Value Pick r

8/13/2019 Value Pick r

1/12

Donald

Profit booking/Exit decision

Well, the idea is to exit/book profits as soon as your targets are met. Assess if it can

still double form here within the next 2-3 years. If not, you are better off taking it outand putting it in the next opportunity that can compound at 25% plus CAGR. If nothingcan, i.e. markets are way overpriced, you better stay in CASH and wait. Mr D can wait

endlessly I can't get him excited at all .

In 2008 I did not have access to Mr D or others. I had no experience of a bear market,like most others who started in 2005 or so. Consequently, I have a pretty poor track

record of exiting in 2008 - I stayed invested, completely, throughout the mayhem...with not much pain...BUT huge huge Opportunity costs!

So, from what I have assimilated so far(understood, but way to go in practice):

1. Short Term Portfolio : You start booking profits once your targets are reached. ThinkPondy Oxides, Rs 30-45, our 50% appreciation target happened in 1 or 1.5 months. Ibooked 20%, saw it ride to 60, booked another 25%, touched 70...sold another 35%,and back at 65...exited completely. Veterans have told me...just as you get in slowlyand keep betting more as conviction builds, exit also slowly never at one go...so youcan ride most of the way...never wait to cream it off fully, either!

2. Long Term Portfolio: Whenever my target of doubling gets met, I must book profitsif I think the stock cannot double from here again within the next 2-3 years. Take thecase of Mayur Uniquoters (it has corrected with overall market) it had almost doubledform my entry of 230, but it had not got over-expensive, the valuation gap had ceased.

In my books Mayur can keep compounding at 30% for next 3 years. I agree with Hitesh,anywhere around 370-380 is a good price for additional buys (may be re-entry forhim!).

2008 like situations - where everything is primed for one big fall. You better conserveCASH. if your picks have been right, then you would have met your targets anyways,and would not find anything that will compound at 25% CAGR

That's only the theory. I have to see how well I can stick to the discipline!

Item Practicaluse/Application

Examples from our ValuePickr PortfolioExperience

1YrForwardPE

Apart from a forwardview on the business,this is the only sure-fire way to get rid ofprice-anchoring.

When I first looked at Mayur it was available~6x at pre-split 240, think in Feb '11. Wevisited Mayur and came back highlyimpressed. Good results came and stockhad climbed to 360-400 by July/Aug I think.


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(Eternally thankful toAyush for planting thisfirmly in my head - inearly 2009/10)

Towards year end it was back to 300-320levels...our calculations showed 5-6x 1 yearforward and we loaded up again. Fewmonths down the line at 400-440 levelsagain we found 6-7x 1 yr fwd and again

loaded up - by the 3rd time we bought Ithink the fab dividends had started. For thefirst-time I was rid of price-anchoring forgood. (Of course it helped that I was in lovewith the business).

I found when we have done detailedhomework to our satisfaction, and weregenerally comfortable with Management-speak and walk-the-talk, and could projectwith a degree of certainty (+/-10%

tolerance), I could apply it successfully toother businesses. My entry price ceased tomatter!

Hitesh

Donald,

Coming to the points put up as a checklist for looking at a company

Business Quality-- This should be relatively easy. We should be able to ascertainwhether quality of business is great or not.

1. Is the business suitable for long term investing? Is there ample opportunity forthe company to grow its business at a smart pace over the next 3-5 years?

2. Does the business entail excessive capex? And does the capex generatesufficiently high returns to justify efforts to expand?

3. Is there any possibility of govt interference creating problems with the prospects

of the business?

4. Is the business sensitivie to raw material price volatilityis the business suchthat price hikes can be passed easily?

5. What kind of business are we looking at? Is it a sunrise sector(agri, water andwaste water management, cloud computing, biotech etc), or a steady growthsector(consumer, fmcg) or a neglected sector(capital goods, infra space)? Many a


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times it happens that todays sunrise or a steady business is tomorrows neglectedbusiness.

6. How are the majority of companies in the sector doing? If most of them aredoing well then it should be a good business to invest in.

Management Quality -- Here there are a lot of subjective opinions possible. Essentialquestions one asks are

1. What kind of promoter holding is there? Any excessive pledging?

2. How have the management handled the companys growth in past few years.Whether they have taken unnecessary risks/debts etc. Whether any bets taken by themin the past have paid off or failed?

3. Does the management have the hunger to grow?

4. How are the shareholders been rewarded? Dividend payment and high dividendpayout ratio is a very big plus for investing in small cap companies bcos that assuresme that the profits reported are for real.

5. Some usual antics of managementswhether they allot themselves convertiblewarrants and dont convert?? Whether they sell their holding at opportune times inopen markets? Whether they are likely to take the minority investors for a ride with thecash in the bag?

6. Management remuneration? Whether it is justifiable?

7. How do they answer investor queries at AGMs or other interactionplatforms? Whether they walk the talk? Whether they promise less and deliver more?Or the other way?

FUNDAMENTALS: We at valuepickr seem to be good at this.

1. Starts with the growth or lack of it. Kind of growth shownfast, medium, slow??

2. Whether growth if any has been achieved by resorting to too much debt orequity dilution?

3. Return ratiosROE, ROCE etc. I dont need to elaborate on these.

4. Any chances of sudden change in fundamentals for better or worse? Is thecompany on the cusp of a phase of explosive growth? Or is the company at the peakearnings levels after which it is supposed to slow down/show degrowth?

5. Again dividend payout and especially increasing dividends with increasingprofits.


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6. Free cash generation or operating cash flows over past few years

Industry Position and Track Record

Here one asks where the company stands in the peer group. Most people want toinvest in sector leaders only and believe that only these create multibaggers. I beg todiffer here. There have been many instances where the sector leaders have reachedsuch a big level that there might not be too much space to grow? Here the smallernimble players with some kind of advantages make smart choice for investing.

And whether the company we want to invest in is growing at higher than industryaverage? If so what seperates it from others? Any advantages/niche?

GROWTH PROSPECTS:

This should has been covered earlier in fundamental analysis itself so does not needtoo much elaboration. But I would be wary of companies which keep growing their

profits without significant increase in the sales figures.

VALUATIONS

I think all of the above factors may be considered in evaluating the company and thenthe valuation part begins? What kind of valuation am I paying for getting thebusiness? Is there some flawed market perception which is giving me a chance toparticipate in companys growth at a very cheap entry point? What is the status of thegeneral market mood? Is it a bear phase/bull phase or sideways market?

What kind of market cap the company has and what kind of opportunity the companyhas to grow a few years down the line. And while looking at market cap it is veryessential to look at the Enterprise Value because only market cap is often a factorwhich is misguiding(. E.g Textile sector stocks)

THE ART OF VALUATION:

VALUATION ART #1

Mr D: All your stock picks are good but I can't help observing almost all of themare processor-type stocks.

Processor-types? What do you mean? Most of these are strongly differentiatedbusinesses with management having a good track-record at the helm - MayurUniquoters, Astral Poly Technik, Suprajit Engineering, Gujarat Reclaim, VinatiOrganics, Balaji Amines. They have been doing well too.

Mr D: Ya. But all seem to be taking in some input, processing that and sellingthe output. Not much value-addition don't you think?


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This time I am stumped. Even though I was always looking out for stronglydifferentiated businesses, I had to admit I hadn't thought about things deeplyenough. I countered, as long as these are growing strongly and are obviouslyunder-valued why shouldn't I be allocating more capital there?

Mr D: Maybe you should examine what is the valuation range accorded toprocessor-type businesses

Frankly till that moment I had invested zero time on finding out for myself -practically - what kind of valuations Mr Market awards different kind ofbusinesses. Let alone spend time thinking about it and the why's? And I wasalready completing 3 active years in the market (`close of 2011, I think), hadread all theMust-Have-Investing-Books,and been turning dozens of stocks!

Please tell me what's the range for my processor-type companies. I pleaded.

Mr D: Just check. It's rare to find Processors crossing 1-1.5x Sales in theirlifetimes. And do we have examples of businesses that add-value. Haven't younoticed Piramal Health being acquired at 9x Sales. There's a clue there!

What a clue that was, Sir! We got hooked to the next refinement in our -Separating the Wheat from the Chaff. We graduated from trying to identify"strongly-differentiated businesses" to identifying those with "High BusinessQuality".

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We started thinking differently about businesses. Even with most things beingequal, we realised there ARE a few things that mark out businessesas significantly more value-added, if you like. We graduated to slottingbusinesses according to business Quality.

B Category - Balkrishna industries, Gujarat Reclaim, Suprajit Engineering

A category - Mayur Uniquoters, Astral Poly Technik

A+ category - Ajanta Pharma, Poly Medicure, Kaveri Seed, PI Industries

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I can't think of any other input that has had as dramatic an impact on ourCapital Allocations, and subsequently Portfolio Performance, as this one singleinput.

VALUATION ART #2
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High Conviction vs High Undervaluation. Right!

Getting to grips with "High Conviction" was easy for us. All of us were capableof putting in enormous amount of homework/dig up data/local scuttlebutt/fieldreports to establish that. Hard work no doubt, but simple enough. No ART in

that .

Getting to grips with "High Undervaluation" was not so simple. This was mostlythe ART part!

How do I decide which business is intrinsically more valuable? It is easy forme to KNOW a ~5-6 P/E, ~30% RoE ~30% grower is a steal! But it gets morecomplicated when anything is available >10x - say 12x and 15x or more.

Mr D: Well, historical valuations do provide some pointers. But it is far moreenriching to think about it from a buyer of the business perspective. Suppose

someone has the 5000 Cr needed to buy out an entire business, which type ofbusiness is he going to value more?

Is he going to value and pay more for Mayur or Astral or Ajanta Pharma or PolyMedicure or PI industries or Kaveri Seeds? Think about it, and there lies theclue! And you will not find the answer from your Excel spreadsheets/ratios mindyou. (He knew about my exhaustive number-crunching excels )

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In many cases some of these businesses were growing splendidly. Some of

them outstripped others just by the phenomenal growth they were recording.

But if we were to have say all things being equal (say Execution track, Growthrecord, Management pedigree, Financials), two things became clearimmediately:

1.The lesser the number of variablesin the business, the greater are its ODDSof delivering consistent business performance. In essence, the more predictablea business is, the more valuable it is.

2. The higher the intellectual capitalbrought into the processes, systems andby extension the products/services of the company - the more valuable it is.

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No marks for guessing now that we started seeing why a PI industries should bemuch more valuable than the 12-15x it used to quote at. Same goes for a PolyMedicure at 12x or a Kaveri Seed at 10-12x, and an Ajanta Pharma at 12x!!


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Q: When do we say a particular stock is fairly valued/richly valued?

A: Some comments from my side. I will try to use ValuePickr Portfoliocompanies as examples. See if these help

1. Balkrishna, Suprajit, Gujarat Reclaim - are all well-managed manufacturingcompanies. With strong, capable managements that have demonstrated greatlong term record. However these are what I would call Category B businesses.There is cyclicality in demand, some years are pretty good, some years aretough, margins do come under pressure. Overall things sort of even outdecently achieving kind of 20-25% CAGR growth. But if you think about it,visibility is poor beyond the near-to-medium term.

Think about how Mr Market prices these kind of companies.

[Current Edit: If I remember correctly, all above were quoting ~10x or

thereabouts then, and we recommended an EXIT as we saw imminentdeterioration in business performance and found Valuations over-priced]

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2. Then there are what I would call Category A businesses. These are muchmore predictable. Size of opportunity is big. Demand visibility remains strong,you don't see a pattern of cyclicality and you CAN see them clocking highergrowth rates for a number of years into the future. Mayur and Astral may fallinto this category.

Think about how Mr Market prices these kind of businesses. Is there adiscernible difference in business quality between these 2 categories?

[Current Edit: If I remember correctly, all above were quoting ~12x orthereabouts then, and we recommended a HOLD. We anticipated steadybusiness performance and found valuations fair]

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3. Then there are Category A+ businesses. There is significant intellectualproperty involved. Once a certain size/profitability is reached and you have a

decent track record established, usually these kind of companies go fromstrength to strength. Can you see an Ajanta Pharma or a Poly Medicure there.Why not a PI industries? Perhaps a Kaveri Seed Company can reach there??

How does Mr Market usually price these kind of companies??


8/12

How are the odds of business performance stacked for thesecompanies??If you can see that difference clearly - that should give you someclues to differentiating among these businesses. And therefore buy, hold or sellclues too! if you can say whether Mr Market is NOW (12 months forward, 24months forward) valuing them cheaply, fairly or richly - w.r.t. that future

picture.

[Current Edit: If I remember correctly Ajanta and Poly Medicure were quoting~12x or thereabouts then, and we had recommended a BUY. We found thesemuch Undervalued]

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It is an ART form - BUT, the more stronger that ODDS (probable businessperformance) picture for you, the more parallels you can cite from studying MrMarket's preferences, the more businesses/stocks you get familiar with - the

better will be that Feel, and we believe the better will be your Calls.

VALUATION ART #3

Mr D: Time has come to become more aggressive. It's not enough to sort yourbusinesses into categories. Even within categories there is that one whichstands apart, you have a hunch probably is by far the best. You have to pit

your Portfolio picks against the other one by one, rank them all the waydown.

Now this was getting interesting and tough. We were being really challenged

and this got us thinking real hard.

Among Category A, we had to choose between a Mayur and an Astral for thelonger term. Remember that discussion (CheckMayur Uniquoterthread aroundSep/Oct 2012, for pointers). Similarly we had to rank Poly Medicure, AjantaPharma, PI Industries and Kaveri Seed in category A+ businesses.

We evolved the Conviction Rating (CR) and Valuation Rating (VR) models guidedby Mr M as illustrated in ourCapital Allocation Framework.We modeled CR on 5parameters - Business Quality (BQ), Management Quality (MQ), Fundamentals(FM), Industry Position & Track Record (IPTR) and Growth Prospects (GP), andassigned weights to each.

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We went on to sub-parameterise each of BQ, MQ, FM, IPTR and GP that allowedus to think more deeply about why one business may be ahead of the other. Ireally needed this logical breakdown effort to think more
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intelligently/deeply/comprehensively about businesses and found it extremelyrewarding - because for the first-time many incremental aspects (that MUST beincluded) got ingrained consistently into my thinking/decision-making (via themodeling ).

In no particular order : such as Equity dilution track, ability to fund growth,reducing debt with growth, incremental return on capital, RM volatilitycorrelation to OPM, consistent reduction in working capital, management depth,attractiveness as an employer, self confidence - doing things differently, faircompensation, sector attractiveness - market fancy, and the like.

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We presented our full-blown model to Mr D within a month. He was prettyimpressed and complimented us on the novel way in which we had attacked hischallenge with gusto. I remember he said we had exceeded his expectations ,

but this is only a good start, no more. All the credit for the modeling goes to MrM - without him we couldn't have done some justice to Mr D's challenge in soshort a time!

Mr D: We are not done yet. Every time you have a new prospect for thePortfolio, it must find its own slot/ranking at least one notch above the leastranked. It has to dislodge at least one of the existing - adding to the bottom ofthe pile, isn't much use, right .

This seemingly innocuous challenge (new entrant must dislodge at least onebusiness from current perch on the ladder) perhaps has been the most

rewarding for us. While our mental models may yet be half-baked, this one testhas ensured the quality of ValuePickr Portfolio hasn't deteriorated, not yet atleast .

Never cease to be amazed by Mr D! His sophistication and his clarity! His never-waning enthusiasm to see folks like us reach the next level.

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We had made a good start. This is a PROCESS and we had just got started on anexciting process . Refinements are incremental, we have miles to go!Everyday there is new learning.

Repeating the processover and over again, having the disciplineto stick tothis regimen, doing it every time with full honesty and integrity(no lip-serviceplease) - maybe there lies the clue to UNDER-PAYING!! Consistently!!

Origination of A+, A, B Kind of companies


10/12

I had sent out a query to some senior investors. Here's the query and a brilliantthrought-provoking response received from a very respected senior and VP well-wisher.

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Sir,

Need guidance - to take our ART of Valuation discussion forward. [Link]How do the best investors think about the right valuation for an emergingbusiness (and therefore the gap) before consensus emerges about thatbusiness in the market?---------------------------------------------------------------------------------------------------------

In Mr M's words

I sort of mentally slot where the stock belongs to - what I call as (C) Laboriousstocks (B) Average stocks and (A+) Smart stocks.

The origin of doing so has something to do with school or hostel days where allof us have classmates of different types.

You have very studious and extremely hard-working guys who generally do wellin a class directly proportional to their study hours, night-out effort and time.Rank toppers & gold medalists generally come from this segment. Mostdisciplined & regimented guys also come from here. Some of the dumbest guysare also placed here because of family & peer pressure etc. they keep slogging

with poor results. All these are Laborious stocks Type C. They typicallyconstitute 20-25% of the universe.

Then you have guys who are average studying types, will make same mistakeswhenever faced with a googly question in the exam or viva. General tastes,fashion, fads etc. You wont find any Sachin Tendulkars here. Theseare Average stocks Type B that typically constitute 60% of the universe.

Then you have few who study little but are actually much sharp, fast graspingpower, excellent subject understanding of fundas and output they deliver inrelation to the inputs gone in . Im referring to only fair study means, noshortcuts or hanky panky stuff. These are Smart stocks Type A+. They maynot be rank toppers and sometimes they can even be laid back but myexperience shows they have done fairly well in life (not always in conventionalsense of the word). May be when you think back, youll find some real lifeexamples.


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It is this Type A+ Smart stocks that I always look for when scanning emergingstocks that are yet to arrive (in terms of markets institutional discovery andconsistency of results) but have some advantage. Scale up, Network effect andexpanding of moats are easier to achieve with this Type C stocks.

Pardon my saying but most of your ValuePickr stocks are the Laborious typesincluding Manjushree, Vinati, Mayur, Balkrishna, GRP, Indag, Astral etc andeven Kaveri that you are putting in A+ category. There is nothing wrong inbeing with laborious stocks and with right traits they make very good money solong as they preserve their traits just like gold medalists and most disciplinedguys display. Mayur is a case in point. HDFC bank is a very laborious stock andvery disciplined at that, so they can be really rewarding if you find them earlyand they themselves dont goof it up.

Ajanta Ill not comment as I dont understand it well.

I can slot PI in Type A+ where results can be disproportionate.

Last year, Alembic was a very easy Type A+ and we made an easy kill there,doesnt always happen. Two Type A+ that Im betting on at the moment are JBChemicals and Accelya Kale, though from much lower levels. One Type A+where Ive probably gone wrong is IL&FS Investment Managers.

While dealing with Type A+ Stocks, one important caveat is that managementquality & integrity should not be suspect. Second is when analyzing such astock, we should be looking at the outcome of big would-be picture. Third is weshould have a handle on the right metric to value such a business, not

necessarily the PE or PB.--------------------------------------------------------------------------------------------------------The term Processor stocks never occurred to me thus far, but its a nice wayof looking at it and they are a subset of Laborious stocks.

Discl: I have no position in any of the stocks mentioned above, except for thelast 4 named stocks. On Laborious stocks, to take the cricket analogy forward,I'm reminded of Australian fast bowler - Glen McGrath who can keep bowlingthe same outside the off stump nagging line to the batsmen the whole day - sodisciplined and so immaculate. If VP stocks are those Glen McGrath, I don'twant to give an impression that these stocks will not be good vehicles to ride,as historic CAGR shows they have given superlative returns, and may continueto do so by all means.

Donald -

My takeaway from this analogy is that we should look for companies which havelaid the building blocks for disproportionate future growth. Laborious stocks


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will produce a rupee worth of incremental growth for the extra rupee ofincremental input. It is not a one to one relationship but an extra rupeewouldn't produce two rupees of incremental growth in this category.

Smart companies will produce disproportionate growth. This is a moat type

company which will be able to rapidly expand because of its brand, IP ornetwork.This is not very different to smart( moat as one is usually born thisway) students who have a great grasp of the fundamentals and can combinediverse disciplines to answer complex problems. PI and Polymedicure clearly arein this group. Having built the base e.g Poly medicure can have adisproportionate growth if some large OEM order comes in. Another stock to beincluded in this category is Amararaja. It has done the hard work of building adealer network and brand building. It is in the process of expandingcapacities.It will capture a larger part of the market share with lesserincremental effort as in a two cornered fight, the spoils to the winner aredisproportionate.

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