Value Investing: Dance without passion is just cultured movement

(Stocks covered: Godrej Agrovet, Laurus Labs, Tata power, Borosil renewables, BEL, BEML, Oberoi Realty, Mahindra Lifespace, Mahindra EPC, Rallis, NH, Max India, HCG)


Passion is growth. Passion is transformation of energy. Once I was travelling in train and a nice fellow who was a classical dancer and dance teacher was travelling with me. He was explaining about dance to other passengers and then he showed us a video of some party where one fellow was dancing full of energy but with unrhythmic steps. Then he explained that there is a natural rhythm in our body but that fellow in the video is dancing badly and then he pointed out another fellow with almost perfect dance steps. But I told him to look at the energy and passion in the dance of first fellow (bad one) while the focus of other perfect fellow was on his steps only as he was looking towards camera and other people all the time. Then dance teacher asked me why focus on passion? “Because dance without passion is just cultured movement,” was my reply. I told him that in Lord Siva’s Tandava extreme passion is the underlying force…it is not the cultured movement…and when Lord Shiva is overwhelmed with passion then even his dance becomes a cosmic event.

And it is strange that I find the implications of passion in each and every sphere of life. Any action without passion is just a cultured movement. Food, sex etc. provide physical contentment and joy but passion is the food for the soul…it is the realm of spirituality. Expression can be in any direction (dance, music, science) because expression itself is the culmination. We do 9 to 6 job but this is not our passion because our focus is not on the “expression” (job) but on the end result-money. Passion is the enjoyment of expression. And strangely when it is about enjoyment of expression then most of the times a passionate businessman (Dr. Devi Shetty) is more spiritual than a religious fellow because most of our religious fellows do not enjoy the journey...the expression but only their expected comforts from religion including ego (the most dangerous thing in this world is the Goodman’s Ego).

When the likes of Dr. Devi shetty (Narayana Healthcare) decides to extend his passion into business then his passion alone is what makes a stock a Value Buy. Value investing for me is finding these passionate businesses because financial data is just the result/demonstration of the actions of these passionate beings. Please note "passion" factor is not just about one man or promoter but includes everything in an organization which makes it capable to create superior products with high entry barriers. Promoter is just one of the factors which create or develop this capability in an organization like technical expertise and superior R&D focus (like Biocon and Laurus Labs), strong brand strength and first mover advantage (like Tata entered in staples via Tata Sampann Brand), Networking effects (like MCX), Superior and vast supply chain etc. Financial metrics do not create a business (and a value buy) but it is the business whose performance creates financial data. So a true value investor does not find value in a stock which is “cheap” on financial metrics but he yearns for “premium-ness” in the business model which can create a great product with strong entry barriers. Passion factor in business implies the ability to create a superior product with scale with high entry barriers. I think in traditional old school value investing there was too much focus on financial metrics like P/BV, PE ratio, FCF, Debt equity ratio, margin of safety and so on and then in the end a small mention of business model.

I think there is a need to realize that this financial melodrama emerges from business only so first value point is the business model not the other way round. Financial metrics are transitory. Strength of business model (passion) is permanent (relatively). Some time back, I gave much better example to a student about real (new age) value investing. I gave him the example of Indian Epic Mahabharata wherein before the start of war both Duryodhan and Arjuna went to meet Lord Krishna for his help and support for the upcoming war. Duryodhan was the old school value investor so he chose the army of Lord Krishna ( Financial metrics) but Arjuna who was the world’s first new age value investor picked Lord Krishna (passion, Transformation potential) and rest is the history how Lord Krishna, even without picking a weapon, was instrumental in the win of Pandavas due to his divine presence and unhuman wisdom.

Present day investing looks more like a simulation model where too much focus is on giving a target price of the stock advised though i am sure that the target given is not achieved 90% of the time in the manner it was proposed. This addiction for giving a target price comes from a feeling to demonstrate the superiority of the research- a target means great study and analysis. But if value investing is this simulation model then very soon computers will do the same much better than us (they are already doing in fact) and there is no job for analysts in the future. But fortunately investing is not simulation model. The main task of investing is to find the right direction which requires creativity, imagination, huge data of businesses and economies, and then some amount of luck. Financial metrics are helpful in choosing or discarding a vehicle to cover the distance in the right direction but they can’t decide the right direction.

So strength of business model which entails future scope of large scale of operations and transformation potential (like in Agriculture and electronics goods manufacturing in India) is the most important value accretion factor than any financial data. In many of my earlier posts I have mentioned this aspect in picking a great stock.

I do use financial data for judging the capacity and sniffing (dubious companies) but value for me emerges from business model and entry barriers.  It is just like mining of Gold. Here, the main capability is not superior mining equipments but the ability to assess the presence of Gold. If someone can't assess the presence of Gold then he is just taking high risk and high possibility that superior mining equipments will prove useless and costly. Financial metrics are just like mining equipments but true value event for business is the superior capability to assess the presence of Gold.

Value investing was more relevant in the age of less competitive business landscape

Value investing was useful (or great) when there was “information scarcity”. In old times, some 50-60-70-80-90 years back there was not much public information about various factors and dynamics about the business and a particular stock because of limitations and capability of media reach in those times. Only the privileged ones had the timely access to the specific information. Also, most of the public was not aware of the dynamics of stock market. For them stocks meant speculation. For them a stock like Colgate and a local Tooth Powder stock were same because for them stocks were just prices…nothing else. So stocks were lying here and there with asymmetrical and irrational buyers. Hence this helped and created opportunities for value picks because financial data/metrics were indeed the representatives of sound underlying business prospectus.

But I think another major factor was that businesses were much simpler and competition was less and globalization impact was much lower. Hence one could easily believe that the business growth line would mostly be a straight line. But not anymore. Globalization and flow of capital and technologies across the globe has rendered businesses very complex. Technological breakthroughs are occurring at such a fast pace that valuation methodologies like 10 year DCF have become useless because in this extremely fast changing environment nobody can estimate future cash flows as far as 10 years. Earlier, businesses were built upon capital but now capital is easily available. The differentiating factor is the business strategy and capability to create high entry barrier products. Like, optical disc storage manufacturers like Moser Baer tasted grand success and destruction of their business completely just in a span of 5-6 years. These days, slight delay in taking critical business decisions may prove catastrophic just like in case of Nokia and Kodak. That’s why study of business model is the first value factor in analyzing a stock/business.

Most important: Business strength is relative not standalone

One thing which I find missing in all business analysis whether it is value investing or credit rating is relative strength. A business is under constant threat from competition and most of the times businesses are vanished not due to mistakes or frauds but due to strong competition. So first thing, strength in business is not standalone but it is relative. Like, recently I was reading a credit rating report on Oberoi realty which was revised downward to negative due to Covid. Their logic is simple that there is pressure on its business but this even a layman can say. But business and life is not that simple. Oberoi is having one of the strongest balance sheet due to low debt and very strong brand positioning so it has much better capability to withstand any short to medium term pressure as compared to other players with very weak balance sheets due to high debt. So there is high possibility that this may knock out many small and weak players and due to scope of leverage (that too at lower interest rates) Oberoi realty can even acquire these properties or land at much lower prices. So if one can see then its relative strength is increased. Same is the case with Mahindra Lifespace which is also having least amount of debt and poised to acquire properties and will enter into partnerships with other weak players. Both Oberoi realty (CMP 300)  and Mahindra Lifespace (CMP 200) are my preferred picks for real estate sector.

So there is nothing like standalone strength in business and many cases when we may be witnessing a deterioration in the business and financial metrics of a stock/firm (and may declare unfit as a value buy) but there are strong chances that its relative strength may have increased massively which will pave the way for even stronger and comprehensive business growth in the future. We can see the impact of this aspect in many cases and I think the interplay will be more prominent in current Covid crisis. There will be many industries like Hotels, restaurants where strong and organized players will reap the benefits of increased relative strength in the future.

Risks and potential are embedded in business and economic realities not in financial metrics

Just to elaborate above points in more details...i am putting some cases below where some stocks were great value picks as per value investing metrics but due to subtle intricacies of their business models there were inherent risks and potential threats to their businesses. And similarly there are some sectors/stocks which are a great buy because of their business model and strengths which will create high growth in the future.

Banks and NBFC stocks

Let’s take the case of banking and NBFC stocks because I have always seen very strong fascination for these stocks in Indian market especially and all the times I have seen metrics like Price over book value being used for pointing out the undervaluation and scope for growth. I have no stock related to banking and NBFC businesses in my portfolio. These two businesses are highly leveraged ones so domain expertise and focus is very important. I have always found these very risky because of their current erratic business model. Like, the main task of Banks is accumulation of savings and creation of credit but they are distributing long term risky infrastructure loans which for me is not their forte. They lack the expertise to assess the risk associated with these infrastructure projects. I invested in NBFC’s in 2016 when I felt that because of their domain expertise in infrastructure sector they can fill up the vacuum created by Banks as banks were busy in repairing their NPA hit balance sheets. But I cashed out of all NBFC stocks in the beginning of 2018 (around 10 times gains) because I realized that they were also going way over the top. Everybody was becoming an infra developer because of low hanging debt money and I thought the debt will never be paid back.

Further, apart from risky loans by NBFC’s other factor was the high rate of interest in India and I was having doubts over the paying capacity of the builders. I don’t think infra development is a viable business at interest rates of 10%-15%. Infra should be developed at lower interest rates and for this it is the duty of government to give interest subsidy. I am waiting for long time to see interest rates falling in India and I hope that this may happen now. It looks absurd to have such a high interest rates for a strong economy like India. In fact large borrowings by the Government is one of the main reason for high interest rates in India as Govt competes for funds with private sector. So if they can’t control or lower it then they should give interest subsidy for infra which is going to add some value into our economy like large scale warehouses for storing agro produce to save the same from wasting, roads and railway enabling faster and cheaper movement of goods. These infra investments pay for their debt on their own as they do value addition. 

But still, the records of our banks and NBFC’s with regard to infra debts is very bad and I think there is more to the story than just bad poorly planned infra projects itself. Because I think, debt and infrastructure are made for each other…made in heaven. The loans taken by normal business entities like Telecom, FMCG, Steel, chemicals are more risky than infra loans because there is tough competition in these industries and often it is happening that two competitors are fighting hard for same business/market share with loans and as we can guess one is going to bite the dust and his loans will turn NPA i.e. the fight we are seeing in telecom now. So debt to normal businesses is very dangerous and requires high skills in allocation of debt. If one particular sector is already having high debt and chances of demand in that sector may go down or there may be severe competition and price war coming so in that case caution is required in allocating loans to that sector.

But Infra is different. Due to competition and miscalculations by businesses, we can create excess (redundant) capacity in steel sector but can we lay extra gas pipeline of 5000 KM length?? Can we make another road parallel to a newly constructed road?? Can we make an additional Airport. So as we can see there is hardly any scope for redundancy in infra and if properly planned (like costs during bid stage) then chances of failure are very less in Infra. That’s why I feel there should be low chances of NPA in infra but it needs lower interest rates. However, government can construct excess infrastructure to create jobs in the economy but which may not add any value to the GDP growth like in the previous post I have given the example of investments made by Chinese government in waste and excess infrastructure just to grow the GDP but these infra is not used. But there is no risk for the infra developer here.

Current consumption vs productive business investments

Further, I don’t rate lending for current consumption (relative to investment) very high. We are just dragging the future consumption into the present and demand for these consumption loans raises the interest rates. Consumer credit is not used to generate the income that will pay off the loan, as with business finance. Instead, payment of consumer loan will make people spend less so any spike in the GDP is reversed.  So interest paid on consumer loan does not have much economic development role and it is more like a rent on the economy. But giving a car loan, housing loan and personal loan is less risky than infra loans so lenders love these and because these are mostly secured so credit creation here is more like a rent. Also the assets like houses, cars etc. do not pay for their debt (more cars means more oil import also) because they do not generate income like that of a business asset. They are paid from the future savings so their impact on GDP growth is lesser. So more lending should be for business asset for a growing economy like India rather than consumption loans. India first needs to put money for business investments then we can think of a consumption based economy.

So banks’ main role should be the credit formation for tangible productive investments in the economy like for electronics goods manufacturing which will generate more income for paying the debt. But these days most of the bank finance is used for financing of real estate, business buyouts and financial assets like Bonds which are already in place. So for me, in their current avatars banks and NBFC’s were always very risky businesses for me regardless of the strength of their balance sheet which is always transitory.

The pressure on GDP growth we are feeling now is because of lesser investments in high growth sectors like electronics goods. Now we need new avenues for growth and for these investments is must like solar power equipment manufacturing. Now focus should not be on growing consumption because those who can consume they are already doing it and those who can’t needs money which will come from jobs and jobs will be generated by business investments. So if you ask me then consumption always follows investments…it is not the other way round as is being felt.

Auto sector woes and new torch bearers for Economic growth

Current pain in the Auto sector does not imply the malfunctioning of our economy. Actually what we are seeing now in our economy and in Auto sector is self-correction mechanism of a growing economy. While growing fast, this is natural that there is some misallocation of resources as one can’t oversee everything in minute details in a vast economy. Like we created vast manufacturing capabilities in Autos but none for electronics goods and saturation in auto is hitting us now. Further most of cars are sold (80%) on credit in India so natural demand was always low. Also, our Auto sector could not capture the export market due to product quality issues as India is a market of cheap and small car. But still, there is still a chance for our auto sector to grow their export business. So in an economy, in correction mode resources shift and structural changes take place like new demand and supply centers will emerge. This is perfectly normal and good thing about our economy is that we can still control it, direct it because we are not primarily an export oriented economy (demand is local) nor we are a saturated one like USA where they are trying to make people consume more and more.

Electronics goods manufacturing is the best alternative because of the sheer size of demand which is met entirely from imports. So here, without growing the aggregate demand in the economy we can grow the size of the economy by import substitution and with our impressive record in Auto sector there is nothing that should stop us because we are already the global leader in chip designing which are used in these electronics products.

Defense is another sector where i think huge scope for local growth and India has no choice but to go for local manufacturing as we can't fund the massive defense spending by imports. Here, i am investing in BEL (now at 73) because apart from defense it has equally potent non-defense business and it has everything to venture big time into electronics products manufacturing in India. Also, it gets the defense work from all other defense firms like HAL, BDL, Midhani etc. so it is like a proxy for the growth of Indian defense sector. BEML i like mainly for its Metro rail manufacturing in India, first Indian player to do this...has 50% share in local manufacturing. It has equally great defense business and govt. is going for the strategic sale of BEML (now at 600) so this alone can trigger a massive upside.

Healthcare is another stunning option and this is where we have unmatchable technical expertise and we can create an affordable global hub for healthcare services to promote medical tourism. We already are one of the biggest and highest growing in medical tourism but we can create a real giant much bigger than IT industry. Unlike other industries, healthcare sector create more jobs as the role of machines are comparatively less. Narayana Healthcare, Max India and HCG are my picks for this sector.

Laurus labs is another stunning stock which I think is ignored by market due to recent variability in financials/Profits though it was having one of the highest passion quotient among all Indian Pharma stocks. It is one of the best in complex API globally courtesy its strong focus and investments in R&D. Last year, due to raw material sourcing issues from China, its profits were hit as it could not raise the price of its products. But this has given Laurus an opportunity to do backward integration to manufacture the same in house cost effectively. Then there was the impact of capital investments for its formulations business. It invested some 500 cr for the business but it takes time for the new business to start generating revenues and profits. Laurus was in investment mode for past few years and it has invested some 900 cr overall in last 3 years or so. So apart from normal running expenditures of these newly created assets, the impact of depreciation was significant and this has alone hit the bottom line and I have seen many times investors lack the understanding of depreciation which is a non-cash item and for new ventures can distort the profit figure artificially. Like its revenues were increased just 30% from 1800 cr in 2016 to 2300 cr in 2019 but its depreciation cost almost doubled to 164 cr vs 92 cr. Other expenses increased from 200 cr to 400 cr. So as we can see, it was not that something has hit the earning potential of its existing business. It was just the impact of expenses/charges related to unused and preliminary assets. At 470 this one is a great buy. I have added good qty at 300-330 amid covid crisis.

Solar power equipment manufacturing in India. It is clear even to a layman that we can’t build our solar dreams on imports (80-90% equipments are imported) because then we are better to stick with thermal power. At least the income will be generated in India. So we have no choice but to promote solar manufacturing in india and for that government should give free land, cheap power, low interest loans and for that they have to ration the resources available in the budget. I am even in favour of RBI creating credit (at 1% interest rate) for solar and electronics goods investments because in any case banks are not lending money to them. Government has accumulated sizeable amount by imposing safeguarding duty on solar and electronics goods so that money should strictly be used for the purpose of growing manufacturing for these sectors in the form of subsidies. Here i like Borosil Renewable very much which is only indian company producing solar glass of top notch quality and recently invested big in doubling its production capacity to cater to coming local demand. I have invested quite a bit in it recently at 35. This is the best pick for solar sector as of now after Tata power which is another one i have added at 30-33 recently having order book of some 9000 cr. Tata power may be the stock of this year.
But if one looks at the financials and books of these two then they are not anywhere near to be regarded as value buys but when you study their business and their relative strength they are deep value buys.

Agriculture one of the best Bet: India has huge land fit for agriculture. Some 60% of our land is fit for agriculture which is among the highest in the world. India has some 160 million hectares arable land which is second highest in the world…larger than china. USA is the first. But just look at our productivity as compared to China. Like in Rice, China’s yield is double of India. So, India has large arable land but less minerals (mining) so it is prudent for India to build an agriculture based economy for exports and build industries based on agriculture like food processing etc. But not much work has been done into this. Corporates and their investments are required for this. So if you ask me, this presents a grand opportunity because sooner or later India has to focus on this. So these days I am again looking for promising bets in agriculture sector and so far has picked stocks like BASF, Godrej Agrovet, Mahindra EPC (got a bargain at 80 recently), Rallis India etc. Godrej Agrovet is a stunning player and a great proxy for agriculture sector growth. I have no doubts that after the recent reforms in APMC acts by Modi Govt, Godrej Agrovet will go for Contract farming for Palm oil at massive scale. Why i feel this is because in other agro commodities India is quite self sufficient but we import huge amount of Palm oil (Pulses is also a very big import) so we need this to substitute imports. Godrej Agrovet has massive turnover of 7000 cr with very diversified streams of revenue. It is into animal feed, Agrochemicals and seeds, Dairy, Oil palm, FMCG (Godrej Tyson foods). Animal food is the biggest contributor of the topline with 3700 cr, Agrochemicals at 1100 cr, Dairy at 1200 cr, Oil palm at 700 cr, FMCG 500 cr. So it is adequately diversified into various sectors related to agriculture. At 370 it is a steal and i am investing good chunk of my portfolio in it.

I think corporates like Tata, Mahindra should be encouraged to make large investments for growing basic agriculture in India. To protect and look after the interests of farmers state governments can become equity partners in these projects. Just take the case of development of large integrated industrial clusters by Mahindra Lifespace (Mahindra world city) in Chennai and Jaipur (1500 and 3000 acres) in partnership with state governments. India needs type of plug and play industrial clusters where manufacturing can be started immediately without putting large investments and time. These are preferred by foreign firms and in these integrated cities developed by Mahindra (Chennai is fully leased out) foreign manufacturers/businesses are the main customers. Mahindra Lifespace is one stock for which I really see a great future and this one is a great value pick at 180.

One last example on DHFL

Lastly, just want to share a part of my blog post on Nelco (click here) posted in Dec-2017 wherein I have explained the relevancy of financial analysis and also expressed my views on the riskiness of DHFL which was around 600 at that time (now at 12):

Sometimes I feel that understanding when and how to use financial analysis is more complex than learning various financial analysis tools itself. Like, for example, let’s take the case of ROE…I have seen people using this ratio to compare one stock with other industry stocks when in fact this ratio should be used first of all for comparing it with the COST OF EQUITY of the stock under analysis. Cost of equity of each organization is different keeping in view the riskiness of the operations of the organization. The more the riskiness higher is the cost of equity. ROE should be compared with this Cost of equity not with the ROE of other companies. Just let me give you a hypothetical example of PNB housing and DHFL. Both have ROE of around 15% but PNB trades at PE of 30 as compared to 20 of DHFL. Now I have seen reports which simply conclude that as ROE is same of the two stocks (not just these two) so DHFL is undervalued to the extent of 50% as compared to PNB.

But business profile of DHFL is more risky because it provides housing loans to low income and self-employed people while PNB is more focused on salaried employees (just assuming) due to its banking reach. So keeping in the view the high riskiness of business of DHFL (due to high rate of default) cost of equity of DHFL should be much higher than PNB (So as its Bond Int rates) and at once the undervaluation margin of DHFL will disappear. This safety is the reason HDFC will go on commanding premium valuations even if its ROE is lower than others.

So I have always felt that for new emerging sectors/products (Like IOT, Geo-spatial, Agri warehousing finance) the focus should be on to evaluate whether they can create/add some value on its own as only that’ll ensure their long term viability. Affordable supply and corresponding high demand is the most significant factor for a new technology/product to achieve widespread acceptability and growth. So in the coming paragraphs we’ll endeavor to find out whether the Satcom industry in India can add some value (solve a problem) on its own, can create adequate supply at affordable prices in order to create long term value for itself. This is going to be more fundamental with least (or no) focus on financial data of the current industry players as at current scale it is not required.

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post. Reach me at oscillationss@yahoo.in).