Wednesday, 20 July 2016

Look before you leap

Rohith Potti, a fellow value investor is analysing a company under the current internship program. In one of our discussions, I mentioned that I also observe the shareholding pattern of  a company and changes in the shareholding pattern before taking the final decision to invest.
Rohith asked if any confusion can be created by studying the shareholding pattern, because somebody credible might be buying and somebody credible might be exiting the company at the same time and would it not create dissonance in our minds ?
I think that's a good question and my thoughts are as under :
I think it is important to know a lot about a company that we are planning to invest in and knowing about the shareholding pattern and its changes over a period of time might be important. It is possible that we might make mistakes in our judgement. But over a period of time, we should try to improve the process by focusing on weights that we put on each piece of information that we get.
I can recall 2 instances where studying the shareholding pattern helped me in the past. Once, a large global investor was selling the shares of a company that I was invested in. Intrigued by the selling, I tried to find out the reasons for the sale. There could be 2 reasons :(1) Either the sale is justified because of the deterioration in fundamentals. So, you need to go back and check the investment thesis. It prevents you from being complacent. (2) The selling is for completely non-economic reasons which has nothing to do with fundamentals of the company. 
In this particular case, I found out that the sale is due to the redemption pressure that the investor is facing and has nothing to do with the intrinsic value of the company.  That gave me confidence that when the redemption pressure subsides, the price of the stock should follow the value. Drawing confidence from that analysis and also the lower price of the stock, I was able to enhance the position size.
The second instance was about a company that I was interested in but something within me prevented me from investing. I was not very sure about the health, safety and environment practices of the company. And anything found wanting on that front could decimate the business and earnings power of the company in the long run. While checking the shareholding pattern, I found a university endowment invested in that company. Curious to know, I read up on that university. I read that the university has very high standards of due diligence when it comes to their investments both quantitative and qualitative; including health, safety and environment. That gave me confidence because a large investor with a stated practice of due diligence & ability and means to conduct that diligence had finally invested in that company. That was a strong vote of confidence for me.   Satisfied with that I was able to take a call to invest in the company.
So, sometimes looking at these pieces of information can provide a lot of qualitative factors which can help us take the final call.
This brings to my mind the process used by Munger. Please see the following excerpt from the Poor Charlie's Almanac.

Munger's check-list includes the current price, volume and trading considerations as well. Does it mean he is trying to assess the technical parameters before investing ? Yes. But is he investing technically ? The answer is no. Out of sheer curiosity, we should know whatever is knowable about the business and the security that we are planning to buy. Most of the time, this information might not throw any substantive clues but sometimes, something very important might jump from the data points that we are looking at. So, we should learn how much weight to put on the data points that we observe.

Two, also notice Munger's timing of looking at this information. This is the final filter. He is not using this data to accept or discard ideas in the initial screening.
Likewise, we are not to accept or discard ideas at the initial screening based on the shareholding pattern or changes in it. But in the final selection, I think we should look at it.