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 on 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.
This time in the wealth creation study you have taken economic moat as a theme. Tell us more about this theme and how investor can benefit from this?
Economic moat is the very simple and effective tool when it comes to investing in equities. The concept has its roots in the idea of traditional moat. A moat is a deep, wide trench, usually filled with water that surrounds the rampart of a castle or fortified place. Similar to a moat, 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 other will come and attack, which is given in any sector whiter we talk about the telecom, housing finance and so many others. Over a period of time a three player game becomes a 30 player game and the companies within the sector go through the stiff competition as a result of supply. This is the fact of the life.
But how do you relate this to investing?
In the stock market we wants the company that makes money so preferably we would like to buy companies which have strategy that despite the competition in the sector makes money. In the cricket terminology, it is like all the eleven players standing and Tendular striking the most difficult ball to the boundary line. Every player has same physic, what differentiate is the skill set and the strategy. So every company should have a strategy in such a way that they are unique. You have to walk the same path in your own way. In investing one needs to invest in companies which have moats.
Has this strategy 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 are economic moat companies (EMCs), which have competitive advantages whereas the rest 106 companies we called as non EMCs. The results were striking the basket of those 71 companies or EMCs grown at double the basket of non EMCs. This is in terms of the share prices, which is more intelligent number or the collective opinion of the market that captures everything. Also worth noting that during the year 2003-2012, the Sensex has given an annual return of 18 per cent whereas the EMCs have given annual returns of 25 per cent. Irrespective of the valuations there is huge outperformance that the EMCs have shown. And if on top of that one can bring the valuations aspect intelligently the returns would have been even better.
Unless company makes 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 the outsiders the company will stop making money. You will have keep on watching and reviewing the companies if they continue to have the moat.
Ultimately the investing how much insight you have? Stock investing is not at all that dumb. Largely the retail investor invests in non EMCs. If you see index constituents are full of EMCs. Globally like in the US index investing is very prominent. I think in India also if you propagate the index investing that would be far better strategy than timing and picking the individual stocks. Remember that blue chip have this habit of making money for the investors. Irrespective of the 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 6 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.
How are you reading the rally in the Indian markets? Is it sustainable?
I think the rally is going to sustain look at the valuations we are trading 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 downgrades. 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. If the rupee goes beyond 56-58 levels against the dollar that will automatically trigger the urgency. We have already seen the GDP hitting the 5 per cent growth levels, so the government will do everything to revive the growth otherwise your tax collection too is going to get hit. Globally also the US will do better next year. So what I am saying is that even if the PE remains same just on the basis of the earnings growth of about 15 per cent the Sensex, which is at lower end compared to the 25 per cent growth in the last twelve months, the Sensex could go to 22,000-23,000 from the current levels of 19000. Importantly once the Sensex hits the 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 of about 4-5 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 the retail money will start to flow in a big way leading to perfect euphoria kind of valuations. Retail investors usually sell at 10 PE and come at 20 PE. In 2008 about Rs 50,000 crore was invested in the mutual fund by the retail investors, which is about 1 per cent of the GDP. This time we could see more than lakh crore coming from the retail investors by may 2014 or 2015.
We have seen in this market rally certain sectors bouncing whereas a large number of sectors 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 line with the changing dynamics. Look at today what is happening in media sector space. I think there is going to be huge action in the media space going forward as well as a result of the digitalisation. Up till now the money was flowing at the local cable operator level, if the consumer money flows to the content provider there is going to be huge gains for some of these players in the coming years. But till now the digitalisation is only seen in the four cities, imagine what will happen if the digitalisation takes place in the entire country.
Where have you put your money in this rally?
I have bought Cairn India, Eicher Motors, Mcleod Russel and GRUH Finance.
