Originals: How Non-Conformists Move the World by Adam Grant

Originals: How Non-Conformists Move the World 

by Adam Grant

This is a very good read. It is centred around being original and creativity. There is a lot of case studies. Lots of suggestions to become more original are given in the book.

Some snippets from the book

According to Berkeley sociologist Arlie Hochschild, if you’re feeling an intense emotion like anxiety or anger, there are two ways to manage it: surface acting and deep acting. Surface acting involves putting on a mask—modifying your speech, gestures, and expressions to present yourself as unfazed. If you’re a flight attendant, and an angry passenger begins yelling at you, you might smile to feign warmth. You’re adjusting your outward appearance, but your internal state is unchanged. You’re furious with the passenger, and the passenger probably knows it. Russian theater director Constantin Stanislavski observed that in surface acting, actors were never fully immersed in the role. They were always aware of the audience, and their performances never came across as authentic. Stanislavski wrote that surface acting “will neither warm your soul nor penetrate deeply into it . . . delicate and deep human feelings are not subject to such technique.”

In deep acting, known as method acting in the theater world, you actually become the character you wish to portray. Deep acting involves changing your inner feelings, not just your outer expressions of them. If you’re the flight attendant in the above example, you might imagine that the passenger is stressed, afraid of flying, or going through a messy divorce. You feel empathy for the passenger, and the smile comes naturally to you, creating a more genuine expression of warmth. Deep acting dissolves the distinction between your true self and the role you are playing. You are no longer acting, because you are actually experiencing the genuine feelings of the character.

If you’re seeking to unleash originality, here are some practical actions that you can take.

Individual Actions:

A. Generating and Recognizing Original Ideas

1. Question the default.

2. Triple the number of ideas you generate.

3. Immerse yourself in a new domain.

4. Procrastinate strategically.

5. Seek more feedback from peers.

B. Voicing and Championing Original Ideas

6. Balance your risk portfolio.

7. Highlight the reasons not to support your idea.

8. Make your ideas more familiar.

9. Speak to a different audience.

10. Be a tempered radical.

C. Managing Emotions

11. Motivate yourself differently when you’re committed vs. uncertain.

12. Don’t try to calm down.

13. Focus on the victim, not the perpetrator.

14. Realize you’re not alone.

15. Remember that if you don’t take initiative, the status quo will persist.

Leader Actions:

A. Sparking Original Ideas

1. Run an innovation tournament.

2. Picture yourself as the enemy.

3. Invite employees from different functions and levels to pitch ideas.

4. Hold an opposite day.

5. Ban the words like, love, and hate.

6. Hire not on cultural fit, but on cultural contribution.

7. Shift from exit interviews to entry interviews.

8. Ask for problems, not solutions.

9. Stop assigning devil’s advocates and start unearthing them.

10. Welcome criticism.

Bandhan and IDFC Bank's bumpy journey since getting banking licence

http://economictimes.indiatimes.com/industry/banking/finance/banking/bandhan-and-idfc-banks-bumpy-journey-since-getting-banking-licence/articleshow/51608127.cms

Bandhan and IDFC Bank's bumpy journey since getting banking licence

By Atmadip Ray & Saloni Shukla, ET Bureau | Mar 30, 2016, 06.51 AM IST

Most of those who scrambled for a banking licence — some to make a quick buck — should be a happy lot. For the two entities that succeeded in getting the coveted licence two years ago, the going since then has been tough. If banking is a cow then one had to transition from an ant and the other had to shrink from being an elephant, both difficult propositions.

In the US, setting up new banks was as easy as opening restaurants. The US market saw formation of more than 2,000 banks between 1990 and 2008, before strong regulations in the wake of the global financial crisis and the fall of banks like a pack of cards put the brakes on the trend. In the next five years, only seven new banks began their journey.

The scenario in the Indian market was vastly different, with just two banks — Kotak Mahindra Bank and YES Bank — forming in a decade. The country saw the entry of a mere 23 banks since the economic liberalisation in the early 1990s. This is now changing with Reserve Bank of India Governor Raghuram Rajan going for on-tap bank licences.

The free market strategy started off with the doling out of licences in April 2014 to two very different entities with contrasting backgrounds and cultures — Bandhan and IDFC. The journey since then has been nothing short of an Ayn Rand classic-like tale for them.

IDFC was essentially a lender to the infrastructure sector, while the licence to Bandhan was an experiment in which a microfinance company was preferred over large corporate houses such as Birlas and Ambanis with the regulator aiming to improve banking penetration in the hitherto untapped rural belt.

IDFC Bank, with a market cap of over Rs 16,000 crore, has navigated a host of issues in the last two years — from complex demerger of the business, setting up new technology, hiring designated senior-level management team to increasing the staff strength from a meagre 220 to over 2,350. The bank was up and running on October 1, 2015.

The structure the RBI asked IDFC Bank to set up was so complex that for assets and liabilities to move from the parent to the bank, they had to take approval from all its shareholders and creditors, including 15 lakh bond holders and over 400 institutional creditors.

"There were obviously nervous moments, but I never felt that we wouldn't be able to do it," Rajiv Lall, managing director, IDFC Bank, says. Few in the country barring Rana Kapoor of YES Bank has had the experience of creating a bank from scratch.

Bandhan's transition from a microfinance company into a bank has been first of its kind. The micro lender, which has been more of an unorganised company with practices to meet rural needs, had to shift its focus beyond villages and equip its staff to think differently.

"Resolving the conflicts between our existing grassroots employees and the lateral recruits with banking experience was the first major challenge for me," Bandhan Bank managing director Chandra Shekhar Ghosh says.

While IDFC Bank did not have to face that problem, it faces the challenge of acquiring clients in hordes, which is essential for a successful bank. The parent company, which has been happy with a few hundred companies for all its profits, now has to fight for tiny customers who give any bank its bread and butter — deposits.

"And, you know, in any nice forum with lots of people, Chandra Shekhar Ghosh can very rightly claim that he is serving seven million poor customers, whereas I have to look away sheepishly and say I have 300 corporate customers of which a good handful are quite colourful shall we say," says Lall.

Of the two, Bandhan Bank was the first to get off the block on August 23 and it has weathered the challenge of earning public trust as a bank well, having garnered Rs 11,000 crore of deposits in the first six months of its operations. It has added a massive 10 lakh customers since August last year and opened as many as 655 branches to gain a stronger foothold before payments banks and small finance banks make their entry.

For IDFC Bank, it has been a tough but eventful ride. At the end of December 2015, it had a balance sheet size of Rs 85,000 crore, of which 99 per cent was due to infrastructure and large corporates.

It also accumulated healthy deposits of over Rs 1,600 crore and expects to close the year with over 48 branches, a bulk of them in the rural areas.

It is a tough market out there. For YES Bank and Kotak Bank, the previous two bank licence winners, it has taken more than a decade for their low-cost deposits to stabilise and even then they have had to pay a few percentage points more interest rate than peers.

"Unless somebody has an extremely novel proposition, banking by and large is a business which is easy to replicate, so traction takes time," says Ananda Bhaumik at India Ratings. "I would expect it could be the same as the last time. So, that would probably be the only similarity with Kotak and YES, in the sense that it would take them some while to build some traction."

Competition aside, the two new entrants have had something in common - coming to grips with the everchanging technology. "We had not used IT of this scale before," says Bandhan's Ghosh. "The entire top management had worked till 3-4 every night in the first fortnight of our banking journey, trying to streamline the existing business into the new platform and manage the flow of deposits from the first day."

An entity dealing with rural customers may have braced itself up for the huge task, but it was a mammoth task even for the urban-centric IDFC Bank.

"What is quite clear in retrospect is that we underestimated the time it takes and how difficult it is to negotiate an appropriate design contract with technology vendors who invariably exaggerate their capabilities." Lall said.

Their experience is a case in point for the up and coming differentiated banks, especially for the eight MFIs on the verge of becoming small finance banks. RBI has awarded 11 payments bank licences and 10 small bank finance licences.

Will they in anyway upset the applecart for the new banks?

"India being a vast untapped market, there will be space for everybody," says Ghosh, who is proud of his 84 lakh customer base.

Crompton Greaves plan to cut debt makes analysts bullish on counter

Src : http://economictimes.indiatimes.com/wealth/invest/crompton-greaves-plan-to-cut-debt-makes-analysts-bullish-on-counter/articleshow/51559994.cms

Crompton Greaves plan to cut debt makes analysts bullish on counter

By Narendra Nathan, ET Bureau|Mar 28, 2016, 08.00 AM IST

The demerger of Crompton Greaves' consumer products business is complete and the counter started trading (excluding the consumer business) from 15 March. It is quoting close to the value assigned by analysts to the demerged entity earlier.

Now, because of several reasons, analysts are beginning to get bullish on this counter. First, because investors prefer focused companies over diversified ones. Most conglomerates quote at a discount to their sum-of-parts valuation, popularly known as conglomerate discount. The valuation discount for Crompton Greaves should also gradually go now. 

Second, Crompton Greaves plans to reduce its loss-making overseas businesses and focus on domestic business. Since the domestic business is a cash generator, this should further help to improve its valuations. This is popularly known as tossing out-the-trash-and-keeping the-cash strategy. The first in line for sale is the company's international systems business. Though systems business contributed only 27% to its overseas revenue, it accounted for most of the company's overseas losses. The other two overseas businesses—automation and drives division—are making reasonable earnings before interest, taxes, depreciation and amortization margins of around 8% now. Once this division is sold, the company's loss from its international operations should come down by the second half of 2016-17. 

Third, Crompton Greaves plans to use the money generated from overseas asset sales for debt reduction to become a completely debt-free company. The company management has already accepted a revised offer to sell its international power business for 115 million to First Reserve PE fund. The operational and organisational transition appears to be going on smoothly. The management has indicated that the company may go for further monetisation of assets in 2017-18 and, this, along with the positive cash flow from the domestic business, should make Crompton Greaves a cash-rich company by March 2018. 

Currently, the counter is depressed because of concerns about overseas asset sales. Though things are expected to improve, low current margin is another factor pulling down valuations. As per consensus estimate, the company's earnings per share may jump to Rs 4.72 by March 2017. This means that the counter is trading only at a forward PE of 10. 

Selection methodology: We pick the stock that has shown the maximum increase in 'consensus analyst rating' in the past one month. Consensus rating is arrived at by averaging all analyst recommendations after attributing weights to each of them (5 for strong buy, 4 for buy, 3 for hold, 2 for sell and 1 for strong sell) and any improvement in consensus analyst rating indicates that the analysts are getting more bullish on the stock. To make sure that we pick only companies with de .. 

100 Baggers by Christopher W. Mayer

100 Baggers: Stocks That Return 100-to-1 and How To Find Them 

by Christopher W. Mayer

This is book based on a study of 100 baggers. It is like a sequel to Phelps book. The book is short and sweet with around 200 pages. It does not confuse us with theories and numbers. It throws a lot of stories about Wall Street and some great Investors. It refers to some more excellent books and studies. At the end of the reading even if you are not convinced about finding a 100X, you will learn to appreciate the importance of long term investing. A must read.

Some snippets from it

“One of the basic rules of investing is never, if you can help it, take an investment action for a noninvestment reason,” Phelps advised. Don’t sell just because the price moved up or down, or because you need to realize a capital gain to offset a loss. You should sell rarely, and only when it is clear you made an error. One can argue every sale is a confession of error, and the shorter the time you’ve held the stock, the greater the error in buying it—according to Phelps.

The biggest hurdle to making 100 times your money in a stock—or even just tripling it—may be the ability to stomach the ups and downs and hold on.

4 STUDIES OF 100-BAGGERS

1.Tony’s 100-Baggers

A fellow named Tony at TS Analysis published one informal 15-page study called “An Analysis of 100-Baggers.”  

There was a good case study of a 100-bagger recently posted on the Microcap Club’s website by Chip Maloney. This is worth spending a little time on and illustrates Tony’s principles. Maloney reviewed MTY Foods, which is a Canadian franchisor of quick-service restaurants such as Thai Express, Extreme Pita and TCBY.

2. MOSL 100X Study

3.Martelli’s 10-Baggers

Presentation called “10x Return Stocks in the Last 15 Years,” by Kevin Martelli at Martek Partners.

4.Heiserman’s Earnings Staircase

Another study is by Hewitt Heiserman Jr., titled “Ben Graham and the Growth Investor.” 

The 100-bagger population seems to favor no particular industry. There are retailers, beverage makers, food processors, tech firms and many other kinds. The only thing they seem to have in common is the subject of the study: they returned at least 100 to 1.

Median sales figure for the 365 names at the start was about $170 million and the median market cap was about $500 million. That’s interesting on two levels: One, it dispels a myth that to get a 100-bagger you have to start with tiny companies. True, these are small companies. But $170 million in sales is a substantial business in any era. It’s not a tiny 50-cent stock with no revenues or barely any revenues.Secondly, these figures imply a median price-to-sales ratio of nearly three, which isn’t classically cheap by any measure. Going through these 100-baggers, you’ll find stocks that looked cheap, but more often you find stocks that did not seem cheap based on past results alone.

So you must look forward to find 100-baggers. You have to train your mind to look for ideas that could be big, to think about the size of a company now versus what it could be.

Another interesting chart to look at concerns how long these stocks took to become 100-baggers. The average time was 26 years.

Case Studies : Monster Beverages, Amazon, Electronic Arts, Comcast, Pepsi, Gilette,

Key to 100 Baggers

“Over time,” Donville wrote, “the return of a stock and its ROE tend to coincide quite nicely.”

A lot of people don’t appreciate how important the ability to reinvest those profits and earn a high ROE is.

To sum up: It’s important to have a company that can reinvest its profits at a high rate (20 percent or better). ROE is a good starting point and decent proxy. I wouldn’t be a slave to it or any number, but the concept is important. You want to think about return on capital in some way—the higher, the better. You want to think about what a business can earn on the money invested in it and its ability to reinvest cash at that rate—the longer, the better. The road to 100-baggerdom is much, much harder otherwise.

In the pursuit of 100-baggers, it helps to back talent. Think about finding people who might be the next Jobs, Walton or Icahn. Invest alongside talented people. Many of the best-performing stocks of the past 50 years had such a key figure for at least part of their history.

The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success, by William Thorndike.

Each of the Outsiders shared a worldview that “gave them citizenship in a tiny intellectual village.” Thorndike writes each understood that

• capital allocation is the CEO’s most important job;

• value per share is what counts, not overall size or growth;

• cash flow, not earnings, determines value;

• decentralized organizations release entrepreneurial energies;

• independent thinking is essential to long-term success;

• sometimes the best opportunity is holding your own stock; and

• patience is a virtue with acquisitions, as is occasional boldness

BET BIG

I can’t be involved in 50 or 75 things. That’s a Noah’s Ark way of investing—you end up with a zoo that way. I like to put meaningful amounts of money in a few things. — Warren Buffett

Thomas Phelps wrote, “Be not tempted to shoot at anything small,” the idea being you want to focus your capital on stocks with the potential to return 100x. You don’t want to own a zoo of stocks and ensure a mediocre result. 

Moats

In his The Little Book That Builds Wealth, Dorsey uses an analogy for why you should pay attention to moats: “It’s common sense to pay more for something that is more durable. From kitchen appliances to cars to houses, items that last longer are typically able to command higher prices.. . . The same concept applies in the stock market.”

Companies that are more durable are more valuable. And moats make companies durable by keeping competitors out. A company with a moat can sustain high returns for longer than one without. That also means it can reinvest those profits at higher rates than competitors. As you’ve seen by now, this is an important part of the 100-bagger recipe. Moats take various forms. Here are some

• You have a strong brand.

• It costs a lot to switch.

• You enjoy network effects.

• You do something cheaper than everybody else.

• You are the biggest.

“Measuring the Moat: Assessing the Magnitude and Sustainability of Value Creation” is a 70-page report on the issue.

The central observation is that even the best industries include companies that destroy value and the worst industries have companies that create value. That some companies buck the economics of their industry provides insight into the potential sources of economic performance. Industry is not destiny.

Berry writes that “high gross margins are the most important single factor of long run performance. The resilience of gross margins pegs companies to a level of performance. Scale and track record also stand out as useful indicators.”

MISCELLANEOUS MENTATION ON 100-BAGGERS

Don’t Chase Returns

Keep that in mind before you reshuffle your portfolio after looking at year-end results. Don’t chase returns! And don’t measure yourself against the S&P 500 or any other benchmark. Just focus on trying to buy right and hold on.

Don’t Get Bored

In the financial markets, people often wind up sabotaging their own portfolios out of sheer boredom. Why else put money into tiny 70-centshare mining companies that have virtually no chance of  being anything at all? Why bother chasing hyped-up biotech companies that trade at absurd levels based on flimsy prospects?

Don’t Get Snookered: Avoid Scams

Do Ignore Forecasters

Sosnoff ’s law. This comes from a book called Humble on Wall Street, published in 1975 and still one of the best books on the experience of investing, on what it feels like. Its author, Martin Sosnoff, wrote that “the price of a stock varies inversely with the thickness of its research file. The fattest files are found in stocks that are the most troublesome and will decline the furthest. The thinnest files are reserved for those that appreciate the most.”

In other words, the best ideas are often the simplest. If I find myself working really hard to justify keeping or buying a stock, I think of Sosnoff’s law. I’ve wasted countless hours on bad stocks and bad businesses.

I feel no shame at being found still owning a share when the bottom of the market comes. I do not think it is the business, far less the duty, of an institutional or any other serious investor to be constantly considering whether he should cut and run on a falling market, or to feel himself open to blame if shares depreciate in his hands. I would go much further than that. I should say it is from time to time the duty of a serious investor to accept the depreciation of his holdings with equanimity and without reproaching himself. 

That excerpt comes from a letter in 1938 by one of the greatest investors of all time. He made money in one of the most difficult markets of all time—that of the Great Depression. He is John Maynard Keynes (1883–1946).

I also learned it was critically important to have some cash. “Cash was king,” Feldman writes of the depths of the Great Depression. “If you happened to have any, you were really in the driver’s  seat.” Cash means you have options and you are not reliant on fickle lenders.

The Essential Principles of Finding 100-Baggers

#1 You Have to Look for Them

So, rule number one for finding 100-baggers is that you have to look for them—and that means you don’t bother playing the game for eighths and quarters, as the saying goes. Don’t waste limited mental bandwidth on stocks that might pay a good yield or that might rise 30 percent or 50 percent.

You only have so much time and so many resources to devote to stock research. Focus your efforts on the big game: The elephants. The 100-baggers.

#2 Growth, Growth and More Growth

So, you need growth—and lots of it. But not just any growth. You want value-added growth. You want “good growth.” If a company doubles its sales, but also doubles the shares outstanding, that’s no good. You want to focus on growth in sales and earnings per share.

Likewise, if a company generates a lot of extra sales by cutting its prices and driving down its return on equity, that may not be the kind of growth you’re looking for. You want to find a business that has lots of room to expand—it’s what drives those reinvestment opportunities.

#3 Lower Multiples Preferred

You don’t want to pay stupid prices.

#4 Economic Moats Are a Necessity

A 100-bagger requires a high return on capital for a long time. A moat, by definition, is what allows a company to get that return. Therefore, it pays to spend some time thinking about what kind of moat a company has.

#5 Smaller Companies Preferred

Start with acorns, wind up with oak trees. Start with oak trees, and you won’t have quite the same dramatic growth. It may seem obvious, but it’s important.

#6 Owner-Operators Preferred

#7 You Need Time:

Use the Coffee-Can Approach as a Crutch. Once you do all this work to find a stock that could become a 100-bagger, you need to give it time. Even the fastest 100-baggers in our study needed about five years to get there. A more likely journey will take 20–25 years.

#8 You Need a Really Good Filter

There is a world of noise out there. The financial media is particularly bad. Every day, something important happens, or so they would have you believe. My own study of 100-baggers shows what a pathetic waste of time this all is. It’s a great distraction in your hunt for 100-baggers.

#9 Luck Helps

Let’s face it. There is an element of luck in all of this.

#10 You Should Be a Reluctant Seller

I’ll end this section on when to sell with one of my favorite quotes, from Martin Whitman at Third Avenue Funds: “I’ve been in this business for over fifty years. I have had a lot of experience holding stocks for three years; doubled, and I sold it for somebody else, for whom it tripled in the next six months. You make more money sitting on your ass.”

China's decline in specialty chemicals business to benefit India

http://economictimes.indiatimes.com/markets/stocks/news/chinas-decline-in-specialty-chemicals-business-to-benefit-india/articleshow/51544998.cms

China's decline in specialty chemicals business to benefit India

By Dia Rekhi, ET Bureau | Mar 25, 2016, 04.21 AM IST

MUMBAI: Shares of Indian companies in the specialty chemicals business could be potential winners as the domestic industry could be beneficiaries of a potential decline in this business in China. 

The Indian market is very small, barely 1-2% of the global market, which is growing at a rapid pace, said a report by Ambit Capital. 

The global specialty chemicals market is likely to expand by 5.2% on a compounded basis from 2013-2018, and is estimated to jump to $761 billion by 2018 from $619 billion in 2014, said the report. "Business is shifting to India from China," said Dhiraj Sachdev, vicepresident, HSBC Asset Management. 

"This is mainly on account of stringent effluent norms and increasing wage costs in China. India is only one-eighth, or one-tenth, the size of Chinese speciality chemicals market, which throws up a huge opportunity for Indian companies with the potential to scale up and grow on a sustained basis." Specialty chemicals are used to improve product quality in various industries such as electronics, paints, coatings, plastics, and automobiles. Though there's a consensus that the sector has huge potential, there are others who tell investors to be wary. 

"There's a huge play in here, but you have to be very careful about where you are investing," said Hansal Thacker, director, Lalkar Group. "We are betting on ABS, which is a basic chemical used in consumer durables, toys, electrical circuits, interiors of cars — the applications are endless. 

There's going to be a shift in consumption pattern and that will trigger the consumption of ABS." What makes the sector a good investment bet is that it's a very highly skilled segment, thus, providing a natural entry barrier. "Unlike the pharma sector, high-quality players in emerging markets which can deliver on innovators' quality and safety parameters are limited," said Ritesh Gupta, oil and gas, midcaps analyst and co-author of the Ambit Capital report whose top picks include PI Industries and SRF. "Facing compliance, cost, and capacity issues, global agrochemical innovators are looking to outsource their manufacturing processes to India. This creates an opportunity for Indian firms over the next 5-10 years." The report pegged PI Industries P/E at 20.3x estimated earnings for 2017-18 and SRF at a P/E of 15x estimated earnings for the same period. Shares of PI Industries have fallen 9% in the last month, while that of SRF have risen about 5% in the same period. 

"Specialty chemical companies will prosper in India because of its chemistry, R&D skillset and economies of scales achieved by the country," said Manish Bhandari, CEO at Vallum Capital. "This is supported by a paradigm shift in Chinese markets towards urgency of reducing pollution and investing in labour cost across industries. "We have established ecosystem of basic chemicals, a key input of specialty and pharmaceutical industry." His preferred companies include PI Industries, SRF, Navin Flurochemicals, Godrej Industries and Balaji Amines. Some believe that valuations are rich while others feel they are justified. 

According to the report, the specialty chemicals sector has been one of the best performing sub-sectors with most of the players delivering returns between 50% and 100% over the past year. This has made multiples increase from 5x one-year forward earnings to a band of 12-30x. It also said a 15-20x one-year forward earnings multiple is not expensive, because of the growth profile and high RoCEs that these companies provide. "Specialty chemicals don't sell a product, they sell a solution which means their margins will remain intact. 

Don't be blinded only by valuation, address the opportunity as well," Thacker said. The fact that Indian players are being preferred for value propositions such as process capability, purity and IP protection rather than merely cost arbitrage is a reason to cheer, said analysts.

'An Investor's Odyssey: The Search for Outstanding Investments' - Chuck Akre 2011

http://www.valueinvestorconference.com/text/transcripts/Chuck%20Akre%20Transcript%20VIC%202011.pdf

Again, compound return really is the center point, and ultimately we spend much of our time trying to identify those businesses which are most likely to compound the shareholder’s capital at an above-average rate. Were we simply a pure value investor, we would be regularly looking to unload those securities, which appreciated to some predetermined notion of present value, and we would lose out, in our minds, on the opportunity to compound our capital because of these sales.

One of the acknowledgements I think we’ll all gladly accept to is that high return businesses have something unusual going on which in fact allows them to earn above average rates on unemployed capital. Often these special circumstances are referred to as moats. In our firm is the properly identify what is the nature of the moat; what exactly is it that’s causing this good result. And to us this is a really critical point.Because the investment business can have so many issues that upset the apple cart, being confident about what it is exactly that’s causing the results is a huge advantage for us. In point of fact, we have on occasion been able to add to positions in time of turmoil, because the confidence in understanding a business allowed us to see through all the noise in the marketplace. 

Now it’s time to go fishing. The pond I want to fish in is the one where all the fish are the high return variety. Naturally, if my returns are going to correlate to high ROEs, then I want to shop among the high-return, high-ROE businesses. In our firm we use this visual construct to represent the three things that we focus our attention on. This construct in fact is an early 20th century three-legged milking stool and before I go on to describe each leg to you I want you to see that the three legs are actually sturdier than four, and that they present a steady surface on all kinds of uneven ground, which of course, is their purpose in the first place. 

Leg number one stands for the business model of the company. And when I say business model, I’m thinking about all the issues that have come into play that contribute to the above average returns on the owner’s capital. Earlier we called this the moat. You know the drill: Is it a patent, is a regulatory item, is it a proprietary business, is it scale, is it low-cost production, or is it lack of competition? There are certainly others but for us, it’s important to try to understand just what it is about the model that causes the good returns. And what’s the outlook? In our office we often say, “How wide and how long is the runway?”

Let me tell you a quick story. About 25 years ago I had an intern working with me and I gave him a box of articles I’d saved relating to businesses which had caught my eye but which I had done no work. And he came back some days later with a piece on a company called Bandad, which was located here in the Midwest in Muskoteen, Iowa, and my intern explained to me that we should look at the business that had 20% ROE, low valuation, growth opportunities and so on, and I said “What business is it in?” And his reply was that it was in the tire business. And so I said that’s interesting, why don’t you go look at all the returns in capital and all tire companies? And he did and he came back and he reported that all those companies had returns on the owner’s capital in single-digits. So here we were with a business which described itself as the largest independent truck-and-bust tire recapper, but our quick return analysis said no way, it can’t possibly be in the tire business.

So our mission therefore was to discover what was the real source of the earnings power for the business, allowing them to have such returns. Well if you went to Musketeen to meet with the CEO, who by the way, greeted us with his feet on the desk eating an apple. I won’t bore you with all of the bizarre history – and it is indeed bizarre – but we concluded that the company’s tie to its independently owned distributers and service centers was at the core of its business value. And those independently owned business men were incredibly loyal to Bandad, especially because of the outstanding way that they’ve been dealt with by Bandad during and after the 1973-74 oil embargo. It turns out that each of these independent business men who typically work from 6 a.m. to 8 p.m., unlike their Goodyear stores who had managers who worked from 8 a.m. to 6 p.m., were enormously grateful for what the company had instituted called the powerfund during the oil embargo. They put this in place to collect all of the excess profits that the company made when the price of oil began to decline, and they made a deal with all of these independent managers that they would return money to them in direct proportion to the sales. You know, they bought the tire tread, which was an oil-based derivative, from Bandad, and used it during the recapping process. So, the independent businessman wasn’t allowed to go buy a new Cadillac, but he could buy a new shop, build a new shop, get new equipment, whatever, all through this power fund that Bandad had put in place. And so this power fund in fact really lost its economic underpinnings and the company ran into difficulty and years later, it was later acquired actually, in 2007 by Bridgestone. We owned the shares for several years and had a very profitable investment, but sold them when we lost confidence in the business model. It was unique, but my point is, simply trying to understand what it is that’s causing the good return, and how long is it likely to last. It was a profitable investment for us, but not a great compounder. 

So my point here is simply that the source of a business’ strength may not always be obvious. Therefore, understanding that first leg of the stool, the business model, has its own level of difficulty. It’s also where the fun is, I might add, and we believe it is absolutely critical. As I said, we spend countless hours at our firm working on these issues every week. 

The second leg of stool is what we describe, is the Peevol model, and what we are trying to do is to make judgments about the focus around the business. We often ask ourselves, do they treat public shareholders as partners, even though they don’t know them? My good friend Tom Gaynor who you heard from yesterday describes it this way: He said do they have equal parts skill and integrity? What we’re trying to do is get at is this: What happens at the company level also happened at the per-share level. My life experience is, once someone puts his hand in your pocket, he will do so again. And presumably, we’re examining the company in the first place because we already determined that the managers are killers about operating the business. And because we run concentrated portfolios, we literally have no time to mess with those managers about who we have real questions about in our real experience.

Here’s another story: About 30 years ago, I owned a very, very, very, let me emphasize, very tiny interest in a company called Charlotte Motor Speedway, which over the years has come to be called Speedway Motorsports. And the principal shareholder then, and possibly still is, is a person who had a negative history with the SEC. The agency had barred him from having any association with the company for a period of several years. And this was perhaps 35 or 40 years ago. At any rate, this majority shareholder returned to the scene, and by the mid-‘80s had accumulated 70% of the stock of Charlotte Motor Speedway, and he … tendered for all of the minority shares that he didn’t own. When I joined … in Charlotte, North Carolina, which after discovery was successful in getting us a settlement that was several times the proposal going private price. This issue confined the CEO, which in all likelihood caused him to settle with a long list of misbehavior including improper valuation, failure to include corporate assets, a lack of independence of outside opinions, and so on. Quite naturally he demanded that a settlement be sealed and it was. I’ve never since held a position in any of that CEOs public or private companies, because he had indeed put his hand in my pocket.

Following my Charlotte Motor Speedway experience I bored down a new holding in International Speedway (ISCA), and I discovered that it was in fact the best out of the three

public companies involved in NASCAR racing. And my experience in International Speedway was a good example of our approach. When we first invested in ISCA in 1987, the metrics were as follows: The ROE was in the mid 20% range, the income margin was over 50%, book value per share had a CAGR 28%, there was no leverage, it had a modest valuation, it had attractive growth prices, and there was huge, over 50%, insider ownership. We owned shares in International Speedway for a good many years, and had good experience of compounding our capital at generally between 10 and 20 times our cost, depending on when the shares were purchased. We later sold all of our shares when we became concerned with the management’s approach to all aspects of the business. The CEO had died, and other family members were running the show, and in addition we were concerned about the runway for their business, as times were changing. So our sales decision was judgment relating to the second leg of the stool, the management model, as well as our view of the business model itself. 

We refer to the third leg of the stool, which quite obviously gives it its stability, as something... as the glue that holds the opportunity together. My next question, therefore, is does an opportunity exist to reinvest all the excess cash generated by a business, allowing it to continue to earn these attractive above average returns? My experience tells me that the reinvestment issue is perhaps the single most important issue facing any CEO today. As in once place where value can be added or subtracted quickly and permanently. So this really relates to both the skill of the manager, as well as the nature of the business. One of my favorite questions to ask a CEO is, “How do you measure the ways in which you are successful in running a business?” And I can tell you that very few ever answer that they measure their success by the growth in economic value per share. Not surprisingly, we hear that the increase in the share price is the answer, rather simply say chief incorporate goals established in conjunction with the board is the answer, and some say that ...accomplishments relating to customers and employees and the community and the shareholders are all the answer. Personally I’m deterred in my view that growth in real economic value per share is the holy grail. Just look at the opening pages of the Berkshire Hathaway annual report, and what do you see? You see a record of growth in book value per share, for 40 years. Forty years. Incidentally, in Berkshire that number, you know, is 20% a year for 40 years, and so it’s no wonder that Warren shows up here as the top of the Fortune 400 list.

After we’ve identified a business that seems to pass the test in all three legs we refer it as our compounding machine. And as we describe it, our valuation discipline comes into play here and we describe it here as simply we are not willing to pay too much.

There’s an old Wall Street ad agent attributed to Goldman Sachs...which says, “Something well bought is half-sold.” Taking a completely different tact, if we had properly identified the compounding in machines and had bought them at modest valuations, we would be set up for the famous Davis double play. That is, the business... will compound our capital at an above-average rate, and we’re in line for an increase in market valuation, but double play indeed.  

Barron's Interview with Seth Klarman - 1991

http://www.pmjar.com/wp-content/uploads/2015/06/Barrons-Interview-19911.pdf

This interview was done nearly a decade after the formation of Blaupost Group. Klarman success has been buying picks where others don't even bother to look. What is very interesting is the amount of cash he held - 40-50%. So when a good opportunity came his way he would swinging his bat when most of the others would have no cash

Some of the snippets from the interview are given below

We define value investing as buying dollars for 50 cents, somewhat like Mike Price's definition.

We will buy dollars for 40 cents, or dollars for 60 cents when they are attractive dollars to buy. I think that we implement it a fair bit differently than many value investors or many so-called value investors who frankly I'm not sure are buying good value at all. Value to some extent is in the eye of the beholder. It is very hard to pin down what the value of a future set of cash flows from a business, be it cable TV or biotechnology, is going to be. Some are easier to predict than others. But it is very hard to predict what those future cash flows are going to be. And it is very hard to ascertain the correct discount rate to bring them back to the present with.

When we look at value, we tend to look at it on a very conservative basis -- not making optimistic forecasts many years into the future, not assuming growth, not assuming favorable cost savings, not assuming anything like that. Rather looking at what is there right now, looking backwards and saying, Is that the kind of thing the company has been able to do repeatedly? Or is this a uniquely good year, and is it unlikely to be repeated? We tend to look at hard assets as much as possible.

For instance, cash is something we understand. When a company has cash on the books, or marketable securities on the books, we think we understand that. And the more you get into businesses that depend on things going right in the future, the harder we find it to understand it. So we tend to buy asset-rich businesses, very predictable businesses. But perhaps most important, we are not just focusing on equities. We focus on any security of a company that is mispriced. We can even find some companies where one security, like the equity, is overvalued, but where another security, like the debt, might be undervalued. We have flexibility in our partnership agreement to do pretty much anything we like. Right now, and for the better part of the last two years, much of our investment has been in the senior securities of overleveraged companies.

What creates opportunities is an interesting question. Often we do best in turbulent times, specially if we are fortunate enough to be holding cash going in. If you think of the stock market as a cauldron of mine strone soup that occasionally somebody sticks a ladle in and stirs up, it takes a while before all the vegetables float back to the level that they were at before.

Q: How do you get your ideas?

A: We originate, I would guess, half or so internally. That would mean reading the newspapers, looking at periodicals, looking at Barron's, for instance

One thing we want to look for is perhaps a market inefficiency or imperfection. And often these are caused by what we would call institutional constraints. The institutions, first of all, because of their tremendous size, and second of all, because many have gotten away from fundamental investing, tend to be prolific creators of opportunities. An example of this would be when a large company spins off a much smaller subsidiary and distributes the stock free to shareholders. The institutions tend to be natural sellers of the spinoffs.

Either they would have to buy an enormous amount to justify a large position, or they sell. And they sell regardless of fundamentals, regardless of the price compared to the value. So we tend to look at spinoffs as one category. That would be a type of rock that we look under. So when in the newspaper it mentions that such and such a company is considering a spinoff, we will follow the progress of that and look at the registration statement when it becomes available for a possible investment. There are, of course, now people who follow spinoffs, including an analyst at one major firm. So even in that area there might be fewer opportunities than before. Although every so often one slips through the cracks, or one is written up but ignored by most of Wall Street. We do find some opportunities even in overpopulated areas.

 Another type of rock we would look under would be when securities get downgraded from

investment grade to below investment grade, i.e., distressed. In particular, many funds that own these are not permitted to own other than investment-grade securities. So when the downgrade happens, they have to sell, they have no choice, given the rules that they operate under. That may create a short-term supply/demand imbalance. Another opportunity created by selling that is not dictated by fundamentals.

Q: And that is with how much cash?

A: It has actually been over 50% until very recently. It has probably averaged between 40% and 50% for the year. We were fortunate to be well-positioned at the beginning of the year with a few major positions in distressed securities that worked out quite well.

Q: What was the lowest cash position you have had in the eight-plus years you have been doing this?

A: We came very close to being fully invested shortly after the '87 Crash.

 

Fairfax India Holding Shareholders' Letter 2015

http://s1.q4cdn.com/293822657/files/doc_financials/annual_reports/Final-2015-Shareholders'-Letter.pdf

The below are bits and pieces of the letter. Please do go over the full letter for more clarity and learning

While we are bottom-up investors looking to buy exceptional Indian companies at reasonable prices, since our investment thesis was predicated on the transformational impact on the Indian economy of Prime Minister Modi, we would like to review how things are tracking in India as compared to our initial expectations. 

We are not in the large camp of naysayers who are disappointed because they expected miraculous changes and immediate results. We had no such expectations for an economy that was moribund from 67 years of socialism, a literally unnavigable bureaucracy and endemic corruption, but we see significant progress on many important fronts since the new government took office. Here is a list of measures already enacted by this government (our apologies that the list is so long!):

• Crack-down on crony capitalism
• Implementation of a biometric-based identity program (Aadhaar scheme)
• Financial inclusion
• Subsidies shifting to DBT
• Improvement in national railway infrastructure
• Corporate tax: Simplification
• Financial turnaround of state power distribution companies (DISCOMs)
• Auction of coal mines
• Other mineral mines are also to be auctioned
• Higher foreign direct investment (FDI) in insurance, defence and railway infrastructure
• Bankruptcy code
• Smart cities
• Metro rail (commuter infrastructure)
• Progress on dedicated freight corridors (DFCs)
• Archaic labour and other laws amended
• Elimination of obsolete laws
• Make In India
• Invest India
• Involvement of states to improve business environment
• National agriculture market
• Populist decisions avoided

Now we are pleased to report to you on the investments we have made in India

National Collateral Management Services Limited (NCML)

NCML is a ten year old company now preparing to expand to take advantage of the significant market potential in India’s under-developed agricultural storage industry. NCML operates in the agriculture value chain by offering end-to-end solutions in grain procurement, testing, storage and collateral management.

IIFL Holdings Limited (IIFL)

By the time Fairfax Financial became a shareholder, IIFL had become a diversified financial services holding company with subsidiaries in non-banking finance company (NBFC) business, wealth management, retail and institutional stock broking, investment banking and financial products distribution

Adi Finechem Limited (Adi)

Adi is an oleo chemicals company. Oleo chemicals are, broadly, chemicals that are derived from plant or animal fat, which can be used for making both edible products and non-edible products. In recent years the production of oleo chemicals has been moving from the U.S., Europe and Japan to Asian countries because of the local availability of key raw materials.