Value investor india

How to miss a 10 bagger

May 31, 2014

7 Min read

What is worse than losing 100% on a stock ? It’s missing a 10 bagger !

What’s worse than missing a 10 bagger ? It missing a 10 bagger which you identified and decided to take no action inspite of knowing about the company. Now you must be thinking – that’s quite dumb ! In a way it is, but as always the story is more nuanced than just being dumb.

So what’s the name of this mystery company ?

Let me give some more hints J ..I wrote about it in July 2010 when it was selling for around 80 Crs market cap. It now sells at around 1400 crores. That’s a 20 bagger excluding dividends during a period where the market has gone nowhere.

I won’t tease you any more ….the company name is Mayur uniquoters! See the post here.

Now I can assign this to bad luck and move on. However I have never operated this way – I want to dissect each failure – failure of losing money or failure missing out on a 10+ bagger.

How did I miss it?

I wrote about this company in July 2010 when it was a micro cap and started a small position in the company. I was comfortable with the financial performance of the company, but was concerned with a corporate governance issue – issue of warrants to the promoter at below market price, when the company did not really need the extra capital.

As the stock price rose, I lost interest in the company and sold my small position as I was not comfortable with the corporate governance issue. In hindsight, I do not fault myself for this decision – it was the right thing to do based on the facts known to me at that point

The downside of labeling

So where did I really go wrong? As I look back, I can attribute the failure to a label I attached to the company. I was not comfortable with the management and attached the label of ‘poor corporate governance’ to the company.

After I sold my position in 2010, I continued to track the company and could clearly see the good performance. Inspite of the facts, I refused to change the label and remain locked to an existing view although the management did not show any new governance issues.

First conclusion or confirmation bias

The other name for this locking is called the first conclusion bias (read here). Once I had reached a conclusion I refused to change it, inspite of evidence to the contrary. It is only after the evidence became too obvious to ignore that I have revisited my conclusion and realized the flaw in my thinking

The illusion of high valuation

If mayor uniquoters was an isolated example, it would have been comforting to ‘label’ it as an aberration and move on. However there are a few more examples (atleast ones which are obvious to me).

Let me give another example and the back story behind missing the multi-bagger

Hawkins cooker: This stock was pointed out to me in 2010 when the company was selling at a PE of around 15. The company was and is easy to understand, has great economics and a wonderful management. So if such a company was presented to me on a platter , why did I ignore it ? The single word for that is valuations – The Company was selling at a PE of 15+ which in my mind was expensive.

I started off my investing life with high quality companies such as asian paints and Pidilite selling at reasonable valuations (15-18 times earnings) and slowly graduated to graham style low PE stocks (the reverse of most people). Over time, I got locked into a mental model where I started equating a low PE with an attractively priced stock and a high PE with an expensive stock.

The above thought process holds true in isolation, but it is important to consider the PE ratio in context of business quality. A business with weak economics is a bad stock even if it has a low PE and an exceptional business with a moderately high PE can still be a great stock. I have been aware of this fact, but still had to relearn this important concept all over again

How to change your mind ?

It would be safe to assume that if you are presented ‘data’ which contradicts your assumptions, you will change your prior conclusions ? Atleast not in my case !

Let me point to two extreme example –

Ajanta pharma has been a multi-bagger since it was pointed out to me by a very smart investor – Hitesh. I still have the email in which he shared the idea with me in 2011. At that time, I was not comfortable with pharma companies and thought that I could not judge Ajanta’s future prospects accurately.

That’s a reasonable argument and can be a plausible reason, but for the fact that this idea was posted on the website – valuepickr by Hitesh and donald. This website is run by Donald Francis and it has a lot of good investors who write regularly on it. The good thing about this forum is that Donald, Hitesh and ayush have encouraged a long term investing mindset with a focus on the process of investing. I am not praising the website due to any vested interest (I don’t have any), but think that one should read through the analysis on some of the picks made by the team

I personally follow this site and occasionally post on it too. Ajanta pharma and Mayur uniquoters are two such ideas which were posted on this site and analyzed in a lot detail. I have been following these companies over the last few years and inspite of over whelming evidence did not take the plunge

So much for changing my mind based on evidence !

How to change ?

The first step in fixing a blind spot is recognizing one. Now that I have recognized multiple biases in my case, I have started focusing on the following points in my investment process

–          Do not equate a high PE with expensive. Analyze the business in detail and determine if the company can still double in 3 years at current or slightly lower valuations
–          Focus on quality before valuations
–          Constantly question my own conclusions. I have started doing this after each quarterly result – does the company match the original thesis (positive or negative)? Do I have access to some new non-quantitative information which should prompt me to revise my original thesis ?

I have already made changes in my stock picks in the recent past and the initial results are good. In summary I think there is a lot of value in analyzing the success of other people – not to be envious of them, but to reverse engineer it and improve your own process.

Ps: if you guys have some stock tips, do send it my way. I will have a more open mind on it now J
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Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

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Shortest investment book

By Rohit Chauhan

In General thoughts, Uncategorized

April 19, 2014

1 Min read

20 comments

1.    Save atleast 20% of what you earn

2.    Buy a term life insurance policy such that the policy value = 30-50 times annual expenses (add health insurance to this if required)

3.    Park 10-20% of savings annually in liquid deposits (Emergency fund or for down payment on a house)

4.    Invest 60-80 % of savings via SIP in an index fund or a basket of diversified mutual funds like HDFC equity.

The above is enough for 90% of the people to retire comfortably at the end of a 40 year working life. Anything beyond this just commentary !

So there you go – no need to listen to any broker , read this blog or any investing book J.

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Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

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Patient Wealth creation

By Rohit Chauhan

In Competitive advantage, Investment process, Uncategorized

April 5, 2014

7 Min read

8 comments

This is a commonly used, but rarely defined word. I am going to argue in this post that the sole purpose of investing is wealth creation.

What is wealth creation ?

Let’s take a numerical example. Let’s say you have 100 Rs. You can invest it in an FD at around 9-10%. At the end of 5 years, you will have around 161 Rs. We can call this the baseline level of return .

However putting money in a Bank FD is not a riskless transaction. If the inflation during this period turns out to be 11%, then you would have lost 5% of your buying power. On the other if we take the average inflation of the last 20 odd years, then the buying power would have risen by 15% over the same period.

Have you created wealth in the above case ? I would say yes, as you have been able to increase your buying power over the investing period, but not by much (15% at best on average).

Let’s say one were to invest in the stock market (via index funds) for a 5 year period. On average, the market has returned around 15-17% per annum over the last 20+ years. If you back out an inflation assumption of 7%, then the buying power would rise by 61% for the period. Now we are talking of some serious wealth creation !

However the above example has a catch – I spoke about an average return of 15-17%. The reality is that the stock market returns are lumpy and you can have a period of 2003-08 of 30%+ returns and then a period of 2% returns for the next 6 years (2008-2013). So in this case, one is talking of wealth creation with an added level of risk.

The above examples are quite obvious , but ignored by many. We need to concentrate on post tax, post inflation returns to evaluate the wealth creation potential of an investment option. If you have a higher buying power after taxes and inflation, then you have created wealth.

The aspect of time
I arbitrarily considered a time period of 5 years in my example. What is the correct period? 1 month, 1 year or 20 years?

I would argue that the time period for wealth creation should be driven by your personal goals. Are you saving (and creating wealth) for the purpose of buying a house or retirement? If that is the case, then the period should be upwards of 10 years.

Let’s put the above two point together – One needs to make a level of post tax, post inflation returns over the investment horizon (10 years +) such that you can meet your personal goals. Why else would you put your money at risk?

Now there a lot of people who invest for the thrill of it (for 100% return in days !!) or to boast of their investing prowess to their friends and impress the other sex , mostly women – who from my personal experience, don’t care about such silly things J ).

It is fine to put your money in the stock market to feel macho about yourself – but let’s not call that investing. Bungee jumping off a cliff is also done for thrills, but no one calls its investing !

Following the logic

If you agree that the purpose of investing is wealth creation over a long period of time, it is important not only to earn high returns, but to also do it consistently over a period of time. There is no point earning 30%+ returns for four years and then losing 50% in the 5^th(Which will translate into an 8% annual return)

Why is consistency important ? If you can earn 15% consistently for 20 years, you will have 16 times your starting capital and 40 times if the rate rises to 20% per annum. This is simply the magic of compounding.

Now If you shift your focus from high returns (to feel good or boast about it) to consistent returns (to create maximum wealth), the investing approach changes.

Implication of consistent returns

If you are looking for above average, but consistent returns for the long run what should one look for ? If you are looking at earning a 15-20% return over a 10-20 year period , I would suggest looking for companies which are earning this kind of return on capital now and have the capability to do so for a long period of time.

If you can find a company which has a sustainable competitive advantage (sustainable being the key) or a deep and wide moat, then it is likely to maintain its current high return on capital. If you buy such a company at a reasonable price (around the median PE value for the company), the results are likely to be good over time.

Let’s look at an example here – This is a current holding for me and not a stock tip. The name is Crisil.

You can read the analysis here.
Following is a table of price, and annual return/ CAGR for the last 10 years

As you can see, even if you purchased the company on 31^stDecember each year (blindly without worry about valuation), you would have done well. This result boils down to the following reason

– The company has a wide and deep moat in the ratings industry due to government mandated entry barriers (none can just start a ratings agency), Buyer power (Companies have to pay to get their debt rated and the cost is usually a small percentage of the debt) and lack of substitutes (even banks insist on company ratings now based on RBI directive).
– The deep and wide moat has enabled the company to maintain a high return on capital of 50%+ for the last 10 years. The company has been able to re-invest a small portion of its profits to fund its growth and has returned the excess capital to shareholders via dividends and buybacks.

A strong competitive position and good management with rational capital allocation approach has resulted in a very good result for the shareholders.

The catch
There always a catch in investing – nothing is as easy as it looks. For starters, this approach requires a huge dose of patience.

How many active investors (me included) would like to select a stock once in a few years and then do absolutely nothing for a long period of time ? In every other profession, progress is measured by level of activity – except investing, where sometimes doing nothing is much better.

The other catch is that this approach is very boring. You find a few companies like crisil and then spend maybe 1 hr each quarter and a few hours every year end reviewing the progress. If the company is still performing as it always has, you have no further work left. If you are a professional investor, what are you going to do with the rest of your time ??

The last catch is that this approach has a level of survivorship bias. If you select a wrong company or if the competitive advantage is lost during the holding period, then the returns are likely to be poor or even negative.

Returns over entertainment
Although this ‘rip van winkle’ approach makes a lot of sense, I am unlikely to follow it fully. I enjoy the process of investing, looking for new ideas and doing all kinds of experiments. At the same time, a major portion of my portfolio is slowly moving towards such long term ‘wealth creation’ ideas.

In the final analysis, investing should be about wealth creation and achieving your financial goals.

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A contingent stock

By Rohit Chauhan

In Investment ideas, Uncategorized

March 8, 2014

7 Min read

5 comments

A few disclosures – This is a borrowed idea. I will not use the word steal, as I got it from a friend J

This idea was published by Ayush on his blog (see here) and then he mentioned it to me via an email. I was intrigued by the extremely low valuation (which is not obvious) and some medium to long term triggers.

I started looking at the company in the month of December, and before I could create a full position, the stock price ran up. Inspite of the run up, the company is an interesting, though speculative opportunity.

Another disclaimer – I hold a small position in my personal portfolio, but as it is a speculative idea, I have not added it to my family or the model portfolio.

The company

The name of the Company is Selan exploration and it is an E&P (exploration and production) company. The company has five oilfields – Bakrol, Indrora, Lohar, Ognaj and Karjisan

As part of the NELP policy, the company has the rights to explore and develop these oil fields. The company was among the first private sector players to get the rights to do so and if successful in finding oil and gas reserves, they have to pay a certain level of royalty to the government. In addition, the entire production of the company is taken up by the government or PSU under the production sharing contracts

The E&P business

The basics of exploration and production are actually quite simple to understand – The government grants the license to explore and exploit a specific area which may be rich in hydrocarbons, under a specific contract. The company winning the contract then undertakes exploration of the area using various advanced technologies such as 3D seismic surveys and exploratory drilling to identify the size of the reserves and the best location to drill wells to exploit these reserves.

Once the reserves are delineated (identified), the company applies for the various clearances (such as environmental) which once approved, allows the company to drill production wells. Although the technology is quite advanced and allows a company to identify deposits accurately, it is not a precise science and hence a certain percentage of the wells may turn out to be dry wells (not enough oil in that particular location). These dry wells have to be abandoned and the cost has to be written off (similar to a product which fails in the market).

The productive wells, once online produce oil and gas which is transported via pipelines or other means to oil refineries.

The problems

Let’s start with the problems which have caused the stock price to stagnate over the last few years. That will also give us an idea of the medium and long term triggers for the company.

The company was granted the exploration rights in the 90s and has been able to increase the production from 62000 BOE in 2004 (barrel of oil equivalent) to roughly 2.82 Lac BOE in 2009. I described the process of license, survey, clearances and approvals to get to the final production stage of drilling the production wells and pumping out the oil.

As you see from the process, we have government involvement at each step and anything where the government is involved means lack of clarity and uncertain timelines.

As has happened for multiple sectors in the economy, the clearances for drilling production wells came to a halt in the last four years. Due to the nature of oil exploration and production, the current wells start getting exhausted in time and if you are not drilling new wells, the overall production starts dropping.

In case of Selan exploration, production dropped from 2.8Lac BOE in 2009 to 1.64 Lac BOE in 2013. The revenue dropped from 99 Crs to around 97 Crs in 2013 and the net profit was roughly the same (at around 45Crs)

A mumbo jumbo of terms

Before I get into what is the opportunity here, let’s talk about a few terms for the Oil and gas industry. For starters, barring Selan and Cairn (I), I don’t think the PSUs in this sector are worth considering as investments. These companies are run as piggybanks by the government to subsidize fuel in the country. It is debatable on how good that is for me as a citizen, but I am clear that it is a disaster for a shareholder.

If you want to understand how the industry works (without the chaos of government interventions), you may want to look at US and Canada based companies such as Chesapeake, Devon energy or Exxon Mobil. If you are looking at a pure play E&P Company, there are several small companies such as Novus energy or Jones energy.

Why bring up these non Indian companies? Any US or Canada based company has to declare several key parameters which help an investor to analyze an exploration company. Some of those parameters are

2P reserves (proved and probable reserves)

Operating netback per BOE : revenue minus cost

NPV10: DCF valuation of the reserves (revenue based)

EV/BOED: Enterprise value/ Barrel of oil equivalent in reserves (valuation measure)

Cost curves, EUR, Exploration cost and well IRR (for each field)

Current oil flow rate (BOED) to understand the current revenue levels

You can find the definitions easily by doing a Google search for these terms.

So which of this data is provided by Selan exploration? None!

Are they doing anything illegal? No, because I don’t think there are clear disclosure norms on the above for Oil and gas companies in India (none that I could find). In comparison, Cairn (I) has more disclosures and communication.

The thesis
In absence of this disclosure, why even bother and move on to something else? That is a valid point and hence I have called it a speculative bet as I am making it with minimal information.

What do we know here?

For starters, it seems that the company has 79.2 Million (7.9 Crore) BOE of reserves in two fields alone (Bakrol and Lohar). The company sells at around 1.2 dollar/ BOE (EV/2P) versus 5.5 for cairn (I). Comparable companies in the US/Canada sell at around 8-12 dollar/BOE. Of course the foreign companies are not comparable, due to a very different regulatory environment.

In addition to this valuation gap, we are not even considering the potential reserves in the other fields (which seem to be bigger than the ones in production). So we are talking of a situation where the market is valuing the company based on the current production rate (Which is suppressed due to lack of approvals) and is not giving any credit for its reserves.

The company is able to generate a pre-tax profit of around 70 dollars / BOE versus 10-25 Dollars for the US/ Canada companies. The huge difference is due to the fact that Selan produces mostly oil compared to oil and gas in case of other companies.

So the company is very cheap based on known reserves and is also quite profitable. In addition the company has spent close to 65 Crs in the last three years on exploration expense (remember the surveys to find the oil and gas reserves?). Once it starts getting the approvals, it can start drilling the wells and start pumping out money …sorry oil.

So why is this still speculative or contingent? It is contingent on the company receiving approvals – Which is seems to be getting recently based on the update in the latest quarterly report. These approvals are based on the whims and fancy of our government and one can never be sure what will the scenario be next year.

Why is it speculative – because there is so little disclosure and we are using the reserve numbers from a past annual report? We do not have any clear updates in the latest reports and so it is like driving with a foggy windshield window.

I have taken a small bet on the company to track the company and may buy or sell in the future based on new developments. As always, please do your homework and make your own decisions.

Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog

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