"It was possible to avoid Yes Bank stock fiasco in 2018 itself" - Amey Kulkarni

There are very few people who have the temperament and the skills to be a successful stock investor. You have heard all big names and stories behind them.

Today, I want to introduce you to a ‘hidden gem’, someone whose name you don’t see as much on the charts today. I am confident, though, a few years down the line, it will be a well known one.

Let’s get chatting with Amey Kulkarni, a direct equity investor and advisor who also shares his knowledge through his blog and workshops. Amey is based out of Pune and is also a speaker at various Indian and International fora.

VK: Amey, I know you don’t like to talk much about yourself.

So, let me straightaway take up on the claim. You wrote on your blog that it was possible for investors to foresee the Yes Bank fiasco in 2017-18 itself and they could avoid all the ensuing pain with the stock. Isn’t that talking in hindsight? No one mentioned anything then.

AK: I agree, it was very difficult to predict that Yes Bank will fail, but it was very easy to avoid investing in the Yes Bank stock. Let me explain.

Let us first understand how a bank works.

A bank borrows money from the depositors and in turn lends it to the borrowers (home buyers, industries, car owners etc.) They charge a higher interest rate to the borrowers say 9% and pay a lesser interest rate on the depositors say 6%. Banks make money by keeping the 3% margin.

Now banks will bring Rs 10 as equity capital – their own money, borrow Rs 90 from the depositors and lend the entire Rs 100 to the borrowers.

Now, imagine if 10% of the borrowers don’t pay back their loans. The bank suffers a loss of Rs 10, gets back Rs 90. This Rs 90 has to be repaid back to the depositors. What is left for the equity holders – a big ZERO. The stock should theoretically be worth zero.

So, banking is essentially a game of trust; trust that the borrowers will repay, trust in the minds of the depositors that the bank will refund their full deposits. What happens when the depositors lose trust in the bank and start withdrawing their deposits?

The bank fails.

Do you know how many banks failed in the US between 1929 and 1932 during the Great Depression? – 3000 banks failed.

So, essentially a bank is a very fragile business, and trust is the only factor that keeps the business running. So, as an investor (stock holder) of a bank, you want to invest in a bank which enjoys the highest trust of the depositors and you have the highest trust that most of the loans will be repaid by the borrowers.

Now let us turn to Yes Bank.

24^th Oct-17: RBI imposes penalty of Rs 6 Cr on Yes Bank for non-compliance of norms related to classification of bad loans. What does it mean? – Yes Bank is hiding from RBI the true extent of NPAs. (Stock price was Rs 320)

29^th Oct-18: RBI refuses extension of tenure to Yes Bank founder and CEO – Rana Kapoor. What just happened? – RBI threw Rana Kapoor who founded Yes Bank in 2003 out of his own company! (Stock price was Rs 172)

No reason was given – RBI does not reveal reasoning behind its action to the public.

Now, assume a person has bought a house with his own hard-earned money. Can the government confiscate his property? NO

Suppose this person steals, is a murderer – can the government confiscate his property – NO. The Constitution guarantees right to property as a fundamental right.

But, RBI has the power to throw out the founder/CEO/owner of a bank if they find some serious enough charges. And they exercised this power in the case of Yes Bank.

What does this mean? – RBI the regulator has lost “trust” in the management/CEO of Yes Bank.

Now if the regulator has lost trust, do you as an investor have “trust” in the fact that Yes Bank borrowers will repay in full? Do you imagine depositors of Yes Bank maintaining trust in the ability of Yes Bank to refund the deposits under all circumstances?

Being a fragile business model based on just one thing – “trust” — things can get very ugly for a bank especially when there is a lack of that only factor.

The drama played out over 2 years, and investors kept on buying the Yes Bank stock thinking how much more can it fall after falling 80%, 90%, 95% from its previous high levels.

To summarize, keep investing simple. Pay attention to the fundamentals – the basic stuff, ignore all the hype and the media coverage, think for yourself and make your own decisions without getting influenced by herd mentality or because some big investor also invested in the stock.

VK: Interesting! So, a more fundamental question now. How do you go about picking stocks for the portfolio? Do you have a model or a particular style?

AK: The principle that I believe and have also experienced which works in the stock markets is

“If profits of the company go up, stock price goes up, if the profits of the company go down, stock price goes down”.

What will be the price of your stock 2 days/ 2 weeks / 2 months from now is almost impossible to predict. So, let us turn that into a simpler question. Where will the profits of the company be in 3/5 years. This is a much simpler question to estimate and if the profits are going to be 3 times in 5 years, most probably the stock price will also increase by 300%.

So, my investment philosophy is simple

Buy quality businesses at reasonable valuations and hold till the company executes”

And what is a quality business?

Business has a competitive advantage – a moat
Consistent performance over a long period – typically 10+ years
Consistent high Return on Equity & Return on Capital Employed
Low / No Debt
Honest Management with a sense of stewardship

There are more than 2000 stocks actively traded on Indian stock exchanges. So, the first thing we need is a good filter to reject stocks.

I have a checklist with about 30 parameters divided into 4 sections – Financial Analysis, Business & Industry Analysis, accounting fraud & finally Management Analysis.

This checklist helps me to quickly reject stocks and leaves me with a much smaller list of stocks which I would like to research further and decide if I want to invest or not.

I then dig deeper to make sure that the management is honest and hungry. Everyone appreciates why the management has to be honest – otherwise the promoter will make a lot of money and not leave anything for the minority shareholders. And we also need hungry management because we make money only when the company grows after we have made the purchase.

Today, in the world of internet, access to knowledge has become universal. All relevant information is available in the annual report, quarterly presentations, industry reports. The edge that has remained is your analysis, your insights into the business and your temperament.

And the way to hone these skills is deliberate practice.

(1.01)^365 = 37

A 1% improvement everyday will make you 37 times better in 365 days

(0.99)^365 = 3%

A 1% loss of skill will make you lose 97% of your former ability over 365 days

This is the secret to becoming better at any skill – not just investing.

VK: That sounds reasonable. However, I believe and something I have experienced myself too – it is not possible to be right all the time. Mistakes do happen!

I am sure you have had your share of mistakes too. How do you overcome them or what do you do to ensure that you don’t repeat those mistakes?

AK: The pain of losing money is a very good teacher and a very effective one. But one may not necessarily make mistakes by himself to learn how to avoid them.

Read history – a lot of what is happening today is a combination in some form of what has happened in the past. Of course, history never repeats in the exact same way, but it definitely rhymes.

Read about mistakes made by other people.

Maintain an investment journal – always write down your decisions. Clarity emerges when one revisits them in the future.

Don’t be afraid of losses.

Have a system for when to sell.

When do I sell?

When the company is no longer as good/attractive as it was, say 3 to 5 years back.
I found a much better company to invest.
I realize that I have made a mistake in the initial assessment of the company – without paying attention to whether I am in profit or loss.

Let me share with you how I avoided major losses with Poddar Housing.

Poddar Housing is an affordable housing real estate developer. For those of you who are familiar with the city of Mumbai, it runs from South to the North. Every 2 km, the average income of a resident reduces by 10%. It is very common to see people travel 1-2 hours one way each day to go their places of work in the south of the city and earn a living. A half-decent house inside the city of Mumbai can easily cost at least a Crore and the good ones in the heart of the city in the south cost a minimum of Rs 10 Cr.

I discovered Poddar Housing in the year 2016. Poddar had constructed two mega townships at a travelling time of 90-100 mins from the city center. Imagine, one can buy a 1 BHK house 90 min away from Mumbai city center for Rs 12-15 Lacs. The townships had 2500 apartments each with facilities like cricket ground, tennis courts, gardens, jogging track, ample parking and also a full functional school and a hospital right inside the campus. I was amazed.

I went to the annual general meeting (AGM) and the CEO informed us that Poddar Housing will be starting a project within Mumbai city limits in Goregaon within the next 3 months. And I was sitting at the AGM listening to the CEO speak thinking that this stock is going to help me retire 10 years before I had imagined. Think about it, they were selling each house in Badlapur for Rs 2500 per sft. In Goregaon, Poddar would sell each house for at least Rs 15,000 per sft. Selling one apartment in Goregaon is like selling 6 in Badlapur.

Immediately after the AGM, I went to the project site. In Mumbai, there is not even a square inch of land available for building new homes and essentially every real estate project has to be a slum redevelopment project. I spoke to the slum dwellers and realized that no agreement had yet been signed with the slum dwellers. It will take a minimum of 3 months just for the agreement to be signed, after which Poddar Housing applies to the municipal corporation for building permissions. One project required 60+ different approvals from local and central government (environment, airports authority, etc.) for the project to even get started. After approvals, Poddar had to construct alternative houses for slumdwellers after which the main project will start.

The entire approvals process would take anywhere between 18 to 24 months.

I realized that the CEO was either fooling the investors or worse, he was fooling himself. In the case of the former, I was willing to tolerate a little, but if the case was the latter, I just wanted to run away from the stock.

I had bought the stock at Rs 950 and I sold it at Rs 830, pocketing the loss.

VK: Well, you did manage to avoid a major hit. Let’s come to the current times. How are you positioning your portfolio through the COVID crisis?

AK: The current COVID crisis we are going through is unprecedented at many levels.

Let us also accept that we won’t be able to predict what is going to happen over the next 6/12/18 months.

However, what is certain? The world will face an economic recession and that we are in the midst of a bear market.

And bear markets are succeeded by bull markets – the only uncertainty is when – 2/3/5 years down the line.

Money invested in bear markets yields more than handsome returns when the bull market arrives provided of course you invest in the correct companies.

What is the bad news?

Severe disruption of livelihoods and economic activity because of harsh lockdowns all across the globe. Massive unemployment at the global level. Supply chain disruption. Basically, the economy has come to a standstill. Sectors like entertainment, travel, restaurants, airline etc. will be severely affected for a long time to come.

The worst-case scenario is when large scale loan defaults start happening. The entire global financial system is inter-linked and all hell will break lose. Therefore, if you observe the first thing the US announced was buying of corporate bonds. Then they announced direct cash transfers.

What is the silver lining?

Unlike a physical war, no real assets have been destroyed. Factories and machinery are standing, houses are intact. Only the circulation of money has come to a standstill. So, what Coronavirus has done is just shifted your income by 6 months. Everything else stays the same. So, what was the first measure announced by RBI? – Loan moratorium. No need to repay your home/vehicle/personal/credit card loan for 6 months if you cannot afford it.

Also, if you see the trajectory of patients in countries like Italy, Germany, South Korea, the number of active cases is fast reducing. The human race is beginning to overcome this seemingly unsurmountable problem.

So, what should be our portfolio strategy?

As investors, we cannot over-commit to one particular outcome. Maybe the world will go into a prolonged recession or may start growing again in say 8-12 months.

What am I doing?

I am about 60% invested. If the market goes down substantially, I have enough firepower in my portfolio to take advantage of the bargains it will throw up.

If the markets and stock prices go up, all my existing holdings end up giving me good returns.

Also, I have re-oriented my portfolio towards businesses which will be least impacted by the Coronavirus situation. As an example, I own IEX India. Electricity gets traded on the IEX platform. Now, electricity is a basic need today and not much is going to change for it in the near-term or any foreseeable future. This business is the least affected by Coronavirus.

Another theme could be start buying stocks of highly impacted companies, which, you are sure, will not go bankrupt if the situation remains bad for another 3 years. E.g. commercial vehicles player – Ashok Leyland. When the recovery happens, this company will likely have a reversal in its fortunes.

VK: I am curious. Why go through all the pain of the work of picking, managing stocks. Why not give your money to someone else to manage (a mutual fund?) or just buy an index fund, and sit back and relax?

AK: For most people, buying an index fund or a well-run mutual fund is a very good way of investing your money.

However, let me draw your attention to stock returns of some companies which are household names

15 year returns from 2005 to 2020

HDFC Bank – 1 lac invested in 2005 is today worth Rs 15 Lacs
MRF Tyres – 1 lac invested in 2005 is today worth Rs 20 Lacs
Asian Paints – 1 lac invested in 2005 is today worth Rs 38 Lacs
Eicher Motors (Bullet) – 1 lac invested in 2005 is today worth Rs 42 Lacs
Jockey underwear (Page) – 1 lac invested in 2005 is today worth Rs 67 Lacs

Whereas, if you had invested Rs 1 Lac in the Sensex in May-2005, it would have grown to Rs 5 Lac as of May-2020

And then there are stocks which one could have discovered with a little bit of research

Astral Poly – 1 lac invested in 2005 is today worth Rs 1.04 Cr
CERA Sanitaryware – 1 lac invested in 2005 is today worth Rs 1.45 Cr
Vinati Organics – 1 lac invested in 2005 is today worth Rs 3.6 Cr

And there are several others

This is the power of investing your money in stocks.

Why do most people never achieve these returns?

One word – DISTRACTION

What will be India’s GDP growth because of Coronavirus? -5% or -10%?
Will RBI cut interest rates?
Will Trump get elected again in the US?
What will happen with the US-China trade wars?
Let us check what is said in the budget
Market main mandi hai.

We are forever trapped in controlling things we can’t instead of focusing on what makes a business tick.

VK: I believe that individual stock investors operate from a particular edge. That’s what allows them to do better for themselves. What advantages do individual investors have over institutions, say Mutual Funds?

AK: So, let me state it upfront that investing in equity through mutual funds in a disciplined manner is very good for your financial future.

However, mutual funds do suffer from a few problems

Mutual Funds are in the size-game. They get more fees if they manage more money. This is fine, but the problem arises because mutual funds get measured by the returns they make in the last 6/12 months.

Investors are ruthless changing in funds. So, fund managers are more concerned about where the stock price will be in the next 12 months rather than what if I hold this stock for 5/10 years – can it become 10 times?

Also, if you observe, mutual fund managers change every 2/3 years – they either get fired or get promoted and move out.

So, the fund manager is again looking for the stock which will go up in the next 12 months, and at all costs avoids stock which is down because of temporary reasons, but may go up 10 times in the next 5/10 years

How many mutual funds have held an Eicher Motors or a Page Industries for 10 years?

When it comes to you as the individual investor, the single biggest advantage you have is patience – i.e. your investment time horizon. E.g. Do you think Asian Paints is going to be the biggest and the best paints company in India 10 years from now in 2030?

If the answer to your mind is yes, then why do you have to bother about the impact of Coronavirus on the Indian economy and how many people are not going to paint their houses in the next 12 months? In fact, you will probably buy more of Asian Paints if its stock price happens to fall in the next few months, you are in a position to buy more of Asian Paints unlike a mutual fund which is worried about how many people will sell my mutual fund if the NAV falls more in the next 3 months.

The individual investors can let his winners ride and create an orbital change for his own portfolio.

The individual investor can treat the game of investing as test cricket – you are free to leave most of the deliveries (stocks), but when a full-toss comes you aim for the stadium. When the opportunity is so good that you have a high probability of making huge money, you put in large money. Such opportunities were presented in 2013, 2009 and also back in 2001-2002. Investors who showed courage and invested wisely during these years, reaped large benefits.

Institutions suffer from a problem called “institutional imperative”. Suppose the mutual fund portfolio is unconventional and they go right, then everyone gives the fund manager awards, but what if his unconventional goes wrong?

The fund manager is fired from his job and probably never gets another job anywhere else. Thus, fund managers always buy “safe bets”. How can you go wrong buying Reliance Industries or a HDFC Bank?

If you just look at the holdings of mutual funds, every mutual fund owns HDFC Bank, SBI, Reliance Industries, Asian Paints, L&T. What they are doing is – “I don’t want to be wrong”. If I give negative returns to investors, I will just say – “Everyone has given negative returns, I am no exception”.

Mutual Funds are not aiming for the stars, they are doing just enough to not get fired from their jobs.

VK: Well, that was hard hitting. But you are right. Spare a few good ones, most mutual funds exist only to make money off investors. Amey, you are a stock investor and advisor. What led you to become a stock investor and then also an advisor?

AK: I am investing in the stock markets since 2006.

I read the book Intelligent Investor by Benjamin Graham in 2007. And then an interesting thing happened in 2008. Warren Buffet says that the best thing that ever happened to him was that he got rejected by Harvard and ended up learning investing from Benjamin Graham at Columbia University.

Similarly, though my CAT score was 99.3 percentile, I did not get an interview call from any of the IIMs and ended up studying for my MBA at MDI Gurgaon. There I met Prof Sanjay Bakshi who is India’s Benjamin Graham and learnt investing from him.

Investing was a hobby and a passion, but I never considered it as a career choice back in 2010 when I completed my MBA.

In fact, in 2005/2006 during my engineering days, bidding for the 4000 MW ultra-mega power projects was my dream. That was also my motivation to do an MBA so that I could work on the techno-commercial side rather than just the technical side of the business which I did for 2 years with Siemens Ltd immediately after my engineering.

After completing my MBA, I worked with corporates like Jindal Steel & Power and Larsen & Toubro. In fact, in 2013 when working for with Jindal Power Ltd. I prepared the bids for two ultra-mega power projects – these are 4000 MW power plants with an investment of Rs 25,000 Cr each.

So, its true what they say – be careful of what you dream about, because your dreams have strong chances of coming true.

When work would get hectic and weekends would be spent in office, I would imagine my ideal holiday as a day where I do nothing else but just read a book.

Then, on one fine day in 2015, my friend told me – Amey you keep talking about stocks and keep telling us stories from the books you have read, take my Rs 20 Lacs and invest the money for me. I will pay you fees so that I can also hold you accountable.

And this is how I got my first client.

Then over the next year the entrepreneurial seed germinated in my mind. I had made some money in the 2014 bull market and had the financial muscle to start out on my own. It was also the right age – I was in my thirties neither too young, nor too old for going full-time into investing.

So, after completing more than 9 years in corporate life, I turned a full-time investor and a portfolio advisor in Feb-2017.

And today, I do spend the entire day reading – books, annual reports, biographies of famous people, financial history.

VK: For the reader, what is the way to succeed with stock investing? Who should even try to invest in stocks? Are there some specific traits that one can identify to know that they will make a successful investor or not?

AK: Successful long-term investors distinctly tend to have certain common traits.

Stock market is a game of regret. Lose money – regret, don’t make money – regret, make little money – regret because others have made more money, make a lot of money – regret why I did not make even more. Successful investors know when to stop.

Ability to make mistakes and not to curse yourself for it. Learn from mistakes, sure, but don’t crucify yourself

Being ok with a lost opportunity.

You see, my friend had told me in 2018 to buy Bajaj Finance. I did not, saying it is too expensive. He borrowed money and bought and the stock went up from Rs 2,500 to Rs 5,000 while my portfolio was down.

I was still ok. I will always make money in some other stock, some other opportunity.

Doing your own research and having your own conviction – one will never become rich on borrowed wisdom. Yes, sure make some money on a few trades, but never make it BIG.
Ability to see other people getting rich faster than you.
Ability to change your mind with changed facts/circumstances.
And last, but not the least – to make a lot of money in long-term investing, one has to be an optimist. Sure, don’t play blind, but one must have an optimistic attitude especially towards the economy, country and businesses and human ingenuity.

To summarize, people who have what is called as an “Inner Scorecard” have it in them to succeed in the stock market.

Thanks Amey for all the insights. I am sure the readers too will benefit from your journey and experience.

More about Amey: He is a full-time investor and also help people make money through investments in the Indian equity markets.

He loves reading books on investing, psychology, biographies and business books.

He has a 5-yr old son and makes it a point to play amongst young kids for an hour every day to help relax, have some fun and get inspired by the enthusiasm and energy of young kids.

You can follow Amey on Twitter

[Note: All stock names used in this interview are as examples and for educative purposes only. They are not recommendations to buy or sell.]

And now, Amey and I are happy to bring to you the Wealth Compounder Direct Stocks Portfolio on the smallcase platform. Read more about it here.