Bye Bye Bias–Key to successful investing

Fundamental analysis and technical levels are all fine. But those who have been in the markets for any length of time understand one important dimension of successful investing, and that is – Behavioural aspects of investing. Overcoming investing bias is key to superior results in the investment process.

Making mistakes is acceptable because they are the best teachers. But the problem is unless one understands behavioural side of investing, it is difficult to figure out the primary mistake itself. With this background, I intend to discuss some of the investing biases in this post which often lead to mistakes on the part of the investor.

Human mind is wired to fixed tendencies, and takes decisions according to emotions and those mind patterns. Self-control over impulses is generally difficult to exercise for ordinary investors. Hard wired to herd and inability to look beyond the obvious (however silly that may be) can often be undoing a good investment decision.

Bias # 1 : Thirst for Agreement

We also know this as confirmatory bias. In simple words, we form a view and then spend rest of the day or week looking for information that agrees with that view, howsoever wrong that view or hypothesis may be. As humans, it feels good to hear the same opinion as ours. In investing, it can be a huge disadvantage if we can't accept refutation. Another manifestation of this "thirst for agreement" bias is that any media source, TV channel or information that disagrees with our view, we label that as biased.

Bias # 2 : Price Anchoring

Let me explain anchoring bias with an example psychologists and experts give on this factorial calculation. What is the value of 8! This is asked to participants in 2 different surveys, one as 8 x 7 x 6 x 5 x 4 x 3 x 2 x 1 and another as 1 x 2 x 3 x 4 x 5 x 6 x 7 x 8.

Surprisingly, median result of both surveys was not found the same. Under first scenario, median answer was 2250. In second scenario where smaller numbers are appearing first, median answer was 512. What's your guess? Want to know the correct answer, without troubling your excels and calc. Well, it's 40,320.

Coming to stocks, we see the price tape and screens for so long that we are "anchored" to a particular price point, and anything optically different is not readily accepted even if that valuation may be more realistic. People have become so used to Reliance quoting in range of Rs 950 to 1050, that if I say I want to buy it at Rs 750, most would grin or frown at me depending on which side of the position you're.

Bias # 3 : Heads my skill, Tails bad luck

Remember the period - October 2008 to March 2009 in markets when anything we touched turned gold, well almost. But smart folks say it was entirely their skill to have got those stocks right (Heads). I can give them credit for courage and timing because those were gloomy days, but for skill…no. It was nothing great to create multi-baggers in one year for anyone who invested then. On the other hand, poor stock selection (Tails) whatever may be the month or year, is called by us as bad luck. At this time, we don't bring our bad skill set on to the fore. After all, it hurts self-esteem to admit so. This self attribution bias, is a big hurdle to recognizing mistakes and learning from them.

We have discussed only 3 biases in this post, they are many more…will continue some other time.

Good thing is these mind patterns can be attuned or set right with a little bit of mind re-training and self-regulation. It's not without reason old timers stress upon discipline and patience for success in all walks of life, investing included. Give it a try and share your experiences.

I conclude with gem of a quote attributed to WB:

"You’re neither right nor wrong because other people agree with you. You’re right because your facts are right and your reasoning is right- and that’s the only thing that makes you right."

South Indian Bank

First things first - South Indian Bank is not among the strongest or biggest private sector banks. Still, I find it a very attractive long term investment opportunity for its robust operating parameters, good regional presence, growth plans and a possible M&A play.

Business & Operations:

1. Operating background

South Indian Bank (SIB) was incorporated at Thrissur in Kerala, South India. It was among the first private sector banks in Kerala to become a scheduled bank in 1946 under the RBI Act.

2. Branch network

SIB has a pan-India presence with a network of 641 branches, 3 extension counters and 494 ATMs across 23 states, and 2 Union Territories. Nearly 55% of the branches of SIB are in Kerala.

3. Robust business growth

(i) NII at Rs 791 crore in FY11 recorded a growth of 39% compared to Rs 568 crore in FY10. Estimates for FY 12 are at Rs 923 crore marking a growth of 17%.

(ii) Loan book is expected to grow at higher rate than this over the next two years through network expansion and increased penetration

(iii) Total Business is expected to grow from Rs 49,076 crore estimated for FY11 to over Rs 62,000 crore by the end of FY12.

(iv) We expect balance sheet size of SIB will cross Rs 40,000 crore as at March 31, 2012.

4. Stable Asset quality

(i) Asset quality has been among the best (gross NPA of 1.1% and net NPA of 0.3%), with lowest restructuring (~2.6% of the loan book).

(ii) PCR for FY11 is quite comfortable at 73%.

(iii) Gold loans that constitute a good portion of SIB's loan book (17% of advances), register strong traction.

(iv) Low exposure to MFI sector and Real estate sectors which are considered higher risk and have been in the news for wrong reasons over the last 1 year is a positive.

5. Decent CASA

CASA ratio of SIB is decent at about 21% which has declined compared to previous quarters, but NIM has improved. It is also supported by NRE deposits of about 13%. We expect CASA to be in the range of 20-21% for ensuing quarters.

6. Tech savvy

SIB implemented core banking solution (CBS) platform covering the entire business many years ago in 2007. It has since made further advances in other technology led initiatives like Anywhere banking, remittance platforms, e-Commerce services, data center upgradation etc.

7. In 2010, SIB was awarded the Businessworld India's Best Bank award.

Industry prospects:

1. Financial & banking services is the mother of all services and provides a huge opportunity at the current stage of India's economic development. However, in the short term there are headwinds for the banking sector due to increasing trend of interest rates and inflationary pressures.

2. Savings and capital formation in the economy is at about 34% of GDP which provides a big opportunity in financial intermediation. Over the next decade, nominal GDP is expected to grow at about 8-9%, and excluding agriculture this will be higher. In that case revenues from the financial services sector will grow at around 20%. More efficient and nimble banking players like SIB will utilize this business opportunity to their advantage.

Management:

1. SIB does not have any identified promoters.

2. SIB is led by Dr VA Joseph who is the CEO & Managing Director.

3. Public shareholders holding more than 1% of total shares can be seen here.

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Financial summary:                                                    

                                                                       

Particulars	FY2008	FY2009	FY2010	FY2011E	FY2012E
NII (Rs crore)	394	523	568	791	923
Op. Income (Rs crore)	537	687	777	988	1,151
Pre-prov prof (Rs crore)	289	359	411	525	630
PAT (Rs)	152	195	234	293	339
EPS (Rs)	1.7	1.7	2.1	2.6	2.9
BVPS (Rs)	10.2	11.5	13.1	15.3	18.0
CAR (%)	13.8	14.8	15.4	14.0	12.3
NIM (%)	2.6	2.9	2.7	3.0	2.9
Cost/Income	46.2	47.8	47.1	48.8	48.5
Net NPA (%)	0.3	1.1	0.4	0.3	0.2
Gross NPA (%)	1.8	2.2	1.3	1.1	1.2
ROE (%)	16.4	15.8	16.9	17.8	17.4
ROA (%)	1.0	1.0	1.0	1.0	0.9

Investment Rationale: 

1. We like South Indian Bank as one of the best regional-based private banks. It has strong regional presence backed by good technology network. SIB is planning to add 60 new branches to its existing network of branches.

2.Improving asset quality and estimates on business and profits to grow at by 20-22% make it an attractive option at current valuations.DPS increased from Re 0.40 last year to Re 0.50 for FY11.

3. SIB is a possible M&A play which gives it that extra in investing, but it will need patience on the part of investors.

4. Expansion plan - Bank's long term target is to reach Rs. 75000 crores in total business with 1500 delivery channels and a well-trained staff of 7500 by the end of March 2013. CAGR of about 20% is expected in business growth over the next 2 years.

Risks:

1.High dependence on southern states, particularly Kerala, increases geographical risk.

2. Intense competition among private banks for premium customers.

3. Sectoral headwinds of rising interest rates and RBI moves for controlling inflation through monetary control measures.

Stock parameters:

CMP: Rs.22.75 (FV Rs 1); Market Cap: Rs.2,559 crore; 52-week high/low (NSE): Rs.29.50/14.10;  200 DMA: Rs.22.93

Valuation parameters:

PE: 8.71; P/BV: 1.48; Dividend yield: 2.20% (based on FY11).

MCap/No. of branches is quite attractive at Rs 4 crore.

Some of you will observe that MCap/Branches was not in the list when I mentioned about few valuation indicators here. Well, these are the nuances of investing which emerge specific to a sector or a stock. We include this due to possible M&A play in SIB (we don't know when, how and at what rate it could happen, if at all).

Among its peers, SIB compares very well in terms of valuation matrix.

Outlook:

SIB offers excellent prospects of capital appreciation to put it conservatively. I would not like to put a number to it but could be worth the while to hold it for next 2-3 years.

What drives PE of a Stock

While dealing with the topic of valuation measures in the previous post, we discussed Price-to-Earning (PE) multiple. In the simplest terms, stock price can be seen as product of EPS and PE as given below:

1.       Stock price = EPS ttm  x PE ttm

2.       Stock price = EPS forward x PE forward

In equation (1), EPS and PE ttm are trailing twelve months say for FY2011 at this point.

In equation (2), EPS and PE are 1-year forward, for FY2012 (sometimes 2 year forward say for FY2013).

EPS is known or quantifiable. For FY11, EPS ttm is already known from the financial results. On forward EPS, many companies/their managements like Infosys give guidance for next fiscal i.e. FY12. Moreover, analysts work out earnings estimates for most companies based on revenue growth, margin structure etc. In other words, forward earnings estimates are known to the markets though these estimates can go for a toss due to factors such as business under-performance, hikes in raw material price, margin pressures, equity dilution during the year and so on. Still, a broad idea on forward EPS is available.

That means in both the above equations, we have PE as the real unknown. One more way of looking at PE is as the number of years it will take to earn back the initial investment. Having said that, PE ttm in equation (1) is just a derived figure since EPS ttm is known and fixed in history. That leaves the forward PE in equation (2) as the magic number or the X-factor that makes investing difficult since forward earnings are uncertain and nobody can be sure whether markets are going to de-rate, maintain or re-rate this PE multiple with the passage of time.

So, the question is what drives this forward PE?

Well, a lot of factors including the following (listed not necessarily in order of importance):

(a) Earnings growth rate trend;

(b) Sustainability of earnings in future;

(c) Return on capital (ROE/ROIC/ROCE);

(d) Free cash flow generation;

(e) Barriers to entry;

(f)  Status within industry : leadership/also-rans/laggards;

(g) Peer comparison & positioning;

(h) Cyclical trend;

(i)  Management trackrecord;

(j)  Shareholder friendliness of management– dividend policy, bonus/rights;

(k) Sectoral outlook;

(l)  Trading volume: like index constituent, FnO trading;

(m) Market perception & sentiment.

Different determinants have varying influences and dynamics. Big money is made when you hold a stock whose PE is being re-rated by the market and one is lucky enough to spot it before that sets in, and hold it through this process. TTK Prestige is a recent example which got phenomenally re-rated by the markets in 2010.

Ultimately, it's the sum total or interplay of different factors that makes up the PE and market keeps adjusting it on a daily basis.