Suppose your favorite car is a Honda… which is worth Rs 10 Lacs. And in your city, there is only one Honda dealer. Now this Honda dealer is facing some unprecedented personal crisis and decides to close down his dealership. And since he wants to close down quickly, he wants to clear his stock of available, unsold cars at throwaway prices. In fact, he is offering a whopping 40% discount on your favorite model, if purchased within next 7 days.
So here you are faced with an interesting situation…
– You always wanted that Honda car. And you have absolutely no doubt about the brand or quality of the car.
– You did not have (or want to pay) Rs 10 lacs for the same.
– You are now getting it 40% cheaper at Rs 6 Lacs.
– You have 7 days to buy it.
– You are still 100% sure about quality, efficiency and beauty of the car and that, it has not deteriorated at all (with prices coming down to Rs 6 Lacs)
So what is that you want the most right now?
Of course…Rs 6 Lacs!!
But here is the problem. You don’t have Rs 6 Lacs. And your 7 days are over. The offer and your dream Honda car are gone.
You had the CRISIS (dealer was closing down) and the COURAGE (your belief that Honda remains good enough even if dealer closes down). But the only thing missing was the CASH.
You did not have the CASH to take advantage of the opportunity.
The same is applicable in stock markets as well.
Warren Buffett, in 2008 said:
“CASH combined with COURAGE in a CRISIS is priceless.”
With markets making new highs and being somewhat Overvalued, many people will laugh at those who are building up their cash reserves. And that is because of the perception that, it’s very easy to make money in markets and hence it does not make sense to remain in cash.
Yet CASH is the exact asset, which can help you buy wonderful businesses at really cheap prices (Remember 2009). Having a decent amount of cash (atleast when markets are not cheap) allows you to take advantage of any pullback in the market or any other opportunity that comes up. Holding Cash should be viewed as an opportunity, and not just as a cost. Now this strategy effectively means that you are ready to purposefully lose a small amount of money to inflation over this period. But that would be in exchange for the opportunity to offset it with a larger profit down the road. Now all investors may not have the mindset to endure this pain, caused by waiting for opportunity to strike. But for those who are patient enough, the gains can be, what Warren Buffet said – PRICELESS.
Also if you think that earning lower interest on your cash is bad and a drag on your portfolio, just wait until you are forced to liquidate stocks during the next bear market or in time of need.
Pardon me if all this makes me sound like a person advocating timing of markets. But this is not just about market timing. It’s more importantly about trying to avoid overvalued markets and trying to reduce the chances of making mistakes, and less about trying to find the bottom and pick the next multibaggers.
So if you think, I am making some sense here…then do bookmark this post for future reference. My idea of doing this post about market crisis during a bull run is simple. When markets around you are falling and you are losing your money, you will not be reading blogs about long term investing. 🙂
Just out of curiosity, how much cash weight-age do you like to have? Been patiently sitting on around 25% of portfolio in a liquid fund, mostly because of the current bull market stretched valuations. There is some value in select stocks but no screaming bargains, so currently preferring to nibble at them in during the odd pockets of bearishness between the exuberance. Probably going to spend more time reading annual reports than anything else, unless a fed hike makes things interesting 🙂
Even if you have cash available and your fav. stock is at lucrative
price, even then you have to keep an eye on overall market valuations, because the
due correction in market will further lower the valuation of your fav stock too….
Just my personal view 🙂
priceless advice!!! in this market, when the brokers have started sending messages like “Buy symphony above 2290 for 5000 sl 1800” “HDIL above 118Shamaka”:) i can only put this message printed on my wal to not get tempted!!!
Sir is
Kilitch Drug a classic case of undervaluation as performancewise its profits
and turnover has already doubled compared to LY within 9 months of CY, it has
cash bal of Rs30/-share and reserves of more than 100cr. company did well
between 2008 to 2011 and then sold its few plants to multinational and paid
300% spl div to shareholders in 2012 now since last few quarters growth is also
good also no debt, no pledge, promoter stake 65% with good management
credentials so then why stock should be
at 35 when markets in bull run? Besides the company planning some major
expansion recently and also owns land
and assets worth hundreds of crores, have i missed some aspect pls guide.Does this stock qualify as value pick right now?
The Honda example is a good one, but does not capture the complexities of real world stock investing.
Firstly, this Honda car has a clean price tag of 10L, so there is no exercise of evaluation of its intrinsic worth. This is the first BIG stumbling block, to calculate what is the real worth of an asset and in this case is not necessary since price tag of car is known, whereas the value of a company and thus its stock needs to be carefully evaluated.
Next, this car is not even an asset that will appreciate, it will actually depreciate over time, so earning power in reality is negative. Why would I treat this car as I would a stock?!
Now I dont know if the dealer has taken on a loan with some or all of the cars as collateral? Is there a possibility that if I buy at 6L, I still owe someone another 4, 5 L? Clearly, this is a Management Quality discussion for a company I would buy, but in this example of buying a Honda car, has been conveniently ignored. Focussing on the product is good, but management quality is very important too.
If at all I had to evaluate this car as a stock, I'd need to calculate its earning power – i.e. to assume I run it as a taxi and earn money on that. Most buyers of such taxis buy cars on loan, i.e. leveraged asset.
I could go on, but I think the point is made. WHile the example certainly drives home the point of having cash at the right time, nonetheless the example glosses over the real world factors involved in stock market.
I think you captured this in one of Charlie Munger's quotes, which talks of patience and discipline in the past, enabling one to make great returns on future – this quote clearly hints at conserving cash and refusing to invest in securities that one believes do not offer margin of safety.
Thanks
Arun
Nice post Dev. IMHO the idea of sitting on cash depending on market valuation is great in theory, but a very tricky one to implement, more for behavioral reasons than actual returns.
Couple of reasons why, first is behavioral and second is just uncertainty:
1. Consider drawing a line to say, for example: I will only buy when markets are under 19x and sell completely when it crosses 23x. On the way down it will feel like markets are going to go much lower than 19x and so will feel like we should wait before entering. On the way up, it will feel like maybe the line needs to be more a guideline and therefore I'll let it go to 24-25-26x PE before selling. Also if you were disciplined enough to sell at 23x, and then watch it go higher, the pull to get back in when there's a small correction will be great
2. Any valuation metric is a combination of price and corporate performance like earnings, book value etc. While we can observe price on a daily basis, the earnings are only reported quarterly, which then can change the denominator unexpectedly. So, at 19x the markets might seem undervalued and then earnings growth might shrink which will immediately push up your PE back up over 19, making implementing such a strategy difficult
Great interesting information Thanks..
http://www.xycles.com
Looking for suggestions from various stable & lazy investors here. Which broker firm/demat/trading account firm do you guys suggest for an 'investor' who 'rarely sells' ? For now I have been investing only via mutual funds, so want to have a fair idea where to begin with stocks.
I have gone through various articles or comparison topics about various brokerage firms but still in dilemma. Hoping for a better guidance from this community of patient investors.
Thank you for help!
Thats true Shyam…but if the company I am interested is available at sensible valuations, I think I will slowly start accumulating the shares of the company and wait for lump sum investments if market goes down further.
I will tell you why I say this…Suppose I am ready to buy a stock at 100. And markets are at 30K. Now markets tank to 25K and my stock (which I still havent purchased) goes down to 80. This movement from 30K to 25K will force me (confession) to wait a little longer…maybe till 22K-21K so that stock is available at lower levels. But risk with that would be that it might never happen. So I will buy small chunks at 100 and more as it goes lower…assuming the stock is really good one. 🙂
I also get those SMSs a lot…feel like changing my number every few months ;p
I would love to be 0% in cash. But I know its not happening soon 🙂 Currently even I am hovering around 15% cash levels wrt equity portfolio.
Would avoid making stock specific comments Smart Student. But if other readers are interested, I will not stand in their way 🙂
Appreciate your comment Arun. And you are right that I have ignored the complexities of investing in general. But that is just to keep the focus more on Power of Holding Cash (& Using it Judiciously), and not on what and how to select stocks for long term investing. 🙂
But your point is still 100% valid 🙂
Agree with you Calm Investor 🙂
All these analysis etc are good in theory and very tough to implement in practical scenarios. But these posts are more to serve as guidelines and reminders to myself and other investors 🙂
Its just to drive home the message that one should 'not' avoid investing when others are running away from markets because of fall. If at all a person doesn't want to invest in direct stocks, the MF route can be taken.
But you have raised a valid concern in second point. Any thoughts on how to negate this issue?
I personally use ICICI and have no bad words to share about the service 🙂
Good point about serving as a reminder. Just how we should be eating healthy and exercising regularly for long-term quality of life but most of us still do things that are harmful to our own health. 🙂
On the 2nd point about shifting PE and other valuation metrics, I think the only way to guard against it is to look for companies that offer some consistency in results. I use that as one of the metrics when evaluating a stock. If two companies offer identical growth, profitability and cash-flow trends over 5 years, I pick the one with less volatility in its results.
Makes sense 🙂
Lower the volatility, better and less stressful and 'Calmer' it is 🙂
agree with 'stable investor ' ,, icicidirect is good for investors as well as people who like tight hold on their money. There 3in1 account combining bank+demat+ trading is good.
I have been using ICICI direct for last 14 yrs. It is good, clean UI (I have not used other providers, so i dont know if they may be better, but ICICIDirect does the job well). However I have one big concern. The brokerage they charge for amounts which are less than around 7.5K is huge, i think its 2.5% !. Meaning, if your trade value is less than 7.5k for a particular trade, they charge much higher brokerage than the standard 0.5-0.75 % they would charge otherwise.
Now why is this a concern. Sometimes, you may feel like you want to buy very small quantities of equity, say you want to do a equity SIP hwere you want to invest Rs 1000-2000 per month in a stock. That would prove costly in ICICI.
So I looked around and found that SBI does not penalize investors (like ICICI is doing) for investing small amounts. So I have recently opened a demat account with them.