I received a letter (yes, snail mail and not email) from a friend, Anand some time back, reproducing snapshot below:
Considering that Anand had just started his investment journey, the above letter provoked my thoughts and hence thought of penning it down below:
# Each of us gets (mis)influenced and attribute greater accuracy to the opinion of an authority figure and be more influenced by that opinion, known as Authority Bias.
In this case, my friend had got (mis)influenced by Porinju who had recommended investing in LEEL Electronics (formerly Lloyd Electric & Engineering). It’s only when the damage had been done (the stock had eroded almost 44% of investor wealth in just 5 days) that he realized that it was a “flawed investment” and admitted his mistake of having invested in the stock.
# Allocation of Capital is the 2nd most important function of the Management, 1st being widening the moat of the company. However, how can management expected to allocate capital optimally, when they have not done their first job of running the company operations properly?
It’s like a novice forcefully trying to hit a penalty shot when he can’t even make proper passes.
In this case, Average Return on Capital Employed (ROCE) for LEEL Electronics was less 8% p.a. (less than the government yield) since the last couple of years. While the company was profitable, however, summation of Cash Flow from Operations (‘CFO’) since the last 21 years was negative. This, when, combined with an approx. debt of INR 10 bln made the company vulnerable from a financial standpoint. This clearly meant that the management of the company was not doing a good job of widening the company’s moat in terms of increasing its brand, patent power (if any), pricing power, switching costs, cost advantages, etc. If the base is weak, the structure obviously will not uphold. That’s basic!! Obviously, investing basis that the windfall proceeds of the business to Havells would be accretive to shareholders was like fooling oneself.
# Stock Price is a function of “Story” and “Fundamentals”. Investing based on story alone is a cardinal sin.
Most people love stories, however basing one’s investment decision upon a story is committing suicide. In this case, while the story suggested that since the sale proceeds was higher than the then prevailing market capitalization, the stock looked attractive from a valuation standpoint. However, obviously, it panned out way too differently. The stock was priced at INR 75 on November 2018 and had already lost 74% from its peak. (Recommended by Experts, Invert please!!). Since November 2018 until today, the stock is now priced at INR 4.10 (Yes, 95% price erosion since then).
Next time, you hear a story being rattled by an expert, shut off your device (mental and physical).
Disclaimer: Please note that these are my personal views. While, I am NOT a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014, all investors are advised to conduct their own independent research into individual stocks or industries before making any decision. In addition, investors are advised that past stock performance is not indicative of future price action.
Pearls of wisdom !!
Thanks Alok!!!