A new dimension of survival of the fittest doctrine in the world of investing
The world of investments has enamoured countless individuals and produced the most competent and intelligent investors worldwide. Though this profession is sought after for its incredible returns, perks, glitz and glamour as portrayed in popular media, in reality individuals fail to reckon the countless hours of study, analysis, deliberation, debates and discussions involved in final investments decisions. Pure fundamental investments are where real wealth is created and this has been time and again proved by the performance and wisdom of successful investors like Warren Buffet, Benjamin Graham, Charlie Munger, Philip Fisher, Peter Lynch and many more.
A little word on the contributions of these master
investors.
Benjamin Graham has been a mentor to Warren Buffet. He has
made immense contribution to the world of investment with his books, most notably
the ‘Intelligent Investor’ that is considered as a bible to investing. He is a
proponent of value investing and quantitative fundamental analysis. He stresses
on the concept of margin of safety when buying stocks. This essentially means
buying a stock at a discount from its intrinsic value hence reducing the
chances of major losses in case the stock doesn’t perform well.
Furthermore Graham advocated diversification of a portfolio
within and across asset classes. He proposed to take advantage of market
volatility to get best value eg: buy during market downturn and sell at good
times.
Warren Buffet the oracle of Omaha has been a highly
reputable figure in the world of investing and is a disciple of Benjamin
Graham. Buffet is known for his nuggets of wisdom like adopting an owners
mindset whilst investing in a company and the concept of investing in a
business that has a strong moat or competitive advantage. His idea of adhering
to your circle of competence i.e. invest in businesses that are easy and
comfortable to grasp and understand, is a critical step to contemplate whilst
studying companies. He is a proponent of the phenomenon of compounding that is
the ultimate recipe of creating long term wealth if invested in a good quality
business.
Buffet’s business partner and friend Charlie Munger has played a pivotal role in refining Buffet’s investment practices by introducing him to take a look at businesses from a qualitative lens (i.e. quality of management, quality of business) than just scrutinising a businesses based on its quantitative aspects. Munger promoted the idea of buying wonderful businesses at a fair price and giving up buying fair businesses at wonderful price. He emphasised the idea of independent thinking and decision making (carrying out your own study) and avoiding herd mentality. He has been an advocate of life long learning and having the ability to constantly learn and acknowledge personal biases whilst making investing decisions.
Philip Fisher has created a mark in the investing world by introducing the term ‘scuttlebutt’ i.e. collect data about a business from all its stakeholders ( competitors, customers, suppliers, employees, research analysts or industry experts) to analyse and scrutinise a business, an innovative form of due diligence apart from the usual quantitative due diligence. He also advocated a buy and hold strategy for good quality businesses. In his book Common Stocks and Uncommon Profits he shares his 15 stage strategy to identify star businesses. He lays emphasis on the qualitative factors of a business for instance studying its industry, its competitors, its right to win, management team, it products or services, it ability to invest in R&D (to constantly innovate), its organisational structure and much more.
Peter Lynch is another celebrated name in the investment world and has made his contributions. He was also a proponent of the PEG ratio to value businesses. He promoted the idea of writing down a thesis for your investment so you don’t get clouded by your own psychology biases and judgements of others or event that occurs in the external environment. He stresses on investing in high growth niche companies.
In the world of business, innumerable businesses are at war with one another. At the end the businesses that survive the test of time are the ones that innovate, are flexible and adapt to the changing competitive landscape, consumer behaviour, technological innovations, the economic and geopolitical scenario. These businesses that survive for decades or centuries are clear examples of the survival of the fittest in Darwin’s theory of evolution.
The theory of survival of the fittest plays a humongous role in many different fields and investments is one of them as well. The investor has to be adept to respond to the changes in the external environment and refine his investment portfolio accordingly to survive the uncertain business environment.
One Indian investor has gained fame for his intellectual contribution to the world of Indian equities. Pulak Prasad has studied and taken a holistic view of how investments work and married the concepts with Darwin’s theory of evolution. He has created a customised concoction of investment strategies to invest in the Indian markets using the investment theories of legendary investors mentioned above and the theory of Darwin.
‘What I learnt about investing from Darwin’ is an exceptional repository of teachings to invest in the stock market for the long term fundamental business investor. Pulak Prasad enlists and discusses about how he and his team at Nalanda have conceptualised a chronological framework via which they filter out companies and take a deep dive into evaluating companies that are worth to invest in. This enticing book can be synonymous to being called the bible to invest in the Indian Stock Market. It is an absolute delight to read the book and every reader will not only learn about investing but also learn interesting facts about biology and the parallels drawn between the two fields.
Prasad enlists a series of quantitative and qualitative
factors that can be applied to drill down on the most deserving companies.
Let’s have a look at some of these interesting concepts.
Prasad firmly states that he and his team judge a companies
quality by studying its past performance eg: 10 year history of the business.
The past ensures that the company is reliable and its performance over time
highlights its ability to function and perform well over time.
Monitoring the historical ROCE of a company can highlight numerous positives aspects of the business. A high (around 20% or more) historical ROCE indicates a good quality of the management, essentially highlighting the management’s execution capability to deliver superior products and services compared to competitors, manage their cost structure, allocate capital wisely, attract and retain employees, ensure continuous innovation by taking calculated risks and maintaining a quality balance sheet. He introduces the concept of robustness of a business suggesting its ability to evolve according to changes in the external environment as well as internal changes that take place in an organisation.
- Has a fragmented customer and supplier base
- has no debt but surplus cash
- Has strong competitive barriers
- a stable management
- Is a part of a slow growing industry.
Prasad shares his views on how to avoid risks in investing. He lists certain pointers and situations to scrutinize whilst studying and investing in businesses.
- Avoid investing in turnaround businesses
- Avoid businesses that have debt
- Ignore businesses that are M&A junkies
- He prefers to investing only in established industries
than new age ones
- Avoid companies that ignore shareholders interests
Prasad introduces the concept of proximate causes and ultimate causes used in biology but uses them as a metaphor to apply to investments. Proximate causes are short term in nature, unpredictable in nature and hence can be ignored whilst making an investment decision to buy or sell. Albeit, due to human nature, individuals tend to react to these causes due to sheer panic. Proximate causes include macro-economic conditions (wars, changes in monetary and fiscal policy, geopolitics), market movements (market corrections) and investment in thematic themes. Thematic themes essentially mean industries that are hugely in favour because of euphoria. Multiple industries over the few years have garnered investor interest such as: EVs, fintech, edtech, AI, renewable energy, biotech, food delivery etc. These businesses are usually valued in billions whilst their revenues may not be even touching millions due to extreme investor frenzy that a certain industry will perform phenomenally in the future.
Ultimate causes refers to paying attention to the fundamentals of a business. Tracking if the business performance is declining due to temporary factors or permanent factors (i.e. serious issues at the business level). Some red flags that signal declining fundamental performance include: constantly declining market share over subsequent years, lack of innovation at different levels of the organisations, issues regarding the management team, not being able to respond to change in customer behaviours and not reacting to changes in the external environment.
Prasad sculpts the concept of GKPI- Grant Kurten Principle of Investing (taking inspiration from a biological study by Grant and Kurten)- buying high quality businesses with strong fundamentals during short term fluctuations in the market caused by proximate causes. This essentially implies taking advantage of market corrections when there is a fall in equity prices and de-rating that ultimately create a conducive environment to buy high quality businesses at fair prices. After all proximate causes are temporary in nature and seldom shaken the fundamental strength of a business.
Prasad mentions about being aware of dishonest signals. These are signals that are not costly to produce eg: press releases, management interviews, roadshows, earning guidance, face to face management meetings. Honest signals are costly to produce for instance the past operating and financial performance and reputation of a business amongst its stakeholders i.e. scuttlebutt
He gives an interesting twist to studying businesses in industries that are new in the Indian market, he introduces the concept of convergent investing. He suggests studying businesses using examples of peers that have a similar business model operating in another country. For example in the case of new age businesses like Zomato, investors and analysts studied the business models of American or Chinese counterparts to understand the business models and decide on relative valuations for the business.
Prasad promotes the idea of finding good quality business and then staying invested for the long haul to reap the benefits of compounding to exponentially multiply wealth. He suggests scenarios where an investor can decide to sell a business: if there is a major corporate governance issue and decline in governance standards of the business, wrong capital allocation by the management and irreparable damage to the business.
Prasad has made a commendable contribution to the world of investing by sharing his insights and perspectives on how to utilise investment principles and theory of evolution to identify high quality companies and create wealth over time.
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