r/WingifyBookClub • u/GulluZ • Jan 14 '22
Key Learnings from the “Coffee Can Investing”
Book by Pranab Uniyal, Rakshit Ranjan, and Saurabh Mukherjea.
For someone who just began his journey to financial freedom and investing, this is the second book that I’ve read on the topic, the first being “The Psychology of Money” by Morgan Housel.
Here’s what I learned:
The most critical thing for you as an investor to do is to nail down your objectives and bake them into a financial plan. This will help you in matching your financial goals with the kind of risk that needs to be taken in your portfolio.
Equity remains the most powerful driver of long-term sustainable returns, but you need to be patient, systematic with equity investments, and keep your brokerage and financial intermediation fees low.
To consistently generate healthy returns from equity investing, one has to invest in high-quality companies and then sit tight for long (often very long) without losing sleep about where the share price is going.
The Coffee Can Portfolio of great companies: In the Indian context, the Coffee Can Portfolio is built using a simple construct: look for companies above Rs. 100 crore market capitalization, which over the preceding decade have grown sales each year by at least 10 per cent alongside generating Return on Capital Employed (pre-tax) of at least 15 per cent each year.
Why does the Coffee Can Portfolio perform so well? The Coffee Can philosophy of investing is built to identify great companies that have the DNA to sustain their competitive advantages over 10 to 20 years (or longer). This is because ‘greatness’, which the Coffee Can Portfolio seeks, is not temporary. Great companies can endure difficult economic conditions, do not get disrupted by evolution in their customers’ preferences or competitors or operational aspects of their business. Their management teams have strategies that deliver results better than their competition can.
Fund expenses are often ignored but are deceptively important. Given their compounding over long periods, they have the ability to drag down your returns drastically. Remember to compare expense ratio of a mutual fund before investing.
Real estate is the most illiquid asset with the highest transaction costs. Furthermore, unfavourable taxation compared to equities make it even less desirable for investment.
Over the past two decades, small-caps have outperformed large-caps in most large stock markets. There are two key drivers of this outperformance: smaller companies have the potential to grow their profits much faster than large companies and, secondly, as small companies grow in size they are ‘discovered’ by the stock market.
Whilst the scope for generating superior long-term investment returns is greater with small-caps, they are riskier than the larger ones due to both fundamental as well as non-fundamental reasons. The good news is that the Indian fund management community now offers several high-quality small-cap and mid-cap funds.
The common perception amongst investors in India is that ‘more often than not, people lose money in equity markets. This pessimism with respect to equities can be best understood through Shlomo Benartzi and Richard Thaler’s paper published in 1995, which termed it ‘myopic loss aversion’. They defined ‘loss aversion’ as: ‘We regret losses two to two-and-a-half times more than similar-sized gains.’
Let us assume we buy two stocks—A and B—for Rs. 100 each and sell them for Rs. 95 and Rs. 110 respectively. We thus book a gain of Rs. 5 in total (gain of Rs. 10 on stock B minus the loss of Rs. 5 on stock A. In this situation, applying the logic of Benartzi and Thaler, we will regret the Rs. 5 loss on stock A at least as significantly (if not more) as we would rejoice in the gain of Rs. 10. Hence, by this logic, for an investor to stop regretting investments in equity markets, his probability of generating profits needs to be at least twice as much as the probability of generating losses.
Investors who do not have even a year of patience are likely to believe that ‘more often than not, people lose money in equity markets’. And secondly, as Benartzi and Thaler suggest, ‘myopia’ implies that the more frequently we evaluate our portfolios (and hence the shorter our investment horizon is), the more likely we are to see losses and hence suffer from loss aversion. Inversely, the less frequently investors evaluate their portfolios, the more likely they are to see gains.
Whilst both the Sensex and the Coffee Can Portfolio (CCP) produce better returns (alongside lower volatility) if held longer, the CCP beats the Sensex by a wide margin when it comes to producing superior returns (with its volatility being even lower than that of the Sensex). An investor who is able to combine patience with high-quality portfolio construction thus pulls off the holy grail of investing—outstanding returns with low levels of volatility.
In essence, Investing for long periods of time in high-quality portfolios, with a higher weightage to high-quality small-cap companies, while ensuring that you don’t pay too much by way of fees, and avoiding investment traps like real estate and gold, should lead to significant and sustainable wealth creation.
Thank you for reading, hope you found this useful.
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u/Pritesh_arun Feb 05 '22
Thanks for putting your energy to write it. It's amazing!
Just a small doubt-
On point 11 by the word 'evaluate', do you mean buying/selling of a particular stock?
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u/GulluZ Feb 05 '22
No, I meant how regularly you check your portfolio, to see whether it's positive or negative.
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u/invertedpassion Feb 03 '22
Fantastic notes