Q&A: Diversification, CFO, Inventory, Face Value

Modified on July 5, 2018

The current article in this series provides responses related to:

  • Sharing of his investment philosophy by a reader, Ashish Malhotra
  • Clarifications about “Change in Inventory” expense
  • A reader’s (Vikrant Yadav) perspective on diversification
  • Treatment of interest expense while preparing cash flow statements
  • Clarification about importance of face value of stocks in investing
  • Importance of macroeconomic factors and asset bubbles for investors

 

Query

Friends, I am just 3 months old into the world of investing and have been learning about the investment methods quite intently.

I have read The Intelligent Investor by Benjamin Graham and I am currently reading Security Analysis, by Dodd and Graham. These are profound books on investing.

Dr. Malik comes very close to the concept of investment as suggested by Graham and he has presented a more practical approach by way of step-by-step approach.

For a defensive investor, one should invest in index funds without trying to time the markets. Again, an important aspect is to look for value proposition in these index funds by way of looking at their PE ratios.

If one has a long investment horizon and invests regularly by way of systematic investment plans (SIPs), then there is no threat of losing money. A little knowledge of ups and downs of an index would come handy in getting good return from your investments as one can take advantage of the boom and gloom periods. This statement is better explained by Warren Buffett “Be fearful when others are greedy and be greedy when others are fearful.”

I count myself to be a defensive investor at the moment until I gain enough insight and understanding of our stock markets and identify & shortlist stocks that I would be comfortable investing for a long period of time.

Dr. Malik has given the first hand understanding of how stocks should be chosen and invested into. I appreciate both the depth of his understanding and a simple and unnerving way of deciding the stocks that one would like to invest in.

If we gain the basic understanding, follow his guidelines in identifying stocks and courageously back our investments and hold on to our nerves during the irrational exuberance of highs and lows we would do reasonably well in growing our wealth.

Stock markets in the short run are voting machines and in the long run are weighing machines, which have to do an auto correction over a long period of time. Stock markets are like “mandis”, where there are buyers for every seller, if there are more buyers than sellers, individual stocks would go up and vice versa.

Stock movements are random movements which one should take advantage of as much as possible. Although these are distractions for investors, these distractions make certain stocks very expensive and others very cheap and therefore an important behavior of the stock market is to shuffle the funds/investments.

This movement/shuffling of funds is very well explained by Warren Buffett’s statement that the stock markets is a machine for putting the money from the impatient to the patient. For us as investors, as long as we can understand this phenomenon we should be more appreciative of this behavior.

I, being a defensive investor, have started to buy banking exchange traded funds (ETFs), infrastructure ETFs and energy stocks, which are selling cheap by way of valuations. These stocks do not look to be darlings of the stock markets currently but should do well in the 3-5 year horizon.

However, with a better understanding learned from Dr. Malik and more learning with various articles online, I have started to create my own portfolio as well, which I would build as a portion of my investment. Based on my experience in the next 3-5 years, I would change the ratio of my investments from defensive side to the enterprising investor like Dr. Malik.

I would sincerely appreciate Dr. Malik’s comments on my strategy: Should I be continuing with this approach or should do some course correction?

I would like to learn more and would welcome suggestions for good books to read for refining my approach further.

Thank you Dr. Malik for your articles and on behalf of all readers would like to extend our heartfelt thanks for extending your help in answering to our questions and concerns in the most prompt manner.

God Bless!

Regards

Ashish Malhotra

Author’s Response:

Thanks for your feedback & appreciation! I am happy that you found the articles useful!

It feels good to see that you have started to build a good foundation for your investing journey, by reading Benjamin Graham.

Book Review – The Intelligent Investor by Benjamin Graham

He is indeed one of the greatest teachers of stock investing to a common investor. I can appreciate that you have been inculcating teachings of great investors when you mention:

“Be fearful when others are greedy and be greedy when others are fearful.”

Stock markets in the short run are voting machines and in the long run are weighing machines which have to do auto correction over a long period of time

The stock markets is a machine for putting the money from the impatient to the patient.

You are right in saying that an investor should get the basic understanding of stock investing, make a system/framework for identifying stocks, courageously back her investments and hold on to her nerves during the irrational exuberance of highs and lows, then she would do reasonably well in growing her wealth. And until an investor feels that she has got the requisite expertise of stock investing, she can always choose to invest in mutual funds so that her errors of stock selection during initial phases do not have a lot of impact on her portfolio. Later on with gaining expertise, she can shift her money from mutual funds to her direct stock portfolio.

I feel happy that you have started in the right direction. After reading Benjamin Graham, you may read Peter Lynch. I have reviewed one of his books: One up on the Wall Street in the following article:

Book Review – One Up on the Wall Street

All the best for your investing journey!

Query

Hello Sir

1) I want to understand the ‘Change in inventory’ (CIN) expense in the financial statements. For example, let’s take Sanghi Industries Limited:

CIN is shown negative (₹24.22 cr) this quarter in expenses section which means the expenses reduced and hence the Profit increased.

  • Will this negative entry be included as an expense in next quarter and which will mean a reduction in the Profits?
  • Does this effect stock price?

2) Does ‘Change in Inventory’ in negative means that the inventory was not sold in that quarter?

Thanks

Author’s Response:

1) The raw material or goods that are purchased in a quarter may or may not be sold in the same quarter. If they are not sold in the same quarter and are available as inventory with the company; however their purchase cost is included in the cost of goods consumed, then the value of increase in inventory is deducted from the expenses.

Moreover, if inventory that was already available at start of the quarter, is sold during the quarter, then the value of decrease in inventory is added to expenses.

2) You are right that negative entry under inventory expense (CIN) means that the inventory was not sold in that quarter.

Read: Understanding Annual Report of a Company

Regards,

Query

As usual fantastic post doc.

The returns in stock market depends on 3 factors:

  1. Amount invested (p)
  2. Holding period (t)
  3. Rate of return (r)

Diversification affects ‘p’ of the above three factors. An Investor does all the good work by identifying right stock but might not get the benefit of upward movement if ‘p’ is small. Therefore, an investor should invest significant portion in the stock if she is convinced about the story.

Typically retail investors have small capital to invest. Diversification will further reduce ‘p’. An investor gains by identifying a company which provides him high ‘r’ by holding for significant period ‘t’ till the time story is good.

Regards,

Vikrant Yadav

Author’s Response:

Thanks Vikrant, for your valuable inputs! These are helpful for the readers as well as the author.

Read: How Many Stocks You Should Own In Your Portfolio?

Regards,

Query

Amount invested will of course determine the number of stocks. However the holding period may not be easily adhered to.

Quite a few stocks go up by 5-12% in the short time of 5-15 days and retract too similarly and one finds it convenient to catch the see-saw movement.

Dividend alone is not the criteria as one can, even in short term trading, get much more.

Of course this is for a full time observer and not one who is engaged in some employment/business full time.

Determining ‘r’ is not easy.

A few shares give more returns if traded comfortably in short term investment buy and sell even in small quantity than the annual dividend dished out.

Author’s Response:

Thanks for sharing your inputs.

I followed technical analysis as a trader for 2 years before I found that fundamental analysis is more suited to investors like me. I left short term trading after I learnt fundamental investing.

You may read about my views on technical analysis vs fundamental analysis in the following article:

Why I Left Technical Analysis And Never Returned To It!

Query

Hello Vijay, It was a pleasure reading your posts about Shilpi Cable Technologies Limited among others. You have brought out some interesting facts, which hadn’t caught my eye before.

Read – Analysis: Shilpi Cable Technologies Limited

I would like to point out its cash flow from operations on page 156 of Annual Report for FY2014. Under cash from operations it has added ₹52cr as financial charges (inflow) and it has deducted a similar amount from cash from finance activity (outflow).

Is it a routine thing or it smells like a boomerang transaction?

It has done the same previous year too.

Thank you for your reply in advance.

Author’s Response:

Thanks for writing to me!

It is a routine and correct entry.

The impact of this entry is to remove the effect of interest (which is financing activity) from cash from operations and classify it under cash from financing, where it actually belongs.

Read: Understanding Annual Report of a Company

Regards,

Query

Sir, face value of ₹10 or above is good or we can invest in companies with face value of ₹5, ₹2 or ₹1 as well. I have noticed that all good companies like Page Industries Limited, Eicher Motors Limited or MRF Limited are with face value of ₹10

Author’s Response:

It does not make any difference in the stock analysis. Investor should be indifferent to the face value.

Regards,

Query

Respected sir,

I have some general queries relating to the aesthetics of the macroeconomic environment today.

The ECB has started its own quantitative easing a few months back and the FED has almost done with that.

A question which bothers me is that with all this money floating in the markets the economic fundamentals are still at a low indicating that this money is creating some asset bubbles.

Of late we have seen that the Indian tech startup environment has also begun receiving voluminous amounts of funding despite a weak revenue generation by these companies (the tech startups).

This brings me to my question which is the possibility of a bubble being created in the Indian economy.

Author’s Response:

Thanks for writing to me!

The bubble might be there or might not be there. It might be there in certain asset classes and might not be there in others.

My reading of other investors as well as investing experience over last 9 years has established a belief that the investor should select quality stocks regardless of their industries and buy them at attractive prices. If stock prices go down due to general economic situation, then it provides excellent buying opportunities.

Read: Getting The Right Perspective Towards Investing

Therefore, I would advise that investors should not pay attention to macro-economic factors and focus on buying good stocks at attractive prices.

Regards,

P.S.

 

DISCLAIMER

  • The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
  • I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
  • Currently, I do not own stocks of the companies mentioned above in my portfolio.

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