Rakesh Jhunjhunwala's Real CAGR

I have always wondered about the real CAGR achieved by the big investors. Stories are created and floated in the market to make their achievements look much bigger than what they actually are. Rakesh Jhunjhunwala is unarguably the most successful investor on Dalal Street. I was always interested in knowing his real CAGR. The problem is that the stories created around him make it almost impossible to gauge that. It requires some glimpses into his early years as an investor/trader to know the approximate CAGR achieved by him.

As per the fable, he came to Dalal Street with 5000 Rs in 1985.  And now considering that his net worth is close to 2 billion dollars(12000 crores), the CAGR achieved will be closer to 77%. For a 30 year period, achieving a 77% CAGR looks almost impossible, and I never bought into the story.

Recently, RJ was interviewed by Ramesh Damani and N. Jaikumar (of Prime Securities fame in which I successfully managed to lose two thirds of my original capital in 2008 in just 3 months. Sometimes, I will write a blog on phony, nice sounding, TV-appearing people and their investment (mis)achievements but for time being let us focus on their interview). A good portion of the interview was spent around the early years of RJ in Dalal Street. Some facts were stated about his early years, which make his story much more clearer to us. As per the story, even though RJ came to Dalal Street with 5000 Rs in 1985, in 1986 he made 25 lakhs. This is a very very important fact and takes us much closer to the real achievements of RJ.

Being investors in the market for long, we all know that by no means one can convert 5000 Rs. to 25 lakhs in a single year. So, assuming that RJ started his investing journey with 5000 Rs is either false or only partially true. At least, the fact that RJ started his investment journey with only 5000 Rs should not be interpreted as "he had only 5000 Rs and all his net worth was created out of these 5000 Rs by investing them in the stock market" as most of us do. Based on the facts stated by him, it is highly likely that he had at least 10 lakh Rs to invest (assuming that his networth jumped by 3.5 times (highly optimistic) in the first year). So, a much more realistic scenario is that RJ started his investing journey with 10 lakh Rs in 1985 and now in 2015 he has 12,000 crores. This is a CAGR of close to 48%, which is great by all standards but much more realistic.

The other way to calculate his CAGR will be to ignore the first year and go by the fact stated by him about his networth in 1986. So, if we remove the first year and start from 1986, his networth has jumped from 25 lakhs to 12,000 crores in 29 years. That will still be closer to 45%. So, based on all the realistic facts, RJ has achieved a CAGR of 45-50% for 30 years. That is a great achievement, but not very unrealistic. All of us can target for it, and probably many of us will be closer to that for a shorter period of time.

The most important lesson of this fact is as follows. "If one can compound his networth at 45% for a 30 year period, he can easily become a billionaire starting from a modest sum of 10 lakhs". Another important fact that we should not ignore is the drop in CAGR rates with the increase in the corpus size. So, in the same interview, RJ mentions that his networth was 20 crores in 1990. That is an increase of almost 100 times in the first 4 years of operation. That will put his CAGR for first 4 years at 200+%, which is truly remarkable. But this also points to the fact that RJ has achieved only 30% CAGR since 1990 which is remarkable but not very far from what many investors have achieved on Dalal street for a shorter period of time with smaller corpus sizes.

Based on all these facts, it appears that RJ's journey has been great but not an impossible one. Many of us can try to emulate his journey and hope to do equally well.

Please find the link to the interview below.

http://www.moneycontrol.com/news/market-outlook/grab-opportunities-buy-first-research-_1329409.html

Some Risk Management Lessons From Guru Warren

The blindness to risk in the buoyant environment of 2003-07 and the subsequent fall in 2008 (67% down for the year) taught me a lot of useful lessons. Some of those were captured in my earlier blog on Risk Management here. Those lessons still serve as guiding principles to me. From time to time, reading books like "Black Swan" and "Fooled by Randomness" also helps in emphasizing the importance of risk management in investing. But, there is a continuous need for improvement, esp. in an environment where stocks are becoming costlier by the day. Reading the latest letter from Warren Buffet to Berkshire's shareholders gives some good insights into the risk management strategies practiced at BH. Interestingly, whatever is applicable to one of the biggest corporations in the world is also applicable to small investors. Here is what Guru has to say.

Financial staying power requires a company to maintain three strengths under all circumstances: 
(1) a large and reliable stream of earnings; 
(2) massive liquid assets and 
(3) no significant near-term cash requirements. 

If one pays attention, it is not difficult to understand that individual investors must practice these mantras as well.

A large and reliable stream of earnings -  This statement simply means that we should own many sources of earnings(diversify) and the companies that we own should have reliable earnings(Consistent). At some other place in the letter, he mentions the criteria that Berkshire applies before purchasing a company.  One of the important ones is as follows.

Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations).

Above mentioned criteria clearly tells us what kind of companies we should own and what kinds we should avoid.

As far as diversification goes, everyone has their own criteria and comfort level. Too much diversification leads to leniency in stock selection, while too less diversification exposes one to black swans. One needs to find his comfortable mean and stick to his principles. But definitely owning one or two stocks is ruled out.

(Massive) liquid assets - Many individual investors utilize leverage. It really works well in early stages of a bull market. I myself used 10% leverage for generating higher returns in 2014. But, as the market matures, we should definitely move towards liquid assets. Remaining invested only to the level of 75-80% and keeping 20-25% as cash in a matured bull market should be considered by every serious investor. In challenging times like 2008, it helps us in keeping nerves calm and allows us to invest in some really good businesses at reasonable prices. After all, longevity in investing is far more important than a great performance in the short run. In Guru's words:

At a healthy business, cash is sometimes thought of as something to be minimized – as an unproductive asset that acts as a drag on such markers as return on equity. Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent.

No significant near-term cash requirements - This is directly related to the liquid assets. If you are debt laden elsewhere and you have obligations to pay, then your liquid assets will be of no use in bad times. All the lenders will want you to pay in the bad times. And, liquid assets are useful only when the times are really bad. So, if you have an obligation to pay in near term, please don't count on your liquid assets as they might get utilized for near-term cash requirements. Actually, to reduce risk, we should try to remain debt/obligation free at all the times.

There are many important nuggets of wisdom in the letter and I would recommend all of us to read it. But, if one could only take this risk management part and practice it, his investing life would be much more satisfying and fruitful.

Windfall

WOW!!! What a year for the equity investors. Everyone, who was serious about equities, got rewarded substantially (most investment books tell us that a return in excess of 25% is substantial, but here I am talking about much higher returns). There are many portfolios with returns in triple digits.  A search on money control website shows at least  fifteen mutual funds with returns in excess of one hundred percent with the best among them "Sundaram select Micro cap fund- Series 1" returning close to 128% for the year.

Let us flash back a little bit and think about the start of the year. Then it appeared that stocks will give good returns for the year, but the returns achieved seem to have surpassed even the best estimates. Most investors have surpassed their own highly optimistic estimates. This reminds me of the proverb "Bhagwan jab bhi deta hai chappar phar ke deta hai".

Coming back to my own portfolio, the returns achieved are in excess of 145%. This is the best performance achieved ever by me in a single calendar year both in terms of absolute value as well as percentage. The important thing is that these returns have come on the back of 110% achieved in the last calendar year.  

At the end of the last year, I decided to take some risks to improve my portfolio performance. For most part, it turned out extremely well. There were two parts to this strategy.

• Use of around 10% leverage.
• Invest 20% of the portfolio in not-so-good but cheap companies.

Use of leverage works best in the bull markets. I was lucky to use leverage in a raging bull market. This alone might have added around 10-15% to the overall returns. Of course, towards the end of the year, I removed the leveraged portion and currently invested only at 100% levels. It appears imminent that I may move some part of my portfolio into cash, as valuations are becoming richer.

Investing in not-so-good but cheap companies worked out extremely well and almost all such companies returned more than 100%. RS Software with a return of 255%  in just 10 months was the star performer among them. But others like Canfin homes with 200% returns in a year and  VST Tillers with a 100% return in just 4-5 months did wonders to the portfolio. I have already exited RS Software and VST Tillers, but continue to hold Canfin homes as home finance companies are expected to do well even this year.

My old war horses like Ajanta Pharma, Cera Sanitaryware and Kaveri Seeds continue to perform extremely well. Cera is up roughly 160% for the year, while Ajanta is up around 145% and  Kaveri is up 113% for the year. Kaveri is faltering off-late with promoter related issues, but I continue to hold as the business continues to do well. Interestingly enough, Ajanta shares bought in Feb 2012 are up by almost 20 times in last three years. Also, its returns this year are exactly mirroring my portfolio returns. This may be because it is the largest holding in my portfolio.

Several switches were made during the year. To start with, Astral was replaced with MindTree and Alembic Pharma. Both stocks are up by roughly 65%, thus surpassing the returns provided by Astral,which in itself has been a stellar performer. Selling portions of Ajanta to diversify into Shilpa Medicare has also worked well with Shilpa outperforming recently and surpassing Ajanta's returns from the point of purchase. Some recent switches like replacement of RS Software with CCL Products and PIIND with Bajaj Finance has also worked well.

Now its time to enumerate some mistakes and lessons for the year. First mistake came in the form of overstaying with HCL Tech. It cost me in terms of opportunity rather than money. The stock under performed in a raging bull market.  Probably, I need to avoid large cap companies and concentrate on the smaller companies.

Second mistake is more noteworthy as it is directly related to psychology and human behavior under stressed conditions. It came in terms of two consecutive errors of judgement.As the markets continued to outperform, most of the quality names became costly. Selecting good bargains represented a problem of searching a needle in the haystack. Stocks with sub standard quality but with hard to spot deficiencies appeared cheap and anyone looking for a bargain could get trapped in them. My searches along with the pressure to find something quickly before it jumped heavily in prices led me to companies like Astra Microwave and Superhouse limited. Both companies appear cheap on all parameters, thus looking like a bargain, but Astra is completely dependent on govt defense orders, which are not flowing through currently and Superhouse was bought just before results which turned out to be poor. I sold Astra immediately after realizing the mistake but I am still holding Superhouse with a hope of recovery post this quarter's results.

After strong performance this year, a great performance in the next year looks very difficult. Quality names are becoming very very costly. Value is hardly available in any of the quality names. Unless poor quality companies start performing significantly better, market re-rating appears almost impossible. We need to be cautious as markets have a bad habit of making our senses numb towards high valuations before they take a deep dive. Every body starts thinking that this time it is different just before the inevitable crash. We need to make sure that we don't get trapped in this numbness. Books like "Fooled by Randomness" are a must read in these times as they try to restore some level of sanity by showing us the dangers of foolhardiness.

Still, we should get our glasses out and say three cheers to a great year with the hope of decent returns for the current year.

Disclaimer- The opinion presented above is not a recommendation to invest in the companies mentioned. These are just my observations and any decision to buy and sell should be taken only after sufficient due diligence. I am not a SEBI certified research analyst and expect readers to take that into account while making decisions.

Relativity

Einstien's famous theory of relativity states that "Measurements of various quantities are relative to the velocity of observers." Even though the theory is related to the field of physics, it is extremely relevant to the stock markets. The satisfaction and sense of achievement that a market participant derives from performance of his portfolio is relative to the performance of portfolios of other market participants. To a general investor, it does not matter whether he has done well in absolute terms, what matters more is how others have performed.

Sample this- last year my portfolio was up 110%  and I was so gung ho about it. I wrote this rather boastful article here. This year my portfolio returns have surpassed last years' returns in 8 months. But, I am not that excited this year. The reason being, last year I was not coming across people whose portfolios have done better than mine. This year every serious investor is claiming returns in triple digits. Even some of the mutual funds have given that kind of return.

Is 110% a bad return for 8 months? Of course not. Anyone should be extremely happy with that kind of performance. But then why I still believe that I have not done as well as I wanted to. I understand that there is theory of relativity that applies to stock markets as well. But that is just one part of the puzzle. The other part is even more interesting. Many stocks which were rejected as investment candidates by me are up by 300 to 400% YTD. I keep thinking that it was possible to construct a concentrated portfolio of following stocks to improve my performance by at least another 100%.

Stock	YTD Performance
Avanti Feeds	459.01%
Kitex Garments	309.92%
Granules India	307.51%
Symphony	227.64%
Shakti Pumps	218.62%
RS Software	211.86%
Acrysil India	204.88%

One would think that these stocks are picked on the basis of  "survivorship bias". But the truth is that I have considered all these stocks at some point of time in last one year and rejected all of them except RS Software for investment. These are very popular stocks among small investors and they exist in many portfolios. Actually, one can argue that these stocks were ignored because of "ownership bias" of existing stocks. Performance of "Ajanta Pharma" - up 70% for the year and "PI Industries"- up 80% for the year pales in comparison to these stocks. A "HCL Technologies" which is up by 35% for the year appears like an absolute dud.

Is this situation telling me something about the market conditions and an imminent market crash? I still believe that a significant market crash is far off as current PE of Sensex is only 18. Markets don't crash considerably from 18 PE. The other interesting fact is the growth of EPS of Sensex, which is more than 20% y-o-y for last 2 quarters. This is exactly what happened in 2003. The only difference being the Sensex PE, which was 11 then. Considering both these facts, it appears that a serious crash is far away.

If markets are not poised for a serious crash then the above discussion points me to a lacunae in my stock picking process. There are two clues about what can be improved. If one looks closely at the stocks mentioned above, all the stocks except for Symphony were trading at a single digit PE on trailing basis at the start of the year. Symphony itself was growing its profits by more than 200% per annum. These are probably two lead points that need to be kept in mind while selecting next set of stocks. If a stock matches these criteria, then it can be provided some leeway on management and business quality or on valuation front. That seems to be the only way to perform relatively better. Of course, one should not give so much leeway on quality front that instead of relative out performance one gets relative under performance. After all "Ati Sarvatr Varjayet".

Template for analyzing a stock story

There are many ways to analyze a stock story. But, at the core, one needs to pay attention to the following.

• Business model
• Sources and Quality of growth
• Risk/Bear Case
• Management
• Profitability 
• Financial Health 
• Valuation
• Moat
• Opportunity Size
  

Some of these are subjective, while others are more objective and they can be derived easily from financial statements. In any case, one needs to go through annual reports of many years to get these details right.  One should also be aware of the various happenings in the company and keep a track of all the news available about the company. One important aspect is not to miss any of these details while analyzing the stock story. For that, one needs to keep a template and try to fill it for every business that one is analyzing. The template listed below is the one that I use. It has been created based on Pat Dorsey's "The Five Rules for successful stock investing".

What does the company do aka Business

Sources of Growth

• Selling more goods or services?
• Raising prices?
• Selling new goods or services?
• Buying another company? 

Quality Of Growth 

• Is there a big difference between growth rate of net income, operating income and cash flow from operations? 
• What is the tax Rate? Has it changed recently? Why has it changed? 
• Are there one time gains? 
• What is the equity Dilution over a period of time?   

The Bear Case

• List all the potential negatives
• What could go wrong with my investment thesis?
• Why will someone sell this company?

Management 

• Does the management have a reputation of cheating minority shareholders?
•  Does the management have a political connection or involved in political deal making?
• Is management conservative in its guidance and projection or over aggressive?
• Has management been candid in telling about impending slowdown earlier? 
• How is management compensation relative to company profit? 
• Were executives given loans that were subsequently forgiven?
• Does the company rank and file get the stock options or it is given only to top management?
• What percent of company's equity is given as stock option every year?
• What percentage and kind of transactions are related party transactions?
• What is the attrition rate in the company?

Profitability

• ROE
• Free Cash Flow = Cash From Operations-Capital Expenditure

Financial Health

• D/E Ratio 
• Number of years of Net Profit(FCF) needed to pay off complete debt

Moat

• Does the company have superior technology or provides better features?
• Does the company have a trusted brand?
• Does the company run its operation far better than others(superior process)?  
• Does the company have locked in customers?
• Can the company lock out competitors by creating creating high entry barriers?
• How long will the moat last? Short, Long, Very Long?
• Does the industry generally have companies with high ROE or is the company unique? If industry itself has high ROE, Moat is more sustainable.

Valuation

• P/E
• PEG
• P/B
• P/S
• IV

Opportunity Size

• What is the overall size of opportunity? How long the company can continue growing with high rate?

What To Buy From "Common Stocks And Uncommon Profits"

"Common Stocks And Uncommon Profits" remains one of the best books ever written on stock market investing. It has a very important chapter on what stocks to buy. Ideas mentioned there would add to the arsenal of any serious investor. One can also add these to the investing checklist to make better choices in future. Below is a short summary for future reference:

a. Size of Opportunity - Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years? E.g., Large number of Indian homes do not have toilets. As the economic status of people improve, they will install more and more toilets at home. That represents a huge size of opportunity for a company like Cera Sanitaryware.

b. Innovation/Related Products - Does the management have a determination to continue to develop products or processes that will still further increase total sales potential when the growth potentials of currently attractive product lines have largely been exploited. E.g. Cera Sanitaryware is trying to enter related areas like Faucet ware, Mirrors, Tiles and Air Fresheners. If any of these areas click, they can substantially increase their sale.

c. Effectiveness of R&D - How effective are the company's research and development efforts in relation to its size? Ajanta Pharma is the best example of such effectiveness. Company puts a lot of money on research and the kind of products it is producing is helping them grow their businesses tremendously.

d. Sales Strength - Does the company have an above-average sales organization? This should be directly visible in the kind of sale growth the company is showing.

e. Profit Margin - Does the company have a worthwhile profit margin? this data can directly be tracked from profit and loss account.

f. Profit Margin Improvement - What is the company doing to maintain or improve profit margins? This can be traced by looking at profit and loss account for several years.

g. Labor Relations - Does the company have outstanding labor and personnel relations? New tools like glassdoor may help us in extracting this information.

h. Executive Relations - Does the company have outstanding executive relations? Glassdoor should help us in getting this information.

I. Depth of Management - Does the company have depth to its management?

J. Accounting Standard - How good are the company's cost analysis and accounting controls?

k. Leadership Position - Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

l. Long range outlook on profit - Does the company have a short range or long-range outlook in regards to profits?

m. Equity Dilution - In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders' benefit from this anticipated growth?

n. Candidness of Management - Does the management talk freely to investors about its affairs when things are going well but "calm up" when troubles and disappointments occur?

o. Candidness of Management - Does the company have a management of unquestionable integrity?

Himmat-e-Marda Toh Madad-e-Khuda

"Fortune favors the brave" is a popular saying. This proverb describes my stock market performance for the last year very aptly (though I prefer more rustic and local "Himmat-e-Marda toh Madad-e-Khuda"). After almost 10 years of active stock market investing, this year turned out to be the most fruitful for my investing career not only in terms of the percentage returns but also in terms of the absolute performance. I don't know any investor that have come close to my performance for the year. This year, I achieved returns in triple digits(110%).  It is important to note that these returns have come at a time when 110% of my net worth was invested in the markets. The importance of the last line increases in view of  an interesting tweet by venerable Samir Arora.

Interestingly, this tweet came exactly a day after I disclosed my portfolio performance on one of the equity forums while responding to a query. Is this too much of a co-incidence or the online equity world is really too small :). Anyways, we need to get back to the contributors of such a performance which is more important.

The biggest contributor to this performance has been the lesser number of mistakes made during the year. Actually, only one trade was a loss making trade this calendar year. AmaraRaja was purchased around 296-297 in Jan this year and it was sold around 260-270 in the march, causing a loss of close to 10-12%. The reason for selling at a loss was more pledging by the owners. I still don't consider selling this stock as a bad decision even though the share has bounced back to 325 levels. Staying with the stock would have given me a 20% return from the march time till now, but the opportunity cost would have been higher as my other picks have done much better.

Now with the bad news out of the window, let us discuss some brilliant decisions, which in hindsight appear almost divine.(P.S.- I was told by a friend that 2013 was my year because my birthday is on 13th).

a. Ajanta Pharma was suffering from taxation related issues at the start of the year. Most of the investors shunned the counter after receiving this news. My decision to stick with this scrip proved almost divine as the share went up by 250%  this year.

b. I was bullish on Bajaj Corp and have been buying this share from August 2012. I started buying this share from 165 levels and kept on buying till Feb 2013 when the price was almost 247. Towards the end of May 2013, the stock touched 275 levels for the first time and I sold all of the Bajaj Corp at that level. The decision hit the bulls eye as the stock never crossed that level and is trading currently at 214.

c. Last quarter Cera Sanitryware did not post good quarterly results. Its bottom line was almost flat. Many investors sold their shares seeing the results. I stuck with my position and Cera jumped from 550 to 700 in a quarter. Not a bad outcome for sticking with a company with bad results. Now, everybody and their cook are recommending this share.

d. My call on the Rupee that it will not fall below 65 turned out to be extremely correct (Please read the old blog for the thought process and analysis of the same here). From the stock market perspective, I switched from HCL Tech(exporter) to Astral(Importer) based on that call. Astral is up by 40% since then compared to a 20-25% jump in HCL Tech. Recently, I made a reentry into HCL Tech based on the better fortunes of USA and European economies and hoping to make money in that counter as well.

e. My firm belief on improvement in rural economy despite huge media outcry of sinking Indian economy fetched huge dividends with Kaveri Seeds up almost 40% and PI Industries up almost 90% for the year.

f. Some brilliant decisions were taken at the start of the calendar year 2013 to sell RS Software, Zensar Tech and PC Jwellers at a huge profit. These companies have struggled through out the year at best. RS Software has recovered itself to come closer to my sell price of 175 after an years' hiatus. PC Jwellers is in dumps and is trading at less than half of the price at which I sold it around a year back. The only decent performer is Zensar Tech which is trading 40% higher than my sell price. But most of the gains in this counter has been achieved in the last quarter only. This company has almost doubled in the last quarter and looks like a lot of froth is built into the price.

Now that this stupendous year is over, hoping to do good in current year as well. The ground is still fertile, but the terrain is becoming difficult with most of the under priced opportunities getting recognized by the market. These are the times when people tend to make stupid decisions and all the good performance of last year gets lost. Let us see how much I have learnt from my previous mistakes and can I avoid becoming dud this year after such a good run.

Happy New Year !!!

Disclaimer:
a. Above discussion is not an invitation to invest in the stocks mentioned.
b. One needs to put a lot of effort and energy to get buy/sell decisions right. Please do your own due diligence before making any investment decisions.
c. I sleep, eat, drink and watch only stock markets and hence I can exit or enter any stock in a jiffy and I may not inform anyone about my decisions before or after the trade.
d. The stocks mentioned above are small caps and they represent a minefield to navigate for any passive investor.