Top PMS fund manager explains his BMV model of picking stocks
0 10 mins 2 weeks

Anand Shah, Head of PMS & AIF Investments at ICICI Prudential AMC, says he and his team goes about picking winning stocks using the Business-Management-Valuation (BMV) framework. “If we like business potential and management quality, the last step is valuation. A good business and competent management may not always come cheap. If the business has a moat and steady cash flow, we might consider paying a reasonable premium,” he says.
Edited excerpts:

Can you help us understand your BMV model of picking stocks? Does it work across business and market cycles?
We have an in-house Business-Management-Valuation (BMV) framework that aims to identify resilient companies with a potential for long-term growth. Through this framework, we aim to identify strong companies with competent management that are trading at reasonable valuations.

Under the business filter, we aim to identify strong businesses that have the potential to grow rapidly, wherein we identify industries that can grow faster than the GDP and companies that can grow faster than competitors in those industries. The second focus is on companies with an enduring moat, or companies with a sustainable competitive advantage.

And, lastly, we prefer industries that are consolidating over those that are fragmenting. These steps are important because we look at investing from a 5- to 10-year perspective. If we do not like a business, we do not proceed further in evaluating its management and valuation.

Once potential businesses have been identified and deemed appealing, we aim to focus on their management teams, who have a solid track record in terms of corporate governance standards, competency, and engagement with stakeholders. If the management does not pass these filters, we do not go ahead.

If we like business potential and management quality, the last step is valuation. A good business and competent management may not always come cheap. If the business has a moat and steady cash flow, we might consider paying a reasonable premium. But good business and good management at any price is not our approach. If the valuation is not right, we are ready to let go of some good businesses as well. Thus, we aim to buy good businesses run by fairly competent management at reasonable valuations.
Your funds such as the contra strategy have been among the top performers in the last year. Which part of the strategy is working right?
The performance of our strategies is more an outcome of the process we follow. When it comes to our contra fund which follows the ‘contra’ style of investing, we take exposure to businesses that are currently not in favour but expected to do well in the medium to long run. The idea is to select companies in sectors that have high entry barriers, sectors that are in consolidation or companies that are in a special situation.

In general, we have a bottom-up approach when it comes to stock picking. We believe there will always be businesses that are inherently good and getting better. This is where our 20-member+ research team becomes relevant. They help identify companies with good business quality. Over time, every company has the ability to develop a moat and management bandwidth and, over the years, they invest further in strengthening their moat, thereby becoming a better-quality business. Good quality means companies that can generate higher returns on equity, higher returns on cash invested or capital employed. We also have an independent investment risk team that reviews the portfolio to understand the risk one faces, given the significant deviation from the index, in a boutique product like PMS. Further, the risk in terms of operations, compliance and audit will be addressed systematically when investing through an institutional PMS. That’s the strength of investing through an institution.

Your small cap-focused PIPE fund has given a return of nearly 15% in the last year. Can you elaborate on this PIPE theme?
ICICI Prudential PMS PIPE Strategy is a small and mid-cap-focused strategy. Here again, we have a long-term approach towards investing, where we identify small businesses that have the potential to become medium-sized or large businesses in the medium to long term. And as these businesses grow over the years, not only their EPS grow but even their P/E multiples rerate as balance sheets and business strength both improve.

Over the past year or so, through our BMV framework, we turned positive on companies in the manufacturing and manufacturing-allied sectors. In hindsight, the earnings trends have shifted towards the infrastructure and metals sectors. At the same time, the information technology and pharmaceutical sectors delivered lower earnings growth, and we were underweight in these sectors. The companies in our portfolios benefitted from this trend and helped the key portfolios in generating a reasonable alpha over their respective benchmark. This was primarily due to the process set in place to identify resilient businesses.

How are you rejigging your portfolios after the Q3 earnings season? Which pockets are you finding enough value in?
The companies in our portfolio are held from a long-term perspective and would not change significantly on a quarter-on-quarter basis. Depending on how businesses are poised to grow based on the research and analysis done by the team, we believe these companies have the potential to generate earnings over a period of time. Therefore, we believe these companies may be poised for a rerating as others take cognizance of their growth potential.

We are constantly reviewing companies through the BMV framework, and the moment a company begins to show potential, it is discussed by the investment team members. It is only added to the portfolio if it meets the filters.

Currently, we believe companies in the manufacturing area have potential, as the risk-reward appears favourable. Tremendous efforts have been made by the government to make India a manufacturing hub, not only for domestic consumption but also for exports. Over the past decade, manufacturing has been under pressure and has delivered negligible returns but that seems to be turning the corner. The balance sheets have become stronger, and businesses have seen the worst phase of competition behind them. This allows the survivors in a whole set of industries to benefit from emerging opportunities, reshaping global/regional/local supply chains through improved earnings growth in an RoE-accretive manner. Hence, as per our BMV framework, select companies in manufacturing appear attractive.

Exports are another lever that we see significantly playing out over the next few years. Each of these pockets holds the potential to improve both in terms of valuations and return on equity. Apart from this, the outlook for industries related to manufacturing (or what we called as manufacturing allied sectors) such as corporate banking, logistics, and utilities is also improving as manufacturing activity gathers steam.

A number of new-age stocks have also bounced back in between as investors looked convinced on their path to profitability. But do you think adjusted EBITDA profitability is a metric promising enough for long-term investors?
We do not want to paint all new-age companies with the same brush. Within this space also, we evaluate businesses on a bottom-up basis through our BMV philosophy—like every other business. There are businesses that have strong growth potential and strong moats. Valuations are a problem but that will be solved one way or another. The key is management execution and management communication with minority shareholders. We believe some of these businesses have an uphill task of first identifying the path to profitability, second convincing the investors that they will adhere to that path to profitability and lastly walking the talk and executing in the same manner over the next few quarters. It’s a long journey for them before they will win the trust of listed equity investors.

Is your team positive on any of the new-age stocks?
We are tracking these companies, and as we mentioned, they need to tick-mark every aspect of the BMV framework. The moment this happens, we are likely to see these companies form a part of our portfolio. On that, we find a handful of companies from our portfolios are industry leaders and have a sharp profit focus, good balance sheets, and cash flow hygiene with a decent risk reward.

Nifty IT has been the top outperformer so far in CY2023. Have investors started looking beyond the recession?
IT had a tough CY22. But given the uncertainty in the markets and the declining high valuations in the sector, investors seem to be rebuilding their positions in the sector. We are actively looking at the sector and have gradually added a few names to a few of our portfolios. We are nowhere near benchmark weight on the sector, and we aim to build positions the moment we get valuation comfort—most names in the sector are trading at 20-40% premium to pre-covid levels, for fairly similar revenue, margin, and earnings growth profile.

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