Dear Fellow Investors,
“Bull markets go to people’s heads. If you’re a duck on a pond, and it’s rising due to a downpour, you start going up in the world. But you think it’s you, not the pond.”
-Charlie Munger, 1924 – ∞
Charlie Munger, partner of Warren Buffett, passed away last quarter at the age of 99. Warren credits Charlie for the mindset shift and phenomenal track record of Berkshire Hathaway. Charlie’s teachings have had an important impact on our thoughts and behaviour. While it is difficult to do justice to cover it all here, but as a token of tribute, we take a shot at sharing some of his worldly wisdoms around thinking, living and investing better:
- Lifelong multidisciplinary learning: “To a man with a hammer the world looks like a nail”.
Munger said that a single discipline often lacks tools to look at the world holistically. Having key mental models from multiple disciplines – compound interest from Mathematics, margin of safety from Engineering, natural selection from Biology, breakpoint, tipping moment and autocatalysis from Physics and Chemistry, behaviour from Psychology and many more – give better tools to analyse problems or opportunities. For eg. Economic theory predicts that demand falls as price increases. However psychology provides exception to this rule– often high prices of certain products indicate their exclusivity and in turn increase their demand.
- Read read read: “In my whole life, I have known no wise people who didn’t read all the time – none, zero. Spend each day trying to be a little wiser than you were when you woke up. I believe in the discipline of mastering the best that other people have ever figured out. I don’t believe in just sitting down and trying to dream it all up yourself. Nobody’s that smart.”
The road to better thinking and learning is to read. Munger read in truck loads across diverse topics. Buffett said that Munger has the best 30 second brain, he can think about the answers before the question ends. Munger admits that he is able to do this because of hours of study and analysis that has gone into forming opinions on wide range of topics of general importance. Those who keep learning will keep rising.
- Seek to invalidate: “Any year that we don’t destroy one of our best-loved ideas is probably a wasted year. Recognize reality even when you don’t like it – especially when you don’t like it.”
Seeking to invalidate long held incorrect beliefs is necessary to progress. The key is not to ignore disconfirming evidence but to embrace them. Munger gave example of Charles Darwin (father of the theory of natural selection), who trained himself to intensively consider any evidence that went against his hypothesis.
- Human Biases: In his famous talk “Psychology of Human Misjudgement”, Munger shared 25 human tendencies/ biases that lead to judgement errors. An awareness about them can reduce errors. Here are a few popular misjudgements:
- Incentive caused biases: it is difficult to do something that goes against incentives. For eg: AUM based fee or brokerage will lead to asset gathering or portfolio churn respectively.
- Reciprocity bias: tendency to return favours and disfavours. For eg: releasing favourable equity research reports in exchange for investment banking deals (IPOs, M&A, block trades etc.).
- Liking/ loving bias: tendency to ignore faults or grant favour to those liked or loved. For eg: getting investment opinions influenced by good looking/ presentable top management of a company.
- Confirmation bias: tendency to look at facts selectively so as to support already held beliefs or conclusions. What a man wishes, that also will he believe. For eg: overlooking bad news around owned stocks.
- Invert, always invert – “If you want to achieve X, find how to avoid non-X. Invert, always invert. To live a good life, find how to live a bad life and don’t do it. All I want to know is where am I going to die so that I donot go there. It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”
- Track Record: “I think track records are very important. If you start early trying to have a perfect one in some simple thing like honesty, you’re well on your way to success in this world. Remember that reputation and integrity are your most valuable assets – and can be lost in a heartbeat.”
- Work/ Career: “Three rules for a career: Don’t sell anything you wouldn’t buy yourself. Don’t work for anyone you don’t respect and admire. Work only with people you enjoy.”
- Happiness: “Avoid envy, avoid self-pity, avoid resentment and have low expectations.”
- Mistakes: “A meaningful life cannot be lived without making mistakes (corollary: pursuit of returns higher than risk-free rate will invite chances of mistakes). But try avoiding fatal ones by first learning from others’ mistakes.”
Below are few useful thoughts that Munger has shared on investing:
- All intelligent investing is value investing – acquiring more than you are paying for. You must value the business in order to value the stock. (inference: growth and quality are components of value)
- A great business at fair price is superior to a fair business at great price. (Warren Buffett attributes the shift of his style and resultant success of Berkshire Hathaway to this one secret.)
- There are worse situations than drowning in cash and sitting, sitting, sitting. I remember when I wasn’t awash in cash —and I don’t want to go back.
- We have three baskets for investing: yes, no and too tough to understand.
- The wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, which can be very long, they don’t. It’s just that simple.
- I want to think about things where I have an advantage over others. I don’t want to play a game where people have an advantage over me. I look for a game where I am wise, and others are stupid. And believe me, it works better. God bless our stupid competitors. They make us rich.
- How could economics not be behavioural? If it isn’t behavioural, what the hell is it?
- Bull markets go to people’s heads. If you’re a duck on a pond, and it’s rising due to a downpour, you start going up in the world. But you think it’s you, not the pond.
- Understanding both the power of compound return and the difficulty of getting it is the heart and soul of understanding a lot of things.
- It’s (investing) not supposed to be easy. Anybody who finds it easy is stupid.
Book suggestion: Those interested in reading more about him can start with Poor Charlie’s Almanac
A1. Statutory PMS Performance Disclosure
|CED Long Term Focused Value (PMS)
|S&P BSE 500 TRI (includes dividends)
|*From Jul 24, 2019; Since inception performance is annualised; Note: As required by SEBI, the returns are calculated on time weighted average (NAV) basis. The returns are NET OF ALL EXPENSES AND FEES. The returns pertain to ENTIRE portfolio of our one and only strategy. Individual investor returns may vary from above owing to different investment dates. Annual returns are audited but not verified by SEBI. W.e.f. April 01, 2023 SEBI requires use of any one from Nifty50, BSE500 or MSEI SX40 as a benchmark. We have chosen BSE500 as our benchmark as it best captures our multi-cap stance.
Protecting our wicket
Broader markets scaled new peak this year. BSE 500 index was up 34% since Mar 2023. Higher euphoria was seen in mid and small caps with BSE Midcap and BSE Smallcap indices being up 53% and 58% respectively. Despite being only 73% invested, we were also up 28% thanks partly to the general rise in market prices.
While evaluating investment performance in bullish times like current one, entire focus needs to be on portfolio risk with a complete blind eye to headline returns. For, these are the heady times that mess up human mind and engender mistakes. Without worrying about lagging index or FOMO, we continue to adhere to price and quality discipline while deploying capital in the current expensive market. This discipline, we hope, will allow us to fall less and make up for current relative underperformance versus the index. To invoke cricket parlance, the pitch is difficult, conditions overcast and the ball is swinging and bouncing. This calls for playing defensive and protecting our wicket. Stance: Cautious.
A2. Underlying business performance
|Past Twelve Months
|Earnings per unit (EPU)2
|FY 2024 EPU (expected)
|Jun 2023 (Previous Quarter)
|Sep 2022 (Previous Year)
|CAGR since inception (Jun 2019)
|1 Last four quarters ending Jun 2022. Results of Jun quarter are declared by Nov only. 2 EPU = Total normalised earnings accruing to the aggregate portfolio divided by units outstanding. 3 Please note: the forward earnings per unit (EPU) are conservative estimates of our expectation of future earnings of underlying companies. In past we have been wrong – often by wide margin – in our estimates and there is a risk that we are wrong about the forward EPU reported to you above. 4 Adjusted earnings.
Trailing Earnings: Trailing twelve months Earnings Per Unit (EPU) of underlying companies, grew by 59.3% (including effects of cash equivalents that earn ~5%).
1-Yr Forward Earnings: We had upgraded the expected earnings per share for FY24 in the last letter from 6.5-7.5 to 8.0-9.0. The actual earnings are moving in the direction we had expected and therefore we maintain the guidance.
A3. Underlying portfolio parameters
|CED LTFV (PMS)
|1 ‘sale of equity shares’ divided by ‘average portfolio value’ during the year to date period. 2Source: BSE. 3Portfolio RoE is on core equity positions
B. DETAILS ON PERFORMANCE
B1. MISTAKES AND LEARNINGS
There were no new mistakes this quarter. A rising market generally hides them, to be fair.
Update on Music Broadcast (Radio City) position: We have recovered our 30% loss in this small position. The position is up 3% as of writing of this letter. The annualised yield to maturity if we sell the equity position immediately and hold the preference share till maturity is 6%. This is net of tax and therefore better than liquid funds or FDs.
A brief background: We had participated in a special situation whereby we got free bonus preference shares of Music Broadcast (aka Radio City). Our thinking was that this play could give us a low risk 10% return on our free cash that otherwise was earning 6-7% in liquid funds (the tax effect is also favourable on former). The combined position (equity shares + bonus preference shares) was around 3% at inception. At the end of that quarter we were down 30% (or 1% of portfolio). We had shared that we made a mistake and learnt that we should engage in these plays only if the underlying equity shares are traded in futures so that we can lock our selling price. However we decided not to sell immediately, believing that upcoming elections will help radio advertising.
Cut to today, the net position has changed from -30% to breakeven. Hike in central government radio advertisement rates before elections and a buoyant market helped. We will take a decision to sell the equity part of the position in due course to harvest tax losses (will save tax).
B2. MAJOR PORTFOLIO CHANGES
We increased our position in one holding. It is now a major holding. We exited from one minor position at an annualised gain of 19% including dividends.
When to sell
Selling is easier when either the thesis turns out to be wrong or unexpected events impair the business fundamentals. However, the difficulty arises when business and share price both are doing well. The biggest mistake many renowned investors have admitted making is selling winners too soon (selling a potential 10-50 baggar at 2x). If the business is fundamentally sound, interim price fall may be temporary. Selling sooner would mean forgoing all the future upside.
On the flip side, however, endowment effect – overvaluing one’s things/ efforts – can fool us to mistake an ordinary company to be a future winner. Even if we remain dispassionate in assessing the business quality and immune ourselves from endowment effect, we are dealing with the future which can bring negative surprises. Promoters often failing to predict the future of their companies is a case in point. Therefore, on the sell date, we can never be fully sure that we have sold right.
Another aspect around selling is an opportunity to re-balance the portfolio by reducing strongly correlated positions. Over time, the mutual weights of positions change. If price changes lead to increase in portfolio exposure to one or more themes/factors – capital expenditure, crude oil, rural demand or capital markets for instance – selling may allow lowering excess exposure to a single theme/factor.
The middle road, then, is to vary the extent of selling depending on dispassionate assessment of fundamentals, portfolio exposure to a theme/ factor and degree of overpricing.
B4. FLOWS AND SENTIMENTS
Fearing absence of fear
Retail participation and general sentiments towards equities remain worryingly exuberant. This is evident from highest ever flows to SME IPOs, higher number of smaller companies in main board IPOs, high inflows into riskier mutual fund schemes and record derivatives volumes. Insiders (promoters and private equity investors) are using this opportunity to happily exit at lofty valuations. It is not difficult to guess that in this bi-party trade involving retail buyers and insider sellers, who is going to be proven right.
SME IPOs are at the riskier end of IPO segment. 181 issues have raised Rs. 4,600cr in CYTD 2023. This is highest ever and double of past high recorded in 2018. BSE SME IPO index is up 99% in last twelve months indicating high retail participation even post listing. Many of these companies have weak business models and unknown governance track records.
45 main board IPOs concluded in CYTD 2023, second highest in last decade. The average size of IPOs this year is half of average of last 6 years indicating higher share of many smaller IPOs. Smaller IPOs indicate wider retail tolerance.
Smallcap, midcap, and thematic schemes of mutual funds garnered over Rs 87,000cr net inflows in last 12 months, constituting over 57% of all net inflows into actively managed equity schemes, an all-time high. These schemes gain favour mostly during bullish times.
Derivatives volumes as a factor of cash volumes has reached alarming proportions in India. Derivatives volumes that used to average around 26x of cash volumes in India between 2015 and 2021 and much lower in the world, have jumped to over 400x of cash volumes in the current year. This is mainly due to higher participation in weekly expiring options contracts that allow low ticket bets. Sadly, as per a recent SEBI study, over 90% of retail derivatives traders lose money.
Promoters and private equity investors (insiders) have smartly used the retail euphoria to sell stakes in their companies. Insiders have sold over Rs 90,000cr worth of their stakes in CY2023, highest in last 5 years.
There is no fear among common investors today. This calls for fear.
C. OTHER THOUGHTS
India’s inflation in last 150 years
What has been the rate at which Indian Rupee has lost its purchasing power in last 150 years? We stumbled upon an objective measure some days ago.
We had an opportunity to visit a coins exhibition. Amid coins and currencies as old as the 3000 years old Magadha silver coins, one gold coin caught our attention. This was an extremely rare 5-Rs currency coin of year 1870 weighing 3.88 grams in gold. The exhibitor was kind enough to allow us to take a picture.
This coin, which is of 22k (91.7% purity) gold, tells us the price of gold – Rs 5 for 3.88 grams or Rs 1.4/gram in 1870 for 24K gold. The price of same gold is around Rs 6,500/gram today. Rs 1.4 turned to Rs 6,500, a growth of 4600x in around 150 years.
Gold is considered as a hedge against inflation. If we take liberty to equate rise in gold price as rough indicator of inflation, this translates to an inflation of 5.5% annually over 150 years. To cross check, we inquired price of Ghee (clarified butter) with some senior citizens. They recollected it to be around Rs 5 per kg during 1940-1950. That also translates to inflation of over 6%.
What does this convey about future? We can take a 5%-6% as possible inflation range over this generation. A savings instrument should beat this after tax to keep the purchasing power of our savings intact. This translates to a pre-tax asking return of around 8% (for those in highest tax bracket).
As always, gratitude for your trust and patience. Kindly do share your thoughts, if any. Your feedback helps us improve our services to you!
Wishing you a great 2024,
Team Compound Everyday Capital
Sumit Sarda, Surbhi Kabra Sarda, Punit Patni, Arpit Parmar, Sanjana Sukhtankar, Anand Parashar
Disclaimer: Compound Everyday Capital Management LLP is SEBI registered Portfolio Manager with registration number INP 000006633. Past performance is not necessarily indicative of future results. All information provided herein is for informational purposes only and should not be deemed as a recommendation to buy or sell securities. This transmission is confidential and may not be redistributed without the express written consent of Compound Everyday Capital Management LLP and does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product. Reference to an index does not imply that the firm will achieve returns, volatility, or other results similar to the index.