Confession Of A Value Investor - Part 3

In the final part, the two stocks that turned out to be more than super multi-baggers

Lo and behold

The first stock is LIC Housing Finance, and the second one Unitech. Both were micro-cap then, and both catered to a similar market-segment, i.e. Housing, albeit in different ways. Both were relatively big players in their respective industries and both had a long runway ahead of them. Let me run you through the subsequent events to determine how robust my thought process was, and any inference that may be drawn from the same.

With respect to LIC Housing, in 10 years running upto 2011, the company had a lacklustre financial performance during the first five years, and a robust and secular performance in the next five. The valuation had gone from 3x to 10x P/E and from 0.4x to 2x P/B. Given the historical valuation, the then prevailing absolute valuation, return ratios, competition getting more aggressive leading to depleting market share, quality of management and the fact that the stock had risen more than 20x, I considered it prudent at this point to sell-out completely the balance (almost half of the quantity I originally had). But since then, a moderate growth in earnings coupled with a valuation expansion has led the stock further quadrupling. Currently it is quoting at 15x P/E and a little short of 3x P/B.

As for Unitech, it was a less arduous journey except the initial bit, wherein the stock tanked 25% soon after I bought it, as is usually the case. Thereafter, it was a one-way ride as described above. Within four years, the topline became 8x and profit multiplied 70 times! However, debt grew 60x as well. And this was not for the core operations but for a foray into a totally new and unrelated line of business. And this new business was already entrenched with many deep-pocketed players and the economics of the business was suspect. In subsequent years, the company went on an equity raising spree before a scam broke-out and the company went from one abyss to another. It hasn’t recovered till date, neither in terms of its financial performance, nor its stock price.

Ponder awhile

The above commentary is a matter of post-mortem. In one case, I seem to have got it wrong, and right in the other. But this is being too simplistic about the whole thing. When the game is on, a lot many questions need to be answered cumulatively. Will the business fundamentals remain intact? If so, for how much longer? Will any competitive or policy pressure compress margin? Can demand keep growing at a robust pace? Will there be many blips along the way? How might the management handle the same? Or to avoid blips in growth, might the management take short-cuts and repent later?

On the valuation side, who is to say whether the right valuation is 0.5x P/B or 3x P/B? Or the valuation parameter should be EV/EBIDTA or EV/Sales or P/E. And within these parameters, what is the ballpark number close to which a company’s true value lies? It may take more than a decade to go from the lower end of the range to the higher end of the range of any of these parameters. Or it may never go at all to the higher end, or may go and start receding to finally settle somewhere in between. It all depends on the mood of Mr. Market.

Thus with so many variables at play, I consider it naïve on part of some money managers to continue holding very richly-priced stocks under the garb of quality. Perhaps it’s about the bigger picture of keeping up their NAV which, in turn, helps them gather ever-larger sums of assets on which they can feast via fees. In such a scenario, it surely helps to never sell stocks, whatever the valuation and with any number of risks attached. But for anyone investing his own money, it is advisable to be a seller of even a quality stock at a particular price than cumulatively run the risks as described supra.

I need not illustrate the plight of someone who gets in at peak valuation, and it moderates thereafter even though the company keeps performing well (example: HUL). Alternately, for someone who happened to buy at the right price and the company did well but Mr. Market remained depressive for half a decade and the investor lost patience and checked-out in that period (example: LIC Housing). Or, the company started performing poorly after a prolonged period of good performance and you happened to get into the stock at that very inflexion point trying to extrapolate the past well into the future (example: Bharti).

In the end, your return as an investor is determined by what you buy, the price you pay, the industry doing well, the management riding over a tough period, Mr. Market finally deciding to take notice and changing its mood, and you having the tenacity to hold-on until such time. To get all these variables right together at the same time is a low probability event. To attribute it to pure skill without any role of luck would tantamount to being ‘fooled by randomness’. And it’s surely not as simple as buy something at a good price and going into hibernation. If that be so, it makes a case for Sebi to ban annual recurring fees on old AUM!

But strangely, some money managers seem to be actually hibernating in the comfort of their stocks climbing manifold in value, riding on excessive valuation expansion, and still charging an annual recurring fee. Some people get paid to sleep but c’est la vie! And yes, if someone claims to have the divine skill to crystal-gaze and come up with the next 100-bagger, my reply to them would be ‘Vielen Danke und haben einen schönen Abend (many thanks and have a nice evening). Or maybe it’s a concoction of blood on the street, accentuated by my wife’s ire, while on a holiday to Lugano. I am going there again in a few months. And this time, with my children. I hope I am virtually guaranteeing myself the next big idea! ;)

This is the final part of a three part series. You can read the first part here and the second here