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Acknowledgement
Entire presentation is inspired from reading interviews/articles of Mr. Bharat Shah and
Prof Sanjay Bakshi. Needless to mention any error in this presentation is due to my
misunderstanding
The concept of Good Business and Bad Business is inspired from the post by
Abhinav/Niren on Manufactured Luck blog here .
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Bharat Shah Says Quality growth sustained over time will enhance value. Therefore,
even if one has misjudged the value and overpaid, rise in value over time will give a
chance to catch up and will let avoidance of permanent loss of capital. A pure cigar butt
may not enjoy such luxury.
Question: How many companies have destroyed value over long term [> 5-8 Y]
despite enhancing value over time [> 15% CAGR driven by PAT and ROE > 15%, self
funded growth]
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Growth of intrinsic
value will bail you
out in case of
misjudgment of
value
Stable or declining
intrinsic value. If you
Misjudged value
Permanent
destruction of capital
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Findings of Study: More Wealth Destroyed by Companies Which Failed to Sustained Profits than by High
Valuations
Market Cap > 100crs
All Market Cap
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If one had bought Nifty Fifty at the peak of Dec 1972 and held for next 25 years,
returns closely match S&P 500.
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Bad News!!! Finding Companies with Sustainable ROE > 15% is NOT Easy
In 2004 about 26% of companies ROE > 15% [568 out of 2,200]. By end of 2014 this
number declined to 4%. Putting another way in 2004 there were only 4%
companies with sustainable RoE > 15% [86]
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On Survivorship bias
Take any idea in value investing and youll find the same survivorship bias. But extreme
success in investing has come to those who have found patterns that have worked
really well.
Mr. Taleb has roughly said that there wont be enough data in Mr. Buffetts lifetime to
know if he had any skill or whether he was just lucky.
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Take Charlie Munger. He talks about learning by studying great failures and great
successes and identifying common elements. He wants you to recognize patterns. If
theres a pattern associated with success, he implicitly assumes causality. If theres a
pattern thats associated with failure, he does that again. He said avoid the patterns that
cause failure (all I want to know is where I am going to die, so I never go there). He says
look for patterns which produced extreme successes and if you find them, back up the
truck on them.
Maybe, just maybe theres a pattern which helps us understand whats a good business
and what's a bad business ex ante and not ex post.
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Note: 15% is not that important.. What's important is that this number should be equal to or more than nominal
GDP growth of the country over long term.then only I think its possible to beat inflation and earn some real
rate of return.
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Price is perhaps the single most important criterion in sound investment decision
making. Every security or asset is a "buy" at one price, a hold at a higher price, and a "sell" at
some still higher price.
From above quote its clear that Seth Klarman does not think at a particular price, any business is bad for
investment
How do we reconcile this entire presentation with above quote
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Appendix
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Out of 350 companies which destroyed wealth during 2000-16 < 1% are cases where PAT CAGR > 15% and
ROE avg > 15%
Source: Ace Equity, all the data last updated in Jan/Feb 2016
There were around 1,600 active companies as on March 2000. Out of these 550 [34%] companies had destroyed wealth
during 2000-2016 and the common characteristic among them is either PAT CAGR < 15% or ROE avg < 15%. Out of
these only 4 companies whose PAT CAGR and ROE average was > 15% still destroyed wealth.
Alok Industries increased its PAT at 18% CAGR but due to repeated dilution its EPS declined from INR 7 in 2000 to INR 2
by 2015. It was trading at 7x PE compared to > 400x for Wipro. Still Alok destroyed more wealth compared to Wipro
Why Infosys which was trading at more than 200 PE [TTM basis] not present in the above list. Of course paying high
valuations for Infosys resulted in mere 9% CAGR in price despite massive increase in earnings..
No way I am suggesting that we should ignore valuation for good businesses. What I am suggesting is we should give
more importance to sustainable PAT and ROE. Valuation can increase/decrease returns, cannot cause or prevent
permanent destruction of capital over long term
[> 5-8 years].
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Source: Ace Equity, all the data last updated in Jan/Feb 2016
There were around 2,000 active companies as on March 2003. Out of these 200 companies destroyed wealth
during March 2003- June 2016. common characteristics of these companies again either PAT CAGR < 15% or
ROE avg < 15%.
Both Jupiter Bioscience and Alok Industries are cases of repeated dilution.
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Out of 1,800 companies which destroyed wealth during 2007-16 < 1% are cases where PAT CAGR > 15%
and ROE avg > 15%
There were around 2,800 active companies as on Dec 2007. Out of these 1,800 companies destroyed wealth
during Dec 2007-June 2016. Common characteristics of these companies again either PAT CAGR < 15% or ROE
avg < 15%. Only 16 companies out of 1800 were those whose PAT and RoE > 15%
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There were around 2,500 active companies as on March 2009. Out of these 800 companies destroyed wealth
during March 2009- June 2016. common characteristics of these companies again either PAT CAGR < 15% or ROE
avg < 15%.
Out of the above, Coral, Temptation foods and Parekh Aluminex appears to be case of mismanagement. Other six
companies market cap is less than 15crs on average as on March 2009
Last four [Zicom, Jupiter, Lycos and Neo] are cases of repeated equity dilution
Out of 1,470 companies which destroyed wealth during 2011-16 only 2% are cases
where PAT CAGR > 15% and ROE avg > 15%
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