Disclaimer: Please note that the views expressed in this interview are those of Mr. Basant Maheshwari and do not necessarily represent the views of, and should not be attributed to, Safal Niveshak.
- Click here to read Part 1 of the interview.
Safal Niveshak (SN): Compared to when you started investing in 1992, the sheer amount of irrelevant information faced by investors is truly staggering today. How can investors trapped by irrelevant information make independent investment decisions? What are the 4-5 factors investors can use to improve the quality of their decision making?
Basant Maheshwari (BM): You have to look at a piece of information and ask, “What difference does it make to the company that I own?” Like, I bought Pantaloon and made money. That’s well-documented everywhere.
When Pantaloon was doing its books, it used to carry inventory at sales minus gross margin. Normally, you have to do at cost or market value, whichever is lower. So there was a buffer there.
So if the inventory should’ve been valued at Rs 40 crore, they used to value it at Rs 60 or 70 crore. There was a lot of hue and cry about this. People said, “They’re overvaluing it!”
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At that point, I was also into this confusion as to how to evaluate this inventory part of Pantaloon. Then, one day as I was thinking about it, I thought of calculating how much it worked to. It came to about Rs 20-30 crore. Compared to this, the company’s market cap was about Rs 1,000 crore. The company was making more than Rs 20 crore in quarterly profit. So anybody would have said, “What difference does it make anyways? Pantaloon can write it off in one quarter.”
I am not saying they were doing a great job. All I am saying is that all information has to be converted into numbers.
You cannot have a situation where you just look at the information and then you worry about it without getting into the numbers part. Once you do that, you won’t be bothered too much.
And just like I said earlier, a person who doesn’t own the stock, he will always have 20 more reasons not to own it.
Also, for all multi-baggers, for every one reason to buy them, there are ten reasons why you should not buy them.
Like I’ll tell you, in 2009, when I bought Page Industries, it was at Rs 350 and their license was valid only till 2010. I called and asked the Company Secretary whether I could meet the President of Jockey International. He said I can’t do that.
So I went to the company’s AGM that year. I asked the President whether he was going to cancel Page’s license. He asked “Why?” I said, “It’s valid till only 2010. Are you going to extend it?”
He said, “Yes, we will extend it. But I can’t give you any more information.”
Then I asked, “Have you cancelled any licence in the past?” to which he replied that he hadn’t done that till date. He also mentioned that a license can be cancelled, as per the agreement, only if Page did not produce anything for sixth consecutive days and there is no force majeure involved, or if the promoter holding went below 51%.
So these two reasons were enough for me to frame an opinion that this licence wasn’t going to get cancelled in 2010. For anyone else, he would have discussed it at least 200 times on internet forums as to what would happen if this license was not renewed etc. etc.
Of course that was a very relevant point, but for a relevant point, you need to dig deeper. At such times, what happens is that people don’t want to give much of leverage to any company. But then, most of the big money is made by betting on first generation promoters, where there is no track record.
So all information you get about them will be unsubstantiated, and undocumented. It will mostly be on hearsay. But then, you have to give him some leverage, some benefit of doubt.
Who knew Narayana Murthy before 1994? Who knew Subhash Chandra before 1992? Who knew Kishore Biyani before 2002? Who knew Mr. Genomal of Page or Mr. Jagannathan of TTK Prestige before 2009? Of course, we had heard about them, but there was nothing we knew about them.
So most, not all, of the big money will be made on first generation promoters where there will be too much of negative information. And you have to convert all that information into numbers.
SN: You’ve mentioned in the past that your way of making money is by riding trends while keeping the downside risks in check. Please elaborate on your processes of (a) identifying trends, and (b) keeping the downside risks in check?
BM: Let’s look at 2-3 trends from the past – the software trend of the late 1990s and then the infra trend of 2000s. Of late, we have this consumer discretionary trend from 2009. Now look at these things – new highs for all the stocks enjoying a trend.
So if ACC and Ambuja were making new highs in 1992, and Infosys, Wipro etc. were making new highs in the late 1990s, Unitech, IVRCL, Nagarjuna Construction etc. were making new highs in mid-2000.
So the first thing is that if a trend is there, all companies in that sector, or at least most of them will be hitting new highs. It’s not a 52-week high. It’s a new all-time high.
Secondly, most of these companies should show above average growth. You can’t have a situation where Bharti Airtel is growing at 18% and you say it’s a new high.
Nobody is interested in buying a company that is growing at 18%. Many are interested if it grows at 25%. Plenty will be interested if it grows at 35%. And everybody will be interested if it grows at above 50%.
So, the percentage change in growth is only 10-15%, but the amount of incremental investors it can draw in is huge. So 25% and 35% is like day and night.
Secondly, above average growth has to be there, for almost all companies in that sector, for a new trend.
Third, most of these companies when they are hitting their new highs, the scale of opportunity has to be big. For example, you can’t sell wipers for somebody who’s wearing spectacles and say this is going to be a new trend. Or you can’t sell remote-controlled toothbrushes, and say this is going to become a new trend.
More often, you have to do a copy-paste job. So if you throw a company to me and ask, “How does this ABC Company look to you?” I’ll ask, “Is there any company in the US or Europe that has made it big in this business?”
If there is none, then I would not be interested, because business models don’t change too much. Human nature is same and what humans consume remains same. Our culture might be different, but the end consumption levels don’t change too much.
So if something has worked in the US, it will work in India. And we can get a fantastic head-on advantage. We are 20 years behind them. So you can choose to do a copy-paste job there.
Also, new trends will mostly have first generation promoters, about whom you would not have heard before.
Like Mukesh Ambani did not go into software in 1992. Tatas did not go into infrastructure and construction in 2003. So these things will keep on happening, because when a new trend is starting, you will not have too many known names there.
Now that’s a problem, because you have to bet in the unknown. But that is where the money is made.
So these are a few things. Of course there are other checks as well. But if you give me a stock that is making a new high, and another one that is making a new low and irrespective of how much fundamental analysis I do, I will be more attracted towards a stock that is making new highs than one that is making new lows, because most of the time new lows take place when shareholders don’t know what is happing with the company.
SN: Well, that was about identifying trends. How do you keep the downside risks in check?
BM: Earlier, I was willing to lose what I had. So, the only downside risk I had was that I used to sell stocks just like that. Now, I try to buy companies that are showing increased dividend payments. So if it’s paying Rs 10 today, next year it should pay Rs 11, the year after it should pay Rs 13, and then Rs 15 and so on.
Like I gave you an example of the capex thing. If I bought a high growth company that puts, say, 30% of its profits into capex every year because it needs to put up a new plant and machinery for catering to new growth that is going to come, and it also pays you dividend. So when growth slows down, and the trend starts to break (which can only be known in hindsight) more of that money will be diverted as dividends.
There are companies that like to hold cash and not pay anything. There it becomes very difficult. But with companies that pay you dividends every year at a certain rate, and the dividends are rising, in those kind of companies if the growth does not come across, then they would divert money for dividends. And the dividend would come in as a protection.
So from a 1.5% yield, it will become a 2.5% yield. But, normally, in a very high growth company, I need a 1% yield at least. This is because a 1% yield with 30-40% earnings growth is very good, because when the growth slows down, the money will come back to you.
Apart from this, you have to assume that when the trend breaks, you won’t know in foresight. It will come to you in hindsight, and you have to act 20-30% down. In the past, all companies who were leaders in their sectors, they almost doubled up before the trend broke.
Like ACC was at Rs 130 in 1992, three months before the trend broke. And at the peak it went to Rs 399. Then it fell down from there.
Similarly, Infosys from Rs 600 went to Rs 1,700 in three months in 2000, and from there it fell back to Rs 900. So before a trend breaks, the stocks would normally move up 50-100%. That’s the final blowout phase.
So, many times what happens is by looking at just the price of the stock, I get a sense – whether it’s right or not I don’t know – whether it is the final terminal value or is it going to go back a little more.
But, basically, you have to take it that you will never know it in foresight. It will only come to you in hindsight that the trend has broken. But you should make enough with the trend.
And who said you have to buy at the lowest point and sell at the highest point to make money?
You can buy somewhere near the lows and sell maybe 30% lower than the highs and still make enough money.
SN: I think not knowing the trend breaking up in foresight is what causes people to overpay. How do you differentiate between whether you are paying up for a stock or overpaying?
BM: It depends on which year’s earnings you consider. Are you in FY14 or FY16? Today, if you look at many of the engineering companies, they are doing well because people assume things will change. And on an FY16 basis, they are at around 25x P/E. And a classic secular growth company, on an FY16 basis, could be on 30x P/E.
So why won’t I pay 5x more and buy a classic secular growth company instead of trying to become the smart guy out there by first assuming how this engineering company will turn around and how much it will make in FTY16 and then try to say that this company is better because in FY16 it will trade at 25x against your secular growth company that is trading at 30x?
The first problem of overpaying or not overpaying comes because who will decide which year’s earnings have to be looked at.
And for companies that have predictable growth, where there is surety, the market will put the stock at an expanded level for as many years as much as you can predict the growth. Like HDFC Bank, I think, remained in a range for four years between 1999 and 2003. It traded at a price-to-book of more than 7x. And then it came down to less than 3x also. But the point is, how many people would have thought that at 7x, HDFC Bank could have done nothing from there on, and sold it.
Good companies, like good life partners, are not too many. You find one, you stay with it, till the time the partner doesn’t do that you don’t want it to do.
But I think the biggest problem is that when we compare companies, we compare them with trailing earnings. Like I will compare Tata Steel’s with Tata Motors’s trailing earnings.
But Tata Motors’s earnings are more predictable than Tata Steel’s. ITC’s earnings are more predictable than Tata Motors’s. Because of government regulations on ITC, Nestle’s earnings are more predictable than the former. So I can’t put everything in FY14 (trailing) earnings. And nobody knows whether you should look at FY15, or FY16, or FY17.
In all, overpaying is not a problem, as long as the trend remains, and as long as you can predict.
Also, overpaying is not a problem with predictable businesses. However, you also need to see that the prediction you are making is on the right scale. You just can’t predict endlessly.
SN: How does one escape from over-analyzing? In other words, how much time does one devote to analyse a stock idea? Are ‘few hours per week’ sufficient, as Peter Lynch suggests?
BM: It depends on what company you are analyzing. If you have bought a company whose future is based on what the Supreme Court has to offer, then you got to go into the Supreme Court and sit there, and listen to what the judges say. But if you got a Hindustan Unilever in your hand, you can just hold it for 10 years.
See, the thing is that 80% of the company information is available in the first 20% of the time you put into it. And in the balance 80% of the time, you will never be able to get the balance 20% of the information.
So then it becomes like he law of decreasing returns, in fact, ever-decreasing returns. Then we start looking at useless things.
That incremental analysis does not add too much value. But again the thing is, first 80% of the information comes to you in the first 20% of the time and from then on you will get the hang of the company, unless you have left it entirely to the mercy of the government, and regulations, and judiciary, and the London Metal Exchange (LME), then you need not analyze also.
SN: Also, when you over-analyze, you get into that illusion of control. I feel the more I know, the more I can control the outcome, which doesn’t happen actually.
BM: Yes, that’s very true. So, when someone calls me about a stock, after a brief discussion, the first thing that comes to my mind is and that I ask him is – “Is this analysis making any difference to whether I’m going to keep holding on this stock or am I going to sell it?”
Like somebody can tell you, “I bought this product from that store and this product doesn’t work!” But if the company is growing at 30-40%, probably you are the odd one out. And if the company is making 5-10 million pieces, then obviously there will be 20 products that will not work.
The first indicator of the customer feedback will come to you in terms of rising or dropping sales.
But most of the time we spend in getting the balance 20% information, which is not relevant at all.
Then it also depends on how many stocks you own. If you own 20 stocks, you can give a business a little more time to perform. If you have 5, then you don’t have any margin for error. Then, on the first sign of distress – not a confirmation but the first sign of distress – you got to say, “Thank you so much! I can’t be with you anymore!”
SN: You seemingly keep a concentrated portfolio with no more than 10 stocks. What is your maximum cap (as a % of your portfolio) on a single stock and how do you arrive at that allocation? If someone were to start investing today as a fresher with average knowledge, experience and emotional intelligence, would you advise a concentrated portfolio?
BM: If he wants to concentrate, then he should let the market concentrate for him, or if he understands the company very well. If I’m working in TCS and I know what Mr. N. Chandra is doing to TCS, I don’t need anybody else’s advice. I will put my entire money to work in TCS.
People might say that you are working in TCS, your salary is coming from there, and your investment is also there. But then, that is what I understand best. I might be able to sell the stock the moment I get the pink slip. But if I’m working at TCS and I bought a lot of Infosys, and there’s some problem in Infosys, I might never be able to know about it.
You see, concentration is for creating capital. Diversification is for protecting capital. If you got 40 stocks, you will do only as good as a normally diversified mutual fund or an index fund.
A new investor should start with a certain sense of diversification. And when he starts understanding the companies he owns, then he got to concentrate.
This is also a function of how much stock market allocation you have out of your net worth. If your net worth is Rs 1 crore, and you have Rs 5 lac into the stock market, and you have diversified it across 40 companies, then it makes no difference.
But if my net worth is Rs 1 crore, and I put that entirely into the stock market, then I’ve got to diversify.
So I think it is a function of how much of my net worth I have in the stock market. I think most people forget their net worth while analyzing the stocks they own. But I think that has to be in combination of that.
To be continued…