Hiren Ved of Alchemy Capital has evolved from being a deep value investor to growth at reasonable price (GARP), to growth with quality. But he does concede that certain attributes remain unchanged: business model, sustainability of the business, size and scale of opportunity, and longevity of the business.
Here are some of his insights he shared at the Morningstar Investment Conference in Mumbai.
With so much of disruption and technological change, can we even think of longevity?
Yes.
The real results of investing are only visible in the very long term. In the short-term, there are cycles. Maybe the cycles are getting shorter, but nothing can be achieved in a very short period of time. A lot of these great successes that have been built in a very short period of time die out very quickly.
When somebody says, I earned a 15% CAGR, it's not every year that he made that return. There would be phases of subpar returns and then all the returns come up in a few years.
The process of wealth creation or earning returns is not a switch and returns in stock markets are truly nonlinear.
How long do you hold on to a stock?
I don’t have a standard holding period. When I invest in a company, I go with a view that I want to hold it for at least two to three years, if not more, but I'm happy to hold companies for 8, 10 – there are companies that I've held for 10 plus years, 15 years, but it depends on several things.
It depends on the opportunity.
It depends on my hypothesis.
It depends on how companies execute on that hypothesis.
Every company cannot be a HDFC Bank or a Bajaj Finance because things change.
There is a blind faith that people have in the fact that you just have to buy quality, and everything will be fine. No, it's not fine. The context in which you invest changes and it is very, very important to understand that.
For example, there is a raging debate about Bajaj Finance valuation, about Avenue Supermarkets valuation and equally good quality companies are Eicher, Page, Bosch. They're all great companies. But why is it that some companies are still very close to their highs, all-time highs in a market like this and some companies have corrected significantly from the top? I don't think that the quality is in question. I don't think the opportunity is in question. I think what is in question is that currently in an equation, if growth slows down, it is going to impact your valuation in the short to medium term. And that is a reason that, you know, Bajaj Finance, when there was a growth scare in between very recently, where I think Sanjeev Bajaj's tweet was misinterpreted, the stock was down 10%. Because at that valuation, if one of the two equations falter, which is growth and return on capital, then you could see a de-rating of a stock that could happen.
You like growth with quality. How do you define quality?
Simplistically, there are two parameters.
Metrics like return on capital, leverage, is one. The other is how respectful has the management been of the capital that they have or the surplus generated? How disciplined in terms of capital allocation? Everything can be good, the opportunity can be significant, the entrepreneur can be great in executing their opportunity. But if you are not disciplined enough to allocate the capital and the surpluses that you generate from your success, it all goes down to nil. And that is where the biggest accidents happen.
When it comes to valuation, there are two equations to look at. One is growth and the other if I simplify is return on capital. If you have both, you have fantastic results. If one of the two gets diluted, the valuation of the company will get diluted.
How do you look at investment opportunities?
The most important thing is that the opportunity for that business has to be large and growing. If you look at the history of the best-performing stocks over 5, 10, 15, 20, 25 years, one thing that stands out is that these are companies that have been able to scale. If what you were doing at Rs 500 crores, can you do that at Rs 1,000 crores, can you do that at Rs 5,000 crores, can you do that at Rs 50,000 crores?
Be it Infosys, TCS, HDFC Bank, the common thread that runs through all these businesses which have created tremendous value is that the opportunity has to be significantly large. Obviously, you need disciplined management.
Tell us about the logic behind your Select Stock strategy.
I think the 80-20 principle applies everywhere in life. It is the few ideas – if you study all the successful investors, whether in India or abroad, they are all a product of few big ideas that made it big for them. So, why should it be any different in investing? Why do you have to invest in 200 companies to make money? I think it's a very suboptimal way of investing your money. Maybe when you are starting out, it is fine. You start with a mutual fund, where you have 40, 50 companies. But I think as you evolve as an investor, you have to narrow down your universe to a few companies. Too much diversification kills returns.
We had a Harshad Mehta bull market in 1992. And then, there was a crash. Between 1993 and 1999, the market was consigned to one range. The Sensex went from 2800 to 4000. Until that peak got taken out in 2000 by the tech boom. And again, we fell down to 2800. People forget that we can be in a broad range for years together.
More often than not, I have seen that the equity market in India is generally sideways, consolidating or correcting interspersed with 18 to 24 months of raging bull markets, which we think is going to be the norm. Now, what happens when you have a market which goes nowhere or is consolidating in a range, when you have 200 stocks, your returns are going to get diluted because something will do brilliantly well, something will do average, something will do very badly.
So, we decided that we need to change the way in which we invest money. Under the Select Stock strategy, we create a portfolio of 8 to 10 companies. The portfolio construction is very, very important. These are our highest conviction ideas. And we kept the minimum ticket size as Rs 3 crores.
Over 5, 7, 10 or 11 years across the strategy, we've been able to generate an alpha of somewhere between 750 to 800 basis points and it is possible by running a fairly concentrated strategy.
The standard deviation has been far lower than the benchmark and the beta of the portfolio. People think that, oh, a concentrated portfolio will be very, very risky and volatile, but I think over a long period of time, it has been less volatile than what your index is.
Do you gravitate towards any market cap?
We have always been market cap agnostic. I don't want to be boxed into saying I do certain market caps. I go where I think the opportunity is.
There is a cycle for everything. There is a time when small and mid-caps are attractive, and you can invest. But you have to be clear that very few small and mid-cap companies are able to cross the chasm.
We did a study. Between 2008-2009 and 2018-2019, we looked at 1,350 companies, which were as per the definition of SEBI small and mid-caps. And we saw how many of them over a 10-year period, which actually graduated to become large gaps. And out of 1,350 companies, only 82 companies moved into the large cap bracket, which is a 5% success rate.
Some advice to investors….
- You need to understand the context behind an investment. You need to have conviction in a stock or strategy. That is why this business is part science and part art.
- It's very important to have a positive attitude when you're investing. It's important to be cynical, but by and large, you cannot make money if you are always doubting things.
- Avoid complexity. Investing is a simple business. Simplicity is easy to scale. You can't scale stuff that is complex.
- It's very important to be humble. Investing is all about killing your ego.
- Be able to accept the other points of view, even if they do not conform to what you think.
