The Star Principle & the Coffee Can Portfolio -looking at the same picture from different angles

Financial Independence, Uncategorized

I was re-reading the book – The Start Principle: How it can make you rich by Richard Koch.  If you have been following my posts you will know that I am quite a fan of his writings and have almost all the books that he has written.  Each time I re-read them, I identify something which I had not noticed earlier.

For all those of you who haven’t heard of Richard Koch, he was the first one to write a book on the 80/20 principle, also known as the Pareto principle.  He has written a lot of books related to the application of the 80/20 rule but in addition to that his basic slant has always been on strategy and has a lot of wonderful books written with strategy as the back drop.

If you want to read an author who simplifies strategy, not only for corporates but in real life, then he is one author you should read.

This time while I was reading the Star Principle once again, one aspect which leaped out of the book was that the Star Principle is so very similar to the Coffee Can portfolio which is covered by Saurabh Maukherjea in his book – Coffee Can Investing.

As per Richard if you invest in a company which is a leader in the market place and the market itself is growing at more than 10% compounded, then you will make money hand-over-fist if you can see that the market itself has longevity.  His logic is- if you invest in such a company in its early stages, then the possibility of making massive returns is even higher.  These companies are very few and far between and hence are STARS.

The concept of Stars, Cash Cows, Dogs and Question Marks was first propagated by the consulting company BCG (Boston Consulting Group) where Richard had his first job.

The concept of the Coffee Can portfolio was first espoused by Robert Kirby in 1984.   It was serendipity because Kirby had recommended a certain portfolio to a friend’s husband who did not sell any shares in the portfolio over a period of 10 years while Kirby did.  The amount of wealth that the portfolio created was way higher than what Kirby created in his portfolio.  This is the central concept of compounding which I keep harping about in each of my posts.  If you let something compound over long periods the amount created is enormous.

Saurabh takes the concept further and shows us examples with research, done over multiple blocks of 10 year periods, on companies which grew every year at a minimum of 15%.  If you had bought shares in those companies and then forgotten all about them for the next 10 years you would have got a very large return on your investment.  The number of such companies would be quite small.  If you extend the research to 15 year periods then the number of companies which had such consistent growth would be even smaller, but the certainty of returns would be much higher.

At the end of the day if there are only a few companies which can grow consistently year on year over such long periods of time then thats only possible if they are market leaders in the niche they occupy.  They also cannot continue to keep growing over long periods of time at such high rates, if the market itself is not growing fast enough.  Which then end up being STARS by the definition given by Richard.

The one difference which I perceive is that the Coffee Can portfolio does take into account the fact that some of the companies may close down  or lose market leadership by emphasising that you need to have a “portfolio of companies” with these characteristics.

So its not only about compounding but about creating a sensibly constructed portfolio of STARS which can create enormous wealth.

Wealth generation is not complex if you follow some simple rules….its not easy either though.

Till next time.

Carpe Diem

Books that have influenced my financial education – part 2

Financial Independence, Uncategorized

After the first 4 books that I listed in my last post which had predominantly US based authors, the first book this time is written by an Indian author.

Saurabh Mukherjea’s – Coffee Can Investing – Saurabh had written 2 books before this book.  Both the books were very focussed on the Indian equity market.  This book however provides a very simple framework of identifying stocks in the Indian context and also builds a case for how asset allocation has to be done with the Indian context.  If you are an Indian investor wanting to get into equity markets then this book is a must read.  I have given copies of this book also to young men who are getting into college or coming out of college.  The other thing about this book that I liked is the typical Indian examples. In India food inflation, medical inflation and inflation related to commodities like petrol can play havoc with your savings. By taking specific examples of Indian people and their saving patterns he goes about constructing portfolios.  Therefore I would reiterate, if you are an Indian investor then, this book is a must read.

The next book which is written extremely well is by Joel Greenblatt – The Little Book of Investing – which still beats the market.  This book explains the concepts of Return on Equity / Return of Capital Employed along with the value of a stock so simply that once you read this book you can read through most financial ratios and easily get an understanding of the relative value of the companies. The tables and the resources however are not of value to an Indian investor.  But if you understand the concepts then you can individually build the relative tables on your own.  One of the challenges which I faced when employing his simple technique was that he suggests selling off the complete portfolio every year.  Since I was buying shares over a period of time, putting this into action became difficult.  However inspite of this, I would strongly recommend, this book to everyone who is getting in new to investing.  Like Dhando Investing by Mohnish Pabrai, which I had mentioned last time, this book explains concepts with simple examples, so a must read.

The third book this time is by Tony Robbins again – Unshakable.  Another of Tony’s masterpieces, simply written, explaining the working of the markets.  Key thing especially if you are in the US market is that every 3 years markets will tend to fall.  Psychologically if you understand this concept then you can drive big returns in the long run.

The fourth book – it is supposed to be the guiding book for Warren Buffet and a lot of other famous investors – is the Intelligent Investor by Benjamin Graham.  Quite frankly when I read this book for the first time, I was new to investing in equities myself.  A lot of the concepts that he brings out were totally new to me and the book didn’t appeal to me much.  One of the reasons for that was also the fact that this book also had the US context in mind where the markets are more mature and hence not growing so rapidly.  The Indian markets on the other hand are still nascent and reporting is not transparent. Another fact is that the Indian markets are now in a growth phase. It was only after I had spent a couple of years trying to see how things work that I reread the book and understood it. There a lot of practitioners in India also who would like to buy a company at 5 cents to a dollar as suggested by the author.  However I have personally preferred to look for growth stocks, even if they are expensive but they should have ethical management teams.  In India I think that is the bigger challenge.

I will continue with some more books in my next post.

Meanwhile if you can recommend some books to me on investing, please out it in the comment box.

Till next time then.

Carpe Diem!!!