Many people view processes as an initial input, but I see them as an outcome resulting from a deep understanding of your investment framework. This outcome is shaped by recognising your circle of competence, your investment time horizon, and, consequently, your risk-reward profile.
Developing and adhering to a process serves as a defense against two significant pitfalls in investing.
Firstly, it keeps you aware of the temptation to venture outside your circle of competence, preventing you from succumbing to the allure of "something new." For example, my investment preference leans toward tangible manufacturers which are ideal candidates to be great reinvestment compounders. If I suddenly encounter an opportunity involving asset monetisation (such as Company 'x' planning to monetise prime real estate), I should recognise that it doesn't align with my established process. If I still wish to invest in it, I must invest the effort to understand the intricacies of such transactions. A documented process helps you acknowledge what you don't know.
Secondly, it shields you from the fear of missing out (FOMO), particularly in the kinds of markets we've witnessed this fiscal year, where the small-cap index has surged nearly 40% from its March lows, and individual thematic stocks have multiplied in value. It's easy to be lured into buying hastily due to FOMO but having a well-defined process in place ensures that you don't make hasty mistakes in your eagerness to participate.
Consider, for instance, a company boasting of extravagant growth projections despite already operating at close to 100% capacity utilisation. With no addition visible in a gross block on the balance sheet and no immediate plans for capex, where would this growth come from? In such cases, a simple set of questions in a checklist can aid in detecting substantial disparities between the narrative and actual reality. Another scenario to examine involves smaller firms promising rapid 4-5x growth opportunities, particularly in more talked about sectors such as defense and railways. However, there appears to be minimal digging on how these companies intend to secure the necessary working capital to support this purported growth.
Establishing a structured approach is essential to prevent impulsive investments without conducting proper due diligence on the asset. It's not about moving slowly, but rather about having a set of tools to prevent getting carried away during market booms. During the development of our own process at Tamohara, we included the concept of a "pre-mortem" in our toolkit. This involves envisioning the failure or demise of an investment and thoroughly analysing all conceivable reasons for this outcome before it actually happens.
Many long-term investors inevitably form emotional connections to their investments. However, the pre-mortem approach enables us to maintain a level of objectivity regarding our investment choices. It allows us to create a structured plan of action in the event of any adverse developments within the companies we've invested in. This prepared playbook prevents us from making emotionally driven decisions, whether fueled by fear or undue attachment, and instead guides us toward rational choices. Our investment framework typically involves assessing companies over a 3-4-year horizon, during which we may develop strong attachments to our positions. Recognising this, we've incorporated pre-mortem analysis into our toolkit as a valuable output.
Market fluctuations occur rapidly, so it's crucial to have your toolkit prepared to capitalise on them rather than being overwhelmed. At Tamohara, we've readied ours, complete with our exclusive checklist, pre-mortem analysis, scoring system, and more. You should also have a toolkit tailored to your investment philosophy.
Harini Dedhia is Portfolio Manager and Head of Research, Tamohara