'Excellence in a business tells you about its success'

Blessed with an affable and practical approach, stock-market veteran Raamdeo Agrawal can stump you with his one-liners. Having seen the Indian markets evolve over the last 30 years, Agrawal, 60, has had the privilege of seeing both the primitive and the prime. In an interview with Kumar Shankar Roy, Raamdeo Agrawal or RA - as he is fondly addressed by colleagues - talks about the drastic shift in his investment thinking after he came across Warren Buffett, the reasons he bought multi-baggers like HDFC Bank, Eicher Motors and IndiGo, and why he always tries to understand the number of years a company will take to earn its current market capitalisation.

How do you assess the magic of entrepreneurship when it comes to investing in a company?
Assessing entrepreneurship is like assessing the company's potential. It's about understanding the person behind the company. I want to find out who the entrepreneur is, what he has done and what has been his upbringing. Upbringing is important because we must know whether the entrepreneur comes from a lower or upper middle class. Most successful entrepreneurs in India have come from a very modest background. Their educational background is also extremely important. How the entrepreneur advanced in terms of education shows the desire to progress.

Next, I look at how the entrepreneur started the business. Typically, a first-generation entrepreneur has some skill, knowledge or some circumstantial opportunity because of which he ended up starting the business. Sometimes one has a big dream and this acts as the prime driver for starting a business. So, all entrepreneurial stories are in essence a piece of art. Human perseverance, ambition, passion and competence are required to build an enterprise.

The word 'passion' carries a lot of weight. It's a key differentiator. Is the entrepreneur looking for retirement cheque or does he wan to make a company go from x to 10x. Typically, I have seen companies become what they want to become. But if the desire to make it is not there, you cannot make it. It's a tough world out there, and people with big dreams convey a message. Is the entrepreneur looking for moonshots? Is it feasible? These things make a big difference in how our investment will play out. What the entrepreneur has done in the last 30 years and what his plans are for the next 20-25 years, i.e. our investment period - all this should be clearly understood.

You have a track record of spotting winners early, like HDFC Bank, IndiGo and D-Mart. What made you sure about their success?
Excellence in a business is something that always tells you about success. In the case of IndiGo, as a consumer, I could see how they were different. It represented excellence. IndiGo had 35-40 per cent market share and was growing at 25 per cent. One common thing between HDFC Bank and IndiGo was a large opportunity. IndiGo showed excellence not only in its business but also in its numbers. To my mind, the excellence in profits should always be there.

In the case of D-Mart, I had some advantage. I knew how good the man behind D-Mart was since he is a friend. But having said that, if you visit any D-Mart shop, you will see almost through the day there are huge footfalls and big queues. In any other departmental store, there are just a few people during the daytime. D-Mart's success has been stunning and is in fact a case study.

HDFC Bank has been a big beneficiary of value migration. You have the best management team led by Mr Aditya Puri. There is also Mr Deepak Parekh. Banks are the longest-living animals all over the world, if I were to say it like that. What we had to figure out is a passionate and knowledgeable banker with a good brand equity. I could see that in HDFC Bank. We have been buying for a long-time now. The size of the opportunity is very large.

From the primitive market and investing days of 80s and 90s to the super-fast 2017, what has changed in your investment philosophy?
Till about 1995, I was no different from anybody else. Everything was welcome in my portfolio. I would buy small companies. I always had the small- and mid-cap bias. Some of your stocks do well and you keep on talking about them. The rest don't do well but still stay in your portfolio. You have small allocations across a huge number of stocks. So, as a result, I had 225 stocks in a Rs 10 crore portfolio. It was not that we were not making money, but the portfolio was not under control. With so many stocks, I couldn't even remember many of the names.

Market also changed, but the change in me was bigger. Full credit goes to Warren Buffett's philosophy. I came across him, and then I decided to have a focused strategy. From 225 stocks, I brought it down to 15-20 companies. Things became much more sophisticated. We looked at which companies to say no, what price to buy them at, etc. The change is still happening, as things are improving with every passing year. However, the fundamental shift in my thinking happened in 1994-95.

Did you tweak Buffettology to suit the Indian markets?
Buffett always says that price is what you pay; value is what you get. Our focus should be on estimating the value, and then we should look at the price. That's essentially value investing.

I started reading about Buffett and his advice. I also read books like Common Stocks and Uncommon Profits and Other Writings by Philip A. Fisher and Value Migration: How to Think Several Moves Ahead of the Competition by Adrian J. Slywotzky. So, I came across some value-investing principles.

In fact, I had started out as a value investor right from day one, even in those days. As a chartered accountant, I could read the balance sheet and understand stocks. What I could not do at that point of time is assess when a company is a good investment for the next 20-30 years or for the next two-three years. The understanding about the longevity part was not there. But I could understand what company had value seen in terms of the price. I was practising that part on my own.

When I listened to Buffett, I realised that I must focus on return on equity rather than just earnings per share or EPS. Next, I realised that I was focusing on too many companies. Then, I learned how to look at the management. Next, I started looking at franchise companies and brand owners. Buffett had talked about Coca-Cola, which was at the top of the world at that time. I started learning about quality companies. All this obviously did not happen in one year. Over a period of time, I learned the difference between a good company and a bad company, a short-term growth company and a long-term growth company. This started explaining why the valuation multiples will be different for two companies.

How important are return on equity and return on capital? Most investors are still stuck with price to earnings?
Till 1996, there was excessive focus on two ratios - price to earnings (P/E) and earnings per share (EPS). One used to buy at a P/E multiple of five-six and sell it at a multiple of 15. But markets were smarter. Markets knew what a Colgate, Hindustan Lever, ITC or Asian Paints was and hence they were valuing them at high multiples. Most investors didn't bother so long as some stocks were doing well. This entire ratio thing evolved. However, a ratio by itself is not an end to everything. We must look at ratios in proportion when we want to understand and find value. This is true whether you look at price to book (P/B), P/E, return on equity (RoE), cash flow and free cash flow (FCF). A lot of people look at cash multiples.

I myself am very comfortable with EPS growth, P/E and RoE. I have reduced it to those three metrics. I feel it's equally important to get a sense of the value. Is it Rs 1,000 crore, Rs 5,000 crore or Rs 1 lakh crore? My formula is simple: to understand that a company is valued at, say, Rs 50,000 crore, I see when exactly it will actually earn Rs 50,000 crore. This way of looking at a stock doesn't get due attention but I use it frequently. Whatever be the market capitalisation today, in how many years will the company earn the same money?

What arouses suspicion in your mind when you come across companies with uncommon or abnormal profits?
Ninety per cent of investing is about investing in business or things you understand.

When you do not understand something, leave it. It's that simple. Two things can happen - the stock will either be a multi-bagger or it will be worthless. There will be many things that happen and you cannot understand everything. For instance, a large bank says that its consolidated gross slippages for a quarter stood at over Rs 30,000 crore. I simply do not understand how a bank can lose that amount of money, so I would be a seller.

When we do not understand something, we should not feel bad about not making money from it. My entire focus is on the company I have bought. It's like in a tennis match. The thing that is most important is which ball you hit.

Can you tell us about value migration happening in various sectors/stocks and how you spotted them?
There are many such examples. The value migration from public sector to private sector is still on. The shift in global generic pharma companies is also something to track. In a sense, most export opportunities are value migration. Besides, in telecom we have already seen how value migrated from wireline to wireless and this is where Bharti Airtel emerged. Now its from wireless to Jio. Value migration is happening all around us. We have to keep a track of this trend. Even in the stock-broking business, from traditional way of broking now it is all about professional broking services. When we started in 1987, there were so many Gujarati and Parsi broking firms. They are all gone. I expect to see value migration in asset management as very rapidly fund management is getting institutionalised.

Your hits in terms of stocks like Infosys, Hero Honda and Vyasa Bank are well known. Can you take us through your thought process behind liking Eicher Motors and Ajanta Pharma?
Eicher Motors was the creation of a niche. You can say it was a beneficiary of a new fad. Motorcycles are not new, but Royal Enfield (a division of Eicher Motors) is not threatened by anyone. There is nobody in its segment, and it's are 80-90 per cent of that segment. It's a monopoly and it makes a lot of money. This makes it probably the most valuable two-wheeler company.

Ajanta Pharma is a story of good entrepreneurship. It's a small pharma company. It's very ambitious. Let's see how far it goes in the domestic as well as global markets.

In the case of Eicher, by the time you spotted the stock it had been already moving up fast. In such a situation, how do you convince yourself that there is a lot of steam left?
That is where the vision part comes in. In investing, you need vision, passion and courage. But it all starts with a vision. When we understand the company, it means you have to visualise what is going to happen in five years. Honestly, I saw Eicher doing very well on the truck side and we were moderately positive on the motorcycle side. But as we have all seen, its motorcycles just took off! It was a complete lucky strike. As an investor, when it starts working, you also change your view about the investment thesis.

Just like successes, there are also some misses. Tell us where you went wrong about Mastek and Financial Technologies.
Mastek shot to fame when the dot-com boom was on. The stock must have gone up by 20 times or so in nine-ten months. So, the gains hadn't become long-term capital gains. Despite knowing the fact that the end is near, I didn't sell. Finally after two-three months, the whole thing became zero! The important lesson from all this is 'never wait'. When you realise you have to run, you have to run.

In Financial Technologies, my calculation was that it was one of the most wonderful business opportunities. It was a unique company. Little did I know that its accounts were cooked up, and my assessment of the management was wrong.

When it comes to the price, most stock pickers advocate buying at a price that can be justified as reasonable in terms of valuations. But how do you justify a stock that trades at 70-80 times one-year forward earnings?
Even if you value companies of this type with a five- to ten-year earnings-growth view, then also you will not make money. You can keep going forward, but the chances of making money are low. Why should you take that risk? That's why one should say no. As per my QGLP philosophy, if one of the four components, quality, growth, longevity and price, is not there, you have to say no. If the price is exorbitant, you have to learn to avoid the stock at that time.

How do you understand whether 10-15 years down the line a business will still be relevant?
Longevity is a very subjective thing. To my mind, longevity in businesses comes from two things - one the type of business and the type of management. When a stable business is run by a stable mind, then the combination gives you longevity. If either of them is wacky, then longevity will not be there. You need both of them.

How do you deal with losses in your portfolio?
'Bounces are temporary; ups are permanent'. You have to learn to say such things to yourself so that you stay on course. Last month, we made 7-7.5 per cent return. This is unnatural. I know for a fact that mean reversion will happen soon. We should make 2-3 per cent, which means giving up 3-4 per cent. One has to be ready for these situations. Psychologically, you have to tell yourself that you cannot get away with the top. In fact, if equity markets don't go down, it is very unnatural. Unless a portfolio goes up and down, it is not a live portfolio.

You have sometimes said it is important to have a private-equity approach to public markets. Why?
A private-equity approach makes you sit on that opportunity for five, seven or even 10 years. You buy right and sit tight for as long as 10 years. When you buy a company, you obviously take a position thinking of a great future. What is important is to allow the company to become successful. All companies go through challenging times. This is why a private-equity approach is essential.