Fundamental Analysis by Oldtimer | Discord Sessions

Part 5
1
Link: https://www.youtube.com/watch?v=S5eH9hfzc_o&t=1748s
Date: Jul 5 2021

– It is easier to understand regular companies because it’s

straightforward to understand them. You have P/L, balance sheet and
cash flow statements. They have standard sales, standard income,
standard expenses, standard net profit, ROE, ROCE etc. Whereas in
the case of banks you have to look at them in comparison to others.
Business model for all the banks is the same, little difference you may
find is somebody will have higher retail book, corporate book etc.

– If you wanna do advanced analysis you’ll do ROIC or DuPont analysis

or Altman z score analysis to find out if the company will sustain for a
long time or not. Models like Altman z score are higher level, you’re
looking at whether the company will remain there for a long time or
not. The overarching thing for all these things are sustainability of
the business model

– Is the business model good enough to be sustainable for a long

time?

– A company is setup to operate in perpetuity (the state or quality of

lasting forever) and in the business of generating profits.

– DCF analysis (discount cash flow) makes sense only for people who
want to invest for certain period and get out but if you see that the
company is great and you wanna hold it for a very long time, you don’t
leave the company.

– When you’re building your portfolio you’ll do it in a way that’s

reflective of the macro and micro factors

– Strategic allocation vs Tactical allocation (The strategic asset

allocation approach is more of a buy-and-hold approach and is
focused more on the long-term returns on the portfolio. The tactical
asset allocation approach, however, is more willing to divert assets to
short-term investments that might generate a higher return.) When
you’re building your portfolio you look at it more from a point of view
of strategy.

– What should your portfolio offer?

. It should contain good companies with sustainable business models
5
4
3
. Able to grow at a steady pace
2
. Not too volatile
. Widely diversified enough
. Consistently all seasons business

– If you look at the construct of nifty it has 30-35% companies in

financials. That shows financials are essential for a country/
economy/business. So you need to have some financials definitely.

– Financials is a large sector. It consists of BFSI (Banking, Financial

Services & Insurance). Depending upon your capability in
understanding the three, you can fill it sufficiently for your portfolio.
There has to be a good zone between how many companies make
sense and how many don’t.

– Portfolio should not have more than 18 companies roughly. Logic is,
it gives clarity on each company, what you’re doing, why you’re
holding etc.

– Concentration is critical to superior performance.

– For every investment there is a risk that is associated with it. The
risk comes in two parts:
. Systematic risk (same for everybody having the business ex: interest
rates) -> Always exists and can NEVER be diversified
. Un systematic risk (associated with a particular company for a
particular sector ex: Regulatory risk in Pharma) -> Only risk you can
eliminate, how? by diversifying your portfolio! Ex: Let’s say you
have a banking sector which is affected by interest rates. Interest
rates move, issue with lending arises. So to counter that what can you
do? Pick a company that is less dependant on interest rates like a
FMCG company, IT company etc.

– While you’re running strategic allocation, there comes certain

opportunities that don’t last for long but are based on certain
cycles. For ex: Sugar, Metals etc. Allocating to these opportunities is
tactical allocation, here you don’t buy and hold.

– Your portfolio should have strategic allocation and capacity to

absorb tactical allocation

– In your portfolio you can’t have all Britannia like stocks, why? They
are saturated companies. The growth is at a steady pace they don’t
outperform or underperform the industry averages. These are going to
be stability providing companies for you. On top of stable
 companies sit Growth companies (growing at 20-35% on a quarterly
basis, giving amazing returns, EPS etc.)

– On top of growth companies, sit companies which are not yet ready
to delivery that growth but have the business model, management and
potential to grow. Ex: Chemical stocks in 2018, China + 1 narrative.
Such type of portfolios can only be built if you understand what’s
happening at the Macro level.

– Global change in winds (new tech, politics etc.) -> Check if there’s
an Indian company for it -> Add

– Metals: Last metal boom came around 2004 to 2008/2009, they were
doing well because China was hosting olympics and consuming
commodities from all over the world at such a fast pace that it
grabbed everything that came it’s way. So metal companies built
capacities so large by taking debt that they were able to supply to
China but after China stopped taking, they didn’t know what to do.

SAIL

– In High interest rate cycles you would wanna look for companies with
low/no debt.
 – Some companies are immune to interest rates ex: FMCG. Capex heavy
companies, work on credit terms which are 90-180 days, when that
happens time for their money to come back to them increases during
the time they need to borrow the money for their operating cost and
pay interest on it. Whereas for FMCG and short cycle companies it is
cash and carry business. Most they give is 30 day credit to dealer.
Faster the cash moves less pressure on the system. Capex heavy
companies you gotta look at from long term perspective.

– According to studies he did, Nifty 50 at any given time, less than 30

stocks actually contribute to positive movement of the nifty and 17-18
actually contribute to the negative movement.
– Doesn’t vouch for index IF you have competency in equity. Index
investing is fine for passive and long term though.

– Liquidity story:

It's a slow and hot day in the little town somewhere in the middle of nowhere.
Times are tough, everybody in town is in debt, and everybody lives on credit.

On this particular day, a rich tourist is driving through town. He stops at the
only hotel in town and lays a $100 bill on the desk, telling the hotel owner he
wants to inspect the rooms upstairs in order to pick one to spend the night. The
owner gives him some keys, and as soon as the visitor has walked upstairs, the
hotelier grabs $100 and runs next door to pay his debt to the butcher.

The butcher takes $100 and runs down the street to retire his debt to the pig
farmer.

The pig farmer takes $100 and heads off to pay his bill at the feed store.

The guy at the farmer's Co-op takes $100 and runs to pay his debt to the local
prostitute who has also been facing hard times and has had to offer her
services on credit.

She, in a flash, rushes to the motel and pays off her room bill to the hotel owner
with the same $100 bill.

The motel owner now places the $100 bill back on the counter so the rich
tourist will not suspect anything.

At that moment the tourist comes down the stairs after inspecting the rooms,
picks up the $100 bill, states that the rooms are not satisfactory, pockets the
money, and leaves the motel.
– Technically, there is no increase in income but everybody is now debt
free. This is what liquidity can do. This is what central banks do from
time to time. You pump in the money so it goes around clears
everybody’s debt and comes back to them.

– Remove whichever 12-17 of these NIFTy companies are recurring

in under performance, among remaining companies see which
doesn’t fit your profile, if you keep going you’ll end up with 22-24
companies, in those 24 pick 18 and invest. This becomes your
large cap portfolio incase you only wanted a large cap pf.
– In your pf you look and see you have 3 FMCG companies and you
don’t want 3, you can keep the best one. That way you can bring
down total companies to 10 or 11. For the rest 5 or 6 you can add
stocks from Nifty Next 50 (growth stocks)
– From Nifty Next 50 pick 6 or 7 business which are diversified and
not similar to the large cap ones.

– This portfolio will outdo the Index. Portfolios can be designed

whichever way you want. It all depends upon:
● what risk you’re willing to carry
● for how long
● and how much position you want to take

– If you invested 1 lakh Rs in NIFTY, you would have invested 35k Rs. in
Financials. But let’s say you are now going to do 15k Rs only. IT 5%,
FMCG 5% keep on doing that until you reach 50-55% let’s say. You’re
doing 11 stocks in large cap 5% each you reach 55%. Next 9 you can
pick small and mid caps this way you keep adding to your pf every
year 1 lakh. But some new company might come up, that is where you
might have tactical allocation. This is strategic allocation later comes
tactical allocation.
– Ex: Last year you came to know steel stocks will do well. You created
an additional 50k Rs corpus for that. In that 50k you can pick 2-4
stocks, why? you are trying to grab the pace of the return. Let them
run to a point where in they have doubled or tripled. When this
happens take away the original 50k and leave the rest. Two things
happen 1. You are now not worried if the stock is going to fall or even
become 0 because you got your original investment back (First line of
defence: Return of capital then return on capital) 2. Either returns will
start slowing down after 1-2 years that time you can sell and take
profits OR you feel that you wanna keep it forever, those shares
become part of your strategic allocation.

– This PF could prolly return 18-20% for ex. Let’s say some event like
–
March 2020 happens. Your original portfolio is there, at the most you
would have lost all the pro-fits on it if you were invested for 3-4 years,
you have two choices here 1. Since you already trust your companies
you can bring in fresh capital and invest in them 2. No, you find some
tactical allocation opportunity (ex: sector fell a little too much) you can
do that also. His advice would be to first average out whatever is in the
original pf. Why? because they’re good companies for the long term.

– You have to understand the business model of the company. When

you understand the business model two things you gotta look at 1. Is
this going to click? (Read annual report and see what is the
management’s vision) 2. Look at the prospects of it from other side
(If you were a customer, would you take that product?)

– Three imp things in a company. 1. Product portfolio 2. Profitability

3. Management (hands on, ethical & proper guidance). Companies
with these three you’ll find at premium valuations. Those two Ps
always go together.

– Risk management of pf > returns

– Shouldn’t have second thoughts of buying or selling companies.

Shouldn’t have to think about your long term strategic allocations.

– Be the type who can invest -> be patient -> do reviews (at the end
of each Q spend time to see results, what management said, read
concall, annual report once a year) then your pf is set.

– Invest in what you understand

– First thing you should always know is your risk capability, what is the
risk you can take. If you can afford to lose 100 Rs then you should
invest only 100 Rs.