Friday, December 07, 2007

Re: free cash from ops


Averaging the past in a growing economy will: (1) force you to be more sanguine than a guy who takes more recent data, becomes over-optimistic and projects it into the future stupidly assuming that all trends are destiny, thereby making many errors of commission; and (2) make you ultra-conservative because many things will now start looking too expensive, which will inevitably lead you to make errors of omission.

So its a tradeoff between errors of commission and errors of omission. You know which error I'd rather make...


On 06-Dec-07, at 11:21 PM, pratik gandhi wrote:
Question that has troubled me for some time - should one always take the average of the past few years? Or should any leeway be given for a smaller fast growing company as opposed to a large company not growing by as much?

Tuesday, December 04, 2007

What Should Infy Do to Restore its Honor?

Take a look at the chart below. It shows something very very interesting. This is the stock price chart (adjusted for splits, bonus issues etc) of Infosys, one of India's most admired companies.

The fellow who bought the stock in March 2000 (the peak of the tech bubble) and held on to the shares in Infosys for more than seven years, essentially did not make any money!

One of the most-admired companies in one of the world's fastest growing economies - a company which is debt-free, earns super returns on capital, and is run by a management team which is renowned for its operating skills as well as integrity. And the stock earns nothing in the biggest bull market India has ever seen!

What could explain an outcome like that???

Has the company's earnings declined?

NO! See the chart below:

Infosys's earnings have grown consistently ever since it went public. Moreover, the earnings growth rate has always been well in excess of India's GDP growth rate.

Now see the chart below - it shows what really happened to Infy.
As the above chart shows, Infy's P/E Multiple chart resembles that of a speculative bubble -and indeed it was a speculative bubble.

At the peak of the tech bubble, the investment (speculative?) community was so optimistic about Infy's prospects, that every rupee of earnings was thought to be worth Rs 350 or so. Today, markets are so pessimistic about Infy that every rupee of its earnings is thought by Mr. Market to be worth no more than Rs 23.

Ben Graham's "Security Analysis" starts with Horace's observation: "Many shall be restored that are now fallen and many shall fall that are now in honor."

What can Infy do to restore its honor, given its current market value, its competitive position, and its financial strength?

What should Infy do?

Monday, December 03, 2007

Quiz: If IFC buys into IFCI, then what?

The stock price of IFCI (IFCI@IN) shot up by 13% today, presumably on rumors that International Finance Corporation (IFC) may buy a strategic stake in IFCI. See, for example, the following:

Suppose that the rumor was true. I have no clue, but let's just suppose that it was true.

That is, suppose that IFC bought a strategic stake in IFCI.

Further suppose that the stake was in excess of 15%.

Further suppose that the stake was bought at a premium to today's closing price of 106.80 at NSE, which incidentally is the highest price the stock has seen in more than a decade.

Then, under India's Takeover Code, what will (or won't) happen and why?

Sunday, December 02, 2007

The Mystery Behind Mastek's Buyback

On 29 October, Mastek made the following announcement:


Mastek Ltd has informed BSE that the members of the Company will consider to approve the following Special Resolution by way of Postal Ballot:

- Approval of Board of Directors (which expression shall Include a Committee of Directors of the Company constituted for the purpose) for the purchase of the Company's fully paid up Equity shares each of a face value of Rs 5/- to the extent not exceeding 25% of the Company's paid up Equity Share Capital at a price not exceeding Rs 750 Per equity share from the Open Market through Bombay Stock Exchange Ltd and National Stock Exchange of India Ltd and the total aggregate amount to be expended by the Company for the Buy-back not exceeding Rs 65 crores, i.e. within 25% of the Company's fully paid-up Equity Share Capital and Free Reserves as per audited Balance Sheet as on June 30, 2007, subject to necessary provisions & approvals.

The Board of Directors has appointed Mr. V V Chakradeo, Practicing Company Secretary as the Scrutinizer for conducting the Postal Ballot process in a fair and transparent manner.

The Postal Ballot form duly completed and signed, should reach the scrutinizer not later than the close of working hours on November 26, 2007. The results will be announced on November 27, 2007.


Why did the company give a maximum price of Rs 750 per share for its buyback, even though the current market price is Rs 280 per share. Indeed, adjusted for stock splits and bonus issues, this company has not seen its stock price hit Rs 750 in the last seven years.

So, could this be gimmick? How can we ascertain this? (Hint: The company has done a buyback before. What happened then?)

Does the buyback make sense at a small premium to current stock price? Why? Why not?

Mr. Buffett's Model of Circle of Competence

From: Sanjay Bakshi [
Sent: Sunday, December 02, 2007 8:39 AM
To: Ashutosh Datar
Subject: Re: Circle of competence - what is it?
Hi Ashutosh,
Hope all is well.
Here are my comments on your mail:
  1. Mr. Buffett's "circle of competence" has several meanings. One is simply the need to not stray outside an area of one's own skills. The probability of success is much greater if one's does not stray outside one's circle. Mr. Buffett likes to say he has a very large "too tough" basket where most of the things go. But occasionally, he comes across something compelling which he really understands. 
  2. Risk: Mr. Buffett's framework of risk has the circle of competence model at its heart. In his 1993 letter, in which he wrote about his thoughts on risk (defined as probability of permanent capital loss, as opposed to mere quotational losses), he mentioned that risk depends to a large degree on one's ability to accurately predict the future about the situation being examined. He connects the circle of competence model to his idea of risk by relating it to the certainty with which the long-term prospects of the business, the operating skills, the capital-allocation skills, and the integrity of the management can be ascertained by an investor. So, the same investment, may carry different levels of risk for different investors. This, as you know, is contrary to what academic finance teaches. Mr. Buffett, however, believes, that risk comes from not knowing what one is doing. 
  3. I don't think the circle of competence model is industry specific. For example, I consider my own circle of competence in the deep value space and within that space,  I have sort of found my calling in the field of special situations. Over the years, I have accumulated a substantial experience in those fields. I think its possible to find deep value in a sector which you do not have to understand to the degree required of a sell-side research analyst.
  4. My own view is that sell-side analysts often go wrong because they know too much - they have too much information to work with and as a result they often miss the obvious, which can easily, perhaps, be observed by a generalist, who maintains a distance from the noise that surrounds sell-side research. There is a very famous experiment in psychology called the "fire hydrant" experiment. A class of students is divided into two equal groups and each group is separately shown a very blurry image of a fire hydrant which is unrecognizable. Then, the image is brought into focus and the process is stopped at a point well before the image is totally clear to anyone. However, for one group, the image is brought into focus in ten increments, while in the other group its brought into focus in five increments. Note that both groups start with the same image and end with the same image. Surprisingly to many, the group which had more information (ten increments) take much longer to recognize the fire hydrant than the group which had less information. The chief reason is that the members of group which was exposed to more increments come to initial judgments (first conclusions) derived from the pattern-seeking human brain, and then in subsequent information it tend to under-weigh disconfirming evidence and over-weigh confirming evidence of their initial notions (confirmation bias). The second group, on the other hand, does not suffer from these biases. They see no relation between the first image and the next and the next and suddenly they see something that resembles a fire hydrant. The second group - the one with less information - identifies the fire hydrant- much more quickly than the first group which had too much information. The analogy with sell-side research is obvious, in my view. 
  5. Cost of capital - Circle of competence has much to do with cost of capital. The opportunity of cost an investment is the expected return of the next best investment which is available to me. The key phrase is "available to me". Now, most of the things that happen in the stock market and fall outside my circle of competence, are not "available to me" so they must not influence my thinking about opportunity costs. This is fundamentally logical, in my view, and is totally at odds with Markowitz's model of portfolio optimization. 
  6. This means that there will always be some strategy which will be doing far better that what I know and understand. Does that mean that I must run after that strategy? No! So long as my own strategy, derived out of my own circle of competence, has delivered me satisfactory results and is expected to do so in the future as well, I don't have to be envious (envy being the deadliest of the seven deadly sins), I should be contended. This is consistent with the Herb Simon's idea of satisficing as an application of his theory of bounded rationality. 
  7. One's own circle of competence expands over time through personal and vicarious experience - the latter one obtained primarily through careful reading of extreme successes and failures - the lollapalooza outcomes - and relating them to the causal factors (mental models) which combined to produce those outcomes. In this respect, vicarious experience is terribly important, according to Mr. Munger, for "you do not have to to do it to learn not to pee on an electrified." :-)
  8. You really have to choose a field that you feel passionate about - it could be a sector, it could be a strategy (deep value, special situations, growth, momentum - whatever), it could be top-down or it could be bottoms up - It does not matter. What does matter is that you have real passion for it, and you have determination to build a circle of competence in that space and to expand it over time through the accumulation of experience - both direct and vicarious.
I'd like to blog this thread because there may be other people who may benefit from this exchange. If you prefer, I can protect your identity from being revealed when I post it. Do let me know.
Thanks and best wishes
Sanjay Bakshi
On 25-Nov-07, at 11:27 AM, Ashutosh Datar wrote
Hello Sir
I am struggling with this concept for the past few weeks and so writing to you to get your perspective.
Circle of competence is a good and a fairly intuitive concept but I am not clear what it means in actual sense…

If by it we mean knowing one particular sector inside out, then the typical sell side analyst should be the best guy. He covers a particular sector, does not go beyond it and pretty much knows every small thing that is happening in it. But then he doesn’t seem to produce good results – what’s the problem there? Does he know too much? Or does he not know the right stuff
  • WB talks about buying businesses that he understands, buying businesses that are simple, what does it mean? I mean Coca-cola is a simple business but Petrochina I guess is a whole lot complicated than that… add the political risk of dealing with ppl as opaque as Chinese and it seems kinda odd to me.
  • Is circle of competence necessarily a sector thing? I mean someone could say I can call the interest rate cycle or politics for that matter, so he could use it for a wide range of sectors which are affected by that…
  • Lastly, how does one go about developing his/her own circle/niche? Is it just a natural process driven by time?
Could you help?
Best Regards
Ashutosh Datar