Based on the performance of our investments, we believe that our Investment Approach is the biggest difference from other investment companies and funds; it has also been the biggest contributor to our profitable decisions in the market.
Before we even come to the company level, we first want to ensure that the industry has favorable demand-supply situation, because then, the risks taken by the company’s leaders have a higher chance to pay-off in due time. Once we are confident that a particular industry is worth investing because of its growth propsects, then its a question of build vs buy, i.e., whether to build own business in the target industry, or to buy a minority shareholding in an operational company.
Following are various examples of where we see clear benefits of being minority shareholders. These examples will give you an idea of how we think about our investments:
- We believe that global energy consumption will continue to increase with the growth of BRIC (Brazil, Russia, India, China) countries. While we can’t do oil & gas exploration worldwide, our portfolio company Reliance Industries (RIL) can. For example, RIL is the leader in natural gas production in India, and has been buying natural gas fields in the USA and elsewhere, at the lower end of the natural gas price cycle. We fully support these investments that will drive future growth.
- We all know that India has a large deficit of electrical power, and sustained 8% GDP growth is just not possible without adequate power. Businesses are often planning their work schedule around power availability, which is bad. We can’t build 30,000 MW of power plants in India’s difficult regulatory environment, but Reliance Power can, and we support them with our shareholding. We appreciate that Reliance Power is making arrangements to secure fuel supply in terms of coal mines purchase and gas supply agreements because we know that NTPC has faced issues in fuel supply. There are project execution risks in all power projects in India, due to the large number of regulatory approvals, but we are confident Reliance Power team will get things done. We believe Reliance Power should be part of every long term portfolio of India investors.
- Steel is absolutely essential for any infrastructure growth; in fact per capita steel consumption is a good indication of economic development, and India has a long way up to go. Steel industry is very competitive, with constant threat from lower cost imports. We know the value in backward integration in steel business to reduce costs, but we can’t buy iron and coking coal mines worldwide, but Tata Steel can, which is already one of the lowest cost steel producers worldwide.
- Australia has some of the best quality metallurgical coking coal (met coke), which is an essential component of high quality steel production. Gujarat NRE Coke is one Indian company that owns and operates high quality coking coal mines in Australia, and supplying coke to steel producers in India and China. We could not have executed this business by ourselves, and we are happy to be shareholders in Gujarat NRE Coke. We love this business for its competitive advantage derived from its hold on natural resources.
- As the Indian economy grows, the demand for housing is predicted to increase massively across Indian cities over next 10-20 years. But real estate needs a lot of effort in terms of land acquisition, construction, sales, and property management. Within Indian real estate, we believe the best of DLF is yet to come. Real estate investors worldwide know about the depth of DLF’s real estate holdings, and we believe the company will growth well in the next 10 years on the back of increasing wealth with India’s middle class. The stock is trading at a good discount to its NAV, and we plan to remain DLF shareholders for at least 10 years till 2020.
- The Indian financial services sector is likely to grow about 20% year on year till 2015, thereby presenting strong growth opportunities for both Banks and NBFCs. Our top picks in this space are: IDBI Bank, IFCI, Reliance Capital. Together they can cover industrial capex cycle funding, retail/consumer financing, and infrastructure investments. IDBI Bank is well managed and IFCI has made some top quality investments. Reliance Capital is the only insurance company in India that has not sold strategic equity to foreign insurance companies. Insurance can be very profitable in the long term, though short term learnings can be expensive. We are willing to take short term pain for long term gains.
- We also like Tata Investment Corporation as an investment holding company and want to be long term shareholders with them because they have top quality management and have access to a wide range of opportunities in the non-listed/private equity space that not everybody can get. We like their lean set up and long term thinking, which matches our own approach.
We have great faith in the companies we invest in, and they are in our portfolio after a long evaluation of the business, quality of management and their vision; all our companies are led by some of the most dynamic business executives in India today.
As shareholders in these companies, we realize our aspirations by supporting these companies. Our portfolio has about 15 such stocks, of different market caps, offering different levels of risk and return.
We want growth stocks but we do not want overvalued stocks where the price to earnings (P/E ratio) has already run up significantly, leaving is no room for further appreciation in near term, or which means that there will be very few buyers to buy the stock from us at our cost price, if the company faltered on its earnings due to any reason. In other words, high P/E leaves no room for business errors and we don’t like that situation.
In our experience, a company trading at P/E 10 can deliver as much growth as a company with P/E 25. A recent example is Surya Pharma (which was trading at P/E 5 and then doubled in price within 3 months with growth plans). And a Price/Book (P/B) above 5 does not make any sense, except in the case of mining companies or real estate companies with real assets that will increase book value in coming years.
We avoid buying companies at with high P/E multiples. For example, we like the following top quality stocks that are available at or below P/E 15: Reliance Industries, Reliance Infrastructure, Reliance Power, Tata Steel, Hindalco, IDBI Bank, IFCI. An exception here is Fortis Healthcare, which has a high P/E today, but they are on a visible high-growth path for the next 5 years at least, and quarterly earnings are increasing regularly as new hospitals become operational.
Overall, we urge investors to be cautious with investments in high P/E, high P/B companies, where a lot of growth and upside has been factored in already in those stocks, and any disappointment will see the stock falling badly with no takers.
So one has to be careful in the selection of stocks going for growth but going where the valuation has not factored all the growth and it takes a research of 500+ companies to be able to see few such companies where the growth has not been priced in yet and our conviction on such selection has paid off in the past when we have chosen stocks which were at much lower valuations and today just in a span of 12 months they are three to four times the price at which we first made a buy call on those stocks.
You can always say that the same has happened maybe for a stock which is over-valued but what we have seen is that when the markets correct, the overpriced high P/E stocks are the first ones to come down crashing and it’s a fact that it is because there are very few takers for a stock which is very overpriced.
Therefore, we focus on acquiring stocks of companies that are not overvalued (fair value is fine too) because then we have a room of error in execution of business plans of the company, because we have not overpaid and hence our risk is less. This is a fundamental guideline for our portfolio – never to pay too much for acquiring a stock. We also appreciate companies that share their profits through dividends. A dividend yield less than 1% is almost the same as no dividend.
There are many times we see some small-cap/mid-cap stocks run up 20-30% within a few days. In most such cases, we would stay away, unless the EPS growth trend is compelling and some major new development has happened. But we put that company on our tracker. If the share price moved up for genuine reasons, it will hold even after a few days/weeks, and that is when we enter. Once we spot a company, if we remain patient, we can get a 10-20% lower purchase price from current prices, and we remain alert to it.
So our investment advisory service gives you the portfolio and portfolio updates on 1-2 times per month. We don’t think you will need more than 1-2 updates on the portfolio because as part of our inputs, we will already share the target buy and sell prices for the short-term, and you can use them to execute your trades.
As long-term investors, we are always happy to see stock prices fall, because we known they won’t remain down for long. So we are happy to see lower prices on the stocks in our portfolio because they become that much more attractive for us to buy some more, and build up our share holding.
If we see opportunities where any of our portfolio stocks is becoming very cheap we will come out with a separate email to you saying that this is a special opportunity to acquire more of this stock at a good price. Such prices come due to knee-jerk reactions of the market, which always happen 2-3 times every year, and such special prices don’t last long, so one must act fast in these cases.
Overall, our investment approach believes in choosing companies carefully, and then investing in them for the long term, with no fear, and using economic/seasonal cycles to buy and sell for some additional trading profit.
