Is INR a Turkey ?

Rupee has seen its biggest single day fall in last 5 years and it has hit 70 against the US Dollar (USD) for the first time. This has led to a furore and pandemonium. One end of the political spectrum is portraying it as the failure of the ruling dispensation and as expected, the Govt. of the day is saying that the fall is nothing worrisome and is due to the external factors. Infact Subhash Chandra Garg, Secretary, Department of Economic Affairs, GoI has gone to the extent of saying  “Even if the rupee falls to 80, it will not be a concern provided all other currencies also depreciate.”

Rupee or for that matter any currency falls against the US Dollar whenever outflow of US$ is more than the inflow of US$, therefore to understand this fall in INR, let us see what has prompted higher US$ outflow this time.

1. The Turkish Lira Contagion – Whenever there is economic uncertainty, big money rushes towards the safer currencies. The Turkish embroglio has impacted all emerging markets and investors are moving their money from India/Turkey/other EMs to US$ based assets. This has increased the outflow of US$ thereby increasing the price of US$.

2. Higher Crude Oil Prices – Higher Crude Oil prices mean demand for more US$ as the Oil Imports are US$ denominated. Just as an example, The crude Oil Import Bill of India for May’2018 is $115 billion as compared to $76 billion in May’ 2017 that’s a whooping 51% jump, which is in line with the year on year jump in Brent prices. Even if the crude oil price tapers a bit, India will continue to pay more because of the fall in INR.

 

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3. Non-Oil Non-Gold Trade Deficit – This simply means that even if we exclude Crude Oil & Gold, India is importing more than its exporting. This non-oil, non-gold merchandise deficit is consistently widening. The deficit widened to $53 billion in the year ended 31 March 2018 compared with $17 billion in the year ended 31 March 2015. To finance more imports we need more US$.

4. Outflow of Foreign Capital – As per the of National Securities Depository Limited (NSDL), Foreign investors have taken out Rs 35,356 Crore since 1 January 2018. Whereas their net addition was Rs. 43,127 Crore in year 2016 & 2017.

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Now let us see how the Rupee Depreciation affects the economy & us:

1. Higher Inflation – The Crude Oil & other imports will become expensive, this will mean that the general price level will increase as the fuel cost and the cost of other material will increase. The Reserve Bank of India estimated in its monetary policy report in April that for every 5% fall in rupee, retail inflation will increase by 0.2%.

2. Higher Interest Rates – To combat the resultant inflation RBI will have to raise interest rates so that less money flows in the system. Because if a lot of money chases things, the prices increase further. Higher interest increases the cost of loans, this affects individuals as their Home/Car Loan EMIs go up and industries also get impacted.

3. Slow Growth of Economic Activity – Higher interest rates control inflation but they restrict the money supply in the economy, thereby impacting the circulation of money which means brakes on the economic growth.

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4. Widening of the current account deficit – The gap between foreign earnings against expenses have the potential of increasing CAD. Normally, foreign capital inflows help in bridging the gap and easing the overall balance of payments, which includes both the capital account and current account balances. But given the global risk aversion, those prospects are dim. As per a Nomura Securities report, every $10 rise in the crude oil price widens India’s fiscal deficit by 0.1% of the GDP.

5. Impact on Corporate Profits – A declining rupee adds to the pressure on corporate profit through higher input/fuel costs. Their Loan costs increase too. Companies with foreign currency loans are doubly affected.

6. Impact on Foreign Investment – As the currency value goes down more and investors pull out and more and more investors pull out the currency depreciates more.

7. Gain to Exporters – The only happy party in the case of a depreciating INR is an exporter. A falling rupee helps exporters as they get more local currency per US$ but the impact is partially offset by the rising input costs. As per the studies, a 1% change in the rupee-dollar exchange rate has a 0.40%  impact on margins on average.

What can RBI do to stem the INR Fall – RBI has substantial Forex Reserves (US$ 406.1 Billion as on 29-06-2018) they fully meet the IMF norms for reserve adequacy and there is no cause for undue concern.

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                                                                                                          Image Courtesy – IMF Website

With that large war chest, RBI can intervene in the currency market if the Rupee Depreciation continues. However, this seems to be an over reaction to the Turkish Lira situation and the situation is expected to improve soon. Though, to present both the points of views Peter Brandt, a well known Finance Professional has given a statement that if INR breaks the level of 71, it may fall upto 80. Will it play out or not only the time will tell.

 

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Why Stock Markets fall & Can we Predict it ?

When Stock Market boom, nobody asks any question as to what resulted in 1000 points rise in Sensex  or why the markets recovered so quickly from the drop of 1000 points. Whenever the stock market drops, the hunt for an explanation immediately begins. For Friday’s correction it was escalation in tension between USA and North Korea. This happens because our human minds need some sort of explanation, a reason behind everything. We do not like uncertainty, we want something to hold onto to, however flimsy it may be. But more often than not we have a tendency to miss the woods for the trees.  This is mainly because we ask wrong questions and also because of the fact that these wrong questions get answered.

People seeking reason of a market fall and people answering them usually focus on the immediate events that triggered a selling, whereas these events are nothing but minor symptoms of much more severe underlying problems.

Geo Political Reasons: Usually the prime suspect is some Geo Political event being played out, and one of these is normally on hand like Doklam Border Tension was there till last month, if no such thing is available nearby, one can always scan the world to find something, like the ongoing USA – North Korea Situation or testing of Missile by Iran. Since every US president has to have a war of his own, you can always count on US to find something there.  

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F&O Expiry: In case no such macro event is being played on the world stage, most markets experts identify F&O expiry, profit taking and Algo/Quant trading as a major cause of the stock market drops. While its true that derivatives trading divert capital from real investments and may cause skidding due to some oversized bets. Algo or Quant trading is straight forward arbitrage between actual stock prices and stock future prices that the smart guys take advantage of.

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If for example Stock Futures dip substantially below the Spot Prices, Algo/Quant Tranding Software would automatically buy stock futures and sell the underlying stock, locking in return. Now in a falling market, general investors would see this as putting pressure on on stock prices triggering a fall. But are they actually at fault ? No ! they just benefitted from the opportunity that was created by the Future Writers who anticipated that the prices would fall and entered in a future contract. If Algo trading was nonexistent, general investors too would have seen the gap between future & spot prices and would have acted in the same way. Therefore Algo/Quant traders work to narrow down the gap between Spot & Future prices, they are not the underlying cause of the Stock market correction.

Short Selling: Another reason proffered by investors is short selling. It is said that short sellers have caused this correction because they think market is overvalued. But is it really a cause of the correction? In my opinion no. Short sellers actually work towards controlling overvaluation. Anytime a market looks overvalued short selling takes place and prices start to cool down. Moreover market lives on optimism in fact over optimism fuels investment universe. You get plenty of buy calls from analysts, brokerages and fund houses but very few sell calls.   

Liquidity: It is said that liquidity is fueling this market. There is no doubt about this, but the question when it wasn’t ? There is no period in the history when stock markets surged in the absence of liquidity. Money is always there, it keeps shifting from one asset class to another, if real estate looks profitable it flows there, if gold looks attractive, it moves there. As long as stock markets look attractive, money will keep flowing to it and there won’t be any problem of liquidity.

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Profit Taking: – This is a very simple reason which even a layman can understand and it looks like a very obvious reason. But if we invert (as the legendary Charlie Munger recommends to do every time)  what was causing Stock market Rise ? Was it Profit Giving ? This inversion clears our mind that profit taking can not be reason behind fall, because when somebody is selling, somebody is buying too.

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Can you Predict the fall: That brings us to the original question again that what brings the stock market drop. And that has a very simple answer. Stocks cannot outperform the returns of the underlying business and anytime the stock prices factor in more than possible returns on the underlying stock, sooner or later it will correct and the prices will drop to reflect the performance of the business.

The other reason for market fall is a black swan event like the Demonetisation or the subprime lending crisis. Now by definition black swan events are those events which cant be foreseen but have huge impact. 

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Now the next logical question is can you measure if the stock prices are running ahead of the fundamentals and the most important one can you forecast the next correction? The short answer is no! Nobody can forecast a market fall.

A slightly long and more nuanced answer is that while you can’t pinpoint exactly when would a market fall, you can have a general idea as to when is the market overvalued i.e. running ahead of the fundmentals and when its within safe range by looking at the P/E ratio of the market as a whole. The P/E Ratio takes into account the Earnings and Price of the NIFTY-50 stocks and is a good marker to assess the over/undervaluation of the market at any given point of time.

If you want to do it yourself, historical P/E of NIFTY-50 can be taken from NSE website. However, there is an easy way Dev Ashish of www.stableinvestor.com whom I consider an astute investor and financial advisor, has done a fantastic job of compiling Monthly Average of NIFTY-50 PE from January 1999 onwards. He has plotted & colour coded the matrix and has named it NIFTY-50 Heat Map. It shows that anytime NIFTY-50 PE has ventured beyond 25, a correction has ensued sooner or later. Now having something like this is a lot better than groping in the dark.

Historical-Nifty-PE-2017-AugustCredit – http://www.stableinvestor.com

Two Important things about NIFTY-50 P/E –

1. Its important to understand is that this figure of 25 should not be taken as a gospel word. P/E is a dynamic matrix and it goes up & down based on the Earnings & Market Prices. But till the general PE of market get revised upwards, this P/E of 25 can be safely taken as a thumbrule.

2. This matrix hints at the general situation of the market and is not stock specific. Some Stocks keep rising even in falling markets as some keep dropping even in rising markets.

Finally always remember the sobering market adage from the legendary economist and investor John Maynard Keynes ‘Markets can remain irrational longer than you can remain solvent’.

Happy Investing !

How to Pickup a Stock

How to select a Stock to invest is a conundrum that all the new investors face. There are a plethora of stocks and there’re are all sorts of recommendations. There is always somebody in our circle who is into investing, he will have his list of favorites ready for anyone who cares to listen. Then we have brokers and analyst reports that are available on internet and there is the ultimate social media like Twitter, WhatsApp and telegram which are ubiquitous today.

All these sources create confusion in the mind of investors specially those who do not have sufficient knowledge or analytical skills to analyse these stock recommendations on their own.

We all have limited capital and in stocks markets opportunity cost is big, therefore if the money gets committed to a wrong or sub optimal stock the returns would suffer and if the stock is a dud or a manipulated one, investors may burn their hands too.

So is there a solution ? or a small investors or somebody who doesn’t have much knowledge of accounting & Finance is doomed ? Well the answer is that an investor need to understand at least the Financial Ratios (Even better if an investor understands accounting too).

The good thing is that there is hope… though the investors will need to put in some efforts but they can very easily avoid getting into traps. The investors may use the power of internet to their benefit for this purpose.

Once an investor get an investment idea from some source (whatever it is) he should immediately run a check on www.screener.in . Screener is a beautiful website which the labour of love of two accomplished young investors Ayush Mittal and Pratyush Mittal who are Chartered Accountants by qualification. Screener gives you complete financial analysis of all listed companies in a jiffy. I highly recommend that any serious investor should join screener.in website . It has several financial ratios on its default screen and the user can customize the report to include more Financial Ratios.

Screener looks like this:

Screener

The financial aspects that one must see are:

Sales Growth – Since a business has to earn profit and generate cash, the importance of sales can not be overemphasized because the profits come from revenue after meeting all the expenditure. Companies should be growing their sales at least at 15%  over a period. A lower growth rate of sales needs further probing to see the reason whether competition has become tough i.e. prices are falling or the demand has declined. This further needs to be studied whether these are temporary phenomenon or the business is on a regular decline.

Profit Growth – Business can not survive without generating profits. Hence business should earn Net Profit Margin (Profit Afetr Tax/Sales) of at least 10% .

Debtors Turnover Days – The ratio tells about the efficiency of credit collection. Since companies need cash to run their day to day business a higher debtor turnover ratio is better. It must be compared with the other competitors in the industry. Low Turnover ratio generally indicates that company is not prompt in collection receivables.

Cash Generation – Cash Flow Statement indicates the cash generation & its deployment by the company. The first thing to check is that Cash from Operations must be positive, otherwise it means that the company is dependent on cash coming in from the investing or Financing activities and not from its core business activities.

Current Ratio – Current Ratio shows how much current assets are available in comparison to current liabilities. A ratio of at least 2 is preferred because inventory and debtors may not realise their full value.

Working Capital Days – This simply means in how much time company is able to convert its working capital to revenue. The smaller the no. better it is as it means faster conversion of Working Capital into Income.

Debt Equity Ratio – Companies finance their capital by equity and loans in varying degrees. An ideal Debt Equity ratio is upto 0.5. Which means that a company should have a maximum loan of 50% of its equity capital. Now some industries where product gestation period is long (Example BHEL where products take years to build) or which are into Real Estate/Infrastructure (eg. Airport Companies like GMR/GVK or Road companies). The Debt Equity Ratio should be seen in relation to the Debt Service Coverage ratio.

Debt Service Coverage Ratio – This ratio indicates the loan and interest paying capacity of the business. The bare minimum is 1 but the ideal ratio is 1.5 which indicates that the business has the potential to serve its debt & interest on it and also has the potential to absorb sudden shocks and or to invest money in business.

P/E Ratio – This ratio indicates the relationship between the Net Profit per Shares (denoted by EPS) and its market price of the stock. A P/E ratio of 20 means that the investors are ready to buy a stock at a valuation of 20 times its current earning. This ratio has some serious flaws (topic for another details post) but is very widely used to ascertain the expensiveness of a stock. Generally a PE Ratio of 15 and above is considered to be high (Though in bull runs like we are having now its difficult to find companies with P/E < 15).

P/B Ratio – Every stock has a book value which simple means that if all assets of the company are sold and all liabilities are paid whatever is remaining is divided amongst shareholder than whatever amount is received for each share is the book value of the shares. This is all calculated based on the balance sheet values which may not reflect the true current value of the assets, for example land is shown in accounts at purchase value but after 10 years its actual value might have increased multifold while the inventory or debtors may not be realized in full. But keeping these shortcomings aside for the moment, a P/B ratio of < 1 is considered good (Though in bull runs like we are having now its difficult to find such companies).

The legendary investor Ben Graham gave a thumb rule which stated that he didn’t buy stocks with a PE above 15 and a P/B greater than 1.5 i.e. stocks having PE X PB Value of 22.5 and more. As per him these stocks did not have margin of safety which meant that there is no margin of error in these stocks and if business doesn’t do well, the investment may give loss.

A study of these aspects will indicate an investor whether the stock is investment worthy or not. This study needs to be combined with other qualitative inputs about the management quality, execution capability, Capital allocation record and corporate governance standards etc. (I plan to write a post on these qualitative aspects too).

Happy investing !

My small library of books on investing

I like books and I like the printed ones, no E-Books or Kindle for me. For me the rustle of pages can never be replaced by a click. Here is my ever growing collection of books on investing…

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I’ve read quite a lot of books on investing and other stuff (here you see only investing books). And I plan to post reviews & summaries here on my blog.

The top 5 investing books as per me are:

1. The Intelligent Investor by Benjamin Graham – This is the book that started it all, the art & science of Value Investing began with this.

2. Common Stocks & Uncommon Profits by Philip Fisher – A practical book that tells you how to select stocks for extraordinary profits. It lays down some very simple yet effective ground rules.

3. One up on Wall Street by Peter Lynch –  A masterpiece from the doyen on mutual fund industry of US of A. The books offers practical & usable strategies for picking winning stocks.

4. The Most Important Thing Illuminated by Howard Marks – Its a book to be read & reread many times. Its not about picking stocks, it’s about behavioural aspects of investing. I understood the concept of risk from this book. A must read for all investors.

5. Where are the Customer’s Yachts by Fred Schwed – This is a super hilarious book, though it has neither stock picking nor risk management strategies, it offers valuable insights into the psyche of investors & brokers. As long as Stock Markets will exist this book & its message will also remain relevant.

I plan to post reviews & summaries of above mentioned & other books from time to time.