In investing, it is a given that equities is the way to build wealth. They practically mean the same thing. Just keep buying some top stocks and over time you can expect to build good wealth.
Now, I know this sounds simple. It is not easy. An investor’s journey is paved with lots of mistakes, mostly behavioural. If only there was a way to prevent them.
Well, there is. As the wise people say, learn from some of the best, who have already been down the path.
I once again reach out to Amey Kulkarni of Candor Investing and seek out his approach to building wealth with stocks. Things he does and things he doesn’t. What is simple and what is not. Let’s dive in.
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VK: Amey, let me start with a general question first. India has proven to be sort of an outlier. Markets are hitting all time highs. It seems like a bull market and also not. Is this a BULL market or is the real pain hiding behind?
Amey: (smiles) Even I am baffled as to why Indian stock markets are not falling in spite of global markets declining 25+% across Europe, US and Asia.
In fact, look at some representative stocks of the US stock bubble of 2021
Robinhood – the Zerodha of the US markets
Robinhood is down -84% from its top of $55 per share in Aug-21
Look at the listed cryptocurrency exchange – Coinbase
Coinbase is down -85% from its top of $343 in Nov-21.
Shanghai composite index is -40% down below its Jun-15 peak.
However, I do not base my portfolio decisions too much on whatever my current hypothesis of the direction of the markets is.
Predicting where stock markets are headed is just an impossible task.
Even chatGPT cannot tell us where the stock markets are headed?
Even though I strongly feel that Indian markets will / should fall, I am not withdrawing money from my stock investments. Selling some investments partially because I need the money for something else – YES, I have done that in the last 1 month. Not investing my incremental cashflow for the last 6 months – YES, I have done that, I am just being more careful with what new stocks I am buying and what price I am willing to buy.
I have 85% of my networth invested in the markets and I am very comfortable with this allocation even though many of my current holdings have significantly gone up in the last 12 months.
Now, let us try and dig a little deeper below the headline stock Indices.
Even though both Nifty and the Sensex are making new all-time-highs, out of the total 1056 stocks above a market-cap of Rs 1000 Cr, 519 stocks are -30% down from their all-time high stock prices.
Check out this screen on screener.in
When so many stocks (above Rs 1000 Cr market-cap) are so much down from their ATH prices, can we call it a raging bull market?
Look at some of the darling stocks of the last 2 years
Alkyl Amines is down -27% from its top of about Rs 4386 in Jul-21
Have a look at the IT darling L&T technology services (LTTI)
LTTI is down -35% from its top in Jan-22
And, nothing is wrong with these companies in terms of business performance.
To summarize, with market mayhem across the globe – US, Europe, UK, Asia, rising global interest rates under the backdrop of higher sustained inflation, and so many stocks in India down more than 30% from their all-time-high prices, this does not seem to be a raging bull market.
Are we in a severe bear market? – I do not think so.
In my opinion, these are times to be cautious, remain invested and be choosy with incremental capital deployments.
VK: I tend to agree with you on this. And I think ChatGPT does too. (laughing)
Now, lots of new investors have started to invest in equity over the last few years. There has been an argument that most have come in as speculators.
How should any investor know if s/he is speculative?
Amey: One of the signs to detect whether you are yourself an investor or a speculator is to observe whether you are running out of patience with your own investment thesis.
Value investing / contrarian investing is a slow painful process.
Stocks do not perform on the timeline that the investor expects. If you are running out of patience because stock price has not gone up as you expected it to and you are tempted to go and invest in other ideas by selling your old investments, it is a sure shot sign that there is a higher element of speculation in your investment process.
VK: That was a hard hitter. I am quite sure many readers will have a smile on their face. Let’s now start with some serious ones.
One of the important aspects of value investing is to have a Margin of Safety (the room for error). What does it mean to you? How do you put it into practice in your work?
Amey: Margin of safety is the most important aspect of investing.
Margin of safety can come from multiple aspects
- Price
Most obvious to control risk
However, I have missed many good investments because I was not willing to pay a “expensive-looking” price when I evaluated these companies. (Today many of them are 5X and more up) - Business quality
Time is a friend of the good business and the enemy of the bad.
Good things happen to great businesses over time. In fact great businesses always end up surprising us on the upside – both on business performance and stock price movement. Eg. Look a the business and stock price performance of Dmart, Bajaj Finance over the last 5 years.
- Conservative asset allocation of your personal portfolio ie a balanced/moderate debt /equity ratio
This is an under-rated tool for increasing the robustness of your portfolio. If you have a conservative asset allocation, it will not only shield you from mistakes and general market declines, it will also give you more room in increasing equity exposure during severe market disruptions like global financial crisis in 2008-09, taper tantrum in 2013, Coronavirus decline in Mar-20 etc. - General market situation – whether it’s a bull market or a bear market or somewhere in between
My single biggest takeaway from reading the book Reminiscences of a stock operator – a biography of the greatest trader of all Jesse Livermore was that it pays to recognize / feel the general direction of the stock market.
A bull market forgives a lot of mistakes till it lasts and everything goes down in a bear market irrespective of whether one has bought the correct business / stock.
For an investor with a long time horizon of 5+ years, he/she should be careful of making mistakes on business quality during bull markets and running out of patience during bear markets.
- Allocation to individual stocks
For me personally, the margin of safety is in recognizing that the future is unpredictable and I can never know 100% of the company I invest in.
So, making a mental map of what can go wrong with my investment thesis and how much I stand to lose in such cases. What surprises in future events have I factored in my allocation
E.g., I have been holding on to CARE Ratings since Jan-20 for practically zero returns for the past 3 years. I believe my investment thesis is now playing out. However, I was mindful enough to not take the allocation to CARE Ratings to beyond a certain percentage even though stock fell more than 30% from my initial purchase price and the stock looked more attractive at that price
VK: Basically, margin of safety is about reducing the possibility of going wrong. As a practitioner / adviser, I really like the way you put the asset allocation as a practical application of margin of safety.
Let’s move to valuation side. When you analyse and value businesses for investments, what are you most careful about in arriving at a valuation?
Amey: I approach the valuation puzzle from the other side.
I do not analyze a business and work out a valuation for it. I try and do the reverse – I try to understand what assumptions – growth, return on capital (ROCE), PE multiple, operating margins, debt / equity capital structure etc and baked into the current valuations of the stock.
Given the current valuation, If my estimates of the above parameters especially growth and return on incremental capital leave room for me to make good money, I invest in the stock.
My job is not to solve complex problems (solving for the correct valuation to pay is a tough problem). I get paid to take bets in the stock market where I know with a high degree of certainty that current market valuations are low compared to the future potential / growth of the underlying business.
VK: That’s quite an insight. So, once you have bought into a stock, what do you do from there on? Is there daily, monthly or quarterly monitoring? What do you track?
Amey: Before investing, I first reduce my investment thesis to 2/3/4 key parameters. These key parameters could be quantitative eg growth, margins etc or event based – eg merger, share buyback, some business related milestone, etc.
I track these few key parameters closely to understand if my hypothesis about the business is working out or I have made the wrong investment.
E.g., in CARE Ratings, the single biggest KPI is bank loan growth (which is actually external to the company).
In case of Ujjivan, it is monthly collection and trajectory of gross NPA.
For IEX India, it is daily volume of electricity traded, progress on introduction of new products like electricity futures etc. and regulatory changes in the power sector eg introduction of general network access for transmission of electricity (a big positive), electricity distribution reforms (always a pain point)
VK: That does sound like work. However, one thing that doesn’t need much work is an SIP. SIPs have become a predominant way to take equity exposure either via MFs or in direct stocks where investors buy at all the prices over time and hope to average this price over time. In your last chat, you had mentioned about the BAAP myth. I want to ask you again, why is buying at the right price important? How does one put in the work required to know the buy price?
Amey: SIP is a fantastic way of inculcating discipline in savings / investments and also removing the anchoring bias – eg “I bought IEX India for Rs 140 last month, should I buy again this month at Rs 150 or should I wait for the price to fall to below Rs 140 before buying?”
There are times when SIP works well and there are times when lumpsum big chunk investments work better.
When the prices are extreme (either on the lower side or the higher side) – lumpsum investment / withdrawals work well
When it is a matter of discipline and a sideways market, SIP works wonders.
Recognising when prices are extreme (on either side) will give the investor a lot of clarity and confidence to invest large sums of money lumpsum.
For all other investors / cases SIP is a good method of investing.
VK: True that. Amey, what does diversification in a portfolio mean to you? How should one approach diversification in a portfolio? How do you diversify?
Amey: The entire purpose of investment analysis is to make it safe not to diversify.
The entire purpose of investment analysis is to make it safe not to diversify.
Having said that, one needs to carefully consider the unknowns. There are a lot of unknowns in business and investments. In such a case, one is much better off restricting one’s exposure to one single stock / strategy / asset class.
When it comes to a stock portfolio, for me diversification happens across business models, sectors, stage of growth / maturity of the company, impact of macroeconomic conditions on business growth / performance, sensitivity to interest rates etc.
When investing, rather than diversification for the sake of diversification, high margin of safety and low downside risks are more important for me. Low downside risks also count for scenarios / uncertainties which I am not able to predict / imagine at the time of making the investment.
VK: I now ask one of the more important questions. Lots of new investors in the market, as I said, but they have not seen profits to the extent to 2x or 10x on their investments.
Even a 20% or 50% gain in their investment makes them anxious with an urge to book and keep in the bank. A bird in hand is worth two in the bush, as they say.
Now the downside here is that probably with this action, they cap the upside. They will never see that 10x in their portfolio nor build generational wealth. What do you suggest an investor can do about this?
Amey: Equities is to make 10X, 100X and more over multiple decades. There is no point wasting energy and time trying to make 20% and 50% in stocks.
Positioning yourself to make 10X or 100X (on overall portfolio) takes time. Let me share my personal journey.
From the first stock I bought, it took me 4 years to understand the stock market terminology and to understand what genre of investment philosophy I want to follow. Then it was 5 years of part-time implementation along with my job to get to a point where I felt I need to give it more time, energy and money (by this time I had also built up a small savings kitty).
And it is the last 7 years that I have been practicing investing with full sincerity and dedication out of which in the last 5.5 years I have been a full-time investor and investment advisor.
So to say, it has taken me 16 years from the time I bought my first stock to reach this level of maturity, commitment, clarity of thought and intensity towards investing.
Have I made 10X on my portfolio?
Since the time I started tracking my personal portfolio rigorously since 2015, I have made a 3.5X on invested capital (these include additions between 2015 to 2022 as well)
Now I am confident of a 100X and more over the next 20 to 30 yrs and beyond.
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Wonderful! This has been a masterclass on investing as well as a confidence builder that so much more is possible.
Thanks so much Amey.
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You can also download Amey’s eBook – Magic, Myths and Mistakes of stocks investing from here.
