Saturday, May 16, 2015

Total Market Cap to GDP: Does the 1x hold for India too?

Total market cap to GDP at the end of April 2015 stood at around 84%. Still below the buffet statement of 1 times total market cap to GDP. At the end of Feb 2015 it went up to 89%.

A graph of the Market cap to GDP is here:

The question I am trying answer is whether the 1 times total market cap to GDP holds true in the case of India. The private to public paid up capital ratio is 36:64. This very surprising to me because I thought the majority would not be listed in India. Also paid up capital does not include retained earnings and this factor could very well be off the mark but its a start.

Tuesday, May 12, 2015

Dewan Housing Finance (DHFL) - Used to be cheap and probably still decent quality

My notes on DHFL - Dewan Housing Finance Limited from Feb-Mar-Apr 2014. The company continues to have some good shareholders like Rakesh Jhunjhunwala and the government of singapore. The LTV is falling and the NPAs are up a bit but not very much. The company still claims they have excess provisioning. I wonder why Mr. Market has been reducing his bid on the stock all the way from 552 to 431. 

Disclosure: I am long.


Value Canvas

Sunday, May 10, 2015

Do FII flows drive market returns?

FII flows are the drivers of the Indian market as we have learnt in the institutional derby article. Just to refresh the numbers, total institutional flows are about 80% of the market volume. Of this 3/4ths is FII flows. This made me wonder how well the index return and the FII flows would be correlated with each other. Thus about 60% of the market volume is being controlled by foreign institutional investors. From January 2002 net FII flows into the country have been 122 Bil USD - Which is over 5% of the current GDP!

The following chart sums this up:

Thursday, May 7, 2015

ValueQuest India Moat Fund Portfolio

Unfortunately only I have been able to find only 2 stocks where it is confirmed that the ValueQuest India Moat Fund (VQIMF) run by professor Bakshi is invested. They could be invested in a universe of over 4000 other companies and I am going to make an attempt to figure out which companies those are.

Some assumptions I am going to make

  • The fund is unlikely to engage in short term trading and will not sell a position for at least a year
  • The internet will find out about Prof. Bakshi's positions a few months after he probably starts taking the position
  • The data given on trust net offshore ( about the NAV of ValueQuest India Moat fund is correct
  • The Quarter end shareholding number change report is bought at the average of the closing prices on the quarter
  • The stocks that do not show VQIMF as a holder cannot be held by VQIMF more than 0.99%. I am assuming that the fund does not hold any equity swaps and always holds direct equity.
The aforementioned assumptions may or may not be true but in order to figure out what the portfolio holds I have to do this.

The following are the stocks I could find by googling Prof. Bakshi's positions and the earliest date I can find online talking about that stock.

Company Earliest Date
Eicher Motors 19-Oct-08
NESCO 12-Aug-12
Ashiana Housing 7-Dec-12
Thomas Cook 1-Dec-13
Symphony 1-Jan-14
Relaxo Footwears 18-Mar-14
Kitex 12-Aug-14
Poddar Developers 5-Oct-14
Ambika Cotton Mills 1-Jan-15
Vaibhav Global 27-Jan-15

Tuesday, May 5, 2015

ValueQuest India Moat Fund: Prof. Sanjay Bakshi's fund

We all trying to practice value investing are always trying to follow Professor Sanjay Bakshi and his blog. I was googling around to figure out his current portfolio and I came across a fact sheet for the fund at Trust Net Offshore. The data on the site say that, as expected, professor Bakshi had outperformed the market by a very large percentage. The fund is a USD denominated fund domiciled in Mauritius. Launch date is stated as 3 Apr 2014. ISIN is stated as MU0449S00019.

This data is not confirmed and has been taken from The INR return is basically derived from the USD return graph and from FX rates online.

Unfortunately I have been unable to find the portfolio of the fund anywhere. I will attempt to take a shot at what the fund might own by reading the Fundoo Professor blog and making a list of the companies that professor Sanjay Bakshi talks about.

Tuesday, April 28, 2015

The Value Canvas: Conviction grading

Eric Ries has written a wonderful book on Lean thinking for start-ups. The book describes a method to analyse your start up on a single page – albeit a large A3 or an A2 or a whiteboard page. I put that together with the framework Donald Francis came up with and now use something called a value canvas with consists of:
  • Conviction canvas
  • Pricing canvas

The Conviction Canvas

Sunday, April 26, 2015

Macro factors: Corporate profits to GDP

"In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well. In addition, there's a public-policy point: If corporate investors, in aggregate, are going to eat an ever-growing portion of the American economic pie, some other group will have to settle for a smaller portion. That would justifiably raise political problems—and in my view a major reslicing of the pie just isn't going to happen."
Warren Buffett

While doing some research for a completely orthogonal topic to this one, I found a Buffett saying similar to the one above. That got me thinking about why Buffett says the magical 6% number. Putting that 6% number together with his quote on total market cap to GDP being under 1x we can conclude that he believes the maximum price to earnings for all companies should be 1/6% or 16.67. The average P/E over the last 16 years of the NIFTY in India is 18.48 which is consistent with this notion as well.

Let’s look at the history of this macro factor: corporate profits to GDP in India:

Saturday, April 25, 2015

Controlling the value chain

“You know, someone once told me that New York has more lawyers than people. I think that's the same fellow who thinks profits will become larger than GDP. When you begin to expect the growth of a component factor to forever outpace that of the aggregate, you get into certain mathematical problems. In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well.”

Warren E. Buffett

Ability of a company to control the value chain is a testament to the management of the company and is exhibited by high profit margins and high returns on capital.  There are 3 components to a firm’s economics:

  • Customer side
  • Supplier Side
  • Productivity

Thursday, April 23, 2015

Cloning the Dolly Khanna portfolio blindly: 40%+ in fy2014 with 14% Index outperformance!

Several value investing students in the US follow the 13F filing of their favorite managers. A 13F is a public disclosure of an institutional manager's holdings to the SEC. Now, the bad news is that unfortunately I do not know of a 13F equivalent in India. The good news is that moneycontrol has a shareholding screener where you can search for a shareholder name and the site will search the company filings for that name. You can also scour online blogs to figure out who holds what. Then you can look at the shareholding history on the BSE (Bombay stock exchange) website and calculate the shares they held.

After the article on "Dolly Khanna's ridiculous 89% return" many a reader asked me "This is all very good, but what's in it for me?" so I thought I should run an analysis to see if I bought/sold all that I could find about Dolly Khanna stocks 50 days after the end of the quarter what return would that portfolio get? The reason I picked 50 days after the end of the quarter is because by then all companies have reported their shareholding patterns. You could buy some earlier and some later but that analysis would take too long. In any case I think this one is more punitive on the return as well.

Wednesday, April 22, 2015

Valuation of the ability to command prices: The brand

“Your premium brand had better be delivering something special, or it's not going to get the business.”
Warren Buffett

Willingness to pay for a brand is something that has to be measured in the marketplace. If you are looking at something like Tide from P&G and see a generic washing powder you could see the reaction of people who may or may not pay up for the brand. Another way to check this is to compare the margins of the company in question with competition and with generic manufacturers of the same thing. Ajanta pharma is a generic branded formulations manufacturer whose margins are more than the non-branded generic manufacturers.

Tuesday, April 21, 2015

Valuation of very high quality companies: Low rate of change economics

“Our approach is very much profiting from lack of change rather than from change. With Wrigley chewing gum, it’s the lack of change that appeals to me. I don’t think it is going to be hurt by the Internet. That’s the kind of business I like.”
- Warren Buffett

Low rate of change is a confusion concept and it took me a while to understand this. The “low” part of this statement is very relative and is highly interlinked with your circle of competence. In general businesses like Coke are the lowest rate of change. The product of coke has been constant for over half a century and people are willing to pay up for it. In terms of rapid change you can see semiconductor companies. Now Intel could be a business that people find a great moat in but the rate of change is very high.

Monday, April 20, 2015

Valuation of very high quality companies

As per popular demand I will get back to the getting conviction: Fundamental factors - points to watch out for later. Lets cover another very interesting topic for now.

The aforementioned concepts are the basics of valuation but as you might have noticed there are few subjective questions that remain unanswered:

  • How do you find the right discount rate?
  • How do you find the right growth rate?
In addition you will never find a hindustan lever or a dabur or a Britannia trading in single digit P/E multiples - despite the mood swings of Mr. Market. Does that mean the intelligent investor never buys into these wonderful companies?

Saturday, April 18, 2015

Getting conviction: Fundamental Factors #4: Cash flows

Cash flow is the best indicator of the health of a company. It also typically has tell tale signs of what is really going on. I, of course, cannot cover this entire topic in an article but definitely can give you some pointers on where to look and a flavour of the cash flow analysis methodology:

8.        Cash flow quantity – If the cash flow from operation is on an average lower than net income it should be a huge warning sign that earnings are overstated. In some cases even when cash flow from operations is good some expense items may have been capitalized by classifying them as cash flow from investing. Now the best way to judge this is to see the delta revenue, Net income and cash flow from operations that that investing has created. Studying the cash flow from investing is also a good practice to understand the expensing and capitalization practices.

Friday, April 17, 2015

Getting conviction: Fundamental Factors #3

This post is a continuation of the following posts:
Lets continue on the list of things to watch out for:
6.        Options dilution - Many companies give stock options to management in order to motivate them to perform better. Companies with too many stock options typically are not great to invest in – in my experience. A small amount of stock options can be a good tool although I must say no options is better than some options. 

Thursday, April 16, 2015

Getting conviction: Fundamental Factors #2

In the previous post we learned the board metrics to judge the fundamentals and a couple of things to watch out for. Unfortunately there are several other things to watch out for.

Continuing the list (of things to watch out) for:
3.        Expensing or capitalizing grey area items – for example some companies may capitalize and show as cash flow from operations their research and development costs. What needs to be determined is that whether the item capitalized actually has long term value. You also need to study how previously capitalized grey area items are depreciated.

Tuesday, April 14, 2015

Getting conviction: Fundamental Factors

Fundamental factors are typically the numbers in the game for the intelligent investor. In this section one typically looks at:

  • ROE and ROIC over the years and their volatility
  • Dividend percentage of earnings
  • Net profit after tax margin
  • EBITDA margin
  • PAT Growth
  • Working capital usage as a % of sales (Debtors, creditors and inventory)

Sunday, April 12, 2015

Envy in the driver’s seat

“It’s not greed that drives the world, but envy.”
Warren Buffett

Envy is an emotion triggered in a person when she or he thinks that another has something better. Envy can cause a series of wrong decisions and make investors do things that are completely irrational. During the pre Y2K dot com boom several investors made lots of money on technology stocks. Companies with very large negative margins were valued at billions of dollars. It was said that a man with an idea could be funded with millions. At this point Buffett clearly said that he did not understand technology and thus wanted to stay away from it. It was probably Buffett’s control on his envy that enabled him to stay away from this potentially disastrous trade. During the ensuing dot com bust he got several opportunities to buy lots of cheap high quality moat businesses.

Saturday, April 11, 2015

Is too much math bad for investing?

“If you need to use a computer or a calculator to make the calculation, you shouldn't buy it.”
Warren Buffett

We've already talked about the LTCM debacle and they were very good with their math. There are entire funds running based on mathematics today such as Renaissance technologies and other statistical arbitrage shops. These products are good and probably very few statistical arbitrage (statarb) shops are able to do this consistently. Even statarb shops have to sit it out when they are unable to find any opportunities. Then why does Buffett say don’t do the math?

Friday, April 10, 2015

The IGValue Feedly Channel

If you like feed readers you should definitely try feedly. It was a wonderful interface and formats content to make it easy to browse. Check out the IGValue feedly page at:

I would be obliged if you could tell me whether you like the content in the Feedly format and if you could compare the content to the flipboard format mentioned in the IGValue Flipboard Magazine article.

Thursday, April 9, 2015

Social proof is not an investment thesis

“the prices on the market are the ultimate form of social proof”
Charlie Munger

The most common form of this bias is where an investor feels “I have bought 2 stocks and both have gone up by 20%. I told my friends and everyone says I am a good stock picker”. This as you all probably already know is not true. Many a time people look to other people to see what they are doing. Yes this is also called cloning – but blind cloning is also dangerous. You should definitely look at what other successful investors are doing but should understand the investment thesis before taking the plunge. All decisions of any legendary investor are not correct – even Berkshire makes mistakes and Warren Buffett is the first one to report all on each annual report.

Wednesday, April 8, 2015

Reciprocation maybe good manners but bad for investments

“You’re like a one-legged man in an ass-kicking contest.”
Charlie Munger

Reciprocation is a powerful psychological tool. Recently a box showed up to my house address to my sister’s from Dabur. It had several products of Dabur – and in standard packet sizes. The whole thing in a store would probably cost 500 rupees. It forced us to try the products and after six months I found myself asking for several of those products in a grocery store which I never knew about before. It got me thinking why was I asking for those products? The answer lies in reciprocity. Dabur had given us some products for free and now my mind somewhere in the subconscious had registered that I need to reciprocate. The products in question were not bad but not really better in quality than the competition. But they got my attention.

The question is how does this impact investing? Its impact on the investor can be small gifts from a broker make you want to give him some business. Now you may not realize it (and in some cases the broker also may not realize it) but you may end up buying something you shouldn’t have. Several banks and wealth managers send their customers gifts on festivals. In order to avoid this bias you have to return these or not do business with the ones who do because it can cause reciprocation bias.

Tuesday, April 7, 2015

Why does very high IQ not give you an edge in investing?

“You don't need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.”
- Warren Buffet

In the hedge fund world you find fund manager after fund manager pitching the smartness of their investment team to the investors. Some will only hire out of the Ivy leagues. Some will have an interview process that could match that of the most competitive companies in the world like Google or Facebook or General Electric. The results, however, don’t seem to correlate with IQ. Take the example of Long Term Capital management (LTCM). It was led by John Meriwether and had Myron Scholes and Robert Merton on the board who shared a Nobel prize! 

Monday, April 6, 2015

How to get started with Value investing - Step 2: Common sense check

On popular demand this section is a continuation of the articles in on getting stared with portfolio management:

“Some of the worst business decisions I’ve ever seen are those with future projections and discounts back. It seems like the higher mathematics with more false precision should help you but it doesn’t. They teach that in business schools because, well, they’ve got to do something. ”

- Charlie Munger

In order to avoid the “fake precision in math” problem I usually do a common sense check. Here is where you want to think about the investment thesis that you can do in your mind. Typically to simplify things I use only the following data points for this:

Saturday, April 4, 2015

Pavlovian association bias: We are no smarter than the dogs

Pavlov was a Russian physiologist who conducted an experiment where he sounded a bell at the time a dog ate food. Over time just the sound of the bell caused the dog to salivate. This type of conditioning is called the Pavlovian association bias and can be lethal in investing. This is the bias running in the background that sometimes drives customers to buy the higher value item linking expensive=better quality. The automotive industry has this syndrome played out in wonderful detail. BMW has created a brand for itself where car buyers believe that its quality is better. Several studies have shown that car makers like Honda and Toyota have similar or sometimes even better quality, provide the same features but still consumers continue to buy BMW and it remains one of the most profitable car companies around. Cars like the Rolls Royce or the Bentley have often been proven of poorer quality than several cheaper cars but they continue to sell because of the Pavlovian association bias.

Thursday, April 2, 2015

How can consistency & commitment be bad for the investor?

Consistency and commitment are supposed to be virtues in society. When you take a stance after researching it thoroughly it becomes very difficult for you to see the other side of the picture. This is also stated as resistance to change in management folklore. When the added pressure of public disclosure of the stance is present very few people have the capability to change the stance.

Incentive cause bias: the most common pot hole

The incentive cause bias is rationalization by the professional that what is good for the professional is good for the client (and maybe the world) as well. This is rampant in the financial services industry. The article on avoiding IPOs is a prime example of this kind of bias in the financial world. Trusting your broker or for that matter any financial institution blindly can cost you a lot of money. A financial institution serves its own interest by making money on financial transactions. At the same time you believe that the financial institution is acting in your interest. The interest of the financial institution and yours can only go hand in hand if the institution through systems and processes ensures that it is a win-win situation for both parties. This is very rarely the case. 

Wednesday, April 1, 2015

Common anchors and how to get rid of them

Anchoring is defined as the common human tendency to rely too heavily on the first piece of information provided to make subsequent decisions. Dangerous market anchors in the world of portfolio management are (but not limited to):
  • Index P/E – relatively valuing companies to the index P/E is very dangerous
  • Price relative to the all time high – if a stock was trading at 50% over its fair valuation and is now trading at 25% over its fair valuation, it does not imply that one should buy it just because it’s down by 15%
  • Trading close to the all time or 5 year or one year low – Just because something is at an all time low or close to it does not mean it’s cheap. There could be something really bad going on with the company
  • Buying on days when the stock is down and selling when it’s up – again these are path dependent results and do not add to your returns. If it did many people would chase this arbitrage, some might even write computer programs to do this, and it would no longer be true. If you don’t believe me you can back test this to realize that the return generated from doing this is pretty much the cost of trading.

Tuesday, March 31, 2015

Relative valuation & why anchoring is dangerous

One of the big problems I was having earlier was that I was rejecting a company with similar economics at a valuation of 10 times earnings and thinking of buying another company with similar economics at 15 times earnings. It took a while before I realized what was happening. The problem does not lie in valuation methodology as much as it does in psychology. Robert Cialdini in his book about the psychology of influence talks about real estate dealers who have a couple of houses listed at an exorbitant price which are in horrible state. These are shown to buyers before showing them the actual house they want to sell. It drives people to say yes to the actual house because relatively it looks like better value.

Monday, March 30, 2015

Behavioural finance: Psychology of the astute value investor

“All of humanity's problems stem from man's inability to sit quietly in a room alone.”
- Blaise Pascal

Charlie Munger espouses a concept called the latticework of mental models. This section is my understanding of that concept applied to value investing. Robert Cialdini’s book “The psychology of influence” is also a wonderful read and probably encapsulates most of what one needs as the basis of behavioural finance. I already had this book on my bookshelf somehow and then started seriously reading it when I heard Munger recommend it on his 1995 lecture on "The psychology of human misjudgement". The psychological element of value investing is the most important advantage that you have. There are several intelligent investors who do not raise capital to manage for others for the simple reason that they don’t want their investors to liquidate at exactly the wrong time.

Wednesday, March 25, 2015

Dalal Street (or Wall Street) Research coverage: Bait for the sharks

We have already learnt in the article about why it might be best to stay away from IPOs that IPOs are a massive section of a bank’s fees. Now let’s think about why a client picks a bank?

One of the principal agent problems that an investment bank has is that they typically have a research coverage team that is not explicitly paid for by anyone. Their trading clients (typically mutual funds, hedge funds, insurance companies, portfolio management companies, etc.) use the research to help them make investment decisions. Now the principal agent problem comes in where the IPO or secondary offering side of the business is pitching to raise capital for a company. At this point do you believe it is easy for the bank to give a negative rating to the stock of this company?

Tuesday, March 24, 2015

Getting conviction: Management quality factors

High conviction positions are the holy grail of portfolio management. The basics of this judgement have been covered in the judging the quality of management chapter in the principles section. Management matters a lot but not as much as business quality. Typically it is the most important factor after the business quality in the world of portfolio management. The idea here is the focus on the factors that need to be graded. I have to thank the Valuepickr forum and its contributors (especially Donald Francis) for helping me with this thinking. Typically I would give equal weight age to each of these 6 factors.

Monday, March 23, 2015

Brokerage fees & the art of delaying activity

“We don't get paid for activity, just for being right. As to how long we'll wait, we'll wait indefinitely.”
- Warren Buffet

Brokerage fees sound like a pittance when you are trading, but if you trade too often then you end up hitting your returns. If the brokerage fee is 0.3% (including trading taxes assuming you're trading on Dalal Street) you end up giving up a good 0.6% if you turn over 100% of your portfolio and 1.2% if you turn over 200%. Now your broker wants you trade as often as possible so you will keep getting calls to trade out of what you bought last month and trade into the new fad. But does that really enhance return?

Leverage: The fastest & most likely way to go bankrupt

“If you're smart you don't need it, and if you're dumb, you got no business using it."
- Warren Buffet

Leverage is used by many funds (hedge fund more than mutual funds) as a financial tool to improve returns. Now in the value investing world of equities leverage can be a very dangerous thing. Leverage increases your chances of going bankrupt rapidly. A portfolio management strategy with 1:1 leverage that moves down 50% will be out of the money and the game will be over for the investor. Typically in the value investing world a market move downwards of 50% is a wonderful thing as it provides many opportunities to the intelligent investor. Value investing should then require you to hold a minimum percentage of cash (arbitrarily let’s say 5%) so that in the extreme “six sigma” event you can attend the buying party. For the uninitiated a six sigma event should mathematically occur 0.00034% of the times but in the markets when the going is good the markets find it very unlikely that a 30% fall will happen. And every time it does happen some people start (wrongly) calling it a “six sigma” event. This so called six sigma even seems to happen once or sometimes even more times a decade. So in the value investing communities a “six sigma” event is a buying party!

Sunday, March 22, 2015

Verdict Log: Systematized learning from failure (and successes)

“I’ve learnt so much from mistakes that I am thinking of making a few more.”
- Unknown

The verdict log is a tool I developed when I heard many people in the investment community talk about it. Even in my professional investing experience (with investment banks or a hedge fund) I have seen the stark difference in the clarity of thought of investors who keep a verdict log and those who don’t. The verdict log maybe kept in one form or another.

So what is the verdict log? A verdict log, in my definition, is a two column table with dates and verdict notes. Verdict notes are the bottom line opinion in 3 lines or less of the analysis and data collected up to that point on a company. I maintain a separate verdict log for each company.

The biggest advantage is that with 20/20 hindsight one can very easily analyse the thought process that went into the investment and how it could have been improved. The things that were right are stark and so are the things that are wrong. It is absolutely fine if you are not one hundred percent sure of what is going to happen to a stock – in fact if you are a hundred percent sure the verdict log will create doubt as it forces you to think about all the aspects of the investment.

Other methods I have seen to achieve this are to maintain an investment thesis history, or financial model versions for those who rely on them. How the log is maintained and kept is not important. What is important is for you to be able to look back and understand how you thought about a particular situation and how you think about it now.

Several professional funds (read highly successful ones - mutual funds and even a hedge fund) use this tool in many forms. Some have traders do a write-up which is signed off by risk before the trade happens. Yes – all funds are not cowboys saying yeehaw before each trade. Some are actually systematic. Some of these funds might not create massive returns in a single year but over time the systematic approach definitely yields better results.

The bottom line is that all these tools are there to remove your biases and reduce your reliance on your memory. There is too much information that is going to be running through your mind during the process of value investing and it is very difficult to remember everything. The intelligent investor knows what to tune out as noise and what to listen to as music.

Saturday, March 21, 2015

Proprietary positions, front running & being a pig

“Bulls make money, bears make money, pigs get slaughtered”
- Old adage

Imagine a sales representative trying to sell you a latest stock which he or she claims is going to run up in the coming months. You are told about the wonders of this company and how bright the future is. Now at this point if I told you that his bank holds a large position on it and is on the other side of the trade would you buy it? It would probably surprise you to know that even professional investors at a hedge fund or at mutual funds sometimes fall prey to this situation. These large positions are taken by a portfolio manager within the bank working on a 'prop desk'. After the sub-prime crisis several banks shut down these portfolio management desks and focussed on their core business but you can be sure that something akin to this will be back within the decade.

Every time the brokerage arm of an investment bank is selling you something how do you know they are not selling out their own position? On the flip side how would you know if the brokerage arm was telling you to sell when they were buying for their own proprietary desk?

There is supposed to be regulation in most countries that suggests this to not be allowed. Proprietary desks are on the other side of the ‘Chinese wall’. But do you believe it? Proprietary desks often have the highest paid traders on the firm's payroll on them. They typically yield lots of power within the institution.

Front running is when your brokers respect your investment decision so much that when you tell them to buy something for your they go ahead and buy it for themselves first. With small amounts of capital this may not be a big deal but when funds are buying large percentages of a company then this becomes a very big deal - a big enough deal to be illegal in most countries. Several people I know who trade for hedge funds say that they don’t want large investment banks like Goldman as they have a significant proprietary trading business. This has lead to many a fund to trade with smaller firms. The internet world has democratized the business of stock trading and made it a technology play from an old boys club.

One way to stay away from this problem is to research whether the bank has a position in the company via filings, but filings are only quarterly and they maybe at the start of an operation. Also they could be invested via various legal entities so it may not show up on filings. Some jurisdictions require large financial institutions to club their holdings in their reports. But why not just stay away from buying anything that is being suggested by a large brokerage or investment bank?

The science behind capital allocation & how to make sense of concentrated positions

“Diversification may preserve wealth, but concentration builds wealth.”
- Warren Buffet

Position sizing is the biggest determinant of overall portfolio return. At a 10000 foot level the following table summarizes the allocation concept:

Conviction Level
Discount to fair value
Position size
Very small or zero

Thursday, March 19, 2015

Against all odds: IPOs and why you should fear them

"It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors)."
- Warren Buffet

Typically an investment bank (on wall street, dalal street, or other financial hubs) will make anywhere from 3% to 7% of IPO proceeds as fees. Brokerage fees are typically very small (below 0.15%). This should make it very clear that financial intermediaries make the bulk of the money via initial or follow on public offerings by listed companies. When the bank is going to get such a large percentage of the proceeds as fees they are naturally motivated to drive the price up as much as possible. This is why many a seasoned investor will tell you not to buy into IPOs as most of them are overpriced by the banks via their massive marketing and sales channels.

Wednesday, March 18, 2015

Financial intermediaries & the principal agent problem on Dalal Street

 "Stay away from anything that an investment bank is selling. Their bread and butter depends on their sales skills not their investment skills."

- Rephrased Buffet saying

    Financial intermediaries are typically compensated in a manner that drives their interest contrary to investors. Let’s think about how most financial intermediaries make money:
  • Proprietary positions - Would you like to buy something the bank wants to sell from its own portfolio?
  • Investment banking fees - If you know that the bank was paid 6% of IPO proceeds then you essentially at least loose 6%, and because the bank puts its best salesmen at IPOs you can be sure that its not just 6%.
  • Brokerage fees - Doesn't take a rocket scientist to figure out that a broker wants you to trade in and out as often as possible irrespective of the return.
  • Research coverage - If a company promises an investment bank its market offering or other business isn't it more likely to give it a high rating on research? If not why don't sell side research analysts clearly state their investment performance.
  • Leverage given to investors - The bank makes money on money lent to you. Wouldn't they want to lend as much as possible as long as they know they can liquidate your portfolio fast enough to not loose the entire capital?
  • Sales commission for distributing financial products - If you know that 1% of the mutual fund you buy goes to the broker and then there are entry, exit loads and several fees. Would you still buy it?
  • Asset management (Mutual funds, hedge funds, etc.) - If you are being pitched a fund and that is the only fund that the asset manager runs and it has a great track record maybe you could consider it. If the asset manager runs 20 funds of which 2 are outperforming the market how does that tell you that the asset manager is generating alpha?
  • New financial products - This is the highest risk and most fun. I am going to cover how people have been fooled in the past - even sophisticated investors and asset managers by financial products innovation. As a rule of thumb financial products innovation is designed to increase the EPS of the innovating investment bank not your net worth.
The primary principle that I am trying to drive home is that never buy any equity that is being sold by Wall Street or Dalal Street or any bank or financial intermediary. These institutions are selling machines. They run through several training programs that try to sell you several financial products which might sound excellent to you but when you do the analysis they might not sound as good. Now I am not saying you ignore what your trust broker of the last 2 decades says or that you cannot find a good and honest broker. But before you bring the broker into your circle of trust please evaluate the value of the ideas presented forth in an unbiased manner. I will run through each of these scenarios to describe how they are not very good for investors in the next few articles.

The IGValue magazine on Flipboard

I don't know if you are as big of a Flipboard fan as me but I find the easiest form of reading on Flipboard. For the uninitiated Flipboard is an app for an iPad, tablet, smart phone or even the web that can turn any content into a digital magazine that you can literally flip.

Please do check out the IGValue flipboard magazine at:

I would be obliged if you could tell me whether you like the content in the Flipboard format.

Monday, March 16, 2015

How to get started with Value investing - Step 1: Finding the first investment

If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you'd need. If you're driving a truck across a bridge that says it holds 10,000 pounds and you've got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay, but if it's over the Grand Canyon, you may feel you want a little larger margin of safety...” – Warren Buffet

Finding the first investment is always the hardest. This is primarily because there are over 55,000 listed companies globally and literally gigabytes of data available on and off the internet on each. These businesses directly employ millions of people and indirectly probably deal with a large part if not a hundred percent of the world’s population. Each one of these people can have perspectives on the businesses you are looking at. I hope by now I have convinced you that knowing everything there is to know about all the listed businesses and then making the first investment would never lead to that first investment!

Rules of the game

  Here are a few simple rules that I use to kind of keep on track. A few of them were borrowed from Guy Spier's book, The Education of a Value Investor: My Transformative Quest for Wealth, Wisdom, and Enlightenment. Would love to hear your feedback on these and if you agree with them.
  1. Never sell for 2 years after you have bought: This does multiple good things for you. Firstly if you know this you will always think a lot before you become a partner in the business. Secondly it eliminates all biases and gives you enough time to do in depth research before you sell out your interest in the business. This by no way means that you should stop thinking about the business or reading or doing research during the two years. On the contrary it means that you do highly diligent research during those two years in order to affirm or dispute your thesis.

Friday, March 13, 2015

How to get started with Value investing

Many times I am asked: This is all very good but how can it benefit me? And I was planning to cover this in a short few articles but I was chatting with a friend of mine who said 

“All this motherhood stuff is great but I will only read your stuff if it can benefit me!” 

And this is coming from a guy who has lots of experience in various business fields in various countries for decades. He has probably read more business books than I have seen in libraries and bookstores. This probably means what he is saying might actually have a tiny bit of weight to say the least. You can thank him (or not if you don’t like this section) for this factor being covered over several articles.

Saturday, March 7, 2015

Long short & the myth of market neutrality

“The market can stay irrational far longer than you can stay solvent”
-      John Maynard Keynes

Long short strategies when right can produce wonderful returns as well but the risk associated with these is far higher than you think. On paper these strategies look wonderful. Imagine if you can make the market return without the downside because your longs and shorts offset each other. Many funds claim to be market neutral but in reality they have massive amounts of implicitly leverage. When you short a stock the most you can make is 100% but the most you can lose is infinite.

Tuesday, March 3, 2015

Why focus on equities?

You can generate much larger and outsized returns with minimal riskusing arbitrage strategies. There are several arbitrage opportunities available to investors in warrants, Rights, Options, Futures & forwards to name a few. These are typically wonderful opportunities especially if the capital you are running is small. The annualized returns from these can be much larger than buy and hold on good companies. So then why should you even look at at equities?

Monday, March 2, 2015

Volatility: Friend or foe of the value investor?

Volatility is the variation in stock prices. Mathematically it is the square root of the variance. The more a stock moves up and down the higher the volatility. Investors typically fear volatility and are much happier in lower volatility environments as it is perceived is lower risk. But image if you know that you have the opportunity to buy something at various prices every 365 days at prices that differ by over 50%? Wouldn't this be very exciting for you if you knew the value of the underlying security?

Saturday, February 28, 2015

Has the advent of the internet moved the cheese of value investors?

Several of my blog readers have asked me whether the advent of the internet and digital age made markets a lot more efficient. It is true that it is much easier to get access to information today than it was before the digital age. For example till a couple of decades ago you had to order annual reports in physical form but today you can go to a website and get the information. Several value investing blogs, forums and social media have information about publicly listed businesses. The exchanges on Dalal Street and elsewhere provide tons of information on actions, financials, key dates, conference calls and more. The key management personnel are on facebook, twitter, LinkedIn and various other social and professional networks. You might even have them as 2nd or 3rd degree connections in the worst case. This could enable to get their bio-data and contact your friends to get impressions.

Friday, February 27, 2015

Judging the quality of management

Management is a big issue in value investing in India. From the US perspective Buffet is of the view that you don't need a great management to run a good business and a business with poor economics cannot be turned in a business with good economics with good management.

In India the control environment is not as great and thus investors are in the dark about how to judge management. My attempt here is to provide a framework checklist that can give you some cues into how to judge management.

Thursday, February 26, 2015

Circle of competence

Your circle of competence is the companies for which you can think like the owner, CEO or board. What does think like the CEO mean? It means you understand the:

·        Products & services –
o   what the product or service s
o   How is the product or service beneficial to the customer?
·        Customers
o   Why they buy
o   what are their alternatives
o   how does this product or service benefit the customer
o   what is the customer willing to pay for this
o   How does this company create value for its customers?
o   How loyal are the customers?
o   Can the customers be made more loyal over time? Is the company taking rapid actions to make the customer more loyal?
·        Suppliers & supplier economics
o   How much control do suppliers have over the business?
o   Can the business grow large enough to be able to control the suppliers?
o   Does the business have supplier alternatives?
o   How can the costs be controlled?
·        Pricing
o   How will an increase in price impact sales?
o   Can cost increases be passed on to the customers?
o   Can unreasonable price increases be done over time?
·        Competition
o   Is the competition smarter than this company?
o   How can the company beat the competition?
o   What are the advantages and disadvantages of the company over the competition? How will these evolve over time?
·        Change management
o   How rapidly is the customer, product, service, delivery
o   Can this product or service become obsolete?
o   Can the entire industry become obsolete?
o   Is the company a change leader, follower or will it succumb to change?
·        Industry
o   What is the market size?
o   What are the related products that can be forward or backward integrated?
o   Is this company the industry leader or does it have the capability to be the industry leader?
·        People
o   How well are they compensated?
o   Does the best talent work for this company? If not who does the best talent work for and why?
o   How will the people costs evolve?
o   Will the company be able to scale management like its people?
·        Scalability
o   How can the business be scaled going forward?
o   How rapidly can the assets be made to sweat?

As you can probably guess – no one is born with a circle of competence. As you go along your value investing journey your circle of competence will rapidly expand. Over time your sense of an industry or business will improve rapidly if you continue to look incisively at companies.

Before you finalize on an investment I would strongly recommend you study a few of the competitors with the same level of detail. That will give you a sense of the overall business model. You should especially study the top few companies in the industry and a few of the large laggards. That way you can understand what drives success and failure.

Increasing your circle of competence is very important as it keeps opening new avenues to you. If you find something that you don’t understand going at it with all gusto is good but only to a point. Sometimes some businesses are best left alone. If the complexity is something you don’t understand it does not necessarily mean you are not smart. It may mean that you don’t have the pieces of the puzzle together yet or it does not suit your style of thinking. All businesses need not suit everyone. Examples of industries that some investors have been known to leave alone due to complexity in the past are technology companies and pharmaceutical companies.