Welcome to the world of simplifying Investing! We're about to dive into a mental model called "Proxy Plays". Proxy plays help you take advantage of exciting trends by investing in related industries and areas.
In this article, I will give you a simple introduction to proxy plays and how they can be a useful part of your investment ideas. So, let's get started and learn how proxy plays can help you make better investment decisions. We will start with a story today:
The California Gold Rush was a historic event that took place in the mid-1800s. It all started when gold was discovered in the foothills of the Sierra Nevada mountains in California, and it led to a massive migration of people from all over the world who came in search of their fortunes. While the main trend was obviously the search for gold, there were some interesting side stories that turned out to be even more profitable than digging for the precious metal.
One of the most iconic aspects of the Gold Rush was the invention of blue jeans.
A guy named Levi Strauss, for instance, saw that miners needed tough pants. So, he made Levi's jeans, which became super popular and made him a ton of money.
Similarly, businesses that supplied essential tools like picks and shovels thrived as they catered to the ongoing demand of miners, regardless of their success in finding gold.
The lesson from the California Gold Rush is clear: The success of the gold rush was uncertain. While there was undoubtedly gold to be found, not everyone struck it rich. Many miners spent months or even years searching without finding much gold. However, the demand for jeans, picks, and shovels remained constant because they were essential for the mining process. So, by investing in these auxiliary industries, individuals could enjoy a more stable and reliable source of income.
In the world of investing, this strategy is often referred to as "picking the picks and shovels" or "investing in the infrastructure." It means looking for businesses and products that support a broader trend or industry rather than trying to predict the success of the trend itself. This approach can be less risky and more profitable because it focuses on the enduring needs of participants in the trend rather than the uncertainty of the trend's success itself.
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Another excerpt from Peter Lynch :
Trends in the Indian Stock Market:
Steel VS Refractories
Investing in steel companies is cyclical. Cyclical because their profit margin is based on Supply, Demand of the commodity and the determined global prices. This creates uncertainty and so margins are volatile and business is more capital intensive.
Refractories companies manufacture equipment that is used by steel companies in their day-to-day operations. Refractory material is a type where the material is resistant to decomposition by heat or chemical attack and retains its strength and rigidity at high temperatures.
Examples of Operating Profit Margin for two players are below:
Tata Steel
RHI Magnesita / Orient Refractories
As is visible in the financials, the commodity company Tata Steel has more volatile margins in comparison to RHI Magnesita. The volatility brings uncertainty to the company's earnings and shows that the company has no earnings power from its customers. It does not have control over its own margins, which is a big risk.
Companies with a deep dependency on commodity prices like steel are less likely to do well as they become cyclical. The commodity prices define their earnings potential, which keeps going up and down. Like here, margins are varying from 5% to 24% as a result, the stock price repeats the same cycle of ups and downs. Companies like these are to be avoided, as we can’t and don’t want to predict commodity prices. That’s where the mental model of Proxy Play comes in.
Lets now dive into more Big themes and Some Proxy Plays
Bullish on themes like Increasing Infra Expenditure, Electricity Transmission, Real Estate can be participated using proxy Plays. These Proxies are Polycab and KEI.
Polycab:-Polycab is India’s leading manufacturer of cables and wires and allied products such as uPVC conduits and lugs and glands. We have a range of cables and wires for practically every application. More recently Polycab has also launched a wide range of consumer electrical products like Fans, Switches, Switchgear, LED lights and Luminaries, Solar Inverters, and Pumps.
KEI:- KEI Industries Ltd manufactures wires and cables (W&C) like EHV cables, HT cables, LT cables, and sells them in India and overseas.Company manufactures and markets Extra-High Voltage (EHV), Medium Voltage (MV) and Low Voltage (LV) power cables. It caters to retail and institutional markets and also provides Engineering, Procurement and Construction (EPC) services.
Auto Ancillary/EV Play:-
There are various companies which can be proxy plays in the auto industry since there are too many moving parts in the industry and quite literally in the vehicle.
We can target Battery manufacturers, EV chargers, EV charging stations,Driver Information System etc.
One Such Play is Pricol. Pricol is a Coimbatore-based supplier of diversified auto components like instrument clusters, sensors & switches, pumps and mechanical products, telematics solutions, and wiping systems. Pricol is a market leader in DIS & Telematics.
In conclusion, opting for proxy plays when investing in themes such as increasing infrastructure expenditure, electricity transmission, and real estate can be a prudent strategy. These proxy plays offer a range of benefits, including diversification, potentially better margins, and improved return on capital employed (ROCE). By investing in companies and sectors closely associated with these themes, investors can harness the growth potential of these trends while spreading risk across a broader spectrum, providing both flexibility and opportunity for long-term financial success.
In upcoming articles, we will delve deeper into specific proxy play opportunities within these themes and explore further strategies to maximize investment potential. Your support is greatly appreciated – please share, like, subscribe, and comment with your ideas and feedback. Your engagement motivates us to keep delivering valuable insights and information to help you make informed investment decisions. Stay tuned for more in-depth discussions on this exciting mental model.
Credits : SOIC for all the learnings, data and Images
Good nuances for the general public to understand what you wanted to convey. A nice writeup! Keep up the good work.