Forget gloom and doom, cataclysmic changes create great opportunities: Bharat Shah
Every attempt at making profits out of lousy investing is a foundation for future losses.
Last year, you had made a presentation on India 2025 where you gave a detailed analysis of how the building blocks of good structure for the economy are being put in place. A lot of stuff has happened since then. How are you analysing those building blocks now?
Bharat Shah: Tremendous cleansing and purifying efforts are going on. Demonetisation was an effort to clean up behaviour at an individual level. GST is aiming to do the same at business level. Insolvency & Bankruptcy Act is to clean up the behaviour of the so-called big promoters and industrialists. RERA is to clean up a murky sector like real estate. The tremendous cleanup of bank balance sheets is altering both the lending and borrowing behaviour.
No reform can be painless and reforms definitely will mean disruption. If it were to be a status quo, then it cannot be a reform. So, reforms have to hurt, they have to be painful and then only can the rotten be destroyed and good things will be created. That is exactly what is going on. A lot of rubbish businesses and rubbish managements are getting destroyed and the good ones are flowering. You are seeing a tremendous contrast. Markets in entirety may have suffered in terms of an overall drop in last 18 months or so, but good and bad businesses have been segregated. So many of them are hitting life-time highs and lows and that contrast is healthy.
I would say we are building a base for a tremendous opportunity going forward. I remain hugely positive about what is happening rather than the picture of gloom and doom and worry that is abounding in media.
How are you analysing the balance sheet of India Inc right now? We have seen promoters being forced to sell their family silver to repay pledges because the market is treating these kind of companies very harshly. Do you think India Inc’s balance sheet is improving now?
If you structurally look at Nifty, the Nifty return on capital employed in aggregate is about 14.8%, return on equity (ROE) is at about 13.5%. Debt equity ratio is about 0.85:1. If you look at it in the context of the character of the businesses, the capital efficiency ratios do not indicate such a great bunch of names and therefore the harshness that you are talking about is not really harshness, it is catching up with reality.
Bad businesses and bad managements had to go through the punishment and trying to find value out of the bad businesses is a terrible effort. More often than not, you are going to drown yourself and therefore sticking to the right things in a disciplined way is very, very vital. Every attempt at making profits out of lousy investing is a foundation for future losses.
But you have seen 6-7 very vicious cycles in your 30-year plus of investing. How did you compare this one to some of the historic examples?
Never before has the cleaning up been such a concentrated one and carried out so ruthlessly and that is very healthy. The earlier changes were important ones but what is going on right now is a cataclysmic kind of a change. It is really sharp and very rough kind of sorting out the good from the bad and the bad from the ugly. And to that extent, it is going to bite deeper and will be visibly more harsh but ultimately, creative destruction entails that. The change which is going on right now has been longer, deeper and far more punitive in character, but eventually, it means much better conditions over a period of time.
In the last one and a half years of correction, veterans with 20-30 years experience also got badly shaken. What are you looking for in companies’ managements now?
Other than capability, integrity and passion of the managements, there are three, four more things which are vital. There has to be a very responsible sense of capital allocation, a ruthless record of denying capital to the unworthy and allotting capital only to worthy causes. Equally, not just great foresight but a terrific sense of execution . Like Phil Fisher would say, return on equities is a holy grail of a great management. It is something that you discover over a period of time. Trouble comes when we are trying to make sweeping judgement on a management too quickly at a point of time.
While it is a process that you have built up over a period of time and therefore that calls for patience. Judging management is something that you do not want to do in a hurry and if that means something is allowed to be gone, so be it. Actual error of getting into wrong one will hurt you much more than letting go off something which is worthy. To that extent, that decision about believing in a management is something that should happen only over a sufficient period of time in which you have enough measurement points to believe that what you think is right.
So if hard red on one side and green on one side, where do you see market, all the indicators put together, has it become amber or light green or is it still near the dark red?
Bear market gains are a treasure and it is something that may look like a small thing in numerical terms, but it is such a powerful thing to have. It is not merely in terms of the returns that it generates which may be a small number in a deep red territory otherwise, but psychologically, it equips you and allows you to be strengthened, so that you can deal with the market in a right way. I was not bright enough to protect in 2008 or 2001 but in the current period of mayhem, when markets nominal numbers may show double digit drop in indices, the real pain is actually deeper than that. Even a single digit or a double digit kind of positive gains has yielded what sounds like a Nirvana because it is something which is really valuable. That is what I think I was referring to when I originally talked about that process of creative destruction.
For PMS as a product, the kind of immediate attraction is that it would be midcap centric. The way inflation and interest rates in our country are structurally coming down, would it not be become even more challenging for fund managers here to produce that alpha when the index return itself will come down to 10-12% on an average?
There is a bit of a mythical construct about midcaps, smallcaps and largecaps and like fashion, people say now it is the time for this and now it is a time for that. I think very few things are more ridiculous than that. Ultimately a lot of small or mid-sized firms have gotten to be large and equally some of the large firms have gotten down to mid and small, but more importantly, the reverse also is equally true. A lot of smallcap and midcap companies have vanished and a lot of large ones have gone on to become much larger. You are investing not for the cake, you are investing for the underlying set of attributes which will create value. The virtue lies in the ability to recognise those attributes and finding the right package at the right value, irrespective of whether size.
Secondly markets are about the future and when you talk about mid and small or large, it is an opinion about how large it is today. But what is far more critical is how large something is going to be tomorrow and that is what investing is all about -- 95% marks are for future, 5% is for the present and the past. The entire debate about mid and large etc. is mechanical and really out of any investment intellect.
Recently we tried to find out the most googled market term right now and the word was slowdown -- it was at a multi-year high. The one market term which was at a multi-year low was multibagger.
Negativity is a fashion in markets much like in social media.