Super Investors of India

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TABLE OF CONTENTS Page No. Preface

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The Secret of India's Superinvestors

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Cloning Warren Buett

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__ __ __ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ Forget the CNBC Gurus...It's Time to Listen to India's Really Successful Stock

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Pickers

__ __ __ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ Our Meeting with India's Peter Lynch

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Finding Multibaggers - The Kenneth Andrade Way

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Professor Damodaran: Our Meeting with an Authority on Valuations

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Meet the Fund Manager Who Walks the Less Trodden Path

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__ __ __ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ Our Private Class with India's Value Investing Guru

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__ __ __ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ Part II of Our Private Class with India's Value Investing Guru

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__ __ __ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ __ __ _ __ __ __ _ __ __ __ __ __ __ _ __ The Man Who Knows the Secret to Spotting 100 Baggers

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A Little Known Way to Clone India's Super Investors

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How I Discovered Smart Money Secrets

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Author Prole

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Disclaimer

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Index

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Preface Dear Reader, A year ago, my colleague Kunal Thanvi and I revisited Warren Buett’s classic presentation about The Superinvestors of Graham-and-Doddsville. This elite group of superinvestors had an envious track record of beating the S&P 500 index for more than a decade. Kunal and I couldn’t help but wonder: Who are the superinvestors of India? What is their secret recipe? Which stocks are they buying? And most importantly, how can we develop a way for retail investors to benet from that knowledge? These questions led to us to meeting, and interviewing some of the most successful stock-pickers in India. And we are happy to bring to you what we learnt from them in this special report worth Rs. 950. We hope that you nd their insights as deeply inspiring and enriching as we did. But let me tell you…this is just the beginning of our project of following ‘Smart Money Secrets’. This journey will get bigger and deeper in the coming weeks and months. Our goal is to enable you to ride the wealth-creation journey of the superinvestors of India, sitting secretly next to them in their sidecar. Happy reading. Rohan Pinto (Research Analyst) P.S: We had the great opportunity to interview two investing geniuses outside of India Professor Aswath Damodaran and Chris Mayer. We didn’t want you to miss out on their valuable insights. So, we decided to include their interviews in this special report. 3 |

Preface

The Secrets of India's Superinvestors Winning a coin ipping contest does not sound exciting enough. Does it? One would remotely associate such an exercise with his intellectual capacity. And evaluating success in investing based on such menial task would seem like a joke. But exactly 35 years back, Warren Buett used this example to prove the ecacy of a small group of investors. In his 1984 speech at Columbia University, Buet made an interesting argument. That if Americans were to participate in a national coin ip, only a small group would be consistently successful. This group would be more than eager to aunt their success. And everyone would be curious to know their secret. It would be intriguing if the individuals had similar srcins. Perhaps it would explain their luck. Of course, each individual would have their own technique, but maybe some common thread causes them to win. As you may have guessed, Buett was referring to himself and his co-disciples the followers of Benjamin Graham who swore by their teacher's value investing principles. He called this group The Superinvestors of Graham and Doddsville and attributed the success of their varied stock-buying techniques to the common thread of Grahamian value investing. Even at the time of Buett's speech, the funds managed by Graham's nine disciples had outperformed the benchmark indices by two to seven times.

The Secrets India's of Superinvestors

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Gold to Silver price ratio Times Benchmark Index 8.0

6.0

4.0

2.0

0.0 Walter Schloss

Buffett Partnership

www.equitymaster.com

Pacific Partners

Tweedy Brownie

Munger

Sequoia Fund

Source: Superinvestors of Graham and Doddsville

Each superinvestor at Graham and Doddsville had a dierent approach to selecting stocks. Yet they owed their success to keeping a common principle at the core. Years later, Charlie Munger laid out what he believed was the reason for his stock picking mastery too.. I believe in the discipline of mastering the best that other people have ever gured out. I don't believe in just sitting down and trying to dream it all up yourself. Nobody's that smart. Now, this group of superinvestors committed to the art of value investing remains disproportionately small. In the Indian context, just nding the truly successful value investors is a tall task. But we've been able to conduct a series of exclusive interviews with some India's best, yet largely unknown, superinvestors of the value investing tradition. As we make the attempt, the secrets and track records of some of these little known superinvestors we came across, left us hugely impressed. More on this in the days to come...

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The Secrets of India's Superinvestors

Cloning Warren Buffett I clone my mentors. I copy everything they do, and then I innovate on top of it. - Henry Markram. Warren Buett's performance as a stock picker and business manager is par excellence. The numbers speak for themselves. The man has trounced the benchmark big time over the past ve decades. Now, what if we could tap into Buett's stock picks and mimic his portfolio? And what if we didn't have to pay a cent for the privilege? Well, the Securities Exchange Commission (SEC) requires all institutional investment managers with more than $100 million in assets under management to le Form 13F every quarter. Form 13F asks for positional level details of all securities the rm has invested in. The catch is that these details are led online after a delay of 45 days from the end of every quarter. Berkshire Hathaway latest Form 13F was led for the December 2016 quarter. The top ten holdings form almost 80% of Berkshire Hathaway's public investments.

BerkshireTop5Holdings(%)

Dec-16

Se p - 1 6

Kraft Heinz Co.

19.2

22.6

Wells Fargo and Co.

17.9

16.5

Coca Cola

11.2

13.1

International Business Machines

9.1

10.0

American Express

7.6

7.5 Source: Seeking Alpha

Cloning Warren Buett

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Now, starting in, say, 2000, if you decided to mimic Berkshire's top ten holdings to form a group...and rebalanced, added, and sold every quarter based on Buet's SEC disclosures...how would you have done at the end of fteen years? In his book, Invest with the House, Meb Faber did precisely this exercise. Here are the results: The cloned group of stocks returned 10.5% compounded annually compared to 4.3% for the more volatile S&P 500.

Berkshire Hathaway Clone Beats the S&P 500 Rs 100 invested...

500

Berkshire13FClone

S&P500

BRK

375 250 125 0 2000

2002

2004


2006

2008

2010

2012

2014

Source: Yahoo Finance, Mebfaber.com

While we don't have similar disclosure requirements in the Indian market - and therefore can't employ the same strategy - we still learn a very important lesson from this approach. Stock picks of these smart minds available in the public domain could act as a basic yet eective rst level lter towards identifying some great businesses. Not to mention they could be potentially rewarding as well.

The Art and Science of Cloning Mohnish Pabrai, famed value investor and managing partner at Pabrai Funds, is a big believer in cloning. However, he has a slightly dierent take on it. He seeks to learn

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from the processes of respected value investors rather than just blindly copy their actions. We agree: Learning and mastering the philosophies of respected value-style investors can give us a long-term edge. The key here is to go beyond the stock picks of these smart minds and understand their thought process behind buying them.


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Forget the CNBC Gurus...It's Time to Listen to India's Really Successful Stock Pickers I believe in the discipline of mastering the best that other people have ever gured out. I don't believe in just sitting down and trying to dream it all up yourself. Nobody's that smart. - Charlie Munger Some of the most successful people are shameless copycats. You don't need to reinvent the wheel every time. Take what others have built and develop it further. The world's richest person, Bill Gates, understood this. He setup Microsoft, one of the most protable enterprises in the world, building on the work of others. Warren Buett, too, internalises this philosophy. Inspired by his mentor, Benjamin Graham, Buett began investing in statistically cheap and undervalued companies. And later in his career, Buett added Phil Fisher and Charlie Munger's philosophy of paying up for quality. Mohnish Pabrai, a respected value investor, copied Buett's partnership setup and imbibed his investment philosophy. In fact, Pabrai is a self-proclaimed clone aka copycat. The message from these three giant's is simple: Copy the process of people you admire and then build on it further. If I have seen further, it is by standing on the shoulders of giants. - Isaac Newton

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Forget the CNBC Gurus...It's Time to Listen to India's Really Successful Stock Pickers

That's why I made it my mission to meet some of the most successful investors in India.

Riding on Coattails Imagine this. You are sitting in a sidecar. Warren Buett is driving. You make a fortune just letting him drive you around.

Source: Lalocracio/www.istockphoto.com

In investing terms, riding on Coattails of the best stock picker involves understanding their investment philosophy and looking to prot from their ideas. yes, including their stock picks. The driver could be any investor you admire. Wouldn't you just love to ride with your hero and prot along with them? But who you ride with does matter. You should connect with your driver's investing philosophy. And of course, you wouldn't want a driver who isn't extremely successful. On my mission to uncover some of the most successful investors in the Indian stock market, I have found a competent and curious partner in Kunal. He's an avid reader

Forget theCNBCGurus...It'sTimetoListen to India's Really Successful Stock Pickers

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who believes it's better to learn vicariously than from experience (that way, you get the lesson without getting the scar). Kunal, a contributor to Equitymaster's Hidden Treasure and Phase One Alert services, brings with him his unique insights on small obscure companies few know about. Together, we have set out to nd and talk to the best investing minds in India, relatively unknown ace stock pickers. We have spent the better part of the last six months doing this. We reached out to these investors and interviewed them in detail. Beginning next week, every Wednesday, we will bring you a personal discussion with one of India's nest, yet relatively unknown, stock pickers. Here is a preview of next week's conversation... He works out of a non-descript location. If he walked by you on the street, you wouldn't know him. And yet, he is one of the best thinkers when it comes to synthesizing stock ideas.

In our conversation, he told me about a new idea that is exciting him... and I think it could be the next big idea for our readers too. More on that next Wednesday...

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Forget the CNBC Gurus...It's Time to Listen to India's Really Successful Stock Pickers

Our Meeting with India's Peter Lynch... As promised, Kunal and I are extremely excited to bring you a personal discussion with one of India's nest stock pickers. But rst, a quick question. What does it take to be called a successful fund manager? One who beats the benchmark market indices by a few percentage points over three to ve years. Now you might not think that's a dicult task. But it is. The competition is intense. Every year new funds are launched. Most fund managers chase the same stocks. The result? Underperformance. It's very dicult to beat the index year after year. But Kenneth Andrade beat the market by three times over a decade. That period included the global nancial crisis. So, who is Kenneth Andrade? From 2005-2015, Andrade managed IDFC Premier Equity mutual fund. The fund produced a stellar absolute return of 616% over a decade. The benchmark

Our Meeting with India's Peter Lynch...

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Midcap index returned 201% during the same period. This is an outstanding outperformance. This placed him comfortably in the top quartile of fund performance in the small and mid-cap segment. How did he do it? The short answer - smart stock picking coupled with prudent risk management. I am an avid reader of all that Kenneth has to say. I've been inspired by his clear, simple, yet powerful approach towards picking stocks since the past ve years. Take his bet on Asian Paints way back in 2008. While the whole paints industry bled, Andrade was one of the rst to identify the potential of Asian Paints. The stock has multiplied almost 10 times since then. This was not an isolated bet that worked for him. He successfully replicated his bets with others like Page Industries, MRF, Bata India, Va Tech Wabag, among others. His unique and dierentiated thinking style gives him an edge. In his present avatar, Kenneth is the Founder and Chief Investment Ocer of Old Bridge Capital Management. When we met him recently at his Mumbai oce, we asked him his formula for selecting a stock. "Scale of opportunity, quality of the business, and price to be paid." Andrade has been active in the stock markets for over 25 years. He began investing at the age of 16.

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(Left to Right: Kenneth, Kunal and Rohan)

We asked him, what got him interested in stocks.

"It was the process of...what was the science that drove stock prices." His rst investment was in an IPO of a company called Digital Equipment India. The company no longer exists, as it was acquired by HP. The large gains made during the IPO boom of the late 80's and early 90's further boosted his passion for stock investing. A big transition for Andrade happened in the 1999-2000. He got an opportunity to head the portfolio advisory business working for Sharekhan. "The tech bubble taught me how to manage risk." His rst investment was in an IPO of a company called Digital Equipment India. The company no longer exists, as it was acquired by HP.


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The large gains made during the IPO boom of the late 80's and early 90's further boosted his passion for stock investing. A big transition for Andrade happened in the 1999-2000. He got an opportunity to head the portfolio advisory business working for Sharekhan. "The tech bubble taught me how to manage risk." On Circle of Competence: "I

He then moved to Kotak AMC in 2002 where he managed a small fund called Kotak MNC fund. A limited universe of stocks to choose from taught him a valuable lesson.

can do only one thing right. I can buy right or sell right. I have far fewer cases of selling right than buying right."

"I learned to optimize given the constrained universe of stocks at my disposal and tried to come out better than most."

His next stint saw him become the CIO of IDFC Asset Management. The learning was good and according to Andrade, he did better than what he set out to do at IDFC. His investing mantra is simple: "Buy when no one else is buying. In times of maximum pessimism is when you get right prices to buy. The risk-reward is most favorable. "I look for price to be paid for any company. I also look at status of the industry the company is in." We quizzed him further. What type of sectors does he like? Here are the tell-tale signs Andrade looks for in a sector:

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1.

Consolidation in the sector -> Resulting in fewer players.

2.

Low future capital needs -> It means there's enough capacity to full future demand.

3.

Improving industry protability.

And when you are looking to sell, the reverse holds true. Look for signs of fragmentation of industry (addition of new players), large build-up of capital needs, and slow improvement in protability. How did he navigate the 2008 market crash? "We stayed out of businesses that had too much debt." The ability to minimize mistakes by knowing what not to do was of prime importance to him. Looking back at his varied experiences through life and having seen multiple market cycles has taught him the importance of staying curious and being a life-long learner. So, who are his role models? Andrade thoughtfully replied that he doesn't have any one role model in particular. There are many people who study other people's successes and make them their role model to emulate... Not Andrade. "You learn a lot from people who have succeeded but you learn even more from those who have not been able to." "I learnt from the mistakes that other people made. What not to do is also as important as what to do. In the last fteen years, a lot of management have taught me what not to do." In November 2016, Andrade referred to notebandi like a speeding car having hit a wall. He felt it would take at least a year for the economy to stabilise. We asked him about his views on the current situation. "I misjudged that one completely. Indian economy is much more resilient than I had anticipated. Overall, it got over pretty fast."


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Towards the end of our interview, we asked him to answer a few rapid re questions.

Questions MRForAsianPaints M ov i e or An n u a l R e p o r t Growth or Valuation Management or Strong Business Price/Earnings or DCF or Enterprise Value/ sales Investing Horizon - 5 Years or 10 Years Stocks - Historical Performance or Future Expectations Cash Flow Statement or Proft & Loss Statement Your Favourite Movie/TV Series

KennethAndrade'sQuickFireResponses B ot h . Annual Report. I don't watch many movies. You look for a scalable business but it's always dependent on the price to be paid. Strong Business. Enterprise Value/Sales. 5 years itself is too long! Historical Performance. Cash Flow Statement. I don't have a television that works at home!

In today's interview, we've covered some ground with Kenneth Andrade. Stay tuned. In this week's edition of the Research Digest, I'll discuss his investment philosophy, his views on analysing stocks in detail, and more...

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Finding Multibaggers The Kenneth Andrade Way In a recent edition of The 5 Minute WrapUp, we wrote about our meeting with Kenneth Andrade, one of India's most successful stock pickers. In case you missed it, here's an excerpt: So, who is Kenneth Andrade? From 2005-2015, Andrade managed IDFC Premier Equity mutual fund. The fund produced a stellar absolute return of 616% over a decade. The benchmark Midcap index returned 201% during the same period. This is an outstanding outperformance. This placed him comfortably in the top quartile of fund performance in the small and mid-cap segment. How did he do it? The short answer - smart stock picking coupled with prudent risk management. In today's Research Digest, we're sharing our in-depth discussion with Andrade on his investment philosophy and stock-picking approach. Rohan Pinto: Mr Andrade, can you tell us about your investment philosophy? What kind of businesses do you like to buy?

FindingMultibaggers The - KennethAndradeWay

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Kenneth Andrade: I love to invest in businesses that are ecient allocators of capital. As a nancial analyst, you have to buy businesses that are ecient allocators of capital and you have to decide how much money you would pay up for such a business.

The Core Idea - I love to invest in businesses that are ecient allocators of capital.

I look for a scalable business. I look for a company that is doing well in its industry. And the valuation needs to be attractive. For example, I go for an industry that is consolidating (the number of players are shrinking), where 65-70% of the industry participants are losing money. And you probably got the bottom of the cycle there. I want to allocate my money to the leadership in that segment. A leader who has survived with the highest return on capital in a down cycle. Return on capital of 8-10% is ne. And when you are doing that the valuations are always in your favour. So, you don't lose much, and risk-reward is in your favour.

Business Checklist in Brief: Deleveraging Balance Sheet, Increased Market share gains.

Kunal Thanvi: How do you nd great stocks? Can you take us through your stock shortlisting process? Kenneth Andrade: I usually run screeners. I go back into history and look for companies that have shown resilience across multiple business cycles. If they have survived through multiple cycles, it establishes their sustainability and longevity. Which companies survive over long periods of time. It is those that have got the nancial liquidity to sustain multiple cycles. So, when I talk about deleveraging, ecient allocators of capital. I don't mean a 30% return on capital throughout the cycle. A business can be 10% return on capital when the entire industry is losing money. But the 10% return on capital where the guy has got no debt. Now what kept his mortality rates so high when 75% of its competitors struggled? Its nancial discipline. Identify reasons for

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why the business has been in existence through multiple cycles. This is my framework when I want to identify potential bets. I also have communicating lines open with the industry for bouncing o ideas. Rohan Pinto: What is the right price to pay for a business? Kenneth Andrade: First, you look to protect your capital on the downside, then you can make money on the upside. Look at industries which is not doing too well. Here you will get the right prices. In a downcycle you invest only in the leader in that space. When the entire industry cycle changes, you can invest in the next rung of leadership. Go back to March 2013, look at the small cap index, and look at companies that made losses versus those who made prots. The ratio was 3:1. The small cap index bottomed out in the same timeframe. Peak protability of small cap index was Rs 55,000 crores. It went down all the way to Rs 13,000 crores in 2013. That was the best time to buy leading businesses.

Don't buy underlying business, buy underlying proftability. The reason for my preference for both tyre and paint stocks has been the fact that both the sectors were consolidated. There are 3-4 major market players in these sectors. We bought MRF in 2004-05. Asian Paints in 2009. We got the valuations right. We simply rode the cycle for all the companies. We kept tracking the cash ows. Remember, it is not always about good business or good stocks. You also have to nd the stock that will make the most money for you. Kunal Thanvi: Can you tell us about your winners and losers? Kenneth Andrade: My winners had a scalable opportunity, and multiple years of growth. The industries were getting consolidated. All you had to do was pay the


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right price. For that you needed patience. That was the greatest diculty. We had our fair share of errors too. Whenever we looked at valuations in isolation, we struggled. We bought PSU companies...mostly public sector banks just looking at valuations. It taught us a lesson. Looking at valuations in isolation was incorrect.

"I am open to look at anything and everything. Every balance sheet tells you a story."

Rohan Pinto: Can you tell us your secret to identifying and riding multi-bagger stocks? Kenneth Andrade: Everyone talks about growth in earnings. You can have growth only if the size of the opportunity is large. Everyone also talks about earnings multiples. I need both of those to work for me. I need a price to earnings (P/E) multiple of 10x to expand to a PE of 40x. And I need the company's earnings to grow from Rs 10 to Rs 100. That way I compound both together. Kunal Thanvi: According to you, what's the next big theme in the Indian stock markets? I am trying to nd the next MRFs and Asian Paints. PVR, Eicher Motors and Interglobe Aviation came in the last decade. They captured a chunk of the industry protability. You have to nd companies who would demonstrate their ability to garner higher protability of that industry. As long as you do that you will do well. Every investor is dierent. Everyone has his own way of pricing companies. I won't turn blind eye to valuations if business opportunity looks great. I look at opportunity that exists rst and then I am willing to pay an 'X' price for it.

"My objective today is to go out and nd new businesses that are exhibiting the same characteristics of those businesses that were successful earlier."

My objective today is to go out and nd new businesses that are exhibiting the same characteristics of those businesses that were successful earlier.

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I am not saying it will come from only one particular industry now. It can come from anywhere. Now balance sheets have stopped growing in the past two years. Payback of debt is huge and it is all coming out of cash ow from operations. Let's take the BSE 500, and particularly the manufacturing companies. Prots have remained range bound for about ve years. These have to revive now and the revival in prots will come in the operating cash ows. If you just followed that metric, then this year saw cash ows at an all-time high for sugar and oil & gas companies. The power industry might just perform well next year. Overall, I think companies are deleveraging and balance sheets are shrinking which is great.

Our Three Key Takeaways from Kenneth The three critical factors that were essential learning for us from the meeting with Kenneth were these: 1.

Invest in businesses that are great capital allocators - Put simply, one needs to look for businesses that have earned decent returns on capital invested over a complete market cycle.

2.

Try to buy assets when they are out of favour - Times of maximum pessimism creates buying opportunities in the market. During this time, good businesses are available at reasonable valuations.

3.

Multibaggers or Compounders have two levers, growth in earnings and an expansion of its valuation multiples. Both of them need to work in your favour to create disproportionate wealth in stocks over a long period of time.

We hope you enjoyed reading investment insights from one of India's most successful stock-pickers.


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Professor Damodaran: Our Meeting with an Authority on Valuations Kunal and I have been working on a project. To tell you the truth, it has consumed us. The inspiration behind this little project was nothing short of mastering The Art of Stock Picking. This took us on a journey to track the smartest minds in the world of investing. In an earlier WrapUp, we wrote to you about how tracking smart money can give you an edge. We then shared with you what we learned from India's Peter Lynch, Kenneth Andrade. In this week's edition, we bring you an international guru, a professor who has been teaching valuations to students for decades. Professor Aswath Damodaran is an authority on valuations. He teaches a popular course on corporate nance and valuation at the Stern School of Business at New York University. We have been the beneciaries of Professor Damodaran's pearls of wisdom in the past. However, this time around, we covered more ground. Without any further delay. Here is our conversation with the legendary Professor. What got you interested in stock markets?

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To be honest, I am not that interested in stock markets. I don't follow stocks religiously, don't watch market TV shows, or read about stocks intensely. I am interested in markets of any sort, since I nd it fascinating that thousands of buyers and sellers can create a market clearing price even on the most obscure and complex of claims. Who has been your biggest inspiration? My inspiration has always come from within. I think that looking to other people for inspiration is a dangerous thing to do. Even the best and most amazing people are human beings, lled with all of the false pride, blind spots, and frailties of humanity. What according to you is the most dicult part in investing? Learning what you don't know and what your blind spots are in investing. We all have our weaknesses, and often we are the last ones to recognize those weaknesses. If you could change one thing about your investing approach in the past, what would that be?

Nothing. I am who I am today (as a person and as an investor) because of the mistakes (and right decisions) that I have made in the past. I don't believe in regretting or reliving the past and I also believe that going back and selectively changing only the things that you don't like about your own history is never as easy as it looks. Could you tell us something about your mistakes in picking stocks? If by mistakes, you mean stocks that I have bought that have gone down, what is there to tell? The nature of investing is that you are going to be wrong not just sometimes but a lot of the time and the way you insulate yourself is not by trying to avoid making mistakes but by spreading your bets. What kind of businesses do you think will be the biggest wealth creators over

ProfessorDamodaran:OurMeetingwithanAuthorityonValuations

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the next two decades? Who knows? This is the kind of hubristic macro question that people like to hear profound answers to, and I am afraid that I not only don't have the answer but don't even try to answer. What do you think is the 'one thing' that every Indian investor should keep in mind? That we live in a world where change is the only constant, that you have to keep an open mind, learn from everyone around you, and be willing to say the three most dicult (and freeing words) that anyone can say, 'I was wrong'. If you had an extra hour each day, what would you like to do? Sleep. Do you prefer a concentrated portfolio or a diversied one and why? I am surprised that people still ask this question. It takes a special combination of arrogance and ignorance to think that you are so good at picking the right stocks and that so convinced that the market will come around to your point of view that you put all their money into four or ve stocks. I don't have that conviction and I have always held a broader portfolio. Contrary to popular wisdom, there are enough stocks in the world that I can both pick stocks and be diversied at the same time. What is your preferred Valuation metric and why? I don't use metrics (by which I think you are talking about multiples like PE, price to book, or EV/EBITDA). To be honest, if you pick stocks based on metrics, you should just throw in the towel and just buy an index fund or ETF. After all, if you can screen stocks based on metrics, what makes you think that an automated process cannot do it much more eciently and cheaply?

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Towards the end of our interview, we asked him to answer a few rapid re questions.

Questions Your Top Three Favourite Books Your Favourite Movie/TV Series

ProfessorDamodaran'sResponses Moneyball. A Conspiracy of Paper. Thinking Fast and Slow. Lost, ABC. The Walking Dead. The Twilight Zone.

Graham or Fisher or Lynch

Lynch.

Alphabet or Apple or Amazon

Amazon.

Growth (Size of the Opportunity) or Valuation

A false choice!

Movies or Annual reports

Movies.

Great Management or Business Moat

Neither; the right price.

Historical Performance or Future Expectations Cash Flow Statement or P&L

Come on! Does anyone pick historical performance? Cash ow statement.

We appreciate the Professor taking the time to answer our questions, and we hope you enjoyed his often-amusing insights. As I mentioned earlier, we are on a journey. In the process, we have met-discussed-debated with some of the smartest minds in the world of investing, both India and abroad. Now, there are many ways of picking stocks. Dierent investment philosophies exist to exploit the ineciencies in the market. However, we believe there is a great merit in marrying dierent yet proven investing approaches. I highly recommend you to watch this space closely as Kunal and I are fully geared up to bring some interesting stu in the coming days. And Next time, we will share more value investing insights with you from one of

ProfessorDamodaran:OurMeetingwithanAuthorityonValuations

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India's best value investors. In our view, this man is both an accomplished teacher and successful practitioner of his craft. In the interview, he told us what patterns investors should seek, which ones to avoid, and much more. We are excited to share all his learnings with you. Stay tuned...

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Meet the Fund Manager Who Walks the Less Trodden Path A slight detour before I introduce you to this brilliant fund manager we've been tracking... I was part of the interview panel when my colleague Rohan Pinto applied to join our equity research team. I remember a particular moment during the interview when Rahul Shah, in his usual measured tone, asked his famous questions: What do you like to read? Who are the three people you admire the most and why? (Read about the neuroscience behind these questions here.) The mere mention of the word 'read' brought a big smile on Rohan's face. As he talked (and talked, and talked) about his love for books, the people that inspired him, and the investors he admired and studied, we realised we'd bumped into a learning machine...and an obsessive bookworm. I remember him quoting Charlie Munger: I believe in the discipline of mastering the best that other people have ever gured out. I don't believe in just sitting down and trying to dream it all up yourself. Nobody's that smart. The reason I'm sharing this is because sometime last year Rohan came up with a novel idea: I want to develop a way to copy the best investors out there... Our other colleague, Kunal Thanvi, a very savvy stock picker, also shared Rohan's passion for 'copycat' learning and investing. He was instantly drawn to Rohan's idea. I'm thrilled to announce that Rohan and Kunal have been working on this exciting project for several months. They've been studying the secret recipes of India's super


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investors...and even more interestingly...they've been actively tracking and evaluating their recent stock picks. (You will hear more about this in the coming weeks.) I hope you read their deeply insightful interview with Kenneth Andrade - India's Peter Lynch. And also an interesting conversation with famous value investing guru Professor Aswath Damodaran. I've been keen to participate in this project. So, today I'm going to talk about yet another Indian super investor who we like to track...Akash Prakash. Akash Prakash is the co-founder and CEO of Amansa Capital, a Singapore-based fund management company. An MBA from IIM-Ahmedabad, he was ranked among the top 20 Fund Managers in Asia by Asia Money in 1999. In 2004, he was ranked among the top three by Indian corporates in Institutional Investor's 'Best of Buy-Side' survey. To date, he has a knack for picking winning stocks, one after another. According to Economic Times, many of his stock picks - including Cholamandalam Investment, Edelweiss Financial Services, Bharat Financial, and Ashok Leyland - have more than doubled in a couple of years.

Besides an enviable track record, Akash's investing philosophy resonates with our own in-house approach. Here's some interesting aspects about his investing philosophy... Investing approach in a nutshell... Akash prefers 'companies that are well managed and nancially disciplined, with a strong growth potential that can be held for multiple years and trade at a reasonable price'. And before making the investing decision, he follows a rigorous research process that spans the entire eco system in which the company operates. Bottom-up or top-down? He follows a bottom-up stock-picking approach. This means that he focuses more on individual stocks, and that his investment decisions are not primarily driven by macroeconomic calls. He also doesn't believe in following a sector-focused approach.

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Relative returns or absolute returns? Let me rst explain the dierence between 'relative returns' and 'absolute returns'. The term 'relative returns' refers to returns as compared to a benchmark index. Most fund managers aim to produce returns that beat a benchmark. Given the intense competition, a fund manager who beats the benchmark by even a few percentage points over three to ve years is said to be successful. Because of this intense focus on relative performance, many fund managers tend to follow what Warren Buett calls 'the institutional imperative' - a tendency to blindly imitate the action of peers. But what happens when let's say the Sensex falls 25%? A fund manager who produces a 20% fall will appear successful, relatively speaking. And that's the trouble with relative returns. On the other hand, 'absolute returns' are not compared with any benchmark. Managers focused on absolute returns have a long term orientation and therefore are able to take contrarian bets and not be index huggers. And this is the orientation that Akash follows.

Short-term or long-term? Akash follows a long-term investing approach. In an interview with ET Now in February 2017, this was his message:

Investors should remain invested and just ll it, forget it and look at it after ve years. They will hav e very strong return s. Small cap, midcap, or large caps? Akash invests across the market cap spectrum. But he does have a special liking for midcap stocks. Popular or contrarian?


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Akash likes to take the less trodden path. He likes to go where not many fund managers would go. He particularly likes midcap companies that have limited or no coverage by brokerages. Let's talk a look at some of his top holdings. The chart of the day shows the top holdings of Amansa Capital in value terms. At Rs 6.5 billion, Federal Bank is the largest holding.

Akash Prakash: Walking the Less Trodden Path Amansa Capital - Top Holdings*(Rs bn) 7

6.5

6.1

6 5 4.3 4

4.0

3.9

Chola-

Tata Comm

3 FederalBank

SRF

Bharat Financial


mandalam Investment

Source: Economic Times *Data is based on December quarter shareholding at prices as on 7 April 2017.

Economic Times estimates Amansa Capital's total holdings to be in excess of Rs 81 billion. Some of the big winners for Akash Prakash have been Cholamandalam Investment (up 5.6 times since December 2010), Edelweiss Financial Services (up 4.2 times since December 2009), Cyient (up 3.4 times since June 2011), Triveni Turbines (up 3 times since March 2012), among others. 2017, too, has been a big success for the fund manager. Right after the Union

31 |


Budget this February, he was bang on with his prediction that the benchmark Indian stock indices could hit new highs during the year and stabilise at that level for some time. He was proven right in less than two months with the Indian markets zooming higher in recent weeks. As per Capitaline data, among the 29 stocks where Amansa Capital has more than 1% stake, twelve have given 20-86%, sixteen are in double digits, and ve stocks are down so far for the year. Now, let me caution you. Do not blindly copy Akash's stock picks. Or for that matter any other successful investor. That's not how copycat investing works. Copycat investing is an art that requires a disciplined and diligent process to imitate successful investors. And that's exactly what my colleagues Rohan and Kunal are working on. They're building a solid process to sift through the stock ideas and strategies of the smartest and most successful investors in India...and to help you ride along with their success. Stay tuned for more...


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The Small-cap King You Haven't Heard Of There's enormous advantage in nding your calling early in life. The word has it that by the time he was in his teens, Warren Buett had read every investing book at his local library. And he was all of 17 when he rst chanced upon Graham's The Intelligent Investor. The rest as they say is the power of compounding. I wasn't all that lucky. I was introduced to the world of Graham and Buet investing at a not so early stage in my life. And the more I talk and interact with two of my colleagues, Rohan and Kunal, the more I am reminded of this small injustice meted out to me. These guys are only in their 20s. Yet, they already know so much about value investing and its most successful practitioners that I struggle to keep pace. Regular readers of this column would be aware that both Rohan and Kunal have already started turning their passion into a full-blown project. A project that involves getting into the minds of some of the most successful value investors and come out with the most penetrating insights on succe ssful stock picking. They have travelled far and wide and they have put in a lot of energy to reach out to experts who they think have extremely valuable investing ideas. Their eort is beginning to bear fruit.

Their interesting interview with a man they rightfully call India's Peter Lynch has already been published and so has been their interaction with famous value investing guru Professor Aswath Damodaran.

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The Small-cap King You Haven't Heard Of

Today, Kunal is going to shine the spotlight on a gentleman who has such an amazing track record he is surprised he is not already well known. Over to Kunal......... We like to invest in companies where we can get an edge. - Sumeet Nagar He's not like the pseudo experts you see daily on television. This man is truly a wizard of Dalal Street. Sumeet Nagar is the co-founder of Malabar Investments LLC. Malabar is an Indiafocused foreign portfolio investor (FPI). It collectively manages more than US$15 billion. Malabar specialises in value investing in small and mid-sized Indian stocks. Nagar is a graduate of Indian Institute of Technology, Bombay. He has an MBA in Finance and Entrepreneurial Management from the Wharton School, University of Pennsylvania. Prior to starting Malabar in 2008, Nagar was a consultant at McKinsey. He was a founding member of McKinsey's dedicated private equity group. Malabar Investments has won numerous awards including 'Best Single Country Fund' from Asia Hedge in 2014 and 'Best Fund for Small-Cap Indian Investments Since Inception' from Hedge Fund Awards in 2015. Sumeet Nagar is someone I like to read and listen to. He always talks clearly and sensibly. He rarely uses nancial jargon. Most importantly, he thinks long-term.

Multibaggers Are a Result of Long-Term Investing Many of his top small-cap picks have been multibaggers. La Opala, Page industries, eClerx Services, Symphony, Mayur Uniquoters, Hawkins, Cholamandalam, Eicher Motors, Motherson Sumi, CCL Products, and Avanti Feeds. The Small-cap King You Haven't Heard Of

34 |

These stocks have created huge wealth for investors. Many of them are no longer 'small'. It pays to be patient. Let compounding do the work for you. Today's chart below gives an idea of just how high the compounded returns were.

Defying Convention The common theory about small caps is that they are risky. Thus, it's wise to spread the risk by diversifying widely. But Sumeet Nagar does not diversify. He runs a concentrated portfolio. He has about fteen core holdings. The top ve are about 35-40% of the total portfolio. I found this very interesting. It's rare to nd an advocate of concentrated investing in small cap stocks. In contrast, the portfolios of the top performing small-cap mutual funds in India are all very diversied.

But What about Risk Management? As per Malabar's website, Nagar mitigates risk by focusing on companies that... •

Are leaders in niche industries.

•

Have a long history of excellent nancials.

•

Are run by highly capable managers who have the best interests of shareholders in mind.

•

Have a sustainable competitive advantage, i.e. a moat.

•

Have demonstrated pricing power.

•

Have a long runway to grow protably.

Finally, he'll buy them only when these stocks trade below his conservatively estimated intrinsic values.

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Then he'll hold them for a long time. He invests with a three to ve-year perspective. He doesn't mind holding for longer. His portfolio turnover is very low, about 1015%. This means the overall capital turnover is seven to ten years. Nagar also adds to his positions if the stocks oer enough margin of safety. In an interview with the Economic Times in October 2015, he summarised his stock picking process: The underlying thought process is that you are buying businesses that can compound well over a long period of time. Valuation - to an extent - is not under your control, so at times it will be low, and at other times it will be high. As a matured long-term investor, you need to take advantage of that. When things get beaten down, you like these businesses, you add to them, and when it becomes too expensive, you either hold on to them or eventually trim them. This may sound simple. But Nagar's investing philosophy is not simplistic.

An Investing Edge

He knows that managements can make or break a small rm. So he doesn't rely only on the what they say in public. He spends a large part of his time assessing whether they have the drive and the capability to take the business to a whole new level. He is known for conducting extensive due diligence by talking to competitors, regulators, suppliers, distributors, retailers as well as visiting factories, depots, and retail outlets. This is his edge: Conducting very deep fundamental analysis to identify the key growth drivers of a stock.

A Contrarian View on IT and Pharma: Go Where the Fish Are Sumeet Nagar thinks there are good long-term opportunities in IT and pharma stocks. The Small-cap King You Haven't Heard Of

36 |

Unlike many people on the street, we share this view. In August 2016, he told Economic Times: I think today is an environment where there is a lot of optimism around. So you are not going to nd great bargains like that, but I think as Warren Buett said if you want to sh, go where the sh are, not where the shermen are. So go where investors are not looking today. Things which are unloved so perhaps things like IT and pharma and maybe there are some great opportunities there for a long-term investor. I couldn't agree more.

Are Markets Overvalued? Nagar believes they are. Why? Because earnings haven't caught up. In the same Economic Times interview, he said: Either the markets have to get aligned with the earnings so that they get time corrected or they get pulled down or the earnings have to move up. What we have seen over the last say two or three years is that the earnings always seem to be two quarters that is six months away but it has been slow in coming. I do not think you will nd a lot value in today's market given all the positives that are out there. There are no screaming buys out there but you would nd pockets of opportunities here and there. Indeed. Many stocks have clearly run up well above their fair values. But I believe there are still opportunities to be found.

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Sumeet Nagar's bottom-up approach is one we like very much. In fact, his process closely resembles the one followed by Richa's monthly small-cap recommendation service, Hidden Treasure. But this doesn't mean you should blindly follow Sumeet Nagar's picks...or anyone else's for that matter. If you must copy a successful investor, you still need to follow a proper method. Rohan Pinto and I are building one. We ha ve been sifting through the strategies of the smartest and most successful investors in India...and I believe we can help you ride their coattails.


38 |

Our Private Class with India's Value Investing Guru I am fascinated by the idea of learning from the successes and failures of other people. My colleague Rohan Pinto is also a rm believer in this practice. I joined Equitymaster last year. My rst day at work, I was assigned a desk next to Rohan. A great coincidence! We spoke a bit. Conversation drifted to books. I remember how animatedly Rohan talked about the book he was reading, Grinding It Out by Ray Kroc. I too had read the book and loved it. Rohan and I had another passion in common: tracking India's super investors. It came naturally to us. We both knew we could reduce our learning curve in the markets if we stood (metaphorically, of course) on the shoulders of the giants. And thus, we began our journey to meet those giants... Our goal was to understand their approach to stock picking. Our rst conversation was with India's Peter Lynch, Kenneth Andrade. The second in the series featured the famous valuation professor, Aswath Damodaran. Then my colleagues Ankit and Rahul introduced you to other super investors like

39 |

Our Private Class with India's Value Investing Guru

Akash Prakash and Sumeet Nagar. And this week, Rohan and I are excited to bring you our conversation with a highlyrespected professor and practitioner of value-style investing in India. Introducing Professor Sanjay Bakshi... We have been following Professor Bakshi for many years. In fact, I was fortunate enough to attend his three-day workshop on behavioral nance at FLAME University Pune. The professor teaches MBA students (at Management Development Institute Gurgaon) a popular course on 'Behavioral Finance & Business Valuation'. He also helps countless students understand the nuances of value investing through his blog and Twitter.


(Left to Right: Kunal Thanvi, Sanjay Bakshi, Rohan Pinto)

Without any further ado, here is our conversation with the legendary Professor Bakshi. Rohan Pinto - Professor how did you get introduced to the world of stock markets? Could you walk us through that initial period of your life?

OurPrivateClasswithIndia'sValueInvestingGuru

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Sanjay Bakshi - My father used to invest in stocks including initial public oerings (IPOs) and was a big fan of Dhirubhai Ambani and his company. While pursuing chartered accountancy (CA), my rst investments were in IPOs of Orissa Synthetics and India Polybers. Both companies went bust, so that was a pretty good start for a career in investing. Chartered accountancy taught me the language of nancial analysis, i.e. accounting, but didn't teach me anything about business economics and human psychology. While studying for my masters course in the London School of Economics, I read about Warren Buett in a newspaper. I read that he had a wonderful track record, works from a place far away from Wall Street, believes that the markets are often inecient, and also that he writes wonderful letters that anyone can ask for. So I wrote to him for the letters and I got a reply from his secretary, Debbie, asking me to send her the money for the postage! That was probably the best investment I ever made. The letters arrived within a few days of my sending Debbie the money. And reading them changed my life forever. Basically, reading those letters made me nd my calling. Kunal Thanvi - Warren Buett started his career as a strict follower of Graham and then got inuenced by people like Charlie and Phil Fisher. Was there any eventperson-company-management that in anyway changed or improved your investment philosophy? What is your story professor? Sanjay Bakshi - I too have evolved as an investor over the last 23 years. Buett's letters marked the beginning of my investing journey. Those letters also led me to his mentor Benjamin Graham. Graham was a big inuence towards shaping my investment philosophy in the initial days. Between 1994-2011, I was a statistical bargain investor, a risk arbitrageur, and also an activist investor. My focus was more towards risk arbitrages, special situations, and cigar butt investing.

41 |


By 2011, I transitioned from a quantitative-focused investor who would look for margin of safety only in a low price in relation to estimated intrinsic value, into a qualitative investor who sought margin of safety from the quality of the business, the quality of the people running it, and of course also from a low price in relation to probable future value in the future. This transition was, in a way, prompted by an introspection about a few mistakes I had made over the years. While the consequences of these mistakes did not show up in the returns, they still mattered because they showed up in the 'opportunity P&L account', which measures the cost of what you could have done but did not do. One mistake was that, by focusing on cigar butts selling for low single-digit multiple of earnings or a low price in relation to liquidation value, I missed out buying into higher-quality businesses like Asian Paints and Pidilite, which compounded capital at high rates of return for a long time. And the second mistake was that, while I would sometimes buy into a great business because it became cheap by the standards laid down by Ben Graham in his books, I also sold out of them when they were no longer cheap by Graham's standards. And that cost me helluva lot of money. For example, I bought Eicher Motors at Rs 200 and sold it at Rs 600 and now it sells for Rs 26,000. This type of mistake helped me realise that one can get disproportionate payos by staying invested in high quality businesses for a long time. Realising the importance of keeping an 'opportunity P&L' account marked a turning point in my investing career. I also realised the importance of slowing down. More action means more decisions, which increases the likelihood of error and often results in selling your winners too early. Rohan Pinto - You are a rm believer the role biases play in investing. What do you see as the most dangerous bias?


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Sanjay Bakshi - Well, it is not correct to point out any particular bias as the most dangerous. All the biases like availability, anchoring, commitment bias, social proof, among others are important. One needs to overcome all of them through deliberate practice over the long term. And of course, that's not easy because one is really ghting biology... Charlie Munger has talked about twenty or so behavioral biases in investing. I believe one cannot aord to ignore any of them. Kunal Thanvi - According to you, what is most dicult part in investing? How do you tackle both Buy and Sell decisions? Sanjay Bakshi - Both decisions require dierent approaches. Decision to sell is the more dicult of the two because one tends to not sell something that should be sold thanks to commitment bias including endowment eect, social proof, and psychological denial. What's interesting to note is that endowment eect is not always bad. If you look at successful investors that didn't sell stocks of great companies, they bought and their money compounded over the years and made them very wealthy. If you take a sample of 100 very successful investors who made money in the stock market, I would argue that an overwhelming majority of them will be long-term buy and hold investors. They would have bought into great businesses and just held on to them through thick and thin. If this is not endowment eect, then what is? Incidentally, Ben Graham's best idea - the one that made him the most money - was GEICO, which he bought and held for long time. So the decision to sell is very complicated. One needs the right dosage of detachment, but then one also needs to be very much attached to the right kinds of businesses and people who run them. The buying decision comes with its own set of complications. Dierent investment

43 |


strategies have dierent rules for buying. But the kind of investing I now like requires me to look at three key things before I decide to buy a stock. Those are business quality, management quality, and valuation. All three are critical and a low price cannot, under the investment process I now follow, compensate for poor quality of business or management. Now, of course this does not mean that everyone should follow this approach and the other approaches don't work. They do. In fact, they may even work better than mine. But I like mine because it suits my personality. And my partner likes it too, because it suits his personality. And we are very much at peace with that kind of investing, even if other approaches may do better. Rohan Pinto - How do you start your day? What you love to do when not thinking about investing and teaching? Sanjay Bakshi - I do not have any structured day schedule. I like to keep things very simple and do things that stimulate creativity. Usually that means lots of reading. So out of 24 hours, I try to read around seven to eight hours a day. It's hard for a teacher who loves teaching to not think about teaching when he is not teaching. So I am always looking for new ways to teach and become a better teacher over time. I think this is important for all professions and sports. You don't have to compare yourself with others (although they may inspire you). But one should compare oneself with an earlier version of oneself and seek ways to get better over time. Kunal Thanvi - When you went through testing times, especially in your earlier days in London, how did you learn to endure the pain? What were you thinking then? Sanjay Bakshi - Well, it was not just in the early days, even when I came back to India it was a struggle. I had to make compromises in my life to make ends meet, for instance, by teaching things like CAPM and EMT and MPT to CFA Students (their curriculum did not allow me to say that markets can be inecient). But I did it because I needed the money. Those were very tough times. Adversities and tough times give you determination and make you stronger. It forces you to visualise a better future and makes you move in the right direction. And a lot of persistence with a bit of luck can do wonders in the long run. OurPrivateClasswithIndia'sValueInvestingGuru

|44

As for pain endurance, well, the stock markets teach you that very well indeed. Rohan Pinto - Value investing is simple but not easy. How do you bridge the gap between what is written in supertexts versus reality? Transitioning the gap between professor and practitioner. Sanjay Bakshi - Practise. Practise. Practise. You need to train yourself to think dierent. For instance, if you are playing tennis for the rst time, you will mistime your shots. When Roger Federer plays in court, he consistently hits winners. However, imagine Federer when he was starting out. He too would have made mistakes like you. He went through a steep learning curve and improved himself. Here's the key. Deliberate practice is required to be successful in any craft. This applies to investing as well. Focus on learning. Keep at it. And you will get better over time through deliberate practice. Now, there is a big dierence when we compare sports and investing. And that dierence is to do with feedback. In sports, you get instant feedback. The learning improves faster - i.e. if you mistime a shot, you know it instantly and can work on your mistake. In a long-term investing process, the feedback is delayed. So if you invest in a company with a time horizon of say ve years. That's a long time to gure out whether you made mistake in buying the company or not. This is exactly where reading has helped me. I have learned and observed from extreme investing successes and failures i n the past. So you need to know a lot of things beforehand. It is thus imperative to learn from others, to study the past and apply those learnings in the current context. Life is not long enough to learn long-term investing because there aren't sucient data points of feedback to

45 |


Rohan and Kunal's Rapid Fire Questions Questions

Professor'sRapidFireAnswers

Graham, Buett or Munger

Munger.

P.V Chandran, Prem Watsa, Ajay Piramal or Achal Bakeri

All of them.

Management M eeting o r A nnual r eport

Annual r eport.

Growth (Size of t he O pportunity) o r Valuation

Growth.

Management or strong business

Management.

Your Preferred Valuation Metric

Expected return over 10 years.

100% in a year or 15% cagr over 5 y ears With respect to Stocks - Historical Performance or Future Expectations Cash Flow Statement or P&L

15% C AGR o ver 20 years. Always future expectations. The Trinity. Balance sheet, P&L, and cash ow. Poor Charlie's Almanack by Charlie Munger. All

Your Top Three Favourite Books

I Want to Know is Where I am Going To Die So I Never Go There by Peter Bevelin. My Name is Red by Orhan Pamuk

Y ou r F a v ou r i t e A n n u a l R e p or t Your Favourite Movie & TV Series

B e r k s h i r e Ha t h a w a y . Sherlock Holmes.

Rohan and I admire Professor Sanjay Bakshi a lot. We and countless others have been beneciaries of his teachings, his blog and course lectures, and his book recommendations. We made full use of our meeting the professor. Our curiosity and a long list of questions ensured we overran the one-hour time limit. But the professor was very gracious to allow us to call him later to continue the interview. 'I don't want any good question to be left unanswered,' he said with a smile.


|46

In our tomorrow's 5 Minute WrapUp, Rohan will bring you the second part of our interview. Teaser: It's even more exciting and thought provoking. Here's a sneak peek: I am a pattern seeker. I seek success patterns and avoid failure patterns. Please join us in the classroom again tomorrow.

47 |


Part II of Our Private Class with India's Value Investing Guru We hope you didn't miss class yesterday. Kunal and I shared the rst part of our interview with Professor Sanjay Bakshi. Before we get to the second part, allow me to share our experience meeting the professor in his oce. As soon as we walked through the doors of ValueQuest Capital, the rm Prof Bakshi and his partner Paresh Thakker manage, this quote welcomed us... The dierence between successful people and really successful people is that really successful people say no to almost everything. - Warren Buett We thanked our lucky stars he agreed to the interview!


PartIIofOurPrivateClasswithIndia'sValueInvestingGuru

(Left to Right: Kunal Thanvi, Sanjay Bakshi, Rohan Pinto)

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We found the oce layout very unconventional. Imagine this: No television screen - an oce detached from the daily ticker. We saw more philosophical and investment quotes. When we asked about the oce layout, the professor replied with a knowing smile: 'This is denitely by design. It helps induce creativity.' On entering his personal cubicle, we saw a neat collection of his books. Again, no screens. No distractions. Now here, we thought, is a teacher and practitioner who understands the importance of atmosphere for creative work. Without any further ado, lets us continue where we left o yesterday... Rohan Pinto - Professor, what is your investment philosophy in brief? Sanjay Bakshi - Oh, I will be very brief: Own quality. Kunal Thanvi - How do you nd stocks to invest in? What is your inve stment checklist? Sanjay Bakshi - Stock picking is a creative pursuit. I need to have some inspiration for good ideas to come. Here is an interesting book titled Where Good Ideas Come From by Steven Johnson. I highly recommend it to you. Also read Peter Bevelin's A Few Lessons from Sherlock Holmes. I am a pattern seeker. I seek success patterns and avoid failure patterns. One needs to nd common patterns over and over again across businesses. One pattern I seek is that of an Owner-operator with a right mix of conservatism and aggression and 'soul in the game'. I like the pattern of managers who are 'learning machines' - i.e. they learn from both their own mistakes and those of others. I also like the pattern of niche businesses hiding underneath a commodity label because that's what creates a market

49

Part II of Our Private Class with India's Value Investing Guru

ineciency. These patterns can be found in annual reports, magazines, and where not. One needs to be alert to recognise these patterns and act on them. Further, you need to be open to reject your own idea. Any good pattern may or may not turn out to be an investment opportunity. One needs to enjoy the whole process of identifying good ideas and rejecting them. The mindset one has to adopt is that of a detective or an investigative journalist. That's why I highly recommend Peter Bevelin's book on Sherlock Holmes. Kunal Thanvi: You just spoke about importance of recognising both success and failure patterns. Can you run us through some of the important ones, say the top ve patterns, to seek and avoid? Sanjay Bakshi: Well, I have a longer list of patterns to avoid as compared to success patterns. Serial acquirers: I generally dislike companies which grow inorganically, especially when they take a lot of debt to nance the acquisitions. While some platform companies - Berkshire Hathaway being the prime example - are huge wealth creators, generally speaking, platform companies destroy value. So one needs to be skeptical while evaluating serial acquirers. Industries going through disruption: I like to avoid companies in industries which are susceptible to disruption. For instance, if you look at the automobile industry, it looks attractive now with good growth, but I believe electric vehicles will be a big disruption in the long run. Weak balance sheets: I avoid businesses with weak balance sheets. One needs to understand there is a big dierence between weak balance sheets and highly levered balance sheets. All banks are highly leveraged, but some have very strong balance sheets.

Inecient capital allocation: I also avoid businesses where there are serious


|50

instances of capital misallocation. Any poor capital allocation in the past is ne, if the management learns from that. I don't like businesses where one segment is doing good and other segment is burning cash. I much rather prefer partnering with managers who understand and apply common sense principles of capital allocation and don't throw good money after bad. Bad governance: I try to avoid managements with bad corporate governance track records. I don't mind high compensation for executives, but it should not be at the expense of the shareholders. I avoid companies where related party transactions reect greed in the management at the expense of the minority shareholders. Short term over long term: I really don't like managements which display propensity to show near-term earnings at the expense of long-term earnings. I like it the other way around - i.e. hurting short-term earnings to build sustainable long-term earnings with strong entry barriers. About the patterns I seek in the companies I invest:

Moat: I love businesses with moats around them. Isn't it obvious that a business which can protect its margins and returns on capital is likely to last longer than one which can't? People factor: I would much rather invest in a reasonably good quality business or even a touch business run by an exceptional manager who is creating a culture of excellence which will last for a long time. Owner-operators: Owner-operators with soul in the game, statistically speaking, do far better than professional managers who don't have ownership or managers of government-owned companies. Learning machines: I like managements/owners who make mistakes and learn from both their and mistakes made by other people.

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Market ineciencies: There are times when a business is treated as a commodity business and priced as such by the investment community for a long time. However, sometimes there is a wonderful niche in there which has escaped the attention of many others. Management investing for the future: Businesses where management is investing heavily for the future but still generate cash ows. Basically, one is looking for managers who, when they were kids, would have done very well in the 'marshmallow experiment'. Someone like Amazon's Je Bezos. I am always trying to nd people who understand long-term free cash ow, focus on customers, and have plenty of staying power - both nancial and psychological. Rohan Pinto - In your last year's address at FLAME University. You spoke about a preference for Indian consumption driven stories over export dependent ones. Can you walk us through with your reasoning for that? Sanjay Bakshi - Well, other things remaining the same, one should be investing in business models with fewer movable parts. The problem is that other things are never the same. While, it's true that Indian companies targeting Indian customers are easier to understand, it's also true that many of them - especially those that are already dominant in their respective markets - are so well known that their stock market valuations make them unattractive as investments. I like to look for businesses that are globally competitive or are on a well-dened path to become so. For instance, they sell products for which Indian markets are not ready right now. However, when Indian markets develop, they are at right place and the right time. Kunal Thanvi - Professor how do you decide exit multiples and what are your thoughts on averaging up? Sanjay Bakshi - Thinking about exit PE multiples is very subjective, but one can use a framework. One needs to de-anchor from entry multiples. There is this wrong perception in value investing community that a high PE multiple cannot be cheap. As a group, high PE stocks will probably underperform, but there are exceptions. The way


|52

I try to de-anchor from 'high' or 'low' PE multiples at the time of potential purchase is by thinking in terms of expected returns over the long-term. Now, expected returns consist of expected dividends and expected stock price appreciation over one's prospective holding period - say, a decade. And that second component - expected stock price appreciation - is itself derived from the entry PE multiple, expected earnings growth over the prospective holding period, and the exit PE multiple. So it makes a lot a sense to focus on expected returns instead of entry multiples. Elementary math shows that a high PE stock that sells at a lower multiple a decade from now may still be cheap today because of other factors in the expected returns equation - for example, earnings growth. So for me, the expected return framework has been very helpful. Now, how does one think about exit PE multiples? What factors determine PE multiples? Well, I wrote about that in 1999 (see here). Those factors are 1) stability, 2) growth, 3) dividends, 4) return on invested capital, 5) Leverage, 6) proportion of nonoperating assets in a company's asset base, 7) the nancial community's appraisal of the industry and the company, including its managers, and 8) interest rates. So one has to think about those factors when estimating exit multiples. One also has to recognise the reality that, over time, high-growth rms become low-growth rms and PE multiples will contract over time. As to your other question about averaging up. I love the idea of averaging up when it makes sense and it often does. If you have done the job well, there will be multiple buying opportunities. Again, it's foolish to anchor to historical cost price paid, which is what many investors do. If they have paid Rs 100 for the stock of a great business with a long runway for growth, they will refuse to pay Rs 200 to buy more. But the reality is that it may be cheaper and more attractive at 200 than it was at 100. When it was at 100, it was perhaps a much smaller and riskier businesses. Perhaps the moat was just getting established. At 200, it may be a larger, stronger, and more resilient business with a wider and deeper moat. And the expected return, conservatively estimated, over the

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next ten years may have become very attractive again. So it's foolish, in my view, to anchor to sunk costs. Ironically, many value investors love averaging down but hate averaging up. They are making a big mistake. Kunal Thanvi - Just a small follow up on that. Does it make sense to look at historical median PE multiples? Sanjay Bakshi - Median price to earnings for broader market is ne. It gives us a good sense of the overall market valuations. However, median PE for individual businesses is not something that I look at very much. A historically low PE multiple for a value-creating business may be a buying opportunity. And then, maybe not, especially if the business is prone to disruption. The past should be used as a guide, but it's foolish to assume that everything will mean revert. Sometimes, mean reversion doesn't work. Rohan Pinto - What gives you the condence to face a nancial write-down of 50% or more? Sanjay Bakshi - Well nothing gives me that kind of condence. I never met anyone whose portfolio shrunk by 50% in a joyous mood. Nevertheless, one needs to distinguish between a 50% drop in the market value of a stock vs a 50% drop in the average earning power of the business underneath the stock. The latter is far more important than the former, provided one has staying power - structural (for example, in the form of permanent capital) and psychological. If one is structurally and psychologically sound, then one can aord to ignore the market and only worry about the possibility of permanent impairment in earning power of the businesses in the portfolio. And if one is not structurally or psychologically sound, one must try to become so over time.


|54

Rohan Pinto - Professor, you mentioned the three characteristics in the eighth intelligent fanatic. Integrity, energy, intelligence. What has Modi done right and missed? What are your parameters/criteria to judge the Indian economy? Sanjay Bakshi - I completely misjudged him. I underestimated his risk taking propensity for the benet of the country. People don't understand the importance of the structural changes he has brought about, but that should not be surprising to anyone who understands the 'boiling frog' syndrome. I believe that, net-net, he is very good for the country. With this, our session with professor Sanjay Bakshi came to an end. The learnings will continue with us forever. Learn and evolve continues to remain our mantra. I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines. - Charlie Munger We hope you enjoyed this conversation as much as we did. We want to thank the professor for answering our questions with great enthusiasm despite his busy schedule. See you next time.

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The Man Who Knows the Secret to Spotting 100 Baggers Forty ve years. That is how long ago Thomas Phelps published his now famous book 100 to 1 in the Stock Market. But the relevance and succinctness of the contents of the book were lost on most of us. For decades. That is until a gentleman who answers to the name of Chris Mayer took inspiration from the book for his herculean project. I had the privilege of meeting Mr Mayer at a few conferences of Agora Financial. But it was only 2015 when he published his own book 100 Baggers, that I realized why Phelps' book is as much an investor's Bible as are Graham's Intelligent Investor and Security Analysis. What Chris Mayer did was that he studied in-depth about 365 stocks returning at least 100x between 1962-2014. That's loads of research whichever way you look at it. And he presented what he called the secrets to nding 100 baggers in his book by the same name. Now, my colleagues Rohan and Kunal, as you already know, are on a mission to track every smart investor who can give you an edge. Their interviews with Kenneth Andrade, Ashwath Damodaran and Sanjay Bakshi have been widely appreciated by our readers. And recently they had the chance to have a one-one-one with Mr Mayer too... What got you interested in stock markets? I remember being curious about the 1987 crash. I was 15 then. I remember just being fascinated by this thing called 'the stock market' and wanting to know more about it. The only investor I could think of then was the most famous one of all: Warren Buett.

TheManWhoKnowstheSecrettoSpotting100Baggers

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So I started to read and study his career. He talked about his teacher, Benjamin Graham and so I read and studied his books as well. I remember holding Graham's Security Analysis, a big fat book, with a sense of wonder. I couldn't understand it. It was like a book of magic spells to me. But I wanted to learn. And so that set me on my path studying nance. Could you dene in brief your investment philosophy? There's an acronym I use that sums up what I'm looking for: CODE. C is for Cheap - I want to buy stocks that are undervalued. O is for owner-operator. I want to buy stocks where the people running them have skin in the game. D is for disclosure, meaning the public disclosures should not raise any red ags. And E is for Excellent nancial condition. I look for companies with great balance sheets. I think of stocks as representing ownership interests in businesses and I aim to hold them for a long time. Who has been your biggest inspiration? Hard to say... I've taken inspiration from many dierent investors - Warren Buett and Charlie Munger, of course, and Ben Graham. But also Peter Lynch, Martin Whitman, Seth Klarman and Joel Greenblatt. I've also been inspired by lesser known investors such as Murray Stahl and Steve Bregman at Horizon Kinetics, Martin Sosno (who wrote a few entertaining books on investing) and Thomas Phelps (the author of 100 to 1 in the Stock Market). What according to you is the most dicult part in investing? Selling. Nobody is a good seller. Waiting can be hard too. It's hard to be patient and give your ideas time to work, to allow the power of compounding to work for you, and sit through the crazy ups and downs of the market - and your own emotions.

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The Man Who Knows the Secret to Spotting 100 Baggers

If you could change one thing about your investing approach in the past what would that be? I wish I'd taken an approach more like what I write about in my book 100-baggers earlier. I think I would be much wealthier. Early in my career, I started out more as a conventional value investor in the Graham mould. I'd buy a cheap stock and when it became more fully priced I'd sell it... I would've been much, much better o looking for quality businesses I could've sat on for 20 years. Could you tell us something about your mistakes in picking stocks? When asked this question, most investors will think of stocks where they lost money. But my rst reaction is to think of stocks I never bought that went up huge. These are mistakes of omission, as opposed to mistakes of commission. Mistakes of omission are easy to hide. No one sees them except you, but they are the most costly by far. Why didn't I ever own Apple, for example? A great stock right under my nose... I guess my biggest mistakes in picking stock have always come when I've gotten involved in a lower quality business. You think a business is okay, but it turns out not to be what you thought it was. I think you're better o sticking with high-quality assets, even if you have to pay up a little, than buying the cheaper inferior business. What kind of businesses do you think will be the biggest wealth creators over the next two decades? They will probably be businesses that solve the biggest human problems. The company that does actually cure cancer, or the company that makes 3-D printing aordable to the masses, or the rst gene-editing company that makes a widely available commercial product... My guess would be those sorts of businesses. But there are other things that are less obvious that I think can create a lot of wealth. Aerospace is an interesting one because the number of passenger miles own seems to only go up. Financials such as banks and insurers reliably generate wealth. There is always a consumer brand that creates something new.


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Also, let us not forget the rapidly developing markets such as India and China. Probably there will be enormous wealth creation in these countries over the next twenty years and in the businesses that serve these populations. What do you think is the 'one thing' that every Indian investor should keep in mind? Stick to businesses where time is your friend. There will be lots of ups and downs, but if you buy quality assets that you think are a near cinch to be worth a lot more money in 5 years or ten years, you'll be ne. If you had an extra hour each day what would you like to do? Probably more of the same things that I spend most of time doing now. Read and think. Do you prefer a concentrated portfolio or a diversied one and why? Denitely concentrated. It's hard to nd good ideas. It's easier to nd 10 good ideas than 30. Why own your 30th best idea? Why own your 20th best idea? What is your preferred Valuation metric and why? My favorite is to see what private buyers are paying for the similar assets as I can buy in the public markets. If, for exampe, I see private buyers paying $150,000 a room for hotel properties in the private markets, but I can buy them for $100,000 in the public markets, that might point to something interesting. We call it "private market value." It's my favorite because it's usually overlooked by most investors who are focused on things you can readily look up such as price-earnings ratio, dividend yield, price to book ratio, etc. But I use whatever valuation metric is most appropriate for the business at hand.

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Please tell us about: Your Top Three Favourite Books Investing books? I'll pick three are less well known... 100 to 1 in the Stock Market by Thomas Phelps Humble on Wall Street by Martin Sosno Modern Security Analysis by Martin Whitman Your Favourite Annual Reports Berkshire Hathaway Fairfax Financial Holdings Markel Your Favourite Movie/TV Series The Big Lebowski

Kindly pick one of these: Graham or Fisher or Lynch I grew up on Graham and to a lesser extent Fisher, but today I'd pick Lynch... His books One Up on Wall Street and Beating the Street are still worth reading today. Alphabet or Apple or Amazon Amazon, because I use it all the time and love it. Movies or Annual reports Annual reports. I don't watch many movies in any given year. Maybe 5, tops.


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Growth (Size of the Opportunity) or Valuation Valuation... I really like growth and the opportunity set, but if the valuation doesn't make sense, I'm not buying it. Great Management or Business Moat A tough one. I'll take great management because there are plenty of businesses that don't have much of a moat - like in insurance - where I'm happy to invest with great management (Berkshire, Markel, Fairfax, etc.). Moats are tricky. Very few companies have a real moat and most moats are crossed over time.... Whereas, smart people don't usually get dumb. Historical Performance or Future Expectations Historical performance. Track record can be everything in investing. If you did nothing but invest with people who had great 10-year+ track records, you'd do quite well. Cash Flow Statement or P&L Cash ow. It's much harder to fake cash. And, as we used to say in my banking days, cash ow repays loans, not earnings. Stay tuned. As Rohan and Kunal travel the length and breadth of the country to bring these pearls of wisdom from the smartest minds in investing, you will nd yourself asking for more...

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A Little Known Way to Clone India's Super Investors I wrote to you on the merits of cloning a super investor. Warren Buett. The results were clear. The cloned group of stocks outperformed the benchmark indices over a time horizon of 15 years. We learnt that stock picks of these smart minds available in public domain could act as a basic yet eective rst level lter that would help in identifying quality businesses. Chris Mayer is of the belief that one needs to hold on to quality businesses once you own them. Stick to businesses where time is your friend. There will be lots of ups and downs, but if you buy quality assets that you think are a near cinch to be worth a lot more money in 5 years or ten years, you'll be ne. Unfortunately, for us, in India, we don't have such an individual disclosure as is available in the US. However, there is a silver lining. The regulations require companies to report any public shareholding that is more than 1% to be mandatorily reported every quarter. Mind you, tracking all these company disclosures is not an easy thing. However, doing this provides you with an access of what these super investors are investing.


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Kunal and I believe cloning India's Super Investors could be a great source of idea generation. This disclosure has some limitations. The companies update their shareholdings only every quarter. Generally, there is a huge time gap between time a super investor may have bought in a stock versus the actual disclosure. However, there is another potentially rewarding tool available with us to help track these super investors. Enter: Bulk and Block Deals Both the exchanges are mandated to report deals that are over a certain set threshold daily. On an everyday basis, the exchanges release the data for all the bulk and block deals that have happened on its exchanges. While, over 90-95% of these are mostly noise.

Sifting through the wheat from the cha could be potentially hugely rewarding for the curious mind. Let me walk you through an example. Now, we spoke in detail about Akash Prakash, co-founder of Amansa Capital. A Fund manager who walks the less trodden path. Akash prefers companies that are well managed and nancially disciplined, with a strong growth potential that can be held for multiple years and trade at a reasonable price. If you have a similar investment philosophy of Amansa Capital and track the rm's activities.

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On 15th Oct 2008, one would have found a bulk deal wherein, Amansa bought a 0.56% of a stake in Eicher motors at a price of Rs 201.

Da t e

ClienN t ame

15-O c t -08

AmansaCapital

Deal

Quantity

B uy

156,727

Price 201

Imagine this, if fundamentals of Eicher Motors at the time passed your earnings quality checks and you stayed invested in the company. Every Re 1 invested in the company then would have multiplied by 128 times in April-2017. That's a whopping compounded annual return of over 77%.

Eicher Motors - The Compounding Machine Stock Price Performan ce - CAGR (%) 80% 60% 40% 20% 0% EicherMotors www.equitymaster.com

BSESensex Source: Ace Equity

Imagine this, if fundamentals of Eicher Motors at the time passed your earnings quality checks and you stayed invested in the company. Every Re 1 invested in the company then would have multiplied by 128 times in April-2017. That's a whopping compounded annual return of over 77%. Well, Amansa Capital has stayed put and rode on this multibagger the whole way.


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According to the Top 10 shareholders list provided in the Annual Report of Eicher Motors in 2016. Amansa continued to hold around 0.73% of the company. Now, there are plenty of other examples, wherein tracking such bulk/block deals could have been resulted in huge wealth creation. The critical aspect here again is to go beyond the stock picks of the smart money and understand their thought process behind buying them. Our research co-head Rahul Shah often says, "it is all about exploring unrecognized simplicities." There is another simple yet powerful way to identify promising companies. This person has the best view of what is happening to the business. He proverbially is in the driver's seat of the car. Kunal has all the details. Watch this space tomorrow.

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How I Discovered Smart Money Secrets The idea of meeting and tracking India's super investors wasn't random. We gave this very serious thought. Following the smartest minds in nance helps with idea generation and gives an edge over other market participants. We, Rohan and I started working on this project, we made a list of our favourite super investors. We drew down the history of successful yet relatively unknown stock pickers in India. Now, stock exchange requires every company to disclose all shareholders with more than 1% in the company. We used that public information to 'back track' the activity of these savvy stock pickers for the last ten years. We wanted to know what happens when a savvy stock picker buys more than 1% stake in a company. We thought it would be a great idea to track this data closely. The problem is by the time the information becomes publicly available, the stock has already shot up because the super investor exceeded the 1% shareholding threshold before the disclosure was made public. This led us to level-two thinking. How can we catch them earlier, we wanted to know? Enter bulk and block deals. Now the basic idea here was to track the smart money early. If we can do so, we can denitely have an edge.

How Discovered I Smart Money Secrets

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This led us to level-three thinking. And to the important question: What or who is the 'smart money' in stock market? Generally, the answer is funds, smart stock pickers, FIIs, etc. But we were missing something: Promoters. A promoter knows everything about his company. When you see, a promoter increasing his stake, it's a strong indicator since he believes in his own business. We believe, one of the strongest source of the smart money is 'Promoters increasing the stake in their own company' So, we back tested the idea. The results were overwhelming. Just to give you a avor... Imagine a company with return ratios of around 9% and a debt-equity ratio above two times. Add a declining EPS growth rate...and our screeners would never throw this kind of company. However, somewhere between these depressed numbers was something magical increasing promoter holdings.

The question here is: Why would the owner buy more into a company with such depressed numbers? The reason is simple...yet ignored: The owner knows more about his company and its prospects than anybody else. Specically, in this example, I am referring to auto ancillary company, Steel Strips Wheels Ltd. The promoter group has been increasing its stake in the company. From 53.8% in March 2013, it grew to 54.2% in June 2013 and continued inching upwards a nd is at 58.7% in March 2017.

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Early Signs of Promoters Increasing the Stake %ofShares

Mar-2013

TotalofPromoterandPromoterGroup

Jun-2013

5 3 .8 2

Mar-2017

5 4 .2 1


5 8 .7 7 Source: Ace Equity

The business fundamentals improved a lot over the same period. As of FY16, the ROEs improved to 16% and the balance sheet got leaner with debt-to-equity at 1.6 times. The stock's performance has been stellar, multiplying six times in the last four years (a CAGR of 65%).

Stellar Stock Performance - Steel Strips Wheels Ltd. Steel Strips Wheels 1,000 CAGR ~ 65% 750 500 250 0 Jul-13

Apr-14


How Discovered I Smart Money Secrets

Jan-15

Oct-15

Jul-16

Apr-17

Source: Ace Equity

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This is just one example. Rising promoter stakes often precedes an improvement in business fundamentals and stock price returns. So, all the three approaches combined i.e. Tracking shareholdings of Super investors, catching these investors early (Bulk & Block deals) and increasing promoter holdings has helped unveil some critical smart money secrets to us. The excitement level continues to build by the day. Stay tuned.

69


Authors Profile Rohan Pinto (Research Analyst ), Managing Editor, ValuePro,

holds a bachelor's in engineering and a master's in nance. He is a practitioner of value investing philosophy inspired by Warren Buett and Charlie Munger. Being a voracious

reader, Rohan believes in the philosophy of mastering the best of what other people have already gured out. In his pursuit of worldly wisdom, he has constructed a multidisciplinary mental models framework, which he believes aids in eective decision making. His search for outstanding stocks is driven by a relentless pursuit of learning from the greatest living investors and the eminent dead.

Kunal Thanvi (Research Analyst), a member of the Institute of Chartered Accountants and the Companies Secretaries of India, started his career with a PMS as a buy-side analyst. He

is a balance sheet driven analyst who loves niche businesses with competitive advantages. He practices value investing based on Ben Graham's principles of 'Margin of Safety' and 'Mr Market'. He is an avid reader who believes it's better to learn vicariously than the hard way.

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