How We Beat the Index Nearly 3X

Aug 18, 2020

Richa Agarwal, Research analyst

Think of the biggest decisions of your life in the last one decade.

Now group them into good and bad.

It's likely your good decisions would have probably led to positive outcomes, and vice versa.

So, what's wrong with that?

I'll come to it in a bit.

For now, let's travel back in time a little more.

How sure were you of these decisions, when you were taking them for the first time, and when you did not know the outcome?

Let me share my examples of recommending stocks...

In October 2013, I recommended Kolte Patil Developers Ltd in Hidden Treasure, at Rs 76. It was trading at a price to book value of 0.7 times back then.

I closed the position four years later, at a price of Rs 225, with 196% gains. That is 31% on a compounded basis.

Why did I recommend a sell?

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I thought the valuations had priced in the positives in the business, unlike at the time of recommendation.

For this real estate sector player, there were just too many known unknowns to come up with high conviction estimates. Respecting the uncertainty and limitations in forecasting, it made sense to exit.

Within the next three months, the stock went up another 71%. Had I recommended subscribers to hold, the gains could have been 413% (instead of 196%) from the recommendation price.

In hindsight, closing the position seemed like a premature call. Some subscribers did remind me of that.

To be honest, there was a point when it felt like an opportunity lost. It overshadowed the sense of achievement on getting solid gains on the closed position.

But what happened next?

In the following months, the stock fell back to Rs 204, well below my closing price. As I'm writing this, the stock is languishing at Rs 172.

My sell call was a good decision after all.

But would it still be right if the stock touches Rs 1,000 over the next 2 years?

Do you see my point?

We tend to determine the quality of decisions based on individual outcomes.

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In the process, we discount the role of luck, probabilities, and random events that are difficult to incorporate while making decisions.

But they are all significant factors in deciding the outcome - either positive or negative.

This brings me to limitation of this approach of attributing the quality of decisions to standalone results. It serves you well only in hindsight.

This a common affliction among many investors.

You see, in all probability, the outcomes are more than one. Sometimes, new variables like the Coronavirus are thrown into the equation. We can never account for these.

Don't judge your decisions based on singular outcomes. If you do, then you will believe you are a genius if your call goes right or you will feel like a failure if it didn't.

This will affect your stock picking. The chances are you will end up gambling rather than investing. You may win sometimes but a false sense of confidence could make you lose all the gains on one bad bet.

To prevent this, it is important to follow the right process, and follow it with discipline.

Sometimes, sticking to the right process makes you look bad. For example, closing the position on Astral Polytechnik with 143% gains and then missing its spectacular run to become a 15 bagger...

...or giving a buy at lower level recommendation when the entire market is witnessing positive momentum...

...or closing HEG Ltd with 24% losses in 2013, only to see it shooting up 24 times from there.

The right process is not one that makes you win jackpot. It might offer some unexpected and undesirable results.

But the right process helps you win in the long term. It lets you fare well when you average the outcomes in the long term.

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Now this does not mean you have to be rigid about your process. It is important to keep refining the process based on experiences.

But you should not abandon your investing process if it occasionally throws a bad result your way.

A process should be judged not based on individual outcomes. Instead check if has stood the test of the time.

This way, you might lose some battles, but will eventually win the war.

We have had fair share of failures in Hidden Treasure but we've stuck to a disciplined process. We've not let luck-based outcomes bias us.

This is the reason for Hidden Treasure's internal rate of return (IRR) of 24.38% since inception.

This compares favourably to the IRRs of 9.6% for the Sensex, and 8.8% for the smallcap index in the same period (February 2008 - June 2020).

By the way, this includes all positions - open, closed, successful, and failed. It captures the up and down cycles in smallcaps for over a decade.

Our performance did suffer in the short term after the 2018 crash in smallcaps. However, the long term track record and the post Covid rebound underscores the strength of stock picking process.

And it validates the faith our subscribers have in us.

Speaking of the smallcap rebound, the BSE Small Cap index is up 17% in last one month.

Nine of our recommended stocks are up more than 25%.

The top three stocks have rallied above 40%, with the biggest gainer clocking nearly 60% gains.

I believe this is just the beginning.

My team and I are focused on bringing to you the best money-making stock recommendations. We want you to participate in this once in a decade opportunity to get rich in smallcaps.

In my report last Friday, I recommended one such stock - a high quality NBFC. Subscribers can read the report here.

I expect a long road to recovery for this sector. That's exactly why it is out of favor with the market.

The market crash impacted all stocks, but finance stocks took the worst hit.

Even as the Sensex has made a comeback to pre-Covid levels, the slowdown and asset quality concerns amid the moratorium extension, is an overhang on the financial sector.

Just to be sure, being cautious in this sector makes sense to me.

However, I believe it would be folly to paint all financial stocks with the same brush.

Financials, especially NBFCs, have gone through multiple disruptions and challenges in the last few years - demonetisation, the IL&FS crisis, and now...coronavirus and moratoriums.

This has led to a liquidity squeeze for these players, due to a risk aversion attitude among investors and lenders.

The streak of disruptions will force inefficient and unorganised players in this sector to scale back.

I also see a consolidation happening. The survivors and beneficiaries of this shift will be the well capitalised companies with balanced growth and high asset quality.

Investors who identify these stocks now and are willing to be patient with returns, will be rewarded with huge rebound gains.

Here are just some of things I like about the company I recommended...

  • A strong asset quality with low net NPAs
  • Good provision buffers.
  • An experienced management with a robust track record of over 2 decades
  • Growth in assets under management and net profit of over 40% each
  • A diversified lending portfolio and strong sourcing network loan sourcing.
  • Attractive return ratios
  • A well-capitalised balance sheet.

All this makes it a strong business to bet on for the long-term.

The stock is down nearly 40% from the pre-covid level on account of an uncertain environment for the finance sector.

And has all the elements of a big smallcap rebound bet.

Let me tell you, this is not an isolated stock. There are huge profit-making opportunities in the market today. I hope you will make the most of them.

Warm regards,

Richa Agarwal
Richa Agarwal
Editor, Hidden Treasure
Equitymaster Agora Research Private Limited (Research Analyst)

PS: Get my top the small-cap stock recommendations here.

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