Will the second Covid wave spell economic disaster for India?

 Our generation has probably not witnessed a worse crisis in its lifetime. A tragedy of this magnitude & scale was unimaginable sometime back, but the second Covid wave has brought a tsunami of destruction along with it. 

The number of daily infections (3.5lakhs) & deaths (2500) may be much higher than reported, looking at the cremations and obituaries in newspapers (which are daily showing 10-12 x normal). So the picture is very grim and most experts agree that the peak is yet to come !! 

Apart from a humanitarian crisis, I think this "Black Swan" event has a potential to spell doom for the Indian economy. I have jotted down a few points I think can adversely affect our economy. 

1. The humanitarian crisis

With a death rate of appx 7.3/1000 till 2020, india had approximately 35,000 deaths everyday. Covid second wave's officially reported death  figures are about 2500/day but i think we all agree that the real picture on ground is much worse and actual figures may range from 15-20 thousand deaths per day. 

From a personal experience I can share that many of these Covid-induced deaths were owners of small & medium businesses, many of them the only bread earners of their family. 

This humanitarian crisis can quickly turn into an economic one due to :-

(a) Business closures - Many small businesses, which have no one else to run them would unfortunately shut. 

(b) NPAs and defaults - although small businesses have very less formal bank debt but many tragic businesses succumbing due to factor (a) above may lead to defaulting on their creditors, who supply them goods & services. This can lead to a chain reaction & affect the cash flow across the supply chain in near to medium term. 

Overall bank NPAs are also bound to shoot up. 

(c) Reduced business Efficiency - since most small businesses are owner dependent & not system dependent, even if there are others to manage, things can get very difficult and take a lot of time to normalise for them since the owner's traits and relationship with labour, suppliers, customers and bankers would be difficult to replicate. 

(d) demand destruction - overall demand for goods & services can take a hit in short term. For a family that may have lost a dear one, limping back to normal consumption pattern may be long & painful :(

2. The political crisis

Many of you would agree with me that the current situation is to BJP what the Anna Hazare movement was to the Congress & ultimately paved way for BJP to come to power. The popularity of our PM has dipped to an all-time low, owing to his engagement in Bengal rallies & arrangement of Khumbh in Haridwar, instead of taking proper measures to stop the pandemic.

 We don't know what exactly would it turn out to be for BJP, till UP goes to elections next year, may be they can do some damage control given how short - lived voter's memory is, but they would really have to struggle to attain power and may be look for coalition politics again, because those who have lost someone will definitely owe a grudge! And opposition would leave no stone unturned in cashing on this disaster & pin down the Central Govt. 

Political instability can lead to economic instability since many bold and flagship programs of current regime can be done away with by the new one - recently launched PLI scheme, divestment program etc. Even if there is no change in Govt, the current regime can adopt many populist measures for achieving an image makeover. Whatever the case is, the challenge for the BJP-led alliance would be tougher than ever in the coming State elections next year! 

3. A nation under Lockdown

Last year's lockdown for 2 months made our GDP fall close to 20%. Although, the Govt has not adopted such stringent lockdowns yet, but with the crisis spiraling out of control and this time people voluntarily staying indoors out of fear, the effect on economy can be disastrous! 

Big businesses such as Mobility (aviation, automobile & logistics), hospitality, infrastructure, Retail, entertainment & many more are the direct losers. Many small businesses such as MSME manufacturers (most of their customers having reduced or temporarily suspended business activities), restaurants and many consumer oriented business can be damaged severely and again as seen last year, the reverse migration of labour to their native villages, has put a spanner to production in many units, those which are willing to operate. 

Other than effect on business financials, during the lockdown, overall economic activity & consumption reduces drastically and unemployment becomes very high, it went from 6% to high double digits during the last one & was just coming back to normal in Feb. 

On top of it, we don't yet know how many regions would go under prolonged lockdowns to contain the pandemic. 

4. Inflation & Debt

High inflation is perhaps the biggest enemy of a stable and growing economy. The inflation trajectory has already been  upward since the last lockdown, we can only pray that our financial institutions do their best to keep it under check because that following factors can lead to higher inflation in present scenario

(a) supply  side restrictions - with many regions under formal & informal lockdown as mentioned earlier, the supply chains are disrupted across industries, and sourcing for some material has become very difficult & comes at a higher price than earlier. This reduces purchasing power for an average household. 

(b) Metal prices - almost all Metals , be it Steel, Copper, base metals are trading at their all-time high currently, due to international prices. These metals are used as raw materials in industries such as real estate, automobile, electrical components, capital goods and can have a cascading effect on general retail & wholesale prices inflation index in India. 

Not just metals, a rally in oil & petrochemicals since last year, has led to many consumer industries such as small PVC pipe & garment manufacturers to shut shop. Even if they don't shut down completely, it is a huge strain on their working capital & margins. 

(c) Low interest rates & loose monetary policy

An immediate response from almost all governments during an economic crisis is to offer stimulus to the economy by reducing Interest rates that would enable people & businesses to borrow at low interest rates and buy goods & services or invest in expansion or upgradation of infrastructure. This policy does provide respite in the short term but can lead to increased inflation on the flip side. There is a very high chance that the government would be forced to stick to this policy in the forseeable future & it needs to be seen what steps can they take to control inflation which would be definitely a by-product. 

(d) High debt 

High Borrowing by Govt (both state & central institutions) to fund the expenditure deficit which is expected to be high both on account of reduced revenues and increased health expenditure (cost of vaccination, setting up health infrastructure, paying up insurance money) would mean an additional risk of Sovereign credit rating to be downgraded for India which has happened earlier also. 

Reality vs Stock Markets?? 

The stock markets, which are a forward indicator of economic performance, have been rising by 1% daily for the third day in a row today. Nifty is close to an all-time high even when March has seen Foreign investors taking out their money in bulk.

 Although many sectors have been posting very good financial results since quarter 2 of FY21 such as Pharma, IT, Steel companies, Banks etc but don't you think such exuberance looks a bit too overstretched? The number of companies' shares tradng at their all-time highs may have been fuelled due to a global liquidity induced by the panic. 

I may be irrational or too pessimistic right now seeing all that's good around and may not be looking at the big picture in its totality and may be Rakesh Jhunjhunwala was right last week when he said that "the second covid wave would just be a temporary blip".

 But i have a habit of listening to my hunch and have offloaded 25-30% of my equity portfolio. 

Selecting good quality Value Stocks using a secret formula !!

Oil Futures traded in negative territory for the first time in history, going as low as -$37.63 in yesterday's trade!! We are indeed witnessing history being made in front of our eyes! Things seem pretty bad on the economic front with the Coronavirus creating havoc & panic all over the world. With India still deep into lockdown for a month now, it's very difficult to assess how much more damage would be incurred. But sooner or later, like all bad things, hopefully this too shall pass !

So, with the key stock indices still down by 30% from their recent highs, even after rebounding from 7500 to 9000 levels in April, brings us to a question - " Is the right time to invest or wait for further Blood Bath to happen??" To be honest, I don't have an answer to this question, but I definitely know one thing from my past experience during the Global Financial Crisis of 2008-09 that it is times like these that present your best bargains. I am not saying to jump with all your cash in the markets but since Stock investing comes with an inherent risk, if you have a time horizon of minimum 2-3 years with no immediate liquidity concerns, some proportion of your wealth can be allocated to Stocks.

But, a word of CAUTION.....as far as I comprehend it, this time India's economy is as badly affected unlike the 2008-09 crisis, where mainly the banking & finance sector was in trouble. This lockdown will affect many sectors & businesses adversely & many of them can go belly up & declare bankruptcy and in this largely interconnected financial world, the contagion can spread as fast as the COVID itself. So we need to pick our stocks very wisely.

I would like to share a very simple formula which, if used judiciously, can help picking good companies with compelling valuations! Before coming to the actual formula, let's discuss the various factors that I keep in mind while selecting a stock. These are the main compelling factors, other than some more research & parameters that need to be kept in mind.

1. Return on Capital Employed 

In layman's term, it is similar to the profit a company generates on every rupee invested by the company in its business. Companies generating higher Return on Capital Employed (RoCE) have better competitive advantage than their peers with low RoCE. Let's assume that TCS & Infosys both incur a cost od Rs1,000 cr to open a new office campus with similar workforce capacity but if TCS generates a profit of 200cr from this  office compared to Infosys which generates 150cr then definitely TCS is doing something differently than INFY or must be having some "Competitive advantage" which allows it to generate a much better profit on same incremental investment!!

RoCE = (EBIT / (Net Fixed Assets + Net working Capital)) 

where EBIT = Profit before Interest & Taxes 

& Net Fixed assets = Value of Plant, Equipment & buildings (after depreciation) except Goodwill

Net Working capital = Accounts receivable (Debtors) + Inventory(Finished & Raw material Stock in hand) - Accounts payable (Creditors)

To keep it simple, EBIT is the Profit a company generates before paying Interest expense on its Debt & Taxes to Government. It is a better indicator of profitability than Profit after tax or Net Profit because it is not affected while comparing companies having different levels of Debt & different tax rates.

Net  capital is  simply the total capital which has to be deployed for profitable operations - it has two components :

 (1) Fixed Assets - No viable operations are possible without establishing good Plant, Machinery & Offices to produce quality goods & services which a company intends to produce & profit from!

(2) Working Capital - After you have established the Fixed assets, you need working capital to purchase raw material, pay salaries, pay utility bills, give credit to your buyers, keep stock of finished goods & raw material for hassle free operations. 

Summary - Better RoCE distinguishes better businesses from not so good ones, because somehow they are able to generate better profits with same amount of capital, isn't it interesting?

 2. Earnings Yield

Now that we have shortlisted some names that are consistently generating better returns on their capital, but our investment in them won't mean much if we are paying too much for them. In short, even after the company is good , it doesn't mean the Stock is good! Remember Price is what you pay & Value is what you get, so if you pay 1000 bucks for something which which earns just 1 buck per year, would you buy it even if it has fabulous return on capital?? 

Earnings Yield (e/p) = (EBIT / Enterprise Value)

Enterprise Value (EV) = Market Capitalisation + Net Debt 

Market Cap = Share Price x Number of Shares Outstanding

Net Debt = Outstanding Debt - Cash in Hand 

EBIT - already explained along with RoCE

It would be simpler to understand Enterprise value as the tangible value of a company if the entire company is acquired by someone, inclusive of Net Debt which the new acquirer has to assume as part of the takeover. To acquire the entire company the acquirer has to buy all the shares outstanding @ prevalent share price (market cap) as well as takeover the debt outstanding of the target company or repay it. In both cases it would be part of the cost of acquisition.

A practical aspect of this ratio is that it determines how much return are you getting on your investment? Compare two companies in this regard - again we take a hypothetical case of TCS Vs INFOSYS. We have seen earlier that TCS was generating better RoCE but it may be possible that it's stock is not cheap. May be the market cap of TCS is 50,000 cr & debt is 10,000 cr making its EV as 60,000cr. On other hand due to recent under performance & bad news, INFY shares may be trading at a very low price making its market cap 25,000cr & assuming same debt as TCS at the level of 10,000cr it's EV turns out to be 35,000cr. 

Now, as previously mentioned, we assumed that both have office creating profit of 200cr & 150cr respectively.  Now to demonstrate the effect of Earnings yield assume both companies have 50 identical offices generating exactly the same earnings spread across the world. Total EBIT for TCS would be 50 x 200 = 10,000cr and for INFY would be 50 x 150 = 7,500cr. 

Earnings yield for TCS = 10,000 / 60,000 = 0.167 or 16.67%

& for INFY = 7,500 / 35,000 = 0.214 or 21.42%

So even if TCS has better profitability, it's still not as good a bargain as shares of Infosys!! Only a judicious combination of both factors can help us getting over this dilemma of chosing which stock is a better investment!

Summary - Better earnings yield means better "Bang on our buck", we have to ensure that we are getting the best VALUE out of the PRICE we are paying. 

3. Compounded Average Growth Rate (CAGR)

The only logic behind investing in stocks is that we are actually investing in businesses which we hope will increase their revenues & profits over time and we ,being a partner, will benefit from that growth. A relevant analogy is if we take the case of a company such as Reliance - suppose it was earning 100cr in profits in 1990 & the company was valued at 1500cr (all these figures are just hypothetical to get some clarity of thought). Over the next 30 years from 1990, the company diversified into Refining, Telecom & Retail and with the help of little luck and a very dedicated & hard working management team, which was willing to take calculated risks, the company was able to make 25,000cr profits in 2020. 

Now are you getting along with the practical aspect of this powerful concept? Will the market cap still be the same? I wish it was, but even by a very conservative estimate the Market cap would be upward of 200,000 cr now. Assuming no or very less equity dilution of shares during this period, you & I can imagine what fabulous returns this single investment would have generated for us ! A growth of 250 times profit in 30 years is no mean feat yet there are many examples that have achieved relatively similar performance and we can't afford to overlook these marquee management driven companies!!

CAGR (g) = (((Profit of latest year) / (Profit 5 years back)) ^ (1/5)) - 1

CAGR for Reliance over 30 yrs would be 250^(1/30)= 1.202-1=0.202 

We are considering 5 year CAGR of Net Profits (Profits after Tax & all expenses) for our calculation. We could have used EBIT here but for growth rate, PAT is a better indicator of the bottom line growth of the company compared to EBIT & with similar margin levels, tax rate & debt and % interest both figures would yield identical results. It would be helpful for us in identifying growth accelerators and considering them for further study because even a single stock like that in the portfolio can generate fabulous overall returns !

Summary - Growth is Life & that's the reason we invest in stocks rather than Bank FDs so successfully identifying high growth companies and investing at the right price would multiply our wealth many times over a considerable period of time!

4. Debt To Equity Ratio

From my personal experience as the owner of a business, I can surely tell you all is not so simple when we have a business to run & generate profits. There are regular threats & opportunities that present themselves before us from time to time. Sometimes the market for finished products is bad for a prolonged period may be due to an aggressive competitor and we start  making lesser profit margins than earlier or may be even a loss temporarily in hope of improving our efficiency & restore the profits. Sometimes, the debtor cycle gets prolonged and the receivables take 90 days instead of earlier 30 days. Many times a regulatory disruption such as GST or Demonetisation or a Black Swan event (a perfect example being current Pandemic) wreaks havoc on businesses. Sometimes, a new business proposal for new business verticals or factories (to support growth)  is executed by managements in a hope of taking their companies to the next orbit.

But many of the above & other factors compel the company to borrow money to finance their operations, either in the form of borrowing from Banks or issuing interest bearing Corporate Bonds on which a regular interest payment has to be made and the principal to be returned in the end.

Now suppose a company has borrowed a huge amount of money to establish a new factory & some time later the factory starts generating loss or less then expected profits, which make even the interest payments on the loan very difficult. Unless prudently resolved, this debt keeps on increasing due to the power of compounding; the company reaches a stage where it's existence is at stake due to the spiralling debt !!

In business history, there are numerous examples of businesses that were once very profitable & had the best brands , which exist no more and have become insolvent. Besides scams, family feuds and inability to adapt to new business environment, I think high Debt is one of the most important reasons for business failure & it needs careful & cautious consideration while selecting the stock.

Sometimes, taking Debt is a very effective capital allocation decision & debt must be taken otherwise achieving high growth is not possible, especially in businesses that require setting up huge initial Fixed investment in terms of Plants, Licenses, Mines or Technology to keep generating profits but how much Debt is too high and can the company safely assume & repay it is a valid question !     

Debt to Equity Ratio (d/e) = Net short & Long term Debt  / Net worth or Shareholder's Capital

Net Debt = Short term debt (payable within 1 year) + Long term debt - Cash & Bank balance

Net worth = Total Assets - Total Liabilities

Net debt is simple to understand & its elaboration can be safely skipped. Net worth is the money which will be left if the company is liquidated today and the proceeds from sale of its plant, equipment, land bank, stock in hand, getting all receivables from customers is used to pay all creditors including suppliers, banks, corporate bond holders, Government liabilities such as taxes & any other unpaid utility bills - electricity & gas etc. In simple terms it is the "Leftover Tangible Value" if the company ceases its operation & decides to return all money back to shareholders. It can also be considered the sum of initial investment by promoters while starting the company plus the total retained earnings every year from the beginning of operations. For a profitable company, this figure would keep on increasing year on year!!

Debt equity ratio helps identifying companies having High Financial Leverage or risky assets which can be prone to disaster in unfavourable business environment. With great emotional & financial pain I have learnt to stay away from red flagged companies with high d/e ratios even if they are available at a throw away price because the market is already betting on their failure & that's the reason why they are available at a throw away price. Although d/e ratio depends a lot on industry but I have made it a point from some of my past investing experience to prefer companies with d/e below 0.5 & completely rule out those with a d/e ratio more than 2.0. Also, the direction of d/e ratio over period of years help identifying companies which are progressively reducing their debt levels, a good example is Indian Hotels.

Summary - High profitability, Decent Valuations & past growth are meaningless if we waste our money buying a stock which is on the verge of collapse, better take a two wheeler ride than boarding a plane which is destined to crash because it is short of fuel !! 

5. Dividend Yield

As we discussed earlier, a company finances its operation either by borrowing or by introducing capital from its shareholders. Lenders take their return in the form of interest payments but what about Shareholders? Are they not entitled for return on their capital for bearing the risk of investing in the company rather than choosing a less risky investment?? 

Some solace for shareholders can be found in the process of reinvestment of the earnings in generating progressively higher returns in future by expansion. With higher earnings in future, the revaluation in share price can more than make up for the returns expected by the shareholders. However, what if things go bad? Ten years down the line some scam is uncovered & the company heads into turmoil? What a bad deal for an innocent investor who had the patience of holding this stock for 10 years, only to be cheated in the end whereas a simple investment in an FD would have fetched him appx 1.5 times return on the original investment.

With the advent of capital markets, things were very simple. There were two types of capital - risk free debt capital & risky equity capital. Debt holders had a preference on the assets of the company in case of liquidation of assets but their earnings were capped at a fixed rate of interest only. However, the shareholders had a subordinate or lesser right on the assets of company in case of liquidation & were to receive anything leftover after paying all liabilities. To compensate for this risk, they were logically provided a higher return on their capital in terms of redistribution of all profits after tax among them. This redistribution of profit came to be known as Dividends. Starting with a very simple concept, things started getting complicated over time partly due to need for expansion, partly due to tax purpose & most of the times due to our inclination towards earning super normal profits, in short greed & speculation!!

Compared with initial days when most earnings were redistributed as dividends, we are now in an era when getting good dividend from our investment has become a rarity! I assign a decent weightage to dividends due to 2 factors:

(1) It provides some comfort even when stock markets are not doing very good & they have tendency to do that for years at a stretch! Its very discomforting to watch the value of our investment going down although the company is doing fairly & generating good profitability but stock prices are suppressed due to overall pessimism in the market.

(2) A covert reason is that companies regularly paying handsome dividends remove the doubt of any wrong doing such as cooking the books for showing profit instead of actual loss because dividends are paid from actual / physical cash and not an arbitrary PAT figure which can be adjusted by financial jugglery by adjusting Depreciation, off book liabilities etc (many of creative accountant friends know what I am talking about !). 

So both of the above factors provide some comfort for a shareholder & good companies have a track record of returning a good proportion of their earnings back to shareholders. Sometimes due to tax purpose, companies buy back their own shares, this can also be considered a positive indicator.

Dividend yield (d/p) = Dividend per Share / Market price per share 

or in simple terms total dividend paid in whole year by the company divided by the market capitalisation of the company. In case of buy backs, I add the figure of total buybacks in the year in dividend paid to account for this positive step by the company to avoid taxes on dividends.  

  Summary - A good dividend yield provides an annual cash flow from our investment which can serve our liquidity need or can be reinvested in any better opportunity or may be the same stock, whatever we may deem fit. Better stick to the basics of capital allocation, we need some annual return on our capital !

Here Comes The Formula ....  

Now we have the 5 factors with us, which I think are most important. There are many many other factors that prudent investors consider while researching on their targets but these are the ones I pay attention to:-

1. Return on capital employed (RoCE) - indicates good profitability & competitive advantage. 

2. Earnings Yield (e/p) - indicates good valuation.

3. CAGR (g) - indicates history of good growth & potential to continue doing so in future.

4. Debt/Equity ratio (d/e) - its absolute value as well as direction over time indicates financial leverage & riskiness of the company.

5. Dividend Yield (d/p) - indicates stable profit generating companies which reward their shareholders consistently for the risk capital (buy backs inlcuded )

Let's call all these factors as the "5 BASIC PREMISES".  Follow them religiously & you will be able to distinguish the leaders from the laggards! 

The formula = ((1+RoCE)^2 ) X  (1+e/p)  X  ((1+(d/p))^2)  X 100                                                                                         ((1-g)^2) X (1+(d/e)/3)

I have absolutely no tendency or affinity for financial jargon & believe me the ratio is conceptually very simple if you have understood the 5 basic premises , you just have to recognise the logic that we have put in deriving at the ratio. The positive factors such as RoCE, earnings yield, dividends yield & growth have a positive effect on the ratio. Dividend yield usually being a small fraction is considered exponentially by adding it with 1 to provide a multiplier effect. Similarly, Growth & RoCE are probably very important factors in our calculation & need to be given more representation in the formula to reward those companies which have demonstrated higher growth & return on capital than the laggards, hence the squaring!!  

Debt to Equity ratio is divided by 3 (its an optimum since 2 is too low & 4 won't practically have much effect) so that companies with high debt generate a lower ratio. The squaring & division of ratios by various numbers have been done after going through a wide range of companies to properly reflect the effect of each of the 5 basic premise on the final formula!   

It can be explained by a practical example of Hero Motocorp to arrive at the ratio. For a quick explanation I have jotted down some data from Moneycontrol

Share Price = Rs 1827

No. of shares outstanding = 19.97cr

Total Market Cap = 1827 x 19.97 = 36,485 cr

EBIT = 1012+1098+1136+1081 = 4327cr 

( A very important consideration is that we have removed all exceptional earnings accruing due to sale of non core business or any other such factor otherwise results will be affected, also we have taken a sum of last 4 quarters to consider the most recent performance instead of last full year results.

Short & Long term term debt - both zero

Net debtors - 2845 cr (incl short term loans & advances)

Net creditors - 3350cr 

Inventory - 1070 cr

PAT in 2015 - 2385 cr

PAT in 2020 - 3385 cr

Dividend per share in FY20 - Rs. 97

Cash & equivalents - 136cr.

Shareholder's Equity - 12850cr.

Total Fixed Assets - 9525  

Above set of data is sufficient to calculate all the 5 BASIC PREMISES

1. RoCE = (4327/(9525+565)) = 0.429

Net Working Capital = 2845+3350-1070=565cr

Net Fixed Assets = 9525

2. Earnings Yield = (4327/(36485+0)) = 0.119

3. g = ((3385/2385)^(1/5))-1=(1.4193^0.2)-1=1.07254-1.000=0.073

4. D/E = 0/12,850 = 0

5. d/p = 97/1827 = 0.053

Jotting the above in our ratio we get a value of:

((1+0.43)^2) x (1+0.119) x ((1+0.053)^2)   X 100
           ((1-0.073)^2) x (1+0/3)

= 2.045 x 1.119 x 1.109 X 100     = 253.8    =      295 

                 0.86 x 1                             0.86 

I think the simplicity & logic behind the concept is now evident after actually jotting down the actual parameters for a real company. As per my experience a number ABOVE 300 is a spectacular score & it must break the ice for us & make us more inquisitive about the company and look for other parameters & information to develop an investment thesis into the company.

By repeating this exercise for a vast array of companies you can yourself discover how powerful this is ! 

I would suggest to spread your investment  in 10-12 different companies spread across various sectors to take advantage of the power of averaging & de-risk your portfolio. Also calculating & updating this ratio over many different stocks can help in arranging them in a descending order and then we can determine our picks from that universe at an opportune time. I am pretty confident it yields good results!! 

Due to the length of this article, I would like to elaborate with some more practical examples, later on in a separate post, where we can calculate the formula value of many companies spread over various industries & also give sector wise comparison across industries (some industries have inherent tendency to get low value compared to others, but still we can compare different companies in that sector successfully)

In the end, I would like to reiterate that a prudent analysis can help you pick winners for long term capital appreciation, so try it & see for yourself if you distinguish between good & bad stocks. 

Also, my research & analysis may be prone to bias & faults so any suggestions / comments to improve upon the formula would be mutually beneficial. Another thing, 

I am yet to arrive at a suitable name for this ratio, any suggestions would be most welcome :))

Happy Investing !

Oberoi Realty - better invest in its stock than buy a flat

Real Estate companies in India are going through a rough phase. There has been significant slowdown in demand and prices - the worst hit have been the ones which over-stretched themselves during the boom to buy land at lavish premiums, funded with debt. I think real estate business has huge potential in India, considering the demographics, low urbanization and rapidly increasing demand for residential and commercial space. The current slump would subside and sooner or later the growth in real estate sector is bound to happen, think it makes sense to invest in this space. After going through a number of listed real estate players, the one that captivated me the most is OBEROI REALTY. 



This company is a Mumbai-centric developer with mainly 3 segments - residential, commercial and hospitality. It has a reputation for building quality projects and enjoys a good brand value in the market, for which its projects are often sold at premium compared to peers. Its promoters (not be confused with those of Oberoi Hotels) have a reputation of good corporate governance and clear vision. I have listed down some reasons which, according to me, make this stock a good buy.


a) Revenue mix - The company gets revenue of around 800 crores annually, of which rentals from its commercial properties account for roughly 160 crores, nearly 20%. This is interesting from an investor's point of view, considering the fact that the rental business enjoys EBITDA margins of whooping 99% !!! Practically every penny it gets from rental adds to its profit and can be assumed to be royalty payment which the company would keep on getting from properties it has invested in. The rentals (around 125/sq ft/month) have a fair chance of heading north, given the strong presence Oberoi Mall has in Goregaon/Malad area.

b) Good Margins  - Oberoi Realty works with EBITDA margins of around 60% and PAT margins of 45% !! There are very few companies with market cap of 6,500 crores plus operating on such healthy margins. The hospitality business (which runs Westin) has the lowest margins of 30% (not bad at all for Hotels), otherwise the residential and rental business are highly profit-making. This gives an insight into the mindset of the management, which is more focused on quality than quantity and has restricted itself to few projects with good sell-ability rather than stretching itself and working on many projects with lower profitability.

c) Cash Reserves - Oberoi Realty is sitting on cash reserves of appx 1000 crores!! This is very important in current context when companies in similar business and same geography and in neck-deep trouble owing to high debt levels and have engaged in desperate asset sale to service their debt. It presents a great opportunity for the company which is now in a position to get a great bargain to purchase land, when there aren't many buyers and the prices are low. To just give an example, there were talks with HDIL to buy TDR (transfer of development rights) @2100/sq ft instead of 3000/sq ft, at which HDIL was already selling TDRs. This was due to the fact that HDIL was keen to bring down the debt levels and was ready to sell TDRs at below market value.

d) Good Valuations - At current market price of 185 and EPS of 15 on a trailing basis, P/E works out to be just 12, which I think makes it highly undervalued. For a company which has grown well in 5 years, maintained good margins, built quality projects and saved cash even in troubled times, the valuations are cheap. The cash reserves alone work out to be 30 per share, leave alone the investment properties of Oberoi Mall (6 lacs sq ft), Commerz I (4 lacs sq ft), Westin Hotel (4 lacs sq ft) and many more properties under construction (as well as land bank!). The share trades at 1.5x the book value of 125 and EV/EBITDA of 9x. I don't have the precise information, but I am sure the sum of parts valuation of the portfolio of Oberoi Realty's properties would yield the same conclusion, that is, the stock is fairly undervalued.

e) Upcoming Projects - Besides having a strong brand presence in the suburbs of Goregaon, Oberoi Realty is doing a big residential project of 1.5 million sq ft in the premium Worli area of Mumbai (has already constructed 20 plus floors till date). With projects lined up in Mulund and Pune as well, the company seems to be in no mood to leave any opportunity present in the current market conditions. It has great expectations from the Worli project, which would start contributing to its bottom line from next quarter. In a recent interview, the management said that they have already sold enough and just have to build more to realize profits.


A few negatives have contributed in keeping the share price depressed, some of them being:-

a) Poor performance in Q1FY14 - the company was able to sell just 48,000 sq ft residential area, equivalent to 23 flats, which was a huge disappointment compared to previous year's figure of 115,000 sq ft area. This reflects the kind of slump Mumbai's real estate players are going through.

b) The Mulund project has been delayed due to regulatory hurdles and environmental clearances and may pose a threat for the company in future.

c) The slowdown may be more prolonged than expected and the poor performance of last quarter, if repeats in coming quarters can adversely effect the valuations and fundamentals of the company.

Though the negatives pose risk for the company, it is relatively well shielded from major downside, unlike its peers. It doesn't have to worry about inflows, with rental income contributing well, it has good projects in hand and doesn't have to worry about bookings, has the capability to complete these projects with own capital, in case required bookings don't happen and can get bargain on land deals. Although it may be premature to say that the real estate sector is headed for a turn around immediately, I think the valuations, fundamentals and the sensibility and vision of management make Oberoi Realty a good bet. Investors with some appetite for risk and looking for a proxy for real estate play definitely stand a chance to earn good returns on their Investment. 

Heading for a paradigm shift?

Today's Economic Times carries the story of a possible stake sale by Tilaknagar Industries (maker of Mansion House, the second best selling Brandy in the world) to retire its debt. Almost everyday, for the past quarter or so, we have seen so many marquee names, opting for asset or stake sale to reduce their debt burden. Yesterday it was IRB Infra, which plans to offload some of its key projects, DLF desperate to sell its Dubai Hotel chain, Suzlon is on the verge of going bankrupt. When there are so many assets on the block, the prices would go down and companies would have to bring in more assets to pay-off debt, leading to a downward spiral and heavy asset depreciation going forward. Conversation with a friend who works in the Asset side of a leading bank reveals the situation on ground is much worse than it appears in news. There is practically very little liquidity with MFIs and loan disbursement is going to dry up due to lack of funds. What adds to the woe is tight monetary policy pursued by RBI to keep the rupee from depreciating further.

In contrast with 2008, one fact which disturbs the most is during that time, markets crashed because of the global factors and lack of 'Investor funds', which were diverted from equity. This time, there seems to be a degradation in business fundamentals itself. Success of the 'India Story' is being questioned - good companies have made suicidal bets by over-leveraging and mismanaging their funds. For example, Financial Technologies, running MCX and NSEL was found running a quasi-ponzi scheme, the rot seems to be prevalent everywhere.

The question, however is, are we heading for a paradigm shift? Is there going to be a change in mindset of Indian Corporate, from high leverage to optimization of balance sheets? Sooner or later, the realization must dawn that borrowing money more than their balance sheet could afford is going to bring doom and lead to a catastrophic end. The policy paralysis, starting with UPA 2 from 2009 onwards is starting to bear fruits now, don't know how deep the rot is going to be. Business, be it manufacturing, tourism, banking carry a mark of pessimism and frustration, because there seems to be no hope, with Government concentrating on more populist policies to appease their vote banks. Seems it is a folly to expect more from the Government, however what businessmen can do is improve efficiency and reduce cost wherever possible. Demand would remain subdued and things don't seem to improve till next year, it is important to stay afloat in this tide. Conservation of capital has to be the key objective, we can afford a slow growth for a couple of years but we can't afford more companies going down. It would lead to a crisis of confidence. What makes matters worse is unlike 2-3 years back, when everyone was buying the emerging markets story, this time with US economy reviving, the FIIs won't waste much time in shunning the Indian markets and park their funds in more lucrative markets and asset classes.

May be things are not as bad as I perceive, still I think Austerity is needed and corporates have already started relooking at their policies. We haven't come across recent buyout deals where the buyer has lavishly overpayed, which was the case earlier. On the contrary, Markets have started punishing companies looking in that direction, as was the case with Indian Hotels' bid for Orient Express or Apollo Tyres' bid for Cooper Tire, both of which being withdrawn. There may be a painful unwinding of Assets going forward, but that would be a good thing, at least the balance sheets would get cleaned up and then the Indian Corporates, with specific advantages of low cost and intellectual capital would be able to prove their mettle in the the global space once again!

NMDC-a great buy at current levels!

After a hiatus of 2 years, I have started looking at the markets once again. Somehow, I get the feeling that there are plenty of opportunities waiting to be explored, when the mood on the street is pessimistic and everyone is selling. Of course, the turbulence prevalent in the market cannot be ignored, there are some serious implications of the falling rupee and rising current account deficit, due to which the high beta and cyclical sectors like realty, infra, metals along with banks have been severely punished. The most severe impact is shared by companies that carry high leverage on their books and undertook huge debts to fund ambitious projects.

However, amid the panic prevalent on the street, one cannot ignore the fact that in times like these, solid companies with very healthy business and strong balance sheets are also punished just because of exodus of investors from the equity markets. This throws up a good opportunity for value investors. One may doubt if that is the case why have investors not already capitalized upon the opportunity. We need to understand that investor psychology is the most important force driving the markets. The 'Mr. Market' analogy of Benjamin Graham aptly explains this psychology when he compares the market to an imaginary person 'Mr Market' who tends to be very emotional. When he is optimistic, he tends to buy everything that is offered, at a premium and when he is sick he is ready to offload whatever he has with him at a discount. With careful fundamental analysis, we can choose which stocks offered by Mr Market are priced below their intrinsic value.

After scanning a large number of companies, I selected few stocks which are worth considering from point of investing, best among them is National Mineral Development Corporation Ltd. (NMDC). It is a public sector company and the largest producer of Iron ore in the country (appx 27 million tons annually!). Without going through the pain of writing a detailed research report, I have listed down some reasons which I think make this stock a stealing buy.

1) Monopolistic business - NMDC has exclusive rights for Iron Ore mines with more than 1,360 million tons reserves - Bailadila and Donimalai being the largest and most important ones. Bailadila is known for its high Iron content ore, more than 65%, with best physical and metallurgical properties required for making steel. The company is hopeful of getting some more mining leases, making it one of the few companies which have access to such huge natural resources. The market price of Iron ore (avg of lumps and fines) is INR 3,500 per ton at present. The price has been subdued for more than a year now due to poor demand from steel makers. However, as we see an uptick in the economic cycle, the demand in automobiles and Infra would lead to a demand of Steel and in turn demand for Iron ore. It is interesting to know that NMDC is among the world's lowest cost produces (appx USD 20 per ton including royalty payments!). Don't you think it makes absolute sense to invest in a company which is running a simple business, having monopolistic control of the industry, no dearth of customers, and good operating margins ,appx 65% in NMDC's case?

2) Strong Balance Sheet - In times like these when companies one after the other are opting for Corporate Debt Restructuring or defaulting on their debt obligations, here we have a company which has cash reserves of 21,000 crores! At the current market price of INR 97 per share, the total market cap stands at appx 38,000 crores. In a  way, we can say that out of the price we are paying to buy NMDC, 55% is HARD CASH, almost INR 54 per share. To put it simply, being a debt free company, if the company gets liquidated tomorrow and we don't get back any money from the debtors or from selling the company's assets, we still would be left with 54 rupees cash! The company doesn't need to spend much on expansion and we can assume that the cash rich company would continue to be so in foreseeable future.

3) Good Operating Performance - The company has doubled its turnover from 5,000 crores in FY08 to 10,000 crores in FY13. The operating margins have been consistent during the period about 75% in FY08 to 78% in FY12 and lower at 68% in FY13 (due to lower production and poor demand scenario compared to previous year). I think the operating margins showcase the solid business potential of the company. Of every 100 rupees worth of material it sells, it pockets 75 rupees as cash operating profit. Even after paying 35% income tax, we still get a Profit after tax margins of appx 50%, a very healthy figure not many companies of such scale are capable of posting year after year. This adds significantly to the cash reserves of the company and I see no major downside to the company going forward.

4) Cheap Valuations - The Earnings per share works out to be INR 16 for NMDC. At INR 97 per share market price, it is trading at a price earnings ratio of 6.06. Put simply even if the company continues with the same performance without growing an iota in earnings, it would accumulate enough cash to double its value in 6 years! It is considerably cheaper than the Industry ratio of 12-13 historically. The book value (value of assets - liabilities) stands at INR62 per share. We can safely assume this price to be the bottom where the stock can fall to, given the high cushion its cash reserves offer.The price to book value multiple is appx 1.5, again very cheap. The compounded annual growth in PAT has been appx 15% from FY08 to FY13, the PEG ratio (ratio of PE to historical 5 yrs growth)  stands at a mere 0.4. By market standards, for a stable company like NMDC, a PEG ratio below 1 represents that the company is undervalued. To supplement the above research, it is important to look at another important parameter often used to value metals and mining stocks - EV/EBITDA. The Enterprise value (total of mkt cap and net debt) of NMDC is 38,000-20,000=18,000 crores for NMDC, and EV/EBITDA miltiple of 2.0x. NMDC came up with a FPO in March, 2010, post which the shares have traded at P/E of 10x and EV/EBITDA of 6x, reiterating the fact that compared to the historic valuations, the current valuations are extremely cheap.

5) Good Dividend Yield - The company has a history of giving regular dividend payout. It has been paying more than 20% of the PAT as cash dividends to shareholders for the past many years, increasing substantially to 25% in FY12 and 40% in FY13. The dividend per share was INR 6.50 in FY13 and is expected to be 7.50 or more  going forward. The dividend yield turns out to be ~8% for NMDC, one of the highest among companies of its size. Bank FDs are currently paying 9% as interest, it makes complete sense to buy NMDC shares and earn 8% dividend yield and a fair chance of price appreciation instead of earning 6.3% post-tax return on bank FDs.

Possible Negatives
Being a Government enterprise and administered by the Steel Ministry, we know the potential disadvantages the PSUs are sometimes subjected to - whether it comes to bearing the subsidy burden (like Oil refiners) or bearing the price of extending undue benefits to private sector companies. 
Another possible negative may be the plans of venturing into steel making. The company has already started manufacturing sponge iron 2 years back and is setting up a 3MT per annum steel plant. It may seem that the move would benefit the company by integrating it forward. However, it might deviate from its 'core competency' of mining and divert its excess cash into highly capital intensive and cyclical steel production.

Besides the negatives surrounding the metal and mining industry, I am convinced that the cheap valuations, strong balance sheet and good dividend yield are compelling reasons to take a plunge and buy this stock. It has a considerable 'margin of safety' to safeguard the interests of investors in case the downtrend continues for a prolonged period and has the potential to deliver very good price appreciation when the economic cycle improves.

The man who sold the world

Yippie!
I am back after a long break. Believe me, the past few months in my life had been more eventful than the stock markets !! had you been long the volatility index of my life- you would have made a fortune. Finally, I have switched my job and 'm back in Bombay. It seems I am reliving the old times- Hawaiian shacks, Bandra, late night outings, marine drive, money, ambition, packed-weekends AND SO MANY FRIENDS.
This blog is going to be a short one (unlike the previous ones) bcos it's 1 in the night and I have a an employer waiting for me every morning. Morover, I have been so out of touch with writing that I think I'll end up with a mess if i even try something elaborate. I have read some books on Dhirubhai Ambani of late - Poyester prince, Ambani vs Ambani, Dhirubhaism are some of them. Reading about him is always so much fun - a street-fighter ready to make a mark in this world, there are n't any good movies anyways (except 99 and Angels vs. Demons). Good or bad, I can't be judgemental about the man but there are principles which Dhirubhai believed in and all of them combined together shaped up the thought process of the man who was loved or hated in extremes but could never afford to be ignored.
1. "No one is a permanent friend and no one is a permanent enemy, the roles keep changing as you progress from one orbit to another". Be it politicians, businessmen, mediapersons- the protagonist of our story had more than his fair share of enemies (and enemies-turned-friends and friends-turned-enemies), but the roles of friends and enemies kept interchanging. There was a time when Arun Shourie was one of the biggest critics of the Ambanis, but the times- they always keep changing!
2. "You need to throw something for the crows before you eat the bigger pie"- no wonder Dhirubhai had everyone from bureaucrats to mediapersons in the list of "crows". He was very generous with rewards to anyone who was useful or could be potentially useful :)
3. Dhirubhai used to say - "There is only one thing I think I don't posess and that is EGO!" He was someone who wasn't shy of doing menial tasks if they solved his purpose. It once happened that retailers refused to buy cloth manufactured by him. He packed sample pieces in the boot of his car and kept trying from shop to shop convincing small owners that they'll make good money if they buy his cloth.
4. He was a man in hurry - Think fast, think big and think ahead was his motto. He once came up with an idea to get artificial rainfall in the Thar desert to make the land useful!! No idea what happened to the project but ideas are ,for sure, no one's monopoly. And the scale and pace of his ambition could be judged from the sheer scale of his grand projects. Even now, if a new Reliance project is planned, it is almost taken for granted that it will go online sooner than expected.
5. The most lethal combination is a shrewd mind, humble nature and unmatched courage. Dhirubhai was a master politician, ruthless yet down to earth. Had he not been a businessman, he would definitely have been a succesful politician. And the courage - some people are god-gifted!!. I am not sure about the credibility of the story, but it is said that during his stint in Aden, he used to swim across a particular stretch of sea which was full of sharks, just to win a small bet placed with friends!!
6. An ace manipulator but a hard-working person- he believed in the "there is no substitute to hard work" philosophy. The manner in which he presented facts was commendable, even if the statistics were right, the manner of presentation was enough to change the meaning. And the legacy continues... (recently, after RIL pumped the first bottle of crude from Bay of Bengal, Mukesh Ambani's first public statement had nothing to do with RIL's profit estimates, rather he said this discovery is going to make India self-reliant!!)
7. The Great Gambler- it is said that he made it big initially by speculating! Be it the price of spices and metals in Aden or trading textiles in Paidhoni, the man had a flair for gambling (not literally). He once even went broke but was saved by a lifeline extended by some of his good friends otherwise india's corporate history would have been so less exciting!!

There are so many other stories about the man who became a legend, every thing he did had a midas touch, but it's time to say good night now bcos I have no intentions to start a business anytime soon and in a still-recovering market (or that is what it seems to be), I want to keep myself away from the raised-eyebrows of my employer. I wanted to write something more productive but may be you guys have to wait for the next article!!

Tanuj

The fun of Wealth mangement!!

Hi Friends!!

Life has suddenly started resembling an adventure movie- with the startling pace at which things around us are changing everyday!! It’s not just the economic events which consume most of the space in media these days, but also other geopolitical events like US presidential elections; the MNS propaganda in Mumbai; blasts in Assam and violently fluctuating stock market movements everyday- volatility seems to be at an all-time high!!

Well, coming to the topic of this article, I have been spending some of my time in the past few days trying to figure out the manner in which I can best utilize the cash lying idle in my bank account. Everyone these days is talking about cash being the king; but cash lying idle in a savings bank account can’t even cover inflation. It’s my effort through this article to share some ways which I think can be useful in managing our wealth and making our cash work!!

Over the next few paragraphs, I have mentioned the different asset classes where our money can be invested; the importance of diversification; tax benefits on investment and an arbitrage opportunity which can fetch you a small (but risk-free) return. The ideal candidate I have in mind while writing this article is a salaried individual who falls in the highest income tax bracket; is yet unmarried and has a time horizon of at least 8-10 years to build a substantial portfolio.
How much cash must be there in my savings bank account?

• I know it is a feel-good-factor to have a lot of cash in our bank accounts- it gives a sense of accomplishment when we check our bank balance; but apart from that cash is the worst kind of asset class an investor can possibly think of!! This asset class; which earns a 3.5% p.a. pre-tax income (or 2.45% after-tax return) which Indian banks offer on savings account; has the potential to destroy our wealth in terms of purchasing power.
• But we can’t keep a zero cash balance in our account either- there are recurring monthly expenses, contingent unforeseen expenses, cash needed for infrequent trips, shopping and other purposes. I suggest a formula which can spare us the pain of determining the minimum liquid cash required.
• The formula is not to let more than 3 months of our recurring monthly expenses as liquid cash. The logic is simple, one month cash is what we need on a regular basis, and this can stretch to two months expenses if we have to travel, shop or have some other one-off requirement whereas three months is an extreme case when we need money for an unplanned or unforeseen event.
• Now considering a lavish personal monthly expenditure of 30% of the cash salary credited to our account; I think the maximum amount of liquid cash we need to keep in our savings account is close to one month of cash salary component (3*0.3*monthly cash salary). It’s better to enjoy the privilege of having 2-3 different bank accounts- when some of them have a good ATM network, some have good online and phone banking facilities and some may be willing to offer us value-added services.
• Now that we know what our “working capital requirement” is; we need to know how we can utilize our surplus cash.

Fixed Income investments- slow but steady way to enhance wealth

• There are different ways by which we can earn fixed return on our money- bank fixed deposits (FDs), Fixed maturity plans (FMPs), Public provident funds (PPFs) and corporate debt depending upon the conditions prevailing in the market.
• I think PPFs are evergreen fixed investment vehicles because they help us to save money for a longer time horizon (the minimum lock-in period is 7 years). Also, they help in saving tax (up to a maximum amount of Rs 70,000 is tax free under section 80c)
• FMPs are funds floated by asset management companies and mutual funds for a fixed time horizon- 1 month, 3 months, 6 months and so on and provide an indicative return on the investment close to the interest rate regime prevalent at that time. Although FMPs invest in debt instruments, the catch here is that they don’t guarantee a rate of return. But they carry an advantage in terms of tax savings- income from FMPs is subjected to dividend distribution tax (which is lesser than 30% income tax) and can also be adjusted for inflation index. Thus, FMPs are good investment vehicles for individuals looking to park their surplus cash.
• The next instrument is also the most common one- bank fixed deposits. I would like to recommend some good deals in FDs offered by the banks right now. Kotak Mahindra bank is offering a rate of 10% p.a. on a 10 year FD. It looks very ordinary, but I think it’s a good opportunity to lock in such a high rate of interest for 10 years – presently interest rates are high because of severe global liquidity issues but that may not be the case a few years from now. What differentiates this scheme from others is that there is no premature withdrawal penalty- in other words we get an option to earn 10% interest if interest rates are lower in the future. On the other hand, if interest rates go further up, we can redeem this money without any penalty and invest in the other high interest schemes. Similarly some banks are offering handsome rates of 10.5% on 390 days, 590 days and 890 days FD. The only disadvantage is the fully taxable status and the less flexible nature of most FDs.
• Now the difficult question- how much money shall I park in fixed income instruments? Well, there are no clear cut answers but it’s our endeavor to explore how we can best enhance our investments. I think 60% of our monthly cash surplus (monthly cash salary minus monthly recurring expenses) can be invested in fixed maturity instruments. And, out of the different options available PPFs can be used to the maximum limit (i.e. 70,000 annually), the remaining can be invested in FMPs, FDs and corporate debt according to the time horizon for which we don’t need the cash back for some other purpose. Corporate debts by some government bodies like NHAI have a favorable tax treatment but these schemes are not very frequently available.
• So, for an individual with a monthly cash income of Rs 50,000- the fixed income investment can be close to 21,000 per month after accounting for monthly expenditure of Rs 15,000 (60% of monthly surplus or 0.6*0.7*50,000). On an annual basis this comes out to be Rs. 2,52,000!!! After exhausting the tax free limit of 70,000 in PPFs we still have nearly Rs.1,82,000 for investment in other fixed income schemes. A prudent choice needs to be made between long term and short term schemes and also considering the tax benefits offered by FMPs.

Equities???- give me a break !!!

• We have a very short memory and try to recall only those instances which have happened in the recent past. Of course, the recent plight of stock markets across the world has made many individuals shy from investing in equities. But equity is still considered to be a lucrative asset class for wealth enhancement in the long term. This opportunity is compounded by the depressed prices prevalent right now and expected to remain subdued over the next few months, may be some years.
• Equities offer another opportunity in terms of favorable tax treatment (15% tax on gains if we sell off within a year and no tax beyond a year!!). Also, it probably is the only asset class which gives us so much choice and flexibility in terms of sector wise exposure, time horizon and dividends.
• Remember friends, we still have 40% of our monthly cash surplus available with us. Now, the amount of equity investment depends upon the risk appetite of an individual, I think the money which we direct towards equities must vary between 25-40% of our monthly cash surplus. This comes to Rs 8,750- Rs 14,000 (for a monthly salary of 50k) based on the opportunity offered by the market and our risk potential. On an annual basis, this turns out to be a substantial investment of Rs1,05,000 to 1,68,000!!!
• There are many ways by which we can invest in equities, but we need to choose the one which is the most optimum for us. Remember that we have exhausted just 70,000 from the limit of 1,00,000 on tax free income prescribed under section 80c. So, it’s a wise thing to invest at least 30,000 annually in tax free mutual funds. This provides us distinct advantages in terms of tax savings (not only on gain from investments but also on our regular income!!!), longer time horizon which spares us the pain of timing the markets and a substantial amount of savings (most tax saving MFs have a lock in of 3 years).
• Out of the remaining amount to be invested in equities (over and above tax-free MFs), it’s an individual’s call whether he/she wants to manage his/her own portfolio of stocks or wants to invest in MF with a particular theme or sector wise exposure. There are many mutual funds available to choose from; an individual can look at the past few years’ return history and the sector specific allocation of MFs to decide the ones he / she wants to invest in. Those who like to invest themselves need to be careful about diversifying their portfolios across value/growth stocks, large/mid cap stocks and diversification across sectors as well. Also, there must only be a few well researched picks in the portfolio because adding too many stocks can make monitoring difficult and can also cap the gains from the portfolio.

Alternative investments!!!

• Debt and equity investments are not sufficient investment vehicles if we consider a long time horizon of more than 10 years. We need exposure to some other asset classes as well which can help in diversifying our wealth and have a potential for generating superior returns in future.
• Two common asset classes in this category are Gold and Real estate. Its worth noting that these two asset categories offer a very good opportunity in terms of utility derived from investing in them. Gold is widely used as jewellery and real estate can provide utility either in terms of rental income or using the property for our own use (self-rented)
• Gold is usually considered a hedge against inflation and also the ultimate haven of safety. Now that we have just 0-15% of our monthly surplus left to invest, some of you might be wondering whether it’s still worth exploring the alternative asset classes!!! I would like to remind that there are other components of our salary which are not paid out by the employer on a monthly basis as cash. These include medical allowance, leave & travel allowance, annual bonus, on site allowance etc. This can be a significant amount for some of us. Alternative investments can be considered when we have satisfactorily invested in debt and equity, have a decent life style (don’t require to buy a major consumer durable for our day to day use anymore) and have adequately insured ourselves (both medical and life insurance!!)
• Real estate is an investment where timing plays a crucial role- more importantly because it’s a single bulky investment and a few percentage points can make a huge difference in absolute terms. Leverage can be used to invest in real estate. Buying a flat is more convenient by paying 25% upfront and the remaining 75% financed by a bank. This has a major advantage in terms of tax savings too. A total amount of Rs 1,50,000 annually as interest expense is tax-free under section 24. So it’s better to finance the house in such a manner to claim the maximum tax benefit!!!
• I would like to mention that the money required for real estate and gold is usually large and this can be made available from our earlier investments in debt and equity as and when we feel like booking profits or the need to buy gold or real estate arrives.

The ideal scenario

• The optimum scenario would be one where we have all the working assets at our disposal (the best consumer durables) and we still have a substantial cushion of earning assets which can help us maintain and enhance our lifestyle.
• A very important thing that must be kept in mind is to avoid over-exposure to any particular asset class. This is difficult to visualize when we start our investments because the amounts invested are not significant (especially on a monthly basis). But after a few years, the power of compounding starts playing its role and these assets start inflating. It’s very important that we don’t let our exposure to any particular asset class go beyond a comfortable level (as a proportion of our total wealth). This way we can hedge ourselves against unfavorable price movement in the particular asset class; in short reduce our risk.
• Partial profit booking and redemptions from inflated asset classes and channeling this money into other / sometimes more lucrative assets can be doubly rewarding.
• I think our exposure to a particular asset class must not be more than 25-30% of our total net worth (sum of all the assets we own minus the total liabilities we have to pay)

An arbitrage opportunity for salaried individuals!!

• A few employers have a policy of giving tax-free loans to their employees. This loan carries some tax liability in the sense that the interest calculated according to the market rate is added to the salary component which is taxed accordingly. Assuming an interest rate of 12% and tax slab of 30% this comes out to be less than 4% tax liability on the loan amount.
• If the funds loaned can be deployed in a risk free manner so that they earn a post tax return greater than 4% then we have an arbitrage opportunity to exploit.
• This is not difficult if we invest this money for equal to/less than 1 year in bank FD/ FMPs earning close to 10% p.a. Even after paying taxes we get a spread of 3.5% on FD (even more for an FMP!!). This is a small spread but why leave it when you can earn without any effort. Moreover, when the loan amount rises over a period of time, this small spread too can fetch handsome gains

Just a small recap after a lengthy article ....

• Liquid cash doesn’t earn returns; so maximum liquid cash must be 3 months of our monthly expenses; the surplus has to be “disposed off”.
• Fixed income investments- approximately 60% of monthly cash surplus spread across FDs / FMPs / PPF of different maturities depending upon interest rates and our cash requirement. Out of this 70,000 annual investment in PPFs is preferable.
• Equities – an exposure of 25-40% of monthly surplus is advisable. Out of this at least 30,000 annually in tax-free MFs, the remaining across value/growth, large cap/mid cap and sector wise diversified portfolio of stocks.
• After substantial insurance cover and consumer durables, investment in real estate and gold can be made for a long term wealth enhancement perspective. Timing and leverage are important because of the bulk amount required.
• Churning across asset classes and restriction of exposure to a single asset class can reduce our risk and enhance returns.

Guys, I hope you will benefit from some, if not all, of the points mentioned in this article. I wish I could have finished this topic in a comparatively shorter article but given the amount of detail this topic required; I was not able to do so. Moreover, there may be some more asset classes which could possibly have been worth mentioning here. Though, individuals have different risk and return objectives and we can’t apply a rigid set of rules for everyone, some amount of flexibility can be applied to the above mentioned logic to suit his / her condition. Wealth management, if followed in a disciplined manner, can work wonders for us. And it’s better that instead of “working for money” we make our “money work for us”.

I hope you will enjoy the process of managing your wealth and see it grow substantially by the time you grow old!!

Regards
Tanuj

(This article is a compilation of my academic, professional and personal knowledge in this field. Please feel free to comment and suggest changes you would like to see in my next articles. Also, in case of any doubts or further clarifications, don’t hesitate to contact me on my mail id- I would try my best to resolve them!!! )