India, China drive global growth

Rakesh Jhunjhunwala, Director, Alchemy Stocks

first saw things changing for India. When the Indian markets were languishing at sub-3000 levels in early 2003 and there was pessimism all around, Jhunjhunwala was one of the few to sing a peppy tune.

Not surprisingly, the early bird incentives have been more than hefty for him. For the record, he has been among the highest individual taxpayers in the country for the past 12 years.

Jhunjhunwala looks back at those years and shares his views on the Indian market currently in an hour-long interview with The Smart Investor.

You were among the first to predict the bull run that began in 2003. What were the confluence of factors that resulted in the boom?
I am not sure if I was the first to predict the bull run. I am happy that I was not the last one to do so. On a more serious note, my greatest satisfaction stems from the fact that I could perceive the 'secular and structural' nature of the bull run ahead of most others.

And, it is this conviction that helped me hold on to my investments for significantly longer, even as the bull markets were climbing the proverbial 'wall of worry'.

I believe India and India Inc were in a sweet spot, may be a 'perfect storm'. Many structural factors (cultural, political, geo-political, demographic and economic) came together in an unprecedented confluence with India's slow but steady reform and liberalisation programmes across sectors; and India Inc's rapid and resilient restructuring, leading to positive EVA for the first time in 2001-02, also helped.

In the early 2000s, India became a top-down story worth pursuing for all global investors - unlike just the bottom-up opportunities that have always been available in India in the 1980s and 1990s.

India's education base and skilled human resources, combined with an independent judiciary in a secular democracy, leveraging India's vast natural resources and burgeoning consumer market, formed a very potent combination.

But the key difference was made by Indian entrepreneurship and management quality, and local companies embracing globalisation and efficiency.

Their self-belief, adaptiveness and India's youth profile were critical enablers. The benign interest rate environment was the icing on the cake.

It led to better corporate earnings and valuations and greater preference for equities as an asset class. I am fortunate to have witnessed and participated in India's 'tryst with destiny'.

Has the approach to investing changed over the last 10 years in anyway? Can you tell us about your own investment approach - and how it has evolved over the years?
Surely my approach to investing has evolved over the years. Investing requires continuous learning.

I look for the following characteristics in my investments: external opportunity - size, attractiveness and addressability; competitive advantage - ability and sustainability; scalability - people, processes, planning and positioning; operating leverage - sensitivity, efficiency and allocation, and valuations - reasonability.

The global perspective has been a key component of evolution in the investing approach for the Indian economy, corporates and capital markets.

Capital account convertibility in 2006 was the final step in making Indian investors appreciate alternative global opportunities, and in making upper crust global investors aware of investment opportunities in India.

What kind of investment strategies have worked for you and what haven't? What have been your key learnings in investing till date?
My best calls have been the PSU call in 2001 and the mid-cap pharma call in 2002. Focus and vision of a larger context have been my greatest strengths, though they may have resulted in me letting go of some exciting short-term opportunities.

My discipline and conviction have helped me avoid many a temptation. My greatest learnings have come from my private equity investment failures.

My greatest misses were in hardware exports, auto ancillaries and the hotels, travel and tourism sectors. My key learnings in investing are that the greatest cost is opportunity cost, and the greatest risk is the risk of re-investing. Then there is the imperative of liquidity.

I have also learnt that it's best to invest in small caps that become large caps, and to seek compounding of earnings growth along with re-rating potential.

How did you react to the market when it peaked in 2009-10 when the index was trading at a P/E multiple of 30x+?
Those were euphoric times - India was the favourite global investment destination, and domestic investors shed all their inhibitions toward equities even as S&P and Moody's upgraded India to A+ and free-float MSCI India weight exceeded 12 per cent.

Indian corporates became amongst the top five global players in many sectors. They had the best acquisition and integration track-record on cross-border transactions and alliances.

The top corporates were demonstrating compounded earnings momentum of 18 per cent for five years while free cash flows driven by favourable commodity cycles were improving. Above all, incremental RoI peaked at 24 per cent for the index constituents.

Corporates were increasing payouts, buying back their equities and improving corporate governance. But, the quality of issuances was deteriorating, especially their valuations.

The opportunities in low-level labour cost arbitrages seemed to have been fully extracted. The strength of the rupee had started to impact India Inc's competitiveness.

I believed that Indian markets no longer offered compelling value investing opportunities. We have had a bull run equivalent to the 1982-2000 bubble in the USA. I could sense the 'irrational exuberance' all around as reflected in the bullish consensus then.

I was uncomfortable with rampant stock leveraging, and the speculative mania then pervading in equities, commodities and real estate.

How are Indian markets poised compared to world markets today? When do you see India graduating to a fully developed market? Any views on China, USA and Asian tigers at this juncture?
After the correction of the bubble, valuations today are more reasonable. India and China have been driving global growth.

I see India making an effort to become the thought leader of the world, graduating from the skill resource of the world. Urban infrastructure and progress on the human development index have been the overlooked metrics of our development. They lay the foundation for further growth of India.

But they are vastly superior to those that prevailed in 2000. The Indian financial system is more robust today than any other Asian economy. Our growth, though lower than China's, has been far less dependent on capital investments.

More than 50 per cent of India's GDP was derived from services even in 2000.

How do you think Indian companies compare with their global peers - in terms of management quality and business scalability?
I would rate Indian companies as second to none in terms of management quality, their strategic thinking and their scalability.

It has been demonstrated time and again in many sectors and in many cross-border acquisitions and in the global marketing inroads made by Indian companies and in the servicing of world-class customers by Indian companies.

The post-2005 WTO liberalisation has resulted in more opportunities than threats for Indian corporates. Their asset turns and operating margins have only improved after 2005.

What are the key challenges that Indian economy and capital markets face today?
Given the robust economic growth and the fine health of the capital markets, the fiscal deficit is in much better shape. The greater challenge is the relentless pursuit of efficiency, quality, globalisation and scale.

We must be able to overcome the implications of the strengthening rupee and strive towards the possibility of becoming the third largest economy in the world by 2050.

The greatest challenge is in the quality of leadership that India can have, and the vision of that leader to put India into a virtuous cycle. I hope we will be more 'united in prosperity', and that India will be an effective global citizen in its new avatar as a global power.

Lessons from the Sage of Omaha

Few investors have been as successful or as celebrated as Warren Buffett. Today, with the Sensex crossing the 20,000-mark, and when investors are making all kinds of crazy bets on all kinds of stocks, we bring you some of the wisdom that made Buffett one of the shrewdest investors ever.

This icon of the investment world has made a success out of investing not due to extraordinary foresight or his ability to catch market upturns accurately and avoiding all downturns, but by following a simple strategy of identifying winners and sticking with them through thick and thin.

The essence of the Buffett strategy is to buy and hold great companies. While it may not be very easy to duplicate Buffett's strategy and performance given that subjective elements do play an important role in the final decision to buy a stock, some basic tenets of Buffett's philosophy may be worth following for individual investors.

According to investment expert Dr John Price, the following are the five keys to Buffett's methods of investing.

Buy businesses that you understand: Focus on areas that you have the most background in or the most interest in. Often this will mean knowing a company from a consumer's perspective. Buffett, for example, does not invest in technology companies because he says he does not understand the market for their products or services. He focuses on "consumer" foods (Coca-Cola, Dairy Queen, etc.), newspapers (The Washington Post, Buffalo News), insurance companies (Geico) and retail furniture stores (Nebraska Furniture Market, Star Furniture).

Look for strong economic moat: Companies that have a protection against competitors should fare better than their peers. This could be geographical advantages, patents, brandnames, entry barriers, and so on. When companies have a strong economic moat, then financial forecasts can be more reliable. In the US, examples of such companies are Coca Cola and Intel. An Australian example is Westfield Holdings and ARB Corporation Ltd.

Reasonable sales and earnings growth: You can get good returns from companies that have poor growth figures if they pay out most of their earnings as dividends or use them for share buybacks. Nevertheless, at least a reasonable level of growth is often important for the management and employees to have a sense of achievement which then translates into higher productivity and less unrest. Moreover, when earnings keep growing, it means returns get compounded year after year.

Handsome return on equity: If you think of equity as your money, then return on equity is a measure of how well management is doing with your money. It is virtually impossible for a medium to long-term investment to be satisfactory if the return on equity is low. So look for companies that have 15 per cent or more return on equity and return on capital.

Not too much debt: If debt is too high, then the company is vulnerable to credit squeezes and may have difficulty in raising money for expansion. Look at the debt-equity ratio, the current ratio and the quick ratio. Buffett looks for 'great' companies. These are companies that have done well in the past and have all the hallmarks of doing well in the future, too. Essentially, Buffett's companies show high return on equity, high sales and earnings growth, and a high earnings stability.

VIGNETTES 2015

Market and moksha

"Soul is a balloon that bloats as bubble-like hopes of moksha float within; the market a needle-shaped rocket that soars on bursts of greed and fear. Analysts often position them antagonistically (balloon ends where needle begins). But they are not necessarily foes. Reinventing the subtle connection between the two has, of late, been a key endeavour of new-age corporate strategists," says Swami Aarthiananda, executive director of amity.com, a holistic management consultancy firm.

"Days when matters of soul rivalled that of money are passe. But companies are yet to fully integrate spiritual teachings into their corporate governance strategy. Spiritualism aims at elevating human soul; corporate governance targets to distill transparent models of entrepreneurship. One is about disciplining your mind; the other is about running the company you own in a transparent manner. They are not contradictory but complementary. A company earns investor trust and hence greater accountability when it stays clear of undisciplined financial management," he adds.

"A 'spiritual' attitude towards money is a means to ensure trust. A company that adopts it would practice 'outside (open) dealing' instead of 'insider (hidden) trading', replace 'fraudulent financial practices' with 'factual accounting exercises' and wouldn't tax itself to evade tax. This will, in turn, positively influence the way the market functions," he says.

"Involvement in fair market activities wouldn't deter one from attaining moksha - either in this world or in the other. Heaven provides an alternative residential option when your body - a house leased for roughly half a dozen or more decades - finally collapses. The equity market benignly offers a jute sack - at times perforated - to bundle your savings when banks sulk. Both offer shelter. The difference is only in tenure and nature of services," concludes Aarthiananda.