Investing in Stalwarts

According to Peter Lynch, stalwarts are large and established companies that have the ability to grow at a steady annual rate of 10-12%. I’d say the equivalent companies in India would show returns of about 15-18%, especially if bought at the right price. These are a very special group of stocks due to their ideal blend of growth potential and predictability and hence these stocks form the backbone of my stock portfolio – after all a growth rate of 18% would have these investments doubling every 4 years!

I believe ‘stalwart’ companies should have shown consistent and significant EPS and book value growth over the past 10-15 years. My method for finding a good purchase price for such companies is to calculate anticipated share price using 3 approaches and then take the lowest. To do this, the following are necessary:

Step 1
Calculate the average share price, EPS and book value growth rates over the past 10 years at least and then extrapolate these over the next 10 years (my expected holding period for stocks of stalwarts). In this manner I can find the expected share price, EPS and BV after 10 years.

Step 2
One can easily derive the stock price from these:
- Expected stock price using EPS = future EPS * lowest historical PE
- Expected stock price using BV = future BV * lowest historical return on net worth * lowest historical PE

Step 3
Take the lowest expected value from among these three methods and then work backwards to find the price at which the share should be bought in order to achieve the targeted returns

Step 4
Have the patience to wait for the target price to be reached.

What does this achieve? Well, for one you are confident of having taken the most conservative estimates for growth and can be fairly sure of meeting your targets, barring extenuating circumstances. At least there is little need to monitor these stocks’ performance on a daily basis. Further, there is a bit of a bonus, as dividends have not been considered in the above calculations.

Using these methods I was able to identify companies like Infosys and ITC as candidates for my portfolio and then had a bit of luck when the market crashed immediately after the elections and allowed me to buy both these companies at prices below my target price. These investments are currently doing well.

Setting a Goal

One of the most memorable things I learnt from reading about Buffet is that your returns are not determined by the price at which is you sell but instead at the purchase price of a share. In other words, every share (even a blue chip) has a ceiling price above which it is no longer a good investment.

A good investor must learn to determine the price at which to buy a share in order to make the kind of returns which he / she expects.

There's more to this sentence than meets the eye. Look at the implications - to make money, an investor:

• must have a well defined target percentage return in mind. The higher the target, the smaller the universe of stocks (or, for that matter, the universe of investments in general)
• must identify promising candidates and research them to get an idea of their long term prospects. The time horizon must necessarily be long (5 years or more) because short term fluctuations in price are difficult, if not impossible, to predict
• must be willing to wait for share prices to reach a level at which buying them makes it possible to achieve the target returns

Of these, the first is the one which people are likely to gloss over. Much has been said and written about research and the importance of patience in value investing but little is ever said about setting a target. But then, what use is all the research if you don't even know what your goal is?

Your goal should be a function of your own requirements and circumstances. Some people might expect 50% returns from their investments year after year whereas others would be happy with 15%. Most mutual funds in India would struggle to generate more than 15-17% on a consistent basis, desipite the high level of inflation and market volatility; Buffet apparently has a track record of growing money at a blistering rate of 23% per annum. (Note that Indian mutual fund returns seem to be usually stated in 'simple interest' terms whereas what we're looking for is compounded growth rate). Hence the purchase price ceiling for the same share would vary between individuals depending on what they're looking for.

I personally would like to see returns of 22-23% on my investments. What this implies is doubling of my investments every three years or, in other words, retirement in 15 years!! ;-)

Ambitious? Maybe, but I have great hope on the Indian markets. We're powering forth in the 21st century - India Inc. as a whole is going great guns and markets have enough pep to keep the right stocks going at rates possibly even a lot better than this. The trick is to finding these growth stocks. And my search has just started...

A New Beginning

It came as quite a shock when I found that my laptop was stolen. Not only did that have my office documents and a lot of personal information, it also contained a year's worth of research into shares and real estate investing. And while the former were backed up in the form of mails and soft copies, my investment research was gone forever. I'd have to start all over again.

Somehow, however, I feel that's not such a bad thing. Sure, I'd lost a lot of work but then there was also a fair amount of baggage there, wrong conclusions, poor assumptions etc. that I was willy-nilly carrying around. Perhaps these were even colouring my perceptions of the value of my investments. And then there were also some 'pet' stocks that I refused to give up on even though there were all indications that they were - or were about to become - lemons.

The value of research in not in documents and records. Research is best applied when it is internalized and over a year I'm sure I've learnt something. It will definitely not take a year to make up the lost ground and perhaps I'll gain some more insight in the process. Yes, there are worse things than losing a laptop.

Having said that, I think I'll blog everything just to be on the safe side!

These postings are mainly notes to myself and as such are not expert comments on investing. I'm no expert. However, I am a keen student with a strong desire to create wealth and achieve my financial goals at the earliest. As a result, this commentary is necessarily serious, practical and much of it would be applied on my own finances. That might make some of these notes interesting reading.

The research will focus on my home country - India - though the applications would perhaps be generic across markets. Being a private investor with no particular axe to grind, I would be touching upon all forms of investment that might intrigue me - stocks, bonds, art, real estate, business et al. There are many roads to wealth creation and this journey would probably take me through all - even the bad ones! It's only the beginning.

A final point - I would be grateful for comments from wiser fellow investors who may wish to save me from bankruptcy and point me in the right direction from time to time. Your experience and knowledge would greatly enrich (no pun intended!) the contents of this page and also add value way beyond my personal, fumbling efforts at prosperity.

So, who wants to be a millionaire?