Pabrai, marketing, relationships and today

Longevity is more important that a short lived, sudden success.

Am currently watching Pabrai talking about Marketing and human relationships. One would think that someone in the stock market shouldn't care too much about the seemingly thoretical subject of marketing.
But, everything adds up.
For example, I can well imagine why Bajaj Auto will succeed where Hero will become mediocre.

Also talks a lot about cloning in businesses. It's fantastic to copy; somehow kids in India are more than happy to do so, but as grown-ups, they find it demeaning. 

In other news, there is a sudden bout of euphoria in the Indian markets because Narendra Modi will be India's next Prime Minister. Let's see what he does.
Meanwhile, I refuse to buy things based on prospects and at a price above my understanding.

There is a beautiful Seth Klarman quote.

“…conservatism may cause investors to refrain from making some investments that in hindsight would have been successful, but it will also prevent some sizable losses that would ensue from adopting less conservative business valuations.”

I think I am currently there right now. 

Price Actions

It's odd that one feels better with a paper gain than with a paper loss.
Particularly, when the underlying companies have similar performance, and potential prospects.

No wonder Buffett once said at an interview with the FCIC "... price action alone starts dominating people's minds."
Those words stuck with me, and now I see the gravity of the statement.

The potential of a value trap, the gnawing feeling of envy, and the doubt about an investment decision, all, after a period of time, are influenced by an asset price.

It is then that one has to sit back and question whether the mistake is in one's decision or in the markets'.

Mr. Market is there only to guide you, not to influence you.

I read this, and I spoke about this, but it is only in the face of exuberance that one questions one's judgements.

So many value investors

It's fun to see so many value investors out there who tend to focus on a company's moat and its growth potential. I find it odd that the word 'moat' has become so prevalent now, it seems that many companies have a moat.

People forget that a moat has to be wide, with crocodiles and Arnold Schwarzenegger in it (and Justin Bieber).

Anyway, I write today to emphasize the need for a margin of safety if one wants to be called a value investor. A margin of safety dictates that in the face of a downturn, the business is capable of withstanding the slowdown/ shock and then, able to realise its potential value.

In good times, investors forget about the margin of safety and conveniently account for that in terms of the growth of the company; said company shall grow, and in face of growing cash flows, my investment becomes safer.

It's easy to see the global potential for air coolers vis-a-vis air conditioners, but air cooler manufacturers may not be able to hold on to pricing pressures.
Consumer good manufacturers will compete with each other in a growing pie of the African and Asian and Latam continents, but only the best will be victorious.

Sanjay Bakshi recently wrote about the beauty of quality companies and how some of them have managed to deliver returns to shareholders even if shares were purchased at seemingly high valuations in the past. But very simply, people are focusing on the winners and not the losers. One could pick a potential good quality company today, and buy it at a good price, only to see it becoming Dexter Shoes, facing regulatory issues, or management issues.

Good quality companies are difficult to determine, and even when one finds such a company, what price allows for a margin of safety? Does a Bajaj Auto at 16-19x and 40-50% payout qualify as a good company with an adequate margin of safety? I think so - it's one of those rare beautiful companies. But does that make it a good investment today?

A rising tide lifts all boats. It is time for caution and hold on to that life vest.
Am afraid of Canada, China and Japan.

Mistakes

It's important to chronicle one's mistakes; it's humbling, humiliating and growth inducing.

People prefer talking about their winners, but it's the losers that one ought to worry about.

Luckily, position sizing helps with understanding the actual performance in a portfolio.

I bought Zylog Systems around the beginning of 2013. 

Of course, I have my original investment note citing a pure behavioural and Graham play.

There's a press release by the company saying nothing unusual is happening, and it is business as usual. This was when the share price was falling drastically, lower circuit after lower circuit.

" On the other hand the Promoters of the company have been buying and increasing their stake in the Company"

- Press Release.

I saw the balance sheet and said:

" Unless there is a fraud, I make money. " - this was at a share price of 73.

I did some background check on US visa applications, linkedin profiles, the canadian subsidiary (does it actually exist) and it did.

And then, there was some sort of a fraud; haven't been able to decipher what really happened. 

But, something wrong with receivables and the promoters used company money to buy shares in their own names.

So, there we go.

My hurry to invest and my disregard for potential fraudulent activity, caused me a few % points.

Lesson:

• Take it slow.
• Understand the downside
• Make sure you believe in the management
• Graham net-nets are quite a waste of time
• Spend more time on finding quality companies
• Understand the mistakes of others.

Mistakes of others:

• Dexter Shoes
• MTNL
• Cort Furniture
• Delta Financial
• US Air
• Berkshire Hathaway (original)
• General RE
• Renuka Sugar
• Bajaj Hindustan
• Suzlon

Lessons from Mistakes:

• Understand debt and debt covenants/ restrictions
• Understand industry changes
• Regulations have a tendency to kill companies
• Un-understandable liabilities are a pain to work with
• Can this business be seriously challenged?

I wrote this post after much deliberation, and based on the 2007 Berkshire letter where Buffett writes about his mistakes in "The good, the bad and the gruesome".

Portfolio

Writing after a long time on this blog.
Have learnt quite a few things, but the most recent thing is interesting.

Was going to increase a position size in one of my companies, and then read Confessions of a Value investor - Sanjay Bakshi, and something else by him where he says that some investors have the ability to increase their concentrations, but there is no need to.

• Just because that company is available, doesnt mean that you keep buying into it.
• There are many things that can go wrong with it even at this price of 3-4 PE; electric motors, oil prices, supply chain block
• Focus attention elsewhere
• Can always find another company in due time. 
• Am getting too greedy

Currently capping my cost-based investment in any security at 10%

1987

I believe that Classics are called Classics because they are. I read WB's 1987 letter to BRK's shareholders today.

• Mr. Market can act crazy, so it's important to wait for the right opportunities
• The best businesses are those which don't have to change themselves too much over a multi-year time frame
• It's better to be prepared with a loaded gun while hunting rare elephants - liquidity more important than opportunity cost
• He wasted his time (while at the partnership) by hunting for mediocre or bad businesses at cheap prices. His preference has become excellent businesses managed by good managers
• They are not macroeconomic analysts, or technical analysts or security analysts - they are business analysts. If they don't understand it, they won't go ahead
• There is no need to churn a portfolio based on a target price being reached. As long as a well bought business (marketable securities) is run well by good managers and is making a satisfactory return on equity, is churning out good quality earnings and is not overvalued - there is no need to sell out. Example: In 1987, GEICO, Cap Cities and the Washington Post Co. had a cost price of USD 560 Mn and a Market Value of USD 2 Bn. The Earnings were approx USD 100 Mn which is a 5% yield on market value of holdings; but I believe that his philosophy was that as long as things dont get wildly overpriced, the holding wont be sold

Market Inefficiences

One of the beauties of the markets is that they are based on the whims of human behaviour.
This is quite brilliant.

Tata Motors DVR 'A' shares
1/10th the voting rights, equal claims under liquidation and entitlements and 5% more dividend.
i.e. I need 10 DVR shares to cast a vote equivalent to a normal share's vote.
5% dividend: On a face value of INR 2/-, a DVR shareholder is entitled to 5%*INR 2 = INR 0.10 more of dividend against a normal share's dividend.

A company which has good corporate governance need not need shareholder activism especially if the some strong insurance funds and the promoter holding is excessive. Ergo, A Kingfisher Airlines may need shareholder activism whereas an Infosys would not. This of course is debatable but even in case of a dispute, the odds of shareholder activism in Infosys would be limited to something like "Please disburse cash" or "Please change your auditor".

If more A Shares are issued, the entire shareholder base is diluted and hence A shares are more or less the same as the normal shares (except for the voting rights).

If I were to say all the above, which flows correctly in terms of logic, one would assume both classes of shares to be trading at a similar price.
Fact: A Shares have traded at a 30%-50% odd discount to normal shares for a long time now.
However, and this is what most analysts fail to recognize, the shares are not convertible, and hence that does not necessitate convergence of values. But, the above information does necessite convergence.
In addition, the convergence can be in any direction.
All the posts I have read or people I have spoken to say that there is no logic for the huge discount, but they always talk in relative terms.

I say: Forget the discount. Focus on the price that is being demanded. Forget the normal shares' price. Focus on the DVR shares because they offer a roughly similar entitlement.
DVR A shares trade at INR 140 on a total base of 320 Cr odd shares which gives the company an equity value of INR 44,800 Cr or INR 448 Bn. Factor in some conversion and issues and we may come to INR 47,000 Cr.

PAT for the year was INR 13000 Cr largely because of a tax break. However, the tax break was real although not sustainable. Let's negate for taxes and PAT may reach INR 9000 Cr.
In addition, FY12 was not what one would call a good year; it was a 'decent' year. Just read about the Eurozone crisis, and the India slowdown and the US recovering and the China mystery :P
Alternatively, when one looks at fund flows to equity shareholders from JLR, it is a hefty INR 8500 Cr after R&D expenses and capacity investments of about GBP 1.5 Bn or INR 12000 Cr.
Muy Bien?

The India business' fund flows are not very clear but my estimate is that it was negligible because of the poor performance of the passenger vehicles segment and investments in capacity.

Based on broad ranges, the price of DVR shares seem to be attributing a value of 4x-6x P/E or a 5x-7x P/Cash Flow based on FY12 earnings.

The markets are brilliant because very few people can wait to see this market inefficiency be erased.
Retail investors are not patient.
PE investors will move away in 5/7 years.
MFs are subject to retail investor moods and always hold a diversified portfolio.
Luckily, I have a 10 year + horizon.

The potence of Tata Motors and of JLR is formidable - that evaluation will remain proprietary.