Warren Buffet's Annual Letter: Key Points for the Indian Investor

Warren Buffet, one of the greatest investors of the world, the Chairman and CEO of Berkshire Hathaway, in his annual letter to the shareholders, presents investment insights, which are eagerly awaited by investors all over the globe. The annual letter to Berkshire Hathaway's shareholders 2016, was recently released. It encompasses Berkshire's performance, it's operating units, the American economy and the most looked forward to, pearls of wisdom from the investment guru. Out of the 28 pager annual letter, we have brought to you the key elements, which are particularly relevant in the Indian Investing context:

He says

We’ve experienced both outcomes: As is the case in marriage, business acquisitions often deliver surprises after the “I do’s.” I’ve made some dumb purchases, paying far too much for the economic goodwill of companies we acquired. That later led to goodwill write-offs and to consequent reductions in Berkshire’s book value.”

Our view

When you buy stocks of companies, you pay for its fundamentals, it's past performance, it's future outlook, and for its brand value or Goodwill. The goodwill increases the PE multiple of the stock, which means you are paying a higher price for a given level of earnings. Purchasing a stock at a higher PE is not wrong as it may be high because it has good growth prospects, but it may be inflated because of higher goodwill. Hence you must be very cautious as this goodwill may fade away with time, bringing down the value of the stock. So, when you take a decision, don't just look at the name, rather focus on the fundamentals and the future prospects of the stock.

He says

Charlie Munger, Berkshire’s Vice Chairman and my partner, and I expect Berkshire’s

normalized earning power per share to increase every year. Actual earnings, of course, will sometimes decline because of periodic weakness in the U.S. economy. In addition, insurance mega-catastrophes or other industry-specific events may occasionally reduce earnings at Berkshire, even when most American businesses are doing well.

Our View

Be positive and have conviction in your investment. Your investment might sway due to periodic macro economic factors like the economics of the country or turbulence in the industry, but in the long term you'll have a positive average annual growth rate.

He says

Charlie and I have no magic plan to add earnings except to dream big and to be prepared mentally and financially to act fast when opportunities present themselves. Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.

Our view

Buy Low and Sell High is the simple formula for profiting. But the tendency of the investors is the other way round. They invest when the markets are bullish and panic and sell when the markets start falling. So, eventually they are buying high and selling low = Loss. Wise are those who see a fall in the markets as an opportunity, you get to invest in good companies at lower prices. Investors should invest in market downturn because when the market starts accelerating, and your investment takes the upturn, your gains would be soaring.

He says

You need not be an economist to understand how well our system has worked. Just look around you.

See the 75 million owner-occupied homes, the bountiful farmland, the 260 million vehicles, the hyper-productive factories, the great medical centers, the talent-filled universities, you name it – they all represent a net gain for Americans from the barren lands, primitive structures and meager output of 1776. Starting from scratch, America has amassed wealth totaling $90 trillion.

Our view

Believe in your country. India is the fastest growing economy in the world. Just look around, see the tall buildings, the flyovers, the new cars on the roads, the airplanes flying in the Indian sky, look at your own house, how you grew from a 2bhk to a 3bhk, from a Bajaj Super to a Swift Dzire. We are growing each day, it is an opportunity that we are living in a growing country, so it makes sense to invest when the graph is moving upwards, help the country grow further and relish the rewards from its advancement.

He says

Moreover, the years ahead will occasionally deliver major market declines – even panics –

that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media.…....... During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.

Our View

The markets have historically declined and risen again, and the only certainty is they will fall again and rise again. But no one can tell you when. The news analysts will advise you to sell your stocks during a slump, there will be panic. During such times, be calm. When there is panic around, consider it as an opportunity. When others sell, you get to buy at cheaper prices, and you'll be the one benefiting amid all the tension. If you panic, you'll be essentially contributing to your loss and an intelligent investor's gain.

So, the above were the important ideas, among many, extracted from Warren Buffet's Annual Letter 2016. Let's consider these insights as pious sermons of investing and incorporate them in our investing demeanor. Happy Investing!

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Budget 2017: What it means to the Common Man

Post the chaos faced by the virtue of Demonetisation, the Aam Aadmi of India was hopeful of a liberal budget. And the budget did stand up to the expectations of the Common Man to some extent. The Budget 2017 has brought some good news for the common man. Following are some key highlights of the budget which a Common Man should know:

Tax: Individual Taxation has witnessed a number of welcome changes in this budget,

The biggest announcement made for the Common Man is the slashing of tax rate by 5% for individuals falling in the Rs 2.5 Lakh – Rs 5 Lakh Slab. This is a big relief for the taxpayers. There is a tax rebate of Rs 2,500 for individuals having an income of less than Rs 3.5 Lacs. This means if the income is Rs 3 Lacs, there will be zero tax liability, if the income is Rs 3.5 Lacs, then the tax payable will be Rs 2,500 only and if the limit of Rs 1.5 lakh under Section 80C is fully used, then the tax liability would again be zero for people with an income of Rs 4.5 lakh. For individuals falling in the subsequent slabs, there is a benefit of Rs 12,500 in total for them too.

The tax filing process has also been simplified by introducing a one pager return for individuals having a taxable income of upto Rs 5 Lakh.

However, the rich taxpayers falling in the slab of Rs 50 lakh to Rs 1 cr will have to pay an additional surcharge of 10%, while those whose income exceeds Rs 1 cr will have to pay a surcharge of 15%.

The budget has also put to an end to the RGESS scheme, under which the first time equity investors could claim for a deduction of upto Rs 25,000 for three years under section 80CCG.

Real Estate The budget has brought reasons to cheer for home buyers.

The unit size calculation under the scheme for profit-linked income tax deduction for promotion of affordable housing has been changed from "built up" to "carpet area", thereby increasing the size of the unit by around 30%.

For calculation of Long Term Capital Gains for immovable property, the holding period has been reduced to 2 years from 3 years.

Further, for those whose land is being pooled in for the creation of Andhra Pradesh's state capital, they will be exempt from Capital Gains for holding such land as on 2 June 2014.

For those living on rent and not claiming a deduction in respect of rent paid under any other Section of the Income Tax Act, you can now claim a deduction of up to Rs 60,000, up from the previous Rs 24,000 under Section 80GG.

The base year for indexation has been shifted from 1981 to 2001 now. So, for those holding property since ages, it is a good news. Since the cost of acquisition will be inflated while calculating Long Term Capital Gains.

Traveling: The budget was travel friendly.

There wasn't any announcement on increase in the railway fares. And the icing on the cake is you do not have to pay any service tax for railway tickets booked through the irctc website.

You will get clean coaches as an sms based 'Clean My Coach' service has also been started.

A new facility 'Coach Mitra' has also been announced which will provide a single window interface to register all coach related complaints and requirements.

Students

An e-learning platform called SWAYAM to be launched with 350 online courses, to enable students acquire knowledge virtually taught by the best faculty. And the best part is it comes for free. It is an effort towards providing the best education to all, including the most vulnerable.

Two new AIIMS for medical Students to be set up, one in Gujarat and another in Jharkhand.

Others: In addition to the above,

The banks have targeted additional 10 lakh new POS terminals by March 2017 and encouraged to introduce 20 lakh Aadhar based POS by Sep 2017. So, if you do not have a debit card or credit card or other modes of cashless banking, Aadhar based Sale Terminals will come to your rescue.

For senior citizens, Aadhar based smart cards, containing their health details will be introduced. This is a vital step taken to provide affordable healthcare and a good quality life to senior citizens.

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Let's Learn from Past: Investor's Behavior

There are two ways to look at investor behavior in the context of markets. Although, there can be many more perspectives for investor behavior if we can include various markets and different types of investors, but broadly these two perspectives stand out in the open:

1. From the perspective of an Individual Investor

2. From the overall Market perspective

From the point of view of an individual investor, many try to exceed the market return by trying to time the market runs or taking additional risk. In fact, even the fund manager performance is assessed according to Alpha (Additional return over the expected market return) generated by the portfolio manager. While, professional portfolio managers managing large investment portfolios and backed by an infrastructure to analyze market movements, far more efficiently than any individual investor, may beat the opportunities and benefit from anomalies, for small individual investors it is equally difficult.

Therefore, from the point of view of an individual investor, the objective can be to generate returns equal to the market return, portfolio managers may be forced to generate additional returns so as to provide for infrastructure and other expenses. For an individual investor this will be an impossible task to perform as there is only enough time and money to create a small basket of securities.

Because of this limitation individual investor only apply very few strategies to safeguard themselves against market risks. Buy and hold, systematic investments etc. are a few such strategies. These strategies alone are usually not enough to protect the value in the times of crisis. Awareness and financial maturity play major influencing factors in decision making especially in the time of crisis.

Awareness

Awareness is not limited to the market, stock and economic information. It also includes awareness of objectives, goals own behavioral patterns and factors that may influence your financial decisions. As an investor you may ask yourself if the decision you are making is not influenced by any of the following common behavioral patterns:

1. Biases: It’s an influence which causes a tilted or one sided view of the situation or decision.

2. Herd Behaviour: Herd behaviour is better known in Hindi as ‘Bhedchaal’; i.e. one tends to do what everyone in the group is doing.

3. Active/Passive Investment Style: The style of investment of an investor can significantly affect the income generated on the investment, while passive style requires less involvement. It also requires the investor to have a long investment horizon, while active investor must spend lot of time in the market adjusting the trade.

What Went Wrong When Markets Crash?

Each of these crashes was followed by three behavioral phenomenons:

I. Overconfidence

II. Herd Behaviour

III. Panic

Panic
Figure: Stock Market Panic of 1929

Overconfidence
Figure: Dot Com Bubble

Overconfidence
Figure: 2008 Subprime Mortgage Crisis

Lack of awareness leads to herd behaviours, and afterwards overconfidence and when market starts to disappoint the new and the old investors panic to get out of the loop. As discussed earlier awareness encompasses awareness of macro-economic factors as well as factors affecting the own situation of the investor.

Since it’ll be really difficult for an individual investor to spend time and effort on completely understanding the intricacies of the market, best way is to understand their own risk profile and behavioral choices. This awareness will ensure that the investment decisions are not biased, not based on incomplete information or at least not fully exposed to the inherent market risk.

How to become aware of Self Position?

This question has been addressed time and again by financial advisors, planners and senior investors, who suggest that your purpose of investing should be clear. In a way you should know in the beginning (before starting to invest) following facts:

1. The purpose of investing: The asset choice depends on this purpose and important goal must be achieved through safer means, and so if you save your retirement funds in equity market in final few years of your retirement, more likely you are to panic in case of an adverse movement. Thus, as the wealth managers say, ‘define your goals smartly and prioritize before starting to invest.’

One example: Higher education of younger son is five years away, and marriage another three after that. Education requires Rs. 500,000 each year for three years but marriage is a Rs. 10 lakh onetime expense. Considering education loan is also available for education expenses with tax benefit on repayment, saving for marriage is going to be more meaningful and important as there is not cheap alternative to it.

2. How much you know about the asset: Know about the asset behavior and risk profile. For example: If your aim is to achieve results within five years equity may not be a good place to park your money, but if your aim is 10 years it may be. Similarly all other asset classes have their own risk profile and behavior.

3. Know Thyself: This is a very famous teaching of many of the religious texts that one should know himself, and be aware of the decisions he/she makes. Knowing yourself will start from personality definition and go on to include family, dependents, own aspirations etc.

How does this Awareness help?

The clear awareness and knowledge of your objectives, needs and goals allows you to make decisions which will ensure that you remain unaffected from market driven panic situations and are able to meet your obligations timely. Panic and wrong decision making strikes only when there is some lack of clarity over goals and purpose of investment. In summary it can be said that following learning can be made out from past market crashes:

1. Always define your financial goals with amount, time and importance.

2. Know your risk appetite; i.e. comfort level with temporary paper losses.

3. Understand the economic behavior of investment asset; i.e. economic cycle of the market.

With this awareness sometimes even taking a tactical benefit from the market may rewarding and not difficult.

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