Success Patterns!

Lessons from Mr Market
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We have opened atleast 3 threads for identifying “Failure Patterns”. These are Lessons from Corp Misadventures, Lessons from Corporate Fraud, and Investor Checklists. And these are for helping us AVOID mistakes.

But Avoiding mistakes does not make us a super investor. It probably makes us little better investors than the run-of-the-mill crowd.

As I see it, Investor Edges come incrementally

1). Make sure to AVOID mistakes - by identifying and incorporating as many failure patterns into your Mental Models, or investing decision making process. And, then

2). Identify “Success Patterns” (of Businesses) - how do you separate the wheat from the chaff?

There are many ways of looking at Success Patterns. Some of these we have discussed and documented in our Capital Allocation Framework thread.

And there are the classic textbook patterns, which you can read everywhere. This thread is NOT about the classic patterns -Strong business models with Moats, Ethical & Competent Management, Favorableindustrycharacteristics, High Return on Capital, etc. If found useful (say for Newbies), we can discuss that in a separate thread on Classic/Essential Success Patterns.

THIS THREAD is about, as the title says, beyond textbook patterns )- small small things, that you may not read so often in investment books, but are nevertheless pretty important to notice in a business/or changing dynamics in the business. In addition to the basics )- decent growth, decent profitability & margins, decent BS and cash flows - **should you notice a few of these patterns **in a business you are investigating, that should alert you to a more promising investment opportunity?

One way of identifying these kind of success patterns could be - If we can identify what is in the DNA of this company that will make it successful, or supremely successful.

When I start thinking like this - a few example immediately spring up in my mind. And I am sure the community will throw up many more examples:)). I will start sharing a few thought patterns.

-Donald

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Pattern 1: Companies with Huge Perseverance. They set out to do something different!

Struggle for many years, survive. They demonstrate huge staying power, many others would have given up in their situation. Slowly, gradually efficiencies improve, operational scale leverage kicks in. And then comes a time, when they flourish. That strong foundation built slowly and gradually over the years, is very very DURABLE. No one can shake it easily. It MAY NOW achieve breakthrough success.

These are companies that have deliberately chosen a different path, a difficult path. When do folks chose a path, which they know is very difficult to proceed on. When they have a passionate belief in their choice - they likely say, "Hey its difficult, but that's exactly why its worth doing".

There are different degrees of difficulties. Success doesn't come overnight. Some may achieve it faster, reach somewhere on the path and carve a niche for themselves in 5-10 years, some may take even longer.

But what distinguishes these companies/businesses is theirPerseverance.

Time for examples: Companies exhibiting this pattern??

1. Gujarat Reclaim


 2012 2008 2004 2000
Sales (Cr) 240 118 39 16
OP (Cr) 40 20 7 2
NP (Cr) 26 9 4 0.11

The track record is good, everyone knows it, that isn't the point. As a new insight, I have now started appreciating - is how long it took the company to show 1 Cr in Operating Profit or Net Profits. The company was incorporated in 1974!! Contrast this with the rapid success, thereafter.

The success is what we readily see, but sometimes the struggle & perseverance to reach there isn't immediately apparent.

2. Kaveri Seeds


 2012 2008 2004 2000
Sales (Cr) 372 97 39
OP (Cr) 77 25 0.9
NP (Cr) 58 17 0.9

Incorporated in 1986, it took the company almost 20 years to reach the first 1 cr in Operating or Net Profits. And then you notice the exemplary success!!

This pattern by itself may not guarantee success. But all things being equal, if I additionally identify this strength in a company, I am happy to note it. And then if I see a couple of other success patterns converging in the same company, it may make for what Charlie fondly calls, a Lollapolloza effect!

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Over to our Market Edge guys - like Ayush, Hitesh and others.

If you see a company with all the good things - say our ValuePickr kind of stocks - and additionally if you see this Huge Perseverance pattern too, Do you value this? How much?

Your views are greatly appreciated.

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Perseverance pattern should be valued, but the valuation would bearbitrary.Only with experience can one decide on the premium that should be paid.

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Donald,

The features you described in companies with perseverance are the hallmarks of great small cap stories. In the initial phase these companies are not given their due recognition by the markets and it often takes a lot of time before people latch on to the story and some kind of market fancy begins.

We have seen similar pattern in mayur uniquoters. Almost similar picture. You may have described Mayur and its management in a few sentences in the first paragraph of your write up.

And then once we get on to such story, add the usual filters and formulas to unearth great stocks to invest in.

namely consistent growth, business sector prospects, low or negligible debt, calibrated expansion, good management, high promoter holding, high ROE, etc.

There will be a lot of doubts initially but it will be up to you to make out the significance of these things. e.g in Mayur there was a lot of hue and cry raised about the pref allotment done by promoters blah blah which was of no significance. There will always be some or other kind of such deterrents for someone researching the stock initially. But thats where one has to seperate the wheat from the chaff by logical thinking or better still, meeting the management.

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Question is not on valuation:) How much importance would you attribute to a company that has this factor additionally,. Say you are looking at 3 companies - all 3 look good on BS, growth, etc and at similar valuation. But company 3 has this huge perseverance factor.

How much differentiation will it bring to your mind - when you think about the 3 companies. To make the question simpler, will you allocate more in company 3. how much more. Say all were at 5% allocations. and now you have this new insight about this huge perseverance quality?

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Donald, to make better sense of this, look at perseverance from the lens of necessity and sufficiency. If it is a necessary condition of success (rapid profit growth is how you are defining success, I think), then its absence predicts failure, but presence is not much use in predicting outcome. If it is a sufficient condition of success, then its presence predicts success, but even then you need to weigh its prediction power against other signals that may have higher sufficiency rating.

So perseverance as a necessary signal - I’m not sure if a business needs to struggle for a long time to see rapid expansion. There are enough examples where businesses that enter late grow very fast and outpace the incumbents.

And perseverance as a sufficient signal - there are far many more businesses that have been languishing for a long time and go nowhere than the other way round. So again, I’m not sure of this.

In my opinion, in any industry with low or little growth which means very few new players are excited to enter it, there will always be scenarios where a new factor emerges (like rapid market expansion, or new technology introduction, or even new human talent entering) that shakes things somewhat and thus may cause a previously unremarkable business go into a different trajectory. It will be more likely that some business that has been trodding along for a long time catches the wave and grows rapidly since most of the businesses have been there for a long time. So post facto, this will look like perseverance was what caused the success, but then, all other businesses in the same sector that did not make it big were persevering too. It was the other factor that caused the difference between success and failure and that’s what you need to identify.

valuation:))

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And just in case you think I’m suggesting that perseverance is not important, there are a lot of cases where perseverance is a must - I mean if you want to become a chess grandmaster, you are not going to do that in a day.

But at the same time, in my opinion, just because someone took 20 years to reach 1cr in profit does not have any predictive power in future success.

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donald

I think I would not attach much significance to the perseverance factor if all other things are equal in all the companies. That would be like looking in a rear view mirror.

What would take higher allocation would be what future prospects there are for the companies from here on.

e.g Guj Reclaim Rubber – It has shown what you describe as perserverance but still I wont allocate more to it on that basis. If there were to be any developments on the thermoplastics front, the allocation can be increased. Currently it seems in a nascent stage. Without any new revenue stream I dont think GRP can show growth better than what it has shown in the past.

At the end of the day there are very well defined uses of reclaim rubber and I dont see the market for that expanding too fast for the company to grow faster.

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donald,

I would urge you to look at it from a different angle. ThePerseverancePattern gives the extra comfort to the investor.It reduces the risk (ie: justbecausethe companyhas been through several business cycles, it has gained experience and is moreequippedto deal with adverse circumstances in the future).This portion of risk is hard to quantify.

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Though this is a very subjective concept,it can be factored into valuation either by adjusting the discount rate(in present value models) or by adding a premium to enterprise value using method similar to goodwill valuation.

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I would allocate more to the company that has been there for a long time because it is less risky.I don’t have a perfect answer for how much,but still i would try to explain ittheoretically.

assuming the following

return requirement is 15%

maximum deviation the portfolio can bare is 20%

these are the only three stocks that are to be there in the portfolio

expected return from all the three companies 15%

standard deviation for the two identical companies are say 25%

standard deviation for the third company(which has been there for a longer period of time) is say 15%

depending on the correlation we can get the appropriate allocation using the excel solver.

which obviously will allocate more to the company having a lower standard deviation how much will completely depend on the numberschosen.

(Caution: This method suffers from all the drawbacks from which the Modernportfolio theory suffers)

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There are a number of companies in the Indian Corporate Space who have been around for decades & are actual examples of Wealth Destroyers.

My sense is that thelinearity association (perseverance = success) is not valid.

If you want to look for success pattern it will be found in the WB wisdom:

Strong business models with Moats + Ethical & Competent Management +Favorableindustrycharacteristics

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Hi,

Actually we were discussing in Kaveri & GRP, that if one goes into the history of these cos then both the mgmts started from very small and were on of the first in their industries. They kept pursuing the fields despite no/not much success for initial 10-15 years. So while looking at the success these guys haveachieved, their roots and initial hard work will always be a big factor and lead. These guys have faced lot of hardship initially and perhaps its their passion which has brought them so far and made them leaders.

But, yes, this is relevant only when the co is doing quite well in recent times :slight_smile: Infact, while screening stocks we prefer young cos, as they have more aggression and growth prospects…ideally 10-15 year old cos (having gone through 1-2 business cycles) are really good. While old cos especially legacy names don’t do that well.

Ayush

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So, to bring a proper perspective back:). Success Patterns, so we are discussing reasonably successful companies (not failures). Among the reasonably successful companies, how do you ascertain if a company X or Y has something extra in its DNA?

1). We are NOT trying to discuss textbook patterns - Moats+Management+favourable industry et al.

2). We are trying to discuss, discover, identify Patterns beyond the usual stuff. Patterns that you you will usually NOT find in investment books. But patterns that are nevertheless there in a discerning investor’s head/toolkit:)

3). Perseverence by itself is not a success pattern that is obvious to us all. But if you notice Perseverence in addition to other usuals )- good margins & profitabilty track record, strong balance sheet, decent growth, decent visibility/outlook for 2-3 years ahead - do you make something of it?

If I see that the company is today successful, but has had to really struggle in its early years - against many odds -upwards of 10 years - that’s some conviction, man. I would reckon this company would hugely value those struggle days, passion & great belief, self-confidence made it sustain in those days. Now with all the struggle behind them, and they have tasted good success in the next 10-15 years, if I see this company is actually in a niche leadership position today, I would be pretty confident that this company will go from strength to strength here…and that very few companies will be able to come up and dislodge this company from the grip it has today.

Shouldn’t that give this company EXTRA MARKS?? Shouldn’t Gujarat Reclaim and Kaveri Seeds get extra marks, and therefore maybe qualify for a higher allocation in your portfolio, if all other things say are accounted for.

Can everyone relook at your earlier comments from this perspective and revert back. I am not about to write-off “Perseverance in Successful companies” as a pattern.

In-fact it may be a not-to-be-missed pattern!?

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I am not sure if these below patterns are part of any investment books, still listing them:-

1). Absolute boring industry + Industry leadership and/or Consistent growth (Example: Mayur Uniquoter). These companies usually have pretty good ROE/ROCE ratio >20.

2). Turn-around pattern : Good company+Able management somehow miscalculating future, dive the company to a deep soup, leaving stock price, pe to rock bottom. After a while, by persistence they get rid of their issues (debt/pledging/re-org) and things fall in place one after another. (Example: Wockhardt, Dishman Pharma, Unichem, Granules, Hikal (forex loss)). Slowly reducing DE ratio, reducing pledged share ratio, slowly increasing EPS (even with a flat sale because of reduction in finance expenses), are few of their characteristics. To me this seems to be the pattern where one can make some good profit in small time, with moderate risk.

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Hi all,

I feel that any business that focuses on combination of a strong brand and reach issurely moving towards success. Here, let me clarify that a “brand” is one which gives company pricing power and helps it protect its margins.Typically quantitative parameters that one may look for are steady or improving profit margins and very good retun ratios (ROE/ROCE). Typical example of companies slowly building such moat are Cera, Amara Raja, Astral and may be eventually Atul Auto too…

Best Regards

Dhwanil Desai

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1).

2).

Hi Subhash,

I think you made a very relevant point. A leader in a boring industry is more likely than not going to be a good business! Another example may be GRP! Processing used tyres is surely not fancy yet GRP represent excellent business! I think Peter Lynch was a big fan of this approach. He even went to say that a boring business with old fashioned name is most likely a great investment.

Best Regards

Dhwanil Desai

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I have been struggling with this “Success Pattern” thingy:) for some time now. Just how to capture it in simple things - patterns- that we can learn to spot in the companies, that we are investigating - and therefore, accord higher weightage to these patterns - and therefore to these companies - in a sort of accumulated, aggregated way:))

already too complex…not to fear…think I have a clue to solving this puzzle…and am I excited by it?

I realised suddenly - the simplest way is to look at your own success in investments made till date - what were the 1 or 2 key things that attracted you to investigate the business more closely, or what are the 1 or 2 things that you think made this company stand out & execute solidly, that made for exemplary performance - and hence exemplary returns. (The Basics were always strong - good BS, low debt, decent margins, decent growth, etc - no gainsaying that!)

And if we can collate in this format from many senior and active investors - boy - we will have a wealth of “elementary mental models” (a la Munger, but reinforced by Dhwanil somewhere in a recent post - this guy is gooood!).

No more suspense…out with it in the next post…hope it turns out as promising as it sounds to me right now!!!

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Some Elementary mental Models (from my limited experience base).
This will be a work-in-progress doc for some time; please bear with me, but encourage all to keep adding their patterns in this thread.

Disc:
a) This is an attempt to document elementary mental models from aggregating "patterns" from our successes; this is NOT a comparative assessment of the company/business; this is NOT an investment case for these companies (at current levels)

b) my views are biased as I have made money/or am invested in these companies significantly

Company Success Pattern(s) identified Elementary Mental Model(s)
Manjushree a) supplying to ALL the big names/MNCs in FMCG business
b) consistent big jumps in Operating Margins - from 13% to 16% to 19% plus in almost consecutive years in a very competitive industry
c) industry-beating metrics - better than global biggies in the business - MNcs at ~10%+ OPMs
d) management meet - grounded simple guys, excellent grip over their business, knew exactly what it takes to be successful in this extremely competitive industry - knew what they were doing to a T		 Jump in Operating Margins

Servicing Global Brands
Mayur Uniquoter a) asset-light business model in a manufacturing industry?!! (fixed ssset turn ~8x - first wow!!)
b) consistent increasing efficiency trend - take anything - power costs, employee costs, SG&A costs, margins, asset turns, working capital, debt - take anything - I couldn't find a better example - (this was a classic textbook case -total wow!!)
c) management meet - humble grounded guys, underpromise n over-deliver type was apparent even in my first meeting, again excellent grip on the business
operationals
d) global marquee customers like Chrysler & Ford - should go on to next level!
e) Consistent reduction in Debt		 Jump in Operating Margins

Consistently increasing Asset Turns

Servicing Global Brands

Consistent reduction in debt with growth
Balkrishna a) best in industry metrics - comfortably beats all the MNC biggies in its off-highway tires niche; competence built over many years
b) a global Indian brand!!? - Michelin Investor presentation mentions BKT as #3 in Europe! (Wow!)
c) management meets - shows us the company is in top of all operational challenges/issues - whether forex, or raw material or execution on ground
d) ability to take price hikes on regular basis to counter RM hikes		 Ability to take price hikes

Servicing Global Brands
Astral Poly Technik a) huge Size of opportunity - this is the first time I really got to appreciate this - every house/every building in this country would need these products (but effectively few suppliers)
b) exclusive tech relationship - Lubrizol controls 80% of this worldwide market - and these guys have the strongest relationship with Lubrizol (most products licensed all over the world) - tells me something, again (?)
c) focus on innovation - coming out with new products every year; focus on growth; focus on building capacities as the ways to sustained growth
d) Very tightly-knit, superbly motivated distribution network
e) positive feedback loop from every level - management, employees, distributors, plumbers
f) ability to take price hikes on regular basis - good understanding with fellow licensees		 New Products every Year

Ability to take price hikes
Suprajit Engineering a) dominating its niche of automotive cables totally - 100% of TVS, 85% of Hero Honda, 80% of Bajaj - hey this guy is going to be pretty difficult to dislodge by any competitor
b) consistent margins & returns and growth
c) cost of product negligible to cost of assembly/product; so can take that 1or 2 rupee hike needed to ensure margins without big scrutiny of OEMs
d) winning global customers like BMW - should go to next level!		 Niche Monopoly

Servicing Global Brands
Gujarat Reclaim from Ayush -
a) Good consistent growth of 25-30% with ROCE of 30%+
b)Consistently growing liberal dividend
c) The co had low working capital requirement and hence BS looked strong
d)It's a "green" business - i.e. environmentally positive business and hence great future
e)The promoters seemed honest and very well qualified - MD, ex IITian & son had work ex from Boston Consulting. On meeting this held out really well and the promoters seems hard working, honest and hands on the business		 Servicing Global Brands
Kaveri Seed Company a) astonishing numbers - huge growth
b) Play on Intellectual Property of home grown hybrid seed companies in India - that made the Monsantos of the world ineefective - had to change their business model - to remain relevant in India - for the first time Monsanto licensed BT gene tech to others
c) huge size of opportunity
d) a certain street smartness - to ensure production scalability - the other major success ingredient needed for success in the market, other than having the right product

- yet to play out decisively; needs watching
Atul Auto a) simple case of replicating "home" success in other states - they had the right product, was #1 & #2 in Gujarat & Rajasthan, and now moving to new territories
b) low base effect - big competitors with negative growth, only small competitor growing consistently 30-40%
c) management meet - simple grounded folks, knew what they were doing; emphasised sustained growth depends a lot on coming good on the "right" local distributor
d) very Low Working Capital requirements
e) Strong reduction in debt with growth - as sales went from 81 Cr to 300 Cr - debt reduced from 34 Cr to 4 Cr in last 5 years		 Low Base Effect

2nd/3rd Largest player in its market

Consistently increasing Asset Turns

Consistent Debt Reduction with Growth
Indag Rubber will get Viraj Mehta to fill this; he was the GUY behind the conviction on Indag:)
Oriental Carbon a) "second alternate supplier" to major OEMs; Solutia supplies 80% of the market; the majors have a vested interest in keeping this guy alive - even share/upgrade tech secrets, long term arrangements!!
b) sudden jump in operating margin to 25% plus (2-3 years back) is a HUGE thing for most companies; and exemplary in chemical industry; not sure of sustainability - despite a oligopoly situation - very few worldwide suppliers
c) management meet - establishes sustainability pretty effectively - convincing facts/arguments; when growth returns there should be big kicker!		 Jump in Operating margin

2nd/3rd largest player in its market

Protected Margins
Poly Medicure from Ayush
a)The co was growing at about 30% and was in an interesting field of medical disposables which has a great future
b)The management was young and looked honest and quite capable. Interestingly they had appointed Mr D R Mehta on the board and he is a very honest person with a great vision
c)The product had entry barriers in terms of patent, product designs etc and usually doctors won't use a new name very soon.
d)Company had shared its vision/plans of scaling up and is seen to be walking-the-talk
Amara Raja & Cera from Dhwanil -
Another pattern that I noticed is focusing on second/third best companies in an oligopoly industry that is growing at crisp rate.

a) Take example of Cera and Amara Raja. Both these companies operate in an oligopoly market and are second/third largest players catching up with the leaders. Logically also it makes lot of sense.

b) One of the advantagecompanies playing secondfiddle to leadersenjoy is that typically their margins are protected because most of the time market leader in an oligopoly markethas pricing power and hence market leader protects its margins. This ensures that even second/third largest players also protect their margin.

c) Another obvious advantage is low base second/third largest players have. So if the company operate in a reasonably growing industry having,say, 10% CAGR, second third largest players typically outgrow the industry by some margin hence decent growth is a highly probable scenario. Growth with protected margins ensures earning growth.

d) Moreover, typically market discount second/third largest players with respect to market leaders. Hence valuation wise they trade at discount to leaders while growth/other matrix are comparable to leaders.

 Low base effect

2nd/3rd largest player in its market
Ajanta Pharma a) Introducing 10-15 new products every year
b) consistently increasing operating margins from 14% in Fy06 to 19% in FY09 to 22% in FY12
c) Focus on niche segments/innovation		 Jump in Operating Margins

New Products every year

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