My Stock Convictions - Githubissues

Being Wise

Facts

Although Berkshire has done an amazing job of creating value over the long run (20.9% annualized growth over 54 years), there have been times when Berkshire's performance has been absolutely terrible. Specifically, the stock lost 59.1% of its value over a 22-month period from 1973-1975, lost 37.1% over a 25-day period around Black Monday in 1987, lost 48.9% from June 1998 through March 2000, and dropped by 50.7% during the Great Recession from September 2008 through March 2009. And he cautions investors that declines like this will happen again. @AD says on an avg. every 10 years, even the best of the best will have hiccups!!
@RT says... I think someone who has parents who have been salaried employees and who does conventional education like MBA, CFA, Chartered Accountancy or Engineering and then straight away comes to investing, starts with a big disadvantage. Buffett has said this numerous times and it’s absolutely true. He says I am a better investor because I am businessman and I am better businessman because I am an investor. When you have an experience in running some kind of a business or a professional service it gives you unique insights to investing. Being in business and actually being an entrepreneur gives you that multidisciplinary thing.
@RT says... success will come when you make fewer decisions. This thing I have seen very strongly in Mr. Chandrakant Sampat. He would stick to an extremely small set of companies that he would cover and understand or decide upon. Again, number of trades in a year would be very few. At most times there are thousands of cons to either buying or not buying, selling or not selling. Whereas at some points it’s blindingly obvious. You can’t miss it. It screams at you that this should be done. When you act at such time the quality of decision making will be far superior.
@RT says... If you’re paying 40 times for a business, ignoring the growth part of the business, then you’re saying that it will take 40 years for the business to earn back your initial investment. And if your visibility is not beyond 5 years then how can you pay that valuation. It’s a very rough heuristic. If you are paying 40 times earnings and next year, the profits grow four-fold it’ll be a 10x P/E. I’m not saying P/E is the be all and end all of valuation. But it has to be in conjunction with how strong you think the moat is.
@RT says... So when Prof. Sanjay Bakshi says about Cera that its business would not change much with technology or Internet, I tend to agree. Making basins and toilet pots isn’t going to change dramatically. But if you’re a cable TV operator or a satellite channel then streaming video could change things dramatically. If you are a newspaper, then you are aware of the threat that internet poses for your company. So it depends on the horizon that you can project into, or where you can have some reasonable visibility, and most case it would be not more than 5-10 years and in some cases it would shorter. Shorter the visibility, lower the valuations.
@BM says ... Now, why would Gruh do so well? A guy who borrows Rs 2-5 lac to actually build his home will always be someone who does not maintain a bank account, at least in most cases. This is because, in most cases, the situation is where the husband is driving a truck and the wife is selling vegetables. They don’t have a bank account, so how can banks fund them? They won’t, because there is no income proof. So, even if they are creditworthy, they have nothing to show that they are creditworthy. And thus this market remains untapped. This is why these guys lend at 12% whereas banks lend at 10%.
@BM says, Now, I try to buy companies that are showing increased dividend payments. If I bought a high growth company that puts, say, 30% of its profits into capex every year because it needs to put up a new plant and machinery for catering to new growth that is going to come, and it also pays you dividend. So when growth slows down, and the trend starts to break (which can only be known in hindsight) more of that money will be diverted as dividends.
@BM says... But if you give me a stock that is making a new high, and another one that is making a new low and irrespective of how much fundamental analysis I do, I will be more attracted towards a stock that is making new highs than one that is making new lows, because most of the time new lows take place when shareholders don’t know what is happing with the company.
@VM says, upon reading SSGR article, if a company achieves its SSGR and it is able to convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.
@RC says, a business which is growing at 15%+, earning 20%+ ROE and selling at less than 10 times earnings is good & cheap. Just think if this business can sustain just exactly this for the next 10 years. This in-fact is a NBFC co. If yes, BUY it else DO NOT.
@Jae says, FCF/Sales = 23% for XYZ. For @Jae FCF/S is a Quality metric. FCF/S shows the ability of the company to generate FCF for every dollar of sales. In this case, XYZ is able to transform ever $1 of sales into $0.23 in FCF. Any company that does more than 10% in FCF/S is a cash machine. There has been an increase in debt, but it is easily serviceable with the magnitude of their FCF.
RC on Financial Cos... The company faces the usual risks of a financial services firm. It faces NPA risks from its corporate book, which is now reducing as the company expands in the retail space. This risk is further mitigated by the non credit business which continues to grow rapidly and is earning a fairly high return on capital. Although the non credit business is volatile, it has much lower risk and can give disproportionate profits once it reaches scale.
Contd... In addition the overall upturn in the market and a long term tailwind from migration of savings into financial assets should help this segment grow for the next few years.
Contd... As shared earlier, the NPA has risen slightly, though the company continues to maintain an 82% coverage ratio which should help contain the credit costs. On an aggregate basis, the company has a 45% loan to book ratio which should reduce the overall write offs from the NPA in the future.
Contd... The company has three main segments – the credit business with retail mortgage, agri finance, SME finance, wholesale mortgage and structured credit. The non credit business is mainly into wealth management, asset management (mutual funds), broking etc. The final segment is a life insurance...
Contd... The improvement in ROE and higher profit growth is mainly due to improving cost to income ratio which dropped to 46% from the previous quarter.
Contd... The gross NPA was stable at 1.74% and net NPA at 0.68% respectively. The company raised around 1500 crs via QIP during the quarter and the CAR ratio is now at 19.2%. This provides the company enough capital to grow at the current rates for 1-2 years.
Saurabh Madaan with Vishal... Let’s take a company which has a technology product, and because technology is prone to disruption, its shelf life is very small. This means any new technology can come up. And as you said, value investors stay away from the fact that a new company could come up any day and break this technology with a better one or a cheaper one. So, there is no moat as Mr. Buffett might say. Therefore, value investors typically would stay away.
Contd... Let’s say that this company now has 1/ not one but a few products on technology 2/ and it also reduces its profit margins, e.g instead of making a 20-30% profit margin, this company makes minimal profit margin. In our thought experiment, two things should happen. One, the multiple lines of products, if they are interrelated and reinforce each other, should start creating some sort of a competitive advantage. Second, the reduced margins. What do you think the reduced margins would do Vishal?
Contd... VK: I think low margins would create a barrier for new players from entering the market. If the incumbent is working and sustaining on lower margins, my understanding is that it creates a moat. In some way it inhibits competition because competitors are looking at industries with high profit margins and not challenging industries with low profit margin.
Contd... SM: Yes, you are right. If someone is making low or no margin, you must lose money to compete with them; 1/ assuming you cannot come up with a better technology, 2/ If the number of technologies and products is more than one and they are related to each other, you must make three of them and lose money on three of them to compete with the incumbent. So, this adds some durability in an otherwise vulnerable situation. There is less incentive for competition to come and lose even more money.
Contd... SM: Now the shelf life, the lifetime of this company could be, probabilistically speaking, more than the previous company that we had talked about. Therefore, as a value investor it makes sense for you to at least try and look at it because its lifetime is going to be longer than a typical company, and that gives you the opportunity to invest in it at the right time.
Contd... SM: The other thing I would add is the effect of scale on longevity. If you are delivering your product not just to one person but lots of people. You have a huge network and network effects start showing up in wonderful ways. A new competitor must first develop multiple products, then at low margin, then gather millions of users to compete with the incumbent. So there is some first-mover advantage beyond a critical mass. You can displace one product, one technology but to do it over all products, all interrelated technologies, across billions of users is going to take time and effort. You can still do it. It’s not impossible but base rates start declining.
Contd... Me: In tech world, opensource is one such way to cultivate the networking effect.
Contd... SM: You can see how these several lines of business where Amazon doesn’t make money help it attract and get a sticky customer base.
Contd... SM: This gives the same economies of scale where you add the Nth line of business and you can light it up with profits. If you were looking at Colgate, instead of looking at their annual revenue growth or profit growth what you should be focused on is that they have the shelf space across all the retailers and when they add a new line of product, let’s say a shampoo, even if they have spent 10-20 million dollars researching it, the incremental returns on capital on that business are so huge. Because of the network and brand, other things take care of itself.
Contd... SM: Here we are not talking profit margin and linear growth and revenues. We are not doing any of that modelling. But we’re trying to get to an insight about the business that is not dependent on precise numbers, but could lead to a better predictive outcome than other quantitative models. If you have an insight like that in any business — we just used technology as an example because you asked me — I think that could differentiate you as a value investor.
Contd... VK: Since you talked about Amazon, it reminds me of Jeff Bezos who mentioned that the only sustainable advantage that a business has is long- term thinking. If you are thinking in terms of 1 to 3 years, then you are thinking like everyone else. But if you are thinking in terms of 7 to 10 years, then you are thinking uniquely. It’s a very valid point that you made. My feeling is that it applies so well, not just to technology but to any industry, any promoter, any management who in an era of shrinking attention span and shortening business cycles is willing to think long term.
the real estate sector sells for roughly 20 bn which is around 1% of the country’s GDP (from around 5+% of GDP during the last peak). In comparison, most economies have the organized RE sector (including REIT) market cap in the range of 7-10% of GDP.
The key in investing is to buy companies which are mis-understood and hence mispriced. It could be related to under-appreciation of quality or from an over estimation of risks. Please note I am not using the term low PE or something like that. A coal company may be cheap by conventional measures, but turn out to be expensive if solar disrupts the energy markets in the next few years.
The real estate market is cyclical with a duration of roughly 8-10 years. For those of you who were old enough in the 90s, would recall that the industry went through a mini boom from 93-96 and then had a bust from 97 to around 2002. The sector revived after that and had a boom for the next five years. The peak was reached in the 2008-2010 period and since then prices have stagnated. As a result, the speculative demand which built up during the boom time has been washed out in the last five years.
Contd... The first reaction would be – This is a bad sector, a cesspool of corruption and most of the companies in this sector have destroyed wealth. On top of that the recent demonetization event, RERA and GST have further impacted demand. The drop-in demand is not even a guess – If I look around, everyone is telling me how bad the demand is and why it could remain low for a long time.
Construction Risk – ... executes infrastructure projects that have a long time run, are highly capital intensive and require huge volumes of finance. Further, these projects have to face hurdles like land acquisition issues, forest and environment clearances etc., which can result in time overrun and cost escalation, thereby impacting profitability.
Contd... Interest Rates – Fuelled by inflation, interest rates are likely to move upwards during the life span of a project leading to lower profit margins. To mitigate this risk, the Company ensures that it considers the possibility of a higher interest rate and includes it in the cost of a project before bidding for it. Despite this, ... is open to resorting to interest rate hedging in case the need arises. Also, faster decision making and execution by the Company enables timely completion of projects, keeping unnecessary high interest cost at bay.
The Indian road network spanning 4.7 million km is the second largest in the world and consists of expressways, national highways, state highways, major district roads, and rural and other roads. This is used to transport over 60 % of all goods in the country and 85 % of total passenger traffic. Recognizing the paramount importance of a developing a good road network for improving connectivity and sustaining the road traffic, the 12th Five-Year Plan (2012-17) has set aside 20 per cent of the total investment of US$ 1 trillion for infrastructure, towards road development.
However, there are some sectors which one cannot invest in. Food demand and consumption are growing. However, food is produced by the unorganised sector and we do not have direct investment opportunities. Some companies are wrongly labelled as ‘food’ producers. For example, there are rice-millers (who, while mainly trading in rice, sometimes brand their products) who can never make super profits on a sustainable basis, given that the business has no unique proposition to offer. I would not chase rice-millers or edible oil-refiners. To me, they are simply trading entities or low value-added manufacturing with little pricing power.
And most of us forget that the Indian per capita income is less than 10% of that in the developed world.
Stocks have been sorted and displayed according to a composite rank of high return on net worth and low valuation. You cannot buy these stocks mechanically. To actually select a stock to buy, you may want to glance at other parameters and apply your own understanding of a sector or a company. Remember, for value investors, there is something called a ‘value trap’. This refers to a situation when an attractive company is reasonably valued but its internals are deteriorating – which is probably why the stock was cheap to start with. One way to avoid this is to consider sales growth; so look at the ones with strong sales growth. Also, keep an eye on the tax payout, which is a measure of corporate governance. The best combination is great financials, low valuation and a rising stock price. One should buy in an uptrend, though a flat trend of a value stock is perfectly fine too. A ‘value’ stock in a strong downtrend is best avoided. Remember, price could go down due to an adverse event relating to the company or a severe market decline; in either case you don’t want to catch a falling knife.
I've found that some of my most productive decisions were the ones where I changed my mind on a once longstanding belief. Whether it's business, investing, or life.
I would add that thinking in this way demonstrates why Buffett, for one, thinks so much about the long-term durability of a company’s level of profitability, because that’s where most of the value resides. He tries to guess what could go wrong, along the lines of the well-known adage, “Take care of the downside and the upside will take care of itself.” The less could go wrong, the lower a margin of safety needs to be.
Keep things simple. I’ve never bought a stock because of numbers that a spreadsheet gave me based on specific future projections for growth, cost of capital, etc… I spend most of my time reading and thinking, and I try to keep the math very simple. And I try to give myself a large margin of safety in case my assessment of the situation is wrong. But I don’t want to invest in a situation where heroics are needed to reach a certain earnings level or a complicated model is needed to justify a purchase price.
You could do all sorts of elaborate analysis, but Buffett basically boils down everything to what will the business look like in 5 to 10 years (i.e. what will the business, and all of its assets, be able to produce in owner earnings over time, and how much are those owner earnings worth to a rational buyer).
Kenneth Jeffery Marshall- Regarding more conventional books that I’d hang on to, I think highly of Pabrai’s The Dhando Investor. I don’t get his Kelly formula chapter, but other than that, it’s solid. I also like Cialdini’s Influence and Taleb’s Fooled By Randomness. Taleb’s insight that history is a fiction we tell ourselves to make outcomes seem inevitable is brilliant. I also like Swensen’s second book, Pioneering Portfolio Management. I like it so much that it’s become the required text in my MBA course at Berkeley.
Kenneth Jeffery Marshall- There’s a lot of data that I just don’t take in. I don’t own a smartphone. I don’t own a television. I don’t have a Bloomberg terminal. All of that seems to have led to better decisions. There’s less noise, and little loss of signal.
contd... But when I’m in the financial districts of San Francisco or Stockholm, what do I see? In the street, faces hovering over smartphones. In offices, eyes on televisions and Bloomberg terminals. I see environments that encourage a casual descent into mindlessness. How one can reflect while attacked by pixels eludes me.
contd... I love to read, I love to think, and I love to talk to people who are in the thick of an industry. Not equity analysts that cover the industry, but the people that drive the trucks, repair the units, make the products – those kinds of people. So I do those things. But I don’t do the other things, the things that are popular but fruitless. I unclutter.
Kenneth Jeffery Marshall- Well, the book spends a chapter on this. It lays out the four price metrics that I like. My favorite is enterprise value to operating income, or EV/OI. It’s based on the work of Joel Greenblatt, at Columbia. He’s a great thinker.
contd... In enterprise value, we get the price of all of the stock, all of the debt, and all of the minority interest. In other words, we get the cost of buying out all of the other investors, regardless of what kind of security they hold. EV ignores capital structure.
contd... That’s particularly useful when EV is ratioed against operating income, a line that’s high up on the income statement. OI doesn’t capture interest expense or tax expense. So there’s consistency between numerator and denominator. From operating income comes the means to deliver returns to all investors, whether they hold shares, debt, or minority interests.
contd... Operating income is also nice because interest and tax contexts can change over the long period of time that I plan to own a company. They’re one recapitalization or reincorporation away from shifting. This isn’t to say that recapitalizations and reincorporations are easy. But they’re often easier than improving the core economics of an operating business. Ask anyone who’s tried.
The dopamine rush of obtaining something important that you knew would eventually come but didn’t know when is what keeps you hunting for more.
A company with a high multiple, is not necessarily expensive if the company can grow its free cash flow for a long period of time. This means the market ‘assumes’ that such a company has a sustainable competitive advantage and a large opportunity space. Please note use of the word ‘assume’. The market is not some “All knowing” entity which can see the future. It is just the aggregation of the combined wisdom (or madness) of its participants.
A company selling at a PE of 50 will need to deliver a growth of 25% for 10 years to justify the price. In order to make any returns for an investor buying at this price, the actual growth will have to be much higher and longer.
In the last 10 years, we had around 233 companies in the sub 3000 cr market cap space, deliver a growth of 25% or higher. That’s around 6.2 % of the small/ mid cap universe. As the market cap/ size increases, the percentage of companies which can deliver this kind of performance only shrinks.
contd... How many companies in the above space currently sport a PE of 50 higher? around 22% or roughly 675. So, 3 out of 4 companies in this group of ‘favored’ high PE companies are going to disappoint investors in the coming years in terms of growth
contd... In other words, if you could buy all these ‘favored’ companies (greater than a PE of 50), you have a more than a 50% chance that you will lose money. Why would you take such a bet?
In investing, you can end up on top simply by living a very long life, rather than focusing on finding fastest growing companies. Power of compounding. 12% CAGR over 30 years for Rs. 10000 will lead to a crore.
Hence, read annual reports of companies for as far back as they can find. Read them across various companies over various time frames. You should be able to understand how companies have behaved over business cycles, how their valuations have changed, why did they succeed, why did they fail, etc.
Since the time horizon of compounding at the above average rate of return has an exponential impact on wealth creation, it’s better to invest in a business with little lower compounding rate but far higher longevity of growth than in a business with higher compounding rate but lower longevity.
Lack of humility always catches up to you. In markets you’ll receive some return over the next 20 years, and most people who try to front-load those returns into shorter periods of time will cough up whatever excess short-term returns they earn down the road -- reversion to the mean. It’s very similar with humility. Most ego you have today will be balanced out with humiliation down the road.
Over the long term, value really does seem to work best. And remember, we live longer now. Many of us will see age 80, or 90. The long term has become our term. So we shouldn’t trade as if we had the lifespans of fruit flies.
I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines. They go to bed every night a little wiser than they were when they got up and boy does that help, particularly when you have a long run ahead of you.
Let no one be slow to seek wisdom when he is young nor weary in the search of it when he has grown old. For no age is too early or too late for the health of the soul [and mind].
It’s not about what they do to the dividend or how they should save their way to prosperity. It’s about providing more and better products that meet the needs and wants of consumers. Whether they can do that or not is ultimately what’s going to matter, especially over our time frame in evaluating the company’s progress.
As for the types of businesses that end up in the portfolio, our strategy generally leads us to companies that are either unloved or undiscovered. That’s why we have positions in both well-known and not-so-well-known companies.
Contd... If you pay 15x earnings for something, you’re implicitly saying you know about enough years in the future that the investment will pay off.
Contd... We don’t assume some greater fool will later buy the shares from us at a better valuation. In the current interest rate environment, our expected annualized return has to be at least 10%
Contd... In the unloved category would be Wal-Mart [WMT] and Microsoft [MSFT]. We paid 11x earnings for Wal-Mart in April of 2010 at a time when the market seemed to think it could do no right and Amazon could do no wrong.
Contd... The obsession with Amazon was fair, but at 11x earnings we only had to expect that WalMart could continue to get a few things right in order to grow earnings modestly over the next ten years and deliver us a better-than-10% return on our money.
We started buying Microsoft in 2011, when you could hardly pick up The Wall Street Journal without reading about how irrelevant it was becoming and how companies like Apple and Google were going to leave it in the dust. But the stock was at less than 8x earnings if you backed out cash, which basically meant they could put the business in runoff mode and we’d easily get our money back. We thought the Enterprise and Office businesses were stickier than the market recognized and had earnings power that warranted much better than a 7.5x multiple. Any upside from things like shipping better consumer products and building out the cloud business were tremendous free call options.
The first would be a company that earns high returns on invested capital that we’re able to buy at an attractive valuation relative to its own history.
Contd... The second category of company we find interesting is the quality cyclical company with a competitive edge that we try to buy close to the trough of the cycle.
In energy, I prefer the far better balance sheets of service companies over exploration and production firms. It should have the operating leverage without the financial leverage.
Contd... But it’s the dominant market leader in what it does, which is provide technology and electronics that collect, manage and analyze oil and gas drilling data that is used to help optimize performance of drilling operations.
Contd... It’s actually quite resilient. Revenues fell nearly 70% from peak to trough in the latest cycle, but it has maintained positive cash flow due both to a flexible operating model and the cushion of operating margins that in good times are as high as 50%. The balance sheet is also rock solid, with nearly C$160 million in net cash.
I’ve owned the real estate investment company Kennedy-Wilson [KW] on and off for fifteen years and consider it one of the best real estate asset managers in the world, with a track record to back that up. But it’s also organized in a complex, not-easy-to-understand way, which exacerbates the difficulty of seeing how good they are unless they’re selling things and it becomes obvious. If you peel apart individual projects you can better understand the company's value and take advantage when the market isn’t recognizing it. When they start selling more than they buy – which is starting to happen now – the underlying value tends to surface.
Some cyclic companies fully understand they are in cyclical businesses and manage themselves accordingly, being opportunistic at low points in order to reap the benefits when times are good.
Contd... But in terms of the market for the stocks, the sell side hates them because quarterly earnings are impossible to predict, and investors generally dislike the random things that can happen.
Contd... What we do with companies like this is arrive at what we believe the business is worth, say, on five-year average earnings or some other reasonable estimate of normal. If you keep your head while the quarterly earnings game drives people batty, these types of opportunities can be very attractive over time.
Stocks only look cheap because earnings have been inflated by record-high corporate profit margins–10% versus a historical average of 6%. When profit margins revert back to the mean, as they’ve done every time they’ve reached these levels in the past, S&P 500 earnings will shrink from $100 down to $60, lifting the index’s P/E ratio from a seemingly cheap 12 to a definitively not cheap 20.
Contd... The year 2012 comes and goes. Profit margins stay elevated, so I keep waiting. 2013 follows–again, profit margins stay elevated, so I keep waiting. 2014 after that–again, profit margins stay elevated, so I keep waiting. Then 2015, then 2016, then 2017–each year I wait, and each year I end up disappointed: profit margins fail to do what I expect them to do. But I’m a disciplined investor, so I keep waiting. During the total period of my waiting, the stock market more than doubles in value, trouncing the returns of my cash-heavy portfolio and leaving me with an ugly record of underperformance.
Contd... I was confident that elevated corporate profit margins would revert to the mean, which is what happened every time they were elevated in the past. But that didn’t happen here. Why didn’t it happen? Where did my analysis go wrong? What did I fail to see?
At Fairholme we’re very focused on price. Price matters most to us. And we think that price determines much of the success you’re gonna have in the future. So rather than predict what’s going to happen with the company we try to price it correctly with a large margin of safety. So pricing with a significant margin of safety is very important in our rule number one of not losing.
Contd... Once we determine what a cheap price is, our next step is to look at the investment and the underlying company and stress test it to determine all the ways that business can go wrong, the environment can go wrong, the balance sheet can go wrong. Try to kill the company.
Do not listen to the advice "never catch falling knives". In this case, keep catching with backing studies.
Carl Icahn will buy at the worst possible moment, when there’s no reason to see a sunny side and no one agrees with him.
Contd... I will buy companies that are out of favour. It is way better if the whole industry is out of favour.
Warren Buffet buys companies with sustainable high profits. He calls them “wonderful companies at fair prices.” And he prefers them to “fair companies at wonderful prices”: those that are undervalued but with mixed profitability.
Micro-caps have continued to dominate the wealth creators’ list. These stocks are highly illiquid and volatile and, often, have difficulty in scaling up. If they can scale up, they become multi-baggers.
Contd... Given that the universe of small-and micro-cap stocks is large and that only a tenth of them or less succeed and deliver value to their investors, the chance of finding the next Avanti Feeds or Symphony is like finding a needle in a haystack. While we may not find stocks like these, we can probably find modest wealth creators in the micro-caps space.
Contd... If you want to generate extraordinary wealth over the long term, you will need to put in the hard work to identify such companies and, even tougher, to hold on to these companies because their prices are likely to be highly volatile.
Among the fundamental factors, the best-known is net profit, because net profit is what is available for shareholders. It is also the basis for calculating earnings per share, on which depends the price-to-earnings ratio (P/E), the most popular valuation metric.
Contd... However, there is one other metric of equal or higher, importance—sales. The sales of a company cannot be easily manipulated, especially since closely tied to reported sales is excise duty, service tax or sales tax, as the case may be—now, all subsumed under Goods and Services Tax (GST) which has an even wider scope.
Contd... On a consolidated basis, revenues of the top-500 companies in our list continued to grow after declining in 2015 at an average annualised rate of 13.26%, whereas net profits grew at an average annualised rate of 19.35%.
_Contd... The revenue of the top-500 wealth creators grew 10.76% in the past one year, the highest since 2014 as growth had slumped and recovered slowly. Net profit was 5.15% in the same period, way lower than the 23% growth witnessed the year before.
Contd... This also speaks a lot on; why one should not time the market & continue to sit tight & keep reading as well as observing the macro factors.
From the shortlisted 1,289 companies which qualified for the study, 545 stocks had market-cap of less than Rs200 crore in November 2017. Of these, 38 made it to the top-50 rank. So, one thing is certain. If you want multi-baggers, you are unlikely to find them among the ranks of larger companies. You will have to rummage the small-cap and micro-cap space.
In the top-20 wealth creators, excluding Eicher Motors, Vakrangee and Bajaj Finance, the remaining 17 had a market-cap of under Rs200 crore at the beginning of November 2007. Who would have identified them? Symphony, which now has a market-cap of Rs10,250 crore, had a market-cap of just about Rs26 crore a decade back.
Even though no one can ascertain when we’re at the exact top or bottom, a key to successful investing lies in selling – or lightening up – when we’re closer to the top, and buying – or, hopefully, loading up – when we’re closer to the bottom.
Up-and-down cycles are usually triggered by changes in fundamentals and pushed to their extremes by swings in emotion. Everyone is exposed to the same fundamental information and emotional influences, and if you respond to them in a typical fashion, your behavior will be typical: pro-cyclical and painfully wrong at the extremes.
Contd... To do better – to succeed at being contrarian and anti-cyclical – you have to (a) have an understanding of cycles, which can be gained through either experience or studying history, and (b) be able to control your emotional reaction to external stimuli.
Contd... doing the opposite at the extremes (which admittedly is hard) – how about just refusing to go along with the herd?
To be a disciplined investor, you have to be willing to stand by and watch other people make money that you passed on. You don’t have to invest in everything. You don’t have to catch every trend.
The attractiveness of a stock’s price is dependent on how much optimism there is in the price. So, in the first stage, there is no optimism, and that’s a great time to buy. In the third stage, there is only optimism, and that’s a great time to avoid buying.
As Warren Buffett says – “First the innovator, then the imitator, then the idiot.” How I like to say this is what the wise man does in the beginning the fool does on the end.
Sometimes there are plentiful opportunities for unusual returns with low risks, like after the meltdown of Lehman Brothers (2008). And sometimes the opportunities are fewer and risky. It’s important to wait patiently for the former. You should not act the same regardless of the market environment. You should turn aggressive when things are low, and defensive when things are high.
When there’s nothing clever to do, it’s a mistake to try to be clever.
To be able to take advantage of such situations, you must be able to think in a way that’s away from the consensus. You must think different and you must think better. It’s clear that if you think the same as everybody else, you’ll act the same as everybody else, and have the same results as everybody else.
You can control your emotions. That’s very important. And you can behave in a contrarian and counter-cyclical manner. I think these are the keys to success in the investment business, not predictions of the macro future
Anytime you think you know something others don’t, you should examine the basis. Ask yourself – Who doesn’t know better? Why should I be privy to exceptional information? How do I know this that nobody else knows? Am I really that smart, or am I just wrong? Am I certain that I am right and everyone else is wrong? If it’s an advice from some else, ask – Why would somebody give me potentially valuable information? And why would he give it to me? And why is he still working for a living if he knows the future so well? I am always sceptical of people who will tell you the future for five dollars.
Never confuse brains with a bull market. In investing to succeed you must survive.
Investing is not supposed to be easy & anyone who finds it easy is stupid --Charlie Munger
If there is a business with lousy reputation but has got a manager with good reputation then the reputation of business is going to remain intact. Most lousy businesses cannot be fixed.
The importance of working capital in the valuation of a company has actually gone down
Contd.. in early situations, when companies sold below working capital, they could be liquidated for working capital at least, plus some money for fixed assets, and you could actually get liquidation value which was more than the market cap. Therefore there were good reasons to buy into those situations. The probability of liquidation was higher then, than it is right now.
Contd.. American companies had diffused ownership. Indian’s companies are mostly controlled by a family of promoters who own stakes large enough to prevent any liquidation. So a prosperous company selling below liquidation value is not going to be liquidated. And a troubled company doesn’t have much of a liquidation value for stockholders. Think Kingfisher here. And most troubled companies have no working capital left anyway.
Relying on working capital as a source of margin of safety is a very dangerous idea in the current environment where companies will not get liquidated
What to BUY? Also inverse of When to SELL? A high return on capital with the ability to reinvest that capital at a high rate of return in near history i.e. 5 Years. These returns are sustainable because there is a moat. You can continue to grow without requiring outside capital. Hence, Balance Sheet should become extremely conservative i.e. no debt & plenty of surplus cash. Management is skilled in operations as well as capital allocation and are honest. The entry price at which you bought is not at the frothy end of the bubble market, and the multiple you had paid is not excessive in relation to its own history i.e. 10 Years
SELL... So when it comes to the idea of selling, I wouldn’t want to sell them just because they didn’t do anything for the next 2, 3, or 4 years. I won’t apply the Graham rule to such stocks. It’s very rare to find such situations. Think about Nestle. The guy who found it 20 years ago or 10 years ago, doesn’t need to do anything else in his life. For him, to switch out of that stock simply because it’s moved up a lot, or not gone anywhere for 3 years – either of those two decisions – would have been foolish. Thus doing anything in that stock would have been a mistake, other than just buying and sitting on it. Some stocks are of that nature and true wealth is created by being in those stocks and remaining there – not by jumping in and out.
Who are NEVER Intelliegent Fanatics? If management paying exorbitant perks & salaries. If they merge their private companies into the co you are holding. If they appoint their relatives sans qualifications. If they have a lot of related party transactions with their own privately held companies. If the promoters trade in & out of stock. If they are promotional managements.
Not paying up for quality carries huge opportunity costs. These costs won’t show up in your P&L because a P&L does not reflect what you could have done but did not do. The errors of omission are sometimes far more than the errors of commission. In the long run, opportunity costs really matter in the long run.
Simplest ever DUMB rule to flag a stock as COSTLY. If P/E is more than 13.
Prof. Sanjay Bakshi.. I highly recommend reading Pat Dorsey’s book – “The Little Book that Builds Wealth”. It’s such a simple, common-sense book that investors can learn from. It will help them in spotting moats. It will also help them in keeping away from thousands of companies that have no moats. So, for “business” factor checklist, read that book.
Companies that have no debt cannot go bankrupt
Companies that are growing at rates of 50-100% annually must be looked at with suspicion. One reason for this is that such growth cannot continue for long (for reasons like higher competition that might want to take a pie of this growth opportunity).
Contd.. The second reason is that if such a company still wants to push for higher growth for a few more years, it might have to infuse more capital in the business. This could either mean stretching the balance sheet (by taking on debt) or diluting equity (by issuing new shares). Both these are bad omens for existing shareholders.
Adverse government policies such as farm loan waiver can dampen the spirits of lenders who are actively pursuing tractor loans and thus supporting growth of tractor sales in domestic market.
Agriculture employs over 50% of the domestic workforce and remains a key focus area for the GoI.
According to a National Sample Survey Organisation report on indebtedness of farmer households, of the 89.35 million farmer households, 43.42 million households are under debt. The report says that the most important source of loan in terms of percentage of outstanding loan amount is banks (36%) followed by moneylenders (26%) and cooperative societies (20%)
Despite government’s push for credit coverage for the entire farming community, only 50% of total farmer households in India are under agricultural credit net which includes both formal and informal sources of credit
Cyclical industries due to this nature of ups & downs, tend to enjoy lower return on invested capital. Lack of entry barriers is one reason & total absence of differentiation in the end product. Thus as an investor, the touch points .. are the costs of setting up a facility (replacement cost), the capacity utilisation in the industry and the cyclical demand supply
On pricing power.. Alternatively moat or not moat!! If sales volumes is increasing but profit volume is decreasing, it implies the company has lost its pricing power. It also suggests no innovation, chances of being kicked out by a fanatic!
Identifying increasing competition!! If ROE trend is decreasing i.e. avg 10 Yrs > avg 5 Yrs > avg 3 Yrs > TTM. However, competitor's ROE trend is increasing
Since the turn of this century, China emerged as one of the biggest producers and consumers of virtually all commodities—minerals, metals or chemicals. After a scorching pace of growth, their own demand started to slow down and they started to export. This meant that globally, domestic producers started to face competition; price wars with China are hard to sustain and most producers started to bleed. Add to that, the expansion by Indian commodity producers, the grinding slow down in real estate and sluggish economic growth all added to the misery of the commodities business.
Contd.. investment in this sector is a function of capital costs rather than just revenue
Contd.. In most of these industries, capital costs are standard and so is the product. Thus, it is difficult to continually make more money beyond a reasonable return on the investment.
Contd.. If the returns go very high, it will encourage new investments and the excess profits will vanish sooner or later. Thus, profits peak when the industry reaches full capacity utilisation. And, in today’s world, capacity is not just local or regional, but global.
The nearest proxy for the REPLACEMENT COST is the ‘BOOK VALUE’ per share. However, P/B number is a historical number. The older the company, the lower the number. Thus, a better way to approach is to relate the replacement costs to the ‘enterprise value’ (EV is calculated as market capitalisation plus long-term debts).
Contd.. In the down cycle, capacity utilisation drops, margins drops and a company could lose money. At that stage, the price drops sharply. However, keep a note on the price-to-earnings ratio (P/E) which might actually shoot up due to poor earnings. Whatever may be the case, the EV comes down eventually and normalises the P/E.
Contd.. In a bullish cycle, the opposite happens. Thus, the best time to buy a commodity stock is when the EV is LOW. Rather than looking at P/E or price-to-book-value (P/B). The closer the EV is to the ‘REPLACEMENT’ cost, the better the chances of making money on the stock in the future.
Operating Efficiency the Working Capital Requirement of the company is just about 2% of its Sales which can be easily funded from internal accruals as against many other companies which have to depend on working capital loans and therefore bear the burden of interest cost. It is awesome if it is constantly decreasing.

AmitKumarDas / Decisions

My Stock Convictions #24

Being Wise

Facts

Classic Real Life Samples