High Quality Stocks Selection Filter

1. ROE (Return of Equity) is the most important metric. The ROE approach helps us filter and identify high-quality stocks. 7%-8% of ROE represents a fair price that equals one-time book value. If a company earns 24% ROE, do not mind paying three times its book value.

2. Price at which the stock is trading is another important parameter. A quality stock may be a very good buy at price X which it may not be an appropriate buy at price 2X. (from the perspective of Returns)

3. Timing is difficult, especially when it comes to purchasing high-quality stocks. In a bearish market, there is a flight to quality which pushes the prices higher; whereas in a bull market such stocks are mostly neglected.

4. Growth, generally, has two components: inflation and volume. Even if a company is not growing by volumes, it can still show some growth on account of inflation. In nominal terms, the ‘average’ growth in sales and profits should equal the growth in GDP plus inflation.

5. A track record that is at least 10 years old. preferable 15 years

6. As far as possible, no issuance of new equity or convertibles

7. Tax payout at the highest corporate rate of taxation applicable

8. Consistent dividend payout

9. Promoter holding of at least 30% is ideal

10. No pledge of promoter holdings

11. Low debt. I prefer total debt to be less than half of shareholders’ funds

12. As few subsidiaries as possible

13. Not more than one acquisition of another company in a 10-year span. If there are more than that, examine each, on a case by case basis

14. No merger of wholly-owned promoter companies

15. Increase in year-on-year turnover should exceed the increase in fixed assets

16. A stable business should not demand much capital expenditure on an ongoing basis

17. No change in auditors

18. If the Annual reports of the last 10-15 years are read chronologically, validate whether the company's thought process has been coherent or not. Also, whether the management keeps the promises it makes in the previous years or not

19. It is very important to observe as to how the company is reacting the to changes in the Macro environment and how smoothly it is adapting itself to the change without compromising with its value

20. Business are run by Men and Women and ultimately it is their character which manifest itself as the Character of the Business. Hence, important to assess the character of the people running the business

Understanding of fundamental, market technical and patience are required as well, to invest successfully. Stocks should not be bought simply because one has money to invest. Keep the money in a liquid fund until you spot opportunities.
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Here are 10 Reasons on Why you Should be Investing in Stock :

1.) Market Positioning :- Company is the No:2 Player in its Area of Operations along with a Strong Market share. The company is also the Fastest growing amongst its Peers, outperforming its competitors in a big way. Company Brand Name is consistently improving and closing on the Market Leader.  

2.) Strong Business Model :- The company has a very strong Business Model where there is very little CAPEX involved and there is regular growth. The Business also works on Relationships and Credibility which gives the companies an Edge over new players.

3.) Long Term Opportunity :- Company is tapping into a huge Opportunity and the Management has just scratched the Tip of an Iceberg. India's Long term Structural story gives this company's Business a big boost and the Growth of its Target Market is a necessity for India to become a Large Economy.

4.) Financial Parameters :- C**Z**E has very strong Financial Parameters where the company has very Strong Margins upwards of 50% which is there in very few Businesses. Also the company has a Clean Balance Sheet with Zero debt which will help it in tough times.

5.) Consistent Track Record :- Company has a strong Track Record of Performance. The company's revenues has grown at over 35% CAGR for the last many years and the Margin performance has been very stable during this period highlighting its Performance.

6.) Growth Prospects :- Company has recently diversified into attractive Sub-Niches of the area it operates in and we believe these would emerge as Big Revenues generators going forward. Company also has gone into Acquisition route to boost its growth Inorganically.

7.) Business Moats :- The Market has a limited set of players as this Business inherently has a lot of Moats in the form of Client Relationships and Credibility which is hard to Build. Also the Knowledge base which it has accumulated over a period of time is difficult to replicate, thus acting as a good Moat.   

8.) Cash Flows :- Company generates very strong Cash Flows from its Operations regularly. The Free Cash flow component is high as there is very little Investments required. This allows the company to consistently target Niche companies for Inorganic growth.  

9.) Management/ Corporate Governance :- The company is promoted by a set of Institutions which are Highly credible and the company has a very strong Corporate Governance and most importantly, a Share-Holder friendly policy.


10.) Valuations :- In spite of so many advantages, the company is quoting at very attractive Valuations of less than 10x.

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Speaking about the mindset the following steps are very important.


1. Buying a stock is buying an ownership interest in that business

It is very important to have this perspective while investing in stocks. Are you ready to evaluate a stock as if you are planning to invest in that particular business? If not it is better to invest in some Index Fund or some Equity Mutual Fund with proven track record. It is very important to behave like an owner to a particular business, so that you can rationalize the functioning of that business and evaluate it's decisions more pragmatically.

2. If you can’t explain the business to a five year old or your grand mother, you don’t understand it.

You should be absolutely comfortable in understanding the day to day operations and other facets of the business of the stock you plan to invest in. Absolutely, no negotiations with this.


3. When purchasing an interest in a business, only use those funds which are not needed in near future.

Do not use reserve funds or day to day money. Create a separate fund for Equity Investment. Very very important to be disciplined.

4. If you value your leisure time, do not invest in stocks.

Investment in stocks require time to time re-evaluation of the business and to keep yourself updated of the geo-political macro conditions and their possible implications on the business. It is a tedious job and requires considerable amount of time. Evaluate this aspect before making a decision to invest.

Golden Rule of the market.

Buying is best done when others are desperate. Selling is best done when others are euphoric.

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Here is how to judge a promoter:

1. Reputation of fairness in dealing with all, including       

   shareholders;

2. Promoter holding is at least 30% for family-run companies;

3. A high RoE that is consistent over at least 10 years;

4. Low level of debt (unless it is a banking or finance business);

5. Good track-record with all their promoted ventures; 

6. Built profitable business with scale and leadership positions;

7. Good capital allocation decisions, so far.

Acknowledgement - Some parts of this article is based on an article of MoneyLife.

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Two ratios which will be very useful for Banking and NBFC stocks

LCR, Liquidity Coverage Ratio

The LCR measures a bank’s liquidity risk profile,  banks have an adequate stock of unencumbered high-quality  liquid assets that can be easily and immediately converted  in financial markets, at no or little loss of value. This category would include, for example, central bank deposits, corporate promissory notes or guaranteed bonds. The goal is to ensure that the institution can meet its liquidity needs for a 30 day hypothetical financial stress scenario.

The LCR is the percentage resulting from dividing the bank’s stock of high-quality assets by the estimated total net cash outflows over a 30 calendar day stress scenario.  Total net cash outflows is defined as the total expected cash outflows minus total expected cash inflows (up to an aggregate cap of 75% of total expected cash outflows).

Total  expected  cash outflows  are calculated by  multiplying the current balance of liability products (such as accounts and deposits) and  off-balance sheet commitments (such as credit and liquidity lines to customers) by the rates  at which they are expected to run off or be drawn down in accordance with the aforementioned stress scenario.

As of January 1, 2019, the minimum liquidity coverage ratio required for internationally active banks is 100%. In other words, the stock of high-quality assets must be at least as large as the expected total net cash outflows over the 30-day stress period.

NSFR, net stable funding ratio

The NSFR requires banks to maintain a stable funding profile in relation to their off-balance sheet assets and activities. The goal is to reduce the probability that shocks affecting a bank’s usual funding sources might erode its liquidity position, increasing its risk of bankruptcy. The NSFR standard seeks that banks diversify their funding sources and reduce their dependency on short-term wholesale markets.

The NSFR is defined as the ratio between the amount of stable funding available and the amount of stable funding required. Available stable funding means the proportion of own and third-party resources that are expected to be reliable over the one-year horizon (includes customer deposits and long-term wholesale financing). Therefore, unlike the LCR, which is short term, this ratio measures a bank’s medium and long term resilience. The stable funding requirements for each institution are set based on the liquidity and maturity characteristics of its balance sheet asset’s and off-balance sheet exposures.

Basel III requires the NSFR to be equal to at least 100% on an ongoing basis. In other words, the amounts of available stable funding and required stable funding must be equal.

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Notes on Wise Investing, Value Investing

On Business Success

"The great personal fortunes in this country weren't built on a portfolio of fifty companies. They were built by someone who identified one wonderful business."

-- The Tao of Warren Buffet, Simon & Schuster, 2006


On the Value of Firsthand Experience in Business

"Can you really explain to a fish what it's like to walk on land? One day on land is worth a thousand years of talking about it, and one day running a business has exactly the same kind of value."


On Challenges

"I don't look to jump over 7-foot bars; I look around for 1-foot bars that I can step over."


On the Skills Needed to Become an Investor

"If calculus or algebra were required to be a great investor, I'd have to go back to delivering newspapers."

-- The Tao of Warren Buffet, Simon & Schuster, 2006


On the Difference Between "Price" and "Value"

"Long ago, Ben Graham taught me that 'Price is what you pay; value is what you get.' Whether were talking about socks or stocks, I like buying quality merchandise when it is marked down."

-- Letter to shareholders, 2008


On the Traits Needed to Be a Great Investor

"You don't need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ."

-- Warren Buffet Speaks: Wit and Wisdom from the World's Greatest Investor, Wiley Publishers, 2007


On Surrounding Yourself with the Right People

"It's better to hang out with people better than you. Pick out associates whose behavior is better than yours and you'll drift in that direction."


On Learning How to Invest

"Investing is like baseball. If you want to score runs, don't study the scoreboard, study the playing field."


On Protecting Your Business Reputation

"It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently."


Source - Taken from various articles available on the Internet. I wish to acknowledge the respective authors.

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Publishing some pearls of wisdom on Value Investing from varied sources.

1. Choose Simplicity over Complexity

When investing, keep it simple. Do what's easy and obvious. If you don't understand a business, don't buy it's stock.

2. Make Your Own Investment Decisions

Don't listen to the brokers, the analysts, or the pundits. Figure it out for yourself. Become a value investor. It's proven to be a very rewarding technique over the long term.

3. Maintain Proper Temperament

Let other people overreact to the market. To succeed in the market, you need only ordinary intelligence. But in addition, you need the kind of temperament to help you ride out the storms and stick to your long-term plans. If you can stay cool while those around you are panicking, you can surely prevail.

4. Be Patient

Think 10 years, rather than 10 minutes. Don't dwell on the price of stocks. Instead, study the underlying business, its earnings capacity and its future. If the question is, "How long will you wait?" – "If we're in the right place, we'll wait indefinitely" .

5. Buy Business, Not Stocks

Once you get into the right business, you can let everyone else worry about the stock market.

Business performance is the key to picking stocks. Study the long-term track record of any company that is on your buy list. Look for following five main things before investing in a company.

(i) Business you can understand

(ii) Companies with favorable long-term prospects

(iii) Business operated by honest and competent people

(iv) Businesses priced very attractively

(v) Business with free cash flow

Don't think about "stock in the short term." Think about "business in the long term".


6. Look for a Company that is a Franchise

Some businesses are "franchises". Franchise generates free cash flows.


7. Buy Low-Tech, Not High-Tech

Successful investing is rarely a gee-whiz activity. It's less often about rockets and lasers and more often about bricks, carpets, paint, shaving blades and insulation.

Do not be tempted by get-rich-quick deals involving relatively complex companies (e.g., high-tech companies). They are the most unpredictable in the long run. Look for the absence of change. Look for the business whose only change in the future will be doing more business, e.g Gillette Blades.


8. Concentrate Your Stock Investments

A the "Noah's Ark" style of investing – that is, a little of this, a little of that. Better to have a smaller number of investments with more of your money in each.

Portfolio concentration – the opposite of diversification – also has the power to focus the mind. If you're putting your eggs in only a few baskets, you're far less likely to make investments on impulse or emotion.


9. Practice Inactivity, Not Hyperactivity

There are times when doing nothing is a sign of investing brilliance. Be a decade's trader, not a day trader.

10. Don't Look at the Ticker

Tickers are all about prices. Investing is about a lot more than prices. It is about value. It is about wealth. Abstain from looking at share prices every day. Study the playing field and not the scoreboard. Know the value of something rather than the price of everything.


11. View Market Downturns as Buying Opportunities

Market downturns aren't body blows; they are buying opportunities. Change your investing mind-set. Reprogram your thinking. Learn to like a sinking market because it presents great buying opportunity. Pounce when the three variables come together. When a strong business with an enduring competitive advantage, strong management, and a low stock price come onto your investment screen.


12. Don't Swing at Every Pitch

What if you had to predict how every stock in the Standard & Poor's (S&P) 500 would do over the next few years?

In this scenario you have very poor chance of being correct. But if your job was to find only one stock among those 500 that would do well? In this revised scenario you have a good chance. A few good investments are all that is needed.


13. Ignore the Macro; Focus on the Micro

The big things – the large trends that are external to the business – don't matter. It's the little things, the things that are business-specific, that count. It's possible to imagine a cataclysm so terrible that the markets would collapse and not bounce back. Externalities don't matter – and you can't predict them, anyway. And what can you do about them? Focus on what you can know: the workings of a good business.


14. Take a Close Look at Management

The analysis begins – and sometimes ends – with one key question: Who's in charge here?

Assess the management team before you invest. A investing in any company that has a record of financial or accounting shenanigans, (creative accounting, accounting jugglery). Weak accounting usually means weak business performance. Strong companies do not have to resort to tricks.

15. Remember, The Emperor Wears No Clothes on

Wall Street is the only place where people go to in Rolls Royce to get advice from people who take the subway. Ignore the charts. A value investor is not concerned with charts. Search for discrepancies between the value of a business and the price of small pieces of that business in the market.  This is the key to value investing, and it's far more productive than getting dizzy studying hundreds of stock charts. Offer documents of most mutual funds say – in small print – that past performance is no guarantee of future success. 


16. Practice Independent Thinking

When investing, you need to think independently. Make independent thinking one of your portfolio's greatest assets. Being smart isn't good enough. Lots of high-IQ people fall victim to the herd mentality. Make it one of your own.


17. Stay within Your Circle of Competence

Develop a zone of expertise, operative within that zone. Write down the industries and businesses with which you feel most comfortable. Confine your investments to them.


18. Ignore Stock Market Forecasts

Short-term forecasts of stock or bond prices are useless. They tell you more about the forecaster than they tell you about the future. Take the time you would spend listening to forecasts and instead use it to analyze a business's track record. Develop an investing strategy that does not depend on the overall movement of the market.

19. Understand "Mr. Market" and the "Margin of Safety"

What makes for a good investor? A good investor is one who combines good business judgment with an ability to ignore the wild swings of the marketplace. When the emotions start to swirl, remember Ben Graham's "Mr.Market" concept, and look for a "margin of safety".

Make sure that you also understand the concepts of Mr. Market and the margin of safety. Like the Lord, the market helps those who help themselves. But, unlike God, the market doesn't forgive those who "know not what they do". Bide your time, and wait for Mr. Market to get depressed and lower stock prices enough to provide a margin-of safety buying opportunity. 


20. Be Fearful when Others Are Greedy and Greedy When Others Are Fearful

You can safely predict that people will be greedy, fearful, or foolish. Trouble is you just can't predict when or in what order.Buy when people are selling and sell when people are buying.

21. Read, Read Some More, and Then Think

Mr. Warren Buffet spends something like six hours a day reading and an hour or two on the phone. The rest of the time, he thinks. He therefore advises get in the habit of reading. The best thing to start is to read Buffet's annual reports and letters. Finally, restrict your time only to things worth reading.

22. Use All Your Horsepower

How big is your engine, and how efficiently do you put it to work? Warren Buffet suggests that lots of people have "400 – horsepower engines" but only 100 horsepower of output. Smart people, in other words, often allow themselves to get distracted from the task at hand and act in irrational ways. The person who gets full output from a 200-horse-power engine, says Buffet, is a lot better off.

Make sure that you have the right role models. Strive for rational behavior, good habits, and proper temperament. Write down the habits, practices and philosophies that you want to make your own. Then be sure to keep track of them and eventually own them. Financial success is a "matter of having the right habits".

23. Learn from the Costly Mistakes of Others

This is self explanatory and need no comments!

24. Become a Sound Investor

Buffet says that Ben Graham was about "sound investing". He wasn't about brilliant investing or fads and fashions , and the good thing about sound investing is that it can make you wealthy if you are in not too much of a hurry, and it never makes you poor.

To become a sound investor, you need to develop sound investing habits. Always fight the noise to get the real story. Always practice continuous improvement.It's less about solving difficult business problems, says Warren Buffet, and more about a finding them. It's about finding and stepping over "one-foot hurdles" rather than developing the extraordinary skills needed to clear seven foot hurdles.

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The commandments of Value Investing

Benjamin Graham is regarded as the father of value investing and his books are investment classics. Securities Analysis (first published in 1934) and The Intelligent Investor (first published in 1949) continue to sell steadily. In addition to this legacy, he has permanently influenced many successful investors, including Warren Buffet, the wealthiest man in America; William Ruane, founder of the super-successful Sequoia Fund; and well-known investor Walter Schloss.

Ben was a prophet in a very specialized but important realm of life. He preached commandments that any investor can use as stars when navigating the vast and mysterious seas of the investment world. An individual investor, who is not under pressure to shoot comets across the heavens but would like to earn a smart and substantial return, especially can benefit from Ben’s guidance. In greatly simplified terms, here are the 14 points Graham most consistently delivered in his writing and speaking. Some of the counsel is technical, but much of it is aimed at adopting the right attitude:

1. Be an investor, not a speculator

“Let us define the speculator as one who seeks to profit from market movements, without primary regard to intrinsic values; the prudent stock investor is one who (a) buys only at prices amply supported by underlying value and (b) determinedly reduces his stock holdings when the market enters the speculative phase of a sustained advance.”

Speculation, Ben insisted, had its place in the securities markets, but a speculator must do more research and tracking of investments and be prepared for losses if they come.

2. Know the asking price

Multiply the company’s share price by the number of company total shares (undiluted) outstanding. Ask yourself, if I bought the whole company would it be worth this much money?

3. Rake the market for bargains

Graham is best known for using his “net current asset value” (NCAV) rule to decide if the company was worth its market price.

To get the NCAV of a company, subtract all liabilities, including short-term debt and preferred stock, from current assets. By purchasing stocks below the NCAV, the investor buys a bargain because nothing at all is paid for the fixed assets of the company. The 1988 research of Professor Joseph D. Vu shows that buying stocks immediately after their price drop below the NCAV per share and selling two years afterward provides an excess return of more than 24 percent.

Yet even Ben recognized that NCAV stocks are increasingly difficult to find, and when one is located, this measure is only a starting point in the evaluation. “If the investor has occasion to be fearful of the future of such a company,” he explained, “it is perfectly logical for him to obey his fears and pass on from that enterprise to some other security about which he is not so fearful.”

Modern disciples of Graham look for hidden value in additional ways, but still probe the question, “what is this company actually worth?” Buffet modifies the Graham formula by looking at the quality of the business itself. Other apostles use the amount of cash flow generated by the company, the reliability and quality of dividends and other factors.

4. Buy the formula

Ben devised another simple formula to tell if a stock is under-priced. The concept has been tested in many different markets and still works.

It takes into account the company’s earnings per share (E), its expected earnings growth rate (R) and the current yield on AAA rated corporate bonds (Y).

The intrinsic value of a stock equals:

E(2R + 8.5) x Y/4

The number 8.5, Ben believed, was the appropriate price/to/earnings multiple for a company with static growth. P/E ratios have risen, but a conservative investor still will use a low multiplier. At the time this formula was printed, 4.4 percent was the average bond yield, or the Y factor.

5. Regard corporate figures with suspicion

It is a company’s future earnings that will drive its share price higher, but estimates are based on current numbers, of which an investor must be wary. Even with more stringent rules, current earnings can be manipulated by creative accountancy. An investor is urged to pay special attention to reserves, accounting changes and footnotes when reading company documents. As for estimates of future earnings, anything from false expectations to unexpected world events can repaint the picture. Nevertheless, an investor has to do the best evaluation possible and then go with the results.

6. Don’t stress out

Realize that you are unlikely to hit the precise “intrinsic value” of a stock or a stock market right on the mark. A margin of safety provides peace of mind. “Use an old Graham and Dodd guideline that you can’t be that precise about a simple value,” suggested Professor Roger Murray. "Give yourself a band of 20 percent above or below, and say, “that is the range of fair value.”

7. Don’t sweat the math

Ben, who loved mathematics, said so himself: “In 44 years of Wall Street experience and study, I have never seen dependable calculations made about common stock values, or related investment policies, that went beyond simple arithmetic or the most elementary algebra. Whenever calculus is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience, and usually also to give speculation the deceptive guise of investment.”

8. Diversify, rule #1

“My basic rule,” Graham said, “is that the investor should always have a minimum of 25 percent in bonds or bond equivalents, and another minimum of 25 percent in common stocks. He can divide the other 50 percent between the two, according to the varying stock and bond prices.” This is ho-hum advice to anyone in a hurry to get rich, but it helps preserve capital. Remember, earnings cannot compound on money that has evaporated.

Using this rule, an investor would sell stocks when stock prices are high and buy bonds. When the stock market declines, the investor would sell bonds and buy bargain stocks. At all times, however, he or she would hold the minimum 25 percent of the assets either in stocks or bonds — retaining particularly those that offer some contrarian advantage.

As a rule of thumb, an investor should back away from the stock market when the earnings per share on leading indices (such as the Dow Jones Industrial Average or the Standard & Poor’s composite index) is less than the yield on high-quality bonds. When the reverse is true, lean toward bonds.

9. Diversify, rule #2

An investor should have a large number of securities in his or her portfolio, if necessary, with a relatively small number of shares of each stock. While investors such as Buffet may have fewer than a dozen or so carefully chosen companies, Graham usually held 75 or more stocks at any given time. Ben suggested that individual investors try to have at least 30 different holdings, even if it is necessary to buy odd lots. The least expensive way for an individual investor to buy odd lots is through a company’s dividend reinvestment program (DRP).

10. When in doubt, stick to quality

Companies with good earnings, solid dividend histories, low debts and reasonable price/to/earnings ratios serve best. “Investors do not make mistakes, or bad mistakes, in buying good stocks at fair prices,” Ben said. “They make their serious mistakes by buying poor stocks, particularly the ones that are pushed for various reasons. And sometimes — in fact, very frequently — they make mistakes by buying good stocks in the upper reaches of bull markets.”

11. Dividends as a clue

A long record of paying dividends, as long as 20 years, shows that a company has substance and is a limited risk. Chancy growth stocks seldom pay dividends. Furthermore, Ben contended that no dividends or a niggardly dividend policy harms investors in two ways. Not only are shareholders deprived of income from their investment, but when comparable companies are studied, the one with the lower dividend consistently sells for a lower share price. “I believe that Wall Street experience shows clearly that the best treatment for stockholders,” Ben said, “is the payment to them of fair and reasonable dividends in relation to the company’s earnings and in relation to the true value of the security, as measured by any ordinary tests based on earning power or assets.”

12. Defend your shareholder rights

“I want to say a word about disgruntled shareholders,” Ben said. “In my humble opinion, not enough of them are disgruntled. And one of the great troubles with Wall Street is that it cannot distinguish between a mere troublemaker or “strike suitor” in corporate affairs and a stockholder with a legitimate complaint that deserves attention from his management and from his fellow stockholders.” If you object to a dividend policy, executive compensation package or golden parachutes, organize a shareholder’s offensive.

13. Be Patient

“... every investor should be prepared financially and psychologically for the possibility of poor short-term results. For example, in the 1973-1974 decline the investor would have lost money on paper, but if he’d held on and stuck with the approach, he would have recouped in 1975-1976 and gotten his 15 percent average return for the five-year period.”

14. Think for yourself

Don’t follow the crowd. “There are two requirements for success in Wall Street,” Ben once said. “One, you have to think correctly; and secondly, you have to think independently.”

Finally, continue to search for better ways to ensure safety and maximize growth. Do not ever stop thinking.

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1. Risk: measure it, avoid it if possible, have a margin of safety, and limit downside.

2. Independence: don't follow the herd, the herd will only do average. 

3. Preparation: learning, building mental models, and continual improvement.

4. Humility: acknowledge what you don't know, don't be overconfident, stay within your circle of competence, and watch for errors. 

5. Analytic rigor: calculate value before looking at price, and be a business analyst and not a securities analyst. 

6. Allocation: consider opportunity costs.

7. Patience: Wait for the right opportunities.

8. Decisiveness: great ideas are rare, so bet big when they come along and when you have confidence in them.

9. Focus on Companies that pay full Income Tax along with consistent ROE of 20% over a period of 15 years.

I wish to acknowledge the authors of the original articles. Excerpts are taken from various websites and blogs.

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Diversification - View and Counterview

There is a very old saying "Failing to plan is planning to fail". This may sound simplistic but people who wish to be successful should always plan before doing any activity.

The world that you live in is very dynamic. Things change in a split second, so you should have a plan to prepare yourself face those uncertain changes and not let your daily routine be affected by that. People today, have understood the importance of planning right from the beginning, so in future, they are ready to face any unfortunate event.

Investments should also be done with proper planning and homework. The key for successful investment planning is proper asset allocation. Asset allocation is investing your savings in appropriate sectors and fields, so that you get decent returns in the future, that you anticipate, will help you achieve your financial goals. As an investor, you need to make sure that you carefully study the various processes involved in investments, how they work and have you properly allocated your hard earned money in different asset classes in order to fulfill your investment objective.

There are two very important factors that can have a great impact on asset allocation:

1. The ability to bear risks

2. The time horizon for the goal of the investor

Time horizon refers to the duration for which the person desires to invest the money in any particular field. Every person has a specific financial goal in mind and the time horizon can play a significant role in helping the person achieve that financial goal. Therefore the asset allocation of a 25 year old planning for retirement and a 40 year old planning for retirement will be quite different, even though their end goal is the same.

Risk tolerance is another key factor in asset allocation. The willingness and ability to lose part or whole of the money invested in return for larger potential returns is termed as risk tolerance.

Larger risk in investment is directly proportional to larger chances of revenue generated. Investors who are highly aggressive often accept investments with high risk in the hope of getting better results. Investors with lower risk tolerance are tagged as conservative investors. They invest money in avenues which offer lesser risk, but do not earn as much return.

A portfolio designed to cut down the risk by combining investments of different asset classes, i.e. equity, debt and gold, which generally doesn't moves in similar direction in terms of market movements is termed as diversification. The prime aim of diversification is risk mitigation. Diversification paves the way for more reliable and steady performances of the various asset classes under changing economic conditions.

Another adage springs to mind when one thinks of diversification - "Never put all your eggs in one basket." Diversification is nothing but splitting those eggs appropriately, so even if one basket breaks, you do not face too many losses.

However, the Buffet school of thoughts says that you should keep all your eggs in the same basket and should guard that Basket well. This view is recommended for people who are matured and wise enough to understand the meaning of risk, the various risks associated with the investment and how to measure and monitor them.

Lastly, what matters is that you carefully understand your own intuitions and carve out your own niche Investment Philosophy based on your preferences.

References and acknowledgement - Some part of the article and the basic premise has been taken from Quantum Mutual Fund Newsletter

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Terms explained - Normal Distribution, Bayes Formula

Normal Distribution Explained from the Indian Stock Market Perspective

Between 1998-2013, out of a total of 3,785 days, movement in the CNX 500 was outside 3 sigma on 60 occasions, that is 1.59% of the total. By normal distribution, less than 0.03% observations should fall outside the 3 sigma

In the world of investments, returns are measured by the first moment of prices (mean) and the risks are measured by the second moment (standard deviation or sigma). Most of the classical theories of finance are based on the assumption that the returns are normally distributed. In the probability theory, the normal distribution is a bell shaped curve of probability values for various natural events—hence the word ‘normal’. This distribution assumes that the tails or the ends are flatter and extreme events are rare. For example, this means that the probability of returns moving more than three standard deviations beyond the mean is 0.03%, or virtually nil. But what is ‘normal’ in markets?

In the Indian context, taking daily CNX 500 data from 1 January 1998 to 28 February 2013 (more than 15 years), 99.73% of the daily returns should ideally fall within -4.97% and 5.09%. Or less than 0.03% observations should fall outside the 3 sigma.

Out of a total of 3,785 daily observations during the period of analysis, 60 times the returns were outside 3 sigma in the case of CNX 500, that is 1.59% of the total observations. Clearly much more than we bargain for. The rule book says that if we are looking at daily events, a 5 sigma event would occur once in 4,776 years. A 6 sigma event would occur once in 1.388 million years and after that, the numbers are, let's just say too big to bother.

On 17 May 2004, the financial market experienced a more than 7 standard deviation fall, when markets crashed due to political uncertainty. Markets fell more than 5 to 6 standard deviations many times in 2007 and 2008, owing to global melt down. Similarly, the market posted a more than 9 standard deviation gain, once again due to the political scenario in the country at that time.

In reality, we have experienced 5, 6, 7 or even more than that, sigma events more frequently than what the normal distribution suggests and we dare to accept.

This is true globally, not just in India. For instance, Goldman Sachs, Citigroup, UBS, Merrill Lynch, all experienced large (as large as 25) sigma events on multiple days in 2007 and 2008. There was the South East Asian crisis, the 11 September 2001 attacks on the World Trade Centre, the Euro crisis, all in the past two decades.

Source - Moneylife Website

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Bayes Formula

Bayes Formula relates inverse representations of probabilities concerning two events.

Calculate and interpret an updated probability using Bayes Formula

P(A/B) = P(AB)/P(B) 

(Note - P(A/B) means Probability of A given B has occurred)

P(B/A) = P(BA)/P(A)

Hence,

P(AB) = P(A/B) * P(B)   P(BA) = P(B/A) * P(A)

Since, P(AB) = P(BA)

Hence, P(A/B) * P(B) = P(B/A) * P(A)

P(B/A) = {P(A/B) * P(B)}/P(A)

Total Probability Rule to find P(A) 
That is P(A) = P(A/B)*P(B) + P(A/B(compliment))*P(B(compliment))


Replace B with Event
Replace A with Information

P(Event/Information) = {P(Information/Event) * P(Event)}/P(Information)

To solve problems such as, 

In a school, there are 54% boys and 46% girls. The girl students wear Blue sweaters and red sweaters in equal numbers, while all the boys wear blue sweaters. An observer sees a random student wearing a blue sweater. What is the probability that the student is a girl?

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Equity Mutual Funds - Notes

SIP or VIP in Equity Mutual Funds - which one works well for you?

While investing is a personal decision based on everyone’s unique situation, every financial plan will have some allocation to the 3 major asset classes: equity or stocks, debt or fixed income instruments, or precious metals like gold and silver.

But investing in the stock markets can be a challenge, what with the wild and unpredictable swings in share prices. To reduce the risk of investing “at the wrong time”, many investors have opted for a Systematic Investment Plan (SIP) or a Value Averaging Investment Plan (VIP): simple ways to invest your money in regular intervals

A SIP, or a Systematic Investment Plan, is a mode of investment whereby you, the investor, invests a pre-determined amount on a monthly basis, on a pre-determined date, into a particular mutual fund scheme. Today, it is the most common and conveniently chosen method of investing by retail investors.

Some of the best known SIP benefits are:

Benefit of Rupee Cost Averaging:
Since you're buying units every month, you'll be buying at dips and rises, so you are averaging your cost over the time period.

Benefit of Power of Compounding:
If started at an early age, SIP helps you to start investing to meet the greater expenses of your life. Saving a small sum of money regularly makes your money work with greater power of compounding with significant impact on wealth accumulation.

Helps you avoid panic selling:
SIP investors tend to scare less easily than lump sum investors when the markets fall - as they get the chance to buy low, and later when they want, sell high.

It's possible to start small: 
You don't need a large amount of money to start an SIP, you can start with as little as Rs. 100/- and slowly build up your wealth.

Helps you avoid market timing: 
An SIP effectively stops you from trying to time the market and inculcates automatic financial discipline into your investing method.

One Form, Multiple Regular Investments: 
An SIP cuts down the paperwork you need to do. With just one form you can invest for 10 years or more into your chosen scheme.

An SIP is especially useful for salaried individuals who can save and invest a certain amount each month; however the benefits of SIPs apply to all investors.

Making investments in stock markets via Systematic Investment Plan (SIP) has been proved as a successful strategy which helps you to play safe given the volatile nature of stock markets.

Investment in a Value averaging Plan (VIP): 
A Value averaging Investment Plan (VIP) is an investment strategy that works like an SIP – you invest on a pre-determined date, into a fixed mutual fund scheme, thus achieving the purpose of disciplined investing and following the teachings of finance gurus when they say 'Buy Low'.

But while in an SIP the amount is fixed and units may change, in a VIP you have a target value of your portfolio, which increases by say Rs. x,000 per month, and you invest the difference between the current value of your portfolio, and the targeted portfolio investment value.

For example, suppose you set a target level of Rs. 5,000 per month. You invest for 2 months (Rs. 10,000 invested totally) and the market falls. So the current portfolio value of your Rs. 10,000 invested is now Rs. 8,500. To make up for this fall, you invest Rs. 5,000 for your third month's investment, and also an additional Rs. 1,500 (Rs. 10,000 minus Rs. 8,500). So in the third month, when the market has fallen, you invest Rs. 5,000 + 1,500 i.e. Rs. 6,500, instead of Rs. 5,000.

Similarly, if the market has risen, and your Rs. 10,000 has grown to Rs. 12,000, then when the time comes to make your third month's investment, you will not invest Rs. 5,000, but instead Rs. 3,000 (Rs. 5,000 - Rs. 2,000 = Rs 3,000– the profit you have made due to the market rise). In essence, the VIP bridges the gap between the target portfolio value, and the actual current portfolio value. It buys less when the markets are high and more when the markets are low.

The benefits of this approach is very apparent:
If the markets go down, you invest more and if the markets go up you invest less. So if there is value to be held, and if you can buy on the cheap, value investment plans will help you do this. And if the market rises and investments become 'expensive', the value investment plan strategy will ensure you do not invest as much. It might even ask you to redeem some of your investment, booking profits in the process.

By buying more when markets go down, you are also benefiting from the concept of rupee cost averaging. Investing regularly also inculcates financial discipline, and again you don't have to worry about too much paperwork.

One thing you need to keep in mind though is that you need to have sufficient cash flows to meet the investment that will be required in market dips, as at these times, you will be investing more – sometimes much more.

Courtsey : My additional inputs on the base article by Quantum Mutual Fund knowledge Series

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