# Does the word ‘Compounding’ excite you? 

# Have you always wondered what ‘Value Investing’ is and how can you follow this approach?

# Are you biased in your investment decisions? 

Then, this is an episode you shouldn’t miss. Our guest, Gautam Baid, CFA & Founder at Stellar Wealth Partners, and Founding Creator at Chapter talks about his journey in the stock market from his early days, learning through great books on investing to eventually becoming a writer and fund manager himself. 

During the episode, Gautam talks about his personal experience of gaining and compounding knowledge, his recommendations (in terms of books, checklists, biases) for first-time investors entering the stock market, and much more.

Notes – 

03:46 – His family background and childhood

09:21 – Compounding of Knowledge: Spent on hours of learnings

14:28 – “Nothing teaches you the biggest lessons of life, more than an empty pocket and empty stomach.”

21:19 – His thoughts about ‘Value Investing.’

31:35 – Checklists in his investing decisions

33:15 – 3 biases every investor should know

49:28 – “Time is the new status symbol.”

50:35 – His book recommendations  

Additional links:

Link to Gautam Baid’s smallcase: www.stellarwealthpartners.com

Link to Gautam Baid’s Chapter: https://getchapter.app/@gautam

Link to Gautam Baid’s book: www.TheJoysOfCompounding.com  

Read the full transcript here:

Siddhartha 1:03

Dear listeners, this is your host Siddhartha Ahluwalia. Before we begin, I would like to thank our sponsors Prime Venture Partners. Prime is the first institutional investor in the category creating tech startups like Mygate, Neo, Dozee, PlanetSpark. Prime is now investing out of its fourth Fund, which is more than 100 million dollars. Today, I have with me Amit Somani, Managing Partner, Prime Ventures. Amit, we would like to know how you evaluate founders, and what are the different evaluation criteria like?

 

Amit 1:39  

Siddhartha, so at Prime we look for what we call category creating or category defining startups. So we’re really looking for in what way is a startup 10x Better or 1,000% Better than the current state of the art. It could be a product, it could be technology, it could be go to market, it could be a business model, whatever. So that is one of our criteria. As for the founders themselves, we’re really looking for founders that have very high learning agility or a very high learning quotient. Why that is important Siddhartha, is as you’re going through your seed to pre series A to series A and journey to build your company, to get product market fit to accelerate it, you have to make a lot of trade offs and a lot of decisions. So we’re really looking for founders that have very high learning agility.

 

Siddhartha 2:24  

Thank you, Amit. So listeners, let’s dive straight into this week’s podcast. Today, I have with me one of my favorite writers. He explains long term thinking in investments and in life. If you have to know about the methods of compound interest and how it creates wealth and abundance in your life, there is no better person than the speaker that we have today. Welcome Gautam baid. Gautam Baid,CFA is the founder of stellar wealth partners, a SEBI registered research analyst firm, a small case manager for investors in the Indian stock market. He’s also the founding creator at ‘Chapter’ a curation based learning platform where he teaches the discipline of investing. 

 

Gautam is author of international bestseller on value investing “The joys of compounding”. Previously, he served as Portfolio Manager at Summit global, and SEC registered investment advisor based in Salt Lake City, USA. Gautam is a CFA charterholder and member of CFA Institute and in 2018 & 2019, he was profiling Morningstar, learning from the master series. Gautam, welcome to the podcast. 

 

Gautam 3:40

Thank you for having me Siddhartha. 

 

Siddhartha 3:43

Gautam before we dive deep into your lessons on compounding, I want to explore your journey, how you started investing. And what are the sources from where you learned the real power of compounding yourself? 

 

Gautam 4:00

Sure, so I come from a family of four and I was born and brought up in Kolkata, India. And as you very well know that the Marwari community in India is known for having business in its genes. So ever since my teenage years, I was very fascinated by the concept of entrepreneurship, especially by the fact that once a solid foundation is established for a business, the owners do not work for money. Rather, money works for them.

 

I did my graduation with a specialization in accountancy, so pursuing higher studies in the field of finance, seemed like a natural extension. I did my MSc in Finance from ICFAI University, Hyderabad, India and I also did my MBA in finance, from Nirma University, Ahmedabad, India, and later on, I went on to obtain my charter from the CFA Institute USA. After completing my MBA programme I got placed as an analyst in the investment banking team of Citigroup, and I worked at their Mumbai office for three years. And after that I moved to Deutsche Bank where I worked as a senior analyst in their investment banking team for almost four years. 

 

As regards how I got my start in the Indian stock market, as is typically the case of most investors, I was simply pulled into the stock market out of sheer greed during the final euphoric phases of a bull market. In my case, it was the 2003 to 2007 bull market in India. I still remember purchasing the mutual fund named Reliance power cetera mutual fund in late 2007. And at purchase the stock name is pastille in January 2008, because both of these belong to the hot and fancied sectors of power in steel at the time, but vividness and recency biases are very powerful, but highly costly behavioral mistakes. Both these investments crashed 70 to 80%, within the first 15 to 18 months of my purchase, and I had successfully gained admission into the stock market by paying my tuition fees. 

 

Despite this initial setback, my interest and curiosity about the stock markets remained very high. Throughout the first seven years of my professional career in investment banking. And one fine day I came to the deep realization that we just have this one short life to live and I did not want to waste any further time doing something that I was not truly passionate about. I was earning good money in the investment banking field, but many people tend to confuse job satisfaction with having a very high salary income. That’s not the case. The only definition of success is to live your life your own way, to live a life aligned with your personal values. And that is what I strongly believe in. 

 

So I was so keen for a career shift that I relocated to the US in May 2015. Without any job in hand, one of my close relatives sponsored my USA green card. I was under the impression that since I’m a CFA charter holder, I should easily land a stock market job because this particular degree is highly valued in the investment industry. But as you know, life is not a bed of roses for those trying to carve their own destiny. I was rejected in my first three stock market job interviews in the US in the first six months. But I did not give up. I was very adamant that I’m not going to go back to my previous field of work in investment banking, where the presence of incentive cost buyers constantly led to conflict of interest and did not suit my personal nature. 

 

At the same time, I ran out, I ran out of whatever little money I brought with me from India. And to take care of my living expenses in the US, I took up a minimum wage job as a front desk clerk at a hotel in San Francisco, where I worked for 15 months. And even though it was a big challenge for me, intellectually, physically, emotionally and culturally. Today, in hindsight, I highly value those days of my life because for the first time since the beginning of my busy professional investment banking career, I finally got some time for myself to read and learn and invest in my personal development. Little did I know at the time that I was laying down the strong building blocks for compounding in my life. 

 

The pace of work at the hotel was pretty slow. And I made full use of the free time I had with me to read up every single blog article published on blogs like Janav WordPress, fundo Professor, base it investing, micro cap club and Safal niveshak among others, and the passionate pursuit of lifelong learning had finally begun. Now luck, chance serendipity and randomness have always played a big role in various aspects of my life till date. One fine night during November 2016. While working at the hotel, I randomly clicked on the quick Apply button on a job application on LinkedIn and wonder of wonders, I was shortlisted for the interview for a senior role in an investment firm, even though I had no formal stock market job experience. And this was a phase in my life during which I was about to realize the power of compounding knowledge in action. 

 

You see, all these hundreds of hours over the previous 15 months spent at the hotel reading all these blog articles, had now established a very strong foundation intellectually for me in the investing domain. This is what I was lacking during the first six months when I was rejected in those first three stock market job interviews. And this time, I was able to successfully clear all the three rounds of my job interview because as you very well know, body language derives from confidence and confidence derives from knowledge. And I was offered the role of portfolio manager and it was like a dream come true for me because never in my wildest dreams did I imagine that I’ll land the role of a portfolio manager straight away. I thought I’ll be hired as a junior analyst, then be promoted to an analyst, then senior analyst, then an assistant Portfolio Manager and then I may reach the level of portfolio manager in 14-15 years but this is how the magic of compounding works. 

 

So, here I would like to take out a moment to also share the significance of passion. During those 15 months at the hotel, every single night, I used to apply to a minimum of three stock market jobs online. And as you very well know, every single time we take out the time to fill up the job application, attach our resume and click on the submit button, there is always so much hope attached behind every single submission. To be rejected more than 1300 times, because over those 15 months, I distinctly remember I had applied to more than 1300 stock market jobs, to be rejected more than 1300 times and still keep on going is only possible if you’re fiercely passionate and absolutely sincerely dedicated to what you want to pursue in life. So this is the significance of passion. And that’s why in my book also, I have dedicated an entire chapter to that particular topic. 

 

There is indeed power in passion, and the big takeaway from this entire experience for me was that compounding will bestow its magic and benefits upon you only after a very long time, after testing your patience and conviction to the fullest. And I never lost sight of what Thomas Edison had said that most of life’s biggest failures are people who did not realize how close they were to success before they gave up. So never give up. Keep going because you never know when you’re going to hit it big. So that was how I landed the role of the portfolio manager. As you also know, I’ve written a book named “The joys of compounding” and it has become an international bestseller. And what the success of this book has done is that it has brought me on the radar of many technology startups in Silicon Valley. And many of them approached me to collaborate with them and join their platforms. But I decided to collaborate with Chapter, a curation based learning platform where I teach the discipline of investing. 

 

The reason I chose chapter was because the mission of the founders of Chapter Kyle and Steven really resonated with me. Kyle and Steven want to bring highly specialized education to the world and make it very affordable and accessible. And I just strongly believe in their mission. So I quit my job as a portfolio manager on 31st July 2021. And at the same time, I had also applied to the stock market regulatory in India SEBI for research analyst corporate license, which was approved a few months ago. And I’ve also established an investment firm in India named Stellar Wealth partners, where we offer small case model portfolios for investors in the Indian stock market, and we aim to build generational wealth for many families in India over the next few decades. So that in a brief is a snapshot of my past experience and background. 

 

Siddhartha 12:35

This is terrific, how all the three things randomness, luck, and passion played a role as you said in your life. Gautam I would like to know, in 2015, what was your age when you were doing the clerk desk job?

 

Gautam 12:51  

That time I was 32 years old. 

 

Siddhartha 12:55

Wow. And I can imagine, spending so much time before in investment banking, you would have so much doubt at the back of your mind. Did it all land up to this? And where would it go from now, if you didn’t get a job in the stock market? How did you overcome that doubt? 

 

Gautam 13:19

It was not easy. Let me be very clear about it. It was not easy in those 15 months. But basically, today, those 15 months seemed like 15 long years, it was a never ending experience. And it was not easy because having faced rejection time and again more than 1300 times it does become very disappointing at times and I used to work in the graveyard shift. So for those who don’t know the meaning of the graveyard shift, this shift at the hotel ran from 11pm at night, to 7am in the morning. I was working at four minimum wages, I knew no one locally. So I was all alone, facing financial trouble. But I just did not give up because for the first time since the beginning of my career, I finally got time to read and learn and grow. And I had such strong conviction that if I just keep on going one day, I will taste success. But these difficult times are the period when you get to know who really cares about you and who are really vouching for you both in your personal and professional circles and they become your close associates and friends and family members for life. 

 

So nothing teaches you the biggest lessons of life more than an empty wallet and an empty stomach. So I guess, living through adversity, accepting whatever comes in life, taking it with a positive mindset. I think these are really life changing experiences for everyone as individuals. 

 

Siddhartha 14:53

And were you always a writer, writing short blogs or maybe giving an attempt at longer ones.

 

Gautam 15:00

So I didn’t, I used to write blogs. But I had a very personal habit of just curating and collecting articles of interest and articles, which really made a big impression on me. At the same time, I had a habit of making notes in a word document. So that in turn greatly helped me while writing the book. Basically the book was more of an organization of all my various thoughts on different subjects. I remember I self-published the first edition of the book in 2018-19. And when I’d self published the book, the idea was just to help others unconditionally, and I had not charged any royalty to cover the costs of production, marketing and distribution, I had never expected the book to become so popular. But how the world works is that when you help others unconditionally without expecting anything in return, the Universe works in such a way so as to come back and reward you back multiple times over. 

 

After the self published edition became very popular. During May 2019. During the Berkshire Hathaway Annual Meeting weekend in Omaha, Nebraska, I was in Creighton University signing copies of my book for the readers and Myles Thompson from Columbia Business School publishing, New York, flew all the way down to Omaha to meet me, and they offered me a publishing contract with them. And the rest, as they say, is history. With the help of Columbia Business School’s global distribution and marketing prowess, “The joys of compounding” has become an international bestseller. And I’m very thankful to all my readers for their love and affection and their trust in me. And I hope to keep adding value to the investing community.

 

Siddhartha 16:43  

And why did you want to write a book? Is it because you wanted to help others? Or is it because you had achieved financial freedom in life? What was the case? 

 

Gautam 16:55

That’s a very good question. And between December 2013, and December 2017, during this four year bull run in India, I had earned a pretty good amount of wealth from the Indian stock market. And I just mentioned a short while ago about how I was shortlisted for this particular job role at Summit global during November 2016. Around that same time period, something very incredible happened. So I joined Twitter in November 2016. And I started sharing my thoughts on various subjects like philosophy, psychology, and history, investing. And within a few months of me joining Twitter and sharing my thoughts, two individuals from India flew all the way to Salt Lake City, USA to meet me and thanked me for what I was sharing on Twitter. And they were the ones who suggested to me the idea of writing a book. And that is basically where the whole origins of “The joys of compounding” came from. It was those individuals from India who first suggested the idea to me of writing a book. 

 

So that is when I started actively working on the process. And I was not a professional writer. So I must admit that writing is actually very hard, very, very hard exercise. Because writing is more of a thinking exercise. It’s all about putting yourself in the position of the reader and trying to add maximum value from every single word, every single sentence, every single page. And the most difficult part of writing is the editing part. Because we writers tend to become so attached to every single sentence or line that we have written that it’s really difficult for us to edit out the non essential parts or the parts that are not that engaging, because we just tend to feel a sense of ownership and belonging to whatever we have written. But at the end of the day, the objective is to add a lot of value to the readers and respect their time. So that discipline really helps you become a much better writer over time. 

 

Siddhartha 18:50

And today, I believe you’re just 38 years old, right? 

 

Gautam 18:53

Yes.

 

Siddhartha 18:54

And you have achieved so much in the last six years. That’s what compounding really is. If you have to say.

 

Gautam 19:04

That really is what compounding all about, basically for the first 32 years, nothing happened. And then the last six years, like you mentioned, I’ve just experienced the power of compounding and the joys of compounding. And that’s what really inspired me to write the book because all the great things in life come from compound interest. That’s why in my book I have written about compounding positive thoughts, compounding good health, compounding, good habits, compounding wealth, compounding knowledge, and compounding goodwill. The idea is to just have a long term focus and have a sound process in mind and just be directionally correct. As long as you’re directionally correct in life, time and the power of compound interest will take care of the rest. 

 

Siddhartha 19:45

So directionally correct, is the main focus area here, and staying on the path. So my second question is, how do you find that direction that you feel confident that it is the correct direction before everybody else says that, yes it’s the correct direction.

 

Gautam 20:03 

It is very simple like I’ve written in the book as well. Let’s think in terms of first principles. First Principles are basically the very basis of any truth. Basically, those are the facts which cannot be refuted. We simply focus on first principles. And this applies to almost every single field, be it our mental health, physical health, our wealth of knowledge, everything if you simply focus on the basics, and just get the basics right. And then after that you just need to be consistent and just stay on the path. That’s it. It’s not that complicated. It’s simple, but not easy. Why do I say it’s not easy, because we’re living in the world of social media full of distractions and noise all the time. And we tend to end up losing focus. And we focus more on what others are doing and saying, rather than what we should be doing and saying. 

 

So I think it’s very important to live life as per the inner scorecard that has written an entire chapter in my book to that particular life philosophy. It’s very, very important. The path to durable success is through authenticity, to live a life aligned with your personal value system and not to live a life just to please others. At the end of the day, you just, it’s life is a one player game, you should just try to please yourself. While keeping very strong models in mind. I think that’s the right way to live. 

 

Siddhartha 21:21

And why do you think value investing philosophy has endured over decades, now almost 100 years? What makes it evergreen?

 

Gautam  21:29  

It’s because of the basic principle that buying something for less than what it is worth will never get old. Philip Fisher rightly said that the stock market is filled with individuals who know the price of everything, but the value of nothing. Stock prices are known to everyone in the stock market, but value is understood by only a select few. And focusing on what is moving is part of our evolutionary instincts. This explains why market participants focus more on volatile stock prices which keep bobbing up and down every day, rather than on business values, which change very slowly. Stock prices randomly fluctuate every day, sometimes widely on either side. But the underlying business value changes very slowly. And therein lies the opportunity for us as value investors. Capitalizing on this desire to avoid volatility is what makes value investing work. And Joel Greenblatt had very aptly said that value investing works, but value investing does not work all of the time. And that is why value investing works. 

 

Siddhartha 22:33

For our listeners, can you summarize again what value investing is? 

 

Gautam 22:40

Value Investing simply refers to buying an asset for less than the intrinsic value and intrinsic value of any asset is simply the present value of all the future cash flows from that asset discounted for the uncertainty of receiving those cash flows. So you simply use a discount rate, a particular rate of return to discount the future cash flows and bring them back to the present. And if the stock price is less than that present value, then it is undervalued and it’s cheap compared to intrinsic value. 

 

Siddhartha 23:11

And how has your investing journey evolved over the years? What core set of ideas did you start off with? And what ideas did you slowly inculcate in your investing mindset as you started learning new things. 

 

Gautam 23:24

So my personal investment philosophy has significantly expanded over the years with time and experience in the market. Initially, I started off by investing in low price to earnings and low price to book stocks or cheaply valued stocks, statistically cheap securities because I started off like most investors by reading Benjamin Graham’s “The Intelligent Investor”. Later on, I read Warren Buffett, Charlie Munger, Philip Fisher and I started buying quality businesses at reasonable fair valuations. But today, it covers multiple areas of the investment universe, including deep value cyclicals, commodities, turnarounds, and special situations like demergers and reverse mergers instead of being restricted by my personal biased views, as was the case in my initial years. I’m now able to invest in a variety of industries and situations wherever I find mispricing of value and highly favorable risk return trade off. 

 

You see no single strategy works all of the time and in every kind of market. And that is why it is essential to build up one’s investing arsenal to be able to hunt for value from within different areas and over the years I have come to realize and appreciate just why this is so critically important. It is because a bull market is always going on at all points of time in some specific sectors of the Indian stock market. For instance, during the 2009 to 2013 bear market in India. Investors in IT services, pharmaceuticals and FMCG made a lot of wealth for themselves. And new trends always emerge during the fag end of a bear market. 

 

And that is why investors should always be alert which stocks and sectors are actually breaking out to all time highs during a bear market because the market itself will tell you where the next leg of winners and for the next bull cycle will come from. So just pay attention and respect the collective wisdom of the stock market. 

Siddhartha 25:17

And Gautam what did you learn because learning new things, everybody looks forward to and what is your process of unlearning?

 

Siddhartha 25:26  

The biggest thing that I have consciously, it was difficult but what I’ve decided to consciously unlearn over the years is to not fret too much about entry valuations in the India stock market, because in the Indian stock market out of the 1000s of listed companies, barely 1% of them are actually quality businesses and they tend to enjoy what is known as a scarcity premium, they tend to be very highly valued. And this tends to act as a deterrent to the traditional deep value investor, what will happen in these cases is you may not make a return on these expensive stocks for the first year. But after that first year’s time correction from the second year onwards the compounding agent begins. 

 

So, the opportunity law cost which you basically lost in the first year is more than made up by the long term compounding which begins from the second year onwards. So, a portfolio well made is made up of multiple mega trends, which provide long term compounding, as well as shorter term tactical opportunities like deep value, cyclicals commodities and special situations which provide you alpha. And what will happen is when you construct a portfolio like this of 20-30 stocks, then at any particular point of time 5-10 stocks may be taking rest, while the others are firing for you. So, over the long term, the composite overall portfolio returns turn out to be very, very healthy.

 

Sidhhartha  26:51  

Gautam one of the key things, which you highlighted is, sticking with the value stocks, which you believe in over cyclical markets like today, US stocks are more than 50% down. Russia has troops over the Ukraine border, the US has put its navy beside the South China Sea to prevent China from jumping into Russia, Ukraine. So many factors are coming together, the federates. So, do you think this is the onStart of the or the onslaught of the bear market? And how do people figure out which are the stocks they want to hold through in this market? 

 

Gautam 27:44

So here, let me quote an example from my book. So we keep fretting about bull markets, bear markets, sideways markets, non trending markets, there’s so much noise around but from December 1964 to December 1981, 17 long years, the Dow Jones Industrial Average in the US advanced one single point. Point to point over the 17 years, the Dow Jones rose only one single point. Yet, Warren Buffett compounded his capital at more than 20% per annum. Good investing is all about individual bottom up stock picking, focusing on the macro economics of each individual business and just ignoring all the noise around geopolitical tensions, disease outbreaks, rising interest rates, rising inflation, and all the noise in the media. That is the key to investing success. 

 

In my book, I’ve also shared a table in which I’ve shared some great Indian businesses and some gruesome bad Indian businesses at the beginning of January 2008, which was the peak of the previous bull market. And I’ve shown the returns from the peak of that previous bull market till the bottom of this subsequent bear market. And what the table shows is that the great businesses tend to create wealth, even when measured from the bull market peak to the subsequent bear market bottom. Whereas gruesome and bad businesses eventually destroy wealth across market cycles, irrespective of whether the media headlines are positive or negative. Over the long term, it’s all about the underlying economics of the businesses you’re investing in. That’s really the short term sentiments and emotions driving the stock prices. But in the long term, it’s all about earnings and cash flows. That is what determines the returns over the long term because there is no dearth of capital in the world, capital is always looking for the next best option, next big opportunity. 

 

The advantage of buying good stocks is during every single market fall when they become cheap, they tend to find support in the form of buyers at lower levels. But the gruesome and bad businesses which were basically just simply bid up due to easy liquidity conditions during a bull market, when they collapse in a bear market crash, they never recover for years. And basically you end up incurring permanent loss of capital, the quality of the business and the quality of the management is the most important variable for retaining and growing your long term wealth. Because making paper profits, large paper profits on a bull market is very easy. But making money is relatively much easier than preserving and growing that money over time. So, survival, endurance, this is the key to compounding. 

 

This is what we at stellar wealth partners focus on. We are focusing on endurance, durability, and sustainability. And we are focusing on the long term. How do you ensure that you’re not wiped off during your future bear market crash? You can do that by investing in businesses, which are quality, which have got no debt on the balance sheet and which are free cash flow generative run by promoters who are not shortchanging the minority shareholders. If you simply do the basic hygiene checks, and do not invest in bad quality, you will come out fine in the long term. But this discipline is very, very difficult for most people. Because in a bull market, when you see your neighbors becoming rich on foreign stocks and Penny stocks, you tend to end up chasing those very stocks and companies and then you end up incurring permanent loss of capital and you lose your hard earned wealth in the subsequent bear market. Bull markets and bear markets will keep occurring throughout the remaining 10 year of our lifetimes and our investing careers. What we need to do is stick to a solid process and be disciplined about it. You don’t have to be smarter than the rest. You just have to be more disciplined than the rest. 

 

Siddhartha 31:34

And how do you incorporate checklists in your investing process? And how do they help you make higher quality decisions in investing, because you are seeing through the cycles which you mentioned.

 

Gautam 31:49

So a prudent prudent investor never purchases ownership in a business without conducting the necessary due diligence, you should study about the company and its competitors both listed and unlisted from the company website, company filings, and information on the internet. And you should read the last 10 years annual Reports, proxies notes and schedules to the financial statements and the management discussion and analysis section or what we call MDA. Within the MDA check for the changes in management tone and industry outlook, and also observe the recent trends in insider shareholding. After you’ve concluded the initial groundwork, proceed to study the following parameters in checklist fashion, Income Statement Analysis, cash flow analysis, balance sheet analysis, returns ratios analysis, operating efficiency analysis, management, quality analysis and a psychological checklist of the standard causes of human misjudgment. All these seven categories are detailed in my book chapter on checklists. 

 

At the same time, it’s very important to understand and realize that the ideal checklist is subjective and it varies from individual to individual. For instance, the primary checklist items you look at when evaluating deep value cyclicals or commodities is very different from the primary checklist items you look at when you’re evaluating high quality secular growth stocks where the quality of business and the quality of management is the most important. 

 

Siddhartha 33:13

And in your book, you speak about various psychological biases that prevent investors from making rational decisions. Could you speak about an example where you avoided falling prey to bias and how it helps you in decision making?

 

Gautam 33:25

Sure, so in my book, I’ve talked about my investment in a stock named HEG Ltd in 2017 in India, and which had made a big profit and a big allocation. And it was a life changing experience for me, I had sold off my position in HEG in early February 2018, one month after the date of my sale, I came across a news report, which mentioned that graphite electrodes, which is HEGs main product, are selling at an even higher price per metric tonne, and that the supply situation in the market was becoming even more tighter. When the facts change, you should change your mind. I immediately repurchased HEG, this time with half the percentage allocation I had at the time of my previous exit. And in one single goal, I was able to conquer a host of personal biases that had affected me since the beginning of my investing career, namely, commitment and consistency bias, anchoring bias and status quo bias. 

 

So let me quickly just elaborate these biases for the benefit of your viewers. Commitment and consistency bias refers to clinging on to a publicly stated position, even though the facts have changed for the worse. But investors should understand that the idea is not to be consistent. The idea is to be right. So one easy way to avoid commitment and consistency bias is to avoid touting your holdings in the media or on social media or in the on TV channels, because facts and situations change in the stock market very quickly. So the idea is not to emotionally get attached to any single stock or promoter. The idea is to focus on the underlying reality and the facts So that’s about commitment and consistency bias. The second bias, which is referred to as anchoring bias, this refers to clinging on to a meaningless reference point, like the cost price, for example. Investors should immediately forget the purchase price they paid for security after the purchase date, but otherwise, this will forever affect your judgment. Because the price which you’re paid for a stock is a sunk cost, it’s meaningless. All that is relevant today is what are the potential future returns from the current stock price. That is what we as investors should focus on. So that’s about anchoring bias. 

 

And the third bias which I referred to is status quo bias, this, again comes from evolutionary biology, we humans are designed to conserve a lot of mental energy. And status quo bias refers to sticking onto a losing investment, hanging on to a bad relationship, or simply not changing your past views, or your past positions, just because you’re not willing to admit that you made a mistake. But the rational person always is focusing on opportunity costs, he’s always focusing on the present, and where the future trajectory is from the present equation. So if once you have found yourself within a hole, stop digging. There is no dearth of opportunities in the stock market. So if you have made a mistake, just sell the stock and move on to a better opportunity. That is the right way to go. So this is about status quo bias. 

 

So this is why the HEG investment will always be very special to me, because it was a big step forward in my evolution towards rationality. I finally exited my second investment in HEG in August 2018, at a good profit, resulting in a total compounded profit of more than 350% in less than one year, on this company stock. And it was only possible because I paid heed to the facts and acted rationally, instead of acting emotionally. 

 

Siddhartha 36:54

And for our listeners, because they understand individual numbers more than the percentage gain, if you could share it, how much you had invested in rupees or dollars in HEG, what was your exit value, 

 

Gautam 37:12

So I had invested more than 20% of my portfolio value in HEG in mid 2017. And by the time I finally exited the position, it was more than 30% of my portfolio value. So the idea is when you find a truly great idea, you should buy enough of it to make a meaningful difference to your life. And that is what the HEG investment did for me, it basically propelled me towards financial independence. 

 

Siddhartha 37:39

And could you walk us through an example for instructional purposes,the way we use analytical principles, tools or processes outlined in the book, and how you apply them to make a successful investment?

 

Gautam 37:50

Sure, so traditionally, there have been three sources of advantage for the individual investor. The first advantage was informational. But with the advent of the Internet and widespread information dissemination, the informational edge is basically gone. The second source of his edge traditionally has been the analytical edge. But with more and more smart people entering the investing profession, even the analytical edge is fast getting compressed. But the one edge, which in my view, is the most durable and long lasting and sustainable is that of behavior, and temperament. And I’ve written about the same in elaborate detail in my book’s chapter on delayed gratification, and implementing the principles from that chapter has helped me achieve some of my biggest multibaggers still to date. 

 

And let me illustrate this with the help of a personal example. During 2018 and 2019, after the 2018 NBFC crisis, the Indian auto industry was undergoing a down cycle. And there was an auto ancillary company named Rajratan global, which was undergoing a big capacity expansion, because the entire auto sector was out of favor, the investors attention on this particular stock was very low. But as soon as the company’s capacity expansion got over and the earnings visibility went up post recovery in the auto cycle, after March 2020, the stock of Rajratan global has given more than 1100% returns since April 2020. So, this is an example of deep value investing, you want to buy these big capex plays during the industry down cycle and then patiently hold on to them till the industry upcycle is in full force. This is how you reap maximum capital appreciation and this is how you get the big multi bagger returns. This is why Howard Marks has said, rule number one, most things will prove to be cyclical. And rule number two, some of the greatest opportunities for gain and loss come when people forget rule number one. 

 

Gautam 39:43

And there are certain final nuances to individual position sizing which is initial allocation plus subsequent paramitting. Which one gets to learn over time with experience in investing. How has your experience been with this and how have you evolved your approach on this? 

 

Gautam 39:58

So I size individual allocations in my portfolio according to my evaluation of potential risk, with the largest allocations having the lowest likelihood of permanent loss of capital, coupled with above average return potential, I initiate new positions with a minimum weighting of three to 5%. And subsequently average upwards. If the management executes above my expectations, it’s very important to realize that individual position sizing is important not only for its impact on overall portfolio performance, but also for one’s mental peace of mind. I sell down to my sleeping point, if any single position becomes a discomfitingly large percentage of my portfolio value, and one should have higher allocations and businesses with disciplined capital allocators, solid growth prospects, and longevity of growth. As Mae West very aptly put it, “too much of a good thing can be wonderful”.  

 

Siddhartha 40:55

And you have mentioned in your book, frequency of correctness doesn’t matter. It’s the magnitude of correctness that matters. Can you please elaborate? 

 

Gautam 41:03

Sure. So success in investing is not just about being right, per se. Far from it, success and wasting boils down to how the great ideas are executed, or what we call the art of execution. This refers to the initial allocation and the subsequent pyramiding. When you find a truly great idea, you should buy enough of it to make a meaningful difference to your life and invest. Good investing is not about the batting average. It’s about the slugging percentage. And this is what George Soros was referring to when he said that “it’s not whether you’re right or wrong, that’s important, what matters is how much money you make when you’re right, and how much money you lose when you’re wrong”. Given that the average success rate of even the best investors in the world is less than 50%. It really does matter that when you find a truly great idea, you make it count. 

 

Siddhartha 41:58

Is it the same for Warren Buffett, Charlie Munger, that they’re right only like 50% of the time, but when they are right, they make billions? 

 

Gautam 42:04

Charlie Munger has basically very famously said that if you take away the top 10 winners from all of Berkshire Hathaway’s past investments, their overall career track record would become below average. So even in Berkshire Hathaway’s case, just 10 investments out of hundreds made over their lifetime accounted for the bulk of the wealth creation. 

 

Siddhartha 42:29

And if you could provide more color on what you refer to as culture as a vote in your book, what does it really mean?

 

Gautam 42:39

So we often discuss the traditional sources of competitive advantage or modes like high switching costs, pricing power, distribution advantages, network effects, but a much under appreciated and difficult to replicate competitive advantage is that of culture. And culture is best exemplified by companies such as Berkshire Hathaway, constellation software, Geico, Nebraska Furniture Mart. Culture matters to long term investors because it empowers the company’s employees to perform their daily tasks slightly better than their competitors do. And overtime these small advantages compound into much larger advantages that last far longer than conventional wisdom suggests. And, as investors, we are looking for companies that are fanatically obsessed with the well being of their customers and empathize with them more than their competitors do. 

 

To illustrate the significance of culture, consider this, between 1957 and 1969 when Warren Buffett was running the Buffett partnership hedge fund, he did not mention the word culture even once in his letters to investors. But from 1970 to 2020. Warren Buffett has mentioned the word culture more than 35 times in his annual shareholder letters. The answer to the question of what will widen the company’s mode should drive the management strategy and the corporate culture. For Facebook, it’s all about improving the user experience on its various social media platforms like Facebook, WhatsApp, and Instagram. For Amazon, it’s all about improving the customer experience in the form of speed, flexibility, options, convenience, wider selection for Nebraska Furniture Mart, Geico and Costco, it’s all about sharing economies of scale with their customers in the form of lower prices. And when we are investing in companies that are widening their mode, over time, they invariably turn out to be much more valuable than the results from our initial validation work. And this is the significance of culture for long term investors. 

 

Siddhartha 44:41

Your firm Stellar wealth partner specializes in identifying emerging and fundamentally strong businesses based on variant perception and long term structural trends. Could you please elaborate on these two investment themes? 

 

Gautam 44:56

Sure. So let me talk about variant perception first, variant perception refers to having a differentiated view on the short to medium term trajectory of a business and fairing perception refers to situations where you get ROIC or return on capital employed expansion coupled with earnings growth, this gives you valuation derating and you end up getting multi baggers. And there are various triggers for varying perception that claim the product mix changes into a higher margin category, a big capacity expansion, which is then followed by operating leverage and deleveraging. Deleveraging refers to cutting down your debt as debt goes down, interest costs go down, net profit goes up, market cap goes up. Varying perception can also come from an industry cycle shift. So we have seen how residential real estate in India has turned around after almost a decade from the middle of 2020. It has already led to many multi baggers from the real estate and building materials space. 

 

Varying perception can also come from a favorable government regulation. So since early 2020, we have seen a heavy emphasis by the government of India on ethanol blending that in turn has led to many good opportunities and multi baggers from the distillery space varying perception can also come from improvement in asset turns. This is an information which you can easily get from the conference calls. You can ask the management how much is the fixed asset turnover they’re expecting on the newly expanded capacity and between margin expansion and improvement in fixed asset turns, I prefer improvement and asset turns because high margins tend to attract competition. Some further triggers for varying perception comes from promoter or management change demergers, reverse mergers, divestiture of a loss making business segment or divestiture of a non core operation of the company.

 

And here I would like to quickly share a very important principle of value creation. There are two kinds of companies in the stock market, one having low returns on capital employed, one having high returns on capital employed. In case of companies having low returns on capital employed, the maximum rate of change the maximum delta the maximum intrinsic value creation takes place when they focus on improving the return on capital employed. And in case of companies having high returns on capital employed the maximum delta the maximum rate of change the maximum intrinsic value creation takes place when they focus on increasing the top line growth. So in varying perceptions at Stellar Wealth partners we focus on companies which are improving their return on capital employed. 

 

The second category of companies is companies having high returns on capital employed, this is what we focus on in our mega trend small cases in which we focus on long term structural trends. Long term structural trends are found in industries with favorable structure. They are usually organized as a monopoly or a duopoly or oligopoly at best, they are experiencing some form of an industry tailwind. They are characterized by consistency and predictability of cash flows. They also tend to be characterized by value migration. So in India we have had value migration for many years from public to private, unorganized to organized, offline to online and there are multiple structural growth places available in the Indian market. You have got contract development and manufacturing organizations, contract research and manufacturing services companies. You’ve got animal healthcare, FinTech, music streaming, e-commerce, cloud computing digital transformation, multiple mega trends are playing out in India and when you juxtapose a high return on capital employed against a large addressable total market size, you get compounding machines. 

 

So this is about the mega trends, a small case at Stellar Wealth partners and both the Flexi cap small case which is focused on variant perception, and the mega trend small case, which is focused on long term structural trends. Both of these are benchmark agnostic portfolios of 25 to 30 stocks. The rationale for having 25 to 30 stocks holdings in each of these small cases is that this is the optimal number of holdings to maximize the risk return trade off. As per study published in the international bestseller, A Random Walk Down Wall Street at 25 to 30 names you have basically captured all of the benefits of diversification. Yet the number of companies you need to know is still manageable. So this is why we diversify prudently in both the small cases and hold between 20 to 30 names. 

 

Siddhartha 49:32

One question, which I always had is, now you’re financially retired, which means you don’t need to work for money, which you said, the money works for you. And you can decide to spend your time wherever you want. So how do you structure your day and your time on a daily basis?

 

Gautam 49:49

I think one of the best parts of being financially independent is that you don’t have to wake up to an alarm clock anymore. I think that feeling is wonderful. And having no scheduled meetings and having an empty calendar is a luxury in itself. I believe the rich have money, the wealthy have time and time is the new status symbol. So basically, there is no fixed schedule per day as such, I just engage in whatever activities make me happy and focusing more on the activities that are more meaningful and carry a lot of meaning to me, like devoting time to my family and friends, my creative pursuits, philanthropy, personal health, and my reading and learning activities. So, I just hope to live the remaining part of my life this way only.

 

Siddhartha 50:36

Gautam, one last question. If you have to pick only five books from your collection, and throw away the rest of them, which would these five be?

 

Gautam 50:47

Let me share three non investing books and three investing books for the benefit of your audience. In terms of non-investing books, I would recommend “More than you know”, by Michael Mauboussin, “Seeking wisdom” by Peter Bevellin and “Poor Charlie’s Almanack”, which has been edited by Peter Kaufman. I think these are three of the best books written on multi disciplined thinking. As far as investing books go all beginner investors should definitely read “One up on Wall Street” by Peter Lynch, “Common stocks and uncommon profits” by Philip Fisher. And “The most important things” by Howard Marks I think these are very good foundational books on investing. So six books in total. 

 

Siddhartha 51:22

Thank you so much, Gautam, it’s been extremely insightful to have you on our podcast. Thank you for sharing your knowledge and experience with authenticity. I think I loved it. I hope my listeners love It too.

 

Gautam 51:35

Thank you Siddhartha.

 

 

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