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Value Investing - II

Deep Value Investing Themes


Deep Value Strategies
1. Classic Ben Graham 7. Shareholding Structure
related Strategies
2. Capital Structure
Strategies 8. Mean Reversion Strategies
3. FM Strategies 9. Value + Momentum
Strategies
4. Dividend Policy Related
Strategies 10.Over-optimism related
Strategies
5. Event-Driven Strategies
6. Availability Bias Strategies
Classic Ben Graham
1. Cash bargains
2. Debt-capacity bargains
3. Earnings yield bargains
4. Large unpopular companies
5. Low-priced common stock
6. Special situations
Cash Bargains
• What I said in 2002:

• Be careful about risk of cash being dissipated away.

• My current view:

• Holding companies - Nalwa Sons, Jindal Southwest Holdings,


Consolidated Finvest: Where is the catalyst? (is it a family
dispute, is it the presence of Mr Soros e.g. in Jindal
Southwest Holdings - hedged trade)

• Graham: Inferior form of corporate structure from


market valuation, like closed-ended mutual funds and
conglomerates.
Cash Bargains

• Operating companies with cash far better than boxes of


cash

• Future cash bargains - Neyveli Lignite, Gail etc


• Predicting when they will become cash bargains.
• Why do markets hate the most easily valued asset on a
balance sheet?
Debt-capacity bargains

• No change in my views since 2002

• Graham was right when he wrote that “an equity share


representing the entire business cannot be less safe [and less
valuable] than a bond having a claim to only a part thereof.”

• Private equity boom is here to stay - an alternative to stock market.

• Companies like Abbot India which don’t deserve to be there in


the stock market.

• The debt-capacity bargains idea led me to think about capital


structure theme.
Capital Structure
• Optimum Capital Structure

• M&M vs. Graham & KKR

• Too much equity

• Too much cash- distribute it!

• LBO/Leveraged Recap - Bonus debentures - HLL, Thermax, Marico.

• Too much debt

• Pay it down

• Debt reduction- CDR- Nagarjuna Fertilizer, JVSL- Banker’s incentives.

• Equity as a balancing figure


Earnings yield bargains

• Graham’s elegant idea of twice of AAA


bond yield.

• Adjustable aspiration level - no beta,


CAPM and other nonsense

• Herb Simon’s model of satisficing


rather than optimizing.
Large unpopular companies

• Dogs of Nifty
• Part of mean-reversion strategies.
• Reversion to the mean as a mental
model from statistics

• Deeply out-of-favor sectors


• Sugar
Low priced common stock

• Arithmetical advantage

• Pseudo low price - importance of PSR

• Example: Nagarjuna Fertilizer


Special situations
• A vast, fertile field for security
analysis- move into event-driven
strategies

• Explosion in volume of corporate


events

• Milestones - market is inefficient

• Kelly near closing

• Not fully immune from market


risks

• Its not done until its done - GE


Shipping

• From Graham to Rubin to Taleb- to


FM Strategies

• Focus on expected value not probability-


Requires training for the brain does not work
the Fermat/Pascal way.

• “Take the probability times the amount of


possible loss from the probability of gain times
the amount of possible gain. That is what we
are trying to do. its imperfect, but that's what it
is all about.”
FM Strategies

• Budget announcements
• Dividend announcements
• Other market value sensitive
announcements
Why FM works in Value
• Asymmetric response to news- • However, even a mild positive
good or bad. news will have a significant
positive impact on price.
• Stock is cheap because its out of
favor • What matters is not whether
the news is good or bad, but
• Market does not expect much whether it will surprise the
from this company market.

• Assume random news (in fact if • What you get is asymmetric


you think about mean payoffs with favorable odds
reversion, it may not be random
at all).

• Then, a negative news will not


have much of an impact on the
market price
Dividend Policy
• M&M vs the real world - dividend policy matters

• MM assumed that capital markets will always welcome


companies with open arms

• MM assumed efficient markets- no dilution risk


• MM assumed no agency problems - no bladder theory.

• Two P/Es of a stock


• Bonds inside stocks - e.g. VST Industries

• Need for activism huge


Dividend Policy
• Market prices very sensitive to dividend announcements and rightly so.

• 1st time dividend payers, restoration of dividend

• Cut in dividends

• Dividend skipped

• Hike in dividends

• Special dividends

• Dividend capture using futures

• Often we let someone else take the dividend- FM trade


Availability Bias
• “The brain can’t use what it can’t remember or what it is blocked from
recognizing because it is heavily influenced by certain psychological
tendencies.” - Munger

• Jumping to first conclusions - human egg metaphor

• Huge opportunities in exploiting other people’s availability bias.

• People assess the frequency, probability, or likely cause of an event by the


degree to which instances or occurrences of that event are readily
“available” in memory- Vividness and Recency

• Markets over-react to events- social proof

• The annual budget drama

• Long-short strategies arising out of availability bias


Shareholding Structure

• I think its very important to monitor what the insiders are doing and what
else is happening in the shareholding structure.

• Over-valued stock + large FII interest plus + F&O + insider selling+ weak
accounting + slowing growth (not factored in market price) = short
candidate when market is also over-heated.

• Holding companies

• Ultra-cheap + insider buying +low FII interest = an excellent combination.

• Insider buying vs insider selling asymmetric

• What are other smart investors doing?


Mean Reversion
• Fundamentally important mental model
• Toss of a coin
• Business cycles
• Tobin’s Q, Incentives
• Sugar will be sweet one day.
• Stock prices vs Stock returns
• Mind tends to put an arrow at the end of a trend line-
all trends are not destiny
Mean Reversion
• Raw material theme
• Why important?
• Britannia- one thing leads to another - my
(financial) love affair with Vinita Bali
Value + Momentum

• Munger taught me to combine ideas -


jump jurisdictional boundaries,
connect things.
• My hunch is that value investing will
give better results when combined
with momentum strategies.

• Trade-off involved, FM
Over-optimism
• 80% of drivers consider themselves to be “above
average”

• Bias in analyst reports - buy vs sell calls - incentive


caused bias

• Managements under-weigh competitive threats - e.g.


chinese competition.

• Investors become wildly optimistic about certain


sectors sometimes, and then backward thinking forces
you to be more objective and see the lunacy in market
prices.