Investing in stocks is always an enigma because of the plethora of advice available by various experts everywhere. Representatives of brokerage firms as well as fund managers are in the media every day, suggesting the best options while asking potential investors to weigh risks. In fact, hearing them on a daily basis can confuse the layperson as they frequently get technical while doling out advice. Movements in the stock indices by virtue of their components moving up or down often lead to herd mentality and become self-fulfilling. Are there better ways out?
Here, Pulak Prasad, the founder of Nalanda Capital, a Singapore-based fund, has a different take, similar to maybe what a Warren Buffet might recommend. While asking investors to be conservative and not give in to animal spirits is the general theme of this book, the author uses basic principles of how species operate to tell us how to keep it simple.
He supports three principles when working in the market. First is to not take unnecessary risks, which is what even animals do. The second is to invest in high quality companies at a fair price. When they are of high quality, the prices never tend to be exaggerated even at the best of times. Here one can see similar advice given by another market guru, Saurabh Mukherjea. The third is even more compelling when he asks us not to be lazy but be ‘very lazy’. This means that one should buy and hold and not get swayed by the moods of the market, which are always short-term in nature.
Each of these principles is explained drawing analogies from the animal species, which also follow these tenets in a similar manner for reasons that may be different. For example, about not taking big risks, animals do so to ensure that they are alive. Therefore, to be a good investor one must know how to reject stocks that don’t sound right. Now this may sound a bit quizzical as prima facie it is hard to figure out which stocks are risky.
The author takes us through some of the factors that sound big trouble. He says one should avoid ‘criminals and crooks’. Well, no company says they are criminals, but his research and experience show that owner-driven companies could tend to fall in this category and hence need greater investigation before investment. He uses third parties to do the audit before taking a decision. In particular, this pertains to IPOs where one can end up being swindled. He says that while one may miss out on some good issuances, as all of such companies are not bad, it is better to skip than to be sorry taking this risk when one is not certain.
The other kind of stock he avoids are those which are famed for turnarounds. New CEOs who did well in their earlier companies cannot be trusted to carry on the same work forever. One can’t be certain and hence the risk can be avoided. He is also against companies that have large debt, which sounds fairly logical. Often one looks only at profit or sales numbers to believe that the stock will do well. But once there is a pile up of debt, other compulsions follow and often diminish strategic flexibility and long-term value creation. Next, the author is not a fan of M&A companies as the probability of failure has always been high. In this process one could miss some good picks, but that does not matter in the larger scheme of things.
In short, the author writes that Nalanda invests in companies that have a high return on capital employed, minimal or zero debt, a strong competitive advantage, fragmented customer and supplier base and a stable management in a slowly changing industry. This sounds logical enough, as one can intuitively see that all these characteristics make a company look strong in the medium to long term.
When the author advises to be very lazy, the suggestion is that we should buy and hold the good stocks and not get swayed by everyday events. Companies always go through different cycles and there will always be good and bad phases. One should accept the two and not panic and sell when the going is bad. If the company is good and the prospects steady and positive (an example given by almost any stock analyst is Asian Paints), there is no reason to lose faith.
In this context he says something that is significant. We should not pay too much attention to press releases, management discussions, investor conference, etc, when taking a purchase-sale decision. The honest information is the financials. All communication made verbally by CEOs are heavily biased to sounding good and the picture is always rosy. That’s why there is less honesty there.
Therefore, his approach is similar to Warren Buffet’s, who refuses to sell, as empirical studies show that for a 90-year perspective, great businesses create enormous wealth and the concept of holding forever works well to give value to investors. He attributes the success of Nalanda Capital to being better while buying rather than selling, which is sound advice. In a way the concept of index buying falls in place here.
Prasad’s book is quite insightful and warns against the pitfalls of being influenced by swings seen in some companies. One has to be cautious when buying as this is when one can fall into the trap of herd mentality. Some bits of advice on what are dodgy companies are noteworthy and one can identify with this template when one looks at the performance of some of the IPOs in India in the recent past.
The so-called alpha stocks need to be analysed closely before investing and one should be able to put ticks to most of what Prasad has mentioned in the book. In this process one may miss some good picks, but there is no reason to regret. By drawing in analogies from biological evaluation there is added novelty in the narrative. It may get a bit heavy at time on this side, but is interesting nonetheless. The stock investor will agree with most of what has been written in this book.
What I Learned About Investing from Darwin
Pulak Prasad
Columbia Business School
Pp 312, Rs 799
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