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Being a Fundamentalist

May 1, 2010

Lest you are tempted to conclude that I am a rabid religious fanatic, defending my way of life, let me assure you I intend to keep politics out of this blog(post, for now). This is about being a fundamental investor or atleast the efforts of trying to be one.

My first investment picks were very well thought out, researched fundamental buys, in sectors I knew and worked in. All the good things, which the folks on the other side of river exhort beginners to do. You know what, I lost. Not a lot, but it was enough to make me realize I dont understand this stuff, or even if I understand I am not gifted or exactly on top of it. Well,going fundamental in March 2008,when markets tanked so sweetly, it made my neighbours tank tops look skimpy, didnt help either.

But, I felt it would be good and might give me some “edge” or advantage if I can learn this. “Edge”, I never meant in making more money, but more accurately of understanding and bettering my process of speculation. For truly professionals, money becomes a means to keep scores.Me.just trying to achieve that.

In June 2009, I once again, started reading the balance sheets of companies. Not out of an immense urgency but because the balance sheets used to be mailed to us at my home(the intended reciepient was my Dad). So I kept reading. I scoured through a few, and then found a stock called LGBROS.

“LGBROS”: No half measures

Even after the initial analysis, I spent around 14 days making absolutely sure, what I am getting myself into. The thing looked promising. It was trading at around 12. Book Value of around 18. And paid solid,solid dividends. I realized even if I dont do anything, I should and can expect dividend by the end of June 09 quarter and can bring out something. PE was low, and it was just emerging out of the crisis. My bet was pure thematic and plain and simple. I was highly bullish on auto. Earlier, in the year, I was heavily long in auto stocks like Ashok Leyland, Amtek Auto and Tata Motors.

My bet was, LGBROS , a primarily ball bearing company is Coimbatore based auto ancillary plant. Supplied heavily to the motorcycle and in a limited way to the four wheeler companies. Its debt was low, its books looked good, didnt really take help of “one-time expenditures” or other such gimmicks.

So, ultimately, almost all of my conditions were met.
A stock, where not much speculative activity takes place. Check.
A company with low debt. Check
A company trading at a discount to book value. Check,Check, Check
A company at low PE. Check
Solid Dividends. Oh yeah,check!

Even to foresee the future, I ran some complicated Monte Carlo Analysis predicting the discounted free cash flow variation with the EPS growth rate.

Further, to predict the EPS growth, I tried to model it using some moderately complicated models of extrapolation. It came that the pending results should show, 10% growth in EPS(atleast) and around 25% (max). And looking forward one year hence, around 25% EPS growth for ’10. I needed it to grow 14.5% per year for the next three years, to achieve my target. Looked reasonable.

So I bought around 10,000 shares of  LGBROS trading at 12bucks odd. The thesis, if I am wrong, I dont lose much, dividends will take care. If I am right, I win big.

My time horizon three years. I underestimated the power of a bull market. Invested in June 09, I cashed out in September 2009, three months later,with a neat 50% gain.

My point is not that, all the great complex analyses in Excel and spreadsheets is going to make you money. Its possible to go wrong as much as its possible to go right. But leaving  half measures is surely a pathway to doom- financial,mental,psychological and emotional. Dont try to jump seas, because others are jumping. But try to climb mountains,if you think its necessary.

In between last year and this year, I have picked up a few fundamental picks. Needless to say, even now, I am trepid of going a totally, “fuck the stop loss way”. I still am afraid of riding without SL. But yes, what I do is, I try to get myself into such down and out stocks, totally hated stocks, totally ignored, long forgotten stocks, that even the most consummate bull thinks twice. Often, when there is nobody to buy something, the sellers are caught in a trap. They cant really sell anymore. So tails I dont lose much, heads I win big.

I try to look at three or four big markers of health of company,stocks and balance sheet. For company, I seek to make sure, the long term debt is near zero. Dividend payout is healthy, the bigger the better, the more frequent the better. And Free Cash Flow growing steadily.  For the health of stock, my omnipotent solution, Price to Book Value should be always less than 1(I shy away from anything above 1.5), Price Earnings Ratio should ideally be less than 4.5ish.  But often at times, I do relax it to 7. And lastly, the Price to Operating cash flow should ideally be less than 2. I relax it to 3.5.

And finally to check, if I am duped, I check ,how often the company uses one time expenditure or other such accounting gimmicks to take care of low bottomline.Such companies are red flags for me.

I think, its too superficial for me, to talk about my investment strategy when I dont have a long track record to claim and boast about. But hey, I am building it!

2 Comments leave one →
  1. Narasimha permalink
    May 1, 2010 5:15 am

    Great post Soham.
    Would like to hear more about what other models of extrapolation you applied to get EPS growth.

  2. May 1, 2010 11:49 pm

    The one thing I never really understood about fundamentals is (no, not theorizing with too little data), why is the guy(s) who writes (read authorizes) the financial statements not as eager as the guy who deduces Alice in Wonderland from it while piling up?

    Company information comes with a significant lag to retailers. Funds are at an advantage in direct company interaction and often have access to more “material” information. While not indirectly suggesting a strategy based on fund holdings, I should like to highlight that if the insiders and the funds are ignoring it, are we intelligent, lucky or simply overlooking some information?

    While one spends time in determining what information is included in structuring the edge, the information ignored often overlooked (Confirmation bias?). By that, I mean ex-ante vs ex-post in a low frequency data.

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