Gautam Baid, CFA, is Portfolio Manager, Global Equities at Summit Global Investments, an SEC-registered investment advisor based out of Utah, USA. Prior to his current role, he served at the Mumbai, London and Hong Kong offices of Citigroup and Deutsche Bank as Senior Analyst in their healthcare investment banking teams. Gautam is a CFA Charter holder from CFA Institute, an MBA in Finance from Nirma University, Ahmedabad, India and an MS in Finance from ICFAI University, Hyderabad, India. He is a strong believer in the virtues of lifelong learning and is an ardent student of the value investing philosophies of Benjamin Graham, Warren Buffett and Charlie Munger.
Safal Niveshak (SN): Gautam, could you tell us a little about your background and journey, how you got into value investing?
[show_to accesslevel=’almanack’] Gautam Baid (GB): Prior to my relocation to the US two years back, I served for around seven years at the Mumbai, London and Hong Kong offices of Citigroup and Deutsche Bank as Senior Analyst in their healthcare investment banking teams. I obtained my CFA Charter from CFA Institute in 2013, my MBA in Finance from Nirma University, Ahmedabad, India in 2008 and my MS in Finance from ICFA University, Hyderabad, India in 2005. I am the youngest of the four siblings in my family and my parents, my two elder sisters and my elder brother reside in Kolkata, India.
As is typically the starting story of many investors, I got lured into the stock market out of greed during the final euphoric phases of a bull market. In this case it was the 2003-2007 one in India. I invested in Reliance Power Sector Mutual Fund in late 2007 and Ispat Steel in January 2008 as both were in hot sectors of those times and both had appreciated very sharply in a very short span of time when I had first noticed them. So, I just engaged in blind extrapolation of the recent price trends in them without paying any attention whatsoever to their valuations.
Vividness and recency biases are very powerful but highly costly behavioral mistakes. Both the investments crashed 70%-80% during 2008-2009 within 12-18 months of my purchase. I had successfully gained admission into the stock markets by paying my tuition fees. But it did not end there. We humans are a sucker for punishment as we are always trying to “get back even” and foolishly engage in mental accounting. I had read about options trading while studying for my CFA examinations and thought that if I could magnify my gains to such an extent that I recover all my past losses then I will never enter the stock market again, so let me just try “one last time.” I started dreaming about the quick large-sized profits that were about to come in a few days’ time, conjuring vivid images in my brain and getting dopamine rushes. But reality soon paid me a visit and I ended up losing 100% of the entire upfront premium which I had put up for buying options on a few stocks in early 2010.
In the powerful preface of his recent book Good Stocks Cheap,Kenneth Marshall wrote something which resonated strongly with me as it will with many value investors across the world – “Those who discover value investing tend to do so via one of two routes: trauma or exposure. Trauma, alas, is far more common.”
In January 2011, two personal tragedies – emotional and financial – of a large magnitude struck my family and me in quick succession. I was in a state of depression for the next twelve months and recovered only gradually with the passage of time and the support of my family members and close friends. Depression is not a pleasant state to be in. You struggle to sleep peacefully for even a few hours at a stretch, you wake up in the middle of the night and go stand in front of the mirror and cry hopelessly, you are putting on a fake smile in front of everyone you come across while hurting deep inside all the time, you stop enjoying any happy activity – travelling and visiting beautiful places, eating good food, shopping for new clothes and gadgets, watching fun movies, listening to great music or hanging out with your family and friends. Heck, you even stop enjoying eating ice-cream! In short, you are only alive but not living.
None of the world’s most successful people have experienced a life devoid of failure or tough times. In fact, the world’s most famously successful people have failed the most times and have gone through prolonged periods of ordeal. The only difference between them and others is that they didn’t give up. But that’s also why success is so sweet after so many bitter failures, roadblocks and personal struggles.
It’s hard to stay positive during such trying times. However, when your goals are meaningful enough to you, you do what it takes to push through by staying mentally tough. That’s how you eventually reach your goals. That’s how you eventually follow through to complete every single task and give it that little extra every single day which gradually adds up and leads to a snowball effect over time.
But to develop this high level of resilience during tough times, one needs a source of big inspiration to completely transform his mindset and outlook towards life. Some people are lucky enough to discover it in their lifetime while others are not so fortunate.
One fine day during late 2012, while looking up self-help books online to fix my depressed state of mind a financial situation, I came across two books books Think and Grow Rich by Napoleon Hill and Rich Dad Poor Dad by Robert Kiyosaki. Reading these two books changed my mindset forever. In my view, the former is the greatest piece of work ever written on personal development while the latter is the most motivational book ever written on attaining financial independence and making money work for you.
Later, I came across The Richest Man in Babylon by George Clason which I believe is one of the greatest books written in the history of personal finance, and The Intelligent Investor by Benjamin Graham which in my view is the best book ever written on investing. It is rightly said that college education will get you a job, but self-education will make you a fortune. Beginning 2013, I began my journey to attain financial independence by making sincere efforts to educate myself on investing and initially used to read the blog posts on ValuePickr Forum, Safal Niveshak, Fundoo Professor and MicrocapClub at a measured pace.
The process of compounding knowledge had begun in the right earnest. In late 2013, I came across Warren Buffett’s letters for the first time and fell in love with the simplicity and deep meanings in his teachings about life, business and investing. Inevitably, soon afterwards, I came across the teachings of Charlie Munger. I was instantly captivated by his multidisciplinary approach to solving problems as demonstrated in his 1994 speech on elementary worldly wisdom at USC Business School. Since those days, I have embarked on the passionate pursuit of lifelong learning and life has been highly fulfilling ever since.
SN: Wow Gautam! That was a wonderful description of your life, struggles, and journey so far. It was an enriching read for me personally because I could relate to what you have gone through both in your journey in life and investing.
Anyways, how have you evolved as an investor and what’s your broad investment philosophy? Has your investment policy changed much through the years?
GB: My personal investment philosophy has greatly evolved over the years with time and experience in the markets. Initially, it was restricted only to secular growth stocks at reasonable to slightly expensive valuations. But now, it covers many different areas of the investment universe like commodities, accelerating fundamental momentum, deep value, special situations and loss-making companies which are turning around as reflected in slow gradual changes (low contrast) in their improving balance sheet, working capital cycle and margins and/or a significant positive change in their industry dynamics. Basically, I now invest wherever I find mispricing of value and a highly favorable risk return trade-off.
SN: That’s a wide canvas you cover.
GB: Yes Vishal. Another key area of my evolution as an investor has been my understanding of human nature and the significant role of incentives in governing individual behavior. Always think about the possible incentives involved in any situation before making your final decision.
SN: What big ideas in investing have you changed your mind on in the last few years?
GB: As my circle of competence has gotten bigger over time through continuous reading, learning and practice, I have been able to get rid of certain widely accepted conventional wisdom/notions/blanket statements about investing and benefited greatly by expanding my investable universe –
1. Turnarounds never turnaround – As of six months back, I owned four loss making companies in my personal portfolio of eighteen stocks. Two of them have already turned out and become profitable. The second largest current holding in my portfolio is a loss-making company. If one can identify these erstwhile loss-making companies at their turnaround stage or just ahead of a big upcoming near-term value unlocking catalyst, a lot of wealth could be created.
2. Never invest in commodities – Since the beginning of 2017, I have started studying different commodities and learnt about sugar, ferrochrome and metal convertors. I also got a good understanding of graphite electrodes and calcined petroleum coke. I was able to invest in the latter two industries in a timely manner while for the former three industries, I am now in a much better position to act decisively in a timely manner when they again undergo their respective cycles in future. In case of certain commodities like sugar, graphite electrodes, etc. the cycle usually lasts for a longer time as compared to other commodities giving investors sufficient time to enter a bit late and still make a lot of money during the remaining phase of the cycle. Always remember Howard Marks’ two rules for investors:
• Rule No. 1: Most things will prove to be cyclical.
• Rule No. 2: Some of the greatest opportunities for gain and loss come when other people forget Rule No. 1.
In investing, all knowledge is cumulative and the insights we acquire by putting in the effort today will help us in a serendipitous way at some time in future. I can personally vouch for this from my personal life experiences. Work hard today to let good luck find you in future.
3. Using quantitative screening tools to get a list of initial names to research on – Earlier this year, I invested in a company trading at a trailing P/E of 240x (no exceptional or non-recurring items so this was the accurate trailing P/E). In just two quarters, the trailing P/E has compressed to 20x on the back of its expanded capacity contributing to earnings. A mechanical screener would have excluded this stock at the very beginning itself. There is no alternative to hard work. The person who turns over the most rocks wins the game.
4. Never add to a losing position – One very important area of the investing field which I have picked up well in recent times is special situations. A big opportunity often arises when a very high quality but small size demerged company from a large parent company gets listed and has residual institutional holding by accident or default. In its initial days of trading, you will often observe “forced selling” by these very institutions who cannot hold this new small cap stock because of certain rigid institutional mandates of being allowed to invest only in certain sectors and/or restrictions on market cap and you will end up with sizeable paper losses on your existing holding of these demerged shares. However, whenever someone sells in desperation, he tends to sell cheap and as a buyer I love to be on the other side of these kinds of trades where the other party is forced to liquidate his holdings at any price irrespective of underlying value.
5. Avoid watching the financial media – You should ignore all the macroeconomic forecasts, stock trading recommendations and price targets, the overly excited and hyper-charged bulls who will be shown on television during sharp rises and the overly pessimistic doomsayers who will be shown on television during sharp corrections, etc. But you should pay close attention to the “micro” discussions about individual stocks and industries’ prospects. I have often got some of my best investment ideas while watching financial television. Management interviews give important insights regarding their businesses and industries while individual stock-specific special segments which are scheduled on a daily/weekly basis keep throwing up many great turnarounds and special situation ideas for further study. One of the best sources for new promising ideas is the last five minutes of market closing where the TV anchors highlight the most active and volatile stocks of the trading day.
Graham had correctly said that Mr Market is there to serve us. Let me explain how this works. Over time, as an active and highly engaged investor, you develop what is known as a “feel” for the market. If a group of stocks from one single industry are all rapidly going up “together at the same time for a few successive days in a row”, then that is a very powerful signal that the fortunes of that industry may be turning around and should be investigated further. This is one of the most effective ways to identify inflection points of a sectoral trend during the early days of an industry’s fortunes turning around. Most of the time you will observe that the stocks which are going up so rapidly do not have any current earnings to support their valuations, but in hindsight it almost always turns out that the market was an extremely smart discounting machine. Always pay respect to the wisdom of the market. Always. Second, if a stock displays a price volume breakout to 52-week/multi-year/all-time highs on “very large” volumes (in technical analysis language, if the price rise is on low volumes then it may be topping out and if the price remains range bound on large volumes then it means there is distribution going on) then that is another strong candidate to start researching on. Even if you do not end up investing in the stock, the biggest positive takeaway from this exercise would be the fact that your “mental database” of companies would have expanded by studying the annual reports, research reports, presentations and conference call transcripts of the company and its listed peers. The importance of insatiable intellectual curiosity and hard work along with a deep passion for continuous learning cannot be understated in the investing profession.
Although I had read a lot of stock market books on the importance of trading volumes, it was only when I read The Wisdom of Crowds by James Surowiecki last year that I finally learnt to recognize the significance and deeper meaning of trading volumes. Knowledge compounds over time. As new neural connections are formed in our brains through both direct and vicarious experience, a latticework of mental models starts developing in our minds. Keep learning every day to constantly nurture and nourish this vibrant latticework because you never know when a big “Eureka” finding will suddenly come to you. Any one or some of these big findings could make you very rich during a sudden fortunate phase in your investing career. Continuously create active opportunities for serendipity to find you in the unlikeliest of times & places.
6. Avoid investing in IPOs – While it is true that most of the times, they turn out to be an IP-Oh! experience for the investor, a well-chosen IPO can create a lot of wealth if you stick with the stock for many years. Some of the young as well as mid-size companies with a first-generation promoter or a new management which has turned around the business in the last few years, a strong balance sheet, healthy margins and operating in a growing industry which tap the capital markets during their early high growth phase should be seriously studied for potential long-term investment. Many times, these stocks shoot up 30%-40% immediately after listing and because of anchoring bias, we investors spontaneously/subconsciously erase them from our mental database since we assume that the stock is now fully priced on a one-year forward basis. This invariably turns out to be a big mistake. Because some of these companies may have a very high longevity of predictable growth for the next 5-10 years, even if we do not make money in them for the first year, they still create a lot of wealth over time because of continuous compounding of their intrinsic values. A smart opportunity comes even during bull markets if on the day of the listing of a high quality & reasonably priced IPO, the global markets are crashing, that lets you comfortably buy these IPOs immediately after their listing without the initial pop in their stock prices because of a bad overall market sentiment on that day. If you are constantly alert to your surroundings then opportunities will keep coming regularly.
SN: Well, some of what you mentioned above stands in contrast to what I believe – like your points on watching business media and applying to IPOs. But I get your point here, which is about leading investors to question some norms and thinking well for themselves. These I believe are critical aspects of a sensible investor’s thought process.
Anyways, let’s talk about the characteristics you look for in high-quality businesses. What are your key checklist points you consider while searching for such businesses?
GB: High-quality businesses typically demonstrate sustainable competitive advantages or “moats”. Strong brands with “share of mind” which confer pricing power, network effects, high switching costs, patents, favorable access to a strategic raw material resource or proprietary technology, and government regulation which prevents easy entry – these can confer a strong competitive advantage which in turn enables high returns on invested capital for long periods of time (also known as the Competitive Advantage Period/CAP).
Growing firms with high Return on Invested Capital (ROIC) and longer CAPs are more valuable in terms of net present value. One of the most highly underappreciated sources of a sustainable and difficult to replicate competitive advantage is “culture”, best epitomized by companies like Berkshire Hathaway, Amazon, Costco, Piramal Enterprises, HDFC Bank to name a few. To illustrate the critical importance of culture just consider this: Between 1957 to 1969, Warren Buffett did not mention the word “culture” even once in his annual letters. From 1970 to 2016, he has mentioned the word thirty times!
Some of my favorite books on competitive advantage are The Little Book That Builds Wealth by Pat Dorsey, Understanding Michael Porter by Joan Magretta and Different by Youngme Moon. For learning about how to evaluate the culture of an organization, I recommend reading A Bank for the Buck: The Story of HDFC Bank by Tamal Bandopadhaya, Intelligent Fanatics Project by Sean Iddings and Ian Cassell and Investing Between the Lines by L.J. Rittenhouse..
SN: Wonderful! Let’s talk about valuations. What are your thoughts on this subject?
GB: I believe rather than thinking in terms of absolute valuations, thinking in terms of “opportunity costs” & “expected return” is a more effective method in investing. Most investors fall in love with their existing holdings (especially if they had initially identified it after a lot of hard work) and subsequently engage in lazy thinking and do not conduct a rigorous opportunity cost analysis on a regular basis. Every single dollar spends the same and investors should strive to achieve the biggest bang for their buck from every single dollar invested. Use a very high hurdle rate/absolute return expectation when assessing any potential investment opportunity. In Mohnish Pabrai’s words – “Be Unreasonable.” Personally, I avoid investing or remaining invested in any security unless it can potentially deliver at least 26% CAGR over the next three years with a “very high degree of certainty/predictability/probability.”
Many times, you will hear investors making irrational statements like “I am happy to hold this stock since I bought it at a lower price,” even if the medium-term appreciation potential is poor. Anchoring bias is very powerful and occurs automatically at a subconscious level. One effective way to counter this is to mentally liquidate your portfolio at the start of every trading day and ask yourself a simple question – “Given all the current and updated information I now have about this business, would I buy it at the current price?”
I have difficulties assessing any business’ prospects beyond three years, so I initially think in terms of three-year periods. I do not need to get my valuation exactly right to the last decimal. All that I need to ensure is that I am buying at a large discount to what I believe the business will be worth 5-10 years from now, while initially making sure that it has robust growth prospects for the immediate upcoming three years. The only question an investor really needs to ask is whether the business is going to earn far more money over the next 5-10 years, and if the answer is yes and if the stock is available at a sensible current valuation, then one does not need to ask any more questions.
SN: What about your thoughts on the difficulty investors have in differentiating between paying up versus overpaying for a stock?
GB: I think most investors think about paying up and overpaying only in terms of the P/E ratio. Understanding the drivers of a P/E ratio is far more important than the absolute value of the ratio itself, since the latter should always be looked at in the context of interest rates prevailing at the time. Interest rates act like a force of gravity on the valuation of any financial asset in the universe. While determining the fair P/E ratio for a stock, most investors focus on topline and earnings growth, margins, capital intensity and working capital requirements of the business but end up neglecting the duration of competitive advantage period. This “longevity” is what leads to great wealth creation over time through compounding.
The market is very smart because it immediately gives very high current valuation multiples to businesses with established moats and assured longevity of earnings growth over the next ten years. The longevity of the growth is always given a greater weight by the market than the absolute rate of growth, so you will often notice stocks with 12%-15% assured earnings growth for the next 10+ years getting current P/E multiples of 40x-50x. This phenomenon perplexes most new investors, but with experience one comes to appreciate the finer nuances of the market and respect its wisdom.
As investors, we are constantly trying to identify “emerging moats” so that we benefit not only from the high earnings growth during the initial stages of the company but the subsequent valuation multiple expansion as well. Even if you miss the initial phase but can identify these emerging moats during their intermediate stages, a lot of wealth is still created over time.
SN: How do you determine when to exit from a position? Are there some specific rules for selling you have?
GB: If I come across a “far superior” opportunity, then I will sell the weakest current stock (relative to the other holdings in my view) in my portfolio immediately without any hesitation since I am now less affected by loss aversion in stocks after studying behavioral finance. At any point in time, there are always 1-2 stocks in our portfolios which are our “least favorite”. They are not bad stocks, it is just that you are always subconsciously aware that they are weaker than the other stocks in your portfolio (but you will still hold them!) and you would not mind selling them at a future date if required.
Sometimes the valuation of a stock just becomes so plain absurd that you can sell it instantly without any hesitation or doubt. This kind of sale is easy to execute. In other cases, when you have been invested in a stock for some time, over time you develop a very good understanding of the evolving business and industry dynamics, and you just “know” when either the sustainable growth rate has permanently slowed down for good or when cracks start to appear in your original investment thesis. This helps you exit in time ahead of the subsequent painful P/E de-rating period in the former case which is particularly painful (and perplexing for many new investors) to experience amidst the company’s earnings which continue to grow, but “at a slower pace than originally discounted in the steep valuations.”
This art aspect of investing can only be developed through real life experience in the markets and increasing familiarity with the finer nuances of multiple industries and their evolving market valuation dynamics over time and cannot be taught through textbooks.
SN: Do you involve the concept of position sizing in your selling decisions?
GB: Yes Vishal. Individual position sizing is very important not only for its impact on overall portfolio performance but also for your mental peace. I always sell down to “the sleeping point” if a single position has become a “discomfortingly large” percentage of my portfolio value.
Sometimes, it will so happen that one of your existing holdings makes your stomach churn because you are no longer comfortable holding it for certain corporate governance reasons / management integrity issues which you may have discovered “after” your initial purchase. Even though I expect that company to report very high earnings growth and it is in a hot sector and may go up multifold, in those cases I usually exit my position as I do not want to trade a peaceful night’s sleep for a few extra percentage points of return. Investing should be a fun and enjoyable learning experience for life, not something to stress about or lose sleep over.
I never defer a sale of a stock solely for trying to make it a long term holding and save some short-term capital gains tax. This is a common behavioral tendency which many investors exhibit. Resist being penny wise and pound foolish.
SN: When you look back at your investment mistakes, were there any common elements of themes? What’s the biggest investment mistake you’ve ever made and how did you deal with it? What lesson did you learn from this mistake?
GB: I have luckily made very few mistakes of omission within my circle of competence so far in my investment career. I can honestly make this assertion based on the circumstances and available information at the time of my historical sale/exit/not investing decisions. However, I have made multiple mistakes of commission because I fell prey to different behavioral biases at different points of time.
As investors, we always make our initial purchase based on incomplete information and our own personal biases and highly favorable assumptions about the future of the business. Let us be honest, endowment effect is deeply embedded within us and we start feeling more confident about the prospects of a business after we have bought its stock. Happens all the time with everyone, we are human after all and we are a messy living compilation of a multitude of cognitive and behavioral biases.
We cannot avoid biases totally even after being fully educated about them, we can only try to reduce their frequency to the maximum extent possible through the use of checklists, maintaining an investment journal, conducting a pre-mortem, demonstrating intellectual honesty by actively seeking disconfirming evidence to kill our ideas (especially our best-loved high conviction ones), consciously thinking about the potential incentives at play in a particular situation, engaging in second-level thinking about “the consequences of consequences” by asking “and then what?” and using other relevant additional tools as applicable to the individual situation. The Thinker’s Toolkit by Morgan Jones and The Art of Thinking by Ernest Dimnet are great books on this subject.
SN: How can an investor improve the quality of his/her decision making?
GB: Stick to your circle of competence, only invest in businesses you can understand well and in which you can reasonably assess that they will be earning significantly higher profits many years from now. Such businesses are usually less vulnerable to technological or “app” risk and will be present in stable industries with low rates of change.
Embrace inactivity and devote most your time to reading, learning and improving your thinking. Once you start treating any and every news item only in terms of its potential impact on the intrinsic value of your stock, your turnover will come down drastically. Low turnover leads to low frictional costs and these few extra percentage points saved every year lead to very large absolute savings over long periods of time because of the power of compounding.
Maintain an investment journal which contains your original investment thesis at the time of making the purchase as well as the rationale for making the sale. We all know that “man is not a rational animal; he is a rationalizing animal.” A journal is the most objective way to remain true to yourself and avoid hindsight bias. More importantly it helps you to continuously keep learning from your mistakes since they will be your greatest teachers in life, business and investing.
The significant positive intrinsic value of learning from one’s personal mistakes (and even more importantly, the vicarious learning from others’ mistakes) over an investing lifetime is highly underrated in the investing community.
Pay extra emphasis on management quality (capital allocation), balance sheet quality (debt, receivables and inventory) and quality of “reported” accounting earnings (free cash flows and ratio of operating cash flows to net profit). You should partner only with ethical and prudent promoters in businesses that have very low debt (finance companies are the exception to this rule) along with favorable working capital cycle and solid free cash flows.
SN: How do you think about risk? How do you employ that in your investing?
GB: I define risk as 1) permanent loss of capital 2) not knowing what you are doing and 3) losing purchasing power of time because of inflation which is an invisible tax.
One of the big lessons I learnt from the book Winning the Loser’s Game by Charles Ellis is that investing is like tennis and decreasing unforced errors is highly important. A very effective method of mitigating the risks of individual companies in your portfolio in a timely manner is the pre-mortem technique developed by a social psychologist named Gary Klein.
Before you buy a stock, simply imagine that a year has passed from the date of your purchase and your investment decision turned out to be wrong. Now, write down on a piece of paper about what went wrong in the future. This “prospective hindsight” technique forces you to open your mind, think in terms of a broad range of outcomes, consider the outside view and focus your attention on the many sources of potential downside which did not intuitively come to your mind the first time when you thought about buying the stock. Avoid compounding in reverse, if you lose 25%/33%/50% then you need to make 33%/50%/100% just to come back to the starting point. Rule No 1: Never lose money. Rule No 2: Never forget Rule No 1. As value investors, we always think in terms of potential downside risks first when evaluating a potential investment since the upside then takes care of itself. Even the dean of value investing Benjamin Graham placed more emphasis on return of capital and placing it before return on capital in his definition of investing in The Intelligent Investor –
An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.
SN: Which of your life habits you think has most positively impacted your investing? How can one cultivate such a habit?
GB: Well, there are a few very important ones –
1. Realizing the power of compound interest – As per the rule of 72, you double your capital every 3 years by compounding at 26%, 10 times in 10 years and 100 times in 20 years. The human mind is not wired to think in exponential terms. The day I understood compound interest, I knew I was going to become super rich. I just had to get started. Time and compound interest are the biggest free lunches in the world of investing, provided we pay them their due respect by behaving in a disciplined manner.
To imbibe the virtues of gradually compounding small positive actions over long periods of time, one should read One Small Step Can Change Your Life by Robert Maurer and The Snowball: Warren Buffett and the Business of Life. These two books had a significant impact on my thoughts about life and I started looking forward to every new day as an opportunity to get better, learn and improve. You will constantly notice this trait among most value investors that the day we finally understand the power of compound interest, we embrace frugality and simple living as a way of life. It is a kind of a nirvana moment in our lives.
2. Embracing lasting humility which is a prerequisite to keep learning from others – Hang out and interact with people better than you and you cannot help but improve. And when I say better, I mean not only in terms of intellectual horsepower, but in terms of morals, values, ethics, character and discipline. These are the attributes which ultimately lead to a very fulfilling and satisfying life.
3. Passion for lifelong learning – Earlier this year, I attended the Berkshire Hathaway annual meeting in Omaha. Apart from the great networking opportunities which the Woodstock for Capitalists offers to meet and interact with like-minded individuals, it was a wonderful experience personally to witness my role models live on stage. Both Buffett and Munger answered questions on a range of topics for more than five hours. It was a humbling experience to see the breadth and depth of their knowledge and the level of mental alertness at their age. My first big takeaway was that without “deliberate practice” such a feat is not possible. After coming back from the Berkshire AGM, I read Talent is Overrated, which is one of the seminal pieces of work on this topic, and I recently ordered several additional books on deliberate practice as I am finding this topic highly fascinating. The second big takeaway for me was the importance of building up a large “mental database” of different businesses over time. Great opportunities keep arising periodically in industries outside one’s circle of competence and this is how enlarging one’s opportunity set can be highly profitable for investors.
4. Focus – When Bill Gates first met Warren Buffett, their host at dinner, Gates’ mother asked everyone around the table to identify what they believed was the single most critical factor in their success through life. Gates and Buffett gave the same one-word answer: “Focus.” Focusing on what is “important and knowable” is a great attribute to possess, perhaps one of the most vital in today’s world where we are constantly bombarded with so many distractions and a barrage of information, data and opinions from individuals having “chauffeur knowledge.” Relentlessly focusing on a specific passion or problem leads to achievement. But focus alone is not enough. Putting in the necessary time to engage in deliberate practice of something important to us is also crucial to achieving success and that often entails a lot of personal sacrifice & delayed gratification. During this phase, learn to value your time. No matter how much money you have, you can’t buy more time. There are only twenty-four hours available to all of us every day. Minimize your commute time to work and outsource all the non-core time-consuming menial tasks to free up valuable time for your self-development. The extra money spent on these small luxuries will pinch initially, but over time you will realize that they were well worth it, I can personally vouch for this from my personal experience.
SN: What’s you two-minute advice to someone wanting to get into value investing? What are the pitfalls he/she must be aware of?
GB: I agree with Buffett’s thought that the best investment you can make is an investment in yourself. The more you learn, the more you earn. An investment in knowledge pays the best interest.
In today’s noisy environment, having a long-term mindset is a huge structural advantage to have as an individual investor. It allows you to reap the full benefits of compounding, the eighth wonder of the world.
Learn to distinguish between investment and speculation. A speculator looks at a stock as a piece of paper. An investor looks at a stock as part ownership of a business.
Mr Market is always eager to hand you great opportunities from time to time on a platter. Stock prices fluctuate far more than the intrinsic value of the underlying business, sometimes wildly on either side – and therein lies the big opportunity. Widespread fear is your friend as an investor, personal fear is your enemy.
Be an ardent student of crowd psychology, cognitive biases, market history and human behavior since objectivity, rationality and temperament are far more critical than raw intellect to succeed as an investor. Your personal behavior matters much more than advanced excel analytics and complex math. Always think quantitatively (numbers and probabilities) and not dramatically (vivid images and futuristic stories).
Develop a working knowledge of accounting as it is the language of business through which you understand how the balance sheet, income statement and cash flow statement tie together.
Always focus intensely on the underlying process rather than obsessing about the eventual outcome. Resist the illusion of control.
Always consider the outside view which takes base rates and statistics into account rather than only the inside view which makes predictions based on a narrow set of inputs.
The frequency of correctness does not matter; it is the magnitude of correctness that matters. Michael Mauboussin calls this “The Babe Ruth Effect”.
SN: You’re one voracious reader. How did you first get interested in reading and how has been your evolution on this front? What’s your trick to remember the key ideas from so much reading you do?
GB: The inflection point came when I read Buffett’s letters for the first time in late 2013 and then got to learn about Munger which in turn led me to learning about his philosophy on attaining worldly wisdom. I was bitten by the reading bug the day I realized and imbibed the golden wisdom I found in Munger’s words – “Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day.”
Knowledge started compounding along with ever increasing levels of intellectual curiosity and my anti-library has become very large over the years so I know for sure that I have a very fulfilling life ahead of me.
I generally underline my favorite sections of a book and write my personal notes on the big learning points on the side of the pages as I read them and I keep referring to them from time to time. Read, re-read and reflect on your learnings from the books you read. When you read them more than once you will notice that with the passage of time, because of your accumulated personal and vicarious experience – you are able to obtain additional and newer insights from the same book and develop pattern recognition. Be a learning machine.
SN: Which unconventional books/resources do you recommend to a budding investor for learning investing and multidisciplinary thinking?
GB: Michael Mauboussin authored a brilliant paper in August 2016 titled Thirty Years: Reflections on the Ten Attributes of Great Investors. Let me outline those attributes below along with my favorite book(s) on each topic for the benefit of all your readers
- Be numerate (and understand accounting) – How to Read a Financial Report by John Tracy, Accounting for Value by Stephen Penman, Financial Shenanigans by Howard Schilit, Quality of Earnings by Thornton L. O’glove, The End of Accounting by Baruch Lev
- Understand value (the present value of free cash flow) – Creating Shareholder Value by Alfred Rappaport, Valuation: Measuring and Managing the Value of Companies by McKinsey
- Properly assess strategy (or how a business makes money) – Business Model Generation by Alexander Osterwalder and Yves Pigneur, Competitive Strategy by Michael Porter
- Compare effectively (expectations versus fundamentals) – Expectations Investing by Alfred Rappaport and Michael Mauboussin
- Think probabilistically (there are few sure things) – The Drunkard’s Walk by Leonard Mlodinow, Innumeracy by John Allen Paulos
- Update your views effectively (beliefs are hypotheses to be tested, not treasures to be protected) – Stalking the Black Swan by Kenneth Posner, A Few lessons from Sherlock Holmes by Peter Bevelin, Superforecasting by Philip Tetlock and Dan Gardner, and Book of Value by Anurag Sharma
- Beware of behavioral biases (minimizing constraints to good thinking) – Thinking, Fast and Slow by Daniel Kahneman, The Art of Thinking Clearly by Rolf Dobelli, Your Money and Your Brain by Jason Zweig, Why Smart People Make Big Money Mistakes by Gary Belsky and Thomas Gilovich
- Know the difference between information and influence – The Crowd by Gustave Le Bon, The Art of Contrary Thinking by Humphrey Neill, Influence by Robert Cialdini, Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay, A Short History of Financial Euphoria by John Galbraith
- Position sizing (maximizing the payoff from edge) – The Warren Buffett Portfolio by Robert Hagstrom, Fortune’s Formula by William Poundstone
- Read – How to Read a Book by Mortimer Adler and Charles Van Doren
SN: That’s quite an exhaustive list. Thanks!
GB: I would add two more vital qualities to the above list – extreme levels of patience coupled with the ability to act decisively when the no-brainer opportunities present themselves. Mohnish Pabrai has beautifully explained these attributes in his wonderful book,The Dhandho Investor.
Investing is multi-disciplinary in nature as demonstrated in Robert Hagstrom’s book Investing: The Last Liberal Art. Cross-pollination brings together ideas from different fields and one should focus on the really big ideas from the important disciplines since 80 or 90 important mental models carry 90% of the freight in making you a worldly-wise person.
Lastly, everyone should use the inversion trick for the most important decisions in life, business and investing. All I Want To Know Is Where I’m Going To Die So I’ll Never Go There by Peter Bevelin is the seminal book on the theme of inversion.
SN: Which investor/investment thinker(s) so you hold in high esteem?
GB: I consider myself fortunate to have had the privilege to learn from some of the greatest thinkers in history through their writings. They have helped shape my investment philosophy over the years and have greatly aided in helping improve my thinking process & rationality quotient. They include Benjamin Graham, Warren Buffett, Charlie Munger, John Maynard Keynes, and Phil Fisher among others.
SN: Hypothetical question: Let’s say that you knew you were going to lose all your memory the next morning. Briefly, what would you write in a letter to yourself, so that you could begin relearning everything starting the next day?
GB: It’s an intriguing question Vishal, and a very meaningful one at that. Here is what I will write in that letter –
You have lost your memory. But do not worry, your dear family and your best friends are right here besides you like they always have been. What you are about to learn about your past may surprise you, but you have lived a truly inspirational life and you had noted down many remarkable events in your personal diary which you wanted to share with the world at large to spread the message of hope and resilience. You have been a true fighter and have successfully endured many personal setbacks and financial, social, emotional, physical & mental hardships in your life. For now, here are some of the most important things you need to know:
You are very close to your loving family and best friends. Always cherish them and prioritize their happiness and well-being like you always have. Your late grandfather taught you the virtues of hard work and integrity; your mother who is a noble soul taught you the virtues of honesty and kindness; your father always motivated you to aim higher and never settle for mediocrity; your eldest sister showed you the beauty of being spontaneous and cheerful; your second elder sister showed you the virtues of humility and objectivity and your elder brother used to embody ambition, thrift and resourcefulness. Your close friends have always stood by you during tough times and have always unconditionally helped you. Always be thankful and faithful to them.
You love your job and you highly admire your office colleagues who are a great bunch of people and they will bring you up to speed again when you resume office in future.
You are very fond of reading and vicarious learning of success and failure patterns. In particular, all that you want to know is where you are going to die so that you will never go there. You had embarked on a passionate pursuit of lifelong learning and had gotten adept at analyzing diverse businesses across a variety of industries. Patiently utilize the next couple of years to re-learn from your investment journal and the books in your library and to also learn the new emerging concepts relevant to the present & our future. You were a firm believer in the power of compounding knowledge and daily small positive actions, so patience and delayed gratification should hopefully still come naturally to you.
You were very generous in sharing your knowledge with others to help them rise in life like you did in your own life as you were inspired by the teachings of one of your role models Charlie Munger who had said – “The best thing a human being can do is to help another human being know more.” You had started discussing your planned philanthropic activities with your father and you were keen to give back to society because you were on the verge of attaining financial independence soon.
Here are a few more key life principles which you had learned: The best investment you can make is an investment in yourself. Associate with people better than you and you cannot help but improve.
Control over your personal time is much more valuable than high absolute levels of money. A long and healthy life is the key to harness the power of compounding so eat less junk food and sugar, get sufficient sleep and engage in regular moderate exercise.
Be kind, humble and empathetic to others and always help people unconditionally without expecting anything in return as Good Karma is like a BIG snowball which eventually pays you back multiple times over. Never underestimate the role of luck in every sphere of life. Always be thankful to God, your parents and those who helped you during your difficult times.
Lastly, never forget your late grandfather’s eternal words of wisdom to you during your childhood which had a lasting impact on your life – “There is no alternative to hard work.”
SN: That was quite a letter, Gautam. Thanks a lot for sharing your thoughts there. Finally, what other things do you do apart from investing?
GB: I am highly fond of reading different subject matters from a wide variety of fields. To me it feels like an intellectual treasure hunt, you never know what hidden gems you will stumble upon when you start on a new book and start flipping through the pages. I enjoy watching superhero, sci-fi, action thriller, comedy and Bollywood movies. I also love traveling as I find it fascinating to personally experience the diverse beauty which exists in our world. Whenever I visit my home town in India, I enjoy spending quality time with my family, friends and relatives.
SN: Thank you Gautam for sharing your insights. I wish you all the best for your work and life.
GB: Thank you Vishal. It was a pleasure sharing my learnings and life philosophies with you. I hope they add value to your readers and I wish all of them the very best in their lives.[/show_to] [hide_from accesslevel=’almanack’]
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