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There is generally no shortage of recommendations, tips, or get rich – schemes which are pedelled to the general public. You will notice that the number of such ‘schemes’ (for want of better word) increase almost proportionately with the rise in the corresponding asset or the market. So if there is bull market in gold, you will find more of such tips for the gold market. If the stock market is up, then you will get such schemes for the stock market.

Just think about it, how many recommendations or tips did you see for gold in 1999 (gold was 3900 at that time) or for the stock market in 2003.

And now gold is being touted as an investment and so are a lot of low grade stocks. Mutual funds who are supposed to be for the small investors are no better. Try to check on the number on new launches in the last one year versus 2003. I don’t blame the industry for more launches now, because the subscription would be low if the fund gets launched during the bear market. What irritates me that these funds play on your greed. Now you can argue that if one is greedy then one deserves to be punished for it (well , I definitely was for all the IT funds I bought in 2000). But is the behaviour of the mutual funds not that of a drug dealer who supplies the drug to an addict (rather than a doctor or counseller who prevents it)

So what is the antidote to all of the above. The starting point of this post was this comment from abhijeet . If you know that there are people trying to part you from your money, either by preying on your greed or fear or through fraud, how does one protect himself? Here is what I think

No. 1 protection is knowledge. Learn how to invest. I have mad
e it a point never to invest money in any opportunity if I don’t know what are the risks in it (rewards will take care of itself). Now, I have lost a number of opportunities by that, but have also avoided severe losses.

In my case, I tend to remember the losses far more (I think my pain for loss is far more than average) than an average person. It is not the loss of money which has hurt (that hurts too) as much as loss of faith on my own skills. In cases where I have made a bad decision, I tend to remember that very long, even if I may not have lost as much.

As a result, I am extremely cautious in making my investment. That is not same as avoiding it though. The difference is that I try to do as much homework as possible on an opportunity. I try not to make a decision immediately if I find a good opportunity. I make my notes and wait for a couple of days. Then when the intial excitement of finding an undervalued stock is gone, I tend to be more rational.

Finally, I never go any one recommendation. I read a lot of broker reports, blogs etc. but never accept any recommendations on face value. So if I find a recommendation, I try to analyse it on my own and reach my own conclusions.

In some areas which are out of my circle of competence or interest, I don’t even bother. They include gold, commodities etc. Does not mean that one cannot make money on them, just that I am not competent to do it.

Finally, my thinking is derieved from this quote from warren buffett

‘Risk is not knowing what you are doing’

ps: by the same logic, please do not base your decision on stocks which I post here.

My decision to sell L&T in 2003 (after holding for 4 years) has been my worst investment decision till date. Although my cost basis was 190 odd (pre-divesture) and I sold at 230 odd (again pre-divesture) and did not lose money on it, I consider it to be one of my worst decisions because of the following reasons

1. The stock has since then become a 10 bagger (sells at around 2250 without considering the value of cemex)
2. I sold off because I became exasparated with the management. Between 2001 and 2003, they would constantly pay lip service to divesting the cement division and would then drag their feet on it. What I failed to realise at that time was that the Kumarmangalam birla group would be able to force the management to divest the business eventually.
3. Did not appreciate the importance of the business cycle. The E&C sector was in doldrums at that time and as a result L&T (E&C) division profits were depressed. The E&C sector turned around big time after 2003 and every E&C company has benefited since then
4. Did not do the sum of parts analysis – basically that the sum of value of the various L&T divisions was more than the complete entity.

In the end, my regret is not that I missed a 10 bagger. What clearly pricks me is that my analysis was sloppy and I did not evaluate all the factors clearly. I was looking at the company with a rear mirror view (the Margins and the ROE were poor then and I expected it to continue).

However, I have tried to learn something from this disaster. So here goes

• understand the sector dynamics when investing in a stock.
• Appreciate the importance of business cycle. Although predicting it is not critical, but a basic understanding is a must.
• Focus on sum of parts versus looking at a company as a whole, especially if the company has various different businesses.
• Have patience
• Try to avoid a rear mirror view.

Have you had such an experience?

As a value investor I have always been concerned about a value trap. A Value trap is a company, which remains cheap forever, and you are not able to make any money out of it.

Now a company can be a value trap for a variety of reasons, which can be

1.The company performance keeps deteriorating and as a result the intrinsic value keeps going down
2.The market just ignores the company and the sector because there is nothing exciting happening in that sector and most of the companies are hardly glamorous
3.Management action can result in a value trap too. The management keeps blowing away the excess cash into unprofitable diversification instead of returning it to the shareholders

So how does one avoid a value trap. I think this is a very important consideration of value investors especially if one is investing in ‘graham’ style bargains. A ‘Catalyst’ is something which one should look out for to avoid a value trap.

A catalyst can be any of the following

1.Likely management action such as buyback, bonus etc
2.Likely asset conversion opportunities such as LBO, de-merger, accquisitions (think L&T for an example of de-merger)
3.Likely shift in demand supply in favor of the company due to changes in the business cycle – steel and commodity companies in the last few years come to mind.
4.Regulatory changes – Banking comes to mind
5.Unexpected earnings increase
6.Finally time – However one should have a defined time horizon in which one would expect the investment to work out.

So when I look at value or deep value stock, I tend to look beyond the numbers. Is there a likely catalyst, which would unlock the value, or am I getting into a value trap? and how long will it take for the catalyst to be play out. That would define my expected returns too.

Ofcourse this concept of catalyst is not some original concept of mine. It is referred to frequently by Mario gabelli and Marty whitman.

I work in the tech industry and have always been fascinated by technology and the role it is playing in improving our lives (definitely mine – cannot think of life without broadband, internet, e-mail, google etc).

Back in 2000, during the tech bubble, like others I got swept by the internet and technology mania and went ahead in invested in technology stocks. The basic logic of my analysis was correct, but I got the valuation wrong (overpaid for the optimism). After promptly losing money and later reading munger and buffett’s thoughts on technology, I have changed my approach to technology.

I am by no means a techno-phobe. I spend time reading tech blogs, looking and trying to understand changes happening in technology and how it seems to be impacting various businesses such as newspapers, media, advertising etc. But it is diffcult to realistically forecast a technology business out for several years. It is more so for technology businesses as valuations of most of these companies is high and to make any money, one has to be able to forecast the cash flows for 5 years or more.

Over time based on what I read and based on my experience, I now prefer companies which are predictable than which will have the highest growth. My own experience has been that markets tend to pay more for growth than predictability ( FMCG v/s IT services stock ?)

At the same time the decision to invest in tech stocks also boils down to one’s investing philosophy. I have tend to have a focussed portfolio with a few names and want to hold for 3-5 years with low maintenance (quarter or annual followup). As a result it is difficult for me to hold technology stocks as it requires too much effort to follow them.

As an aside I work in IT services. So my professional career is tied to the Tech industry. The last thing I want to do is put all my eggs in the same basket. That is not the typical way of looking at diversification. But for me the income stream through my career and my stock portfolio need to diversified sufficiently. Who wants to be lose a job and also see the stock portfolio crash at the same time, because the industry hit a roadblock !!

I keeping reading this debate on whether long term buy and hold is a smart strategy or is it a fad followed by buffett followers.

It would seem to me that such a discussion clearly shows that the person debating it really does not get the core idea of the approach. Long term buy and hold is not long term buy and forget. There is no such business which one can buy and forget. When there is such intense competition, one has to follow or track the company in which one is invested.

My typical approach to understand the industry and then the company in detail. If I am comfortable with the company and the industry and if the valuation is compelling, I tend to slot the company into one of the three buckets

Type 3 companies are value stocks (graham style) where the intrinsic value of the business is flat or at best increasing very slowly. I hold such companies till they come within 90% of my estimate of intrinsic value and then I sell them. I do not see a benefit of holding such companies too long if the company is selling close to the intrinsic value which is turn is flat or worse, shrinking

The other end of the spectrum are my type 1 kind of companies. These are dominant companies with strong competitive advantages and their intrinsic value is increasing at decent pace. Such companies are more of the buy and hold ‘longer’ type of companies for me. I typically read the quaterly updates for these companies and try to check if their competitive strenghts are intact and they would continue to increase their moats as time passes. I have found that selling such companies when they touch their intrinsic value (atleast my conservative estimates) has not been a good idea. Most of these companies do well over time and their intrinsic value keeps increasing. So even if the company is moderately overvalued, then I would tend to hold on. Ofcourse if the company is wildly overvalued, then I would sell the stock.

The type 2 companies are between 1 and 3. This is grey area where majority of my picks lie. Most of these companies have decent comptetive advantages and their intrinsic value increases erratically. So these kind of companies require more attention and at the end of each year, I go over my thesis and try to re-think whether I should hold onto the stock or sell it , especially if it is selling close to the intrinsic value.

All of the above is a decent amount of work. Which is why I don’t hold more than 10-12 stocks in my portfolio. But finally I think there is no buy and forget kind of stock. Ofcourse I don’t follow the stock on daily or weekly basis. My follow up is more quaterly or annual.