The end of a year is a great time for self-reflection and to assess how we’ve grown as individuals and as an organization. At Marcellus, one of the key elements of growth (and something we take pride in) is learning more about the world we live in. It’s our constant endeavor to keep building on our existing knowledge base and keep disrupting our own thought processes. The five newsletters we share here are the result of our learning journey over the past 12 months. And we have many people to thank for it. First of all, we wish to thank all our investors as well as distribution partners, whose piercing questions keep us on our toes and drive us to think ever more thoroughly about our investing philosophy as well as our portfolio stocks. A big thank you to our investee companies, from whom we have learnt invaluable lessons in building and sustaining competitive advantages, and in making smart capital allocation decisions. And finally, a thank you to our readers who regularly share feedback on our newsletters, blogs, and books, helping us think deeper and better. Wish you all a very healthy and happy 2023!

1.Four years of CCP: 98.2% total returns, 18.6% CAGR (CCP, December 2022)

A review of the last four years of CCP returns highlights the consistency of performance across investee companies – almost all constituent stocks have compounded their share prices at 15-30% annually demonstrating that stock selection contributed significantly to portfolio returns. Additionally, portfolio management tools such as the Longevity Framework and Margin of Safety & Sustainability (MOSS) have added extra layers of portfolio performance and risk reduction through position sizing and rebalancing. We continue to focus on deepening our research processes and sharpen our portfolio management tools to increase the value add to our clients in future.

2.Separating the Men from the Boys (KCP, November 2022)

Financial services companies in general and Indian NBFCs in specific tend to encounter a crisis every few years. High-quality management teams not only deal with such crises but actually benefit from it. NBFCs in India have seen three challenging events in the last six years – demonetization, the failure of a large NBFC (leading to tightening of liquidity) and finally the Covid crisis. The Kings of Capital have emerged from these crises stronger, not weaker, on account of: (a) Smart risk management, (b) Proactive introduction of course correction measures, and (c) Leveraging their strengths to find better opportunities even when competitors are collapsing. While we cannot predict when the next crisis will hit us, the behavior of the Kings of Capital in difficult situations gives us the confidence that they will rise to the challenge when the crisis arrives

3.P/E Multiples are Deceptively Dangerous (CCP, October 2022)

A stock trading at a P/E multiple of 50x could be cheaper than one trading at 15x P/E multiple, even if both stocks deliver the same profit growth. This is possible due to factors such as superior capital efficiency (measured by Return on Capital Employed) and greater longevity of free cashflow compounding. Moreover, a focus on improving capital efficiencies incrementally over time justifies a higher P/E multiple for a company compared to its own historical P/E. Almost all companies in Marcellus’ CCP portfolio exhibit such characteristics. Discounted Cashflows (rather than P/E multiples) clearly capture these characteristics in the valuation of Consistent Compounders.

4.Three Glorious Years of Compounding (LCP, August 2022)

In Little Champs’ third anniversary newsletter, we dissect the portfolio’s performance and the key drivers thereof. On the whole, our stock selection – including the calls on exits and fresh additions – appear to have been on the mark. However, there are important learnings over the last three years around: (1) more robust evaluation of the portfolio companies’ bargaining power in the value chain (drawing from our auto ancillary holdings’ experience); (2) giving due regard to potential disruptions (something we underestimated in case of Music Broadcast); and (3) sticking to our philosophy of investing in market leaders (deviating from this in case of DCB Bank did not work out). The culmination of these learnings resulted in the creation of Marcellus’ longevity framework which has given us important tools to plug the above loopholes.

5.Rising Giants: Focus on the Signal, Ignore the Noise (RGP, July 2022)

In this newsletter we focused on the portfolio stocks that had witnessed significant drawdowns (>20%) since inception. For Dr Lal Pathlabs, we emphasise how turnaround time, quality and accuracy of reports are more important drivers of competitive advantage than pricing. Aavas’ asset-liability matching gives us confidence regarding the resilience of its spreads in a rising interest rate environment. For InfoEdge, the strength of its core business (particularly Naukri) and the firm’s investing track record are much bigger value drivers than the stakes in Zomato & Policybazaar. For L&T Technology Services, structural opportunities around outsourcing outweigh attrition concerns and a possible US recession. For Alkyl Amines, a strong growth runway (thanks to pharma supply chain diversification), continuous focus on R&D and capacity additions should drive long term value creation. Further, Astral’s expansion into sanitaryware and paints does not put its existing business at risk while VMart and Relaxo are facing transient inflation related disruptions.

Happy reading, happy investing, and a very happy new year!

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