Some Thoughts on Roller Coaster Investing

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Published by fundooprofessor

I am Distinguished Adjunct Professor at Flame University, Pune. Previosuly, I was Adjunct Professor at MDI, Gurgaon, where I taught MBA students two popular courses titled “Behavioral Finance & Business Valuation"(BFBV) and Forensic Accounting and Corporate Governance (FACG) for many years. I am also Managing Partner at ValueQuest Capital LLP— an investment advisory boutique which helps its clients invest their capital in good quality businesses.

20 thoughts on “Some Thoughts on Roller Coaster Investing”

  1. Respected Sir,

    Thanks again for another insightful post and covering one more important and integral aspect of investing specially in mid/small cap cos. It gives a lot of confidence and inspiration to all the budding investors like me.

    Sir, I have a question and i will be really obliged if you can please take some time out to answer it or guide me to any source which you have posted earlier on the same topic (apologies for my ignorance). I asked the same question to you on your earlier post but I appreciate given the scarcity of time you have, it didn’t get your attention. My question is below:

    1) Extended Valuation: You have mentioned it as one of the reason of selling the stock in your portfolio. And in this post also you have mentioned to acquire a quality business only at reasonable valuation. I am struggling to get a reference point/benchmark for it. Does extended valuation mean the valuations at which your expected return based on your earnings growth expectations & an exit multiple of 20x (which is the maximum that you apply) becomes less than the bond yield (i.e. 10%)? If it is true then should we also not look at the end market growth potential of the company and if it is very high then probably taking an exit multiple of 20x becomes a conservative assumption?

    Thanks
    Mukul

      1. Thank u so very much sir for replying…This is exactly what I was looking for..Cleared all my doubts…It seems like your today’s post and the post you shared above, have come at the divine time to answer all my doubts that I was struggling with..

        Feeling really privileged to be taught by you at MDI…As happened with many people/ex-students, you have a defining role in shaping my future life and I am very grateful for the same…

  2. Respected Sir,

    A recent case in point is Kitex which has dropped ~30% from its peak in just one week. I hold the stock and it looked overvalued to me too. And to top that, its share in my portfolio (at the higher price) also looked on the higher side.

    I think the runway ahead of the company is long enough and there is only a very small probability that I will regret this decision. Still, I could manage to control the temptation only with great difficulty and, strangely enough, did not feel bad when the well-anticipated drop actually occurred (possibly because I felt good that I was right).

    Related to this experience, I wonder if one should (could) stick to this principle even when the share of the stock in one’s portfolio is much beyond what can be called normal?

    So, for example, let us assume my estimate of fair value of Kitex is 800 and it reaches 1040 (i.e. 30% above FVE) and has an allocation of 8% at that price. I decide to hold and see the price drop resulting into a loss of ~2% in my and it does not feel too bad. The question is whether I should (could) do the same if the allocation to the stock in my portfolio reached 18% or 28% or 38% at that price?

    Such anomalies do happen when one has a poor hit ratio and the best pick(s) got slightly higher allocation from beginning. My concern is that I would not have been equally strong / rational had the allocation been very high. My question is whether the same action would be termed rational if the allocation was actually that high.

    Thanks & Regards
    -Lucky

      1. Respected Sir,

        The question was not about Kitex or any specific stock for that matter. I just shared my recent experience with Kitex to highlight a general dilemma that can apply to any company with good fundamentals and a long runway ahead of it. It could be Infosys, Titan or HDFC Bank 10-20 years back or could be any of Symphony, Ashiana or many such promising ideas today.

        One always keeps a 30-40% margin of error in valuing of a company. The problem only gets aggravated for the steady compounding machines and one is almost always behind the curve . One might be conservatively estimating the FV to be a half or even a third of what it should ideally be.

        In my opinion, one would not worry about holding a seemingly overvalued great business if its share in the portfolio is reasonable (say less than 10%). But I wonder if one should (could) stick to this principle even when the share of such stock in one’s portfolio is much beyond what can be called normal (say 20% or 30% or 40%).

        So, in short, my question is whether this principle of enjoying the ride applies irrespective of the position size or whether one needs to limit the same by booking partial profits when *both* the extent of overvaluation and position size appear to be very high.

        Thanks & Regards
        -Lucky

        1. I don’t think in terms of fair value. I think in terms of expected returns. Pl refer to my lectures on Relaxo which I used as an illustration to explain how I do that. I revised some views afterwards and expressed them in a blog post titled “rules for buying and holding” are not the same. Read them please for guidance on this. Thanks.

  4. Sir Good Evening
    Can you suggest a book in easy to understand laymans language which traces the Rise and Rise of China in all sphere s of life,ie whether it is sports, military might ,infra manufacturing.How and When the transformation happened and the thought process behind it.
    Regards
    pankaj pant

  5. Sir,

    In your 2009 article ‘Keeping you out of trouble’ you talk about a resolution to avoid equities when they are historically expensive, say nifty pe close to 24(like now). The reason you gave was that all stocks fall in the brutal bear market that usually follows. Have your methods evolved from then and you no longer think such a resolution is valid and that it is better to be invested 100% in good stocks across the cycles?

    Krishnakumar.

    1. I believe that the 2009 article applies to deep value type of stocks. Quality stocks should be held regardless of market levels and should be sold only when their market cap gets into bubble territory. Am I correct Prof? 🙂

      1. Absolutely. The evidence shows that if you own a high-quality business you must worry about the overvaluation of the business, but if you own a mediocre quality businesses (acquired at a bargain basement price), then you must worry about overvaluation of the business AND overvaluation of the market. That’s because if the market bubble bursts, everything will fall, but quality will bounce back and future highs in such cases will be much higher than previous highs.That would happen because of outstanding fundamental performance over time.

        So, if you buy better quality businesses AND if you can think long term, then you have one less thing to worry about…

        So yes, my thoughts on top down asset allocation have changed as I have changed from pure Graham & Dodd investing to what investing in what I think are moated businesses.

        Am impressed that you spotted the change. 🙂

        1. Thanks, Prof. There’s an important lesson in this wonderful book http://goo.gl/MdTxed

          Another fabulous underwriting was that of Air Products stock by Reynolds & Company of New York on May 6, 1946. The offering comprised: 100,000 Class A shares and 100,000 common shares in units of one share each at $11 per unit; 150,000 common shares at $1 a share.

          As for you and me, $10,000 would have bought us 10,000 shares. Today those 10,000 shares would be 25,111 shares valued in 1971 at $1,450,000.
          I did not buy any. Four days after the Reynolds & Company offering, I wrote under date of May 10, 1946, a widely quoted market letter concluding, “Under the circumstances, retention of a fully invested position in common stocks would seem to be, like second marriage, ‘a triumph of hope over experience.”
          I could hardly have been more right on the market. The Dow-Jones Industrial Average reached its 1946 high of 212.50 before the end of that month, and then declined 24 percent. Not for nearly four years did the Dow-Jones Industrial Average get back to the level against which I had warned. But by that time Air Products stock had trebled in price and another opportunity to make $100 on a $1 investment had escaped me.

          The point I am trying to make, of course, is that even if one knew what the stock market was going to do, it could still be more profitable to forget it and concentrate on trying to find the right stock to buy. Some will argue, as I have argued for many years, that good timing plus good selection is better than either alone. But bear market smoke gets into one’s eyes and blinds him to buying opportunities if he is too intent on market timing. And the more successful one is at market timing, the greater the temptation to rely on it and thus miss the much greater opportunities in buying right and holding on. Like an explorer going down an unmapped river in a dugout canoe, the investor must keep alert for the signs and sounds that warn of an undiscovered Niagara Falls. But in the last 100 years most investors have not encountered such all-engulfing liquidation more than once or twice in a business lifetime. For the rest, if you are reasonably cool and skillful, history suggests you probably will do better to shoot the rapids in well-bought stocks than to portage around them in cash.

  6. Examples galore from my portfolio of yester years of the pitfalls of the popular notion of ” booking profits ” an amount of Rs 10000 or thereabouts which I have ( actally ) invested during years around 2000 in companies like CCLProducts , TTK Prestege ,Auro Pharma , etc etc… would have yielded tons of money

    1. Thanks for sharing your experiences. There are many young investors out there who I hope will benefit from the mistakes of the elders (including mine).

  7. Thanks, Prof. It makes sense. But can the recent rise in Wabco be attributed to the bull market, than the market realising the intrinsic value of the stock? Nowadays any decent company is going up, even after short term declines when the stock do not meet the quarterly expectations, which is absurd. What about buying when others are fearful, like 2009 recession, and selling when others are greedy, as in the current market? I doubt if the great companies will be able to hold on to the competitive advantage for multiple decades, as earlier. As buffett says, buy when others are fearful and sell when others are greedy.

    Also, how long is long term? What if the stock does not give adequate returns even if the underlying fundamentals look good. For e.g. HUL did not go anywhere from 2000 to 2010.

    1. If u read the doc carefully u will find that I wasn’t talking about “nowadays”. I used 3 year rolling period returns to illustrate the point I was making.

  8. Awesome lecture sir :). Really relate to the past experience, I had similar experience with Acrysil(purchased in 2012), and I for sometime stopped seeing stock market, and saw the stock up :). Not sure what I would have done if I would have seen the stock fall 20-30% earlier. But this lecture gives me strength to increase my capacity to hold the good businesses. Thanks

  9. Prof

    All the declines in the stock correspond to the period when the market as a whole declined. A lot of stocks, good or bad, must have have moved similarly.

    Again the rise in the stock price corresponds to the period when the mod cap stocks [ the whole bunch of them ] just took off. Again the good, bad and possibly even the ugly moved.

    It is interesting that when you check the quarterly earnings for the last three years [ link from economic times below ] nothing significantly changed except in the last quarter.

    I believes the case illustrates, that investors should not get too perturbed by the market movements – if you believe that the market will inevitably move up as it has done for the last forty years. I do not believe it illustrates any unique behavior of a “good stock” where we might benefit by holding on.

    I doubt any analyst [ other than a very brave exception] would have confidence in their analysis if the stock price declined to the extent WABCO [ particularly with the 60% decline] has done if the overall market was flat or moving up.

    Paresh Shah

    http://marketgraphs3.economictimes.indiatimes.com/charting/CompanyQuaterBarchart.aspx?companyID=22706&noOfQuarter=12&currencyFormat=1&columnName=afterDilutedEPSValue&Width=97&height=19

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