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Value Averaging



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Recall from our earlier classes that when we want to invest for the long term, we need

1. a proper cash plan and

2. a proper investing strategy.

The advantage with long term investing is that, there is:

1. No hurry to invest large amount in a single transaction

2. No need to time the market.

However, funds in our bank account will always be limited.

Also, the allocation we do will be spread among 5 carefully chosen stocks (core-portfolio).

So we need to plan and use case carefully.

As far as stock markets are concerned, they will always exist as long as buyers and sellers are there.

So, when it comes to long term investing, there is absolutely no need to run or hurry to put your money in.

Many people invest for short term or for intraday.

The shorter the time frame for investments in the market, the more riskier they are.

For instance, we know:

Intraday is riskier than short-term

Short-term is riskier than long-term

I already introduced you to Dollar Cost Averaging method earlier.

Mutual Fund call this process as Systematic Investment Plan (SIP).

You might have observed that Cost Averaging is a very simple process.

You need not have to think hard about when to invest, where to invest, how much to invest.

In fact the Cost Averaging Method is sufficient method for most investors who do not have much time to spend in the markets every day.

Right?

I don't think any one can find a more simpler plan than this for investing.

Now lets move on... to a little more advanced method of investing.

Lets take an example first.

Lets say, our daily budget is Rs. 1000 and our share price is Rs. 100

If we want to buy, On Day 1, we get Rs. 1000 / Rs 100 = 10 shares.

If on Day 2, the share price is Rs. 82, we get Rs. 1000 / Rs. 82 = 12 shares.

So, in two days, we invested Rs. 1000 + Rs. 1000 = Rs. 2000

We got 10 + 12 = 22 shares

Our total average cost is Rs. 2000 / 22 = Rs. 90

If you notice, using our Dollar Cost Averaging method, we have put our investment amount fixed for all stocks and all days.

Right?

So, the inflow of money is constant irrespective of market conditions.

And we get different quantity of shares every day because of the stock and market fluctuations.

If you spend more than the average time on stock markets daily, you can try a better investment method.

Now, lets get to Value Averaging or Value Investing concept.

This is a little advanced topic. But it will be simple if you concentrate.

Assume that you have lot of money to investment (i.e unlimited budget)

You have high risk appetite

And you want to grow every day. i.e attempt to improve your profitability.

i.e You are ready to take additional risks if required

And you are sure that your chosen stock is fundamentally a good one and is available at attractive price.

ie. stock is fundamentally good one for long term investing and you see some exciting triggers to push it upwards.

Such as: Some top expert has given a buy call, technicals are showing positive signs, good economy, positive global factors etc.

Please note:

We have 3 conditions to be satisfied to use Value Averaging.

1. Lot of money to invest in a short duration of time

2. High risk appetite to grow

3. Availability of a good stock (possibily with some positive triggers / news)

Value Averaging works in similar method to Cost Averaging.

One important point!

Value Averaging is *not same* as Value Stocks !

  • Value stocks* are some special type of stocks.

They are low volume stocks, could be penny stocks, could be low traded but they have some special features that make us feel they have huge potential to go upside in the long term.

We are not discussing about *Value stocks*.

We are discussing about *Value Averaging* only in this class.

For now, u should not confuse Value investing with value stock. Both are not related at all.

This session is about *Value Averaging only*.

Now, lets get back to our example.

Let us see how Value Averaging concept works with an example.

On Day 1, we started with our daily budget of Rs. 1000

Assume CMP = Rs. 100

We got 10 shares.

On Day 2, when we went to the market and saw the CMP, the CMP is down to Rs. 82

As of now, you will notice that the value of our holding is Rs 82 x 10 shares (bought yesterday) = Rs. 820

So, in one day, the value of holding fell from Rs. 1000 to Rs. 820

Right?

Why we do averaging when we know low for a year.. 52w high 52 w low.. I mean

We can never know the lows fo any thing in stock markets. There could be fresh 52-week high/lows coming going foward and we can never be sure

Also, we are not timing the market.

Coz we are not looking for quick or short term gains

We are planning to invest in good and bad times of the market.

These are the premise with which we started long term investing

I will ask after all ur inputs

Now, in value investing, the idea is that ur portfolio is always at a certain pre-determined predictable levels

According to value investing, on Day 2, the value of ur portfolio should be Rs. 2000

i.e Rs. 1000 more than yesterday

So, we do a reverse calculation.

CMP on Day 2 = Rs 82

Target value = Rs. 2000

I have unlimited cash.

How many shall i buy today?

This is what value investing aims at.

Now lets calculate.

How much should i invest today?

Rs. 2000 - Rs 820 = Rs. 1180

Notice that the amount that i invest on Day 2 is not same as Day 1

On Day 1, i invested Rs. 1000

On Day 2, i will have to invest Rs. 1180

Because we have unlimited cash (assumption), VI says,

invest such that the value of ur holding grows by a fixed quantum everyday.

Now, on Day 2, how many shares do we have to buy?

Rs. 1180 / Rs. 82 ~ 14 shares

This means that the number of shares we buy and amount we invest will be drastically different from where we started.

Now, how many shares do we have?

Day 1 = 10

Day 2 = 14

Total = 10 + 14 = 24

How much have we invested?

Day 1 = Rs 1000

Day 2 = Rs 1180

Total = Rs 1000 + Rs 1180 = Rs 2180

How much price goes down that much more investment ?

Yes. Just 1 transaction for that day.

What is the value of our holding?

CMP = Rs 82

Total Shares = 24

Value = Rs 1968

Notice the value of our holding is close to what we wanted ~ Rs. 2000

Understood?

Holding value is 2180 and the current value is 1968

Yes. What we have done is to bring the value of our holding to the current market price.

We will attempt to do this daily.

Only 1 transaction per day.

Now lets continue to Day 3

Assume the share price fell to Rs. 75

According to value investing, on Day 3, the value of ur portfolio should be Rs. 3000

CMP on Day 3 = Rs 75

Target value = Rs. 3000

I have unlimited cash.

Value of holding on Day 3 is Rs 75 x 24 = 1800

How much should i invest today?

Rs. 3000 - Rs 1800 = Rs. 1200

Shares to be bought are Rs 1200 / 75 = 16 shares

Total Shares = 10 + 14 + 16 = 40 shares

Value of holding *after* the transaction Day 3 is Rs 75 x 40 = Rs 3000

Total Investment so far: Rs 1000 + Rs 1180 + Rs 1200 = Rs 3380

If you notice, the faster the market price falls, the more money we have to invest

Also the more shares we are taking delivery

So we should notice that in a way, we are trying to catch a falling knife. This is risky!

On the other hand, if the share goes up faster, we invest less money and take delivery of less shares.

Now, lets take it to Day 4

Assume CMP went to Rs. 90

Target value for Day 4 = Rs. 4000

Value of holding on Day 4 is Rs 90 x 40 = 3600

How much should i invest today? Rs. 4000 - Rs 3600 = Rs. 400

As of Day 3 end, we have 40 shares. Right?

So on Day 4 morning, the CMP is at Rs. 90

Hence, the Value of holding on Day 4 is Rs 90 x 40 = 3600

Our target value for Day 4 is Rs. 4000

So investment to be made of Day = Rs. 4000 - Rs 3600 = Rs. 400

So we get Rs. 400 / Rs. 90 = ~4 shares

Total Shares after the transaction on Day 4 = 40 + 4 = 44 shares

Value after Day 4 transaction = Rs 90 * 44 = Rs 3960

See the change in the amount to be invested.

On Day 3: Rs. 1200

On Day 4: Rs 400

This happened because of the sudden upward moment in share.

So, the daily budget for this method changes from day to day and is unpredictable.

Now let us go to Day 5

Assume CMP on Day is Rs. 115

Target value for Day 5 = Rs. 5000

As of Day 4 end, we have 44 shares.

Hence, the Value of holding on Day 5 is Rs 115 x 44 = Rs 5060

So investment to be made of Day 5 = Rs. 5000 - Rs 5060 = - Rs. 60

This means that we need not have to invest on this day at all because the stock price increased a lot than what we wanted.

Based on this, what happens when the share prices goes to Rs. 125 on Day 6?

Will the value of our holding be more than what we actually wanted for the day?

So what you notice is that when the stock CMP is slowly moving upward, we are still buying with low volume

But if stock price moves way too faster, there will be some days on which you will not invest at all!

If you see, we have taken highly random CMP from Day 1 to Day 2 and so on to Day 6

In actual market conditions, in most cases, adrupt price moments might not happen

But there are certain type of stocks called *High Beta Stocks* that move this way

So, Value Averaging method can be used for all type of stocks but works well for high beta stocks.

Now coming back to our VA lesson.

There will be certain situations in which the share price goes abnormally high.

And there will be a situation that we dont have to buy

i.e investment to be made in the day according to VA calculation will show negative

So what does that mean? Investment to be made is negative

It means, we shd remove money from our investment already made.

How do we remove money? By selling shares!

So, VA says that you should be selling shares when investment to be made is negative because of abnormal increase in share price.

Understood?

But we know, selling shares from demat means we have to pay demat charges!

Also, we are long-only investors. i.e we only keep buying. We wont sell unless in dire situations.

So, when such a situation comes, do not sell any shares. Just skip the transaction for the day.

i.e On a typical day, you either buy shares or do nothing

When the next day comes, either the price cools off, or you might have to do calculation to decide to buy more or to do nothing.

but can we reuse this day budget on some other day?

Of course yes. The next day the target anyways increases by Rs. 1000

We don't have any fixed budget for this method. Right sir

Yes. Lack of a proper predictable budget is the disadvantage for the method.

We plan according to stock price on given day

And we are better using the daily price fluctuations for our good.

This method is a lot riskier than Cost Averaging method.

Because, if you get into a fundamentally bad stock and start VA, you might never come out.

And sooner or later, you will end up dry and out of money.

For instance, JP Associates fell from Rs. 96 to Rs. 6 levels in a metter of two years.

I dont think we can ever recover money if we get stuck

So, this is for high risk seekers with unlimited money

Or to those who want to deploy money in the market in a short period of time

If some one gives me Rs. 10 lakhs to invest in the market in one month. May be i will try this

Another important thing is that CA and VA are both different methods.

We should not mix both

So, when you start investing, decide on which method to go.

It is already 10 ! So lets stop here for today.

I hope you understood VA and when it should be used.

I will give you two assignments for tomorrow.

Assignment 1: Applying VA for RCOM

Assume i have unlimited money to be deployed in RCOM in 30 days time.

Assume i started investing from July 1 in the stock

Take historical values of RCOM from http://www.google.com/finance/historical?q=NSE%3ARCOM

Take closing value of the day as the price at which you have to value buy the shares.

Prepare an excel sheet to determine how much money is to be invested and how many shares we will get after the 30 day period

Assignment 2: Preparing the VA Excel file

Create a new excel file (similar to CostAveraging file) and save it ValueAveraging

Start from tomorrow, value average buy shares in your 5 chosen stocks (in similar lines to CA)

Enter 1st day values for the sheet based on any price that occurs during trading day tomorrow.

So, basically you will have to be maintaining two sheets from tomorrow. One for CA and the other for VA

Understood the work?

In tomorrows class, we will use our third method of investing: *Modified VA*

This Modified VA used features from both CA and VA.

I will explain about them in tomorrows session

If you have any questions about the topics, ask them here.

If you have questions or problem with calculating or Excel, message me personally.

Thank you for your time!

Good Night!

Assignment

Take the last 15-day historical values of RCOM from Google Finance and apply Value Averaging concept with a hypothetical budget of Rs. 1000 per day.

Prepare and excel file to automate this computation and analysis.

Message me the excel sheet (or its screenshot) personally.

So value averaging is more rewarding for high beta stocks only ?

N for normal volume stock normal sip n value average methods yield almost same result?

Actually VA concept works for most of the stocks but it is dangerous as well. If there is a fundamentally bad stock, your money will get sucked into it the stock everyday without any hope of recovery. So, this method is to be used for high risk investors only.

Ideally, it can be used on all stocks but high beta stocks, because of their price volatility will take advantage more.

Yes. For flat non moving stocks, cost averaging and value averaging give almost the same result.

There is another final method of investing that uses the features of cost averaging and value averaging.

It is called Modified Value Averaging.

We shall discuss about it in subsequent classes.

investing on book value basis is worth?

i see 1 2 interesting scripts so asking however many r there

Generally, we shd consider investment strategies based on how much can we invest rather than from the view that for a certain BV, how much you will invest.

Rounding up

Many of you have implemented the Excel file for the Value Averaging Method

When determining the number of shares, we need to divide the investment amount with the CMP

So we get a decimal number there

To round off the decimal point, use the ROUNDUP() function.

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