We are not yet at the bottom of the valuations, says this value investor
- Current investment process is all about elimination of what not to do.
- History says the present crisis will also pass.
- You cannot make a good deal with bad management.
The market is going through one of its worst phases. I am sure you have seen many such phases before. How do you navigate this situation?
One needs to realise that the market is inherently a cyclical beast and there are many cycles playing out at the same time. There is a business cycle, there is an economy cycle, there is a fiscal cycle, and more importantly, there is investor behaviour cycle. If you have spent adequate number of years in the market, you know this too will turn around. The history of the stock market is a history of cycle of human behaviour and business cycle. It is inherent that this too will pass.
What are the signals for bottom fishing in the market? Are we seeing those signals currently?
Valuation in the current market is a function of two things: firstly, the interest rates globally which are almost at a multi-decade low; and secondly, the profitability and asset utilisation of the industry which in Indian context, are at the two standard deviations below the mean. Mean reversion is going to be likely so it will have to affect the capacity utilisation and profitability should move up. But at the same time, the interest rate has to move up too. I do not think we are at the bottom of the valuations, given that interest rates are too low.
How do you manage risk while investing specifically in this kind of scenario?
There are certain risks which can be eliminated altogether like diversification, asset allocation, and so on but only certain kind of risks have to be managed because otherwise nobody can perfectly time the market. It is the inherent nature of the stock market that unless you are able to buy the stock at the bottom, after your purchase, invariably the stock is going to go down. So the volatility in the prices of the stock is not the risk. The risk is getting your process of identifying the stock and duration and the longevity and the growth assumption about the stock going wrong. The way I look at it, risk management can manifest in multiple ways.
How did you get interested in stock markets and particularly value investing?
I am an engineer by qualification and I am investor by profession but I am a teacher by vocation. I have been teaching about investing since 1994 to be precise. I entered the stock market in the midst of the Harshad Mehta stock boom in 1992. I used to understand the cement industry and the cement stocks were getting buzzers. I used to wonder what is wrong? What is it that the market knows which I do not know? Later, it was proved that the funds from the banking system were getting diverted to the stock. If you could figure out what determines the asset prices and what drives the stock prices and if you had a contrarian view it was a good puzzle to solve and it could be a very enriching professional experience.
How do you spot a value buy?
The best way to do so is to develop insight into the business, the management and its competition over a long period of time and then work backwards. In a classical valuation case, you assume a lot of things and you get the valuation right now. But in the case of the stock market, the current price which you pay is known to you. You can work out in a reverse way what the embedded current market valuations are telling you about the growth of the business. If you have a variant perception, then you can act on it and if your perception about the growth and the pricing is different, you have an opportunity either to buy or sell and be proven right later.
As a value investor, do you follow any market guru? If yes, who and what have you learnt from them?
I have learnt a lot from people who are no longer alive and whom I refer to as eminent dead. The beauty about them is they cannot let me down by doing something stupid going ahead. I have learnt heavily from them. Nowadays knowledge is abundant and you have multiple role models to play with. Some of the people whom I have liked to read about are some of the doyens of value investing ranging from Graham & Dodd to Seth Klarman, from Howard Marks to Warren Buffett. Back home, in India, we have also several good value practitioners one can look up to.
How do you see the roles of luck and skill in the stock market?
That’s a very interesting paradox. In the earlier part of my career, the participant skill was missing and luck played a lesser role and skill played a bigger role. But now the participants are getting more skilful and collectively that requires that you have to be luckier. The harder you work, the luckier you will get. It is a counter-intuitive argument.
What is your current investment process? How do you invest right?
The current investment process is all about elimination of what not to do. Actually the strong focus is on what to eliminate in the long run. Anything multiplied by zero is zero. Try to avoid companies where there is a strong probability of an accident waiting to happen.
Secondly, you cannot make a good deal with bad management. Where the management and corporate governance issues are problems, you try to avoid them. Ultimately. it is all boiling down to a process which follows elimination and then focus on what is left behind.