Few interesting learnings from Market Wizard Series [still WIP]

Last year, few good investors highly recommended reading Market Wizard Series by Jack D. Schwager. I think every value investor should read it. I have complied my personal learning from this series. Its quite possible that you might interpret the same thing in a different manner and its fine. In some of my interpretations I might be completely wrong. Its still work in progress……

Here is the link to the document .. its still work in progress, but thought of sharing to get some feedback  ….

PS: Link to the series

Book 1

Book II

Book III

Book IV



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My key learning from J P Morgan Chairman’s letter from 2005-16

I know many of you would have already read Jamie Dimon letters to JP Morgan shareholders, if anyone has not .. Please do read all letters in full from 2005-10 and selectively from 2011-16… Few important takeaways for me are [my understanding might be wrong at few places, please correct if come across any mistake]
1) Diversified risk by way of diversified loan book. Within this diversified stream there should be segments with durable profits which can absorb losses of cyclical segments.   Mix of businesses lead to effective cross sell….

2) Deeper penetration of customer using technology and cross selling

 3) Strong balance sheet by way of adequate tier 1 capital and access to retail deposits

4) Innovation by introducing new products and meeting customer needs

5) Most banks failed due to lack of diversification – customer and geography wise and using ST liquid assets [mostly overnight or for 45 days CD] for long-term illiquid assets. To never fail banks require 1) BS strength 2) Sufficient Liquidity [essentially no ALM mismatch] 3) Diverse earnings [reduces risk]

6) Scale very important to be low-cost provider. Only low cost provider will survive for long [both interest cost and other expenses]

7) Cross selling not bad, if done properly. In fact most imp competitive advantage

8) Innovation should be part of DNA..

9) Best way to compensate top management is by way of stocks. They should be made to retain majority of the stock option till they continue to work.

10) Home mortgages through brokers produced 2-3x more losses than direct sourcing. Eventually completely stopped sourcing through brokers.

11) In one of the letters he recommended providing provision for credit losses based on loss over complete cycle and says this will be counter-cyclical measure [I think new IND AS rules on credit cost is same as what James is talking about]

12) It was interesting to note that during 2007-09 crisis retail banking posted more losses than corporates, in India it was opposite.  Which shows it more important to keep analyzing whose BS is more stretched. Corporate or retail.

13) Regulated entities compromise with their system to compete with unregulated entities…where regulatory arbitrage is big. [May be gold loans during 2008-11 in India, future could be real estate loans to developers – ]

14) Crisis generally emanate from 1) Trade imbalances 2) Foreign exchange issues and 3) Real estate speculation

15) In US payback of branch is 7 years [2013 letter] 

16) Both physical and digital network is required… [2012 letter]. Customers get confidence when interact face to face. For small and middle business customers physical branch must….  

17) Moats of Bank: 1) Strong BS 2) Economies of scale 3) Technology 4) Ability to cross sell…..

18) Geopolitical risks: Starting from Korean War to till date, only Middle East crisis of 1974 which resulted in spike in oil prices caused problem to banking sector.
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What Can Long Term Investors Learn from Private Equity/Venture Capitalist

I am generally obsessed with learning from other participants in equity ecosystem like short sellers, traders etc. Some time back I did post on What LT investors can learn from short sellers. This time lets look at what can long term investors learn from successful Private Equity Players and Venture Capitalist.

Private equity mindset

Private equity tend to hold for much long periods of time than most investors with an average hold time of more than five years right now. They tend to favor smaller companies.

Focus on Absolute Long-Term Returns

Private equity investors do not benchmark their performance in the same way many public market investors do. In private equity, the goal typically is to generate absolute investment returns over a long period of time. By adopting a similar focus, public equity investors gain an edge over fellow market participants who make decisions based on short-term results or emotional swings. The increasing “short-termism” of many investors has created an opportunity for those willing to apply private equity principles to the public markets.

Read more here

Error of omission is much more costly than error of commission

“The thing all the venture firms have in common is they did not invest in most of the great successful technology companies.” “The mistakes that we make in a field like venture capital generally aren’t investing in something that turns out not to work. … it’s the big hit that you missed. And so every venture capitalist who had the opportunity to invest in Google and didn’t just feels like an idiot. Every venture capitalist who had the opportunity to invest in Facebook and didn’t feels like an idiot. The challenge in the field is all of the great VCs over the last 50 years, the thing that they all have in common, is they all failed to invest in most of the big winners. And so this again is part of the humility in the profession.” Warren Buffett and Charlie Munger call this type of mistake an “error of omission” (i.e., what you don’t do can hurt you more than what you actually do). No one describes this category of mistake better than Charlie Munger: “The most extreme mistakes in Berkshire’s history have been mistakes of omission. We saw it, but didn’t act on it. They’re huge mistakes — we’ve lost billions. And we keep doing it. We’re getting better at it. We never get over it. There are two types of  mistakes:  1) doing nothing, what Warren calls “sucking my thumb” and 2) buying with an eyedropper things we should be buying a lot of.”

Source: 25iq Blog post


Venture capitalists “spend a lot of time talking about markets and technology…. and we have lots of opinions. …but the decision should be around people…. about 90% of the decision [is people].”… “We are looking for a magic combination of courage and genius .… Courage [“not giving up in the face of adversity”] is the one people can learn.” When you have a team of strong people in a startup, their ability to adapt and innovate gives the company and the investors optionality. Weak teams which can’t adapt to changing environments usually fail. Identifying the right people is all about pattern recognition

Source: 25iq Blog post

For Anandan, the team is the most important parameter. Two to three co-founders are ideal, he says. “A great tech bent is a huge plus. They should have a track record and should have been around for some time,” he says.

We invest more in people than in a specific plan, because plans often change.” “Failing quickly is a good way to plan. Failing often makes failures small and successes large….In small failures you accumulate learnings about what works and what doesn’t. Try many experiments but don’t bet your company on just one, keep trying, keep failing small.” “There are probably three or four things you can control out of ten that matter for the success of your company.” Competitors control another three or four. “The rest is just luck.” Partly for that reason, he is dismissive of business plans. “I’ve never seen one that’s accurate.”  Entrepreneurs who can adapt are far more likely to achieve great success. No plan survives first contact with the competitors and customers in a real market. Investing in great teams generates optionality since great teams can adapt. 

Source: 25iq Blog post on Vinod Khosla 

Emerging moats

“You want to tilt into the really radical ideas… but by their nature you can’t predict what they will be.” “There will be certain points of time when everything collides together and reaches critical mass around a new concept or a new thing that ends up being hugely relevant to a high percentage of people or businesses. But it’s really really hard to predict those. I don’t believe anyone can.”  This set of quotes describes the best way to deal with complex adaptive systems – rather than trying to predict the unpredictable, it is best to purchase a portfolio composed of mis-priced optionality

Source:  25iq Blog post 

Market potential

“Anyone who has pitched VCs knows they are obsessed with market size.” “If you can’t make the case that you’re addressing a possible billion dollar market, you’ll have difficulty getting VCs to invest. (Smaller, venture-style investors like angels and seed funds also prioritize market size but are usually more flexible – they’ll often invest when the market is “only” ~$100M).  This is perfectly rational since VC returns tend to be driven by a few big hits in big markets.”

“If you are arguing market size with a VC using a spreadsheet, you’ve already lost the debate.” For early-stage companies, you should never rely on quantitative analysis to estimate market size. Venture-style startups are bets on broad, secular trends. Good VCs understand this.” “Startups that fill white spaces [areas where there is latent demand without supply] aren’t usually world-changing companies, but they often have solid exits. They force incumbents to see a demand they had missed, and those incumbents often respond with an acquisition.”

Source: 25iq blog post 

“A big (scalable) idea and a great team are key,” says Kalra. Also, the fundamental due diligence of an idea is necessary while the market size needs to be big enough to lure him. “I would not invest in an idea where the market size is restricted. It should have the potential to grow and be able to give better than the [average] market returns,” he says

Read more here

Customer pain

Jim Goetz is a venture capitalist at Sequoia Capital> He says “Many of the entrepreneurs that we back are attacking a personal pain.” “Our view is that, early on, if you’re solving a meaningful problem, even if it’s for a small group of people, there is an opportunity to expand beyond that over time.If a business is not solving a genuine customer problem in a unique and compelling way and in a manner that is defendable via a moat, a business is unlikely to succeed.

Source:   25iq blog post 

Power Law

In 1906, economist Vilfredo Pareto discovered what became the “Pareto principle,” or the
80-20 rule, when he noticed that 20% of the people owned 80 % of the land in Italy— a
phenomenon that he found just as natural as the fact that 20% of the peapods in his garden produced 80% of the peas. This extraordinarily stark pattern, in which a small few radically outstrip all rivals, surrounds us everywhere in the natural and social world. The most destructive earthquakes are many times more powerful than all smaller earthquakes combined. The biggest cities dwarf all mere towns put together.

The error lies in expecting that venture returns will be normally distributed: that is, bad
companies will fail, mediocre ones will stay flat, and good ones will return 2x or even 4x.
Assuming this bland pattern, investors assemble a diversified portfolio and hope that winners counterbalance losers. But this “spray and pray” approach usually produces an entire portfolio of flops, with no hits at all. This is because venture returns don’t follow a normal distribution overall. Rather, they follow a power law: a small handful of companies radically outperform all others. If you focus on diversification instead of single -minded pursuit of the very few companies that can become overwhelmingly valuable, you’ll miss those rare companies in the first place. The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined. This implies two very strange rules for VCs. First, only invest in companies that have the potential to return the value of the entire fund. This is a scary rule, because it eliminates the vast majority of possible investments. (Even quite successful companies usually succeed on a more humble scale.) VCs must find the handful of companies that will successfully go from 0 to 1 and then back them with every resource. Of course, no one can know with certainty ex ante which companies will succeed, so even the best VC firms have a “portfolio.” However, every single company in a good venture portfolio must have the potential to succeed at vast scale.

Return per unit of time invested

As a venture capitalist once told me, venture investors are investing two things: time and money. The concern with the financial investment is obvious. Less obvious, however, is the opportunity cost in terms of time. Because the cost of continuing to invest time in the entrepreneur’s venture is the inability to take on another, potentially much more lucrative venture, the venture capitalist often has an incentive to shut down the venture and move on before the entrepreneur is willing to do so.

Source: The Masters of Private Equity and Venture Capital (p. 149). McGraw-Hill Education. Kindle Edition.

How to take long term view?

“Five-year plans aren’t worth the ink cartridge they’re printed with.”  Great teams are able to respond to a world which changes in ways which cannot be foreseen. This is why venture capitalists spend so much on the people employed by the startup. A strong team of people means the startup itself has optionality. The ability to “steer” as conditions change is more valuable than the ability to create medium- and long-term plans. Good venture capitalists mentally giggle when see hockey stick shaped distribution curves based on unrealistic assumptions that don’t map to reality

Source: 25iq Blog post 

Estimates do not matter, what’s matter is the thinking behind those numbers

“Even though the numbers [in the entrepreneur’s business model] will likely be wrong, your thinking behind how you arrived at those numbers is critically important. Think of each assumption as a dial.  Which ones connect to things that matter, and what impact would they have on your ultimate outcome if they turn out to be only half as effective – or then again twice as effective? Of the ones with the biggest impact, what underlying factors determine their outcome?  Which ones can kill your business?”

 Source: 25iq Blog post 

 “When they have their five-year plan and they come down to net profits, that’s okay. But then when they tell you how much your earnings per share is going to be and what the dilution is going to be and then how much, at what price earnings ratio the stock is going to sell at and then they tell you, well, you know if you invest it today you would make twenty times or a hundred times or something on your money, at that point I don’t want to talk to them anymore. Very nice to have met you. Goodbye. Good luck.”

Source: 25iq Blog post 


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Investment Philosophy of John Maynard Keynes

Why read about Keynes Investment Philosophy?

Under Keynes’s tenure as First Bursar of King’s College— a period that encompassed the 1929 market crash, the Great Depression, and World War II— the discretionary portfolio of the King’s College grew through Keynes’s investment prowess and cash inflows from just over £ 20,000 to £ 820,000. Keynes’s investment performance on behalf of the King’s discretionary portfolio generated over the quarter-century to 1946 an annualized return of 16 percent, outperforming the comparable U.K. equity market by 5.6 percent per year.

Source: Concentrated Investing: Strategies of the World’s Greatest Concentrated Value Investors

Here is the Link on short compilation of investment philosophy of Keynes from few books


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Interpreting Seth Klarman quotes using Howard Marks Memos

Couple of years back I tried to compile Howard Marks memos from 2001-2011 in a 75 page document. It was quite a learning experience for me to go through this document again. You can download this document from here.

I have generally found it difficult to understand many of the Seth Klarman quotes. Few of my friends says I am trying to read too much into it 🙂 . May be they are right? But nevertheless I have found it very helpful to read couple of Mr. Seth quotes along with Howard Marks memos. Find below two of such quotes.

Please share your interpretation of below quotes, more so if you disagree with my interpretation.

Seth Klarman says

“The investment challenge of providing liquidity to out-of-favor asset classes is more complex than simply identifying areas that others are avoiding. First, it is important to never be blindly contrarian, betting that whatever is out of favor will be restored. Often, investments are disfavored for good reason, and investors must consider the possibility that recovery may not occur. Second, it is important to gauge the psychology of other investors. How far along is the current trend, what are the forces driving it, and how much further may it have to go? Being extremely early is tantamount to being wrong, so contrarians are well advised to develop an understanding of the psychology of the sellers. Finally, valuation is extremely important in reducing risk. Investors must never mistake an investment that is down in price for one that is bargain-priced; undervaluation is determined only by a security’s price compared to its underlying value.”

I found the quote highlighted in bold quite interesting. Isn’t it same thing as timing? With the same question, I was struggling during demonitisation led crash too. Something unprecedented had happened and I really could not understand what to do more so with some of my stocks which were directly hit by demonitisation.  Ofcourse prices fell by 30-40%, but in absence of adequate information this means nothing. I was not waiting for consensus but wanted to wait atleast for 2 quarters to see the impact of event and then take a call. I have asked this question to many investors and except for couple of answers found most not to be satisfactory. I think finally I got answer to this in Howard Marks memo. This is what Howard Marks says in his January 2008 memo

“Nevertheless, I do think we’re in the early going: the pain of price declines hasn’t been felt in full (other than perhaps in the mortgage sector), and it’s too soon to be aggressive. Things are somewhat cheaper (e.g., yield spreads on high yield bonds went from all-time lows in June to “normal” in November) but not yet on the bargain counter. Thus, I’d recommend that clients begin to explore possible areas for investment, identify competent managers and take modest action. But still cautiously, and committing a fraction of their reserves.

“Don’t try to catch a falling knife.” That bit of purported wisdom is being heard a lot nowadays. Like other adages, it can be entirely appropriate in some instances, while in others it’s nothing but an excuse for failing to think independently. Yes, it can be dangerous to jump in after the first price decline. But it’s unprofessional to hang back and refuse to buy when asset prices have fallen greatly, just because it’s less scary to “wait for the dust to settle.” It’s not easy to tell the difference, but that’s our job. We’ve made a lot of money catching falling knives in the last two decades. Certainly we’ll never let that old saw deter us from taking action when our analysis tells us there are bargains to be had.

In the period ahead, cash will be king, and those able and willing to provide it will be holding the cards. This is yet another of the standard cyclical reversals, and it will afford bargain hunters a much better time than they had in 2003-07.  Some of those who came to the rescue of troubled financial firms in 2007 may have jumped in too soon. There’s a fair chance they didn’t allow maximum pain to be felt before acting, (although the prices they paid eventually may turn out to have been attractive). I’d mostly let things drop in the period just ahead. My view of cycles tells me the correction of past excesses will give us great opportunities to invest over”

In his book “The Most Important Thing Illuminated“, Howard Marks added more on the same topic of catching falling Knife:

Investors score their biggest gains when they buy an underpriced asset, average down unfailingly and have their analysis proved out.

Investor sentiment was extreme in October 2008. Valuations were incredibly cheap, and stocks offered wonderful returns looking forward. In fact, over the next two years returns were spectacular. Unfortunately, stocks first fell another 20 percent from the already low October 2008 levels before they eventually turned around (in March 2009). As contrarians it’s our job to catch falling knife with a view on intrinsic value.

I try to look at it logically. There are times to buy an asset that has been declining: on the way down, at the bottom, or on the way up. I don’t believe we ever know when the bottom has been reached, and even if we did, there might not be much for sale. If we wait until the bottom has been passed and the price has started to rise, the rising price often causes others to buy, just as it emboldens holders and discourages them from selling. Supply dries up and it becomes hard to buy in size. The would-be buyer finds it’s too late. That leaves buying on the way down, which we should be glad to do. The good news is that if we buy while the price is collapsing, that fact alone often causes others to hide behind the excuse that “it’s not our job to catch falling knives.” After all, it’s when knives are falling that the greatest bargains are available.

How do we resolve when to buy problem. Simple we buy when something is cheap. If it becomes cheaper, we buy more. If we see something attractive today, we never say we will wait another six months because It will be cheaper then. It never works that way.

He further added in his book that

” The one thing I am sure of is that by the time the knife has stopped falling, the dust has settled and the uncertainly has been resolved, there will be no great bargains left. When buying something has become comfortable again, its price will no longer be so low that it’s a great bargain. And the high volumes that accompany a sharp sell-off will also likely be over. Not only will prices be on the rebound, but buying a sizeable position will be much harder. 

A hugely profitable investment that does not begin with discomfort is usually contradictory. It’s our job as contrarians to catch falling knives, hopefully with care and skill. That’s why we hold a view of value that enables us to buy when everyone else is selling and if our view turns out to be right – that’s the route to the greatest rewards with the least risk. “

 Seth Klarman another quote add a little more interesting perspective to above question. He says “This massive influx of capital, ironically has led to a market where almost everyone has wanted to reflexively buy the dips, where the market’s high have been higher, and lows higher too..”

 Second Quote

“What happens when you are wrong is everything is investing. You must construct a portfolio to survive those times”….

I was confused again by this quote. How can we construct a portfolio to survive all the risky scenarios? Some of them though possible, may be very low probability event. Again I think I got answer to these questions in Howard Marks memo.

So What Do We Do Now (after Sept 11 bombing)?  We could assume that the combination of further weakening of the already-weak economy plus continued terrorism will make for a very difficult environment. If we then based our investment process on that assumption, we would hold cash and make very few commitments. I call this “single scenario investing.” The problem, obviously, is that arranging our portfolio so that it will succeed under a scenario as negative as that means setting it up to fail under most others. We do not believe in basing our actions on macro-forecasts, as you know, and we certainly don’t think we could ever be that right.

Thus Oaktree will continue to invest under the assumption that tomorrow will look a lot like yesterday – an assumption that to date has always proved correct. At the same time, we will continue to insist on an investment process that anticipates things not always going as planned, and on selections that can succeed under a wide variety of scenarios. As long-term clients know, this part of the story never changes. In the current environment, we will allow a very substantial margin for error. We will continue to work only in inefficient markets, because we feel it’s there that low risk needn’t mean low returns, and upside potential can coexist with downside protection.

And we will continue to strive for healthy returns in good markets and superior returns in bad markets. We do not promise to beat the markets when they do well, but we also don’t think that’s an essential part of excellence in investing.”

Howard Marks further elobaorated on this in his Dec 2008 memo

One of my favourite adages concerns the six-foot-tall man who drowned crossing the stream that was five feet deep on average. It’s not enough to survive in the investment world on average; you have to survive every moment. The unusual turbulence of the last two years – and especially the last three months – made it possible for that six-foot-tall man to drown in a stream that was two feet deep on average. UShould the possibility of today’s events have been anticipated? It’s hard to say it should have been. And yet, it’s incumbent upon investors to prepare for adversity. The juxtaposition of these sentences introduces an interesting conundrum.

 If every portfolio was required to be able to withstand declines on the scale we’ve witnessed this year [2008] that no one would ever invest in these asset classes, even on an unlevered basis.)

In all aspects of our lives, we base our decisions on what we think probably will happen. And, in turn, we base that to a great extent on what usually happened in the past. We expect results to be close to the norm (A) most of the time, but we know it’s not unusual to see outcomes that are better or worse (B). Although we should bear in mind that, once in a while, a result will be outside the usual range (C), we tend to forget about the potential for outliers. And importantly, as illustrated by recent events, we rarely consider outcomes that have happened only once a century . . . or never (D).

Even if we realize that unusual, unlikely things can happen, in order to act we make reasoned decisions and knowingly accept that risk when well paid to do so. Once in a while, a “black swan” will materialize. But if in the future we always said, “We can’t do such-and-such, because we could see a repeat of 2007-08,” we’d be frozen in inaction.

So in most things, you can’t prepare for the worst case. It should suffice to be prepared for once-in-a-generation events. But a generation isn’t forever, and there will be times when that standard is exceeded. What do you do about that? I’ve mused in the past about how much one should devote to preparing for the unlikely disaster. Among other things, the events of 2007-08 prove there’s no easy answer…”

 In his October 2008 letter he further says that “But in dealing with the future, we must think about two things: (a) what might happen and (b) the probability it will happen. During the crisis, lots of bad things seemed possible, but that didn’t mean they were going to happen. In times of crisis, people fail to make that distinction. Since we never know much about what the future holds – and in a crisis, with careening causes and consequences, certainly less than ever – we must decide which side of the debate is more likely to be profitable (or less likely to be wrong).”






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How to Learn

For long time I was planning to do a blog post, but somehow was finding it difficult to take out time. So finally decided to take a short cut. I am posting some compilation of thoughts from my EVERNOTE. Its not in the best format abut lesson is PRICELESS. I was astonished to see consistency of thought process from Swami Vivekananda to Bruce Lee and Sam Walton to Paul Sonkin on ‘How to Learn’ ..Here is the link

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Failure Patterns of Companies

Acknowledgement: This is mostly a compilation of material from various books and blog post. I have tried to quote source wherever I could recollect. 

I have a firm belief that any investor can easily outperform market over 5-10 years by a wide margin only if he follows two rules 1) Focus on the size of the win. In other words refuse to invest in any situation if the upside is less than 5-10x in next 5-10 years 2) Avoid big mistakes [Where you loose more than 50-80% ]. My entire focus of studying failure patterns is to eliminate BIG MISTAKES.

I have received varied feedback from senior investors about utility of studying FAILURE PATTERNS in eliminating big mistakes.

  1. Some say act of studying failure patterns is nothing less than INTELLECTUAL MASTURBATION, an act just to satisfy our ego with no utility. Just study annual reports and that should be sufficient.
  2. Some say they do not think in terms of patterns at all. What counts to them is what is priced in the stock price and how the current financial numbers look like.
  3. Third group of investors feel that studying failure patterns might help, but this is an act of laziness. One should study the business model in-depth, do lot of scuttlebutt and then try to identify all the key risks and keep a close eye on the key risks.
  4. Fourth set of investors says, number of variables which can go wrong in the business model are far higher than we can think of. In investing we cannot do control experiments, so one has to study patterns of what has worked in the past and what has not worked in the past. Studying success and failure patterns are very important and one should not get too fussy about survival-ship and hindsight bias. [I fall in the fourth category]

I am in no way suggesting that my view of studying failure patterns is the only way or the correct way. I will continue to look for ways and means to reduce BIG MISTAKES and if I come across another better way, I will switch to that.

In my earlier post on “What Causes Long Term Destruction of Capital – High Valuation or Lack of Sustainable Profits” I have highlighted that

Almost all cases of Permanent Loss of Capital has happened in Bad Business.Good bad business

In the same post I have tried to group cases of PERMANENT LOSS into FOUR category.


In this blog post I have tried to study various failure patterns which I have come across. In my definition, a non-financial company will get classified as FAILURE if it fails to generate SELF FUNDED Sales, PAT and EPS CAGR of > 15% over next 5-10 years [15% is in Indian context based on last 10-15Y nominal GDP growth rate. Infact the rate 15% is not that important. What’s important is that over long term PAT should grow at higher than or equal to nominal GDP growth rate of the country]. At the current stage I do not have lots of Indian examples. I plan to do this over next year. If you have any failure examples or patterns please do share.

You can download detailed write up from here.

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Transcript of my talk delivered at Flame Alumni Meet

What Causes Long term Loss of Capital – High Valuations or Lack of Sustainable Profits

Note: This is slightly edited version of my talk delivered at Flame Alumni meet which I have reproduced based on my memory. You can download the copy of presentation from here …..Some time back I did a similar post. This time I have tried to follow different approach

Dear Friends,

First of all I would like to thanks Flame for giving me an opportunity to present my thoughts. Entire presentation is inspired from reading interviews/articles of Mr. Bharat Shah and Prof Sanjay Bakshi. Needless to mention that any error in this presentation is due to my misunderstanding.

I have a very limited value investing experience of little more than 4 years. In these 4 years my biggest learning is that it’s very important to know your investment personality and stick to it. After experimenting with deep value, turnaround situations and special situations, I realized that my personality is best suited for buy and hold kind of investment, where one buys and hold the stocks for five years or more.

During the initial years I struggled a lot on valuations and kept asking everyone how they arrive at intrinsic value of a stock. I was of the belief that to avoid permanent loss of capital, valuations are of outmost importance. And then I came across few interviews of Mr. Bharat Shah and that made me to reconsider my views. He says

Quality growth sustained over time will enhance value. Therefore, even if one has misjudged the value and overpaid, rise in value over time will give a chance to catch up and will let avoidance of permanent loss of capital. A pure cigar butt may not enjoy such luxury.”

Above quote is very important. Take your time to go through it again before we proceed further.

The first question which came to my mind after reading above quote was to check how many companies have destroyed wealth over period of time even after delivering quality growth.

[Note: In Indian context I am interpreting quality growth as situations where PAT CAGR is more than 15% and average ROE is more than 15%, so that it’s a self-funded growth. The number 15% is not that important. What’s important is that this number should be equal to or more than nominal GDP growth of the country over long term….then only I think it’s possible to beat inflation and earn some real rate of return.]

Mathematically the above quote can be represented thus


Now in the first case where intrinsic value is growing at 15% and intrinsic value is INR 50crs, suppose one misjudges value and by mistake buys this stock at INR 100crs. It will take five years for intrinsic value to catch up with the excess price paid. But if one continue to hold it for longer term and profits remain sustainable then growth will bail you out. If one holds this stock for 10 years, one suffers in terms of returns and not nominal capital.

Now let’s take the third case where intrinsic value is either flat or declining. If by mistake one overpays here, it will result in permanent loss of capital.

Approach followed

To verify the previous statement by Mr. Bharat Shah, I have tried to find cases where wealth destruction has happened despite PAT growing at 15% CAGR and average ROE more than 15% for various periods like 2000-16, 2003-16, 2007-16, 2009-16 and 2011-16. Valuation is always subject to the earnings growth. So, if one has incurred loss even after PAT grew at more than 15% CAGR while maintaining ROE above 15% and still have incurred losses, we can say that most probably one has overpaid at the time of buying. [Only exception is if at the time of selling markets are extremely depressed]. I have assumed that one will buy at the beginning of the period and will continue to hold the stock till the end of this period.

The entire study is based on historical numbers whereas in investment one need to assess future. One can reject this study as HINDSIGHT and SURVIVALSHIP BIAS. But I think one can learn from history on what has worked and what has not worked in the past.

Finding of study

finding of study

Except for 2003-16 period, in all other periods 30-50% of the active companies have destroyed wealth.

But when we consider the companies which were able to grow their PAT at more than 15% CAGR and at the same time maintain their average ROE at more than 15%, only less than 1% of the companies have destroyed wealth.

Results are similar even if we exclude companies with market cap of less than 100crs in all periods. In the above study I have ignored valuation, not because I think valuation are not important. But I want to find out what happens even if one ignore the valuations and focus exclusively on sustainable profits.


Source: Motilal Oswal Wealth Creation Study 1993-98

Even for 1993-98 period results are same. Most of the companies which destroyed wealth had low ROE.


Nifty fity

As per one study, even if one had bought the infamous Nifty-Fifty at the peak of Dec 1972 and held it for the next 25 years, results would have closely matched S&P 500. Now S&P 500 is rebalanced often and underperformers keep getting eliminated whereas Nifty-Fifty remained same throughout the 25 years. Even then the results of Nifty-Fifty closely matched S&P 500

Bad News!!!


Is it easy to find companies which can sustain their ROE at more than 15% for next 10 years or more? Not at all. As per study conducted by Motilal Oswal out of 2,400 active companies in 2004, ROE was more than 15% for only 26% of them. By 2014 this ratio declined to 4%.

In other words with perfect hindsight, in 2004 there were only 4% of the active companies with sustainable ROE of more than 15% for next 10 years.

So now the obvious question is how to find such companies?

Before we reject the entire study saying that its only SURVIVORSHIP AND HINDSIGHT BIAS, let’s see what Prof. Sanjay Bakshi has to say.  He says

“Take any idea in value investing and you’ll find the same survivorship bias. But extreme success in investing has come to those who have found patterns that have worked really well. ……..

…….Mr. Taleb has roughly said that there won’t be enough data in Mr. Buffett’s lifetime to know if he had any skill or whether he was just lucky.

Mr. Bakshi further adds that

“Take Charlie Munger. He talks about learning by studying great failures and great successes and identifying common elements. He wants you to recognize patterns. If there’s a pattern associated with success, he implicitly assumes causality. If there’s a pattern that’s associated with failure, he does that again. He said avoid the patterns that cause failure (all I want to know is where I am going to die, so I never go there). He says look for patterns which “produced” extreme successes and if you find them, back up the truck on them….. “

He further adds that

“Maybe, just maybe there’s a pattern which helps us understand what’s a good business and what’s a bad business ex ante and not ex post…..”

Seek Answers in Past Success and Failure Patterns.

All the sources of permanent loss of capital can be broadly classified into four

  •  Management risk
  • Business Risk
  • Balance Sheet Risk
  • Valuation risk

Out of the above valuation risk can be managed by having some thumb rules. It’s the management, Business and Balance Sheet risk which is most complex to understand and evaluate. I have no easy answers on how to analyze this risk. Following Mr. Bakshi advice I am trying to study past success and failure patterns. This is still a work in progress. Here I would need help of all of you.

I request you to please share the patterns which you have observed in your failed ideas or companies which have not done well. Also the patterns which you have observed in the companies which have done extremely well. My email id is anilt@contrarianvalueedge.co.in or anil1820@gmail.com

Good Business vs Bad Business

Based on the finding of this study I have tried to classify the entire business universe into two:

1) Good Business

2) Bad Business.

A Good business [Non-financial] is one which over long term can sustain Sales, PAT and EPS CAGR > 15% while maintaining ROCE and ROE > 15%

All the five items [Sales, PAT, EPS, ROCE and ROE] need to be above 15% [or equal to or above nominal GDP growth rate] for it to be sustainable growth.

Mere high ROE does not make any business Good Business [Even if ROE > 50%] e.g.. HLL, Castrol etc. At minimum, Sales and PAT CAGR should be equal to or higher than nominal GDP growth rate.

Benjamin Graham

Source: Security Analysis, Benjamin Graham

If a company provides only assurance of long term durability without any assurance on minimum growth in intrinsic value over long term [> 5-8 yrs.], then I would classify such companies under Class II rather than under Class III.

In the words of Mr. Bharat Shah

“When growth goes away, Equities reduced to a Bond. It will be treated like a bond for a while. If the picture deteriorates further, then it will be treated worse than a bond”

None other than Seth Klarman has said

“Price is perhaps the single most important criterion in sound investment decision making. Every security or asset is a “buy” at one price, a “hold” at a higher price, and a “sell” at some still higher price. “

How do we reconcile this entire presentation with the above quote?

Good bad business

I am not suggesting it’s impossible to make money in bad businesses. What I am saying is that almost all cases of permanent loss of capital has happened in bad businesses. If one is buying bad businesses one should be careful of entry and exit timing. In such businesses your losers will control your return.

Notes on data:
1) Source of data: Ace Equity
2) No adjustment made for spin-offs and mergers
3) Dividends are ignored in the calculation of return

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Turning Back Pages of My Investment Journal – Engineers India

Disclaimer: This is NOT a recommendation to Buy / Sell or Hold

Note: I had written the below extract in April 2013. Things must have changed now.  ” since exceptional judgment is crucial to virtually all investment strategies, a critical element of our due diligence process is to evaluate historical decision points           [Website: Massachusetts Institute of Technology Investment Management Company ]. After reading this I have decided to review my investment decision taken 3-4 years back. Purpose is just to highlight the process I followed in rejections of stocks in the past and to evaluate whether rejection was right or wrong based on increase in intrinsic value over last 3-4 years.

I hope it might be of some use to investors who like me, are in an early stage of their value investing journey.

Engineers India share price

Change in Share Price or Change in Intrinsic Value

Between Change in Intrinsic Value and Change in Share Price, change in intrinsic value is a better indicator. Share price may remain depressed for longer period for various reasons. I have highlighted in my post on Good Business Vs Bad Business  that average of PAT growth and Book Value growth  over 5 years or more is a good indicator for change in intrinsic value.A good business is one where over 5 years intrinsic value increases by more than 15% CAGR [Of-course while making investment we have to think about possibility of increase in intrinsic value in future]

Book value has grown at 8% CAGR between 2013-16 and profits have declined by about 50%. Taking book value as indicator for change in intrinsic value, we can say that intrinsic value has increased at 8% CAGR during 2013-16. Share price has remained about flat. Ideal period to measure change in intrinsic value is 5 years or more. Unless and until intrinsic value grew rapidly over next two years, it will fail to register 15% CAGR.

What attracted me to Engineers India at first place was

  1. EIL gets 65-70% of the orders by nomination by the ministry of Petroleum or negotiated settlement basis where the company has signed MoU with the PSUs. Unlike other E&C cos. which can only win through competitive bidding.
  2. EIL was generating free operating cash, had a negative working capital requirements and limited capex resulted in 21bn of cash (~27% of then market cap)

Reason for rejection: Extract of the mail which I sent to one of my friend in April 2013

My limited analysis suggests that Engineers India historical growth [last 20 years] was much influenced by refining capacity expansion plan of PSUs. This should not be surprising as even in Q3 FY13, more than 65% of its order book from consultancy and turnkey project is from hydro-carbon sector. Its revenue have grown exceptionally during 2008-12 [2.5 times compared to 2003-07 period] and it enjoyed average ROE > 32% [more than double the average of 1998-2008]. Numbers suggest, downturn has just started for Engineers India and we should let the downturn play itself before entering the stock at current price. Of course at current price it’s quite CHEAP, but provided we can identify demand drivers for next five years. Still major chunk of the revenue are from Hydro-carbon sector. I do not know what will drive the refining capacity over next 5 years [even vague clarity is enough, but here I am unable to predict any reason which will result in another period of growth like 2008-12].

Some details

  • Engineers India revenue performance over next 5 years depends on refining capacity expansion plans of PSUs. As per 12th five year plan document 70 MMTPA is expected to added over next five years out of which 30 MMTPA is from private sector. If we analyse last 15 years performance 2008-12, clearly stands out as an exception. I think Engineers India recent performance [2008-12] was more driven by rapid expansion in refining capacity. Aggregate revenue for period 2008-12 is almost 2.5x of total revenue of 2003-07 and profitability is 3.6x higher. If we look at refining capacity for 2007-12 periods, it expanded by 62% and in absolute numbers refining capacity increased in total by 90 MMTPA. This increase is highest in any of the five-year plan since 1997. Now if we look at period when refining capacity growth was mediocre, for instance during 2000-06, aggregate refining capacity increased only by 18% [from 113 to 132 MMTPA]. Revenue during 2002-07 was volatile, but essentially flat between 550-570crs or even if we look at revenue CAGR of 2000-06 it was mere 10%. Again during 1993-99, refining capacity almost double [from about 55 to 100 MMTPA], revenue more than doubled from 150 crs to 377crs.
  • Average ROE for 1998-2008 was 15%, avg ROE for 2002-04 was merely 7%. As I explained above 2008-12 was exceptional period which is also reflected in avg ROE of 32% during this period.
  • Refining capacity: India’s current refining capacity is around 215 MMTPA out of which close to 30% is exported. China accounts for 20% global oil consumption

Disclaimer:  This is not a recommendation to Buy/Sell/Hold.

Registration Status with SEBI:

I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”

Details of Financial Interest in the Subject Company:

I  may or may not hold any of the companies discussed above in the portfolio which I managed for my family and close friends. Please consult your financial advisors before taking any buy/sell/hold decision. I may change my opinion post publication of this note and may not be able to update because of time constraints. 





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Lakshmi Machine Works – Process Vs Outcome

Disclaimer: This is NOT a recommendation to Buy / Sell or Hold



I analysed Lakshmi Machine Works [LMW] around July 2012 and decided not to invest in the stock. Main reason for the rejection was my belief that

“Over the next five years LWM sales CAGR should be around 5% only and in addition with increased competition (now there are six manufacturers having base in India compared to three earlier) there will be pressure on margins and in the best case scenario margins will not improve over 2012 levels. “

Process Vs Outcome

In one of the interviews to SafalNiveshek, Prof Sanjay Bakshi said

“The thing I like to say here is the idea of process versus outcome. The world looks at outcomes but really should look at the underlying processes that produce those outcomes”

I am trying to analyse whether there was any problem with my  process of rejection of LMW.

When I rejected it, it was trading it around market cap of around 1,600crs and now it’s trading around INR 3,500 crs market cap. Stock price had doubled in three  and half years providing more than 20% CAGR.  One can interpret this in two ways 1) Process of rejecting the stock was bad as stock has provided more than 20% CAGR 2) Process was right but bad outcome. So where does this situation falls on Process Vs Outcome matrix.


I believe its the second case, right process but bad outcome.  The entire upside was driven majorly by PE re-rating and my thesis that growth will be a challenge proved right. Both sales & operating profits grew at less than 5% CAGR during 2012-2016.


I believe one should focus on INCREASE IN INTRINSIC VALUE rather than increase/decrease in share price to judge whether the process was right or wrong. The above extract from my blog post on Good Business Vs Bad Business shows that even over last 20 years LMW had increased intrinsic value only at the rate of 8% CAGR. As I have explained in my blog post on Good Business Vs Bad Business, PAT growth provides reasonable indication of increase in intrinsic value. [Here I have taken operating profit rather than PAT growth as interest income on surplus cash constitute substantial portion of PAT]


Here is the complete note which I made at the time of rejection of LMW in July 2012.

Industry analysis – I think over next five years sales CAGR should be not more than 5%.

If one go through the spindles data from 1980 to 2010, it becomes clear that 2003-2010 periods is just an outlier in which spindles production increased dramatically compared to past decade.  During 1980 to 2000, spindles production on the average was 6-7 million p/a. But during the last decade of 2000-10, it increased dramatically and increased to 10-15m during 2003-10. Even for India spindles consumption remain static during 1990-2004 and on the average was around 1.2m but during 2005-10 it increased to around 2.4m and during 2006-08 spindles consumption was more 3m. I guess this dramatic increase has to do with removal of textile quota from early 2005.

Further Rieter has target  of 5% increase in sales over the next cycle. For the last five years LMW sales CAGR is around 3-4% and I believe that over the next five years LWM sales CAGR should be around 5% only and in addition with increased competition (now there are six manufacturers having base in India compared to three earlier) there will be pressure on margins and in the best case scenario margins will not improve over 2012 levels.

I believe that with all the above negatives LMW is priced higher at PB 2x and PE multiple around 14x (trailing multiples).

Rieter, one of the competitors has reported 50% decline in sales from India and guided for decline in sales for CY2012

Rieter, one of the competitor of LMW, which derived almost USD175m (~18% of its 2011 sales) has reported very pathetic 1H 2012 results which were released couple of days back. It has reported 40% decline in order intake (1H 2012 vs 1H 2011) and 50% decline in sales from India. Further  Rieter currently reckons that  in the second semester with a weaker trend in sales compared to the first semester as part of the order backlog reaches into 2013.

Compared to Rieter which is guiding for decline in sales in CY2012, I understand that LMW is guiding flat sales for FY13. It has currently active order book of 1,200cr so to report flat sales, it need to get additional 500cr. Sales from spot booking which appears quite a challenge.

Disclaimer:  This is not a recommendation to Buy/Sell/Hold.

Registration Status with SEBI:

I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”

Details of Financial Interest in the Subject Company:

I  may or may not hold any of the companies discussed above in the portfolio which I managed for my family and close friends. Please consult your financial advisors before taking any buy/sell/hold decision. I may change my opinion post publication of this note and may not be able to update because of time constraints. 


Posted in Investing, Rejected Stock ideas, Uncategorized | Tagged , , , | 3 Comments