Thread by @sahil_vi

Lets discuss how to invest in equity directly, the end to end picture, taking as an example my largest holding: RACL ⚙️ 🖥️

🧵🧵👇👇

I am not a financial advisor & please don’t treat any of this as financial advice. Also, please dont think of whatever i say here as gospel or the absolute truth. This is only my perception of the truth.

I am not your Guru.

A little bit of framework/paradigm building up-front, please bear with me.

Here is the 1 tweet summary. 1000s of hours of reading, writing & contemplation.
Then, decades of patience. If we get both the steps roughly right, then some 💰💰.

The first step a Direct Equity investor with little knowledge has to do is to perceive their world accurately.

We do this by seeing interviews by experienced investors, books they're writing & reading company communications.

When we perceive our world through reading & listening, we go from being an investor with little knowledge to an investor with some knowledge. We are building mental models by learning from experienced investors

See how many our investor became :D

This learning helps us build a framework into which we then fit all the information we process: Capex, capacity utilization, margin accretive, asset light, demand scenario, sticky client relationships, how long it takes to break into client supply chains, moats.

But it is not enough to perceive our world. The only way to go from being wise to being experienced, is to act. That is the only way to go from having some knowledge to having some knowledge + some experience.

Discuss your thesis with anyone & everyone who will listen. That is what this account is to me. I learn through disagreement & thus become a better investor.

https://twitter.com/sahil_vi/status/1468144589328375814

If youre a newbie, make paper trades. If you have enough experience, courage & conviction, make real positions. Many investors have said & it bears repeating: without skin in the game, there is no learning.

Is it enough to perceive & act. No, we must contemplate on our actions. Just because i sold Poly medicure & sequent scientific does not mean its out of sight out of mind. I must constantly monitor both my omissions & commissions & contemplate whether those decisions were good.

Contemplation causes us to realise how little we know. Madhu Kela sir always says that despite being in market for 30 years he only knows 20% of all there is to know. Thus, contemplation helps us realize that we are only an investor with little knowledge.

The trifecta of learning flywheel looks like this: perceive, act, contemplate.

If we do 1 level deeper, how does this look like for equity research?
There are 3 steps:
(i) Idea generation
(ii) Deep research & Conviction Building
(iii) Probabilistic Update of beliefs

I will take the example of RACL Geartech to walk us through this process.

The idea of investing in RACL could have been generated in many ways in June 2020. 2 prominent ways that I generally generate ideas is through Screeners & by tracking investors who i consider as efficacious (high ability to generate alpha).

1. Idea Generation - Screener
I was running a screener looking for companies which were
(i) microcap (highest assymetric risk reward once we understand business)
(ii) I wanted a company which earns above its cost of capital & thus creates value through growth. 3 yr ROCE > 15%

(iii) I was looking for companies which were not stretched on valuations. So I was looking for companies which even optically appear cheap. so P/E < 10

(iv) In Indian equity market generally growth is what creates value. So I looked for company continuously growing its sales. So Sales growth 5Years > 10

(v) I wanted a company with improving cashflows. So i looked for average operating cashflows in last five years < average operating cashflows in last 3 years.

Putting it all together I ran a screener similar to this:

Market Capitalization < 3000
AND
Average return on capital employed 5Years > 15 AND
Price to Earning < 10
AND
Sales growth 5Years > 10
AND
Operating cash flow 5years /5 < Operating cash flow 3years /3

The result of running such a sceener in June 2020 was a list of around 30 companies. I read all of them. Might have taken 1 weekend.

I generally do 3 things in reading a company.
(i) Check its screener wiki.

(ii) Check the company's website to read about its products.

(iii) Check screener for how its return ratios have behaved. Its last few years margins, ROCE, asset turn etc.

When i did all of this, RACL stood out to me & i decided to study it more deeply. That is how i discovered this idea. One could have discovered it in an alternate way.

1. Idea Generation - Cloning

One of the most famous cloners among investors is mohnish pabrai. At the same time, its important to add your own hardwork to add your own conviction.

If you are tracking the right investors, you could have seen RACL on your screen as early as Jun 2019 and definitely in Jun 2020

2. Deep research & conviction building

Once an idea has been generated, we must go as deep as we can, talk to as many professionals, investors, tom, dick & harry as we can to understand the business/dhanda of the company as deeply as we can.

Different investors have different methedology for going deep. For me, valuepickr is a sureshot brahmastra to do so.

pre-cooked research spanning over decades & many years available waiting for us to go & read it, consume it, understand it, use it to build our conviction.

This is what I did. I started reading the RACL thread.

When we do that, we get to know about the company's history. It's humble beginnings. How it went to hell & came back. Through the hardwork of 1 technocrat 1st gen promoter

If we do that, we get to know how difficult company's life had been in bankruptcy & how it came out, how it not just survived but thrived.

We get to know what their secret sauce is. We get to know the story behind the numbers. The narrative behind the industry leading 22% Operating profit margins. We get to know how they manage operate at double the industry margins.

We get to know, that their customers care about quality, first & foremost. We get to know that in a 40,000$ bike, client will not do bickering over 10-20$. We get to know what for the client sitting 1000s of KM away, the quality of the part is most important.

When we read this thread, we get to know about management's strategic vision to focus on niche luxury bikes, looking at its demand as an inelastic curve. We get to know that management has some appreciation for the anti-fragile nature of luxury goods markets.

In a concall today, RACL disclosed its full sorted lost of customers. And what a list it is. BMW, Porche, Kubota, Piaggio, TVS, Yamaha, ZF.

But there were no concalls in June 2020. At that point investor was wondering how the hell can it be that this tiny nanocap has such amazing clientele. it is at that point that reading the VP thread would have helped the investor build conviction.

The main advantage RACL has is that its CEO & MD is a technocrat & an engineer first. Not what one has in mind when we think about an engineer led 'start-up'.

This helps them because the clients get to discuss hard technical details. MD understands client needs better than any management leader could & is able to then promise & deliver the quality standards they are looking for.

RACL was 1st auto anc to export to Japan.

They got Kubota as a client serendipitously in 2004, started with 1 part & today supply 100s of parts to Kubota. a 17 year old relationship. I think their client stickiness speaks for itself.

So what did we see in June 2020:
A differentiated auto ancillary company that was :
(i) Bucking the slowdown trend (headwinds) in auto sector & growing,
(ii) Had pricing power with its clients (shown in its operating margins)
(iii) Has wonderful unit economics (20% ROCE)

(iv) Has sticky customer relationships built over a decade.
(v) Operating in a niche market (Luxury bikes, tractors) where quality matters more than price.
(vi) Doing capex signalling growth.
(vii) Available at 5 P/E
(viii) 200cr topline company available at mcap of 70 cr.

Now tell me if this was not a screaming buy, what would be

Warren buffett has said about valuation that it should be so juicy that it hits you on the head with a 4x4 plank. That is exactly what RACL was in jun 2020. Deep research led to conviction. Conviction => position sizing

As important as our endeavour to perceive, is our endeavour to act. Only by acting into, engaging with & adding value to the community can I hope to develop the deep conviction required to hold companies through gut wrenching 50% drops. This is the essence of taking actions.

All my past RACL sharings:

https://twitter.com/sahil_vi/status/1469268618542125057?s=20

https://twitter.com/sahil_vi/status/1433775117675294726?s=20

https://twitter.com/sahil_vi/status/1410931200147873792?s=20

Should be looked at from this prism. I share my thesis. You poke holes. All of us improve.

3. Probabilistic updation of our beliefs

Perceive => Idea Generation
Act => Position sizing, investment, sharing investment thesis

But this is not enough. We need to contemplate on our investment. Update our beliefs based on new information

What happened since my initial investment?

(i) Company Started doing concalls. Great step in transparency & also enabling investors to understand company even better.

(ii) Great steps taken on corporate governance: Pleasant surprise for a co of this size

https://twitter.com/sahil_vi/status/1469268618542125057?s=20

strong preference NOT to create information asymmetry for investors.

Refused to meet investors privately 1:1. even meeting with white oak uploaded to BSE.

(iii) We got to understand their ambitions of doubling topline in 3 years. They want to become 500cr company by 2025. Have concrete plan for that based on confirmed orders & advanced discussions with enough margin of safety.

(iv) We got to understand their R&D led product co-development model.

Around 20% of employee costs are spent in process R&D being done jointly with customers. Shows how deeply they are integrated into customer supply chain.

(v) We got to know that their revenue is EV-proof.

Just in today's concall we got to know that share of wallet will be same for EV & ICE, 150$ per bike for one of the example projects, though parts will go down from 40 to 7-8. Higher value addition per bike in EV.

Already getting 1% of revenue from EV, planning to get 4% in FY23 from EV. 8% more to be engine agnostic.

(vi) We got to know that they signed a 10 year contract with a customer.

We got to know that they developed BMW CE4 jointly with BMW in last 3 years since 2018:

We got concrete details which show customer stickiness & thus predictability of revenues.

(vii) We got to know that they started supplying to Passenger vehicles too (BMW in last 2 concalls, and Porche we got to know today itself).

Porche is the poster boy example of Veblen goods. What happens when you are a supplier to Veblen goods??

With all this new info, the investment thesis got updated too. We now know a lot more about the company.

RACL:
A differentiated auto ancillary company that consciously chose to focus on luxury bikes as a niche market & was thus able to outgrow the auto industry.

Due to their deep sticky client relationships focussed on joint process R&D developed over many years, due to their deep integration into the client supply chain, ...

... due to client dependence on RACL not just for cutting costs but also upholding quality required for a 40k Euro bike, they have pricing power.

EV will actually prove to be positive for company. Even though Number of gears going into electric bikes is lower, the demand for precision is much higher which results in much higher realization per gear.

Margin will remain the samee, but could asset turns be higher leading to better ROICs?? We have to confirm but that is what it seems like to me.

Result of investment process:
Even though initial investment has become 9-10x.

Runway is much longer, company is executing well so i am adding to my position based on my conviction & expanded probabilistic understanding.

Having said all of that, future is not deterministic. I could be wrong.

Will continue to watch out for anti-thesis pointers on RACL i shared already.

https://twitter.com/sahil_vi/status/1427810915504693251?s=20

🙏🙏

<End of thread>

Having said all of that, of course margin of safety is not there any more. It is fairly valued now. Any slip ups in execution can be published by downward pressure.

Do your own due diligence before investing. 🙏🙏🙏

Some interesting things we got to learn in today's concall:

(i) share of wallet in ev expected to be same but with 4x lower volumes & same margin. Could lead to higher asset turns & thus ROCE.

(ii) racl supplies to porche. That's pretty interesting & amazing. Have to figure out the details in subsequent concalls.

(iii) the ev scooter which was under development was bmw ce4 to be sold in Europe.

Production Supplies have started already.

(iii) in talks with an indian ev 2w company for supplying. Production supply to bmw and porche passenger vehicles could begin in Feb 2022.

(iv) inventory is high because of high SKUs. 500 different gears. Low volume high value products. Need to maintain inventory.

(v) won't do individual plant visits since it creates information assymetry for investors. Will try to create a factory interactive video or something & share in some upcoming concall.

(vi) expecting 4% from ev in fy23 & 8% from chassis & steering which is engine agnostic.

Expecting ice to be around for 10 years in some form.