How do spinoffs create value?

Value investing is the process of buying securities that are trading at prices well below their intrinsic value and then waiting for the market to discover the value and raise the price in line with the value. As per the legendary value investor Seth Klarman, securities market can throw up many opportunities for the savvy investor to buy securities at significant discount to the intrinsic value.

Management actions like spinoffs present two benefits. One, they help the market close the gap between the price and the value by giving shares directly to the investors. Two, they send a clear message that management is shareholder friendly. 

Market regularly throws Value Investing opportunities

One such opportunity arises when company decides to spinoff its subsidiary into a new company. In the chapter 10 of the book Margin of Safety Mr.Klarman discusses the value investing opportunities provided by spinoffs.

Spinoff is the distribution of shares of a subsidiary company to the shareholders of the parent company. Spinoffs help parent company to divest businesses that no longer fits strategic objective. The goal of spinoff is to create parts with a combined market value greater than the present whole.

They present attractive opportunity since immediately after Spinoff, the shares of the spun-off companies are bound to trade at low prices as markets discover their value. Many shareholders of the Spinoffs sell their shares quickly since they follow the decisions of the management of the parent company. Sometimes the shareholders sell the spun-off company because they know nothing about the new company. Large institutional investors will sell spinoffs since they may be too small for them. Index funds will sell spinoffs since they are not a part of the index they are tracking.

In case of spinoffs, as the shareholders dump the shares immediately after the spinoff, the share prices get significantly depressed. Unlike other securities, the selling is not because the sellers know something more than the buyers, in many cases, the selling happens because the sellers know nothing. 

Wall street do not follow spinoffs. The analysts following parent company may not follow spinoffs that are in different industry. Sometimes management wants to keep the share prices down. Another reason spinoffs are valuable in the initial stages is because there is an information lag. Sometime opportunities exist in the parent company shares and not in spinoffs.

In summary, Spinoffs present a great value investing opportunity due to the following reasons.

• Spinoffs help increase the market value of the group.
• Shareholders are ignorant and tend to dump shares
• Spunoff companies do not fit the strategic objective of the Institutional Investors and hence they dump the shares
• Management wants to keep the share prices low
• Not many analysts track spiinoffs

Spinoff opportunity is the most valuable in the first few weeks of trading.

Book Review #41: Margin of Safety: Author: Seth A. Klarman

This is the review of the book Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor written by Seth A Klarman

In the introduction to the book, Mr.Klarman sets out two goals for writing this book. One is to highlight the investment pitfalls so that the investors could avoid them. Two is to explain why value investing method works and often works spectacularly.

Value investing is the strategy of investing in security trading at an appreciable discount from underlying value. This approach has a long history of delivering excellent returns with limited downside risk. It requires a great deal of hard work, strict discipline and a long-term investment horizon. Few are willing to put that effort.

How do you value a business?

The practice of Value Investing, any investing for that matter, calls for valuing a business. The concept of Margin of Safety for instance, talks of buying a security when there is a significant gap between the price of a security and its intrinsic value.

The question is how do you define value? What are the different methods available to value a business. What are the pros and cons of each method? Which should be the method of choice? 

Chapter 8 of the book 'Margin of Safety' written by Seth Klarman talks of Business Valuation. The reported valuation numbers like book value, earnings and cashflow are best guesses of accountants. Also value is not static. It changes over time with different macro-economic factors. The business value cannot be precisely estimated, but the apparent precision offered by mathematical formulae like NPV and IRR can lull investors forgetting that these are based on assumptions of cash flow far into the future.The other assumptions in valuation could be regarding future, different intended uses of the asset and different discount rates used.

Three valuation methods that author finds useful are Net Present Value (NPV) - valuing the cashflows of a going concern, and its offshoot Private Market Value, the value paid by a sophisticated buyer of the business, Liquidation value - the expected proceeds if the company were to be sold off, an offshoot of which is Breakup value that values each components of the business separately and Stock Market Value - the estimated price at which a company will sell in stock market.

These valuation methods are illustrated in the diagram below.

Two aspects of valuation are Expected Growth in earnings and Discount Rate. If future cashflow is predictable, NPV can be very accurate. However cashflow depends on many factors like market share, the volume growth, pricing power, brand loyalty etc, each of which can be assumptions. 

Growth investors face many challenges One, they show higher confidence in their ability to predict future value than is warranted. Two, even small differences from one's estimate can have catastrophic consequences. Three, since many investors are focused on such companies, the prices may go up lowering the margin of safety. Four, investors tend to oversimplify growth into a single number, while it is based on many factors. Just as an example, earnings growth can come from more units being sold due to increase in population or it may also be due to increased usage by the existing customers. It could also be due to increased market share or due to price increases. While some of these are predictable, others are less so.

Investors by nature are overly optimistic of the future. Since future is unpredictable, value investors have to be conservative in their assumptions of growth as well as discount rates.

The other factor in valuation is the discount rate. The more conservative you are, the higher rate you will use to discount future cash flows. The discount rate should depend on Investor's preference of present consumption over future returns, his risk profile, the risk of investment under consideration and on the returns available from other comparative investments. However, investors often simplify and use 10% as discount rate.

When interest rates are low, investors pay high multiples assuming rates to remain low.

Once future cash flows are forecast conservatively and an appropriate discount rate is chosen, present value can be calculated. In theory, investors might assign different probabilities to numerous cash flow scenarios, then calculate the expected value of an investment, multiplying the probability of each scenario by its respective present value and then summing these numbers.

Given many valuation methodologies, which one should an investor choose? The answer to this question depends on the nature of the company the investor is evaluating.  NPV may be a good approach to value a company with stable cash flows, liquidation method may be used to value a company selling well below its book value, a mutual fund may be valued at stock market price. Sometimes you may used different methods for different units of a conglomerate. Ideally multiple methods should be applied and the lowest value chosen.

A wild card in valuation is the theory of reflexivity propounded by George Soros. It says that stock prices can influence the valuation, rather than the other way round. For example, an under-capitalized bank, trading at high multiple can raise cheap capital in the market based on its price multiple. On the other hand if the stock was trading at low multiples, it would not have been able to raise funds leading to bankruptcy. In this case, the stock multiple acted as the valuation cue for the bank. It could be true for a highly leveraged company with impending redemption. Good market perception can help it raise funds to honor the redemption. Sometimes managers accept the market value as a signal of the business value and may issue additional shares at values lower than market thereby worsening the situations. A bad market can depress prices lowering the liquidation value, thus becoming a self fulfilling prophesy.

The author gives reasons why valuation based on Earnings, Book Value and Dividend Yield are easily manipulated by crooked management. He suggests not to trust such valuations.

Difference between investors and speculators...

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In his book 'Margin of Safety', the legendary investor Seth Klarman explains the difference between investors and speculators. To investors stocks represent a fractional ownership of business. They transact securities that offer an attractive risk reward ratio. Investors believe that over the long run security prices tend to reflect fundamentals of the business. Investors in a stock expect to profit in at least one of the three possible ways. From free cash flow generated by the business which will be reflected in higher share price or will be distributed as dividends, from increase in multiples and by the narrowing the difference between price and value.

Speculators on the other hand, buy and sell securities based on the expected price action based on the behaviour of others. For them securities are a piece of paper. Speculators are obsessed with guessing the direction of stock prices. They use technical analysis to predict the direction of market. Many investment professional are speculators in the garb of investors. Investors have a chance to make money over the long-term, while speculators are likely to lose it over time.

The author tells the story of 'trading sardines' versus 'eating sardines' to explain speculation. It was observed that sardines were disappearing from their traditional waters in Monterey, California. The commodity traders bid them up and the price of a can of sardines soared. One day a buyer decided to treat himself to an expensive meal and actually opened a can and started eating. He immediately became ill and told the seller the sardines were no good. The seller said, "You don't understand. These are not eating sardines, they are trading sardines."

Like sardine traders, many financial-market participants are attracted to speculation, never bothering to taste the sardines they are trading. Speculation offers the prospect of instant gratification. Moreover, speculation involves going along with the crowd, not against it. There is comfort in consensus.

Viewing stocks as piece of paper precludes rigorous fundamental analysis. Neither rigorous analysis nor knowledge of underlying business is required. Speculators play the 'greater fools game'. Speculative activity can erupt in Wall Street at any time and is not identified as such till considerable money has been lost.

Even assets can be catagorized as investments or speculations. Both can be purchased from market and both fluctuate in price. The main difference is that investments throw cash flow, but speculations do not. For example, stock is an investment, gold and other collectibles are speculation. Value of speculations fluctuate solely based on supply and demand since they do not throw any cash flow.

In financial market it is important to be an investor and not a speculator. Successful investor is unemotional taking advantage of the opportunity provided by the greed and fear of others. They respond market with calculated reason. Investors use the opportunities provided by Mr.Market, without looking up to him for investment guidance. It is important for investors to differentiate the stock price fluctuation from underlying business reality.

Value Averaging: A different path to investment success

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There are three types of Investment strategies. These are Fixed Share, Fixed Dollar and Value Averaging.

In fixed share strategy, you buy fixed number of shares of a company regularly over an extended period of time. For example, you buy one share of Infosys each month for say 24 months. As the prices rise, you will invest more amount and as prices fall you will invest less. Your average prices is the simple average of the prices you paid over your investment horizon.

Fixed dollar strategy is also known as 'Dollar Cost Averaging (DCA)' or 'Systematic Investment Plan (SIP)'. In this approach you invest a fixed amount regularly over an extended period of time. For example you will invest 10000 rupees every month for 24 months to buy shares of Infosys. If the price of Infosys goes up, you will buy less number of shares if the price of Infosys goes down, you will buy more number of shares. In this way, your share purchases mirror your normal purchase behaviour. Since you are buying more number of shares when prices are lower, your average price ends up lower than the simple average prices that you get in Fixed Share approach.

How a market bubble and crash can strengthen your country

As the Indian elections approach a fever pitch, there are lots of debates going in social media about the Credit Crisis that led to NPAs escalated during the UPA1 years. There has been rampant and mindless credit growth and the credit control processes were significantly weakened. There was a feeling all around that 'This crisis' was different from other 'Credit Risk Crises' due to the following reasons.

1. Credit risk has been globalized and hence insignificant for any one country
2. Securitization and collateralization of debt has ensured that the credit risk is spread across many people and hence is insignificant for one person
3. Technology has ensured that adequate controls are in place. 
4. Credit risk has been transferred those who can pay. 
5. There is no credit risk. Housing prices are going to stay where they are or are only going to go up.

This was a bubble. It was a matter of time before the cookie crumbled. 

Different types of investment approaches

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Normally there are two different approaches to investing in stock market. One is based on the market price and the other is based on the intrinsic value of the stock. 

Those who follow the first approach are called Traders and those who follow the second approach are called investors. 

My Assumptions about Equity Investing

From 1991 to till 2018, there have been three major corrections in the Indian Stock Market. 

The first one was caused by the Harshad Mehta Scam of 1992, the second one was the Dotcom bust of 2000 and the third one was the major correction in 2008.

Each of these scams shaved off huge amounts of investor wealth. A number of investors were driven out of the market due to these brutal corrections, never to return again. These people have become strong votaries of Bank Fixed Deposits, despite their tax implications and the vagaries of inflation. 'I still have my capital in my bank account' is their constant refrain. 

I am currently reading the book 'Four Pillars of Investing'. It is an amazing book, which should be in the reading list of any person who wants to invest their money. In this book  the author, William J Bernstein discusses the real losses that accrued to people during the multi year corrections in the stock market. The losses have been stomach churning. In the 1929 correction people lost upward of 80% of their wealth.

If you are planning an ‘all equity retirement strategy’, when markets fall, you are hit with a double whammy. One is that you have to withdraw more of your savings to maintain same level of expenses and two, you will have less savings to recoup your losses during the eventual reversal. That made me scared.

In the last one year, my portfolio has seen a loss of about 20 - 30%. But still I continue to remain invested in the stock market. What am I thinking?

What are the assumptions that I am making while I remain invested in the market.? Here are a few.

• Global Growth Assumption: Global economy is poised to enter a long-term growth phase.
• India Growth Assumption: I believe that Indian economy is poised for a major leap and Indian stock market is poised for a multi year bull run in the next five years. 
• 'Mother of all bull runs' Assumption: Every expert and his mother in law on TV talks about how India is on the cusp of MOABR. Wild projections of Sensex and Stoke dote the landscape wherever you look. You can't afford not to be a part of this. What if it doesn't happen? I feel India is in the middle of a bull market, not as wild though.
• Quick Recovery's Assumption:  Stock markets might fall, but they will recover quickly.
• Sufficiency Assumption:  I have sufficient savings in equity market for my retirement planning. I will be able to fund my son's higher studies, if he requires funding.
• Risk Tolerance Assumption: I believe that I have a higher risk appetite and can withstand losses much better than others. I will not freak out with a huge fall in the market. I will not make any hasty moves like abandoning the market or make 'Tracking Error' decisions like exiting the under performing asset classes and buying into over performing asset classes. 
• Positivity Assumption: I am an eternal optimist and believe that there will not be a major correction any time soon. Even if there is correction, I will be able to tide over that.
• Smart Guy Assumption: I am smart and intelligent and learn quickly from my mistakes and from other people's mistakes. Mistakes is what others make. I have enough intellect not take any unnecessary risks.
• Knowledge Assumption: With an MBA in finance and with years of investing experience, I believe that I know all that is there to know about equity investing. I know how to anticipate the downturn of an industry, I know how to identify if the correction in stock price is temporary or permanent and take decisions accordingly. I also know my limitations.
• Decision Maker Assumption: I am a decision maker and make unemotional and objective decisions based on available facts. I do not fall in love with my stocks (HUL, you didn't read this...). When data asks me to sell, I sell.
• Market Timer Assumption: I will be able to exit the market at or near the peak of a bull run and move bulk of my investment into bonds
• Satisfaction Threshold Assumption: I will be satisfied if I get X times return on my investment and X is an achievable goal. 
• Tax handling assumption: I am ok to handle tax complexity inherent in the investment operations. 

Backed with these assumptions, I am making some real life choices. If any of these assumptions prove to be wrong, I will be devastated.

What are the investment assumptions that you are making?

The Fallacy of Long term returns in Stock Market

“Invest in stock market”, says my friend a stock market enthusiast.

 “Why?” I question. I am not a fan of seeing my money vanish into thin air.

“In the long-term you make high returns in the stock market. Look at Sensex. It was valued at 100 in 1980. Today it is 36,000. If you had invested a Lakh (100,000) of rupees in Sensex in 1980, you would be sitting on 36.000,000, that is almost half a million USD at the current exchange rate” my friend is gloating.

How junk learning messed up my career...

I am not bragging here.

I have multiple MBA in Finance from prestigious institutions in the country and have been implementing Financials applications for the last 20 years or so. But I still get confused about the idea of money.

Early in my career I remember my project manager asking me while we were on the way to a customer meeting, 'What would you expect from work, achievement or money?'

Do not oversave for future...

In this post I want to discuss something that I call 'The fallacy of savings'. This is related to the habit of over-saving for a rainy day. I have seen this happen with many Indians. We love to save. The importance of saving is instilled in our mind from early childhood. 

Almost all of us save for the ‘Rainy Day’, that time in future when we do not have earnings but will need to maintain our standard of living and would need to support our possible spurt in expenses. Because we are worrying by nature, we over-save for the future sacrificing our current expenses. 

Let me explain with a small math. Let us say that we need to One Lakh rupees a month for our future expenses. That will be 12 Lakhs per year. If we consider 30% income tax, we will require 12/0.7 =17 Lakhs per year of income. At a conservative interest rate of 7% per year, this will call for a saving of 17/0.07, about 2.5 Crores. Factoring in a buffer of 1.5 crores for unplanned expenses, we will need about 4 Crores of savings. 

A saving of four crores will allow us to live luxuriously, pay our taxes and cover unplanned expenses. 

Many people over-save. They sacrifice their current spending for future saving. They postpone their vacation. Instead of going to Paris, they decide that they want to ‘See India’ Instead of staying in five star hotel, they search for cheap home stays. They do not enjoy now, over-saving for a rainy day in future. 

What is the result? At old age they have money but nowhere to spend it. Their educated children  are well off and do not need inheritance. Children asks their parents to ‘enjoy’ For the old parent, the enjoyment is lazing in Verandah sipping hot coffee. 

I am not saying we should not save. We definitely should. But also spend. We are a visitor to this earth. Enjoy what it has to offer. Take the vacation, stay in the five star hotel. Do that skydiving, Enjoy that cruise. Don’t live like a prisoner, not taking any vacation and not going anywhere. 

Live now, do not regret later.

Missed Opportunities...

To make money in stock market, you need to do two things. One identify opportunities and two, play long term. Despite my professed knowledge of Stock Markets and investments, I sucked at both.

Consider the facts.

In 2004, I was working for India's largest IT consulting company. And we were implementing the project for India's leading Watches and Jewellery manufacturing company.

In the year 2005, my company came out with its IPO (Initial Public Offering). The shares were priced at 850 rupees and there was a discount of 5% for employees. In addition, the company was giving very good financing options to the employees to purchase its shares in the IPO.

Since I was the 'expert' on share market, my team members asked my opinion.

Book Review #38: How to be a billionaire: Author: Martin S Fridson

Just finished reading the book 'How to be a billionaire, proven strategies from the titans of wealth', written by Martin S Fridson,

Fascinating book.

Author sums up the layout of the book in the first chapter. This is the first book that I have read that does that. So let us dive right in.

Traditional wisdom on building wealth stress on the individual. Have a new idea and single minded focus, keep hope and optimism and keep dreaming and visualizing success, so they say, and you will eventually become a billionaire. The focus is on thoughts and attitudes as a means of attaining wealth. This thought is exemplified by the book 'Think and Grow Rich', written by Napoleon Hill.

 

The above approach is simplistic as per Mr.Fridson. The traditional wisdom miss two important qualities of a billionaire, their ability to negotiate great deals and their  understanding of financial concepts including taxation.

Why market timing do not work?

Let me tell you about my experience in stock market in India in one sentence.

'I have tried everything there is and lost money every time'.

Still I am in the stock market.

Recently my friend Niranjan and I were having a debate on Facebook. I have updated saying that Indian market is at a historically high PE ratio and that one should be careful about investing in the market now. The Nifty PE is above 28 as I write and this has happened only twice in history. Once in 2003 and the other in 2008 and both times markets crashed. 

Niranjan had an idea. 'Why don't you sell your portfolio lock stock and barrel now and buy it back after the inevitable crash?', he asked me.

I have been there. It never worked. Here is what happened.

You think that market has topped out and sell your shares an immediately it goes up by 20%. I used to own the shares of Bombay Dyeing earlier. I purchased it at about 300 and it was vacillating (they call it 'consolidating') around 550. I felt that it was bound to fall and sold it. In the next two days, the stock touched 730 !

After selling the shares at top, you wait for it to bottom. You assume that it has bottomed out and buy it and immediately afterwards, it falls another 40%. I purchased Vakrangee recently at 65 and it fell to 45 in just three sessions !

Another reason it works is this. You identify a great stock and want to play this 'Sell and buy' game. You time the top perfectly and sell it. Now you wait for the price to fall to a particular level so that you can buy it again. The problem is that the stock starts consolidating on the down, with a downward bias, all the while you are sitting with cash in hand and other shares are going up. You keep observing a few shares that are going up and after some time, you lose patience and use the cash to buy the novenu shares that have already run up. Once your cash dries up, the original target share falls to your target level and you do not have cash !. 

Another problem is that after selling a share, you forget about it and later on you see that the share price reached its target level, reversed course and now trading at a price that was higher than when you sold originally !. I remember buying Subros at 50 and selling it at 70 and waiting for the price to reach 50 again so  that I can buy it. Then I used the cash to buy some other shares and then I forgot all about Subros. Later when I checked the price it was trading at 300 !

The main reason that the strategy of 'Sell high and buyback low' doesn't work is that you can neither predict the high or the low of individual shares, nor can you do that for the market.

For example, currently the Nifty PE is 28 as I mentioned earlier. However, there are some people who say that the current situation is not comparable with 2008 because only five stocks are driving Nifty Up. These are TCS, Reliance, Infosys and two more. Other stocks are still trading much lower than their peak valuations. As per this view, when the corporate earnings of the other stocks revert to mean, the Nifty PE will fall and market will become less risky.

Do you see what is common among all these strategies? All these are looking only at the share price, none of them are looking at the underlying business. And that is what you should work on.

It is all very complicated. So, in times of peak PE, the only strategy is to sit tight and do nothing. Buy some solid companies and let them deliver returns for you compounded over long time.

There are many great companies out there. 

The futility of knowledge....

'All the knowledge and wisdom that one accumulates is futile if one do not act on that knowledge'

Take it from me, I should know.

Readers of this blog know that I am running a blog series on reading and reviewing 50 Books in Finance, currently I am in Book Number 37, Think Like a Billionaire, become a Billionaire

The incident that I am about to narrate happened in the end of 2015. I was in the middle of reading and reviewing the book 'New Buffetology'. This amazing book gave countless examples of stocks trading at significant discount to intrinsic value. The basic premise was than a value investor should buy great businesses trading at low valuation.

Such stocks are not generally available.

Lessons from Tulipomania

This is a story from the book Zulu Principle written by Jim Slater.

Buy 'Zulu Principle' @Amazon

In the early seventeenth century, many people in Holland were collecting tulips to such an extent that it was proof of bad taste for a man of fortune to be without a rare tulip bulb collection. The desire to possess tulip bulbs spread to the Dutch middle classes. By the year 1636, the demand for rare tulip bulbs increased so much that regular marts for their sale were established on the Stock Exchange in many of the principal cities. 

The evolution of a value investor: Tom Gayner

Gyan on Treadmill dated 12-Apr-2018

Thomas Gayner graduated from the University of Virginia in 1983 and started his career in accounting and began working at Price Waterhouse Coopers (PWC) as a Certified Public Accountant. Soon he moved out and after multiple transitions, has been working with Merkal Corporation since late eighties. Currently he holds the post of Chief Investment Officer in the company. 

In this presentation Mr.Gayner discusses his evolution as a value investor. 

You can watch the presentation here.

Gayner started off as a quantitative analysts, looking a the numbers. However, as he gained experiences, he has added other qualitative aspects to his approach of identifying value. 

The investors alphabet: Advices from Tao Jones Averages

In his book 'Tao Jones Average', the author Bennett W Goodspeed gives a set of 26 advices to a a budding investor. It is structured as one advice per letter of the English alphabet. Here is a summary of the advices.

Buy the book Tao Jones Averages @Amazon

1. Be a light sleeper: Be aware of the changing conditions so that you can act on them quickly.
2. Be your own judge of value: Bargains are rarely announced, so learn to assess bargains.
3. Do not be too sure: The time to be careful is when you are sure. You may be right now, but could be wrong the next time.

Book Review #34: The Tao Jones Averages: Author: Bennett W Goodspeed

The book 'The Tao Jones Averages: A Guide to Whole-Brained Investing', written by Bennett W Goodspeed promised to give me a different perspective on investing. It did not much.

Human brain consists of two hemispheres, the left hemisphere that is analytical, deductive and logical and the right hemisphere that is artistic, creative and intuitive. The author's point was that while the markets always behaved non-rationally (right brained), the traditional analysts approached the market with a rational approach,  focusing mostly on the analytical part of their brain. By focusing on hard numbers - the trend, growth projection, DCF, financials etc - they were missing the potential of half of the brain. And they (the analysts) were wiser post-facto. They were good at explaining 'why an event happened as it did' and 'why they couldn't have anticipated it'.

The most important thing:- origins and inspirations Howard Marks

Gyan on Treadmill dated 11-Apr-2018

In the world of Investing, Howard Marks stands up there with Buffett. He heads Oaktree and his funds have given phenomenal returns over the years. In the talk that he gave at Google, he talks about his book 'The most important thing'


The title of this presentation is 'The most important thing: origins and inspirations'.

(You can watch the presentation here.)

Marks started off by explaining why he named his book 'The most important thing'. As he sat in his client's office, he used to hear himself say 'the most important thing is controlling risk', then in another client's office it will be 'the most important thing is buy at a low price' and at another occasion it is 'the most important thing is being contrarian' etc.

Over a period of time, he found that he had identified almost 19 different 'things' at different times as 'the most important thing'. So when he wrote the book, he titled it that.

Why did he write the book in 2011? Originally he was planning to write a book after retirement, but Warrren Buffett promised him that if he ever wrote a book, he will give a quote for the jacket. That was a motive enough to work on his book sooner. As per Mr.Marks, the book is not designed to tell the reader how to make money or how to do investing. 

Mr.Marks did not plan to end up as an investor. After graduation he applied for 6 jobs and ended up joining an investment firm. He developed his investment and life philosophy over more than 2 decades and which is embodied in his memos to the customers. 

He titled this speech 'Origins and Inspirations'. These are the sources from which he got his ideas and inspirations to write this book. In this presentation, he explains some of these. 

The first reference to the book 'Fooled by randomness' by Nassim Nicholas Taleb. The key point is that in investing, there is a lot of randomness. You can't tell from an outcome whether the decision was good or bad. This is due to randomness. In the world of randomness, good decisions may not work out and bad decision may work out quite well. The book is about the role of luck. Even if you know what is most likely outcome, many other outcomes are possible. You should not act as if the things that 'should' happen are the things that 'will' happen. Even when what should happen actually happens, it may not happen within the given timeframe. 'Never forget the 6 foot tall man who drowned while crossing the 5 foot deep pool on an average'.

Buy the book 'The Most Important Thing' @Amazon

Second reference to a quote by John Kenneth Galbraith. The quote is 'we have two classes of forecasters. Those who don't know and those who don't know that they don't know.' Here Mr.Marks talks about the quality of forecasts. Most of the forecasters are just extrapolaters. The problem is that such forecasters do not make money, since that forecast is already factored in the price. The forecasts that make money are the ones that predict radical change. The problem with that approach is that if you look at the previous forecasts of the same forecaster, they are not right consistently. Which means that this correct forecast is just a fluke.

The third reference is to a quote from a book called 'Winning the Loser's Game', written by Charles Ellis. This book refers to another book called 'Extraordinary tennis for the ordinary player'. In this book, the author Simon Remo talks about two different strategies for winning in Tennis. The professional tennis players win by 'winning' more points. They his harder, constantly find the angles and win aggressively. On the other hand, amateur players win by 'not losing', by making lesser mistakes than the opponent. Their objective is to simply return the ball on to the opponents court. 

Charles Ellis, says that investing in stock market is like the 'loser's game'. In stock market, you win by making 'fewer mistakes'. Paradoxically, you lose in stock market by 'playing to win'. That is the reason why defensive investing is so important. 

The fourth reference is to the meeting Mr.Marks had with Michael ('Mike') Milken the famous junk bonds specialist. Milken single-handedly created a market for junk bonds (bonds rated AA- and below). Mr.Marks met Milken in November 78. As per Mr.Milken, there is only one way to go for AAA bonds. They are already valued high, and they can go only down. Whereas, a B rated bond, and if they survive, they can only go up. 

Making money in stock market is not by buying fairly priced stocks of good companies. The way to make money is by paying for an asset at a price lower than its intrinsic value. This reminded me of my purchase of Amara Raja Batteries, a fairly priced stock as any. I purchased it about two years ago at about 800 rupees, and the stock is still trading at the same price today. It is not that the stock is bad, it is just that it is a good stock but fairly priced and captures all the potential upsides. 

The key here is 'if they survive'. If they survive, the junk bonds tend to get re-rated upwards and you make money. So the only task for the analyst at Mr.Mark's firm is to analyse the 'survivability' of the bonds. If they survive, the bonds will make money. Bond trading is a 'Negative Art'. The performance of bond portfolio comes not from what you buy, but from what you exclude.

Based on the above inputs and many more, Oaktree Capital  came up with their philosophy. These are as follows.

• Primacy of risk control
• Emphasis on consistency
• Importance of market efficiency
• Benefits of specialization
• Macro-forecasting not critical to investing
• Disavowal of market timing.

The idea is not to become best at all times, The idea is to be consistently above the middle. 

Marks ends his presentation with three investment adages. 

One, what wise man does in the beginning, the fool does in the end. First the innovator, then the imitator and then the idiot. 

Two, never forget the 6 foot tall man who drowned while crossing a stream that is 5 foot deep on the average.

Three, being too far ahead of your time is being indistinguishable from being wrong. 

The session was followed by a QA session. Some great questions were asked. one of them being on the efficacy of index investing. Marks says that while index investing is good, still you run a risk that your portfolio value will fall along with the index. On the other hand, if you choose a portfolio focused on risk mitigation, you get the upside of the index without the risk of downside.

Another question was that how and when the price reach the value since the value investor is betting on the difference between the two. While he do not have the exact answer to this question (remember that the same question was asked to Mr.Benjamin Graham during the Senate Committee hearing), there are one or two catalysts that push the move towards value. One of them is that the bond is close to maturity. As the bond matures, it moves towards its face value. Another catalyst is the activist investors who force the company to change its processes so that the price will match with value. 

Great stuff guys....