What financial investors do has little relevance to the world, whereas Darwin’s research is diametrically opposed.
Editor’s Note Many investors would recommend reading books on evolution, but there had been no book that explained in depth the connection between investing and evolution until Indian investor Pulak Prasad, founder of Nalanda Capital Nalanda Capital What I Learned About Investing from Darwin, came out. After reading dozens of books on evolution, he realized why he was so fascinated by the subject, because he found that every topic studied in evolutionary biology usually had similarities with investing, and even more in common with Nalanda’s approach to investing. This is an excerpt from the Investing as a Historical Discipline section of the book.
Editor’s Note
Many investors recommend reading about evolution, but there was no book that explained the connection between investing and evolution in depth until Pulak Prasad, founder of Indian investor Nalanda Capital, came out with What I Learned About Investing from Darwin. After reading dozens of books on evolution, he realized why he was so fascinated by the subject, because he found that every topic studied in evolutionary biology usually had similarities with investing, and even more in common with Nalanda’s approach to investing. This is an excerpt from the Investing as a Historical Discipline section of the book.
Many investors would recommend reading about evolution, but there was no book that explained the connection between investing and evolution in depth, until Indian investor Pulak Prasad, founder of Nalanda Capital, came out with What I Learned About Investing from Darwin.
After reading dozens of books on evolution, he realized why he was so fascinated by the subject, because he found that every topic studied in evolutionary biology usually had similarities with investing, and even more in common with Nalanda’s approach to investing. This is an excerpt from the Investing as a Historical Discipline section of the book.
The investment industry has never been short of prophets of all types. Some are mystics, but most are well-intentioned professionals who spend a great deal of energy arguing for the future, but Nalanda is not one of them.
Before going further, I would like to clarify an important point. Darwin and his theory of natural evolution are incomparably great achievements, and in my opinion no scientist has ever caught up with him Perhaps only Einstein can match him, but probably not even Einstein could match his subversive results.
When I compare Darwin’s great achievement in advancing science with Nalanda’s contribution in the field of investment, I realize that it is no less than a glow competing with the moon. In a broad sense, I don’t think what financial investors do is very relevant to the world, whereas Darwin’s research was the opposite.
Based on the lessons that Darwin taught us, Nalanda’s approach to investing is just like his research
Nalanda explains the present only in the context of history.
Nalanda sees the same historical facts as everyone else.
Nalanda is not interested in predicting the future.
Like Darwin, before investing in a business, a Nalanda completes the following tasks studies its history to understand its financial condition evaluates its business strategy measures its competitive position and finally assigns a value to it. Let me analyze each of these tasks below.
Understanding history without making predictions
People engaged in the financial industry must have read countless analyst reports, but if you are not a financial professional, or have never seen an analyst report, then allow me to briefly popularize it for you. It’s a type of report that stock brokerage firms such as JP Morgan, Morgan Stanley and Goldman Sachs employ research analysts, as the name suggests, to publish to their clients, investors, after conducting a detailed study of a publicly traded company.
A typical analyst report usually contains information about a company’s business and financial condition, as well as its overall strategy and direction, and recommends that clients buy, hold or sell shares in the company. Different brokerage firms have different reporting techniques, so you’ll see analysts frequently use a variety of industry jargon to rate stocks, such as Underperform Overweight Accumulate Neutral and other esoteric terms to express their recommendations and opinions. Overall, however, the recommendations made by these analysts’ reports basically don’t go beyond buy, hold, or sell.
In addition to business commentary, most analyst reports usually include the target’s income statement and balance sheet for the most recent fiscal year, as well as financial projections for the next 25 years. However, many analyst reports do not put the financials of the business for the past 2 3 years, and the financials for the past 5 10 years are even rarer. If you’re curious to know the company’s revenue growth over the past 5 years the long-term historical trend in profit margins, or how return on capital employed and free cash flow have moved over the decade, you’re on your own to gather that.
During the time I was writing this chapter, I had in my possession five brokerage analyst reports on Tata Consultancy Services, India’s largest technology services company with a market capitalization of about $150 billion. All of these analyst reports provided financial projections about Tata for the next 2 3 years and actual financials for the past year Only one of them provided historical financials for the past three years, but none of them could give historical financials for the past 5 10 years for this company.
A real life incident that I have personally experienced may explain the reasons for this situation. A few years ago, a group of three from the Nalanda investment team visited one of our portfolio companies. The investment team met with the CEO and CFO of the company for about an hour, and just as we were about to leave, the CFO received a phone call in which he clearly expressed his displeasure with the caller and impatiently shouted out I have no comment, wait for the company’s release in a few weeks! It turned out that the caller was a well-known investor who wanted information about the company’s revenues and profits for the quarter.
If even an investor, who is the owner of the money, has to pester the management of a company in a lowly manner to get the financial information of the next quarter, can a research analyst get it easily? If it is so difficult to get financial data, why do analysts bother to study a company’s long-term historical data? Analysts make forecasts in their reports because they have to, purely at the behest of their employers. But I believe that many analysts have realized that these forecasts are simply futile for the following reasons.
Let’s say I need to forecast a company’s financial position for the next fiscal year, and I need to forecast at least ten or more metrics, including the number of units sold, unit prices, cost of goods sold, selling expenses, receivables, capital expenditures, and so on. Let’s assume that I am a superb prognosticator and that my guesses on these ten items are 90% accurate, but the probability that I will accurately predict all ten items for the next year is only about 35,9010.
One might argue that the ten data items are not all independent variables, and therefore should not be calculated in deciles. This logic is correct, but you have to realize that the number of variables in the actual case is much greater than ten, and they are all at least semi-independent. Whichever way you assess your probability of guessing the entire financial picture for the next year, the success rate is not much higher than guessing the heads and tails of a coin.
With such a low rate of correctly predicting next year’s one-year results alone, and with me needing to predict the year after that and the year after that in general, how much more likely do you think my guesses will be to hit the mark?
Therefore, Nalanda usually only provides historical financial data for the past ten years or more and does not make any predictions about future performance. Furthermore, Nalanda uses real financial information that is equally available to others, not unlike Darwin.
Darwin had no special access to any confidential data or information when he conceived his theory of the origin of species. The voyage of the Beagle did give him access to entirely new ecosystems and species, but he did not make any new discoveries. During his five-year-long trip, Darwin did collect information on 1,529 species and skin, bone and other tissue samples from 3,907 different species. But based on what I know about Darwin’s research, I don’t think that anything significant that he discovered that was unknown to science came from a series of coincidences .
However, there did come a few surprises when experts in other fields made new discoveries about specimens collected by Darwin. In 1845, for example, Darwin’s botanist friend Joseph Hooker Joseph Hooker determined that of the more than 200 species of plants that Darwin and his team had collected in the Galapagos, about 150 were unique to the individual islands from which they had evolved, but that they were also related to plants on other islands that were found nowhere else on Earth. The ancestors of some of the plants, like the ancestors of the island’s birds, accidentally took root in the Galapagos a long time ago and, over time, diverged as they adapted to the local environment.
Many ornithologists and naturalists have been observing the mating rituals of peacocks for centuries, but no one knows why females choose their husbands based on the showiness of the males’ plumage. Even amateur ornithologists know that only males are adorned with magnificent plumage, and the diversity of sizes, shapes, and colors of feathers in all birds is truly astonishing. But no ornithologist has interpreted the observations in terms of sexual selection as Darwin did.
Similarly, it is no secret that Linnaeus’s natural system became famous for its botanical classification system based on male and female sexes, which brought Linnaeus great renown and set the stage for a lifetime of achievement and prestige. In his subsequent publication Species Plantarum, Linnaeus modified his system of classifying plants on the basis of sex, i.e., according to Linnaeus, the classification of plants at the level of genera needed to be based on the natural characteristics of that taxonomic class The morphological features of the flowers and fruits of plants. However, neither he nor anyone else could explain the origin of this natural order, other than to say that it was ordained by God. Eighty years after Linnaeus’s death, Darwin finally explained this natural order through his theory of common descent, discussed in the Origin of Species.
As mentioned earlier, Darwin was not given the same historical facts as anyone else under the same circumstances, but he gave a completely new and radically different explanation. I believe that Nalanda can take a similar approach to investment.
If Nalanda refused to predict future financial conditions, then what is the use of these historical financial data? They are actually of much use. As perpetual holders of corporate stocks, we are incredibly paranoid about the financial performance of companies. Therefore, I will explain below the methodology for evaluating high quality companies within Nalanda’s portfolio in terms of utilizing a company’s historical financial data.
Absolute and relative analysis
Let me take the example of Berger Paints India Limited, India’s second largest paint company. Nalanda has been holding the shares of Berger Paints since 2008 when he bought them. When the company announces its quarterly performance figures, Nalanda performs two types of analysis on its extensive historical data Absolute and Relative analysis.
For example, we will analyze The company has a long term revenue growth average of 15 16 , why did its revenue growth drop to 10 in the past year ? What might have been the reason for bringing in three consecutive years of high profitability? Could the reason be that the company has begun to cut back on its spending on sales and marketing? What led to the sharp decline in accounts receivable during the quarter? Has capital spending been higher than the norm over the past year? What caused its return on capital employed to increase over the past two years compared to the previous five years’ figures?
Not only does Nalanda analyze Berger Paints’ recent performance from the perspective of long-term historical data, but as a perpetual shareholder of the company’s stock, Nalanda also wants to invest in a company that is performing better on a relative basis – in other words, it should outperform most of its competitors on an overall basis. Therefore, Nalanda compared Berger Paints’ quarterly performance for the last 12 months and long-term performance with its competitors, starting with parameters such as revenue and profit market share return on capital employed and free cash flow. The four major competitors used for comparison are Industry leader Asian Paints India’s third largest paint company Kansai Corona Paints Kansai Nerolac Paints Akzo Nobel Akzo Nobel and Indigo Paints Indigo.
In addition, Nalanda actively seeks feedback from the market on small or private companies that may have begun to grow aggressively. This competitive analysis based on financial data allows us to determine whether Berger Paints has lost or gained market share this quarter and last year. What has driven Guanciale Corona Coatings to increase its revenue share over the past two years? Who has gained the most from AkzoNobel’s loss of market share? Has Indigo Paints been able to expand its business outside Kerala? Has Berger Paints’ advertising spend gone up or down relative to its competitors?
As mentioned earlier, there is a lot that Nalanda can do with historical financial information, and what I have outlined here are only sample questions for companies that are already in Nalanda’s portfolio. Nalanda can use the same ideas to analyze a brand new business. Regardless of the type of business the potential investment is in, Nalanda’s investment requirements are always the same Absolute and relative analysis based on its actual financial history can lead to a bright performance.
Why waste time making useless predictions when we already have access to real historical information about the business?
What I learned about investing from Darwin
Original Name What I Learned About Investing from Darwin
Author: Prakash Prasad
Translated by Peng Sang-jin
Publisher China Publishing Group
Text Prakash Prasad
Edited by Yu Zhou
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Barron’s barronschina Original Article, No Reproduction Without Permission.
The content of this article is for reference only, does not constitute any form of investment and financial advice Market risk, investment must be cautious.
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