CONTENTS

Part 1: Learn
Chapter One: Goldmine to Create Wealth
Chapter Two: Financial Freedom Flywheel
Part 2: Implement
Chapter Three: First Principles - Drivers of Mega Compounding
Machine
Chapter Four: Screening For Mega-Compounders
Chapter Five: Everything is Cyclical
Chapter Six: Core and Satellite
Chapter Seven: Megatrends
Chapter Eight: Action
Chapter Nine: Competitive Advantage
Chapter Ten: High Quality
Chapter Eleven: Improvement
Chapter Twelve: New Factor
Chapter Thirteen: Execution of Earnings Growth Triggers
Chapter Fourteen: Bamboo Investing - The Satellite Portfolio Play
Part 3: Refine
Chapter Fifteen: Allocation and Position Sizing
Chapter Sixteen: Riding Winners
Chapter Seventeen: Risk Management, Rebalancing and Exit
Strategies
Chapter Eighteen: Vicarious Learning - Learn from Other’s Mistakes
Chapter Nineteen: The Most Important Thing
Chapter Twenty: Compounding Beyond Money
Appendix
Further Reading Recommendations
Acknowledgments
Endnotes
To download free bonuses visit:
http://youcancompound.com/
CHAPTER ONE

G O L D M I N E T O C R E AT E
W E A LT H
“The trouble with being in the rat race is that
even if you win, you’re still a rat.”
—Lily Tomlin
Chatur Champak and Rocking Ranjita are a happily married Indian middle-
class couple. Chatur worked in an IT Services company as a project
manager, and Ranjita was a homemaker. The initial few years were fantastic
- frequently ordering food from outside, buying the latest gadgets, partying
on weekends and vacationing in exotic destinations twice
a year.
Their life was like a plain sail until they entered a new phase of life:
parenting. This awakened them to a new reality of life. The same salary that
was enough to live a classy lifestyle now looked deflated. One Sunday
morning, when the Chatur and Ranjita calculated what they had in the name
of savings for their kid’s future education, they were thunderstruck. They
realized they had pint-sized savings resting in their account. A major
portion of Chatur’s income leaked into paying credit card bills, rent, EMIs,
grocery, rent and other bills. To add insult to the injury, he received a salary
hike of not more than 4-6% annually. For them, it was like trying to
overtake a car rolling at twice their speed. They were now facing the brutal
brunt of inflation.
It is a human tendency to toss the accountability on someone or the
situation when entrapped in challenging times. Therefore, Ranjita blamed
government policy, the external environment, low-interest rates, capitalism,
etc., for all their hardships. She asked, “Aaj kal mein mehengai bahut badh
gayi hai?” (hasn’t inflation shot up too much these days?). I am sure this
must be the case with a lot of us when we face the deterioration of
purchasing power because of inflation.
Like a drowning man trying to catch at a straw, Chatur decided to seek
help from this friend Ayran Azad. Chatur and Aryan studied in the same
college and landed the same job. However, Aryan quit his job and start his
venture after achieving financial freedom. So, Chatur invited him to dinner
on the same weekend. As Ranjita was busy making preparations in the
kitchen, the two friends started discussing their financial situations. Chatur
explained that he was working hard at the office to keep his job and
compete with colleagues, but still struggling to get a decent salary hike. He
further shared the financial mess he was caught in. After being all ears to
Chatur, Aryan spotted many issues in his finances and explained those to
him.
Aryan explained three significant issues:
1.Chatur was not saving enough. Only 5% of his net salary was going
into savings.
2.He had invested his savings into FDs and some real estate property
for the tax benefit, which was barely yielding a return of 3-5% post-tax
returns.
3.Despite working hard, his salary barely rose by 4-5%, which could
not keep up with much higher inflation rates to maintain the same
lifestyle.
Aryan said, “You have fallen into a rat race, my dear friend. You are toiling
hard for the money, but your money is not working hard for you. You are
scarcely investing, and that return, too, is not beating inflation. So, at best,
if you keep running like this, your standard of living will remain the same
or even become worse.”
With raised brows, Chatur immediately asked, “How can I come out of
this deep well? What did you do to achieve your financial freedom? How
can I become financially aatmanirbhar (independent)?”
After a brief pause, Aryan replied, “You are running on a hedonic
treadmill; even though you are running hard, you are in the same place.
Right now, you are working for money. Instead, it would be best if you
made money work for you. Make money your slave, not your master.”
 The book Classics: An Investor’s Anthology features an essay about P.T.
Barnum that rightly covers this aspect of the hedonic treadmill:
“Thousands of men are kept poor, and tens of thousands are made so after
they have acquired enough to support them well through life, in
consequence of laying their plans of living on an expensive platform…
Prosperity is a more severe ordeal than adversity, especially sudden
prosperity. “Easy come, easy go” is an old and true proverb. Pride, when
permitted full sway, is the great undying cankerworm which gnaws the very
vitals of a man’s worldly possessions, let them be small or great, hundreds
or millions. Many persons, as they begin to prosper, immediately commence
expending for luxuries, until in a short time their expenses swallow up their
income, and they become ruined in their ridiculous attempts to keep up
appearances and make a “sensation” [emphasis added].”1
 Aryan continued, “Right now, the equation you are following is Income -
Expenses = Savings. Instead, it should be Income - Savings = Expenses.
This will change the way you think about money.”
Warren Buffett has said, “If you don’t find a way to make money while
you sleep, you will work until you die.” Hence, it is important to generate
passive income.
Aryan then tapped on his phone and showed Chatur this quadrant:2

Employee: This is how most people earn their income. You slog it out at
the office from 9 to 5, grow your salary by 5-7% through hikes and
promotions to cope with inflation, and earn money. The more you work, the
more you earn, so you need to keep working to earn. The moment you stop
working, your income goes to zero. This is not bad, but you can do better
by working for yourself.
Self-employed: You run your independent practice like a doctor, lawyer or
chartered accountant. Here too, the moment you stop working, your income
goes to zero. But in this case, you have the flexibility of your work hours
and you are not answerable to a ‘boss’. This is better than a job, but not the
best.
Business owner: In the first two quadrants (E and S), you worked for
money. Now, others too are working for you. So, even if you stop working,
your income will not drop to zero. This is a very good situation but still not
ideal.
Investor: This is the ‘dream come true’. This is how Warren Buffett built
his massive fortune- by investing in other companies. We will soon learn
more about this in greater detail.
Aryan quoted Sir Albert Einstein - “Compound interest is the eighth
wonder of the world. He who understands it, earns it. He who doesn’t, pays
it.” Aryan then continued, “Do you understand? Compounding is the
aanthva ajuba (eighth wonder) of this world.”
With curiosity hovering over his face, Chatur asked, “How does this
work?” Like many of us, Chatur had learned about compound interest in his
school, but mugged up the formula for the exams and did not understand its
true power.
Aryan explained, “Let’s say you have ₹200. You put ₹100 each in two
different accounts. One with 10% simple interest, and the other with 10%
compound interest. At the end of the first year, both accounts will have
₹110. But at the end of the second year, the simple interest account will
have ₹120, while the compound interest account will have ₹121.”
Chatur asked, “But this is such a small difference. Only one extra ₹ after
two years?”
Aryan continued, “Wait and watch, my friend. Good things take time…”
Next what Aryan shared took Chatur by surprise and he kept staring at the
bottom figures without batting an eyelid.
Years Simple Interest Compound Interest 10%
10%
1 110 110
2 120 121
3 130 133.1
4 140 146.4
5 150 161.1
6 160 177.2
7 170 194.9
8 180 214.4
9 190 235.8
10 200 259.4
11 210 285.3
12 220 313.8
13 230 345.2
14 240 379.7
15 250 417.7
16 260 459.5
17 270 505.4
18 280 556.0
19 290 611.6
20 300 672.7
21 310 740.0
22 320 814.0
23 330 895.4
24 340 985.0
25 350 1083.5
26 360 1191.8
27 370 1311.0
28 380 1442.1
29 390 1586.3
30 400 1744.9
 Now that you have understood the power of compounding, let’s see what
incremental compounding can do to your purchasing power.
If you invested 10K each month for 30 years, results:
5%- 15,00,000
15%- 24,36,000
25%- 40,00,000
As Morgan Housel explains in his excellent book The Psychology of
Money , “Buffett is the richest investor of all time. But he’s not actually the
greatest—at least not when measured by average annual returns. Jim
Simons, head of the hedge fund Renaissance Technologies, has
compounded money at 66% annually since 1988. No one comes close to
this record. As we just saw, Buffett has compounded at roughly 22%
annually, a third as much. Simons’ net worth, as I write, is $21 billion. He is
—and I know how ridiculous this sounds given the numbers we’re dealing
with—75% less rich than Buffett. Why the difference if Simons is such a
better investor? Because Simons did not find his investment stride until he
was 50 years old. He’s had less than half as many years to compound as
Buffett. If James Simons had earned his 66% annual returns for the 70-year
span Buffett has built his wealth he would be worth —please hold your
breath—sixty-three quintillion nine hundred quadrillion seven hundred
eighty-one trillion seven hundred eighty billion seven hundred forty-eight
million one hundred sixty thousand dollars.”
With a trail of questions surfacing one after another in Chatur’s mind, he
jawed another one, “But Warren Buffett started investing when he was 11
years old. I am already 35. How can I benefit from the power of
compounding?”
Aryan leaned forward, forked out a slice of pineapple from the fruit bowl,
tugged it into his mouth, and munched it slowly, feeling the tangy taste with
closed eyes. Once done, he voiced, “Better earlier than later, but better late
than never!”
 Veteran investor Ramesh Damani has explained how you can turn 10 lakh
into 100 crores in 30 years. You need only to double your money every
three years, which works out to a 26% compounded return. In fact, 26% is
such a golden number that Mohnish Pabrai has made a number plate of it!
Chatur said in amazement, “If I can compound by 25%, it would be a great
journey in the next 30 years. I will become one among the top 1% of the
richest people in the world if I have ₹ 100 crores. But the savings account
gives 4 to 6% interest. Bonds give around 8 to 10%. Gold and real estate
too yield around 10 to 12% returns. So how can I achieve 25%?”
Aryan replied with a smile, “Invest in businesses directly, or in equities
through the stock market.”
 Total Returns Comparison 3
Ranjita, who was all ears to the conversation from the kitchen, immediately
questioned, “But isn’t investing in the stock market the same as gambling
your money?”
And then, Aryan explained a few more powerful principles.
Suppose your friend is doing business. He owns 100% of that company.
Now he wants investors to invest in his company. Assume that he has 100
shares in this company, and you buy one share from him. Congratulations,
you just became a 1% partner in that company. Similarly, when you buy
shares of any company from stock markets, you become a part-owner of the
business proportionate to the number of shares you purchase.
The power of investing is that if the business grows profitably, you also
compound your money by investing in underlying companies. Peter Lynch
has said- “Stocks aren’t lottery tickets. Behind every stock is a company. If
the company does well, over time the stocks do well, and vice versa. You
have to look at the company—that’s what you research.”4
Immediately Chatur asked, “So instead of spending time starting my own
business, I can invest in multiple businesses through the stock market?”
“Exactly!” Aryan replied. The stock market is even more beneficial than
running your own business! You can be a part-owner of many businesses
rather than owning just one.
Firstly, it gives you the flexibility of switching businesses at your own
will. You can be the owner of an FMCG business today; you can be out and
into a steel company tomorrow; you can switch into a pharmaceutical
business the day after tomorrow. Do you have this versatility in the case of
your own business?
Secondly, you have the option of having the brightest, most talented
managers and businessmen, like Aditya Puri and N Chandrasekaran,
working for your company, that too at no extra cost! Do you have this
privilege when you run a business? Of course not!
Thirdly, you can run multiple businesses simultaneously. You can run a
specialty chemicals business, a pharmaceutical business, an FMCG
business, and a bank simultaneously! If you had to set up a chemicals
factory yourself, it would cost many crores of ₹. However, you can
purchase part-ownership stakes in listed chemical businesses for a few
hundred ₹ by buying shares of the company on the stock exchange. This
option of a small ticket size means you can run a conglomerate (i.e., your
portfolio) for as low as a few thousand ₹!
Unlike your own business, you have no emotional attachment. Also,
certain businesses like liquor, pharma and banks require regulatory approval
and licenses. This is a very tedious and hectic job if you are running your
own business, whereas, as an equity investor, you do not need to worry
about this.
Closing and shutting down a business is difficult, but as an equity investor,
you can simply sell your shares in a few clicks. Equity investing is also
much more scalable, as a portfolio of 1 crore will not need significantly
more monitoring than a portfolio of 10 lakhs. Whereas in a business, you
will need to hire more employees, open a new factory, etc. to grow from 10
lakhs to 1 crore.
 The stock market is also a place that offers you incredible bargains, like
businesses for less than the cash in the bank, which is impossible in a
private business. You also earn dividends as passive income, thus making
your money work for you while you sleep.
Best of all, you don’t need to go to the office! What can be better than
being the owner of multiple businesses for a few thousand ₹, having top-
notch professional managers working for your business, and relaxing in the
comfort of your home? You can continue to earn through active income
from your job or other means and keep deploying to generate your passive
income, eventually becoming a full-time investor once you achieve
financial independence.
Chatur was amazed. He said, “This is a fantastic way to earn passive
income and make money work for me. But I have heard so many
professional, institutional investors invest in the stock market. How can I
compete with them? What is my edge?”
Another myth that people like Chatur harbor is that retail investors have a
disadvantage over professional, institutional investors. This cannot be
farther away from the truth! Firstly, you are investing your own money and
you are not answerable to anyone else for your returns. You do not have any
external pressure to outperform the indices, so you can take relaxed
decisions. You do not need to chase the latest IPO or follow ESG norms,
etc. Secondly, your amount of investment is small; hence, your buying or
selling will not drastically impact the stock prices. You will also have
liquidity and you can sell whenever you like. Mutual Funds (MFs) have
extremely large holdings and if they wish to sell their stakes, the price will
fall significantly. Institutional investors also have certain limitations; for
example, a single stock cannot be beyond 10% of their portfolio. Hence,
when you average up and add to your winning positions (more on this later
in the book), MFs must sell their winners periodically! However, you, as a
retail investor, do not have these restrictions. Mutual Funds need to
gradually build up their positions, so they need to accumulate even when
the stock is stagnant. On the contrary, you do not need to do this and can
directly buy stocks when they are in stage 2, instead of holding in stage 1
(we will walk through stage 2 in more detail later in the book).
Another big disadvantage for funds or institutions is size. If you think
about the size of the mutual fund, typically it can be anywhere between
1000 to several thousand crores. As a result, the universe of companies,
which they can select out of 3000 to 4000 listed companies, gets narrowed
down. The number of investable companies for institutions is very low, and
is often restricted to large caps, which are relatively more efficiently priced
than small caps.
Most fund managers are also risk-averse. As the classical adage goes,
“Nobody gets fired for buying IBM.” Similarly, nobody gets sacked for
buying TCS or Infosys. But because their high-paying job is at stake, they
are reluctant to buy a 700-crore market cap company, irrespective of its
growth potential.
MFs also have constant scrutiny on insider trading, etc.
Besides, they must invest as a team. There are CIOs, fund managers,
analysts, etc., and a senior CIO’s opinion may not be disagreed with,
because there is a job on the line! As Mohnish Pabrai has said, “Investing is
not a team sport, it is more of an individual pursuit”5
When a news trigger comes and a promising opportunity appears, retailers
can directly buy, but Mutual Funds cannot. They must create a report, get it
approved through the internal committee, etc., and by the time they buy it,
the stock may have already spiraled up significantly.
65 to 70% of mutual funds cannot beat the index consistently for the long
term!
So, before you buy, ask yourself: Can I analyze the company? Everybody
has a good idea of what McDonald’s does. But it’s hard to analyze
biotechnology companies or computer software companies. Do you know
something about the company? What can you add to the math? Do you have
an edge?
You could be an interventional cardiologist, and you put in a heart pump.
You say, wow, this is an incredible breakthrough, preventing shock and
providing hemodynamic support. You are in the operating room, seeing this
breakthrough way ahead of most people. That’s an edge. You need an edge
on something.6
Meanwhile, Ranjita ferried in a tray of snacks; the fragrance penetrating
through the layer of air in the room and invading the olfactory sense of the
two friends.
While popping in a cheese ball from the plate, Chatur exclaimed, “With all
these advantages, I am guaranteed to make money!”
As he said this, he did not realize that the appetizer was piping hot, he
instantly requested Ranjita to pour a glass of water to silence the aftereffect.
Watching Chatur rolling water in his mouth, Aryan tried to instill a
realistic mindset in Chatur without killing his dopamine rush. “Dost
(friend), in the stock market, there is no guarantee. It is all about
probabilities. If there is a coin toss where the probability of heads and tails
are both 50-50, and landing heads give you a 100 ₹, while landing tails
yields only 50 ₹, that is also investing. Most important, you should keep the
return expectations moderate. If other asset classes give 8 to 12% per
annum returns, then the stock market can fetch you 15 to 18%. However, if
you expect your money to double in six months, this is not the right place
for you.”
As Charlie Munger has said, “You’re looking for a mispriced gamble.
That’s what investing is. And you have to know enough to know whether
the gamble is mispriced. That’s value investing.”7
Chatur, now less euphoric, bombarded Aryan with his questions. “There
are 5000+ companies; how can I select a few handfuls of stocks among
these? How can I research companies and select which ones to invest in?
How can I learn when to buy stocks and when to sell?”
Aryan, sensing Chatur’s inquisitiveness, replied calmly, “Don’t worry, my
friend. I will answer all your questions before I bail out for the day.”
Chatur added, “I am so excited to know the answers. My pulse is a race
car!”
Investing is just like any other game, but not in a derogatory way. You play
with the right discipline, mindset, ethics and behaviors, and know the rules
(processes/systems/tactics). Bet big when the odds are in your favor. But,
unlike other games, investing is like a dice loaded in your favor. That is
because, firstly, very few people play this game. Even more important, out
of those who play this game, around half the people don’t even understand
the rules of the game! So, do you want to participate in this wonderful
game? But, like every game, you also need to do your homework before
playing.
Aryan chimed, “Let me share some remarkable examples and proven
techniques with you that can answer most of your questions.”
Ranjita intercepted, “But before that, let’s appease our palate as the dinner
is ready.”
And the conversation continued as they feasted on the dessert over the
dining table.8
Your task for this chapter is to find at least five companies that have given
returns of 26% CAGR (100x in 20 years) or more in the last 20 years and
share this list with me over email at [email protected] to get an
awesome return gift. As Philip Fisher has said, “To make money, you need
to understand how money was made in the past.”

CHAPTER SUMMARY
• Financial intelligence is key. However, a story of a young, happily
married couple (Chatur and Ranjita) has fallen into a rat race as,
despite working hard, the money was not working for them.
• The reason the couple is struggling financially is their high-end
lifestyle (regularly ordering food outside, going on exotic holidays, and
buying fancy gadgets).
• With such a lifestyle and the high inflation, the couple’s purchasing
power deteriorates.
• Ranjita lacked financial intelligence and argues that the main causes
for their suffering include capitalism, low-interest rates, and
government policies.
• Chatur realized his mistakes and sought financial planning help from
a long-term friend, Aryan, who seemed financially intelligent.
• In Chatur’s expenditure and income story, Aryan picked three main
things the couple was doing wrongly. They include:
• Not saving enough- they saved only 5% of the net salary
• Investing in FDs and real estate for tax benefits. Unfortunately,
they received only 3-5% post-tax returns
• Low salary growth of only 4-5%-such could not cater to higher
inflation rates
• Living a high-end lifestyle mostly affects the saving plan. From
Chatur’s story, such a lifestyle resulted in them running on a hedonic
treadmill (remaining at the same position even with his fast-running
speed).
• Many adopt the following formula: income-expenses =savings.
However, to effectively save and become financially independent, they
should adopt the income-savings = expenses formula.
 • Attaining financial freedom and independence requires one to make
money as “a slave”.
• Exploring various investors’ lives, such as Buffett, veteran Ramesh
Damani and James Simons, compounding makes one’s money grow
faster.
• Invest in businesses directly or in equities through the stock market.
• Compounding is not like gambling as many think. A good plan
shields one from losing.
• Investing in the stock market is even more beneficial than owning a
business. The benefits include:
• Investing in many businesses at once
• Flexibility to switch businesses
• Benefit from the most talented managers’ knowledge of business
• Incredible gains are also noted as an individual expects to earn
dividends from passive income where money works for someone
• In conclusion, investing is like any other game. However, one should
play with the right ethics, know the rules, and have the right mindset
and discipline.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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ENDNOTES
1.Charles Ellis and James Vertin, Classics: An Investor’s Anthology
(New York: Business One Irwin, 1988)
2.Chad Carson, https://www.coachcarson.com/cash-flow-quadrant-
how-earn-matters/; Inspired from Robert Kiy1.osaki’s book Cashflow
Quadrant
3.Jeremy Siegel, Stocks for the Long Run: The Definitive Guide to
Financial Market Returns & Long-Term Investment Strategies (New
York: McGraw Hill, 1994)
4.Lessons from an investing legend,
https://www.fidelity.com/viewpoints/investing-ideas/peter-lynch-
investment-strategy
5.https://www.youtube.com/watch?v=9tGjXPhnp-s&t=387s
6.https://www.fidelity.com/viewpoints/investing-ideas/peter-lynch-
investment-
strategy#:~:text=Lynch%3A%20Stocks%20aren't%20lottery,company
%E2%80%94that's%20what%20you%20research
7.Farnam Street (blog), https://fs.blog/charlie-munger-wisdom/
8.Sources:
https://www.dr-mikes-math-games-for-kids.com/rice-and-
chessboard.html
https://twitter.com/Sanjay__Bakshi/status/1329369171491135491
(https://www.youtube.com/watch?v=9tGjXPhnp-s&t=387s )
https://www.coachcarson.com/cash-flow-quadrant-how-earn-matters/
CHAPTER TWO

FINANCIAL FREEDOM
F LY W H E E L
“It is important to view knowledge as sort of a semantic tree - make sure
you understand the fundamental principles, i.e., the trunk and big branches,
before you get into the leaves/details or there is nothing for them to hang on
to.” 1
—Elon Musk
The financial freedom flywheel concept inspired by Jeff Bezos, for
Amazon, starts by recommending individuals to make a few adjustments,
reevaluate their expenses, and save up a little more. According to this
concept, individuals are encouraged to start saving for an investment, for
example, the stock market or elsewhere. The amount saved may not be
huge, but developing the habit is the key element. Once the saving flywheel
starts spinning, it gets easier to keep adding more velocity. Each step in the
flywheel requires action and provokes the next one.

APPLYING AMAZON’S FLYWHEEL

TO BECOME A GOOD INVESTOR
The platform Mega-Trend has become common in this day and age where
businesses build online digital structures and enable human activities,
including shopping and selling. Such a platform allows businesses to scale
up even without owning assets. For example, Uber, the world’s biggest ride-
sharing company, does not own any cars. Airbnb, the largest
accommodation provider, has no real estate. Lastly, Alibaba, one of the
most valuable retailers, has no inventory.
 What is the reason behind the success of these platform businesses? From
Amazon’s example, the flywheel model has been beneficial to them. In the
flywheel illustration below, the first element that Amazon focuses on is the
customer experience; by creating a solid platform, customers can browse
easily. The second one is increasing the platform traffic (both customers and
sellers). Every additional platform visitor or a customer can create more
value for the existing ones. This traffic ensures that more products are listed
on the platform, and once listed, they get customers. When satisfied
customers write reviews, it encourages others to purchase from their
platform. Bezos’s second approach was to lower the cost of the structure, a
major phenomenon in the platform business. These businesses require a
good infrastructure that costs a lot, including high capital, to build the
system. However, once this is done, with any incremental customer that
comes in, the business can lower the prices while, at the same time,
improving the customer experience.2
 From the above wheel, you learn that Amazon’s lower prices result in
more customer visits, and with more customer visits, the volume of sales
increases. More customers in the platform also encourage commission-
paying third-party sellers, allowing the company to get out of fixed costs,
such as fulfillment centers and servers required to run the site. All the above
tend to reduce the products’ prices.
Examining the below diagram, it is evident that Amazon is ruthless in
boosting efficiency. Their main focus is to improve productiveness, lower
prices, and amplify customer experience. With such efficiency, the wheel
moves faster. For the Uber business strategy, getting more people to use the
cab results in more cab drivers joining their ecosystem. In the company’s
platform, customers enjoy an improved quality of search. They can also
easily book the nearest driver, see the charges and track their driver’s
location without leaving the app. This reduces driver downtime and lowers
transport costs; eventually, real magic was created that outran the entire
competition.

APPLICATION OF THE FLYWHEEL

MODEL IN INVESTING
Now that you already understand the flywheel concept and how businesses
benefit from it, how can it be implemented in investing? Before starting
your investing journey, you should follow the below steps, including
examining your mindset, understanding the principles of investing, action-
taking, and building investing system. Others include building a portfolio,
maintaining investing journal, and reflecting on actions. Finally, we should
be improving the thought processes and adding a layer to efficiency. After
implementing the first layer, investors should move to the second one,
including savings and investing, generating a customized portfolio, risk
management, and asset allocation.
STEP 1: LEARNING
MINDSET/INVESTMENT
PSYCHOLOGY
The first principle when it comes to investing is understanding yourself.
Anyone who wants to succeed in the investment journey should be willing
to learn. Before embarking on this journey, you should ask yourself, am I an
aggressive or conservative investor? What is my risk appetite? Am I a
fulltime or parttime investor? Is my family income enough to withstand any
losses that might be faced, or is it fragile? Do I have adequate reserve funds
that can sustain me if I am unable to generate returns in the next 2-3 years?
Am I dependent on a single income, or do I have a diversified income
stream? Once you know yourself fully, you can then blend your personality
with the right investment strategy. In this case, work on your mindset first.
The above, among many other questions, allow investors to blend their
investment strategy based on who they are.
Unfortunately, many investors never explore their mindset, and they
choose an investing plan blindly. Even though there are many elegant and
fancy investing plans out there, you need to know what is the best suit for
you. Investment plans are never a “one-size fits all” activity, it is highly
personalized, and you should choose whatever fits your investment goals
and resources. When making equity investments, you should always know
the risks involved and hand-pick the right plan accordingly. Moreover,
similar to any other occupation, investing is an occupation that requires
professionalism.
When sick, do you take a stethoscope, examine yourself and prescribe
medication? Of course, not. Similarly, investing is a full-time profession
that requires much expertise. Some people effectively educate themselves in
investing, which is good. However, others hire an adviser or invest through
a mutual fund or PMS for the equity portfolio. With such a plan, you can
manage the remaining 5% and monitor whether it overperforms the
advisors. If it does, you can gradually shift capital from MF to your own
funds. The take-home from this step is that you should always work on your
mindset before investing.
STEP 2: ACTION TAKING:
TECHNOFUNDA
Knowledge is power, but knowledge without actions becomes useless.
Some people spend much time acquiring knowledge that they seldom or
never use. When it comes to investing, learning is the first step, but it
should be followed with knowledge implementation in the investment
framework. Investors should ensure that they understand various
compounding principles. Any investor who understands these principles can
take advantage of them. These fundamentals have been proven and worked
for or against the entire universe over the years. Before investing, you
should always have an investment goal/objective. Why am I investing?
Some people invest in their children’s education, while others invest in
buying a house or even a car. Unfortunately, people continue making
mistakes when choosing an investment goal. For example, if you want to
buy a car after a year, investing in stocks would be a bad idea because of
too much fluctuation. Within one or two months, the market can go
anywhere.
After selecting the investment goal, the second principle is to understand
the compounding effect. Different asset classes tend to compound at
different rates. However, the thumb Rule of 72 exists. If you divide the
expected rate of return by 72, the quotient is the number of years required to
double the money. For example, when you divide 72 by 10, you will require
7.2 years to double the money. For high-growth investing, if 72 is divided
by 24, the answer is 3, which means you will need 3 years to double your
money. Interestingly, for ₹ 100 growing at 24%, it will become ₹ 200 in 3
years. But after another year, it will be ₹ 800. This is how compounding
works. Once you have understood the principles, the next step involves
developing a plan related to your asset allocation in various asset classes. It
is worth noting that different classes require different competencies. There
are two competency options available, which include developing
competency towards a particular asset class or outsourcing competency by
hiring an investment advisor.
Screening is also the key to making investment choices. With many
companies operating in different sectors, one cannot possibly analyze every
one of them. Hence, you need to filter companies and eliminate those that
fall outside the defined investment criteria. With the ones left, a deeper
analysis should be conducted to examine whether they have qualities that
match your investment universe and coverage bracket. Thoroughly screen
the company you want to invest in through fundamental (relating to
company-specific rations, e.g., financial statements) or technical screening
(relating to price and volume).

STEP 3: BUILDING INVESTING

SYSTEM
As an investor, you need to build an investing system, the entire investing
framework. This includes how you will buy various stocks and how to add
them and exit when necessary. Without such a framework in place, it
becomes challenging to make the grade. Being jumpy from one step to the
other is a recipe for failure. Hence, prudent investors go from one step to
another, including learning, understanding investing principles, start taking
action, and later, start building investing systems. Building an investing
system requires the investor to conduct sector, company, and technical
analysis. Investment companies are analyzed through metrics and ratios,
and as an investor, you have to choose the sector you want to invest in, e.g.,
mining, real estate and so on. Before making an investment choice, it is also
imperative to conduct company-specific research. This research compares
companies with their peers, historical financial statements analysis, forensic
accounting, and management quality analysis.
The next analysis is known as technical analysis/PV action. Investors
should use both technical and fundamental analysis when choosing a
company to invest in. Many investors prefer the fundamental analysis
because of past successful histories. However, this analysis has some
drawbacks, and one of them is fixated data and numbers. Another limitation
of technical analysis is, as it focuses on market psychology, this largely
ignores the business’s big picture. In this case, a wise investor chooses to
blend both the technical and the fundamental analysis.

STEP 4: BUILDING PORTFOLIO

In this step, you should customize a capital allocation portfolio. Capital
allocation refers to investing the company’s financial resources in a way
that increases its effectiveness and maximizes profits. Companies, look
forward to investing their resources in a way that generates as much wealth
as possible. As an individual investor, an effective portfolio should indicate
your wins, losses, and errors. Later, you should analyze the errors and
reflect on the next actions. This helps investors to avoid repeating mistakes.
For portfolio allocation and rebalancing, a stock market crash results in
dislocating the portfolio of high-quality companies. This occurs due to the
differential drawdowns in the share prices of constituent stocks.
Rebalancing such a portfolio leads to the generation of more returns, and it
also sidesteps the risk of being left with uninvested cash. One of the major
issues investors face when it comes to rebalancing is the test of conviction
of fundamentals of various portfolio companies when undergoing
significant drawdowns.

STEP 5: MAINTAIN AN INVESTING

JOURNAL
Many people maintain a trading journal but fail to maintain an investment
journal. An investing journal is imperative in investing as it shows what is
profitable and the residue risk in the system trading, among others.

STEP 6: REFLECT ON ACTIONS

Know what should be maintained and what should be changed. For
instance, equity remains one of the most rewarding asset classes. However,
it has risks, and hence, it is unwise for an investor to keep all the eggs in
one basket, i.e. to put all their savings in an equity market. Therefore, you
should diversify your investments across asset classes while ensuring that
equity remains a significant portion. What you examine, measure, and
analyze are what matter.

STEP 7: IMPROVE THOUGHT

PROCESS
If you need to thrive in life and the investing sector, you must be a lifelong
learner. There is always the next level to pursue. This is where the right
ecosystem where you can connect with like-minded investors becomes very
important. Also, in markets, one should not only learn from own mistakes
and losses but also from the mistakes of others. I have covered this concept
of Vicarious Learning in a later chapter.

STEP 8: ADD LAYER TO

EFFICIENCY
The internet remains one of the major sources of information nowadays.
With a single mouse click, one can attain an unbelievable amount of data
that can assist in making an effective investment decision and help monitor
how various investments are performing. As an investor, you should ensure
that you get the best resources and tools that can help you easily monitor
the progress of your investment while you focus on things that matter. This
fetches exponential results. These tools also offer better and faster insights,
and they help investors analyze more business and investment frameworks
speedingly. For example, investors can use various tools on the internet to
gain information.
After the above first layer of the flywheel has been dealt with, another
wheel illustrated in the diagram below kicks in. The flywheel’s second layer
steps include savings and investing, generating portfolio returns, risk
management, churning losses/adding winners, and ensuring better capital
appreciation. While the first layer focuses on investing, the inside layer
focuses on the money element. If an individual learns about his/her mindset,
builds an investing system, and even develops an investing journal but fails
to learn the principles of personal financing, including a budget, the earlier
steps become futile. Therefore, saving and investing alongside this whole
system becomes critical. The second step in this second layer is, generating
portfolio returns. The investor should examine and test the waters by using
real money instead of a paper portfolio. It is advisable to observe the actual
portfolio returns rather than the paper one.
 The next step involves asset allocation. Once you realize the losses and
churn them, and add wins, you should optimize returns through asset
allocation. The link below can help you in sketching out your assets.3 This
is where you can create better capital appreciation and then reinvest both
the capital and the returns. You can fabricate a compounding cycle that
generates wealth. Once you get the flywheel kicking, you will build wealth
and create a magic of financial freedom where you will never have to worry
about money. You will become financially aatmanirbhar (self-reliant)!

BONUS:
To Learn Building Investing System >>
http://TechnoFunda.co/Live

CHAPTER SUMMARY
• This chapter explores more on TechnoFunda’s pillars of investment,
which include:

1. MINDSET/INVESTING PSYCHOLOGY
• Before investing, an individual needs to answer a few questions.
What is your risk appetite? What kind of investor are you, conservative
or aggressive? Are you entering the stock market full-time or part-time
(alongside another occupation), among other questions?
• Investing is never a “one size fits all”; hence, one should research and
choose what works for them.
• If you plan to make an equity investment, you should thoroughly
research it, know the risks involved, and choose the right plan
accordingly.

2. PRINCIPLES
• As an investor, always understand the proven universal principles and
take advantage of them.
• Have investing objectives and later choose an appropriate asset class.
 • As an investor, understand the compound effect. Compounding has
different asset compounds; however; the thumb rule is 72.

3. SCREENING
• Thoroughly screen the company you want to invest in either through
fundamental (relating to company-specific rations, e.g., financial
statements) or technical screening (relating to price and volume).
• After the first screening, conduct a deeper analysis to have a few
companies that can be included in the investment and coverage
bracket.

4. SECTOR ANALYSIS/COMPANY ANALYSIS

• Investment companies are analyzed through metrics and ratios.
• As an investor, you have to choose the sector you want to invest in,
e.g., mining, real estate, etc.
• Before making an investment choice, it is imperative to conduct
company-specific research.

5. TECHNICAL ANALYSIS/PV ACTION

• When choosing a company to invest in, investors should use both
technical and fundamental analysis.
• Many investors prefer the fundamental analysis because of past
successful histories. However, it has one main issue that includes
fixated data and numbers.
• Technical analysis also has an issue since it focuses on market
psychology and largely ignores the business’s big picture.

6. CAPITAL ALLOCATION
• Refers to investing in a firm’s financial resources to increase its
efficiency and maximize profits. Other key pillars to check include:

7. PORTFOLIO ALLOCATION AND

REBRANDING
8. ASSET ALLOCATION
9. TOOLS AND RESOURCES

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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ENDNOTES
1.Elon Musk, “I Am Elon Musk, CEO/CTO of a Rocket Company,
AMA!” Reddit, 2015,
https://www.reddit.com/r/IAmA/comments/2rgsan/i_am_elon_musk_c
eocto_of_a_rocket _company_ama/?st=jg8ec825&sh=4307fa36
2.Original Amazon Sketch: Jeff Bezos (2001)
3.https://technofunda.buzzsprout.com/1667647/8267603-010-
powerful-portfolio-allocation-strategies
CHAPTER THREE

FIRST PRINCIPLES -
DRIVERS OF MEGA
COMPOUNDING MACHINE
“As to methods, there may be a million and then some, but principles are
few. The man who grasps principles can successfully select his own
methods. The man who tries methods, ignoring principles, is sure to have
trouble.”
—Harrington Emerson
When Elon Musk, who has built several multi-billion companies, started the
development process of the TESLA car, many experts cautioned him about
the high costs that could make those cars unpopular due to inherent battery
costs. The battery costs were $600/kw, which were super expensive.
Elon Musk asked - Why $600/kw? And the rest is history. Below is the
explanation of how Elon Musk broke this problem with First Principles:
…they would say, “historically, it costs $600 per kilowatt-hour. And so it’s
not going to be much better than that in the future.” … So the first principle
would be … what are the material constituents of the batteries? What is the
spot market value of the material constituents? … It’s got cobalt, nickel,
aluminum, carbon, and some polymers for separation, and a steel can.
So break that down on a material basis; if we bought that on a London
Metal Exchange, what would each of these things cost? Oh, jeez, it’s … $80
per kilowatt-hour. So, clearly, you just need to think of clever ways to take
those materials and combine them into the shape of a battery cell, and you
can have batteries that are much, much cheaper than anyone realizes. 1
 Bottom line: Take a problem, break it down to build blocks by using first-
principles, and deep dive into these building blocks. This can help in a
logical outcome.
Even billionaire investor Charlie Munger analyses companies from the
perspective of first principles to make his investment decision.
The ancient Greek philosopher Aristotle describes how to gain knowledge
from basic elements as he defines the first principle as “the first basis from
which a thing is known” .
First-principles thinking is one of the best ways to reverse-engineer
complicated problems and unleash creative possibilities. The idea is to
break down complicated problems into basic elements and then reassemble
them from the ground up.
It’s one of the best ways to learn to think for yourself, unlock your creative
potential, and move from linear to non-linear results.2
Legendary hedge fund manager Ray Dalio has written, “Principles are
fundamental truths that serve as the foundations for behavior that gets you
what you want out of life. They can be applied again and again in similar
situations to help you achieve your goals. Every day, each of us is faced
with a blizzard of situations we must respond to. Without principles we
would be forced to react to all the things life throws at us individually, as if
we were experiencing each of them for the first time. If instead we classify
these situations into types and have good principles for dealing with them,
we will make better decisions more quickly and have better lives as a result.
Having a good set of principles is like having a good collection of recipes
for success. All successful people operate by principles that help them be
successful, though what they choose to be successful at varies enormously,
so their principles vary.” 3
Let’s now apply these first principles to investing.
What are the building blocks of investing returns? It’s entry price and exit
price. Let’s say, you bought a stock at INR 100 and sold it at INR 1000, you
will generate 10x capital of your investment. So, remember, the entry price
is very important and so is the exit price.
Now, let’s break it down further. What are the drivers of entry and exit
prices?
1.Business Performance : Let’s say, when you bought a stock at INR
100, the earning per share was INR 10. And during the exit, the
earning per share was INR 50. This means growth in earning due to
business performance contributed 5x returns out of total returns.
2.Market Psychology : Your entry P/E (Price/Earning) multiple was
100/10, i.e. 10x, and when you exited, someone bought from you at
P/E multiple of 1000/50, i.e. 20x. Hence, PE re-rating generated the
remaining return.
 Further breaking it down to first principles…
How can we understand business performance? Through fundamental
analysis, namely the ‘four cylinders’ of sales growth, operating leverage,
margin improvement, and debt reduction.
 And how to understand market psychology? It’s through technical
analysis, namely price-volume action.
The problem is that most investors focus on just one aspect, either
fundamental analysis or technical analysis and miss the bigger picture.
Logically, we must understand both sides of investing to apply the first
principles. “Man with a Hammer” syndrome, popularized by Charlie
Munger, is the idea that if you have only one model in your mental toolkit,
you will approach all your problems with the same solution, even when
it may be better to use multiple tools. Either technical or fundamental
analysis in isolation is like a single tool; if you only use that one tool for
every problem, you will be the metaphorical ‘man with a hammer, to
whom every problem looks like a nail’.
This is where blending both technical analysis and fundamental analysis
helps, which I call TechnoFunda Investing methodology.
“Value doesn’t move stock prices; people do by placing buy orders. Value is
only part of the equation. Ultimately you need demand .”
—Mark Minervini 4
‘Value’ stocks, in isolation, can remain undervalued for long periods.
Think of holding companies that always, sustainably, trade at a discount to
the cumulative value of their investments (holding company discount).
What works is value investing with a ‘trigger’ to unlock that value. That
push is typically a special situation, e.g., a demerger, promoter/management
change, etc. Ultimately, when an undervalued stock reverts to intrinsic
value, it occurs through price appreciation. Hence, technical analysis can
help capture such potential occurrences, while fundamental analysis will
confirm it.
Howard Marks shared the importance of understanding market psychology
in his book The Most Important Thing , “Would-be investors can take
courses in finance and accounting, read widely and, if they are fortunate,
receive mentoring from someone with a deep understanding of the
investment process. But only a few of them will achieve superior insight,
intuition, sense of value and awareness of psychology required for
consistently getting above-average results.”5
 You can’t do the same things as other investors do and get an edge. While
most investors follow only one aspect, you can master the art by
understanding both business performance and market psychology.
Essentially, price movements are the collective buy and sell transactions of
the market and, hence, price-volume action is a crucial insight into
investors’ psychology.
Let’s now dive deeper into price-volume action. This is something that
investors rarely practice or shy away with. It helps us make better decisions
around screening and is an early warning indicator for our investing
decisions - whether to buy, add or sell.
Chatur, while resting his chin over his knuckles, “If there is so much
fundamental information available out there in terms of books, research
reports, conference calls, industry reports, etc., then why do I need to do the
hard work to understand all this?”
Aryan beamed his cheek-to-cheek smile and replied, “Well, the answer to
this will unfold slowly as we delve into this subject.”

THE CONTEXT
Now, let’s put our thinking hats ON and reckon what happens on a normal
day in the stock market? Of course - we all know >> buying and selling of
securities.
Further digging deeper, each transaction leaves its footprints and there are
decisions from investors/traders/speculators that have caused that
transaction. And for every transaction, there are two facets - quantity and
price at which the transaction has happened.
This tells us that PRICE and VOLUME are two fundamental building
blocks of all the transactions that happen on the stock market. And most
importantly, they leave a footprint on transactions of all market participants
and, indirectly, their behavior and decision points.
An interesting point is that all the technical indicators are second-order
derivatives of these two basic building blocks with certain mathematical
formulas applied around them. Think of RSI, Moving Averages, ADX, etc.
As in physics, so in statistics: the output cannot be more precise, in terms of
the number of significant figures, than the inputs. The same applies to price
volume action: indicators derived from price and volume cannot be more
precise than price and volume themselves.
So, it gives a tremendous advantage logically, if we can capture price-
volume action firsthand and can infer the actions of market participants to
an extent. It can work as an early warning indicator. Hence, we should
never ignore price-volume action.
The next question that might surface in your mind is how to capture these
footprints, how to apply and how to make the best use of them?
Well, it depends upon our creativity and depth of fundamental implications
of various actions and we can back-calculate such parameters from price-
volume action to our advantage.
Let me give a few simple examples:
(a)We know there are price-volume breakouts when some fundamental
news about the company excites the market participants - say CapEx
announcement, above expected results, any approvals, new product
announcement, tax sops for the sector, etc. Most time, these things
happen even before the news is out.
A simple way to capture these mathematically is by putting screens
like - Today price increase >4% and volume > 2x the 1-week-average.
(b)Say there is sector news that moves all the sector participants due to
positive happenings in the sector. When stocks of the whole sector rise,
it is a powerful signal.6
 You can capture these by building screens mapped by sector to get a
glimpse of such price fluctuations.
These are powerful tools.

Now let’s understand what drives earnings growth and business

performance.
 The essence of fundamental analysis can be summarized in terms of four
cylinders. These are the four main catalysts and all the aspects of
fundamental research can be categorized under one of these four. You will
also notice that all the questions asked by analysts and investors in
conference calls revolve around these Four Points.
Below are the four-cylinders that fire compounding MACHINE:
1.Sales growth,
2.Operating leverage,
3.Margin expansion and
4.Debt reduction
Another important aspect to understand besides earnings growth is the
quality of business, mostly captured by the return on capital employed. We
will learn more about this through the TREES analogy in subsequent
chapters.
Beady-eyed Chatur: I am enthused to know more about this analogy, but
before we forge ahead, can you recommend some visual way to retain this
knowledge about technicals and fundamentals?
Aryan: Of course, Chatur, if you are interested in learning through
audio-visual format, you can watch my video at:
https://www.youtube.com/watch?v=umkUDnHjXM4
Traders Carnival 2018: How to Blend Technicals and Fundamentals by
Vivek Mashrani, CFA

CHAPTER SUMMARY
• Investment principles are few compared to methods, and when one
understands principles, method selection becomes easy.
• To maximize profits as well as reduce inputs, businesses should
incorporate the first principles.
• First-principles include taking the challenge (the problem), breaking
it into building blocks using principles that assist in the logical
outcomes, and later deep-diving into building blocks.
 • First-principles thinking is one of how people reverse engineer-
complicated issues and unleash creative possibilities. E.g., breaking
down complicated issues and later assembling them from the ground
up.
• First-principles thinking is a great way to learn to think by oneself,
unlock creative potential, and move from linear to nonlinear results.
• An example of an individual who used the first principles is Elon
Musk. When he began developing the TESLA car, he was warned of
the high cost of batteries ($600/Kw). Using the first principle, he broke
down the materials used to shape the battery cell. Later, he realized that
by buying the materials from London Metal Exchange, the costs would
come down from $600/Kw to $80/Kw hence profit maximization.
• What are the first principles of investing? What are the building
blocks of investing returns? The answer is the entry and exit price. For
example, with a stock of 100, one can make 1000, which means 10x
capital of the investment. The business drivers for both entry and exit
prices include:
• Business performance - analyzed through fundamental analysis
that involves sales growth, operating leverage, margin
improvement, and debt reduction
• Market psychology - analyzed through technical analysis, also
known as price-volume action

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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ENDNOTES
1.Farnam Street (blog), https://fs.blog/first-principles/
2.Farnam Street (blog), https://fs.blog/first-principles/
3.Ray Dalio, Principles: Life and Work (New York: Simon & Schuster,
2017)
4.Mark Minervini, Trade like a stock market wizard (New York:
McGraw Hill, 2013)
5.Howard Marks, The Most Important Thing (New York: Columbia
University Press, 2011)
6.Business Standard
CHAPTER FOUR

SCREENING FOR MEGA-

COMPOUNDERS
“Simplicity results from long, hard work, not the starting point. The ability
to reduce something to its essence is the true mark of understanding. But
one of the greatest ironies in life is that when the smartest minds generously
share the secrets of their success with us, we ignore them, because they
sound too basic and simple for us to appreciate.” 1
I have tried to simplify mega compounding into a simple Tree analogy so it
is easier to understand. It took me a long time to come to the essence of the
entire business selection framework. Let’s now scuba-dive into this.
The first step of mega compounding is to look for great businesses rather
than mediocre ones. This is when the compounding of capital will be
intrinsic, i.e. within the business. As per the first principles, the bulk of the
returns is directly proportionate to the business performance. In the
TechnoFunda construct, this is categorized as the core portfolio. Ideally, this
comprises 70% of an investor’s equity allocation.
We will use two parameters to classify businesses: return on capital
employed and earnings growth. Using these two metrics, we can arrive at a
2x2 grid.
RoCE - Return on Capital Employed
 The top right quadrant, which is a high return on capital employed and
high earnings growth, is what we call the Banyan Tree. This bucket is the
holy grail of long-term investing. If you can find even one or two Banyan
Trees in your lifetime, you will be very rich.
High RoCE but low earnings growth is like a Mango Tree. This depicts
companies that cannot reinvest capital at high rates of return. Thus, they
distribute profits to shareholders in dividends, which we have equated to the
mango fruit. You can finance your lifestyle with these dividends, equivalent
to enjoying aamras or aamrakhand (mango juice).
Low RoCE but high earnings growth is a weed. It grows rapidly but
consumes the nutrients and water required for the Banyan Trees in your
portfolio.
Low RoCE with low earnings growth is a cactus- full of thorns, and it is
often obvious for the investors to stay away from these. Let us learn the
nuts and bolts of each of these.
Also, we have Bamboo Trees, which are on the path to improvement and
Palm Trees, which are primarily cyclical companies transitioning very fast
between low to high and vice versa.
Banyan Trees: These are companies whose operating profit is going back
to the fixed asset to create new capacities and generate growth. This is
where there is intrinsic compounding within the business. These businesses
are consistent compounders. They have longevity, sustainability and
consistency. Often, such companies are well-known among the market
participants and are thus richly priced, which is well-deserved. You can reap
the reward by investing in these companies after detailed research into the
company’s source of competitive advantage. You can compute the market
factors in the next 3 to 5 years of earnings in such businesses through a
reverse DCF (Discounted Cash Flow). DCF is a technique used to estimate
the value of an investment depending on its future cash flows.
Here’s the formula to calculate DCF:
DCF = CFt/(1 +r)t
CFt = cash flow in period t
R = Appropriate discount rate that has given the riskiness of the cash flows
t = life of the asset, which is valued

Being an investor, you can gain an edge by a) understanding whether

growth in cash flows will outpace growth in net profit (e.g. by working
capital cycle reduction) b) having a time horizon of greater than 5 years, as
the market can very rarely discount beyond this. In such Banyan Tree
companies, the correction from the peak valuation is limited. They optically
appear to be expensive at the time of buying, but in hindsight, they almost
always are undervalued due to the unexpected longevity and magnitude of
growth. With a broader market crash, an investor may find the valuations of
these Banyan Tree companies attractive - buying them is usually a wise
choice. Stock price follows the earnings growth and a lollapalooza effect
(coined by Charlie Munger – it means a confluence of factors acting
together can be especially powerful drivers of human behavior and this can
lead to both positive and negative results) occurs. Banyan Tree companies
show superb capital efficiency and outstanding growth of earnings. It is
fertile territory for finding multi-year compounding machines and yet offers
great safety during tough market conditions. These are the Enduring multi-
baggers.
Mango Trees: What is the USP of a mango tree? It keeps giving you
juicy, sweet fruits. It gives all the cash flow in dividends or buybacks.
These are the blue-chip companies that dividend investors often hold in
their portfolios. However, if all the cash flow generated by a firm with a
high RoCE is returned to shareholders, then it is difficult for the firm to
grow its revenues over time. These are usually the large and aging
companies expected to grow slightly faster than the economy. Such
companies started as fast-growers and eventually drifted to becoming slow-
growers. When an industry, at large, slows down, most companies within
the industry lose momentum.

For example, penetration in the toothpaste market has increased

dramatically, therefore, there is little room for further expansion in this
industry. Hence the growth rate of Colgate has decreased significantly and
it has become a Mango Tree company. The quality of Mango Tree
companies is unquestionable, but an investor should know the possible
growth rates. An expectation of generating 20 to 25% of returns through
these is imprudent. The right way to look at these is not from the lens of
capital appreciation but capital preservation. An example could be ITC. The
stock chart of a Mango Tree company over 4-5 years, is typically flat or
there is a very slight increase. The steepness of the slope is very small.
Peter Lynch writes- “Another sure sign of a slow grower is that it pays a
generous and regular dividend … companies pay generous dividends when
they can’t dream up new ways to use the money to expand the business.”2
Such mango companies may prove to be Quality Traps. The high quality of
these companies blinds the investors to the possibility that these companies
may not be able to grow their earnings at a healthy pace due to low
underlying base rates, e.g., Colgate. As a result, stock performance remains
disappointing.
Cactus: What are the characteristics of a cactus? How does cactus
operate? It does not grow too much or too fast (low earnings growth), and it
has sharp thorns (returns below the cost of capital). But it doesn’t consume
too much water either! It is very conservative in its intake of water. These
are low RoCE businesses that do not grow much. Due to its visible
numerical economic characteristics, just like the sharp thorns of a cactus,
investors know they must avoid them. The only good part about these
businesses is that they generally don’t re-invest cash flow for growth and
mostly pay it as dividends or buybacks.

Typically, these businesses trade below book value and low price-earnings
ratio for obvious reasons of low growth and low RoCE. There could also be
a high dividend yield if management is distributing cash flows to
shareholders.
Often those who poorly understand businesses can get lured by low
valuation and/or the high dividend yield, only to eventually realize these
were value traps. They think they are doing “value investing”, but they
aren’t applying the principles of value investing properly.
Warren Buffett has beautifully explained the true meaning of value
investing in his 1992 Annual Letter to Shareholders:
“Whether appropriate or not, the term “value investing” is widely used.
Typically, it connotes the purchase of stocks having attributes such as a low
ratio of price to book value, a low price-earnings ratio, or a high dividend
yield. Unfortunately, such characteristics, even if they appear in
combination, are far from determinative as to whether an investor is buying
something for what it is worth, and is therefore operating on the principle of
obtaining value in his investments. Correspondingly, opposite
characteristics—a high ratio of price to book value, a high price-earnings
ratio, and a low dividend yield—are in no way inconsistent with a “value”
purchase [emphasis added]. ”3
Weeds: They suck enormous amounts of water and will not allow a good
flower to grow. Such investments will just grow for the sake of growth, but
these are low RoCE businesses, so the more they grow, the more they
destroy value. They spoil the growth for the remaining part of your garden.
Therefore, they just suck out the resources, but don’t give optimal RoCE.
These are the businesses earning 6% RoCE and you keep growing and keep
putting capital again and again. It is like a bottomless pit of capital. Or we
can say, it is like pouring petrol into a tank which is hollow, and all the oil
goes down the drain- but you keep pouring it! Often, market participants,
including institutional investors blindly chase growth. They fail to
understand that in a low RoCE business, low growth is better than high
growth! When RoCE is high, growth creates value; if not, growth destroys
it! If a company’s RoCE remains below the Cost of Capital for long, then
high growth decreases value. So, the company must raise significant levels
of capital from its equity holders to fund its growth. If a company’s RoCE is
equal to its Cost of Capital, then no amount of growth adds any value.
Growth adds positive value only when RoCE is higher than the Cost of
Capital. This is counterintuitive for most investors, but it is a crucial
principle. Such companies may prove to be Growth Traps. High growth in
these companies is most likely due to cyclical upturns but gets mistaken for
secular high growth. Such stocks may still end up as multi-baggers, but at
best, transitory multi-baggers. Therefore, it is very important to have exit
criteria because not exiting can lead to ‘giving back’ all your previous gains
to the market.
 As Warren Buffett wrote in his letter in 2007:
“The worst sort of business is one that grows rapidly, requires significant
capital to engender the growth, and then earns little or no money. Think
airlines. Here a durable competitive advantage has proven elusive ever
since the days of the Wright Brothers…”
Further, he wrote in 1983:
“…as they generally earn low rates of return – rates that often barely
provide enough capital to fund the inflationary needs of the existing
business, with nothing left over for real growth, for distribution to owners,
or for the acquisition of new businesses…”
Bamboo: Bamboo Trees are the ones that are not cyclical but potentially,
they have low growth and/or low RoCE. There are certain triggers that
manifest and finally, it does exponential growth along with high RoCE (just
like bamboo, which remains below the ground for initial few years and then
shoots up).

Again, whether they will stay there as Banyan or Mango or come back to
Cactus is not known in advance. Therefore, we need to continuously
monitor and allocate gradually to these businesses, as this can give multi-
fold returns if we ride them correctly. Eventually, if they become consistent
compounders, i.e., Banyan Tree, they give super-normal returns through re-
rating as well. So, there is a dual benefit here: exponential growth coupled
with high RoCE and the possibility of re-rating if they perform as expected.
Turnaround scenarios can fall under this category.
Palm: This is a typical short cycle - what is popularly known as cyclical
stocks. Their sales and profits rise and fall frequently. It can include
companies in sectors like paper, sugar, steel, etc. These companies
transition between low RoCE and low growth to high RoCE and high
growth. The key differentiating factor between Bamboo and Palm is that
Bamboo has a small probability to become Mango or Banyan, but Palm will
always come back to its roots. Entry and exits are very important for taking
positions in this category of business.

Palm businesses are the most misunderstood of all types of businesses.

Most investors get excited at the peak of the cycle where earnings are at
their peak. The PE ratio might optically look cheap/low and stories float
around that these earnings are to stay and businesses are undergoing
structural change. This is a perfect recipe for disaster most of the time.
For further elaboration on whether all growth is good, let us hear from
Terry Smith. “In our view, growth cannot be thought about sensibly in
isolation from returns. Rapid growth may be good news or it may be bad
news. It depends on how much capital you must invest to generate that
growth. The “earnings” of a bank savings account will grow faster, the
more money you deposit into the account. But it is unlikely to be a good
investment strategy to put most of your assets into such an account, and you
certainly shouldn’t rejoice at the fact that if you double your capital
invested, you will get twice as much interest. That is not growth. The
source of growth is also a factor to consider. Growth in profits from
increasing prices can simply build an umbrella beneath which competitors
can flourish. We are more interested in companies which have a physical
growth in the merchandise or service sold than simple pricing power,
although that’s nice too.”4
It is very important to make a distinction between Mango and Banyan.
Banyans can re-invest either organically (e.g., by setting up a new factory)
or inorganically (e.g., by acquiring other companies). As Chuck Akre says,
“If a business has a high return on owner’s capital, we would like them to
be able to take all the free cash they generate and put it back into that
business to continue to earn those high rates of return. It’s way more
efficient than paying us a dividend.”5
The biggest paradox in long-term investing is choosing between Cactus
and Weeds. Most investors prefer Weeds over Cactus, as at least there is a
growth in earnings. However, Cactus is often better than Weeds. Because
Cactus has distinctly visible thorns, it is often obvious to avoid them.
However, Weeds do not have such explicitly available warning signs.
Often an investor in Mango Tree companies will make small profits, an
investor in Banyan Tree companies will make large profits, buying Weed
companies will cause large losses and an investor in Cactus companies will
only suffer small losses. If you can just avoid Weeds, that is large losses,
you will do very well as an equity investor.
 Chatur: I am impressed by this analogy of yours. I strongly recommend
that you get it patented. Here’s another question for you: Now that I know I
must look for Banyan Trees, the question is, how can I find them?
Aryan: This is a million-dollar question. Well, nobody will come and tell
you this is a Banyan Tree company. You must do the research and the
analysis. We will understand further in the coming chapters how to do this
research, but the first principle is to narrow down the number of companies
to research. This is done through screening. A website like screener.in is a
boon for investors; you can create customized screens based on your
preferred criteria.
Palm and Bamboo Trees are mean-reverting; Banyan Trees are upwards
trending; and Weeds and Cactus are downwards trending
 For banyans, the highs can be much higher than you can ever imagine!

The interesting aspect of the stock market is that often the categorizations
of businesses are not stagnant. Banyan Trees are seldom Banyan Trees
forever, and so are other categories. Peter Lynch aptly writes, “Companies
don’t stay in the same category forever. Over my years of watching stocks,
I’ve seen hundreds of them start out fitting one description and end up
fitting another.”6
When Banyan Trees transition into Mango Trees, i.e., quality remains
intact, but growth rates slow down, this is often referred to as quality traps
in the investing parlance. Often these businesses suddenly face
technological disruption and terminal value might go for a toss unless they
re-invent. The P/E multiple contracts significantly during such phases,
which may lead to long periods of underperformance for the stock. It could
be in time-wise correction or a sudden decline in stock price. Most
importantly, because of the wisdom of crowds, this happens before actual
earnings deceleration is visible in financials. Thus, an investor restricting
oneself to fundamentals and ignoring price movements is likely to hold on
in such scenarios. This is one of the major risks when investing in Banyan
Trees. Therefore, investors in such companies should always be on the
lookout for signs of slowing earnings growth. One needs to have an exit
strategy in place if it is structural. The worst mistake to make is to buy them
thinking that growth might come back without understanding business
transition.
“The traditional “value investor” mentality of
buying cheap securities, waiting for them to bounce back to “intrinsic
value,” selling and moving onto the next opportunity, is flawed.
In today’s world of instant information and fast-paced innovation, cheap
securities increasingly appear to be value traps; often they are companies
ailing from technological disruption and long-term decline. This rapid
recycling of capital also creates an enormous drag on our after-tax returns.
In addition, by focusing on these opportunities, we incur enormous
opportunity costs by not focusing instead on the tremendous opportunities
created by
the exceptional innovation S-curves
we are currently witnessing.”
—Marcelo Lima
On the positive side, usually, Cactus transitions into Mango Trees or
Mango transitions into Banyan Trees. This often occurs in small and Mid-
Cap companies and occasionally in commodity and cyclical businesses.
This aspect is played in the techno-funda approach through the satellite
portfolio, which we will cover in the next chapter.
The table below captures the market condition vs. likely screen outcome.
 Your task for this chapter is to identify one Banyan Tree and one Mango
Tree, and email the names of these companies to me at
[email protected] (I will send you special return gift)

CHAPTER BONUS:
Download Powerful Excel Screener >>
http://TechnoFunda.co/excel

CHAPTER SUMMARY
• When trying to mega compound, the first step should be to search for
a big business rather than the mediocre one. Such compounding of
capital is intrinsic, i.e., within the business. Refer to the earnings and
earnings growth portfolio:
• High RoCE companies- companies unable to reinvest capital at
high rates of return. They distribute profits to shareholders in terms
of dividends
• Low RoCE- grows rapidly but may affect Banyan trees’ growth,
evident in the portfolio. Low RoCE does not attract investors as a
result of low earning growth
BANYAN TREES (REFER TO EARNINGS AND
EARNINGS GROWTH)
• Banyan trees refer to companies where operating cost goes back to a
fixed asset. Such creates new capacities and generates growth
• Involves intrinsic compounding within the business
• Consistent compounders. Have longevity, consistency, and
sustainability
• Well-known among market participants (highly-priced)
• Investors in this group can edge through detailed research of the
company’s competitive advantage source
• Show superb capital efficiency and outstanding earnings growth;
fertile territory for finding multi-year compounding machines
• Offer great safety during tough market conditions. These are
enduring multi-baggers.

MANGO TREES
• Gives all the cash flow in the form of dividends or buybacks, making
it challenging for them to grow their revenues
• Blue-chip companies that dividend investors hold in their portfolios
• Mostly large and growing companies are expected to grow faster
compared to the economy
• They start as fast growers, then slow down. When an industry
slowdown, companies under it follow. With an increased toothpaste
penetration, there was little room for further expansion of toothpaste
through penetration. Hence, Colgate’s growth rate decreased

CACTUS
• Has a low earning growth and returns below the cost of capital
• As a result of their visible numerical economic characteristics,
investors tend to avoid them
• They do not reinvest cash flow for growth (pay it as dividend or
buyback)
 • The businesses trade below book value and low price-earnings ratio
as a result of low growth as well as low RoCE
• When management distributes cashflows to shareholders, the cactus
business can have a high dividend yield

WEEDS
• Low RoCE which grows for the sake of growth
• The more they grow, the more they destroy value
• They earn approximately 6% RoCE, but people continue putting
capital on them (bottomless pit of capital)
• When a company’s RoCE remains high, growth creates value. If not,
growth destroys value. When it’s below the Cost of Capital, then high
growth decreases value since the company has to raise significant
levels of capital from its equity holders to fund its growth. When it’s
equal to the Cost of Capital, no amount of growth adds any value

BAMBOO
• Not cyclical, but had low growth/low RoCE. However, various
triggers activate them to manifest exponential growth
• They need constant monitoring to check whether they will behave as
Cactus, Mango, or Banyan

PALM
• Have a short cycle known as cyclical stocks, e.g., sugar, steel, and
paper companies
• Sales and profit may rise and fall within a short period
• Represent a transition between Low RoCE and low growth to high
RoCE and high growth
• Palm difference from bamboo is that bamboo has a probability of
becoming mango or banyan, but the palm always comes back to the
roots
• They are mostly misunderstood since investors get excited at the
cycle’s peak. When earnings are at their peak, the PE ratio might look
 cheap/low, and stories floating around that these earnings are to stay
and that businesses are undergoing structural change

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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ENDNOTES
1.Gautam Baid, The Joys of Compounding (New York, Columbia
University Press, 2020)
2.Peter Lynch, One Up On Wall Street, (New York: Simon & Schuster,
1989)
3.Warren Buffett, Berkshire Hathaway 1992 Annual Letter to
Shareholders, March 1, 1993
http://www.berkshirehathaway.com/letters/1992.html
4.https://www.fundsmith.co.uk/media/mv3abv1h/owner-s-
manual.pdf#page=10
5.https://economictimes.indiatimes.com/markets/stocks/news/akres-
three-legged-stool-theory-to-spot-good-businesses-to-invest-
in/articleshow/76659443.cms?from=mdr
6.Peter Lynch, One Up On Wall Street (New York: Simon & Schuster,
1989)
CHAPTER FIVE

EVERYTHING IS
CYCLICAL
“The more time I spend in the world of investing, the more
I appreciate the underlying cyclicity of things.” 1
“Mechanical things can go in a straight line. Time moves ahead
continuously. So can a machine when it’s adequately powered. But
processes in fields like history and economics involve people, and when
people are involved, the results are variable and cyclical.”
—Howard Marks 2
Howard Mark in his book The Most Important Thing
writes:
“Very few things move in a straight line. There’s progress and there’s
deterioration. Things go well for a while and then poorly. Progress may be
swift and then slow down. Deterioration may creep up gradually and then
turn climactic. But the underlying principle is that things will wax and
wane, grow and decline. The same is true for economics, markets and
companies: they rise and fall.”
As stated in a previous chapter, psychology is very important. Particularly,
in economic activities where humans are involved, we will see cyclicity.
Therefore, we must respect the cyclical nature of life. And when we are
aware of where we stand in the cycle , we can make better decisions.
The efficient market hypothesis assumes that investors always act
rationally and stocks always trade at their fair market value. However, this
is a flawed theory, as the psychology of investors causes them to overreact
or underreact in the same situation. This causes cyclicity of undervaluation
and overvaluation.
 “The market is a pendulum that forever swings between unsustainable
optimism & unjustified pessimism.
An intelligent investor is a realist who sells to
optimists and buys from pessimists.”
—Benjamin Graham, The Intelligent Investor

The Market Pendulum moving between

optimism and pessimism
To understand this better, we should first get to the bottoms of the mental
model called FEEDBACK LOOPS.
“Every action creates an equal and opposite reaction. When reactions
loop back to affect themselves, a feedback loop is created. All real-world
systems are composed of many such interacting feedback loops — animals,
machines, businesses, and ecosystems, to name a few. There are two types
of feedback loops: positive and negative. Positive feedback amplifies system
output, resulting in growth or decline. Negative feedback dampers output,
stabilizes the system around an equilibrium point.” 3
Howard Marks has a beautifully shown example.4
“When people feel good about how things are going and optimistic about
the future, their behavior is strongly affected. They spend more and save
less. They borrow to increase their enjoyment or their profit potential, even
though doing so makes their financial position more precarious. And they
become willing to pay more for current value or a piece of the future. All
these things are capable of reversing in a second…The extremes of cycles
result largely from people’s emotions and foibles, nonobjectivity and
inconsistency.”
Most sectors are cyclical - could be shorter or longer cycles, but it’s
everywhere. Edward Chancellor has explained this very effectively in his
book Capital Returns.
“Initially, investors are optimistic and they put capital in a particular
sector/business attracted by the prospect of high returns. This results in
competition and returns fall. Eventually, returns fall below the cost of
capital and there is industry consolidation and exits. New players are not
interested in investing capital. Again, due to lesser supply, returns rise
above the cost of capital making - existing players enjoy good returns and
make it lucrative for new prospects to enter the industry. This keeps
repeating.
It’s the game of demand and supply that causes cycles everywhere - be it
economy, sectors or businesses.”5
 The best part is that the cycle keeps repeating. The more understanding we
develop around these patterns and cycles, the more likely we are to benefit
from them when they repeat in the future.
There is a powerful mechanism called STAGE ANALYSIS which can be
used to understand these cycles. This has been used, popularized and shared
by many prominent traders/investors, including Richard Wyckoff, Stan
Weinstein, Mark Minervini, etc. I have adopted this concept to blend with
fundamental analysis and use it with my framework.
While studying the number of growth stocks in the past, as we discussed in
the first principles, the major driver of share price appreciation has been
earnings growth and PE (Price-Earning) re-rating. Earnings acceleration
due to certain earning triggers which changed the trajectory of the business
has been instrumental in PE re-rating (or sometimes even overall market
sentiment). Institutional buying has also been one reason for this.
 By keenly observing the price movements, volume traded and
fundamentals of the company, one can classify these cycles into 4 stages:
1.Stage 1 - Basing Phase: Bowling Alley
2.Stage 2 - Accumulation Phase: Mega Compounding
3.Stage 3 - Distribution Phase: Main Street
4.Stage 4 - Declining Phase: Laggards
Some of these terminologies have been inspired by Geoffrey Moore’s book
Crossing the Chasm . (Harper Business; 3rd edition)

STAGE 1 - BASE PHASE: BOWLING

ALLEY
This is the phase of equilibrium. There are mainly 3 cases when this
happens:
1.When a business has low growth with no incremental growth triggers
 2.When a business is working on future growth triggers but the
execution is uncertain
3.When the overall market condition is lackluster
Bottom line: There is hardly any buying interest. Business is yet to prove
its future earnings potential. Stage 1 usually occurs after a fall in prices and
looks like a consolidation period.

CHARACTERISTICS OF STAGE 1:
• Overall buying and selling activity will be sluggish
• Price movement is in equilibrium with relatively much lower
volumes as bulls and bears are in equilibrium
• The ratio of up days to down days is equal
• There is no trend, and the stock keeps consolidating
• The stock price is below key moving averages
• The average volume on up days is almost equal to the average
volume on down days

UNDERLYING REASONS FOR THIS:

• Market participants are in no hurry to buy, waiting for earnings
growth triggers
• Due to lack of any institutional buying interest
• Even if potential earnings triggers are in place, execution might be
risky
This stage can go on for any timeframe, from days to months to years,
based on the characteristic of the company. The understanding of TREE
Analogy will help you here.
The most interesting companies are a BOWLING ALLEY, which is
undergoing subtle changes within it and are working on future earnings
growth triggers. Just like in Bowling Alley, they put down pins like
distribution network, branding, improving management, etc. which help
businesses scale faster in the future.
So, should we pick the bottom in Stage 1?
 Many smart investors who understand value, if they do their homework
properly, will know that they might get the lowest price for business if
things go in the right direction. So why not go all in?
There is a powerful concept of the opportunity cost of the capital and the
time value of money. Even though we might pick a bottom or near-bottom
price, we never know how long this consolidation will last or how long the
execution of earnings growth triggers will take. This will not help us
compound our money efficiently.
And often, this information is restricted only to the insiders, and it is very
difficult to make an objective buying decision. Therefore, it is always
prudent to revisit these companies when the execution starts.
As Mark Minervini mentions in his book Trade Like a Stock Market
Wizard :
“My goal is not to buy at the lowest or cheapest price but at the “right”
price, just as the stock is ready to move significantly higher. Trying to pick
a bottom is unnecessary and a waste of time; it misses the whole point.”

AVOID HOPE STORIES

This phase also gives birth to many hopeful investors. These are the ones
who just get in by looking at the so-called cheap prices but get little growth.
Even if growth may be far away or non-existent, these investors keep
holding the shares for a long time, hoping someday something will happen.
This, in my view, is just an illusion of value, particularly in a country like
India. My observation is market values incremental growth and not value
without growth.
This scenario also occurs when Banyan Trees transition into Mango Trees,
i.e., the quality remains intact, but the growth rates slow down. This is often
referred to as quality traps in the investing parlance. It’s like just looking in
the rear mirror and hoping that it will continue moving forward in the
future.

STAGE 2 - ACCUMULATION
PHASE: MEGA COMPOUNDING
At this stage, the market has been stable for a while and is moving higher.
The early majority are getting on the bandwagon.
Here, the base breakout is crucial. What are breakouts? And why do they
happen? A majority of investors wait for a fundamental trigger (capacity
expansion, demerger, buyback), re-rating or tailwind for the next level of
growth. When it’s about to materialize, demand picks up in a short while.
And this results in a breakout.

CHARACTERISTICS OF STAGE 2:
• Price breaks out of the accumulation phase in a range breakout after
base formation
• Price forms higher highs and higher lows (Dow Theory)
• Short-term moving averages are above long-term moving averages,
e.g., 20 DMA is above 50 DMA, and 50 DMA is above 200 DMA
• There are more up days than down days
• The average volume on up days is much higher than the average
volume on down days
DMA = Daily Moving Averages

NEVER IGNORE STAGE 2 IN ALL-

TIME HIGH TERRITORY
What happens when a stock enters from Stage 1 to Stage 2 with a price
volume breakout and enters a new all-time high territory? It signifies the
zone of least resistance. There is no pain. Each investor in that stock is
sitting on a profit and thus, there is no incentive to sell. Supply remains
limited as the existing shareholders want to ride their winners, and the price
movements accelerate.
This is a powerful territory where we should closely study the fundamental
triggers and take advantage of zones of least resistance. Most of the time, if
a stock is hitting an all-time high, it’s for a reason. Know the fundamental
trigger, build the conviction and make the most of this phase.
As also stated earlier, we should pay close attention to buying volumes.
There should be a significant increase in buying volume (at least 2x-3x of
average volumes over the past few weeks) during this phase.
One should be cautious of breakouts that happen at a very low volume.
Again, it’s all about increasing the odds in your favor. Breakouts with little
increase in volume can also succeed, but the probabilities (and hence, the
risk-reward equations) are not in your favor.
Another important point is to respect Primary Trend. In bear markets, the
probability of breakouts succeeding decreases drastically. It’s simply
stacking probability to have odds in our favor.

STAGE 3 - DISTRIBUTION PHASE:

MAIN STREET
In the third phase of the market cycle, sellers dominate. This part of the
cycle is identified by a period in which the bullish sentiment of the previous
phase turns into a mixed sentiment. Prices can often stay locked in a trading
range that can last a few weeks or even months. When this phase is over,
the market reverses its direction. Classic patterns like double and triple tops,
and head and shoulders patterns, are examples of movements that occur
during the distribution phase.

EXAMPLES OF STAGE ANALYSIS:

STAGE 4 - DECLINING PHASE:
LAGGARDS
As we have learned earlier in this chapter, everything is cyclical - Nothing
is permanent. So is the case with earnings growth and business momentum.
There are several reasons why companies will stagnate and ultimately, even
growth will taper.
Some sectors might get saturated due to high penetration or disruption
forces or companies might face increased competition. Business models
evolve, and so do the ways of doing business. Companies that do not evolve
or are slow to evolve undergo a Declining Phase and are often termed as
Laggards, i.e., Stage 4.

KEY CHARACTERISTICS OF STAGE 4:

• Price breaks down with severe down moves
• Price forms a series of lower highs and lower lows (Dow Theory)
• Short-term moving averages are below long-term moving averages,
e.g., 20 DMA is below 50 DMA, and 50 DMA is below 200 DMA
• There are more down days than up days
 • The average volume on down days is much higher than the average
volume on up days

WHAT DOES THIS ALL MEAN?

The ideal way is to do fundamental research using a 4-cylinder model
during stage 1, but not buy yet. This way, there is ample time to do research
and you are well prepared to seize the opportunity when stage 2 begins, as
your research is already done.
It makes sense for institutions to accumulate during consolidation before
breakout (otherwise, they will not get the opportunity). But for retail
investors, it’s best to wait until the consolidation is completed. This is
because consolidation can last for weeks or months, or even years. As a
retail investor, we can quickly enter within a fraction of seconds. Then why
waste the opportunity cost of capital with no returns?
Later, stage 3 is where one should be extremely cautious and once you can
spot it correctly, it’s even a good time to book profits, either fully or
partially. Finally, stage 4 is when we should not participate. This stage is
much easier to identify than stage 3. One should not fall into a hope story in
stage 4, nor should one average down. The only thing to remember during
stage 4 - STAY OUT.

CHAPTER SUMMARY
• The more time an individual spends in the investing world, the more
they appreciate the cyclicity of things.
• By keenly observing price movements, the volume traded, and the
fundamentals of the company, one can generally classify these cycles
into four stages:
• Stage 1 - Basing Phase: Bowling Alley
• Stage 2 - Accumulation Phase: Mega Compounding
• Stage 3 - Distribution Phase: Main Street
• Stage 4 - Declining Phase: Laggards

STAGE 1- BASE PHASE: BOWLING ALLEY

 • It is a phase of equilibrium. Cases, where it happens, include when a
business has low growth without any incremental growth triggers/
when it is working on future growth triggers. Still, the execution is
uncertain and in cases when an overall market condition is lackluster.
Stage 1 characteristics:
• Overall buying and selling activity will be lackluster
• Price movement is in equilibrium with relatively much lower
volumes as bulls & bears are in equilibrium
• The ratio of up days to down days is pretty much equal
• There are no trends, and stocks keep consolidating
• The stock price is below key moving averages
• The average volume on up days is almost equal to the average
volume on down days

UNDERLYING REASONS FOR SUCH

• Market participants are never in a hurry to buy and wait for earning
growth triggers
• Because of the lack of any institutional buying interest
• Even with potential earnings triggers being in place, execution
becomes risky
Should investors go for Stage 1? Yes, if one does his/her homework well,
they might get the lowest price for the business.

STAGE 2 - ACCUMULATION PHASE: MEGA

COMPOUNDING
• In this stage, the market has begun getting stable and moving higher

STAGE 2 CHARACTERISTICS
• Price breaks out of the accumulation phase in a range breakout after
base formation
• Price forms a series of higher highs and higher lows (Dow Theory)
• Short-term moving averages are above long-term moving averages,
e.g., 20 DMA is above 50 DMA, and 50 DMA is above 200 DMA
 • There are more up days than down days
• The average volume on up days is much higher than the average
volume on down days

STAGE 3 - DISTRIBUTION PHASE: MAIN

STREET
• In this stage, sellers start dominating
• The stage is marked by the period in which the bullish sentiment of
the previous phase turns into mixed sentiment
• Various patterns that occur in this phase include double and triple
tops and head and should patterns

STAGE 4 - DECLINING PHASE: LAGGARDS

• Nothing is stagnant, and in business, companies are stagnant, and
eventually, growth tapers

STAGE 4 KEY CHARACTERISTICS INCLUDE;

• Price breaks down with severe down moves
• Price forms a series of lower highs and lower lows (Dow Theory)
• Short-term moving averages are below long-term moving averages,
e.g., 20 DMA is below 50 DMA, and 50 DMA is below 200 DMA
• There are more down days than up days
• The average volume on down days is much higher than the average
volume on up days
In stage 1, investors should do fundamental research but don’t buy yet. In
stage 2, investors should consider the research given, and in 3, one should
be extremely cautious. Once it’s spotted correctly, it creates a great time to
book profits. In the last stage, one should be keen not to fall into a business
hope story of one day excelling.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
__________________________________________________
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ENDNOTES
1.Howard Marks, The Most Important Thing (New York: Columbia
University Press, 2011)
2.https://www.nasdaq.com/articles/few-thoughts-about-investing-
cyclicals-2016-01-25
3.Universal Principles of Design by William Lidwell , Kritina Holden ,
Jill Butler Rockport Publishers, 01-Jan-2010
4.Howard Marks, The Most Important Thing (New York: Columbia
University Press, 2011)
5.Edward Chancellor, Capital Returns (Basingstoke: Palgrave
Macmillan, 2016)
CHAPTER SIX

C O R E A N D S AT E L L I T E
“To suppose that safety-first consists in having a small gamble in many
different [companies] where I have no information to reach a good judgment,
as compared with a substantial stake in a company where one’s information is
adequate, strikes me as a travesty of investment policy.”
—John Maynard Keynes
Letter to F.C. Scott, February 6, 1942 1

SETTING PORTFOLIO GOALS

As an investor, we should have goals of compounding and generating portfolio
returns.
The simplest goal one can keep is beating benchmark returns by a minimum
of 10%. In the Indian context, if we consider Nifty/Sensex, the average returns
have been in the range of 15%. In essence, we are aiming for 25%
compounding, i.e. on an average, your money should double in at least every 3
years.
This might not look that great, but as Ramesh Damani has explained in his
famous lecture - If you compound 10 lakh at this rate, it will become 100
crores in 30 years. This is the magic of compounding.

HOW TO ACHIEVE AT LEAST 2X

RETURNS IN 3 YEARS?
After understanding the tree analogy of Quality vs. Growth, one should
allocate capital to “Banyan” type businesses.
If you have a 100% portfolio allocated to such businesses, there are some
challenges:
 • Generally, these businesses, at large, would be available at reasonable
valuations only during a bear market, so we have to time the market and
sit on cash until the opportunity arises
• During the Bull Market, these businesses will be priced to perfection
and they will have a substantial premium attached, so there is a chance of
lower returns if we give a higher entry valuation
• There is a significant risk of de-rating if there are earnings de-growth
(compared to market expectations), and hence, portfolio
underperformance
• There is little room to outperform the index with a huge margin
Given the above scenario, there is a low probability of generating 25%
compounding either by sitting on cash for a long duration or by entering at a
very high valuation. Of course, if you are lucky and reading this in the bear
market, and just got started, you may achieve it. Below is an illustration of
what can happen when you compound at 25% every year.
Power of Doubling money every three years
(without even fresh capital addition) 2
AGE ₹
25 10 Lakh
28 20 Lakh
31 40 Lakh
34 80 Lakh
37 1.6 Crore
40 3.2 Crore
43 6.4 Crore
46 12.8 Crore
49 25.6 Crore
52 51.2 Crore
55 102.4 Crore

WHAT SHOULD BE DONE TO SOLVE

THIS?
The solution is to construct CORE:SATELLITE Portfolio. I prefer keeping a
70:30 allocation.

In this case, the CORE portfolio consists of 10-15 high-quality businesses,

i.e., Banyan Trees.
While the Satellite portfolio consists of potential winners, which might be the
following categories:
• Potential Mango to Banyan transition: Growth coming back in high
RoCE businesses
• Potential Bamboo Trees: Increase in RoCE and Growth either
temporary/permanent
• Palm Trees: Cyclical businesses transitioning from low to high
RoCE/Growth and vice versa
• Any such similar situation where business is potentially improving and
in transition
Satellite portfolio companies have the potential to give great payoffs if they
play out as expected. But there is a little edge in terms of understanding the
business due to the inherent nature of business.
The purpose of the Satellite portfolio is to constantly look for future core
portfolio stocks and simultaneously keep learning about new businesses, as the
churn in the core portfolio is minimal.
 “So I think it was just looking at different companies and I always thought if
you looked at ten companies, you’d find one that’s interesting, if you’d look at
20, you’d find two, or if you look at hundred, you’ll find ten. The person that
turns over the most rocks wins the game.”
—Peter Lynch 3
Another key point here is that the satellite portfolio goes to cash during
down-trending markets. Hence, it creates an automatic hedge that gives mental
peace and the opportunity to take advantage of steep market falls to
accumulate core portfolio companies.

STRENGTH IS EVERYTHING
A powerful concept of Relative Strength calculates performance vs.
underlying index under comparison for a given timeframe. If stock returns are
the same as the underlying index, the stock will have zero relative strength.
As soon as stock returns outperform the returns of the underlying index for a
given timeframe, relative strength becomes greater than zero.
 While selecting stocks for investing, generally, it is prudent to screen stocks
showing strong relative strength. It’s not a good idea to buy stocks if the
relative strength is in negative territory (i.e. less than zero).
Relative strength further helps us to increase the odds in our favor. It
indicates which side of the demand-supply equation is tilting.
There are mainly 3 scenarios around relative strength for a given timeframe
under consideration:
(1)The index is moving upwards with positive returns and stock is
outperforming with even higher returns
(2)The index is flat, but still stock is outperforming the index with
positive returns
(3)The index is falling with negative returns, but the stock is positive, flat
or has fallen lesser than the index
Below is an example of BSE that explains base breakout on a daily chart
coupled with increasing volume towards breakout and relative strength line
crossing above zero. The stock has become more than 4x in less than 1 year.
 During the market correction or bear market, defensive stocks like utilities,
FMCG, etc., will naturally show relative strength due to the nature of the
sector and the above concept is not much relevant in such scenarios.

CORE PORTFOLIO SCREENING

FORMULA
The starting point of screening core portfolio companies is the MACHINE
formula, which we learned along with risk management using the technicals.
However, for the satellite portfolio, the starting point is technicals (price
volume action) followed by fundamentals using the 4-Cylinder Model.
So, the only way to mitigate the risk of permanent loss of capital is to bet
small on many potential companies. And to bring the edge, we use price-
volume action as an indicator of potential growth and improvement in the
business.
I will share more information about bet size, allocation and position sizing in
a separate chapter later in this book. We will also discuss risk management
strategies for the core portfolio corresponding to the points mentioned in a
separate chapter on risk management.
In Mega Compounding machines, here is a mnemonic for MACHINE that
can help you structure your investments:
M = Megatrends
A = Action - price volume (e.g., institutional accumulation), even corporate
actions we can include here to touch on special situations like buyback,
demerger, etc.
C = Competitive Advantages
H = High Quality (usually measured by High Return on Capital Employed)
I = Improvement
N = New Developments (new products/management/new price highs)
E = Execution of Earnings Growth Triggers
CHAPTER SUMMARY
SETTING PORTFOLIO GOALS
• Investors should have goals in terms of compounding and generating
portfolio returns.
• One simple goal that investors should keep includes beating
benchmarked returns by a minimum of 10%.
• One can attain at least 2x returns in three years. Such can happen
through utilizing the tree analogy of quality vs. growth, where one
allocates capital in Banyan businesses.
• When one allocates a 100% portfolio in such a business, challenges
faced include:
• The business is available at reasonable valuations only during the
bear market. In this case, investors have to time the market and sit on
cash until an opportunity arises
 • In the Bull Market, the businesses are prized to perfection and have
a substantial premium attached. Given a higher entry valuation, a
chance of lower returns exists
• Face a risk of de-rating when earning de-growth occurs, and hence
portfolio underperforms
• A little room to outperform the index with a huge margin
• There are two types of portfolios, including core and satellite portfolios.
Core maintains a 70% while Satellite maintains a 0-30%. The core
includes 10-15 high-quality companies. It has consistent compounders,
stringent selection criteria, and a long-time horizon. On the other hand,
Satellite is trigger-based, involves price volume action, and has earnings
momentum.
• The satellite portfolio examines a future business while the core
portfolio stock keeps learning about new business.
• Satellite potential winners:
• Potential Mango to Banyan transition (Growth comes in high ROCE
business)
• Potential bamboo trees (Increase in ROCE and growth, either
temporal or permanent
• Palm trees-cyclical business

CORE PORTFOLIO SCREENING FORMULA

• The MACHINE formula starts with core portfolio screening.
• MACHINE, in this case, means:
• M = Megatrends
• A = Action - price volume (e.g., institutional accumulation), even
corporate actions we can include here to touch on special situations
like buyback, demerger, etc.
• C = Competitive Advantages
• H = High Quality (usually measured by High Return on Capital
Employed)
• I = Improvement
• N = New Developments (new products/management/new price
highs)
 • E = Execution Of Earnings Growth Triggers
• The only way to mitigate investment risks is to bet small on many
potential companies.
• In the core portfolio, business growth is examined through potential
growth and business improvement.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________

ENDNOTES
1.Donald Moggridge, ed., The Collected Writings of John Maynard
Keynes (New York: Cambridge University Press, 1983)
2.Vishal Mittal and Saurabh Basrar, Masterclass with Super-Investors -
Ramesh Damani Interview (New Delhi: Maple Press India, 2018)
3.https://www.pbs.org/wgbh/pages/frontline/shows/betting/pros/lynch.ht
ml
CHAPTER SEVEN

M E G AT R E N D S
“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.”
—Charlie Munger
Understanding the big picture is very important before going deeper into
analyzing individual businesses. It’s all about increasing your odds and
ensuring you are not facing headwinds. This big picture is the driving force
of a giant shift that can keep happening for years or even decades. This
whooping shift is called megatrends.
These are long-term structural trends with irreversible consequences.
India’s IT services revolution, the shift from PSU banks to private sector
banks, unorganized to organized economy, discretionary consumption
theme, Indian pharmaceutical APIs, specialty chemicals manufacturing shift
from China to India, etc., are all examples of megatrends. Other synonyms
for megatrends are value migration and sector tailwinds. These should not
be confused with short/medium term, temporary, cyclical trends, or those
that occur regularly in sectors like steel, sugar, commodity/bulk chemicals,
paper, etc.
Now let us understand why we need tailwinds at all? If the company is
great, it will do well despite the sector tailwinds, right? Consider flying a
kite on Makar Sankranti (an Indian festival dedicated to Lord Sun)- even if
the kite is thin, lightweight and aerodynamic in structure, it will not fly if
there is no wind!
Consider swimming: if the tidal currents are in the direction opposing you,
you must swim much harder. If there are no waves, it is neutral and your
swimming pace is the only determinant of your speed. If the wave is with
you, you can swim at a high speed even with little of your own force. As
the saying goes, the rising tide lifts all boats.
 Therefore, to create wealth through mega compounding, one needs to align
with powerful forces. It keeps expanding the size of opportunities for
businesses and creates strong acceleration.
“One should identify a fish in the ocean and
not a crocodile in a pond.”
—Vijay Kedia 1
There are 3 Powerful forces that create strong acceleration:
1.A positive trend in the primary economic cycle
2.Tailwinds in sector
3.Strong underlying drivers contributing to the megatrend
 For example, India’s economy is undergoing strong economic growth and
sectors like Financials have strong tailwinds coupled with underlying
drivers like digitalization, mobile penetration, internet connectivity,
urbanization, formalization of the economy, etc. This megatrend has created
huge wealth which can be observed in many companies in this sector.
“One of the lessons your management has learned—
and, unfortunately, sometimes re-learned—is the
importance of being in businesses where tailwinds
prevail rather than headwinds.”
—Warren Buffett
So how can one identify megatrends? John Naisbitt, the pioneer of this
concept, writes, “Why are we so confident that content analysis is an
effective way to monitor social change? Simply stated, because the news
hole in a newspaper is a closed system. For economic reasons, the amount
of space devoted to news in a newspaper does not change significantly over
time. So, when something new is introduced, something else or a
combination of things must be omitted. You cannot add unless you subtract.
It is the principle of forced-choice in a closed system.” When you find
frequent talks about a new sector or industry in the newspapers, it is
generally a sign to dig deeper. For example, multiple articles have been
published in recent times about the recovery in the real estate sector. One
can look at this as a starting point for further research.
Another way is through the price volume action of multiple companies in a
sector. We will study this further in the next chapter.
One megatrend going on for the future is the shift from atoms to bits.
Something like Airbnb, they have no real estate and they are the largest
accommodation provider. In the same way, if you think about Uber, they
don’t own any cars; if you think about Alibaba, they do not own any
inventory. So, these are the emerging platform businesses coming up.

As per the 26th Motilal Oswal Wealth Creation Study- “India is on the cusp
of a digital revolution. For a population of 1.3 billion, India’s wireless
subscriber base is at 1.2 billion and broadband subscriber base at 0.8 billion.
Almost 0.75 billion users access the internet through their mobile phones.
Even as the customer base is rising, the corporate and investment climate is
also getting conducive by the day. Entrepreneurs are conjuring up digital
business ideas across domains – from fintech to foodtech to edutech. They
are backed by a whole host of venture capital and private equity funds,
leading to the emergence of several unicorns (companies with a valuation of
USD 1 bn or higher), numbering over 70 at the last count. The Indian
government too is doing its bit. Almost 99% of India’s adult population
now has Aadhaar (unique identification number). In 2016, the government
launched a Unified Payment Interface (UPI), enabling peer-to-peer
interbank transfers at zero cost. Under a scheme called Jan Dhan, over the
past 7 years, 430 million low-income strata people now have bank accounts,
a trigger for widespread financial and commercial inclusion. On the stock
market front, regulator SEBI (Securities & Exchange Board of India) has
relaxed its regulations to permit the listing of loss-making companies as
well. Thus, India is all set for an exciting Bits era.”
In sync with our hypothesis of price reflecting the actions of smart buyers
and the collective wisdom of the market, consider this: Of the top 10 market
cap companies in 1995 in the USA, Microsoft is the only company to
remain in the current list as well.2

CASE STUDY OF CDSL:

CDSL is listed depository where our shares and other important documents
are being held in dematerialized format. This is an example of platform
business with huge operating leverage. It has been beneficiary of
confluence of megatrends i.e., financialization of savings and
digitalization.3
 During the last few years, there has been a huge surge in the number of
Demat accounts on both CDSL and its unlisted competitor, NSDL.
Shareholders have been rewarded handsomely due to excellent profit
growth. The share price of CDSL surged almost 9x from the lows of March
2020 to its high in December 2021, in less than 2 years. Quarterly, EPS
jumped from ₹ 2 to ₹ 6 during the same period. And remember, these are
sticky businesses with recurring revenue streams. So, the incremental
impact on valuation will be huge.
This is what identifying powerful megatrends can do for you!
 These businesses also have so many optionalities due to the digitalization
megatrend.
I was fortunate to identify this business early on in Dec-2019 and had
listed these optionalities:4

Disclaimer: This is not a recommendation to buy or sell. Kindly consider

this as an educational case study. Our family members are currently
invested in CDSL while I am writing this book.

CHAPTER SUMMARY
• The key to analyzing businesses is focusing on the impetus of the
enterprises, also known as the megatrend.
• The revolution in India’s IT services, the shift from PSU to private
sector banks, and the shift from specialty chemicals manufacturing
from China to India are all megatrends.
• Other terms for megatrends are value migration and sector tailwinds.
• If you want to create wealth through mega compounding, you must
be in sync with powerful forces to expand opportunities in your
business and develop strong acceleration.
• The three powerful forces to identify are a positive trend in the
primary economic cycle, tailwinds in the sector, and strong underlying
drivers contributing to the megatrend.
• One example of a megatrend in India is in the financial sector.
• The Indian financial sector is currently exhibiting positive economic
growth.
• Finance sector enterprises also make huge profits from notable
tailwinds and underlying drivers like digitalization, mobile penetration,
internet connectivity, urbanization, and economy formalization.
• There are also notable sources of identifying megatrends.
• One source of identifying megatrends is by analyzing newspaper
content where there is always information about the industry and new
sectors.
• However, according to John Naisbitt, a pioneer of the megatrend
concept, content analysis alone is not feasible in identifying
megatrends because it also highlights other social issues, limiting depth
coverage of the former.
• Naisbitt asserts that it is because of the closed newspaper system,
which limits newspaper space, that the volume of the information
displayed remains fixed, leaving out content.
• Newspapers must delete some of their information to accommodate
new data.
• You can use the newspaper to identify megatrends and then carry out
in-depth research using other content-heavy sources because of the
depth scarcity.
• Price volume action is another way of identifying megatrends.
• There is also an emerging megatrend in business platforms like Uber,
Airbnb, or Alibaba, which requires no inventory or property
 ownership.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________

ENDNOTES
1.Vishal Mittal and Saurabh Basrar, Masterclass with Super-Investors -
Vijay Kedia Interview (New Delhi: Maple Press India, 2018)
2.Motilal Oswal, Atoms to Bits, 26th Annual Wealth Creation Study
(2016-2021)
3.https://www.business-standard.com/article/markets/india-s-demat-
account-tally-up-63-to-89-7-million-in-fy22-shows-data-
122041401088_1.html
4.https://forum.valuepickr.com/t/cdsl-stock-for-our-children/18078/88?
u=vivek_mashrani
CHAPTER EIGHT

ACTION
“The big money is not in the buying and the selling, but in waiting.”
—Charlie Munger
Any economic activity generally is based on the law of supply and demand.
And markets are no different. Every single second, each transaction on the
stock exchange ultimately reflects demand-supply factors. Price is the result
of demand and supply that we see even in stock markets, just like any other
commodity we purchase.
Investing returns are simply the difference between the price at which you
buy and the price at which you sell (net of transaction costs and any
dividends, etc.). Hence, understand actions that can ultimately increase the
price in the future.
Some examples of these actions that can signify an improvement in
demand are:
• Promoter Buying
• Institutional Buying
• The Action of Management to execute effectively
• Prudence of Management in taking leverage
Investors also need to pay attention to a concept called FREE FLOAT. One
needs to understand that the supply of shares is freely available in the
market for transactions out of the total number of shares outstanding.
The lesser the percentage and number of shares available freely, the higher
will be the fluctuation in terms of share price movement (on both sides).
Many investors miss this simple demand-supply logic while investing.
Generally, in my anecdotal experience, the best-performing stocks have
floats under 1 crore shares.
 The “float”—the number of company shares available to trade in the open
market—is a key determinant of how easy it will be for momentum traders
to manipulate the stock to higher levels. These are the shares in the public
domain not held by company insiders.
One should look at the volume-to-float ratio, i.e. average daily traded
volume divided by free float. If the float is 15 lakh shares while the average
daily volume is 75000 shares (V/F of 0.05), it is unlikely that the stock will
move wildly until there is a spike in volume. But if the float is 10 lakh
shares and the average daily volume is 2 lakh shares (V/F of 0.2), the
available float will be ‘eaten up’ quickly. So, more likely, there will be
dramatic price swings.
Less liquidity can give faster up-move, but it comes with the additional
risk of a faster downside. Risk management is key in such situations.

PROMOTER BUYING ACTIVITY

“Insiders might sell their shares for any number of reasons, but they buy
them for only one: they think the price will rise.” —Peter Lynch 1
Insiders know the company in and out and have much more knowledge than
the outsider market participants. If they are buying their own shares, it is a
sign they are confident of better performance and a higher share price in the
future. Further, not only insider buying is an indicator of future fundamental
success at the company level, but it also promotes significant levels of
investor confidence in the stock. This confidence ultimately translates into
higher multiples on earnings, resulting in much higher stock prices. Peter
Lynch writes in his book One Up on Wall Street , “There’s no better tip-off
to the probable success of a stock than that people in the company are
putting their own money into it.”
Most times, when the promoter of the company buys shares from the open
market or the company is doing buybacks at attractive signs, it’s a good
sign. Of course, we must look at other MACHINE criteria, not just look at
this criterion in isolation. Other than the promoter, even purchases from the
CFO are a good sign. As Gautam Baid writes, “Pay special attention when
you see a chief financial officer buying stock from the open market. It’s
generally not in their DNA to think like an owner.”2
 One also needs to look at the percentage of buying vs. overall percentage
holding. If it’s too tiny, in a broader context, it has little meaning and
sometimes can be due to manipulative intent as well. One should see that
the size of the purchases is large in relation to the insider’s remuneration.
For example, even a small insider purchase of ₹ 5 lakh can be meaningful if
the buyer’s salary is ₹ 30 lakh. As Peter Lynch states, “Although it’s a nice
gesture for the CEO or the corporate president with the million-dollar salary
to buy a few thousand shares of the company stock, it’s more significant
when employees at the lower echelons add to their positions. If you see
someone with a $45,000 annual salary buying $10,000 worth of stock, you
can be sure it’s a meaningful vote of confidence. That’s why I’d rather find
seven vice presidents buying 1,000 shares apiece than the president buying
5,000.”3 In such cases, one should take notice and begin further research,
especially if multiple executives are buying. This is called cluster buying;
when multiple insiders from a management team make open-market
purchases within a narrow period.
Lynch adds, “If the stock price drops after the insiders have bought, so that
you have a chance to buy it cheaper than they did, so much the better for
you.”4
For example, as we can see from screener.in, promoters of Kabra
Extrusion Technik were constantly and aggressively buying shares and
increasing their shareholding.
 Not surprisingly, the stock has been performing well and is up over 200%
in the last 1 year.

INSTITUTIONAL BUYING
Big demand gets created when big pockets start buying. These big pockets
in markets are institutions. What are these institutions? They are domestic
mutual funds, FIIs, big PMS houses, hedge funds, pension funds, sovereign
wealth funds, AIFs, small cases, etc. The transaction volumes they bring are
very large. The institutional buyers are, by far, the largest source of demand
for stocks. Outperformers usually have institutional backing.
There are two demand triggers created by institutional buying:
1.When one or more institutions buy shares for the first time in the
history of the company.
This one is special as this creates huge interest in the investor community,
particularly if there are credible institutions buying. William O’Neil calls
this analyzing the quality of institutional sponsorship.
Chatur: But why and when does it happen?
Aryan: Bingo Chatur, I am carried away by your inquisitiveness.
Generally, liquidity is a big hurdle for large institutions. If there are
companies with an overall market cap of less than 2000-3000 crores and
free float, which is even less than 500-1000 crores, it’s difficult for
institutions to enter. This is subjective, and there are exceptions. Second,
they want to see consistency in performance and the company should pass a
stringent due diligence process. Also, multiple retail investors and HNIs
have a strategy of ‘coat-tailing’ and ‘cloning’ the portfolios of savvy fund
managers. Their buying can create additional demand.
Especially note new positions. As O’Neil writes, “A significant new
position taken by an institutional investor in the most recently reported
period is generally more relevant than existing positions that have been held
for some time. When a fund establishes a new position, the chances are that
it will continue to add to that position and be less likely to sell it in the near
future.”5
Retail investors can get hugely rewarded if they can use this SWEET
SPOT by buying shares of quality companies that can potentially cross this
liquidity threshold and institutions get interested. Again, both fundamental
analysis and technical analysis can spot such opportunities. One must also
note that investment decisions should not be solely on potential institution
buying but also all other MACHINE criteria of long-term growth should be
followed.
2.When a company with existing institutions sees an increase in
institutional holding and/or more institutions start buying.
 These are generally mid to large companies with existing institutional
ownership and the holding steadily goes up. Most times (not always), this
shows higher conviction in the underlying company. Often even new
institutional investors enter and buy shares.
This should be viewed alongside business performance, growth potential
and management quality. Sometimes, just due to large-cap mandates, many
institutions might buy matured companies. If we enter late in the party,
when most institutions have entered, it might probably be too late and can
give suboptimal returns.
Expectations of some institutions like foreign pension funds, etc., might be
just capital protection with single-digit returns. As a retail investor, we
might want to compound much better and have a better stock selection
(companies with high growth potential).
One can get quarterly shareholding patterns from stock exchanges -
BSE/NSE in India and check details under public shareholding.

THE ACTION OF MANAGEMENT

TO
EXECUTE EFFECTIVELY
Owner-Operators have their skin in the game, and an efficient capital
allocation as an owner can create miracles for the company.
 Also, it is easier to hold onto a stock through the rough patches knowing
we have a talented owner-operator with money on the line.
Ultimately, execution is the key. If there is a public company with “Puppet
Managements” that are not agile, less growth- oriented and with interest at
stake, there is a low probability of generating extraordinary returns.
Ultimately, the barometers of all these activities are - price and volume,
popularly known as Price Volume Action.

PRICE VOLUME ACTION

Let’s say we are finding the companies based on price volume action
initially, which are going from stage one to stage two or sometimes even
from stage three back to the continuation phase or stage two. Most times,
when these companies are going from stage one to stage two, it is due to
some fundamental trigger. Now, the problem is that the fundamental news is
not yet known to the public, right? This is where we have the smart money
getting in. And we also have people who are insiders, who have good
experience around cycles and who are doing a lot of scuttlebutts, entering
this very, very early. We, as retail investors, do not have such bandwidth or
expertise. So this is where the price-volume action helps us. Basically, there
is a price spurt in the stock, there is a surge in trading volumes, the stock
comes near a 52-week high and then the news comes out in the public
domain.
So, when the price breaks out of a consolidation band (base) with good
volumes, this is where a TechnoFunda investor will first initiate a position.
Stage one is more of a consolidation phase. This is the phase where the
stock is not doing anything. And later, when it gets to stage two, this is
known as an uptrend. Hence, it’s very important to first identify that we are
at the beginning of the trend. This is where the price-volume action helps us
catch the transition from phase 1 to phase 2.
The second part comes into play when it’s into stage two and the
advancing phase. This advancing phase is when, most of the time, the news
comes out. In this phase, a lot of research reports will start getting
published. They will do earnings upgrades and all sorts of those things. A
lot of euphoria will be there, and people will start talking about it on social
media. This is where you know that your stage two has started. Many good
value investors might think that they are right in picking up the company at
the initial phase of stage one. But they are not able to ride stage two
because they feel there’s a lot of noise, and most of the time, even before
the earnings come out, they have valuations that seemingly look very high.
They feel, ‘it is a 52-week high and valuation is very high’. Therefore, most
people sell up on very small returns, right? 10-20-30% returns. But if you
can write this properly, you can make multiple returns. It could be
anywhere up to 40, 50 or 80X. You never know, right? Again, it depends
totally upon how long the stage prevails. But if you can write it, and if it is
really a big trend, you will make a killing out of it. And if this is coupled
with good allocation, it will be a deadly combination.
Below is the case study of HLE Glascoat (earlier Swiss Glascoat). You can
see the below chart and do this exercise to go through various news that
came after the advancing phase. This became ~30x in less than 2 years. You
too can compound like this if you follow the system I have shared.
CHAPTER SUMMARY
• Markets and economic activities like stock exchange and transactions
operate on supply and demand; this impacts pricing and investment
returns.
• A FREEFLOAT is the stock supply freely available in the market for
transactions out of the total number of shares outstanding.
• The lesser the FREEFLOAT, the higher the fluctuation in share price
movement.
• The best-performing stocks generally have floats under 1 Crore
shares.
• The float is the number of company shares in the public domain not
held by company insiders available to trade in the open market; it
determines how easily traders can manipulate the stock to higher
levels.
• The daily volume of traded shares to float ratio determines the
volatility of share pricing.
• Lesser liquidity means quick profits and higher losses risk.
• Promoter buying is when insiders buy their company’s shares; it
affects stock demand.
 • Promoter buying indicates the future fundamental success of the
shares, enhances investor confidence in the stock, and increases stock
price.
• Look at the percentage of buying vs. the overall percentage of
holding to determine the value of promoter buying.
• Demand also increases when big institutions like domestic mutual
funds, FIIs, big PMS houses, hedge funds, pension funds, sovereign
wealth funds, AIFs, small cases, and so forth buy stock.
• Institutional buying creates two demand triggers;
when a credible institution makes its first stock purchase, it spikes
interest in the investment community. More institutions start buying
when a company with existing institutions adds its institutional
holding.
• Stock demand also increases when owner-operators with sufficient
capital are at the helm of the stock and can hold the stock value
through rough patches; this concept is the action of management to
execute effectively.
• The barometer of stock demand is the price volume action.
• Demand for shares increases when the stock price remains high
without any news or fundamental drive over a long period.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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ENDNOTES
1.https://www.investopedia.com/articles/02/061202.asp#:~:text=One%
20of%20the%20greatest%20investors,six%2Dmonth%20period%3B%
20therefore%2C )
2.Gautam Baid, The Joys of Compounding (New York, Columbia
University Press, 2020)
3.Peter Lynch, One Up On Wall Street, (New York: Simon & Schuster,
1989)
4.Peter Lynch, One Up On Wall Street, (New York: Simon & Schuster,
1989)
5.William O’Neil, How to make money in stocks (New York: McGraw
Hill, 2009)
CHAPTER NINE

COMPETITIVE
A D VA N TA G E
“The guiding principle of value creation is that companies create value by
using capital they raise from investors to generate future cash flows at rates
of return exceeding the cost of capital (the rate investors require as
payment). The faster companies can increase their revenues and deploy
more capital at attractive rates of return, the more value they create. The
combination of growth and return on invested capital (ROIC) relative to its
cost is what drives value. Companies can sustain strong growth and high
returns on invested capital only if they have a well-defined competitive
advantage. This is how competitive advantage, the core concept of business
strategy, links to the guiding principle of value creation [emphasis added].
The corollary of this guiding principle, known as the conservation of value,
says anything that doesn’t increase cash flows doesn’t create value.”
—Timothy Koller
If you are competing against many peers, you always need an edge to
succeed. In kite flying, someone who has a sharp maanja (string) has a
competitive advantage. Even someone flying the kite from the terrace of a
taller building has an advantage. Most probably, these are the people who
will cut the most kites.
Companies are no different. Outstanding companies with competitive
advantages are popularized by Warren Buffett as having “Moats”.
“A truly great business must have an enduring “moat” that protects
excellent returns on invested capital.”
—Warren Buffett
In business, a competitive advantage is an attribute that allows an
organization to outperform its competitors.
 Aryan: OMG, I did not realize that it is almost midnight. So, I better get
going as you two must be bone-tired after the day’s work. We can continue
this on some other day.
Chatur: Not at all mentor Aryan, rather we are feeling awakened now.
Please, we insist that you continue showering the wellspring of your
wisdom on us. So far, we were living in ignorance and made many
mistakes. But now, we certainly have our thinking caps on.
Ranjita: I am sorry, I too went with the flow and did not realize that it has
been a couple of hours since we had our dinner. Let me brew some black
tea for the three of us.
Aryan: Oh, that will be great Ranjita. Chatur, there is nothing wrong in
making mistakes, as they say, to err is human. Even I made a boatload of
mistakes, which I will be sharing later. But we should not make the same
mistakes again. Mistakes or failures are the stepping stones to success. So,
the faster we fail, the quicker we navigate to the superhighway of success.
By the way, you just now said the word cap, which has reminded me of
another CAP in the world of investing.
The competitive advantage period (CAP) is the time during which a
company generates returns on investment that significantly exceeds its cost
of capital. Economic laws suggest that if a company earns supernormal
returns on its invested capital, it will attract competitors who will accept
lower returns, eventually driving down the overall industry returns to the
economic cost of capital, and sometimes even below it. However, a
company with great business and management sustains its superior rates of
return and keeps extending its CAP. This creates incremental excess return
both for the company and for its equity investors. The ability to maintain
longer-than-average CAP comes from a moat.
Some very common forms of Moats are:
• Strong Brand : Branding is one of the powerful aspects that helps
businesses keep competition at bay and helps to enhance pricing
power. It takes time, effort and vision to build powerful brands.
Consider the case of Page Industries. They are primarily into the mid-
premium innerwear segment and have created an aspirational brand in
India. They have used a unique approach to branding and advertising.
 In his book The Unusual Billionaires , Saurabh Mukherjea has dissected
this strategy:
Firstly, its advertising campaigns have consistently been high-impact
affairs, like ‘Just Jockeying’ in FY2010-14 and ‘Jockey or Nothing’
launched in FY2015. Secondly, Page has placed significant emphasis on in-
store advertising, to the extent that Jockey advertisements cover the bulk in-
store advertising space at most multi-brand outlets (MBOs). Thirdly, in a
neat play on the worldview of Indians, Page has consistently used
Caucasian models in its advertising and thus firmly entrenched its brand
recall as an international brand.1
Coupled with excellent capital allocation, high return ratios and a focus on
profitable growth, Page Industries’ stock price has compounded >30%
CAGR, becoming >100x in the last 13 years and counting.
• High switching costs : This is synonymous with financial and/or
psychological pain caused to customers when they switch to an
alternate product or competitor. Imagine you are using all your
business operations on Oracle’s SAP software, and each datapoint
around your processes is linked to a single software. What kind of
business disruption will happen if it is suddenly shut or switched
elsewhere?
• Network effects : This competitive advantage comes when the
addition of a new user to the ecosystem and/or increased usage by any
existing user increases the value for other users. In an online
marketplace, the addition of every new buyer attracts more sellers to
register in the marketplace, in turn, leading to more buyers, leading to
more sellers, and so on, into a virtuous cycle. Similarly, a stock
exchange like BSE or NSE where a greater number of participants will
bring more liquidity and lesser bid-ask spread, thus inviting more
participants. Some other examples are Indiamart Intermesh, Nazara
Technologies, etc. Networks, themselves, are of various different types,
some of which are:2

The more exponential the network of a company, the wider and deeper
it's moat.
• Low-cost advantage : If two companies have an identical selling
price, but if one can produce for a lower cost, it will have a higher
profit margin. Low cost also allows the company to lower its prices
and thus gain market share. E.g., Balkrishna Tyres.
• Economies of Scale . Larger companies can produce more by
spreading the cost of production over a larger amount of goods, leading
to lower unit costs. E.g., ITC and Asian Paints. This moat is even more
potent when the company passes on these lower unit costs to the
customer, in the form of lower prices; Nicholas Sleep calls this scale
economies shared. He writes- “Scale economics shared operations are
quite different. As the firm grows in size, scale savings are given back
to the customer in the form of lower prices. The customer then
 reciprocates by purchasing more goods, which provides greater scale
for the retailer who passes on the new savings as well. Yippee. This is
why firms such as Costco enjoy sales per foot of retailing space four
times greater than run-of-the-mill supermarkets. Scale economics
shared incentivizes customer reciprocation.”3
• Patents and IP : E.g., L&T Technology Services has large numbers
of patents of their own and co-filed with clients. Autoline Industries
has a patent on certain aspects of the pedals and brakes of their ‘E-
Speed’ electric cycle. Coke’s syrup recipe and Nestle’s Maggi masala
are perfect examples of IP.
• Strategic assets : The relationship of the Genomals, promoters of
Page Industries, with Jockey International, USA, is Page’s biggest
strategic asset. Jockey renewed its license with Page in 2010 for
twenty-one years instead of five years, which was the earlier practice.
Thus, until 2030, Page will remain Jockey’s exclusive franchise in
India and the UAE. Similarly, the relationship of Jubilant Foodworks
with Domino’s International is a very crucial strategic asset.
Moats are a way for companies to fight mean reversion, which is like a
strong current in markets that pulls everything toward average. Michael
Mauboussin has done some good work on Measuring the Moat. He
suggested an interesting mental model to find Moat in the sector value
chain using an industry map.
This details all the players that touch an industry. For airlines, this would
include aircraft lessors (such as Air Lease), manufacturers (Boeing), parts
suppliers (B/E Aerospace) and more. Michael aims to show where the profit
in an industry winds up. These profit pools can guide you on where you
might focus your energies. For example, aircraft lessors make good returns;
travel agents and freight forwarders make even-better returns.
Often, though, the most profitable investments occur when moats are in
the making rather than after the moat is already established . Hence, one
should consider companies that have relatively narrower moats, that are
widening rather than already wide ones, which are stagnant.
There might be instances when companies are spending on R&D, Brand
building, building distribution networks, trying to launch new products,
trying to enter new markets, spending heavily to gain economies of scale, or
creating network effects, etc. Basically, they are bleeding today to achieve
sustainable long-term growth. This is also known as short-term pain for
long-term gain, and is a form of delayed gratification.
This reflects poorly on income statements in the short term, but the long-
term owner earnings power of the company is constantly increasing, which
results in exponential long-term growth.

EXAMPLES INCLUDE:
• Amazon hiring staff to increase future sales by
making systems and servers more efficient
• Thyrocare taking a hit on the margins to quickly gain market share
from lower prices and harness economies of scale in future
• Pharma companies expensing out their R&D costs rather than
capitalizing on them
Also, due to the accounting principles in certain businesses, the earnings
appear depressed. As Marcellus Investment Managers writes, “Indian life
insurers are not allowed to amortise expenses incurred to acquire the
customer over the life of the insurance policy. As a result, while the
premium income is earned over a period, the customer acquisition expenses
are debited to the P&L in the year of acquisition itself. Given that life
insurance policies are long term in nature and extend to more than 20 years
in many cases, upfronting of expenses for revenues which will be accrued
over the next twenty years substantially understated accounting profitability
of life insurers.”5
Some indicators of companies in the value-chain having Moats:
• Pricing power
• Track record to earn a high return on invested capital
• High gross and operating margins for long periods of time
Pricing Power can be understood through the ability of a company to
consistently raise prices at levels exceeding inflation. As Warren Buffett has
further explained this aspect:
“The single most important decision in evaluating a business is pricing
power. If you’ve got the power to raise prices without losing business to a
competitor, you’ve got a very good business. And if you need to have a
prayer session before raising the price by 10 percent, then you’ve got a
terrible business.”
Pricing power will also ultimately reflect a high return on capital
employed coupled with high operating margins and an efficient working
capital cycle.
A high return on invested capital signifies that competition is at bay and
the company can consistently produce returns above the cost of capital.
The Gross/Operating profit margin is a good indication of the price people
will pay relative to the input costs required to provide the goods. It’s a
measure of value-added for the customer.

COMBINING IT WITH
REINVESTMENT
Saber Capital Management, in their blog, has described the powerful
concept of “Legacy Moats” and “Reinvestment Moats”.
Most businesses with a durable competitive advantage belong in the
Legacy Moat bucket, meaning the companies earn strong returns on
capital but do not have compelling opportunities to deploy incremental
capital at similar rates. 6
These are essentially our Mango category of businesses. These businesses
are of high quality due to legacy competitive advantages but struggle to
deploy incremental capital at similar/high rates.
There is an even more elite category of quality businesses that classify as
having a Reinvestment Moat. These businesses have all the advantages of a
Legacy Moat, but also have opportunities to deploy incremental capital at
high rates. 7
These are essentially our Banyan category of businesses. Not only do they
have strong competitive advantages but they keep reinvesting at high rates
for future growth.
And the math of Total IRR generation, even if Banyan category
(Reinvestment Moat) businesses are bought at higher multiples, is
astonishing when held for a long time. This math of MEGA
COMPOUNDING MACHINES is rarely understood by investors. Notice
the difference it creates even if 10-year exit multiples are assumed to be the
same. This is the power of compounding.8

CHAPTER SUMMARY
• In the value creation principle, companies create value by using
investor capital to generate future cash flows at return rates that
surpass the initial capital cost.
• The combination of growth and return on invested capital (ROIC)
relative to its cost drives value.
• Companies can sustain strong growth and high ROIC only if they
have a well-defined competitive advantage.
• According to Warren Buffett, great businesses must have an enduring
"moat" protecting their ROIC.
 • A competitive advantage is a business's ability to outperform the
competition.
• The competitive advantage period (CAP) is the duration that a
company generates returns on investment (ROI) exceeding its cost of
capital.
• Only a moat can maintain a longer-than-average CAP.
• A strong brand is a moat; it restrains the competition and enhances
pricing power, as seen in Page Industries operations.
• A moat has a high switching cost enough to cause psychological pain
when replacing it with another brand.
• Network effects are another type of moat; value creation occurs when
a customer is added to the ecosystem, as seen in the BSE or NSE.
• A low-cost advantage is another moat; it increases a company's profit
margin when the market price rate is constant and enables it to increase
its market share by lowering prices.
• Strategic assets like Page Industries' exclusive partnership with
Jockey International, USA, are also moats; the alliance makes Page
industries Jockey's sole franchise distributor in India and the UAE until
2030.
• Profitable investments occur when moats are in the making, not after
establishment.
• Companies are the best moat indicators because they have narrow
moats that are widening instead of broad and stagnant moats.
• One example of a moat in value chains is pricing power, which
translates to high returns on capital.
• A company with the ability to raise prices at levels exceeding
inflation without losing consumers has a pricing power moat.
• An enterprise with a durable competitive advantage is a legacy moat.
• Legacy cannot deploy incremental capital at similar rates to
Reinvestment Moats, also legacy moats.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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ENDNOTES
1.Saurabh Mukherjea, The Unusual Billionaires (Penguin Random
House India, 2016)
2.https://www.nfx.com/post/network-effects-bible
3.https://igyfoundation.org.uk/wp-
content/uploads/2021/03/Full_Collection_Nomad_Letters_.pdf#page=
151
4.https://csinvesting.org/wp-
content/uploads/2013/07/Measuring_the_Moat_July2013.pdf
5.https://marcellus.in/newsletter/kings-of-capital/simplifying-life-
insurance-and-why-we-hold-hdfc-life/
6.Saber Capital Management,
https://sabercapitalmgt.com/importance-of-roic-reinvestment-vs-
legacy-moats/
7.Saber Capital Management,
https://sabercapitalmgt.com/importance-of-roic-reinvestment-vs-
legacy-moats/
8.Saber Capital Management,
https://sabercapitalmgt.com/importance-of-roic-reinvestment-vs-
legacy-moats/
CHAPTER TEN

HIGH QUALITY
“Return on capital employed is one of the most
important measures of corporate performance –
it is the profit return which the management earns
on the capital shareholders provide.” 1
—Terry Smith
A high-quality business is one that can sustain a high return on the capital
employed and is consistent over long periods of time. Why so? When you
select a bank to open a savings account, given the risk of bank fraud is
equal, wouldn’t you choose the one with the highest rate of interest?
Somehow, in businesses, people talk about growth in earnings per share.
Firstly, earnings per share differ from cash flow, but more importantly, it
does not factor in the capital employed to generate those earnings or the
return earned on it.
This is one of the most important parameters. If a company can continue to
reinvest at high rates of return over long periods of time, the stock and
earnings keep compounding, which gives an exponential effect.
In our earlier tree analogy, the top two quadrants, Mango and Banyan,
represent high quality, while the bottom part, Cactus and Weeds, represent
low quality. One should never touch bottom quadrants unless there is
potential to become bamboo (transitioning possibility to high quality), or
one is consciously betting on cyclical in satellite portfolio, i.e., Palm tree.
It’s simply a play of probability - the more you are exposed to high quality,
the higher the probability of success in the long run. Hence, the core
portfolio should be majorly allocated to high-quality businesses.
According to Charlie Munger,
“Over the long term, it’s hard for a stock to earn a much better return than
the business which underlies it earns. If the business earns 6 percent on
capital over 40 years and you hold it for those 40 years, you’re not going to
make much different than a 6 percent return even if you originally buy it at
a huge discount. Conversely, if a business earns 18 percent on capital over
20 to 30 years, even if you pay an expensive looking price, you’ll end up
with a fine result.”2
Many investors just look at Earnings growth but miss an important
complementary aspect of investing, i.e. Return on Capital Employed.
“Growth can enhance or diminish the value of a company – growing a
business with inadequate returns is simply sending good money after bad.
But when a company has superior returns on capital employed, and a source
of growth that enables it to reinvest a substantial portion of those returns,
the result is a compound growth in its value and share price over time. It is
important to realize that this is over the long term.”3
A company deploys capital in asset manufacturing facilities, generating
cash flow and profits. The total capital deployed by the company consists of
equity and long-term debt. RoCE is a metric that measures the efficiency of
capital deployment for a company, calculated as EBIT divided by capital
employed. The higher the RoCE, the better is the company’s capital
allocation. Any business that is not making a RoCE of 12-15% is earning
below its cost of capital essentially. Most businesses that earn RoCE of less
than 15%, become value traps. If the RoCE earned by a firm is less than its
cost of capital, it cannot pay the capital providers for this limited resource.
The business destroys value for the shareholders, as they would have earned
a higher return on their capital had they invested it somewhere else.

CHAPTER SUMMARY
• A high-quality business consistently makes a high return on capital
employed over long periods.
• Earnings per share, not to be confused with cash flow, measure
business earnings growth.
• Earning per share does consider capital employed to produce those
earnings, or the earned return.
• When a company sustains high rates of return on reinvestments for a
long time, the stock and earnings keep compounding, giving it an
 exponential effect.
• An investor’s portfolio should contain high-quality businesses
because exposure to such enterprises increases the odds of success.
• The price of a company’s stock reflects its rate of return; thus, the
share never out-earns the rate of return.
• The Return on Capital Employed (RoCE) is a significant
complementary investment aspect for earnings growth.
• Many investors concentrate on earning growth and overlook RoCE
even though it is a better indicator of capital allocation.
• Growth impacts the value of a company.
• Investing in a business with low returns is akin to sending good
money after bad money.
• Invest in companies with high returns on capital employed and
growth because it permits reinvestment of a substantial portion of the
returns, resulting in a compounding value and share price growth over
time.
• ROCE is a metric that measures the efficiency of capital deployment
for a company, calculated as EBIT divided by capital employed.
• A higher ROCE is indicative of better capital allocation.
• A business with a RoCE below 12% -15% earns below its cost of
capital.
• Enterprises with a RoCE below 15% become value traps.
• When RoCE is below the cost of capital, a company will be unable to
pay the capital provider.
• Businesses with a lower RoCE than the capital cost destroy value for
shareholders; the shareholders would have earned a higher return on
their capital had they invested in a firm with a higher RoCE.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
__________________________________________________
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__________________________________________________
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__________________________________________________
__________________________________________________
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__________________________________________________
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ENDNOTES
1.Terry Smith, Investing for Growth: How to make money by only
buying the best companies in the world – An anthology of investment
writing, 2010–20 (United Kingdom: Harriman House, 2020)
2.Charlie Munger, “A Lesson on Elementary, Worldly Wisdom as it
Relates to Investment Management and Business,” Farnam Street
(blog) 1994, https://fs.blog/great-talks/a-lesson-on-worldly-wisdom/
3.Terry Smith, Investing for Growth: How to make money by only
buying the best companies in the world – An anthology of investment
writing, 2010–20 (United Kingdom: Harriman House, 2020)
CHAPTER ELEVEN

IMPROVEMENT
“A business should be viewed as an unfolding movie,
not as a still photograph.”
—Warren Buffett
Investing is all about delta, that is, the rate of change. A poorly run
company with improvement may be preferred over a well-run company
with deterioration.

IN MARGINS:
A company can improve operating margins and net profit margins by
increasing pricing power, through innovative products, building efficiency
and adding premium products. These improvements can result into
excellent profit growth, either for a temporary period or for the long term if
the changes are structural. One often-seen pattern in margin expansion is of
the shift from trading to manufacturing; this has occurred in Raghav
Productivity Enhancers and Trident Texofab. It could also be due to a shift
in product/segment mix, towards higher-margin areas, e.g., Goodluck India
increasing its share of the higher-margin forgings. Another pattern in
margin improvement is when the exports share rises; often, margins for the
same product are higher in exports than in domestic sales. This is noticeable
in Panama Petrochem and Ramkrishna Forgings.

IN CAPITAL ALLOCATION:
Promoters/CEOs have five basic options to allocate capital:
1.Invest in existing operations
2.Acquire other businesses
 3.Pay dividends
4.Pay down debt
5.Buyback stock
Here are three basic ways to raise money:
1.Issue stock
2.Issue debt
3.Use the cash flow of the business

This forms the collective toolkit for capital allocation decisions which, if
used wisely, can generate excellent results for the company.
When companies demonstrate the ability of efficient capital allocation to
create shareholder value, then it can get re-rated and further execution
accelerates this. An example could be the divestment of non-core assets,
e.g., Piramal Enterprises sold part of the Healthcare business to Abbott in
2010 when it was trading at a cash bargain, and now it has been rapidly re-
rated due to efficient capital allocation.
Some companies have a stellar track record of successful acquisitions, e.g.,
Pidilite. They acquired Dr. Fixit, M Seal, Steelgrip and so on. It is not that
all their acquisitions have succeeded. Even the best of companies do make
mistakes. However, as we have observed in this book, if your mistakes are
small and your gains are large, you can create a lot of value.
Another example of a successful acquisition is when SJS Enterprises had
acquired Exotech Plastics in CY 2021 at a cost of Rs 64 Cr, and has been
able to achieve improvement in margins due to synergies, cross-selling to
existing customers, etc. Through the Exotech acquisition, they entered
chrome-plated parts, and have a plant near Pune with a capacity of 29.5
million units. They continue to selectively assess inorganic opportunities.
Snapshot from the prospectus:

One key indicator of improvement in capital allocation is when a company

divests/monetizes its non-core/idle assets, e.g.:
1.La Tim Metal & Industries has a land parcel in Khopoli-Pali area and
they are monetising it by converting it into an industrial park
2.Cineline India is selling its windmills
3.Autoline Industries is creating an industrial park from its excess land
Interested readers can go through the recent concalls and the FY21 annual
report of Mahindra & Mahindra to understand improvement in capital
allocation through a live case study (as of the printing of this book in 2022).
They are systematically categorizing loss-making subsidiaries, improving
the cash flow position by lower fixed costs and working capital, etc.

IN DISCLOSURES/CORPORATE
GOVERNANCE STANDARDS:
There are several instances where disclosures for many small and midcap
stocks are minimal. Also, some of these companies are too small to form
part of a mandate for large investors.
E.g., companies like Poddar Developers and Mold-Tek Packaging did
QIPs (Qualified Institutional Placements), which resulted in higher
disclosure and comfort from institutional shareholding.
Where governance improves, e.g., Mirza International, where there is a
demerger of Indian business and corporate governance is improving, there
is often a big re-rating factor. With Mirza, the company took loans from the
bank. The promoters guaranteed that the company will pay the loans. For
that guarantee, promoters charged a guarantee commission.
This was in FY 2016:1

In FY21, this got reduced to only 75 lakhs!2

Corporate governance can also improve when there is a renewed focus in
the management and dedication to resolve previous poor governance
activities, e.g., Tilaknagar Industries wanting to resolve auditor
qualifications. From investor presentation:
 (https://www.bseindia.com/xml-data/corpfiling/AttachHis/75526b2b-553a-
444e-b3b3-06e5c2691a9e.pdf#page=12)
It can also be due to new promoters, e.g., Burman group coming in as
promoters in Eveready Industries; the previous promoters, Khaitan family,
had several inter-corporate deposits etc.

CHAPTER SUMMARY
• According to Warren Buffett, businesses constantly evolve like a
movie and are not stagnant like a photograph.
• Investing focuses on the rate of change or improvement.
• Even a poorly run company showing improvement is better than a
well-managed business with decreasing value.
• The five basic options for capital allocation are investing in existing
operations, acquiring other businesses, paying dividends, paying down
debt, and buying back stock.
• The three basic ways to raise money include issuing back stock,
issuing debt, and using the business’s cash flow.
• When businesses utilize the capital allocation collective tool kit
wisely, they can improve their results.
• Efficient capital allocation generates shareholder value and can
become re-rated with continued efficiency.
 • Companies with sustained capital allocation efficiency accelerate the
re-rate execution function.
• Piramal Enterprises is an example of a company that achieved a rapid
re-rate.
• Piramal Enterprises sold a section of its healthcare business to Abbott
in 2010 when it was trading at a cash bargain.
• Currently, Piramal Enterprises is rapidly re-rated because of its
efficient capital allocation.
• Even the best companies make mistakes— so long as the mishaps
remain small and the gains great— there will still be shareholder value.
• Disclosures and corporate governance also influence shareholder
value.
• However, the disclosure effect may be negligible for small
companies.
• Nevertheless, companies like Poddar Developers and Mold-Tek
Packaging did QIPs, which resulted in higher disclosure and comfort
from institutional shareholding.
• An improvement in corporate governance boosts a company’s re-
rating factor.
• An example of corporate governance boosting the re-rated factor is
Mirza International, where the demerger of the Indian business and
corporate merger is improving.
• Mirza International took loans from the bank, and promoters
guaranteed the company would pay the loan and charged a guarantee
commission.
• Corporate governance can also improve when there is a renewed
focus on the management and dedication to resolving past governance
insufficiencies.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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ENDNOTES
1.https://www.bseindia.com/bseplus/AnnualReport/526642/526642031
6.pdf#page=97
2.https://www.bseindia.com/bseplus/AnnualReport/526642/704535266
42.pdf#page=106
C H A P T E R T W E LV E

N E W FA C T O R
“Innovation distinguishes between a leader and a follower”
—Steve Jobs
Why new? Newness is the mantra of the modern world. Do you ever read old
magazines? There is a reason the newspaper is called the new spaper. While
the EMH is false and the market is never efficient all the time, it is efficient the
majority of the time. Thus, for a large majority of the time, the market has
factored in (hence ‘priced in’) old factors. Hence, as William O’Neil correctly
writes, “It takes something new to produce a startling advance in the price of a
stock.”1 Sales Growth generally comes from gaining market share in the
existing markets, expanding into new markets and creating new products.
What can be included under new?
New capacity: Companies doing a large CapEx could be potential
opportunities, as earnings could potentially rise multi-fold post this. Generally,
companies that double their capacity can be interesting, e.g.:
1.Fineotex Chemical recently did greenfield CapEx to take the total
installed capacity to 79000 MTPA from the earlier 43000 MTPA, at a cost
of ₹ 27 Cr.
2.Vidhi Specialty Food Ingredients.
3.Poddar Pigments is setting up a plant with an initial capacity of 5,000-
6000 tonnes per annum, entailing a capital expenditure of ₹ 85 crores to
be funded through internal cash accruals.
 4.Raghav Productivity Enhancers is expanding its ramming mass
manufacturing capacity from the existing 180,000 TPA to 288,000 TPA.
New product launch: Apple launched new products like the iPad, iPhone and
so on, and these became major drivers of Apple’s revenue growth. That leads
to earnings growth, and ultimately stock prices are slaves of earnings growth.
Also, new product launches help to diversify the company’s revenue stream.
For example, a company may be overly dependent on only one or two of its
products, and any stagnation in the sales for these products can lead to poor
growth for the company. Hence, a company that launches new products
continuously adds new drivers for its growth, thus extending its growth period.
This gets rewarded by the market in rising share prices.
Here are some examples of how Indian companies that launched new
products created excellent returns for their shareholders:
1.Eicher Motors came out with Royal Enfield Classic 350 and 500
models in 2009, which changed the trajectory of the company. From its
lows in 2009, the stock surged almost ~100x in the next 6 years, coupled
with other successful new product launches like Thunderbird, Continental
GT, etc.
2.Radico Khaitan rose after launching Magic Moments Dazzle Vodka and
Royal Ranthambore Heritage Collection Royal Crafted Whisky.2

(Source: Company Disclosures)

3.Somany Home Innovation is launching IoT-enabled chimneys and
stoves under the Hindware brand.
4.Amrutanjan launches roll-on balms and Comfy sanitary napkins.
5.Mahindra & Mahindra is launching several new automotive models.3
6.Autoline Industries has launched “E-Speed” electric cycles and is
planning to launch electric scooters.
 7.Raghav Productivity Enhancers is launching a new value-added boron
oxide ramming mass.
8.Tilaknagar Industries is planning several new product launches in the
coming quarters.
9.Inflame Appliances is planning the launch of dishwashers, oven-toaster-
grill (OTG), etc. in the coming years.
New management/promoters: Let us continue with the kite analogy we have
used. One of the most important factors is how good the kite flier (company
management) is. Even if there are huge amounts of breeze enough to generate
power through windmills, and the kite is optimally designed in its weight and
structure, if you give it to someone who does not know how to fly a kite, what
is the point? Often, there are instances of the next generation of promoters
taking over the operations of the business and changing business strategy.
Often, the next generation has a hunger, a ‘fire in the belly’ and large
aspirations for business growth, which were not present in the older
generation, who were ‘content’ with modest, mid-single-digit growth rates.
When growth rates accelerate, a company can move from the Mango Tree to
the Banyan Tree category, creating tremendous shareholder value. This is
precisely what transpired in Lupin when Vinita Gupta took over. She played an
instrumental role in taking Lupin beyond India and into the overseas markets.
“If we did this in the US, we would be ten times the size, given the market
potential,” she would often tell her father, Desh Bandhu Gupta.4
There are several such examples where changes in top management played an
instrumental role to take the company to a new trajectory:
1.We covered new product launches by Eicher Motors and this was also
the case of new management, i.e., Siddharth Lal as the think-tank behind
the success story.
2.In 2013, Varun Berry joined Britannia Industry. Under Berry’s watch,
the company has doggedly pursued a strategy to improve its sales and
distribution reach, better the overall cost management, increase its in-
house production capabilities, infuse operational efficiencies across its
supply chain and scale up its innovation capabilities.5 The net profits
surged almost ~4x between 2013-2018 and the stock price soared almost
~10x within the same period.
3.Mr. Shivaji Akhade replaced Mr. Umesh Chavan as CEO of Autoline
Industries, and Mr. Venugopal Rao Pendyala (ex-Tata Motors) came in as
 CFO.
4.Panjri group bought Vistar Amar (earlier Shubhra Leasing) and the
stock is up more than 15x in less than 7 years!
New Geography: Continuously expanding across new geographies can give a
great scale for the company. We all know how multi-national companies like
Pepsi and Coke have expanded into different countries to keep compounding
in profit growth.
A classic case study in India is V-Guard Industries. It was having
predominantly South India-based distribution with 95% revenue from the
south and a mere 5% revenue from non-south (North India) back in 2008.
They adopted a long-term strategy to expand rapidly into a non-south
distribution network. In 2012-13, non-south markets contributed ~25% of
revenues. In FY21, they had ~42% of revenue from non-south markets.6
Due to this strategy, and other key initiatives, the profits of the company grew
from ₹ 25 crores in FY 2010 to ₹ 200 crores in FY 2021
Distribution of Revenue South Non-South
FY2011 78% 22%
FY2012 79% 21%
FY2013 75% 25%
FY2014 70% 30%
FY2015 67% 33%
FY2016 67% 33%
FY2017 65% 35%
FY2018 63% 37%
FY2019 61% 39%
FY2020 60% 40%
FY2021 58% 42%

Source: Company Annual Reports and disclosures

Aptus Value Housing Finance India is planning to expand geographically and
enter Maharashtra, Orissa and Chhatisgarh.
New price high of stock: Imagine the following: you buy a stock at ₹ 100.
Where would you prefer the stock to go, ₹ 200 or ₹ 50? ₹ 200, right? Now
consider this. How can the stock ever possibly go from ₹ 100 to ₹ 200? It must
hit ₹ 110, ₹ 120, ₹ 130… and so on. In other words, it must create new highs!
Most naïve investors try to look for stocks at or near their 52-week lows! It is
important to note here that the time frame is crucial and must be adjusted
depending on market conditions. During a strong, broad-based bull market
rally, one should look for stocks making multi-year highs. But hardly any
stocks will be making multi-year highs during a market crash. In such a
scenario, one should look at stocks making one-month highs or quarterly
highs. During a largely sideways market, 52-week (i.e., one year) highs are
optimal. As Gautam Baid has aptly written, “A stock going to a new high is
typically a bullish event, because the market has eliminated the supply of all
previous buyers who experienced a loss and were waiting to get out at even. A
stock hitting a new high has no overhead supply to contend with and has much
more of an open running field. Everybody has a profit; everybody is happy. In
contrast, a stock near its fifty-two-week low has a great deal of overhead
supply to work through and lacks upside momentum, because it is vulnerable
to fresh bouts of selling by the old investors at every higher level…The fifty-
two-week high list is often a shortcut to the minds of smart investors.”7

CHAPTER SUMMARY
• William O’Neil accurately stated, “It takes something new to produce a
startling advance in the price of a stock.”
• Sales grow when a business increases its market share in the existing
market, ventures into new markets, and diversifies its product portfolio.
• Apple is a good example of how a new product launch can promote
sales growth; when the company introduced the iPad, iPhone, and iPod, it
increased its revenue generation, which, in turn, boosted its earnings
growth and stock prices.
• Eicher motors increased its stock prices six years in a row after a low
period when it introduced Royal Enfield Classic 350 and 500 models in
2009.
• A change in management is instrumental in catapulting a company’s
sales and increasing stock prices.
• A stock needs to create new price highs for long-term profitability.
• It is naïve investing to look for stocks experiencing a 52-week low.
• The investment time frame is vital and is modified depending on market
conditions.
 • During a strong-broad-based bull market rally, investors should look for
stocks making multi-year highs.
• During a market crash, invest in stocks making one-month highs or
quarterly highs.
• Highs are optimal in a largely sideways market in a 52-week time
frame.
• According to Gautam Baid, when a stock goes through a new high, the
event is typically bullish because previous buyers who experienced loss
from the supply got eliminated.
• When a stock gets to a new high, it does not need to contend with
overhead supply; the event resembles an open running field.
• Every investor profits when the stock hits a new high.
• On the other hand, a stock nearing a 52-week low has an overload of
overhead supply to work through and lacks upside momentum because it
is vulnerable to fresh bouts of selling by the old investors at every higher
level.
• Smart investors regard 52-week high lists as shortcuts.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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ENDNOTES
1.William O’Neil, How to make money in stocks (New York: McGraw
Hill, 2009)
2.https://www.business-standard.com/article/markets/radico-khaitan-
rallies-11-after-launches-two-new-premium-imfl-121101200328_1.html
3.https://www.mahindra.com/resources/investor-
reports/FY21/Earnings%20Update/TRANSCRIPT-M-M-Annual-Analyst-
Meet-28th-May-2021-FINAL.pdf
4.https://wow.outlookbusiness.com/vinita-gupta/
5.https://www.forbesindia.com/article/super-50-companies-
2015/britannia-industries-the-taste-of-success/40701/1
6.https://www.vguard.in/uploads/investor_relations/annual_report_2012_
13.pdf
7.https://www.bseindia.com/bseplus/AnnualReport/532953/68929532953
.pdf
8.Gautam Baid, The Joys of Compounding (New York, Columbia
University Press, 2020)
CHAPTER THIRTEEN

EXECUTION OF EARNINGS
GROWTH TRIGGERS
Steve Jobs said, “To me, ideas are worth nothing unless executed. They are
just a multiplier. Execution is worth millions.”1
The point is not to debate whether an idea is more important or execution.
The point is that promoters often have a tendency of being overly optimistic
about their business prospects. It may not necessarily be intentional to deceive
potential shareholders; this may be purely due to excess optimism, which may
not play out due to any external factors. Hence, it is important to not only look
at what vision or guidance the management has given but also track whether
they can execute it. As a part-owner of a business, one should look for
management teams that actively walk the talk rather than over-promising and
under-delivering.

CASE STUDY - RISE IN INDIAN

TELECOM INDUSTRY
The period of 2003-2009 was probably a glorious one for the Indian Telecom
Industry. The advent of competition later, like Tata DoCoMo, Videocon,
Reliance Jio, etc. then made this sector highly competitive.
Let us now look at the comparison of MTNL vs. Bharti Airtel - both had
sector tailwinds, megatrends in place, demand for their product, and
competitive advantages. The execution of these earnings growth triggers made
a huge difference. MTNL destroyed wealth vs. Bharti Airtel created enormous
wealth for its shareholders.
All Number in INR Crores
MTNL Mar/2003 Mar/2009
Net Sales 5,809 4,496
 PAT 878 206
Market Cap 6,051 4,353

Bharti Airtel Mar/2003 Mar/2009

Net Sales 3,050 37,352
PAT 176 8,044
Market Cap 5,245 1,18,792

The best way to track execution is to closely monitor the quarterly results.
Like the weather has seasons- summer, monsoon, winter, spring, and autumn;
investing has four seasons/quarters. These are the four quarters- Q1, Q2, Q3
and Q4. Closely tracking quarterly results can help an investor to identify the
change in a company in the initial stages, for example, an increase in profit
margins, increase in depreciation (which could be a signal of new CapEx being
capitalized), decrease in interest cost (which could indicate that debt has been
reduced), etc. One should also attend post-earnings conference calls. Often,
many smart analysts attend these conference calls and ask questions that one
could have never even imagined.
One of the most important patterns in investing is called post-earnings
announcement drift (PEAD). It describes the drift of a firm’s stock price in the
direction of the firm’s earnings surprise for an extended period. An earnings
surprise does not lead to a full, instantaneous adjustment of stock prices, but a
slow, predictable drift. It describes the tendency of stock prices to continue to
behave as if the market participants were still anticipating the results, even
though the results have been published and are widely known. This shows that
studying quarterly results, even after they have been published, can yield great
returns.
As Jesse Stine explains, “Asc is often the case, many investors will assume
that a ‘monster quarter’ is a one-time event. Because of this thinking, investors
don’t initially bid the stock up in line with its newly improved fundamentals.
While a substantial temporary disconnect exists between the stock price and
the improved fundamentals, the astute investor is presented with an excellent
low risk/high reward window of opportunity for entry.”2
‘Breakout earnings’ where a company grows profit by more than 50% QoQ
(Quarter on Quarter) and 300% YoY (Year on Year) for the quarter, are often
an early indication of some structural change occurring. These can often be
spotted using quantitative screeners on websites like screener.in
 After the initial hyper and high growth phases, growth rates taper off to the
mean rate (which is usually the nominal GDP growth rate). This is due to both
competition and the company’s own high-base effect. However, competent
managements can delay such reversion to mean either by new streams of
organic growth, and/or inorganic growth via judicious, earnings accretive and
value-enhancing acquisitions.

CHAPTER SUMMARY
• Steve Jobs aptly said, “Ideas are simply multipliers without execution
because the latter is worth millions.”
• As an investor, it is crucial to look beyond the vision or guidance
provided by management by analyzing a company’s proactiveness in
executing.
• Business owners should look for management teams that walk the talk,
not overpromising and under-delivering.
• In a case study of the highly competitive India’s Telecom Industry,
MTNL destroyed wealth, and Bharti Airtel created enormous wealth for
its shareholders, despite both companies having tailwinds, megatrends,
and product demand working in their favor.
• The case study shows the difference between the two companies in
executing these earnings growth triggers.
• The best way to track execution is to monitor quarterly results closely.
• Closely tracking quarterly results enables investors to recognize changes
in a company in the initial stages—an upsurge in profit margins or
depreciation is indicative of the capitalization of a new CAPEX, and a
decline in interest cost shows debt reduction.
• Investors should also attend conference calls to ask every imaginable
question regarding their potential investment.
• There is a significant investing pattern called post-earnings
announcement drift (PEAD).
• PEAD describes the drift of a firm’s stock price in the direction of the
firm’s earnings surprise for an extended period.
• An earnings surprise does not lead to a complete and instantaneous
adjustment of stock prices, but a slow, predictable drift.
 • Earnings surprise defines the tendency of stock prices to act as if market
participants were still anticipating results despite results publication and
investor knowledge.
• Studying quarterly results even after their publication can yield great
returns.
• Breakout earnings are an indication of ongoing structural changes.
• The first hyper and high growth phases always taper off to a mean rate,
usually the nominal GDP growth rate, because of competition and a
company’s high-base effect.
• Competent management can delay the nominal GDP growth rate by new
streams of organic growth and inorganic growth through careful earnings
of accretive and value-enhancing acquisitions.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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ENDNOTES
1.https://www.azquotes.com/quote/1059401
2.Jesse Stine, Insider Buy Superstocks (Superstock Letter, 2013, Page 89)
CHAPTER FOURTEEN

BAMBOO INVESTING - THE

S AT E L L I T E P O R T F O L I O
P L AY
“Experience tends to confirm a long-held notion
that being prepared, on a few occasions in a lifetime, to act promptly in scale,
in doing some simple and logical thing, will often dramatically improve the
financial results of that lifetime. A few major opportunities, clearly
recognizable as such, will usually come to one who continuously searches and
waits, with a curious mind that loves diagnosis involving multiple variables.
And then all that is required is a willingness to bet heavily when the odds are
extremely favorable, using resources available as a result of prudence and
patience in the past.”
—Charlie Munger
The title of the chapter is Bamboo Investing, however, let me first clarify that
it’s not about investing in bamboo trees. It’s about mental models’ ways of
learning.
Before we get to the point, here is a small puzzle. Below are the share price
charts of a few companies over a certain time. What is common between
them?

COMPANY-1: SPECIALTY CHEMICAL

COMPANY
COMPANY-2: AUTO MANUFACTURING
COMPANY

COMPANY-3: SHRIMP EXPORTING COMPANY

 So, in this puzzle, there is another anecdote for you. This is about Chinese
Bamboo. For those who haven’t seen it, the picture is below. This will help
you understand the Bamboo Investing concept.

The Chinese bamboo tree is very typical. It can grow vertically to almost 90
feet (that’s almost as tall as a building!). This is how it GROWS: The farmer
waters the bamboo tree for four straight years and nothing happens –
absolutely NOTHING! The seed remains in the ground. Then suddenly, a
miracle happens in the 5th year. The Chinese bamboo tree finally emerges
from the ground. Within a matter of six weeks, it achieves the height of 90
feet….in just 1.5 months after waiting 4 long years! This is exactly how
compounding works- in the initial days, it tests your patience, but in the later
days, it tests your bewilderment.

LEARNING FROM THE STORY…

This is the common theme of the initial puzzle. A good stock may remain
dormant and boring for many years, and then it would accelerate to surprise
everyone. As such, this can happen for the entire sector or most stocks in any
country, depending on triggers.
Therefore, one should watch for improvement in business fundamentals and
Earnings power. If the prices don’t move and the business is improving, that’s
the best ground to hunt.
So, the answer to the puzzle is that all the above companies were boring and
dormant but accelerated to become multi-baggers in a very short period. The
companies were Vinati Organics, Eicher Motors and Avanti feeds, but that’s
not important here.
What is imperative is, what are the triggers?
The above outcome is surprising as we say that markets are efficient. Then is
there any anomaly?
Well, after a prolonged spell of research and rumination, I have found there
are mainly two broad factors that drive it: Rapid earnings growth and PE re-
rating (we have read about this in the core-satellite concept earlier).

1. SECTOR AND COUNTRY RE-

RATING:
This can happen when there are certain key changes in the sector and country
that can expand the PE multiple rapidly despite no change in earnings growth
(mostly in anticipation of future earnings growth).
Examples:
• The entire Indian market got re-rated in 2014 after the new government
got the majority in the 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 the shutdown of factories in China

2. COMPANY IS WIDENING MOAT

FOR THE LONG TERM:
There might be instances when companies are spending on R&D, brand
building, building distribution networks, trying to launch new products, trying
to enter new markets, spending heavily to gain economies of scale or creating
network effects, etc. Basically, they are bleeding today to achieve sustainable
long-term growth.
This reflects poorly on income statements for the short term, but the earnings
power of the company is constantly increasing, which results in exponential
long-term growth.
Examples:
• Amazon hiring staff to increase future sales by making systems and
servers more efficient
• Thyrocare taking a hit on the margins to quickly gain market share from
lower prices and harness economies of scale in future
• Ola/Paytm keeping 0% fees for partners (drivers/merchants) to achieve
the network effect
• Tata Sky giving set-top boxes free/subsidized to new customers to
bargain better with content providers in future

3. EFFICIENT CAPITAL
ALLOCATION:
When companies demonstrate the ability of efficient capital allocation to
create shareholder value, then it can get re-rated and further execution
accelerates this.

EXAMPLES:
• Piramal enterprises sold part of its healthcare business to Abbott in 2010
when it was trading at cash bargain, and now it has been rapidly re-rated
 due to efficient capital allocation

4. INCREASED DISCLOSURE OR
MARKET CAP LEVELS/LOW
LIQUIDITY:
There are several instances where disclosures for many small and mid-cap
stocks are minimal. Also, some of these companies are too small to form part
of the mandate for large investors.
There may be low liquidity for the stock. In these cases, the stock gets re-
rated fast once it falls under the mandate of institutions or after improved
disclosure levels.
Examples:
• Companies like Poddar Developers and Mold-Tek Packaging did a QIP,
which resulted in higher disclosure and comfort from institutional
shareholding
• Companies like Sirca Paints coming out from SME exchange and
getting listed on BSE and NSE, thus constraint of many funds that cannot
buy on SME platform gets removed

5. STRUCTURAL TURNAROUNDS:
Many companies could show lower earnings or losses due to some structural
bottlenecks. But when this gets resolved, there may be a turnaround in the
fortunes of the company.
This may be triggered due to single events like debt repayment, management
change, regulatory change, change in strategy, consolidation of the industry,
structural fall in raw material prices, etc.
Examples:
• Indo Count industries changed its strategy and product lines after
coming out of BIFR and it became 100x in ~2-3 years thereafter
• Symphony changed its strategy from buying assets to becoming asset-
light and its stock became a multi-bagger
 • Autoline Industries is reducing debt, improving liquidity, entering EVs,
reducing customer concentration, etc.
There may be several such factors that may result in multifold returns in a
very short period. But not every company which is dormant or boring will
move like this.

HOW TO IDENTIFY SUCH

COMPANIES?
We can use the TechnoFunda approach, i.e., a combination of Technical and
Fundamental analysis to find such Bamboo Investing stocks. Some of the
technical indicators like price-volume break-outs, momentum indicators and
formation of trend lines are very powerful in identifying such companies at an
inflection point.
10 Powerful Indicators/Patterns for Investors
Sr. No. Patterns/Indicators
1 Moving Averages
2 Parabolic SAR
3 Cup and Handle
4 Donchian Channels
5 ADX
6 Relative Strength
7 RSI
8 VStop
9 Channel Breakouts
10 ATR

You can research more on these indicators/patterns to understand how you

can use them in your investing journey.
Adding fundamental analysis on top of it (remember the 4-cylinder analysis
model) 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.
Example:
 Companies like BEPL, HEG, etc., gave clear technical indications and this
was coupled with fundamentals like ABS prices going up along with CapEx
for BEPL and graphite electrodes prices going up for HEG along with the
shutdown of capacity in China.
See the technical chart below for HEG:
There was a price-volume break-out during Aug/Sep 2017 at ₹ 250-300 and
the stock became almost 8x in less than 12 months. The fundamental news
around the closing of the competitor came soon after the break-out, giving
fundamental confirmation and conviction to hold. This was further accelerated
by a shortage of supply in the market and promoter buying.
Do note, it is important to also have an exit strategy in place as it falls under
cyclical stocks (Palm Tree stocks). More on the exit strategy in later chapters.
For now, enjoy the Bamboo Investing process.
Thus, one must use the TechnoFunda approach to identify such stocks and
once these are identified correctly, just SIT TIGHT until the story plays out
and then average up to enjoy the Bamboo Investing way of wealth creation…!!

Bamboo stocks are not long-term investments. They generate alpha in

portfolios in a short period of time, and you must exit them before the tide
turns. The best way to exit them is to not get too greedy and keep some money
on the table for the next buyer while strictly following your exit criteria.

CHAPTER SUMMARY
• A good stock remains dormant for years before it finally shoots up in
price like a Chinese bamboo.
• Dormant stock can accelerate suddenly in any sector in a country with
the right triggers.
• Investors should analyze business fundamentals and earnings power
improvement; unchanged pricing indicates business improvement.
• Two broad factors trigger acceleration: rapid earnings growth and PE re-
rating.
• Sector and country re-rating occurs when there are certain key changes
in a sector and country expanding the PE multiple rapidly, even without
changes in earnings growth.
• Exponential long-term growth is achievable by a company widening its
moat; the company may experience short-term low-income statements as
its earnings power continues to increase during this period.
• A business with efficient capital allocation creates shareholder value and
gets re-rated; further execution accelerates this outcome.
• Minimal and numerous small and midcap stocks — for small businesses
without large investor mandates—have low liquidity; such stock gets
quickly re-rated when it falls under institutional mandates or after
improved disclosure levels.
• Structural turnarounds also accelerate earnings growth; examples
include debt repayment, management, regulatory and strategy changes,
industry consolidation, structural fall in raw material prices, etc.
• Investors can identify businesses with earnings growth through technical
indicators like price-volume breakouts, momentum indicators, and the
formation of trend lines at their inflection point.
• Add fundamental analysis to filter false evaluations from technical
indicators when identifying accelerating companies; together, the two
identifying criteria make the TechFunda approach (from Technical and
Fundamental analysis).
• Use the TechnoFunda approach to identify accelerating stock prices and
wait until the prices average—this is the bamboo investing method of
wealth creation.
• Bamboo stocks are a short-term investment strategy; they are significant
for short-lived investment portfolios because investors must exit before
 the tide turns.
• The best way to exit is to practice contentment and leave some of the
benefits for the next buyer; always abide by an exit strategy with bamboo
stocks.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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CHAPTER FIFTEEN

A L L O C AT I O N A N D
POSITION SIZING
“It’s not whether you’re right or wrong that’s important, but how much money
you make when you’re right and how much you lose when you’re wrong”
—George Soros 1
A common pattern among most successful investors across the world, be it
Warren Buffett, George Soros, John Templeton, Rakesh Jhunjhunwala,
Mohnish Pabrai, is that they allocate significant capital to their winners. When
they are right - THEY BET BIG.
Most investors keep running behind the next big idea, that next big HDFC or
next big Asian Paints, but they seldom think about allocation and position
sizing. This is the most under-appreciated idea in investing. I am sure all of us,
in our journey, would have bought HDFC Bank or Astral Poly or Pidilite or
Asian Paints, etc., but why did it not create similar wealth as other successful
investors? The first factor is Riding Winners, and the second and most
important is riding them by allocating big capital behind them.
No matter how well you may know your stocks, every business has unknown
risks. The only way to protect against such risks is to diversify. What is the
optimum number of stocks one should hold in a portfolio?
A portfolio of 15-20 stocks offers the best of both worlds – adequate
diversification and a meaningful allocation to move the needle.
The graph below shows that somewhere around 19 stocks are the ‘sweet spot’
where most of the benefits of diversification are achieved. Adding more stocks
beyond that is suboptimal.
 Now let’s understand the allocation part and how one can ride winners. In the
below example, we have assumed a portfolio of 20 companies (to first have
reasonable diversification in place). Now an important aspect of allocation
plays a key role to determine portfolio returns.
Let’s understand that Investing is a game of probability. We must always
think in terms of “expected value”. As Warren Buffett mentioned, “Take the
probability of loss times the amount of possible loss from the probability of
gain times the amount of possible gain. That is what we’re trying to do. It’s
imperfect, but that’s what it’s all about.”
As Anurag Sharma rightly explains in his masterpiece Book of Value - “Make
no mistake: both gambling and investing are about making decisions now for
outcomes in the unknown future. As such, they both require making
assessments about the odds; understanding the underlying math is essential in
either case. The difference is that where gamblers usually seek low odds with a
high payoff , investors are inclined to seek out much more favorable odds for
reasonably good returns (say, 9–1 odds for a 15 percent return with much
upside potential). Marginally favorable odds (say, 51–49) would induce eager
action from gamblers but none from investors.”
No matter how good we are at stock selection and understanding businesses,
we will only know in hindsight that any investment had a good or bad
outcome. We will only know the odds or probability of winning. So how to
naturally allocate more to winners and how to reduce allocation to non-
performers?
 The ideal strategy is to keep AVERAGING UP the businesses that keep
performing and TRIM the ones not performing. This can fetch returns to your
outstanding portfolio. Take a small initial allocation and then follow a
pyramiding strategy.
Let me caution you that Averaging up is mentally very difficult due to
Anchoring bias. Our mind gets fixated on the initial price even though a
business might have improved significantly to justify the higher price.
“As soon as our intuition gets fixated with a number—and that can be any
number—it sticks with us. Most of our decision-making errors result from
mental shortcuts that are a normal part of the way we think. The brain uses
mental shortcuts to simplify the very complex tasks of information processing
and decision-making. Anchoring is the psychologist’s term for one shortcut the
brain uses. The brain approaches complex problems by selecting an initial
reference point (the anchor) and making small changes as additional
information is received and processed.”
—Vishal Khandelwal
But if you can get rid of your own Anchoring bias and understand this math,
it can give excellent portfolio returns that can help you accelerate your journey
to achieve financial freedom and wealth creation.
The example below can give you an idea of it.
Here is how your portfolio returns will shape up based on various allocation
strategies.
 Portfolio A is an equal-weight strategy.2
The ideal way to add a position is through tranches. Charlie Munger has said,
“To get what you want, you have to deserve what you want.”3
Similarly, the stocks that eventually form 10, 15 or 20% of your portfolio
should deserve that weight. And how do stocks deserve a large allocation? By
earning it through price appreciation.
Diversification is not only about the number of stocks, but also about the
correlation between stocks. This includes the geographical risk- your portfolio
companies should not all be based in the same location, as any natural
calamity like floods, earthquakes, etc. could be a problem. It also involves
macro factors. As Gautam Baid writes in The Joys of Compounding ,
“Sometimes, factors like currency depreciation or rising interest rates hurt
some of our portfolio companies while benefiting others, so that the overall
impact is muted. Most notably, if we invest in a diversified portfolio of good
businesses, then the tailwinds pushing a few businesses forward most of the
time will compensate for the headwinds pushing back the others, thus
protecting us from permanent loss of capital.”

HOW TO SIZE THESE BETS?

There is very little academic study done on this aspect, but the best and closest
which I have found was by John L. Kelly called “The Kelly Criterion”. It is a
mathematical formula that gives you output on Capital to Bet given win-loss
probabilities and payoffs (odds).
The following appeared in Ed Thorp’s interview in the book Hedge Fund
Market Wizards :
F = Pw - (PL / [$W / $L])
Where,
F = Kelly criterion fraction of capital to bet
Pw = probability of winning the bet
PL = probability of losing the bet
$W = dollars won if the bet is won, and
$L = dollars lost if the bet is lost4
Let’s understand $W / $L >>. It is basically a payoff, or what is commonly
known as a Reward for the Risk Taken. Let’s take the example of tossing the
coin. Let’s say you bet on either side and you are offered twice the reward if
you are right. Then $W / $L becomes 2:1, so if you bet ₹ 500 and you are
right, then you get ₹ 1000.
Pw and PL are 50% each with tossing the coin. But when you are investing, it
will depend on the probability of positive outcomes in your investment thesis,
and similarly, the probability of downside risk materializing.
If we are just following the fundamentals, it becomes quite a tough exercise,
but still, we can come to a reasonable estimate, given we understand the
business well. If you use objective trailing exits and upside targets based on
earnings and re-rating estimates, it becomes slightly easier.
Let’s say we had a 75% probability of winning (basically, it is a high
conviction idea in terms of investment thesis) and we were also having
favorable entry conditions (in terms of valuation and market condition) with
5:1 reward:risk. Here 25% is the probability of losing.
Applying Kelly’s formula with starting capital of ₹10,000, the bet size would
be:
F = 75% - (25% / 5), i.e. 70% of capital, i.e. ₹ 7,000
Another example with a winning probability of 50% and 2:1 reward:risk
would mean,
 F = 50% - (50% / 2), i.e. 25% of capital, i.e. ₹ 2,500
In his book, The Mathematics of Gambling, Thorp explains the Kelly
system’s attractive features:5
1.The chance of ruin is “small”. Because the Kelly system is based on
proportional bets, losing all your capital is theoretically impossible
(assuming money is infinitely divisible). A small chance of a significant
drawdown remains.
2.The Kelly system is highly likely to grow a bankroll faster than other
systems. Provided comparably attractive opportunities continue to appear,
there is a high probability the system will generate a bankroll that exceeds
other systems by a determinable multiple.
3.You reach a specified level of winnings in the least average time. If you
have a financial end goal in mind and continuous opportunities, the Kelly
system will likely allow you to achieve the objective in a shorter time
than other systems.
You can also decrease volatility using the “half-Kelly.” This means that if the
formula suggests you put 30 percent of your bankroll in one stock, you put
half of it (15 percent).
William Poundstone writes about half-Kelly: “This is an appealing trade-off
because it cuts volatility drastically while decreasing the return by only a
quarter. In a gamble or investment where wealth compounds 10 percent per
time unit with full-Kelly betting, it compounds 7.5 percent with half-Kelly.
The gut-wrenching and teeth-gnashing are diminished much more. It can be
shown that the full Kelly bettor stands a 1/3 chance of halving her bankroll
before she doubles it. The half- Kelly bettor has only a 1/9 chance of losing
half her money before doubling it.”6 7
 The horizontal axis is the multiple (or fraction) of the Kelly Criterion applied;
zero is betting nothing at all, and two is twice the Kelly bet. The vertical axis
is the total compounded return. If one is looking only for the highest rate of
return in the shortest period, then following Kelly Criterion is the best method
for bet sizing.
In the mid-1960s, Buffett allocated close to one-quarter of his assets into one
stock, American Express, when he was convinced that the security offered
superior return prospects.8
Ranjita: But how to gauge when to bet big and when to abstain? Is there a
cut-and-dried technique?
Aryan: Bravo Ranjita, I admire your acumen.
Let’s nose-dive deeper into this topic.

WHEN TO BET BIG AND WHEN NOT

TO?
 • The most favorable scenario occurs when both the Probability of
winning is high and when the odds are in your favor, i.e., Asymmetric
Payoff.
This means when you have a high conviction idea (with a high probability of
winning) and the odds are in your favor (entry valuation, market condition),
BET BIG
Keep in mind - these kinds of situations are very rare. Either you will get it
during Bear Markets, some market anomaly or some special situations.
As Mohnish Pabrai in his book The Dhandho Investor mentions, “You need
to take such - “Few Bets, Big Bets, Infrequent Bets” to make it big.”
• When you have a low conviction idea with a low probability of winning
but with high payoffs, BET moderately
• When you have lesser probability and low reward:risk, don’t BET
Also, remember that subsequent bets are a function of winning the first bet as
the overall capital increases. If we think in the context of averaging up, it
implies that if the probability of winning keeps increasing as the business
performs and the price responds together, we need to keep adding capital.
Similarly, during the investing journey, if the probability of losing starts
increasing due to risks in the business materializing and the reward-risk
deteriorates, we need to keep trimming our positions.
For long enough bets, this overall strategy will maximize portfolio returns.
That’s exactly the table in the example proved mathematically:
Portfolio A - we do not give attention to position sizing and give 5% capital
to each of the 20 businesses and portfolio returns are 5%
Portfolio B - we average-up winners and give more allocation to winners and
much less to losing bets and portfolio returns are a whooping 52%
Portfolio C - we average down and keep buying losing businesses with low
reward:risk (reverse of Kelly formula) and the portfolio returns are pathetic
negative 42%
Raamdeo Agrawal rightly mentioned his key lesson in the market:
“A significant learning was to average up - we used to make one-shot
investments. If the research is good, one should average up. Now there is
wisdom and experience. Companies have their own life, and success breeds
success. Now I am an entrepreneur as well and I am talking from my business
experience. I run a slightly diversified company, not a monoline business.
When you start a business, you struggle for five to ten years, and then you
develop some competitive advantage and pick up. You won’t know how big a
success you can become. Even Hero Honda did not know that they could move
from 12-13% to 55-60% market share. Clearly, it is very difficult to discover
all the successes in advance.”9

IMPORTANCE OF EDGE
One more variation of Kelly’s formula is found in the book Fortune’s Formula
by William Poundstone, i.e.
F = edge/odds
F = Kelly criterion fraction of capital to bet
Edge = Expected value of the financial proposition
Odds = How much you win if you win
Now, let’s understand this with the same coin-tossing example. We discussed
a 50% probability of each winning and losing (as it’s a fair coin). But the Odds
or Payoffs were in our favor. If we win it is 2x and if we lose it is 1x.
F = (50%*2 - 50%*1) / 2 = 25% (one should put 25% of total capital in one
bet)
For investing, generally, the key edge is the information edge, and the other is
the analytical edge. As most investors follow only fundamental analysis and
markets are becoming more and more efficient - there is hardly any edge.
When you blend fundamentals and technicals (along with price volume
action), it gives you an information edge as most times price volume action
reflects fundamentals much ahead of information distribution in public.
FOCUS ON THE RISK OF RUIN:
 Who is the person on the rightmost? Everybody would know- Charlie
Munger. Who is the person on the leftmost? Many would know- Mohnish
Pabrai. But who is the person in the middle? Hardly anybody knows him. He
is Rick Guerin.
Let us hear the story of Rick Guerin, who was Warren Buffett’s and Charlie
Munger’s partner in the 1970s. But what happened to him that nobody now
knows him? Warren explains, “Charlie and I always knew that we would
become incredibly wealthy. But we were not in a hurry to get wealthy; we knew
it would happen. Rick was just as smart as us, but he was in a hurry. And so
actually what happened was that in the 1973-74 downturn, Rick was levered
with margin loans. And the stock market went down almost 70% in those two
years, and so he got margin calls, and he sold his Berkshire stock to me. I
bought Rick’s Berkshire stock at under $40 a piece, and so Rick was forced to
sell shares at … $40 apiece because he was levered.” 10
Guess what is the share price of Berkshire Hathaway today? Over $400,000!
Charlie, Warren, and Rick were equally skilled at getting wealthy. But Warren
and Charlie knew how to stay wealthy.
Gautam Baid writes, “Whenever someone sells in desperation, they tend to
sell cheap. As a buyer, I love to be on the opposite side of such trades in which
the other party is being forced to liquidate holdings at any price, regardless of
underlying value. The time to buy is when those investors are in a hurry to
dump shares at any price.”11
If someone asks you to play tossing the coin game. You know that the
probability of winning is 50% and losing is 50%. And you are told that bet size
is compulsory ₹ 10 lakh. If you win, you get ₹ 1 crore, and you can lose ₹ 10
lakh. The payoff is 10:1. Will you play this game?
Mathematically, it may look very tempting and a no-brainer to play, but what
if you have only ₹ 10 lakh capital? It means there is a RISK OF RUIN if you
lose. So, here is what I strongly recommend; never play such a game that takes
you out of the game, particularly in the game of investing.
As Rick Mears said- “To finish first you must first finish.”12
Nassim Taleb says- “Rationality is avoidance of systemic ruin.”13
In Investing, we also need to focus on consequences, not just probabilities.
Never leverage. As Buffett said: “If you’re smart, you don’t need leverage; if
you’re dumb, it will ruin you.”14
Morgan Housel writes- “The road to financial regret is paved with debt…
It’s amazing what percentage of financial problems are caused by borrowing.
Debt is a claim on your future, which you’ll always miss, to gain something
today, which you’ll quickly get used to… Most debt is the equivalent of a
drug: A quick (and expensive) hit of pleasure that wears off, only to drag you
down for years to come, limiting your options while weighed down by the
baggage of your past.”15
True, no leverage may give you lower returns. But are returns more important
than a good night’s sleep? Buffett writes, “Our aversion to leverage has
dampened our returns over the years. But Charlie and I sleep well. Both of us
believe it is insane to risk what you have and need to obtain what you don’t
need.”16
The risk of being multiplied by zero is too big a risk for a few percentage
points of better returns. Buffett writes, “Unquestionably, some people have
become very rich using borrowed money. However, that’s also been a way to
get very poor. When leverage works, it magnifies your gains. Your spouse
thinks you’re clever, and your neighbors get envious. But leverage is addictive.
Once having profited from its wonders, very few people retreat to more
conservative practices. And as we all learned in third grade—and some
relearned in 2008—any series of positive numbers, however impressive the
numbers may be, evaporates when multiplied by a single zero. History tells us
that leverage all too often produces zeroes, even when it is employed by very
smart people.”17
Never bet too much, it wipes you down if you are wrong. And in markets, the
best-laid plans of mice and men go astray. No matter how much conviction we
might have, things can get ugly.
“In almost every case of catastrophic failure that we’ve observed, we believe
the root cause can ultimately be boiled down to one or a combination of just
five factors. The five factors are 1) leverage 2) excessive concentration 3)
excessive correlation 4) illiquidity and 5) capital flight.”
—Zeke Ashton 18
“In addition to magnifying losses as well as gains, leverage carries an extra
risk on the downside that isn’t offset by accompanying upside: the risk of
ruin.”
—Howard Marks 19
Portfolio Loss Gain Required to Breakeven
-10% 11%
-20% 25%
-30% 43%
-40% 67%
 -50% 100%
-60% 150%
-70% 233%
-80% 400%
-90% 900%
-97% 3,233%

“Whenever a really bright person who has a lot of money goes broke, it’s
because of leverage.”
—Warren Buffett
Morgan Housel has written:
“Getting money is one thing. Keeping it is another. If I had to summarize
money success in a single word it would be “survival… The ability to stick
around for a long time, without wiping out or being forced to give up, is what
makes the biggest difference. This should be the cornerstone of your strategy,
whether it’s in investing, your career or a business you own. There are two
reasons why a survival mentality is so key with money. One is obvious: few
gains are so great that they’re worth wiping yourself out over. The other… is
the counterintuitive math of compounding. Compounding only works if you
can give an asset years and years to grow. It’s like planting oak trees: A year of
growth will never show much progress, 10 years can make a meaningful
difference, and 50 years can create something extraordinary. But getting and
keeping that extraordinary growth requires surviving all the unpredictable ups
and downs that everyone inevitably experiences over time. We can spend years
trying to figure out how Buffett achieved his investment returns: how he found
the best companies, the cheapest stocks, the best managers. That’s hard. But
equally important is pointing out what he didn’t do. He didn’t get carried away
with debt. He didn’t panic and sell during the 14 recessions he’s lived through.
He didn’t sully his business reputation. He didn’t attach himself to one
strategy, one worldview, or one passing trend. He didn’t rely on others’ money
(managing investments through a public company meant investors couldn’t
withdraw their capital). He didn’t burn himself out and quit or retire. He
survived. Survival gave him longevity. And longevity—investing consistently
from age 10 to at least age 89—is what made compounding work wonders.
That single point is what matters most when describing his success.”20
In a way, the risk of ruin is the risk of starting over. It is the risk of going back
to square one.
 Buffett writes, “Charlie and I have no interest in any activity that could pose
the slightest threat to Berkshire’s wellbeing. (With our having a combined age
of 167, starting over is not on our bucket list.) We are forever conscious of the
fact that you, our partners, have entrusted us with what in many cases is a
major portion of your savings. In addition, important philanthropy is
dependent on our prudence. Finally, many disabled victims of accidents caused
by our insureds are counting on us to deliver sums payable decades from now.
It would be irresponsible for us to risk what all these constituencies need just
to pursue a few points of extra return.”21
Further, not only does survival protect your downside, but it could also
expand your upside! If you survive, you can invest while everyone else is
wiped out.
“By being so cautious in respect to leverage, we penalize our returns by a
minor amount. Having loads of liquidity, though, lets us sleep well. Moreover,
during the episodes of financial chaos that occasionally erupt in our economy,
we will be equipped both financially and emotionally to play offense while
others scramble for survival. That’s what allowed us to invest $15.6 billion in
25 days of panic following the Lehman bankruptcy in 2008.”22
In businesses, too, the risk of ruin is present. It is called fragility.
Chatur: Ahaa, this is a new term for me. What are sources of fragility?
Aryan: Well, there are a few triggers of fragility, let’s review them one by
one.
Lack of entry barriers : Lack of entry barriers causes fragility in the business
in a way that the business loses its competitive advantage, e.g.: Go PRO
Businesses, where both input and output are commodities, are susceptible to
fragility.
Disruption through innovation , e.g.: Nokia, Blackberry, Kodak.
Dependence on one or few customers, dependence on one or few suppliers,
dependence on government subsidies. Dependence on the kindness of others
can be a major source of fragility in the business.
Vulnerability to the price of something that is volatile and beyond control can
bring out the fragility in the business, e.g., Titan when it was purchasing gold
(before the gold-leasing model was adopted).
Rigid cost structures . High operating leverage cuts both ways: it is a double-
edged sword. Gambling tendencies by managers can bring about the fragility.
 Buffett writes, “Leverage, of course, can be lethal to businesses as well.
Companies with large debts often assume that these obligations can be
refinanced as they mature. That assumption is usually valid. Occasionally,
though, either because of company-specific problems or a worldwide shortage
of credit, maturities must be met by payment. For that, only cash will do the
job. Borrowers then learn that credit is like oxygen. When either is abundant,
its presence goes unnoticed. When either is missing, that’s all that is noticed.
Even a short absence of credit can bring a company to its knees.”23

There are prominent behavioral biases that investors go through and make
mistakes related to allocation.
This concept also shows the importance of Risk Management and Exit
Strategies which we will learn later in this book.
Allocation mistakes:
• Under-allocation. Due to risk aversion: People prefer to avoid or
minimize uncertainty, even at the cost of a lower payoff.
 • Over-allocation: Overconfidence bias: People overestimate their
knowledge and skills. And Confirmation bias: People search for and
interpret information so it confirms one’s pre-existing beliefs or
hypotheses, while disregarding contrary information and alternative
possibilities. Both these biases combined are a potent recipe for over-
allocation.
• Overstaying with winners: Endowment effect: this is the tendency to
overvalue what you own simply because you own it.
• Overstaying with losers: Loss aversion: People feel twice as bad about
losing money as they feel about winning it. This causes investors to hold
on to bad choices for far too long, hoping that things will eventually
improve and the loss will be avoided.24

CHAPTER SUMMARY
• Successful investors allocate a significant portion of their capital to
wins; they put in most of their stakes when they are right.
• All businesses have unforeseen risks; the best risk mitigation strategy is
to diversify stocks.
• The minimum stock types in an investor’s portfolio range from 15 to 20;
this amount of stock provides adequate diversification and meaningful
allocation for some gains.
• An average of 19 stocks in a portfolio is the sweet spot; an investor
enjoys maximum diversification benefits at this point.
• Investment is a game of probability, and investors think in terms of
expected value; every investment avails equal chances for a good or bad
outcome.
• A good investor must continue averaging businesses that are performing
and trim non-performers.
• Averaging up is complex because of anchoring bias; investors must
overcome anchoring bias to succeed.
• Determine the stock allocation size by its price appreciation.
• Correlation between stocks is also essential for diversification—it is a
mitigation strategy against geographical risks, currency depreciation, and
interest that may hurt a portfolio in one area and benefit it in another.
 • The Kelly Criterion is a mathematical formula that gives output on
Capital to Bet given win-loss probabilities and payoffs; it is essential in
sizing stock in a portfolio.
• The best time to bet big is in an asymmetric payoff—when the
probability of winning is high, and the odds are favorable.
• Conversely, avoid betting when the probability of winning and the
reward to risk ratio is low.
• An asymmetric payoff is rare; it may be possible in Bear Markets,
market anomalies, or on special occasions.
• Subsequent bets are a function of winning the first bet as the overall
capital increases.
• Trim out positions when their reward-risk ratio decreases continuously.
• Another variation in Kelly’s formula is the edge: the information edge
and the analytical edge.
• Blending fundamentals and technicals along with price volume action)
provides an information edge.
• Avoid under location due to risk aversion and over-allocation because of
overconfidence bias.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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Notes
1. https://www.forbes.com/sites/bryanrich/2016/06/01/do-you-think-like-
george-soros/?sh=77938a555f0d
2.https://www.investopedia.com/articles/stocks/11/illusion-of-
diversification.asp
3.https://www.goodreads.com/quotes/1399571-to-get-what-you-want-
you-have-to-deserve-
what#:~:text=Quotes%20%3E%20Quotable%20Quote-,%E2%80%9CTo
%20get%20what%20you%20want%2C%20you%20have%20to
%20deserve%20what,undeserving%20people.%E2%80%9D
4. Jack Schwager, Hedge Fund Market Wizards: How Winning Traders
Win (Hoboken, NJ; Wiley, 2012)
5.Edward O. Thorp, The Mathematics of Gambling (Hollywood, CA:
Gambling Times, 1984)
6.William Poundstone, Fortune's Formula: The Untold Story of the
Scientific Betting System That Beat the Casinos and Wall Street (Hill &
Wang, 2005)
7.William Poundstone, Fortune's Formula: The Untold Story of the
Scientific Betting System That Beat the Casinos and Wall Street (Hill &
Wang, 2005)
8.Roger Lowenstein, Buffett: The Making of an American Capitalist
(Random House, 1995)
9.Vishal Mittal and Saurabh Basrar, Masterclass with Super-Investors -
Raamdeo Agrawal Interview (New Delhi: Maple Press India, 2018)
10.“To Get Rich, Don’t Be a Rick”. Safarl Niveshak, December 13, 2021.
https://www.safalniveshak.com/dont-be-a-rick/
11.Gautam Baid, The Joys of Compounding (New York, Columbia
University Press, 2020)
12.https://www.passiton.com/inspirational-quotes/6447-to-finish-first-
you-must-first-finish
13.https://www.economist.com/books-and-arts/2018/02/22/nassim-taleb-
explains-the-power-of-skin-in-the-game
14.https://www.dividendgrowthinvestor.com/2021/04/warren-buffett-and-
charlie-munger-on.html#:~:text=
%E2%80%9CIf%20you're%20smart%20you,you%20double%20your%2
0net%20worth
15.https://www.fool.com/investing/general/2015/10/13/financial-advice-
for-my-new-son.aspx
16.Warren Buffett, Berkshire Hathaway 2017 Annual Letter to
Shareholders,
https://www.berkshirehathaway.com/letters/2017ltr.pdf#page=3
17.Warren Buffett, Berkshire Hathaway 2010 Annual Letter to
Shareholders, 2010,
http://www.berkshirehathaway.com/letters/2010ltr.pdf
18.http://mastersinvest.com/leveragequotes
19.http://mastersinvest.com/leveragequotes
20.Morgan Housel, The Psychology of Money: Timeless Lessons on
Wealth, Greed, and Happiness (United Kingdom: Harriman House, 2020)
21.https://jameslau88.com/2020/05/13/warren-buffett-on-debt-or-
leverage/
22.https://www.smh.com.au/business/buffett-seeks-major-buys-as-
berkshire-profit-gains-20110228-1ba9t.html
23.https://www.cbsnews.com/news/5-things-warren-buffett-wants-you-to-
do-in-2011/
24.http://institution.motilaloswal.com/emailer/Research/WC21-
20161209-MOSL-2011-16-PG044.pdf
CHAPTER SIXTEEN

RIDING WINNERS
“To make money in stocks, you need to have the vision to see them, courage to
buy them and patience to hold them. Patience is the rarest of the three.”
—Thomas Phelps
Each one of us might have bought the likes of Asian Paints, Nestle, Pidilite,
Astral Poly, etc., which have created enormous wealth for its shareholders. But
why do most of us fail to replicate the same in our portfolio? The simple
answer is - we don’t ride our winners and do not add capital (averaging up as
business keeps performing). This is the biggest mistake most investors make
after understanding business selection. Business selection is overrated but
holding and adding to great businesses is underrated. Ride your winners,
period.
One of the most frequently heard investing advice is to “take some of your
winnings off the table”, “cash some of the chips” and “book some profits”.
The idea is that if a stock has gone up significantly, you should sell enough
stock to recover your original investment, so you will be left with “free
money” which you can afford to lose. Unfortunately, this poor advice has cost
many investors a lot of money in opportunity costs, namely mistakes of
omission and selling too early.
You can’t make big money in stocks if you don’t give them a chance to make
big money for you. There is nothing easier than making big money in the
market once you have latched onto a big winner, because at that point, all you
are doing is sitting tight and riding the winners.
It is also wrong to say that one should hold on to a rising stock forever. So let
us understand when to sell.
If you apply all the procedures described in this book, a mere handful of Big
winners can catapult you to financial independence. Even two or three
companies identified with an appropriate allocation in the bull market are
sufficient for you to retire.
 It is equally important to cut losses quickly. Legendary speculator Jesse
Livermore wrote- “You should have a clear target where to sell if the market
moves against you. And you must obey your rules! Never sustain a loss of
more than 10 percent of your capital.
Losses are twice as expensive to make up. I always established a stop before
making a trade.”1
Our body has several lines of defense- mechanical barriers like skin, chemical
barriers like stomach acid and cellular defense like antibodies. Similarly,
investors should have multiple lines of defense. Your first line of defense is a
stop-loss order, ideally placed when you make the trade, or immediately
thereafter. If you fail to limit your risk at inception, make a practice of looking
over your positions once every week and selling out at the market (not limit
order), all showing a loss. Refinement is not an improvement in the best-case
scenario, but an improvement in the worst-case scenario. If your worst-case
scenario is not too bad, the gains will take care of themselves. Limiting your
downside comes first, and extending your upside comes second.
Bernard Baruch rightly said: “If a speculator is correct half of the time, he is
hitting a good average. Even being right 3 or 4 times out of 10 should yield a
person a fortune if he has the sense to cut his losses quickly on the ventures
where he has been wrong.”2
George Soros stated aptly- “It’s not whether you’re right or wrong, but how
much money you make when you’re right and how much you lose when
you’re wrong”3
William O’Neil suggests a 3:1 ratio of gain:loss, i.e. if your average gain is
20% to 25%, you should cut your losses at 7% or 8%.4 He continues,
“Remember: 7% to 8% is your absolute loss limit. You must sell without
hesitation—no waiting a few days to see what might happen; no hoping that
the stock will rally back; no need to wait for the day’s market close. Nothing
but the fact that you’re down 7% or 8% below your cost should have a bearing
on the situation at this point.”5
O’Neil further writes, “Institutional investors who lessen their overall risk by
taking large positions and diversifying broadly are unable to move into and out
of stocks quickly enough to follow such a loss-cutting plan. This is a terrific
advantage that you, the nimble and decisive individual investor, have over the
institutions. So use it.”6
 Are you getting rich backward? Then you are taking two points of profit and
letting your losses run. Why not invert this rule? Limit your risk to one, two or
three points and let your profits run.
As they say - Amateurs book profits. Experts book losses.

VALUATION DILEMMA
When investors are invested in great businesses with rapid growth rates, often
when the market understands it better, these businesses get re-rated. This
might cause optically higher valuation ratios or delusion of overvaluation. As
discussed in the chapter on Competitive Advantages, it’s sometimes difficult to
comprehend these great businesses’ long-term mega compounding potential.
Investors who are too much stuck to the theoretical implication of these
valuation ratios often exit too early and these businesses keep creating wealth
for a long time. One should not make this mistake. It’s better to trail exit and
ride them. We will deep dive into this aspect in the Risk Management chapter.
Phil Fisher, in his book Common Stocks and Uncommon Profits, explains this
aspect:
“How can anyone say with even moderate precision just what is overpriced
for an outstanding company with an unusually rapid growth rate? Suppose that
instead of selling at twenty-five times earnings, as usually happens, the stock
is now at thirty-five times earnings. Perhaps there are new products in the
immediate future, the real economic importance of which the financial
community has not yet grasped. Perhaps there are not any such products. If the
growth rate is so good that in another ten years the company might well have
quadrupled, is it really of such great concern whether at the moment the stock
might or might not be 35 percent overpriced? That which really matters is not
to disturb a position that is going to be worth a great deal more later.
...If the job has been correctly done when a common stock is purchased, the
time to sell it is—almost never [emphasis added].” 7

WHY AVERAGING UP IS
IMPORTANT WHILE RIDING
WINNERS8
From what I have read, economist Vilfredo Federico Damaso Pareto noticed
that 20% of the pea plants in his garden generated 80% of the healthy pea
pods. Pareto extrapolated this imbalance to other aspects of life and found that
roughly 20% of the population controlled 80% of the wealth.
The Pareto Principle is ubiquitous and finds an expression in virtually every
aspect of life. Some examples:
20% of the population own 80% of the world’s wealth
20% of time spent on various activities produce 80% of the results
20% of customers generally bring in 80% of the revenue
20% of focused employees create 80% of the impact in an organization
Why would this principle, observed in so many spheres of life, not apply to
investing? If we observe our investment portfolio, we will witness a similar
trend: 20% of stocks in our portfolio generally produce 80% of the returns. To
understand this, we need to delve deeper.
Every business begins with an idea before it becomes a start-up. Then comes
the journey from a micro-cap to a small-cap to a mid-cap to, eventually, a
large-cap.
No matter how brilliant the idea is, or how adaptable and relevant the
business is, there are inevitable challenges. Distribution network, supply-
chains, deploying the right technology, employee training, management
bandwidth, logistics, etc. Not all the companies which started from the idea
phase can grow big.
Durgesh Shah shared this during CFA Society Value Investing Summit in
2018:
“There are just 175 Indian companies that make over $100 million (₹ 700
crore) in annual pre-tax profit. Out of these, only 78 companies saw their
market value increase 100x. Others may have listed at a decent size or got
carved out from a group.”9
No. of Companies Owners 100 Baggers Example
59 Individuals 39 Asian Paints
46 Groups (16) 20 Tata
35 PSU 3 BEL
 16 MNC 12 HUL, Nestle
19 Others 4 HDFC Bank

Even if we consider approximately 3,000 decent listed companies, only 5%

of companies can scale up extremely well and 20% will scale to a decent
extent.
Let’s understand the math behind portfolio returns before we figure out how
to maximize them.
Portfolio returns are a simple weighted average or sum product of (%)
allocation and (%) returns generated. Naturally, we need our winners to have a
higher allocation and ride them, at the same time trim laggards to prevent them
from dragging portfolio returns.
I quote the legendary Peter Lynch here:
“It’s easy to make a mistake and do the opposite, pulling out the flowers and
watering the weeds. If you’re lucky enough to have one golden egg in your
portfolio, it may not matter if you have a couple of rotten ones in with it. Let’s
say you have a portfolio of six stocks. Two are average, two are below
average, and one is a real loser.
But you also have one stellar performer. Your Coca-Cola, your Gillette. A
stock that reminds you why you invested.
You need not be right all the time to do well in stocks. If you find one great
growth company and own it long enough to let the profits run, the gains should
more than offset mediocre results from other stocks in your portfolio.”
Retail investors rarely have an information edge. And future predictions are
made with great uncertainty. So, it’s fair to assume based on the efficient
market theory that even if we can select fairly good businesses in our portfolio,
at best, we are getting that at a fair price and our predictability of finding
stellar performers is like that of tossing a coin (otherwise we would just buy
one company and allow it a 100% allocation).

HOW DO WE ENSURE THE

HIGHEST ALLOCATION TO
WINNERS?
It’s only possible by averaging up –adding an allocation to businesses that
keep growing and scaling up with time. And this will automatically mean we
are not allocating or trimming our laggards in the portfolio. Eventually
maximizing portfolio returns. So, we are not only staying invested in our
stellar performers - that Coca-Cola, Asian Paints, Pidilite, etc. - but also
allocating higher as they become stronger.
As an investor, how do we manage risk by buying at higher prices?
It is very important to have an exit strategy in place when averaging up.
Let’s say, your initial purchase was at ₹ 100 and had a 30% drawdown
threshold for the exit. This means that your initial risk was ₹ 30. If the price
moves up to ₹ 200 and you have the same 30% drawdown threshold, your exit
price criteria are ₹ 140. So, in either scenario, you take home ₹ 40 as a profit
vs. your buying price of ₹ 100. This is known as residual risk and here it is
minus 40.
Effectively, if you are averaging up your position at ₹ 200, you are funding it
from the negative residual risk of your earlier tranche, and thus your
cumulative risk is decreasing as you keep averaging up.
Also, averaging up improves your risk/reward metric. Initially, we take a
small position to start with, and if it doesn’t work out, we don’t give back
much. For example, if we take a 1% initial position and it didn’t work out as
expected and we lost 30%, effectively it’s just 0.3% of the capital (1%*30%).
But if we win, and keep averaging up, we might have increased the position,
sizing to 5% allocation and even 60% of return on full position will increase
our capital by 3%.
Hence, the risk/reward is tilted in our favor (1:10 of risk/reward in this
example) and the probability of maximizing portfolio returns increases
drastically.
Ultimately...
More than stock selection, investing is all about having the probabilities in
your favor, having the right mindset and proper execution based on universal
mathematical principles. This will give you those 20% winners that will create
80% of returns in your portfolio using the powerful concept of averaging up.11
Chatur: In my office, I often see my colleagues, who are keen investors,
immersed in the stock indexes for almost the complete day. They are into the
habit of buying and selling every day. At times, they are lucky to make a
profit, but usually, I hear them hammering their hand on the table. Why are
they so impatient that they keep switching lanes?
Aryan: You have got it right, Chatur. They are bitten by the bug called
boredom.

BOREDOM ARBITRAGE
“People are dying of boredom.”
—Raoul Vaneigem, The Revolution of Everyday Life
Investors crave activity and stock markets are built on it. And we are
surrounded by too much noise due to all sorts of media which makes it seem
that we need to act on every piece of information. This is the primary reason
investors cannot sit tight and ride their winners.
Investors keep searching for the next big thing and sell their mega
compounders. They get bored of the same names of wealth creators. These
businesses keep compounding at their own pace, so where is the excitement?
And they prematurely sell their compounding machines, which are rare to find.
So, how to kill boredom?
We need to practice “Boredom Arbitrage” - having a system or process which
lets us ride our winners. I extensively take help from technical indicators like
Donchian Channel to objectively suggest when to add to my winners and
various other indicators like ATR, PSAR, VStop, EMA, etc., to help me stay in
the game until an exit alert is triggered. This way, we can avoid noise, stick to
the system and stay focused on the path of mega compounding.
The ecosystem rarely wants you to sit tight, they want you to keep churning
so they can charge you fees, brokerage, taxes and sell you stuff. The greatest
fortunes come from riding your winners and adding more capital as they keep
compounding.

CHAPTER SUMMARY
• Sometimes an investor’s portfolio does not reflect the companies they
have investments in, although those companies have created enormous
wealth for their stakeholders.
• Capitalize on both business selection and averaging up businesses as
they keep performing.
• Avoid premature selling and give the stocks time to make big money.
• Know when to sell; do not sit on a rising stock forever.
• Never sustain a loss that is more than 10% of the capital.
• Portfolio refinement is a necessary improvement for a worst-case
scenario.
• According to Bernard Baruch, cutting losses quickly on wrong ventures
is a wise move.
• William O’Neil states if an investor’s average gain is 20% to 25%, they
should cut their losses when the profits drop to 7% or 8%.
• O’Neil also states having large positions and broad diversification slows
down the loss-cutting plan.
• There is a valuation dilemma for re-rated businesses with investors and
rapid growth rates; such conditions lead to overvaluation.
• Investors usually exit too early from such investments because of over-
reliance on the theoretical implications of these valuations instead of
having a better exit trail and riding winners for long.
• Averaging up is crucial while riding winners because businesses take
time to grow a larger market cap from inception, regardless of the nature
of the business idea.
• Portfolio returns are the weighted average or sum product of percentage
allocation and percentage returns generated.
• Winners in a portfolio need a higher allocation for the investor to ride,
and laggards require trimming to keep them from dragging the portfolio.
• The only way winners can get a higher allocation in a portfolio is by
averaging up.
• Additionally, have an exit strategy while averaging up.
• Averaging up reduces negative residual risks and improves the
investor’s risk to reward metric.
• Aside from stock selection, investing is about having a favorable
probability.
• Investors can resist premature selling and ride their winners by
practicing Boredom Arbitrage.
• Technical indicators are excellent Boredom Arbitrage tools; by focusing
on ATR, PSAR, VStop, or EMA, an investor can stay put until exit
 triggers become loud.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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ENDNOTES
1.Jesse Livermore, How to Trade in Stocks, Greenville: Traders Press,
1991, Page 171
2.https://marketsmithindia.com/post/secret-to-success-in-the-stock-
market
3.https://www.fincash.com/l/investment/george-soros-quotes-on-
successful-investing
4.William O’Neil, How to make money in stocks (New York: McGraw
Hill, 2009)
5.William O’Neil, How to make money in stocks (New York: McGraw
Hill, 2009)
6.William O’Neil, How to make money in stocks (New York: McGraw
Hill, 2009)
7.Philip A. Fisher, Common Stocks and Uncommon Profits and Other
Writings , 2nd ed. (Hoboken, NJ: Wiley, 2003)
8.https://www.morningstar.in/posts/59579/averaging-important-
investing.aspx
9.https://cfasocietyindia.org/session-by-mr-durgesh-shah-2nd-value-
investing-pioneers-summit-2018-delhi/
10.https://cfasocietyindia.org/session-by-mr-durgesh-shah-2nd-value-
investing-pioneers-summit-2018-delhi/
11.https://www.morningstar.in/posts/59579/averaging-important-
investing.aspx
CHAPTER SEVENTEEN

R I S K M A N A G E M E N T,
REBALANCING AND EXIT
S T R AT E G I E S
“Rome was not built in a day but Hiroshima and
Nagasaki were destroyed in a day.”
—Vijay Kedia 1
It takes years to build a great portfolio and create wealth, but if there is no
Risk Management in place, it can destroy our wealth in seconds. Risk
management is of paramount importance in the investing journey. We all, as
investors, are risk managers. Our key job is to protect the downside, and the
upside will take care of itself.
As Howard Marks has rightly mentioned in his book The Most Important
Thing 2
“Investing consists of exactly one thing: dealing with the future. And
because none of us can know the future with certainty, the risk is
inescapable. Thus, dealing with risk is an essential-I think the essential -
element in investing. It’s easy to find investments that might go up. If you
can find enough of these, you’ll have moved in the right direction. But you
are unlikely to succeed for long if you haven’t dealt explicitly with risk. The
first step consists of understanding it. The second step is recognizing when
it’s high. The critical final step is controlling it.”
Now, you might wonder what is meant by risk. Howard Marks explains,
“In the investment world, we talk about risk all the time, but there’s no
universal agreement about what risk is or what it should imply for
investors’ behavior. Some people think the risk is the likelihood of losing
money, and others (including many finance academics) think the risk is the
volatility of asset prices or returns. And there are many other kinds of risk
—too many to cover here. I lean heavily toward the first definition: in my
view, the risk is primarily the likelihood of permanent capital loss. But
there’s also such a thing as opportunity risk: the likelihood of missing out
on potential gains. Put the two together and we see that risk is the
possibility of things not going the way we want.”3
Thus, the risk is the possibility of events turning out, so it is different from
what we expect.
Now, think about what do we control as an investor? We have no control
over returns, no control over the business performance or macro events.
However, the three key things we can control are:
1.Allocation - how much to allocate and sizing our position
2.Downside Risk - how much amount to lose on each investment
3.Our Behavior - how we react to different external situations

UNDERSTANDING RISK IN HIGH

GROWTH QUALITY BUSINESSES
Warren Buffett said at the University of Florida in 1998: “Coke Cola IPO-
ed in 1919 for $40. A year later, it was $19. You can always find a few
reasons why that was not a good time to buy it, but if you bought 1 share at
$40 and reinvested the dividends, you would have $5 million today. This
factor overrides everything macro concerns you could have. There is never
a perfect time to buy a great business; there is always a reason to worry, but
you should also know when it is wise to worry at all. For things that are
unimportant or unknown, you should not worry. If you are right about the
business, you will make a lot of money over time.”4
For 17 years after his speech, the stock price return of Coca Cola was
23%. Impressive, right? But consider this: the stock of Coca Cola did not
return 23% CAGR, but an absolute 23% for the entire period! This shows
that even high-quality Banyan tree businesses have their risks of periodic
underperformance.
Although we focus on high-quality businesses in the core portfolio, we
need to understand that businesses change, disruption is for real and even
faster. As an investor, the general goal is to identify companies with
excellent earnings growth at reasonable prices and expectations this will
last for the long term.
Now, let’s take an example of 2003-2008 wealth creators. Some of the
quality and highly respected names were Reliance Industries, BHEL, Bharti
Airtel, L&T, Unitech, Essar Oil, Hindustan Unilever, Neyveli Lignite, Tata
Communications, MRPL, Aban Offshore, Zee Entertainment, Essar
Shipping, Sterlite Industries, HDFC Bank, Wipro, Infosys, etc.
PAT CAGR of most of the above names in 2003-2008 was more than 25-
30%. These were India’s great companies with a great outlook for even
future growth. They were also richly valued as investors thought the party
would go on.
Fast-forward now, after more than a decade, where are most of these
companies? What went wrong? For most of them, growth faltered. Names
like Bharti Airtel, Tata Communications, Aban Offshore, etc., got
decimated by disruption in the sector. Others like Reliance Industries,
Hindustan Unilever, Wipro, etc., had to struggle for growth. Some even
went on the verge of bankruptcy.
This reminds me of that quote from Bill Gates:
“WE ALWAYS OVERESTIMATE THE CHANGE THAT WILL OCCUR IN
THE NEXT TWO YEARS AND UNDERESTIMATE THE CHANGE THAT
WILL OCCUR IN THE NEXT TEN. DON’T LET YOURSELF BE LULLED
INTO INACTION.”
The idea is to be constantly vigil - act when needed. Have risk
management and exit strategy in place even if we have bought great quality
growth businesses in our portfolio.
Here are examples of what happens when growth goes away and why we
need to be vigilant.

EXAMPLE 1: BHARTI AIRTEL - THE LOST

DECADE
EXAMPLE -2: ABBAN OFFSHORE - THE
DEAD SOULS

NO ROOM FOR HOPE STORIES

Often, we have price anchoring in our minds. As humans, we are always
hopeful and hope has helped us evolve and survive in the toughest of times.
But in investing, it’s dangerous most of the time. If we just hope these past
winners will somehow come back and survive, we are mistaken. If data
says that business is deteriorating and we made a mistake, we need to get
out. Follow risk management. And yes, one can always re-enter if the
business performs again. Alternatively, we can move that capital to better
businesses and compound our money in a much better way. We need to
have a flexible mind.
“The traditional “value investor” mentality of buying
cheap securities, waiting for them to bounce back to
“intrinsic value,” selling and moving onto the
next opportunity, is flawed.
In today’s world of instant information and fast-paced innovation, cheap
securities increasingly appear to be value traps; often they are companies
ailing from technological disruption and long-term decline. This rapid
recycling of capital also creates an enormous drag on our after-tax returns.
In addition, by focusing on these opportunities, we incur enormous
opportunity costs by not focusing instead on the tremendous opportunities
created by the exceptional innovation S-curves we are currently
witnessing.”
—Marcelo Lima

ON INTRINSIC VALUE OF
GROWTH BUSINESSES
I have seen many investors argue that don’t look at short-term quarterly
results, look at long-term business potential. They have also done the
homework to find the intrinsic value of a business by applying methods like
DCF (Discounted Cash Flows, etc.), which has so many underlying
assumptions on growth, interest rates, terminal value, etc.
Literally, value changes every day as information and variables affecting
businesses keep changing. One cannot anchor to old data of intrinsic value
to make future decisions.
As Howard Marks has rightly mentioned in his book The Most Important
Thing 5
“In Investing, as in life, there are very few sure things. Values can
evaporate, estimates can be wrong, circumstances can change and “sure
things” can fail. However, there are two concepts we can hold to with
confidence:
Rule number one: Most things will prove cyclical.
Rule number two: some of the greatest opportunities for gain and loss
come when other people forget rule number one.”

REBALANCING
During a market crash, one should rebalance the portfolio to increase
allocation to companies that have undergone high drawdowns (we can
finance this investment by reducing allocations to companies that have not
undergone high drawdowns).

EXIT CRITERIA
My simple logic is, if we want to take buying decisions on such businesses,
we need to continuously re-evaluate the intrinsic value which most
investors don’t do. They are fixated on old calculations and do not
incorporate reality.
We need to learn from a 260-year-old mathematical equation called Baye’s
Rule. Also known as conditional probability, it measures the probability of
an event, given that another event has occurred.
Below is the simplified version which Daniel Kahneman shared in his
book Thinking fast and slow:
Posterior odds = Prior odds × Likelihood ratio
where, the posterior odds = the odds (the ratio of probabilities) for two
competing hypotheses.
Prior Odds are Base Rates (i.e. historical statistical information)
The likelihood ratio is information specific to the current situation being
examined
So, there are 2 parts to it:
1.If there are strong low base rates (for example, the odds of an airline
company creating wealth for shareholders is too low), will you invest
 in an airline business where there is a powerful positive narrative
around the business or situation you are examining?
2.If there are strong high base rates (for example, the odds of a
consumer durables company creating wealth is too high), and there is
new strong evidence of corporate governance around the situation you
are examining, will you sell or avoid it?
Basically, what Baye’s rule tells you is that we need to follow a balanced
approach.
As Charlie Munger rightly said when he was asked about the process to
read annual reports:
“You have to have some idea of why you’re looking for the information.
Don’t read annual reports the way Francis Bacon said you do science—
which, by the way, is not the way that you do science—where you just
collect endless (amounts of) data and then only later do you try to make
sense of it. You have to start with some ideas about reality. And then you
have to look to see whether what you’re seeing fits in with that basic
thought structure. Frequently, you’ll look at a business having fabulous
results. And the question is, “How long can this continue?” Well, there’s
only one way I know of to do that. And that’s to think about why the results
are occurring now – and then to figure out the forces that could cause those
results to stop occurring.”6
Also, as we understood from a discussion on growth and disruption, it’s
impossible to predict growth after 5-10-15 years. And disruption can make
the terminal value go to zero overnight, which forms a major part of
intrinsic value.
Bottom line : We need to have an objective exit strategy for such
businesses. I use a combination of technical indicators to alert me and then
go back to fundamentals to understand business deterioration. Capital
protection is the most underrated concept in investing community.
Example :
I have used a simple indicator called EMA (Exponential Moving Average)
on a monthly time frame to help us take exit decisions on Zee
Entertainment. See how it helped us in riding the growth phase and then
exit with little capital erosion.
 We can use multiple such indicators like ATR, PSAR, VStop, EMA, etc.,
to take exit decisions. Again, we can use different timeframes based on our
tree classification (remember - Banyan, Mango, Bamboo, Cactus, Weeds
and Palm) to sync it with the fundamental business model of the company.
Over the years, I have understood that we need to have a framework for
the selling process, just like how we have for buying the shares. Based on
our tree classification, here is my broad thought process (and this keeps
evolving) on how to make a sell decision:

WHEN TO SELL CACTUS

BUSINESS CATEGORY
These are typically low growth and low RoCE companies. I rarely prefer to
buy them in the first place, as the more you hold them, the more it harms
your portfolio returns.
If I have bought any businesses which might have been either Mango or
Banyan with high growth and it starts turning to Cactus, I would watch for
the fundamental signs given below along with technical indicators
mentioned earlier to sell:
• The company getting affected by competition and losing pricing
power as well as growth
 • Lack of new products and company getting affected by disruption in
the industry
• Loss of market share for a prolonged period of time
• Bad capital allocation decisions like unrelated acquisitions,
reinvesting cash flows in low RoCE businesses, etc.

WHEN TO SELL MANGO

BUSINESS CATEGORY
This category is generally a very small percentage of the portfolio. The
purpose is mainly capital protection and sometimes defensive play during
bear markets or periods of high macroeconomic uncertainty.
As they are generally stable businesses with predictable cash flows, the
fluctuation in the share prices is generally a function of overall P/E multiple
swings that occur due to different market conditions. Then, it again reverts
to meaning.
The selling decision here can be considered by the below factors:
• When it goes into high P/E territory due to extreme euphoria in the
overall sector or broader market condition but business growth is the
same; we can trail our exits in such scenarios to make most of the
euphoria
• Sometimes the return ratios deteriorate due to the erosion of
competitive advantages and it’s time to consider selling
• Overall portfolio allocation decision is changed from capital
protection to high growth focus when you get Banyan businesses at
lesser valuation like market corrections or bear market
• When similar businesses are available at attractive valuations
• Instead of giving back free cash flow as dividends/buyback, if
management starts misallocating capital, it’s time to sell

WHEN TO SELL BANYAN

BUSINESS CATEGORY
Ideally, we should be holding these businesses as it keeps compounding and
performing. But we know that the world is dynamic. Disruptions are even
faster and things can go wrong.
Below are key parameters to consider while taking Banyan Business
selling decision:
• Structural impairment to future growth due to various reasons like
disruption, saturation in the market, lack of innovation, etc., (basically
Banyan turning into the Mango category)
• Management change: top-performing management exiting the
company
• Erosion of competitive advantages
• Profitable reinvestment opportunities are missing, and the company
starts returning significant capital to shareholders or starts
misallocating capital

WHEN TO SELL BAMBOO

BUSINESS CATEGORY
As we discussed earlier, the Bamboo category is majorly to experiment and
test businesses under potential transition to better categories like Mango or
Banyan. Sell decisions are more frequent here as we need to understand
these are satellite plays with a low probability of structural shift.
Another key point to consider is that although the structural transition to
Banyan may fail, if the business shows significant improvement from
Cactus or Weeds, it can get re-rated fast and once it disappoints, then it can
get de-rated very quickly. Idea is to stay agile and vigilant with the exit
process here.
Some of the key parameters to focus on selling decisions for this category:
• Initial improvement is business fades away due to competition or
sector headwinds
• Sector Tailwind was a major driver of improvement and, if that
reverts to mean
 • Company struggling to find reinvestment opportunities beyond the
initial stage
• Execution of earnings triggers is not done properly to translate into
structural growth
• When improvement in earnings growth and RoCE proves to be
temporary in nature

WHEN TO SELL PALM BUSINESS

CATEGORY
These are typical cyclical stocks. Entry and exits are extremely critical here
and one should take a position in these types of businesses after carefully
learning the traits of these businesses. Technical exit indicators on daily
charts are generally best used for this category to make faster decisions.
Some of the key points for selling decision for this category are:
• When these cyclical businesses are termed as structural long-term
growth stories
• When PE multiple looks optically very low compared to peak
earnings
• The demand starts to collapse or the supply picks up or both.
Remember, it’s mainly a play on the demand-supply equilibrium
• Existing plants in the sector are running at full capacity and new
capacities are coming into operation
• Margins peaks and end-user industries shut down due to high input
costs

WHEN TO SELL WEEDS

BUSINESS CATEGORY
In the first place, we should not be owning these businesses. Even if the
business has become weed-like by transitioning from Mango or Banyan, it
should have been sold much earlier when signs are visible. The best time to
exit weed stocks was yesterday; the second-best time is today. Exit them!
Not tomorrow. Not today. Now. It’s like asking for how much time we
should hold stinking garbage in our house - throw it out NOW.

CHAPTER SUMMARY
• Wealth takes years to build, but it can perish in seconds without risk
management.
• There are three steps to dealing with risk management: understand,
recognize, and control risks.
• Risk is the possibility that things may not go as planned, expected, or
desired.
• While investors have zero control over returns, business performance,
or macro events, they control allocation, downsizing risks, and their
behavior.
• It is crucial to remain vigilant as an investor; develop risk
management and exit strategy regardless of the quality growth of
businesses in the portfolio.
• Adhere to risk management, not hope; when data says it is time to
exist, do not linger around.
• Remember re-entering is always an option.
• The intrinsic value of business growth is dynamic because variables
keep changing; therefore, you cannot use old data for future decisions.
• Two important investment principles are that most processes are
cyclical, and wins and losses occur when investors forget the first
principle.
• In case of a market crash, increase allocation to companies with
higher high drawdowns.
• Have an objective exit strategy.
• Sell the cactus business stock when it loses pricing power because of
the competition, lack new products, experience industry disruptions,
get prolonged market share loss, and evidence of poor capital
allocation.
• Sell mango business category when it goes into high P/E territory,
return ratios decrease because of erosion from the competition,
 allocation decision changes from capital protection to high growth
focus, similar businesses are available at attractive valuations, and
when management misallocates funds
• Sell Bunyan when there is structural impairment to future growth,
management change, decrease in competitive advantages, and
profitable investment opportunities.
• Sell bamboo when the competition and other headwinds impair initial
business improvement. When sector tailwinds revert to mean
unavailable reinvestment opportunities, execution of earnings triggers
does not translate to structural growth. Earnings growth and ROCE
improvement are temporary.
• Sell palm when cyclical businesses become structural long-term
growth stories, P/E translates to low peak earnings, demand dwindles
or supply increases, there is an easy market entry, margins peak, and
the end-user industry shuts down.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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ENDNOTES
1.https://economictimes.indiatimes.com/wealth/invest/why-you-
should-not-invest-in-junk-stocks/articleshow/57452293.cms
2.Howard Marks, The Most Important Thing (New York: Columbia
University Press, 2011)
3.Howard Marks, Mastering The Market Cycle (HarperCollins, 2018)
4.https://www.tilsonfunds.com/BuffettUofFloridaspeech.pdf
5.Howard Marks, The Most Important Thing (New York: Columbia
University Press, 2011)
6.Charlie Munger at 39th Annual meeting of Wesco Financial
Shareholders in 1998
CHAPTER EIGHTEEN

VICARIOUS LEARNING -
LEARN FROM OTHER’S
M I S TA K E S
“You don’t have to pee on an electric fence
to learn not to do it.”
—Charlie Munger
We generally overestimate the power of learning and doing things
ourselves, but underestimate the power of observation, learning from
others’ mistakes - Vicarious Learning. Particularly, it is very important with
markets and investing, where mistakes are very costly and result in
monetary loss.
Morgan Housel writes:
“Everything’s been done before. The scenes change but the behaviors and
outcomes don’t. Historian Niall Ferguson’s plug for his profession is that
“The dead outnumber the living 14 to 1, and we ignore the accumulated
experience of such a huge majority of mankind at our peril.” The biggest
lesson from the 100 billion people who are no longer alive is that they tried
everything we’re trying. The details were different, but they tried to outwit
entrenched competition. They swung from optimism to pessimism at the
worst times. They battled unsuccessfully against the reversion of mean.
They learned that popular things seem safe because so many people are
involved, but they’re most dangerous because they’re most competitive.
The same stuff that guides today and will guide tomorrow. History is
abused when specific events are a guide to the future. It’s way more useful
as a benchmark for how people react to risk and incentives, which is stable
over time.”1
 I have listed down 10 powerful mistakes which we can learn from. These
are again my vicarious learning and some I have made myself.
The acronym to remember these mistakes is - CHALLENGES
1.C - Cheap Trap
2.H - Holding Hope Stories; Loss Aversion
3.A - Averaging Down Losers
4.L - Lack of Process or System
5.L - Leverage; Overconfidence
6.E - Extrapolating Past
7.N - Next HDFC Syndrome
8.G - Gambling; Lure of Quick Money; Tips
9.E - Emotional Attachment
10.S - Selling Winners too Early

1. CHEAP TRAP
Many investors get fixated on past prices and when a stock is declining
(particularly much more than the market fall), the perception is that the
stock has become cheaper. Optically, even the PE ratio based on past
earnings looks low. This is generally a trap. My friend bought shares of
Indiabulls Housing Finance in late 2018 when the stock was making 52-
week lows after awesome ~6x returns during 2014-17. The low made in
2018 was ₹ 640 (compared to 2017 all-time high of ₹ 1400. He thought he
bought it cheap, but it never came back to that price. Earnings deteriorated
in the next 3 years and in February 2022, it was trading ₹ 150.
Understand that proven quality companies are seldom available too cheap,
particularly when the broader market is not falling much.
Many investors even have the notion of buying low-priced stocks, thinking
they are buying cheap. They will always be on the lookout for companies
trading less than ₹ 10-20 (also popularly known as penny stocks) and they
hesitate to buy the shares of companies that are priced high, e.g., MRF,
Eicher Motors, Page Industries, etc. They ignore the concept of market cap
or valuation multiple and always think that cheap price means cheap
valuation. This is far, far away from the truth and should be avoided.
 The most common logic given for buying low-priced stocks is - how much
more it can fall? - I call it “Aur Kitna Niche Jayega” syndrome. Well,
technically, it can go down another 100% from the buying price..!! Think
about it.

2. HOLDING HOPE STORIES; LOSS

AVERSION
In today’s time, we are blessed with the speed at which we get information.
We might have bought a company during its good times and then slowly
things change, businesses saturate or deteriorate. The best part is we see the
results not promising and now slowly we are turning into losses.
Logically, we should be selling the position and finding a better-
performing company, but then our mind plays the game. We become averse
to booking the loss and keep holding hoping someday something will
happen even if no growth triggers are visible.
In such scenarios, we not only forgo the opportunity cost of our capital,
but sometimes it results in a huge loss if business deterioration continues,
which usually does happen.
“If you take the best text in economics by Mankiw, he says intelligent people
make decisions based on opportunity costs—in other words, it’s your
alternatives that matter. That’s how we make all of our decisions.”
—Charlie Munger
Remember, capital is finite and we are in the business of finding the best
possible opportunity for that capital corresponding to the risk we are taking.
Sticking to hope stories is extremely injurious to your portfolio returns, and
thereby, your long-term wealth creation goals.
Example: Bharti Airtel had excellent business growth with PAT CAGR of
>30% during its good times in 2003-2008 (with ~45x returns from 2003
low until it’s high in 2007). Then the sector became extremely competitive,
starting with the entry of Tata Docomo with its disruptive pricing, followed
by the entry of Jio, issues around spectrum allotment and many internal
execution challenges. For the next decade, the hope investors would have
hardly made any money.
 As Dan Sullivan has rightly said:
“The difference between successful investors and unsuccessful investors is
how they react to being invested in a losing stock. There is absolutely no
reason to allow a mistake to become an ego-shattering experience. Being
wrong is not a problem. Making mistakes is not the problem. The problem
is being unwilling to accept the mistake. The problem is staying wrong.”
Being wrong is not a mistake. Staying wrong is.

3. AVERAGING DOWN LOSERS

This is one of the worst mistakes investors make, and it can cause a
permanent loss of capital. Let’s say, investors are buying shares at ₹ 100
and then again when it falls further to ₹ 50 due to business deterioration or
potential future growth issues. They think that they are averaging out the
cost and bringing it down to ₹ 75 but in reality; they are chasing losers with
their good capital. As they say - throwing good money after bad.
Think about the eventual outcome: if you keep doing this, say at ₹ 25, then
₹ 10 and then ₹ 2, what will happen? The majority of the portfolio will have
capital allocated to losers and winners will suffer as they don’t get
incremental capital. This is surely a recipe for disaster.
Let’s take the example of Aban Offshore. It had a great run in the bull
market of 2003-2008. In its good times, from say 2006-2007, it became
~10x and earnings were very strong thanks to underlying oil and gas
industry tailwinds.
Later, the company struggled for growth and made huge losses from 2015-
16. From its peak of 2007 which was ₹ 5500, it came crumbling down to ₹
13 during the Mar-2020 fall. Imagine what would happen if someone kept
averaging down this stock for the last 10-12 years?
 I believe we should keep averaging up instead of averaging down. As
business improves, we should not anchor ourselves to historical prices, but
if the business has become better than earlier, we should put capital to work
behind them.
Peter Lynch has rightly mentioned in his book One Up on Wall Street :
“Consistent winners raise their bet as their position strengthens, and they
exit the game when the odds are against them, while consistent losers hand
on until the bitter end of every expensive pot, hoping for miracles and
enjoying the thrill of defeat. In stud poker and on Wall Street, miracles
happen just often enough to keep the losers losing.”
According to Mark Minervini, “Remember that only losers average
losers.”2

4. LACK OF PROCESS OR
SYSTEM
Now, this is one of the most important parts of investing, i.e., having a
system in place. It means, we should have a proper framework around stock
screening, buying decisions, when to add and exit decisions. In earlier
chapters, I have shared the broad process of portfolio allocation, i.e. core-
satellite along with the screening process (remember MACHINE) and we
also covered various portfolio allocation as well as position sizing
principles. Finally, we also thumbed through the importance of risk
management. Having clarity in the end-to-end process helps us remain
decluttered from noise, follow our rules during panic situations and always
remain objective.
However, it is important to note that just building a system or having a
process is not important, but having the discipline to follow and keep
refining the same is very critical. Also, this system should be in sync with
one’s personality.
“Complexity is about tactics; simplicity is about systems. Tactics come and
go but an overarching philosophy
about the way the world works can help you make
 better decisions in multiple scenarios. Simple doesn’t
go out of style but complex does.”
—Ben Carlson
Another advantage of building systems or processes is that it will help you
avoid noise. There is so much overwhelming information around us,
particularly during uncertain times and with a lack of a system, it will
overpower us.
Nassim Nicholas Taleb writes, in his book Fooled by Randomness,
“Minimal exposure to media should be the guiding principle for someone
involved in decision making under uncertainty - including all participants in
financial markets.”3

5. LEVERAGE; OVERCONFIDENCE
Many investors become overconfident when everything is going fine. They
feel they know it all. And even worse, they take leverage in the lure of
making quick money. They ignore or underestimate risk.
Morgan Housel has rightly pointed out:
“Your personal experiences make up maybe 0.00000001% of what’s
happened in the world but maybe 80% of how you think the world
works. People believe what they’ve seen it happen exponentially more than
what they read about has happened to other people if they read about other
people at all. We’re all biased to our own personal history. Everyone. If
you’ve lived through hyperinflation, or a 50% bear market, or were born to
rich parents, or have been discriminated against, you both understand
something that people who haven’t experienced those things never will, but
you’ll also likely overestimate the prevalence of those things happening
again or happening to other people.”4

6. EXTRAPOLATING PAST
This is again a very common mistake investors make. We get too fixated on
past winners, past performance and try to extrapolate that in the future to
justify our buying decision. This thought process can lead to disaster,
particularly in the following scenarios:
 (a)When high growth, high-quality Banyan is transitioning to Mango
(low growth), it could be due to industry headwinds, disruption in
business model, competitive intensity or simply due to lack of
execution. Sometimes, they will have deceptive relatively low PE just
before the earnings collapse.
(b)Cyclical sectors when a stock is around the peak of its earnings and
everything looks perfect. And investors think of this as structural
growth that will continue for years.
In both these scenarios, there could be a sharp fall in earnings growth
coupled with PE de-rating (remember - for cyclicals, you need to see PE
based on mean earnings over a cycle and not using peak earnings).
“Just as styles in women’s gowns and hats and costume jewelry are forever
changing with time, the old leaders of the stock market are dropped and
new ones rise to take their places…In the course of time new leaders will
come to the front: some of the old leaders will be dropped. It will always be
that way if there is a stock market…Keep mentally flexible. Remember the
leaders of today may not be the leaders two years from now.”
—Jesse Livermore

7. NEXT HDFC SYNDROME

We have discussed in earlier chapters about the Banyan type businesses,
i.e., great businesses with Reinvestment Moats, which can keep reinvesting
capital at high rates. These are a minority. And the best part is they keep
compounding for a long time in the future.
But again, investors are bored of listening to the same compounding
names and they feel they can find another HDFC mega compounder and get
lured by stories that vested parties keep pumping. And the result is obvious,
great businesses are not just made from stories, it takes a confluence of
many factors to become great businesses. It is difficult.
Example: Many investors kept chasing Yes Bank and DHFL, thinking of
them as the next HDFC Bank and the next GRUH finance (this has got
merged with Bandhan Bank). We all know the outcome.
You need not sell your gems just because they have doubled or tripled so
soon in the quest for the next HDFC where the caliber is not yet proven.
You just need to keep riding it until the business deteriorates - ‘next HDFC
is probably again HDFC’.

8. GAMBLING; LURE OF QUICK

MONEY; TIPS
This is one of the biggest mistakes that not only starters but even experts
make - getting carried away in the lure of Quick Money. I would admit that
I have made most of these mistakes during my investing journey, which I
am sharing here.
a.The most prominent one during bull markets is chasing shares of
“hot” IPO for quick money, i.e., listing gains. We have seen that
euphoria in 2008 when Reliance Power came with IPO and it again
repeats. We saw in 2022 when again investors rushed for overvalued
technology platform IPOs. This is generally coupled with the “hot”
sector, where there is a mad rush from the investing community.
b.Gambling or speculating on the direction of shares - whether it will
go up or down in the next few seconds, minutes or hours is again
suicidal. It’s a zero-sum game. Add to it the underlying leveraged
instruments like F&O, high margin products can create a permanent
loss of capital in a very short period.
c.Buying shares of random companies on tips and multi-bagger
recommendations for quick money doing no research is another area
where most investors get trapped. They lose their hard-earned money.
I have seen that many investors are averse to learning, they are tight-fisted
about investing in their own education around investing. The result: they
pay much higher tuition fees to market by incurring huge losses.

9. EMOTIONAL ATTACHMENT
One should never mix emotions with financial decisions. The biggest
financial mistakes are made when emotions become part of the Decision
Process. You should not have an emotional attachment to a company’s
shares, for example, because they were gifted to you by your parents. The
stock doesn’t know you own it. Similarly, one should not get carried away
with an attachment towards the company’s promoters. As Gautam Baid
writes- “I wish I had read Cialdini’s book before I made my investment in
Virat Crane Industries in 2016. I felt emotionally attached to its founder,
Grandhi Subba Rao, after I read about his life story of hardship, struggle,
and perseverance. My strong liking bias for the promoter in turn drove
confirmation bias, and I began to justify my entry into the stock by
considering only the positive points and completely sidelining various
negative aspects, such as low margins and related-party transactions, even
though I was aware of them.”5

10. SELLING WINNERS TOO

EARLY
If you watch the interviews of several successful investors, this is the
biggest mistake they all regret. One always underestimates how high a
stock can go. A stock that goes up 100 times first doubles and then goes up
another 50 times! There is Temptation to book profits, but wise investors
know that doing this is the exact opposite of rational behavior. Following
the trailing stop loss method enables you to make the most out of the
winner. Perhaps the biggest regret investors have is not holding a winner for
long enough. Finding a hundred baggers is about the vision to see, the
courage to buy, and the patience to hold; the third is probably the most
difficult yet the most important.

CHAPTER SUMMARY
• Vicarious learning happens through observation and drawing lessons
from the mistakes of others; it is crucial in marketing and investment
because mistakes are costly.
• A cheap trap is a fixation on past stock earnings when prices are
declining; even the P/E ratio based on past earnings is always low.
• Investors forgo their capital opportunity cost and expose themselves
to huge losses when holding hope on stocks despite data showing to
implement an exit strategy.
 • Averaging down losers is the worst mistake an investor can make; it
takes away capital allocated to winners, denying them the opportunity
for incremental capital while compounding losses.
• The lack of a process or system for stock screening, buying, adding
and exiting decisions, and so forth, brings confusion in strategy and
execution.
• It is wise not to become overconfident or take leverage to make quick
money when everything is running smoothly.
• Avoid extrapolating the past; when investors fixate on past winners
and performance, they project the outdated data to the future to justify
their buying strategy, and the outcome is always disastrous.
• Great businesses and investment moves are not a by-product of
stories—sometimes investors get lured into the next HDFC syndrome
because of boredom from the monotony of investing with the same
players and rules.
• The allure of quick money can send investors into a gambling frenzy;
common gambling incentives include chasing hot IPO shares in bull
markets—it never ends well.
• Never mix emotions with financial decisions because mistakes are
rampant when feelings get intertwined.
• It is wise not to attach sentimental value to investment, even when
shares have sentimental value because they were a gift; similarly, do
not get attached to a promoter.
• Never underestimate how high a stock can rise; it leads to the quick
selling of winners.
• Investors always regret giving up their shares too quickly because of
underestimation.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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ENDNOTES
1.Morgan Housel, “Ideas That Changed My Life” , Collaborative Fund
(blog), March 7, 2018, https://www.collaborativefund.com/blog/ideas-
that-changed-my-life/
2.Mark Minervini, Trade like a stock market wizard (New York:
McGraw Hill, 2013)
3.Nassim Nicholas Taleb, Fooled by Randomness: The Hidden Role of
Chance in Life and in the Markets (New York: Random House, 2005)
4.Morgan Housel, “Ideas That Changed My Life” , Collaborative Fund
(blog), March 7, 2018, https://www.collaborativefund.com/blog/ideas-
that-changed-my-life/
5.Gautam Baid, The Joys of Compounding (New York, Columbia
University Press, 2020)
CHAPTER NINETEEN

T H E M O S T I M P O R TA N T
THING
“I fear not the man who has practiced 10,000 kicks once, but I fear the man
who has practiced one kick 10,000 times.”
—Bruce Lee
Investing is simple, but not easy! Why is it so?
When I started my journey, I started with intraday and F&O. On some
days, I made a lot of money. On others, it was terrible to the extent that on a
few instances, my entire monthly salary got exhausted in just 1-2 days.
I was getting frustrated, I could not eat my food or sleep properly, I used to
get angry without reason...yes...I have been through that. I even blew off
my entire capital. The stress and pain were too much.
Then I tried my hands on investing, again the same thing. I fell flat on my
face. And I was about to quit, but thought, I will try it.
I quit my job with no savings. Thereafter, I surrendered myself to my
mentors and went through the grind. Read many books. Tested many things.
Changed my mindset. Changed my belief systems.
And...
Things started to change. I got the path. I worked on my mindset. Created
systems.
I always thought it was the outside world stopping me. But I was wrong, it
was ME. It was my mindset, my belief systems, my thoughts that were
barricading me from getting great results. And then there was no looking
back.
As an investor, we always look for the holy grail, the next big multi-
bagger, the next best strategy, the next best system. We have also seen many
investors disputing which investing style is the best, whether it is value
investing, growth investing, momentum investing, technofunda investing or
any other similar streams.
The truth is, it is never about investing philosophy, it’s about how well one
executes it, how well one understands it, how well it is in sync with one’s
mindset. And this requires dedication, a winning mindset and most
importantly - implementation by practicing it.
In his book Outliers , Malcolm Gladwell mentioned that the difference
between those who succeed and those who do not is 10,000 hours. One
needs to put at least 10,000 hours (which is roughly 5 years) to master the
craft. There are no shortcuts in life. Yes, some can do faster or slower, but
mastering your investing style is very important. Many investors ignore this
aspect and then blame the system.
I am sure you will implement what I have shared with you and practice it
to achieve excellence in your investing journey.
Believe in yourself. Be Prepared. Implement your learnings. Trust your
process. Achieve excellence.
“More important than the will to win is the will to prepare.”
—Charlie Munger
Let me conclude this chapter with a powerful insight shared by Friedrich
Nietzsche:
“Because we think well of ourselves, but nonetheless never suppose
ourselves capable of producing a painting like one of Raphael’s or a
dramatic scene like one of Shakespeare’s, we convince ourselves that the
capacity to do so is quite extraordinarily marvelous, a wholly uncommon
accident, or, if we are still religiously inclined, a mercy from on high.
Thus our vanity, our self-love, promotes the cult of the genius: for only if
we think of him as being very remote from us, as a miraculum, does he not
aggrieve us…
But aside from these suggestions of our vanity, the activity of the genius
seems in no way fundamentally different from the activity of the inventor of
machines, the scholar of astronomy or history, the master of tactics.
All these activities are explicable if one pictures to oneself people whose
thinking is active in one direction, who employ everything as material, who
always zealously observe their own inner life and that of others, who
perceive everywhere models and incentives, who never tire of combining
together the means available to them.
Genius too does nothing but learn first how to lay bricks then how to build,
and continually seek for material and continually form itself around it.
Every activity of man is amazingly complicated, not only that of the genius:
but none is a ‘miracle.’” 1

CHAPTER SUMMARY
• Investing is not easy, but it is simple.
• Investors get things wrong plenty of times; the urge to quit is always
strong some days even with momentary gains.
• However, most times, hindrances are self-made and not external
forces working against the investment progress.
• Work on your mindset, belief systems, and thought patterns.
• There are many investment philosophies from TechnoFunda to
momentum and growth investment strategies; however, it is an
investor’s dedication to execution, understanding, and beliefs in the
endeavor that brings results, not the investment philosophy.
• According to Malcolm Gladwell’s supposition in his book Outliers, it
takes approximately 10,000 hours to master one craft - that is
approximately five years.
• While the mastery duration is not set in stone, the analogy goes to
show it takes time, patience, determination, and resilience to master
any craft - including investment.
• Investors must master their investment style; many investors ignore
this principle and then blame the system when they fail.
• Believe in your abilities - prepare and implement the lessons from
your investment journey.
• It is also crucial for investors to trust the process and strive for
excellence.
• Charlie Munger rightly stated, “More important than the will to win
is the will to prepare.”
 • Friedrich Nietzsche shared insights on the disbelief in capabilities; he
asserts humans are too quick to dismiss perfection as odds, accidents,
or supernatural gifts when they are humanly achievable.
• People create outliers out of success, talent, and achievers because it
is only through distancing from such excellence that they avoid
aggravation.
• However, perfection and excellence are a product of zeal. Even
genius people lay the foundation early on once they become familiar
with their abilities.
• Investors must hone their investing style - that is their craft and it
comes with a lot of practice.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
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ENDNOTES
1.Robert Greene, Mastery (London: Profile Books, 2012)
CHAPTER TWENTY

COMPOUNDING BEYOND
MONEY
“More than your salary. More than the size of your house. More than the
prestige of your job. Control over doing what you want, when you want to,
with the people you want to, is the broadest lifestyle variable that makes
people happy.”
—Morgan Housel 1
Many investors just run behind money during their investing journey and
forget the true purpose of life. Money is just a means to achieve time
freedom. It’s an enabler to help us become the best version of ourselves.
Each of us gets a gift of 86,400 seconds every single day. And at the end
of the day, it’s gone. Imagine what would you have done if this was costing
you, say ₹ 86,400 each day, would you spend your time the same way? If
the answer is “no”, we need to look in the mirror and ask ourselves: what
can I do to live each second in a fulfilled way?
“The rich invest in time, the poor invest in money.”
—Warren Buffett
Compounding applies to habits, knowledge, goodwill, networks and
experience. Each activity, every single thought, every second of our life
compounds.
As soon as we think that we will do it tomorrow, let’s compromise just for
today, the game is already lost. In 2005, Steve Jobs gave a powerful thought
during his Stanford commencement speech, he said, “When I was 17, I read
a quote that went something like: “If you live each day as if it was your last,
someday you’ll most certainly be right.” It made an impression on me, and
since then, for the past 33 years, I have looked in the mirror every morning
and asked myself: “If today were the last day of my life, would I want to do
what I am about to do today?” And whenever the answer has been “No” for
too many days in a row, I know I need to change something.”2
Bottom line : Life is too short to delay working towards your passion,
something you care about, something you always wanted to achieve. Start
now, seize this moment. No excuses.
As Warren Buffett has said, “Chains of habit are too light to be felt until
they are too heavy to be broken”3
Small incremental progressive steps in life can create magical
compounding. Unfortunately, people underestimate the power of small
consistent steps. This can be understood when we consider the contrast mis-
reaction tendency in psychology.
Simply reading a few pages daily, a few minutes of daily exercise,
spending quality time with loved ones, regularly doing charity and giving
back, taking action towards your long-term goals, regular saving and
investing - doing these regularly can improve your life multi-fold.
One of the best habits an investor can develop is that of writing. I see most
of my friends in the trading community maintain a trading journal. But very
few people maintain an investing journal. So, it is very important to
maintain your own journal and focus on how you can improvise it. What is
the residual risk that is embedded into the system? You must be very
granular because what you measure is what matters. If you don’t measure it,
if you don’t analyze it, it doesn’t matter to you and if portfolio returns don’t
matter to you, you will never create wealth. You need to reflect on your
actions, and then continuously improve your thought process.
Gautam Baid writes- “Carry a notebook and track all of your important
decisions. A decision journal helps you collect accurate and honest
feedback on what you were thinking when you made decisions. This
feedback helps you realize when you were just plain lucky. Sometimes
things work out well for very different reasons than we initially envisaged.
The key to understanding the limits to our knowledge is to check the results
of our decisions against what we thought was going to happen and why we
thought it was going to happen.”4
For example, many investors would have bought Eicher Motors for the
commercial vehicle business, but the money ended up being made due to
the two-wheeler motorcycle segment. Similarly, many investors might have
bought Titan for the watch business, but the real cash cow ended up being
the jewelry business. Thus, noting your reasons for buying and later
reflecting is a powerful way to create a feedback loop and refine the
process.
Noting our decisions and thought processes helps us overcome the
intuitive feeling of “I knew it all along”, known as the hindsight bias. The
ideal way to do this is pen-and-paper, especially as we cannot deny our own
handwriting. Alternatives include emailing or messaging a
friend/colleague/mentor/relative and reflecting on that.5
Becoming the best version of ourselves and unleashing our peak potential:
1.First think of where we want to reach. It’s like setting a goal.
Decide what is the best version of yourself. Use affirmations and tell
yourself that you can do it.
2.Choose that one thing that you can make your Ikigai (a reason
for being). Choose one task where you have passion and talent, it is
something the world needs, and that people are willing to pay for.
Focus. Once you find your true Ikigai, you will realize what you do is
not work, it is enjoyment. It is not effort, it is fun.
(https://www.forbes.com/sites/chrismyers/2018/02/23/how-to-find-your-
ikigai-and-transform-your-outlook-on-life-and-business/?
sh=33f093102ed4)
3.Once you have focused on the goal of becoming the best version of
yourself, then learn the tools to achieve your goal. Implement these
tools because knowledge without implementation is not knowledge. As
Yogi Berra has said, “In theory, there is no difference between theory
and practice - in practice there is.”6
4.Focus on how I can solve problems and not on how I can earn.
Learning first, earning second.
5.Create processes that will develop good habits. Avoid things that
take focus away from the goal. Choose delayed gratification.
6.Connect with a lot of like-minded people and network. This will
help you stay on the right path. In today’s day and age, your network is
your net worth. If you surround yourself with people better than you,
then the logical outcome is you improve drastically.
7.Build a great distribution network – connect with people through
various mediums.
8.The goal should be to be the best in whatever you want to be. The
goal is to achieve excellence in the field chosen. Become a leader in
the industry.
9.Delegate tasks, automate stuff and stay away from distractions.
This is how we can make the best of the most important asset. Time.
As the quote says, “Life is too short to do everything by yourself.”
10.Longevity – Focus on Goals or design goals in sectors that will stay
long term. Build bonds with people who think farsightedly. Be
adaptive and be relevant. Humans are inherently obsessed with the
short term. We always overestimate what we can achieve in the short
term, but underestimate what we can achieve eventually. Thinking
about the long term rather than the near term is a sure way to get an
edge over the rest of the crowd. Jeff Bezos said, “If everything you do
needs to work on a three-year time horizon, then you’re competing
against a lot of people. But if you’re willing to invest on a seven-year
time horizon, you’re now competing against a fraction of those people,
because very few companies are willing to do that. Just by lengthening
the time horizon, you can engage in endeavors that you could never
otherwise pursue.”7
11.Selling is the most important thing. Selling is not a bad thing.
Don’t shy away from learning to sell. It’s a good service for the world.
Without sales, great products/services will never reach those who need
them. As Naval Ravikant said, “Learn to sell, learn to build, if you can
do both, you will be unstoppable.”8
12.Cutting Out the Noise: Most of what we hear is not signal, but
noise. Even during all the crises, eventually, the market bounces back.
So never get too pessimistic during any crash.
The market corrects in expectation of a crisis and rallies during the crisis.9
 (https://blog.abakkusinvest.com/wp-content/uploads/2022/02/Market-
Outlook-Views-on-Current-Events-Feb-2022.pdf)
13.Keep reinvesting in yourself. This is the most important thing.
Dividend equals giving something to yourself. Use this as a positive
feedback loop. Ask for feedback and keep improving. To quote Charlie
Munger- “I constantly see people rise in life who are not the smartest,
sometimes not even the most diligent, but they are learning machines.
They go to bed every night a little wiser than they were when they got
up and boy does that help, particularly when you have a long run ahead
of you.”10

POWER OF SMALL INCREMENTAL

STEPS - THE KAIZEN WAY
In life and investing, we see bigger goals and give up at the initial stage
thinking they will be impossible to achieve. But the secret to achieving your
goals, becoming a better version, to be successful, is to take small
incremental steps - consistently.
 Kaizen is a Japanese technique that means “taking small steps for
continual improvement.” One Small Step Can Change Your Life: The
Kaizen Way by Robert Maurer is a powerful book that covers this concept.
It talks about how taking small incremental steps can make a big difference
in one’s life.
In his book, Robert Maurer talks about six strategies that can help us bring
about big changes in our life by taking small incremental steps consistently
for a long time:
1.Asking small questions
2.Thinking small thoughts
3.Taking small actions
4.Solving small problems
5.Giving small rewards
6.Recognizing small moments
This is a powerful mental model which each one of us should follow in our
life and investing journey to compound every aspect to achieve great
results.
“The journey of a thousand miles begins with a single step.”
—Lao Tzu

COMPOUND YOUR KARMA

“Life is an echo. What you send out, comes back.
What you sow, you reap. What you give, you get.
What you see in others, exists in you.
Remember, life is an echo. It always gets back to you.
So, give goodness.”
—Zig Ziglar
We all know about Newton’s third law of motion which simply means - that
to every action, there will always be an equal and opposite reaction. Life
works in the same way through the “Law of Karma” - what goes around
comes around.
 Unfortunately, most schools only teach theories that will only make us
employable. But life is beyond that. Each action is like a seed, we reap what
we sow. Let’s do good deeds, give back to society, have good intentions,
have the right thoughts, be kind and respect others.
Stephen Covey wrote, “You are free to make whatever choice you want,
but you are not free from the consequences of the choice.”
In one beautiful passage about his autobiography, Ed Viesturs, a high-
altitude mountaineer, wrote, “Although I remain uncertain about God or any
particular religion, I believe in karma. What goes around, comes around.
How you live your life, the respect that you give others and the mountain,
and how you treat people, in general, will come back to you in a kindred
fashion. I like to talk about what I call the Karma National Bank. If you
give up the summit to help rescue someone who is in trouble, you’ve put a
deposit in that bank. And sometime down the road, you may need to make a
big withdrawal.”
Let’s keep doing good deeds and keep compounding balance in our Karma
Bank. This is true compounding, this is the true meaning of life.

FINAL THOUGHTS:
Financial Freedom is possible for each one of you when you thoughtfully
build the Mega Compounding Machine for yourself by saving, investing
and implementing the system. Have positive intentions, keep learning, stay
in the game, respect risk, be humble and do good karma. India is a land of
opportunities, so be prepared to grab these opportunities - find them, ride
them. May the force be with you.
As Aryan said the last words, the trio noticed sun rays leaking through a
gap in the curtains. Silence punctuated for a couple of moments. For the
couple, it was like basking in the sunbeams of enlightenment. At the same
time, they were shellshocked, as they had spent a long time in the bubble of
ignorance, battling with their finances.
Chatur and Ranjita thanked Aryan for sharing his wisdom with them and
also promised him to transform their learnings into action.
And, a new day, a new life blossomed thereafter.
You too can compound! All the best.
CHAPTER SUMMARY
• According to Morgan Housel, if you want to be happy, you should
gain control of the things you do, how you do them, and the people you
do them with - control is the solution.
• There is more to life than making money - there is also living.
• Money is simply a means of reaching time freedom.
• Make the most out of the gift of time; there are 86,400 seconds worth
investing in living.
• Each second, action, and thought in life compounds.
• Procrastination is the enemy of time.
• Life is short; therefore, make every moment count - carpe diem.
• Journaling is an essential aspect of investment; it provides an
unbiased source of data for the investor, brings thought structure, and
impacts the endeavor’s success.
• Make habits out of gainful experiences; Warren Buffett said it well,
“Chains of habit are too light to be felt until they are too heavy to be
broken.”
• Tiny incremental steps eventually compound into big moves; never
underestimate the power of small beginnings and consistency.
• The first step to living to your full potential is setting your goal to
determine where you want to reach.
• Prioritize your passion and talent in the goal establishment.
• Learn the tools to achieve the set goal.
• Focus on problem-solving rather than earnings first.
• Learn beneficial habits that steer you toward the goal.
• Interact with like-minded people and have interactions across
different mediums.
• Aim for excellence as you work to achieve this goal.
• Streamline and automate tasks; you can also capitalize on delegation.
• Always focus on the long-term when building relationships,
developing tasks, or determining the main goal.
 • Be comfortable with selling; it is a natural necessary practice.
• Eliminate the noise; it is always a distraction.
• Keep reinventing yourself.
• Robert Maurer provides six strategies for making small incremental
steps: asking small questions, thinking small thoughts, thinking small
actions, solving small problems, giving small rewards, and recognizing
small moments.
• You reap what you sow and every action has an equal reaction;
therefore, be prepared to face the consequences of your actions.

YOUR REFLECTIONS
(Reflect on what you have learned and pen down your thoughts)
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
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ENDNOTES
1.Morgan Housel, The Psychology of Money: Timeless Lessons on
Wealth, Greed, and Happiness (United Kingdom: Harriman House,
2020)
2.https://news.stanford.edu/2005/06/14/jobs-061505/
3.https://www.brainyquote.com/quotes/warren_buffett_384858
4.Gautam Baid, The Joys of Compounding (New York, Columbia
University Press, 2020)
5.https://malharmanek.wordpress.com/2021/08/29/on-overcoming-
psychological-biases/
6.https://www.brainyquote.com/quotes/yogi_berra_141506
7.https://www.goodreads.com/quotes/7648364-if-everything-you-do-
needs-to-work-on-a-three-
year#:~:text=Quotes%20%3E%20Quotable%20Quote-,%E2%80%9CI
f%20everything%20you%20do%20needs%20to%20work%20on%20a
%20three,a%20fraction%20of%20those%20people%E2%80%A6
8.https://nav.al/build-sell
9.https://www.reddit.com/r/Damnthatsinteresting/comments/t059g7/im
pact_of_global_crises_on_dow_jones
10.https://learnrepeatacademy.com/charlie-munger-quotes/
APPENDIX

10 POWERFUL
INVESTING
A F F I R M AT I O N S
1.I Earn Massive Passive Income. I am Financially Free
2.I have a choice. I work because I choose to, not because I have to
3.I admire and Model Rich and Successful People
4.I am Truly Grateful for all Money and Knowledge that I have
5.I am committed to constantly learning. I take Investing seriously
6.I always follow my system and remain objective at all times
7.I always avoid noise and distractions
8.I always Respect Risk
9.I think and act in my long-term interest
10.I am a Mega Compounding Machine
To Download these Affirmations in HD Poster Format:
https://TechnoFunda.co/affirmations
FURTHER READING
R E C O M M E N D AT I O N S
Go to my latest book list on Amazon:
http://technofunda.co/books
ACKNOWLEDGMENTS
I would like to thank my family for supporting me in my investing journey
and motivating me to write this book. Also, I would like to extend my
special thanks to Malhar Manek who helped me in articulating this book.
Finally, gratitude to all my mentors, investor friends and TechnoFunda
Investing Community for helping me become lifelong learner of markets.
Gratitude to my dear friend and author coach Som Bathla from whom I
could learn writing this book. Thanks to entire Penman publishing team for
helping me publish this book.
My sincere thanks and all credits to Tradingview for all the technical
charts shared in this book.
ENDNOTES
I know that investing is a wide subject and a lot of data points can keep
changing from time to time. I am committed to making changes to the
references as needed in the future.
I would also like to acknowledge that I may have made a mistake in this
book - either in attributing something incorrectly or not giving credit to
someone inadvertently. If you find any such case, please email me at
[email protected] and I would be happy to fix it as soon as
possible.
A full list of updated endnotes and corrections can be found below:
youcancompound.com/endnotes