The Seven Immutable Laws of Investing

James Montier of GMO, LLC recently penned a piece titled “The Seven Immutable Laws of Investing.”  These “laws” are certainly not new to adherents of value investing.  However, I believe we need to constantly reinforce these laws, especially since they are often inconsistent with our natural tendencies.

So, now, for the moment of truth, I present a set of principles that together form what I call The Seven Immutable Laws of Investing.

1.  Always insist on a margin of safety

2.  This time is never different

3.  Be patient and wait for the fat pitch

4.  Be contrarian

5.  Risk is the permanent loss of capital, never a number

6.  Be leery of leverage

7.  Never invest in something you don’t understand

MANAGEMENT FAIR OR FOUL

· Promoters who keep diluting equity. In Corporate finance studies the cost of equity capital is taken to be higher then that of debt. It therefore makes sense for companies to take on debt for further growth and be very conservative with equity dilution.

· Promoters who issue warrants to themselves at substantial discounts to market price.

· Check whether the company sticks to its guidance. Mastek and Polaris are two Indian software companies that have often deviated from what they promise. While Mastek and Infosys were incorporated at around the same time the latter trades at a market cap of more then 100 times the former.

· Whether the stock price moves just about a fortnight before the unexpected news (e.g. acquisition, hefty dividend etc). Investors will have to distinguish between what is known asmosaic theory. This theory assumes that the analyst committee can forecast some of the corporate actions. Stock specific news that hit the market after the stock has been ramped up is a bad sign indicating that the insiders knew of this development. E Serve and Digital Software were up quite a bit before the company came out with their open offers.

· Companies that buy back their own shares only to reissue them later at huge premiums areagain playing foul on small investors. Bharti Airtel did this but investors have benefitted since then. there is nothing easy in this business!

· Companies that buy back their own shares are always a great bet on the bourses

· Companies having good managements have a large dividend pay out ratio.

· Decline or rise in promoter holdings. After the 2000 tech debacle the promoter holdings in companies like DSQ Software and Himachal Futuristic saw a continous decline.

· A very high Tax Payout Ratio is a signal that earnings are for real and the management genuine.

· A very large Institutional Ownership means that the company is well researched and prima facie management concerns are not there. But companies that have large institutional ownership do not generate above market returns.

· The CEO position. Whether it is within the family or outside?

· Educational Qualifications of the top Brass. It has been my personal observation that companies that are headed by graduates from IIM and IIT perform very well. They also follow a very high level of Corporate Governance. Alternatively Companies headed by Accounting professionalsare unable to perform that well.