Sunday, June 13, 2021

Musings on Stock Investment - Part 1: Abhimanyu and the Chakravyuh

When I was in Fidelity, a Gujarati stock trader who was a big guy in the Finance Industry - I forget his name -  was invited by the company to give a talk.  I will never forget one analogy that he drew,


We all know the story of Abhimanyu and the Chakravyuh. Abhinmanyu was taught the secret of entering the Chakravyuh when he was in his mother's womb, by his uncle Krishna. At a crucial juncture in the War, Drona arranged his army in this formation. The only three people who knew how to enter this formation were Arjuna, Krishna, and Abhimanyu. Now, Arjuna and Krishna also know how to extricate themselves once they entered it, Abhimanyu did not. Krishna and Arjuna, as it happened, were away in another section of the battlefield and would be unable to help.


So, the uncles ask Abhimanyu, a mere kid in age though not in prowess, to enter the formation. Abhimanyu demurs, saying he does not know how to get out once he is in. All the uncles assure him that they will be just behind him, and help him to get out.


We know how the rest of the story pans out. The uncles who are close behind, are stopped by Jayadratha, and Abhimanyu perishes fighting a glorious battle.


The stock market is also like that. Everyone will tell you when to buy, but no one will alert you when it is time to sell. Once you enter the Chakravyuh, you are left to fend for yourself!


While we recommend stocks for buying, we also intend to keep a close eye and indicate when it is time to sell. That is a process that is easier said than done, for there is no answer to the question 'when is the right time to sell?'.


There are many theories for that. At one extreme is the opportunistic approach of the person who has a typical trader mentality. The moment the price rises a little bit, he wants to sell. 10 percent up, sell part of holding! Another 10 percent up, sell the whole thing! What this person may be missing out on, is on the phenomenal rise later on, the initial twenty percent may just be an appetiser.


Then there is the Warren Buffett school which says, even if the stock market is shut for the next five years, and there are no daily quotes, it does not matter, since I do not intend to sell, for say 10 years, or sell never.  Now Buffett and his partner Munger are both in their nineties, Bhishma Pitamahas, Maharathis who can fight better than people half their age. They have spent the last seventy years, only studying and thinking and living and breathing Stocks. And just like Bhishma when he was a teenager learnt from Vashishta and Parashurama, Buffett had the advantage of directly learning from Benjamin Graham. The point I am trying to make is, hearing what Buffett says is one thing – and there are several books on Buffett Sayings – but actually implementing it is another thing altogether.


There is also the fact that the market dynamics keep changing, and what was a good philosophy for the last decade may not be applicable any more in the new world.


For example, most stocks today don't do well at all, and are at best middling in their returns, but a few, a very very rare few, shoot up, up, up and away.   Just see the tech behemoths in the US, with market-caps in excess of a trillion dollars, and check out their prices, say, seven or ten years back. We are taking of returns in excess of 1000 times!


Take this story of Goldman Sachs who bought a 30% stake in Alibaba in 1999 for 3 million dollars. They were offered 50% stake for 5 million but refused, and invested 3 million instead for the 30%. They sold in 2004 for 22 million.  How lovely, they would have thought, and smiled to themselves.  If they had held on, their stake would be worth 200 billion dollars, that is 2 lakh million dollars today. From 3 to 2 lakh in 22 years – that is about 65,000 times, or 65 lakh percent.  Winner takes all!


When we look at stocks, and try to decide on when to sell, the following considerations are all relevant:


1.     Try to identify companies with potential for extreme growth. Now, being value investors at heart, we are always tempted to buy it at the right "value" as well. Whether the 'value' parameters are relevant or not we do not know, but it is difficult to let go of them. Graham was a total 'value' kind of investor, following what is called the cigar-butt approach to investing, but Buffett went beyond that and tried to identify companies that had potential for strong growth, i.e. companies with 'moats'.  Hence the Coca Cola type of scrip, and also insurance companies which threw up cash, and railroads when they were at a low – all this propelled Berkshire Hathway to where it is today. But even Buffett missed out on the tech boom – he has made amends in the recent past, and it may be a bit late, but it shows that the two Pitamahas are still not too old to learn.

2.     Now, we do not know which companies of the ones we have shortlisted for their 'extreme growth potential' will do well. A couple of them may. The rest may die a gory death. But, let us look at it this way. The downside is capped, at 100 percent of our investment. The upside is almost infinite, like the story of Alibaba illustrated. So, if we invest in ten such companies and even if one of them does spectacularly well, we will be fine. For such stocks, never sell, hold for the long term.

3.     Buy companies with a "moat", which is Buffett's preferred strategy, and hold them for the Long Term. These will always be expensive, at any point in time, but like Buffett says, it is better to buy a great company at a good price, than a (merely) good company cheap. For such stocks, never sell, hold for the long term.

4.     Indulge in value buying, if you feel that the stock is unnecessarily beaten down, and will definitely correct to its "average" levels. For such stocks, sell when the "valuation" goes much above the average. Do not hasten to sell, for you may never know if the market is going to take it up still higher – perhaps, a trailing stop-loss is the answer in such a situation, like it happened with us in the case of Ion Exchange. We had recommended it at 700 levels in September 2020, but it rose to 1600 levels by end May, and then shot up in one day by twenty more percent hitting the circuit, and is currently at 2100 levels. We have put that on a trailing stop loss.

5.     The mistakes: Huhtamaki PPL which we kept recommending, never went up, and finally dropped more than ten percent below our average purchase price. We recommended booking a loss.

6.     For cyclical stocks, rather than 'analyse' them based on the usual parameters, it is probably better to have a floor price below which you will buy and a ceiling price above which you will sell.



These are some of the considerations that I keep thinking about when we buy stocks, and think about when is the right time to sell. I am not comfortable with the Coffee Can philosophy of buy, hold and forget for ten years; but I am not comfortable with the 'quick turnaround' philosophy either.  And, just because I have listed some considerations for buying and selling, does not mean that I will be able to consistently follow them. The stock market tests all your theories, all your models, and all your resolutions, constantly shakes your self-belief and makes you doubt yourself. Having said that, I do have a process, which I keep honing all the time, and I shall hopefully be able to stick to it and make us some meaningful money.


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