Thursday 14 November 2019
Friday 8 November 2019
The Quality Conundrum
This note is more to myself and for other small
investors. Last few years, I have had the opportunity to interact with a very
large number of small investors and have seen first hand atleast a thousand different
portfolios. This note is more to reassert to me the importance of looking
for quality first and price thereafter.
People are deriding quality companies and saying that
quality is in a bubble.
But let’s take a step back and ask what is quality? Is it
defined only by high PE stocks? Does quality exist in midcaps and small caps or
is only large/mega-cap companies’ quality? Can quality exist in companies
whose stocks are cheap? Are all expensive stocks good quality businesses?
Secondly, why is there a premium to perceived quality
companies today? Or conversely, why have small & mid-cap stocks corrected
so much? Are they all poor quality?
Some of the reasons that I think of are as follows:
- Failure of companies, including in large and famous corporates – Zee, NCLT cases
- Governance deficit in large well-known companies – Infosys whistle-blower, Yes Bank, DHFL
- Frauds and other issues – PNB, PMC Bank, IIFL
- Lack of ready information about small and mid-cap companies
- Midcaps & smallcaps had rallied to obscene valuations by 2017
- Weakness in the economy impacts the smaller companies slightly more than the larger ones
Investors are scared. Return of capital has taken precedence
over return on capital. That is why stocks of companies which investors think
are safe is at a premium. And everything else is relatively cheap.
Now, let me look at over-pricing. A lot of companies are at
very high PE multiple. Though I am not a very strong believer in looking at PE
in isolation, it does help in understanding the overall market sentiment when
used as a collective. I had tweeted a couple of days back about people talking
about high PE are ignoring the interest rate reduction. All things equal, if
you reduce interest rates from 12% to say 6%, the fair value that a DCF will
throw up is about 4 times. Now, you might argue that if interest rates fall,
all other things can’t remain equal. Fair point. So, lets discount that 4x to 3x. Heck, let's reduce it some more, say 2x or 1.5x. The broad point I am making is
that the median PE of stocks as a whole rise. And we have seen this play out in
real life as well. The NIFTY PE, for example, has moved up from 16-17 a few
years back to now about 26-27.
Now think from this angle, 10 years back, people were ready
to pay a 2.5-3x premium on median PE for the so-called high-quality companies. Now,
my contention is that that multiple for perceived quality will not change. Even
now investors would pay a similar markup. So, a high-quality company used to be
available at 30-40 PE when the market was at 15-16PE. How has that ratio changed
now? It is more or less the same.
I am for sure not making a case for buying a stock with
very high multiples or which is expensive based on its future earnings. But I
do have a problem when people are saying that quality is expensive, what
remains unsaid is “therefore move to cheaper, poorer quality businesses”.
Perhaps the most important thing is for those who can
identify great companies at cheap prices, then they should do precisely that.
But a vast majority of people can’t do that and end up buying mediocre or poor companies
just because they fixate on cheapness.
In my personal experience, retail investors are much much
better off being in quality companies with longevity than poorer companies
which can cause permanent capital damage. If you can find equally great kind of
companies at cheaper prices, then it is a no-brainer and no need to discuss at
all.
So, the next question is what happens next? I don’t know. My
take is this phenomenon will also mean revert. It may take some time, but it surely will. We are
going through a massive exercise of cleaning up corporate India and also a sort
of formalisation of the economy. As the good quality smaller companies come up
on governance as well as consistency of results, the premium for others will
reduce. People will then not take refuge in only a handful of stocks.
Are
there bubble-like valuations there today? Sure, a lot of stocks to me
definitely feel that way. But like any phase, this phase of over-valued quality
stocks will also change facilitating a more broad-based rally.
I am, like always, trying to find good quality companies
which are cheap based on their earning potential. But quality comes as the
first filter and cheapness next. I am willing to compromise on cheapness but
not on the quality of the business. Because history and my personal experience
tell me that buying and sticking to good quality does not hurt.
Another
example of holding on to quality that most people often cite is HUL’s flat
returns for 10 years. Trust me, I was there. I bought and finally sold HUL at
about the same price after a decade. Now, as a retail investor, the way I look
at it is this.
- I did not only have HUL in my portfolio, but there were also other stocks which did much better (or worse).
- I kept getting good dividends and also a good debenture,
- I did not lose money. I know a lot of people who put money in JP Associates, DLF, Unitech and other similar companies and lost 40-50% or more during the same period,
- If I had put a basket of 10 such strong business companies, I would actually have done quite well. I actually did this exercise much later after found that even well discovered fundamentally sound strong businesses have given exceptionally good CAGR returns over 20-25-year periods.
Another very important point to remember is that we
invest in a portfolio of stocks. Peter Lynch, one of the most successful
money managers, had different categories of stocks in his portfolio – slow
growers, stalwarts, fast growers, asset plays, turnarounds and cyclicals. So,
in a diversified portfolio is not about having only one or two categories of
stocks but a mix of different types of stocks.
Another point that is missed in this discussion is the time
horizon. For fund managers and advisors, usually, the time horizon is a problem
because they get “judged” by the returns in the short term. And quite a few
times, what is good in the short term ends up being harmful in the long term. Individual
investors can and should have much longer time horizons. As a retail small
investor, you don’t need to do anything all the time. If you are in the
market for the next 20-30-40 years, you are much better off with a collection
of great businesses than trying to get in and out of iffy companies because
they are cheap by some arbitrary parameter. For example, one approach to this
is to just pick 9-10 industries you like and which have long term growth
characteristics and pick either the best or two best companies in that
industry and build a portfolio. And then do nothing. Re-look at the portfolio
once every year. If you think the businesses are doing well in their respective
industry, again, do nothing. After 10 years, you are likely to end up much
better than most people who are trying to get in and out of stocks and markets
by giving the flavour-of-the-month reasons.
Happy investing.
Friday 1 November 2019
Weekly Reading - Some Interesting Stuff
1) Target fights back against Amazon, and wins!
In March 2017,
Target made a huge announcement: It planned to invest over $7 billion in a
turnaround strategy that would include:
- remodeling existing stores (and opening
smaller ones in urban areas);
- introducing new, private label brands; and,
- enhancing its digital shopping experience.
Wall Street thought
the plan was a disaster. On the day of the announcement, Target suffered its
largest stock plunge in almost a decade.
But fast-forward to
today, and Target is thriving. First-quarter results for 2019 beat analysts'
expectations. The store's private-label lines are exploding. And as comparable
store sales continue to rise, the stock price is trading at an all-time high.
2) Using Sequential Market Identification for
identifying stocks
In 1977, we financed
Apple… It was an era where knowing about microprocessors made the evolution of
the PC obvious. Steve Jobs was an employee at Atari in its early days. So I had
the advantage of all that knowledge before anybody else.”
It became very
apparent that Apple needed a different memory system. So Sequoia financed a guy
by the name of Jugi Tandon to go into a small five-inch disk drive business.
That decision was clearly driven by an application need in the PC which
required a solution that was faster, far more reliable, and had greater density
than an audiocassette. So we financed Tandon. And it was a spectacular
investment.” Tandon became a pioneering company in the PC disk drive
industry.
In 1987 we started
the internetworking industry with Cisco. We had previously invested in 3Com and
other similar companies, so we understood the connection of the Internet, and
all that it encompassed, probably better than most people. So we were looking
for Cisco when they were looking for us. That is how we prefer to invest, in an
anticipatory way.
The identification
of Ethernet and Internet infrastructure, specifically routers, were the third
and fourth successful applications of the the Sequential Market
Identification Model.
3) The skill of managing luck
Algorithms
are often much better at many decision tasks than humans.
Yet, research shows we’re more likely to choose a human forecaster
than an algorithm. And it’s ever worse when we see how an algorithm performs,
especially if it occasionally makes a wrong call. This is called algorithm
aversion.
epitomize the skill
of managing luck: they’re never certain, but constantly improving the odds.
That’s boring! It’s
not memorable or exciting. You don’t root for an algorithm. They never surprise
you on the upside. They’re never a hero, defying the odds. They don’t ‘try
hard’. They don’t offer a narrative.
4) What is happening in Venezuela?
Consumer prices have skyrocketed, and
the International Monetary Fund expects the inflation rate to
reach 10 million percent in 2019, which would be one of the worst cases of
hyperinflation in modern history.
Violence and hunger are widespread. Food shortages have reached new highs in recent
months, and 80 percent of Venezuelan
households don’t have sufficient access to food, according to monitoring groups. Grocery store shelves are
bare. Hospitals struggle to treat severely malnourished children.
The country’s public health system has collapsed,
leaving many without access to lifesaving medicine. The rates of several
preventable diseases have risen.
The migration of Venezuelans out of the
country has reached levels not seen before in modern history.
More than three million people have left since 2014
5) Why don't rich people stop working?
Studies over the
years have indicated that the rich, unlike the leisured gentry of old, tend
to work longer hours and spend less time socializing. And they
continue to diversify. Many of these people have been navigating work and
life in sixth gear for decades. Once they have no financial need to work they
have trouble shifting into lower gears.
Friday 25 October 2019
Weekly Reading - Some Interesting Stuff
1) Studying English may be a better career option than
science / engineering
There’s no denying
that the typical computer science major makes more money shortly after
graduation than the typical English major.
Contrary to popular
belief, English majors ages 25 to 29 had a lower unemployment rate in
2017 than math and computer science majors.
That early STEM pay
premium also fades quickly, according to research from Harvard. After
about a decade, STEM majors start exiting their job fields as their skills are
no longer the latest and greatest. In contrast, many humanities majors work
their way to high-earning management positions. By middle age, average pay
looks very similar across many majors.
2) Amazon starts making private label alcohol
Amazon is adding to
its own-label product line with its first spirit brand in the U.K. called
Tovess Gin. Amazon has been expanding its own range of goods, listed under “Our
Brands”, which are created by Amazon or its partners and sold exclusively on
the site. These benefit Amazon by offering better margins and can be used to
help persuade big brands to cut prices. Tovess gin is the only alcohol product
listed as an Amazon brand on the U.K. site, while other groceries include
Amazon Brand Solimo coffee capsules, Presto! kitchen rolls and Happy Belly
dried fruit and nuts.
3) McDonalds is using ML and AI to
make you order more
The chain has digital boards programmed to market that
food more strategically, taking into account such factors as the time of day,
the weather, the popularity of certain menu items and the length of the wait.
On a hot afternoon, for example, the board might promote soda rather than
coffee. At the conclusion of every transaction, screens now display a list of
recommendations, nudging customers to order more.
At some drive-throughs, McDonald’s has tested
technology that can recognize license-plate numbers, allowing the company to
tailor a list of suggested purchases to a customer’s previous orders, as long
as the person agrees to sign away the data.
In March, McDonald’s
spent more than $300 million to buy Dynamic Yield, the Tel Aviv-based company
that developed the artificial intelligence tools now used at thousands of
McDonald’s drive-throughs.
The deal “has
changed the way the high-tech industry thinks about potential M&A,” said
Liad Agmon, a former Israeli intelligence official who co-founded Dynamic
Yield. “We’ll see more nontraditional tech companies buying tech companies as
an accelerator for their digital efforts. It was genius on McDonald’s side.”
4) When Peter Lynch speaks, we listen
On the way to work, the amount of bad news you could
hear is almost infinite now. So the question is: Can you take that? Do you
really have faith that 10 years, 20 years, 30 years from now common stocks are
the place to be. If you believe in that, you should have some money in equity
funds.
It's a question of what's your tolerance for pain.
There will still be declines. It might be tomorrow. It might be a year from
now. Who knows when it's going to happen? The question is: Are you ready—do you
have the stomach for this?
More people have
lost money waiting for corrections and anticipating corrections than in the
actual corrections. I mean, trying to predict market highs and lows is not
productive.
5) Nike goes hi-tech, gets a tech CEO for itself
Donahoe is currently
the CEO of ServiceNow, a provider of cloud-computing services for global
businesses. Prior to that, he served as CEO of eBay from 2008 to 2015, and also
did a stint as CEO and managing director of the management consultancy Bain &
Co. He may not sound like the most obvious choice to succeed Parker, who
started at the company as a footwear designer and has deep knowledge and
experience in sneakers. What Donahoe does understand is technology, something
Nike has been investing in heavily. Last year it acquired the data-analytics
firm Zodiac. This year it bought Celect, a company specializing in predictive
analytics.
Thursday 17 October 2019
Weekly Reading: Some Interesting Stuff
1) The new marathon record, which was not a marathon!!
Like the moon
landing, Kipchoge’s run was a technical achievement that required unprecedented
planning and support. In fact, it was so heavily engineered that his new time
will not count as a world record. Kipchoge ran the fastest time ever over the
marathon distance, but for heated reasons that get at the heart of the sport,
he did not run a marathon.
To sustain this
blistering pace, Kipchoge ran under conditions that had been painstakingly and
exclusively arranged to push him beyond the two-hour barrier.
Challenge was not a
race by any strict definition: It was simply Kipchoge, joined by a rotating
phalanx of pacesetters, rocketing along the pavement against the clock.
2) We are nearing the endgame for PE funded
non-businesses burning cash
Consumer tech
companies, along with their venture-capital backers, help fund the daily habits
of their disproportionately young and urban user base.
But this was never
going to last forever. WeWork’s disastrous IPO attempt has triggered
reverberations across the industry. The theme of consumer tech has shifted
from magic to margins. Venture capitalists and start-up founders
alike have re-embraced an old mantra: Profits matter.
And higher profits
can only mean one thing: Urban lifestyles are about to get more expensive.
3) Facing unbearable heat, Qatar has begun to
air-condition the outdoors
Qatar is one of the
fastest warming areas of the world, at least outside of the Arctic. Changes
there can help give us a sense of what the rest of the world can expect if we
do not take action to reduce our greenhouse gas emissions.
To survive the
summer heat, Qatar not only air-conditions its soccer stadiums, but also the
outdoors — in markets, along sidewalks, even at outdoor malls so people can
window shop with a cool breeze. “If you turn off air conditioners, it will
be unbearable. You cannot function effectively,” says Yousef al-Horr, founder
of the Gulf Organization for Research and Development.
Yet outdoor air
conditioning is part of a vicious cycle. Carbon emissions create global
warming, which creates the desire for air conditioning, which creates the need
for burning fuels that emit more carbon dioxide. In Qatar, total cooling
capacity is expected to nearly double from 2016 to 2030, according to the
International District Cooling & Heating Conference.
And it’s going to
get hotter.
4) Afternoon siesta is good for you (now I am
guilt-free!!)
There is evidence to
suggest that normal sleep does not consist of one block of 7 1⁄2 hours during
the night. It is more likely that our biology is designed to allow us to sleep
for about 6 hours during the night and 1 1⁄2 hours during the day. Sleeping
just once in 24 hours is called monophasic sleep, whereas broken sleep is
polyphasic. In evolutionary terms, polyphasic animals are the most common,
whereas monophasic animals have evolved more recently. Polyphasic patterns of
sleep are the most common.
In an ideal
biological world, napping (polyphasic) sleep might be best, as the body is
never unduly stressed.
5) The US military is trying to read minds
The goal is to
eventually develop accurate and sensitive brain-computer interfaces that can be
put on and taken off like a helmet or headband—no surgery required.
Human skulls are
less than a centimeter thick: the exact thickness varies from person to person
and place to place. They act as a blurring filter that diffuses waveforms, be
they electrical currents, light, or sound. Neurons in the brain can be as small
as a few thousandths of a millimeter in diameter and generate electrical
impulses as weak as a twentieth of a volt.
Saturday 12 October 2019
Weekly Reading - Some Interesting Stuff
From its reign as
king of the mall just a few years ago to its tumble into bankruptcy court last
month, Forever 21 is a spectacular success story that seems destined for an
unhappy ending.
South Korean
immigrants Jin Sook and Do Wan Chang started the chain in 1984 with $11,000
that they saved from working in low-paying service jobs. Their first store was
a 900-square-foot space in Northeast Los Angeles that offered cheap and trendy
clothing to a young, mostly Korean-American clientele.
Their fast-fashion
business model, which was based on quick-turnaround designs that could be
inexpensively mass produced, proved wildly popular with young customers who
didn’t have much money to spend but wanted the latest looks. By 2015, global
sales peaked at $4.4 billion, with 480 stores occupying enormous spaces in
malls across America
2) Look who is certifying our food
International Life
Sciences Institute, a U.S. nonprofit with an innocuous sounding name has been
quietly infiltrating government health and nutrition bodies around the world.
Created four decades ago by a top Coca-Cola executive, the institute now has branches
in 18 countries. It is almost entirely funded by Goliaths of the agribusiness,
food and pharmaceutical industries.
The organization,
which championed tobacco interests during the 1980s and 1990s in Europe and the
United States, has more recently expanded its activities in Asia and Latin
America, regions that provide a growing share of food company profits. It has
been especially active in China, India and Brazil, the world’s first, second
and sixth most populous nations.
After decades
largely operating under the radar, ILSI is coming under increasing scrutiny by
health advocates in the United States and abroad who say it is little more than
a front group advancing the interests of the 400 corporate members that provide
its $17 million budget, among them Coca-Cola, DuPont, PepsiCo, General Mills
and Danone.
3) Disinformation for hire
The staples of
Russian misinformation campaigns—fake news and social media propaganda—are
turning up in a new place: the private sector. For a small fee, companies can
pay Russian operatives to boost their image or smear their competitors,
employing some of the same tactics used by the Kremlin to disrupt the 2016 U.S.
presidential election.
The range of
services offered by the Russian PR firms is startling. Not only do the firms
deploy fake accounts on social networks like Facebook and LinkedIn, but they
offer a service to plant news articles in English-language media outlets.
4) Mental toughness is the key to success
Research is starting
to reveal that your mental toughness — or “grit” as they call it — plays a more
important role than anything else when it comes to achieving your goals in
health, business, and life. That’s good news because you can’t do much about the
genes you were born with, but you can do a lot to develop mental toughness.
Mental toughness is
like a muscle. It needs to be worked to grow and develop. If you haven’t pushed
yourself in thousands of small ways, of course you’ll wilt when things get
really difficult.
5) How Fogg came to dominate the deo market and
displaced MNCs
An old article on
how Fogg went about dominating he market and overtook HUL, ITC, Nivea and
others. The domination continues even today.
The answer lies in
the brand’s ability to reinvent itself, constantly. From being a newbie
pitching product attributes such as ‘No Gas, Only Perfume’ to a brand
talking to youngsters as well as the older generation, Fogg has done
it all in a bid to stay relevant to its consumers.
Patel admits his
strategy has been to expand the toehold that Fogg initially gave him. ‘No
Gas, Only Perfume’ was all about how the fragrance of the deo lingered on
the body rather than vaporising into thin air, which was a flaw in most deodorants
back then.
Fogg also advertised
this proposition heavily in its early days, comparing number of sprays of
average deos versus its own ability to do so. The consumer was clearly
excited.
Friday 4 October 2019
Weekly Reading - Some Interesting Stuff
1) Thomas Cook, which pioneered the concept of
packaged holidays, is now officially bankrupt
The bankruptcy of
Thomas Cook Group Plc, the company whose founder is credited with inventing the
modern tourist industry, is being blamed on Brexit, a series of
bad management decisions and an unsustainable debt level. Perhaps, however,
it’s worth looking at Thomas Cook’s failure as the beginning of the end of the
tourism model the company helped create.
2) How our memories work against us
Our memories are not
an accurate recording of the past. They are constructed from imperfect
perception filtered through our beliefs and biases, and then over time they
morph and merge. Our memories serve more to support our beliefs rather than
inform them.
There is no easy way
to develop a deep understanding of a topic. In-depth research requires that we
consider a variety of perspectives. One way to reduce the risk of memory
contamination is to inform ourselves with facts before exposing ourselves to
the tabloid version. When we have a fully informed opinion and a broad
understanding, sensational headlines have less of an emotional impact.
Personally, I don’t
think it’s healthy to read too many sensational headlines. I find that these
exaggerations can get mixed into my memory and mess things up.
3) How technology disrupts in unpredictable ways
In 1978, Head got
one of his new oversized rackets into the hands of a talented 16-year old named
Pam Shriver. Although Shriver entered the U.S. Open unseeded, she ended up
beating Martina Navratilova in the semifinals. Pros took notice: by 1984,
composite rackets had taken over the tour.
This is a portrait
of technological disruption.
Why were composite
rackets so hard on the oldest players? Head, after all, invented the composite
racket to help old guys like himself hit good shots; it was supposed to level
the playing field. And yet, his invention ended up doing the exact opposite, tilting
the competitive balance in favor of youth.
While Howard Head
was trying to create a bigger sweet spot for amateurs, professionals didn’t
really need a bigger sweet spot. Instead, they used these new rackets to give
their shots more topspin.
4) We are all ignorant & confident idiots!
In many cases,
incompetence does not leave people disoriented, perplexed, or cautious.
Instead, the incompetent are often blessed with an inappropriate confidence,
buoyed by something that feels to them like knowledge.
An ignorant mind is
precisely not a spotless, empty vessel, but one that’s filled with the clutter
of irrelevant or misleading life experiences, theories, facts, intuitions,
strategies, algorithms, heuristics, metaphors, and hunches that regrettably
have the look and feel of useful and accurate knowledge. This clutter is an
unfortunate by-product of one of our greatest strengths as a species. We are
unbridled pattern recognizers and profligate theorizers. Often, our theories
are good enough to get us through the day, or at least to an age when we can
procreate. But our genius for creative storytelling, combined with our
inability to detect our own ignorance, can sometimes lead to situations that
are embarrassing, unfortunate, or downright dangerous.
5) Brazilian football is dying (of corruption)
If football is a
religion in Brazil, a prayer might be in order. A conspiracy of blunders and
malfeasance by professional football’s elite handlers has squandered talent and
left the cherished national institution in shambles. As a result, Brazil’s
signature sport has suffered a drought of trophies (Brazil’s last World Cup
title was in 2002), empty bleachers and abandoned stadiums, not
to mention the dreaded “foot drain” that sends the game’s most
promising players abroad in their prime.
Without thorough
reform, the football system that put ballet on grass and captured five
World Cups with marquee stars from Pele to Ronaldo is headed for an
international reckoning and almost certain insolvency.
https://www.bloomberg.com/opinion/articles/2019-10-03/brazilian-football-is-on-the-brink-of-self-destruction
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