Book review: Unlocking Nalanda Capital’s best guarded investment formula

If you have been in the market for a long time, it is likely you would have come across the name Nalanda Capital. Nalanda Capital (Nalanda) is a private equity firm that invests in listed stocks in Indian stock market. It was founded in 2007 by Pulak Prasad. Prasad has a vast consulting and private equity background having worked earlier at McKinsey and Warburg Pincus.

Prasad’s book What I learned about investing from Darwin, unlocks Nalanda’s closely held investing secret and has already found its way to the shelves of serious investors and fund managers. 

Book review Nalanda Capital

While Nalanda’s investment philosophy was never in limelight, this book suggests that its core investing philosophy has been defined by Charles Darwin’s Theory of evolution. The firm has met immense success in its investing journey in India with a CAGR of over 20% since its inception during the 16-year period between 2007 and 2023. Since Pulak Prasad has not been much of a public figure, nothing much was known about the secret behind Nalanda’s superior investing outcome. This book sheds light on this mystery. 

Please take a quick look into Nalanda’s $3 billion investment portfolio in the link below. The stocks have been in public domain, always and most of the investments are a decade or more old as well. 

Nalanda Capital » Portfolio

The three parts to the book

The book is all about how Nalanda framed its core investment principles of long term and patient investing from the basic concepts of evolutionary biology. It is divided into three parts and ten chapters. The three parts are titled based on the three elements of Nalanda’s investment strategy:

  1. Avoid Big Risks
  2. Buy High Quality at fair price
  3. Don’t be lazy – Be very lazy

The first part, with just one chapter, deals with the most critical aspect about Nalanda’s investing journey and will awaken the mind of every investor to figure out how he or she wants to pursue this journey. 

The second part, comprising seven chapters, deals with how Nalanda goes about investing – What they buy and how they buy. 

The third part, comprising three chapters, deals with how buying and selling decisions are framed. 

Let’s discuss each of these parts in detail and unlock the closely held investing secret of Nalanda. 

While this part is about avoiding big risks, it will awaken every investor’s mind to figure out how he or she wants to pursue this journey. 

The author starts this by giving a firm message; before making money, learn not to lose money. This talks about the common mistakes that investors make and the consequences. This also fully gels with Warren Buffett’s rules of 1) Never lose money and 2) Don’t forget rule No.1

In any investments journey two question arise. They are: 

  1. Being highly selective so as to avoid making bad investments (to avoid error of commission), there by missing out on some good investments. 
  2. OR making a lot of investments so as to not to lose out on some good opportunities (to avoid error of omission) and as a result living with some failed investments. 

This chapter is all about this. The Error of Commission is referred to as type 1 error and the Error of Omission is referred to as type 2 error in this book.

The Darwin analogy to Type 1 and Type 2 errors.

The author takes you through how “deer” as a “prey animal” has survived millions of years by avoiding type 1 error through few thought-provoking observations. A thirsty deer avoids a watering hole because a cheetah may be hiding there. While it may cost it in the form of its ability to run fast when a cheetah chases, it avoids type 1 error in the first case.  Likewise, there is an interesting observation of how male deers (called Stags) compete to take exclusive control of harem (group of female deers) without indulging in locking horns. These Stags perform various acts independently such as making sounds or roars, walking with stiff legs in parallel movements, etc to determine relative strength. In the last stage they may choose to clash antlers, a more of a push and shove match. Most of these run several minutes and at the end one Stag walks away. Deers have found great evolutionary success because at each stage of the contest, they minimize the error of committing self-harm. Otherwise, deer as a “prey animal” would not have survived millions of years. 

Given a choice which error would you like to reduce and why?

The author takes us through an interesting mathematical assumption with a universe of 4,000 listed stocks to show how outcome varies with each type of errors. It is based on the assumption that 25% of this universe are only good assumptions (and is generally so that only top 10-25% of companies make for great investments in any market)

Interestingly, reducing type 1 error has increased the success rate by 16% while minimizing both type of errors has only led to 2% further improvement (over reducing type 1 error). The author concludes that “a great investor is a great rejector”.

Please read the mathematical illustration in the book and go through the author’s thought process in detail. It may help you figure how you want to pursue your investing journey. 

This part has seven chapters (2-7) that deals with what Nalanda buys (2-4) and how they buy (5-7).

Chapter 2 deals with a ‘single” filter’, which, if applied, will give stocks with many other qualities already inbuilt in it. Sounds exciting? What is that single filter?

The author identifies it as high Historical RoCE. That’s just the starting point, NOT a theme or a narrative or a tag (growth, value, quality).

So, what all things that a high Historical RoCE bring with it?

  1. A consistently high RoCE business is likely to be run by an excellent management.
  2. A consistently high RoCE business is likely to have a strong competitive advantage.
  3. A consistently high RoCE business allocates capital well.
  4. A consistently high RoCE business allows companies to take business risk without taking financial risk, which increases the chance of business success.

While this single filter comes with many qualities, you may miss many opportunities going by historical numbers. In author’s own narrative, you may miss an Eicher or a Tesla! Because the numbers have turned better much later for them after stock prices went up multi-fold. 

You might have noticed analysts and fund managers using the term “Incremental RoCE” where they are hunting for companies where prospects are getting better. It involves lot of forward estimates.

But Nalanda goes the other way (sticking to historical ROCE) and prefers to do so, they are happy missing Eichers and Teslas, committing a type 2 error! 

While we have discussed some traits of businesses with high RoCE in points 1 to 4 above, Chapter 3 discusses about ‘robustness’ of businesses. The author takes a turn to living organisms like Sea Urchins that survived for millions of years and wants his investee companies to be robust to survive the onslaught of AI or other disruptive technologies, to withstand multiple recessions, deal with changing industry dynamics, competitive forces and more. 

Just as living organisms have exhibited robustness over generations at multiple levels - be it genes, proteins and body plan - the author wants his investee companies to exhibit robustness (examples of robustness listed in Page 76 of the book).  And high level of robustness helps business evolve by taking calculated risks as well, be it through acquisitions to fill product gaps or add new capabilities or expand their market or acquire new technologies. 

The core of all these is high RoCE, that itself reflects robustness and cash flows and using that muscle to further increase the robustness. He doesn’t miss pointing to the example of Asian Paints that gave increments to employees during Covid and liberalised credit period to its dealers, even though it is not his investee company (Nalanda is invested in Berger but analyses what competitors do).  Moving to Chapter 4, the idea is to look at businesses from the point of view of ultimate causes (long term business success) rather than proximate causes (near term disruptions). Proximate causes such as macro-economic causes, market related, thematic and company specific causes can cause significant stock price fluctuations but doesn’t change anything for the business in the long term. Having discussed what (kind of businesses) they buy in Chapter 2-4, the book moves to how they buy in the next three chapters. The Chapter 5, “Darwin ate my DCF” is interestingly titled to communicate that Nalanda pursues the profession of investing in the same way as evolutionary biologists do - explaining the present by interpreting what occurred in the past. Evolutionary biology does not make predictions nor does Nalanda.

The Darwin analogy on historical connection

The author pitches three revolutionary theories of Darwin – natural selection, sexual selection, and common ancestry and goes on explaining with the help of examples, each of these. You may have to read this long section in the book itself and how the author considers investing as a ‘historical discipline’. 

The idea at Nalanda is to study history of a business to understand its financials, assess its strategies, gauge its competitive position, and finally assign value to it. This is being discussed in greater detail in the book under four different sections with some examples.

The process ends here, NO projections, NO forward PE multiples, NO DCF. 

The process at Nalanda is to arrive at a fair multiple based on delivered financials and NOT projected financials. Not relying on forward multiples ensures that they don’t get deceived often. 

Next on discussion is another very interesting factor that forms the core of Nalanda’s overall investing philosophy – its hunting ground, explained throughout Chapter 6. 

If we go by what we have discussed so far, we may get a feeling that Nalanda goes and invests in ‘Great’ businesses or ‘Quality’ businesses that we often hear about. That stands true, but its hunting ground is premised on the idea of “Convergence” and deserve special attention of readers.

The Darwin connection on Convergence

The author takes you through Caribbean Anoles, Dolphins and Sharks to explain how convergence has worked in the living world. 

Caribbean Islands are home to about one hundred and fifty species of lizards called Anoles. All the species are the descendants of just two species. Darwinian natural selection is well alive in Caribbean according to observers. The Caribbean Anoles on different Islands have evolved the same solutions such as tail length, body length and colour, independently of each other. DNA Analysis has demonstrated that they are not the same from Island to Island, but evolved with similar characteristics independent of each other. They are a textbook example of “evolutionary convergence” wherein unrelated organisms in similar environments develop the same body form and adaptations independently.

Dolphins are mammals and sharks are fish. But their fusiform body shapes are pretty similar, and more interestingly, they have the same coloration. Both have a light under belly and a darker back, making them harder to spot from above and below. George Mc Ghee, a palaeontologist, claims that the reason dolphins, sharks and tuna looks alike is that there is only one way for a fast swimming animal to evolve.

At Nalanda, the idea is to invest in “Convergent Patterns” and not individual businesses. In author’s own words, “We don’t care about a business; we are deeply attached to a business template”.  The author takes the example of how they narrowed down on Info Edge ( while looking at similar companies in other markets. While the world is full of praise for its founder Sanjeev Bikhchandani and CEO Hitesh Oberoi, the author makes a clear opinion that they would not have invested in the company with the same duo at the top had it been in No. 2 or 3 position in the business. Likewise, the author discusses several industries including airlines, IT services, chemicals, footwear, etc. where all the companies in an industry either make money or lose money.  The industry structure can provide the template or pattern as to whether companies are likely to make money or not. 

“Convergence is the dominant pattern in the business world, on rare occasions it isn’t”. 

The last chapter of this Part 2 largely deals with how to avoid traps or false signals. This deals with a string of things including media headlines, press releases, road shows, management interviews, earnings guidance, face-to-face meetings, etc that may also throw up false signals. The chapter is an interesting read with examples of Frogs and Guppy from the living world to narrate how they deceive their mates by emitting false signals.

To summarise what we have discussed thus far in Part 2, it starts with RoCE as a single filter that brings to light many other qualities of a business in one shot! Then starts the job of assessing the robustness of a business and finally arriving at a valuation based on delivered financials. This process is complemented by identifying right hunting grounds using the idea of ‘Convergence’ to further increase the probability of investing success.

“We rarely buy and seldom sell”. In his own words, this is what author means by “Be very lazy”

As quoted in the beginning, Nalanda wants to be permanent owners of high-quality businesses. 

Darwin’s theory of natural selection

The author then gets back to Darwin’s theory of Origin and a challenger to that exactly 100 years after it was published from a Finnish Scientist, Bjoron Kurten. His claim was also supported later by a palaeontologist who demonstrated mathematically and empirically that phenotypic change (i.e.. Changes in the bodily characteristics of a species) could be rapid from one generation to the next. In contract, evolution can be slow on long time scales. This has been further supported later by a study on Darwin’s finches (a bird species) by Peter and Rosemary Grant, professors at Princeton.  The study was about how beak sizes of finches changed rapidly with evolving situation of heavy rainfall and drought though finches as a species stayed as such for millions of years.

Few years hence, two palaeontologists published an essay that seemed to blow a large hole in Classical Darwinism. Darwin’s theory of natural selection makes a robust case for “Phyletic gradualism” (gradual evolution over millions of years). But palaeontologists found from fossil records that majority of the species appear suddenly in the fossil records and then persist unchanged until they go extinct. This led to the birth of an alternative in the form of “Punctuated Equilibria” to Darwin’s “Phyletic Gradualism”. They claimed that the history of organic world could be viewed as comprising long periods of stability interspersed with brief periods during which new species emerge.

Nalanda’s investment principle is formulated on this basis, called Grant-Kurten Principle (GKPI) while the theory of “Punctuated Equilibria” has a profound influence on its buying decisions.

“When we find high quality businesses that do not fundamentally alter their character over the long term, we should exploit the inevitable short-term fluctuations in their business for buying and NOT selling”. 

Looking for evidence regarding longevity of businesses, the author quotes a study on Fortune 500 companies between 1955 and 2015 (60 years). The study revealed survival rate of 12% and quoted “creative destruction” as the key reason for this low survival rate. But a detailed interpretation of the data by the author revealed that the survival rate is far higher at close to 25%. Here are his observations:

  • 72 companies continued to be part of Fortune 500 after 60 years.
  • 73 companies became part of another Fortune 500 company (mergers, acquisitions).
  • 60-75 businesses continued to survive despite falling out of Fortune 500.
  • Almost 280-295 companies out of the 1955 list failed.

With such high survival rates for businesses in the long term, the author goes on to define ‘long term’ as 50 years! Another outcome of this study is that new businesses do replace old ones, but at a far slower rate than we think. 

This is extremely relevant now when we hear of disruptions every now and then but without much ultimate success.  The evolutionary theories discussed above combined with evidence on survival rates cements the argument for long-term investing despite the “noise” around disruptions and survivability of businesses. The 12% survival rate posed by the quoted study might have influenced the minds of many investors and fund managers to churn businesses quite often if they overlooked the reality of 25% survival rate as arrived at by the author. 

Nalanda has correlated events like the Global Financial Crisis and Covid to ‘Punctuated Equilibria’ and how making investments during those events have completely changed the portfolio (new species as explained in evolutionary theory) to look different from what it was before (holdings, allocation, composition). Nalanda bought stocks such as MRF, Sundram Finance, Thyrocare and Thermax during Covid while it also added to its existing holdings such as Cera Sanitary and Triveni Turbine.  With that, we are into Chapter 10, the last chapter of this book where the author quantifies how successes and failures have impacted its portfolio over 16-years of its investing journey during which the firm has delivered compounded returns of over 20%.  Nalanda had seven failures which he calls Sorry 7 out of 17 businesses, a failure rate of 40%. But its winners really did wonders in such a way that the “returns” from each of them was far higher than the cumulative amount invested in the Sorry 7. Here’s a quick glimpse below:

In the above table, Page Industries delivered 82.2 times. This gain alone is 5.2 times the total investment in the sorry 7. In other words, a single successful stock more than made up for the cumulative investments in the dud stocks. 

And Nalanda doesn’t want to sell its winners! 

The author has given detailed explanation as to why they don’t want to sell winners with seven reasons in detail through the remaining part of Chapter 10, including the Sorry 7 that we just discussed. 

However, there are three situations where the firm will take a call to exit completely when there is;

  1. A decline in governance standards (0)
  2. Egregiously wrong capital allocation (3)
  3. Irreparable damage to the business (6)

The numbers in bracket represents the number of exits made for those reasons.

The divested companies include (Nalanda Capital » Portfolio) Carborundum, Exide, Kirloskar Oil Engines, Kewal Kiran Clothing, Lovable Lingerie, Mastek, Shree Cement and Sun TV.

While the author has not discussed in detail about each of these, he expressed his regret in selling Shree Cement early.  He also seems to have discussed in detail about what led to the exit from Kirloskar Oil Engines without directly naming it (Page 210). 

The author concludes this chapter by mentioning that “Investing is a unique profession in which to inactivity can be hugely rewarding” – Be very lazy!

To summarise what we have discussed in Part 3:

  • you will make mistakes in investing and in order to overcome those mistakes, you need big winners
  • And those big winners happen over long holding periods only
  • And if the process you applied across investing universe was superior, your failures will cause less pain and the winners will lead to superior overall results which is healthy compounding!

Is Nalanda walking alone?

Nalanda’s philosophy has close parallels with what Warren Buffett and Charlie Munger has practiced for decades at Berkshire Hathaway. Their famous investing quotes definitely point to that;

  • Our holding period for ever
  • Be fearful when others are greedy and be greedy when others are fearful
  • It is far better to buy a wonderful business at fair price than a fair business at a wonderful price
  • An investor should act as though he had a lifetime decision card with just 20 punches on it
  • The big money is in waiting and not in buying and selling

Beyond Buffett and Munger, there are domestic fund managers like Bharat Shah (ASK), Saurabh Mukherjea (Marcellus) and Hiren Ved (Alchemy) who follow a somewhat similar investment philosophy in my view. Bharat Shah has for long been an advocate of buying high quality business where he looks for growth combined with quality of growth (RoCE) and longevity of growth. Interestingly, we have seen Bharat Shah making some shifts with PSUs, cyclicals and airline stocks in his portfolio. He argues that these stocks now fit into his philosophy than him deviating from his philosophy. 

Nalanda, on the other hand, may not buy such arguments of change and would likely stick to historical information and Convergence patterns, instead.

Saurabh on the other hand is so particular about investing in businesses with “robustness” as discussed earlier with a comprehensive analysis of historical information like Nalanda does. But where Saurabh differs with Nalanda is in the entry valuation. Nalanda is so particular about how much they pay while Marcellus is ready to pay super rich valuations for a high-quality business.

Meanwhile, investment managers such as Bharat Shah and Saurabh Mukherjee are also bombarded with inflows every day and they must survive the performance comparisons that happens every quarter. They can’t wait for the black swans or otherwise “punctuated equilibria” as Nalanda calls to plunge in to shopping once in few years.

There are also many individual investors, not so known in public domain, who have made fortunes through long term ownership of businesses since the days of paper shares. They may have also encountered a Sorry 50 list or  even a Sorry 100 in their journey but the winners may have compensated for all. 

If you are an individual investor with the rare luxury of being able to study companies the way Nalanda did and have the kind of capital, then the ground may all be yours to play!

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7 thoughts on “Book review: Unlocking Nalanda Capital’s best guarded investment formula”

  1. Well written Chandra. This is one of my favourite books and have read 3 times till now.

    One trick that I follow is,
    -Just look at all companies that Nalanda invested in. So all the due diligence is done by them.
    -Check in Screener to get an idea on what price they bought them.
    -We will be able to find few companies that are still trading at fair price.
    -Buy them and do nothing.
    -Sell them only if Nalanda sells them and we know Nalanda sells rarely.

  2. Dear NVC
    What a coincidence ! I just completed this book today morning ! I may or may not have liked the book, but I must say that your summary is spot on ! It could have saved two weeks for me if I had read this summary before starting the book – as conceptually you’ve not missed anything.
    Anyways, PI readers will get definitely get benefitted from this summary.
    Thanks !

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