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Thoughts on business risk

By Rohit Chauhan
In Investing Philosophy, Uncategorized
December 24, 2005
3 Min read
2 comments
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There are several business models which are seem to be inherently more risky and then there are some businesses which may not be risky to begin with, but changes in industry dynamics can make them risky for some time.

The indian pharma industry seems (atleast to me) to be one such industry. This industry is one of the few industries which is in the process to globalizing. A few years back companies like ranbaxy, Dr reddy’s lab etc got into the mode of releasing generics of blockbuster drugs which were going off patents. I remember distinctly that some of these companies were selling at fairly high PE. The analyst’s could see only a bright future and market was pricing accordingly. To be fair, there were murmurs of litigation risks etc, but somehow that was not visible in the price (with PE of 40 and more).

Later some of these companies had high profile clashes with pharma giants and lost some of the law suits. As a result the stock crashed when the expected payoffs did not materialise. I would look at this strategy of the pharma companies akin to bets in a casino, but where the odds in your favor. What I mean is that the expected payoff is positive in the companies favor, but often some of these bets could fail. So if the market values these companies as if all the bets are going to succeed, then there is a distinct over-valuation. But at the same time, every time a bet fails, if the market prices the company based on the latest failure, then there could be underpricing happening.

The problem (for me only) with the above business model is that I am not able to project the cash flow for such companies as I am not competent to evaluate the odds of success for such bets (investor who can could and should profit from it).

The business risk in the other globalizing star ‘IT services’ seems to be lower as these companies have used mainly labor arbitrage in the initial phases which is a lower risk strategy. However the market recognises that and has bid the stock prices up and so we have a lot of stock related investment risk.

I was have started analysing the textile industry recently. This industry seems to be globalising with the quotas gone. My initial thoughts on the business risk are

  • execution risk for some companies. Not all managements have the capability to manage ‘hyper’ (50%+) growth. Look at arvind mills track record in mid to late 90’s. They invested heavily in denim using debt. The denim cycle turned south and this company was left saddled with huge debt

  • Commodity nature of the product could result in pricing pressure on an ongoing basis

  • Limited leverage with customers – Being a supplier to one of the major retailers will constantly expose these companies to pricing pressure and stiff competiton

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Warren Buffett on Benjamin Graham

By Rohit Chauhan
In Uncategorized, Warren buffett
December 19, 2005
2 Min read
4 comments
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Found the following post on motley fool. I am waiting eagerly for the complete transcript of the Q&A though (emphasis mine)

I recently had the pleasure of taking a large group of students to Omaha for a Q&A with Buffett. When available, I’ll post the results of that Q&A if there is any interest here. In the meantime, I thought I’d mention my most memorable take-away from that meeting.A student noted that Buffett has been a much more successful investor than Graham, and yet Buffett attributes much of his success to Graham, why is that?For the first time, I heard Buffett address this issue head on. Buffett said that it’s true, Graham never got really rich from investing. Ben was much more interested in ideas than in making money. However, the lessons Ben taught are very profitable (in order):1. Stocks represent part ownership in the business. Before Ben, Warren charted prices and did lots of other silly stuff. Ben’s perspective was eye-opening.2. The concept of Mr. Market is vital. The market is very efficient, but not perfectly efficient–and that difference can make you very, very rich. At any point in time, the market price is usually, but not always, appropriate. An intelligent investor is one who can tell the difference between the current market price for a stock and a resonable interpretation of what that part of the business is really worth.3. The margin of safety concept is also vital. Once an intelligent investor discerns the difference between the current market price for a stock and a resonable interpretation of what that part of the business is really worth, it becomes important to build in an appropriate margin of safety.These lessons are Graham’s most important contribution to Buffett and to you and me. Graham’s sensible perspective, combined with Phil Fisher’s (and T. Rowe Price’s) insights on wonderful companies, has made all the difference for Buffett. If we are paying attention, they can make all the difference for us too.

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My investing philosophy

By Rohit Chauhan
In Investment process, Uncategorized
December 17, 2005
3 Min read
3 comments
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I think it is extremely important to have well defined investing philosophy to guide one’s decisions and to also to keep your head when there is too much fear or greed in the market.

With the Indian market touching new highs everyday, resisting the urge to get on the bandwagon is fairly important. I have had a loosely defined approach with which I have become comfortable both in terms of the risk and the return and most importantly I am able to sleep soundly in the night.

So here goes my personal investing philosophy (in no specific order)

  1. Invest in companies with sustainable competitive advantage in my own circle of competence with a time horizon of 3-5 years.

  2. Invest in companies where the risk reward ratio is atleast 3:1 in my favor and I have a ‘variant perception’ from the market.

  3. Avoid investing based on any macro-economic point of view or short term opinion (mine or someone else) of the market

  4. Try to beat the market by 5% over a period of 10 years and lowest possible risk (the key word being try)

  5. Avoid loosing money

Thoughts behind each point

  1. I feel comfortable investing in a company whose business is simple to understand and preferably will increase its intrinsic value over a period of time. This enable me to practise a buy and hold philosophy

  2. I prefer 3:1 odds in my favour and a 40-50% discount from conservatively calculated intrinsic value as it enable me to get an average return of 18% per annum

  3. I have avoided investing based on macro-economic point of view or any short term outlook as I am not good at it and consider most of it as noise to be avoided

  4. A return of 5% over the market give translate roughly into 17-18% per annum. Not exactly a return which would get me into investing hall of fame, but over a long period of time it is good for me as it comes with low risk

  5. Point 5 has meant that I have passed a lot of opportunities which looked good, but were not obvious slam dunks. As a result I have been guilty of omission than commision (though I have had my share of duds)

So how has above philosophy worked for me. I would say pretty well, because I think I have been able to achieve more than my targeted returns with very low risk and most importantly, have been able to sleep well.

Please feel free to share your investing philosophy

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One way of looking at market valuation ?

By Rohit Chauhan
In Market analysis, Uncategorized
December 14, 2005
3 Min read
2 comments
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I have followed a thought process (and here) in terms of looking at market valuation in terms of PE bands. So if the market is below a PE of 12 or below, it likely to be undervalued (odds are favorable for an investor – to the tune of 7:1 or better). At the same time if the PE is more than 20, the market is moving towards overvaluation (unless there is a recession in the economy and earnings are really depressed) and the odds are against an investor (1:3 or worse). However, I found it difficult to form a firm opinion between the above PE levels. The market is typically between these two levels 60-70 % of times and as result I am inactive and not buying an ETF or Index funds. However if the market drops below a PE of 12 or below, I usually start buying actively and if the market goes above a PE of 20, I start a slow liquidation.

I don’t use the above approach to individual stocks, where it is possible for me to have a better idea on whether the stock is over or undervalued (provided the stock is in my circle of competence).

I was pleasently surprised to find the following reply from Warren buffett in his Q&A at Wharton.

I would suggest downloading the Q&A (pdf) and going through the complete transcript for other nuggets of wisdom from buffett.



Q: You made an argument for 7% returns over the next decade in Fortune. Given that (1) profit margins are at least 30% above historical averages, (2) the ratio of prices/GDP is at least 25% above historical averages, and (3) interest rates are ~25% below historical averages, assuming mean reversion, wouldn’t one conclude that while economic earnings growth plus dividends may be 7%, that we are at an unsustainable valuation plateau?


A: We are near the high-end of the valuation band, but not really at an extreme. I have commented on the market 4 or 5 times in Forbes interviews previously (1969, 1974, 1981, and 1977 in Fortune). Most of you can say if something is overvalued or undervalued, you can spot the occasional extreme cases.
There is a big band of valuation and the idea is to calibrate extremes. When I look at a business, I look for people with passion. I can recognize a 98 or a 6, not a 63 (emphasis mine). This rule is good enough in life and investment. You refer to my 2001 article, but returns have not exceeded 7%, so I guess that this is not that precise of a band.


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