Jayendra Kulkarni, a value investor from Mumbai, shares his 20-year journey in stock market and recounts his discovery of value investing and how it helped him build a framework for finding value.
In this issue, we profile a Mumbai-based value investor, Jayendra Kulkarni. Jayendra has been investing for close to 20 years and invests largely in small and medium sized businesses.
Safal Niveshak (SN): Could you tell us a little about your background, how you got interested in investing, and how you’ve evolved over time as an investor?
Jayendra Kulkarni (JK): I did my Hotel Management from IHM, Mumbai and then a Business Management Diploma. I don’t have any foundational background of Finance. So I started from ground zero – clueless. Naturally the learning curve was steep. It was not intimidating though; simply because I did not know, what I did not know.
I worked for the stock broking division of Apple Finance in the mid 90’s in Marketing and Dealing and that for me was the embarking point. I’d heard about ‘book value’ and ‘PE ratio’ and would spend days sifting through Capital Market and Dalal Street Journal searching for what I thought were under-priced stocks. When only a few of what I thought were Eureka stocks, worked out, I slowly began realizing that the investing process is not a simple two dimensional graph.
[show_to accesslevel=’almanack’] My approach has evolved since then through experience, mistakes and numerous books. I have a core portfolio of about 5-7 stocks. One of the great sayings is that you never really know all about a stock until you own it. Nothing could be more true. You’re looking at the stock originally as an outsider and the involvement or rather passion you can bring to the table is far lesser. After you get into it, it reshapes and you can see the weaknesses and shortcomings with much more clarity. Of course, after you’ve owned something for a while, you find that there are a lot of strengths and opportunities you didn’t see at first.
SN: Well, how did you train yourself to be a value investor? Did any particular books or investors inspire you?
JK: I got my hands on a copy of The Warren Buffett Way sometime in 2000 and quickly followed it up with whatever books I could get on the Buffett. His books and the approach they expounded became a sacrosanct component of my investment process. I altogether stopped buying stocks which did not fit in with his investment philosophy. This went on for a better part of 2-3 years with modest returns till I bought a copy of Money Masters of our Time by John Train. I read the book thrice in a month and realized that the Buffett books had opened my brain but closed my mind. I had only myself to blame. I was trying to blindly replicate his valuation model purely from a quantitative aspect ignoring the qualitative part. To use Munger’s words, I was calculating but had stopped thinking.
SN: Well, that’s what most investors tend to do – more of calculating and less of thinking. But how does one get over this? How did you do it?
JK: The ‘more of calculating’ should never stop. The objective is to supplement it with ‘even more of thinking’. But it can never be a forced process. The thinking evolves over a period of time in response to the various inputs one keeps getting. At every level of thinking, I try and translate the idea into numbers and see if they make sense or if they are way off the mark. So the investment process per se has to be a broad decision.
Seth Klarman summed it up elegantly when he said, “Value Investing is at its core the marriage of a contrarian streak and a calculator.”
SN: Wonderful! In your experience, what characteristics or attributes are advantageous for an investor to have?
JK: First, I don’t think there is a better starting point than having an open mind. So, every stock I approach and look at, I try to clear my mind of any prejudices or biases I might have about the company, industry or management. I let the facts, as I get them, shape up my thinking. It is easier said than done and I continue to struggle. Effectively, time is money, so when one is investing time in studying a business, the effort must be to make it count in an unbiased manner.
Second, nothing beats financial rigour and studying the fine print. So, before one even decides whether to set on a journey in a stock, one has to relive its past. So a thorough analysis of the past financials, commitments vs actual delivery, and management actions is a great kick starter.
Third, aim to anticipate and recognize change. The earlier the better. There are always some tell-tale signs of change irrespective of whether it’s positive or negative. It will show up somewhere in the financials or some obscure footnote. So one really needs to keep a watch for things which are implied rather than explicitly stated. At a macro level too one can form mental patterns after observing innovations, disruption and trends which we see in our everyday life.
Let me share an example here. I used to track and own a thermoplastics compounding company which supplied a vital air bag component. Just about 3-4% of Indian cars came with an air bag then as it was not a mandatory safety feature (still isn’t). Somewhere in October 2012, Maruti Suzuki launched the Alto 800 and the full page advertisement highlighted that for the first time (for an entry level car) the company offered buyers of the top end version a choice to opt for company fitted driver air bag at an additional cost. To all appearances, it was another product launch with an added feature. The underlying message though was the change in the manufacturer’s mind-set. And when the dominant player sets the pace, others follow suit. This could possibly have a disproportionate positive effect on the underlying business. So, many a times innocuous events can have far reaching implications over time.
Fourth, it’s important to have ability to not only identify an inexpensive company but more importantly find why it won’t be inexpensive any more. Many companies and businesses have the fundamental blocks in place. Maybe not all the blocks but a few. It is our job to see which of the building blocks they have in place can really be a potential ‘driving force’. These businesses await a catalyst or what in homeopathy is called the ‘exciting cause’.
Here’s an example. I was invested in a music company which had a library of more than a quarter million songs in various Indian languages. The management was not inspiring to put it mildly but the asset was invaluable. Either you had it or you didn’t. It was not something which could ever be replicated. The company floated around aimlessly for years together. They had digitized a large part of their catalogue so that was one of the few capital allocation decisions, which they had got right. Then cheaper smartphones, 3G, relatively faster videos, music streaming companies, impending 4G launches, FM auctions happened and the promoters found in their lap a business model which wouldn’t need too much exertion from their side. So the point is, though these kind of companies don’t have the management bandwidth to bring about change, they can piggyback on the change that the macro environment brings about.
Fifth, remind yourself every day that it is not our birth right or life goal to benefit or profit from every single stock or every single move.
Sixth, focus on how big the company can grow. Operating leverage can be magical.
Seventh, never commit more money to your stock that you can afford to see sterile for at least 2 years.
SN: That’s indeed a wonderful list of attributes that are advantageous for an investor to have, so thanks! Now, what’s been the most difficult part of being a value investor?
JK: For someone who is more inclined towards a value mindset than a growth one, when a company’s earnings start getting better and the stock price goes higher or at times the stock price goes higher and earnings catch up, it’s somewhat difficult to adjust to the new facts.
By nature, the value school is sceptical. It’s hard to adjust to the new reality. So there is a tendency to sell too soon. The second challenge is time management. The value guys always have a lot of time on their hands. How do you invest the time in identifying opportunities for the future and how does one match those opportunities with your present portfolio? A new stock always looks more attractive than the one we are holding.
SN: Good that you mentioned about the difficulty in selling stocks or knowing when to sell. Is there a sell-checklist you have? What factors would lead you to sell a stock?
JK: It’s easier to know when a stock is cheap than when it’s overvalued. Selling unlike buying comes with a lot of emotional baggage, especially when one has been holding the stock for a long period. The problem is a stock can be overvalued and it can still double from there as a new set of momentum investors come in.
I have struggled with selling and frankly have no easy answer on this as I continue to make mistakes. Though one thing I do is revisit my original investment rationale, map it with the present and ask myself if I would buy the stock at this price.
Only when the answer is an unhesitant ‘No’, do I pull out. I normally exit a position in small lots over a period of a few weeks. On the other hand, if I am convinced beyond doubt that my original investment reasoning was flawed, I sell then and there without any hesitation, unease or reluctance.
Now, though I don’t have a sell checklist, valuation wise I critically look at a couple of factors –
1. Are the underlying fundamentals of the business same, better or worse?
2. Is the growth sustainable vis-à-vis the new P/E?
I find it extremely difficult to do an objective evaluation without being biased on either side. As I mentioned earlier, I continue to struggle to strike the right balance.
SN: Well, everyone seems to be struggling there! Anyways, what are some of the characteristics you look for in a high-quality business?
JK: I look for a niche which is not easily replicable. It can be low cost production, market share, distribution, technology leadership, IPR or anything else. I keep a very open mind while assessing these.
Naturally, the addressable opportunity which can translate this niche advantage to bottom-line is equally important. There are instances where the addressable opportunity is clear and visible but will evolve over a period of time. I am happy to wait. I avoid businesses with debt or management integrity issue.
Some of the questions I ask myself are –
1. Is this niche advantage currently translating into profits? If yes, how much larger can the profits be in 2, 3, 4 years?
2. What is the company doing to nurture and capitalize on this niche? If not, what is the management doing or what can happen which will change the current position?
3. What is the probability of that happening? What is the time frame?
4. Is this business more valuable for somebody else? Can they monetize it better? How would they value this business?
SN: With so much disruption all around, how do you look at niches? I mean, everything – low cost, market share, distribution, technology leadership, IPR etc. – can be disrupted. How do you look at this aspect of businesses? Do you factor in a greater margin of safety?
JK: In today’s world, the very concept of a moat is without a moat. So the concept of a perfect investment per se, if ever there was one is long dead. Since the early 20th century we’ve seen more disruptive technologies emerge than all of history put together. Some impending disruptions are easier to spot than others.
From an investor’s perspective, as long as you are able to get in before the disruption at a price which factors in some possible disruptions, I think one stands on a good wicket.
So the operating words for me are ‘ease of disruption’, ‘possible pace of disruption’ and most importantly the ‘safety net in the price’.
SN: Very well put! Now, how much weight do you put on the quality of the management versus other quantitative or qualitative factors? Also, how do you assess a management’s quality?
JK: Within quality of the management, I look at two factors: Integrity and Efficiency. I avoid a management where the first is lacking. I would make an exception only if the business has a super niche and valuations are extremely attractive and the management integrity factor is more than baked into the price.
To assess quality, there is no option but to read up as many past annual reports as possible, management interviews, past announcements and see the gaps between promises and delivery.
I think one has to be subjective here in evaluation as at times there may be genuine reasons for under performance. Every single piece of management communication is useful as here or there a quirk or character trait will emerge which I find very useful in building a personality profile. I make it a point to attend AGMs to get a feel of the people who are running the company.
SN: Talking about valuation, how you think about them? Do you have a preferred valuation framework to assess the attractiveness of an investment?
JK: Most of the investments I own stand somewhere in no-man’s land if one looks at aggressive growth investing and Grahamian value investing as two poles.
Most of what I’m invested in isn’t growing fast enough for the first pole and not cheap enough for the second. I seek companies where a significant re-rating possibility exists and where businesses have created the groundwork and poised to take advantage of structural change or value migration. I guess it has to do with one’s mental makeup and the fact that I tend to look at the softer and subjective aspects of value than the purely numerical one.
SN: And what are those softer and subjective aspects of Value that you look at?
JK: Dr. Garry Hamel says competition in the marketplace is not between products and services but between the ‘business models’ of competing companies.
The underlying strengths and efficiencies of a business may at times not translate into growth for a period of time. The question then arises, does one let go of such opportunities or dig deeper to understand these?
To give an example, if one is evaluating pharmaceutical businesses, the mind tends to gravitate automatically towards the largest and best performing stock as the benchmark and then every other business knowingly or unknowingly gets evaluated qualitatively and quantitatively against it. In the process, one may miss out on a few unique models.
The ancient Jewish scripture Talmud says –
We don’t see things as they are, we see things as we are.
It says how we judge and misjudge. I attempt to try and search for these inefficiencies which get created.
SN: That’s a great thought! Anyways, how do you look at value traps? How long will you hold onto a non-performing position?
JK: To me a “value trap’ exists in three cases –
1. Management cannot be trusted;
2. The ‘real value’ of the perceived value is questionable; and
3. There are enough contingent liabilities to eat into the value, if ever it is unlocked.
Value, like truth, by its very nature is tendentious. Otherwise, a value trap is many a times something one ends up categorizing on in hindsight after it has tested one’s patience. If there is value ‘trapped’ in the stock and the management is not hopeless, it’s a matter of time. The call one has to make is capital being sterile vs the possible pay offs. It may suit those who are not capital constrained and can warehouse. In any case, I don’t think one can have more than ten percent of capital in such stocks
SN: Well. have you ever been trapped in such a situation? If yes, how did you deal with it?
JK: Investment convictions are important. But blind hope and belief is self-destructive. Whenever I have realized in hindsight that an error of judgement has been made, I have exited from the investment irrespective of whether it’s a loss or profit making one.
SN: There’s a great lesson for other investors in what you just said i.e., exiting from a mistake irrespective of whether it’s a loss or profit making one. Anyways, do you believe in investment checklists? If yes, what are the most important points in your checklist?
JK: I tend to collate my reasons for buying a stock into one or two pages which include the negatives and concerns. The key 3-5 buying influencers are listed. I update this as and when any new piece of information or fact is available.
Investment checklist is a discipline provider and a great tool to make sure that we don’t experience a rush of blood when buying or selling. How one maintains it and in what format is an individual decision. The more comprehensive it is, naturally the better. But as a process mechanism, I believe it’s indispensable.
SN: So, can you please share down the biggest qualitative and quantitative points from your checklist?
JK: I do not maintain a formal checklist. I’m listing below a few points I look at in every company I study.
• Do I understand the business model and how the company makes money?
• Brand strength/ equity
• External opportunity
• Management’s past action history and overall track record
• Trade confidence
• Low labour costs but well paid employees
2. Quantitative (past 10-15 yrs)
• Free cash flow
• Sales and profit growth + profitability ratios
• Return on invested capital (ROIC)
• Contingent liabilities
SN: That’s useful. Anyways, what are some of the tricks that you use to save yourself from behavioural biases? In other words, how do you minimize the mistakes of behaviour in your investment decision making?
JK: One question I ask myself again and again is – Do I have the temperamental bandwidth to own this stock? Does it suit my personality? So, I like to wet my feet in the stock and have a ‘live in’ for some time till I’m convinced. This is of course, after I have done the complete groundwork.
Over a period of time I have realized my reaction to a stock J going up or down by X percent or performing below or above par business wise, may be completely different vis-à-vis my reaction to the same movement happening in stock K.
SN: Can you talk about your biggest real-life investment mistake, what caused it, and the lessons you learned from it?
JK: Somewhere early 2012, I had zeroed in on three companies which were seriously undervalued. These were all sub Rs 150 crore Enterprise Value businesses. All three were good companies, great pedigree and pregnant with possibilities. There was no ambiguity on the fact that they were all seriously under-valued. Over a period of nearly one year, I committed nearly half my capital to these companies. So far, so good.
Somewhere is the first quarter of 2013 a new trading system called ‘periodic call auction mechanism’ was introduced by SEBI and in a matter of a few days, half my capital was close to being largely illiquid. This lasted for nearly one year.
The big learning for me was – Never commit more money to a stock than what you are mentally and cash flow wise prepared to see sterile for at least two years.
SN: Well, a part of that was outside your control, i.e., the SEBI event. But any other mistake that you continue to make even today?
JK: It is said that sometimes being too early becomes indistinguishable from being wrong. I have never been able to time my purchases to be as close to the inflection point (as I see it) as they ought to be. More than once I’ve misread the velocity of the change or allowed my thinking to be more optimistic than what the prevailing situation warrants. In such times, it is very easy for one’s investment process to break down. Maintaining the discipline and patience during such periods of underperformance is something which tests me time and again.
SN: That’s true! Now let me ask you a 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: Read ‘The Essays of Warren Buffett’ by Lawrence Cunningham and Annual Reports of Berkshire Hathaway.
SN: What’s your two-minute advice to new investors or students interested in a career in investing?
JK: A piece of wisdom I read many years back has stayed with me – “Investing is a journey and the journey is the destination.”
If we stay focussed on the process, the proceeds will take care of themselves. I have learnt that there are no readymade short-cuts. Smart thinking comes in only after the hard grind in finding all possible subjective and objective realities on a company are done.
SN: That’s a great lesson and I wish more investors could learn it sooner than later. Anyways, which investor/investment thinker(s) do you hold in high esteem? And why?
JK: I try to learn and draw from every different style which seems logical and workable to me temperamentally. So I look up to and absorb from all the well-known and unknown names who fit the bill.
People like Radhakishan Damani, Ramesh Damani, Prof. Sanjay Bakshi, John Neff, Peter Lynch, and Warren Buffett have unknowingly opened many a door for me.
SN: Which books/resources do you recommend to a budding investor for learning investing and multidisciplinary thinking?
JK: As a starting point, I think Margin of Safety by Seth Klarman is excellent. The Most Important Thing by Howard Marks can be read and re-read multiple times and each time one comes out with new learning and takeaways. There is a plethora of books on Warren Buffett, a few books by Peter Lynch, some books on successful investors which are all enriching. I personally do a lot of non-investment based reading across the board on multiple topics like history, politics, and business. I enjoy reading biographies/autobiographies of successful people irrespective of the field in which they have achieved fame.
The insight that these books provide on the mind maps of these great people and the ability to tap into their life processes is a learning joy. I equally enjoy reading fiction and light reading too and find it to be a great way to open up the mind and shrug away the shackles of stereotypes. As long as we grab the right ideas, I feel every book has something to offer.
SN: Great, Jayendra! Thanks a lot again for sharing your amazing insights with Safal Niveshak readers.
JK: It was my pleasure, Vishal. Thanks[/show_to] [hide_from accesslevel=’almanack’]
- Spotlight: Big ideas from Value Investing and why applying them in your investment decision making will be a great deal
- InvestorInsights: Interviews with experienced value investors, learners, and deep thinkers
- StockTalk: Thorough analysis of business models of companies (without any recommendations)
- Behaviouronomics: Deep analysis of human behaviour and how it impacts investment decision making
- BookWorm: Reviews of the best books on Value Investing and related subjects
- Free Course – Financial Statement Analysis for Smart People (otherwise priced at Rs 5,900)
- Archives: Instant access to our huge archive from the past three years