Sanjoy Bhattacharyya, managing partner at Fortuna Capital, and one of India’s most recognised value investor. In his interactions with the media over the years, he has shared a wealth of information. Here are some amazing nuggets repackaged as myths.
- Myth: Value and Growth are completely different.
All investing is value investing, the differences are just semantic.
To say that value investing is all about low PE stocks is farthest from the truth. Quantitative metrics such as PE and PB and dividend yield are statistical measures to test hypothesis; they do not define what is value.
Growth is the largest component of value.
Value is when you put in Re 1 in the hope that after adjusting for inflation, at a future point in time, that unit is worth much more. The aim is to own a business at a price less than what you think it is worth going into the future.
How do you do that? Buy businesses that over time will have an advantage over their competitors, and shall sustain and increase that advantage. Buy businesses that will earn a reasonable growing rate of return on the capital they deploy in their business. Most important is the quality of the business, and if your interests are aligned with the people who manage it. Once you are sanguine about the prospects of the company, then you look at what you are paying for it.
Which brings us to the next point - valuation.
- Myth: Markets are always efficient.
Markets are mostly efficient, maybe 85-90% of the time. But markets do break down. And when they do, opportunity presents itself. That is the time you can make a fortune if you have the emotional and financial stamina to capitalize on adversity. When a stock is priced to perfection, there is insufficient margin of safety. And that is why we should welcome dramatic downturns.
We often go overboard during a sale. Because we love discounts. Whether it is shopping, planning a holiday, buying antiques or art - we hunt for bargains. Ironically, the stock market is the only place where the appetite goes up when the price goes up. And the appetite is tamed considerably when bargains are available.
Investing is about buying a business. It is the price that determines value. If you pay a great price to buy a great business, it will make money. If you pay the wrong price you are unlikely to do well. Buy at a price that you don’t have to sell smart to make money. But at a price that you don’t need a great sale to make money.
- Myth: Greater the risk, higher the return.
An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative. - Benjamin Graham
While we happily concede to the “greater the risk, higher the return” maxim, it is evident that the first step of value investing is to cut risk. Investing is about minimizing the risk. Smart investors – whether fixed income or equity, always pay heed to risk. Safety of principal is paramount.
What does it mean to cut risk? You act to ensure preservation of capital. How do you do this when buying stocks? You work with a Margin of Safety when you buy.
- Myth: The crowd can’t be wrong.
Information is processed by the human mind, and the mind is not always rational. The key is to evaluate whether or not the crowd is reacting rationally. Time is the most important variable when differentiating between Signal and Noise.
Short-term jolts could hit the stock price, but you need to figure out if it is consequential over the long term. It could be a bad quarterly result, a sudden hike in raw material prices due to a supply blockage, or even a temporary problem with one of the brands. Remember how Nestle had to recall Maggi Noodles in 2015, taking a big hit? The company’s stock settled at Rs 5,828 by the end of December 2015. Today it trades at over Rs 16,000 (that too, a dip from Rs 18,000 levels at the start of 2021).
If you think that the business from a long-term perspective is well run, profitable and growth oriented, has a strong dominant brand and a sustainable competitive advantage, don’t let a bump in the road throw you off. Ask yourself: How substantial is the impact over the long term?
The moment there is a significant long-term impact, you have to evaluate whether it is damaging or beneficial. For instance, let’s say Company A can manufacture its product with two sources of raw material. One is gas and the other is crude; the former being a cleaner and cheaper option. Company A now gets a significant allotment of gas at a plant. This has far reaching consequences and a long-term implication on the value of the business. Take Kajaria Ceramics. They did not have the allocation of gas to run their plants at full capacity. When it did happen, it was obvious that it would have a dramatic sustainable improvement on its operating margins.
- Myth: Large caps are less risky.
Hindustan Motors of India manufactured the Ambassador, and Premier Automobiles, the Fiat. They were blue chips back in the day. It was their lack of vision and complacency that was their downfall.
Container Corporation of India has seen its advantage diminish significantly over time. Since it was a spinner of the Indian Railways, it had preferential access to wagons. In the freight handling and moving business, that was critical. It was one of the biggest beneficiaries of India’s growing trade - export and import. Those who invested in it for a decade (2000 – 2010), it would have been exceptionally rewarding.
See the fall of GE (General Electric). It was a founding member of the Dow Jones Industrial Average in 1896. It has been cast from the DJIA, where it was once the sole name to have endured for the benchmark’s first 100 years.
Being a large cap does not make the investment less risky. It is the business that matters, the leverage, the cash flows, its sustainable advantage, and so many other parameters.
Investors tend to think of large caps as “safer” because of the liquidity risk. Since the cost of liquidity is a significant cost, you must be disciplined about what you think is the right price to pay for a business. Don’t get swayed by the Fear Of Missing Out, or FOMO, and make a hasty buy. It is easy to get into a stock, but it will come to haunt you when you want to exit. In India, the impact cost can be very, very high, especially in small and mid caps. It is important to buy at the right price, rather than be punished after you buy it.
Also, disruption can affect all companies, irrespective of market cap.
Where the rate of change is slow in terms of how the business evolves going forward, there you have much less to be worried about. A company that makes biscuits or bread, for example, is likely to change at a slower rate, is less likely to be disrupted and remain relevant longer. When you look at these kinds of businesses, you ask whether that competitive advantage will hold up and how much money will they earn going forward.
The tricky businesses are the ones which are not overtly disruptive, appear less vulnerable to change, yet will change dramatically going forward. Some examples are the automotive, pharma and construction industries. Large significant businesses which seem to be well entrenched with no evident risk in terms of being affected by disruptive change. Not only does one have to figure out the nature of that change and how it will affect the businesses that are leaders today, but also consumer expectations and aspirations in a changed environment. An electric car, for instance, may cost a lot more to own and run over a decade but it also appeals to the socially responsible and environmental conscious.
Don’t needlessly trade. But don’t be complacent either.
