Friday, October 17, 2014

A Simple Brief

If you cannot write the reasons you are buying a stock for, then do not buy it. I was referring to simple notes made a few years back (August 2011) when we bought a consumer stock with idealistic brand value. The personal note said that the company is growing and poised to grow at >25% for several years and its brand is desirable by millions of Indians. It’s a relatively new company with passionate promoters in an old industry that will never change, the trends of consumerism is driving its markets bigger. We then checked discounted cash flow and other financial metrics to consider valuations to make a BUY decision. The stock was then 2200 but had appreciated multifold already, almost 8 times in the previous 4 years when we bought. To the many I discussed this stock with, it had already appreciated 8 times leaving no headroom. this is a common mistake our brains will do, comparing with the past than what is possible. Behavioral scientists attribute the reason for this; we are bad at estimating future prospects so we compare with the past which makes it easy.

In the above example it was easy to look at the fact that it had run up very fast and made people believe they lost out on the opportunity and the risks are high. What was difficult was to analyze future prospects of the industry, the financial metrics as this required effort and a lot of work to be put in. We miss many opportunities due to improper comparison. Here the tendency to compare with past than what is possible. Comparison changes the value of things as a Harvard psychologist Dan Gilbert puts it. To loosely translate his example, if a great company that you believe in goes through a price correction from 9500 to 8000, you call it cheap. But if I tell you that it has moved already now to 8800, you will say it is expensive. Gilbert says 'our beliefs about what will make us happy are often wrong'.  He gives an example of how you would decide between two options of getting Rs 10,000 today and Rs 11,000 after a month. Now if you are given an option of getting 10,000 after 12 months and Rs 11,000 after 13 months, you may change your decision although the situation has not changed considerably. Our brains are developed to decide from fewer choices, if the situation gets complex we behave irrationally.

In the investing world, it is paramount to be aware of our brain's limitations and therefore  be disciplined & trust a process than our instincts. 

On teacher's day I got to listen to PM Modi speak. To  a student's question whether he aspired or ever imagined that he would become PM some day, he said he never did, he was never even a class leader . He only wanted to work with absolute sincerity. He never wanted to become ‘someone’. He exhorted students to work with dedication while enjoying what they do and that will make them someone in the path. Such a great lesson it is. 

There is so much truth in it for us and as investors there are obvious lessons too. Look for companies managed by leaders with dedication and sense of purpose; they will go on to deliver the best for shareholders.

Like in life, not all companies are created equal. I heard ‘nobody makes wealth from salary; it’s from how they invest what they save’. Move from a pay check mentality to net worth mentality.

Knowledge is wealth :The business that will grow at 25%; email