I have an engineering background and a very quantitative/rationalistic lens of looking at the world (does not mean I am rational). What I mean is that when I am analyzing a company and valuing it, my  assumption is that all investors will ‘objectively’ look at the numbers and value it in the same fashion.

This approach to investing has its merits and works most of time. However, it has limitations and overweighing it leads to problems.

The above is the performance of a company which by all objective standards has done reasonably well. It has grown topline at 14%, profits at 19% with an ROE of 17% over the last five years. However, the stock is down 70% during this period.

Now you may thinking that this company has some governance issues and there is something seriously wrong with its business model. Let me share the name of the company – Its Repco home finance. This is an old position and you can read the prior analysis here.

We closed the position in Dec 2016 when the company was selling at around 22 times earnings. The main reason for exiting the stock was that I was concerned about the quality of the book (NPA). How did the NPAs turn out?

I hate to say this, but I was right for the wrong reasons. The NPAs have risen in the last few years, but the rise has not been alarming, and it includes some of the worst periods for economy and the financial services Industry. Inspite of that the company closed FY20 with 4% GNPA (which is similar to most private sector banks).

The net NPA for the company is 2.8% which is not high and should improve going forward. So by all objective measures the company has done well but the stock is down 70%. It is selling at around 5 times earnings and 70% of book value.

We  can all debate about what the future holds, but based on the past few years it is unlikely that it will be worse than the last few years. The above is but one example of how narrative often overwhelms the performance of a company.

A rationalist like me would say – Lets wait for some more time and the market will eventually recognize the true worth of the company. But the point is how long should one wait ? 3,5 or 10 years ?  There is an opportunity cost of holding such a position

This kind of scenario has played out with a few of our other positions and has made me question the limits of fundamental analysis. This does not mean that fundamental analysis has no value and should be thrown out of the window. That would be equally foolish.

In order to account for such cases, I have become more sensitive to the narrative around a company and a sector. If the narrative does not change and the stock price does not reflect the fundamentals, then I am more likely to exit a position even if the numbers are fine. We can always re-enter the stock when the market starts changing its view.

Investing in the markets is not an engineering problem which can solved by logic alone. In the past I have failed to account for that to our detriment. The best way to manage this kind of trap is to have a time fuse for each idea. If market does not come around to your view inspite of no change in fundamentals, then one should just exit – No questions asked !

It seems ages since I wrote the following comment three months back

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.

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 such 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 have been 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 will not tar all managers with the same brush. A lot of them, including us, are invested the same as their investors. In such cases, the behavior of the manager changes quite a bit. In such cases, your focus shifts to survival, than shooting the lights out. It does not mean that you will not make mistakes, but are very focused on managing the risk.

If the goal of investing for an individual is to achieve his/her financial goals, then the first priority is to ensure that you don’t incur a massive loss from which you cannot recover. The older you are, the higher the risk. I would recommend an individual investor to NOT look at the performance (especially near term) of professional investors. You should never do what this class of investors is doing, not because they are smarter (they are not), but because of the asymmetry of risk faced by them.

I took the following approach in the middle of the crisis

Under the circumstances, my approach is that of ‘regret minimization’. That’s a fancy way of saying that I will do something in middle, so that I can avoid FOMO (fear of missing out) if the first scenario occurs, but at the same time have enough dry powder available incase the economic recovery takes longer.

Instead of going all in, we have slowly added (and even sold) positions as shape of the crisis has become clear at the company level (and not at a macro level). It has allowed me to sleep well and live to fight for another day.

In investing, there is no finish line and gold medal at the end of it. The end goal is survival and meeting your financial goals.