What makes Parag Parikh a great investor

By Morningstar |  28-11-14 | 
 

At the Morningstar Investment Conference 2014, Parag Parikh, Founder & Chairman, PPFAS AMC Pvt. Ltd, shared his views in a panel discussion on value investing. Parikh is an expert on behavioural finance, a stock market veteran and an author. Below is an excerpt of his views. 

What type of value investing works in India?

The Warren Buffett way of value investing would really work in India where you maintain a margin of safety when you buy. It is difficult for the Benjamin Graham style of cigar butt investing to work because we don't have corporate raiders here who can unlock value. We have courts of law, but no courts of justice. So if someone attempts to do something, it will take years and years before value is unlocked. So, in this sort of a system I think Warren Buffett philosophy would work very well.

You have often stated that your basic investing philosophy is based on the “law of the farm”. Can you explain that in the context of value investing?

When investing, you must understand that you are buying a business and not a piece of paper which will tomorrow go up or down depending on market sentiment. When you are buying a business, it is very important that you understand how the system works.

There are certain laws which are made by men. They change and are manipulative in nature. For example, you short and you make money, you buy futures and options and you make money. You give him an upfront commission and you get more clients. These are all short-term manipulative practices.

On the other hand, there are laws made by God-- the universal principals. One of them is the ‘law of the farm’. You cannot sow something today and reap tomorrow. A seed has to go through different seasons, before it turns into a fully grown tree and starts bearing fruit. Value investing is boring. You have to wait for years.

People may want to follow the value style of investing but then miss out on the waiting part—which incidentally is the most difficult. You can learn all the right things and invest, but it will be futile unless you have a long-term view. Imagine growing grass. You water the ground every single day. You may not see any shoots come up for a while. But in the long run, your effort at watering the garden will help.

Can you give us a bit more insight into what behavioral principles are most important for value investors?

Value investing is all about buying something which is less than the intrinsic value. So, it's all about common sense, it's no rocket science. Nobody should be buying a stock at a rate higher than its intrinsic value, because then you are looking at the greater fool theory to come into play -- that someone would buy it again from you enabling you to make a profit.

There is a difference between value in use and value in exchange. Water is an essential commodity for us which has got a fantastic value in use, but not many people will give you any money for it. And value in exchange is something like a diamond; it may not be useful to you. If someone is dying, it would be more useful to offer them water than a diamond. But the diamond has got a tremendous amount of exchange value.

So, when we normally look at value investing, we must realise that when chasing power stocks or something like that, the company will not have pricing power. But it has got a fantastic value in use. If you think those companies will be able to make phenomenal profits for you and make you really wealthy over a longer period of time, you could be wrong. Simply because there are certain constraints on how much power can be priced at.

So, from a behavioural finance point of view, you have to be really sure as to the right opportunity. As Warren Buffett said, “Be fearful when others are greedy, be greedy when others are fearful.” If you have the conviction and the patience to really wait for such times, the market will come and give you such times. But the problem is that investors perceive a stock to be more risky when nobody is buying and the price is low and less risky when everyone is buying and the price is high.

Can you name four parameters of a good business as per your philosophy?

1) Businesses run by credible management. One of the biggest challenges in India is that you are going to be a minority shareholder so you must invest with a credible management who really treats its minority shareholders well.

2) Businesses which I would be able to understand and which are simple to understand.

3) Businesses which have strong moats around it.

4) Pricing power.

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