The Benefits of Multi-Act’s Investment Approach

Investing is simple, but not easy – Warren Buffet

If you follow a few rules in investing the probability of you actually doing well in investing is quite high. But we also say investing is not easy because you are constantly bombarded with cues from the external world which make it difficult to follow those set of rules.

So the way to think about it is that optimism forms market peaks and pessimism forms market bottoms.

And the rule is to buy at a bottom but it is extremely difficult to do that because of negative news coming through the papers, TV channels, or other people telling you something is going to be at the highest level.

GRAF - A Rational, Risk-Controlled Approach to Investing

At Multi-Act, we follow the Global Rational Analysis Framework (GRAF). It’s an adaptation of what John Bollinger wrote about in an investment journal called the Rational Analysis, or Rational Investing Approach. What Bollinger is essentially asking is: Are you better off using one tool in your tool kit or are you better off using as many tools that you think can do the job? Obviously, if you have more tools effectively doing the job you’re better off using all the relevant tools.

So you’ll be much better off when the fundamental analysis telling you the stock is cheap, you have the technical analysis telling you that the market is now beginning to see that the stock is cheap or it’s coming under accumulation or it’s coming under certain chart patterns. Quantitative analysis tells you again, that the stock is quantitatively cheap against all historical parameters.

Here’s how it works:

Fundamental Analysis

Only if a stock resides in our “estimated business value” of the company, do we consider investing in it. Stocks are classified as Moat (companies with long term competitive advantage & valued on a discounted cash flow), or Asset Based Valuations (based on balance sheets, stocks are identified as cheap due to low liquidity or weak market price.)

Technical Analysis

Post identifying fundamentally sound stocks, determining how the company stands vis-à-vis the rest of the market and gauging whether the stock is facing “headwinds” or “tailwinds” from other participants, helps us time our investments accordingly. This is an essential timing tool, and helps us determine strategic entry and exit points before we invest.

Quantitative Tools

These help us judge asset and commodity prices against their historical data and determine how far away they have moved from their average price, making it easier to identify potential investing entry

and exit points. Statistical analysis of asset classes is useful in determining whether they are cheap or expensive, when compared to their historical pricing data.

Behavioural Analysis

We recognize the human element in the investment world, to avoid falling prey to emotional decisions like market greed and fear. We have a process to identify and use such market sentiments. Hence, we have a predetermined exit price for all our investments. The small upside loss eliminates greed and ensures we always miss a stock peak.

The Benefit of GRAF, a process-driven research and investment framework

What Multi-Act’s process is about is to use each of these different tools to make sure that when we actually recommend an investment, when we actually take or elect an investment decision as many as these 4 different tools in the toolkit are saying the same thing. The GRAF makes the investment both simple and easy because the rules are all laid out.

The first rule is that you want to buy from good companies, and by good companies we mean positive cash flows, those that generate free cash flow over a full cycle, have at least return on capital employed or return on net worth equal to the cost of equity or required return on equity. They have clean accounting so the quality of accounting is clean.

The second thing we’re looking at is the valuation right and we have 16 different tools of valuation. We don’t value a business without any barriers to entry in the same way we value a business with barriers to entry.

And final thing. Is the timing right? And there we look at behavioural analysis or technical analysis.

All these three questions are answered through the GRAF process:

Is it a good company? Is the valuation right? Is the timing right?

After 20 years of accumulating data we have a repository of data on 150 Indian companies and 350 global companies. GRAF enables us to:

Focus on Preservation of Capital Focus on Prudent Asset Allocation

GRAF in Action

So let’s take an example of a commodity company. We would have data about a commodity business but these are long cycles and we would also have short-term data about commodity companies. For example, we know that there is a particular business and the underlying commodity trades at a particular price.

Let’s take oil. Over the last 15 years on a monthly basis, this company whose underlying economics are driven by the oil price trades at this level relative to the oil price. And the behavioural analysis is telling you the same thing – it’s telling you that the market is fixated on some sort of short-term phenomena forgetting that when you’re buying an equity you’re actually buying cash flows 30 years or 40 years into the future.

From a behavioural point we’re always trying to understand when the market is down, what is the market worried about? If the market is up, we are focusing on what the market looking at? Are they extrapolating some recent phenomenon which we believe is not sustainable? And in the case of the market going down, again, are they extrapolating some recent phenomenon and saying this is going to go keep on going on and on as far as the eye can see and again, it’s not sustainable and not permanent. In the case of oil, we feel that prices in the $20 to $30 range are not really sustainable over a 3-year kind of time frame. We are not saying it’s going to change tomorrow. We’re saying in a 3-year time frame we can’t see how you can have the producers producing 800 billion barrels per day with a $20 or $30 oil price. Are investors taking a near term situation and making a classic extrapolation error and saying this is going to continue for the foreseeable future?

When we come to a different view from the rest of the market in terms of what they are doing that’s when we can actually say that we have a trigger point because investors are extrapolating either good news or bad news far into the foreseeable future when economics would dictate that this is not going to be sustainable beyond period of time. Because this process helps us to be market agnostic, we are able to provide independent and conflict free research and investment advice.

We believe that if all our analysts, all our portfolio managers follow the GRAF process and as long as they adhere to the GRAF process we can all sleep well at night and investors can sleep well at night.