Archive for the ‘General thoughts’ Category.

 

It is widely understood that stock prices are forward looking – they discount the future expectations of cash flow of a company. In bear markets, these expectations are lowered as markets extrapolate recent trends (and assume a recession forever). On the flip side, the reverse happens during bull markets, when investors extrapolate the recent good results into the future and assume that there will be no hiccups along the way.

Finally, we have markets like now, where investors have gone ahead and extrapolated ‘hope’ and discounted that too.

The idea funnel

I maintain a 50+ list of stocks which I track on a regular basis and have created starter positions in a few companies which appear promising. The process i follow is to create a small position (usually 0.5% to 1% of my personal portfolio) and then track the company for a few quarters/ years.

In atleast 50% of the cases or more, I realize over time, that I am not too excited about the prospects of the company and exit the stock immediately. In a few cases, however the company and its stock may still hold promise. In such cases, I start raising the position size in the portfolios I manage.

The above approach allows me to run experiments with lots of ideas and controlled risk.

Discounting infinity and beyond

I am now noticing that some of the positions I hold on a trial basis have started running up based on hope.

Let me take one example to illustrate – Repro India.

Repro India is a printing business with operations in India and Africa. The company performs print jobs for publishers for all kinds of printed materials like books, reports etc. The company has had a chequered past with uneven performance.

The company was growing till 2012-14 with rising sales in India and Africa. The return on capital of this business was mediocre as the printing business involves high fixed assets, high and sticky receivables with average operating margins in the range of 15-18%.

The export business in Africa went into a nose dive in 2014 due to the drop in oil prices. The company was not able to collects its receivables as these African countries faced currency issues and hence incurred losses. Since then the company has been slowly recovering the receivables and nursing the business back to health. In addition the domestic business continues to be competitive and sub-optimal due to the lack of any competitive advantage

I would normally avoid such a company unless there are some prospects of improvement or change in the future. One such possibility exists for the company. This is the new BOD – books on demand business of the company.

The BOD business is similar to an aggregation model followed by companies such as uber or Airbnb. In the case of repro, the company has a tie up with Ingram (another US based aggregator) and other publishers in India to digitize their titles and carry them on its platform. These titles are then made available through ecommerce sellers such as Amazon or flipkart. When a user like you and me finds this title and purchases it, Repro prints the copy and delivers it you.

The business model is depicted in the picture below (From the company’s annual report).

The above business model ensures that there is no inventory or receivables for Repro or the publisher. The payment is received upfront and the product is delivered at a later date. This is a win-win business model for all the value chain participants as it eliminates the need for working capital. As a result, this business model is able to earn a high return on capital with the same or lower margins than regular publishing

Illustration from the company’s annual report

Repro is doing around 40-50 Crs of sales in the BOD segment and growing at around 70-80% per annum. The company has loaded around 1.4 Mn titles on its platform and plans to load another 10 Mn+ titles in the future. This business is at breakeven now. The BOD business has a lot of promise and it’s quite possible that the company will do well.

However, success in the business is not guaranteed. The company needs to scale its operations and could face competition from other print companies in the future (as the entry barriers are not too high).

The market of course does not care about the uncertainty. There are times, when markets refuse to discount good performance in the present and then there are time like now, when the market is ready to discount the ‘hope’ of good performance in the future. The stock sells at around 100 times the current earnings. As the legacy printing business continues to be mediocre with poor economics, it is likely that the high valuations are mainly due to the exciting prospects of the BOD business

I had created a small position a couple of months back and have been tracking the company. The stock price has risen by around 50%, 60% since then even though the company is just above breakeven on a consolidated level.

I am optimistic about the prospects, but the execution needs to be tracked. I am not willing to pay for hope and so I am a passive observer for now.

 

 
 

I wrote the following note to my subscribers in response to two questions which are frequently asked by new prospects

  1. Please share your past performance
  2. How many stocks can I buy if I join your advisory today

The note below, seeks to answer the second question.

Pizza versus investment advice

If you walk into a store or restaurant, you are handed the item or service as soon as you make the payment. Any delay or refusal to offer the said service is considered a breach of faith or fraud.

The above standard mode of exchange breaks down when we come to investment advice. The job of an investment advisor is to ensure that his or her clients make decisions which helps them in the long run (in achieving their financial goals). This can mean that the most sensible course of action often is do nothing and wait for the right opportunity to invest.

This is however not understood by the vast majority of investors who behave like a customer in a restaurant. A typical investor likes to be handed a menu card of stocks and would like to buy as many as possible even before the ink has dried on the cheque (metaphorically speaking). This expectation works if you order a pizza, but not when you are investing for the long run (5+ years).

The investment industry panders to this behavior and even encourages it. As much as one would like to blame the industry (and they have much to blame), the investor community is equally responsible for it. Stock markets are seen as a place to pat your ego (for recent high returns), indulge your gambling instinct or just entertain yourself.

In all my years, I have found very few who look at the stock market for what it really is – A place to invest your capital for the long term to earn returns above the rate of inflation and thus achieve your long term financial goals.

If you are in for the long haul, it makes sense to invest your hard earned money in the right company at the right price (price being very important). Often this happens, when everyone is running for the exit.

Walking the talk

It is easy to talk, but not easy to do the same thing unless your own money is on the line. My own funds,that of my partner kedar and our families is invested in the same fashion. Nothing focuses you on the risk, when your own money is on the line.

I get turned off when I read about fund managers and analysts who recommend a stock, but do not have skin in the game. It clearly means that they do not believe in what they say.

I made a conscious decision several years back that I will eat my own cooking and as a result, any loss in the portfolio is borne equally by me. In addition to this point, both me and kedar have made it a point to under-promise and hopefully deliver more. As result, inspite of a 100%+ rise in 2014, we decided to go low key as I knew that future results could be subdued for a period of time. I did not want to attract subscribers based on recent performance and disappoint them when I failed to meet their un-realistic expectations.

We continue to follow the same approach today. We will get excited when the market drops and go into hibernation when the market gets euphoric. The hibernation is limited only to activity and not to the effort of finding new ideas. We continue to build the pipeline, but the pizza will be served only when the time is right.

 
 

A lot of people are celebrating these days and patting themselves on the back. We have a parade of investors touting their returns and claiming that 100% CAGR is for chumps. Multi-bagger could soon be a new name for kids 🙂

A bull market feels good and should be the best of times, right? How can one argue with that?

It feels great when your stocks are going up, making you richer by the day. You feel smart, on top of the world and in some moments can even see that retirement on the horizon when you stop working and live on the beach < insert additional fantasy as needed>

By my own estimates, I have lived through around 4 major and a couple more minor bull runs. It felt great during those periods as I  felt vindicated for sticking it out during the drops when everyone was rushing to the exits. It is only in hindsight, I have realized that bull market are dangerous in their own way and I was lucky to have survived the full cycle.

Let me explain

A confluence of factors

A typical bull market usually coincides with decent economic numbers when most companies are doing quite well. As a result, most participants become over optimistic and bid up the stocks of these companies. We thus have a confluence of factors – companies performing better than usual and being valued at higher multiples of peak earnings.

In addition to these factors, there are several psychological factors which come into play at this time. Let’s go over some of them

– Social proof: At such times, you see people around you getting rich and more reckless the person, higher the returns. It is not easy on the psyche to watch your friends get rich , whereas you sit around doing nothing.
– Scarcity: During bear markets, waiting helps. As the numbers are bad or getting worse, stock price for most companies stay stagnant at best. As a result, if you like to dig deep into a company, you have all the time in the world. No such luck during bull market. Any company with a half decent results gets bid up. As a result, you can either forgo an opportunity or buy the stock with lesser due diligence
– Confirmation bias: A bull market gives a positive signal and makes you feel that you are doing something right. As a result, there is a tendency to ignore risks and not look for disconfirming evidence
– Authority bias: If you switch on a channel, every other talking head and self-proclaimed guru on TV is painting the vision of a glorious future where all of us would be rich. This makes you feel as the only idiot who does not get it

In effect there are multiple psychological and other factors, which conspire to get your guard down and ignore the risks

A bad hangover

I can recall the emotional roller coaster in the previous cycle, with the only difference that these cycles used to run over a period of 3-5 years. The years 2001-2003 (which is ancient for most investors) was a grinding and slow bear market.

It was the exact opposite of what we see now. I can remember buying companies selling for 5 times earnings, growing at 15-20% per annum and still going down in price. If you think these were low quality stocks, then that was not the case. I am talking of companies like Marico and pidilite which are the darlings of the quality school of investing now.

A new investor like me just could not understand why the market was behaving in this fashion.

The market started turning in 2003 and from there it took off for the next 5 years. A lot of my personal holdings went up multiple times (no one used the term multi-baggers as often then) and it was great to feel vindicated/ smart.

The problem with feeling smart was that is that you also feel invincible. The net impact of all these emotions is that I made a few picks, which were marginal at best.  These sub-par picks came back to bite me during the next downturn when they performed far worse than the overall markets.

A fight against instincts

The natural instinct for any investor is do the opposite of what should rationally be done.  When the markets are dropping due to poor fundamentals and bad sentiments, the tendency of most investors is to withdraw into a shell and wait for the sky to clear up.

This is usually the wrong action. Unless you believe that the world is going to end (in which case, stocks should not be your worry), it makes sense to buy attractively priced companies as markets usually have a tendency to extrapolate the recent trends into the future.

The same tendency is also visible during bull markets which leads investors to buy at the wrong price. The right action at such times would be to sell or do nothing, if the company is not overpriced. I personally think that one should go one step beyond – use this period to clean up your portfolio. If you hold some companies, which you are not as confident about, sell them down and increase the cash holding. A bull market is a good time to  swallow the bitter pill when the overall portfolio is doing well.

It is not easy

I wrote this a year back after the market dropped by 15% and this still holds true, except the circumstances have changed to a bull market.  Instead of courage to manage the fear, one needs the same courage to manage greed and euphoria.

It requires an equal amount of effort (or even more) to watch everyone around you make easy money, while you stick to your principles and refuse to take part in the madness.