Value Investing - II

Deep Value Investing Themes

Deep Value Strategies

1. Classic Ben Graham
2. Capital Structure
Strategies

3. FM Strategies
4. Dividend Policy Related
Strategies

5. Event-Driven Strategies
6. Availability Bias Strategies

7. Shareholding Structure
related Strategies

8. Mean Reversion Strategies

9. Value + Momentum
Strategies

10.Over-optimism related
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 dont 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- Bankers incentives.

Equity as a balancing figure

Earnings yield bargains

Grahams elegant idea of twice of AAA
bond yield.

Adjustable aspiration level - no beta,

CAPM and other nonsense

Herb Simons 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 newsgood or bad.

Stock is cheap because its out of

favor

Market does not expect much

from this company

Assume random news (in fact if

you think about mean

reversion, it may not be random
at all).

Then, a negative news will not

have much of an impact on the

market price

However, even a mild positive

news will have a significant
positive impact on price.

What matters is not whether

the news is good or bad, but
whether it will surprise the
market.

What you get is asymmetric

payoffs with favorable odds

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 cant use what it cant 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 peoples 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
Tobins 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 lineall 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.