Raamdeo Agrawal Is Not Hunting For Value Anymore
Raamdeo Agrawal of Motilal Oswal Financial Services Ltd. (Photographer: Dhiraj Singh/Bloomberg)  

Raamdeo Agrawal Is Not Hunting For Value Anymore

One of India’s best-known value investors is no longer going after value.

“Value is out of fashion right now, deeply out of fashion. Even Warren Buffett is having a tough time,” Raamdeo Agrawal, chairman of Motilal Oswal Financial Services, said at a PMS AIF World event in Mumbai. “Earlier you used to buy cheap. If you end up buying cheap, you were guaranteed to make money. That's not the scene now.”

India’s equity benchmarks have been scaling new highs as investors chased heavyweights when the broader markets didn’t return much in the past two years. The polarisation forced stock pickers and investment advisers to change strategies. Agrawal is among those who’ve had to realign some of his investment ideas.

Agrawal always focused on the quality of a business and its earnings growth and return on equity. But in recent years he started chasing value. “I don’t know what got into my head,” he said.

“At some point, I realised that quality and growth, if you find it right, it is good for a good time and good for a bad time,” Agrawal said. “In the good times, everything is good, but in bad times only QGP (quality, growth, price) works. Which is what is happening now.”

He said this experience has reposed his faith in focusing on quality and growth. “Nobody follows quality. The kids who come from college they would want to buy cheap and small and those kinds of things,” Agrawal noted. “When you talk about long-term compounding, the compounding can happen only by the quality and if there is no quality, it will falter.”

Watch | Full interaction with Motilal Oswal’s Raamdeo Agrawal.

Here are the edited excerpts from the interview...

With your relentless focus on QG&P (quality, growth and price) and quality across various facets, and not just the quality of the management, if still minefields can creep into portfolios at Motilal Oswal, how would somebody who doesn’t focus so much on all of those aspects still stay safe?

Stock market is a learning process. Continuously keep learning until you die. Keep learning, so there is no end to the learning process. One other thing is that, as Buffett says, rule number one, don’t lose money. Rule number two, don’t forget rule number one. So how do you ensure rule number one, don’t lose money.

You don’t learn it from day one. Even if Buffett is taking one-hour session every day, then also you cannot learn not to lose money. In fact, the biggest problem is losing money in the stock market. So, how do you not lose? The filters keep coming, the framework keeps maturing. You keep looking at the country and looking at your own background. To create the opportunity in the country, you have to find your own set of frameworks.

Those frameworks cannot be built in one day. If I committed a mistake or I met with two-three accidents in my portfolio, then I said, “Let me figure out how do we do it.”

So, we found our way and that cannot be a 100 percent proof that will not commit a mistake again. But instead of having say, one out of 10 times, it should be just one out 20 or 30 times because as somebody said, there’s only one way to write honest account, but there are millions of ways of writing dishonest accounts and many more million new ways of writing bad accounts. So, you will not be able to completely avoid the risk. What is risk in the market? Risk in the market is losing opportunities.

But what’s the biggest learning over the last so many years wherein you have seen wealth destruction, arguably in your own mission at times when you started off in your portfolios as well?

You don’t buy quality. When you talk about long-term compounding, it can happen only by quality and if there is no quality, it will falter. If it doesn’t falter, it will not work out in the long run in compounding. In compounding, what is most important is it is not a five-year game or a 10-year game, it has to be 20-30 years game. You might have invested for 10 years, but the person who’s buying from you at a fancy price, he’s looking at another 10 years and that guy who has exited is again dependent on the next 10 years. So, whether you want to stay 10 years or not, but the longevity of the company is extremely important in the current valuation. So, getting the management right, getting the quality of the company right—all this QG&P, all four components are very important.

Destruction happens because of bad managements. In businesses 90 percent is management, 10 percent is everything else. So, if you don’t get your management right, you don’t make a lot of money. A lot of money will be made by big managements and people come here to make a lot of money.
Raamdeo Agrawal, Chairman, Motilal Oswal Financial Services

Like when I heard about Buffett in 1995, first I thought quality is very important. So, I became a bhakt (follower) of quality without bothering, and taking quality at any price. That was a game to start in 1995. Then in 2003, I read this book ‘Intelligent Investor’. The margin of safety, when the market collapsed in 2000, then we learnt margin of safety. So, quality also you cannot buy at any price.

Then Q&P came. In 2014, we realised that G is equal to R, growth and return is one and the same mathematically. If the company grows at 45 percent, from 1994 to 2014, Infosys grew at 43 percent and the stock returned 43 percent. Colgate grew at 11 percent it gave 11 percent. So, we realised that G is extremely important. Quality is important, G is important, but then you want to make a lot of money in a compounded way. So, longevity is also important. So, longevity is important in quality, and longevity is important in growth. So, like that you’re learning.

Now having written QG&P in 2014, again, we missed out on the quality of management because we thought it is not numerical and is very quality based. How do you figure out? Then we had two accidents. We said let’s write it. So, this time they wrote quality of management. So, like you’re plugging. Again, we will commit some mistake in the next one or two years, then again, we’ll find some other method.

You quoted Thomas Phelps in your wealth creation study, right? One of the best defence against fraudsters is to run away from them as fast as possible. The first hint of a sharp practice.

Now my question is this, it’s very practical to say this or very easy to say this, but maybe at times, a bit difficult to implement simply because you may see that there are sharp practices, but the market loves the business, you’ve already created some wealth in it. Let’s assume a hypothetical example. What do you then do?

So, you read that, quote, fully, what we have written. At the first hint of sharp is, see what happens is, most of the entrepreneurs they start nicely. They’re nice guys to start with. Then little later, the pressure of valuation comes in for some reason, he wants to show more valuation. For that, he wants to show more profit, which is not there. He thinks that for a quarter, I will do it but in the next quarter, when the moment comes, we’ll be all right.

Then, the managers have got the permission to do it. The managers then show them bigger ways of doing it and if market starts rewarding them, then there is no more going away. Satyam kept on getting rewards and he kept on selling. So, half the fault is of the market also. The market keeps appreciating these guys until they punish these jokers, the show doesn’t stop.

You need to know how to control your greed.

There are accounting processes. In accounting, you can do cash accounting, or you can do accrual accounting. The moment you start accrual accounting, that is the biggest tool in the hands of the management. Now the management can use it conservatively or aggressively. In aggression what happens is, it’s a bordering between aggression and fraudulent accounting.

So, managers, they keep going out into the fraudulent and keep coming back. At some point of time, they’re permanently out. So, when you see in the books or from any comments or something, it will come to you, when you’re holding the shares, somebody will tell you that there is something wrong here. The moment you get that confirmed, run because it is going to zero. We are seen in this last 24 months; how many heroes have become zeroes. Even global multi-billion-dollar enterprises have just disappeared and disappeared in less than 12 months.

So, some of those risks Mr. Agarwal are not necessarily only corporate frauds, right, there are business risks too? We’ve seen that over the last 24-36 months. So how do you identify what’s a good point to get out of a business, wherein let’s assume it’s created, some non-banking finance firms created a lot of wealth then, when the IL&FS crisis happened. How do you as an investor identify a try and go about that process?

You have to keep it very crude. The moment you’re in trouble, run.

But you can’t identify trouble a lot of times because it’s not a management problem. It’s a sector wise or a liquidity risk problem which you do not have to communicate at all?

If the business is sound and temporarily is going through some kind of issues, you can take a calibrated call. The management integrity is not in doubt. They may have some kind of credit cost issue temporarily for 4-6 quarters or whatever. That’s okay. You have to take a temporary quotation loss, stock comes from Rs 1,000 to Rs 500 and again, it’ll go to Rs 2,000-4,000. That’s not an issue. I think, honestly-run company, even Motilal Oswal, has a problem. We started Aspire and we had a problem. The market was not happy, but that’s how it is.

This is a business. So, if the management is upfront and forthright in declaring whatever is a mistake, that’s fine. Now it is your call whether you want to back Motilal Oswal or not.

Investing is all about long term. If you want, if you believe in the management team, every management team under the sun will commit a mistake. Sometimes it is bigger, sometimes it is smaller. So, that’s why the maximum money is made by the management team only. Because management team doesn’t have option to get out every time, they sit through for 15-30 years and then they become lucky at some point of time from the market or from the business opportunity or something and you make a lot of money.

The other aspect of wealth destruction is also the cycles turning against. Again, I wanted to understand from you how easy or difficult it has been for you to identify turns of cycles and not get tempted?

Fundamentally, at the time of buying your buying should be very good. If you’re not clear about it—see, what Buffett says is that first thing is whether you understand, aapki samaj hai ki nahi (If you have the understanding) that this is a good business, run by good management. If that fundamental understanding is flawed, then you are in deep trouble. Because you don’t know whether it’s right or wrong at a later stage. When the signals are coming wrong, still you can say everything is alright, it is temporary, and I will stay on.

The first sign of little bit of weakness in the system, you cannot run. So, if something turns out to be completely unexpected, you thought that this is like this, but turns out to be very deeply cyclical. Typically, what happens, is like cyclical companies, well-run cyclical companies and say commodity price goes from $1 per kg to $5 per kg and profit is through the roof and the stock also goes through the roof from 100 to 1,000.

Now, at 1,000, you go and meet the management. Typically, management says earlier it used to happen, that commodity will come down, but this time the China demand is so massive, we have just scratched the surface and there is no supply and we are the only guys under to supply. This 10 actually should be 20 and what happens is that again comes down to $1.

I have seen enough of this thing happening and now, because got once caught in Sterlite Technologies Ltd. in 2003 when fibre optics came first, I was very excited that the world is going digital. Then it played out like that from $8 to $1. Now second round again it came in and I know them very well. I said ‘No. I know what will happen. I don’t want to get caught in this.’ So, you paid your price last time. I bought at Rs 500, I saw Rs 900. Again, sold it at Rs 100.

There is nothing wrong with the business or the management, it is just a cyclicality. So, you don’t understand, and you have to commit a mistake. I mean, these kinds of losses will happen and avoid next time, don’t repeat it again. Don’t get caught into this comedy thing going up and right at the top, all sorts of guys will come, analysts will come. Management will come. Certainly, the management was not willing to meet, they come to your office with a full bandwagon and they are willing to explain you all the technology underlying. So, you got to be very careful.

I want to revisit something that you had said in a query when we had done that series of the QG&P, power of compounding part of quality. A good business with an average promoter or good promoter with an average business—what is your preference? You had said then that a good business with an average promoter because a good business is non-negotiable. Do you still stick to that?

I would revise that. Now, I would not like to compromise on the promoter.

See, in promoters, there are two things — integrity and competence. I can take an average promoter in terms of competence, but on integrity, I want AAA absolutely. I can have an average competent promoter, but not average integrity, integrity should be top class.
Raamdeo Agrawal, Chairman, Motilal Oswal Financial Services

Competence can be average because that element can be very high. If I think in banking, your integrity is top class, and you are an average banker and you are in the private sector, you will make tons of money.

What of the last three years? A lot of events got bunched up into India at least to my experience. What have those three years of saved wealth/observing wealth destruction around you, taught you? Has it taught you something new?

See from 2015 what has happened is that earlier you used to buy cheap. If you end up buying cheap, you’re guaranteed to make money. That’s not the scene now. So, value is out of out of fashion right now- deeply out of fashion. Buffett saab is also having a tough time.

Despite with all his framework and Apple in his portfolio is underperforming. In 2014, I don’t know what got into my head. I was always quality and growth and this quality and growth I thought it is going to be our style, but now it has become global style and the market style. Actually, at some point in time I realised Q and G if you find it right, to QG&P, if you get it right, it is good for good time and good for bad time. See, in the good time everything is good, but in bad time only QGP works, that is what is happening now.

So, are you altering your investment thesis in that case?

No, in fact I am going closer to QGP. So, what happens is when a manager is wrong on a stock, he becomes a value manager. He bought it as growth and then later on, he changes the story. He says, “Humne socha tha ki 25 percent growth aayega, par nahi aaya. Lekin 5 ka PE isme kya jaa sakta hai?” (We thought we will have 25 percent growth, but it did not come. But I won’t lose much if I buy it at a PE multiple of 5?)

Then, you are stuck. You don’t change the story, the story which you have bought, please pursue that. If you are wrong, run.

Am I understanding this correctly, you and are not necessarily chasing value. Value as in growth and value is not necessarily in the ticker that you see?

As Buffett said, value and growth, the growth is at the joint. So, I was a true believer that my DNA is for a little bit of growth in the system. Bucket of value is basically three values—breakup value, franchise value and growth value. Growth value in India is almost like more than 50 percent. So, I always focused on that. To start with, nobody follows quality. The kids who come from college they would want to buy cheap and small and those kinds of things. So, I also started like that. So, quality came because of Buffett and growth probably is our own Indian psyche.

There’s one just interesting point that I saw in the wealth creation study, which was interesting as well that I think you guys have mentioned that- if a company is available at the current market cap is at a discount to the sum of the next five years of estimated profits, then it’s turning out to be a great multi-bagger. Is there something like that which points towards how you can avoid value destruction?

So far, about 70-80 P/E multiples, they never work. In fact, in the last year study, we ran a lot of data for 20 years.

We figured out that if you buy above 80 P/E, typically, either in most of the cases it is outright losses, or you make very moderate returns, maybe 5-10 percent if you’re lucky. That’s becoming very difficult. Just one year, the whole character of the market has changed so much. The only thing you can buy and make some money is the 70-80 P/E multiple companies. So, it’s upside down.

To that extent, I’m still scared of touching of 70-100 PE but that still remains still a question mark. But I think people who are buying at 80-100 as a bucket, one company can definitely be a seven-sigma event or something, but otherwise, you’ll not do well.

You thought of a portfolio management services as a business or as a scheme at a point of time, and it was not as prevalent as it is right now. 17-18 years ago, what made you think of it then? And how do you think this space will evolve over the course of the next 15-20 years?

So, we didn’t have mutual fund licence also. They were all our clients but we thought it is for the big guys. For small guys like us, we said, if I have to replicate my portfolio for somebody else, then what’s better is PMS. I was a broking company so selling PMS through broking outlets was easy. I mean, we never thought of a separate asset management company and creating all the bureaucracy around that.

By that time, by 2002-2003, asset management business itself was not that big, it was just about coming up. It was in 2003-2008 when all these AMCs became Rs 1-2 lakh-crore AMCs. So, it’s all a little later when it happened—the government also helped, SEBI also helped to make things for MFs much better.

So, now I think that kind of taxation laws which they’re putting, I think SEBI and all in this structure, what actually most of our investors want to see and look and feel the stocks. If I put 10 percent in HDFC Bank and 5 percent some other, through the blind pool in MF, they’re not that happy. Then so many customers in 2008-2010 they took their portfolios. You don’t do anything, why should we pay 2 percent we’re taking our portfolio, they were very happy to take the portfolio away. That is not possible in MF. Somehow liking for direct stock in their name is a lot there and that’s where the PMS comes.

Second, I think SEBI has come with a rule that a PMS manager cannot be a mutual fund manager. So, if I am a PMS manager and I do only PMS and I’m a wonderful guy, so then the customer doesn’t have any choice but to come to me. So, now they’re making a difference between the taxability of PMS profits and mutual fund profits and that will kind of handicap the future of PMS. If my taxation is same, then I want to go to Raamdeo, whosoever is a great guy, because in equity it’s all about the manager, his philosophy, behavioural makeup and experience.

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