What i look for in "owning forever businesses".

The Businesses i want to concentrate & own forever.

Why Buffett's quote of “my favorite holding period is forever” is the most misunderstood quote? because most people nitpick on his churn rate etc.

In principle there should be only one type of investing, buying assets that you going to hold till the decision (liquidation) day or theoretically forever if the business keeps on growing. Your sole goal is to make money through cashflows from the business.

The moment you as an investor think, you will be able to sell it to someone else at a higher price tomorrow, I think logically you are not investing but trading or playing an arbitrage game. There is nothing wrong with it but we should not confuse our actions of trading (arbitrage) with investing.

Now the obvious question is what are investable (owning forever or till decision day) businesses then?

All businesses are investable businesses, it is up to us how good we are in assessing its cash flows till decision day or forever, Even the declining cashflow newspaper businesses are investable businesses but why focus on them when markets offer you the opportunity to own growing cashflow forever businesses.

A thought experiment, what should be the intrinsic value of a business growing Rs 100Cr of net profits by 25% cagr for 10 years & going bankrupt in the 11th year?

It’s a trick question almost everyone comes up with some intrinsic value, but if you think practically every business needs capital to grow so, it’s practical to assume all the 10 years of cashflows reinvested into the business and on the 11th year your equity is wiped out.

Saying I’ll own this till the 9th year and give it to somebody in the 10th year works only if the other person doesn’t have the information you have & is foolish to believe in today’s information age you are the only holder of information (if it has reached you, it has possibly reached many others) and moreover, it’s not worth making money by playing these unethical games (passing on the bag of turd - or flipping worthless NFTs).

The intrinsic value of this business should be 0 (but if you leave it to markets it will make Rs10,000 Cr net profit on 10th year could be valued >1 lac cr by markets on 10th year and 0 on 11th year) & because very few declining businesses in the world die by giving out dividends every year and because most of the businesses will die over time, we can conclude the intrinsic value of most the businesses is 0 except for the very few growing cashflow forever businesses.

Do growing cash flows forever businesses exist? How can we identify them?

There is no moat that is permanent enough except the cultural ingenuity of the company, the culture which is evolving over time and culture is the hardest thing to copy, specifically impossible to copy if it keeps on evolving over time.

As an investor today my sole goal is to understand this very culture and the very DNA of companies where we can say with a fair degree of confidence that it is growing cashflows forever businesses and we want to buy them at a fair price (generally when everyone is bearish about them.)

In investing guessing the future right is not enough if it is already priced in, I often see in fintweet and youtube videos all the focus goes into analyzing financials let’s say for banks typically you will see people talking about - ROA, ROE, many other ratios, asset mix, liability mix, past growth rates, everything hunky-dory but if you get the lending culture of the bank/ nbfc wrong you got it all wrong and if you get the lending culture of the bank/nbfc right and ignore analyzing - “ROA, ROE, many other ratios, asset mix, liability mix, past growth rates, everything hunky-dory” 95% chances are you will end up making money overtime at least you will not lose it.

Why many investors got the yes bank wrong? because everyone invested based on rear-view mirror analysis - “ROA, ROE, many other ratios, Industry analysis, peer comparison, asset mix, liability mix, past growth rates (25% CAGR), everything hunky-dory & hence 3x price to book“ whereas there were early indicators that lending culture of yes bank wasn’t good enough & same is true with DHFL, Indiabulls. You can apply the same for CARE ratings its the only rating company of the 3 was ready to rate anyone & whereas CRISIL beyond profit-making backed out from rating fat customer IL&FS when IL&FS didn’t agree to CRISIL’s assessment (IL&FS used to keep their rating agencies happy by giving out fat checks & other perks). There was a time when any microcap I used to find squeamish was rated by CARE, despite wonderful “ROA, ROE, many other ratios, Industry analysis, Peer comparison, past growth rates” in fact during its heydays CARE was gaining market share from CRISIL due to its lower cost of rating & hence lower fee (you know what salary CARE pays vs CRISIL) in SME segment which is the product CRISIL innovated but despite all that I was dead wrong in CARE Why? because focusing on things that don’t really matter “ROA, ROE, many other ratios, Industry analysis, Peer comparison, past growth rates, gaining market share in SME, etc” and I ignored the thing which matters a lot “Culture” because heydays don’t last forever and when bad time comes all of this go for a toss very quickly “ROA, ROE, many other ratios, Industry analysis, Peer comparison, past growth rates, etc”.

Even today if you apply the same framework (“ROA, ROE, many other ratios, Industry analysis, Peer comparison, asset mix, liability mix, past growth rates, everything hunky-dory”) while analyzing AU small finance bank - you can’t resist betting on it but I won’t until I understand what’s the undercurrent driving this growth, what are they doing differently than other helping them gain market share, how they came out unscratched from COVID and what’s their lending culture really? For some reason they never talk about the culture, maybe its the secret sauce they want to protect but generally, people who have figured it out openly talk about it may be it Warren Buffett, Ray Dalio, Elon Musk, Jeff Bezos, No Rules Rules a book on Netflix culture by Reed Hastings, etc and until you don’t have the answer to these questions, it’s futile even looking at ROE, its simply meaningless number for us whatever it may be.

I don’t really understand the fetish of the Value Investing community on “ROA, ROE, many other ratios, Industry analysis, Peer comparison, asset mix, liability mix, past growth rates etc”. It’s like asking Elon why tesla is great? and he is saying because “ROA, ROE, many other ratios, Industry analysis, Peer comparison, past growth rates, etc are wonderful”. These are by-products of the great culture & principle on which the company operates.

On the other hand, if you take Bandhan bank for instance unlike AU small finance bank you can learn a great many things about their culture too from various sources like by reading the book “Bandhan: The Making of a Bank”, simply listening to Mr. Chandra Shekhar Ghosh interviews or if possible taking to banks customers & employes, They were in fact the OG of microfinance in India and RBI granted them full fledge banking license (not small finance bank license) after doing the maximum scrutiny possible and credit goes to Entrepreneurial spirit of Mr. Ghosh who convinced RBI to give him banking license by asking right questions to regulators persistently “Why Bandhan should not be a bank ?” why I can’t bring down the cost of lending to microfinance borrower? if you do so I’ll bring it down by 400 bps and like Amul (which is another increasing cashflow forever business due to its unique culture) Bandhan's goal has been to reduce the lending rate for its borrower, which actually gives more wings to borrowers to borrow more & grow more (win-win).

For me gaining these insights is 95% of investing, the rest 4.9% is figuring out what’s priced in (consensus view) and why and what are my views vs the consensus view and the rest 0.1% of my time goes on looking at (“Industry analysis, ROA, ROE, many other ratios, asset mix, liability mix, past growth rates”).

Many investors poured into Bandhan at 5 to 9x book value post IPO “ROA, ROE, many other ratios, Industry analysis, Peer comparison, asset mix, liability mix, extrapolating past growth rates” despite they got the culture right they were pricing in something which was unlikely to unfold in future and the best day to buy this bank was when they report their worst-ever quarterly loss of Rs -3000 Cr because suddenly all of it “ROA, ROE, many other ratios, Industry analysis, Peer comparison, past growth rates” went for the toss and these rearview mirror static analysis investors dumped it at a value which was pricing in most pessimistic future.

Another great company due to its miles superior culture in the industry dumped by the investor during the historical migrant labor crisis, in fact During Oct - Nov of 2020 nifty had fully recovered and L&T was still hovering around Rs 800- 900 range. The narrative was migrant labors will never return, all projects going to get stuck or delayed, company going to post record losses and nothing was fitting into the framework - “ROA, ROE, many other ratios, Industry analysis, Peer comparison, extrapolating past growth rates, etc” and it turned out to be the best time to buy this company because all migrant labors came back, to kick start economy gov push more infra projects ever before, company IT subsidiaries got record inflow of orders due to pandemic is driven digital wave around the world and they ended the year by posting record profits (helped by divestment).

Unlike AU small finance bank you can learn a great deal about 70 years old company culture by reading books & articles about it, through annual reports, earning calls and listening to AM Niak & other management interviews, etc.

In the late 1950s, Larsen & Toubro (L&T) founded in India by two Danish engineer ex-pats two decades earlier (for manufacturing daily equipment), was contracted to construct the bridge for the Academy Award-winning film The Bridge on the River Kwai. The story goes that the crew didn’t know the bridge was supposed to be leveled in the movie’s climactic scene; it withstood the first blast and had to be reengineered to be destroyed. Today, this very same company has established itself as an infrastructure leader with high-profile projects such as Gujarat’s Statue of Unity, which, at 182 meters, world’s tallest statue; the Dhubri-Phulbari bridge over the Brahmaputra River, which, at 19 kilometers, will be India’s longest bridge when completed; and a major section of the proposed high-speed rail corridor between Mumbai and Ahmedabad, the first of its kind in India. The company is also building one of the world’s largest solar photovoltaic installations—with a capacity of 1.5 gigawatts—in Riyadh, Saudi Arabia.

Today L&T operates in three main areas. EPC infrastructure and projects business is the largest pie, and makes up about 70% of the company; it is followed by manufacturing, which includes precision engineering and defense, and makes up 10% of the company; and then a services business, at 15%, that includes three IT companies as well as financial services. The remaining businesses, including Hyderabad Metro and Nabha Power, make up the last 5% (which they want to divest off). In times to come, their EPC projects will continue to grow, while IT services will grow faster. Manufacturing should remain more or less at the same level but has lot of potential if government opens up defence manufacturing to private players, while some of the new initiatives will also go up by 5% or so like IT was 15 years go.

One of the critical part of their culture is (like amazon) they keep spawing new businesses (look where they have come from darily equipment manufacturing company in 1930s to today) and the sole purpose these businesses were created internally to solve their internal problems.

Like IT businesses were started in early 2000 to just stop record employee attrition, During IT boom record number of their engineers where leaving to join Infosys of the world to arrest this L&T created its own IT branch (None of the infra / non IT company did this), As AM NIAK puts it, if my engineers want to work in IT i have to give them the option.

Their Financial services business started because they found their sub contractors, suppliers needed credit and no traditional NBFC or bank ready to serve them.

L&T technology services created internally to give something extra (Automation / Engineering solutions) to its EPC customer apart from just building factories for them.

During pandemic to solve internal problems they created two new businesses -

Why company stayed ahead of innovation curve (survived since 1930 long after promoters were gone) is because of the culture of constantly assessing how they can use today’s technology to give somthing extra to their customers or improve their own productivity.

Listen from the current CEO himself how they stay ahead of the industry - (something AU small finance bank never talks about)

There are endless examples like how Larsen & Toubro (L&T) had played a critical role in building India's first indigenous nuclear-powered submarine, INS Arihant and they were the first to build house using 3D printing technology in India.

Point is if you look at the company from the narrow static lense of “ROA , ROE, many other ratios,Industry analysis, Peer comparison, extrapolating past growth rates, PE, PB” you will miss out the forest for the trees. L&T is increasing cashflow forever business but it’s good investment only when everyone think that migrant labors will not come back and then goal is to hold these types of businesses forever.

Probably why Buffett quoted “my favorite holding period is forever”.

Thanks,

Dhruva Pandey 

Email : dhruva.pandey@outlook.com

Twitter : https://twitter.com/Dhruvapandey