Have you ever thought about investing ??
Investing if done right, it has the power to generate returns more than an entire lifetime of working. The first process of investing is having a good financial plan and understanding the goal you want to achieve with the returns from the money.
Once you have your financial plan ready, it will help you understand the average return that is required from the investment to achieve your goals. It is important to link the investing style to your financial goals.
There are multiple avenues that one can invest in, they are as follows:
- Stocks and Mutual Funds
- Real Estate
- Government bonds
- Gold and Sovereign Bonds
- Fixed Deposits
There are various concepts and strategies in investing, Today we are going to speak about one of them known as Coffee Can investing from the book Coffee Can Investing by Saurabh Mukherjea. This Strategy basically says Buy and Forget. In this method, it is about finding the right companies according to criteria mentioned in the Coffee Can Investing philosophy and sit tight to watch these companies grow.
This means staying invested in the companies even in the times of ups or down in the market.
Most successful investors hinge to two questions – Which stocks should I buy & for how long should hold these companies? When it comes to investing in India it is surrounded by sub-level advisors and common thinking “ To make higher returns in stock markets One must take higher risk.
Warren Buffett suggests that when investing in the companies we should understand the following things
- Understand the business plans
- Management and its trustworthiness
- A sensible price tag to the business
- Enduring Moat, a competitive edge that competition cannot replicate
- Once we find a company like these stay invested forever
Then the next question arises why most of the investors aren’t adopting this. It’s because emotions sway the decision making of investors.
Coffee Can investing strategy was founded by Robert Kirby in 1984, where he had suggested his client buy shares of Xerox for $ 500 each and held it for 10 yrs. And the portfolio grew to $ 8,00,000 which came from the zillion shares of Xerox.
How to Create Coffee Can Portfolio
The process starts with identifying the companies having a minimum market capitalization of Rs 100 Cr. Once this filter is applied the next filter is looking for companies that have grown in sales by at least 10 % year on year along with 15% ROCE ( Return on Capital Employed) in the last decade.
The median portfolio returns (compounded and annualized) has remained robust at around 24 to 25% historically, regardless of whether the investor’s holding period has been as short as three years and as long as 10 years. If held for at least five years, there is more than a 95 % probability of generating a return greater than 9 %.
The Coffee Can philosophy of investing is built using the twin filters to identify great companies that have the DNA to sustain their competitive advantages over ten to twenty years. Hence able to generate such returns.
CCP in action – Page Industries
Page industries the master franchise of Jockey in India. The firm has consistently achieved revenue growth in excess of 10 % per annum and ROCE above 15 % each year. Page’s Revenues have grown at 31% CAGR and ROCE has averaged a staggering 55 %.
Page has, on an average, reinvested around 50% of its operating cash flows back into the core business via fixed asset investments to expand its manufacturing capacity. More importantly, although the stock’s trailing P/E multiple re-rated from 27 times in 2007 to 70 times in 2017. The firm has delivered 32% earnings CAGR over this decade.
Once the portfolio is created, then during the 10 years there are no changes to be made. While churn in a portfolio goes against the basic philosophy of long-term investing, it ensures a higher probability of profits over a longer period. Investing and holding for the long term is the most effective way of killing the ‘noise’ that interferes with investment decisions.
The Coffee Can portfolio attracts businesses with smaller ticket sizes and repeats the purchase of products and services. Businesses in B2C can leverage loyalty with consumers and can be one of the competitive advantages. Also, a great B2C firm is better able to respond to or drive an evolutionary trend of its end-consumer. CCP Prefers the company with Strategic Asset.
Strategic assets are those that give a firm a platform over which it can build a stack of initiatives like raw material procurement, product development, marketing strengths, great distribution, pricing power, supply chain, etc. For most good (but not ‘great’) companies, strategic assets are only tangible in nature.
But CCP prefers companies whose strategic assets are a combination of such tangible strengths alongside intangibles and hence difficult to replicate no matter how much money a competitor is willing to spend.
Gross return is not a true reflection of a portfolio’s performance because it is inclusive of fund managers’ and brokers’ fees. Investors should instead look at net returns
Also called brokerage, it is the fee you end up paying every time you enter a transaction. If a broker charges you a 0.5 % fee for a stock purchase, it may not seem like much. If, however, in the course of a year you bought and sold five times, your total fee as a percentage of your portfolio becomes 5 %.
This is more typical of funds (like mutual funds and PMS) wherein the fund manager charges an annual fee which can actually be paid on a monthly or quarterly basis as well.
In insurance products and structured products, it is not easy for investors to understand exactly what fees are being charged. Expenses too can compound over time!
The Indian mutual fund industry now has more than forty fund houses offering approximately 2500 schemes across various asset classes like equity, debt, hybrid, and commodities (gold). The industry now manages more than Rs 20 lakh crore.
Mutual Funds have exit loads which are charged from 0.25% to 2.25% if investors redeem in less than a year. The distributor of mutual funds used to earn as much as per 5% to 10% annually from the upfront commissions alone.
Read more about Mutual Funds here
Active Funds & Passive Funds
Active funds are those funds that are actively managed by fund managers and focus to outperform the benchmark index. While Passive funds are those funds that replicate the index and are not actively managed and hence have lower managing charges.
Direct Schemes investments give investors an option to deal directly with the fund house without any intervention by intermediaries like distributors, agents, financial planners, banks, etc. Direct plans are much cheaper, by 0.5 to 1% per annum in equity and 0.05 to 0.5% per annum in debt.
The Real Estate Trap
As we all are aware, Real Estate is a large size transaction and due to this remains one of the largest components in most Indian investors. Most Indians associate property with safety, status, and prestige, given the feudal traditions of our country.
In the previous era, people typically built houses when they retired. A house was something which was built for staying, never as an investment. Fast forward ten to fifteen years. In the opening decade of the new millennium, we saw a paradigm shift in the way retail investors started viewing residential real estate
Why do Investors get trapped in residential Real Estate?
Compared to the familiarity of buying land or gold, investment in any form—either in mutual funds or in stocks or bonds—is alien to most Indian investors.
Unlike other asset classes like equity and debt, which can have a cycle of three to five years (i.e. price movements change their trend every three to five years), real estate runs into a supercycle of over ten years. So, most people who made significant profits in the bull cycle of 2003–13 don’t have any experience or memory of a downward cycle.
More importantly, outsized gains on this scale leave a lasting imprint on not just those who made the gains but also on their friends and relatives—envy is a powerful emotion. returns: All investment decisions have to be considered relative to their opportunity costs. Most real estate investors are usually satisfied simply because they look at absolute returns in isolation.
But the compounded annualized return that property has generated over the last twenty years is just 8.3 %. In that same period, the Indian stock market’s benchmark index is likely to have risen at 15 % per annum which, compounded over twenty years translates to a sixteen-times return.
When it comes to real estate, investors are happy to buy and hold for long periods. As a result, they end up holding their properties through thick and thin, which is why they are able to see an appreciation in the value. In contrast, inequity, investors typically end up buying at the peak, trade frequently, and then exiting at the bottom. The harshness of most investors experience of the stock market versus their happier experience in real estate
How to own real estate at low cost
Non-convertible Debentures / Real Estate debt funds
NCDs are similar to bonds issued by borrowers which promise to pay a certain coupon along with the principal back within a predetermined tenure. They were issued by real estate developers, typically at a project SPV level. The high-interest rates offered—anywhere between 18 and 25%—was because these projects could not get funding from banks and other avenues.
REITs, or Real Estate Investment Trusts, are structurally similar to mutual funds in that they pool investors’ monies and invest in real estate projects.They are allowed to invest in income-bearing assets only and mandated to return more than 90% of the rents they get as annual income to investors. The pooling gives an excellent opportunity to investors with small ticket sizes who cannot afford to invest in a single property.
Real Estate has given far lower returns compared to equity over long periods of time. Along with that, its high correlation with equity means that real estate offers little by way of diversification.
Patience & Quality
What explains this investor pessimism with respect to equities, given that the asset class has given healthy returns?
The answer to this can be best understood through Shlomo Benartzi and Richard Thaler’s paper published in 1995, They defined ‘loss aversion’ as: ‘We regret losses two to two-and-a-half times more than similar-sized gains.’ Let us assume we buy two stocks—A and B—for Rs 100 each and sell them for Rs 95 and Rs 110 respectively. We thus book a gain of Rs 5 in total (gain of Rs 10 on stock B minus the loss of Rs 5 on stock A).
In simple words, we will regret the Rs 5 loss on stock A at least as significantly (if not more)
As we would rejoice in the gain of Rs 10. to stop regretting investments in equity markets, his probability of generating profits needs to be at least twice as much as the probability of generating losses.
At what point investors lose their regret about investing in equities, is the probability of generating profits twice as much as the probability of generating losses.
The Patience Premium
‘Patience Premium’ is the difference between annualized returns generated by a stock or an index over any holding period compared to the return generated by the same stock or index over a one-year holding period. A positive value of ‘patience premium’ implies that the longer the holding period of the stock, the higher is the return generated from it for an investor.
For example, if holding stocks for five years gives you 10 % per annualized returns whereas holding stocks for one year gives you 7 % returns, then the patience premium is 3 % (10 % minus 7 %)
‘Quality premium’, which we define as the difference between the annualized returns generated by a stock or a portfolio and the benchmark index ( the Sensex) over a particular holding period.
As the holding period increases from one year towards three and five years, volatility (and hence risk) of returns for a Sensex investor reduces.
The degree of risk involved in a one-year holding period has been three to four times higher than the risk involved in a five-year holding period and six times higher than the risk involved in a ten-year holding period.
There were certain observation made on the CCP
- The shorter the holding period, the higher the quality premium
- A high-quality portfolio with a very long holding period delivers the highest return with the lowest risk
We conclude that investing in stock markets is a long term game that ensures a higher probability of returns. The Coffee Can investing Philosophy is completely based on the game of patience.
If you are looking to invest to in the stock market for the short term, then definitely this CCP is a philosophy would not work for you. Even Warren Buffett mentions to be successful in the game of investing one needs to have systems in place.
Coffee Can investing is one system. As they say, one size does not fit all same goes for the investing.
Chech out the book on Amazon:
About the Author
Saurabh Mukherjea is the CEO of institutional equities at Ambit Capital, an Indian investment bank. In 2014 and 2015, he was rated as the leading equity strategist in India by the Asiamoney polls. Mukherjea has spent most of the past decade trying to construct and implement systematic methods for analysing Indian companies in the midst of the chaos that surrounds the Indian stock market. A London School of Economics alumnus, Mukherjea is also a CFA charter holder.
Roopesh is an author at Hackedwits and writes on summary for books from Business and Finance.A Project Manager at day and content writer at night. Love to learn new things, to connect dots in life. Follow him on LinkedIn for collaboration for freelancing projects.
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Roopesh is an author at Hackedwits and writes on summary for books from Business and Finance. A Project Manager at day and content writer at night. Love to learn new things, to connect dots in life.