On vacation earlier this month my wife and I visited a casino during an evening with friends. We were clearly the poorest of our group. We started setting a limit to the amount we would lose that evening. Like all our friends, we lost. The difference in amounts lost was just a matter of decimals.

The losses showed us who paid for plush setting of the casino, good liquor and food, served “free.”

The capital markets are in some ways akin to a casino. Large advertisements by merchant bankers, stockbrokers and mutual funds are paid for - by the person in your mirror.

I have written earlier about methods of analysis. At the risk of repeating them, then: they are fundamental, technical, and logical. Call them the three guides to making money.

Three ways of losing money would be:

1. Gambling on horses, cards or at the casino - the fastest

2. Women - the most pleasant

3. Speculating on the stock market - the most certain and definitely the most boring

Add to these, a fourth - watching too much TV or reading too many expert opinions, mine included. Rewind to the beginning of the last boom and early April 2003 when the jokers on TV suggested a drop to 2,200 for the Sensex from 2,800. Less than a fortnight later, this same bunch was speaking of the Sensex going up to 6,000. There had been no fundamental change during those two weeks.

Fast forward to January 2008: 25,000 was almost the overnight target, 40,000 in the rather near future, for the Sensex (which was then at 21,000). During a meeting with a brilliant fund manager recently, he showed me a clip from a TV channel. It had a number of the most respected names in the capital markets providing sound bites on the Sensex crossing 20,000. Everyone was advocating a buying spree. There was to be no end to the boom.

Now the same purveyors of garbage suggest 6,000 and lower. The difference is that we have a fundamental change in lower earning forecasts, which was obvious even before Diwali 2007 when the index was around 20,000. Will the experts be correct in their bearish forecast? Unlikely for an extended period, would be my guess.

Yes, they will be for a few days, or weeks. Fear and the memory of recent losses will ensure the investor will refrain from committing fresh money to the markets. But the smart money that exited the markets in January, close to their peak PE of 30 on the Sensex will nibble at choice stocks on offer, now at a market PE of about 10. Along the way will be opportunities to grab at the feast table - opportunities such as a payment crisis, the failure of a large institution, announcement of elections or formation of a Government, when shrill loudmouths, only distinguishable by their shrillness, from Mayavathi, Jayalalitha, Mamta Banerjee, Yechury, and the Karats confirm their idiocy on TV. Each occasion such as the ones mentioned above that causes a temporarily sinking Sensex, the smart money will refill its pockets with the crème de la crème of the equity markets.

Start loosening your purse strings in bits and build a quality portfolio. Take a couple of years doing that, for the opportunity cost of money in a stagnant market would mean an erosion of 50% of your money’s risk-adjusted value in 3 or 4 years. At 10%, the current bank FD rates, your money doubles in about 7 years. Expecting double that rate of return on equity investments is fair considering the market risk, thus leading to my above assumption. However, the markets might just surprise and double next year or stay flat till 2015. I am not gambling on the time frame!

Getting into an SIP in mutual funds, or directly in a personal portfolio is a good idea now. This will likely be a good sum in 10 years, if not sooner.

Meanwhile, if you decide to visit that casino carry just as much cash as you believe you’d pay for a nice evening. You will also find that it’s a lot more fun losing it yourself, than on the advise of an expert.

Naveen Fernandes is Vice President - Sales at Orbis Financial Corporation Ltd., a SEBI approved custodian. He is a Certified Financial Planner. On good days, he fancies himself an investment expert.

Microsoft Excel is a wonderful tool. Even a tech dummy like me recognizes this.
In the hands of a semi-educated financial planner/advisor the tool is lethal.
At the turn of the millennium, “analysts” used Excel to extol Infosys and its growth at over 100% compounded annually. I am an unabashed Infy fan, but I could not imagine Infosys being bigger than the rest of India, which it would have been at that growth rate. Logic and economics combined to tell me that that would be impossible. I now have no Infosys on my portfolio, but will surely buy when I like the price.
Planners use their financial calculators and Excel to drag columns and rows to tell you what you will earn, need at retirement, how much you can spend and the like. The parameters are extrapolated to show a fixed rate of increments, returns and inflation. This is stupid, because life and economics has little respect for the Excel drag function. Inflation and deflation can follow each other before one realizes it. One does not die as one plans, or hopes. Real life takes a break from Excel!
Magazines and papers are full of advice for government employees about to receive their increments and arrears. Of all the template material that masquerades as the best thing to do, I find the home loan pre-payment suggestion hardest to digest.

Should you pre-pay your home loan?

As I mentioned, a popular bit of advice I read on many papers and a few magazines is on handling your bonus and increments. They ask you to use most of the money to pre-pay your mortgage (home loan), considering the high and rising interest rates.
Let me use a personal and very real example - my mortgage has risen from 7.5% to 13.25% (mine is the costliest bank lender). This is terrifying. Still, if I ignored the 80C benefit on payment of the loan principal (I have nothing left of the Rs. 1 lakh after Life Insurance premia and PPF), my cost on the loan is 8.75% considering the tax at 33.99% being the top of the bracket, inclusive of surcharge and cess. The will be a lot higher for those who avail of the 80C on home loan EMIs paid and lower for those in a lower tax bracket. The principle does not change under either of these circumstances. My surplus invested in a 375-day FMP during March at 10.25% would be over 10% post-tax in the growth option, considering double indexation. The 6 month FMP I invested in last week at 11.75% will fetch me 10.08% post tax in the dividend option.
Simple commonsense, which makes up most economics, tells me that cash is a nice thing to have - I might use the FMP maturity or any surplus in more attractive investments, if I can get them, while a prepaid home loan is cash permanently with the bank. Vitally at times of turmoil and uncertainty it is good to increase the amount of liquidity one has for contingencies
I also make more money in the process; every Rs. 1 lakh not prepaid fetching me an annual surplus of at least Rs. 1,250.

Naveen Fernandes is a Certified Financial Planner and Vice-president, Orbis Financial Corporation Ltd, Mumbai. Orbis Financial is a SEBI-approved custodian.

In my last article I had mentioned that there are several methods, or styles, to investing profitably in the equity markets.

Let me start with suggesting that you, the potential investor, spend some time analysing your investments. If one were to assume that your money is indeed “hard earned”, would it not be unfortunate if is easily lost?

Most professional advisors compare their performance to benchmarks, which are indices. For example, if a fund generated returns of 20%, while its benchmark’s returns were 15%, this “outperformance” of the index by 5% is called an ‘Alpha’. This is a good measure to evaluate fund performance, provided the benchmark is reliable. If reliable, it would be a good measure to evaluate even personal portfolios returns.

The BSE Sensitivity Index of 30 shares is the most popular Indian stock market index. If one were to track this over 5 year periods, starting in 1992 (this is the year of the infamous Harshad Mehta boom, which is a relevant beginning simply because this is the first time there was retail participation in the capital markets), we would find that pre-2003 (the start of the latest boom), the index returned less than bank FDs. Even if we go from 1992 to the current date, the index returns are disappointing. This should indicate that equities are a poor long term investment, but are actually among the best options!

In fact, a well diversified portfolio, built over time and given a few years, at reasonable valuations (PE of close to 10, certainly lower than the Sensex’s long term average of 14 times) will outperform the benchmark or almost any other investment. The great Warren Buffet, however, considers that “wide diversification is only required when investors do not understand what they are doing”. If you know, and you need to know, why you make an investment, you should also have guts to invest plenty in it. Again, quoting Mr. Buffet, “Why not invest your assets in the companies you really like? As Mae West said, “Too much of a good thing can be wonderful.””

Diversification or concentration of portfolios can be achieved through investments in mutual funds. Concentration is through sectoral or thematic funds. Concentration is good only if you are an expert and can time your entry and, more importantly, your exits. Avoid being carried away by the noise. Most fund managers consider themselves to be God’s Greatest Gift to Investments (GGGI) in a bull market. However, when they crash with the markets they are quick to point to outperformance, if any, on the index, i.e. “The index has fallen 30%, but I have been brilliant and have lost only 25% of your money”. I have not met any investor who hands out money to be lost, whatever the market conditions. My advice is to ignore the froth from the fund managers, or brokers. If you are convinced the market is cheap, put in all your money. In an uncertain market do an SIP. But when the market seems overvalued sell. (By the way, have you ever heard a fund manager advice you to sell, or redeem your units in a bull market?) A crash always follows a euphoric bubble. Cash is supreme in bad times. It is a good feeling, and also very profitable to buy when the market is down 70%!!

Is this a good time to invest? Yes and no. An important lesson from Joseph Kennedy, almost a century old, is to sell when the shoe-shine boy gives stock tips. I believe this is true today. When the taxi driver is thrilled to take you to the share bazaar and asks for stock tips en route, the stranger at the party gives you sure shot stock bets and the daily newspaper has headlines of the local housewives club betting their grocery money on stocks – GET OUT. This is the best signal to sell your shares.

And buying? This would be when that party animal with best buys stops partying, the Big Bull has jumped off the 13th Floor and there is a funereal feeling at Dalal Street. Buy when the mention of a good company has people grit their teeth and give you dirty looks. And, of course, the index has a low, mouth watering PE!

One of my own gurus told me never to confuse the market with stocks. “The market is irrelevant”, he said, “buy the right stocks and you will always make money.” If you have his stock picking skills, which I do not, this article is not for you. If you are one of the simple folk, hoping to beat inflation and make a little money on your savings, the market at over 18 PE all this week (18.80 on Nifty on September 4, 2008) remains expensive. Look then for gems that might become multi-baggers.

Otherwise hang on to your precious cash. A better day to buy will dawn, when PEs are closer to 10 than 20. Get into SIP mode then. Market corrections can be both deep and long. Losing opportunity (interest cost of your money) is about as unfortunate as losing capital.

Naveen Fernandes is a Certified Financial Planner and Vice-president, Orbis Financial Corporation Ltd, Mumbai. Orbis Financial is a SEBI-approved custodian.

Inflation is the rate of increase in prices. Simple.

In times of low inflation people grumble that prices still go up. They will, but at a low rate. Deflation is prices going down!

We have recently seen prices galloping. This has rightly been blamed on crude petroleum oil prices that have been accelerating, seemingly without the hint of a brake.

How is oil the spoke in our own wheel? Why does it cost so much more to fill the kitchen shelves? Oil. Crude oil provides petrol and diesel - fuel for our transport. A hike in its price makes it costlier to produce the fertilizer (an oil product), run the tractor, pump the water (a lot of electricity is also produced from oil products) and bring it to your neighbourhood mandi.

Some inflation is a good thing. Just like a bit of temperature is good for the body (98.6˚F is normal temperature), a bit of inflation makes the economy grow, justifying salary increases and interest on our deposits!

Inflation is dangerous when it is out of control. This can happen when plenty of money is printed. Foreign money entering our economy produces local money; the Government running deficit budgets also creates money supply. When a lot of excess money tries to buy the normal production of goods and services prices go up – INFLATION!! Your salary increases and bonuses also cause inflation, as also the higher interest you get on your deposit. Inflation is a dragon eating up the value of your money, as you need more money to buy the same product.

In the interest of the ecology and driven by higher petro prices, a lot of sugarcane and corn produced is being used to produce ethanol (ethanol is being used as a substitute for oil in cars, trucks), instead of being directly consumed. With agricultural land being limited, there has been a decrease in food production, taking food prices up. We have a new term for this, Agflation.

The Reserve Bank of India (RBI) has been increasing interest rates and reducing the money in the economy to curtail inflation. Will it work, and if it will, how?

Less money available will buy less. Higher interest rates will reduce the feasibility of borrowing to consume – most homes and a lot of vehicles are bought on credit. This will surely impact inflation. But is it enough? What is the cost of the rate hikes?

I believe it was in the year 2000 that our then RBI Governor, Mr. Bimal Jalan, said that the Central Governments of the world do not react to supply side inflation. In the current situation of the RBI’s monetary tightening, would the price of oil drop in response to the Indian rate hikes? Not likely, is my bet.

What then, could this tightening do? For one, this will hurt banks. As money becomes scarce, they need to raise deposit rates. They will also have to maintain a higher Cash Reserve Ratio (CRR, now at 8.75% of their deposits), earning no interest on amounts above 3.5% (and getting only 3.5% interest on that portion). At higher interest more loans will default, ouch! Projects being set up become costlier at higher interest rates. Ongoing housing projects may get delayed as rising interest costs will impact the borrowing of builders. There will be less industrial investment, which will hurt us with lower production in the years to come, meaning a lower GDP, less jobs and a lot more pain. This could just be a return to the old Indian “Hindu rate of growth”, or worse, recession. Oil for the moment, is likely to remain expensive, leading to ‘Stagflation’, which is prices rising in a stagnant economy.

Do you say a prayer, or are we left without a hope or prayer?

Naveen Fernandes is a Certified Financial Planner and Vice-president, Orbis Financial Corporation Ltd, Mumbai. Orbis Financial is a SEBI-approved custodian.

I had just started college in 1981. Some saved pocket money and small prizes added up to Rs. 125, which became my first investment in shares. 3 years later I got out of college with some education, a portfolio of about Rs. 10,000 and a lesson in keeping my mouth shut…Knowing my dad also had some investments in shares (from the addresses on the mail) I mentioned a particular stock at home. Dad promptly took me out and warned me never to speak of shares in my grandmother’s hearing. The belief was that investing in shares was as big a sin as gambling – anathema for a small town middle class family.

Stories of legendary wealth created from investments (Warren Buffet, according to an email doing its regular rounds, started at age 11 and used profits to buy a farm at 14, to turning into one of the richest men in the world), to tales of suicides by big losers would suggest that investments in shares is gambling and that the stock market is a huge gambling den. Is it?

Starting at the beginning, what is a share? If I may use examples, a person starting a small business could use his/her money, if a little more money were needed. He/she could rope in friends as partners, or borrow from banks, but would be hard-pressed if the capital required were substantially larger. Such a businessman could split the entire owners’ capital into small units, of normally Rs. 10 and sell it to a large number of ‘investors’, each being a partner in the business to the extent of the money invested (’shares’ bought). The business would be in the form of a ‘Joint Stock Company’ (Company).

The share market? If the investor, from my previous paragraph, had invested in a share of a profitable company, others interested in being a part of the venture would try to buy shares in that company. This would take the prices up. Conversely, if the company were not profitable the holders would try to sell it bringing down the price of the shares. The share market is a forum that facilitates and controls the transactions, to ensure the investors’ transactions are safeguarded.

This does not mean that the stock exchange guarantees profits to all investors. Every transaction of a share bought involves another where a share is sold (shares are not created at will). While the buyer would purchase a share expecting the price to go up, the seller would expect it to drop. One would be right. The Stock Exchange is a place where a seller can find a buyer. The Exchange also ensures that the buyer receives his shares and seller his payment.

Returning to the beginning and my grandmother? How is investing different from gambling? While gambling involves chance (I do not know anything more about gambling in any form), investing involves the science of numbers. All stocks traded (stocks are bundles of shares) are at a price. This price is normally based on measurable factors, including but not limited to the profit of the company (from which is derived the profit per share, also called Earnings per Share or EPS), Book Value (which indicates the amount of profit plowed back in the business), ROE (Return on Equity) and ROCE (Return on Capital Employed, showing how well money has been used to make profits by the Company). Out of these come other ratios relevant to the price, like PE (Price/ Earnings, a fundamental value), PEG (PE/ Growth), P/BV (Price/ Book Value) and others. The market becomes a casino when these values are ignored and shares are bought because it is fashionable to have some!

The guru of investors, Warren Buffet, has said that he considers ROE, followed by PE, the most important values.

Returns are the most important simply because that is the reason for any investment. With a number of options available, the investor would be unwise to use the less profitable. Therefore, knowing that your company earns reasonable returns on the money invested in its business (Return on Equity and Return on Capital Employed) is the basic parameter to value a company and its share.

PE tells us the price we pay for the returns. Simply PE is the number of years it takes to get your investment back as profits, at the present rate of profit. Obviously the investor would like to recover his investment early, so a small PE would normally be better. An example, most small businesses are started with loans from parents or uncles, autorickshaws, fruit juice stalls, vegetable vending and the like, which are numerous successful businesses in India. The loans are taken with a promise to repay (mostly honored) the loan after deducting daily personal expenses. The loans are to be repaid in 2 or 3 years, indicating a PE of 2 or 3. Would the lending ‘uncle’ be as generous if the loan were to be repaid in 30 years? I doubt it. But in shares investors often disregard their ‘pay-back’ period (the BSE Sensex was at a PE of 30 a few months ago), clearly indicating gambling was getting the better of investing. The market fall to a current level of about 18 PE was a natural phenomenon of valuations and better sense descending!

There are several methods to investing and they will be covered in time. The most important is to invest with some knowledge. Data is available today, as easily to the rookie, as a professional. If the money invested is hard earned, the investor has a duty to himself, to see that the money is not lost to stupidity. Three basic types of research are Fundamental, Technical and Logical.

Fundamental research is a study of the Profit & Loss account, as well as the balance sheet of a company to check the financial health and profitability of the business. The ratios mentioned earlier all stem from this.

Technical research is a study of graphs and patterns, best left to experts. This is used to identify the best time to buy, or sell, a stock.

Logical research is simply keeping ones eyes open. The daily news often provides information on opportunities. For example, increases in interest rates hurts companies that borrow, and banks that would see erosion in the value of their bond portfolios. Increased customs duty on steel would benefit the local steel manufacturers.

Till we meet again, a word of advise. Gather some knowledge, or go to experts (through Mutual Funds). Invest so that you keep your losses low (therefore invest cheap – not at low prices, but at cheap valuations). Prefer to lose opportunities, not money (Buffet’s 2 rules to his managers are:

1) Never lose your investors’ money

2) Never forget Rule 1

May your investments be profitable and your days peaceful.

Naveen Fernandes is a Certified Financial Planner and Vice-president, Orbis Financial Corporation Ltd, Mumbai. Orbis Financial is a SEBI-approved custodian.