Author: Barath Mukhi

And when these new businesses come in, there are huge advantages for the early birds. And when you’re an early bird, there’s a model that I call “surfing” – when a surfer gets up and catches the wave and just stays there, he can go a long, long time. But if he gets off the wave, he becomes mired in shallows. But people get long runs when they’re right on the edge of the wave, whether it’s Microsoft or Intel or all kinds of people.

Charlie Munger

Today I am gonna be writing about a specialty chemicals company that has shown a compounded growth rate of 60% in one of it’s verticals. The growth of this vertical is being driven by demand from lithium ion batteries, which are critical to the continuation of this EV wave.

We’ll take Tesla’s sales, currently the biggest and the most undisputed successful electric vehicle company in the world, as a proxy for what’s happening in the EV industry. Here’s how they’ve grown over the last decade plus.

The electric vehicle wave is here to stay. Here’s a chart that shows the kind of explosive growth EVs have been seeing, worldwide. And we are just getting started in EVs. EVs were just 8% of total cars sold in 2021. Can this number become 50% over the next decade? Nobody knows!!

Demand for EVs in turn is leading to demand for Lithium Ion batteries.

“What about the next 10 years? I’ll be surprised if it’s not over 100 million in 10 years.”

Elon Musk about the future volumes of Tesla – Aug 2022

In 2022, Tesla is likely to produce 2 million cars. And Musk thinks they’ll be able to produce 50x that number of cars in 10 years.

50x in the next 10 yrs!! To grow 50x in 10 yrs, Tesla will need to grow at 50% per annum, every year for the next decade. To put things into perspective, the total number of cars (ICEs + EVs) registered in the US in 2021 was 290 million (This includes old as well as new cars). And the EV market leader there, is selling a miniscule 2 million cars this year. Wow!!

And here’s what he recently said about Lithium batteries!!

The Indian business we are interested in, is Gujarat Fluorochemicals, a 37 thousand Crs Market Cap co. that I expect, could surf the EV wave neatly, over the next few years, or at least it looks so, at the moment. So GFL makes stuff that goes into Lithium Ion batteries.

Let me start with a notice that GFL gave to it’s customers in April 2021.

Basically they were saying:

• There was high demand for PVDF & FKM and will continue to remain so.
• R142b was in acute shortage, globally!!

What exactly are FKM, PVDF & R142b? What does this stuff have to do with the EV wave? I’ll come to that in a minute.

First, here’s an overview of GFL’s backward integration, which it has painfully developed over many many years.

Let me start with a story.

So back in 1987, countries basically came together and decided to gradually phase out CFCs that were killing the ozone layer. R22, which GFL also makes, is one of the gases that was phased out. R22 can still be made by cos and used as a raw material for other stuff.

If a competitor needs to make PVDF and FKM, they’ll need R22, R142b (which again is in high demand worldwide, without enough supplies).

So what is PVDF? And where does it fit in the EV battery chain?

PVDF is a fluoropolymer that is used in stuff that requires the highest purity, as well as resistance to solvents, acids and hydrocarbons. Below is an image which describes the stuff that goes into batteries.

More on PVDF Binders and Coatings from Solvay, another global player that is into fluoropolymers.

Moving on to FKM. What exactly is it?

Why is FKM, another fluoropolymer, in demand? And what kind of market share does GFL have in this product? The answers are in their July 2022 concall.

And they will have at least 10% worldwide market share in FKM.

Okay so what’s the big deal in having a 10% market share? Can’t another set of players just come in and make more FKM and other stuff that GFL makes?

Here’s one more from another site, which says building chemical plants will take longer than building semiconductor plants. Semiconductors are another industry where FKM is used. This comes from an executive from Daikin which is a major fluoropolymer manufacturer.

What stops a potential new entrant from coming in with new capacities here?

Besides, GFL started out as a commodity Fluoropolymer player and over a course of time created a large no. of Fluoropolymer grades specific to their customer. This leads to a lot of customer stickiness and makes life difficult for a potential new entrant.

One of the raw materials that is not available for producing FKM, PVDF and other fluoropolymers is R142b, a refrigerant gas that not many cos on the planet are allowed to manufacture. New approvals for these gases take a long long time because of the ozone depleting potential of these gases.

And here’s a co. that will not only use R142b for captive consumption but also export it. Talk about having your cake and eating it too.

Essentially these facts mean fluoropolymer cos worldwide are:

• In huge demand, thanks to rising consumption of Lithium Ion batteries.
• There are not enough capacities that can meet this demand.
• Players that make both, the raw materials as well as the end product, are at a huge advantage, compared to the others.
• It takes many years, lot of effort, approvals and expertise to add capacities.

This puts players like GFL in a sweet spot. Btw GFL is the only company in India to make and export some of the products I have written about and other spec chem players in India are likely to take a while before they can catch up.

One of the things I’ve learnt as an investor is that we should view businesses as stories that are unfolding and not as pictures of still water. A lot of these growing businesses spring up happy surprises when you least expect them to. I am sure very few investors or perhaps nobody, a few years ago, would have imagined PVDF would become such a big business for GFL.

Yet, here’s how the movie unfolded. Starting with PTFE suspension, they gradually moved to PTFE Emulsion, FKM, PFA, FEP, Additives and eventually to PVDF.

And here’s how the management is expecting their Specialty Chemicals business to play out. Specialty Chemicals which is a 300 Crs business in June 2022 could potentially transform into a 2000+ Crs business over the next few years, thanks to battery chemicals such as LiPF6 that they are planning to make in the near future.

Here’s a Chinese player, Guangzhou Tinci Materials, which makes LiPF6 and below we can see the kind of supernormal growth they are seeing in their business.

And Tinci’s business in no mood to slow down. Here’s a recent news article which shows the kind of exponential growth they are seeing. The article also states they are expanding capacities.

The fact that the lithium ion battery market is growing at more than 20% was also confirmed by GFL’s management in their May 2022 concall.

The future will tell whether or not GFL can execute their LiPF6 business the way they have done for PVDF & FKM. If LiPF6 works out well, that’ll be an icing on the cake.

New Fluoropolymers, which consist of PVDF & FKM are just 18% of their TTM sales. I foresee this division becoming a larger chunk of the overall pie in the near to medium term. Specialty Chemicals which would consist of LiPF6 in the future, is 7% of TTM sales and that could become a big one as well.

Risks

• Corporate guarantees worth 1000 Crs+ given to Inox Wind – Inox Wind is another entity from the same promoter group. This one has been a bee in the bonnet for GFL’s stock for quite sometime. Promoters have committed to return this money to GFL by March 2023. Any other hanky panky in this area would be a show spoiler.
• Disruption risk – If EVs start adopting other technologies owing to supply chain issues in PVDF / FKM and other fluoropolymers, this would lead to GFL’s business getting hurt. As of today, I haven’t been able to find any evidence to support this argument. But then technologies & supply chains can evolve rapidly given there is enough moolah involved, and one can never say for sure.
• Fire hazards – Last year there was a fire at one of the GFL’s plants and that led to a shut down of that plant for sometime. Although it was covered by insurance, something similar happening again could spook investors.
• Environmental hazards / gas leaks in the future.
• LiPF6 business not kicking off as expected.
• Other unpredictable risks – Risk is what is left over after we’ve thought about everything else.

More availability leads to more consumption

Charlie Munger once said “You’ll drink a hell of a lot more Coke if it’s always available.”

Charlie was implying the power of Coca Cola’s worldwide distribution network. Just because Coke is available everywhere, we tend to consume more of it. Imagine someone keeping a new Coke bottle at your and all your colleagues’ desks every day. Without doubt, it will lead to more sales for Coke, no matter how health conscious you or some of your colleagues are.

Here’s one more from one of my favorite self-help books.

“Environment is the invisible hand that shapes human behavior. Despite our unique personalities, certain behaviors tend to arise again and again under certain environmental conditions. In church, people tend to talk in whispers. On a dark street, people act wary and guarded. In this way, the most common form of change is not internal, but external: we are changed by the world around us.”

Atomic Habits

It’s easy not to read a book when the bookshelf is in the corner of the guest room. It’s easy not to take your vitamins when they are out of sight in the pantry. When the cues that spark a habit are subtle or hidden, they are easy to ignore. If you want to remember to take your medication each night, put your pill bottle directly next to the faucet on the bathroom counter. If you want to practice guitar more frequently, place your guitar stand in the middle of the living room. If you want to remember to send more thank-you notes, keep a stack of stationery on your desk. If you want to drink more water, fill up a few water bottles each morning and place them in common locations around the house.

Atomic Habits

Will something similar happen with EV adoption? What will happen when charging stations become available at more and more parking lots, malls, restaurants, offices and apartment car parks? Chances are high that if the external environment makes more charging stations available, it will lead to faster adoption of EVs.

And your guess is as good as mine on what kind of an impact this will have on the financials of EV beneficiary companies such as GFL.

Disclosure – I have a position in this company and my views are certainly biased. This blog is not to be construed as an investment advice. Please consult your investment advisor before investing.

Disclaimer: This is NOT investment buy/sell/hold advise. I am not SEBI registered. May change stance on above business anytime with new developments and/or new insights, and/or overall market conditions. May NOT be able to update periodically. Please do your own diligence and/or take professional advise, before investing.

Barath Mukhi
12-August-2022

There’s this German company that makes a key component for automotive, aerospace, and industrial uses. The company initiated a restructuring program in Sep 2020. Due to rising costs, management wanted to reduce headcount & manufacturing capacity in Germany.

Here’s the press release from the company in Sep 2020.

Now, if we were to read between the lines, a big chunk of these jobs and production capacities would be moved elsewhere.

How do we know where these jobs are moving to? One, by reading between the lines and two with some data. First, let’s see what the management of the Indian listed entity of the same group, is saying.

So the Indian co. is saying, they will grow their exports but cannot reveal, at what rate. My guess is they either don’t have a go ahead from the parent due to geo-political reasons or perhaps it is an evolving situation and they don’t know themselves, what their German bosses have in mind.

Now let’s move to the data. A rising export trend, indicates that management is walking the talk and business is indeed moving to India and could be an indicator of things to come.

Now let’s look at, what sales look like for the German parent and for the Indian entity.

The German group’s worldwide sales are 29 times that of the Indian entity’s 3762 Crs, last year and that means there is a lot of room for growth here and scalability is not likely to be an issue.

Now, this is not a company that is struggling to sell its products. It is a company which is trying to cut costs and move jobs to lower cost locations such as our very own. In fact, it is an seven decade old company which holds a significant global market share in the segment in which it operates.

Risks

• Plants are operating at full capacity and future growth relies on Capex. Current fixed assets = 1000 Crs. Capex for next 3 years = 1200 Crs.
• German politicians are already doing everything they can to retain jobs within their geographies. As of today, cost economics are winning over politics and business is moving to India. This may or may not turn out to be the case, in the future.
• Margins drop due to fluctuation in raw material prices. Although margins have stayed relatively stable for the company in the past, there is no guarantee that they will be able to pass on commodity price risks over to their customers in the future and remains a key risk for investors.

At the time of this writing, the business trades at 50 times earnings. For a business where things can change quickly, does it make sense to value the business based on a P/E multiple?

I’ll leave you with that thought.

Disclaimer: Invested in the Indian co. from lower levels. These are my views and are not to be construed as investment advice. As always, please do your own research before proceeding to buy/sell/hold.

Barath Mukhi
5th Jan 2022

Let me just start by saying that my views are positively biased because I have stayed invested in this company since much lower levels.

This post is an attempt to articulate what I have learnt so far, about Indian Pharma.

We have all read recent news reports about the Chinese government cutting power to polluting factories in certain areas. These power supply cuts mean that the factories operating out of such provinces will have lesser capacity to produce goods and operate at a much lesser scale.

This change could mean that if Chinese manufacturers are unable to produce as much chemicals or APIs (active pharmaceutical ingredient) or Key Starting Materials, as before, there would be a shortage of these products across countries. This could possibly lead to higher prices of these products for whoever is able to make them and thereby result in increasing sales and margins. These manufacturers could be from China, India, Timbaktu or anywhere else.

In our case, it could either be beneficial or not, depending upon which side of disruption, the companies that we are invested in, are on.

What are Key Starting Materials (KSM)?

The textbook definition of KSMs – Critical input used in the manufacturing of an essential generic medicine, as well as ingredients or components that possess unique attributes essential in assessing the safety and effectiveness of such essential generic medicines, including excipients and inactive ingredients.

From what I have understood so far, KSMs include stuff like Amines, Solvents, Reactants, Acids & Salts. Maybe there are things beyond this too.

With this background, let’s define the problem now. Raw material supplies for Pharmaceutical companies are likely to get hit and these shortages will lead to spikes in input costs.

Question – Who will be impacted negatively and who will be impacted positively, by this change?

There are certain products where Indian API manufacturers are completely dependent on China for APIs and KSMs. For instance, fermentation-based products like anti biotics, statins, vitamins etc. These players may see cost escalations in input costs of fermentation based products and some of them will pass it on to their end customers over time. Conversely, Pharma players without pricing power won’t be able to pass on these increased costs and their margins will get negatively impacted.

Since I am interested in Laurus Labs, I was worried about this angle and decided to deep dive.

What will happen if Laurus Labs is not able to pass on these price increases to their customers?

Here’s what I found.

This China problem is not new. It keeps cropping up every once in a while. They had a similar issue in 2019 as well.

And here’s how they handled it.

Let’s go back another year now. The year is 2018 and they were having the same troubles. Prices of key raw materials had gone up and Laurus was able to convert a challenge into an opportunity.

Based on the above events, one gets a gut feel that even if there are challenges in the supply chain, here’s a team that can do things, to resolve the issue.

Now let’s look at the situation from the vantage points of various stakeholders involved.

The Chinese factory owner: Last week it was the pollution control officers. This week it is the damn power cuts. How am I gonna pay my bills? How am I to pay salaries to all those people working on the shop floor? I am not sure how long I can sustain in this business.

The Indian Entrepreneur: There’s a plant closing down in China. I am sure there are opportunities out there for me to go out and grab, and thereby grow my business. While that happens, my margins could take a hit and let me keep my eye on the ball and focus on the long term.

The Customer: Everything was going so well and then thanks to all the polluting factories, I need to find another skilled guy in another business friendly geography where my supplies are guaranteed with equal or perhaps better quality.

Mr. Market: He is swinging in between what will happen in the next quarter and what will happen over the long term. On days when he is worried about the next quarter, he offloads his stake. And on days when he is focused on the long term economics of the business, he thinks “This China + 1 thing is real after all. More and more business could fall into this company’s lap. Let me just hold on to this business. Better yet, let me increase my stake in this business.”

Let’s look at some disconfirming evidence too. Below is one instance wherein they were unable to pass on price increases to their customers.

That being said, here are my conclusions.

• Equity investing is not a science. Sometimes, we just need to stomach the volatility, the uncertainty & the self-doubt that accompanies falling stock prices. Particularly so, if the entrepreneur has a decent, execution track record.
• Disruption in APIs isn’t new. It’s been there for a couple of years and is here to stay. And entrepreneurs who have handled it successfully before, could possibly handle it well in the future too.
• What Mr. Market perceives as disruption, is perceived by the entrepreneur as an opportunity. There are times when blind belief in the entrepreneur is foolhardy. Yet there are times, when you need to go with your gut feel and just trust that the jockey will make things right.

You don’t want to be that guy who calculates too much and thinks too little.

Disclaimer: I have been wrong with my thesis in the past and could be wrong this time or in the future too. These are my thoughts today and could change as and when the situation evolves or whenever disconfirming evidence presents itself.

Barath Mukhi
11-Oct-2021

I recently revisited an interview by Mr. Raamdeo Agrawal, where he said “I am very happy when the markets fall and I can buy something that adds more value to my portfolio. Markets don’t understand high quality value in the short term. Focusing on value is the key. What we have learnt is that the value of the company remains steady even if there are external events. Only the price changes. Till 1998 nobody knew about the index. People looked at only individual stocks. This focus on index has spoilt the game. We focus on value instead.“

The question I am seeking an answer to is whether the index really matters or is it just plain noise and we should be focusing instead on what our portfolio companies are doing currently and expected to do in the future, while disregarding what the market does.

The idea behind doing this post is to explore what happens when a small or a mid cap investor buys a basket of growing small caps and does not worry about the small cap index or the Nifty or the Sensex or any other indexes, at all. And should one really worry about index levels if businesses we are holding in our portfolios are doing well regardless? Articulated differently, is time in the markets more important than timing the markets.

What kind of profits or losses would one encounter, if he/she bought small & mid caps in Nov 2010, when the small cap index topped out & held them until Aug 2013, when the index was down by 54% from its previous peak?

And here’s how the BSE Mid cap index moved during the same period. The mid cap index was down by 40% while the small cap index was down by 54%

Methodology used

• Filtered companies that grew their profits by at least 15% in FY2009, FY2010 & FY2011.
• Removed a handful of companies where charts are not available due to corporate actions such as delisting, mergers, etc.
• Removed large caps since most of us are interested in small/mid caps only.
• Analyzed the out-performers from this group.
• Dividends excluded.

Note: Blue lines in each of the below graphs represent the BSE Small Cap Index while orange lines represent the corresponding stock.

Solar Industries
Estimated Market cap in 2010 – 1124 Crs
Outperformed vs the small cap index
62% absolute returns

Redington India
Estimated Market cap in 2010 – 3671 Crs
Outperformed vs the small cap index
Negative absolute returns

Apollo Hospitals Enterprise
Estimated Market cap in 2010 – 7628 Crs
Outperformed vs the small cap index
69% absolute returns

Va Tech Wabag
Estimated Market cap in 2010 – 2094 Crs
Outperformed vs the small cap index
Negative absolute returns

Cadila Healthcare
Estimated Market cap in 2010 – 16042 Crs
Outperformed vs the small cap index
Negative absolute returns

Vardhman Textile
Estimated Market cap in 2010 – 1977 Crs
Outperformed vs the small cap index
Negative absolute returns

Swaraj Engines
Estimated Market cap in 2010 – 599 Crs
Outperformed vs the small cap index
9% absolute returns

Cera Sanitaryware
Estimated Market cap in 2010 – 238 Crs
Outperformed vs the small cap index
180% absolute returns

Castrol India
Estimated Market cap in 2010 – 12893 Crs
Outperformed vs the small cap index
48% absolute returns

Mayur Uniquoters
Estimated Market cap in 2010 – 171 Crs
Outperformed vs the small cap index
89% absolute returns

Engineers India
Estimated Market cap in 2010 – 10029 Crs
Under performed vs the small cap index
Negative absolute returns

Jenburkt Pharmaceuticals
Estimated Market cap in 2010 – 40 Crs
Outperformed vs the small cap index
Negative absolute returns

Torrent Power
Estimated Market cap in 2010 – 17250 Crs
Under performed vs the small cap index
Negative absolute returns

Exide Industries
Estimated Market cap in 2010 – 14350 Crs
Outperformed vs the small cap index
Negative absolute returns

Indian Toners & Developers
Estimated Market cap in 2010 – 39 Crs
Under performed vs the small cap index
Negative absolute returns

Consolidated Finvest & Holdings
Estimated Market cap in 2010 – 297 Crs
Under performed vs the small cap index
Negative absolute returns

Superhouse
Estimated Market cap in 2010 – 79 Crs
Outperformed vs the small cap index
Negative absolute returns

R S Software (India)
Estimated Market cap in 2010 – 63 Crs
Outperformed vs the small cap index
177% absolute returns

Pennar Industries
Estimated Market cap in 2010 – 782 Crs
Under performed vs the small cap index
Negative absolute returns

Phyto Chem (India)
Estimated Market cap in 2010 – 6 Crs
Outperformed vs the small cap index
60% absolute returns

Narmada Gelatines
Estimated Market cap in 2010 – 41 Crs
Outperformed vs the small cap index
31% absolute returns

Shree Renuka Sugars
Estimated Market cap in 2010 – 21040 Crs
Under performed vs the small cap index
Negative absolute returns

Ushdev International
Estimated Market cap in 2010 – 1429 Crs
Outperformed vs the small cap index
Negative absolute returns

Kama Holdings
Estimated Market cap in 2010 – 352 Crs
Outperformed vs the small cap index
Negative absolute returns

P I Industries
Estimated Market cap in 2010 – 771 Crs
Outperformed vs the small cap index
140% absolute returns

Supreme Industries
Estimated Market cap in 2010 – 2078 Crs
Outperformed vs the small cap index
134% absolute returns

Torrent Pharmaceuticals
Estimated Market cap in 2010 – 4756 Crs
Outperformed vs the small cap index
58% absolute returns

Balaji Amines
Estimated Market cap in 2010 – 164 Crs
Outperformed vs the small cap index
Negative absolute returns

RPG Life Sciences
Estimated Market cap in 2010 – 182 Crs
Outperformed vs the small cap index
Negative absolute returns

Kaveri Seed Company
Estimated Market cap in 2010 – 486 Crs
Outperformed vs the small cap index
338% absolute returns

Veritas (India)
Estimated Market cap in 2010 – 1080 Crs
Under performed vs the small cap index
Negative absolute returns

eClerx Services
Estimated Market cap in 2010 – 1872 Crs
Outperformed vs the small cap index
50% absolute returns

Vinati Organics
Estimated Market cap in 2010 – 411 Crs
Outperformed vs the small cap index
8% absolute returns

Agro Tech Foods
Estimated Market cap in 2010 – 108 Crs
Outperformed vs the small cap index
54% absolute returns

Stylam Industries
Estimated Market cap in 2010 – 28 Crs
Outperformed vs the small cap index
Negative absolute returns

Garware Polyester
Estimated Market cap in 2010 – 641 Crs
Under performed vs the small cap index
Negative absolute returns

Atul Ltd
Estimated Market cap in 2010 – 579 Crs
Outperformed vs the small cap index
83% absolute returns

Somany Ceramics
Estimated Market cap in 2010 – 286 Crs
Outperformed vs the small cap index
35% absolute returns

Vidhi Specialty Food Ingredients
Estimated Market cap in 2010 – 21 Crs
Outperformed vs the small cap index
Negative absolute returns

Page Industries
Estimated Market cap in 2010 – 1565 Crs
Outperformed vs the small cap index
225% absolute returns

Thangamayil Jewellery
Estimated Market cap in 2010 – 240 Crs
Outperformed vs the small cap index
12% absolute returns

DHP India
Estimated Market cap in 2010 – 11 Crs
Outperformed vs the small cap index
Negative absolute returns

Sudarshan Chemical Industries
Estimated Market cap in 2010 – 468 Crs
Outperformed vs the small cap index
Negative absolute returns

Oriental Carbon & Chemicals
Estimated Market cap in 2010 – 142 Crs
Outperformed vs the small cap index
Negative absolute returns

Bajaj Electricals
Estimated Market cap in 2010 – 3640 Crs
Outperformed vs the small cap index
Negative absolute returns

DFM Foods
Estimated Market cap in 2010 – 106 Crs
Outperformed vs the small cap index
138% absolute returns

Ashoka Buildcon
Estimated Market cap in 2010 – 1994 Crs
Under performed vs the small cap index
Negative absolute returns

Manali Petrochemicals
Estimated Market cap in 2010 – 312 Crs
Outperformed vs the small cap index
Negative absolute returns

BASF India
Estimated Market cap in 2010 – 3023 Crs
Outperformed vs the small cap index
Negative absolute returns

India Motor Parts & Accessories
Estimated Market cap in 2010 – 303 Crs
Outperformed vs the small cap index
19% absolute returns

Gravita India
Estimated Market cap in 2010 – 351 Crs
Under performed vs the small cap index
Negative absolute returns

HSIL
Estimated Market cap in 2010 – 278 Crs
Outperformed vs the small cap index
Negative absolute returns

Caprihans India
Estimated Market cap in 2010 – 278 Crs
Outperformed vs the small cap index
Negative absolute returns

Dr Agarwals Eye Hospital
Estimated Market cap in 2010 – 40 Crs
Outperformed vs the small cap index
Negative absolute returns

Triton Valves
Estimated Market cap in 2010 – 103 Crs
Under performed vs the small cap index
Negative absolute returns

Simran Farms
Estimated Market cap in 2010 – 29 Crs (Can be considered a penny stock)
Under performed vs the small cap index
Negative absolute returns

Ramky Infrastructure
Estimated Market cap in 2010 – 2568 Crs
Under performed vs the small cap index
Negative absolute returns

Josts Engineering Company
Estimated Market cap in 2010 – 35 Crs
Outperformed vs the small cap index
Negative absolute returns

DIC India
Estimated Market cap in 2010 – 305 Crs
Outperformed vs the small cap index
Negative absolute returns

Educomp Solutions
Estimated Market cap in 2010 – 7708 Crs
Under performed vs the small cap index
Negative absolute returns

JMD Ventures
Estimated Market cap in 2010 – 297 Crs
Under performed vs the small cap index
Negative absolute returns

Nakoda Ltd
Estimated Market cap in 2010 – 570 Crs
Outperformed vs the small cap index
Negative absolute returns

Samtex Fashions
Estimated Market cap in 2010 – 53 Crs (Penny stock)
Under performed vs the small cap index
Negative absolute returns

SEL Manufacturing Company
Estimated Market cap in 2010 – 2 Crs (Penny stock)
Under performed vs the small cap index
Negative absolute returns

Silver Oak (India) Ltd
Estimated Market cap in 2010 – 6 Crs (Penny stock)
Outperformed vs the small cap index
10% absolute returns

Technofab Engineering
Estimated Market cap in 2010 – 192 Crs
Under performed vs the small cap index
Negative absolute returns

Pratibha Industries
Estimated Market cap in 2010 – 1912 Crs
Outperformed vs the small cap index
Negative absolute returns

Opto Circuits (India)
Estimated Market cap in 2010 – 7063 Crs
Outperformed vs the small cap index
Negative absolute returns

Him Teknoforge
Estimated Market cap in 2010 – 84 Crs
Outperformed vs the small cap index
142% absolute returns

Kwality Ltd
Estimated Market cap in 2010 – 3084 Crs
Outperformed vs the small cap index
Negative absolute returns due to suspected operator manipulation in the stock

IRB Infrastructure Developers
Estimated Market cap in 2010 – 3084 Crs
Outperformed vs the small cap index
Negative absolute returns

Fluidomat
Estimated Market cap in 2010 – 25 Crs
Outperformed vs the small cap index
39% absolute returns

Garden Silk Mills
Estimated Market cap in 2010 – 619 Crs
Under performed vs the small cap index
Negative absolute returns

Simplex Castings
Estimated Market cap in 2010 – 73 Crs
Under performed vs the small cap index
Negative absolute returns

Sacheta Metals
Estimated Market cap in 2010 – 154 Crs
Under performed vs the small cap index
Negative absolute returns

Mahalaxmi Rubtech
Estimated Market cap in 2010 – 417 Crs
Under performed vs the small cap index
Negative absolute returns

ARSS Infrastructure Projects
Estimated Market cap in 2010 – 3006 Crs
Under performed vs the small cap index
Negative absolute returns

Supreme Infrastructure India
Estimated Market cap in 2010 – 748 Crs
Outperformed vs the small cap index
Negative absolute returns

Inani Marbles & Industries
Estimated Market cap in 2010 – 44 Crs
Outperformed vs the small cap index
20% absolute returns

Jindal Hotels
Estimated Market cap in 2010 – 45 Crs
Under performed vs the small cap index
Negative absolute returns

Emmbi Industries
Estimated Market cap in 2010 – 39 Crs
Outperformed vs the small cap index
Negative absolute returns

Paramount Cosmetics
Estimated Market cap in 2010 – 20 Crs
Under performed vs the small cap index
Negative absolute returns

MBL Infrastructures
Estimated Market cap in 2010 – 1446 Crs
Under performed vs the small cap index
Negative absolute returns

XPRO India
Estimated Market cap in 2010 – 1446 Crs
Under performed vs the small cap index
Negative absolute returns

25 stocks that gave positive returns until 2013, despite the small cap index being half of what it was in 2010.

13 Companies grew their sales by more than 15% throughout 2011, 2012 & 2013.

4 companies grew their profits by more than 15% throughout 2011, 2012 & 2013.

22 out of 25 companies had above average ROEs, throughout.

Now, some of the above companies might have had ongoing capacity expansion projects which might have optically suppressed their ROEs. Yet, these companies’ businesses and stocks continued to do well in what was perceived to be the worst possible time to get into small caps, in many years.

Let’s try some dis-confirming evidence now. First some data.

Total # of companies (small & mid cap) that grew PAT by at least 15% YoY in that period 95
Total # of companies that outperformed 25
Total # of companies that under performed 59
Total # of companies excluded due to corporate actions / lack of data 11

Did any of the companies that showed negative returns, have an ROE of 15% consistently? None. Zero.

Did any of the companies that showed negative returns, have consistent growth of more than 15% per annum? Again, the answer is no.

This would mean that ROE & growth are the engines which drive stock prices.

How can we make this study better?

If you have suggestions on how we can make this study better and as bias-free as possible, please drop me a note at barath@bigvisioninvesting.com or in the comments box below and I’ll try to see how best we can incorporate it.

Conclusions thus far:

• Businesses (and stocks) can do well despite all odds. Imagine the pain you’d have gone through, had you sold one of the out-performers because of all the market related noise in the media, thereby trying to time the market.
• Stock prices are driven by growth, ROE (& the US Fed) in the long run. And stocks of businesses which tick both boxes can do well, in the worst possible market conditions.
• Focus more on the business is doing than on what the market indices will do.

I will do a similar blog for the next small cap cycle which happened from Jan 2018 to Mar 2020 (chart below), just to find out if these conclusions hold good in another time frame. Stay tuned.

Barath Mukhi
28-Sep-2021

This is a case study of how a lot of investors missed a big trend in Indian markets, costing them a 25+ bagger and how we can avoid falling prey to such a trap, ourselves.

Bull markets can delude one into believing that good times will continue. Likewise for bear markets. In bear markets we may start to believe that things around us are gradually getting worse when they could actually be getting better. This notion is compounded by the fact that everybody around us is bearish and negative about the future state of the economy and the markets. As investors, it is our job to keep our eyes on the ball (data) and not lose focus by believing what everybody else is saying.

Imagine what might been on investors minds, after reading scary headlines, such as these.

Imagine that the Sensex goes down from 50000 to 31000, over the next 3 years. What effect will it have on your psyche?

Sensex – March 2021	50000
Sensex – March 2022	37500
Sensex – March 2023	36750
Sensex – March 2024	31973

Yet, this is exactly how it played out in the 500+ trading days between 2001 & 2003, in percentage terms.

March 31, 2001	-25%
March 31, 2002	-2%
March 31, 2003	-13%

Most investors are likely to have lost both, the money and the confidence in the above kinda market. Some of us may think, yeah the market rises, every time it falls and we might have just kept buying, had we been investors back then.

However, this ignores the psyche of most investors of that era. In 2000, just when the market was starting to forget the Harshad Mehta scam of 1992, and investors would have been less worried about manipulation, came another blow to their faith in the markets, in the form of the Ketan Parekh scam of 2001. And after they or their peers lost money, some of them are likely to have believed, Indian markets will never change and there will always be scams like these.

Also, in 2001, FIIs started to pull money out, after the Sep 11 attacks on WTC. Back then, FIIs were considered the major drivers of stock prices in India, because collectively, they had the muscle to move markets whichever way they wanted and FIIs selling could mean just one thing.

Investors were perhaps twice bitten, thrice shy (First Harshad, then Ketan). This was an era where the internet was still a luxury and wasn’t considered too important. Information flow wasn’t as smooth as, it is today. Perhaps, not many would have foreseen the impact, the introduction of demat and online trading would have, on making it harder & harder to manipulate the markets at the scale of previous scams. Even today, some old timers believe the market is a gambling den, thanks to historical scams like these ingrained in their memory and to a genetically programmed human emotion, called loss aversion.

Enter, the era, when mobile phones went from being a luxury to becoming a need, and landlines were still the norm. To put things into perspective, this bulky phone, the Nokia 6600, a rage back then, thanks to it’s relatively lower price tag and the all new camera feature, was launched in India, only in Oct 2003 and it took some years for it to be widely accepted.

So, in the middle of all these things, in 2003, why would you want to put your money into a company whose losses had kept increasing for 4 years? It also had a seemingly insane market cap, of 5000 Crores.

Investors were also expecting this company to continue making losses for the next few years.

Yet the stock price started moving up and went on to become a multi bagger over the next few years.

This is a story about Bharti Airtel. And here’s how one very smart investor kept his ears to the ground, thought differently and made solid money from this stock.

Raamdeo Agrawal’s investment thesis “Bharti Airtel was a big investment for us. It was a combination of two frameworks – value migration from fixed line to wireless phone and the network effect. In network business, the winner takes it all. The number one player makes 80% of the profits and the number two player 15%. I had read this in Michael Mauboussin’s book. In 2003, Bharti was making losses. In Jan 2003, Bharti’s CMD, Sunil Bharti Mittal, announced on the analyst call, that they had started breaking even. I did a five year excel spreadsheet analysis and deduced that they will make Rs. 28 thousand crores, cumulative PAT, in the next 6 years. The cash flows were expanding, the operational cost was fixed and there was a ten year tax holiday. The market cap was just Rs. 5000 Crs then. In life, you get very rare opportunities like these when the market is blind to the numbers. The market was also very depressed in 2003, which contributed to the under valuation. We bought the stock at Rs. 12.5 (adjusted) and it went to Rs. 590 within 3 to 4 years, but I did not sell then. I sold the stock at Rs. 325, when they bought businesses in Africa. So, it was still 25x. Investments like these give you the confidence that your frameworks work. In earlier times, just buying stocks at cheap valuations, made money. But the world has changed. You cannot just buy cheap and do well. You have to buy quality stocks with growth at cheap valuations.”

His investment thesis was a lollapalooza, where multiple mental models came together, which isn’t practically easy to do, by the way. Perhaps there are more models, but here are the ones that come to my mind.

• Network effects (Pat Dorsey)
• Loss to profit company (Ben Graham)
• Using spreadsheets which are frowned upon otherwise (Mr. Agrawal projected a PAT of 28000 Crs. Actual number 22000 Crs)
• Focusing on the story and not on numbers (RK Damani’s HDFC Bank example?)
• Operating leverage once fixed costs are covered
• Focusing on Cash flows (Buffett)
• Mr. Market was depressed (Ben Graham)
• Focusing on quality + growth and not just cheap valuations (Munger)

Focusing on cash flows instead of profits

Conclusions

• Depressed markets can impact investors’ judgements, even without they realising it. Why else would somebody ignore a massive change in consumer preferences, that was very evident (in hindsight)? If there is a multi-year bear market in the future, keep your eyes and years open. Do not forget that, things will eventually get better.
• Do not underestimate the effect, negative news flow from social media, can have on your psyche.
• Buy what you see isn’t always easy.
• Keep an eye on companies which are reporting losses, yet are cash flow positive.
• Growth + Quality + Reasonable valuations due to Mr. Market’s bias = Multi baggers.

Barath Mukhi
1st April 2021