When picking stocks in India, think baseball, not cricket.
That’s the advice from Sumeet Nagar of Malabar Investments. What he means is investors should not be afraid of buying when an opportunity is in their zone even if the market conditions are not conducive.
“In baseball, if something is out of your zone, you leave it. Unlike cricket, you don’t get penalised for it,” Nagar said on BloombergQuint’s special series Alpha Moguls. “But if something is in your zone and you know it very well and that there is a great opportunity there, and you feel comfortable that in the adverse future environment, you can generate good returns in it, then, by all means, invest in it.”
Nagar was sanguine about the prospects of the domestic market. India will be the fastest-growing economy over the next decade, and earnings will follow economic growth, he said. Mid and small caps will outperform because small-sized companies can grow faster, according to him. The broader market not having done well in last four to five quarters lays the foundation as the valuations are not as high as earlier, he said.
The multiples were falling because value investors like him would be getting off such companies, he said. If the growth slackens a bit, a stock with lofty valuations will not generate good returns, and that’s the time to start trimming positions irrespective of how the company may be doing, according to Nagar. That’s the reason his investment firm exited Page Industries Ltd. It’s fine to lose some upside in an expensive stock and protect the downside, he said.
And he doesn’t believe in the strategy of getting out before there is a stampede. “Some people do it very well. Stay in the momentum, until you saw some faltering, and you get out before everybody else,” he said, adding that said Malabar doesn’t follow that.
According to Nagar, quality financial and auto stocks will bounce back. The last three to four investments made by Malabar included housing finance, banking software, consumer and internet advertising companies on a bottom-up basis, he said. For the next leg of the rally, the firm is betting on the firms that are doing well in a niche and are run by terrific managements, Nagar said.
Watch the full video here:
Here are the edited excerpts from the interview:
At a point of time when people like you are looking to generate alpha in Indian markets but coming off the euphoria of election verdict, the equity markets are trading near-about highs and stretched valuations. How comfortable are you of putting big money to work at the broader end of spectrum?
The broad framework which we use for investing, which is basically over the course of next decade, India will be the fastest-growing large economy in the world.
If the country grows to that level, then companies will have very strong tailwinds and they will perform, and overtime stock markets will reflect that. Over that long period, you are bound to generate very good returns by investing into equities in India. Within that small and mid caps will generally will start to outperform because these companies can grow faster. That is a broad framework.
Within the context of environment, you have to figure out your stance. There are points in time you need to be more aggressive or defensive. In today’s times, the Sensex or Nifty is at all-time high, but the broader market has not done well in last four to five quarters. As a result, their valuations are not as high. So, it is neutral stance. I don’t think for small and mid caps you find valuations very high or very low today. If earnings trajectory picks up, you can be on front foot. If valuations are higher, they can go back foot.
When facing an opportunity if it is not full toss but somewhere there. Then do you make an investment without considering the external environment and valuations of market, presuming it is in listed space? Or at times those factors also influence the decision. Lot of people say if the bride is good then suitor will come. So, if we get good opportunity we don’t see where the market levels are whether the market will fall in the next 6-12 months. We go out and buy wholeheartedly. Do you do the same?
In baseball if something is out of your zone, you leave it. Unlike cricket, you don’t get penalised for it. It is like wide ball that you don’t want to touch it and it is not your zone. But if something is in your zone and you know it very well and that there is great opportunity there and you feel comfortable that in adverse future environment, you can generate good returns in it then by all means invest in it. If you look over a period of time then you will find even in times when the valuations are higher then there are always good opportunities. They may be fewer and more difficult to find but they are always there. When you are at the bottom of market then you find many more opportunities like that. Even at near peak of the market in the past, you could find some great opportunities that will help you generate great returns over long term.
The last six months was different in listed universe compared to last six years. In that some very stretched valuations have moderated in part due to growth rates coming off, in part due to NBFC crisis leading to consumption names as that is because the high P/E multiples have parked predominantly. Market is starting to wonder as game of exorbitantly rewarding some companies with high ratios and slightly lower growth is thing of the past. Whether in consumption or otherwise what do you think happens in next five years? Would you believe that there is exorbitant premium paid for companies which are able to show sustainable growth at higher return ratio or will the market start be rewarding in its true sense?
Exorbitant premiums are never a good recipe for generating good returns. If you are invested in a company which is trading at very high multiples, then it is tough to generate returns from there because those exorbitant premiums will go away in a period of time. They will normalise.
For many consumer companies, the growth rate is also not high enough. That risk reward is not attractive. Interesting thing is that consumption is great theme and it is not going away. It has been around 70,000 years since human beings came in. It is linked to your survival. That’s is why consumption is not going away. It is only increasing. It is just that investing on consumers is becoming more difficult because people have bid up valuations so high. If those valuations were not as high, then it will still be a great place to invest in.
What has happened to Page Industries in the last few days by virtue of the fact that they didn’t meet the expectations that markets had in stock. Not just from last few days but from peak levels of 36,000 odd and peak valuations multiples has come off severely. The whole argument which market had about the up trading wherein Indians will move from lower cost cars to higher cost cars or unbranded clothes to branded clothes and therefore apparel companies will go to the roof. It has played out selectively or not have played out. It become difficult theme now to invest in. How does one approach this pocket?
We were earliest investor in Page industries in more than 10 years ago. At that time, it was trading at 10-11 times trailing P/E. At that point of time, it was growing at 40-60 percent year-on-year. As they continue to deliver, people’s willingness to pay has kept on increasing. People say that it is long runway for growth and pay a little bit today. But that can go too far. When a company starts trading at 80-90 trailing P/E, then it is not a good investment anymore. It is still a great company, but it is not a good investment. In case of many other consumer companies, where the valuations went so far ahead of themselves and the underlying growth could not sustain with them. Because there is assumption that high level of growth will continue forever, if you see any faltering of that growth then it brings that thesis into question. If you are investing in those names at very high valuations, the risk reward is not very favourable. You have to be so sure that this earnings growth will remain for a long period of time.
Even if people are invested in this high growth companies at very high multiples then will it be prudent that at first signs of growth showing faltering even if the investment is not d as it was a month ago because typically markets tends to discount events a lot earlier than what normal investors figure them out. It is prudent to get out of it as you are priced in for perfect growth and that is showing some chinks in armour. Is it something that investors like you do as you held some high growth companies and you have got out of them successfully? So, what where your trigger points?
We are investors. When we think that company should trade at lofty valuations and were under reasonable future scenario, and then you don’t see generating very good returns, that’s the time you start trimming, irrespective of how the company is doing. That’s the reason we have exited from Page as valuations have become too high. This notion of getting off before others come and there is a stampede. I don’t think it is something we follow. Some people do it very well. Stay in the momentum, until you saw some faltering and you get out before everybody else.
Doesn’t it hurt you psychologically? You might get out and the market will still be rewarding, and the stock may move up before it falters. How difficult is that psychological aspect that you got out of stocks and still it continues to move up?
We never lose money by doing it.
Your style of investing has changed than the last two to three years because times have changed. Have you moderated or modified your style to suit the current times or do you think it is same?
The philosophy and approach remain the same. Your emphasis on different points of time changes a little bit. A couple of years ago, we were just coming off demonetisation. So, at that point of time the focus was only on defence, as which is the business that can withstand whatever happens in market and economy. That was a lot more important. It is still as important now as it was back then. Today given the valuations, you have to understand that the longevity of growth, extent of growth, trajectory, and build deeper into it because that will justify some of the valuation. If you can’t justify, then don’t invest. In terms of philosophy or approach, it doesn’t change but what you emphasise from time to time changes.
I hear a lot of investors talk about buying into companies which may not necessarily have the longest runway for growth but because they have been beaten down relative to other expensive pockets that people believe that there will be mean reversion. Since you are investors, do you subscribe to that style of investing?
It’s not something that we do usually. The challenge is that people beating on other people thinking the same way you think, and which result in valuation arbitrage going away. At that point of time, you have to sell. Once that valuation arbitrage goes, then underlying growth is not enough to compound that investment for you. If that happens in three months, then after that they are finding the next opportunity. Our bias is towards companies where we think that capital could compound over many years. If they can find at cheaper valuations when they are beaten off, then we are more than happy to allocate capital at that point of time. If you see for many of the companies where you find that there may be some cyclicality to their businesses or earnings, then that approach works very well. In higher points of cycle, you can take a step back, trim a little bit and in lower points of cycle you can allocate heavily. That approach can work very well. But the underlying company has to be solid, good balance sheet, good management and on a secular growth path.
How do you identify that the investment which you have which you believe is on a secular growth path, but the market believe that it is not and punishes the stocks and stocks come down. Therefore, it is not portion of your portfolio and you have the levy to put in more money. How do you choose whether to do it nor not? There is countless example where the fund manager community is divided on what growth numbers a company will show and stock has been punished because may be a larger portion of community believe that the growth is not there.
It boils down to your conviction and how much work you have done on that industry, company, what is your belief or conviction on the longevity of growth of that company. Their ability to come back from whatever slow period of time that they are going through. If you have that conviction, then invest more at that period of time. But you have to have that conviction. It can’t be because you heard it from somebody or seen in the report. It has to be your own on the ground board which gives you that conviction.
Is management meetings are integral part of it or not necessarily?
Management meeting is an important part of this because you want to hear from them as how they are tackling the situation. One of the best things is to talk to management during bad part of cycle or company and see what kind of things they are doing at that point of time to strengthen the company and widen it. And not that for everything to take at the face . But it gives you some sort of reference and you can evaluate that over a period of time. But equally it is more important to validate that outside. You can talk to their company’s customers, dealers, distributors and see what they say about it. Through some of these conversations you find very valuable insights. That can build your conviction further or otherwise.
Your current approach, is it more centered towards bottom-up story that you hear, irrespective of the sector in which company is in or do you right now go around looking for pockets, where there might be and then zeroing on the basis of that? For example, you actively go out where there is opportunity say auto ancillaries because they have beaten down or NBFCs which are by and large beaten down or some of these beaten down pockets. Do you actively go looking for opportunities in those pockets or are you completely sector agnostic.
We are sector diagnostic and we are open to looking at companies in any sector. Having said that through past experience you know that some sectors are just not going to work for you. Think about sectors like mining, infrastructure, it’s not been good hunting ground for us, and we didn’t find good opportunities there. So, it’s unlikely to have final opportunity in those spaces. But otherwise we are open mind.
If you look at over a last year and half or so, our biggest investments have all been in different sectors. We are open minded from that perspective. Having said that, I agree there are point in times where sector gets unfairly beaten down and that sorts of create good hunting ground. For example, financials in six to eight months ago was like that, because post crisis what happens is that everything corrects and this notion of sort of shoot first and ask questions later results in some great companies correcting in a short period of time and that gives you a chance to invest in those companies at reasonable valuations. And then you know that the good quality companies are recovering very quickly and that’s what you saw even in the financial space in last six to eight months.
Do you reckon that opportunity is gone away?
I think that opportunity is by and large gone. Still there are many companies which are beaten down but perhaps there are good reasons for it. Separation of quality and valuation sort of happened by now but worse on the case when crisis first come in.
So your theory was that financials will bounce back?
The good quality financials will bounce back.
But as the space it will do well as it is here to stay. Is the same conviction going to hold true for autos currently?
For auto, it will also be true. It’s not that people will stop driving. So, there desire to own a vehicle and drive a vehicle is not going to go away. And, there are theories around what happens as EVs are coming in. The level of penetration in India will be safe bet that there will be more cars and more vehicles in future. Yes, it is cyclical. It’s a very big capital investment, very discretionary investment, so it will go through its own cycle. And I think it will come back and probably there will be good opportunities in there. But you have to be cognisant of the cycle that it takes a while to play out and many of the component suppliers are not just Indian suppliers, but global. So, there is a global cycle that is there. You could probably see a bigger downturn in some point of time. But through that you will find some great opportunities.
Where are we in the cycle right now? Are we closer to end or between or is it difficult to predict that right now?
In India, you are well into the low part of the cycle. You haven’t seen much growth happening in last several quarters. Relative to that the economic growth has fallen down but I think globally the down cycle has just recently started and when there is recession or there is a real slow down, you could see auto sort of comes down a bit more.
Within the listed universe, where is it that you recently made bets? What sector and themes look interesting?
In last three to four investments we made, one of them has been in housing finance company, one has been in banking software company, one is a consumer company, and another is an internet advertising company. These are really different types of companies. It is really bottom-up. Companies that are doing very differentiated and meaningful in a niche area and within that area doing extremely well and run by terrific management teams. So those are the companies we invested in.
We got lot of positive feedback on thesis around the luggage market. Have you changed your view on the listed luggage sector in India?
No, it’s not. Desire to travel just continues to increase. Even today a vast majority of Indian population hasn’t traveled by air and it is going to change. It is just a question of affordability. And as affordability becomes wider and wider, more people are going to travel. Yes, it can go through a hiccup. Jet is not there; supplier flights are not there. Maybe it takes a little bit of it in the short term. But I think in the longer term, at least in the medium term, the desire to travel will continue to increase. And when people travel, they need luggage. That sort of growth story is there. Within that what is boosting that story is unorganised to organised conversion. That again is clearly happening because post GST there is more of level playing field. Backpack, which is additional driver of growth, is also there.
But competition that Chinese companies selling backpacks directly online and maybe it happens in luggage too.
India has the largest stock of two wheelers in the world. We have 200-250 million two-wheelers in the country. When you are travelling by motorcycle you want to carry something and the place you can put it on is backpack. There 250 million scooters and motorcycle out there. Only 7 million branded backpacks are being sold. So, you can do the math. There is a lot of room for that to grow. Unlike luggage, backpack is something that you use heavily every day. So, tends to wear off. You will probably be being replacing less in five years that would take for luggage. I think many people sort of replace it within a year but there is fairly big market out there and I think the branded companies are doing a very good job in terms of not just providing a product with a brand but also having right features, right functionalities, segmenting market and I think that is what creating opportunities for that.
What about some unlisted investments? Can you tell us about one large unlisted investment that you have recently made and the rationale behind the same?
I will talk about Affle. It is a company that is leader in internet advertising. So, let me just go through this peeling of onion kind of notion, with each layer of onion that you peel I think the thesis needs to get stronger.
India’s population is growing, GDP is growing faster than that because productivity is improving, advertising spending is growing even faster than that because as GDP per capita increases, spending on ads increases because people are buying more discretionary item. So, it’s the result that India is one of the fastest growing advertising markets in the world. So that sort of the to three layers.
And the next layer is that within the advertising bucket you are finding spend on digital continuously replaces. That’s because people are already spending time on digital and internet and advertising has been sort of trailing that. And you have seen in other countries eventually it catches up. So, the result is digital advertising in India is growing at 30 percent year-on-year.
Within digital advertising you are finding that spending on mobile is increasing faster. It is because in India more people are spending time on mobile and mobile becomes a primary source of internet connection and that spend is actually shifting there. So that is your fifth layer.
And the layer beyond that is when you think of internet or mobile advertising it happens in two parts. It’s your brand advertising or it’s action-oriented, which is basically you have an app installed on your phone; you want information that is on your phone. Mobile phone is the most expensive real estate in the world, because more and more commerce and transaction will happen through that and so whoever is going to get on that is very valuable to the companies and people are willing to pay money for that and this is where Affle sets in.
So, it’s on so many layers of positive trends that each one of them feed into it. So, that is the tailwind which is behind them. They are already the largest player in India. Increasingly, they are growing internationally too. Already a profitable company, 100 percent return on capital and keeps growing at a perfect rate. I think this past year they have grown earnings by 70-80 percent. So, it’s a phenomenal company and run by great management theme. They should likely come up with an IPO before end of the year. It is a fantastic company that we liked and we invested in it.
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