Ashish Chugh, Investment Analyst and author of investment bestseller Hidden Gems, tells CNBC-TV18 what to look for when hunting for multibaggers and when to exit a stock.
Below is the verbatim transcript of an interview.
Q: How do you pick a company which could be a multi-bagger. Do you run screeners -- what is that you are looking at in terms of looking at price earnings ratio, RoE, ROCE and all those things?
A: There is no one method or methodology which I follow for picking stocks for investment. It is a combination of a number of things. I am generally on the lookout for stocks, which are out of favour, whether they are from sectors which are out of favour or companies which are out of favour. Another thing is that sometimes when the companies are not doing well, the stock gets hammered to such low levels because there are short-term negatives that those price points provide you very good opportunities to buy.
Q: Give me one example because the reason is we don’t often meet the management, we don’t have a track records of those companies because you invest majorly in the microcap club, we don’t have anything to track as an analyst but how do you judge that that is or probably could be the company which could be a multibagger?
A: It has got to do with the valuation of the company vis-à-vis whether those negatives are curable or not. To give you an example, about three-four years about there is this company called Balaji Amines. It got hammered down to a level of about Rs 35-40 and the problem with the company at that point of time was that the company invested some capital in building a hotel.
Number two was that they also came up with an expansion project, which was not going as per the schedule. So because of these two things, there was a capital allocation and market construed that as a management which is not deploying their capital correctly but the real problem was that the expansion project which they undertook, there were some problems and they were not able to establish the quality of the product and they had to change the process a few times. So the marketcap or the valuation came to a point where the company was available at just about two to two and a half years of cashflow.
Q: How did you thought that Rs 35-40 is the right price to enter into because if things are wrong, it could fall 10-20-30 percent from those levels as well, right?
A: It does happen.
Q: I remember GVK, Deccan Gold Mines, you have been sitting on them for the longest of times but nothing has been happening.
A: Absolutely. It does happen in a number of cases but then you have to take a judgement call based upon the valuation parameters. The expansion project with the company is doing will someday see the light of the day. It is not that it is going to go on till eternity. It may not happen in the next quarter or the quarter after that but maybe the next financial year or the year after that the company and it is not a company, which is closed down. It is still generating cash and good amount of cash from the existing business.
Q: What I wanted to ask you was all the technical analysts tell us that you should have a trailing stop loss and all those things, as a person who is doing microcap investing, do you have a stop loss, do you think that if things don’t work out for next two-three quarters then I will be moving out of it? What is the process because the numbers may not come for the next two-three quarters? As they say, there is always pain before gain
A: Microcap investing is a totally different piece. Here you have to have a very high risk appetite and at the same time have stomach for profit. What happens generally is that people are willing to book their positions out at 50 percent gains but hold on to the losing stocks till eternity.
Here the thesis is that suppose you are investing in a basket of 10 stocks, there are two stocks which will become zero. Suppose you have allocated same amount of capital in all the 10 stocks. There will be two which will go to zero, there will be three-four which will give you returns which is probably slightly higher than the market or the market related returns but there would be two-three stocks which will multiply 5-10 times.
Q: How do you judge to sell a stock because as smallcap could be 300 times, 3000 times in whatever timeframe but how do you judge that this is the right time now to move out of this company?
A: Selling decision is more difficult than buying a stock. It has happened to me also that I have sold out very quickly and I have seen that stock going up many times after my selling. Now, I have a few parameters, which I look for which are basically valuation based parameters where I look for cases where the valuations have gone up much ahead of the fundamentals or the growth which you were expecting or anticipating. So that maybe one opportunity.
Q: Example?
A: Atul Auto used to be at about Rs 100 marketcap – stock price was about Rs 90-100 and the stock became Rs 800. If you adjust for splits and bonuses, the marketcap became 8 times without a corresponding increase in the sales growth or the fundamentals. So it came to a point where the marketcap was Rs 800 crore and at Rs 600 crore, you were getting a similar stock -- maybe Force Motor which was five times a size of Atul Auto and also doing five times profit of Atul Auto. Since the stock has gone up too much too soon without a corresponding change in the fundamentals of the company, it made sense to – this is again a case of relative valuation within the same sector or the same industry.
Q: What are your top investment ideas?
A: Broad themes which I am buying is -- there are number of companies which have done a lot of capex in the last two or three years where the results of those capex have not started flowing into the financials of the company. That is because of the capacity not being utilised, or the demand pickup not happening. What happens in such cases is that your losses get magnified because the depreciation is higher, finance cost is higher, losses appear higher, you get stocks at low valuations. However, this is a case of operating leverage. So, what happens is that whenever that capacity starts performing, then you get a big gain.
Q: Which sectors you see this kind of opportunity?
A: Something to do with the rural themes or building material segment is one which I am keenly looking at where I see a big demand pick up happening but at the same time, there are companies which have done capex, which are lying low, demand pickup is not happening.
Q: So rural themes, building materials, I am just guessing it could be Everest Industries, Sahyadri Industries, Sahyadri I think maybe that is a micro-cap company, maybe that is what you are hinting at?
A: That could be again one of the stocks where the losses are higher, there are problems in the company.
Q: It has been making losses, right?
A: It has been making losses, but if you go to the cash flow, they have been making good amount of cash profit because of higher depreciation and because of that they are able to reduce their bank loans. So, those are some opportunities which are there.
Even Everest Industries, since that is again a great management, not doing well for the last few quarters, but I think whenever the demand pickup happens, these building materials companies could do well.
Q: Last time we met in Diwali, you were the one who was bullish on the real estate sector and thought that there is a huge opportunity over there. Are you still bullish because a lot has happened in that sector?
A: Many of the stocks which we discussed during Diwali have gone up. Ajmera Realty is almost up by about 70-80 percent. I am holding on to these stocks, I am not selling out because what is going to happen is that real estate is a sector where there is no Chinese competition. There are problems in the sector which everybody knows, but I think most of these companies in the real estate sector are already discounting these problems in the stock prices.
Q: Do you think the run up has already happened and that is fair enough now?
A: No, not in all companies. The ones with high leverage, I think the run up is yet to happen. So, I am looking at some of those where the debt is high and in case they can find a way to reduce their debt, and of course the real estate prices may not go up, but the stock valuations have come to a point where they may be a fraction of the actual valuation of the company.
Q: If I ask someone about GVK, they will just say it is a highly indebted company, Rs 7-8 share price right now, why you thought of – I am sure you are still invested because you have made this disclosure earlier also that you have bought GVK, haven’t done anything but you are still holding. I want to just understand your psychology in terms of why GVK when no one wants to touch it?
A: I recommended GVK on the presumption that the problem with GVK was they had very high debt. I thought that they will be able to sell some assets and reduce debt and maybe make it into a leaner balance sheet company. That unfortunately has not happened the way I would have liked it to be. So, that is the reason it is lying low.
Q: You will keep on holding it like even if they don’t do anything for the next two years, isn't that capital misallocation?
A: In a way you can call it misallocation, but the thesis is that if you like a stock -- I am not overly bullish on GVK, but I don’t see too much of downside from these levels. It may become zero if the company goes bankrupt, but the kind of assets they still have, it is unlikely that that kind of a situation may come.
Q: What I am trying to think is that there are companies where people have been listening to some of the stories like Deccan Gold Mine - the company will get licence, BF Utilities - the clearance will come, GVK - debt will go off, but things don’t happen for two-three years, you still keep on holding it to think that sometime, someday it will happen?
A: In microcap investing, these things will continue to happen. Even in the new stocks which we buy, we may have -- there is an investment thesis we are working on that is not taking the amount of time in which we anticipated it to -- say even Deccan Gold if you take an example, the problem with the company is that it is the only – the good thing is it is the only listed company in the gold mining segment. However, the problem is, there is so much of bureaucracy involved in gold mining, and the unfortunate part is that gold and oil are some of India’s largest imports and we are not encouraging – with a new dispensation, the things have changed and they have probably got approvals for mining of some of the assets.
So, these are long gestation projects, but once they go into operation, then the amount of profitability it can generate, could be very high. I believe that it is very difficult to time the market if you think of -- I will give you an example, Natco Pharma when I was buying at Rs 70, at that time the company had just tied up with Mylan for glatiramer acetate, the molecule which they discovered, and the litigation process were supposed to take five years. So, nobody would buy that things will start improving after five years.
However, the stock has become 50 times. So, if you wait for the actual event to happen, then sometimes you tend to buy the stock at much higher levels. So in many cases you just have to sit on the sidelines without seeing the stock to move up.
Q: Tell me one company which you are most proud of being discovered of in the last 13-15 years of your work experience?
A: There are many companies but one which I have held on to for all this while is Natco Pharma. Luckily I did not sell out.
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