Our investment philosophy draws upon the
teachings and thoughts of investing starlwarts such as Benjamin Graham,
Philip Fisher, Warren Buffett, and Peter Lynch, all of whom
have always pointed to a path of rationality and intelligent
analysis as the pillars on which investment success is built.
We will always be indebted to them for sharing their insights
with investors at large.
Below, we have enumerated the salient features of our investment
philosophy pertaining to investments oriented towards long-term
Capital Appreciation, our principal investment strategy. In particular,
we talk about our approach towards acquiring ownership of
businesses via publicly-traded equities (as this is the primary
means we are likely to use in our pursuit of capital appreciation
for our clients). However, the broader philosophical themes
are likely to permeate all investments that we will make,
irrespective of asset class, market cap, or geographical considerations.
Our investment philosophy/ approach and the subsequent results
that it is likely to produce may not be compatible with what
every investor or client expects. Hence, we urge every prospective
client to go over the following points carefully to form an
opinion on whether we fit the bill as stewards of their hard-earned
capital. We would also like to point out that the highlights
discussed below are guiding lights (and by no means exhaustive)
that we use to manage investments and should not be construed
as rules etched in stone—we are likely to deviate on
occasions when we feel it makes rational sense to do so.
Acquiring Ownership Of Businesses
We see buying equities as equivalent to buying portions of
businesses and subsequently becoming an owner in these entities
as opposed to buying pieces of paper. The stock market merely
serves as the medium that enables us to buy these businesses
more easily than if we were to try to buy them privately.
We analyze our prospective investments from the standpoint
of becoming a long-term future owner of these businesses.
Factors that are important to long-term ownership of a business
are thus meaningful to us—factors such as the kind/quality
of business we are buying, the managers running the business,
the financials of the business, and importantly the price
at which we are buying a business relative to its worth.
Market Price, Intrinsic Value, and Market
Efficiency
The price at which we buy a business relative to its worth.
This statement deserves a closer look. It is important for
us to point to the distinction we draw between the stock price
or the market price of a business and the worth or the intrinsic
value of a business. The market price or the stock price is
subject to volatility based on various influences on the stock
market, the economy, overreaction to a negative piece of news
on the company, and other such factors. The intrinsic value
or worth of the business, on the other hand, is likely less
volatile and is a reflection of the value of the business
as determined by a rational investor. Whatever the method
used, intrinsic value is calculated independent of the market
price.
In an efficient market place (i.e. the stock market or any
financial market place), the market price of a business should
closely track the intrinsic value of the business. However,
history and evidence to the contrary suggests that the markets
are not efficient 100% of the time (If that were the case,
our clients should be putting their money into index funds
and forget about using external money managers such as us).
We believe that there are times when the market price of a
business can deviate significantly from the intrinsic value
of a business. We focus our efforts on finding such deviances
in the stock market, opportunities that we believe are undervalued
by the market, opportunities that can prove advantageous to
a rational buyer of these undervalued assets. Typically, periods
of market inefficiency tend to be bear market periods or times
of overreaction to some negative news/events on a company
(events that don’t impact the intrinsic value of a business
to the degree the market price reaction suggests) —in
other words any situation causing market efficiencies that
a long-term owner of a business would consider transitory/
temporary.
Long-term Safety of Principle, Adequate
Returns, and Buying Investments on “Sale”
Long-term preservation of capital while producing an adequate
rate return for our clients are extremely important to us.
By this we do not imply that there will not be any volatility
in the market prices of the investments that we make. On the
contrary, investments oriented towards Capital Appreciation
are likely to see significant changes in market prices, both
above and below cost, over time, particularly over the short
term. However, our approach is to make investments where the
probability of permanent loss of principle over longer periods
of time is low. We believe this typically happens when we
are successful in purchasing attractive investments that are
bought on a “sale,” i.e. well below what they
are actually worth or their intrinsic value. We believe that
the market prices of such securities will eventually move
towards their intrinsic value, especially over longer periods
of time, and in the process we expect to make a decent rate
of return on our investments. We stress the phrase “longer
periods of time” because we believe that over the longer
term, the financial markets tend to do a good job in pricing
the true worth of a security while over the shorter term these
markets tend to slip up, from time to time. And it is during
occasions where we believe the markets are wrong that we love
to buy our investments—occasions when we are likely
to see these investments on “sale,” hopefully
a “super sale.” Ben Graham, the father of value
investing, once famously compared the market to “a voting
machine” over the short term and “a weighing machine”
over the long term. By buying investments on “sale”
with enough margin of safety relative to our calculated estimate
of its intrinsic value, we believe that we are also able to
limit the downside risk inherent in the investment and, in
the process, increase the probability of long-term preservation
of capital.
“Beating the market” will take a back seat to
ensuring that capital is preserved. In other words, we intend
to shy away from speculative situations that exist in the
investing environment. We would rather wait on the sidelines
with cash than overpay for a business or security—even
at the cost of short-term relative underperformance to the
market (as measured by the S&P 500 Index or the Dow Jones
Industrials Average), especially in a speculative environment.
Such a stance (very difficult to assume) of not doing what
everyone else is doing is likely to result in short-term underperformance
relative to the market. However, during speculative periods
we are happier protecting our clients’ capital (from
the inevitable eventual burst of the speculative bubbles)
than following a mob mentality and buying investments that
do not make rational sense to us. This tendency of the financial
markets to oscillate between speculative and non-speculative
periods is one of the reasons why we urge that our performance
be judged over longer periods of time (typically 3 or more
years and preferably including some speculative periods) and
not on a shorter-term basis. Focus on returns, preferably
absolute returns, with adequate capital protection will thus
be an important focus for us.
A Contrarian Approach
We belong to the school of thought that to be a successful
investor over the long term, one should zag while the market
or the “crowd” is zigging and zig while the market
is zagging—in other words approach investing with a
contrarian mindset. We believe that this approach, while clearly
not the only approach in investing, will allow an investor
to capture market-beating risk-adjusted returns. This approach
should help us ferret out bargains in the marketplace that
will provide for adequate long-term returns with reasonable
downside protection. Bulk of our investments are therefore
viewed through a contrarian’s lenses and we can be expected
to sift through out of favor companies, companies neglected
by Wall Street, and companies with short-term problems (at
least in our view) while looking for undervalued opportunities
that meet our investment criteria.
Types of Investments
The investment vehicles we typically use to achieve our objectives comprise
an appropriate mix of:
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| Individual Securities: |
We are agnostic to several investment
characterizations—capitalization, growth, value,
sector, type of security, and so on. When it comes to
equity investments, our primary concern is to determine
whether we can fully understand the business underlying
an investment or company (enough to value it to our
satisfaction so that we can compare this value to the
market price to determine if it is undervalued to our
satisfaction or not), whether that business and its
financials fit into our set of criteria, and whether
it is run by good managers. Typically, such businesses
tend to be simple, understandable businesses—ones
with simple products and/or services whose competitive
advantages are simple for us to comprehend. We are thus
very likely to be restricted to businesses that we can
understand well.
While we will look for investments primarily in the
US, we are open to opportunities that might present
themselves anywhere in the world, provided (i) we understand
these opportunities well and (ii) we are comfortable
with the risks inherent in such opportunities. |
| Funds/ Other Money Managers (primarily via No-Load
Mutual Funds): |
We are also happy to use other investment managers that
share our investment philosophies and in the process become
a partner in and benefit from the opportunities that such
managers may come across. We intend to do this primarily
via no-load mutual funds run by such managers that will
find a place in relevant portfolios and funds managed
by us. While identifying suitable no-load mutual fund
investments, we will also give due consideration to their
past performance, transaction fees, expense ratios, and
management style, among other factors. |
Investment Criteria Used
We analyze our prospective and current investments on four
dimensions:
(i) The quality and nature of the businesses underlying its
value
(ii) The quality of the management running the businesses
(iii) The financial soundness of the company
(iv) The market price of the investment relative to its estimated
value/worth
Selling Our Investments
Once we purchase an investment we consider attractive for
the long term, we will usually part with it under the following
conditions:
- When we believe we have made a mistake in analyzing the
attractiveness of the investment
- When due to the passage of time, this investment no longer
meets our investment criteria for attractiveness
- When the market price of the investment far exceeds our
calculated intrinsic value
- If a better opportunity comes along and we need funds
to purchase that opportunity
We track the progress of an investment that we have committed
to and periodically we will calculate the intrinsic value
of the business and compare it to the market price. We also
recognize that some businesses may be so good that they are
capable of increasing their intrinsic value for years to come
and in such cases we are willing to hold on to them for as
long as it makes rational sense for us to do so (subject to
the conditions mentioned above ).
Time Horizon and Performance
We intend to grow our client’s capital over the long
term and we prefer to be judged on that basis rather than
on a quarter-to-quarter basis. By long term, we are talking
of periods in excess of three years or more (preferably more)—periods
that include bear markets if possible. There are likely to
be occasions when we don’t meet some of our benchmarks—for
example, during periods of speculation, when our concern is
for protection of principal rather than trying to match the
returns being posted by the out of control markets. Long-term
protection of principal and posting an adequate return, preferably
absolute returns, will always be foremost on our agenda.
Diversification and Risk
We strongly believe that it takes time to evaluate and understand
businesses; that good investment opportunities meeting our
criteria are not very common. Therefore, when we identify
attractive opportunities, we are willing to take positions
that are larger than the norm by conventional standards. We
intend to limit the number of investments we make to well-researched
and manageable numbers rather than holding a large number
of under-researched, sub-optimal investments.
Contrary to the popular notion that total risk in a portfolio
is a function of the number of holdings in it, our opinion
is that this risk is a function of the level of careful study
and research that has gone into the evaluation of each investment
within the portfolio. Per the popular notion, lower the number
of holdings in a portfolio, the greater the likelihood of
short-term price volatility and hence, greater the risk. This
notion, in our opinion, does not recognize factors important
to the long-term protection of capital that has been put to
work. To us, what is more important than the likelihood of
short-term price volatility is the long-term protection of
capital and to ensure that adequate research and analysis
has gone into evaluating the investments. Thus, as we see
it, a portfolio comprising a large number of holdings that
have not been researched thoroughly enough is not necessarily
less risky than a portfolio comprising well-researched limited
number of holdings/ investments.
Use of a limited number of well-researched investments in
conjunction with a suitable number of mutual funds (primarily
no Load) offers an adequate level of portfolio diversification,
in our view.
The Markets, The Economy, and All Things
Macro
We do not attempt to forecast the direction of the security
markets or the economy nor make decisions based on such forecasts.
Many of the investment managers who have proven successful
over the long term (with low levels of risk/loss of capital)
have been ones who were/are good at individual security selection
and in exploiting the market inefficiencies (investors such
as Warren Buffett and Phillip Fisher, to name a couple).
Our efforts will be directed towards finding undervalued
opportunities, one at a time, in all macroeconomic and market
environments. We are not concerned with what the “market”
does on a daily basis. Our concern is with individual securities—to
determine whether they are undervalued, overvalued, or fairly
valued relative to our estimate of their intrinsic value.
Of course, the gyrations of the market are what provide us
with the opportunities to buy businesses at discounts to their
intrinsic value.
There will always be investing fads, markets will go up and
down along with greed and fear that are part and parcel of
its character, recessions will come and go, some countries
will do better than others. Trying to time investments based
on such factors, in our opinion, is very difficult, if not
futile. We prefer to stick to evaluating one opportunity at
a time rather than trying to base our investments on some
expected macro behavior or trends. We also note that the forecasting
record of macro experts is not particularly encouraging.
Our View on Expected Returns
In our opinion, long-term returns and the risk we should expect
from any investment is, first and foremost, a function of
the intelligent effort that has been poured into evaluating
an opportunity. Other characteristics such as market capitalization,
sector and so on likely play a secondary role, if at all,
in generating returns over the long term. We will always strive
to thoroughly analyze all investments before we commit any
capital on behalf of our clients.
Putting Money Where Our Mouth Is
Our personal investments will be invested alongside our clients’
investments-- if our clients do well so will we, and vice
versa.
Mistakes
We are likely to make mistakes from time to time, and when
we do make them our clients will hear about them in an honest
fashion. While we see making mistakes as an unavoidable result
of investing in an uncertain world, we will also do our best
to minimize our mistakes, learn from the ones we make, try
not to repeat them, and to limit the damage caused. We believe
that by sticking steadfastly to a disciplined approach our
successes will outweigh our mistakes over the long term.
We hope the above discussion helps you get a feel for the
process we follow and our stance on various issues that influence
how we invest. For any clarifications or further discussion
please feel free to contact us.
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