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Our philosophy is best explained by the mentioned below investment principles. We feel it is important for our clients to comprehend the same, as it will
- Provide insights into what we feel is a proper investing strategy and
- Enable them to understand our investment decisions.
Investing in a set of high-quality companies, bought at reasonable valuations is usually profitable over the long term. While past performance may not always repeat, it is a fact that such stocks have outperformed other investment avenues like bank deposits, gold, commodities, etc. over holding periods of five to seven years.
Principle No 2 - Invest for the long-term:
We feel that maximum profits are made in the stock markets by investing for the long-term; i.e. by not shifting in and out of stocks on a regular basis, but by investing in a good company and remaining there. There are analysts who advise "Book profits at every rise," and "Do not get attached to your stocks" and the like, but we do not subscribe to this theory. It is easy to see why this is so.
Money compounds only over time. The power of compounding means that the longer you invest, the higher are your returns. Assume Rs 1 lakh that doubles every year. The first year you earn a lakh. The second year you earn 2 lakhs, the third year 4 lakhs, the fourth year 8 lakhs and so forth. Thus the major gains in your portfolio will be evident only after a sustained period of time, as your profits earn profits upon themselves. The more you hold on, the more money you make.
An added advantage is that unlike interest earned from fixed interest instruments which is liable to tax year after year, the profit from investing in shares (under current Income Tax Regulations) is liable to be taxed at a discounted rate of 10% if sold within a period of one year from the date of purchase and not liable to tax at all if sold beyond a period of one year. In addition, the dividends earned, also do not attract income tax.
Principles 1 and 2 together ensure that investing for the long-term in shares is immensely more profitable than investing in any other instrument.
A sum of Rs 1 lakh invested in bonds at 15% per annum grows to Rs 12 lakh after 25 years; the same Rs 1 lakh if invested in shares at 25% per annum becomes Rs 2.10 cr in the same period. Not investing in shares can be hazardous to your wealth.
Principle No 3 - Keep cash and cash-equivalents:
We do not consider the possession of a comfortable bank balance a cardinal sin. Through experience we have found that the performance of a portfolio does not suffer even if as much as 20 per cent of the portfolio is held in cash. Having cash on hand is an automatic hedging mechanism against the vagaries of the market. Secondly, when the market declines, as it will from time to time, the cash provides liquidity to invest in the right stocks at the right time. Never mind if you earn a little less interest on your cash deposits. The lost interest is more than made up for by having ready cash to buy a scrip at 60% below its intrinsic value in a depressed market.
Principle No 4 - Focus on the company; take advantage of the stock market:
In all the history of investing, there has not been a man who could time the market with any degree of precision, for an extended period of time. The market will rise and the market will fall - it will behave pretty much as it wants to behave. So we do not attempt to time the market. Instead, we try to take advantage of it by focussing on the long-term intrinsic value of a company. In a falling market, as the stock price falls, companies with attractive long-term fundamentals get cheaper and cheaper. We keep cash handy and jump in the midst of pessimism. We attempt to be greedy when others are fearful, and fearful when others are greedy. The market exists not to be timed, but to be taken advantage of. In line with our philosophy of investing for the long-term, we try to buy the shares of the best companies, Companies which:
- Operate in the most profitable sectors of the economy
- Have favorable long-term growth prospects
- Are operated by honest and competent people
- Are available at an attractive price.
The aim is to ensure that the bulk of the portfolio is made up of world class companies that operate in non-cyclical industries and can sustain above-market rates of earnings growth.
We do not believe that diversification beyond a point yields any substantial benefit. It is statistically proven that after diversifying into 10 to 15 stocks, further diversification does not reduce risk any further. In fact, in an unnecessarily diversified portfolio, only a small percentage of stocks end up yielding good returns without any concurrent reduction in risk. We believe that risk does not emanate from a lack of diversification; it emanates from a lack of knowledge and a lack of experience. It is our desire to systematically get our clients invested in 10-15 world class companies that can provide maximum appreciation in the long run.
Our investing experience also leads us to believe that it is imperative to be invested in the right sectors, rather than spreading one's investments all over the place. We have found that in India, the best industries to invest in are the 'defensive' ones like pharmaceuticals and fast-moving-consumer-goods (FMCG) which provide consistently high returns rather than 'cyclical' ones like steel and cement, which perform well only when the economy is doing well. It is possible that a commodity stock may temporarily outperform the stock price of fundamentally sounder companies, however as long as we are able to obtain above-market returns on our stocks, such short-term fluctuations do not make us lose sleep. The chart below shows the price performance of TISCO and HLL since January 1991. Though there were short periods when TISCO outperformed HLL, over the long term investors in HLL made fifteen times the money investors in TISCO did.
We are also more comfortable investing in globally competitive multinational companies, which have more efficient operations, transparent policies and better accounting practices. Our investment strategy will thus predominantly concentrate on the multinational companies which operate in the FMCG, pharmaceutical, software and other such sectors. We also feel that in the new information age more money can be made by investing in companies whose major assets are brands, ideas, innovation and information rather than in companies which are still operating in the manufacturing age with their major assets being bricks, steel and mortar.
Through "Cognito" we attempt to structure your portfolio to include companies which operate in the right industries, have an honest ethical management and the capability to last. There may be times when stocks in a particular industry catch the fancy of the market and register large gains. Though we may make attempts to identify and take advantage of such short-term trends the bulk of our time and energy will be directed towards identifying long term trends that can generate above-average returns over a period of time and we will attempt to get our clients invested in such companies at the right time at the right price.