Watched a fantastic interview on YT of Prof Sanjay Bakshi
Here are my notes:
Masterclass on Value Investing with Prof. Sanjay Bakshi
Professor Sanjay Bakshi discusses his approach to investing, which is deeply rooted in multi-disciplinary thinking and influenced by Charlie Munger’s ideas on elementary worldly wisdom. He has been teaching this subject for over two decades.
Multi-Disciplinary Thinking and Worldly Wisdom: Professor Bakshi emphasizes drawing knowledge from various disciplines taught in school and college, such as statistics, economics, psychology, and biology, and applying them to the real world of business and investing. He feels that many people learn these subjects but fail to see their practical utility until much later.
- Mean Reversion: A concept from statistics combined with elementary economics. Just as coin tosses revert to 50% heads/tails over time, returns in businesses with low entry barriers will eventually revert to the mean due to competition. When people make a lot of money in an industry with low barriers, psychological factors lead to reckless expansion, eventually turning shortages into gluts and driving down prices. This concept applies to business cycles. However, stock prices of great companies are not necessarily mean-reverting, though stock returns across the market are (bull markets followed by bear markets). The market, over time, reflects the underlying business performance. If underlying returns on capital are 12-14%, you can’t expect market returns of 18% long-term; this is the nature of mean reversion in markets.
- Momentum: Contrasting with mean reversion, this concept comes from physics. Great businesses can gather momentum and become better over time, like a snowball rolling down a hill (Buffet’s concept). These are called compounders.
- Frameworks: It’s crucial to understand whether a business is cyclical (prone to mean reversion) or a compounder (exhibiting momentum) and apply the correct analytical framework. Applying a momentum framework to a cyclical business will lead to errors.
- Scarcity and Moats: A key factor in determining if returns will be mean-reverting or enduring relates to who controls the scarcity.
- Example: Ferrari vs. Toyota. Ferrari produces limited cars, and scarcity can only be addressed by Ferrari, leading to strong stock price performance (25%+ annual returns). A scarcity of iron and steel can be solved by any iron and steel company, making it more susceptible to mean reversion.
- Example: DeBeers and Diamonds. DeBeers successfully controlled the supply of diamonds and thus scarcity, leading to strong performance. However, the advent of lab-grown diamonds has weakened their control over scarcity, impacting their business. Understanding the nature of scarcity and whether the underlying assumptions causing a business to do well will change is critical.
Value Investing vs. Venture Capital (VC): Professor Bakshi, primarily a public market value investor, contrasts his approach with venture capital.
- Value Investing (Public Market): Focuses on finding good/great quality businesses at fair prices where there is a track record of execution and data. The market generally demands “show me the money”, meaning real earnings, owner earnings, and cash flow. Markets can be crazy but mostly reflect fundamentals, except during speculative bubbles. Financing post-IPO happens at a discount. Public companies face more accountability and financial discipline (quarterly earnings, analyst calls) compared to private companies.
- Venture Capital: Looks for market creation and tapping into large, underserved opportunities. Aims for exponential multi-baggers. Operates under the power law, where a few outlier successes must make up for many failures. Asymmetric pay-offs (potential gain vastly exceeds potential loss) are even larger than in public equity. Investments are made at earlier stages, often day zero of formation. Valuations in private rounds can be very high, leaving little room for later-stage value investors. Valuations are often based on metrics other than cash flow or profitability; sometimes, not making money is even seen as positive in early stages. Founders may be advised to delay monetization. This requires a “complete behavioral flip” when transitioning to the public market environment. VC involves betting heavily on the founder’s ability and past track record, even if the current business lacks extensive data.
Margin of Safety: A core principle of value investing. It can come from various sources.
- For Public Value Investing: Quality of the business and management, existing moat.
- For Venture Capital: Asymmetric pay-offs, betting on the founder’s capability or track record. Benjamin Graham, according to Professor Bakshi, sought a margin of safety by ensuring the minimum value was significantly more than the price paid (e.g., value cannot be less than 150 when paying 100). He didn’t focus on precise valuation (like DCF, which Bakshi jokingly calls “fiction writing software” in a rapidly changing world) but on the minimum potential value.
Evolution as an Investor: Professor Bakshi describes his own evolution, starting as a Graham-style investor focused on statistical bargains, moving to a Fisher-style focused on quality growth, and now blending the two. He seeks reasonably high-quality businesses with a competitive advantage at prices that Benjamin Graham would approve of. This combination is rare, naturally leading to a more concentrated portfolio and longer holding periods compared to Graham’s approach.
Investment Examples and Themes: Professor Bakshi discusses two areas he has found interesting:
- Government-Owned Companies (PSUs): About four years ago, he invested in selected PSUs, viewing the strong prejudice against them as an unjustified mispricing opportunity. Despite being monopolies with strong balance sheets, debt-free status, high Returns on Capital Employed (ROCE) (30-40%+), and long order books, they were trading at very low valuations (4-5x earnings, 6-7% dividend yields). While acknowledging the general governance risk in PSUs, he notes this risk also exists in private companies. He saw these as unique exceptions being treated like the norm. This investment theme worked out extraordinarily well.
- Fossil Fuels: This sector is deeply out of favor globally due to the ESG push. Investors have a strong prejudice, considering these stocks “untouchable”. However, Professor Bakshi argues that the world cannot quickly wean off fossil fuels, and economic growth, especially in India, requires them. Demand for coal, oil, and gas will likely grow. The industry is not building new capacity due to this sentiment, reducing future competition. He found businesses in this space trading at low valuations (5x earnings, 6% dividend yield), with debt-free balance sheets and high ROCEs. He believes one must ignore the “noise” (narratives) and focus on the “signals” (numbers and ground reality). The energy requirements of AI are also exponential and will likely be met by fossil fuels. This involves confronting reality (“It is what it is”).
- Financial Stocks (NBFCs and Banks): Especially in the micro-lending space, this sector has been out of favor, presenting opportunities. Micro-lending is cyclical. During down cycles, strong companies with experience navigating previous cycles get “thrown out like the baby with the bathwater” or painted with the same brush as weaker players. Professor Bakshi looks at the numbers: provisioning is not always a loss, the interest rate spread is large enough to absorb potential losses, and strong capital adequacy ratios allow them to handle stress. The “peri-mutual” nature of the industry means that weaker players are eliminated during tough times, making the surviving strong companies even better positioned.
Bayes Rule and Overcoming Prejudices: Drawing on Thomas Bayes’ theorem, Professor Bakshi explains how to form views using base rates (general statistics, e.g., restaurant mortality rates are high - 9 out of 10 fail) and update them with specific information (e.g., the chef’s track record, location).
- Mistakes: Insensitivity to base rates (falling for a compelling story without considering the low success rate of the industry, e.g., perfumery, airlines). Oversensitivity to base rates (stereotyping, e.g., “all PSUs are bad,” “all commodity businesses are bad”). Value investors exploit Mr. Market’s prejudices, who often acts like a Bayesian but takes time to correct his initial mispricings based on evidence. The opportunity lies in recognizing exceptions that are being treated like the norm.
Behavioral Biases and Spirituality: Professor Bakshi stresses the importance of managing behavioral biases and draws parallels with spirituality and Stoic philosophy.
- Dealing with Charisma/Halo Effect: Encountering charismatic founders can lead to biased impressions. An antidote is to create a time gap between meeting someone and making a decision to reduce the influence of initial impressions. As he has gotten older, he prefers relying on data and transcripts over personal meetings to insulate himself from the “halo effect”. He also highlights the dangers of FOMO and being pressured into quick decisions, citing examples from the Covid-era venture market.
- Stoicism and Radical Acceptance: Influenced by Swami Chinmayananda’s Bhagavad Gita series and Stoic philosophers (Epictetus, Seneca, Marcus Aurelius), he incorporates concepts like radical acceptance, impermanence, detachment, equanimity (treating gains and losses the same), and focusing on duty/process over outcome. These timeless ideas are antidotes to biases like loss aversion and attachment.
- Signal-to-Noise Ratio: The modern world has a worsening signal-to-noise ratio due to social media and constant information flow, leading to short attention spans and agitation. Meditation and consciously slowing down thought processes (comparing the mind to a fast, muddy river vs. a slow, frozen one) are crucial for focusing on what truly matters in investing.
- Avoiding Stupidity: This is “far better than chasing genius”. Common portfolio-destroying mistakes include:
- Leverage: Borrowing money (loan against shares, F&O) is dangerous because it can force you to sell at the worst time during downturns due to margin calls, even if you bought good businesses. This creates an asset-liability mismatch.
- Day Trading: Highly speculative with a very low success rate (90%+ loss rate).
- Staying Wrong: Failing to acknowledge a mistake and clinging to a losing position due to anchoring, sunk cost fallacy, or the endowment effect. Being wrong is okay, staying wrong is not. He regrets being too slow to take corrective action in some situations.
Identifying Enduring Competitive Advantage: There is no certainty, only probabilities. Assess both quantitative (high ROC, margin trends, robustness indicators like diversification of plants, products, customers, vendors, balance sheet strength) and qualitative factors (why customers buy, what stops competitors, threats from adjacent or different industries). Continuously obsess over entry barriers and potential threats. Assess management quality (operating skills, capital allocation, integrity).
The Selling Decision: This is often harder than buying. Anti-dotes include:
- Ignoring Cost Basis: Don’t think about what you paid for the stock.
- Reframing as a Switch Decision: Instead of just asking “Should I sell?”, ask “Should I sell this to buy something else (either inside or outside the portfolio)?”. This makes the decision more objective by forcing a comparison with other opportunities that might be qualitatively better or significantly cheaper.
Learning and Growth: To become a good investor, one needs Accounting, Economics, and Psychology skills. These can be learned through self-study. Initial losses are valuable as they teach conservatism and the meaning of permanent capital loss, countering the overconfidence that can come from easy early gains. Successful students he has seen are low-profile, humble, and learning machines.
Reflections and Legacy: Professor Bakshi finds no point in dwelling on past regrets or what could have been done differently, viewing it as an opportunity cost. His goal is tranquility, noting that financial independence and health contribute to this, and it’s not solely about accumulating wealth. He sees the pursuit of money for its own sake as potentially addictive. He suggests that people realize the opportunity cost of spending time solely on wealth accumulation versus time with loved ones as they get older. The most underrated skill in investing is a peaceful mind, silence, and detachment, helping one avoid interfering with the power of compound interest. Markets constantly present temptations, and getting caught once in unethical or illegal activities can lead to ruin.
India Opportunity and Risks: While acknowledging the general optimism about India’s economic future, he highlights the significant, though low-probability, geopolitical risk posed by troublesome neighbours as a serious potential threat to India’s long-term story. Dealing with this risk effectively is crucial. Despite this, he believes India is potentially the best place to be if these risks can be managed.
Underrated skills: Peaceful mind, detachment, acknowledgement of mean reversion, moderate expectations, frugal living, avoiding extrapolation, avoiding leverage, contribution of luck in results, patience
Recommended Books: He typically recommends Warren Buffet’s letters, Peter Lynch’s One Up On Wall Street, and Philip Fisher’s Common Stocks and Uncommon Profits.
