investment strategy: Stock picking: 3 factors that are driving Rahul Rathi’s investment strategy
How are the markets looking? Where are you picking your spots?
Rahul Rathi: Let us look at the background and then I will tell you how things have changed. Over the last 15 years delivering returns, we have always believed that good companies with large volume growth meant a certain value-addition and asset appreciation could happen to the portfolio. We believed in businesses that had a certain volume growth, which was about 10% and which did not borrow money. That means they also had pricing power and these companies would create a significant amount of appreciation and we were in an environment where interest rates kept on coming down. Because of that asset appreciation fell in two parts, just because interest rates kept on coming down, valuation started going up and then these businesses continued to grow at a healthy pace.
There was a certain return that was more than the cash flows that they generated. There were multiple expansions and the second part that happened was the fact that operating cash flows continued to do well because of volume growth and both created a very nice mix of asset appreciation.
This was Purnartha 1.0 when we used to talk about it. It was easy and was almost similar to people who held Asian Paints for 20 years, held HDFC Bank for 20 years and continued to do well because the opportunity cost of capital at that point because of interest rates coming down was almost 20-25%. So, it was criminal not to concentrate because you are getting great businesses with an asset inflation and that strategy worked very well for almost 15 years.So that was the first phase. What about the 2.0 strategy or 3.0 strategy? Where are you investing right now? What is your view on the market and where are you picking the spots?
Rahul Rathi: Here is the background on data given the names that we mentioned earlier. The thought process for us is that returns are going to be lumpy. If large-cap bets can deliver significant alpha, then you have liquidity and your opportunity cost of waiting for serious multi-baggers is very low because these stocks are delivering 25-30% returns. And then you have a chance to continue to bet on emerging businesses, which can give you the next 20-30 times of returns.
Our strategy depending on volume growth has changed because interest rate environments have changed. We have added two more drivers to our strategy. The first driver is volume growth, the second driver is operating margin expansion and the third driver is a valuation and our understanding of valuation. We picked up GAIL last year at Rs 110, margins were at 1% compared to historical margins of 13% to 15% and we knew that margin contraction was temporary. Valuations were lower. It was a largecap and we rode the benefit of that. We are riding the benefit of a similar thought process in Tech Mahindra.
So, it is a bottoms-up strategy and instead of one driver and the environment where interest rates came down, we are continuing to focus on three drivers, regardless of what the interest rate environment is and continuing to deliver a certain amount of return.
Apart from GAIL, what else?
Rahul Rathi: Apart from GAIL, we have got Bajaj Finance and HDFC Bank which have not done well for the last three years. But while Bajaj Finance has not done well, Bajaj Holdings has delivered a 33% CAGR over the last three years. Taking cues from that thing, what we realised was we bought Bharti, but we got partly paid. So, the alpha that you get because of the Rs 400 difference is much higher.Why do you like financials? Ultimately financials have a leveraged balance sheet and the return on capital, which is an important metric, is in the 20s while for Asian Paints and Pidilite, it is 30s or 40s. So, with a leveraged business, if you are getting this kind of a return on capital, is it a good business to invest in?
Rahul Rathi: Think about 2020. During COVID, how many financial institutions went bust? So, Indian borrowers are so good that we do not need to bother about risks. The reason why we picked up great franchisees was because of their ability to collect and their knowledge about risk management.
After 2020, I do not see any value premium paid for a good business with very good risk management fundamentals. Essentially, it is just about growth, not about the risk side of things and if I pick up a great business, I apply all my expertise in the team and find out that here is a business that understands risk, knows how to price risk and will continue to deliver a certain risk adjusted superior return.
I look at the premium that it should have compared to any other business that is just growing. I do not see a difference. So, I do not know what value add will I have in identifying that. My knowledge is a liability in the financial investment sector because I will look at risk first.
link