Value Vs Growth: Here’s What These Portfolio Managers Think

Vikas Khemani: I think the way we look at India, it is a growth market. Not now buy I think historically whether you look at the last 10-20 years. India is a very young country and we have a huge amount of growth which is there. So, I believe that  given our setup, India will continue to grow, and growth investing will sort of do very well.

Having said that, it is also very important to understand that investing outcome is also dependent on the person or investor. I mean, if a growth investor starts looking for , investors start looking for growth, it will get sort of confusing and have a different outcome. We as a firm, firmly believe that growth investing is what works. We understand how to look at growth investing.

Of course, in recent past, depending on the market cycle, growth at any price is in vogue and probably that might come into question. So, the way we look at as a firm is growth at a reasonable price. Now, what is reasonable is a question and one can keep on debating about it. That is where the lines are blurred and we’ll have to keep looking at it.

But we believe that over the next 5-7 years as India goes towards $5 trillion economy, you will see ample amount of growth ahead of it. Previously, there was a talk about volatility.

The analogy I give is let’s say to take a period of 2001- to now. If I remember distinctly, 2002 Nifty was 800 approximate points. Now, today, we’re at 12,000. In 17 or 18-year period. In this period, imagine what all has not happened from a volatility perspective- UPA 1, UPA 2, Global Financial crisis, coal scam, 2G scam, demonetisation, GST, Brexit, geopolitical situations. All kinds of possible global and local six-sigma events also have taken place despite that India’s GDP has gone up. Returns have been 16-17 percent compounded growth.

So, I think we believe that growth investing is what wins over a long period of time but I must caveat that it also depends on the psychology, style and understanding of the investor. Then, in every market, every strategy can win.

Varun Goel: No, our sense is very clear that there are hundreds of ways of making money in the market and we all need to figure out what works best for us. As far as we know, as a fund house are concerned, we are very clear that for us, the way to make money is growth with quality. So, in our sense and in our word, there is no compromise with quality.

Samit Vartak: So, everyone defines differently. For me, investing is where you more rely on the re-rating of the company. But you can find with expensive stocks- seemingly expensive stocks where growth is high that everyone talks about. So, think in a tough economy, it’s very difficult to get re-rating.

Value investing doesn’t work and that’s what’s happened over the last 5-7 years. In a tough economy, more and more investors migrate towards the quality companies. In quality companies, if you also have reliable growth, even if it’s lower level of growth in it may not be 15-30 percent kind of growth but even if it’s double digit kind of growth, people tend to give more and more to that.

So, the re-rating definitely happens, but it happens only in a select sector and it just happened, not just in India, but across the world, people are migrated. So, I think question is whether investing versus growth investing would work is whether we are entering into a bullish economic cycle or not.

If we enter into a bullish economic cycle, generally, the companies, which are the cheap price-earnings multiples, double or triple in terms of valuation itself. So, if you get that cycle right. In investing, getting the cycle right is very important. Unfortunately, not many people have the ability to predict that cycle right. Because, many people thought that 2014 was the start of that kind of a cycle, but actually didn’t work out the way everyone thought. Every point in time, you may feel that the cycle is starting. Sometimes you’ll get it right.

I believe that today we are at a point where the probability of that cycle occurring over the next two to three years is high. That’s where I think investing with some growth can definitely outperform and that’s what I tried to showcase in that in my memo is that- if the growth comes through, and if you’re buying at a really cheap . The average P/E multiple then in 2011, when I looked at that it was 13 times and that 13 times became or 35 times on an average because the growth came through those companies and this was in a tough cycle. In a really good cycle, that re-rating can be even significantly higher than that. So that’s where investing can make you tons of money if you get the cycle right.

If you’re investing in the high-quality companies where you’re paying 60-80 times multiple, the returns from re-rating is almost impossible. It’s very difficult. So, you will probably make the earnings growth, which is probably in the low teens, which is the returns that you would expect from.

Vartak: Absolutely, but the philosophy that I follow is that I look for 20 percent growth. I’ll definitely look for growth but again, I for me, the re-rating of valuation multiple trigger has to be there. For that reason, I will never pay something like a 60-80 times kind of multiple. I’m fine paying 25-35 times if the growth is commensurate to that.

Anshul Saigal: Taking on from what Samit said, we believe that is not just about buying cheap. It’s not about buying four- six times P/E , maybe they’re in companies which are trading 25 times P/E but when growth is not priced in that even at 25 times P/E, the market believes that the growth in this company is going to be 15 percent, but in our judgment, it’s going to be 25 percent. When that growth comes in, even 25 times P/E can get rerated.

In that context, we are in the camp that is finding growth that is not priced in. We do believe that with the correction that has happened over the last two years in the broader markets, that stage is where we are at today, where you have so many companies, quality large businesses, leaders in their space, where there has been bout of derating which has played out over the last two years.

That derating is not commensurate with their earnings power or their ability to grow their businesses. As that earning power or their ability to grow their businesses comes to the fore, there is a high likelihood that we will see a rerating pattern play out in these companies.

So, we are firmly in the camp that this is a time for . Now, of course, as I said is something that each one defines on his own. In our judgment, is not as I mentioned earlier, buying cheap only but is buying growth, which is not priced in. I can give you instances from the past you could have bought very expensive companies in the environment that they were in at that time, like the largest biscuit manufacturer.

At one time, it had a 6 percent Ebitda margin, trading at 25 times P/E while the market was trading at anywhere from 12- 13 times. You could have well said that this is a very expensive name. But what you will not pricing in is that this 6 percent Ebitda margin is going to move to 10-13 percent over the next three to four years. So, that 25 times P/E is really not expensive at this time, it is in fact cheap versus what the earning power of this company is which is not priced in. In that context, we do believe that again taking from what Samit mentioned, that it is important to get the cycle right.

In the last two years, we played out the down cycle, maybe some more of that is in the works, but largely that cycle is behind us.

Goel: First of all, we believe that we are coming out of a long period of consolidation, a painful period. GDP has gone down. A lot of businesses have kind of suffered IL&FS crisis made the situation worse. So investing is about making a hypothesis and assigning a probability to it. If your probability and hypothesis is true, then you should be making a lot of money.

We believe that this economic cycle stage as Samit was also saying that- I think the probability of a reasonably higher growth ahead of us over the next four-five years is very high across the spectrum.

I believe that this recovery would be fairly wide, it won’t be focused on a particular sector only. I think you will see a reasonably widespread recovery across sectors. I think that is a setup and pretty much everything will make money, but you have to obviously choose your winner you have to do that. So, you have to make a hypothesis industry which you understand.

Vartak: So, I think it’s important to first be clear about what are the return expectations. If you are betting on high-quality companies where what kind of earnings growth you’re going to get and you know that there is not going to be rerating of valuations. If you’re fine with that low teens kind of returns, then there’s no reason for you to switch.

If your expectations are high, and if you are expecting to make more than 20 percent, kind of return and I think that’s where you need to think about those, that’s where you, obviously you need to take a little more risk,. Nothing is free in this world. So, as Vikas said, you need to make a hypothesis of what would be the next theme. It may not be that the entire portfolio needs to be betting on the new upcoming themes but at least some portion of that your portfolio has to be there because if you get it right, and if the valuation is in your favour, those companies can go up not just 10 times in 10 years, but you can go up to 30 timesin 10 years.

Those are the bets an investor who wants to make higher returns than the usual earnings growth kind of returns have to make and it’s an individual call.

Goel: So, no, I think just to elaborate on the point that you said. India is in the midst of unprecedented transformation. As we speak, India’s economy is only 50 percent organised. To draw a comparison, United States is 90 percent organised- which means 90 percent of the products and services that the consumers there purchase, are coming from the organised sector.

Now, what we have done in the last 3-5 years is with this digitisation, Aadhaar, Goods and Services Tax and demonetisation. We are breaking the way in which India used to operate earlier moving to a time where the organised sector is going to get stronger and stronger. So, which means now who are the guys who are going to benefit? The number one, two three players in each sector are expected to gain market share. It’s to me it’s no wonder that these companies are doing well.

I’ll give you an example, paint sector— 30 years back 75 percent of the sector was unorganised and 25 percent is was organised. Today, the ratio has split- 75 percent is organised and in the process, the leader has become 100 bagger. So, if you invested one crore today it’s worth more than hundred crores. So, what we are saying is that what the process which took 25 years earlier will probably happen faster now because of all the underlying transformation that we see.

Goel: So, what I’m saying is if you take any sector, the it could be a mid-cap, it could be a small cap. When we talk about growth and when we talk about quality, it does not have to be a large cap. We are saying the largest luggage manufacturer in India- it’s a company with a market cap of Rs 6,000 crore right. The company which is one of the largest small finance banks is a market cap of under Rs 20,000 crores. If you’re looking at lot of these sectors, there is a very strong underlying push.

Let me give you one more example, Jewellery sector for last seven years is zero growth- Rs 4-lakh crore industry has remained Rs 4-lakh crore in the last 7 years, but the number one player has grown at 15 percent in a sector with stagnant. That is why the stock has tripled in the same time.

Saigal: Very clearly, there is competition for capital and capital flows towards growth. Now, there are cycles in which certain segments grow well, there are the cycles in which other segments grow well.

Let’s take the case of the last two years. You’ve seen names like HUL continue to grow, while you have building material companies not growing for various reasons. I mean, I don’t want to go dwell into too much detail, but for various reasons, that’s the situation that exists at this time.

You’ve seen capital flowing to an HUL and out of building material companies- certain building material segments. Now, if your belief is that building materials is not going to grow even in the future, and this valuation is justified for this low-growth segment, then the situation will persist. But if your belief is that HUL at 80 P/E is largely building in that 15 percent growth, and if building materials can start to grow from 4-5 percent to now 15 percent, then this competition for capital will ensure that capital flows out of HUL are at least not incrementally into HUL and towards building material companies.

So, it again comes down to that- what is your belief on where growth is and in which segments. If you are belief is that growth in a certain segment is going to accelerate, this sort of contraction in multiples is going to reverse.

Saigal: See, I was in a presentation the other day and I was telling people that we Indians are because we are close to the ground, we are very pessimistic about what’s happening in India. But think of the reason why you have foreigners lining up to come into the country. Every large company wants to come into the country. Now, for the reason that we are 1.3 billion people and our per capita income is rising.

So, I can’t find a space where India will not grow. Now, of course, it may be that in cycles in the next six months orone year, there may be situations where India will not grow. But that India is going to grow over 5 or 10 years is to my mind, a given. In all segments, I do believe in addition to that, this growth is best captured when the perception of growth is low. This is that time when the perception all around is that growth is going to be weak- which is reflected in prices.

Khemani: There are two categories. One is where you can get consistent compounders. I think, you will see banking and financial services has a huge potential. Still, countries going to a huge amount of penetration. We’ll see many years of compounding ahead of us- insurance, asset management and many more non-credit space players.

Secondly, like know, your last two-three years set up in India, I think a few old school businesses. Where unorganised to the organised theme is at play, the manufacturing side- I think they are completely ignored. I think a lot of deep players there, as the environment changes, you will see utilisation levels going up, pricing improving, employee operating levels coming into play. There you can find a structural change in the business cycle happening. We have a really positive outlook on that.

Lastly, the structural theme- where the cycle is probably a 10-year cycle where I probably will find 15-25 baggers or maybe more. It’s hard to find good players out there right now in the real estate theme. I think the realty sector has well done well in the last year, but we think it’s a 10-year cycle. Post RERA implementation, the game has completely shifted in favour of good players with a good brand, balance sheets and the execution capability. Anybody and everybody will not be able to compete and become builders. The demand is going to be strong.

Goel: So, or us the biggest theme for the next 5 to 10 years is the shift from unorganised to organised. We have a fund woven around the theme and we believe it’s going to be an incredibly powerful theme.

Saigal: Building materials, we are positive on that space, consumption very positive on that space. There are in fact opportunities as we speak in consumption spaces. We’re very positive also on certain segments of capital goods, real estate. I mean, to the point that we are all products of the dematerialisation, what is happening in real estate today is something akin to what happened in equities when dematerialisation played out. So real estate is another space, quality balance sheets will work very well.

Vartak: I think it’s important to understand that the biggest problem that India faces today is unemployment and that’s going to get more and more acute. Because you look at the top employing industries, whether it’s real estate, the smaller players are out of business, many of them. The larger players do not need as many employees as the smaller players needed.

The auto ancillary, auto industry, it’s getting so much more automated that there is very little incremental hiring and you have such a huge population, which is coming into the employment base. The same thing is with textiles, what is the government going to do? I mean, there is no option but to attract more and more manufacturing in India. So, I think if you look at the steps that they’ve taken, it’s in that direction, because I’m pretty sure that’s the top-most priority for the government. So, if you don’t address this in three to four years, you will have social unrest and you are seeing signs of that.

I think the corporate tax cuts, especially for the new companies to come in is to attract these manufacturing companies into India, you will probably have to focus on the job-creating industries, which could be tourism. So, for all of that, the theme is going to be your you will have to build factories, the companies who come from outside will build factories, you will need to build airports, you need to build infrastructure. So, I think building material is definitely going to be one of those themes but again, you got to be very careful in that.

You have to pick niche players, where there are only one or two players. The barrier to enter that business is going to be very high. The gestation period for someone to come into that industry has to be very long, so you can’t bet on generic building materials, but you will have to look at specialised building materials. It could be some structural engineering side or in the electrical cable side, but those are going to be in high demand.

So, I’ll focus on many of those businesses. It’s not that they have stagnated, they have done well beyond most of these quality companies. You look at the last 10 years of history, their growth has been about 20 percent in the worst of the economic environment, and they are still trading at 13-15 times multiple and these are companies which are having a high return on capital employed. So, I just can’t believe that these companies if the economy picks up, can trade anything less than at least 2 times of the valuation where they’re at now.