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A few key themes

February 21, 2013

Greg Speicher in his ebook 115 Investment Ideas talks about a particular theme (among many) which is especially pertinent and timeless :- AVOID STUPID MISTAKES.  In investing this is a pure gold because an investor how much ever good or nuanced is always prone to making mistakes. Its easy to overlook or even underestimate the importance of a particular element. With such mistakes one is set back quite substantially in his personal wealth. I have observed and caught myself making mistakes in the past. Though its a shallow consolation to see the number of  mistakes reducing with time (Note to Self: it will be interesting to make a study of the mistakes/per 100 analysis I commit and perhaps try to put it on a Poisson distribution ) yet it is still serious enough problem for me to ignore it.

A mistake doesnt only set you back in money but also in time and thats a serious cost. And to reduce it, I have a list of lessons I have built for me which I periodically go through. These lessons are reproduced here:

  1. Evaluate Management, Business and then Valuation , in that order and importance. Bulk of the effort will go in evaluating management credentials, the second part in understanding the industry challenges and problems and developments. And if the field is clear, move in the valuation side of things. Management has to be evaluated on three dimensions:- their integrity,their cash allocation skills and their operational skills. Management is hired by you to handle the last two but when you hire you will look at the first quality right at the start. My biggest mistake had been Kothari Products.I bought it in Feb 2011 at a price of 374/- with an aim of about 750-800. It was a standard gutkha, pan masala brand, the iconic Pan Parag is from their stables, had good amount of cash, in fact cash holding was more than their market cap. Its volatile and low ROE business like Construction and Share Trading was camouflaged and the company deserved a good price for its business. Except it didn’t. The stock was a value trap purely because management were rentiers. I finally sold it at 407 in 2012 September. The stock barely paying me a return of AAA bond.
  2. Growth will not be value accretive if there is no competitive advantage , this is an extremely pertinent idea as this market stupidly chases growth in its any form, any price and at any potential. Consider company in an industry which has no competitive advantage. None, nada, nothing. Its a  highly fragmented industry and competitors are bleeding just like this company. One year by the usual bearings of providence, the company gets bumper profits and decides to grow in itself. Which implies capex. This decision is wrong on many levels. Firstly, this industry has atrocious ROCE in itself and your company is no better than most. So investing in a low ROCE business is stupidity which stands to reason that the money wont be value accretive, i.e a 1Re investment will add a maximum of 1Re value and can even add less than it, which will mean that its value destructive. In another level, if you build capex in a business where there is no competitive advantage then it stands to reason that the great profits which you earned in one year is the average experience, i.e everybody made money that year. Which in turn implies that everyone is going to invest in growth just to stay afloat just to earn more money, which implies that the price of the final product will plummet. Growth is simply not value accretive! Consider just one small change here. The protagonist company has wonderful competitive advantages. In a business environment replete with competitors selling products utterly indistinguishable from each other, your company builds products which are sheer art in itself. Then, you as a CEO can invest as much money as you want to and still earn value accretive growth for your shareholders. Hence, what is the key lesson coming from here. If the industry is in a commodity business, then its value is its on going “no-growth” valuation. Hence a commodity business is buy-able only if its quoted valuation drops significantly from its on going asset value. e.g to think construction business, or iron ore business or even electronics business as other than commodity business as foolery. However APPLE is in Electronic Devices business but it is not in the business of selling electronic devices, its in the business of selling experiences and thats a great thing. My mistakes in this hall of fame: Polyplex, Precision Wires
  3. PE is not a measure of value , this theme is repeated elsewhere as well, however its worth allocating time and effort to it. PE calculation bungles up at two distinct levels- to believe that market cap is the valuation of the company and EPS is the true cash flow to the shareholder/company. And as we know two wrongs dont maketh one right. Consider for instance CRISIL, a business which is quoting at an enormous PE of 25 or so. But if you are a strategic buyer you will not only get huge cash in its books but also a very high quality cash flow stream, a moat almost impossible to dislodge to say just the least. And even from a valuation perspective using EV/FCFF is a winning idea than using EV/EBITDA or PE. My mistakes in this hall of fame: Selling STRIDES ARCOLAB too early, DECCAN CHRONICLE (you can put this as an example of any mistake on this list and still be right, it was a wrong decision on so many levels for me)
  4. Once you have found a good investment, the right time to sell is almost never, Imagine your bank comes to you and says that we held a lottery last month to select the lucky few customers who will get extraordinary high rate of interest. For ever! You are one of the three customers chosen and starting today, your money is being compounded at the new rate of interest. Will you rush to your bank and withdraw your money today? Or tomorrow? Or a year later? Or rush to your friends to borrow money from them so that you can store ever increasing amount of money in this wunder bank! Now what is a good investment? An investment is a good investment which can grow sustainably very high amount of money for a very long time. Which means the key concepts are: high rate of return, long time and highly scalable business. My mistake in this hall of fame: Selling Strides Arcolab too early.
  5. Overconfidence Bias: Amateurs have a wonderful ally with them- their sense of confidence, their sense of can-do spirit, naivety. But such an ally also have to be reined back. Overconfidence is a highly infectious disease and have killed many a brilliant mind. Fight it. My mistake in this hall of fame- too many to even recall 

These were mine, and now it time to reveal yours. What mistakes did you make?

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