Learnings from the book “The Thoughtful Investor” by Basant Maheshwari {Part 2}

April 4, 20194:10 pm

Following up on my last blog ‘Learnings from the book “The Thoughtful Investor” by Basant Maheshwari {Part 1}“‘, the next part of the book covers many “How t0’s…”. Let me take you through some of them.

Learnings from The Thoughtful Investor

How to find the next trend?
learnings from the thoughtful investor
Learnings from The Thoughtful Investor - Steps to identify the next trend

Some more indicators to identify the trend:

  1. Stocks that start hitting new highs before the indices are expected to continue their winning run in the next bull market.
  2. The public should have a disbelief in the business model of the companies: Unexpected profit and sales growth. Eg HEG, Sadhana Nitrochem, etc
  3. In order to spot the trend is to check whether the business has done well in other parts of the world. Most of the new businesses come to India do so after already established in the developed parts of the world. For eg. IT boom of 2000-01 in India had followed similar trends happening for the past few years in the US, similar was the Real estate boom of 2003-08 etc

Learnings from The Thoughtful Investor ​

1. A good business is one that purchases on credit & sells on cash.

Credit purchase: Plenty of competition amongst suppliers

Selling on cash: Buyers are weak & Dispersed

Trade payable >> Trade receivables

2. Basant Maheshwari in his book ‘ The thoughtful investor’ emphasizes that Mindshare capture is most important than market share capture.

Mindshare capture: Pull strategy- Customer comes looking for the product

Market share capture: Push strategy- Pushing products through lucrative pricing, better distribution or advertising

With mindshare capture, market share capture automatically happens. This is more suited for consumer-facing companies.

3. Companies selling low ticket price items forming a small % of consumer disposable income have it easier to increase prices. For examples, a drug manufacturer will have a higher ability to increase prices than a car company. Car purchase can be delayed by a year but not medicine.

Mergers & Acquisition

Most often than not as the empirical evidence suggest M&A does not add to the expected benefit for the Acquiring company. It is the shareholders of the acquired company, that gets benefited the most.

Many might not be aware that most of the M&A are done to project cosmetic beautification to the world. Either it is done to show growth or for CEO’s ambition to prove that he is working or to increase in size of the company and remain in the limelight.

Evaluating Management

During the bull market, the management quality gets ignored but towards the end of the bull market, it starts getting prominence and it won’t take much time when you lose all the gains in a very short period.

1. Avoid companies with high debt. High debt if not serviced properly can make the company go haywire.

2. Avoid companies with a lot of subsidiaries.

3. One needs to evaluate the management salary with respect to the size of the company.

4. The issue of warrants at a discount to the price in the stock market is a red flag.

Number Manipulation

He lists out several ways one can find out if a company is fudging its numbers:

1. If a company has a lot of cash on its book, then it should be earning a minimum 4-5% of interest income. If that is not the case, it is most likely to be fictitious. 

2.  A company which is overstating its profit will avoid paying dividends and instead show the increased earning being used to purchase assets.

3. Any company which is always looking to raise funds both through equity or debt by frequent equity dilution or debt addition needs to be looked into carefully. With debt, there are numerous ways to manipulate the numbers. 

“A company that is debt free and not diluting equity is not in the process of cooking its book”

4. Increase in Inventory or receivable without a corresponding increase in Sales is a red flag unless there is some reason for the same.

5. Lot of subsidiaries and a lot of related party transactions is a very easy way to hide the sins. That should be looked into. In the market, we have so many standalone companies doing great business, why should one want to complicate their life by buying such complex companies. Also, one needs to understand that the market loves simple standalone businesses.

6. Frequent changes in accounting methodology is another red flag especially in case of inventory.

Learnings from The Thoughtful InvestorWhat to avoid?

1. If you are expecting for a stock to turn around, it should be better to buy once the stock has turned around rather than buying anticipating the turnaround to happen as there are a lot of challenges involved in execution which we might not be aware of.

2. Avoid a company that keeps on diversifying into the unrelated sector. It takes away the management focus.

The market pays a higher multiple for pure plays. Eg. the recent diversification by the Textile company Raymond into the unknown territory of Real estate is a clear case of unrelated diversification.

3. If the valuation of the company increases much higher than the size of the total market opportunity, it is a clear sell.

4. Cyclical stocks report record earnings and expansion plans when the cycle is in full swing and then aggressively expand but later goes into distress when the cycle turns. Here timing of exit is very important.  Eg: Steel companies expanded mindlessly in the 2000s with the steel prices remaining elevated but with the prices dropping after the 2008 crisis, these companies got sold recently under IBC. 

5. If the management of the company interacts too much with the press giving projections, it’s better to avoid such companies. Great returns are created by companies where there are no expectations. 

Some more learnings from the thoughtful investor:

1. The market pays for sudden surprises than for known expectations. 

LARGER THE SURPRISE LARGER THE RETURN.

2. When you invest in a debt-free company, you have complete and clear ownership of the company.

3. Stock price is a slave of earnings.

4. Exceptional company should be able to grow faster than the market and the competitors taking away the market share.  Example- BEPL, a small-cap stock has gained market share from its larger peer Ineos Styrolution without diluting the ROE.

Companies gaining market share by diluting its ROE will face challenges in long term. Eg. Pantaloon retail

5. Companies with a high gross margin and a low net margin are more likely to experience an expansion in margins. An example would be of the textile company Himatsingka Seide ltd which is increasing gross margin by backward integration and hence higher gross margins. But the interest expense eats away the profit. But gradually as the interest amount decreases, the PAT will start showing growth.

learnings from the thoughtful investor
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Shekhar Yadav

I am a full time stock market investor. The blog is an extension of my research, thoughts & opinion. Please don't consider anything on this website to be an investment advise.

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