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Sanjay received M. He is also a fellow member of the Institute of Chartered Accountants of India. At least it is if you want to win. Few are willing and able to devote sufficient time and effort to become value investors, and only a fraction of those have the proper mind-set to succeed. You must value the business in order to value the stock. In practice, there is. Anyone who finds it easy is stupid.
The first is the extreme brevity of the financial memory. The time to get interested is when no one else is. Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose. It is adherence to the concept of a margin of safety that best distinguishes value investors from all others, who are not as concerned about loss. It is either absorbed and adopted at once, or it is never truly learned.
There is more business to be done by issuing an optimistic research report than by writing a pessimistic one. The element of a bargain is the key to the process. That cast of mind, kept over long periods, gradually improves your ability to focus on reality.
If your new behavior gives you a little temporary unpopularity with your peer group… then to hell with them. Value is what you get. Such persistence is necessary, however, since value is often well hidden. My children laugh at me. That is very uncommon in American business. We read and think. So Warren and I do more reading and thinking and less doing than most people in business.
But you may be working hard on something that is false. To the contrary, risk erodes return by causing losses. By itself risk does not create incremental return, only price can accomplish that. The only answer is conservatism. I may be wrong, but I would know the answer to that. With long-term debt, increases in interest rates can drastically affect company profits and make future cash flows less predictable. Skepticism calls for pessimism when optimism is excessive.
But it also calls for optimism when pessimism is excessive. Moreover -- and this is even more inexcusable in my view -- they refuse to buy more shares at prices higher than their cost, even though management has executed even better than what was originally estimated by the investors. In a sense, the investors fall for "anchoring bias" where they anchor to their cost price and keep hoping the stock price will fall below that price so they can buy more shares.
The reality is that in high-quality businesses, there will be multiple times to buy more shares, and one must never focus on the cost price of existing shares or the fact they happen to be selling at an all-time high price and much higher than one's own initial purchase price. Equity investing has asymmetric payoffs. But you can makes tens of thousands of percentage points over your cost if you pick the right kind of businesses. I love John Templeton's quote on the subject of when to invest: "The best time to invest is when you have money.
This is because history suggests it is not timing which matters, but time. Sanjay Bakshi: I am as guilty about this one as anyone else. What's the remedy? Another remedy is to study the history of long-term wealth creation in equities.
And to my mind, what that history tells us is that wealth creation comes from buying outstanding businesses at reasonable prices and then ignoring the market for a long long time. Just by sitting on your ass with outstanding, scalable businesses for a long time is a proven formula to create wealth. But for most people, sitting on their ass is just too painful.
They want "action," and they fear losing their mark-to-market profits and want to jump from one stock to another like butterflies do with flowers. My suggestion is that one's thirst for action can be met through other activities like bungee jumping, and one should switch off the TV and get rid of all apps on phones that provide real-time stock market data.
Focus instead on fundamental performance of the portfolio and other businesses and their likely future value a decade or so from now. Rana Pritanjali : Are you lenient on valuation for quality companies with huge market potential or huge optionality? In the U. Have you bought companies that might not fulfill the conservative wisdom of value investing? If so, what was your rationale? Sanjay Bakshi: One of the most important pillars of value investing is the idea of margin of safety.
But where does margin of safety come from? For a Graham-and-Dodd value investor, it comes from asset value, or from earning power over the purchase price, which is high in relation to a AAA bond yield. There is far less focus on the quality of the business or the management. This type of investor does not hesitate in paying up for quality. But, by no means does this have to mean that he or she is overpaying. The way to figure it out is by comparing the price paid by him or her with the earnings delivered by the business many years later.
To be sure, paying high multiples of near-term earnings will make sense only if future earnings will be significantly higher than at present. So, the focus should be on long-term earning power and not current or past earnings. In a sense, the classic Graham-and-Dodd investor believes in mean reversion. For him or her, bad things will happen to good businesses, and good things will happen to bad businesses.
In other words, these businesses do not conform to the principle of mean reversion -- at least not for a very long time -- long enough for them to become great investment candidates at the right price. Now, momentum is a dirty word in value investing, but it need not be because I am taking about momentum in fundamental performance of businesses and not momentum in stock prices although the former tends to create the latter. And he or she chooses to focus on those and those alone.
And when she finds them, she does not hesitate in paying up a bit for such outstanding businesses. So, in a sense, among value investors, there is sort of a clash between two different ideologies in value investing -- mean reversion and momentum.
And both ideologies are correct in my view. For most businesses, mean reversion applies, but for some exceptional ones, it applies after a long long time, and until then, momentum applies. Rana Pritanjali : Do you think one should evaluate a business at the company level rather than at the sector level? For example, you might get a good company because of its unique characteristics, even in the airline sector.
Do you agree? Or are you biased against any sector s? Sanjay Bakshi: Both. A business does not exist in a vacuum. You have to compare how well or poorly it performs in comparison to its peers. Isn't that an astonishing statistic? One way to search for exceptional businesses is to find those that deliver astonishing performance, and one cannot do that unless one looks at the business and the industry to which it belongs.
As for your question about the airline industry, my answer is yes. The correct way to think about such situations is to think like a Bayesian. So, there are prior odds, which reflect how tough the business is, and airlines is a tough business. We know that because we have all read Buffett, and we know the rate of failure in that industry is high. So we have this baseline information that warns us that there is this industry where most participants don't earn sufficient returns on invested capital.
But that's just one part of the equation. The second part is to focus on specific factors relating to the airline business you are evaluating. Those factors reflect likelihood ratio ; that is, the degree to which this particular airline is far better than the average airline. And then you combine prior odds with likelihood ratio to determine posterior odds, which reflects the probability that your chosen airline could be the next Ryanair.
So you must never ignore baseline information, but you should also focus on factors that might deliver far higher posterior odds than prior odds. I covered this in some detail in a talk I delivered. The other thing you have to focus on is to think about the prejudices of Mr. Market because he has this tendency of painting everything with the same brush.
So, occasionally you may find a Ryanair priced like the average airline company. And that's a good thing to find out. I spoke about the prejudices of Mr. Market a few months ago. Get the transcript here. Rana Pritanjali: People say that volatility is your friend and that permanent loss of capital is the real risk. But we're talking about human beings. If history has any significance, isn't volatility the real risk? But the more interesting question for me is under what circumstances volatility equates risk.
And of course, there are many situations where this happens.
The book revolves around the interview with Sanjay Bakshi wherein he explained complex fundas in simple terms. Must read for value investors. Reading these books is extremely instructive because investing is as much about understanding human nature, as it is about understating business economics. Prof. Sanjay Bakshi recommends all books on the lists of Warren Buffett and Charlie Munger (see above), plus the following Business and Investing (incl.