DAILY VOICE | Rakshit Ranjan of Marcellus has 3 simple rules for picking winning stocks

When we look forward to the next year we expect our portfolio companies to benefit significantly from the aftermath of the ongoing pandemic, since in the wake of every such crisis market share gains become easier for the best quality corporates.

Hence, over the next 2 to 3 years we expect the earnings CAGR of our overall portfolio to be 18-20% or higher.

Q) The year 2020 was a tough year for investors and more so for the fund managers. But, despite the pessimism and volatile, Consistent compounders outperformed. What has been your core strategy in combating volatility?

A) I think the last 5 years have been pretty disruptive for the fundamentals of the broader market because when you look at FY15 to FY20 earnings growth of Nifty50 as an index, it's been almost zero percent.

And FY21 has been another year of weak fundamentals for the broader market. Having said that our portfolio companies over the last 5 years have delivered around 20 percent CAGR in their earnings with very low volatility.

And, similar healthy momentum in our portfolio companies’ fundamentals has continued since June/July 2020.

This resilience in fundamentals of our portfolio companies during a disruptive external environment is due to their ability to benefit from an external crisis by accelerating market share gains. For instance we have a large exposure to the paints sector in our portfolio.

Once COVID-19 struck it was clear that since people will hesitate to call labour workforce into their homes for painting projects in light of the pandemic, the paint industry will see a decline in demand this year compared to last year.

However once the lockdown was lifted, from the month of June itself hey Asian Paints and Berger started reporting year-on-year growth in volume as well as revenues and over the last few months, their growth rates have been in healthy double digits.

This is not because the overall paint industry is growing. Instead, it is a result of market share gains primarily from unorganised players and also from some of the organised competitors.

Q) What were your key learnings from the year 2020 which you would like to share with investors?

A) There are two key learnings. The first and the biggest learning that we would like to highlight is the resilience of high-quality companies’ fundamentals in an increasingly disruptive world.

Because of this not only do high-quality portfolios deliver a healthy return they also minimize the risk of drawdowns and capital erosion during such a crisis.

The second important learning from 2020 is that it is very difficult to time entry exits particularly in high-quality stocks based on your view around a macro event’s impact on the broader economy.

Q) What is the core philosophy of Consistent Compounders strategy while picking stocks?

A) We have three parts to our philosophy – 1) Clean accounts – where our proprietary forensic accounting model filters out corporates with dodgy accounting practices; 2) a decade or longer historical track record of consistent and healthy fundamentals – this helps reduce speculation in our stock picking where we don’t want to expect consistent compounding in the future if its history has not been equally good.

Also, we believe that analysing a long and successful history is the best way to understand about various aspects of the firm like capital allocation discipline, succession planning, quality of the board of directors and hence incremental deepening of moats on an ongoing basis; and 3) Bottom-up research to understand the depth and sustainability of competitive advantages of a firm, where our team of 12 research analysts spend several months doing primary and secondary research on the last couple of decades of the firm’s evolution, to understand why the firm has delivered a great historical track record and why its strengths are not easy to get competed away.

The primary data research includes collecting hundreds of data points by talking to ex-employees, distribution channel partners, competitors, suppliers and third-party consultants in the industry.

Q) When did you feel in love with equities and stock markets? Who has been your biggest inspiration in life?

A) It was completely accidental. When I first started working with my colleagues Saurabh and Pramod in 2005 on UK equities, I liked the analytical part of the role and within a few months, started enjoying stock analysis.

But it was only in 2014 and 2015 when I was working on the Coffee Can Philosophy in my previous avatar, that I realised the power of consistent compounding through a select few stocks.

The biggest inspiration in life – I won’t say it is only one person. Instead, I have been inspired by several people equally – from my parents from whom I learned the importance of discipline, to my colleagues at Marcellus with whom I have worked for the last 16 years and have learned a lot about independent thinking, and also newsletters written by several fund managers globally about the merits of their investment philosophies.

A) Equity investing can be very complex because here are several variables at play – external events like macroeconomic variables, competition, disruptions, FII/DII flows; or company-specific events like valuations, change in management, capital allocation decisions; or personal factors such as the investor’s purchase price (and hence unrealised gains or losses currently), capital gains tax liability, risk appetite, financial goals and hence expected returns, etc.

Clarity of thought in equities investing is perhaps the most critical factor that can help investors meet their investment objectives.

Just like humans have developed several mathematical and scientific tools to improve our ability to understand the world around us, investors need to follow the same approach in equity investing.

Decisions based on myths or one’s personal beliefs expose an investor to more luck than skill. Instead, a rigorous hunt for mathematical and scientific tools helps reduce the contribution of luck and enhances the probability of success in equity investing.

For instance, mathematical logic can help an investor understand the importance of P/E multiples in the equation of investing, the importance of capital reinvestment of a business rather than just ROCE, the futility of profit booking, purchase price averaging, capital gains tax-related decisions, or excitement around bonus shares, etc.

Then there are scientific tools or frameworks which can help understand the competitive advantages of a firm, the risk of disruptions, absolute valuations of stocks, and the importance of a disciplined but evolving investment philosophy.

Lack of deep understanding of these tools makes the approach more ‘artistic’ than ‘scientific’ or ‘mathematical’. And this is where the vast majority of investors live life at the mercy of Lady Luck.

Q) What is your outlook for the year 2021?

A) From a macro-economic perspective, to begin with, whenever there is a crisis that leads to a reduction in US Govt bond yields and a fall in crude oil prices, the combination of cheap oil and cheap money becomes a massive tailwind for India in the 3-4 years after such a crisis.

From a micro-economic perspective, great companies find it easier to gain market shares during a crisis, rather than during widespread euphoria.

Hence, when you combine the macro and the micro together, we expect high-quality companies to deliver strong fundamentals over the next 3-4 years which should lead to healthy share price performance for these high-quality companies.

Hence, we remain very convinced about the prospects of Consistent Compounders from an investment standpoint.

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