Gurus of Chaos: Investment theory

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Published: December 21, 2014 12:26:18 AM

Gurus of Chaos, a book on how to work the stock market, is easy to read and in which every tip makes a lot of sense

Gurus of Chaos: Modern India’s Money Masters
Saurabh Mukherjea
Pp 171

INVESTING IN shares is not an easy job. While one might like to go with the herd, it is not the best approach, because, to be successful, you need to do something different. There is a lot of psychology that goes into investing and there are some simple rules that should be kept in mind. This is the crux of Gurus of Chaos, a book by Saurabh Mukherjea, one of the best-known names in the market.

In a book like this, which carries interviews of people like Sanjoy Bhattacharya of HDFC Asset Management, Alroy Lobo of Kotak Mahindra AMC, Akash Prakash of Amansa Capital, S Naren of ICICI Prudential and the likes—and also Mukherjea’s take on how to work in the stock market—it becomes difficult to question what these experts are saying. The reason is simple: they are fund managers of repute whose funds have done extremely well and if they are telling the reader how or where to invest, they cannot be wrong. That’s where the beauty of this book lies. While these experts do not give names of companies one should invest in, you can easily pick up clues on what one should look for when looking at hundreds of stock prices. Every tip in the book makes a lot of sense.

The book is written from the point of view of a long-term investor and not a day trader. Therefore, one can think in detail about the rules given and not just go by instinct. A long-term investor is a different kind of species and displays traits that typically involve being risk-averse, sceptical and patient. He will have an open mind and, above all, be a contrarian. We need to control what psychologist Daniel Kahneman called the ‘reflex’ brain, which controls our response to external stimuli. In investing, if the ‘reflexive’ (the so-called spot reaction) brain overrides the ‘reflective brain’ (which introspects), it can lead to regrettable decisions.

The author’s belief is based on what journalist Matthew Syed has maintained: to become an expert in any field, one needs to develop at least 10,000 hours of expertise, which can mean 10 years. The process of learning becomes efficient if done under a guide and a favourable environment. Mukherjea’s starting point is that there are three tenets that should be followed at all times: intense training and research to analyse companies, intellectual integrity, and the ability to deal with greed. We need to also look beyond the obvious and meander into the realms of political and psychological aspects of the market to get a better grasp of the situation.

Mukherjea has a template with four parts, which can be used when selecting which companies you should invest in. The first is the strength of the ‘franchise’, which includes the brand, architecture and innovation of the company. Mukherjea’s illustrations are quite revealing. The longer the warranties offered by the firm, the stronger is the brand, as it gets the trust of customers. And this can’t happen unless the firm is sure of its product. Also, the age of the company and the price premium charged on its products reflect the cutting-edge of the brand. Further, the company’s behaviour with employees, customers and suppliers throws light on the franchise. Companies like Hindustan Unilever, Hiranandani, Gujarat Cooperative Milk Marketing Federation and Asian Paints stand out in this respect. Similarly, access to patents makes a difference to the brand. Also, minor aspects like after-sales service or number of distributors can tell you a lot about the company.

The second part of this picture is the quality of financial statements. Mukherjea prefers to look at the cash tax rate and cash conversion ratio to judge a company, and is wary when he sees high amounts of loans given, as it reflects interconnected lending, which is not a good sign. He also stresses on the quality of the auditor here.

The third aspect to watch out for is the promoter’s competence. We hear the management speak every year about the company’s performance. However, one should go back to what they had said the previous year and then question whether or not the company has achieved what was promised last year. In fact, the presentation of results is often done to camouflage numbers. Hence, every time there is a change in the structure, one can guess that they are hiding something.

This leads to the last criteria, which is promoter’s integrity. Mukherjea points out that in any sector, which has a lot of government intervention, like power, infrastructure, metals, mining, real estate and telecom, promoters have to circumvent laws to build a profitable enterprise. But can you trust such people? Logically, one should keep away from such stocks. This view is also shared by Akash Prakash, who has a dislike for sectors with government interference. Hence sectors such as natural resources, property and infrastructure become untouchable. Further, promoters who continuously reward themselves with employee stock ownership plans need to be watched.

Mukherjea also has some rules for buying shares, which are again based on common sense. First, we should buy in only those companies whose business we understand. Second, these companies should be in a position to generate cash flows and high return on capital for long periods of time. Third, the companies should be bought at prices that build a margin for safety. Generally, it is believed that an underpriced stock of 50% sounds good, as it can withstand a 10-20% margin of error. The author pitches for 30% underpricing to be the point of entry and gives the example of Maruti Suzuki, whose prices fell when there was labour unrest and, with this margin, did well when normalcy retuned.

Mukherjea’s final suggestions are to be sceptical, though not pessimistic, believe in iconoclasm and be a contrarian. One should not get carried away by the latest fads and be tenacious. Keep doing your research and be patient, he says. Don’t see the prices and value of your investments every day. Diversify the portfolio to avoid the risk of being overruled by reflexivity and take it easy.

Gurus of Chaos is a very easy-to-read book with a lot of common sense. With various fund managers giving advice on how to tackle the markets, you need to choose what sounds the best, there is consonance in the general approach to the game of investing in the chaotic market.
Madan Sabnavis is chief economist, CARE Ratings

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