At the Morningstar Investment Conference held last week, Shankar Sharma had the audience from the word go. The vice chairman and joint managing director of First Global, not only has amazing stage presence, but he also gave the audience a lot of meat of chew upon.
He titled his presentation: Four Easy Ways to make VC-type returns in the listed market. He explains: The reason I gave that title to my presentation is because I'm not good at venture capital investing. Anybody's story I hear, I say: How is this possible? How will this happen? I'm skeptical by nature and I specially find startups hard to digest. But I still want to make the VC returns. So, my method focuses on the listed market where you can hopefully make something similar to VC kind of returns.
The stock picking strategy...
My view on investing is that 80%, maybe 85-90%, of investing success is luck. But that 90% won't work unless you've done that 10%. I'll explain what to my mind constitutes that 10%, which you need to have done to get the 90% to work for you.
It takes a lot of guts. It takes a lot of conviction. It's very scary. But above all, it requires a lot of deep thinking, a lot of data. It requires an understanding of psychology. What is the market thinking about this stock? Trying to read the mind of the market.
Here are some of my success stories.
In February 8, 2001, we had a strong buy on Amazon at $15 and the title of the report was 'The Truth about Amazon's Liquidity.'
In Amazon, Mary Meeker, who had been Morgan Stanley's analyst at that point, was a big cheerleader for the Internet sector. She released a report stating that she is throwing in the towel on Amazon. When I read that, I knew I was on to something. Because usually that is the bottom of the market for a particular stock. When we did the numbers, we found that Amazon had turned free cash positive in that very quarter when the lead analyst for that stock is saying this company is going to go bust. We did the math and we saw that the company had made $139 million in free cash in that quarter. For a company going bust, $139 million of free cash is telling me that somebody's math is wrong here.
We got into a call with Amazon - Jeff Bezos and his CFO. We told them, don't tell us anything forward looking, just confirm whether our math correct or not. They confirmed. That was enough for us to know that we are on to something very, very big here. The bankruptcy risk which was weighing Amazon down was gone and the beginnings of a big trade was born.
In 2001, we picked on Apple when it was at a price of $19 and the market cap was only $6.7 billion. Net of cash the market cap was $3 billion; the market cap was less than Infosys Technologies back then.
Apple launched the iPod. Our back-of-the-envelope calculation showed that based on the figures for Sony Walkman, it could be a reasonable hit. This was in 2001. In 1996 or 1997, the stock was at all-time lows. Steve Jobs was struggling. Apple was in a loss, at that point in July-October 2001. When we say great managements, it is always in hindsight. At that point, he was the worst management in the entire hardware industry.
We were the first in the industry to have identified IndusInd Bank at a price of Rs 46, which was about the book value of the company. It was the cheapest of private sector banks. Risk/reward was terrific at Rs 46, the book value I think was Rs 40. The market cap of the company then was Rs 1,400 crores which is about two-quarters of profit now for this company.
They then had a management change. I rationalized that the new management cannot mess up compared to what the previous one had done. So even if they improved a little bit, and being in an attractive sector, it would be good. This is a limited competition sector. Banking licenses are not doled out like broking licenses. So, within an overall good sector we found a good stock at an amazingly cheap valuation. It was makings of a good trade.
The common threads when identifying multi-baggers:
1) The stock must be at multi-year lows. That is the momentum part, but we look at negative momentum where a stock has had negative momentum for years. I'm not talking months, but years.
2) The stock should be preferably loss or near loss making. Bharat Shah has been consistent with his method over the last 20-25 years. He has not wavered from buying quality companies at a reasonable price.
On the other hand, we have never wavered from buying trash companies at an even cheaper price. But you need to be consistent. You need to have patience. Whatever be your method.
3) Within its own industry, the weight that this stock occupies should be at the lowest-ever level. Raamdeo Agarwal very correctly said that the index is a game of manipulation wherein over-hyped companies because of high market caps make their way into it and the companies which have actually slid in terms of market cap are removed from it. Usually, you will find that those are the tops and the bottoms for most of those stocks. I remember in 1999-2000 they included four tech companies - Zee, Infosys, Wipro and Satyam made their way into the Sensex, and were pretty much the top of the tech market for probably a decade.
So, it is a game of bad selection. But that is the way the indexes work.
We look at it in the reverse. We are looking at a company which has the lowest weight it has ever occupied in its own sector. And if you see in retail Amazon was its all-time low weight, Apple in the hardware industry was, and IndusInd Bank wasn't even in the reckoning as a meaningful bank back then.
4) With the first three being in place, watch for just one spark. It could be anything.
Apple’s trigger was the launch of the iPod.
For Tata Motors it was the new JLR launch. When I saw the cars I thought that they are sufficient for it to get X market share from a very low base. If they get their market share, the numbers that I came up with was $500 million of profit. So, it was a big swing from $1 billion loss to a $500 million profit.
Management change in IndusInd Bank was the trigger.
Cash flow turnaround in Amazon.
So, stock all-time lows. There is some spark that comes through. Then you have the makings of a real absolute out-of-the-park six.
5) I look at what the sell-side is saying, especially for well-covered stocks. And if almost all are negative, that is usually a big positive as far as our thinking goes.
The luck factor...
We identified stocks to invest in. We got into the trade. But, nobody could tell you how far those stocks are going to go. That - is only a matter of luck. Even Jeff Bezos never thought his company would be worth $400-500 billion. Steve Jobs had no clue that his company would even survive and later on be worth $700 billion. I doubt if the management at IndusInd Bank thought that one fine day their market cap would be what it is now. That part is luck.
So you can get into a good trade. You can make a bit of money. But to make 100x, that promoter's luck and his luck chart has to be extremely strong. Hence I stated at the start, 90% is purely luck.
