The Interview

The market is similar to an ocean, there is just too much information to assimilate, process and analyze, an investor needs to make sure he/she is on the right kind of a boat while traversing the rough ocean waters.

Recently, I was re-reading some of the very insightful interviews of reputed investors which Vishal (Safal Niveshak ) has been gracious enough to share with. This gave me an idea to conduct a small experiment

So my friend and I decided to conduct mock interviews of each other, to better understand our thought process, I have listed some of the questions we covered:

  • Why do you invest in the stock markets? Isn’t it too risky?
  • What stocks do you usually invest in?
  • Where do you find good investment ideas?
  • How do you decide which ideas to buy and which ones to let go?
  • What are your return expectations from the markets?
  • What???? Just 20% P.A, don’t you think you should be making more, at least wanting more?
  • What percentage of capital is allocated to each idea of your portfolio?
  • Do you buy into the full position at one go or in stages?
  • How do you decide when to add more to your existing holdings vs adding new positions?
  • When do you sell? What factors do you consider before selling?
  • Do you sell the entire holding together or in stages?
  • How do you handle your emotions when stocks you own are losing or appreciating in value ?
  • How do you develop conviction to hold on to stocks in spite of a huge up/down move?
  • What is your typical holding period?
  • Do you meet management of your portfolio companies?
  • What has been the worst performing stock idea for you?
  • How do you ensure downside protection, prevention of capital loss?
  • How do u handle and process the constant stream of information? How do you cut down the noise and clutter?

And so on…

To my utter disbelief I flunked this interview big time, I realized, I had no objective and concrete answers to most of the questions above.

This was a great learning experience, it forced me to think these questions through, I sat over the following weekend and wrote down the answers to each and every question, not only did I feel more confident but it made me more aware of my temperament and inherent personality as an investor.

The future is unknown and unpredictable, however managing risk is something we can control and influence, writing and documenting in detail, your entire investment philosophy and process can take you one step closer to that, it forces you to acknowledge the chinks in your armor and rectify the errors in your decision making process.

Go ahead, see if you can pass this interview, if not introspect. Repeat.

The Reading dose – 5

Another one in the series:

  • Emerging markets -1: This one is written by fellows at poseidon financial and has some really great insights to offer, do give it a read
  • Emerging markets -2: Another post from them, very insightful
  • Do something bias: This one is written by Anshul at Safal Niveshak, its an awesome read
  • Musings on markets: This one took me a long time to read, my 2 cents, read it slow and absorb it line by line ( Don’t miss the video )

 

Dangers and Hazards – 1

It’s been almost 2 years since I gave up watching or reading news, I know it sounds weird and often I end up twiddling my thumbs and have nothing to say in a passionate discussion on Narendra Modi / An overhyped murder case / State and future of the economy, you get the idea.

I may be wrong and I often am but I don’t regret one bit of having taken this step.

You see most of the so called news that we watch or read is actually more of a super-opinionated orgy, I don’t blame the channels, they produce what sells and people want this stuff.

Another aspect is, understanding – what kind of news actually sells? a simple answer is BAD, DISTURBING & SENSATIONAL.

You are continuously fed over-hyped opinions of disturbing and bad events occurring around you from people you don’t know, ask yourself, do you really need this?

Now let’s think about the consequences of investing based on news-flow, trust me and I am not wrong – It will ruin most. (Few are lucky).

A simple solution which I find extremely useful is that I seek out only that information which can add some value to my life,as an example, I read investing blogs, follow works of interesting people and companies, study business models of various sectors and companies, read trade journals, watch movies etc, internet makes all of this possible with ease, this line of thought keeps me away from most clutter, helps me relax, release some stress and enables me to focus on important tasks.

Of course there’s a risk of twiddling thumbs at dinner table conversations but it’s a small trade-off, if you ask me.

 

 

 

Greed is good?

 

Would you sell your house in exchange for a few flower bulbs? , No? If I had put this offer across 375 years back in Netherlands (Holland), you probably would.

For those who don’t know, I’m referring to Tulip mania”, one of the first economic bubbles in recorded history. Tulips were originally introduced to The Dutch by the Flemish botanist ~ Carolus Clusius in the late 16th century, It was unlike any other flower known to Europe at the time, it soon rose in popularity and became a status symbol among the rich and affluent.

It usually takes between 7-12 years for the seeds to grow into flowering bulbs, so you can imagine the scarcity in production in contrast to the prevailing demand.

Combined forces of their demand, rarity and time taken to grow these beautiful and exotic flowers caused prices to rise dramatically over a period between 1600’-1636’. This hike in prices was fueled by speculative trade, traders and merchants entered into formal futures contracts to buy and sell bulbs at the end of the season, what is more surprising is that neither party paid any margin money or mark-to-market margins, only a paltry deposit- “Wine money” prior to entering into a contract.

Things got out of hand when at its peak a single tulip bulb sold for more than 10 times the annual salary of a skilled craftsman, sometime around 1635, 40 bulbs were exchanged for 100,000 florins which equates to 2500 florins for a single bulb, For that amount  you could buy all of the following:

2 Lasts of wheat 448 f
4 Lasts of Rye 558 f
4 fat oxen 480 f
8 fat swine 240 f
12 fat sheep 120 f
2 hogshead of wine 70 f
4 tuns beer 32 f
2 tons butter 192 f
1000 lb. cheese 120 f
A Bed 100 f
A Suit of clothes 80 f
A Silver drinking cup 60 f
Total 2500 f

 

*Courtesy Wikipedia

By 1636, it wasn’t just the traders and merchants involved in this rampant speculation, the common masses  joined in too, so much so that people ignored their primary occupations and participated in Tulip trade. In the last few months leading to the subsequent crash of this irrational euphoria, the prices of tulip bulbs rose by close to 20 times.

Tulip trade reached its peak during the winter of 1636’-37 and had attention of the entire nation. February 1637, tulip bulb contract prices suddenly began to fall, and no deliveries were made to fulfill any of the contracts, this lead to free-fall in the prices of these bulbs, the market for “Tulips” evaporated overnight, there were simply no buyers for any contracts any more, only sellers. There was widespread panic and merchants turned to the government for help. Tauntingly, the Government announced that anybody could pay a 10 percent fee and void the contracts; the courts of law wouldn’t help either as they termed this activity as “Gambling” and declared that these contracts weren’t enforceable by law. This led to further fall in Tulip prices, any attempts to reach an agreeable solution failed and they couldn’t find any brakes to halt or even slow down this continued fall in prices.

The mania finally ended and People were left with flowers, worth a fortune just a few weeks back, now fetched a fraction of that amount. The Dutch economy was in recession for a few years following this event. The market values of various commodities was questioned, people were now fearful and more cautious than ever.

Think about it, Prices of these bulbs which took years to appreciate and rise in value were beaten down to almost nothing in just a few weeks.

At the crux of this incident lies a very basic human instinct and emotion ~ Greed. It’s a drug which you simply can’t afford to abuse.

 

* Primary source of facts and figures – Wikipedia. 

 

Keeping it simple!

 

Investing can be as simple or complicated as you make it to be. I’ ll share a personal example:

I used to be in awe and often get overwhelmed on reading these brilliant analyses of companies and concepts on various blogs across the internet, ” Wow how am I ever going to get so good” or ” I am going to start reading 6 hours a day, everyday (orders top 10 recommended books from Amazon)”.

After passing through a period of mindless reading and running about to various seminars ( which promised the fruit of identifying the next multi-baggers ) in the pursuit of gaining nirvana, I ended up with a 10 page framework and check list to analyse companies. I thought to myself ” Now, finally I am going to crank up those returns and become the best money manager ever”

This feeling did not last long, for 2 reasons:

  1. As I progressed, I realised that most of it was repetitive and as a result I had to think and write the same points over and over again and it took a really long time to finish researching a company
  2.  The framework itself was so vast, it was intimidating, most times as I sat down for research, to my surprise, I was bored rather quickly

On some introspection, I understood the following:

  1. Your only competition is yourself, focus on absolute returns
  2. Understand that knowledge grows gradually with time and experience
  3. Reading the wrong kind of stuff is very dangerous
  4. Reading too many books too soon will not add optimum value, it takes considerable time to absorb concepts and ideas of each book, relax there’s a lot of time, one book at a time, slowly
  5. If the idea is not appealing within the first 30 minutes of the time you spend understanding it, it probably never will be
  6. Luck plays a huge part in determining returns, it is often futile to know everything out there
  7. You are not really investing in the business itself but on the probability of the business doing well in future
  8. Your investing strategy must suit your temperament, different things work for different people, find what works for you
  9. There is no superior or inferior analysis, only returns

So what do I do?:

  1. I read about 1 book every other month(related to investing) and I am really choosy about what I read
  2. My investing framework is only 2 pages
  3. I usually complete my homework on the company within a couple of days max
  4. I try and know enough to understand if the business is going to do well 3-5 years out, My focus is generally on the larger picture
  5. I avoid crunching too many numbers, future is unknown, I’m good if I like the business model of the company and the people running it
  6. I allocate minimum capital at the start and keep adding and averaging up as and when I get more comfortable with the business and the management
  7. I follow very selected blogs of people I admire and which I believe can add good value to my investing life
  8. I don’t watch stock prices very often specially of companies I am invested in
  9. I often write down stuff rather than typing

The investing process has to be fun, engaging and most importantly simple!

Hope this has added some value to your investing journey!

Happy investing!

 

 

The reading dose – 2

Here’s another set of articles and material which I have found very insightful and interesting.

1. The 400% man: This one is a very inspiring read, it’s about this guy called Allen Mecham, who, without any college education, no wall street contacts, operating from a small town in Utah ( USA ) beat most of mutual funds on wall street over the past 12 years, it teaches the importance of hard work, discipline, patience and simplicity.

2. Investing framework: Having a good framework to scrutinize ideas and companies is a must for any investor, this article has provided me with great insights and guidelines in order to deepen my understanding of ideas I am working with, I have used many of aspects of this in my own framework of analyzing ideas.

3. Finding Value: Whenever I get tempted and need to find my shoes on the ground, I visit Base hit investing, it really helps me stay disciplined.

4. Rejecting a stock: This remains one of my most favorite blogs to visit for deep insights into investing, this article deals with developing a framework to reject ideas, it’s a brilliant read, don’t miss it

Reading such material provides the foundation to building a good investing career.

The other side of risk

Risk is often assumed to be “volatility” (measure of variation of price over a period of time), which is quite bizarre, ask any trader, for him / her it is bread and butter. 

Volatility in stock prices creates opportunity, your actions create risk.

So what is risk

One aspect of risk is loss of capital, so when we buy into something which has a high probability of faltering and going down we tend to take more risk ( think : buying IT stocks ’99, real estate and infra ’07 )

There is another aspect to risk which tends to get sidelined.

Picture this, there are ~5000 securities to choose from (India alone), As long term investors, we will typically hold ~20-25 ideas in the portfolio (beyond which diversification loses its significance).

We are betting on the fact that this small portfolio at any given point of time, comprising just 0.5% of the overall universe of stocks available will beat the market consistently over the long run (Only referring to long term, not the short term variations)

  While buying into an idea we are faced with two kinds of risks:

  1.     Loss of capital: Risk of downside from purchase price
  2.     Opportunity risk: Risk of under performance relative to better ideas

So let’s say, I bought Reliance Industries in the 1st week of January, 2009 at ~Rs.700, 1st week of January, 2015, price is ~Rs.930, so 6 year CAGR works out to be ~5%, my fixed deposit did better.

There is no loss of capital and I even got dividends, however it turned to be a poor investment decision, opportunity risk was very high (think: returns in Pharma, IT in the same periods)

Historical market returns have been ~16%, our portfolio has to beat this to justify the extra effort and risk.

We have to find ideas where the risk to capital and opportunity are low and consequently the probability of market beating returns higher.

 

Investing Framework

The information overload we face can be quite overwhelming, I find it really important to have a framework in place to filter and crystallize ideas, it enforces discipline.

Below, I have tried to consolidate my process to make an investing decision ( Seasoned and brilliant investors have helped me in this process through their selfless sharing of knowledge )

BUSINESS MODEL & INDUSTRY ANALYSIS:
  1. General intro about the company  ( Brief background, no. of production facilities, employees, etc )
  2. What is the business model? do you understand it? ( If you don’t understand it that well and if you still want to buy it, make sure the price you pay is really less compared to value )
  3. Is the business scalable? Can the products find a large number of customers? ( This is important, however again, if not scalable make sure you are buying with lots of operating leverage on the upside and current utilization is low )
  4. Where does majority of the business come from? ( Geography, clientèle ) ( It helps when client profile is well spread out and diversified in numbers as well as across geographies )
  5. Existing market share? expected 5 years out? ( Better if increasing, at least it must be stable, very difficult to make money of declining market share companies )
  6. Is the business capital intensive? ( Lesser the capital intensity the better it is, if you must buy a capital intensive company make sure, CFO, interest coverage is high and debt as low as possible and not to forget make sure you don’t pay a bomb to acquire it )
  7. Is the business heavily regulated? ( This is a good thing and a bad thing, good thing as it acts a entry barrier, bad thing because recurring interference is a pain, think airlines, alcohol, oil & gas etc)
  8. Name, Nature ( cyclical, secular ), size of industry? ( Own cyclicals when they are ugly and malnourished, not when they are fat and plump )
  9. Business ecosystem ( This is important, don’t be lazy, it’s going to throw useful insights into the business, preferable do this at the last just before the expected returns module )
FINANCIAL ANALYSIS:
  1. Growth in sales, profits, production capacity, realizations? ( Growth in all is very important, again if currently there is no growth make sure there is good build in operating leverage built in )
  2. Operating efficiency? ( check for margins, receivable, inventory, payable days, this is a good indicator to identify if the company has some edge over its competition  )
  3. Investing efficiency? ( check for ROE, fixed asset turnover , again its a good sign of competitive advantage )
  4. Capital structure? frequent debt & capital raising? ( raising too much debt is very risky and diluting equity too often is not a healthy sign, avoid both unless compelling reasons are there )
  5. Cash flow generation, free cash? ( very important, avoid companies that do not generate cash flows from its operations, free cash is a boon, market will always provide rich valuations for FCF + companies, also a sign of competitive advantage )
  6. Funding for growth? ( Substantial funding for growth should ideally happen through internal accruals, avoid companies which only rely on external sources )
  7. Red flags, concerns, contingent liabilities ( Read notes to account carefully )
  8. Other important observations from KPI ( Key performance indicators ) sheet
MANAGEMENT ANALYSIS:
  1. Key people in the management, promoter holding? ( Do some back ground check on key managerial personnel, promoter group ideally should have reasonable amount of their wealth tied to the company )
  2. Project execution & business expansion history? ( Timely execution of projects and expansion activities says a lot about the management, also check how management has tackled recession and problems in the past)
  3. Any deliberate adverse action against minority shareholders? Related party transactions? ( Watch out for amalgamation of subsidiaries, preferential share allotments to promoter group, too many related party transactions etc,)
  4. Compensation? ( 3-5 % is fine, don’t fuss too much about this unless there is something obviously alarming, think sun tv network )
  5. Ambitious? pursuing profitable growth? any diworseifications in the past? bad acquisitions? ( Beware of management getting carried away by growth, eventually many end up in a mess, think DLF, suzlon, ADAG companies, having said that also avoid companies with no ambition at all, think GM breweries,  )
  6. Management / promoters buying / selling shares? ( Naturally, you want them buying and not selling )
EXPECTED RETURNS:
  1. Brief note on why you want to buy / sell / hold ( If all / some of the above segments are in bad shape, there better be a really good reason for you to buy this company, for eg if a company is facing some temporary headwinds and has a strong probability of recovering think wockhardt, mcx, )
  2. What kind of upside is probable in future? Expectde returns? Approx time frame? ( if <100% in 3-4 years forget about it, look for something else, again there are always exceptions )
  3. Things which have to go right for you to make money on this idea ( fewer the better )
  4. Major risks?
  5. Under what circumstances would you sell? ( This is perhaps one of the most critical aspects of investing, risk is not only loss of capital but also loss of opportunity )

 

P.S : I am learning and evolving as an investor, constantly trying to improve, hence this framework is subject to changes. 

The Reading Dose – 1

Just a small compilation of some very good articles and posts I have read over the week :

1.  What happens when you lose sight of prudent risk management  – Disastrous story of a fund manager who lost close to a $100 million in a matter of weeks.

2.  Another brilliant post from Prof. Sanjay Bakshi – This time its an idea from the e-commerce sector, it’s a brilliant read.

3.  How to spot a 100 bagger – Raamdeo Agrawal on how to spot large trends and companies with huge potential,  make sure you read this over the weekend.

4.  Keeping things simple – Immensely insightful post from on of my favourite investing blogs, more often than not,one needs to weed out all the clutter and keep things simple and straightforward.

Adapt or Perish

Investing in capital markets is a RISKY business.

Not committing a decent portion of your wealth in equities is one of the largest sources of that RISK.

I stumbled upon a useful insight recently.

“A well-functioning stock market is the best medium available to adapt to the ever-changing dynamics of the world.”

Most of us work in industries which focus on providing very specific products or services, for e.g. real estate, IT services, pharmaceuticals, banking etc. Essentially we devote significant resources including time and money to hone a very specific skill set required for advancement and success in our professional lives.

The world is changing much faster than it used to and business cycles are shrinking, new technologies are re-shaping the very fabric of the business environment

It’s all too overwhelming, businesses which enjoyed huge monopolies are now faced with stiff competition, entrepreneurs are required to adapt too fast ( Think: textiles, real estate, stock broking, impact of e-commerce on brick & mortar retail )

Stock markets provide a very natural and an efficient hedge against this, with a decent mind and a rational perspective, you tend to invest in good businesses which are likely to perform well in future, in this pursuit you will pick up emerging companies of tomorrow and not yesterday.

It’s not surprising that the equity market is the best engine of wealth creation amongst all asset classes over a multi-decade period.

It’s also a pity that only ~2% of India’s population currently participates in the capital markets.