Its been a whole year since I created this thread. I wanted to share some common learnings from past 1 year. Threads which cut across multiple companies, books, experiences. Will try to keep it brief.
- Predicting nifty levels and what broader markets will do is an exercise in futility. Nobody can do it consistently. This is because there are too many random variables (probabilistic outcomes) which control the level of nifty including but not limited to: investors ease of access to money, federal bank action across the world, profitability of cos, demand, supply, extent of formalisation of economies, expectations of aforementioned factors and very broadly, the extent of innovation coming into the market (eg: listing of zomato, nykaa, policy bazaar will certainly increase market levels in the interim). The predictions tell us more about the predictor than they do about the underlying.
- If the volatility of equity class scares the investor, there are a few different courses of action available to the investor: buy some hedges (which only serve to smooth the equity ride. Net net you ideally (if options market is efficient) should neither make nor lose money)), or control level of exposure to the market. In last month i was scared by the valuation of my portfolio so i decided to reduce the level of SIP i do each month, working to generate some cash. A couple of bad Q results however have meant that overall PF valuations are starting to look reasonable again and possibly will continue to become more reasonable in next Q (will track this closely).
- Companies trading at high valuations have high expectations embedded in the price. This means that any quarterly biz volatility will result in severe derating. Why? I think of the investment class of each equity instrument as a layered cake. Depth of the cake shows the depth of the research done by investor to buy the co. On the very top are the intra-day positional and momentum traders. Below that are Technofunda traders/investors and people who might be tracking only financial statements (QoQ YoY growth). Below that might be people who read research reports and 2nd hand material. Below that are people who probably started reading latest concall and Investor presentation. Below that are investors who have read all or most or many concalls and annual reports of the company and its competitors, understand industry structure well and go above and beyond investor material by doing scuttlebutt and research into the unit products of the company (for pharma/chem it means EC filings ANDA and DMF tracking etc). Conviction also increases as one goes down the layered cake. The cake unravels itself at 1st sign of trouble. Fear becomes a self-reinforcing loop and LC cause more LC as one’s borrowed conviction vaporises in the absence of deep fundamental research. 1Q of bad earnings, 20-30% drop. 2Q of bad earnings, 40% drop. Neuland labs is best example of this. Will come to that later too.
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In trying to generate outsized returns, Valuations matter deeply. Perhaps the current best performing company i own is RACL Geartech. A dull drab and boring biz which makes gears. No platforms. No API. No Chemicals. In fact it sits inside an industry which was itself facing headwinds when covid started. And yet, RACL has been an almost 8 bagger for me since my initial buying. Why? Because, it turns out, valuations matter. More so if you can find a business which seems to have some durable competitive advantages. A biz with industry leading operating margins of 20%, ROCE of 27%, supplying to all luxury
, high end 
(and now some 
) of the world, co-developing products with clients growing topline at 15% while industry was stagnant or shrinking was available at a grand total 5 p/e because nobody wanted to own microcaps. Is this a travesty or not? I think it is. Now, granted that some of the granular details about biz were not known when i 1st invested, which is also why my conviction was limited. Rality is stochastic/probabilistic and so was my position size limited (what if my understanding has turned out to be incomplete?) it was my largest microcap investment, but not my largest capital deployment. It still isnt (by a long shot). Earnings grew 40% in last year. Return was 8x. So, definitely starting valuations matter. As warren Buffett says, It needs to hit you on the head with a 4x4 plank. You dont need to do DCF when such an opportunity presents itself. - Numbers and narrative need to align for rerating to happen. Valuations persist as long as numbers persist: So many examples to give here. Saregama, Vaibhav Global, RACL, Laurus, IDFC first (to some extent). Right now Neuland is a counterexample because currently investors that are in panic selling mode do not seem to think numbers and narratives align. But what is also fascinating to see is that my layered cake model seems to explain some timewise corrections as well. VGL is a great franchise with strong earnings power (David) taking away market share from a Goliath (Qurate) 20x its size consistently every year little by little. However, post pandemic, their sales growth accelerated to 25% topline. Will it slow down? I think that concern is very genuine and it is reflecting in market price. Hasnt moved a bit since last 5 months. This includes 2 Quarters of earnings growing at > 30%. From 60x earnings it has come down to 40x earnings. As people with higher earning growth expectations sell, people who are alright with 25% earnings growth buy in and stock doesnt move (as long as buyers and sellers balance). IMO until all people who had earnings growth expectations of 40%+ sell out, it will undergo timewise correction. After which due to imbalance i expect it to start performing again. Key take-away: time-wise correction & thus better valuations despite great earnings performance due to imbalance in expectations and reality. Reasoning along similar lines, i fully expect a correction in saregama stock (timewise or price wise) when they start doing more content acquisition and low margin carvaan sales pick up with marketting spends (as economy normalizes post covid). There is a set of investors which is projecting saregamas profits and costs into the future without going deeper into reasons for the said profits. They will be unpleasantly surprised, and the panic loop will repeat.
- To sell or not to sell. That is the question: When pf companies like IDFCF, neuland, strides show poor quarterly numbers, an investor is faced with a question. An important question at that. Do i sell, or do i not sell. How does one answer that? Why did i chose to hold 1st two (with intention to buy more at the point of high pessimism) and sell the last one? There are several factors but let us tease them apart. (i) Admittedly, my conviction was higher for IDFCF and neuland to begin with. My investment in strides was despite knowing about commodity nature of large part of their biz (regulated market) and was due to stelis stake that i was expecting to get on demerger. (ii) Investor has to figure out to what extent investment thesis is playing out and to what extent the poor results are optical/temporary in nature compared to the earnings power of the biz. Both in IDFCF’s and neuland’s case, i am convinced my original investment thesis is in tact. If anything, investment thesis has been strengthened. Why? IDFCF has practically confirmed something i had modelled and predicted many months ago in january which is that they are targetting 2% credit losses with 9% incremental NIMs. Do you know who else has 9% NIM 2.5% credit loss combination? Bajaj finance. Most investors go by narratives, not numbers. Right now, narrative is being controlled by price which is itself controlled by short term/temporary pain. Im glad. Will load up, when time is right. The VI exposure is also a temporary blip, if it does happen. Any informed IDFCF bank investor already knew about it (when IDFCF price was at 60 rs VI was equally unhealthy). In Neuland’s case, multiple temp headwinds at same time. Scaling up NCE chemistries like deuteration and peptides is crazy crazy hard. Very few companies can do it, and will do it. Concentrated profit pools. Investment thesis is in tact. Expect this to happen in next 3 years. Not overnight or next Q. In mean while need to judge on medium term growth and profitability. 20% EBITDA has been hard for them, 15% topline growth they are able to meet. As NCE CDMO increases i do expect higher margins. Destocking is an industry wide phenomenon. Have seen most API players degrow or show flat growth. Neuland exists inside of an industry. Temporary headwinds will impact. Does it change investment thesis? No. I can answer that confidently because i did deep research and have conviction regarding their durable competitive advantages.
- Some mistakes that i have learned from: Cant say the same about strides. Most biz is commodity. Stelis is great but now there are clouds over whether strides investors will get any ownership directly or only some appreciation in form of holdco discount affected valuations of strides. I was too quick to jump the gun with investment here. I should have waited for more clarity regarding precise nature of stelis listing. Lesson learned. Other mistakes: garware hi tech films. Great biz, competitve advantages, growth visibility. Then what is the problem? Promoter unwillingness to share profits with minority shareholders. This sort of co deserves much higher valuations, and it would get it, if only promoter were more shareholder friendly. Now in the craziness of a bull market it could transiently achieve such said high valuations but if i am fearful about derating all the time, is it worth investing if it doesnt let me sleep peacefully at night? I dont think it is.
- Discovery, the powerful tool of rerating: Many stocks/companies are simply under-researched and not in favor in the market. When their discovery happens (due to any specific reason) then rerating ensues ferociously. So many examples but best ones i can think of: angel, pix, racl, sastasundar. Broking is a cyclical and everybody agrees with it. However, if a traditional broker becomes digital broker and digital broker then seeks to become leading fintech provider, that is too juicy a stock to miss out on. Most investors (including institutional ones) would feel some degree of FOMO in my humble opinion to not own such a transformational company. Despite price moving up 100% before my buying i took a large position because the valuations were still cheap. it went from being very very cheap to cheap. I still had a margin of safety and so i bought. Position is up 3x since i 1st bought. And IMO as long as bull market lasts, best is yet to come. Angel is simply a leveraged play on broader equity markets doing well. In mean while if they can diversify cashflows through distribution and other revenue, some of rerating might be permanent. Pix. Another great example of dull, drab and boring biz making rubber bands (anyone who reads this probably already fell asleep). but as more investors discover the anti-fragility of the biz model, the concentrated profit pool due to industry structure becomes more widely known, the critical nature but low cost of product to end industry becomes widely known, the global and national tailwinds supporting the industry become widely acknowledged, rerating is only a matter of time. Have already written on racl. Sastasundar is a classic example of a co which 99% investors would avoid just by looking at its name. What a funny name. Cant stand in front of the PE might of Pharmeasy (what a wonderful name! Making pharm easy for users). If only biz were run based on attractiveness of names. An investor willing to dive deeper and do scuttlebutt would understand and acknowledge the hidden power of the franchise. The competitive edge SS has over its hyperscaling competitors who dont seem to care about customer experience at all. But, very few investors care about the real intangible competitive advantages. Many investors look for a dynamic english educated manager who speaks the language of the PE investors and attracts them with complex terms. The tailwinds the industry facing and the ‘discovery’ of a listed e-pharmacy is alone responsible for the 50-60% rerating which has happened in last few months or so. I wonder to what extent rerating would happen once investors discover and acknowledge the competitive advantages of SS’s business model.
- Selling on overvaluation, when do i do it?: Well certainly not always. I still hold saregama and vaibhav global despite valuations being out of whack with growth and profitability. But, I did sell polymed and sequent due to overvaluation. Why? What’s the difference? Well, IMO a 15% bottomline growth deserves a very different valuation than a 25% bottomline growth. Also, both vaibhav global and saregama provide diversity to cashflows of my portfolio which are very unique and difficult to replicate. Both also enjoy higher competitive advantages than polymed (my biased view). Not higher than sequent scientific. But would i be happy paying 70-80 p/e for a biz growing at 15% bottomline? I am not happy to do that. If both fall 50% overnight, i’d be a buyer.
- Reality is probabilistic, how do i hedge against it: Despite our best efforts all of us make mistakes and misallocations. options only smooth equity return, do not take away risk of equity ownership (co you own can blow up its biz performance). One word: diversification. But, not by owning too many businesses. Because it is focus and concentration that builds wealth. Also there is the practical problem of tracking more than 20 businesses as deeply as I had mentioned. At the same time, 50% allocation to 1 sector? No, thanks. Not for me. Key question is: diversification of what? Diversification of cashflows generated by biz. I try to keep a Good mix of exports and domestic focussed biz. I try to maintain a Good mix of all sectors. Businesses that lie at the conjunction of multiple sectors are great because it makes it easier to pivot. SS is into epharmacy. If the sector gets a body blow and they simply can’t operate on that, I wouldn’t be surprised to see a pivot. I do want to own tech, which is the super mega trend of our lives. A secular growth story playing out globally. But im not a tech investor. Why let myself be defined by such labels? Nobody can foresee the future. But if i can find a group of businesses which are highly uncorrelated at a business level and well diversified in terms of where they make money from (medicine, consumers, jewellery, food, cars, music, all of above), then I am well protected against downside risks. This is what I alluded to when I talked about Vaibhav global and saregama being unique niche businesses that provide diversification at cashflow levels to the portfolio. The threshold to replace them, then, also has to be high. Tolerance for overvaluation also has to be high. Because we need to balance the upside (returns) with the downside (risk in terms of portfolio cashflows coming from a small group of companies with correlated cashflows)
I have more to say but in interest of length of post, I end here.
Disc: invested, biased in most biz stated above. Not a buy or sell reco.