I wrote the following as part of my half yearly letter to subscribers. Hope you find it useful (Names of specific companies have been edited out )
Some of our positions are a bet on Long term trends. Let me describe a few
- Migration of manufacturing to India (CDMO, CRAMS, Higher exports etc.) – The underlying trend is migration of manufacturing, especially high value added to India. There are multiple drivers behind it such as the China + 1 approach by the importing countries, Comparative advantage of India in certain sectors and so on
- Change in Real estate cycle – Real estate has been in a downtrend for the last decade. This is a cyclical industry with long duration cycles. Once the upcycle begins, it tends to last for 5-7 years
- Re-start of the capex cycle/ Infra cycle – The Capex cycle peaked in 2008-09 and has been down since then. With rising demand and utilization, we should see capacity addition in the private sector.
- Financialization of savings – Indians are increasingly investing in financial products and moving away from hard assets such as gold and real estate.
- Formalization of the sector – We are seeing the formalization and consolidation of several sectors in the economy
There are some names which are repeated, and it is normal for an Industry to benefit from multiple trends at the same time. When this happens, it increases the tailwinds for the sector
There are a few factors to consider when investing in companies benefiting from long term trends
- Betting on the right management: Companies riding a trend have a long runway ahead of themselves. If the trend holds and management is capable, the company can compound value for a long time. Identifying the trend is easy, betting on the right management is much more difficult
- Optically expensive: Such companies appear expensive based on near term earnings. The reason is that the market is discounting a long period of above average compounding.
Case in point – HDFC bank and our own holding, Vinati organics. Vinati organics is up 50X since we first bought it in 2011. Our mistake was to look at the valuation in isolation and not in the context of the broader trend. As long as the trend holds and management is executing, one should hold the stock and be tolerant of higher valuations
- Boredom is the enemy: Unlike cyclical stocks, timing the purchase is not critical. Most of these trends last for a long time. Betting on the right management and holding through periods where the business keeps moving forward, but the stock price remains stagnant is the key
It is easy to overdo this trend-based investing and get carried away. However, the most common problem I have seen is investors, including me, lose patience during periods of slower growth even when the primary trend is active.
This has been the case with Vinati Organics where the stock has compounded at 40% CAGR but in spurts. The picture below shows the periods of stagnation
As the above example shows, a great long-term result does not mean absence of short-term pain
