rakesh jhunjhunwala on value investing
Mr. Rakesh Jhunjhunwala, combines diverse skills as a equity trader, visionary investor and incubator of new businesses through private equity.He is the first dollar billionaire from India to have made all his money by investing–primarily in stocks.Converting Rs 5000 to a billion dollars is no mean feat.Moreover since he deals exclusively in Indian stocks and often in publicly traded companies, whose shares we all have access to,it’s well worth spending time learning how to invest one’s way to wealth from him.
Firstly,Rakesh believes that the choice of asset class is important . As he says”If you bought gold in 1970 and sold it in 1980, you bought the Nikkei Index in 1980 and sold it in 1989 and then bought the NASDAQ [till before the dot-com bust], you would have made 33% compounded returns in three decades.”Personally, under the guidance of Mr Radhakrishna Damani, he made a lot of money shorting stocks at the time of the Harshad Mehta scam post 1992.As he says,”My decision to aggressively invest in the asset class of Indian equities at the right time was a very important determinant of my success.”As Rakesh believes that the mother of all bull runs is still to happen in India ,for people like us,sticking to Indian securities as an asset class might not be such a bad idea!
Secondly, he advises people to have realistic expectations of returns from their investments.As he is fond of narrating, while relaxing in the evenings in clubs or restaurants, he is often approached for stock tips. Once, unable to refuse a lady who asked him for investment advice, he suggested a stock that he expected to double in three years’ time. The lady, disappointment writ large on her face asked, “Just double?” Even the Rare(ing)Bull considers a 24% compounded annual interest pretty darned good!Remember this!Returns that seem unbelievable should often be disbelieved.
Thirdly,Rakesh Jhunjhunwala believes in value investing.For him the price at which you buy is as important what you buy.So, while Infosys as a fledgling company was a great buy for him,no one buying Infosys shares at dot-com bubble prices has become rich from it. However, while being attracted to the value paradigm, Rakesh who is self-taught in investing,and has done his share of reading of the Gurus, has developed his own version of value-investing.He was never one for slavishly following anyone’s ways.As he puts it no one became rich with borrowed ideas.To quote him: “Value investing is relevant in all circumstances. But thought processes and principles are dynamic and not static. Be open to change.”.So learn from the best but ultimately ‘T0 thine own self be true’ if you wish to be truly extraordinary.To find value Rakesh Jhunjhunwala suggests looking for companies which have low institutional holding or are under- researched as the valuations will be low due to obscurity and they might scale up quite quickly and where there is there general pessimism about the stock.
Fourthly,he believes that unwavering courage is the hallmark of serious wealth and lack of conviction and courage is the root cause for mediocrity.As he says,”If you see an opportunity, grab it today!” A lot of people say: “Wow, I could have become really rich if I had loaded up on that stock 10 years ago…” And that’s a big ‘if.It is important to identify the opportunity. But that’s not enough. you have to be decisive. This is especially true of value investors who often get stuck in a trap where they are perpetually seeking extra information to validate their idea.The biggest challenges for value investors are hesitation, procrastination and questioning their own judgments.This is especially so during market crashes. This is because things always look bloody terrible at the bottom. People’s hands usually shake uncontrollably when the prices are hit new lows every day.Value Investors say to themselves things like: “Well did I make a mistake? Should I wait a little and maybe the price will drop a little more?” If it’s cheap, it’s best to buy it. There is no point in passing up something cheap today in the hope that it will get cheaper tomorrow.In this matter traders find things easier than value investors .They ride the downward wave and seize the opportunity to make money.Personally Rakesh Jhunjhunwala buys with a great deal of conviction.So he has a large amount of money invested in a few companies and his portfolio shows a great deal of concentration.
Next Rakesh Jhunjhunwala counsels patience.“Patience and conviction are both important for investors. If you have both, while your patience may be tested, your conviction will be rewarded.” Having done your hard work, you must wait for the market to do its work and reward you. Also a person needs to have the patience to give things a chance to work.“Give your investments time to mature. Be patient for the world to discover your gems,” says Rakesh Jhunjhunwala.So Rakesh Jhunjhunwala holds on to his winners for a long time while they achieve their full potential.
Rakesh Jhunjhunwala is known for the multi-baggers he picked up early on.To buy and hold multi-baggers for years ,like Rakesh does,while they create wealth year after year ,we need to buy as he does.Rakesh Jhunjhunwala believes in buying a company’s stock after judging the company’s growth potential and longevity . To do so he gives top priority to the ‘competitive ability’, ‘scalability’ and ‘management quality’ of the enterprise.As he says “Don’t emphasize too much on analysis of profits.” “Profits are created due to various stages of circumstances. “As he puts it”I always look at how large is the opportunity for that business in the sector.” By way of an example he cites how he bought Praj Industries, a bio-ethanol company that gave him large returns. “When I bought Praj, we thought there would be a humongous demand for ethanol. The opportunity was huge but it was not recognized.”Similarly with IT bellwether Infosys, “Nobody knew about Infosys in 1993 but Infosys could become Infosys because the opportunity for the internet went through the roof.” So a person needs to use observation to locate growth potential,eg. the increasing use of toothpaste should push one’s attention towards an FMCG company.Also his focus on growth leads him to focus on the small caps that will be the large caps of the future.
Rakesh is often seen as a Bull who chases growth.This is so because in addition to picking obscure small caps he is not beyond ‘momentum trading’ .He endorses the homily ’trend is your friend’.He grew his wealth by using leverage to generate trading income which he added to his capital base.’However he is alive to the dangers of chasing growth.He cautions people from getting carried away by short term market trends. Personally he looks forlongivity“In 1999, people used to buy Himachal Futuristic, Global Tele, Pentasoft, I used to buy Shipping Corporation and Bharat Electronics because I saw long-term value,” he adds. During the tech boom, Jhunjhunwala his friends would laugh at his elation when his staid company stocks moved up by Rs.2, compared to their holdings, which often moved 20% a day.He has only this to say.“Never get carried away by aberrations, recognize and respect them but do remember that the market corrects its aberration though it takes time.”
A company is able to grow taking advantage of favourable circumstances and grow due to its competitive ability. Similarly a company is able to maintain its position ie show longevity due to its competitive ability. Competitive ability comes from brand strength, marketing,capital invested etc.Rakesh believes that its important to learn to recognize competitive strengths.As he puts it:“When opportunities come, they can come through technology, marketing, brands, value protections, capital, etc. You need to be able to spot those.”
After competitive ability Rakesh Jhunjhunwala looks for scalability.In his words:“Then I look at scalability of a particular company that I choose in a sector’” “A friend of mine asked me: should I invest in a small cap or large cap? I said we must invest in the small caps, which will be the large caps”.After one has identified a potential investment, it is important to keep an eye on scalability. If a company is able to duplicate its successes elsewhere, then it is worth buying. It should show a business model which it is able to grow beyond its current size.
Next Rakesh looks at management quality;According to him the ‘entrepreneur’ makes an invaluable difference to his expected investment returns. Believing in the vision and the beliefs of the entrepreneur and validating the risks that may not be perceived by the entrepreneur are the key success factors for an investor. He also believes in observing how managements handle money to understand their quality.“You can have an idea by looking at companies’ capital raising. Are they distributing profits, are they using the surpluses in the right manner,” he says. .“For me, quarters don’t matter. There can be always be an aberration in one quarter when the company has less profits. You should examine the reason for it and whether it can revert back on its growth.”
After judging the growth potential and longevity of the company by analyzing the competitive ability, scalability and management quality Rakesh is in a position to decide how a company’s profits may grow in the next four-five years, and by that account, its price-to-earnings and valuation.He is then is a position whether to invest or not.Moreover after investing in a company,he revisits his decision after 4-5 years.As he says: “If I succeed in making the right call, then after four-five years, I do a proper re-examination of the business model and accordingly reallocate capital because the business model can undergo change. Intense competition could emerge in that sector,” he says. “This is when I examine the earlier opinion I had made when I first bought, whether those assumptions still were valid.”
Exits from one’s investments also determines ones gains.In the course of his periodic re-examinations of his investments ,if Rakesh finds that the fundamentals of a sector have changed for the worse or if an investment has not lived up to his expectation he exits them.Also at some stages he has felt compelled to sell some good stocks in favour of better competitive opportunities when he has fallen short of capital.Besides these situations when he sells stocks out of compulsion Rakesh believes in picking the right opportunity to sell his stocks.He holds that a good time to sell a stock is when the ‘earnings’ expectations have peaked or the business model has peaked or the valuations appear ridiculously unreasonable.
For those of us who find the patience required for value investing tough and would love to try a hand at trading,here is Rakesh Jhunjhunwala’s take on why trading is not so easy.”Trading is against human nature.All risk taking is associated with two human conditions, viz the greed for profits and the fear of losses. The ability to strike the right balance between fear and greed is the most vital determinant of profitable risk taking. Human nature operates on the chance of a gain rather than maximizing gains.There is lack of focus on the magnitude of gains and losses, which is why I maintain that successful trading and investing requires you to go against the basic tenets of human nature. We are programmed to learn, and we learn to a pain. But in trading and investing, you have to learn to take a loss.In trading, the first and the last principle is that trading is trend and price based, and not opinion based. This requires you to square an unfavorable trade regardless of your opinion. This means that if I buy a stock at Rs 100, and then the price falls to Rs 95, I take my loss and square off my trade. This is counter-intuitive to most people. This is the one common quality of all successful traders.I have tried to rationalize this many times, and am always reminded of Winston Churchill, the British prime minister who led the country into WWII, who said, “You have to lose many a battle to win the war”. I think anybody who wants to trade should not only remember what Churchill said, but also what George Soros says, “It’s not important whether you are right or wrong, it more important how much you lose when you are wrong and how much money you make when you are right”.”
Here is Rakesh Jhunjhunwala on how to be a successful share trader -“Great fortunes are made by the occurrence of the unknown, and the first portend of the unknown is price, price and only price. Good trading requires three qualities: broad idea of direction what and how much to risk, and knowing when and how to take a loss. To be successful in investing, many elements have to fall into place. But four things are critical. There has to be an attractive, addressable, external opportunity; a sustainable competitive advantage; scalability and operating leverage; and the management should be of high quality and integrity. All have to be present but they still constitute only 50% of our necessary requirement. It is important what one buys, but it is more important at what price one buys.In The Smart Manager, I have talked about my ten commandments of investing. The top three are:
- Be an optimist. It’s a necessary quality for investing success
- Expect a realistic return. Balance fear and greed.
- Invest on broad parameters and the larger picture. Make it an act of wisdom, not intelligence.
I am happy to say that a loss in investing has been a rare occurrence in my career, and the key to it is that I am an investor who focuses obsessively on value. Therefore, I may have made a mistake in buying NIIT in 2001, but I still made a profit.”
Many value investors including Buffett have a poor opinion of leverage.They highlight the dangers of leverage especially in inexpert hands.So if you must leverage here is some gyan from Rakesh Jhunjhunwala who is not averse to leveraging.He advocates emotionless and disciplined leveraging.He emphasizes leveraging only to extent of one’s ability to service interest cost and principal repayment.He advocates structuring one’s leveraging in such a way that dividend from one’s investment is enough to repay interest and establishment costs.Personally leverage doesn’t exceed more than 10% of his portfolio value.He emphasizes that liquidity is the key to leveraging. He believes that a person should hold liquid shares at least five times greater than the amount of leverage so that he can de-leverage himself at great ease whenever so desired.
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