Bharat Shah
Partner and chief executive
ASK Raymond James
Would you agree with the view that the rapid change in technology will lead us to an era of no capital formation?
Technology is going to cause destruction. As we have seen, time-periods are increasingly getting compressed. What would have taken some decades to build earlier can be done in a few years now and going forward it will be even quicker. Many of these changes are unleashed with the help of technology and there is no doubting the fact that the pace of change and its intensity are exorbitant. But having said that, I do not agree that capital formation will get throttled.
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You must distinguish between micro and macro level changes here. While an individual company can perish because it is unable to adapt to the change in environment or was unable to envisage the change well ahead of time, the overall system cannot collapse. Any change will create new winners and losers.
However, that does not mean capital formation will get nullified at a macro level. I would think that any technology, however disruptive it may sound in the beginning, tends to get absorbed over a period of time. As the usage of new technology gets absorbed, it no longer remains disruptive.
Besides, all major events in economic history indicate that everytime there is a sudden change, it is followed by a period of tranquillity. This period of tranquillity ensures consolidation. We must understand that technology is not a master, but a slave. To confuse technology as a master will be insulting mankind.
Then, what do you think will be the impact of this shortening of business cycles, which is a result of accelerated pace of change?
Competitive advantage is getting more commoditised. So a company is unable to really enjoy the benefits of the competitive advantage it created for itself for long a time, compared to earlier. In that sense business is getting riskier.
But to say that the period of investment and the period of time when you enjoy the benefits from the investment will become equal is a drastic view to take. This would imply that investment and consumption will be simultaneous. I do not agree with this view.
What implications does the change in pace of technology have on business and investment?
Well, apart from the fact that the business life cycle is shortening, businesses are becoming commoditised. For instance, look at the brands. As we get more and more brands in a particular product, they lose there potency and value. As a result, many companies in the US and even in India with good brands are trading at single digit earnings multiples.
Then, there is a lack of predictability and more risk in the environment. Forget companies, even nations today cannot talk about 10-year plans. Overall, businesses have become more fragile. Their level of influence in the economic system has also declined.
What implications does this have for long-term investors?
Firstly, it has implications for the period for which you can visualise a business. Secondly, it has a direct impact on a period for which you can hold a business in your portfolio. And thirdly, the amount of risk you can bear on your portfolio.
Earlier, any change in the marketplace could bring about only a marginal change in the value of a business. Today, in a matter of hours, the value of your business can erode by 30-40 per cent. That is an enormous risk. Controlling this risk is a big challenge.
Earlier, it sufficed to buy good business esmanaged by good people. Now you need to be more vigilant. Your basic criteria does not change. You would still want to buy good businesses at a good price. The change has really come about in the "good price" part. In other words, compared to what you regarded as a good price earlier, the asking rate has gone up.
The margin of safety has gone up considerably because you are much more vulnerable to hits that are not in your control. So, you can go wrong not because you made a bad buy decision, but because of some external factors you have absolutely no control over. Besides, portfolio construction must be far more tighter in future. Can't have too few stocks because of the risk associated with concentration of stocks.
Can't have too many from the dilution of returns point of view. You can afford to put your money only if you are absolutely convinced. Again, the level of monitoring will have to be very high. But the ways of valuing a business will be predominantly the same.
Do you think the pay-offs will be higher for traders in future, given that there will be unpredictability and time horizons will have to be shorter?
No, not at all. In fact the risks will only be higher for traders. In fact, it would be wrong to confuse shorter investment time-frames with trading. The idea of investing is that you buy a rupee worth asset at half a rupee. The underlying principle is that the market price and the fair value of a company will converge at some point and you will realise your gains. So, the pay-offs will always be in favour of investors.
Will valuation metrics have to change in the new era? For instance, bookvalue-based valuations may become irrelevant in the knowledge world.
No, the basic principles will remain the same. About bookvalue-based valuation, yes. Where intellectual capital matters you are generally willing to pay much more than the bookvalue. But that comes with its share of risks. In basic industries where physical assets are important, you benchmark against bookvalue and hence your risks are also relatively lower.
The only difference is that you have to lay much more emphasis on competitive durable advantage than ever before. Since you can't predict earnings for long time periods, you have to be more cautious in your approach. Your terminal growth rate assumptions will have to be on the side of caution.
Overall, I think technology cannot be a differentiator between good companies and bad company. It is the overall value proposition that a company offers which matters in the end.