1. Abc of Equity Market
Basic Terminology
Highly educated have problem of Analysis Paralysis, i.e. habbit of collecting lot of data, becomes in-decisive with confusion by lot of data
Two major stock exchanges in India
NSE
BSE
NSE has well known Index called NIFTY
BSE has well known Index called SENSEX
SEXSEX
basket of 30 stocks, by market capitalization
value determined by price of stocks
The highest m-cap company is ranked as no 1 in Top 30 list
While price of stock of a company changes, its m-cap changes which leads to its rank change in top-30
Even the companies change in top-30 or sensex, as the company m-cap changes
If a company m-cap\rank change from 30 => 31, the company moves out of index and replaced by company with higher m-cap say which was rank 31 => 30
NIFTY
basket of 50 stocks, by market capitalization
Why is SENSEX or NIFTY needed?
Misconception: To have a barometer for stock market
It is not only relevant for person investing is stocks, but also for others
It is actually a barometer for your life, reflection of how well an average indian is doing in life
It is reflection of the consumption capacity of the country
Companies which do good, would bubble up to be in Sensex or Nifty (so you don't need to worry about picking the top companies)
GDP - Gross Domestic Product
Value of all good and services produced (or say consumed) in the country
GDP is ~2.5 trillion $ for India
Now, let's drive the relevance with the NIFTY
The m-cap of top 50 companies in NIFTY is ~1.25 trillion $
This reflects NIFTY is 50% of GDP and how NIFTY is barometer for the consumption capacity of the country
GDP growth is either by increase in price of sold goods and\or increase in quantity of sold goods, there-by increase in value of sold goods
GDP growth by inflation i.e. increase in price of sold goods is not real growth
Nominal GDP growth : increase in price of sold goods and increase in quantity of sold goods
Real GDP growth : increase in quantity of sold goods only (i.e. removing affect of inflation) : Nominal growth - Inflation
In long term, co-relation between GDP & NIFTY growth would be ~1
What to Buy
Buy Index - Sensex or Nifty and leave it to grow
Problem - What do people engaged in Active stock exploration do - Where is entertainment in it
That's correct many people do active stock for entertainment for a kick
How to pick a Stock
You don't have to pick a Stock, just pick the index
Investing Vs Speculation
Trading in stocks with news around is a speculation not investing
Investing is buying(not selling) a asset which has future earning growth potential
Active Vs Passive Income
Active
Require effort, from the daily work
High returns , 100%, Infinity
Not scalable
Full fill the needs\expenses
Passive
Gives return while you sleep
Moderate return
Scalable
Wealth creation
What makes you rich?
Its not the return but the scalability that makes you rich
Active return should feed the Passive
Passive with time ingredient makes you rich
Young age, both active and passive should go together
Risk and Return
Bank Deposit: Secure with low returns (~7%)
Any asset with higher security will have lower return and vice-versa
Stock Market:
Index can't become zero, as some of other company to be part of it
Capital risk isn't applicable in long term
Risk of volatility
Golden Rules
Rule-1: Protect your capital, moderate return with low risk
Rule-2: Never forget Rule-1
Compounding should continue even with moderate returns
Flaws
High risk high return
> Risk should not high enough to vanish the capital
FAQ
Market Cap or value of a company : No of shares * price of 1 share
=rate(38,0, -100, 35000)
38 years, 0 recurring, invested 100 in beginning, 35000 current value
Source of Investment
Save from planned expenses by lowering the budget e.g. vacation, car, home etc
Use saved money for investment
Have to sacrifice something to fund the investment
This small saving could turn big in 10-15yrs with power of compounding
Approach for Gains
The simple way for gain is to buy at a low price and sell at a high price.
Now the determination of price as low Vs high is usually done by PE theory (price to earning ratio), i.e. PE of a stock
PE Analysis
How to calculate PE, say a Stock
PE = Price/Earning
Price = price of 1 stock
Earning i.e. EPS (earning per share) = (Quarter Profit * 4)/ No of shares
Suppose a PE of 10, if Rs 10 is invested, end of year earning would be Re 1
PE ratio isn't absolute, its comparative. PE cant tell whether its cheap or costly.
PE is used to compare companies and evaluate which one to buy
Use Case-1:
Large Petro company C1 with PE ratio 10, For earning Re 1 invest Rs 10
Small Agri company C2 with PE ratio 1, For earning Re 1 invest Re 1
Which one to Buy?
Now, if its so obvious why is market is so dumb to invest in C1 instead of C2, or why is price of C2 not 10x. Usually its not a case
Let's understand why is market giving premium of 10 PE to C1
Could be - future credibility (mgmt, product, company won't close) of C1 giving earning is high
future credibility of C2 would be lower for market analysis
Now, suppose we buy C2 seeing PE and technology changes leading to C2 collapse
So, it is difficult to choose a company only based on PE
Conclusion: PE only tells what's price you are paying for the investment in a company. PE doesn't tell future visibility of a company
Use-Case-2:
Flaw in Use-case-1 is different industry, should be comparing company in same industry
Even in same industry it could be same domain e.g. urban focused private bank Vs rural focussed Govt bank are not same, with 2 differences rural and govt
Usually companies in very similar domain and future visibility would have similar PE, not like 10 and 1
Now lets have same domains, say HDFC and ICICI bank
Suppose ICICI PE is 800/80 = 10, HDFC PE is 80/80 = 1 and their future visibility is same
You might say buy HDFC for low PE, however there could be flaws
ICICI might not be costly, suppose ICICI is having real earning Rs 800 and reinvesting Rs 720 for expansion and might return even > 800 post expansion (stop reinvesting 720 and earning growth from expansion)
HDFC might not be cheap, suppose it got one time earning of Rs 72 due to some win or asset realization. This may turn real PE as 80/8 = 10
Conclusion: Flaws of PE, Hidden Real earning (Reinvesting Vs one-time earnings)
Use-Case-3: How to use PE ratios to overcome the flaws of PE
Calculate PE of Bank FD = FD of Rs 100\Interest per year say Rs 10 = 10 (risk free)
C1 Large Company Suppose PE = 10 (risky since company)
Which one to choose with same PE however different risk
C1, since entrepreneur is working with vision of increased earning with GDP growth, otherwise would have sold business and invested in Bank
Now PE of C1 is not high as people doesn't know\believe of growth potential which entrepreneur might be believing
Now suppose we buy C1 being available at discount, and market fear comes true that earnings didn't grow
Say, there is new invention which reduced petro use to 0, and C1 collapse
However, this will make energy free and people would buy something else with saved money say electronics etc
C1 may collapse still the next generation is going to lead a better life upon disruptions
If we invest in C1 at discount there may be a chance to loose money(becoming zero)
Rule No 1, Protect your capital is not followed
Conclusion: Market disruptions may collapse some company however create big earnings for other sectors or company
Use-Case-4:
Open a company with 1Cr investment and earn 1L in 1st year
PE is 100, why did you invest if Bank could give 10L
Justification is risk of 1Cr is taken for higher future earnings, which might be higher than bank 10L earnings
PE of risky should be higher than safe bet with higher future earning potential
This means use-case-3, PR of C1 should have been > 10 e.g. 15 to signify higher earning with higher risk, Since PE of risky was at par with of safe bet, PE should become more so buy C1
Rule No 1, Protect your capital is still not followed
Conclusion: Leaving market disruption, better to buy with higher risk with higher future earning potential
Use-Case-5:
In previous example we saw C1 could close
Now sensex can't become zero, some company would be present in it
Why not compare Sensex PE with Bank PE
Sensex PE = Price of all companies in Sensex/Earning of all companies in Sensex with weightage in Index , suppose its 10
Bank PE was also 10
Now PE is same for risky Sensex with high future earning potential Vs Bank, so we should buy Sensex
Rule No 1, Protect your capital is followed
People who want to know when to buy Sensex Index, when PE of Sensex is similar to Bank
Bank FD PE with 6.5% interest rate 100/6.5 = 15
Conclusion: When to buy Sensex Index, when PE of Sensex is similar to Bank FD
Use-Case-6:
Earlier Bank FD rates were ~8%, Bank FD PE was 100/8 = 12.5
When to buy was PE 12.5 earlier, now its PE 15 based on Bank FD interest rates
When Bank FD PE used to be 12.5, historically it was considered PE of 26,27,28 as expensive
PE 12.5 was logically based on Bank FD rate
PE 26,27,28 was only historic, there was no logic attached to it
Lets consider for PE 15 cheap, expensive PE is 30 (historic view not based on reason). Average PE = (15+30)/2 = 22.5
Earnings Analysis
How is Price of a Stock effected by the earnings
Price = Earning * PE Ratio (Sentiment of market\crowd for that earning)
Suppose Sensex Today: 30,000 = 1500 * 20
Price could increase by earning or the sentiment
2014 just before election, Earning was 1, PE was low as 10 with uncertainty on govt formation factors (policy etc)
Price 10 = 1* 10
2015, after election results price increase 15 = 1 * 15 (sentiment)
Price increase 50% by sentiment
2016, assume some reform increased earning (1.5), Price 22.5 = 1.5 * 15
2017, assume sentiment increased (say 20) with same earning, Price 30 = 1,5 * 20
2018, assume earning increase (2) with same sentiment, Price 40 = 2 * 20
Conclusion: Best time to invest in market, when both earning and sentiment (PE) are low
Conclusion: Bad time to invest in market, when both earning and sentiment (PE) are high
Learnings:
1. PE only tells what's price you are paying for the investment in a company. PE doesn't tell future visibility of a company
2. Flaws of PE, Hidden Real earning (Reinvesting Vs one-time earnings)
3. Market disruptions may collapse some company however create big earnings for other sectors or company
4. Leaving market disruption, better to buy with higher risk with higher future earning potential
Rule:
1. When to buy Sensex Index, when PE of Sensex is < 100/10 year Govt Bond yield
2. When to buy Sensex Index, when PE of Sensex is > (26 - 0.5 - (12.5- (100/10 year Govt Bond yield)))
2. PE has limitation, low PE is logically, however high PE is illogical (historical)
2. Best time to invest in market, when both earning and sentiment (PE) are low i.e.
3. Bad time to invest in market, when both earning and sentiment (PE) are high
Why SIPs are hard to continue
Incorrect return analysis
Support invest 5,000 for 7yrs (Rs 4,20,000) and FV at the end is Rs 8,20,000
First thought comes is money just got doubled, that could happen in Bank as well. What's the benefit. This is incorrect return analysis.
Actual returns: =RATE(7*12,-5000,0,840000,), 1.52% per period i.e. month compounded. This means 20% annual return
During market downturn, fear make stop the SIP. Instead SIP to be increased at downturn
Focus on short-term returns of 2-3yrs, Equity is not meant for < 7yrs investment journey
What make us believe that 15% CAGR is possible for Nifty?
Price of asset = Earning * PE Ratio
In long term, PE ratio may be volatile 10-30% Avg 20%, however cant have consistent growth
Price growth needs to be driven by Earnings, hence earning is driver for price growth
Earnings need to be give Nominal GDP growth ~15% (Real GDP 8-9% + Inflation 6%)
Developing country target Growth (to provide employment) with wider inflation rate (4 +-2%)
Developed country target inflation (low), since they have enough jobs for citizens so growth is not a concern
Top company sales should growth as Nominal GDP, and earnings should follow the same
Top company represent the Nifty, hence Nifty should grow by 14%
Forecasting the Levels of Nifty
Long Term (15 yrs)
Rakesh Jhunjhunwala said Nifty to grow from 9k to 125k in 15yrs, i.e. ~20% compounded growth
=RATE(15,0,-9000,125000,), 19%
Justification was, Nifty grown from 943 in April 2003 to 8600 in Dec 2014 with 20% compounded growth
=RATE(12,0,-943,8600,)~20%
Short Term (4 yrs)
Earning = Price / PE Ratio
Price is Sensex price
PE Ratio is on bse sensex website => markets => indices
Earning 2017 = 33618/24.85 = 1352
Use historic earning-change % to determine current phase of earning growth cycle, Lower cycle means next cycle would be higher
Earning 2021 projection = Earning 2017 * 1.17*1.17*1.17*1.17 = 2533
PE Ratio 2021 projection = Similar 2017 i.e. 24.85
Price 2021 projection = E2021 * PE2021 = 2533 * 24.85 = ~62000 (Average view)
However path could be volatility, might be lower and higher in between
Create Table for Earning cycle Analysis
||Year||P/E||Price||Earnings||Change In Earnings||% Change in Earnings||