The article was also published on MOI Global at https://moiglobal.com/key-learnings-from-2020/
Warren Buffett’s animated series “The Secret Millionaires Club” has a catchy tagline, “The more we learn, the more we earn.” We are on a journey to learn and earn!
An important consideration is that the biggest returns from compounding are all back-ended. Warren Buffett made his first Billion at the age of 56. All the remaining billions he has made, and many more that he has given away, have been accumulated from that first billion at the age of 56. Similarly, what we do in our future years will have an even bigger impact on what we achieve.
Hence, we should continue to learn and improve. How do we learn continuously? It pays to listen to Charlie Munger, “I know I’ll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn.” The lessons below are our efforts at rubbing our noses in our mistakes. Hopefully, we will remember them better.
The best time to buy a stock is when there is blood on the street, even if the blood is your own
March of 2020 left most investors bloodied and bruised. There was no place to hide. We were no different. We would wake up, see our holding go down another x% for the day, and return to bed. The next day was no different.
My wife rightly diagnosed that I wasn’t sleeping well. I knew I was not. However, I told her I was sleeping soundly not to spread the panic I was feeling inside. Everything that we owned was in free fall.
Many investment managers I spoke to during March told us they have moved 50% of their portfolio to cash or are in the process of raising cash to a very high proportion. Most investment managers also talked about another down leg in the coming months.
Such market moves and responses from investment managers left me numb. Yet, when we looked at our portfolio holdings, we saw something totally different. Expected returns in many of our holdings looked unbelievably good, even under pessimistic scenarios.
Our investment approach gave us the courage to be active buyers with our cash. I am glad we did. It helped us do much better than the benchmarks.
Of the various stocks that we bought during the March period, we put out a thesis for a few in the public domain. The thesis on KRBL was presented at the MOI Global Asian Investing Conference and submitted to Sumzero in late March and early April. We were already invested in KRBL when March came. However, when the stock tanked, we loaded it up. It has worked out very well so far.
A good business and good management at a bad price is not a good stock
The ten-year bull market in technology stocks has fuelled the narrative that investing is about finding good businesses and management. Price doesn’t matter.
Trees don’t grow to the sky no matter the soil and the care with which they are looked after. Similarly, a company won’t keep growing forever at very high rates, and prices matter. Resistance can come from unknown quarters, including government policies, the company’s bureaucracy, industry development, the business environment, or even a virus!
We had such an experience with a company called Piramal Enterprises in 2018. We liked the management of Ajay Piramal, who is a good capital allocator. We liked that they are going into business areas with much white space and a long runway. However, as the business performed, the price ran far ahead of the fundamentals.
We knew that the price didn’t justify the fundamentals. However, we were intoxicated by what could happen a decade out rather than what could happen in the next few years. Mr Market gave us a whacking and a lesson that we will try to remember for the future.
The misplaced craze for compounders
Another narrative developed with the bull market is that one needs to find Compounders and hold them for multiple decades. This narrative discusses how FANGAM (Facebook, Amazon, Netflix, Google, Apple, Microsoft) has rewarded its shareholders. However, the narrative misses how many such “perceived” compounders have also failed in the past. Think of Nokia, Yahoo, General Electric, Myspace, and many more.
Unfortunately, compounders are only known in hindsight. However, one must manage the portfolio for the future. Thus, buying and selling a stock should be done based on our assessment of the business prospects and the valuation. It should be done irrespective of the activity’s tax consequences and frictional costs.
Ian Cassell wrote an interesting article recently in which he talked about portfolio turnover as the price of progress. He mentioned, “Peter Lynch had a 300% turnover per year in the early years of the Magellan Fund. Joel Greenblatt had a similar turnover at Gotham Capital. Even Warren Buffett’s public company portfolio ranged between 50-100% turnover per year during his first three decades.”
We had carried low turnover as a “badge of honor” in the past. However, over time we have realized that low turnover is not the goal, good returns are!
Portfolio allocation is key
Unless one actively guards, many trifles get collected in the portfolio, which doesn’t add much to the portfolio but takes away a lot of time. It is essential to eliminate them as soon as one realizes that there are trifles in the portfolio.
We realized that while our portfolio grew multi-fold over the last seven years, we had not proportionately increased our buying/selling of the position to account for the increased size of the portfolio. Hence, we ended up with a sub-optimal allocation to positions.
We instituted a simple rule to correct for the above: There will be no position in the portfolio unless it is >1% of the portfolio. The only exception is if the position is being actively sold, being actively bought, or if we want to “watch” it closely.
To some, 1% may seem too small a position. However, conviction in a new position comes with time. So, we will take baby steps in a new position and gradually build our conviction over time.
Diversification versus Concentration
One of the key investment questions is the concentration level in one’s portfolio. When we started, we preferred a concentrated approach, with most of our allocation in the top ten positions. While there is no correct answer, our thoughts continue to evolve here.
We now prefer a diversified portfolio for the same expected return-risk profile of securities. This viewpoint reflects our experience that occasionally, stocks move wildly without a corresponding change in the business outlook. Having a diversified portfolio allows us to take advantage of these moves.
However, we will not diversify our portfolio for its own sake. New positions must provide a compelling return-risk profile to get into the portfolio. We need to be comfortable with our understanding of its business and management. Lastly, we metaphorically ask these positions to justify “why they should be in our portfolio?”
Mistakes are a sign of progress if you are learning from them
In 2018 we beat the indices (but not our internal benchmark) but in 2019, we underperformed the index. We are glad that in 2020, we are out of the woods, beating the industry benchmarks and, more importantly, our internal benchmark.
2018 and 2019 gave us a lot of opportunities to think about and learn from. While many lessons outlined here remind us of the corresponding pain it caused, we are glad we went through it. We are even happier that we talk about them with our investors and improve ourselves and (possibly) our investors through that.
If we take the proper lessons from life and invest, the inferior part of life is the “earlier part.” Ray Dalio puts it succinctly, “Pain + Reflection = Progress.” Charlie Munger elaborated, “Any year that passes in which you don’t destroy one of your best-loved ideas is a wasted year.” By Charlie’s measure, we have been on a fruitful journey!
Dare to be different and right
Too many investors and institutions run towards positions that have done well recently and out of positions that have gone down. There is no denying that momentum in stocks is alive and well. Understanding who is buying and selling stock and why can provide essential insights.
However, insight into a stock’s incremental supply and demand is only a start. It is even more important to understand the business, management incentives, and competitive landscape.
IDFC’s stock price had gone only one way since 2010 – down! Nobody wanted to talk about it. It was a pariah. Most investors were selling it as soon as they were getting even! Due to the fall, the stock turned compelling, drawing our attention to it.
Our investigation found that Management was hugely incentivized, and management talk and action had been consistent. There was a regulatory trigger point as well. In June 2020, we wrote a thesis on why we like IDFC on Sumzero. We also gave a few talks – talk1 and talk2 – in which we briefly discussed IDFC and other ideas.
So far, IDFC has worked out well. It is up more than 100% since we put out the thesis 7 months back. Being willing to be different and right can be very rewarding! However, being different also entails the risk of being wrong. We have the scars to show for our audacity. In the words of Lou Brock, one of baseball’s best players of the late 1960s, “Show me a guy who’s afraid to look bad, and I’ll show you a guy you can beat every time.” We don’t want to be that guy!, you are a long way home. Finding the right spouse is 90% of it.
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