A Q&A with stock market gurus

By Morningstar |  08-11-16 | 

Bharat Shah, Executive Director at ASK Group, Shankar Sharma, the vice chairman and joint managing director of First Global, and Raamdeo Agrawal, Joint Managing Director at Motilal Oswal Financial Services, answer queries at the Morningstar Investment Conference held last month in Mumbai.

Can you pay too much for quality?

Bharat Shah: Quality is unlikely ever to be particularly cheap. Even in the worst of the times, it’s unlikely that quality falls to a down-in-the-dumps valuation. Relatively, it can get cheaper from market to market levels and based on the sentiments. On an absolute level, I have rarely seen a quality stock touch a cigar butt valuation.

A lot of difficult businesses can get particularly cheap, either due to specific factors of that particular company at a point of time or due to the market condition being exacerbated. Then the lower quality will get unduly punished even higher.

Typically, it is our own internal framework which is important -- as to how much we want to go. And if you are paying, to your mind, a little higher than what the economics of the investing is telling you in terms of reduced actual investment returns that you gave. So, it can't be done in a very generalized sense. You have to reduce it to a more precise economics or mathematics of investing and saying that if you are paying this much more for quality, how much is the implied return over the time horizon you’re getting and whether that is acceptable. Without that, if you're floating in a general way, you can end up making a sucker of yourself.

As a retail investor, how do I assess quality? I don’t get to meet management.

Bharat Shah: Quantitatively, as Phil Fisher says, the holy grail of a good management is long-term return on equity.

Qualitatively, if you are patient and diligent, you can check verify over time the kind of reasoning displayed by the management, its integrity and fairness, whether they've been improving in capital distribution and capital allocation.

It is not about a retail or otherwise. Investment is investment, whether it is in Rs 1 lakh or Rs 1,000 crores. The diligence and attention has to be the same. Whatever needs to be done, needs to be done with the same level of intensity in the mindset, otherwise you'll grieve forever.

Bharat Shah on his investment philosophy

Are there particular areas in the market you feel are overvalued?

Shankar Sharma: If you look at the composition of the large-cap space, I don't see those companies giving you any earth-shattering growth. On the other hand, all the companies I've been meeting for the last 2-3 years in the small- and micro-cap space, I could see them growing 100% from their low base.

My basic call is that India is going to be a small- even micro-cap market. And if you see the last 24-30 months, it has been an off the charts performance in this space versus the large-cap space.

I still continue to believe that Indian small caps are the best single equity class in the world, bar none. And even now I can find several opportunities out there where I think I can double my money in a year's time. I don't see that happening in the large caps.

As you said, the smaller market caps have already performed well. Can you still find stocks with multi-year lows?

Shankar Sharma: Much more difficult because they have done phenomenally well in the last couple of years. But I'm constantly looking. Ultimately, the market is a seesaw. So many stocks are at highs, but not everything can be at high, it's not financially possible or arithmetically possible. There will be enough stock at the lows. So, I start to get interested in those.

By the way, wherever one has invested and one is up let's say 20x or 50x or even 100x, I'm not selling out any time soon, because I still see a lot of growth ahead for a lot of those companies.

Also, it doesn't mean that if you've missed the absolute bottom it is no longer a good buy. If I see something going to go up 5 or 10 times, sometimes I wait for it to double, because at least I'm buying with positive momentum. So, it's not to say that you get the absolute bottom stock price and only then you should buy.

In the example I shared how I bought Apple and Amazon cheap, but even if you bought Apple at $30, instead of $19, you're still okay. Or Amazon at $20, you're still okay. So don't look at timing it down to the bottom.

How Shankar Sharma picks multibaggers

 Why Shankar Sharma bets on this stock

How hard is it to pick the time to sell?

Raamdeo Agarwal: First, the important thing is to buy right. Quality is very expensive. So unless you mix it with good amount of growth, there is no hope in hell that you can make it in quality companies. So your risk is already contained in the allocation itself. So even if you go wrong, if you stay on and growth continues, think you will be more than paid off. For example, TCS and Infosys are two global quality giant IT companies and very respected. Every parameter of quality is there, but growth is slowing down. You have to take a call.

In order to generate alpha, did you ever offloaded stocks looking at the price levels it has reached?

Raamdeo Agrawal: Sometimes. But most of the big wins which have really contributed to alpha is because of the right purchase at the right time. For example, Bharti. We bought at Rs 25 when the market cap was 5,000 crores. I could see that in the next five years, this company will be around 27,000 crores. The stock went from Rs 25 to Rs 1,200 in 2 to 2½ years. The market cap touched 32,000 crores.

The story played out the way we thought. But then we didn't sell at Rs 1,200. I sold at 650. The company misallocated capital and went to Africa. Then the 2G scam and all.

So, typically, whenever a company is growing, I would not put my head and say that this is the right valuation. It could have been a Rs 2 lakh crore company, it could have been a Rs 10 lakh crore company. But the moment it starts slowing down, I start looking for a newer opportunity and then get out of the existing one.

You talked about pay-off weighted portfolio -- pay-off is the predicted number. Is it not contradictory to what Bharat Shah said- that you can’t predict the markets?

Raamdeo Agarwal: You’re talking about portfolio allocation strategy on a pay-off basis. You are right. I was not talking about the market. I’m talking about the stock.

The first point is whether you understand the stock deeply. I mean, after the management you should be the best person to understand their stock, so that’s why you need a focused strategy. When you have 15 stocks, for say, 5-6 years, you know the stock so deeply, even if you cannot predict 100% you get a sense of it - what is the corporate strategy, how much is the tailwind, how much is the market share gain. There will be gaps, but there is some way you can figure out whether, say TCS or Infosys or HDFC are not going to grow at 35-40%, but some insurance company can because insurance in the private sector is a new phenomenon.

We are going to see giant insurance companies coming up. So you buy these insurance companies and hold on for 10 years. It could grow at 25-30% for many years to come. It all depends on kind of estimates you have and what kind of pay off you have in your mind. Ultimately, whether you’re buying a completely rotten, beaten down stock or a very popular stock, you have to have a pay-off in mind.

Raamdeo Agarwal on how to create alpha

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