Investment Objectives & Advice

The Story of a Middle Class Investor – Part 1(Learning from our Parents)

In India, I have always heard that the rich people are growing richer and the poor are getting poorer. When I grew up and started to understand how our society and system works, I realized that what I heard is true. But as most of the Indian middle class people, I have not stopped there and started experimenting with this reality to understand why that is the case? I found some reasons and trying to share with you people to make it more clear and take one second opinion to check if I am true. (Most of Indians do not take second opinion 🙂 )

Let us start with one story, story of my dad, he had worked since his childhood may be from the age of 13-14yrs. What did he learn from working so early in life? I think the common motto of our society, which was reinforced on everyone that working-hard will make you earn good money. He learned that very well, he started from scratch and created one line of business but as the business have their cycles during downturns he failed because of lack of cash-flow and have to change his line of business to start from scratch all over again. He was a good money saver, but as all middle people say it is almost a cardinal sin to withdraw money from your deposits for cost of living, so he always just kept on depositing. He bought number of insurance policies offering protection to his family and receiving maturity/seasonal benefits in case of survival. The second option he chose was Post-office, where money was safe and you can do fixed deposits as well as recurring deposits buy Kisan Vikas Patra or NSCs (National Stock Certificates). The third option he got stuck to was fixed deposits with banks. He saved lot of money in FDs. He also tried in the era of defaulting financial institutions like Golden Forest, Swarnabhumi and other private institutes in hope of better fixed returns, but end up losing his hard earned money.

As the time passed, his money grew but his expenses multiplied faster and grown bigger than savings. He bought house but have to shell out more than he would have imagined, the education for his sons became expensive that ever thought by him. In the last, he end up being without money for his retirement. What went wrong? He did everything right as it was taught in old school of thought, work hard save money and don’t overspend. Let’s try to list out all the reasons and how to avoid it:

  1. All of us spend a great deal of time while switching Jobs/changing business, why? Because our expenses run on our salary/profits and we have to make sure we earn more than that. But as my dad most of us do not think about our future incomes and expenses, which will primarily be generated by our present investments. We neither spend time on learning the art of investing nor spend time on selecting the right avenue of investments. We think about our new job which we might stay just for 1 yr at least a month but we never spend time on our investments which will fund our retired life of 25-35yrs as per requirement.
  2. Understanding the effect of inflation, when my dad planned for us the cost of graduation was INR 10,000 in the most famous institute but when we graduated even INR 3,50,000 was the bare minimum to do proper graduation. In 20-25 yrs it grew by 35 times. The cost of education grew at a CAGR of 15% did he plan for it? I think not because no one ever explained him the time value of money.
  3. Selecting the right investment instrument to gain the maximum, He bought many insurance policies thinking it will meet his future expenses but never realized that the return of any traditional insurance policy (Endowment plans) never been more than 6-8% and it can be as low as 3.5% per year. Like most of us, he never realized insurance is not an investment option it is a risk cover.
  4. He went to barber to ask does he need a shave. As barber will make money he will always suggest yes. Same is the case of financial service segment, you meet any insurance agent/post-office agent or bank clerk and ask is this the right product for you? They will always say yes. But you should always take a second opinion analyze the product if it suits your requirement and the take a decision.

How should we avoid these issues/fallacies? I think I explained it already in the above pointers but lets summarize it once more for our benefits:

  • Educate ourselves about the financial products, spend some time reading financial articles, magazines, blogs to understand them
  • Plan your major expenses accordingly keeping inflation and its effect in mind
  • Select the right instruments to give better returns and enable you to meet your expenses
  • Always take a second unbiased opinion on your investment decisions to double check any errors you might be committing

All these steps will not able to help you in managing your finances well but also it will enable you to meet some of your dreams. In next blog we will try to see identify the pitfalls of Modern arena, till then read more and educate yourself.

Uncategorized

PE Ratio: Essential or Controversial Method

Most of the time, in the stock market investments we hear about PE ratios of like: for company X PE ratio has come down to make it more attractive or PE ratio of company Y has gone extremely high to make it overvalued. Do you understand what they mean? If not, Let us try to understand what this ratio is and then we will decide do we need to bother about it or not.

P/E Ratio is nothing but Price to Earnings Ratio. It explains the relationship between the stock price and company’s earnings. It is calculated as below:

                P/E Ratio = (Market Value per Share)/ (Earnings per Share)

Market Value per Share = Current market price of the stock

The earnings per share is the net income of the company from the most recent results published by company divided by number of outstanding shares of the company.

Annual Earnings per Share (EPS) = Net Income / No. of Shares

Example: Canara Bank is having a share price of Rs. 440/- and its EPS is Rs. 84. Then the P/E Ratio of Canara Bank would be 5.24 (440/84).

But what does P/E Ratio explain?

First thing, P/E Ratio gives you an idea of what the market is willing to pay for the company’s earnings. It helps an investor compare the valuations of a stock to that of its peers and in the same industry.

Some Interpretations are:

Higher P/E:  it means that stock is overvalued but market, in expectations of higher earnings growth, is willing to pay that extra money. But, some investors look at it in a different way. They will say company is overpriced as compared to its peers so it is not advisable to pay higher price.

Low P/E Ratio: It indicates “Sign of no-confidence” by the market which means the investors have undervalued the stock due to lack of confidence in its future growth. However, it could also mean that this is a stock which has been overlooked by the market and does possess strong future growth potential.

A low P/E ratio stock can become a “Value pick” before the rest of the market discovers its true value.

Do not depend only on P/E Ratio, but use this as a very directive tool. The PE Ratio should match the growth rate of company. If it is matching the growth rate then you can call it as fairly valued stock. If Growth rate is more than PE Ratio, means the company is undervalued. If Growth rate is less than the PE Ratio, then the company is overvalued.

Let’s try this learning in identifying some value picks based on PE ratios, in the below chart: we mapped the PE ratios of various banks in Increasing order.

 

The average PE ratio of the banking industry is ~10.3 but it does not men all the banks with PE ratio less than 10 are attractive or all the banks with PE ratio more than 11 are costlier to buy. One thing you can notice that most of the banks with PE ratio >11 are private sector banks. intuitionally you can say that the private banks are more nimble in its operations and better managed so their earnings growth is better than public sector banks, so its justified.

Now the issue is how to select our value pick? Let us see in PE ratio chart we can see among Private sector banks Indusind bank and Yes bank had the strongest performance yet the Yes bank has the Lowest PE multiple and Indusind does not have the highest multiple. This indicates that the upside opportunity in Indusind bank and Yes bank is more likely than any other private bank in list. But one should also read and make sure that the strategy of these banks should be aggressive for next few years to sustain their high growth.

Happy investing!!