Improving Investment odds by application of ‘Rational Analysis’ framework

Contributed by: Mandar Chapekar,CFA

Indian Association of Investment Professionals (IAIP) Pune hosted a session on “Improving Investment odds by application of ‘Rational Analysis’ framework” by Vikas Biyani on 15^th October 2016. Vikas heads Client Advisory team at Multi-Act. He has 13+ years of experience in the field of equity research, capital markets and portfolio advisory to high net-worth and institutional clients.  He has been associated with Multi-Act since 2003. He has earned his Chartered Accountancy qualification from ICAI in 2003. He is also pursuing his CFA (L-3 Candidate).

The Crux of the Topic was how to use Global Rational Analysis Framework (GRAF) which combines Fundamental, Technical, Quantitative and Behavior analysis and leads to a process driven approach to Investment Decisions by making it simple and easy. It is aimed to improve the investment expectancy by adding conviction from various streams of analysis rather than relying on only one.

Vikas initially started off with discussion on why investment managers find it difficult to consistently outperform their peers and behavioral biases they face viz.

• Use same Research, same Earnings Models. Indirectly subscribing to ‘group think’.
• Focus on upside (reward).ignoring downside (risk).
• Biased view on stocks that have consistently performed
• Past performance of stock gets extrapolated into future fundamentals. Mean reversion is ignored.
• Bias towards Structural shifts

Vikas stressed upon the point that Investment returns are driven by arithmetic and not by stories.

Vikas explained components of GRAF viz. Fundamental, Technical, Quantitative and Behavior analysis and how the blend of four components:

• Helps in objective analysis of companies
• Enables structured investment decision making
• Limits inherent behavioral biases involved

Vikas moved on to discuss three critical questions Investors need to answer in investment decision making viz.

• Is it a “Good company”?
• Is the“Valuation”right?
• Is the“Timing”right?

The question “Is it a Good Company?”  is answered by Fundamental Analysis which mainly involves analyzing Quality of Numbers and Quality of business .

Analyzing Quality of Numbers involves assessing Quality of Earnings , Capital allocation, Du-Pont Analysis, Long term Returns, Cash Generation , Capital Structure , Industry Nature and Corporate Governance

Analyzing Quality of Business involves identifying whether business has Moat or Not.Sources of Moat are viz. Network Effect, Switching cost, Economies of Scale, Intangibles.Characteristics of No Moat Business are viz.  Cost of capital Business , No barriers to Entry and Low Cash Generation

Regarding Valuations, Vikas touch based upon 3TV approach by Prof. Bruce Greenwald.He discussed about Two Bucket approach wherein Moat Businesses are valued based on Income Statement Approach i.e. DCF, No Growth Value, Historical Module etc. On other hand No Moat businesses are valued on Balance Sheet basis i.e. Replacement cost of Assets and Adjusted Book Value

He stressed upon using range of valuation i.e. pessimistic, optimistic and fair valuation instead of using single target price approach. Also he mentioned about using “ Margin of Safety” Principle in Valuations

He also emphasized on different valuation models are required to be used for different business models “One Size doesn’t fit all”

Vikas elaborated on Quality of Earnings in detail and why it is important to have clean set of numbers and right valuation model

About the Timing, Vikas stated importance of using Technical Momentum Indicators and Earning Momentum Indicators as these indicators help to

• Identify Market Headwinds or Tailwinds
• Improve Efficiency of Capital
• Improve probability of taking profitable decision

He mentioned that these tools are required to be used with an overlay of Fundamental Valuation and not in Isolation

In Quantitative Analysis, Vikas discussed about Mean Reversion, Standard deviations, Regressions Analysis as tools to identify short term euphoria /pessimism in the market and exploiting those situations to for taking contrarian Investment decisions.

In Behavioral Analysis, Vikas explained Typical Investors’ behavior and few biases viz. Herd Behavior, Hindsight bias , Comfort Bias through very good comic cartoons

He provided checklist to mitigate behavioral biases

In conclusion Vikas mentioned that Mr. Market is a zero sum game. Investing is interplay of assumptions, probabilities, uncertainties, noise and emotions.  Information edge is almost non-existent. With Process, discipline and rules one can attain behavioral edge. By following rational approach and with set of tools, one can make investing simple and easy and thus can turn investing odds in favor.

All in all it was very good informative and educative session full of real life illustrations which would help attendees to take Rational Investment Decisions.

–MC