Thread by @sahil_vi

Time for a thread on things I have learned in last 1 year. My key takeaways, and also mistakes I made.

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1⃣ Predicting nifty levels and what broader markets will do is an exercise in futility

Nobody can do it consistently. This is because there are too many random variables (probabilistic outcomes) which control the level of nifty including but not limited to:

investors ease of access to money, federal bank action across the world, profitability of cos, demand, supply, extent of formalisation of economies, expectations of aforementioned factors and very broadly, the extent of innovation coming into the market

(eg: listing of zomato, nykaa, policy bazaar will certainly increase market levels in the interim). The predictions tell us more about the predictor than they do about the underlying.

2⃣ If the volatility of equity class scares the investor, there are a few different courses of action available to the investor
buy some hedges (which only serve to smooth the equity ride.

Net net you ideally (if options market is efficient) 1 should neither make nor lose money)), or control level of exposure to the market. In last month i was scared by the valuation of my portfolio so i decided to reduce the level of SIP i do monthly, working to generate some cash

A couple of bad Q results (idfcf and neuland) however have meant that overall PF valuations are starting to look reasonable again and possibly will continue to become more reasonable in next Q (will track this closely).

3⃣ Companies trading at high valuations have high expectations embedded in the price. This means that any quarterly biz volatility will result in severe derating. Why? I think of the investment class of each equity instrument as a layered cake.

Depth of the cake shows the depth of the research done by investor to buy the co. On the very top are the intra-day positional and momentum traders. Below that are Technofunda traders/investors. Below it are people who might be tracking financials (QoQ YoY growth).

Below that might be people who read research reports and 2nd hand material. Below that are people who probably started reading latest concall and IP.

Below that are investors who read many concalls of the company & its competitors, understand industry structure well & go above and beyond investor material by doing scuttlebutt and research into the unit products of the company (for pharma/chem it means EC filings ANDA & DMF).

Conviction also increases as one goes down the layers cake. The cake unravels itself at 1st sign of trouble. Fear becomes a self-reinforcing loop and LC cause more LC as people’s borrowed conviction vaporises in the absence of deep fundamental research.

1Q of bad earnings, 20-30% drop. 2Q of bad earnings, 40% drop. Neuland labs is best example of this. Will come to that later too.

4⃣ In trying to generate outsized returns, Valuations matter deeply.

Perhaps the current best performing company i own is RACL Geartech. A dull drab and boring biz which makes gears. No platforms. No API. No Chemicals.

In fact it sits inside an industry which was itself facing headwinds when covid started. And yet, RACL has been an almost 8 bagger for me since my initial buying. Why?

Because, it turns out, valuations matter.

More so if you can find a business which has some moats. A biz with industry leading operating margins of 20%, ROCE of 27%, supplying to all luxury 2W (and now some 4W) of the work, co-developing products with clients growing topline at 15% was available at a grand total 5 p/e.

Why?

Nobody wanted to own microcaps. Is this a travesty or not? I think it is. Now, granted that some of the granular details about biz were not known when i 1st invested, which is also why my conviction was limited, reality is stochastic and so was position size limited.

It was my largest microcap investment, but not my largest investment. It still isnt. Earnings grew 40% in last year. Return was 8x. Definitely, starting valuations matter. It must hit you on the head with a 4x4 plank. You dont need to do DCF when such an opportunity presents.

5⃣ Numbers and narrative need to align for rerating to happen. Valuations persist as long as numbers persist

So many examples to give here. Saregama, Vaibhav Global, RACL, Laurus, IDFC first (to some extent).

Right now Neuland is a counterexample because currently investors that are in panic selling mode do not seem to think numbers and narratives align. But what is also fascinating to see is that my layers cake model seems to explain some timewise corrections as well.

VGL is a great franchise with strong earnings power (David) taking away market share from a Goliath (Qurate) 20x its size every year. However, post pandemic, their sales growth accelerated to 25%. Will it slow down? Concern is very genuine and it is reflecting in market price.

Hasnt moved a bit since last 5 months. This includes 2Q of earnings growing at > 30%. From 60 pe it has come down to 40 pe. As people with higher growth expectations sell, people with 25% earnings growth buy in and stock doesnt move (as long as buyers and sellers balance).

IMO until all people who had earnings growth expectations of 40%+ sell out, it will undergo timewise correction. After which due to imbalance i expect it to start performing again.

Key take-away: time-wise correction & thus better valuations despite great earnings performance due to imbalance in expectations and reality.

Reasoning along similar lines, i fully expect a correction in saregama stock (timewise or price wise) when they start doing more content acquisition and low margin carvaan sales pick up with marketting spends (as economy normalizes post covid).

6⃣ To sell or not to sell. That is the question:

When pf companies like IDFCF, neuland, strides show poor quarterly numbers, an investor is faced with a question. An important question at that. Do i sell, or do i not sell.

How does one answer that? Why did i chose to hold 1st two (with intention to buy more at the point of high pessimism) and sell the last one? There are several factors but let us tease them apart.

(i) Admittedly, my conviction was higher for IDFCF and neuland to begin with. My investment in strides was despite knowing about commodity nature of large part of their biz (regulated market) and was due to stelis stake that i was expecting to get on demerger.

(ii) Investor has to figure out to what extent investment thesis is playing out and to what extent the poor results are optical/temporary in nature compared to the earnings power of the biz.

Both in IDFCF’s and neuland’s case, i am convinced my original investment thesis is in tact. If anything, investment thesis has been strengthened. Why?

IDFCF has practically confirmed something i had modelled and predicted many months ago in january which is that they are targetting 2% credit losses with 9% incremental NIMs.

Do you know who else has 9% NIM 2.5% credit loss combination? Bajaj finance. Most investors go by narratives, not numbers. Right now, narrative is being controlled by price which is itself controlled by short term/temporary pain. Im glad. Will load up, when time is right.

The VI exposure is also a temporary blip, if it does happen. Any informed IDFCF bank investor already knew about it (when IDFCF price was at 60 rs VI was equally unhealthy). In Neuland’s case, multiple temp headwinds at same time.

Scaling up NCE chemistries like deuteration and peptides is crazy crazy hard. Very few companies can do it, and will do it. Concentrated profit pools. Investment thesis is in tact. Expect this to happen in next 3 years. Not overnight or next Q.

In mean while need to judge on medium term growth and profitability. 20% EBITDA has been hard for them, 15% topline growth they are able to meet. As NCE CDMO increases i do expect higher margins. Destocking is an industry wide phenomenon.

Have seen most API players degrow or show flat growth. 🌋 exists inside of an industry. Temporary headwinds will impact. Does it change investment thesis? No. I can answer that confidently because i did deep research & have conviction regarding their durable competitive advantage

7⃣ Some mistakes that i have learned from:

Cant say I have same level of conviction about strides. Most of the biz is commoditised. Dont ask me how much price will erode. Its not possible to predict.

Stelis is great but now there are clouds over whether strides investors will get any ownership directly or only some appreciation in form of holdco discount affected valuations of strides. I was too quick to jump the gun with investment here.

I should have waited for more clarity regarding precise nature of stelis listing. Lesson learned.

Other mistake: Garware hi tech films. Great biz, competitive advantages, growth visibility. Then what is the problem?

Promoter unwillingness to share profits with minority shareholders. This sort of co deserves much higher valuations, and it would get it, if only promoter were more shareholder friendly. The rerating i had assumed in my valuation model looked more and more hopeful than certainity

Now in the craziness of a bull market it could transiently achieve such said high valuations but if i am fearful about derating all the time, is it worth investing if it doesn't let me sleep peacefully at night? I dont think it is.

8⃣ Discovery, the powerful tool of rerating:

Many stocks/companies are simply under-researched & not in favor. When their discovery happens (due to any specific reason) then rerating ensues ferociously. So many examples but best ones i can think of: angel, pix, racl, sastasundar

Broking is a cyclical and everybody agrees with it. However, if a traditional broker becomes digital broker and digital broker then seeks to become leading fintech provider, that is too juicy a stock to miss out on.

Most investors (including institutional ones) would feel some degree of FOMO imho to not own such a transformational company. Despite price moving up 100% before my buying i took a large position because the valuations were still cheap.

Did not let myself get anchored to price. Had already done that once in chemcrux and paid the price. Angel went from being very very cheap to cheap. I still had a margin of safety and so i bought. Position is up 3x since i 1st bought.

And IMO as long as bull market lasts, best is yet to come. Angel is simply a leveraged play on broader equity markets doing well. In mean while if they can diversify cashflows through distribution and other revenue, some of rerating might be permanent.

Pix transmissions. Another great example of dull, drab and boring biz making rubber bands (anyone who reads this probably already fell asleep).

But as more investors discover anti-fragility of biz model, concentrated profit pool due to industry structure becomes more widely known, critical nature low cost of product to end industry becomes widely know, the global supporting the industry become widely acknowledged...

...Rerating is only a matter of time. And it did happen. Up almost 100% since i started buying.

Have already written a lot on racl in this thread.

Sastasundar is a classic example of a co which 99% investors would avoid just by looking at its name. What a funny name.

Cant stand in front of the PE might of Pharmeasy (what a wonderful name! Making pharm easy for users). If only biz were run based on attractiveness of names. An investor willing to dive deeper and do scuttlebutt would understand and acknowledge the hidden power of the franchise.

The competitive edge SS has over its hyperscaling competitors who dont seem to care about customer experience at all. But, very few investors care about the real intangible competitive advantages.

Many investors look for a dynamic english educated manager who speaks the language of the PE investors and attracts them with complex terms.

The tailwinds the industry facing & the ‘discovery’ of a listed e-pharmacy is alone responsible for the 50-60% rerating which has happened in last few months or so.

I wonder to what extent rerating will happen once investors discover moats in SS’s business model.

9⃣Selling on overvaluation, when do i do it?: Well certainly not always.

I still hold saregama and vaibhav global despite valuations being out of whack with growth and profitability. But, I did sell polymed and sequent due to overvaluation. Why?

What’s the difference? Well, IMO a 15% bottomline growth deserves a very different valuation than a 25% bottomline growth. Also, both vaibhav global and saregama provide diversity to cashflows of my portfolio which are very unique and difficult to replicate.

Both also enjoy higher competitive advantages than polymed (my biased view). Not higher than sequent scientific. But would i be happy paying 70-80 p/e for a biz growing at 15% bottomline? I am not happy to do that. If both fall 50% overnight, i’d be a buyer.

🔟 Reality is probabilistic, how do i hedge against it:

Despite our best efforts all of us make mistakes and misallocations. options only smooth equity return, do not take away risk of equity ownership (co you own can blow up its biz performance).

One word: diversification.

Not by owning too many businesses. Focus and concentration builds wealth.

But I do want to diversify my portfolio as much as possible. At same time, 50% allocation to 1 sector. No, thanks. Not for me. Then, diversification of what?

Diversification of cashflows generated by biz. Good mix of exports and domestic focussed biz. Good mix of all sectors. I want to own tech, but im not a tech investor. Nobody can foresee the future.

But if i can find a group of biz which are highly uncorrelated and well diversified in terms of where they get their money from, then I am well protected against downside risks.
I have more to say but in interest of length of 🧵, I end here.

Disc: I am invested & biased in most biz stated above. This is not a buy or sell reco.

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