Weekend Learning

Last weekend I had a chance to meet some fantastic investors (Gaurav , Ayush , Neeraj, Ashish, Puneet, Suhail) and also got a mail from a friend of friend who attended Valuex (An investor conference in Mumbai held last Saturday). Basis these interactions i have tried to capture the learning i had and highlighted one's which I personally find of key importance

Investment Philosophy:

1. In India Statistical Bargains remain cheap for a very long time, due to limited catalysts. These catalysts such as form of investor activism, minority stockholders doing some corporate action etc are usually inactive. Statistical Bargains originated in US, where there are means to induce these catalysts. Also, lack of growth in US companies has led to investments moving to these ideas.
2. India, we all agree is a growing economy, and hence the best bets are the ones which have a growth component attached. Buy stocks at reasonable valuation( Margin of Safety) which show signs of growth and then ride the growth. Also, in such stocks be mentally prepared for horizon of 3-5 years and also ups and downs in between. If one is able to ride the growth they can be the big winners.
3. Their are 3 segments to broadly classify businesses B2C , B2B & B2G (Business to Government)  and clearly B2G is most frowned upon
4. People are scared of investing in illiquid stocks because they are scared of working hard --> Stocks are usually illiquid because they have not yet been discovered. Infosys used to trade less than 1,000 shares / day in 1994.
5. In an Indian context Price is what you pay, Value is what the promoter allows you to make. Cash, real estate, assets should be taken with a grain of salt as most likely a promoter will not allow you to realize its value.

Investment Methodology:

1. Promoter integrity is the top thing too look. Indian promoters find ways to take out money and hence it is key to be associated with right kind of people. Meeting distributors, creditors, end-users is one way to see how involved the management is in the business. Attending AGM's is another way to get a feeler on the company and also to understand the outlook and future plans of promoters.
2. RoE is the holy grail. If RoE is less than cost of capital creating sustainable wealth is almost impossible. 
3. Also evaluate company on asset turnover and margins. These are the 2 levers which company has to increase RoE
4. Double Counting creates bubbles: During periods of boom margins are the highest to which we apply high valuation multiples. Margins are mean reverting, thereby in your analysis it is important to adjust for this factor
5. Don't mix your investment themes. Example, Special Situations with bargains or with long term ideas.
6. Even if stock is up 100% from your purchase,but if you find growth story intact and valuations cheap keep adding.  Its all about buying well, rather than selling well.
7. Have an exclusion list. If any company falls in that sector/ concept don't waste time. For example, most of us agreed that B2G is an example of ideas to avoid.
8. Dumbest thing to do is forecast. Be comfortable with the idea that you don't know the future. It is very difficult to comes to term with this.
9. In bear markets don't use relative valuations but use your judgement on absolute valuations. In bull-markets use relative valuations to make selling decisions.

Psychological Biases and other thoughts

1. Use Anchoring bias as a tool to take decisions. If you find a stock good, buy it then you will be anchored to that price rather than waiting for price to come down.
2. Assuming that all stocks which you have will be a 10 bagger is living in fool's paradise, but if your process is right you will get once in a while a large bagger. 
3. Make sure your investment process does not change in good or bad periods. Good performance makes one complacent while bad performance makes one defensive
4. Differentiate between Hold-to-Maturity and Revert to Mean Ideas in your portfolio:

   Hold-To-Maturity: Great businesses which are compounding machines that have been bought at reasonable valuations. These are long-term investment ideas. 

   
   

   Revert to Mean: OK businesses at beaten down valuations because of poor performance where performance can bounce back in the foreseeable future. 

5. Markets are not efficient but they reflect current investor psychology. 
6. How do you determine in an investment decision whether you suffer from overconfidence or are just an independent thinker. Every business has certain milestones, when those milestones are not being hit by the business you must reconsider your investment 
7. Use simple scenario analysis to avoid investment pitfalls. For e.g. to Justify 2000 valuations for IT they would have to go at 75%-100% in the foreseeable future. If they did this for over 10 years, they would have become 40% of India's GDP. Even if they did manage to do this the Rs would have to go down to Rs 25 whereby margins for these companies were not sustainable. 
8. Read, read and read more. Few books recommended
1. Finding the next Starbucks
2. The Warren Buffet Way
3. Commentary of international value funds

And finally, we did discuss some stock ideas like Suprajit, GRP,Atul Auto, Magma Fincorp, Ashiana Housing, Ashok leyland, Clariant, BASF etc.

Hopefully we all will benefit from these thoughts, and incorporate the same while evaluating an idea.

cheers,

saurabh

PS- Don't consider all of us bores. We did discuss things beyond stocks and investing :)

A Tale of 2 Situations

Once there was an investor,  who one fine day entered the holy gates of big bad city called Stock Markets.  To help me in this city he found there were various types of people. The most talked ones were the high priests who sat in high temples of finance, and eulogised about everything and anything. Then there were a lot of traders, merchants who helped him in navigating the city on weekly, daily and hourly basis and finally there were the outcasts, who said generally spoke less and did all contrary things.
After meeting all of them and getting fairly acquainted with the city our hero decided to venture where few went, to the den of alchemists who made money without taking risk. They did this by finding special situations which nobody would see.

There he met a gatekeeper who gave him 2 tests and said that he had to go through to them to meet the alchemists.

Gatekeeper: Company Name: IGL Ltd
The price of the company was going all over the place (some times variation is as high as 30-40% in a day) as the company was engaged in a legal battle with a government body on pricing of gas prices. The ruling for the case is coming on 10th August and CMP is 250 . What will you do?
Hero: Interesting since company can either win or lose the case I will do the following:

• Buy a put option of August Expiry with strike price of Rs.220. The present price of such an option is Rs. 0.78 and lot size is 1000 my cost will be Rs.780
• Buy a call option of August Expiry with strike price of Rs. 270. The present price of such an option is Rs. 2.79 and lot size is 1000 my cost will be Rs. 2790

So by paying total of Rs.3570 i have given a wager on both positive and negative decision for company. If ruling goes against, stock price falls by around 20%  and i make a killing on my put option. Similarly, if it is in favour i make a killing on call option.

Gatekeeper:  Good. Now let me take you to the courtroom and you can see how things pan out. 

In the courtroom, as our hero waits anxiously proceedings begin and end in 5 minutes. The ruling is neither positive or negative but has been deferred till November 31st. 

Hero: Horror! Horror! this cant happen to me. I never thought of this scenario and now i will lose a fair bit of my wager as a lot of people would have bet on either side and now they will sell.
Gatekeeper: Aye Aye Sir! You will lose money but more importantly learn these 2 lessons

• A special situation is really "special" only if the outcome is known. Else, it has speculation involved in it.
• Always do a probabilistic analysis of all scenarios. For example, in this test all 3 scenarios of favorable, unfavorable and status quo were equally probable. 

Now let bygone be bygone, let me give you another test:

Gatekeeper : Company Name: Muthoot Finance Ltd- The company has a zero coupon bond maturing on 11th Oct 2012. The maturity value of this bond is Rs.1132. Suppose today is 7th Sept 2012 and value is Rs.1115. What will you do?

Hero: Aha! this is a simple one. As in previous test i know the outcome and also there is only 1 scenario of company paying me back. Although another scenario could be of company defaulting on its bond, but past track records and recent performance of company tell me that this is has a negligible chance. So, I will buy this bond at Rs.1115 and then on maturity i will get Rs. 1132. If i use the XIRR function my return is around 16.5% p.a, which is far higher than bond investments.

Gatekeeper: My friend you take things too simplistically. Did you consider the brokerage and tax? Suppose your brokerage is 0.3%, then your purchase price becomes Rs. 1118.3 and returns lessens to around 13%. Add short term taxation to it and returns further fall to around 9.1%.  Does it look that exciting now?

Hero: Hmm...no it surely dose not, but i never thought that these things impact returns.

Gatekeeper: As i said there are no mistakes only lessons. The lessons here is that Returns in special situations are moderate, so always consider transaction costs and tax and then take a decision.

That is it from me for now.

Hero: So now can i go in? 

Gatekeeper: Of course you can. The fact that you have taken tests is good enough. Now proceed to the real alchemists who reside here and here.

Regards,
Saurabh
PS- The protagonist was yours truly, and gatekeeper in one case was Kiran.