Book Blurb – Investing Decoded: Simple Path To Building A Portfolio In Millions
Anirudh Rathore believes the stock market is for everyone―you shouldn’t need a degree in finance to be able to invest and grow your money. Led by this tenet, he distills his learning in Investment Decoded, based on classic treatises on value investing and years of experience from growing his own portfolio. This is the definitive beginner’s guide to acquiring the tools and mindset required to start securing your financial future.
Know the Author- Anirudh Rathore
Anirudh Rathore has over two decades of experience in equity investment. After completing his schooling from Mayo College, he went on to pursue his graduation from St Stephen’s College, Delhi University, and later, got his MBA from University of Rajasthan.
He then worked as a banker at IndusInd Bank, HDFC Bank and Citibank for nearly a decade before starting his own business ventures. He is now the owner of two heritage hotels in Rajasthan.
Extract from the book- Investing Decoded: Simple Path To Building A Portfolio In Millions
Investing Decoded: Simple Path To Building A Portfolio In Millions (Penguin India) by Anirudh Rathore, formerly a banker, now an entrepreneur is an extremely accessible and real guide for learning about the risks, benefits, methods and tools required to start building a good equity portfolio on your own.
Rathore’s years of experience and research come together in this book, offering simple tools and mindset tips to help you understand stock markets, manage risks, and follow trends.
Extract : Pg 31 – 34
Chapter – 7
Demystifying Contemporary
Finance Theory
Modern finance theory was built on the foundations of the capital asset pricing model, random walk theory, the efficient market hypothesis and the modern Portfolio Theory.
The Capital Asset Pricing model or [ERi=Rf+βi(ERm−Rf)]—don’t worry, was just writing it to scare you a little bit—tried to answer what returns should be expected whenever a security was bought. The random walk theory (Burton Malkiel) hypothesized that all stock prices took an unpredictable path and that any fundamental analysis of a stock was futile. The efficient market hypothesis (Eugene Fama) claimed that all available information will already be factored into the stock’s price. Modern portfolio theory (Harry Markowitz) is about maximizing the return that investors could get in their investment portfolio by considering the risk involved in the investments.
All the above theories are taught at business schools throughout the world. The objective of this discussion is to give students of value investing a peek into alternative hypotheses that have emerged over the decades. One can only strengthen their understanding of value investing after comparing the other styles with it. What emerges is the simplicity and clarity of the Graham and Dodd approach, which serves to build up its convictions further. These other theories were flying in the face of the Graham and Dodd style of value investing.
Students have been indoctrinated in the above theories only, leading to complication of a simple price versus value approach into abstract mathematics used to support the other theories. The underpinnings of all these theories was that, basically, a person can most definitely not outperform the markets. They argued that the stock market is an efficient system and the prices are reflective of all the available information relevant to them. They further argued if an investor beat the market year after year, then they were just pure lucky. They also emphasized the ‘beta’ characteristics of stocks as well as ‘covariance’ of securities, which value investors have no interest in defining. Value investing, on the other hand, gives us a framework for embracing ‘risk’ and using it to see if a good enough margin of safety exists to achieve superior portfolio performance.
Luckily, we know that the market swings between optimism and extreme pessimism, which distorts the value of the stock and most certainly allows for outperformance from an investor as they can buy stocks during periods of pessimism and possibly selling stocks during periods of optimism.
The point is that we can immerse ourselves in trying to understand all theories and hypotheses. One can spend a lot of time in practically trying to make investments on the basis of these theories, but the simple fact is that very frequently, the markets misprice various securities at lower rates than warranted and that is when an investor should look into buying those securities to get larger returns.
The academic approach is a bit like assuming that the investment future is more or less already decided. Their prognosis is to instil in students that a narrow range of potential results is what an individual could hope to attain. It is a bit like going to your family astrologer, who sees your janampatri (birth chart) and predicts your future life events, and you readily accept and abide by making all your life’s decisions based on his ‘findings’. As in astrology, once your life events unfold, you are free to react and respond based on your personal choices and predilections, in the same way, markets are constantly bombarding us with different prices of securities. We can use our own insights, discipline and courage to decide what securities we would like to purchase and neglect.
The discounted cash flow method articulated by John Burr Williams, is another popular method used by finance professionals to estimate the value of an investment based on its expected future cash flows. Discounted cash flow analysis is widely used in investment banking, real estate projects, corporate finance and patent valuation. The key feature of the formula is the discounting at an appropriate interest rate. While interest rates a year or two ahead are difficult to predict, imagine how a single interest rate assumption can alter the entire present value. For example, recently, Adani Enterprises’ fair value was calculated by Professor Aswath Damodaran at `948 by assuming cost of capital to be at 10 per cent. If we were to input 12 per cent as the cost of capital then the fair value drops to `645.* One small change in the assumption creates a huge variation. Further, trying to assume future cash flows can lead to false estimations which could prove inaccurate as it is very difficult to predict long-term cash flow growth rates in companies. Working on a small range of interest rates in addition to cash flows can provide us with a better estimate of the value that we are seeking.
There is this perverse tendency in humans to overcomplicate straightforward conditions and throw a spanner in the works. It is observed that a lot of fresh investors like to straight away dive into futures and options trading strategies. They are pursuing the latest algorithm trading fads and even test arcane quant trading strategies. There is nothing wrong with attempting to adopt all these complicated investing approaches and there are some participants who have a good record in adopting such investing styles successfully. However, these are very few. When far simpler methods whose efficacy has been proven over decades, are available to us—such as value investing—for growing our portfolios, then why take to esoteric game plans?
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