Investing is 90% luck, 10% guts: Shankar Sharma, First Global

In a chat with ET Now, Shankar Sharma, VC & Joint MD, First Global, explains how an investor can get VC type returns in the listed market. Edited excerpts

What is your view on investing?

My view on investing is that 80-90 per cent of investing success is luck and I am also going to show you from my perspective what to my mind constitutes the rest 10%, maybe even 5%. But you need to do it to get the rest 90% to work for you.

The title of my presentation is “Four easy ways to make VC-type returns in the listed market’. Reason why I say VC-type returns in listed market is because I am not good at VC investing at all. When I hear anybody’s story, I say yaar yeh kaise ho sakta hai boss? I am a sceptical person and find it especially hard to digest start-ups. But I still want to make the VC returns. So my focus is on the listed market where you can hopefully make something similar to VC-kind of returns.

But it takes a lot of guts and conviction. It is very scary. Trust me and I do a lot of that. But above all, it requires a lot of deep thinking, lot of data. It requires a lot of understanding of psychology and trying to read the mind of market. That also takes up a reasonable part of the time engaged in picking up stocks that give you VC returns.

Here is our method: First of all, the stock must be at multi-year lows. That is our first mantra. There is one end of our thinking which is the momentum part but we look at negative momentum there where a stock has had negative momentum for years.

Second, the stock should be preferably loss or near loss making. We do not like profitable companies and we have never wavered from our method of buying trash companies at an even cheaper price.

Coming to mantra no# three, within its own industry, the weight that this stock occupies should be at the lowest ever level. The index is a game of manipulation. Overhyped companies because of high market caps make their way into it and the companies which have actually slid in terms of market cap are removed from it.

Usually, you will find that those are the tops and bottoms for most of those stocks. I remember in 1999-2000, they included four tech companies. So Zee, Infosys, Wipro and Satyam made their way into the Sensex and those were pretty much the top of the tech market for probably a decade.

It is a game of bad selection but that is the way the indexes work. So we look at it in the reverse way that we are looking at a company which has the lowest weight it has ever occupied in its own sector.

Fourth point is that, with all the first three being in place, watch for just one spark. It could be anything. It could be a launch of the iPod which was the trigger for Apple.. It could be the Tata Motors’ new JLR launch. I did not include Tata Motors, I have spoken about it many times. When I saw the cars, I thought that these cars are enough for it to get X market share from a very low base and hopefully if they get that market share, the number that I came up with was $500 million of profit.

So it was a big swing from a billion dollar loss to a $500 million profit. So you needed that one spark. I saw that spark. Management change in IndusInd Bank. Cash flow turnaround in Amazon. So stock all-time lows. There is some spark that comes through.


The other thing we will also look for which I have not mentioned is for well covered stocks; what the sell side is saying and if almost all are negative, that is usually a big positive as far as our thinking goes, so that is point number five.

Companies that have the spark

I will pick up some of the most prominent ones. Amazon was one. On February 8, 2001, we had a strong buy on Amazon at $15 and the title of the report was ‘Truth About Amazon’s Liquidity’.

The next one that we have been particularly proud of is Apple. At a price of $19, the market cap was only $6.7 billion and net of cash, the market cap was $3 billion. That was in 2001. The market cap was less than Infosys Technologies back then.

Coming to stock in India, there is IndusInd Bank. We were the first in the industry to have identified it at a price of Rs 46 which was about the book value of the company. The market cap of the company was Rs 1400 crore which is now about two quarters of profit for this company.


Amazing Amazon

In Amazon, Mary Meeker who had been Morgan Stanley’s analyst at that point was a big cheerleader for the internet sector. She released a report saying I am throwing in the towel of Amazon and when I read that I said boss idhar kuch hona wala hai dekho (something's happening here) because usually that is the bottom of the market for a particular stock.

When we did the numbers, we found that Amazon had turned free-cash positive in that very quarter when the lead analyst for that stock was saying this company is going to go bust. We did the maths and we saw that the company had made $139 million in free cash in that quarter. But for a company going bust, $139 million of free cash is telling me that somebody’s math is wrong here. So I asked my analyst that if you are not right on this, I am going to kill you. He said let us get on to a call with Amazon. So we got into a call with Jeff Bezos and his CFO and we said that do not tell us anything forward looking, just tell us, confirm this number to us that is our maths correct or not? They said yes your maths is correct and that was enough for us to know that we are on to something very big here.

The bankruptcy risk which was weighting Amazon down was gone and the beginnings of a big trade was born.

Apple has worst management in hardware industry

Apple launched the iPod and as I mentioned the market cap, net of cash was just $3 billion, less than Infosys’s. Our back of the envelope calculation showed that based on the figures of Sonywalk because iPod was nothing but Sonywalk with a hard drive, it could be a reasonable hit. So we did kind of a broad proxy analysis, came with this number. This was 2001. Steve Jobs came back after Pixar in 1996 or 1997 and the stock was at all-time lows, five years after he had come. So, Jobs was not a magician. He was struggling. Apple was in loss at that point.

When we say great managements, great is always known in hindsight. At that point, Jobs was the worst management in the entire hardware industry.

IndusInd Bank as I mentioned was trading at near book value of the private sector banks. It was by far the cheapest. It met the test and then, of course, they had management change. Risk reward was terrific at Rs 46, the book value was I think Rs 40 and with a new management, they cannot screw up at all compared to what the previous management had done.

So even if they do a little bit of a good thing, and he sector was attractive. It still is because it is a limited competition sector, banking licenses are not doled out like broking licenses. Within the overall goods sector, you found a good stock at a amazingly cheap valuation. So it had the making of a good trade. In hindsight, it looks terrific that all these stocks are up 20, 50, 100, 150 times and we are all looking good.
The point is what is this method telling us what looks good now and remember as I said in the beginning, you need a lot of luck. Also, you need a lot of guts .

Why Twitter is great

The stock I am going to tell you now is Twitter, that meets the test of what to our mind, to my mind looks like a great bet and I will give you broadly what our line of thinking is. Net market cap, actually the stock had fallen 10% since I wrote this because Salesforce said that they are not going to acquire it. It is now about $12 billion market cap with $3 billion of cash, so about $9 billion of net market cap. It has very little debt. The market cap is less than Flipkart’s market cap. EBITDA is $600 million, runs at about 25% EBITDA which is terrific by any standards. Free cash is about $600 to $700 million every year, so it is not a loss making, cash burning tech company.

Twitter is a solid company with a solid EBITDA and a solid free cash flow. Below EBITDA, they have only depreciation and stock compensational losses. So actually, it shows a loss at the bottom line but that is basically some element of depreciation and a big element of the stock options they have granted which is being expensed out. So in reality, they are a profitable company. They are not a basket case company by any standards.

But the stock is near all-time lows, from the time it listed.despite being profitable by any normal method. Again, I will give you one example of a comparable – Snapchat is doing an IPO $25 billion valuation, probably in March, market cap is $25 billion versus $10 billion for Twitter;, 15 crore subscribers for Snapchat versus 35 crore for Twitter, $300 million in revenue for Snapchat versus nearly $3 billion for Twitter. So revenue is 10 times of Snapchat, the number of subscribers is just two times. That tells you how much more Twitter milks its subscribers than Snapchat.

Snapchat is very American centric, limited sphere of influence while Twitter has a vast sphere of influence. It is a global play. Many things get broken on Twitter, faster than any other media platform in the world and with a 2019 elections coming up in India, US elections coming up shortly, sharp increase in extreme right wing politics across the world, we can see that in the US, India, Europe, extreme politics coming in,. Centrist politics is out. Wherever it is right wing, that is replaced by left and wherever it is left wing, being replaced by right. People want the incumbent out. When you have environment like that, and I see that continuing for a long time worldwide, Twitter is the only place where you can go and attack your opponents. Where else can you do that? Not on Facebook. Trolling is great. It will add subscribers.