Pulak Prasad is the founder of Nalanda Capital, a Singapore-based firm that invests in listed Indian equities. He is the author of What I Learned About Investing from Darwin.
When I spoke to Pulak Prasad, he was so assuredly self-confident, genuinely pleasant, and least interested in any media attention. And I deeply suspect that he is not easy to provoke, though I have absolutely no intention of attempting to validate my belief.
This man lives on his own terms, a privilege few have.
Pulak’s thought-provoking narration in his recent book has enthralled global audiences. There is so much wisdom packed in that book, that it is impossible to capture it all in one single article. But underlying his thought process is one word: Survival.
In August 2017, Pulak’s letter to Financial Times questioned a sweeping statement made on CEOs being irreplaceable. He pointed out to the logical flaw in the argument and the misplaced underlying sentiment. But what caught my attention was the last paragraph, and this sentence: The corporate world is a tough place and companies succeed and fail all the time.
While Pulak chooses to be extremely mindful of what is fluff and what is brilliance, his eye is on survival. He looks at all the factors that strengthen or weaken it. In this case, good leadership is worth its weight in gold.
In his book, Pulak has delved into a deep repository of knowledge and drawn some amazing parallels between evolution and investing. While on the face of it, it appears seemingly non-related, his lateral thinking will not only prove you wrong but leave you mesmerized.
Think about it this way. Nature is brutally apathetic when it comes to ethical issues. It doesn’t take sides. It has no remorse. It is not concerned with good or bad, moral or immoral, right or wrong, just or unjust, suffering or mercy. Or as Richard Dawkins says, “Nature is not cruel, only pitilessly indifferent”.
Isn’t that the same with investing? Isn't that the same with the stock market? Isn't that the same with a corporate? The stock market doesn’t care about your well-crafted narrative or debt or balance sheet. It doesn't care about your convictions. It is not cruel, only pitilessly indifferent. You play your cards wrong, you won’t survive. You get over aggressive, you could fall flat on your face. You get over confident, you could be weeded out.
The corporate world is a tough place and companies succeed and fail all the time.
I believe that Pulak’s entire strategy is encapsulated in finding companies that have a higher chance of survival.
Here’s what I have picked up from his book.
Long-term survival is much more important than improving short-term RoE and EPS.
In the early 1990s, he almost always focused on the P&L account – revenue, cost, profit, loss. After many years of investing, he realised that he needed to focus as much on the company’s balance sheet – receivables, inventory, payables, fixed assets, debt.
While not having high leverage makes sense to most, he perches himself on the other side of the pendulum.
A vocal advocate of NO leverage, he walks the talk. He states that more than 90% of his portfolio companies have excess cash. Only 3 businesses out of about 30 in his portfolio have some debt, though quite small – the maximum debt/equity ratio is 0.3.
In the second quarter of 2020, the well-known companies that declared bankruptcy all had a large amount of debt: Gold’s Gym, Hertz, Intelsat, J. Crew, JCPenney, Neiman Marcus, Sur La Table.
The 20 biggest bankruptcies in the U.S. – with Lehman Brothers at the top and LyondellBasell at number 20 – were heavily indebted.
Asian Paints, India’s largest paints business, made news in May 2020 when it announced no layoffs and salary increments to boost employee morale. This happened at a time when India was under lockdown, there was no visibility on when the situation would improve, and every business was witnessing catastrophic declines in revenues and profits.
What is even more commendable is that Asian Paints also was hit. The April – June 2020 quarter saw the company’s revenue decline by 43%, and net profit down 67%, compared to the same period in 2019.
After announcing no layoffs and salary increments, the company went on to sanitize its dealers’ paint shops without charging any fees, offered medical insurance to its painters, gave 45-day extension on payments to its dealers, and announced relief worth more than $5 million to its contractors.
This was possible because of the cash reserves and no debt. In March 2020, the company had $220 million in cash. The CEO pointed out, “we have been debt free for years and are quite comfortably placed even if the uncertainty goes on for the next four or five months”.
The guidelines of Pulak’s philosophy.
- We avoid many categories of risks because of the wide range of possible outcomes in these situations.
- We invest only in exceptional businesses because most businesses fail, and we want to reduce uncertainty.
- We buy at an attractive valuation because, while we don’t know what will go wrong, we assume that something will.
- We rarely buy, and sell even more rarely, because every activity may have unintended consequences we can’t foresee.
- The academic claim that companies need to have an “optimal” level of leverage to improve returns, is mathematically true but realistically dangerous.
- A long-term investor in a business, doesn’t want the company to go bankrupt. I can live with a slightly lower RoE and EPS growth, but at least I will live.
- Debt diminishes strategic flexibility and hence long-term value creation. Any constraint that prevents a business from taking calculated strategic bets is undesirable.
- Bad things happen to businesses at remarkably regular intervals. The reason to have cash is not that things can go wrong, but they do go wrong. The macroeconomic environment can become a stiff headwind (GFC), a recession could hit, the industry can suffer a cyclical downturn, a competitor may give discounts or increase spending on advertising, one or more major customers can leave, the company may lose some of its best and key employees to competition, consumer tastes can change, a strategic investment/acquisition may not pay off, regulations can change, and so on.
- Only when financial risk is low, can management focus on mitigating business risks. While worrying about market share loss, low supplier commitment, employee dissatisfaction and competitor aggression, the management doesn’t need to stress of interest payments.
Even on a personal front, Pulak advises investors to first look at survival. An essential prerequisite for making money is the ability not to lose money. Before making money, learn not to lose money.
But that calls for another write-up.
Abbreviations
- P&L: Profit and Loss Account
- RoE: Return on Equity
- EPS: Earning Per Share
- GFC: Global Financial Crisis of 2008
- CEO: Chief Executive Officer
Larissa Fernand is an Investment Specialist and Senior Editor at Morningstar India. You can follow her on Twitter
This Morningstar Learn From The Masters article is sponsored by ICICI Prudential Mutual Fund.
Disclaimer: None of the stocks mentioned above are recommendations to buy/sell/hold.