Use principles of reduction to avoid most avoidable mistakes. This is not the first time, neither will it be the last time you will hear me say this.
Let us get around to defining what investing is NOT
- An exercise in precision (precise estimates of growth/profits/valuation)
- A macroeconomic discourse (predicting what the GDP/inflation/fiscal deficit will be)
- An intellectual activity where one gets too definitive or deterministic
- A debate with anyone who has a contrarian view (for this very reason, I hate posting opinions on social media platforms)
- A display of unwarranted confidence (this is good for selling but not for investing)
- Getting married to stocks because someone thinks that is the best way of investing
- Switching between mean reversion and extrapolation based on convenience (this one is complicated and deserves a whole post by itself)
- Having a view on every company that is listed
- Having a view on everything under the sun (works in a B-school GD, not in investing)
- Having a view on what the FM/PM should do
- Having a view on what the RBI Governor should do
- Tracking what some famous fund manager is buying/selling and for what reasons
This list can go on but the big message is that investing is not what business news channels tells you it is. Investing should not feel like this
For the record I do watch these business news channels but only to get a sense of what narratives are being peddled and to what reasons market gyrations are being attributed to. These are the kind of headlines I am talking about
“Equity markets fall on fresh fears over the COVID-19 pandemic”
“Equity markets rise on hopes of a vaccine before end of the year”
Delving deeper into some of these factors
The number of businesses and sectors one needs to track
For more than 8 years, I did not hold single business from either of these sectors –Financials, Pharma, IT. I did not have any strong views on these sectors either, I was largely clueless about pharma till 2017. These three sectors have generated some of the best-known wealth creators in the Indian market, together they accounted for a weightage of more than 50% in the NIFTY 50 in Feb, 2020. Well, it did not compromise my ability to generate healthy returns.
In spite of being micro-cap heavy and not being present in these sectors, the 5-year annualized return of my legacy portfolio as of September 30, 2020 is close to 18%. Not bad when one considers that the largest equity PMS delivered a similar return in their flagship scheme over the same period. Even more so given the carnage that happened in the small and micro cap segments in 2018 and 2019. Also note that the ratio of up/down quarters relative to the benchmark is 3:1
Since 2018 my style is more market cap agnostic, if I take into account the return on my overall portfolio, the return will be much higher than what you see below.
You just need to know your set of businesses well enough and be reasonably diversified.
20 stocks more often than not get the job done, for the record I had less than 15. Rather know 40 businesses well than knowing a bit about 500 businesses.
Estimating growth and earnings accurately over the near term
This is important if your investment horizon is less than 18 months, but if your horizon starts to approach 5 years this becomes less important. My accuracy in estimating next FY’s earnings is pathetic to say the least. But over the medium term, I manage to get the business trend right more often than not.
When I sit down to build my valuation models for a business, I am more interested in figuring out the possible range of outcomes, what the medium-term trend is likely to be and what scenario the current price appears to be pricing in. Getting the next few quarters or next FY’s growth/earnings number right has never mattered much to me, my style of investing affords me that luxury.
Case in point, read my public post from 2016 here – https://forum.valuepickr.com/t/apl-apollo-tubes/366/4
I got the medium trend spot on but my estimates for near term earnings were inaccurate as usual, did not cost me much. Netted me a 10 bagger in 6 years, not a bad outcome at all.
Having a view on most things under the sun
There is a saying that only fresh B-school graduates have a firm opinion on everything. Though I was not a fresher when I went to B-school, I was as idiotic in this aspect back then.
“I don’t know, let me figure this out” – This is my answer today to things I don’t understand well enough, which is 95% of the listed businesses in the country. Investors are an opinionated lot by nature, sometimes we shoot off opinions even when we haven’t done the work it takes to have an opinion. The market does not punish you for making idiotic statements, the market punishes you for wrong actions.
Unless one is in the business of asset management (which I am and hence need to profess my opinion on things occasionally), it does not make sense to express opinions without doing the ground work. If “Don’t know, don’t care” is the motto of the passive investor, the active investors motto should be “I don’t know, let me figure this out”
One does not need to play every single theme in the market
This way, you stick to the pockets where outcomes are more likely to be in your favor over time. Sticking to your “circle of competence” is one way of doing this, having a well-crafted negative list is another way. As of date, I am tending towards the latter more than the former.
I can go on about more aspects but that would be an overkill.
Once you have a clearly articulated process that demarcates what you will do and what you will not do, you drastically reduce the complexity involved in investing. Some of the best fund management houses have an investible universe of hardly 80 companies, in spite of having a ten-member research team. In the fund I run, I have a universe of 40 companies at this point of time.
For a part time investor, it is unbelievably tough to understand and track 20 businesses, leave alone 100 businesses. I’ve been there, done that. Before I became a full-time investment manager, I could hardly track 25 businesses well enough.
Have a well-defined investment process that is durable, in line with your objectives and one that you can follow across market cycles.
It took me more than 5 years to crystallize things to a level of simplicity that I can explain in a single slide. Simple but not easy. If you can’t explain your investment process in simple terms, you most likely do not have one.
