COFFEE CAN INVESTING

 

 COFFEE CAN INVESTING

-          Saurabh Mukherjea, Rakshit Ranjan and Pranab Uniyal

 

Most of the Indians do not invest in Equity at all, all those who do, do in a very haphazard manner. Hence long term gains have eluded the majority of affluent Indians. An investor holding `5000 in equity and `95000 in debt (assuming 15% and 7.5% compounded annualized returns respectively) will end up with a corpus of `4.85 lks in 20 years. If on the other hand holding `25000 in debt and `75000 in equity the same investor would have a corpus of `13.3 lks in 20 years.

About MFs:

MFs got originated in 1774 in Netherlands and reached America by 1800. In India MF was born in 1963 when UTI (unit trust of India) was formed through an act of parliament. For almost 25 years UTI was the only entity offering MF in India. By 1987 UTI managed `6700 cr in assets under management. In 1987 for the first time non-UTI public sector entities were permitted to enter the industry. This allowed companies like SBI, Canara bank, Punjab bank, LIC. By 1993 the total industry assets under management were close to `50,000 cr. Kothari Poineer (now Franklin Templeton) was the first private sector MF registered in 1993. Today the MF industry now manages more than `20lk cr of which `6lk cr is equity.

ULIPS is one of the greatest example of mis-sellings done by investment bankers. ULIP require high brokerage commissions to be sold. The tenure runs into decades and this allows the company to implicitly charge the customer a hefty brokerage (around 30 to 40% premium) and yet promise good absolute returns.

The mistakes we normally make

·         Unclear investment objective.

·         Trading too much, too often.

·         Lack of diversification.

·         High commissions and fees.

·         Chasing short term returns.

·         Ignoring inflation and taxes.

 

Coffee can Investing:

HQ in LA, this capital group is one of the world’s largest asset management forms with asset under management around $1.4 tn. The company name got coined in reference to a term in which ‘Coffee Can” harks back to the Wild West, when American before the wild spread advent of banks, saved their valuables in a Coffee can and kept it under their mattress. This was the approach of save and forget.

How do they process?

Use investment filters to identify 10 to 25 high quality stocks and then leave the portfolio untouched for a decade. To begin with, there are 5000 listed companies in India. They limit the search to companies with minimum `100 crs (around 1500 companies) as the reliability of the data smaller than these companies is a suspect. Look for the companies that over the preceding decade have grown sales each year by at least 10% alongside generating Return on capital employed (pre-tax)(ROCE) of at least 15%. 15% is bare minimum return required to beat the cost of capital. Adding risk free rate of 8% in India to the equity risk premium of 7% gives the cost of capital broadly 15%. Moreover India’s nominal GDP growth rate for a decade is around 10-12%. As only 9 out of 1300 companies have managed to have continuous 12-13% revenue growth for ten consecutive years, it reduced to 10% instead of 13%

Why ROCE?

 Higher the ROCE, better is the company’s efficiency of capital deployment.

ROCE = (Earnings before Interests and Tax ,EBIT) / (Capital employed)

Capital employed is the sum of debt liabilities and shareholders’ equity)

 

ROE of 15% : Return on equity is preferred over the return on asset as it is fairer measure. ROE is the profit earned after paying corporate taxes as a % of shareholder’s equity.

 

The takeaway:

Intermediaries make equity investing a complicated affair: Not only because they are surrounded by substandard advisers, but also because they imbibe incorrect investment theories.

Expenses Matter: Fund expenses are often ignored but are important.

The real estate Trap:

Investment size is high.

Liquidity is a problem.

Transaction costs

Transaction time (High Lead time)

 

Absolute returns vs. Compounded returns:

An investor normally has a very fond memory of his property going up by five times in the last twenty years, but the compounded annualized return that property has generated over the last twenty years is just 8.33%. In the same period the Indian stock market’s benchmark index is likely to have risen at 15% per annum which compounded over 20 year, translates to a sixteen times returns. We’ve lost count of the real estate millionaires in India who have never done the ‘Opportunity cost’ comparison.

On the flip side commercial real estate is a really interesting asset class it offers a mix of rental yield and capital appreciation.

 

Small is beautiful:

Over the past two decades, small caps have outperformed the large caps in most large stock markets. Smaller companies have higher potential to grow faster and they observed closely by the investors.

 

Patience and Quality Intertwine:

Patience Premium: This is the difference between the annualized returns generated by a stock over any holding period compared to the return generated by the same stock or index over one year holding period. Eg. If a holding stock for five years give you 10% annualized returns whereas the holding stocks for one year gives you 7% returns, then the Patience premium is 3%.

 

 

Disclaimer:

The objective of writing the review is to preserve the good points mentioned by the authors. In the process of doing so, I have used my opinion, experience and discretion to land on a point.

Vinay Wagh

Bulls Eye, Nasik.