Sharmaji Ka Multibagger Formula: Pros & Cons 

Hello everyone, Rahul Shah here, trying to make investing accessible and profitable for the average investor.

The other day I came across a fascinating interview of Shankar Sharma, one of India's well known investing gurus.

To be honest, I look forward to his interviews as they are full of colourful metaphors, witty one-liners, and smart observations.

And this one was no exception.

I particularly liked his analogy where he called his style of investing as investing in 4 A.M. stocks.

Here's why he has given it such an interesting name.

• The world is sleeping. But a faint bit of light is creeping up at the edges. That's the home run period.

He further added in his own inimitable style that his 4 AM investing principles can get an investor from a 'slum to a penthouse.'

Here's more...

• Investing in the Levers, Nestles, and Asian Paints of the world cannot help you get a penthouse. Money can be made only in the unloved sectors of the markets.

I think I will have to agree with him on this point. If you really want to earn market beating returns over the long term, you not only have to invest in unloved sectors, but you also must have a solid investment strategy.

You see, the Levers, the Nestles, and the Asian Paints of the world may not help you earn market beating returns over the long term.

However, they won't lose you a lot of money also. They are world-class companies. They will at least ensure your capital is safe to an extent, and you are not at a big risk of incurring huge losses.

But this is certainly not the case with Shankar Sharma's potential multibagger stocks or 4 AM stocks as he likes to call them.

They may have huge upside potential, but they also come with a high amount of risk. Therefore, unless you have a proven strategy to invest in these stocks, you could be headed for a disaster.

So, does Mr Sharma have a strategy that he thinks will put us in a penthouse in a few years and not end up wiping away our hard-earned money.

Well, of course he does. And this is what his rest of the interview was all about.

You see, Shankar Sharma does not mind investing in the Apples, the Amazons, and the Tata Motors of the world. However, he wants to invest in these stocks when they are unloved and beaten down and not when everyone wants to invest in them.

Metaphorically speaking, he likes to time his entry into these stocks at 4 A.M. just when a faint bit of light is creeping up at the edges.

He argues that you should buy these stocks when they are trading at their multi-year lows and when their weightages in their respective sectors are also at lows.

And then the moment you see some traction in the stock in the form of a good quarterly performance or good product reviews, you should make your move.

According to him, this is the time the stock is about to embark on a turnaround journey and may end up giving a tremendous return over the next few years.

Will each and every 4 A.M. stock end up giving huge multibagger returns?

Absolutely not. As per Shankar Sharma, many 4 A.M. stocks will fail and go back to midnight. However, the ones that survive and eventually turnaround, will go up so much that their gains will more than make up for the losses in the failed stocks.

And this is why he is a big believer in position sizing. He argues that because of the high failure rate, one must not invest more than 2% in a single 4 A.M. stock and the total investment in such stocks should not exceed 20% of the corpus.

His selling criteria is also interesting and quite sensible in my view.

As per the interview, he would prefer exiting to the extent of 25% once the stock doubles from his purchase price. Then at every substantial gain thereafter, he will try taking a small bit off the table.

At the end of the entire life cycle of such investment, he would like to have not more than 10-15% of his original investment in the stock running for him.

If I were to summarise his strategy in a nutshell, his 4 A.M. stocks are trading at multi-year lows, have among the lowest weightage in their sectors, and are showing signs of turnaround, in the form of improved quarterly numbers or favourable product reviews.

Also, he likes to restrict his investment in these stocks to not more than 2% per stock. He also believes in staggered selling when the stock is going up and being ruthless and cutting his losses as fast as he can when the stock is going down.

Surprisingly, Shankar Sharma hasn't spoken about valuations at all. There was no mention about concepts that are central to value investing like intrinsic value and margin of safety.

What do you think? Do you think it's ok to formulate an investing strategy, a value investing strategy in particular, without bringing up things like intrinsic value and margin of safety?

Well, the approach seems to have worked for Shankar Sharma and we are happy for him.

However, the reason the same approach of investing in 4 A.M. stocks may not work for others is because they may lack the huge experience that Shankar Sharma has.

You see, as per Mr Sharma's own admission, he has spent close to 35 years researching and analysing stocks. Therefore, he has built up a huge database in his mind about the attributes that separates a multibaggers stock from the rest.

Put differently, his judgement is likely to be much superior than those of investors who don't have the same experience as him.

And this is why blindly copying Shankar Sharma's 4 A.M. strategy, especially the part about knowing which stocks to buy and which to hold on to, may not work out as spectacularly as it did for him.

In a way, it's similar to trying to copy Warren Buffett by reading his investment letters and understanding his investment strategy. However, there is only one Warren Buffett and to come anywhere close to him, we need his level of judgement and experience.

Now, we are in a real dilemma, aren't we? If we can't have the same level of success investing in 4 A.M. stocks that Shankar Sharma did, should we stop investing in such stocks?

Should we only invest in the Levers, the Nestles, and Asian Paints of the world and be happy with low returns?

Well, certainly not. We can invest in 4 A.M. stocks but with a strategy that involves less judgement, and insights and is also easier to implement.

And there is such strategy I would like to call the 4 M strategy and it's inspired by Ben Graham, the father of value investing.

Here are the 4 Ms that make up this strategy.

• Mr Market
• Margin of Safety
• Market value vs Real Value
• Mental Peace

You see, every 12 months, you need to assess Mr Market's mood. If he is greedy and if the broader stock market is expensive, you need to have less exposure to stocks, say only 25%.

If he is fearful and the broader market is cheap, you need to have 75% exposure to stocks. The remaining corpus can be in bonds or fixed deposits.

You should have a portfolio of not more than 20-25 stocks such that each investment is based on the stock's real value and not its market price or market value and you should also have an adequate margin of safety.

A good indicator of value can be the stock's latest book value per share where you are buying the stock only if it's trading at a discount of at least 20% to its book value. Here, the real value of the stock is its book value and the 20% discount is the margin of safety.

You sell your stocks after they have gone up 50-100% from their buying price and then invest the proceeds in another stock or fixed deposits depending on the broader stock market valuation.

Last but not the least, this method will give you mental peace. You don't have to worry about stuff like macroeconomics, inflation, interest rates, geopolitics, etc.

In case you are wondering how different this approach is to Shankar Sharma's 4 A.M. strategy, this one is a lot easier to implement in my view.

Also, it has sound logic written all over it. I have personally used it to earn market beating returns for my subscribers over the long term.

This strategy has clear well-defined rules that even a lay investor can follow provided he has the emotional discipline required to implement the strategy.

Shankar Sharma's strategy on the other hand, requires a fair deal of legwork and also involves using considerable judgement to know when to pull the trigger and when to wait.

Ben Graham's 4 M strategy has clear buying, selling, and asset allocation rules. Shankar Sharma's strategy needs an investor to exercise his own judgement and expertise for entry and exit.

I'm not saying Shankar Sharma's strategy is bad and mine is good.

I am thinking from the point of view of which strategy would be simpler for a common investor to implement and does not require a lot of time and effort.

I believe mine i.e. Ben Graham's 4M strategy is simpler for a common investor to implement...and it is known to work in the long term just as Shankar Sharma's strategy has done for him.

So, it all boils down to which one you are more comfortable in implementing.

Also, if you are a new investor, you can start with Ben Graham's 4 M strategy and then move on to other complex strategies as you gain more experience.

Mind you, this is exactly what Warren Buffett did when he moved from Ben Graham's approach to a moat-based strategy that's more complex but at the same time more rewarding.

You can do the same.

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I will see you again next time. Happy investing.