Investing in PSU Stocks

One of the major events of the last quarter was the announcement of a massive bank recapitalization plan by the central government. Over the last few years, PSU banks have been saddled with extremely high levels of bad debts which has eroded their capital position, limited their ability to compete with private banks and impacted overall credit growth in India.To ensure that the asset quality problems at PSU banks do not impact the economic growth, the government has proposed a 2-lakh crore PSU bank recapitalization plan.

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Tweetstorm: Anatomy of a Bull Market Fraud

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How we generated “Alpha”

This section will address queries that our readers had on how we could outperform in a rising market despite 1) being conservative/risk-averse in our investment strategy and; 2) holding an average of 25%+ cash in the portfolio.

  1. Being greedy when everyone was fearful

During large parts of last year, we preferred to remain in cash rather than buy stocks at exorbitant valuations. There were long periods when we did not buy or sell a single stock. We used this time to research and build a pipeline of stocks we would buy if prices fell to attractive levels. This discipline of being patient and staying true to our value investing philosophy helped us create a large alpha. 

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Luck vs Skill

We are close to completing our first year of investing at 2Point2 and this is a good time to take stock of our performance so far. Since inception, we have generated 34.74% in returns compared to 11.64% of the Nifty 50 and 24.74% of Nifty Midcap 100 index. The overall performance has been quite good on both absolute and relative basis. This calls for a celebration. But, maybe not.

Consider the game of cricket. If you aren’t a good player, it is certain that you would struggle to even make it to the gully cricket team let alone dream of being part of the Ranji or national team. Thus, cricket is largely a game of skill. On the other hand, investing (over the short term) is an activity which has a high component of luck. Over the long term, the role of luck diminishes substantially in investing.  However, sometimes luck can play a role even in a reasonably long investing period.

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Stock drives business Or Business drives stock?

As stock markets reach dizzying heights in the absence of any fundamental change in business outlook, we increasingly see promoters employ various creative means to support or help prop up their company’s share price. While there is no harm in wanting to see the company stock reach new highs and create shareholder wealth, what is worrying is that promoters seem to be more focused on the stock’s performance rather than the business performance. Probably they miss the fundamental point that stock performance is an outcome of business performance and not vice versa. As long-term investors, we look at promoters’ undue focus on stock price as a warning signal that something is amiss. We discuss some such signals below.

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The Value of Cash

One of the most frequent questions that potential and existing investors ask us is about our high cash position in the portfolio. Currently, the cash allocation is ~19% of the portfolio value. This is clearly a high level. Most other funds do not have even 5% of their assets in cash.

Our high cash holding is not intentional due to our desire or belief in ability to time the markets. The cash holding is entirely an outcome of our investment process and capital allocation process – (1) finding an investment idea that meets our return objectives and (2) deciding the stock idea’s allocation in the portfolio. (1) and (2) are not disconnected. Very attractive ideas will invariably have a higher portfolio allocation.

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The Curious Case of Manpasand Beverages

Building strong consumer brands is hard. Building them at scale is even harder. Especially in the food and beverages market, building a new brand can be exceptionally difficult. A new player must garner market share from incumbents that have (1) a high brand loyalty amongst consumers, (2) a large distribution footprint built over decades, and (3) benefits of scale due to a portfolio of brands (distribution, advertising, overheads etc.). This explains the resilience of brands like Maggi and Coca Cola which survived the lead and pesticide controversy respectively. Over the last 10 years, the number of new brands built in the food and beverages segment are quite low.

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The Curious Case of Kitex Garments

The last 3 years have been exceptionally good for small cap investors in India. The BSE Small Cap index has more than doubled, driven by an increase in P/E multiples and also fairly good earnings growth. There are several companies in the small cap universe which have delivered astronomical returns of over 10-50x in a short period of time. Small cap investing is the latest get-rich-quick scheme. As history has shown, this kind of euphoria rarely ends well.

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India’s First Unicorpse?

“The reason why it is so difficult for existing firms to capitalize on disruptive innovations is that their processes and their business model that make them good at the existing business actually make them bad at competing for the disruption.”  

Clayton Christensen, The Innovator’s Dilemma

Over the last few months, it has become clear that the funding frenzy that led to the rapid growth and emergence of hundreds of tech start-ups is beginning to lose steam. The talking points have changed from “large market size” and “growth at any cost” to “profitable unit economics”. Drying up of easy capital has led to several companies scaling back their expansion plans and focusing on profitability. Despite the funding slowdown, India is now home to several tech unicorns (fancy word for a company valued a billion $s or more) which have raised humongous amounts of venture capital funding. However, as the underlying businesses of these unicorns are far from profitable, a weaker funding environment will probably lead to several unicorns being forced into consolidation or risk becoming unicorpses (fancy word for dead/bankrupt unicorns). Continue reading India’s First Unicorpse?

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