month to ten years.

PATIENCE PREMIUM

* The one-year investment horizon has the widest range of equity returns, from a peak of 256 per cent delivered over April 1991 to April 1992 to a trough of -56 per cent delivered over December 2007 to December 2008. The one year investment horizon can be an intense roller-coaster ride.

* The range of equity returns narrows over the three-year investment horizon from a peak of 62 per cent (CAGR) delivered over January 1991 to January 1994 to a trough of -18 per cent (CAGR) over April 2000 to April 2003.

* The range narrows considerably over the five-year investment horizon. The early '90s saw some of the highest returns, with a peak of 47 per cent (CAGR) recorded in the period spanning October 2002 to October 2007 and a trough of -8 per cent (CAGR) recorded over August 1997 to August 2002.

* The range of returns narrows further in the seven-year rolling period. The highest return of 29 per cent (CAGR) was delivered over October 2002 to October 2009 and the lowest of -7 per cent (CAGR) was recorded over September 1994 to September 2001.

* The ten-year rolling period offers the tightest range of returns with least returns at -3 per cent (CAGR) over April 1992 to April 2002. The peak return of 21 per cent (CAGR) was earned in the period spanning May 2003 to April 2013. The ten-year rolling period is also the period with the highest median return of 13.1 per cent.

The key message is that whilst both portfolios- the Sensex and the CCP-produce better returns (alongside lower volatility) if held longer, the CCP beats the Sensex by a wide margin when it comes to producing superior returns (with its volatility being even lower than that of the Sensex). An investor who is able to combine patience with high-quality portfolio construction thus pulls off the holy grail of investing outstanding returns with low levels of volatility. That is the essence of the Coffee Can Portfolio.

--- Investing for long periods of time in high-quality portfolios.

--- with a higher weightage to high-quality small-cap companies.

--- While ensuring that you don't pay too much by way of fees

--- and avoiding investment traps like real estate and gold

--- Should lead to significant and sustainable wealth creation.

GOALS.

1. Security: These goals are extremely important to us and provide protection from anxiety. 

2. Stability: These goals are not as important as the security related goals; however they ensure that we maintain a desired standard of living.

3. Ambitions: These goals may not be necessities but they help us achieve upward wealth mobility and give us a certain status in our social circle.

Smaller companies have outperformed larger-cap companies albeit with higher volatility.

Small-cap mutual funds continue to outperform their benchmark, the BSE Small-Cap Index.

There are a number of hidden gems(small cap stocks) waiting to be discovered in this ocean of stocks.

The Good and Clean framework

There are two filters that are run on the whole universe of stocks:

--- 'Good': helps in identifying stocks that have done a great job in creating shareholder value-right from judicious capital expenditure to profitability and to return of surplus cash to shareholders.

--- 'Clean': helps in identifying how good the company's corporate governance is and what the quality of their published accounts is. It is a measure of the long-term sustainability of a company and its performance.

The central theme in all our chapters is the power of compounding,

Large-cap stocks will be the anchor for most investors, mid- and small-cap stocks have the potential to give super-normal returns to the investor.

Create a financial plan which helps you deliver on your life goals. Unless you do so, you will be shooting in the dark. A financial plan helps you quantify and rationalize your life goals. It also helps you set up a return expectation from your investment portfolio so that you can build an appropriate portfolio with just the right amount of required risk-no more, no less.

It is important to link your investment style with your financial objectives; otherwise you will end up either taking unnecessary risks or undershooting your financial goals. The essential link between your investment style and your financial objective is made through financial planning.

We have made the Ambit Financial Planning Tool freely available at www.ambit.co/fp/ambitfp.xlsm. This tool helps you build your own financial plan with the help of basic information like your annual cash flows (primarily your income and expenses), your liabilities (primarily the loans you have taken), your assets (including your house, shares, mutual fund portfolio and any other investments you have made) and most importantly your goals (which include your financial as well as personal goals).

We take the universe of listed stocks with market capitalization of more than Rs 100 crore and look for companies that meet these parameters:

a) Revenue growth of 10 per cent and ROCE of 15 per cent every year for non-financial services companies, or 

b) For financial services companies, ROE of 15 per cent and loan book growth of 15 per cent every year.

---- Saurabh mukherjea