Category: Investing Process

Using secondary Information

Using secondary information is one of the best sources to top up our investment hypothesis, I have previously written on it here & here . One of the best sources of secondary information is research done by others, especially brokerage houses who do a good job and not one’s like this.

Recently Nirmal Bang’s Gaurang Dadwal & Akhil Parekh did an excellent initiating coverage for Atul Auto. This is close to the best investment report you will find freely from brokerage houses.

I have highlighted some of the new things that I was not aware about the company (Like they are paying more than competitors for engine) and have also tried to highlight how I read these reports – questioning, understanding, highlighting, scribbling until and unless I feel, i have got most out of it.

Download part 1 and 2 and share your observation and learning in comments
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Learn to evaluate management

Evaluating management is one of trickiest part while building an investment case. Especially, when it comes to small caps and mid cap companies run by first or second generation promoters, were much information about them in not available publicly.

Also many of retail investors don’t have privilege to meet management, time to attend AGMs and question management over quarterly conference calls (if they do). So how does one evaluate management ?

Well I don’t have a panacea but in this post we will try an establish a process which can give us reasonable ammunition to understand and evaluate management. As an investor you start with a hypothesis that management is honest, able, trustworthy and intelligent and then as you run a series of checks, you may find that one or more components you wished for are missing therefore at the end of checks you can take a call whether you want to partner with such management or not.

While there are numerous parameters which you can use to evaluate management quantitatively we believe below are good for a start

  1. Depth
  2. Integrity
  3. Disclosure Norms
  4. Compensation
  5. Skin in the Game
  6. Regulatory compliance issues
  7. Walking the talk

 

Depth – While evaluating depth … Read the rest

How to evaluate a CEO’s capital allocation skills

Read below excerpts from Warren Buffet’s share holder letters

Over time, the skill with which a company’s managers allocate capital has an enormous impact on the enterprise’s value.

The lack of skill that many CEOs have at capital allocation is no small matter: After ten yearson the job, a CEO whose company annually retains earnings equal to 10% of net worth will have been responsible for the deployment of more than 60% of all the capital at work in the business.

 

Now pause and reflect, how often financial pundits talk about capital allocation skills of a manager when they are evaluating a CEO or MD of a company, not often. In fact a lot of reported results and press releases focus on earnings and sales, while the crucial capital allocation decision and their consequences are missed.

In this post we would learn through an example on how you can assess a management’s capital allocation skill though reported numbers. This post is largely built on a superb paper written by Michael J. Mauboussin in August 2014, download a copy from here

To evaluate capital allocation of any firm’s manager, you need to focus on following things

  1. Sources and Uses of
… Read the rest

Why Paying up can cost you – Analysis using payback box

Motilal Oswal wealth studies are great source of learnings for any investor, They adopt a unique approach of taking up a theoretical concept every year and then explain it through numbers.

In year 2000, they introduced a concept called payback period, this is what the study said

Focus on payback period

As the legendary Warren Buffett says, “Investing is laying out money now to get more money back in the future in real terms, after taking inflation into account”

Generally, it is observed that market price is often based on the assumption that earnings will grow at their current rate for another five or more years and then remains constant

P/E is a very useful tool of valuation but does not reflect growth assumption upfront

PEG is another useful tool but assumes stable growth rate for a long time. It also relies too much on current growth rates. But the reality is that new economy companies record high growth rates in the initial stages, but are unable to sustain for a long period. This leads to mis-pricing

Keeping the above shortcomings and market wisdom in mind, we decided to examine the concept of “pay-back ratio” or “purchase price recovery in

… Read the rest

True Diversification

Why do we add a new security to our portfolio ?
To reduce risk and ensure not all our eggs are in same basket, the underlying thought process is if stock A doesn’t do well at least stock B will provide some returns and compensate for loss if any in stock A
This makes perfect sense if you go by what Harry M. Morkowitz said in 1950’s [emphasis mine]

The investments have different types of risk characteristics, some caused systematic and market related risks and the other called unsystematic or company related risks. Markowitz diversification involves a proper number of securities, not too few or not too many which have no correlation or negative correlation. The proper choice of companies, securities, or assets whose return are not correlated and whose risks are mutually offsetting to reduce the overall risk

It explains why investors invest in diverse spectrum of industries whose fortunes are not tied to each other
However many investors feel discomfort in adding a new company from a similar industry, At least I do. My thinking process is I already own TCS what the use of adding another IT company in the portfolio ? After all the company related … Read the rest

Why sitting on your ass works in Investing

In my last month’s newsletter, I briefly touched upon deliberating on idea of selling and not holding stocks at over stretched valuation

Charlie Munger says ,

Investing is where you find a few great companies and then sit on your ass

Fisher famously stated that

the time to sell a stock is almost never if the right kind of company is purchased after extensive research and analysis

Another theory could be that I am operating under disposition effect i.e. instead of looking at the overall portfolio performance, I am looking to gain from every stock. This narrow framing leads to selling winners and holding onto losers, I partially mitigated this by always looking for performance at portfolio level rather than at individual level

Also, it’s painful to sell winners too early. If they really skyrocket

See how some of our exited positions have sky rocketed in this bull run

Sitting-1

My investing philosophy is also evolving, I liked what Buffet wrote in 1967 letter

sitting-2

My logic was that for a small portfolio, this is the best way to gain size, i.e. buy things at attractive prices and then resell them when price catches up and keep doing this till portfolio attains … Read the rest

What is maintenance Capex ?

Let me share the story of Jenny and her lemonade stand

If you are unable to read post click this link

Slide1Slide2Slide3Slide4Slide5Slide6Slide8Slide7Slide9Slide10Slide11Slide12Slide13Link

 

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Other good articles on the subject

1 and 2

Images – Google image search… Read the rest

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Investing in turnaround situations

For many value investors investing in turnaround situations is a simple ‘No’, they go buy what Warren buffet wrote few years ago

 

Both our operating and investment experience cause us to conclude that “turnarounds” seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price

We have written in past reports about the disappointments that usually result from purchase and operation of “turnaround” businesses. Literally hundreds of turnaround possibilities in dozens of industries have been described to us over the years and, either as participants or as observers, we have tracked performance against expectations. Our conclusion is that, with few exceptions, when a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact

 From WB Shareholder Letters

Investing in business with poor economics is going to lead to poor investing returns, there is no doubt about that but many a times a business makes few bad decisions (mindless expansion by taking on debt) or due to a key external situation (change in … Read the rest

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How using earnings power box lets you ask right questions ?

Over my limited experience in equity markets, I have come to conclusion that earnings power box is a powerful tool to analyse authenticity of corporate earnings. While I am not going to repeat much of much I have written earlier, you can go through it here and here

One of first things I do after getting annual reports of the companies I hold is to update their earnings power box (EPB)

Updating it sets me in right frame of mind to query annual reports, let me run through an example to elucidate my point

In 2014 this is how Kitex ‘s  EPB looked like

kitex-14

A company in wealth maximizing quadrant 2, the more number of years it continues its advance in this quadrant the more it will continue to create value for owners

2015 EPB will blow your mind away

kitex-15

The company made a significant advance in quadrant 2, no wonder stock market rewarded the stock in the bull market

Kitex-3

This is where we start our investigation

First let’s look at raw data for per share earnings

Kitex-4

The accrual EPS (one which is reported as diluted EPS in Profit and loss account) had a significant jump from INR 12.08 /Share … Read the rest

Why you should not mix emotions and investing

I love the below quote related to emotion and investing

Emotions can be a great asset in life, but when it comes to investing, they may be a liability

Very important line and one needs tremendous patience and practice to avoid mixing emotions with acumen when making an investing decision

Let me tell you story of Anil, a retail investor,and how his emotions cost him dearly

Few years ago his friend told him about an established NBFC Bajaj Finance as a stock tip, he looked at the company’s ticker it was INR 88, he added stock to his watch list and waited for price to drop so that he can buy

Bajaj-1

 

 

 

 

 

 

 

 

A year went by and one day while browsing prices of his watch list he was stuck, Why ?

Bajaj-2

 

 

 

 

 

 

 

 

The stock suggested by his friend has moved almost 50% up, there was huge guilt in him on having missed 50% returns but then he consoles himself by saying ‘We can’t make money on every stock in markets’

He thought this would be end of his story with Bajaj finance, but almost a … Read the rest