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Carnelian Investing Principles

Updated: Oct 9, 2022

Greetings from Carnelian!!

While you receive our monthly updates and newsletters highlighting our views on the markets along with our performance (“output”), we thought it will be a good idea to start sharing Carnelian Investing Principles (CIP): the source behind our performance. While output is beyond our control, we can control and consistently improve the input. We channelize our resources on things which we can control, as we believe this will enable us to maximize our investor’s wealth in the long term. We will continue to share CIPs with you on an ongoing basis.

Carnelian Investing Principle - We assign more weightage to “where is my profit” vs “what is my profit”.

At Carnelian, our analysis starts with “where is my profit” (Balance Sheet) vs. “what is my profit” (P&L). We firmly believe shareholder value is not created merely by reported profits unless it is re-deployed efficiently in good quality assets in a timely and transparent manner. Quality of assets in the Balance Sheet should pass both “return of capital” and “return on capital” test. To put it simply, in the Carnelian world “what is my profit” is relevant only if a company passes “where is my profit” hurdle.

Our forensic skill DNA can be traced back to our childhood days, wherein we observed our parents/grandparents (Indian Marwari entrepreneurs) look at accounts and profitability from a very different perspective. They neither had any qualified accountants, nor did they follow sophisticated accounting rules, yet they were able to calculate business profits precisely from the statement of assets and liabilities.

They used to maintain only 2 books - “Rokar” (cash flow statement) and “Bahikhata” (ledger) - a record of amounts payable (liabilities) and receivable (assets) by the business. Statement of assets and liabilities (“Talpat”) was the most important tool available with them to analyze business performance.

Business profit/loss during the year was the net increase/decrease in the realizable value of all assets after reducing all liabilities.

Business Profit = “delta increase in the value of net assets”

Advantage of the above approach is intense focus on quality of profits and elimination of any deviation from the income statement. They used to analyse assets and liabilities (quality of profits) prior to calculating profits. In this process “where is my profit” used to precede “what is my profit”.

Our childhood learning and working with them has immensely helped us while studying numerous listed companies over the last two decades wherein we have spotted issues (ahead of markets) which were beyond reported profits (Divergence between reported profits and assets raises our eyebrows!).

We generally see two kind of risks to a company’s asset side of balance sheet:

a) Real Value risk: Where absolute realisation is at risk. “We have zero tolerance if we foresee real value risk to the asset portfolio “

We will avoid companies wherein material portion of the profits are deployed in assets mentioned below:

- Huge built up in loans and advances – high yield bonds/ICDs, overseas funds etc.

- Large quantum of long duration inventories/receivables susceptible to value diminution

- Large payables supporting large receivables/inventory

- Profits getting re-deployed in non-core/expensive/uncertain inorganic growth

- Profits getting into intangible assets/goodwill – without visibility of commensurate profitability

- Subsidiaries/JVs which require consistent infusion of profit without any visibility of returns

Some recent companies which we have avoided based on the above criteria’s:

- A good profit making garment company where large sums of profits are piled up on hanger (stock).

- A media company showcasing profits with large pile up of inventory/loans and advances, receivables, overseas assets.

- An infra company building NBFC kind of Balance Sheet – large payables supporting large receivables. We focus on gross working capital instead of net working capital.

Some past examples, how our forensic analysis helped avoid accidents and poor investment candidates:

b) Time Value risk: At times this risk is unavoidable, considering companies have to park surplus money to fund future growth opportunities. However, idling shareholders money for prolonged period in low return generating assets is counter-productive and should be valued at discount to face value.

We believe, in the investing world avoiding accidents is equally important as is investing in right companies. This might result in us missing some of the ideas which fall on the fence, but we would rather miss that than take risk. We will continue to share our Investment Principles and learning experiences with you on regular basis through “CIP” series.

We will be very happy to receive your feedback/suggestions on our approach, principles or anything in general. We believe investing is a continuous learning process and we have to constantly adapt to the changing realities.

If you are satisfied with our approach and performance, please do share with others as your word means a world to us.

We once again thank you for your patronage.

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