Spotlight

Is it worth studying the macro factors while analysing a stock? The answer is both Yes and a No. We explore what kind of macro should an investor be concerned about and what should be avoided.

We don’t know what lies ahead in terms of the macro future. Few people if any know more than the consensus about what’s going to happen to the economy, interest rates and market aggregates. Thus, the investor’s time is better spent trying to gain a knowledge advantage regarding ‘the knowable’: industries, companies and securities. The more micro your focus, the great the likelihood you can learn things others don’t.~ Howard Marks

We look at opportunities, as they come along, we try to figure whether we can understand the long term economic prospects of the business. A lot of times the answer is no, then we forget it. We are not making any judgment about where the market is going or we are not looking at any macro factors.

My partner Charlie Munger and I have been working together now 55 years. We’ve talked about every business you can imagine and stocks. We have never had one decision that involved a macro factor. It just doesn’t come up.” ~ Warren Buffett

A profession that has been the butt of most jokes is that of an economist. Though I am sure it is not fun being an economist, whose work involves examining a system with, literally, billions of different moving parts and then trying to come up with predictions or reasonable explanations that, quite frankly, don’t actually exist.

I still remember what they taught me in my college’s macroeconomics class. The equations were always assuming something.

If government increases spending by X, output would grow by Y, but only if you assume taxes weren’t used to support the spending, only if you assume full employment, only if you assume full price elasticity, only if you assume no substitution effect, etc. In short, macroeconomics was and remains a science that behaves with the certainty of physics, but has the track record of alchemy.
[Read more…] about Spotlight: The Folly of Macroeconomic Forecasting

The current volatility in the market is creating unfounded panic but at the same time it holds the dangers for others to start loading up recklessly. We explore the current market turbulence in the light of age old wisdom from Buffett and Klarman.

“I don’t know and I don’t care!”

This was my response to a friend who called me last week asking how much more markets could fall. This fellow is a VP in a stock broking company, and was seemingly trying to check on my prediction of the next market move, and how far or close it was to his own prediction.

“Why do you guys make a fool out of people by constantly making horrific predictions?” I asked him.

“What do you mean by horrific predictions? We also make some brilliant ones,” he replied. I laughed out loud and shared with him some brilliant predictions I had recently come across, made by one of his clan –

Nobody Knows

After the crash in 2008 people would ask me, “Well, what are you doing differently now? What are you doing now?” And my answer was, “Well, it’s the same thing I’ve always been doing. I’m looking for cheap stocks.”

It doesn’t really change whether the stock market is rising or it is falling. You would always want to look out for stocks selling at discounts to their intrinsic values, isn’t it? So that activity doesn’t change.

It’s not based on what the US Federal Reserve or India’s RBI is going to do; it’s not based on what China or Brazil is going to do. It’s the same activity throughout market cycles.

But most people I see in the stock market are made nervous by volatility, especially when stock prices are fast on their way down. The Indian market, as represented by the BSE-Sensex has been falling since February 2015, but the fall has been gradual and with some intermittent rises. The reason people have gotten extremely worried now (starting late-August) is simply given the magnitude of fall.

[Read more…] about Spotlight: Value Investing During Turbulence

What’s interesting about moat is that if a moat needs to be continuously built, it isn’t a moat at all. How do you know if you’re paying up or overpaying for the moat? This time we invert the conundrum of moat to explore the symptoms of false-moat trap.

Proper allocation of capital is an investor’s number one job.” ~ Charlie Munger

“Charlie and I have only two jobs…One is to attract and keep outstanding managers to run our various operations. The other is capital allocation.” ~ Warren Buffett

One of the great skills that any investor or businessperson can have is a talent for capital allocation. And when it comes to capital allocation skills, one of the people even supposedly the world’s best capital allocators, Warren Buffett, looks at is Tom Murphy.

“Who’s Tom Murphy?” you may wonder.

Well, I’ll discuss more on my key learnings from Mr. Murphy some other day. But here’s what Buffett once told Lawrence Cunningham, the author of Berkshire Beyond Buffett1 about this man – “Most of what I learned about management and capital allocation, I learned from Murph. I kick myself, because I should have applied it much earlier.”

In fact, Mr. Murphy has been such a great inspiration for Buffett that when you study what the latter has said and written about managing a business, in many cases you are learning indirectly from the former. That is a good thing since Mr. Murphy did not say or write very much in comparison to Buffett. Like many great capital operators (like Henry Singleton) and managers he mostly let his business results speak for themselves, and did not spend any significant time seeking to be noticed by the public.

Along with Buffett himself, Murphy is one of eight CEOs praised in The Outsiders, a cult business classic, which attempts to define what differentiates a small number of leaders who massively outperform the market through their capital allocation skills.

Buffett is quoted in that book as saying that “Tom Murphy and [his long-time business partner] Dan Burke were probably the greatest two-person combination in management that the world has ever seen or maybe ever will see.”

As you can read in the book, the capital allocation formula that Mr. Murphy practiced and what made him so successful, was – focus on industries with attractive economic characteristics, selectively use leverage to buy occasional large properties, improve operations, pay down debt, and repeat.

Anyways, contrast what Buffett says about Mr. Murphy’s capital allocation skills with what he wrote in his 1987 letter3…

“…the heads of many companies are not skilled in capital allocation. Their inadequacy is not surprising. Most bosses rise to the top because they have excelled in an area such as marketing, production, engineering, administration or, sometimes, institutional politics. Once they become CEOs, they face new responsibilities. They now must make capital allocation decisions, a critical job that they may have never tackled and that is not easily mastered. To stretch the point, it’s as if the final step for a highly-talented musician was not to perform at Carnegie Hall but, instead, to be named Chairman of the Federal Reserve.

The lack of skill that many CEOs have at capital allocation is no small matter: After ten years on the job, a CEO whose company annually retains earnings equal to 10% of net worth will have been responsible for the deployment of more than 60% of all the capital at work in the business.
[Read more…] about Spotlight: Capital Allocation – Part 1

A business’s long-term staying power is determined by its corporate culture. Despite this, most companies pay less heed to building a good one, and more to short term profit making. Let’s explore what you as an investor must look at while assessing how cultured or uncultured a company is.

I was recently travelling with my family in a luxury bus from Goa to Mumbai. I call it luxury because it had a working AC and the seats that adjusted a bit. That’s it!

It was a night journey, which began on a bad note (the bus was late), and ended in a nightmare (the bus broke down in the middle of night near a lonely place called Chiplun in Maharashtra). That we were travelling with four kids added to the nightmare. Twice, the bus got filled with smoke from a faulty electrical system, so twice we had to run out with kids and luggage in our hands.

The next bus was called for only after an hour of getting stranded, and this replacement bus was supposed to reach us only five hours later.

I called up a nearby hotel and the manager there was courteous enough to send a cab to pick us up and then arrange one to send us to Mumbai. In all, a journey that was supposed to take 10 hours, took 18. The cost of travel was higher by almost 75%.

“I want a refund for the breakdown of the bus and the harassment it caused the passengers,” I asked the customer service representative on reaching Mumbai. First, he did not have any information that his company’s bus had broken down, and then when he confirmed with his representatives, he agreed on a refund.

“We will refund you Rs 400 per passenger,” he told me. “Just 25% of the total fare?” I countered. “That’s less than half of what it costs to travel from Chiplun to Mumbai in a similar bus! And what about the trouble the entire episode has caused us?”

“This is what the head office has decided!” he replied and kept the phone down before I could say anything else.

I called up their head office, and got the same answer from their senior manager. And the casual way he and his team dealt with the entire situation was equally sad!

“I won’t ever travel with your bus!” I told him. “That’s fine!” he said, and banged the phone down.

“That’s what you get in the name of customer service,” I told my wife who was constantly asking me to calm down.

Well, the bus I was travelling in was from a company called VRL Logistics, a company that recently came out with an IPO, and which constantly talks about how they delight customers! They were in fact recognized as Service Provider of the Year 2013 by some World Travel Brand Awards (says a lot about how awards are won!)

Damn the Customer!
I am willing to bet my money on the fact that if I ask you to name 10 companies in India that have delighted you with great customer service, and 10 that have troubled you with a poor one, the second list will come out faster and the first would not get complete at all.

I am sure the situation is bad across countries, but the unprofessional way companies treat customers in a populated country like India truly deserves a case study (on how not to treat customers) at Harvard Business School.
[Read more…] about Spotlight: It’s the Culture, Stupid!

It was sometime in 2003 when, after joining my job as an equity analyst and after getting my first measly paycheque, I wanted to get my rented apartment painted. I was about to get married and welcoming my bride in a house with unpainted walls was a bad idea.

So, with the little I could afford then, I searched for the cheapest painter, and with him, went searching for the cheapest paint. But I couldn’t find one. In fact, no paint store was willing to sell me the cheapest paint, and instead, everyone seemed to nudge me to buy the most expensive of the lot.

“Sir, you would get your house painted once in five years, so why go for a cheap, low-quality paint?” one shopkeeper tried his persuasion technique, “So my suggestion is that you must go with this XYZ brand of paint.” My painter added, “This brand is really good, sir. Or why would everyone buy this one only?”

“But isn’t this expensive as compared to other brands?” I revolted.

“If you don’t buy this now and come back a year later,” a shopkeeper warned me, “it would get even more expensive!”

“How can you say that?” I retaliated. “Because this company has been raising its prices every year,” he replied, “and despite this, more and more people are buying it.”

Well, what I had heard from these paint shopkeepers was true, as I saw from the previous years’ financial statements of this XYZ company. Year after year, the company had been raising the price of its products, and year after year, its volume sales were also rising.

When I talked about this business with my senior colleague, he dismissed it as a random idea coming from a junior.

“But see the pricing power,” I told him, “And everyone is buying its products despite the constant increases in prices every year! And the company has no debt. And the management is clean.”

I tried to hard-sell this idea to my seniors, but not many took it seriously. And I, being an obedient, inexperienced junior into his very first job, stopped taking it very seriously, and did not buy the stock. What a huge mistake of omission it turned out to be!

If you have not realized by now, the XYZ company was Asian Paints, and the quoting price then was less than Rs 30 per share. Today, it’s around Rs 800, a 27-bagger in 12 years, or a 31% CAGR return.

I did not buy Asian Paints in 2003, which was otherwise a great insight then and one that was sparked off by nothing more than an observation of what people around me were buying and what people around me were hard-selling.

If I were to use the language of human psychology, Asian Paints was a business (and still is) that benefited tremendously from the biases of social proof (everyone was buying) and anchoring (high and rising price, and thus better products). And, to repeat, I got the insight out of simple observation and common sense, and no deep analysis of the business and no complex theories to support my arguments.

“My simple art,” said Sherlock Holmes in The Blanched Soldier, “is but a systematized common sense.”

Many times in life, all we need is a touch of common sense to reach a Eureka moment. And of course, we need the knowledge of separating sense from nonsense, because the latter is in great supply all around.
[Read more…] about Spotlight: Where Do Great (Investment) Ideas Come From?