Jatin Khemani is Founder & CEO at Stalwart Advisors, a SEBI Registered Investment Adviser. He has seven years of experience in investment analysis and portfolio management. In his last stint with a Delhi-based brokerage house he was solely responsible for the research activities of the organisation right from picking new ideas to tracking the existing portfolio thereby assisting the directors in managing the proprietary book. He is a CFA (US) Charter holder, earned his MBA in Finance from Christ University, Bangalore and graduation in Commerce from Delhi University. Thanks to his admiration for Peter Lynch & Philip Fisher, Jatin has over the years become proficient in scuttlebutt, a primary research method to find out truth about a company or an industry. On weekends, he teaches finance to MBA students and is an active volunteer with The Art of Living since 2006, where he leads state level fund-raising campaigns.
Safal Niveshak (SN): Could you tell us a little about your background, how you got interested in value investing?
Jatin Khemani (JK): I had a decent exposure to how businesses operate since a very young age. My family used to run a manufacturing setup which I often visited, and later on I studied commerce in high school and graduation. But my perception towards equity markets was bad then. I had seen my father trade and lose money. The lesson that got passed on to me was that individuals do not stand a chance in this market, which is manipulated by ‘operators’, dominated by institutional investors, and its nothing less than gambling.
However, that completely changed during my MBA days, when I met my mentor Mr. SG Raja Sekharan. He was a very senior IT professional who had left his fancy job as soon as he became financially independent and started following his passion of teaching and helping others get financially independent. He could do that by smartly investing in real estate as well as great businesses like HDFC Bank, Asian Paints, Pidilite etc. and holding on to them for years, and in some cases decades.
The nirvana moment for me was when I read ‘One Up On Wall Street’ by Peter Lynch and later on was introduced to the writings of legends like Warren Buffett, Charlie Munger and Philip Fisher. That’s when I decided to pursue investing as a career and enrolled myself for CFA (USA), which I eventually cleared in the first attempt and was awarded the charter. I worked two jobs, first at an independent investment research firm, and second as an analyst and later head of research at a Delhi-based brokerage house.
In 2014, I ventured out on my own and started Stalwart Investment Advisors, a SEBI registered independent equity research firm with an objective to help individuals invest sensibly and build a portfolio of solid businesses.
I have been lucky to have met the right mentors since the very beginning, I think it’s extremely important to have the right guidance and mindset in a challenging profession like investing. Thanks to that, I never traded or leveraged till date. I am a slow thinker and patient by nature, so long-term moat investing is something that really gels with my temperament.
I like to take fewer decisions but prefer them to be extremely well thought out. I strongly believe one just needs to make a few right decisions in his or her lifetime to be a successful investor.
SN: Thanks for sharing your journey, Jatin. How have you evolved as an investor and what’s your broad investment philosophy? Has your investment policy changed much through the years?
JK: I started as purely a bottom-up stock picker. However, over time, I realized that some of the best winners in our portfolio like Relaxo Footwear or Page Industries did not achieve those wins entirely out of their own greatness but equally on account of a very favorable competitive landscape where their organized counterparts were busy diversifying and weaker unorganized players kept on losing market share to them. This evolved into my research titled India’s Consolidation Wave with which I started focusing more on industry analysis as well.
Though I am sector and market cap agnostic, I still have a bias towards smaller companies as they are easier to understand, are mostly owner-operated, have a favorable base and are generally lesser known and lesser owned by institutional investors due to obvious constraints like low float and liquidity translating into high impact cost.
SN: You said you have a bias towards smaller companies. So can you explain your process in researching the same? I mean, smaller companies don’t disclose as much as their bigger counterparts, plus there isn’t much detail available about the management and its history. So how do you go about researching such companies? What is your process like?
JK: I think the notion that more information is always better is misplaced. One needs to understand the basic business model for which there are plenty of sources available especially for all consumer facing businesses – we can get a lot of information from a company’s website, ecommerce portals, by visiting market and interacting with channel partners, through trade exhibitions etc.
Further, on management there are three parts – one is ethics side for which there is a lot of information one can find from the Annual Reports. For instance, one such mandatory disclosure is Related Party Transactions, a small table which reveals the maximum – if the promoter is involved in a similar business outside the listed entity and has any transactions with the listed entity, it would be reflected here. You would also see the salaries drawn by promoter and his relatives, loans and advances given to promoter entities, the interest received from them, any royalty paid by company for brand ownership which could reside under some other 100% owned promoter entity. All of these are major red flags.
Secondly, we judge skin-in-the-game by looking at shareholding pattern which reveals how much the promoter owns, the ownership trend and whether any of it is pledged.
The final part is competence for which we study capital allocation track record from the reported financials over previous 5-10 years.
Beyond that, in some cases I find it important to meet the management to understand its strategy and vision for the company better, which in a lot of cases happens to be at the AGM itself. The management part is the most critical element; I prefer owner-operated businesses and like it more if it’s led by a first-generation entrepreneur.
SN: What are some of the characteristics you look for in high-quality businesses? What are your key checklist points you consider while searching for such businesses?
JK: There are many filters I use, and thus my checklist is extremely long (you can download it here), however the most important ones are –
• A high-quality business is one which exhibits pricing power, which essentially means the ability of a business to pass on the rise in input costs without losing much on volumes whereas it can retain a part of benefit in times of softer input costs. This is mostly true for businesses that buy commodities but sell brands.
• It should be part of an industry which is growing and has a large size of the market opportunity (current/potential). A company cannot only grow by winning market share, as beyond a point in time it would become the industry itself. So, it is important that the industry should be fast growing which also keeps the competitive intensity among incumbents in check. Unless there is a huge size of the market opportunity, it would not be practical for revenues to grow multi-fold, no matter how amazing this company is or how good is the management execution.
• It does not need to resort to debt or equity dilution to support growth. A high-quality business generates enough internal accruals to fund growth (capex and working capital). That is why most capital intensive businesses don’t make the cut.
• It should look attractive on ‘‘Porter’s Five Forces’’ framework, specially ‘the threat of new entrants’ should be low.
• Its products/services serve a need, can be imagined a decade down the line and is net positive for the society. Now, this is a bit debatable, but I think we all know what happened to Valeant Pharma. Based on the four points mentioned above, even tobacco and liquor would qualify as ‘high quality businesses’ but they fail on this parameter as they are net-net not good for the society, which is why the regulations have only been getting stringent. I avoid such businesses.
SN: Thanks for sharing your checklist, Jatin! How do you think about valuations? How do you differentiate between ‘paying up’ for quality and ‘overpaying’?
JK: Until a few years back, I used to give importance to entry/trailing multiples, but I no more commit that mistake. I think these multiples don’t tell you anything. What is important is our assessment of what could be a reasonable exit multiple 5-10 years out (a function of growth potential during this period) and based on a conservatively done earnings growth assessment, is it likely to meet the hurdle rate in terms of stock return, which is currently 18-20% in our case.
The most common valuation method used is P/E which is often abused. I have written a post on the three follies of using P/E.
Unfortunately, there are no set rules for ‘paying up’ and ‘overpaying’, as it is very subjective. I believe it depends on your conviction on earnings growth and where you see it going forward. This in turn is a function of in-depth understanding of the business, the opportunity size and management strategy. Businesses evolve over time and so do managements, so basing decision only on average multiples of last 5 or 10 years may not be the most optimal way. One must discount these changes and see if multiples have expanded/contracted for the legitimate reasons.
SN: On the About page of your website, you’ve mentioned and I quote – “We channelize all our energies into discovering companies that have some sustainable competitive advantage run by an ethical and competent management; in other words, companies that have potential to be tomorrow’s blue-chip.” Can you please explain your process of identifying –
• Moats that are sustainable, and
• Managements that are ethical
Identifying moats, especially, is an easier part. But assessing its sustainability is terribly difficult. So how do you do it?
JK: I think the term ‘moat’ nowadays is a bit loosely used. An economic moat implies a ‘sustainable’ competitive advantage, the one that is temporary does not qualify as moat in the first place.
For instance, a ‘specialty’ chemical company which is posting super results because a major Chinese plant has shut down leading to prices hitting the roof, might not really have any moat because this sweet situation is not going to last for long.
In case of real moats, the moot question is what is the management doing to maintain or widen that moat. For a consumer brand, it could be tracked by advertisement spend as a percentage of sales, distribution expansion, entry into adjacent categories to leverage the brand etc. For a pharma company, it could be tracked by R&D spend as a percentage of sales, registration/product pipeline and so on and so forth.
SN: What about selling stocks? How do you determine when to exit from a position? Are there some specific rules for selling you have?
JK: I believe the selling decision is more difficult and more important than buying decision. Having tracked and invested in something for years can create its own set of challenges through endowment bias, being ‘close’ to managements etc. and this is especially true if this is a winning position, which makes it difficult to take an independent view of incremental changes.
My selling strategy is still evolving and as of now, here are the rules we follow –
1. At the first instance of any unethical act by company or its promoters: I strongly believe in the saying ‘there is never one cockroach’. So, in such cases, the first reaction is always to exit immediately. You can always come back if things turn out to be clean.
2. When management misallocates capital at a scale that can jeopardize the base business: Small experiments are always fine. Ben Franklin put it nicely, “Keep your eyes wide open before marriage, and half shut afterwards.”
3. When I realize my original investment thesis has gone wrong or isn’t likely to play out for whatever reasons.
4. When I find better opportunities: From time to time, I rank all the portfolio positions from highest conviction to lowest and when I find an opportunity which is better than our lowest conviction position, I make the switch.
5. When current valuations price in a blue sky scenario: This one is most difficult to apply for me and I am learning how to be more stringent on this one.
The first three rules above involve selling at current market price irrespective of whether the stock is 50% below our buying price or 500% above. The original buying price is completely irrelevant in this decision.
Let me share an anecdote of one such sell decision. We started working on a company called ‘Asian Granito’ back in Nov. 2015. It was the fourth largest ceramic tiles company in India after Kajaria, Somany and Johnson. This was a company which we had given a pass earlier but the entry of Mr. Tapan Jena, very senior sales and marketing professional with 27 years of experience in ceramic industry, got us interested again. We met him during Buildings Material Exhibition in New Delhi in Dec. 2015 and later visited the company’s head office in Ahmedabad during Jan. 2016 which also involved meeting promoters and senior management. This due-diligence also included visiting their largest plant spread over 80+ acres. Finally, on 14th Feb. 2016, right in the middle of market panic, we decided to pull the trigger at Rs 115 (the stock had fallen 35% in the last two months). We were confident we can’t lose money in buying this at o.3 times sales and there were multiple triggers to take care of the upside, largely on account of the strategy by the new management.
The same evening, we read an exchange filing that Mr. Tapan Jena had quit. It was a tricky situation to be in – on one hand we saw immense value at that price and there was a lot of hard work that had gone into this research including multiple rounds of channel checks etc. On the other hand, the very foundation of the investment thesis was shaken. Within an hour, we sent out a notification to all our investors to exit it the very next day irrespective of the price. Over next few months, we saw the stock going up 3x, but looking back I don’t regret selling out as that’s what was right as per the process we follow.
SN: How easy or difficult has it been for you to change your mind in the past when facts about a certain company changed? Were you able to revisit your decision and change it – like selling a stock earlier then you would have wanted to, because the company did something you did not like? Can you please explain with the help of a real-life example of how you did it?
JK: I can’t say it has been easy. Selling is always trickier than buying. However, since we write our investment thesis and key risks in detail, it helps in tracking and identifying divergence from original thesis, which in turn helps us in overcoming biases and base our decisions on incremental facts. I can share another anecdote. We were invested in TV Today Network (AajTak). Other than cable digitization, and massive improvement in balance sheet, expectation of capital allocation getting better was a key part of investment thesis. Everything else played out as expected, barring the last one. Though we were still bullish on the business, we exited.
SN: When you look back at your investment mistakes, were there any common elements of themes?
JK: I made some grave errors of commission very early in my career, the worst was Opto Circuits. One common element among most of these was focusing too much on P&L and the ‘story’ and less on balance sheet and cash flows. Looking back, these mistakes taught me an extremely important lesson that balance sheet and cash flows reveal much more about a business than anything else, and over time my checklist grew stronger.
Goes without saying, there have been plenty of errors of omission.
SN: And which error of omission tops your mind? Why did you not buy that stock?
JK: MPS. The stock moved up while I was working on it; I couldn’t buy as I was anchored to the price I first saw. It has had an outstanding run in last four years. Including dividends, I think it’s been a 15-bagger.
SN: How can an investor improve the quality of his/her decision making?
JK: In this regard, nothing beats an investment journal where every time you take any decision you make a detailed note as to why you bought or sold something. The real learning would be when you revisit this few years down the line and see how things panned out.
The other is having a sounding board, which could constitute your colleagues or investor friends. When one studies something in too much detail or meet managements, there is a chance of getting carried away or getting overly positive. That’s the time you need this person playing devil’s advocate for you.
This is applicable only when you are deciding for yourself i.e., you are not cloning anyone or investing out of respect quota, which could be very hazardous to your wealth. There is simply no substitute to having your own conviction in every position you have. If you are riding on somebody else’s conviction, first you would not be able to bet big and miss out on the most important element of investing i.e., position sizing. Secondly you can enter on someone’s conviction but you must still ride the position through thick and thin yourself. Most cloners get scared out of a position when it moves +/-50%, instead of averaging up/down.
SN: How do you think about risk? How do you employ that in your investing?
JK: Since we are long-only investors with decent time frame, the everyday volatility is not really a true ‘risk’ to the portfolio. The actual risk emanates from the probability of permanent loss of capital which is managed in two ways –
1. We have a negative list of companies which are to be avoided at all costs. Businesses which deal in commodities, are state run, debt heavy and those run by promoters with chequered past.
2. Despite all the due diligence, there are always ‘unknowns’ so the second way we manage risk is through position sizing. Based on conviction on business, management and margin of safety (valuations), we decide position sizing which varies between 3% to 10%. We never cross 10% at the time of investing, though we don’t mechanically chop if a position goes beyond 10% because out-performance; why cut flowers to water weeds. Similarly, there are rules for averaging down.
SN: What’s your two-minute advice to someone wanting to get into value investing? What are the pitfalls he/she must be aware of?
JK: Investing is not easy as it may seem from outside, so get into it only if you are passionate about investing. If at all you are getting into it for making quick bucks, this could be one of the most regretful decisions of your life. It is easy to get swayed in a bull market to quit job and become a full-time investor. However, for vast majority of people, perhaps continuing, focusing and growing in the work and outsourcing money management could be a much better alternative.
Regarding common pitfalls, I would say we are living in fascinating times and the rate of change is only accelerating. Technology is disrupting every business. Lot of erstwhile businesses with great reputation and history are on their way down, and might look cheap to you. Most value investors start as a Grahamian, and seek margin of safety in valuation and other quantitative parameters. Having this narrow view is very dangerous and riskier than even paying higher multiple for some other business that will at least stay relevant. These are called ‘value traps’ and we are surrounded by them, which makes it more difficult to avoid them specially in the beginning of one’s investment journey.
SN: Which unconventional books/resources do you recommend to a budding investor for learning investing and multidisciplinary thinking?
JK: I don’t think I can make any meaningful addition to the library of a reader of Safal Niveshak, thanks to all the great work you and Anshul have been doing.
I will just add one point, it is without a doubt that reading books is the most important element in successful investing. However, what’s equally important is to keep implementing what we are reading and in the process answering – What’s working for me? How’s my temperament? Which strategy suits my personality?
Investing is like getting to the top of a mountain with many ways to reach. It will be hard not to make money once you can pick a strategy that gels with your temperament and implement it consistently.
Secondly, investing is also like swimming in some sense, no matter how much you read in order to prepare, you will still struggle for a while in water before eventually learning the technique. You are bound to make mistakes, and trust me they will teach you some valuable lessons. Those losses are tuition fees paid to Mr. Market, so sooner you make those mistakes better it is as your absolute amount of losses will be lesser. For example, even if you have read everything on biases, there is no substitute to experiencing it yourself.
SN: Which investor/investment thinker(s) so you hold in high esteem?
JK: I am an admirer of Prof. Sanjay Bakshi and have learnt a lot from his writings. I also look up to Kenneth Andrade for his clarity of thought and simple yet powerful investment style. The other default names are Warren Buffett, Charlie Munger and Peter Lynch for their invaluable contribution.
SN: One question about your educational qualification. Would you recommend the CFA charter to someone looking to get into investing full time – whether on a job or personally? What was your biggest takeaway from doing the CFA? Would a diligent study of the best books/resources on investing do a better job than the CFA charter?
JK: Nothing beats self-learning specially in a profession like investing. Having said that, I would rate CFA above an MBA/CA as it is the gold standard in investment management industry. It’s a professional course with content that is practical (as opposed to theoretical stuff taught in most university/colleges). This content is created and updated by practicing CFA charter holders. It is not restricted to equity but gives a holistic exposure to all asset classes, portfolio management and offers a multi-disciplinary perspective picking relevant topics from economics, accounting, statistics, behavioural biases etc.
SN: What other things do you do apart from investing?
JK: On weekends, I teach securities analysis and portfolio management at an MBA College in New Delhi. Apart from that, I like meditating and have been following Art of Living since 2006, where I also participate as a volunteer in some programs dedicated towards the upliftment of the underprivileged primarily through education support.
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?
JK: By the way I have seen the movie Ghajini, so the first thing I will do is attach a family picture, and add a note ‘I like investing and teaching.’
SN: That was nice, Jatin. Thank you so much for sharing your insights with Safal Niveshak readers. I wish you all the best for your work and life.
JK: Thanks for the interview, Vishal! I really enjoyed it.[/show_to] [hide_from accesslevel=’almanack’]
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