Mr Market is driving us crazy. I think most investors have this on their mind, this feeling today as they look at the huge disconnect between rising stock markets and a yet to recover economy coupled with the flood of ‘massively oversubscribed’ IPOs.
If you are already invested in stocks or have money waiting to be invested, you have gone from ‘numb’ in March 2020 to ‘numb’ again in August 2021.
What should I do? Or, what should I NOT do?
Well, I reached out to the person who can dispel this dilemma – Amey Kulkarni. He has always been generous in sharing his wisdom and insights related to investing in a direct stocks portfolio. I reached out to him again to see what is his position on the current state of the markets.
He takes us through his learnings in the last year and a half, how to ensure that one makes money from stocks and more importantly, how not to lose money in stocks!
Let’s get started.
VK: From the lows and fears of March 2020 to the highs and the lesser fears of Aug 2021. As an investor, what lessons have you drawn from the past year and a half?
How have your own mental models / thought process changed during this course?
Amey: Investing in Corona times has been a very enriching experience.
Rather than change, it has reinforced my thought process and investment methodology. 2019/2020/2021 was the time to actually live through what we read in books about market bubbles and market crashes.
As a contrarian value investor, I buy good businesses run by honest and hungry management at reasonable valuations.
I think Dmart is probably amongst the top 3 best businesses in India. But, I just can’t bring myself to buy it at a PE ratio of 200. I try and buy good businesses which may be out of favour right now due to temporary problems which can be resolved or buy businesses where the market is not pricing in growth that will come in the next few years.
We had a severe bear market in small-cap and midcaps even before Coronavirus between Jan 2018 to Mar-2020. A lot of stocks that I bought in 2018 and 2019 either went down or did not go up for a long time. My in-depth study of these businesses and patience paid-off in 2021 when several of these stocks more than doubled from their original purchase price in 2018/19.
Let me cite three examples.
I first researched IEX (India Energy Exchange) India around its listing in Oct-2017. I did not buy it at the time because my perception was that it was too expensive for the potential growth that it held.
When I first bought IEX India in Oct-19, it was a small allocation (5% of portfolio) at that time. Around Apr-20, I realized that not only IEX India is a corona-proof business, but also has significant growth triggers in place. At this point, I increased my allocation to 25% of the portfolio. Today, this stock has become 3X of my original purchase price in less than 2 years.
Another example is Sanghvi Movers – the largest crane leasing company in India. Sanghvi Movers derived 55% of its revenues from the wind energy sector. Due to several well-known reasons, wind installations were down by 50% and Sanghvi Movers became a loss-making company. It also had very high debt even though the cash flow was good.
I estimated that in the next 2-3 years, wind energy sector problems will be resolved and a large portion of the debt will also be repaid. I first bought this stock around Rs 110 in Sep-2018.
Sanghvi Movers went down to Rs 73 in Nov-19 and to Rs 45 in Mar-20. However, today the stock price is around Rs 200.
I have made 20% CAGR returns on this seemingly “mediocre” business in 3 yrs.
I researched CDSL in mid-2020. CDSL had grown revenues at a CAGR of only 8% in the last 9 years ie revenues doubled 9 years after the previous financial crisis. I was also anchored to the fact that the stock price had fallen by 50% from Rs 400 in Jul-17 to Rs 200 in Apr/May-2020.
I just could not imagine the massive growth this business will see in the next 12 months. And when CDSL started showing this massive growth, I just could not believe it. I was too anchored to the low price and the low growth in subscribers / revenues over the last 10 years. Actually, I under-estimated the power of the internet, lockdowns and discount brokerages like Zerodha, Upstox, Groww had on the increase in number of investors / DEMAT accounts.
I never ended up buying CDSL and now think it is too expensive.
So, what are my learnings?
- Micro-economics of the business always trumps macro-economics.
When growth picked up at IEX, the stock price went up. The economic slowdown in India in 2019 and the 2020 Coronavirus pandemic could not prevent the business becoming better and stronger.
- Investment thesis needs patience to work out. Sanghvi Movers really tested my patience and conviction in the 2019 and 2020. All along, my investment thesis was on track. It was actually delayed by 12 months due to Coronavirus pandemic, but has eventually worked out after 3 years.
In fact, I was scared to buy more at lower levels when I should have. However, I am happy with the outcome because the conviction to hold that I got because of my research meant I made good money on Sanghvi Movers in 2021.
- Unless we are able to de-anchor ourselves from past prices, we will not be able to fully appreciate the future potential growth of a business / stock price.
VK: The oft repeated phrase by investors today is “markets are too expensive”. Is that true? What action does it call from an investor? Should she sell and go away?
Amey: Are markets very cheap – NO.
On the contrary, markets are high only if you compare them to the lows of March 2020. Let’s look at the events in India and the world.
- Massive printing of money in the US
History suggests, this results in a global economic boom
- China + 1 strategy.
The democratic world has come to realize that they cannot rely on China.
- Economic reforms in India over several years – GST, Bankruptcy code, RERA, farm laws, labour laws, disinvestment, etc.
- Ease of doing business – India’s ranking has massively improved.
- Reduction in corporate tax to 15% – This will aid a lot of manufacturing to shift to India.
- Low inflation, low interest rates
The perennial problem of the Indian economy has been expensive capital. Over the last 7 years, the high inflation / high interest rates problem seems to have been resolved. Lower cost of capital will significantly help growth.
Now, can the markets correct by 10% – 20%? Anytime and for no apparent reason.
The solution is not to withdraw from the markets and “book profits”.
In fact, I think booking profits is the worst thing that investors do in the investment journey. We earn for 35 years and invest for 50 years. Why have such a short-time horizon for your investment decisions?
The correct approach would be to now recognize that the next 12 months may not bring in the returns of the last 12 months.
Think of the market from a 3-year perspective. What additional money can you as an investor invest in the next 3-years? How much every year for the next 3 years?
Thinking this way will suddenly reduce the fear of markets correcting and also release the pressure from expecting too high returns in the short-term.
VK: OK, let’s say the investor does gather the courage to keep investing. But as markets surge, what mistakes a direct stocks investor is likely to make?
Amey: As of Aug-21, we are in a bull market. One needs to be mindful of not making the following mistakes in a bull market.
- Being under-invested
Bull markets are always preceded by bear markets. Those who lived through the bear market of 2018/19 lived through disbelief during the entire 2020 and most of 2021.
I fear many have actually booked profits and are sitting on very high levels of cash (>30% of the portfolio).
The way I am approaching this problem is that I have a set target of what portion of my monthly savings I want to invest in the stock markets. I am going to invest them over the next 3 years irrespective of whether markets fall or rise further.
I may not buy every month like a mutual fund SIP, but that portion of my savings mentally go the my DEMAT account to be invested when I find the correct stock at a price that I am willing to pay up for.
- Mistake short-term cyclical trends to be long-term growth engines.
When we transition from a severe market crash to the next bull run, lot of bad / mediocre businesses go up 3X / 4X for very valid reasons. However, only few businesses are able to sustain the growth momentum. Many of these 3X / 4X wonders will end up losing 30% in the next 3 years.
This is the time to be more realistic about future growth expectations and be careful to not over-pay.
VK: How are you investing in the current scenario? What’s your mantra for finding opportunities?
Amey: I am finding it difficult to find obvious opportunities.
It is no longer as easy as it was in May/Jun-20 to find obvious opportunities to invest in. However, investing is an ongoing process. There are 2000+ listed companies in India and at any point in time, there is always a bull market going on in one or the other section of the market.
I tend to practice the contrarian style of investing and buy into companies at prices where the downside is low and upside probability is high.
Having said that, I have not bought any new company in the last 4 months. There is a long list of “to-research” stocks on my calendar and it only means I have to work harder and search harder.
The formula of making money is simple – buy into companies where the most probable future growth is still not factored into the current market price.
This investment process is not bothered too much about market corrections. Of course, it is obvious higher returns are made when you buy during bear markets (when prices are lower) than during bull markets.
However, if you are buying the right business, it will not matter that much if you bought during bear markets or bull markets.
VK: Let’s talk about the favorite topic of the day IPOs. It’s raining IPOs and we recently had one of the most popular IPOs ever in India – Zomato. A loss-making company today getting listed on the market at a huge premium. The whole model of cash flow-driven, valuation based traditional investing has been shaken up. The value of intangibles seems to form a big part of startup valuations.
So, how do you see Zomato (an other such) as a business? Is it worth investing in?
Amey: Let us first understand how these new age businesses are different than older business models.
- Businesses like Zomato, Paytm, Policy Bazaar, CRED etc. tend to operate in a “winner-takes-all” type of a market. The winner is much bigger and much more profitable than the 2nd best.
- These businesses do not require too many fixed assets like factories, machinery, go-downs. In fact, their initial capital requirement is much lower than businesses like Reliance (Oil & Gas), HPCL (petrol pumps), Coal India (mines), JSW (Steel plants) etc. So, capital requirements are low.
- Customer adoption is very-very fast. E.g., it took more than 40 years for the electric bulb to reach everyone. The Apple iPhone was adopted across the globe in 4 months. So, many of these businesses acquire customers very quickly and achieve scale very quickly
After acquiring dominant status, it might become very difficult to compete with them – people become too habitual to using the app / service.
So, for winning companies sky is the only limit.
Now, coming to the loss-making part. My understanding of all these loss-making businesses is that they “can be profitable today”. If they stop spending on advertising and discounts, all of them will become profitable.
The downside is that they will stop growing at 80% to 100% every year. Till the time dollar VC money is available, these businesses will spend aggressively on new customer acquisition.
The best example is CRED. When CRED became a unicorn, many articles were written mocking its business model and the large losses it makes. However, these articles ignored the fact that India only has approx. 1 Cr people who have the real spending power. CRED has the access and the attention of most of these 1 Cr Indians.
CRED has data on the spending habits of these 1 Cr Indians. Most Fortune 500 businesses will pay anything to get this data.
Now, should one invest in a company like Zomato?
I would wait and mainly for two reasons
- Everyone wants to own the stock of Zomato today.
We want to buy these stocks when there are temporary problems and other people do not want to own them – so that we can buy them at reasonable valuations or during bear markets when stock prices are depressed.
- Investing is a game where we want to position ourselves in situations where probability of winning is high and impact of being wrong / losing is low
Most of these new-age businesses are right now in the “habit formation” stage. Right now, they are trying to change customer habits and they are not certain winners as of now.
At current valuations of Zomato, everyone is probably factoring in all the good things without factoring in the challenges any business faces.
VK: That’s an interesting perspective. What have you been reading lately? Any key takeaways.
Amey: Two books had a great impact on my investing in the last 18 months
- The Forgotten Depression of 1921 – James Grant
- Bull! – History of Boom & Bust 1982 to 2004 – Maggie Mahar
The US suffered a severe depression in 1921 – a full three years after the Spanish Flu pandemic of 1918. So, that pandemic did not have such a large impact on the economy. So, I thought why should Coronavirus have a large impact?
And the reason was simultaneous global lockdowns. However, unlike a war, no factories were destroyed, all productive assets were just lying vacant. Internet has drastically changed the world since the last pandemic in 1918. A lot of work can now be done online without leaving the house.
So, I was quite confident that this is not the end of the world – the businesses and stock prices will bounce back.
In fact, there was no Federal Reserve at that time, no money printing, no stimulus packages. This time in 2020, there was massive government and fiscal stimulus all across the globe which helped on economic and stock market recovery.
However, where I was also bewildered like many others was the pace at which stock prices went up. Here the second book – Bull! by Maggie Mahar helped a lot.
The tech bubble burst in 2000, however, many experienced stock-market investors were calling the market “overpriced” as early as 1996, a full 4 yrs before the actual bubble burst. This clearly indicated that we are not just afraid of market crashes, we also grossly under-estimate how high the markets can go.
In fact, the most popular blog post I have written till date was Is the stock market going to crash in Jun-20 exactly 14 months back.
This made me realize most investors including me were under-estimating the economic recovery and the increase in stock prices. We were being too early in calling the market a bubble.
Other than investing, I read “PV Narsimha Rao – Half Lion”. It is a fascinating book about our former Prime Minister. The contradictions in his personality and legacy, the difficulties he faced, the power struggles and the difficulty of enacting the economic reforms. It is a must-read for someone even slightly interested in economics and politics.
If I may summarise quickly, as an investor, I need not get scared. I must focus on finding the right opportunities and invest at the right price and keep my time horizon reasonable (at least a few years).
Well, I am glad to have you as my advisor and get you to do all the hard work. 🙂
Thanks Amey. This has been as insightful as always.