Tag Archives: perception

Direxion Shares Exchange Traded Fund Trust Up 300% This Year As Gold Soars

The Direxion Daily Gold Miners Index Bull 3x Shares ETF (NYSEARCA: NUGT ) as on a high-powered flight on Thursday as it shot to an intraday trading high of $101.29. The ETF later settled with gains of 13.25% at $99.90 – by then, the market had already made its point, gold is on the rise and there’s not much you can do to stop its ascent. The yellow metal has been on a bullish ascent since Monday and Thursday marks the fourth straight session of gains. The reasons behind the rally in the bullion markets are not farfetched. High on the bullish factors supporting a rally in the yellow metal is the fact that the U.S. Federal Reserve did not raise interest rates in April and the first rate hike might not happen until June. The second reason for the rally was the fact that the Bank of Japan has surprised the global market by keeping its interest rate unchanged in sharp contrast to expectations that BOJ would retreat deeper into negative territory. Gold climbs for fourth straight session The decision of the fed to keep interest rates unchanged, its cautious stance, and the refusal of the BOJ to weaken the Yen has forced the U.S. dollar to fall lower. A weak dollar often boosts the prospects of gold and the yellow metal is milking all the gains in the greenback for what it is worth. On Thursday, spot gold climbed 1.6% to settle at $1,266.50 an ounce and gold for June delivery gained 1.6% to close at $1.266.50 an ounce. In the year-to-date period, the yellow metal has gained 17.14% to erase the losses that it recorded in 2015. NUGT has gained a massive 310.6% in the year-to-date. The rally in gold slowed down at the start of the second quarter – in the last one month, the yellow metal has gained 1.70% and Thursday’s gains records the highest closing price in the bullion since March 10. It is worthy of note that analysts seem to think that gold had reached a bottom last year and that the rally will continue for much of this year. For instance, George Milling-Stanley, strategist at State Street Global Advisors notes that “in the continued absence of any surprises from policy makers, the gold price could still see further gains in 2016… A price of around $1,350 by year-end could be sustainable.” Nonetheless, I wouldn’t be surprised if the yellow metal runs into occasional volatility that pull the price down. Crude oil also benefits from weaker dollar The weaker dollar has lifted gold and NUGT – but it is also lifting crude oil in global trade. Yesterday, crude oil had more reasons to climb partly because the prospects of a production freeze by OPEC and Russia looks brighter and partly because the BOJs economic policy has weakened the dollar. U.S. West Texas Intermediate (WTI) Futures gained 1.5% to settle at $46.03 and Brent crude gained $0.93 to $48.11 per barrel nearing its highest point since November last year. Dominick Chirichella, a senior partner at the Energy Management Institute observes “the perception view crowd are starting to call the oil market rally the beginning of what will be a long bull market… Clearly, the market is primarily focused on the forward supply-and-demand picture while continuing to push the bearish nearby fundamentals further into the background.” Link to the original post on Learn Bonds

Trade Like A Chimp! Unleash Your Inner Primate

It is a long established fact that a reasonably well behaved chimp throwing darts at a list of stocks can outperform most professional asset managers. While there would be obvious advantages with hiring chimps over hedge fund traders, such as lower salaries and better manners, there are also a few practical obstacles to such hiring practices. For those asset management firms unable to retain the services of a cooperative primate, a random number generator may serve as a reasonable approximation of their skills. The fact of the matter is that even a random number generator can, and will, outperform practically all mutual funds. Such random strategies may seem like a joke, and perhaps they are, but if a joke can outperform industry professionals we have to stop and ask some hard questions. When designing investment strategies, it can be very useful to have an understanding of random strategies, how they work and what kind of results they are likely to yield. Given that random strategies perform quite well over time, they can act as a valid benchmark. After all, if your own investment approach fails to outperform a random strategy, you may as well outsource your quant modeling to the Bronx Zoo. Click to enlarge Meet your new boss. Portfolio Modelling Frequent readers of my articles (both of you) shouldn’t be surprised that we’re dealing with portfolio models here. A portfolio model is something very different from what most retail traders call a trading system. Oddly, the perception of trading system as a set of rules for timing buys and sells in a single market is still pervasive. That’s still what you tend to see if you ever pick up a trading magazine. That’s normally not how things look in reality of course. Not on the sharp end of the business. What we’re normally dealing with is portfolio models. In a portfolio model, the position level is of subordinate importance. The only thing that matters is how the portfolio as a whole performs. We’ll always have many positions on, and it’s the interaction of these positions that matter in the end. Portfolio modelling is a more productive way to spend your time. It would certainly be more useful in the asset management world. What may surprise some not in the industry is that often portfolio models don’t even bother to try any sort of entry and exit timing. Stop loss methodology is rare and concepts like position pyramiding would simply never be a topic. What we’re dealing with here are usually simple models, with mechanisms for selecting components, allocating to the components, rebalancing the components and of course benchmarking the result. Portfolio Model Benchmarking isn’t what it used to be Let’s start with that last point. Benchmarking. Every portfolio has to be measured against something. Very few professionals actually have the zero line as their benchmark. That’s what hedge funds are for. If you work in the industry, odds are that you have a specific index as your benchmark. We’ll go with one of the most common benchmarks here, at least for American equities; the S&P 500 Total Return Index. When you’ve got a benchmark index, you’re being measured against that. It doesn’t matter if you end the year +10% or -10%. It matters if you outperformed or underperformed the bench. At times it can be very comfortable to be measured relative to the index. It removes many difficult investment decisions. You gain and lose at the same time as everyone else. On the other hand, it can be frustrating when the markets are falling and you still have to be in. The index we’re using in this article, S&P 500 TR is different from the normal S&P index that you always see quoted. This is a total return index, meaning that all dividends are reinvested. The traditional S&P index is highly misleading over time, as the dividends appear as losses. So keep in mind that the S&P TR index will always show a better performance than the regular price index over time. In the long run, we’re all dead. Not too impressive, is it? Well, perhaps mutual funds can help. Mutual Funds Can’t Help The mutual fund industry is fundamentally flawed. There’s really no reason at all to ever, for any reason buy a mutual fund. If ever the internet memes about “You had one job…” fit any industry, this would be it. The mutual funds are tasked with tracking and outperforming an index. On average, around 85% of all mutual funds fail. How do I know that? The freaking SPIVA reports . A monkey would have a better chance. How can the Chimps Help? Professor Burton Malkiel once famously wrote in A Random Walk Down Wall Street that A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts. Now I think that’s highly unfair. After all, why would we want to blindfold the monkey? In what way would that contribute? As we all know, academic research has to be confirmed by empirical observation to be of much use. Ladies and gentlemen, I give you Ola the Ape. Back in early 90 when I was in business school in Sweden, we had a highly prestigious national investment championship. This was normally won by the famous analysts at the big investment banks. This was quite a big deal and getting a high ranking in this competition was a big career move. Then in 1993, somehow a chimp from the local Stockholm zoo got entered into the competition. Ola the Ape threw actual darts at the actual stock listings of the newspaper to pick his stocks. And he won. Amateurs! Random Simulations Unfortunately, our office chimp Mr. Bubbles has just accepted a higher offer from a competing firm, so I will have to resort to random number generators to prove this point. The first strategy we’ll test is something you’ve probably seen elsewhere. But we have to start somewhere. Here are the rules: We only pick stocks from the S&P 500 index. Historical membership accounted for of course. At the start of each month, we liquidate the portfolio and buy random stocks. We buy 50 random stocks for each new month. Each position is given an equal cash weight. Monkeys 1 – Index 0 Not too bad, is it? Not a single monkey failed to beat the index. But what’s going on here? Surely there’s a trick here? Let’s push this concept a little further and see if it falls apart. Our next simulation is even randomer. Yes, I’m sure that’s a word. The previous simulation had equal weighted position allocation. Perhaps that’s the trick. But would a monkey really allocate an equal amount to each stock? Or would he pick that at random too? Here’s our next simulation: We only pick stocks from the S&P 500 index. Historical membership accounted for of course. At the start of each month, we liquidate the portfolio and buy random stocks. We buy 50 random stocks for each new month. Each position is given a totally random allocation . Yes, we’re allowing any position sizes here. Perhaps a position is 0.0001% or perhaps it’s 99.99%. Let’s go wild. Monkeys 2 – Index 0 Ok, this is getting ridiculous. We’re still clearly outperforming the market. Not a single monkey loses against the index. Sure, there’s a lot wider spread here and that’s to be expected. There’s quite a large difference between the best monkey and the worst one, but they’re all better than the index and certainly better than the mutual funds. So where’s the trick? Is it the 50 stocks? Could this whole thing have to do with the magical number 50? After all, isn’t this a Fibonacci number ? And why would a monkey pick this number of stocks anyhow? Fine, let’s relax this one as well. Let’s do another one. We only pick stocks from the S&P 500 index. Historical membership accounted for of course. At the start of each month, we liquidate the portfolio and buy random stocks. We buy a random number of random stocks for each new month. Each position is given a totally random allocation . A random number of random stocks at random allocations. Now that’s how a proper monkey trades. Will the monkeys finally lose this time? Game, set and match. No. The monkeys still win. Now we see some really wild swings, but in the end our primate friends persevere. But now it’s really getting silly, isn’t it. What are we doing here that’s clearly working? Actually, it’s the other way around. The single largest positive factor is that we avoid making a mistake. That mistake being market capitalization weights. Simply by avoiding market cap weighting, we outperform. The larger issue here is benchmarking against an equal weighted index, such as the S&P 500. We all know that there are (approximately) 500 stocks in the S&P 500. But is that really true? Did you know that the top 10 stocks in that index has an approximate weight of 18%? And that the bottom 300 stocks also have a combined weight of about 18%? We’re all pretending that the S&P 500 is a diversified index, but it’s really not. It’s tracking a handful of the largest companies in the world and the rest really don’t matter. There’s practically no diversification in the S&P 500 To be fair to the index, and the index providers, I’d have to point out that indexes were not originally meant to be investment strategies. They were meant to measure the health of a market. As such, they’re not all that bad. But that doesn’t mean that you should invest like the index. It’s easy to check out equal weighting performs against market cap weighting. Just compare the S&P 500 Equal Weighted Total Return Index with the S&P 500 Total Return Index. Same stocks, same index provider, same methodology. Easy. Some stocks are more equal than others. In the random simulations above, we’ve seen that both equal weights and random weights are better than market capitalization weights. Obviously only a chimp would use random weights. Equal weights are quite common, though in my own opinion it makes much more sense to use volatility parity weights. That’s nowhere near as complicated as it sounds. Vola parity just means that we size our positions according to inverse volatility. A more volatile stock gets a smaller allocation. Why? Because if you put an equal amount of cash in each stock, your portfolio will be driven by the most volatile stocks. If you buy a utility stock and a biotech, the biotech stock is likely to be the profit and loss driver of the portfolio. An equal weight in the two would mean that you put on more risk in one stock that the other. Vola parity weighting means that you, in theory, put on equal amount of risk in both stocks. Yes, I deliberately used the word risk here so the comment field will be filled up with quants pointing out that I don’t understand risk. Go ahead. I’ll wait. Let’s do one more of these funny simulations before getting to the real stuff. We only pick stocks from the S&P 500 index. Historical membership accounted for of course. At the start of each month, we liquidate the portfolio and buy random stocks. We buy 50 random stocks for each new month. Each position is given a volatility parity allocation . Best monkeys so far. This looks pretty good, doesn’t it? Now we have better performance and more importantly, a narrower span of performance. The monkeys all do really well and there’s not all that much difference between them. If only we could figure out a way to be one of those better chimps. Let’s be the better primate! Why should the chimps get all the fun? Clearly these guys know how to trade, but perhaps we can figure out a way to beat them. We’ll have to take out the random factor and find a better way to pick our stocks. The volatility parity seems to work though, and so does the monthly rebalancing. We’ll keep those. There are several valid ways of picking stocks. You could use value factors, dividend yield, quality, momentum etc. I’m going to use momentum here, because clearly it’s the best one (not at all because I wrote a really neat book on that topic ). Besides, it’s the easiest one to quantify and model. The data is more readily available and so are the tools needed. Here’s our new, chimp free simulation: We only pick stocks from the S&P 500 index. Historical membership accounted for of course. Trading is done monthly only. Rank stocks based on Clenow Momentum™ . If cash is available at start of month, buy from top of ranking list until no more cash. Inverse vola position sizing, using ATR20. Sell at start of month if stock is no longer in top 20% of index or if Clenow Momentum ™ is lower than 30. Some may recognize this as a simplified version of the one presented in Stocks on the Move . It’s much simpler, but performs in a very similar manner. It has slightly deeper drawdowns and slightly higher return. Those of you who didn’t read Stocks on the Move, may wonder what a Clenow Momentum is, and whether or not I’m joking about that name. Step one, put my name on stuff. Step two, get a comb-over. The Clenow Momentum ™ is clearly a silly name for a pretty decent analytic. This is just an improved way of measuring momentum. First we take the exponential regression slope, instead of the linear, since it’s measured in percent and can therefore be compared across stocks. It will tell us the slope in percent per day, which will give you a number with too many decimals to keep track of. So we annualize it get a number that we can relate to. Now the number tells us how many percent per year the stock would do, should it continue the same trajectory. But the annualized exponential regression slope doesn’t say anything about how well the data fits the line. The coefficient of determination, R2, does. That’s a number between 0 and 1, where a higher value means a better fit. If we multiply the two, we essentially punish stocks with high volatility. And there you go. Clenow Momentum ™! Not too bad for a human! Now we’re seeing some interesting results! Even without the help of the chimps, we’re now clearly outperforming the bench. It’s a consistent outperformance too, during both up and down markets. The reason that we outperform in bear markets is that we don’t buy stocks with a low absolute momentum value. When there are no stocks moving up, we don’t buy any. This all seems good and well, but I’m sure you’re all wondering about the most important point. How did we do against the chimps? You can’t beat all the chimps. We may not be the best primate, but we’re certainly among the smarter ones! Being in the upper 5% of the chimps is pretty good. On the evolutionary scale, we have now moved beyond the mutual fund managers, beyond the index itself and we’re competing with the best of the chimps! So what’s the point here? There are several important learning lessons from all of this. Perhaps the best way to summarize it would be to paraphrase Gordon Gekko: The point, ladies and gentlemen, is that chimps are good. Chimps are right. Chimps work. Chimps clarify, cut through and capture the essence of the evolutionary spirit. Well, with all due respect to Gekko the Great, perhaps there are better ways to sum this up. Random models reveal the weakness of index construction. Benchmarking against random models help you put your own results into context. Does your portfolio model really add value, or is it just another chimp? It’s very easy to make a simulation that beats the index. Systematic momentum investing is likely to beat the index, and most of the chimps. You will never beat all the chimps. The recent book Stocks on the Move, incidentally written by yours truly, contains a more in depth analysis of how momentum strategies can be used to outperform the benchmark. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: No chimps were harmed in the production of this article.

Value Investor Interview: Samit Vartak

I recently interviewed Samit Vartak of SageOne Investment Advisors for my premium newsletter, Value Investing Almanack. Samit is one of the founding partners and Chief Investment Officer at SageOne, and is responsible for ensuring SageOne’s adherence to its core investment philosophy and discipline of risk management. As you would read in the interview below, Samit believes in risk management not by seeking extreme diversification or buying sub-par businesses at low multiples, but by building a reasonably diversified portfolio of high quality businesses having long term competitive advantages in attractive and high growth industries. Samit returned to India in 2006 after spending a decade in the US working initially in corporate strategy with Gap Inc. and PwC Consulting, and then with Deloitte and Ernst & Young advising companies on business valuation and M&A. This experience forms the backbone that helps him better understand businesses and their fair value. Samit is a CFA® charter holder, an MBA from Olin School of Business of the Washington University in St. Louis and holds a Bachelor of Engineering degree with Honors from Sardar Patel College of Engineering, Mumbai University. In his interview with Safal Niveshak, Samit shares his wide investment experience and how small investors can practice sensible investment decision making. Safal Niveshak (SN): Could you tell us a little about your background, how you got interested in value investing? Samit Vartak (SV): I come from a village named Mahim which is along the Konkan coast about 100 km north of Mumbai. My father is a farmer, who does that for living even now. As a kid I grew up on the farm and studied there until the 10th standard after which I came to Mumbai for higher education and completed my engineering. Financially, my father had to struggle immensely to educate me and my two younger brothers from his illusive farming income. Experiencing and living through my family’s struggle for money is the background that has influenced my investment style. After working with Mahindra and Mahindra for 3 years, I received scholarship from a prestigious US university to pursue an MBA for which I left for the US in 1997. Post MBA, I worked in the US until 2006 with the likes of PwC Consulting and Deloitte Financial Advisory Services. Half of my US experience was in Management Consulting, advising companies on improving operational efficiency, business processes and strategy. The other half was as a valuation professional advising PE/VC funds and corporates on valuations for their investments and M&A. This experience has helped me with the two most important aspects of investing – understanding businesses and understanding fair valuation for them. I caught the stock market bug in 1999 at the peak of the dot com bubble when making money had become very easy. This was the time when I followed exactly what is currently in my “what not to do” list as an investment process. I followed analyst recommendations, looked at simple valuation metrics such as PE ratio/PEG ratio, believed in forecasted numbers of analysts, and invested in companies where buy recommendations were the highest. No surprise that as the markets peaked, I started losing money and to recover my losses quicker I used derivatives/margin money and the result was that by 2001 my entire portfolio was wiped off. I cannot describe the agony that I went through in losing all I had earned and especially given my family’s financial struggle during my childhood. The guilt of wasting money which would have been so valuable for my family back home left such an indelible mark on me that I took a break from investing to introspect my mistakes and learn before investing again. That was the turning point and blessing in disguise in my investment journey. To further my learning, I decided to enroll for becoming a CFA (Chartered Financial Analyst) wherein I really learned the fundamentals and theory behind investing. I read about different investment styles, about experiences and methods used by successful investment gurus and tried to figure out what suits me and my temperament. My ultimate goal was to develop an investment style in which protecting capital was the primary goal and return on capital was a secondary goal. Currently I am the CIO and cofounder of SageOne Investment Advisors LLP, wherein we advise an offshore fund and few large domestic HNIs. We are three partners (Kuntal Shah and Manish Jain being the other two) who have been working together for the past 8+ years. SN: Pretty inspiring journey you have had, Samit. Thanks for sharing that. How have you evolved as an investor and what’s your broad investment philosophy? Has your investment policy changed much through the years? SV: Before talking about the evolution of my investment philosophy, let me start with our current investment philosophy we employ at SageOne. My personal portfolio replicates that of the clients’ and hence the philosophy is common. My path from engineering to business consulting to valuation professional to becoming a fund manager has been different and long compared to most and my philosophy has evolved accordingly. When you look at a business and if you get a feeling “I wish I owned this business”, that’s the kind of businesses we are looking for. We look for a business with long-term competitive advantage, in a stable industry, that has a huge and growing market for its products/services. If a business is inferior, then the price of the stock does not matter and it would not interest us. For improving the probability of finding such businesses, you need to focus on the right sectors. To put it other way, if you want to find the best marathon runner, first you need to know the right countries to focus on. Focusing on the right sectors is half the battle won in finding the right companies. I have written in detail regarding our philosophy and process on our website as well as in our quarterly newsletters found on the website. During my initial years, my sequencing was the other way around. Cheap valuation was the primary focus and then came the business. I would say, that has been the biggest change over the years and this has changed the downside risk profile associated with investing for me. SN: Apart from managing your own money, you are also managing others’. So, how is it being a money manager, especially during the extreme situations – euphoria or market crashes? How do you keep yourself sane when dealing with clients with undue expectations? SV: As an advisor or a money manager, choosing the right clients is extremely important. We are extremely choosy when it comes to accepting clients. You don’t want investors who would call you each time the market is down few percentage points. You want to make sure that the investor is sophisticated enough to understand the risks associated not only with equities but more importantly with the manager’s investment strategy. This is easier said than done, but continuous education of the clients regarding the risks and returns definitely has helped us. I came back to India in 2006 and it took me a while to get comfortable with investing in India and understanding the business environment here. Until then, I was just managing my own money to make sure I don’t use clients’ money for my education. I started advising external money only in April 2012. I think it’s very easy in this field to become insane with the kind of information overload with respect to global risks, industry risks, company risks, management risks and a never ending list. I moved to Pune in 2008 to stay away from market noise in Mumbai. Too much interaction with fellow investors can lead to diverting your focus from finding strong businesses to things like global macro, short term trends/changes in some industries, etc. SN: Choosing your clients well is a very important lesson for future money managers I believe. This is exactly what Rajeev Thakkar of PPFAS Mutual Fund told me when I interviewed him a few months back. Anyways, what has been the best and worst times in your experience as a money manager? How did you handle, say, a situation like 2008? SV: Given that I started advising external money only 4 years ago, the best times were 2011 to 2013 period when the expectations of most investors from India were so low that it reflected in the valuations of companies and one could pick really strong businesses at really attractive valuations. Last couple of years have been the really tough, since nothing really changed in India on the ground but the expectations from the new government went through the roof. In fact, the valuations rose when earnings were coming down in reality with global environment worsening. I have done a detailed analysis of the situation and the risks in my latest newsletter . As far as 2008 goes, it was period when I was managing my own money. One can’t escape the carnage if you are a long only investor in such periods, but what saved me relatively was the cash levels I maintained. I track valuation multiples and margins at sector levels over a long period of time. I try to keep cash levels based on risks associated with the current absolute valuation multiples as well as my assessment of sustainability of current margins. In 2008, the P/E multiples as well as profitability were at all-time highs and the Indian market faced dual risk of not only the P/E multiples contracting but also the net profit margins contracting to a more sustainable level. Assuming that the P/E multiples as well as margins would contract to the mean levels, P/E faced downside of 40% and net profit margins downside of 24% with combined downside risk of 55% which unfortunately for everyone more than played out. I have presented a detailed analysis on this in our July 2015 and October 2015 newsletters if anyone is interested in historical levels. SN: Good that you talked about the idea of sitting on cash when there is a dearth of opportunities, or when you find things heated up. For most investors, it is a painful decision i.e., not doing anything with cash and sitting tight on it especially for a longer period of time. What would you advise other investors, and especially money managers, on how to remain liquid when the situation demands and while defying the steady drumbeat of performance pressures? SV: It’s much easier for an individual investor to remain liquid as he is not answerable to investors. For a fund manager, it’s a very complicated situation with uncertainty of markets. If you are sitting on high levels of cash because you believe that the valuations are high and the markets are risky, the market can continue its uptrend for much longer and each such month can be extremely painful to watch. You may be eventually right, but answering questions of investors who are paying the opportunity cost can be frustrating and with that building pressure you may end up deploying that cash at higher levels. Opportunity cost is extremely difficult to handle even for the best of investors. See how even Stanley Druckenmiller flip flopped during the dotcom bubble. Even Warren Buffett was written off as past during that period since he stayed away from the best performing sector. I believe that you have to lose the small battles to win big in the long term and patience is the key. Investment is a test match. I invest my money the same way I advise our clients and if I personally find it risky to be fully invested, how can I take the risk with clients’ money? SN: Great thought! Anyways, what are some of the characteristics you look for in high-quality businesses? What are your key checklist points you consider while searching for such businesses? SV: As I have said before, the starting point for finding a high-quality business is to finding a high-quality sector. I am very numbers oriented and love tracking and analyzing various metrics at sectoral levels. You can’t judge a sector by looking at short term performance but evaluating how it did during couple of down cycles. As a process we have broken down the top 1,600 companies in terms of market cap into sectors. For each sector we evaluate parameters such as sustainable profitability (ROE/ROCE), volatility in margins, leverage, topline growth and cash generating history. Based on these, we had shortlisted top sectors and about 300 companies within those. Next step was to painstakingly look at each company to eliminate companies having history of bad corporate governance, loose/questionable accounting policy and inefficient capital allocation. Post this we came to our “fishing pond” of about 150 companies. Out of these strong businesses we look for companies that, based on our analysis, have potential to grow topline at more than 20% (ideally > 25%) with sustainable net margins over a 3-5 year period. Generally, 20-25% growth isn’t easy for companies when the nominal GDP is around 14%. The only way it’s possible is if the company can capture market share from unorganized players or public sector competitors or organized private competitors within the country or from competitors in other countries if export oriented. So we consciously look for such enablers of growth. SN: Nice process I must say. Well, if it’s possible, can you suggest a few sectors/industries you find appealing (based on their past performance and future prospects)? SV: Sectors such as building materials where the unorganised segment is huge (70%+ in some industries) and where brand is still valued by customers is appealing. Even batteries segment has a big unorganized segment and it’s a consumable, so demand isn’t cyclical and relatively less affected by capex cycles. I prefer sectors where demand isn’t dependent on favourable environment and product replacement can’t be postponed for too long. It’s very important to pick the right company in each. Once you study the sector, pick the one which you believe has the right targeted customer segment, has the right marketing strategy and the management is focused on that exciting opportunity versus having diluted attention on multiple businesses. SN: How do you think about valuations? How do you differentiate between ‘paying up’ for quality and ‘overpaying’? SV: Having worked as a valuation professional has helped me significantly in this area. Valuation is about your input assumptions or else it’s garbage in and garbage out. For coming up with reasonable inputs, you not only need to understand the company but also the industry, the competitive environment, business model, strategy of key competitors, etc. to be able to estimate the factors such as growth, profitability, re-investment rate and return on future investments. This may sound complicated, but if you have done thorough work on understanding the company and the industry/competitors you won’t find it difficult to judge whether the current valuation is a bargain or expensive. Rather than trying to come up with a specific number, I try to evaluate what’s a reasonable multiple for the company and if I feel that the probability of the current multiple contracting is very low, I get comfort. “Paying up” or “overpaying” are terms we have started using based on our perception of whether the P/E multiple is high or low. P/E multiples can be very deceiving. For e.g. let’s consider an example of a company from two analysts’ perspectives who are ascribing it a fair P/E multiple. A company generating ROE of 50% and both analyst expect earnings to grow at 25% for the next 2 years. So theoretically the company needs to deploy 50% of the profits for this growth (Growth = Reinvestment x ROE). The residual profits are paid out as dividends. Beyond two years, one analyst expects the growth to drop to 10% up to the 20th year. The second analyst expects the 25% growth to continue up to the 20th year. Let’s assume the terminal value of the company is the book value at the end of the 20th year. For the first analyst the fair one-year forward P/E multiple would come to about 12x, but for the second analyst it would be 32x (see workings below, or click here to download ). So the point I am trying to make here is that the duration of high growth has a huge impact on the eventual P/E multiple. If the company is trading at 20x, the first analyst would find it expensive but the second would find it a bargain. If your business analysis is in-depth, your chances of accurately evaluating the duration and hence the valuation would be much better. Please note that if a company’s ROCE is above its weighted average cost of capital (WACC) and if the company continues to grow above the WACC forever, the valuation and hence the P/E multiple would tend towards infinity. Conversely if the ROCE is below WACC and the company continues investing in new capex at ROCE lower than WACC, its valuation would tend towards zero. So theoretically no P/E multiple is low or high. If anyone is keen on learning more, you may find my lecture , given at Flame Investment Lab, useful. SN: That’s a brilliant way to look at valuations, Samit, and it solves a lot of questions in my head. Let me ask your thoughts about selling stocks. Are there some specific rules for selling you have? SV: For me the highest numbers of my exits have been driven by deterioration of the business environment. So either the business model has deteriorated because of regulatory changes such as what happened recently in cotton seeds, or the competitive intensity has changed and that makes it incrementally difficult to meet my 20% growth hurdle. Other reasons are management decisions regarding capital allocation or in financials the lending standards been relaxed. Valuation running beyond comfort is another common reason, but I am a little more flexible here versus brutal in the first two aspects. SN: Can you please share a real-life stock example when selling turned out to be a great decision for you, and one when it turned out to be a mistake? SV: J&K Bank worked out well when we exited it at the first signs of its lending standards deteriorating. La Opala exit didn’t work out well as we exited too early because of concern on valuations. The growth continued and with that the multiples kept increasing. We exited with a 5x return and the stock continued going up 5x further. SN: When you look back at your investment mistakes, were there any common elements of themes? SV: There have been many mistakes. The most common is in the event of any bad news (significant enough to trigger an exit) coming with regards to a portfolio company that you have held for some time and have developed connect with. The natural tendency is to find arguments against the bad news and try and shove it under the carpet. You try talking to the management and typically they are the worst people to talk to in such events because they will give you great comfort in their business as always. Holding something in your portfolio is as good as entering that stock at current market price. Many a times, I have held on to positions even if I would not be comfortable buying at current market price. You may justify it by giving false comfort of having bought at much lower price, but it’s a behavioural mistake that has to be rectified as a part of improving decision making. SN: Yeah, that’s true. Talking about behaviour, any specific biases that have hurt you several times as far as your investments are concerned? And what have you done to minimize the mistakes caused by such biases? SV: One very common mistake that has hurt me is that if you buy even a small quantity at low price, it’s much easier to add at higher level. But if you miss that first entry at extremely juicy price, it’s very difficult to buy later as you keep repenting that lost opportunity. Other mistake that is common is the cost of purchase. The entry point if low gives a lot of comfort to hold on even if you see business environment deteriorating for the company or if you find valuation uncomfortable. In reality we know that the exit point should be independent of the entry, but it’s very difficult to de-link. These are tough decisions and I consciously try to be aware of such biases to avoid them. I can’t say that I have mastered them 100%. SN: How can an investor improve the quality of his/her decision making? SV: As I just said, an investor needs to look afresh at his/her portfolio without the bias of having the stock already in the portfolio. This discipline would surely help in making better decisions. Other aspect which is extremely important and underappreciated in investing is temperament . For this, keeping your mind relaxed and away from “noise” is critical. I find exercise, meditation and frequent breaks away from investing very helpful. Each individual needs to find a way to relax and keep his/her mind fresh and peaceful. One can read and learn a ton about behavioural aspect, but if the mind is stressed, tired or confused, the chances of taking wrong decisions significantly rise. SN: How do you think about risk? How do you employ that in your investing? SV: I am not going to talk about the theoretical aspects of risk such as diversification, illiquidity, etc. which are a given for a money manager. I am sure your readers would have heard and read about them multiple times. I will stick to specific things that I follow. Once I am broadly excited about a business, my major analysis is on digging holes into my excitement. Once you like a stock, the natural tendency is to just jump in before the price runs up. When you take short cuts that’s exactly when risk crops in. As part of my analysis, I avoid talking to co-investors who already have vested interest and are also excited about the stock. Talk mainly to the company’s competitors because they generally will give you a different point of view on the industry and about why certain strategy is inferior. Talk to analysts who have negative view on the company. Find a strong devil’s advocate who will try and destroy your hypothesis. In that respect, having partners helps each of us as the other two play that role. Equity investments involves considerable risk. The key is to find ways to reduce it. There is no better way than to understand the dynamics of the business and run stressed scenarios of how it would survive in the toughest of economy. For me, mitigating risk is about building margin of safety and I try to use it in the outlook when I am valuing the business. E.g. If based on your study, you are confident that the business can grow at 25% for 7 years, assume only 4 years and see if you still find the price attractive. One other factor I would like to bring up is to be careful when blindly copying investment theories and strategies used by legendary investors in the United States. You have to remember that the US is one of the most successful and innovative countries in the world. When you companies with strong brands, IP and technology which is recognized all over the world things like “moats” and extremely long term investing works there. India is an emerging economy and many things such as regulations, government incentives, tax structure, FDI policies, IP policies, etc. keep evolving. Plus, we are relatively much weaker on brands, IP, technology and hence your investment strategy has to change accordingly. One has to be very vigilant about the above changes on your portfolio companies and be ready to exit with changing business dynamics. Following wrong investment strategy can be hugely risky. SN: That’s a nice insight. Well, what’s your two-minute advice to someone wanting to get into value investing? What are the pitfalls he/she must be aware of? SV: Most people want to be independent and for that they would have liked to own and run a great business, but for majority of them starting a business is too big a risk. Investing in stock market should be considered as a much lower risk option because you are able to partly own diverse set of already successful businesses. Look for businesses with the same passion as you would to start an exciting business you like. Set that priority and purpose right, and only then think about the price to pay for it. Learning about valuation is much easier once you do this. Don’t fall into the trap of scanning for value first and forgetting the real purpose of investing. SN: Which unconventional books/resources do you recommend to a budding investor for learning investing and multidisciplinary thinking? SV: Here are the three I would recommend – Understanding Michael Porter: The Essential Guide to Competition and Strategy by Joan Magretta The Little Book that Beats the Market by Joel Greenblatt The Five Rules for Successful Stock Investing : Morningstar’s Guide to Building Wealth and Winning in the Market by Joe Mansueto and Pat Dorsey SN: Which investor/investment thinker(s) do you hold in high esteem? SV: Being a numbers oriented guy, I like Joel Greenblatt’s way of scanning for great businesses. History and right parameters could be a great starting point to shortlist companies. There are different aspects to learn from many great investors. SN: Hypothetical question: Let’s say that you knew you were going to lose all your memory the next morning. Briefly, what would you write in a letter to yourself, so that you could begin relearning everything starting the next day? SV: Before investing, I will surely focus on writing about my family and people I love and are important in my life. I will write about the philosophy I follow in life. It’s too little a time to spend on writing about investing. In any case, I can always refer to my newsletters and our website to remind me of the philosophy I had followed. So some documented help is available on that front. SN: What other things do you do apart from investing? SV: I love sports and many of them, so watch and play whenever time permits. We came back to India in 2006 and one of the purpose was to make some difference to our home country. I involve myself during weekends in various activities such as cleaning garbage in our area, tree plantation in the forest that had been completely destroyed over the years, but my real passion is education. We all know the quality of education in our municipal schools. Students are not failed until grade 8th, but beyond that many find it extremely difficult to continue and the dropout level jumps. If quality help is provided at this stage, many can be helped not only from dropping out but also to complete graduation so that they can find meaningful employment. Even better, if they are provided good guidance to find their passion, many could become employers and big contributors towards development of our country. I am currently just helping monetarily in education of about twenty 8th to 10th grade students from a poor community, but I am working with an NGO in Pune which is doing phenomenal work in this area. My goal is to adopt an entire class of 8th graders and help them in the above aspect until graduation. SN: That’s very kind of you Samit! You definitely have inspired me and a lot of people reading this interview. Thank you so much for sharing your wonderful insights on investing. Thank you! SV: You’re welcome Vishal.