If markets r cheap, as much as 75% can be in stocks and when they turn expensive, we can have 75% in bonds

Sensex down 1,500 points as I write this.

These are of course scary times.

However, the key is to not panic.

Here’s what I would do.

If you have good quality stocks in your portfolio that were brought at attractive valuations, it makes sense to continue holding on to them.

Maybe it is still not too late to get out of risky mid and small caps that were bought on hope but have weak fundamentals and leveraged balance sheets.

These stocks go down the most during a market crash.

Is this is a good time to take more exposure to stocks? I don’t think so.

Investing is all about getting the odds in your favour and I think these are still not in our favour.

The broader markets are still expensive.

I think it could be a good idea to increase exposure once the Sensex PE moves to around 20x-21x, which is its long-term average.

Right now, it is still at 25x PE.

Lastly, investing is all about having a sound and a proven process in place and then having the discipline to follow it at all times.

A well-documented process helps in staying the course and stops us from panicking and taking a rash decision.

In my paid services, I moved from a 75% stock allocation to a 50% allocation in the past few months based on a well-documented process.

I will start thinking of increasing exposure to stocks once the broad market PE moves towards its long- term average. 

 

The portfolio managers at US based Clipper fund have done an interesting comparision.

They have pitted current market darlings like Tesla, Nvidia and Shopify vs quality stocks like Berkshire Hathaway, Intel, American Express and others.

Market darlings trade at a huge market cap of US$ 2.3 trillion with the combined PE ratio of 115x

The quality basket comprising Berkshire and others also trades at a similar market cap but a low PE of just 17x

Perhaps market darlings like Tesla deserve a premium but should the premium be as high as 115x vs 17x.

They are almost 7 times more expensive despite earning profits that's almost 1/7th the quality basket.

It looks highly unlikely that stocks like Tesla and Shopify can outperform the other group over the next 10 years.

Of course in order to invest successfully, both the company' current earnings and future prospects need to be considered.

In fact, looking for companies growing at above average rates but available at below average PE multiples is the holy grail of investing.

But paying a very high PE multiple upfront is not how you should go about it. That way lies danger.

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Photo from Rahul Shah

Got this one pager on one of my What'sApp grps.

Let's understand how to approach this situation with the help of a story.

There r two friends Ram and Shyam.

Ram is a trader. For him bhaav bhagwan che (price is supreme).

Shyam is an investor. For him value bhagwan che (intrinsic value is supreme)

Ram buys a basket of 10 stocks that have gone up after the war broke out.

Shyam buys a basket of 10 stocks that have gone down after the war broke out.

Ram had to pay 10% premium because there was a lot of demand for his stocks and their prices went up.

Shyam on the other hand ensures that his stocks has decent fundamentals and were available at atleast a 25% discount to their true values, which in this case is Rs 100.

So, instead of paying Rs 100, Ram paid Rs 110 and instead of paying Rs 100, Shyam paid Rs 75.

Ram's stocks continued their good form and went up to Rs 150 over the next few months. However, since Ram didn't know when to sell, he kept a 10% trailing stop loss and exited at Rs 135. Thus, he made 23% on his investments.

Shyam's stocks kept going down initially and even touched Rs 60. However, market soon realised that the war was only a temporary set back to the stocks and their long term fundamentals are intact.

Thus, the stocks start going up, allowing Shyam to finally exit at his intrinsic value estimate of Rs 100. His overall profit - a cool 33% and perhaps more if he would have averaged at Rs 60.

So, dear readers, would you rather be a Ram or a Shyam? As a value investor myself, I would lean towards being a Shyam provided you buy at a big fat margin of safety and know how to calculate intrinsic value.

By the way, I have figured out a simple way of estimating a stock's intrinsic value that has allowed my subscribers to earn gains like 545% and 276% in only 11 months, 206% in 19 months, 180% in 10 months, 176% in 11 months and more.

In fact, over 8 years, this method has helped me achieve an impressive strike rate of 80%.

I have packed the entire detail in my brand new learning course, The Lazy Millionaire.

The course has been specially designed for the busy professional and can be completed by him in 4-5 hours flat. The learnings however will stay with you for a lifetime. I am sure you will take away a lot of valuable lessons from this course.

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https://www.equitymaster.com/lazy-millionaire/YT-promo-EG.aspx

Warren Buffett’s 2021 letter to shareholders is out and you may have already zeroed in on your favorite part from the letter.

My favorite is this one line: Charlie and I are not stock-pickers, we are business-pickers.

There’s an interesting story around Ben Graham and how he let go of a potential 100-bagger because he stuck to his core principle.

Graham’s junior colleague recommended that they buy a stock known as Haloid. The company had the rights to a promising new process called Xerography. It’d been paying dividends for many years now. The colleague felt that they should buy the stock because its future looks very promising.

Graham refused. He said that the stock is not cheap enough at US$ 21 per share. Well, the company was none other than Xerox, whose share price went to as high as US$ 2,000 in the following years.

Why did Graham refuse Xerox? Simply because he considered himself a stock-picker and not a business-picker. He did not understand the business of technology and stayed away from it.

Graham did not invest for the very long term. He was happy taking his 50%-100% profits and moving on to the next business.
 
Warren Buffett on the other hand stays invested as long as the fundamentals of the business is intact. Coke is a great example. He did not sell Coke even when it reached exorbitant valuations in the early 21st century. He was focused on the quality of the business and since that was intact, he stayed put.

I think this distinction is very important. Are you more of a stock-picker or a business-picker? If it is the former, then your holding periods should be 2-3 years or max 5 years. But if you are a business-picker then you should have a much longer horizon and you should stay invested as long as the fundamentals of the business remain intact.
 
You should not sell no matter how high the valuations go.

Can the Sensex fall to 40,000 levels?

Well, if we enter a new bear market (technically defined as a fall of 20% fr yeh top), then there's a strong chance it may.

In fact, if what has happened in the last 7 out of 9 market cycles repeats itself, then Sensex 40k-42k is definitely on the cards.

The good news is that we are not in a bear market yet. We are down only 10%-12% from the top.

But shouldn't we know what exactly can cause the Sensex to fall to 40k and what steps to take should such an event present itself?

Well, do check out my latest you tube video for all the details. Link below.

A very good message I received on my What'sApp today....

Prepare For The Worst, Hope For The Best

To investors,

The last two years have reminded us that humans are very bad at predicting the future. In 24 months, we have seen a pandemic, financial recession, double-digit unemployment, 40-year high inflation, social unrest, oil fluctuating between -$20 and $140, multiple bitcoin all-time highs, the largest wealth inequality gap on record, war in Europe, the most severe sanctions ever levied against a single nation, negative yielding debt around the world, and trillions of dollars pumped into the global economy through quantitative easing.

It is an understatement to say that the events that have transpired since March 2020 have been chaotic and unpredictable. The rise of social media makes it seem like the world is unraveling, dystopia is inevitable, and there is nothing that any individual can do to slowdown the madness.

While there have been plenty of difficult times to navigate, humans still live in the safest, most prosperous time in human history. It is hard to balance the long-term trend of improvement for the human condition with the short-term recognition of chaos and uncertainty.

This truth reminds me of two important ideas that have solidified in my mind over the last few years. The first comes from Jim O'Shaughnessy, founder and Chief Investment Officer of O'Shaughnessy Asset Management, who was kind enough to record a podcast conversation with me in August of 2018. We discussed everything from bitcoin to stock indexes to traditional investing insights. I was surprised at how many times Jim said “I don’t know” during our conversation. It wasn’t once or twice, but over and over again.

The more experienced an investor gets, they tend to feign intellectually humility, but it is usually just a strategy to signal mastery of their craft. This wasn’t what Jim was doing though. He has spent decades building software and data sets to overcome human bias and mental inaccuracies. Jim’s firm, which has billions of dollars under management, is built on the idea of “I don’t know.” And as you would expect, he is right. None of us know what the future holds. Humans are really bad at predicting the future. We could all benefit from saying “I don’t know” more often.

The second idea that I am reminded of this morning is the importance of probabilistic thinking. According to Farnam Street, “Probabilistic thinking is essentially trying to estimate, using some tools of math and logic, the likelihood of any specific outcome coming to pass.” When humans are faced with uncertainty or chaos, it makes us feel comfortable and safe to have a high degree of confidence in a specific outcome. We feel in control. We get the psychological benefit of certainty. But, of course, this is an intellectual error that leads to bad decision-making.

The proper framework is to assign probabilities to a variety of potential outcomes across a spectrum of results. This more nuanced process of evaluating a situation allows for more rigor, more accuracy, and a faster iteration speed to change your mind when you receive new information.

Take the current Russia-Ukraine conflict. Will Vladimir Putin pursue the usage of nuclear weapons? Will Ukraine successfully defend their country from the invasion? Will gasoline prices in the United States reach $6 per gallon in the next 6 months? The answers to these questions, and hundreds more, are unknown. Rather than seeking binary yes/no answers, you are better off arriving at probabilistic outcomes.

So why is it important to say “I don’t know” more, while also thinking probabilistically?

Humans are horrible at predicting the future. This is a lesson as old as time. Regardless of the period in history and the specific events that are being analyzed, humans have a hard time analyzing the complexity of a situation and correctly identifying what happens next. We shouldn’t fight this truth.

It is important to understand it and act accordingly. When it comes to investment portfolios, it pays to park your wealth in great assets that you can hold for very long periods of time. Trying to trade in and out of financial assets, even in just the last two years with all the various developments, proves to be nearly impossible. The economy is a complex machine with many inputs and intricacies. Individual assets are influenced by macro and micro factors, which makes predicting future moves difficult to say the least.

We don’t know the future. No one does. If you want to live a less stressful life, accept this truth and position yourself to win over long periods of time, regardless of what is thrown our way. Your quality of life will be better, your decision-making will be better, and your portfolio is likely to perform better.

These are not ground-breaking ideas. But we need a reminder every once in awhile. Hope you have a great start to your day.

Chinese stocks are crashing.

The Hong Kong China index was in the vice like grip of panic selling yesterday.

It closed 7.2% down, the biggest drop since November 2008.

The index is now down 28% in one month and a whopping 45% in one year.

Contrast this with the Sensex which despite recent volatility is still up 12% over a 1-year period.

Now, here’s some data that will really shake you to the core.

Since its inception in December 1992, the MSCI China index has returned just 1.5% per annum in USD terms.

If you include fees, taxes etc, the returns could come to almost zero.

Yes, that’s correct.

The stock market of the fastest growing economy, an economic miracle of the current century, has given almost zero returns over a period as long as 30 years.

Here’s the chart for a quick overview.

 

Manan (@thakkarmanan) Tweeted:
Msci China in USD terms since 1992
Returns near 1%!
#chartoftheday
@nooreshtech https://t.co/Vb3LmtdKdL https://twitter.com/thakkarmanan/status/1503564411570728960?s=20&t=j4dDk3lzMeLWu-KKhuMbSw

Is this crisis an opportunity by the way?

Charlie Munger definitely likes to think so.

He made his love for the Chinese economy and its dominant stocks loud and clear at the recently held AGM of Daily Journal Corporation, a firm where he is the Chairman.

Here’s what he is believed to have said.

China is a big modern nation. It’s got this huge population and this huge modernity that has come in the last 30 years. We invested some money in China because we could get more value in terms of the strength of the enterprise on the price of the security than we could get in the United States. Other people, including Sequoia, the leading venture capital firm in the United States, have made the same decision we have. (Source: Junto Investments)

There’s an important investing lesson here. The future is always going to be unclear. So, do your homework, ensure that the underlying stocks is of good quality and buy it with an enough margin of safety.

It doesn’t matter what others think. If the stock ticks both the quantitative as well as qualitative boxes, go ahead and take the plunge without worrying about the popular opinion out there.

For Munger, his Chinese investments of BYD and Alibaba ticked these boxes and he is also confident of the Chinese economy doing well going forward. This is all that matters to him.

Equitymaster has been Hit by a Ransomware Attack

Dear Valued Member:

There’s no easy way to say this.

Equitymaster is now a victim of a ransomware attack.

In effect, this means you and I, along with our base of subscribers and the Equitymaster team, have been locked out of our website.

For now, you can no longer visit Equitymaster.com or our Android App and access our honest opinions on investing.

We are doing our best to address this situation.

I am sure you have many questions you want answered...I will pre-empt some here which I think will be most critical.

First, did Equitymaster have systems to prevent such an attack?

In a word, yes. We subscribe to the best-in-class firewalls, antivirus and malware software and have in place policies that prevent such attacks from happening.

The fact that this attack still happened gives us pause. We are already reviewing everything and have already initiated steps to further tighten our systems and processes to prevent such attacks.

Second, did we keep backups?

Again, yes. We have a well-defined back up policy. It has worked perfectly for over 25 years. Until now. The ransomware hacker has managed to break through and infect our backups as well.

How will this impact you?

If you are a reader of Equitymaster, there’s almost no impact.

If you are a subscriber, again, the impact will be limited as we are working towards restoring data from other internal sources. We expect your subscription account to continue without any inconvenience.

If you are a user of the Portfolio Tracker, this is not good news. While we will try our utmost best to resolve the ransomware matter, any adverse outcome will impact your data. If this would happen we know how disappointed you would be. It would nothing less than shatter us.

Third, will Equitymaster continue to publish?

YES. Our entire team is on ground and finding ways to fight off this challenge. We will definitely continue to publish ALL our premium research. And we are working hard to get back to publishing all the other stuff that we do.

Fourth, when will things go back to normal?

We just cannot say. But we are working to address this at the earliest.

Fifth, is the data safe?

We cannot confirm that. But it appears the intention of the hackers is not the take the data, but to ask for money to unlock the data on our own servers.

What about credit card data and other payment related information?

Equitymaster never saves personal payment details. So no worries at all there.

Sixth, what happens to the missed days of my subscription?

As soon as our systems come online we will more than make up for these lost days.

Like I said, you probably have more questions. I can already see our Customer Service team swamped with queries. I hope you will be patient with them as they do their utmost best to address your concerns.

Meanwhile, my team and I continue to work hard towards addressing this ransomware issue.

Your patience and support is deeply appreciated.

Stay safe,
Warm regards

Rahul Goel
CEO, Equitymaster

PS: The entire customer service team is on standby to address your concerns in the most transparent manner. If you have queries, drop them an email... Thank you, once again.

Fun way of saying that stocks like Paytm are extremely difficult to value.

Because the company has no profits, you either value it based on future profits or its current book value.

Both these methods are fraught with risks as future profits are hard to calculate and current book value is fast eroding.

In short, paytm is a business difficult to wrap your head around.

Charlie says we have three boxes: “In,” “Out” and “Too hard.” You don’t have to do everything well. At the Olympics, if you run the 100 meters well, you don’t have to do the shot put…” — Warren Buffett.

As you are aware, Equitymaster.com is a victim of a ransomware attack.

We will not let this come between you and the credible and honest opinions we publish for you.

The entire Equitymaster team is all here, and publishing daily as usual.

Just that you will receive our content and research updates over email till we sort out things.

Thank you for your patience.