“VALUE

LIES not only in low PE, low book value, or other conventional measures of
value,” says market guru and bestselling author, Ashu Dutt. “Value originates from many
sources and exists in all markets at all times. For example, catching value from structural
shifts in a stock, sector or the market offers once-in-a-lifetime returns.”
In this book, Ashu reveals secrets of value investing that go
beyond the traditional measures of value, methods used by
successful value investors, market-tested techniques that can give
you the professional edge and make you very rich:

How to identify market periods when the rewards will be

many times the risk
Why “cheap” and “value” are not the same thing
How identifying emerging value investment themes ahead of the crowd leads to
super profits
Why the maximum money is made in a short span of time — and from just a few
stocks
When do IPOs constitute a good value buy
How to find extraordinary value in investment manias, market chaos, rational
bubbles, commodity cycles and market falls caused by credit squeeze
Why you must lock in the sector before picking a stock
How to find value in bull and bear markets
How to boost your returns from the traditional metrics of value investing
Value investing lessons from the masters.

PLUS, much, much more.

~
ASHU DUTT is a financial markets guru and one of the best known and respected faces in
Indian financial markets. He is the author of ten best selling books on subjects ranging
from commodities to value investing and trading. Ashu strives to bring to retail investors
the trading secrets, techniques and market strategies that are typically the exclusive
domain of big investors.
Ashu was the Associate Editor at CNBC TV 18, Chief Consulting Editor at Bloomberg,
Senior Anchor at NDTV and Star News, anchoring some of India’s marquee programmes
on financial markets.
Ashu has also been a Master Trainer and a Conference speaker across Asia speaking at
investment banking, private equity, real estate structured conferences like Barclays, UBS
and Citibank. He has also been invited as a Master Trainer by prestigious investment
banking associations, such as the Malaysian Investment Banking Association and
EuroMoney. He is considered an authority in several areas, including mergers and
acquisitions, wealth management, private equity and real estate finance.
Ashu has held several key positions at top tier investment banks like MD-South Asia at
Northbridge Capital and Celadon RE.
Before returning to India in 1996, Ashu was Manager- International Taxes and Special
Projects at Continental Grain Company, the world’s fourth largest private company and
the second largest trader of commodities and commodity options and a member at the
Chicago Board of Trade headquartered in New York. He has also worked as a Tax Policy
Analyst with the Office of Tax Policy, New York City Department of Finance in New
York.
Ashu is a Certified Public Accountant, certified in the state of Maryland, USA. He holds
an M.B.A. and a B.B.A. (Summa Cum Laude) in Finance and Investments from Bernard
M. Baruch College, City University of New York, New York.
He can be reached at ashu@ashudutt.com

www.visionbooksindia.com

Disclaimer
The author and the publisher disclaim all legal or other responsibilities for any losses
which investors may suffer by investing or trading using the methods described in this
book. Readers are advised to seek professional guidance before making any specific
investments.

ALL RIGHTS RESERVED; no part of this publication may be reproduced, stored in a retrieval
system, or transmitted in any form or by any means, electronic, mechanical, photocopying,
recording, or otherwise without the prior written permission of the Publisher. This book
may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of
binding or cover other than that in which it is published without the prior written consent
of the Publisher.
A Vision Books Original

First eBook Edition, 2013

First Print Edition, 2012
eISBN
ISBN 10: 81-7094-898-3
ISBN 13: 978-81-7094-898-8
© Ashu Dutt, 2012, 2013
Published by
Vision Books Pvt. Ltd.
(Incorporating Orient Paperbacks and CARING imprints)
24 Feroze Gandhi Road, Lajpat Nagar 3
New Delhi 110024, India.
Phone: (+91-11) 2983 6470
e-mail: visionbooks@gmail.com
Electronic edition produced by
Antrik ExPress

Dedication

~
To my son,
Ahren.
May you continue to
put a smile on every face!
 Contents
Title Page

Copyright & Permissions

Dedication

Introduction: Beyond the Traditional Measures of Value

Value Investing — The Traditional View
Beyond the Traditional Measures of Value

Secret # 1: Understanding the Value Investor’s Psychology

Start Afresh
Accept the Limitations of Your Analysis
Loss is a Probability That Will Happen
Consensus Will Eventually Set the Price of a Stock
Higher Risk is a ‘Chance’ of Higher Rewards

Secret # 2: Are You Really Value Investing?

Watching the Winners is Not Enough

Secret # 3: Preparing for Value Investing

Have a Plan and Arm Yourself
Parameters for Value Investing
Don’t Get Excited by Events or ‘Excitement Creators’
Chart Your Own Course
Think About Risk Before Returns

Watch for the 7th, the 8th … Chamber in the Revolver

Carry Only What You Don’t Have to Sell in a Hurry

Secret # 4: Beware the Myths of Value Investing

Investing for the Long Term
Don’t Pick Stocks on the Wrong Syllabus

Secret # 5: The Reality of Value Investing — Six Degrees of Under-Valuation

and Over-Valuation
An Under-Valued Stock May Remain Under-Valued for Years
 Value Investing is Like Pegging a Tent in Shifting Sands
Is There Anything Fundamental About ’the Fundamentals’?
Short or Long Term Does Not Depend on You — It Depends on the Management
‘Cheap’ and ‘Value’ Are Not the Same Thing

Secret # 6: Mastering the Rules of the Game

Secret # 7: The Ways of Value
Sell When Investment Themes Run Out
Increasing Excitement Equals Over-Valuation
Markets Will Over- and Under-React to the Underlying Dynamics
Fast Growth May Increase Revenues but Squeeze Margins — Or May Even Put Companies
Out of Business
Emotional Temperament
Diversification is Not the Done Thing
Don’t Confuse Beginner’s Luck with Skill
Timing the Market is the Only Way to Beat It
Technology and Financial News are Not a Competitive Advantage
Human Behaviour Guides Markets
Experience Has No Substitute
The Blind Spot
Full Points for Being Right, None for Winning Arguments
A Booming Economy Whips Most Stocks in the Long Run
‘The Anchor Effect’ Sets the Price of a Stock
Overcharged Bull Markets Make Value Elusive
Look Over Your Shoulder at All Times
What Do We Get from the ‘Gurus’ of Value Investing
A Stock’s Price is Only as Good as the Management’s Intent
Value is Oblivious to Bull or Bear Markets

Secret # 8: Where Does Value Originate?

Markets Never Rise or Fall Forever — The Law of Means Catches Up
Cycles and Trends
Catching the Structural Shift in the Market
Buying in a Fire Sale and Selling as the Plane is Taking Off
Not by Diversification
Tune Out the ‘Noise’
Long Term Thinking, Yes, Staying Put in a Stock, No
In Getting One Right and Letting the Other Nine Go
 Not in ‘Cheap’ Stocks
In Holding On Till the Tank is Full
In Structural Shifts
A Diamond Comes Mixed in a Ton of Mud
In Staying Invested as Long as is Necessary
In ‘New Era’ or ‘New Asset Class’
Black Swans Bring Value

Secret # 9: Where Does Value Disintegrate?

Two Dimensional Thinking in a 3-Dimensional World
‘Buy’ and ‘Hold’
Out of Favour, Out of Value!
Awe and Reverence
Accounting Ponzi Makes a Mockery of Value

Secret # 10: The Value Mirage

Risk and Reward Have an Absolute Correlation
Booming Economies Produce Value Stocks
Markets are Efficient

Secret # 11: How to Find Value

The Courage to Act on Your Beliefs
Hang in There When an Investment Mania Starts
Lock in the Sector before Latching on to the Stock
All Falls are Not Created Equal — Some are Created for Value
A Liquidity Squeeze Offers Value and is Different from a Bubble

Secret # 12: Finding Value in the Market’s Dynamics

Human Behaviour Holds the Secret to Stock Prices
History is Stuffed with Precedents
Market Cycles
Trends are Not Cycles
Eras, Bubbles and Manias
There are Often No Rational Explanations for Market Meltdowns

Secret # 13: What the Market is Saying About Value

Value Lessons from the Market
Reading Investment Themes
 The Economic Domino
Watch Out for Window Dressing
The Changing World of Miss Value
Cash Flow Rotation
Value Investing on Themes
Value Investing is Linked to Commodity Cycles
Value Emerges as Sectors Clean Out
A Rising Tide Takes Up All Ships
Contagions Pollinate Value
The Commoditization of Stocks and Sectors
How Value Emerges in Chaos
Execution Record in Emerging Sectors is Value
The Scarcity Premium
Looking Out of the Window May Help You See Value
Value in Debris
Value Lies in Deconstructing Myths
Sails Need to be Redirected If the Winds Shift
Whose Boat are They Rowing?
Objects of Popular Fantasy are Fuel to the Fodder
Value is Built and Destroyed Over a Number of Actions and Reactions
Ask the Hard Questions — Or Face Soft Returns
Empty Vessels Make the Loudest Noise — But Remember, It is Only Noise
‘If You Have to Spin Off, Then I Must Be a Part of It’
Value in the ‘House of Horrors’
24-Hour Media Coverage Magnifies Contagions
Manic Behaviour Comes to Roost

Secret # 14: Value Investing Lessons from the Masters

 Introduction
~
Beyond the Traditional Measures of Value
‘The gods perceive things in the future, ordinary people, things in the present,
but the wise perceive things about to happen. In their intense meditation, the
hidden sound of things approaching, reaches them and they listen reverently,
while in the street outside, the people hear nothing at all.’
– Philostratus, Ancient Greek Poet
OVER THE PAST DECADE I HAVE RECEIVED THOUSANDS OF MAILS asking me why is it that
despite buying a stock based on all the known parameters of picking value stocks, the
stock either did not move higher or actually headed down. What did the investors do
wrong and why did the stock not behave the way they thought it would?
Value investing carries a sophisticated connotation. It carries a feeling of making money
in stocks through hard work and research. Perhaps it appeals to our middle class mentality,
namely ‘To make money, you have to work hard.’

Value Investing — The Traditional View

Value investing in the traditional sense refers to buying shares which are under-priced.
Under-pricing is determined by using various metrics of fundamental analysis, like PE
ratios, discounts to book value or high dividend yields, etc.
Value investing also refers to buying stocks at less than their ‘intrinsic value’. The
intrinsic value is the present value of all future distributions from the company. The
discount is supposed to provide a ‘margin of safety’ to value investors. To arrive at a
stock’s intrinsic value, an investor must make accurate assumptions of all future dividend
and bonus distributions of the company and a correct rate at which to discount them. That
is easier said than done. For most of us, it is neither possible nor feasible to determine all
future distributions of a company or the correct rate at which to discount these
distributions to arrive at a share’s present value. That is why following Warren Buffett
does not produce the same returns for most people. You may follow his method but how
will you follow his supposed ability to determine the discount to intrinsic value.
Book value works well for companies or sectors that have tangible assets like real estate,
factories, etc. The concept may not work for sectors like technology where physical assets
are insignificant. For such companies, discounted cash flows or finding the present value
of all future cash flows may provide a better measure.
Value investors have to be extra careful. In bear markets, stocks that appear cheap can
fall further because the need for cash or liquidity makes people sell. In bull markets,
stocks that appear over-valued continue to rise because larger and larger groups of people
get into the stock.
Key Tenets of Value Investing
Tenet # 1: Companies Have Intrinsic Value

All companies have a value to them if they sold their assets today. It could be their real
estate or their factory land or their brands. This is their ‘intrinsic value’.
Tenet # 2: Invest When There is Margin of Safety

Investing in a stock below its intrinsic value increases the margin of safety or reduces the
risk.
Tenet # 3: Markets are Not Efficient

Value investors believe that markets misprice stocks, periodically either over-valuing or
under-valuing them and that provides them the opportunity to invest.
Tenet # 4: Contrarian Approach

Value investors usually go against the herd. They buy when others are selling and sell
when others are buying.
Tenet # 5: Long Term Investing

Value investors invest for the long term. They are not concerned with the movement of
prices in the short term.
Value investors come up with their own combination of parameters to invest. A few such
parameters are:

Share price should be lower than the intrinsic value of the stock; for example, 75%
or less than intrinsic value.
P/E ratios should be in the bottom 10% of the industry average.
Stock price should be at a discount to book value, e.g. a discount of 25% to book
value.
Debt should not exceed equity.
Current assets should be more than current liabilities.
Dividend yield should be 75% of bond yields.
Earnings should be growing at a compounded annual growth rate (CAGR) over
many years (30% per year for a 5-year period).

Beyond the Traditional Measures of Value

In this book, I will go beyond this narrow definition and understanding of buying stocks
because value investing is largely misconstrued as ‘buying cheap’, ‘buying stocks with
low PEs’, or ‘buying stocks because the book value is way lower than the price’. While all
these may be part of what value investing is all about, such an approach rests on
conventional thinking and makes several assumptions which may clearly be wrong. It is
like getting into a swimming pool expecting it to be five feet deep and finding out it is
actually eleven feet deep. In that case, either you should know how to swim or you needed
to make a much better guess of the depth before entering the pool.
Once you finish reading this book, you will have a pretty good idea about figuring out
the depth of a pool or learn to swim even if the pool is deeper than you thought.
Use this book as your reference and guide to value investing. Refer to it as often as you
need to. Go back to it when a stock is not behaving the way you thought it should, and
find out why. And share your experiences on value investing with me at
www.ashudutt.com or ashu@ashudutt.com
Enjoy the book! And may your returns multiply and bring you happiness!
~
 Secret # 1
~
Understanding the Value Investor’s Psychology
‘One with a hundred longs for a thousand, one with a thousand yearns for
millions, one who lords over millions wants to rule a kingdom, the kings aim
to gain Paradise itself.’
– The Panchtantra
VALUE INVESTING SUITS PEOPLE WITH A CERTAIN TEMPERAMENT or mental makeup. This
temperament can be developed. In fact, it is essential to do so. If you don’t already have
that temperament, you can develop it. Once you have the right temperament, your value
investing abilities will deliver the returns you expect.
Here are a few essentials that value investors need to keep in mind:

Enthusiasm is great for life, success and ambition, but it is absolutely fatal for value
investing.
Investing on historical parameters, such as financial results, and price earnings
ratio, etc. is not value investing. Doing so is like driving a car by looking only at
the rear view mirror. Rear view mirror driving is a crash course to a definite crash.
Control over impulses is the corner stone of value investing. You need the calm of
the Samurai before a battle and the peace of a monk in meditation.

Start Afresh
‘When you are working with an existing portfolio and reshaping it, there are
unrecognized, subconscious, emotional hang-ups that block you from impartial, cold-
blooded investment actions like selling. Your baggage is what you already own, and
it gets in the way of excellence. There are always positions you believe in, but for
one reason or another, the market stupidly has not discovered them yet. It’s hard to
make yourself give up on a position, especially since you suspect, as soon as you do,
that the ornery, cussed thing will rally. There is a bias against switching, because
subconsciously you know you can be wrong twice. By the same token, it’s hard to
sell winners because of what they have done for you and because you hope they have
more to deliver.’
– Barton Biggs

Most of us find it difficult to get rid of the rubbish we have at home, let alone stocks that
we own. That drags us further back from the starting point. If you are starting out on the
value investing journey, start off afresh without any baggage. That will help you leave
behind any emotional attachments which are making you hang on to stocks you already
own.

Accept the Limitations of Your Analysis

‘Our knowledge of the way things work, in society or in nature, comes trailing clouds
of vagueness. Vast ills have followed a belief in certainty.’
– Nobel Laureate Kenneth Arrow

No matter how much information we have on a stock or a sector, chances are it is not
sufficient. We then have to rely on our instincts or hunch. Don’t fight your instincts and
hunches, especially if they have proved correct in the past. Most of what we know in life
and about markets is based on limited information and we are therefore wired to use our
instincts and hunches. Make full use of them in value investing, especially if your instincts
and hunches work for you and you are able to establish a workable pattern.

Loss is a Probability That Will Happen

‘Of course, if a man is both wise and lucky, he will not make the same mistake twice.
But he will make any one of the ten thousand brothers or cousins of the original. The
Mistake Family is so large that there is always one of them around when you want to
see.’
– Edwin Lefèvre, Reminiscences of a Stock Operator

We take losses personally. We feel they somehow reflect adversely on our personality or
our abilities. This is a wrong and unhelpful way to look at investing losses.
Loss is a probability in any game you play; you will always lose sometimes. That is a
certainty. Accept it and don’t try to stop a loss from happening. If you do, it may turn out
becoming the mother of all losses.

Consensus Will Eventually Set the Price of a Stock

John Law, the land-bank projector and progenitor of the Mississippi Bubble, realized
that the values of all money, including gold, rested ultimately on a consensus.
– Edward Chancellor

As value investors we often assume that the parameters we have used are correct, and
that the stock must necessarily react to those parameters. But stocks react to where the
money flows. Sometimes the money flows because of others seeing what you see. Many
times, money flows to where the majority thinks they will make the quickest buck. While
picking value stocks, ask yourself if conditions are ripe for money to flow into the stock
you have picked.

Higher Risk is a ‘Chance’ of Higher Rewards

‘… higher risk does not guarantee higher returns, it merely offers the chance of
higher returns.’
– Maggie Mahar

When you take a higher risk by buying a stock that is in deep trouble but which you
believe has value, all you are hoping for is a chance of higher returns, and not higher
return itself. Chances are that the higher returns will not materialize. Preparing for that
eventuality will give you the ability to screen out a lot of stocks in which you are invested.
This is contrary to what happens to most of us. We end up holding the worst stocks —
hoping they will turn around.

~
 Secret # 2
~
Are You Really Value Investing?
‘Water comes not only in the form of rain dropped from the sky, But also by
digging deep in the earth.’
– The Panchatantra
IF WE ARE ASKED WHAT OUR INVESTING STYLE IS, nine out of ten of us would say we are
value investors. (I assume that is why you are reading this book.) Yet there is a 100%
chance that none of the nine will agree on what value investing is. Most of us would
perhaps quote some academic definition learnt from our idealistic college days or by
reading works of one of the ‘gurus of value investing’.
But are we really value investing?
Let us start with defining value investing. Value investing is buying under-valued stocks
and selling them when they get over-valued, irrespective of the length of our holdings.
This definition, in turn, begs the question as to what is meant by under-valued and over-
valued?
This is where successful value investors shine. They define their own set of parameters
to determine whether a stock is under-valued or over-valued. They then test their system
by investing based on these parameters to pick under-valued stocks or sell over-valued
stocks. And they constantly adjust the parameters, and their relative importance, in picking
stocks and in selling them. Then and only then can they become successful value
investors.
Most of us who call ourselves value investors will agree we don’t do all of this. Even
when we have a set of parameters based on which we buy and sell value stocks, we either
change the parameters often or don’t apply them uniformly. Even when we apply them, we
rarely test our parameters to figure out if they work as we expected them to. And even if
we do test them, we rarely take any steps to make changes in our parameters to make them
work better.

Watching the Winners is Not Enough

‘Unlike a well-defined precise game like Russian roulette where the risks are visible
to anyone capable of multiplying and dividing by six, one does not observe the barrel
of reality. One is thus capable of unwittingly playing Russian roulette — and calling
it by some alternative ‘low risk’ name. We see the survivors and never the losers… .
The game seems terribly easy and we play along blithely.’
– Nassim Nocholas Taleb

Everywhere around us, winners are celebrated. We are constantly told how the winners
succeeded. But there is no information or data that highlights how many others, who
followed exactly the same strategies that the winners did, lost everything, or lost big. This
bias in the way we perceive information makes us believe that there is something in the
method of winners that justifies our unthinking use of the same methods. That is a fatal
error in value investing.
As a value investor, you will need to judge through experience and trial and error
whether something works or not. Under no circumstances should you take any advice or
information at face value, no matter what it is or who is offering it. Sometimes a winner
may have made it simply by fluke or luck but if he were to say so, you won’t respect him.
So he ends up weaving an elaborate story on how he ‘made it’.

~
 Secret # 3
~
Preparing for Value Investing
‘Those who seek to relate stock movements to the current statistics of
business, or who ignore the strongly imaginative taint of stock operations, or
who overlook the technical basis of advances and declines, must meet with
disaster, because their judgment is based upon the humdrum dimensions of
fact and figures in a game which is actually played in a third dimension of
emotions and a fourth dimension of dreams.’
– Barton Biggs
IF THE WORLD WERE MADE UP ONLY OF THOSE WHO FOLLOWED your definition of value
investing, things would always go your way. But the markets are made up of all kinds of
people who are driven largely by emotions. Appreciating the diverse nature of markets is
one of the first steps to successful value investing.

Have a Plan and Arm Yourself

‘An enterprising man with skill and expertise is always a master of wealth. But the
biggest failing of the most enterprising men is unplanned enterprise.’
– The Panchtantra

Have a plan in place before you go shopping. The plan must include:

1. What are the three or four factors or parameters that will make you consider a
stock to be under-valued?
2. What are the three or four factors or parameters that will make you consider a
stock to be over-valued?
3. Using the above parameters, buy three stocks and test if the parameters you use
end up giving you the correct indications of under-valuation and over-valuation.
4. The best parameters are those that let you pick stocks which move from under-
valuation to over-valuation in the shortest possible time and thus give you the best
returns.
5. If the parameters fail to work as per your expectations, carefully analyze what
went wrong.
6. Based on the analysis, tweak or modify the parameters — add or remove one or
more parameters, or increase or reduce their importance.
7. Then again buy three stocks based on the modified parameters to test the new
parameters and their level of importance in picking under-valued stocks.
8. Repeat the process again and again, adding and removing parameters till the time
you have a personal value investing system that works and delivers you the best
returns in the shortest possible time.

Parameters for Value Investing

The most critical parameter for value investing is figuring out if the market is interested in
the sector or stock you are looking to invest in. If the market is not interested, or is
unlikely to get interested in the particular stock, chances that the stock will move up are
low. Some of the things to confirm interest include:

Is there enough interest in the sector?

Is there a reason there will be interest in the sector?
Has there been a rise in volumes in the stock you are looking to buy? Has the rise
in the price of the stock been accelerating?
 A confirmation of market interest in the sector or stock comes from an increase in
volumes and price at an increasing pace. The longer this has been happening, the more the
chances of the stock continuing its upward move.
Increasing volumes and price may also indicate that there are certain things you may not
be aware of that are being used by other value investors to drive up the price, such as a
structural shift in the company’s business, expectations of better margins, potential
acquisition, etc.
To confirm if your investing decision is right, check the operating cash flows of the
company. A company with healthy cash flows from operations confirms a value
investment. Don’t spend too much time on PE ratio or the profits of a company.

Don’t Get Excited by Events or ‘Excitement Creators’

‘Great fortunes (are a) consequence of a long life of industry, frugality and attention.’
– Adam Smith

World-wide, debt markets are way bigger than equity markets, yet equities occupy the
financial media’s imagination. That is because stocks are ‘excitement creators’. They feel
like a video game. When we get excited or buy stocks because they are excitement
creators, the results are similar to those of video games, i.e. the fantasy ends and there is
nothing left to show for it.
Value investing requires serious planning and execution. More often than not, it requires
you to cut out the noise, the constant chatter of financial nonsense, and concentrate on the
task at hand, i.e. finding under-valued stocks using the parameters you have defined for
yourself — and selling over-valued stocks, again using your self-defined parameters.

Chart Your Own Course

‘To obtain better than average investment results over a long period requires a policy
of selection or operation possessing a two-fold merit: (1) It must meet objective or
rational tests of underlying soundness; and (2) it must be different from the policy
followed by most investors or speculators.’
– Benjamin Graham, The Intelligent Investor

Value investing is all about charting your own course. You do that all the time in your
life. In fact, you work very hard to stand out as an individual. Yet when it comes to
investing, we jump into the herd. We do what others are doing. Don’t. Bring out the
individual in you and follow your own value investing style.

Think About Risk Before Returns

‘I was convinced that I was totally incompetent in predicting the market prices — but
that others were generally incompetent also but did not know it, or did not know they
were taking massive risks. Most traders were just ‘picking pennies in front of a
stream roller’, exposing themselves to the high-impact rare event yet sleeping like
 babies, unaware of it.’
– Nicholas Nassim Taleb

Risk and reward are not related — at least not in the way we are taught. There will be
times in the market when the rewards will be many times the same risk that you take at
other times in the market.
A value investor waits for the times when risk produces the maximum returns. When the
risk is not likely to produce returns so good as to make the risk look small, the value
investor sits tight and does nothing.
For example, if markets have fallen because of a shortage of cash in the system or an
increased demand for liquidity, chances are stocks are way below what they are worth and
may produce significant returns with a low risk of losses. So, too, for a stock that has been
beaten up severely because of some negative news or poor short term financial results.
Investors often react in panic creating large falls in stock prices not justified by the event

Watch for the 7th, the 8th … Chamber in the Revolver

‘Reality is much more vicious… . First, it delivers the fatal bullet rather infrequently,
like a revolver that would have hundreds, even thousands of chambers instead of six.
After a few dozen tries, one forgets about the existence of a bullet, under a numbing
false sense of security.’
– Nassim Nocholas Taleb, Fooled by Randomness

No matter how good you get at picking stocks, don’t lower your guard. A chicken is fed
and fattened by its owner for months only to find its neck knocked off one fine day.
Markets can deliver a similar blow any time. Remain nimble and keep your powder dry. If
things are not working out the way you expected them to, head the exit.

Carry Only What You Don’t Have to Sell in a Hurry

‘It is true that an investment contains a risk if there is a fair possibility that the holder
may have to sell at a time when the price is well below cost.’
– Benjamin Graham, The Intelligent Investor

You can pick all the value in the world but if you need that money for other purposes, all
value will come to naught. It is a rule written in stone — invest only that money in value
stocks which you can leave invested for as long as it takes to realize the value. This rule is
the canvas that holds all value investing together.

~
 Secret # 4
~
Beware the Myths of Value Investing
‘A questing mind, the gambling instinct, and the ability to make tough
decisions on inconclusive evidence are all essential characteristics (for
investing).’
– Barton Biggs
Investing for the Long Term
‘If there is any “iron law” of very long term investing, it is that superior returns are
only temporary. Competition from imitators or new inventions; government
intervention through taxation, nationalization, price controls and expropriation, and
the obsolescence inevitably associated with progress; something will inevitably drive
above-average returns down to or below the mean for the whole economy. At all
times, therefore, the opportune selection of the “right and under-valued investment
theme” was of crucial importance — as was the speedy abandonment of fully valued
popular themes that are bound to underperform.’
– Marc Faber

The ‘long term’ is the most abused word in the financial dictionary. It does not fit most
of us in terms of personality and temperament, and there is no clear understanding of what
is the ‘long term’ anyway. Even more baffling is the conventional wisdom that you cannot
be a value investor unless you invest for the long term. It is as if becoming a value
investor is like going to class 12, and you cannot get there without going through class 11
(i.e., without ‘long term’).
Think about how we live our lives. Today, life is fast-paced, instant, and our very vision
of long term has been reduced. Yet the long term persists in the context of value investing
from the time when people had time and more time at hand, and perhaps had nothing
better to do but wait. Moreover, a century ago companies did the same thing day in and
day out. In contrast, promoters of companies today hop, skip and jump from business to
business, proposal to proposal. If we buy a company’s stocks on a buy and hold mode
without understanding the way its promoters behave, chances are the stock is going to turn
into pickle for us.
Value investing in the current context does not have anything to do with the duration of
holding a stock but has more to do with how we pick it (when it is under-valued) and
when we sell it (when it is over-valued), irrespective of the time between picking it up and
selling it.

Don’t Pick Stocks on the Wrong Syllabus

‘And those who were seen dancing were thought to be insane by those who could not
hear the music.’
– Nietszche

Finding value using conventional academic tools like PE, book value, etc. is like trying
to be the general of an army in a real war after winning a couple of war games on the
computer. It is a fantasy to believe you can handle a real sword if you have been ordained
a ‘master of the universe’ in a video game for your swordmanship.
Yet, most of what we consider value investing is just that. The right way, however, is to
first define your own set of parameters for finding under-valuation and implement it, test
it, and improve it. It’s only by this method will you find value investments that deliver
according to your plan.
One of the ways to put boosters to value investing is by investing in stocks based on:

The traditional measures of value investing like low PE, discount to book value,
discount to intrinsic value; and
Making sure these stocks have the uptrend in price and volume to deliver returns.

~
 Secret # 5
~
The Reality of Value Investing
Six Degrees of Under-Valuation and Over-Valuation
‘… be extremely cautious when investing in a widely accepted and highly
popular major investment theme, be cause, once it is known to just about
every investor around the world, the market is likely to enter its most
speculative and final-phase … this phase is fraught with high risk and always
ends in tears once the bubble bursts.’
– Marc Faber, Tomorrow’s Gold
A STOCK THAT IS UNDER-VALUED CAN MOVE TO A GREATER DEGREE of under-valuation;
similarly, a stock that is over-valued can move to a greater degree of over-valuation. So we
need to decide what level of under-valuation we need to get in at.
In bear markets, under-valuation may continue for a long time — or prices may head
even lower. When cash is scarce and investors need cash or liquidity, they don’t pay much
attention to the quality of the stock. This creates a downward spiral in prices that has no
other rationale than the need for cash.
In bull markets, a stock that seems over-valued may rise even further. The rationale here
is that while some people may be invested in the stock, others may not have had a chance
to get in. When they, too, try to get into the stock, they take high prices even higher.

An Under-Valued Stock May Remain Under-Valued for Years

‘The habit of relating what is paid to what is being offered is an invaluable trait in
investment.’
– Benjamin Graham

A boat may sink to the bottom of the sea and stay there. Similarly, a value stock can sink
to under-valuation, be forgotten by investors, and stay at the bottom of the ocean for years.
If you have been an investor for some years, you would have come across several
instances of stocks that fit perfectly into the value investing category but which either
never moved up — or drifted even further down.
If a stock is not moving, you have to think about the interest you could have earned
elsewhere on that money. If the stock is not even giving you the interest a bank can, it is a
good time to exit no matter what your conviction on the stock.
A stock may appear under-valued but there may be a problem with the company’s
management, accounting, project delays or many such reasons that are keeping the stock
where it is. What appears as under-valuation may, then, be a chronic problem that you may
not be aware of.

Value Investing is Like Pegging a Tent in Shifting Sands

‘Someone should have owned property in Venice in the 14th and 15th centuries, then
in 16th century Lisbon, 17th century Amsterdam, 18th century London, then 19th
century East Coast and 20th century West Coast, USA. Similarly, someone should
have switched stock holdings from time to time, over the last 200 years, from one
sector to another or from one country to another; German stocks in the 1950s, US
growth stocks in the 1960s, oil and mining in the 1970s, Japan, Taiwan and South
Korea in the 1980s and US stocks in the 1990s. In the very long term, a buy and hold
strategy is certainly a losing proposition.’
– Marc Faber, Tomorrow’s Gold

A ship may have sunk and stayed on the ocean floor for a century. It was not retrieved
either due to want of technology, or because the available technology was too expensive.
The same is true in value investing. The parameters, or factors, that tell us whether a stock
is under- or over-valued are shifting all the time. What worked yesterday is meaningless
today.
Let’s consider investing in gold. Just a few years ago, the only real driver of gold prices
was selling by the central banks of various countries and buying by India. Central banks
have turned dormant although India remains a buyer of gold. The real players now are
exchange traded funds (ETFs) and they have changed the very dynamics of gold prices.
The objects of investor attention are shifting all the time. Investors may move their
attention from one country to another, from one sector to another, and from one stock to
another. As a value investor, you must be aware of the shifts in investor preferences. It is
no use staying invested in automobiles if investor attention has shifted to pharmaceuticals.
The way to figure out where investor attention is moving is to check the sector and stock
in which volumes and prices are increasing.

Is There Anything Fundamental About ’the Fundamentals’?

‘Conventional economic theory holds that market prices are set by prudent and
rational buyers and sellers. When all the profits flow to the imprudent and the
irrational, though, they set the prices — and economic laws temporarily cease to
apply.’
– Justin Fox, Fortune Magazine

‘I invest on fundamentals.’ And what might those ‘fundamentals’ be?

A strong foundation is essential for a great looking building that commands the highest
rent or price. But a strong foundation by itself is not a sufficient reason for the building to
command the highest price or rent. So while I won’t buy a building with a weak
foundation — I would consider a strong foundation a pre-requisite but not a sufficient
reason by itself. Similarly, while strong fundamentals are important, by themselves they
don’t make a stock a value investment.
What I am trying to drive at is the mirage created by ‘fundamental analysis’. What are
‘fundamentals’? It’s the interpretation of the company by an analyst with all his bias. Once
human bias enters — and bias is there in all of us — facts are no more facts but
interpretations of facts. So what we consider as the fundamentals of a stock are, in fact,
nothing but multiple levels of interpretations, with their inbuilt bias, of a few facts.
The fallacy we may be suffering from is to consider a map to be the territory — i.e.
thinking that a map denotes what we consider our territory. But consider how China and
India interpret the same maps where they have a dispute. Interpretations distort the picture,
and if investment decisions are made on such fundamentals, fatal investing errors are
almost certain.
Real ‘fundamentals’ that work in finding stocks that will deliver returns are those that
reveal popular appeal or following. So if the market is focused on low PEs, you must pay
special attention to this as a ‘fundamental’ factor. Investors will shift their view of
fundamentals from low PEs to price to book value (PBV) to the cost of replacing assets,
etc. If a certain ‘fundamental’ is not in fashion, avoid using it

Short or Long Term Does Not Depend on You — It Depends on the

Management
‘… no matter how great the growth prospects of a region, a country, a sector or
individual company, timing of purchase and sale remains a crucial consideration.’
– Marc Faber, Tomorrow’s Gold

The holding period of your stocks must be based on the type of company promoters
whose stocks you hold. Some promoters like to share information, others don’t. Some like
to tell stories, others state facts. Whatever it may be, holding stocks for the long term
when the company’s promoters think short term may be like running a high speed train on
a toy train’s track.
Let’s say you bought a stock because the company had significant real estate holdings.
What the company does with these holdings should decide your holding period. If the
company decides to give its existing shareholders a share in the spun-off real estate
company, it is indeed a long term stock. On the other hand, if they spin off the real estate
as a company and then sell the company to other investors, not only has the company
stripped value but it does not have the credibility for you to remain invested in it.

‘Cheap’ and ‘Value’ Are Not the Same Thing

‘When you leave it to chance, then all of a sudden you don’t have any more luck.’
– Pat Riley, Basketball Coach

You can buy a cheap watch and it could break the next day. Or, you could buy an
expensive watch that could turn into a collector’s item over a decade and get you more
than what you paid for it. Which one would you buy?
As a value investor, we should buy the watch that will turn into a collector’s item.
What seems to be cheap in the first instance may well be a piece of junk. Value investing
is not about buying junk. It is about buying stocks that hold more value than is represented
by their price.
How do you differentiate between ‘cheap’ and ‘value’? If the economic dynamics have
changed such that even at lower prices the stock is not worth a buy, it may be cheap but
not value. But if the stock has been driven down because of a need for cash or liquidity by
investors, it may have value. If everyone is in one sector like technology or banking
because it is a popular sector and other sectors are not even getting a second look, many
stocks in those other sectors may be value. When everyone was jumping into technology
stocks, no one paid attention to hotel or steel or industrial stocks. They represented value
at that time.

~
 Secret # 6
~
Mastering the Rules of the Game
‘Follow the course opposite to custom and you will almost
– J. J. Rousseau
AS WE START ON THE QUEST FOR VALUE THAT BUILDS on itself over the years, the following
form the themes of this work.
The history of financial markets has precedents
Human beings will show similar behaviour over generations; whatever we see in today’s
markets has happened in the past. A reading of financial history provides insights into
when a trend or a cycle is turning. Markets behave in cycles in any era and any period of
history; in other words, history always repeats itself. Some examples of rallies that have
taken place in the past with remarkable cyclicality are the commodity rallies, the ‘new
technology’ rallies, the ‘new era rallies,’ etc.
Greed and fear will always remain the two guiding factors in all markets
And as long as they do, history will repeat itself in whatever be the market with whatever
amount of available information and whatever level of understanding. The objects of
passion and speculation change, the countries in fashion change, the year, decade and
century look different, but greed and fear remain constant.
Around the early 1990s, companies lined up plans to set up plants ranging from steel to
fertilizers. That created a glut both in capacity and stocks in these categories. These were
the popular stocks at that time. Then, most of them went bust for various reasons, such as
high interest rates, a down turn in the business cycle, etc. But that’s irrelevant because
that’s what managements should have calculated anyway. Then came another frenzy
where ‘replacement value’ became the fashionable ‘new’ metric for buying stocks. No one
spoke of pharmaceuticals and technology at that time. Then came the technology boom in
2000. In that period, steel, fertilizers, textiles, or for that matter any stock apart from
technology, was in the dumps.
Wherever the mass of investors move, you will see significant increase in prices. The
trick is to be in such stocks before the mass moves in. But the mass must then move in to
move up prices.
Market behaviour is cyclical
At the end of the day, markets have to react to the economic cycle — and to investors’
moods and perceptions about economic cycles though they do so with some time gap.
Market mood is constantly moving from one sector to another and from one stock to
another. When it reaches euphoria, it reverses course and often shows equally sharp falls.
Emotional temperament is the key to taking action on the structural shifts
the markets may be undergoing
It takes courage to follow our own beliefs and analyses because at the point of making
investment calls ahead of the market, the crowd is usually betting the other way.
If you find yourself persuading others to buy a stock or a sector, then your conviction is
not strong enough. You must be convinced about the sector or stock, and whether anyone
else is or not, you must invest and stay invested waiting for the tide to turn.
Knowing what everyone knows is not a competitive advantage
Knowing what to do with what you know is the advantage that we need to practice. The
value investor’s skill lies in interpreting the data and anticipating the mood of the market
for a stock. Think about whether the large mass of investors in the market will look at the
stock favourably in the long term rather than how the stock will perform in the long term.
You don’t need any investment gurus to guide you
Unlike other arts, investment mastery is a proprietary art. Investment gurus can show you
a method but the method requires your personal skills and judgement. For example, how
low is low PE or how much discount to book value should a stock be at for you to invest?
Human behaviour is the underpinning of all market action
Despite all technological advancements in financial markets, the explosion of financial
news and the financial understanding of investors, there is no empirical evidence to show
that investors today can generate any better returns than investors did a hundred or two
hundred years ago.
Identifying the right theme ahead of the crowd is critical, but it should be
just ahead of the crowd
If the crowd has no desire to follow you soon then though you may well have bought the
stock for the right reasons, but it will not move. Investor psychology is to buy with the
crowds and sell with the crowds. It is similar to buying real estate. If you can guess the
direction in which the town will move, you can buy land very cheap. Buy ahead of the
crowds and sell ahead of the crowds — but only just ahead — but don’t go against the
flow.
Take a look at your portfolio and you will find many stocks that seem to fit the value
investing tag perfectly. Yet they don’t move. Perhaps you invested much too early before
the crowd could see what you saw.
All you need in order to make money are a few stocks
The more you diversify, the more your returns will mirror returns offered by the stock
market index. The sensible investor puts his money in only a few stocks. It is not possible
to understand and monitor numerous stocks and companies.
A value investor should not have more than ten stocks in his portfolio. If a stock drops
below a target loss — anywhere between 5% to 10% — the stock must be removed from
the portfolio and another one added. Stocks that have losses, or don’t show any return,
drag down the entire portfolio.
Understand the nuances of the sectors and stocks you invest in
Let’s consider coffee. Coffee is usually of two types — Arabica and Robusta. Arabica is
the expensive, exclusive coffee grown in smaller quantities in countries like Ethiopia,
Cuba and Brazil. The cheaper and more abundantly available coffee is Robusta. In
Vietnam, growing Robusta has almost become a cottage industry creating a long term glut
situation. The coffee you get at an upscale café is 100% Arabica — or so they claim —
and thus expensive. The coffee you get in your Nescafé is a blend of Arabica and Robusta
— and the manufacturers increase the Robusta portion when they want to cut costs.
For almost a decade, both the Arabica and Robusta coffee markets were severely
depressed. Then, Arabica started to pick up. China and India started to become coffee
appreciating, as opposed to coffee drinking, countries. A little earlier, the share of Tata
Coffee was trading at around 60 to 70. Since the Arabica coffee cycle was then turning
around, and Tata Coffee was more in the Arabica business, it was clear that the company
would see a big jump in revenues. And that’s what happened. In early 2005, Arabica
prices were at 4year highs and the stock of Tata Coffee had moved up to 340. So if you
had picked up the stock about two years earlier at 60 to 70, you would have gained an
appreciation of 500% in two years. No mean achievement, wouldn’t you agree? And there
is no special skill to it. Just follow a sector or commodity you understand and figure out its
nuances. Surprisingly few investors do this — and those who do, usually are in the
industry concerned and not in stock picking. You would not have the time or mind-space
to do this kind of investing if you had a hundred stocks in your portfolio.
There is no substitute for experience
Every mistake is a learning experience and adds to your mastery of the art of investing.

~
 Secret # 7
~
The Ways of Value
‘The wisdom god, Woden, went out to the king of the trolls, got him in an arm
lock, and demanded to know of him how order might triumph over chaos.
“Give me your left eyes,” said the troll, “and I will tell you.” Without
hesitation, Woden gave up his left eye and said, “Now tell me.” The troll said,
“The secret is watch with both eyes!”’
– John Gardner
STOCKS TEND TO RUN IN HERDS. Sometimes the herd is the market. Sometimes it
comprises other stocks in the same sector. In most cases, stocks will run in the direction of
the markets — maybe at different speeds but usually in the same direction. There are rare
instances when stocks move against the market, i.e. going up when the markets are
heading down, or vice versa.
If you had to decide between two stocks that appear to be equally under-valued, your
choice should be the stock which you expect will receive recognition in terms of value
first and will get to over-valuation. Why? Because an under-valued stock has the risk of
staying under-valued for a long time — or of not rising fast enough. Picking a stock in a
sector that you expect will turn around can reduce your risk.

Sell When Investment Themes Run Out

‘By pursuing a buy and hold strategy with railroad securities from 1850s up to this
very day, an investor would have totally missed on the auto boom of the 1910s, the
appliance, radio, movie and utilities booms of the 1920s, missed first the great
German stock market boom of the 1950s and the highly rewarding Japanese bull
market post Second World War upto 1989 — and failed to participate in the colossal
rise of hi-tech companies of the 1990s.’
– Marc Faber, Tomorrow’s Gold

Sell when an investment theme has run out of fuel. Investment themes are usually very
strong at the early stages of a sector as companies are still trying to establish the exact size
of the market and their position in it. For example, Indian telecom and mobile companies
were an extremely strong theme for the first few years of the growth of mobile telephony
in India. At that stage, no one knew how big the market could be or who could emerge as
the strongest company in the business. As mobile rates fell, there was an increase in the
number of subscribers.
A point was reached where the number of subscribers plateaued, the rates could not be
increased and there was competition from elsewhere. As the quality of broadband
improved, upstart companies like Skype also began changing the very structure of the
business.

Increasing Excitement Equals Over-Valuation

‘The fools, the Casanovas, and the blind risk takers are often the ones who win in the
short term.’
– Nicholas Nassim Taleb, The Black Swan

Excitement has the same effect on investing as smoking has on your lungs. The stock’s
over-valuation increases proportionately with the crowd’s excitement. It is good to be
holding a stock which excites the crowd but a bad time to be buying it then.
The important aspect is to anticipate when most of the crowd is in the market or in the
stock. That point is usually reached when all and sundry, including those far removed
from the markets, start investing. Until that point is reached, the stock may continue to go
up.
Conversely, a stock which does not excite the crowd is a prospectively under-valued
one. The less the excitement, the greater the chances that the stock is under-valued. This is
a bad time to be holding the stock but a good time to be buying it.
The important aspect here is to anticipate a point where almost everyone is pessimistic
about the prospects of the market or the stock.

Markets Will Over- and Under-React to the Underlying Dynamics

‘Markets rarely reflect reality. Either they overstate it or understate it. But they are
almost always off.’
– Ashu Dutt

Good economic growth and prospects for sector growth are always a prerequisite for
finding value stocks, but the markets will almost always over- or under-react to the
prospects. If you are investing on a broader economic theme, you may need to hold a
stock for longer than you think.
If a majority of investors interpret the prospects to be good, they will run the stock up.
The interpretation of economic growth and prospects by a majority of investors is far more
important than the actual numbers.

Fast Growth May Increase Revenues but Squeeze Margins — Or

May Even Put Companies Out of Business
If you are investing on the basis of a sector’s spectacular growth, stick to those stocks that
have value among the leaders in that sector, or to a stock you believe will stand out. As a
sector grows, more and more players enter it, eventually squeezing out any abnormal
margins there may have been.
As a sector matures, physical assets, balance sheets, etc. become less important and the
company’s management quality and its ability to maintain strong financials becomes
critical. In a mature sector, invest in companies with strong managements. They will not
only grow themselves but will be active in acquiring poorly run competitors at discounted
prices.

Emotional Temperament
Emotional temperament is the key to taking action on the structural shifts the markets may
be showing. It takes courage to follow your own beliefs. It also calls for sharp analysis
because at the point of making investment calls ahead of the market, the crowd is usually
betting the other way.
Instead of being a suitor running after a damsel (stocks) and seeing your infatuation
increase as she spurns you (read, the stock’s price rises), treat stocks like products. Buy
when they get cheaper or seem like value for money, or buy them ahead of their becoming
the pursued; and sell them when they become the crowd’s favourites. But do hold on till
they become the favourites of the most ignorant among the crowd.
Diversification is Not the Done Thing
‘Diversification is a protection against ignorance. It makes little sense for those who
know what they’re doing.’
– Warren Buffett

Diversification is a tool to use when you are looking for average returns and want to
make sure that your overall portfolio is not severely affected if one or two stocks don’t
perform. It is a defensive investment strategy and will not produce the returns value
investors expect.
Diversifying into stocks from different sectors does not work either. Most sectors move
the same way as the economy or the market. In fact, concentration in a sector when the
sector is having a good run is a smart value investing strategy.

Don’t Confuse Beginner’s Luck with Skill

If you have just started with value investing and have made money, it is advisable to keep
your investments minimal rather than increasing them. For most of us, it is beginner’s
luck. Value investing is best learnt if mistakes happen early in your investing lifecycle.
That way you can test your parameters, and adjust and refine them to deliver results.
Many first-time investors who get into equity investing in a bull market rally don’t
realize that everyone is making money at such times. They attribute their gains to their
value investing techniques. This can create severe losses when the market turns. If they
continue to apply the same methods when the market moves down, not only will they see
all their profits from the bull market wiped out, they will also make more losses from their
desire to make up for their existing losses from the market.

Timing the Market is the Only Way to Beat It

Chances are most of us spend almost our entire time making buying decisions and almost
none on selling decisions. In fact, most selling decisions usually originate on impulse,
cash requirements, etc. You are sure to improve your returns almost immediately if you
pay a tad more attention to selling.
The only two prices that matter are the price at which you buy a stock and the price at
which you sell it. Everything else is pure noise. ‘Don’t time the markets’ is a myth. While
it is not helpful for investors — as opposed to traders — to time the market’s short term
moves, it is essential to time the markets based on a structural shift. This holds especially
true for emerging markets like India. India did not suddenly rise in potential or growth
prospects. By 2002, global investors took fancy to the India story. For anyone who timed
their purchase to take advantage of the ensuing deluge in global interest — based, of
course, on a strong Indian economic story — the rewards would have been significant.
This is also true at the stock selection level. Consider the example of Bharti Tele. As
Reliance launched its mobile service, the price of the Bharti Tele stock dropped to a
ridiculous level of 20-odd rupees. At that price, the market was almost assuming that
Reliance would drive Bharti out of business. But all Reliance was doing with its
aggressive pricing was getting phones into the hands of those who would never have
bought them before. It was a structural shift in the market. Cheaper phones opened up a
market that never existed and led to the strongest growth in telecom any economy had
ever seen. And that brought benefit and growth for all telecom operators. Reliance
expanded the market for its largest competitor, Bharti, and Bharti’s customers grew at a
rate far surpassing any fall in its prices. In the subsequent three years, the stock rose
almost fifteen-fold.

Technology and Financial News are Not a Competitive Advantage

‘There is no observed improvement in the emotional stability of the average
investors, notwithstanding dramatic advances in financial literacy or in the
sophistication of computer software.’
– James Grant

Access to increased information and technology has not improved our emotional
stability or temperament as investors. Moreover, once something becomes available to all,
it ceases to be a competitive advantage. It turns into a commodity. Take the example of
computers. If we had a computer when few people used them, it was a competitive
advantage. Today if we don’t have one, we are at a disadvantage; but if we do have a
computer, it is not a competitive advantage.
The availability of technology and information has made markets more accessible to an
increasing number of people. It has also reduced the extent of losses because of naked
fraud or ponzi schemes. But easy availability of technology and information has
contributed little to increased investor returns. This proves the single biggest truth about
the markets, i.e. investor decisions have more to do with emotional outpourings of greed
and fear and less with mathematical facts.
This becomes especially relevant when markets start getting driven by foreign money, as
was the case in Indian markets between 2000-2008. While the money pours in, the
markets run. But once foreigners change direction, all hell breaks loose.
Financial reports broadcast on television magnify the ups and downs of the market —
usually the ups. Profits of financial television channels depend on viewership; so they
must retain and stoke the viewers’ enthusiasm to invest. This results in TV channels
making the serious activity of investing look like child’s play. TV anchors and reporters
speak breathlessly of stocks that rise 10% on any day — even though the same stocks may
have dropped by 80% in the past two years. Most market ‘experts’ and ‘commentators’
have an interest in keeping the market from declining since going short is not everyone’s
cup of tea, and their explanations range from being naïve to being repetitive. Comments
like ‘India is in a secular bull run’, ‘The Indian economy will continue to grow in double
digits’, ‘India is a local consumption story’, ‘Weakness is a buying opportunity’, etc. show
how repetitive and simple-minded the serious business of investing can be reduced to.

Human Behaviour Guides Markets

‘That warm sense of everything going well is usually the body temperature at the
 centre of the herd. Only if you’re far enough ahead to be at risk do you have a chance
for large rewards.’
– Barton Biggs, Hedge Hogging

Let’s say you have ten stocks. A market crisis hits and you lose your job. You have to
pay your house and car mortgages and need to liquidate your portfolio. If you need the
money, does it really matter if five out of those ten stocks are outstanding investments.
When we hold a number of stocks in our portfolio, the stocks automatically become
related to one another, especially when we need to sell the portfolio to raise cash or
liquidity.
Diversification turns futile in such a scenario.
All stocks in your portfolio have the same umbilical chord — you. Your own perception
of the market will shape your entire portfolio holding.
Take the example of the technology bubble. Even though we may have diversified, most
of our holdings would have been in technology stocks. And when we sold off, we sold
technology, not any particular stock.

Experience Has No Substitute

‘Human beings never think of themselves, they find it too uncomfortable. For the
most part, members of our species simply repeat what they are told, and become
upset if they are exposed to any different view. The characteristic human trait is not
awareness but conformity… .’
– Michael Crichton, The Lost World

Value investing is like going through twelve years of 6th school. You don’t get to the
standard till you have cleared the 5th standard, and you don’t move up to the 12thstandard
unless you have finished the 11th standard. So when you say, ‘I bought X stock because it
was a value stock but it went nowhere’, you are implying that you expect to get to the 12th
standard while you are still in the 5th standard. The reason X stock went nowhere is
because you ‘thought’ you bought value but perhaps did not get your parameters right.
Let’s say you bought an infrastructure stock because you found ‘value’. But how does
one determine value? Does a stock have value merely because it has a PE of 2 and because
the company has an order book of a couple of billion? Yet the stock price hardly budges.
But is this really value? What if I told you that most of the contracts were running behind
schedule and the order book was a liability because the company would end up spending
more than what it was going to get paid on most of those orders. Worse still, the company
may not get paid at all because of its delay in fulfilling orders. Do you find value now?
Perhaps there was no value to begin with? To top it all, there is no scarcity premium, i.e.
there are literally hundreds of infrastructure companies to choose from and not one of
them is different enough to be in the spotlight. So no one company stands out for
institutional investors.
The Blind Spot
‘Imagine an eccentric and bored billionaire who offers you $10 million to play
Russian roulette. He gives you a revolver with six chambers, a bullet in only one of
those chambers, and challenges you to hold it to your head and pull the trigger.
Chances are five in six that you’ll come away with $10 million; chances are one in
six that you won’t come away at all. In other words, there are six possible paths that
your story will take — but after the act, we’ll see only one of them … (and if you
survive) you may be used as a role model by family, friends and neighbours.’
– Nassim Nicholas Taleb, Fooled by Randomness

In most cars, there is a blind spot between the side view and the rear view mirrors. That
is the spot which neither of the mirror covers and only the driver’s expertise prevents an
accident.
Value investing, too, has a blind spot And it is of vital importance to cover this blind
spot.
The single biggest blind spot for value investors is not fully understanding the sector
they are investing in — and even when do understand the sector, missing the nuances of
the particular stock within the sector.
For example, let’s say you are buying a pharmaceutical stock. The first question then is
— how deeply do you understand the sector? Can you differentiate between a
manufacturer of sterile cephalosporins and cephalosporins? Can you differentiate between
a Para III filing or a Para IV filing with the US FDA? Or, can you predict the outcome of a
court filing on a drug? Such finesse is what gives you the edge and covers your blind spot.
Build on this and you will see how your value stock starts to deliver.

Full Points for Being Right, None for Winning Arguments

‘You’re neither right nor wrong because people agree with you. You’re right because
your facts and your reasoning are right. In the end, that’s all that counts.’
– Warren Buffett

Those who like to prove a point, or win arguments, may find value investing difficult.
Or they may have to keep their points and arguments aside while they look for value.
Think of yourself as water and the stock as a tumbler. You have to take the shape of the
tumbler, not the other way round.
You have to figure out what the stock is all about and then fit yourself in there. When
you have a fixed set of beliefs, it is like water telling the tumbler what to do.

A Booming Economy Whips Most Stocks in the Long Run

‘A severe financial crisis can occur for a number of reasons, including excessive
speculation … and not necessarily because of a general and long-lasting downturn in
the real economy.’
– Marc Faber, Tomorrow’s Gold
 Few stocks survive economic booms and busts. Fewer still survive beyond a decade, let
alone a century. And here lies the market’s biggest irony. As the economy grows and
liberalizes, most companies die out. Only a few survive. Unless we happen to be invested
in the five companies out of the fifty that survive, on an overall basis we end up losing. A
growing economy increases competition and productivity and puts to test management
quality. In such a scenario, those ahead in the race, get ahead even faster.
Google is a prime example of those ahead in the race getting ahead even further — the
‘power law’. The Internet changed the world but look how the winner, i.e. Google, took
all.
Those falling behind, fall further behind. Take the example of India’s technology sector.
The number of technology companies that are doing well can be counted on one’s finger
tips — Infosys, Wipro, TCS, HCL Technologies, etc. Yet thousands of technology
companies exist in India, hundreds launched their IPOs during the technology bubble, but
unless we were with the top ten companies, or were able to identify them, chances are we
ended up in the negative. And in order to buy the top ten technology companies, we would
have needed to subscribe to just about every possible IPO. Statistically, we would end up
buying ten or more dud companies, i.e. companies with negative returns, for every one
success story.
A similar phenomenon will play out in sectors as diverse as pharmaceuticals, cement,
power, etc. As India moves from deficit to surplus in many products, a few companies will
rake in the benefits — and consequently market valuations. A majority will fall by the
wayside, becoming the victims of easy money, ill conceived plans, poor management
quality and an inability to price products higher in a surplus economy.
Airline companies are a classic example. Airline traffic in India is shooting off the roof.
And yet the airline stocks go nowhere. Differentiation becomes very difficult when
everyone realizes there is an opportunity.
Moreover, we only look at listed companies and tend to disregard that they may have
multiple competitors among private, unlisted companies or foreign companies. As a
market opens up wide for everyone, while overall business may grow it is only quality
companies with new innovative ideas and superior execution skills that survive.

‘The Anchor Effect’ Sets the Price of a Stock

Advances in behavioural finance show that we remember events that are the most recent,
and not necessarily the ones that are the most important or powerful. So if prices have not
risen for years and then they rise suddenly, small investors take the recent rise as a
window to exit their stagnating investments. The longer prices have stagnated, the
stronger the belief that any increase in an opportunity to exit.
The price that you get used to for a stock is called the anchor price. You measure any
change in price from that anchor price. You also start to measure over-valuation in terms
of how far the stock has gone from the anchor price.
Making decisions based on anchor prices must be consciously avoided. The economy
may have turned for the better, the stock’s prospects may have improved dramatically
because of a new management, etc. Focus on these factors rather than how much the stock
has moved from its anchor price.
Value investing requires us to look for information that is not just recent, but also
information from the past, and leverage on the habit of most investors to look at value
only in the context of current information. Take, for example, a real estate company
having valuable property in Mumbai. Let’s say its stock is quoting at 1,000. For some
short term reasons, the management is tangled in all kinds of problems and the stock falls
to 100. Most investors would get out. A good value investor, though, will hold on to the
stock keeping in mind the complexity of Mumbai’s real estate market and realize that once
the immediate problems are resolved, the developer still has quality land and at 1,000
per share the investor has the advantage of being on the other side of the fence in a market
where the barriers to entry to new players are extreme.

Overcharged Bull Markets Make Value Elusive

‘Investment themes only become obvious to most investors long after they have
emerged — only once the bowl has been leaning and overflowing to one side for
quite some time and created a bull market in a particular sector. Not surprisingly, we
find that the largest flow of money into an asset class such as stocks, bonds, real
estate or commodities will occur when just about everybody has fully understood the
theme — which will inevitably coincide with that sector’s peak in popularity and
prices.’
– Marc Faber, Tomorrow’s Gold

One of the biggest hurdles value investors face is timing their exit from a stock. Because
their orientation is value, they are often too early in selling out. If you use the traditional
measures of value investing in bull markets, you will find the stock over-valued way
before it ends its price run. In bull markets, valuations take a back seat and the price of the
stock is decided by the rush of ever increasing buyers who are ready to pay higher and
higher prices for a piece of the pie.
This has to do with the nature of bull markets. Once a stock catches the fancy of the
crowd, there is no way to know how high it will go — or how far it will move away from
its anchor. Once it breaks its anchor, the stock’s moves will be driven by the increasing
amounts of money chasing it and such moves will only stop when the money stops
flowing in. In this situation the value investor should assume that over-valuation can
continue to get magnified if more money comes in. You should exit only when extreme
over-valuation combines with a complete frenzy in buying.
Often, value investors either sell out early or sit through a bull market or, even worse,
turn believers towards the end of the bull market.
Bull markets are more about anticipation of further returns and a highly optimistic
mood. A value investor would look at traditional benchmarks and sell a stock because it
trades at a PE of 20 or 30. In a frenzied market, PEs become meaningless. In such
markets, a mob psychology takes over and prices rise because the biggest mass of
investors — and often the least knowledgeable in the market — starts to enter at this point.

Look Over Your Shoulder at All Times

‘It’s not whether you’re right or wrong that’s important, but how much money you
make when you’re right and how much you lose when you’re wrong.’
– George Soros

Most of what we learn in life is as a student; as a student at school, a student at college,

a student at work. Once you believe that you have become a master, you stop learning.
That is a big mistake. The trick then is to remain a student forever. And learning includes
making mistakes. Accept that mistakes will happen and focus on learning from those
mistakes and improving your skills.
Average returns can be turned into superior returns by following just two simple rules:

Getting out of a losing value stock early.

Staying with a winning value stock way after ‘over-valuation’ has set in.

Because losing, even a petty loss, goes so much against our grain and everything we
grow up with, you will have to practice the first rule. See what this simple change does to
your returns.

What Do We Get from the ‘Gurus’ of Value Investing

Many of us read Warren Buffett and almost believe we can replicate his returns by
following him. But it is not what Warren Buffett buys or sells that is important. It is his
temperament, his personal reactions, his ability to accurately determine a stock’s intrinsic
value, etc. that is critical to his success.
We are not all champions. If one isn’t Olympics material, one does not aspire to
participate in the Olympics. Similarly, one doesn’t watch Wimbledon matches and
believes that anyone can become a tennis champion.
Yet, markets make us believe that we can all do as well as the gurus. The truth is we
may just not have the make up to play like Warren Buffett or George Soros.
What will work for you is accepting who you are and where you stand — and a strong
desire to learn to make up for your shortcomings. Considering your real investing abilities,
check out whether you have done better than what you would have done without growing
your knowledge. Don’t needlessly compare yourself to some big time investor or trader.

A Stock’s Price is Only as Good as the Management’s Intent

‘The degree of one’s emotion varies inversely with one’s knowledge of the facts —
the less you know, the hotter you get.’
– Bertrand Russell

While a growing economy is critical for companies, two things become extremely
important for value investing in a growing economy:

Management quality, and

Management’s intent toward its shareholders.

Think about the number of times you have bought a stock thinking there was value in it
without keeping one or both of the above parameters in mind. There is no value investing
without these two parameters.
Management quality implies the ability of the management to do better than the
industry, innovate ahead of it, and take the initiative to keep growing into the future. Then,
too, while many companies may have quality management, they don’t have the intent of
sharing their profits with minority shareholders.
Here are some examples of lack of intent — spinning off parts of the business or real
estate by listing it or selling it rather than giving the spun-off shares to existing
shareholders; and selling a subsidiary or a business and not paying out most of the
proceeds as a dividend. We have to especially watch for such behaviour where stocks are
used more as an instrument to raise capital rather than to broad-base shareholding. Most
Indian investors hold stocks of companies that were going to set up power plants,
infrastructure facilities and all kinds of other things but which never really delivered or
fell way short of their promises.
The integrity of the management infects both the integrity of its financials and the
company’s fundamentals. On this edifice rests our entire value argument. So if you have
doubts about a company’s management, it is not a value investing candidate.

Value is Oblivious to Bull or Bear Markets

‘Progress is cumulative in science and engineering but cyclical in finance.’
– James Grant, Historian

Cheap is an anchor concept. If a car is priced at 20 lakh, it is cheap at 15 lakh. If a

house is priced at 50 lakh, it is cheap if you get it at 40 lakh. Cheap to us is cheaper
than what we expect the price to be.
Bull markets backed by economic growth or a rapid demand for commodities tend to
build multiple opportunities for companies. Companies that cash in on those opportunities
have value which may not immediately show up in their financials. Anticipation of those
opportunities in a profitable manner will create value in such stocks in a bull market.
In bear markets, stocks are cheap but bear markets in a slowing economy also reduce the
number of opportunities. And while the stocks may appear cheap relative to their
financials, they may be facing a reduction of future opportunities.
Thus, while there is value in both bull and bear markets, it gets lost quicker when bull
markets correct.
~
 Secret # 8
~
Where Does Value Originate?
VALUE ORIGINATES NOT JUST FROM LOW PE OR low book value, or other such conventional
measures of value, but from a number of sources. That opens up a whole new world of
value investing.

Markets Never Rise or Fall Forever — The Law of Means Catches

Up
Stocks and stock markets will always gravitate to the mean, which means that in the long
run stocks will grow only as much as the growth in the concerned sector or the growth in
the economy.
Every sector follows a cycle. When there are only a few listed stocks in a sector and the
sector catches the fancy of investors, those few stocks get very high valuations. This
attracts unlisted companies in the sector to list. More and more companies list until the
supply of stocks of companies in the sector far outstrips the demand. At that point, stock
prices fall and move towards the valuation of stocks in the index.
By this logic, if Infosys is trading at a PE of 30 and continues to trade at this PE in
expectation of higher and higher earnings, it is only a question of time before it will adjust
to replicate the PE of the index — or the PE of its global peers. How long investors would
continue to give any particular stock higher valuations than the rest of the market is
impossible to guess but the gravitation to the mean is a given.
Investors paid unheard of valuations to buy technology stocks during the Internet boom.
And then these stocks dropped to levels where their valuation was close to the valuation of
other stocks on the index.

Cycles and Trends

Insiders understand market cycles and that is why they rarely get caught averaging — the
harmful habit of investors to buy more stock if the price falls. When the market cycle
turns, the savvy insider will sell no matter what the price.
Thus, many insiders realized that the technology cycle had turned once technology
stocks around the globe started to correct; and they sold their technology stocks as the
markets dipped. Many individual investors, on the other hand, either continued to buy tech
stocks or did not sell the ones they held. An understanding of cycles would have indicated
that the technology cycle was over and that it was time to cut losses at the earliest.
Markets work in cycles. A cycle lasts for several years. Within cycles, there are trends.
So we could be in a bull market cycle and yet see the market periodically lose 5% to 10%
in a month. Such a fall is a bearish trend within a bull cycle.
If you can judge the start and end of a cycle, you are almost sure to come out a winner
since you will then calmly sit through even severe bearish trends within the bull cycle.
Knowing the type of cycle we are in also allows you to wait out big but temporary falls
in the market and leverage any unusual fall to your advantage.

Catching the Structural Shift in the Market

Structural shifts in a stock, sector or market’s outlook could change the basis and rationale
of making an investment. Such structural shifts could be mergers and acquisitions,
consolidation, the maturing of an industry, a change in the structure of the market, etc.
If the rules of the game are changing, and we can catch this early enough in the game —
though not too early — that may be a big opportunity.
Take for example the consolidation in the Indian multiplex theatre industry. Adlabs’
stock rose almost twenty-fold from its lows once the ADAG group bought it over. Fame
went up eight-fold in about three months when it became an acquisition target. Other
multiplex stocks moved, too. For instance, INOX and PVR rose three- to four-fold on
expectations of an acquisition.

Buying in a Fire Sale and Selling as the Plane is Taking Off

The question that you should ask as a value investor is: ‘What price am I paying for the
opportunity?’ You may be paying too much for an Infosys notwithstanding its profile or
pedigree. On the other hand, you may find a mid cap stock where you are paying a small
price for a big opportunity.
The price we pay, and not just the growth prospects of a company, determines our
returns. Returns are inversely proportional to the price we pay.
In the long run, most stocks start to produce a negative return; in the very long run, they
often vanish from the exchanges! Just pull out a list of the top fifty stocks on the BSE at
the turn of the century, in 1947, and in 2000. For every great stock pick, many stock picks
fail. This has been the history of the markets and it will remain so in the future.
If an economy liberalizes and grows at the rate India grew for about the first ten years of
the 21st century, chances are only a few of the listed companies will survive, even fewer
will do well. Faster economic growth brings in new local and global competitors. It also
encourages a number of private companies to list on the exchanges as capital becomes
easily available. That, in turn, increases the pool of players where management quality and
scalability start to become critical issues. Technology companies are an example.
The flip side of the argument is that abnormal returns are almost assured in very
pessimistic or down and out markets. If no one wants stocks and there is bad news all
around, it is almost certain that investors have slammed the stocks way below their true
worth. Think of what steel, shipping, automobile stocks, i.e. anything but technology
stocks, looked like in 2000. Had you bought those stocks, imagine your returns in just five
years. In all likelihood, even if you selected such stocks randomly using a dart board, you
would have made 10-fold to 20-fold returns in 5 years on these stocks.

Not by Diversification
What is diversification? Is it having 1 lakh invested across 20 stocks or is it having
100 crore invested across 10 stocks? Someone who has 1 lakh and invests it across 20
stocks has just too many stocks in his portfolio. If the markets fall, chances are all his
twenty stocks will head down. On the other hand, if the markets rise, each of the twenty
may behave very differently. Moreover, with such a small amount, the chances are
miniscule of the investor doing any real research to find twenty value stocks.
Diversification is another way of saying, ‘I am not sure and so I am going to put my
money in all kinds of stuff.’ If that is your philosophy, then value investing is not for you.
However, if that is not your philosophy, then you may need to keep your eggs in one
basket and watch it. Or, pick only a few stocks — never exceeding ten — and watch them
like a hawk.
Select the sectors which you believe will stand out before picking up stocks from those
sectors. Your sector selection should be one that you expect will rise in the near future. As
a comparison, consider a train journey. It is no use entering a train on a platform that is not
going to move till the next day. Take the train that is ready to move soon.

Tune Out the ‘Noise’

Probably the biggest intellectual problem an investor must wrestle with is the
constant barrage of noise and babble. Noise is extraneous, short-term information that
is random and basically irrelevant to investment decision making. The serious
investor’s monumental task is to distil this overwhelming mass of information and
opinion into knowledge and then to extract investment meaning from it. Meaning
presumably leads to wisdom, which should translate into performance — the only
thing that matters.’
– Barton Biggs, Hedge Hogging

The best and the brightest market experts are too busy making money themselves to go
around pontificating on one stock or another. What, then, are you listening to on TV or
upon the Internet?
Do yourself a favour by reviewing your investment record over the last two to three
years and figure out whether your investment performance has been enhanced by the
numerous hours that you have wasted hearing all types of analysts and experts.
Invest the same time in doing some work on value picks — like picking a sector and
digging deep into how it works, and then selecting companies which you see stand out
within that sector, and are perhaps under-valued. Then you have a winner in that value
pick.

Long Term Thinking, Yes, Staying Put in a Stock, No

‘The problem with the person who thinks he’s a long-term investor and impervious to
short-term gyrations is that the emotion of fear and pain will eventually make him
sell badly.’
– Robert Wibbelsmen

Value investors often confuse value investing with doing nothing about the stocks in
their portfolio. Some leave stocks in their portfolio for years without a review or cleaning
out. Companies work in very dynamic environments where regulations, competition, raw
material costs and a hundred other things could change their dynamics. A value investor
has to keep in mind these dynamics and regularly review his portfolio to weed out stocks
where the outlook has changed.
What constitutes the long term is today becoming shorter and shorter. It took Ford or GE
a hundred years to get where they are and then a Google and Starbucks took just ten years
to do the same.
Typically, companies earlier survived on proprietary technologies or capital. Neither is
now the preserve of a few anymore. It is getting more and more difficult to find companies
that can sustain their advantage over any extended period of time.
This is especially true of companies listed in India. Market leaders in most of these
companies remained leaders either because of some sort of regulatory protection or access
to capital or just their first mover advantage. That phase is now over. From automobiles to
power to infrastructure, barriers of entry are falling and it is difficult to say who will be
left standing after ten years.
In this scenario, the long term is only about two to three years. And if you see a
company falling behind because of management, competition, or for whatsoever reason,
accept it and sell the stock even if it was once a value pick.

In Getting One Right and Letting the Other Nine Go

‘All my life I have made mistakes —, but in losing money I have gained experience
and accumulated a lot of valuable “don’ts”. I have been flat broke several times, but
my loss has never been a total loss. Otherwise, I wouldn’t be here now. I always
knew I would have another chance and that I would not make the same mistake a
second time… .’
– Edwin Lefèvre, Reminiscences of a Stock Operator

Look at your value investments in the context of the entire set of value stocks you have.
Let’s say you picked ten stocks. One stock is doing very well, three are not doing as well
as you expected and six are not doing anything at all; in fact, they are heading lower. What
is important is being a winner when you tally up how you did in all the ten stocks
combined. That would require you to let that one stock that is doing well continue to
accumulate gains, hold the three that are not doing so well and watch if they show any
signs of moving up. As for the other six, just let them go. If you hold on to them, they will
only drag down your overall performance.
Even the best value investors rarely get more than three to four picks out of ten right.
When you start out in value investing, expect to get just one stock out of ten heading the
way you expected. The secret is to let that one stock accumulate gains to the extent it can
and limit the losses on stocks that you did not get right by getting out of them early on.

Not in ‘Cheap’ Stocks

If a stock is cheap because investors are not looking at it at that time, there could be two
reasons. The first could be that there is a bull market in a particular sector and it is easier
making money by flipping stocks than by good old value investing. The other could be a
structural or regulatory problem in the sector concerned.
During the IT boom, investors got so busy flipping IT stocks that they disregarded other
stocks available at attractive prices. The result was that steel, hotel and other sectors
started to trade at such low valuations that any change in demand would have to be
accounted for by higher prices. This is the ideal fishing point for value investors; stocks
are cheap, the dynamics of the sector or stock are moving towards higher demand and no
new capacity is being planned. Such stocks are waiting to explode. When? That we don’t
know. But it will be sooner rather than later.
Alternately, stocks could be cheap because there are structural problems in the sectors
concerned. Think of the Indian oil and gas and fertilizer sectors. With so much confusion
on subsidies and no real political will to change the status quo, this is not a pond you look
into for value fishing. It is possible, however, that structural changes, such as deregulation
or easy availability of crude or gas, may be starting to happen. A structural change that
you can spot before the market as a whole has figured it out provides another value
investing opportunity.

In Holding On Till the Tank is Full

Value investing is a game of patience. It may happen that you picked the right stocks for
the right reasons and then sat with them for five years. After this long wait, the stock
doubled and you jumped ship. You were perhaps correct in your assessment that the stock
is now over-valued but it may be based on past parameters. What if the dynamics of the
business were changing and this had not yet reflected in the company’s financials?
Take for example an IT company working in the defence space. Let’s say it has a two-
decade working relationship on defence contracts. Then the company decides to bid for a
US $2 billion contract. Now, such a bid does not even show up on the revenue side of the
company’s financials since at this stage the company is only running a pilot project to get
the US $2 billion contract. However, they do mention this opportunity in their annual
report. Is this a value buy? Perhaps not in the traditional sense of PE, etc. It may be a
value buy if you looked beyond the horizon and saw what this could become. If you have
the stock, you may sell if the stock doubled. But that may be too soon. Maybe the stock
could go up ten-fold. Maybe a couple of institutions or smart investors have already
figured out what is coming and the rise in prices shows their intentions.
There may be value in IPOs, too, though in such situations the specific phase of the
market is important. As a market emerges from a depressed phase into the first stage of a
bull rally, IPOs are rare, and those who have the stock hold on to it. In the second stage,
some stock is sold and a few IPOs come to the market which are generally of good quality.
In both these stages, demand for the stock is higher than the supply and value investors
must avoid selling out too early when stocks are bought in an IPO at this stage. In the third
stage, the stock appetite is high but so is the sale of stock and the number of IPOs hitting
the market though these IPOs are either of poorer quality or are very aggressively priced.
It is in the fourth stage that the sale of stock and the flow of IPOs begin to outstrip
demand, leading to a bust cycle.
In Structural Shifts
Had someone told Vasco de Gama when he landed on the shores of Kerala that the world’s
financial capital would be New York, Asia’s financial capital would be Hong Kong and
India’s financial capital would be Mumbai, he would have considered that person mentally
unsound. At that time these cities were nothing but jagged pieces of rocks or fishing
villages. Over extended periods of time, structural shifts, like those recently witnessed in
India and China, shift a market’s overall trajectory. Those of us who can read such a shift
early enough — and hold on long enough — will see the kind of exponential returns that
come once in a lifetime.
Structural shifts happen because of a change in regulations. Examples of structural shifts
include foreign direct investment in retail or a change in the price telecom companies pay
for spectrum

A Diamond Comes Mixed in a Ton of Mud

Diamonds require sifting through a ton of mud. Experienced diamond prospectors know
how to concentrate on where the diamond may be. They cannot get rid of the mud but they
can reduce the amount of mud they need to sift to get to the diamond.
Similarly, with experience value investors find an increasing number of value stocks
because they test their parameters with actual purchases and continuously improve on
their selection parameters for finding real diamonds. They don’t necessarily dig where
everyone else is digging, blindly following the crowd, or disregard what a crowd can do,
i.e. rush in and destroy their chance of finding a diamond. Instead, they chart their own
course.

In Staying Invested as Long as is Necessary

Most people who have done extremely well in the market made their fortunes in just a few
stocks — and in a short span of time. Even those who are made out to be financial gurus
made most of their profits in a short span of time. Being human, however, even when we
luck out, we like to believe it is our intelligence that gave us the gains.
To some, wealth comes easy and god just decided he was going to hand them a golden
lollipop. If you have that fortune, well, great! If you are like most of us, we don’t usually
get too many short cuts. The short cuts we take for making money end up in losses.
The maximum amount of money will be made in a short span of time. What you need to
do is to be ready with a bag to catch all that money. To get ready, pick the right value
stocks and then wait for that massive surge. Once the storm has gone, the market will calm
down and the stock will go about its business as though nothing spectacular ever
happened.
Take, for example, the rise of Infosys. Most of its spectacular rise came in just three to
four years. Before or after that, you could have held the stock for years and there would
have been nothing much to write home about.
In ‘New Era’ or ‘New Asset Class’
Stock market bubbles are usually caused by the discovery of a new technology or a new
country’s potential or a new asset class. Essentially, anything that creates a structural
imbalance in an existing system, whether it be airlines, railroads, the Internet, China, etc.,
will cause a market bubble to build up as investors try to price the new asset class. In a
sense, then, stock market bubbles are almost a price discovery mechanism that provide a
once-in-a-lifetime opportunity to cash out big time at the peak of irrationality.
Whenever a new technology, discovery or country promises to ‘change the face of the
world’ or impact it greatly, the markets adjust to this new reality. For example, railroads,
the Internet, then China and India, all promised to change the face of the world. Investors
rushed in to get a piece of the action. It is this rush that take prices to stratospheric levels.
Unfortunately, most investors get in late and at very high prices.
In most cases, though, the market overshoots and then corrects itself. Once in every
decade or two, it runs into euphoria. The euphoria is not so much plain greed or fear —
which it may eventually turn into — but is the expectation that a new technology or
country could result in such great profits in the future that even the previously ridiculous
valuations are justified.

Black Swans Bring Value

‘… the awareness on the part of a considerable segment of the speculating
community that a rush for liquidity — to get out of other assets and into money may
develop with disastrous consequences for the price of goods and securities … as
distress persists, speculators realize … that the market cannot go higher… . The race
out of real or long term financial assets and into money may turn into a stampede.’
– Charles Kindleberger, Manias, Panics & Crashes

Black swans happen once in decades. They have little to do with the economy,
fundamentals or stock markets. Instead, a black swan has everything to do with investor
confidence. It clearly proves that investors let their hearts, and not their heads, do the
thinking in such times. For those who can step away and see what this really is, i.e.
extreme psychotic behaviour of the herd, opportunities are enticing as stocks become
extremely mispriced and reflect, in many cases, nothing close to their real value. Of
course, the caveat is that you should have the power not just to buy, but hold both
financially and psychologically, till the storm passes over. This is bound to happen sooner
rather than later, and then we will be kicking ourselves for not being buyers in a fire sale.

~
 Secret # 9
~
Where Does Value Disintegrate?
VALUE DISINTEGRATES WHEN INVESTING IS DRIVEN by an overestimation of demand or an
underestimation of the supply’s ability to react to demand.
During economic booms, businesses overestimate the demand and the cyclical mismatch
of demand and supply which is usually referred to as the demand-supply mismatch. Let’s
say that company A Steel sees steel demand rising faster than it can produce steel and
believes it is time to increase capacity and goes about doing so. It will take a couple of
years for the new capacity to come up. In most cases, it would be creating this capacity
without any real understanding of how much capacity is being added by others — and
whether demand would remain as strong when all the additional capacities become
available. By the time A Steel’s new capacity gets on line after two to three years, other
companies would have similarly expanded, creating a combined capacity which is then
usually ahead of the demand. Moreover, the supply was created to meet a demand that
existed two or three years ago and may well not exist any more.
When buying value, don’t just look at the overall demand and assume that the stock you
are picking is going to pick up that demand. This should be especially kept in mind when
projects have a long period of completion before becoming operational. It is possible that
looking at large margins, many other companies may also get in and create a situation
where supply matches up with demand and puts severe pressure on prices.
Take the example of India’s power sector in recent times. In anticipation that power
would be in short supply for years and that extremely high merchant power prices will
exist, all kinds of companies — not just those who understood power, but also those
whose only claim to fame was capital — entered the power sector creating a situation
where merchant power tariffs were 40% of their peak. This kind of a situation would put
severe pressure on the stock prices of listed power companies and their business prospects
then won’t seem as great as they did earlier.

Two Dimensional Thinking in a 3-Dimensional World

What is the maximum number of books one can read from a library in a lifetime? Most of
us may read 500 or 1,000, or maybe 2,000 books in a library of a million books. Someone
who has read more than 2,000 books in the library is perhaps a PhD. Yet, even in his case
what he has read is not an iota of what the library has.
Think of value investing in a similar vein. Most of our value investing decisions are in a
two dimensional format. While we cannot know everything, it may help to start thinking
in the third dimension.
For example, if you buy an auto ancillary stock because its PE is 2 or book value is 3
times its market price (two dimensions), you must also think of current the state of the
auto ancillary sector as a whole. Is there any investor interest? Is it possible that PE ratios
are low because the market is anticipating higher input costs or lower orders from
automobile companies? This is the third dimension.

‘Buy’ and ‘Hold’

Most value investors focus the bulk of their energies on the buying decision even though it
is the selling decision that is critical for your investment.
Should you sell when there is no value any more? Or should you hold over-valued
stocks when the mood of the market is euphoric? When does one sell out in a market
mania? These are the sell out questions that are critical. For example, at the end of a
market mania most analysts say, ‘It’s a good time to buy.’ Actually, maybe it’s a good time
to sell since the race, i.e. the momentum, is over.
Value must be combined with momentum in the volumes and price of the stock for
maximizing gains. Let’s say you had bought a stock like Unitech in 2001 as value with a
dividend yield of 10% or more at a price of 40. By 2004, the stock was trading at 400.
So, should you sell? The answer depends on the market’s mood for real estate stocks at
that point. By 2004, it had become clear that real estate would be the next big investment
theme. That meant that the market would take a fancy to real estate stocks and could push
them anywhere. And that’s what happened. Unitech went to over 12,000 by 2006, and
over 20,000 by 2007 on a pre-split basis. A dynamic mix of value and momentum,
which takes into account the mood of the market for that particular stock or sector, at a
stage when it seems the stock has moved away from value, will help us capture gains that
may not make sense but exist because a large swathe of investors will push up prices.
It is not important if we have made, lost, or will lose money by selling off. What is
important, and what should drive our selling decisions, is whether we can get much more
— or lose much more.

Out of Favour, Out of Value!

‘There is a key difference between a share and a pair of dice. With dice, there is risk
but no uncertainty because you know (for certain) the chances of getting any number.
For stocks, though, there is a risk that the price will fall and there is uncertainty about
how likely it is to do so.’
– Roger Lownstein, When Genius Failed

Once a major market mania, like technology, or a country mania, like Japan or India,
goes bust, investor interest also moves elsewhere. Once a bull market bursts, especially a
frenzied one, investors develop an aversion to stocks, particularly the large number of
first-time investors who suffer the most quite like younger couples turning vicious with
each other on separation.
Usually, it then takes a new generation to come up and start buying stocks again at the
end of a frenzied market.
Such change in leadership changes the direction of the market for extended periods of
time. In some cases, the market may not move anywhere for even ten to fifteen years, as
has been the case with the Japanese markets. Similarly, the Chinese markets remained
depressed for almost eight years culminating in 2006. By 2006, they had lost 50% of the
value they had in 1998.

Awe and Reverence

If you are in awe and reverence of a certain management and you believe just that name
alone can generate value, you are on the wrong course.
Awe and reverence for managements, individuals, gurus, cannot create value. Chances
are that many are buying stocks in awe of these people. That in itself is driving up the
prices of the stocks to levels where there is no value.

Accounting Ponzi Makes a Mockery of Value

Value investors must pay attention to dubious accounting practices being used by
companies to create revenues and profits. For example, a real estate company using the
‘percentage of completion’ method creates revenue even when a building is not finished.
This assumes as if people can live in an incomplete building, or that there is no risk of the
building never being finished. Although this may be acceptable in accounting terms — i.e.
showing revenues when there are none, and when revenues are a 20% markup to the
amount spent on construction — it is humbug for value investors. If you took into account
such methods and eliminated any revenue that is based on these methods, perhaps the
stock will not have value anymore.
Or, take for example the methods employed by real estate companies to sell properties.
Pay a deposit (usually 4060%) on an under-construction property — and sometimes no
construction at all — get an allotment letter, find another buyer in 30 to 90 days, make
money on the ‘flip’, and move on. That’s the state of a significant portion of the real estate
sector in India today. The anticipation of profits by flipping properties is the new game in
town. Over-construction driven by speculative buying and selling is creating a supply glut,
like never before, of substandard residential and commercial space.

~
 Secret # 10
~
The Value Mirage
Risk and Reward Have an Absolute Correlation
Investors who bought stocks in the US after the crash of 1930 — the markets were off
50% from their highs then — would have lost another 80% as markets fell that much more
again by 1932. It was only in 1955 that the Dow Jones touched its 1929 high — yes, it
took the index 26 years to get to the same point — and it then rose three-fold.
The correlation between risk and reward in stocks is not clear. Buying at the bottom of
bear markets could deliver exponential rewards, far in excess of the risk. On the flip side,
at the peak of bull markets the reward may be small compared to the risk. What many of
us fail to consider is the impact of the market’s mood and liquidity on the future outlook of
stocks.
The maximum rewards are reserved for those who take little risk. Investment bankers,
brokers, market gurus, and company promoters usually have a first cut at stocks. And it is
not always because they have some insider information. Rather, they are so close to the
action that they can see the structural shift happening before individual investors can.

Booming Economies Produce Value Stocks

Economic growth, especially of the exponential kind, is not always good for stocks. As a
business shows exponential profits, more companies rush in, raise money — and the profit
margins get squeezed. The ensuing squeeze out leaves only the best around. So while
railroads are still around, railroad stocks have been relegated to museums. The Internet has
brought about the most profound changes in our lives but only a fraction of Internet stocks
are around and kicking.
We often equate a strong economy with rampaging bull markets. But if many Indian
companies rise to world standards and can produce at such cheap rates, how can it be good
for investors? Pharmaceuticals are a classic example. A few years ago, Indian companies
were competing with Spanish and Italian companies in selling pharmaceutical
intermediates to US pharmaceutical companies. The Indian intermediates were cheaper by
a mile. With cheap access to capital and stock prices that were up 300% to 500%, they
were all building global capacities and would have to compete with one another. The
beneficiary will be the global customer while the companies and their investors could feel
the squeeze. You can call it the ‘big company vendor’ effect. A big company gives its
vendors huge business, but also squeezes the sweat out of them. These companies work on
wafer thin margins and lose their ability to survive if the big company withdraws its
business from them.
In strong globalized economies, the rate of failures and fallen companies increases
exponentially. Margins become wafer thin and companies compete on volumes or because
they have an intellectual capital edge. Only the best survive. There is no place for
inefficient companies.
As India becomes mainstream for the world, global companies come in, competitors
with cheap access to capital rush in, and companies build up capacities to meet their hyped
and over-hyped demand projections — after all, no one rose up the corporate ranks by
suggesting that sales could fall! The next stage is a glut, a frenzy to get out, and a fall in
stock prices to levels that make no sense.
And that’s why stock picking, as opposed to sector picking, then becomes the order of
the day. Betting on entire sectors, like we saw happening with the Indian banking sector in
2010-11, is outright dangerous, except during a frenzy. For example, it is preposterous to
assume that all banks will be able to survive a burst in productivity and efficiency
improvements.

Markets are Efficient

‘Observing correctly that the market was frequently efficient, they [the efficient
marketers] went on to conclude incorrectly that it was always efficient. The
difference between the two propositions is night and day.’
– Warren Buffett

Share prices reflect information that we know as well as information that others have.
For example, while you may not be able to explain why a stock has moved based on the
information you have, that does not mean others who bought or sold the stock don’t have
information based on which they traded the stock. The information does not necessarily
have to be fundamental in nature; it can be all kinds of information, including
fundamental, market mood, etc.
However, markets sometimes are unable to factor in all the information, especially in
times of extreme moves where the force of liquidity, or the lack of it, moves the markets
more than what all the information is likely to do. These are precisely the points at which
we can make significant returns.

~
 Secret # 11
~
How to Find Value
‘The art of getting rich consists not in industry, much less in saving, but in a
better order, in timeliness, in being at the right spot.’
– Ralph Waldo Emerson
THINK ABOUT YOUR CLASS IN SCHOOL. There would have been thirty to forty students in
your class. Can you think how many have done exceedingly well? With exceptions, most
of us would be surprised by the largely ‘middle of the road’ performance of most of our
classmates. Why? What happened? What became of those who seemed brilliant?
Somewhere they lost their individuality and felt the need to belong, and fell for the
trappings of life.
Value investing requires us to take conscious steps to set our own course in life without
losing our individuality.

The Courage to Act on Your Beliefs

Once you have identified value stocks, act on it. The difference between thinking that you
have found value and actually putting your money where you believe you have found
value is conviction. How many people do we meet who say that they knew the stock was
going to go up or that the economy was going to move? Ask them how much did they
make and you will be surprised to find that most made nothing. The ones who did — less
than 5% — had conviction. Right or wrong, they had conviction and they acted on it.
Once you have acted on your conviction, however, don’t make it an ego issue. If it’s
working out, fine; if not, get out.

Hang in There When an Investment Mania Starts

‘Speculation may do no harm as bubbles on a steady stream of enterprises. But the
position is serious when enterprise becomes the bubble on a whirlpool of speculation.
When the capital development of a country becomes a by-product of the activities of
a casino, the job is likely to be ill done.’
– John Maynard Keynes

Investment manias are like landslides. You can often predict that a landslide is likely, but
when might the rocks come rolling down is anybody’s guess. They may slide now, or the
next day, or stay put for another year. Investment manias too can continue as long as
people continue to support them. In fact, in our current environment — with 24-hour
financial channels on television, hordes of analysts and instant communication — the
public enthusiasm and interest can be retained for far longer than we can imagine.
The market for industrial commodities like aluminium, copper and zinc bears this out.
Though copper, aluminium and zinc had already reached stiff levels by August 2007, they
got into a vertical rise for the next four years, sustained by continuous talk of the rising
consumption of these commodities by China and India. The fact, however, was that
including the consumption of such commodities by China and India, the overall GDP
growth of the world was only 4.5%, nothing more than it had been in the past decades.
There was nothing to show that, on an overall basis, the world was consuming any more
industrial commodities than it had done in the past.
Or, take the example of Indian real estate stocks. Just a few years earlier many of them
sold at single digit prices. Their prices then rose to triple digits within two years. In some
cases the gains were not five-to ten-, but more than a hundred-fold. Using traditional
measures of over-valuation, most of us would have sold out. Yet some of the best gains
greeted those who hung on to the meteoric rise.

Lock in the Sector before Latching on to the Stock

The credit rating of a company never exceeds the credit rating of the country it belongs to.
Similarly, the valuation of the sector puts a ceiling to the valuation of stocks within that
sector.
Value shifts continuously from sector to sector. Once value shifts from one sector to
another, it really does not matter which stock you hold in that sector. Chances are that all
of them will get revalued downwards. That calls for a hawk-like focus on any shifts in
money flows, investor preference or structural shift in sectors. The latter must be the
overriding factor before picking any specific stocks in that sector.
Over a decade, you may see the rise and fall of a number of sectors; first IT may rise
fast, followed by, say, infrastructure which may be taken over by banking that rises and
falls, only to be taken over by oil and gas, followed by metals and mining, and so on. And
that is just in a decade. Imagine what would happen if you would have held the same stock
for those ten years. The stock may still be a leader in its sector but investors may have
long deserted the sector, or its scarcity premium may have vanished.
The rule then is that a sector in favour, or one attracting investors, or one with a scarcity
premium — i.e. a sector which has only a few listed stocks — will generate multiple
returns for most stocks and the gains will extend from the leader to the laggard. That
reduces your risk and increases your chances of value, irrespective of which stock you
have. On the other hand, even the best stocks in a sector that has no investor interest will
not deliver any returns.
The Indian IT sector demonstrates how the world has come a full circle. It does not
matter if you own the biggest and the best or the smallest and the worst; the chances of
finding value in this sector now stand greatly diminished. It started out with a few
companies that hit a windfall on some imaginary Y2K bug that was going to hit us in the
year 2000. The bug never hit, but the frenzy made the big IT companies huge and brought
thousands of new IT companies into the market. Hundreds of them got listed on the stock
exchanges — and then disappeared. The few that survived went through the motions while
at the end of it all, fewer than ten companies had achieved any real global scale. All this
huge up and down happened in less then a decade. In the process, millions of investors
found what they considered value only to find their cupboards stacked with certificates of
companies which don’t trade any more. The lucky few who did find value by investing in
a company that reached the top, never enjoyed the fruits of their lucky picks because they
sold off too early. Only a microscopic minority got it all right, had the right stock, the right
luck, and sat with the stock as it moved up — not just ten- but hundred- and maybe even a
thousand-fold.

All Falls are Not Created Equal — Some are Created for Value
What the world saw in 2008 was a credit squeeze or a credit seize. This was different from
the earlier dot com bust, or the Asian financial crisis, or the railroad crisis in the UK, or
the Tulip bubble. All those were asset class bubbles. What the global credit crisis of 2008
led to was a loss of confidence and a freezing up of credit which impacted the real
economy in ways that an asset class bubble cannot. Liquidity, though, in such seizures,
comes back sooner rather than later.
In situations like a credit freeze, the chances of shares being mispriced downwards are
great. Lack of liquidity forces institutions and investors to sell things in their portfolio that
make perfect sense to hold; however, they sell them because need the money. This kind of
selling throws up unbelievable opportunities. However, it is important that the portfolio be
limited to ten to fifteen stocks, otherwise excessive diversification takes returns closer to
the index.

A Liquidity Squeeze Offers Value and is Different from a Bubble

Bubbles are nobody’s babies and hurt only the rich and the greedy. A liquidity squeeze or
freeze has many godfathers as they hurt the main street. Central bankers and governments
can ill-afford not to intervene by increasing the cash supply to banks and lowering interest
rates so that people consume more. And as the problem becomes bigger, the interventions
will become extreme till the time the damage stops. And, stop it will. Once it does, we will
wonder why we were not buying earlier.
A liquidity squeeze usually leads to gross under pricing or mispricing of assets and asset
classes, such as equities, real estate, etc., because of a mismatch of sellers and buyers.
There is too little money chasing too many assets. Often, there are usually no buyers at
any price. Consequently, such markets throw up unbelievable opportunities to buy stocks
at prices which are way off from their real value.
In liquidity squeeze situations, you also find the owners of stocks getting decoupled
from the sellers of stocks. From promoters to investors, many use stock as collateral to
borrow. In a liquidity squeeze, the people selling the stock are the collateral holders and
not the owners of the shares — and the collateral holder does not care if the price is right
or wrong. His sole aim is to get back the money he had lent. Consequently, he is willing to
sell at prices which no owner in his right mind would. This compounds the fall in the
markets.
In a bubble, on the other hand, we see an extreme correction of over-valuation. A
bubble, as we saw in the dot com boom, is caused by pure greed and delusion and neither
central banks nor governments care whether such investors go under. That’s why bubbles
are usually long drawn and more painful.

~
 Secret # 12
~
Finding Value in the Market’s Dynamics
MOST PARAMETERS OF SUCCESSFUL INVESTING DEFY CONVENTIONAL LOGIC. It is by
mastering these that many legendary investors made their fortunes. Let’s look at a few
such parameters.

Human Behaviour Holds the Secret to Stock Prices

‘One with a hundred longs for a thousand, one with a thousand yearns for
millions, one who lords over millions wants to rule a kingdom, the kings aim
to gain Paradise itself.’
– The Panchtantra

Why have investor returns not gone up despite an explosion in financial knowledge,
technology and tools? That’s because what has not changed over the centuries, is human
behaviour. While the means have changed, human motives and goals remain the same.
In essence, the twin human traits of greed and fear, more than any valuation story, set
the tone for a market’s direction and swings.
We are comfortable with sitting tight. If we lose money, we tend to double our bets. The
two transactions are mutually exclusive and there is nothing to ensure that we will not
double our losses, instead of recouping them, merely by doubling our bets.
Once a bull market is in full swing, the sequence of events has been amazingly familiar
over the past three hundred years of market history. Stocks will reach a high point which
has little to do with value. Then momentum kicks in and the market goes into an
overdrive. Those new to the markets are usually the last to turn believers but when the
market moves into an overdrive, they then turn believers with a vengeance — and in very
large numbers. That provides the final push to the market and takes stocks to ridiculously
high levels. In this phase, stocks are running because people are ready to pay any price to
buy them.
At the end of this euphoric phase, a massive blow out takes the stocks down very
sharply. The hangover is equally severe and stocks lose as much as 90% of their value.
Then the market looks for scapegoats to hang. One or more brokers are taken to the
laundry by regulators and the markets settle into a period of investor apathy.

History is Stuffed with Precedents

‘During each speculative revival, merchants and bankers fancy the prosperity
they see will last always, that it is only the beginning of a greater prosperity.’
–Walter Bagehot

The economic boom in India since the late 1990s had some striking parallels to what
happened in other Asian countries in the 1970s and 1980s. Looking at their experience
may give us a good idea of what the future could hold for India.
From 2004 to 2008, foreigners were bullish on India the same way they were on Asia in
the early 1990s. In every single market fad — from the Asian Tigers to Japan to China to
India — foreign brokers, investment bankers and wealth managers conjured up new
theories about why the market would move up. In each of these booms, the market faced a
shortage of experienced brokers, analysts and fund managers. Foreign brokers and
investment bankers set up large infrastructure to cater to the potential new business and it
was in their interest to talk the market up.
Investor interest was sustained by terms that became common parlance — ‘India’s
consumer boom’, ‘Dance of the elephant’, ‘Structural shift in demand’, etc. Just replace
these words with Asia instead of India and flash back to the 1990s, and it looks like
nothing has changed.
In 1997, the boom in the markets of the Asian Tigers came to an abrupt end. Currencies
collapsed overnight, stock markets lost their bottoms and real estate was not worth even
the mortgage. The Thai currency collapsed to half its value and this started the contagion
that was to become the Asian financial crisis. The Thai Bhat fell from 25 to around 55 to
the US dollar and the Indonesian Rupiah became 15,000 to the dollar, as against 2,500
earlier.
In India, as in the Asian boom, private equity, stock markets and foreign borrowings
replaced traditional sources of financing like banks. These new investors never had the
patience of banks and bolted for the door at the sign of the collapse, thereby making a bad
situation worse.

Market Cycles
‘Technology ushers a new era in market cycles’, ‘India is a domestic consumption
story’, ‘India is a secular growth story’, etc. All these headlines and many arguments were
advanced to justify why India may not be vulnerable to economic or business cycles, and
would continue to see robust market rise without any real cyclical behaviour. I am afraid
there is no empirical evidence that this may be the case. Business cycles have weathered
structural changes in economic and social conditions and improvements in industry,
banking, agriculture and technology, and yet have come back with striking regularity.
Markets, too, have not found a way out of cycles, irrespective of the country, its
development stage, or the structural shifts an economy may be seeing. Some cycles are
more extreme than others. For example, if you make a call that India is in an upward cycle
when the Sensex is at 21,000, then all falls are mere ‘trends’ from which the market would
recover. Actually, once the market is in a downward cycle, it could last a few years, or a
decade, or even longer.
Economies like India, with massive growth needs, require massive amounts of capital.
Whether the growth actually comes about depends on their ability to raise this capital. In
boom times, global investors don’t just provide the capital but flood the market with
liquidity. This causes spending, investing and real estate prices to ramp up sharply. Often,
though, the increasing amounts of capital fund inefficient expansions, causing excess
capacity to build up in many sectors. Market cycles have also been compressed in terms of
expansion as we have witnessed in China and India.

Trends are Not Cycles

A distinction between cycles and trends is critical for buy and sell decisions. How do you
read a cycle? Usually, it lasts for years and is unrelenting in its up or down moves.
Notwithstanding any intermediate down trends, the market moves up consistently.
Cycles will also go through phases with the last phase being, perhaps, the sharpest in its
upward move. And, inevitably, the cycle will end in a blow out and the market will then
take a couple of years to recover.
The Japanese markets are a case in point. After touching surreal levels of 40,000, the
Nikkei lost then almost 75% of its gain and languished for over a decade at those levels.

Eras, Bubbles and Manias

Investors make big mistakes when they try to invest at the early stages in new emerging
areas, like airlines, the Internet, or in new emerging countries, like India. Such mistakes
have been made for centuries especially when there have been new discoveries and
inventions or the opening up of new lands like the US or, within the US, California. In a
t
way, India was in a similar situation in the first decade of the 21s century. For foreigners,
it had just opened up. While investors are usually right about the prospects of a technology
or a country, they are often wrong about the companies that may make it and those that
will not survive. Moreover, in their euphoria to catch the wave, they usually pay very high
prices for anticipated returns. When returns don’t match anticipation, overall selling
follows.
Whenever a new asset class is identified, investors try to figure out what the new idea,
country or sector should be valued at. Some may call it speculation, but it is a process of
discovering the correct price since there are no existing benchmarks. In that process, the
obvious euphoria takes stocks way higher than their real delivery capability as investors
factor in the future potential in current prices. A key feature of such times is that demand
is always overestimated and supply underestimated.
This is a phenomenon that has repeated itself over the past three hundred years of
market history, perhaps longer. From railroads to canals to technology to the opening up of
the US to Peru to the Asian Tigers to China and, then, India, the identification of a new
asset class by investors — usually foreign investors — takes markets to ridiculous heights
before a severe adjustment sets in. The up move, though, before the severe correction is
usually unimaginably large.
There are often times in a market when we know there is a bubble building up, as was
the case in India in January 2008, especially in real estate and infrastructure stocks.
However, most investors buy or hold stocks not because they may not be aware that there
is a bubble, but because they believe that the bubble will grow much bigger before it
bursts. This phenomenon is called a rational bubble.
Rational bubbles are also created when investors push up prices of new era, e.g. airlines,
or new technology, e.g. the Internet, stocks. In such cases, the growth possibilities are
enormous and investors are trying to figure out what a stock could really be worth.
Accordingly, in these conditions stocks could run up to crazy valuations, like Yahoo or
Ebay did, and then adjust equally severely. When the dust settles, these companies do
change the way the world does business, but their stocks regress back to delivering the
same type of returns as does any other business.
A study of a couple of recent bubbles would be of great value for you to visualize what
Indian markets could look like in the future as a result of its recent ‘discovery’ by the rest
of the world.

There are Often No Rational Explanations for Market Meltdowns

‘When reward is at its pinnacle, risk is near at hand.’
– John Bogle

In late 2008, the markets lost almost 60% of their value within a quarter. No market and
no asset class was spared. This kind of fall is what is called the black swan effect. While
we know swans are white, there is always a (rare) chance that we may see a black swan.
Just because we have not seen a black swan till now does not mean they don’t exist. Thus,
while on most days, and even years, markets behave rationally, nothing says they will
continue to do that.
In fact, the same phenomenon was earlier repeated in 2004. Markets took a 17% hit in
just one day in May 2004 — at what was presumably the height of a bull market. Much to
the Indian market’s shock, the Congress party came back to power. True to its delusional
quality of mistaking what it wants as what will actually come to pass, the markets had
assumed that the ruling NDA alliance would be voted back in. The shock of the upset
caught an overheated market on the wrong foot. Like an active volcano, it required just a
spark of a trigger to shoot off its ashes. And that’s what happened.
As the selling aggravated, the stock exchanges put pressure on brokers to pay up or
liquidate their positions. In a banking system where even a high value cheque takes
twenty-four hours to clear, there wasn’t a fighting chance that brokers could pay up. And
then the crisis started. As brokers began to call clients and clients began to tell them it
would take them a day to pay, brokers began to sell. And to keep their trading terminals
from being disconnected, they sold anything and everything.
When the dust settled and the din of the trading floor was engulfed in silence for the day,
it was a day that investors would like to have wiped out from history books.

~
 Secret # 13
~
What the Market is Saying About Value
Value Lessons from the Market
Here are a few key learnings garnered from my notes over the years. I learnt, re-learnt and
recorded these lessons numerous times in various market cycles, sector-specific and
country-specific stock markets.
Opportunity exists in all markets at all times. Let’s take a look at the technology boom, or
bubble if you will, of 2000. In hindsight, if all of us had not been so focused on
technology but could see that the commodity cycle, which had been in a down trend for
almost twenty years, was starting to show some signs of a pick up, we could have it picked
up stocks like SAIL (not to speak of many other steel stocks) literally for the price of
scrap. And had you picked up such stocks, imagine the gains. In many cases, between
2000 and 2007, such stocks appreciated anywhere between 10- to 40- fold. No mean
achievement and in 2000, most analysts thought the markets were stretched
Markets and economies contract suddenly. The last quarter of 2008 proved this point. Who
would have thought that the world would head into a recession and that even booming
economies like India and China would get the shivers? Who would have expected markets
across the globe to lose 50% or more of their values in a brief period of three to four
months?
Nothing works all the time. Value works in some market cycles, momentum in others.
Momentum refers to stock prices being driven by an excessive flood of money flowing
into the stocks. In bull markets, investors try and get into the same stocks that have
already risen sharply. They do this because of the expectation of a continued rise in the
prices of such stocks.
In bear markets there is little if any interest in stocks. The stock’s movement then
depends on investments by value investors who understand the worth of the company and
the value a stock represents.
At the end of the day, broker research is a way to sell stocks. Brokers will usually write
optimistic reports and may not cover a stock if there is nothing positive to talk about it.
Because of this positive slant of equity research reports, a value investor must decide if the
stock is really worth buying.
When a large part of the market’s rise is funded by leverage, margin, borrowing or hedge fund
money, it is the most reliable indicator of the end of a boom. When markets are run on borrowed
money, any fall creates a requirement for more collateral or security. If investors don’t
have enough money to put up the additional collateral, they start selling shares, creating a
downward spiral in stock prices.
Many trends — both up and down — make up a cycle. But the biggest and the longest lasting
wealth opportunities are thrown up in getting the cycle right even if we are wrong on the
trends.
It is not always economic activity that moves markets. Sometimes markets move first and this
brings in a flush of money into both productive and unproductive enterprises which drives
up stocks.
 Just because we know that the markets are behaving irrationally or that there is a bubble does not
mean we cannot make money. We can do so by following the bubble for some time, and time
our exit before it bursts.
History repeats itself. Human beings are driven by habits. And they tend to repeat their
behaviour and mistakes. That gets reflected in the market cycles of boom and bust,
extreme euphoria and extreme pessimism.
A real estate boom follows a market boom, or vice versa. As investors make money in the
markets, they diversify into real estate creating a boom in real estate prices.
A fund manager will rarely outperform the intelligent individual investor because he is a victim of
his own trappings. Two drawbacks that a fund manager suffers that individual investors
don’t are: (a) We don’t have to buy stocks if they are expensive; and (b) We don’t have to
invest our money in stocks if we don’t wish to. A fund manager has to do both. He has to
put our money to work and, given his mandate, he can only buy stocks. He has to buy
momentum stocks even when they are ridiculously priced; otherwise, he will not be able
to report great quarterly returns. He may know perfectly well that the stocks he’s buying
are over-valued but he has to deal with the flood of money he receives in already crazy
markets.
There is often an inflection point in a company which the market typically notices only with a time
lag. Let’s consider M&M. When the company introduced the Scorpio, someone who could
see what it meant for a stock that was trading at 80 with a 6 dividend would have
made out like a bandit. By now everyone knows the story and price of the stock already
reflects the value the stock has.
Managements make companies. All companies in a sector don’t do well even if the sector is
on an uptrend. Managements make companies outrun competition. Just because the
economy is doing well, there is no particular reason why all listed stocks in a sector will
do equally well. In fact, quite the contrary is true. With easy access to capital, many more
companies will enter, or grow, in the sector, enhancing capacities and competition and
putting pressure on everybody’s profits.
When the bubble bursts in one asset class, investors invariably move to another asset class. They
will not stop to even consider whether the busted asset class now offers great value.
Buying for the ‘long term’ may work well in bull markets. In bear markets, it may leave us you
holding stocks with no returns.
Supply and demand imbalances may take years — or even decades — to reverse in stocks,
commodities and real estate markets.

Stock prices may remain depressed for years. Equally, they may gain exponentially in just
one or two years.
Higher the markets go, lower should be the return expectations.

Reading Investment Themes

‘The cities that were formerly great, have most of them become insignificant; and
such as are at present powerful, were weak in olden times. I shall therefore, discourse
 equally on both, convinced that human happiness never continues long in one stay.’
– Herodotus

A friend bought stocks for the first time and proudly announced the names of the
companies. When I asked him why he had bought those particularly stocks, he said he was
confident they were going to deliver 100% return in a year. In all bull markets, everyone
knows someone who knows for sure how things will turn out. I wanted to comment on
what he had bought but refrained because he seemed so sure he had done the right thing
and wasn’t seeking any advice.
When I met him again after a year, he asked me what I thought of the stocks he’d bought
and whether they would deliver 100% in three years; note he had already gone from 100%
in one year to 100% in three years. I said he should be happy if he could generate
16%-17% a year for the next three years. In telling him so, I was going by historical
precedence that stocks will not outperform bonds over any extended period of time when
we take into account the fact that many stocks in a portfolio will die out.
But herein lies the tale of equity investing — uncertainty on returns. For India, the ‘Big
Mo’ or the ‘Big Swing’ that happens when an asset class gets recognized, is over. Such
swings happen once in a lifetime and India has had her day under the sun with its
emergence as a globally preferred asset class. From now on, we may well move faster than
other stock markets, but it is not going to be an ‘up two-fold in a year’ type of run. Also,
there was nothing unique about India’s run. Depending on when they emerged as the
preferred asset class, Taiwan and the Philippines markets went up tenfold, and the Thai
and Malaysian markets jumped five-fold in a five-year span. But once it got over, these
markets moved the same way as any market in the world does, i.e. keeping close to bonds.

The Economic Domino

Stocks react with a lag to an upswing or a downswing in the economy. Stocks in a sector
may start trading at PEs of 3 or 4, or fall below book value. Does that indicate a value
buy? The only way to answer this question is to look beyond today and anticipate what is
happening to the sector. Perhaps a slowdown is around the corner. If that happens, how
much can the profits fall by? What if profits fall by 80%; this can happen in low margin
businesses. In that case, PEs may not be 3 or 4, but 20. Does the stock still look like a
value buy?
Economic activity may not directly impact stocks, but it certainly can take the wind out
of a sector. When that happens, the first to go are the weaker stocks — those that were
already operating on lower margins.

Watch Out for Window Dressing

Sometimes a sector and its stocks continue to indicate value because of creative
accounting or leveraging what is within the company’s hands. For example, banks can
increase the income from their investments if it seems that their bread and butter income,
i.e. interest income, is getting squeezed. Or, real estate companies could show higher
revenues and profits by showing a larger number of completions.
 While picking stocks for value investing, check to see that the numbers are not window
dressing but reflect the correct picture of the company.

The Changing World of Miss Value

Value is a fickle lady. She finds a stock — and then leaves it for another one. She finds a
sector, and then leaves it for another sector. But Miss Value wants you to develop the
knack for finding her next destination. Many of us sit at the same destination hoping that
Miss Value is still there while she has already moved on, or expect her to be where she has
no intention of being.
Value is also in the eye of the beholder. If the beholders are institutional investors, you
can expect the stock to make significant gains. If the stock is not being pursued by anyone,
it may be a long wait if you decide to buy it.

Cash Flow Rotation

Companies show value by revenue, profits or other such financial measures. Let’s take the
example of a retail company. You may pick up the stock because you find value. Your
value may be driven by the number of stores opened, increasing revenues, additional
products, etc. All these may well be a smokescreen for rotation.
Rotation may take place when a company ploughs back its cash sales into buying more
inventory and showing products as sold merely by invoicing them. Such tactics are often
used and end up leading you on a road where the final destination does not read value.

Value Investing on Themes

Investment themes are driven either by actual changes in the dynamics of a business or a
sector, or by the change in attitude or interest of investors towards that sector. Value
investors try to identify these themes before they become part of everyone’s investment
portfolio.
Let’s look at some examples of themes.
The Agricultural Land Theme
For the past few years, farmers and owners of agricultural land in India have run riot in
terms of the money they have made selling out their lands to dream merchants. That has
brought unheard of money to the Indian rural economy. What was different about the
money in this real estate rally is that it was enough to finance a boom in real estate and
automobiles and two wheelers, among other things. When this trend stopped and reversed,
it had severe repercussions. Most real estate deals are signed on part payment. All such
deals got stuck. Farmers, and especially their indulgent sons, had become used to the good
life, what with driving white Scorpios and building tiled houses, not to speak of the
number of liquor shops that dot the rural landscape of states like Maharashtra and
Haryana. This had severe repercussions on car sales, two wheeler sales and materials like
cement.
Consumption Theme
Job generating industries in India may be done with their ramp up. In the first decade of
the 21st century, insurance, IT, financial services, hospitality, etc. were key drivers in
bringing millions of Indians into the big ticket consumption cycle, i.e. homes and cars.
This is without including the millions of ancillary jobs these sectors created. All these
industries are now in replacement only mode or marginal growth mode. The days of
sudden ramp ups are over. In fact, in the case of IT what has largely gone unnoticed is that
job creation (I mean overall job creation and not just at Infosys and a few such flag
bearers) has become negative. India is no more the world’s BPO and call centre
destination. Places like the Philippines are getting most of the new additions to such jobs.
Any unexpected increase in interest rates by the RBI in such situations hits harder than
we think, acting like the proverbial last straw on the camel’s back. For example, in the
boom of the first decade of the 2000s, most Indian home and auto borrowers were salaried
employees. Post-2008, they were either confronted with a freeze on their salaries or were
even staring at the possibility of losing their jobs.
It is Their Time under the Sun!
Our own lives replicate value investing. There are days and years when we do extremely
well professionally or in our personal lives. That is our time in the sun. Stocks go through
the same phenomenon — packaging stocks, followed by auto ancillary stocks followed by
pharmaceutical stocks, etc. Any group of stocks can suddenly find favour — sometimes
backed by real changes in the dynamics or potential of the business; at other times,
because a power group of investors deems that sector needs to be revalued.
In either case, you should look for stocks whose time it is under the sun. While
conventional value investing may have wired us into finding stocks that are out of favour,
such thinking closes out a whole universe of stocks that have value but cannot make it to
your portfolio because they may be yanking up the engines driven by changes that are
increasing their profits, or investors who have decided to take them to another level.

Value Investing is Linked to Commodity Cycles

Investors either follow equities or follow commodities. Rare is the investor who follows
both. Yet equities and commodities are so closely linked that an understanding of a
commodity’s price behaviour could lead to excellent opportunities for finding stocks that
have value — or otherwise set the tone for an increase in commodity stock prices.
Sometimes we buy a commodity stock because the price of the commodity is going up.
But the company may, in fact, be a consumer of that commodity as a raw material, making
the price increase painful rather than helpful for its stock.
Take the example of copper. Copper stocks go up when copper prices rise. But most
copper stocks are those of copper smelters. When copper prices are high, copper smelters
are even ready to refine the copper for free since they have to keep the ‘fires burning’ in
their smelters as shutting off a smelter is not an option. Yet, copper smelter stocks move
up when copper prices rise. This is value investing gone all wrong.

Value Emerges as Sectors Clean Out

Sectors go through three stages.
In the first stage, there are only a few listed companies in a sector. Take the example of
real estate stocks, or consumer stocks, or fast food chains. When there are only two or
three listed companies representing a sector, the sector stocks move up the fastest. Every
investor tries to get a piece of the pie but the only way to play is to buy the two or three
listed stocks that there are. And when everyone tries to buy them at the same time, stock
prices sky rocket. This phase lasts about six months to a year.
As unlisted companies in that sector see what is happening to the valuations of their
listed peers, they too start to list. It starts with a few listings but then everything under the
sun in that sector lists. A point is reached where there are too many options for investors
wanting to get into the sector.
As investors get into poorer and poorer quality stocks in the sector, returns start to fall
and prices cannot hold up. A crash follows. After the crash there is a lull of two to three
years during which stocks in the sector go nowhere. Market leaders then emerge. Most
companies fold up. Business starts to increasingly flow manly to the market leaders.
This completes the value cycle — from a few stocks representing the sector back to two
or three market leaders who dominate most of the business in that sector.

A Rising Tide Takes Up All Ships

Value can be found in rising tides. In fact, finding value becomes simpler as all ships rise
with the tide.
Let’s take the example of ‘The Disposable Income Revolution’.
India boomed throughout most of the first decade of the 21stcentury but it mostly helped
the educated to get better paying jobs. What is happening subsequently is a revolution of
unprecedented proportions that is going to propel a large swathe of Indians, anywhere
from between 100 to 200 million people, from subsistence salary to disposable income
salary. This has profound implications. This would lead to sustained growth rates in retail,
automobiles, housing, etc. as this large number of people start to consume. Added to that
is the massive growth in planned transport infrastructure and you can be sure real estate
around cities and towns is up for some very large returns.
Since this boom began, Indian domestic help such as cooks, maids, drivers, etc. got their
annual increments of around 10% but their salaries were not keeping up with the growth in
the economy. Then, just about everyone got a 100%+plus increment (pay or you lose
them). In future, don’t be surprised if hiring maids from the Philippines will be cheaper
than hiring an Indian one. The point I am trying to make is that once this group of people
reach monthly incomes of 15,000 to 20,000 and payments by cheque or paying into a
bank account starts to become the norm, we are talking about some massive numbers in
consumption, automobiles, and real estate.

Contagions Pollinate Value

Contagions across world markets are knee jerk reactions to bubbles. After the reaction,
markets typically show sharp bounce backs, but what is lost is the market’s momentum
and the easy availability of money.
Some contagions come on the back of an unprecedented rally in stocks, commodities
and real estate across the globe. Such contagions seriously hit economic growth. In such a
situation, the very fundamentals driving equity prices, namely robust earnings,
commodities, namely robust demand and real estate, namely easy money could be called
into question.

The Commoditization of Stocks and Sectors

Most sectors end up being commoditized at the end of a cycle. A sector starts its journey
with just two to three listed stocks and end up with only two or three stocks controlling a
large chunk of the sector. In the process, the sector gets commoditized and its valuations
start looking similar to stocks in other sectors. Look back at real estate or infrastructure
and you will see that these stocks went through a wild surge but settled back at around the
same levels as they started from.
Take technology, for example. In India, technology is entering a zone where it can only
be treated as a utility. That means PE ratios of 10 or 11 should be enough. Clearly, an
Infosys cannot continue to grow at its current rate, not that they are beyond the ‘sweet
spot’. Technology out of India has become mainstream, and other global competitors have
caught on and offer the same outsourcing model as India. If that’s the case, an Infosys
cannot continue to price its services at a 30% margin. With many others being able to offer
the same price and scale, technology stocks will retreat to the mean and have PEs of
around 10 or 11.

How Value Emerges in Chaos

Bull markets create a number of companies whose only claim to fame is the availability of
excess capital that feeds their inefficient growth and ill-conceived plans.
When companies get into new businesses for no other reason but because they have the
money, they typically start to destroy value. Take, for example, an SUV maker who gets
into making scooters or motorcycles — or vice versa. What competence does it have?
Nothing in these two businesses is common, except transport. Their customers are
different, their sales and service centres are different and, most importantly, running the
two businesses requires very different mindsets.
Or, take the example of a passenger car company getting into the business of making
trucks. Why? What do they think they know about making trucks or truck buyers that
gives them the edge over existing companies in the truck manufacturing business?
Stampedes, by their very nature, are without logic, and in the sheer force of their fury,
crush anything in sight. They are also usually in the wrong direction. For those who can
stand aside when a stampede is in progress, and then go the other way to pick up what
others have left behind, it is like being let into a gold vault with a choice to take as much
gold as they can as long as they can carry it (afford it).
Execution Record in Emerging Sectors is Value
Beware of the creation of bull markets. During bull markets, all companies rise but value
investors must absolutely avoid companies with no real competency or delivery record.
Don’t construe wanton expansion as business acumen. As the Asian Financial Crisis of
1997 showed, easy capital created business monsters that were sent back to the Ice Ages
in tough times.
If you are searching for value in an emerging sector, look for companies which have a
proven track record of delivery and scalability. These are the companies which are able to
deliver increasing revenues based on these abilities. Technology presents some of the best
examples of execution record. Infosys, Google, Intel are examples of companies that
executed, innovated and kept growing their revenues while most other companies in the
same sector have gone into oblivion.

The Scarcity Premium

Value emerges when there is a scarcity premium. At the beginning of any sector’s rise,
only a few listed stocks are available. These become the poster boys of the sector and the
maximum amount of money flows into their business and stocks. This makes such stocks
run up ten, twenty or even a hundred times. This is perhaps the best time to find
unbelievable returns.
Take, for example, infrastructure in India. In the first phase of the infrastructure run,
most infrastructure stocks gave fantastic returns. Then every Tom, Dick and Harry who
was a ‘contractor’ gave itself new tags and fancy titles. Nobody verified their ability to
scale up, or their execution capability, or their ability to arrange funding in bad times. As
the infra boom tapered off, most such companies gave investors only headaches, not
returns.

Looking Out of the Window May Help You See Value

Activity outside your own markets may indicate what may happen in future to a sector in
your market. Take, for example, banks. Short term vision may sometimes bring prices to
levels where they make perfect long term sense. M&A activity in Indonesia and Vietnam,
for example, may be an indicator of potential interest in Indian banks. Some of the banks
there may have seen M&A deals for four to six times their book value.
In such a case, value may be driven by what foreigners think the banks are worth rather
than by traditional benchmarks, such as interest rates, growth in consumer demand, etc.

Value in Debris
‘Investors long for steady water, but paradoxically, the opportunities are richest when
markets turn turbulent.’
– Roger Lowenstein, When Genius Failed

A stock or sector may get mauled by a market’s apathy. Years will pass without the
market recognizing that the factors that took the stock or the sector down do not exist
anymore. Moreover, the stock or sector could have reinforced itself, increased capacity,
paid off debt, and seen demand for its products shoot up.
Real estate stocks are an example. For years, real estate companies, especially the top
tier five or ten companies, were getting mauled by a silly market. Money may be tight but
if you have 6,000 acres of land, it is not like the land is going away anywhere. There is an
intrinsic value to these businesses and they are the true blues for a five-year holding
period. Prices continued to remain depressed although real estate developers graduated to
constructing larger developments, picked up execution and delivery skills on the way, and
paid off their debts.

Value Lies in Deconstructing Myths

The monsoon is one of those myths. Indian markets have a preconceived notion that a bad
monsoon will be bad for the markets, and vice versa. Over the years, the monsoon’s
impact on the markets has diminished, but not the notion.
Finally, the Indian farmer does not give a damn about monsoons because his near
subsistence existence either got worse, i.e. he got cheated out of his land, or his existence
has become opulent as he goes around selling land that produced his subsistence living.
With agricultural land from Mumbai to Pune and from New Delhi to Jaipur now in the
hands of land grabbers, developers, etc., there is no land to farm. Where there is land to
farm, there is no need to farm.
So who cares what the monsoon does? The buying power of rural India no more comes
from agriculture. It comes from appreciating real estate. For every farmer, there are ten
villagers who have turned brokers. Go to buy a piece of land and ten people land up to
show you the land. For every acre, there are numerous MoUs and the price difference
between the buyer and the seller is getting wider with rotten parasites (read, brokers)
killing an already over-hyped market.

Sails Need to be Redirected If the Winds Shift

‘The financial markets generally are unpredictable. So that one has to have different
scenarios. The idea that you can actually predict what’s going to happen contradicts
my way of looking at the market.’
– George Soros

Cheap labour, communications and an English speaking ability gave rise to the IT
outsourcing industry in India. Perhaps it created a number of value stocks. Over the years,
the cheap labour has all but vanished, the quality of labour has turned fickle, foreign
customers want to speak to someone in their own country, and real estate prices have shot
through the roof. Everything that created the IT outsourcing and made stocks in the sector
worth picking, is out the window. Yet high valuations of IT stocks persist. Value investors
realized that the winds had changed and got out of these stocks. There is no point in
holding on to a stock when the very basis of the business has changed.
Crazy real estate, fickle-minded employees who behave more like mercenaries, and a
volatile rupee make a very dangerous cocktail. The way things are going, doing business
from the US may be cheaper!

Whose Boat are They Rowing?

‘There are no facts, only interpretations.’
– Friedrich Nietzsche

Almost 90% of the analysts who churned out research that brought in the crazy amount
of money we saw come into India between 2003 and 2008, were below 28 years of age.
Assuming that they joined a brokerage house at 22 or 23, they had never ever seen a bear
market. And in the great bull bazaar they grew up in, they turned more into cheerleaders
than analysts without any real experience of market cycles. From the market’s perspective
you have to go through one to become a ‘complete man’. That was exactly the point of
time when the Asian financial crisis hit, i.e. when most research was being churned out by
kids barely out of college.

Objects of Popular Fantasy are Fuel to the Fodder

‘When the investment community is fascinated by a major investment theme,
outstanding opportunities arise elsewhere. Undervaluation must take place in sectors
to which nobody is paying attention. In fact, the greater the mania in one sector of a
market or in one stock market, the more likely that neglected asset classes elsewhere
offer huge appreciation potential. This is one of the cardinal rules of investing and
will always work for the patient long-term investor.’
– Marc Faber, Tomorrow’s Gold

In a liquidity squeeze, the markets severely misprice certain sectors and stocks. Take, for
example, infrastructure or construction companies in India. Many of them are increasingly
moving on to BOT models. This means that their revenue streams will look like annuities
in the subsequent two to three years, making them almost comparable to a fixed income
product. Their prices just don’t reflect what they are worth.
In such situations, look at replacement value. When you see automobile companies
trading at prices which are less than the cost of setting up a plant to manufacture the same
number of automobiles, or when a pharmaceutical company trades at a market
capitalization that is lower than the cost of building two new FDA approved plants, you
know you have value on your hands.

Value is Built and Destroyed Over a Number of Actions and

Reactions
‘The doomsayers work by extrapolation; they take a trend and extend it, forgetting
that the doom factor sooner or later generates a coping mechanism … you cannot
extrapolate any series in which the human element intrudes; history, that is the human
narrative, never follows and will always foil the scientific curve.’
– Barton Biggs, Hedge Hogging
 We usually build our value argument by assuming a stock will continue to go up based
on its current trend. But wherever people are involved, the human element takes over. The
stocks in which you found value, start behaving differently. The companies that you
expected to continue on their growth path, start to develop other thoughts. They start to
use the money they have to get into new businesses which often they don’t understand. Or,
they make costly product blunders. A hundred different things can happen that move the
stock away from the course you expected — one more reason why you cannot buy a value
stock and sit with it for years.

Ask the Hard Questions — Or Face Soft Returns

‘In truth, the press was only mirroring the public’s enthusiasm. Yet the bubble
might never have grown so large, nor lasted so long, if the media had not
promoted hot stocks, anointed gurus, marginalized “the naysayers” and
substituted “good news” for analysis. The cult of personality was key. Chief
executives became “celebs” while Wall Street analysts were treated as
shamans. You do not ask a celebrity hard questions, and you do not question a
shaman at all.’
– Maggie Mahar, Bull!

Value investing requires asking hard questions. This requires that you don’t rely heavily
on the media to unearth value stocks for you. Media is severely competitive and is in no
position to annoy market gurus and ‘big shots’. So it may end up asking stuff that is of no
value for your investing.
Ask questions like:
‘Is the management going to share anything with me?’
‘What are these guys doing with the money?’
‘Are the owners getting into businesses that they don’t understand?’
If you cannot find answers, or if the answers don’t fit your value parameters, get out or
stay out.

Empty Vessels Make the Loudest Noise — But Remember, It is

Only Noise
Good companies generally don’t need to show off their talents. The companies you end up
hearing about the most are those which need to raise capital, or those who need to get the
public interested. While there is nothing wrong with either, it is for you to differentiate
between empty vessels making noise or a full vessel presenting itself in a better package.
If the vessel is empty and you get tempted by its public prominence, chances are the
stock will not hold up for long. This is not the way to search for value.

‘If You Have to Spin Off, Then I Must Be a Part of It’

‘If the facts change, I change my mind, sir. What would you do, sir?’
 – John Maynard Keynes

Companies that use spin offs to raise capital don’t present a value picture. They may do
that in the garb of ‘unlocking value’ but what is in it for you as an investor? You sat with
the stock for years hoping to see value in some part of the business that was hidden within
the company’s investments but when the time came, you had no part of it or in it.
Take, for example, a retail company that spins of different retail ventures, such as
apparel, electronics, groceries, etc. into different companies and raises capital separately
for each spun-off venture. Or an automobile company with an IT business which lists the
IT business separately instead of giving shares to its current shareholders. This is a
destruction of value for the value investor.
Ask the following questions if the stock you are invested in, starts to spin off businesses.
What was the need? Why could they not have funded the venture in their existing
company?
Such companies make a mockery of long term holdings in shares. While the company
grows, they continuously water down the stock by spinning off legal entities and bringing
in more shareholders. This is nothing but pure old ‘watering’ down of stock — a modern
way of doing what John Drew did in the wild west days of US markets.

Value in the ‘House of Horrors’

‘I worry less about advertised and sensational risks, more about the more vicious
hidden ones. I worry less about the terrorism than about diabetes, less about matters
people usually worry about because they are obvious worries, and more about the
matters that lie outside our consciousness and common discourse. I worry less about
embarrassment than about missing an opportunity.’
– Nicholas Nassim Taleb, The Black Swan

From time to time, value investors will face a market that will make them doubt their
thought process. Such situations can arise if there is a scarcity of liquidity or credit in the
financial system and a rush to cash out of stocks at any prices.
Most value investors rubbed their eyes at the value opportunity that the credit squeeze of
2008 threw up. Take a look at the drop in stocks and commodities:

Gold lost 17% in October 2008; it was the biggest percentage monthly loss in 25
years.
Copper lost 34%.
Silver lost 21%.
The Dow lost around 15% making it the biggest decline in October since 1987. It
also had the most down days since August 1973.
Crude oil futures lost 32% on the NYMEX; it was the biggest fall in any month in
15 years.
 The dollar gained 14% against the euro, 22% against the Canadian dollar and 32%
against the Australian dollar.
The MSCI emerging markets index dropped 30%; it was the biggest fall since
August 1998.
The Japanese Nikkei 225 hit its lowest in 26 years.
Iceland’s stocks fell 80%.
Argentina’s markets fell 37% and Brazil’s markets lost 25%.

While the world frets, value investors realize the opportunities that will appear driven by
a crash like this. Most investors would have lost so much money that they would continue
to sell to make up for their margins. Such selling would take stocks that may already be
cheap, even lower.
In fact, if such selling is not a result of rising panic but from an inability to pay margins,
chances are such under-valuations will not last. Central banks will start to flood the
financial system with cash so that banks don’t collapse. As banks start to recover, the
entire cycle will reverse with an equal ferocity. That’s where great value investing
opportunities will lie.

24-Hour Media Coverage Magnifies Contagions

‘The speedier the communication, the faster the contagion spreads.’
– Edward Chancellor, Devil Take the Hindmost

Banks, insurance companies, etc. cannot return all the money their investors put with
them on any single day, no matter how solvent they are. If there is a run on their money,
even the biggest firms will have to shut down.
24-hour coverage of financial news may spread a contagion, causing panic withdrawals
and other actions that would not be perpetrated otherwise. When investors sell out of
financial stocks in sharply falling markets, such falls trigger many clauses in their
borrowing and other agreements causing a complete landslide as the end result.
Equally, 24-hour financial news can also have a significant role in transmitting market
upsides across the globe, leading to an upward contagion.
While 24-hour news is important, value investors need to understand that it is an
addiction that you can get hooked on to. And investing has nothing to do with addictions.
It requires a cool calculated head and a thought process which is your own.

Manic Behaviour Comes to Roost

‘A panic seized upon the public, such as had never been witnessed before; everybody
begging for money-money-but money was hardly on any condition to be had. It was
not the character of the security that was considered; but the impossibility of
producing money at all.’
 – Charles Kindleberger, Manias, Panics & Crashes

A severe fall in the markets may create a massive loss of confidence among investors in
financial institutions, and may alter their consumption and spending behaviour. Banks and
other lenders or investors may not be ready to lend or invest irrespective of the security
being offered. And consumers may hunker down on their spending. At the end of the day,
consumption, lending, and investing have more to do with perception and confidence
about the future of asset prices and direction rather than the reality of the situation.
So when does this ease? While equity markets may stabilize, the real economy may take
time to heal. Till then, farmers won’t get buyers for their land, real estate sales may all but
stop, IT companies may hit a wall and banks may have gone into a huddle. With brakes
like these, it is unlikely that sectors that drive GDP like hotel, travel, financial services,
etc. can drive growth.

~
 Secret # 14
~
Value Investing Lessons from the Masters
‘The panic feeds on itself … until one or more of three things happen: (1) prices fall
so low that people are again tempted to move back into less liquid assets, (2) trade is
cut off by setting limits on price declines … . (3) a lender of last resort succeeds in
convincing the market that money will be made available in sufficient volume to
meet the demand for cash.’
– Charles Kindleberger, Manias, Panics and Crashes

~
‘Men, it has been well said, think in herds; it will be seen that they go mad in herds,
while they only recover their senses slowly, and one by one.’
– Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds

~
‘The securities might be unrelated, but the same investors own them, implicitly
linking them in times of stress. And when armies of financial soldiers are involved in
the same securities, borders shrink. The very concept of diversification would merit
rethinking.’
– Adapted from When Genius Failed

~
‘It (the market) looks just a little more mathematical and regular than it is; its
exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait.’
– Adapted from a quote by G. K. Chesterton

~
‘“Liquidity” is a straw man. Whenever markets plunge, investors are stunned to find
that there are not enough buyers to go around. As Keynes observed, there cannot be
“liquidity” for the community as a whole. The mistake is in thinking that markets
have a duty to stay liquid or that buyers will always be present to accommodate
sellers.’
– Roger Lowenstein, When Genius Failed

~
‘Time is your friend; impulse is your enemy.’
– John Bogle

~
‘If you have trouble imagining a 20% loss in the stock market, you shouldn’t be in
stocks.’
– John Bogle
 ‘The real trouble with the world of ours … is that it is nearly reasonable, but not
quite. Life is an illogicality; yet it is a trap for logicians. It looks just a little more
mathematical and regular than it is; its exactitude is obvious, but its inexactitude is
hidden; its wildness lies in wait.’
– G. K. Chesterton

~
‘Risk comes from not knowing what you’re doing.’
– Warren Buffett

~
‘Men resist randomness, markets resist prophecy. The fact that something has
happened many times in the past does not mean it will happen in the future. The fact
that it has never happened does not mean that it cannot happen.’
– Maggie Mahar, Bull!

Value Investing Deals with Probability Not Certainty

‘All we can learn from history is that the unpredictable will happen — and does —
time and again. The most dangerous error that an investor can make is to mistake
probability for certainty.’
– Nicholas Nassim Taleb

~
‘… past volatilities do not prepare investors for shocks that lie in wait — nor do they
signal in advance just when such shocks might choose to occur. A key condition of
random events is that each new flip is independent of the previous one. The coin
doesn’t remember that it landed on tails three times in a row, the odds on the fourth
flip are still fiftyfifty.’
– Roger Lowenstein, When Genius Failed

~
‘The idea of risk is often extended to apply to a possible decline in the price of a
security, even though the decline may be of a cyclical and temporary nature and even
though the holder is unlikely to be forced to sell at such times.’
– Benjamin Graham, The Intelligent Investor

~
‘As we grow older, wiser, richer, or poorer, our perception of what risk is and our
aversion to taking risk will shift, sometimes in one direction, sometimes in the other.
Investors as a group also alter their views about risk, causing significant changes in
how they value the future streams of earnings that they expect stocks and long term
bonds to provide.’
– Peter Bernstein, Against the Gods

~
‘One of the central problems of investing is that people focus far too much on the
purchase of equities and not enough on selling them. They spend a lot of time
analyzing companies and looking to buy ‘value’ — that is, they want to buy bargains
in a market. But little time is spent analyzing when to sell ‘value’ — that is, when to
sell assets for which the risk-reward is no longer attractive.’
– Marc Faber, Tomorrow’s Gold

~
‘Buffett understood that everything depends on the price you pay when you get in. In
that sense, any value investor is a market timer; at the end of a cycle when prices are
highest, he stops buying.’
– Maggie Mahar, Bull!

~
‘As was the case in the 19th Century American economy, great entry points into
emerging stock markets do present themselves whenever the foreign investment
community is reeling from losses from having overpaid for stocks or real estate
investments in emerging economies and is vowing to never again purchase stocks in
this asset class.’
– Marc Faber, Tomorrow’s Gold

~
‘Fundamental analysis may help you understand how things work, it does not tell you
when, or how much. Also, by the time a fundamental case presents, the move may
already be over.’
– Ed Seykota

~
‘The art of getting rich consists not in industry, much less in saving, but in a better
order, in timeliness, in being at the right spot.’
– Ralph Waldo Emerson

~
‘The most common feature of all great investment is that in the long run, they start to
produce negative returns and eventually vanish from the surface of the earth. And for
every successful undertaking or company, there were always many more failures to
maintain the shape of the wealth pyramid — with few rich at the top and many poor
at the bottom — more or less constant throughout history.’
– Marc Faber, Tomorrow’s Gold

~
‘Wealth is a king’s friend through forging treaties in war, to philanthropy, to winning
fame, happiness and attaining and remaining in power.’
– Chanakya

~
‘Wealth is unmatched beauty, wealth is auspicious, wealth is bursting youth, wealth is
life itself.’
– Chanakya

~
‘The old, the famous, the learned, the skilled, the brave, the clergy, poets and noble
men all have this to say to a rich man, “May you be victorious! May you live long!”’
– Chanakya

~
‘Where does it come? Where does it go? It is impossible to figure our wealth’s path.’
– Chanakya

~
‘Wealth has no place for those who consult the stars. Wealth is its own star. What can
the stars or skys do?’
– Chanakya

~
‘It is the rich who have the power.
That’s always been the universal fact
That much is clear even in the king’s dominion.’
– The Hitopadesa

~
‘Wealth looks for enterprising men.
Just as frogs seek wells and birds a lake with water.’
– The Panchtantra
 ~
‘It is not the loss of wealth that makes me sad, for wealth will return.
It’s the way friends disappear when I run out of money.’
– The Panchtantra

~
‘I totally disagree with holding any one age to be richer in opportunity than another.
Openings always exist somewhere in the world and in some sectors of the economy.’
– Marc Faber, Tomorrow’s Gold

~
‘Follow the course opposite to custom and you will almost always do well.’
– J. J. Rousseau

~
‘“When a man’s vision is fixed on one thing,” thought Ponzi, “he might as well be
blind.”’
– Charles Kindleberger, Manias, Panics and Crashes

~
‘The degree of one’s emotion varies inversely with one’s knowledge of the facts —
the less you know, the hotter you get.’
– Bertrand Russell

~
‘The stock is worth what someone will pay for it.’
– Unknown

~
‘Scarcely any man who has evolved a striking and original conception ever gets rid
of it.’
– Charles Kindleberger, Manias, Panics and Crashes

~
‘A boom is just capitalism’s way of setting up the next bust.’
– James Grant

~
‘More is learned from one’s errors than from one’s successes.’
– Primo Levi

~
‘I must create a system or be enslaved by another man’s.’
– William Blake

~
‘… large errors were especially liable to occur in enterprises in new fields, whose
limitations have not been accurately measured by investors, or even by capitalists of
proven judgement and experience… . New discoveries and the opening of continents
have contributed greatly to these mistakes… .’
– A. C. Pigou, Industrial Fluctuations, London

~
‘Prophesy as much as you like, but always hedge.’
– Oliver Wendell Holmes

~
‘A broker is a salesman of stock. And a salesman never says, “Don’t buy what I
have.”’
– Ashu Dutt

~
‘The cities that were formerly great, have, most of them, become insignificant; and
such as are at present powerful, were weak in olden times. I shall therefore, discourse
equally on both, convinced that human happiness never continues long in one stay.’
– Herodotus

~
‘It is easy in the world to live after the world’s opinion; it is easy in solitude to live
after our own; but the great man is he who in the midst of the crowd keeps with
perfect sweetness the independence of solitude.’
– Ralph Waldo Emerson

~
‘It is imprudent for the buyer to trust himself to the judgement of the seller.’
– Benjamin Graham, The Intelligent Investor
 ~
‘I worry far more about the “promising” stock market, particularly the safe blue chip
stocks, than I do about speculative ventures — the former present invisible risks, the
latter offer no surprises since you know how volatile they are and can limit your
downside by investing smaller amounts.’
– Nicholas Nassim Taleb, The Black Swan

~
‘Would you tell me, please, which way I ought to go from here? That depends a good
deal on where you want to get to.’
– Benjamin Graham, The Intelligent Investor

~
‘… Those who realize that investing is a game, have the edge. They know that they
cannot be right all of the time, the future is, by definition, unpredictable. This makes
it easier to ride a bull. You know that, from time to time, you will be tossed over his
horns — and gored. It is part of the game.’
– Maggie Mahar, Bull!

~
‘I find it hard to explain that when you have a very limited loss you need to get as
aggressive, as speculative, and sometimes as “unreasonable” as you can be.’
– Nicholas Nassim Taleb, The Black Swan

~
‘God almighty does not know the proper price-earning multiple for a common stock.’
– Burton Malkiel

~
‘Markets can remain irrational longer than you can remain solvent.’
– John Maynard Keynes

~
‘Yes we must mix with herd; we must enter into their feelings; we must humour their
weaknesses; we must sympathize with sorrows we do not feel; and share the
merriments of fools. Oh, yes! To rule men we must be men… . Mankind then is my
great game.’
– Benjamin Disraeli, Vivian Grey
 ~
‘You’ve got to be careful if you don’t know where you’re going, “cause you might
not get there.”’
– Yogi Berra

~
‘There is nothing like losing all you have in the world for teaching you what not to
do. And when you know what not to do in order not to lose money, you begin to learn
what to do in order to win. Did you get that? You begin to learn!’
–Edwin Lefèvre, Reminiscences of a Stock Operator

~
‘It is more difficult to be a loser in a game you set up yourself. In Black Swan terms,
this means that you are exposed to the improbable only if you let it control you. You
always control what you do; so make this your end.’
– Nicholas Nassim Taleb, The Black Swan

~
‘The bear side doesn’t appeal to me any more than the bull side, or vice versa. My
one steadfast prejudice is against being wrong.’
– Edwin Lefèvre, Reminiscences of a Stock Operator

~
‘The happiness of those who want to be popular depends on others; the happiness of
those who seek pleasure fluctuates with moods outside their control; but the
happiness of the wise grows out of their own free acts.’
– Marcus Aurelius

~
‘I feel grateful to the Milesian wench who, seeing the philosopher Thales continually
spending his time in contemplation of the heavenly vault and always keeping his eyes
raised upward, put something in his way to make him stumble, to warn him that it
would be time to amuse his thoughts with things in the clouds when he had seen to
those at his feet. Indeed she gave him or her good counsel, to look rather to himself
than to the sky.’
– Michel de Montaigne

~
‘… When many begin to wonder if declines will never halt, the appropriate
abracadbra may be: “They always did.”’
– Bernard Baruch in his 1931 Introduction to a reprint of Charles Mackay’s Extraordinary Popular
Delusions and the Madness of Crowds

~
It is literally true that millions come easier to a trader after he knows how to trade
than hundreds did in the days of his ignorance.’
– Edwin Lefèvre, Reminiscences of a Stock Operator

~
‘In this business (markets) if you’re good, you’re right six times out of ten. You’re
never going to be right nine times out of ten.’
– Peter Lynch

~
‘The investment calibre of accompany may not change over a long span but the risk
characteristics of this stock will depend on what happens to it in the stock market.
The more enthusiastic the public grows about it, and the faster its advance as
compared with the actual growth in its earnings, the riskier a proposition it becomes.’
– Benjamin Graham, The Intelligent Investor

~
‘A man must believe in himself and his judgment if he expects to make a living at
this game. That is why I don’t believe in tips. If I buy stocks on Smith’s tip I must
sell those same stocks on Smith’s tip. I am depending on him. Suppose Smith is away
on a holiday when the selling time comes around? No, sir, nobody can make big
money on what someone tells him to do.’
– Edwin Lefèvre, Reminiscences of a Stock Operator

~
‘If a man didn’t make mistakes he’d own the world in a month. But if he didn’t profit
by his mistakes he wouldn’t own a blessed thing.’
– Edwin Lefèvre, Reminiscences of a Stock Operator

~
‘The market is fond of making mountains out of molehills and exaggerating ordinary
vicissitudes into major setbacks.’
– Benjamin Graham, The Intelligent Investor

~
‘The recognition of our own mistakes should not benefit us any more than the study
of our successes. But there is a natural tendency in all men to avoid punishment.’
– Edwin Lefèvre, Reminiscences of a Stock Operator

~
‘Most people are beat up by the market, instead of beating the market.’
– Mark Hebner

~
‘I never fight either individuals or speculative cliques. I merely differ in opinion —
that is, in my reading of basic conditions… . I try to stick to facts and facts only, and
govern my actions accordingly.’
– Edwin Lefèvre, Reminiscences of a Stock Operator

~
‘This brief review indicates that the stock market’s attitude toward secondary
companies tends to be unrealistic and consequently to create in normal times
innumerable instances of major under-valuation.’
– Benjamin Graham, The Intelligent Investor

~
‘None of us is as smart as all of us’
–A sign at Wells Fargo Bank during the creation of the Index Fund, circa 1971

~
‘While enthusiasm may be necessary for great accomplishments elsewhere, on Wall
Street it almost invariably leads to disaster.’
– Benjamin Graham

~
‘Many individual investors think that institutional investors dominate the market and
that these “smart money” investors have sophisticated models to understand prices —
superior knowledge. Little do they know that most institutional investors are, by and
large, equally clueless about the level of the market.’
– Robert Schiller, Irrational Exuberance

~
‘That a bull market has added to my bank account or a bear market has been
particularly generous I do not consider sufficient reason for sticking to the bull or the
bear side after I receive the get-out warning. A man does not swear eternal allegiance
to either the bull or the bear side.’
– Edwin Lefèvre, Reminiscences of a Stock Operator

~
‘Occasionally one is too close to a stock. In such cases, the more one knows about a
subject, the more likely one is to believe he can outwit the workings of supply and
demand. Experts will step in where even fools fear to tread.’
– Barton Biggs, Hedge Hogging

~
‘Before I can solve a problem, I must state it to myself. When I think I have found
the solution, I must prove I am right. I know of only one way to prove it; and that is,
with my own money.’
– Edwin Lefèvre, Reminiscences of a Stock Operator

~
‘It’s amazing how difficult it is for a man to understand something if he’s paid a small
fortune not to understand it.’
– John C. Bogle

~
‘The moral seems to be that any approach to moneymaking in the stock market which
can be easily described and followed by a lot of people is by its terms too simple and
too easy to last.’
– Benjamin Graham, The Intelligent Investor

~
‘… I have found an easy way and I stick to it. I simply cannot help making money. I
will tell you my secret if you wish. It is this: I never buy at the bottom and I always
sell too soon.’
– Baron Rothschild

~
‘… there is always a disposition in people’s minds to think the existing conditions
will be permanent. When the market is down and dull, it is hard to make people
believe that this is the prelude to a period of activity and advance. When prices are up
and the country is prosperous, it is always said that while the preceding booms have
not lasted… this time there are “unique circumstances” which will make prosperity
permanent.’
 – Charles Dow, The Wall Street Journal

~
‘There’s no investment idea that is so good that it can’t be spoiled by too high an
entry price.’
– Howard Marks

~
‘Focusing on the market’s recent returns when they have been rosy will lead to a
quite illogical and dangerous conclusion that equally marvellous results could be
expected for common stocks in the future.’
– Benjamin Graham

~
‘Those who have knowledge, don’t predict. Those who predict, don’t have
knowledge.’
– Lao Tzu

~
‘A man can’t spend years at one thing and not acquire a habitual attitude towards it
quite unlike that of the average beginner. The difference distinguishes the
professional from the amateur. It is the way a man looks at things that makes or loses
money for him in the speculative markets.’
– Edwin Lefèvre, Reminiscences of a Stock Operator

~
‘To be angry at the market because it unexpectedly or even illogically goes against
you is like getting mad at your lungs because you have pneumonia.’
– Edwin Lefèvre, Reminiscences of a Stock Operator

~
‘Odds are you don’t know what the odds are.’
– Belsky, Gary and Thomas Gilovich

~
‘Losing money is the least of my troubles. A loss never bothers me after I take it. I
forget it overnight. But being wrong — not taking the loss — that is what does the
damage to the pocketbook and to the soul.’
– Edwin Lefèvre, Reminiscences of a Stock Operator
 ~
‘All of human unhappiness comes from one single thing; not knowing how to remain
at rest in a room.’
– Blaise Pascal

~
‘More than one man I know has done the same thing; but has coaxed his wife to sign
off when he needed the money. And he has lost it.’
– Edwin Lefèvre, Reminiscences of a Stock Operator

~
‘A man can excuse his mistakes only by capitalising them to his subsequent profit.’
– Edwin Lefèvre, Reminiscences of a Stock Operator

~
‘Holding for the long term works beautifully in a bull market. In a major bear market,
it can be an absolutely disastrous policy.’
– Richard Russell, Richard Russell’s Dow Theory Letter

~
‘The really dreadful losses (always occur after) the buyer forgot to ask, “How
much?”’
– Benjamin Graham

~
‘This is a timeless irony: when you need money most, the most likely sources of it
are likely to be hurting as well.’
– Roger Lowenstein, When Genius failed

~
‘Diversification is a hedge for ignorance.’
– William O’Neil