Building the Right Investment Temperament - Excerpts from Howard Marks - Part 4

Howard Marks has written extensively on risk and its management.

The riskiest things: the most dangerous investment conditions generally stem from psychology that's too positive. For this reason, fundamentals don't have to deteriorate in order for losses to occur; a downgrading of investor opinion will suffice. High prices often collapse of their own weight.

The greatest risk doesn't come from high quality or high volatility. It comes from paying prices that are too high. This isn't a theoretical risk; it's very real.

Most investors think quality, as opposed to price, is the determinant of whether something's risky. But high quality assets can be risky, and low quality assets can be safe.

Risk is inherent in the price you pay for stocks. The higher price you pay, the higher risk there is. Irrespective of the quality of the business.

The possibility of a variety of outcomes means we mustn't think of the future in terms of a single result but rather as a range of possibilities.

No one knows the future, so deterministic projections make little sense. It is better to think in terms of a range of outcomes that covers the most likely future scenarios.

Invariably things can get worse than people expect. Maybe "worst case" means "the worst we've seen in the past". But that doesn't mean things can't be worse in the future.

Careful risk controllers know they don't know the future. They know it can include some negative outcomes, not how bad they might be, or exactly what their probabilities are.

Case in point, 2008, was much worse that what most investors had expected.
 

I'm very happy with the phrase "perversity of risk". When investors feel risk is high, their actions serve to reduce risk. But when investors believe risk is low, they create dangerous conditions. The market is dynamic rather than static, and it behaves in ways that are counter-intuitive.

My core investment assumption is that the market is a complex adaptive system and is auto-correcting in nature. we cannot determine outcomes from a linear thought process.

The road to long-term investment success runs through risk control more than through aggressiveness. Over a full career, most investors' results will be determined more by how many losers they have, and how bad they are, than by the greatness of their winners.

If you minimize your losers, the winners will take of itself!

Building the Right Investment Temperament - Excerpts from Howard Marks - Part 3

There are two essential ingredients for profit in a declining market: you have to have a view on intrinsic value, and you have to hold that belief strongly enough to be able to hang in and buy as price decline suggests you are wrong. Oh yes, there's a third:you have to be right.

This will only come from experience of being right about your view.

For a value investor, price has to be the starting point. It has been demonstrated time and time again that no asset is so good that it can't become a bad investment if bought at too high a price. And there are a few assets so bad that they can't be a good investment when bought cheap enough.

There's no such thing as a good or bad idea regardless of price!

This is a critical point that people miss in their quest for "quality" stocks!! **Quality is not irrespective of price.**

Investing is a popularity content, and most dangerous thing is to buy something at the peak of popularity. At that point, all favourable facts and opinions are already factored into its price, and no new buyers are left to emerge.

There is no easy way of identifying when the peak of popularity is reached. But one should have a general sense of when prices have gone up way beyond their worth. And then the trick is to have the emotional fortitude of getting out of the position.

The safest and potentially mist profitable thing to do is to buy something when no one likes it. Given time, it's popularity, and thus it's price, can only go one way: up.

This requires a certain mindset of contrarianism and ability to sit through extended period of non-performance of stock price. This may specially be difficult when other stocks are running up consistently.

Building the Right Investment Temperament - Excerpts from Howard Marks - Part 2

Since other investors may be smart, well-informed and highly computerized, you must find and edge they don't have. You must think of something they haven't thought of, see things they missed bring insight they don't possess. You have to react differently and behave differently.

Out of the main four edges that an investor can have, namely i) information, ii) analytical, iii) knowledge and iv) time, here Marks is talking about the analytical or insights edge. With the same set of information, can you have better or different insights which will result in a differentiated result for your portfolio.

To achieve superior investment results, you have to nonconsensus views regarding value, and they have to be accurate.

For your performance to diverge from the the norm, your expectations - and thus your portfolio - have to diverge from the norm, and you have to be more right than the consensus. Different and better: that's a pretty good description of second-level thinking.

I think this is the simplest yet most overlooked part. You cannot get superior results by doing what everyone around you is doing. Some investors I know of surround themselves only with people who have very similar viewpoints about life and markets. To me, they are living in an echo chamber. To really have a nonconsensus view, you have to actively look for disconfirming evidence. That is, an idea which is exactly opposite to the one you hold.

As Charlie Munger has said, " It's bad to have an opinion that you are proud of if you can't state the arguments for the other side better than your opponents."

Building the Right Investment Temperament - Excerpts from Howard Marks - Part 1

Over the years, I have come to the conclusion that the most critical aspect in investing is to be able to build the right temperament. To me this is the secret sauce that separates the men from the boys and enable some to consistently outperform others, and their benchmarks.

Temperament is something that needs to be learnt through experience. We can augment it by taking a leaf out of the book of the masters. Over the last 15 years, I have tried to read as much as possible about experiences of great investors and fund managers, to try to understand how to improve my temperament.

Let me start a series of posts on this topic over the next few days, with the writings of a great investor who I have followed for the last decade. Not only is he a great investor but he is a fantastic communicator and has that rare gift of making complex subjects appear simple. He also is extremely generous in sharing his knowledge and experience with the general public. He is Howard Marks.
You can read his book "The Most Important Thing Illuminated"


His memos are available at https://www.oaktreecapital.com/insights/howard-marks-memos

Here are some excerpts from his book and some commentary where it is necessary:

To me, risk is the most interesting, challenging and essential aspect of investing.

The real test of investing is not getting returns but ensuring the downside is always protected. As Buffett has said famously, "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1."

You must be aware of what's taking place in the world and of what results those events lead to. Only in this way can you put the lessons to work when similar circumstances materialize again. Failing to do this - more than anything else - is what dooms most investors to being victimized repeatedly by cycles of boom and bust.

History, of markets and in general, is essential to know. You need to understand the causality of consequences of events. Those who do not know history are condemned to repeat it. Which basically means you need to have some mechanism of capturing your past mistakes for posterity and are able to ensure that they are not repeated again.

ACTIONABLE - A checklist of past mistakes and the reason those occurred is a good starting point.

Techno Electric: Q2 Concall Summary

Q2 Concall Summary

• Order book as on 30th September 2016 stands at Rs.2,500 crores, which includes our L1 position in 765 kV Substation Package at Raigarh, Indore and Itarsi and the package value is about Rs.150 crores.
• For PGCIL, the ratio of investment between line and substation has undergone change from 80:20 to 65:35.
• In Wind segment the related challenges have eased, we are witnessing improvement in grid availability in State of Tamil Nadu and the overall wind flow has been positive.
• Revenue from EPC almost jumped by 47% from Rs.202 crores to Rs.297 crores. Consolidated revenue for the quarter also grew by 34% to Rs.368 crores against Rs.253 crores achieved during the same quarter of the previous year.
• Operating profit for the EPC segment for the quarter stood at Rs.45.88 crores as against Rs.33 crores, showing a jump of 38.56%. Operating profit margin for the quarter stood at 15.46%.
• The PAT on standalone basis for the quarter stood at Rs.44.79 crores as against Rs.34.07 crores last year, showing a growth of 31.46%. On consolidated basis, the PAT has jumped by 58% for the quarter at Rs.70 crores against Rs.44.5 crores.
• Able to manage the receivables within 100-days cycle which is one of the best in the industry.
• Outlook is very positive. States are now coming more ahead of the Power Grid also in building their own networks particularly the states having more of renewable power with them as well as some transmission networks with the other states. Seeing a strong momentum in the State of MP, Rajasthan, Chhattisgarh, Andhra, Telengana, Tamil Nadu, all are becoming fairly active.
• There is no impact on margins with more orders from state electricity board
• Payments are received directly from the funding agencies like REC/PFC/ADB
• Domonetization has not adversely impacted operations. On the contrary, it has helped. Construction material cost is now 10% to 15% lower.
• Consolidated debt is 300cr (275 cr in Simran and 25cr in Techno). Practically, short term debt free (5 cr)
• Cash balance is 225 cr
• Expect PAT margin over consolidated top line to be around 14.5-15% this year as against 11-11.5%

Stock Idea - PNC Infra

SECTOR BACKGROUND
Awarding activity in road sector has picked up pace in the past two years and is expected to remain firm in the next 2-3 years. In FY16, the government awarded 10000 km of road projects and in the current financial year, it targets to award over 25000 km or Rs 3 trillion of road projects. This trend is expected to continue in the coming years.

COMPANY BACKGROUND
•    PNC Infra Ltd (PNC) is a north-based EPC/BOT contractor
•    Strong order book visibility: PNC has an order book of ~ Rs 5100 crores (2.5x FY16 EPC revenues). Further, PNC has won Rs 1374 crores worth of orders won from April 2016 till date, financial closures of which are expected to be achieved by October 2016. 
•    Strong execution track record: PNC has a proven track record of early completion of projects in a sector marred by inordinate delays. It has the distinction of being among the
first few to receive an early completion bonus from NHAI.
•    Multiple operating efficiencies: PNC’s four pronged strategy:

    a.    conservative bidding
    b.    operating in a core geographic cluster
    c.    ‘No subcontracting’ policy in critical construction activity and
    d.    a large equipment bank, have enabled the company expand its EBITDA margin 500 bps during FY13-FY16 to ~17%.

•    In FY16, PNC enjoyed a 11% market share of the NHAI’s Rs 48,100 crore EPC order book, second only to the infrastructure behemoth, L&T (12% share).
•    PNC has executed ~75-80% of its road projects in UP, Jharkhand, Bihar and Rajasthan. These states have a robust pipeline of road EPC projects over 2016-17 – 4 states alone account for 36% of the 6631 kms of road projects that NHAI intends to award in FY16.
•    The govt is now acquiring 80-90% of the land before announcing the date for commencement for construction
•    Gathered enough qualification credentials to independently bid for a single project to a tune of over Rs. 3,000
•    Currently co is executing 16 projects in roads & airport runway sector
•    Currently we have 7 operational BOT projects of which 5 are Road BOT projects, 1 is Road OMT project and 1 is Industrial Development project
•    Our consolidated net worth as on June 30, 2016 is Rs. 1,364 crores whereas total debt is Rs. 1,722 crores. Net debt to equity comes at consolidated basis comes at 1.13 times.
•    There are 17 new EPC orders worth Rs 15,000 cr that will be up for bidding
•    Toll Revenues - Gwalior - Etawah MP Highway is Rs. 15.5 crores; Kanpur - Ayodhya is Rs. 69.8 crores; Kanpur Highway is Rs. 24.7 crores and Bareilly - Almora was Rs. 9.6 crores; Ghaziabad - Aligarh is 37 - 38 lakhs per day
 •    PNC has long history in the roads sector with over 15 years of experience in executing NHAI projects. PNC has track record of timely and before schedule completion of projects and received early completion bonus.
•    PNC is focused on the northern region and is expected to be a strong contender for grabbing future opportunity in road construction from poll bound states like UP and Punjab.
•    PNC has robust current order book of Rs 64.7 bn and further targets to add another ~Rs 40 bn of orders in the rest of the year based on robust pipeline of orders specifically in road space. This gives high revenue growth visibility for the next 2-3 years.



Understanding the Hybrid Model of Road Development
Funding - The government will contribute 40% of the project cost in the first five years through annual payments (annuity); developer to raise remaining 60% through debt or equity. Semi-annual annuity payments will be paid to the developer for the balance 60% of the project cost

Disbursement - Government's 40% contribution will be disbursed in accordance with the project completion milestones (24%, 40%, 60%, 75%, and 90%)

Revenue Collection -
i) Responsibility of NHAI
ii) The Government / NHAI will collect the toll and pay the developer annuity payments over 15 years along with interest thereon at bank rate + 3%. The developer will also receive O&M payments bi-annually along with annuity payments.
iii) All project payments will be inflation indexed.

RISKS & CONCERNS
•    Slowdown in road sector
•    Aggressive bidding of projects
•    Inflows of large size BOT projects





FINANCIALS
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Disclosure: I am invested in the stock and my views are likely to be biased. Please do your own due diligence or consult a SEBI registered investment analyst.