NAFA’s Balaji on why promoter selling is worrying, importance of tail in portfolio

Promoter selling can be for a host of reasons, not always because valuations have become expensive

Promoter selling is at a six-year high, with shares worth Rs 87,000 crore having been offloaded in 2023 so far, according to a Kotak Institutional Equities report. The market has taken it in its stride and many of the stocks have been rising even after the stake sales, leading to a general perception that outlook on business growth matters more than anything else.

Balaji Vaidyanath, director and CEO of NAFA Asset Managers, sees it differently.

“Promoter buying is any day a more powerful indicator than promoter selling,” says Balaji, who was an analyst at Sundaram Mutual Fund between 2004 and 2010 and then a fund manager of one of its PMS schemes till 2015 before leaving to co-found NAFA. Balaji oversees around Rs 300 crore of equity assets at NAFA. In a freewheeling conversation with Moneycontrol, Balaji spoke about his strategy, observations, learnings and how his investment philosophy has evolved over time.

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“Promoter selling can be for a host of reasons, not always because valuations have become expensive. But in the current context, the price earnings multiples have expanded like crazy in many sectors.

“For instance, look at the valuation of a Nykaa compared to an international brand like Estee Lauder or Louis Vitton which are available at 30-35 times earnings, or that of a Metro Brands against Columbia Sportswear or Crocs available at 15-17 times, the difference is stark. One can always argue that the growth in India will be higher, but even after factoring a growth premium, the differential is simply too wide,” he said.

According to Balaji, investors who get in at high valuations in any sector run the risk of lower returns when there is a valuation de-rating, meaning the market does not value the companies as highly as it did in the past.

Signs of de-rating

Balaji says that there is ample of evidence of stocks getting derated without drawing too much attention. He cites the case of Eicher Motors which at one point use to quote at 50-60 PE multiple and is now quoting at half of that. Another example is HDFC Bank which used to be once available at 4.5-5 times book value and is now available at 2.5 times book value. Maruti was once 40-50 PE, it is now 30 PE. “Slowly we are seeing multiples contract. Many other businesses could suffer the same fate. It could be through a time correction, price action or combination of both,” he said.

Strategy

Balaji looks for sectors in which there is a major shift in consumer preference, leading to market share gains for some players. It is happening in automobiles where the first four-wheeler purchase is many cases now a mini-SUV or even SUV, unlike in the past when it used to be hatchbacks. In the plumbing pipes segment, the preference has shifted to PVC and CPVC pipes, away from galvanised iron and copper pipes in the past.

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In the home improvement segment, customer acceptance for lighter and sleeker furniture is on the rise, leading to market share for companies specialising medium density fibreboard (MDF), away from plywood. In the dairy segment, many households are now buying milk byproducts like curds, ghee, paneer unlike in the past when it used to be homemade.

Are midcaps and smallcaps overvalued?

“We look at the share of Sensex 30 companies market cap as a share of the overall market cap. Over the last 20 years, the average has been between 40-50 percent. When the share of Sensex 30 companies is 60 percent we take it as a sign that mid and small caps are undervalued vis-à-vis large caps. When the ratio is 40 percent, it means mid and small caps are undervalued. Right now we are at 40 percent, compared to 50 percent two years back. Not saying this ratio is foolproof, because ratios often work till they don’t. But if we have to respect the historical pattern, large caps are set to do better over the next 18-24 months", he said.

Second order plays

Balaji looks for second order plays in sectors that are overvalued, or tries to play popular themes with uncertain outcomes though ancillary companies.

“The Quick Service Restaurant (QSR) sector is valued at over Rs 1.5 lakh crore while the profit pool is just Rs 600 crore. Mrs Bector Foods supplies to many of these QSRs. We got an attractive entry point when raw material prices soared following the Ukraine war and hit the company’s profits severely,” he said.

“Tourism may be booming, but aviation may not be the best play, it could well be the luggage makers. In the renewables sector, we don’t know who the final winner is going to be because there are so many players involved. But for us Linde is a good proxy play because whether it is a solar player, hydrogen player or semiconductor firm, they will all need different kinds of industrial gas. And Linde is able to supply all of that."

Long tail

“In the early part of my career, I would try to deliver superior returns through concentrated bets, but I have now come to the view that diversification works as well. Look at the returns of the small cap indices—16-17-18 percent—despite having so many stocks,” Balaji said.

“People look at my portfolio and say stocks 1, 2 and 3 are your top picks because they have the biggest weightage. But it's not necessarily like that. For me, my tail of the portfolio plays an equally important role as the head of the portfolio. It is something like the Ganga originating in the Himalayas." he said.

"For me, the future winners begin life at the tail of the portfolio. Because when you like an idea, you don’t go and buy the entire quantity on day One. We wait till we see signs that the management can deliver on what they promise. Even if we may not be willing to pay a high price initially, we may do that once once we are convinced and keep adding to the positions."

When we started off with Greenpanel, it was a tail weight because MDF (medium density fibreboard) was an unknown thing, but it had come on our radar. We spoke to many carpenters, architects and designers across various cities who gave a lot of pros and cons about MDF. As we did more research and got interested, we met up the management and were convinced about the prospects, and so built a decent-sized position in the company,” Balaji said.

Average holding period

Typically, it has been about 5-6 years, Balaji said. “Five years means a good 20-24 quarters for the management to perform and deliver it for you. But there have been instances when we've been holding stocks for much longer when the growth outlook continues to remain strong,” he said.