The Hindu Business Line : Betting on erring businesses for ‘value'

What I'm trying to buy are stocks with the lowest expectations… the ones people love to hate. When expectations are low, I don't lose too much money. If I buy something based on momentum and then I'm wrong, the downside can be huge.

NITIN BAJAJ, FUND MANAGER, FIDELITY INDIA VALUE FUND

Aarati Krishnan

“I'd like to buy stocks that are in the front page for the wrong reasons,” says Mr Nitin Bajaj, Fund Manager for Fidelity's new India Value Fund.

Excerpts from an interview with Business Line:

How will you identify stocks that offer “value”?

Value investing means buying something for less than what it is worth. It means that I would like to buy something that is worth Rs 100 at Rs 50. But to decide that something is worth Rs 100, you need to understand the business. How does it make money, why it does so and how sustainable are the competitive advantages, what does the competition do. Basically, try and understand the whole environment around the business. I need to talk to competition, suppliers and consumers.

As a value investor, I don't want to buy good businesses at good prices. I want to buy them when they make a mistake, when the managements go wrong. I want to buy when the market makes a mistake about the business. Markets operate on greed and fear. These are very strong emotions and cause irrationality. Therefore, I see two components to value investing. Understanding the business better than anyone in the market. Then studying the valuation historically. Then you decide whether the market is paying too much or too little for it.

What quantitative parameters would you use to identify value stocks?

That depends on the franchise I am looking at. For hard asset-based businesses like refining or cement or a zinc processor, I would look at replacement cost. How much would it cost to put up a plant and how much am I now paying for it in the market? For a business driven by its economic goodwill, its brands or intellectual property, I would look for the price-earnings ratio, free cash flow yields (free cash flow/market cap), or dividend yield.

If you look at the track record in India, value investing performed well in the initial phase of recovery from a slump. However, when recovery becomes well-established, value investing may not deliver as much as growth investing. So, is today a good environment for value investing?

Value investing does very well at inflexion points and badly in bubbles. No one wants to buy a company with bad fundamentals when you go into a bubble. However, the question today is, are you sure we are in a bubble? Are you sure growth is sustainable? We don't know. So these questions are all about whether you can tactically time the market or a recovery. But who is confident about what will happen with the global economy? Therefore, I would say it is better to stick with value investing. Understand well the business you are investing in. Stick with the process you understand. If you are saving money for the long term, stick with a strategy that delivers secular returns.

Why does Fidelity India Value Fund allow overseas investments? Is it a call on valuations abroad being cheaper?

No, not at all. I have a lot of experience investing outside India and Fidelity has a huge network of analysts and intellectual property which is engaged in tracking companies worldwide. I thought it would be good to leverage this for the benefit of investors in this fund. I am not saying the actual allocation to overseas stocks in this fund will always be 10 per cent.

The intention is to make money for investors. For instance, suppose we have a textile stock in India which may double my money. If I find a stock in China which can treble my money in the period, I should probably opt for the latter! There is also the matter of sectors which are not represented in India. I own platinum mining companies in one of my other funds. I don't have those options in India.

What's your take on broader market valuations?

They are not cheap. They are not in bubble territory either, but they certainly are not cheap. Between March and now it didn't matter what stocks you bought. Ninety per cent of the stocks went up. From now, over the next two-three years, you will see greater divergence. Some stocks will move up and others down. So if you research and understand valuations before making decisions, you may be able to make the best of these markets. I will take a bet that there are quite a few stocks which, even if you enter today, will be much higher three years later. So it is back to basic research.

Do you find more pockets of value in the mid- or small-cap space?

Yes, for the present the fund will have a mid-cap bias. However, that may not be a longstanding strategy, and may change depending on how valuations move.

In March, stocks that traded at the lowest PEs were the distressed companies with a lot of debt on the balance sheet. So, does value investing not mean that you run a risk on the business at times?

In some cases, yes. But often times, no. One example I used in my presentation is that of European tobacco companies in the early part of the decade. They traded at 8-10 per cent dividend yields. Their balance sheets were fantastic, but people just hated them. So, what is the risk you are running? Hero Honda traded at single digit PEs for much of this decade, with a great business and a good management.

What I'm trying to buy are stocks with the lowest expectations… the ones people love to hate. The key question is “What if I'm wrong?”. When expectations are low, I don't lose too much money. If I buy something based on momentum and then I'm wrong, the downside can be huge. If you bought into housing when expectations were high or technology stocks when they were high, you lost your shirt. But if you bought textile companies you didn't make too much money, but the downside wasn't that high. Risk really is all about losing money.

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