Types of Investment opportunities

06Jul10

There are different types of investment opportunities one comes across. I have tried formalizing this into many different categories for clarity of thought.

1. Stable Companies with no significant competitive advantage but decent fundamentals quoting at a significant discount to its intrinsic value:

In these companies, I try to buy at a discount and sell it once the value comes close to the intrinsic value. I would prefer buying at 50-60% of intrinsic value and start selling at 85-90% of intrinsic value. One cannot tell with confidence whether these companies can increase their intrinsic values at a CAGR of 15-20%. Hence it is better to sell such positions once they reach intrinsic value. Some companies which comes to my mind in which I have invested are: Ador Fontech, Patels Airtemp, Jet King Infotrain. I have started reducing my holdings in both Ador Fontech and JetKing after a fast run-up in prices.

2. Stable Companies with significant competitive advantages but quoting at a significant discount to its intrinsic value:

This is a wonderful combination. The reason being I would not necessarily like to sell the position even if it reaches intrinsic value on conservative estimates. This would stem from the fact that one would believe the company would be able to grow the intrinsic value at a rate faster than the general market and at a rate higher than what I could get out of any other investment. I would be willing to accept a less than “opportunity cost return (i.e. return I can generate by selling this holding and investing in Type 1 opportunity)” since it comes at a significantly lower risk of losing money. Buffet loves such investments, especially at a later stage of his career (post 1980), since it becomes difficult to keep shuffling positions when your fund size is very large. These investments may generate lower return than what may be generated by actively shuffling your portfolio with mispriced securities. CRISIL, Nestle, Asian Paints, CCI are some examples of such investments. I have not got an opportunity to invest in such companies yet. Such conditions are in fact very rare in my opinion.

3. Companies with no significant competitive advantage, at least at earlier stage, but growing at a very fast pace of 30%+ yoy due to industry dynamics

This is usually the space growth investors operate. The company may look expensive on usual value investors parameters like PE and usually one will not make money from PE expansion since such companies may have high PEs already but still will make money from earnings expansion at a very fast rate. It is difficult to nail the intrinsic value in such companies since it is difficult to predict how fast they will grow in future and with what kind of fundamentals they will end up with. The interesting aspect is these companies may not have any competitive advantage to begin with but “may” build it on over a period of time. There are four types of cases which can happen:

a. The company grows, matures and ends up with significant competitive advantage: Infosys, Google

b. The company grows, matures but does not seem to have significant competitive advantage, at least as of now: Bharti Airtel

c. The company grows, matures, but ends up with no competitive advantage and ends up in an industry with bad economics: Dish TV

d. The company fails or is close to failure from an investment standpoint: Subiksha, Vishal retail, Suzlon

It is important in growth investments to figure out what is happening to the industry dynamics very closely. Things are changing pretty fast here. One can make money during various stages of such investments however one should remember that the value is very closely tied to the future.

The best way to play this is to combine value investing concepts with such investments. One should be sensible not to pay crazy PEs (PRIL/Educomp) for such investments. I would be vary of any economic normalized PE above 20 and 15-20 is the maximum range I would be willing to operate. I have not made any investment in this though JetKing I hoped would turn out to be something like this.

4. Turnarounds:

These can be good investments if one figures out that some change is happening in the company for the good. There is usually some catalyst. Symphony is an example. There was some restructuring due to bad debts and the company paid off most of its debts, emerged debt free and has been able to grow fast in 1-2 years. Conventional valuation parameters wont help one much in such cases.

Every investment depends on how the future plays out and one cannot escape from that. However futures of certain companies/certain investments/certain situations are more certain than others. Risk, I would say, is not the volatility of stock prices, but on how the future may pan out.

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