IntraSoft Technologies Limited : Recent Developments

I would not provide details analysis of recent quarterly result , It has superb numbers . I was expecting revenue of 270-280 cr for full year but now we will have to increase that target to 340-350 cr since last 12 months trailing revenue is already around 290 cr .

I would like to focus on behind the scenes development . I have identified 2 developments .

First development .If you visits https://www.linkedin.com/jobs2/view/25829786 then you can see that they are looking for V.P. Corporate Finance at 123Stores.com . This job advertisement has following description .

S/he will work with the founders to collate data, present to investors and be the central figure in closing each transaction.
The V.P.'s responsibilities will include:

•   Collating, preparing and analyzing complicated numerical information.

•   Compile and pitch presentations to the Investors.

•   Liaise and identify appropriate Investors.

•   Participate in the negotiation of term sheets, due diligence and the preparation of
      definitive documents.

•   Investor Relations.

Management has taken tiny step in right direction by seeking profession help instead of doing each and everything themselves .

Second development .

They have mention during quarterly result announcement "To increase our focus on the E-Commerce business, a new company was set-up in USA under the name of 123Stores, Inc. to carry out the E-Commerce operations. " This looks bit confusing for existing investor since we were already aware about 123Stores, Inc. But they actually means 123Stores was under 123Grectings.com, lnc.  Now it is moved from 123Grectings.com and became direct subsidiary of Intrasoft technologies .

If you connect both the developments then we can come to conclusion they are looking for funding for their  E-Commerce business . So, I will not be surprise If see first round of funding for 123Stores, Inc in next few months . They can start with around 10 % but they will have to make sure after few funding rounds their holding should not drop below 50% else it will become their associated company .

Benefits of Funding :
No doubt about it will bring dilutions . But it will help company to accelerate it growth further . We should appreciate the company for getting this much growth with internal accruals .We don't know what should be the correct valuation for Intrasoft but this funding may give some hint for valuation of the company .


Worst case for E-Commerce in India :
        All the E-Commerce running their business on mercy of state govt policies . If all the state follows rules & regulation like Uttar Pradesh does then all the E-Commerce companies will be on their knee .Right now , We don't need to worry about it for Intrasoft . I am not CA but may be GST will make life of E-Commerce companies comparatively easier  .

Most of the E-Commerce companies are not accepting order from Uttar Pradesh  including Noida . All most all the courier companies like Blue Dart , Fedex has stopped shipping to Uttar Pradesh .The  following process is the reason behind it . They don't even have any minimum limit for item value to follow following process . So, if buyers order even 200 worth of item he has to follow this process .

Uttar Pradesh  Process:  
Non-commercial shipments addressed to individuals, Govt. Agencies and unregistered dealers require to be accompanied with Form 39.

Forms 39 are in 3 parts marked original, duplicate, triplicate. Original part is retained by Sales Tax department of check post at the time of entry and the duplicate delivered to consignee along with the shipment.

Form 39 are issued by UP sales tax authority. Form 39 is valid for one month only. Validity of Form 39 is mentioned on the form.

These forms are obtained by the consignee(buyer) signed & stamped and the triplicate copy is retained by the consignee and the original and duplicate are sent to the consignor(seller) by consignee (buyer). The original and duplicate copies of these forms as applicable should be signed and stamped by consignor (seller), consignee (buyer) and sales department of UP.

Form 39 without signature and stamp of Sales tax department of UP is not valid. It should be properly filled with stamp and signature of consignor & consignee.

Collect original & duplicate of these forms as applicable from the consignor(seller) at the time of pickup.

Check whether the forms bear the signature of the consignor & consignee and are properly filled.

If the sales officer finds the goods are undervalued then a penalty of up to 40% on the assessed value is levied.

The consignee(buyer) either pays the penalty for clearing the shipment or has to prove to the sales tax officer the correctness of invoice value to get the penalty waived.

Again , I am not CA their might be some other if else conditions for E-Commerce companies but if it is current process in UP then why individual buyer will take all this pain ?


Worst case for Intrasoft : 
I don't believe in theory of  that big E-Commerce companies are going to finish all small E-Commerce companies . In case of IT all bigger companies become more bigger but small remain small or got finished . But that not be true in case of E-Commerce since in IT Industries the main customers were big companies they needed scale and expertise . But in case E-Commerce there might be some customer become loyal to biggies but there will be always some customers who will chase low price and even can become loyal to small E-Commerce companies if this small companies concentrate on customer stratification instead of increase in GMV . Big companies can acquire small companies and consolidate industry but with my limited understanding I can say that they can't kill all the small E-Commerce, may be some will die natural death .

 Nevertheless , if you assume that after 5-10 years only top 4-5 player will be exist in  E-Commerce industry then in that case also Intrasoft will not go to dust due to company's business model . Right now, It generates revenue firstly from direct sale at 123stores.com and secondly it generates revenue from shop in shop ( marketplace inside marketplace) format from companies like Amazon . If Amazon is going to survive then there is good chance even Intrasoft will also make some money .Their platform integrated with Amazon is in production and they are still working on similar platform for Alibaba .

This it the all information available in public domain If any brokerage house setup a conf call then we get some details in deep . Not sure, if currently any brokerage house is following this stock .

Conclusion : Intrasoft Technologies Ltd (CMP 45)

I had posted on Intrasoft Technologies Ltd here

Now posting follow up and conclusion .

Retail e-commerce market potentials : 

The Indian e-commerce(all including retail and travel) market is estimated at $11 billion. It is expected to stand at $20 billion by 2015, a compounded annual growth rate (CAGR) of 37 per cent through 2013-15, according to a recent report by Motilal Oswal Securities. The e-retail segment would be the biggest growth driver (with an expected CAGR of 60 per cent), increasing from $1.7 billion in 2013 to $7 billion in 2016, it added .
Pramod Kumar, managing director, Barclays Capital India, said, “The online retailing segment in India today accounts for a mere 0.5 per cent, compared with 8-13 per cent in developed countries. The sector is expected to grow sevenfold to $30 billion by 2020 and the number of e-shoppers could grow from 20 million to about 90 million. Clearly, India is a massive e-commerce opportunity, which cannot be ignored.”

Source : http://www.business-standard.com/article/finance/softbank-turns-largest-investor-for-indian-e-commerce-cos-114121700329_1.html


Today (18 Dec), Qatar fund invests $150 million in Flipkart . QIA is the new investor buying into Flipkart, valued at around $11 billion (more than Rs 68200 crores at conversion rate of 62) , taking it among the top five privately held technology startups in the world.

Source : http://timesofindia.indiatimes.com/business/international-business/Qatar-fund-invests-150-million-in-Flipkart/articleshow/45556408.cms

I know it it is at crazy valuations but Early investors are making huge money . It may follow "greatest fool theory" . However , They are not investing because of charity , They might have their own reasoning. All the retail e-commerce players are making huge losses but It doesn't matter for them since they are concentrating on future and trying to achieve economical scale first like Alibaba did .

SoftBank’s $20-million investment in Chinese e-commerce group Alibaba in 2000 is now worth $86 billion, following the Chinese company floating an initial public offering in the US. That is very very huge return . They had patience in early stage when Alibaba was making losses and that time Alibaba was not listed . Mr market does not give good valuation to companies which are under investment stage unless promoter has proven track records . Same times it throws opportunity to buy companies whose valuation are cheap , past is not good but future is bright . Retail e-commerce is such huge opportunity that even companies with decent management will also do reasonably good .

Conclusion :
By seeing comments , email and Market Price , I feel most of them suggested to ignore Intrasoft due to it past performance . Most of them also not realizing how big is retail e-commerce opportunity . So , I have decided to invest 2.5 percentage of my portfolio (May be risky bet) regardless of all concerns like deprecation write off, past track records  .I will allocate more money based on future fundamental changes . I am sure if company does not do any fraud and promoters have good intention for minority shareholder then I believe I will make some return in this if I can wait for long regardless of noise.Same time I will keep watch on fundamental changes and my assumptions that they will launch http://123stores.com in India. If they sell other business (websites) and just concentrate on future that is http://123stores.com (USA, Canada, India and other countries) then that will be added advantage. My logic is simple If retail e-commerce market grows like expected and stabilized(start making money) then not only Flipkart and Snapdeal is going to make money there will be few small players in retail e-commerce will also make money . Indian consumers are going to be loyal to discount and value for money and not only to big brands like FlipKart or SnapDeal . Flipkart and Snapdeal will be get listed in future once they start making money to give exit to early investors. But we don't have any other opportunity right now in listed space of retail e-commerce apart from Intrasoft technologies. Right now, I am looking like contrarian fool and alone investor .

We are shopping from USA based companies like Amazon and eBay here in India . If any of your friends and relative is in USA then please request them to buy any low price item from http://123stores.com/ for experience . Please don't buy anything which is not needed .

If you are interested in reading multiple blogs from other blogger then please open your account on http://www.feedly.com/ which I find good to read and track all blogs .

 P.S. (on 25 Dec 2014)

Magic of Compounding :  Why Venture Capitalist are investing in loss making companies ? Because , they are have their own assumptions and firmly believe in power of Compounding . I tried number crunching and Magic of Compounding on Intrasoft and numbers were unbelievable . So, I initially thought I am not going put these numbers since I will be look stupid and I did similar exercise for Indsil but those variable never turned positive so I sold recently my entire holding in Indsil . I have changed my style of investing from 2013 and moved towards growth . I feel little better investor If I see my portfolio, most of those stocks I have not disclosed here , frankly most of successful stock ideas are borrowed one from others (No intention to return them back:))  . Nevertheless , I collected some courage and put the magic of compounding on Intrasoft even though I will look stupid but I am not alone some Venture Capitalist are also looking similar:) .

Intrasoft Technologies's 123Stores can earn revenue/profit in future from Transaction Fees , payment Gateway fees(net off paying to actual gateway charges) ,  Vendor Subscription monthly fees , Advertising (like AdWords ,AdSense) , Other Affiliate marketing, From Channel Partner ( sending email to their register customers of channel partner like insurance company) and shipping charges (net off paying to courier companies).

Whenever , these e-commerce companies will chase profit instead of GMV (GROSS MERCHANDISE VALUE) then they can earn profit margin of 7-12% (not more than that) on GMV .

Let's assume Intrasoft Technologies's 123Stores will earn only 5% (worst case scenario) net profit margin once e-commerce stabilized and concentrating on profit .

123Stores reported record sales over the long holiday weekend from Thanksgiving Day through Cyber Monday of over $2 million, a 243% percent increase over last year .I can trust number of 123Stores because they are showing audited numbers with annual report of subsidiary in USA. These numbers are audited by ZBS Group, LLP . New York .Click here
 If they start their operations in Canada and India then this growth may be increase further but assume for margin of safety that they just grows by 55% against current 200% plus compounding .

So there 4 assumption in the my following calculation
1. I can hold it from 4 year to 10 years provided that I do not smell something wrong/fraud .
2. NP margin of only 5% of sales /GMV
3. Sales /GMV growth of 55% compounding for first 4 year then 30% for next 3 years then 15% for 8 to 10th years period.
4. Equity dilutions of 20% for 4 years period , 30% for 7 years and 40% 10 years period.


Now , lets consider 3 periods when they will profitable either in 4 years or  7 years or 10 years . I can hold these share long term at least for this period as long as my assumptions on track . I will have to take call if assumptions get off-track depend on circumstances .

This year they will show at least 270 crores of sales ( last 4 trailing quarters already 220 crores ) we will start from that .

Try : http://www.moneycontrol.com/personal-finance/tools/magic-of-compounding-tool.html

	4 Years	7 years	10 years
GMV/Sales	1558 (55% compounding)	3422 (30% compounding from 5th year to 7th year)	5204(15% compounding from 8th year to 10th year)
Profit@5%	77.9	171.1	260.2
Mcap @ 10 PE (Cr.)	779	1711	2600
Share price @ 20% Equity Dilution	Rs 423
Share price @ 30% Equity Dilution		813
Share price @ 40% Equity Dilution			1059
Mcap @ 15 PE (Cr.)	1168.5	2566	3900
Share price @ 20% Equity Dilution (15 PE)	634.5
Share price @ 30% Equity Dilution (15 PE)		1393
Share price @ 40% Equity Dilution(15 PE)			1588

Numbers look unbelievable , This stock price for me can be achieve if 4 assumptions remain on track which I don't think unreasonable either . Is 5% NPM is unreasonable ? Is 55% CAGR in sales for first 4  years is  unreasonable for sun rising e-commerce sector ? Is equity dilutions unreasonable ? For me , answer is not unreasonable .

Another import point , Intrasoft Technologies Ltd should not be get delisted .

We can get good return in any growing quality stocks but we can get impressive return /multibagger if we are early investor and market has not discovered potential of that stock .Right now , so far only Venture Capitalist Intel has invested in it. If Intrasoft Technologies get some other investors(or even some good stock picker investors/brokerage houses) then It will start getting valuations based on sales, first 1x then 1.5x like that .Journey has just started let's see where it take us , hope not backward at least .

If you are interested in reading multiple blogs  from bloggers (including stupid like me) then please open your account on http://www.feedly.com/ which I find good to read and track all the blogs .

This will be last post for this year . So ,wish you very happy and prosperous new year 2015 . I hope your compounding m/c for other investments continue with same or higher speed .

Hidden Treasures and e-commerce Play : Intrasoft Technologies Ltd (CMP 52)

           As per new regulations of SEBI, it seems that only SEBI qualified research analyst can express buy , sell , hold , accumulate etc. recommendation about a stock through any public media. SEBI has given six months time(May2015) to comply with it for existing research analyst .I am not SEBI qualified research analyst but I am aspire to become research analyst in next 3-5 years .So , purpose of this blog learn and put analysis of company with whatever I know and get input from SEBI qualified research analysts . I am sure this learning method will help me to become SEBI qualified research analyst one day.I think this rule is quite appropriate since how can person like me who is still learning give any opinion of buy , sell particular stock.

              Today, I would like to get input on "Intrasoft Technologies Ltd" . Since you are experience research analyst you will say what is special here . They have www.123greetings.com which offer greeting services free of cost, generate revenue from add services and as per current market cap trading fairly .

            My interest in this counter is not generated because of www.123greetings.com but something else . Look at the following screen shot and let me know if a e-commerce company in USA growing with these figures wouldn't attract your interest . How much will you pay for this company ?

Source : http://www.inc.com/profile/123stores


This is nothing but http://123stores.com/ e-commerce division of 123greetings.com USA which is wholly own subsidiary of "Intrasoft Technologies Ltd" .

 Please look into following links for highlight of last quarter . We cannot compare data directly with Snapdeal and Flipkart . It is growing fast with small base , same time present tremendous opportunity for me to participate in growth of e-commerce since very few e-commerce companies are listed like Info Edge , Just Dial etc. Those are available at high valuations and already discovered by market .
http://www.itlindia.com/investor-relations/press-releases/Intrasoft-Technologies-Limited-Reports-128-Growth-In-Revenues-For-Q2-FY-2015
During the quarter they entered the US Internet Retailer Top 500 list at 499 from last years more than 650.

I still need to analysis business model but as per my initial analysis it generate revenue by two ways .
1. Partnership with other top USA marketplaces (“shop in a shop” format) like Amazon, Ebay .We can describe in another words as marketplaces inside marketplaces .If it get commission from register vendors and not hold actual inventory . I do see quite low inventory in balance sheet .
2. Direct sale from http://123stores.com/ . I believe this is small portion at the moment since as per Alexa only around 5000 unique visitor visit daily this site but that count is also growing fast .
 http://123stores.com.alexaview.com/

 Open question to management .

1.  What is mix of above mention channels ? 
2.  You mentioned "Our growth in the E-commerce business can be directly attributable to the strength of our proprietary enterprise software" . What are these strengths ?

 I do also see good growth potential in http://www.123invitations.com/ but they need to make UI impressive and add few more value added features.

 123Stores, Inc, reported record sales over the long holiday weekend from Thanksgiving Day through Cyber Monday of over $2 million, a 243% percent increase over last year. The Company sold one item every 7 seconds on Cyber Monday.
 Please refer http://www.webwire.com/ViewPressRel.asp?aId=193500#.VIhzAdKUf3Q


 Shareholding pattern:

Kotak Mahindra Investments Ltd was holding around 6% share but recently they have release around 3% share . Not sure who has pledge those share since no promoter shareholding was pledge may be some HUF . As you can see retail investor holding is not even 10% in this stock . All the shares are in strong hands .
"Intel Capital (Mauritius) Limited" also hold around 12% of "Intrasoft Technologies Ltd" which gives confidence but I believe it is may be just strategic investment by Intel .

Corporate Governance :

I am still learning to scan corporate Governance level . I have not found any red flag as such . Just need to dig more on Kotak Mahindra Investments Ltd's release of shares . I saw around 465 crores of cash in balance sheet of 2009-10 but next year was reduce to just 3 crores . I was at my wits end to figure out where they have spent so much money or spinned off but when I check annual report of 2010 and 2011 then I realized it was IPO money company had received(before financial year ending) due to over subscription and returned it next month(year) . So no issues on this front .
"Intrasoft Technologies Ltd" also put audited annual reports of it subsidiaries on their website that is good move .http://www.itlindia.com/investors/financials.html

Valuation :
          e-commerce companies are getting valuation based on sales instead of PE . The range stars from 3x and goes to 7-8x . "Intrasoft Technologies Ltd" has sales of around 220 crores in last trailing 4 quarters and expected to finish this financial year with more that 280 cr of revenue . It has only 75 crores of market cap right now .

E-commerce companies need lot of time to start making money so we should concentrate on top line instead of bottom line

Alibaba for the first 10 years continued to make a loss, it was only in last three years that they started making money and this year it was several billion dollars of net income and it is growing very quickly. They were not in a rush to start making money; rather they created a robust platform, good services and good number of merchants on the platform. As per them This is still the investment stage and not the harvesting stage.

Apart from top line growth and debtor turnover ratio nothing looks good for this company but that is the case with most of ecommerce companies when they are in investment stage .

Future Plan :
       They are going start using platform of Alibaba similar to Amazon ."Intrasoft Technologies Ltd" is also planning to launch same platform in Canada which will again help top line to grow and obliviously they will target India as well . If that happen then top line growth will again get some boost . Management has also indicated that "We continue to focus on growing the business and re-invest the cash surplus’s back into the business. As a result, in the short term, the bottom line may not correspond to the topline growth but we are confident that once economies have reached, it will yield even greater financial results."  They can easily leverage huge database of customer base of www.123greetings.com to promote new e-commerce website.

Conclusion : 
             It is not Flipkart or snapdeal , business model may not be same but for me it is Flikart or Snapdeal of poor man. If it achieves even 3-4% of flipkart in next  4-5 years then that will sufficient to create some wealth.I am sure If I dig more then I will get few more positive and negative but at current market price of 52 market cap of company is only around 75 crores , growing fast, it holds cash around 8.33 crores and dividend yield is around 2% . I believe at this price I am not going to loss much but if not all the things but most things click for this company then sky is the limit who knows. I would like to get input from qualified research analyst on my analysis made for myself .

IRDA Insurance claim settlement ratio/data 2012-13.

Online term insurance is getting quit popular day by day . Most important criteria to compare are ...

1. Claim settlement ratio 
2. Size of insurance Company / No of yearly policies issued .
3. The Fine Print – Terms & Conditions.
4. Insurance Premium 

Some of the insurance companies give late surprises of increase in premium after medical test . So , before applying make sure how much refund you will receive in case you gets late surprise of hike in insurance premium and not wish to continue with same policy .

I think most important data to compare is claims repudiated data instead of plain claim settlement ratio . Most of the insurance companies repudiate claims with higher amount which give them two befits first improves their bottom line(profit) in P&L accounts and secondly it does not harm much to their claim settlement ratio since claim settlement ratio is based on number claims . Generly, claim settlement ratios is mostly looked by insurance buyer while comparing policies.

So , if you are buying term insurance with comparatively low sum assured then you should look into claims repudiated Number (declined) percentage . But if your sum assured is high then you should look into claims repudiated benefit amount percentage instead of just plain Claim settlement ratio while comparing policies  .

IRDA Claim settlement data for FY 2012-13 .

If you are investor of Max India Ltd then you will see last year company has improved lot on Claim settlement parameter . It will bring more business to them if they maintain it for coming years as well . No doubt Max India need to improve on repudiated(rejected) benefit amount percentage front .

One more interesting observation about ICICI Prudential and HDFC Standard . ICICI Prudential is claiming best pvt sector insurance settlement claim ratio of 96.29 but rejected claims count percentage of I HDFC  Standard(2.62%)  is better than ICICI Prudential (3.63%) and claims repudiated(rejected) benefit amount of HDFC  Standard(6.22%)  is far better than ICICI Prudential (8.57%) . Almost all the major insurance companies are having claims repudiated benefit amount percentage is higher than repudiated (rejected) Numbers of policies count  percentage . However , There is only one major exception is SBI Life which has  repudiated (rejected) Numbers of policies count  percentage (3.69 %) vs claims repudiated(rejected) benefit amount percentage (2.68%)

Note : Claim Settlement Ratio refers to the % of claims settled by an Insurance Company against the number of claims submitted . Ideally it should be 100 - repudiated (rejected) Numbers of policies count percentage but some policies goes on hold or carry forward to next year.

Motilal Oswal : 18th Wealth Creation Study(2008-13)

Weekend reading

18th Wealth Creation Study(2008-13): Uncommon Profits - Emergence & Endurance by Ramdev Agrawal 

http://www.motilaloswal.com/Financial-Services/Research/Detailed-Report/Wealth-Creation-Study/7971

Intresting Annual Report

Please look at the interesting snaps shots of annual report of small cap Vikash Metal & Power Limited.

How can news channel skipped this masala news of more than 90 crores robbery ?  Why not RGV making movies on it ? But , I believe it has enough material for Madur Bhandarkar to make Corporate -II .  What's your thought ?

Value Investing Queries Answered by Charlie Munger

      

            Failure sure is the best teacher as long as we learn from our mistakes.

Failure is simply the opportunity to begin again, this time more intelligently. I have faced few failures by net net value investing. I would like to do investing more intelligently by moving from net-net of Ben Graham to Charlie Munger’s invest in quality business for very long time investing.

       In an article he published in 2006, the magnificent Munger describes the “Art of Stock Picking” . This article gives answers to lots of curious queries in mind of value investor.I am trying to answer those queries by “Art of Stock Picking”  article of Charlie Munger. It is Gita and the bible of value investing. These are just answered I interpreted from the article and not actual conversation with Charlie Munger.

Why net-net of Ben Graham is not working for an Indian value investor like me ?

Charlie Munger : Graham was, by and large, operating when the world was in shell shock from the 1930s ‑ which was the worst contraction in the English-speaking world in about 600 years. Wheat in Liverpool, I believe, got down to something like a 600-year low, adjusted for inflation. People were so shell-shocked for a long time thereafter that Ben Graham could run his Geiger counter over this detritus from the collapse of the 1930s and find things selling below their working capital per share and so on.

     And in those days, working capital actually belonged to the shareholders. If the employees were no longer useful, you just sacked them all, took the working capital and stuck it in the owners' pockets. That was the way capitalism then worked.

      Nowadays, of course, the accounting is not realistic because the minute the business starts contracting, significant assets are not there. Under social norms and the new legal rules of the civilization, so much is owed to the employees that, the minute the enterprise goes into reverse, some of the assets on the balance sheet aren't there anymore

Warren Buffett was considered as Graham’s student and a great follower of the Graham in his early days . How much Berkshire Hathaway made by following the value investing style similar to Graham’s ?

Charlie Munger : The bulk of the billions in Berkshire Hathaway have come from the better businesses. Much of the first $200 or $300 million came from scrambling around with our Geiger counter. But the great bulk of the money has come from the great businesses.And even some of the early money was made by being temporarily present in great businesses. Buffett Partnership, for example, owned American Express and Disney when they got pounded down.

        However, if we'd stayed with classic Graham the way Ben Graham did it, we would never have had the record we have.

How did you evolve from classic Graham way investing to great business investing?

Charlie Munger : Graham didn't want to ever talk to management. And his reason was that, like the best sort of professor aiming his teaching at a mass audience, he was trying to invent a system that anybody could use. And he didn't feel that the man in the street could run around and talk to managements and learn things. He also had a concept that the Management would often couch the information very shrewdly to mislead. Therefore, it was very difficult. And that is still true, of course human nature being what it is.

    And so having started out as Grahamites which, by the way, worked fine we gradually got what I would call better insights. And we realized that some company that was selling at 2 or 3 times book value could still be a hell of a bargain because of momentums implicit in its position, sometimes combined with an unusual managerial skill plainly present in some individual or other, or some system or other.

       And once we'd gotten over the hurdle of recognizing that a thing could be a bargain based on quantitative measures that would have horrified Graham, we started thinking about better businesses.

       We've really made the money out of high quality businesses. In some cases, we bought the whole business. And in some cases, we just bought a big block of stock. But when you analyze what happened, the big money's been made in the high quality businesses. And most of the other people who've made a lot of money have done so in high quality

Businesses.

Tell us something about the lousy textile business of Berkshire Hathaway ?

Charlie Munger : We were in the textile business, which is a terrible commodity business, we were making low-end textiles which are a real commodity product. And one day, the people came to Warren and said, "They've invented a new loom that we think will do twice as much work as our old ones." And Warren said, "Gee, I hope this doesn't work because if it does, I'm going to close the mill." And he meant it. What was he thinking? He was thinking, "It's a lousy business. We're earning substandard returns and keeping it open just to be nice to the elderly workers.But we're not going to put huge amounts of new capital into a lousy business." And he knew that the huge productivity increases that would come from a better machine introduced into the production of a commodity product would all go to the benefit of the buyers of the textiles. Nothing was going to stick to our ribs as owners.

That's such an obvious concept ‑ that there are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that's still going to be lousy. The money still won't come to you. All of the advantages from great improvements are going to flow through to the customers.

Conversely, if you own the only newspaper in Oshkosh and they were to invent more efficient ways of composing the whole newspaper, then when you got rid of the old technology and got new fancy computers and so forth, all of the savings would come right through to the bottom line.

       So you keep buying things that will pay for themselves in three years. And after 20 years of doing it, somehow you've earned a return of only about 4% per annum. That's the textile business. And it isn't that the machines weren't better. It's just that the savings didn't go to you. The cost reductions came through all right. But the benefit of the cost reductions didn't go to the guy who bought the equipment. It's such a simple idea. It's so basic. And yet it's so often forgotten.

What is “circle of competence” idea ?

Charlie Munger : Again, that is a very, very powerful idea. Every person is going to have a circle of competence. And it's going to be very hard to advance that circle. If I had to make my living as a musician.... I can't even think of a level low enough to describe where I would be sorted out to if music were the measuring standard of the civilization.

So you have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don't, you're going to lose. And that's as close to certain as any prediction that you can make. You have to figure out where you've got an edge. And you've got to play within your own circle of competence. If you want to be the best tennis player in the world, you may start out trying and soon find out that it's hopeless ‑ that other people blow right by you. However, if you want to become the best plumbing contractor in Bemidji, that is probably doable by two-thirds of you. It takes a will.It takes the intelligence. But after a while, you'd gradually know all about the plumbing business in Bemidji and master the art. That is an attainable objective, given enough discipline. And people who could never win a chess tournament or stand in center court in a respectable tennis tournament can rise quite high in life by slowly developing a circle of competence ‑ which results partly from what they were born with and partly from what they slowly develop through work.

So some edges can be acquired. And the game of life to some extent for most of us is trying to be something like a good plumbing contractor in Bemidji. Very few of us are chosen to win the world's chess tournaments.

Why investors don’t always invest in great business stock when you say it is not hard to figure out the great business stock ?

Charlie Munger : The model I like to sort of simplify the notion of what goes on in a market for common stocks is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based on what's bet. That's what happens in the stock market.

Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc.is way more likely to win than a horse with a terrible record and extra weight and so on and so on.But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2.Then it's not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it's very hard to beat the system.

In the stock market, some railroad that's beset by better competitors and tough unions may be available at one-third of its book value. In contrast, IBM in its heyday might be selling at 6 times book value. So it's just like the pari-mutuel system. Any damn fool could plainly see that IBM had better business prospects than the railroad. But once you put the price into the formula, it wasn't so clear anymore what was going to work best for a buyer choosing between the stocks.So it's a lot like a pari-mutuel system. And, therefore, it gets very hard to beat.

The market is efficient as a pari-mutuel system is efficient with the favorite more likely than the long shot to do well in racing, but not necessarily give any betting advantage to those that bet on the favorite.

How can I get above average return in the Stock Market ?

Charlie Munger : One thing that all those winning betters in the whole history of people who've beaten the pari-mutuel system have is quite simple. They bet very seldom.It's not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it ‑ who look and sift the world for a mispriced be that they can occasionally find one.

And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don't. It's just that simple.That is a very simple concept. And to me it's obviously right based on experience not only from the pari-mutuel system,but everywhere else.So you can get very remarkable investment results if you think more like a winning pari-mutuel player. Just think of it as a heavy odds against game full of craziness with an occasional mispriced something or other. And you're probably not going to be smart enough to find thousands in a lifetime. And when you get a few, you really load up. It's just that simple.

So the trick is getting into better businesses. And that involves all of these advantages of scale that you could consider momentum effects. How do you get into these great companies? One method is what I'd call the method of finding them small get 'em when they're little. For example, buy Wal-Mart when Sam Walton first goes public and so forth. And a lot of people try to do just that. And it's a very beguiling idea. If I were a young man, I might actually go into it.

Ideally and we've done a lot of this you get into a great business which also has a great manager because management matters. For example, it's made a great difference to General Electric that Jack Welch came in instead of the guy who took over Westinghouse ‑ a very great difference. So management matters, too. And some of it is predictable. I do not think it takes a genius to understand that Jack Welch was a more insightful person and a better manager than his peers in other companies. Nor do I think it took a tremendous genius to understand that Disney had basic momentums in place which are very powerful and that Eisner and Wells were very unusual managers.

So you do get an occasional opportunity to get into a wonderful business that's being run by a wonderful manager. And,of course, that's hog heaven day. If you don't load up when you get those opportunities, it's a big mistake.

However, averaged out, betting on the quality of a business is better than betting on the quality of management. In other words, if you have to choose one, bet on the business momentum, not the brilliance of the manager.

But, very rarely. You find a manager who's so good that you're wise to follow him into what looks like a mediocre business.

Should we always invest in stock with huge discount ?

Charlie Munger : Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result.

But if you can find some fairly-priced great company and buy it and sit, that tends to work out very, very well indeed especially for an individual.

What is “untapped pricing power” of great business ?

Charlie Munger : Within the growth stock model, there's a sub-position: There are actually businesses, that you will find a few times in a lifetime, where any manager could raise the return enormously just by raising prices and yet they haven't done it. So they have the huge untapped pricing power that they're not using. That is the ultimate no-brainer.That existed in Disney. It's such a unique experience to take your grandchild to Disneyland. You're not doing it that often .And there are lots of people in the country. And Disney found that it could raise those prices a lot and the attendance stayed right up.

        So a lot of the great record of Eisner and Wells was utter brilliance but the rest came from just raising prices at Disneyland and Disneyworld and through video cassette sales of classic animated movies.

At Berkshire Hathaway, Warren and I raised the prices of See's Candy a little faster than others might have. And, of course, we invested in Coca-Cola ‑ which had some untapped pricing power. And it also had brilliant management. So a Goizueta and Keough could do much more than raise prices.It was perfect. You will get a few opportunities to profit from finding underpricing. There are actually people out there who don't price

Everything as high as the market will easily stand. And once you figure that out, it's like finding in the street ‑ if you have the courage of your convictions.

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