Correction in ongoing bull market underway: Raamdeo Agrawal

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Outlining the basis behind this year’s study, Agrawal said companies that it is a well-know fact that firms that generate a lot of wealth typically trade at expensive valuations in the stock market.

But such companies were also in the birth stage at some point, he said. “The study looks into trying to identify pointers that could help investors get into such companies at an early stage.”

Elucidating on the simple point of investing in high-growth firms early and staying in for the long run, Agrawal, one of the country’s most well-known value investors, pointed out that over the past 25 years, ITC had grown 2500 times in market-capitalisation terms.

“Hero Honda was Rs 22 crore market-cap when I started my career 25 years ago, now it is more like Rs 42,000 crore,” he said. “The idea behind our study is: if you can catch them young, you can buy a lot and you have the comfort of low purchase price.”

The ideal way of creating wealth in stocks, he added, was building a portfolio of promising emerging stocks and classic bluechips.

Here is the verbatim transcript of the interview.

Q: The last four-five days have been slightly cautious for the markets, is this just a correction in an ongoing bull market or are you getting a sense that we have topped out for now?

A: My sense is this is a classic correction. The built-up to the mini-election of December 8 and the results, which turned out to be far better and far more dramatic gave it a positive wave.

But clearly a lot of people had built lot of profits so my sense is that this is more of a correction from that and now we have some [negative] news both global and local in nature.

So it will cool off for sometime and then again run up to the next election move. I think things will really perk up. I think if you look at 12-18 months out into the future, things look good, things look healthy for investing.

Q: What would you advise traders to sell even now because you see a significant downside -- a positional sell?

A: I cannot advise anything to traders because I really don’t know the game of trading so you are asking the wrong person about trading.

Q: It is your 18th annual wealth creation study that you will be talking about today. Since you do believe that this will be just a correction in an ongoing bull market what would be the next wealth creators from hereon?

A: This is 18th part of this study. Every year, we try to learn something about the entire process of wealth creation. The study is titled ‘Uncommon Profits: Emergence and Endurance’.

Why we need to look at uncommon/abnormal profits in companies is that whatever company makes, that is what the people at the end of it make in the stock market.

So if the companies make abnormal profits, the return from the stock market is also about matching or maybe more than that. So what is important is to figure out the companies, which are going to make lot of money and what those conditions are.

We have some conclusions and one of the very important thing is that the companies which make lot of money are actually expensive, say ITC, Nestle, Hindustan Unilever (HUL) and all these companies, we know that they have made lot of money in the past and they will make lot more money in the future, but they are typically very expensive to buy, but these kind of companies also take birth in the marketplace and that is what emergence is all about.

They are far and few, maybe one or two in a year, or maybe many times even for three-four years none of those kind of companies come, but there is always an HDFC Bank coming out, HDFC Limited coming out or Gujarat Ambuja Cement coming out.

The moment these companies shoot, the valuation is small, the market cap is small and that is a time you can buy in tonnes and if you hold them for 15-20 years the amount of money which will be made is just staggering.

In the last 25 years, which are the companies which have made largest amount of money? ITC was just about Rs 117 crore company in 1988 when I started my career and in next 25 years they have made upwards of 2500 times only in market cap not counting dividends.

Second biggest is Hero Honda. At that point of time, it was available for about Rs 22 crore, today market cap is more like Rs 40,000-42,000 crore, 2,500 times plus dividends. So if you can catch them young, you can buy a lot. You have a comfort of purchase price and you can hold them on for a very long time.

It is not that you can build the portfolio of emerging companies only. You have to balance between the emerging companies and classic bluechips.

The thing to look for when selecting stocks is: whether management misallocating capital, whether it is paying out what is due to investors. So these are the things which are coming out in the report and there are specific recommendations and frameworks to how to think about emerging companies.

If one is lucky and allocates 2-3 percent of the portfolio into them. Just about a crore or two put in ITC maybe in 1998, would have given more than a billion dollar today to the investor. So that is the kind of potential of making money through abnormally profitable companies in the market and that is the theme of the study this time.

Q: If I were to only stick to the Sensex companies do you spot multi-baggers there or are they all richly valued?

A: The blue-chips today are very richly valued but it doesn’t mean they will not create wealth. In fact bulk of the wealth in next 10-15 years will be created by these companies whether it is Tata Consultancy Services (TCS), whether it is Infosys, Hindustan Unilever (HUL), Nestle or ITC, Hero MotoCorp.

These are franchises that are going to beat inflation, they are going to beat the index. If you buy a basket of them and I am quite sure if market does 15 percent as it has done in last 30-40 years, you will make upwards of 18-20 percent or may be even 25 percent in these stocks.

The issue is that do we have the patience to hold these stocks peacefully without bothering about today’s opening price, closing price. You need to bring that unlimited patience for holding these stocks for 14-15 years to get the benefits because for most stocks, the great returns happen in burst of a few months.

So when you try to time the market, you miss out on the benefits of those few months where the bulk of the return is. So buying and holding for long period and having patience to buy the blue-chips is a very simple but difficult trade that would get 20 percent return in the market place.

Q: Even for an investor who holds for the very long term – imagine if you held HUL in the mid 90s till 2005-06, he’d have been in a loss. So do you don't look at prices at all or are there times when even in these wealth creators you have to take profit?

A: HUL hit a high in 2001 and did perform for six years. That doesn’t mean you try to exclude such stocks from the basket of blue-chips you have bought.

I am not saying that you put 100 percent in HUL. Even if you had 10 percent out of your Rs 100 in 2001 and rest were other blue-chips, as a portfolio of 10 companies you would have done fabulously well.

Q: Should an investor think of booking profit at any point in time or should he just not look at the gyrations even month on month gyrations of his stock?

A: If the company is performing well in terms of their quarterly performance, if the business is in good shape and management is behaving in a rational way, they make money. If they have started putting their capital in treasuries or misallocate capital by doing some gigantic loss-making acquisition, in those kind of situations obviously you have to sell.

But otherwise if the enterprise is running well, you are getting your dividends, if the company has run absolutely in a rational way I think there is no need for anybody to book profits because if the future is very big, the company is likely to see much higher highs in days to come.

For example HDFC or HDFC Bank, for last one year it is underperforming, does it mean that one year back we should have sold to buy it back again at some point of time in the future? I don't think that’s possible.

Do I see a brighter future, higher highs for these two companies? I think 10 years hence these companies would have delivered more than 20 percent returns for those who hold it for the next 10 years. So I would want to try to sell and buy back such companies [only on the basis of price gyrations]. But if some company has done complete misallocation of capital, I won’t mind selling it.

To read the previous Wealth Creation Study reports, click here.