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We at Stallion Asset strongly believe that there are 3 Ways to Learn Investing

1) Study of history of last 50 years (Experience of Market Cycles)

2) Study of what Stocks have created wealth (Factors that make money)

3) Study of People who have created Wealth and How (Qualitative factors that make money)”

 

This blog is about the Second factor i.e. Stocks that have created wealth in the Long term.  The biggest problem in being a long term Investor is that most business’ get worse with size & growth rates fall down hence its really difficult to hold stocks for the long term.  Smart investors use this opportunity to shift out from low growth stocks to higher growth stocks to get their expected returns.

 

The Idea of long term Investments is buy business’ that get better with size not worse.  

 

Jeremy Siegel in his book “Stocks for the long run” did a study of the 20 biggest winners from 1957 to 2012 (55 Years) and  the results were surprising. Out of 20 Biggest winners, 12 were consumer companies,  4 were Healthcare companies.

 

 

In the Same book, the weights of Consumer, Financials, Health Care & Information Technology was 10% in 1957 of total S&P 500 Market Cap, whereas by end of 2012 the weight of these four sectors rose to 57% of Total S&P market cap.  Of course this can happen as more business’ of this sector got included in S&P 500 but remember S&P 500 includes the most successful 500 Companies in America.

 

Surprisingly the World’s most Popular Long Term investor Warren Buffet in December 2018 disclosure had 45% Weight in Financial, 23% in Technology, 18% in Consumer Staples i.e. 86% of Portfolio in these 3 sectors.

 

We Went back 10 years in 2008 end (This is when Financial crisis was at Peak) and we found the story to be similar. Buffet had 45% in Consumer Staples,22% weight in Financials(even after a massive fall of 50-70% in financial stocks) & 6% in Healthcare.

 

Why are smart long term Investors backing Financial Services, Consumer, HealthCare & Information technology Companies, History also tells the same thing these kind of companies do well but why?

 

The Reason is Simple, they get better with Size. A construction company doesn’t get better with size infact a small economic slowdown can trigger massive volatility in Earnings, A steel company has no correlation with size as the price is going to be exactly the same weather you produce 10 Million tonnes or 1 million tones, Similarily an Airline companies as it gets bigger will have to get into less profitable routes as that’s the only way to grow.

 

Long term Investments need to get better with Size not worse!

 

Financial Services – Given an option to Open an Account with HDFC Bank or a New bank with 100 Branches where would you open your account? The answer is simple a bigger bank who has more ATM’s, more Branches & More products. If you are a Shark in a Ocean like HDFC Bank you simply sell more to the same customer.  HDFC bank Serves 8000 Customer per branch & in a company like India where credit + Saving + Protection will be growing at 15% YOY for next 10-15 years. HDFC Bank just keeps getting better with size as it introduces new products & Scale them in no times like insurance & wealth products.

 

Consumer companies – You may produce a better product than Fair & Lovely for fairness but how would you distribute it to lakhs of Retailers? The game of Consumer Staples is distribution, the bigger you get you can keep selling old products as well as keep introducing new products to the same channel. Lately i have started learning start up Investing and have spend sometime with both start up companies as well as old consumer legends. The game the Big Consumer companies play is simple – The second a Consumer company like Marico see’s one product of a smaller competitor reaching 25-30 Crore of sales which typically means that the product is solving a problem & is loved by the consumer, they come out with similar product & use distribution network to sell it to millions via their distribution network. Here again being Large works in your favour & not against you. You just have to see which products are doing good, replicate it & Distribute it.

 

Pharmaceutical – Most IT & Pharmaceutical companies in India are B2B outsourcing kind of business model whereas typically companies with large R&D Expense and massive marketing network have done fabulous compounding in the past like Abbott has done a 14% CAGR from 1957 to 2012 as it became bigger it could invest more into R&D which other smaller players couldn’t. Even if the Smaller players got a patent they had to partner with a larger player for distribution. The Business model of Larger companies kept getting better with size.

 

Consumer Technology companies like Google, Facebook, You tube, Amazon are all winners take all game. The bigger you get, its next to impossible for a smaller player to solve the same problem. You go to instagram, because your friends are on instagram. The Moat here is a large network effect. Content marketers use youtube because the audience is on youtube & the audience is on youtube because majority of content is on youtube. The Bigger these business model’s get the better is it for me. They become better with size.

 

Conclusion – Are you holding business’ that are getting better with Size or Worse?

 

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Disclosure – Stallion Asset is a Equity Advisory company & this blog is for educational purpose only.

We at Stallion strongly believe that there are 3 ways to learn about Stock Market.
1) Study the history of last 50 years (Experience of Market Cycles)
2) Study the Stocks that have created wealth (Factors that make money)
3) Study the People who have created Wealth and How (Qualitative factors that make money)”

 

The Problem of Determining valuation for most companies in India is that the Growth Rate is well above the Equity cost of Capital hence absolute Valuation techniques like DCF cannot theoretically work well.

 

What has happened in the Globe will happen in India and we Indians have an advantage of learning how wealth was created in other developed countries. We strongly believe that High PE Ratio alone can’t justify that a stock is Undervalued or overvalued, it’s the opportunity size and Market Position of the company which will determine the Valuation. We at Stallion Asset use valuations of Global Giants to compare it with Indian Companies and see where they stand against the global leaders. We found some amazing data points in our study of terminal value.

 

Page Industry V/S Hanes (Hanes) – Ofcourse this needs no Introduction, what a class compounder this Page (Jockey) has been. Page has Increased sales from 250Crores in 2009 to 2500crores in 2018 (30% Compounder) and in the Year 2018 it made a profit of 346 Crores. The Company trades at a Market cap of 30000 Crores or 4.2 Billion Dollars (That’s a Whooping 86 PE FY2018). Hanes the Global Market Leader of Inner Garments is present in 80% of USA Households has Sales of 46,800 Crores and a Normalized Profit of 4300 Crores this year. Interestingly the Profit of Hanes is 1.8x the Sales of Page Industry though Hanes get a Market cap of 5.6 Billion $ v/s 4.2 Billion$ for Page Industry.

 

Whirlpool of India V/S Whirlpool Corporation – Whirlpool of India is an amazing company and in Last 9 years it has Increased its Sales from 1700 crores to 4832 Crores (12% Compounder) , whereas it made a profit of 344 Crores in FY2018. The Company trades at a Market cap of 18000 Crores ($2.5 Billion). Whirlpool Corporation (Global) has 16% Global Market share of Appliances and does a Sales of 21 Billion$ (1.5 Lakh Crores) and made a Normalized Profit of 800 Million $ (5,760 Crores) this year. Interestingly Whirlpool Corporation (Global) who does 15x More Sales & Normalized Profit than whirlpool of India, trades at Valuation of 7.2 Billion $ and Whirlpool India Trades at a Valuation of $2.5 Billion. Whirlpool of India hold 20% Appliance Market share in India whereas Whirlpool Global Business holds 16% Market share of Appliances in the World.

 

Retail in India V/S Retail Globally – Globally Grocery Retail has Created a lot of wealth. With Walmart & Costco in USA, Carrefour in France, Woolsworth in Australia, Seven Eleven in Southeast Asia, Tesco In United Kingdom whereas in India the Total Market cap of Grocery Retail is $13 Billion for Dmart, $4 Billion for Future Retail, $0.4 Billion for Spencers, 0.6 Billion$ for Aditya Birla More (PE Deal) i.e. India’s Total FMCG Retailers have a market cap of less of $20 Billion Dollars whereas in USA Alone WalMart & Costco Combined have a Market cap of $370 Billion, Woolsworth an Australian retailer with 31% Market share of FMCG retail in Australia has a Market cap of $29 Billion which is more than the Entire Indian FMCG Retailers though Australia has a population of 2.5 Crore people which is at similar level to Mumbai metropolitan region.

 

Conclusion – This is no secret that the Valuation of a Company is determined by the Sustainable Growth Rate (opportunity Size), Long term ROCE (Capital Allocation) & Cost of Equity Capital (Interest rate). There are some Business models which are proven to create wealth globally and High PE Ratio Alone doesn’t make them bad. In India businesses like Page Industries are highly valued compared to their respective  global giants because of the opportunity size but the question every investor needs to ask himself is that how much this growth has already been priced in by the Market. 

 

Disclosure – This is not a Buy or a Sell Recommendation, we have just done a study on Terminal Valuation. We Strongly Recommend you to use it for education purpose only. Stallion Asset is a SEBI Registered Equity Advisory Company. (INH000002582). The data has been taken by various datasets we at Stallion Asset use.

Yesterday my team at Stallion Asset & I attended the Edelweiss Investor Day meet, and these are the 5 main take away’s from the meet

1)The Larger Trend in Financial Services Space – Financial Services in India are at the same stage as they were in the US in 1980 where it was 2.4 Trillion $ Economy (GDP) and China was at 2.4 Trillion in 2003.

India will be a 5 Trillion Dollar Economy i.e. it will double in the next 8 years. China took 5 years to double, US took 10 years to double from 2.4 to 5 trillion$. It is expected that when India Grows from 2.4 Trillion GDP to 5 Trillion Dollars, financial services will grow 5x in revenues and 6x in Profits.

 

Rashesh Shah mentioned that PSU Banks are growing at 3-4% which is about 70-75% of India’s Credit, whereas Private Banks are growing 18-20% and NBFC’s are growing at 22-25%. He sounded Optimistic that this trend will continue for the foreseeable future though he did believe that NBFC’s are scalable to 1,00,000 Crores AUM and post that it’s smarter to be a bank. Edelweiss has a Loan book of 42,000 Crores and being a NBFC for next 3-4 years is prudent for them.

 

2) Democratization of Credit in India – OMG FACT – The Top 45 Business houses in India are 50% of Nation’s banking debt even after nationalization of banks. The Top 20% of India is well banked and Opportunities are now on the lower ticket size retail lending (80% of Population). With Upsurge of MFI, SME Lending, consumer finance is the next big trend which are small ticket size loans with higher NIM spreads. Rashesh Sounded very positive on Retail Finance and he has walked the talk with retail Credit growing 46% in last 3 years. There are market rumours that Edelweiss may acquire Manappuram as Nandakumar’s 2nd Generation isn’t Interested in running the business. We believe this could be a marriage made in heaven as Manappuram would be immediately re-rated to 3.5-4x Book, and moats are very strong in gold finance business. Every NBFC and a few banks at some point have tried getting into gold finance but failed miserably.

 

3) My Chat with Siby Anthony (CEO of Edelweiss ARC) – He is also called the Mogul of turnarounds in India and very smart guy, obviously knows the distressed debt game really well. He is the person who has made edelweiss get 40-50% Market share in ARC in India. Rashesh Sounded very positive in India and Said about 20,000 Crores of fresh investments will be needed every year in Distress debt and the opportunity size is massive.

I knew ARC will be a big business, but why did Rashesh sell 20% of it so cheap at a valuation of just 2,500 crores to Canadian Pension is what i asked Siby Anthony? – He said we need the tap of money to be always open, Canadian pension has a lot of money, and we need a lot of investments, it made sense to us.

I wanted to understand the ARC business, and i asked a few questions on it and the ROE of the business, where he jokingly told me that unless he screw’s up very badly, he will make a ROE of 13% on it. If he works mediocre they are good to make 20-25% ROE in it, but if they get it right, they could make a killing.

I Asked him that if there are stock & sectors he could buy now, what would those be? Well the Answer of this Question was superb but lets say i cant disclose it here and keeping it for Clients of Stallion Asset.

 

4) Loss Given Default not NPA – Rashesh Shah gave a heads up of what he exactly thinks about the NPA Situations especially about banks. He Said i would rather have a 4% NPA in a Housing Finance Business rather than a 2% NPA in a Project finance Business.  He Said, GNPA is not really the true assessment of the health of a bank and the strength of its balance sheet going forward. To truly estimate the potential financial hit the bank will take, Loss Given Default (LGD) is a more comprehensive and appropriate measure. LGD is the share of a loan that is lost when a borrower defaults. This will, of course, vary  depending on the kind of loan and the extent of collateralisation.

He gave out Industry Numbers which got my eyes glittered as this is a new way of thinking about defaults.

 

 

 

 

This meant that if Some one Defaults 1000 crores in a Housing Finance book, the real loss would be just 150 crores and the rest would be recovered as there is collateral whereas on a project finance book if someone defaults worth 1000 crores, the loss would be 600 crores. We at Stallion Asset have decided to now go deeper in NPA profile of banks, probably there might be some bank which has high NPA but its actually due to its home finance or SME book which can get recovered but the markets are mispricing it.

5) Diversified NBFC will survive – Rashesh Shah has understood that the key for a sustainable NBFC is right capital allocation and risk management which can be done very smartly by diversification. Lets take an example of a only microfinance business like Ujjivan which had to lend even after demonetization, but if they had only 7% of their assets in Microfinance, they would have obviously stopped lending for some period like Arman Finance did. Mahindra & Mahindra finance was aggressively lending to the farm sector in 2012-2015 even though the farmers were defaulting because thats the only business they were in. Someday Interest Spreads in housing finance business will get squeezed as more and more Housing finance companies enter the market, but One product housing finance companies will have to continue to lend, just to survive. Edelweiss wants to create a 1,00,000 Crore loan book divided in 10 verticals so they can stop lending as risk increases, or increase lending in a vertical as opportunity increases. We believe a diversified NBFC is atleast 5x more safer than a concentrated one segment NBFC and deserves a higher valuation.

 

Conclusion – India is in a long term secular trend and Financials are expected to grow 5-6x faster than the country’s GDP Growth. We remain bullish on financials where there is a passionate management team, who is ready to go a extra mile for its stakeholders.

The above was written by Amit Jeswani, CFA, CMT (Founder of Stallionasset.com)

We provide independent equity Advisory services Plans Start 8,999

Disclosure – Amit Jeswani & Family may or may not hold the stocks discussed. Please use this education purpose only and Stallion Asset won’t be responsible for data.

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