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:
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.