Monday, April 22, 2019

Book Review #40: The Most Important Thing Author:Howard Marks

Book Name: The Most Important Thing:  Uncommon Sense for the Thoughtful Investor

Author: Howard Marks

Published by: Harper Business

ISBN: 978-9-35-302279-2 (Print)

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This book gets rating of 3/5

This is the review of the book 'The most important thing - Uncommon sense for the thoughtful investor', written by Howard Marks. Mr.Marks is a famous investor who is the co-founder of Oaktree Capital Management that he and his friends started in 1995. This book is an elaboration of various memos that Mr.Marks wrote to his investors over the years. Each memo deals with one thing that he considers to be the most important thing in investment. There are 19 'Most Important Things' covered in this book.

In comparison to other books that I have read in the genre of finance and investments, this is a much lighter read, devoid of any math. Personally I did not find a lot of value in this book since almost all of what I read in this book is covered in other books. However considering that this book has sold over 4.5 Million copies, it has to find a place in the list of finance books that I review as a part of my project.

Monday, April 15, 2019

LTCG on Equity Shares India: Example Calculations

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If you have purchased shares before 1st April 2018 and have sold them in the FY 2018-19, based on the date of purchase, you may be expected to pay Long Term Capital Gains Tax on the sale of those shares.The calculation of LTCG tax is complex with words like Fair Market Price and Cost of Acquisition being thrown in.

In this post I am trying to declutter the tax calculation with a few examples. Remember, these are based on my understanding. I am not an auditor and this is not professional advise. Kindly verify the numbers with your auditor.

The key to calculation of LTCG is the 'Cost of Acquisition'. This is calculated as per Formula 1 given below

Formula 1: Higher of Original Purchase  Price and ( Lower of the highest prices on 31-Jan-2018 and the Sales Price)

And LTCG is calculated as Formula 2:  [(Sales Value - Selling expenses) - (Cost of Acquisition + Purchase Expenses)

Little confusing. I request you to read the above two sentences again. First one talks about calculating the Cost of Acquisition and second one talks of using that value to calculate the LTCG.

Let us look at some examples:

Example 1: IPO Purchase and additional purchases in secondary market

Subbu got 199 Shares of  of Coal India allotted on 20-Nov-2018 at an IPO price of 233. Later he purchased 301 shares of Coal India on 22-Sep-15 at an average price of 339.65. The highest price of Coal India on 31-Jan-2018 was 304.55. He sold off the entire 500 shares on 24-Sep-18 at an average price of 278.55.

This set of transactions is eligible for LTCG. Let us calculate the LTC Gain or Loss.

Step 1. For 199 shares received in IPO

1. Original Purchase Price: 233
2. Price as on 31-Jan-2018: 304.55
3. Sales Price: 278.55
4. Lower of 2 and 3: 278.55
5. Cost of acquisition as per Formula 1: Higher of 1 and 4: 278.55
6. Purchase Expenses (Brokerage and Taxes): 0 (IPO purchase)
7. Selling Expenses (Brokerage and Taxes): 491.55
8. LTCG as per Formula 2: [(199*278.55 - 491.55) - (199*278.55+0)] : -491.55

Step 2: For 301 shares purchased on 22-Sep-19

1. Original Purchase Price: 339.65
2. Price as on 31-Jan-2018: 304.55
3. Sales Price: 278.55
4. Lower of 2 and 3: 278.55
5. Cost of acquisition as per Formula 1: Higher of 1 and 4: 339.65
6. Purchase Expenses (Brokerage and Taxes):877.88
7. Selling Expenses (Brokerage and Taxes): 742.98
8. LTCG as per Formula 2: ((301*278.55 - 742.98) - (301*339.65+877.88)) : -20012

Total LTC Gain / Loss: -20012 - 491.55 = -20503.55

Since this is a loss, no tax is applicable. 

2. Bonus Issue

Rahul purchased 100 Shares of Infosys on 12-Apr-2015 at a price of 1640 and the purchase expenses were 1000 rupees. on 22-Feb-2017, the company issued Bonus Shares at the rate of 1:1. The shares were trading at a high of 952 on 31-Jan-18. Rahul sold the 200 shares on 12-Nov-2018 at a price of 840. The selling expenses were 1200 rupees.

Step 1. For 100 shares purchased in secondary market

1. Original Purchase Price: 1640
2. Price as on 31-Jan-2018: 952
3. Sales Price:840
4. Lower of 2 and 3: 840
5. Cost of acquisition as per Formula 1: Higher of 1 and 4: 1640
6. Purchase Expenses (Brokerage and Taxes): 1000
7. Selling Expenses (Brokerage and Taxes): 1200
8. LTCG as per Formula 2: ((100*840-1200) - (100*1640+1000)) :-82200

Step 2: For 100 shares received as bonus shares

1. Original Purchase Price: 0
2. Price as on 31-Jan-2018: 952
3. Sales Price: 840
4. Lower of 2 and 3: 840
5. Cost of acquisition as per Formula 1: Higher of 1 and 4: 840
6. Purchase Expenses (Brokerage and Taxes):0
7. Selling Expenses (Brokerage and Taxes): 1200
8. LTCG as per Formula 2: ((100*840-1200) - (100*840+0): -1200

Total LTC Gain / Loss: -82200 - 1200 = -83400

Since this is a loss, LTCG Tax is not applicable

3. Mix of STCG and LTCG

Venkat purchased 500 Shares of IDFC Bank at a price of 30  and purchase expense of 150 on 01-Sep-15. He added another 300 shares of IDFC Bank on 03-Feb-18 at 40 rupees with a purchase expense of 120. He sold 800 shares of IDFC First Bank on 9-September 2018 at a price of 47 and selling expense of 200. The price of IDFC Bank on 31-Jan-18 was 42

Step 1. For 500 shares purchased on 01-Sep-15

1. Original Purchase Price: 30
2. Price as on 31-Jan-2018: 42
3. Sales Price:47
4. Lower of 2 and 3: 42
5. Cost of acquisition as per Formula 1: Higher of 1 and 4: 42
6. Purchase Expenses (Brokerage and Taxes): 150
7. Selling Expenses (Brokerage and Taxes): 125 (200 * 500/800)
8. LTCG as per Formula 2: ((500*47-125) - (500*42+150)) : 2225

Step 2: For 300 shares purchased on 03-Feb-18. This will be considered as STCG

1. Original Purchase Price:40
2. Sales Price:47
3. Purchase Expenses (Brokerage and Taxes):120
7. Selling Expenses (Brokerage and Taxes): 75 (200*300/800)
8. STCG as per Formula 2: ((300*47-75) - (300*40+120):1905

Total LTC Gain / Loss: 2225
Total STC Gain / Loss: 1905

Hope this clarifies. In case you have any crazy situations, do let me know. Let us work on it together. 

Since this is a profit, but the amount is less than 100000, LTCG tax is not applicable. However STCG Tax at the rate of 15% is applicable.

Friday, April 5, 2019

Value Averaging: A different path to investment success

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There are three types of Investment strategies. These are Fixed Share, Fixed Dollar and Value Averaging.

In fixed share strategy, you buy fixed number of shares of a company regularly over an extended period of time. For example, you buy one share of Infosys each month for say 24 months. As the prices rise, you will invest more amount and as prices fall you will invest less. Your average prices is the simple average of the prices you paid over your investment horizon.

Fixed dollar strategy is also known as 'Dollar Cost Averaging (DCA)' or 'Systematic Investment Plan (SIP)'. In this approach you invest a fixed amount regularly over an extended period of time. For example you will invest 10000 rupees every month for 24 months to buy shares of Infosys. If the price of Infosys goes up, you will buy less number of shares if the price of Infosys goes down, you will buy more number of shares. In this way, your share purchases mirror your normal purchase behaviour. Since you are buying more number of shares when prices are lower, your average price ends up lower than the simple average prices that you get in Fixed Share approach.

Sunday, March 31, 2019

How a market bubble and crash can strengthen your country

As the Indian elections approach a fever pitch, there are lots of debates going in social media about the Credit Crisis that led to NPAs escalated during the UPA1 years. There has been rampant and mindless credit growth and the credit control processes were significantly weakened. There was a feeling all around that 'This crisis' was different from other 'Credit Risk Crises' due to the following reasons.
  1. Credit risk has been globalized and hence insignificant for any one country
  2. Securitization and collateralization of debt has ensured that the credit risk is spread across many people and hence is insignificant for one person
  3. Technology has ensured that adequate controls are in place. 
  4. Credit risk has been transferred those who can pay. 
  5. There is no credit risk. Housing prices are going to stay where they are or are only going to go up.
This was a bubble. It was a matter of time before the cookie crumbled. 

Saturday, March 30, 2019

Different types of investment approaches

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Normally there are two different approaches to investing in stock market. One is based on the market price and the other is based on the intrinsic value of the stock. 

Those who follow the first approach are called Traders and those who follow the second approach are called investors. 

The diagram below explains the classification

Traders look at the current price and decide on the next action based on how they think the price will move today, tomorrow, next week or next month. They will say for example, the current price is 40, this stock has a potential to move to 44. Buy it with a stop loss of 38 (which means I don't know if I will be right. In case I am wrong, get the hell out quickly)

The analytical approach they follow is called Technical Analysis. The only parameter is the expected short term price movement. They use words like resistance and support very regularly. 

Investors follow the valuation approach. For them decision parameter is the intrinsic value of the stock. This approach is called fundamental analysis. There are two flavours to the Value approach. One is to look at the current value and compare it with the current price. The investors who follow this approach are called Value Investors. They look for good companies with great track record that are undergoing temporary difficulties. Once they find such companies, they analyze the cause for the downturn, and if it is temporary in their opinion, they will make a decision to buy the shares of the company. Once they find that the price is trading well below the intrinsic value, they buy the stock and then wait for the company to tide over the uncertainty and the market to 'discover' the intrinsic value. Once the price exceeds the intrinsic value, the value investor exit the share.

There are other types of value investors. They look for companies in businesses that are expected to perform well in the future. The current price of these companies may be well above the intrinsic value, but these investors feel that the current price is low in comparison to the growth potential of the company. These investors are known as Growth Investors and they follow 'Growth Investing'. 

The main difference between Value Investing and Growth Investing is that Value Investor looks for companies with established track record of performance, while the Growth Investor looks for potential spurt in performance. This approach is riskier just because the expected growth might not materialize and rewards the investor spectacularly if this growth does indeed materialize. 

Every one of us has a favourite approach. What is yours?

Tuesday, February 26, 2019

Book Review #39: Four Pillars of Investing: Author: William J Bernstein

Four Pillars of Investing: Lessons for building a winning portfolio written by William J Bernstein is one of the best books on investing that I have reviewed in my book series on 50 Finance Books.

This book gets that rarest of rare rating of 5/5

Published by: McGraw-Hill

ISBN: 978-0-07-175917-5 (ebook) / 978-0-07-174765-9 (Print)

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As per Mr.Bernstein, any investor in the financial markets should know the scientific basis of investing which consist of four broad areas which he calls the four pillars of investing. The pillars are Investment Theory, History of financial markets,  Investor Psychology (Behavioural Finance) and Business (How the mutual fund industry works)

15 Chapters of the book are covered under five sections, four of which cover each of the four pillars and the final sections puts it all together and guides the investor on his investment journey. One has to understand each of the four pillars deeply before venturing into the world of investment. In the preface to the book, author says that the key principle used in this book are accessibility and enjoyment. To that end, he has kept the math simple.

Monday, February 11, 2019

My Assumptions about Equity Investing

From 1991 to till 2018, there have been three major corrections in the Indian Stock Market. 

The first one was caused by the Harshad Mehta Scam of 1992, the second one was the Dotcom bust of 2000 and the third one was the major correction in 2008.

Each of these scams shaved off huge amounts of investor wealth. A number of investors were driven out of the market due to these brutal corrections, never to return again. These people have become strong votaries of Bank Fixed Deposits, despite their tax implications and the vagaries of inflation. 'I still have my capital in my bank account' is their constant refrain. 

I am currently reading the book 'Four Pillars of Investing'. It is an amazing book, which should be in the reading list of any person who wants to invest their money. In this book  the author, William J Bernstein discusses the real losses that accrued to people during the multi year corrections in the stock market. The losses have been stomach churning. In the 1929 correction people lost upward of 80% of their wealth.

If you are planning an ‘all equity retirement strategy’, when markets fall, you are hit with a double whammy. One is that you have to withdraw more of your savings to maintain same level of expenses and two, you will have less savings to recoup your losses during the eventual reversal. That made me scared.

In the last one year, my portfolio has seen a loss of about 20 - 30%. But still I continue to remain invested in the stock market. What am I thinking?

What are the assumptions that I am making while I remain invested in the market.? Here are a few.

  • Global Growth Assumption: Global economy is poised to enter a long-term growth phase.
  • India Growth Assumption: I believe that Indian economy is poised for a major leap and Indian stock market is poised for a multi year bull run in the next five years. 
  • 'Mother of all bull runs' Assumption: Every expert and his mother in law on TV talks about how India is on the cusp of MOABR. Wild projections of Sensex and Stoke dote the landscape wherever you look. You can't afford not to be a part of this. What if it doesn't happen? I feel India is in the middle of a bull market, not as wild though.
  • Quick Recovery's Assumption:  Stock markets might fall, but they will recover quickly.
  • Sufficiency Assumption:  I have sufficient savings in equity market for my retirement planning. I will be able to fund my son's higher studies, if he requires funding.
  • Risk Tolerance Assumption: I believe that I have a higher risk appetite and can withstand losses much better than others. I will not freak out with a huge fall in the market. I will not make any hasty moves like abandoning the market or make 'Tracking Error' decisions like exiting the under performing asset classes and buying into over performing asset classes. 
  • Positivity Assumption: I am an eternal optimist and believe that there will not be a major correction any time soon. Even if there is correction, I will be able to tide over that.
  • Smart Guy Assumption: I am smart and intelligent and learn quickly from my mistakes and from other people's mistakes. Mistakes is what others make. I have enough intellect not take any unnecessary risks.
  • Knowledge Assumption: With an MBA in finance and with years of investing experience, I believe that I know all that is there to know about equity investing. I know how to anticipate the downturn of an industry, I know how to identify if the correction in stock price is temporary or permanent and take decisions accordingly. I also know my limitations.
  • Decision Maker Assumption: I am a decision maker and make unemotional and objective decisions based on available facts. I do not fall in love with my stocks (HUL, you didn't read this...). When data asks me to sell, I sell.
  • Market Timer Assumption: I will be able to exit the market at or near the peak of a bull run and move bulk of my investment into bonds
  • Satisfaction Threshold Assumption: I will be satisfied if I get X times return on my investment and X is an achievable goal. 
  • Tax handling assumption: I am ok to handle tax complexity inherent in the investment operations. 
Backed with these assumptions, I am making some real life choices. If any of these assumptions prove to be wrong, I will be devastated.

What are the investment assumptions that you are making?