Thursday 6 November 2014

To Sell Or Not To Sell: My Viewpoints And Few Ground Rules: Part I

"To be or not to be"... are the opening words of the world famous Shakespearean play Hamlet in the context of quandary that Prince Hamlet faces with respect to weather to live a miserable life or to end the life and embrace the unknown after death.The dilemma that an investor faces is no less perplexing and multi-dimensional than the words of prince Hamlet. I am reasonably convinced that making a correct decision to Sell is as important as making the decision to Buy for generating above average returns over a long period of time. There is ample material and thorough discussions around how to make a prudent buying decision, however, I have yet to come across  a well developed and comprehensive framework on "how to sell". 

In absence of any structured framework and principles/ground rules, the decision to sell is many a times arbitrary even for seasoned investors. However such arbitrariness is counter-productive to the very objective of generating above average returns for investors. I have formed some ground rules while making a decision to sell which I refer to while making the decision to sell. Obviously, I am just a beginner in this long journey of investing world and as one progresses through this journey, these rules are likely to evolve/change based on the real-world  experiences that I will live through in the market. It goes without saying that I will end paying some hefty tuition fees in the process as well!  Notwithstanding,  stick my neck out and adhere to these rules till proven wrong...

When not to sell:

Before we start discussing when an investor should sell, it is extremely important to understand when NOT to sell. I have in my initial years made a very costly mistake because of not knowing "when not to sell". However the only solace I can have is that I have the esteemed company of some very senior and serious investors in this! I have come across many investors who have spent enough years in the market and still continue to sell for the wrong reasons. Many a times, this "cashing out early" results into a huge opportunity loss for an investor, especially if he/she has bought into a high quality business at right price. So what are some of those reason where investors feel compelled to sell without realizing that they are making mistake? Here they are

Thursday 17 July 2014

Ashiana Housing Limited: Opportunity For "Real" Gains Through Differentiated Business Model

Since my last post in mid march, the market has briskly moved upwards and sentiments have changed dramatically. Many market players and analysts have proclaimed that the "decisive victory" for the BJP led NDA in general elections is going to be the game changer. It is felt that the new government will usher in the "directional" changes for Indian economy leading to structural bull market for many years to come. This "optimism" has clearly reflected in the way market has behaved since May 16. In last 4 months, Indices have increased by 20% and broader market has outperformed indices by significant margins. Personally, I do agree that there are some palpable green shoots on number of front and pro-business and stable government can bring the "growth" back to Indian economy. However,at the same time I also believe that it is still too early to treat the current economy and business environment as "clear sky"!

For a bottom-up value investor, the market gyrations are less relevant though rising market does pose a challenge of "bargains" suddenly disappearing from the horizon! I am sure like me, many of you would have given a pass to some high quality businesses because of the steep valuations or would have stretched "paying up for quality" theory to the extreme for justifying the "buy" decision at high valuations. However, in this market it is increasingly important to focus on "value" and not get carried away by various "rationales" offered by number of market participant for paying up! In this market and with current valuations, it is important to recognize the fact that one may not encounter the opportunities to make 5-10 baggers in 3 years like it used to exist 3-4 years ago in businesses like Mayur/Cera/Atul Auto and many others. The prudent approach should be to invest in companies with strong, scalable and differentiated business models run by efficient and ethical management by paying up "fair value". In numerous companies that I have analysed in the past 3 months, I have identified 4-5 such companies which fits the bill in my opinion. In this post, I am going to talk about Ashiana Housing Limited which belong to real estate sector and in my opinion has sustainable, scalable and differentiated business model. The company is also available at decent valuations, making it all the more interesting. 

Ashiana Housing Limited:

I must admit that I too fell prey to stereotyping real estate companies and ignored AHL in spite of AHL popping up in the my stock screener number of times in last 3 years. However, once I completed my analysis recently, I realized how far the realities can be from stereotypes! I have no hesitation in saying that AHL's annual reports are the best amongst the ARs that I have come across so far. They provide clear  and accurate picture about the dynamics of the business and substantiates the same through enough information to validate what they tell about business. Management clearly articulates the risk and limitations while defining the way forward with clear road map. Even if you decide not to move ahead with further analysis of the company in this article, my sincere request to you is to read the ARs once to understand, what it takes to provide holistic and accurate perspective to shareholders about the business!  Now let's talk about the business.

Saturday 15 March 2014

Capital Allocation Framework: Game Changer for Long Term Wealth Creation: Part I

Long term and disproportionate wealth creation is a dream chased by many of us. Value investing is not-so-exciting yet perfect to tool to achieve this objective in the long run. As we all know value investing is all about investing in businesses at price substantial discount to its intrinsic value. It's all about buying "$1 worth of business at 50 cents". However, I personally feel that identifying an investment idea based on value investing principles is only half the job. It is a necessary but not a sufficient condition to achieve the long term objective of disproportionate wealth creation. We still have a missing piece in the puzzle..and the missing piece is capital allocation! What I have observed is that many a times we keep generating very good ideas but fail to allocate capital that each idea deserves. We end up over/under allocating capital to some very good and not so good ideas. 

In the initial few years of my journey in value investing, I was solely focused on stock-picking and paid very little attention to allocation of the available capital amongst my ideas. Allocation of capital was completely arbitrary. However, as I interacted more with some seasoned investors, I realized how important capital allocation was for disproportionate wealth creation! Even on most of the blogs and forums focusing on value investing, the discussion threads largely revolve around stock ideas and capital allocation is seldom discussed. I still don't know why it is so as most of the senior investors invariably point out the importance of capital allocation in wealth creation. My guess is, because the stock picking exercise is far more stimulating than following a dodged process of capital allocation.

It  is very difficult to outline complete capital allocation framework and process in this blog. However, there is an excellent discussion thread on this topic at Valupickr that I would recommend all of you to go through! It's worth your every minute that you spend on it! However, in this post I will try to present distilled ideas from the valuepickr thread and learning from some well known value investors on capital allocation principles with my own "idiosyncrasies" superimposed on them!  

Optimal number of stocks in a portfolio: This is one topic on which I have witnessed many discussions which never end conclusively! Proponent of both concentrated portfolios and diversified portfolio  pound on the other side with merits of their own philosophy and de-merits of others's philosophy. Here are some key ponderables for an investor

  • One must achieve a balance between sufficient diversification and dilution in return from potential winners due to diversification. Let me give you an example: Consider two portfolios of same size 40 Lakhs but having different capital allocation.  
                    1) Portfolio A has 40 stocks and each stock gets equal 
                        allocation of 1 Lakh 
                    2) Portfolio B has 10 stocks (A subset of 40 stocks only)  and                             each stock gets equal allocation of 4 Lakh each.
       Now let's assume that in 5 years one of the stocks turns out to be a 10 
       bagger, 1 stock 5 bagger and both the stocks are common to both the 
       portfolios and rest of the  stocks generate average return of 15% 
       annually.  Following will be the performance of both the portfolio

       Port. A: 38 * (1.15^5) + (1*10) + (1*5)= 91 Lakhs= 18% CAGR in 5 yr 
       Port. B: 32 * (1.15^5) + (*10) + (1*5)= 124 Lakhs= 25.5% CAGR in 5 yr

       So the investor who diversifies highly and have substantially lower                allocation to its "winners" will generate far lower returns than the 

       investor who commits substantial capital to its potential winners.
       Naturally, the opposite of this scenario is if investor made a mistake and
       incurs permanent loss of capital. The returns in a less diversified 
       portfolio will be lower than a highly diversified portfolio. However, two 
       things are important to consider in loss of capital scenario 
       1) As a value investor, one always tries to avoid/minimize permanent 
          loss of capital. Hence if the due process is adhered to, the probability 
          of permanent loss of capital shall be less

       2) It is important to recognize that investor's limit to downside is 
           maximum 100%. You can't lose more than 100% of your money in 
           stock while theoretically there is no limit on upside. What if you                    stumbled upon a 100 bagger? your upside will be 10,000%
       So, how do you strike a balance? How much is good enough to diversify 
       enough to cover risk while gaining decent "kicker" on returns from your 

My personal take is 12-15 stocks provides reasonable diversification while still giving decent upsides from potential 5,10, 50 and 100 baggers!  Having 12-15 stocks on portfolio will ensure that each of the ideas get decent allocation and hence a winner can create serious wealth for the investor

Capital allocation based on judicious mix of different investment approaches:

Even within value investing framework, different investors follow different investment approach and yet generate remarkable superior returns compared to benchmarks. Even though each investment approach has its own advantages and limitations, at the heart of each of these approach remains three golden words of investing "margin of safety". Even though such as deep value investing, growth at reasonable price, high quality businesses at fair price, turn around, cyclicals and special situations.  My hypothesis based on the understanding that I have gained by analysing the investment return of various successful investors following different investment approaches is as follows:

   Investments under each investment approach behave differently under 

specific market conditions and is likely to under-perform or outperform the market under given market conditions. Hence, creating a portfolio of stock covering various investment approaches can increase the likelihood of  out-performance across varying economic conditions and market cycles. 

So stocks in one's portfolio belonging to high quality business bought at fair price (ITC/Colgate/Asian Paints/Pidilite) are well placed to outperform in the declining market because of the high predictability of the business and consistency in performance. At the same time, same set of companies are likely to under perform in rising markets. On the other hand cyclicals are likely to display quite the opposite behaviour i.e. out performing in rising markets while significantly under performing in the declining markets. Similarly, a well understood special situation is likely to provide significant out performance in declining market while may under-perform in raging bull market. 

However, this does not mean that one has to consider allocation to all investment approaches all the time. The ideas is to be open and flexible in trying and understanding various approaches instead of sticking to just one particular approach and  take advantage when appropriate opportunity arises. Having said this, two important things shall be kept in mind

  • Even though investment in turn around and cyclicals can yield excellent returns if one has acquired the skill of spotting cycles and sustained recovery in ailing companies, in general, the failure rate is much higher and one is more prone to incur permanent loss of capital if the prediction about length of cycle or end/start of cycle does not work out as assumed
  • Irrespective of the investment approach used for selecting an investment, the basic tenet of "margin of safety" must be followed.
I will cover some other important points in capital allocation framework in the next part 

  • Capital allocation based on conviction,business quality and valuation.
  • Cash allocation in the portfolio 
  • Displacing the existing investment with new idea
  • Rebalancing the portfolio (Sell decisions and entry of new investment ideas)

 Till then happy investing and happy Holi to you all.

Monday 10 February 2014

Beginning of A New Journey: Stay Hungry, Stay Foolish

When I first listened to the famous speech delivered by Steve Jobs  at Standford University, my reaction was similar to that of many others. I was moved, motivated and challenged! But as it had happened numerous times in the past, I assumed that the effect of this too would be ephemaral. However, as years passed by, the words spoken by this self made creative genius, lingered onto my psyche much longer than I had anticipated!

"Your work is going to fill a large part of your life, and the only way to be truly satisfied is to do what you believe is great work. And the only way to do great work is to love what you do. If you haven't found it yet, keep looking. Don't settle. As with all matters of the heart, you'll know when you find it. And, like any great relationship, it just gets better and better as the years roll on. So keep looking until you find it. Don't settle.


"Your time is limited, so don't waste it living someone else's life. Don't be trapped by dogma — which is living with the results of other people's thinking. Don't let the noise of others' opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition. They somehow already know what you truly want to become. Everything else is secondary "

Eventually,  One more emotion that his speech evoked was  that of "determination"! Determination to follow my heart and eventually settle for nothing less than what I like doing for rest of my life with same passion.  I kept looking, with the hope that one day I will come across something which will garner my undivided attention. Something that will ignite passion and give satisfaction every time I did work. Then came a moment, when I was introduced to this concept of Value Investing.It was indeed "love at first sight!". Simple, subtle and powerful! But, as in love, the first impression and first reactions can sometimes be treacherous. One has to spend enough time with each other before making a life long commitment! Hence, I started spending more and more time to get better grasp of value investment philosophy. Warren Buffet, Charlie Munger, Phil Fisher, Peter Lynch, Mohnish Pabrai, Howard Marks, Seth Klarman, Prof. Sanjay Bakshi and many other senior value investors became my "virtual" gurus! I was learning vicariously.. following the teachings of my great gurus! With all the theories and concepts in stride, now was the time to test my mettle in the battleground and start investing serious money! It's been 4 years since I started managing my personal and family's capital by applying value investing philosophy. Though 4 years is not a long time in life span of an investor, the results so far has at least given me the confidence to pursue this journey further. It is satisfying to note that in the tumultuous market of last few years, I have been able to compound the capital at more than 40%+. Also for each of the individual years and cumulatively, the fund has outperformed the benchmarks by a wide margin.  These four years have also been fabulous in terms of learning new concepts, meeting some well entrenched value investors and paying up "huge tuition fees" for the mistakes I made!

Hence, finally, I felt the time had  come to make the commitment! I have decided to devote significant portion of my time to Investing. To begin with, I will largely manage my friends and family's portfolios. The scope may expand eventually, but definitely not for now. I also intend to eventually start an investment advisory firm  rooted in value investment philosophy. My motivation to start an investment advisory stems from my strong belief that value investing is an extremely powerful and yet hugely underrated and unknown philosophy for creating disproportionate long term wealth for many ordinary mortals like me! I can add my "bit" of value to the society if I can help some people create wealth from themselves.

I also want to acknowledge that taking this decision was not easy at all! It meant making tough choices. It also meant, changing the status quo. It meant, moving out of the realms of known world to chartering into hitherto unknown territories. Though it was difficult, I had a promise to keep to myself! Once again quoting Steve Jobs showed me the way

"You have to trust in something — your gut, destiny, life, karma, whatever. This approach has never let me down, and it has made all the difference in my life"

One thing that I have realized in last 4 years that I have spent as an active investor: Ability to correctly differentiate between risk and uncertainty  can be very rewarding. In the same vein, it is also equally true, that not getting this distinction right can result into substantial permanent loss of capital. I only wish that I have got this distinction right this time.....

Wednesday 1 January 2014

Warren Buffet partnership letters: A treasure trove for a value investor

Since last few days, I have been reading and re-reading Warren Buffet's partnership letters written to its limited partners from 1958 to 1969 and oh boy, what a pleasure it has been reading them! These letters gives very useful insights into thought process of this legendary investor in formative years of his investment management career. However what is more striking is the candour and forthrightness coming out of these letters. WB clearly articulates his investment philosophy, sets the expectations and moderates them fabulously while striving to provide a realistic picture of investment operations, its pitfalls and how the performance of such investment operations should be measured. These letters not only demonstrates clarity of thoughts and perseverance to stick with them but also the extremely strong character. My words will sound pale and insufficient to describe the richness of character and knowledge these letters carry. Hence I shall rest my desire to write any further and share the compiled letters from 1958 to 1969 here. 

It would be great to receive views on what are the key learning from these letters? Few pointers from my side

1) He created a basket/portfolio of stocks along different investment methodologies such as

 Generals: Undervalued business when analyzed from how much a private owner would pay; 

Work outs: special situations with specific time tables such as mergers, take over, de-merger etc and

Controls : where they had a management control or say in the day to day operations (resulted out of sustained buying of generals for long period of time)

This "portfolio approach" was very useful in ensuring consistent returns

2) Work out as a category was important factor in ensuring that returns from partnership outperformed the market in down years

3) WB always made it clear that this approach will substantially outperform the Dow Jones in declining market while may just match the market performance or slightly under perform Dow Jones in advancing market! 

4) Warren buffet had set a goal of outperforming index by 10% over long run and in most of the years, he made that goal "look" conservative...!

5) From a diversified portfolio, he moved towards loading up around 1965. This worked out handsomely in favour as Amex investment, single handedly helped partnership significantly outperform the index, in spite of lack lustre performance in other two categories

6) When there is no opportunity in sight which fits the criteria set by him he gave it "pass" and chose not to invest. He rather declared his inability to find such opportunities and liquidated the partnership.. a brave call indeed.

I am sure as you read through, you will gain many more insights and it would be immensely helpful to all, if you can share the same through your comments!