INVESTMENT PHILOSOPHY AND STYLES


Our Philosophy

We believe that the best way to generate superior returns is to identify good companies with sustainable competitive advantages, to buy them at fair prices.

The core tenets of our philosophy are:

On Investments
  • For good long term investment outcomes, it is extremely important to protect the capital
  • Deep, fundamental research is a good way to reduce the element of luck in investments
  • Probabilistic approach helps in limiting the impact of mistakes
  • A combination of skepticism towards stock ideas, and optimism on equity markets is required for investment success
On Entry Price and Margin of Safety
  • Every asset has a fair value range
  • Purchase price plays a big role in alpha generation
  • Even good stocks with poor entry point damage wealth creation process
  • Meaningful gap between fair value and stock price helps during prolonged irrational market moves
On Risk
  • Markets are inherently risky, and only partially efficient. However, markets’ inefficiency also provides instances of mispricing in stocks
  • Relentless focus on capital protection
  • Reasonable level of diversification – in terms of both, quantity as well as quality- to curb portfolio correlation - to optimize risk-reward
  • Top down- Strive to avoid getting caught in bear market traps. Bottom up - Strict corporate governance filter
On Stock Selection
  • Focus should be on fast growing and/or mispriced companies led by good management
  • Leadership – existing or potential- in a sector or sub-sector, backed by sustainable competitive advantages are some key indicators for good companies
  • Corporate governance is an important filter to use

Investment Style

We focus on identifying mispriced stocks and try to assess the margin of safety. For the purpose, we perform fundamental research to estimate fair value of a stock and possible catalysts.

  • Not shy of taking cash calls even if rarely, on macro views to avoid nasty bear markets
  • Act aggressively if a mistake is spotted in the portfolio
  • For our tactical calls –identified based on fundamental research but that have potent near term triggers too- we follow an active management approach depending on stock catalysts and change in stocks’ fair values

Magadh Capital is extremely conscious of managing risks. For us selecting good companies stocks with healthy growth ahead of them – that is currently not fully recognized by the market - is crucial for wealth creation. At the same time entry price too plays an important role in stock returns. We work with the belief that stocks move as per their future potential – not on their past developments, having a long-term horizon is a must to reduce the element of luck in investments, and a probabilistic approach is a good way to limit the impact of mistakes in investing.




We follow a mix of value and growth style - growth at reasonable price, and value with clear catalysts.

Clear focus on value as opposed to price – Magadh Capital believes that price is the least important factor to track in analyzing a stock and instead emphasizes on drawing scenarios and ranges for the intrinsic value of the stock.

Keen for contrarian opportunities, Look for simple businesses, Timely identification of and corrective action on mistakes

Keen for contrarian opportunities if convinced – We work with the premise that the strongest returns are made when a stock purchase is made amid extreme general pessimism. Obviously, the expectations on future prospects of the stock need to be met – against general pessimism – in order to deliver good returns.

Timely identification of and corrective action on mistakes – Another aphorism that we take seriously is “If facts change we change our views”. While deep and wide fundamental research provides Magadh Capital an edge in its stock picks, there are still possibilities of some mistakes and in some instances, rapid erosion in business prospects. In such eventuality the portfolio strives to act quickly and to realign the portfolio to mitigate the impact of any mistake, or to reflect the change in business environment.

INVESTMENT PROCESS


Investment Process

Bottom up is the way, though top-down guidance can be helpful too – We often begin investigating a stock on the basis of our screens, or sell side recommendations or media reports. Industry themes too can serve as good starting points even though final investment decision are largely driven by bottom-up/top down stock analysis.

Use all the relevant valuation methodologies but keep discounted cash flow as the bed rock - For valuation exercise Magadh Capital employs various methodologies like earnings multiples based, asset multiples based or cash flow analysis based depending on the situation. However, in the stock selection process one common thread across various situations is the application of discounted cash flow analysis which is used as a starting point in evaluation of almost every stock. Here particular emphasis is given on analyzing a range of scenarios rather than a point forecast.

Stock selection process

Magadh Capital has a rigorous, fundamental research-based approach to stock selection. Below is the list of the main steps in our stock selection process -

Initial filters: Corporate governance, and management vision and ability

Magadh Capital takes corporate governance standards as a very important yardstick in its process. This is the first elimination parameter in its investment process. Magadh Capital looks at track record and at the company’s perception amongst its various stakeholders. Similarly, management vision and execution capabilities are important criteria. Special focus is attached to management’s track record on capital allocation, cost optimization and focus on shareholders’ return.

Every stock that we invest in has some common traits - robust corporate governance, good management, existing or potential competitive advantages. Apart from this the portfolio consists of a wide mix - some portion of our portfolio is allocated to stocks that are out of favour in the markets for some reason, some stocks are delivering solid earnings growth and return ratios.

An industry or macroeconomic theme, or a qualitative screen
  • Screeners that we typically use in the 2nd step of our stock selection process
  • Growth: Revenue, EBITDA, net profit, EPS, net worth, net block etc
  • Returns: RoE, RoCE
  • Margins: EBITDA, PAT
  • Valuations: P/E, P/BV; current, and 5 years and 10 years averages


As mentioned earlier, an industry or macroeconomic theme often acts as a good starting point in this process. Some quick analysis of the long-term impact of an ongoing or potential development in an industry or on the broader macroeconomic landscape, and identification of stocks that may get affected by that development can present a small bunch of stocks that can be taken up for further analysis. Similarly, at times the portfolio runs qualitative screens based on some selected fundamental parameters to get a small set of stocks that prima facie Looks good. These stocks are then tested for investment attractiveness at the following steps.

Apart from the above, Magadh Capital also keeps doing preliminary work on potentially interesting stocks that are referred to in media, or which are alluded to by its industry contacts or during its routine channel checks – to see if they can fit into its framework for further investigation.

Identification of competitive advantages, their analysis and assessment of their sustainability
What do we aim to decipher from fundamental analysis in the 3rd and 4th steps of our stock selection process?
  • Return ratios and growth – existing, or potential- and their sustainability are the critical quantifiable markers for competitive advantages of a company
  • Look for impending structural improvement in metrics like earnings trajectory, operating costs, return ratios, financial leverage etc – analyze their impact on fair value
  • Keep an eye on industry tailwind-they often aid sharp earnings growth and potential rerating
  • Fair value ranges for the stock in more than one scenarios and probability of those scenarios playing out


This is the first level of detailed analysis of the company with higher emphasis on strategy and vision. Here attempt is made to analyze last 10-15 years’ earnings, competition, entry barriers, suppliers, products, customers, capital allocation, and project execution in the context of industry. Companies’ annual reports, result presentations, interview with the company, and sell side analyst reports are some of the key source of information for this exercise. Conversation with senior managers as well as mid and low-level employees in the company is an integral part of this process. Equally important is the fact that the Investment Managers talks to people (like customers, suppliers, competitors etc) in the company’s business ecosystem to get new and more perspectives.

This step of the process is conducted in conjunction with the next step.

Forecast of P&L and Balance Sheet for next 5-7 years

In this step we continue with the process to understand the finer points of the business drivers and the company’s ecosystem. Along with this, earnings models are created to forecast cash flows, income statements and balance sheets for 5-7 years.

Initially this step and the previous ones are taken at a relatively cursory level. If good upside potential is spotted in the first cut, then a detailed run of these two steps is taken.

Valuation in context of business economics

Multiples based (industry as well as historical on earnings basis and/or asset basis) methodology and the DCF method are the two important methods that the Magadh Capital applies in valuation exercise. Based on outcomes of the two earlier steps we attempt to generate valuation scenarios under various assumptions and then try to estimate potential entry price, margin of safety, and upside potential in the stock under various scenarios. Here we also try to quantify the risks associated in the stock.

Our portfolio construction process is based on our proprietary FACTS Box- validation process which optimizes the risk-reward profile of the portfolio. All stocks in our portfolio must be amongst the potential winners in at least one of the FACTS Box categories.

FACTS stand’s for Fast growers, Asset plays, Cyclical, Turn around, Stalwarts

We sell if our price objective has been achieved, if the business environment has changed for the stock, or if the drivers of our call are turning out to be wrong.

OUR INSPIRATION


We list below some of the aphorisms/thoughts/views - from the below named and some other leading thinkers, that we like and try to incorporate in our thinking and action. At the same time, as one of the quotes below suggests we do not take any rule – with the exception of some like those relating to integrity and values- as sacrosanct in every circumstance.

On long term perspective in investing

Investing should be more like watching paint dry or watching grass grow. If you want excitement go to Las Vegas – Samuelson

Our View: Patience and discipline are fundamental requisites of Magadh Capital’s investment process.

In the short run market is a voting machine but in the long run it is a weighing machine – Benjamin Graham

Be patient. Watched stock never boils - Peter Lynch

In and out may be out of money - Philip Fisher

If you aren't prepared to own a stock for ten years don't even think of owning it for ten minutes –Warren Buffet

In short term you may experience good or bad luck and that may overwhelm skill but in the long term luck tends to even out and skill determines the result – Michael Mauboussin

Our View: All of the above reinforce our belief that long term investing has higher probability of delivering attractive returns in equity markets.

On fundamental research

Real knowledge is knowing the extent of one’s ignorance – Confucius

Our View: Accordingly we do not invest in stocks whose business we do not understand. This also helps us in our pursuit of keeping things simple.

Investment in knowledge pays the best interest – Benjamin Graham

Know what you own and know why you own it – Peter Lynch

It amazes me how often people are more willing to act based on little or no data rather than to use data that is a challenge to assemble - Robert Schiller

Our View: These reinforce Magadh Capital’s belief in fundamental research based approach. At the same time this necessitates a relatively concentrated portfolio.

I'd be a bum on the street with a tin cup if the markets were always efficient –Warren Buffet

Our View: Our belief in inefficiency of the markets is the reason for its confidence in its long term, bottom up fundamental research process.

Investors should be wary of history based models. Constructed by a nerdy sounding priesthood using esoteric sounding terms these models tend to look impressive. Too often though the investors forget to examine the assumptions behind the models - Warren Buffet

Our View: In the Investment managers’ experience in the investment industry they have seen on many occasions that a strictly model based approach often delivers poor forecasts. Too much complication in the models, insufficient emphasis on qualitative aspects required to nail down the assumptions, and a lack of a bridge between past and future in the model at times are the culprits.

An investor should have an adequate idea of stock market history particularly of the major fluctuations –Benjamin Graham
The four most expensive words in English language are ' this time it's different ' - John Templeton

Our View: Magadh Capital aims to be aware of possibilities in various outcomes and continuously tries to seek parallels and ideas from the past. We like reading about history, economics, politics, sociology, psychology etc to draw mental patterns applicable in current context.

On behavior and biases

To every rule there are exceptions ...but not many – Philip Fisher

Our View: We do work with values and boundary conditions but also values the importance of flexibility.

All men's miseries derive from not being able to sit in a quiet room alone - Blaise pascal

Our View: This is the inspiration for the portfolio’s ability to remain inactive during periods of extreme volatility. Its principle of not being tempted to buy some stock just because it has fallen a lot is rooted in this sentence largely. In addition, this is the inspiration to delve deeper as a part of Magadh Capital’s process of fundamental research.

Art of being wise is the art of knowing what to overlook – William James

Our View: Magadh Capital looks at investment more as a process of rejection. Accordingly our stock selection process is driven by sceptical optimism.

We don’t see things as they are but as we are – Anais Nin

Our View: The portfolio consciously strives, at every stage, to avoid this behavioural pitfall so that facts are not distorted

We have a passion for keeping things simple – Charlie Munger

Our View: This is how Magadh Capital Investment managers try to run the portfolio and this is what they look for in a stock. Indeed, simplicity is one of the basic principles in everything we do.

Stock price is the least useful information you can track and it's the most widely tracked - Peter Lynch

Games are won by players who focus on the playing field and not by those whose eyes are glued to the scoreboard – Warren Buffet

Our View: We believe that fixation with the price of a stock is one of the key reasons for irrational behaviour by stock investors. The key is the inherent value of the stock rather than the stock price movement.

The malady of commercial crisis is not a matter of the purse but of the mind - John Stuart Mill

Our View: All bubbles and manias in the past have been fuelled by human behaviour and passion. In our investment process study and practice of behavioural science plays a crucial role.

October – this is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February - Mark Twain

Avoid hot stocks in hot industries - Peter Lynch

Our View: We aim to create wealth on the basis of fundamental research and are fairly disciplined in our approach. Capital preservation is central to our investment strategy. Accordingly, we stay away from sophisticated financial instruments or short term approach.

Don't quibble over eighths and quarters - Philip fisher

You don't need to know a person’s exact weight to know whether they are overweight or underweight - Benjamin Graham

I'd prefer to be approximately right than to be precisely wrong –John Maynard Keynes

Our View: Magadh Capital believes in range based forecasting and attempts to analyze the drivers for various scenarios in as much detail as possible. As a corollary we do not try to time the market and its cycles.

There is always something to worry about. Keep an open mind to new ideas- Peter Lynch

Our View: Even as we are quite sceptical in our approach we also recognize that for creating wealth one needs to have some amount of optimism regarding the long term future.

Opportunities come infrequently. When it rains put out the bucket, not the thimble - Warren Buffet

Our View: This is in line with our perspective of running a concentrated portfolio.

You can't predict, you can prepare - Howard marks

Don't become so attached to a winner that complacency sets in and you stop monitoring the story - Peter Lynch

Our View: It is easier to come up with new ideas than it is to let go of old ones

The narrative fallacy is associated with our vulnerability to over interpretation and our predilection for compact stories over raw truths. - NassimTaleb

Chief losses to investors come from the purchase of low quality securities at times of favourable business conditions - Benjamin Graham

On contrarian investing

It is largely the fluctuations which throw up bargains and the uncertainty due to the fluctuations which prevent other people from taking advantage from them- John Maynard Keynes

The horse to bet on is the one more likely to win than most people expect - Will Bonner

Don't follow the crowd - Philip Fisher

Investors should put money to work amidst the throes of a bear market appreciating that things will likely get worse before they get better - Seth Klarman

The true contrarian is not one who shorts a stock that everyone else is buying but one who waits for things to cool down and buys stocks that nobody cares about, and especially those that Wall Street yawns at - Peter Lynch

Our View: Catching tops and bottoms of a stock price is ideal but extremely difficult to achieve. Hence if proper research is done and if the stock is sought to be bought for long term then it should be purchased in a bear market rather than attempting to time the market.

On portfolio construction

We try to buy businesses with good to superb underlying economics run by honest and able people and buy them at sensible prices -Warren Buffet

Our View: This essentially summarizes Magadh Capital’s philosophy.

Buying a company with mediocre prospects just because the stock is cheap is a losing prospect- Peter Lynch

Our View: Magadh Capital looks for bargain stocks but in this pursuit does not compromise with the stock quality. Our strategy is a mix of value and growth philosophies.

Liking a store, a product, or a restaurant is a good reason to get interested in a company but it is not enough of a reason to own the stock - Peter Lynch

Don’t overstress diversification – Warren Buffet

All you need for successful investing is a few big winners and the pluses from those will overwhelm the minuses from the stocks that don't work out- Peter Lynch

Do you know the only thing that gives me pleasure? It's to see my dividends coming in- John D Rockefeller

You won't improve results by pulling out the flowers and watering the weeds- Peter Lynch

On bottom up investing

It's self-defeating to invest in good markets and get out in bad ones. It is difficult to predict markets. Also investors can become optimistic and pessimistic at precisely the wrong times - Peter Lynch

Our View: Invest in companies not in the stock market. Ignore short term fluctuations.

Predicting the economy is futile. Predicting the short term direction of the stock market is futile – Peter Lynch

Our View: While Magadh Capital is quite interested in trends in economy and markets it does not try to forecast them due to the multitude of driving factors and hence low probability of getting these forecasts right. Accordingly, in Magadh Capital’s investment process bottom up drivers take a much bigger role than the factors like macroeconomics, liquidity etc.

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