October 29, 2008

Warren buffett or Rakesh Jhunjhunwala style ?

I received this excellent question from prabhakar via email and have taken the liberty of posting the reply on the blog.

Hi rohit,

I have a query that's bothering me a lot for quite some time now. Let me clarify at the outset that i believe in value investing(Buy something good way below its intrinsic value),no doubts about it.
Now i am stuck between two schools of thought here.
1) The Warren Buffett way -- Buy a "great company" that is stable, when there is temporary trouble and it is selling below its intrinsic worth. Your returns will be decent(no multibaggers here) and compounded long term it work out well for you.
2) The Rakesh Jhunjhunwala way -Buy companies that are selling below intrinsic worth but that have a huge potential to scale big. You possibly get a multibagger here or you dont get anywhere.Example would be Titan & Pantaloon retail that he bought when they were relatively unknown.
Now the question is should we sacrifice multibagger potential for something that is stable?Or should we have both types of stocks in our portfolio.Whats your opinion?Which of the two philosophies is better?

Let me know your views if you find time.

I have thought along the lines of this question for quite some time and can reply from my personal perspective. Let me caution you – The answer to this question is very personal and depends on your own skills and beliefs.

I believe both the styles are equally good and can provide good returns. I would actually extend the question to RJ or WB or Benjamin graham (BG) style or a combination of each.

Key points of each approach
There are some key elements to each of these approaches. Benjamin graham’s (BG) approach is a very quantitative approach to value investing. The selection of an undervalued company is done based on various quantitative criteria such as low PE ratio, Market cap less than net current asset etc. There is a low to almost non-existent focus on the nature and quality of business. This approach is easy to follow, low risk and requires ample diversification.

WB’s approach takes elements of Graham’s approach such as margin of safety etc. However this approach relies less on the quantitative elements of the company and more on the qualitative elements of the business such as sustainable competitive advantage. The undervaluation is due to temporary factors such as losing a customer or some scandal, which has caused the earnings to drop in the short term. However the long-term prospects are still intact and hence the company is a good bet. WB’s approach focuses on the certainty of the long-term prospects of the company.

RJ’s approach builds further on WB’s approach. Here you are looking at companies, which are not undervalued by the traditional measures such as PE, DCF etc. The value lies in the business model and what the company will develop into.

Some Indian examples
A typical graham style company would be Denso or Cheviot Company. Here the company is selling for less than cash on the books or close to it. These companies are cheap by the traditional valuation measures.

A WB type investment could be GSK consumer or Concor or maybe Asian paints. These companies have a long operating history. They have a predictable business model and some competitive advantage. It is easy to look at the long term history of the business and project it to arrive at some measure of value. This investment approach is more difficult than the Graham style investing as it depends on the qualitative aspects of the business too. However it is possible to follow this style as it has quantitative elements to it and does not require a very deep understanding of business models.

An RJ type investment could be pantaloon or titan. This approach to investing requires a very deep understanding of business models and an appreciation of the qualitative aspects of business such as management quality, addressable opportunity etc. The current numbers of the company will not help you make a decision. If you get it right, the rewards are huge.

In addition RJ is moving deeper into this style by investing in smaller and smaller companies at an early stage (VC style) where the risk-rewards are higher.

So which is it ?
For me it is the BG or WB style. My skills have not matured enough for the RJ style of investing. I have looked at titan in the past and could not see the value. The reason I could not see value was due to my own shortcomings.

You may notice that my core portfolio is based on the WB style of investing, where as the other portfolio is based on the BG style of investing. I don’t have an RJ style investment at all and it is possible that I may never reach that level to make that type of an investment.

A common mistake
Don’t get me wrong on these examples. Yes bank, ICSA, Pyramid saimira and Dish TV are some examples, which fall under the RJ style of investing. The current numbers do not show an obvious undervaluation. The value lies in the future prospects of the business. Some of these companies have a new business model and if you can figure it out correctly, then you will make it big on these stocks.

I have however stayed away from these stocks as they are outside my competency.

I have seen a lot of new investors look at RJ’s philosophy and apply it to their picks. There is nothing wrong with it if you have it figured out and have the results and confidence to follow it. However I personally would not recommend following this approach till you have the knowledge, skill and temperament to follow it.


RJ’s approach is not for the faint hearted who is not ready to do his homework. RJ's approach is easy to understand, but quite diffcult to execute and that where his genius lies.

7 comments:

Anonymous said...

Hi Rohit.
I fully agree with you on the views you presented here in this article. Mainly on RJ. Last line of the article is important.

Thanks for this post
Ani

Manish said...

I believe what approach we should take depend on what is our risk apetite and what is our investment goal.

RJ style investment will work for us if we are looking for multibaggers and at the same time ready to loose a good share of our investment. Only 30-40% of his investments have made money and rest of his investments either gave mediocre return or negative return. But, if we spot one or two Pantaloons and hold it for a long period, our overall portfolio return may be excellent.

Also, we need to understand that RJ can (and I am sure he does) meet the Company Management and get the information that make him comfortable for investments in new industries/relatively new companies. We, as Individual Investors, have access to company report and news that is available on internet/TV/newpaper/magazine. We cannot see the value what RJ can see. For us, it will be safe to invest based on information available to us (Annual Report and other publicly available information). Rohit is doing excellent work of sharing his experience and justifying the numbers that he is presenting, all from information that is publicly available. We may not be able to spot multibaggers from his portfolio/approach but we have high probability of decent return.

- Manish

Rohit Chauhan said...

manish
a lot of us have almost the same information for several companies via conference calls and other management interviews. however for smaller companies you are right that access to management will make a big difference. that is one advantage RJ enjoys.

however i would not over wiegh this advantage. several other fund managers have similar access as RJ, but do not have such results.

you have recognize that people like buffett and RJ can look at the same information as others and still come up with better decisions. that is why these individuals are superinvestors..

maybe the difference between a tendulkar and very a good player.

that however does not discourage me. even a good investor (not necessarily a great one as WB or RJ) can do very well in the long run

regards
rohit

Anonymous said...

Hi Rohit,
AS I understand about Graham approach ( read it in book value investing) , one of the main criteria is to have net current asset > total libality

Now I use moneycontrol to look at these figures , in case of denso as you have mentioned I do not see net current asset less exceeding total libality. In fact even in current invironment I have not found a single company that fits this criteia.

Therefore can you explain me what numbers you are looking at , am i looking worng numbers to compare , or you are a more relaxed criteria specially for net current asset to total libality ratio

Regards

Neerav said...

Rohit,

Key thing in a growth or RJ style of investing is looking for picks where you can say that business has a strong possibility of growing 10/20/30 times. Such an objective naturally leads one to scalable businesses like Retail, Real Estate, Banks, etc.
Obviously when one is looking for such growth it depends a lot more on the management and how well they are able to manage the growth. They have to balance not getting into debt trap vs. getting enough funds to fuel continuos growth. All this brings higher risks.

But obviously there are some approaches one can apply. Peter lynch in his book "One up on the Wall street" says he favors Retail stocks for their ability to scale up - To start with the retail format should prove itself in 1-2 areas before you can be sure that it can expand successfully. As long as same store sales do not fall and company expands as per the plans laid out in annual reports etc. it has a good chance of growth.

This style of investing along with good knowledge of management practices requires that we are aware of how consumers are spending or what are new trends emerging. A good domain knowledge can be a plus (if you are into FMCG marketing yourself see if you can apply that knowledge to picking winners in the sector.

Obviously this approach is more that just a thorough financial analysis and depends lot more on knowledge/experience/intuition.

RK said...

How about having a mix? Like having 80-90% of your portfolio based on WB/BG style and rest on smaller companies. Even if all 10% of these investments are bad then you would not lost much but if 1 or 2 in that 10% turn out multibaggers then gains could be high!


rk
http://thedumbinvestor.blogspot.com

akshay ramnani said...

A common sense in both
WB style =less risk less return(he himself mentioned DECENTreturns)
RJ=more like more risk more return

So doesn't really matter stop copying others get urself Ur own ideas they will make money anyways