Learning from Superinvestors #3 - Govind Parikh Ji
Notes, reflections, and learnings from the book Masterclass with Super-investors by Vishal Mittal and Saurabh Basrar
⚠️ ATTENTION
I am not SEBI Registered. Whatever follows is not a recommendation or investment advice. Please consult your financial advisor.
Any stock mentioned is not a recommendation.There are many paths to Nirvana! Here is an attempt to learn from the best in investing rather than re-inventing the wheel. Investing is a personal phenomenon, one can’t copy the investment style of another person perfectly. So let’s learn from wide sources and incorporate what resonates with our psychology, goals, and temperament.
Let’s draw inspiration and learn from the wisdom of these super investors.
Previous posts:
First Impressions
Timeless advice - Quality Business + Quality Management + Initiate from an early stage (low m.cap) + held for a long duration.
Another important aspect of his strategy is "Bear Market buying power" - selling stocks when they reach absurd levels and keeping cash to capitalize on severe market corrections.
Background
He is a chemical engineer by qualification and started investing in the 1980s. It was an interesting time as the policies during that time prompted the MNCs to list leading to numerous MNC public listings. Another thing to remember is that it was still Licence Raj so the demand-supply equation was very faulty (I have grown up with stories of waiting time in scooters/telephone connections etc.) i.e supply was at the mercy of govt approvals irrespective of the underlying demand which also created a black market.
One perennial takeaway is that "Change is the only constant". These super-investors started when the economic conditions were vastly different than what it is now. Yet they adapted, evolved, and thrived. This is what we, the current and future generations of investors will have to imbibe. Learnings from Govind Parikh Ji
(1) Focus on the future - where is the puck moving
For valuation more than 3x, you had to study the company further. So I used to mechanically buy any good share trading at less than 3x PBDT without looking at the future earnings. After following a few good companies over time, I realized that the earnings of companies recommended by Mr. Khandwala or Kisan Bhai grew every year, so the P/E became cheaper on the future earnings. That made me realize that one should not only see the past alone but also look at the future cash flows. That is one of the key lessons I learnt from them. One should look at the past for attributes like company pedigree, management quality, etc., but also keep a keen focus on the future.
There are two lessons here:
1) First look at the valuations...3X is considered as expensive. That was the market environment. However, let's look at it through the lens of the cost of capital i.e. interest rates were very high. The Lower the interest rates, the higher will be the valuations.
2) We should not try to bucket investments into growth/value etc...the most gains one can get if we are playing the long game is through earning growth.(2) Management - the most important piece in the Investment Puzzle
Case Study: Ramco Cements
They bought an equipment called Combidan Mill, which is used to grind cement. They had purchased it for Rs.9 crore and expensed it equally over two years instead of capitalizing it. I was told that the investment in Combidan Mill would pay back in just one year. Since they were the first in India to install it and the suppliers wanted to make it popular in India, they got the mill at a very cheap price. Similarly, they got a lot of machines cheap as they were always ahead in technology.
I realized that you should look for companies like these, which are the first ones in the industry to do things. There are a lot of such aspects that are not written in the annual report, aspects you only get to know when you visit the company - at the AGM or their plants/factories. You get to know their philosophy, the company culture and how clean the management is. So I made it a habit to go and visit companies.
I also learnt a lot about the company from other competitors. They said that the Ramco Cement people are too good. We also learnt a lot from transporters who knew how the things were going. Those days, there was shortage of trucks (in fact everything was in short supply). We spoke to their transporter who said that it was such a good company that he loved to take his trucks to them. He said that they have good facilities, a restroom and they even gave very good food. The employees' loyalty to such companies and the passion they have for the company says a lot about it. This will again not be seen in the annual report.
These days information is democratized. However, one can still look for subtle cues. These cues can help in framing the quality of management in thesis.Case Study: Laxmi Machine Works
As soon as I entered the factory, I felt that I have entered a different place. One couldn't see the other end of the factory standing at one end - it was that big.
So I calculated that you were getting this whole company at a market cap of just Rs.6 crore (a stock price of Rs.150 on the Rs.100 paid up!). It had zero debt. There was a 10-year waiting period for its products. An international company in the same field, Rieter Machine Works, had a 10% stake in this company. The local textiles players told us that one needs to use influence to get a machine from LMW. One has to pay in advance and then wait.
Getting advances for an order is a very potent mental model. One the operating costs reduce as working capital requirements for operations decrease. The company gets float. More potently it signifies that the products are in such a high demand that customers need to pay upfront to get their orders booked.Case Study: Dr Reddy’s
He (Dr Reddy) had such amazing ideas. Some global plant of Methyldopa had closed down and there was supply disruption. He started manufacturing it. After getting to know that the plant was going to reopen, he immediately stopped manufacturing it and went on to make Norfloxocin and other products. The whole crowd followed him. They all started making Methyaldopa and then somebody set up a huge plant to make Norfloxocin. He was always moving ahead. By the time the crowd followed him, he had set up something new. All the other companies would spend a lot of money, get the best of equipments, and build the best plants. Finally, they ended up selling those to Dr. Reddy at dirt-cheap valuations like 10 paisa to a rupee.
Management prowess took this into another trajectory. One investment like this with decent allocation can change your life.(3) Have dry powder to capitalize on crises
1985 crises - Prime Minister Indira Gandhi Assasination
Then the 1985 budget came. The then Prime Minister, Rajiv Gandhi, with Sam Pitroda as an advisor, came with a vision statement. There was a lot of emphasis on growth and capital expenditure during the first two to three years of that government. We were also forced by IMF to carry on reforms. The biggest lesson I learnt was that by investing in crisis time, you can make a lot of money.
Big money can be made during extreme phases of panic and euphoria. I have learnt this from the experiences of the politically volatile times of the 1980s, the Harshad Mehta Scam in 1992, the Dotcom crash in 2000, and the Global Financial crisis in 2008. I took big bets during these periods of crisis and sold in good times, though we might have been early sometimes.
(4) Don’t burn hands by short-selling
Another major learning was about short selling. I took so much beating in short selling. I think this was in the 1980s. I looked at Ingersoll Rand and calculated that they would make an EPS of Rs.25 that year. Since it was an MNC, I thought it might trade at higher valuation of 6-7 P/E, so the fair price should be Rs.150-175. I short sold some shares at Rs.190. (It was a naked short - the position was eventually covered at 300 creating a huge loss)
I learnt that when you buy a stock, the maximum amount of money you can lose is what you have invested. But when you short sell a share, the amount of money you can lose is infinite. When you short a stock just because of high valuations, you still might not make money or in fact may lose money. The stock might undergo time correction. Also, if there are no shares available in the market, then the stock may even sustain high valuations or even go up further.
A lousy risk-reward proposition. Not my style plus the environment in India is not conducive to short-sell. Venture in this field only if you have an edge.(5) Process
Have cash to capitalize on extreme macro events. Purchases made in these situations lead to Alpha
I am pretty sure of compounding at 20%. It depends what price you buy at. I am keeping some cash in today's market. If you keep about 10% cash, when the market comes down, you can really use that cash effectively. If some bad macro event happens, the market will fall like a pack of cards and then you can pick up anything you want.
If you keep this cash for even three years and there is a big crash then, you can deploy that 10% cash and it can give you a 40-50% upside when the market stabilizes. Then you again take back the 10% cash. So if you have kept the money for five years, at 5% tax-free bonds, its equal to 50% tax free bonds. That is one thing that has helped us - keeping some cash.
There are different ways to approach this. Govind Ji has a cash component in his portfolio. Another way is to have a satellite and core portfolio i.e. some trading bets where it is likely that SL will be triggered in advance and can be deployed in extreme circumstances. You may also follow the permanent portfolio approach and rebalance at regular intervals. 
In bull markets, people feel that no shares will be available and there is an unlimited amount of money that will keep coming into the market. In bear markets, there is no one to buy shares.
Foot-in-the-door approach and relatively conservative
First of all, I do not want to lose money on any investment. So if I find something very good, I take a very small position, like a platform ticket. I will closely watch that company and slowly build up the position, in a decided price range.
If the money doubles in three to four years, then I am more than happy with my net worth in today's environment. When I was young and had much less money, I only thought of multiplying my portfolio. Today, compounding at 10-15% is good enough, because I don't want to lose money today - I want to conserve the wealth.
Concentrated allocation wise and wide enough to study more companies
We have about 70-80 stocks, but the top 10-15 will be almost 90% of the portfolio. We normally limit the exposure of a share to 10% of the portfolio value, at market, unless we are very sure.
Idea Generation
We have been following the market for so many years, so generally we know what's happening. We look at the same companies in which we had invested earlier. I don't look at many new companies, but my son Chinmay looks at them. There are so many research reports that come these days. One also tries to meet the company managements, go to the AGMs, visit the plants, meet the distributors, etc.
Managing the positions
Though most of the positions are long-term (8-10 years), he sells some shares in-between.
Markets are risky, so even if you are fully convinced, you don't need to hold all the shares till the full potential is realized. For example, Sundram Fastners is my largest position today. I had sold 20% of my holding between Rs.50-150 since we had seen it trade at Rs.40 for so many years and also fall to Rs. 13 in between. It also gives us the cushion to hold the balance shares comfortably. Moreover, it gives us buying power - if the markets fall and the stock falls in the interim, we can buy again.
Stay in the circle of Competence
I didn't understand technology and I didn't want to invest in what I didn't understand. The Y2K problem was coming up and people said it would lead to billions of dollars of business. But I could not register that size of business in my mind. Though we bought shares of IT training institutes - NIIT and SSI.
Psychology - mentally prepared to see a 75% drawdown
I had a large portfolio in beginning of 2008, which fell 75-80% during the global financial crisis. The stocks that we held fell the maximum. They were illiquid and there were no buyers. Stock prices of even companies like Bosch, Sundaram Clayton, and Sundram Fastners fell a lot. Sundaram Fasteners fell from Rs.50 to Rs.13! The value of my investments fell from Rs. 100 to just Rs.20-25, but that Rs.20 was also big enough for me to sustain. At that level you can't do much, you just relax. Your expenses are taken care of. You wait for the good days to come again.
Sell, Regret and Grow Rich
Normally, it's very difficult to sell at the top, especially during irrational exuberance in the market. We try to initiate selling much before the peak is reached. Invariably, the prices still go up after our initial sales. But over a time, when the markets normalize, the prices come down. That's why the phrase - sell, regret (when price go up after you sell) and grow rich (when the prices come down later and you have cash to deploy).
In a nutshell, the philosophy is to buy shares of very good companies at a low market cap and hold them for a long time.
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Disclaimer: I am not SEBI registered. The information provided here is for educational purposes only. This is not a buy or sell advice. I will not be responsible for any of your profit/loss based on the above information. Consult your financial advisor before making any decisions.
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Excellent insights and learnig.