Investing chat with Gautam Baid

 A Single conversation with a wise man is worth a month’s study of books  Chinese proverb

Continuing with my investing chat series with smart minds, I had a deeply thought provoking conversation with Gautam Baid.

Gautam Baid, CFA, is Portfolio Manager at Summit Global Investments, a SEC-registered investment advisor based out of Salt Lake City, Utah, USA. Prior to his current role, he served at the Mumbai, London and Hong Kong offices of Citigroup and Deutsche Bank as Senior Analyst in their healthcare investment banking teams. Gautam is a CFA Charter holder from CFA Institute, an MBA in Finance from Nirma University, Ahmedabad, India and an MS in Finance from ICFAI University, Hyderabad, India. He is a strong believer in the virtues of compounding and lifelong learning.

When I reached out, Gautam was gracious enough to spare some time for a chat. Italo Calvino famously quipped “A classic is a book that has never finished saying what it has to say”. On similar lines, every time I go back and re-read this conversation, something new strikes me.

The distilled essence and wisdom acquired by spending thousands of hours over the years in reading, thinking and investing in the markets by Gautam has permeated into this conversation.

Dear reader, please grab a cup of coffee; sit back and enjoy the conversation.

Ravi: Hi Gautam, Please tell us something about yourself and how you decided to pursue a career as an investment professional?

Gautam:

I am the youngest of the four siblings in my family and my parents, my two elder sisters and my elder brother reside in Kolkata, India. Prior to my relocation to the US in 2015, I served for seven years at the Mumbai, London and Hong Kong offices of Citigroup and Deutsche Bank as Senior Analyst in their healthcare investment banking teams.

As is typically the starting story of many investors, I got lured into the stock market out of greed during the final euphoric phases of a bull market. In this case it was the 2003-2007 one in India. I invested in Reliance Power Sector Mutual Fund in late 2007 and Ispat Steel in January 2008 as both were in “hot sectors” of the times and both had “recently” appreciated “sharply in a very short span of time” when I had first noticed them.

So, I just engaged in blind extrapolation of the recent price trends in them without paying any attention whatsoever to their valuations. Recency and vividness biases are very powerful but highly costly behavioral mistakes. Both the investments crashed 70%-80% within 12-18 months of my purchase. I had successfully gained admission into the stock markets by paying my tuition fees.

Despite this bad initial experience, my curiosity and interest about the stock markets always remained very high throughout all the years of my investment banking career. We have just this one life to live our dreams and I did not want to waste any further time doing something that I was not passionate about.

I was so keen for a career shift that I relocated to the US (one of my relatives who is an American citizen sponsored my green card) without any job in hand! I thought that I will land a job in my desired profile within a short period of time since I was a CFA Charter holder and this particular degree is generally considered to be highly valued in the investment management industry.

Alas, life is not a bed of roses for those trying to carve their own destiny. I got rejected in my first three stock market job interviews, but I did not give up. I was adamant that I am not going to go back to my previous field of work where the presence of perverse incentives constantly led to incentive-caused bias and conflicts of interests and did not suit my personal nature, so I kept declining all investment banking job interview calls that came my way (even though they would have had very high dollar salaries).

At the same time, I ran out of whatever little money I had brought with me from India and to take care of my living expenses in US, I did not want to sell even a single share from my portfolio of Indian stocks as I did not want to interrupt the process of compounding. So, I took up a minimum wage job as a front desk clerk at a hotel in San Francisco where I used to work during the “graveyard shift” (for the uninitiated, this is the shift that runs from 11pm at night to 7am in the morning).

Even though it was a big struggle for me physically, emotionally, culturally and intellectually, today, in hindsight, I highly value those days of my life because for the first time since the beginning of my professional career, I got some free time for myself to read and learn. This was the phase during which my learning curve really took off from a tiny base.

Little did I realize at the time that I was laying down the strong building blocks for compounding in my life. The pace of work during late night to early morning at the hotel was pretty slow and I made full use of the free time to read every single article published on blogs like Safal Niveshak, Fundoo Professor, JanavWordpress, Base Hit Investing, and Microcap Club among others. The passionate pursuit of lifelong learning had begun.

All of us who discover our calling in life get to do so through a defining moment, event or experience. Let me share mine with you.

During a stormy night in San Francisco in mid-2016, I was at home (I used to rent and live in a single room as a paying guest. I was trying to save every single dime that I could during this phase) reading the 2012 edition of Tap Dancing to Work, a compilation of articles on Warren Buffett published by Fortune between 1966 and 2012. Immediately after finishing the book, I came to know that there was a more recent 2013 edition of it which contained one additional chapter.

I did not want to spend money on buying the newer version of the book, so I went to the local bus stand, got badly drenched (even while using an umbrella) while waiting for over an hour in the midst of the storm, and travelled all the way to a distant Barnes and Noble bookstore to read the final chapter of the book inside the store and save a few dollars. (I had a monthly bus pass at the time, so the bus ride did not cost me anything.)

That night I realized that I had finally discovered my calling in life. It is difficult to express in words the sheer intensity of the emotions, thrill, joy and excitement that I experienced. I could not sleep that entire night. Only the fortunate few who discover their true passion in life will be able to relate to what I am trying to convey.

Luck, chance, serendipity and randomness have always played a big role in various aspects of my life till date. One fine night during November 2016 while working at the hotel, I randomly clicked on the “quick-apply” button on a job application on LinkedIn during the course of my routine online job search.

I unexpectedly received an interview call for the job and that too for a senior role in an investment firm even though I had zero formal work experience in the stock market! And this was the phase in my life during which I was about to experience the power of compounding knowledge in action.

All those hundreds of hours which I had spent during the previous year at the hotel reading the blog articles had built a strong intellectual foundation for me in investing (this is what I was lacking during my first three stock market job interviews in US) and I excelled in all the three rounds of my job interview (body language derives from self-confidence and self-confidence in turns derives from knowledge).

I was offered the role of Portfolio Manager and it was like a dream come true for me. Today, even after achieving financial freedom, I continue to work in my job because I just love the work that I get to do and the icing on the cake is that I get paid for getting to learn and improve every day.

 

Ravi: WOW, that’s a fascinating story. I completely agree on finding your passion part. As Steve Jobs said “The Only way to do great work is to love what you do”. It is a beautiful thing when passion meets profession.

Moving on, how has your investing philosophy / process evolved over the years? What has influenced your current line of investment thinking?

Gautam:

My personal investment philosophy has evolved over the years with time and experience in the markets. Initially, it was restricted only to secular growth stocks at reasonable to slightly expensive valuations.

But now, it covers multiple areas of the investment universe like commodities, cyclicals, fundamental momentum, deep value, special situations and loss making companies which are turning around as reflected in slow gradual changes (low contrast) in their improving balance sheet, working capital cycle and margins and/or a significant positive change in their industry dynamics.

In a nutshell, I now invest wherever I find “mispricing” of value and a highly favorable risk return trade-off.

Another key area of my evolution as an investor has been in understanding of human nature and the significant role of incentives in governing individual behavior. Always think about the possible incentives involved in any situation before making your final decision.

Ravi: Knowing about your investing philosophy I just remembered what Seth Klarman once said “If only one word is used to describe what Baupost does, that word should be “Mispricing”. We look for mispricing due to over-reaction.”

Based on your current thought process that you have mentioned, what are the criteria’s or characteristics that you look for in a business for it to be considered as investment worthy?

Gautam:

Between low quality businesses at a cheap valuation and high-quality businesses at a fair valuation, my preference is always for the latter since I can have meaningful allocations of my portfolio in them with peace of mind and higher stress-adjusted returns. High-quality businesses typically demonstrate sustainable competitive advantages, known in investing parlance as “moats”.

Strong brands with “share of mind” which confer pricing power, network effects, high switching costs, a collection of patents (as opposed to relying on only one or two), favorable access to a strategic raw material resource or proprietary technology, and government regulation which prevents easy entry – these can confer a strong competitive advantage which in turn enables excess returns on invested capital over the cost of capital for long periods of time (also known as the Competitive Advantage Period/CAP).

Growing firms with high Return on Invested Capital (ROIC), opportunities for reinvestment at those high ROICs, and longer CAPs are more valuable in terms of net present value.

One of the most highly underappreciated sources of a sustainable and difficult to replicate competitive advantage is “culture”, best epitomized by companies like Berkshire Hathaway, Amazon, Costco, Piramal Enterprises, HDFC Bank, to name a few.

To illustrate the critical importance of culture just consider this: From 1957 to 1969, Warren Buffett did not mention the word “culture” even once in his annual letters. Since 1970, he has mentioned the word more than thirty times.

Some of my favorite books on competitive advantage are The Little Book That Builds Wealth by Pat Dorsey, Understanding Michael Porter by Joan Magretta, and Different by Youngme Moon. For learning about how to evaluate the culture of an organization, I recommend reading A Bank for the Buck: The Story of HDFC Bank by Tamal Bandopadhaya, both the editions of Intelligent Fanatics by Sean Iddings and Ian Cassell, and Investing Between the Lines by L.J. Rittenhouse.

 

Ravi: Warren Buffet famously said “Rule No. 1: Never Lose money. Rule No. 2: Never forget Rule No.1”. Corollary to the previous question, if there were to be “Gautam Baid’s 5 rules for successful stock investing” then what would that be?

Gautam:

1. Learn to distinguish between investment and speculation. A speculator looks at a stock as a piece of paper. An investor looks at a stock as part ownership in a business.

2. Mr Market is always eager to hand you great opportunities from time to time on a platter. Stock prices fluctuate far more than the intrinsic value of the underlying business, sometimes wildly on either side – and therein lies the big opportunity. Widespread fear is your best friend as an investor, personal fear is your worst enemy.

3. Be an ardent student of crowd psychology, cognitive biases, market history and human behavior since objectivity, rationality and temperament are far more critical than raw intellect to succeed as an investor. Your personal behavior matters much more than advanced excel analytics and complex math. Always think quantitatively (numbers and probabilities) and not dramatically (vivid images and futuristic stories).

4. Develop a working knowledge of accounting as it is the language of business through which you understand how the balance sheet, income statement and cash flow statement tie together.

5. Always focus intensely on the underlying process rather than obsessing about the eventual outcome. Resist the illusion of control.

And if I had the liberty to add 3 more important rules to the list, it would be the following:

6. Always consider the outside view which takes base rates and statistics into account rather than only the inside view which makes predictions based on a narrow set of inputs.

7. The frequency of correctness does not matter; it is the magnitude of correctness that matters. Michael Mauboussin calls this “The Babe Ruth Effect”.

8. Lastly, and most importantly, for any investment decision (and for all important decisions in life), always take the potential consequences into account instead of focusing only on raw probabilities

 

Ravi:  Those are a great set of rules to follow for successful investing. Next up, what has been your best investment idea (need not be the most profitable) till date? Can you also elaborate on the thinking that went behind the investment idea?

Gautam:

The best investment idea is always known only in hindsight. As value investors, we derive intellectual satisfaction from the mental process of investing. Let me share an example to illustrate. The prospects of Kilpest India’s new business subsidiary look very promising.

Kilpest India owns 97% of 3B Blackbio, a fast growing and highly profitable molecular diagnostics business. So, in effect, for less than INR 25 crores (~$4 million) market cap, we were being given the opportunity to become part owners of a business generating free cash flows and having a return on capital employed of 100% and net profit margins of 20%+, all while having the lowest-cost producer advantage.

When I looked at 3B Blackbio for the first time, it reminded me of these words by Jeff Bezos:

“A dreamy business offering has at least four characteristics: Customers love it, it can grow to very large size, it has strong returns on capital, and it’s durable in time – with the potential to endure for decades. When you find one of these, don’t just swipe right, get married.”

Ravi: Kilpest India looks like a great idea. Reading Jeff Bezos words I remembered what Buffett once said “Opportunities come infrequently. When it rains, put out the bucket, not the thimble”. When a dreamy business does turn up, one should seize it with both the hands.

From master stroke let’s move on to mistakes. Mistakes are sometimes referred to as “unexpected learning experiences”. Can you share any investing mistake(s) you have made?

Gautam:

I have luckily made very few mistakes of omission within my circle of competence till date in my investment career. I can honestly make this assertion based on the prevailing circumstances and available information at the time of my past decisions.

However, I have made multiple mistakes of commission because I fell prey to different behavioral biases at different points of time, notably bias from over-influence of authority, bias from anchoring, bias from liking and disliking tendency, stress-influence tendency, cognitive dissonance and loss aversion.

As investors, we always make our initial purchase based on incomplete information and our own personal biases and highly favorable assumptions about the future of the business. Let’s be honest, endowment effect is deeply embedded within us and we start feeling more confident about the prospects of a business after we have bought its stock. Happens all the time with everyone, we are human after all and we are a messy living compilation of a multitude of cognitive and behavioral biases.

This self-awareness and acknowledgement is the necessary first step towards attaining wisdom.

We cannot avoid biases totally even after being fully educated about them, we can only try to reduce their frequency to the maximum extent possible through the use of checklists, maintaining an investment journal, conducting a pre-mortem, demonstrating intellectual honesty by actively seeking disconfirming evidence to kill our existing ideas (especially our best-loved high conviction ones), consciously thinking about the potential incentives at play in a particular situation, engaging in second-level thinking about “the consequences of consequences” by always asking “and then what?,” and using other relevant tools for improved decision-making as applicable to the individual situation.

The Thinker’s Toolkit by Morgan Jones and The Art of Thinking by Ernest Dimnet are some great books on improving one’s decision-making process.

 

Ravi: Loved the part on self-awareness which I believe plays a large part on what you do and become as an investor. As Aristotle said “Knowing yourself is the beginning of all wisdom”. Cannot be more truer for our investing journey.

Moving on, what has been the most important investing lesson(s) you have learnt from your time in the market?

Gautam:

The answer lies in your question itself Ravi. It is “time in the market” and not timing the market that drives wealth creation. If I had gotten scared and exited the market during the periodic phases in 2013, 2015 and 2016 when my portfolio value fell 30%-35% (with many individual stocks down 40%-50%), then I would have completely missed out on the big bull market years of 2014 and 2017 which helped me achieve financial independence early in life. The words of Peter Lynch on this subject are noteworthy:

“Whatever methods you use to pick stocks, your success will depend on your ability to ignore the worries of the world long enough to allow your stocks to succeed. No matter how intelligent you are, it isn’t the head but the stomach that will determine your fate.”

 

Ravi:  Cannot agree more on the perils of market timing. Some people claim to do it successfully but I seem to be terrible with that. I believe more in what Daniel Kahneman said “The average investor’s return is significantly lower than market indices due primarily to market timing”

Next up, what has been the most important investing advice(s) you have received on investing? How has it influenced your investing process?

Gautam:

It was from my mentor, Utpal Seth, who enlightened me on the fact that the key to investing success is to simply remain invested in good businesses for a long period of time and “stay the course” amidst all the noise and cacophony about negative macro developments and global geopolitical or local political issues.

Simple. Simple but not easy.

 

Ravi:  That is a great piece of advice to heed to and I have seen this happening with my friends. As David Dreman said “Investors repeatedly jump ship on a good strategy just because it hasn’t worked so well lately, and, almost invariably, abandon it at precisely the wrong time.”

Is there any particular investor(s) or author(s) who have had a significant influence in your investment thinking? How? (In terms of say mentoring or inspiration)

Gautam:

While I have learned from many great investors and authors, my personal investment philosophy has been largely shaped by the teachings of Benjamin Graham, Warren Buffett, Charlie Munger, John Maynard Keynes, Phil Fisher, Peter Lynch, William O’Neil and Joel Greenblatt. Daniel Kahneman, Richard Thaler and Robert Cialdini have also played a key role by teaching me how to minimize behavioral biases to a great extent.

Ravi: Next up is one of my favorite questions. Let us say a bunch of enthusiastic investing beginners approached you for advice on how to be a successful stock investor. What would your advice for them be? (If you could elaborate on the Do’s and Don’ts then it would be really helpful)

Gautam:

• Stick to your circle of competence, only invest in businesses you can understand well and in which you can reasonably assess that they will be earning significantly higher profits many years from now. Such businesses are usually less vulnerable to technological or “app” risk and operate in stable industries with low rates of change.
• Embrace inactivity and devote most your time to reading, learning and improving your thinking. Low turnover leads to low frictional costs and these few extra percentage points saved every year lead to very large absolute savings over long periods of time because of compounding.
• Create an investment checklist. Every investor should read Atul Gawande’s The Checklist Manifesto and The Investment Checklist by Michael Shearn.
• Maintain an investment journal which contains your original investment thesis at the time of making the purchase as well as the rationale for making the sale. This is the most objective way to remain true to yourself and more importantly to continuously keep learning from your mistakes.
• Focus on investing at reasonable valuations in low debt, cash flow generating businesses with high returns on equity and strong competitive advantage(s) which can grow for long periods of time with minimal or no equity dilution.

Ravi: The 5 things you have mentioned are indeed the basic building blocks to chart a successful investing career. I find Investing checklist to be slightly underrated among beginners and so is the case with maintaining an investing journal. On the checklist point, it’s good to remember what Munger said “No wise pilot, no matter how great his talent and experience, fails to use his checklist.”

Continuing with the previous question, if they sought your advice on the best book (s) for a stock market beginner then which book (s) would you recommend? Why?

Gautam:

Michael Mauboussin authored a brilliant paper in August 2016 titled “Thirty Years: Reflections on the Ten Attributes of Great Investors”.

Let me outline those attributes below along with my favorite book(s) on each topic for the benefit of all your readers:

• Be numerate (and understand accounting) – How to Read a Financial Report by John Tracy, Accounting for Value by Stephen Penman, Financial Shenanigans by Howard Schilit, Quality of Earnings by Thornton L. O’glove, The End of Accounting by Baruch Lev
• Understand value (the present value of free cash flow) – Creating Shareholder Value by Alfred Rappaport, Valuation: Measuring and Managing the Value of Companies by McKinsey
• Properly assess strategy (or how a business makes money) – Business Model Generation by Alexander Osterwalder and Yves Pigneur, Competitive Strategy by Michael Porter
• Compare effectively (expectations versus fundamentals) – Expectations Investing by Alfred Rappaport and Michael Mauboussin
• Think probabilistically (there are few sure things) – The Drunkard’s Walk by Leonard Mlodinow, Innumeracy by John Allen Paulos, Thinking in Bets by Annie Duke.
• Update your views effectively (beliefs are hypotheses to be tested, not treasures to be protected) – Stalking the Black Swan by Kenneth Posner, A Few lessons from Sherlock Holmes by Peter Bevelin, Superforecasting by Philip Tetlock and Dan Gardner, Book of Value by Anurag Sharma
• Beware of behavioral biases (minimizing constraints to good thinking) – Thinking, Fast and Slow by Daniel Kahneman, The Art of Thinking Clearly by Rolf Dobelli, Your Money and Your Brain by Jason Zweig, Why Smart People Make Big Money Mistakes by Gary Belsky and Thomas Gilovich
• Know the difference between information and influence – The Crowd by Gustave Le Bon, The Art of Contrary Thinking by Humphrey Neill, Influence by Robert Cialdini, Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay, A Short History of Financial Euphoria by John Galbraith
• Position sizing (maximizing the payoff from edge) – The Warren Buffett Portfolio by Robert Hagstrom, Fortune’s Formula by William Poundstone
• Read – How to Read a Book by Mortimer Adler and Charles Van Doren

I would add three more important attributes to the above list:

• Extreme levels of patience coupled with the ability to act decisively when the no-brainer opportunities present themselves. Mohnish Pabrai has beautifully articulated this concept in his book, The Dhandho Investor.
• Investing is multi-disciplinary in nature as demonstrated in Robert Hagstrom’s book Investing: The Last Liberal Art. Cross-pollination brings together ideas from different fields and one should focus on learning the big ideas from the important disciplines to become a worldly-wise person.
• Lastly, everyone should always invert while making important decisions in life, business and investing. “All I Want To Know Is Where I’m Going To Die So I’ll Never Go There”  by Peter Bevelin is the seminal book on the theme of inversion.

 

Ravi: That is an eclectic selection of books and makes a great reading list. As they say “So many books…So little time”.

Staying with the topic of books, Let us say there is a situation where you could retain only three books from your entire book collection then which books would those be? Why?

Gautam:

1. Poor Charlie’s Almanack – A life-changing book for investors and non-investors alike
2. Seeking wisdom by Peter Bevelin – The finest book I have ever read on multidisciplinary thinking
3. All I Want To Know Is Where I’m Going To Die So I’ll Never Go There by Peter Bevelin – The best book ever written on the theme of inversion

And I would print out the Buffett Partnership letters and the Berkshire Hathaway letters and owner’s manual separately.

Ravi: Again a great set of books . Can you tell us what a typical day in the life of Gautam Baid would look like? Have you made any conscious changes to your daily routine to become a better investor?

Gautam:

I usually reach office by 8am. A large part of a typical work day is spent reading newspapers, SEC filings, earnings concall transcripts, periodicals, trade publications, investing blogs and random articles of interest on the net. We also have our periodic investment committee meetings to discuss/review business development, strategy and portfolio management decisions.

I am back home from work by 6pm. After an early supper, I spend the time between 7pm and midnight reading books, watching movies on Netflix/YouTube, listening to music, and having phone conversations with my family, friends and peers. Currently it is that time of the year when Indian companies are coming out with their annual reports and I find reading them to be highly informative and educational.

Studying the filings, press releases and presentations of both your investee companies and their peers is a very enjoyable exercise for someone who is highly passionate about learning on different businesses and industries. This in turn helps expand one’s mental database. Work hard today to let serendipity find you in future.

The one minor change to my daily routine for the last few weeks has been that I have been spending most of my evening time watching the recorded videos of the past Berkshire Hathaway Annual Meetings which have been released for public viewing just a month ago. It has been a great learning experience so far.

 

Ravi: Last question, outside your passion for stock market and investing, are there any other interests / activities which are close to your heart?

Gautam:

I am very fond of reading on different subject matters from a wide variety of fields. To me it feels like an intellectual treasure hunt, you never know what hidden gems or new insights you will stumble upon when you begin a new book and start flipping through the pages. I enjoy watching Marvel and DC Comics, sci-fi, action thriller, comedy and Bollywood movies as well as live performance shows of magic and illusion.

I also love traveling as I find it fascinating to personally experience the diverse beauty which exists in our world. Whenever I visit my home town in India, I enjoy spending time with my family, friends and relatives.

 

Ravi: Any special message for the readers of stockandladder.com

Gautam:

I would like to share some life principles whose importance I have come to appreciate more and more with the passage of time:

• The best investment you can make is an investment in yourself. The more you learn, the more you earn. An investment in knowledge pays the best interest.
• Live life as per the inner scorecard. Self-esteem beats social approval. Every time.
• Associate with and learn from people better than you and you cannot help but improve.
• Control over your personal time is much more valuable than high absolute levels of money.
• A long and healthy life is the key to compounding so eat less junk food and sugar, get sufficient sleep and engage in regular moderate exercise.
• Be kind, humble and empathetic to others and always help people unconditionally without expecting anything in return. Karma is like a big snowball.
• Always be thankful to God, your parents and those who helped you during your difficult times.
• Never underestimate the role of luck in every sphere of life.

Lastly, I would like to share my late maternal grandfather’s eternal words of wisdom to me during my childhood which have had a lasting impact on my life – “There is no alternative to hard work.”

 

Ravi: That was an insightful, informative and illuminating conversation, Gautam.  Thanks for sharing your thoughts, experiences and wisdom with Stock and Ladder readers. Wishing the very best for your life, career and investing journey.

It is said that you will realize the book you are reading is a fine one when you feel a little sad and lost on reaching the last page. At over 5000 words this investing chat is fairly long. But I genuinely hope , dear reader,  on reaching the last question  you too wished like me that this conversation had never ended.

Stephen King famously said “Good books don’t give up all their secrets at once”. On similar lines, I honestly believe there is so much wisdom packed in this conversation that bookmarking the page and re-reading it again later will do well for your life and investing journey.

Keep learning.

Happy Investing!!!

The views and opinions expressed by Mr. Baid are solely his own and do not reflect the views of Summit Global Investments. Any recommendations, examples, or other mentions of specific investments or investment opportunities of any kind are strictly provided for informational and educational purposes and do not constitute an offering or solicitation, nor should any material herein be construed as investment advice

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