During the last 28 years I have been in the markets, I have seen various market cycles, starting with the Harshad Mehta boom (while I was in management school). Every cycle is a learning experience and teaches something new, shaping one's investment philosophy and style.
Some of these lessons are:
- Don't sell your winners too early even as they reach your estimated target price. Great companies continue to deliver year after year and can surprise you as they gain more efficiencies and scale benefits. Patience is key here and continuous re-evaluation of the new data is important.
- Devote enough time to get the narrative about the company right while building its investment thesis, rather than focusing only on valuations. The narrative could be the opportunity size, key competitive advantage, etc. This approach is particularly relevant while evaluating high growth and expensive stocks. I have been able to invest in some early-stage growth companies with this approach, which I would have otherwise avoided because of high valuations.
- Take advice from others but invest based only on your conviction because that is what will give you the confidence to hold onto your investment when the company is going through a temporary rough patch.
- Keep an open mind and be willing to accept your mistake early on and move ahead. Carrying the baggage can be a huge opportunity cost. Personal biases can be a big impediment here and to overcome them one should keep on continuously questioning the underperformers objectively.
- Never rely on one valuation parameter to base your decision. A combination of P&L, balance sheet, cash flow and asset valuations should be looked at to overcome pitfalls of smart accounting. Focus more on cash flows rather than profits.
- As the size of the fund becomes large, portfolio risk management becomes very important. Watch out for large sector concentrations, especially when a sector has outperformed for an extended period of time because such a sector tends to mean-revert. Remember the tech sector in 2000.
- Design a framework for assessing the management capability and quality and integrate it in the investment process. Betting on the right management is the key for long-term wealth creation. A lousy management can ruin even a good business and destroy value for minority shareholders.
In my investment journey there are some interesting lessons which moulded my investment philosophy. For example, when I first identified an NBFC, the company had emerged from a chequered past and was reinventing itself as a technology-driven NBFC with a robust risk-management framework. It was an easy decision at that point in time once the big picture was in place as valuations were reasonable.
Over a period of time, the company became a gold standard in the industry and grew rapidly. It was a big multi-bagger (the stock rose 30 times in seven years) and the valuation multiples kept on expanding. I partially booked profits and started trimming the stock at every rise as the multiples went beyond my comfort zone. The stock continued to outperform big time. The key learning was that with certain stocks one should rather take a long-term view, say five years forward, considering the big picture and factoring fully the structural change in the growth trajectory and profitability. Then re-evaluate the target price rather than selling it early when it reaches the estimated target price.
Sometimes the most-hated stocks can provide a great opportunity if one is willing to move away from the crowd and do some original deep-dive work. After the scam erupted at Satyam in 2009, the stock crashed more than 90 per cent and was virtually an un-investible institutional stock. When we evaluated the company closely in 2012 as a contrarian idea, we did some channel checks with its customers and peers and found that the company continued to have a substantial business even after the crisis, with a diversified client base and a core competency in enterprise IT solution. The balance sheet was reasonable, old management was out and valuations were bombed out. Only if it survived and got the right leadership, it could be a great turnaround story.
We evaluated the company taking in the worst-case scenario and found a good margin of safety. We invested early in the stock across our funds and very soon the company started to get noticed not only by other investors but other peers and was acquired by another tech giant later, giving handsome returns. Taking such large contra calls requires teamwork to thrash out the various things which can go wrong and to build conviction.