Killing your own idea!

WHAT AN IDEA, SIRJEE!!!

Yes, this post is about investing. I am not going to talk about how great Abhishek Bacchan was in Yuva or how baaaaad he was in Tera Jadoo Chal Gaya.. (Didnt see the movie, the trailers were enough to scare me off!)

Anyway, lets come back to the point before I start talking about Drona and frustrate you all!!  :-)

"Killing your own idea" is a concept that can save an investor's "synonym for donkey" time and again. Imho, any and every investor should understand this concept and try to apply it as much as possible. Lets see what it is all about...

The concept

The concept is pretty simple and common sensical. Basically try finding fault with any stock idea that you get. If you think something is good to invest in, try and find out as many reasons as you can, to come to a conclusion that it is not good to invest in. Try and kill your own idea as much as possible.

The process

The process is much more difficult than the concept. e.g. If someone asked you to describe yourself, how many negative points will you put forth? Similarly, when we like a particular investment idea, our mind automatically and subconsciously starts weeding out or justifying negative points associated with the idea. To counter this is extremely difficult, yet extremely important. (I also am not fully there yet). The first thing to do is to mentally disconnect yourself from the stock idea and look at it afresh. Be as skeptical and negative as possible. Best thing to do is, try and write down, point-wise, why that particular idea would be a terrible investment. You will, of course, be in denial first and will try to avoid and justify the worst things about the idea. But its a process and you will surely get there slowly. In the mean-time, what you can do is, ask a friend of yours, who hasnt seen the stock, to point out bad points about it. That should surely help.

The utility

Has this ever happened to you: you bought a stock after studying it properly. Few months down the line, some event unfolded which hit the company and the price sank. And you thought ' Oooo why didnt I think of that???' This happens to all of us a lot of times. We miss out some key point or factor, which seems obvious in hindsight a few months later. This happens because we have not taken a 360-degree view, we have not considered the negatives, we have not killed our own idea..

An example...

One idea I mercilessly killed recently was that of Gujarat Reclaim. Now, this idea seems actionable to a lot of respectable investors I know. But to each his own!
A bit about Gujarat Reclaim:

• Essentially, the company recycles waste rubber. With rubber prices hitting the roof, the prospects of the company seem bright. Its the largest company in its sector in India.
• I really liked the management of the company. They are very conservative, they have grown well, the books seem clean and the way the management talks makes me very comfortable. They also know their business and have been working continuously on technology.
• Gujarat Reclaim has established numerous collection centers and agents, which supply the necessary waste rubber (essentially waste tyres) for recycling. (can be thought of as an entry barrier)
• The company has also announced an expansion plan recently. All details can be found in the annual report.
• The valuations are not very expensive. Market cap of about Rs.125 cr, 10 times trailing, 2% dividend yield, manageable debt on books, 18%+ operating margin.

So what killed the idea?

The above table shows the rupees per ton cost of rubber scrap and chemicals (raw materials) and the per ton selling price of reclaimed rubber (finished product) for various years. The last column shows the raw mat consumption as % of sales. It can be seen that while the rubber scrap prices have gone up 70% since 2005, the selling price of reclaimed rubber has gone up only 40%. Meaning, that the company has not been able to pass on hikes in raw material prices. There seems to be no pricing power. So will this situation worsen as rubber prices go up? (Since scrap rubber prices also go up). So, will this company benefit due to increase in rubber prices or will it be hit because of the same? Something to think about! (Btw, for the December 10 quarter, raw mat consumption to sales stood at 46.67%.)

I really like the company, but the valuations do not seem to reflect the above. They are not 'sitter' valuations. I will wait for the stock to correct, if at all, and then take a decent position in the same.

Cheers and happy investing!!