14 – Current temptation, future frustration

Posted on April 4, 2023 by Jimit Zaveri under Current temptation, future frustration

The 14^th part of the Series is “Current Temptation, future frustration”. This series is based on the companies which are currently darling of the market and many trying to catch such opportunities but it has a probability to become a reason for future frustration. It can wipe out the majority of gains in wealth. I am trying to put some of the number-crunching facts by which we can identify ongoing issues in the companies and can save our wealth.

I am starting this article with one of the company which is engaged in the business of Solar consulting & EPC have a 52 weeks low price of Rs.296, 52 weeks high price of Rs.1,990, and LTP is Rs.1,133. This company has rewarded ~283% of return in a year with LTP, and 572% of return in a year with 52 week high.

Let’s start looking at the numbers.

We can see that the company has a decent promoter holding which gives confidence to many people but with it, promoters of the company have ~30.93% of their holding pledged.

We can see the all-time high sale of the company with Operating profit. Even if we look at the CAGR of sales as well as profit then it is also on the higher side.

When we look at the balance sheet then we can see that the company has continuously raised its share capital, now need to check that either through fundraising or through corporate actions. The borrowing of the company is also growing rapidly. If we look at it in detail then the company has raised funds in FY20 and announced a bonus in FY22.

If we look at the numbers with connections then we can come to know that share capital is growing in line with sales growth. But borrowings and working capital are growing at a rapid pace compared to sales growth, which indicates that the company requires a higher working capital as well as borrowings to fund its growth. The reserves of the company are also growing rapidly which is a good sign to fund the growth of the company.

When we look at the cash flow statement then Cash from Operating Activity is -ve in some of the years. The cumulative CFO of FY17-22 is Rs.-19 cr with FCF of Rs.-79 cr so the company needs outside funding for supporting the growth. If we look at the cumulative operating profit and net profit then it is Rs.47.72 cr and Rs.29.65 cr for the same period. This indicates that the company cannot able to convert accounting profit to cash profit.

If we look at the receivables and inventories as a % of sales then it is 60% of sales whereas payable is just 8% of sales so the company needs a higher working capital to fund growth. The Cash Conversion Cycle is continuously worsening mainly due to higher inventory days. The company takes almost 8.5 months to convert its spending into cash.

We can see that the company keeps on diversifying from its original business, even though the company has not properly captured its original business. The existing business is still struggling to strengthen its financial performance and venturing toward new business can be harmful to the business going forward.

This entire series is based on past available data and ignored the future development of companies and the stock market always looks at the future.

Disclosure – Companies mentioned in the article are just for example & educational purposes. It is not a buy/sell/ hold recommendation.

This series contains learning from books –

Financial Shenanigans

Quality of Earnings

The Financial Numbers Game

Creative Cash Flow Reporting

Sequoia The Risks of Concentrated Investing

Posted on May 5, 2019 by Jimit Zaveri under Bibliophile, Bibliophile: Big Mistakes

One of the wise advice given on risk management is we don’t have put all your money into one basket. If we have 100 stocks of a portfolio and equal 1% allocation to each company then erosion into any company will affect the entire portfolio by 1%. Whereas if we have a 10% allocation to the 10 companies then erosion to any one company will affect the entire portfolio by 10%.

When we have concentrated our portfolio to the winning businesses then we will be a winner and if we have concentrated our portfolio to the losers then we also are losers.

BM C11 01

Sequoia fund which has done a concentrated investing, they are not interested in the short term profit making, also not interested in the low allocation to the portfolio and which is known as –

BM C11 02

Mr. Buffett has closed his partnership in the year 1969 and suggested Mr. Bill Ruane manage the capital of partners so that Mr. Bill Ruane has set up the Sequoia fund. During the dot-com bubble, Sequoia fund has lost ~16.50% whereas the S&P 500 gained 21% and NASDAQ gained 86%. But after the dot-com bubble in the year 2002-2002, Sequoia fund has gained by 29% whereas the S&P 500 lost value by 38%.

In the year 2010, Sequoia fund has started acquiring a position to the Valeant Pharmaceuticals which becomes the second largest position. And in the year 2011, it becomes the largest position of the fund which has overtaken Berkshire Hathway which was the largest position in the 20 years.

BM C11 03

In the year 2015, many consider Valeant business practice as an unethical and after that, it caught under accounting fraud. As Valeant was the largest position of the Sequoia fund, the fund lost 9.03% whereas S&P500 gained by 8.44%. Sequoia fund has bought again when Valeant fall by 50% and Sequoia fund becomes the largest shareholder of Valeant. But Valeant fall by 90% and Sequoia fund has to sell the entire position of the Valeant. Sequoia fund’s assets have fallen from around $9million+ to $5million. A single stock becomes a reason for the fall of their asset massively.

For avoiding such impact, we need to write down our assumption for buying a business so that we can take an exit when our assumption started getting wrong. This practice helps us to reduce the effect of endowment bias towards the stock which we hold. This also reduces the emotional bias towards the stock and help us to protect our capital. I always make a write up of the entry and exit reasons for the investment which help me for making a better decision and reduce my emotional bias. After all such activities, we need to be thankful for the role of luck which can support us. Concentration is good till we stay within our predefined process, assumptions, rules, etc. When we go out of any of the mentioned, we need to pay huge tuition fees for the concentration.

BM C11 04

Read for more detail: Big Mistakes: The Best Investors and Their Worst Investments by Michael Batnick

WARREN BUFFETT’S LETTER – 1996

Posted on October 20, 2018 by Jimit Zaveri under Bibliophile

Warren Buffett’s Letter – 1996

Acquisitions

Kansas Bankers Surety (KBS)

The company is an operating into the business of insurance which has a presence in 22 states, decent underwriting record with Don Towle as a manager. They made a deal to acquire a company at $75 million.

FlightSafety International

The company is the world’s leader in the training of pilots. The company operates in 41 locations, outfitted with 175 simulators of planes ranging from the very small, such as Cessna 210s, to Boeing 747s. About half of the company’s revenues are derived from the training of corporate pilots, with most of the balance coming from airlines and the military. They made an acquisition at $1.5 billion.

WB 1996 01

We need to prepare a list of the errors which can be dangerous for the health of our investment and work to avoid those errors. If we work on the avoiding mistakes then we can win 50% of the battle.

List of mistakes which I have experienced during my investment journey –

Never ignore the true value of the company—Every business has some value and that we should not have to ignore. If we commit such a mistake then the market will defiantly punish us. Be careful with the true worth of the company and only buy it when it falls below its true worth. And if business not available below its true worth then ready to missed that opportunity. Loss of opportunity is better than the loss of capital.
Don’t buy HOT —-If we buy the hot business such as recent trend, new IPOs, business on which everyone is bullish etc., then we must have to exit it at the proper time. So if we aren’t able to exit at the proper time then it’s better to let it go such opportunities. If we buy HOT then that HOT will BURN our portfolio.
Buying a high leverage business — We need to avoid a business which has a huge borrowings, such borrowings can kill the business and also kill our investment journey.
Using the wrong valuation method — Every business will not get valued with a similar valuation matrix. We need to identify the nature of the business and then value a particular business. Such as we should not use the valuation matrix of growing non-cyclical business for cyclical business, should not use the valuation matrix of assets light business for assets heavy business and vice-versa. If we made such a mistake then whether we might miss a decent investment opportunity or we might lose our capital.
A mistake of buying a story, not a fundamental — I have never ever made such a mistake because I am a hard-core lover of numbers. But I have seen many of the people who always focus on the story and also which is very trending to the market. I believe that without the support of numbers, no story can survive for long. In the year 2014-15, Logistics stocks due to GST gets a trending story but due to lack of good numbers, the story gets failed. People generally avoid numbers due to lack of understanding of it. I firmly believe that “Stories are for kids, not for investors.”
Investing without a process and philosophy — I can overcome this mistake at the initial period of my investment journey and that is only because of my guru – Neeraj Marathe Sir (who always believe on having a process and philosophy for making an investment). I have seen many people who spent lots of time into the market but they do not have any process or philosophy. They change their philosophy as they meet various people. If we do not have our own process and philosophy for making an investment then we will not able to create a successful investment journey. I also learn from my guru that we must have our philosophy in a written format so that we can refer it over a period of time and stop ourselves from occurring a mistake.
Not using a checklist — We should have a checklist for a business, industry, financial, management etc. so that we can focus on the points to study and also not forget any point to study. I am using a checklist for the last 3 years and I can say that having a checklist helps me a lot. My checklist keeps on improving as my experience grows.
Making an investment decision with disturb mind — We should avoid making an investment decision while our mind is disturbed. Disturbance in mind will end up with the faulty investment decision and which can be harmful to our wealth.
Cloning a well-known investors/fund managers — Again I can overcome this mistake at the initial period of my investment journey and again credit goes to my guru. If we have our process and philosophy then we will not try to clone others. I have seen many people who have spent 10-15-20 years to the stock market then also not having any process and philosophy & they clone others. Many of the people have cloning as their investment philosophy because they love to use shortcuts. I always remember the quote of my guru –

WB 1996 02

When Company does not have an opportunity to reinvest earnings at a higher rate than the company should distribute those earnings to the shareholders so that they can use it somewhere for getting a higher return. If the company does not have a good opportunity to reinvest earnings and then also company does not distribute earnings as a dividend then we need to be careful with a company (Question on the capital allocation decision of a management or earnings can be manipulated or business always needs a huge capital to sustain only).

Examples – No/Low growth high dividend payout

Examples – No/Low growth low dividend payout

WB 1996 03

We need to check the above-mentioned factors in the company where we have made an investment and where we want to make an investment. Most important is to gain a market share. The company cannot able to gain market share, though the company has a competitive advantage then that competitive advantage not useful for us. We should not focus on the leadership position of the company rather need to focus on the companies which focus on the manufacturing, distribution, packaging and product innovation. Market leadership can be changed if the company does not focus on the mentioned points.

WB 1996 04

According to Mr.Buffett, paying a higher price does not risk for the good companies compared to paying higher prices for the bad companies.

WB 1996 05

Let me take an example of one the biggest wealth creator company of the Indian stock market—

INFY Chart

If someone has bought this company during the March-2000, at the high price of around Rs.431 then after the 16 years of the period, he gets returned at 7% CAGR. And if enter to the similar company at the low price of around Rs.275 during the March-2000 then after the 16 years of the period, he gets a returned of 10% CAGR (*Considering all-time high price for calculating returns). Though revenue has grown at 30% CAGR, Operating profit grown at 27% CAGR and Net profit also grown at 27% CAGR during the same period with supported by a good management team. During March-2000, the company was traded at 64x P/E at the low price of Rs.275 and this multiple is common nowadays.

When management of a good business diverts their focus into the business which is not performing well then such decision of the management affect the performance of the business.

WB 1996 06

Example – We have seen examples such as liquor manufacturer enter into the airlines business, airport contraction business has diversified into the power business.

Mr.Buffett has also mentioned the Circle of Competence concept –

WB 1996 07

WB 1996 08

Control on our temptation, control on our emotion towards our investment is essential to survive and create wealth from our investment.

Warren Buffett’s Letters 1957 – 2012

WARREN BUFFETT’S LETTER – 1966 – 1968

Posted on February 26, 2018 by Jimit Zaveri under Bibliophile

I am really grateful to Riddhi for helping me with editing work.

WB Letter 1966

Mr. Buffett had acquired a controlling stake in Berkshire Hathway in the year 1965. Berkshire was a textile company and Mr. Buffett had started acquiring the stake of Berkshire since 1962 at the price of $7.60 per share. During the year 1965, Berkshire had closed down certain mills and only 2 mills were working as they were profitable and with about 2300 employees. As per the calculations, networking capital alone was worth about $19 per share.

Diversification

Mr. Buffett gave his view on diversification and also gave his opinion on why aren’t all managers generating superior returns.

WB 1966 01

Mr.Buffett says that he diversifies less as compared to what majority of the investment managers does. He can willingly invest upto 40% of the net worth into a single company; where the probability is higher about his facts and reasoning being appropriate in enhancing the value of the investment.

WB 1966 02

Mr. Buffett mentions that we should have a proper diversifying policy rather than behaving illogically as others do by owning one hundred securities into their portfolio. Rather, we should work as per our own view and understanding.

WB 1966 03

During the year 1966, Mr.Buffett had fully acquired Hochschild and Kohn & Co. The quantitative and qualitative aspects of the business were evaluated and weighed against price, both on an absolute basis and relative to other investment opportunities.

WB 1966 04

WB Letter 1967

During the year 1967, Mr.Buffett had faced difficulty in identifying new investment ideas. And the reason he felt was as below –

WB 1967 01

Mr. Buffett does not make an investment into the business which is difficult for him to understand (like technology business). He prefers staying away from the stocks which are in fashion into the market as such approaches don’t fit properly with his stock selection policy.

Mr. Buffett believes that big money can be made by making investment decisions based on qualitative factors whereas sure money can be made by making investment decisions based on quantitative factors. And hence, on the basis of this; he considers himself as a quantitatively focused investor.

Warren Buffett’s Letters 1957 – 2012