January 9, 2007

Importance of a simple business

I generally analyse a good number of companies before investing in a few. A lot of times i am not able to figure out, with reasonable confidence, the range of intrinsic value estimates for the company. I have had this problem with telecom, retail companies etc. These are companies in a new, sunrise industry. There is a lot of promise and enthusiam around the companies and the valuations may reflect that. I do not have a doubt that these companies and industries will do well. The problem for me is figuring out how well, and how much of that is already built into the stock price.

On the other end are companies which are essentially conglomerates or a combination of businesses such as Reliance, IOC etc. These are in mature industries and are good companies. They may very well be undervalued. The problem for me is that they have a lot of moving parts. IOC has a 400 page annual report, relaince has (or used to have) a lot smaller businesses such as telecom, asset management and now retail etc. So analysing these companies would mean taking apart each of the sub-businesses, valuing each of them separately and then arriving at the whole value. Impossible …no, but definitely tough and a lot of work.

Compare that to the simple (as least to me) businesses such as castrol (lubes), Lanxess ABS(ABS), marico (FMCG), asian paints (paints), concor etc. I could go on and on. These companies are engaged in a single line of business, nationally or in some cases in international markets. They have a decent operating history, dominant position in a stable market, and in some cases attractive valuations. To boot, some even have a small annual reports to analyse (just joking!).

I have invested in both the complex and in the simple businesses (avoided the sunrise type industry as I don’t have a better idea of these businesses). Overall, I found that the simple businesses are easier to understand, to follow on a regular basis and in the end give good returns.

I am clearly influenced by the following quote by warren buffett

"Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-of-difficulty doesn't count. If you are right about a business whose value is largely dependent on a single key factor that is both easy to understand and enduring, the payoff is the same as if you had correctly analyzed an investment alternative characterized by many constantly shifting and complex variables."

So if I have an option between a diffcult to understand, complex conglomerate and a simple business(all else being the same), I generally opt for the simpler business.


Prem Sagar said...

Very true.. simplicity matters a lot. And man (here I mean 'I')has this tendency to complicate things. In fact, I was reading a book called Simplicity by Edward De bono, but it was actually a complex book!!
It definitely makes sense to stick to simple stocks. And simple single businesses are easier to research!!

Prem Sagar said...

Not sure if u visit my blog..so thought I would reply to ur question here.

I do sector (and other similar) analyses bcos of this
1. to diversify against ignorance bcos I know I am not yet there in terms of proficiency. My investing philosophy is still in nascent stages. So I want ot have a system in place where I make sure that I dont over do things...so i have some systematic rules. not to buy more than 8% of folio in one shot, to average purchases, not to be more than 20% in one stock, not more than 25%-30% in one sector. Basically its a hedge against ignorance of the unknown (yet)

2. I dont want to be invested heavily in any single sector even if that is extremely attractive until I gain more proficiency and confidence.

3. I dont want to be single stock biased for the same reasons.

4. And I do such analysis and charting etc bcos I am a BI professional and I enjoy doing it..I like manipulating data and making sense out of it...creating reports etc. That could be a reason.

5. I am not top down, but dont want to be sector biased unconsciously so do a sector analysis.

6. The decision to increase IT holdings is due to the fact its my work area and I understand it better.


chitspeaks said...

Your articles are just great.I wud like to read something about the ongoing trend of people from almost every stream entering the finance sector. No problem with that but there are youngsters who are just making a career out of the stock market,out of investments. Is'nt this irrational?