Among the list of books written by legendary foreign money managers like Peter Lynch and Benjamin Graham this book is particularly exciting as it is coming from an Indian money manager. It covers some of the most important parts of long-term, fundamental-based investing to succeed specifically in the Indian stock market. It includes anecdotes and interviews of some of the most popular money managers in India – How they did it? What factors they looked into before making an investment etc.
So this is a summary of what I learned from “Gurus of Chaos: Modern India’s Money Masters” by founder and chief investment officer of Marcellus Investment, Saurabh Mukherjea.
1. Read every single part of the balance sheet:
Most people tend to ignore things like ‘Notes to the accounts’, contingent liabilities, etc. Just like reading a story, go through every single part of the balance sheet, find a flow and try to connect it; rather than just reading the most important parts in a disjoint manner. Sometimes those few parts you think are important; are only important to you and don’t tell the whole picture. So, go through everything. This was the advice given by the founding Chief Investment Officer (CIO) of HDFC Asset Management, Sanjoy Bhattacharyya.
2. Promoters
Looking at promoters is as important as looking into the debt of a company. In the words of Sanjoy Bhattacharyya himself, “Character counts just as much as debt servicing ability.” So researching the habits and character of the promoters is very important.
3. Great companies can survive sudden surge in competition.
Sanjoy Bhattacharyya gives an example – He sold Glaxo SmithKline Consumer (NSE: GSKCONS) way too early thinking that Cadbury’s entry into the health drinks market will hurt GSK’s Horlicks. Cadbury even launched the new product at the cheapest price possible, but still wasn’t successful to take away Glaxo’s market share. Survivorship is one of the tests of high-quality companies.
4. When to sell a stock as per Sanjoy Bhattacharyya?
- Clear reduction in quality or strength of the company, thus reduction in earning power.
- Stock price exceeding your estimate value by a considerable amount.
- Assumptions you made while buying the stock, turns out to be unrealistic.
- When the value of your recent investment falls by 15% or more.
5. Quality of financial statements. How to determine if a particular company is publishing the true picture of their performance?
- Cash Conversion Ratio (Operating cash flow/Operating profit): Promoters often show strong operating profits in order to boost up their stock price. In order to check if it’s real, look at the ratio of CFO/EBITDA. If the company has a lower cash conversion ratio than its peers for a sustained period of time, then the stated profits may not be completely true.
- Cash Tax Rate: Amount of cash the company has paid as a % of profit before tax. Now remember this is not the tax payment shown on the profit & loss statement, this is the tax outgo mentioned in the cash flow statement. According to Saurabh Mukherjea, if the tax rate is significantly lower than 30% for multiple years, it should raise a red flag about the profitability of the company (He suggested “30%” by looking into the corporate tax rate of 34%, which has now been significantly reduced.)
- Loans and Advances: Keep a check on the ratio of loans and advances to shareholder’s equity. If the industry is not known for requiring high advances to customers and suppliers, but the ratio tends to be high for a long time; then the promoters may be siphoning off cash from the listed company to somewhere else which might not be in the best interest of shareholders.
- Identity of the auditor: Auditors are very susceptible to manipulation. So always keep a check on the quality of a particular company’s auditor i.e. how reputable is the audit firm? How much audit fees they charge? Is it too less as compared to that of its peers? How much non-audit fees (tax advice, payroll services, consultancy) they are paid? It should raise a red flag if it’s too high.
6. Margin of safety
Only buy when the share price is at least 30% below your estimated fair value.
7. When to buy a stock as per Saurabh Mukherjea?
- Only buy a stock if you understand it’s business model.
- Only invest in companies that can generate high cash flows and high Return on Capital Employed (ROCE) for a long period of time.
- Buy the company when it satisfies the above point and is also available at a price with a good ‘margin of safety’.
8. Mean Reversion
Great companies with long upward move in share prices, often tend to start faltering in terms of successfully investing that capital, thus dragging the ROCE down which in turn takes the share price down too. Saurabh gives an example of how Infosys’s (NSE: INFY) share went down by 20% because of poor capital allocation, whereas TTK Prestige (NSE: TTKPRESTIG) multiplied about 500 times (90% CAGR) by doing brilliant capital allocation.
9. One particular thought will never work for you all the time
As per Sankaran Naren, Chief Investment Officer (CIO) of ICICI Prudential Asset Management, with time you need to keep changing the way you judge a stock. He gives an example of how to check whether a sector is cheap or not – Look at the weightage of the sector in the index over a period of time. If he sees a very large weightage for a sector then he becomes cautious. Banks would fall in that category today; in 2007 it was telecom. He says market cap and weightage in the large-cap index is a great way to determine a sector.
10. Ask questions
Investor’s desire to buy stocks in fast-growing sectors often leads to destruction in wealth. Saurabh gives an example of the bull market which began in March 2009. In just 6 months, people bought nearly $3 billion worth of stocks issued by newly created power utility companies, just because of India’s growing power demand. None of them asked whether these companies have access to coal, or do they have any experience in managing power plants.
11. How to become a successful long-term investor? Here is Saurabh’s ‘Cheat Sheet’ for investment success:
- Have a realistic expectation of the amount of return stocks can deliver you.
- Frequently don’t look at the share price of your investment.
- Diversify your portfolio. A good portfolio should contain at least 15 stocks from a mix of sectors and different market capsizes.
- Always ask “What could go wrong?”. Focus less on the current stock price and more on the actual worth of that stock.
- Take it easy. Over-activity won’t guarantee investment outperformance.
- Set simple investment rules and keep following them. Don’t make investing complex.
So these were the 11 things I learned from the book. And full disclosure, any of the stocks mentioned above are not a recommendation; I am in no way a certified investment advisor. But what I can recommend is Saurabh’s book, you will learn a lot from it. You can find the book on Amazon and Flipkart.
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Your man,
SIR
