Art of buying undervalued businesses

Ramesh Damani speaks to Dalal Street whiz Bharat Shah, on what got him
interested in the stock market and how did he prepare himself to play
the big stakes game.

Ramesh Damani, who is member of the Bombay Stock Exchange, BSE, speaks
to Chief Executive Officer and Managing Partner of ASK Raymond James
Securities', Bharat Shah on what got him interested in the stock
market and how did he prepare himself to play the big stakes game. He
simplifies stock market investing by saying that, "it's the art and
science of buying  undervalued businesses."
Q: When did you first get interested in the stock market?
A: Back in 1982. At that time, I was about 20-years old and I just
wanted to make some extra money because I was not earning anything and
somehow the markets always sounded, fascinating, naturally. I mean I
would soak-up every annual report that would be around.
Q: Was any of your family members in the stock market?

A: Not really. My brother would put some very small sums once in a
while, but it fascinated me and I just pursued the journey more than
most.
Q: What fascinated you about stocks?
A: Well I don't find any reason but it just came out naturally, where
I felt that this is what I want to do. It sounded like a very
fascinating journey, so I would read up every business magazine that I
could lay my hands on, I used to go to the vendors to buy the
balancesheets and go through them. Then slowly, I started organising
myself and started reading more business books and trying to get a
little more formal knowledge about the subject but I don't know how it
started, but it just came naturally. At one point of time, I ended up
collecting almost about 10,000 annual reports at home before all the
people at home got very angry.
Q: How did you go about preparing for a career in Dalal Street?
A: My interest in finance and interest in investing, propelled me to
take CA as a career. Then I went over to do cost-accounting and I went
over to do my MBA. At that time, the thought was not that whether I
will get any formal career in investing. It was just that I felt that
these degrees will provide me some fundamental background as well as
it will provide me an opportunity to earn bread, if my joy or passion
is not able to translate into professional activity. At that time,
markets were compared to gambling and it was considered almost
disrespectful activity to be in and my family was against it, even
that I was entertaining such an idea.
Q: What was your first job in Dalal Street? Did you take up a job
somewhere or it was just investing in Dalal Street?
A: My job came much later, it was in 1990. So that came after full
nine years, after I started taking an interest in investing. I was
doing the normal kind of finance work for a few years and one fine
day, I just jumped the gun and I said that I want to move over to
something different.
Q: You went in for work and became one of the more colourful legends
of Dalal Street? Didn't you?
A: Yes. There was a phase where markets were beginning to acquire some
new shape and markets were shrugging away from its earlier past to new
kind of future. That is what it appeared to me at that point of time.
Most importantly, it appeared to me at that time, that there is now
some systematic organisation around the investing area. So which is
why, I just took to it and I had zero formal experience to talk about
but my burning desire was very high. By that time, I think, I had read
about lot of companies and I thought about many companies without even
having a formal position or any formal work in that area. So when I
applied for the job, I got the call and I went for the interview and
it lasted for almost three hours and I think it must have appealed to
them, at least I knew something about the company, that's how I joined
as head of research.
Q: The bomb blast and then the market falling, were that the low
points of your professional career?
A: Well that entire year was one of the most depressing points of my
life. Just before that, for a length of time, the markets were in
turmoil and I was without any work and I wasn't too sure what's going
to happening, the way markets were, it didn't look like that there is
going to be any formal career in markets.
Q: But then you did hit the ground running, after all these incidents,
you joined Birla?
A: That came about almost two years later. In between that, I worked
for one finance firm, they were having their own investment budget
portfolio. So I was doing research and managing money. That were to
close for about 20-months and then I moved to Birla Sun Life Mutual
Fund.
Q: You were the king of tech stocks at that time. How did your love
with technology stocks begin?
A: The technology stocks were like any other normal bread and butter
businesses. The kind of esoteric take for that came later, what is
popularly called as the triangle of consumers, pharmaceutical and
technology. So, I think investing, fundamentally, never changes. I
believe that in 300-years of recorded history, I don't think investing
essentially has changed. It still remains an art and science of buying
undervalued businesses, if I had to capitalize on value and price gap,
which is what I felt.
Here were the businesses where there is massive size of opportunity,
the size of opportunity itself was going at a rapid pace and I could
feel very clearly, on my dialogue with good companies, like Infosys
and others, that there are some wise people who are running these
businesses, who have an ability to tap this opportunity in a
meaningful manner and I felt in the context of all that, the
valuations in single-digit sounded quite unjustified.
Q: At the time, the street was looking at the old economy, you
transformed because you understood the concept, the margin of safety,
or management of quality in these new companies?
A: Absolutely, because margin of safety was enormous, these businesses
were still available in single-digits, were generating solid cash-flow
on earnings that provided superior return on capital, and with the
world as its courtyard and not just the domestic markets. There was
huge external opportunity.
Q: Critics says that you fell in love with your stocks in 2000 and you
were the permanent bull in tech stocks, was that a mistake that you
regret?
A: Yes, I do regret the mistake without any doubt but I don't think if
I look back in retrospect, I don't think I fell in love with the
stocks. Part of the situation was that you had to remain invested
given the general compulsions, that you have to remain more or less
invested in your portfolio, but certainly I made the mistake of not
rationalising the weight on some of those businesses. It's not that I
bought at expensive prices. In many of the cases I had bought at such
hugely rock bottom prices, the position just grew and grew and grew in
appreciation and they became an overbearing percentage of the
portfolio, I could have cut it out and I could have reduced the weight
rate and I could have brought it in instead and invested those monies
for something else.
I think intellectually, that was a mistake, whether other things would
have fallen or not is hypothetical, but here was an actual failure
that I could have sold and I could have converted that into something
else. The profits at even reduced prices were huge, but they were
lower than what they were at a pick.
Q: What is it like finding a ten-beggar, is it just money?
A: It think it's a spirit of adventure, it's a discovery, it's joy.
Investing to my mind is not just means to an end. Even if I sound
silly about it, I think it's an end in itself.
Q: The financial market attracts all kinds of people, doesn't it?
A: I don't think that's different in any industry. Probably given the
stakes, this industry has a different proportion, so one always
recognises that, but invariably markets give you both learning as well
as an experience or path, to enrich oneself.
Q: Ultimately in the mutual fund business, what do you need to do, to
be in that business?
A: I think globally, that is the structure of the mutual fund business
because you are fighting on relative comparison with your peers or on
shorter periods of time, which I think doesn't make for my fundamental
belief about what investing is. Investing is anything but short-term,
that is the way mutual fund business is globally and that's tough.
Q: So you did a partnership with ASK Raymond James to manage
portfolios rather than daily NAV driven funds?
A: Absolutely. Because your focus is on absolute returns, you are not
so much focused on day-to-day kind of movements of the prices, and you
remain steadfast on judging the value of the businesses, rather than
rocking of the prices everyday.

Q: Absolute return, of course, is very important concept for all value
investors, is there a Bharat Shah investment philosophy?
A: Investing to my mind remains perpetually an art and science of
capitalising on value- price mismatch, which forever exists, whether
it's fear or greed or hubris, anyone of the three factors.
Q: You said value and price and that gives you that margin of safety?
A: Yes, price is a servant and value is the master but a large part of
the market is constantly devoted to treating price as God and very few
people try to engage, judging value. I have a very strong belief and
empirically proved over centuries of investing, that if there is a
real value of a business and price is below that, no matter what,
price will eventually rise and converge and if price is above the
value, no force in the world will be able to prevent it from falling.
Q: How do you judge value?
A: If you can't understand businesses and you can't appreciate what
will make it work and what will make it kick or otherwise, and what
will make it happen over a longer-term rather than just the next
quarter or two, you can't be in investing. So investing thus, called
for, an ability, an interest in understanding businesses and ability
to value them. Valuation to my mind, is both art and science. The
science part is relatively more straight forward and it's more a
skill. But the art part is more important.

The business has a history, cash-flows (and profit & loss) etc that
you can reasonably portray into the future. If nothing else were to be
done to change the business, what it would generate? I think that's a
straightforward computation that one can make, about what the past
will represent as a kind of sustained cash-flows into the future, i.e.
if the business is not rundown without further investments.
Then there is the task of trying to judge whether there is an
opportunity for growth in the environment, whether that industry has
the capability to grow, whether this company has displayed its
character to be able to harness that growth. That's an art form. And
how much of that growth will get eaten away by increased capital
needs, so that's the remaining balance which is value adding. That's
what will give you a pick or help you gaze into future incremental
value-added cash-flows that can emerge.
Q: If the stock market doesn't exist in the world, what would you be doing?
A: Then I would have taken to my equal big joy of reading. To me,
reading and investing are two sides of the same coin.
Q: But reading won't make money?
A: Yes, it would have made life more difficult. It would have made me
do, at least, something to ensure that I pay for my books if not
anything else. But reading is a passion, as much a passion, as much a
joy as investing is. I think in some form or shape I would have
withered. I don't think I would have done just normal corporate work
for a living, forever, in my life.
Q: The world has moved to equities, so do you think that the
opportunities for investors in the next decade or so are going to be
as they were in the last decade?
A: I think several times over because what we have seen is, not even
an incipient sign of what there is there to be enjoyed in future. I
very firmly and passionately believe this decade belongs (to India)
and I think the kind of wealth creation which is going to occur for
India is of an enormous proportion. I think it's a country at a point
of inflection and if the point of inflection, like Shakespeare says
that 'when you harness that tide, the maximum fortune is made' and I
believe in a country where less than 2% of household assets are in the
form of equity investments, it can go up. There is no other way for it
to be otherwise. Especially, if your joy is not to earn 5% returns by
investing in bonds.
Q: Is there any example - that an ordinary man can study the market
and become wealthy in the market?

A: I think you don't need to be a genius to be a good investor. You
don't need to be an Einstein. I believe that many of the legendary
investors are not geniuses in that IQ kind of definition, but they are
good readers of businesses, they have good discipline of sticking to
price discipline and they have got character to last the markets, and
if you have a good combination of these virtues - you can't have none
of some and all of the others, that will not be a good combination -
but you need to have, at least, a fair combination of all of these,
and I think that's enough for one to do well in the markets.