Professor Sanjay Bakshi, a value investor, behavioural economist and adjunct professor at Flame University, Pune, gives his unique perspective on how to choose a stock, in an interview with Nidhi Sinha, editor, Outlook Money, as part of the Wealth Wizards series. He also shares his learnings from role models Warren Buffett, Charlie Munger, Benjamin Graham and others, and how being a chartered accountant, economist, investor and teacher make him into what he is today. Edited excerpts from the interview:

Could you tell us something about your journey and your main learnings from it?
I started practising in India in 1994, after returning from England, where I studied at the London School of Economics (LSE), which is where I caught the value investing bug.

Prior to that, I was a chartered accountant in India. (At that point) I knew accounting, but I had zero idea about business, economics or psychology. I picked these while reading the letters of Warren Buffett, who I discovered at LSE. Through those letters, I found my calling and decided that I want to be a value investor and sort of plunged into it.

I’ve been lucky in the sense that India has grown over the years, and I think a lot of growth lies ahead.

One of the learnings from my three decades of practice is that you should not interfere with the workings of compound interest, so slow down. Initially, as an investor, I used to do a lot of trading. I would buy 60-70 securities, and churn the portfolio twice or thrice or more in a single year. Now I make two to three decisions in a year, and I think even that needs to be reduced.

The reason for that is my approach to investing (in stocks) is (to treat it) like a business. That’s what I have learnt from my gurus. Stocks are not pieces of paper. They are claims on a business and you’re a partner. As a partner, say, in a commercial real estate business, you’re forced to look at it exactly the way a businessman would look—at competition, at the quality, at the potential of earnings to grow over time, at the downside risk as to what can go wrong with the building or with regulations, and so on. But you’re not looking at the price of the building, because there is no such price out there.

You talked about going slow when it comes to investing, but that’s what most of the younger generation is not doing. What’s your advice?
Nikhil Kamath, the co-founder of brokerage Zerodha, disclosed some time back that 90 per cent of the people who get into trading don’t actually make money but see losses. Out of the remaining 10 per cent, I think only a small fraction beat fixed deposit (FD) rates.

So, trading is a very tough, zero sum game. Basically, there is a huge difference between trading and investing. When you are investing, you’re a partner in a business. The business grows and becomes more valuable over time, so investors end up making money along with the company. In trading, for somebody to win, somebody else must lose, and there are almost always many more losers than winners because of the transaction cost, taxes, and mistakes that traders end up making.

The other part is that trading costs have come down to almost nil now, and when that happens more people trade. And, more people trade because it’s easy to do so with apps available. So, the propensity to gamble goes up because the frictional costs have gone down.

That might be good from an efficient market point of view because liquidity is good. But there is a perverse outcome, which is that it turns people into gamblers.

I’m actually in favour of higher trading costs because that will bring down the amount of trading that happens in the markets.

How do you balance the multiple hats you don-being a successful investor, a loved teacher and a CA? Do you have a favourite?
I like them all. I use them all. In fact, accounting is the language of business, and as a chartered accountant if you have done articleship with a firm that makes you do a lot of audits, which is what happened with me, then you get to know how transactions end up becoming financial statements, how balance sheets, profit and loss accounts, and cash flow statements are made and how these statements talk to each other.

If you want to do well in investing, I think learning that language is very important. But at least then, the CA curriculum did not delve into things like business economics or social psychology or how crowds behave or how businesses develop competitive advantage, and so on. All that I picked up through Buffett’s letters. He basically combined accounting, business economics and psychology beautifully, and explained complex ideas in a very simple way.

I don’t have a favourite, but every time I look at a financial statement, whatever I learned as an accountant comes handy. And whenever I am spotting an opportunity, almost always there are models from psychology that come into play.

You’ve had your ups and downs. What does it take to start from scratch and build upon it?
I love the quotation that failure is not the opposite of success, it’s an ingredient of success. You make mistakes and then learn from them.

I think every investor goes through that. You can’t learn how to be a good cyclist, for example, by watching the videos of the best cyclists in the world, or reading the best books in the world. You have to get on the bike and fall many times, and get hurt before you learn how to balance the cycle. So mistakes are inevitable, and that’s going to be the case in any profession, including in investing.

So, I’ve had terrible periods when I made huge mistakes, and I paid dearly for them. And one of the big lessons that I’ve learned is that when you make a mistake, you should frame it into a lesson, and quantify the mistake, the money that you lost, and think of that as a tuition fees that you’ve paid to get that lesson. Write that lesson down and try not to make that mistake again, and move on. There’s no point in getting depressed.

One thing which I have learned is the spiritual idea about impermanence. I think it applies to the world of business and investing. There will be good years, followed by years when you will not do so well, because nothing is permanent. The same thing applies when you’re going through a terrible downturn, and your portfolio is really down. You would feel upset about the whole thing, but the reality is that even that is impermanent. Once you get that balance right about having an equanimous mind and know that things are not permanent, you will be able to ride through many of these cycles, provided you don’t make serious mistakes.

How did you come to focus on the areas of value investing and behavioural finance?
It happened by accident. When I started as a value investor, I had no clue about psychology, and I was just trying to copy the methods of Buffett and his teacher, Benjamin Graham.

And one day a friend gave me a copy of one of the talks of Charlie Munger, titled The Psychology of Human Misjudgment. There are two versions of that talk as he revised it (the original) many years later. Those two talks gave me the raw material to deep dive into the field of social psychology. From that work emerged my paper called Behavioral Finance and Business Valuation, which I taught at the Management Development Institute, Gurgaon, for more than 17 years.

By the way, teaching has been very helpful to me. I think I’m a better investor because I’m a teacher, because when you teach, you reinforce the ideas that have really worked for you, you also learn from other teachers. You talk about your own mistakes with your students. So the two hats that I wear have been very synergistic in that sense.

Coming to behavioural economics, there are two parts to it. There is behaviour and there is economics. The economics part came to me from Buffett’s letters, and he talks about many models, the low cost models, the branded businesses, the economics of a commodity business, the concept of pricing power, and so on. These are pure ideas coming from micro economics.

But he also once in a while talked about inefficiencies in the market, how people get into herding and why people become so fearful. Those are all concepts from psychology.

But then I was able to relate what he was writing, to the concepts and models of Munger. I was able to get a good sense of the framework that Munger used, to identify 20-21 standard causes of human misjudgment, or mental models as he called them-the tendencies which make people go wrong in terms of their decision making.

What were the main lessons you learnt from Munger?
I don’t want to talk about lessons I learned from one person, because I think synthesis is very important. I’ve synthesised ideas from accounting, economics and psychology. I’m not saying that this is the right approach, but it worked for me to pick up the ideas that resonated for me from Buffett, Munger, Graham, (economist) Phil Fisher, and so on.

So when it comes to business quality, I like to follow the lessons of Munger and Buffett, but when it comes to the price that I want to pay for those businesses, then I strictly follow Graham’s approach.

What that means is I will not end up paying up a lot for quality; I will insist on a bargain base price, which almost never happens because, by definition, good businesses are well recognised and get sold off only if something bad is happening to the industry, or that particular company temporarily, or when there’s a market wide sell-off like what happened during Covid. Usually, these stocks don’t tend to become a bargain based on prices, but when they do, you have to be very opportunistic.

What’s your parting advice to retail investors?
First, think like a businessman; focus on the business, not the stock. What that means is that don’t worry about things that have no impact on the long-term fundamentals of a business. Focus on the business and assess if you want to be a partner in the business 10-20 years later.

How does it matter if the market is high or low. The things that truly matter are the quality of earnings 5-10 years later and the valuation of the business right now. So, if there’s any news story which has no impact on the fundamental of a business, you should treat it as noise.

Second, think of markets and business like a pari-mutuel game (where all bets of a particular type are placed together). In the world of business and investing, the behaviour of other people changes the odds.

In investing, for instance, when a market-wide sell-off happens, things become cheaper, and the odds of success go up if the fundamentals of the business are intact.

The same thing happens when a downturn happens in an industry. In the long run, it turns out to be good news for the strong players. The aggressive (weak) players drop out of the game. This is exactly how the world of business and investing end up replicating a pari-mutuel game. Once you understand that, you start thinking about what happens next.

Take the example of what is happening in the micro-lending industry right now. A lot of regulatory action has resulted in a market-wide sell-off in the micro-lending business. The micro-lending industry has grown over the years, and the strong players keep getting better and more profitable over time. The weak players, or the aggressive players drop out.

But the markets are treating the stocks of all the companies in that industry (in the same way). Everything gets sold off the moment you start looking at it from a pari-mutuel point of view and you start thinking there is a downturn. But this downturn will actually remove some of the bad practices that are being followed in the micro-lending business. The Reserve Bank of India is doing a good thing by stopping all the aggressive lending practices. It’ll mean the more conservative, well-financed and well-run players are going to be better off in the long run. But the latter’s stocks are also down; in fact, they have fallen almost as much as the other stocks. That gives you an opportunity.

So investors should think about markets as a pari-mutuel game.

In conversation with Outlook Money: Prof. Sanjay Bakshi, Adjunct Faculty, FLAME University.