In a special series Wizards of Dalal Street - A Fresh Breeze, Ramesh Damani caught up with Jatin Khemani, Founder & MD of Stalwart Investment Advisors.
Below is the verbatim transcript of Jatin Khemani's interview to Ramesh Damani on CNBC-TV18.
Q: You write on your website that you don’t analyse stocks, you analyse businesses, what is the difference?
A: You analyse stocks when you are trading and you analyse businesses when you want to invest and you want to invest in them for long-term. So the ticker only tells you what price it is but what value it is is only after you understand what the business does, who runs it, what is the strategy, what it can be 5-10 years out. For that, all the analysis has to fall in place.
Q: Buffet put it well, he said price is what you pay but value is what you get. Let us move ahead and say, you have studied businesses, you studied the paint industry, you studied the footwear industry, many industries, are there any characteristics that you find that winning businesses have in common?
A: I think from an India standpoint today, a framework which has worked well for us is something I call Consolidation Wave. So these are industries which are large in size and you would find few organised players but a lot of unorganised players. Almost 60-70-80 percent of lot of industries is dominated by unorganised players who get away without paying taxes and organised counterparts do not have a level playing field. So you look back and look at companies like Asian Paints, Relaxo Footwears, Page Industries, these companies have expanded and grown their topline at 20-30 percent, some even 40 percent like Page Industries for a fairly long period of time. The industry has grown at 10-12 percent. The underlying principle, which was shaping up, was they were winning market share from their weaker counterparts.
Q: One of the techniques that you use to figure out, which companies to invest is called Scuttlebutt, what is Scuttlebutt and how exactly do you do it?
A: Scuttlebutt is getting information from the ground before they are reflected in numbers. Once it is in the numbers, it is for everybody to see. We don’t have any advantage. But if you are connected to the ground, if you are connected to what is happening to businesses, I think we have some edge. All this we write, there could be sampling error, first conclusion bias but in our experience the benefits of far outweighed those small misses here and there.
Q: Another way is called Kicking the Tyres, give me the example of how you use Scuttlebutt in one of your picks?
A: Relaxo Footwear back in 2012 -- if you had looked at profit and loss (P&L), it was pretty average P&L in terms of margins but the company was doing a lot on the ground through advertisements endorsing the best of Bollywood, hiring Accenture as consultant, increasing distribution.
Q: Katrina Kaif is brand ambassador.
A: Yes, Katrina Kaif, Salman Khan, Akshay Kumar -- so they were trying to do a lot of unconventional things, which didn’t happen in footwear earlier and the P&L was being -- we were suffering in the near-term for the longevity of the business. So if you were basing decisions on P&L, we might not like that business.
Q: Don't invest in the stock, invest in the business. That played out well.
A: Absolutely. The execution was being seen on the ground but the numbers were yet to come.
Q: The layman looks at the market, he often looks at tips, inside information, wanting to make a quick buck, fairly hazardous way to delve into the stock market, isn’t it?
A: There are two ways to participate in markets. One -- trade, follow tips and get poor quickly or invest in great businesses and get rich slowly. That is the time tested way and we see a lot of millionaires and billionaires who have created a lot of wealth like that but not the former.
Q: That is a great point you make, you said you can get poor quickly or rich slowly, the choice is yours.
A: Absolutely and unfortunately we spend a lot of time buying cell phones but not even few hours before buying a stock because there is a tip and this is the stock, which will make us rich, so we just invest Rs 5 lakhs in that stock and don’t even think.
Q: That is something that is human nature, to believe in a tip or to believe in what some superior being tells you but spending lot of amount of time in searching a washing machine or a cell phone as you said. You read a book called 'Retire Rich', which changed your life?
A: I always had decent understanding of businesses because my dad worked at a manufacturing site. I had been to the factory since childhood and being a commerce student, I understood how businesses operate. But I did not have a very good perception about markets because my dad tried his hands trading and like most, lost money. When your dad tells you that market is not where an individual investor has an edge, it affects your mindset. That completely changed in my MBA.
Q: Who changed that?
A: S. G. Raja Sekharan. He was a visiting faculty and my mentor in MBA. He was a very senior IT professional, left his job when he became financially independent and started following his passion of teaching and stocks contributed to that, investing in great businesses contributed to that. He invested in businesses like Asian Paints, HDFC Bank, Pidilite, way early and held on to them and that made all the difference.
Q: Buying not stocks but great businesses and holding them, businesses mature over decade sometime.
A: So that was the turning point and that was the first time I was looking at stock markets very differently. I was not looking at them as tickers but as businesses behind them and then he made me read Warren Buffet, Peter Lynch and Philip Fisher and that I believe was the turning point in my life.
Q: When you go to New York, they always say to you that you are taking a bite out of the big apple; you took a big gulp of a company called Tasty Bite. Tell me how your education, practical experience, philosophy came together in that stock pick?
A: We came across this company because we were studying the packaged food and we understood that in India it is very difficult to do that. We are still too early for that kind of a product.
Q: We are not mistaken ConAgra Foods said that India is not going to 'ready-to-eat' market because lots of fresh food available almost in every mohalla in Bombay.
A: Yes, so when we came across this company Tasty Bite eatables, the only differentiating point was that this was not selling to Indians. So it was making Indian food but exporting to US and not selling to NRIs but selling mostly to Americans, millionaires who wanted to try different cuisines.
Q: Creating a new niche almost.
A: Absolutely. We found an owner operated business, creating a niche out of nowhere following a blue ocean strategy with lot of skin in the game and it was still only Rs 150 crore topline and we saw huge size of the market opportunity and that is when we thought it could be a great opportunity.
Q: They were riding a wave, weren’t your millionaires wanted to try new food, organic food, healthy food, was that example of great management, showing fire in the belly?
A: Absolutely, so these are guys earlier working for HUL and Pepsi and they left their jobs and bought this company from HUL and from nowhere, Rs 4 crore turnover, they took it to this level. So when I met them, I could see that they are not just working for money, they are passionate about what they are doing and there was enough skin in the game visible.
Q: You talked about better earnings kicking in through operating leverage. I have often heard that, for my viewers, explain to me how operating leverage works and why it is important when you look at a stock?
A: It is a very important concept as investors, as analysts we should look at because when we think about earnings growing by default, we assume expenses will also grow but that is not always the case. There are some businesses where bulk of the cost is fixed and as their sales grow, most of it falls down to their bottomline. A beautiful example of that could be another company in which we have invested called Wonderla Holidays. Again it is not a recommendation, this is just for illustration purposes.
Q: How does operating leverage kick in to Wonderla -- first what does Wonderla do?
A: This company is the largest amusement park operator in our country. They operate three parks based out of Kochi, Bangalore and recently opened one in Hyderabad. So let us talk about the first two parks. These two parks on an average daily entertain 3,300 guests but they have a capacity to handle 12,000 guests.
Q: So as they come in, they start flowing straight to the bottomline?
A: Your cost does not grow in proportion to your topline. So your bottomline grows disproportionately.
Q: You have often talked about management having fire in their belly, what do you mean by that? Is it just a colourful expression or is it something that you can gauge in managements?
A: There are two parts to it. One we always -- whenever we like or study a business, we try to go behind and spend a lot of time on the management. Is it an owner-operated business or is it professionally run. We generally find owner-operated businesses have more skin in the game and especially if it is first generation entrepreneur, that is something that excites me because he started from scratch, growing it, it is his baby, chances are high that he is passionate about it. We can go wrong also but the probability is high that he is passionate about that.
Incentives are aligned and there were other ways to look for it -- skin in the game, what kind of promoter holding he has, is he drawing a lot of salaries before sharing the rewards with minority, are there entities in similar business outside the listed entity. So this is something you need to focus a lot on, related party transactions. That tells us about the skin in the game.
Q: When you run Stalwart, people come to you for advise, is there a lot of pressure for you because you are still fairly young, your nascent in your career, is there pressure for you?
A: So far it hasn’t been because we have tried to attract likeminded investors. We have been very vocal about our philosophy -- we have put a lot of information on website.
Q: You are pretty transparent, your website says a lot?
A: We have tried to be very vocal about what we are trying to do. We are not selling 'get rich quick' dreams. We are saying 'retire rich'. So it will take time, it will be a long-term thing but the probability will be higher that something beautiful could come out of it.
We are looking for great businesses and we are a partner of those managements. We are not looking for quick bucks.