For its Investors, it was a Decade of Trials, Triumphs, Drubbings, and Intrigue.
This isn’t my first encounter with Rajratan Global Wires; that happened in 2020. I assessed many stocks as investment opportunities in the second half of 2020, which largely proved right, as their later performances attested; Rajratan Global Wires was one of them. However, constrained by the capital at my disposal and certain portfolio management rules I followed then, I couldn’t invest in all the stocks I liked, so I had to make some hard choices. When I chose one stock, I was choosing against another, and Rajratan Global Wires happened to be one among those I chose against. To the best of my recollection, I circled the stock’s low and volatile gross profit margins as my reason for rejecting the stock. When I reflected on those decisions two years later, sometime in 2022, there was regret because although the stock I chose over Rajratan Global Wires had delivered enormous returns by then, they were nowhere near the gigantic returns Rajratan Global Wires delivered. However, the regret I felt then was unwarranted and has no merit; it stemmed from my ignorance. In the business world, the rearview mirror is always clearer than the windshield; it’s easy to understand past events, but hard to see what will happen.
What was thrilling in the first couple of years soon turned disheartening; reflecting on the past six years, it has been eventful for Rajratan Global Wires, a company engaged in the manufacture and sale of tyre bead wires, the high-strength steel wire loops inside the inner edge of a tyre that anchor it firmly to the wheel rim. The undisputed market leader in India and one among the top five globally, its share price multiplied nearly twenty times, from ₹65 to ₹1,200 per share, in the two years between October 2020 and October 2022; however, very soon, it reversed course abruptly, and declined 65 per cent over the next two and a half years, from ₹1,200 to ₹400 per share. For the past year or more, the stock has traded within a range of ₹300 to ₹500 per share.
Despite the sharp retreat over the past four years, the stock has delivered a comfortable 35 per cent annualised return since October 2020. But this fact can in no way make up for the emotional trauma investors endured while watching the prolonged and substantial fall in the price of a stock in their portfolio.
The First Four Years (2016 – 2019)
An extended period of inertia preceded the rally that began in October 2020. Rajratan Global Wires’ share price remained almost dormant for nearly four years at around ₹65 per share before the exhilarating rally began in October 2020. Meanwhile, its business progressed well during the said dormant period (FY17-FY20), with revenue and operating profit increasing at an annual rate of 14 per cent and 12 per cent, respectively; cash flow, capital allocation, and financial position were also favourable. Our valuation estimated 4.03 times book value as a fair valuation for the stock in 2016; the stock was trading at 4.92 times its book value at the time – a benign overvaluation.
Although the business progressed during these first four years, it involved multiple vicissitudes. The stock’s earnings declined and profitability moderated during the first two years (FY17 and FY18), which may explain its underperformance in 2017 and 2018. By mid-2018, the stock was trading at ₹50 per share at a book value multiple of 2.21, and the share price discounted an RNOA (return on net operating assets) of 14.25 per cent, a marked moderation from the 18.50 per cent discounted RNOA two years earlier. Both earnings and profitability improved considerably over the next two years (FY19 and FY20), but the share price didn’t follow through, at least proportionately, thereby further moderating its valuation; by mid-2020, the stock was trading at a book value multiple of 1.90 and discounted RNOA of 12.90 per cent, while its trailing RNOA stood at 16.0 per cent; the stock was surely undervalued, by at least 35 per cent. But it was undervalued two years back as well (mid-2018), albeit less intensely. The stock stayed undervalued for close to two years before the momentous rally from October 2020 to October 2022 began.
Gross Profit Margin: How Significant?
Today, at a 5-year median of 38.5 per cent, Rajratan Global Wires’ gross profit margins remain generally low and have changed little over the past five years. However, the company has made significant progress on volatility. These margins, which were extremely volatile during FY19 and FY20, remarkably moderated in the ensuing years and, over the past three years (FY24-26), have achieved considerable stability. During the past decade, during which all the exalted and sunken performances mentioned occurred, gross profit margins declined on two occasions, first during the three years of FY17-19, when it declined an aggregate of 10 percentage points, and the second during the two years of FY23-24, when it declined an aggregate of 5 percentage points. In the former case, revenue growth accelerated, while it markedly decelerated in the latter case; on both occasions, however, the share price underperformed. This observation supports the possibility that changes in gross profit margins have a greater influence on a stock’s market price than changes in revenue or profit growth.
With revenue and gross profit increasing at an annual rate of 26 per cent and 24.5 per cent, respectively, Rajratan Global Wires’ business grew rapidly during the five years between FY18 and FY22. Yet its share price remained indifferent to this advancement for the first three years, and only reacted positively during the latter two years, during which the humongous rally several times already discussed here materialised, the reason for which probably lies with gross profit margins, which diminished during the former three years while improved during the latter two years.
We should be suspicious of faster revenue and profit growth if declining gross profit margins accompany it. The most problematic situation a stock can face is poor profit growth accompanied by declining gross profit margins. Rajratan Global Wires unfortunately fell into this situation during FY23-24, when its revenue declined by 0.3 per cent, its gross profit declined by 13.2 per cent, and its gross profit margin fell by 5.2 percentage points, from 39.9 to 34.7 per cent. It can’t be a mere random coincidence that the stock’s 66 per cent drawdown from ₹1,200 to ₹400 per share happened during this period.
If poor profit growth together with declining gross profit margins is most ominous, then high profit growth and improving gross profit margins should be the most auspicious sign for a stock’s investment prospects. FY25 saw gross profit margins recover by 2.3 percentage points, from 34.7 to 37.0 per cent, but growth remained sluggish, with revenue up 5.0 per cent and gross profit up 12.0 per cent. However, the next and most recent financial year, FY26, was hopeful: revenue and gross profit increased by 23.7 per cent and 30.9 per cent, respectively, while gross profit margins improved 2.2 percentage points to 39.2 per cent. The share price, which crossed the ₹500 per share mark in recent days for the first time in eighteen months, appears to be responding well to this progress.
About the low value of gross profit margins, over which I rejected the stock six years ago to eventual great disappointment; I think its absolute value isn’t what really matters; instead, it is how it stands relative to its peers and, most importantly, how it changes over time. At least, that seems the least I could infer from this perusal. Anyway, I cover gross profit margins in greater detail later.
The Eventual Years (2020 – 2025)
A sharp slowdown in revenue and profit growth, along with a steep decline in operating profitability, characterised Rajratan Global Wires over the past four years (2022-2026). Revenue growth significantly moderated from 26 per cent in FY22 to 12 per cent today (FY26). Operating profit in FY26 is 32 per cent lower than it was four years ago (FY22); it first declined sharply in FY23 and FY24 and then stagnated in FY25 and FY26. Because this reversal followed the strong performance of FY19-22, investors largely did not anticipate it, forcing multiple downward recalibrations of expectations. Alongside the decline in earnings and profitability, investors’ recalibration of expectations also played a major role in the sharp fall in Rajratan Global Wires’s share price between 2023 and 2025.
Rajratan’s RNOA (return on net operating assets) accelerated from 15.4 per cent in FY20 to 34.7 per cent in FY22, which was enormous in itself, but the elevation in investor expectations this performance induced was astronomical. The market priced an RNOA of 12.70 per cent into the ₹65 per share just before the massive rally began in October 2020. A year later, in October 2021, the price had risen by 650 per cent to ₹490 per share, and the discounted RNOA had moved much further ahead to 29 per cent (from 12.70 per cent a year ago), while the increase in trailing RNOA during the year was only from 15.4 to 18.8 per cent.
Any sensible person who thought this kind of valuation was exorbitant and precarious, and would therefore soon revert to more rational levels, has no idea, when driven by optimism, how far investors can drive up stock valuations and then find a convincingly ludicrous explanation for those grandiose valuations. As earnings and profitability continued to increase, by October 2022 the trailing RNOA had risen to 34.7 per cent, briefly validating investors’ lofty expectations from the previous year. Now, with the faster expansion in earnings and profitability into its fourth straight year, investor confidence was at its highest, and the price had been driven up to ₹1,200 per share; it was discounting an RNOA of 39 per cent; relative to the trailing RNOA of 34.7 per cent, this might not have seemed too unreasonable at the time, given the prevailing high growth momentum.
However, the imminent vicissitude arrived abruptly in the form of an earnings decline and consequent moderation in profitability in FY23; operating profit declined by 13 per cent, and the trailing RNOA moderated to 23.6 per cent in FY23 (from 34.7 per cent in FY22). This unanticipated reversal caused the market price to fall 37.5 per cent to ₹750 per share by October 2023; the falling price significantly moderated the discounted RNOA to 23.50 per cent (from 39 per cent a year ago). The downfall continued into the next year as well. In FY24, operating profit fell another 23.57 per cent, and RNOA moderated further to 13.8 per cent. In line with this disappointing performance, the market price fell further to ₹575 per share; it now discounts an RNOA of 19.25 per cent. Over the next two years, FY25 and FY26, operating profit remained largely unchanged while RNOA slightly subsided to 11.2 per cent. However, this moderation in the decline in operating performance couldn’t provide a backstop to the falling stock price, which now seems more influenced by investor despondency than operating performance. By mid-2025, the price had fallen to ₹350 per share, reflecting an RNOA of 14.65 per cent. The price has since recovered, now trades at ₹500 per share, and discounts an RNOA of 15.60 per cent.
Cash Flow and Capital Allocation
Although cash flow has been brisk for the past five years, the share of operating cash profit in cash flow has gradually declined, while the share of borrowings has increased over the period. While this might not be a healthy trend, it is quite normal during capital expansion periods such as the one Rajratan Global Wires is going through now. Moreover, despite the diminishing role, operating cash profit still comprises 75 per cent of average annual cash inflow.
As the company has been in a capital expansion phase for some years, capital expenditure has outpaced operating profit over the past five years, necessitating debt financing, a constant feature of the past four years. Over the past five years, borrowings have financed nearly 22 per cent of Rajratan Global Wires’ operating and investing activities, up from 11 per cent five years ago. Yet this has happened healthily, with no increased strain on cash flow or financial stability. Five years ago, 18 per cent of cash flow went to interest payments; today, it has moderated to 12.5 per cent, despite the company raising additional debt of ₹186 crores during the period, due to a much faster increase in operating profit. In short, the company has prudently navigated a capital expansion phase so far through efficient cash flow management.
Periods of heavy capital expenditures usually come at the cost of reduced or limited shareholder rewards, which accrue through either dividends or share buybacks. However, Rajratan Global Wires was an anomaly over the past five years: while its average annual capital expenditure increased at an annual rate of 25 per cent, its average annual dividend payout increased at a higher annual rate of 53.6 per cent. This pattern is evident in the firm’s capital allocation composition, with the share of capital expenditure reducing from 97 per cent to 92 per cent while that of dividends increasing from 3.0 per cent to 8.1 per cent over the past five years. A rising share of shareholder rewards in capital allocation, whether through dividends or share buybacks, favours the firm’s share price.
The ability to allocate capital to activities that enhance a firm’s prospective value-generation capacity is a principal determinant of a company’s long-term success. The capital allocation score measures this efficacy by assessing how management has allocated capital across four broad avenues: financial assets, capital expenditures, deleverage, and shareholder rewards. Each category is assigned different weightage based on its significance, timing, and certainty in long-term value creation, with shareholder rewards having the highest weightage, followed by deleverage, then capital expenditure, and financial assets with the lowest weightage. For Rajratan Global Wires, the capital allocation score has increased by at least 15 per cent every year for the past seven years or more. Capital expenditure has the highest share at 92 per cent, but has been moderating over the past five years, while shareholder rewards (here, specifically dividends) contributed the remaining 8 per cent share, which has meanwhile been expanding over the past five years—all these point towards a superior capital allocation profile for Rajratan Global Wires.
For most of the past decade, Rajratan Global Wires has enjoyed superior operating profitability, which has greatly aided the company in meeting a large share of its increased capital expansion internally, a privilege only a very few companies of similar size are seen to be endowed with. Rajratan Global Wires’ net operating assets increased by ₹573.48 crores (a 156 per cent increase) over the past five years, but its net financial obligations increased by only ₹149.58 crores during the period; internal accruals financed 74 per cent, while borrowings financed the remaining 26 per cent of the fresh operating assets.
Although Rajratan Global Wires’ outstanding debt more than doubled over the past five years, its net worth nearly tripled during the same period, thereby maintaining or perhaps enhancing the company’s financial strength and stability. Rapid growth in net worth is a supplementary benefit of superior profitability, provided incremental profits stay within the company and continue to generate superior return on capital. However, superior profitability alone can’t deliver an enduring rapid growth in net worth. Management’s ability to invest incremental profits productively, and the industry economics that allow such productive investments, matter just as much.
Nature of Earnings Growth
Although earnings growth drives shareholder value, it sometimes fails to do so. Any stock price gain achieved without a commensurate increase in shareholder value is more likely to be easily given up. We aim for sustainable, superior stock price gains. It all comes down to how earnings growth is achieved, or at what cost. Because sustainable stock returns tend to come from earnings growth that enhances shareholder value, understanding how earnings growth is achieved matters more than its pace.
One instance that comes to mind is at least a decade old: a specific company’s stock has turned into a huge multibagger on the back of a sharp increase in earnings and profitability. The stock came to my attention when it was already up significantly, earnings growth was still robust, and valuation, even so, seemed reasonable. I bought the stock; why shouldn’t? Everything seemed so fine. However, fortunes abruptly reversed soon after my purchase; one year later, earnings had precipitously fallen, and the stock had lost nearly 70 per cent in value. Quite naturally, I was greatly disgruntled, but even after time dispelled most of the emotional trauma, the incident kept me confounded for some time for lack of an explanation for what really happened there.
Clarity eventually dawned, or so I believe: growth occurred on fragile ground. The incremental revenue that fuelled the growth was mostly accrual-based; that is, it didn’t generate cash flow but instead created varied receivables on the balance sheet. Trade receivables outpaced revenue during this high-growth phase, while operating cash flow failed to keep pace with revenue; I now know to view such a pattern with great scepticism.
Anyway, Rajratan Global Wires warrants no such worry, as its working capital has only lagged revenue, and its net working capital lately has been less than 20 per cent of revenue. In short, the company has lean, efficient working capital conditions, and whatever earnings growth it had in the past or may be having now is on a robust foundation.
Measuring Progress
All that a discerning investor could have known about the stock in October 2020, just before the massive two-year rally began, was that it had strong fundamentals, hopefully brisk activity, and a reasonable valuation. However, the quadrupling of operating earnings over the subsequent two years, which prompted an 18-fold increase in its share price, was not foreseeable. So is the subsequent halving of operating earnings and the 60 per cent decline in share price over the next four years. Every effort we make to forecast changes in earnings momentum to guide our investment decisions is futile. It is a quandary: earnings growth drives stock prices, yet their trajectory can’t be foreseen; so on what grounds should we base our investment decisions?
Great wealth creators are those companies on a path of continuous progress. However, as outsiders, we equity investors find it challenging to assess progress from the outside of a company we’re considering for investment. For financial and manufacturing companies, this task is clearer-cut than for service companies, such as those providing legal services, restaurants, or software services, because the operating assets that generate income in the former case are more tangible, conspicuous, and thus reliably quantitatively measurable. In contrast, in the latter case, most income-generating operating assets are largely intangible and minimally represented on financial statements, making progress assessment difficult. Manufacturing companies have their factories, plants, equipment, inventories and so on, while financial companies have their loans and investments. Meanwhile, for software companies, income-generating prowess lies in the technical know-how and problem-solving skills of their employees, which never show up in financial statements.
If so, then, as a manufacturing company, assessing progress from financial statements should be straightforward for Rajratan Global Wires. Let’s see. Or let’s think through it. Typically, we infer that any consistently improving parameter signals progress. Consider manufacturing capacity, for instance.
Rajratan Global Wires’ manufacturing capacity, which includes tyre bead wires and high-carbon steel wires, is set to triple in less than a decade. Distributed between India and Thailand, capacity increased from 70,800 TPA at end-FY19 to 1,06,800 TPA at end-FY20; to 1,12,000 TPA at end-FY22; to 1,62,000 TPA at end-FY24; and finally to 1,92,000 TPA at end-FY26. A further 30,000 TPA expansion is planned at the Thailand facility. It is reasonable to assume that enhanced capacity strengthens a company’s ability to capitalise on market opportunities. However, management typically augments capacity in response to strong traction from clients and the market; any serious industry competitors would have felt the same vigorous traction and, as is typical, may have decided to expand capacity themselves as well. When all major industry players embark on capacity expansion simultaneously, as everyone tries to outdo others, it engenders an industry glut; supply far exceeds current demand, resulting in intense pricing pressure and lower realisation for industry players. For us equity investors, progress in a company’s fundamentals should lead to durable, superior stock returns. In that respect, manufacturing capacity is not a reliable parameter on which we can wager.
Another measure is the capital allocation score, designed to measure how efficiently capital is allocated across functions at a company; Rajratan, with a superior score that has consistently advanced at a high pace over the past half-decade or more; though it imbues optimism, with capital expenditure comprising more than a 90 per cent share of the score, its reliability as a measure of progress is put into question. However, deeper investigation reveals that the share of capital expenditure in capital allocation has declined from 97 per cent to 92 per cent, and that of dividends has increased from 3.0 per cent to 8.1 per cent; this is a promising trend. From an investment perspective, that is surely a sign of progress. More than the overall improvement in capital allocation, the progression (or regression) of its constituent components within the capital allocation score is a more reliable indicator of the progress we seek.
Competitive Advantage
Suppose that, for instance, all companies involved in the business of a specific product incur a cost of ₹100 to produce a single unit of that product, and all of them, except one, sells the product in the market at ₹200 per unit while the exceptional one can sell the same product, the only difference being they make them, at ₹250 per unit, and can do that for all years. The same phenomenon can happen another way, wherein all companies sell their products at ₹200 per unit in the market, including the exceptional company; however, while all other companies incur a cost of ₹100 per unit, the exceptional one incurs only ₹90 per unit. What this one exceptional company possesses is a durable competitive advantage, and the truth of the matter is that this one fundamental aspect, competitive advantage, is the most decisive ingredient that goes into long-term business success and, in turn, long-term superior investment returns.
If so, then it would surely be a dream-come-true moment for equity investors if there existed one or even two plain but powerful fundamental parameters that could accurately convey a company’s competitive position. Mediocrely erudite me knows only one, a very straightforward one: gross profit margin. But how does it work? Is a company with a gross profit margin of 30 per cent competitively disadvantaged while another one with a gross profit margin of 60 per cent competitively advantaged? No, that’s not true. It’s not that plain and simple. It stops being a conundrum if you understand three things. Firstly, the merit of a company’s gross profit margin lies not in its absolute value, but in how it stacks up against its immediate peers. A company with a gross profit margin of 30 per cent while its competitors’ average gross profit margin is 25 per cent is better competitively placed than a company with a gross profit margin of 50 per cent while its competitors’ average is 60 per cent.
My efforts to find peers for Rajratan Global Wires with businesses nearly resembling its own, to compare their gross profit margins with Rajratan Global Wires’ and assess how competitively better positioned Rajratan Global Wires is, were almost unavailing, because Rajratan’s long-past decision to singularly focus on tyre bead wires was as much idiosyncratic as judicious it was. In the listed space, I couldn’t find any company other than Rajratan whose primary business activity is ‘manufacture of tyre bead wires’. If we can’t find closely resembling peers, we go for distantly resembling ones, because we must compare. This renewed effort towards a downgraded objective was not in vain.
Two distantly resembling peers among listed Indian companies, apparently, are Bansal Wire Industries and Bedmutha Industries; both are involved in steel wires, but tyre bead wires comprise only a small part of their overall business. Despite being aware of the clouds of uncertainty that will surely prevail over the merit of such an ill-suited comparison, I went ahead, and the results overwhelmingly favour Rajratan Global Wires in every possible sense in terms of the relative superiority and stability of gross profit margins; the 5-year median gross profit margins of Bansal Wire Industries and Bedmutha Industries at 19.9 per cent and 15.2 per cent respectively are overwhelmingly dwarfed by Rajratan Global Wires’ 38.5 per cent. A gross profit margin more than double and nearly double the gross profit margins of partly analogous firms, that too, at half their volatility, is a profile truly suited for an undisputed market leader.
Now, after considering to a reasonable extent the relative standing of gross profit margin relative to peers, the first aspect in assessing a firm’s competitive position, the second aspect of gross profit margin we must be aware of to assess a company’s competitive position is its variability over time.
A competitive advantage gives its possessor resilience against economic shifts, industry dynamics, and competitor behaviour. Akin to how mangroves protect shores by neutralising the undulating water waves rushing from the other side, a strong competitive position acts as a protective shield against economic waves (forces), which are mostly undulating but also sometimes capricious. A gross profit margin fluctuating, that too widely, in response to every variation of these extrinsic factors, is not the hallmark of a good competitive position. A gross profit margin less perturbed by extrinsic factors will remain steady and stable, signifying a better competitive position. Rajratan Global Wires’ gross profit margin’s standard deviation (the standard measure of variation), which stood at a concerningly high 4.2 percentage points seven years ago (in FY19), consistently diminished over the following years, to 1.8 percentage points two years ago (in FY24), and has more or less stayed steady there since then; for FY26, it stood at 1.9 percentage points. That I arguably consider a promising trend.
The third aspect is the trend. Not many things remain the same for long. Things change. Competitive advantages can wane over time, too. A relatively superior and stable gross profit margin, and the robust competitive position indicated by it, are never forever fixed but are susceptible, like everything else in this material world, to change and disruption, whether as a reaction to intrinsic or extrinsic economic forces. Eventually, all industries mature, and all products commoditise, reflected in companies as low growth, reduced profitability, and sluggish share prices. Companies whose bloodlines are devoid of entrepreneurship and innovation are marked for oblivion not far ahead in time from now in today’s complex economic landscape. The trend in gross profit margin, up or down, can to some extent inform us about this gradual and subtle loss or gain of competitive position. For Rajaratan Global Wires, 5-year gross profit margin lately stood at 38.5 per cent; five years ago, it was 38.4 per cent; the fact that it remained steady suggests the company has held on to its undisputed market leadership… for now.
These three aspects of gross profit margin are one way past numbers can be used to understand a company’s competitive position. Comprehension beyond numbers through the power of reasoning should be attempted as well. My humble attempt in that direction, which I describe ahead, fills me with a newfound reverence for the company because of what it unearthed.
There are certain products, services, or industry segments for which, by the nature of their economics, fortune greatly favours them, thereby translating into durable above-average growth and profitability for companies engaged in those businesses. Cost insensitivity and functional criticality are the two fundamental factors that give these businesses such favourable economics. If the cost of a specific product that goes into the production of another product is insignificant relative to the final product’s overall cost, purchasers are less likely to bargain over price. However, despite the negligible cost, if the proper and efficient working of this specific ancillary product is critical to the normal functioning of the final product, and if its failure comes with terrible consequences, then its producer definitely has greater leverage or pricing power in this bilateral producer-customer transaction, opening the gateway towards enduringly superior profitability.
Rajratan Global Wires, which a few decades back rightly decided to focus singularly on tyre bead wires and succeeded in maintaining that focus all the following years, resulted in them becoming India’s largest tyre bead wire manufacturer with nearly 42 per cent market share, and among the top five global tyre bead wire manufacturers; this principal product of tyre bead wires profusely possesses the two fundamental favourable aspects just mentioned. Bead wires constitute only 2–4 per cent of a tyre’s cost (cost insensitivity); their role in anchoring the rubber tyre to the metal wheel rim and resisting compressed-air pressure is critical to safe driving (critical functionality).
Valuation
The stock was trading at ₹65 per share in October 2020 at a price-earnings multiple of 11 and a price-to-book value of 1.75, an attractive valuation for a stock with a trailing return on equity of 18 per cent. Earnings and profitability rose rapidly from the September 2020 quarter onward and continued for eight consecutive quarters, which abruptly ended in the September 2022 quarter; from there, earnings and profitability declined for the next fifteen quarters. Because these developments are in the past, they are easy to see and understand.
Presently, although it provides hope that earnings and profitability, which have consistently declined for more than four years, are showing signs of bottoming over the past two to three quarters, we should be alert to the fact that a stock’s future price performance is not decided by its past earnings performance but rather by its future earnings performance, which may or may not deviate from the past pattern and is generally not foreseeable to any useful degree.
The key to navigating an uncertain future is to anticipate the unforeseen and expect the unexpected, which essentially is entertaining the possibility of errors or mistakes in our analysis; pretty unsettling for the analyst who put in the effort; a reason why an analyst’s work is best put to use not by him but by others, supposedly, a professional money manager, who, unlike the analyst, is not constrained to put a critical eye on the analysis and its conclusions. However, a handicap of such a segregation of money management work between the analyst and the money manager is that, by disallowing any skin in the game for the analyst, by forbidding him from viscerally experiencing the outcomes of the decisions his analysis brewed, his learning curve is terribly impaired. Interestingly, the ultimate sufferer of such an impairment is neither the analyst nor the money manager, but the person whose money these intermediaries manage. However, no segregation of money management tasks is warranted if the analyst has certain character traits: humble enough to have a detached, critical view of his analytical work and to accept the heightened fallibility that comes with any work dealing with uncertainty.
Unless under the spell that collectively besieges investors’ minds during those rare occasions of manias and panics, stocks are priced most of the time based on certain assumptions that investors hold about future earnings; they don’t expect future earnings to match the past exactly; neither do they expect future earnings to deviate drastically from the past. Currently, for Rajratan Global Wires, the trailing return on equity (earnings rate) stands at 12.0 per cent while the current market price (₹500 per share) discounts a return on equity of 21.50 per cent. The fact that investors are discounting a much higher rate of earnings into the current market price than the prevailing rate of earnings is because they believe the prevailing rate to be depressed and transient; they also believe the earnings rate will soon rise from the allegedly depressed level towards its natural rate, which they assume to be the rate of earnings reflected in the current market price. They can’t be blamed for their assumptions; the earnings rate (return on equity) has stayed above 21 per cent in seven of the past ten years; its median value during the period stands at 22.0%.
However, with a price-earnings multiple of 40 and a price-to-book value of 3.90, either way you look at the valuation, few are likely to descry any margin of safety, the hypothetical cushion that buffers investors against adverse developments before they (investors) start suffering losses. If the prevailing earnings rate (12%) is to continue for some time, then perhaps investors doubting the plausibility of their assumed natural earnings rate (21.50%) might eventually decide that changed circumstances necessitate toning down of their assumptions about the natural earnings rate; the decision is incorporated into market prices by driving them lower, gradually or rapidly (the choice being a very random one).
For instance, let the new, tempered assumed natural earnings rate be 18 per cent for Rajratan Global Wires; the appropriate share price reflecting that rate is around ₹232 per share, more than 50 per cent lower than the prevailing market price. In contrast, if the earnings rate improves going forward, and for that improvement to raise investors’ expectations of the appropriate earnings rate for Rajratan Global Wires from the already elevated prevailing expectations, earnings would need to jump substantially from current levels. So, in sum, at the prevailing trailing earnings rate, investors may reduce earnings expectations, which could cause the stock price to fall. Meanwhile, for them (investors) to augment their expectation, which can essentially ignite a rising stock price, a large advance in earnings is warranted. In short, the risk-return ratio for Rajratan Global Wires currently looks like this – above-average losses (risk): mediocre returns (return), indicating that the odds are against us.
Margin of Safety
Indeed, I am excited and optimistic about the stock. But that is not a diligent reason to purchase the stock. Investment decisions are judicious only when preceded by detailed analysis grounded in the right facts and reasoning; excitement and optimism are more likely to lead us astray. So far, our analysis of Rajratan Global Wires paints a picture of a high-quality company with a durable competitive advantage and bright prospects. Yet, it lacks any sense of margin of safety. If I try hard enough, I can recall a few instances from my past investing experience where being too adamant about a margin of safety led me to discard certain stock ideas that later delivered exceptional returns. Although margin of safety might be the backbone of a sound investment policy, being too rigid about it often causes us to miss great opportunities. The reason isn’t margin of safety per se. It usually backfires only when applied in a mechanical, formulaic way, irrespective of the varied context each stock idea resides in; such as, I won’t buy a stock at any price above a price-earnings multiple of 18, or else, I won’t buy any stock at a price-to-book value greater than 2.0, such and such.
Investors were first introduced to the concept of ‘margin of safety’ in the seminal investment classic Security Analysis by Graham and Dodd, published in 1934. Another of Benjamin Graham’s books, The Intelligent Investor, published in 1949 and written mostly for the ordinary investor, further popularised the concept. No subsequent concepts or theories have provided the giant leap that the ‘margin of safety’ concept bestowed on the field of security analysis, except perhaps ‘Prospect Theory’ by Kahneman and Tversky and the ‘Black Swan’ concept by Nassim Nicholas Taleb. Both may come close to matching the contribution but never supersede it.
Margin of safety is a concept or tool that helps us think through a stock’s risk-return prospects, so that we don’t get into situations of mediocre prospective returns but large, irrecoverable prospective losses. At the same time, we must ensure, in the process of confirming sufficient margin of safety in an investment situation, we don’t miss out on above-average return opportunities. I typically seek investment situations where, when business performance improves, the stock delivers exceptional returns, while if it doesn’t, no material losses on invested capital ensue. A sufficient margin of safety is the quality that gives an investment situation these merits. However, the source of margin of safety doesn’t lie in the present economic conditions or the respective company’s business performance, but rather in the market price of the respective company’s stock, or to be specific, the price at which you purchase the stock.
I surmise no margin of safety in Rajratan Global Wires’ stock at the current market price of ₹500 per share. It might be hard to digest at first that things haven’t yet turned favourable despite all the suffering of the past three to four years. The large decline in the market price since September 2022, which saw the market price decline by 60 per cent or more, was closely followed by a significant earnings decline as well; it is quite reasonable for us to deduce a causal link between them, inferring that the earnings decline precipitated the price decline, while what it really was was that the market price gave up the massive excesses accumulated during full-year 2021 and the first half of 2022. The current market price may convey a false sense of safety, given where it stands today relative to its recent past, a significant discount from its all-time peak four years ago. Giving up excesses is not synonymous with the emergence of a margin of safety. Given where things stand now for Rajratan Global Wires, there is significant downside risk if the earnings rate continues at the current level or declines; in contrast, a large earnings increase is needed before any significant upside prospects emerge.
Hard to desist after all the propitious things we have learned about the stock over these few days, yet now is not an appropriate time to entertain Rajratan Global Wires from the perspective of investment merits; its market price currently has no margin of safety, and this is the leading and only reason for the stance. The aspired-for margin of safety may never arrive, a bane that typically befalls many a stock once they become widely discovered. I sense a deleterious preoccupation with this stock, which presumably has something to do with the decision not to invest in 2020. I made every decision in 2020 with what I knew then. The hindsight that instils guilt now, for forsaking the stock six years ago, is based on what I know now. The guilt lacks sound basis. I made a choice, and its outcome had a huge opportunity cost; that’s exactly what happened with me regarding Rajratan Global Wires. The sad feeling that typically follows such experiences is regret, which is normal and harmless, and can even be harnessed for progress. However, guilt is what you feel when you believe you have done something wrong, which in this case is an apparent no. Guilt has a haunting, destructive aspect about it that, if not promptly addressed, can make life miserable.
Guilt
This piece began as a contemplation of what happened to the stock of Rajratan Global Wires over the past six years; the stock chart showed that period was eventful; evaluating investment prospects was less the motivation; the main purpose was understanding. However, the discussion now slipping into a discourse on guilt seems to be too much of a transgression. Yet, by the nature of an endeavour whose outcome is heavily influenced by an uncertain future, most investment decisions tend to produce some degree of adverse outcome; the possibility of those adverse outcomes engendering guilt within is very much alive; such guilt, when accumulated over the years, is very likely to tarnish the quality of later decisions. However, recognising this emotional risk and addressing it rightly can go a long way toward maintaining the quality and effectiveness of our investment decision-making process.
Guilt arises when we attribute adverse outcomes to having done something wrong. The usual approach people employ to deal with guilt is to remain unaware of it through suppression, repression, expression, projection onto others, or blame; these never solve the problem but instead accumulate guilt in the subconscious mind over years, which eventually manifests in our lives through varied misfortunes. However, the most insidious aspect of guilt is the terrible misery it gives rise to. This misery is self-generated: subconscious emotional self-punishment when no external punishment for our wrongs is meted out. We are all programmed at a very young age how we ought to be, what we ought to do and achieve, and most of us believe, or pretend to believe, we have a great degree of agency over this program. In reality, the program’s code is nearly entirely written by our parents, immediate family, community, employer, society, political and religious institutions, to enslave and exploit us for their petty selfish interests, because they themselves have failed to deal with their own accumulated negative emotional baggage. Instead of working on climbing out of the hellhole they are in, they would rather manipulate innocent others into it. This way, we have been made pawns meant to soothe their wounds, thereby concealing our true nature from us, and distancing us from virtue and understanding, and the joy that follows them.
Guilt is the most effective weapon for mental entrapment: either we have sinned, or else whatever we do is never enough; the ever-haunting desire to do more, to get better, has its origin in guilt. The answer to guilt, to permanently dissolve the long accumulated guilt, is to empower ourselves to see through the trickery played on us, the unaware programming installed in us, by varied nefarious entities. For instance, the previous day, I watched a movie late into the night, one I have wanted to watch for some time, due to which I woke up late today and missed my regular morning brisk walk. I can sense my nurture (the programming) trying to induce guilt over missing the routine (which has negligible effect on my quality of life) and make the rest of the day miserable. But I understand I have a choice not to. A choice not to stay the entire day miserable over a trivial slip-up and thus miss all the opportunities for joy the rest of the day has to offer.
Every time you feel miserable or distressed, know that you are not a victim; rather, it was a choice you made. However, your programming makes you believe you never have a choice. Know that you may not be able to control what happens to you on the outside, but on the inside, how you respond to what happens to you, there is always a choice. And this choice is whether to be joyful or miserable. This choice strongly influences the quality of your later life. For joy, let your choice be guided by love, hope, and compassion; in contrast, if your choice is guided by fear or hate, you choose to be miserable. Surely, the programming will attempt to put strong barriers in place to prevent you from discovering your true worth because once you know your inner innocence – the source of love, and the abode of your true worth – you are free and thus no longer available to enslave, exploit, or manipulate. Moreover, you have your own inner demons to deal with: the fear that this journey of self-discovery might reveal some dreadful, awful truth. Anyway, once you break through this barrier, you realise you weren’t bad or less, but just ignorant, and briefly feel anger about it, which soon subsides, and before long you move on to liberate yourself. Lightness is a sign of progress in this journey: the lightness you feel as you gradually shed your illusions, falsehoods, and other negative constructs.
Final Thoughts
Those who trod the path of investing don’t often know that it was a choice that put them on this path: the choice to be courageous. What quality other than this would have allowed a person to choose a path that is nowhere near the preferred list of paths that society wishes for young and aspiring individuals entering the real world? Not long after embarking on this path, I have been putting in strenuous efforts to dodge questions about the nature of my principal vocation to avoid the deep revulsion often revealed in the querier’s speech and body language on previous occasions when I answered it.
Nevertheless, by the very nature of this chosen path, at the end, slip-ups are indeed to exceed rightness substantially; a fertile ground for guilt to germinate and pervade our mind. But this adversely skewed ratio between slip-ups and rightness doesn’t decide the quality of our investing journey, unless we want it to, or allow it to. Whether this journey turns out to be the enriching one it rightly is or miserable, it all depends on the traveller. It is a choice between joy and misery. Who would choose the latter one, anyway? Unfortunately, humans have fallen for it from time immemorial. Hopefully, now that we know we have a choice, we can do better.
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