The two most important traits required to become a successful investor are temperament, followed by experience, says Durgesh Shah, director of Corporate Database, and governing body member of Flame University.
In an interview with CNBC-TV18's Ramesh Damani for his series Wizards of Dalal Street, Shah was discussing the virtues required to become a successful investor.
"Markets are a subset of nature. In markets, as in nature, you have to be humble or you will be humiliated," he says. "Those who do well in the markets say that they realize how little they know. Also, when they do well, they know how much of the result was because of luck and how much was skill."
Shah managed the institutional desk at investment bank ENAM before setting up Corporate Database, and rubs shoulders with market veterans Nemish Shah, Vallabh Bhanshali and Manish Chokhani (all of whom are associated with Flame).
In the interview, Shah espoused the idea that knowledge is over-rated in financial markets, echoing legendary investor Charlie Munger's advice [as well as that of his famous partner Warren Buffett], who rates temperament above virtues such as intelligence or knowledge.
He elucidated this with the example of a "large investor" -- pointing to big bull Rakesh Jhunjhunwala -- who a few years ago took a large position in oil refinery HPCL.
"His knowledge about the company was not a fraction of most analysts who track the company. But he had the courage and temperament [to understand the opportunity arising out of the oil slump and deregulation]," he said. "The brokerages will carry out the stock's brokerage but he will make the money."Ramesh Damani: Buddhism has a saying, “There is no wealth like knowledge, there is no poverty like ignorance.” Today, we begin an extraordinary three-part series, the ‘Wizards of Dalal Street 35 years", by asking the question, “Are great investors born or can they be taught?”Below is the transcript of Durgesh Shah's interview.
Q: We are sitting at the seat of great learning that FLAME University hopes to become. Let us learn about markets. I talked to Sunil Singhania just a few episodes earlier and he said that he felt like a zebra in Lion country, meaning that nature taught him a lot about markets. You also believe that markets are essentially a subset of nature, do you not?
A: Very clearly, the laws of the markets, you will understand very easily if you understand the laws of the nature. Or the other way, if you understand the laws of nature, you will clearly start beginning to. To start with, Raag and Dwesh is the commonality in nature. You conquer that and you become a person who knows yourself.
Q: Raag meaning attachment and Dwesh meaning hatred?
A: Exactly! Same thing in the markets, you just need to conquer greed and fear. And you are there. Half the battle is won.
Q: Between say temperament, knowledge and experience, what is most important thing for a good investor to have?
A: I would think it is obviously, temperament first, experience thereafter and knowledge.
Q: That is surprising. Everyone says knowledge is all important.
A: I agree with you. In fact, the problem is it is over-rated. Any child is told that go and do engineering degree, go to an MBA school and then you will be all set to become a good investor. However, if you go down to see corporate performance or performance in the stock market with relationship to knowledge and temperament, let us take the example of HPCL. We all know a large investor, proprietary investor took a large position a few years ago, I am very sure that he knows less about Hindustan Petroleum than most analysts who cover the company on the street. However, at a certain point in time, the basic understanding that at this price there is enough he knows for him to buy the stock. There was a complete disbelief in a public sector undertaking (PSU) in the fact that this was a company which was going to get eaten up by the new private entrants. The subsidies of the government, the cash flow issues.
Q: The wisdom was knowing the difference between an HPCL and an MTNL.
A: Exactly. He knew what he needs to know of buying this at this price he can't lose money. How much he would make, how much how soon will make, may probably not have been important. And that is clearly the important thing.
You mentioned about Buddha talking about knowledge. In one of his sermons, Buddha mentions that whatever I am talking to you is like a handful of leaves compared to my knowledge which is the whole of this forest. The fact is you only need to know that much. For salvation in the real world or when it comes to market, to know that this is what you need to know and then go out and act more than doing analysis paralysis beyond a point.
Q: Markets are not just about ratios and cash flows, they are also about psychology and greed and fear and history and geography?
A: I agree completely that FLAME is a school of liberal arts and investing is the ultimate liberal art. You need to know enough about economics but without psychology economics is incomplete. You need to know about history, you need to know about geography, communications all of it.
Q: You need to know about history because the pendulum always swings. Whether it is in history empires are born, become great, fall. So do stocks, so do companies, so do investors.
A: Cycles very clearly. In fact the interesting part of the markets is that corporate performance also moves in pendulums like we talk about cycles everywhere but that pendulum movement is not that large. Cyclical companies are a little wider, but corporate performance or the stock market performance will clearly go much beyond the pendulum swings of corporate performance.
Q: Price discounts everything but give me an example of a second level thinking that you have seen in your career?
A: The best example would be 1988 starting with the Madhu Dandavate Budget who was considered to be a socialist going on to the assassination of Rajiv Gandhi, going up to a situation where literally the country had to pledge gold to get foreign exchange. All the Gulf War, all the things that the world saw were going wrong for India. There were these few guys on Dalal Street who had the faith. The way things are going wrong this will only get better for the investor, the country will move in its behaviour from a pendulum to do things which it should have done any way and rest is history. The Sensex went up from 380 in 1988 to 4,500 in April 1992.
Q: But here is the question I want to ask you. The first level thinking; bad headlines, so the market would be bad, sell. What does the second level thinking do?
A: It goes on to think that okay, whatever is in the news is it discounted in the price and can all these people who are rushing out finally realise that enough is enough. So, the pendulum will surely at some point have to come back and rarely the pendulum comes back to fair price and stops. You are going to get a swing which is positive and that is something that most of these guys got it right that it is under priced and it won't come back to fair price. It is going to overprice zone.
Q: Which we saw on April 2, 1992 at 4500.
A: That was clearly the first large phase of wealth creation for a lot of Indians after independence._PAGEBREAK_Q: A lot of young kids who come to the market want to understand speculation better, investing better. What are the differences and what path should they choose?A: I guess there is no question that speculation is extremely risky. Let us define speculation clearly as taking positions where either you make a huge amount of money on change networth with orbits or you are going to lose your shirt.Q: Binary, zero, one?A: Binary, clearly, zero, one. In investing, it is much different. You have enough room to make mistakes and still come out quite well-off. Investing I would say is much easier than speculation.Q: Would you rather be a wicket keeper though? Watching the flow of the game and then hitting a strike-out when you see the opportunity or taking a catch when you see it? Is that the role you see for yourself?A: I clearly feel that if you are going to be in the game, you have to be in a position where you can see the game being played out and see the best players. Fortunately for me, I had the best seat in the show from 1980 onwards. I have seen great players, not only play extremely well, but kind enough to share their techniques of everything they did with what is going on.Q: Yes, of course, that is important, but is that the seamless web of trust that you talk about so often, that the like-minded people actually help each other in the markets.A: I think it is the seamless web of trust of life, whether you are talking about a doctor or a lawyer or an accountant. But, this entire business of relationships, you need to identify people who you think have the potential to get into a positive relationship.Soon, you find a bunch of people who all are willing to forget as soon as they give and the guy who takes it, remembers for the rest of his life. You have people who are making a mistake and acknowledging it as soon as they realise and the person who is impacted has forgiven even before the person is apologising. So, these relationships can be far and few. I guess I was blessed to have a lot of them.Whenever, you find those kind of people, you need to make sure that you cherish those.Q: But, the underlying theme is that when you create this web of trust in the market, you share a philosophy, you do not necessarily share a portfolio.A: That is something again, that most people do not understand. Very few people believe that Radhakishan Damani and Rakesh Jhunjhunwala have a very small sub-set of common stocks. This is where the whole thing comes in. The faith and respect admiration for each other is much beyond ideas. Everyone has their own ideas, everyone is using the other guy as a bouncing board for finding loopholes on whatever they are thinking but they are quite clear and humble to accept that just because I like a certain stock, does not mean that you should be buying it.Q: But then what is the philosophy that binds them? What are the common threads in their friendship or their approach that binds them?A: I guess they have seen each other’s values over a long-period of time and whether it is markets or life, just come to think of it. How many guys do you know whom you would be willing to make an executor to a will? So, there are certain qualities that you believe that some people have seen through times and their behaviour makes you feel that when somebody is putting trust on to you, you know it is a burden, but you are willing to take that and deliver because you know there is a reciprocation from the other side. In more such relationships, the person feels obliged to be a part of the group or a part of the relationship rather than the other way around.Q: You were talking about speculation and investing as being two different disciplines and I wanted to touch some more on that point. Do you find people can segregate the two, is it easy to segregate speculation and investing?A: If you can do one well, that is good enough for a lifetime, but there are a few people who proved they have done both very well. That I think is very unique. Somebody is trying it he better be forewarned.Q: What are the different skill sets here?A: For example, as an investor, you are buying something where timing is not important, where the fundamentals are important. You know what is going to happen, but you do not know when.Q: And if it goes down, you buy more?A: Exactly. You were waiting for it to go down to add, whereas, when you are trading, it is exactly the opposite. The stock you buy, timing is the most important thing. The direction is very important. You keep buying more as it goes up and you keep selling out as it goes down. In fact, most people do not understand 'Buy as it keeps going up and sell as it keeps going down', it is something that outsiders that just do not figure out. Most people will not understand, but that is what traders do.Q: It is counter-intuitive.A: It is very counter-intuitive and for a fund person to have both those skills is like having a Chinese war in your mind. I cannot think of it.Q: But you have seen it.A: I have seen people do it, deliver unreal returns on both.Q: But very few.A: Very, very few and I would say that these are clearly prodigies.Q: Picasos and Rembrandts.A: Very clearly and I think anyone who is trying to do that should be extremely careful.Q: When you do speculation or satta. ‘Satta hamesha apna slip book se hota hai, cheque book se nahi hota hai.’ What does that mean?A: There are many rules which other people are not able to understand. Very simply they say that 'satte ka nafa hajam karna, charas aur gaanje se jyada mushkil hai'. So, the fact is most people cannot understand why it is difficult, but it is a matter of an intoxication. The person starts believing that he is much sharper than the markets and that is all that the markets wait. It gives you the gain and then gives you real pain.Q: Takes it away.A: Takes it away with a vengeance.Q: So, the opinion that you can throw your cheque book and get a speculative position to be bullish is foolhardy at best?A: Because, that is what most investors do. You set out and try to place a dollar assuming that this would be worth much more than what you are paying over time. But in speculation, it is exactly the opposite. The more you are going to put in is more going to be at risk. Nobody can afford to do that. There is no way, in fact, the richer you are, the more difficult it is going to be right on speculation.Q: One of the greats, which you mentioned, RK Damani, once told me that if you want to create an enemy in life, teach your son how to speculate or tell your son how to speculate.A: Socrates was a Jew and he said that all Jews are liars. So, Radhakishan Damani does it extremely well and then tells you not to. But he realises that it was extremely difficult, he realises there were points in time where he could have gone seriously wrong and history would have been different and so he is humble enough to tell you that this is not easy, do not try it.Q: Let us talk about money. You mentioned money and money is what Dalal Street is somewhat about. The great ones use money to keep score?A: Very clearly. As a matter of fact, you will see that most investors, value investors in particular, they are so innate in their nature of frugality that forget being a spend thrift, they will never be able to do things that sometimes, when they do it, they feel they are a victim of their own image and they have to do it just because the rest of society is doing it.Q: So, the better house or better car is against the grain?A: It does not matter to them at all. I do not think the bother about it. Jim Rogers used to say that I told my wife that why buy a sofa set, we buy a stock and then we will buy something bigger. These guys will think that instead of buying a house, why not rent out something and that is cheaper.Q: Never buy depreciating assets. Keep your focus on appreciating assets?A: Very clearly they would think about that even when they are buying antiques or paintings.Q: But when you have this kind of money that the market affords you, you have been though 3-4 bull-markets, what do you do with that money? If it is just a measure keeping score, what is the second step with that money?A: Sooner or later, in the Indian philosophy also, we consider that donations is an English word. It is a part of your moral obligation to give back.Q: Philanthropy?A: Now, as I said earlier, it will come naturally to you that instead of spending it on yourself, you want a higher return on investment and you feel that philanthropy gives you a higher return on investment. It will come down very naturally to you to go and give it to people who are more deserving, underprivileged and that will come very naturally to any value investor.Q: In fact it is success in that money creates a humbleness or a gratitude inside you?A: Like we talked about nature, the more they acquire, the more they bow down.Q: The more the fruits in the tree, the more it bows down.A: Exactly, they realise very clearly that many a times, they were right for different reasons, not for their smartness. The more they realise this, the more they are feeling humbled by the fact the world is acknowledging their skill while they were lucky at times. These are the guys who realise that Narayan Murthy was the horse who drew the cart and they were dogs walking beneath it. And they just made the right call of which cart to follow.Q: That is the wisdom that they have bought into.A: That is the thing that makes a difference. There are a huge flood of people on Dalal Street who think being the dog following the cart or walking under the cart think they are the ones that carried the burden of the cart.Q: I think Carl Wright was ambassador to India during the Kennedy administration who said it best that everyone thinks he is a genius in a bull market. We know better now.A: Very clearly, most people overrate their skill and underplay their luck.
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