Saturday, December 30, 2017

The Best Investments are made during difficult times

As a legendary investor said we are all eager to buy bargains but are not willing to endure the pain of price decline that creates bargains in the first place.

Today, no respectable business is available to be bought with a margin of safety, they are overvalued, so the question is which is the cheapest of the expensive ones, this has led to competition from investors which is driving price up. You have to invest when competitors are not there and not when they are willing to pay up more than you are.

investors are hyper worried they may miss out on the rally and are willing to pay a premium, this can lead eventually to a crash as they run out of funds with strong hands unwilling to back them, and then the same investors will regret their decision and leave the markets thus creating huge value for investors, that’s when bargains will be available

As the markets decline, the risks also vanish, on the contrary as the markets spike the risks only increase. A bull market lays the seeds for a bear market and is preceded with the Suspension of all logic in valuation or financial analysis, saying no price is high for this great company.

And suddenly the future changes in unexpected ways. A brief history look up says that the entire business idea itself has disappeared from the canvas, let alone successful businesses, as a result of unforeseen changes and newer ideas replacing them.

People get lucky but they think it is skill. Hyper growth is risky, the best growth is that which is profitable and that can be financed by a company by its own internal resources.

Bruce Greenwalt said growth is not worth very much unless the profit is at the margin they are already doing and can be financed without weakening the balance sheet.

Many Indian companies chase growth blindly by taking on debt and weaken balance sheet or sacrifice incremental profitability for that growth which both leads to unhappy outcome. So growth should be such that capital efficiency is not affected.

Experience has shown the futility of forecasting. When everybody forecasts the same future and it turns out to be so, there is no profit to be made as the probability has been discounted. However when someone is able to forecast a very contrarian view and that turns out to be the outcome, there is profit to be made, but such forecasts can rarely be consistently made and hence it is pure luck.

Today most investors are knowledgeable, thanks to the internet and ‘forward the message’ culture. But what we lack is the judgement and discipline which is a fine art. As Edgar Wachenheim puts it, Knowledge is knowing that Tomato is a fruit, Judgment is not putting it in your fruit salad. To have good judgment you need knowledge + common sense, stable emotion, confidence and a sixth sense.

Tuesday, December 12, 2017

Carpe Diem

The addressable market-size is the base foundation on which successful businesses are built. In the last 5 years, we have seen that companies like Page industries, which commands high valuation, have continued to grow and offer profits to investors. They were able to grow owing to the large size of the addressable markets that they were in. The story is about where you can go, and not about where are you today. We are constantly in search of companies that are hungry to go far, and when this is coupled with a market that is large enough to grow and a management with a growth mindset, there is no stopping them. Look at Suprajit Engineering, which has delivered in excess of 300 times since listing, or Page or Edelweiss- these are examples of compounding machines, because they were in businesses that could scale. So while evaluating a stock, it is important to estimate the size of the market at a future time and see if the business can have a long runway, so that the stock (business) can compound and create value. The essential question is therefore whether the market potential for the business can become very large.

The character of the management and the economics of the business will be the catalyst for compounding. Take the story of TTK Prestige, the cooker business that was impacted by what we refer to as “value migration”. The onset of nuclear families meant that more people will need cookers. So the trend was that of nuclear families, and the outcome was a long run-way, where companies manufacturing cookers could sell more for a long period of time, as the size of the market expanded.

The “New Generation” business offers an opportunity in outsourcing: companies like T Q S are in the range of 4000 crores to 14,000 crores MCAP. We do need to visualize which of these could grow 2x or 4x in the very big pond of outsourced services, staffing and facility management. For instance, we are witnessing a one-time opportunity in ARC resolution, that Uday Kotak calls a “once-in-a-lifetime” opportunity. (Article link here)

Here we see an E NBFC that has put up a system in place to capture the ARC headroom for growth and is available at a reasonable valuation compared to the growth opportunity; and with a market cap of 24,000 crores- run by a management with vision and integrity.
A growing company needs a large opportunity-size for it to sustain high growth and become a compounding machine. There is a trap in this that sometimes, large market-size does not necessarily contribute to profitable growth like we have seen in the education sector, or in the retail. Merely a large opportunity size is not sufficient; the business should have the right character to seize the moment.