‘Concept of price-earnings ratio is all wrong’

Nearly two decades ago, when Chandresh Nigam entered the fund management business, the absence of research meant that multibaggers were easier to come by. Today, investors and fund managers have a more difficult job. However, Nigam feels that India is still a great place for asset allocators.

The head of investments at Axis mutual fund, who manages over Rs1,000 crore in equity investments, tells DNA why it may make sense to ignore price to earnings ratios and a simple formula by which investors can match Warren Buffett.

You’ve been a part of the mutual fund industry since the early nineties. How has the game changed?
In the olden days, India would not have reacted so sharply to the issues in Libya. But now, with so many foreign investors, the correction has been sharp. There was hardly any research in those days with plenty of undiscovered companies. Today, if you find a good company, you will also find that some institution has already invested in it. So, it’s harder to get those large multibaggers. You could hope to get returns of 25-30%. You still can get high absolute returns but it is more difficult today.

What is your investment strategy?
I believe in fundamentals. Volatility is opportunity, provided one has a grip on medium to long-term fundamentals.

Our core investment style is “growth at a fair price”. The Indian economy provides significant opportunities for a growth investor to earn financial returns much in excess of cost of capital over a long period. A major portion of the portfolio returns in our funds are expected to come from buying and holding these growth stocks.

I always say that Warren Buffett is 20% compounded over 40 years. So, if you can do that then you can be the next Buffett. Investors in India are very lucky. They can easily invest in an equity market where one could get returns of around 18%. And, add to that the couple of percentage points that you get from rupee cost averaging or investing through systematic investment plans. It is not rocket science.

There has been a sharp correction for a lot of the mid-cap companies in recent times, with many of them trading at the lower end of the P/E band. Does this suggest opportunity?
The whole concept of P/E (ratio of share price to company earnings) is wrong. Some time ago, the top two to three IT companies and their valuations were much more expensive than some of the mid-cap firms in the same space. But you see how they have done in terms of business and cash flows since then. The top companies have done a lot better than the mid-cap ones. So, what did you pay for? You have to look at companies with high cash flow and see how much premium you are willing to shell out for that currently. You pay for a sustainable business model. You can’t look at this year’s earnings or next year’s earnings because you don’t know in the case of some of these businesses if there would be any earnings at all. What is the point of assigning a price to earnings to a company if there are no earnings?

How do you pick your stocks?
Whenever we look at a company, we say, if this company was not listed, how much would we pay for it? Then there is no P/E. You are ultimately just paying for cash generation. The strategy is to invest in growth-oriented companies. I am a firm believer of growth investing where you put your money into businesses having sustainable growth. We prefer predictable businesses over volatile ones.

Which are the sectors you see maintaining growth over the next few years?
Considering the business growth and investments in India, the banking sector would continue to remain a great story for the next 10-15 years. Similarly, in the IT sector, the top three to four large players will continue to generate strong cash flows and sustain growth considering their global presence. We also like the consumer story.

You have been in hedge fund earlier. How different is it to mange funds there?
Sometimes when there are newsflashes you need to know how to react. That can only happen if you know what it means for the company. Basically, the skills required are the same. The fundamentals have to remain strong. If you have knowledge, it is easier to react and take action quickly. Sometimes the market doesn’t react to news, but it overreacts. Our idea is to know the companies we invest in better than anybody else. It is an impossible goal, but that’s what we aim at.

There are governance issues in mid-cap stocks. How do you guard against them?
One of the most important things for fund mangers is ‘quality risk’ control. One needs to look at parameters like competitiveness, management integrity, capability and business environment. Investors have to be very careful when it comes to these companies and the growth opportunity should be much larger for making investments in them. Their ability for free cash-flow generation and return on equity has to be high. If you make a mistake with management quality in case of large caps, it can be corrected at much lower cost. But, in case of mid-caps the impact cost is much larger and you may face a long-term capital loss.
Foreign investors have been net sellers in the last two months.

How do you see outflows affecting the markets?
After huge inflows in the last two years, it is quite natural that there would be some outflows. From that perspective, it is quite possible that we may see further selling of $4-5 billion if the crude oil prices remain high. Only the short-term investors have been selling and following them is a recipe for disaster. Chasing momentum is not always good and price followers often end up destroying the value. Long-term investors continue to hold on to their positions and it is these firm believers who will always make money.

How do you see markets in the near term?
These are tough times with global events and oil prices likely to determine the market movements in near term. The budgets have been encouraging. Even though the numbers on fiscal deficit look difficult to achieve, the fact that focus of the government remains on fiscal consolidation and they are moving ahead on reforms agenda and inclusive growth gives us comfort that we are not going to see anything which may deeply destabilise the financial macro environment except for large rise in crude prices. While there may be negatives like rising interest rates and high commodity prices resulting in manufacturing inflation that may impact the corporates in near term, at the end of the day it is all about growth. If we are able to grow even at 8-8.5%, the medium to long-term outlook for markets remain positive. In the short-term, though, if problems in the Middle East linger for too long and oil remains at $120/barrel, then we may see some more downside in the short term. One should utilise these opportunities and downfalls to invest in good stocks as the Indian markets would continue to remain volatile.