2018

Investors Interview Series

Compilation of interviews by Vishal Khandelwal
with different investors. These interviews will give
insights of different investors philosophy.

No editing to the original content has been done.

Any mention of stocks is meant for education

purpose only. None of these are recommendations
from me, Vishal Khandelwal or the Interviewed
Investors.

Source: https://www.safalniveshak.com/

Compiled by Venkatesh Jayaraman

J, Venkatesh

@VenkateshJayar2 4/2/2018
Interviews of:
Kenneth Jeffrey Marshall
Morgan Housel
Brent Shore
Jason Zweig
Kuntal Shah
Rohit Chauhan
Rajeev Thakkar
Samit Vartak
Hazaifa Husain
Jae Jun
Basant Maheswari
Stable Investor
My Interview with Kenneth Jeffrey Marshall
safalniveshak.com/interview-kenneth-jeffrey-marshall/

Vishal Khandelwal January 21, 2018

Note: This interview with Kenneth Jeffrey Marshall was originally published in the
November 2017 issue of our premium newsletter – Value Investing Almanack (VIA). To
read more such interviews and other deep thoughts on value investing, business analysis
and behavioral finance, click here to subscribe to VIA.

Kenneth Jeffrey Marshall is an American value investor,

teacher, and author. He teaches value investing in the
masters in finance program at the Stockholm School of
Economics in Sweden, and at Stanford University. He
also teaches asset management in the MBA program at
the Haas School of Business at the University of
California, Berkeley. He is the author of the 2017
bestselling book Good Stocks Cheap: Value Investing
with Confidence for a Lifetime of Stock Market
Outperformance published by McGraw-Hill. He holds a
BA in Economics, International Area Studies from the
University of California, Los Angeles; and an MBA from Harvard University. He splits his
time between California and Sweden.
Safal Niveshak (SN): Thanks for doing this interview, Kenneth! Please tell us a little
about your background and journey, and how you got into value investing?

Kenneth Marshall (KM): Well, I was first shown value investing in the late 1980’s. But it
wasn’t like some sudden enlightenment. It actually took me a decade to get it. I’d rather not
think about the cost of that delay.

I grew up in Irvine, California; between Los Angeles and San Diego. My best friend’s father
started a value fund in 1979. We were kids then, of course. But when we graduated from
college in 1989, my friend went to work for the fund. He’d tell me about fundamental
analysis, how they went to Omaha every May, and so forth. But I was slow to appreciate
what I was being handed. It wasn’t until the dot-com hypefest of the late 1990’s that I
started to grasp the common-sense approach that value offers.

What did it for me was drawing the link between value investing and freedom. Once I got
that value investing meant high returns, and that high returns meant personal freedom,
value became irresistible to me. So it remains.

SN: You also teach value investing. When did you start teaching the subject and
what have been your key learnings as a teacher of the subject?

KM: I first taught value investing at Stanford in early 2014. I proposed the course, and
luckily, the department agreed to put it in the catalog. But it did so on the condition that at
1/9
least 15 students register. So I was ready to enroll my infant daughter, deceased relatives –
anyone that would take me over the hurdle.

Fortunately, the course turned out to be quite popular. About 20 students signed up right
away, then 20 more, then 20 more. I kept getting upgraded to larger and larger classrooms.
In the end, we topped out at 90 students, and the class was held in an auditorium in
Stanford’s Lane History Corner building. It’s a big oak-paneled hall that looks like a
television set for a show about college. It was great. I still teach that course today.

What I’ve learned from teaching is that people with no financial background can become
good investors. Those from the hard sciences – physics, engineering, chemistry – seem to
have a particular advantage. They’re already trained to chase solid answers via logic and
math. They’re not satisfied with ambiguity; they want the truth. That’s a very useful mindset
to have.

SN: That’s interesting! Which is more challenging – practicing value investing or

teaching it – and why?

KM: Well, challenging isn’t the word I’d use to describe either. Neither is a cinch, of course.
And if I aimed to get 25% annual average returns, or standing ovations every time I walked
into a classroom, I’d find it all challenging to the point of impossible. But I don’t.

Plus, by now, investing and teaching have for me become inseparable. At Stanford,
whatever company I’m analyzing myself that week becomes our case. Class becomes like
walking into a room full of motivated analysts.

Teaching makes me a much better investor. Much. It does so in at least three ways.

First, students directly improve my framework. For example, a few years ago in my masters
course at the Stockholm School of Economics we considered Geberit. It’s a Swiss
manufacturer of plumbing components. The topic turned to moat. Did the company have
one? It seemed to, but it was hard to identify its source. Was it brand? Kind of. European
plumbers thought highly of Geberit. But it seemed deeper. Then a Swiss student described
how the company involved itself in the careers of plumbers. It offered professional
certifications, free project planning software, training – it ingrained itself into the worklife of
its channel customers. That student’s remark led to the concept of ingrainedness. It’s one
of six sources of moat that I lay out in the book.

A second way teaching makes me a better investor is by forcing clarity in my thinking. It’s
one thing to understand a potential investment well enough to satisfy yourself. But it’s more
demanding to understand it to the point where you can run a discussion on it.

Third, I get better investment ideas. Because I teach in both the US and Europe, I hear
about all kinds of things. For instance, this week I’m looking at a European natural
resources company that I never would have heard of had one of my Stockholm students
not mentioned it. She grew up near it.

SN: You’ve written this nice book Good Stocks Cheap. What’s the core premise of
the book and which section did you like writing the most?

2/9
KM: The core premise is that good value investors know what to do, do it, and don’t do
anything else.

If a step in that flow is missing, outperformance is unlikely. Consider angel investing. It’s an
activity that – over time and on average – returns poorly. Sure, it’s exciting. And it puts one
in the company of engaged, gifted people. But on balance it doesn’t work. So, a value
investor that angel invests on the side is likely to stunt overall returns. And that’s a
deserved outcome. It’s a violation of the third step, don’t do anything else.

I loved writing the whole book. I really did. I loved needing to resonate with people I’d never
met – people with different backgrounds, different interests, and often with different native
languages. It conjured up discipline in my writing. So did limiting my time frame. I
committed to delivering the manuscript to McGraw-Hill by September 1, which – given my
teaching schedule – gave me exactly five months finish it.

I remember Michael Eisner – the old Disney CEO – once saying that his job was to take a
creative project and put it in a box, a box with sides defined by the constraints of a timeline
and a budget. I think that this was from back when he was running the Paramount Pictures
film studio. Anyway, that’s what I tried to do with myself. I put myself in a box, a box with
sides defined by the constraints of a September 1 deadline and a 60,000 word budget.

I’m lucky to have viewed writing not just as a way to get my thoughts out, but as something
to get right on its own. So, I read books about writing. The best was On Writing by Stephen
King. It’s beautiful. And it recommends another great one, The Elements of Style by Strunk
and White. That my undergraduate curriculum at UCLA didn’t include that book is
shameful.

Another reason that I loved writing the book is that McGraw-Hill was so good with editing.
They made few changes, but when they did, they really nailed it. For example, some
investors consider the amount of a company’s excess cash to be equal to 5% of its annual
revenue. I think that’s insane. Different businesses are different. My original sentence on
this was “Applying the same percent every time is like always using chopsticks regardless
of what’s for lunch.” I pictured some bozo trying to lift up a sandwich with chopsticks, an
image that I thought made the point nicely.

But then my proofreader said “you know, in some parts of the world they really do use
chopsticks regardless of what’s for lunch. Why not say spoon?” That’s smart editing.

SN: Let’s now talk about Kenneth Jeffrey Marshall, the investor. How have you
evolved as an investor and what’s your broad investment philosophy? Has your
investment policy changed much through the years?

KM: I’ve evolved from an investor of modest talent and no strategy into an investor of
modest talent and a value strategy. And my returns have improved. So that improvement
can only be attributed to value.

Since committing to value at the end of the century, my investment policy hasn’t changed
much. The only shift is that I stopped selling. Most of my errors had come from selling
prematurely. They were profitable sales, so it wasn’t natural to see them as mistakes. But

3/9
I’d rub my nose in the high returns that those businesses continued to enjoy long after I’d
left their shareholder rosters. That was a useful exercise.

SN: What are your thoughts on the disruption that’s killing businesses all around?
How does one identify businesses that can sustain competitive advantages over a
period of time in such an environment?

KM: Is disruption truly killing businesses all around? I’m not sure that I’d agree with that.
Some retailers are getting their comeuppance, yes, often because of the collision between
debt and the internet. Print news is dying because compared to the web it’s costly and late.
Taxis are in trouble because smartphones increased the capacity utilization of privately-
owned cars.

But, on balance, there’s not greater disruption today there was in earlier decades.
Admittedly, this is hard to see. After all, yesterday’s disruptions made today’s status quo.

Earnings power is always sloshing around. That’s a feature of a dynamic economy. We

wouldn’t want it otherwise.

But there are businesses with sustainable advantages, ones that survive disruptions.
They’re the ones that Nassim Taleb would call antifragile. They strengthen under stress.
And spotting them is straightforward. The book shares four tools for doing it.

The first is what I call breadth analysis. It asks, is the customer base broad and unlikely to
consolidate? And, is the supplier base broad and unlikely to consolidate?

Second is what I call forces analysis. It’s my twist on Porter’s five forces model. It forecasts
the profitability of a single business, as opposed to the average profitability of an industry,
which I think was more Porter’s aim.

Third is moat assessment, a way to see if there’s a real barrier that protects a business from
competition. And last is market growth assessment, a basic check to make sure that a
company’s market isn’t shriveling up.

SN: Thanks for your thoughts on disruption. Anyways, how does one build in a
margin of safety to minimize this risk when choosing a portfolio of companies?

KM: For me, the margin of safety doesn’t come from minimizing disruption risk. It comes
from price. I try to buy good companies that I understand, and to do so at a discount of at
least 30% from the lower end of my estimate of value. That discount is where the margin of
safety comes from.

If a company faces a real disruption risk, it’s not a good company. I don’t want it. I’d never
pretend that I get a margin of safety by buying it at, say, a 60% discount. Others play that
game, some to success. But they’re smarter than me. They can buy well and sell well. I
have just enough watts to get the first half right.

SN: What has been the best time – that tested you – and worst time – that tested you
– in your experience as an investor?

4/9
KM: The big tests come when prices plunge, and when prices soar. A plunge test came in
2008, during the financial crisis. Listed equities went on sale because there was a scramble
for liquidity. Folks needed cash to make good on other obligations. So I gave them their
cash. I bought.

It’s possible that we’re heading towards the second sort of test – a soar test – now. I say
this based on the observation that my cash balance is higher than I’d prefer. I don’t have
some profound macroeconomic insight or anything. It’s just that good companies that I
understand haven’t gone on sale in a while. What’s particularly trying this time is that the
interest earned on cash is so low. In some of Europe it’s negative. But I hope to pass this
test too.

SN: How do you think about valuations? Which is your favourite valuation model
that has stood the test of time?

KM: Well, the book spends a chapter on this. It lays out the four price metrics that I like. My
favorite is enterprise value to operating income, or EV/OI. It’s based on the work of Joel
Greenblatt, at Columbia. He’s a great thinker.

In enterprise value, we get the price of all of the stock, all of the debt, and all of the minority
interest. In other words, we get the cost of buying out all of the other investors, regardless
of what kind of security they hold. EV ignores capital structure.

That’s particularly useful when EV is ratioed against operating income, a line that’s high up
on the income statement. OI doesn’t capture interest expense or tax expense. So there’s
consistency between numerator and denominator. From operating income comes the
means to deliver returns to all investors, whether they hold shares, debt, or minority
interests.

Operating income is also nice because interest and tax contexts can change over the long
period of time that I plan to own a company. They’re one recapitalization or reincorporation
away from shifting. This isn’t to say that recapitalizations and reincorporations are easy. But
they’re often easier than improving the core economics of an operating business. Ask
anyone who’s tried.

SN: You have mentioned about never selling your stocks. But just in case, are there
some specific rules for selling you have?

KM: Yes. Don’t.

Everything I buy I intend to hold indefinitely. Of course sometimes a company that I own
gets acquired. That happened with BNSF, Anheuser-Busch, and some others. I had no say
in those cases. But I don’t want to sell. And that makes me a better buyer. If I know that I’m
stuck with whatever I put in the portfolio, that portfolio becomes pretty robust. It has to.

My no-sell policy has hurt me just once. It was in 1998, when Coke shares flew past $80.
As I say in the book, that price suggested that every man, woman, and child on earth had
just pledged to drink a bathtub full of soda a week for life. But I held, foolishly, and was
treated to a long, slow decline to $40. And rightly so.

5/9
But greater pain came when I failed to hold. For example, I sold Nike profitably, but early.
Nike continued to sprint ahead without me. And of course your brokerage statements never
tell you that. They don’t say how you would have done had you not sold. And yet that’s
exactly what those prone to cashing out would do well to see.

SN: When you look back at your investment mistakes, were there any common
elements or themes? A real-life example would be helpful.

KM: It really always was premature selling. I would bag these beauties and then on some
goofy day decide to dump one of them. Like Nike. So I just stopped placing sell orders.
That was over a decade ago.

SN: How can an investor improve the quality of his/her decision making? How have
you done it?

KM: There’s a lot of data that I just don’t take in. I don’t own a smartphone. I don’t own a
television. I don’t have a Bloomberg terminal. All of that seems to have led to better
decisions. There’s less noise, and little loss of signal.

But when I’m in the financial districts of San Francisco or Stockholm, what do I see? In the
street, faces hovering over smartphones. In offices, eyes on televisions and Bloomberg
terminals. I see environments that encourage a casual descent into mindlessness. How one
can reflect while attacked by pixels eludes me.

I love to read, I love to think, and I love to talk to people who are in the thick of an industry.
Not equity analysts that cover the industry, but the people that drive the trucks, repair the
units, make the products – those kinds of people. So I do those things. But I don’t do the
other things, the things that are popular but fruitless. I unclutter.

SN: How do you think about risk? How do you employ that in your investing?

KM: Risk to me is the chance of a bad outcome. Those are the words I use to define it in
the glossary of the book. And to anyone thinking about risk in everyday life, it makes sense.

So to me, risk is reduced by paying an inexpensive price for shares. It’s reduced by waiting
for those infrequent, unjustified moments when good companies go on sale. This by itself
makes bad outcomes less likely.

I reject wholesale the suggestion that risk is related to the average daily change in the price
of a stock. That’s volatility. And it’s irrelevant.

In most endeavors, a theory that fails empirically gets tossed from the endeavor. If some
nutcase civil engineer came up with the idea that suspension bridges should be held up
with dental floss, that idea would fail, and would be dismissed. But look what we’ve done in
finance. We’ve taken volatility – – a total canard – – and dressed it up as a linchpin of our
endeavor. We’re stringing up suspension bridges with dental floss.

SN: Which is one widely held notion that value investors believe in, which you
believe is wrong or does not work anymore?

6/9
KM: There’s not a widely held notion I can think of that I’d reject outright. But there’s a few
terms that puzzle me.

Take enterprise value, for example. Shouldn’t it be enterprise price? After all, it’s the
theoretical takeover price of the whole company. It’s what you’d pay to take out all other
financially interested parties. Value is what you get, isn’t it?

Another term that puzzles me is value stock. Stock in a company that’s good, and that I
understand, might be a value at $9. But it might be overpriced at $20. So value would seem
to attach to a situation, not to a stock.

All of this may sound like minutiae. But language really drives behavior. So if you want the
right behavior, you want the right language.

In this spirit I actually introduce 17 new terms in the book. I didn’t set out to. It just
happened that there were some long-recognized notions in value investing that lacked
terms. Ingrainedness, for example.

Another is miscontrast. It’s a mental bias. It’s when something looks good just because
everything around it looks worse. This surfaces in bull markets. If every stock is trading at
40 times earnings, and one drops to 30 times earnings, that one might look cheap. But it’s
only cheap in a relative sense, since 30 times earnings isn’t obviously inexpensive in an
absolute sense. But it’s harder to spot this trap if you don’t have a word for it.

SN: What’s your concluding advice to students wanting to get into value investing
after learning through your course? What are the most important things they must
practice, and the pitfalls they must be aware of?

KM: Well, one big pitfall is drift. It’s so easy to drift away from value investing and into some
lesser strategy, particularly when you first start out, because value takes some time to
deliver.

You buy some very profitable brick manufacturer when it gets cheap because of a lousy
housing starts report, and a few years down the road the price hasn’t budged. Meanwhile
some knucklehead just made $1,000,000 on a freak currency arbitrage. Who wouldn’t be
tempted?

But over the long term, value really does seem to work best. And remember, we live longer
now. Many of us will see age 80, or 90. The long term has become our term. So we
shouldn’t trade as if we had the lifespans of fruit flies.

SN: Which unconventional books/resources do you recommend to a budding

investor for learning investing and multidisciplinary thinking? If you were to give
away all your books but one, which one would it be and why?

KM: Most of my reading is outside finance. My formal training in the hard sciences is weak,
and I’m fascinated by those subjects, so I like books on things like physics and medicine. If
something I’m reading makes me feel dumb I know I’m spending my time well. I want to be
awed.

7/9
This carries over socially, by the way. I love talking to chemists, astronomers – people of
accomplishment in fields far away from my sphere. I was at a child’s birthday party last
month and the dad was a postdoc in fish pathology. I wouldn’t let him go. Everyone’s eating
cake and I’m pushing for details on sea lice.

Regarding more conventional books that I’d hang on to, I think highly of Pabrai’s The
Dhando Investor. I don’t get his Kelly formula chapter, but other than that, it’s solid. I also
like Cialdini’s Influence and Taleb’s Fooled By Randomness. Taleb’s insight that history is a
fiction we tell ourselves to make outcomes seem inevitable is brilliant. I also like Swensen’s
second book, Pioneering Portfolio Management. I like it so much that it’s become the
required text in my MBA course at Berkeley.

SN: Which investor/investment thinker(s)/business owner you hold in high esteem?

And why?

KM: Well, you’ll please forgive me for citing someone with my same last name, but my
father was a real crackerjack entrepreneur. He built a serious business that became part of
Nuance, the company that makes Siri for Apple. He really knew how to make things
happen. I couldn’t have hoped for a better influence.

SN: What other things do you do apart from investing and teaching?

KM: I swim and bike a lot. I just got back from a two hour bike ride, actually. I’m lucky to still
be able to do those things. And not just because of the physical benefits.

Near Stanford we have a big, 50-meter outdoor public pool. One morning a few years ago I
finished my laps there just as did another regular, an older fellow. We got out of the pool at
the same time. He stretched his fists up towards the blue sky, sighed, and turned to me
and said, “you know, swimming is always a good idea.”

He was right. The mind runs some sort of defragmenting utility when you swim. Or when
you bike, or even just walk. Afterwards I always seem to think better about whatever I’ve
been working on.

I also still do some exploratory travel. If I’m giving a talk somewhere I often stay for a few
extra days just to look around. I just did this in southern France, near Monaco, where I’d
never been. Last year I did it in Riga, Latvia; where the Stockholm School of Economics
has a satellite campus.

I don’t speak Latvian, or French. Nor am I particularly familiar with either culture. But
dropping yourself into an environment where you’re without bearings – where you’re
essentially a child again – is enlivening. It triggers a mental energy – a forced alertness –
that we all had when we started this game. I love that feeling.

SN: Wonderful, Kenneth! Thanks for sharing your insights. I wish you all the best for
your work and life.

KM: Thank you Vishal.

8/9
Note: This interview was originally published in the November 2017 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.

9/9
My Interview with Morgan Housel
safalniveshak.com/interview-with-morgan-housel/

Vishal Khandelwal October 31, 2017

Note: This interview was originally published in the April 2017 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.

I sincerely believe in what Charlie Munger often says about

envy, that it is a really stupid sin because it’s the only one you
could never possibly have any fun at. I am lucky to have
stayed away from this sin as far as investing and other
aspects of life are concerned.
But if there is one, and just one, person who arouses this sin
in me every time I read him is…Morgan Housel. And it’s for
the simplicity of his thoughts that he puts across through his
powerful writings. I have tried to emulate Morgan several
times in my writing endeavor, but he raises the bar each time he publishes something new,
more simple yet more powerful.

Morgan’s posts at The Collaborative Fund, where he is currently a partner, have been a
great source of learning for me. I have also read him for years at his earlier stints at The
Motley Fool and The Wall Street Journal.

Morgan is a two-time winner of the Best in Business award from the Society of American
Business Editors and Writers and a two-time finalist for the Gerald Loeb Award for
Distinguished Business and Financial Journalism. He was selected by the Columbia
Journalism Review for the Best Business Writing 2012 anthology. In 2013, he was a finalist
for the Scripps Howard Award.

In this interview, Morgan shared with me his simple investing thought process, what gets
most people into trouble in investing, and the people who have inspired him the most in his
journey.

Let’s get started right here.

Safal Niveshak (SN): Tell us a little about your background, how you got interested in
writing and investing, and how you have evolved in these fields over the years?

Morgan Housel (MH): I started in college in investment banking. I always loved investing
and knew I wanted to do it as a career. But the culture of investment banking totally put me
off. I like to have time to think things through, and any culture that emphasizes 24/7 speed
and fixed process over deliberation is one where I wouldn’t do well at. So, I moved on
pretty quickly from that.
1/7
I then got into private equity, which I enjoyed. But this was summer of 2007, and global
credit markets started freezing up, which is devastating for private equity firms that own
highly leveraged companies. So, I needed to do something else.

A friend of mine wrote for the Motley Fool and said I should give it a shot. I never thought
I’d be a writer, and I majored in economics in college, which meant I didn’t write much at all.
But I applied, thinking a) they wouldn’t hire me, and b) if they did I would do it for six months
before I found another private equity job. I ended up staying for 9 years and fell in love with
the process of writing about investing.

Two years ago, I met a guy named Craig Shapiro from Collaborative Fund, a venture capital
fund. We hit it off right away. Even though we come from very different backgrounds we see
the world through a similar lens. I joined Collaborative Fund nine months ago and it’s been
an amazing team to work with.

How has my writing evolved? Whenever you do something for 10 years you’d think it’d get
easier. But writing has become much harder for me. I’ve written 3,500 articles, which
means all the low-hanging fruit is long picked. It’s much harder for me to come up with
ideas than it was, say, five years ago. So, I’ve slowed down as a writer. If I used to write 10
articles a week, now I write one or two. Now the stuff I write is generally deeper and longer,
but every year it gets harder to come up with new ideas and topics.

Also, I’ve just become much more sceptical over time. That’s probably the biggest change
in my writing.

SN: That’s an interesting journey you have travelled, Morgan. Anyways, as much as I
understand, you aren’t a full-time investor nor do you manage other people’s money.
How do you manage your own money? Is it through direct stock picking, or mutual
funds, or both?

MH: My entire net worth is a house, a checking account, and the Vanguard Total Stock
Market Index. I don’t think investing needs to be complicated so I keep it as simple as I
possibly can. The fewer knobs you have to fiddle with the fewer opportunities you have to
screw up over time.

SN: Wonderful! That’s as simple as it could get. What’s your broad investment
philosophy? Has your philosophy changed much through the years? If yes, how?

MH: My broad philosophy is that investors are their own worst enemies, and the real key to
good investing over time has little to do with the investments you pick and lots to do with
how you manage your behavior.

Financial journalists spend years quibbling over investing strategies that might improve
your returns by, say, 50 basis points a year, and then a financial crisis hits, people are
forced to sell stocks to pay their bills or keep their sanity, which ends up costing them 400+
basis points a year. It’s so clear which one matters more.

To me the evidence is overwhelming that if you spend 10% of your investing energy on
picking a portfolio and the other 90% on focusing on keeping your emotions in check,
putting market volatility into proper context and doing everything you can to take a long-term
2/7
view, you’ll end up doing better than the majority of investors.

SN: It’s good you talked about emotions, and how it is a huge mistake investor make
falling into emotional traps time and again. When you look back at your own
investment mistakes, were there any common elements of themes?

MH: Overconfidence. That’s true for most people and I was no different. At various points in
my career, I thought I was cleverer than I was or had more insight than I did. The few times
it “worked” was likely due to luck. More often it just didn’t work.

Some people are very good at certain segments of active investing. But everyone, no
matter how they invest, must fight overconfidence. It’s pervasive and is probably the
second-largest cause of investing regret, after ignorance.

SN: When it comes to direct stock picking, the worst problems investors get them
into is by falling into behavioural biases. How has been your experience on this
front? What tricks do you use to minimize mistakes of behavioural biases? What are
the most common behavioural mistakes you make, apart from overconfidence that
you mentioned earlier?

MH: This might sound like a weird comparison, but it’s one I think about a lot. I vividly
remember on September 11 2001, looking out the window and thinking about the amount
of suffering that was going on at that very moment. It’s a weird feeling to know that
thousands of people are suffering at a specific spot in real time, in a way that you can
accurately visualize, rather than a hypothetical. It just melts your mind.

In 2008 and 2009 I remember having a similar feeling, thinking about all the people who at
that very moment were taking actions that would affect them for the rest of their lives —
selling when stocks were cheap in a way that would almost certainly impact their ability to
ever retire.

Of course, the impact was orders of magnitude less than 9/11, but I had the same strange
feeling of thinking about the number of people who, at that very moment in October 2008,
were experiencing something that would hurt them the rest of their lives. It felt strange.
That’s when I started getting really interested in the behavioral side of investing. I see about
80% of investing as a psychology game.

The big takeaway from 2008 and 2009 was how quickly your own actions could harm the
rest of your financial life. It really came down to understanding your own risk tolerance and
how that fit into your time horizon. Panic selling is the most common behavioral mistake in
investing.

For me, fighting it has been a combination of holding a lot of cash and studying market
history. But there’s no easy solution to behavioral biases. These things have millions of
years of evolution backing them up. The best you can do is be honest with yourself about
your goals and your tolerance for decline.

SN: Okay, what’s the behavioural mistake with the biggest impact that’s the least
understood or noticed?

3/7
MH: How people think about fees are probably the least-noticed bias.

Most investors don’t actually write a check for their fees. They’re deducted from your fund
or investment account automatically. When something is so out of sight, out of mind, you
don’t pay rational attention to them in the same way you do, say, the price of a gallon of
gasoline.

The result is that investment fees may be one of the largest — if not the largest — annual
expenses for upper-middle-class households. A couple nearing retirement with $800,000 in
mutual funds could easily pay 1% in fund fees, 1% to a financial advisor, and 0.5% in
trading and other costs. So, 2.5% in fees on $800,000 is $1,666 a month — an amount that
is very real but for which the customer never actually sees or pays an actual bill. For
perspective, the average mortgage payment in America is about $1,300 a month.

A lot of financial advisors earn their fees, especially if they can manage a client’s emotions
and endurance. But the way investment fees are structured means people end up paying
way, way, way more than they would for other service-based products.

SN: How can an investor improve the quality of his/her decision making? Does
maintaining a journal help? What has been your experience in improving your own
decision making over the years?

MH: Most medical doctors still go to a doctor to get their own check-up. Investors should do
the same. Even if you don’t have a financial advisor I think it’s important for all investors to
bounce their ideas off trusted advisors — friends, mentors, family, whatever.

Robert Shiller once said, “You have to understand that your own thoughts are not really
your own thoughts.” Everything you know is a product of the people you’ve met and the
experiences you’ve had, most of which were out of your control. That’s always stuck with
me. It’s a reminder of how hard independent thinking is, and how important it is to hear out
the views and thoughts of a diverse group of outside experts.

SN: That’s a very pertinent point you made, that independent thinking is hard. Now,
with so much noise all around, it’s become terribly hard. With traditional media, TV,
bloggers, twitter, etc., there’s so much information flow these days. It can feel
overwhelming. How do we go about curating signal from noise?

MH: I’d think about two things.

One, when someone on TV says (or a journalist writes), “You should do X with your
money,” stop and think: How do you know me? How do you know my goals? How do you
know my short-term spending needs? How do you know my risk tolerance? Of course, they
don’t. Which means you shouldn’t pay much attention to it. Personal finance is very
personal, which means broad, general, advice can be dangerous.

For media, I’m most interested in historical finance, which helps put investing into proper
context, and behavioral finance, which lets you frame investing based around your own
goals, flaws, and skills. But taking direct advice from someone who has never met you is
asking for trouble (this includes me).

4/7
SN: How do you think about risk? How do you employ that in your investing?

MH: I have two definitions of risk –

Risk is the odds that you won’t be able to do something in the future that you
reasonably need to do to keep yourself happy.
From Carl Richards: “Risk is what’s left over when you think you’ve thought of
everything else.”

The first is a reminder that risk is different for everyone, and is highly dependent on your
time horizon.

The second is a reminder of how hard risk is to think about. Risk is, almost by definition, the
stuff we aren’t thinking about.

SN: Indeed! Anyways, if you had just two-minutes to advise someone wanting to get
into investing, what would your advice be? What are the biggest pitfalls he/she must
be aware of?

MH: Keep it simple. Don’t try to be a hero. Compounding takes a lot of time. Volatility is the
cost of admission for high long-term returns. That’s the message I’d get across. It’s simple
but encompasses the majority of what you need to know.

SN: What are the most important qualities an investor needs to survive the
complexity of the financial markets?

MH: I think it’s a combination of humility and a fine-tuned bullshit detector.

You need humility to prevent yourself from overcomplicating investing more than it needs to
be and taking risks greater than you’re able to handle.

And you need a fine-tuned bullshit detector to protect yourself from the swarms of sales
pitches and get-rich-quick schemes that plague the industry.

There are other things — a good grasp of basic arithmetic, delayed gratification, the ability
to live below your means. But those first two are most important.

SN: You wrote a wonderful note in Feb. 2017 on getting vs staying rich. You
mentioned about cultivating humility as the way to stay rich. If one is not humble by
nature, can humility be cultivated?

MH: Yes — through humiliation. Lack of humility always catches up to you. Look, in
markets, you’ll receive some return over the next 20 years, and most people who try to
front-load those returns into shorter periods of time will cough up whatever excess short-
term returns they earn down the road — reversion to the mean. It’s very similar with
humility. Most ego you have today will be balanced out with humiliation down the road.

SN: Which investor/investment thinker(s) do you hold in high esteem?

MH: My top five include –

Michael Batnick
5/7
 Ben Carlson
Jason Zweig
Craig Shapiro
Brent Beshore

All have an incredible mix of insight and humility that is incredibly rare. They’re also just
great people.

SN: You inspired many through your writings. Which are some of the books, blogs,
and other resources on investing, behaviour, and multidisciplinary thinking that
have inspired you the most over the years?

MH: This might sound odd, but I think reading about World War II has had the biggest
impact on my thinking. There are few events in history that were as transformative and as
well documented as World War II, so it’s just an incredible period to study to learn how
people dealt with adversity, uncertainty, despair, and hope. The most accessible piece of
content here is Ken Burns’ documentary, The War. It teaches you more about human
behavior than anything else I’ve come across.

SN: If you were to give away all your books but one, which one would it be and why?

MH: Nassim Taleb’s book Antifragile is probably the book that I go back to the most. Taleb
is a prickly personality but he’s an incredible writer and can explain complicated topics in
easy-to-understand ways without dumbing it down at all. It’s a very hard skill and he’s
mastered it. If you look past his ego and sharp personality I think he’s one of the smartest
thinkers around today. Or at least he’s a very smart thinker and an excellent communicator.

SN: Hypothetical question: Let’s say that you knew you were going to lose all your
memory the next morning. Briefly, what would you write in a letter to yourself, so
that you could begin relearning everything starting the next day?

MH: I love the hypothetical question, but I think it’s impossible to relearn stuff in a planned
way, since so much of what you know is based on past experiences that can’t be
replicated. How do you teach someone about what it felt like to lose half your money in
2008? You can’t. You must experience it. Same for bubbles. No book can recreate the
emotions of 1999.

But … I’d leave a list of 10 people to talk to, and I’d ask each of them for four or five hours
of time where I sit them down and say, “Tell me the basics of your field that explain the
majority of the outcomes.”

SN: What would you be doing if you weren’t writing and investing?

MH: I have no idea. I think I might enjoy teaching elementary school, but I’d probably get
bored of teaching the same thing repeatedly. But if you strip out the career luck I’ve had
and look at my academic background, I should probably be an accountant working 90
hours a week in a dark basement somewhere.

SN: What other things do you do apart from writing and investing?

6/7
MH: Mostly reading. I try to read more books and fewer articles. I’m also a growing fan of
podcasts. And I try to walk a lot. We have a young son, so we sleep when we can — which
isn’t much.

SN: That was brilliant, Morgan. Thank you so much for sharing your insights with
Safal Niveshak readers. I wish you all the best for your work and life.

MH: Thanks Vishal! I hope your readers find this useful in some way.

Note: This interview was originally published in the April 2017 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.

7/7
Value Investor Interview: Brent Beshore
safalniveshak.com/value-investor-interview-brent-beshore/

Vishal Khandelwal July 3, 2017

Note: This interview was originally published in the March 2017 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.

Brent Beshore is the Founder and CEO of adventur.es, a

family of North American companies that invests in
family-owned companies with unfair advantages. For the
past nine years, Brent’s firm has started, funded, bought,
and operated organizations across a wide range of
industries.
The companies adventur.es owns have recruited doctors
for the U.S. military, provided online public relations to
some of the world’s largest organizations, manufactured
cutting-edge home solutions, created software products
for small businesses, curated the latest in women’s
fashion to sell on the internet, and even helped make a couple of blockbuster movies.

Brent founded adventur.es in 2007 with the goal of creating an organization that allowed
him to do what he loved, in places he enjoys, with people he admires. Since then,
adventur.es has made over 50 investments, and was ranked #28 on the 2011 Inc. 500.
Brent reads a lot, writes occasionally, dabbles in wine-making, and was nominated for a
VH1 Do Something Award for helping his hometown of Joplin, Mo. recover from the
devastating tornado.

As you would have understood from Brent’s profile, he isn’t a typical public markets
investor like the ones I usually profile in this series, but an owner of private businesses. The
thoughts Brent has shared in this interview, however, are equally valuable for a public
market investor, as you would realize as you read forward.

So, over to Brent!

Safal Niveshak (SN): Could you tell us a little about your background, how you got
interested in value investing and what you are doing now at Adventur.es as an
investor in other businesses?

Brent Beshore (BB): I’ve been interested in investing since I was very young and have
always had an idea of building a family of companies. Living near Omaha, I heard a lot
about Berkshire Hathaway and was drawn towards their goals, performance, and ways of
doing business. I’d call Warren Buffett my gateway drug into the value investing world.

1/9
From there, I studied the greatest investors in history, from Ben Graham and Henry
Singleton, to Carl Icahn and Howard Marks. I tried to take note of their commonalities and
differences. I found each shared a commitment to deep fluency in their chosen
specialization and a commonality in how they assessed opportunity, while their styles
diverged greatly. It gave me confidence to find my own path.

I assumed I would work in corporate America for 15-20 years before I built up enough
capital to start executing on it. But, things accelerated unexpectedly when I founded a
business while getting my law degree and MBA. While my first business was a failure, it
allowed me to taste a variety of other industries and showed me other ways I could use my
talents.

Fast forward to today and my organization, adventur.es, buys small, boring businesses and
helps them be less boring. Our current portfolio includes five late-stage companies: a
military and education recruitment firm, a construction company, two manufacturers, and a
niche PR firm. We look for durable moats that are disconnected from the owners, which are
rare in our size range.

Our customers are usually retiring business owners who want to preserve their legacy,
ensure their employees and customers are well taken care of, and want to reap the
financial benefits from building the business. We co-create a plan for them to gain liquidity,
share in the upside post-close, and appropriately transition out of the business.

SN: That’s a pretty interesting and insightful journey and work you are doing, Brent.
Anyways, how have you evolved as an investor and what’s your broad investment
philosophy? Has your investment policy changed much through the years?

BB: As an investor, I’m searching for the largest and most inefficient markets in the world,
where prices frequently dislocate from value. This provides fertile ground for hard work and
skill to create consistent and meaningful outperformance.

As an operator, I’m looking for places of low competition that are unsexy, fragmented, and
with little professionalism. These businesses are usually “blue collar,” or dirty jobs, while
occasionally they’re highly specialized niches that operate below most peoples’ radars.

The intersection of these strategies is where we’re building adventur.es. We believe the
lower end of the lower-middle market, companies with earnings between $1-10 million in
pre-tax income, are frequently mis-priced and offer an opportunity to outcompete through
operational improvements. Our goal is to have the highest investment opportunity costs in
the world and to bring systems, skills, and strategies to our portfolio companies that allow
them to prosper with less risk.

My understanding of moats and price continue to evolve. I’ve always been attracted to
cheapness, because of the perceived margin of safety. But most assets are priced
appropriately. In other words, they’re cheap for very good reasons. I’ve passed on some
expensive opportunities only to watch them blossom. While my default is still to be attracted
to inexpensive assets, I’m slowly learning that quality can justifiably warrant a much higher
price.

2/9
Another area of evolution has been in my understanding of incentives. Incentives are
outrageously important and I have learned humility around being able to pick the right
combinations. We’re all messy and biased, and often don’t understand what we want, or
want conflicting things. If it is challenging to consider proper incentives for yourself, how
much more difficult is it to do so for others? This gives me pause when someone suggests
“straightforward, simple, or easy” incentives.

SN: You’ve raised a very pertinent point about incentives and how they drive us and
our decision making. Anyways, as I understand from your site, you started your
current business (Adventur.es) in 2008 i.e., during the times the financial markets
were going through a great turmoil and the incentives in the financial services
industry had raised their ugliest heads. What caused you to begin then?

BB: Yes, I went into business at an inconvenient time. I didn’t know any better. I was
frustrated with my JD/MBA program and wanted to test my abilities in the market, as
opposed to talking about concepts and taking tests. I irrationally partnered on a terrible
business and learned ten times more in that first year than I had in all my schooling
combined.

SN: And what was that business about?

BB: It was an event marketing company, which was the popular, “new” marketing technique
around that time. While it was an attractive business from the outside looking in, it was also
low-margin, with a small number of potential clients. It didn’t scale easily and had a low
perceived value. I now joke that it’s one of the worst business models in the world.

SN: So, what was the biggest lesson you learned from this mis-adventure, if I may
call it so?

BB: You see, failure is instructive and those early years felt like stumbling around in the
dark, constantly falling on my face, while occasionally getting hit in the head.

But those experiences led me to start another company, then buy a company, start another
company, and buy more companies. The difficulties forced me to learn quickly, made me
appreciate when things went better, and certainly gave me a heaping dose of much needed
humility.

The last five years have gone uncomfortably well, so I’m currently experiencing the best of
times. But, I always maintain a healthy amount of paranoia about what can go wrong.

While we’ve worked very hard and learned a lot along the way, we’ve also gotten lucky. We
know it is highly unlikely that we’ll sustain our current level of returns, but we’re happy to
ride this wave as long as we can.

SN: You mentioned a very important point about maintaining a healthy amount of
paranoia about what can go wrong. How do you bring that into your investment
process?

3/9
BB: We start from a default of “no.” We’ve learned that while everything looks easy at
30,000 ft., anything worth doing is brutally difficult. The only people who think it’s easy are
fools, or those who got lucky. Every organization is challenged in numerous ways and
comes with complexity, politics, and disorder. Thinking otherwise is folly.

We’re looking for companies that pull us to “yes.” These companies have something
unusual about them that we find particularly attractive. It can be market position, customer
entrenchment, brand, or a rare type of expertise. And of course, the purchase price
matters.

In practice, we spend considerably more time analyzing what could go wrong than what we
think might go right. If we take care of the losers, the winners take care of themselves.

We frequently debate the merits of the situation, spend time getting to know the company’s
leadership, and try to understand the weaknesses. We also use checklists and always seek
outside counsel to give us a fresh perspective.

SN: Your Twitter profile tells me that you are in the profession of “cultivating a
disaster-resistant compound interest machine.” Can you please elaborate more on
that?

BB: There are two challenges almost all successful organizations experience:
unsustainable risk and poor capital deployment. As the company becomes successful, the
environment breeds over-confidence. Numbers must be hit and steel is taken out of the
bridge. Debt is used liberally. “Moonshot” projects are green-lighted and heady acquisitions
are made. The culture transitions from supportive and open to closed and transactional.

We try to avoid these pitfalls through maintaining humility, a long-time horizon, disciplined
reinvestment strategies, aligned incentives, and high opportunity costs. We’re alert to risk
and are constantly trying to mitigate it. We centralize capital deployment and set a high bar
for re-investment.

Our goal is to steadily compound returns over a very long period while maintaining a
diversified portfolio and cash balances that let us operate comfortably, and be a buyer,
during challenging times. We don’t think this happens overnight, nor is the process ever
complete, which is why we use the term “cultivate.”

SN: That’s a nice elaboration. Thanks! What are some of the characteristics you look
for in businesses you are looking to own that can help you build such a machine? A
checklist of points would be useful here.

BB: As for characteristics that we look for, it all comes down to the quality and durability of
the moat compared to price. We evaluate family-owned companies with consistent annual
pre-tax net earnings between $1 million and $10 million, and two or more of the following
characteristics:

Stable and diversified client base

Healthy layer of non-owner management
Closely held ownership looking to retire
Quality brand name/strong reputation
4/9
 Established niche expertise

SN: How do you think about valuations? Is your practice of valuations different when
you are investing in companies for your personal portfolio vis-à-vis when you are
buying them entirely through Adventur.es?

BB: Because of our structure and having not raised outside capital, there is no difference
between my personal portfolio and adventur.es’. It’s all the same pool of resources and it’s
100% in private investments, or cash. I/we hold no public investments, because we’re able
to generate far larger returns, with greater control, in the private markets.

As for valuation, it’s all based on opportunity costs. We’ve spent well in excess of $2 million
over the past eight years building a pipeline of investment opportunities and it has been the
best investment we could have ever made. We like to choose between very good
opportunities and excellent ones.

Right now, we don’t explore any opportunity where there’s not a clear path to at least a
30% cash IRR over five years.

We don’t do fancy financial models because we believe if you need those tools to evaluate
an opportunity, it should go into the “too hard pile.” We try to ask simple questions – Will the
industry be around in its current form 10 years from now? Is it susceptible to disruption?
What are the sources of their competitive advantage and how durable are they? What
relationships matter? What can go wrong and still have this work out?

SN: Simple processes often work out better than complex one. I can vouch for that
from my personal experience as an investor. Anyways, while you own private
businesses, do you have a laid-out exit strategy?

BB: Our default is permanence. We buy with no intention of ever selling and operate the
companies to maximize long-term value. We believe this gives us a tremendous
competitive advantage over a traditional private equity strategy. Where they slash and burn
to maximize short-term cash flow with hopes of flipping the company quickly, we make high
ROI reinvestments they can’t make, because they may not pay off for 5-10 years.

SN: ‘Permanence’ is such a potent word in investing. Anyways, how do you think
about position sizing? Which side are you on – concentration or diversification?

BB: We never want to risk all our chips and start over, but we often invest 60%+ of our cash
in a single investment. We construct the portfolio so that income streams are subject to
different macro trends and aren’t strongly correlated. Plus, we maintain plenty of cash to
weather a storm, or two.

SN: When you look back at your investment mistakes, were there any common
elements of themes? A real-life example would be helpful.

BB: All my biggest investment mistakes have a common theme – people. We’re all messy
and that messiness gets multiplied by mis-communication. I’ve experienced significant
mismatches in expectations where relationships were badly bruised and I’ve pulled out of

5/9
deals due to personality. Almost all losses we’ve experienced have been self-inflicted and
due to challenges with people.

It’s easy to distil a company down into financial statements and competitive analysis, but
that never provides a clear picture of reality. Businesses are collections of people and it’s
crucial to understand how those people interact. Through some painful experiences, we’ve
become inflexible on shared values. We insist on partnering with leadership that is high-
integrity, kind, and long-term oriented.

SN: Do you look at some numbers while assessing people you want to partner with?

BB: Absolutely. I don’t want to give the impression that the numbers don’t matter. In fact,
there are plenty of terrible businesses run by wonderful people. But I’ve never seen an
investment work out well in the hands of l0w-integrity, short-term oriented operators. There
are ten thousand ways leadership can harm owners, and it only takes a couple to inflict real
damage. Plus, the time commitment necessary to watch someone closely is enormous.
We’ve found the best strategy is to partner with kind, hard-working, honest people on a
business that has a durable competitive advantage.

SN: How can an investor improve the quality of his/her decision making? How have
you done it?

BB: My biggest gains in decision-making have come from absorbing the mental models that
carry the heavy freight, learning from my mistakes, and surrounding myself with smart,
intellectually curious people who will speak truth. All three are simple, but never easy.

The big ideas, like probability, opportunity cost, and margin of safety are inescapably
important. If you don’t understand them, or are not able to apply them regularly and
appropriately, then you’ll be at a major disadvantage.

Learning from your own mistakes is probably the hardest, because it’s an acquired taste.
Most people try to cover up their mistakes, explain them away, or blame others. Those are
defense mechanisms that allow us to look in the mirror and sleep at night. The problem is
that they dramatically distort reality and lead to a form of self-induced blindness. Reality is
what it is, and no amount of wishing will change it. I’ve learned to be brutal with myself.

Surrounding yourself with top-notch people is the most important. We are an average of
our ten closest relationships. If you think about it that way, it will change your life. Choose
wisely.

SN: Wonderful! What about ‘risk’? How do you think about it, and employ it in your
investing?

BB: I think about risk all the time and far more than returns. If you take care of risk, the
returns will take care of themselves. Here’s an excerpt of what I wrote for Forbes on the
subject:

6/9
 Risk is tricky. It’s always in the background and underneath the surface, lurking and waiting.
Ignore it and you’ll probably be fine – until you’re not. And when that happens, watch out,
you’re likely in a world of trouble. Embrace risk mitigation and your upside will necessarily
suffer. Eliminate risk and you will get between almost nothing and literally nothing, especially
in today’s low-inflation, low-rate environment.

Risk is not uncertainty. It is not volatility. At its core, risk is the likelihood and magnitude of
permanent loss. It is the probability of a collision between a detrimental event and a lack of
planning, resulting in a permanently negative outcome of some potential size. Howard Marks
said, ‘Loss is what happens when risk meets adversity.’

We look at buckets of risk for each investment and try to mitigate them to the level that
makes sense based on the probability of expression and the magnitude of the potential
result. Here are the types of risk we frequently explore:

Culture Risk: How the company treats people and how people treat one another.
Technology Risk: What could disrupt us and what would cause our technology stack
to fail?
Systems Risk: What information bubbles up, to whom, and what is done with it?
Expectations Risk: What unspoken and unwritten promises have been made?
Leadership Risk: How stable is leadership and how do they make decisions?
Concentration Risk: Do a handful of clients, or suppliers, represent an abnormally
large volume?
Competition Risk: Does the industry attract skilled and well-funded competition?
Financial Risk: How levered is the business in terms of long-term debt, working
capital, and cash flows?

SN: What’s you two-minute advice to someone wanting to get into value investing?
What are the most important thing he/she must practice, and the pitfalls he/she must
be aware of?

BB: Study great investors and try to understand why they behaved the way they did. Wade
in slowly and be cautious. If it seems easy, you’re not getting it. When you make mistakes,
pay close attention and learn. If you experience immediate success, chalk almost all of it up
to luck.

SN: Which unconventional books/resources do you recommend to a budding

investor for learning investing and multidisciplinary thinking? If you were to give
away all your books but one, which one would it be and why?

BB: I’d immediately say the Berkshire letters, but those aren’t unconventional anymore.
Howard Marks’ letters are packed with wisdom, and about 60% is distilled into his book The
Most Important Thing. Poor Charlie’s Almanack by Peter Kaufman is expensive and worth
every penny. A Short History of Financial Euphoria by Galbraith was highly impactful for
me. The Lessons of History by Will and Ariel Durant is an incredible summary of life’s
repeated themes. Seeking Wisdom by Peter Bevelin is excellent.

SN: I think that should cover a lifetime of an investor’s readings. Anyways, which
investor/investment thinker(s)/business owner you hold in high esteem? And why?
7/9
BB: Buffett/Munger: Their durability and adaptability have created an unparalleled track
record.

Henry Singleton: His hyper-rationality lead to eye-popping results.

Peter Kaufman: Munger has said Peter’s organization, Glenair, has the best culture he’s
ever seen, and that’s no mistake. Peter’s way of doing business is honorable and
unfortunately unusual.

Howard Marks: His pursuit of inefficient markets and unconventional methods are
pioneering.

Chuck Feeney: He made his fortune in Duty Free Shoppes, then spent most of his life
anonymously giving it all away. The way he invested his wealth is something to admire.

Bill Gates: It’s hard to argue someone else been more positively impactful over the past
hundred years.

SN: Hypothetical question: Let’s say that you knew you were going to lose all your
memory the next morning. Briefly, what would you write in a letter to yourself, so
that you could begin relearning everything starting the next day?

BB: Here’s what I will write in that letter –

Brent,

You lost your memory. It may not seem fair, but it’s part of God’s plan. Roll with it. Here’s
what you need to know:

You have a wonderful family. Treasure and prioritize them. You’re blessed with amazing
colleagues. Trust their judgement. You had gotten pretty good at evaluating small companies,
but it’s not going to come back overnight. Spend the next two years looking at a lot of pitches
and start reading the books/letters in your office. Take it slowly. Knowledge compounds.

By the time you get up to speed professionally, circumstances likely will have evolved.
Always be willing to change your mind when the facts change. What got you here won’t get
you there.

Here are a few things you had learned: Avoid sugar and processed carbs. Get plenty of sleep.
Go on long walks. Be kind and humble. Learn constantly. Nothing is ever as good, or bad, as it
seems. Everything meaningful is hard.

Brent

SN: Lovely! Especially the part about family. So, what other things do you do apart
from investing?

BB: I spend time with my family, love traveling, and play tennis. I focus on one non-profit
organization and work through it to give back.

SN: That was brilliant, Brent. Thank you so much for sharing your insights with Safal
Niveshak readers. I wish you all the best for your work and life.
8/9
BB: Thanks a lot for asking and letting me do this Vishal. I hope your readers find this useful
in some way.

Note: This interview was originally published in the March 2017 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.

9/9
My Interview with Jason Zweig
safalniveshak.com/interview-with-jason-zweig/

Vishal Khandelwal February 9, 2017

Note: This interview was originally published in the December 2016 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.

“I wish I could talk to this guy,” I told my wife when I read Ben Graham’s The Intelligent
Investor first time sometime in 2005.
“But he is dead, right?” she said.

“Oh, not Graham,” I exclaimed, “But Jason Zweig who has edited this version of Graham’s
book.”

“I am sure you would one day,” she said with an air of confidence. But I junked her thoughts
saying, “Why would he even want to talk to me?”

Well, I had this discussion in mind when I wrote to Mr. Zweig in mid-October last year to
request him for an interview for our Value Investing Almanack newsletter. I knew it was a
shot in the dark, something I had not done for a long-long time after missing a few such
shots in the dark on stocks I lost money owning.

But this shot worked, and worked well for me. Not only did Mr. Zweig agree immediately for
the interview, he also made me comfortable by asking me to address him as, well, Jason.

It turned out to be a great interview for me as a learner, and I hope Jason also found it
worth his time and effort. Before I begin, I remember this quote from Jason in his starting
note for The Intelligent Investor –

In the same way, I envy you the excitement of reading Jason’s thoughts in this interview for
the first time. So let’s start right here with a brief introduction.
1/10
Jason Zweig is the investing and personal-finance
columnist for The Wall Street Journal. He is the author of
The Devil’s Financial Dictionary, a satirical glossary of
Wall Street (PublicAffairs Books, 2015), and Your Money
and Your Brain, on the neuroscience of investing (Simon
& Schuster, 2007).

Jason edited the revised edition of Benjamin Graham’s

The Intelligent Investor (HarperCollins, 2003), the classic
text that Warren Buffett has described as “by far the best
book about investing ever written.” He also wrote The
Little Book of Safe Money (Wiley, 2009); co-edited Benjamin Graham: Building a
Profession, an anthology of Graham’s essays (McGraw Hill, 2010); and assisted the Nobel
Prize-winning psychologist Daniel Kahneman in writing his book Thinking, Fast and Slow.
From 1995 through 2008 Zweig was a senior writer for Money magazine; before joining
Money, he was the mutual funds editor at Forbes.

Jason has also been a guest columnist for Time magazine and cnn.com. He has served as
a trustee of the Museum of American Finance, an affiliate of the Smithsonian Institution,
and sits on the editorial boards of Financial History magazine and The Journal of
Behavioral Finance. A graduate of Columbia College, Jason lives in New York City.

Safal Niveshak (SN): What inspired you to write your latest book, The Devil’s
Financial Dictionary? What’s the biggest lesson you wish the reader should take
from the book?
Jason Zweig (JZ):

Ever since I was a college student, I’ve been an admirer of Ambrose Bierce, the 19th
century American author who wrote The Devil’s Dictionary, one of the greatest works of
satire in the English language.
A few years ago, my teenage daughters were teasing me about how my personal website
never featured anything new (at least in their opinion). I looked out the window of my home
office and wondered: “What could I do that would be new every day without making readers
feel that I’m encouraging them to respond to the market’s every move?”

To the left of my window, I glimpsed the paperback copy of The Devil’s Dictionary that I’ve
owned since 1979. I glanced to the right and there, on my other bookshelf, was my second,
hardcover copy of the same beloved book. I suddenly realized that I could write and post
one satirical financial definition per day on my website. I didn’t expect it to turn into a book; I
wrote the entries for fun. Then several publishers stumbled on it, and suddenly it became a
book.

Of course, Wall Street and the rest of the financial world provide such a wealth of
absurdities that eventually it may turn into a multi-volume encyclopaedia.

2/10
The lesson readers should take from the book is that the language of finance is often used
not to explain, but to obfuscate. Those who know what terms mean can make a lot of
money. Those who think they know what terms mean will lose a lot of money.

SN: What do you think happens inside our brains when we hear the financial experts’
gibberish? We all want to simplify our lives, so why is it that many of us admire
those in the financial markets who throw at us the most complex stuff?

JZ: Neuroeconomist Gregory Berns of Emory University and his colleagues have found that
listening to financial experts triggers a neural response they call “offloading,” which is a
lower level of activation in the posterior cingulate and other regions of the frontal cortex
normally engaged in decisions about risk and return. Conformity and deference to authority
are part of human nature; man is a social animal, and we evolved to learn that following the
leader and staying inside the herd helps to keep us alive. That served our ancestors well
on the plains of the Serengeti. It doesn’t serve us well in modern financial markets, where
computers can outsmart us and many people are richly rewarded for giving advice that is
better for their own bottom line than it is for ours.

I also feel that financial jargon is even more insidious than other professional dialects, like
medical lingo or info-tech gobbledygook. When a financial advisor uses jargon, we want to
pretend to understand it so we can feel like privileged insiders who are “in the know.”
Pretending to comprehend financial gibberish confers an illusion of power on those who
purport to know what the jargon means.

In truth, the ultimate power lies in understanding that you don’t know what it means – and
that the person using those words probably doesn’t, either.

SN: That’s true! Anyways, in mid-October 2016 front-page article in The Wall Street
Journal titled The Dying Business of Picking Stocks, you wrote about investors
giving up on stock picking and moving into passive funds. Can you please elaborate
more in that? Do you see it as a long-lasting trend?

JZ: Our article was primarily about the U.S. market, although I believe these trends will
inevitably percolate worldwide. Active management will never disappear entirely; hope
springs eternal, and most people never entirely abandon their belief in magic.

Furthermore, active management gives investors someone else to blame. If you buy an
index-tracking fund that loses 30% in six months, you have no one to blame but yourself; if
you buy an actively managed fund that does the same, you can tell your family or your boss
or your pensioners that the fund manager “strayed from his mandate.” You get to sack him
instead of being sacked yourself. Finally, at least in the U.S. (and I’m sure in many other
places), institutional investors are often required to make periodic “due-diligence” visits to
the asset-management firms they hire. Many such firms seem to have home offices near
beautiful beaches or in historic cities that are delightful to visit. Perhaps that is some kind of
coincidence, but it certainly gives their largest clients a lifelong incentive to ignore high fees
and low performance.

3/10
Nevertheless, index-tracking funds will continue to grow worldwide, as they should and as
they must. Research by Fama and French, among others, has shown that nearly all
outperformance relative to a market index can be explained by such common dimensions
of risk and return as value, size, “quality” (profitability), and momentum. These factors can
be systematically packaged into a tracker fund at extraordinarily low cost. An active
manager whose success has come from picking stocks one at a time that score high on
one or more of these factors must charge high fees to cover the considerable research
costs; a passive fund can algorithmically mimic what the active manager is doing for a
fraction of the cost. In the U.S., such “factor ETFs” are available for annual fees of under
0.1%, or 10 basis points and less. Active managers charging 10 to 20 times as much are
doomed to lose market share.

SN: You define ‘forecasting’ as “an attempt to predict the unknowable by measuring
the irrelevant; a task that in one way or another, employs most people on Wall
Street.” Let’s talk about financial journalists here, who are in the prediction mode all
the time, whether it’s newspapers, television, or the Internet. What role has financial
journalism to play in promoting the devilish financial jargon you have defined in your
book?

JZ: The financial media can’t be dissociated from the prediction industry in general. We are
all guilty of perpetrating the myth that someone, somewhere, knows what the markets are
about to do. Decades ago, the psychologist Paul Andreeassen showed that people who get
more frequent news updates on their investment portfolios earn lower returns than those
with no access to the news at all. That doesn’t mean that financial journalism is useless:
Ignorance won’t make you a better investor. But the financial media should focus investors’
attention on the elements that separate success from failure – how to be optimally
diversified, how to minimize fees and taxation, how to increase one’s own self-control –
rather than pretending to clairvoyance or trumpeting whichever investment has been hottest
lately.

I try to write for my high-school English teacher’s wife, who tells me whenever I see her that
she likes my columns even though she doesn’t understand them. My goal is eventually to
write one she can understand; I think, after 20 years, I am getting closer.

SN: You’ve defined “News” as “noise; the sound of chaos.” Bombarded with such
noise from all sides, how does an investor go about blocking it to be able to make
sound investment decisions.

JZ: Whatever can be a matter of policy and procedure must be. You should have a
checklist that you must follow before taking any action. The rules should be yours, not
mine, but they must be rules, not wishes. A few possibilities:

Never buy a stock purely because its price has been going up, nor sell purely
because it has been going down.
List, in writing, three detailed reasons why you are buying, in terms that – like a
scientific hypothesis – can be falsified by subsequent findings.
Stipulate a price target, a time by which you expect the stock to reach that level, and
an estimated probability that those forecasts are correct.
4/10
 Set up, in advance, automated alerts to remind you when price changes significantly
– for example, 25%, 50%, etc. At those thresholds, assess methodically whether the
value of the underlying business has changed comparably.
Sign a contract with yourself, witnessed by family or friends, binding you to sell only
when the value of the business, rather than the price of the stock, decays.

If that sounds like too much work, then owning individual stocks probably isn’t a good
match for your temperament. Buy a passive fund instead – but don’t forget to sign a
comparable contract with yourself.

SN: You recently quoted Keynes who said that courage is the key to investing. But
showing courage when everyone is running for cover in a falling market is harder to
do than to imagine. Given that such scenarios are playing out quite often in the
current times, how does an investor build the necessary courage to combine with
his/her capital when the opportunities come knocking?

JZ: Cash and courage go hand in hand, as Benjamin Graham wrote in 1932 after stocks
had fallen more than 80%. Cash without courage will do you no good in a falling market, as
you will be too afraid to invest it. Courage without cash is equally useless, as you can’t buy
anything no matter how brave you feel if you have no money to buy it with. So husbanding
some cash is the first step.

I am also great believer in what I call “financial fire drills.” Just as office-workers are
periodically required to rehearse what to do if the building catches fire, investors should
rehearse how they should behave if the stock market erupts in flames.

Build a watch-list of investments you would like to own at much lower prices than today’s,
specifying the prices at which they will become bargains. Cultivate good mental hygiene
now, before it is too late: Break bad habits like watching financial television, frequently
checking the value of your brokerage accounts, or getting constant updates on the market.
Go back and study your behavior during the last market crash: Did you sell? freeze? or buy
more? (Don’t rely on your memory, which is likely to be illusory; consult your actual
brokerage records, and be honest with yourself about what they show.) Then look at how
those decisions worked out: Did your behavior rescue you from further losses, or preclude
you from further gains?

Using what you learn about your past behavior, you should be able to structure rules to
improve your future behavior.

SN: Your book basically mocks the outrageousness of the financial world which, in
other words, is laying bare the truth of how the system works. In fact, you’ve defined
“stock market” as a chaotic hive of millions of people who overpay for hope and
underpay for value. Amidst all this, what advice do you have for a small, individual
investor on how to safeguard his/her capital and grow his/her money?

JZ: The great investment philosopher Peter Bernstein liked to say that investors without
much money should take small risks with most of their money and big risks with a little of it.
Maximizing diversification should be your primary goal. If you put at least 90% of your
investable assets into a small set of low-cost, widely diversified market-tracking funds, then
5/10
there’s nothing wrong with trying to pick a few market-beating stocks with the rest of your
money. You can’t lose much of your total wealth if you turn out to be incompetent at stock-
picking, while you could enhance your wealth significantly if you turn out to be good at it.
But you must be serious about it, willing to devote great amounts of time and effort and
scholarship and emotional resolve. If you treat it as a game, you are certain to lose, sooner
or later.

SN: How can an investor improve the quality of his/her decision making?

JZ: Study the markets. Study history. Study psychology. Above all, study yourself.
Successful investing isn’t about picking the right stocks and avoiding the wrong ones. It is
about making sure that you don’t let your own emotions deflect you from your strategy at
the worst imaginable time. The best investors are those who think constantly about their
own shortcomings and how to overcome them.

SN: What are the most important qualities an investor needs to survive the
complexity of the financial markets?

JZ: Self-control. I don’t know what proportion of people who call themselves “investors” are,
in fact, just speculators, but I wouldn’t be surprised if it is above 90%.

I find it remarkable that in India, the world’s wellspring of yoga, so many investors give
themselves endless stress trying to chase short-term market performance.

Investing is not a 110-metre race. It is a marathon. If you want to finish the race, you
shouldn’t try to go faster; you should slow down. And you need to learn how to resist
investing in any asset or strategy you don’t understand.

SN: You talk about self-control. Can someone learn to have self-control or learn to
behave well, if that attribute is not already ingrained in him/her? I’ve read this
wonderful book called Sapiens, where the author talks about the gorging gene
theory, which suggests that we carry the DNA from our ancestors of gorging on
sugared or fatty food even when we have our refrigerators overstuffed with such
foods. This is because our ancestors used to gorge on sugared fruits but that was
purely out of scarcity and fear that if they did not eat them, the baboons would. So,
with such a DNA, can we as investors really learn to behave well?

JZ: Genetics is predisposition, but it doesn’t have to be predestination. We’re all inclined to
love sweet, salty, or fatty foods, but we aren’t all doomed to like them. With diligence and
discipline, we can train ourselves to have higher resistance to them. And we can recognize
that willpower is insufficient, in and of itself, to achieve that resistance. We must make our
environment more hygienic. Think of alcoholics, for example. You might tell yourself, When
someone offers me a drink, I will just say no. But, over time, you will learn that that doesn’t
work, because of what psychologist George Lowenstein has called “the hot-cold empathy
gap”: In a cold, or emotionally unengaged state, you will picture your future desires as much
more manageable than they will, in fact, turn out to be in the heat of the moment. So
eventually alcoholics learn to control their environmental hygiene: They avoid walking down

6/10
the street where the tavern is, they ask their friends to tell the party host not to serve
alcohol, they bring their own non-alcoholic beverages with them when they travel. All of
those behaviors are intended to keep dangerous emotional cues at bay.

By the same token, investors need to avoid the cues that can trigger self-defeating
behaviors. Use checklists and watchlists to prevent impulse from determining your
behavior. Remove any trading apps from your smartphone. Don’t bookmark any websites
that encourage you to update your account values in real time. Build a spreadsheet of all
your holdings that you refresh only once every calendar quarter. Change the password on
your brokerage account to a personalized variant of
IWILLTRADEONLYWHENABSOLUTELYNECESSARY; there is evidence from
psychological research that frequent subliminal repetition of such a message can change
your behavior.

You should be under no delusion that these techniques will eliminate your genetic frailties.
But they can help you exert at least some control over them.

SN: Are successful investors born, or made?

JZ: Both, of course. A great deal of investing success comes from temperament, which is
(largely) inborn. But every good investor I’ve ever met is a learning machine – someone
who eats information ravenously and who is obsessed not by how much he already knows
but by how much he has yet to learn.

An underappreciated factor that great investors share, I believe, is that they relish being
proven wrong. Most people dread making mistakes with a kind of visceral horror. But great
investors welcome making mistakes, because errors are opportunities to learn. Whenever I
encounter a professional investor with a track record of outperformance who boasts only
about what he got right, I know I am in the presence of someone whose overconfidence is
dangerous, if not deadly.

SN: Apart from Ben Graham, Warren Buffett, and Charlie Munger, who inspires you
the most when it comes to investing and investment behaviour?

JZ: I would name three people: two giants and one few people have ever heard of. First,
John Maynard Keynes: Chapter 12 of his book The General Theory of Employment,
Interest and Money is probably the most concentrated set of profound insights into
investment behavior ever written. He teaches us that to be rational you must reckon with
how irrational other people can be.

Second, Daniel Kahneman, whom I have known for 20 years and whose book Thinking,
Fast and Slow I helped research, write and edit: From Danny I learned how important it is
to try answering difficult questions by beginning with the words “I don’t know.” The
admission of ignorance is the gateway to learning, and the more you learn the clearer it
should become to you how much you do not know. Finally, an individual investor and
retired U.S. Army colonel named Jack Hurst, whom I met when amyotrophic lateral
sclerosis (motor neurone disease) had already paralyzed his entire body save a few
muscles in his right cheek. Unable to speak or move on his own, Jack nevertheless
exemplified the patience, skepticism, independence, discipline, and courage that
7/10
characterize the intelligent investor. Using a computer-brain interface powered by the
electrochemical signals in the facial muscles over which he still had voluntary control, he
meticulously researched stocks, bought them after severe price declines, sold them to
capture tax benefits, and watched financial television – but with the sound turned off so it
wouldn’t influence him emotionally! I wrote about him here. He taught me that courage is
the most underappreciated of all investing virtues.

SN: You have inspired millions through your writing, but which are some of the
books on investing, behaviour, and multidisciplinary thinking that have inspired you
the most over the years? If you were to give away all your books but one, which one
would it be and why?

JZ: I have listed the books I regard as indispensable here, here, and here.

Your last question is painfully difficult for someone who has loved books since he first
learned to walk. I suppose if you held a gun to my head and made me pick only one book
to keep, it would be the Essays of Montaigne. While that book has nothing to do directly
with investing, it has everything to do with learning how to think and live. I can’t think of
another book that is so good a guide to what it means to know oneself, to embrace
uncertainty, to live within one’s means, to value humility above all other virtues, and to
remember that the two greatest intellectual endeavours in life are to learn as much as
possible and to accept how little you will ever be able to learn.

SN: Hypothetical Question: If you had a magic wand, which ill of the financial system
would you eliminate first, and why?

JZ: I suppose I would require anyone providing investment advice to have a formal fiduciary
duty to the client. Enforcing that requirement would be difficult, however. The supply of
people whose minds and hearts qualify them to be fiduciaries for others is probably
insufficient to meet even one-tenth of the demand. The sudden imposition of such a
requirement would force millions of advisors around the world to try meeting a standard that
most would fall short of. Perhaps there should be some sort of centralized training and
licensing regime, the same way most nations require physicians, attorneys, and
accountants to meet rigorous professional standards. Unfortunately, the magic wand you
have handed me doesn’t seem to work; we are probably many years, if not decades, away
from seeing fiduciary duty become universal. That is a shame. Investors, in the meantime,
will have to rely largely on themselves; identifying good financial advisors is going to
require great effort for the foreseeable future.

SN: You’ve talked about the importance of being a learning machine. And it seems
that reading widely – apart from learning from, say, role models – is one of the
important means to becoming a learning machine. In this regard, what are your
thoughts on how one should go about selecting which books to read? There are so
many books that come out these days, and each one of them looks inspiring and
highly recommended by someone. But time is limited. So, is restricting to the
supertexts on investing, thinking, and behaviour a good idea? Else, how should one
go about selecting which new books to read? Do you have such a process in place?

JZ: I don’t have a formal process. However, I do pay close attention to what the people I
8/10
respect the most are reading. When someone I admire recommends a book or a website or
anything else to read, I try to read it. If minds better than mine have benefited from
something, then so can I. It’s also worth bearing in mind that people without high standards
will often recommend reading something that sounds better than it is. It’s disconcertingly
easy for anyone to write a review or summary of just about anything and make it sound
exciting even if, in fact, it is barely better than garbage. So if (for example) Charlie Munger
says a book is “not bad,” you should regard that as much higher praise than if a second-
rate or third-rate mind says some other book is a “must-read” or a “masterpiece.”

SN: As I’ve read at a few places, you also seem to hold Richard Feynman in very high
regard. What are some of the most important things you like about Mr. Feynman and
his teachings, which readers of this interview could also benefit from?

JZ: What I love about Feynman was his determination to think for himself and to be honest
about his own limitations. In his books, he tells remarkable stories that can help even
humanists think like scientists.

When Feynman was young, his wife, Arlene, was dying. Every day, she would send him
little gifts at his office to show how much she loved him. Among them were bespoke pencils
she’d had made with lettering along the lines of “I LOVE YOU, RICHARD. ARLENE.” (I
don’t remember the exact wording, but it was something like that.) Embarrassed lest his
colleagues see these emotional messages on his pencils, Feynman scraped them off with a
knife. Soon, the next round of pencils arrived. This time, the message on them read: WHAT
DO YOU CARE WHAT OTHER PEOPLE THINK?” From that, he – and all his readers since
then – have learned the importance of disregarding the opinions of others when important
matters of the heart (or mind) are at stake. My other Feynman story involves the time he
was asked by the state of California to sit on the committee that approves science
textbooks for schoolchildren. He requested a copy of every single book on the list and read
each from cover to cover. At the final committee meeting, the other members all said their
favorite book was X. To Feynman’s astonishment, they had picked the book with the
prettiest cover but without a word of text. It turned out that none of them had even opened
the textbook; they liked how the cover looked and picked it as “best” on that basis alone.
From that I learned the importance of always reading the source material, rather than
relying on someone else’s representation of it. It still amazes me how many people who
say “studies have shown that…” have never read the studies they are citing.

SN: Can you name some of the current publications (newspapers, magazines, blogs
etc.) you read and respect a lot for their learning quotient? As far as reading
newspapers is concerned, there have been proponents (like Warren Buffett who say
it is a great source of ideas and information) and opponents (like Taleb who think
newspapers are plain noise) of the same. Which side are you on? Is there a way to
read newspapers effectively to differentiate between noise and signal?

JZ: I’ve listed many of the sources I regularly read here. Nowadays, I don’t use the term
“newspapers” much; I call them (including The Wall Street Journal) “news organizations,”
because that’s what we are. We don’t only, or even primarily, publish a newspaper. We
publish online and on your phone and by email and so forth. To be honest, I don’t believe
there is much debate to be had on this matter. Just ask yourself: Would I be able to make
9/10
better decisions if I knew nothing whatsoever about what is happening in the world around
me? It seems to me that the question answers itself, in the negative. While most investors
probably pay too much attention to the news, an investor who pays no attention at all would
be entirely in the dark.

As for me, I read The Wall Street Journal in both print and electronic form. First thing in the
morning and last thing at night, I whiz through the top stories of the day on my iPhone to
get a quick feel for what is happening. When I arrive at my desk for the work day, I read the
print edition. I find that the “What’s News” column on Page One, which provides a one-or-
two-sentence summary of every important article, is an invaluable guide to focusing my
attention. Then I will often open some of the stories in my Internet browser, since the online
versions often have interactive features that the print versions don’t. However, I don’t read
every article every day; far from it. I focus on a handful that interest me, some in finance,
some in politics or economics, some in technology, some in culture. On the weekend I
mainly read our coverage of history and culture. The only other observation I would make is
that when I am not working, I am always reading – but never about work. In my spare time
away from the office, I have an iron rule never to read anything relating to finance or
economics. Instead, I read classic fiction, poetry, history, philosophy, or science. The mind,
like any muscle, must rest in order to grow. If all you read is finance, morning, noon, and
night, eventually you will stop being able to learn anything new about finance. The best way
to deepen your mastery of specific knowledge is by broadening your horizons of general
knowledge.

SN: On that wonderful note, Jason, let me thank you for sharing your amazing and
deep insights for Safal Niveshak readers. I’m sure readers are going to attain great
benefits out of your thoughts and experience.

JZ: Thanks for the interview, Vishal! I really enjoyed it.

Note: This interview was originally published in the December 2016 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.

10/10
Value Investor Interview: Kuntal Shah
safalniveshak.com/value-investor-interview-kuntal-shah/

Vishal Khandelwal January 11, 2017

Note: This interview was originally published in the November 2016 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.

Kuntal Shah is one of the founding partners of SageOne

Investment Advisors and has an opportunistic inclination
towards a value-oriented and risk-controlled approach to
investments. He has been an extremely successful
investor over the past two decades and his success has
come from exploiting the inefficiencies inherent in the
markets.
Kuntal has an in-depth understanding of value investing
with a focus on risk identification and mitigation, emerging
trends, and opportunities in key growth sectors in India,
taxation and accounting. He also loves to teach on these
subjects and in the past has lectured at UTI Institute of Capital Markets, IIM (Ahmedabad),
IIT (Mumbai), Symbiosis, FLAME and Chartered Accountants Institute. Kuntal is an
Electronics Engineer from Pune University.

Safal Niveshak (SN): Could you tell us a little about your background, and how you
got interested in value investing?

Kuntal Shah (KS): I was brought up in a middle-class family in Mumbai. I am an engineer by

qualification. Early life was a constant struggle to make ends meet for our family of five
siblings given our father’s limited earnings. I was lucky to be brought up in an environment
where there was no compromise on education and was fortunate to be inculcated with
middle class working ethos, frugality and conservatism of living within one’s means without
recourse to borrowing to prepone consumption.

I was always fascinated with the capital markets. Hence, a career in the same seemed like
an excellent opportunity to develop a perspective on different businesses and figure out
how their fortunes played out in long run and how stock prices got set in the short and long
run. The initial phase of your career is spent learning the intricacies but the benefits flow all
your life as learning and compounding of capital are both cumulative and a good means to
attain financial independence.

On graduation, I joined a reputed electronics company and resigned by evening aware that
I was not cut out for an engineering job. I also believed then that the prospects of such a
career in India were not too rosy (this was in the era when IT revolution was not underway).
1/15
Anyways, the very next week, I joined a brokerage firm owned by a friend’s father who was
kind enough to accommodate a novice. As soon as I started my career there, I was lucky to
see my investments multiply in a short span of time along with the broader markets. But as
I realized later, that boom was an outcome of diversion of banking funds illegally into the
stock market by vested interests, and run up in my stocks was an outcome of a large
securities fraud.

Anyways, I erred in not booking profits at the right time when valuation went ballistic. This
was because I waited to increase my holding period to longer term to be eligible for long-
term tax exemption. In the process, I gave up a significant portion of my gains. I learned the
hard way that risking more and more to earn less and less and trying to minimize taxes too
much was one of the greatest causes of dumb mistakes in investing. Nowhere does it say
that investors should strive to make every percentage of potential profit. Hence
considerations of risk must never take a backseat to return.

Download PDF of this Interview

SN: You mention about the role of luck several times in your above reply, as the
same seems to have helped you in your journey over the years. How do you view
“luck vs. skill” on a scale? In investing, is it largely luck like Michael Mauboussin
writes in his book The Success Equation? What has been your experience?

KS:

Rumour has it that a subordinate once asked Napoleon, “What kind of generals do you
want?” “I want lucky ones,” he replied. I think a healthy mix of luck and skill is required to
succeed in investing. You can’t get there by relying on either skill or luck alone. You need
both. Having stated that investing is a field where the range of skill is wide, the more skilful
will succeed at the expense of the less skilful.
When I entered the markets, it was much inefficient and I was less skilled. In fact, I was
making more returns with much less skills than I am doing now. With the entry of a lot of
talent driven by passion and incentives which the markets offer, these have gotten
progressively more and more efficient and participants more skilled. This is one of the
lessons of the paradox of skill that with so many skilled participants, the role of luck
somehow seems to be increasing as time goes by and competition sets in. Getting better in
an absolute sense doesn’t matter if it’s offset by the competition. Hence one should focus
on the process and if the outcome is suboptimal, have the humility to take it in one’s stride
and get ready to try again with quick acceptance of whatever results appear.

SN: Well, the humility and acceptance you talked about are so important and widely
missing. Anyways, tell us about your evolution as an investor and what has been
your broad investment philosophy? Has your investment philosophy changed much
through the years?

KS: During the first decade of my investing career, I worked with a family office where I
honed my understanding of how businesses create value and growth, and how equity
markets function over the long term. I was fortunate in getting early lessons in value
investing and yet not pay too heavy a price of this learning.

We ran a two-tiered proprietary book. Let me explain this. A part of our capital was
2/15
deployed based on an external recommendation by principals of the family office, while our
small internal group ran a portfolio with four to five securities accounting for the bulk of
allocation. Since the capital was unlevered and permanent, there was no chance of us
turning to be forced sellers in adverse market condition. We also had the flexibility to
withstand temporary market downturns and in fact average on the downside.

I think running concentrated portfolios requires a combination of skill and stability of capital
base, attributes that only a select few investors truly possess. For managing external
money, combining our best ideas at the top of the portfolio with higher position sizing with a
number of non-correlated ideas at the bottom of the portfolio with lower allocation has
improved both our returns and the reliability of those returns and has helped to soften the
lumpiness in performance.

SN: And that has helped you compound capital at a good rate over the long run,
right?

KS: Yes Vishal. You see, compound interest was described by Einstein as the eighth
wonder of the world. The essence of compounding is captured in the following equation
which states that –

Future value = Current value x (1 + rate of interest) ^ Time period of compounding

As applied to value investing, it becomes –

Longevity of growth + High rate of returns + Reasonable price = Wealth creation

Thus, to compound wealth, you need to invest in businesses that are deploying capital at a
high rate of returns for a long period and purchase them at reasonable prices. Since the
time horizon of compounding at the above average rate of return has an exponential impact
on wealth creation, it’s better to invest in a business with little lower compounding rate but
far higher longevity of growth than in a business with higher compounding rate but lower
longevity.

Also, it follows that a long-term investment horizon is an edge in obtaining superior returns
as it allows the magic of compounding to work. Time, as Warren Buffett says, is the friend
of a wonderful company and the enemy of a mediocre one. As we stand today around 96%
of Buffett’s fortune was created after his 50th birthday and nearly 90% came after his 60th
birthday. (For additional reading refer to Buffett’s note on The Joys of Compounding that he
covered in his 1963 to 1965 annual letters to clients).

SN: Those letters Buffett wrote in the early part of his career are truly amazing and
are a must read for anyone wanting to learn the concept and relevance of long-term
compounding. So, thanks for bringing that up.

Anyways, you’ve mentioned about running concentrated portfolios. What are your views on
the argument between concentration and diversification?

KS: While there is no clear answer for this, I believe the nature of capital one manages
(long term or short term, permanent or transient, levered or unlevered and more importantly
patient or hyperactive capital) must be borne in mind while deciding whether to concentrate
3/15
or to diversify.

Concentration can be considered if one manages patient and permanent capital with an
ability to hold cash and look foolish for an extended period and wait for the fat pitches.
Also, concentration can be accompanied with healthy a dosage of cash which serves as
protection value of keeping portfolio safe during periods of dislocations and provides
optionality of liquidity to invest in bargains after such dislocations. This ability, quite often, is
not available to fund managers who get told by investors that they are taking the
equity/cash call at their end.

Currently, there is a trend towards over-diversification and passive investing. While it’s good
for an average investor with little time to devote to managing capital to buy a broad index or
seek extreme diversification to get passive market returns, same is not good for an active
investor. While there is a limited amount of capital which is overtly indexed, there is a great
deal of closet indexing or index hugging by fund managers who are so diversified that in
effect they own a significant chunk of markets. If you pushed indexing and excessive
diversification, you would get preposterous results.

SN: Tell us about your current investment process.

KS: Our investment philosophy is a multi-step process (see charts below) with special
emphasis on right companies within right sectors, run by right managements with capital
allocation and corporate governance in place and available at right prices.

If we must pick outperformers, we must first eliminate underperformers and work with
residual ideas. The initial screening process we deploy is pure science whereby based on
liquidity, sales and profit growth rates, capital efficiency, we eliminate more than 97% of
listed stocks and make our opportunity set more manageable. Otherwise, the sheer size
and permutation of options would make the process a daunting task. Needless to say,
some good ideas will slip us by in this process but that’s the trade-off we are happy to
make as we need only a few good businesses to construct our portfolio.

(Click on any image below to open its larger version)

4/15
5/15
SN: Thanks for laying out your investment philosophy so clearly. Let’s now talk
about position sizing, which is a critical element of portfolio construction but not
much talked about. Would you like to elaborate on how you look at this subject?
KS:

Apart from finding a good idea with a high degree of conviction, one needs to maximize the
payoff from the same to move the needle in a portfolio. And that can be done only by
appropriate position sizing.
Position sizing is directly related to expected returns. As per the Kelly criterion, what drives
position sizing are conviction level and degree of certainty derived from an ability to
completely understand all aspects of the business especially risk factors, competitive
position, valuation, and liquidity. So, if the investor has two ideas with the same expected
return, but one is in a highly-leveraged financial company and one is a very stable
consumer products company, the investor should allocate substantially more money to the
latter because there must be a premium for certainty. What is overlooked by many is that
higher the range of possible outcomes at the business level and higher the uncertainty with
timelines, lower should be the position size. Then, at a certain wide range, it should simply
be excluded from the portfolio till the range narrows to reasonable levels. This is needed to
guard against the risk-seeking attitude of most investors who are more focused on the
upside and return potential with lower regards to risk and how much they can lose.

SN: That’s true. But how do you take this into account when you are managing such
risk-seeking investors’ money? I mean, how do you keep yourself sane, especially
when dealing with clients with undue expectations?

6/15
KS: One of the greatest risks we face when managing other people’s money is the risk of
having the wrong investors. Hence having a base of intelligent and patient investor clients
is very crucial. This is because your best skills could be undone if your clients panic and
withdraw capital at the wrong time.

We encourage our investor clients to view stock ownership as fractional ownership of the
underlying business and that changes in prices of securities are far unstable than the
changes in underlying business fundamentals. We explain that partial ownership of a
wonderful business is great means for satisfactory returns over long term, both for the
salaried for their retirement planning and for business people for diversification from their
core business which accounts for a bulk of their wealth.

Constant pressure to be fully invested, or the possibility of being hit by redemptions in a

downturn are permanently damaging to the process of compounding as well our behavior.
This risk hinders the ability to invest when markets become irrational. No matter how good
our investment process is, even the best investors go through periods of
underperformance.

If our partners leave us when our stocks are the cheapest, not only will they be doing
themselves a disservice but they will make us a forced seller when in fact we want to be a
greedy buyer.

SN: From what you’ve shared, it seems a real challenge to be a money manager. But
how is it during market extremes? Like in situations of euphoria and market
crashes?

KS: I think such periods are challenging for all investors. The reason is anything to do with
wealth boils down to confidence, greed, and fear. And the pendulum of valuations swinging
away from the center all the time isn’t going away. It swings from too rich to too cheap, but
it never swings halfway and stops. And it never swings halfway and goes back to where it
came from. The momentum always is carried to excess on both sides. Reading about
history whereby the harder lessons you can learn vicariously rather than through your own
hard experience, the better it is for investors and has served us well. George Hegel was
right when he said, “We learn from history that we do not learn from history.”

Now, there is a misconception that fiat currency without an anchor and prone to central
bank printing is responsible for this boom-bust cycle. But one must remember that bubbles,
manias, and panics have been frequent across the world amidst diverse economic policies
and varied timelines. They have occurred even in centuries when the gold standard
prevailed. However, the frequency and magnitude of intervention by central and monetary
authorities coupled with innovations in finance have made them more frequent in nature.

SN: What have been the best and worst times in your experience as a money
manager? How did you handle, say, a situation line 2008?

KS: The best time was 2001 meltdown (after the dotcom bubble had burst). I had sold most
of my stocks during the tech boom and had sufficient cash to take advantage of the
opportunity when several companies were cheaply available. The perfect storm of

7/15
accelerating GDP, rising productivity and capital efficiency combined with low entry prices
resulted in a good set of opportunities across a wide range of sectors.

My worst time in terms of performance was indeed the 2008-09 period. Ironically, we had
seen it coming. While it was playing out in the US, Indian markets kept going up. We
increased our cash position simply due to inability to find worthy ideas to stay invested at
overvaluations witness in 2007. But we didn’t realize the magnitude of downside possible
and hence, in hindsight, didn’t sell adequately.

Liquidity just dried up and small selling by indiscriminate and forced sellers led to a
disproportionate decline in quotations of our portfolio securities. I guess the inability to book
profits at the time of overvaluation and deploy the same in ensuing downturn was an act of
forgone opportunity or a sort of omission on my part as many quality stocks got beaten
down to ridiculous lows in the panic that arose. This was the time I became acutely aware
that the opportunity set for an investor is not the current one but also a range of
opportunities that can arise later, given the current state of business cycles and valuations.

SN: What are some of the characteristics you look for in high-quality businesses?
What are your key checklist points you consider while searching for such
businesses?

KS: Value comes in many forms and there are many ways to skin the cat. All forms of
discovery of mispricing, probability, and source of bridging the gap is intelligent investing. If
everyone chooses to only invest in a high-quality business, what would happen to
businesses not fulfilling the quality parameters? In such a situation, the pari-mutuel nature
of markets would at many instances set the prices accordingly.

In his 2007 letter, Buffett described three types of companies – great, good and gruesome.
This was based on their ability to generate rate of returns. Now, a company can deliver
value in the following manners –

Companies that have superior free cash flows which can be used to increase unit
volumes, which drives commensurate earnings or expand in related areas or acquire
business at reasonable valuations. These companies should have a decent return on
capital, strong financial and competitive position and able to have a decent return on
incremental capital much more than nominal GDP growth rates. The valuation of
such companies is very sensitive to changes in growth.
Companies that have significant free cash flows from operations and can return the
surplus unencumbered cash to shareholders in a cash efficient form namely
dividends when shares are not undervalued and via buyback when they are
undervalued as compared to their future prospects.However, in addition to these two
sources of value creation from free cash flows and high ROE earnings, there are two
other sources of value creation via monetization of asset and having access to capital
markets on favourable terms.
Companies that choose to enhance the value of assets acquired at historical prices
by corporate actions, which involve repositioning assets to higher uses, better
financing of asset acquisitions, the refinancing of liabilities or both; and the creation of
tax advantages. These companies can do so via M&As, leveraged buyouts or

8/15
 gearing to a healthy level by cheaper debt, spin-offs, and asset sales. Equity
ownership is residual claim not only on earnings but also on assets of a company
and repositioning of assets for better usage can create value.
Another source of ignored value is access to capital markets (debt and equity) at
super-attractive terms and prices. There seems little question that far more corporate
wealth has been created by taking advantage of attractive access to outside capital. If
one can acquire capital market currency which can be issued at favorable terms at
periodic intervals of high market valuations, the same can be a superlative source of
competitive advantage if the company is run by an able capital allocator. Issuance of
one’s common stock for another business before or during or immediately after M&A
requires evaluation and valuation of both acquirer and acquired. Hence, the need of
good capital allocator to do so. Thus, an overpriced stock in hand of capable
competent management can be its most important asset and the same can be said
of an under-priced stock if the management resorts to buybacks. This is extremely
neglected in most financial literature but is a great source of value creation if done
right.

With regards to your question on a checklist, each of the above points would have slightly
different considerations. This is given that the first two are based on earnings and use of
retained earnings, the third one is based on corporate action as it pertains to asset usage,
and the fourth one is kind of opportunistic financial arbitrage. Hence you need a different
checklist and different mental models for different companies.

As stated earlier, one needs to develop one’s own framework to understand value
proposition of business (streams of revenue and mix, growth drivers, cost structures and
advantages, ability to price, distribution channels, switching cost and loyalty, cost of search
for alternatives, market share, asset turns, working capital needs etc.) and be alert to
constant value migration within the ecosystem.

SN: Those were quite interesting and valuable insights. What about valuations? How
do you differentiate between ‘paying up’ for quality and ‘overpaying’?

KS: To a value investor, potential investments come in three varieties, based on price, after
having established longevity of growth and superiority of rate of returns generated by
business –

Undervalued at one price;

Fairly valued at another price; and
Overvalued at still higher price.

My goal is to buy the first, avoid the second but keep tracking the same, and sell the third,
all things being equal.

One rough yardstick to use to ensure one doesn’t overpay is to do back of the envelope
calculation that the market cap paid today should be equal to the cumulative sum of profits
likely to be earned by a company in the next 7-10 years without any equity dilution. And if
by chance the profit of the company a decade from now shall be equal to its current market
cap, then you have a sure multi-bagger in your hand.

9/15
Also, current stock prices reflect a set of expectations for future financial performance.
Companies can increase earnings by retention of profits earned along with inflation.
Simultaneously, they destroy value if the returns are below the threshold of comparable
options available elsewhere. Instead of arriving at fair value today, one can examine the
level of free cash flows implied in current valuation and then figure out the probability of
that happening using reverse DCF (refer to Alfred Rappaport & Michael J. Mauboussin in
their book Expectations Investing). Thus, if price implied expectations are very different
from what your view is, there is an actionable idea of buy or sell and a potential profit
opportunity.

Mathematically, it can be proven that over long periods of time, it is hard for equity
investors to earn returns that are much higher or lower that the underlying business return
on capital employed. This can be explained with the mathematics of a long-term bond
where the rate at which coupons are reinvested determine investors’ IRR rather than the
yield at the time of purchase. After all, equities are similar claims as perpetual bonds with
residual unpredictable and lumpy coupons.

Investors who are long-term oriented must not confuse cheap with value as the bitterness
of poor quality remains long after the sweetness of low entry price is forgotten. The issue of
paying up for quality versus overpaying is very much an individual choice which essentially
boils down to the assessment of the size of the opportunity, quality, and longevity of growth
of the underlying business.

SN: Great insights, Kuntal! What about selling stocks, which seems a more difficult
task than buying? How do you determine when to exit from a position? Are there
some specific rules for selling you have?

KS: The discipline to ‘sell’ is as important as the discipline in making the ‘buy’ decisions. A
rational criterion for when to sell a stock is vital to the management of a sound portfolio. As
a rule, I exit investments based on a few factors including –

Adverse changes in long-term sales growth and earnings power, migration of value
across the value chain, wrong assessment of longer term competitive intensity and
pricing power because of which original investment thesis that I used to buy the stock
is no longer accurate.
Loss of confidence in the management due to adverse capital allocation or corporate
governance issue for which I have a low tolerance.
Opportunities to allocate capital to more compelling investments.
Reducing exposure in times of extreme market wide bubble.
Excessive overvaluation of a company due to re-rating, without commensurate cash
flow/earnings growth that can contract as easily.

SN: When you look back at your investment mistakes, were there any common
elements or themes?

KS: Whatever failures I have known, whatever errors I have committed, whatever follies I
have witnessed in the private and the public life have been the consequences of action
without thought, planning, and strategy.

10/15
Good judgment comes from experience, and often experience comes from bad judgment.
And while experience is a good teacher, she sends in terrific bills.

Like most investors, I too have also suffered from the seven deadly investment sins at
different points of time –

Overconfidence/Pride: Needs a checklist and acceptance of disconfirming evidence

Sloth: Inability to deep dive into opportunities and be alert to risk and herding
Gluttony of information: Leading to high noise to signal ratio
Myopia: Overweighing short term vs. long term when investment horizon was long-
term
Greed: Of losing opportunity and missing out
Fear: Of losing capital and missing out
Cowardice: Inability to invest big when odds are favourable and opportunity meets
prepared mind.

However, my acts of omissions far dominate the outcome via lost opportunities. One
common error I have made in the past is overestimating rationality by governments, central
bankers, and regulators. It is very hard to interfere with the functioning of the markets
without having lots of unintended consequences. Also, my inability to book gains by selling
stocks completely when valuations had gone berserk falls squarely under the acts of
omissions.

SN: How can an investor improve the quality of his/her decision making?

KS: Here are a few of my suggestions –

Develop a checklist, analytical framework and start keeping detailed investment

journal to monitor the progress of ideas.
Try to develop informational, analytical, behavioural, and structural advantages in the
process. Being process-oriented means examining all possible outcomes and all new
information and assessing them relative to original thesis.
Do pre-mortem as against post-mortem. Think about what can go wrong prior to
making the investment and keep evaluating as you go along.
Never invest in something you don’t understand well, and have a low conviction on,
and is outside your circle of competence. If one changes his or her investment
approach in response to recent underperformance, one might be doomed to
mediocrity. If adverse situations arise, avoid making decisions under extreme stress
or seek the opinion of a couple of unbiased and independent persons of skill and
repute.
Avoid anchoring bias and don’t get fixated on a number or price. Put a foot in the
door by buying small initial quantity if the business looks appealing. This allows
psychological flexibility to average up. Practice the same while selling by averaging
down. In absence of the above, one can be anchored to prices which may not be
attained for a long period to come. Prices can go from being source of information to
a source of influence due to reflexivity present in the equity market and one needs to
keep them distinct.
Along with the probability of being wrong, weigh the consequences and impact of
11/15
 adverse outcomes. As George Soros has said, it’s not whether you are right or wrong
that’s important, but how much money you make when you are right and how much
you lose when you are wrong that’s important.
Pay attention to the incentives and rewards system of the ecosystem and judge
management from all possible angles of vision, strategy, ambition, execution and
attitude towards wealth creation and minority shareholders.
Be wary of leverage and empire building. Markets are there to serve you and not to
instruct you. The way to get into trouble is doing the thing you don’t understand and
then doing them with lots of borrowed money.

SN: That was some valuable advice, Kuntal. Thanks! Let’s now talk a bit about ‘risk’?
How do you look at it while making your investment decisions?

KS: Let’s get the basics right here. Price movement of securities is not a risk. There are
other forms of risk such as regulatory risk, inflation risk, asset-liability mismatch risk etc.
Also, there is the conception that to obtain high returns, an investor must take
correspondingly high risk. In my humble opinion, risk and return are negatively correlated.
In fact, to attain higher return, one must reduce the risk of permanent loss of capital.
Remember that the first rule of investing is to not lose money, and the second rule is to
never forget the first rule.

An investor faces several kinds of risk, some of which can be eliminated (concentration,
complexity, liquidity, adverse taxation etc.) while some can be mitigated and managed
through framework (capital risk, currency risk, correlation risk etc.) and some which shall
have to be embraced keeping odds, impact and margin of safety in mind (information
asymmetry and deficiency, event risk, key personnel risk, business risk, corporate
governance and capital misallocation risk etc.)

SN: What’s you two-minute advice to someone wanting to get into value investing?
What are the pitfalls he/she must be aware of?

KS: My single most important piece of advice would be to read voraciously. This also
involves conscious efforts to eliminate noise and seek the best use of productive time one
has, which is a finite commodity.

I like business biographies because these tend to show how passionate people who live
and breathe their businesses have created something out of nothing. Also, learn from
business failures as they contain lessons on what not to do. Learn from the works of
eminent dead and living people and companies in different geographies who have
experienced success in related areas who’ve been winners and failures, and then try to
identify why and what it is they’re doing that causes/caused them to be successful or
failure.

SN: Which unconventional books/resources do you recommend to a budding

investor for learning investing and multidisciplinary thinking?

KS: I suggest reading offbeat stuff like biographies of successful/failed entrepreneurs and
businesses. In terms of newsletters, I suggest Outstanding Investors Digest and Grant’s
Interest Rate Observer. Here are some of my other recommendations on what to read –
12/15
Financial History

Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay.

The Great Crash, 1929 along with A Short History of Financial Euphoria by John
Kenneth Galbraith
Manias Panics & Crashes by Charles Kindleberger
This Time is Different by Carmen Reinhart and Kenneth Rogoff

Accounting

Financial Shenanigans by Howard Schilit

Accounting for Value along with Financial statement Analysis and Security Valuation
by Stephen Penman
The Financial Numbers Game along with Creative Cash Flow Reporting by Charles
Mulford
Quality of Earnings by O’glove
Financial Statement Analysis by Martin Fridson
Financial Fine Print by Michelle Leder
It’s Earnings That Count by Hewitt Heiserman

Process Improvement & Multidisciplinary Thinking

Poor Charlie’s Almanack by Peter Kaufman

Best Practices for Equity Research Analysts: Essentials for Buy-Side and Sell-Side
Analysts by James Valentine
The Investment Checklist: The Art of In-Depth Research by Michael Shearn
The Power of Habit: Why We Do What We Do in Life and Business by Charles
Duhigg
100 to 1 by Thomas Phelps
100 Baggers by Christopher Mayer
Thinking, Fast and Slow by Daniel Kahneman
Influence by Robert Cialdini
All three books by Peter Bevelin: Seeking Wisdom, A Few Lessons from Sherlock
Holmes and All I Want to Know is Where I Am Going to Die So I’ll Never Go There

Understanding Business

Understanding Michael Porter by Joan Margretta

Value Migration by Adrian Slywotzky
Competition Demystified by Bruce Greenwald
The Five Rules for Successful Stock Investing by Pat Dorsey and Joe Mansueto
Business Adventures by John Brooks
Berkshire Hathaway Letters to Shareholders, 2015 by Max Olson
The Outsiders by William Thorndike
Business Model Generation by Alexander Osterwalder

Valuing Business

Valuation and Managing the Value of Companies by McKinsey & Company Inc.

13/15
 All three books by Aswath Damodaran on valuation – Damodaran on Valuation,
Investment Valuation and The Dark Side of Valuation

SN: Great list indeed! Which investor/investment thinker(s) do you hold in high
esteem?

KS: I like Charlie Munger and Warren Buffett, Howard Marks and Seth Klarman, Jeffrey
Gundlach, Prem Watsa, and Benjamin Graham. Also, there are a host of great investors
whose letters, writings, and achievements attained in one lifetime have had an influence on
me. I would also suggest reading about works of Michael Mauboussin, James Montier, and
Daniel Kahneman.

SN: Hypothetical question – Let’s say that you knew you were going to lose all your
memory the next morning. Briefly, what would you write in a letter to yourself, so
that you could begin relearning everything starting the next day?

KS: This one has got me thinking. In such a hypothetical scenario, I would focus on writing
about my friends and family and pen down the social framework of my existence and well-
being. I would tell my near and dear ones to be patient and loving with me and help me
regain the semblance of my original self by sharing memories and experiences. With
regards to professional material, there is lots of it stored in my library, emails and Evernote
account and that is well documented and archived.

I believe getting one’s principles, leanings and learnings, emotional and personal life would
be more important to note down as they have not been as well chronicled as business
aspects have been.

SN: One final question – What other things do you do apart from investing?

KS: I have few ongoing efforts directed at giving back to the society and focusing on the
well-being of less fortunate ones. I am a big fan of music and good movies and love to
catch up on the same when time permits. I also love to teach. Teaching and writing require
the discipline of understanding, deliberate practices of communication, constant learning,
and updating material as your idea evolves. Hence I am associated with FLAME University,
which is a pioneer of liberal education in India and is doing some interesting work in the
field of developing good programs for Indian capital markets. They also have one of its kind
of business library in this part of the world with books on diverse topics. This library is an
affiliate of the Library of Mistakes which is very interesting. Please do check it out.

SN: On that wonderful note, Kuntal, let me thank you for sharing your amazing and
deep insights for Safal Niveshak readers. I’m sure readers are going to attain great
benefits out of your thoughts and experience.

KS: Thanks for the interview, Vishal! I really enjoyed it.

Download PDF of this Interview

Note: This interview was originally published in the November 2016 issue of our premium

14/15
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.

15/15
Value Investor Interview: Rohit Chauhan
safalniveshak.com/value-investor-interview-rohit-chauhan/

Vishal Khandelwal November 2, 2016

Note: This interview was originally published in the October 2016 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.

I recently interviewed Rohit Chauhan for our

premium newsletter, Value Investing
Almanack.
Rohit Chauhan is an Engineer / MBA with
20+ years of experience, working in different
functions in large corporations in India and
abroad. Rohit was introduced to the value
investing philosophy in the mid 90s and has
since then followed it in managing money for
himself and others who have entrusted their
capital to him.

Rohit has been writing on the topic of

investing for the last 11 years through his blog.

In his interview with Safal Niveshak, Rohit shares his wide investment experience and how
small investors can practice sensible investment decision making.

Safal Niveshak (SN): You’ve’ widely covered your journey on your blog, but let me
still start with the customary question. How did you get into value investing, and
how has your process evolved over the years?

Rohit Chauhan (RC): I got interested in investing as I had to manage my family’s finances
after I finished my MBA. I started learning the basics by reading newspapers and books as
this was the only way prior to the internet.

I came across a book The Warren Buffett Way in a public library and the book spoke about
this billionaire in Omaha who had become rich by investing in stocks using some very
common-sense principles. I was hooked.

Over the years, I read as much as I could find on Buffett, which lead me deeper into value
investing and to the teachings of Benjamin Graham, Philip Fisher and other greats in this
field. So you can say that I have learnt mainly through books and the internet just
accelerated the process.

1/8
As I was exposed to Buffett at the start of my journey, his philosophy and teachings have
formed the bedrock of my approach. Over the years, I have studied other great investors
and have dabbled in deep value investments, arbitrage and other opportunities. However,
my core philosophy of buying good companies at reasonable prices remains the same.

My process has evolved to become more qualitative and focused on aspects such as the
competitive advantage of businesses, industry dynamics and management as these factors
finally drive the numbers. This evolution has also happened due to the fact that markets
have become much more competitive over the years and it is difficult to find obvious
quantitative bargains now.

[Click Here to Download PDF of this Interview]

SN: That’s a very important point you mentioned about the markets getting
competitive. So how does your qualitative process look like in terms of finding
investment ideas? What are the necessary conditions that you would look at before
you invest in a company and the additional conditions that that will just go about
reinforcing your confidence in the company?
RC:

I used to run screens in the past, but missed some very good opportunities as I was more
focused on the numbers. I have changed my approach to focus more on the qualitative
aspects now.
My search process is usually based on serendipity driven by general reading. I also
maintain a list of companies I like and track, but have not added to my portfolio due to
valuations or some other short term concern.

When I come across an idea, I am looking for possible 2-3X in 3-5 years. It takes me a long
time to analyze and get comfortable with an idea, so a 20-30% upside is not worth the effort
for me. This approach would work only if you are ready to work harder and churn through
more ideas, but in my case it has only added to extra stress rather than returns in the past.
As I hold most of my positions for the long term, I rarely need more than 1-2 ideas a year to
make it a productive one.

When digging through an opportunity, I am looking for a company which has been
mispriced by the market because the true earnings are obscured for temporary reasons or
the market is under-estimating the company’s moat. So in effect I am trying to visualize if
the company can earn in excess of 20% return on capital and maintain a high level of
growth going forward, which is not recognized and priced accordingly by the market. The
rest of the process is really digging into this question further and understanding the
subjective factors which will lead to that outcome.

The quality of management in terms of capital allocation skills and their ability to take
advantage of the opportunities in the concerned industry are the additional conditions
which reinforce my confidence in the idea.

SN: How can investors trapped by irrelevant information make independent

investment decisions? What are the few factors investors can use to improve the
quality of their decision making?
2/8
RC: I don’t think it is possible to list a small list of factors which can help investors improve
their quality of decisions. Inspite of the claims we read and hear, there is no silver bullet for
this problem.

I think the first step in improving your investment decisions is to make fewer of them. The
second step is to understand, with as much depth as possible, the economics of the
business which you are considering. If you understand a business well, you will be able to
identify the key drivers of its performance. Once you cross this stage, it is easy to ignore
the irrelevant details and noise in the financial markets.

Finally, the behavioural aspects are important to convert this knowledge into action. One of
the best ways to do this is to avoid watching financial news. It is not only useless, but quite
toxic to making sensible decisions.

SN: What are your thoughts on position sizing? When you find a good bet with great
risk-reward, at what level do you stop and how do you think about it, whether it
should be 10, 20, or 30% of your portfolio?

RC: I think portfolio sizing is a fairly neglected aspect of portfolio management and I have
been guilty on the same count. The main factor which should drive portfolio sizing is the
level of confidence with which you can analyze a company. This makes it subjective, which
I think is the right way to think about it.

In the above thought process, one needs to be careful about being over-confident and
hence over sizing a position. The best way to calibrate this is to note down your decision
making process at the time of making the investment and check it with how the whole thing
plays out over time. Let me illustrate

At the start of my investing career, I was quite apprehensive about my skills and generally
under-sized my positions at around 5% of the portfolio. In addition, my equity portfolio was
a small size of my overall net worth. I did not want to blow up my portfolio by being over-
confident. Over time, based on the results, I realized that I was too timid and hence started
allocating a larger portion of my net worth to equity.

At the current juncture, I look at position sizing via the lens of overall risk for me. What is
my percentage of net worth invested in equity? How stable are my sources of income? If I
am comfortable on these two factors and find an attractive bet, I will go up to 10% of my
portfolio at the time of purchase. However, I do this rarely and only after I have developed a
high level of confidence on the company and its management.

Finally, I have something called the ‘sleep test’. If a position and its size is making me worry
or lose sleep over it (metaphorically), then I will reduce the position size. Personally, I am
fine getting rich very slowly, rather than facing even a small chance of ruin

SN: How I wish more investors laid importance on this point about their investments
letting them sleep peacefully. Anyways, what are your thoughts on concentration vs
diversification? Which of these styles do you follow?

RC: I think of concentration versus diversification along a spectrum. At one end of the
spectrum is 100% diversification achieved by investing in an index funds/ ETF which would
3/8
represent the entire market. At the other end, an extreme concentration would be investing
your entire net worth in a single business, as many entrepreneurs do.

I like to combine the concept of diversification with the idea of knowledge and control over
one’s investment. Let’s say you are a highly skilled doctor, then it makes sense to invest
your time and capital in running a business which will leverage your skills. On the other
hand, a know nothing investor with almost no control over his or her investments should
invest via a highly diversified fund to reduce his risk.

In my own case, like most active investors, I lie somewhere in the middle of the spectrum in
term of knowledge (a reasonable understanding of the companies in the portfolio), but with
no control over them. If I consider these factors, I think it makes sense to diversify sensibly
to reduce the overall risk.

In terms of number of positions, I have usually maintained between 15-20 position

depending on the valuations and types of opportunities. At the same time, the top 10
positions generally account 60-70% of my portfolio. This level of concentration has also
gone up with time as I have deepened my understanding of various businesses.

SN: Given your reasonably long career in the stock market, you have gone through
several periods of uncertainties and turmoil. How have you learned to deal with such
situations?

RC: I have been investing since mid-90s and have seen a few ups and downs in the
market. I think in most cases, the markets and people over-react to short term events and
miss out on great investment opportunities.

For example – In 2004, the UPA government came to power leading to a large drop in the
indices, as the stock market expected the new government to be anti-business. I am sure
almost no one remembers this event. However, investors who over-reacted to this event
missed a great opportunity to compound their wealth over the next 4 years.

The same held true during one of the worst phases of the stock market: 2008-09 when the
indices dropped more than 50%.

I think the best way to deal with the inevitable turmoil and uncertainty is know that such
events will occur repeatedly over an investing lifetime. The best time to prepare is when
everything is hunky-dory.

I usually ask myself this question when the outlook is very sunny – will I be comfortable
holding, or even buying the current positions if they were to drop by 20%+ in event of a
market correction? If yes, then I will continue to hold. However, if I am not sure of the
answer, then that means I should reduce the position size and move some of my money to
cash or other ideas.

If one cannot do the above, then the second best option is to get into passive investing as
much as possible. Identify a few good mutual funds and set up a regular investment plan.
Once this is done, stop watching the financial channels forever and pick up some hobbies
outside of work. In time, this hands off approach works out much better than the hyper-
active style of most active investors.
4/8
SN: That’s true, Rohit. I have seen this passive approach work wonders for a lot of
people around me.

Anyways, let me talk a bit about the behavioural part of investing. Charlie Munger
emphasizes about building a latticework of mental models in order to make better decisions
in life and investing? Which models have served you the most over the years as far as
investing is concerned, and how?

RC: I have a fairly poor memory and unlike Charlie Munger or other great investors, cannot
really hold these models in my head. As a result, I have developed a process of noting
down all the mental models in a spreadsheet as I have come across them. This
spreadsheet was started in 2002 and has grown each year. My friends now call me a
‘spreadsheet king’.

I use this spreadsheet, running through all these mental models as a checklist, when I am
working on a new idea. It takes a bit of time to do this work, but I think it is absolutely
necessary for me to do it to ensure that I have considered the idea from all angles.

Some of the models I use are accounting and financial analysis models, competitive
analysis and competitive advantage and its source. In addition to this, I will consider the
behavioural models when making the decision.

Finally, I have recently added Bayesian models to think and make decisions
probabilistically.

SN: What are your thoughts on investment cycles?

RC: I have ignored investment cycles in the past, but have realized that ignoring business
cycles is not a good idea. The peak of investment cycles can usually be seen in elevated
valuations and if one is disciplined about not over-paying or holding onto excessively priced
stocks, then one can use these cycles in your favour.

Business cycles are a different matter. As an investor, I think it is important to understand

the degree of cyclicality of a business as that informs the valuations one should pay and
also the time one will have to hold onto a position before the earnings and the stock price
will turn.

SN: How do you think about intrinsic values?

RC: I think intrinsic value is one those concepts which is simple to understand, but not easy
to implement. I think one of the key points to keep in mind is that there is no objective and
single intrinsic value number for a business.

One should think of intrinsic value as a range of numbers with their individual probabilities.
As intrinsic value is based on future cash flows, it depends on the evaluation of an
uncertain future and hence it is important to think of this concept probabilistically.

How does one estimate the numbers and the probabilities involved? I think it comes back to
my earlier point that an investor needs to understand the economics of the business as
well as possible and estimate the range of future cash flow estimates for it.

5/8
The evaluation of probabilities also requires understanding the long term economics of the
business. Now there are some business which are relatively stable and predictable and
thus an in-depth study will enable one to come up with a range of numbers with high level
of confidence – for example a consumer goods company.

On the other hand, there are some industries such as oil and gas, metals etc. where the
future cash flows depend on the price of a commodity which for the most part cannot be
predicted over the long term with any degree of confidence. In such a scenario, any cash
flow estimation and intrinsic value number is not very helpful and can actually mislead an
investor into thinking that he or she is buying a bargain, whereas the individual is just
betting on the price of a commodity.

SN: Most experienced investors say that volatility is your friend and the only real
risk is permanent loss of capital. But we humans have a bad history of dealing with
volatility. So if history has any significance, isn’t volatility the real risk? How do you
deal with it?

RC: I think Warren Buffett has given us one of the best definitions of risk – Risk is not
knowing what you are doing. Let’s look at this comment in more depth.

There are two elements to this – one is knowledge and the other is time horizon. An
investor should know what the time horizon of his or her investment is and should
understand the economics of the business or investment over this time horizon.

As an example, let’s say the investment horizon is ten years, then the main risk for the
investor during this period is not volatility but the risk of business model disruption, change
in competitive intensity etc. It is anything which will change the economics of the business
for the worse during this period.

As a counter example, if an investor is acting as a trader and has a horizon of a few weeks
to months, then none of the risks mentioned above matter. In such a case, the individual
should be more concerned about volatility from various macro factors which may have
nothing to do with the company in question.

So it boils down to knowing what your time horizon is and then evaluating the risks during
that period. If you are ready to hold an investment for a long time period, then volatility is
not a risk as long as the competitive dynamics do not change.

SN: Technology is disrupting every industry, be it services or manufacturing. The

rules of game are changing very fast. Companies are getting into oblivion very fast,
thereby making finding sustainable businesses and thus investing in them difficult.
The old school rules of value investing may not sometime be very helpful. How does
one deal with such a situation? What precautions need to be taken?

RC: I think disruption is both a threat and an opportunity. There is no silver bullet to manage
it. I think the most important asset is to have a curious mind, with a drive for constant
learning.

One needs to keep in mind that the half-life of knowledge (a term from radioactive decay) is
reducing. As a result, an investor or any other professional cannot assume that what he or
6/8
she has learned till date will last a lifetime.

As an investor it is important to understand your companies deeply in terms of competitive

position and disruption risk. In addition to learning, one also needs to think probabilistically.
One should not be 100% sure of any conclusions, but should constantly be reviewing the
company and its competitive position based on current and emerging risks and make
changes to your confidence level.

As an example, let’s say you are invested in a telecom company and had a high level of
confidence on the performance of the company. Let’s say, for argument sake, you have a
70% confidence level on the fair value and competitive position of the company.

Now the launch of Reliance Jio should make you review your estimate of fair value and the
confidence level too. The numerical estimate of the confidence level may sound too
mathematical and un-realistic, but I think it forces one to think and really question one’s
assumptions.

In summary, one needs to have a curious and open mind, a constant drive to learn and be
ready to change your conclusions rapidly when the environment changes due to disruption
or otherwise.

SN: Most people would rather die than change their beliefs and conclusions.
Anyways, where have you made the most of your mistakes over the years – omission
or commission? And what lessons have you learned out of these mistakes?

RC: I have had both types of mistakes, but I think the biggest mistake for me was a sort of
commission. My biggest mistake has been selling a few companies such as Asian Paints,
Pidilite etc. early based on some valuation threshold and not understanding the power of
long term compounding in these ideas. So instead of selling, I should have been buying
these stocks in my portfolio.

To add insult to injury, I did some calculations and realized that the opportunity cost was at
least 50X of all the losses I have incurred till date in all my positions.

I highly recommend analyzing your mistakes in depth – the learning is invaluable and
anyway at least something good should come out of a mistake. I think this mistake made
me realize that if you have a winning hand, play it out fully. A few wining positions over a
lifetime is all that is needed to have a good investment record with a lot less stress.

SN: Hypothetical Question: Let’s say that you knew you were going to lose all your
memory the next morning. Briefly, what would you write in a letter to yourself, so
that you could begin relearning everything starting the next day?

RC: I would ask myself to read the Bhagavad Gita starting next day. If one can
metaphorically wipe the slate clean and start from reading the Bhagavad Gita, I think one
would actually be in better place in life after this event.

Of course I will also list the names of my family members, close friends and a few people I
admire so that I can talk to them and rebuild my life in the right manner.

SN: Which are some the books on investing, behavior, and multidisciplinary thinking
7/8
that have inspired you the most over the years? If you were to give away all your
books but one, which one would it be and why?

RC: Here are a few –

The Intelligent Investor – Benjamin graham

The Most Important Thing – Howard marks
Common Stocks and Uncommon Profits – Philip Fisher
Poor Charlie’s Almanack – Peter Kaufman
Bhagavad Gita

I would keep the Bhagavad Gita. It is the source of all wisdom in life and I think one can
never be wise enough.

SN: Who are some of the people – inside or outside the value investing circles – who
have inspired you the most over the years, and why?

RC: Warren Buffett for his investing philosophy and approach to work, Charlie Munger for
his multi-disciplinary thinking, Ekanath Easwaran for his spiritual teachings, my wife for her
empathy for others, and my mother for her energy and drive.

SN: If you had just five-minutes to advise someone wanting to get into investing,
what would your advice be? What are the pitfalls he/she must be aware of?

RC: I would first ask the person why he or she wants to get into investing? Does the
individual want to learn the basics and thus make better decisions for his or her long term
financial goals?

In such as case, I would ask the person to find a few good books on personal finance and
understand the basics on savings, compound interest and the various options on passive
investments such as mutual funds, real estate etc. This would enable the individual to make
informed decisions about his or her savings over a life time. On the other hand, if the
individual wants to get into this field as he thinks this is an easy way to make money and
get rich, I would advise him to drop the whole idea and find something else to pursue.

One needs to be passionate about this topic and be ready to learn and pursue it for a long
time even if the returns don’t materialize for an extended period of time. If you are
fascinated by this field and ready to learn over your lifetime, then it can be quite a bit of fun
and in the end rewarding too.

SN: That’s a wonderful thought, Rohit! Well, thank you so much for the insights you
have shared!

RC: Thanks for the interview, Vishal! I really enjoyed it.

Note: This interview was originally published in the October 2016 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.
8/8
Value Investor Interview: Rajeev Thakkar – Part 1
safalniveshak.com/value-investor-interview-rajeev-thakkar-part-1/

Vishal Khandelwal July 25, 2016

Note: This interview was published in the January 2016 issue of our premium newsletter,
Value Investing Almanack. To gain instant access to more such interviews and other
interesting stuff on value investing and business analysis, click here to subscribe now.

Rajeev Thakkar possesses over 15 years of

experience in various segments of the Capital
Markets such as investment banking, corporate
finance, securities broking and managing clients’
investments in equities. He is currently the
Director and Fund Manager at PPFAS Mutual
Fund.

Rajeev’s tenure at PPFAS began in 2001. His

passion for researching and analysing the
fundamentals of companies was evident from the
very beginning and very soon he was heading the
Research division at PPFAS. His responsibilities
soon expanded as he was appointed the Fund
Manager for the flagship scheme of the Portfolio
Management Service, titled “Cognito” in 2003.

Rajeev is a strong believer in the school of “value-investing” and is heavily influenced by

Warren Buffett and Charlie Munger’s approach. In his interview with Safal Niveshak,
Rajeev shares his wide investment experience and how investors can practice sensible
investment decision making.

Safal Niveshak (SN): Could you tell us a little about your background and how you
got interested in value investing?

Rajeev Thakkar (RT): A lot of it is luck and lot of it is the ovarian lottery, as Buffett talks
about. I think a lot of credit should go to my father in this regard. He has been an equity
investor since 1980, if not earlier. In those days of no internet and physical annual reports, I
used to see annual reports coming in with some regularity to my home. That made me
curious about equity investing. We had those conversations when I was eight years old. I
didn’t start investing like Buffett at an early age but I knew about equity investing at an early
age.

Also, my father was somebody who was not into the tipping thing or trading. At that time, he
would subscribe to two magazines. One was Capital Market and other was Dalal Street
Journal. I did not have exposure to Benjamin Graham and Warren Buffett at that time. For
that period, we had few investing books. One I remember was by an Indian author who
spoke about investing in India, which had the basic concepts about balance sheet, equity
1/7
base, earning per share, dividend yield, etc. But the framework wasn’t as robust as Philip
Fisher’s or Benjamin Graham’s or Buffett’s. Basically it spoke about investing rather than
speculating. It was a big advantage to be exposed to such a thing as an eight-year-old.

My graduation year was 1992. That was the period when India was getting transformed in
terms of licensing being removed and at the same time there was some glamour attached
to the stock market. Harshad Mehta and the stock boom happened, a lot of which was
because of manipulated stocks. But still stock market was being seen as a place where a
lot of wealth could get created. So post 1992, I went in for Chartered Accountancy but the
plan was always to get into stock investing. From 1992 to 1994 I did my normal articleship.
In the third year of articleship, you’re allowed to be in a company instead of a CA firm. So in
the third year itself I moved to the investment banking field. It wasn’t direct equity research,
it was more of IPOs and stuff like that. At least I was interacting with the capital markets,
knew about companies, and could look at various businesses. Another big pivot was when
I joined this organization [PPFAS] in 2001 and had a chance to meet with Mr. Chandrakant
Sampat. He was a well renowned investor in India, and almost a contemporary of Buffett
and Munger. I learned a lot from him.

So the whole grounding, of looking at quality of business, quality of management and

capital efficiency, came in after meeting Mr. Sampat. Prior to that it was only buying cheap
stuff like net-nets, stocks with good dividend yield, or ones with low price to earnings.

SN: Great! You mentioned about starting from buying cheap stocks, learning about
Buffett and then getting involved into what Mr. Sampat taught about capital
efficiency. It’s very difficult for us to let go of what we have learned in the past and
unlearn and relearn new kind of things. So how smooth was the evolution for you?

RT: I am a living example of how difficult it is to let go of things. Somewhere, intuitively I

clearly knew that an equity investment held over long term will give you superior returns
than owning a bond. Another thing that I roughly calculated in my mind was that if a stock’s
P/E is, say, 5x then its earning yield was 20%, i.e., if a stock with P/E of 5 is earning a 20%
and if part of that is paid out and other part is deployed sensibly, what can go wrong?

That was a simplistic way of thinking in those very-very early days. But understanding
about capital efficiency, understanding the nuances of how some of the FMCG companies
expense out their capex, how all the brand building gets expensed out or the idea of
“capacity to suffer”, or how without deploying capital earnings can grow dramatically –
those things were not known to me. Incidentally, I have spent a few years doing
government bonds and doing fixed income securities. So for me letting go of Graham has
been a very difficult process. Even when I recognize good quality names, I am not very
comfortable in paying seemingly expensive looking valuation. Many of my mistakes are in
terms of not paying up enough rather than overpaying. That’s where I stand currently. I
have recognized that there is a different price that you have to pay for a higher quality
business. But beyond a point I just let go.

SN: I have seen a lot of value investors evolving from Graham, i.e., focusing on
what’s cheap, to paying up for quality. Does Graham’s philosophy really work now?
If we keep aside the margin of safety principle, purely in terms of business analysis,

2/7
is it possible to get Grahamian ideas?

RT: Some of the things like getting net-nets may be very difficult, but otherwise buying
statistically cheap stocks works. The only difficulty is that you need to go in and come out. It
can’t be a buy and hold kind of scenario. And these won’t be compounders. These will be
things where you buy at 50 cents to a dollar and get out at 90 cents to a dollar. Then go out
and buy something else.

When the overall market is at a higher level, sit on cash or twiddle around doing some
workouts or risk arbitrage. It works, but it’s more hard work and probably less rewarding.
But sure you can beat bonds any day and you can grow your money in a low risk fashion.

SN: Have you done that in your career or have you always been a long term
investor?

RT: I have done that. Even in Graham plays you have to wait out 2-3 years for that to really
give returns. I have done a bit of that.

SN: What about now? Currently you focus on long term compounding stories or
you’re still open to statistically cheap bargains?

RT: It’s alluring. You can’t let go off it completely. The other thing is that investing is an
opportunity cost game. It’s an activity where you look at your alternatives. So if you’re
sitting on cash and workout comes around, rather than let that cash be in money market,
you can deploy it for few months in a risk arbitrage or something. So I keep looking at that
space.

SN: Talking about Mr. Parag Parikh, he seems to have had a great impression on
you. What are some of the key learnings from working under him? Can you talk
about a few big lessons from him which have helped you in life as well as in
investing?

RT: The impact has been enormous. One key thing has been the concept of an inner
scorecard. It’s been articulated by Buffett but Parag Bhai was a follower of that. Whether it
was about his decision to not go for opening branches all over the country in the brokerage
business historically or hiring an army of analysts to get into the institutional brokerage
business to gain market share at the cost of profitability. He let go off the fear of what other
people think or what a competitor is doing. He always, whether in business or in life, went
with what he felt was the right thing to do and never got into the trap of imitating others or
being afraid to take a path less travelled.

Another amazing thing was the concept of work-life balance. He wasn’t someone who
would slog from 9 AM to 9 PM. He always believed in devoting enough time for exercise
and physical health, devoting enough time to pursue some hobby or personal interests.

Behavioural finance was something I came across through his writings even before I joined
this organization. I read his article in 2000. That was something that helped a lot in
understanding the traps that we fall into, the shortcuts that mind takes and mind games that
are played by us on ourselves. Those were the key learnings.

3/7
SN: You talked about behavioural finance. In managing your own money and
managing someone else’s money, I think the behavioural biases that we fall into can
be different. So what are the key behavioural issues you often come across while
managing other people’s money?

RT: The first key thing, if you’re managing other people’s money, is to get the right kind of
investors. If there is a mismatch between what you can deliver and what your clients’
expectations are then you are headed for trouble from day one. Although, we run an open-
ended mutual fund, from day one we have been communicating that if your investment
horizon is less than 5 years then this is not the place for you.

I was going through Safal Niveshak’s website and in the “About Us” section you tell your
audience that if you’re looking for short term quick fixes or get-rich-quick stock tips then
don’t waste your time over here, but if ever you learn your lessons and come back, you will
be welcomed with open arms. Essentially we are that. In our communication with clients
and distributor partners, the key message is that our mutual fund scheme is not a vehicle
for short term. We don’t have a dividend plan in our mutual fund, because this is not an
income generating asset class. This is an asset class to grow wealth and to compound
money. It’s not something which will give you predictable returns every year.

A lot of funds, to encourage people to invest in their funds, don’t have exit loads. For us the
money generated from exit load is not an income for the fund house. Exit load is ploughed
back into the scheme so that it benefits the remaining investors. We have said that if you
try and time the market, come in and go out in short intervals, we will levy a penalty on you.
So that also acts as a barrier for people coming in for a short period of time.

So once you have aligned the kind of clients that you have with your investment process, I
think a lot of problems go away. Because then you can manage the money exactly the way
you would manage your own investments. So that is the first starting point. And the second
is, if you look at it as a profession rather than a business, as John Bogle keeps saying, then
you have to completely let go of the fear of losing assets or losing clients. As someone has
said, it’s better to lose half of your clients than to lose half of your clients’ money. If you’re
willing to accept that, then there is no problem at all. When it comes to insurance
underwriting. Buffett and Ajit Jain do not write the insurance at all if the premiums aren’t
right. Your current underwriting may be 10 percent of what you did last year or it can be 10
times. Unless it makes sense one shouldn’t do it.

Anyways, let me now answer a corollary question you have in your list – How we behaved
in 2009 and whether it was a difficult period for us and were we able to buy stocks at that
time? Actually 2008-2010 were the best years for us. And it was very easy. The most
difficult year for us was 2007. In 2007 we were underperforming the indices by huge
margins. And this was the period where the favourites of the market were the likes of DLF,
Unitech, GMR, GVK, and all the commodity companies – Sesa Goa, Tata Steel, SAIL, etc.
We couldn’t understand any of those. We were having zero exposure to infrastructure,
commodities, and real estate sectors. And we were hugely underperforming. For fresh
clients we were holding cash. Most of the clients who had been with us for long, who
understood the process, stuck around. Those clients who were jittery or were impatient

4/7
went away. So the message by Parag Bhai was clear – “Keep your cheque book ready;
anyone who wants to exit let them go. We shouldn’t change our investment process
because of what market is doing.”

And within a couple of years all the performance numbers came back on track. All that
frenzy went away. The cash that we had helped us to buy a lot of good stocks at throw
away prices when the markets were down and out. Our clients also gave additional money,
because we hadn’t lost money for them in the downturn. Some of the out of favour stocks
like FMCG and pharma companies strongly rebounded at the time of global financial crisis.
For us, runaway bull markets are actually more difficult to manage than bear markets.

SN: It talks a lot about having the right kind of process and sticking to it. Right?

RT: Right kind of process and right kind of clients. A lot of a fund manager’s behavior
depends on the kind of clients he has. If there is alignment and if there is commonality in
thinking, it goes a long way.

SN: I think this is in line with what Charlie Munger says about knowing where he was
going to die, so that I he never went there. So you don’t want the clients that can kill
you. And that takes care of lot of biases. That’s great insight Rajeev! Anyways, you
talked about sticking to high quality businesses through ups and downs. Can you
list down some key characteristics of high quality business, or a checklist that you
use to identify such businesses?

RT: We don’t have a long checklist running into many pages and breaking down each
variable. Broadly the starting point of checklist was, as Buffett has been saying all along,
promoters with competence and passion for their business. Then high return on equity, high
return on capital. Businesses with some kind of moat or barriers to entry. Less leverage so
that it’s not vulnerable to down cycle. There shouldn’t be liquidation risk and it should be
within our circle of competence – something which we can understand. And finally it should
be available with some margin of safety in terms of reasonable valuation. That’s the basic
checklist. Within that we can have very detailed break ups.

Of course there is Atul Gawande’s book The Checklist Manifesto. Munger has spoken
about it. Even Mohnish Pabrai keeps talking about it. I think there is an investment book
about it too – The Investment Checklist. It’s not a printed manual for us where we keep tick
marking each box but broadly these are the 4-5 factors we look at. The questions that we
ask in our internal presentations and in the brainstorming session – what are the risks that
are there in terms of the thesis we envisage in what could go wrong.

SN: That’s a simple yet very effective checklist. Now, what are the rules for exit that
you follow? When do you decide to sell a stock from your portfolio?

RT: We start with the same criteria as entry and then look at exit as the opposite of an
entry. Our criteria for entry are – great promoters and management in terms of competence
and passion for business, high return on capital, high return on equity, some moat in form
of entry barriers or some sustaining power, a business that we can understand, low
leverage and a price with reasonable amount of margin of safety.

5/7
In most cases the beginning part remains the same, only the price changes. Sometimes,
out of five buying criteria we have four positives and one negative, then the selling
becomes difficult. Especially when we know that intrinsic value is not a point estimate, it’s a
range. You can’t say the intrinsic value of a stock is Rs 1,562. You can say the intrinsic
value is between Rs 1,000 and Rs 2,000. It can be a broad range also. So if the entire
margin of safety is lost plus the price is moving beyond the upper bound of our intrinsic
value estimate then we start selling in stages. Since we don’t know the precise intrinsic
value and typically such stocks start becoming bigger and bigger proportion of our portfolio,
we try to bring down their portfolio weights and gradually exit at a price which we feel is not
justified by fundamentals. It would happen in stages, not in a single shot where we wake up
one day and completely exit the stock. Whereas, if there is deterioration in any of the other
factors – let’s say we assumed that the promoters were honest and they turn out to be
crooks or we invested in Kodak and suddenly see that digital cameras are gaining traction
and photo film will be out of action i.e., the whole business characteristics have changed
then it may require a sale even at a loss. In this case it would be an exit in a short span of
time. There are these two different kind of exits.

SN: Have you ever faced a Kodak moment in your investment career? I mean a case
where you have sat on an investment thinking it’s going to recover but ultimately you
had to sell off.

RT: Not exactly a Kodak kind of thing but it comes down to a common theme on
investment mistakes. One common theme that I can see in my mistakes in the past and
especially true in the Indian context is that you can place only a certain percentage of
reliance on free market capital or free market economies. Finally, there is public perception,
populism and regulatory mechanism. Somewhere things will not pan out the way you
envisage even if you have taken care of everything because of people not willing to honor
the contract.

I’ll give you some examples which will help understand the concept. Look at oil marketing
companies. What’s their business? Take the crude oil, refine it and sell the products to the
networks. An oligopolistic business. HPCL, BPCL, IOC – mainly three players, all PSUs.
Many years back they were quoting at extremely attractive valuations and crude oil price
started rising continuously after that. So the economic theory will say that these oil
companies will have to keep increasing the retail selling price of their products in the
marketplace. But populism demanded that price increase shouldn’t be allowed so
government clamped down on the retail selling price, while forcing these oil PSUs to take
losses. Some subsidies were given but still it was huge financial burden for these oil
companies and subsidy was also given in terms of bonds.

The other example one can think of is domestic pharma companies, where price controls
keep coming up every now and then. Third example I can think of is – toll road operators. A
lot of these people raise capital, create infrastructure, or improve the infrastructure but
suddenly if public expectation is there – no this should either be free or priced at a very low
level – things may not work out as planned. Or look back to the Enron fiasco in India. The
Dabhol power project. Enron thought it had a great deal. Government guaranteed contract,
dollar denominated returns and everything. But people said – we can’t afford it. We’ll not
honor the contract. And they had a problem. Even in the US context, Martin Shkreli who
6/7
jacked up the prices of the generic drugs by a factor of 10 or 20 and then there was a hue
and cry. Hillary Clinton called it unethical. So what he did was legal, may not be morally
right but within the bounds of the law. This could apply to even private sector hospitals.
People may feel that the medical care cost is similar to what you would pay in Singapore
and somewhere else in Europe and America. We may have the best doctors and best
equipment but if the patients feel that it’s excessive then there could be a riot and political
agitations. In Delhi we have seen power companies where suddenly government
intervened to cut down the power cost by half. Wherever there is government involvement,
be extremely wary of shareholders rights being protected.

In HPCL, BPCL, and Air India we have seen those things happening. And even if you’re in
private sector, if there is a possibility of a political agitation happening or if so called public
interest factor being thrown in, then don’t rely on a patent or a contract. My capitalist rights
will not be protected when push comes to shove. The government, the bureaucrats and the
judiciary will always side with the agitators. Don’t rely on contracts to make your
investment. That’s one recurring thing. I have seen that in PSUs. We have a mixed
economy. Whenever a politician could get involved and lead an agitation and say I’ll
determine what price you can charge, in that business there is a risk.

SN: Being a fund house, how do you feel about holding cash for long period of time
across market cycles? You mentioned that you did well with right kind of clients and
right amount of cash during the 2008-09 crisis, but overall what’s your philosophy
about cash? How do you treat cash?

RT: We don’t deliberately try to keep cash at all points of time. Since our hurdle rates are
very high, we start out with an objective of delivering a 15% kind of return which is a
reasonable bond beating returns from equities. Cash is what’s there as residue after we
have deployed in equities and not finding significant opportunities. So typically cash would
increase where valuations are very high and we are constrained for opportunities. At such
times we’re not averse to holding cash. We don’t start out saying we want to be 20% or
10% in cash. Some amount of cash always needs to be maintained to meet outflows and
redemptions etc. But every small inflow we don’t run out to buy shares and similarly every
small outflow doesn’t require us to sell shares. The final portion of cash takes into account
inflows-outflows. But beyond that it’s essentially lack of opportunity.

To be continued…

Note: This interview was published in the January 2016 issue of our premium newsletter,
Value Investing Almanack. To gain instant access to more such interviews and other
interesting stuff on value investing and business analysis, click here to subscribe now.

7/7
Value Investor Interview: Rajeev Thakkar – Part 2
safalniveshak.com/value-investor-interview-rajeev-thakkar-part-2/

Vishal Khandelwal July 27, 2016

Note: This interview was published in the January 2016 issue of our premium newsletter,
Value Investing Almanack. To gain instant access to more such interviews and other
interesting stuff on value investing and business analysis, click here to subscribe now.

Read Part 1

SN: Is there a mechanism in Mutual Funds where you repay cash to shareholders if
you’re not finding opportunities for a long period of time?

RT: Some people do it by the way of dividend payouts. Other mechanism is that you can
shut the doors for the inflows. What you can say is that I’m not getting opportunities now so
I wouldn’t be buying anymore. Lot of people have done that also. So you shut the door and
say I’ll not take any more inflows from this date onwards. And you can open it as and when
the opportunity arises. You can keep it shut for may be 3-6 months or 1 year or whatever
period you deem fit.

SN: Being a fund manager, what are your thoughts on indexing?

RT: Indexing has a very important role to play but you can’t overemphasize it. People
typically fall into two categories. One category of people are completely pro indexers. And
the other is people who are completely against indexing. I am someone who is in between.
So at one side indexing acts as a huge control on excessive fund management fees. Since
indexing is a low cost mechanism for people to participate in equity markets. It’s a fact that
if all the money were to be managed by professional managers the aggregate return that
they give to investors will be market return minus fees. They can’t outperform themselves
as a group. So mathematics is fine and I appreciate indexing from that point of view.

At the same time, there is a very interesting piece written by Seth Klarman on indexing. He
asks us to do a thought experiment. Let’s say that the entire market moved to indexing and
there are no active managers left in the marketplace. So there was one giant index fund
operating at absolute low cost and whatever was the market return was the return to the
investors.

In such a scenario that fund house should have logically fired all the fund managers and all
the analysts because only one person is required who is allocating the money as per the
index weights. In such a scenario there would be no one left to vote for shareholders
because it wouldn’t matter what salary the promoters are paying themselves, it wouldn’t
matter whether they are doing shareholder friendly or unfriendly mergers and acquisitions or
spin offs. There would be no buyers of IPOs because at the time of IPO the share isn’t in
index so no fresh capital raising would ever happen in the economy. There would be no
relative variation in prices of various companies irrespective of how they are doing in terms
of profitability.

1/9
So if Company A tripled its profits and Company B fell by 90% they would continue to get
inflows from the index funds in the proportion of market weights. That would be a
completely illogical market where everything is formula driven and mechanized.

The role of active managers is to act as a watchdog for the company management and to
allocate funds to more capital efficient promoters and management, to channelize funds to
right direction. At the same time, they can’t be too greedy for charging excessive fees
because ultimately they have to deliver good return after fees and they have a strong
competitor in terms of an index fund which is doing it for low cost. I think both will co-exist
and as asset sizes grow there will be pressure on managers to reduce the expenses in the
system.

SN: How do you think about valuations and how do you address the complex
problem of differentiation between paying up for quality and overpaying?

RT: I think the first decision in any business evaluation that I make is – how many years out
can I see the business. So when Prof. Sanjay Bakshi says about Cera that its business
would not change much with technology or Internet, I tend to agree. Making basins and
toilet pots isn’t going to change dramatically. But if you’re a cable TV operator or a satellite
channel then streaming video could change things dramatically. If you are a newspaper,
then you are aware of the threat that internet poses for your company. So it depends on the
horizon that you can project into, or where you can have some reasonable visibility, and
most case it would be not more than 5-10 years and in some cases it would shorter.
Shorter the visibility, lower the valuations.

The characteristic of the moat is that it either widens on a continuous basis or it reduces.
It’s a continuous widening or reducing action. It doesn’t remain constant. If the moat is not
going to be around, then paying a very expensive multiple doesn’t make sense. If you’re
paying 40 times for a business, ignoring the growth part of the business, then you’re saying
that it will take 40 years for the business to earn back your initial investment. And if your
visibility is not beyond 5 years then how can you pay that valuation. It’s a very rough
heuristic. If you are paying 40 times earnings and next year, the profits grow four-fold it’ll be
a 10x P/E. I’m not saying P/E is the be all and end all of valuation. But it has to be in
conjunction with how strong you think the moat is. And if one is humble then he would
realizes his own limitations and also the fact that the humans are a bad predictor of the
future.

There is this great piece by James Montier on fallacy of forecasting. If you do a google
search on the “famous incorrect predictions”, you’ll realize that even the so called experts in
the field don’t get it right most of the times. For example, IBM thought that there was no
market for personal computers and that’s why they gave away the DOS to Microsoft and
allowed Microsoft to dominate the Operating System market.

So given that track record I am not confident of looking far into the future for most
businesses. Because of that I am most stingy in terms of paying too high a price. Stephen
Penman, in his book Accounting For Value, has given a good framework for this. It says
that you calculate something called true intrinsic value and you calculate speculative value.

So what is true intrinsic value? Let’s say you are able to see somewhat confidently for the
2/9
next five years. You discount those cash flows to present value, that’s the true intrinsic
value. And then you say this terminal value based on some assumptions is the speculative
value. So the bigger the portion of intrinsic value, the bigger the comfort. Otherwise you are
just making wild bet. One of the reasons I am not able to pay far too much, at least it’s my
personal opinion and people have different view on it, because my view of the world is that
it’s changing faster than it used to change in the past.

Look at history. In the initial years the lifestyle and technology didn’t change much from one
generation to the next. The rotary telephones we had, the same instrument would last for
10-15 years. Till it broke you wouldn’t throw it away and get a new one. Whereas these
days, people change their cell phones every 1 or 2 years as new models come in. Given
the fact that change is increasing its pace, you should shorten your horizon to that extent.
True that you can’t pay the same price for a high quality business vs a low quality business.
But there is a limit. I don’t know if that answers your question.

SN: It does and it actually gives me another question about things changing very
fast. If businesses are changing, I think the valuations should be changing. In such
an environment, how do you look at this concept of ‘moats’? You said it’s always
increasing or gradually decreasing, right?

RT: It could be a sudden increase or sudden decrease.

SN: Right. Now, people give high valuations to FMCG companies and to big banks
with brand power. Big companies with deep pockets can easily erode the existing
moat of others. You also said that government regulations and patents couldn’t be
moat. So how do you figure out if the moat is sustainable or fleeting?

RT: You have to be extremely wary and keep your eyes and ears open. There is this signal
vs noise thing. Sometimes you may mistake a noise as a signal and get scared out of a
company which has a good moat, whereas in some cases you would assume it as a noise
where it is a signal and not come out of it before it’s too late. So you have to balance both
the factors. But again some of the things that used to be strong moats earlier may not be
moats anymore. You mentioned one, which is brands. So most of the brands, historically,
have been built by financial muscle and dominating media for a long time.

If you were a Hindustan Lever at that time, then you went down saying “lifebuoy hai jahan
tandurusti hai wahan” repeatedly over decades on television and you kept bombarding your
audience with that message. And that was brand, that was a moat. For someone else to
come in was very difficult. Because you’d have to have financial muscle to buy the
television advertising for all over India on such a scale and have that kind of distribution
network too. But those days of broadcasting of one-way media is now giving way to two-
way interaction between businesses and consumers and things like social media and
‘narrow-casting’.

So earlier a shop owner gave you a shelf space and the consumer had seen that brand
repeatedly on TV so he thinks that it’s a good and reliable brand and buys the product. That
is giving way to things like, different people have given reviews on Facebook or Twitter. On
an ecommerce website like Amazon you’ll have consumer feedback and reviews. And if
customer feedback is not strong your product will fail. Whereas something which has not
3/9
been heavily promoted but has good user feedback and good word of mouth, that brand
could take off in a big way.

Some of the people who have gained a lot of market share, for example Samsung is a very
heavily advertised brand whereas Chinese companies like OnePlus or Xiaomi as phone
makers are not that heavily advertised but they have a good price point, they have word of
mouth recall, they get positive reviews in newspapers and magazines and that is enough to
gain market share and gain customer loyalty. So it’s a changing world and I don’t know how
things will be in the future. So today “fulfilled by Amazon” or an Amazon quality guarantee
or Amazon saying that we’ll take back the product if you’re not satisfied is as good as brand
for me. Even if it’s an unknown company selling to me, as long as Amazon is in between
and they promise to make good any defect, I would be willing to try out new things. So
things are changing fast. A brand and a distribution network was a big advantage in the
past, may not be true today.

SN: This is where Graham comes into picture where you have to have the margin of
safety of whatever high quality business you are buying, because you never know
that the moat or what you are paying for is coming down or whether it will exist for
next 5-10 years.

RT: I would have thought that Dabur is a great moat and a great brand but I didn’t know that
Patanjali would come with someone who is a Yoga teacher and has wide following. He’s
right in terms of following traditional Indian products and Ayurveda but I would be very
worried if I am selling Dabur Chyavanprash or Dantmanjan.

SN: What about risk? You talked about different kind of risk to business – moats
deteriorating, valuation going haywire. How you think about risk apart from general
definition of having permanent loss of capital? And how do you employ that mindset
of keeping risk low in your investing?

RT: It’s here that, to a small degree, there is a difference between managing public
investments and managing your own money. When you’re running an open ended unitized
fund, any person who comes in and invest money in your scheme is buying shares at
today’s market price, not at your historical cost. That’s why you have to be wary of not
owning too many companies which are at the upper end of the valuation bound or beyond.
Even though your original purchase price is quite low.

Second is, the way Buffett defines permanent loss of capital saying I’ll hold it for 10-15
years it will eventually work out, if your client’s investment horizon is 5-6 years, you have to
make sure that within that time period you don’t lose capital rather than 10-15 years.
Volatility isn’t risk is true as far as daily or weekly volatility goes, but for 2 to 5 years’
volatility you have to be aware of those kind of volatility saying you shouldn’t have a big
drawdown in 4 to 5 years.

Again, some people are big fans of very concentrated portfolios. I understand that you can’t
have 100-200 stocks because that will dilute your best ideas, but at the same time one
wouldn’t be too comfortable having let’s say 10-12 stock or a very limited portfolio. You’ll
need to have reasonable amount of diversification say, 20-25 names so that anything going
wrong in one or two businesses doesn’t affect your investment too heavily. You have to
4/9
come at something like a golden mean, not excessively diversified vs not too concentrated,
where one or two things going wrong could upset your overall returns of your capital.

SN: What’s your advice for an investor who wants to improve his/her decision
making? Is reading enough?

RT: Reading is a hygiene factor. You have to do it. But it alone may not improve quality of
decision making. Two things come to mind to improve quality of decision making. One is to
keep an investment journal. Jot down your thought process when you are buying something
or rejecting something and then periodically revisit that as to how things have panned out
and what are the things you missed out originally. That improves your decision making.

The second is make fewer decisions. This thing I have seen very strongly in Mr.
Chandrakant Sampat. He would stick to an extremely small set of companies that he would
cover and understand or decide upon. Again, number of trades in a year would be very few.
At most times there are thousands of cons to either buying or not buying, selling or not
selling. Whereas at some points it’s blindingly obvious. You can’t miss it. It screams at you
that this should be done. When you act at such time the quality of decision making will be
far superior.

Buffett has also talked about it in terms of a punch card where you have 20 investing
decisions over your investing career. So fewer decisions you make the better. You’ll put
that much more time and effort into arriving at that decision whereas if you’re making a
decision every day or every hour then seriousness doesn’t go into that decision. So just like
most people get married once in their lifetime, you give a lot of thought to it – most people
do. Marriage is an extreme example. Even when you take a job you plan to spend at least a
few years in that company. People give serious thought to it. Why should it be different for
stock investing? You can’t be on a train and some guy sitting next to you says that this
stock looks good and you go out and buy it. It can’t be that.

SN: It’s good to be positively optimistic about the world but if you remove the angle
that you are managing money and were a personal investor, what’s your thought
about where the world is headed in terms of money and finance, given the way that
central banks globally are turning the entire planet into a zero cost kind of thing.
How do you think this is going to play out in the long term?

RT: I don’t give too much thought into it. Very recently Charlie Munger has said that he’s
surprised that so much money printing is going on, interest rates are so low and yet
inflation is not there at all in most of the world. This poses a greater risk to fixed income
investments or the currency notes that you and I have in our pockets than to the
businesses. Buffett has said this numerous times.

If you are the best heart surgeon in town, irrespective of what the currency is, whether the
US dollar was up or down, whether people moved back to exchanging gold coins or shells
as currency or bitcoin, your service will be valuable to humankind and people will be willing
to exchange goods and services for your expertise. Same thing carries over to businesses
that provide good or services to the population. So if you are pharma company making life
saving drugs, whether interest rates are zero or 20% or negative, people will still be willing
to give up their time, labour, effort and capital to get your product in return.
5/9
As long as you have that business view right, focusing too much on macro may not make
much of sense. However, there is one thing that confounds me. Switzerland for example,
their 10-year bond is at negative yield and Nestle which is Swiss company is about 22
times earning where earning is equivalent to cash flow because there is not much capex
etc. So if we could borrow money in Swiss currency or government bond for 10 years and
buy a Nestle, this one will at least give you may be 50% of your principal amount in
earnings over 10 years and you just have to repay what you have borrowed effectively or
even less because the yields are negative.

Interest rates, even long term interest rates, are so low, hence the opportunity cost for
equity investors is that much lower. If you are a pension fund or endowment fund, where do
you put your money today? In a low inflation environment, you should be prepared for a
lower nominal return. When Indian inflation was closer to 10% and we were getting 15-18%
equity return, if our inflation were to fall to 5%, you should be happy getting 10% equity
returns.

We should be prepared for lower nominal returns. So I don’t worry so much about macro as
long as the business is right. It’s not that I predicted that in 2009 there would be a crash. I
was clueless. The reason we held on cash was because we were not understanding DLF,
Unitech, GMR or GVK. It’s not that we had any foresight that Lehman Brothers would go
bankrupt. I hadn’t even heard of subprime mortgages or what is CDO or CMO etc.

SN: What’s your quick advice to someone who wants to get into value investing?
What are the pitfalls that he or she must be aware of?

RT: The only pitfall is that you’ll not enjoy the riches of youth. Raw material of investing is
money, so if you start with Rs 100 and make a 25% return the first year, you can’t go out
and consume that Rs 25. You require Rs 125 to compound next year. In your youth you
have to live a frugal lifestyle to really compound wealth to become wealthy.

Lot of people come to investing with expectations. Unfortunately, lot of advertisement on

mutual funds also say that invest now and ride in a Mercedes. Most value investors I have
seen are frugal people who don’t splash money around. They can retire comfortably and
achieve financial independence rather than a flashy lifestyle. If you’ve inherited a lot of
money you can live a flashy lifestyle as well as be a sensible value investor. Otherwise it’s a
long term game. You can get financial independence and you can retire wealthy. You can
either leave behind a large legacy for charitable or philanthropic work but if you’re expecting
to suddenly become a billionaire, it doesn’t work that way. Even Buffett made most of his
wealth in old age. It’s the nature of compounding.

SN: I think compounding should be taught in school. More important in

compounding is that it’s back ended. You have to have time on your side. Great! So
what are some unconventional books and resources you would recommend to a
budding investor?

RT: Rather than a book or a resource, it’s an activity. I think someone who has parents who
have been salaried employees and who does conventional education like MBA, CFA,
Chartered Accountancy or Engineering and then straight away comes to investing, starts
with a big disadvantage. Buffett has said this numerous times and it’s absolutely true. He
6/9
says I am a better investor because I am businessman and I am better businessman
because I am an investor. When you have an experience in running some kind of a
business or a professional service it gives you unique insights to investing. Being in
business and actually being an entrepreneur gives you that multidisciplinary thing.

Let’s say you’re a sole proprietor starting out. You have to understand finance, you have to
raise money and figure out whether that will generate adequate returns or not. You have to
understand accounting to see whether your business is making enough profits or where do
you stand on a continuous basis. You have to have human resource capabilities to recruit,
motivate, monitor and compensate people. You need sales and marketing capabilities to be
able to go out and get customers and grow your business. You need some legal expertise
for clearing all the regulations.

It may be a simple thing like a municipal permit for a restaurant or a shopping establishment
license for your store. It also gives you that perspective that running a business is not
linear. There are ups and downs. And in fact sometimes I laugh when I see brokerage
reports by well renowned people which say that we ran a screener and only these
companies grew profits in each of these quarters. Business doesn’t run that way. You can’t
have a linear growth in each quarter. Why should it grow every quarter? When you run a
business on your own you get that approach to investing in company as a business.
Otherwise your knowledge of this concept – buying an equity share is partnering in a
business, it’s not buying something which is quoted on the exchange and goes up and
down every day – is only at a superficial level. You don’t get an owner’s perspective.

Another thing is, if you have done accounting or auditing for these large corporates as a
chartered accountant or as an auditor, that enables you to take those quarterly report or
even annual earnings numbers with a pinch of salt. I don’t know how you can place so
much reliance on one quarter’s or one year’s accounting estimate for an entity like a bank
or even some of the manufacturing companies. It’s an estimate. Effectively, you should
have a view of the business as an unfolding movie rather than a snapshot. That comes only
after running a business or understanding how that accounting happens. Otherwise people
know it only at a superficial level.

SN: But for most people who neither have a business background or running a
business?

RT: I have not run a business in a traditional sense. But today we run PPFAS. It’s not
linear. We have periods like 2007 where we underperformed severely where we don’t
understand the fancied sectors for a period. Where we see client outflows. We have periods
like 2009 where markets are down and out so growth doesn’t happen and people are
reluctant to put in money. We face challenges in terms of recruiting people and creating
awareness.

Let’s say you run Safal Niveshak. You will face challenges in terms of how to make the
website well known among people. How to get more people to sign up for the programs
and seminars? It could be small things like that. But unless you have actually implemented

7/9
something and you have understood the challenges of human resources, marketing,
finance and you really know how a real life organization or business works you will
understand things only at a superficial level.

In a lot of conference calls and analyst meets that I attend as an investor, the whole
question is on this quarter’s number or guidance for the next quarter or projections. Things
don’t work out that way. Let me ask you – how many people do you predict will sign up for
your course in the next quarter. That depends on so many factors. You may not have a
precise number. If you give a precise number, then you are just making things up or it’s your
best guess. A lot of people don’t get it. A lot of people don’t understand business at an
intrinsic level. They only understand at a superficial level. Also when things go wrong, how
long will it take to rectify? If a pharma company gets a FDA notice, people say by when will
this be resolved? A lot of these things are fluid. Lot of interaction has to happen with a
regulator. A lot of bureaucracy is involved. Timelines are usually underestimated. These
things are known only if you have experienced something similar in your life. Otherwise you
think everything is cut and dried and everything becomes a point estimate for you.

SN: I think running a business helps you empathize better with the promoters.

RT: You asked me a very good question. What happens if you don’t have a business and
you still want to become a better investor. Become a secretary of your cooperative housing
society. It will give you challenges like dealing with the municipal corporations, how tax
notices come out of the blue for retrospective taxes, how dealing with other members of the
society becomes challenging, or how to make compromises. It tells you what the real world
is. Otherwise we are sitting in our air-conditioned offices in silos, and only looking at
spreadsheets. If all you’ve looked at is spreadsheets in your life, you can’t be a good equity
investor.

SN: That should also be an advice for someone who wants to get into value
investing that you need to have the sense of business.

RT: Business or any organization. You could be your class representative in your college.
That gives you a sense of how many variables are involved, that things don’t go exactly as
planned, why the concept of margin of safety is required, why do you over-engineer things
so that there are fall back mechanisms. All those things come only when you have
experienced it.

SN: Which investment thinkers or investors do you hold in high esteem?

RT: The usual suspects. Apart from Buffett and Munger, Prof. Bakshi is someone who I
follow quite regularly. I have mentioned about Mr. Chandrakant Sampat and Parag Parikh.

SN: Coming to a hypothetical question. There are two questions. Let’s say you are
going to lose all your memory next morning, briefly what would you write in a letter
to yourself so that you could begin relearning everything starting the next day.

RT: One is, associate with good people. Applies both to personal life as well as investing.
Then the concept of inner scorecard. Also, the idea of envy being the deadliest of the sins.
What matters is how you are doing absolutely in terms of your mental well-being, physical

8/9
well-being, financial well-being, rather than what someone else has earned or what return
someone else has achieved. The biggest trap that people get, even in investing, is trying to
catch up with someone else who has done better than you rather than being happy with
what you have earned.

SN: Another question, if you could do anything other than managing money for a
living and make twice as much money as you do now, what would you do?

RT: Manage my own investments rather than managing for other people. Apart from
investing, I would pursue other hobbies that I have.

SN: What are the other things that you currently do apart from investing?

RT: Playing chess is one. Reading fiction, listening to music, karaoke singing, travel and
watching movies.

SN: Great! So that’s all I have. Thank you so much Rajeev for all the insights and
your time.

RT: You’re welcome Vishal.

Read Part 1

Note: This interview was published in the January 2016 issue of our premium newsletter,
Value Investing Almanack. To gain instant access to more such interviews and other
interesting stuff on value investing and business analysis, click here to subscribe now.

9/9
Value Investor Interview: Samit Vartak
safalniveshak.com/value-investor-interview-samit-vartak/

Vishal Khandelwal April 4, 2016

Note: This interview was originally published in the March 2016 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.

I recently interviewed Samit Vartak of SageOne Investment

Advisors for my premium newsletter, Value Investing Almanack.
Samit is one of the founding partners and Chief Investment
Officer at SageOne, and is responsible for ensuring SageOne’s
adherence to its core investment philosophy and discipline of risk
management. As you would read in the interview below, Samit
believes in risk management not by seeking extreme
diversification or buying sub-par businesses at low multiples, but
by building a reasonably diversified portfolio of high quality
businesses having long term competitive advantages in attractive
and high growth industries.

Samit returned to India in 2006 after spending a decade in the US working initially in
corporate strategy with Gap Inc. and PwC Consulting, and then with Deloitte and Ernst &
Young advising companies on business valuation and M&A. This experience forms the
backbone that helps him better understand businesses and their fair value. Samit is a
CFA® charter holder, an MBA from Olin School of Business of the Washington University
in St. Louis and holds a Bachelor of Engineering degree with Honors from Sardar Patel
College of Engineering, Mumbai University.

In his interview with Safal Niveshak, Samit shares his wide investment experience and how
small investors can practice sensible investment decision making.

Safal Niveshak (SN): Could you tell us a little about your background, how you got
interested in value investing?

Samit Vartak (SV): I come from a village named Mahim which is along the Konkan coast
about 100 km north of Mumbai. My father is a farmer, who does that for living even now. As
a kid I grew up on the farm and studied there until the 10th standard after which I came to
Mumbai for higher education and completed my engineering. Financially, my father had to
struggle immensely to educate me and my two younger brothers from his illusive farming
income. Experiencing and living through my family’s struggle for money is the background
that has influenced my investment style.

After working with Mahindra and Mahindra for 3 years, I received scholarship from a
prestigious US university to pursue an MBA for which I left for the US in 1997. Post MBA, I
1/10
worked in the US until 2006 with the likes of PwC Consulting and Deloitte Financial
Advisory Services. Half of my US experience was in Management Consulting, advising
companies on improving operational efficiency, business processes and strategy. The other
half was as a valuation professional advising PE/VC funds and corporates on valuations for
their investments and M&A. This experience has helped me with the two most important
aspect of investing – understanding businesses and understanding fair valuation for them.

I caught the stock market bug in 1999 at the peak of the dot com bubble when making
money had become very easy. This was the time when I followed exactly what is currently
in my “what not to do” list as an investment process. I followed analyst recommendations,
looked at simple valuation metrics such as PE ratio/PEG ratio, believed in forecasted
numbers of analysts, and invested in companies where buy recommendations were the
highest. No surprise that as the markets peaked, I started losing money and to recover my
losses quicker I used derivatives/margin money and the result was that by 2001 my entire
portfolio was wiped off.

I cannot describe the agony that I went through in losing all I had earned and especially
given my family’s financial struggle during my childhood. The guilt of wasting money which
would have been so valuable for my family back home left such an indelible mark on me
that I took a break from investing to introspect my mistakes and learn before investing
again.

That was the turning point and blessing in disguise in my investment journey. To further my
learning, I decided to enrol for becoming a CFA (Chartered Financial Analyst) wherein I
really learned the fundamentals and theory behind investing. I read about different
investment styles, about experiences and methods used by successful investment gurus
and tried to figure out what suits me and my temperament. My ultimate goal was to develop
an investment style in which protecting capital was the primary goal and return on capital
was a secondary goal.

Currently I am the CIO and cofounder of SageOne Investment Advisors LLP, wherein we
advise an offshore fund and few large domestic HNIs. We are three partners (Kuntal Shah
and Manish Jain being the other two) who have been working together for the past 8+
years.

[sociallocker id=”24399″]Click here to download the PDF of this interview[/sociallocker]

SN: Pretty inspiring journey you have had, Samit. Thanks for sharing that. How have
you evolved as an investor and what’s your broad investment philosophy? Has your
investment policy changed much through the years?

SV: Before talking about the evolution of my investment philosophy, let me start with our
current investment philosophy we employ at SageOne. My personal portfolio replicates that
of the clients’ and hence the philosophy is common. My path from engineering to business
consulting to valuation professional to becoming a fund manager has been different and
long compared to most and my philosophy has evolved accordingly.

When you look at a business and if you get a feeling “I wish I owned this business”, that’s
the kind of businesses we are looking for. We look for a business with long-term
competitive advantage, in a stable industry, that has a huge and growing market for its
2/10
products/services. If a business is inferior, then the price of the stock does not matter and it
would not interest us. For improving the probability of finding such businesses, you need to
focus on the right sectors.

To put it other way, if you want to find the best marathon runner, first you need to know the
right countries to focus on. Focusing on the right sectors is half the battle won in finding the
right companies. I have written in detail regarding our philosophy and process on our
website as well as in our quarterly newsletters found on the website.

During my initial years, my sequencing was the other way around. Cheap valuation was the
primary focus and then came the business. I would say, that has been the biggest change
over the years and this has changed the downside risk profile associated with investing for
me.

SN: Apart from managing your own money, you are also managing others’. So, how
is it being a money manager, especially during the extreme situations – euphoria or
market crashes? How do you keep yourself sane when dealing with clients with
undue expectations?

SV: As an advisor or a money manager, choosing the right clients is extremely important.
We are extremely choosy when it comes to accepting clients. You don’t want investors who
would call you each time the market is down few percentage points. You want to make sure
that the investor is sophisticated enough to understand the risks associated not only with
equities but more importantly with the manager’s investment strategy. This is easier said
than done, but continuous education of the clients regarding the risks and returns definitely
has helped us.

I came back to India in 2006 and it took me a while to get comfortable with investing in
India and understanding the business environment here. Until then, I was just managing my
own money to make sure I don’t use clients’ money for my education. I started advising
external money only in April 2012.

I think it’s very easy in this field to become insane with the kind of information overload with
respect to global risks, industry risks, company risks, management risks and a never
ending list. I moved to Pune in 2008 to stay away from market noise in Mumbai. Too much
interaction with fellow investors can lead to diverting your focus from finding strong
businesses to things like global macro, short term trends/changes in some industries, etc.

SN: Choosing your clients well is a very important lesson for future money
managers I believe. This is exactly what Rajeev Thakkar of PPFAS Mutual Fund told
me when I interviewed him a few months back. Anyways, what has been the best and
worst times in your experience as a money manager? How did you handle, say, a
situation like 2008?

SV: Given that I started advising external money only 4 years ago, the best times were
2011 to 2013 period when the expectations of most investors from India were so low that it
reflected in the valuations of companies and one could pick really strong businesses at
really attractive valuations. Last couple of years have been the really tough, since nothing
really changed in India on the ground but the expectations from the new government went
3/10
through the roof. In fact, the valuations rose when earnings were coming down in reality
with global environment worsening. I have done a detailed analysis of the situation and the
risks in my latest newsletter.

As far as 2008 goes, it was period when I was managing my own money. One can’t escape
the carnage if you are a long only investor in such periods, but what saved me relatively
was the cash levels I maintained.

I track valuation multiples and margins at sector levels over a long period of time. I try to
keep cash levels based on risks associated with the current absolute valuation multiples as
well as my assessment of sustainability of current margins. In 2008, the P/E multiples as
well as profitability were at all-time highs and the Indian market faced dual risk of not only
the P/E multiples contracting but also the net profit margins contracting to a more
sustainable levels. Assuming that the P/E multiples as well as margins would contract to
the mean levels, P/E faced downside of 40% and net profit margins downside of 24% with
combined downside risk of 55% which unfortunately for everyone more than played out. I
have presented a detailed analysis on this in our July 2015 and October 2015 newsletters if
anyone is interested in historical levels.

SN: Good that you talked about the idea of sitting on cash when there is a dearth of
opportunities, or when you find things heated up. For most investors, it is a painful
decision i.e., not doing anything with cash and sitting tight on it especially for a
longer period of time. What would you advise other investors, and especially money
managers, on how to remain liquid when the situation demands and while defying
the steady drumbeat of performance pressures?

SV: It’s much easier for an individual investor to remain liquid as he is not answerable to
investors. For a fund manager, it’s a very complicated situation with uncertainty of markets.
If you are sitting on high levels of cash because you believe that the valuations are high
and the markets are risky, the market can continue its uptrend for much longer and each
such month can be extremely painful to watch. You may be eventually right, but answering
questions of investors who are paying the opportunity cost can be frustrating and with that
building pressure you may end up deploying that cash at higher levels.

Opportunity cost is extremely difficult to handle even for the best of investors. See how
even Stanley Druckenmiller flip flopped during the dotcom bubble. Even Warren Buffet was
written off as past during that period since he stayed away from the best performing sector.

I believe that you have to lose the small battles to win big in the long term and patience is
the key. Investment is a test match. I invest my money the same way I advise our clients
and if I personally find it risky to be fully invested, how can I take the risk with clients’
money?

SN: Great thought! Anyways, what are some of the characteristics you look for in
high-quality businesses? What are your key checklist points you consider while
searching for such businesses?

4/10
SV: As I have said before, the starting point for finding a high-quality business is to finding a
high-quality sector. I am very numbers oriented and love tracking and analyzing various
metrics at sectoral levels. You can’t judge a sector by looking at short term performance
but evaluating how it did during couple of down cycles. As a process we have broken down
the top 1,600 companies in terms of market cap into sectors. For each sector we evaluate
parameters such as sustainable profitability (ROE/ROCE), volatility in margins, leverage,
topline growth and cash generating history. Based on these, we had shortlisted top sectors
and about 300 companies within those. Next step was to painstakingly look at each
company to eliminate companies having history of bad corporate governance,
loose/questionable accounting policy and inefficient capital allocation. Post this we came to
our “fishing pond” of about 150 companies.

Out of these strong businesses we look for companies that, based on our analysis, have
potential to grow topline at more than 20% (ideally > 25%) with sustainable net margins
over a 3-5 year period. Generally, 20-25% growth isn’t easy for companies when the
nominal GDP is around 14%. The only way it’s possible is if the company can capture
market share from unorganized players or public sector competitors or organized private
competitors within the country or from competitors in other countries if export oriented. So
we consciously look for such enablers of growth.

SN: Nice process I must say. Well, if it’s possible, can you suggest a few
sectors/industries you find appealing (based on their past performance and future
prospects)?

SV: Sectors such as building material where the unorganised segment is huge (70%+ in
some industries) and where brand is still valued by customers is appealing. Even batteries
segment has a big unorganized segment and it’s a consumable, so demand isn’t cyclical
and relatively less affected by capex cycles.

I prefer sectors where demand isn’t dependent on favourable environment and product
replacement can’t be postponed for too long. It’s very important to pick the right company in
each. Once you study the sector, pick the one which you believe has the right targeted
customer segment, has the right marketing strategy and the management is focused on
that exciting opportunity versus having diluted attention on multiple businesses.

SN: How do you think about valuations? How do you differentiate between ‘paying
up’ for quality and ‘overpaying’?

SV: Having worked as a valuation professional has helped me significantly in this area.
Valuation is about your input assumptions or else it’s garbage in and garbage out. For
coming up with reasonable inputs, you not only need to understand the company but also
the industry, the competitive environment, business model, strategy of key competitors, etc.
to be able to estimate the factors such as growth, profitability, re-investment rate and return
on future investments. This may sound complicated, but if you have done thorough work on
understanding the company and the industry/competitors you won’t find it difficult to judge
whether the current valuation is a bargain or expensive. Rather than trying to come up with
a specific number, I try to evaluate what’s a reasonable multiple for the company and if I
feel that the probability of the current multiple contracting is very low, I get comfort.
5/10
“Paying up” or “overpaying” are terms we have started using based on our perception of
whether the P/E multiple is high or low. P/E multiples can be very deceiving. For e.g. let’s
consider an example of a company from two analysts’ perspectives who are ascribing it a
fair P/E multiple. A company generating ROE of 50% and both analyst expect earnings to
grow at 25% for the next 2 years. So theoretically the company needs to deploy 50% of the
profits for this growth (Growth = Reinvestment x ROE). The residual profits are paid out as
dividends. Beyond two years, one analyst expects the growth to drop to 10% up to the 20th
year. The second analyst expect the 25% growth to continue up to the 20th year. Let’s
assume the terminal value of the company is the book value at the end of the 20th year.
For the first analyst the fair one-year forward P/E multiple would come to about 12x, but for
the second analyst it would be 32x (see workings below, or click here to download).

So the point I am trying to make here is that the duration of high growth has a huge impact
on the eventual P/E multiple. If the company is trading at 20x, the first analyst would find it
expensive but the second would find it a bargain. If your business analysis is in-depth, your
chances of accurately evaluating the duration and hence the valuation would be much
better.
Please note that if a company’s ROCE is above its weighted average cost of capital
(WACC) and if the company continues to grow above the WACC forever, the valuation and
hence the P/E multiple would tend towards infinity. Conversely if the ROCE is below WACC
and the company continues investing in new capex at ROCE lower than WACC, it’s
valuation would tend towards zero. So theoretically no P/E multiple is low or high.

If anyone is keen on learning more, you may find my lecture, given at Flame Investment
Lab, useful.

SN: That’s a brilliant way to look at valuations, Samit, and it solves a lot of questions
in my head. Let me ask your thoughts about selling stocks. Are there some specific
rules for selling you have?

6/10
SV: For me the highest numbers of my exits have been driven by deterioration of the
business environment. So either the business model has deteriorated because of
regulatory changes such as what happened recently in cotton seeds, or the competitive
intensity has changed and that makes it incrementally difficult to meet my 20% growth
hurdle. Other reasons are management decisions regarding capital allocation or in
financials the lending standards been relaxed. Valuation running beyond comfort is another
common reason, but I am a little more flexible here versus brutal in the first two aspects.

SN: Can you please share a real-life stock example when selling turned out to be a
great decision for you, and one when it turned out to be a mistake?

SV: J&K Bank worked out well when we exited it at the first signs of its lending standards
deteriorating. La Opala exit didn’t work out well as we exited too early because of concern
on valuations. The growth continued and with that the multiples kept increasing. We exited
with a 5x return and the stock continued going up 5x further.

SN: When you look back at your investment mistakes, were there any common
elements of themes?

SV: There have been many mistakes. The most common is in the event of any bad news
(significant enough to trigger an exit) coming with regards to a portfolio company that you
have held for some time and have developed connect with. The natural tendency is to find
arguments against the bad news and try and shove it under the carpet. You try talking to
the management and typically they are the worst people to talk to in such events because
they will give you great comfort in their business as always.

Holding something in your portfolio is as good as entering that stock at current market
price. Many a times, I have held on to positions even if I would not be comfortable buying at
current market price. You may justify it by giving false comfort of having bought at much
lower price, but it’s a behavioural mistake that has to be rectified as a part of improving
decision making.

SN: Yeah, that’s true. Talking about behaviour, any specific biases that have hurt
you several times as far as your investments are concerned? And what have you
done to minimize the mistakes caused by such biases?

SV: One very common mistake that has hurt me is that if you buy even a small quantity at
low price, it’s much easier to add at higher level. But if you miss that first entry at extremely
juicy price, it’s very difficult to buy later as you keep repenting that lost opportunity.

Other mistake that is common is the cost of purchase. The entry point if low gives a lot of
comfort to hold on even if you see business environment deteriorating for the company or if
you find valuation uncomfortable. In reality we know that the exit point should be
independent of the entry, but it’s very difficult to de-link. These are tough decisions and I
consciously try to be aware of such biases to avoid them. I can’t say that I have mastered
them 100%.

SN: How can an investor improve the quality of his/her decision making?

SV: As I just said, an investor needs to look afresh at his/her portfolio without the bias of
7/10
having the stock already in the portfolio. This discipline would surely help in making better
decisions.

Other aspect which is extremely important and underappreciated in investing is

temperament. For this, keeping your mind relaxed and away from “noise” is critical. I find
exercise, meditation and frequent breaks away from investing very helpful. Each individual
needs to find a way to relax and keep his/her mind fresh and peaceful. One can read and
learn a ton about behavioural aspect, but if the mind is stressed, tired or confused, the
chances of taking wrong decisions significantly rise.

SN: How do you think about risk? How do you employ that in your investing?

SV: I am not going to talk about the theoretical aspects of risk such as diversification,
illiquidity, etc. which are a given for a money manager. I am sure your readers would have
heard and read about them multiple times. I will stick to specific things that I follow.

Once I am broadly excited about a business, my major analysis is on digging holes into my
excitement. Once you like a stock, the natural tendency is to just jump in before the price
runs up. When you take short cuts that’s exactly when risk crops in. As part of my analysis,
I avoid talking to co-investors who already have vested interest and are also excited about
the stock. Talk mainly to the company’s competitors because they generally will give you a
different point of view on the industry and about why certain strategy is inferior. Talk to
analysts who have negative view on the company. Find a strong devil’s advocate who will
try and destroy your hypothesis. In that respect, having partners helps each of us as the
other two play that role.

Equity investments involves considerable risk. The key is to find ways to reduce it. There is
no better way than to understand the dynamics of the business and run stressed scenarios
of how it would survive in the toughest of economy.

For me, mitigating risk is about building margin of safety and I try to use it in the outlook
when I am valuing the business. E.g. If based on your study, you are confident that the
business can grow at 25% for 7 years, assume only 4 years and see if you still find the
price attractive.

One other factor I would like to bring up is to be careful when blindly copying investment
theories and strategies used by legendary investors in the United States. You have to
remember that the US is one of the most successful and innovative countries in the world.
When you companies with strong brands, IP and technology which is recognized all over
the world things like “moats” and extremely long term investing works there.

India is an emerging economy and many things such as regulations, government

incentives, tax structure, FDI policies, IP policies, etc. keep evolving. Plus, we are relatively
much weaker on brands, IP, technology and hence your investment strategy has to change
accordingly. One has to be very vigilant about the above changes on your portfolio
companies and be ready to exit with changing business dynamics. Following wrong
investment strategy can be hugely risky.

8/10
SN: That’s a nice insight. Well, what’s you two-minute advice to someone wanting to
get into value investing? What are the pitfalls he/she must be aware of?

SV: Most people want to be independent and for that they would have liked to own and run
a great business, but for majority of them starting a business is too big a risk. Investing in
stock market should be considered as a much lower risk option because you are able to
partly own diverse set of already successful businesses.

Look for businesses with the same passion as you would to start an exciting business you
like. Set that priority and purpose right, and only then think about the price to pay for it.
Learning about valuation is much easier once you do this. Don’t fall into the trap of
scanning for value first and forgetting the real purpose of investing.

SN: Which unconventional books/resources do you recommend to a budding

investor for learning investing and multidisciplinary thinking?

SV: Here are the three I would recommend –

Understanding Michael Porter: The Essential Guide to Competition and Strategy by

Joan Magretta
The Little Book that Beats the Market by Joel Greenblatt
The Five Rules for Successful Stock Investing: Morningstar’s Guide to Building
Wealth and Winning in the Market by Joe Mansueto and Pat Dorsey

SN: Which investor/investment thinker(s) so you hold in high esteem?

SV: Being a numbers oriented guy, I like Joel Greenblatt’s way of scanning for great
businesses. History and right parameters could be a great starting point to shortlist
companies. There are different aspects to learn from many great investors.

SN: Hypothetical question: Let’s say that you knew you were going to lose all your
memory the next morning. Briefly, what would you write in a letter to yourself, so
that you could begin relearning everything starting the next day?

SV: Before investing, I will surely focus on writing about my family and people I love and are
important in my life. I will write about the philosophy I follow in life. It’s too little a time to
spend on writing about investing. In any case, I can always refer to my newsletters and our
website to remind me of the philosophy I had followed. So some documented help is
available on that front.

SN: What other things do you do apart from investing?

SV: I love sports and many of them, so watch and play whenever time permits. We came
back to India in 2006 and one of the purpose was to make some difference to our home
country. I involve myself during weekends in various activities such as cleaning garbage in
our area, tree plantation in the forest that had been completely destroyed over the years,
but my real passion is education.

9/10
We all know the quality of education in our municipal schools. Students are not failed until
grade 8th, but beyond that many find it extremely difficult to continue and the dropout level
jumps.

If quality help is provided at this stage, many can be helped not only from dropping out but
also to complete graduation so that they can find meaningful employment. Even better, if
they are provided good guidance to find their passion, many could become employers and
big contributors towards development of our country.

I am currently just helping monetarily in education of about twenty 8th to 10th grade
students from a poor community, but I am working with an NGO in Pune which is doing
phenomenal work in this area. My goal is to adopt an entire class of 8th graders and help
them in the above aspect until graduation.

SN: That’s very kind of you Samit! You definitely have inspired me and a lot of people
reading this interview. Thank you so much for sharing your wonderful insights on
investing. Thank you!

SV: You’re welcome Vishal.

[sociallocker id=”24399″]Click here to download the PDF of this interview[/sociallocker]

Note: This interview was originally published in the March 2016 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.

10/10
Value Investor Interview: Huzaifa Husain
safalniveshak.com/value-investor-interview-huzaifa-husain/

Vishal Khandelwal January 4, 2016

Note: This interview was originally published in the December 2015 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioral finance, click here to
subscribe to VIA.

Mr. Huzaifa Husain is the Head of Indian Equities

at PineBridge Investments based in Mumbai.
Since he joined the asset management company
in 2004, Mr. Husain has been a key member of
the team advising the PineBridge India Equity
Fund (a Dublin domiciled India offshore fund).
Prior to this, he was an Equity Analyst at Principal
Mutual Fund and SBI Mutual Fund. Mr. Husain
received a Post Graduate Diploma in
Management (PGDM) from Indian Institute of
Management (IIM) Bangalore and a B.Tech from
the Institute of Technology (Banaras Hindu
University).
In this interview for the Value Investing Almanack,
Mr. Husain shared how he found his calling in value investing, and reveals key insights
about his investment strategy and the underlying thought process.

Safal Niveshak (SN): Could you tell us a little about your background, how you got
interested in investing so much to choose it as a career?

Huzaifa Husain (HH): In 1997, when I completed my management education at IIM

Bangalore, SBI Mutual Fund offered me a role as an equities analyst. Thus began my
career in equity investing.

My management education did not prepare me for equity investing. We were taught how to
mathematically manipulate numbers, especially daily stock prices, most of which had no
conceptual backing. I remember in my first year on the job, I tried every possible trick –
charts, CAPM, etc. – in the textbook to figure out how to predict which stock will do well. I
failed miserably. One day a friend of mine told me to read the letters of Warren Buffett. That
is possibly the best advice I ever got in my life.

After that day, my investment philosophy has relied entirely on understanding the company,
the people managing it and its prospects. Stock prices do not have any information other
than what one can buy or sell the stock at.
1/7
SN: Do you believe in the concept of circle of competence? If yes, how have you
built it over the years?

HH: Yes, of course. The success rate of doing an activity which is within the circle is much
higher than that which is outside the circle. The circle is not a rigid one though and keeps
expanding, albeit rather slowly.

My first task in the late nineties was to research equity stocks in the pharmaceutical sector.
So, I bought a drug index book and catalogued nearly all major diseases and the drugs
used to cure them. These drugs were then mapped onto the companies which produced
them to understand company fundamentals. Then, when Indian pharmaceutical companies
started targeting generic markets in US in early 2000, I studied the Hatch—Waxman Act,
various generic court case judgments, etc. to understand the potential opportunity and
risks. Thus, I gained expertise into the pharmaceutical sector.

Slowly I expanded it to another industry – telecoms – and studied the various technologies
such as CDMA (Code-Division Multiple Access), GSM (Global System for Mobile
Communications), etc. I also then brushed up my accounting knowledge as it plays an
important part in understanding financials. In those days there was a heavy debate on
ESOP (employee stock ownership plan) accounting in the US and so I read and understood
the corresponding accounting standards (FAS 123). Slowly and steadily the circumference
of the circle expanded to include more industries, different accounting policies and different
ways to evaluate management.

The only way the circumference of the circle expands is by constantly accumulating
experiences – either directly or by learning from others.

SN: What are some of the characteristics you look for in high-quality businesses?

HH: A high-quality business should require very little capital but generate a lot of capital and
it should be able to maintain these favorable economics for a long time.

The reasons for a business to achieve these economics are numerous. Most important is
the management’s focus on improving its competitive advantage compared to its peers. A
pertinent question here would be why are such practices not copied by others? One big
reason is the culture of an organization. A culture of success is not as common as one
would assume.

There may still be cases where the best efforts of the management to succeed may still
come to nothing. This can happen when competitors are irrational. This can also happen
when the business itself is very complex. It is easy to estimate the costs and risks of
making and selling shoes. It is probably not so easy to estimate the costs and risks of
constructing a dam.

SN: How do you assess a management’s quality, especially given that disclosure
levels are not high and standardized in India?

HH: Management quality is assessed on two dimensions – ability and integrity.

Ability encompasses the way the management deploys the cash it generates. It could
2/7
invest back into the business to strengthen the competitive positioning of the business, it
could buy another company in the same business, it could invest in a new business or it
could buy a company in a different business. One should be able to assess the ability of the
management by evaluating the management’s actions of deploying cash.

Integrity encompasses the way it treats shareholders. A management with high integrity will
return excess cash back to shareholders. It generally would not overstate its financial
numbers; most probably, it will understate them by reporting its numbers conservatively. In
my experience, there is a high correlation between usage of conservative accounting
policies and high integrity.

I think disclosure levels in India are generally quite high and I have not faced any problem
in judging the past history of management decisions.

A simple discipline can be observed here – if the management is not willing to be

transparent and honest, move on.

SN: Well, let’s talk about valuations. How do you think about them, and how do you
differentiate between ‘paying up’ for quality versus ‘overpaying’?

HH: Good opportunities in investing are rare. A good opportunity is like searching for a
needle in a haystack. One can of course wait for a day when there is a strong wind which
will blow away the hay and make it very easy to find the needle. But then one has to be
very patient as such days are few and far between. On the other hand, one typically will find
opportunities to buy either a lousy business at cheap valuations or a good business at fair
valuations. I would go for the latter.

How much should one pay for a good business? Of course I do not believe in over paying
because I can always put my money in a fixed deposit without risk. So, one should carefully
evaluate various scenarios in which the investment can make money. I can try and put in
some numbers for the future, find out cash flows, discount them with the next best
alternative rate you can get and finally add a buffer to the price. It is quite educational if one
does this simple exercise which some call reverse discounted cash flow (DCF).

One important factor in doing this calculation is to make the right assumption of how much
capital is required in the business. Generally, a good business which can generate high
returns will not require a large amount of capital. Hence, such a business will have to pay
the cash out, which means in applying a DCF model, the benefit of compounding will be
absent and that would make a huge difference to the value.

SN: How do you determine when to exit from a position? Are there some specific
rules for selling you have?

HH: One would exit for basically two reasons.

First, if the original hypothesis itself turns out to be incorrect. One example is when we
bought a company which was a market leader in the domestic industry and was generating
a lot of cash flows. The industry was growing very fast and so was the company. It was
available at reasonable valuations. Then one day, the management decided to take the
cash on the books plus take on debt and buy a company internationally which had poor
3/7
economics. The management thought it could take such a company and make it
competitive. Unfortunately, it paid a price which presupposed that it would succeed in doing
so. Hence, there was no upside left, even if they succeeded. And the existing domestic
business cash flows were now being used for this purpose instead of investing in the
domestic business which needed enormous capital to grow. Since, this was a ‘game
changing’ event, we decided to sell it.

Second, something better can be done with the sale proceeds. This is tricky. It requires two
decisions – selling an expensive name and buying a cheap name. We do it rarely as we do
not think there are so many good companies out there that one can keep churning without
lowering the quality of the portfolio. If we do it, we ensure that the valuation differential
between the stock being sold and the stock being bought is quite significant.

SN: Do you believe in investment checklists? If yes, what are the most important
points in your checklist?

HH: I do have a checklist. Broadly there are three main items on my checklist – quality of
business, quality of management, and price of the stock.

An important aspect of this checklist is that it is applied sequentially. The reason is because
a good manager may struggle to generate good profits out of a bad business. Paying a low
price for a lousy business may also not turn out great. Hence, only when a business is
deemed to have strong economics and quality management, is the price evaluated for
attractiveness.

SN: Apart from the qualitative factors, what are few of the numbers/ratios you look
for while assessing the business quality?

HH: A reasonable idea of how much capital is required to run the business is critical. The
nature of capital employed – fixed versus working – makes a huge difference to the way the
business is run.

The returns generated on the capital employed irrespective of the leverage employed will
demonstrate the quality of the business. Aggregating 10-20 years of financials gives one a
good idea of how the money has been utilized. Cash flow efficiency (cash flow divided by
profit) demonstrates the conservative nature of management in reporting their numbers.

SN: When you look back at your investment mistakes, were there any common
elements of themes?

HH: Among the three things I look for in an investment – business, management and price
– most mistakes happen in evaluating management. This happens especially if the
management does not have a public history which can be evaluated.

The typical management behavior which hurts investors is their overconfidence. Business
managers rarely will admit that they cannot deploy the cash which the business is
generating. They will find some or other use for cash and eventually deploy it in a poor
business.

4/7
Hence, it is best to use a higher threshold for management quality in case the business has
historically retained most of the cash it generates.

Also public history of management is a very good guide. Don’t expect the management’s
behavior will change because you bought the stock. It almost never will.

SN: What tricks do you use to save yourself from behavioural biases? What are the
most common behavioural mistakes you make?

HH: Most mistakes in investment stem from lack of knowledge. When one is walking in the
dark, other senses become heightened. Similarly, when one is operating in the field of
investments and one does not know what one is doing, the basic human survival instincts
(being with the crowd – herd mentality, avoiding danger – loss aversion, etc.) kick in. These
instincts sometimes may mislead one in stock markets which is a massive melting pot of
human emotions.

Many advocate changing behavioural responses. I think if you try to do that you are up
against thousands of years of evolutionary survival strategies. Instead, focusing energies
on accumulating knowledge is a more reasonable task.

SN: That’s a wonderful insight, so thanks! Any specific behavioural biases that have
hurt you the most in your investment career?

HH: Nothing specific. Over time, a better understanding of how incentives drive human
behavior has helped me decipher the happenings around me.

SN: How can an investor improve the quality of his/her decision making?

HH: If the investor’s knowledge of the company is among the top 0.001% of people who
have some kind of understanding of the company he/she is investing the chances are that
the decisions would be good. Hence, read everything you can lay your hands on relating to
the company and its business. We actually do that when we buy a consumer durable or an
automobile. I remember even though my father was no engineer, he used to ask people on
two wheelers at a traffic signal what the mileage was before buying one. It is absolutely
astonishing how much information one can glean if one puts in a slight amount of effort.

The next aspect is that the investor should realize markets are not always rational. I feel this
is easier said than believed.

Investors while buying believe that the price is mispriced but once they have bought they
forget that it can remain mispriced for a long time. Many would want the mispricing to be
corrected as soon as they complete their purchase. Many would also pat themselves on the
back if it does happen. But short term movements of a market are near random. Hence, be
prepared for the worst. For example, the investor should be prepared for a huge drop in the
stock price post his purchase. It may or may not happen but if it does, he should be
mentally prepared to act rationally.

SN: How do you avoid the noise and the overload of information that is available
these days?

5/7
HH: If you carefully analyze the information overload, most of it is very short term focused.
Hence, if the time horizon of the investment is long, one needs to employ a filter which can
eliminate short term noise. After all a company publishes only one annual report and
declares four quarterly results every year. That is not much.

SN: How do you think about risk? How do you employ that in your investing?

HH: As an equity holder one would lose all one’s money if the company goes bankrupt.
Hence, avoid companies which have large debt loads.

Avoid investing in a poor business. It is bad to lose money investing in a poor company. But
it is worse to make money investing in them. The reason is, once you make money playing
with fire, the chances are you will be attracted to it more often and sooner rather than later,
it will burn. Hence, avoid investing in such companies irrespective of the valuations.

Remember no matter how well you think you can guess the future, it will not be as you
predict. Hence, be prepared.

SN: What’s you two-minute advice to someone wanting to get into stock market
investing? What are the pitfalls he/she must be aware of?

HH: Making money by equity investing is very difficult. Treat the stock market as a bazaar.
Go with a list of things to buy. Make the list at home just as one would make a grocery list
based on your nutritional needs. Don’t make decisions by watching the changes in the
prices of stocks just as one would not decide to buy lemons because their prices are going
up. Spend a lot of time deciding what to put on that list. One way to do it is to inculcate a
phenomenal amount of curiosity in researching companies.

SN: Which unconventional books/resources do you recommend to a budding

investor for learning value investing and multidisciplinary thinking?

HH: It is dangerous to read books especially on investing without reading about business
history. It may cloud one’s view. Hence, I would recommend all budding investors read
annual reports of companies for as far back as they can find. Read them across various
companies over various time frames. They should be able to understand how companies
have behaved over business cycles, how their valuations have changed, why did they
succeed, why did they fail, etc.

Once a vast amount of business history is read and understood, all one needs to read are
the letters of Buffett and Poor Charlie’s Almanack to build a framework.

Beyond that, remember what our vedas say on multidisciplinary thinking – आ नो भदाः तवो
य तु िव वतः (Let noble thoughts come to us from all sides).

SN: What a wonderful thought that was! Any non-investment book suggestions you
have that can help someone in his overall thinking process?

HH: I find books written by Malcolm Gladwell quite interesting. Living Within Limits by
Garrett Hardin has many interesting concepts on growth. The Corporation that Changed the
World: How the East India Company Shaped the Modern Multinational by Nick Robins

6/7
literally chronicles the birth of capitalism.

Reading judgments from the Supreme Court of India helps one understand how our
Constitution works. An example would be the Kesavananda Bharati case which I believe
should be a must read for every citizen of India.

Reading various government ministries’ annual reports, regulatory reports (RBI as an

example), global central banker speeches, global anti-trust filings – all these help one
understand how different aspects interact.

Finally, a study of human history is quite important. I would recommend Glimpses of World
History by Jawaharlal Nehru.

SN: Which investor/investment thinker(s) so you hold in high esteem?

HH: Warren Buffett. Many have generated good returns in investing, but he has done it
over larger and larger sums of money. He has never paid a dividend since 1967. That is
what makes him a genius.

SN: Hypothetical question: Let’s say that you knew you were going to lose all your
memory the next morning. Briefly, what would you write in a letter to yourself, so
that you could begin relearning everything starting the next day?

HH: Personal life: Everything

Professional life: Nothing

SN: What other things do you do apart from investing?

HH: Spend time with my family.

SN: Thank you Huzaifa for sharing your insights with Safal Niveshak readers!

HH: The pleasure was mine, Vishal.

Note: We originally published this interview in the December 2015 issue of our premium
newsletter – Value Investing Almanack (VIA). To read more such interviews and other deep
thoughts on value investing, business analysis and behavioural finance, click here to
subscribe to VIA.

7/7
Value Investor Interview: Jae Jun, Old School Value
safalniveshak.com/value-investor-interview-jae-jun-old-school-value/

Vishal Khandelwal June 1, 2015

This interview was part of the May 2015 issue of my premium newsletter on value investing,
behavioural finance, and business analysis – Value Investing Almanack (VIA). If you wish to
read more interviews with value investors, you can click here to subscribe to VIA now.

Jae Jun is the founder of Old School Value, a deep

fundamental analysis tool that helps value investors speed
up the analysis process and make better investment
decisions.
I’ve admired Jae’s work at OSV and thoughts on investing
for long, much before I started Safal Niveshak. So it was
great to interview him for Value Investing Almanack. Let’s
get straight into Jae’s experience and philosophy on
investing.

Safal Niveshak (SN): Could you tell us a little about your background, and also about
your wonderful blog Old School Value?

Jae Jun (JJ): I believe my path to investing is very similar to most people. I met a life
insurance salesman who convinced me that I needed life insurance that also acted as an
“investment” account. A 2-in-1 deal which I blindly agreed to without doing any homework.

The reason for my poor decision was because I saw friends and colleagues making money
in stocks and I wanted to do the same. I also believed that anyone in the financial industry
knew a lot more than I ever would. After I started Old School Value, I realized it was the
opposite. Most people in the finance industry don’t know a thing about finance.

After several months, I would check my shiny new “investment” account, but things didn’t
look right. The market was up 10%, but my account was doing nothing and a lot of the
insurance premium were deducted as fees. After some digging around, the veil fell from my
eyes and I saw the sucker I was. I immediately cancelled the life insurance, forfeited all the
money and locked in my first 100% investment loss.
1/6
I figured that, if I wanted to lose money, I could do it myself and at least have some fun
doing it. That’s when I started digging into articles, magazines and books and documented
my learning through Old School Value.

I thoroughly enjoy sharing and educating people and the blog is an outlet for me so that I
don’t have to bore my wife or friends to death about balance sheet analysis and how to
value stocks.

Coming from a telecommunications engineering background, I grew up with tunnel vision. I

never considered the possibility that I would enjoy business or finance. So my entire
schooling years were dedicated to math, physics and other engineering courses. I never
took a course in accounting, business or economics. Investing and starting Old School
Value really opened my eyes to a new world.

SN: What got you interested in investing, and how you’ve evolved over time as an
investor?

JJ: My dad is a trader and I witnessed the emotional highs and lows he experienced from
making and losing a huge amount of money. At an early age, I concluded that investing in
the stock market was equivalent to gambling.

After having lost everything that I put into the life insurance investment account, the initial
anger was a huge motivator for me to put aside my biases about the stock market and to
really learn how it worked.

My wife (girlfriend at the time) had a book called “The Intelligent Investor” which was
recommended to her because she too wanted to become a life insurance saleswoman.

The irony – the book itself was horrible!

I must have fallen asleep 10 times or more before I finished the book and to this day, the
only aspect I do remember is the reference to Mr. Market which was the only thing that
made sense. However, the book acted as a lighthouse to the value investing path.

In the beginning, I solely focused on buying cheap cigar butt stocks (net-nets) and
experimented with many different strategies to return as much profit as possible. This is
where my biggest evolution has come from. Instead of searching for high upside stocks, I
now look for opportunities where the downside is low.

By focusing on the downside first, the upside always takes care of itself.

SN: How did you train yourself to be a value investor? Did any particular books or
investors inspire you?

JJ: I read about Buffett, read about Mohnish Pabrai, Charlie Munger and all the other value
investing greats you know about. I even learnt how to value stocks using a DCF early on
and I spent days playing around with it and “testing” it with play money.

I did well in those play money accounts.

2/6
But do you remember how in school you come to a realization that there’s theory and then
there’s the real world?

As soon as I put down all those books and started a real money account, that came into
practice immediately.

The best training came from the money I lost. I experimented in areas I wasn’t cut out for;
investing in junior mining stocks, macro calls, bankruptcies and using too much money in a
single arbitrage situation. That’s just a short list.

For a list of books that have helped shaped me as an investor, I’ve created a dedicated
page with the list of books sorted by difficulty.

SN: Speaking of personality traits and life experiences, what are some that you think
have shaped you as an investor?

JJ: There are two.

First, as Warren Buffett said –

I am a better investor because I am a businessman and a better businessman because I am an

investor.

Unless you are an executive level manager at a company or you run your own business,
you won’t fully understand and appreciate what the above quote means.

Before I started my own business, my focus was on making money which caused me to
miss or ignore important information over the profit potentials. Red flags such as excessive
related party transactions, overcompensating a CEO and too much power held by a CEO.

Now I see a much fuller picture and am able to apply it when analysing and choosing the
companies I wish to invest in.

The second is Charlie Munger’s multidisciplinary approach that he believes is the best
method to deal with a set of problems –

You’ve got to have multiple models. And the models have to come from multiple disciplines
because all the wisdom of the world is not to be found in one little academic department.
That’s why poetry professors, by and large, are so unwise in a worldly sense. They don’t have
enough models in their heads. … You may say, ‘My God, this is already getting way too
tough.’ But, fortunately, it isn’t that tough because 80 or 90 important models will carry about
90% of the freight in making you a worldly wise person. And, of those, only a mere handful
really carry very heavy freight.

Many times, my analysis or understanding of a business or industry is enhanced from the

experience I’ve gained from my engineering, marketing, sales, and even simple everyday
life events. Investing mostly involves understanding the situation as opposed to trying to
solve a problem, so that makes it even easier.

3/6
I used to sell a lot of things on eBay during the early years so from that experience, I’m
able to understand the business of eBay, why they make changes to certain fee structures
and the layout of the website, the e-commerce industry, the challenges of growing in such
a space, the disadvantages of eBay compared to competitors as well as the advantages.

All this from simply selling my rubbish on the site. That’s the power of a multidisciplinary
approach.

SN: What are some of the characteristics you look for in a high-quality business?

JJ: Moat is very high on the list but the thing is that most companies don’t have one. So it’s
important to check that the numbers from the financial statements confirm that a moat
exists. Some rules of thumb for a high quality business are – return on invested capital
above 15%, free cash flow growth with a low level of capex needed, and a consistent or
improving cash conversion cycle.

SN: How do you think about valuation? Do you have a preferred valuation framework
to assess the attractiveness of an investment?

JJ: Outside of the stock market, valuation is all people care about. Whether it’s buying a
new home, new car or something as simple as a microwave, people will spend hours days
and months to find that perfectly price car or home. This is how I approach valuation. It’s is
the single biggest controllable factor for an investor that will either make it or break it for
you.

I don’t have a single preferred framework or valuation method as I find that it forces me to
fit things into a box.

Remember those children’s toys where there are holes made of various shapes and you
have to put the correct shape into the matching hole? That’s how I feel about valuation.
With just a single framework or valuation method, it’s easy to use a DCF for companies
where a DCF may not be appropriate, or base a decision using a P/B ratio where P/B might
not make sense.

The first step of any valuation framework is to first understand what type of company it is,
and then apply rules and formulas that are appropriate for that particular business.

SN: What have been your biggest investment mistakes and what lessons have you
learned from them?

JJ: If valuation is the biggest factor for an investment, position-sizing is second. When all
my mistakes are boiled down, it fits into either category, but my biggest are a combination
of both.

I bought a company where I compromised on the price. I was too eager to buy and pulled
the trigger. Buffett calls investing a no-strike baseball game. There was no need to swing
until it became a fat pitch, but I swung anyways.

My position sizing was good to start with, but as the stock moved up a little, I felt like I was
going to miss out on this great opportunity and bought more than I could chew.

4/6
Over the next few quarters, things started to go south and by the time I sold out, the loss
was much bigger and affected my portfolio more than it would have had I stuck with my
original sizing strategy.

Every investment involves risk and the best way to mitigate risk is to make sure you buy it
at an attractive price and limit damage with good position sizing. As small investors, we
can’t take over the board, change the behavior of management, influence how a product
will be bought and sold. These are external factors that certainly need to be analyzed, but
the internal factors that can be controlled are via good valuation and allocation.

SN: Do you believe in investment checklists? If yes, what are the most important
points in your checklist?

JJ: If checklists have proven to work in other industries (aeronautical, medical, car
mechanics), there is no reason why it doesn’t work in the investment field.

However, checklists have to be used wisely. It’s so easy to create a 200-points checklist,
but there has to be a clear purpose to the checklist. Just like what I mentioned about an
investing framework, I believe that it’s best to have numerous short checklists specific for
industries or situations. You wouldn’t use the same checklist that you use on IBM for a
special situation investment like a spin off.

There’s also a danger to a checklist. If you have a 10 page checklist that takes 5 hours to
go through, you run the risk of feeling obligated to buy the stock due to the time you’ve
invested. That’s why it’s important to keep it as simple as possible. Remove old and
outdated checkpoints. Einstein simplified the theory of relativity into an equation that
anyone can remember. E= mc^2.

SN: How do you check for corporate governance in a company? What factors do you
consider in doing so?

JJ: I keep it simple by checking the proxy documents a company has to file in the US to
see whether management are getting special perks that should be personal expenses.
Things like company paid jets, yachts, gym memberships and full health insurance
coverage that should come out of pocket.

I also check to make sure that if SG&A (sales, general, and administrative) overhead rises
sharply, it’s not due to expenses like the ones mentioned above. Lastly, another quick
check I like to perform is to compare the ratio between executive compensation and
revenue.

SN: What are some of the tricks that you use to save yourself from behavioural
biases? In other words, how do you minimize the mistakes of behaviour in your
investment decision making?

JJ: I wouldn’t say these are tricks because the number one defence is to acknowledge your
weak areas and know when it’s likely to happen. In other words, it’s about setting up
boundaries to save yourself from falling to behaviour biases.

5/6
A recovering alcoholic is going to set up boundaries to put himself in a position to succeed
by avoid routes that take him by the liquor store. A business relationship remains strong
when boundaries and systems are set up to help and benefit both parties.

So this is what I do. I’m trying to put myself into a position where I can succeed. If I put
myself in a situation where I’m constantly thinking about the stock price or worried about
losing money, then I’m bound to fall into bad habits. That’s why I stay away from stock
talking media, I don’t talk about stocks with friends or family, I don’t read too many stock
articles, I’m not out looking for a new idea every day.

SN: What’s your two-minute advice to new investors or students interested in a

career in investing?

JJ: Become an expert in accounting. The language of business and investing is

accounting. But don’t just end there. Learn to understand, speak and interpret the language
instead of just knowing the alphabets.

SN: How do you avoid the noise and the overload of information that is available
these days?

JJ: Similar to what I mentioned above. I also go to the source to get my facts like the
company filed documents. Noise is made up of people’s opinions and most people don’t
know what they are talking about. They just regurgitate what they hear. I also make sure to
follow credible people that I trust in order to get information that has been filtered out
already.

SN: Well, thanks a lot Jae for the amazing insights you shared with Safal Niveshak
readers.

JJ: It was my pleasure, Vishal. Thanks!

6/6
Interview with Stable Investor
safalniveshak.com/interview-with-stable-investor/

Vishal Khandelwal December 21, 2014

This is not an interview which I have taken of someone else, but my interview on Stable
Investor, a website dedicated to long-term investing.

So someone has finally found me deserving for an interview!

Dev, who runs Stable Investor, has been a long time tribesman of Safal Niveshak and a
friend. I have come to respect him a lot via our discussions and also via his work.

In this interview, I share my background, philosophy, and journey as far as investing is

concerned, and a guided route map for anyone starting out on his/her own journey as an
investor. Hope you find some value in my experiences.

Let’s start right away.

Click here to read/download the PDF

Dev: When and how did you get started in the stock market, and when did you feel
that stock investing may be your true calling?

Vishal: It’s a long story, but let me still start.

My indirect connection with the stock market started somewhere in the early 1990s when I
was just around 13-14 years old. My father and uncles used to trade in stocks then, and
had earned and lost a lot of money during the Harshad Mehta boom and bust.

My father used to read the financial newspapers with great interest and I remember him
telling me then how important it was to read newspapers. As an obedient son, I started
glancing through the financial pages of newspapers then, though I did not understand much
of what was written (I still don’t!).

Anyways, after a quiet period after the Harshad Mehta scam burst in 1992 and the dotcom
bubble started in late 1999, I don’t remember stocks being talked about a lot in my
household.

As the bubble was building up and the markets were rising, I came to like the way CNBC
anchors talked about stocks day in and day out and how smartly they predicted the next
rise. That was the only channel that was on in my house, and that is all I saw. Though I did
not know much about stocks even then, I surely came to know one very important fact
about the stock market seeing what was happening around me.

This fact was that you could make a lot of quick money when there is euphoria in the stock
market, and lose it all even quickly because each euphoria ends up in a crash.

I saw this in the early 1990s and then in the early 2000s, around me and within my family.
So that was my first brush with the stock market, though indirectly.
1/16
Anyways, in 2001, I came to Mumbai to do my MBA. So you can say that this is when I
came real close to the stock market.

These two years at MBA were the most wasteful years for me as far as classroom
education is concerned. I realized that, around me, everyone was running for the highest
marks to be able to get the best jobs. In fact, we were asked to prepare for our placements
from the very first semester of the Course, and what our professors did for the next two
years was exactly that – cram into us whatever was written in books instead of how the real
life worked.

Now, how did I know then that the reality was different from what the MBA profs were
teaching us?

The books in my college’s library told me that. Whether it was Eliyahu Goldratt’s Goal, or
Jim Collins’s Good to Great, everything pointed at something different than what was
written in my MBA textbooks.

This library was where I got seriously involved in reading. And this is where I first read Peter
Lynch’s One Up on Wall Street and Robert Hagstrom’s The Warren Buffett Way. I don’t
remember falling in love with these books or their ideas at that point of time, but they
definitely got me interested in the business of stocks.

Now, this was around 2002-2003, and the Indian economy and the job market had not
recovered fully post the dotcom crisis.

In fact, howsoever I aspired to get into a stock market job, somewhere in early 2003 I lost
hope of getting any decent job after being rejected by the very few employers who attended
my college’s placement season.

But as luck had it, a small, unknown equity research company called Equitymaster came in
search for candidates to my college for the position of “equity research analyst”. I managed
to pass their interview process and got selected for the job.

I had not known this term “equity research analyst” earlier and neither did I know about my
employer. But I still accepted the offer, which came at a salary that was almost what I would
have earned in the role of a peon. “So much for an MBA degree, huh!” I told myself.

Apart from the fear of becoming an “educated-unemployed”, I also took up that job due to a
promise I had made to my ‘would-be wife’ before joining my MBA that we would get married
as soon as I got my job so that her family didn’t get her married off somewhere else.

As I try to connect the dots now, looking backward, the saying that there is a woman behind
every man’s success has been true in my case. In fact, the woman in my life has not really
been ‘behind’ me, but has walked besides me, holding my hand through the thick and thin
that life has brought.

Well, I am not going to bore you today with my life story (let me keep it for some other day
, but that first job – which was also my last – was the beginning of my love-hate
relationship with the stock market.

2/16
Getting into an independent research company which Equitymaster was, was very fortunate
for me.

You see, I am a firm believer in the fact that our “values” are the things that are most
important in the way we live and work.

For example, if you value family, but you have to work 70-hour weeks in your job, you will
surely feel internal stress and conflict. In the same way, if you value honesty, but you work
in an environment where the incentives are designed to make you dishonest, you will
gradually kill yourself out of stress.

So, the reason I find myself lucky to have accepted that job was that, and I realized this
later, it matched perfectly with the key values I live my life by, which are – family, honesty,
and freedom.

While I was working in the stock market, my job wasn’t stressful, and neither were the
incentives misaligned given that it was an independent research company and not a
brokerage hungry for commissions.

So, I was working mostly in the interest of my clients, and not that of mine, which is so
unlike how the stock market industry generally operates.

That is where I formed the belief that it was possible to do honest work in the stock market.
And that is one of the core reasons I love doing what I am doing now at Safal Niveshak.

Anyways, my job as an analyst typically involved reading annual reports, meeting

managements, working on financial models, and writing research reports. I found all the
three parts of my work exciting – reading, researching, and then writing. And that again is
what gave me the confidence that I could do something of my own based on these
aspects, which also gradually became my strengths.

Now it is another part that, after 2008 happened, I gradually lost the charm in being an
analyst and doling out futuristic recommendations to investors.

I realized over a period of time that I was recommending stocks into the “unknown” – to real
people with real-life savings, but those I knew nothing about – and just because they had
paid in advance for that research.

So if there was a service that was supposed to recommend (either Buy, Sell or Hold) one
stock per week to a paid subscriber, the research team was obligated to write that one
report per week.

While we had a decent internal process of choosing stocks that helped us recommend
some great stocks and avoid some really dud ones, just the velocity of recommendations
created greater chances of making wrong (under-researched) recommendations.

In fact, by the time I was leaving my job, we were writing almost 100 reports a year (or
around eight per month), a gigantic number for any small investor to digest!

3/16
What is more, as I said above, it was a “one-size-fits-all” kind of a philosophy, as the same
stock recommendation was being bought and acted upon by a young executive, and a
retiree.

So after 2008 happened and I got to know that stock market analysts are not masters of the
Universe as they claim to be, a deeper realization set in within me. I asked myself – “What if
my “one-size-fits-all” recommendations have made the difference between a comfortable
retirement and a miserable one?”

The answer pinched me hard, and laid the ground for my exit from the industry, which I had
already started hating for the above-mentioned reasons.

Travelling every day with people, and travelling to a place that I detested (Nariman Point,
the heart of the financial system in Mumbai, and also the heart of arrogance and greed)
had really gotten over my senses. And that pushed me towards quitting my job, which I did
in April 2011, exactly eight years after I had joined it.

So, that was to answer your question – in case you are still awake – when and how I
got started in the stock market. The process was pretty long – 1992 to 2011 – and I was still
a beginner.

Anyways, the seeds of what I am doing now, my liking for the ideas of investing legends
like Warren Buffett, Charlie Munger, Philip Fisher, and Prof. Sanjay Bakshi, and my passion
for educating small investors in their sensible ways of stock investing, were sowed
sometime during the 2006-2008 period.

I am still not impressed when someone calls me a “stock market investor” because
investing is not what gets me up each morning.

What excites me much more is the thought that each day connects me with so many new
small investors whom I can help to change the way they invest, for the better. I have been
extremely pained by how small investors have been taken for a ride over the years, and this
is what I have set out to challenge.

Helping people move from -15% CAGR to +15% CAGR is a bigger goal in front for me than
to earn 20% ROI on my own personal stock investments. So I can say that is my true
calling, and not really investing my own money.

But then, I also love the entire process of being an investor. The very ideas of learning how
various businesses work, what makes some of them great and most of them gruesome,
and why managers and investors behave the way they do, hold great charm for me.

Dev: Once you realised that investing was to play a major role in your life ahead,
how did you begin to learn about the markets and investing in general?

Vishal: While my learning process started on the job, when I was working as a stock
market analyst, the real kick came in after I quit my job and gave a serious thought to my
personal investing and what I had set out to do – help others become better investors.

4/16
So, when I realized this, I found some great companions in the literature of Warren Buffett,
Charlie Munger, Ben Graham, and Prof. Sanjay Bakshi. I started reading and re-reading all
the material that I could find on them, or written by them.

The thoughts on separating great businesses from the gruesome ones, I learned from
Buffett (and the process is still on).

The belief in margin of safety came from Graham.

Munger told me how foolishly I often behave in my investing endeavours, and how I can
minimize my behavioural mistakes.

And Prof. Bakshi taught me that all I learned from Buffett, Munger and Co., can be applied
in the Indian context as well. Plus, I also learned a lot from him on the idea of being an
effective teacher.

So, reading, re-reading, making notes, and sharing my thoughts with my tribe members on
Safal Niveshak have been parts of my process of learning to become a better investor, and
of course a better human being.

Of course, I have just started and there is a long way to go…a lot of things to learn…and a
lot of things to teach.

Dev: Explain you investment philosophy in 20 or lesser words.

Vishal: That’s easy, as I recently did a post on Safal Niveshak asking readers to share their
investment philosophy in less than 10 words.

Anyways, my personal investment philosophy is – Do the best. Expect the worst. Keep
learning. Keep going.

This is the concise version of the five most important things I practice in my investing life –

Do hard work;
Have margin of safety;
Read, read, read;
Learn from my own and others’ mistakes; and
Practice patience and perseverance.

Dev: How do you typically find ideas and what is your selection process before an
idea gets added to your portfolio?

Vishal: I somewhere read Warren Buffett as saying, “Can you really explain to a fish what
it’s like to walk on land? One day on land is worth a thousand years of talking about it, and
one day running a business has exactly the same kind of value.”

And then, he has said many times that he is a better investor because he is a businessman
and he is a better businessman because he is an investor.

So, my experience as an entrepreneur has been very fundamental to being better at

investing. And this has especially happened over the past three years. Of course, I was
investing in the stock market earlier as well, but I did not have a well laid-out process then.
5/16
Most of my investing prior to 2011 happened on the back of recommendations from my
analyst friends, whom I really trusted (and there were just a couple of them), because I was
not legally allowed to buy stocks I was analyzing. Of course, even when I bought stocks
based on my friends’s recommendations, I used some my own understanding as well. But
as I realize now, that was just to confirm the original hypothesis.

Coming to the present times, my understanding of how I must run my own business helps
me a lot on deciding which businesses to buy, and which ones to avoid with a 10-foot pole.

So the first thing I look at is the quality of business. And here are a few things that help me
decide whether a business is good or not.

One of the first things I look for in a business is how simple or complex it is to
understand – the “too hard” stuff as Warren Buffett calls it.

If there are a lot of regulations involved (energy, power etc.), or if the business has an
unproven past (green energy, ecommerce, pharma R&D), I simply avoid it. Then, there are
some businesses – like those from the real estate and infrastructure sectors, and business
groups that have a history of being unethical – I don’t trust, so I avoid these as well.

Then, there is a third category of businesses that I avoid – ones that harm the ecosystem in
which they operate. Like cigarette, alcohol, and stock broking companies. Banking is one
more sector I avoid as I do not understand how they account for the money they borrow
and lend.

Then, I assess whether a business has the ability to sell its products/services to the
world rather than a single region or a single market. In other words, I ask whether it has
a large and unlimited market opportunity in front of it. This is because if the opportunity is
not large, it’s difficult for me to assess the sustainability of the business and its earnings
growth 10-15 years down the line.

This thinking has helped me avoid businesses like retailing store that has been doing well
for years – then another bigger and better retail store moves nearby, and it’s kaput for the
first store.

Anyways, the next question I ask is whether the business is a commodity or enjoys
some brand power in its industry. I try to seek out companies that are either market
leaders or are operating in industries with low competition, either due to an exclusive
licence or brand name or similar intangible that makes the product or service unique.

The reason I look for this aspect in a business is because I am searching for companies
that earn high gross profit margin and net profit margin and also high return on equity –
better than the industry average – and can sustain these over the long run. ‘Sustainability’
is the keyword here.

A high gross margin is an indicator of pricing power, which is the result of a moat the
business has. Investing in moats has worked well for me in the past, and I am in no mood
to shift from this sphere.

6/16
Another important factor that I consider is how the company has grown its earnings
over the past 8-10 years. Research states that a typical business cycle lasts for seven
years, so this is the minimum time for which I study a company’s earnings growth. Here, I
am looking at earnings that have risen consistently in the past, and without much volatility.

So, if I am given a choice between –

A business that has seen sharp surges and cliffs in its earnings growth in the past,
and has earned, say and average Rs 100 per shares in EPS over the past 10 years;
and
A business that has seen a gradual rise in its earnings in the past, and has earned,
say an average Rs 70 per shares in EPS over the past 10 years

…I will choose the latter. So you see, it’s again sustainability that I am looking for.

What is more, I also try to assess whether the business has the capability to grow
earnings at a minimum 15%+ per annum over the next 10 years or not. Again, here, my
idea is not to try and count the leaves on a tree in the next season – quarterly or annual
EPS estimates – but to assess what the next season is going to be i.e., where the business
is headed.

Rising earnings serve as a good catalyst for stock prices in the long run, and thus I try to
seek companies with strong, consistent, and expanding earnings.

The third question I ask is how conservatively or aggressively the business is

financed. I am a debt-averse person myself, and hate the thought of borrowing money to
buy anything. The only times I have borrowed money in the past were to buy my house and
car, and I cleared both the loans as fast as I could.

So, I look for companies that suit my personality in terms of their debt profile. What this
means is that I try to seek out companies with conservative financing, which equates to a
simple, safe balance sheet.

Such companies tend to have strong cash flows, with little need for long-term debt.I look
for low debt to equity ratios, plus companies that have history of consistently
generating positive free cash flows.

The fourth thing that I look at in a company I am researching is whether it sticks with
what it knows. Thus, again, I am looking at a business that suits my personality. I find it
difficult to think or work on things that I don’t understand – my circle of incompetence – and
that is what I expect from a business as well.

So, I look at the company’s past pattern of acquisitions and new directions. They should fit
within the primary range of operations for the firm. I am cautious of companies that have
been aggressive in acquisitions in the past.

This is also given my direct experience in the stock market, where I have seen most
acquisitions been made not for the benefit of the acquirer’s business but to satisfy the ego
of the CEO/promoter.

7/16
Then, I look at how good the company has been in terms of investing its retained
earnings – profit that is left over after paying dividends. Here, I look at the return on equity
(ROE) profile of the business in combination of its debt, which must be low.

Now, as far as ROE is concerned, an absolute number may fool investors, as it has fooled
me in the past. Earlier, I thought a higher ROE was always a great thing, till I came to
realize that companies can artificially raise their ROE using debt.

So, one formula I use now to dissect the ROE is the DuPont model, which captures
management’s effectiveness at three key factors that determine the quality of a business –
(1) Generating profits (net profit margin), (2) Managing assets (asset turnover), and (3)
Finding an optimal amount of leverage (financial leverage).

I see Du Pont model as one of the best formulas ever created to measure the quality of a
company’s business and also the quality of its management, and I suggest all investors use
it before getting happy about companies with high and/or rising ROEs.

Then, I also consider how capital intensive the business is. I have learned from
reading Warren Buffett that companies that consistently need capital to grow their sales and
profits are like bank savings account – you can earn more interest only by depositing more
money – and thus bad for an investor’s long term portfolio.

So, I seek companies that don’t need high capital investments consistently. Retained
earnings must first go toward maintaining current operations at competitive levels, so the
lower the amount needed to maintain current operations, the better. Here, more than just
an absolute assessment, I do a comparison against competitors.

To just sum up what I mentioned above, here are the few key questions I ask every time I
look at a business that can potentially become a part of my portfolio –

Is this business inside my circle of competence?

Is the business simple to understand and run? Complex businesses often face
complexities difficult for its managers to get over.
Has the company grown its sales and EPS consistently over the past 8-10
years? Consistency is more important than speed of growth.
Will the company be around and profitably better in 10 years? This suggests
continuity in demand for the company’s products/services.
How well has the company done in retaining its earnings?
Does the company have a sustainable competitive moat? Pricing power, gross
margins, lead over competitors, entry barriers for new players.
How good is the management given the hand it has been dealt? Capital
allocation, return on equity, corporate governance, performance against competition.
Does the company require consistent capex and working capital expenditure to
grow its business? Companies that have to spend continuously on such areas are
like running on treadmills, which is not a good situation to have.
Does the company generate more cash than it consumes? Cash generators
have a higher probability of surviving and prospering during bad economic situations.

8/16
You see, in tying up my investing with how I want to live my life, I want to study and invest
in a business that leaves me with a lot of free time, which I can spend with my family and in
reading books, instead of worrying about where the business is headed.

And that’s why the simplicity of the underlying business and cleanliness of its management
are the foremost priorities for me.

I don’t want to invest in anything that could potentially give me stress, which could also
affect my personal life.

Finally, I have learned over the years through reading investing greats and more from my
own experience, that sensible investing is always about using folly and discipline – the
discipline to identify excellent businesses, and waiting for the folly of the market to drive
down the value of these businesses to attractive levels.

As an investor, you will have little trouble understanding this philosophy. However, its
successful implementation depends upon your dedication to learn and follow the principles,
and apply them to pick stocks successfully, which I am trying to do.

Dev: After you have assessed a business’s quality, how do you go about valuing
them? What is your thought process on this intriguing subject of valuations?

Vishal: After a company meets my business quality checklist points as I enumerated in the
above answer, I consider its valuations to check how cheap or expensive it is trading at
compared to its long term earnings power.

I use a mix of valuation models like DCF or discounted cash flow, reverse DCF, Bruce
Greenwald’s EPV or earnings power value, Stephen Penman’s Residual Income Model,
and the Graham formula.

Now, as I have realized from the numerous mistakes I have made in the past in valuing
stocks – it’s a fuzzy concept, you see – valuations is not about identifying the “target price”
for the stock. It’s not about estimating or predicting where the stock would or should trade in
the future.

Instead, I now use valuations to understand the perceptions of other investors embedded in
the market price, so those perceptions can be challenged.

As Stephen Penman writes in his wonderful book, Accounting for Value…

The investor is negotiating with Mr. Market and, in those negotiations, the onus is not on the
investor to come up with a forecast or a valuation, but rather to understand the forecast that
explains Mr. Market’s valuation, in order to accept it or reject his asking price.

In simpler words, what Penman suggests is that instead of estimating an intrinsic value for
a business, we must focus on assessing whether the stock’s existing market valuation
(which is based on what others are willing to pay for it now) is right or wrong.

We must focus on identifying the amount of speculation in a stock’s current price, which
causes the stock to be priced more than what the book value and future earnings would
justify.
9/16
So, rather than trusting the market to deliver returns in the long run, I try to assess whether
the market’s long run expectation for the business I am studying is a reasonable one or not.

In all, my view is that investors must not take a valuation model too literally. Instead, they
must see a valuation model as a tool to challenge the stock price.

Rather than plugging a growth rate into a model, apply the model to understand the future
growth that the market expects.

After all, valuation is not a game against nature, but a game against other investors, and
one proceeds by first understanding how other investors think.

As an investor, you are not required to establish a valuation, but only to accept or reject the
valuation of others. That makes the job much easier, isn’t it?

But again, the underlying idea is to use a variety of valuations models instead of laying your
complete faith on only one.

You see, even if a carpenter finds the hammer to be his favourite tool, he never comes on
the job with just a hammer (at least not intentionally). He brings his toolbox with a variety of
tools in it. Right?

It’s the same with investing. You have a few valuation tools at your disposal, and they all
have advantages and drawbacks. However, by using them in conjunction with one another
and being aware of their strengths and weaknesses, you may make a more accurate
valuation of any given company.

Here, it’s important to remember that investing is about trying to predict what will happen in
the future. Our ability to do this is very limited. The future of most businesses is highly
uncertain, because they operate without a durable competitive advantage and are therefore
bounced about and pummeled by the waves of relentless competition and creative
destruction.

On the other hand, there are a select few businesses where you can make meaningful
predictions about where they will be in ten years. You are able to see that the conditions
that led to their success over the past ten or twenty years – or, in rare cases, fifty years –
are likely to remain in place for the next ten or twenty years.

So the most important elements in valuing a business are to have a very clear view of why
a company is a good business and a very clear view of where the business will be in a few
years.

The problem with cranking out valuation methods is that they create the impression of false
precision – like using DCF will make us believe that that we can actually look into the future
and plainly see a company’s free cash flows for the next decade or more.

So before you get down to valuations, spend time and energy on what really matters and
what is doable. Remember that there are things that are important and knowable and there
are things that are important and unknowable.

10/16
A company’s stream of cash flows over the next ten or twenty years is very important but
for most businesses falls into the column of unknowable.

If you don’t get the part right about whether it’s a good business and where it will be in a few
years, the investment most likely won’t work out as planned – whatever its valuation tells
you.

All in all, while analysing businesses, the less non-mathematical you are, the simpler,
sensible, and useful will be your analysis and results. Great analysis is generally “back-of-
the-envelope”.

Also, your calculated intrinsic value will be proven wrong in the future, so don’t invest your
hard-earned savings just because you fall in love with it.

Don’t look for perfection. It is overrated. Focus on decisions, not outcomes. Look for
disconfirming evidence. And then, please act on your conviction.

Dev: Compared to good old days, the amount of noise (useless information in
common terms) is much more today. How do you cut out the noise and remove
personal biases while evaluating potential investment?

Vishal: I think one of the keys to investment success is to avoid noise. And the best way to
avoid noise is to learn to say ‘No’.

I say ‘No’ to a lot of things. In fact, to most things. That helps. I don’t watch business
television, nor do I read newspapers. I have not had a newspaper delivered to my house for
the past 5-6 years now. Also, I do not participate in stock discussion forums. That saves me
a lot of time and energy that I would have otherwise wasted amidst the noise all around.

It was of course difficult at the start to avoid noise because I used to mix that up with
information, and information to me meant wisdom. But ever since I have learnt to
differentiate between the noise/information, knowledge, and wisdom, I have tried to keep as
much away from the first i.e., noise/information, soak in as much of the second i.e.,
knowledge, and work towards building wisdom.

There’s a long road to travel to become wise, but my journey has begun.

You see, the problem with noise or information is not only that it is diverting and generally
useless, but that it is toxic.

Look at how too much noise and information creates commitment and consistency bias
amongst most of us. We want to consume so much information because we are perennially
in search of the ones that are consistent with our worldviews.

So if I believe, say Tata Motors, is a great business, I will scour for information that proves it
is a great business, and dismiss every information that tells me how foolish I am in my
belief.

If I believe the Sensex is heading towards 100,000, I will keep myself busy searching for
information that validates my belief, and ignore every person who tells me how the stock
market does not move in a straight line.
11/16
That’s an utter waste for time and brainpower, both of which are in such short supply (at
least I can say the same for myself).

In a recent post on Brain Pickings, which I suggest every one trying to become wise must
read, the author Maria Popova shared an essay on seeking wisdom in the age of
information. She wrote…

We live in a world awash with information, but we seem to face a growing scarcity of wisdom.
And what’s worse, we confuse the two. We believe that having access to more information
produces more knowledge, which results in more wisdom. But, if anything, the opposite is
true — more and more information without the proper context and interpretation only
muddles our understanding of the world rather than enriching it.

This barrage of readily available information has also created an environment where one of
the worst social sins is to appear uninformed. Ours is a culture where it’s enormously
embarrassing not to have an opinion on something, and in order to seem informed, we form
our so-called opinions hastily, based on fragmentary bits of information and superficial
impressions rather than true understanding.

The Dutch philosopher Spinoza suggested that wisdom is seeing things sub specie
eternitatis, that is, in view of eternity.

A fundamental principle of wisdom is to have a long term perspective; to see the big
picture; to look beyond the immediate situation.

That’s a great advice for me as an investor – to have a long term perspective; to see the big
picture, and to look beyond the immediate situation. That’s the dawn of wisdom.

But them, wisdom requires humility. You must be teachable. You must be willing to live
with understanding, with meaning, and with wisdom. And you can do all this only when you
say “no” to noise.

Dev: This question came in from a reader of Stable Investor. How do you generate
investment ideas? Is it through screening, or reading, or blogs, or from your
personal sources like friends and fellow investors?

Vishal: Well, it’s a mix of all.

As far as screening is concerned, I largely use Screener.in, owned and managed by my

friend and fellow investor Ayush Mittal. I also sometimes use Morningstar and Google
Finance. In fact, I had written a full-fledged post on screening and generating stock ideas,
which I would direct your readers to read.

While don’t read much apart from investment books, among the few magazines I read and
find good are Forbes India and Outlook Business. These publish a lot of good insights on
businesses, both listed and unlisted.

Among blogs, my favourites are Fundoo Professor written by Prof. Sanjay Bakshi, Value
Investor India written by Rohit Chauhan, and of course your own blog, Stable Investor.

12/16
A few exceptional international blogs I read include Old School Value and Farnam Street,
the latter not directly related to investing but to multi-disciplinary mental models.

Finally, I find a lot of great investment ideas inside my existing portfolio itself.

Dev: Thinking back, what would you say was most instrumental in your development
toward investing sensibly and successfully in stock markets?

Vishal: Finding my role models, I must say. Sensible investing is something you either pick
up instantly or you don’t. So I have been lucky to get introduced to the writings of Buffett,
Munger & Co., and then to Prof. Sanjay Bakshi. I just fell in love with what they had to say
and that, I believe, has made the difference.

As I understand, you become the average of five people you spend the most of your time
with. Three of those five people I spend most of my time with (not face-to-face, but
vicariously) are Buffett, Munger, and Prof. Bakshi, and that has really helped me build a
sensible process for investing.

How successful that process will be, only time will tell, but I am not worried about the
outcome knowing that the process is all I have control on.

So yeah, to answer your question, finding the right role models has been the most
instrumental factor in my development toward investing sensibly. And why just investing,
these people have helped me tremendously in becoming a better, more humble person,
than I was a few years back.

I would like to leave you here with a brilliant quote from Guy Spier’s bookThe Education of
a Value Investor. He writes about the criticality for a budding value investor to find his role
models early in life…

…there is no more important aspect of our education as investors, business people, and human
beings than to find these exceptional role models who can guide us on our own journey.

Books are a priceless source of wisdom. But people are the ultimate teachers, and there may
be lessons that we can only learn from observing them or being in their presence. In many
cases, these lessons are never communicated verbally. Yet you feel the guiding spirit of that
person when you’re with them.

Role models are highly important for us psychologically, helping to guide us through life
during our development, to make important decisions that affect the outcome of our lives, and
to help us find happiness in later life.

Dev: What is the best advice you got from your investment guru or mentor?

Vishal: I would mention two advices here. One, keep things simple. And two, learn to say
‘No’. Whether it’s how I pick my stocks or how I live my life, these two advices have helped
me tremendously.

Simplicity – in thinking, in my investment process, and the kind of businesses I pick – is

what I learned largely from Buffett.

13/16
Saying ‘no’ to things is what Munger taught me. I believe, Munger’s quote – “All I want to
know is where I’m going to die so I’ll never go there” is one of the most important ideas that
investors must always remember.

Dev: From your blog I know that you do not prefer Index Funds even though they are
highly recommended as decent options for average long term investors. Do you
think that an average investor is better off picking an actively managed fund over
index funds, despite the risks associated with fund manager and his team’s ability?

Vishal: To clarify my stand on index funds, these are what I personally don’t prefer
because I trust a few active managers more than the index. However, that’s not to take
away from the simplicity of investing in index funds, which people not wanting to choose
active managers or direct stocks, must do.

In investing, the most important thing is to know what you don’t know. So if you don’t know
how to pick stocks directly and how to pick the right active funds directly, it’s better to start
with a passive, low-cost index fund.

Since there’s not much differentiation between different index funds, pick the one with the
lowest cost and from a decent fund house.

Dev: As an allocator of capital for your personal and family wealth, what percentages
do you generally have in equity / non-equity baskets (ignoring real estate
investments)? The percentage allocations might be dynamic depending on market
conditions, but what is the thought process behind the decision making when
allocating capital to various asset classes?

Vishal: Well, my allocation is not so much dependent on the market conditions as it is

dependent on when I need the money.

Any money I need in the next 1-3 years, plus my emergency fund that is around 6-8 months
of my household expenses, I don’t invest much of that in stocks.

However, of all the money I need beyond three years, I invest 80-90% of the same in
equities, either directly in stocks or through equity funds.

Largely, I try to keep 80/20 allocation between equity and bonds, with the latter also
including some gold.

Dev: If you were to go back to the start of your career as an investor, would you like
to change something – add or delete?

Vishal: Nothing to delete, but I will like to add a greater amount of patience. I have always
been a long term investor, but I have lost a lot of wealth-creation opportunities by owning
some great businesses for just 2-3 years which should’ve been owned for 15-20 years. So I
have lost a lot of potential gains.

Another mistake I made, which I would like to correct if I were given a chance to go back in
the past, is that I used to get anchored to stock prices. So I’ve sold a lot of stocks that
earned me 100-200% returns just because they earned me 100-200% return, and because

14/16
I was anchored to my buying price.

Your original cost price, as I realize now, does not matter when you are making a decision
to hold or sell a stock, or buy more of the same. Once you have bought a great business –
and there aren’t much of such businesses – it’s important to sit tight on it for years until the
business itself does not change for the worse.

So yes, if I could, I just want to add more patience to my past investing decisions. How I
wish that was possible!

Dev: What would you say to those who are just starting to learn about the markets
and investing their own money?

Vishal: First, read Safal Niveshak.

On a serious note, here are my ten quick suggestions to a new, young investor –

Start…don’t wait
Read everything
Know that you don’t know…a lot
Keep it simple and minimalistic
Turn off the noise
Have patience
Focus on process, and outcome will take care of itself
Accept that you will make (a lot of) mistakes
Find your role models
Know what to avoid (like leverage, trading, and speculation)

Finally, while these ten suggestions/rules can help a new investor take better care of his/her
money and financial life, I would also suggest him/her to not get too focused on these
things that he/she loses out spending time on the real joys of life.

As a wise man, or maybe a woman, once said, “No matter how hard you hug your money, it
never hugs back.”

Dev: For a young person who avoids investing in stock markets (due to risks &
volatility), what examples will you share to convince him to start investing?

Vishal: I don’t believe in convincing people, but inspiring them.

So, to such a person, I will try to inspire him/her by sharing my own experiences and the
numerous stories of others who have created wealth for themselves using the power of
compounding over long periods of time.

I will also gift him/her a few books like…

The Richest Man in Babylon by George Samuel Clason

One Up on Wall Street by Peter Lynch; and
Think and Grow Rich by Napoleon Hill

15/16
These books have inspired me a lot when it comes to taking proper care of my money, and
I am sure these will inspire the person I gift them to, if he/she were to read them diligently.

Dev: What’s your final, two-minute advice for an investor?

Vishal: Nothing on investing, as I’ve already advised a lot.

Just love your family more than the money. Be a good child, spouse, and parent.

Your best investment in life would not be any stock or bond or real estate or gold, but the
time you spend with your family, and especially your child.

Life can pull you in a thousand directions, and you might ignore it especially when your
child is little. But remember – Children don’t stay little for long. So, slow down…take some
time…give some time…invest some time.

And finally, please take care of your health. If you want to benefit from compounding, you
need to be alive and in good health beyond 50 years of age.

If you have great health and a loving family, there’s no bigger wealth you can ask for in life.

Thank you!

Click here to read/download the PDF

16/16
 Safal Niveshak’s

Interview of
Basant Maheshwari

www.safalniveshak.com
September 2014
 Interview with Basant Maheshwari | Safal Niveshak

Interview with Basant Maheshwari

Safal Niveshak (SN): What are the key factors that shaped your life as
an investor? What inspired you take up investing as a full-time
activity?

Basant Maheshwari (BM): My maternal uncle was into the investing field.
He was actually a broker for the Calcutta Stock Exchange. So, as a kid, I
used to go there and look at the Economic Times. I didn’t get a hang of it. I
won’t say it inspired me, but it made me curious of the market, but I knew
nothing.

So when I was in college, I had a couple of friends who were badly into
stocks. It was the Harshad Mehta era. They would miss classes to look at
the stock markets.

One of our friends used to tell me how a stock was selling at an EPS of Rs
20 and that it would get a P/E of 20 and the price will be Rs 400. So I was
really attracted to his style. We wondered how this guy knew what price the
stock would trade at. Why he was talking about the P/E of 20 was never
our thing, because we didn’t know what the P/E meant.

Harshad Mehta was a great Pied Piper for the Indian community, because
everybody got attracted to stocks in his era. So I had no objective as to why
I was in the market at that time. The only thing was that I wanted to make

www.safalniveshak.com Page 4 of 59
 Interview with Basant Maheshwari | Safal Niveshak

money…and how much money, what to do with that money, there was no
sense to it.

I just wanted to do something because it was making money for me.

Thankfully, I was not into stocks to such an extent that I left my education.
My focus was to make ten, twenty, thirty, and forty thousand. I made it and
then I blew it all.

Next era was during the Ketan Parikh period. I was into stocks all this
while. One of my friends was a stock broker. We used to look at The
Economic Times by running our index fingers to the right of where the stock
was. So we used to identify the lowest P/E stock selling at the lowest price.

So the lowest price with the lowest P/E was the most attractive investment
at that time. That was how we used to do it. For example, if the P/E was 3
and the stock was trading at Rs 9, it was the best deal. If the P/E was 3 and
the stock was trading at, say, Rs 200, it wasn’t as good as the stock that
was trading at Rs 9.

I was into my family business, which was doing well then. I used to tell my
father that I wanted to invest, but he was against it. He said stock market
was gambling and that I would blow everything up.

So we struck a deal. He used to give me a salary every month. I used to

take that money on the 1st of every month to put into the market, without

www.safalniveshak.com Page 5 of 59
 Interview with Basant Maheshwari | Safal Niveshak

any serious thought as to what I was doing. Portfolio creation and allocation
were far-far away.

I just didn’t know what I was doing. If the stock was selling for Rs 50, I used
to buy 500 shares. If the stock was selling at Rs 100, I used to buy 250
shares. If the stock was selling at Rs 500, I wouldn’t buy it. That was the
theory.

Between 1994 to 1998, Infosys came right under my nose. We saw their
good results, but there was always these thoughts like – “Who would buy
Infosys if you take away all their employees tomorrow?” or “It only has
computers and chairs and what are those worth for?” or then “I can create
an Infosys by hiring all those people.”

That was the only concept at that time, and it was thoroughly foolish. But
that is how you start.

By 1998-1999, the tech fever had started, and stocks were surging. That
time, I chased the second-liners. Zee TV was the darling of the market at
that time. In 1999, there was this company called Shree Adhikari Brothers.
They were starting a channel, after having done a lot of good programmes
on Doordarshan.

And I though this will also do well because Zee TV was doing well. So I
bought the stock at Rs 130. It went to around Rs 2,000. Similarly, I had
bought other stocks like Pentamedia Graphics, Silverline, and DSQ

www.safalniveshak.com Page 6 of 59
 Interview with Basant Maheshwari | Safal Niveshak

Software. I also bought a lot of pharma MNCs, but slowly my portfolio got
heavily loaded with technology stocks.

That was when I was really focused on buying the lower P/E – the poor
cousins as you might call. So, in March 2000, if Infosys was trading at a
P/E of 300, I thought it was too much, so I bought DSQ Software which I
bought at Rs 300 and the stock touched Rs 2,800. Now because I could
not draw a higher salary from my father’s bank account, I borrowed a lot of
money from Standard Chartered Bank (owing to our business relationship
with them).

I still remember those evenings when I went to the bank to pledge shares
and withdraw shares. One fine day, we were in Jammu and I was at the
mines (we were a mining company), and there was a complete dislocation
of communication there. The market fell in the meanwhile, the bank would
have sent me a margin call letter at my home here, there was nobody and
the letter got returned, and then the bank sent a telegram, and then they
sold all the shares.

In 2000, around April or May, everything got drained out. But that was one
part of it. The second part was that when I got to know that my bank had
sold all my shares, I went and bought all those shares at Rs 100-200 higher
prices. So that is how it happened. This was the background.

After the year 2000, when I had lost everything, including our family
business owing to the government taking away the mines from us, we had

www.safalniveshak.com Page 7 of 59
 Interview with Basant Maheshwari | Safal Niveshak

nothing to fall back on. That was when I started teaching. It was that time I
heard about this book called One Up on Wall Street.

Before that I had no clue that there was a “book” on the stock market,
because stock market was gambling. How could you have a book on how
to gamble?

So I got hold of that book. In it, Peter Lynch talked about 10-baggers, 50-
baggers, and 100-baggers. And I asked myself, “Can prices go up 50
times, 100 times?”

That was the first serious thought I gave to investing. I realized then that
this was the only place I could have made a lot of money. That was a
concept that was clear.

I had seen people make a lot of money. My maternal uncles were here in
this field. Of course they were brokers. So that is how it actually started.

And then I started reading. I had just heard about Warren Buffett at that
time, but I did not read any of his letters at that time. But the first big break
came to me when I read Peter Lynch’s One Up on Wall Street.

In hindsight, it looks very amateurish to many people, but that is a very

classic way of getting into the market. So that is what really put me there.
And after that, it was all on-the-job kind of learning for me.

www.safalniveshak.com Page 8 of 59
 Interview with Basant Maheshwari | Safal Niveshak

SN: How would you describe your investment philosophy? Has it

changed over the years? What has gone out and what has come in?

BM: First thing, I will never buy a stock unless I think I can make 10-times
out of it. Many ideas look good to me for a doubler for next year, or say
50% in six months, I don’t touch them.

This is because my thought is that if you play for a 50% game and you get
it wrong, you can also lose 30%. But if you play for a 1,000% game and
you get it wrong, you will at least get 100%, 200%, or 300%. That is
assuming all your analysis is correct. The market externalities that are not
in your hands cannot disturb you too much.

So that is my only investment philosophy.

There are many stocks I’ve sold because I thought those stocks would only
double or triple from that point. And by chance, that has almost been the
peak.

Like there was a stock called Television Eighteen (TV18), where I made
around 16 times. That I sold because I thought at max I would only double
it. So why play for a double? If I want to play for a double, I’ll go and buy
HDFC Bank.

www.safalniveshak.com Page 9 of 59
 Interview with Basant Maheshwari | Safal Niveshak

So that is the basic philosophy. Of course, I also look at management

quality, return on equity etc, but those are separate things. But my basic
attraction to a stock will only come from there.

Now how it has changed is that earlier when I had nothing to lose, I just
wanted to be with the stock that would give me the highest possible return
and allocate as much to it. That has changed in the sense that now, of
course I want to be with the growth companies, but I also look at the risk
very carefully. I just cannot afford to lose.

This is because I am willing to put a lot of my own capital and a lot of

borrowed capital also. So when you are on leverage, you just cannot take
any chances.

I figured out that having 50% of your net worth in equities and 50% in bank
FDs, and buying inferior grade companies for a 40% jump on the 50% you
put into equities, is not that good a strategy as having 120% in equities in
high-quality companies that can give you 20-25% return.

Most people would allocate 50-60% to bank FDs and FMPs and those
things, and for the balance 40% they want to maximize returns by trying to
chase 40%. Of course, I also aim for 40%, but that has to come with very
reduced amount of risk.

I will give you an example. Look at cash flows of companies. It is very hard
to lose money on positive cash flow companies.

www.safalniveshak.com Page 10 of 59
 Interview with Basant Maheshwari | Safal Niveshak

Let me give you an example of a company that is growing at 40% per

annum and it generates free cash flow. What it does is it uses its free cash
flow to do capex and to expand business. So when growth slows, and say
the growth comes to 15% or 10%, it would not do much capex at that point
of time. So all that capex money that it was using from its free cash flow
would now be diverted for dividends.

And that is the time when you’ll get a protection. And the stock will not fall.
It will wait for you to get out whenever you want to.

So initially, I didn’t know this. I was holding Pantaloon Retail, a negative

cash flow company. And when it fell, it fell like a stone in water. Same with
TV18. But I was very lucky in TV18, a game of chance you can say, not so
smart enough in Pantaloon where my initial price was Rs 7 and the stock
went to Rs 875, and by the time I actually sold it was Rs 300.

So, nowadays, if there is a high growth company and it has got negative
cash flow, then I am not too much interested in it, because I need both the
buy and sell decisions to go right.

But if it’s a high growth company and it has positive cash flows, then when
growth stops, the capex will not need to be done because the company
won’t have a market to grow, so I will get dividends.

www.safalniveshak.com Page 11 of 59
 Interview with Basant Maheshwari | Safal Niveshak

So this is a small, but very significant change in my investment thought

process. That is how I manage to hold those 30, 40, 50 P/Es because I
know I won’t lose money as dividends would double up. So that is how it
happens.

SN: Value investing requires a great deal of research, discipline, and

patience. What do you suggest an investor just starting out could do
to practice these habits to ingrain them in his/her investing mindset?

BM: First is, he has to read. There is no substitute to it. Reading also isn’t
enough. You have to practice what you have read. A person who practices
5 books that he has read is much better off than a person who has read
100 books and practices nothing.

A general investor, in most cases, is a cynic. You tell him anything, and he
will come up with an argument why that will not happen. He will use 400
questions for things that are not relevant. Like, how many people have said
that Asian Paints and HDFC Bank are overvalued? And since how long? I
think it’s been 10 years.

At some point you’ve got to stand up and say that there’s something that I
can’t understand, which people don’t do.

And as a young investor, first thing he has to do is that he has to catch hold
of his guru (teacher), whoever he is.

www.safalniveshak.com Page 12 of 59
 Interview with Basant Maheshwari | Safal Niveshak

You’ve to catch hold of some guy whom you think is smart enough, and
has got a balanced view. Make friends with him.

Also, avoid blogging too much on equity discussion sites because on online
forums, the guy who buys 50 shares shouts the loudest. And the guy who
buys 5,000 shares doesn’t talk and doesn’t write. He just reads. So the guy
who is screaming the loudest is the one you got to ignore. But he will make
sure that you get chickened out of a position.

There is a confluence of factors. First, you got to read and then second is
this theory of having passion. It’s all linked up. You got to make money first
to be passionate about something. So there is no sequence of events here.
You got to be passionate, you got to be curious, and then you also have to
make money.

So if you don’t get success in the first year or two, then it’s very likely that
you’re going to slip into a trap where you’ll want to recover your old losses
and move away from the original direction.

Now, the young investor, he expects the market to know that he has limited
capital. Market doesn’t care about how much capital you’ve got. If you’ve
got Rs 1 lac, or Rs 1 crore or Rs 10 crore, the market does not care. It’s not
going to make your Rs 1 lac into Rs 10 lac just because you got a lower
figure. The market has no emotions.

The market can cut you into half, whether you’re at Rs 1 lac or Rs 10 lac.

www.safalniveshak.com Page 13 of 59
 Interview with Basant Maheshwari | Safal Niveshak

Mostly, the point is that people don’t have a long term view, despite that
they all understand compounding.

If you meet somebody and say that you can compound money at 26%, he’ll
say “Oh, that’s a lot of money!” And then you tell him that if you buy this
stock at Rs 10 and then next year it will go at Rs 12.6, he will tell you, “No!
Tell me some stock at Rs 10 that is going to double in six months.”

So the same guy who walks out of his bank with a FD receipt that promises
to pay him 8.5% calls up his broker and wants to double his money in six
months. How can there be such a dichotomy in returns?

I believe a large part of this can be cured just be reading, making notes,
and if possible getting into a group of smart guys around.

Overall, I think it’s the chicken and the egg race. You got to make money
also. Because if a strategy does not work for you for 2-3 years, you can’t be
as passionate as like you were when you started.

SN: You’ve talked about the importance of reading. So, is there one
book that has shaped your thought process as an investor?

BM: It is Peter Lynch’s One Up on Wall Street, because it told me I can

make 100 times in a stock. That’s it!

www.safalniveshak.com Page 14 of 59
 Interview with Basant Maheshwari | Safal Niveshak

You can dispute that this book was written in 1989 and by then, the US had
its best bull market and Peter Lynch had a fantastic time to manage money.
But at least he gave you the confidence.

I would put Peter Lynch one notch above Warren Buffett also. Why? Buffett
gets very good deals. He is very smart. He won’t tell you as to how much of
his effort is because of the use of the float that he has.

A lot of people say – “Warren Buffett says we should always hold some
cash.” But please note that he has got an insurance company. He can’t be
fully invested. He’s got to pay the claims also. So this is called selective
listening and myopic thinking.

Go and see what Buffett used to do during his earlier ears. Read the
partnership letters from 1958, and you’ll get a sense.

You see, you cannot follow one person at all times. You’ve got to borrow
something from everyone.

“How to find a stock” has to be borrowed from how Peter Lynch did it. “How
to analyse a business” has to be borrowed from how Warren Buffett does it.
And “how to hold on to a position”, if it goes up 20, 40, 50 times, you’ve got
to fall back on Jesse Livermore, irrespective of whether you are a
fundamental investor or a technical chartist. In fact, chartists don’t follow
Livermore as much as they should, because Livermore was a trader.

www.safalniveshak.com Page 15 of 59
 Interview with Basant Maheshwari | Safal Niveshak

A chartist you see on TV will tell you, “Sell this is this goes up 10%!” Hey,
you are a chartist, a trader, how can you sell it when it goes up?

I think you should mention this specifically. Any stock that you buy can go
down 100% only. How much can it go up? 200%, 500%, 1000%, right? But
still people lose money.

Why? Because when it goes up 20%, you want to book profits, when it
doubles, you want to sell half of it and get the other half free. Do you do this
with your home?

You bought a home in Gurgaon, and it went up 5 times. Would you sell the
verandah and say now my kitchen is free, or sell your kitchen and say my
living room is free, or sell your bathroom and say my bedroom is free? You
don’t do it!

So that’s the problem because we all try and cap our profits.

So, overall, One Up on Wall Street is a fascinating book. Though it’s written
for the US market, but I got many of my ideas from this book. I read it once
every 2-3 years.

This is a wonderful classic. And then there are so many of them.

But then, as I mentioned, beyond a point, books won’t help much. You got
to practice what you read.

www.safalniveshak.com Page 16 of 59
 Interview with Basant Maheshwari | Safal Niveshak

SN: Compared to when you started investing in 1992, the sheer

amount of irrelevant information faced by investors is truly staggering
today. How can investors trapped by irrelevant information make
independent investment decisions? What are the 4-5 factors investors
can use to improve the quality of their decision making?

BM: You have to look at a piece of information and ask, “What difference
does it make to the company that I own?” Like, I bought Pantaloon and
made money. That’s well-documented everywhere.

When Pantaloon was doing its books, it used to carry inventory at sales
minus gross margin. Normally, you have to do at cost or market value,
whichever is lower. So there was a buffer there.

So if the inventory should’ve been valued at Rs 40 crore, they used to

value it at Rs 60 or 70 crore. There was a lot of hue and cry about this.
People said, “They’re overvaluing it!”

At that point, I was also into this confusion as to how to evaluate this
inventory part of Pantaloon. Then, one day as I was thinking about it, I
thought of calculating how much it worked to. It came to about Rs 20-30
crore. Compared to this, the company’s market cap was about Rs 1,000
crore. The company was making more than Rs 20 crore in quarterly profit.
So anybody would have said, “What difference does it make anyways?
Pantaloon can write it off in one quarter.”

www.safalniveshak.com Page 17 of 59
 Interview with Basant Maheshwari | Safal Niveshak

I am not saying they were doing a great job. All I am saying is that all
information has to be converted into numbers.

You cannot have a situation where you just look at the information and then
you worry about it without getting into the numbers part. Once you do that,
you won’t be bothered too much.

And just like I said earlier, a person who doesn’t own the stock, he will
always have 20 more reasons not to own it.

Also, for all multi-baggers, for every one reason to buy them, there are ten
reasons why you should not buy them.

Like I’ll tell you, in 2009, when I bought Page Industries, it was at Rs 350
and their license was valid only till 2010. I called and asked the Company
Secretary whether I could meet the President of Jockey International. He
said I can’t do that.

So I went to the company’s AGM that year. I asked the President whether
he was going to cancel Page’s license. He asked “Why?” I said, “It’s valid
till only 2010. Are you going to extend it?”

He said, “Yes, we will extend it. But I can’t give you any more information.”

Then I asked, “Have you cancelled any licence in the past?” to which he
replied that he hadn’t done that till date. He also mentioned that a license

www.safalniveshak.com Page 18 of 59
 Interview with Basant Maheshwari | Safal Niveshak

can be cancelled, as per the agreement, only if Page did not produce
anything for sixth consecutive days and there is no force majeure involved,
or if the promoter holding went below 51%.

So these two reasons were enough for me to frame an opinion that this
licence wasn’t going to get cancelled in 2010. For anyone else, he would
have discussed it at least 200 times on internet forums as to what would
happen if this license was not renewed etc. etc.

Of course that was a very relevant point, but for a relevant point, you need
to dig deeper. At such times, what happens is that people don’t want to
give much of leverage to any company. But then, most of the big money is
made by betting on first generation promoters, where there is no track
record.

So all information you get about them will be unsubstantiated, and

undocumented. It will mostly be on hearsay. But then, you have to give him
some leverage, some benefit of doubt.

Who knew Narayana Murthy before 1994? Who knew Subhash Chandra
before 1992? Who knew Kishore Biyani before 2002? Who knew Mr.
Genomal of Page or Mr. Jagannathan of TTK Prestige before 2009? Of
course, we had heard about them, but there was nothing we knew about
them.

www.safalniveshak.com Page 19 of 59
 Interview with Basant Maheshwari | Safal Niveshak

So most, not all, of the big money will be made on first generation
promoters where there will be too much of negative information. And you
have to convert all that information into numbers.

SN: You’ve mentioned in the past that your way of making money is
by riding trends while keeping the downside risks in check. Please
elaborate on your processes of (a) identifying trends, and (b) keeping
the downside risks in check?

BM: Let’s look at 2-3 trends from the past – the software trend of the late
1990s and then the infra trend of 2000s. Of late, we have this consumer
discretionary trend from 2009. Now look at these things – new highs for all
the stocks enjoying a trend.

So if ACC and Ambuja were making new highs in 1992, and Infosys, Wipro
etc. were making new highs in the late 1990s, Unitech, IVRCL, Nagarjuna
Construction etc. were making new highs in mid-2000.

So the first thing is that if a trend is there, all companies in that sector, or at
least most of them will be hitting new highs. It’s not a 52-week high. It’s a
new all-time high.

Secondly, most of these companies should show above average growth.

You can’t have a situation where Bharti Airtel is growing at 18% and you
say it’s a new high.

www.safalniveshak.com Page 20 of 59
 Interview with Basant Maheshwari | Safal Niveshak

Nobody is interested in buying a company that is growing at 18%. Many are

interested if it grows at 25%. Plenty will be interested if it grows at 35%.
And everybody will be interested if it grows at above 50%.

So, the percentage change in growth is only 10-15%, but the amount of
incremental investors it can draw in is huge. So 25% and 35% is like day
and night.

Secondly, above average growth has to be there, for almost all companies
in that sector, for a new trend.

Third, most of these companies when they are hitting their new highs, the
scale of opportunity has to be big. For example, you can’t sell wipers for
somebody who’s wearing spectacles and say this is going to be a new
trend. Or you can’t sell remote-controlled toothbrushes, and say this is
going to become a new trend.

More often, you have to do a copy-paste job. So if you throw a company to

me and ask, “How does this ABC Company look to you?” I’ll ask, “Is there
any company in the US or Europe that has made it big in this business?”

If there is none, then I would not be interested, because business models

don’t change too much. Human nature is same and what humans consume
remains same. Our culture might be different, but the end consumption
levels don’t change too much.

www.safalniveshak.com Page 21 of 59
 Interview with Basant Maheshwari | Safal Niveshak

So if something has worked in the US, it will work in India. And we can get
a fantastic head-on advantage. We are 20 years behind them. So you can
choose to do a copy-paste job there.

Also, new trends will mostly have first generation promoters, about whom
you would not have heard before.

Like Mukesh Ambani did not go into software in 1992. Tatas did not go into
infrastructure and construction in 2003. So these things will keep on
happening, because when a new trend is starting, you will not have too
many known names there.

Now that’s a problem, because you have to bet in the unknown. But that is
where the money is made.

So these are a few things. Of course there are other checks as well. But if
you give me a stock that is making a new high, and another one that is
making a new low and irrespective of how much fundamental analysis I do,
I will be more attracted towards a stock that is making new highs than one
that is making new lows, because most of the time new lows take place
when shareholders don’t know what is happing with the company.

SN: Well, that was about identifying trends. How do you keep the
downside risks in check?

www.safalniveshak.com Page 22 of 59
 Interview with Basant Maheshwari | Safal Niveshak

BM: Earlier, I was willing to lose what I had. So, the only downside risk I
had was that I used to sell stocks just like that. Now, I try to buy companies
that are showing increased dividend payments. So if it’s paying Rs 10
today, next year it should pay Rs 11, the year after it should pay Rs 13, and
then Rs 15 and so on.

Like I gave you an example of the capex thing. If I bought a high growth
company that puts, say, 30% of its profits into capex every year because it
needs to put up a new plant and machinery for catering to new growth that
is going to come, and it also pays you dividend. So when growth slows
down, and the trend starts to break (which can only be known in hindsight)
more of that money will be diverted as dividends.

There are companies that like to hold cash and not pay anything. There it
becomes very difficult. But with companies that pay you dividends every
year at a certain rate, and the dividends are rising, in those kind of
companies if the growth does not come across, then they would divert
money for dividends. And the dividend would come in as a protection.

So from a 1.5% yield, it will become a 2.5% yield. But, normally, in a very
high growth company, I need a 1% yield at least. This is because a 1%
yield with 30-40% earnings growth is very good, because when the growth
slows down, the money will come back to you.

Apart from this, you have to assume that when the trend breaks, you won’t
know in foresight. It will come to you in hindsight, and you have to act 20-

www.safalniveshak.com Page 23 of 59
 Interview with Basant Maheshwari | Safal Niveshak

30% down. In the past, all companies who were leaders in their sectors,
they almost doubled up before the trend broke.

Like ACC was at Rs 130 in 1992, three months before the trend broke. And
at the peak it went to Rs 399. Then it fell down from there.

Similarly, Infosys from Rs 600 went to Rs 1,700 in three months in 2000,

and from there it fell back to Rs 900. So before a trend breaks, the stocks
would normally move up 50-100%. That’s the final blowout phase.

So, many times what happens is by looking at just the price of the stock, I
get a sense – whether it’s right or not I don’t know – whether it is the final
terminal value or is it going to go back a little more.

But, basically, you have to take it that you will never know it in foresight. It
will only come to you in hindsight that the trend has broken. But you should
make enough with the trend.

And who said you have to buy at the lowest point and sell at the highest
point to make money?

You can buy somewhere near the lows and sell maybe 30% lower than the
highs and still make enough money.

www.safalniveshak.com Page 24 of 59
 Interview with Basant Maheshwari | Safal Niveshak

SN: I think not knowing the trend breaking up in foresight is what

causes people to overpay. How do you differentiate between whether
you are paying up for a stock or overpaying?

BM: It depends on which year’s earnings you consider. Are you in FY14 or
FY16? Today, if you look at many of the engineering companies, they are
doing well because people assume things will change. And on an FY16
basis, they are at around 25x P/E. And a classic secular growth company,
on an FY16 basis, could be on 30x P/E.

So why won’t I pay 5x more and buy a classic secular growth company
instead of trying to become the smart guy out there by first assuming how
this engineering company will turn around and how much it will make in
FTY16 and then try to say that this company is better because in FY16 it
will trade at 25x against your secular growth company that is trading at
30x?

The first problem of overpaying or not overpaying comes because who will
decide which year’s earnings have to be looked at.

And for companies that have predictable growth, where there is surety, the
market will put the stock at an expanded level for as many years as much
as you can predict the growth. Like HDFC Bank, I think, remained in a
range for four years between 1999 and 2003. It traded at a price-to-book of
more than 7x. And then it came down to less than 3x also. But the point is,

www.safalniveshak.com Page 25 of 59
 Interview with Basant Maheshwari | Safal Niveshak

how many people would have thought that at 7x, HDFC Bank could have
done nothing from there on, and sold it.

Good companies, like good life partners, are not too many. You find one,
you stay with it, till the time the partner doesn’t do that you don’t want it to
do.

But I think the biggest problem is that when we compare companies, we

compare them with trailing earnings. Like I will compare Tata Steel’s with
Tata Motors’s trailing earnings.

But Tata Motors’s earnings are more predictable than Tata Steel’s. ITC’s
earnings are more predictable than Tata Motors’s. Because of government
regulations on ITC, Nestle’s earnings are more predictable than the former.
So I can’t put everything in FY14 (trailing) earnings. And nobody knows
whether you should look at FY15, or FY16, or FY17.

In all, overpaying is not a problem, as long as the trend remains, and as

long as you can predict.

Also, overpaying is not a problem with predictable businesses. However,

you also need to see that the prediction you are making is on the right
scale. You just can’t predict endlessly.

www.safalniveshak.com Page 26 of 59
 Interview with Basant Maheshwari | Safal Niveshak

SN: How does one escape from over-analyzing? In other words, how
much time does one devote to analyse a stock idea? Are ‘few hours
per week’ sufficient, as Peter Lynch suggests?

BM: It depends on what company you are analyzing. If you have bought a
company whose future is based on what the Supreme Court has to offer,
then you got to go into the Supreme Court and sit there, and listen to what
the judges say. But if you got a Hindustan Unilever in your hand, you can
just hold it for 10 years.

See, the thing is that 80% of the company information is available in the
first 20% of the time you put into it. And in the balance 80% of the time, you
will never be able to get the balance 20% of the information.

So then it becomes like he law of decreasing returns, in fact, ever-

decreasing returns. Then we start looking at useless things.

That incremental analysis does not add too much value. But again the thing
is, first 80% of the information comes to you in the first 20% of the time and
from then on you will get the hang of the company, unless you have left it
entirely to the mercy of the government, and regulations, and judiciary, and
the London Metal Exchange (LME), then you need not analyze also.

SN: Also, when you over-analyze, you get into that illusion of control.
I feel the more I know, the more I can control the outcome, which
doesn’t happen actually.

www.safalniveshak.com Page 27 of 59
 Interview with Basant Maheshwari | Safal Niveshak

BM: Yes, that’s very true. So, when someone calls me about a stock, after
a brief discussion, the first thing that comes to my mind is and that I ask
him is – “Is this analysis making any difference to whether I’m going to
keep holding on this stock or am I going to sell it?”

Like somebody can tell you, “I bought this product from that store and this
product doesn’t work!” But if the company is growing at 30-40%, probably
you are the odd one out. And if the company is making 5-10 million pieces,
then obviously there will be 20 products that will not work.

The first indicator of the customer feedback will come to you in terms of
rising or dropping sales.

But most of the time we spend in getting the balance 20% information,
which is not relevant at all.

Then it also depends on how many stocks you own. If you own 20 stocks,
you can give a business a little more time to perform. If you have 5, then
you don’t have any margin for error. Then, on the first sign of distress – not
a confirmation but the first sign of distress – you got to say, “Thank you so
much! I can’t be with you anymore!”

SN: You seemingly keep a concentrated portfolio with no more than

10 stocks. What is your maximum cap (as a % of your portfolio) on a
single stock and how do you arrive at that allocation? If someone

www.safalniveshak.com Page 28 of 59
 Interview with Basant Maheshwari | Safal Niveshak

were to start investing today as a fresher with average knowledge,

experience and emotional intelligence, would you advise a
concentrated portfolio?

BM: If he wants to concentrate, then he should let the market concentrate

for him, or if he understands the company very well. If I’m working in TCS
and I know what Mr. N. Chandra is doing to TCS, I don’t need anybody
else’s advice. I will put my entire money to work in TCS.

People might say that you are working in TCS, your salary is coming from
there, and your investment is also there. But then, that is what I understand
best. I might be able to sell the stock the moment I get the pink slip. But if
I’m working at TCS and I bought a lot of Infosys, and there’s some problem
in Infosys, I might never be able to know about it.

You see, concentration is for creating capital. Diversification is for

protecting capital. If you got 40 stocks, you will do only as good as a
normally diversified mutual fund or an index fund.

A new investor should start with a certain sense of diversification. And

when he starts understanding the companies he owns, then he got to
concentrate.

This is also a function of how much stock market allocation you have out of
your net worth. If your net worth is Rs 1 crore, and you have Rs 5 lac into

www.safalniveshak.com Page 29 of 59
 Interview with Basant Maheshwari | Safal Niveshak

the stock market, and you have diversified it across 40 companies, then it
makes no difference.

But if my net worth is Rs 1 crore, and I put that entirely into the stock
market, then I’ve got to diversify.

So I think it is a function of how much of my net worth I have in the stock

market. I think most people forget their net worth while analyzing the stocks
they own. But I think that has to be in combination of that.

SN: Do you believe in the importance of maintaining an investment

checklist? If yes, what are the most important points on your
checklist?

BM: Let’s take an example of, say, a company like ITC. The first question I
will ask is, “Is it cyclical or non-cyclical?” It’s not cyclical. So, basically it
means that you can predict.

I assume that I don’t know anything about ITC. Now, I will open the
company’s annual reports and see the fourth year figure. So if I’m in FY14,
I will see how much revenue it earned in FY10.

From FY10 to FY14, in four years, it has got to double. If the revenue has
not doubled in four years, then I don’t get excited. I am just looking at
revenue at the moment. I have not yet dabbled with profits.

www.safalniveshak.com Page 30 of 59
 Interview with Basant Maheshwari | Safal Niveshak

I will then look at the return on equity (ROE). ROE should be more than
25%. Then, if I find the ROE to be above 25%, I will look at the dividend
yield.

Then I will look at the profits. So if the revenue has doubled in four years,
and if the profits have quadrupled, and if the EBITDA margin is sitting at
30%, I’ll say that margins can’t expand from here on.

So if the EBITDA margin is at 30% and the revenue is not growing at more
than 18%, there there’s some risk involved. Then I will look at similar
businesses across. I will also look at the management – how much
dividend it pays, and does it pay taxes or not. Then I will ask whether the
industry is growing or not.

You see, this is just a two minute check on how I do it.

SN: While they are very critical, “competitive moats” are also tough to
define. How do you define a moat, and assess whether it is
sustainable or fleeting?

BM: See, some moats are good only in the textbooks. For instance, look at
Container Corporation. It has got a good moat. Indian Railways has a
fantastic moat, but it does not make money.

So, I don’t agree that moat investing will always make you money. Moats
that give you the right to increase prices at will – at will is the important

www.safalniveshak.com Page 31 of 59
 Interview with Basant Maheshwari | Safal Niveshak

term here – those are the only moats that are relevant from an investor’s
standpoint.

Take for instance, Horlicks (Glaxo Consumers). It increases prices by 6%

every year at will. So that is a moat.

The textbook definition of a moat is that you put up a lot of capital, and
there’s a network effect etc. etc. But the moat which really works is pricing
power. This is because prices can increase 100%, but costs cannot be cut
by 100%. Costs can be cut only up to a point.

So I think the definition of a moat is good to debate, but all moats don’t
translate into prosperous shareholders.

If you have pricing power, you will have competitive advantage, you will be
dominant, and you can skim the cream out of the consumers. And in a bad
environment, you can get around the situation as well.

How many companies would have survived an excise rate increase like
what ITC has done? They would have gone bankrupt in the second or third
year.

Of course, we’ve learned a great lot from these American investors like
Warren Buffett, but you also have to consider that maybe Buffett talks
about moat in a different way. He gives us a definition. And Buffett also
does not say that you’ve got to invest in all the moats.

www.safalniveshak.com Page 32 of 59
 Interview with Basant Maheshwari | Safal Niveshak

Facebook has got a big moat, because it has got the network effect. All my
friends are on Facebook so I won’t go to any other social media site. I will
remain hooked on Facebook. But Facebook is slowly losing its challenge to
Whatsapp.

That is what we have to actually look at – the sustainability of the moat and
whether it will translate into higher ROE.

Why? You see, ROE has got three components – net profit margin, asset
turnover, and leverage.

Let’s leave ‘leverage’ aside for a moment. So if you’ve got a low capex
business, your asset turnover goes up, and if you’re making higher
margins, your pricing power comes into focus.

If you’ve got a pricing power, and you’ve got a high asset turnover, you’ll
get a higher ROE, which is the best moat to have.

So you look at the ROE and just try and segregate it away from the
incremental addition it has seen because of excessive use of debt. That’s I
think the best indicator of a moat.

If you don’t want to get into the confusion of moats, just look at the ROE.
But you’ve got to break up the ROE and see.

www.safalniveshak.com Page 33 of 59
 Interview with Basant Maheshwari | Safal Niveshak

Like, let’s look at net profit margin, which is “Net profit / Sales x 100”. What
happens is, between sales and net profits, there are so many expenses –
like employees, raw materials, advertising, distribution, etc.

One thing that nobody talks of is that there is a certain amount of moat
called “distribution”.

All FMCG companies have lac of touch-points. How do you translate that?

You can sell all the products that Dabur sells. But how do you go to the
remotest village and get in relation with a guy who has a small 20 square
feet store there. It’s very difficult. So that is one point that nobody talks
about. Distribution is also a big moat. That distribution helps you again in
making more money.

See, a company can grow in three ways – new products, new geographies,
and new distribution. A company that does well on all these accounts
should have a high ROE.

SN: Value investors generally tend to buy and hold for long periods of
time and literally marry their portfolio. Assuming that we have been
rewarded for our efforts by a few multi-baggers, how and when
should we exit when we are sitting on huge gains and emotionally
attached to the stock?

BM: First is, you’ve got to love your family and not your stocks.

www.safalniveshak.com Page 34 of 59
 Interview with Basant Maheshwari | Safal Niveshak

I love the stock only till the point the stock loves me – in doing what I
wanted to do. If I find that my stock is not rising at the rate I wanted it to
rise, or is facing headwinds, then this is not a place I got to give it a lot of
time.

Because if you relax a little bit with a stock that is not acting in your favour,
then you might lose a lot of money as well.

Talking about when I would sell my stocks, first is when I will get a better
idea. If there is a better relative opportunity, then I will sell.

Let me explain this with an example. Till 2006, I held Pantaloon and TV18. I
sold Trent because TV18 was doing a spinoff, and I had read in this book
called “You Can Be a Stock Market Genius” how spinoffs make money. So
I was sure this stock would do well for me. So there was no big reason to
sell Trent but still I sold it and bought TV18. And Trent, even after eight
years, is still at the price I sold it.

So there has to be a better opportunity when you sell.

Second is when the present discounts a great future. You can look it from a
market cap angle also. When I sold TV18 in 2007, it was trading at a
market cap of more than Rs 5,000 crore, which did not make too much
sense at that point of time. The company had no cash flows, it was diluting
equity, and it was raising a lot of money.

www.safalniveshak.com Page 35 of 59
 Interview with Basant Maheshwari | Safal Niveshak

So at that time, the present was discounting a great future ahead. And that
is why I sold.

Third, I sell when the trend finishes. Take, for instance, Pantaloon Retail. I
did not sell it at Rs 875 and the stock fell all the way to Rs 300, when I sold
it.

I was a little late to react that the trend had finished because Pantaloon
was trying to do its spinoffs at that time. So I thought that once it does its
spinoffs I would get a higher price like I did in TV18. Recency bias got into
me.

I was willing to give it some more time, and then some more time, and then
some more time. By the time it was clear to me that this trend was finished,
I sold Pantaloon.

Then in 2009, I got into a lot of these cyclical names like Voltamp
Transformers, Blue Star, Thermax, etc. They were all cyclical businesses.
So I sold because I made 2-3x in 2-3 months, because with cyclical, the
moment you make money you’ve got to sell. You can’t take a long term
view with these.

As an investor, I am always trying to maximize my last rupee. I don’t have a

concept like, “Okay, I bought it at Rs 200 and now it’s at Rs 600.” What
difference does it make?

www.safalniveshak.com Page 36 of 59
 Interview with Basant Maheshwari | Safal Niveshak

My cost price is the last price that is displayed on the screen. When I do my
excel, I have no column for my cost price. So when people ask me, “I had
bought this at Rs 50 and now it is at Rs 150. What should I do?” I say,
“Forget what you bought it at!”

If I had put Rs 10 lac in a stock and today it is Rs 16 lac, I need to see what
I can do of this Rs 16 lac.

I can’t say that because I came in this world with nothing, I can afford to
lose everything. Whatever money has been made in the market, I have to
take it from there.

Anyways, I also sell a stock because, for instance, there is a government

regulation. For example, I sold Titan. Of course the stock has gone up from
there, but my decision to sell it took just about thirty minutes. For a stock
that I had held for six years, thirty minutes were enough for me to sell it
because there was a regulation that gold companies can’t get gold on
lease.

Then you sell when the management does something that you don’t want
them to do.

But basically, if you can get just one thing right, sell for a better opportunity
and you’ll be saved from all the problems in this world.

www.safalniveshak.com Page 37 of 59
 Interview with Basant Maheshwari | Safal Niveshak

If I may give you an example, for an equal return, assume there is a cyclical
company with a spinning mill in Tirupur and is on a turnaround path. You
tell me that this stock is going to double in three months. I’ll tell you that
HDFC Bank will double in four years at most. Why take that headache?

But you see, there is a great kick in buying an unknown company. That is
what most people do.

I think it’s more about how sure you are about making money rather than
the absolute amount of money you can make. This is because the latter is
dependent on so many variables. And if you can cut down on a few of
them, then you are through.

SN: You do a lot of scuttlebutt before investing in a stock. Is there a

process to it?

BM: There’s no need to do scuttlebutt with every company. What

scuttlebutt can I do with Nestle? Scuttlebutt has to be employed when there
is not too much of management information, or where there is very little
operating history, or where the company itself does not tell you much about
what it is trying to do. That is where it helps.

But beyond a point, scuttlebutt does not help you too much.

There are companies that have passed the scuttlebutt barrier, if you may
call it. With them, you can’t add any incremental value doing the scuttlebutt.

www.safalniveshak.com Page 38 of 59
 Interview with Basant Maheshwari | Safal Niveshak

Let me give you an example. In 2003, I used to stand outside Big Bazaar
(Pantaloon) to see how many people were coming out with bags. I also
used to stand outside Westside (Trent) to see how many people were
coming out from there. For every 10 people out of Big Bazaar with bags,
there were not more than 2-3 people coming out of Westside.

So that scuttlebutt helped, because Pantaloon was an untested company at

that time. Today, you don’t need anybody’s confirmation that Big Bazaar is
a place where people go to buy.

Now, the best scuttlebutt will come from consumers, or from distributors.
You should make friends with distributors of companies which you have
bought, and an easy way of doing that is to go and regularly buy
something.

For instance, if you have bought shares of Page Industries, look at the
business outlet near your place, go to the store, once every month, and buy
a pair of socks. It’s a Rs 120-150 cost, and you get to know what the
company is doing.

So many times the guy at my nearest Page outlet tells me, “Sir why don’t
you buy a pack of three?” I tell him, “I want to talk to you regularly. I don’t
need the socks!”

www.safalniveshak.com Page 39 of 59
 Interview with Basant Maheshwari | Safal Niveshak

So this is how it helps actually. That’s it! But as I said, beyond a point,
scuttlebutt does not help much.

There are companies where scuttlebutt does not help at all. If it’s got a
cyclical element to it, then no matter how much scuttlebutt you do, it’s not
going to save you.

SN: How do you evaluate a company’s management? Is there a

specific process to do this?

BM: There is no specific process that I follow, because management is an

intangible thing.

But a company that is paying taxes, paying dividends, generating a high

ROE, and is a sector leader, will normally not be stealing from
shareholders.

Like Infosys was a high quality company while Satyam was the deceptive
guy. So people lost a lot of money in the latter and not in the former.

Similarly, during the 1992 era, there was an ACC and there was Kakatiya
Cement, and Kalyanpur Cement, and so many such companies. All these
second liner cement companies were washed away but ACC remained.

www.safalniveshak.com Page 40 of 59
 Interview with Basant Maheshwari | Safal Niveshak

So if there’s a company you are planning to analyze or you have invested

in is a sector leader, then you can be more or less sure that the
management is good.

Of course, you have examples of companies like DLF and Unitech. But
here there are other checks. Like Unitech’s management always wanted to
go into diversification like telecom and those things. With DLF, before the
company came with its IPO, there were suits filed against the management
for not having actually given shares to people who had applied for the
shares long time back. So you had enough information there.

Secondly, look at high ROE. A management that steals from shareholders

can do it in two ways – over-invoicing its plant and machinery, and under-
reporting revenues and profits.

If you under-report revenues and over-invoice plant and machinery, you will
never be able to generate a higher ROE. Higher ROE can be generated by
having a higher net profit margin, and lower capex.

So if the ROE is high, obviously without debt, and if the company is paying
you dividends, and pays taxes, the management is often good.

Now, a great management in a great business creates tremendous value.

Like Narayana Murthy with Infosys.

www.safalniveshak.com Page 41 of 59
 Interview with Basant Maheshwari | Safal Niveshak

A great management in a bad business will lose value. Like Tata Sons with
Tata Steel.

A bad management in a great business will lock value. Take, for instance,
Vijay Mallya with United Spirits.

A bad management in a bad business will always blow up value. Like Vijay
Mallya with Kingfisher Airlines.

You can’t get a great management and a great business combination every
time. But remember – you must not partner someone you are not sure
about.

Of course, there are people who won’t tell you too many things about them.
But then, their actions have to speak – like in terms of dividend cheques
and taxes. Like most of these MNCs don’t talk too much. For instance, 3M
is a company that never talks, except on the AGM day. But 3M has the
reputation of having had a long history in the US.

A management which does too many conference calls, you are not going to
make too much money out of them. This because it is sharing its best with
investors beforehand. Markets pay for surprises and not for the predictable.

SN: There are several giants in the value investing field who profess
the use of patient capital (no borrowed capital or debt), whereas you

www.safalniveshak.com Page 42 of 59
 Interview with Basant Maheshwari | Safal Niveshak

profess taking loan for a stock just as taking loan for a home. Can you
throw some light on this aspect of investing?

BM: My first borrowed capital was from my grandmother in 1992, during

the Harshad Mehta days. And from there on, for nine years, I lost money on
borrowed capital.

So I used to make money and give it back, then make money and give it
back. But that was not a primary work for me as I was into my family
business. Thus it did not hurt me that much at that time.

You see, borrowed capital must not be looked at in isolation, because you
are buying an asset that can rise multiple times.

If you buy a car, which is a depreciating asset and which loss value over
time, with borrowed capital, nobody objects. But what you do with that
borrowed capital is more important than whether you’ve used borrowed
capital or your own capital.

So if you’ve bought a stock that goes up 40 times, then if you would have
used borrowed capital, it would have actually expanded your gains.

Most investors, in their initial days, can’t allocate too much to investing. If
you start with a capital of Rs 5 lac and you grow it 10 times, you go to Rs
50 lac. If you grow 10 times, you reach Rs 5 crore.

www.safalniveshak.com Page 43 of 59
 Interview with Basant Maheshwari | Safal Niveshak

But instead of Rs 5 lac, say you had started with Rs 10 lac, if you move it
up 10 times, you will reach Rs 1 crore. You move it up 10 times more, and
you will reach Rs 10 crore.

So the effect of capital comes into force because in the initial days you
don’t have too much of a surplus capital of your own. So you have to take
help from borrowed capital.

But most investors generally don’t like borrowed capital because they are
not focused on buying only high quality businesses.

I can’t buy a turnaround steel company with borrowed capital. I can’t buy a
cyclical copper-mining company with borrowed capital.

With borrowed capital, I can only buy companies where, if I get it right, the
stock should at least get me 30-35% per year. And if I don’t get it right, then
at least the current price should hold itself.

You do an excel calculation. If you grow any amount of money by 30% for
10 years, and you pay 12% interest on that money, then at the end of the
10th year, you don’t make 30% minus 12%, or 18% CAGR. You make 26%
CAGR. This is because the spill-over also grows by that amount.

If you are smart and have concentrated positions, it is possible to grow at

30%. But to grow at 30%, you have to be on the lookout for selling at the
first sign of trouble also.

www.safalniveshak.com Page 44 of 59
 Interview with Basant Maheshwari | Safal Niveshak

I am not saying I have to buy a stock that will grow at 30% for 10 years. I
will buy a stock that should grow at 30%.

But keeping the stock selection process aside, with 30% growth and 12%
interest payment, you will make 26% every year, on a CAGR basis. So why
should you not borrow?

SN: But that’s in hindsight. When you look ahead, isn’t there this risk
of permanently losing money, which can multiply your pain when you
are on borrowed capital? It’s only after 10 years that you realise that
you’ve earned a 30% CAGR.

BM: I agree, but you are not borrowing two times your capital. You are only
borrowing maybe 20%, 30%, or 40%.

This is how you have to look at it. In this market, there is nothing called a
bad thing or a good thing. People have made money in Suzlon. People
have made money in Unitech. Just because I couldn’t or didn’t buy Unitech,
I can’t say Unitech is bad. If it’s made money for someone, it’s good.

I won’t say betting is bad, but obviously it’s a question of probabilities. Why
people get is wrong is, if you are on borrowed capital, and if you are on
borrowed conviction, then that’s a bigger problem.

www.safalniveshak.com Page 45 of 59
 Interview with Basant Maheshwari | Safal Niveshak

Borrowed capital is less dangerous than borrowed conviction. If your

conviction is original, then capital can be borrowed. But if your capital is
original, and the conviction is borrowed, then there’s a problem again. This
is because if the stock goes down, you won’t know what to do of it.

If I met somebody at the airport and he whispered into my ear, “Why don’t
you buy this stock?” and I go and buy it, and then if it goes down, where do
I find that person?

And if I look on TV and buy a stock, and then that expert isn’t available on
TV when the stock price is going down, where do I call up?

So, conviction has to be original, capital can be borrowed.

But the problem originates when people use borrowed money on borrowed
conviction. Most people who have used borrowed capital with original
conviction have made money.

SN: So you still use borrowed capital to invest?

BM: Oh absolutely! If you have surplus to lend, I am there!

SN: One of the problems that new or small investors face is that they
can’t really get their heads around valuation. It seems so complex. A
lot of the terminology is complex, and so are the concepts. How can

www.safalniveshak.com Page 46 of 59
 Interview with Basant Maheshwari | Safal Niveshak

valuations be made easier? How have you made it easier? Or can it

not be made easier?

BM: There are two aspects to valuation. One is to evaluate the longevity of
the business, which is what Buffett talks about – the business quality,
moats, etc. But since we can’t get numbers on them, we don’t do it.

Now, while starting a valuation sheet, how many people ask this question
on the first row of the excel sheet – “Is this company going to remain in
business by, say, 2020?” Most people don’t do!

And then they don’t know which metric to use when. If I am doing a DCF on
Sterlite, or a DCF on Hindalco, and the Supreme Court suddenly thinks that
it should de-allocate the coal mines given to these companies, then all the
DCF goes for a toss.

Let’s assume the Supreme Court is kind enough, and says,” Okay, since
you’ve started work on the mines, we’ll give you time to look into it,” who
will take care of the London Metal Exchange?

So for cyclical companies, there is no valuation metric that can be used

with confidence. Just buy such companies when they are making their five-
year lows, and sell them when they go up 3-4 times.

www.safalniveshak.com Page 47 of 59
 Interview with Basant Maheshwari | Safal Niveshak

Tata Steel, for instance, will go 3-4 times from the bottom to the top. If it
rises so much, you sell. There’s no need to value it anymore. If somebody
has to make money, let him make money on it.

But, on the other hand, if you have bought a stable and structural growth
company, and if you can predict the growth, then ask how much money it
will make in the next 2-3 years. That will be a good time for you to actually
look at it from different angles, because you’re sure about the company.

You see, most of the time, it’s not a numbers game only, or it’s not a
business game only. It’s just a combination of it.

But if you ask me the PEG (price-to-earnings growth) ratio, for instance, I
don’t use it at all. I am a big Peter Lynch fan for the book that he has
written, but I don’t believe in PEG.

Let’s say there’s a company that will never be able to grow, you think it will
sell for free because ‘G’ is zero? PEG is just a very broad approximation.
But in most of the reports, I see people using PEG.

You see, P/E can go up also for high cash companies. P/E can go up for
dividend yield stocks also. You will always try to tear your hair off why this
stock is trading at a P/E of 40x, but if it trades at a P/E of 10x, the dividend
yield will also be at around 10%.

www.safalniveshak.com Page 48 of 59
 Interview with Basant Maheshwari | Safal Niveshak

Look at Nestle. Assume the stock trades at a P/E of 10x – just reduce the
stock price to get it to 10x P/E – and then work out the dividend yield, you
would find that it will be an exorbitantly high yield, which will never happen.

So there’s no single mechanism to get around this thing. Also, there are
companies whose P/E are a function of the management also, which you
cannot define.

Just because growth is a very good number to work on, most people put
P/E equal to G, and then they work on it. It may work in many cases, but in
many cases it won’t work at all. This is when there’s something else that is
more significant than the G, then that will take over, like the dividend. And
there’s nothing more real than the dividend.

Anyways, let me now talk about how to value a moat. Let me give you an
example.

Semi-urban and rural India is going to see a boom in the next 5-10 years.
One thing that this government is also focusing on is rural housing. I will
give you an example of a stock that currently trades at a P/BV (price-to-
book value) of more than 10x – Gruh Finance. Now whether this is
expensive or not is another issue.

Now consider this – there is a shortfall of more than 6 crore households in

India, and Gruh Finance, along with the other rural housing finance
companies, doesn’t even have 6-8 lac accounts with them.

www.safalniveshak.com Page 49 of 59
 Interview with Basant Maheshwari | Safal Niveshak

At maximum, they would have 10 lac accounts. And the total market is for 6
crore homes.

Now, why would Gruh do so well? A guy who borrows Rs 2-5 lac to actually
build his home will always be someone who does not maintain a bank
account, at least in most cases.

This is because, in most cases, the situation is where the husband is

driving a truck and the wife is selling vegetables. They don’t have a bank
account, so how can banks fund them? They won’t, because there is no
income proof.

So, even if they are creditworthy, they have nothing to show that they are
creditworthy. And thus this market remains untapped. This is why these
guys lend at 12% whereas banks lend at 10%.

And this is the 2% that they make. They make it because they understand
the structure so well. They understand the market so well. This is a huge
competitive advantage I think.

Now, why wouldn’t banks get into it? This is because no bank would be
interested in that kind of granular lending.

www.safalniveshak.com Page 50 of 59
 Interview with Basant Maheshwari | Safal Niveshak

If you see India’s banking history, most banks have the higher number of
NPAs when they have tried to lend below Rs 15 lac. So if you ask me, I
think this is one place where can you get the next 20, 30, 40 bagger.

Now whether this company does well or some other companies do

well…some companies will surely do very well, if India is to grow.

Over the last few years, you have seen NREGA, land prices going up,
people from villages going to towns and cities and earning, working in
software companies, and writing cheques back for their parents. So there’s
too much money reaching rural homes these days.

Also, prices of food and vegetables are going up, but in some way that is
helping rural India. So there’s a transfer of wealth happening.

In the Rs 5-15 lac category, there aren’t too many companies around who
can lend and who have a history of lending. I don’t think there are more
than 60 registered housing finance companies in India. So there’s a huge
opportunity here.

The point is, if you try and focus on this sector, then you will make it big.
This is one sector where you can find good companies with sustainable
moats. But then, this is a 20 year story, not a 10 year story.

SN: Could you please share a few lessons you learned from the
mistakes you made in the past?

www.safalniveshak.com Page 51 of 59
 Interview with Basant Maheshwari | Safal Niveshak

BM: I lost a lot of money in Voltas, and went through a lot of pain, because
from 2003 to 2008, I had never lost money.

And when I bought Voltas because I wanted to participate in the cyclical

game, I lost 60% of my money on the stock.

What I learnt from it was that, when next year I bought Thermax, Voltamp,
and Blue Star, the moment they doubled, I sold them off. This is because I
knew they were cyclical businesses. Because Voltas was a cyclical
business where I had lost money, I thought I should get rid of these other
stocks as well, after making 2-3 times.

Now, why this is significant is – I think I sold Voltamp at Rs 700, and I

bought Page at Rs 600. Page today is around Rs 7,500, while Voltamp is
still below that price. That was possible because I lost a lot of money and a
lot of energy analyzing Voltas, which was bad mistake. I shouldn’t have
bought Voltas.

Another big mistake I made was holding onto to Trent till 2006. I should
have got rid of the stock in 2003 itself.

Also, my early days were spent in not buying a stock in as much volume as
I do now. Like if I bought a certain stock at Rs 10, and it went to Rs 20, I
bought. But if it went to Rs 50, I did not buy.

www.safalniveshak.com Page 52 of 59
 Interview with Basant Maheshwari | Safal Niveshak

Like I sold Bharti too early, because I thought that kind of a market cap
couldn’t have sustained. And from the time I sold Bharti, I think it went up
15-20 times. I sold it because I just couldn’t get a hang of it.

Sometimes, not knowing enough is also good. Because had I known too
much of it, I don’t know whether I would have been able to hold on to
Pantaloon Retail.

Not knowing enough was good, the price was acting, the revenue was
growing, market was cheering up, and that is all what was needed. But if I
would have done too much of an analysis, I would have probably sold off
Pantaloon much earlier. But that doesn’t matter, because I would have
made money elsewhere also.

So, sometime not knowing enough is important, as long as your learning

process is on track, and you keep adding to your knowledge.

SN: What is your two-minute advice for an investor who is just

starting out?

BM: First is, he should not look at the cost of increasing knowledge. So he
should not worry – “This book is worth Rs 2,000. Why should I buy it?”

Secondly, even if he looks at the cost, he should remember that these

costs are nothing in comparison to the mistakes he will make in his
investing life.

www.safalniveshak.com Page 53 of 59
 Interview with Basant Maheshwari | Safal Niveshak

In one book – I don’t remember the name – I read of this term called
“jewellery retailing companies”. Immediately my mind went to Titan and
Tanishq. That book may be worth Rs 400-500 but that was it!

See, if you are passionate about investing, then look at is as a focus area.
Even if you look upon investing as a hobby, a hobby always costs money.

Thirdly, a new investor has got to focus on what he knows. If he has

understood a few companies, it’s better to put more money into few rather
than put a few into more.

This is because you can’t buy 20 companies as a first time amateur

investor and expect to do well.

Now, what he should not do is play book cricket, which is, maintaining
dummy portfolios. You won’t get emotional about them, and when you will
lose money, you will reset the entire portfolio and start all over again.

So it’s like playing book cricket that we did when we were in school. You
just open a page and you hit a six. Next page you hit a four, and so on.
This does not work in investing, and is just a waste of time.

Also, if you want to learn, you have to put on the table only that amount of
money that will hurt you if you lose.

www.safalniveshak.com Page 54 of 59
 Interview with Basant Maheshwari | Safal Niveshak

You can’t have a net worth of Rs 5 core and say I will buy 1,000 shares of
Unitech and they will go up. Because if they don’t go up, you will not learn
anything out of it.

To learn, the losses have to really pinch you. If the losses aren’t pinching
you, you aren’t learning.

SN: If you could pick one person other than you, anywhere in the
world, to manage your money for the rest of your life, who would that
one person be, and why?

BM: There are people who are smarter than me across. But the stock
market to me is like my breath. It’s like oxygen to me.

So if I give my money to someone else, it will be like I am put on a

ventilator.

I actually enjoy investing on my own, but if you were to put me to

somebody else and give my money to that guy, it would be Peter Lynch.

This is not because of the returns he made and in what context he made it,
but because of the simplicity with which he approached investing.

Of course, now we have become used to seeing market downturns, but

there have been times, like in 2004 when BJP wasn’t voted back to power
and the markets fell. There was so much of chaos. I had limited capital and

www.safalniveshak.com Page 55 of 59
 Interview with Basant Maheshwari | Safal Niveshak

lot of leverage. And all I did then was read Lynch’s One Up on Wall Street
again. I looked for the areas where he was talking about the 1987 crash
and things like that. It just gave me so much of confidence.

But then, I am in the market because it’s like life and blood for me.

SN: Great, Mr. Maheshwari! That’s all from my side. Thank you so
much for sharing your thoughts.

BM: It’s my pleasure, Vishal. Thank you!

www.safalniveshak.com Page 56 of 59
 Interview with Basant Maheshwari | Safal Niveshak

About Safal Niveshak

Safal Niveshak (Hindi phrase for ‘successful investor’) is a movement to
help you, the small investor, become intelligent, independent, and
successful in your stock market investing decisions. It’s about a new way of
thinking about investing that can unleash the smart investor within you, and
lead you to prosperity and financial peace of mind.

Who Writes Safal Niveshak?

Safal Niveshak is written by Vishal Khandelwal.
You can find me on Facebook and Twitter.

Vishal has 11+ years experience as a stock market

analyst and investor, and 3+ years as an investing
coach. Through Safal Niveshak, he tries to help small investors become
smart, independent, and successful in their stock market investing.

Safal Niveshak, which started in 2011, is now a community of 12,000+

dedicated readers, and was recently ranked among the best value
investing blogs worldwide.

Subscribe
Follow Safal Niveshak blog via Twitter, Facebook, and RSS….or simply
click here sign up for my free e-letter on investing.

www.safalniveshak.com Page 57 of 59
 Interview with Basant Maheshwari | Safal Niveshak

What Readers Say about Safal Niveshak…

“I am sure that any investor (including experienced ones) in Indian markets
would benefit from Vishal’s work. I certainly have." ~ Prof. Sanjay Bakshi

“It means ‘Empowerment’. A powerful force that was lying dormant has
been unleashed.” ~R K Chandrashekar

“Safal Niveshak’s simplicity has stunned me.” ~ Jayant Nikam

“…plain speak, no-nonsense view about investing.” ~ Indranil Maitra

“Vishal’s passion to teach Value Investing is contagious and his informal

yet definitive style of teaching is par excellence.” ~ Gautamjit Singh

“…selfless service to the small investor.” ~ Samson Francis

“I have gone through 100s of sites and 1000s of blogs and finally i have
found my home. Thank you for this experience!” ~ Harshad Parulekar

www.safalniveshak.com Page 58 of 59
My Interview with Niveshak
safalniveshak.com/my-interview-with-niveshak/

Vishal Khandelwal April 6, 2015

I recently did an interview with Niveshak (not related to Safal Niveshak), the monthly
magazine released by the Finance Club of Indian Institute of Management, Shillong.

Here I present that interview verbatim for the benefit of tribe members.

1. We are aware that you are an avid blogger and some of us are regular readers of
Safal Niveshak blog. If we ask you to tell our readers about the 3-5 most vital
investing lessons what would they be?
Thanks for reading Safal Niveshak! It’s good that you have a word limit to this interview,
because the lessons I have learned as an investor over the years would have run into
several pages.

But if I were to list down just 3 of them, they would be –

Have extreme patience

on process, and outcome will take care of itself
that you will make (a lot of) mistakes

Talking about patience, it’s important for investors to understand that ‘t’ or time is the most
important variable in the compounding formula, even more important than ‘i’ or rate of
return. So, the more patience you have to sit on your investments (assuming they are good
investments), the greater is the amount of wealth you can create. In fact, patience – the art
of sitting quiet – is the most important skill an investor can have, even more important than
knowing what stocks to pick.

Another lesson I’ve learned over the years is that of focusing on the process than the
outcome of an investment. If you focus only on the outcome, you are less likely to achieve
it. Instead, if you focus on the process, the outcome will take care of itself. So, it’s important
to judge decisions – especially yours – less on results you achieve, and more on how they
were made.

And then, the third lesson I’ve learned is that it’s important to accept the fact that you will
make many mistakes in your investment career. Knowing that you don’t know a lot of
things, knowing that you will make a lot of mistakes…and accepting these as part of the
game that must still be played, is what creates a successful investor.

Without mistakes, investing would be boring, right?

2. As an investor what are the most prominent mistakes that you have made in your
life that you will want any investor to avoid in the future?
Many! Most of my mistakes have been those of bad behaviour instead of choosing a wrong
business.

One big mistake I have made several times in the past is that of selling great businesses
1/6
early, after having earned a 100-200% return. And interestingly, my reasons for selling
early have revolved more around things outside the business than inside the business I
sold.

So I would sell after a stock rose sharply, or after I made a high return in lesser-than-
expected time, or when I thought the economy and markets were about to go down and I
must protect my paper profits. Note that all these reasons are extrinsic to the business
underlying the stock which, in fact, should be the sole reason for an investor to decide
whether to hold or sell a stock from his portfolio.

The lesson I’ve learned from this mistake of selling too early and then missing out on future
gains because the business remained good is what Philip Fisher said several decades ago
– “If the job has been correctly done when a common stock is purchased, the time to sell it
is-almost never.”

Another mistake I made during the earlier part of my investment career was to buy a stock
without doing any or much due diligence on the business and just because someone else I
respected was recommending/buying it. While cloning a sensible investor can often be a
great idea, the lesson I’ve learned is that you cannot blindly clone anyone, however smart
and successful he/she has been in the past. You need to have your own conviction while
buying a stock. And conviction is something you cannot borrow from anyone else.

A third, and the biggest mistake, I have made in the past is to repeat some of my mistakes
instead of learning from them. I have taken care of this aspect by maintaining a journal of
my investment mistakes, so that I have them in front of me as warning signals every time I
am about to make an investment decision.

3. It is said that Sensex is likely to touch 50,000 in the next 2-3 years. Third quarter
earnings declared last month ended up disappointing the investors as annual profit
growth has been the worst in last five quarters? Do you feel that the Indian stocks
markets currently are overvalued?
While a Nifty P/E of above 22x gives an impression of an overvalued market, I would rather
be stock specific than worry about where the broader indices are and where they are going
to go in the future. So if I find a good business available at reasonable valuations – and
there are pockets of inefficiencies in all kinds of markets – I would invest irrespective of
where the Sensex or Nifty is.

So to answer your question whether the Indian stock markets are overvalued, I have no
clue. But I am surely seeing initial signs of hype and excessive risk-taking, which may
indicate just the start of a mania. When making money in the stock market starts to become
easy, as it seems now, you know you’re in a bubble. Now, when that bubble is going to
burst is anybody’s guess.

4. Corporate governance for an investor is as important as financial statement

analysis. What are the best techniques to measure corporate governance policies in
any company?
I believe corporate governance is more important than financial statement analysis,
because when I buy a stock, I become a partner in a business and I would like to partner
only with people I trust – people who govern ethically and with complete integrity.
2/6
When it comes to assessing corporate governance, it’s difficult given that there are no
clear-cut numbers to judge the same. But here are a few questions I suggest every investor
must try to answer while assessing a company’s governance –

How has the company grown over the years under a given management – has the
growth come on the back of excessive risk-taking (borrowing money, acquisitions
etc.) or has it been steady and without must risk-taking?
How has the management treated debt – Recklessly or prudently? (I generally avoid
businesses with too much debt, because borrowing excessively can lead you to
indulge in a lot of fuzzy things).
How has the management’s capital allocation been? Here I look at high or rising ROE
without much debt.
How much are the senior managers paid? I believe once you are already rich, you
must be happier leading a business than taking out a lot of cash to pay yourself.
Does the management continuously issue guidance or prediction about the future
earnings growth? If yes, I would largely avoid such a business because its managers
would most likely focus on meeting short-term guidance than focusing on long-term
growth and profitability.
Does the management think independently or often gets swayed by what others in
their industry are doing? Look at companies that make a lot of acquisitions because
they want to grow bigger, faster. Then, avoid them.
Are managers clear, honest, and consistent in their communications and actions with
stakeholders? I like to read plain English in annual reports, and not fuzzy words.

These are some of the questions, among others, I try to answer while assessing a
company’s corporate governance. The history of the management and how they have dealt
with the business and all stakeholders tell you a lot about their intentions. And if people
have behaved badly in the past, there is a thin chance that they would behave any different
in the future.

Finally, while assessing a company’s management and its corporate governance practices,
I remember what Thomas Phelps wrote in his amazing book 100 to 1 in the Stock Market –
“Remember that a man who will steal for you, will steal from you.”

5. Some of our readers are novices to the investment world. How do you suggest
they should begin investing? Is it good to have an investment account with a broker
or bank is preferable?
You must have seen a baby take her first steps. Slowly and carefully she gets up…walks a
step…then falls down…then again she gets up…takes a step…then again falls down. The
process repeats till the time she learns how to balance her body while taking her second
step, and her third step.

This process of learning happens in whatever we do in our lives. We first learn to take baby
steps, before we cross bigger hurdles. There’s no reason the cycle should be any different
when it comes to investing in stock markets.

3/6
When you are just testing waters, it’s always good to start small by allocating small amount
of money to the stock market – either directly or through mutual funds – and then increasing
the allocation gradually.

The best thing you as a new investor can do is tostart, and as early as possible (remember
the ‘t’ in the compounding formula).

As far as opening an investment account is concerned, you may do it with a reputed broker
or bank. But always remember one thing – never take their advice.

Do your own homework and then trust your own conviction.

6. Who will be your role model in the investment world and why? Suggest a few good
books for our readers to read?
I must say that finding my role models has been highly instrumental in my development
toward investing sensibly and successfully in the stock market. Sensible investing is
something you either pick up instantly or you don’t. So I have been lucky to get introduced
to the writings of Warren Buffett, Charlie, and then to Prof. Sanjay Bakshi. I just fell in love
with what they had to say and that, I believe, has made the difference.

As I understand, you become the average of five people you spend the most of your time
with. Three of those five people I spend most of my time with (not face-to-face, but
vicariously) are Buffett, Munger, and Prof. Bakshi, and that has really helped me build a
sensible process for investing. And not just investing, these people have helped me
tremendously in becoming a better, more humble person, than I was a few years back.

I would like to leave you here with a brilliant quote from Guy Spier’s bookThe Education of
a Value Investor. He writes about the criticality for a budding investor to find his role models
early in life –

…there is no more important aspect of our education as investors, business people, and human
beings than to find these exceptional role models who can guide us on our own journey.

Books are a priceless source of wisdom. But people are the ultimate teachers, and there may
be lessons that we can only learn from observing them or being in their presence. In many
cases, these lessons are never communicated verbally. Yet you feel the guiding spirit of that
person when you’re with them.

Role models are highly important for us psychologically, helping to guide us through life
during our development, to make important decisions that affect the outcome of our lives, and
to help us find happiness in later life.

As far as books are concerned, here are three I would suggest a new, young investor to
read at the very start of his/her career –

The Richest Man in Babylon by George Samuel Clason

One Up on Wall Street by Peter Lynch
Think and Grow Rich by Napoleon Hill

4/6
These books have inspired me a lot when it comes to taking proper care of my money, and
I am sure these will inspire anyone who is starting new today, if he/she were to read them
diligently.

For more advanced reader, or as the next step after reading the above three books, I would
suggest –

Warren Buffett’s shareholders letters

Howard Marks’ memos
Poor Charlie’s Almanack: The Wit And Wisdom Of Charles T. Munger
Influence: The Psychology of Persuasion by Robert Cialdini

You can base your entire investing career by reading just these books and resources I’ve
mentioned above. But then, it’s important to never stop learning. Keep reading and keep
learning. Be a learning machine.

As Charlie Munger said to students in his 2007 commencement speech at USC Law
School –

I constantly see people rise in life who are not the smartest, sometimes not even the most
diligent, but they are learning machines. They go to bed every night a little wiser than they
were when they got up and boy does that help, particularly when you have a long run ahead of
you.

7. What would be your advice to the B-school graduates who would soon enter the
corporate world (and start earning)?
Noted Irish playwright and philosopher George Bernard Shaw opined, “Youth is wasted on
the young.”

What he possibly meant was that many young people have everything going for them
physically; they’re in the best health they will ever be in, and their minds are sharp and
clear. However, they lack patience, understanding and wisdom which results in so much
wasted efforts.

The energy that can be directed towards building a solid thought process and action plan
for the future is spent on short-lived pleasures. Shaw’s words are especially applicable to
those young adults who are starting a career and wondering if they should start saving and
investing for their future, or spend the next few years living life kingsize.

You see, I am not old enough to complain about the younger generation. And that’s why I
believe youth is not always wasted on the young, if the young can realize that someday
their bodies and time would fail them, and that they would appreciate what they have now.

So as far as my advice to you – the young, about-to-be-earner – is concerned, the first thing
I would do is to encourage you to begin to save and invest starting as early as possible,
and take some simple yet effective steps to kick-start your financial life.

When you are young, time is one of your greatest allies in wealth accumulation and it is the
one resource you will never get more of in the future.

5/6
After starting out to earn your own living, if you waste the early years saving and investing
nothing, they are forever lost. So that you do not lose out on the precious time you have on
your side to start making your money work for you, here is the action plan that you must
(may) follow.

You are free to modify this action plan to suit your needs. It’s just that this has worked very
well for me for the past 12 years, and thus I am happy to share it with you.

Pay yourself first i.e., save money before you spend it;
Create an emergency fund which may be around 6-8 months of your household
expenditure;
But health and term insurance;
Use debt sparingly. As much as possible, completely avoid high-cost debt like credit
cards and personal loans;
Hold tight to your reputation (it takes years to build good reputation and minutes to
destroy it); and
Celebrate life, not money. Avoid trying to find happiness in spending money. In fact,
in the busy-ness of earning, saving, and spending, please celebrate your life and
your accomplishments.

In short, I’ve learned that the real success in life is not about what you earn, own, achieve
or win but who you will become along the way. So work towards ‘becoming’, not towards
‘having’.

I wish you all the best!

P.S. You can read IIM-Shillong’s Niveshak magazine here.

6/6