Investment Philosophy

‘ If you don’t know where you want to go, you will lead nowhere’

 Main aim of this module is to develop a strategy for a

youngster to make money in equity markets. Due to our capital
constrain issues, our sole aim should be to create capital gains-
both over short & long term as well. However, it is not possible
to buy already known stocks to create such gains. Only way out
is to buy underpriced stocks from the market
 Markets are either undervalued or overvalued but never
efficiently valued. So, as a youngster we are trying to make use
of such inefficiencies in the market via investment decisions
which has lowest downside and have all the negativity already
priced in it.
 Benefits of buying undervalued stocks are two-folded :
 P/E Re-rating ( Primary motive)
 Earning growth catch up ( Secondary motive)
 Whereas in cases of higher valuation, odds of losing are much
higher because market already has growth expectations with
that security and if it doesn’t plays out that way, P/E de-rating
happens
 Once you adapt a particular security, don’t break your own
philosophy because that will lead you nowhere. Adapt it and
stay stuck.

Our Philosophy

Our philosophy is to buy securities valued at extremely cheap

prices. Whenever an investment is made, 3 things control your
outcome namely- price, tenure and return. And only thing you
can control in this is Price. Knowing an idle price to enter stock
allows you to make conservative estimates regarding future.
Hence, by being value investor, we are two golden things-
 Buying stocks at dirt-cheap valuations and making up valuation
case being most conservative
We are looking forward to leverage behavioral Finance to
identify distortion- because people always like or dislike
securities to extremes .
Our Framework

1.) Cheapest available stocks: In both bull and bear market,

we are aiming to cover downside i.e permanent loss of
capital and so, we always want to be utmost conservative
with purchase price so that the worst has already been
priced in that security. During bull market when all the
sectors and their respective stocks are making all time
high and trading at insane valuations, we are trying to
figure out which sectors are left alone and why? Eg-
Vanaspati oil sector currently. In bear market also we can
get stocks which are worse but are price at insanely worst
valuations which aren’t justified to a rationale mind
2.) Selecting a specific stock: We are aiming for cheapest
available stocks in such sectors. Also, we can buy sector
leaders as Mr. Basant Maheshwari explains or diversify
ourselves across basket of stocks in that particular sector
and other such sectors/ companies available at cheaper
valuations. Such diversification we don’t wish to have
great strike rate but the stocks which do well will do
phenomenally good. Also, always select stocks with a long
operating history
3.) Chances of revival of earnings: Along with the irrationality
which market shows in pricing the stocks at such cheaper
valuation, earnings revival will do wonders and help to
maximize returns along with P/E re-rating
4.) Building assumptions: This is sort of valuation which is
justified. In this case, we are aiming to make future
estimate of companies earnings keeping current things in
 mind and seeing which opportunities has highest return
possibilities. Assumptions are build regarding sales,
margin, equity etc
5.) Resultant situation: When we are paying a particular price
for a security, it denotes a particular P/E and so knowing
the resultant situation if we buy at current P/E is very
important- basically, you are trying to see where the EPS
should be at current growth rate after 10-15 years and is
it awkward/irrational.
6.) Before buying any stock, follow the discussed framework
and get glimpses of how the company would be in 10
years down the line- sales, margins, equity etc. Many
times such forecasting helps you to know that at current
valuations sector leader are priced way to higher because
after few years they exceeds value of entire sector which
is impossible.
7.) Prepare checklist of all the biases and re-check during
making final buy decision that your mind is not being
biased anywhere.

Diversification

 Extent of diversification depends on risk taking ability i.e

losing the entire amount on a particular stock. There is
no thumb rule of diversification and hence, strategy
changes as per portfolio size, age and conviction
 At this age, it doesn’t makes sense to stay concentrated
because that will increase downside risk

Valuations
 Our sole aim is 25ish % growth rate so we use valuations to
know that if we buy a particular security at current rate &
 related P/E, is it possible for the company to attain such
growth. And most important, how long will it take to attain
such growth.
 Valuations shouldn’t be used to know the exact price of a
security whereas they should be used to know how ridiculously
securities are priced i.e either over-valued or under-valued as
markets are never exactly priced
 Eg.- At current rate even 10% CAGR growth seems difficult and
this is enough to tell that markets are overvalued
 When calculating nifty P/E , use weightage P/E of all companies
and assign weights as per market-cap. While calculating P/E for
individual stock, if latest quarter reports are available than
calculate with that or use previous four quarter’s earnings.
 Index P/E is a great measure of knowing relative valuations at
which market is trading. This helps to know the general vibe of
the market.
 Median P/E of index should be estimated and if current index
P/E is higher than median P/E then we can say that markets are
overpriced and vice- versa. Median P/E should be used in
comparison to average P/E because median P/E reflects the
recent trend in the index and market as a whole.
 You cannot say a particular P/E number as overvalued or
undervalued, It always works out in range. P/E above 24 is
overvalued whereas P/E below 18 is considered undervalued.
Looking at the historical highs we can say that when P/E
reaches 27 it is highly overvalued and one should expect fall in
index.
 While making assumptions for valuations, margin of safety
simply means taking worst case scenario in assumptions of
growth rate.
 Never expect linear growth from a particular company, all we
can calculate is that with current assets and business model,
what maximum EPS can be generated.
 In-depth knowledge and understanding of a particular business
helps you in making reliable assumptions which in-turn helps to
make efficient valuation thesis. Thinking give you a lot of
confidence. So, start learning second level thinking and make
such estimates. Only then, future data points with current
growth rate could be achieved.
 Always take clues from history to check assumptions and see
the P/E multiple given during bull and bear markets to the
company and can be used as benchmark for the same.
 Margins: sales CAGR can easily be achieved by undercharging
the product whereas it’s very difficult to achieve constantly
higher margins as size of your firm increases because base
capital also rises and it’s tough to reduce costs and increase
sales at the same time.
 Assume long term average margin of industry for making
assumptions because if margins are higher, competitors will
soon come to invade the market and margins will reduce and
they are very low, eventually they will reach industry level.
 Conservative approach for multiple variables: Calculate
average of 10-20 years and if recent average of 3-5 years is
higher than the longer average then longer average can easily
be considered for conservative assumptions regarding NPM,
Sales growth, operating margins, OPM growth etc
 Cyclical valuations: when calculating margins- take average of
top and bottom margins and do this activity for average of 2
cycles so that management have seen worse and best during
that tenure and also see the P/E multiple given to these
companies during such time to get clue of future valuations. A
cyclicals real money making opportunity starts when it breaks
previous highs which were earlier considered benchmark.
Market would change those existing perception and P/E would
be rated higher
 Turnaround: It might not always be risky to make such
investments because the worst may have already been priced.
However, always be utmost conservative in estimating future
EPS and related valuations because most of the turnarounds
seldom turnaround.
 Growth Investing: Only experienced investor should follow
growth investing approach because in this, you need to figure if
the EPS is growing on the expected territory or not. A slight
mistake in valuing future EPS may lead to massive capital losses
via P/E De-rating.
In growth stocks, sell immediately if Earnings are stagnant or
below expectations because these companies get higher
valuation because of their consistency. What good are they
with un-even earnings growth.

P/E as valuation metric

 P/E is the most used valuation measure which shows how

much price investor will have to pay for getting Re 1 of
company’s earnings. Formula – Price/EPS.
 EPS and Price are two factors which impacts the P/E ratio of a
security. EPS = P/E if we are paying only for current earnings.
However, we always pay in advance for future estimated EPS of
 the company and higher the expectations of future EPS and its
growth, higher the P/E ratio and vice versa.
 Never take P/E in isolation, always consider a P/E with respect
to earnings growth. If a P/E is higher or lower, calculate what
makes it so- whether EPS or Price because P/E could be
changed by changing a single metric
 A P/E of 5, 50 or 500 do not justify anything unless they are
supported by related earning growth figures. A quick catch up
in earnings growth will drastically reduce the P/E ratio and
what looked expensive would suddenly look very lucrative.
Eg- Price = 200, earning=10 so P/E = 20. But if In next 2-3 years
if earning are likely to doubles to 20 then Actual P/E is lower
than reflected. So, higher growth assumptions in EPS
sometimes justify higher P/E.
 Always double check EPS as per changes in outstanding shares
because wrong P/E will result in wrong adjusted P/E ratio and
that will lead to wrong analysis.
 Taking average P/E vs current P/E depends on drastically
changes in business line or products, regulatory environment
etc. Check for such changes in margin mix and product mix
 Never compare industry P/E with stock P/E because dynamics
of both are very different. P/E of individual stock depends upon
expectations investors have regarding earnings growth of the
company whereas industry P/E is formed via such individual
stocks.

Conservative purchase price – crux of the thesis

 We need to enter buy a security at valid price in order to attain

the expected return very conservatively. So, We follow below
stated model to know the securities which can justify 25ish %
CAGR growth in earnings.
 We aim to predict the situation of selected business after say
10 years via some assumptions and main focus should be on
following metrics
1.) Sales: Forecasting next 10 years sales on basis of last 15-20
years of average sales CAGR. Also, Comparison should be
made with past 3-5 years CAGR so that recent changes in
trend of growth can be captured.
2.) NPM: Forecast next 10 years NPM on basis of 15-20 years
average NPM CAGR. Such long tenure helps to know how
margins are hurt during recessions.
3.) Net Profit: Calculate Net profit for 15-20 years average and
also compare it with recent changes in trend of Net profits.
Also, assume growth in NP
4.) Outstanding shares: Whether company will need to dilute
its equity or not plays a huge factor in valuations and hence,
its most crucial step :

Equity Dilution

While estimating future of the company after 10-15 years, it’s of

utmost importance to know the rough capital structure of the
company in future and whether the equity will be diluted or not.
Following measures helps in knowing everything regarding
equity dilution :
 Find out average turnover of the company over the years-
This will help to know how much Fixed asset is required by
the company to attain stipulated revenue
 As per assumptions of sales CAGR and turnover estimate
Fixed Assets required at end of the estimation period
 Look if company has current assets to finance the deficit
between current Fixed assets and Future fixed assets
required to generate estimated revenue
 Also, if company is operating below its utilization level
then it can easily increase the output so check for capex
utilization
 Calculate IRR via current profits and extent of interest
payment company can honor. Multiply that by interest
costs and you will get maximum debt a company can take.
 Always remember that lenders want fixed IRR only until
then they will lend.
 Company would never like to exhaust full debt taking
capacity and so assume it can take loan up to 75-85% of its
debt taking capacity

After conducting this entire process, you will get only few stocks that
satisfy your growth demand and hence we would also be getting a
purchase price at which if we enter, we would get our demanded
growth in most conservative way and so, odds would be in our favor
via this. We could follow below approaches to invest in such lower
valuation stocks based on our ability to digest risk associated

1.) Basket Approach- Best suited for students with low risk taking
capacity and for working professionals as it requires
comparatively lesser time and odds of permanent loss of
capital are lowest in this. Returns would be very good.
2.) Buying Sector leaders- Few sectorial pattern would be
discovered after doing this exercise and hence, we could buy
sector leaders if we have higher conviction, can constantly
track the changes and our ability to digest higher capital losses
– recommended only for experts. Returns could be
phenomenal.

Also, constantly this pricing model should be checked and come to

conclusion whether or not at current prices it is conservative enough
to assume returns and growth expected by us and accordingly
securities can be changed.

Few ending nuggets :

 Always earnings growth might not be required- suppose
current EPS is 20, Price is 1000 & P/E of 50 but you think with
valid reasons that EPS of 100 is attainable in near future then
even if EPS doesn’t grows from that level and stays 100 with 0%
growth even then valuations may look attractive.
 Same outcome of earnings in two different stocks may not
necessarily result in similar price movement. This is due to
differences in perception regarding earnings and growth. Also,
regarding time tenure taken to attain that growth.
 Businesses with higher optionality is likely to get higher P/E
multiple because they can easily diversify in related industry
and product portfolio. Eg- havells, cera etc
 When you get stocks which look too good to be true even after
applying above filters, you may go wrong in only two things :
- Either EPS estimations are not achieved
- Or, time frame estimated to achieve those EPS is not met