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The art of understanding cycles

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This presentation tries to give a perspective on understanding cyclicals. Understanding of business and market cycles. With examples from Indian market. This was presented at CFA society, Delhi on Dec 14, 2019 and at FOF, PPFAS on Dec 20, 2019

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The art of understanding cycles

  1. 1. Cycles 2.0 - The art of navigating cycles Jiten Parmar Twitter - @jitenkparmar email : jiten.parmar@aurumcapital.in https://aurumcapital.in twitter - @Capitalaurum email : info@aurumcapital.in Dec 2019
  2. 2.  Jiten is co-founder of Aurum Capital. Aurum Capital is a SEBI registered investment advisory company  The stocks discussed in this presentation are not recommendations from Aurum Capital or Jiten Parmar  Some of these stocks may have been recommended to our clients and Jiten Parmar may hold some of these.  This presentation is only for educational purpose and does not constitute investment advice. JP Disclosures
  3. 3. JP
  4. 4. Investing is psychology, history, sociology, politics and ….. science JP Key Learning
  5. 5. JP
  6. 6. The first step to successful investing is knowing self. Knowing your temperament and mental fortitude JP Key Learning
  7. 7. Deep cyclicality (e.g. commodities) Moderate cyclicality (e.g. cars, fin services) Low cyclicality (e.g. FMCG) We have to understand that markets and stocks are far more cyclical then we think. Even the economy is cyclical. Understanding cycles can help, even if one doesn’t want to delve in deep cyclicals JP Types of Cyclicality
  8. 8. Rule No. 1: Most things will prove to be cyclical Rule No. 2: Some of the greatest opportunities for gain and loss come when other people forget Rule One. -Howard Marks JP
  9. 9. We don’t have to be “exactly right”. We are good even if we are “approximately right” Don’t have to get in at “bottom”, nor get out at the “top” You just have to get the general direction right Don’t mind leaving something on the table, during exits JP Timing
  10. 10. Within stocks and sectors, you have to comprehend “business cycle” as well as “market cycle”. They might not coincide. So do make adjustments accordingly. “Best price” may come before “best results” and “worst price” may come before “worst results” “Excel” investing rarely works in cyclicals, especially in deep cyclicals JP What do we have to comprehend?
  11. 11.  A leading FMCG company from 2001 to 2011 increased revenue from 10000 cr to 19000 cr. Profits from 1600 cr to 2300 cr. From 2011 to 2019 revenue went to 37000 cr, profits to 6000 cr. Stock gave 0% returns in 1st period and 900% in the 2nd period  A leading IT company has multiplied profits 37 times since 2000, but stock price yet to see price of year 2000 JP Market Cycles
  12. 12. JP What we expect/want
  13. 13. JP What we get
  14. 14. JP Don’t try this
  15. 15. JP Or this
  16. 16. JP Get help
  17. 17. JP
  18. 18. JP An interesting analogy Cyclical/Commodity plays are like going to a pub. Enter during happy hours and leave at midnight when party is in full swing. Even if you stay late, be near the door, or you might end up paying the bill for others too Jiten Parmar, Investors Carnival, Nov 2017
  19. 19. JP Higher risk, higher returns
  20. 20. JP
  21. 21.  One ends up buying when ratios are bad - EBITDA margins, ROE’s are down. Company might be in loss  One sells when these show sharp uptick and company becomes highly profitable  Buy, let’s say, when PE is 60 (or -ve) and sell when it is 6  Buy when sector is completely neglected and sell when it is hot  Buy when no one is covering the stock and sell when many buy reports come  Basically, a contrarian approach is required  The bet is on “reversal to mean” JP Contrarian Approach/Inversion
  22. 22.  Triggers show up. Identify the sector/commodity behind the triggers  Study the past cycles  Study production data, supply/demand  Check for capacity utilizations  Check for capex (when many companies announce, great signal to relook/exit)  Check the margins  Check Price to Book (current, historical during upcycle and downcycles)  Check replacement costs JP Evaluation
  23. 23. Prepare a list of the stocks with the theme Shortlist to 4/5 plays. Use basket approach in investing Stress test : Can the company survive another couple of years of downturn ? Wait for some companies to go bust or close down some plants JP Investment Process
  24. 24. Check insider buying/selling Don’t look at PE Price to book/replacement cost are better parameters Check if company has cash/manageable debt Start initial buying at highest pessimism levels As cycle starts turning add JP Investment Process
  25. 25. Sugar – 2 years of monsoon failure in India and failed Brazil crop in 2015 Paper – Largest producer BILT plants closing down Fertilizers – A good monsoon after 2 failed years Polyfilms – Increasing delta between RM and finished product JP Examples of triggers
  26. 26. Chemicals - China measures for pollution control and closing of many units, ADD (anti- dumping duty) Metals/mining - Chinese plants started closing down due to pollution. For Steel - MSP (minimum support price), infra focus  Cement - government focus on Infra, supply not coming as per estimated demand leading to higher capacity utilizations JP Examples of triggers
  27. 27.  Try to get out before best earnings. Peak prices come before peak earnings  Always understand that there is “extra-ordinary” earnings in upcycle. Don’t commit the folly of assuming these as normalized earnings and look at it with a PE lens  One can employ a strategy like getting in at 0.2-0.3 of P/B or replacement and getting out at 1-1.2 of these  Try to estimate normal EBITDA margins by averaging them over downcycles and upcycles. Accordingly, calibrate your entry and exit strategies  Never repent if price still goes up after your sell, as long as you have made good returns JP Exit Strategy
  28. 28.  Always make positional plays  These should never be 5-10 year plays  Patience - Be ready to hold for a couple of years  Make sure portfolio allocation is adhered to  Never go more than 25% of your portfolio in a single deep cyclical sector  Do not change narrative, just to hold on to the sector/stock  Be prepared for failures. Cut when you realize it JP Rules I follow
  29. 29.  There are different strategies in investing. And each may have its merits. Choose the one that works for you  Successful Investor trait – remove bias, rigidity  When good times come, make it count. Can use trailing “profit protection”  Many investors keep watching the index, watch the stocks instead  Good stock at bad price may underperform bad stock at good price  Investing is more of an art, than science  Temperament is the most important quality of a good investor JP Observations/Quotes
  30. 30. Graphite Electrode company JP Case Studies PE of 150 at price of 150 and PE of 5 at price of 4500
  31. 31. Graphite Electrode company JP Case Studies
  32. 32. Paper company JP Case Studies
  33. 33. Paper company JP Case Studies
  34. 34. Polyfilm company JP Case Studies
  35. 35. Polyfilm company JP Case Studies
  36. 36. Polyfilm company 2 JP Case Studies
  37. 37. Polyfilm company 2 JP Case Studies
  38. 38. Metal mining company JP Case Studies
  39. 39. Metal mining company JP Case Studies
  40. 40. JP Sector leaders give less upside in upcycle and less downside in downcycle
  41. 41. Sugar company JP Case Studies
  42. 42. Sugar company JP Case Studies Sector Leader
  43. 43. Sugar company 2 JP Case Studies
  44. 44. Sugar company 2 JP Case Studies 2nd tier company in the sector
  45. 45.  www.platts.com  www.steelmint.com  www.lme.com  www.mcxindia.com  www.zauba.com  www.mining.com  www.steel.gov.in  www.businessinsider.com www.google.com JP Sources
  • rmarieswaran

    Jan. 1, 2020

This presentation tries to give a perspective on understanding cyclicals. Understanding of business and market cycles. With examples from Indian market. This was presented at CFA society, Delhi on Dec 14, 2019 and at FOF, PPFAS on Dec 20, 2019

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