Hi Ankit,
How would one be convinced on the margin of safety in a case like Tata Elxi (P/E of 37) and Navin Flouride (P/E of 23, high for the business they are in)? Or would you let go on this if you find the future opportunity is huge or wait until you find a price that you wish to enter. I am unable to draw a balance in such cases.
Thanks
Samir.
Hi Samir,
The margin of safety for any investment is defined by our ability to spot early and allocate meaningful percentage of our portfolio to companies that show promise above average returns over the forthcoming period (1 / 2/ 3 years and further) and the potential to sustain growth for years to come.
Navin Fluorine is not a widely researched story. It has some unique businesses - some of which I would term as super prospects, you should read up more and make up your own mind. They have an investor presentation on their website which will give you some pointers as to how they are differentiated. I am reasonably certain that barring some completely unforeseeable circumstance they will grow earnings north of 40 - 50% over the next 2 years. Current P/E of 22 is therefore not at all a concern to me.
I am still trying to understand the possibility of Tata Elxsi delivering on its promise. I am learning more. No strong conviction on it yet. However, if you understand the business and are convinced they can deliver even a 3x to 4x growth over the coming 4 years while retaining margins, current P/E should not be a concern to you either.
There is a note from Prof. Bakshi on why you should not rely on current optical P/E, but consider the intrinsic quality of business and its possibilities:
https://dl.dropboxusercontent.com/u/28494399/Blog%20Links/October_Quest_2013.pdf
Trust you will find it useful.
With best regards,
A-N-I-K-E-T (not Ankit)
Another story which I felt worth putting here is Wonderla Holidays. It might be trading very expensive currently (or not). I am not a good judge of what is cheap and what is expensive. But I like the story very much. If you are in the US you must have known the amount of time families spend at Disney/Six flags etc. I think the value migration is happening and Indians are definitely spending more and more money. Wonderla has very less competition in their segment. Look at their reviews on trip advisor āThings to do in Bangaloreā (also Kochi). Answer is Wonderla Amusement park. Management has great reputation. They also have good expansion plans. Just opened up a park in Hyderabad. Overall looks a great story to play long. Indo Count, Kelton , Cupid, Tata Elxsi are all good stories too.
I also do understand your sentiments of having a high risk portfolio as I have done the same for sometime. Earned in dollars and put it all in stocks. Every penny. The problem with four stock portfolio is that when one of the stock goes down all of your efforts seem to be futile. Have burnt my fingers in Hawkins sometime back 
(which was also considered as āsafeā because of its dividend yield). Granules is definitely a great story but not sure if any story is worth putting 40% in just because as people pointed out there can be some āunforeseen incidentsā.
Just though of adding my 2 cents to this awesome thread. Really enjoyed reading Aniketās views.
Disc - invested in all the stock I mentioned.
I donāt think that if one of the stock goes down, the effort is futile. The other 3 are chosen in a way to cover it up in 1-2-3 years timeframe. But I have realised that in extreme concentrated porfolio, an even allocation across all stocks becomes more necessary.The effort I put in to discover stocks by triangulating qualitative opinions as well as doing my own extremely conservative quant analysis, very few stocks get through that barrier. Once they get through, I decide to put atleast 10% to it.
In fact if some stocks in a diversified portfolio go up in long term, I feel the effort to be more futile in picking up those. Whatās the point of high conviction after substantial research just to allocate a meager 5%?
I get many ideas which I have to either turn away or keep them in a long waiting list simply because they donāt fare better compared to what I already have in my portfolio.
Nishant, I was trying to do something similar to that couple of years ago. Like you I am in US and sold a bunch of my ESPP stocks in 2014 and had a sizeable amount in hand to invest. I was part of Mr Basant Maheshwariās stock advisory then. My portfolio was top 6 stocks (Hawkins, Page, Gruh, Repco, HDFC and IndusInd) of his list of recos. Here the last 5 stocks were giving very good returns but still Hawkins was ranked as no 1 as it was expected to give blockbuster results in a matter of time.
When I got the money in hand, I wanted to do something outrageous - to put all of the money in Hawkins and not divide it across the portfolio - just because we were almost assured of upcoming surge in profits and stock price. My good sense prevailed and I asked Mr Maheshwari if it was ok to do so. Even though he ranked Hawkins as #1, he very strictly told me to never ignore portfolio balance no matter how bullish I am on one company. I grudgingly followed his advice and distributed money across the whole portfolio instead of putting everything in Hawkins which was at around Rs 4500+ then.
Fast forward to one year later, summers of 2015, Hawkins results crashed the hopes of all the investors like me. It became clear that company is not able to generate growth that we expected. Within matter of days Mr Maheshwari also kicked the stock out of his top 10 list and told his subscribers that he no longer believes in the story. I exited the stock at ~2500 levels thankful that my loss was not too big (I had some earlier buys below 2000 so the 4500 buys averaged out)
But the lesson got imprinted on my mind - that portfolio balance is more important that individual stocks.
Hi nishantkandoi,
As you had requested for my views, so hear it is. First some disclosure. My own experience in stock market is fairly limited (less than 3 years). Although I have also acquired knowledge through vicarious experience of other investors (by reading about them and in some case meeting them personally), my own philosophy is still in nascent stage.
Diversification vs concentration is a question which has equally strong for and against points. Some people see diversification as hedge against their own ignorance while others claim that you would never have same conviction on your twentieth best idea compared to your top idea. I am in the category of those who feel that diversification should be dependent on oneās own psychology (ability to handle volatile situations along with whether the person has other source of income just in case everything blows up). One more reason to have minimum amount of diversification (which is often less talked about) is to accept and embrace the role of luck in investing.
I am not quite sure why but I get the feeling you have been influenced by some of the talks/interviews of concentrated investors. The quotations like even if 1 of 4 falls by 50% but other three performs as per expectation of 25% return in year you end up at +6.25% for the year looks mathematically right, but you need to understand the compounding effect of the returns where even after initial few years of success, 1 bad year in later years can totally decimate first few years of good returns. If you really increase your sample size of investors to include those investors as well for whom concentration led to their demise you will see an interesting pattern. You will find in most cases concentration worked really well for them for initial few years. Only when a major bear market came they realized the problem of having almost 75-80%of their portfolio in top 2/3 companies. For every Druckenmiller (king of concentrated bets) in history you have 100ās or more of brilliant portfolio managers who did everything right accept make some leeway(have margin of safety for portfolio rather then specific stocks) for possible black swan events (I have shared some interesting stories in the end)
My sincere advise would be that while seeing the track record of concentrated investors always see the sample size . I am quite sure if you can somehow compile the list of successful investors (with a record of say atleast 20 or more years), you would find majority of people have done well would be diversified portfolio holders. And please bear most of the top fund managers have unlimited access to management, have number of sector specific analysts and scuttlebutt analysts who keeps daily track of sale of product and still they diversify. If you see the interviews of such investors over time, you will find most of them will have 2-3 stocks as their favorites but still they diversify among 10 or more stocks. In almost all cases over the years, most of the portfolio returns would have had come from handful of stocks but surprising thing would be in many cases the stocks on which we are least bullish on in portfolio will turn up as the dark horse/s.
Coming to my own experience which might be able to explain the above points in a better way. I had started with holding 15 stock in my portfolio then moved to 5 stocks(effect of reading only success stories of concentrated investors) and now finally settled to around 10 stocks since last year. Never thought about holding above 15-20 stocks as even mathematically you dont get diversification benefits beyond 15-20 stocks. One of the great leanings for me of last year was Kaveri seeds (which had portfolio weightage close to 15% and was among the stocks on which I was very bullish- see Kaveri thread for more details). Inspite of having read atleast 20 research reports on the company as well as the sector, reading almost all articles (published in last 2 years) on seed industry and having close to 30 pages of own research note on it, I had somehow not thought of Lollapalooza impact of the scenario where it doesnt rain for 2 continuous years (More details in respective thread). And then when you dont want it Murphyās law comes to make the matter worse (lower crude price impact along with higher price realization for farmers of alternate crops, dumping of Cotton by China and finally government intervention on pricing).
Regarding pharma as sector to be in, I have also been in the same boat since last 3 years. In fact I have been bullish on Granules from the start of my investing days and it is now among my top holding.(I had even argued with one of the marquee investor 2 years back about number of positive triggers for Granules) But it would be downright lying if I now say that from the start did I knew it will be the top performer of my portfolio. Even now for the most part, I am searching for the truth and constantly looking for ways I could be wrong and that could be fooling myself as i am the easiest person to fool. Let me give you some examples. You must be knowing about Granules now trying to do number of new things at the same time which it hasnāt had any prior experience. Example going into CRAMS business, trying to became a formulations player via reducing dependence on its bread and butter- API business by working on complex ANDA filings and trying to make a mark on its own in OTC markets. So even if I now know much more about the company and have higher faith in their abilities after having seen them executing on most of their last few years promises, I am still wary of betting the house on it because there are some many things which can go wrong which are totally out of managementās hand. Same is the case with the likes of Alembic and Torrent. I am pretty sure both of these companies would today not be in such strong positions due to strong sales from Abilify and Nexium if the other filers who had also got the approval at the same time and who had much stronger sales and distribution network not faced regulatory issues with their plants/product right at the crucial time.
Lastly I would like to end by saying there is a reason VP Model portfolio still has companies like Gruh, Page which are now well researched stocks and act as compounders/portfolio stabilizers. Even most of the marquee investors have such stocks in their portolio inspite of knowing from the start that these compounders could end up diluting some of the returns. This is not about not having faith in their ability to get 30-35% CAGR and settling for 20% CAGR, it is more about having the respect for the Mr Market and role of luck. I would also like to share an extract taken from recent Virat Kohliās interview (Hopefully you have basic knowledge of cricket). Try to correlate it with use of diversification (artificial sector/stock weightage limits) to appreciate and embrace the role of luck in investing and not take investing for granted.
Some interesting reads:
Analysis: Bill Millerās fall shows luck at play in investing Analysis: Bill Miller's fall shows luck at play in investing | Reuters
Bill Ackman Valeant Lessons http://tradinggods.net/trading-gods-blog/when-investing-check-your-emotions-and-ego-at-the-door/
Bruce Berkowitz story http://www.gurufocus.com/news/160353/bruce-berkowitz--from-hero-to-zero
Many good comments.
All boarders have mentioned the need for diversification / distribution - but doesnāt the size of the pot play a role? Or be the deciding factor?
If one has 1L principal to invest vs 10L vs 1Cr vs 10Cr?
I would have thought concentrated (bets?) would be better in the first of the two cases and diversification on the latter two. In the first two scenarios, the calculated risk would be to grow the principal, and later compound it. We do not know the size in this case - and of course I do not expect to know it either - but my point would be, the investor with actual pot in hand would be the best judge.
Rgds
Pavan M
Hi Amanji great write up. It was really eye opener with suitable example. Contributions from person like you really make VP a great place to learn
A truly insightful and thoughtful post, thank you!
In addition to recognizing the role of luck, there is another factor that can be decisive in concentration or otherwise. For most of us, the sources of information are secondary - i.e. from research reports, or via other media. It is only in very few companies that we get primary source of information, i.e. directly from the market, or via management. A platform like Valuepickr affords that source of primary information, for instance in case of Kaveri seeds, one knew exactly the usage on the ground ( hahaā¦literally !). Yet, there was a time when many members were caught with headlight in the eye when the Royalty issues exploded to compound poor monsoon.
So faith and conviction is all fine, but if that is based on secondary source of information, there is still lack of true insight into the company and nothing beats getting primary source of information - from the company, from competition, from vendors of the company, from customers of the company, the bankers, the employees. This is the Edge without which concentration can be highly risky, and one may even be unaware of carrying such a risk. As RD says, for every concentrated investor, there are many others that are successful being diversified. The stories we hear of successful concentrated investors might be the ones which carry Survivorship bias.
Howard Marks sums it up best:
Investors who feel they know what the future holds, will act assertively: making directional bets, concentrating positions, levering holdings and counting on future growth ā in other words, doing things that in the absence of foreknowledge would increase risk.
Those who feel they donāt know what the future holds will act quite differently: diversifying, hedging, levering less (or not at all), emphasizing value today over growth tomorrow, staying high in the capital structure and generally girding for a variety of possible outcomes.
Regards
Arun
My 2 cents - In addition to what @Rokrdude and @anshumanshukla told:
Beginning post U mentioned 25% of your net worth in stocks - u r top holding 40% - virtually =0.25*40%=10% of your total net worth, not bad or either too high in totality. A 10 bagger here only doubles your net worth. Balance, rather rebalance your portfolio as on when it increases in size with experience in market.
The key in concentrated portfolio is one as to get out ASAP without thinking when 1) the story does not turns eg; Hawkins or 2) head winds eg: Kaveri - whether u like it or not.
Every experience is a lesson here as long as you r in this game, market will keeps on teaching us.
Regards
I am investing in equity since 1991. I started my investments in concentrated portfolio and initially I was not successful but after many mistakes the theory of ā10 stocksā proved correct to me till the year 2007. However after being successful recently I have changed my method by dividing my portfolio into two parts:-
(1) Portfolio stocks
(2) Experimental stocks.
The coās which have proved themselves over a long investment period qualify as Portfolio Stocks, the examples are Marico, Sudarshan Chemicals, Torrent Pharma, SRF, Aarti Industries, Infosys, Ramco Systems, Balaji Amines .
In my second type of stocks being āExperimental Stocksā I am keeping 25 to 30 stocks with paltry investments in many stocks. In the end of every quarter some companies arise as turnaround cases. And only for the purpose of tracking I purchase 50 to 100 shares of each and every turnaround case (the rule is if you have invested some money in any business you are bound to supervise that business regularly ,because every penny counts). Here strategy is to detect real turnaround cases, after watching for 3 to 4 quarter results the real turnaround stories will continue to outperform. After watching for more than eight quarters, if company performs as per my expectations (i.e. improving EBITA margins, decreasing debt, ROE, positive cash flows)and thereafter I slowly increase my exposure. If company continuously performs better and starts paying dividends than only the stock will qualify as Portfolio Stock.
Therefore concentrated or diversified I have made investments in eight stocks which have given me huge returns and also I am open to increase the number from my paltry investments if any stock outperforms and qualifies as Portfolio stock.
Why? Because in every bear phase some of the best cases are available at throwaway prices.
Few examples from my experimental basket, which I have tracked for years and are slowly creeping towards portfolio basket, are Gokuldas Exports, Meghmani Organics, Himatsingka Seide.
I appreciate your approach as very smart.
Thanks for the appreciation.
Nishant,
Let me first say that your approach is very bold and your openness about accepting the results, good or bad, is appreciable!
A lot of good discussion and advice has already been provided in this thread and a special post by @Rokrdude!
My dilemma with concentrated vs. diversified portfolio is as follows -
Unlike you, I invest a part of my salary into equities, so I donāt have lump sum to invest.
Like you, I am a full-time working individual and I get limited time (10-15 hours a week) to study stocks. I believe in keeping my wits at all times rather than getting attracted to momentum stocks.
I start investing in a stock based on my conviction. The story is playing out well, I like the stock but Iām not convinced about averaging it up on current valuations. Then I end up investing in the next best story and continue to hold the first one. And I end up diversifying.
And this is what has been happening ever since the bull market started in the end of 2013. e.g.
Iām holding Ajanta Pharma from 900 - but not adding more and neither selling.
Iām holding KRBL from price 90 - but not adding more and neither selling.
Iām up averaging CFH and it now forms 17% of my portfolio.
The second point is about what Charlie Munger says - āNot being stupid, instead of being smartā.
I have seen some VP threads (unfortunately), where on bumper results, we are all going gaga over management and ready to justify any valuation. But after one result, we are equally ruthless to rip apart management and find holes in story. (Kitex thread is one good example and @aveekmitra has made good points about this behaviour on the thread).
So many fellow VPers have shared bad experience of Kaveri Seeds but let me tell you - Iām currently sitting on 50% profit on KSCL in 6 months. The market was fearful and irrational and the stock went down to 300. I have bought it then and still holding on - looking forward to results.
Best of luck for your investing journey and hope to exchange many ideas in future as well.
Regards,
Rupesh
Very good approch indeed, I appreciate your willingness to buy the shares of well managed co. in bad time You followed the principle of Warren Buffet " When every one is fearful you must be greedy".
sir
its a real practical approach. for a normal investor it is really difficult to analyse, visualise, all the complicated issues surrounding an economy especially in a globally linked economy. I do practice this invest approach with a few variations and call it core and satellite portfolio construction.
I just rank stocks in my white list in the descending order of conviction and pick all the stocks that are above a threshold level of conviction. Conviction cannot be measured so I just go over the list every now and then decide which ones pass the bar.
At the bottom of the bear market I end up having 20 stocks and as the market moves up the number goes down. For me, number of stocks in a portfolio is not as important as % of my net worth in a single stock. at the top of the bull market I may invest only in 5 stocks because 60% of portfolio might be in bonds. At any point, I try to keep less than 10% of my net worth in any single stock or industry.
I have dumped my original plan of extreme concentrated portfolio containing small cap stocks as I slowly realized that I am still very weak in the art of stock analysis. However. that wont stop me to stay invested in the stock market. Hence, I have decided to play a relatively diversified (or concentrated?) portfolio containing only Large cap stocks. Although the market looks a little stretched, I slowly plan to construct a portfolio of following kind:
IT sector (30% allocation)
TCS
HCL Technologies
Pharma (55% allocation)
Sun Pharma
Lupin
Aurobindo
Alembic
Motors (15% allocation)
Eicher Motors
Meanwhile, I would keep learning about the art of stock analysis and hopefully when I turn 30, I should be able to get a better grip on it.
Thank you everybody for contributing to this thread.
@nishantkandoi Have you already rejigged your portfolio or plan to? Also have you sold out from all your concentrated positions?
Iām really surprised with a/planned 30% allocation to large cap IT which is showing ~10% earnings growth over the past 2 years. I know being contrarian in the market can pay-off in the long run but Indian IT companies need to almost reinvent themselves going forward to generate >20% earnings growth (assuming thatās a minimum return youāre looking at). What is the probability of that happening (atleast at this point in time - isnāt it too much speculation)?
Vineet Nayar, Vice Chairman at Tech Mahindra has admitted in a recent interview that 20ā growth in IT is not going to work going forward. What is your rational with 30% portfolio allocated to IT. I work in IT and I know how much these Indian vendors are struggling with workloads taken over by AWS and Microsoft. This is more like a commodity business now with lower margins unless they provide service which is greater than sum of its parts. Only companies with digital focus, automation, IoT, Cloud and Service design focus could have higher margins.
Please guide us with your views on IT as a sector so that we can take into account your contrarian views.
Cheers,
Amit
