October 27, 2011

Learning from failure

I often torture myself by looking at my past mistakes, every now and then. It may not be fun, but it is a very useful exercise
The idea of doing these exercises is not to beat myself up , but to identify patterns of incorrect thinking, and avoid repeating them in the future.
So why analyze mistakes
The human mind has a tendency to ascribe failure to bad luck and success to one’s own brilliance. In addition to this bias, there is also the problem of social disapproval. In school, did you ever get a pat on your back when you came back home with a bad report card?
In spite of all the disadvantages, I think there is substantial value in analyzing and learning from your own and other’s mistakes. The first and more difficult step is to acknowledge to yourself, that you goofed up.  A more fool hardy step, is to do it publicly like me and make a fool out of yourself J
A recent example
Let’s look at a recent example. I had posted about facor alloys recently. I wrote about it here, here and here.
The key points of the thesis were
-          The company had turned around its fundamentals and was now operating profitability. The balance sheet was sound with plenty of excess cash
-          The company would continue to do reasonably well if the industry economics did not collapse (i.e steel demand did not collapse)
-          Finally and one of the key reasons driving my purchase, was that the company appeared to very cheap.
As I said in the earlier posts, this was a small position with the intention of exploring the small/midcap space in the commodity sector. I was not able to convince myself to carry a big position (call it gut feel or whatever)
The transaction history
I wrote about the company around March 2010 and started buying around that time. I built a small position over the next few months at an average price of around 6.6 Rs per share. I sold around 30% of the position, when the price rose to around 8 / share and booked some profit (I usually never do that – which shows my conviction levels).
I read the annual report of facor alloys later in the year and posted the following
I was also disappointed after I read the annual report of facor alloys. The company has passed several special resolutions to invest to the tune of 300+ crs in other sister firms, which are expanding into power and other businesses. I get fairly mad with this kind of diversifications. Needless to say, I plan to exit the stock in time irrespective of what happens to the business or the stock.
As you can see, the above was posted in Nov 2010, but I finally exited the position in June 2011. Why did I wait? Good question! The answer is that I was slow to accept my own conclusions and was ‘hoping’ the position would work out. In the end, hope is a dangerous strategy in the stock market
Learnings
I lost around 12% on the position after including dividend. So what I learn from this expensive tuition?
-          Hope is a very bad strategy. If your original thesis turns out to incorrect, then exit the position. In this case, it turned out that the cash was never to going to come back to the investor. The management has their own plans, with which i am not comfortable. In such a situation, one cannot have the conviction to hold on to the stock.
-          Accepting mistakes is painful. At the same time, the earlier one does it, the better it is for the overall portfolio (there are opportunity costs involved)
-          The market rewards companies which are able to re-invest capital in their own business at high rates of return. If the company cannot do that, then the expectation is that the cash would be returned to the shareholders via dividend or buyback. If the management decides to diversify without appropriate transparency, the market is likely to take a dim view of it (read poor valuations)
-          Small and midcap commodity stocks are possibly good trading stocks. You buy at specific time of the commodity cycle and exit before just before the cycle turns. It is not a coincidence that companies like facor alloys are the most touted stocks on the various tip services. These kinds of stocks are a bad idea for me as I cannot play this game at all.

Why do this to yourself?
You may ask – why invest in such stocks in the first place. I personally think, it is not possible to become a good investor without committing a few mistakes along the way. The more important thing is to keep the mistakes small, acknowledge them quickly, close them out and finally learn from them. Easy to say, difficult to do
A side project
I am doing an analysis of stocks which have dropped by more than 50% in the last 5 yrs. The reason for this analysis is to understand the cause of failure and hopefully use the learnings to make better decisions. If you are aware of any such stocks, please leave it in the comments. I would greatly appreciate it.
By the way, in case you are wondering, I don’t always lose money on my stocks picks J. Quite a few do well too, but then what is the fun in boasting when every other guy is anyway doing that.
A happy diwali to all the readers. Hope all of you have a prosperous new year.

31 comments:

Raja said...

I would love it, if you could include Allied Digital in the list of companies to analyse.

It was listed around 2007 for a price of 140. Touched 500+ in 2008, Now available for less than 30. Has lost close to 90% in the past 1 year itself.
It's into Remote Infra Mgmt space. Some respected names like Intel's VC arm is invested into it. etc etc...

Yours truly, too is still invested into it from 50 levels thinking it is cheap.
But am still not certain what learning I should take from this scrip.

plus.ly/Suhail said...

Very good post Rohit. I've been a silent student of your blog for past 1-2 months.

Just taking this opportunity to wish you a Happy Diwali too!

Also, I've earlier tweeted you this Qn, maybe you missed it, so you can ans it here.

Which google group are you referring to in this comment?
http://t.co/5g5Lp6T9

Can you make me a member of it?
(MyFirstname AT gmail dot com)

Thanks
-Suhail

Navy Cut said...

Hi Rohit

Good to look back at mistakes and learn and ofcourse accepting when wrong takes time which you have highlighted

One stock which lost more than 50 % is GMR Infra i believe last three years it lost 70% of its value

Arun said...

Hi Rohit,

Nice post. but one challenge I see in doing analysis of failures is identifying failures. There is always some chance of the bet going wrong and it is very difficult to identify if the analysis was wrong or it was just luck. How do you do it?

Regards,
Arun

Vic said...

Thanks Rohit for this very useful post, reminds me to look at my mistakes as well..:-)

I'm late to wish you a happy Diwali, hope you enjoyed your favorite sweets.. I know you love them.

Vikas

rapidriser said...

Hey Rohit

I've lost a good deal of money in mistiming cyclicals. But the reasons for my losses are glaringly obvious in HINDSIGHT.

However, I would really love to know your views on the reasons for the fall of Pantaloon Retail which was a clear leader in a growing sector of the economy, yet has been a big value destroyer since 2008.

Gaurav said...

Dear Rohit

please include TNPL, in your list of stocks for analysis. It sounds a good idea considering it satisfies all the four criterion prescribed by Warren Buffet; viz. sound financials, transforming business model (now the company is shifting to more profitable product categories), good management (presumably, it being a PSU) and attractive valuations (@PE of around 5)

Purav Shah said...

An example of stock that has fallen more than 50% is MOIL. It has done so in almost in 1 year.

Anonymous said...

reliance communication can u highlight about the future of the company

Rohit Chauhan said...

Hi raja
thanks for the name. i will look into it

rgds
rohit

Rohit Chauhan said...

Hi suhail
i am sorry ..the google group is now closed. google basically terminated the group feature and i removed it from the blog too. I will launch one soon from my blog

rgds
rohit

Rohit Chauhan said...

Hi navy cut
thanks for the name. will look into it

rgds
rohit

Rohit Chauhan said...

Hi arun
yes that is always difficult. one way to get around it is to make notes when creating the position. if it does not work out, i tend to go back to my notes and check if my assumptions were incorrect and analysis faulty or something unexpected or unlucky happened

rgds
rohit

Rohit Chauhan said...

Hi vic
a late happy diwali to you too. oh i have a major sweet tooth - had my fill this year too and now trying to work it off :)

rgds
rohit

Rohit Chauhan said...

Hi rapidriser
let me look at pantaloon more closely. however if i remember correctly, the valuations of the company were quite high the past, anyway let me have a look

rgds
rohit

Rohit Chauhan said...

Hi gaurav
is tnpl a buy or a candidate to analyse failure. could not understand from your post

rgds
rohit

Rohit Chauhan said...

purav
let me have a look at MOIL. if i am not mistaken it had an IPO ..right ? typically IPO's have a tendency to underperfrom as the stock is valued at full price at the time of the IPO

anon - where do i start :) ..it is a company in an unattractive sector (where profits are poor and prices dropping) with a poor management. i would personally never touch the stock

rgds
rohit

Suhail said...

Thanks. Glad to know I'll be the trigger in reviving that group :-)

Also, had no idea that you'd be present at last weekend's meet - missed you by a whisker :( Would've loved to meet you in person. Some other time maybe.

Sachin Purohit said...

@Raja..
I had looked at Allied Digital a few months back. It seems to be a case of fudged numbers and a lot of other issues to me. For one, the employee cost appears to be too small based on the headcount they have published. They are not a good manager of working capital. There have been negative cash flows, which they had to fund by placing private equity with Bennett & Colemann group (Times of India)and issuing warrants. It is a stock best avoided. All the hype about cloud computing, etc they are generating seems hollow considering the fact that their employee cost works out to be about Rs.100,000 per employee (including the top management!).

Harmuall said...

gvk power, suzlon, rpower are some of the few i had to learn from but the reasons might be obvious!

Vikas said...

Hi Rohit,
Recently came across Mayur Uniquoters. Then came across your analysis on it.But it was around 160. Now its doubled to 360.
Do you think its still undervalued and worth investing?
Regards,
Vikas Bargale

Venkata Srikanth S said...

Aurobindo lost 65% in one year so makes a good case study i believe

Thanks
Venkata Srikanth S

Anonymous said...

also include take solutions in your list...

amol

Anonymous said...

What i've seen in the past 5 years is that the major causes behind failures have been some overhyped technology or huge debt burden or unsrupulous management or combination of the above. The ones that come to my mind instantly are Asian Electronics,Moser Baer,allied digital, Onmobile Global,tanla solutions, Pyramid Saimira, Educomp, GTL duo, Deccan Chronicle, Pantaloon etc. Apart from these, majority of infra stocks have lost over 50% of their value but that is a whole different story.

Anonymous said...

Add Bartronics, Financial Technologies, Prime Focus, Nucleus to the list of technology disasters

Rohit Chauhan said...

Hi suhail
are you referring to the ISG meeting in mumbai ?

rgds
rohit

Rohit Chauhan said...

Hi harmuall
gvk power and suzlon i think are worth looking into. I am not surprised about Rpower considering its management and past record

rgds
rohit

Rohit Chauhan said...

Hi vikas
need to look into mayur uniquoters again. somehow i have not been able to build a lot of conviction on the company due to the nature of the business and the management

rgds
rohit

Rohit Chauhan said...

Hi venkata/ amol
thanks for the names. will look into them

rgds
rohit

Rohit Chauhan said...

Hi anon
you hit the nail on the head. nice summary of the causes.

some of names you mention such as moser baer had an issue with nature of the biz - CD/DVD manufacturing has poor economics too, whereas others are cases of poor management

rgds
rohit

Rohit Chauhan said...

Hi anon
thanks for name ..some of companies like Financial tech were hyped up names in the past

rgds
rohit