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Sanjay Bakshi: “Quality Is Systematically Underpriced”

Value investors look up to Warren Buffett as an example of what’s possible when you invest with care and discipline, but a recent talk given by Professor Sanjay Bakshi at OctoberQuest 2013 highlights how many self-proclaimed value investors are deluding themselves and choosing small short-term plays over real long-term wealth creation.

Sanjay Bakshi’s clever investments

Sanjay Bakshi starts off by telling about two particularly clever investments that worked out just as he had hoped but still turned out to be foolish.

“In December 2001 this company announced a buyback at Rs 250 per share. I bought the stock at Rs 215, held it for about 40 days and then just prior to the tender offer, I sold it for Rs 240, netting a gain of Rs 25 on an investment of Rs 215,” says Bakshi. “That’s a flat return of about 12 percent and an IRR of about 110 percent. Not bad at all!”

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The problem wasn’t that his gambit failed, it worked perfectly, but he was only looking at a chance to make a quick profit and get out without deciding whether the company had the potential to perform in the long term. Bosch Limited (NSE:BOSCHLTD) (BOM:500530), nee MICO, grew enormously in the years afterwards and Bakshi missed out because he was satisfied with a quick 12 percent return.

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Strategy for bear markets

His second example is based on Graham’s “low priced common stock” strategy which is meant to be used during a bear market. The idea is to look for a low absolute price, a large recent drop, a low equity market relative to revenue, and a high cash flow yield. According to Bakshi “[It] works during a severe bear market. It really does.”

So he set out to find a few stocks that fit all of those criteria, and ended up buying Omax Autos Limited (NSE:OMAXAUTO) (BOM:520021) and Finolex Cables Ltd (NSE:FINCABLES) (BOM:500144). The strategy worked for him—he made money on both deals—but he would have done better by simply choosing a quality company like Nestle India Limited (NSE:NESTLEIND) (BOM:500790) and wait for it to start growing again.

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Quality companies’ performance

Amusing anecdotes aside, the bigger point Sanjay Bakshi is trying to make is that quality companies outperform the market in the long term because performance isn’t random. A great company now will probably be a great company in a few years, and at worst it will be a good company, while a bad company will at best become below average or mediocre, and may simply go bust. For most value investors this poses a bit of a conundrum: if companies keep outperforming, were they underpriced before or are they overpriced now?

For Sanjay Bakshi the answer is simple, “Quality is systematically underpriced by markets over long time periods … because most investors tend to discount delayed gratification too heavily,” he concludes. “You shouldn’t do that.”

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