Confessions Of A Stock Picker

Value investing is a concept that was first coined by the towering intellect, Ben Graham. He wore many hats – those of an economist, investor, author and professor. His concept was fairly simple and states if an investor can buy an asset worth Re 1 for less than that amount, the investor should be happy. If an asset is available at 50 paise to a rupee, the margin of safety is said to be higher, compared to an asset selling for 70 paise to a rupee. The greater the margin of safety, the greater the chance of making lucrative returns in the equity markets.

The Oracle of Omaha, Warren E. Buffett, is the current mayor of Graham’s school of thought. Buffett has helped evolve the concept of value over a period of time. And Graham mainly relied on stringent financial parameters. The sage of Omaha and his alter ego, Charlie Munger, suggest that we should buy great companies at reasonable prices and hold them till eternity! Other investors, such as Philip Fischer, Sir John Templeton and Peter Lynch, vary in their notions of value investing. Lynch asks us to diversify while Buffett tells us to concentrate. But there are different ways to go to heaven – choose the one that best suits you.

Almost all B-schools teach you that the more the risk, the more the returns. But value investing is just the opposite. It says the lesser the risk, the more the returns since the first aim of a value investor is to cut down risk. Value investing also defies the efficient market hypothesis. Great investors have proved time and again that the financial markets are efficient most of the times, but mispricing does exist. Some argue that since data and information are available to us instantly (thanks to the Internet), the markets are always efficient. But who is processing that information? It is the human brain, which is irrational. Human beings “processing information” determine prices. Therefore, stock prices are not always rational. So it is our job to figure out the discrepancy between price and intrinsic value. The more the discrepancy, the more the margin of safety.

However, I feel the concept of value investing has evolved over the years. To begin with, what value are we referring to? Is it simply buying cheap assets? Is it prospective value, enduring value or is it value based on history? These are some of the difficult questions that I often ponder on as a student of Graham and Buffettsville. The predictability of cash flows in a business also acts as a margin of safety, thus providing value.

When Dalal Street was in the backwaters in the early 1990s, there was a stock which was then recently listed – Container Corporation of India Ltd. It is a PSU (public sector undertaking), but most of the investors did not understand the business model of the company and therefore, did not show any interest. There was hardly any liquidity in the market for this particular scrip. However, one of my acquaintances saw this as an opportunity and invested in the company. The rest is history. The stock has multiplied more than 50x over the past decade. This has taught me two lessons: Liquidity per se has nothing to do with value and the fact that most of the investing world does not understand a company which I do, in itself, provides a margin of safety. This has been elucidated by Buffett over the past five decades. He has termed this as the circle of competence – invest in businesses which you understand.

Experience is the best teacher. I vividly remember picking the stock of Agro Tech Food Ltd in July 2008. I had discussed this stock with some of my friends (who are also diehard value investors) but they were not convinced and tried to dissuade me from buying the stock. But I had conviction and I went ahead and bought the stock. Since then, the stock has given me a whopping return of almost 400%. It demonstrates that as value investors, we may frown at each other’s stock picks but the underlying principal remains the same. Rakesh Jhunjhunwala put it very aptly when he said that the two most difficult adjectives in English language are beauty in a girl and value in a stock – it differs from person to person.

To create wealth in the stock market, one needs to be a contrarian. And independent thinking is vital here. To quote Buffett, “A public opinion is no substitute for thought.” Along with keeping an open and independent mind, I would say let common sense prevail.