My investment goal (here mostly talking about equity) is to make money and build wealth and more importantly own shares of businesses that I am keenly interested in and find value in owning them. I don’t see any point of owning the shares of the businesses I don’t understand regardless of the upside potential people seem to see in them. In the beginning of my investment journey, I did own businesses I didn’t understand or care to understand. I didn’t have patience and enough urge to practice curiosity in the journey of investment. There was no strategy. It was a real test and I learned the hard way. Gradually as I maneuvered through the investment world, I started getting the fun of owning businesses that I understand and can keep track on. I also understood what was important and what was not for being a good investor. Being a sell-side equity analyst for last three and a half years, I realized that the excel models and granular processes to derive the forecasted numbers are less important than being able to think clearly and look into businesses from different dimensions. The assumptions analysts put to forecast the business performances are result of that thinking process and calibrating information from different sources to make meaning out of them.
Peter Lynch put it this way, “As I look back on it now, it’s obvious that studying history and philosophy was much better preparation for the stock market than, say, studying statistics. …….. I also found it difficult to integrate efficient-market hypothesis. ……. Already I hade seen enough odd fluctuations to doubt the rational part. ….. My distrust of theorizers and prognosticators continues to the present day.”
Working at a very small equity market for few years and keeping some sort of track of the developed markets, I can understand the essence of Peter Lynch’s stance on traditional theories of investment we are taught in classroom.
Investment is more fun because you can actually verify how well your understanding of the business and macro factors are through looking at your investment result. I liked how mostly borrowed ideas put it. “Investing is essentially my lens to understanding the world. Understanding the world itself is a full-time job and it is wonderful that investing has an embedded scorecard, however imperfect, with it so that I can have some understanding how well I really understand how the world works.”
I consider the act of investing a journey to practice curiosity and find different lenses to look at the changing world around us. I want to demonstrate few of the cases I followed throughout my career so far to give you a glimpse of how I looked at different developments in the macro part and industries I covered and came to different conclusions. Some of those conclusions were bluntly wrong and some of those were partly in the right direction.
Let me show you some cases I found interesting so far.
Macro Lens:
Let me show you a chart.
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In a short span of time, I saw the economic cycle to shift from one end to another end. Equity market reacted to such shift in tandem. I observed closely the 2017 short bull run to 2018-mid 2020 bear run and now we are in the middle of a really. If you match this with interest rate chart above, you will find a strong negative relationship. There are some key factors that work behind the volatility of interest rate.
When I started working as a sell side equity analyst in a brokerage firm, I would see market experiencing a rally everyone hoped for. But it was a short-lived rally and there were reasons for it. In the very beginning of my career, I was assigned to look into macro factors and make a call in relation to the equity market. With such little experience it felt like a big task back then. But thanks to my supervisor, he helped me connect with few money market professionals from some top banks who cleared things to me. Talking to them helped me understand the key factors that connect to the movement of interest rate.
Here are few bullets from those conversations and my take:
Credit Growth and Inflation:
- By end of 2017, private sector credit growth was hovering around 17.0%-19.0%. To put it in perspective, Bangladesh’s nominal GDP growth was around 13.0%-14.0%. In this regard, private credit growth was pretty high.
- Inflationary pressure was evident. Inflation crossed 6.0% during the last quarter of 2017 and was crawling up.
- Meanwhile, aggressive lending by banks also put their asset quality at risk. And most banks were touching or crossing the threshold of ADR (Advance-Deposit Ratio) limit which was 85.0% for conventional banks back then.
Deteriorating External Balance:
- Sluggish performance in export and remittance also fueled the current account deficit. You would find the current account deficit at USD 9.6 billion by end of FY (Fiscal Year) 2018 compared to USD 1.3 billion by end of FY17.
- Higher current account deficit meant that foreign currency outflow compared to inflow was much higher. So, there was depreciation pressure on BDT, the local currency. Central bank wants it to stay stable.
- Since there was higher demand for USD (foreign currency), Bangladesh Bank would sell foreign currency (increasing the supply of foreign currency) to local banks to keep the exchange rate stable. In result, the action mopped up some liquidity from the system (central bank selling USD in exchange of equivalent amount of BDT from Banks).
Finally
- Central Bank’s main concern is to ensure price stability. Since, high private sector credit growth started putting inflationary pressure, Central bank of Bangladesh, BB (Bangladesh Bank), prepared recipe for limiting the credit growth.
- And in the beginning of year 2018, BB revised down the limit on ADR to 83.5% from 85.0% for conventional banks. It implied any bank could give out up to BDT 83.5 as loans out of their deposit of BDT 100.0. Earlier it was BDT 85.0. And most banks were already at a threshold point of the previous ADR limit.
- I finally put out this report in 11 January 2018 concluding that interest rate would go up putting a downward pressure on equity market. In the beginning of my career this was the most enjoyable work I did even though my understanding of the macro economy was less clear than now.
Fast forward to this day, the story has changed again. Read this if you are curious.
Micro Lenses:
In the beginning of my career, I was assigned to look into construction sector. From there, I learned some cardinal factors of cement business. My first task was to look into the industry dynamics. Soon enough, after reading some articles on the industry, I found out the overcapacity problem of cement industry. In the period between 2015-2017 most top cement manufacturing companies made huge expansion doubling their capacities. It was quite clear that there would be supply glut (supply greater than existing demand) and which would most likely drive price war. Our (me and my supervisors) estimate was that almost all the cement companies would see their margins shrink. It was reflected in the following years’ financials.
To make the situation worse, clinker (key raw material of cement companies) price was rising in the international market. Except one cement company, all others import clinker from different countries. Relevant studies showed us that, China’s environmental policy banned clinker production in the country and so the Chinese cement manufacturing companies flocked to Vietnam for clinker import which is key import source for Bangladesh cement producers. Demand for Vietnam clinker rose sharply and so the price. These are the things, when connected, look pretty clear in the changing numbers (e.g. gross margins) of cement manufacturers’ business performances.
Things I Didn’t Look Enough:
There were lots of mistakes too. Looking at a credit driven business that is pretty cyclical, I couldn’t quite gauge the investment risk for that business. I underestimated everything that could go wrong. My macro thesis was not aligned with the business I was looking into. All I needed was to zoom out and see the misalignment and there I failed.
Outside View:
We are always asking the question “what’s next” in our head. Our intuitive thinking aka “System 1” guides us for the actions we do repeatedly. Outcomes of these actions are mostly known. And then we come across situations where there are lots of unknowns. Be it a project you are starting out or a company you are investigating in for investment purpose, you want to forecast.
Inside view informs you about the capacity and resources the subject company has while outside view takes you to a reference point (e.g. success rate of others in the same project with same level of capacity and resources) which gives you an indication of where the ballpark is. From there, you can take your forecast forward. Inside view blinds you to all the external and situational aspects while outside view lends you different dimensions to look from.
I and one of my colleagues were looking into one of the paint manufacturing companies. We are quite impressed with the company’s strong comeback after the lockdown period. To understand what’s going on we can look at neighboring countries where the competitive landscape of the paint industry is to some extent similar. Looking at that market we see big players expanding their market share by taking over the small players who couldn’t cope with the pandemic induced economic downturn. Most small paint manufacturers ran out of fuel during the lockdown period while big players had the capacity to absorb the shock. After the lockdown is lifted, pent up demand and scope for market share expansion helped the big paint companies make a strong rebound. The same thesis may be applicable for Bangladesh’s paint industry.
This is just a simple example of using outside view in your analysis of the companies or the macro.
Scalability:
In Bangladesh market there are very few businesses that I can consider scalable. I consider MFS (Mobile Financial Services) one of them. I took my outside view and looked into different markets where MFS thrived. In most markets, MFS business started out as merely a service for cash in-cash out meaning internal remittance. But as they evolved, within network transaction (e.g. peer to peer transaction, merchant payment) surpassed the cash in-cash out volume. In Bangladesh, the shift is the same and pandemic sped up the trend further. Meanwhile, the possibility of inclusion of different financial services into one platform is immense. Look at how Ant Financial, the parent company of Alipay, made it possible in China. This is one of the businesses I am keenly interested in.
Final Words:
These are just some of the few cases I found interesting and took lessons from them. The act of investing or understanding businesses is a great way to cultivate the curiosity within and make sense of the world.
I have started writing publicly to carry on the practice. In this blog and the youtube channel, my goal is to look at global businesses and economies to widen my horizon and go as deep and as far I can go.