Best Investing Approach?: Wide Moat business vs Undervalued business

Posted byNadakarniat June 28. 2012

Dear Donald,

I would like to understand which one is the best way to approach investing.

1). Invest in great companies with wide moats ( some business advantages) and hold it for a long time - high RoE, high Margin, low Debt, superior product, leadership etc

Companies like Crisil, Castrol, Pidilite, Asian Paints, Gillette, Colgate, P&G etc

2). Invest in undervalued securities

I have been managing my portfolio for 2 years; returns are ~6%; have mix of both.

Regards

Posted byDonaldat Monday 15:46

Dear Nadakarni,

Nice topic…I am sure there will be multiple views…and takes on this…based on one’s experiences…

My views are as follows…from my exp of last ~7 years

1.Stock Returns)- come form theGAPbetweenExpectations(built into the stock price) andResultsdelivered. If there is large outperformance (between results and expectations), there are large returns.

This is a crucial aspect to appreciate. I can recommend reading “Future for Investors” by Prof Jeremy Siegel, that drilled this home into me, early on.

Usually this GAP is pretty narrow in perennial favourites like the stocks you have mentioned as future expectations are pretty much built into the stock price. However, you do get opportunities to pick these up once every 3-4 years - when there is a secular crash. I look to pick them up only at such times …when the GAP is Big!

2.Portfolio Returns)- are dependent NOT on Stock Returns, but onCapital Allocation. How much have you bet and where? There is a very meaty discussion onCapital Allocationin ValuePickr… Surprisingly I am yet to find a book that does justice to this topic… if anyone knows of one, please alert me.

in the words of one of my Mentors, it doesn’t matter how much your stock has gone up…it matters how much you have been able to bet on it…Even if your stock goes up 2x…and you have bet 5 lakhs on it…you have made more money on it, than if you had bet 1 lakh…and it went up 5x!!

3). What strategy is best is a moot question…also depends on how much time you are able to devote…ValuePickr’s aim is to make it easier for passive investors to be better informed…putting in just maybe 20% of the effort, we active investors put in;))…by way of the Stock Stories, the Management Q&As, and the quality of discussions at the Forums.

I am an activeinvestor. Together with other ValuePickrs I devote a lot of time and energy to studying and understanding businesses develop Conviction and weigh that against undervaluation. We follow a pretty concentrated strategy. Our aim is to generate 25% CAGR on our Portfolios…we have been through one bull and bear cycle…So far we have been able to significantly outperform…the next bull/bear cycle…will be the real test!!

Rgds

Donald

Previously Nadakarni wrote:

Dear Donald,

I would like to understand which one is the best way to approach investing.

Posted byHitesh Patelat Monday 18:20

Previously Nadakarni wrote:

Dear Donald,

I would like to understand which one is the best way to approach investing.

1). Invest in great companies with wide moats ( some business advantages) and hold it for a long time - high RoE, high Margin, low Debt, superior product, leadership etc

Companies like Crisil, Castrol, Pidilite, Asian Paints, Gillette, Colgate, P&G etc

2). Invest in undervalued securities

I have been managing my portfolio for 2 years; returns are ~6%; have mix of both.

Regards

hi nadkarni,

most of answer has been given by donald.

Maximum money has always been made when there is some serious re rating in terms of PE expansion in an already growing company. This usually happens in companies which continue to spring positive surprises and are not priced to factor in these positive surprises.

case in point being mayur uniquoters which has been consistently growing at more than 20% cagr since past few years and with very high ROEs and practically no debt and even as of today available at a PE of less than 9. Even with marginal re rating from a PE of 6 to a PE of 9 the company has been able to post market beating returns since a long time.

Another important point dealt with by donald is how much you have bet on your top performers which determines the portfolio returns. I guess one has to go for a relatively concentrated portfolio with the top 4-6 bets occupying more than 70% portfolio.

Regarding the scrips you have mentioned i.e those with moats etc, well most of the positives seems to be priced in the stock prices of these scrips. That leaves very little room for re rating to happen. So the returns generated will be by and large in line with earnings growth.

Among them also asian paints was available at closet o 2700 levels not too long ago when there were some concerns about input prices and lacklustre quarterly results and so on. Thats the time to pick up these companies with moats-- especially when they pass through temporary set backs.

e.g Hawkins Cookers which currently seems to be in a standstill mode due to production constraints. Now we all know production constraints is a thing which can always be taken care of with some amount of lag period. Since the demand is always going to be there, I feel it makes sense to buy stocks like Hawkins currently as it operates in a virtual duopoly market and even though it is currently at a PE of around 25 times ttm earnings, it probably will look cheap 4-6 quarters down the line when the company gets its act together and starts giving robust results.

Posted byRohitat Monday 21:31

Hi Nadakarni,

While Donald and Hitesh have answered your questions, I would like to highlight here that most of the stocks mentioned in 1. have been wealth generators, and I will be surprised to hear if someone has lost their money in these stocks in the past few years. Of course there are some examples in 1. like BHEL where people have lost money in the past few months, however, it is not mentioned in your list:))

That being said, it seems you are losing quite a lot of money in “undervalued” securities, the effects of which seem to be negated upto an extent by 1 (unless you keep on selling the winners in 1. or have not allocated your capital properly).If you can share some of the names in 2., we can discuss them as well.

On capital allocation, what Warren Buffett and Charles Munger have to offer via their writings is very useful. Additionally, you can refer to books by Ben Graham, but like Donald pointed, there aren’t many books on capital allocation. Everybody has to write their own:))

Previously Nadakarni wrote:

Dear Donald,

I would like to understand which one is the best way to approach investing.

1). Invest in great companies with wide moats ( some business advantages) and hold it for a long time - high RoE, high Margin, low Debt, superior product, leadership etc

Companies like Crisil, Castrol, Pidilite, Asian Paints, Gillette, Colgate, P&G etc

2). Invest in undervalued securities

I have been managing my portfolio for 2 years; returns are ~6%; have mix of both.

Regards

Posted byNadakarniat Tuesday 23:08

Dear Donald and Hitesh,

Thanks a lot for your replies. It is really helpful.

I provide a significant importance to RoE. There is one aspect that makes me feel that a superior company with superior sustainable RoE should be able to provide superb returns in the long run even if it is expensive in the short run & a PE rerating happens. I have attached the sample calculation sheet that I use. Request your comment on the same ( Despite the theoretical evidence, I feel there is something I am missing, It cannot be so simple).

I have realised the importance of having a concentrated portfolio. I had a large portfolio which infact included multibaggers along with duds.

Rohit,

Some of the stocks that I owned are Indag ( 4 bagger but 1% portfolio); Shriram Trans Fin ( 2.5 bagger but 0.5% port); VST Industries ( 3 bagger - 1% port). These did not have any significant impact on the overall returns. Some which had significant positive impact were LIC Hsg Fin ( 2 bagger and 5% port), NIIT Tech ( 2 bagger and 10% port).

I lost money in many others undervalued/ mispriced opportunities - Electrotherm, Ramsarup, Nile, Patels Airtemp, Marathon Nextgen realty, KNR, Sicagen, Godrej Inds, Mercator etc.

I assume, I have wised up.

Regards

Attachments

Posted bySubash Nayakat Tuesday 23:43

Hi Nadakarni,

Just feeling curious. How come you didn’t increase your stake in indag rubber when it gained 300% slowly. It must be clear case of one script significantly outperforming the rest of the lots, and to me seems logical to add little more of indag rubber on every 10-20% increase.

It would have resulted in automatic creation of two categories of stocks, the bulk % being the outperforming few, and lower %s of laggards.

The basic problem with pure ROE based investment strategy (or any purely mathematical equation based strategy) is that it looks at the past performance of the company, whereas market pays for the future prospect of the company. Consistent high ROE for last 3-5 years gives a high confidence on investing decision, but one need to consider the underlying story behind the stock along with it.

In an ever changing world, new market realities can create newer opportunities for companies which have been doing poor in ROE front, and can deteriorate the ROE for past super-performer (ex eClerx, opto-circuit, so many infra stocks). These newer market realities can only be evaluated by constantly tracking all the developments that is being happening in and around the company.

-Subash

Previously Nadakarni wrote:

Dear Donald and Hitesh,

Thanks a lot for your replies. It is really helpful.

I provide a significant importance to RoE. There is one aspect that makes me feel that a superior company with superior sustainable RoE should be able to provide superb returns in the long run even if it is expensive in the short run & a PE rerating happens. I have attached the sample calculation sheet that I use. Request your comment on the same ( Despite the theoretical evidence, I feel there is something I am missing, It cannot be so simple).

I have realised the importance of having a concentrated portfolio. I had a large portfolio which infact included multibaggers along with duds.

Rohit,

Some of the stocks that I owned are Indag ( 4 bagger but 1% portfolio); Shriram Trans Fin ( 2.5 bagger but 0.5% port); VST Industries ( 3 bagger - 1% port). These did not have any significant impact on the overall returns. Some which had significant positive impact were LIC Hsg Fin ( 2 bagger and 5% port), NIIT Tech ( 2 bagger and 10% port).

I lost money in many others undervalued/ mispriced opportunities - Electrotherm, Ramsarup, Nile, Patels Airtemp, Marathon Nextgen realty, KNR, Sicagen, Godrej Inds, Mercator etc.

I assume, I have wised up.

Regards

Posted byManish Vachhaniat Wednesday 10:10

Thanks Donald for starting this thread where novices like me can learn the basics of the investing art.

Few things I learned over the time in the company of you guys are : 1. Capital allocation 2. Concentrated portfolio 3. Shed off Losers and Ride on to the winners 4. Identifying possible PE re-rating candidates etc.

Posted byMilindat Friday 06:42

Hi All,

I did things (trading,options as individual ) and last came to value investing after loosing some money:)). I stopped looking to stock market and just read books to understand what is this all about. I read around 1.5 yrs books, may be more than 50 books and some read more than one time. I keep reading books and articles around 2 books in a month and keep watching video on this subject.

I am full time employee in IT but because of passion i keep reading with the available time. I read capital allocation but it seems to me it is more towards person who got money in bulk. for me it is like monthly i get some spare amount to put in stock. i read some discussion that seems to me that very very high quality and in-depth knowledge people can write. Very impressed with all this.I hope i would be able to get good learning from here and hopefully would be able to share something useful to you guys after some time …:))

I would like to share my exp that is around 2 years only and i came to know this site just 2 weeks back.

1). As i can not put full time for research it seems to me that i can not track more than 4 or max 6 stocks. ( i feel out of six only one or two would be of most interest)

2). I can’s afford to loose money much so i put most of money in very very high conviction stocks . Little bit less growth is okay but money should be more safe (in moreprobability)

3). To get high conviction, even though i get stock with some information that it is undervalued (say from value picker itself) i do not feelcomfortable(high conviction) until i follow that stock for a year or at-least for six months. It takes me long time to getcomfortablewith company.

4). Very high importance to management and fundamental and owner buying stocks

5). i prefer to buy stocks in consolidation period where stock may start picking after a six month or year (this gives me chance to bet big)

6). I have seen where foreign promoters are involved , stock commands high PE (This is with observation not from value investing )

7). even though stock is good there would be cycle of up and down (because investor would enter and exit to make profit). this is my observation.

8). if company is growing and fundamental is good then returns would be good in 3 to 5 years (keep buying when it comes down)

9). I have not done profit booking in any of my stock (yes i understand that profit booking is required but still need to figure out). I have observed that even if fundamental keepsgrowingstock may come downsignificantlybecause of profit booking.

10). I am not very muchcomfortable in adjusting portfolio to get return little higher return say 4 to 7% say 20 or 25%( as you guys said correctly that big bets would change things)

I will share my experience more once i get some inputs form you guys.

I would like to understand what your experience says

Thanks,

Milind

Milind,

I relate a lot with your experience, thanks for sharing.

Subhash, Rohit, Hitesh & Donald - thanks for your advice.

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Dear Nadkarni,

I wud always prefer wide n deep moats business. That is the reason i tend to miss many picks by Donald and Ayush!!! Apart from deep and wide moats list there r many companies where investors have made big money. Though i have visited Atul Auto factory, i somehow did not buy that share. It was a mistake which i realised after talking to a fellow who is in the auto industry. So if u do not want to work and do research, then deep n wide biz r best. However, if you are ready to work like Donald, Ayush n Dr H and do your own research then welcome to the world of Peter Lynch, Phil Fisher and Avner Mandelman.

JM

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Every successful investor has to start from Ben. With a concept of value and margin of safety. That is the first step. I dont think anybody can succeed without taking that first step. Once these concepts are deeply ingrained in the mind, the investor can take next step- looking for growth and sustainable advantage. Looking for wide moats. looking for growth with without much capital raising. Looking for companies benefiting from social change. Ben part is quantitative- without much scope for our imperfect brain to muddle. Once it is attained, effort could be made to find that next starbuck… Ben Graham made his maximum amount of money- more money than all the trades he made in 50 years career- from just one growth stock- GEECO!!! But, you can find that only when you understand value and margin of safety.

2 Likes

Agree with Rajesh Kumar :slight_smile:

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