Delhi's cars and its drivers have been discussed in many places, but car parking has not received the same attention. I will focus on Delhi alone, simply because its populace is specially endowed with all the elements of "foolishness" that is so much a part of any bull market. So the parallels between good car parking and good investing are brought home very starkly, every day I take out my car in Delhi.
The trade-off in parking and investing are similar. You get a small benefit (i.e. your car parked) at a certain cost (in terms of time, effort and money). The time you spend in parking and walking to your destination, the effort in doing so, and of course, the parking fee or the absence of it. In the same manner, you invest time (i.e. the investment horizon), effort (i.e. research) and of course, money into your investments.
When I pass by a banquet or wedding hall, for example, I am struck by the number of people, who have taken special trouble to park right at the gate of the hall. This is the most inconvenient place, with a huge crowd jostling around your car, scratching/bumping against it. Yet the maximum number of cars are parked in this region. You would think they would want the comfort of parking at a distance…but no, you would then not be a Delhite. For the small benefit of a shorter walk, they pay a huge cost in terms of the heightened risk to their car, and the inconvenience of driving out.
An outsider would also be excused for thinking that the density of cars should fall uniformly, with increasing distance from the Banquet Hall. In other words, if there are 50 cars in a radius of 10 metre, there would be 30 cars at a radius of 30 metre, 10 cars at 50 metre and so on. But no…and this is the big point…the gradient of this pattern is not uniform. That is, the density of cars has a steep gradient that accelerates as the distance increases. At 100 metre from the banquet hall, you might have no parking fee, lots of space to park and so on, but I find that almost invariably, mine is the only car parked so far away.
We see the same pattern in markets. In option pricing, cost drops disproportionately as the strike price moves off the spot price. The rate of change of cost is disproportionate to the rate of change in strike price. In cash markets, this pattern is not so obvious, but P-E on forward earnings moves in a similar fashion. A jump in profitability, however large, is not discounted by the market if it is sufficiently far away.
For example, in 2000, a Balrampur Chini in the down-and-out sugar sector was available to me at three times forward earnings, simply because there was no short and specific time horizon the market could impute, to the revival of the sugar industry. So a co with a 10-year average RONW of 20 per cent was available at a P-E of 3. This year, profits are up 240 per cent and the P-E is up 133 per cent (at 7), giving a return of 560 per cent (ignoring dividends) over four years. The stock might well double from these levels, as it delivers RONW of 40 per cent this year and may be the next. That would mean a 10-bagger for me in five years.
Warren Buffet gave this kind of investing a name…cigarette stub investing, he called it. Benjamin Graham called it "deep value". They implied that value happens, and a good investor should look for it. Value is assumed to occur regularly, but randomly. If you keep looking hard, you can at best hope to find a couple of ten-baggers in a lifetime, to make you rich.
The car parking metaphor is meant to point out that sometimes, "deep value" occurs in a patterned way. Growth stocks are born because of a business transformation (like IT, BPO or Biotech), but there are equally good investments to be made in old, boring industries, with much lower risk and much higher predictability.
This patterned occurrence of "deep value" will happen in all those cases, where the "cost" of investing (like the "cost" of parking your car) is higher than the market is willing to pay.
This "cost" is measurable in terms of time (i.e. the investment horizon being too long), energy (i.e. too much independent research required) and money (i.e. perceived risk of total loss). For the investor who is willing to do all this when the market is not, there may be disproportionate rewards. The point I am making is that the occurrence of "deep value" is embedded in patterns of human behaviour, and often, it happens in a non-random, patterned fashion.
Let me give you a (somewhat) heretical hypothesis, and we will see how many have the courage to invest there. The jute industry may revive sometime in the future, with the economy gravitating to recyclicable packaging. Another possibility is the emergence of Geotextiles, an industry with a domestic potential of
Rs 6,000 crore. Now, there are listed jute mills available at two times earnings, doing an RONW>15 per cent, even 20 per cent.
Disclaimer: The writer holds shares of Balrampur Chini.
He is a private investor and teaches finance and strategy at Xavier Institute of Management, Bhubaneswar (XIM-B). He can be reached at [email protected]