Gautam Baid, Founder, Stellar Wealth Partners

21 Jun 2022 , 01:49 PM

What is your investment strategy and how did it evolve over last few years?

My personal investment opportunity set has significantly expanded over the years. Initially, it was restricted only to secular growth stocks at reasonable to expensive valuations. But now it covers multiple areas of the investment universe, including commodities, deep value, demergers, as well as cyclical companies that are turning around, as reflected in slow, gradual changes (low contrast) in their improving balance sheet, working capital, margins, or a significant positive change in their industry dynamics.

I am investing in a variety of industries and situations, wherever I find mispricing of value and a highly favorable risk-and-return trade-off. No single strategy works all of the time and in every kind of market. That’s why it’s essential to build up one’s investing arsenal to be able to hunt for value from within different areas. Over the years, I have come to realize and appreciate just why this is critically important: a bull market is always going on, at all times, in some specific sectors of the stock market.

How do you identify growth stocks for your portfolio?

Between low quality businesses at a cheap valuation and high-quality, secular growth businesses at a fair valuation, my preference is always for the latter since I can have meaningful allocations of my portfolio in them with higher stress-adjusted returns. High-quality growth businesses typically demonstrate sustainable competitive advantages, known in investing parlance as “moats”.

Strong brands with “share of mind” which confer pricing power, network effects, high switching costs, a collection of patents (as opposed to relying on only one or two), favorable access to a strategic raw material resource or proprietary technology, and government regulation which prevents easy entry — these can confer a strong competitive advantage which in turn enables excess returns on invested capital over the cost of capital for long periods of time (also known as the Competitive Advantage Period/CAP).

Growing firms with high Return on Invested Capital (ROIC), opportunities for reinvestment at those high ROICs, and longer CAPs are more valuable in terms of net present value.

What has been the single most important investing lesson you have learnt?

Stocks can stay cheap for longer than we expect and then may be repriced much more quickly than we expect. We should judge our businesses based on their operating results, not on the volatility of their stock prices. The stock market is focused on the latter, but investing success is based on the former. If the management team executes, the stock eventually follows. Equity investing is like growing a Chinese bamboo tree. We should have passion for the journey as well as patience and deep conviction after planting the seeds. The Chinese bamboo tree takes more than five years to start growing, but once it starts, it grows rapidly to eighty feet in less than six weeks.

If possible, please share one case study around your investing process?

Fifty years ago, the best investors were the ones with an informational edge. Today, the best investors are the ones with a behavioral edge. As the speed of information dissemination in the markets and competition for short-term outperformance among money managers increased over the years, time horizons and patience levels significantly decreased. Let me illustrate with a help of an example. During late 2018 to early 2020, post the NBFC crisis, the auto industry in India was undergoing a severe downturn and there was an auto ancillary stock named Rajratan Global which was undertaking a massive capacity expansion. Because the entire auto sector was out of favor, investors' attention on this stock was low. But as soon as the capacity expansion was complete and the earnings visibility for this business among the investor community went up post a recovery in the auto cycle from its depressed lows, the stock of Rajratan Global has given more than 1200% returns since April 2020.

What are your views on portfolio construction? What are your key strategies in terms of position sizing?

Excessive diversification can dilute your overall portfolio returns. Although a diversified portfolio indeed may reduce your overall level of risk, it also may correspondingly reduce your potential level of reward.

Both our smallcase portfolios contain 25 to 30 holdings and the reason for choosing the number of 25 to 30 is because this is the optimal number of holdings to maximize the risk return trade off. As per a study published in the international best-seller, A Random Walk Down Wall Street, as the number of stocks in the portfolio approaches 25 to 30 names, the incremental volatility reducing benefits reach near zero, and this is the sweet spot for an active investor wanting to outperform the market.

I size individual allocations in my portfolio according to my evaluation of potential risk, with the largest holdings having the lowest likelihood of permanent capital loss coupled with above-average return potential. I initiate new positions with a minimum weighting of 5 percent and subsequently average upward if the management executes above my expectations. Always have bigger weights in businesses with high longevity, solid growth prospects, and disciplined capital allocators.

What are the key criteria you use for your sell decisions?

It makes sense to sell when, in your judgment, the business is going downhill with no turnaround in sight, the management shows a lack of integrity, or you simply have found a much more profitable alternative in which to invest.

What are some of the key mistakes in your investing journey? What were your key learnings?

Being impatient on many occasions during the first ten years of my investing journey was a key mistake. I remember buying Page Industries in May 2014 at INR 6,000 and then selling it at the same price after holding it for just a month, only because the stock price was not rising immediately after I bought it during a raging bull market. Today the price is more than INR 45,000. Many investors sell their high-quality stocks after experiencing a lengthy period of price consolidation. Not getting immediate returns on our existing high-quality growth stocks builds antifragility. Patience plays a critical role during such times. For instance, Berkshire Hathaway’s stock has delivered a CAGR of ~21% over the past 44 years (as of March 2022). But if you bought it in 1997, you would have had to wait five years before you saw any positive return on the stock. Patience is a great equalizer of cycles in the financial markets. Time in the markets with good businesses, not timing the markets, drives wealth creation. Low- and negative-return years are a routine part of the investing game. You have to be present in this game for a long time to win.

What are your top book recommendations for investors?

1) Poor Charlie’s Almanack — A life-changing book for investors and non-investors alike
2) Seeking wisdom by Peter Bevelin and More Than You Know by Michael Mauboussin — The finest books I have ever read on multidisciplinary thinking
3) All I Want To Know Is Where I’m Going To Die So I’ll Never Go There by Peter Bevelin — The best book ever written on the theme of inversion

And I would print out the Buffett Partnership letters and the Berkshire Hathaway letters separately.