In the portfolio which you manage, I have never seen you play the theory of mean reversion. A lot of fund managers say what has worked in the past may not work in the future because the biggest truism in the market is mean reversion. But you tend to buy good companies when they go down rather than flipping and flopping out of sectors?
Yes, the mean reversion theme across sectors or across quality of companies does not work well. Mean reversion is an important concept. It can happen in the journey of a company and a good quality company that falls out of favour of the market at points in time is a good place to be. It is a good place to invest in because you know that the quality of the management, the quality of franchise is strong and they will come back. Two of the great examples of this are Motherson Sumi. In March, April, May, the company was beaten down and was trading below Rs 60. It is an outstanding franchise with a great track record beaten down so significantly that you can bet that they will revert somewhere close to their mean.
Similarly, there is Bajaj Finance. It was down 60% from its peak at that point in time which basically means that this business will see its earnings and cash flows impacted by 60% every single year from then till infinity. As it happens, even their business in the current financial year was not impacted by 60%. That is where the mean reversion will play out but we do not generally see it playing out saying that the public sector companies are cheap and private sector companies are more expensive. So, there will be a mean reversion there. But mean reversion is not a story that we would bet on.
What about your good old favourite ?
Eicher is an interesting story. It is a very high quality franchise. It is a business that has one of the highest returns on equity and capital in the automotive industry — the Royal Enfield business. And it is a company that can boast of a truly global brand that is owned by an Indian company with possible exception of Jaguar. They are a formidable player in the mid segment globally and are unique in that space. I think the challenge for them has been more in terms of growth over the last few years and part of that had to do with the level of price increases that had happened.
It was already the most expensive sort of motorbike in India and with the price increases over the last few years, it has probably become a little bit unaffordable to many people and it will take some time before the earnings power catches up with that price. But in terms of franchise, it is fantastic. This is an example of the type of companies with high quality franchises which was beaten down six, eight months ago and has shown reversion to the mean. The price has rebounded quite a bit and now they can deliver on the earnings.
They seem to be doing a lot of right things in terms of introduction of new models, in terms of expanding the distribution footprint, expanding the global reach and all of those are the right steps to take. We have to see the impact of that flowing through in terms of numbers and that is a key monitorable over next year.
In Mumbai terminology, if one has to go from Churchgate to Kandivali and that is the duration of the entire market, where do you think the train has reached? How much more does this bull market have to offer?
I would say we are more than halfway through that journey, particularly as it relates to the multiple rerating that has happened. Back in March and April, the price to book basis market valuations for small and midcaps were probably as low as you had seen during the financial crisis or even lower than that.
They have rebounded from there. It happened very quickly and that was surprising. That part of the story in our view is more or less over. There is always this view that the pendulum can always swing a little bit too far so I would not count that out, but the way we are looking at underwriting investments today, we are saying that we want to invest in companies that have that ability to deliver significantly higher than market earnings growth of more than 20-25%.
Even if there is a multiple de-rating, we can still generate fairly good returns. If multiples stay where they are, then we generate 20-25% returns. But even if the multiples derate over the next three, four, five years, you will end up generating mid teens or higher returns and that is the outlook that we are taking when we are underwriting businesses because the multiple rerating can only go up that far.
It has already crossed the median number and from a stock picking perspective, companies or sectors that can deliver that superior earnings growth or fundamentals, can support those high valuations and drive the returns going forward.
The next 12 months could be big for pure internet companies, be it Policy Bazaar or Zomato and perhaps two, three more. Which is the one you are excited about?
These are all great businesses but I will take a step back. India is one of those fascinating places where these great internet stories are either smallcap or midcaps. Even those companies that you mentioned when they come out and get listed, will still be in midcaps. Pretty much everywhere else in the world, these types of companies are largecaps and that is driving the returns in the US or China or maybe in some pockets of Europe as well.
In India, these are still largely small and midcaps and that is what gets us very excited that if one picks the right companies which have that long term success story and buys them at reasonable enough valuation with respect to that growth, one can generate pretty good returns. For companies that are in areas where they are going to be the strongest player with very limited competition ahead of them, say somebody like PolicyBazaar, should do extremely well.
But there are a whole host of these companies which over the next year or two will become public. Some of them are tackling some very difficult problems like Delhivery. It is in the logistics space which is very tough for a number of years but they are trying to tackle that problem. That is a great example of how you could deploy technology in the old economy sort of sectors as well.
We are pretty excited by a whole host of companies where one has to wait and see at what valuations they become available to investors and see at that point in time, what sort of prospective returns are available.