Mean reversion strategy – Generating Alpha by Stalwart fund Jatin Khemani, CFA (Stalwart Advisors):

1. Mean Reversion is the Core Thesis

• Market cycles revert to the mean — in sales, margins, ROE, and valuations.
• Real alpha is created by investing in undervalued businesses where reversion (e.g., P/E expansion) is likely.
• Volatility and cycles are inevitable; smart investors use them to their advantage.

2. Capital Allocation Drives Long-Term Returns

• Even a great business can destroy value if capital is misallocated.
• Look for businesses reallocating capital into high-ROC segments (e.g., SRF, Wipro into IT).
• Avoid sunk-cost fallacies — great management knows when to exit underperforming verticals.

3. Avoiding Landmines Is the Edge of Jatin Khemani’s strategy

• Avoid overvalued stocks, even if they’re great businesses (e.g., Nestle, HUL).
• Avoid debt-heavy, government-dependent, over-regulated, and loss-making IPO/startup companies.
• Watch for poor governance — trust matters more than valuation.

Returns are maximized by not losing money.

4. Owner-Operator & Capital-Light Businesses Preferred

• Preference for owner-operator-led businesses (skin in the game, long-term focus).
• Bias towards capital-efficient, debt-free, and cash-generating businesses.

5. Selective Small & Mid-Cap Bias

• Sweet spot: ₹1,000–10,000 Cr market cap range — less institutional ownership, more discovery potential.
• Balanced portfolio (~20 stocks), avoiding over-diversification.

Practical Application of the Strategy

1. Focus on Cycles:
   • Identify temporary down-cycles in good businesses.
   • Watch for margin, ROE, and valuation reversions.
2. Look Beyond Headlines:
   • Deep-dive into segment reporting, capital allocation history, and promoter intent.
3. Monitor Capital Allocation Announcements:
   • Divestments, demergers, or business exits are key catalysts for rerating.
4. Avoid Popular, Fully-Priced Stocks:
   • Safety lies not in size (large caps), but in valuation + fundamentals.
5. Stay Patient (3–5 Year View):
   • True alpha generation comes from time arbitrage — holding through cycles

Strategies & Investment Philosophy Summary

Strategy/Principle	Description	Practical Application
Mean Reversion	Everything (sales, margins, ROE, valuation) tends to revert to the mean over time.	Identify cyclical lows in good businesses; buy when undervalued, sell after rerating.
Capital Allocation Focus	How companies use their profits—reinvest, diversify, return capital—is a game-changer.	Invest in businesses reallocating to high-ROC segments; avoid misallocators.
Avoiding Landmines	Avoid loss-makers: overvaluation, high debt, poor governance, obsolete or regulated sectors.	Eliminate half of market universe upfront to reduce downside risk.
Owner-Operator Preference	Prefer founder-led or family-run businesses with long-term vision and skin in the game.	Assess promoter quality, capital discipline, and governance record.
Valuation Comfort	Don’t overpay—even for great businesses.	Entry price must offer a margin of safety; prefer valuation mean reversion opportunities.
3–5 Year Rolling Horizon	Investing is done with a rolling mid-term view, not forever holding or short-term timing.	Continuously reassess based on business visibility and changing cycles.
Balanced Portfolio Construction	Maintain 20-stock portfolio with 4–10% allocation per stock.	Balanced exposure across themes; reduces concentration risk while enabling alpha.
Alpha through Discovery & Rerating	Find businesses hidden behind noise or segment drag; buy before market discovers them.	Use segment analysis, capital allocation clues, and promoter intent.
Exit on Triggers	Exit when thesis plays out, doesn’t materialize, or better opportunities arise.	Process-driven exits based on fundamentals—not technical or emotional decisions.

Mean Reversion Investment Past Example

Criteria / Company	Gujarat Ambuja Exports	Suven Pharma	Usha Martin	JM Financial
Original Perception	Low-margin oil processor; seen as a typical commodity business	Core CDMO business masked by NCE research losses	Manufacturer with risky steel integration	Conservative finance house with blocked capital
Undervalued Segment	Maize processing (high ROC, pharma/FMCG client base)	CDMO business (70% gross margin, 30% net margin)	Wire ropes (recurring consumable revenue, high EBITDA/ton)	Investment banking, broking & wealth mgmt (high ROE, asset-light)
Capital Misallocation Issue	Legacy focus on oil; maize hidden in segment data	₹100 Cr/year loss in speculative Alzheimer’s research (NCE)	₹4,000 Cr borrowed for steel mill integration	70% capital blocked in ARC & wholesale lending
Solution / Trigger	Maize business grew; became dominant share of revenue/profits	2019 demerger of NCE segment	Sold steel mill to Tata Steel; refocused on wire ropes	Promoter announced exit from lending/ARC; focus on services
Valuation at Entry	Market Cap < ₹1,500 Cr; Single-digit P/E	₹3,500 Cr Market Cap; 16x P/E	Entered when core business made ₹150 Cr; stock ignored	Traded at Book Value (~₹9,500 Cr); 1:10 risk-reward
Profit at Entry	~₹150 Cr	~₹220 Cr	~₹150 Cr	~₹700 Cr
Profit After Rerating	~₹500 Cr	~₹1,800–2,000 Cr (9x return in 3 yrs)	₹400–₹450 Cr	Projected ₹1,200–₹1,300 Cr from core; optionalities not priced
Valuation Upside	Rerated as maize segment got discovered	Rerated post demerger of NCE	Rerated after steel exit + core growth	Book to P/E rerating expected; optionalities may add delta
Optionalities / Triggers	Further maize capacity expansions	NA (clean separation post demerger)	Structural moat in wires; global share potential	AMC, Wealth Mgmt, Affordable Housing IPO
Final Outcome	Strong rerating; segment leadership unlocked	9x return in ~3 years	Debt-free, rerated, recurring revenue model	Still in transition; high upside potential with limited downside

How to find a moat in a The Stalwart Investment Framework

Pillar	Description
Business (The Horse)	Strong underlying economics & scalability
Management (The Jockey)	Integrity, long-term focus, capital discipline
Valuation (The Odds)	Enter only when valuation is compelling
Exit Triggers	Based on thesis, time stop, better ideas, or overvaluations strategy.