Audience Question: How to manage himself when new ideas are available, but capital is limited as everyone in the market has a limited capital. So how to manage this because people don’t want to sell current holdings for new holdings. I think you also advise that if there is a story, which is good, don’t be tempted to select for everything new that comes about. Can you talk a bit about that? It’s probably the most relevant question for every retail investor.
Raamdeo Agrawal: Let me tell you the way I would do it in this situation because this problem is there with everybody. Capital, howsoever big you have, is limited but with more capital, more ideas come. So, what happens is that when the ideas come, you have to really see how attractive the idea is compared to what you have. Ultimately, even if you’re holding say, 20% of your portfolio, you are holding a two and a half crore worth of ideas or a particular idea, which has been very successful. But today at current prices, what do you think, reassess it yourself and figure out how that idea (will evolve) in the next five years—what do you think it can do? Can it double in five years? Typically, after the stock has done very well, typically, the pressure in my mind would be more like, would it double in five years or maybe four years. So, there’s a kind of 15% – 18% kind of a return potential there, but you are getting something where you are likely to triple your money, 4x your money in the next 4-5years, it’s just a brand-new idea. So, I would not mind trimming my allocation as I said two-and-a-half crores out of 10% or 25% of portfolio. I do not mind trimming it by 5% and putting that money into a new idea, but that ‘calibration’ is really your call. It is about the gap between the value price perception I have of the existing holding and the value price gap of the new ideas that come in. Many times what happens is that, you have the tale of five-seven ideas, which are actually not doing well or it might be below your purchase price and you do not want to book losses, but actually, in your mind the potential is not that high. I do not mind booking loss and moving onto the new idea.
Audience Question: How does one investigate the underlying value of a company? I mean, this is not a value investing conversation, but would you want to take a minute and answer that if you can?
Raamdeo Agrawal: We must know what the 90% rule of success of that particular business is. So, in understanding value, is it in the circle of your competence? Can you figure out, do you know, what the 90% rule of that business is? Once you know that, like in real estate, it is the location, location, and location. Now, what is the importance of that location in looking at a house when you’re buying it? So, once you know that this is a location I’m looking for, it is on the riverside or seaside or whatever, in your mind value is very different for a piece of land, which is overlooking the Taj Mahal. Then there will be a price. So, he (the seller) will say ‘x’ price you are expecting a ‘2x’ price, but he is quoting the single ‘x’ price, then you go and buy. You have to really figure out what the value in your mind is because value, if it is a business enterprise, is determined by current profitability, growth, longevity of growth, because the profitability will decide your free cash flow and the growth will decide how big the cash flow’s stream will be and then the summation of that. So, in the next 10 years, if something is going 25% and 100% free cash flow, the investor will make 42 times of the current profit. But if the profit is Rs 10 rupees today, he will make Rs 420 in next 10 years. Now, you might get this company for 10 bucks, 20, 30 bucks or 50 bucks. It depends how much you are getting it for because the price is there. See, what I have seen is that the market is truly a place where it has stories undiscovered, or it is hated or it is not known to the people. You can get a Rs 100 thing for Rs 5 or Rs 10 and in a particular depressed market, the valuation is even more attractive. So, the price is known to everybody, but you should know how to judge the value of a company.
Audience Question: What is your framework for selling or exiting a narrative?
Raamdeo Agrawal: Ultimately, we are also human and you have read some 30-40 books or 50 books, and you have some 5-7 things which work but it is quite possible that story does not play out and your interpretation of the story is wrong. It happens many times. I met a company in packaging, which has about, 75-80% market share. Clearly, they are the king of what they make. I heard this story and I fell in love. We invested in it also but later on, after five years with 75% of this thing, then you are in the seller’s market. Your working capital cycle is very small, you can call your money whenever you need it, you do not have to borrow, you work on the client’s money, those things are supposed to happen, it did not happen. Even till now, it has not happened. So, what do you do? Then we will have to sell. So, a lot of times, there are exceptions to the rule, and you have to realise that is where you get into a three-year cycle. For any story to be tested, give it a three-year framework. If it does not work in three years, have a serious re-look and just exit.
Audience Question: How do you decide on position sizing and more importantly, the criteria for ramp up? What within the narrative makes you believe that, hey let’s ramp up? Is it the numbers then, do the numbers take over then or something in the narrative can also change?
Raamdeo Agrawal: You do research for initial position sizing. I don’t like to buy less than 2-3% to start with and if the ramp up is very fast, because growth has that magical thing. One is growth in the earnings. Second, the market is scaling the P/E multiples up. So, if the P/E multiple goes from 15 to 30, and the earnings growth just about 25-30%, you imagine, it almost goes to 2x-3x, so you have to, and meanwhile as you buy it, your listening increases, and then you’re doing a lot of micro thinking about the company and the opportunities. Many times in good stories, in fact the conviction increases, the validations come in the quarterly performances, what’s really happening and what are the new plans. See in businesses, one of the advantages that I have is that I’m a businessman, I have seen it from being a simple sub broker to building Motilal Oswal to current levels. One of the things in businesses is, even entrepreneurs don’t know what they will finally become. It is the journey, entrepreneurship is a complete journey and an entrepreneur is pushed by his own successes. Success makes businessmen do crazy things and success breeds success. So, when he is successful, he tries to scale it, that success is being scaled up and wherever he fails, he absorbs the shock and moves on. So, what successes lie ahead? That’s why macro is very important to assess the opportunities which are coming on the way. Market does not price it that efficiently and entrepreneurs also do not know it. We do not know macro and micro either, where it is going to happen, how far away it is and how big can it be. So, a lot of these things just go on in the mind. So, in 1997, I was very clear about value migration from Boston to Bengaluru, and I knew it, but our own mind is so small. We did not know it would be kind of a $1 billion opportunity. We thought if you are doing $200 million and if you want to do $1 billion in next five years, that itself is a huge ambition to have, to do $1 billion. Then having achieved $1 billion, can the company go to $10 billion? That is a very different thing. What has brought them to $1 billion cannot take them to $10 billion, and from $10 billion, can it go to a $100 billion in the same way? So companies also keeping innovating.
Audience Question: Do you believe that ‘India’s per-capita income will grow multifold’ narrative? You’ve always spoken about it but do you think now is the time that this will happen? Do you believe the narrative behind this thesis of rising per capita income?
Raamdeo Agrawal: The global GDP is about 90 trillion, the global population 7 billion so we are talking about $12,000-$13,000 per capita global income. We are at about $2200. It is for you to judge whether this country has potential to go to at least the average, forget about above average. I sincerely believe that this country deserves much better than the average, but at least let’s go to the average. It’s a very large country, and even if you go to say more like even $5000-$6,000, which is more than doubling that is going to happen in 8-10 years, let’s not think beyond that. Going from $2.5 trillion to $5 trillion is very achievable and if we keep growing at 7.5% to 8% -when you say 8% what are you talking about? It is $150 – $160 billion additional per year, when U.S. talks about 2% or 3% on their $60,000, you imagine what the number is that you’re talking about. So, we must see and contextualise when you say 8% of $3 trillion dollars, it is about $250 billion, that is a quarter trillion for the whole nation in a year. When China says 6% on their $15 trillion, it’s almost a trillion dollar. China’s incremental growth in absolute terms, is 4x of India though the percentage looks as if we are doing better. You have got to understand the numbers and the compounding. I am very clear, with the digital prowess we have, we have a stable government, we have a democracy, we are one market. Once the government is hell bent on delivering this 8-9% growth, that should be the economic end of this government. I am hearing now more and more about this economic agenda because that solves all the problems—political and geopolitical, but what about the other agendas? That is completely on them but if you get the economics right, then you have the freedom to pursue other things.