With over three decades in the world of investing, Shankar Sharma does not shy away from calling a spade a spade. His Twitter timeline is a ‘Dear Diary’ of sorts. From the big wins to the big losses, his journey is out there for thousands to see. A part of this journey has been Brightcom Group (BCG) – a Rs 4 stock in May 2021 to Rs 113 in December the same year, and now down at Rs 9 amidst a Securities and Exchange Board of India (Sebi) scrutiny. In November 2021, Sharma called BCG a 4 AM stock. “The world is sleeping. But a faint bit of light is creeping up at the edges. That's the home run period,” he wrote. He believes the 4 AM investing principles can get an investor from a ‘slum to a penthouse’. “Investing in the Levers, Nestles and Asian Paints of the world cannot help you get a penthouse. Money can be made only in the unloved sectors of the markets,” he says. We caught up with him to understand more about his 4 AM investing model, what led him to invest in Brightcom, what has gone wrong with the investment, his views on the Sebi allegations, and much more. Edited excerpts: You’ve talked about your 4 AM Investing Model. What exactly is this strategy? My 4 AM Model is a high-risk, potential high-return model. I call it the equivalent of VC-type investing in the listed space, where one can make VC- type returns but a few may go completely south. 4 AM investing Model has a few components. a) The stock must be trading near its long-term lows. b) Its weight in its sector must be at the lows. A good example is Apple in 2002-03. It had the lowest weight in the US hardware space. Similarly, Amazon had the lowest weight in US retail in 2001. Tata Motors had the lowest weight in the auto space in India; Twitter, in 2015, in the social media space; and IndusInd Bank, in 2009, among private banks. c) There should be some spark of hope visible, meaning that the latest quarterly numbers should demonstrate some traction. Let’s say on the top line. There should be some good feedback from initial product launches and so on. d) Street sentiment must be uniformly negative. Amazon had almost consensus sell recommendations. Apple had no hope because Steve Jobs had been around for six years and he had not been able to bring about any magic at all and the company kept going further down into a hole since 1996-97 when Jobs came back. Ditto for IndusInd Bank. Whenever I spoke to somebody about this, the reaction would be "Hinduja company, low governance." This was the cheapest private bank at a one-time book value, back in 2009-10. Most of Wall Street in 2015-16 had a sell on Twitter, around $9. I bought it then and finally sold it at 40+, a couple of years later. e) Position sizing is very important, and this is where most investors, especially smaller investors, go wrong. They put a very large allocation into such high-risk names. Remember that 4 AM does not necessarily mean that the stock will see the light of the day. Many stocks in this framework will fail. They can keep going back to midnight. Therefore, one must put no more than 2 percent of one's capital in each 4 AM position and not more than 20 percent of total capital into this category of investments. Position sizing is at the heart of this framework. This category of stocks are the equivalent of buying a high-risk venture capital startup in the listed space. One can potentially make venture capital-type of returns in the listed space, if one gets just a handful of 4 AM stocks right. Therefore, one does not need to risk a lot on such stocks because the potential returns are so huge that you do not need to start with big capital. Our initial investment in Amazon was only around $1 million. Apple was even less. And they all made massive money over the next 5-10 years for us. It was the same with IndusInd, which was a 20-40x stock for us. The other point is exit strategy. At the very first 100 percent gain, I will normally take at least 25 percent off the table. And at every substantial gain thereafter, one keeps taking a small bit off the table, so that at the end of the entire life cycle of such an investment, you have not more than 10 percent or 15 percent of your original quantity in the stock running for you. There is always risk in investing. As a professional investor, I only need to decide on what is acceptable risk and what is unacceptable risk and how much I should invest on the acceptable risk. So, the strategy is about lapping it up when others are shunning the stock, but taking a calculated bet that things will turn around… Yes, this is about companies where there are problems of one kind or another. I do this from time to time, for a part of my investable capital. That part ( a small part, I must add) of my portfolio is always going to be high risk and I am prepared to lose money on those because I am a professional investor. To give you a recent example, I bought Turkey last year. It was a hated trade. Every single fund manager was negative on it. But for me, it's worth a bet. It may work out or not, but if the risk-reward ratio is good, I will put personal capital into a trade. Recently, I have been buying REITs in the US, a troubled sector. But yields are 10-14 percent! So they are 4 AM in fixed income instruments. But I never tell anybody else to do the same. Most people can't handle the risk. What was your bet/investment case when you bought Brightcom? Before I tell you that, one word of caution: As minority investors – by the way, I own just around 1 percent in BCG. Even us, professional investors, do not have any other information about any company that we invest in beyond what is publicly available. We may be able to take a calculated bet on that publicly available information and sometimes better than the average investor. That's pretty much what it is. I had invested in a similar company in the US, called The Trade Desk. It did very well for me in the period I stayed invested. BCG looked cheap when I decided to buy it. It is paying 27 percent taxes on its global profit. It has EY auditing its major subsidiary, Israeli company OMS, which, by the way, recently paid out Rs 60 crore as dividend to its Indian shareholders. I had no knowledge of the forensic audit at the time I invested. That came out several months later. You said your exit strategy is to take out money at every stage when there is a gain. How do you deal with a position that has gone wrong? If you have seen substantial erosion, do you simply cut at any price and run or would you prefer averaging strategies and do a gradual exit? If the hypothesis is not working out, I will exit my position even at a 50-70 percent loss, because I am absolutely ruthless when it comes to exits and I have no emotions whatsoever in taking losses. To become a great heavyweight fighter, you don't need just a good jab and good footwork. What you need even more is a strong chin. Tell us about your biggest losing bets and your best lessons from your losers A2Z, in recent times, was a big loser because the whole environment for debt restructuring changed after I made the investment. Again, it is very important to understand that when you make an investment in such problematic companies like 4 AM stocks, it is not going to be a miraculous turnaround within one quarter in most situations. Things can take some time to come through and sometimes they may not even come through. That is not a mistake in investing. That is embedded in the whole premise of investing in this framework. Unforeseen problems can crop up and I don't count unforeseen problems as mistakes because nobody can foresee two years in advance. How do you view Brightcom now? The regulator has raised several concerns, and the stock has crashed. How do you deal with such a situation? My shares, till last week, have been under lock-in. I continue to hold as we speak. I will decide on my strategy as details unfold and I do not need to inform anybody about my thinking because it is my personal capital and not public funds. The regulator has directed them to fix their compliances and reporting. That will go a long way in improving disclosures by the company. This will benefit 4 lakh shareholders of the company. I also understand that this is a show-cause notice and the company will answer the charges. Therefore, one must not jump to hasty conclusions and must watch the developments carefully. Let me also add here that every investor through his/her journey will buy many good companies, and some companies which may not be very good in hindsight. Rakesh Jhunjhunwala had DHFL and Bhushan. Ramdeo Aggarwal had Manpasand. Many investors had Satyam. Every major VC/PE SWF has Byju's, which has been in the news for many accounting issues. Like I said, I am investing my own money and am prepared for the risk. To small investors doing 4 AM investing, I have only this to say: position sizing is key and so is risk management. Do not put 50 percent of your money into a single company, irrespective of how good that company is, and, definitely, not in problematic companies which may turn out to be great investments later. What is your take on the accounting irregularities Sebi has pointed out? The matter is sub judice, and, therefore, it is not appropriate for me to comment in detail on this. Right now, it is only a show-cause notice and the company will, in all probability, reply to these charges, with their reasons for treating impairment charges in overseas subsidiaries, in a particular manner, and not as per Indian Accounting Standards. The nub of the matter is the treatment of impairment charges in their overseas subsidiaries. As regards share sales by promoters, BCG has filed data on stock exchanges, which broadly state that most of the share sales between 2014 and 2020 were pledged shares being sold by various lenders, including banks, and the average price of such sales was Rs 2.7. The company has also uploaded all the financials of its material subsidiaries on its website. Therefore, now we have far better visibility and transparency, thanks to the directions of the regulators. I also welcome this show-cause notice because it will compel the company to strengthen its compliance standards, which will benefit all its current and future shareholders. The market has obviously reacted very negatively to the show-cause notice and that is to be expected. As professional investors, we must evaluate the situation with a cool mind and an analytical perspective about what the matter truly is and whether it is something which is an endgame or addressable and fixable. That is where the difference between professional and retail investors comes in. As a professional investor, I have seen many problematic situations over my 35 years, and, therefore, there is a huge data bank to go by, which most younger and smaller investors probably will not have. My first big winning trade came out of something similar, back in 1996 when the ITC top brass was arrested on charges of Foreign Exchange violations. The ITC stock crashed in panic and I gathered the courage to go in. That worked out brilliantly because the risk-reward ratio had become extremely compelling. Sometimes the market can overreact dramatically, well beyond what fundamentals deserve. Can you talk about some of your other losers? In this category of investing, the 4-AM kinds, I have had one big loser and that was A2Z. My good friend Rakesh kept telling me that the promoter is not trustworthy. He warned me several times. Despite that, I went ahead. It is my belief that I must make decisions independent of people's opinions, and if the opinion is generally negative, that can become a positive for the stock. I probably lost around Rs 15-20 crore in this position some years ago. That happened not because of anything I had missed but because the whole debt restructuring environment changed in India where banks started becoming more and more hard on debt settlement. I had invested in Indian chemical companies back in 2011, 2012 and 2013, riding the debt restructuring theme and that worked out excellently and these 4 AM stocks became 11 AM stocks! But in A2Z, which I invested in 2016, the environment for debt settlement suddenly became very difficult and these kinds of changes are very hard to foresee. One is obviously always prepared to lose money on such investments as a professional investor So, does this mean your 4 AM strategy ignores governance altogether? Governance is a very vague term. I remember telling all fund managers about the low governance for most infrastructure companies back in 2007. At FG, we stopped covering Yes Bank because we could not make head or tail out of their profit numbers! But it continued to keep going up as fund managers from across the world kept piling in despite our pointing out that the profitability being shown by them simply did not add up. Educomp was another case in which we wrote quite a few pieces of research, pointing out a lot of accounting issues but not even a single fund manager reacted to these pieces of research and most told me that it's all okay and that it's a great company. Educomp had marquee investors from local MFs to global FIIs as happy shareholders. More recently, EKI, Tanla, all owned by smart investors, have had governance/ accounting issues coming out, and the stocks are down 60-80 percent. But when all these stocks were running and doing well, nobody bothered. Therefore, as long as a stock or a sector does well, nobody really cares about governance. They only care about it when the stocks fall. It is obvious that a 4 AM stock will have some problem or the other or multitude of problems. This kind of investing framework is not for everybody because it requires nerves of steel and a very strong gut. I was speaking to one auditor 25 years ago and he told me that he has audited dozens of listed companies in his career and in every company he has found plenty of red flags. And he then told me: if you start going down this path of looking for red flags, you will not make even a single investment! Again the premise of 4 AM investing is that the company in trouble will fix all its problems or at least quite a few of them in which governance may well be one of them.
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