20 Investing Ideas from 20 Years of Wealth Creation

Warren Buffett made his first investment when he was just 11 years old.

He is also one of the best value investing teachers I have known in my life.

Unlike Buffett, I did not invest when I was 11. I did not even know what stock markets were until I was 16.

Buffett started writing letters to shareholders, to pass on his learnings, at 35.

I am late for that too.

But the last two decades have taught me more about safe, timeless wealth creation than I would have learnt at any school.

So, it would be a shame if I did not make a modest attempt to pass on few of my learnings.

And what better occasion to do so than the celebration of?StockSelect's?20th anniversary!

StockSelect?is a service I have been associated with since my first month at Equitymaster. I have also had the privilege to guide thousands of subscribers as its editor.

Over the years,?StockSelect?became synonymous with buying safe stocks?without compromising on returns.

Of course, I have had my fair share of hits and misses. But each one has taught me some valuable lessons.

And I would like to share them with you today.

My top 20 takeaways to create timeless wealth in stocks

Price cannot compensate for quality

I was tasked with analysing banks in my initial years as an analyst. So, I understood the importance of quality of a business quite early.

Banks are leveraged business. Bad allocation of borrowed capital can have disastrous impact on profits and valuations.

Cheap and vulnerable banks have the potential to destroy more wealth than any other kind of stock. So, I erred on the side of caution when recommending banks. Those without quality lending practices were a strict no.

Not compromising on quality allowed me to sidestep the value destruction in large PSU banks since 2005. I managed to help them avert disasters in and even behemoths like?IL&FS.

When I told Equitymaster readers that?IL&FS was not a true AAA rated company, I wrote..

Pursuit of return must be balanced against aversion to risk.

Buy price matters more than sell price

The power, telecom, and real estate bubbles of late 2000s saw investors flock to blockbuster IPOs at obscene valuations. While many of these companies were slated to be bluechips, their financials offered no comfort.

Stocks like Reliance Power, Reliance Communication, and?DLF?destroyed shareholder wealth as swiftly as they became popular once the sector bubbles burst.

It was then fashionable for the so-called market experts to endorse popular stocks with sky high sell targets, based on DCF (discounted cash flow) valuation. But such theories were quickly swept under the carpet when the sector's fortune took a U-turn.

Hence, I chose to never ignore the buying valuation in the greed for lofty returns.

Build conviction. Stick to it.

The conviction about owning a business for the long term cannot be built over few days or even months. Rather, it takes years to observe the management's credibility, track record and the business moat to build conviction.

Once built, there is no reason to not stick to it.

Legends like Ben Graham owed a large chunk of this wealth to his conviction in GEICO. Buffett owes it to Coca Cola, See's Candy, and now Apple. Even the late Rakesh Jhunjhunwala owed it to?Titan

So, when I have tracked a business for years and built conviction, I typically recommend subscribers to hold on to the stock for much longer.

Few of my recommendations that have helped subscribers fetch four digit returns over long term are:

1,004% in Exide Industries in less than 9 years

1,082% in?Titan?in just two and a half years

1,197% in State Bank of India in 8 years

1,821% in M&M in less than 7 years

2,740% in Voltas in around 7 years

3,309% in L&T in less than 8 years.

Take care of the downside. Upside will take care of itself.

Recommending a newly listed stock, after a steep market crash, in the middle of a pandemic, may sound like the most stupid thing to do.

But I did exactly that when?I recommended Polycab in April 2020.

Barely weeks after the Covid led market crash, when almost every person was in quarantine, I went ahead and recommended a stock that was listed just a year back. I even had the audacity to call it the?next Asian Paints in the making.

My conviction was based on the company's robust business model, lean balance sheet and widening moat.

As a result, the nearly 250% gains on the stock, in just two years, did not really come as a surprise to me.

Don't be afraid to be a loner in stock markets.

Looking for cheap, hated business, with the potential to outperform markets over the long term, is an ultra-boring approach. Anyone with such an approach is bound to be a loner in the stock markets.

After all, loud and popular consensus views find the most takers.

However, being in the company of my colleagues at Equitymaster, like Rahul Shah and Richa Agarwal, who are contrarians themselves, never made me feel left out.

Rather, being loners with contrarian views , helped us recommend stocks, well before they became market darlings.

For instance, I recommended?Bharat Forge?in 2018 as a 'defence' stock. This was when everyone else called it an auto ancillary company. Hardly anyone recognised its defence potential.

Eventually, both the stock of?Bharat Forge and the Defence Sector became market darlings.

As I write this, Bharat Forge has just announced a new export order for artillery guns.

Always welcome sceptical opinions

Being in the company of analysts who have contrarian views on stocks across marketcaps, helped me question my own narrative and finetune?my own checklist.

My ability to justify views on certain stocks, against their sceptical opinions, to their satisfaction, was important. This process not only helped me avoid behavioural biases, but also allowed me to evaluate businesses from different perspectives.

Selling winners too soon is the biggest folly.

If like Buffett, I were to list my errors of commission, I would have to put out a long list of stocks sold too early.

Now,?StockSelect?has an investment horizon of just three years. So, to cater to the rule, I have often recommended subscribers to exit stocks, at the end of three years, or based on valuations alone.

I do not believe in timing the market and never recommend subscribers to wait for market tops to book profits.

However, recommending Sell on stocks that compound wealth over decades was my biggest folly.

I spoke at length on this when I finally realised the importance of recommending what I call?Forever Stock.

First finish to finish first.

More than 60% of the stocks in the benchmark indices churn every few decades. Similarly, the number of active demat accounts is just a fraction of the total number.

We can draw only one inference from these. Both investors and corporates now have shorter life cycles.

The last two decades allowed me to speak to scores of company managements and individual investors. Incidentally, very few show the resilience to sustain irrespective of hurdles.

Many?high growth companies?succumb to high debt, poor cash flows and poor execution. But businesses with low capital intensity and healthy cash flows widen their moat and last for decades.

Similarly, investors who invest for the long haul are less unnerved by market crashes or economic jolts than those hoping to make quick speculative profits.

The longer an investor benefits from the?power of compounding, the higher the chances of profoundly beating the market.

Look for mangers who are business owners and not just shareholders.

Meeting managements of companies across sectors, over the last two decades, made me realise that stocks are best not treated as pieces of paper.

Managements who consider themselves as business owners are the best wealth creators. Hence, it's important for minority shareholders to consider themselves as part owners of the business.

Capital allocation skills are rare

Very few managements are skilled at allocating capital, especially during phases of very high or very low growth. Most tend to go overboard during phases of high growth and end up investing in low return or risky ventures.

Even the managements of mature companies tend to destroy wealth by hoarding cash on the books when capital intensity is low.

Great capital allocating companies are so rare that they are literally 1% of all listed businesses.

So, whenever I come across a management that is a smart capital allocator, I make sure I keep it in?my?Forever?watchlist.

Cyclical businesses with leverage are leaking boats

Having tracked sectors with leverage, like banks, textile, power, and infrastructure, I know that debt is a double-edged sword. Especially so for cyclical businesses.

So, any cyclical business with the tendency to take debt or keep debt on the books is a red flag for me.

Even after recommending such stocks at cheap valuations, I tend to recommend an exit at the earliest warning sign. Holding on to such stocks could prove to be like waiting in a leaking boat.

Regulators and regulations can be riskier than believed

Debt is to leveraged companies whet regulatory mandates are to the pharma sector. The USFDA warnings have been a dangling sword for even some of the most innovative generic companies in India, with global presence.

However, the impact of regulatory warnings is best not underestimated. Even some of the best companies in the sector have suffered incessantly due to the regulatory risks clouding their future.

Big does not always mean beautiful in stocks

DLF,?Vakrangee, Amtek Auto are just few of the countless relatively large companies that have seen their market capitalisation decimate with their falling fortunes.

When I?recommended caution on the stock of Vakrangee?after its nearly 10,000% gains, almost no one took my warning seriously. Here is what I wrote...

The way?Vakrangee's stock has zoomed in the last nine years, one would think it has all the makings of a great bluechip stock. Heck, I might even come across as a fool to question the so-called 'moat' of the business.

But I am not perturbed, dear reader. My aim is to recommend the?safest bluechip stocks.

This means companies with sustainable moats, great business models, and strong management quality.

Readers were sceptical of my views. Until, of course, the stock crashed 90% within months and languished there.

Vakrangee?is not the only example here. Take the case of?Vodafone Idea. The stock price has crashed from Rs 200 in 2014 to single digits now. It depleted shareholder wealth by 95%!

Apart from heavy debt, the stock has been beaten down due to high competitive intensity after the entry of Jio.

Believe it or not, retail investors still hold about 6% of Vodafone's stock, hoping to recoup their losses or make unconventional gains someday.

Tracking bluechips for two decades taught me to?never take their quality or safety for granted.

When inflation is in sight...buy the exceptionally good

Twenty years is long enough to see an entire cycle of interest rates repeat itself and observe how corporate react or adjust to it.

I have seen companies in India contend with interest rates as high as 12% in early 2000s and the rock bottom rates in late 2000s. Low cost of capital is enjoyed by everyone. But rising cost of capital is like the capital allocation litmus test for corporates.

When cost of capital rises, investors must back the champion capital allocators, promoters who have proven themselves decade in and decade out. These managements can run high quality businesses regardless of where interest rates are.

So, whenever inflation and interest rates were key risks, I have stuck to?recommending only the exceptionally good.

Interest rates have the power of gravity on stock valuations

Interest rates especially have a gravity pull like effect on stock valuations. So, when rates begin rising overvalued and underperforming businesses are among the first ones to shed?premium valuation multiples.

So as much as I would love to recommend a few market darlings to?StockSelect?subscribers, I have refrained from recommending the obscenely valued ones in a rising interest rate scenario.

Focus on margins and return ratios than GDP growt

Some of my best recommendations were in phases of low GDP growth and vice versa. Looking for value among safe stocks is not easy when the economy and stock market sentiments are buoyant.

Rather it is the market's fear that allows me to get greedy about stocks that are proven to be evergreen performers.

So, in my watchlists and checklists I look for volatility in margins, cash flows, and return ratios rather than GDP growth.

Opportunities to buy the best businesses are rare...grab them.

Talking about recommending my best winning stock in times of great adversity, I cannot ignore?Tata Elxsi.

I had tracked the company for a few years. I was convinced that?Tata Elxsi's niche presence in areas like artificial intelligence was at an inflection point.

This was when not just the economy and stock markets, but even human lives were in tumultuous times. The first phase of Covid-10 lockdown had knocked down market valuations to historic lows.

Tata Elxsi, though not very cheap, was reasonably undervalued despite its lean balance sheet.

I knew that buying the stock when fear reigned the stock markets could be a rare opportunity. And my subscribers must grab it!

Turned out recommending?Tata Elxsi?in April 2020 was one of my best decisions.

The stock went on to be a 10 bagger (1,051% gains in two years) by the time I recommended selling.

Assets need not always be visible in the balance sheet

Starting 2021, technology led startups debuted on the Indian stock markets. Most of these seemed ridiculously valued in terms of both earnings and assets on the balance sheet.

The earnings volatility was understandable. But the small balance sheet sizes made me wonder whether the companies deserved such massive premiums in valuation.

As I researched more such disruptive tech business for?Equitymaster Venture, I realised that the assets of new age business are not plant and machinery but patents and manpower.

So, it is no longer necessary for even strong and sustainable businesses to have massive assets on the balance sheet. Rather, their ability to innovate and execute matters most.

Megatrends change market leaders every few decades

Seeing midcaps grow into market leaders and replace index heavyweights made me realise the importance of tracking megatrends.

Be it?electric vehicles?or?defence stocks, I was able to spot the top winning businesses well ahead of the markets, thanks to my megatrend approach.

In fact, even as I write this, there are a bunch of sectoral megatrends I am bullish on...which are still taking shape. They may take a few years to manifest the true wealth creators.

Nevertheless, I am tracking them intently to spot the key index leaders of 2030 or 2040. These are:

• Defence equipment manufacturers?(including drones) and defence technology companies
• China + 1 (PLI incentivised) manufacturers
• Green hydrogen?and?EV battery companies
• Semiconductor makers
• Energy trading and storage companies
• 5G related tech opportunities
• SpaceTech?companies

No goal is impossible in stock markets...if you are persistent and patient.

Now here is a data point that gets audited every quarter and I proudly update my subscribers on.

Since inception in January 2002 till the quarter ended 30 September 2022, 7 out of every 10 stocks recommended in?StockSelect?have met the respective target prices within the given time frame.

The audited success rate is 74.1%.

The reason I am referring to this number is because most investors do not set long term investing goals due to the fear of market volatility.

Fact is that a sound disciplined approach, practiced over long period of time, can yield mind boggling results. Like I showed you earlier, the returns from some of my recommendations are proof of that.

As Equitymaster celebrates?StockSelect's?20th?Anniversary, I hope my takeaways of two decades, make your wealth building journey timeless, immensely profitable, calm, and comforting.

Like Walter Schloss wrote in his?1946 article Hippocratic Method in Security Analysis...

We need theories which stem from experience and close observation, but which are appropriately limited in their pretensions. We must steer a middle course between starry eyed doctrinarism on the one hand and vacillating opportunism on the other.

It is the judicious mix of the theoretical and the practical approach that characterizes the truly successful security analyst and the outstanding physician.