If Sankaran Naren has come to be regarded as the poster boy of value investing in the asset management industry, it is because he has had the grit and conviction to be consistent over the years.
To a large extent, his success can be attributed to his innate ability to latch on to the acumen of other value investing legends.
His longstanding investment paradigm was built upon ideas set forth by Benjamin Graham and David Dodd, and refined by Warren Buffett. But he does not worship at their altar. Instead, his investing style has evolved to effectively amalgamate learnings from Howard Marks, James Montier and Michael Mauboussin. He devoured their views passionately, internalised them and applied them to the Indian context.
Naren’s move from cigarette butt investing (find a very cheap stock, keep buying it and wait for the environment to change) to adopting a contrarian approach was evident a decade ago. He had invested in a number of low valuation stocks which underperformed in 2007 pushing him to re-think his framework. After that he no longer opted for very cheap, low price to earnings (PE) / low price to book (PB) sectors.
He began to look at Price to Earnings (PE) trailing in line with the historic PE of the sector and lack of investor sentiment in it, Price to Book (PB), Return on Equity (RoE) relative to PB, and return on capital employed (ROCE). This would ensure that stocks do not become value traps. He began to resemble the value investor in Seth Klarman’s words: “Value investing at its core is the marriage of a contrarian streak and a calculator.”
Not everyone is cut out to be a contrarian investor. Naren has proven over the decades that he has the psychological edge to stand his ground.
In 2007, Cadila Pharma was facing a problem with one of its products. The company lost a court case and the stock got de-rated substantially. While valuations of the rest of the market had expanded, this pharmaceutical franchise with a good management had hit a rough spot due to a temporary problem. He swooped in on this opportunity and made a fortune on it.
Between October 2004 and October 2009, he avoided Telecom. But when everyone began to shun it, he began to court Bharti Airtel.
During the IT cycle (1998-2000), he found refuge in old economy stocks – steel, automobiles and cement. During the infrastructure cycle (2004-2007), his hunt for value led to tech stocks and pharma. His views on market cycles is the reason he has been suggesting infrastructure for the past six months and now pharma. By identifying the current state of a cycle, he focuses on what he thinks is likely to work and bets against the one which is overextended.
Howard Marks believes in the dependability of cycles in sectors. Human psychology will not change and our attitude towards risk will ensure that the market operates in cycles. The trick is to identify where in the cycle we lie at any given point in time and make the investment decision accordingly.
A cycle should not catch you on the wrong foot. You should ride the cycle to make money. Naren does that. He systematically and consistently applies a process. And, most importantly, has the intellectual and emotional rigor to see it through. Which means that the investor in his funds must also have the patience to see his convictions deliver.
In the 2015 Morningstar Investment Conference, Naren explained to the audience the importance of grasping the state of the market and accordingly positioning your portfolio.
Between 2004 and 2007, the moat strategy did not work; infrastructure companies did not have moats. Naren commented on how he was often questioned on the validity of a moat in investing, and most could not fathom why he gravitated to pharma (despite the margin of safety being huge making them excellent picks).
Now (which was 2015), he could own a metal stock with huge reserves and once again individuals would question as to how he could ever make money in such a stock? He noted later to a journalist: Today, the entire metal sector is valued less than the single largest pharma company or single largest private bank. Can you have a country which grows only by people consuming drugs or through retail lending?
While standing against the crowd is not easy, neither is finding value.
There will be occasions where the entire market gets hit: the terrorist attack on World Trade Centre (2001), global financial crisis (2008), China’s Black Monday (2015), and Brexit (2016), to cite a few examples. Investors who buy at such slumps can make spectacular returns. But those ‘absolute value’ opportunities are rare. Which brings us to ‘relative value’. A stark example is the frenzied bull market of 2007 when pharmaceutical, technology and consumer stocks were highly valued, but investors could still find ‘relative value’ and investors in those three sectors at that time had a very positive experience.
Naren’s kinetic thought process effectively combines learnings from various gurus.
Vardhman was bought on the Benjamin Graham model of a ridiculously low PE. His view on cycles influenced by Marks is combined with Montier’s 10 tenets of investing. This is what resulted in a call on Oil and Metals in 2015 and Telecom in 2016 and Pharma now. Marks looks at “good company, bad balance sheet,” which is different from a bad company which is challenging to turn around. The same philosophy is what led Naren to invest in Tata Steel, Tata Power and Hindalco. He picked up ICICI Bank when it was low and is already benefitting from that call.
Naren probably keeps his cool when the tide is against him by remembering these words of Benjamin Graham: You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.
Something investors in his funds must also make note of.
