Getting it perfectly – Wrong !

I managed to achieve perfect timing this time. It managed to sell exactly before the fundamental performance of VST and India nippon turned around. I wrote the following post on the two companies and my key reason for exiting the two stocks was stagnation of their fundamental performance for the last 2-3 years.

VST reported a 126% increase in their net profit, driven by a 100% increase in topline. This increase is not really a one time increase as the other companies in the industry like Godfrey Philips have reported similar results driven by the topline growth. I have yet to investigate the sudden turnaround in the industry and whether it is sustainable.

Indian nippon reported a 100% growth in profits, driven by a 20% increase in topline. The reason for the profit growth in excess of the topline is due to the operating leverage enjoyed by the company. I need to analyze how sustainable is the performance for India nippon.

My confidence levels in terms of fundamental performance is still higher for VST than India nippon (irrespective of the stock price). The reason is that VST sells a consumer product with pricing strength, whereas India nippon is an auto component supplier which could be benefitting from the upturn in the auto business. The company however, does not enjoy as much pricing power and hence may not derive as much benefit from the upturn in business.

So where did I goof up?
The first thing i do when something turns out different from my expectations is to analyze if I could have analyzed it differently. My reason for the exit was stagnant fundamental performance (irrespective of the stock price).

At the time of the sale, after I had analyzed the two companies, I could not foresee a turnaround in the business. In case of VST an economic downturn will not hurt the businesses and hence when the economy turned, I did not expect the business to turn as much.

In case of India nippon, It can be argued that the auto industry is turning around and hence it just a matter of time that the auto component industry would benefit too. However, it was difficult to reach such a conclusion in case of India nippon as the company has performed poorly in the last 3 years when the auto industry was still doing well.

The other drawback with these companies is the lack of transparency on the part of the management. The Annual reports are very brief or cryptic and there are no management calls which an investor like me can read to get an idea of the likely direction of the business. A professional investor having access to the management would be able to avoid this problem.

The final point is how long should one hold onto a stock before the fundamental performance turns around. I typically hold a stock for 2-3 years and even longer if the fundamental performance is satisfactory. However if the fundamental performance is deteorating, I tend to exit the stock. As someone has said – Hope is not an investment strategy.

Indentifying turnaround in business performance is difficult for me and I tend to get the exact timing more wrong than right. Ofcourse this is not new for me – I have sold L&T in 2003 after holding it for 5 years, right before the company took off

It does not disturb me
The above occurrence does not disturb me. It does not mean that I am proud of missing such turnaround and will not analyze my thought process further to see how I can improve on it in the future.

I have said in the past that if I can get a 70% success rate in my picks, I will do fairly well. What is the logic of this number ..did I pull it out of my hat?. There is a logic to it. I typically invest in a stock with a 2:1 to 3:1 odds. What that means is that if the stock is priced at 100 / share, then the possible upside is between 70-80 and the possible loss is between 20-30. The expected gain (gain * probability of gain + loss* probability of loss) is around 35-40 ( .7*70+.3*30) or 30-40% which provides me a margin of safety too.

My actual success rate has been around 70-80% in the past with the gain/ loss ratio around the same level. As a result, I have been able to meet my return targets in the past. In addition, an additional lever in managing the performance is managing the allocation percentage to a specific idea. One should allocate a higher percentage to the ideas where one has higher confidence.

Follow me – in reverse
Considering my almost perfect record in selling (around 0%), I think it would make sense to hold or buy when I decide to sell :).

When I suggest, that you should do your own research and not buy based on my recommendation, I am dead serious about it. A 70% success rate has worked out well for me. The impact of the 30% failure has been further reduced as i have not allocated too much of my funds to those ideas as I did not have as much confidence in them. If you decide to have a higher allocation than me, your results could be worse.

An additional point: I tend to change my mind suddenly, if the current facts invalidate my expectations. So I may end up buying something which I recently sold or sell something which I bought and realized that my thesis is wrong.