Fundoo Professor Sanjay Bakshi is one of the foremost authority in India on value investing. Below are some notes from his podcast with Planet MicroCap podcast.
SB's investment style has evolved over a period of time as does everyone's into buying value via good managements and businesses. He likes to invest in businesses where the management has 3 qualities:
1) Operational efficiency-how efficient is a management in conducting its business. This is something that is driven by comparing the performance of a company versus its peers.
2) Capital allocation-this differs from point 1 in that a management may know how to operate efficiently but may not be the best group to know about what to do with the money they make. Should they grow organically/inorganically? Should they buy back or give dividends, etc?
3) Integrity-This is the most important trait since if the management doesn't have this then the business you are buying may be just a value trap where the management only makes money for itself and is not interested in welfare of their minority shareholders. Go through the related party transactions to check this, see if management pays large sums to other firms where the same management is directors/beneficiaries.
Good business Vs Good investment - Money is made in stocks by two ways, one the capital gain and the other is dividends. Capital gain is driven by entry P/E multiple, growth rate and exit P/E multiple. If the growth rate and the exit P/E multiple remain same then the return you get is only driven by the entry P/E multiple. If you pay too high, you may not get good output despite the business being good but if you pay a low P/E multiple, it may turn out to be a great investment for you so always be price sensitive even when you have discovered a great business.
Financial Independence - Charlie Munger inspired SB says that people always have to be financially independent irrespective of where they are in career and if they are a huge conglomerate or a small time stock investor. For ex, Birkshire hathaway always has multiple income streams through which money keeps coming in for reinvestment. They had USD 20 billion to spare when everyone else was selling stocks in 2008. Sanjay Bakshi when started investment around 2000 (after initial failed attempts) took up teaching jobs and wrote articles to diversify the income streams.
You become financially independent by becoming a miser. Curtail your needs massively during intial part of your career. When you get your salary/income, first invest the money and then think about expenses (except bare minimum living expenses). Postpone your car, house, luxury purchases and invest and use the leftover money for expenses, not the other way round.
What this miserly behavior gives you is staying power. If you depend on market for your living expenses then you cannot sustain when the market crashes. That's the time when you should be buying more rather than taking your money out (Ex, Birkshire in 2008). If you are leveraged and invested in market with borrowed money, you will bankrupt yourself in market crashes. The process will be slow to build the multiple income streams but gives you massive benefits at the end.
Estimating when a company is cheap -
a) Cash Bargain - This was one of Benjamin Graham's favorite in 1930's recession but these opportunities are hardly ever possible today. No good businesses trade below cash today. There are businesses that do but they do that because of their terrible quality, not applicable today unless there is a miracle. These used to be low quality businesses only.
b) Debt Capacity Bargain - Favorite theme for SB even today, a company has no or little debt on its balance sheet but is not taking any cash. it has stable income cash flows from its operations. At times in market ups and downs, these companies market cap goes below their debt capacity and at such times they are a bargain. It's proven by Ben Graham and several others that a company is always worth several times more than the debt that it can comfortably service.
c) Debt Pay Down - Highly leveraged businesses that used their operational cash flow to pay down the debts they held and became less leveraged and hence improving their value and in the process created value. SB does not use this method also now as he doesn't like highly leveraged businesses anymore. He talked about above 3 points in 2002 and 15 years is a long time in investment that has taught him to stick with only one of the 3 ways he earlier talked about. Debt capacity bargain however is still a very successful way of finding great companies.
At present, SB thinks of businesses in terms of expected returns. You have to first love the business/process, the management and then come to valuation. Noe as I earlier mentioned expected return is a function of entry multiple, growth rate, and exit multiple. An investor may be scared of a 25x entry multiple thinking the business is already costly but you cannot mistake to ignore the growth rate and exit multiple. If the company has amazing growth rate for next 10 years and an exit multiple is de-rated to 20, you may still end with a very satisfactory/above expected return out of the investment.
Charlie Munger stated 'if you can buy a business growing at 18-20% for 20 years then what appears to be a large price may not be a high price at all in the long run'.
SB's Current Philosophy -
Pro social, low stress businesses
Basic Screens -
High quality businesses with market dominance
High return on capital
Strong entry barriers
Strong balance sheet
Strong growth prospects
Ability to fund growth without requiring leverage/outside money
Like to invest in existing businesses that are expected to continue for considerable time in future which have performed wonderfully at least for some time, if not at the moment.
Can the small investor win?
A small investor has better opportunities than a large institutional investor since he c an look at companies that are much smaller in market cap and his/her performance is not being evaluated on a day to day basis or a quarterly basis which happens for institutional investors and fund managers. Even if a fund fund manager knows that a business is going to be great in 10 years, they may not be able to put their money in it given the short term expectations/pressures.
All the benefits will go to a smaller investor but ONLY is he/she has staying power.
Falling into value traps -
Lot of young investors fall into value traps because they can do the number crunching and build excel models to estimate if the screens they are looking for look good for a given stock or not and then jump right in to buy a stock only to realize few years later that it's a value trap. The reason for that is the lack of qualitative analysis. The quality analysis is something that is more like soft skills and comes with extensive experience and reading which the younger generation just doesn't have the time for. These skills are pattern recognition skills, skills to recognize what makes businesses successful that comes with extensive knowledge gathering and understanding that cannot be built by number crunching or screens.
A Primer on P/Es -
P/Es are easily available and likely the first thing an investor uses to see if a stock is values fairly or not. However, the P/E ratio can be fair to deeply flawed depending on the context it is applied in. When you use the P/E to the overall market, it gives you a wonderful idea if the market is valued at the time compared to historical values.
When you apply the same ratio to a stock, you completely ignore the growth rate and exit multiple in estimating if the stock is cheap or not. Additionally, the Earnings part of the P/E may itself be flawed. See how is that possible.
Warren Buffet talks about Geico where they have no intermediaries who sell insurance but the model is a completely online model and Geico advertises heavily to market it. Now the marketing spends are considered as expenses and not investment but in the given scenario is it not an investment that has been generating wonderful returns for them, apply the amortization to it and it is even more attractive. If you take them as investment then Geico's true earnings are much higher than what is being reported. The same phenomenon is true of so many businesses, just like a pharma company that spends on research and stumbles on the new big penicillin.
These businesses penalize the profit and loss in current year but may throw a lot of cash 2 years down the line.
SB talks more about the books, suggestions to beginner investors and things like that which are better learnt by reading/following him.
Final Enlightenment - In last few years, SB has realized that it's important to not be impacted by labels. Ex. Buffet never used to say airlines are bad business but that has changed and now he is buying. The reason for the change is that there may be wonderful future opportunities hiding under the known/uninteresting labels so always keep your eyes and ears open.
SB's investment style has evolved over a period of time as does everyone's into buying value via good managements and businesses. He likes to invest in businesses where the management has 3 qualities:
1) Operational efficiency-how efficient is a management in conducting its business. This is something that is driven by comparing the performance of a company versus its peers.
2) Capital allocation-this differs from point 1 in that a management may know how to operate efficiently but may not be the best group to know about what to do with the money they make. Should they grow organically/inorganically? Should they buy back or give dividends, etc?
3) Integrity-This is the most important trait since if the management doesn't have this then the business you are buying may be just a value trap where the management only makes money for itself and is not interested in welfare of their minority shareholders. Go through the related party transactions to check this, see if management pays large sums to other firms where the same management is directors/beneficiaries.
Good business Vs Good investment - Money is made in stocks by two ways, one the capital gain and the other is dividends. Capital gain is driven by entry P/E multiple, growth rate and exit P/E multiple. If the growth rate and the exit P/E multiple remain same then the return you get is only driven by the entry P/E multiple. If you pay too high, you may not get good output despite the business being good but if you pay a low P/E multiple, it may turn out to be a great investment for you so always be price sensitive even when you have discovered a great business.
Financial Independence - Charlie Munger inspired SB says that people always have to be financially independent irrespective of where they are in career and if they are a huge conglomerate or a small time stock investor. For ex, Birkshire hathaway always has multiple income streams through which money keeps coming in for reinvestment. They had USD 20 billion to spare when everyone else was selling stocks in 2008. Sanjay Bakshi when started investment around 2000 (after initial failed attempts) took up teaching jobs and wrote articles to diversify the income streams.
You become financially independent by becoming a miser. Curtail your needs massively during intial part of your career. When you get your salary/income, first invest the money and then think about expenses (except bare minimum living expenses). Postpone your car, house, luxury purchases and invest and use the leftover money for expenses, not the other way round.
What this miserly behavior gives you is staying power. If you depend on market for your living expenses then you cannot sustain when the market crashes. That's the time when you should be buying more rather than taking your money out (Ex, Birkshire in 2008). If you are leveraged and invested in market with borrowed money, you will bankrupt yourself in market crashes. The process will be slow to build the multiple income streams but gives you massive benefits at the end.
Estimating when a company is cheap -
a) Cash Bargain - This was one of Benjamin Graham's favorite in 1930's recession but these opportunities are hardly ever possible today. No good businesses trade below cash today. There are businesses that do but they do that because of their terrible quality, not applicable today unless there is a miracle. These used to be low quality businesses only.
b) Debt Capacity Bargain - Favorite theme for SB even today, a company has no or little debt on its balance sheet but is not taking any cash. it has stable income cash flows from its operations. At times in market ups and downs, these companies market cap goes below their debt capacity and at such times they are a bargain. It's proven by Ben Graham and several others that a company is always worth several times more than the debt that it can comfortably service.
c) Debt Pay Down - Highly leveraged businesses that used their operational cash flow to pay down the debts they held and became less leveraged and hence improving their value and in the process created value. SB does not use this method also now as he doesn't like highly leveraged businesses anymore. He talked about above 3 points in 2002 and 15 years is a long time in investment that has taught him to stick with only one of the 3 ways he earlier talked about. Debt capacity bargain however is still a very successful way of finding great companies.
At present, SB thinks of businesses in terms of expected returns. You have to first love the business/process, the management and then come to valuation. Noe as I earlier mentioned expected return is a function of entry multiple, growth rate, and exit multiple. An investor may be scared of a 25x entry multiple thinking the business is already costly but you cannot mistake to ignore the growth rate and exit multiple. If the company has amazing growth rate for next 10 years and an exit multiple is de-rated to 20, you may still end with a very satisfactory/above expected return out of the investment.
Charlie Munger stated 'if you can buy a business growing at 18-20% for 20 years then what appears to be a large price may not be a high price at all in the long run'.
SB's Current Philosophy -
Pro social, low stress businesses
Basic Screens -
High quality businesses with market dominance
High return on capital
Strong entry barriers
Strong balance sheet
Strong growth prospects
Ability to fund growth without requiring leverage/outside money
Like to invest in existing businesses that are expected to continue for considerable time in future which have performed wonderfully at least for some time, if not at the moment.
Can the small investor win?
A small investor has better opportunities than a large institutional investor since he c an look at companies that are much smaller in market cap and his/her performance is not being evaluated on a day to day basis or a quarterly basis which happens for institutional investors and fund managers. Even if a fund fund manager knows that a business is going to be great in 10 years, they may not be able to put their money in it given the short term expectations/pressures.
All the benefits will go to a smaller investor but ONLY is he/she has staying power.
Falling into value traps -
Lot of young investors fall into value traps because they can do the number crunching and build excel models to estimate if the screens they are looking for look good for a given stock or not and then jump right in to buy a stock only to realize few years later that it's a value trap. The reason for that is the lack of qualitative analysis. The quality analysis is something that is more like soft skills and comes with extensive experience and reading which the younger generation just doesn't have the time for. These skills are pattern recognition skills, skills to recognize what makes businesses successful that comes with extensive knowledge gathering and understanding that cannot be built by number crunching or screens.
A Primer on P/Es -
P/Es are easily available and likely the first thing an investor uses to see if a stock is values fairly or not. However, the P/E ratio can be fair to deeply flawed depending on the context it is applied in. When you use the P/E to the overall market, it gives you a wonderful idea if the market is valued at the time compared to historical values.
When you apply the same ratio to a stock, you completely ignore the growth rate and exit multiple in estimating if the stock is cheap or not. Additionally, the Earnings part of the P/E may itself be flawed. See how is that possible.
Warren Buffet talks about Geico where they have no intermediaries who sell insurance but the model is a completely online model and Geico advertises heavily to market it. Now the marketing spends are considered as expenses and not investment but in the given scenario is it not an investment that has been generating wonderful returns for them, apply the amortization to it and it is even more attractive. If you take them as investment then Geico's true earnings are much higher than what is being reported. The same phenomenon is true of so many businesses, just like a pharma company that spends on research and stumbles on the new big penicillin.
These businesses penalize the profit and loss in current year but may throw a lot of cash 2 years down the line.
SB talks more about the books, suggestions to beginner investors and things like that which are better learnt by reading/following him.
Final Enlightenment - In last few years, SB has realized that it's important to not be impacted by labels. Ex. Buffet never used to say airlines are bad business but that has changed and now he is buying. The reason for the change is that there may be wonderful future opportunities hiding under the known/uninteresting labels so always keep your eyes and ears open.
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