Saurabh Mukherjea Moneycontrol News
In this episode of Coffee Can Investing, Bharat Shah, Executive Director at ASK Group tells Saurabh Mukherjea about his journey in the market and his passion for investing.
Saurabh: Welcome to Coffee Can Investing and to our interview with Bharat Shah, Executive Director at ASK Group.
Bharat is one of the handful of people who has been managing money in India for the best part of three decades. Bharat welcome to the show. It’s a privilege having you here.
As I said you are one of only two or three people that I know who have been managing money in India since the late 80’s and in these 30 years our markets changed radically, the economy has changed radically.
Q: I would love to hear your thoughts on how you began the journey at a time when I presumed investing in the stock market in the late 80’s wasn’t a favored profession of the bright and the talented. How did you enter the stock markets?
A: I think, the profession wasn't even considered a profession, it was regarded as gamblers’ den and to that extent it was a tough calling to be taken into. But somehow right from the college days, I was drawn towards anything to do with investing. So the whole environment was kind of casual one and I myself was just trying to grope and trying to figure out where things were.
So I began by kind of taking up anything on companies which will come into the newspapers -- magazines were few and far between -- and I began taking up to the investment books at that point of time. So this was not an academic kind of thing…
Q: The first few books that you read any recollection, what were the first few books that influenced your thinking on investing?
A: Four or five of them. The Intelligent Investor, Conservative Investors Sleep well by Phil Fisher, The Theory of Value, the Stocks for the Long Run by Jeremy Siegel. These were some of the very interesting books and of course Secondary Analysis by Benjamin Graham.
Q: So your first job wasn't in the Stock Market?
A: It started with Asian Paints actually.
Q: What was the trigger, what was the catalyst for leaving the world of manufacturing behind and entering the world of investing?
A: Love for investing was something as I mentioned right from my college days and then my professional degrees that I pursued of, management degrees in chartered accountancy and cost accountancy. But I kept my own academic interest alive in this area by self-study, and I would go to vendors and buy annual reports in kilos, because I couldn't have afford it to put money and buy the stocks to get the annual reports on my own.
That love reflected in every spare moment I could get. So my day job, and what I did other than that was very different. At some stage I felt what I love the most, what I am most passionate about is what should be my work as well, rather than doing something. I was doing well in what I was doing in the manufacturing area and in my finance work. But that’s not what I thought was my real love and passion. So one fine day I think, when the sentiment became too dominant I decided to take steps to make a move and in the next three months I did that.
Q: So the entry into the stock market was it into an investment role, research role?
A: I had started with the research role, because I myself was learning… you always do, but obviously that was a stage where a lot of my ideas were immature and not adequately fertile and well backed. To that extent a lot of learning needed to be gone through myself, but I joined straight as the head of the research. To that extent I thought it gave me pretty good initial grounding to get into that area. To get into the investments field.
Q: For people who have only been in the Indian market for a decade or so the picture we have of the Indian market in the early 90s, through the 90s of modest amounts of research or almost no research on lots of stocks, and therefore an inefficient market and gradually we come to the current day increasing amount of brokerages, writing on stocks and therefore market efficiency improving. Now, if that indeed is the case one would presume that fundamentally oriented investor like you, your investment style must have evolved over time. Could you talk us through that journey?
A: In four or five areas… I would say, the journey has evolved. One, typically my buy quality and efficiency relatively was better. It was my sell efficiency which was somewhat inferior compare to my buy efficiency.
Q: This is in early days of your career?
A: Early on, I would say that weakness persisted throughout. But relatively, I would say the mistakes committed in picking the right things were much fewer. The mistakes made in selling at an appropriate time or disengaging at the right point of time, I think that is something that has been required to be more significant at my end.
Secondly, I think the value of intangibles you realise in your investment journey over a period of time… So you start putting too much premium on the tangibles or the numbers and the data, but you realize that more than the tangibles it is the intangibles which make for a great long term investing. Therefore, qualitative filters to my mind are the first ones to filter out the universe rather than the quantitative parts. Because qualitative ones allow you to filter away much larger amount of the universe in one go, maybe 90% and more can be simply eliminated on management quality filter. So you don’t really waste time on looking at the numbers of very vast majority of the universe.
Third, I would say my valuation capability evolved over a period of time. That is one area where certainly I would say the ability to judge the valuation, understand it well, define it in a more crunchable way and to kind of test that valuation understanding from ‘what if’ kind of scenarios… that is something definitely has evolved materially over a period of time.
Fourth, I think more than the intellect the role of wisdom you realise is much higher. More than just the grey cells it is discipline and the temperament which is far more critical. And I think as you go ahead, make mistakes, tumble, fumble, you probably get on the right path. So I think, with innumerable number of errors and mistakes made, finally the value of the discipline, value of the wisdom over just the cutting kind of sedating intellect and the value of sort of say temperament, not to get flummoxed or carried away by the market fads and fashions, and without being arrogant yet at the same time remaining kind of flexible, it is a very difficult combination to be working at. There is only a thin line between arrogance and conviction and over a period of time you learn to kind of get a right balance of the two.
Q: So there is a lot of wisdom packed into those four bullet points. Let me try to see if we can delve into each of those in little bit. Just to start with sell discipline, you said that you were sell discipline, sell efficiency improved over time. Can you sort of spot what are the couples of things or two or three things that helped you to improve sell discipline over time?
A: Most important one is being a very strong valuation model. Once you have a good valuation model you can query the price from a variety of point of view. One way to look at it is, if the price is right what does it imply and whether that tallies with your mental picture of what that business looks like. I mean when we look at will be that if the price is right what is the implied growth, at what kind of capital efficiency, for what length of time for these valuations to make sense to and to that extent you have a more objective and more efficient way to look at that, rather than something which has worked for you for a very long period of time, usually you tend to develop a favorable bias and the blind spots are many and you tend to disregard them. Or even if you recognize intellectually, I think the other side of the brain or heart, kind of prevents you from recognising.
So, I think when you have a good valuation model which you work on it properly and most importantly that you listen to it, then you that you start developing much better way of doing. This is not to say that still some of the old weaknesses don’t come to haunt me. They still time to time do, but by and large I think it is much more solid than before.
Q: So if a bright young analyst comes to you and says, ‘look sir here’s my world class valuation model’, to your mind what are the two or three things you look for to say these are at least three minimum characteristics that a good valuation model should have?
A: First and foremost it must include the character of businesses as part of the valuation model. The English, must finally subsume into the mathematics. So, the English will tell you about how good the business is and what is the character, what makes it invincible, or what makes it fail, what can be weak spots and the strong points. All that understanding that English eventually must translate into a tangible numbers in the form of the understanding of the size of the opportunity feeding into the rate of growth.
It’s sustainability with the kind of quality and character with which that growth will occur. Whether the growth will be pre-dated or anti-dated, growth will be even or volatile, it will be growing faster in the initial phase or later etc. All this is ultimately the mathematical part that you need to answer by having gone through the English of investing or the grammar of investing. So, it begins with the art of investing and it must kind of subsume itself into finally the science of the mathematics of that.
Second, however hard it is to gaze into the future and given the fact that the shelf life of businesses and ideas is getting crunched and crunched more and more given the way the world has become very fast-paced changing kind of a world, but still there is no alternative but gaze into the future. The investing is substantially into the future. Past and the present are based on minor guide and not really a very materially part of the totality.
So gazing into the future, there are no tangible answers when you do that so your own convictions, your experience, your insights, the quality of the good work that you have done all that will give you confidence whether your model is right and even if markets are making it look like other way round -- not to surrender your confidence so long as you believe what you are doing is right.
So, ability to gazing to the future well and with confidence with élan is a must. Third, I would say some of the traditional measures of valuation are so pathetic, price earning multiple is so popular but it is such a misleading way to value a business but it remains eminently popular and it is actually misleading and to that extent because that measurement which is simple to understand and easy to compare doesn't make it a good and efficient one and therefore bad habits of using faulty models of this kind serious investment and people have to give up. And really even if it is harder there is no option but to kind of look into the right one.
Q: The areas of valuation where people like me struggle with most is lending stocks banks, non-banking financial companies (NBFCs). For one, there is no concept of free cash flow for lenders. Secondly these are immensely cyclical businesses cyclical businesses, both in terms of top line and in terms of bottom line because non-performing assets (NPAs) tend to fluctuate through the business cycle and yet lenders form 35 - 40 percent of the market cap of the stock market. So one can't really build a portfolio without having some representation from this constituency. How have you tackled the valuation challenge with respect to lenders?
A: The traditional way to value which is price to book is a false one. Unfortunately, that is the one which is used more often by everybody and to that extent results are completely disparate ones. You got finance businesses at half price the book, 1, 2, 5, 7.5 and 15. You have got the whole range. So that can't really be the answer.
Once again the sustainability part in the valuation which price to book, or price to earning multiple can never capture needs to be brought in. So, really speaking the way to look at the finance business is to convert the price really paid on that book into a kind of a yield for you at a point zero when you start. If a business is making save 20 percent return on equity (RoE) and the price to book is say two times, effectively what you are starting on that business is with a 10 percent yield.
That gives you the starting point to understand how you carry out your valuation model. Then you bring in the element of capital efficiency, you bring in the element of the likely growth rate based on your judgment of size of opportunity, based on their lending capability, and the practices and their approach. What kind of credit losses you think that could arise and the period of time for which you think the kind of growth rate you believe could exist given the size of opportunity and the capability of management.
The final part you need to bring in to account is the payout ratios. In the finance businesses typically the payout are meaningfully small actually and given the fact that raw material is money so they don't give out too much, but you do still have firms where the payout ratios are meaningfully higher than what you traditionally see. Therefore, that element is also to be incorporated into the account. Once you do that then you have a much better way to kind of create a right kind of a model.
To start with that example of 10 percent yield in a 20 percent RoE where there is a two-time price to book once you bring in growth rate then what is that 10 percent yield to begin with let's say with a 20 percent growth may become 12 percent in the year one, and then let's say 14.4 percent and likewise and you can plot a series of annuities to kind of work your way through that.
Also in a conceptual way to look at it is because there is no concept of return on capital employed (RoCE) in a financial space. But there is a ROE, which subsumes within itself everything that is there to be checked really. And that RoE conceptually can be converted into RoCE the way you do it in a manufacturing business. There is a conceptual part to evolve it like that. Once you have a return on capital employee established and you can then really follow a similar valuation model like you would do for a manufacturing firm you can also evolve your valuation for the finance businesses.
So, those two parts really give you good answers in terms of figuring out in a more tangible way the valuation of the finance businesses. Some of the finance businesses, if you observe, despite their remarkable consistent strong growth rate over a period of time, they have not diluted their capital even for decades. Therefore, in some sense they become like consumer firms. Since they don't dilute their capital, really speaking in a similar way to price earning multiple that you would do for an FMCG company, but not price earning multiple the valuation model properly as a DCF similar approach you can adopt for those firms to create a kind of valuation model.
Therefore a firm like Gruh Finance, for example which always looks very expensive it has remained probably amongst the most expensive ones for a very long time compared to its much larger brethren and sisters all around. Consistently, I found that Gruh has remained actually reasonably priced once you bring in all the right elements into the valuation.
Q: Effectively bringing in capital efficiency or ROE.
A: Absolutely.
Q: And you are bringing in growth.
A: And sustainability.
Q: Let me just try to contextualize your career a little bit. So, the one investor on whom tons of books have been written is Warren Buffett and if we look at Buffett's career when he began he was true Ben Graham disciple, deep value investing, cigar butt investing and so on. And as he moved to the 60s and 70s American stock markets evolved, became more richly valued he became more of a growth investor although I am sure he will never clearly admit he became more of a Phil Fisher-style of investor. Stocks like Coke, Microsoft, more recently Apple, entered his portfolio in large measure. Your career obviously is not as long as Buffett’s but you have lived in India through a very similar period where we have moved from being very poor country in the 80s with a underdeveloped stock market to now a $3 trillion stock market with the large caps space having almost 100 large cap mutual funds. Would you say your career, your investment philosophy has also evolved from value investing towards more a growth investing style and so on?
A: Yes, without any doubt I would say that. The journey as I alluded earlier, the journey from tangible to intangibles is really the journey of investing. Tangibles are easy to recognize, easy to feel and touch. But it is the intangible which you kind of ruminate over for a long period of time till they become a part of your culture, part of your investment character. Those intangibles don't merely confine to the ideas like management qualities and the capital efficiency and the sustainability and such rather than pure cigar butt kind of cheapness which Graham came to it.
Clearly, Grahams investing came about at a time when cheapness was the most dominant idea. His investing came about at the time of Great Depression and therefore everything in a market which failed almost 90 percent from the peak in that four year horrendous journey of the great depression everything had become cheap and therefore cigar butt kind of investing got shape because of the value in which Graham considers investing
Clearly the idea of sustainability and the idea of cigar butt are kind of in some sense poles apart and that sustainability brings in the capability to look into the future, bring it to the present and how confident you are about its sustainable future. So, it is those ideas plus I think the intangibles in terms of recognizing our own fallibility, markets fallibility also at a point of time, the role of wisdom and discipline and temperament rather than arrogance which comes from the intellect. All these are critical insights and learning’s that you develop over a period of time.
But at least I would say in a period where I really didn't have people to turn to get learning from you had to learn it by reading and making mistakes. So I have had a fair share of both. So, there was a good recorded history of the Wall Street to read and of course abundant amount of my own mistakes to rely upon and draw inferences.
Q: So whilst most people out there heard about Buffet, many people have read plenty about Buffet, Phil Fisher as an investor is less known in India? Clearly he has had an influence on your thinking about quality and how to access quality could you sort of take us through a little bit as to how basis Phil Fisher sort of inspiration how you have tried to get hand around this whole concept, nebulous concept of quality.
A: Well first and foremost quality is vital because that is an antidote to permanent loss of capital. The least that you will achieve by focusing on quality is that probably you will not lose your money and this is something that doesn't come easily to people. Like Taleb was mentioning probably the craft of investing you learn in 5 to 10 years by and large the techniques and mechanics of it but probably you will take 25 years to learn how not to lose money that you actually made.
Unfortunately lot of time because as a country we are emerging from the shadows of poverty and the kind of destitution that we have had for a long period of time to bigger and more successful country. So, there is a rush and there is a hurry to get appreciation is the prime factor. But I think preservation comes first. Appreciation is almost important, but I would say preservation is firmly 50.1 and appreciation is 49.9 it is that little extra which is critical.
Second quality is not as nebulous as it appears. Management quality is not as nebulous an idea as it appears primarily speaking. Good managements as well as the bad ones they leave their tell tale signs. Over a period of time only we need to have patience and desire to study. More importantly not forget those lessons that flirting with bad management is fundamentally a poor thing and can actually be value destructive. Time to time we tend to forget this lesson and therefore we flirt and therefore we think we have evolved enough to be able to get away with it but you can't get away from that.
Bad management has a way of ensnaring you, getting them into your fold and eventually destroying you. It is a poisonous embrace and it’s very difficult to get out of that poisonous lock that you get into when you sleep with the bad management. So when you study the management what they have done, what they have seen what they have actually left their imprint in terms of the kind of deeds they did.
Q: Their track record?
A: The track record invariably gives away everything that is there to be given away. We need to just have patience and desire to go through that carefully and apply it as a practical principle to be adapted.
As I said Just by putting management quality more than 90 percent of the universe drops away. You don't have to waste your time and energy in trying to figure out those businesses. You don't have to waste time and energy into trying to unravel their balance sheet and all of that is there. You save yourselves lot of time because investing is not about exclusion rather than inclusion. Inclusion is a politically very expedient idea. The world of investment is not about democracy it is about exclusion first and then only picking and choosing out of what is left behind.
Third, quality of business for example again is not as nebulous, RoCE and sustained one over a period of time is a great indicator of how and in what way the quality of business is really shaped and is likely to be there. A good well-judged RoCE in fact rises above the constraints of any sector or any other milieu. It allows a comparison across different kind of businesses in a very efficient way.
Similarly RoE in some sense like Phil Fisher has said is a holy grail of good management. So, there are the quality part, the quality of management, the quality of the business, the quality of the financial position, which often emanates from the first two but not necessarily so. Even a quality honest management when it misallocates capital there is an impact on the financial position and it lingers on for a very long period of time than what they would like to shrug get away with.
So, its sounds intangible but there are enough concrete tangible ways to judge it. Management quality also if really we have to crunch it into more tangible idea integrity, execution, governance, vision, capital allocation, capital distribution, these are several buckets which if you analyze each bucket then you really get an idea. That it’s not only about integrity but also competence, it’s not only about vision but a good execution and it is not only about sound capital allocation to good businesses is within the fold of the business but also sound capital distribution. All of these once you put a template around each one of them then there is a way of making a crunchable data around.
Q: So as an industry Financial Services, Asset Management industry have come a full circle. From the late 80s when the industry was small, career opportunities were few, to now say USD 150 billion of equity assets under management, and we have reached a juncture where many thousands of bright young talented boys and girls want to enter the industry and they want to emulate people like you. What advice would you give to an aspiring fund manager in our country?
A: No advice, but I would really say that the young people are lucky if they are entering into or have entered into the world of investing in India of today as an economy we have evolved, as markets we have evolved. Now there is some level of history about Indian markets. There is a reasonable literature about investment practices that has evolved in the country and of course there is three centuries of global history of investing before the potential investment aspirants in this country.
But in a country which is getting to be prosperous and getting to be successful like India is today and where the practices and craft is being reasonably well embellished it is much much easier to step into those kind of situations and really build your career because you have antecedents and you can look forward.
Q: The foundations are even laid.
A: The foundation is available. Secondly, there is advice also available to look forward to which is something I sorely missed in my time. So all the mistakes were yours. It's the very lonely work. Investing is a work where success rarely gets acknowledged but the failures are always reminded on a day to day basis and all of that you have to leave by yourself. You really have nobody to turn to.
So, in some sense it is very lonely, demanding kind of a work. Somebody whom you can trust into, somebody whom you believe into. Somebody who can give you a genuine shoulder to kind of lean on to learn and take an advice really that is something I shortly missed in my investing career by and large.
Today young people can look forward to at least that support at a critical juncture of their career and of their life. They don't need it on day-to-day basis, but there can be moments where you do everything right but you can be made to look like a fool and also equally when you do it foolish things and markets may make you look like a genius for short period of time. But in those tentative movements, where your confidence is low, where you start questioning your own personal capability or the externality around you, some hand holding and some right advice at that stage takes you and helps you in overcoming those very important moments of life. Otherwise that can make a difference between kind of sinking or sailing through.
I would say, the most important one for them is that they have an opportunity to practice this over a very long period of time. For somebody like me I had to begin in late twenties into the investing. Though I began in my adulthood into investing on my own but in late 20s I got into the professional work and then soon thereafter after I got into the professional investing. And then you spend some years in repairing your mistakes and refining your craft and getting your understanding to be in place while discharging responsibility in a proper way. So considerable time goes away before you really begin the crescendo.
Q: For youngsters the years of learning can be crunched into.
A: Can be compressed and they can get into the high note relatively early enough. And therefore to look forward to that sheer power of compounding for a much much longer period time.
Saurabh: Thank you very much Bharat, thank you for the words of wisdom. So that's it from us, that's it from Bharat Shah, Executive Director of ASK, one of the handful of people I know in India who worked in the stock market for the best part of thirty years. Thank You.
Saurabh Mukherjea is the Founder of Marcellus Investment Managers and author of best sellers 'Gurus of Chaos' and 'Unusual Billionaires'.
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