The Strategy Of An Investor

There are two things required to achieve Greatness - 'Craft' and 'Art'

Craft is learning and learning comes by repetition and art is applying those learning to create novel.

Learning to play piano is a craft and composing is an Art. Craft takes time.

With craft, whenever you ask, you get answers. The art is to get more questions - and the right questions - flowing from the right answers received to prior questions.

When you have capability to ask questions on a real time basis, you are a composer, an artist, a creative and investigative investor.

In my last article, 'Identifying Rationality Under Threat of Existence', I threw light on the current economic and market scenario and tried to link the fundamental human behaviors led by perceptions to those scenarios.

In that article I promised to share with you the strategy to be followed to make money in different times as commonly said, 'At the bottom of all the rules is the rule, that making money is always more important than anything else.'

In this article, I take your time towards making the right strategy to investing.

Let us divide this strategy formation into two parts:

Part 1: Investing during current times. (i.e. During times of Crisis)

Part 2: Investing during times of revival and the period of Bull run.

Part 1: Investing during current times. (i.e. During times of Crisis)

Nassim Nicholas Taleb in his book, Fooled by Randomness writes, "Mild success can be explainable by skill and labour, wild success is attributable to variance."

This is the time when variances (volatility) in the stock market is as high as never seen before. In a single month of March 2020, markets hit lower circuits two times, with one time recovering it completely and closing above 5%.

Before understanding the strategy to be followed in Part 1, let us first look at few basics.

Basic 1: The volatility premium is well captured in Option Pricing. According to option pricing models, options derives its value through 5 Variables.

Variable 1: The underlying stock price.

Variable 2: Time Value of Money.

Variable 3: Volatility in the underlying

Variable 4: Risk Free Rate of Return and

Variable 5: Carrying Cost of the underlying

Thus, when volatility is high, option prices are inflated.

Basic 2: The Concept of Delta Hedging

Delta means change in the value of option for Re. 1 change in stock price.

According to this Principle of Delta Hedging, Change in the value of option is always less than the change in the value of stock price. Thus, if delta of call option is say 0.25, it means that for Re. 1 increase in stock price, the price of option will increase by 0.25 keeping other factors constant.

As a general rule, Delta of:

• At The money option is 0.5
• In The money option moves towards 1 and
• Out of The money option moves towards 0.

Now, let us understand how are we intending to leverage this to our benefit.

Since this Part 1 deals with derivatives, I will divide this Part 1 into 2 sub parts on the basis of risks taking ability of an Investor.

Sub Part 1: Buying Stocks and Writing Call Options (Less Risky Strategy)

Since the underlying assumption remains the same, i.e. we are working in a stressed environment thus buying stocks is not a good idea. We all believe that there are few stocks which should not show much downside even during this environment. However, upside in these stocks seems to be a matter of doubt and conflict.

In such situations, an investment strategy should focus on buying such stocks and writing call options (at the money options or slightly out of the money options)

Advantages:

• Exposure in quality stocks with hedged downside to the extent of Option Premium.
• Full realisation of option premium in case stock prices remain constant or rises.
• Since, volatility is high, huge amount of premium can be realised which can be to the extent of 7% to 12% per month.

How to leverage such opportunity?:

This opportunity can only be leveraged in stocks and industries where the potential of downside seems limited.

I have identified few stock for the same, you may find more on these parameters.

Pharma Industry: Since the advent of Covid-19 and its news coming in, the vast majority of people concerned with any health issues are moving to doctors immediately. This brings in vast majority of people to purchase medicines. Thus, the consumption of medicines have suddenly increased benefiting Pharma Companies. The stocks have not risen much because of certain export restrictions and non-essential medial facilities running low.

Sun Pharma, a pharmaceutical company could be a good match for this strategy of buying stock and writing call as the company has already announced buy back which will restrict its downside further.

FMCG Industry: One of the few major beneficiaries of lock-down, since people have moved towards food & eatables and sanitation products as basic necessaries keeping all articles of luxury aside. The demand for branded products have increased further due to reliability factor.

This brings in this strategy of ours a good chance to success here.

Nestle, HUL and Britannia are the picks for this strategy since they are more or less completely into FMCG.

(Being an investor my strategy has always been to find companies with Low P/E and High returns. These FMCG stocks do not match my investment criteria. Thus, I suggest that only in short term crisis period investing in these stocks only with respect to our Part 1 Sub Part 1 Strategy)

Telecom:

The India Telecom Industry has three major private players. Reliance Jio, Vodafone Idea and Bharti Airtel. Here the play is two sided. As Warren Buffett quotes, "Chains of Habit are too light to be felt until they are too heavy to be broken." In the similar sense, we have already formed the habit to sit on Internet. Another reason for selecting telecom is, the complete end of price war for few years atleast. This is because the one of the largest debt owned companies of India, 'Reliance' is facing difficulties due to sudden sharp decrease in Oil Prices, the refinery business being its major cash generating business and the other player Vodafone Idea has a Debt to EBITDA of more than 9, thus in no case can lead a price war too.

Bharti Airtel being the preferred stock for this industry.

Sub-Part 2: Writing Naked Call Options (Relatively more risky)

Again with the same underlying assumption, that buying stocks in such times of crisis makes no utility and taking short positions in futures makes you fall prey to volatility. This strategy deals with writing out of the money call options and grab the premium of volatility with the passage of time.

During this time of high volatility, a 6% - 8% out of the money call option is having a premium of around 6%. Thus, even with a 12% increase in stock price there is no major risk in losing money.

I have identified few stock for the same, you may find more on these parameters.

Shriram Transport Finance:

It is an NBFC, which finances Commercial Vehicles. During this time of uncertainty and slowdown running past more than 12 months in the industry, the industry is currently facing almost standstill situation. Since, the buyers are small and commercial vehicle loses their value faster, the recoveries of adequate loans seems questionable.

Ashok Leyland:

It goes with the same line as above, since the company has a subsidiary which finances companies vehicles. Further, since a long time truck sales have remained low. One more factor, the Indusind Bank which has come all from Rs. 1600/share to Rs. 350/share are of the same Hinduja Group.

Page Industries:

The company with the brand, 'Jockey'. I have been negative on this stock since quite long, the reason being I don't see any major scope for the company to increase the price of its products to gain more revenue. Secondly, seeing the success of Jockey in India almost all major players have entered into this segment creating very high competition which will force Page Industry to lose its market share. Thirdly, this stock has long being traded at a very high P/e for the reason of high growth being factored in the stock price. The growth was expected to come from the greater women employment coming in India, thus increasing the brand awareness among women in the country. Since this slowdown hit by Covid-19, raises doubt on employment opportunities for both men and women, I doubt that growth story will realise in next 2-3 Years.

[Beside above, if conditions in US becomes worse IT industry can see a big hit. Also Real Estate Industry seems to be much in trouble too. Thus, stocks from those industries can also be considered for this strategy.]

Now let us move to Part 2 of this Article.

Part 2: Investing during times of revival and the period of Bull run

"Every decade or so, dark clouds will fill the economic skies and they will briefly rain Gold. When downpours of that sort occur, it's imperative that we rush outdoors carrying washtubs, not teaspoons." ~Warren Buffett

As written Bhagavad Geeta, "Nothing is permanent in this world", thus, it's important for us to be prepared to play the Big Bet once the signs of revival steps in.

This part is more about getting prepared, yet if stocks mentioned in this part fall significantly, then even if no major signs of revival can be seen yet buying of small quantity can be considered. However, at this so fast changing world, it may happen that stocks mentioned here may lose their relevance if revival is delayed significantly. In that case I will write another article explaining the changes which could be made in portfolio.

The Key Criteria I have considered for identifying these stocks have summed hours of research and reading. Such research and reading are hard to transfer, but I will share the broad outline of the same.

• High Corporate Governance Companies
• Well Managed Capital Structure
• High Growth Opportunities
• Reasonable Prices
• High Brand of Quality, Trust and Reliability
• Growth on accruals rather than on Debt

I have identified few stock for the same, you may find more on these parameters.

Quick Service Restaurants Industry:

The first in line comes stocks in this industry, as by the end of lock down people are already done with home foods and mom's are also tired preparing food. Further, as offices will start, ordered food from these chain restaurants will see a big rise, for reasons of their taste, reliability, trust and brand.

Stocks are: Jubilant Food (Brand: Dominos), Westlife Developers (Brand: McDonald's)

Consumer Goods:

With prolonged consumption slowdown, need of essentials will increase. Further, in India with more than 130 Crores of population, the consumption story can never slowdown. It will also be the earliest revival industry.

Stocks are: Bata India, VIP Industries, Relaxo Footwear

Jewellery:

Titan is a company with the most trust and reliability, once the Gold prices will settle down and wedding season begins again the demand could revive.

Stock Pick: Titan

Air Conditioning/AC Coolers:

Stock Pick: Symphony and Amber

Telecom Industry:

Stock Pick: Bharti Airtel and Reliance Industries

Real Estate:

With a lot of real estate developers suffering this crisis, some may even shut down their businesses and a lot will be forced to carry on business at a very slow rate. This gives an immense opportunity to one company from all corners its balance sheet advantage, business model advantage, market share advantage, location advantage and trust on its brand.

Stock Pick: Godrej Properties

Infrastructure Industry:

On similar grounds as above since almost all the infrastructure companies are highly leveraged, diverting their focus, there is one company which can leap early benefits of it.

Stock Pick: Larsen & Turbo

Miscellaneous:

Maruti Suzuki, SRF, Venky's India, City Union Bank, Kotak Mahindra Bank

This is all here is, I take your leave now. Thank You so much for reading it. Do consult your financial advisor before making any decisions.

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