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 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:
- General intro about the company ( Brief background, no. of production facilities, employees, etc )
- 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 )
- 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 )
- 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 )
- 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 )
- 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 )
- 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)
- Name, Nature ( cyclical, secular ), size of industry? ( Own cyclicals when they are ugly and malnourished, not when they are fat and plump )
- 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 )
- 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 )
- 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 )
- Investing efficiency? ( check for ROE, fixed asset turnover , again its a good sign of competitive advantage )
- 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 )
- 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 )
- Funding for growth? ( Substantial funding for growth should ideally happen through internal accruals, avoid companies which only rely on external sources )
- Red flags, concerns, contingent liabilities ( Read notes to account carefully )
- Other important observations from KPI ( Key performance indicators ) sheet
- 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 )
- 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)
- 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,)
- Compensation? ( 3-5 % is fine, don’t fuss too much about this unless there is something obviously alarming, think sun tv network )
- 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, )
- Management / promoters buying / selling shares? ( Naturally, you want them buying and not selling )
- 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, )
- 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 )
- Things which have to go right for you to make money on this idea ( fewer the better )
- Major risks?
- 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.