Stock bonuses are an irrelevant indicator of a company's share-friendliness while share buybacks are a more favourable indicator, according to veteran investor Jyotivardhan Jaipuria.
Jaipuria, Founder and Managing Director of Veda Investment Managers, believes that bonus payments have no impact on the share price.
"My view is that bonus is the most irrelevant thing you're bothered about, because bonus means nothing. It is a good sentiment booster, typically because people get bonus when they think that the future outlook is good. But dividend or share buyback reflects that. If companies are making a 20% return of equity (ROE) and if they can generate 20% ROE with the cash flow generated, I'd rather have them keep the cash. Dividend stock buyback is one of the measures on how shareholder-friendly it is. But what we also tend to look at is, does ROE drive the business? Or does the size of assets and size of sales drive the business?" Jaipuria told BOOM.
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However, Jaipuria also believes that if a company is generating a lot of cash without distributing it to minority shareholders, that would be a matter of concern. If companies use the extra cash in investing in different businesses, that would be concerning for the shareholders.
"Not everybody's got the same attitude to a minority shareholder. You find companies where they are doing well, but then their strategy is not in line with the minority shareholder's strategy. For example, does the management think that the money which is made belongs to the management or does it belong to the minority shareholders? Do they give dividend out of it or do they keep retaining? If they retain it, and they invest in businesses, good.
"But for me, it's a very toxic issue when a company is generating too much cash, which is not being paid. Because then they start use the cash to do some other business out of it and that normally brings companies down a very dangerous path. They were making cement and then they thought, okay, you don't have my cement is used by somebody to make roads, let me go and build roads also. That's a totally different dynamic and you may not do well," Jaipuria said.
Jaipuria opined that market cap valuations have replaced a company's assets as their selling point due to a change in management style over the years.
"Very often we find that companies change because the new generation has come. The thing which we look at is, if they want to change, then, what is in it for minority shareholders and why do they want us over there? I think another mindset has changed over the last 10 years, which is now the market cap has become the ego booster. When that happens, then you know, people automatically start thinking more of market cap than of assets," he said.
- Highlights
- Asset allocation key to building investment portfolio
- Limit stock-specific and sector-specific risks
- Diversify stocks and sectors in investment portfolio
- Keep track of cyclical trends in stock market
- Dividends and stock buyback indicators of how shareholder-friendly a company is
- Market cap has replaced assets as go-to driving force for investors and companies
Govindraj Ethiraj: Jyoti, when you look back, what would you say are or would be your two or three biggest investing mantras?
Jyotivardhan Jaipuria: I would say first is, there's risk and return. So, everybody wants lowest risk and highest return, this never happens. So, somehow, you have to decide where on the risk-return profile you are comfortable with. And this varies with person to person, it varies with time. There may be times where we are very risk averse, there may be times where we are very happy to take higher risk. So, some of you have to decide, and it's not something like you keep changing every day, the market goes up, you take more risk. And then when the market goes down, you take less risk.
But it's something which you know, you have to do little more stable that you have, this is the sort of this return profile I'm comfortable with. And then you build your investments accordingly. But never forget, asset allocation is key. So even if the markets go up a lot, don't just sell 100% equity unless you can really afford to do it.
GE: Once you've decided this, what would be your next stage where you would start identifying what stocks to invest and where?
JJ: When you do an equity, when you're doing direct equities, one is having some parameters, which is like, I will not invest more than XYZ% in a particular stock, not more than XYZ% in a particular sector, because it's great when the sector goes up. But you don't want to get caught in a situation where you miss the downturn in the sector, then you have a lot of your money there. So, there are stock-specific risks, there are sector-specific risks, and there are country-specific risks.
Now obviously when you do an equity and you're doing Indian equities, assuming you're not diversifying outside India, the country risk is there for all the equities, but you should limit your stock-specific risks and your sector-specific risks. The number may be 10% for someone, it may be 5%, it may be 15%. But at some point, you have to limit that risk so that you are never hit on the downside.
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GE: If you were to take a basket of stocks, and that could be any basket, let's say the basket that comes to your mind first, between the stock-specific and the sector-specific and the country-specific, what to your mind has been the most unpredictable in the last two decades.
JJ: The stock-specific of course is the most unpredictable in the sense that it depends on one particular stock. The sector-specific you've got a basket of stocks, even something was wrong with one, it helps you and India is like, it's a very generic thing. So, you know, if you can, and if you know, it helps you could probably put some money in your equity allocation outside of India. Like I have probably 20% of my equity allocation outside of India. Even though I understand India the best, I still have 20% outside India, because there are times where for example, if you look at the US last 10 years has been a great place. There are some sectors like you know, the tech which is essential in the US and it's been a great place to buy. But even if you ignore that, and you don't want to do US equities, in India try and diversify your thing across a few sectors and stocks so that you're never hit by something really badly.
GE: So let's look at sectors and stocks. Now between the two, what has been your approach? Do you look at the sector first and then choose the stock within that? Or is it more bottom up?
JJ: Both things work. So, it's like what suits you and what is your time frame? I go from top-down. I call it from macro to micro. So, you know, we have some views on the macro. And then you drill that down to the micro. Essentially what I do is okay, where are we today in the cycle in terms of stocks and sectors in terms of the economy? Is consumption not going to do well? Is investment going to do well? And then within that, what are the sectors want to play?
Sometimes we want to play rules. And sometimes we want to play over. So, you know, I have tended to focus more like from macro to micro. But otherwise, there are lots of other very successful people who've done the micro and they say we don't know macro. Ultimately, both are required. Like even for people who say only do micro, I don't care about the macro, a lot of the earnings of a company depends on the macro. You can't ignore the macro. Even when you go top down, you ultimately can't ignore the micro, you can get all your thematic, right that, you know, consumption is what I want to play. But you can't ignore valuations, you can't ignore stock-specific events.
GE: If you were to look at Indian equities over a period of time, where do you think things have been more stable on the sector industry macro front? Or in the company front? So maybe if you took HDFC Bank as a stock in the banking sector, and the banking sector now between the two, what has remained more consistent? And you could take some other example.
JJ: We can pick and choose both. So, if you just take the banking sector, per se, one thing, which was very obvious was that the public sector banks will lose share to the private sector banks. Within the private sector, it was should I buy X bank or Y bank or Z bank. But the thematic was that the banking sector is going to see a change in the market share. And it's something which is going to be like multi-decade. So, it's not like a one- or two-year phenomena. So, a multi-decade shift is going to happen. And then it was like, okay, so public sector will do badly, the private sector will do well, so I want to buy the private sector players. Within the private sector as its evolved and now we know in hindsight that there were some banks which prefer to go down the retail route, there were some others would prefer to go down the corporate route. The retail people have done better in the last 10 years, the corporate people did better.
So, there was a period from 2003 to 2008 where the corporate banks did better than the retail banks in that sense. So, you know, these are cycles which play out and a lot of problems we have is there's a recency bias. So, the last five years, 10 years, you know, X team has done well, we keep sticking to that. And then you know, normally there's like an inflection point which comes and then something else takes over. So, if you see the market every five years, the theme changes, and the inflection point and the theme changes, the same sectors and the same stock don't do well in the next cycle as they did well in the previous cycle.
GE: The contrast between public sector banks and private sector banks is a sub sector theme rather than the overall banking theme, which in any case, I'm assuming is a is an expanding theme, because banking is expanding there is that there are there is enough under bank lender banking in India for banks to reach out to you.
JJ: So, it's like today we take insurance. What happened to banking 20 years ago is probably happening to insurance. It's an under-penetrated market. Insurance as a sector will keep growing. Second is now a lot of the private sectors have come who are probably eager to shell away from the public sector. So, you know, like, the easy thing is, okay, I have to buy the private sector insurance companies, and you know, they'll just keep growing, it's a compounding story over the next 15-20 years. Then you can go down to individual whoever X or Y or Z and you know, it can change.
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GE: Let's talk about companies now. So, assuming we have some handle on the sectors, and the India macro story is looking steady, strong, consistent, whichever way you want to look at it. Now, how do you pick companies? I mean, suppose you had now 10 companies in the sector, what would drive your decision to invest at a particular point of time? Or if you were to remove the technical factors, what would bring you back to that stock over a period of time within a certain sector?
JJ: One thing, which is there, and which is probably going to play out is that the big is going to get bigger. So essentially, you're trying to say within any sector today to see in India, just given what's happened to GST and what's happened with the environment, you'll probably have some market leaders, which will keep getting bigger, you'll have a lot of other people who fall by the wayside. For us, it's always who are the people who will survive this over the next 10 years because they'll keep getting bigger. And, you know, let's say you make a mistake in the sense you say, I think this guy will be number one, but ultimately, number two in the sector doesn't matter. Because, you know, probably number one, number two, number three will do very well once the sector grows and somebody may give you a little higher return than the other. But when you get down to like, okay, which of the two am I going to pick? Then at some point it is which one has what strength.
So, you're typically trying to figure the strength of each one of them. If they have a track record, then it is okay, what's the track record of these people? And second is what do I see? So, you know, I love the photo analysis. What are the strengths of each company? Do they have a better bargaining power with suppliers, with customers? Second, what is their USP? So, if I have to think of X bank versus Y bank, what do I think of them as like, Okay, this guy is very strong on the details, this guy is very weak on his details, but very strong on his corporate. This guy's digital is very good, this guy's digital is not good. If I think, okay, digital is going to be the way forward, you want to go to somebody who's most digitally savvy. And then we think of the people.
For me, people are very important. Ultimately, people make the count. So, people could be the top management, it could be the promoter in a company, it could also be what is the second life. Because quite often with entrepreneurs, you're betting on the entrepreneur. You're betting that he will do well. But at some point, if the entrepreneur is not willing to give up, then what you face is he's got no second line, he's got no third line and he's trying to do what he did with 100 crore company, can do with 1000 crore and with a 10,000 crore also.
So, a lot of times that company then falters because he's not able to delegate. So, you want somebody who's at some point willing to delegate. So, you know, one is finding a company which will do well. Then from an investor point of view is not just that this company does well, but as a minority shareholder, do I do well? A very theoretical thing would be if the company does well, then we'll do well as a minority shareholder. But not everybody's got the same attitude to a minority shareholder. So, if you find companies where they are doing well, but then their strategy is not in line with the minority shareholder's strategy.
I'll give you a couple of examples. One is, does the management think that the money which is made belongs to the management or does it belong to the minority shareholders? So, you know, like, one example, which one can look at is, do they give dividend out of it or do they keep retaining? If they retain it, and they invest in businesses good, but for me, you know, sometimes it's a very toxic issue when a company is generating too much cash, which is not being paid because then you start saying, okay, you know, what, I have this cash, let me go and do some other business out of it. And that normally brings companies down a very dangerous path. They were making cement and then they thought, okay, you don't have my cement is used by somebody to make roads, let me go and build roads also. That's a totally different dynamic and you may not do well.
So, one is do you pay it back or you do not? Second is like, you know, typically, if you go in the history, you will find that companies which do very little equity dilution typically have been more rewarding to shareholders than companies which are constantly doing equity dilution. So, you want companies which are throwing up free cash and the management is always is saying this is belongs to all of the shareholders and we will distribute it to them. Because at the moment, I don't think our business needs that much of money. Whereas there is another set of companies which are like let me raise more money from the market and let me do a third one and a fourth one because I think shareholder equity is good. Seen as a thought process, what is the cost of equity? For some people, they think equity cost is free. For others, it is like, equity is very expensive, because I have ROE behind it.
GE: Suppose you want to measure how friendly a company was to a minority or a small investor. And that's really what we're addressing in this discussion. So, would you say then dividends plus buybacks plus bonuses, I mean, is that the traditional and of course, capital appreciation? But would these three aspects count? Or if not, would it be something else?
JJ: My view is that bonus is the most irrelevant thing you're bothered about, because bonus means nothing. Any company can give a bonus. Theoretically as well as practically, it has zero impact on the share price. It is a good sentiment booster, typically because people get bonus when they think that the future outlook is good. But otherwise for me, bonus means nothing. But dividend or share buyback reflects that. Okay, the company's paying off its excess capital to all the shareholders. So, you know, that way it is a good thing.
Now, you know, it's a good thing and a bad thing in the sense that if companies are making a 20% ROE and if he can generate 20% ROE with the cash flow generated, I'd rather have him keep the cash, because I don't know whether I can generate 20% ROE with them. So, the only danger gets when he has excess cash in which he doesn't want to be paid some point, because then it is like, if he goes and does something stupid with it. So, I do look at dividend and buyback -- dividend stock buyback as one of the measures on how shareholder-friendly it is. But what we also tend to look at is, does ROE drive the business? Or does the size of assets and size of sales drive the business?
Quite often people are like, okay, what's your five-year vision, or, you know, I want to become 20 times bigger than where I am today. And then I ask them how important ROE is in your frame of things. Oh, it's very important, but we want to become bigger. So, you know, then it is the chances are they'll do something stupid with the cash, which may not be stupid from his point of view, because he wants to grow bigger, but from a minority point of view it tends to hurt you.
GE: How much importance do you place on the intangibles and more importantly, when you assess a company?
JJ: Ultimately, it's a gut feel, right? That can this management deliver or not deliver? Especially when you're looking at people who don't have a track record. It's like if you have a track record, then there's a track record to go by, and then you're trying to say, is the management going to change? You know, he says, I made mistakes for five years, but is he going to change? But, you know, my theory generally, has been most people struggle to really change their vision, especially as they get older. There's something ingrained in them.
But what I tend to pay a lot of attention to, is when the next generation takes over. So typically, we do see, once a new generation comes over, they come with a different mindset. And the more powers and more autonomy goes to the next generation, I think, you know, once fresh blood comes in and fresh thinking comes in and probably like, if the company has not been exactly minority shareholder in the past, if you tell the next generation that you started X, and you know, somebody has started, you know, half x, but that half x person is 3X and you are still 2x. The reason for this is this, quite often they are more willing to say, okay, there is something wrong, we are willing to change, whereas even the original promoter may not be willing.
So, for me, one of the intangibles is that is there a change in management? Is new blood coming in, or somewhere, they say, you know, we've done this all our life, but we have not been successful, let me get a professional in. And let me give him some powers at least. So, you know, one is, if there's a change in management then things will change. The second one is where the company does not have a track record. But it is one of those companies which is now aspiring to hit the market leader or start bridging the gap with the market. That one's more interesting. And that one is like more difficult to come by, because quite often you are like, this guy is trying to do the right things. He's got passion. So, most of the things when asked him was why were you so bad? Like why are you sleeping when this guy became the market leader and what is changing your mindset now that you know you want to change?
So, very often we find that they change because some new generation has come or they were a one-man show which now they have bought more family members and more people involved in the business. The other thing which we look at is okay, so if you want to change, then, what is it for minority shareholders and why do you want us over there? You want to raise money from us? Or do you just want to do it? So, for many company's earlier assets used to be what was the driving force and what was the go-to at a party was like I have over 1000 crores in assets. I think another mindset has changed over the last 10 years, which is now the market cap has become the ego booster. So, when that happens, then you know, people automatically start thinking more of market cap then of assets. And quite often they find that having assets which are half of what we were planning, boosts my market cap. So, I'd rather be in that situation and the market cap goes up, rather than assets go up.
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GE: What are the one or two mistakes that you've made which you think people can learn from? And equally, where have you gone maybe even better than right?
JJ: Quite often it happens where one is you think that the management will change. You know, when things are going steady, then you don't feel the bother. But many times, you think ok this management now really wants to change something which is gone into his head and wants to change. Sometimes you go right in it, sometimes you go wrong in it. So as an investor what you're going to bet on is if I go right, then do I make a big return? If I go wrong, then how much do I lose because I go wrong? So as long as the share is valued at a scale where people say nothing's going to change in this company, then you know, your risk return in betting on something will change is very, very high.
For example, we bought one tractor stock around six years ago, and everybody was like nothing's really changing in them and they've been very minority-unfriendly for the last 10 years. I met the management and I said, you know, do you want to change or do you not want to change? So, he was like, okay, you tell me five things minority-unfriendly we have done in the past? So, I said, you know, that's easy as 12345. Do you want more? He said, No. Okay, out of these five, if I change these three in the next two years, what happens? I said you change one at least, then we'll see. So, they actually managed to change because a new generation had come in.
They were there in the business for the last 5-10 years, but they were getting more autonomy in the business, they managed to change and the shares done very well after that. On the other hand, there are like some other people where the company's done very well, the minority shareholders have not benefited, because there's been a lot of dilution in the process when the company did very well. So, you know, though we got the call, right, that this will become a much bigger company over the course of the next 5-10 years. But what you got wrong is how much that will get reflected in my share price appreciation.
GE: In India now, you said you invest about 20% overseas, and I'm assuming some are a lot of that is in the FAAN stocks. As you look at India, in the next decade, what is the kind of bets that you would want to take or are taking particularly at the sector level?
JJ: What we typically try to do is have a bit of diversified mix anyway, like I said, on sectors. But you know, always be looking at what is the starting point of valuation. So, for me, I call it the three Us. I want undervalued stocks, which have underperformed and which are under owned today. So, my starting base is very low in terms of this because nobody likes it, has done very badly, and it's cheap. So unfortunately, some of the biggest compounders over the last 10 years, the stocks you want which are clean, easy cash machines, they are extremely expensive, according to me. So, I think the next few years, I don't think they will do well.
Again, if you look at cycles, what did well from 2008 to today, is probably not going to be the leader of the next cycle. So, these are good stocks to own in your portfolio, but they're not the ones which would be able to give you the big bang for the buck. So now what we are looking at is okay, what is going to give us a big bang for the buck. So those are things which have underperformed all this while. So, there's this mix of value versus growth. Growth has done very well, in the last 12 years, I think it's time value will do better. So, we are generally focusing on value.
But having said that, we also have some things which are secular, like I said, one of them is the insurance sector. They're not cheap, but you know, it's just over the next 20 years you know that these can keep growing, so don't have to worry about them. All of them have pedigrees of existing companies. So, you know what their mindset is. What is the minority shareholder treatment, so it becomes very easy to say, Okay, these are things where the sector will grow, these companies will grow. And typically, many of them have rewarded minority shareholders in the past in their parent companies. So, we know that they will do well. So that would be the other segment which you look at.