If You're Not Doing This, Forget About Great Returns

May 3, 2016

In this issue:
» The rising disconnect between dividends and profits of Indian companies
» Looks like even Mr Rajan does not believe official GDP numbers
» The flaws with India's divestment policy
» Market roundup
» ...and more!
Sarvajeet Bodas, Research analyst

Last year, some friends and I went to Imagica Adlabs. We were excited. And why not? It's a premium outdoor entertainment destination comparable to the best in the world. Thrill rides, entertainment programs, and a variety of restaurants made our trip paisa vasool.

One of my friends was closely observing the business of the company. He liked it instinctively. Premium ticket fees, expensive food courts, positive word of mouth publicity, and a location exactly between Mumbai and Pune. And as they say, seeing is believing. So my friend decided to invest the very next day.

After the stock nosedived more than 50% in one year, he finally decided to look at the company's numbers and read the annual report. That's when he realized his mistake.

Peter Bevelin, author of A Few Lessons from Sherlock Holmes, writes that it's important to not jump to conclusions. Instead, when analyzing a situation, try to collect the facts as open-mindedly as possible.

My friend was a victim of first-level thinking. This level of thinking is instinctive, immediate, fast, and speedy. Howard Marks says that first-level thinking is simplistic, superficial, and just about everyone can do it. Investors require the next-level thinking. Second-level thinking is deep, complex, and convoluted.

The India Letter team knows the importance of second-level thinking. Say a number stocks are attractive; growth-drivers are in place, and they all seem set up to become multi-baggers. But before the team seriously considers a recommendation, these stocks need to pass a stringent test.

This involves understanding the business' competitive advantage, the revenue drivers of the entity's long-term growth, and whether the growth rate is sustainable. Capital structure, capital allocation, cost structure, and industry dynamics are also considered. Arguments, counter-arguments, and multiple mental models are part of the team's discussion.

Here's a glimpse... While discussing Amazon and its business prospects, Tanushree, The India Letter managing editor, had the following critique:

  • Bezos is known to have great business acumen.
  • But I wonder how long is 'long term' for Amazon...in order to get very profitable.
  • They have been around for too long already but are yet to make the mark on profitability front, like say Apple.
  • Of course, the business is such that it constantly needs capital to grow...and given that ...despite the management's acumen...it may never be a great business for shareholders.

Such an open minded critique makes you think hard about the business, its profitability, and its sustainability. This helps you to distinguish between fantasy and fact.

But the process does not stop there. Now comes the interesting part - meeting the management of the company. Here, understanding the management's long-term plans, strategies, relationship with minority shareholders, corporate governance practices, etc are taken into consideration.

Last but not least is the valuations. For The India Letter, we have devised a brand new valuation architecture based on Peter Lynch's famous PEG (price-to-earnings growth) ratio.

The stocks selected in The India Letter are thus fundamentally solid, high-growth stocks across market capitalizations.

To become a second-level thinker, the right conditioning is essential. This includes following the right investment process, which must be refined, and the ability to control emotion, which is difficult to master. Also, inaction is required the most of the time, as nothing kills returns faster than the cost of frequent trading. And of course, you must always learn from experience - your own as well as vicarious.

Remember what Charlie Munger said: 'It's not supposed to be easy. Anyone who finds it easy is stupid.'

Have you ever been a victim of first-level thinking? What lessons have you learnt from it? Let us know your comments or share your views in the Equitymaster Club.

3:00 Chart of the Day

We are all well aware of the controversy with regards to the new methodology for calculating GDP growth. It seems like not just economists, but even key policymakers have little confidence in the new GDP numbers. What else could explain Rajan quoting poor GDP growth as the reason for rise in stressed assets, when the official statistics on GDP suggests growth.

As an article in Mint points out, if one were to go by the Central Statistical Office's economic data on economic growth, India has been claiming GDP growth of more than 7% for two consecutive years. Unfortunately, the ground realities do not offer these estimates enough support. If GDP is actually growing at this rate, then why has it not reflected in India Inc.'s earnings and exports figures? And why is economic slowdown being quoted as one of the key reasons in growing gross non-performing assets (NPAs) for banks? Vivek Kaul, the editor of Vivek Kaul's Diary has pointed out many factors that make this crucial economic data less credible. These are tough questions that concerned authorities need to answer. Unless we get the underlying data right, there is little chance of India making significant progress.

Rising Disconnect Between Asset Quality and GDP Growth

 Rising Disconnect Between Asset Quality and GDP Growth

Note: Gross NPA implies gross bad loans as a percentage of gross advance
Figures at the end of March every year except for 2015-16 where they are September numbers.
GDP data for 2015-16 is based on estimates


The Government has no business being in business.

The poor state that most of the PSUs are in supports this axiom.

The only reason that justifies Government's ownership in businesses is for the benefit of consumer, ensuring efficient operations and avoiding monopolies in strategic sectors and sectors where national resources are involved.

But as an article in Mint suggests, even today, decades after the liberalization, the Government continues to own businesses where its ownership makes little sense and where the business will do better for all stakeholders if it exits. Take for example the airline sector and Government's ownership of Air India.

While there have been cases of divestment, the sole purpose of this exercise has been to bail Government out of some fiscal crisis rather than improving management, performance or accountability of PSUs. As the Government gets ambitious with its disinvestment target of Rs 565 billion for 2016-2017, we hope the divestment will serve more than a tool to cover fiscal deficit.


Well, it would be wrong to blame the Government and authorities for all that is wrong with the Indian economy. Individuals are no less responsible for it, failing miserably when it comes to payment of income tax. As Vivek Kaul, the editor of Vivek Kaul's Diary suggests, just 0.11% of India's population pays 80% of its personal income tax. Do read this interesting piece to know more about Vivek's view on the matter.


After opening the day on a positive note, the Indian indices registered losses and went on to trade in the red. Sectoral indices are trading on a mixed note with stocks from the FMCG and information technology sectors bearing the maximum brunt. Telecom stocks are trading on a positive note.

The BSE Sensex is trading lower by 152 points (down 0.6%) and the NSE Nifty is trading down by 18 points (down 0.2%). The BSE Mid Cap index is trading down by 0.5%, while the BSE Small Cap index is trading up by 0.3%.

4:50 Today's Investing mantra

"Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future." - Warren Buffett

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Equitymaster requests your view! Post a comment on "If You're Not Doing This, Forget About Great Returns". Click here!

2 Responses to "If You're Not Doing This, Forget About Great Returns"

dev golchha

May 5, 2016

I started buying and selling STOCKS from my first job in the year 2005. Every year I have made a loss. My average holding has been less than a year. Though, I projected myself the reverse in public.In the last 5 years, I have started realizing #what real investing means and what it takes to develop a investing mind frame#. I have stopped my stock BUY SELL stupidity and concentrate on my core business(trading crude oil). I follow Equitymaster and also subscribed for HIDDEN TREASURE. Now, I beleive that its better to play to your competence and pay the experts/professionals to do the rest.


Monita Mehra

May 3, 2016

Many a times I have gone with instinct and first level thinking while investing and have realised it is only meant for trading and not serious long term investment. There have been stocks that I invested in haste thinking there is nothing that can go wrong with the business or sector, great company and then I have repented in leisure and waited long time to book my losses.
The lesson learnt is do deep research as that only helps long term investor.

Equitymaster requests your view! Post a comment on "If You're Not Doing This, Forget About Great Returns". Click here!
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