Tuesday, March 18, 2014

Safal Niveshak: Value Investing, the Sanjay Bakshi Way 2.0 – Part 1


Safal Niveshak: Let me start with a question I have been waiting to ask you for some time now. Through a comment on a link I shared on FB and through a few of your posts over the past few months, you have suggested that your investment philosophy has moved further towards high quality businesses, and great managements. Can you please elaborate on the same? What has been this transition all about? And why?

Prof. Bakshi: I started my career as a value investor in 1994. Over the last twenty years, I have practiced most styles of value investing including as Graham-and-Dodd style of investing in statistical bargains, risk arbitrage, activist investing, bankruptcy workouts, and Warren Buffett style of investing in moats. There have been times when I have owned 40 stocks and times when I have owned just 10.

I teach all these value investing styles in my course at MDI. I tell my students that they need to pick a style which suits their personality.

Some students have a statistical bend of mind and prefer to work with situations that can be evaluated more objectively than others. I tell them to focus on statistical bargains and risk arbitrage. I ask them to practice wide diversification.

Others like to delve deep into the fundamental economics of businesses and are comfortable with dealing with softer issues like quality of management. I ask them to focus on moats and diversify less. It all depends on what you enjoy doing over time and what has worked for you.

I have absolutely enjoyed practicing all these styles of value investing. Over the years, I also learnt a few additional things. One of them was about the idea of returns per unit of stress.

You can make a lot of money by being an activist investor, which I’ve done in the past. But it’s stressful. You can make a lot of money by shorting over-valued stocks of companies run by promotional and fraudulent managements. But it’s stressful. You can make a lot of money doing risk arbitrage where you have to monitor — perhaps 20 deals at any given point of time and be ready to react quickly when odds change. But it’s stressful.

I found that investing is moats is not stressful. It involves a slow and more meaningful understanding of how a business creates value over the very long term. And boy does it work!

I’d argue that if you pick 100 successful value investors who have compounded their capital over the long term (a decade or more) at a very healthy rate, then the vast majority of them would have accomplished that by first investing in high-quality businesses run by great managers at attractive prices, and then by just sitting on them for a long long time.

Moats are internal compounding machines. History shows that you get rich by just sitting on them because they do all the hard work for you. And I realized that over the years. Just as Mr. Buffett did when he too moved from classic Graham-and-Dodd to moats.

Let me give you an example. Many years ago, I co-authored a paper on Eicher Motors, which I think your readers would agree is a fantastic company. At the time, in 2008, the stock was selling at a ridiculously low price of Rs 200 per share even though the company had Rs 147 per shares in cash and no debt. That stock now sells at 5,500.

I presented that paper to two investors — both offshore funds. One of them bought it promptly and, over time, Eicher Motors became its best performing position. The other fund bought it too but sold out in less than a year when the stock went up a bit. So, you get two vastly different outcomes from the same stock. The fund that sold out did not have the patience. The other one did. And the fact that I had much more influence over the one which did not, or perhaps could not, exercise patience at the time, tells us something isn’t it?

I learnt a very important lesson from that one. Be patient with great businesses. Let them do the hard work for you. Just sit there.

So, a few years ago, I decided to increase my focus on moats. I enjoyed the process (and the proceeds) so much that last year I decided to exclusively focus on moats.

In this decision, apart from my own experience of investing in moats over the last 20 years, I was also influenced by two thoughts from two wise men. One of them was Pat Dorsey, the author of a wonderful book on moats. He wrote…
Moats can help you define what is called a “circle of competence.” Most investors do better if they limit their investing to an area they know well-financial-services firms, for example, or tech stocks-rather than trying to cast too broad a net. Instead of becoming an expert in a set of industries, why not become an expert in firms with competitive advantages, regardless of what business they are in? You’ll limit a vast and unworkable investment universe to a smaller one composed of high-quality firms that you can understand well.
And the other one was none other than Warren Buffett. I read something he had said a few years ago and it made a deep impression on me. He said…
The difference between successful people and very successful people is that very successful people say “no” to almost everything.
Twenty years is a long time to learn the importance of extreme specialization! If you work hard to specialize in a niche, and you keep doing it following a certain process, you’ll get good at it. It works in sports, it works in medicine and it works in law. It works in investing too.

And it isn’t that other styles of value investing won’t work. They will, if you focus on them.

I chose moats because I wanted to slow down, and not do too many stressful things. And the fact that investing in moats works beautifully if you only let them do the hard work for you, was a compelling argument too.