Wishing you and your near ones a Happy Diwali
Don’t chase prices higher.
I’ve lost count of the number of times I’ve said this over the past year or so. I do sound like a broken record but that is because you need that discipline to get good investing outcomes.
Stock picking reduced to its bare bones comes down to this –
1. Identify good businesses that can do well across market cycles
2. Estimate what might be a reasonable price range for the business
3. Buy the business when the opportunity presents itself
4. Stay put as long as the thesis plays out or till you find something better
There are confusing narratives around point (3) above. In spite of whatever philosophical gyan gets peddled in the media, one cannot debate basic arithmetic. You are better off buying a good business at a reasonable valuation rather than at peak valuation if you are a medium term long only investor.
The market does present opportunities to buy a good business closer to its reasonable price. This opportunity might come once in 18-24 months but it does come. Just that when the opportunity presents itself, there is a cloud of uncertainty around the business or on the broader market conditions.
Kotak Bank fell from 815 odd to 715 odd after demonetization, the same stock fell from 1400 odd to 1000 odd in H2 2019. Even the much revered HUL drifted down from 960 to 820 odd over a period of 15 months starting early 2015. Asian Paints has fallen 15% from the peak many times through bull markets. None of these stocks are in our recommended list as of date but you get the drift. A 15-20% fall from the peak is par for the course even for the best businesses during bull markets.
For the businesses that aren’t yet widely acknowledged by the market as high quality, a 25-30% fall from the peak is par for the course. There were no takers for Marico in Q4 FY20 when the price fell from 390 to below 300 within 6 months even before COVID hit. Many more examples if you take the time to look around.
We cannot know when such an opportunity comes but we can sure as hell make a probabilistic bet that such an opportunity will come for 6 out of 10 good businesses every 18-24 months. The only question is Are you disciplined enough to wait for such an opportunity and to add when things look uncertain?
All we are saying is don’t pay peak valuations for a business driven off an extrapolation of a short term buoyant trend in prices using high quality as a rationalization. Buy the same business when it trades closer to its reasonable valuation after accounting for your investment horizon. If it stays at elevated valuation, let the stock be and focus your efforts somewhere else. This discipline if executed consistently across cycles can add 3-4% to your annual return without having to go down the quality curve.
Through October we have seen some decent businesses fall 20%+ from their peak and we are still talking of mini cycles here, not really a full cycle yet. This pretty much reinforces our way of doing things. The financial media will do it’s best to convince us that these mini cycles do not matter, but the fact is that they do matter even if you cannot predict them. Go talk to the investor who bought HDFC AMC at 3500 two years ago, we’ve had this in our buy list but at a reasonable price estimate of ~2800 till recently. If anything our estimate of the reasonable price has moved higher recently, though the market doesn’t agree yet.
We cannot get it perfectly right on every stock, we just aim to avoid big mistakes at a portfolio level. And we do manage to pick a few multibaggers every cycle.