I am posting my analysis of Equitas small finance bank. Please note this is not a buy/sell recommendation and is only for educational purpose.
You can download the report from this link:Â Equitas small finance bank
Please read the disclosure at the bottom of the report
Decisive action
Our approach in the past has been to hold and ride through the drop. This works if the long term prospects of the company remain unchanged and the company is going through a temporary drop in growth or has high valuations
In the past, we would hope and wait for the performance to turn which led to opportunity loss. More important, each position takes a certain amount of mental energy and the ones performing the worst, tend to take the most
We saw that happen with some of our failures in 2018 and 2020 which took away a lot of my mental energy. Swift and decisive action on exiting a weak position frees up my mind to  concentrate on better ideas
Stop loss
A Stop loss is commonly used by traders and some investors. We have resisted the idea as my approach has been to buy a company with poor outlook in the near term but good prospects in the future. In such cases, using a stop loss means we get stopped out before the company’s performance turns around
I have reflected on the past losses and have noticed my tendency to get carried away by the narrative of a company, especially after it has done well for us. The risk is highest when we have a high allocation in a company with high valuation. In such cases, disappointment in the performance hurts our portfolio more.
It is easy to set a quantitative stop loss and exit as soon as that is hit. However, that would have stopped us out of companies which went on to become multi-baggers
As a result, we are using a mix of subjective and quantitative criteria to set a stop loss for each idea
I recently read a book called ‘Quit’ by Annie Duke and highly recommend it. There are two points from the book which I have taken to heart as it applies to investing
We have a stop loss for most positions and will cut the position in a graded fashion even if it feels early or we are proven wrong. If the position turns and the company starts doing well, we can always re-enter
Evolution
As the saying goes – Never waste a failure. I have always taken this maxim to heart. It’s not that I like to lose money. The problem with not being comfortable with failure in investing is that it happens quite often and not managing it well leads to further underperformance
For example – My tendency to hold on to losing positions in the past is a proof of this tendency
The performance of the last few years has made me reflect on some of the core aspects of our approach. One of them is – Buy and Hold
I continue to subscribe to the notion that wealth is built by investing in good companies and holding them for the long run. However, I have added caveats to it. There are very few companies which can perform consistently for a long period time (over decades) and the bar should be set high
For example, we started a position in PEL in 2012 as a cash bargain. The company evolved into a compounder as it built its pharma and then the financial services business. At the peak this was a 4X for us and a 10%+ position. However, we ignored a flaw in its business model – borrowing short term and lending to risky segment (real estate builders)
As I shared earlier in the note, I bought into the narrative and thought that the management knew what it was doing. To a certain extent, we must trust the management and their strategy or else we can never invest in a company for the long run
We failed in being critical enough, even though the market was telling us otherwise
We have become less complacent of the companies we hold and will not hesitate to exit our large and long term positions if we feel the risk  is high
Holding cash
We have held cash to the tune of 10-20% over the years. This has penalized our performance at around 2% CAGR. We never report our performance without cash as no one forced us to hold cash.
However, this cash holding is like tying extra weights on our feet while running a marathon. Cash has acted as a safety blanket for us and allowed us to sleep better. However, I am now rethinking the level of cash. We may hold lower amounts of cash in the future, but manage risk more actively based on stop losses
That said, we are not going to be reckless. If we don’t find any ideas, then we will hold cash. It’s better to underperform than lose money
Changing process – sudden or gradual
I have been thinking about our process for some time but only recently acted on it. The model portfolio and you the subscribers are not my guinea pigs.
We have a small tracking portfolio to add new ideas and track the companies for some time. I have been actively using stop loss in that portfolio. Some of the recent ideas were in the tracking portfolio for 6+ months before I added them to the model portfolio
This will continue in the future. At the same time, these tracking positions are small positions. Our buying happens at the same time as all of you.
Another change which is an outcome of this process, is higher volume of transactions. We sold 7 positions and added 11 new positions to the portfolio. Â In hindsight, I was slow on the exit. We should have exited a few more positions earlier.
What has worked in the past, has become less effective in the recent years. This is expected due to the nature of the markets. As markets evolve and adapt, the bar is being raised and old timers like us must learn and adapt. We will continue to do so in the future
A long-term partnership
We repeat this every time in the portfolio review and will do so again (more for the benefit of the new subscribers)
We will treat all of you in the same manner as we would want to be treated if our roles very reversed. This means that we will be transparent and honest about our actions even when have made a mistake
I recently had an interactive twitter spaces session. Unfortunately, the first 30 min of the conversation was not recorded
I am posting the video below
https://www.youtube.com/watch?v=ucxiWhkvnG0
To link the questions and my responses better, I spoke about four assumptions in investing. We all make implicit decisions on these questions, but often fail to recognize it
Time horizon
The first assumption is the time horizon for each investment. We have labels such as traders or investors with traders having a shorter time horizon. These are lazy labels. Only a few investors are explicit about their time horizon for an investment. Is it 1-3 months, 12 months, 2-3 years or greater than 5 years?
Thinking on these lines is not an academic exercise and there is nothing superior about longer versus shorter time frames. Also, we cannot be sure about how long we will hold an investment, but we should have some viewpoint about it
Let me take a few examples to make this point
Assume your ‘average expected’ holding period is around 6 months. In such a case, you will be more concerned about the next quarter’s earnings, momentum in the stock and general economic conditions in the near term. You may use technical indicators more than fundamental factors to make a decision
In such a case a cyclical company such as steel or sugar is a good idea
In contrast, if you prefer a 5+ year holding period, you would be focused on the business model, competitive advantage, and quality of the management. You are more concerned about how the company will perform over the next decade and not the next quarter
A pharma or specialty chemical company could be a good idea even if there near term headwinds
One can easily see that an opportunity for one set of investors would be a nonstarter for the other. A lot of argument on social media is often two individuals talking past each other because their implicit time horizon is different
You don’t have to be precise about your time horizon but should have a general idea of the time scale you are operating on. That will define your type of stocks and the investing framework
Cyclicality
This brings me to next topic of cycles. I agree with the idea that in the end everything is cyclical. The only difference is the duration of these cycle.
An FMCG company could have a cycle of decades whereas a sugar company could complete its cycle with 1-2 years
One should combine the idea of cyclicality with time horizon. If you prefer to buy and hold for 5+ years, you must avoid a tier 2 steel producer. On the other hand, an investor with a 6 month horizon, would get frustrated if he or she buys a CDMO or a steady growth FMCG company going through a temporary slow down
Return on time invested
The scarcest resource for all of us is time. You can compound money, but time is finite and reducing by the second. If you accept that reality, then return on time invested is very critical
I will not get philosophical on this. For now, I will limit the discussion to what you are earning in monetary terms per unit of time spent on investing
I covered this topic in detail in the post below on why time spent on active investing has low returns
https://www.valueinvestorindia.com/2019/05/24/a-future-advise-to-my-kids/
Let’s assume that like me, investing is a passion for you. We all have activities in our life where we are not thinking of an economic return. Life would be a drab if we were economic animals all the time. That said, I think it is important to think of Return on time invested as a framework.
Let me give you an example – I used to look at arbitrage situations in the past but realized that increasing competition had reduced the return to low double digit one time return. It was not worth the time for me, and I stopped investing in such opportunities
The same goes for debt investing. I don’t want to spend time looking for the extra yield and add risk for that extra 2-3% return. I prefer to park my surplus cash into Fixed deposits with some large banks. It may be sub-optimal from a money standpoint, but better from a time perspective
I am not sharing these examples as a superior way of spending time. Someone else would feel that I have wasted 20 years of my life trying to beat the index. That said, I think we should all look at each investment opportunity through this lens
Sleep test or risk tolerance
I come to the final point. I have written about it in the past on the blog. The point is simple – Will an investment or level of concentration make lose sleep? If yes, then it’s not worth doing
This test works as a proxy of my risk tolerance. I don’t care what others think about an opportunity if it makes my stomach churn and lose sleep. We are all built differently and this question on risk tolerance will give a different and very personal answer. Trying to imitate others on this point is a sure way to unhappiness
I was in college when my dad passed away unexpectedly.
It was a shattering experience and only those who are unfortunate to experience it early in life can relate to it. Your notions of stability, risk and how you see the future changes completely
As I came to terms with his death, I was forced to deal with my family’s finances. This was the start of my investing journey. Till that time, I was never bothered about money, much less about stocks and bonds
We were financially insecure and that feeling drove me to learn about money & financial independence which led me to stocks, Warren Buffett and so on
I cover my initial years of investing in this video
A lot of time has passed since then and I have done well beyond my expectations. However, I don’t think my world view has changed. Such events influence your thinking on risk & money for a lifetime
I often chuckle when I read about some formulae on risk and all kinds of mathematical approaches. These formulae are without context and designed for some hypothetical person with no emotions and life experiences.
We all go through different life experience and our notions of risk, money and future are different. My own life experiences means that I will always remain a financial chicken all my life
The Defense sector has caught investor fancy, with stocks such as GRSE, Hindustan aeronautics and Cochin shipyard, running up in the recent months
The following factors are supposed to be the key drivers for it
These factors have been in place for the last few years, but are gaining momentum now (achieving critical mass)
We initiated a position in Cochin shipyard in 2020 in the model portfolio which turned out to be early in Hindsight. The main driver was an increasing order book driven by the above factors. As it happens with anything related to the government – You can count on delays inspite of the best intentions. As a result, we exited the position to avoid opportunity loss
This sector continues to be on my radar, though we have no position in it
I am publishing the research report from 2020, as the thesis is unchanged. You can download it from here
I am posting my analysis of Bector Foods. Please note this is not a buy/sell recommendation and is only for educational purpose.
You can download the report from this link : Mrs. Bectors Food Specialities Ltd
Please read the disclosure at the bottom of the report
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I wrote this note to our subscribers today. Hope you find it useful
At the height of the epidemic, I shared my thought process on the next steps
How does one invest under such extreme uncertainty? One option is to assume that there will be a quick recovery and go all in. The other extreme is to wait till it is all clear and then deploy the capital. In the first approach one is making a bet on a specific scenario which may not occur, leading to sub-par results. In the second case, we may end up with sub-par returns too but only because prices will adjust once all the uncertainty goes away.
We paid a price for being conservative. We lagged the indices in 2020 at a time when others rode the surge in small caps and achieved stellar returns
I wrote the following at the end of 2020
At that point of time the future was uncertain and anyone making a specific bet was ‘assuming’ a specific scenario. If we assume that 50% of the investors bet on rapid recovery and the other 50% bet on the whole thing dragging on, the first group turned out to be right.
You are now hearing from investors who went all-in, in the month of March/April. It could have easily gone the other way and in that scenario, the second group would be highlighting the merits of being cautious, whereas the first group would be silent.
I personally avoid taking a specific view of how the future will unfold. The risk of doing so is high, if you get it wrong. If you are managing money for others (like me), then the risk is asymmetrical. If you get it right, you can tout your performance. If not, then your investors bear the brunt
I continue to stand by my conservative approach, though I should have reacted faster when all central banks pumped in a huge amount of liquidity into the system. By the time, I could appreciate the dynamics, it was too late
I have been following this drama closely and by mid of 2021, felt it was getting crazy. Valuations of profitless growth companies in the US went through the roof, Crypto was all rage and then we had the NFTs.
Some of these innovations could change the future, but why would I pay for a promise? If you are a buy & hold buyer (as many claim), then you should be paying a price which doesn’t discount the future. On the contrary at height of the mania, buyers were paying for the most optimistic future
The last one year has reminded me of the 2000-2001 dotcom mania. I had just started investing and resisted the mania for a long time, but finally succumbed to it in early 2000 when the bubble peaked. I promptly lost 80%+ of my meagre investments in the next few months
The advantage of experience is that if you can avoid repeating the same mistake. I have stayed away from all this madness and just watched it with amusement. You can see all the updates on my twitter feed @rohitchauhan
When the tide goes out
I created a presentation last year but did not upload it then for some reason. Interest rates have been on a 40 year downward trend and were close to 0% (and even negative). The investing world has gotten so used to this zero cost capital, that even a slight increase would be devastating to most assets
Although I could not forecast inflation and other macro issues, it was clear than any normalization or even reduction in the liquidity was going to be a problem for the market
We know what has happened since then – Inflation has surged due to war, supply shortage of commodities and all kind of supply chain issue
The net result is that interest rates are rising and have some distance to go. All central banks, including RBI have to raise interest rates and reduce liquidity to control inflation
Flip the script
So what’s my point in all this ? We all know what is happening.
If a cut in rates and increase in liquidity, resulted in a V shaped recovery, then the reverse should cause an extended downturn?
I think a lot of the correction has happened. However that does not mean markets cannot shoot on the downside. Long term investors often ignore the implications of liquidity
The net result is that the tailwinds of the last 2-3 years are now headwinds. If this turns out to be true, then there is no central bank to bail out investors this time around in the near term
Hunker down
My thinking is colored by my experience after the dotcom bust. As liquidity was pulled back, it took the markets years to normalize and start growing again. The current events are not the end of the world. At the same time, we should not expect that market will turn suddenly and resume their upwards trend
We are holding 20% cash as I write this note. My plan is keep looking for new opportunities (as always) and start with small positions. As these companies execute, we will scale into the position over time
Even as we invest and reshuffle our portfolio, we should expect losses in the near term. No amount of conservatism can save us from that. I have harping about diversification and asset allocation for last 2 years as I felt that a lot of the recent rise has been due to liquidity conditions around the globe
We can expect volatility and a tough slog for some time. The key is to manage the risk and focus on building a diversified portfolio
This was posted recently to subscribers of our advisory. Hope you find it useful
We are seeing what I would like to call liquidity crash in markets across the globe
Let me explain
In the last few months, I have been tweeting about inflation going up and prepared this presentation, which I did not post. I laid out my thoughts in the ppt which I created in Dec 2021 and posted a summary on twitter. Judging from the response, most people did not bother about it 😊
As inflation has risen, the Fed and other central banks have raised interest rates. This caused a slowdown in the markets in the last few months
The nifty and other indices have been flat, and several stocks are down in this period.
I think this was the first stage and we have moved into the next phase – that of tightening liquidity. The US fed and central banks have announced a withdrawal of bond buying and other liquidity measures they introduced during the Covid crisis
These measures led to all kinds of asset inflation as liquidity surged across the globe. As this liquidity is withdrawn, we are seeing sudden crashes in asset prices
In the last few months, various tech and SaaS companies have been obliterated. A lot of these company are down 50-90% and the selling hasn’t stopped yet. This is now spreading to other asset classes
We are seeing some early signs in the Indian markets, especially in the small/mid cap space. In the last few days, I am seeing sudden large drops, often for no fundamental or company level reason. This is likely to intensify in the coming weeks and months.
How are we positioned?
This is not new and occurs every few years. What is different this time, is that the Fed and other central banks will not be there to inject liquidity and save the markets. At best, they will continue to deflate the bubble slowly to ensure that markets and economies function properly
We have always been cautious and careful. For example
The coming weeks and months are going to be painful. I have always stressed on asset allocation to all of you and hope you have managed your equity allocations keeping that in mind. Our risk tolerance will be tested in the coming month
The key is to keep the equity allocation at level where a drop in the portfolio will not cause you to sell in panic. We will be tested on that count
As I have repeated ad-nauseum – Survival is key. There is no point making large gain, if we lose all of it and are forced out of the game. That is already happening to a lot of people
Let me share two graphs, which appear quite similar
Are they from the same data but drawn differently? Both graphs show periods of growth followed by consolidation or pullback
Let me zoom out and show the source of this data
The first graph is that of our model portfolio and second is of Vinati organics. One is a portfolio of stocks and another is a portfolio of products. Our portfolio has delivered 24% CAGR in the last 10 years and Vinati organics delivered 40% CAGR over the same period.
There is a deeper lesson in the above charts
Progress is never linear. It happens in fits and starts with periods of stagnation and backtracking.
Short-term thinking and extrapolation
It is easy to enter the portfolio (or a stock) at point A and just extrapolate that trend or at point B and do the same. The problem with this mindset is that the individuals expect progress to be linear and steady (purple line) whereas reality is the brown line of our portfolio
This is a problem no one can solve for us. I have seen this all my life, especially with investing. A lot of investors want immediate gratification and jump in at point A, only to be disappointed.
The right mindset is to zoom out and look at the long term trajectory. Does the mindset and approach of the advisor make sense and will it work over the long run. Is yes, then you must give it time to play out
What drives this behavior ?
I think the problem is our own expectations and lack of patience. We want immediate and consistent results. That’s the point of tweet below
The world is not kind to give something for free. If you want zero volatility – go for a fixed deposit. If you want high returns, the price you pay is the volatility of the returns.
Somehow everyone gets this in other facets of life – everything of value has a price. Patience and persistence is the key to success – in stock markets and a lot of other endeavors
The following was posted to all the subscribers. Hope you find it useful
Market drops have become a once in two year events
2016 – demonetization (note here)
2018 – ILFS crisis (note here)
2020 – Covid Crisis (note here)
2022 – Drop in US markets and now Russia Ukraine war
There is no regularity to these events and does not mean we will get these drops in even years. Such drops have occurred in the past and will occur in the future too.
You have to study the market history to know that there is always something to worry about and scare the markets
Bottoms instead of top down
I have never planned the portfolio based on some specific forecast or event. In the last 11 years of our advisory, we have seen all kinds of micro and macro events occur. At that time, the event appeared to be a big deal and then eventually everyone adapted to the new situation
What I have changed in the recent past (as I noted in the annual letter) is my response to company level events. If a company is not doing well or the management is lacking in execution, we would rather exit than hope things will work out
Doing so ensures that we clear the portfolio of its deadwood and have positions with higher level of conviction. That’s the reason we have 25% cash level in the portfolio, not because my crystal ball forecasted a downturn in 2022
What does the crystal ball say now?
My crystal ball is as murky as it always has been. The same is true for others, even if they claim otherwise
However, a few long term trends which impact investors the most, seem to standout. Inflation and by proxy interest rates appear to have bottomed and could rise in the future. This will exert a downward pressure on valuations.
Commodity prices and supply chains will continue to get disrupted due to this conflict and other geopolitical events
All of this means a lot more volatility in businesses and stock prices
How to invest with higher volatility
In my mind higher volatility means that managements of companies will have to be flexible and adapt faster to change. For us as investors, this means that the operating environment for our companies could change suddenly leading to a break in our thesis
When that happens, we may have to sell and move on. Holding onto an outdated thesis and hoping it works out is a recipe for disaster
We have been doing that for the last 6 months and will continue to do so. I am not counting on luck to bail me out.
The second change is portfolio diversification across companies and sectors. I have tried to spread out our investments across companies and sectors to ensure that a hit in one does not derail the portfolio. The same holds true for your overall portfolio outside of equities. I would recommend being diversified across asset classes with allocation adjusted to your personal situation
A plan of action
A lot of you have asked if you should add to positions which have dropped below the buy price. The simple answer is Yes. The only time when this happens is when there is chaos and crisis in the world. Such prices come only during times of trouble
It does not mean that if you start adding today, you will not see lower prices. No one can predict how low the markets can go and when they will turn around.
This is the price of investing in equities and no matter what system you follow, there will always be losses from time to time. you can use a stop loss but then on the flip side if the market suddenly turns, you will lose the upside.
The best option is to invest in a steady and measured way keeping in mind that your purchases could show a loss in the short to medium term. Invest only if you don’t need that money for the next 3-5 years and the amount is such that these losses will not cause you to lose sleep
We continue to look for new ideas and with the recent drop, a few are becoming attractive by the day.
As always, our money is invested the same as the model portfolio and we continue to eat our own cooking