For wealth creation, what matters the most is a person's investment process. Raamdeo Agrawal, joint managing director of Motilal Oswal Securities, has spent decades studying and perfecting the investment process. In this interview, he discusses the important aspects of investing while presenting the Motilal Oswal wealth creation study for 2012, where he has focused on the concept of economic moat, which was coined by legendary investor Warren Buffett. Jitendra Kumar Gupta spoke to Agrawal on the merits of economic moat and his views on the markets. Edited excerpts:
This time in the wealth creation study you have taken economic moat as a theme. Tell us about it and how investors can benefit from it?
Economic moat is a very simple and effective tool when it comes to investing in equities. The concept has its roots in the idea of a traditional moat. A moat is a deep, wide trench, usually filled with water that surrounds the rampart of a castle or fortified place. Similarly, an economic moat in investing means protection of company's profits from being attacked by a combination of multiple business forces. Traditional management theory terms such as sustainable competitive advantage or entry barriers essentially connote the idea of an economic moat. I believe with clear understanding of the concept and effective application, moats can prove to be fundamentals of wealth creation.
In the corporate world if anybody is making money others will come and attack, which is given in any sector -- be it telecom, housing finance and many others. Over time a three-player game becomes a 30-player game and the companies within the sector go through stiff competition as a result of supply.
But how do you relate this to investing?
In the stock market, we want companies that make money. So, preferably we would like to buy companies which have a strategy that makes money, despite the competition in the sector. In cricket terminology, it is like all the eleven players standing and Tendulkar striking the most difficult ball to the boundary line. Every player has the same physic, what differentiates them is the skill sets and the strategy. So, every company should have a unique strategy. You have to walk the same path in your own way. One needs to invest in companies which have moats.
Has this strategy been proved in the past?
We have done this interesting study. We looked at 177 companies, which fulfilled the basic criteria like market capitalisation, financial history, etc. Out of these, we found 71 companies to be economic moat companies (EMCs), which have competitive advantages, while the rest 106 companies were non-EMCs. The results were striking. The basket of these 71 companies or EMCs, grew at rates double that of the basket of non-EMCs. This is in terms of share prices, which is a more intelligent number or the collective opinion of the market that captures everything. Also, worth noting is the fact that during the years 2003-2012, the Sensex gave annual returns of 18 per cent whereas the EMCs gave annual returns of 25 per cent. Irrespective of the valuations there is huge outperformance by the EMCs. And, if on top of that, one can bring in the valuations aspect intelligently, the returns would be better.
Unless the company makes a lot of money you cannot make money. If Kingfisher Airlines did not make money its shareholders too, cannot make money, which we all know today. So, if the company has to make money it should have some economic moat, which is where the significance of the concept comes into picture. This is the mantra of successful investing I understood after 30 years. And if you too, understood what I mean, you will be blessed. If the moat is attacked by outsiders, the company will stop making money. You will have to keep watching the companies whether they continue to have the moat.
Ultimately, investing is about how much insight you have. Largely, the retail investor invests in non-EMCs. The index constituents are full of EMCs. Globally, like in the US, index investing is very prominent. I think in India too, if you propagate the (concept of) index investing that would be a far better strategy than timing and picking individual stocks. Remember, blue chips have this habit of making money for the investors. Irrespective of all doubts, HUL will find ways to make money, Infosys will find ways to make money. But as an investor we have this tendency, if we are expecting a six per cent return from a stock in a year and if it gives 35 per cent we tend to sell it or book profits. Once the stock is out of your portfolio we regret the move.
How are you reading the rally in the Indian markets?
I think the rally is going to sustain. Look at the valuations - we are trading at only 15-16 times one year forward earnings and the earnings growth is expected to be in the region of 10-12 per cent. Triggers, you do not know, recently the rupee depreciated significantly and there were worries about India's downgrade. The government has to act, it took 30 months to clear one Bill but you will now see 30 Bills being cleared in one session (of parliament). If the rupee goes beyond 56-58 levels against the dollar that will automatically trigger an urgency. We have already seen GDP hitting the five per cent growth levels.
So, the government will do everything to revive growth. Otherwise, tax collection too, will be hit. Globally also, the US will do better next year. So, what I am saying is that even if the PE remains the same, just on the basis of the earnings growth of about 15 per cent, the Sensex, which is at the lower end compared to the 25 per cent growth in the last twelve months, could go up to 22,000-23,000 from the current levels of 19,000. Importantly, once the Sensex hits 21,000, everybody will turn positive and sentiments will change. Then we will have new investors and a new show to begin with.
Could it be a new bull market similar to the one we saw in 2003-2008?
It seems to me that it could be a new bull market. We have already seen the bear market for about four to five years. Remember, we are yet to see the PE rerating of the markets, which can easily take this market to new highs. That will happen once retail money starts flowing into the market in a big way, leading to perfect euphoria kind of valuations. Retail investors usually sell at 10 PE and come (in) at 20 PE. In 2008, about Rs 50,000 crore was invested in mutual funds by retail investors, which is about one per cent of India’s GDP. This time we could see more than Rs 1 lakh crore coming from retail investors by May 2014 or 2015.
We have seen in this market rally certain sectors bouncing back whereas a large number of sectors are still trading at lower levels. Do you like any particular sector at this point in time?
I prefer consumer space. There is value in automotive companies. I would not say that you put 100 per cent of your money in the consumer space. There will be different sectors at different times participating (in the rally) in line with the changing dynamics. Look at what is happening in the media sector space today. I think there is going to be huge action in the media space, going forward, as well as due to digitalisation. Till now the money was flowing at the local cable operator level. (Now), if the consumers’ money flows to the content provider there’s going to be huge gains for some of these players in the coming years. Till now, digitalisation is seen only in the four metros, imagine what will happen if digitalisation expands to the entire country!
Where have you put your money in this rally?
I have bought Cairn India, Eicher Motors, McLeod Russel and Gruh Finance.