BS Books and Bloomsbury: Simple rules for successful investing

Saurabh Mukherjea tackles the simple rules for successful investing in his book, Gurus of Chaos: Modern India's Money Masters, published by BS Books and Bloomsbury

What does it take to be a successful investor? Saurabh Mukherjea tackles this question in his book, Gurus of Chaos: Modern India's Money Masters, published by BS Books and Bloomsbury. Here is the first of a two-part series excerpted from the book that explains the unique philosophies that power investment strategies of experts.

The reality of long term success in the stock market is very different. Whilst there are some investors who rely upon inside information to make money, truly successful long term investors use other techniques to make money. In fact, one sure way to lose money in the market (and get into trouble with the law) is to rely upon inside information. Successful long term investors use a simple but powerful set of rules to make money in the market. We will look at these rules in detail in this section and then, in the next section, delve into the mental discipline required to adhere to them.

Rules for buying
Rule 1: Only buy a stock if you understand the business model.

'I also prefer very simple businesses. If the business model is very difficult to understand, I'm happy to pass on it-there are lots of others that are easy to understand.'

-Anthony Bolton. (Investing Against the Tide, Anthony Bolton, (FT Prentice Hall, 2009), pg 11.)

Before you can start assessing the merits of a business, you need to understand the product that the company manufactures. You need to answer simple questions such as 'who buys it, why does he buy it and how does the company make money'. Therefore, the most basic buying rule is to not even consider a company for investing, if you do not 'understand' the business. This process of understanding how a company works is not as simple as it sounds. Let me illustrate with a couple of examples. Let's take what sounds like a simple business such as pressure cookers and focus on the market leader, TTK Prestige. Most people believe that TTK Prestige manufactures only one product, pressure cookers, and manufactures this largely in India and sells it through third party distributors in India. Hence it is, you would imagine, a fairly simple business to understand and invest in. However, because of the metamorphosis that TTK has been through in the past decade or so, the reality is very different (not just for TTK Prestige but for a host of other Indian consumer durables manufacturers):

• Only a third of TTK's revenues now arise from pressure cookers; the remaining two-thirds of revenues come from selling a variety of kitchenware products such as non-stick cookware (17 per cent of total revenues), kitchen electrical appliances (33 per cent of total revenues) and gas stoves (9 per cent of total revenues).
• Around a quarter of TTK's revenues come from products manufactured in China by outsourced suppliers. At its peak in FY12, as much as 40 per cent of its revenues arose from products sourced by TTK from Chinese manufacturers.
• As much as a fifth of TTK's revenues are generated from sales through Prestige Smart Kitchens (PSK). These are stores owned and operated by franchisees which showcase the entire Prestige product range from pressure cookers to induction cook-tops and electrical appliances. TTK Prestige frequently uses the PSK network to either launch new products or expand its presence in smaller cities where the traditional multi-brand dealer distribution network is not strong enough. The credit terms or capex support available to PSKs consequently depend on the perceived demand pull for TTK products in the region.
• Six per cent of TTK's revenues (and an even higher percentage of its profits) arise from exports (as of FY13). This figure is up from 2 per cent a couple of years ago. These four facets of TTK's business-multiple products (rather than just pressure cookers), sourced from multiple countries, sold through multiple channels (including their own 'Smart Kitchen' stores and sold in multiple countries-has helped accelerate the firm's growth in revenue terms over the past decade (FY03-13 revenue CAGR of 28 per cent), increase its EBITDA margins (minus 5 per cent in FY03 to 15 per cent in FY13), sweat its fixed assets (i.e. its plant and machinery harder) and shorten its working capital cycle. The overall result is not just a surge in profitability (FY04-13 EPS CAGR of 105 per cent) but also acceleration in operating cash flow (FY03-12 operating cash flow CAGR of 64 per cent).

The three critical 'value levers' for TTK therefore have become:

1. Product innovation: Over 70 per cent of TTK Prestige's revenues in any given year are generated from items introduced over the previous three years. This helps the company in two ways:

(a) Introduce differentiated products which are better aligned with evolving customer preferences compared to the products offered by competitors; and

(b) Leverage the strength of its existing brand and distribution to enter into new categories of kitchenware and hence widen the effective size of the market that TTK Prestige caters to.

2. Distribution and supply chain management: With 23 warehouses across India and an efficient hub and spoke distribution network in place, dealers across India acknowledge that in stark contrast to most of its competitors, availability of stock on demand is seldom a concern with TTK Prestige's products. Moreover, franchisee shops (PSKs), help distribute the entire product range, increase competition with traditional dealers, and help TTK penetrate into cities where brand awareness remains low.

3. Talented and well incentivised management team: TTK Prestige's senior management, led by the promoter, TT Jagannathan, is strongly focused on maintaining the company's pre-tax ROCE of 50 per cent. He ensures that the management team is aligned to the same goals and that the company offers sufficient incentives to the team for their efforts. The team consists of high quality home-grown professionals who took control of various senior level responsibilities a decade ago once the firm realised that it was too big to be run single-handedly by TT Jagannathan. Moreover, the company is now in the process of creating several middle management roles to handle the scale of business it targets to achieve in the coming years. Given the transition from a solely promoter-managed company to one which is managed by professionals, the firm has put in place performance based incentive structures for the professionals in order to allow them to increase their shareholding in the firm in the coming years.

The author, who is head of institutional equities at Ambit, has been nominated the Number 1 Strategist in India in 2014 by Asiamoney