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Equity is a Perpetual Bond without any coupon: Navneet Munot, SBI Mutual Fund
Navneet Munot, Executive Director & CIO, SBI Funds Management Private Limited, talks about the ways to time the market and ways to sense the way the market will move.
Navneet Munot, Executive Director & CIO, SBI Funds Management Private Limited, talks about the ways to time the market and ways to sense the way the market will move, how to differentiate good and bad companies during a candid chat with Anil Singhvi, Managing Editor, Zee Business. Edited Excerpts:
You are someone who can time the market weather it will be bullish or bearish. Can you let us know about the thing that helps you in doing so?
There are certain signs in the atmosphere around you and things are visible. Let's talk about 2013 when India became a part of Fragile Five, there was a pressure on the currency, foreign and domestic investors were pulling out the money, IPO market was a dent, mutual fund flows were negative. When such an environment is visible and people suggest not to invest then, generally, it is a right time, when you should invest. As Warren Buffett says, You have to be Contrarian, when everyone is greedy and they think that a lot of money can be made, then you should be fearful. But when they are in fear then you should come out to display your power. The initial phase of the last year was quite the opposite when we felt that any small-cap company placing IPO should have a value of Rs2,000 crore. But, it was able to garner Rs2,500-2,700 through the IPO and then it opened up by 20%. Even shares of several companies, that were heading towards NCLT, were going up and were doubling or tripling. It was a situation in which demands with suggestions were reaching us to open small caps for placement of their money. Thus, there are several signs, which when bought together, will help you to analyze that either a froth is being created or an environment of despair is being built. Apart from this, the number of cycles that I have seen in these many years also allows me to find that either a froth is being created and it is a time to take.
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Do you think that there is a difference between a good company and a good share, if yes, then let us know about it?
If it is a good company then it will be visible in its valuation. But there are times when a company is doing well but is not priced handsomely. There is a difference between the value of the company and its price and. And, everyone is aware of it as it is clearly visible but recognition of the inner value of the company is a difficult task. There are two types of investors (i) one who thinks about the price at which his stocks can be sold, for instance, someone who buys a share today at Rs200 will think of offloading it by selling it to someone at Rs250-300 and (ii) he is an investor who can identify the inner value of the company. So, there is a big difference between the two. Identifying the inner value of the company is the biggest trick and it is something that can help you in earning good money in a long-run.
Besides, we have a big research team who always work with a perspective to identify where the company will reach in the long run. Importance of fluctuations due to macros decreases when a long-term investment is made after identifying the inner strength/valuation of the company. Important thing is to identify a good company, buying it at a good valuation and then stay with it for a long time as it will help you in making good money.
What is the process of identifying good company/business?
You are supposed to have a look at three aspects and they are business, management and valuation. In the case of Business, the return of equity should be more than the cost of equity in the long run. There is an equity risk premium on bond yield because there are fluctuations in equity, there is a premium is needed to take care of the uncertainties. You will get the cost of equity by summing these things.
Return of the company's equity capital and employed capital employed should be more than the cost of the equity. It will happen only if the business is a good one. Good business means there is a competitive advantage which means your business continues to have sustained growth. Michael Porter has framed Porter's Five Forces Framework, which is a bible to analyze a good business. The framework talks about identifying the buyers bargaining power and find it is more than you or less. Similarly, it talks about your suppliers and competitive intensity in the business as even a good business with several competitors will not allow you to make huge returns and you will get normalised returns. If you have limited supplier (one to two) then you are dependent on them, and he may raise the prices if he feels that your business is doing good. If you have fewer consumers and you are manufacturing a product that a consumer knows that you are making more money from it than he will get it managed at your end. Is there possibilities in which a new product that can come in the business which has the power of displacing it, for instance, telecom companies were making money through SMS but the introduction of WhatsApp get it freed. This means, your profitability either decreases or comes to an end with the introduction of a new product. Similarly, if there possibilities in which a new player can come into the business in which you are, if yes, then he may reduce your profitability. In Buffett's language, 'how do you create the mood' as in you create a fort that is surrounded by a lake to make sure that no one can enter into it. Management plays a big role in creating such a mode. There is some business where such a mood is inherent through brand, patent, innovation. There are few people who are cost leaders, whose cost always remains low than the competitors. These are the things that are required to understand either is business is good or not.
What one can do if the business is good but the promoter is not in the same line? Secondly, how a person can identify the nature, good or bad, of the promoter?
I have said earlier that there are two types of investors including the one who thinks only the ways of selling the stock. So, several things can be applied in this case. But, I would like to talk about those who want to be a long-term investor willing to retain the same share for a long time. What is a Stock? It is related to income, its growth and longevity of the growth as well as its certainty. It applies in every asset class as only four things apply in this case in the equity market, which is prone to uncertainties. That's why you will have to work hard in the segment because I always say, 'equity is a perpetual bond without any coupon'. No coupon is fixed in the case of equity, that is why you need to work to find out the kind of profit that you can make and in how many years, how it will grow and its certainties. Buffet and Charlie Munger have also said, 'buy a good business even it is run by a fool because one day a fool will be running it'. But, I feel, it is not right in the Indian context because the management plays an important role in it. You can have a look on any business like cement, which is a commodity business, which has a similar bag and has the same limestone, power and customer and it doesn't have anything to do with the brand. But, you can have a look at Shree Cement - it is not a recommendation - and its value creation and some other cement company that existed when this company came into existence. This proves the kind of role management can play.
Similarly in the case of the banking sector, when 20-25 years ago when three-four private banks were given the licence including HDFC - I will not name others - but where they have reached. They are same and function under the same RBI regulations in the same market and customers. But there is a difference in each of them. Thus, the vision, execution ability, capital allocation by the management plays an important role in paving the ways. The big mistake that management does is related to capital allocation, which is an essential part, as they don't allocate the capital at the right place. The management should have a focus on things like when to grow, the business in which you should grow, how to innovate, plan/create new products, and investment in the existing business. They also make mistakes in M&A (merger & acquisition) as they acquire certain things when the environment is bullish but it is supported by the market. It, the management, should also focus on raising capitals and it should think of a business in which they will not have to raise capital. Management attitude towards the minority shareholders, is it making money for itself or for them and is it passionate in making money even for these minority shareholders. Its relation with other stakeholders like employees, customers and suppliers among others is also something that matters.
There is certain management with an empire-building concept and it also happens in India in which they think of being into Fortune 100 and Fortune 500 or being number one or be among the top three. They are focused too much about their ranking and the top line. Profitable growth, return on equity are important aspects as these are the factors that will help the shareholders to earn but your size can't be the loan contributor in it. These are the places where management makes mistakes. Maximum of the acquisitions fail just because it is just acquired with the aim of expanding yourself. There should be an expansion but it should be along with a share on return on equity.
You spoke about three things, business, management and valuation. But when it comes to valuation than the shares that seem to be a good one are priced higher and those which are available at low costs is termed as a bad one. What is the solution for it?
Valuation is very important. If it is a good company with good management and people are aware of it than several things can happen at the price level. But, at times the longevity of growth and longevity of that business is neglected by the market. There is no second standard formula like people have a look at the PE (Price to Earnings) ratio in which stock with 20PE is cheaply available while the one with 40PE is highly-priced but it depends on several other factors. For instance, if there is an NBFC that is growing (profitable growth) at 15% and has a price to book is two times, i.e. it is priced double to its book value, while the second NBFC is growing (profitable growth) at 40% with good underwriting standard, risk management and is priced six-seven times higher than its price to book. After 10years, the NBFC which is six times to the price of the book will help in making more money if it grows at 40% but it will remain low in the case of the NBFC that grows at 15%. So, there is no such standard parameter and if some stocks price to book or price to earnings ratio is low then it is good but you will have to have a look on other parameters also.
Which sector should be chosen, the one that is in limelight and is growing nicely and there is a feeling that it should be bought, while on the other side we have sectors who are sad? Also, suggest which stock should be brought in these segments, the one that is performing well or the one that is slow?
It is a case of a contrary investor. But it is not necessary that the companies of the sector that is growing nicely will provide good returns to the shareholder. For instance, have a look on telecom sector what would have happened if it was said that 10-15 crore mobiles will multiply and turn up to be 100 crores, data market, which didn't exist then, will turn huge like this. It was a time, when they had an EBITDA margin of 35-40% then you would have thought even of selling your homes and buying these shares. But, it turns into Michael Porter's case in which the government has made money, suppliers made money (hopefully), consumers because the competitive intensity went up. With time the number of players went up from 2-3 to 10-12 players, which decreased the profitability due to which shareholders were not able to make money. So, it is not necessary that the sector that is growing will provide similar returns to its shareholders. That's why there is a need for the focus on return.
There are certain sectors, for instance, the metal segment from the commodities, then there is a cycle in which it performs well and its prices are up but there is a situation when the prices are low. This is where the market commits a mistake and its valuation rises up. In the case of good returns, the market extrapolates that it will remain the same for the next 5 years. It can be timed but if you want to have a structural look for a long time then, you will have to have a look on the size of the opportunity is essential, so that the sector does well and you have a positive view on it. But you should also have a look at the kind of money that the company will make and the kind of return the company will provide to its shareholders.
If there is a continuous need for high capitals then it will not be a profitable choice, if cash flows are not made then it will not benefit. So, you will have to have a look at several things. But certain mistakes are committed and I would like to sight the example from the 1990s, there was a period when IPO's of several 100 per cent export-oriented companies were launched and there was a similar period when IPOs of granite and marble companies were out, then there was a phase when several companies turned itself into IT services. Thus, there are certain signs that hints that things are not going well. I feel one should have a look at the capital cycle, and the segment that is chased by more capital as it will give birth to froth.
Market fluctuations that occur due to global cues or domestic political reasons gives a tense to small traders and retail investors. How they can be safe from such situations?
The investor should protect themselves from three situations and they are
(i) peer pressure in which you feel someone known to me has brought a share that has done well. So they should stay away from it as they are aware of their goal, circle of competence in terms of understanding of the company and the number of shares that they should have and the way the wealth will be created.
(ii) Noise creation from different platforms like media, WhatsApp and Twitter among others that provides access information to you. Such events have an impact on our long-term thinking.
(iii) we have inherent behavioural biases that lead to mistakes like the stock was bought at Rs200 and that's why I will offload it only after it goes up from that point. But, you should have a look at its current value and a sense that it is right or not. So, you should try to safeguard yourself from these three things and have to think long-term and buy a good company with good management and good valuation and stay with it.
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