Summary of Annual Reports

Ever since I left my full-time job and started investing full time, one of the most important things I have looked forward to is reading annual reports, especially of lesser-known companies. But I spent a lot of time in the last two years honing my skills in technical analysis and quantitative analysis.

This year my team at Intelsense and I have decided to read as many annual reports as well and summarize the main qualitative parts into 2-3 page documents. It will help in two ways:

1. Increase the coverage of stocks and understand the stories behind a large number of companies
2. Have an archive that can be referred to later for a quick review of what happened.

The reason I have focused on the qualitative side is that it is fairly easy to just look up the financials on screener.

I will be posting the summaries on the respective company threads on www.valuepickr.com and also on this blog. In case, the company thread does not exist on VP, I will put it on my catch-all thread (link here: https://forum.valuepickr.com/t/aa-abhisheks-attic-place-to-store-stuff-to-clear-my-head/26195)

If there is any particular AR that anyone is looking to read a summary of, do let me know on and I will try to put it in priority in the queue.

The link to all the reports is http://blog.intelsense.in/p/ar-summaries.html

Quantitative Thinking

Quantitative way of thinking is very critical in today's day and age. For example, if we say an industry has high returns on equity, it is technically a meaningless statement. We should dig deeper. How do we define high? Is high to be defined in absolute terms or relative terms. If relative, relative to what and for how long? The moment you start making an effort to quantify things, you will see a lot more clarity. You will need to spell out your assumptions. There is no place to hide behind vague terminology. 

There is a lot of discussion on the market being in bubble territory. Again, we should stop ourselves and ask, what is a bubble? How do we quantify a bubble? There are a lot of academic papers on quantifying bubbles but suffice it to say that there is no universal definition or quantifying methodology of a bubble. So, we should try and define what we would think a bubble would be in our own terms. A bubble is when a particular asset price goes up significantly over a short period of time without the underlying cashflow (if any) of the asset changing meaningfully. 

So, from a stock market perspective, we could think of a finding out how many stocks are trading say 2x-3x above their 200-day moving average. Another similar approach could be to look at the number of stocks that are above 3 standard deviations of their 200-day moving average. Couple that with a valuation metric like say 3 times PE or PEG or EV/EBIDTA over their mean for 3-5 years. And voila, you have a framework to understand what a bubble looks like. It may not be perfect, but you can keep refining it over time. But your understanding of markets will increase significantly more than listening to random people bandying such terms all over the place.

Weekend Reading

Reading across disciplines is one of the best ways to improve our investment acumen. Here is a summary of some of the best articles I read this week. If you like this collection, consider forwarding it to someone who you think will appreciate it.

1. Neuroscience explains why social media makes us feel terrible about who we really are

Today, social media is implicated in an array of mental health problems. A report from the Royal Society for Public Health in 2017 linked social media use with depression, anxiety and addiction.

Concerns around social media have become mainstream, but researchers have yet to elucidate the specific cognitive mechanisms that explain the toll it takes on our psychological well being. New advances in computational neuroscience, however, are poised to shed light on this matter. The architecture of some social media platforms takes the form of what some scientists are now calling ‘hyperstimulators’ – problematic digital delivery systems for rewarding and potentially addictive stimuli. According to a leading new theory in neuroscience known as predictive processing, hyper stimulants can interact with specific cognitive and affective mechanisms to produce precisely the sorts of pathological outcomes we see emerging today.

https://aeon.co/essays/social-media-and-the-neuroscience-of-predictive-processing

2. The future look into Google from the man who runs the search

I want to be able to get to a point where you can take a picture of hiking boots and ask, “Can these be used to hike Mount Fuji?” We have to make enough sense of the physical world and the online world to be able to answer a question like that with fidelity.

I think the real competition is among the people who are going to reimagine search, in the way we just described—who will let the user be far more expressive and who will do a much better job than today. Today everybody is analyzing the world's information and making sense out of it. My goal is to make sure that we are unparalleled in the understanding of the world.

I want our maps to be built on by far the best model of the 3D world around us, that we interact with every single day. For example, we now bring AR into maps. That's an instance where the experience we provide to you is far richer than the plain old map that we had 15 years ago, which was essentially a paper map stuck on a screen. ut the rightness of that information is critical. Is it crowded there now? Is it open for takeout? During Covid, we had to make literally millions of updates to maps just on opening hours. We've done that through a variety of techniques. 

https://www.wired.com/story/prabhakar-raghavan-isnt-ceo-of-google-he-just-runs-the-place/

3. Noise and how to avoid it in the market

Noise is ever-present in the marketplace. It does not vanish simply by holding a company for ten years. It will be present again, and again, and again.

The noise only tends to become weaker when observed in hindsight, as narratives are born and old ones fade in a continuous, repetitive, fashion. In reality, the noise is there throughout the holding period.

If you read the headlines, then there will always be a reason not to invest in something. Even after a decision to take a stake in a company, there will always be a reason to sell. It’s almost as if headlines and media cycles are designed to capture the attention of the reader.

Conviction is born from understanding what you own. An investor’s reaction to an earnings report, an acquisition, or some other event, should first come from their own independent thought. The primary reaction to some event should come from yourself first, and then later can be tested, questioned, or shared, in an attempt to learn. If your first reaction is guided by others, then there is a lack of independent thought, and neglecting your independent thoughts could prove costly.

https://investmenttalk.substack.com/p/reflections-on-noise

4. Speculation is a game you can’t easily win

Realized gains feel like penalties when they’re interpreted as missed opportunities. Walking away with a great 10x return will make you feel terrible if that came at the expense of a future 100x return. If the top turned out to be much further out than you thought, then you can’t help but to be unhappy with the gains you actually did realize (no matter how good they were). This reinforces the dynamic that what you earn is never enough.

That speculation is a game you can’t win. On one hand, there’s the burden of regret resulting from selling too early (or from selling too late at a realized loss). On the other, there’s the schadenfreude you embody by selling right on time. Whichever path the asset ends up taking, there’s a mental tax to be paid on top of any monetary result, and that’s what makes this such a difficult game to internalize.

https://moretothat.com/speculation/

5. Markets are crazy. Crazy is normal.

Markets don’t stay within the limits of sanity, and why they always overdose on pessimism and optimism. They have to. The only way to know we’ve exhausted all potential opportunities from markets – the only way to identify the top – is to push them past not only the point where the numbers stop making sense, but beyond the stories people believe about those numbers.

Always been the case, always will be.

One is acceptance that an insane market doesn’t mean a broken market. Crazy is normal; beyond the point of crazy is normal. Every few years there seems to be a declaration that markets don’t work anymore – that they’re all speculation or detached from fundamentals. But it’s always been that way. People haven’t lost their minds; they’re just searching for the boundaries of what other investors are willing to believe.

https://www.collaborativefund.com/blog/the-limits-of-investing-sanity/

For building a solid long term portfolio, look at subscribing to www.intelsense.in long term advisory.

For technofunda investing and positional trading, subscribe to our Hitpicks advisory service on www.intelsense.in

For momentum trend following systematic trading, subscribe to Quantamental at www.quantamental.in 

Our Quant systems are also found at https://intelsense.smallcase.com

Weekend Reading

Reading across disciplines is one of the best ways to improve our investment acumen. Here is a summary of some of the best articles I read this week. If you like this collection, consider forwarding it to someone who you think will appreciate it.

1. The biggest digital bank heist

Since late 2013, this band of cybercriminals has penetrated the digital inner sanctums of more than 100 banks in 40 nations, including Germany, Russia, Ukraine, and the U.S., and stolen about $1.2 billion, according to Europol, the European Union’s law enforcement agency. The string of thefts, collectively dubbed Carbanak—a mashup of a hacking program and the word “bank”—is believed to be the biggest digital bank heist ever. 

Besides forcing ATMs to cough up money, the thieves inflated account balances and shuttled millions of dollars around the globe. Deploying the same espionage methods used by intelligence agencies, they appropriated the identities of network administrators and executives and plumbed files for sensitive information about security and account management practices. The gang operated through remotely accessed computers and hid their tracks in a sea of internet addresses.

https://www.bloomberg.com/news/features/2018-06-25/the-biggest-digital-heist-in-history-isn-t-over-yet

2. Cobalt is the new Gold in Congo

Among other things, cobalt keeps the batteries, which power everything from cell phones to electric cars, from catching fire. As global demand for lithium-ion batteries has grown, so has the price of cobalt. 

Southern Congo sits atop an estimated 3.4 million metric tons of cobalt, almost half the world’s known supply. In recent decades, hundreds of thousands of Congolese have moved to the formerly remote area. Kolwezi now has more than half a million residents. Many Congolese have taken jobs at industrial mines in the region; others have become “artisanal diggers". Some secure permits to work freelance at officially licensed pits, but many more sneak onto the sites at night or dig their own holes and tunnels, risking cave-ins and other dangers in pursuit of buried treasure.

This year, cobalt prices have jumped some forty per cent, to more than twenty dollars a pound. The lure of mineral riches in a country as poor as Congo provides irresistible temptation for politicians and officials to steal and cheat. Soldiers who have been posted to Kolwezi during periods of unrest have been known to lay down their Kalashnikovs at night and enter the mines. At a meeting of investors in 2019, Simon Tuma Waku, then the president of the Chamber of Mines in Congo, used the language of a gold rush: “Cobalt—it makes you dream.”

https://www.newyorker.com/magazine/2021/05/31/the-dark-side-of-congos-cobalt-rush

3. The Secret Psychology of Sneaker Colors

Aqua blue, acid lime and grape purple. Electric orange interspersed with neon pink. Gray suede and cheetah print mixed with white and gold. These are not descriptions of a minimalist’s worst nightmare, but rather new color combinations from Adidas, Reebok and New Balance. And they are jarring by design.

The links between color and emotion have been studied for centuries, from Carl Jung’s color coding of personality traits to focus groups evaluating the ways in which candy colors can affect perceptions of flavor.

“Between 70 percent to 90 percent of subconscious judgment on a product is made in a few seconds on color alone,” said Jenny Ross, the head of concept design and strategy for lifestyle footwear at New Balance. “It can excite or calm us, it can raise our blood pressure. It’s really powerful.”

https://www.nytimes.com/2021/05/24/style/sneaker-color-psychology.html

4. Can Giraffes help us solve our high blood pressure problem for good?

Giraffes, it turns out, have solved a problem that kills millions of people every year: high blood pressure. Their solutions, only partly understood by scientists so far, involve pressurized organs, altered heart rhythms, blood storage — and the biological equivalent of support stockings.

Giraffes have sky-high blood pressure because of their sky-high heads that, in adults, rise about six meters above the ground — a long, long way for a heart to pump blood against gravity. To have a blood pressure of 110/70 at the brain — about normal for a large mammal — giraffes need a blood pressure at the heart of about 220/180. It doesn’t faze the giraffes, but a pressure like that would cause all sorts of problems for people, from heart failure to kidney failure to swollen ankles and legs.

https://knowablemagazine.org/article/living-world/2021/heads-up-cardiovascular-secrets-giraffes

5. Busyness is an excuse for lack of direction

Sometimes we say, “I just don’t have time! I’m so busy!” But that’s not true. We can always make time for important things. The problem isn’t time, it’s something else. “Lack of direction, not lack of time, is the problem. We all have twenty-four hour days.”

If you want to change your life and make progress, you have to embrace uncertainty. You can’t know everything about tomorrow. And that makes a lot of people uncomfortable. But here’s the thing. You have to get comfortable with being uncomfortable. 

One of the best things you can do for yourself is to recognize when you’re making excuses. The only way to have a good life is to stay active. Work out. Enjoy your job. Find pleasure in small things. Make yourself useful. That’s how we function as human beings, and that’s what gives us joy.

https://dariusforoux.com/i-dont-have-time/

For building a solid long term portfolio, look at subscribing to www.intelsense.in long term advisory.

For technofunda investing and positional trading, subscribe to our Hitpicks advisory service on www.intelsense.in

For momentum trend following systematic trading, subscribe to Quantamental at www.quantamental.in

Our Quant systems are also found at https://intelsense.smallcase.com

My highlights from Stan Druckenmiller's interview

Stan Druckenmiller is one of the greatest macro traders or investors of our times. Recently a new interview was published at https://thehustle.co/stanley-druckenmiller-q-and-a-trung-phanin

Here are my highlights:

I remember a lot of value managers virtually going out of business in 2000. Julian Robertson threw in the towel and said he couldn’t take it anymore and stopped managing money in the early 2000s. Everything Julian was long, went up many fold and the tech stocks went down a lot. 

Amazon at $3200 is not a bubble stock. Not whatsoever. It’s basically decent value. I don’t just mean Amazon, but a lot of the big FAAMG names.

Biggest Risk:  Without a doubt: inflation strong enough that the Fed responds to it. 

This bubble has gone long enough and it’s extended enough that the minute they start tightening, the equity market should go down a lot. 

Particularly with so much of the cap weighted in growth stocks, which would be hit the worst. 

Don’t confuse a genius with a bull market. [Retail investors could] lose enough money that they’re scarred. 

I like a multi-disciplinary approach. My first boss taught me technical analysis. So, I use fundamental analysis and technical analysis. If there are 1000s of securities out there and my portfolio is only going to have 15-20, I’m never going to buy something that doesn’t have a great chart and fundamentals.

The other thing to me [that makes a good investor] is you have to know how and when to take a loss. I’ve been in business since 1976 as a money manager. 

I’ve never used the stop loss. Not once. It’s the dumbest concept I’ve ever heard. [If a stock goes down 15%] I’m automatically out. But I’ve also never hung onto a security if the reason I bought it has changed. That’s when you need to sell. 

Whether I have a loss or a gain, that stock doesn’t know whether you have a loss or a gain. You know, it is not important. Your ego is not what this is about. What this is about is you’re making money. So, if I have a thesis and it doesn’t bear out — which happens often with me, I’m often wrong — just get out and move on. Because I said earlier: if you’re using the most disciplined approach, you can find something else. There’s no reason to hang on to any security where you don’t have great conviction.

You just have to be disciplined and you’re constantly fighting on emotions. It doesn’t make any sense, but when a security goes up, every bone in your body wants to buy more of it. And when it goes down, you’re fighting and making yourself not sell it. It’s just the nature of the beast. And you cannot get crazy when it’s going up.

Don't waste your time on PE - focus on the business instead

There is a raging debate these days on the PE ratio. This debate is not new. It keeps cropping up typically when markets have been running at a high PE for a few years.

My thoughts on the PE debate is that it is a waste of time.

First, let's put an objective and quantitative hat and attack this problem. What is high PE? Is 15 high? Is 25 high? Is 50 high? Or is 100 high? No one answers this question. We cannot have a debate where what one is debating on is a vague notion. 

Second, let's look at what PE is. In absolutely layman terms, PE is the multiple of earnings one pays to buy a stock. Every asset value can be broken up into two parts - i) intrinsic value, which is derived from its tentative future cashflows and ii) transaction value, which is derived from what value someone else will pay for it in a transaction. For example, a painting or a flower vase has no intrinsic value, but it has a transaction value based on what another person is willing to pay for it. As a brief aside here, this is what is happening in something like Bitcoin today. It has no intrinsic value. Its entire value is derived from the transaction value.

Where investing becomes challenging is, both the intrinsic value and transaction value cannot be reliably estimated for the future. A discounted cashflow method is one of the well-known and practised methods of calculating intrinsic value. This method also needs a large number of estimates and guesses. You need to forecast future cash flows, possible capex, discount rate, terminal growth rate etc. Any major deviations in any of these make the entire DCF exercise near about meaningless. What DCF as a practice is good for, if done well, is it helps in thinking through different scenarios and look at different levers that impact the cashflow of the business. You can get a rough idea of a range in which the intrinsic value could be.

The transaction value, on the other hand, is purely a function of demand and supply. So, if you think a Da Vinci painting (or Bitcoin or a piece of rock, whatever) will have higher demand tomorrow than supply, and more people will be willing to pay more than what they are willing to pay today, then the transaction value goes up. Sometimes the transaction value depends on the factors that influence intrinsic value as well. If there is a general consensus that a company is likely to do well in the future even though they may not have done well in the recent past, the stock price does not suffer, as the transaction value compensates for the fall in intrinsic value.

In PE as in real-life asset prices, both these components are present implicitly. Two stocks with the same earnings may have completely different PEs. That is because both their intrinsic value and transaction values could be different. We see this phenomenon play out in the private equity market. Companies with no current earnings get a high PE, because either there is an expectation of higher future earnings or there is an expectation that its stock will have higher demand than supply in the future.

One way to practically use the PE ratio, which I personally use, is to look at the relative PE. It is clear from history that some companies which have better governance, management, growth etc are always valued higher (that is, their transaction value is higher) relative to others. So, a way to quantify this is to look at a company's PE to the index PE. If you do this exercise, what you do is you take away the exuberance of a bull market and the despondence of a bear market and normalise the PE ratio.

Another important point to understand is that PE is not a valuation metric that should be relied on solely for decision making. One reason why it is so popular is that it is easily available and everybody can use it, even if they do not understand anything about the business. 

 

My personal experience is that if, as an investor, you focus on understanding the business and its growth levers and leave the academic debates to others, you will probably do much better than if you focus on the PE debate and waste your time.

This article was first published in CNBC-TV18 - 

https://www.cnbctv18.com/market/dont-overanalyse-pe-multiple-understand-business-growth-levers-9439321.htm

Weekend Reading

Reading across disciplines is one of the best ways to improve our investment acumen. Here is a summary of some of the best articles I read this week. If you like this collection, consider forwarding it to someone who you think will appreciate it.

1. Align your goals to your habits to make lasting changes
A lot of organizations and individuals that are looking to create change just reach for off-the-shelf solutions that sound nice and that have been written about in other bestsellers before — books about setting big, audacious goals, for instance, or visualizing success. That sounds great, but what’s missing is a real appreciation of what is the barrier to change in your particular situation, because what’s going to work depends on what’s holding you back. That’s a key lesson.

If someone isn’t taking their medications regularly, you might not be able to get them to take those medications that they’re forgetting about by simply saying, “Hey, set a big, audacious goal.” If forgetting is the barrier, then you need to solve for that particular problem, probably with really effective reminders.

If you have a challenge of getting to the gym more regularly or staying off social media, then you probably have a completely different kind of problem. You don’t need reminders, you don’t need big, audacious goals. You need to find a way to make it so that the instantly gratifying choice is aligned with your goals.
https://knowledge.wharton.upenn.edu/article/want-to-get-unstuck-how-science-can-help/

2. If you overwork, you expose yourself to great health risk
People working 55 or more hours each week face an estimated 35% higher risk of a stroke and a 17% higher risk of dying from heart disease, compared to people following the widely accepted standard of working 35 to 40 hours in a week, the WHO says in a study. Between 2000 and 2016, the number of deaths from heart disease due to working long hours increased by 42%, and from stroke by 19%.

The study doesn't cover the past year, in which the COVID-19 pandemic thrust national economies into crisis and reshaped how millions of people work. But its authors note that overwork has been on the rise for years due to phenomena such as the gig economy and telework — and they say the pandemic will likely accelerate those trends.
https://www.npr.org/2021/05/17/997462169/thousands-of-people-are-dying-from-working-long-hours-a-new-who-study-finds

3. When push buttons freaked out people - (People are always scared of the impact of new tech)
Electric push buttons, essentially on/off switches for circuits, came on the market in the 1880s. As with many technological innovations, they appeared in multiple places in different forms. Their predecessors were such mechanical and manual buttons as the keys of musical instruments and typewriters. Before electricity, buttons triggered a spring mechanism or a lever.

At the end of the nineteenth century, many laypeople had a “working knowledge not only of electricity, but also of the buttons they pushed and the relationship between the two,” according to Plotnick. Those who promoted electricity and sold electrical devices, however, wanted push-button interfaces to be “simplistic and worry-free.” They thought the world needed less thinking though and tinkering, and more automatic action. “You press the button, we do the rest”—the Eastman Company’s famous slogan for Kodak cameras—could be taken as the slogan for an entire way of life.

People worried that the electric push button would make human skills atrophy. They wondered if such devices would seal off the wonders of technology into a black box: “effortless, opaque, and therefore unquestioned by consumers.”
https://daily.jstor.org/when-the-push-button-was-new-people-were-freaked/

4. Entertainment companies are changing the way they do business
In the 1960s, Theodore Levitt, a resident economist and professor at Harvard Business School unveiled his theory of “marketing myopia”. Specifically, he postulated that too many companies define themselves through their products rather than the need(s) they fulfill. This mindset exposes these companies to displacement and disruption. The classic example here is the petroleum industry, which, in its obsession with fossil fuels, has missed out on solar, nuclear, geothermal, etc. Another focuses on the major railway companies of the early 20th century, which missed out on buses, cars, and trucking due to their focus on trains not transportation.

It’s clear today that these company definitions are no longer right. Disney’s theatrically-focused film studio is inarguably the best in the world (it had roughly twice the revenue and three times the margin of the #2 player in 2019). However, Disney’s parks division generated more than twice the revenue and profit of its studio division. Disney’s future, meanwhile, depends on a direct-to-consumer video platform that’s mostly growing through television series not feature films.
https://www.matthewball.vc/all/what-is-an-entertainment-company-and-why-does-the-answer-matter

5. Why stock markets are not falling due to the pandemic
You would never know how terrible the past year has been for many Americans by looking at Wall Street, which has been going gangbusters since the early days of the pandemic. Even as hundreds of thousands of lives were lost, millions of people were laid off and businesses shuttered, protests against police violence erupted across the nation in the wake of George Floyd’s murder, and the outgoing president refused to accept the outcome of the 2020 election — supposedly the market’s nightmare scenario — for weeks, the stock market soared. After the jobs report from April 2021 revealed a much shakier labour recovery might be on the horizon, major indexes hit new highs.

To put it plainly, the stock market is not representative of the whole economy, much less American society. And what it is representative of did fine.

“No matter how many times we keep on saying the stock market is not the economy, people won’t believe it, but it isn’t,” said Paul Krugman, a Nobel Prize-winning economist and New York Times columnist. “The stock market is about one piece of the economy — corporate profits — and it’s not even about the current or near-future level of corporate profits, it’s about corporate profits over a somewhat longish horizon.”
https://www.vox.com/business-and-finance/22421417/stock-market-pandemic-economy

For building a solid long term portfolio, look at subscribing to www.intelsense.in long term advisory.

For technofunda investing and positional trading, subscribe to our Hitpicks advisory service on www.intelsense.in

For momentum trend following systematic trading, subscribe to Quantamental at www.quantamental.in 

Our Quant systems are also found at https://intelsense.smallcase.com