March Madness

“Everyone has a plan until they get punched in the face” – Mike Tyson

Exactly three years back, I was on a flight to Singapore. Broader indices had fallen 10% in a fortnight, as China virus started to freak out markets. Many businesses of interest to us had fallen more. As the overarching mood was fear, we gathered to systematically review every business we tracked, along with what price we were comfortable buying them at. Having invested little in previous three years due to frothy valuations, our overarching mood was to not miss opportunity. We knew what we had to do. I had even written about it a few days prior (https://www.dhirubhai.net/pulse/questions-amidst-coronavirus-anand-sridharan/). Actually doing it was a different thing altogether.

From that day, markets fell another 30% in less than a month. All of India went into lockdown, parts of the world into outright panic. We were scared too. But personal fear isn’t an input into professional decisions. We invested more in the next three months than we had in the previous six years. In real-time, we had no clue how our decisions would turn out. As always, there was a healthy chance of looking stupid for a while. All we had was conviction in an investment process, not certainty of investment outcome. And what was the point of that conviction if we didn’t adhere to it in tough times, even those that could be legitimately called unprecedented.

Three years later, our actions seem smart and this essay boastful. But that’s not (only) why I write this. That testing phase reaffirmed many facets of investment thinking that I keep harping on in my essays, across both good and bad times. March madness merely exaggerated the value of those facets. And three-year anniversary is a chance for me to rehash them:

Ignore macro and ‘experts’

Panic porn is a thriving industry even in normal times. In extraordinary times, Ramanans and Dings elevated it to an art form. Even outside of so-called epidemiologists, garden variety analysts, strategists, economists and fellow investors were falling over each other to downgrade estimates and declare the world doomed. Obsession over a silliness called ‘Forward PE’ further messed minds as E disappeared (temporarily, not permanently). I have always advocated a state of wilful and blissful indifference towards macro matters and ‘experts’. March madness was a textbook case in favour of my view. As Prashant Jain once said, “People have opinions, not answers”. Not only do I have to work out my own answers, I have to do it in the context of my own objective function.

Focus on the only thing that matters

Intrinsic business value. As a business owner, I have one job: gauge what businesses are worth. I can’t do this for all businesses. Only for a short list of businesses that I find understandable and predictable. This is my objective function, the only damn thing that matters to me. As we went business-by-business in March-2020, our only question was “Is this business roughly worth the same now as it was a month back”. Surprising as it may seem, our answer in every case was YES. The businesses we wanted to buy and prices at which we wanted to buy them were no different from what they would have been had that virus never left the lab.

But what about pandemic, lockdown, disruptions and psychological scarring, you may ask. The answer lay partly in theory, partly in practice. In theory, the value of a business is the cash you can take out of it from now till eternity, discounted appropriately for risk (real, not Greek-letter). It’s not hard to work out that a few bad years don’t make a big change to value, since eternity is kinda long. Eternity part of intrinsic value is why we can ignore macro. By definition, eternity includes all manner of macro, good, bad and ugly. Why fuss separately over small part of eternity, just because it is top of mind.

In practice, the way to handle macro is to never cut it too fine. We didn’t actually project a stream of future cash, optimistically and precisely. As I have written elsewhere, we try to have a good handle on future cash and risk, without actually going through the click-drag-and-discount-back farce. Our empirically-grounded and conservatively-applied valuation heuristics already have enough cushion built-in to cover for a few bad years. The very point of playing it safe is to cover for inevitable bad years without waiting for a time when they seem imminent. So, nothing changed in March-2020, at least professionally.

Margin of safety is protection against risk

But what about business survival amidst unprecedented disruption? Yes, the risk is real. But once again, margin of safety rides to the rescue. The larger margin of safety isn’t in the price we pay, but in the risks we choose to assume and the businesses we choose to own. The idea is to stick to strong boats, not predict storms. Well-placed businesses in attractive industries with conservative balance sheets run by decent people have built-in resilience. While they’re not immune to trouble, they’re as close as it gets to last man standing. If their survival is in question, I suspect humanity has bigger problems than investment returns. And looking back, most good businesses didn’t merely survive but emerged stronger over the past three years vs their weaker competitors.

Wait for a price, not a time

Everything mentioned above is nice but offers little comfort when prices of what we are buying drop like a rock. In every single instance, share price fell at least 25% from where we started buying it. In some cases, fall was 50%. Covid phase reaffirmed what we experienced in prior periods, that we are singularly incompetent at catching the bottom. We are no better at this than we were 15 years back and have no clue how to fare better in future. But had we tried to time it better, I wouldn’t be here writing this essay. I’d likely to unemployed and inconsolable at having missed out on a generational buying opportunity. So, the best we can do is to ensure a prudent buy-price, but not hesitate to act once it is breached. Waiting for a price means looking stupid, waiting for a time means being stupid.

Deep down, be an optimist.

It’s hard to be long equities without being long humanity. Much as we seem capable of self-annihilation all the time, we don’t seem to have achieved it even once. Long history suggests that we have got past a lot of terrible things: wars, pandemics, recessions. Each generation leads a better life than the preceding one, despite each generation cribbing more than the preceding one. While we had no clue about severity and duration of the pandemic, we had no doubt that humanity would collectively come out of it. There was no new normal, only back to normal.

My wisecracking sceptic veneer is to protect me from getting suckered by a few humans, especially ones riding unicorns. But don’t mistake it for cynicism of all of humanity. Deep down, I am an inveterate optimist. Long human ingenuity and progress. Long India too. Without this historically-grounded optimism, we’d have fallen prey to panic, not taken advantage of it.

In closing, there are a handful of investing tenets that have served us well. While 2020’s March-madness made them more apparent, they’re valid even in less mad times. So, bear with me as I rehash them for the Nth time.

Ignore noise and noise-makers. Stay razor focused on knowing what a few safe and good businesses are worth. Keep safety-margin, at all levels and at all times. This will prevent you from freezing into inaction amidst panic under the guise of playing extra safe. Act when risk-reward is favourable enough, without second-guessing yourself or waiting for a ‘perfect’ time. And hard as it is, trust buggy humans to muddle our way out of seemingly intractable problems.