Dear Fellow Investors,
Panic to euphoria in 93 days
Nifty 50 fell 40% from its top in March quarter in 45 trading days due to covid-19 disruptions –the fastest 40% fall in decades. In 48 sessions since then, it rose back 38%. As of June 30, it stands 17% lower from its previous high. Someone sleeping through January-June 2020 would have barely noticed this roller coaster ride.
While India’s lockdown – one of the strictest globally – is gradually opening up, the coronavirus is still out there at large. Active cases and fatalities continue to rise. There is no credible cure found yet. And while high frequency data indicate recovery from April lows, incomes and jobs remain under acute stress. India’s real GDP is expected to contract 2%-7% in FY 2021, first in around 40 years. Yet, markets seem oblivious to the ensuing hardship. Why?
Honestly, we don’t know. It is tempting to weave an explanative narrative after prices have risen (or fallen) – liquidity, US elections, re-opening post lockdown etc. While this gives a false sense of comprehension about random short term price movements, it fails to offer any actionable insight for long term investing. Unfortunately lots of air waves, expert chatter and web space are allocated to this.
Fortunately for us, not knowing what will drive prices in the near term is not a big deterrent. What remains important to us is an assessing current margin of safety and tempering our stance between aggression and defence.
You will recall that at the start of this financial year, our stance was of gradual aggression. Prices were attractive then. We could allocate meaningful portion of our spare cash to undervalued positions. The markets, however, shot back up very swiftly. We have tempered our stance to neutral. We are still not out of covid-19 uncertainty yet and, thanks to you, have enough dry power should fear strike back. We know our batting zone and it has not changed in covid-19 times – (1) to own reasonably priced (2) sustainable businesses (3) within our growing circle of competence. And make fewer mistakes on all the three counts.
A1. Statutory PMS Performance Disclosure
|CED Long Term Focused Value (PMS)||18.2%||-9.5%||6.9%||21.5%|
|NSE Nifty 500 TRI(including dividends)||21.3%||-23.6%||-7.3%||14.2%||NIL|
|NSE Nifty 50 TRI (including dividends)||20.0%||-23.5%||-8.2%||15.1%||NIL|
|*From Jul 24, 2019; Note: As required by SEBI, the returns are calculated on time weighted average (NAV) basis. The returns are NET OF ALL EXPENSES AND FEES. The returns pertain to ENTIRE portfolio of our one and only strategy. Individual investor returns may vary from above owing to different investment dates.|
For the quarter ended Jun 2020 NAV of our aggregate portfolio was up 18.2%. NSE Nifty 500 and Nifty 50 were up, including dividends, by 21.3% and 20.0% respectively. Individual investor returns may vary from above owing to different investment dates. During the quarter we were invested in equities, on monthly average basis, to the extent of 78.5%.
A2. Underlying business performance
|Period||Past twelve months1||FY 2021 EPU (expected)|
|Earnings per unit (EPU)2||Earnings per unit (EPU)|
|Mar 2020||5.7||Under Evaluation|
|1 Last four quarters ending Mar 2020. Results of Jun quarter will be declared by Aug only.
2 Total earnings accruing to the aggregate portfolio divided by units outstanding. Earnings exclude extraordinary items.
3 Please note: the forward earnings per unit (EPU) are conservative estimates of our expectation of future earnings of underlying companies. In past we have been wrong – often by wide margin – in our estimates and there is a risk that we are wrong about the forward EPU reported to you above.
Trailing Earnings: Earnings per unit for the trailing twelve months June 2020 came in at Rs 5.3 higher by 2.0% over last year (including effects of cash equivalents that earn 5% net of tax). Those of Nifty 50 and Nifty 500 grew by -4% and -24% (Source: Capitaline, Adjusted earnings)
1-Yr Forward Earnings: Owing to coronavirus pandemic, assessing the forward earnings for FY 2021 remains challenging. We still take a swing at it and estimate a broad range as per current information with high risk of being wrong. As per our current assessment our portfolio earnings for FY21 may fall by 5%-25% to Rs 4.0-5.0 per unit. They are expected to bounce back sharply in FY22.
A3. Underlying portfolio parameters (PMS)
|Jun 2020||Trailing P/E||1Yr Forward P/E||Portfolio RoE||Portfolio Turnover1|
|1 ‘Sale of equity shares’ divided by ‘average portfolio value’ during the period. There was no sale of equity shares in this quarter hence the portfolio turnover is NIL.
2 Monthly average , 3 Source: NSE , 4 Source: Capitaline
OVERALL INTERPRETATION: Table A1, A2 and A3 shows that despite clocking better earnings growth, and higher return on equity, our portfolio is relatively cheaper than broader benchmarks.
B. DETAILS ON PERFORMANCE
B1. MISTAKES AND LEARNINGS
Investing involves future and is susceptible to mistakes even after bona fide efforts. Good news is – history and our past performance is a testament – that even if four out of ten investments go dud, overall investment returns will be okay as the winners will pull the returns up. Over last eight years, we have had our share of mistakes and hopefully have become better investors due to them. They have involved mistakes of assessing management quality, not picking cycles, underestimating technological disruptions and being early. It is near certain that we will make more mistakes, hopefully newer ones. When we do, you will find their cumulative mention in this section every time.
From our two past mistakes- “Cera Sanitaryware” and “2015-16” – we learnt that unless fundamentals are extremely compelling, it is better to be gradual in selling and buying respectively. From our past mistake on “Treehouse Education” we have learnt that bad management deserves a low price, it’s seldom a bargain. In Dish TV we underestimated the competitive disruption but thankfully sold at breakeven. Tata Motors DVR taught us that cyclical investing requires a different mindset to moat investing and one needs to be quick to act when external environment turns adverse. In Talwalkars, we learnt that assessing promoter quality is a difficult job and we should err on the side of caution irrespective of how cheap quantitative valuations look. From DB Corp we learnt that industries in structural decline will fail to get high multiples even if the industry is consolidated, competition limited and free cash flows healthy.
B2. MAJOR PORTFOLIO CHANGES
There were no new names added or deleted from the portfolio. We added to our existing positions as prices fell below their intrinsic values increasing our margin of safety.
B4. FLOWS AND SENTIMENTS
Don’t fight the Fed
To save jobs and avoid bankruptcies, central banks and treasuries around the world, led by the US, have announced massive stimulus programs going as high as 10% of GDP. This unabated money printing is finding its way, through the plumbing of global finance, into asset prices everywhere. While the virus pain continues to affect real economy, financial economy is buoyed by liquidity and seen a sharp recovery. In India, FIIs have bought stocks to the tune of $2bn in June quarter after selling over $10bn in Mar quarter. Domestic SIPs in mutual funds also remain above INR 8,000cr per month (till May 2020) making domestic institutions net buyers of stocks.
While economic activity seems to have surged post April lows, sentiments remain linked to the uncertain Covid-19 trajectory. Reduced incomes will limit near term consumer and capex demand. India’s FY 21 real GDP is expected to contract by 2%-7%. Corporate earnings will fall even more. Markets, nonetheless, seem to have taken much of this bad news in stride and are focussing on FY22 earnings.
C. OTHER THOUGHTS
Till last year, dividends were taxed at the distributing company’s hands (@~20%) and were tax free in the hands of recipients. This year’s Union Budget has changed this regime. Starting this year, there will be no dividend distribution tax at the distributing company’s end. And, dividends will now be taxed in the hands of the recipient at the marginal tax rate applicable to them. For most of you, the marginal tax rate would be higher than the outgoing 20% rate. Assuming a 2% dividend yield, this regime change, ceteris paribus, will lower equity returns by around 0.2% (10% excess tax on 2% dividend yields).
One more procedural change incidental to this is about TDS on dividends. If a company is expected to pay dividends to an investor above Rs. 5000 in a financial year, the company shall deduct TDS at 10% (currently reduced to 7.5% as part of covid-package). When filing this year’s tax returns (you will file it after March 31, 2021) please remind your tax advisors to claim the TDS on dividends in your tax returns.
A second order impact of this dividend taxation shall be that many companies would prefer buybacks as way to distribute cash to shareholders (including promoters who have marginal tax rate of over 40%). Of course this shall be dependent on share prices and cash availability with a company.
The half year gone by was one of the most volatile periods in the history of financial markets. Normally, when stock statement shows deep red, as it did in March, investors typically run for exit. Not here. Not only did all of you stayed put, many of you joined us and/or raised your bet amid scare and uncertainty. Long term investment orientation is in short supply these days and is an investing edge. Thanks for giving us this edge. We are blessed to have like-minded partners like you.
As always, please help us improve by sharing your thoughts, feedback and criticisms.
Team Compound Everyday Capital
Sumit Sarda, Surbhi Kabra Sarda, Saloni Jindal, Sachin Shrivastava, Sanjana Sukhtankar and Sumit Gokhiya
Disclaimer: Compound Everyday Capital Management LLP is SEBI registered Portfolio Manager with registration number INP 000006633. Past performance is not necessarily indicative of future results. All information provided herein is for informational purposes only and should not be deemed as a recommendation to buy or sell securities. This transmission is confidential and may not be redistributed without the express written consent of Compound Everyday Capital Management LLP and does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product. Reference to an index does not imply that the firm will achieve returns, volatility, or other results similar to the index.