CategoryInvestment process

I have been reading a book ‘No bull’ by Micheal steinhardt. He was hedge fund manager and was able to deliver around 30% returns for almost 30+ years.

I found his concept of variant perception useful. According to micheal, every investment idea should be explainable in 2 minutes and four points

• The idea
• The consensus view around the idea
• The variant perception of the analyst
• The trigger event which would unlock the value

For example, if there is a solid growth company which is expected by the market to grow at 20%, and as an investor my expectations are close to the same number, then I am not going to make more than the cost of equity if the actual numbers meet the expectations (for more detailed understanding of how to evaluate market expectation read the book Expectations investing)

I have used this concept of variant perception in some form although not exactly in the same manner as explained by micheal. Let me give an example

Marico in the year 2003-2004 was selling at around 10-12 time trailing earnings. A simple DCF would easily show that the market was discounting 2-3 years of competitive advantage period -CAP (for detailed understanding of CAP, please read this article) with growth in low teens. Now if one looks at the brands, the history of their New products and their distribution network and management,it is easy to see that this company could grow in low teens for considerably more than the market implied CAP of 2-3 years.

So basically my variant perception was not centred around the growth (which is the the usual variant perception generally given by most of the analysts) but around the CAP of the company.

Marico now sells for a much higher PE and the growth was also much higher than implied by the market (around 15% +).

To a certain extent, one can see the same kind variant perception being exploited by warren buffett, except that he is a genius at recognising such businesses with CAP much higher than implied by the market price (ex: coke, GIECO etc)

Most of us know the problem with simple stock screens such as one’s based on low P/E ratio, low P/B ratio etc. A lot of stocks which get filtered through the screens are typically companies with poor economics. I have tried to overcome this problem by building a screen which has the following additional screening criteria

• An ROCE/ROE of atleast 13% or more
• No loss during the past 5 years
• Above average growth over 5 years in NP
• D/E < 2

Adding the above stock screens has filtered out companies in the following industries (partial list below)

• auto components
• bank
• cement
• Chemical
• Shipping
• Fertiliser
• Shipping
• Paper
• Textile

I have started analysing one company at a time under each of the classification. Unfortunately the reason these companies have filtered out is either due to a cyclical uptick in the industry (cement, shipping, paper etc) or it is tier II company in the industry with high operating leverage and has seen a reduction in interest cost. Due these reasons , the recent PE, ROE etc of these companies is good, debt is down and these stocks look good.
My concern is how these companies would fare once the cycle turns downwards. Let me explain using the example of shipping industry which I am analysing currently.
The main companies in the shipping industry which have filtered out through the screen are

• mercator lines : High asset addition recently through debt which has resulted in high earnings and high ROE. The risk to the business is high if the business cycle reverses as the company may be unable to service its debt
• Varun shipping / Shreyas shipping: high operating leverage, high debt and high growth in earnings in recent times due to high shipping rates. Earnings risk is high due to operating leverage
• Essar shipping : High earnings due high shipping rates. Also ROE is high to asset revaluations. This stock looks interesting and worth investigating further.

I guess the stock screen is throwing up a lot of companies which may be statistically cheap but not really a value stock. So essentially I am not be able to come up with a list of companies which are great value. I guess it is to a certain extent an indication of the kind valuation levels existing in the current market (The same filter in 2003 gave much better companies). So I guess I will have go through the entire list and maybe at the end (the list has 100+ companies) come up with a few good stocks. It defintely not a waste of time because it helps me to understand more companies/ industries which could be helpful in the future

any suggestions on improving the above screens ?

I keep checking on bruce’s blog regularly. He is a frequent poster on fool.com and writes fairly well on topics related to investing. He has a post on mistakes he has made in the past.

The following comment resonated with me a lot. I have had the same experience on my mistakes and agree completely with what he says ( once bitten twice shy ??)

Which leads to ACLN. In hindsight, I probably lost more money in missed opportunities from a loss of confidence by making a mistake in ACLN than the money I actually lost in ACLN. And I think that’s a more important lesson. It was easy to learn how to avoid another ACLN. It was much harder to avoid seeing ACLNs everywhere I looked. As someone said about Barrons (Bearons): the bearish case always looks more intelligent and more responsible.If there’s anything for certain, I’ll continue to make mistakes. If Buffett keeps making mistakes even lately, what chance do I have? I believe the answer is to apply the methodology and rely on experience and do whatever is possible to have a higher batting average.


Bruce has also added a reading list to his blog. Definitely worth noting down the recommended books.

Buffet refers to the concept of moat or sustainable competitive advantage as one of the most critical factor in determining the returns for a long term investor (in addition to other criteria)

I have been reading porter’s book ‘on competition’ and trying to get a better understanding of how to evaluate a company’s competitive advantage for a long term investment.

The five forces model is very helpful in understanding the industry structure and kind of long term returns to expect in an industry. What i was able to ‘understand’ this time (have read the topic several times ) is that not all the factors are equally important and for an investor it is critical to asses which factors impact the industry and the company more and would influence the long term returns.

More important for a long term investor is to understand, how the five factors of competition will change and determine the future returns.

I am now trying the above exercise for some industries like FMCG/IT services / Banking etc . A good evaluation and insight into the trends would be far more useful that chasing some price targets or trying to predict the next quarter which in munger’s words would be ‘twaddle’