Value Investing- A dead end ?

( An old piece from 2010.. revised ..)

As far as I am concerned, the Warren Buffet Graham Dodd School of investment is a complete education in stock picking. Having seen the Indian markets over the last few years, the one thought that comes to mind is that if WB were operating in the Indian markets today, he would perhaps find it difficult to find companies. However, if you take a cycle of twenty years, he would have found many opportunities to buy. WB is associated with ‘value’ investing. India is a ‘growth’ story. ‘Growth’ means buying in at prices that a ‘value’ investor may not buy.

If I look at WB/GD for inspiration, the key takeaway is the relevance of Return on Equity in conjunction with the ‘Margin of Safety’. If one uses these two financial measures, today’s markets are unlikely to throw up any investment worthy candidates. It is simply because our markets are today in an orbit that is being justified by the growth potential as well as the fact that when most of the world comprises of blind people, the one-eyed are looked upon with awe. And if you were to take an ROE cut off of even 20%, the universe suddenly shrinks to around 200 or lesser number of companies. Indian market thrives a lot on HOPE (Highly Over Priced Expectations).

If I look at some of the key qualitative attributes that WB/GD has listed out as pre-requisites for being included in the short list, the following things stand out:

1. Find companies that have strong entry barriers and strengths that enable predictability of earnings. One of the examples in the WB domain is Coca Cola. In India, I have not come across an Indian company that has this attribute. It is only some of the multinationals operating in India that has this attribute. Clearly, India is not a business pioneer even in its homeland, forget globally. Companies like HDFC come close, but one will have to search hard to find many more;
2. Management quality: Here again, most Indian companies suffer due to management being a family affair. Father passes it to son and so on. The best person for the job is not chosen. So, here again, the list of Indian companies is rather small.;

• Forever companies: WB says that he would like to stay invested in a company forever. Here most Indian companies fail the test. Where are the Century’s / Nirlons’/ Mafatlals/Singhanias of the yesteryears? They were the blue chips then. Again, one has to stay content with an HDFC or most of the MNC’s who will be there a hundred years from today. You cannot bet on the longevity of an Indian company or management or family. Their capacity to surprise is immense.

Apart from the key differences, the other issue is a WB approach may simply fail because we have two classes of shareholders, whose returns are different. The promoter shareholder gets his returns from many sources whereas the non promoter shareholder gets incidental benefits. Corporate governance and capital market regulations notwithstanding, the promoter only lets you see what he wants to let you see.

SO, to gain from a WB approach, we need to have the ability to understand the management and take a call on what the odds are of riding his coat tails. The other most important thing, to my mind, is that we have to learn when to sell. The volatility in our markets (illiquid and shallow by characteristic) gives great opportunities. I like to make a shortlist of companies that I like and put against them, prices that I am comfortable paying. And then wait. Surely, in a person’s investment life span, anything from three to five opportunities will come. And the returns will be great. Much better than market returns if I may say so. One must not have the compulsion to invest everything in one go, like a fund manager.

 

(R. Balakrishnan)

May 24^th, 2010