Thursday, March 23, 2017

Return Per Unit of Time Invested: Anil Tulsiram


In some ways the title of this post could be misleading. The other way to say the same thing would be to ‘Time is precious, decide WHAT NOT TO DO’

Time allocation is as important as capital allocation

Free capital is the book which convinced me that for private investors, focus on time allocation is as important as capital allocation. Almost all the investors in the book highlight how they try to optimize their time.
Focusing on a limited number of sectors leads to “economies of scale in knowledge production” – that is, learning about one company in a sector helps you to understand others in the sector. On the other hand, if you spend all your time looking at a few sectors, you “risk getting stuck at local optima” – that is, miss other sectors with much better opportunities. – Free capital
The scarcest resource for successful investors is not money but attention: how to manage the trade-off between time and rationality to best effect. There is not time in life to find out everything about every potential investment. Investment skill consists not in knowing everything, but in judicious neglect: making wise choices about what to overlook. 
American philosopher William James, had said the same thing more precisely  

“the art of being wise is knowing what to overlook.”

Source: Free Capital
  • Warren Buffet refused Mohnish Pabrai’s offer to work free for him. Recall Buffet’s reply “ I have given a lot of thought to optimal use of MY TIME, and I simply do best by operating by myself. “
  • There is no way for an investment manager to be on top of thousands of businesses, no matter how large the team is.
  • Investment manager has to take short-cuts with or without a team

I messed up big-time with time allocation

When I started my investment journey two years back, the most important mistake I did was not thinking about Return Per Unit of Time Invested. I was clear that I will not invest in any company which I am not comfortable for holding next five years. But I was looking for out of favor stocks [at 52 week low price] at low single digit PE & PB multiple. Majority of the stocks which satisfy both the conditions turned out to be cyclical stocks.
I failed to understand that, even after following detailed investment process for stocks like ZF SteeringGM BreweriesLG Balakrishnan etc., I was not comfortable in allocating more than 2-3% each [click on the link to download mindmaps]. I failed to follow a simple rule that TIME ALLOCATED to a particular idea should be in proportion to the CAPITAL ALLOCATED to that idea.
Matrix
The biggest mistake I was doing was not putting businesses in proper matrix before I begin my detailed research. Abhinav Mansinghka [who along with Niren Parekh maintains an excellent blog here, ] helped me in understanding importance of putting businesses in proper matrix. Abhinav explained me that source of permanent loss of capital is almost always the bad businesses. Unless one pays extraordinarily high price for a high quality businesses, generally one would suffer only opportunity cost and not loss of capital.  

In simple words there is no point is doing DETAILED RESEARCH for bad businesses. Such businesses need WIDE diversification to PROTECT against PERMANENT loss of capital. Don’t get me wrong, I am not saying its wrong to invest in bad businesses at ULTRA CHEAP valuation, but then you cannot be spending months in doing research on one such company.
In the post that follows, I have tried to explain how I am trying to increase Return Per Unit of Time Invested. Of-course, it is tailored to my investment philosophy and personality. But I think you can follow the same steps to create a strategy, which suits to your requirements.

Formulate an investment strategy 

The poet E.B. White believed if your thinking is clear, then your writing will be clear. The same is true of investing, so formulate a strategy and write it down. This discipline will help you zero in on the kinds of companies you want most and avoid getting distracted by situations that are of peripheral interest. Naturally, your investment strategy should match your personality. 
Shrinking the Investing Universe
I’m a practitioner of 80/20 investing. Essentially, this means figuring out the 20% of your investing activities that are delivering 80% of your results. I like to start by asking, “what markets/businesses do I have no chance of investing in?”. Don’t be scared of missing out on a great idea by excluding entire markets/sectors. You will miss a lot of good, even great ideas. But we are on a mission to optimize our investing time.  
“Art of Value Investing” is one of the best book which talks about investment philosophy of various successful investors. These philosophies vary from deep value stocks [diversified portfolio] to buying only high quality stocks [concentrated portfolio]. This book enable us to appreciate that there is NO ONE BEST INVESTMENT STRATEGY. I reproduce below few extracts from the book which highlight the importance of time allocation and is inline with my investment philosophy.
We consider ourselves first and foremost value investors, but we don’t start by looking for cheap stocks. We spend our time following outstanding businesses that we would want to own should they ever become cheap. They’re rarely inexpensive when we start trying to understand them, but we follow them closely so that on the rare occasion they become discounted, we can act right away. Coming at it this way also means we’re not wasting our time chasing statistically cheap companies that we will have no interest in owning. Time is precious in this business. —C.T. Fitzpatrick, Vulcan Value Partners
With the market as volatile as it has been, we’ve been more diligent about maintaining watch lists to catch companies whose stocks trade off sharply for reasons that may be more overall-market related. We’re not looking for short-term trades but, as we learned in late 2008 and early 2009, stocks of even the high-quality companies we want to own can get remarkably cheap quite fastWe want to be prepared for that. —David Nierenberg, D3 Family Funds
It’s very important to define where you’re going to look for opportunities. Time is a precious resource and if you make it your task not to miss anything, you set yourself up for failure. There are too many opportunities out there and, by definition, you will miss many of them. That’s why we narrow where we want to look first by the themes we consider most compelling . We’re not necessarily seeing things others don’t see, but we will likely have a very different view on the magnitude of the trend or the speed at which it happens. —Oliver Kratz, Deutsche Asset Management
We’re deliberately concentrated on 10 to 14 investments, for two reasons related to time. First, it takes considerable time to learn enough about a company, its people, and its industry to develop and maintain a proprietary level of insight information, or knowing more than the Street. My view is that whatever edge I have comes more from knowing where to shop than knowing specifically which of the items I buy will be the best. So I maintain roughly equal stakes to reflect that. —Ralph Shive, Wasatch Advisors
The reality is that we can’t do the level of due diligence we want on each idea and also turn the portfolio over quickly by constantly trading out good ideas for better ones. So we typically hold companies an average of five years. —Steven Romick, First Pacific Advisors
It’s the bias of the information age that people feel isolated when they’re not in touch with what’s going on. To me it’s a good discipline to often say, “I don’t really care what goes on in the market today.” When you do that you can actually get something useful done. Even something simple like saying you’ll only answer e-mails in the morning, at lunch, and at the end of the day sometimes can go a long way toward avoiding unhelpful distractions that tend to arise. —James Montier, GMO
We are typically not attracted to most technology businesses because of cut-throat competition, potential technology obsolescence, short product cycles, and the excessive use of stock options. The return on time is also a problem – you spend so many hours analysing new products and technology trends that 50 percent of your time gets spend on 5 to 10 percent of your portfolio.

 At the same time, technology is an important driver of economic growth and grows at above GDP rates, so we want to have exposure to it. We like to attack difficult industries through the side door. –  Pat English, Fiduciary Management, Inc.

How much research is enough?

He [Vernon] also made the point that it is not worth knowing everything about a company: every investigation has a time opportunity cost. Your aim is not to check all possible hygiene factors, but to check enough to reduce your error rate to a time-efficient acceptable level: a low, but probably not zero, rate of error.
A final skill which Vernon highlighted as important for the self-directed investor was effective time allocation. “Time is a limited resource with strongly diminishing returns. The first hour you spend researching a company is much more important than the tenth hour. Some private investors are management groupies – they spend too much time on their favourite companies, posting on bulletin boards and going to AGMs and all the rest of it. They are squandering time which would be better spent looking for new ideas.” To limit the time resource applied to any one company, he reminds himself of psychological research which suggests that in many contexts decisions are best made with no more than five to seven points of information. Any more information beyond that does not significantly improve decisions, and may even degrade them.
Some investors insist on trying to obtain perfect knowledge about their impending investments, researching companies until they think they know everything there is to know about them. They study the industry and the competition, contact former employees, industry consultants, and analysts, and become personally acquainted with top management. They analyze financial statements for the past decade and stock price trends for even longer. This diligence is admirable, but it has two shortcomings. First, no matter how much research is performed, some information always remains elusive; investors have to learn to live with less than complete information. Second, even if an investor could know all the facts about an investment, he or she would not necessarily profit. This is not to say that fundamental analysis is not useful. It certainly is. But information generally follows the well-known 80/20 rule: the first 80% of the available information is gathered in the first 20% of the time spent. The value of in-depth fundamental analysis is subject to diminishing marginal returns. – Seth Klarman

News is costly

News wastes time. It exacts exorbitant costs. News taxes productivity three ways.  First, count the consumption-time that news demands. That’s the time you actually waste reading, listening to or watching the news. Second, tally up the refocusing time – or switching cost. That’s the time you waste trying to get back to what  you were doing before the news interrupted you. You have to collect  your thoughts. What were you about to do? Every time you disrupt your work to check the news, reorienting yourself wastes more time. Third, news distracts us even hours after we’ve digested today’s hot items. News stories and images may pop into your mind hours, sometimes days later, constantly interrupting your train of thought. Why would you want to do that to yourself?

E-mail, participating on public forums etc

Much of the time you spend in your email inbox produces no return on time invested. You can spend countless hours each day in email, especially if you check your email first thing in the morning.  
One needs to be judicious in participating in various public forums. I have already discussed this in my earlier post on Free Capital, so will avoid repetition.

Conclusion

Selection by elimination process 
Choosing the right investment is really a process of elimination. A minority of the thousands of publicly traded companies in which you could conceivably invest have authentic earnings power and even in this select group fewer still will qualify as an Earnings Power Staircase company. If you are a long-term cautiously greedy investor looking for that single wonderful business, most companies are not worth touching; your focus must be on identifying firms that have the potential to be great growth stocks for the next several years without exposing you and your portfolio to excessive risk.
Aim for specialized expertise and helpful shortcuts.
Many investors think they’re smart enough to master anything, or at least they act that way. Further, they believe the world is constantly changing, and you have to be eclectic and change your approach to adapt, racing to stay up with the latest wonder. The trouble with this is that no one really can know everything, it’s hard to constantly retool and learn new tricks, and this mindset prevents the development of specialized expertise and helpful shortcuts. Warren, on the other hand, knows what he doesn’t know, sticks to what he does know, and leaves the rest for others.
 Howard Mark, Foreward to Warren Buffet Way, third edition

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