Notes on The Thoughtful

Investor by Basant Maheshwari

Category Investing

Mental Model

Optimized?

People/Website Basant Maheshwari

Status Read

Type Book

Part A: The World of Investing

The Business Of Investing

An investor has to be lazy in taking profits and agile in

cutting losses.

The process of getting rich for a big everlasting smile

entails sacrificing a lot of small happy moments.

To attain financial freedom one must have a corpus of fifty times their
annual expenses.

The fight remains between a bird in hand and several in

the bush.

Magic Of Compounding

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 A great idea does not come often and when it does the
need of the hour is to bet big and hold it for its up move.

Long time can compensate for little less return rate. Being in the game
matters more.

Equities Don't Outperform All Asset Classes All The Time

Index Investing

In India index is market cap weighted instead of being price weighted

as it is in the USA.

Which means Indian index gives more weightage to few stocks

But I think the same thing is happening in US market too, FAANG

Attributes Of A Full Time Investor

When work becomes passion - wealth follows.

If you don't know why you should be buying a stock then this is not your
cup of tea.

Its the research that needs the passion not the minute to
minute outcomes

Some advise:

 Look for a group of serious investors

 No substitute for reading

 Make Notes

 Read past experiences of others P

 Put real money

 Avoid mocking trading: You don't face the joy of winning or

the fear of loosing the money.

The Pain of Losing

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 Companies don't grow at 40% on an individual basis. There has to be a
sector tailwind for which such stocks are leaders.

Market tops and bottoms are caught by two people: fools

or liars.

Basant suggests that one should not buy immediately when the market
crashes and should wait on the sidelines and wait for the 'blood to dry'.

An investor who buys stocks on borrowed capital is less

likely to make a mistake than the one who buys it on
borrowed conviction.

Risk vs. Return

Most investors get rich by avoiding risk and not by taking

it.

Buy What You See

In the long run shareholder's return is determined by the ROE only

Macro Numbers - How To Analyze Them?

A trader in Chandini Chowk would do nothing differently just because a

macro number has come in a certain way but the passive owner of much
larger and efficient business will be tearing their hair trying to forecast the
actual impact of these number

Any even that affects all the players of an industry should in most cases be
ignored

Part B: Bull Market, Trends and Economic

Bubbles
Identifying Tops and Bottoms

Signs of a bull market:

 Launch of fresh mutual fund schemes

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  Inflow of Foreign institutional investors FII

 Maximum Leverage

 That is when participants of the market are full in and has also
taken leverage with their position

Why market falls suddenly:

Just a little drop in prices leads to leveraged people getting margin
calls which further leads to a chain reaction of selling further dropping
of the prices. This further creates fear in the market and the weak
players start selling.
I fell one must remember that even though a bull market will raise the
prices of the stock, a company would take its own time to perform.

Signs of bear market:

 Valuations are most reasonable

 Public participation is minimum

 Leverage is very small

 Sense of uneasiness around

Sectors that recover first(In order):

 Auto Companies: As people who were delaying their purchases have

now started buying.

 Banking Sector: The probability of bad assets reduces and businesses

start to perform. An increase in economic activity also encourages
expansion which leads to further loans.

 Industrial companies: For expansion you would need to buy machinery

 Cyclicals

Identifying The Next Big Trend

Most investors remain focused on trying to find the next

big trend rather than participate in the ongoing one.

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 Here are some trends:

 There is always a bull market somewhere: in some asset class

 Whatever happens globally happens in India

 New Sector for each bull market

 Above average growth of company and industry

 Scale of opportunity

 First generation entrepreneurs

 Stocks hitting all time high

 Small Market Cap

 Relatively Expensive Valuation

 illiquid and unpopular

 Lack of entry barriers

 Bear market IPO's

 Pickaxe and Shovel Theme

 If ecommerce increases Blue Dart, Gatti like companies will benefit

Part C: Company and Financial Analysis

Understanding Business Models
A good business is which purchases on credit and sells on cash

Purchasing on credit shows competition among suppliers

Selling on cash shows buyers are weak and dispersed

This also means that business is running on float money: Negative

working capital
Business Models:

 Entry Barriers

 Brands

 Market share vs Mindshare

 Mindshare means the customer itself comes to buy the product

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  Franchise led growth

 Such businesses need less capital

 Changing the metric of measurement

 Buying commodity and selling brands

 High gross margins

 But we need to remember as Prof. Sanjay Bakshi said in his lecture

a high gross margin could also make a business fragile as it could
sooner or later attract competition and kill those margin.

💔 Fragility & Optionality in Business Models

 Government Lease

 Patnents

 Low cost of production and economics of scale

 Ex: Wallmart

 Large Upfront Capital Expenditure

 Network Effect and Switching costs

 Product Penetration and Distribution Network

 Low Priced Items

 Possibility of Postponements

 Products whose buying cannot be postponed

 Ex: Toothbrush, medicines, etc.

Growth, ROE with DuPont Analysis

When Does an Acquisition Work Out & When It Doesn't

Acquisition generally signal that company is moving towards slow growth

phase
The ROCE gets diluted because the cash held under investments do not
form part of the capital employed whereas if this cash is used in an
acquisition it will included.

Therefore, if a business has less ROCE than the current one the ratio
will fall.

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 Is Your Company Taking Up The Market Share?
If your company is has a revenue growth more than the competitor and the
rate at which the market is expanding then your company is eating up
market shares of competitors

But do keep probability in mind

If there is growth at the cost of dilution of equity then its not a good
sign

The Leader is always first to gain market share when new competitor
spreads the product awareness.
An unorganized sector suffers from lack of operating efficiencies, financial
support and are generally family business who don't want to expand.

Evaluating the management of a business

Buying an expensive business managed by an honest

management fetches better results then one managed by
suspicious people.

Importance of being with a good management diminishes

in a bull market but increase manifold in a bearish one.

A dishonest management never runs a debt free

company.

Some ways to evaluate management:

 Over ambitiousness of the management can be understood if they

bring a lots of IPOs from the group company. Like: Kishore Biyani's
Future Group.

 Mergers or takeover of companies that are related to the promoters

 Honest management always pays taxes and keeps a good dividend

payout

 Exorbitant salary payments

 First generation promoters

 Transparency in the AR

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  People seldom change: Avoid management that was fishy once but
now is showing a clean chit

Operating Leverage- Looking For Margin Expansion

Operating leverage: When a company expands output it adds less to its

fixed costs and hence the increase in revenue creates a more than
proportionate increase in profits.

Companies with a high gross margin and a low net margin are more likely
to experience an expansion in margins.

How Companies Cook Books Of Accounts?

A company which manipulates its numbers would generally show either

lower revenues, higher expenses or a larger block of fixed assets.
The fixed assets are valued at higher rated due to over invoicing of
assets.

Dividends and taxes are good indicators for quality of earnings as they
need to be paid in hard cash.

Beware of frequent equity dilutions

The rate of increase in inventory and receivables should not exceed the
rate of increase in revenues
Change in auditor or too many related party transactions are also red
signs

Stocks To Avoid
It is more important to avoid losers than finding winners as if a stock that
halves in price needs to double up for the investor to break even.

Chances of making money multiplies manifold with a focused company

rather than one which is running multiple businesses under on roof.

Stocks to avoid:

 Growth through repeated dilution of equity or debt

 Unnecessary diversification

 Lots of acquisitions

 Large Market cap in relation to the size of the sector

 Stocks making new lows

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  Untested business models

 Cheap second line stocks in later stage of bull market

 Leading stocks from the leading sector of previous bull market

 Cyclicals that are performing too well

 Wide coverage relative valuation and priced for perfection

 Too much showcasing

Drivers Of A P/E Ratios

Businesses that get higher PE

 Having predictable and sustainable earning

 High entry barriers

 Positive cash flow

Should a small investor always stick to small cap stocks

If buying small and micro caps is the way to riches it is

also the path to bankruptcy

But if one finds few good small caps they could change one's life.

Getting out of small cap becomes a huge problem unless you are a
investor with small corpus

Part D: Buying and Selling Strategies

Should a Small Investor Stick to Small Cap Stocks?

Small cap companies without entry barriers are not suitable as these
companies don't have the ability to become a large cap.

A company must have revenues of at least Rs.100 cr as it works as a

proof that their business model works.

It is very difficult for small caps to survive a pandemic.

But what if it does? CCL is one of the companies which were not
significantly affected by COVID.

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 You must figure out whether the small cap company has the ability to
scale its business.

Multibaggers From Small and Mid Cap Stocks

The number of times a stock could go up in the future is

dependent on its earnings growth and not on the number
of times it has moved up in the past.

The trigger for multibaggers will be growth and scalability of the

company and not at what valuation is it available.

For example: when a company keeps taking away market share

from the organized sector. VIP Industries or Safari could fall into
this.

Small cap companies that are not leaders in their sector have a risk of
slipping down the delivery and execution of earnings.

But if the sector itself is very huge then you might not need a
leader.

Ex: SUN TV vs ZEE

No equity dilution + less/no debt and increases revenue with operating

leverage is sure shot multibagger.

You need to check whether the management is competent because

often small cap don't have resources to hire professional managers.

A promoter whose incentive is not management compensation but

company's performance would be the best one. Ex: Ambika Cotton
Mills

Temporary down in profitability due to advertising or capex done

should not be given much importance.

Checklist according to Basant:

ROE > 30%

I disagree with this one. I feel 30% is too high and if a company
earns such ratios it will definitely will be face with competition
in the future as it would attract other players.

Refer to:

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 💔 Fragility & Optionality in Business Models
No dilution of equity and less/no debt

Debt should be less than 50% of the net worth

Positive cash flow

Dividend yield is 1.5 to 2%

But this won't apply for illiquid stocks.

Small cap companies are the ones which could lead you
to early retirement but such companies also have
potential to put you back to work from retirement.

When to Catch A falling Knife and When Not to?

The argument that an investor should buy stocks on a

decline isn't as important as the argument as to what
stocks he should actually buy

He divides stocks into three categories

A high quality company in a low quality sector(Infrastructure)

A high quality company in a high quality sector(consumer)

A low quality company in a low quality(Real Sector)

An investor should always stay away from this one as it has the
potential of maximum damage.

Having a part owner mindset sometimes backfires and you tend to not
sell when the fundamental starts deteriorating and you start to
rationalize it.

Basant had taken a long position in Voltas and the stock was falling.
So, he used to go on long walks and used to counter the number of
Voltas AC around his area. which gave him confidence not to sell.

But it was a mistake as he realized that AC contributed only 30% of

the company's revenue.

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 A high growth company rarely goes back to the high growth stage
after it starts to slow down on the growth curve

High quality stocks rarely become cheap so trying to buy them as

bargains is a strategy that never works out as much as it is debated.

The believers of a story generally get in early before the bottom and
have to bear the pain before the gain.

It is always easy to bring down a house than to build it

up!

The Ones I Saw And Missed

An investor who always regrets his misses is like a person

who repents about every girl he saw but did not marry!

United Spirits

Lesson: Even though this stock went up 50 times Basant would still
not buy a company with a shady management

Nagarjuna Construction

Lesson: If a stock moves up like 15% it does not mean it can't

move further.

Aban Offshore

Lesson: It is better to buy a mediocre business with lots of tailwind

than a great business with lots of headwinds

Bharti Airtel

Lesson: If there is a problem like company not being profitable, you

could enter when the company becomes profitable.

It is never too late to buy a good stock or sell a bad one.

Kaveri Seeds

Lesson: If the financials are good and the business is debt free with
high ROCE and promises average growth then one can buy a little
without trying to understand a great deal about the business.

Notes on The Thoughtful Investor by Basant Maheshwari 12

 A debt free business with high ROCE is the first signal to a
robust business model.

A person learns more about a business after he has bought the

stock than he does before buying it.

One should not worry about missing an opportunity as if one goes the
next one will come earlier than you expect.

When To Sell and When Not To?

Love your family not your stock

Selling is making an educated guess.

Reasons to sell

Opportunity Cost

As money is finite

Extended valuations

If market cap of a company is low compared to growth

opportunity ahead then a high P/E does not matter.

A bull sector loosing favour

To make money it is not necessary to buy at the bottom or sell

at the top.

But if someone gets stuck in the fall, it is better to fall with the
leader rather than with a laggard.

Change in original thesis

Change in fundamentals, management not executing, or

Government policy

Take immediate action - irrespective of your purchase

price.

A question to ask is whether you would have bought that

stock if you would have had this information at the first
place.

New competitor

General business slowdown

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 Portfolio Skewness due to movement of one stock

I disagree with this one. As long as one believes in the stock

and the fundaments are good the holding period should be
forever and not selling just because of too much exposure or
volatility.

One should not look at the price of after selling a stock as it could
affect you emotional.

Part E: Analyzing Sectors and Industries

Basic Economy Stocks, Diversified Businesses and Spinoffs

Basant considers Tea as pure commodity play but with an exception.

If the company gets into branding its product and making value
products like green tea or herbal tea.

CCL Products India) ltd is exactly what he is talking about.

They are getting into branded business

They are making products like Freeze Dried, Spray Dried,

Premix, etc.

Similarly like in Textile industry, unless the company gets into

branded business getting a high valuation is difficult.

Basant warns about investing in companies who sales depend on

others. Like Munjal Showa

Power Sector is highly regulated which makes it difficult for the

company to generate high returns. Therefore, if someone want to play
power sector theme then one must bet on equipment manufacturers.

Similar to the story of selling Shovel when everybody is digging for

gold.

Analyzing Companies With Cash on Balance Sheet

Why market discounts cash?

Due to questionability on existence of cash

Earn less than the operating business

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 Holding cash is a double edge sword. It saving you during bear market
but pulls you down in bull.

Analyzing Holding Companies

If you want to make money in holding company then you need to be

bullish on the subsidiaries'.

The gap between them them should be large enough because

holding companies always remain undervalued.

Unless it owns a private company which is doing quite well like,

info edge owns stake in Zomato.

PSU Stocks

You need two things in PSU

Cheapness

Tailwind

Analyzing Secular Growth Stocks

Pricing power

If a company can increase its price every year 68%

or, retain its price with the input cost are low

I think CCL Products cannot do this. As it takes 30% margin on

whatever is cost but still it has the power to command 30%
margin and the economy behavior does not matter.

But business growth is more important because prices can be

raised only till a certain point.

Breaking the product into smaller sizes is an amazing way to retain

customers. As the products becomes affordable.

Some Traits of a secular growth company:

Expensive

Long business life

Generating free cash flow

Part F: Constructing a Portfolio

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 Portfolio construction strategies

Large wealth creation opportunities don't come too often

and when they do they should have the power to make a
difference on investor's balance sheet.

Diversification vs Concentration

Concentration:

Advantages

Reduces changes of making wrong decision as you chose your

investment very carefully

Better risk management as you bet large on few stocks, you

tend to be alert and move out with the first sign of trouble.

I would change this to 'permanent' trouble.

Disadvantages:

It sometimes becomes difficult to get out of the stocks due to

illiquidity

But if you have a small portfolio then this should not be a

problem as big money is made here.

Needs confidence and good knowledge about the company, as

you cannot afford to loose.

Diversification

Advantages:

It provides you with higher level of excitement as there are

many companies about which you need to keep yourself
updated with. On the other hand having few stocks means
most of the times you need to do nothing which makes it
boring.

Not sure if this is an advantage, seems like a disadvantage.

Can compensate any of your mistakes made as you can afford

to loose here.

Disadvantages:

Notes on The Thoughtful Investor by Basant Maheshwari 16

 Lowers the average quality of companies you hold.

When and How to leverage

My thoughts:

Price and not valuation affects your decision to take leverage. I follow
valuation approach and my guru's warn me of taking leverage. Hence, I
have no takeaway's from this chapter.
A leveraged portfolio will give me sleepless night and you need to
constantly track your position as if they go down you need to cut your
losses as to not over leverage.

Don't loose out what you need for what you want

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