Wizards of Dalal Street - The New Breeze - Manish Sonthalia

http://www.moneycontrol.com/news/mf-analysis/free-cash-flowscos-drives-investment-decisions-for-sonthalia_7859821.html

Oct 31, 2016, 01.21 PM | Source: CNBC-TV18 

Free cash flows of cos drives investment decisions for Sonthalia Deep-dive into the free-cash-flow generation capability of a company over at least the following 5-10 years is a must for Manish Sonthalia, CIO & Director at Motilal Oswal PMS to consider investing in it. "Ultimately, numbers don’t lie," he says.

In a candid chat with BSE and NSE Member Ramesh Damani in a special series Wizards of Dalal Street on CNBC-TV18, Sonthalia shares Motilal's principles and methodologies of investing.

The fund house follows an in-house formula called QGLP for picking up stocks, he says, adding, it is nothing but a margin of safety where 'Q' is for the quality of business and management, 'G' stands for the growth prospects, 'L' for longevity of growth and whether competitive advantages are structural or cyclical and 'P' is  the price.

He notes these factors are critical as cost of capital in India is pretty high which results in nearly 65-70 percent businesses barely managing to earn even the cost of capital which ideally suggests they should be trading at nothing over 1 times on price to book value.

Sonthalia also shares insights on some of his early-bird picks like Page Industries and Eicher Motors which gave blockbuster returns.

Below is the verbatim transcript of Manish Sonthalia’s interview to Ramesh Damani on CNBC-TV18.

Q: There is a very popular book ‘All I Really Need to Know I Learned in Kindergarten’. You learnt investing from watching your dad’s portfolio? 

A: Yes, the story began some 25 years ago after I passed out of class 12 and I was a science student obviously inquisitive about the how and why of things. My dad is a practicing chartered accountant so had some stocks in the portfolio which always did well. 

He used to get good dividends and good dividends increased every year and at the same there were some stocks like Tata Iron and Steel, very cyclical, they went up but they came down, dividends were erratic or not there. That made me wonder as to what made stocks move. 

Q: Let me take you to 2004, the Motilal Oswal of Motilal Oswal called you for a job? 

A: That is correct. One fine morning sometime in July or August of 2004 I got a call from him asking me whether I was keen to join them. 

Q: Did you think it was a crank call? 

A: No, I didn’t. The serious voice that spoke on the other side convinced me. He wanted me to come over to Mumbai and face an interview with Raamdeo Agrawal and himself and if I could have cleared that, obviously he was willing to hire me. So, I came, I gave the interview, got selected and now I am here. 

Q: The early part that shaped your investment philosophy was where is the cash. How did that shape the first years of your investment business? 

A: I must say that whatever I am today so far is all been due to the learning’s of this organisation. Motilal Oswal, that has created the foundation. Ultimately numbers don’t lie and what matters the most is the free cash flows of companies, not the P&L account, profit balance; that is the determinant to the free cash flows and if you are able to gauge how much cash flow the business is going to earn over lifetime or maybe next 5-15 years, it is nothing but the present value of the future cash flow. 

So, that is what we focused on and of course Rammdeo Agrawal, he is a great teacher, how he creates, how he goes about explaining how businesses are and what matters and what doesn’t matter and that created the foundation, made me perfectly believe that if you got to get stock prices right, you better get a handle on the cash that the company is going to make over long period of time. 

Q: As you progressed in your job, I have heard a lot of abbreviations in my time, SOS, IOU, GOI, PMO but you guys believe in a different abbreviation, tell me about it.

A: The term is called QGLP. This is nothing but the margin of safety. QGL is the value piece, P is the price, difference between value and price is the margin of safety. The value component has been broken down into three that is Q, G, L where Q is the quality as measured through quality of business and quality of management, G is the growth part -- we want to buy growth businesses so we are following a growth at a reasonable price (GARP) method of investing and longevity of growth is understanding whether the moat or the competitive advantage of businesses are structural or cyclical.

Q: Give me a couple of qualitative and quantitative factors that are very important to you? 

A: Quality, we have two components, one is the quality of business as measured through return on capital employed and free cash flow. At the same time, the quality of the management is quite important. A good business run by a bad management or a bad business run by a good management, answer is a not for you. Only if a good business is run by a good management we will have a winner. 

So, understanding and gauging the quality of the management is equally important and that requires a lot of experience and whole lot of methodology and we have evolved and developed few of the forensics that we use quantitatively to gauge whether the management is of high quality. 

Q: You don’t think it is beating the return on capital right, the cost of capital? 

A: In India the cost of capital is pretty high. We have very few businesses -- 65-70 percent of the businesses in India don’t even earn cost of capital, just about meets cost of capital. They should be trading at maybe one time price to book. 

Q: And don’t deserve a place in your portfolio according to you? 

A: You won’t be beating the markets. 

Q: In certain stocks you have not only doubled but you made 40 times your money. One of them is Page Industries. Tell me how did you chance upon that stock?

A: I had some understanding about the hosiery businesses. Coming from Kolkata you have some of the old names – and if you went through the Draft Red Herring Prospectus (DRHP), we bought into the stock just about after the IPO came. So, if you have gone through the DRHP, you understood how the businesses actually were very successfully managed by them in the Philippines. If you did some internal research, desktop research for yourself, you would have been able to figure out what they were intending to do. 

Then it was all about going to be factories in Bangalore and understanding what they are wanting to do and obviously it was an aspirational brand; you knew it because American brand (Jockey) -- 100-year-old product -- here they were positioning the product at a very reasonable price point so they were offering value for money. Market was expanding, they were doubling every five years, he was present in the mid-premium and the super-premium category which was growing faster than the market. 

Q: What was his moat?

A: His moat is his distribution according to me. This distribution advantage, which he has will be there even today for the next 10 years. 

Q: Despite the stock doubling and doubling and then doubling some more what gives you the confidence to stay on? Is it the sheer numbers that come every quarter? 

A: Long-term is made up of many short-terms and if the short-term, the numbers do come, you just got to figure out what should be the terminal value and terminal value to determine you understand the nuts and bolts of what will make that much. As long as you are confident about these numbers coming, then it is just extrapolating what is the price to earnings multiple that should be for that business. 

Q: Another stock that has been very successful for you, let us go to their strategy. Eicher Motors has been a fabulous stock, one of the great winners of the 2007 bull market. You spotted it young, tell me the exciting story behind Eicher. 

A: Eicher had been a fascinating story but we looked into Eicher initially for their trucking business, when they tied up with Volvo. They opened the joint venture (JV) but it was not doing that well. They were going about it but slow and steady. Then I happened to read an interview of Siddhartha Lal and he was also equally optimistic about the Royal Enfield business. However, it was doing meager numbers those days, 50,000 units. 

In a category of motorcycles, where numbers were big even those days, the entire category was growing, doubling every seven years. So, growth rates were 10-11 percent in volume terms. Here we were talking about company which was setting 50,000 units but it was an aspirational product owned by the British Navy Royal Enfield and the Bullet and the Classic 350 which is the best selling bike just kept on ramping numbers and margins kept on increasing. 

Q: He is in a sweet spot in terms of segmentation you say? 

A: Absolutely. He has created the segment for himself. He does not compete with scooters, he does not compete with commuting motorcycles, he does not compete with ultimately ultimate leisure biking.

Q: He owns this segment?

A: He owns the segment and even today there is no major competition that is coming through. If he has priced its product very sweetly between Rs 1,00,000 to Rs 1,50,000, that range, he will continue to be a winner. There is of course competition trying to position their own products within that segment but he is miles ahead of them and to get latent demand in the system for these sort of bikes is roughly around 2 million units. Today he is at 60,0,000 units. 

Q: Lot of headroom?

A: Lot of headroom to go and the market hopefully should be growing at about the motorcycle category growth rate for long period of time. 

Q: When you first buy a stock, Page, Eicher, anything else, is there bit of heart pounding goes on, are you unsure, do you know that is going to be a winner, is there something that your bloodstream tells you? 

A: Mentally I try to figure out the P&L account model at least for the next three years. Looking beyond that is difficult to take a call on but based on my understanding about the business, what would make money for those businesses, just try to figure out how much money this business is going to make in the next three to five years. 

Q: So it comes down again to numbers and cash flow? 

A: 100 percent, nothing else works. According to me, value investing is understanding growth investing as far as India is concerned. Benjamin Graham’s definition of value, the strictest definition of the term would not apply to India because bulk of the businesses are earning less than cost of capital, how does low P/E stocks would make or create wealth for you. It is about growth, understanding growth and how much cash flow these businesses are going to make. 

Q: The way India is shaping up, there are and there will be a lot of structural stories coming through with good quality management. So, investors, I have missed Page and Eicher, can either buy Page, Eicher again or some other stocks, do you feel that opportunity is still there?

A: Today bulk of the value is getting captured in the private equity space. However, at the same time we will have umpteen numbers of opportunities even in the listed equity space. So, one thing which I look forward to also, is to understand how much the profit pool is going to grow and how many players this profit pool is going to get shared with. So, if you have consolidated sectors, I as a fund manager try to figure out whether company A is going to do well or company B is going to do well or company C, if they all fit into the QGLP framework. My job is easier if there is a growing profit pool and a consolidated space.

Wizards of Dalal Street - The New Breeze - Rahul Rathi

http://www.moneycontrol.com/news/business/rahul-rathiwizarddalal-street-has-2-investing-styles_7814421.html

Oct 30, 2016, 11.40 AM | Source: CNBC-TV18 

Rahul Rathi, a wizard of Dalal Street, has 2 investing styles Ramesh Damani’s popular Wizards of Dalal Street is back, and this time Damani interviewed Rahul Rathi, MD & Chairman of Purnartha Investment Advisors. Rathi spoke about his two styles of investing: Invest in a business, and the other strategy is to invest in the businessman.

In a business, you look at a 11-year history which is a GDP cycle, he said. Rathi analyses how a business does in this period, whether it has perofmed well during times, good and bad.

The key metric to follow here is to see whether the business has created wealth. One way of doing that is to look at how operating cash flows have grown, he said.

“I divide my universe into government-led GDP growth and consumer-led GDP growth. I believe the consumer-led growth is secular in nature and GDP growth isn’t volatile.”

He also spoke about his biggest learnings from mistakes.

Below is the verbatim transcript of Rahul Rathi’s interview to Ramesh Damani on CNBC-TV18.

Q: Numbers do not lie and that is a core belief with you, is it not?

A: Yes,numbers are a measurement of an outcome. If you look at companies like Asian Paints, HDFC Bank, Bajaj Auto, Infosys, Bajaj Finance, they have all returned more than 250 times since inception. That is a number. And why have they returned these kind of stellar returns is what other numbers show.

Q: There are two kinds of businesses that you look at. You divide them in two ways. Tell me about it.

A: There are two styles that are there prevalent in investing. One is investing in a business and another is investing in the businessman. What do you look at when you are investing in a business? You look at the 11-year history because 11-year history is a gross domestic product (GDP) cycle where GDP has gone up, GDP has gone down and GDP has drifted. Within the 11-year cycle, how is the business done during bad times, during good times and drifting times.

Q: What do you look for beneath that number? You get 11-year snapshot. Now, what are you looking at?

A: The key metrics that we follow to know whether the business has created wealth is how has its operating cash flow grown. Operating cash flow is a number that tells you what the cash that the operations generate from the business.

Q: But that doesn't capture the capex that lot of the business requires or a lot of dividend payouts they have to make. So why is operating cash flow that meaningful?

A: We studied about 160 companies over 30 years; companies that have created wealth. However, what we found in a ten year cycle was operating cash flows in a three year period multiplied manifold; where operating cash flows doubled or tripled. We call this the golden period. Three or four years they have averaged above average operating cash flow growth and in three years they have averaged below average cash flow growth.

However, companies that enjoy a golden period have two variables that are common to them. The first is 10 percent volume growth which meant that there is a demand for the company's products and second is being debt free which meant that they have pricing power.

Q: Volume growth implies pricing power?

A: No, there are some companies that also have volume growth without pricing power but companies that have pricing power -- I will give an example where if you look at Maruti Suzuki and if you look at their Baleno and if you look at Swift; Swift's current weight is 1,050 kg and sells at Rs 4.2 lakh and Baleno is 950 kg and sells at Rs 7.2 lakh. So they have pricing power in terms of weight.

Q: But how does that 'no debt' criteria work for you?

A: The 'no debt' criteria means that they have operating cash flows. For volume growth you need capex and you need working capital. If operating cash flows can take care of working capital and capex then you have a debt free scenario. Infosys, Maruti, all have debt free scenarios because capex is done by auto ancillaries for Maruti and they are negative working capital because of working capital creditors.

Q: That is strictly quantitative strategy that almost anyone with a laptop and a database can replicate. What is the value add that you provide?

A: We have three legs when we evaluate a company. One is the numbers, which we have done. The second is identifying what the management team and the organisation is for the company. We found in our studies that there are two sources of leadership in any company. There is one who is a visionary, who thinks about what the world will be in the next ten years, a big picture guy, and there is a data driven guy who is also a leader who tells the big picture guy whether his vision has risks, the data supports his vision or there is a lot of risk to his vision and he should change his vision.

Q: Ted Turner and Jack Welch were notably famous big picture guys. In India, any big picture guys who may have impressed you.

A: Deepak Parekh, Sanjiv Bajaj, Vikram Somany of Cera Sanitaryware are some of the guys whom I believe are leaders in the next millennium and continue to know how India will pan out.

Q: Among the newer sets you find anyone who strikes you as a big picture guy?

A: Sanjiv Bajaj is new; he is only 48 years old. He started the financial services company and has continued to do well.

Another guy who is a recent entrepreneur and whom I believe is going to be the entrepreneur of next generation is Samit Ghosh of Ujjivan Financial Services.

Q: Anyone else that strikes you in all these years?

A: The person whom I follow tremendously and who has given me a lot of energy is Ramdev Baba who has delivered phenomenal growth in Patanjali.

Q: After looking at the qualitative stuff then you look at a valuation matrix. What is that?

A: In our history of 30 years we found that if we can buy a company whose seven to nine years of cumulative operating cash flow is equal to the marketcap of the company then these investments always create wealth. However, for me the golden mean is seven years but I am comfortable between seven to nine years because cost of capital has come down significantly with Japanese interest rate being near zero.

Q: Is there any sectors that is more prone to higher returns on capital, better cash flows, so only look at those businesses as oppose to other businesses?

A: The way I divide my universe is I have government led GDP growth and consumer led GDP growth. I believe that the consumer led GDP growth is secular in nature and GDP growth is not volatile. So, we will invest in companies that have a consumer orientation to it.

Q: How does a retail investor benefit from this enormous database that you have?

A: We are a Sebi registered investment advisor and the Purnartha model's work is where the client tells us that this is the amount he wants to invest and he keeps it with himself. We tell him what to buy for that amount and he gives us a contract note once he is invested from his own account, keeps the money in his own Depository Participant (DP) account, the stocks in his account.

He gives us a contract note and we have a technology that we have build over two years that captures the net asset value (NAV) for that person and at the end of the contract period we calculate what has been the return and then we share the profit in a way. So, all the control of all the money is with the client.

Q: And you put your own money where your mouth is?

A: Absolutely. 95 percent of my total wealth for me and my children is invested in the strategy.

Q: You have had a great career, you analyse stocks and you look at it differently than most people. Give me some learning that you can share with us.

A: The biggest learning have come from the mistakes that I have made and one of the mistakes I want to share is Jammu and Kashmir Bank where data and the outcome did not match.

Jammu and Kashmir Bank has a clear monopoly to be able to recover money whenever they want. But as soon as they started lending in Mumbai and Bengaluru, the recovery mechanism in Jammu and Kashmir did not work and their non-performing assets (NPAs) were much higher than expected. So, we learned that late.

Q: So, what was the learning there? The data itself is not enough?

A: That is true. What we want to see is their current execution and their history, are they in sync or they are different. If they are different, we need to re evaluate whether the capability what we are investing in is what the history matches.

TGIF with Hiren Ved - BloombergQuint

http://www.bloombergquint.com/markets/2016/10/28/investors-may-give-tata-group-the-benefit-of-the-doubt-hiren-ved

 by Agam Vakil

Shraddha Babla

October 28, 2016, 8:19 pm

This week on Thank God It’s Friday, we spoke to Hiren Ved, director and chief investment officer of Alchemy Capital on how he has seen the equity market evolve over the last two decades, the stocks and sectors that he is bullish on, and how he sees the current Tata Group versus Cyrus Mistry spat to play out.

Q: You have been tracking the Indian markets for the last 25-26 years. Just wanted to understand how have things changed over the past two decades in terms of corporate governance and investment opportunities. Was it easier to make money back then?

A: Yes. When markets are imperfect, there is more opportunity to make money. Over time, access to information has improved substantially. You have the concept of quarterly results, you have conference calls, you have analyst meets. You did not have any of those in the early days. In those days you had to go to the stock exchanges to put half yearly results up on the notice board and take them down later. And then probably come back and analyse them in the office. And to get access to companies we had to go and attend shareholder’s meetings of these companies because that was the only time that we got facetime with the management and you could ask relevant questions, try and make friends so that you can reach out to them later. So I think the speed of information and the access to quality information has gone up by leaps and bounds. Obviously, as the market gets more perfect, and the number of players increases dramatically, it becomes tougher and tougher to make money. But I still feel despite that, India is a great land of opportunities. 5,000 listed companies, our economy is still evolving, and for a curious mind, and a person who wants to work hard, there is still money to look at.

Q: Which phase is the Indian economy is in?  Are we still in the recovery phase, are we in the trough or are we climbing the path towards an economic recovery? Has the expansion phase already begun? And is there any scope for further PE re-rating from here on, like the kind we saw in February?

A: I would say that we are in the early phase of the recovery. Clearly, there are parts of the economy that have begun to show some growth, and there are parts of the economy which are still lagging. We all know that private investment is still lagging substantially. There are areas in consumption that have done well and government spending is picking up. So if you look at what drives growth, I think consumption and government capex are driving growth. Private capex and trade or exports is still very slow. India may still take market share in certain areas on exports but, on the whole trade, growth has been very slow. So I think it’s like of the four engines you are running on two and the other two are yet to fire off. So I think you are in the early stages of recovery. And that is probably also reflected to some extent in the market valuations because what happens is that when you are going from trough profitability, usually the PE of the market goes off first and then earnings follow. Earnings is always a lagging indicator. PE is a leading indicator. Similarly, in 2008 when the market started to correct, and you would ask a company or management, they would say, ‘no my business is going fine but I don’t know why the stock price is falling’. But the market is smart. In 2008, the PE contracted first and the earnings fell later on. You only realised it in March 2009 when earnings de-grew. Expectations were very high in 2008 that earnings would keep growing and growing at 20-25 percent plus. So I think we are in a reverse situation right now where margins are at 15-year-low, capacity utilisation in many sectors is very low, so you are not on your normalised profit growth. But at the same time, there are a few things which have started to turn around. And obviously, the easy liquidity that we have seen around the world, and the fact that cost of capital in India is falling, means that we have got a lift-off in PE first. And hopefully the earnings will follow.

Q: I am sure you are following the ongoing issue with respect to the Tata Group and the ouster of its chairman. And this is going to be in the run of speculation because we do not know what is going to happen but if the Shapoorji Group were to move out of the Tata Group with respect to shareholding, would you have any guesses what could happen? And secondly if there is a correction right now, we have seen some correction in all the Tata Group stocks, would you buy some of these companies?

A: First of all, we have to understand that the Tata Group is a group which has been around for many years. So it is not the last 10-year or 20-year phenomenon. It is a last 100-year phenomenon. When you have such deep rooted history...a group will never crumble just because something happens. Now obviously the group has become fairly large and complex. And it is going through its usual metamorphosis. So typically groups that survive have to change. Sometimes that change leads to friction. It causes things to unsettle for a while. But then things will get back in shape. If you ask me, will it dent the reputation of the Tatas as we see it? Probably a little bit of the sheen has worn off. People are a little surprised at the manner in which things have been done. But having said that, I think that it is a large institution. And now things will sort themselves out over a period of time. As to whether I would buy on a correction, we have to realise that some of the things which have come out in the open are not necessarily new revelations. I think the market was very smart. And if they believe that Tata Steel Europe was a bad decision than the market discounted it in that manner. It is not something new. The fact that the overseas properties of Indian Hotels are not making money, or are RoCE dilutive, the market is much smarter, it discounts this much quicker. From here on I think what investors would want to see is that now that many of these issues are out in the open, how some of these capital allocation decisions that were taken in the past. You can always in hindsight question some of the decisions. But it is not about the history, it is about the future and what the managements of each of these companies decide to do in order to improve the profitability of their businesses is to my mind more relevant from a future stock price perspective. These shocks can keep coming and you will see a downgraft and then obviously you will see things coming back to normalcy. The longer-term trajectory of the valuations of these companies will solely depend on the fundamentals and the future action that managements take to grow these businesses’ profitably. So if you ask me, I would still say that they would have a stellar reputation despite what has happened. Investors are likely to give them the benefit of the doubt and some more time.

Q: Do you think there is a case for reshuffling as far as the senior managements of some private banks are concerned? You’ve already seen some of that happening in PSU banks which have seen a big pile up of bad debt. Should managements really be made liable for some of this?

A: In India, the equity market adjusts to the new reality very quickly. So if a company is highly indebted, and it is not able to service its debt, you see a massive drawdown on equity value. In the enterprise value what remains is dead. Equity value becomes a very small part of the enterprise value. So the market in its own wisdom penalises. But our structure was not amenable to fast change, as in banks could not easily take out a management and take in a new management. And therefore there was a flaw in the laws and regulations governing change of management. The Bankruptcy Law is a seminal regulation that has been passed in India. Obviously you still have to iron out and see how this is implemented. But I think that just like any other developed market, companies should be free to be bankrupt. Lenders should be free to sell their assets and recover their money and if required, even change managements. Have we reached there in India? I think we are far from there. Have we taken the first few steps towards that? I think so. And I think that today more than at any point of time in the past, I think investors are looking at governance as a very very important pivot around taking investment decisions. So whether the law does it or not, the investors will penalise you if they believe that your governance structure is not right. And I think it is going to be increasingly difficult for some of these companies to go and raise future capital for growth. So the market mechanism is taking of care of a few things, but I think for sustainable growth and to attract foreign capital, we definitely need the ability to change managements if required, to sell assets if required more freely, and not have these judicial interventions all the time which take years and years to be resolved. I think some managements have taken advantage of the fact that they could block any of these things because of where the regulations are today and the judicial system is not geared to take such decisions.

Q: Bajaj Finance has been a multi-bagger for you. It has been one of the best performing stocks in your portfolio. Just wanted to understand what your stand on the stock is? What have you done with your allocation and secondly which is your next bet as far as the NBFC space is concerned?

A: I think we have had a very good experience as investors in Bajaj Finance. They were there at the right time, at the right place with an excellent, cutting edge management team. And I think they have been able to exploit the opportunity to the full. I still believe that from a long-term perspective, there is a lot of growth ahead. All said and done, it is still a Rs 50,000-60,000 crore balancesheet. The balancesheets of most of the large banks are almost 10 times that of Bajaj Finance. So I think that the market is growing. Financial services in India is fairly underpenetrated. So if you ask me, long-term growth is still there. Obviously because of the stellar performance that was shown in the last 4 years, the market has rewarded them with a very high price to book ratio, high PE ratio. It is hard to argue that there is further upside as far as valuations are concerned. So I think as investors now you will probably get the earnings compounding. Possibly if you bought this 3-4 years ago you have got a combination of earnings growth and multiple growth. You can’t argue for a multiple growth from here onward. Will the multiples remain high? I think the multiples will remain high because of the sheer quality and growth opportunity that is ahead of it. On the whole, I think I am still bullish on NBFCs in general. We are in the unique situation where the economy has to grow and therefore financials is a great way to play the growth in the economy in several sectors, whether it is through corporate landing, whether it is through retail landing, whether it is through selling or distributing financial products. I think the biggest opportunity in financial service is, the way I see it today, is at the bottom of the pyramid. The fact that this government has rolled out the UID program, the previous government and then carried forward by this government, and the whole DBT framework, I think they have laid the basic infrastructure on top of which many financial services will lie. What was supposed to be the mandate of the public sector, which is to go into the hinterland where the private sector is not going to go and deliver banking services, to some extent they have been able to fulfill. To a large extent because of the structure of PSU banks they were not able to fully exploit that opportunity. That is today being done by some smarter private banks, largely by the NBFCs, and even more importantly by the microfinance companies. So I think that is where I see a future opportunity for growth.

Q: What trends are you picking up with respect to consumption, specifically in the discretionary space? 

A: As I said, discretionary consumption is a big driver of growth in India. But it’s been a winner-takes-all strategy. If you look at four-wheelers, for an instance, I think that other car companies are not growing as well as Maruti. This despite the fact that Maruti has capacity constraints. But that tells you that, yes, there is demand, but it’s not a secular demand for everybody. So you will see differential growth rates within sectors. If your product is good, if your pricing is good, if your distribution and reach is there, then you have a better chance of attacking the consumer’s wallet. We have to keep in mind that while consumption is growing in India and will continue to grow, the big challenge I see is creation of new jobs to get consumption growing. Some of the consumption growth that we’ve seen in India has been driven by consumer debt. Right now, it is not alarming as consumer debt in India is much low. But we cannot take our eye off the ball. We have to keep at the back of our mind that the more sustainable consumption is one where you create more jobs and income and not take on more debt. That is a big challenge in front of the government, which they do realise. The problem is that 10-15 years ago, a lot of tech companies offered high-paying jobs and that created a consumption boom due to high salaries and employee stock options. You now need either manufacturing or high-quality service jobs to maintain that consumption. The tech industry is itself going through a metamorphosis. They are focusing on growing employee productivity than just growing the number of employees. They are not hiring as many software engineers as they were 10 years ago. Therefore that’s a challenge. The investment cycle needs to kick in for creating high-value jobs. For example, the construction sector, one of the largest employers of unskilled labour, is lagging. A lot of those things need to start to kick in if we want to sustain consumption. The good thing is the monsoon was very good this year after two consecutive bad monsoons. That’s likely to give a boost to rural consumption this year. But what about the next year and the year after and so on? Yes, consumption is a bright spot driving the economy but we need to start creating jobs to make it sustain.

Q: Are you seeing any contrarian bets in underperforming sectors like industrials or commodities which have run up?

A: I think the time to bet on commodities was earlier this year in January and February. Commodities have rallied, oil prices have rallied $25-26 to almost $60 plus per barrel. Commodity prices were so battered down that we had to see a rebound, and we’re seeing that now. In some sectors we see oversupply in China and that’s why we see coking coal and iron ore prices go up. Is it a secular rebound? I don’t think so. I think global growth is still very challenged. The people I speak to in shipping and logistics tell me they’ve never seen days as worse as these in international trade. It’s more about supply being managed in the short run which is leading to a run-up in prices. It’s not about demand growing at a very heavy clip. I wouldn’t bet on commodity companies in general. I don’t think this is an area where you’ll bet and say ‘I think commodity prices will keep going up’, although I could be wrong there. On a contrarian basis, I think money can be made in some of the stressed sectors. Some of the large PSU banks can be a contrarian play. Or maybe some infrastructure companies which are able to deleverage their balancesheet. We know there is business happening in areas like roads and so on. So there could be some pockets of good EPC companies that might do well. There will be pockets in manufacturing, infrastructure and some of these beaten-down sectors where there could be a turnaround if the company is able to resolve some of their balancesheet issues.

Q: What is your stock selection criteria and what style of investment do you relate to the most?

A: At Alchemy, we are growth investors. The market is willing to give good valuations to sustainable and high quality growth because there is underpenetration in many areas in India. Does value investing make sense in India? Yes, but money has been made in India by investing in growth, whether it is HDFC Bank or ITC or the generics pharma industry or the private banks. In absolute terms, the big money, the big market caps have been made because these companies have compounded at 20-25 percent growth for several years. At Alchemy, our framework is that we look for a large external opportunity which is expanding. We look at companies with competitive advantage. If the opportunity is large then everyone can take a shot, but why is one company performing better than the other. You need to have competitive advantage to exploit the opportunity better than your rival, and that differs from industry to industry. In a consumer business it could be brand and distribution. In a manufacturing business like cement it can be your cost leadership and logistics capabilities. You have to look at every industry to see what is the competitive advantage. The other factor is scalability. Can a company have the same or better profitability with a Rs 5,000 crore turnover than what it has with a Rs 500 crore turnover? Scalability is important. Niche businesses are exciting. But if it can’t grow it’s not going to create absolute market capitalisation and therefore wealth. Then you need a good management team. Subjects like governance and so on are equally important. And lastly, all of these should come at reasonable valuations. So I think our framework is – large external opportunity, a competitive advantage, scalability and operating leverage in the business, good quality management and all of these at a reasonable price. If we find an opportunity that falls in this broad criteria then it becomes a potent universe for us to invest in.

Q: How often do you come across potential opportunities which fulfill these critieria?

A: As I said, if you look at domestic consumption stories, India has had large opportunities in many categories. You have to look at companies which have that competitive advantage and who exploit the opportunity. Take Maruti for example. There’s so much of opportunity for four-wheelers in India because we have one of the lowest cars per 1,000 people. But the opportunity is so big that every other car company from the U.S., Japan, Europe have come into India. Yet Maruti still has the No.1 position. I remember when there was a lot of competition people said, “oh you should sell your Maruti because they are going to lose so much market share due to competition.” But why has Maruti after losing market share regained it? Because of its competitive advantage. The other guys came but they don’t have the volumes. They don’t have the dealership and distribution network. Maruti had a natural advantage of being in India for so many years. They’ve built a massive network. That was its competitive edge. The opportunity in India is big. In India, across the consumer markets, the number one player has an outsized market share and the others are way below. So take liqour, United Spirits has over 50 percent market share. Take beer and United Breweries has 51-52 percent market share while the next guy is at 15-16 percent. So when you have a lead that is so big, especially in a complex country like India where the consumer in the north thinks differently from the consumer in the south, it takes time for a new person to come in and establish themselves. Obviously the advent of e-commerce and the internet is going to make things difficult for incumbents. Today if you’re a third party seller you could go on Amazon and sell your product. But not every product will be amenable to that. I think that this is an interesting juncture in India where in some cases the strong will become stronger while in others the strong will be challenged due to new business models that come in with e-commerce. But there’s still lot of opportunities.

Q: Tell us about three of your favourite books?

A: The book I’d read early in my investment career was Peter Lynch’s book. The other book which I liked was Edwin Lefevre’s Reminiscences of a Stock Operator. On a very different take, I like to read books on Indian philosophy, Bhagavad Gita being one. But over time I’ve read several books on the Vedic philosophy which I find very interesting. It’s amazing to see such sophisticated thoughts almost 5,000-6,000 years ago.

BloombergQuint

Wizards of Dalal Street - The New Breeze - Kuntal Shah

Src: http://www.moneycontrol.com/news/market-outlook/how-this-d-street-wizard-conquers-greedfear_7651661.html

Oct 25, 2016, 09.22 AM 

How this D-Street wizard conquers greed and fear

Ramesh Damani has returned with his signature Wizards of Dalal Street, this time focusing on young investors.

In the latest episode, he sat down with Kuntal Shah, Partner of SageOne Investments, and asked him about his investment processes and how he controls emotions of greed and fear.

Below is the verbatim transcript of Kuntal Shah’s interview to Ramesh Damani on CNBC-TV18.

Q: How did an engineer get interested in equity investing?

A: When I was in the last year of engineering, I had a colleague whose father was Director and then MD of ACC Cements and I used to learn the business from him and if you recall during that time the stock and the sector per se was one of the best performing sectors. In 1992, exactly 1991-1992 and I bought few shares and I understood the business that the business had de-regulated and the upside was there but the quantum of upside was even amazing to the management.

I had a roller coaster ride in a sense that I didn’t book adequate profit in trying to plan the tax and I gave up almost all the gains and this experience gave me the exposure to the equity investment. I realised that if you could figure out these decisions are getting made, there is an intellectually satisfying career opportunity out there.

Q: So, you chucked up engineering?

A: I joined TVS Electronics for one day at a salary of Rs 6,000. By evening I could realise that I was not cut out for this job, I quit and I joined the stock market next day.

Q: What was your first exposure to the Dalal Street?

A: My first exposure to the Dalal Street was learning at the school of hard knocks on what is working at that point of time and the market was highly inefficient at that point of time. I got tutored by a friend’s father who had a Dalal Street broking licence. They gave an introduction to a London based family office where we initially started with all kind of event driven and catalyst driven strategies starting with close-ended Mutual fund arbitration.

Q: Give me an example of that?

A: During those times there were several close end funds launched like Unit 64, Mastergain, Mastershare, Morgan Stanley where those shares were listed on the stock exchange and were used to quoted a huge discount to their net asset value (NAV).

Q: But could be redeemed?

A: Could be redeemed once a year at a fair NAV level. So, we used to simulate the NAV during the year, pick up the units at discount and redeem to the mutual fund. We used to do several kind of arbitrages like open offer, buyback, merger and acquisitions (M&A) related, so we did open offer arbitrages of companies like NALCO, Wimco, Ondeo Nalco so on and so forth.

Q: What was stage II, I mean that strategy clearly didn’t last long?

A: That strategy was predominantly oriented to attain financial independence and had limited opportunity set available to it and you could only deploy x number of capital inside the strategy and as the trade got crowded we moved out and that is why the stage II of bottom-up stock picking of good compounding stories was born.

Q: The Americans call it the All-In strategy, isn’t that what you followed?

A: The initial phase once having attained the financial independence was wealth creation and for creating that we invested heavily in a concentrated manner in few selected ideas, which had asymmetric risk-reward return.

Q: Example?

A: The classic example which comes to my mind was a stock called Burroughs Wellcome a 51 percent affiliate of Glaxo PLC, which had a separate arm Glaxo which was also a listed company. Both were listed but Glaxo was highly liquid and had a 4x-5x valuation multiple compared to Burroughs Wellcome.

Q: Why?

A: The institutional imperative of liquidity I guess -- Glaxo was on the A group Burroughs Wellcome was not but Glaxo owned more of Burroughs Wellcome, had better superior attracts and the price that at which we got in was below the cash on the book of balance sheet of the Burroughs Wellcome.

Q: Buffett's net-net?

A: Net-net and that too it was size because Unit 64 was being wound down and they were the sellers and we picked up below the cash.

Q: You picked up how much of Burroughs Wellcome?

A: Our fund picked up 8 percent of the component.

Q: 8 percent of the Burroughs you picked up over there?

A: This was a classic mispriced trade with a catalyst of liquidity in a very short-term horizon.

Q: How did you work out?

A: The labour court case which was preventing the merger domestically got wound up in one and a half years time. The mergers were announced and we landed up making something like 7.5x in one and a half year.

Q: There is a lesson in there that in finance school they teach you risk and return are directly proportionate, are they?

A: I think it is exactly opposite. Risk and return are not at all co-related in fact negatively co-related because fundamental rule of investing is don’t lose money. The rule number two is remember rule one. So, if you have to attain superior return, it is very incidental that you need to take lower risk.

Q: Give me an example of the quest for value investing? Why did that begin there?

A: As I said the wealth creation strategy of concentrated investment had a periods of lumpy but superior returns. However, it was a journey where alternative history could have been painful if your couple of investment idea were to head south. This was a strategy, which is not ideal for managing third party money. For third party money it is all about processes, processes, processes.

Q: What is the process that Kuntal Shah was at 3.0 in his life?

A: We -- at SageOne Investments Advisor with a help of my colleagues Samit and Manish -- have evolved a detailed framework of first filtering the ideas with a sole objective that the fishing pond in which we fish has the highest number of high quality fishes. This is attained by filtering the 550-600 ideas which typically constitute the investment universe of an average investor to 150 companies by simple filtration and then applying a bottom-up investors.

Q: What were those filtration techniques that you used?

A: The things which we look for the businesses are businesses which can grow their sales at far than higher than nominal gross domestic product (GDP) growth. Here we look at two factors how the companies can increase the unit volume, unit price realisation and product mix and on the margins side the product mix, economies of scale and the cost efficiencies. Then we look for the companies with high return on capital, return on equity, low leverage and free cash flow after accounting normalisation.

Q: Give me a few examples of your approach in this field?

A: I will give you an example that if I had to replicate a success story of my version 1 in version 3 -- was that we invested in time sharing company where accounting was such that 55-65 percent of what they collect, which had to be serviced over 25 years was accounting as revenue in number one while it was a front loading of income and back loading of expenses and this kind of investment would not have passed through the process that I am talking about.

Q: Give me an example of where the process actually helped you?

A: The process has helped us to minimise the volatility of the returns and helped us to have a very scientific way of constructing portfolio from a huge permutation and combination of outcomes, which are possible.

To give you an example, if there is a oil well and if it runs dry then people say it is a bad investment. However, if it gushes out with oil then we say it is good investment but both are mathematically equivalent of the same. It is a hole with liars standing on the top of it.

Q: You have learnt a lot from your mistakes, I think sometimes mistakes is the best experience. Tell us some of the mistakes, what have they taught you?

A: The years of investing journey has taught me that sometimes the biggest enemy of investor is investor himself. While biblical era has taught us seven sins and with the compounding and the complexity of the current investment life the number of sins have multiplied, there are three sins I would like to particularly focus on and which are at the extremities of human emotions namely the fear of losing out on opportunity or losing capital, which results during the time of extreme pessimism in the market.

The greed of missing out on the opportunity or compounding of capital, which typically happens at the bull end of the spectrum.

Q: We always swing between fear and greed.

A: The trick there I have evolved is to have a foot in the door strategy which by means I divest or acquire a part of the stock and I tend to average up. So that I don’t miss out and don’t have an anchoring or a confirmation bias.

Second thing is at the time of extreme dislocation, many people are frozen to act. The correct answer to that is again the process because as Benjamin Graham has said all an investor need during the time of dislocation are cash and courage. The process will give you cash allocation to take some money off the table at a time of the bull market and re-invest at the time of following bust if you follow the process.

Q: You have often talked about the three phase of your life. You have been educated a lot, 25 years in the market who have been some of the most significant influences in your life?

A: Courtesy the technology and the internet sweeping in I have been able to read works of eminent people who have been in other locations which normally I wouldn’t have access to. I have been lucky enough to meet doyen's of investing in India some of them being Nemish Shah and Vallabh Bhanshali of Enam. Manish Chokhani, Durgesh Shah of Corporate Database, yourself and so many others whom I interact on a regular basis and learn from my colleagues and peers.

Q: You are happy with this business or you are missing engineering sometime?

A: I have forgotten I am an engineer. Good you reminded me today.

Wizards of Dalal Street - The New Breeze - Hiren Ved

Src: http://www.moneycontrol.com/news/market-outlook/great-cosdifficult-times-can-bebest-bets-hiren-ved_7641741.html

Oct 24, 2016, 04.15 PM | Source: CNBC-TV18 

Great cos in difficult times can be the best bets: Hiren Ved

Asserting that over a period of time investors look for scale, sustainability and maturity in companies, Hiren Ved of Alchemy Capital Management said that great companies going through difficult times can be the best bets.

On Ramesh Damani's signature show "Wizards of Dalal Street", Ved explained that Bajaj Finance came up trumps after the global financial crisis by tapping into domestic growth and consumption story. 

The company, an early entrant then in the consumer finance business, capitalised on the business opportunity by placing in stores executives who would instantly assess and check customers' eligibility for loans, Ved said. Its peers went for scale and cut interest rates instead, he added.

Below is the verbatim transcript of the Hiren Ved's interview to Ramesh Damani on CNBC-TV18.

Q: I said in my introduction that your passion has become your profession. How did your passion start?

A: It started quite early. I used to go along with my father to attend the annual shareholders meeting of several companies and I was over-awed watching Rahul Bajaj or Deepak Parekh and Dhirubhai Ambani stand up and speak about the vision of their companies and then we used to get those colourful annual reports at home, I used to flip through them.

Q: Not understanding much.

A: Yes, but over time, developed a keen interest to try and understand what makes companies move, why they grow, why do the stock prices go up and down. Then being a commerce student, I ran a small stock market game with my accounting professor. So, got indoctrinated.

Q: But what is your first job on Dalal Street?

A: I started my career with a firm called KRChoksey and Company, worked with Kisan bhai and Deven bhai there. So, I learned my basics there, going and visiting every annual general meeting, every initial public offer (IPO) meeting, marking out the papers, cutting them, making files on companies, writing copious notes.

Q: It is hard to believe 20 years ago, there was not internet.

A: Exactly, you had to go to the stock exchange and physically write down the results because after three days they would take it off. So, those were the fun days, but I got my grounding in research when I worked at KRChoksey. Then subsequently, in 1994, I joined Prime Securities where I was part of the investment team, which was supposed to pick stocks so that the prop book could invest in those companies.

Q: How did you get to Alchemy?

A: After working nine years in the markets, I thought it was time to strike out on your own and do something on your own. So I thought I would start a portfolio management company. When you take these career defining decisions, you sit with your best friends. So, Lashit Sanghvi and Ashwin Kedia -- whom I had known since 1991 -- we sat together one evening.

Q: And your co-founders now.

A: Exactly. I told them that I was planning to quit and start something on my own and one thing led to the other and we decided that why do we not all get together and start an asset management company and that is how Alchemy Capital came into being.

Q: But how do you generate an idea today?

A: We look for a large external opportunity. We look for a competitive advantage that a business has got to exploit their opportunity, we look for scalability, good quality management and valuations and today, with the advent of technology, we are using some algorithms to refine the process and make it more scientific as we go along.

Q: Give me an example of this formula, process driven system that you employ now of an idea that it has generated.

A: We were looking at the consumer businesses. We are back in, after the global financial crisis because we were not sure whether the global economy will grow, what will happen? There was a lot of uncertainty. But one thing we were very certain about was that the domestic market was likely to grow. We picked several consumption stocks which came up at that time. So, sales were growing at a healthy clip, margins were expanding and that came through in our filter process and then came Bajaj Finance and we thought this was a great way to play indirectly the India consumption story.

Q: Second level thinking?

A: Exactly. While we bought the stocks like Bata and the TTK Prestige of the world, this was a great way to play the credit consumption boom in India. People were buying cell phones, refrigerators, washing machines and you could not buy an LG or a Samsung.

Q: They are not listed right?

A: Yes, so the best way to do was to play the consumption theme through Bajaj Finance. There was great under-penetration of credit in India and they had a unique business model to attack this opportunity.

Q: Explain that to me. What was unique about their business model?

A: It is not new. There were other players who saw the opportunity in retail consumer credit markets. What they did was that they went after topline growth. So, they appointed third party agents to go and source business for them.

What Bajaj did was that they had their own person sitting in a consumer electronics store. They had their CIBIL database, they had their own algorithms, so they could figure out -- if a customer approached them -- in 20 minutes whether you were eligible for a loan or not, which means that they acquired their own customers. They did not leave it to somebody else to do that. So, their process, their systems, their credit.

Q: So, you went to Vijay Sales to check this out?

A: Yes, we did. We have done all our desk work and then I hopped across to the closest Vijay Sales, I went there on a weekend and I saw the person out there from Bajaj Finance sitting there, and I was there for about two hours and it was great to see customers walking by, interacting with them and walking out with a product.

Q: It also helped that Bajaj had some of the best management in the business?

A: Absolutely. All the 3-4 people at the top were great. Sanjiv Bajaj with a big picture thinking, he mapped out the opportunity. Nanoo Pamnani, obviously, being a veteran in the financial services businesses.

Q: Ex-Citi banker, good in processes, systems.

A: Absolutely. Cutting-edge processes and systems. And the obviously Rajiv Jain who executed the business plan. Every time we would go and meet them, we were surprised. We came away surprised and wowed. They were always two steps ahead. While they liked the growth and they were aggressive in pursuing their growth, they never took their eye off the risks in the business, whether it was providing ahead of the curve or whether it was using technology or whether it was using the best processes.

Q: I know one of your partners at Alchemy is probably India’s best investor, Rakesh Jhunjhunwala. What have you learned from ‘Bhaiya’ as you call him?

A: Many things. It has been a great learning experience.

Q When did you first meet him?

A: I met him when we were supposed to start out Alchemy and Lashit and Ashwin took me to him and I was obviously over-awed.

Q: He was already a legend by them.

A: Absolutely. Learned a lot. But the three most important things I have learned from him is humility, risk-reward and the conviction to play big.

Q: Humility? He is not known for humility.

A: I think people mistake it. He speaks his mind, so he is not a ‘yes’ man and it is not very easy to convince him.

Q: You talked about his conviction and he is known for having brains of steel almost if you will. You have an example of that?

A: As one of the big learnings in the stock market is what George Soros said. When you are convinced, you should go for the jugular. It is not about you going right, but it is about how much money you make when you go right. As far as Bhaiya is concerned, A] he bets big when he is fully convinced. But more importantly, he bets big at the right price.

So, the risk reward has to be in your favour. If the risk reward is in your favour, you can afford to be a long-term investor. If you buy at the wrong price, then you will always make a mistake somewhere along the way. Those are important learnings that we have tried to imbibe from him.

Q: Interest rates are negative and USD 13 trillion worth of bonds. So how does investment principles work in this kind of an environment that we have learned for 30 years, that you say for 30 years.

A: I agree with you that we are in uncharted waters today. I have never seen this kind of a scenario where there is unlimited quantitative easing (QE), negative interest rates, but what the investment grades has taught you is that stick to the principles. I do not think that the basic principles of a successful business change. So, cash flows still matter, sustainable growth still matters, return on capital employed (ROCE) still matters and those basic principles do not need to be violated. It is like the Bhagavad Gita. The basic principles do not change, times change, the context changes, but the principles remain the same. That is what we have got to do. Stock to the basics and you will be fine.

Q: That is great because if they could change, they were not principles.

A: Exactly.