Musings on Market Wisdom – Stock and Ladder

The capacity to learn is a gift; the ability to learn is a skill; the willingness to learn is a choice” Brian Herbert

Mr. Market (Master) is happy to teach you every day. As investors (Students) all that is needed is a willingness to learn and more importantly a willingness to act on the lessons learnt. This piece is a reflection on a few lessons learnt over the last two decades of my investing journey in the Indian stock market.

I have consciously tried to steer away from the obvious lessons: Invest within your circle of competence, Always seek a margin of safety, Invest but do not speculate and so on.

Key Lessons

Management is the Key

I cannot emphasize this enough.

Dishonest managements, creative accounting, siphoning of funds, Insider trading, Conflict of interest, Related party transactions, poor corporate governance standards are not just some pieces of fictitious imagination but the history of corporate India is replete with many such examples.

An investor must realize that they are part of the “outsiders” or minority shareholders and the management as the insiders will have a great influence on the actual returns a shareholder eventually enjoys.

There are two aspects to this: Competence and Integrity.

One without the other is not useful for long term wealth creation. Competence without integrity as well as integrity without competence produce mediocre results for the long term investors.

An investor is best served by investing in companies that are run by competent management with an impeccable track record of integrity.

In the beginning and for a short while such stories are wonderful and gullible investors jump into the band wagon. But the ending of such investing stories like Satyam is invariably really a painful one for an individual investor.

Forget Satyam, let me give you a recent example. Vakrangee Software until very recently was a darling of Dalal Street. It has been a stellar performer (multi-bagger) for many years with lots of media coverage.

What happened in the last few months, the stock has fallen 90% as its auditors quit citing concerns about the books of accounts and corporate governance. Earlier, this company was also under investigation from the regulator in 2012 for alleged insider trading.

And it’s not just Vakrangee. Gitanjali Gems, Shilpi Cables, Manpasand Beverages are few of the companies where the management honesty has been questioned.

The point here is that irrespective of the returns (multi-bagger) a scrip is delivering, management integrity and corporate governance matters a lot for an individual investor. When you can’t be certain about the integrity and honesty of the management, investors are better served giving the scrip a pass and watching the party from the sidelines.

Compounding works best only with outstanding companies

Albert Einstein famously said that “Compounding is the 8th wonder of the world”.

But before you submit yourself at the altar of compounding magic, be sure about the stocks you are hitching your financial dreams to. If mediocre companies or good companies turned mediocre are left untouched expecting the power of compounding to work its magic then the results will be counter-productive.

Investing in mediocre or good companies is like speed dating or having a romantic one night stand. The fun may last for a short while but after that you are mostly left to regret.

On the other hand, staying invested in outstanding companies for a long time is like being in a traditional Indian marriage. If the going is good then you are in it for the long haul through the various ups and downs. Actually, the party never ends and it actually gets better with time.

Be like a gardener who removes the weeds regularly so that the plants can grow to become trees. As an investor you should also not allow weeds to grow in your financial garden (portfolio)

Keep your Investing Gun always loaded

When it’s raining gold, reach for a bucket, not a thimble” – Warren Buffett.

To reach out for a large bucket and not a thumb sized tumbler when an opportunity presents itself, we must have sufficient capital ready to be deployed at short notice. If you are 100% invested without any surplus to invest then you are at the mercy of market gods.

Mr. Market will not provide the opportunities to match and sync up with your cash flow position. Always maintain a certain percentage of your investment capital as surplus and ready to be deployed at short notice whenever an opportunity presents itself.

Half knowledge is a dangerous thing

Combine half knowledge with a blind belief in Buffett’s catchy phrases without knowing why and in what context did Buffett or any other super-investor say that. What we then get is a fine recipe for financial disaster.

Before you take out your daggers, let me explain:

Let us look at a sample statement which you must have heard a zillion times: “It’s better to buy a wonderful company at a fair price than a fair company at a wonderful price”.

I have a few questions as a lay man:

How do you decide for sure if a company is really “wonderful”?
With certainty can you tell how long this “wonderfulness” will last?
How can you be sure that a “fair” company will not become “wonderful”?

And I haven’t even come to the subject of price and valuation.

How do you decide what is a “fair” price?
If it’s okay to overpay for quality then how much to overpay?

On the face of it the statement looks fine but when we start making our investing decisions only on the basis of such statements then it does more financial harm than good.

This leads us to the crux of my point. If you are unaware of the rules of stock market investing and the basic principles of valuation then taking meaningful investing decisions becomes a challenge.

Any field including investing is a specialized field which requires continuous learning, dedication and practice. Do not invest with half knowledge.

Few more short lessons

a) Do not be too rigid with the target price. If you decide to buy a scrip at a target price of INR 450 then you should have a range of values as the target and not an absolute value. The scrip may come down to 455 but may never actually reach 450 in your lifetime. You would not want to miss a great opportunity trying to save a few pennies.

b) Try maintaining equanimity as Mr. Market is fine at teaching humility. Neither get too elated when you make large profits nor be too sad when you make a loss. Don’t forget to learn at both times.

c) An ounce of action is worth tons of theory. You can read all the investing material in the world but if you cannot act and apply the learning when the opportunity arises then all the reading is useless for your investment journey.

d) Not just buying or selling but doing rigorous analysis and then deciding NOT to invest is also an act of investing. Waiting patiently for a “fat pitch in your zone” is one too. Controlling your desire for pressing buy / sell button regularly will be rewarding to your investment journey

e) Good ideas are a premium and you are perfectly entitled to keep it to yourself. Having said that it would be wonderful to have a selfless, genuine friend/colleague (not idea stealers) as a sounding board who will give you an honest feedback and also will enter into an honest debate.

f) Unless required legally, never discuss or disclose your portfolio publicly. A lot of effort goes in justifying your rationale in the future. You can give and share your stock picks but you cannot transfer your conviction.

Confucius said on wisdom “To know what you know and to know what you don’t know, That is real wisdom”. In the world of investing and stock markets this can’t be truer. Those who will understand this will be successful.

Hope you find these thoughts useful.

Keep Learning, Happy Investing.

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