SUMMARY OF COFFEE CAN INVESTING

CHAPTER 1-Mr Talwar’s Uncertain Future

1. It is critical for an investor to nail down objectives and bake them into a financial plan and apply it to portfolio

2. It is important to not adhere to the age-old wisdom of investing heavily in fixed deposits, real estate and gold. These assets have unperformed equity by significant margins over long periods of time. In fact, these assets have often given returns lower than inflation over long periods of time and thus damaged investors’ wealth.

3. Equity remains the most powerful driver of long-term sustainable returns. However, investors need to be patient and systematic with equity investments. They also need to keep their brokerage and financial intermediation fees low.

CHAPTER 2-Coffee Can Investing

1. Intermediaries make equity investing a complicated affair:

Our learning from legendary investors like Warren Buffett, Akash Prakash, Sanjoy Bhattacharyya and K.N. Siva Subramanian is that to consistently generate healthy returns from equity investing, one has to invest in high-quality companies and then sit tight for long (often very long) without losing sleep about where the share price is going.

2. The Coffee Can Portfolio of great companies:

Author look for companies above Rs 100 crore market capitalization, which over the preceding decade have grown sales each year by at least 10 per cent alongside generating Return on Capital Employed (pre-tax) of at least 15 per cent each year. Detailed back-testing of the Coffee Can Portfolio in India, based on data going back to 1991, shows that such a portfolio beats benchmarks across all time periods.

3. Why does the Coffee Can Portfolio perform so well?

Great companies do not get disrupted by evolution in their customers’ preferences or competitors or operational aspects of their business. Their management teams have strategies that deliver results better than their competition can. Often, such companies appear conservative. However, they do not confuse conservatism with complacency. These traits are rarely found outside great companies

CHAPTER 3-Expenses matter

1. Fund expenses are often ignored but are deceptively important. Given their compounding over long periods, they have the ability to drag down investor returns drastically. Below picture shows difference in return towards 2.5% vs 0.1% expense ratio

2. Unlike earlier years, the alpha (or outperformance) in large-cap equity mutual funds is now negligible. In this scenario, it makes much more sense to invest in passive funds or ETFs. Already, in the US, active funds have started seeing massive outflows, which are becoming inflows for passive funds.

3. A broker suggesting funds to an investor leads to a conflict of interest. Driven by SEBI, the country has already moved on to an ‘only advisory’ or ‘only broking’ model.

CHAPTER 4-The Real Estate Trap

1. In India and developed markets, real estate has given far lower returns compared to equity over long periods of time.

2. Real estate is the most illiquid asset with the highest transaction costs, which are now in excess of 10 per cent. Furthermore, unfavourable taxation compared to equities make it even less desirable for investment.

3. India has had a once-in-a-lifetime bull run in real estate between 2003 and 2013. Most of the people in this era got a solid confidence on Real Estate, hence they are expecting it to continue further

CHAPTER 5-Small Is Beautiful

1. Over the past two decades, small-caps have outperformed large-caps in most large stock markets. There are two key drivers of this outperformance: smaller companies have the potential to grow their profits much faster than large companies and, secondly, as small companies grow in size they are ‘discovered’ by the stock market. That is to say, successful small-caps gradually attract more research coverage from brokerage analysts and thereafter attract more interest from institutional investors with deep pockets.

2. Ever since the NDA-led government launched its multi-pronged attack on black money in India (2015), affluent Indians have diverted savings away from real estate(black money) and towards the financial system. This deepening of the financial markets is helping reduce the cost of capital in India, which in turn benefits smaller businesses disproportionately (relative to large household names that dominate the stock market).

3. Whilst the scope for generating superior long-term investment returns is greater with small-caps, the need for professional help is disproportionately greater. This is because small companies are riskier than the larger ones due to both fundamental as well as non-fundamental reasons. The good news is that the Indian fund management community now offers several high-quality small-cap and mid-cap funds.

CHAPTER 6-How Patience and Quality Intertwine

1. Patience premium in equity investing:

stock holding periods less than one year, are likely to believe that ‘more often than not, people lose money in equity markets’. For stock holding periods greater than one year, the Sensex’s return over the past twenty six years suggests that as the investment holding period increases from one year to ten years, the investor’s position on a risk-reward matrix moves from ‘high-risk low-return’ to ‘low-risk high-return’.

2. Quality premium in equity investing is higher for shorter time periods: Let us assume that the ‘quality’ of a stock is defined as the quality of its returns profile—healthy and sustainable being better than weak and unsustainable. Intuition suggests that shorter investment horizons are akin to speculative investing, where investors do not need to focus too much on the quality of the company to generate good returns.

3. Combining quality premium with patience premium: Whilst both the Sensex and the Coffee Can Portfolio (CCP) produce better returns (alongside lower volatility) if held longer, the CCP beats the Sensex by a wide margin when it comes to producing superior returns (with its volatility being even lower than that of the Sensex).

CHAPTER 7-Pulling It All Together

1. Create a financial plan which helps you deliver on your life goals. Unless you do so, you will be shooting in the dark. A financial plan helps you quantify and rationalize your life goals. It also helps you set up a return expectation from your investment portfolio so that you can build an appropriate portfolio with just the right amount of required risk —no more, no less.