Seven Intelligent Fanatics from India

Yesterday, I delivered a talk titled “Seven Intelligent Fanatics from India” at Value Investing Seminar, Trani, Italy.

None of the stocks of companies run by any of these seven entrepreneurs were recommended for purchase. Nor am I recommending them now.

I know that some of you may disagree with me about the conclusions about some (or even all) of the individuals profiled by me in my talk. However, I do not wish to get into a public debate on the subject. Think of what I said as my own personal views please.

Why did I choose these seven or only seven? Well, I had only 20 minutes to deliver this talk (I actually took 21). And I chose the ones I was more familiar with. To be sure, there are many more intelligent fanatics out there.

The reason I am publishing this is to help investors understand that: (1) an intelligent fanatic has the ability to turn what looks like a poor business into a very good one; and (2) the force (I call it “fire in the belly”)” of an intelligent fanatic, when combined with a good business, has a tendency to produce what Charlie Munger calls a “lollapalooza” outcome.

You can get the transcript of the talk from here.

Interview with Ian Cassel of MicroCapClub

I became a twitter follower of Ian last year and have enjoyed interacting with him on that platform, and through email over the last few months.

Ian runs MicroCapClub in the U.S — a forum meant for microcap value investors. Over the months, I have enjoyed reading up the materials posted on that site. But even more interesting has been receiving Ian’s wisdom through his wonderful tweets. Here are some of them:

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These are just some of Ian’s tweets that I loved. There are dozens of others. Follow him on twitter and learn from his wisdom and experience.

I am overwhelmingly in sync with Ian’s thoughts on investing, some of which are expressed in his tweets above.

A few weeks ago, Ian persuaded me to answer a few questions for an interview which you can read from here.


What is Staying Power?

A few days ago I asked a question on twitter: What is Pricing Power?

Yesterday, I asked another one: What is Staying Power?

I wanted to illustrate the power of focused thinking by “letting your mind wander.” What happens when you think about an idea and that idea only from multiple points of view?

Well, you get insights you wouldn’t get if you were distracted by other ideas.

Staying power is a very powerful idea. But where does it come from? The common answer I get from people is that it comes from a strong balance sheet. But that’s only part of the answer.

You have to keep asking where else does it come from. And one way to find out is by asking where does a strong balance sheet come from?

The insights gained through focused thinking on a question and that question alone produced some answers which I think will be useful for you. These are listed below. Remember that this is not an exhaustive list but is a pretty good first attempt to answer the question.

Business Model

From the vantage point of a business model, staying power comes from:

  1. A product or service that will not be obsoleted for a long time – usually these are things that serve basic human needs and aspirations.
  2. Multiple sources of revenue streams.
  3. Low customer concentration risk.
  4. Low supplier concentration risk especially when dealing with critical raw materials.
  5. A business which does not derive its key advantages from political clout.
  6. Slack in the form of un-utilised capacity especially in case of industries when most money is made during periods of shortages.
  7. High customer switching costs (financial or psychological e.g. in brands)
  8. Solid entry barriers which prevent a business from a competitive attack that can destroy it.

Corporate Culture

From the vantage point of corporate culture, staying power comes from:

  1. Willingness to cede market share when irrational competition drives down potential returns – and in the extreme case exiting a businesses.
  2. Refusal to invest in a business which deserves to die – i.e. not throwing good money after bad – and conserving it for productive uses.
  3. Unwillingness to bet the bank on a single idea – intelligent risk management as part of the DNA of the firm (including avoidance of gambling in the garb of risk management through derivatives).
  4. Willingness to make multiple small bets to grow the business so that no single bet or a group of bets, if they turn bad, can destroy the business.

Ownership Structure

From the vantage point of ownership structure, staying power comes from:

  1. Rich promoters who will, when needed, add financial strength to the business by infusing their own cash when no one else will (usually happens in family run businesses)
  2. Controlling stockholders who support investment for future prosperity instead of treating the business like a cash cow (although doing that makes sense in many circumstances)
  3. An ownership structure which, when combined with a great management team, creates stability for the firm e.g. through non voting shares (e.g. Google)

Balance Sheet

From the vantage point of balance sheet, staying power comes from:

  1. Low or no debt levels whether on or off balance sheet.
  2. A liquid balance sheet.
  3. Presence of non operating assets that can be sold for cash to save the business when needed.
  4. Absence of other encumbrances e.g. litigation that can drain resources or managerial focus.
  5. Low short-term debt, especially during cyclical downturns.

Profit and Loss Account

From the vantage point of P&L, staying power comes from:

  1. Size of revenues – generally speaking large businesses have better ability to withstand economic shocks than smaller ones.
  2. Multiple sources of earnings.
  3. Pricing power.
  4. Low cost advantage over competition so when industry conditions worsen the others suffer a lot more than you.
  5. Flexible cost structure – the ability to shrink the business without losing profit margins – low operating leverage.
  6. Low financial leverage as reflected by low interest cost in relation to earnings available to pay interest.
  7. Low economic depreciation – coming from a business that is not very capital intensive, and one that is not prone to become obsolete soon.
  8. Significant discretionary spending which can be curtailed during really bad economic and industry conditions – e.g. advertising.

Cash Flow Statement

From the vantage point of cash flow statement, staying power comes from:

  1. Low interest and principal repayments in relation to operating cash flow.
  2. Low maintenance capex and maintenance working capital needs.
  3. Ability to fund even growth and maintenance capex with internal resources.
  4. Low dividend payouts.

The Investor

From the vantage point of the investor, staying power comes from:

  1. Large number of years left to invest.
  2. Ability to handle volatility through financial strength – low or no debt and significant disposable income preventing the need to liquidate portfolio during inappropriate times.
  3. A frugal nature.
  4. Ability to handle volatility through psychological strength.
  5. A very long-term view about investing.
  6. Structural advantages – investing your own money or other people’s money who will not or cannot withdraw it for a long long time.
  7. Family support during tough times.

Creative thinking can be taught. It can be learnt. It requires deliberate practice. One of my favourite tools for creative thinking is Creative Whack Pack — a pack of cards that make my creative juices flow. Buy these cards. The author also sells them as an app for your smartphone. Buy the app. Here are a few cards I used for this particular exercise. Creative Whack Pack - Be Dissatisfied

Creative Whack Pack - Let Your Mind Wander

Creative Whack Pack - Change Viewpoints

Creative Whack Pack - See the Big Picture

Creative Whack Pack - Look Somewhere Else

This post is the outcome of the efforts of many twitter followers. Thank you.


ET Phones Home

Shailesh Menon of The Economic Times called me at home a few days ago and persuaded me to speak to him for a profile he was doing on finance academics in India who also practice value investing.


Clarification: Quoting unnamed sources, the profile refers to a number of businesses I own. As of now, that’s not an accurate reflection of reality.

Implications of the Coming Capex in Coal

I wrote this mail to myself after reading several articles on the coming capex in coal and thought of sharing it with you.

Begin forwarded message:

From: Sanjay Bakshi <sanjay.bakshi>

Subject: Very balanced article on India’s dependence on Coal

Date: 27 May 2015 17:47:06 IST

To: Sanjay Bakshi <sanjay.bakshi>

Apart from huge investments in solar power, India is going to see huge expansion of coal mining capacity.

Abundant and cheap energy could make many businesses vulnerable to disruption (e.g. genset, inverter, and battery manufacturers). Overall, I am very cagey about investing in businesses that generate or store energy. But there will be other businesses which will benefit from this huge capex – businesses which facilitate the capex or benefit from that capex.

The idea is analogous to what Ralph Wanger calls “downstream effect.” Here is an extract from one of his interviews which I quoted in an article I wrote for ET in 1997.

“The airline example was a good case of a transforming technology. The jet engine was a terrific invention, and General Electric and Pratt & Whitney and Rolls Royce, I suppose, made reasonable money making jet engines. But for every dollar the jet engine manufacturer made, probably the airline made more. And the airline customers turned out to be the big beneficiary.

A good reason the western United States grew rapidly in the last 40 years was the jet plane. It made travel very practical… So the concept of transforming technology is that the big money is downstream…

…The railroads transformed the United States in very dramatic ways. The guys who made steam locomotives and railroad cars made some money, but you may not be able to name the major makers of locomotives, because they barely exist today…

…As you go downstream the dollars spread out. Now you probably can name the railroads that made a lot of money buying the steam locomotives and using them to build the railroad industry. The railroads made some good money. But the people who made even bigger money were the people along the right of way who could use the railroad to develop mines and factories and cities. So the guys who owned the silver mine here in Aspen saw the value of their mine at practically nothing before the railroad showed up, because they couldn’t ship the ore out on a practical basis without the railroad. But as soon as the railroad showed up the mines became economically profitable, the city grew, and the people who owned the land and built stores made a lot of money…

…Another example – one that is the most obvious and the most lasting trend is the whole idea of electronics, computers, communications, and information processing of all sorts. Here your transforming technology is really the semiconductor. It made computers practical, it made telephones much cheaper. All of the things you didn’t have in your house you can’t get along without today. Things like your cellular phone, your fax machine, your PC, your e-mail and your phone mail.

…Well until a few years ago I would guess the amount of money made by the American semiconductor industry was zero. There are many companies that made some money, but there were many companies that went out of business and made no money at all. Now everyone remembers how well Intel and Motorola have done, but they’ve forgotten about the Fairchilds and dozens of others who started barely and failed. Some of them took a lot of money down with them.

Intel was the exception. But when you think about the amount of money that Intel has made, I think you would easily find that Intel’s customers made more. The people
who are making real money on it are people like you. The reason you are in business is because of cable TV. That is a new technology and has enabled people to sell blue jeans and pantyhose to millions that they couldn’t have reached otherwise. And it needed electronics to make it possible. And we’ve made a whole lot of money owning cable TV stocks than we ever would have owning semiconductor stocks.”

One should think both upstream (businesses that benefit from supplying goods and services to facilitate the capex that is coming) and downstream (businesses that benefit from cheap energy – a cost benefit they will be able to retain because they have a moat).

Key questions:

  1. Which businesses will benefit from being facilitators of this capex?
  2. Which businesses will benefit from being beneficiaries of this capex?

Seven Patterns of Inefficiency in Pricing of Quality Businesses

Here are some of broad patterns of inefficiency that I have encountered over the last few years of practicing value investing in better quality businesses:

  1. The market’s inability to appreciate the probable future value of higher quality businesses with very long runways (something I covered here);
  2. A niche business which is doing something remarkable but it belongs to an unremarkable, largely unprofitable, commodity-type industry and the market is failing to make the distinction;
  3. Mispriced B2B businesses which are enormously profitable but remain below the radar because, unlike B2C businesses, their output doesn’t show up in the final product or service;
  4. The market’s inability to spot an emerging moat that is growing slowly over time (the “boiling frog syndrome”);
  5. The market’s inability to forgive an entrepreneur “learning machine” who has learnt very important lessons from his or her past mistakes and is unlikely to repeat them;
  6. The market’s propensity to misunderstand the integrity of an entrepreneur;  and
  7. Because of its intense dislike of conglomerates, the market’s inability to treat as exceptions, the great capital allocators who create well-managed, and highly profitable diversified conglomerates over time.

There are several other patterns that play out in classic Graham-and-Dodd style cigar butts but the above list pertains only to patterns that I could identify with in better quality businesses misunderstood by markets.

I am not citing examples because I don’t want to talk my book. Nevertheless, some of you may find this framework useful in two ways: (1) It may help you relate what you already own to one or more of these patterns; and/or (2) It may help you find new opportunities which conform to one or more of these patterns.

Note: Among other things, this post was inspired by a wonderful excerpt I recently saw from “Margin of Safety” by Seth Klarman in which he writes:

Necessary Arrogance
“At the root of value investing is the belief, first espoused by Benjamin Graham, that the market is a voting machine and not a weighing machine. Thus an investor must have more confidence in his or her own opinion than in the combined weight of all other opinions. This borders on arrogance, the necessary arrogance that is required to make investment decisions. This arrogance must be tempered with extreme caution, giving due respect to the opinions of others, many of whom are very intelligent and hard working. Their sale of shares to you at a seeming bargain price may be the result of ignorance, emotion or various institutional constraints, or it may be that the apparent bargain is in fact flawed, that it is actually fairly priced or even overvalued and that sellers know more than you do. This is a serious risk, but one that can be mitigated first by extensive fundamental analysis and second by knowing not only that something is bargain-priced but, as best you can, also why it is so. You never know for certain why sellers are getting out but you may be able to reasonably surmise a rationale.” [Emphasis mine]


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