Friday, January 25, 2013

Selling decision

Normally we expect to buy a company stock at a sufficient discount to intrinsic value and sell it when market price is close to intrinsic value.  

As it may not appear, but selling a stock generally is a more difficult decision than buying a stock. It is not only emotional attachment with the company, but fear that price may further go up and particularly a bit more difficult when returns are linked to tax.

As all of us must be aware that capital gain tax on long term stock holdings (more than 1 year) is NIL in India. Hence when we are holding company stock quoting close to intrinsic value, while holding period is less than 1 year, we try not to sell but hold for more than 1 year and avoid paying tax. I have done this few times in past.  



Irrational decision

Recently I started to believe this being an irrational decision. Let me try to explain this:

We try to buy company at significant discount to IV(intrinsic value) and sell at around IV. Our aim is to get maximum return on the invested capital. For example, I bought a company stock with a discount of 50% to IV. if market price goes close to IV, theoretically I am getting 100% return. Assume worst case company is quoting at IV after 11 months from the shares purchased. Now question is - shall I wait for another month to sell off or sell off right now?

If I sell off my holding, my annual returns are 100/11x12=109% and after paying tax of 15%=93%. while from this point of time to 1 more month, quote may go up or down. 


Let us evaluate decision to sell in 11 month:

Positive
  • Company is quoting at or close to IV. So my investment purpose is achieved, assuming IV of Company is not increasing.
  • Company may not quote around IV in near future, hence selling will not affect my returns in future.
  • I will have extra cash to invest in new opportunities.
  • Avoiding risk of any new negative development in company, which could affect the IV of company.

Negative

  • I need to pay 15% tax on return, hence lowering my return on investment.
  • Company quote may go up far beyond IV, due to market irrationality or any positive development, hence I may loose extra return.
  • I may not find attractive idea, IV of company increases and I have to keep the money idle.



There may be more positive or negative reasons to sell the stock at IV, irrespective of holding duration. The question is where we go?

My 2 cents

I am starting to believe now, that selling decision shall be based on the current understanding of company, with out considering the market outlook and tax impact.

The reason being I can not predict the future of market or direction in which quote will move. I can only estimate the fair value of the company. If I can not see more value in company, it is better to sell it off and wait for new ideas than hoping market to be irrational and quote far more then fair value. This approach may not be correct for all cases and shall be applied on case to case basis. 

In the end, this reasoning may looks very simple, but very difficult in practice.

Friday, January 11, 2013

Stock investing vs real estate (bet)

As noted in my Introductory post, I started investing in stocks from 2008. Since then I am able to achieve 15% + annual return on investment in stocks and I am happy with it. If somebody has made investment in real estate around 2009 end in NCR, he is now sitting on 3-4 times returns on investment (assuming he / she made 100% down payment). If he / she took loan, returns will be much more. This situation could be similar else where in India.


Which way would you prefer?


I do not know about others, but I would still prefer to invest in stocks. This doesn't mean that I do not own or never buy real state. I did purchase an apartment but that's for my own use.

For me investing in real estate is risky and if situation like US happens in India (though unlikely in near future), you will be in big trouble.


Why real estate investment is risky

I do not know how to value real estate properties. If you value the property on the basis of rent yield ( net of maintenance expenses) you would find the price very expensive, as effective rent yield would not be more than 2% (that too after developer deliver the property with in schedule). So I should spaculate an appreciation in property price of around 10-12% to justify the investment (assuming i am happy with 12-14% return). I personally instead of spaculation, would rather prefer to deposite the money in bank and earn risk free (almost) interest, multiple time rent yield. In India, real estate value does not depend on the demand and supply situation, infrastructure, etc but on developers, whom practically dictate the price. A nice article on how things are moving now. Still I do not have any tool or source to know this in advance, hence I am incompetent to do proper valuation of real estate.

What is the difference?

Main difference between real estate and stock investing is associated assets. Though real estate has some use, but they are not productive like stocks (read Company). In case of economic problems, Stocks / Companies can survive by their productive activities, but very likely real estate price will drop (or you will not find any buyer) significantly, as their productive return is very low (2% of rental yield). I am not mentioning GOLD here, which has no productive value and even worst than real estate in this perspective.

Another difference is liquidity: In case of urgent need, stocks can be sold with in current market value in very quick time, while selling a property can easily take few months unless you are willing to sell it to a significant discount to market price (and that too may take considerable time).


Having siad that, I think no body will loose money in real estate in India as 100% of politicians money is into real estate (I have never heard any politician investing in share market) and they will ensure that real estate price remains buoyant forever :-).