Jatin Khemani is an experienced investment professional and shares his thoughts on investing through his blog. Jatin is the founder and managing partner at Stalwart Investment Advisors, a SEBI Registered Investment Advisory Firm. SA provides a bouquet of services right from stock advisory for retail and institutional investors to financial planning and wealth management.
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My April’19 Article Written For Financial Express
While Nifty is at a lifetime high, the average fall across 3,000 traded stocks is still 40-50% from their 2018 highs. Smaller the market capitalization bigger has been the bashing its stock has taken. Though there is nothing unusual about it – small companies swing wildly in both directions depending upon market sentiment; after all, they are thinly traded with low free-float (non-promoter holding, available for trade) so the rise in volumes can lead to high impact.
The onlookers and investors who entered markets recently might have concluded by now that it is so safe to invest in large caps which not only did not fall much in the correction but now when markets are improving they are also participating on the up move. While purely on the basis of this divergence seen between select large caps and broader markets during 2018, the observation cannot be dismissed. However, it is nothing but an outcome of recency bias.
Most of these so-called high-quality large caps are trading at ridiculous valuations from which it is very unlikely for investors to make reasonable returns even over the next 3-5 years. The real opportunity lies in broader markets and emerging companies, where once again valuations have turned reasonable (if not cheap like 2013) and one could at least expect those stocks to mimic earnings growth without the risk of any meaningful de-rating.
In previous occasions when we had such a steep fall in small caps in such a short period of time, the reversal too had been swift. Also, the returns over following one and three year periods have been above average.
A basic tenet of long-term investing is to look for high quality listed businesses. This essentially implies 1) they earn returns above the cost of capital (reflected by return on capital employed), and 2) generate strong free cash i.e. they don’t require a lot of capital (fixed assets and/or working capital) to grow revenues and profitability. Those retained earnings can then be utilised either to acquire other companies in the same line of business or diversify. Alternatively, excess capital could be returned to shareholders via dividends or buyback.
But have you ever wondered why would a promoter of such a business list his company as it involves diluting a significant chunk of his ownership to minority investors?
For instance, why is a business like Castrol listed? It generates annual revenues of Rs 4,000 crore. On a gross block of merely Rs 220 crore, (a staggering 18x asset turn) and enjoys a negative working capital, which helps it generate an RoCE of over 100%. Since it hardly needs any capital to grow, it pays out 75-100% of its profit every year as a dividend.
If I was a promoter of such a business why would I divest even a single share? This is true for almost all the multi-national corporations operating in India – be it FMCG companies like Nestle and Colgate, host of high-tech capital goods and fast moving industrial goods or auto ancillaries like Schaeffler.
We analyzed top 40 Indian-listed subsidiaries of MNCs and found that the average fixed asset turns is 6.3x, the average return on capital employed is a whopping 36%, barring five, all are debt-free and net-cash companies while the average dividend payout is 35%. And this brings us back to the fundamental question, why are they listed?
My March’19 column written for Safal Niveshak’s ‘Outside the box’ newsletter
One common advice I find veteran investors passing on to next-generation investors is to look for companies dominating their industry and enjoying entry barriers ensuring their profit pool share is protected.
Now, ideally, we may think that the top 3-4 players by market share in any category should be qualified as ‘dominant players’ even if their respective market share is in single digit. However, for the purpose of this research, I have restricted my analysis to only those companies that enjoy at least a 35% share in their respective categories.
You must be thinking that it is quite a stringent filter and there would only be a handful of companies that will make it to the list – after all, we are a free economy with enormous capital chasing opportunities on one side and ever-tightening regulations in the form of competition commission etc., on the other.
But you would be surprised to learn that having spent just a couple of days and recollecting about all the companies I have studied or read about over the last decade, I could actually pin down a list of 60 listed companies that enjoy a market share of 35% or higher.
I am sure I must have missed out on many other listed companies and so the list may get longer and even more if one were to include a few unlisted businesses like NSE, a virtual monopoly, or Amul, which boasts of a 40% share of the cheese and other value-add dairy products market.
You would see the complete list at the end of this article. But before that, let me share the top 10 observations while analyzing this distinct sub-set of dominant businesses –
The beauty about being in investing profession is that your mind is always curious and observing even when you aren’t ‘working’. Any occasion — a family holiday, house renovation or wedding — can effortlessly translate into scuttlebutt (primary research) where you experience so many products and services as a consumer, get to interact with dealers and also get to observe your family and other consumers engaging with those products and brands.
I had one such wonderful experience recently. There was a wedding in my family and like all Indian weddings, it meant shopping jewellery for the couple, relatives, gifting, etc. My family and relatives have been traditionally dealing with two jewellers in our neighborhood who belong to same community (Sindhi) – one of them specializes in gold jewellery and other in diamond studded.
This time my family wasn’t happy with the designs these two stores offered and so they visited six-seven other mom & pop stores only to find none as a good place to buy from.
I was then consulted to suggest a jeweller, and being in stock markets and having read so much praise about it, I instantly suggested Tanishq (India’s leading jewellery brand operated by Titan, a Tata company).
The suggestion was instantly turned down saying it levies a very high making charge (a common perception among masses buying jewellery from traditional/unorganized channel). I had never been to a Tanishq store earlier so I did not want to lose an opportunity to visit. Luckily, I found online that during that time period Tanishq was offering up to 30% discount on the making charges which helped me convince my family to give this place a try.
What transpired next is an amazing set of experiences which I am going to share in this post
While there are various styles of investing, we can categorize them under three key heads:
Special Situations (Arbitrage): Open offers, rights issue, mergers would all fall under this category. One is betting on a specific corporate action with well-defined timelines and aim to make a certain return independent of what happens to the company’s fundamentals or market sentiment. Typically aim is to beat fixed income return while not taking any material risk. Holding period ranges between few days to few months. Re-investment risk is high as one has to keep looking for new opportunities which also involves sitting on cash in between. (Suggested Reading: You Can Be A Stock Market Genius By Joel Greenblatt)
Statistical Bargains: These are average businesses which are available very cheap - below liquidation value/cash, at a high dividend yield or low price-earnings multiple. The focus is largely on quantitative parameters rather than qualitative; analysis starts with valuation followed by financials and involves little assessment of business quality or management quality. One is betting on mean reversion either in business performance or valuations or both. Cyclical and commodity businesses would fall in this category. While the downside is low, the upside too is restricted to mostly the undervaluation part with little scope of any significant increase in intrinsic value over long periods of time. Hence, these are short to medium term opportunities with an investment horizon ranging from a few months to as long as 3-4 years. (Suggested Reading: The Intelligent Investor by Benjamin Graham)
Stock Idea Presentation at TIA's 20:20 Ideas Meet by Jatin Khemani - 20th Oct, Chennai - YouTube
Moat Investing: This involves studying business fundamentals in depth and trying to spot ones which enjoy a high return on capital employed because of durable competitive advantages (economic moat) like brand loyalty, access to raw material, distribution, strong research & development, switching costs, economies of scale, network effects among others. Besides quantitative analysis, this style involves significant qualitative analysis in order to assess the reasons behind superior financial performance i.e. to spot what is the source of the competitive advantage, if any. Interacting with customers, vendors and competitors often lead to such findings, which can later be discussed with company management as well. These businesses often trade at valuations which optically look high and one needs to dig deeper and think differently to value such high-quality businesses. Investment horizon here can be fairly long, sometimes as high as 10-20 years or even longer. While initial research could take months but maintenance research is very limited in moat investing. This also has the lowest re-investment risk as investment horizon is longest. (Suggested Reading: Berkshire Hathaway Letters to Shareholders)
Wonderla Holidays - Investment Thesis by Stalwart Advisors - YouTube
Stalwart Advisors’ Model Portfolio has 20 stocks currently and a majority of these would be from 3rd category of Moated Businesses with remaining from 2nd category of statistical bargains, we don’t do special situations. Our focus area is moat investing while opportunistically when we are able to spot businesses that are available cheap we deploy some capital if these meet our other key parameters around management quality (integrity & capital allocation) and balance sheets (unleveraged).
20 Stocks in Model Portfolio
16 Market Leaders
15 Stocks in Buying Range
Deploy 75% Capital Immediately
We rush to shopping street when there’s a sale, unfortunately, we often do the opposite when it comes to stock markets. One such sale is going on right now and we believe it is a good time to start deploying meaningful capital and also increase allocation to equity asset class – Jatin Khemani
Initiating Coverage Reports on Gujarat Ambuja & Wonderla Holidays along with all updates can be freely accessed on the dashboard
Disclaimer: This is not a recommendation to Buy/Sell. Read complete disclaimer here.
Mega-Caps, Large-Caps, Mid-Caps, Small-Caps, Micro-Caps, Nano-Caps… As if the business analysis wasn’t complicated enough, we have divided the universe based on size as well. But does size really matter? The answer will be a big yes if you are running a mutual fund, or some other regulated fund like a pension fund, which has to 1). Comply with SEBI guideline and stick to fund mandate by investing in the universe of stocks which comply with that and 2). Ensure enough liquidity so as to be able to enter and exit with minimal impact cost. But the same isn’t true for individual investors and in fact is their biggest advantage (See Jatin Khemani’s presentation on ‘Individual Investor’s Real Edge – TIA 28th Jan 2017’).
Generally speaking, large caps have been around for longer and hence are perceived to be less fragile than smaller companies, which has indeed some truth to it. But there are many small sized companies which are market leaders in their respective industries and in a better competitive position than many of the large organizations (in other industries). Yet they are small because their addressable market itself is small, though that could be growing fast. Some of these companies would fit all your checklist no matter how stringent they are in terms of return on capital employed, debt-free balance sheet, high cash flow generation, sensible capital allocation, high promoter holding without any pledge etc. To not consider them purely on the basis of their small size may not be prudent.
Though the opposite of this is also widespread- investors often pass on large-cap ideas no matter how attractive they look, thinking they are well discovered. There are so many examples of steady compounders from private banking, IT, pharma, FMCG etc. which despite being large cap and well-discovered have continued to compound at high teens for long periods of time.
Instead of classifying businesses based on market cap, internally we prefer to use following segmentation:
1.Established Businesses: These are companies which have been around for long and have been able to create a strong franchise. In these cases, one needs to focus a lot more on the strength and longevity of business than the key man like promoter or CEO. For example, in a business like Nestle or Asian Paints or Pidilite, it is okay if you don’t even know the name of the CEO, leave alone his personality, background etc. because the franchise is so strong that it will most likely continue to do well. Maggie’s quick comeback from that disaster is a perfect testimony to this. Perhaps these are the kind of businesses which Warren Buffet must be referring to while saying he likes businesses which even an idiot can run. Of course having a great leader adds further to that momentum and is a bonus. (See Anti-Fragile – 20 Companies that are century-old)
2. Emerging Businesses: These are companies that have come into existence only in the last two or three decades. In this case, besides conducting the usual business analysis, a significant time & effort goes into finding information about the key man, we usually prefer to back first-generation owner-operators in such cases. It is crucial to find out how ambitious the leader is because no matter how profitable and big the opportunity size is if the promoter is complacent, the opportunity may never get seized. When Infosys’ IPO came it was a bet on Mr Narayan Murthy much more than it was on IT business, similarly, it was more on Mr Chand Sehgal in case of Motherson Sumi than it was on the Auto Ancillary business. Whereas for those investing in these businesses today, it is much more about the business than the key man.
Stalwart Advisors’ Model Portfolio has 20 stocks currently and the majority of these are from 2nd category of emerging businesses, which is our focus area. We believe big money is made by investing in emerging businesses having the potential to graduate to the first category. Although being an institution, we pick stocks with adequate liquidity so as to minimize impact cost.
16 Market Leaders
20 Stocks in Model Portfolio
15 Stocks in Buying Range
Deploy 75% Capital Immediately
We rush to shopping street when there’s a sale, unfortunately, we often do the opposite when it comes to stock markets. One such sale is going on right now and we believe it is a good time to start deploying meaningful capital and also increase allocation to equity asset class. – Jatin Khemani
We should prefer investing in businesses that are hard to kill. But how do we assess that?
In 1950s average life cycle of a business was around 80 years, today it is less than 20 years. Clearly, entrepreneurship is more like a deadly roller coaster than just a smooth sail. Disruption has always been prevalent but what has changed is the speed and complexity with which things get disrupted. Whenever one talks about disruption, one has to bring up anti-fragility and how important it is to have in a business. Such a business has the potential not just to survive the test of times but thrive in chaos. Businesses that have a very little rate of change, low dependence on suppliers/government and are run conservatively have a higher chance of surviving extremities like wars or full-blown recessions.
Last 100 years have witnessed many geopolitical events- starting with World War I that lasted four years. This was followed by the World War II which went on for six years. That in itself covers about a decade of extreme unrest. During the times of war, businesses practically shut down, stock markets are closed, the government’s only focus is on defence so there is negligible public spending, and economies are usually either on their last legs or in some cases are completely destroyed.
Apart from the geopolitical issues that we’ve had, survival during the major economic crisis has also been equally challenging- from the Great Depression in 1929 which lasted for an entire decade to the global financial crisis in 2008 led by the collapse of the housing market in the USA. The effects are similar to wars- stock markets crash leading to loss of billions of dollars of savings, major cutbacks leading to rising unemployment, fall in global trade resulting in recession in most economies and a sovereign debt crisis in some. All of this mostly leads to rising interest rates, inflation and a poor standard of living for those who survive.
Though India in itself wasn’t directly involved in the World Wars, since independence it too has had its fair share of geopolitical issues (multiple wars with Pakistan & China) and economic disruptions like that of early 1990s which led to opening up of the economy, Asian currency crisis of 1997, dot-com burst of 2000 to contagion effect of the financial crisis in 2008.
Keeping all the above in mind, there are more than a few companies which have seen the light at the end of the tunnel and are in fact blossoming to greater heights even today. We have made a list of such companies both of Indian origin as well as international. Though there are always some exceptions but certain common traits would be applicable to most of the companies that have survived – they are highly customer oriented, have consciously reduced dependence on the external environment, have stayed away from leveraging balance sheets and are run by focused management teams with proper succession planning in place.
Following are some of the popular Indian companies which have been in existence for over a century:
Name of Company
Year of Establishment
Bennett Coleman (Pvt.)
Shapoorji Pallonji (Pvt.)
Bombay Dying Co.
Some International Companies:
Name of Company
Year of Establishment
Jim Beam (USA)
Brooks Brothers (USA)
General Electric (USA)
Bata (Czech Republic)
Rolls Royce (UK)
Disclaimer: This is not a recommendation to Buy/Sell. Read complete disclaimer here .
My post on ‘What Really Goes Behind Stock Research?’ where I talk about Initial Research Vs Maintenance Research & returns per unit of stress, dwelling further upon an old post by Prof. Sanjay Bakshi, written for Safal Niveshak’s Outside the Box newsletter:
Jatin Khemani, CEO of Stalwart Advisors presented on ‘The Art of Selling Stocks‘ at Investors Carnival, Goa, 4-8th October 2018.
Having a sound exit strategy is crucial to protect gains for value investors. This presentation covers Stalwart Advisors’ framework developed over the years through own mistakes as well as vicarious learning along with numerous case studies to help investors understand the nuances better.
The conference was covered by BloombergQuint. The video of the talk along with slides can be accessed below: