The Adani Multibaggers: HOLD or SELL? 

Hello everyone. Rahul Shah here, trying to make investing accessible and profitable for the average investor.

Unless you are living under a rock, you wouldn't have missed the meteoric rise of Mr Gautam Adani.

But what next? Is the bull run in Adani group of companies over or there is still a lot more to come?

More importantly, if one is sitting on sizeable gains in some of the group companies, should he stay put or exit at least partially, if not fully?

Well, I am going to try and answer this question in this video.

But not before we go through a very important concept in investing.

In fact, this concept is also the reason behind why I have a certain view towards Adani group stocks and why I recommend the stocks the way I do.

So, what exactly is this concept? Let me tell you an interesting story to explain this concept in detail.

I am sure you would have heard of Terry Smith. He is currently one of the most successful fund managers going around in the world.

In fact, he has been referred to as the English Warren Buffett for his style of growth investing.

Now, in an interview that Terry Smith gave a little over a year back, he was asked why he has not invested in the technology giant Apple, especially when he had invested in other tech stocks like Microsoft, Automatic Data Processing and Facebook.

Terry Smith replied that he has lived through the rise and fall of Nokia and he was worried that something similar could happen to Apple as well.

He was just not comfortable with a business has to depend on churning out new products not very different from their previous Avatars.

And this was the main reason he did not invest in Apple.

Now, interestingly, the original Warren Buffett i.e. the Oracle of Omaha has Apple as his single largest holding. This means that his views on Apple are diametrically opposite to Terry Smith's views.

When Buffett was asked why he invested in Apple, he did not talk about Apple's technology, manufacturing, or design prowess.

Instead, he spoke of how reluctant consumers were to switch away from the iPhone to a rival brand.

Apple has an extraordinary consumer franchise, Buffett once told CNBC. You are very, very, very locked in, at least psychologically and mentally, to the product you are using. The iphone is a very sticky product, Warren Buffett further added.

Well, if the performance of Apple stock is anything to go by, Buffett has won hands down and Terry Smith seems to have misjudged Apple's potential.

I think there is a deep lesson here.

I loved how both Warren Buffett and Terry Smith had their own investment framework with which to judge businesses. And while Terry Smith may have made a mistake in Apple, he is a very successful investor mind you.

But Apple did not fit into his investment criteria and therefore, he decided to give it a pass. Warren Buffett on the other hand, understands the true value of a brand when he sees one. In fact, he has earned majority of his wealth by riding on the power of brands.

Coca Cola, American Express, Gillette and now Apple. It is amazing how he has managed to crack the brand code on such a consistent basis.

Therefore, Terry Smith has his own circle of competence and so does Warren Buffett.

And although there is very little overlap between the two, both have achieved enormous success by trying to stay as much within their circle of competence as possible.

And this is the concept I wanted to talk about today. The concept of circle of competence. Every investor should have his own circle of competence in my view and should be well aware of its boundaries.

For if you don't know your circle of competence or you know it but you frequently step out of it, you are going to struggle to make good returns from stocks over the long run.

Now, how do you figure out your circle of competence if you haven't already? Is there a specific way of coming up with one?

Well, if you need to understand that in detail, you are welcome to join my Lazy Millionaire learning course where I take you through a step-by-step guide on how you can achieve success in investing and create your own millionaire portfolio by spending not more than a couple of hours every year.

Click on the link in the description box for more detail.

In this video though I am going to give you a small snapshot of the whole thing.

Take a look at these two companies and their historical performances.

NTPC is better than Tata Power across all parameters. It has better earnings profile, lower debt to equity and a much better return on equity.

And which is why I chose to recommend NTPC over Tata Power.

Here's how they have done since my recommendation back in Aug-Sep 2020.

Tata Power has outperformed NTPC by a big margin despite NTPC having a better historical performance. However, this does not change my opinion. I prefer a company with a stable past performance rather than a rosy future.

If a company has a very rosy future but has not delivered in the past, I will most likely reject it in favour of a stock that has a great past and a future that's at least stable if not rosy.

So, that's rule number one of my circle of competence. Past performance matters more to me than future promises.

Let's move to the second rule which I'd like to highlight using these two companies as examples.

Once again, the past performance of two companies. It is obvious that company C has done much better than company D across all parameters. Growth for company A has been better, ROE also and debt to equity ratio is also not very high.

However, once again, I chose company D over company C.

Although company C is better in terms of business quality, company D is an above average business model with very decent numbers.

Therefore, the main reason for selecting company D over company C is this slide.

Company C, the better-quality company was almost 8 times as expensive as company D. Now, company C certainly deserves a high PE multiple because of its better quality.

But I don't think I should pay 8 times as much for company C versus company D. I would be willing to pay 2x or maximum 3x for company C over company A.

Besides, company D was trading at a very attractive valuation of only 7x and therefore I preferred recommending company D to my subscribers than C.

Here's how the decision turned out to be. Company C which is none other than Page Industries gave 125% returns between April 2020 and December 2021, Ambika Cotton, the company D and from a somewhat similar sector, outperformed Page Industries by returning 161%.

Now, many of you will say that despite being 8 times as expensive as Ambika Cotton, returns from Page Industries were not bad. Besides, when it comes to holding for the long term, Page Industries is a better business than Ambika Cotton.

I completely agree. However, I get to define my circle of competence. And the way I see it here is not many stocks will give you good returns if you consistently pay a PE multiple of 50x-60x no matter how good the quality of the business.

Besides, if you pay 55x-60x and the quality does not turn out to be as good as you'd expected, you will lose a lot of money in no time.

Therefore, even if you are buying the best quality business out there, it helps to keep an upper limit in terms of the PE that you'd be willing to pay.

For me personally, this upper limit is around 12x-15x for mid and small cap companies and 20x-30x for good quality blue chips.

At these valuations, the odds are in my favour that I will make a good amount of money over the long term.

So, here are the two rules of my circle of competence.

Past performance matters more to me than future promises.

Always have a valuation upper limit beyond which one should rarely venture.

Well, there's one more rule which I try to adhere to. And it is the rule that I would rather be a securities analyst than a business analyst.

A securities analyst is someone who buys undervalued assets and exits them once he makes his 50%-100% on the stock whereas a business analyst is someone who focuses more on the quality of the underlying business. If the quality is intact, he will continue holding on to it for 5, 10, 15 and even 20 years.

Warren Buffett is one of the best examples for someone who's focussed on the business whereas Ben Graham, his mentor, was more a security analyst than a business analyst.

This is the reason that across my services, my holding period for a stock is 1-2 years and average gain per stock is in the region of 50%-100%. I prefer to be a security analyst rather than hold something for many years depending on the quality of the business.

So here are the three rules of my circle of competence again.

When it comes to assessing business quality, focus more on past performance than future promises.

Do not overpay even though the business is of extremely high quality and

Be a securities analyst and not a business analyst.

So, these are my rules and to be honest, they have worked quite well for both me as well as my subscribers over the years.

Of course, your rules can be totally different. But as far as possible, try to have rules that are simple to apply, are based on sound logic and have a long term track record.

And once you frame them, always make it a point to stick to them. You should rarely venture outside your circle of competence.

This brings me to the last and the most important part of this video. What next for Adani Group shares?

Let us analyse the group companies using the three rules of my circle of competence I just discussed.

So, I got a list of 7 Adani group companies when I looked for them in our database.

Here's how their historical financials stack up.

Now, if we apply my first rule of having a strong performance history, we will have to leave out Adani Green and Adani Power for sure. Their historical performances are hardly inspiring and therefore, no matter how bright their future is, my rule tells me that I should not consider such stocks.

Of the other 5, all of them seem to have a decent financial history although poor return on equity is a concern for Adani enterprises while debt is a concern for Adani Transmission. Let's overlook these deficiencies for the moment and go to my second rule of my circle of competence.

The second rule was about having an upper limit in terms of valuations to pay for stocks and let's see whether any of the Adani group companies qualifies on this count.

Well, as you can see, almost all the Adani group companies are way, way higher than what I'd like to pay for a stock. The only stock that has a PE in double digits is Adani Ports but even there the multiple is higher than the maximum 25-30x that I'd like to pay for the best quality stock. So, even this option is ruled out.

Therefore, as you can see, none of the Adani group stocks clear the first 2 rules of my circle of competence. All the stocks are well outside my circle of competence and I'd be more than happy to give them a miss rather than step out of my circle and recommend them to my subscribers.

I know that by insisting on staying inside my circle of competence, I have missed some of the biggest multibaggers of the last couple of years.

However, this is fine in my view. As long as I am earning good returns for my subscribers by staying within the circle of competence, I have no regrets. And neither should you if they don't fall inside your own self-defined circle of competence.

For those of you who'd invested in Adani group shares quite some time back and are now sitting on good gains, you will have to take your decision based on your own circle of competence.

As far as I am concerned, my rules happily recommend to exit these counters if you've made 50%-100% even 200% gains on these counters.

It is altogether a different matter if you are not a security analyst but a business analyst and are in it for the long haul. Whatever it is, act solely based on your circle of competence.

In case you don't already know your circle of competence, I'd recommend that you create one as soon as possible.

Otherwise, you will find the stock market to be a brutal place where there are temptations galore. Falling prey to these temptations is not a good position to be in. That way certainly lies sorrow over the long term.

Do let me know what you think of this viewpoint and please do not forget to like and leave your feedback in the comments box.

Until next time, good bye and take care.