Sunday, May 13, 2007

Timing the Market

People often glibly issue warnings against "timing the market" without thinking about the underlying assumptions. What is "timing the market"? It is usually taken to mean buying (selling) when you think a share is due for immediate appreciation/depreciation. However, we all buy (sell) only when we expect gains inside a time frame we consider acceptable. And time frames can be very flexible.

To a day-trader, "immediate" is the next 15 minutes. For a position-trader, it could mean within the same derivative settlement -that may be several weeks. For a medium-term investor, it is a deal that incurs short-term capital gains – that is, within the same year. For a long-term investor, it may mean a full business cycle– that could be several years.

The flexibility of time frames is partly personal convenience. You find it most convenient to oversee your investments on a weekly or monthly basis. So, you choose a month or week as your time frame.

But there is also a sound mathematical reason why investment time frames are flexible. Share prices are fractal. Like other fractal quantities, they fluctuate indistinguishably across different time frames.

The easiest way to understand this is to examine price trends across different time frames. Say you take printouts of 5-minute bars, daily bars, weekly bars and monthly bars. Now black out the price values and timestamps. It's impossible to say which time-series represents what periodicity. This is typical fractal behaviour. Another example is a map of a physical location such as a coastline. If you don't know the scale, the same map could represent a continental coastline or five metres of beach.

The fractal nature of share prices means that, if you pick the right direction, across your chosen time frame, you make money. It doesn't matter what time frame you choose; you must pick the right direction. That means, you have to "time the market", whatever your chosen time frame.

This is where investment philosophy breaks into several different schools. The "random walkers" say it doesn't matter what shares you pick, across what time frames. If the market is efficient, your return will be random. If you're lucky you will make lots of money and if you're unlucky, you'll lose a lot.

The value investors say that if you buy sound businesses cheap over long time frames, you beat the street. The technical analysts believe that if you study the specifics of price movements, and buy or sell when you can decode the trends, you beat the street.

All three schools boast spectacular successes. All three schools also boast spectacular failures. Any system which offers you personal comfort is more likely to work for you. There is another question where market philosophies differ. Let's say a stock is down across a given time frame but the underlying business isn't bankrupt. Should you buy or sell?

The random walkers would suggest tossing a coin – previous price should not influence future trends according to them. The value investors say buy. The business is sound; you're getting it cheap. The technical analysts say that you shouldn't buy until a trendreversal. In fact, you should sell to make profits on the downturn.

Both the value investment school and technical analysts have some logic on their side; both methods can work or fail. If the value-investor has misjudged the fundamentals, he loses. The technical analyst will, at the least, forego profits and he may lose heavily if he shorts at the wrong moment.

After all that philosophising, consider a specific case – the universe of Indian stocks, minus the 300 largest. Over the past year, this "sub-300" set has underperformed bigger stocks. Over the past three years, it has outperformed. And, this universe contains many sound businesses.

Pick the right ones and you're buying them cheap. Of course, they may lose some more ground so long as the current trend continues. But if you pick the right ones and then mix in a rough 2:1 ratio with bigger stocks, you're creating a low-risk portfolio with a decent upside. But it may take another three years or longer to generate good returns.

Can you do this and thus, time the market over a period of about three years? DSPML is betting that it can, by launching a new Micro Cap closed end fund which will aim to do precisely this. The Micro Cap Fund will turn open-ended three years later so that is the effective minimum time frame. I like the concept because just one ten-bagger will balance off several mediocre picks. And the sub-300 universe is a good place to look for ten-baggers.

DSPML Micro Cap Details:
Type of scheme: Close-ended equity scheme
NFO closes: May 25, 2007
Minimum investment: Rs 10,000
Cost per unit: Rs 10
Entry load: Nil during NFO
Exit load : 0%-4% (if held for more than 36 months or sold within 12 months of allotment)
Mandate: Stocks that are not part of the top 300 by market capitalisation will constitute 65%-100% of portfolio. Stocks in the top 300 will be allocated 0%-35% of portfolio.

Saturday, May 5, 2007

Is this a Global Mania and if so when will this Global Mania End?

We all have a lot of money invested in the markets globally in one way, shape or form. Either we are working for companies that are dependent on the global players, or are invested in the stocks of the global companies, or are trading partners of these companies that trade across borders. Either way, we are 'invested' in them, and therefore dependent on the growth of their trade......

Is the Indian, Australian, Chinese, Hong Kong, Argentina, Brazil etc emerging markets going to continue it's growth and stock market mania or will 2007 show a topping formation that will take it all stumbling down. Neither of these markets when looked inside-out have any great reasoning to do so (i.e. future view is very bright), but it might not be any single country or market that will correct, but, it will be one feeding the other. We often call it a domino effect. As I was traveling from US to Asia in Apr'2006, I noticed this phenomenan.....So, if you have done homework to see how 2006 corrections started, and what happened, you will soon see that it was 'more' a correction of 'excesses' than a correction with logic, that started from one country, and was bleeding over to another, as if in a spiralling wave downward! If we have the same thing happen in 2007, we are starting at higher level across the board on all markets.

If you dip into the historical accounts of financial manias in classics like Extraordinary Popular Delusions and the Madness of Crowds, or even more contemporary accounts like Devil Take The Hindmost: A History of Financial Speculation

Thursday, May 3, 2007

Talk of India, China dominates Wharton summit


India and China were the main topics of interest at The Wharton Economic Summit held last month by the University of Pennsylvania's The Wharton School in Philadelphia.

Several panelists across all sessions highlighted the underlying importance of the two Asian nations and the value they hold for companies to do business. Senior economists and top-level managers stressed the need for companies to look at China and India and their booming potential.
Their message was succinct — multinationals cannot encompass the concept of globalization without having set foot either in India or China.

In a lunch session, Wharton professor of finance Jeremy Siegel took this a step further in discussing some of his findings from closely monitoring China and India. According to his research, China and India will jump to the first and third positions, respectively, in terms of consumption of goods by 2050. The United States will be sandwiched between the two and he pointed out that companies should not view this Asian explosion as a threat, but should consider it an opportunity to target a population of almost 2 billion and the vast potential it holds.

Following Siegel's thoughts, panel sessions focusing on outsourcing and emerging markets drew some of the largest crowds of the summit.

In the session on emerging markets, Manuel Montero, the chief executive officer of SAFTPAY, a non-credit card company that offers a payment system allowing bank customers worldwide to make e-commerce transactions, said that 86 percent of the world population is part of emerging markets.

"Even though 86 percent of the world population comes from these emerging markets, they constitute only 23 percent of the world economies," Montero said. "So, it's very difficult to find the perfect partner country. You have to select the country and have to understand the culture and how the country functions. You have to make sure that you have a commitment and also a strong, close and continuous management."

Montero focused predominantly on the Latin American markets while Rohit Aggerwal, co-founder and managing director of RAS Capital Management, focused on India.

He laid out several favorable facts that would entice potential entrepreneurs to do business in India. A 13-year veteran of handling foreign investments in India, he said that the greatest asset of India was its human capital.

"The greatest asset that has India going is its population," Aggerwal said. "Fifty percent of the population is under 25 and that represents a large, potential workforce entering employment."
He attributed India's sudden spurt of growth to a favorable economic climate in the last 10 years.

"Between 1998 and 2007, cable subscribers have gone from 25 million to 85 million," Aggerwal said. "Cell phone users have gone from a million to 120 million. There has been a huge explosion in consumer service.

"The interest rate has come down from 40 percent to 10 percent," he said. "Inflation has fairly come under control. There is a strong flow of foreign investment and that has resulted in an increase in mergers and acquisitions."
Finally, Shiv Khemka, vice chairman of the Sun Group, summed it up when talking about choosing the perfect partner to do business with in emerging markets.
"You have to choose the right partner," Khemka, who spoke about the benefits of Russia, said. "Get the best human capital and have a long-term view in these emerging markets. These are the keys to succeed in these regions."
Rajat Gupta, senior partner at McKinsey & Co., was the keynote speaker of The Wharton Economic Summit. Panels throughout the two-day summit, held on April 12 and April 13 at the Pennsylvania Convention Center, covered a number of business topics, including the future of technology, "Wall Street meets Hollywood," sports business, real estate and security.
The summit also featured a focus on ethical issues confounding business organizations and on equity markets.

Wednesday, May 2, 2007

Cognizant's Growth Is Slowing Slightly More Than Expected

When we previewed earnings for Cognizant Techonolgy Solutions (CTSH) we said “one of these days the growth will hit a wall, but probably not this day.” Today the company reported earnings:

Revenue for the first quarter increased to $460.3 million, up 8% from $424.4 million in the fourth quarter of 2006, and up 61% from $285.5 million in the first quarter of 2006. GAAP net income was $75.4 million, or $0.50 per diluted share, compared to $47.2 million, or $0.32 per diluted share, in the first quarter of 2006. GAAP operating margin for the quarter was 18.2%. Excluding stock based compensation expense of $7.4 million, non-GAAP operating margin was 19.8%, in-line with the Company’s targeted 19 to 20% range.

So far, so good as the consensus was expecting $0.48 on $451 million in sales. Likewise, next quarter’s consensus target of $0.51 on $496 million in sales appears to be in the bag. However, Cognizant’s full-year “at leasts” don’t quite make the cut of current estimates.

2007 Outlook - Second Quarter & Full Year Based on current visibility, the Company is now providing the following guidance: — Second quarter 2007 revenue anticipated to be at least $500 million.

– Second quarter 2007 diluted EPS expected to be $0.51 on a GAAP basis, and $0.56 on a non-GAAP basis, which excludes the impact of stock- based compensation expense of $0.05.

– Fiscal 2007 revenue now anticipated to be at least $2.07 billion.

– Fiscal 2007 diluted EPS expected to be at least $2.13 on a GAAP basis, and at least $2.34 on a non-GAAP basis, which excludes the impact of stock-based compensation expense of $0.21.

– Total headcount by end of 2007 expected to be approximately 55,000, reflecting the Company’s plan to increase utilization throughout the remainder of the year.

Let us first say that it is time for Cognizant to toss aside the “non-GAAP” adjustment for options. It sure looks like the estimates are GAAP-based, so why bother?

The company did not disclose net employee additions in the body of the press release, but the company description at the bottom says “Cognizant has more than 43,000 employees.” This compares to “over 40,000” at year-end. While we remain impressed that a company can add even 3,000 employees in three months, the pace is below the 4,500 added in Q4 and below the run rate to match last year’s 14,500 additions. Further, since the company is now larger the 3,000 additions represent a sequential growth rate of 7.5%, or approximately 33% annualized. This is not only below the current growth rate of 61% but also below the consensus 2008 revenue growth rate of 36.3%.

This is important because Cognizant is a consulting firm, and increasing headcount is the primary way such firms can increase future revenues. While 33% annual growth is indeed good, a trailing P/E multiple of 55x probably requires a bit more. With the growth slowing just a bit faster than expected, however, we still don’t believe that “this day” is “the day.”

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