Tag: returns

Where do returns come from?

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Philosophical Economics has a gem of a piece out on what influences total return.

Total returns on holding equity securities come from:

  1. the change in price from purchase to sale, and
  2. the dividends paid in the interim

i.e. Total Return = Price Return + Dividend Return
 

Price Return =

Price Return from P/E Multiple Change
+ Price Return from Earnings Growth (Realized if P/E Multiple Were to Stay Constant)

 

Stock prices don’t change because market participants choose to assign stocks different P/E multiples. Rather, they change because the eagerness of the aggregate investment community to allocate wealth into stocks rises or falls. More investors try to “put money to work” than try to “take money off the table”, and vice-versa. In the presence of the imbalance, the price has no choice but to change.

 

So, Price Return =

Price Return from Change in Aggregate Investor Allocation to Stocks
+ Price Return from Increase in Cash-Bond Supply (Realized if Aggregate Investor Allocation to Stocks Were to Stay Constant)

 

For a given set of environmental contingencies–e.g., history, culture, demographics, etc.–the equity allocation preference is mean reverting. It rises in expansionary parts of the cycle, as people become more optimistic about the future and more eager to maximize what they see as attractive returns, and it falls in contractionary parts of the cycle, as people become less optimistic about the future and more concerned about protecting themselves from losses.

 

This is also backed up by another piece of research that shows that in the long-run, economic growth and stock market returns are negatively, not positively, correlated. Why? Because investors routinely appear to overpay for growth. Besides stock returns is determined by earnings growth per share, not economy-wide corporate earnings growth. The two can vary markedly.

equity returns vs gdp

In other words, investors should invest more in equities when the economy is in the shitter and exit when they hear “India Shining” ads.

 

Source:
The Single Greatest Predictor of Future Stock Market Returns
Rising GDP not always a boon for equities

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Making your portfolio more efficient

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We spend way too much time picking stocks and too little time figuring out how to allocate our capital between them. Even if you end up picking the “right” stocks, poor allocation will drag down the performance of your portfolio.

For the first time in India, you can now find out the appropriate weights that individual stocks should have within your portfolio and constantly monitor your portfolio as the market changes – automatically.

Users who have uploaded their portfolio can have a look at these statistics under the “Analytics” section:

efficient portfolio analysis

And if you just want to upload an adhoc set of stocks and just see what the most efficient allocation is, you can do that using our Marko tool, named after Harry Markowitz who introduced Modern Portfolio Theory.

Be efficient, be smart!

 

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There is no such thing as “Risk-Free”

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People are afraid, very afraid. The most recent carnage in the stock-market notwithstanding, CNX 100 is back to where it was in September 2010, a very volatile 30 months.

CNX 100: March 2010 - 2013

The conversations I have been having recently typically ends with “I don’t want to take any risk right now, let me wait and watch.” And therein lies the rub – there is no such thing as “risk-free.” Not in life, not in investing. The total risk in this world is a constant – we only transform it by our action or in-action. So let me walk you through what I mean.

“I don’t want to invest in the stock-market right now.”

The most dangerous part of the statement is “right now.” It means that either you, or an Oracle sitting somewhere, can correctly predict the right time to enter and exit the market. Some people have spent their entire lives (and countless computer cycles) to divine market-timing. Ever heard of the Elliott wave principle? Its a beautifully complicated mathematician’s wet-dream come true. Read the Wikipedia article first and then read this Quora thread. Forget market-timing, your odds of dating Deepika Padukone is better.

“I don’t want to invest in stocks.”

I totally agree with you if you are older than 70 years. You have no business investing in stocks or bonds for that matter. Hopefully you have made the right financial decisions so far – focus on spending all that hard earned money on pampering your grand-kids and what not. For the rest of you: bonds, especially in a country like ours, is a bad idea. This is how the benchmark yield curve looks like:

Yield curve

You are basically lending at about 7.5% for 10 years while the historical annual inflation rate is 10%. So essentially you are paying the government 2.5% for the privilege of taking your money. Want to take a walk down the credit-curve? There are NCDs that pay 12% you say? After all, aren’t they called “company fixed deposits?” You should really direct these questions to the holders of Deccan Chronicle, HDIL and Hubtown NCDs (these are the most recent examples of NCDs under default). So NCDs are not all that “risk-free” are they? Remember: the rate differential is meant to compensate you for the risk that you are taking. See how risk got transformed from inflation-risk to credit-risk?

“Can you guarantee that I will not lose money?”

Will anybody write you insurance without a premium? Of course there are ways in which principal can be protected, but that protection will come at a cost. For example, Birla Sun Life has a ULIP that guarantees that you will always buy low and sell high – after taking 10% in fees, every year.

“I will only invest in gold”

The most important thing before “investing” in gold is to know that the price of gold is governed only by the laws of supply and demand, like any other commodity. Sure, the last few years have been kind to the yellow metal – mostly driven by the “fear trade.” But the world is still turning and the sky has not fallen on our heads. Gold is already a major part of assets on Indian household balance-sheets, why double-down especially when the macro thesis is no longer valid?

“I will not invest in anything”

Yup, there was a time, back in 2008, when some nut-jobs withdrew all their money from the bank and kept it under their mattresses. But we are in 2013 now. Inflation has clocked over 10% year-over-year-over-year. Not doing anything is costing you money.

So what should you do? First, understand that there is no such thing as “risk-free.” As long as you are breathing, you will be taking risks – either actively or passively. Knowing what kind of risk you are willing to take is the first step towards coming up with an investment strategy. Once you have an investment strategy in place, draw up a risk-management strategy and stick to it.

And, most importantly, have a look at some of our investment themes – we can help you craft your investment and risk-management strategy. Give us a call!

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Setting Trailing Stop Loss Percentages

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Using a Trailing Stop Loss (TSL) is one of the best ways to limit your downside and protect your winning trades. Instead of relying on your gut, here’s a straight-forward way to derive the appropriate TSL percentage for your trades.

ATR based TSL Percentage

ATR stands for Average True Range. It provides a measure of volatility that incorporates gap/limit moves. The range of a day’s trading is simply high – low. The true range extends it to yesterday’s closing price if it was outside of today’s range.1

To set a TSL percentage, just multiply the latest daily ATR value by 2 and divide by the previous close.

What you are doing here is simply attaching a risk tolerance level (2) based on the stock’s intra-day moves averaged over a period of time.

Example

technical analysis chart

For example, if you were trading [stockquote]COLPAL[/stockquote] today, you would set the TSL to

2 * 30.5/1,250.65 = 4.88%

You can use StockViz to set a TSL alerts for your trades. Read this to see how.

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Trailing Stop Loss

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Setting a stop loss can often times be an emotional decision. When you buy a stock, you expect it to go up; setting a stop loss at that point in time makes you play the devil’s advocate with yourself. Its not a nice feeling. However, setting a trailing stop loss, takes some of the pain away.

Quite simply, a trailing stop is not a fixed price at which you exit a loss making investment – it is a percentage below the most recent high set after you have made the buy.

image

For example, lets assume that you bought a stock at Rs. 100. It then proceeds to move in this fashion:

image

Watch how the trailing base, hugs the highs made by the stock after you bought it.

The stop loss is then triggered when the price falls x % below the trailing base.

In this example, if you set the trailing stop loss % as 5, the stop loss is triggered at point (7) highlighted in the chart.

 

The positives are many:

  • You will never let a profitable trade turn into a loss making one
  • It acts like a regular stop loss if the stock turns negative right after you buy it
  • You don’t have to reset your stop every time the stock makes a move

StockViz is proud to announce the availability of Trailing Stop Loss Alerts for our users. Start using them now!

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