It’s been close to 2 years since I started this blog. A 2 year anniversary gives me the permission to distribute some learnings and hence a few random thoughts I’ve learnt over these couple of years –
a) The curse of ‘value investor’: The term ‘value investor’ is a burden. In fact, I think it’s a burden to be categorized into any one particular type of investing theme. Almost everybody in the world is trying to buy stocks cheap in the hope of selling it at a higher price (even a speculator thinks he is buying Rs. 1 worth of stuff for Rs. 0.90 in the hope that the market will eventually correct itself in the next 1 hour; a growth investor thinks a 60x P/E stock is worth it etc). Ben Graham himself called it a ‘mystery’ when he deposed in one of the Congressional sessions when asked what exactly causes an undervalued stock to reach its intrinsic value. Some others call it the Invisible Hand which corrects all prices. The axiom of ‘Markets are voting machines in the short term and weighing machines in the long term’ is said by all and sundry. And so is ‘Heads I win, tails I don’t lose much’. At times, I feel I don’t understand any of this stuff. And in other times, I feel that these axioms are too simple to encapsulate the complexity of investing. However, all the above afflicts almost every type of investor – value, growth, GARP etc. However, only one curse hits the ‘value investor’ very hard. It is the perennial search for the undiscovered stock. Nobody wants to hear the same old stocks anymore; stocks which have been wealth creators and probably will create wealth for a long time to come. ‘Value investors’ want their next kick in some unknown stock (or a stock that is not widely known). We sort of believe, after we have read ‘Intelligent Investor’ again and again (too much for our own good) that we have to discover an undiscovered stock (rather, we presume an undiscovered stock = inefficient market and hence larger chances of mispricing). We are like the addicts who screen for stocks for various parameters and miss gems just because they are widely known and we assume an efficient market in the stocks that are widely known. The faster I get out of this affliction, the better it is for me.
b) Concentration vs Diversification: This is a perennial question asked in many forums – which one is better? The real question underlying this seemingly innocent question is actually ‘which methodology would make me the maximum return in the minimum amount of time, without losing a paisa’? The answer, obviously varies from person to person and is entirely subjective. In my view, I think it is dependent on so many factors. I will just elaborate on what worked for me.
I have realized off late that I don’t have the skill to monitor and keep track of a lot of stocks (Ayush, Safir and a lot others have this skill as an instinct). In fact, I have fallen in the trap of spreading my little time available (outside of my day job) into researching every new stock that is quoted on twitter/other forums. In fact, not only have I spent time on these ideas most of which are outside my circle of competence, but have also made the cardinal mistake of investing in them. Now, given that I have been lucky to find guys like Ayush, Safir, Hitesh, Devesh writing about these different stocks, I haven’t lost money on them, but I haven’t gained much either in absolute terms. Let me explain. To quote a psychological term, I suffered from deprival super reaction syndrome. When these guys tweeted about certain stocks (let’s say pharma for instance, of which I am only learning baby steps now), I had found that over a period of time that these ideas made money (by and large). So, whenever these guys tweeted/wrote about some stock, I invested 1-3% of my portfolio in these ideas (given that these are usually outside my circle of competence, I can’t get myself to invest more) and made money – Nitta gelatine, Unichem, Ajanta, Smartlink being some of them. However given my limited time and resources, I couldn’t keep track of events, tweets, qtrly results etc. of all these stocks (and maybe I couldn’t understand even if I looked at all of these). Although the end result turned out alright, the process is clearly wrong.
On the other hand, stocks which I understood, which I researched and which I put in 10-20% of my money are clearly outperforming and wealth creating. HDFC Bank (my alma mater, and I had put in the greater part of my networth into this stock back in 2007), Cera (which I wrote on this blog long ago), Mayur (valuepickr’s choice, and the undervaluation and the business screamed at me), Astral, Atul Auto (this was a cinch), Oriental Carbon (to Ayush’s credit) are some of the examples.
The experience has taught me that a concentrated portfolio with 6-8 stocks have worked much better for me than spreading my bets across many different stocks. Of course, if I encounter a black swan event in any of these stocks, that’s when the chicken will come to roost, but I think given that I give a very high weightage to management integrity before it becomes a substantial part of my portfolio and I don’t play with F&O, the chances of a wipe-out are low and I hedge it off by not allowing more the 10-20% allocation for any stock.
So, net-net, identify where your strengths are, how your past experience has been, how much time/ability you have to analyze many stocks and then bet accordingly than listening to anybody’s opinion on concentrated vs diversified question.
c) Price anchoring: The fallout, of course, of a concentrated portfolio is that you will be subject to the extreme bias of price anchoring. For example, I saw Mayur at Rs.150/- (adjusted for bonus), bought quite a bit and then it went to Rs.230/- and then bought a little more. Now, given that the market was recognizing the undervaluation, and it was still undervalued at Rs.230/- levels, ideally I should have bought more and more (subject to my limit for the stock). But I didn’t. I fell into the trap of ‘let it come down, and I will buy more’. Today, it is at Rs.460/- and counting and although I don’t see a huge undervaluation from these levels, if it goes to say Rs.700/- in 1 year’s time, I am sure to experience hindsight loss aversion. The same thing got repeated in Astral (bought it first at Rs.130/-, bought some more at Rs.160/- and then stopped buying and now it has doubled) and Cera, and Atul Auto etc. I am slowly coming out of this bias (believe me, it’s been a very difficult process because you encounter a thought of – if the market falls rapidly from the elevated levels that I bought the stock, then what?) and I am slowly buying Atul Auto now (also, when you are trying to get out of this bias, you will keep hearing of the BSE small/midcap index overvalued, QE3 not having much effect, reforms not taking shape leading to a market sell-off etc. which makes this process excruciatingly difficult and you’d just want to hold cash and do nothing). Doing nothing is great, holding cash is great too if and only if your mentality allows you to invest all of this cash when the world is going down rapidly. For example, Charlie Munger held money in Treasuries for about 10 years and when the moment was right, invested 70% of net worth into one stock, Wells Fargo. You just got to decide(within yourself, not as a justification to others/in some forum) if you possess the same mentality.
d) Bailing out vs Doubling down: This has been one question which I loved playing around with. When do you bail out of a stock and when do you double down on a stock (in other terms, average down) when there has been a savage fall in the price. Let me state some recent examples.
SKS Microfinance, initially invested by Narayan Murthy (at Rs.300/- level) as venture capital and then IPOed at Rs.980 levels shot up to Rs.1400/- levels very quickly. Most forums claimed that it would be a great buy at Rs.700/- levels. One forum also claimed that it would be a blind buy at Rs.300/- levels, if and when it came down. And crashing down it did (allegations of fraud). From the highs of Rs.1400/-, it crashed to Rs.60/- levels (CMP: Rs.112/-). Nobody squeaked of buying this stock when it was crashing from Rs.1400/- to Rs.700/- to Rs.300/- and then to Rs.60/-. Everybody wanted the picture to be clear before they invested. Of course, we all forget from time to time that if the picture was clear enough, the market wouldn’t price SKS Micro at Rs.60/- levels.
Manappuram Finance, the premier gold loan provider, touched an all time high of Rs.95/- in Nov 2010. People started buying this as a proxy to multiple things (rising gold loan prices, rural growth proxy, network effects, rising acceptance of gold loans etc). It came crashing down to Rs.20/- levels as recent as June 2012. So, do you bail out or do you average down? In my mind, I have one criteria for further evaluation. Was there a fraud or not? If there was no fraud (or fraud allegation), I am perfectly willing to double down (rather average down). In this case, there was a RBI objection, there was a large investor bailing out, there were promoter pledged shares being sold etc., but there was no allegation of a fraud. A perfect case for further evaluation to average down (as usual, this is just the starting point to check on intrinsic value and buy cheap shares). If it was fraud, then treat as sunk cost and just bail.
In recent examples, IRB Infra was another which fell to Rs.100/- levels, moved up to Rs.150/- quite quickly (and now at Rs.120/- due to another allegation of a crime). Ajanta Pharma which quite a few in the forums that I am part of are invested, is facing some kind of tax evasion problem. Although the prices haven’t crashed yet, it’d be good to monitor and evaluate whether your reasoning tells you to bail or average down. (When I say ‘double down’, I am not talking of doubling down blindly and get into gambler’s fallacy – that would lead to disaster).
e) Special Situations: I look at my blog search feeds and it delights me that most people land up on this blog because of special situation analysis, although I have hardly put up any actionable special situation which can lead to a profit. Evaluating Special Situations personally is very satisfying compared to let’s say stock analysis since there are so many parameters to consider and secondly, it helps in sharpening the stock analysis scenarios. Some of my friends have suggested that I start a paid special situations newsletter (actionable ideas) for a nominal cost. I am considering it actively, and would like to know your views in the comments section if that is something you’d like.
Disclosure: The stocks mentioned in the post are only for educational purposes and not a recommendation for buy/sell. Please do your own due diligence before investing in any of the stocks mentioned in the post.