Your wealth-creation study has completed 25 years. What has been your biggest learning?
The main learning is that the fastest and biggest wealth creators are high quality companies. It is very clear that only quality wins in the long run. On a five-year basis, the fastest growing companies need not be good in terms of quality. In fact, 20-40% of such companies are poor quality. But, in 25 years, the real quality of the company comes out and they tend to be pristine.
One aspect that stands out in your study is that only 100 companies have beat the Sensex’s 9.2% compounded returns in the past 25 years. What does it say about equity investing?
This shows that long-term money-making is very tough. One thing the study doesn’t talk about is the newer companies. And this is only one third of the wealth created in 25 years; two-thirds of the wealth have been created by the newer companies that came in the past five years, 10 years or 15 years. So, the message is you must play with your winner, but keep looking in the horizon for newer companies, which will grow and create wealth bigger and faster.
Infosys has been the fastest wealth creator in your study but it lags behind in terms of consistency rankings.
Infosys is one odd man out here. It is the fastest wealth creator and third in the biggest wealth creator list but it is on the 61st spot in terms of consistency. That is because of the handling of the leadership changes in recent years. There was a crisis in the leadership and then Nandan Nilekani came back. That resulted in them losing 8 to 10 years. In fact, the crisis spoiled the outlook for the entire industry. In 1995, their PE (Price to Earnings ratio) was 26 and now it is 17. It was never a performance issue at Infosys but mainly a leadership issue. So, when you have a large-cap quality company in a sector at 17 PE, how do you expect mid- and small-cap companies to trade above 12-13 PE? So, it was a case of a bellwether impacting the whole sector. Now, that is what Nandan said, Infosys wants to get back the bellwether status which is now with TCS. There can be a joint bellwether status for the industry.
Consumer companies have been the most consistent wealth creators. Will it continue?
It is clear that the market overly values those companies which are consistent. If a company is growing at 15% consistently, it would prefer a company that is growing at 25% inconsistently. The market punishes any kind of inconsistency big time. This is what I have learned. That is why two-thirds of the wealth creators are consumer businesses, which are the most predictable. It is so predictable that 99% of the consumers in Maharashtra behave exactly the way consumers in Punjab behave.
Why have infrastructure companies not been able to create value? Historically, in most developed markets, value creation started with infra companies and then it shifted to consumers. In India, the infra piece seems to be missing.
The problem is with the government finances. Infrastructure cannot be done by the private sector. It is the fundamental responsibility of the government because there are a lot of difficulties. They are very complicated and are very low IRR (Internal Rate of Returns) businesses. Invariably, many of them are social projects. Our real problem is tax to GDP remains at about 11-12%. And when our GDP was less than a trillion, it was 11-12% and when our GDP is at Rs 3 trillion, then also it’s at 11-12%. Basically, there is no buoyancy in the tax collection and there is no surplus available for essential services by the government.
So, the government does not have enough to spend on infrastructure. That is why all companies related to construction and infrastructure are growing at a slow pace. Infra spend can go up from 2 to 2.5% but is that enough. Elevated infra spend should happen consistently for almost a decade.
Many of the top wealth creators in your study are at premium valuations. Is it worth buying them now?
All these companies are great but the stocks are overvalued. The moment you buy too much overvalued stocks, even if they do well for three to five years, your returns could be mediocre. You can afford to pay for the overvaluation on a 25-year basis. But that cannot be done on a 3-5-year basis. And let’s face it, we all are ‘3-5-year-investors’. So, our appetite to pay for overvaluation is very low. And if you are buying these companies for less than five years, you should be prepared for mediocre returns.
What is your assessment of the market now?
One of the things is that central bankers have emerged as Gods. The US and European central bankers are literally bigger than Gods. They are printing money left, right and centre and that too at zero interest rate. What has happened is that fixed income has crumbled. Who wants to buy fixed income at 1% except for some pension funds which must buy? So, it is more of a crisis in fixed income. There is nothing else left other than equities. But since equity is risky everybody is not that comfortable.
Just eight months ago, there was a 50% erosion in market value and whatever confidence was created in the past six years just went down the drain. So, the market is really climbing the wall of worry. I hope in 2021 the world will overcome Covid completely and get on with business normally.
How should investors approach 2021?
That’s a tough question. But, the first thing I always say is do not time the market. Nobody has ever got it right all the time. If somebody managed to sell pre-Covid, they ended up missing the market bottom in March. The key will be to understand your risk appetite in equities, buy high quality companies and hang in there. You will make your money.
Mid and small-caps are playing catch up with large-caps. Can this sustain?
FPIs (Foreign Portfolio Investors) are buying all the large-caps through ETFs (Exchange Traded Funds). This means we locals are selling all the large-caps. So, whatever money we are getting by selling, we are putting it in mid-caps and small-caps. So, someone would sell Infosys and buy Tata Elxsi. This time the thing is that they are not buying through the active route. Majority of the flows are passive. And because of these flows, valuations of many of these stocks are not even justified.
The leadership in the market rally since November has shifted from quality and growth to value-oriented stocks. Is this shift long-term?
Increasingly markets are becoming so complex that we should not bother too much about what is happening in the market. What Benjamin Graham said 48-50 years ago was that don’t bother too much about the market. Bother about what we have to do. Market leadership will keep changing every month. I cannot keep changing my portfolio every time as per the market conditions. I have to buy my set of companies and wait for my time to come.