Returns of stocks listed on this blog

This blog has been around for more than 5 years now and i have at different times (although not a lot) written about stocks i liked.

I thought this is a good time for me to check how my public investment “calls” have performed. So here goes:

Most of these stocks are still going good and are worthy of your long term money.

Disclaimer: Goes without saying, do consult your investment advisor before investing.

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Why is Gruh Finance the most expensive financial stock?

CMP:  139/share (post bonus).

If i ask you to invest all of your savings in any one business of your choice, what business would you choose?

More importantly what would be the characteristics of that business? Let me venture a few guesses:

  1. Healthy and almost never ending demand for whatever that the business sells: Gruh is in the business of providing housing loans. There are way too many people who want to buy a house in this country for the demand to die down anytime in the foreseeable future. You actually have to regulate how much loan you give out and to whom, enough demand is always there as long as your rates are competitive.
  2. Control on costs: If you have healthy demand for your product the only thing that can stop you from making healthy profits are your costs. One of the biggest expenses for any business is the raw material cost and Gruh is no different. However in this case the raw material is money or capital (to lend out). In this area Gruh is a class apart. It gets access to very low cost funds due to its HDFC parentage and its track record. Not only that with a great mix of fixed and floating capital sourcing Gruh ensures that its costs and hence its margins are always under control. The low cost of funds also helps it remain more profitable than everyone else even if the competition heats up and lending rates have to be slashed. If the competition goes crazy and starts lending at unsustainably low rates, Gruh just withdraws from the market not willing to sacrifice its margins for mindless competition. They did this back in 2007 during the lending boom and came out stronger where everyone else is nursing their wounds today.
  3. Healthy profit growth: If you have 1 & 2 going for you, then the profits just follow since, profits = sales – costs.
  4. As little additional capital as possible for growth: This is the true test of any great business and almost unheard of in the financial business, a company that can just grow from the cash it generates rather than ask for more external capital. Every financial business goes in for equity dilution once every few years. Equity dilution means you have to get more people to invest money in you and you have to issue them new shares. When this happens the share of existing shareholders goes down proportionately which is generally bad. But for a financial business like we discussed the raw material is money so they need as much of it as possible and the only way to grow is to dilute equity often. Not Gruh. Why? Because Gruh has one of the highest ROEs in the business. It can generate enough capital to grow at a  25% CAGR and give out dividends!  This is one of biggest reasons why Gruh trades at a P/B to 8-9 whereas the rest of the financials trade at less than half of that.
  5. Use leverage but not lose money: This is almost like a dream. Being a financial business Gruh can use leverage i.e. if it has Rs. 10 of capital it can possibly lend out Rs.100 or more. On this 100 if it just makes a profit of Rs.3 its return on equity comes to 3/10 or 30%. Other businesses like FMCGs that don’t use leverage need to make Rs.30 on their 100 to get the same ROE. If this is so good why doesn’t everyone do it. The problem is if you have Rs.10 and lend out Rs.100 and lose 3% instead of gaining the 3% you’ll end up wiping off 30% of your net worth. You do that for 3 years and you’ll be bankrupt. Gruh on that other hand has been able to use leverage 100% of the time to its advantage. It has a Net NPA of ZERO, which means it ensures it never loses money (if it does it shows it as an expense from it profits, called provisioning) while continuing to grow at nearly 25% every year AFTER provisioning for any bad loans.

So what have we got here: A business with a continuous demand for its product, access to low cost raw materials to “manufacture” that product, translating into high margins which give rise to a predictable and above average continuous profit growth. Not just that, it is able to run this profit machine with no additional investments required ever. And due to its ability to use leverage profitably it generates enough capital to even give out healthy dividends to its shareholders while other financial companies are doing the reverse i.e. asking for additional capital from existing and new shareholders.

Are you still wondering why it deserves that 8 times book?

If you didn’t know that Gruh was a financial business you could as well mistake it for a predictable FMCG business. I think that’s what the market is doing and valuing it on a PE (of 30-35) basis rather than on book value.

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Is investing in stocks a two way sword?

Its is quite general a knowledge that if you want to make higher returns you need to assume more risk. Common wisdom is that if you want to make more than the standard 7-8% (post tax) that a fixed deposit offers you need to seek “riskier” avenues like  the stock markets. Within the stock markets also there is a range of returns that are possible depending on what kind of strategies (risks?) you or your fund manager choose. 

Strategies like concentration, diversification, and leverage are also symmetrical two-way swords i.e. it will help you if you are right, and hurt you if you are wrong. Anyone (including yourself) who takes risks stands an atleast 50% chance of doing better than when you’re not taking any risks. So is smart investing about taking higher risks for higher returns?

It should not be and that is what differentiates a good fund manager from a bad one.

So how does your fund manager/advisor actually add value? If she/he runs a concentrated portfolio for you, it is simple math that there is a good possibility that she/he’ll do very well but there also a similar possibility that they’ll blow up your money as quickly. I mean you don’t need a fund manager for that, even you  can yourself invest and work with the same probabilities i.e take higher risks and hope for higher returns. So what differentiates a good money manager from a bad one. It is in my opinion an ability to generate asymmetric returns.  Asymmetry  comes from superior personal skill. Asymmetry is higher returns on a lower risk.

Good fund managers add asymmetry to your portfolio in a number of ways, such as security selection, knowing when to drop down in quality and when to raise quality, which stocks to concentrate with  and which ones to diversify, when to lever and when to delever, etc. Most of those things come under the big heading of knowing when to be aggressive and when to be defensive. 

I think that investors have to balance two risks: the risk of losing money and the risk of missing opportunity. The good fund manager knows when to emphasize the first and when to emphasize the second – when to be defensive (i.e., to worry primarily about the risk of losing money) and when to be aggressive (i.e., to worry primarily about the risk of missing opportunity). In the first half of 2007, you should have worried about losing money (there was not much opportunity to miss). And in the last half of 2008, you should have worried about missing opportunity (there wasn’t much chance of losing money). Knowing the difference is the biggest job of your money manager.

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How do the best investors succeed?

I figured there is a lot written and read about Buffett, Munger et al . So over the last few months i have been reading about some of the greatest investors the world has seen but those not often talked about. This includes:

Julian Robertson
Joe Steinberg and Ian Cumming of Leucedia
Joel Greenbalt
Howard Marks of Oaktree
Rales brothers of Danaher Corp
and Carl Icahn of Icahn Enterprises

Surprisingly, some like the Rales brothers’ Danaher Corp has outperformed Buffett’s Berkshire Hathway in the last 3,5,10 and 15 years! Trust me, they are all the real deal.

What i was really keen to find out was, are there any common threads to the kind of businesses these guys (and Buffett, Munger) own, or a common investment philosophy and so on.

Of course it was very clear very soon to me that the only way these guys have succeeded is by exploiting inefficiencies in the markets and individual stocks time and again. That is all they did, repeatedly.Not only that, they have all done well across different macro environments. In other words, these guys did stunningly well just picking inefficiently priced stocks all through all kinds of debacles like the asian currency crisis, 9/11, crude going to $150, the once in a lifetime 2008 financial crisis etc.

Having read them, I concluded that the motto of investment success is this: try and find mis-priced individual bets in all kinds of macro environments. And repeat.

It sounds very simplistic at first but i think its very very profound. But that’s really the easy part: theorizing how these guys succeeded.

The bigger insight i was looking for was, how do they identify mis-pricing? It isn’t easy. Let’s think about this – so you have a business called Mispriced Inc and its quoting at a price to book of 0.7 and a PE of 4. These (and other) numbers are there for everyone to see and theoretically if the mispricing is really obvious the business should very quickly trade at or near or above fair value.

But in reality, this doesn’t happen. The mispricing is rarely apparent to me and you. There is always something to worry about. Its only these investors that see the prices and situations differently, understand that it is probably mispriced and start buying – sometimes continue buying across multiple months (or years) while it remains mispriced before eventually moving to fair value and making a neat return for these "genius" investors.

How do they manage to see things differently than the rest of us?

Howard Marks spoke for all his peers and summarized this for us in three simple words: Second Level Thinking.

Marks’ contention is that a lot of people do first-level thinking, but very few can or do second-level thinking. First-level thinking is things like, " Wow, this is a nice store and it’s crowded; let’s buy the stock!" or some such thing.

Here is one of Mark’s examples:

First-level thinking says, "The outlook calls for low growth and rising inflation. Let’s dump our stocks." Second-level thinking says, "The outlook stinks, but everyone else is selling in panic. Buy!"

This is super profound. First level thinking ( or jumping to conclusions) is all around us:

"This stock is at 40 times earnings, so it must be a bad investment."

"This stock is at 4 times earnings, so its definitely a great buy"

" The governor will raise interest rates, i should definitely sell all my stocks"

Also bubbles in the past occur partly due to the masses stuck in first-level thinking:

1999: The internet will change the world, let’s buy internet stocks!

2007: China will grow forever, let’s buy Chinese stocks!

You can go back and look at all the bubbles and you will see a lot of first-level thinking as the cause of many of them.
After a few people made huge killings in the subprime bubble collapse, everyone seems to be looking for the next great trade by calling the macro. Right now we’re all stuck in this first level thinking "Fed will taper and our markets will crash."

Second level thinking is: "Yes Fed would eventually taper but isn’t that known to everyone? How much impact do known events generally have on prices? Should i really bother so much about it or should i just go about picking quality businesses that are mis priced?"

Listen to CNBC or read the business section of newspapers, all of media is full of first level thinking. They just state the obvious conclusions. FIIs are fleeing our markets, so you should sell too and so on.

If we want to outperform, we have to practice second level thinking. Contemplate on these:

" Could Page Industries be a great buy at 40 times current year when everyone says its expensive?"

" Infra and Realty stocks are so cheap right now. Are they really bargains?"

"PSU Banks are trading at 8% yield, they are definitely a buy."

The only way to make serious money is to have what Michael Steinhardt calls "Variant Perception" and this variant perception (a view different from the general crowd) can originate only by practicing second level thinking.

So the next time you’re buying a stock, stop and observe if you’ve put in any second level thinking into it (do i have an insight the market is not pricing in) that makes the current price inefficient.

So look at your portfolio today and for each stock you own, really validate if you have an intelligent variant perception derived by second level thinking. This is the only way our investments can meaningfully succeed.

Comments welcome.


Prabhakar Kudva

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Stumbling on Predictions

I just finished reading Daniel Gilbert’s book ‘Stumbling on Happiness’. Although the name might make it sound like a self-help book, it is anything but.

In the book Gilbert uncovers behavioral research (both his own and borrowed) and explains how bad we all are at imagining both how we felt about a particular situation in the past and how incorrectly we predict/imagine our futures and how we’ll feel when we get to that future.

We get these future predictions wrong because we are wired to project our present onto our imaginations of the future. In other words our present influences how we think about our future. For example if i asked you how would your life be if you lost your job one year from today? Your brain would take you on an elaborate tour and confidently show you how miserable you’d feel about missing everything you are enjoying in your present and run you into a mini depression. But, the brain doesn’t fill you in on the other possibilities like may be the job market will be great in an year and you’ll get a better job, or may be it’ll motivate you to finally turn you into an entrepreneur. The research proves that we actually do not end up as miserable as we think we’d be. Think this through with some examples from your own life and you’ll know what i am talking about.

The take away is that we’re very bad at predicting our futures because we fail to (or rather cannot) account for all possibilities that’ll unfold from now till our future arrives.

Isn’t our behavior similar in markets? Aren’t we confidently projecting the present on our imaginations of our future for the market and the economy? Are we considering the different possibilities?

Our brain, sophisticated as it may be just knows how to imagine within the bounds of our present. For eg. for the longest time, may be a decade, the rupee was mostly in the 40-50 range – if two years back i asked you or any of the accomplished economists and experts to imagine where would the rupee be trading you’d most likely say 35-55. Who would have thunk we’d see 65? And who would have thunk something that moved 5-10% in decades,we’d see 5-10% moves in weeks?

Two years back we aligned our portfolios (future bets) assuming a stable rupee because heck it was stable at that point in time. We were projecting the present on the future – and like Gilbert proves given our track record our estimation of future was wrong then and by corollary is most likely wrong now too?

Many years ago Warren Buffett came up with what are the now investment cliches (i will paraphrase from memory):

"Be fearful when others are greedy and be greedy when others are fearful".
"We do not know how to predict the macro"
"Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results."
"We need businesses where change is minimal"

There are many other quotes, all of which point to the fact that we are all very bad at predicting futures and hence we should not base our investment decisions on any predictions about how the future will turn out – especially of an economy which has so many variables and so many possibilities.

Buffett understood human psychology long before these behavioral research papers were written and he exploited it time and again. That was his genius. He’s maintained it – it was his temperament to act when the brain told him not to and not his analysis skill that contributed to his success.

All Buffett did was to go out and bet against the future predictions of the majority of the people around him because given the record, the odds that they’re wrong about the future was very high. And following this formula and some common sense, he did alright for himself.

So when someone tells you that our currency will go to 75 or 100 and how our economy and the future and the stock markets are doomed, remember how wrong the world has been about these predictions.They could be right this time but then the odds are that, they’re way off the mark.

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Downgrading Titan to SELL

Titan was one of the stocks in our wealth creator series. I am removing the stock from the list. Eventually I will add another name to replace it.

Due to unprecedented gold imports the government/RBI has intervened by preventing jewelers from using the gold on lease model. This model was Titan’s mainstay and jewelry contributing to almost 80% of Titan’s revenue this is a big hit. Titan now will need to incur debt and a lot of capital to grow its business which changes the character of the business model itself.

If and when the RBI reverses this we will revisit the stock. For now one can sell this stock and reinvest the proceeds in the rest except gsk consumer.

Feel free to write to me as always.

Cheers!

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GSK Consumer at 5200 (Our Recommedation: 3060) – Important update!

Followers of this blog would know that GSK Consumer is one of our “Wealth Creators”.

I am happy to report that its remained true to that name and is up 69% in about eight months.

Two reasons why it did so well, no wait actually three:

1. First and most importantly like we discussed, its a phenomenal company with a very strong brand name with pricing power to drive sales and profit growth for a long long time.

2. The parent company increased its stake by offering you to sell your shares at 3900/share.

3. A very popular index followed by FIIs called MSCI included GSK Consumer in its list thereby forcing many funds/ETFs that benchmark to this index to compulsorily buy stocks in this company at any prevailing market price.

After the parent company increased their stake by offering to buy out your shares at 3900 i’d advised you not to sell – “I am not sure if people who hold their shares will sell it at 3900 and the open offer might be revised to a higher price. So those of you who bought it can stay put.” 

Now its time for some caution.

Its reason number three (which is temporary) that’s driven the price about 5000 – i would advice caution at these levels. Do not purchase GSK at these prices, in case you’re doing a SIP. Let’s wait for it to cool off.

Unless you have a better opportunity to invest elsewhere in the market there is no reason to sell either. Sit tight and enjoy the ride.

Cheers!

Prabhakar

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