Value-investing revisited (Part III)

Value-investing involves investing in assets, which are priced substantially below their intrinsic value. This valuation discount or “margin of safety” serves as a buffer and provides protection against non-achievement of intrinsic value.

This article (as part of a series) deep-dives into the individual components of value-investing

Research is an integral part of value-investing- Value-investors firmly believe that extensive research is essential for identification of sound investment opportunities. While most of the investors typically do some form of research to validate their decisions, value-investors consider research to be the mainstay of their investment framework and follow uncommon practices (some of which are listed below) to extract its true value.

  1. Unique paradigms - Value-investors’ research paradigms are often unique in understanding the businesses and are not intended to second-guess what the assembly-line of analysts would say.
  2. “We don’t get paid for activity, just for being right. As to how long we’ll wait, we’ll wait indefinitely.”
    -Warren Buffett

    Research irrespective of investment - They understand that the true goal of research is to evaluate a hypothesis and it does not need to be followed by an investment. Other investors often succumb to the pressure of justifying the amount of time spent on a particular decision and end up investing in sub-optimal ideas.

  3. “Investment is most intelligent when it is most business-like.”
    -Benjamin Graham

    Entrepreneurial mind-set - Their attitude is similar to an entrepreneur evaluating a business opportunity and not merely of a participant infusing and collecting cash. This leads to a more detailed analysis and gives them a holistic and long-term view of the business. Just like entrepreneurs, they try to invest in businesses with strong growth potential and robust, non-replicable competitive advantages.

  4. Cumulative nature - Research is paramount for value-investors in all the investment decisions regardless of whether they eventually choose to invest in a business or not. They understand that knowledge is cumulative and keep building upon their knowledge base over time and quite often, their first investment in a particular industry is a culmination of numerous rejected options.
  5. Research is not meant to justify an ‘exciting’ idea - As discussed in confirmation bias; many investors manipulate their research to support their preconceived ideas. For value-investors, however, investment decisions always follow extensive research and never vice-versa.

Their investment choices bear a pattern - There are some commonalities in the investments made by value-investors.

  1. Invest in people - Most of the value-investors scout for people with passion for their businesses and ambitious long-term vision. Even if the business does not look extremely attractive in its current state, value-investors still go ahead with extraordinarily visionary people while maintaining a balance between letting them retain their freedom and guiding them.
  2. Businesses they can understand - Warren Buffett is one of the strongest proponents of this investment tenet that if one does not understand a particular business, one should not invest in it. Due to their utmost reliance on extensive research as a prelude to any investment decision, value-investors don’t venture in areas, which look hazy to their comprehension. Intuitively too, an investor cannot possibly take a call on the long-term prospects of a business without understanding its valuation drivers in and out. There are investors, however, who invest in the ‘next big idea’ or in the ‘flavour of the month’ because others are doing it. Any ensuing success could only be attributed to mere luck and would be non-replicable, at best and could lead to heavy losses because of over-confidence, at worst.
  3. “I want a castle I can understand, but I want a castle with a moat around it.”
    -Warren Buffett

    Strong competitive advantages - Value-investors invariably invest in businesses with strong competitive advantages, which not only lead to customer loyalty but also cannot be easily emulated by other players in the industry. This ensures sustainable long-term growth and resilient margins, which in turn, result in higher valuation over time.

  4. Reinvest in new businesses to ensure sustainably resilient return on capital – Very few businesses possess the ability to keep generating high returns on incremental capital for a reasonably long period of time. Value-investors understand this better than anyone else, hence,  they keep looking out for the inflection point of their portfolio businesses, which helps them exit at the opportune time and redeploy their capital in a new venture with superior growth potential.
  5. Exit from mismanaged businesses - Despite extensive research, value-investors sometimes get saddled with a business that is sound in its prospects but is making questionable management choices. A strong contract could be used to persuade the management to mend their ways but it doesn’t always work and an exit becomes necessary. Nevertheless, with considerable margin-of-safety at the core of any investment decision, it is very unlikely for value-investors to lose money in such a situation also.

ArthVeda Star’s focus on research can hardly be overstated. At the ideation stage itself, numerous innovative frameworks were applied to rigorously evaluate its investment proposition. Detailed models were developed to estimate the potential demand for housing in Indian cities and multiple databases were utilized to validate the results further. On-ground housing availability data was used to verify the hypothesis of insufficient supply. At no stage was the feasibility of initial investment thesis taken for granted; there was always room to refine and if required, even reject the original idea. It is a conscious decision to go to similar depth of research even during the investment stage when evaluating the developers.

ArthVeda Star team understands the importance of partnering with the appropriate developers who display a real sense of commitment to their projects and hold somewhat unique advantage in the city/segment they operate in. AVFM also believes in constantly evaluating its portfolios at fund as well as investment-level to advise the investee companies as necessary*. Fund-pipeline is planned to take advantage of relevant pockets-of-inefficiencies at any point in time.

*If required, AVFM could potentially take over project management as its funds normally maintain a controlling stake in its investments and substantial expertise in its investment verticals. However, if controlling stake or/and expertise is not there, AVFM would exit the project at the earliest possible opportunity but would ensure capital redemption and a certain minimum return as built in the contract. ArthVeda Star, for instance, targets to hold 51-75% stake in its investments and should anything go wrong, it also has enough expertise in its own team and through its tie-ups (with DHFL’s Property Marketing & Sales and Technical Consultancy & Project Management arms) to manage the project to completion.

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