November 23, 2005

Concept of variant perception

I have been reading a book ‘No bull’ by Micheal steinhardt. He was hedge fund manager and was able to deliver around 30% returns for almost 30+ years.

I found his concept of variant perception useful. According to micheal, every investment idea should be explainable in 2 minutes and four points

  • The idea

  • The consensus view around the idea

  • The variant perception of the analyst

  • The trigger event which would unlock the value

For example, if there is a solid growth company which is expected by the market to grow at 20%, and as an investor my expectations are close to the same number, then I am not going to make more than the cost of equity if the actual numbers meet the expectations (for more detailed understanding of how to evaluate market expectation read the book Expectations investing)

I have used this concept of variant perception in some form although not exactly in the same manner as explained by micheal. Let me give an example

Marico in the year 2003-2004 was selling at around 10-12 time trailing earnings. A simple DCF would easily show that the market was discounting 2-3 years of competitive advantage period -CAP (for detailed understanding of CAP, please read this
article) with growth in low teens. Now if one looks at the brands, the history of their New products and their distribution network and management,it is easy to see that this company could grow in low teens for considerably more than the market implied CAP of 2-3 years.

So basically my variant perception was not centred around the growth (which is the the usual variant perception generally given by most of the analysts) but around the CAP of the company.

Marico now sells for a much higher PE and the growth was also much higher than implied by the market (around 15% +).

To a certain extent, one can see the same kind variant perception being exploited by warren buffett, except that he is a genius at recognising such businesses with CAP much higher than implied by the market price (ex: coke, GIECO etc)


abhi said...

good article. i guess CAP in other words is the economic moat that Buffet uses to describe the strength of the business.

Rohit said...

yes ...CAP is a term developed by micheal mauboussin. It is the same as the term "economic moat" that buffett uses.

what i have seen (strictly my personal view without any data to back it) is that the market typically tends to overvalue companies with high growth but typically tends to undervalue ones with moderate to low growth (but with long CAP). as a result such companies do have a high intrinsic value as they can earn over their cost of capital for long periods of time. in some cases even the intrinsic value keeps growing

An added advantage is that such companies due to their moderate growth do not have high operational risk , normally associated with high growth.

As as result i tend to prefer such companies as it is easier to project moderate to low growth (which seem to be more sustainable) as long as one can figure out the strenght of the economic moat

abhi said...

I agree with you that the low moderate growth company with some kind ( low/high) moat and their valuation assesment.
And at soem point in the life of these compabnies they do find high ROIC type projects that increases their cash flow and market is caught offgaurd and then there is a rush to overvalue it.

Trouble i find is in reconizing these types of company and the period in which their projects are going to give high ROIC than market expectation. knowing this edge can make a good value buy.

Hungry said...

Hi Rohit,

I have been following your blog for quite sometime now. I just wanted to know if you have written an entry on how you calculate the intrinsic value of a stock. I am an amateur and I wanted to learn. I have downloaded a few of your calculation excel sheets too. Hope my question doesn't sound too stupid.