Goal Based Investing: Goals which we can accomplish from the markets

[DeveshGaur]

I think there is very little attention that is paid to this topic which is around how one can utilise the market to achieve certain specific goals. But this is a very structured query, and therefore there can be a very good response to such a question when one tries to solve the problem from a first principles basis.

I’ll try to take the approach of taking up a query which is commonly asked and try to resolve it through a framework and then give specific recommendations using that framework to satisfy both audiences, i.e. those who want to answer questions themselves and those that just want the answers.

Gradually if this thread does see good engagement I think we can start picking up queries that people might have and try to resolve them collaboratively.

There is no such thread already on VP so hoping to get some first mover advantage here.

See you in the first edition.

[DeveshGaur]

Edition 1: How to generate sustainable dividend income?

Challenges with Dividend Investing:

Establishing a reasonably large dividend income tends to be one of the primary questions that many investors have. It has its own advantages which we’ll not talk about as much. We are more interested in the challenge that dividend income tends to usually pose. Understanding challenges inherent in our paths is the first step in trying to overcome them.

So if I were to break it down, there is one large challenge to dividend investing:

Capital Appreciation Challenge: If a company is providing a large dividend, it automatically means that there is little in terms of growth opportunities for the company and therefore capital might not appreciate even in a roaring market.

A good investor would like to think of dividends as downside protection or some kind of stability that is brought into their lives, but they wouldn’t like missing out on the part related to growth.

Solution to the Challenge: We have to then build a framework to find companies that don’t really have large capital requirements to take part in future growth. This might look a little complicated, but typically in a business setting, there are ways to make money without putting in extra money every single time in terms of capacity or new products. We have to essentially find such companies to address the capital appreciation challenge.

Inverting the problem: What to not look for

Now in looking for what we need to find, let us first think about where we won’t find it for sure, here are a few kinds of companies that don’t give out dividends:

1. Banking and Financial Services Firms: There is a Capital Adequacy Ratio that banks have to maintain, plus they have to also invest aggressively in setting up branches and growing their asset base. This is why they don’t give as many dividends.

2. Non-Shareholder friendly companies: Companies that tend to have high cash and investments on the balance sheet are not supportive towards shareholders.

3. High PE Companies: The valuation for these companies tends to mostly come from the multiple that is assigned to them and not necessarily their actual profits. So the ability for them to grant dividends is severely constrained.

4. Low Growth Proposition: These are typical value traps type businesses. Wherever there is lower growth, the ability to grow in India is really crucial because of the kind of market we are, without it any investment will have terminal value risk.

With this assessment we have eliminated a large universe of companies from which we’ll not look to invest for dividend purposes.

Framework for the companies we are looking for:

Now we shall look at the framework for companies that can provide a good dividend, this will be in the increasing order of risk:

1. PSU Companies which are seeing good growth:
   PSU companies have a mandate to give dividends to their largest shareholder ie the government. If they are seeing good growth or you feel there are triggers in the future that can ensure this, they present a great opportunity for capital appreciation and dividends. This is what has happened in the past few years in these companies with the growth coming back.

2. Large cap companies that are diversifying to fast growing sector:
   examples like ITC would include these companies. Essentially the company should be gaining market share or staying constant in terms of market share but have better growth plans for the future. The fast growth would ensure these stocks don’t become a value trap. It is better if these companies have an announced policy of a set percentage dividend distribution for their shareholders.

3. Hold Cos:
   Holding companies of fast growing companies can present another good opportunity but what tends to help here is some sort of understanding about how the hold cos discount tends to move and how it has moved in the past.

4. Fast Growing IT companies:
   IT companies that are exhibiting growth regardless of their size are another candidate of good dividend generation. These are truly asset light companies as we discussed above. Track IT companies for when there are valuation gaps that you perceive and invest heavily to reap in good times.

5. Commodity Business with high growth rates at the right time:
   Commodity businesses with high rates of growth in good cycles can present a good investment opportunity if you invest at the right time. What is a right time? It is when the margins are at their lowest cyclically or are bottoming out. I think the Poly films businesses are at that stage currently.

I’m sharing an illustrative list for what kind of companies we have discussed here.

In the next post, I’ll discuss a few examples of good dividend opportunities.

[gsapte]

Apart from regular income (which can be accomplished using Dividends), there could be various other goals which can be achieved through Direct stock investing.

Investors can set aside some Direct Stock corpus for goals like Retirement, Children Education, Vacation, so on and so forth. When profits are booked in Individual stocks one can use all or some of those profits to satisfy these goals, by investing those profits in FD/Liquid Fund and then using those funds for some of these goals.

This aspect is sometimes ignored by Direct Stock investors. This can be also discussed.

[ChaitanyaC]

@gsapte

Retirement, Children Education

When one has ample time, one can go with MFs because the corpus required for these goals can be calculated and the time is also known, particularly education goal, as it cannot be postponed. One can rebalance as per returns or % growth of the funds, and as time goes forward, even if 70% or 80% of the corpus is achieved, one can move to debt.

Investing in stocks for goals could be risky, as one cannot manage a large group of stocks like MFs do, and what kind of stocks should consist of such a group is also a big question. High growth stocks, GARP, value, undervalued, dividend etc etc.

One can look at stock advisories though, as the work is done by them just like MFs, and all one does is to read the reports sent, invest and sell as per the recommendations.

And retirement is complex compared to education, there are a lot of moving parts.

Just my thoughts.

[gsapte]

I have been using Direct Stock Corpus for various goals.
As & When I book profits on over valued stocks, I shift some part of it to few goals using Bank FD, Liquid Funds, Overnight Funds. I have a process for this, which I have been using for past 10+ years.
Since I invest mainly in undervalued stocks from 3-5 years perspective, it is possible for me to allocate some funds to goals on Regular basis. Every year, there are some Sell opportunities and some Buy opportunities.

I also use Equity MF(s) for goals like Children Education, Children Marriage, but also have some small Direct Equity Corpus for all my goals.

I mainly use Dividends for regular monthly expenses as I am partially retired. Even though I churn stocks, but still have some Dividend Yielding stocks all the time in Portfolio. This partly gives me some funds on regular basis.
For retirement, I have some portion of Direct Stock Portfolio which I may need after another 10-15 years. Also I keep Debt (PPF, FD(s), Post Schemes) for the Retirement Goal and also use Short term Debt Funds for regular income.

You have to manage Direct Stock Portfolio more on regular basis. Also, some portion of Direct Stock portfolio is for Wealth Generation.

I have a process and framework for all this hence it might be possible for me.
For most of the people, I think, MF will be better as you know the time frame for Goals and can predict MF returns reasonably well.

[ChaitanyaC]

@gsapte

For most of the people, I think, MF will be better as you know the time frame for Goals and can predict MF returns reasonably well.

This is what I was going for, along with the fact that direct stocks investing is very time consuming, as we all know, and whose results could surprise us on the negative side. So some may feel that they have lost opportunity and time by doing this, despite working for it.

So it is recommended for many to start with MFs, understand the markets, understand volatility, gain some experience, and one can start dabbling directly, and go forward.

Your participation and management is very structured and even if some mishaps happen here and there, it wont be significant. And it appeals to some, and they can emulate and build what you are doing.

[DeveshGaur]

Absolutely right @gsapte , these objectives are pretty much in line when it comes to objectives I want to cover. But thank you for the heads up, helps us in being accountable with regards to starting these discussions.

[DeveshGaur]

@ChaitanyaC

One can look at stock advisories though, as the work is done by them just like MFs, and all one does is to read the reports sent, invest and sell as per the recommendations.

Again very relevant comments here @ChaitanyaC , but I think this thread is just designed keeping in mind people who want to achieve the goals we are talking about through direct stocks. The big concern I have with a lot of investing around me is that people are too focused on getting the highest returns when they could have been better with risk management had their focus been on achieving their objectives.

[ChaitanyaC]

The allure of stock returns could make one think beyond the objectives. It is hard to sell even one has a gut feeling, and when one is reasonably sure of growth because he has gained some experience in the market, selling a stock PF, even if it was created for goals, is more difficult. Easy to do this with MFs was my point, the returns will not surprise us, and one can have a separate stock PF, which can be managed any which way one deems fit.

Of course, these change from person to person, one can have a stock PF and can always sell the necessary portion of shares to get the corpus required.

[Deepak1]

Very informative post. Giving examples was the best part for understanding the concept.
Just a suggestion. Giving e.g. of companies where not to invest would have made it still better.

[Deepak1]

A very good suggestion. People mostly use mutual funds for goal based investment strategies, but direct stock investing can also be a part for same goals.