Appendix 3: Investment philosophy and lessons learned

Investment Philosophy

We are fundamentals based investors with clear focus on understanding value. We manage a concentrated portfolio of 15-30 companies that 

  • Are likely to deliver growth based on end market and market share gain opportunities
  • Have Clear and sustainable Competitive advantage in form of pricing power, cost structure, capital efficiency 
  • Are run by Competent Management with sufficient bandwidth and depth
  • Follow conservative accounting practices and have taken sound capital allocation decisions
  • Pass our stringent corporate governance checklist
  • Are likely to deliver sufficient ROIC, earnings and cash flow
  • Have relatively low dependence on capital markets 
  • And are available at a price from which we can expect to realize sufficient returns adjusted for risks and liquidity premium over a period of two to three years

The last point of ‘investing only at the right price’ is quite important to us and a key difference between us and many other investors. More specifically, the following key points define some relatively unique aspects of our investment approach:  

  • We are an absolute return focussed investors and do not invest based on relative valuation logic that can become self fulfilling in frothy markets
  • We look at Value through the framework of dynamic discounted cash flow analysis, with the view that all investments must have a minimum expected future return based on current valuation derived from our analysis of the business and estimate of future cash flows
  • We invest with a clear price objective set two to three years out but reevaluate every position that reaches that price objective and then decide whether to hold or take an exit
  • We have created macro model for India and then we estimate potential of growth for the company based on the prospects of the industry in which the company participates keeping in mind the growth rates achieved for same industry in other countries that are ahead of India in economic development
  • We thrive on opportunities that are not yet fully appreciated by the market and hence offer potential for appreciation from both growth as well as multiple expansion
  • We are “roll-up the sleeves” investors and do what it takes to learn about a business that we want to evaluate for investing and this may include showing up at AGMs and sitting in audience to wait for our turn to ask questions or showing up unannounced at a plant to get to the bottom of a situation
  • We have a very disciplined process mapped on process management software to track process compliance and we have rules in place to avoid style drift
  • Having started out six years back as a 100% cloud based company, We are always in the look out for use of technology to aid our research and investment process and to improve productivity
  • We manage risk both through clearly defined portfolio construction process and through modulation of cash levels either because of very significant macro factor (e.g COVID in March 2020) or based on availability of investment opportunities or lack thereof
  • To manage risk, we also monitor sector exposure with an upper cap of 40% for any sector and monitor single stock exposure with an upper cap of 15% at cost and 25% at market price
  • On aggregate, our portfolio trades close to a market multiple, but with better ROE and ROIC, superior cash flow metrics and lower debt to capitalization ratio
  • We have focused portfolios with high active share
  • We have a long-term focus and avoid short-term trading
  • Though we are market cap agnostic, we work with clear rules of position size determined by liquidity in the stock to enable us to achieve quick exit when required 

Lessons Learned:

The period between April 2016 and now has been full of many events that affected the stock market significantly and hence forms a very meaningful backdrop to hone our investing skills. Though we have delivered very strong performances, we have also had many learning experiences. Here we summarize some of the lessons we have learned:

  • Margin of Safety: This is a critical element of value investing and we endeavor to make it a core part of our company analysis. We have been reasonably successful in avoiding these situations (with few exceptions) since we are comfortable holding higher levels of cash when attractive valuation opportunities are scarce.
  • Political or Regulatory Risk: This is often a risk, especially in Emerging Markets, where the rules of the market economy are evolving. We did not consider this aspect when we invested in BLS International  (discussed further in Appendix 4). We have adapted to this risk by entirely avoiding companies where such risk is not low and by building higher margin of safety where a great business may have a low level of political or regulatory risk.
  • Quality of business vs Valuation: We have on a few occasions sold positions when a great company went from being undervalued to fairly valued. Most of the time, this was a mistake. Companies with durable business models are likely to keep investing and executing well. We have adapted our investing methodology to re-visit such situations and consider if the re-rating of the stock is due to potential growth being stronger than our original estimate.
  • Corporate Governance: Governance is a core part of our investment analysis. In the case of companies where such issues happen after our investment, we would exit the position if we felt the issue was significant. In the case of minor issues, the company enters a penalty box where we would exit if another governance issue, even a minor one, occurs. Because of a very high focus on corporate governance, we have not had a serious mishap that is not uncommon in Indian equities. On an aggregate basis, the companies we rejected have performed poorly. We will share more details of our study of past investment decisions in another letter. We have also gotten out of stocks in which we discovered a corporate governance issue after we invested and that has hurt our performance in one or two instances. 
  • Position Sizing: The batting average (% of times your stocks outperform the market) for even the best investors is well below 100. The key to success is often the ability to make meaningful portfolio returns when your positions are winners and to avoid material losses when your positions do not do well. Overall, we have done this fairly successfully with many of our winners being large positions and having avoided material loss of capital on positions that did poorly.
  • Rigor and Discipline: Equity markets in the short and even medium-term can be driven by investor behavior, but in the long-term it is fundamentals that matter. Success requires maintaining discipline in investing- avoiding the fads that crop up periodically. Staying disciplined involves building a robust and rigorous process and the ability to let it guide you through the noise that pervades the markets on a daily basis. We have continued to learn from our mistakes and improve our investment process. We have a team of analysts that are well trained to seek new ideas, use our rigorous analytical framework to filter the ideas and help us build client portfolios.


Main Page: Review of Our Journey from Inception

Appendix 1: Update on the performance of our fund

Appendix 2: Structural factors and Economic Reforms driving Indian economy

Appendix 4: Cash Calls and Portfolio mix across market cap buckets

Appendix 5: Examples of strong positive and negative performance contributors