the elusive terminal value

“Zinda hathi lakh ka mara hua hathi sawa lakh la” (the terminal value of a dead elephant is worth more than a live one because of the ivory)
In real life there might not be many examples but financial jugglery is filled with examples where investors are lured by promises of unimaginable riches if they hold the asset for perpetuity. Terminal value, as the term would suggest is the value of your assets beyond the visible horizon/useful life.
When I started using computers, WinAmp was the best music player, Real was the best movie player, Netscape was the best internet browser, hotmail, yahoo & Aol were the default mailboxes etc. I wonder if the owners of these products were able to realize any terminal value. If you believe technology firms are different then go to typewriter manufacturers. A decade ago MG road, Bangalore was the commercial hub, now most of its buildings are either derelict or vacant.
The dividend yield of nifty is paltry 1.46% indicating that most people don’t invest for the dividend income but believe that their wealth will be generated due to the ability of the portfolio stocks doubling its price every 2-4 years. One can argue that companies are going-concerns and have perpetual existence (although I am sure <10% of the companies incorporated 100 years ago are still functional), But apartments or any concrete structure will crumble and deteriorate over time.
The rental of a residential apartment/house is roughly 0.25% of the property value. which means that without discounting for time value of money, it will take roughly 400 months (33 years) to recover your initial investment (annual rental hike is typically less than the interest rate so a proper DCF would be even more unfavorable). Yet people believe that that value of 100sq feet of land (1000 sq feet equally shared between 10 floors) would be worth more than the whole apartment that they have bought today.
It is said that in the long-run everybody is dead, but looks like the MBAs from Finance have discovered the elusive elixir of immortality.


Place of stock in personal portfolio

Most people debate whether they want to be a passive investor or active investor, but I have a more fundamental question: is stock market just a hobby or an economically viable investment avenue for the common man?
Indian stock market is clearly not a passive investment tool. The quantum of money that can be made by timing the market right (even blue chip or Sensex/Nifty) exceeds the returns made by a 1-3 year buy & hold strategy/monthly SIP in a diversified portfolio (not speculative penny stocks). Hence it is not surprising that most investors and part-time traders spend at least 5 hours a week in reading financial news, analyzing the results/analyst reports or even exchanging tips. Even the mutual funds (passive investors) are profitable when the individual is able to time the market and pick the right sector/type of fund.
So let me rephrase the original question and add 2 dimensions to it:
Firstly, most (sane) humans work 40-50 hours a week. Sacrificing an additional 5 hours a leisure time for stock market will be economical only if I can derive 10% of my salary from stock market (in addition to the cost of capital).
Let me elucidate:
Assume your salary is 10Lakhs and you have 15Lakhs invested in the stock market. This portfolio will be economically viable ONLY IF you are able to generate: 2.5Lakhs annually as stock market profit (1 Lakh for the 5 hours/week, and 1.5Lakhs for the lost interest rate & risk premium (CAPM)).
To be really professional, you should also apportion cost of your TV, internet & newspaper subscription.
The second dimension is on the size of the stock market portfolio:
If the asset allocation <10% then my base is too low to improve my financial situation. (i.e. even if I achieve a fabulous 100% return in the stock market, my net-worth would only marginally improve by 10%)
How many seasoned investors have you met, whose stock market exposure is more than their exposure in real-estate or gold or business (as sleeping partner)? Esp. if you consider that this Diwali stock market reached its all-time high. “If I believe that money attracts money” then most people would have not only ploughed back their profits into their portfolio, but also allocated a major chunk of the savings.
For me a hobby is an economically non-profitable pursuit undertaken as part of the leisure time available. And somehow, I have not met many *part-time* stock market investors/speculators/traders who earn economic profits.  If stock market is unable to compensate me for the time devoted or is the transformational lever that will enable me to retire rich… then it’s just a hobby.
PS: Please read this humorous dialogue elaborating that not many common men made money.


Bonds Part V: Options (Put/Call/Convertible)

No article on indian bond market can be complete without discussing the various embedded options available in them.
1. Convertible Debentures: The holder of the bonds have an option to buy a particular number of common stock (shares) of the issuing company at a pre-determined rate. If prudence is exercised then its a win-win situation for both companies. The issuing company has made their bond issue attractive and hence can offer a lower coupon rate (more operational profit). Also if the stock market is doing well, then they would be able to roll the debt by converting it to equity. Hence it is a backdoor way of IPO/FPO.
You also benefit because it will offer you capital protection because you can always redeem your bond at the face value if the stock market tanks. If you are a buy and forget kind of an investor then buying such debentures of *Blue Chip* companies will enable you earn extra returns if the price goes above the conversion price.
2. Put option: Most infrastructure bonds seem to have a put option. I.e. if the interest rate goes up, then you can encash the bonds and reinvest the proceeds at the prevailing rates. So it is a hedge against rising interest rates. Fixed deposits are popular because the investor can encash them whenever they want. Most bonds don’t offer this flexible put option, but it is a good to have feature in any bond.
3. Call Options: Unlike the Put option, the Call option gives the issuer the right to recall all the bonds from the market. This can never be good for you, because it exposes you to reinvestment risk. i.e. interest rates have fallen and you now end up with money that can only be invested in bonds that offer a fraction of the interest rates. However because of the administrative and bond issuance cost, it does not become economical for companies to exercise this option for <1% difference in rates. (so that is the only relief you get)
Being the last article in the Bond lecture, I would consider myself successful if now you realize investing in bonds (or fixed income securities) is more than just getting the highest interest rates.