My overarching list of filters

Dated: 2nd of Feb, 2017

Performance and Portfolio Activity
The portfolio was up 5.6%  Dollar terms for the month of January, 2017, compared to the investible  Indian index, Nifty, which was also up 4.8%. The turn in market  direction happened at the back of slow realisation, amidst lack of  evidence of expected effect of the demonetisation, as more and more  companies, especially in the financial services sector and also consumer  discretionary names reported good numbers.


In my last  commentary, I had eluded to the fact that many market participants,  including myself had no real idea as to what the negative or positive  impact of the currency ban move would be. As is often the case,  investors in the market, naturally most being risk averse, acted on  expectations of extreme negative scenarios. I have a directive to myself  on my wall written, "Uncertainties present the best opportunities, have the courage to act", and that is what I did when the portfolio cash went down to almost zero by December, 2016. I am still fully invested.


In  the midst of all this, the portfolio has moved to more concentrated  bets. This has been done at the back of evidence from quarterly results  that there was no impact of the currency ban on their growth story. It  made sense then, when prices of some of them are still below pre- event  levels, to load up on them. A thing to note is that there are no new  names added but more capital added to the existing ones while axing ones  which, 1. Don't have excellent visibility on future earnings, and, 2.  Do not anymore meet up to the standards of compounding range I require  my invested business to have given the changed business environment. 

This thing about forecasting.
I  write this at the risk of offending some people who read my updates,  but I will note it anyways. There are many investors, and you will  probably find them imparting their opinion on markets especially, who  talk about investing as a derivative of their macroeconomic  understanding of the world/ country/ sector they are investing in. I can  understand asset allocators undertaking such an exercise but it is  quite odd to see fundamental equity investment managers speaking about  their predictions of what markets will do (especially short/ medium  term) and how they manage their portfolios based on those views. I  understand this is sometimes as a result of what the media wants. Nitty-  gritty news about a particular business does not probably produce the  strong sound bites a macro economic opinion does. Any publicity is good  publicity I guess.

As Alan Greenspan said, "People don't  realize that we cannot forecast the future. What we can do is have  probabilities of what causes what, but that's as far as we go. And I've  had a very successful career as a forecaster, starting in 1948 forward.  The number of mistakes I have made are just awesome. There is no number  large enough to account for that.". Indeed, determining fundamental  value of a company I am investing in involves certain assumptions about  probable future prospects of the concerned business but the way I have  approached the basic problem of forecasting is not forecasting at all. I  have developed certain rule based approaches to future business growth  assumptions and all I am doing is applying a systematic margin of safety  to growth assumptions. For example, if I observe that previous 5 to 10  years earnings growth has been 30% odd, my future growth assumptions are  systematically below that 30%. Ofcourse the haircut in growth  assumptions depends on the business concerned and the industry dynamics  as well.

Indeed, I could be wrong even then but I comfortable  (till now) that such an approach should serve me well enough. That also  means that at no point in time I will invest in business that has  projections and nothing else. Any tech names, any rosy futuristic ideas  go right past me. I will not assume that a loss making business will  come to profit. An asset liquidation method is more suitable to value a  distressed company, and in which case, I am not making any future  assumptions at all.

I am not trying to be smart, I am in an effort not to do something stupid.

My overarching list of filters to identify ideas...
Over  many years, I have developed a set of initial working filters to  identify ideas which ensures that I stay away from losing my marbles. To  clarify, these are not quantitative filters and the answers to these  filters are not certain. However, I think that if my idea passes atleast  one filter (two or three is even better), it becomes a good case for  further analysis. Quality of the balance sheet and proven business  success are issues which come afterwards when I look at companies in  greater detail.

Subject to changes and improvements, without  order of preference, I have a list of questions that I ask myself about  the business of an idea I am working on. The questions are:

  • Does  the business enable people to fulfill their aspirations? By  aspirations, I mean enabling people to better their standard of living  by bringing forward their future consumption to the present.
  • Does  the business produce a good which people can show off with and which is  a stretch or beyond means for most people? A thing to clarify is that I  am not talking about luxury goods here. 
  • Does the business produce a good that people buy for the feeling associated with the brand mostly? Coke is a prime example.
  • Does  the company offer a service which is significantly better in terms of  delivery than previously known methods? Micro-finance companies in  emerging markets is playing this game handsomely.  
  • Does the company produce a good which is a necessity for people to live their daily lives? Many staples will come in this area.

As  I noted before, if a business passes through atleast one filter, than  the business becomes an idea for further consideration. I generally look  for businesses which passes multiple filters among varying degrees.