Of Stories, Trends and Megatrends

I grew up on a diet of reading about Successful Entrepreneurs. I was young and naive at that time (and old and naive these days) and the one common thing I saw among these successful Entrepreneurs was that they all started off from a Garage. I always wanted to be my own boss and would you believe, my Grandmother even had a Garage. All I required was to start a business and voila

30 years later, having floundered in 3 businesses I started or co-started off with and with a bit more understanding than I had in my youth, I now know that the secret ingredient behind those successful fellows was not having a Garage. 

Yet, in the world of investing, we read about the traits of Successful Investors, try to distill it to a few common pieces of wisdom and believe that if we copy that, we shall be Successful too. 

Success has many fathers, Failure is an orphan is a wonderful saying and one that has had profound impact on people and nations. Who doesn’t love a Success story – be it in the Movies or in life. Our optimism is boosted by reading about other’s success and one we hope we can enumerate in our own life as well. But if only life was that simple.

One of the most successful investors of all time is Warren Buffett. While he himself has not authored a single book, on Amazon you can find over a 1000 books where the authors have tried to dig deeper into his philosophy and what it would take for a small investor to be able to be as successful, I doubt how many books talk about the fact that he had advantages a present day investor doesn’t possess.

For a long time, common stocks were perceived to be much riskier than bonds, the investors required that the income from common stocks must be greater than that from bonds. The guy who challenged that thesis was Graham. But old beliefs don’t go away easily and for a long time, investors like Buffett had an advantage that most others lacked. 

Today, there is little of any informational advantage you can have over your peers. Today, everyone wants to buy good quality companies, having strong cash flows, a business that is easy to understand and one that is available with Margin of Safety. Basically, everyone wants to live in Lake Wobegon.

In 2016, Saurabh Mukhejea came out with his book – The Unusual Billionaires which provided a good hypothesis and back-test of the Coffee Can strategy. I was impressed enough to invest a portion of my brother’s funds into one such portfolio. The key here is to wait for 10 years – some have been good winners, some haven’t, but the portfolio as a whole has done better than the benchmark I could have invested.

The table below lists the Stocks I purchased, their Price to Earnings at that time and the same today plus the Change in Stock Value.

What is immediately evident is that most of my wins have been massively helped by positive price to earnings ratio revaluation while the losers were because of contraction of PE. While the portfolio has been better than the benchmark, that was because of differential weighting. An equal weight would have underperformed.

Today, the stocks that qualify for Coffee Can have an even higher Price to Earnings Ratio. What if Price to Earnings decrease even as the companies continue growing. Would the strategy still hold water?

What I am trying to suggest here is that there is a huge tailwind if you are able to pick up stocks or a strategy before they become famous. Once a strategy becomes famous, the money that chases it more or less dampens future returns.

A new theme I keep hearing about how Investors can do better is by catching “Megatrends”. It’s not a new word or theme though – John Naisbitt in 1982 first wrote a book titled Megatrends where he tried to outline how to “identify and ride a large trend”.

How nice it would be to know the sector or industry that shall flourish over the next decade or decades and benefit by betting on the same. But is identifying a Megatrend the same as being able to profit from it?

The Internet has changed the lives of Billions and heralded a new way of life for most of us. But identifying this trend was one thing and being able to bet on it quite another. The other day, Devesh asked me if I could recollect some of the stocks that were listed during the heydays of the Dot com bull market. While Bangalore Stock Exchange alone had 50+ stocks listed, so much time has passed that it is not easy to recall. But those I could find, it’s amazing how few of them have even survived to this day, lets not even talk about returns.

Bangalore Stock Exchange itself had 50+ companies. Unfortunately don't remember all. A list from memory + BSE data (pic) pic.twitter.com/cq3lvZiIlS

— Prashanth (@Prashanth_Krish) October 22, 2020

It’s nice if you can spot a megatrend before others do, but it’s not really necessary to be a better investor. In fact, it may actually be harmful. In 2013 – 14, one theme that made all the news was Logistics. With a new BJP government in play, focus on GST and growing eCommerce was supposed to change the companies. Stocks did play it out for a bit. But even if you had identified them early and held till date, your returns would be inferior to someone who identified no such trend but invested in Nifty 50.

We love stories and while they can make for a good movie, stories have a huge appeal as investors for we are not just investing our money but also investing emotions. This makes it a double edged sword, something Investors need to aware of.