The Last Blog we wrote was Called “The Biggest Bubble” & we wrote that in May 2020. Click Here to Read that Blog, Well 5 months later with Negative GDP Growth of -23%, Highest Unemployment Rate, Highest Ever expected NPA, Cities shut for 6 month+ & Yet Markets are near LifeHighs.
While this Blog is not about a Bubble, it about a thought process and framework around Stock Selection, Portfolio Construction and Selling in general.
Our style is of Growth Investing and we look for Trends. And we classify Business Models into 3 types-
A) Business to Consumer (B2C)
B) Business to Business (B2B)
Trend Number 1 – Business to Customer (B2C)
B2C Trends are the best trends, as these trends are very long term in nature. Even though the growth rate isnt very high (1-2x Norminal GDP Growth), the risk of witnessing a de-growth is the lowest in such trends. These trends offer consistent year-after-year growth, making them great stable compounder’s in general.
The reason why such trends are so long term in nature and grows year-after-after is the fact that the these business’ typically get better with size & opportunity size in most of these companies very large and once you have established distribution, all you have to do is come with New Product line which compliment existing products. A B2C business is typically driven by a large number of customers, who’s collective preference- The Brand, is something which cannot be changed so easily & quickly which makes B2C business gets better with size.
Plus, such trends offer the lowest level of risk and volatility unless we buy them on some very high valuations.
In most cases B2C trends do not offer discovery premium or re-rating since such companies are mostly well know and discovered. The key consideration here is Growth; being able to find high growth in a B2C company is the Holy Grail of long-term investing. Also, timing as such do not add high value to overall returns.
So Quick Recap of B2C Trends: Long Term + Consistent Growth + Low Volatility + Timing Not Important
Trend Number 2 – Business to Business (B2B)
B2B Trends are medium term in nature and follows the underlying business cycle; these trends can be 3-5 years long on the higher end. The key problem here is that post the end of the business cycle, the possibility of a major de-growth is very likely. Thus, timing of business cycle is important, at least the end of cycle. Plus, the growth can be lumpy in nature, thus such trends have higher volatility. And then there is added risk of business concentration. However, during a good business cycle, B2B trends offers very high growth and on account of high growth rates, such trends can also provide re-rating if caught early on.
The key consideration here is Secularity + Competitive Advantage. Secularity is required so that the volatility is within limits and Competitive Advantage is required to ensure that the company that we are betting on, is able to capitalize on the business cycle; because if you bet on the weak player, irrespective of a good business cycle, you will not make good money. And the entire thought of taking a higher risk and betting on a B2B trend for higher growth will go for a toss.
In case of B2B Trends, our focus is on what we call Niche B2B Trends. So, what do we mean by Niche B2B Trends?
The product/service of such B2B players is an operating cost for its customer i.e. for your customer the cost of your product/service is a Profit and Loss item and not a Balance sheet item.
And I’ll tell you why this is very important, if say Capital good Company makes a machine and its customer Lets say Pharma Company uses it for manufacturing a specific good. Now for Pharma company, the product of Capital good company is a part of its CAPEX right.
The Pharma Company might not do capex every year because nobody does CAPEX every year & this will be the case with all of Capital Good customers, so establishing a secular trend in such B2B business is very difficult. Plus, since the ticket size of individual product of Capital Goods is high, the lumpiness is even higher.
What we are looking for is basically companies whose products are required by its customers round the clock, year-after-year. Take an example of a company manufacturing API for a Pharma company. Here since the Pharma Company sells Drugs every day, it requires API every day. The API is a recurring operating cost for the Pharma Company, which means a recurring business for the API Company.
This provides the much-required Secularism in a B2B business.
The 2nd filter is establishing the competitive advantage of such B2B company. Because the exact product/service provided by such B2B company, would also be provided by many other companies as well. So, such B2B company needs to have some competitive advantage which will allow it to be the preferred supplier of product/services. And this can come in form of many things like, Brand (difficult to establish in B2B business), Cost Efficiencies, and Technological Capabilities etc.
Plus, we also have to ensure that such competitive advantage will last, because overtime others can also achieve a better cost-efficiencies or acquire new capabilities. The company has to continuously ensure that it will not only hold, but improve its competitive advantage.
So Quick Recap of B2B Trends: Medium Term + High & Lumpy Growth + Higher Volatility + Timing Is Important.
Trend Number 3 –Pure Commodity/Cyclical Trends
These are 1-1.5 year’s kind of trends. The growth and volatility here is through thereof. The play here is of trying to time the cycle perfectly and get out also at the right time. Such trends offer highest bucks, but are the riskiest as well. Because getting caught on the wrong side of the cycle results is massive draw downs, which in most cases are non-recoverable.
Key Consideration here is Timing; and it is everything here.
We believe that a mix of High-Medium growth B2C and Niche B2B trends offers a perfect construct to deliver our target of 20-25% Growth with a limited volatility. In terms of selection, our 1st preference will always be B2C trends, but we are very well aware that sometimes Niche B2B Trends do offer some very good opportunity, plus there are times when finding 15 medium-high growth B2C trends is difficult, in which case we will definitely look to add Niche B2B Trends to our Top15 List. We have recently added one Niche B2B Trend in the list.
Now on our Selling Framework, there is this book called “The Art of Execution” which provides a very good context to explain how we look at selling.
The author in the book has classified investors into 3 categories when investors have a losing position and into 2 categories when investors have a winning position.
Type of Investors, in case of a losing position-
- Rabbits– These investors have Buy & Hope mentality. Whenever they have a losing position, they will never take any action to course correct. Such investors will let their investments go to Zero.
- Assassins– These are the investors who are ruthless in cutting their loosing positions. They follow the rule of Warren Buffet “Never Lose Money” by heart. These investors have a set of rules for exiting a losing position.
- Hunters– These are the Investors who buy more of existing shares at lower prices. They are the ones who waiting for lower prices to invest more. They do dollar-cost-averaging, which if done in well-chosen investments can be very beneficial.
Type of Investors, in case of a Winning position-
- Raiders– These investors are always after booking profits. They don’t let their winners run. The biggest problem with Raiders is that it requires you to have a very high success rate in order to make money. According to the Author, Raiders are typically Rabbits in case of a losing position.
- Connoisseurs– These investors ride their winners. Such investors typically invest big and might have lower success rates, but makes the highest money since they make large gains in whichever stock works for them.
Such investors invest in companies wherein future growth of earnings is
We believe our self as Assassins and Connoisseurs. We never average down and we don’t do buy & hold. We want to cut our losers as fast as possible and ride our winners as long as we can.
This is of course not a recommendation & just views of the Author, Use this for Information purpose only!
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