The moral is - the more you lose the tougher it gets to get back to your original price

Rule No 1: Never lose money 

Rule No 2: Don’t forget Rule No 1 

-Warren Buffett

Can most investors follow the two rules? Not really. Simple behavioral changes can help investors to implement these two rules in their portfolios. 

Consider two investment options, which one will you choose?

The first option offers very large double-digit returns in three years and one large negative return in one year.

The second is a “little boring” option. It offers modest double-digit returns, all positive, in all the four years.

When asked to Choose an option, most investors chose Option A because it shows a higher average return on investments than Option B. 

Take a look at the results which will surprise most investors 

Rs 100 invested in option A became Rs 139 at the end of four years, much lower than Rs 194 accumulated in option B. Option B might look boring, but it is giving very decent stable returns compared to Option A by not losing money.

The point here is to make sure there is no big negative in your portfolio. The idea is to expect and go for reasonable average returns and let it compound over a long term if you wish to make money.


How badly can a single big negative return hit your portfolio?

Suppose if a stock worth Rs 100 falls by 25 per cent to Rs 75. Your stock has to jump by 33 per cent to recover to its original price. Similarly, if Rs 100 stock falls by 50 per cent, it has to go up by 100 per cent to reach its original value. Likewise, if it falls by 75 per cent, the stock needs to gain 300 per cent to recover and if it falls by 90 per cent, it needs to jump 900 per cent to recover

The moral is - the more you lose the tougher it gets to get back to your original price. Little five, 10 or 15 per cent is normal in the market to go down but if you go down around 30-40 per cent it is really hard to recover to your principal.

Preservation of capital, earning a reasonable rate of return and investing in a disciplined manner can help you to avoid big negative returns in your portfolio.

Value Investing

Amongst the various thesis and styles in investing, value investing is very relevant at the moment where the markets have hit a high and there seems to be minimal upside and more downside.

It merits to look at this style where we pick stocks that are trading at a discount to their intrinsic value, offers reasonable margin of safety. Other metrics to look for, is if company is operating in a space that has room for exponential growth, and the overall quality of its business. Generally in markets like today, we will be able to identify such companies which are no so popular and are mid-caps in category.

Better still if such companies are going through temporary disruption or through a difficult period. You get to buy a bargain when the seller is selling in distress. The famous example is of investing in Rain industries which was available at P/E of 1 when the profits were Rs 90 crores and the company was going through disruption. The company then multiplied its profits over the next few years by 10X to Rs 800 crores profits. An investor would have multiplied his wealth 10 times in this period.

The most important criteria in value investment is that the down side should be minimal which makes the investment 'low risk'. As they say, Minimize the downside and upside will be taken care of by the business.

Currently a company in the mid cap space that adds value in commodity space is available for a mcap of Rs 390 crores with headroom for growth. Aluminum is consumed by almost every industry one can think of and offers exponential growth prospects. The business is cyclical as it is closely connected to commodity cycle but available at reasonable valuation. Because these companies are small in size, they have a lot of room for growth and could even become potential multi-baggers. An ideal time frame for which to invest in these companies would be 3-5 years.

As the legendary investor said “Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results”. India continues to offer businesses with prospects for long term growth and opportunities for multi fold returns to investors.

The Best Investments are made during difficult times

As a legendary investor said we are all eager to buy bargains but are not willing to endure the pain of price decline that creates bargains in the first place.

Today, no respectable business is available to be bought with a margin of safety, they are overvalued, so the question is which is the cheapest of the expensive ones, this has led to competition from investors which is driving price up. You have to invest when competitors are not there and not when they are willing to pay up more than you are.

investors are hyper worried they may miss out on the rally and are willing to pay a premium, this can lead eventually to a crash as they run out of funds with strong hands unwilling to back them, and then the same investors will regret their decision and leave the markets thus creating huge value for investors, that’s when bargains will be available

As the markets decline, the risks also vanish, on the contrary as the markets spike the risks only increase. A bull market lays the seeds for a bear market and is preceded with the Suspension of all logic in valuation or financial analysis, saying no price is high for this great company.

And suddenly the future changes in unexpected ways. A brief history look up says that the entire business idea itself has disappeared from the canvas, let alone successful businesses, as a result of unforeseen changes and newer ideas replacing them.

People get lucky but they think it is skill. Hyper growth is risky, the best growth is that which is profitable and that can be financed by a company by its own internal resources.

Bruce Greenwalt said growth is not worth very much unless the profit is at the margin they are already doing and can be financed without weakening the balance sheet.

Many Indian companies chase growth blindly by taking on debt and weaken balance sheet or sacrifice incremental profitability for that growth which both leads to unhappy outcome. So growth should be such that capital efficiency is not affected.

Experience has shown the futility of forecasting. When everybody forecasts the same future and it turns out to be so, there is no profit to be made as the probability has been discounted. However when someone is able to forecast a very contrarian view and that turns out to be the outcome, there is profit to be made, but such forecasts can rarely be consistently made and hence it is pure luck.

Today most investors are knowledgeable, thanks to the internet and ‘forward the message’ culture. But what we lack is the judgement and discipline which is a fine art. As Edgar Wachenheim puts it, Knowledge is knowing that Tomato is a fruit, Judgment is not putting it in your fruit salad. To have good judgment you need knowledge + common sense, stable emotion, confidence and a sixth sense.

Carpe Diem

The addressable market-size is the base foundation on which successful businesses are built. In the last 5 years, we have seen that companies like Page industries, which commands high valuation, have continued to grow and offer profits to investors. They were able to grow owing to the large size of the addressable markets that they were in. The story is about where you can go, and not about where are you today. We are constantly in search of companies that are hungry to go far, and when this is coupled with a market that is large enough to grow and a management with a growth mindset, there is no stopping them. Look at Suprajit Engineering, which has delivered in excess of 300 times since listing, or Page or Edelweiss- these are examples of compounding machines, because they were in businesses that could scale. So while evaluating a stock, it is important to estimate the size of the market at a future time and see if the business can have a long runway, so that the stock (business) can compound and create value. The essential question is therefore whether the market potential for the business can become very large.

The character of the management and the economics of the business will be the catalyst for compounding. Take the story of TTK Prestige, the cooker business that was impacted by what we refer to as “value migration”. The onset of nuclear families meant that more people will need cookers. So the trend was that of nuclear families, and the outcome was a long run-way, where companies manufacturing cookers could sell more for a long period of time, as the size of the market expanded.

The “New Generation” business offers an opportunity in outsourcing: companies like T Q S are in the range of 4000 crores to 14,000 crores MCAP. We do need to visualize which of these could grow 2x or 4x in the very big pond of outsourced services, staffing and facility management. For instance, we are witnessing a one-time opportunity in ARC resolution, that Uday Kotak calls a “once-in-a-lifetime” opportunity. (Article link here)

Here we see an E NBFC that has put up a system in place to capture the ARC headroom for growth and is available at a reasonable valuation compared to the growth opportunity; and with a market cap of 24,000 crores- run by a management with vision and integrity.
A growing company needs a large opportunity-size for it to sustain high growth and become a compounding machine. There is a trap in this that sometimes, large market-size does not necessarily contribute to profitable growth like we have seen in the education sector, or in the retail. Merely a large opportunity size is not sufficient; the business should have the right character to seize the moment.

How to make multibagger returns

When the market has been going up in the recent past and many stocks hit their all time highs, its definitely time to be cautious. As an investor said "The best of times always seed the worst of times in the life of every investor. Life turns 360 degrees when you least expect. Something every investor must remember as things seem to only get better with every passing day". This can’t be truer than now. Companies that are making profits are getting crazy valuations and investors are in a hurry to buy at any premium even while many of them were languishing at lower prices only a few years ago. 

Ace investors who believe in making multiples of returns, know this is not a buyers’ market and prefer to look at businesses which are out of favour, making losses but have prospects of turning around. Some believe that luck is imminent to finding multibagger stocks.  Still we can put some method to the madness.

First the stock must be quoting at its lowest in its recent history, which could happen only when the business or the sector is in negative momentum or sentiment like what the pharma and IT sectors are today. Or if the company has huge debts and making losses but has strong management which can make it turnaround in the future. If you are catching a fancy stock chances are that it is already making highs and you might have missed entering at a right value. I know of an investor who invests when company is doing at its worst or near loss making and then he believes they will turnaround because they have a capable, trust worthy management and a ‘spark idea’ that will turn them turnaround.  This forms the basis for long-term high returns and multibaggers. 

Joseph Mazur in his book explains the difference between a coincidence (a meaningful conjunction of things without any apparent cause) and a fluke (an improbable outcome the cause of which is clear – such as a multibagger returns, where buying the stock is what makes the win possible)

The Art of Attracting wealth is Knowledge and Expectancy

Most popular question from a stock investors is "when will I see growth of my portfolio?", very often this question is within a couple of weeks if not months after investing. Otherwise it is from an anxious investors who calls up worried about a decline soon after making his investments. The expectation from almost all is that the stock should never decline and must shoot up immeidiately after investing. No one can answer these questions to the satisfaction of an investor who has not based his investing on knowledge, hence this blog.

As Graham said, the investor has the choice NOT to follow what the market is doing now! The primary reason for investing faliure is because an investor is paying undue attention to what the stock price is NOW. Instead the investor must focus on where is the company headed in future, couple of quaters and years down the line. Is the management capable of seeing the changes and are competent to spot and take advantage of the future opportunties. There are challange in every business, but capable management will ride through tough times and prepare to grow in the best times. To give an idea of business cycles and how managment should take a view and excute for growth, take a look at the Letter from Edelweiss financial services. 

There are various philosophies to invest, some focus on investing in companies selling at very low multiples of assets , earnings or cashflows. Others look for undervaleued small companies and wait for their revival. Then there are those that look at margin of safety coupled with detachment from the market but with great emphasis on future growth. There are investors with no time compulsion who look at making VC type multifold returns, they look at the right stocks which are in negative momentum and at a multi year low. They go against the tide as to capture the larger part of the rally during the growth phase.There are those who avoid profit making companies but run by clean managment with potential to come out of the red, they buy when the stock is making a loss and wait for years to make serious long term return.

Each investor has to decide which style will suit his personlality, this can't be borrowed knowledge and he has to build his individual conviction. If shortterm dilution in value keeps you awake, look to exit the stockmarket and invest where you understand and feel secure.

If you have not experienced a bear market phase that can last for years, it is easy to delude yourself that you have nerves of steel. Reality can turn out to be very different making you to exit at the first drop in prices and causing avoidable losses.

Expectancy : you must expect to be wealthy, as Al Koran said, when you were young,  you expected money form your parents, uncle, aunt who came home. The expectancy got us the money. The magic of getting in expectancy.. and Knowledge of course

How to value a stock? The complex game of mind and accounting

There is too much focus to today. As in there is great interest to what is happening now as opposed to how things are going to shape tomorrow. Infosys results is the case in point. Why so much of interest in going into this one bad result?  Are we missing out the bigger picture and log terms prospects of the business?  While I am not specifically sure about the particular stock or the business, one thing is sure as a pattern, stocks go down a lot but they will go up a lot more – if the future prospects of the business is positive. Is the company in a high growth business? Is the total income increasing continuously? Is the EPS growing aggressively? Is the Profit after Tax growing? What is the ROE?  How much intangible value is acceptable? Often a stock sell off is never because of investors who have answered these questions.

How to value a stock? Accurate valuation is difficult. One can look at the above factors, dividend track record, its place in the industry as size matters, governance, institutional holding.

Is it a good time? One can achieve this methodically by stock diversification and time diversification.

Entry price and exit price band can be evaluated by finding the intrinsic value of the stock or a discounted cash flow analysis.

Then of course one has to understand the economics of the business. There is a very huge sector of trades, hotel, restaurants, transports which are non-corporate. There is a huge opportunity to corporatize these sectors in the next decade or two. Investing in these sectors can lead to huge wealth creation. Any business will have a life-cycle of growth and after that it can stall and fall apart. The stock market generally moves up because the old and aging businesses are replaced by faster, newer and innovative companies. The innovators and disruptors have growth ahead of them and we must be invested in them. The needs of people are few but wants are many. The successful companies cater to the wants of people through their brands and marketing.

Learn how the stock market really works, the dangers, the opportunities, common mistakes and how to overcome them, the mental attitude to succeed in stock market. Register for a free learning session and discovery into the modern investing at research@learnivest.in

 

When do you decide ?

Repetitive decision making takes its toll on the decisions. The energy levels and time of day when you make decisions also impact the quality of analysis. Researcher Jonathan Levav analysed 1112 parole hearings assigned to 8 judges. The Judge's pace of decision making was grueling with 6 minutes to make a decision. The impact of the study is interesting for the investing world, the chance of a parole being released was as high as 65% in the mornings and after breaks and dropped to near zero at the end of the day, when the will power and energy was sapped. He concluded that we revert to default decision making when the process is repetitive and will power is low.

In the investing world, a person who is regularly taking decision & analyzing the volume of information or reversing his previous inferences will suffer the same behavioral obstacle. Mind is a monkey whose priority keeps changing with times. A learned investor has to chain the urge to change the opinion every once in a while. Give time for businesses to perform once you have made a decision based on wise counsel.

The story on this Stock was based on this principle. Avoid too many decisions or doubts. As you can see form charts the stock did not give good returns for 3 years between 2011 and 2014. Since the decision basis to invest in the stock captured in the Blog written 5 years ago did not change, there was no need to revisit or make new decision. In the period from 2014 to 2016 the stock gave 400% returns. 

We tend to revisit the stocks that we hold if they do not give paper returns in a few months if not week. We must resist this temptation to look at the stock price and continue to look at the fundamentals of the business. Lets move from being Stock investors to business investors.

By investing in such sound businesses, the risk and downside is reduced, when you manage risk, it manages the returns. 

Read more about this here 

Future of the Stock

A Value Stock is the one which trades at a discount to its intrinsic value. The intrinsic value can be found out through future cashflows or dividends or by using a discounted cash flow analysis. such stocks exhibits high dividend yields and lower price to earnings ratio. The intrinsic value of a stock is based on the future prospects and predictability of earnings. Many of us look at the past earning and history of performance but this in my opinion can lead to a trap. Business landscape today is changing so radically, the past formula of success is being re-written. Technology, changing demographics play a crucial role is such unprecedented change. So the value of the company is based on the future earnings and performance which should be the new reference. Recently we sold most of our holdings in a FMCG company that we held for almost 4 years. The earnings had not only deteriorated in the past few quarters but we see a huge dilution of demand. This company had grown at rapid pace for the past several years and likely to see slackened future earnings prospect, a good enough reason to sell the stock. In the portfolio, we have replaced with a Finance company that we believe should offer future prospects.

How does one predict the future? Some businesses especially technology firms believe you create a future by disrupting the present. Visionary business leaders have the magic eye to see what is changing and adapting their business models to take advantage of such changes. With such changes we will see value migration that will result in huge uptake of demand. A well known example is the how the nuclear family lifestyles has created demand for cookers. More nuclear families meant more cookers. TTK Prestige was able to take advantage of this change is lifestyle by launching products that looked and felt better. But companies like Hawkins failed to take full advantage of such changes.

The opportunity is the same for the market, but the management that has an eye for how the markets will change are the ones that will succeed.

In the Banking industry HDFC bank has proven how they could anticipate and manage change better than others. But Change is constant and so will have to be the management to keep ahead of change.

On a side note, Lupin drew some negative attention correcting by a whopping 40% in 6 months. Do we see value in it at 1300? 

Check this Video to see how they are managing the change 

Make the most of it !

The best investments are done during times of uncertainty and tough conditions. Market overreacts to good news and bad news. They respond more strongly than what is appropriate. That's why when Modi took over almost 20 months ago, it touched an all time high with out any change in business fundamentals. Today it is overreacting to many negative cues on global as well as domestic fronts. These are cycles and while we can't predict accurately when the direction will change, one thing is sure. In the long run, markets will behave rationally. The broader markets have come down by about 20% from its peak without considering long-term market prospects.

Some of our best companies whose stocks we hold, have also corrected significantly making them juicer. It requires a clear mind void of confusion and one that appreciates 'business like investing' to identify the opportunity. The same market that behaves in an irrational manner will be rationale in the long run, the ones who understand this will profit immensely. Again this cant be borrowed belief, it has come from ones own experiences and analysis. 

We have seen world-wars, Lehman crisis, terrorist attacks, but we are doing well. That's the nature of the world and business. As the RBI governor rightly summed it up, The Stock Plunge is a market problem, Not Economy's. We must differentiate between market sentiments and business fundamentals.

Invest when times are tough and there is no better time than today. We need to be mentally prepared to do this as we normally get swept in the emotional turbulence. You can start by looking at recent looser, stocks that have been battered between 20% to 50%. Make a list of stocks that you wanted to own but found them expensive in the past, they might have become reasonably cheap. Make the exercise objective and attach no emotion to this. The Sale is on

For help and a list of stocks that we wanted to own and are on sale please email research@learninvest.in

Trends and Off Trends

Microfinance, Real-estate, Hospitality and Publishing are now not really in the trend. But these provide reasonable margin of safety on stocks of some good companies. A microfinance glut and government apathy turned this into a spoilt broth, but there are opportunities lurking here with companies that have grown at 60% CAGR and long lived for 25 years with legacy. The sectors such as real-estate too have some good beginners with ethical practices that can grow very big in the coming years. This is time when we can invest in these companies as the sectors are out of fashion and hence beaten down stocks provide a good degree of margin with limited downsides. These stocks are quoting at reasonable valuations at current prices of of  360 and 1300 respectively. They are likely to grow and create wealth for the contra-investors.

Same with new trends that will become main stay. When Infosys leveraged on the trend of services outsourcing, it was a new trend that made wealth. Today the world of  Big Data and cloud will turn to become mainstay in the years to come as many enterprises adopt them for their business. There are 2 companies that have very unique positioning in the market today and will likely get bought out or grow organically. We look at the size of the opportunity here, how big is this adoption going to change the quantum of revenue and earnings. Mere growth is not sufficient, this growth should bring more economic value to the investor. Economic value is created when the return on capital is more than the cost of the capital, while the company continues to grow. So we need growth with economic value being added.

As a long term patient investor, you need to continuously water plants while cutting of the weeds.Our economy is on the upswing if you ignore the immediate issues at hand. Our duty as investor is to look for great businesses run by capable management of integrity and with execution skills that result in consistent and profitable growth. The business that have longevity, predictable performance, large opportunity size.

To know of the stocks discussed, please mail us at research@learninvest.in

Check blog The Money Making Machine

The Magic Formula

Greenblatt presents a “Magic Formula” for buying good companies at good prices. A good company and good price is identified based on two financial ratios.

 (ROIC)  Return on Invested Capital represents “good company” while Earnings Yield represents “good price" 

ROIC tells us how much cash a business is able to generate in relation to the capital invested in them. As an investor, it means how much money you are able to take away from the business in relation to what you have invested.

 Earnings Yield tells us an an investor how expensive the company with respect to the earnings it generates.  Is a rupee worth more than or lesser than itself at the given instance. This is a key ratio to determine an investment.

The Magic Formula considers these ratios in equal weight and ranks all companies as Good Company (ROIC) and Good Price (Earnings Yield).  Their ratings on both counts are added together.  As per the formula, the investor buys and holds the companies with the best combined rankings for a period of only one year. He then sells them and does the same allover again. This method is clean and simple, yet effective for someone who wants wants to learn about investing. You can start by reading the little book on investing.  

In India, we need to consider an important parameter, which is quality of the management. We have to consider management that are highly focused and believes in allocation of capital. Companies that dilute equity very often will not reward investors.  As a noted investor quoted about JSPL, a company operating in a sector where there external problems. the company although is in the commodities (steel & power) had returned a CAGR of 37% over the last 15 years (share price from Rs 1 (2001) to Rs 156 (2014). It goes to prove that if the management is good, it can grow and survive in any market.