Shalabh Agarwal is the founder of Snowball Capital Investment Advisors LLP. After spending a decade in the equities industry, Shalabh quit his steady and lucrative job in one of the best mutual fund houses in India to follow his passion of value investing. With a strong desire to unravel the stock market mystery, he read varied literature on investing – it was all quite confusing till he came in contact with Warren Buffett through his annual letters and books written on him. Since then Shalabh has been an avid follower of the Value Investing philosophy.
Shalabh has a professional experience of more than ten years including seven years as a ‘buy-side’ analyst in the Indian mutual fund industry. He graduated as a Mechanical Engineer from IIT Delhi and went on to acquire an MBA from IIM Bangalore.
Safal Niveshak (SN): Could you tell us a little about your background, and how you got interested in value investing?
Shalabh Agarwal (SA): I graduated from IIT Delhi in Mechanical Engineering in the year 2000. Generally, the fourth year is less intensive and so most of my time was spent on my B.Tech Project (final year major project), billiards and on surfing. Internet was still new to the campus and I remember Moneycontrol launching virtual stock market games. This was a period when markets were going berserk – shares hitting circuits on almost daily basis.
With absolutely no knowledge of stocks, this euphoria was intriguing enough for me to start participating in virtual stock market games. As luck would have it, I won some weekly / monthly portfolio contests and started receiving Rs 200 / Rs 500 bank cheques as prize money. Now this was something big as the dosa (a South Indian delicacy) at IIT Delhi’s subsidized restaurant used to cost ~Rs 5 then – suddenly, the cash starved me had enough to treat his friends!
I guess it is this lure of money (at least initially) that hooked me on to the markets. Given free internet and ample time, I started reading on stocks – what and why of stocks (some real basics) using Alta Vista (no Google then). This was my first ‘knowledge’ of stocks and the more I read, more I got overwhelmed by it.
My enthusiasm also led me to take permission from a Prof (IITD MBA faculty) to attend his classes; I started issuing ‘MBA books’ (on ‘time-value of money’ concepts) on my library cards. Once an aspiring design engineer, keen on doing MS, was for sure getting brain-washed.
By the time of passing out in April 2000 (all the above happened over the previous 6-9 months) I had already made up my mind of pursuing a career in the field of stock markets / investing, which required me to take CAT instead of GRE.
Unfortunately, this realization was late enough for me do any justice with my first CAT attempt in December 1999. With eyes set on the December 2000 CAT exam, I joined ITC as a Management Trainee from the campus. Though ITC was a ‘royal’ company (took 14 flights in 5 months of job) and I had an interesting profile (helped me to open my ICICI Demat account) it was tough for me as the company made us to visit factories even on Sundays. With plateauing CAT scores in sample papers, I quit the job in October 2000 to go back home and prepare for the exam.
My reading on markets continued post joining IIM Bangalore and there I got a chance to read Peter Lynch’s One Up on Wall Street. This book was an easy read and it had a mention of Warren Buffett a couple of times. This led me to dig around for Mr. Buffett, and there has been no looking back since then.
With the benefit of hindsight, I am sure I did not really understand a lot (which I thought I was understanding then), though there was an instant attraction to his theory / way of doing things – it all seemed just too common sense (and easy). Unknowingly I guess I was being sucked into the world of Value Investing.
SN: That was a wonderful journey you have travelled, Shalabh. And it goes to the core of Buffett’s teaching – do what you love. So, I am happy to see you here.
Anyways, how have you evolved as an investor and what’s your broad investment philosophy? Has your investment policy changed much through the years?
SA: Looking back, I believe evolution has been more continuous with multiple step-functions in between.
I started putting my savings into the market in the year 2000 with the notion of making 1% each day – even accounting for some misses, this would have made me more than 300% a year.
The naiveté I was, it took me a couple of years and some losses to realize the fallacy in my earlier assumption. This does not mean that I knew what would work though I was sure that this would not work. It was also a time when I had started reading on Peter Lynch, Warren Buffett – probably the first notion of ‘investing’ was getting formed.
Armed with an MBA and supposedly accounting knowledge, my focus shifted towards companies’ financials – I remember copying and analyzing loads of companies’ data from Moneycontrol. Though I was focused on ROEs / ROCEs, I am not quite sure if I understood well how everything connected; certainly I was still away from understanding the business (behind the numbers) and its qualitative appreciation.
Nevertheless, these few years of grunt work gave me a good working knowledge of excel models for companies. A big eureka moment for me came after reading Buffettology by Mary Buffett, when suddenly the concept of a ‘good business’ started dawning upon me. I started looking at companies in the sectors (FMCG, media, etc) mentioned in the book – I guess somewhere deep down I was getting an appreciation of the linkage between a good business and its fundamentals.
The second part of evolution relates more with softer (though more important) aspects like market behavior, human psychology, self-discipline and decision making. This made me read more serious investors like Seth Klarman, Charlie Munger and Howard Marks. I also re-read works of Vitaly Katsenelson and James Montier. Here, realizations have been subtler and come with actual investing into the markets.
So, from buying just stocks, dictated by price movements, today I look to buy businesses (if I had enough money, I would buy the entire company). Of course, we don’t have so much money but our mindset even when buying a few thousand shares, is the same.
We try to answer the following two questions before investing in a company:
1. Why a customer is buying products / services from that company and why would he continue to buy the same (in other words why competitors would find it difficult to poach); and
2. Can we buy the above business at a price which is low when compared to its earnings / cash generation potential.
I believe this journey of evolution is perpetual. The fun is probably during the journey and not in its end.
SN: True, Shalabh. And as a wise man once said, it’s the journey that teaches you a lot about your destination.
Now tell me how is it being a money manager, especially during the extreme situations – euphoria or market crashes? How do you keep yourself sane, especially when dealing with clients with undue expectations?
SA: I would not be serious if I say that it is easy. How so ever one is careful in taking money, extreme situations in the market do have an impact on us as well as on clients’ behavior / outlook. It becomes more difficult because we have a fiduciary responsibility of managing money – a good part of which may be from friends and family.
Though such situations are inevitable and part of the business, the following steps have helped to us to lessen its impact –
• Focus is on returns & not assets: As it is easier said than done, we structurally:
Do not market – all our new clients are only through ‘word of mouth’. This helps us to control the quality of capital coming-in
Base our fees only on returns and invest our own savings in the same stocks as our clients. This completely aligns our interest with that of the investors’, which brings more trust to the entire relationship
• Proper communication not only before taking capital but even during the process. Again our ‘detachment from assets’ perspective helps us to clearly explain our philosophy / way of doing things to a potential investor. We also communicate to all our existing investors through a six-monthly newsletter where we re-iterate our investment process / mindset.
Though it is yet to happen, I would be far happy to return capital to an investor with undue expectations than burn my energy to retain him / her and run the risk of becoming insane.
SN: Glad to know about your ‘non-advertising’ policy and ‘client-favouring’ fee structure. This combination is unusual in this industry, and thus refreshing.
Anyways, what has been the best and worst times in your experience as a money manager? Please explain with real-life examples?
SA: I guess the worst time as an investor for me was in the year 2008 during the global financial crisis. I was primarily managing my own money then and it was my first experience of a real big correction in the markets. Satisfaction from a much lower percentage correction than the markets didn’t help in the face of absolute losses as I had 70-75% of my savings in equities. This sudden ‘erosion of wealth’ started making everything else look ephemeral – I believe such are the real testing times when an investor needs to have a good control on his / her emotions to be able to take further decisions objectively. I remember re-reading Graham’s The Intelligent Investor again and actually realizing the importance of Mr. Market allegory mentioned therein.
It is difficult to pin-point the best event as I really enjoy my every working day. I look forward to stepping into my office every morning and I consider myself very lucky to be really doing what I had always wanted to do. I hope that I will keep doing this with the same passion and energy till I really get conked-off. In fact, these are the best times.
SN: Great to know that! Let’s now talk a bit about businesses. 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?
SA: As mentioned earlier, we are looking for businesses where we can understand consumer behavior – why a customer is buying products / services from that company and why would he continue to buy the same in future (in other words why wouldn’t he switch to competition). This requires some qualitative thinking about the business in terms of how the company is making money, is it sticky enough and more importantly reasons behind that stickiness, if any. We also try to gauge its sustainability by thinking through various disruptive risks that the business may face.
Our qualitative reasoning must also get corroborated by the quantitative data – historical financials of the company. We put a lot of emphasis on the consistency of the reported numbers over the last decade or so as this is a long enough period to have exposed the business to different external conditions.
Given our disinclination towards volatility (in business), we typically like businesses which have created (or in the process of creating) scale by repetition – manufacturing (providing) similar products (services) over the years. They are less dependent upon macro / external factors & also generally have a solid market share in their respective categories. These qualities should finally also get reflected in the reported financials of the company – esp. in the consistency of return on capital and cash flow generation.
Historical analysis also helps us to get a peek into the management quality as the business today is nothing but a reflection of the numerous management decisions taken over a period of time. Wrong decisions or poor capital allocation would result in poor ROCEs / cash flow generation, etc. We also additionally look out for red flags – related party transactions, recurrent execution gaps (from what was guided), improbable financials / business transactions, sagging incremental ROCEs, etc
We also think about the possible growth in the business. We like to distinguish between quality (as measured by stickiness) and growth where quality is more inherent and growth is more a function of current scale, management actions and macro factors. To that extent, growth becomes a variable in valuing the business – obviously a good quality business with higher growth potential would be more valuable than a similar quality business with lower growth potential.
SN: You talk about growth here. How do you look at growth in an age of widespread disruption and shrinking lifetime of corporations? Here there been an instance in your personal investment experience wherein you mis-read growth?
SA: This is so true – many businesses are under-going a structural disruption. Recently I was reading on how top-four coal producing companies in the US have lost 99.9% of their combined market cap over the last 6 years, driven by lower coal demand and production. The same article further argued on how oil demand may get affected over the next decade on the back of reduced sales of gasoline based cars – thanks to the much lower per mile cost of electric self-driven vehicles. This would not only affect oil demand but would also have a significant repercussion for the gasoline car industry (and its related engine, drive-train businesses). We have already witnessed similar disruptions in other industries – case studies on the fall of Kodak, Nokia, US Newspaper industry are well known – all affected due to the changing consumer behaviour.
It is not easy to fathom a change of this magnitude much ahead in time and far less to build that in our financial valuation models, nevertheless it makes one thing very certain – increasingly future is becoming uncertain, where even some well-established business models of today, may look obscure in the next decade.
In this backdrop, the only arsenal we less-prescient investors have is to be conservative in our assumptions of future growth. Our DCF valuation framework necessitates us to think through this growth and helps us to work out different scenarios as even a CEO would find it difficult to estimate his / her business growth 5-10 years ahead.
Using this approach, we have mis-read growth a few times though almost every time error has been on the positive side – we have rejected some very good companies in the past whose market prices at that point of time were implying a much higher business growth than what we were comfortable with. Of course, these businesses went on to report much higher numbers (than what we anticipated) and create substantial shareholder’s wealth, which we missed. Luckily such businesses are few and far in between.
SN: How do you think about valuations? How do you differentiate between ‘paying up’ for quality and ‘overpaying’?
SA: We use the classical DCF approach to value companies. Our aim to invest into stable and sticky businesses ensures better forecast-ability and compatibility with DCF. We also like to analyze the build-up of future free cash flows to gauge the kind of annual cash return we would have made if we would have bought the entire company. Being a conservative and absolute methodology, DCF also helps us to remain grounded and not get carried away by the changing moods of the market.
We also carefully study the trading history of our businesses to get an understanding of the changes in the market accorded multiples over time. This allows us to develop an appreciation of the inherent cyclicality in the market valuations.
How-so-ever well read on the company / sector, we know that we do not know the future and thus always play with a margin of safety to account for any potential errors /omissions. We love to wait for full-tosses and full-length balls before swinging our bat (in cricket parlance) and thus buy only when the market offers a price significantly lower than our calculated value.
We believe ‘paying for quality’ is really a function of future expected growth in the business, which is a variable in the DCF equation. We like buying growth but are averse to paying-up for it. This strategy has had some misses (errors of omission) though overall across market cycles, it has kept us in good stead.
SN: Great insights here! What about the selling decision? How do you determine when to exit from a position? Are there some specific rules for selling you have?
SA: Like buying, selling is also driven by a comparison of price and value. Though value is also a function of time (goes-up mostly), changing moods of the market at times price the stock far ahead of the possible value – this is when we typically sell.
We tend to get more liberal in cases where we might be running a risk of under-estimation in our DCFs – this generally happens in businesses which are highly scalable and have a long growth runway available to them.
Apart from this, we also sell when there is a realization of mistake either in terms 0f understanding the business (unanticipated changes in the company / industry making it less sticky and stable) or valuing it properly. Luckily most of our ‘sell’ decisions have fallen in the first bucket so far.
SN: When you look back at your investment mistakes, were there any common elements of themes?
SA: I think mistakes have primarily been of two kinds – probably both being driven by our conservative approach to investing:
1. Missing to buy a business which was quite within our realm of understanding due to its then perceived expensive valuation. The name that always comes to my mind is Gruh Finance as I have never been able to justify its valuations and have always been proven wrong. I remember first evaluating this company somewhere in 2011 – it checked all my boxes in terms of quality, management, history though I was not very comfortable with the price. Since then it has been a 15-bagger (very expensive mistake indeed).
2. Selling too early – again this has been due to our under-estimation of the potential re-rating in the stock. One name that often reminds me of my folly is Page Industries – I remember buying this company at around Rs 450 post the global financial crisis in 2008 & then selling it in 1.5 years at about Rs 1,000. I was happy to make >2x in less than 2 years though obviously I didn’t know what I was going to miss.
Such mistakes have made us tweak our selling process over a period of time wherein now we are more liberal (and get less concerned) with either very high-quality companies or ones which may be a notch lower in quality but have many years of growth available to them.
SN: How can an investor improve the quality of his/her decision making?
SA: Investing is nothing but a game of decisions – buying is a decision, selling is a decision and even not-to-do-anything is also a decision. We, investors, knowingly or unknowingly are always taking some decisions. Statistically then even if our decision-making process is following Six Sigma, there will be mistakes. Mistakes are inevitable part of investing, though over a period of time, we can attempt towards reducing their impact on the portfolio.
First and foremost, I think decision making process needs to be very well articulated – both at an ‘investment philosophy’ level and at the ‘company-at-hand’ level. Using a rough analogy, unless all the equipment parameters at various points in a manufacturing set-up are being monitored and controlled, it would not only be difficult to attribute a reason behind a poor-quality output but also to correct it (by changing a parameter). This articulation helps in establishing a feedback loop mechanism which is useful to tweak the process over time.
‘Focus’ is another trait which helps. As re-counted by Alice Schroeder in her book Snowball, 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 important factor in their success through life. Gates and Buffett gave the same one-word answer: “Focus.”
I believe it certainly helps to concentrate at the company in hand without really worrying about what is being anchored on business channels / broker reports. This enables us to list and analyze the facts more objectively without really getting carried away with the mood of the market.
SN: How do you think about risk? How do you employ that in your investing?
SA: Risk for us is ‘permanent loss of capital’ which typically happens in either of the two conditions:
1. Unanticipated structural (adverse) changes in the industry or company affecting the business almost permanently; and
2. Non-fulfilment of investors’ future expectations in terms of growth (originally expected to be driven by new products / customers / geographies, market share advancement, etc.), capital allocation by management or broad direction taken by the company.
Given this ‘risk’ is captured by price, a lower acquisition price in relation to the value of the asset, in effect would make it a ‘low-risk, high-return’ approach (in contrary to the general economic theory). As Mohnish Pabrai puts it in his book The Dhandho Investor, it becomes a case of “Heads I win, tails I don’t lose much.”
We also try to follow the same philosophy and build-in a margin of safety in our acquisition price to account for any errors / omissions from our side. It is for this reason that we are reluctant to pay-up for growth.
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?
SA: Charlie Munger calls ‘investing simple but not-easy’. Simple probably because it is more common sense driven and can be followed by even the smallest retail investor with a rational frame of mind.
At the same time, it is also difficult to practice given the requirements of certain behavioral traits which are not easily found in this action-obsessive world. Patience is needed to wait for the right opportunity, courage to act against the markets and discipline to follow the above consistently across time periods.
Thus, value investing can be quite a non-glamorous profession where a self-driven investor painstakingly follows a set of rules with a belief in the process and not in the outcome. There would also be (long) periods when this philosophy will not work and test the resilience of the investor. It is only when the investor enjoys the journey, will value investing work for him / her.
SN: Which unconventional books/resources do you recommend to a budding investor for learning investing and multidisciplinary thinking?
SA: With the availability of YouTube lectures and investor letters (from renowned value investors), I believe that there are unlimited resources for learning. Constraint would be on time and not on supply. Still a top few books that come to my mind are (apart from Warren Buffett’s annual letters and lectures given by him to MBA students at various colleges) –
- Common Stocks and Uncommon Profits by Philip Fisher
- The Intelligent Investor and Security Analysis by Benjamin Graham
- Active Value Investing by Vitaly Katsenelson
- Margin of Safety by Seth Klarman
- Value Investing by James Montier
- Poor Charlie’s Almanac by Peter Kaufman
- The Five Rules for Successful Stock Investing by Pat Dorsey
- The Most Important Things by Howard Marks
- Competition Demystified by Bruce Greenwald
Certain books on markets’ history and how the financial systems work (or doesn’t) have also been helpful in developing an overall appreciation –
- When Genius Failed by Roger Lowenstein
- The Great Crash 1929 by John Kenneth Galbraith
- Manias, Panics and Crashes by Charles Kindleberger
- Speculative Contagion by Frank Martin
- The Big Short by Michael Lewis
SN: That’s quite a good list! Which investor/investment thinker(s) so you hold in high esteem?
SA: Warren Buffett and his partner Charlie Munger, Seth Klarman, Prem Watsa, Howard Marks, James Montier, Vitaly Katsenelson, and Mohnish Pabrai are some of the investors whom I am always eager to read about.
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?
SA: Despite losing memory, hopefully I would still be left wired for value investing. Thus, I would list down the names of all the books that I have read / written above. In fact, I would include this interview as well given it covers a fair bit of my investment journey.
SN: Glad to know that! Anyways, what keeps you occupied outside of investing and managing money?
SA: I spend time with family – love playing board and card games with my kids. I also watch movies (post going through their reviews) and listen to Hindi songs. I am also learning to play guitar.
SN: That was brilliant, Shalabh. Thank you so much for sharing your insights with Safal Niveshak readers. I wish you all the best for your work and life.
SA: Thanks Vishal! I hope your readers find this useful in some way.[/show_to] [hide_from accesslevel=’almanack’]
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