Following is a copy of an Investor Memo shared with Treasure Trove subscribers
We have received feedback from some subscribers questioning & wondering if we made a mistake by exiting businesses like Mrs Bectors (2x) & Sanghvi Movers (5.3x) early. It is natural to feel this way given these stocks have continued their run-up after our selling and it can feel like that we left too much money on the table.
But this is clear only now i.e. in hindsight. At the time when these decisions were being made, we did not have the benefit of knowing how exactly the future would unfold, hence we had to use our foresight amidst uncertainty. In any pursuit that involves betting on the future (like investing), not having perfect outcomes is a given as only time will reveal whether decisions were right or wrong.
We received similar feedback when we sold most of our holding in IEX (5x) in October 2021, given the momentum the stock was enjoying at that time. While there were many business tailwinds that could have taken stock even higher, there were also risks from regulations and high valuations which could have contracted sharply, even in the slightest of earnings disappointment. Subsequently, some of the risks played out leading to steep de-rating in the stock which came down 50% over the next two years.
Another example is Gujarat Ambuja Exports (4.5x), having tracked & invested in this business for so many years we could sense that FY22 margins were near peak & not sustainable given the nature of the business. Meanwhile, market exuberance & an entry by a coffee-can portfolio re-rated the stock materially ascribing peak valuation (PE) to peak earnings. We sold most of our position (at 4.5x returns) around mid-2022. The next few quarters were disappointing and they probably realized processing maize to get starch isn’t really a coffee-can business that can be bought-at-any-price (BAAP) & held for a decade – they dumped the stock & market sentiment too got weak leading to a 35-40% correction. Interestingly, as price corrected the value re-emerged as we felt the earnings cycle had close to bottomed out with multiple growth levers via new plants & products getting materialised. A couple of months ago, we started buying again and since then the stock has bounced back sharply to near all-time high.
Like most cases, even for Mrs Bectors we were pretty confident in our analysis of earnings trajectory which luckily played out to perfection right from the quarter we entered. With stock doubling in a short period of time, we believed the earnings recovery got fully priced in and given incremental risk-reward did not seem favorable, we exited. In reality, the stock found many new buyers who continued to re-rate the same earnings projection to as high as Britannia’s valuation, which neither we could’ve guessed at that time, nor does it make any sense to us even now.
We cannot & should not assume that the stock can’t go any higher once we exit (or a stock cannot go below our entry price once we have bought). We cannot catch the top or bottom. In fact, if stocks crash immediately after our selling, we should wonder if we just got lucky and question the kind of businesses we are investing in. We are not playing momentum with stop losses, rather we are investing in well-run businesses that can continue to do well even when we exit (the business doesn’t know who bought or sold its stock). The only reason we exit a good business is because the valuation is too high & we don’t find incremental risk-reward favorable anymore. Maybe after we exit, the risks do not play out at all, while more & more positives get added to the story making it very rewarding for continuing shareholders. It is absolutely fine and we should make peace with it.
Once the crop is harvested, the focus should shift to sowing the next crop and its growth potential. Similarly, once we exit a stock, the focus should be on what we are doing with the cash released. Sometimes we sit on cash waiting for the right opportunities and deploy it slowly as opportunities present themselves.
This year we have added three new stocks to the Treasure Trove basket – one which is a special situation is already up 45% in just a month, while the other two are quality businesses spotted at an attractive time in their business cycle and hopefully the journey should be rewarding over next 2-3 years. Often confidence in a new position does not come immediately, rather it follows the subsequent stock price movement – most people had doubts when we bought Usha Martin at Rs 56 in 2021, that’s no more the case at Rs 320 now (~6x & counting). So, the time frame for new positions to deliver can obviously differ from the incremental returns we sometimes miss on the exited stocks, hence, a comparison would not serve any purpose. In the long run, the over-valued stocks (we exited) might enter a long consolidation phase or even face steeper drawdowns during bad quarters versus the ones we have replaced them with.
We believe at a portfolio level, we have been better off following a disciplined process of managing risk over returns. For every Mrs Bectors where we missed some upside, there are many IEX or GAEL where we protected our gains by avoiding subsequent risks. In a typical bull market whatever we sell would seem like a mistake, whereas in a bear market whatever we buy would seem like a mistake.
The other part we are very careful about is liquidity; as an institution, we ensure there is enough liquidity in stocks we want to buy/sell without too much impact cost for our subscribers – if the stock moves up 20% before subscribers can buy and stock moves down 20% before subscribers could sell, the real returns made by them would be far far lower than what’s claimed by a Model Portfolio or a smallcase. It’s certainly good for marketing & promotion, but bad for investors. We aren’t playing that game.
For most institutions & investors, it becomes easy to ignore the liquidity aspect in bull markets and get a comfortable entry in stocks, however, this becomes a massive problem once the market turns, sucking out the liquidity from small cap & micro cap stocks. They go down circuit-to-circuit leaving no possibility of exiting. With a gap-down opening, the trailing stop loss becomes useless.
For us, exiting a Sanghvi Movers during good times with negligible impact cost is preferable versus playing momentum and getting stuck on a reversal with -20% circuit. Let us not forget, that three bad trading days can wipe out 40-50% value of a stock. It hasn’t happened in a long time, doesn’t mean it won’t happen ever again.
Caution is advised while dealing in illiquid names, especially SME & micro caps, these are truly Abhimanyu’s Chakravyuh with no exit. Following random content on social media & YouTube by amateurs in their first market cycle, who are advising in the garb of ‘education’ with a vested interest (sponsored content/pump & dump), can be really hazardous to your wealth.
During a bull market (like current one), most investors tend to focus solely on the positives – monthly SIP flows are massive at Rs 16,000 Cr, with Make-in-India & China+1 the manufacturing sector is the new IT, GST & income tax collection trend is rocking, power demand is at a new peak… with all these positives how can Indian economy or the stock market do badly? While all of this is correct & it could truly be India’s golden decade, it doesn’t mean we will go up in a linear fashion. There will be business cycles, inventory cycles, market cycles, implications of currency/bond market turmoil, ad hoc regulatory shocks, geopolitical tension & consequences for businesses…all magnified by the human greed & fear cycle which will be fast & furious.
The harsh truth in the market is that those preferring a peaceful 15-16% CAGR following a disciplined approach often end up making 18-20% CAGR, while those chasing only multi-baggers & 25-30% CAGR often end up even losing their capital. Money after all has a tendency to move from the impatient to the patient.