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Oct 20 17

Some Mistakes…

by Altais

So much has been written about vicarious learning i.e. learning from mistakes of others. It is humbling to admit that despite all the knowledge out there, I failed to learn vicariously. The purpose of writing this piece is to put down the learning’s (very expensive ones) over the last decade or so.  I hope to smarten up in the future though.

Before writing about what did not work, it is important to set the context. There is no best or the right way to invest – investors have successfully generated huge returns from different investing strategies – be it buying and holding quality companies, chasing growth even at high valuations, buying cheap companies betting on turnarounds etc. People have made large amount of wealth by having concentrated as well as diversified portfolio. So investors have to explore what works for them, given their financial requirements, temperament, skill and time horizon.

Two important factors to consider while looking at the mistakes (and lessons) are:

  1. Allocation strategy: diversified or concentrated. I go with a concentrated strategy so these mistakes are more relevant in that context.
  2. Portfolio approach: It is important to look at the portfolio return and how the portfolio is structured. This is different from trying to maximize returns from each individual stock.

The major mistakes (with very high opportunity cost) made over the past years:

1. Selling good businesses too early: I typically sold out too early without giving due importance to long term growth outlook and the potential of the business to scale vis a vis the short term expensive valuation. Sundaram Finance, CRISIL and Gruh Finance are among the mistakes in this bucket. They went on to become multibaggers in the years ahead after the sale. Also these stocks were never cheap enough to be bought again. When you are too early into a stock (which is a good thing), your mind gets anchored to historical valuation range, without adjusting for new potential of the stock – either with better performance or increased market interest.

Lesson: If you are invested in a growing business, do not sell it for temporary overvaluation – there may be some time correction which is fine, which should be managed at a portfolio level. At the same time, one needs to be careful of slowing growth or fundamental deterioration in the business e.g. Exide Industries/ Shriram Transport Finance.

2. Going down the Quality curve: This is a derivation of the above (first) mistake. Mostly when I have sold out of good companies, which were growing well, I ended up investing in cheaper but low quality/ growth companies. Over the cycle, this resulted in sub optimal returns. E.g. Sold out of Page Industries and Indusind Bank, and invested in IDFC Bank/ IDFC Ltd.

In theory, it is logical to say – ‘What’s the sense in holding an overvalued company, when you don’t see making any money in the next 12-18 months. One should just sell it and invest in something where you can make good returns over the next 1-2 years’. Now that’s all good to say but in practice the challenges are:

a. When you sell and raise cash, there is a mental pressure to invest. The pressure increases with time and level of cash allocation. The market may move against you for a long time, and even if you get a correction, it may still be at a higher level than what you sold out at.

b. Because of the pressure, you end up investing in low quality companies. (Value traps, no growth, hope value trades, relatively cheap trades etc.)

3. Waiting for a little lower price to buy: This has been a very expensive lesson – losing 10-20 baggers waiting for 20-25% lower price! I missed the boat on so many opportunities trying to just get them a bit cheaper, which never came. The buy price keeps moving up, just behind the actual market price! If you have your thesis right, you will make good money if the business does well, so it’s stupid to wait for just a little cheaper price. What I prefer to do now is:

a. Buy a base position even at 20-25% higher than the ideal price

b. Keep adding to make it a full allocation (either with time correction or price correction)

c. If the stock goes up without any correction, atleast you have a base position and have not missed out totally, though it’s not the ideal scenario

There may be times wherein you have a drawdown or a loss because of buying expensive than the ideal price, but the potential profits forgone due to waiting for a little cheaper price are far more than these losses. Some examples here are Bajaj Finance, Hatsun Agro, Avanti Feeds, Supreme Industries.

To think about it from another angle: over a 5 year period, the stocks you like on a fundamental basis can go up multiple times and the downside to them is say 20-30%. So on a portfolio of such stocks, it’s better to be long atleast with a smaller & growing allocation than not to buy them. On a portfolio level, the downside would be even much lesser and maybe it’s just the dead money or opportunity loss.

4. Failing to consider overall market change and its impact: This is one of the least talked about topics of investing. Different stocks work in different market environments. In a bear markets, companies which are consistently growing their earnings give surer returns, while in the bear to bull market transition, major money is made from valuation rerating relative to earnings growth. e.g. In the 2010-2013 bear market, growing companies like Cera, Kajaria, Astral, Indusind Bank etc gave good returns, while in the bear to bull market environment from 2014 till date, stocks like KRBL (where earnings went up 2-3x times and the stock got rerated from 4 P/E to 25-30 P/E in last 4 years), Escorts (earnings went up 3x and the P/E rerated from 11 to 40) gave far higher returns.

5. Not experimenting enough in the portfolio: In my concentrated portfolio, the minimum position used to be 10-15%, which meant that to add anything to the portfolio, it had to pass very exacting standards. Also when adding anything to the portfolio, I used to do it in one shot rather than building up a position gradually. Now this prevented me from adding stocks with smaller allocation, due to any of the following factors:

a. New company or sector which I haven’t looked at in the past so I was not comfortable investing big there, but the company looked good per. se e.g. Chemical companies.

b. It was difficult to get more information about the company and the sector e.g. Avanti Feeds, Garware Wall ropes

c. Stocks which were very expensive, even though they were a good growing company. e.g. Gruh Finance

d. No future visibility within a timeframe e.g. Hitachi Home, Cyclicals

e. Special situations – demergers etc. e.g. Gulf Oil

Buying GARP stocks in Indian stocks makes one disinterested to look for new opportunities, which might add value to the portfolio in terms of differential alpha. One needs to have many arrows in one’s quiver, which can be used depending on where one can find best and easiest opportunities. Focusing only on a single style – Moat stocks/ Special situations/ Cigarbutt stocks can make one a man with a hammer. What we learn most from Warren Buffett is sheer range of investing strategies – Cigarbutts, high quality in distress situations, pricing power high cash flow stocks, Cyclicals, Commodity, special deals, business buyouts, index derivatives, super cat insurance bets, and now technology moats! How do you become a learning machine if you don’t experiment in real time with real money?

Now, I think it makes more sense to allocate a part of portfolio (10-20% depending on each investor’s own comfort), as a hunting ground to scale up positions as one gets more comfort. Also, it allows to allocate some capital to companies which potentially can give very large returns but you cannot make them core holding at the outset due to any of the above reasons.

6. Having a very large cash allocation: In volatile or sideways markets, cash gives mental relief. While possibility of deploying cash in steep corrections is there, but it’s very difficult to get it consistently right. It is better to be more invested (based on overall allocation), even if there is short term over valuation and gradually take profits. I have been guilty of keeping large cash balance and often times one of the 2 has happened:

a. Either the stocks, which I wanted to buy, did not correct much


b. The price to which they came down after correction was still not much different from the original price I saw them initially at.

From a portfolio perspective, how much cash one is holding also has a major bearing on the decision to hold or sell high growth expensive stocks. With a relatively higher cash allocation (20-25%+), it is easier to hold these stocks since any market correction which will lead to drawdowns in these stocks, will also give you an opportunity to invest the cash. High market valuations should be used as an opportunity to move from low quality to high quality stocks and not vice versa. Most of the seemingly cheap or relatively cheap stuff in a rising market is junk so that has to be avoided totally.

Even in the 2008 crash, very very few people got both the legs right – they either went into cash and did not reinvest reasonably well or they went into cash the wrong time.

7. Holding on to the non-performers for too long: When these stocks don’t move for period of time, we start treating them as cash proxy, hoping for an earning rebound. Also, we start paring down good performing companies in the portfolio as their marked to market allocation keeps increasing with performance, further impacting portfolio performance and quality.

8. Thesis change, market view changes: Often the eventual reason of the success of a stock has little to do with the initial thesis. One needs to be open minded about new data points. The initial reason for bullishness on Eicher Motors was cash and CV business, with RE being a side business. Investors got into Hatsun Agro for valued added products, but it was the liquid milk business which got success. Hawkins, TTK Prestige and Gruh Finance were slow compounders, until they hit sweet spot and then the market fancy took over.

9. The need to be Contrarian: When we see markets or stocks moving up fast, the natural urge is to be contrarian and call it speculation. It sounds more intelligent to be bearish and contrarian. In our interaction with top investors, one thing came out clearly – the overall bet has to be on economy, capitalism and entrepreneurship. One can be selective as to the economic segments or timing where one wants to be bullish, but the underline trait has to be optimism and confidence. This need to be contrarian is especially true for fast growing, quality companies – earlier examples being HDFC Bank, Asian Paints. Even in down markets, they are relatively expensive. And when they get discovered, the rerating happens very fast. Though moat is a much abused word now, it is true for select companies! Being reasonably early with fast accumulation of stock and long term view is the better way.

10. Focusing on macro: Again talking about macro sounds intellectual, but for a bottoms up individual investor, it has little relevance. Spending more than couple of percentage of your time on macro tracking or discussion is normally waste of time. Economic macros can mostly be dealt at portfolio level decisions, which need not be done on a regular basis. Mostly, only sector and company specific macros are worth tracking.

A lot of these mistakes can be avoided by focusing on the portfolio return rather than each individual stock return. This makes it much easier to hold part of the portfolio which may time correct in the near future with earnings catching up with valuations. Additionally, you can selectively invest in stocks which may not give linear returns over the next 1-2 years, but hold potential to give very high returns over a longer period of time. When large part of the portfolio compounds at 25+%, the overall portfolio return can still respectable. Essentially it comes down to optimizing the portfolio return rather than trying to maximize it.

Sep 16 14

A Tale of Two Stocks

by Altais


1. All numbers and metrics are rounded off for simplicity.

Apr 29 14

Investor vz. Entrepreneur

by Altais

I have fond memories of looking at the Forbes list. It was while looking at the Forbes List in 2002, sitting ideal in office, that I read the name ‘Warren Buffett’ for the first time, and it changed my life, mostly for the better. His wit and wisdom were easy to idolize, and hopefully is leading to some wealth!

While looking at the current list, one thing that I found striking was the difference between number of Investors and Entrepreneurs/ Businessmen in the list.

In the top 100 list, there are only 12 who owe their massive wealth to Investments (Stocks + Real Estate + Others). Even in this list of 12, many owe large part of their wealth to business ownership or operational leverage of managing other people’s money.

Even Warren Buffett, the Icon of Investing, made his initial money in stock markets, but his real wealth came by full ownership of businesses, especially insurance business.

This is quite contrary to general impression about stock market being the place to become very rich.

Please note that we are talking about hugely successful entrepreneurs and investors only. There would be enough failures or modest successes in each category.

The same case is in India. Maybe only 2-3 investors, to my limited knowledge, can be called superrich (say Networth of more than Rs. 1000 crore).

So while stock market might be a good way to become rich, if you are successful in making and keeping money; it’s difficult to become super rich like an Entrepreneur.

Why this difference between promoter owner and part owners?

One of the key reasons for this is that while an Entrepreneur starts by investing at face value, we as Investors pay multiple times of that to invest in the same business.

Let’s take few examples – Average, Good and Great Business.

An Entrepreneur starts a business with Rs. 1 crore of Net worth and leverages with 0.5 Debt/ Equity, (hence total capital at Rs. 1.5 cr), and generates RoE of 15% for 5 years. Then he lists his business at a valuation multiple of 7 in the market, creating a market value of Rs. 3.2 crores. So far so good. For an Investor to create similar value, he will need to compound his money by 25.9% for these five years, effectively eliminating 90% of Investors! And this is for an average business created, with RoE of only 15%!!

The numbers for a good/ great business are just too depressing for a pure investor, so just have a look at the table.

No wonder the wealth lists are so skewed…

Though at one level, there is a sense of justice in this, as it is Entrepreneurs who create value and we just trade value. They normally keep all their eggs in one basket and we keep it in various baskets and shuffle it at the first sign of trouble.

Entrepreneurs put in some of their sweat and blood, and a lot of other people’s sweat (and sometime blood) in their ventures; while we Investors sometimes merely spill some blood on the streets.

So more power to Entrepreneurs, while we piggyback some of them.

Aug 15 13

2 Good Interviews

by Altais

The country urgently needs to shift focus from finance to commerce: Uday Kotak, Kotak Mahindra Bank

Sugata Ghosh, MC Govardhana Rangan & Anita Bhoir, ET Bureau Jul 10, 2013, 08.27AM IST

Is the India story fading?

As we were all growing up there used to be a very big mantra in India which was called ‘export or perish.’ There was a long period when we used to focus on import substitution. In the past eight years, these two phrases ‘export or perish’ and ‘import substitution’ are no longer a part of the Indian economic vocabulary. I was looking at all the equipment and facilities, furniture for our new office. I was shocked that so much of it is imported. Tables and chairs are coming from Malaysia and China. You ask yourself what is happening to our manufacturing. If we are going to start importing, then we have a big challenge on our hands.

Is the adverse trade balance the problem?

You have to look at the March 2013 numbers and the number that strikes me the most – $500 billion imports and $300 billion exports. We have a $90-odd billion gap in terms of current account. It is a problem of commerce which is becoming a problem of finance. We have to get competitive. Can we afford to import Chinese Ganeshas?

Are import curbs a solution?

Today it has become a problem of finance. How are we trying to solve this – by getting more money to fix this. What about reducing the trade gap? If one is a heart patient, he needs a long walk. It’s a long walk we must do.

Is the young population an obstacle, or a boon?

We have a billion mobile demand and 800 million users. Many are using more than one handset. Why are we not manufacturing it in the country? What is it that a Korea has that we don’t? That’s where the whole psychology and system in the last 10 years has moved away from competitiveness and we have not addressed the 500/ 300 problem.

When there is a finance problem staring at us, how do we attempt to fix broader issues?

We need to glorify people who solve the 500/ 300 problem. A weaker currency is a national tariff. After we get a weaker currency, we have to take advantage of that. Or else, we will waste it once more in inflation and in the inability to raise competitiveness.

So is a weak rupee a blessing?

If properly used and not frittered away. If a software professional’s salary is in rupees but earnings are in dollars, then you are competitive. But if it leads to a disproportionate increase in inflation, then we would have wasted the opportunity.

Isn’t inflation already a burning issue?

If I look at my branch one thing that shocks me is the rate at which ground floor real estate rentals have gone up and it is completely lazy money that a landlord gets. It reduces my competitiveness. We need a policy that is brutal about commerce. We have to think about this as not a problem of finance but a problem of commerce. Unfortunately, all our minds are focused on finance. But the issue is that a problem of commerce is being handled as a problem of finance.

Are financing problems addressed with higher debt limits for FIIs?

There is too much of pressure about cost of funds. In a country where your consumer price inflation is 8-9%, savers will not save money at less than 8%. Which depositor today will accept less than 8%? Then if you try and reduce interest rates  your financial savings move to gold and real estate. We have to ensure that financial savings continue to be attractive. The move on FII debt was because borrowers are complaining. Most of the borrowers borrowed in dollars and did not hedge. So they thought they were borrowing at 2% while they were borrowing at 20%. The first principle of business is to borrow in the currency of your business, otherwise you are a forex speculator.

So there’s a financial sector challenge?

There are issues when you have such a high government ownership. If the asset side of the balance sheet has pressure, you need capital. The correct liberalisation of the financial sector would have been broadening the public ownership in public sector banks. Which means you would have all public sector banks as widely-held private sector banks. But we can’t take that decision for political reasons.

Is the financial system in trouble?

The banking system is going to be under greater pressure than what banks are willing to show. For both public and private sector banks, it is an issue of governance. It is about trusting the numbers. If you look at 2009, why did the recovery happen? Recovery happened because somebody in the world’s largest economy opened the tap, the US, followed by Europe and now Japan. US is now shutting the tap and it’s like all water levels coming down. Buffet’s statement comes to my mind – only when the tide turns you know who all have been swimming naked. Therefore, for a quick recovery you need steroids. I don’t see global steroids in a hurry. If steroids are being withdrawn, it is back to productivity, competitiveness, getting commerce right. It is about back to basics.

What needs to be done?

I was completely dreamy eyed in early 90s with Manmohan Singh as Finance Minister, Oh India is changing. Twenty two years later, cash in the economy, as a percentage, is more than what it was then. Control cash. The Gangotri of all problems is cash. Stop that. Find ways and means of encouraging non-cash payments or discouraging cash payments. We need to encourage exports, encourage manufacturing. We will make our laws simpler in every aspect so that people think it is worthwhile to set up businesses and factories. Most Indian enterprises are become arbitragers. Free coal… free land… free things and arbitrage profits. We need to move to an era where value-add is given a premium over arbitrage. Most of us have been brought up in the 90s and 80s on the core middle class values where something is right something is wrong. And then if you mix it in 2000, it got mixed with drugs and everything got blurred.

What you are saying is more scary than the Harshad Mehta scams because investors are doubting the integrity of companies.

There is a significant need to put building blocks. Go back to the 1980 and 90s. Why did the equity markets turn around? Because you had created a convertible instrument called UTI where downside was protected. Now there is no such product. That’s gone. So the downside is fully to the investor. So if the upside and downside are fully to the investor and the poor guy for the first time came to the market in 2007-2008 and many of his ilk have been ravaged. For the longer term, you have to build trust.

Is there hope?

If you want growth in the next 10 years, it has to come from people-intensive and skill-intensive business. The single biggest resource India has is people and skill. The power of capital dominated over the last 10 years over everything else. If we threw money at a problem, you will fix it. Therefore, if we can get people, skills and knowledge as basis of our future, we will create jobs and we will create a future.

If you had to start your career all over again what would you do?

It would be in the real economy with digital. How can we not waste the opportunity created by a depreciating rupee? A simple example is that we had a 20% depreciation in a year. Our annual inflation rate is 10%, We have to make sure real wages don’t go much more than inflation. Then your entire depreciation is bonus. It increases your competitiveness by 20%. We must focus on using this currency devaluation as a tool for economic turnaround. Environment is yet another big issue for me. Are we going to stay with blackouts for the next 50 years? It is not an easy one because there is huge destruction but how do we get the balance?


Jim Rogers: Why I’m shorting India

The hedge fund manager on the financial crisis, his bets for the future and his decision to be extremely negative about India in his just-released book

First Published: Tue, Aug 13 2013. 06 26 PM IST

What lessons have you learnt from the financial crisis that started five years ago and how has your investment mantra changed since then? Can you tell us how your portfolio has changed over the course of this crisis?

Governments and central banks have reacted to the crisis in what they view is the correct manner, but, in my view, it is an artificial manner, and they are only making the crisis worse. The reason it is stretching out as a problem is that they never let the problem cure itself.

For instance, in 2001 and 2002, there were economic problems in the world and they hurt, but they were not that bad. The next one came in 2007-08 and it was much worse because the debt had risen by then. Central banks, especially the American central bank, started printing money and everything felt better for a while. Then the problem came again and central banks led by the Americans, and governments led by the Americans, again ran up even more debt and continue to do so. Many of us feel better, especially the ones getting the money, but, overall, it is worse now and the situation continues to deteriorate because the debt is so much higher now. The next time we have a slowdown, it is going to be a lot worse. In America, the debt quadrupled and a lot of it is garbage—we are floating on an artificial sea of liquidity, and it is wonderful if you are in the right boat.

Problems always come no matter what governments say and we have always had slowdowns in America after every six or seven years even in good times. Be very worried because the next time around, things are going to be much worse, especially in countries where the debt is much higher. In the 1920s and 1930s, the centre of the world moved from the UK to the US, primarily due to financial problems and mistakes made by the politicians. The same thing is happening now, and the centre of the world is moving from the US to Asia, exasperated due to the financial crisis and mistakes made by politicians. In the 1930s, US was a creditor nation, but it suffered badly, but not as badly as some of the European nations. Asia will suffer the next time around, but the West will suffer even more. I would rather be with the creditors than with the countries (that) have huge debts.

Any new reasons why you are shorting India? Have you ever invested in India?

I used to own tourist companies in India at a time. India should have had the greatest tourist companies in the world. If you can only visit one country in your life, my goodness, it should be India—it is an astonishingly spectacular place to visit. There is no place that has the depth of culture that India has. Yes, I have new reasons to short India—just read its newspapers everyday and you will see why.

The government goes from one mistake to another—no matter what the controls are, no matter how much the debt keeps rising, Indian politicians are only looking for scapegoats. Look at the latest thing with gold—Indian politicians want to blame the problems of their economy on someone else, and now it is gold. Gold is not causing India problems, but it is quite the contrary. Exchange controls in India are absurd, the regulations that India puts in place result in foreigners going through 70 loops before they can invest in India. Foreigners cannot invest in commodities in India.

India should have been among the world’s greatest agriculture nations—you have the soil, the people, the weather, but it is astonishing that you have not become one—it is because Indian politicians, in their wisdom, have made it illegal for farmers to own more than five hectares of land. What the hell—can a farmer with just five hectares compete with someone in Australia or Canada? Even if you put together the land in all your family, it is still not possible to compete. Much as I love India, I am not a fan of its government. Every one year, they (Indian government) come up with more reasons for me to be less optimistic about that country.

Do you think India’s democracy is a problem to its success?

I can only make some observations. Japan, Korea, Singapore, China were all one-party states and, in some cases, were very vicious one-party states, but, as they became more prosperous, their people wanted more, demanded more and got more democratic, and they say this is the Asian way.

Greek philosopher Plato in The Republic, says that societies develop from dictatorship to oligarchy to democracy to chaos and then back to dictatorship. Chaos develops out of democracy. This seems to be what is happening in some of the Asian countries.

In the Soviet Union, they did the opposite—they said we will open up and let all people complain and they did. The people there were poor and they complained about being poor and hated the government. When South Korea opened up, the people were rich and they decided to get rid of the government without ruining the place. Taiwan did the same. Democracy being a problem may have credence in some Asian countries. But, I am not sure if India has been really a democracy in the true terms—from 1947 onwards, the opposition has had just one full term at the centre. The first five decades of its democracy, the centre has only seen a government led by a single party.

Power corrupts. Singapore was lucky. There has been plenty of criticism of Singapore’s (founding father) Lee Kuan Yew, and some of them are probably valid, but look at the results. Congo had a dictatorship for a long time, but has nothing to show for it. Singapore had a strong central government and look around you—I did not move to Congo, but I moved to Singapore. So it can go both ways.

In 1947, India was one of the most successful countries in the world relative to others. Even as recently as 1980, India was more successful than China, but then you know how that story turned. It was more successful than South Korea, more successful than most places in Asia—but, for me, it is unfortunate that you have failed to take advantage of some of your most valuable assets. India has some of the smartest people in the world, but it does not have an education system to support it. Infrastructure is equally poor. So, I don’t know if India would have been better without a democracy, and some of the greatest periods in history have been without democracy. But these are just my observations, and it is the Indians who must decide what they want.

What do you think should change in India for it to attract investments? There are several multinationals that have been successful in India despite all its policy and regulatory uncertainties. They have adapted and changed their business practices to suit India.

Yes, but on the other hand, there are not many successful Indian companies, outside those that are associated with the government. Look around in Singapore and you don’t see many Indian products, except for some restaurants. There are very few Indian brands that you would recognize outside India.

In India, many of its companies are successful because of their links with the government. Apart from a couple of software companies, I literally cannot think of Indian firms who have made it big in the international scene. But there are many Japanese, Korean, Chinese, Taiwanese companies that are very big globally. All Indian companies that are successful there are because of their relationship to the government.

If I were an Indian politician, I would make the country’s currency convertible tomorrow and stop deficit spending this afternoon. I would take a chainsaw to government spending as you continue to run up debts, I would free up the economy, especially agriculture, to make India the greatest competitor in this sector. You know, to open a retail outlet in India, even for Indians it is so tough—but for foreigners, it will take years in the current system. You keep companies out of India citing national security—just go to China and there are foreign companies everywhere.

There are millions of entrepreneurial, driven and smart Indians, but most of them want to be abroad because they know that unless they are involved with the right people in India, they are not going to be successful. Fewer than 50% of Indians stay in school till their 12th grade. How many universities are there in India—nothing when compared to the population! There are very good Indian universities, but they are nothing compared to the qualified Indians who need good education. One reason you see so many Indians going abroad is to compete or to get education. It would be such an exciting country to do business, if it were opened up. Historically, it has been an economic power and I would try and restore it to that position. Oxford and Cambridge can fill up all their seats with Indians who would pay their own way.

In your latest book, you have been critical of the numbers put out by the Indian government. I’ll quote from your book: “All growth rate figures are unreliable. It is stupefying to me that India could claim to have a clue to what is going on even in India, much less in China or in the US” or “When it comes to growth rate, Indians base their numbers on what China is reporting, making sure that theirs are better than, or at least in line with, China’s”. But, institutions in India are pretty strong and the numbers, be it GDP or any other put out by the Indian government, are considered to be largely reliable.

All government numbers are suspect. Last week, the US government revised its economic statistics and added a whole economy bigger than the Swedish economy—so America just went up a level in a week because they revised the numbers. I don’t trust what any government says. The Soviet Union used to have great numbers, but they were all made up in offices in Moscow.

I was not just picking on India, but using it as an indicator. If you go back over the last few years, you will see the Indian economy, as per the numbers its government has put out—some of the numbers its government has projected—are comparable with those of China. Then you go see both countries and you’ll realize something is wrong. If India’s growth over the last couple of years was comparable to that of China, where are the schools, the highways, the infrastructure, the housing, where has it all gone?

I was using this to state that we should be very careful about what governments tell us. In one of my books, I’ve come down hard on Germany—the Germans who were supposed to be hardworking and disciplined were also found to be making up some of the numbers they had been reporting related to job creation.

Where is gold headed? When is the good time to buy it? Of late, India has taken a slew of measures to curb its import. Many say that if India were to steeply reduce its import of gold, it will be able to alleviate its current account deficit, which, in turn, would help its economy get back on track?

It is a great question because I too am fascinated with gold and I do own gold. Gold went up 12 years in a row, which is extremely unusual, and there has been no asset in history that has seen something like this. The anomaly in the gold market is how strong it has been—it has never happened ever—technically, gold was overdue for a big correction. But the correction should be different from most corrections because the rise was so different from most rises. I was expecting it to decline and it has.

In my view, the main reason for the correction, other than the fact that it needed it, was on account of Indian politicians who suddenly blamed their problems on gold. The three largest imports to India are crude oil, gold and cooking oil. Since they can’t do anything about crude and vegetable oil, the politicians said India’s problems were because of gold, which, in my view, is totally outrageous.

But like all politicians across the world, the Indians too needed a scapegoat. Is this the reason why gold started correcting? I don’t know. But, India is the largest importer of gold, and whenever the largest buyer cuts back, there will be a correction, whatever is the commodity. The correction may continue for several more weeks, months or even a year or two. A 50% correction is common for commodities, but if gold were to correct 50% before it made its final bottom, that would be between $900-1,000.

In my view, gold is in the process of making a complicated bottom that will last a while. I hope that I am smart enough to buy more near the bottom because gold will go much higher over the next decade, because as I had said earlier, governments across the globe are making mistakes of printing money. When gold went to $1,200, I did buy more. But don’t sell your gold. I am not selling my gold.

If India curbs its gold imports, will its economy be back on track? There is no question that if you have money, it is better to invest it than put it into a stagnant asset—according to this argument, women should not buy dresses or shoes, or we should not be buying houses…the one billion Indians are smarter than the market and also the government. If they see that they are better off putting their money in gold, that is what they will do—the solution is not a ban on gold (import), but to make the economy exciting enough to make people want to put their money into other things. That will be better for the economy, but this is putting the chicken before the egg or the cart before the horse.

In the BRICS (Brazil, Russia, India, China, South Africa) countries, the rising middle class appears to be angry with their respective governments and have been demanding changes, reforms and better living standards. Governments of most BRICS countries—including India and Brazil—are confronted with the youth taking to the streets in protests. Do you think this can derail the emerging markets story?

It could derail, or it could open-up these countries further. If the billion plus people in India demand more and say the current system that is going on since 1947 is absurd, then it might make India a whole lot better. Compared to many of the countries globally, India was on top in 1947, but relatively India has only declined since then. Remember that you move from dictatorship to oligarchy to democracy to chaos—may be they will throw out these absurd oligarchs who rule India and then it may have a vibrant democracy and regain its proper place, its historic place in the globe.

Jul 31 13

When Titan went the Titanic way…

by Altais

Many times in our investing careers, regulatory changes wipe out years of returns and make waste of all the time we have invested in studying and tracking businesses.

It happened some time back in Indrapastha Gas – one of our earlier core and loved holdings. We were plain lucky to have already sold out our shareholding near the peak price on pure valuation considerations (some benefits of having a value mindset!), without having any inkling of drastic regulatory changes around the corner.

A similar thing happened in Titan Industries sometime back, though for a short period of time.

But before that, a flashback….

Titan Industries was one of my first rookie investments way back in 2002, more so on coat tailing and simplistic analysis. Well, it turned out to be a good investment and I exited after making satisfactory returns (but only a fraction of what could have really been made). With hindsight, we see that everyone made money in that period in whatever they bought!!

With strong price anchoring and looking at high valuations, we never looked at investing in it ever again (plain stupidity – it’s much easier to analyze stocks that you have known for a long period of time).

We again missed investing in it in the golden period of early 2009, when it was available at rational valuations, with earnings having doubled over 2 years and stock remaining stagnant. We were quite focused on investing in cheap stocks, which gave very good and faster returns, but lacked the elusive mystique of “Fill it, Shut it, Watch it” stocks.

So, in early 2012, when the same situation arose (earnings having doubled over 2 years and stock remaining stagnant), we decided not to repeat the mistake (first sensible decision) and started analyzing the company in detail.

Here is a snapshot of the company, as we saw it:

Quite an incredible business achievement by the management of Titan Industries, we thought.

We figured that with even some of the following easily identifiable and high probability catalysts, the stock should be worth atleast Rs. 300/ share in sometime – a 40-50% upside in a large cap with years of potential compounding of around 25% and where you can make a good size bet (we love such bets).

1. The bull run in gold seemed to be correcting, and even some gold price correction should lead to increased business volumes (which were subdued due to record gold prices).

2. The management had nearly doubled the retail space over the past 2 years, which should lead to higher growth and increased operating margins.

3. The focus on studded jewellery should improve margins (studded jewellery has 3 times margins of plain gold jewellery).

4. The transformation of the balance sheet over the years should enable the management to meaningfully increase the dividend payout ratio from current 25%, without compromising on growth or balance sheet strength. We all know what happens to stocks of companies with increasing dividend payout ratio. Even RJ alluded to this in a recent con call.

5. The new incubated businesses were turning corners and should add to the profitability margins, instead of lowering margins.

So, we bought Titan Industries in a meaningful quantity.

Mr. Market obliged pretty quickly and the stock went to Rs. 300/ share within a year. We sold a part, looking at full near term valuations (blame the value mindset), but kept most of the holding for the long term compounding.

Now, comes the regulatory angle…

There were some regulatory headwinds that the jewellery companies were facing, though none of this was their own making but more to do with macro-economic issues, given the dismal situation of the economy.

These regulatory issues were supposed to have gone either way in March 2013, but nothing happened then. Then in May-Jun 2013, Mr. Integrity Management of Titan Industries themselves went to the RBI and asked to be wacked. Just kidding, they asked RBI for some clarifications.

With this, all hell broke loose. We were again in IGL, but this time with most of our shareholding intact. The stock fell from Rs. 280 to Rs. 200 within a week, and panic set in, with rumours of Rs. 150!! Now, when you are surrounded by panic, you need to think coolly. Read other people’s opinions, but finally frame your own opinion.

1. First question is, whether the stock can go the Arshiya way?

a. Management Integrity: Check

b. Balance Sheet strength: Check

Current is very strong, even with new business workings, it will be pretty ok.

c. Medium Term Product Demand: Check

Will likely continue – Indians going to stop buying gold jewellery? It’s part of “Roti, Kapda, Makaan, Sona, Padai” that every Indian spends on.

2. How will the new financials look like?

Capital Intensity of business will go up. From a cash surplus business, it will become a net debt business. ROCE will reduce from 60% to around 30%. (But how many businesses today are doing 30% ROCE?). Though catalyst no. 4 is gone.

3. What are the chances of further regulatory impacts?

No visibility

4. What is the change in intrinsic value?

Based on the reduced growth rates, higher capital intensity, but still 30% ROCE, new intrinsic value seemed like Rs. 240. All other catalysts remain intact, though further expansion will moderate.

So, we just kept our cool, and finally exited near the new estimated intrinsic value, at a minor profit with >1 year of holding.

Selling at the new estimated intrinsic value was logical, given lack of visibility of any further regulatory impacts. We sometimes are willing to invest in low visibility stocks, provided the gap between the market price and intrinsic value is mouth watering.

Some Thoughts:

1. Most people who lost large amount of money were people who had no idea of its intrinsic value – they had no idea when they were buying at Rs. 300 and they had no idea when they were selling at Rs. 200! Most people who did not think of its valuations at Rs. 300 were forced to think at Rs. 200!!

2. Though if an investor is not comfortable, it’s better to sell and invest elsewhere, rather than lose sleep over 20% probable gain in the short term.

3. Strong companies tend to help recover your money, unless you have bought the stock at very high valuations.

4. Contrary to popular opinion, investing in low P/E stocks does not help salvage such situation.

Jun 16 13

Nifty Fifty – Part I

by Altais

Nifty Fifty was an informal term used to refer to 50 high flying growth stocks in the late 1960s and early 1970s that were widely regarded as solid buy and hold growth stocks. ‘Nifty Fifty’ phenomenon is often cited as an example of speculation resulting from unrealistic investor expectations for growth stocks – where these are touted as ‘one-decision’ stocks, just to be bought irrespective of price, held onto irrespective of valuations, and never to be sold.

Though there was no official list of Nifty Fifty stocks, it composed of blue chips like Coca-Cola, IBM, Xerox, Polaroid, Walmart, Philip Morris, Pfizer, Gillette etc. The common characteristics were solid earning growth, stable businesses with long term visibility, and high valuations (Average P/E of 41.9 times vz. 18.9 for S&P 500, and dividend yield at 1.1% was less than half that of other large stocks). Because their prospects were so bright, many analysts claimed that the only direction they could go was up. The delusion was that these companies were so good it didn’t matter what you paid for them; their inexorable growth would bail you out.

When the stock market crashed in 1973, the Nifty Fifty defied gravity for a while, held up by institutional enthusiasm that created a two-tiered market of the richly priced Nifty Fifty and the depressed rest (sounds familiar?). Then, in the memorable words of a Forbes columnist, the Nifty Fifty were taken out and shot one by one.

As Buffett notes in his 1996 letter “You can, of course, pay too much for even the best of businesses. The overpayment risk surfaces periodically and, in our opinion, may now be quite high for the purchasers of virtually all stocks, The Inevitables included. Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid.”

Further, he adds “A far more serious problem occurs when the management of a great company gets sidetracked and neglects its wonderful base business while purchasing other businesses that are so-so or worse. When that happens, the suffering of investors is often prolonged. Unfortunately, that is precisely what transpired years ago at both Coke and Gillette. (Would you believe that a few decades back they were growing shrimp at Coke and exploring for oil at Gillette?) Loss of focus is what most worries Charlie and me when we contemplate investing in businesses that in general look outstanding. All too often, we’ve seen value stagnate in the presence of hubris or of boredom that caused the attention of managers to wander. That’s not going to happen again at Coke and Gillette, however – not given their current and prospective managements.”

Now that would be what Munger calls Lollapalooza effect – you pay an inflated price and management does something stupid!!

Since we do not know about the management mistakes for these companies, let’s focus on the valuation part only.

I came across an article by Perma-Bull Jerermy Siegel (Author of ‘Stocks for the Long run’ and whom Charlie Munger famously described as ‘demented’!). (Do read it first)

and contrary view

My conclusions looking at his data/ analysis are a bit different:

  1. Nifty Fifty stocks just matched returns of S&P 500 over the long term (1972-1998), inspite of investing in best of companies (which logically should outperform general markets), and after buying/ holding stocks at lofty multiples (poor risk reward ratio).
  2. This set of stocks dramatically got sold off in a bear market and underperformed the broad markets in stress times. (Newton’s Law?). So don’t chase valuations, Mr. Market will redeem you in times to come, so be patient and prepared.
  3. Jeremy however does note one aspect “If you examine the actual price-earnings ratios of the Nifty Fifty stocks, the 25 stocks with the highest ratios (averaging 54) yielded only about half the subsequent return as the 25 stocks with the lowest price-earnings ratios (averaging 30).”

Stocks with strong moat, long term growth visibility, high profitability and cash flows, and capable managements can be purchased at higher valuations but only to an extent. Don’t stretch the logic. GARP investing is fine (Growth at reasonable price), not GAAP investing (Growth at any price).

Jun 3 13

Cost of being in a Hurry!

by Altais

Recently, I came across a startling fact that I did not quite know before, which really made a deep impact on the way I looked at investing in general and the utter importance of ‘preservation of capital’ in particular.

This is what Mohnish Pabrai spoke in an interview, and what he learnt from his meeting with Warren Buffett.

From the interview

I asked Warren a question about Rick Guerin. When Charlie and Warren had started out, there were three of them. It was Charlie, Warren, and then the third guy, Rick Guerin, and they used to make investments together. They ran separate funds, but they used to work together. In fact, even when they did the See’s deal, Rick, Charlie, and Warren had interviewed Chuck Huggins to be the CEO together. The three of them were firing questions to him together to figure out whether he was the guy.

Then Rick Guerin pretty much disappeared off the map. I’ve met Rick recently, but he disappeared off the map, so I asked Warren, are you in touch with Rick, and what happened to Rick? And Warren said, yes, he’s very much in touch with him. And he said, Charlie and I always knew that we would become incredibly wealthy. And he said, we were not in a hurry to get wealthy; we knew it would happen. He said, Rick was just as smart as us, but he was in a hurry.

And so actually what happened — some of this is public — was that in the ’73, ’74 downturn, Rick was levered with margin loans. And the stock market went down almost 70% in those two years, and so he got margin calls out the yin-yang, and he sold his Berkshire stock to Warren.

Warren actually said, I bought Rick’s Berkshire stock at under $40 apiece, and so Rick was forced to sell shares at … $40 apiece because he was levered.”

Additionally, in “The Snowball”, Buffett notes that he bought 100,000 shares of Blue Chip in 1973-74 from Rick, at 5 bucks, because Rick was getting squeezed.

Now, Rick Guerin is one of the Superinvestors mentioned in the Buffett’s famous “Superinvestors of Graham & Doddsville” speech.

His track record is as below:

Some thoughts,

1. This guy was not a novice investor who lost money due to ignorance. He was a super investor with a great 18 year track record, including the 1973-74 period!

2. The Berkshire stock he sold at USD 40 in 1973 is worth USD 171,000 today in 2013 (no dividend, no split so simple calculation :) ), and that’s compounding at 23.2% for 40 years!!

3. He lost the chance of being among the most famous of all investors around the world, in league of Warren Buffett and Charlie Munger!!!

Quite a heavy cost for being in a bit hurry to get rich!

I am reminded of Goldman Sachs motto “Be Long Term Greedy”.

So, Rule No. 1: Don’t lose capital. Rule No. 2: Don’t forget rule no. 1.

Mar 26 13

Concept of ‘Concept Stocks’

by Altais

The past few months have not been great for concept stocks, to put it mildly.

and so on… the list is actually quite long…

Why this fascination for concept stocks, even for big investors? Humungous returns? Challenge of being offbeat/ first to discover? Or the fact that they earned their money investing in such concept stocks earlier?

After all, these were also concept stocks to begin with….

or for shorter time frame, Pantaloon Retail and Bharti Airtel…

Of course, with hindsight bias, now we can think of the differences between the two set of companies:

- Promoter Integrity

- Balance Sheet Strength

But the whole seductive charm of concept stocks lie in the future – future gonna be better, this is just the beginning….

After all, prediction is very difficult, especially about the future

But of course, with a venture capital mindset, one can still justify investing in concept stocks.

Let’s take the above set. We invest Rs. 100 in each of the above stocks and the above returns materialize over 8 years i.e. we lose 80% of capital in 2 stocks, 75% in third, 50% in fourth, but have 30 bagger in one stock and 16 bagger in another. This will yield Rs. 4715 on an investment of Rs. 600 over 8 years – CAGR of 29%.

Not bad at all, but perhaps one could have achieved similar/ slightly lower returns in a simpler fashion. Further, this is very dependent on getting the two home runs. Though one can argue about mid course correction and taking money from weeds to flowers, but isn’t it better to be a Dravid than a Sewhag?!

Jan 24 13

Snapshot: 2008 – 2013

by Altais

It’s that time of the year. 5 years back. The first time Sensex hit 21K. Cut to Jan 2013. Sensex is still below that number.

Jan 2008: 21,206

Jan 2013: 19,580

Cumulative Return including dividend: Near Zero

Cumulative Cost Inflation : Near 50% (At conservative 8% a year)

Now we like to think ourselves as long term investors. But that’s not our idea of long term investing!

But there have been enough wealth creators even from the Top.

Such lists normally have a lot a hindsight bias, but do provide some good hunting ground to see what worked, and which companies are thriving.

So, let’s look at them.

I have taken all companies with current Market Cap > Rs. 200 cr, and compared adjusted stock price in Jan 2008 and Jan 2013, and listed all companies with CAGR more than 12%. I have removed some companies which I found a bit fishy, though some might have still slipped into the list, as I haven’t researched many of these companies.

* For Financials, I have taken P/B and Book Value instead of P/E and EPS. These are marked in blue colour.

** Dividends are additional, impacting various companies’ Total Returns differently.

*** In many cases the starting P/E seems high, but these could be turnaround cases/ with low initial profitability – hence need to be analyzed individually.

Frankly, I did not expect so many companies on the list. There are 123 companies with CAGR of more than 12%, and 54 companies with CAGR more than 25%. Though in many cases, it would have been extremely difficult to forecast the rapid earning growth, or current excessive valuation multiple in order to imagine the high returns.

Of course, a large number of companies are consumer names, given the current stock market fancy. Also, such companies tend to perform relatively better in a tough economic environment, which we have been facing over the past few years. The list between 2003-2008 would have been quite different.

What is surprising is the low rank of HDFC Bank (14% CAGR + Dividend) and HDFC (7% CAGR + dividend). While they continued to grow at fast pace (20-30% like a clockwork), the initial high valuations took away all the juice, and turned them into growth traps.

How to use such lists:

1. Many of these are good strong companies (right combination of business opportunity, moat, management), and need to be studied and bought when available at attractive valuations.

2. Have a special look at companies which are trading at lower valuations than Jan 2008.

3. If many of these companies could have made money from the market top, they could have created even more wealth from more attractive valuations (or in a SIP fashion for impatient investors).

This is in spirit of how Mohnish Pabrai illustrated the difference between Graham and Munger style of investing. He said – ‘Graham goes to the supermarket everyday and sees what’s on sale. Munger decides what he likes and wants to buy, and then goes to the supermarket and sees if it’s on sale.’ (Sounds a bit condescending on the Father of Value Investing, but should be seen in regard to the approach and not the personality).

Some Big Caveats:

1. Such list are very much dependent on beginning and end dates taken, so we need not take the sequence very seriously. E.g. If we had taken ending period as Jan 2012 instead of Jan 2013, the list would have been quite different.

2. Also, not all the companies on the list, irrespective of the CAGR, are equal. Some had higher probability/ visibility, and could have accounted for a far bigger investment bet than others. And size of the bet is more important than few extra percentage points of CAGR on lower allocation.

3. The fact that these companies made money for investors over 5 years does not belie the fact that most of these stocks also fell by 50% or more during the 2008 carnage, and would have severely tested conviction/ courage and also potential  opportunity loss.

As discussed, this is the starting of analysis, and not the end of it!

And I am sure, the list for the period 2013-2018 would be quite different! Call me now if you know any potential candidates :)

Jan 13 13

Portfolio Construction

by Altais

Constructing the right asset portfolio is one of the most important part of investments, perhaps more than or equal to deciding where to actually invest in. The options are plenty – from cash under mattress to fixed deposits to equities to real estate to gold to commodities to art etc. It’s a very personal choice with only one rule, Invest in what you understand well. It’s not a fixed template as most financial planners pronounce. My thoughts on it have evolved over a period of time, and am pretty sure will continue to evolve further with experiences, learnings and lessons.

First, I am a one trick pony, with all my net worth in equities (or cash meant to be deployed in equities), save ancestral property or wife’s jewellery! So I can’t really comment on most asset classes other than equities. Second, I consider only debt, equities and real estate as bona fide asset classes, and rest as speculative or too hard to predict for me.

So, the key questions that we will focus on are:

1. Equity as a part of Net Worth

Of course, it’s a very individual preference but people have very strange formulas.

Equity as part of Net Worth should be (100 – Age).

What about your knowledge about equities, availability of right investment options or the fact that with age, your knowledge about equities will only increase and this is an area where knowledge snowballs?!

I will invest 20% of my net worth or 1 year salary into Equities, speculate with that and Invest balance in safe FDs.

Why can’t you invest the whole amount in moderate gain Equities? Suppose you are successful in speculating, and you earn 50% return on that 20% allocation, and earn post tax 6% on balance 80%, cumulative return will still be only 14.8%, and that is assuming you are right about getting 50% on your equity portfolio every year. Targeting moderate 20% on your entire or majority of your net worth over the long term would be far better. There have been many high quality businesses like ITC, Asian Paints, HDFC Bank, HDFC, Hero Honda, CRISIL which have given these kinds of returns in the past. Of course, you need to study current outlook and valuations before investing for future.

The real determinant of equity allocation should be:

a. Your knowledge about equities (and whether tested by time and vagaries of the stock market)

b. How much time you are willing to commit to this task

c. Your financial net worth – whether financially independent or with laden with high/ uncertain liabilities

d. Correlation of income/ savings with stock markets, in case you are from fund management background/ full time investor

e. Expected Income and Expenses over the short/ medium / long term

f.  Availability of Right opportunities in the market

My personal preference is to invest fully into equities given the right opportunity/ keep cash to invest into equities when the right opportunity comes. Of course, this calls for some safety nets, which I would talk about in a while.

2. Individual stock allocation in Equity Portfolio

People run various type of portfolios – from very concentrated (1 stock!) to very diversified (some stock at 1% of portfolio!!).

Well, this is less strange than the above examples, as there are different equity strategies which people employ. If you buy cigar butts, you have to be diversified. If you buy big moat businesses at reasonable/ cheap valuations, you can be very concentrated. (See for a very intelligent discussion on this).

My personal preference is to be moderately concentrated – around 8 stocks with minimum allocation at 10% and maximum at 30%.

The size of the bet depends on the following factors:

  1. Quality of Business
  2. Margin of Safety/ Upside Potential
  3. Presence of Catalyst
  4. Cash in Portfolio/ expected cash inflow
  5. Alternative Investment Options
  6. Overall Market Valuations

Lot of factors to check :) Actually, implementing it is pretty simple.

These factors also play an important role given the first condition – being 100% in Equities and running a moderately concentrated portfolio. I can’t speculate – either by way of quality of business or by way of valuations. I can’t invest in companies which make my stomach churn, or valuations which make my head spin. I might miss lot of opportunities, and then one can always count on Mr. Market to offer another opportunity.

To quote Warren Buffett, “In investments, there’s no such thing as a called strike. You can stand there at the plate and the pitcher can throw the ball right down the middle, and if it’s General Motors at $47 and you don’t know enough to decide General Motors at $47, you let it go right on by and no one’s going to call a strike. The only way you can have a strike is to swing and miss.”

As it is, we will make some mistakes in investing; we don’t need to compound it further by forced swinging. After all, all we need are a couple of investments a year.

A quick word on how a typical investor’s asset portfolio analysis evolves (from direct and vicarious experiences):

a. When we start investing, we just focus on how much money we can make on a particular stock.

b. Then as we gain some experience, we start looking at how much we can lose in a particular stock before thinking of gains.

c. As we encounter value traps, we start calculating Expected Return : estimated profit on a particular investment * probability of return within definite time frame.

d. Then we come across growth traps, companies where earnings keep increasing but stock remains stagnant due to initial high valuations. We start thinking about how much growth is already priced into stock price.

e. Then we start looking at correlated risks across the portfolio

f. We stop indulging in mental mathematics – calculating current dividend yield on historical portfolio value, selling half of a stock which has doubled and treating balance as free, netting off profits from investment value to lower our “holding cost”. We start looking at potential risk and returns of our portfolio at current market value.

g. Finally, we start evaluating the impact of the potential portfolio increase or decrease on our net worth. That’s where it hits the hardest.

Maybe there a few more stages to cover?!

So, the actual equation becomes something like this:

Happy Investing!