The title of the post is Bamboo Investing. Let me be very clear that this is not about investing in Bamboo grass! We will look into various mental models of learning. Also, there is no phoenix.
Before we get to the point, here is a small puzzle. Below are share price charts of a few companies over a certain time period. What is common between them?
So having kicked-off the puzzle, let's throw some information to add context. Have you heard of the Chinese Bamboo?
Within matter of six weeks, it achieves the height of 90 feet i.e. taking only one and half months after a wait of 4 years..!!
Lessons from the story
There is a clear linkage to the earlier puzzle. A good stock may remain dormant and boring for many years, and then accelerate to surprise everyone.
As such this can happen for the entire sector or most of the stocks in any country, depending on the triggers.
One should watch out for improvement in business fundamentals and earnings power. If prices don't move but the business is improving - that is the best ground to hunt.
So the answer to the puzzle is that all of the above companies (Balaji Amines, Maruti and Avanti Feeds respectively) were boring and dormant but accelerated to become multi-baggers in a very short period of time.
What are the triggers?
Now, the above outcome may look surprising in an efficient market. Is there an underlying anamaly?
Well, I have tried to think through and found that there are two broad factors driving this: Rapid earnings growth and PE re-rating.
Sector and country re-rating: This can happen when there are certain key structural changes (in the sector or the country) which expands the PE multiple rapidly without any change in earnings growth (mostly in anticipation of future earnings growth)
- The entire Indian market got re-rated in 2014 after the new government achieved an impressive majority in the general elections
- PSU oil companies got re-rated due to deregulation of fuel prices
- Specialty chemicals and graphite electrode industry recently got re-rated due to shutdown of factories in China
Company is widening its moat for the long term: There might be instances when companies are heavily investing in R&D, brand building, expanding distribution networks, launching new products, to enter new markets, to gain economies of scale, to create a network effect etc.
Basically, they are bleeding cash today to achieve sustainable long term growth tomorrow.
This reflects poorly on their immediate P&L but the earnings power of the company is constantly increasing, resulting in exponential long term growth.
- Amazon hiring staff to increase future sales and making systems and servers more efficient
- Thyrocare taking a hit on their margins to quickly gain market share by lowering prices
- Ola/Paytm fixing 0% fees for partners (drivers/merchants) to achieve a network effect
- Tata Sky giving set-top box free/subsidized to new customers to bargain better with content providers in the future
Efficient Capital Allocation: When companies demonstrate an ability to efficiently allocate capital and create shareholder value - they can get re-rated with further acceleration due to continued execution.
- Piramal Enterprises sold part of its Healthcare business to Abott in 2010 when it was trading at a bargain. Now it has rapidly re-rated due to a more efficient capital allocation (Read case study by Sanjay Bakshi: The Grand Strategy of Ajay Piramal)
Increased disclosure or market cap levels/low liquidity: There are several instances where disclosures for many small and midcap stocks are minimal. Also, some of these companies are too small to qualify for the mandate of large investors.
There may be low liquidity for the stock.
In such cases the stock is re-rated very quickly once it falls within the mandate of institutions or once disclosure standards are improved.
- Companies such as Poddar Developers and Mold-Tek Packaging did a Qualified Institutional Placement (QIP) which resulted in higher disclosure and comfort for institutional investors
- Companies like Veto Switchgear moving from a SME exchange to BSE and NSE - thus bringing them within the mandate of many funds who mechanically exclude companies listed on the former from their portfolio
Structural turnarounds: Many companies could be showing a lower earnings or worse losses due to certain structural bottlenecks. When these roadblocks are resolved, the company is naturally well positioned for a turnaround.
This may be triggered due to single event such as debt repayment, management change, regulatory change, change in strategy, consolidation of industry, structural fall in raw material prices etc.
- Indo Count Industries changed its strategy and product lines after coming out of BIFR to become a 100x stock in ~2-3 years
- Symphony changed its strategy from an asset acquirer to being asset light and the stock became a multi-bagger
There may be several such factors which can result in multi-fold returns in a short period of time. However, this does not imply that every company which is dormant or boring will follow this trajectory.
One needs to ignore short-term price movement and see if the business is continuously improving.
The lesson is that one needs to stick to the original theme and if it is intact or improving - then just hold on.
Thomas Phelps in his book 100 to 1 in the Stock Market wrote that - Investors have been conditioned to measure stock-price performance based on quarterly or annual earnings but not on business performance. Ideally the focus should be on business performance.
Its important to focus on Earnings Power coupled with business strength.
How to identify such companies?
A combination of Technical and Fundamental analysis. Some of the technical indicators like price-volume break-outs, momentum indicators, formation of trend lines are very powerful to identify such companies at their inflection point.
Adding fundamental analysis on top of it can filter some of the false signals generated by technical and helps to identify and ride such companies with conviction and then again technical analysis can be used to determine the Hold or Sell criteria.
Companies such as BEPL, HEG etc. gave clear technical indications and this was coupled by fundamentals like ABS prices going up coupled with capex for BEPL, graphite electrodes prices going up benefiting HEG, along with shutdown of capacity in China.
See technical chart below for BEPL: There was price-volume break-out in Mar-2017 at ~25 and stock became almost 8x in less than 9 months. The capex approval came soon after break-out giving fundamental confirmation and conviction to hold. This was further accelerated by the PE exit and promoter buying from the market.
For more on examples/approach you can see my presentation in article: Technical Analysis Overview
Thus, one must use this approach to identify such stocks and once these are identified correctly, just SIT tight until the story plays out and enjoy the Bamboo Investing way of wealth creation...!!
Disclaimer: All stocks quoted are just taken as examples, these are not buy/sell recommendations.
Chart credits: Moneycontrol, ChartNexus
Originally published on TECHNOFUNDA