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PJ Pahygiannis
PJ Pahygiannis
Articles (149) 

23 Questions With Bakul Lalla

'I have used up nine punches of my lifetime 20-hole investing punch card'

December 02, 2016 | About:

1. How and why did you get started investing? What is your background?

I started investing for savings to maintain future purchasing power against my personal lifestyle inflation rate. Savings are primarily earmarked for future consumption such as retirement and college education. My background comes from a family of farmers migrating from the Asian continent to the African continent, and finally to the United States. Formal background is in electrical and computer engineering.

2. Describe your investing strategy and portfolio organization. What valuation methods do you use? Where do you get your investing ideas from?

My investing strategy is to identify high free cash flow generators with low capital intensity for inclusion in a concentrated portfolio. Currently, my portfolio consists of nine companies. In Warren Buffett (Trades, Portfolio) parlance, I have used up nine punches of my lifetime 20-hole investing punch card. Discounted cash flow is my primary valuation method. My investing ideas come from SEC filings such as 8Ks, 10Qs, 10Ks, DEF14As, 13Ds, 13Gs, etc. and the 52-week low list. Also, news events pertaining to special situations in the form of spinoffs definitely piques my interest.

3. What drew you to that specific strategy? If you only had 3 valuation metrics what would they be?

Staying within my circle of competence to focus on my best ideas drew me to this strategy. A side benefit is low portfolio turnover with low transaction cost. SEC filings such as 8Ks, 13Ds, 13Gs, etc. and looking at 52-week low lists at the appropriate time allows for low activity with the possibility of finding hidden gems in plain sight when they do occur. Valuation metrics that I use are discounted cash flow (DCF) , return on equity (ROE) of 15%-plus and cash return on invested capital (CROIC) of 10%-plus.

4. What books or other investors changed the way you think, inspired you or mentored you? What is the most important lesson learned from them? What investors do you follow today?

I am inspired by Benjamin Graham, Philip Fisher, Warren Buffett, Charlie Munger (Trades, Portfolio), Martin Whitman (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio) and many more. Primary lesson for me is to have the correct temperament while preserving and growing capital to maintain purchasing power.

5. How long will you hold a stock and why? How long does it take to know if you are right or wrong on a stock?

I will hold my portfolio companies as long as the ROE and CROIC requirements are met. It usually takes a few quarters to observe deterioration of fundamentals, evidenced by a downtrend in financial ratios of interest. With each new quarter, new information is presented via 10Q. If a 12-month trailing basis trends of margins and or balance sheet structure begins to deteriorate, then a red flag is up with portfolio position earmarked as “available for cash.” However, if my investment thesis, business model understanding or valuation proves to be wrong, I will exit the portfolio holding.

6. How has your investing approach changed over the years?

The number of portfolio holdings was reduced over the years as I got better in my investment process to focus on key ideas. This approach may not be suited for everybody as the portfolio needle gyrates in either direction on any given day.

7. Name some of the things that you do or believe that other investors do not.

When the bullish percent indicators (BPI) of indexes such as New York Stock Exchange, Nasdaq, S&P 100, S&P 500 and Dow 30 trend below 30%, I get busy looking at the 52-week low lists to identify quality companies trading at price value discrepancies. For your information, October 2008 and March 2009 were very busy months based on this BPI criteria. Other than that, my portfolio activity is in slumber mode and I am reading books and daily news most of the time.

8. What are some of your favorite companies, brands or even CEOs? What do you think are some of the most well-run companies? How do you judge the quality of the management?

Some of my favorite and well-run companies are Factset (NYSE:FDS), Total System Services (NYSE:TSS), S&P Global Inc. (NYSE:SPGI) and PayPal Holdings Inc. (NASDAQ:PYPL). Quality of management is judged by how well management can execute capital allocation decisions envisioned by the CEO. Disclosure: I own the companies mentioned above.

9. Do you use any stock screeners? What are some efficient methods to find undervalued businesses apart from screeners?

I do not use any stock screeners other than looking at the 52-week low lists and SEC filings to find undervalued businesses.

10. Name some of the traits that a company must have for you to invest in, such as dividends. What does a high-quality company look like to you and what does a bad investment look like? Talk about what the ideal company to invest in would look like, even if it does not exist.

Some of the traits a company must have are strong shareholder-oriented management, the CEO having an excellent understanding of capital allocation and who is explicit in stating the capital allocation strategy, and management that is able to execute said capital allocation strategy.

11. What kind of checklist or homework do you utilize when investing? Do you have a specific approach, structure, process that you use? Or do you have any hard-cut rules?

Here’s my simple checklist:

  1. Gross Margin: above 50% is good, above 70% is better.
  2. Operating Margin: above 15% is good, above 20% is better.
  3. Net Margin: greater than 10% is good, above 15% is better.
  4. Return on Equity (ROE): above 15% is good, above 20% is better.
  5. Cash Return on Invested Capital (CROIC): above 10% is good, above 12% is better.
  6. CapEx/Sales: lower than 10%, lower than 5% is better.
  7. Free Cash Flow/Sales: greater than 10% is good, above 15% is better.
  8. Free Cash Flow/Net Income: close to 1.00 or higher.
  9. Long Term Debt/Assets: under 30%, under 15% is better.
  10. PP&E/Total Assets: Under 30% is good, under 15% is better.
  11. Goodwill/Total Assets: Under 20% is good, under 30% is better.

12. Before making an investment, what kind of research do you do and where do you go for the information? Do you talk to management?

I do not talk to any management. If I cannot find the information I am looking for in disclosure documents such as 10Qs, 10Ks or annual reports, then it is a pass for me.

13. How do you go about valuing a stock and how do you decide how you are going to value a specific stock? When is cheap not cheap?

For high free cash flow generators, estimate the growth of expected future free cash flows and run it through a DCF model. If the company is trading at a 35% discount to my DCF estimation of valuation, then I would be interested. Cheap would be when the discount to valuation is 50%. Otherwise, it is not cheap.

14. What kind of bargains are you finding in this market? Do you have any favorite sector or avoid certain areas, and why?

No bargains at this time. Bargains are rare unless there are quality companies that are fallen angels due to a temporary setback while the institutionals are exiting on a short-term basis. But these fallen angels might be good for long-term commitment. I do not have any favorite sectors but I have a bias towards companies that are not capital intensive.

15. How do you feel about the market today? Do you see it as overvalued? What concerns you the most?

I have a tendency to ignore the market due to bottom-up analysis style. But it is a good idea to know where the indexes are trading. To this end, I use the bullish percent indicators (BPI) as a barometer to indicate when to get busy looking at the 52-week low list. Currently, BPI for indexes are in the 60% and above range, that is pretty high. So, bargains or reasonable prices are in short supply. In addition, PE multiples of indexes are not at nose bleed levels, so I would not classify the indexes to be overvalued. I am not concerned about anything.

16. What are some books that you are reading now? What is the most important lesson learned from your favorite one?

I am rereading the unabridged version of Charles Mackay’s "Extraordinary Popular Delusions and Madness of Crowds." Most important lesson is to understand crowd psychology and keep an even keel regarding one’s own temperament. Other books I am reading are "Complexity" by M. Mitchel Waldrop, "Intuition" by David G. Myers, "Grit: The Power of Passion and Perseverance" by Angela Duckworth and "Consilience" by Edward Wilson. In odd years, I usually reread chapters eight and 20 of "Intelligent Investor" by Ben Graham and "Poor Charlie’s Almanack" by Charles Munger.

17. Any advice to a new value investor? What should they know and what habits should they develop before they start?

Understand how a company creates cash and generates shareholder value. Read a lot about different investing strategies and identify one strategy that will be in sync with your temperament. Then use this strategy through thick and thin. Reference: "Creating Shareholder Value" by Alfred Rappaport.

18. What are your some of your favorite value investing resources or tools? Are there any investors that you piggyback or coattail?

My main resource is SEC filings, and I do not piggyback or coattail anyone.

19. Describe some of the biggest mistakes you have made value investing. What are your three worst investments that burned you? What did you learn and how do you avoid those mistakes today?

My biggest mistake in the early years was not understanding how to read and interpret financial statements. I had one that burned me due to financial shenanigans or outright fraud that was unavoidable. Also, I had another portfolio position that I thought would grow organically. Over time, the company changed its strategy to be a serial acquirer and the subsequent ROE and CROIC downtrend caused me to exit the position. Investing time to learn about financial statements was taken care of but the “black swan” event of fraud is unavoidable.

20. How do you manage the mental aspect of investing when it comes to the ups, downs, crashes, corrections and fluctuations?

I always welcome downswings since that is the time I am hunting for bargains. Crashes, corrections and fluctuations do provide opportunities that are ephemeral in nature; regardless, opportunities to pounce on an infrequent bargain is always welcomed.

21. How does one avoid blowups in value investing?

I am not sure about how to avoid blowups, but companies in my portfolio must have strong balance sheets. What I do know is that incorrect valuation due to misunderstanding of a business model can get one into trouble.

22. If you are willing to share, what companies do you currently own and why? How have the last five to ten years been for you investing wise compared to the indexes?

I own nine companies in my portfolio. Some of my companies are already mentioned above. These companies have ROE of 15%-plus and CROIC of 10%-plus. I do not compare my returns to any indexes. Anyway, my five-year portfolio CAGR is 14.04%. My 10-year portfolio CAGR is 13.6%. My 20-year portfolio CAGR is 10.6%. From the March 2009 low to Nov. 30, my portfolio CAGR is 20.2%. These returns definitely have an element of luck more than my investment process and temperament.

23. Here is a fun one - What stock would Warren Buffett (Trades, Portfolio) or Benjamin Graham buy today if he were you?

I have no clue. The last time I checked, Oracle of Omaha had about 14% of Berkshire total assets in cash and cash equivalents to the tune of $84.4 billion (and counting!). That is a pretty large wad of cash to deploy based on his selection criteria to acquire companies.

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