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

• Position size
• Long term compounding v/s a short term cyclical play
• Technicals such as 200 DMA
• Company level issues

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

• Quitting on time, always feels early: remember when we quit IEX close to the top. It felt early to me
• Make the exit decision beforehand. At the time of executing the decision, the mind tends to come up with excuses. I experience it all the time

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.  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 do not have timing skills and cannot prevent short term quotation losses in the market.
• Our approach is to analyze and hold a company for the long term (2-3 years). As a result, our goal is to earn above average returns in the long run and try to avoid losses during the same period
• Despite our best efforts, we will make stupid decisions and lose money from time to time. The pain felt will be equal or more as we invest our own money in the same fashion

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