This is a post with a difference. For the first time on this site, I’ve tried to articulate my thesis for a specific stock. Note that this is not a recommendation to buy or sell this stock but more a look into the various aspects to consider when identifying your stock picks, which I described conceptually in my post on investment checklists. The sources for financial data are the annual reports and screener.in, those for the industry analysis are various reports available online.
Disclaimer: I currently own the stock and therefore more than likely to be biased.
Source: Techcrunch ‘The battle is for the customer interface”
This is an oft-repeated graphic on the internet, since it was published in a tech crunch article by Tom Goodwin in Mar, 2015. Below, a short excerpt:
“The value is in the software interface, not the products. It’s not just the smart home. Uber provides average cars in a premium way; Seamless makes the most disgusting of greasy kebab joints appealing and makes its margin from both sides. iTunes for many years took virtually all the profit made in the entire music industry by being just the thin software between the hard work making tunes and the money selling them.”
Persistent Systems is looking to capitalize on this need, for every business to digitally transform the way it interfaces with its stakeholders.
Persistent: Strong player in a niche segment
Unlike the outsourced IT services market worth over USD 500 BN of which IBM, Accenture along with Indian IT majors like TCS, Infosys, Wipro, are well known competitors, outsourced software product development is a niche segment with a 2016 global market estimate of USD 15 BN, growing at a steady rate of 4 – 5% annually.
Difference between traditional IT Services and Outsourced Product Development:
Product development needs a different set of operational skills to be successful. Established in 1990, Persistent has a demonstrated track record of it’s operational capability in outsourced product development.
In Q4 2016, Forrester classified the company as a “Leader” in the BPM Service Provider space, rated better than much larger overall competition like Accenture, Capgemini, TCS and Cognizant.
In one of his memos at Oaktree Capital, Howard Marks refers to the market as a pendulum swinging between greed and fear. That at any given time, the pendulum i.e. the general consensus tends to be either too greedy or too fearful, and it is when the pendulum is at its fearful extreme that the value investor comes into her own to make intelligent buys. This will sound familiar to most investors.
“Mimicking the herd invites regression to the mean” – Charlie Munger
“Be fearful when others are greedy and greedy when others are fearful” – Warren Buffett
The point of this post is not to belabour the obvious but to highlight how difficult it actually is go against “general consensus” and to sell when the market is hitting new highs or to buy when the opposite is happening.
There is stark evidence of how incredibly difficult it is for you and I to not succumb to the temptation of “going with the crowd”. The video below is the outcome of an experiment done by Solomon Asch, a pioneer in social psychology. The video was featured in an episode of a popular television series, “Candid Camera” in 1962
The experiment went like this. An unsuspecting subject enters an elevator. He’s joined by several of the show’s staff (the subject having no awareness that they are part of the staff). As the elevator makes it’s way up the building, the staff adopt various coordinated positions e.g. first by together facing the back of the elevator, facing the left, taking their hats off and so on. The objective is to observe the reaction of the test subject to these coordinated actions. What would you do if everyone around you does one thing?
It’s well worth the 2 min 31 seconds watch. Make sure to listen to the voiceover for context on what’s happening.
A million years ago, if everyone around you was screaming and running away from the big shadow moving towards your settlement, trying to be contrarian would mean you were quickly weeded out of the gene pool. The very fact that you exist means your ancestors did not make the mistake of pausing to question whether their screaming neighbours might be wrong. The need to conform to the behaviour of the crowd is deeply etched into your lizard brain, like a normal reflex action.
Which is why so few investors beat the market consistently. And it is also why it is an essential skill to develop, to be successful in the long run. Next time the lizard brain tells you to take action out of fear, of missing out, or of losing your savings, pause.
And consider this Rudyard Kipling classic:
If you can keep your head when all about you Are losing theirs and blaming it on you, If you can trust yourself when all men doubt you, But make allowance for their doubting too;
If you can wait and not be tired by waiting, Or being lied about, don’t deal in lies, Or being hated, don’t give way to hating, And yet don’t look too good, nor talk too wise:
If you can dream – and not make dreams your master; If you can think – and not make thoughts your aim; If you can meet with Triumph and Disaster And treat those two impostors just the same;
If you can bear to hear the truth you’ve spoken Twisted by knaves to make a trap for fools, Or watch the things you gave your life to broken, And stoop and build ’em up with wornout tools:
If you can make one heap of all your winnings And risk it on one turn of pitch-and-toss, And lose, and start again at your beginnings And never breathe a word about your loss;
If you can force your heart and nerve and sinew To serve your turn long after they are gone, And so hold on when there is nothing in you Except the Will which says to them: ‘Hold on!’
If you can talk with crowds and keep your virtue, Or walk with kings – nor lose the common touch, If neither foes nor loving friends can hurt you, If all men count with you, but none too much;
If you can fill the unforgiving minute With sixty seconds’ worth of distance run – Yours is the Earth and everything that’s in it, And – which is more – you’ll be a Man an investor my son dear reader!
What bad design can teach us about investor behaviour – link
Survivorship Bias OR How a mathematician helped win a war
In 1942, in the middle of the bloodiest wars ever seen, the United States military, brought together some of the brightest minds borrowed from the top universities around the country and called it, the Applied Mathematics Panel.
“Here is how it worked: Somewhere inside the vast machinery of war a commander would stumble into a problem. That commander would send a request to the head of the Panel who would then assign the task to the group he thought would best be able to resolve the issue. Scientists in that group would then travel to Washington and meet with top military personnel and advisors and explain to them how they might go about solving the problem. It was like calling technical support, except you called a computational genius who then invented a new way of understanding the world through math in an effort to win a global conflict for control of the planet.”[Source]
One of the members of this group was the Hungarian-born son of a Jewish baker. Abraham Wald had fled to the US in 1938, as the Nazi threat in Europe was reaching it’s pinnacle. The group within the AMP that Wald worked with specialized in air combat and the latest problem he worked on was keeping airplanes in the air.
“In some years of World War II, the chances of a member of a bomber crew making it through a tour of duty were about the same as calling heads in a coin toss and winning. As a member of a World War II bomber crew, you flew for hours above an entire nation that was hoping to murder you while you were suspended in the air, huge, visible from far away, and vulnerable from every direction above and below as bullets and flak streamed out to puncture you. “Ghosts already,” that’s how historian Kevin Wilson described World War II airmen. They expected to die because it always felt like the chances of surviving the next bombing run were about the same as running shirtless across a football field swarming with angry hornets and making it unharmed to the other side. You might make it across once, but if you kept running back and forth, eventually your luck would run out. Any advantage the mathematicians could provide, even a very small one, would make a big difference day after day, mission after mission.”
Given the limitation on how much weight a bomber could carry, military engineers wanted to know “the best places on the planes to add protection (extra armour)”. The military commanders already had a plan in mind. They had done extensive analysis of bombers that had returned from enemy territory, and meticulously tracked where the planes had taken the most damage. Their analysis found bullet holes tended to be clustered around the wings, the tail gunner, and down the center of the body. And this is where they wanted to add extra protection.
to recognise, and protect against the potential influence of those market sentiments on our decision-making i.e. our susceptibility to behavioural biases when making investment decisions
These elements are common sense, but they take a lot of conscious effort (learning) to understand and even more effort to implement. Most investors aren’t able to.
Ryan Shmeizer, in his post on “Cached thoughts” drew a parallel between how we typically think about any topic to a computer retrieving data stored in it’s RAM, or cache. He says, when a concept is spoken of, our mind dips into it’s memory cache to access precomputed thoughts instead of computing our opinion or understanding of the topic based on the facts available to us at the time.
If our information diet consists only of a twitter stream of borrowed quotes by Buffett, Munger et al, we’ll be able to readily access phrases like “buying for less than intrinsic value”, “buy stocks like you would buy groceries, not like perfume” thinking we really understand value investing, but our investment results will suggest otherwise.
We need resources rich in insight, that will help us build understanding of those foundational elements to keep learning, unlearning and relearning.
What has worked in investing
One such resource, is a paper “What has worked in investing – Studies of investment approaches and characteristics associated with exceptional returns” by Tweedy, Browne Company LLC. It is a compilation of the findings of over 50 major quantitative studies over 50 years, some academic, others by investment companies about the returns from various schools of investing.
The key findings of the paper, as to what works in investing according to Tweedy, Browne are:
Low Price in relation to Asset Value: Stocks bought at less than book value or even more conservatively, at less than Net Current Assets (cash, receivables, inventory minus liabilities)
Low Price in relation to Earnings: Stocks bought at low Price / Earnings offer high earnings yield when considering their potential dividend payment to prevailing stock price
Insider buying: Inside information on likely improvements, not a tough one to imagine
Significant Price decline: Poor recent performance resulting in lowered expectations
Small Market Capitalisation: Smaller base, higher growth rates and therefore more price appreciation
These findings apply to studies done for markets outside the US, a couple included India.
It is a truth universally acknowledged that a man (or woman) wanting to be in possession of a good fortune needs the services of a reliable spread betting brokerage company. Yes, I’m paraphrasing Pride and Prejudice but with the current state of the Sterling, savings rates at their lowest since 1960, the continuing volatility of the stock market, “hard Brexit” seeming to be the preferred government option and to top it all the possibility (albeit increasingly remote) of a Trump presidency choosing profitable forms of investment has become like Harry Potter chasing the golden snitch.
How low can it go?
The pound, since that June day has plummeted to its lowest exchange rate with the US dollar since February 1985 when it bottomed out at $1.05. The current predictions by spread betting companies such as CMC Markets is that Sterling won’t stabilize during the remainder of 2016. Mark Carney, governor of the Bank of England, however, continues to be perceived as a safe pair of hands who when he speaks inspires confidence in the pound.
The annual average saving rate is the lowest it has been in the last fifty years and with such a fragile economy the Bank of England may hold off raising interest rates for longer than planned. Employing a wait and see policy there is a chance that if there is no sign of stabilization then interest rates may indeed be lowered.
Stock Market Volatility
The continued uncertainty is placing some pressure on the UK’s top companies resulting in a stock market which although strong in comparison to the currency is still not in the best of places.
It was sometimes thought that although the UK had voted to leave the European Union it would still want to keep its place in the single market accepting a degree of free movement in exchange for this concession. As time has gone on and positions have become more entrenched this degree of rapprochement is looking exceedingly unlikely. The “hard brexiteers” seem happy to forego the benefits of the single market in exchange for maintaining the sacrosanctness of the UK borders.
Brexit would be a ripple in the pool compared to the hurricane which could hit the financial markets if Donald Trump was elected to the White House. Where Hillary Clinton could be regarded as a safe pair of hands the loose cannon which is Trump could throw everything to the four winds.
Why spread betting?
What is the difference between spread betting and the more conventional trading? When a conventional trader buys shares, currencies or any other type of asset they are speculating that the price will rise enabling them to sell at a profit. A spread better trader recognizes that they have the potential to profit from both rising (going long) and falling (shorting) prices as long as they correctly predict which it will be, providing many more opportunities for trading. For instance, a company such as Talk Talk is about to publish their annual report and the spread better trader considered opinion is that the information contained in the report will be detrimental to the share price. They can place a trade based on their opinion and have the added advantage that spread betting is tax free. The degree of accuracy in the prediction determines the potential profit or loss.
A further advantage is that since spread betting is a leveraged product it can allow the spread better trader to make a deposit of as little as 1 to 10% of the total trade value. It should be remembered however that while this does allow for any potential profits to be much higher than those gained by more conventional methods of trading the same holds true for any losses incurred. The importance of choosing a reliable spread betting broker or company which adheres to a regulatory authority and with a competitive range of commodities therefore cannot be over emphasized.
“In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time – none, zero.” – Charlie Munger
And so, here’s a short list of valuable value investing resources that I’ve found, offer insight into developing that mindset essential to successful investing. You’re much better off spending your time absorbing the content from resources like these than seeking out ‘Buy’ and ‘Sell’ recommendations in the pink papers.
Named after the street in Omaha, Nebraska where Berkshire Hathaway keeps it’s headquarters, Farnam Street is run by Shane Parrish, who apparently worked with an intelligence agency with a three-letter acronym before enrolling and almost dropping out of an MBA course because of the lack of insight into decision-making. He persevered and started this valuable site.
The best place to start on this site is the helpfully titled “Best Articles” link.
Monevator is a UK-based site, run by two bloggers with slightly differing perspectives on investing as evinced by their handles; ‘The Investor’ and ‘The Accumulator’. The underlying theme of the site is to “get rich slowly” as opposed to offering “sure-shot strategies”. Some of the content is relevant only to UK citizens but there are still tons of articles to help develop your investing personality.
He’s the professor of Corporate Finance and Valuation at the NYU Stern School of Business and literally wrote the textbook: Damodaran on Valuation. His ability to break down the most complex valuation questions to arrive at a number for any company is legendary, an example, his techcrunch article on why he believes Uber is overvalued.
He posts on contemporary issues, like his latest post is about the ailing Deutsche Bank. While the companies he discusses are not necessarily of relevance to Indian investors, they provide hints on how to think about breaking down a seemingly complex task to arrive at a fair value for any business.
Jason is a personal finance columnist with the Wall Street Journal. His articles appear in many prominent publications including Time, Money magazine. What is likely to really get your attention is that he’s the editor of the revised publication of The Intelligent Investor by Ben Graham published in 2003. His articles are similarly insightful, while staying away from financial jargon.
A compilation of his responses to the most frequent investment questions here
A veteran of the investment management industry, Michael is the author of The Success Equation, He’s even better known for the lucid papers he writes in his role as Head of Global Financial Strategies at Credit Suisse which have been compiled into a book More Than You Know – Finding Financial Wisdom in Unconventional Places and named as “The 100 Best Business Books of All Time” by 800-CEO-READ, one of the best business books by BusinessWeek (2006) and best economics book by Strategy+Business (2006).
A link to some of his best papers is available here helpfully compiled on valuewalk.com
Bonus resource: The writings of Charlie Munger
One of the legends of the value investing world, Charlie’s work on mental models is considered path breaking and gives insight into applying different frameworks to understand pretty much anything and to apply it to investing. Problem is his book Poor Charlie’s Almanack: The Wit and Wisdom of Charles T. Munger is not in publication and can only be obtained at significant cost. To meet this unmet demand, a host of copy cat publications and sites using various combinations of the phrases “mental models” and almanack have sprung up. Hence I was exultant to find a resource with some of his best speeches and writings compiled here (hat tip to Indraneal twitter id @omnilogist for pointing me to this resource)
My suggestion, explore these sites, click through the various source links, immerse yourself in the insight, think about how it might apply to you, then apply and assimilate into your investment philosophy. Become a calm investor, untroubled by the noise.
What are the best resources you’ve come across? Send me a note and I’ll add them to this post here.
This is a practitioner’s post for someone looking for help to develop their own investment process, using a freely available resource: screener.in
Rule #1: Don’t f*** up
The financial newspapers have a section on them everyday – top ‘Buy’ and ‘Sell’ recommendations from brokerages. Financial news channels have a segment called something like “Top Trading Ideas for today”. During other segments, every interviewee, whether head of research at a brokerage / mutual fund house / hedge fund gets asked this question about top stock picks to invest, in India. They all oblige, with a fresh set of stocks (companies), every day, that will benefit from some overnight development, be it auto stocks with GST, export stocks with rupee devaluation, oil marketing stocks with oil price declines and so on.
Those new to investing, get swept up in the barrage of information, trying to keep up with what the “experts” say. Those who’ve been at it longer, know not to drink from the fire hydrant. If you’re a successful professional investor, you know the flurry of information is so damaging, you relocate to a different country and set clear rules of value investing for yourself.
As a broad rule, to not f*** up, Do not buy something because financial news media told you to.
While this awareness helps with the preliminary hurdle of not reacting to the whims of Mr. Market, it doesn’t solve the value investor’s problem.
If the stocks everyone is talking about are the wrong stocks given they are likely to have run up in price already, and if the right stocks are those that no one is talking about right now, how does the value investor develop his own list of stock picks?
Developing your investing “technique”
All unsuccessful investors are alike; every successful investor is successful in her own way – The Calm Investor
The first stock I ever bought was recommended to me by my father. I then added stocks from an industry sector I had worked in previously, thinking my superficial familiarity would be an advantage. But I knew this was really like a drunk man looking for his keys under the streetlight because it was too dark to look where he had actually dropped them.
What followed was the quest for the ideal process, from going top down (picking sectors then companies), going contrarian (looking for stocks at 52 week lows), even using price movements (gasp! technical analysis), to name a few. I was unable to develop any conviction in any of these methods, thus rendering me susceptible to switching back and forth, a sure recipe for disaster.
This was the time I came across the traditional investing tomes by Ben Graham – The Intelligent Investor and Security Analysis. These books provide the essential foundation of being able to think about the company behind the stock symbol, essential to be any kind of successful investor, and especially one that looks to buy low and sell high.
Books by Graham, annual letters sent to Berkshire stockholders are immensely valuable in equipping you to arrive at an opinion on the value of a given company and the pitfalls to watch out for. Taking the principles from those and applying the fantastic lessons from surgeon Atul Gawande’s The Checklist Manifesto : How to Get Things Right, I devised my checklist for evaluating potential investments; The checklist approach to investing
However, in a investment universe of thousands of companies, they do not give you the tools to know where to look to begin with.
While the “buying what you know” framework is a great way to get started, it is limited to consumer-facing sectors, thus leaving out large parts of the investible universe. It also works mostly for companies you’ve already encountered, often, for a large part of your life.
What I felt I needed was a quick and dirty way to classify companies into the “Maybe” and the “Do not touch” pile. Only companies in the “Maybe” pile warranted further analysis and a deeper look at their business. For example, if a company’s interest payments have been increasing and account for the bulk of its pre-tax profits, as an equity holder, I have no interest joining the very back of a long line of those having a claim on the company’s earnings, irrespective of whether it is the next hot thing.
Unable to resist using catchy monikers, I called it the TCI Rapid X-Ray, outlined in a previous post with a similar theme: So many stocks, so little time – an approach to stock selection. I received a flurry of emails on this post asking to share the tool. However, the problem was this was a very manual process, involving importing financial statements into a google sheet template with formulae. However, this is an error-prone process and the output is not easily shareable. Also, when moneycontrol, the site from where I imported the financial statements changed their format, it meant having to rebuild my scoring template from scratch.
I am currently reading a book on design called The Design of Everyday Things by Don Norman. As opposed to the usual sources of reading recommendations from friends, websites top 10s or the ubiquitous Amazon recommendation engine, I came across this book when letting off frustration on google. Let me explain.
For a long time, my professional designation was “management consultant”, a profession that gets its fair share of eyerolls and wisecracks, not unlike…
“If you see a consultant on a bicycle, why should you never swerve to hit him?
It might be your bicycle.”
A regular part of my job meant flying to various client locations and spending large parts of work weeks in hotels. Now, I didn’t mind hotel rooms for the most part, except when it came to the showers, to be precise, hotel shower controls. Bleary eyed from waking up in a different time zone, I’d go into the shower, to then stare blankly at the gleaming polished metallic contraption on the wall, not unlike this one.
How was one to figure out the right setting to avoid being blasted by a jet of scalding hot or freezing cold water? When the water flowing from the tap still feels cold after I set it to what seems right, is it because it takes a while for the heating to kick in? Am I the problem? Should a comfortable shower need a PhD.?
I’d mostly get it with a bit of trial and error, but there was this one time, that I just couldn’t. No matter what I did with the various knobs, freezing cold water kept gushing out. The prospect of not washing off remnants of a 10 hour plane ride made me steel myself and shower in the ice cold water. Later that day, I punched irately into google “Why are shower controls so badly designed?” which took me to an article referring to Don’s book.
The three levels of cognition
I started reading the book recently, several years after adding it to my mental reading list, and quickly saw why it’s considered necessary reading for anyone building products or services for other people, i.e. an understanding of how the human mind thinks, feels and reacts is essential to building great user experiences. And how there are implications for investors, from how our minds react to information.
There are different models about the working of the human mind, my all-time favourite being the seminal piece of work Thinking, Fast and Slow by Nobel winner Daniel Kahneman. The design of everyday things puts it as three levels of cognition:
Visceral: the “lizard brain” – basic protective mechanism – quick judgments about the environment – good / bad, safe / dangerous – enables quick response without conscious awareness
Behavioral: home of learned skills – triggered by situations that match appropriate patterns – largely unconscious actions, like picking up a cup, balancing a tray
Reflective: home of conscious cognition – deep understanding and conscious decision-making takes place – cognitive, deep and slow
The author goes on to summarize the significance of the distinct thought process:
“Reflective memories are often more important than reality. If we have a strongly positive visceral response but disappointing usability problems at the behavioral level, when we reflect back upon the product, the reflective level might well weigh the positive response strongly enough to overlook the severe behavioral difficulties”