Studying global trends and their impact on local markets is crucial before investing in a stock according to veteran investor Andrew Holland.
Apart from looking at growth prospects, valuations, cash flows, balance sheets and P&L of a company, Holland told BOOM that investors should also study how global trends will affect its growth prospects before investing.
"By doing that overlay, you're looking at what globally can happen. So, for example, you are an auto parts supplier. Now, locally, India might be doing fine, but globally, there could be some problems in the auto industry. And therefore, anyone exposed to exports or having a manufacturing facility offshore would obviously be hurt by the global factors, not necessarily by the local factors," Holland said
Holland, Managing Director at Avendus Advisors, also revealed that being able to understand a company's balance sheet and cash flows is important in deciding whether to invest in it.
"If I don't understand the balance sheet and cash flows very readily, then it's a red flag for me because I should be able to understand it. I should be able to kind of look through the numbers and be able to get a good idea. Things get hidden which you don't want to having to search for. So, if I have to search for something, it means that someone's been trying to hide something. Cash flow to me is very, very important. Because for any company, you don't go bankrupt because you have lots of debt, you go bankrupt because you can't service your debt," he said.
- Analyse global trends before investing in a company
- Balance sheets and cash flows are good indicators of a company's health
- Market is a good indicator of how a company functions
- Sectors which will be in a recovery mode post-pandemic will be profitable
- Environmentally Sustainable Goals will shape how investors will work in the future
Edited excerpts follow
Govindraj Ethiraj: Andrew Holland has been investing actively in India through a fund for more than 15 years and is a long-term investor who also academically studies what's been happening or how Indian markets have been behaving over time. Andrew, do you have a philosophy of investing?
Andrew Holland: When I first came to India you had two products. You had debt products or mutual funds, and you had equity products and both of them have their own risk. Debt is obviously lower risk, and equity is higher risk. And there is nothing in between. So, when we started to look at how we could approach that, then obviously, a hedge fund is one approach which kind of helps you get those risk adjusted returns on a consistent basis. So, you're not facing as much volatility as maybe the markets can afford you at times. We've seen more recently, obviously, you know, what happened in March. And whilst we recovered from that the swings in your portfolios, would have been sometimes very worrying, you're kind of a little bit more soothed by the fact that you're back to where you were. But the volatility in between time has been very high for investors, and therefore causes you worry and pain in terms of your net worth.
GE: So, when you look at companies, specifically, as you've looked at companies in the Indian markets, or for that matter elsewhere, what are your defining principles? How do you choose a stock or a company to invest in?
AH: Slightly differently than the typical long-only. We look at the same parameters as any long-only fund manager in terms of the growth prospects, the valuations, cash flows, balance sheets, P&L, all of those parameters you look at. But where we differ, I believe, is that, we think about what's happening globally. What is happening globally to the world growth, and how that impacts in particular, interest rates globally, currencies globally, and commodity prices globally, because ultimately, that has an impact in India. It could be from an economic viewpoint, it could be that the Rupee depreciates or appreciates, it could be from funds flow in terms of funds buying Indian stocks, or it could be for certain sectors or companies, which will either benefit from these tailwinds of global growth or kind of hit hard because of some other factors as well.
By doing that overlay, you're looking at what globally can happen. So, for example, if you like, say, an auto parts supplier. Now, locally, India might be doing fine, but globally, there could be some problems in the auto industry. And therefore, anyone exposed to exports or having a manufacturing facility offshore would obviously be hurt by the global factors, not necessarily by the local factors.
GE: Could you illustrate that a little more? And would there be cases where the fate and fortunes of a company or a stock that you're investing in India has not much to do with what's happening globally?
AH: Well, obviously, those would be the more mid and small caps, which are more domestic orientated in terms of their prospect. So really then you're banking on the growth of India rather than the global growth or factors. But even there, let's just say, pharmaceutical companies. They've been hit, even though they might be a little more domestic driven in terms of their revenues. They've been hit by obviously the problems in China and APIs. So, you know, it could be a supply factor as well, which virtue from a global perspective, but even though you're only selling in India.
So, I think you have to look at all the parts now, all the moving parts, not just are we selling only in India? Also, are we manufacturing in India only, are we relying in India inputs into our products? For example, FMCG, oil prices would be something to watch. So, all of these things, you can't not think globally anymore, in terms of risk.
GE: So that is one way of saying that, here's a company, here is how it is affected by global behaviour, or behaviour of global markets. But how do you arrive at something? Do you say that okay, here are the big mega trends that are happening globally, in terms of demand, supply, supply chains, capital? And let me find companies that feed this? Or is it the other way around?
AH: It could be a combination of the two, actually. So, let's just take I know, it's more topical, and we're getting through this. But with the onset of COVID, I mean, obviously digitalization is something that it's going to continue. Going forward it is all working from home. So therefore, IT companies of all kind have been beneficiaries of this problem. Now, if you look into the themes going forward, and we're all working from home would we need to live in cities anymore? Would we have to pay such high prices? Could we live outside of the city? So again, affordable housing, could be the big theme. So, these are kind of global factors, which become local factors over a period of time.
The big debate at the moment is sales in terms of car sales will it continue afterwards? Or is it trend now that we want to own our own car, and transportation, because we don't want to use public transportation over the next few year. Because we're working from home, we don't really need to use public transport, but we still want to get away and do things. So, these are the trends which I think will emerge from all of this. So, it can be global in nature, but obviously, locally is how we're going to what we're going to drive. And that's going to be the interesting patterns and disruptive patterns I think which also become a risk.
GE: Is this the way you've always invested? You always begun with the macro view on maybe the sector or industry at a global level? And then gone down?
AH: Yes. So, you start off globally, one of the global factors, as I mentioned, and then we look at India's GDP growth, what's it going to be and why and then identify those sectors which you want to buy which are going to be the drivers or the beneficiaries of our economic growth in India. And on the opposite side are the hedges, the ones that you would want to kind of avoid if you're not hedging. Are those sectors which are going to underperform could be local factors, global factors, or combination of the two. Those become the sectors you want to avoid and the companies you want to avoid. And then let's just say we like the auto sector for this example, then it's your what's driving the auto sector, is it four wheelers, two wheelers, tractors? What do we want to kind of look at and where do we feel the value is in identifying the company or companies that we want to invest in?
GE: It's important, as you said, Andrew, to know what to avoid, particularly if it doesn't sync with some of those macro trends that you spoke off as much even as you figure out what to invest it. To go further with your example of an auto component company, what would be your next step?
AH: Then, obviously, you know, you're looking at each of those companies individually and saying the prospects into those companies and then trying to project what you feel would be the profitability and the growth of that profitability. And then you start looking at the actual valuations. How does A compare to B? Has B got more products coming through? Is the market share increasing? Is there any margin pressure? What's the management, governance? So, all of these kinds of questions get looked at, in terms of getting your pecking order right. But, of course in between time, you can have company A, who you feel has got the valuation, it's very cheap. But there's no catalyst in the very short term to move that stock.
The other side, you have auto parts company, which is not doing as well, valuations are a little higher, but there are catalysts. It could be a new product, having won a new account. Whatever it might be, could be that short term, kind of move is a lot quicker. So, what you have to think about is the opportunity cost between owning stock A and stock B. The value might be in stock A, but you might have to wait one and a half years to get any returns, where stock B has those catalysts in the short term, where you'll get the shorter term returns that you were looking for. So, I think you have to look at a lot of factors and not just the fundamentals.
GE: So now, assuming both stock and stock B are similar in nature in as much as they're similarly priced. What are the three most important things that you look at even as you delve into a company with the objective of investing in it? What are your benchmarks, or what are your trusted guides?
AH: If I don't understand the balance sheet and cash flows very readily, then it's a red flag for me because I should be able to understand it, I should be able to kind of look through the numbers and be able to get a good idea. So, things get hidden which you don't want to having to search for. So, if I have to search for something, it means that someone's been trying to hide something. I understand that the balance sheet is one day in the life of a company, but you can do lots of things in that last day to make your balance sheet look a bit rosier.
I think that the second thing is cash flow. And cash flow to me is very, very important. Because for any company, you don't go bankrupt because you have lots of debt, you go bankrupt because you can't service your debt. So, cash flow is very, very important to me. And I think the third and most important is obviously management and governance. Because the first two factors could actually be because of bad governance in the company. Because the hidings have in the balance sheet, or the cash flow that they're generating is being put into assets which don't really give me any economic return as a shareholder.
GE: You mentioned the quality of balance sheets and maybe things being hidden. What has caught your attention and can help people maybe spot anomalies, if so imbalances that they research, or they look into?
AH: I'll keep on looking at a working capital cash flow. You go over the years and see how cash flow is moving. And let's say for one example your day to day goes from 70 to 120. And there's no rhyme or reason that should have happened. And there's no commentary behind that. In terms of the company, then obviously, this is a red flag that something's happened for them to have the day to days go so high. So, you're looking at all the different elements of a balance sheet and cash flow, and P&L to try and get that kind of picture of how even margins are moving, costs are moving, raw material prices are moving, to give you that idea of what might have changed over the years.
If you see one thing moving out of, relatively to your history, then it's something that you want to make a note off. Is this something I need to be wary of, or it's just a one-off event? I could have been a one-off event and therefore it's okay that they'll go back to their normal business next year.
GE: So, would you say that, that debtor positions or cash flows are the reasons you have not invested in companies in the past assuming all other factors have been constant?
AH: Yeah, it can it can be. I mean, you've had that across many, many companies. Let's say they passed that test, and there's no problem in the balance sheet and the cash flows. But obviously, then what are they done with that cash flows? Have they invested wisely to get a better return? Or could they have just put the money on deposit and get a better return? Or could they give it back to shareholders through dividends, or buybacks or whatever it might be? So, all of those things, you start to look at, of what the company can do. Because if you've got a good company growing very quickly, you would want to see it investing these own businesses, right? Not generating so much cash, particularly in a low interest rate environment that we have.
Now, if they can't invest it, or they see new opportunities, that tells you one thing about the business that they're in. And two, as a shareholder, what are you doing for me? What are you giving back to me for all this cash flow that you've generated? And then again for those companies which are seeing negative cash flow, what's going to be the impact on that in terms of the increase in debt? Can they service the interest? What's the cover of interest, in terms of the profitability, and so forth? So, all of these questions that you have, you know, initially can be looked at, just by analysing the P&L, balance sheet and cash flows.
GE: When managements are proactively transparent, and they set higher and higher standards of disclosures, and even in areas maybe, which you would never expect it. The other is, where people may be just do what has to be done. So how do you view these two situations, assuming both are, let's say exciting growth opportunities?
AH: What's quite fortunate for us is that the market does it for us. If I go back to when I first came to India and a few years on, we looked at the IT sector at that time, if I remember this it was TCS, Wipro and Satyam. Satyam was always at the bottom, it was always at a discount, you know, to the others and it never ever bridged that gap. So, the market has its own way of telling you that there's something that you're missing because the valuations. It could be management, it could be something that you're not seeing, but someone knows something, that's for sure. And it's not just in India. It's been in other markets that I've worked in the UK and South Korea and Thailand. Markets will discriminate very quickly on corporate governance.
GE: What are the other things you feel people should look at? The temptation is that the markets are strong, there are a lot of stocks which are run up. There is no doubt that there are some companies in, the BSE 30 or the NIFTY 50, which meet most of these early filters of management quality, balance sheet quality and so on. But the temptation can also give lead to maybe investing at very high prices, and maybe never seeing them again, because maybe the, the stocks lost its fancy, or maybe the markets lost at fancy, and we're seeing some good examples there, too. So how do you then build your approach?
AH: So, it's all depending on the cycle that you you're in. So, if we take the more recent last six months you would say that being in those defensive sectors like consumer goods - because we're all going to eat, we all need to eat and drink and so forth. Pharmaceutical, because we're still going to take pills. And IT because we're all still working from home so we need some kind of technology. Those your safety sectors. Now, coming out of that and you think that the economy is going to rebound in 2021. Then where are you going to see the growth? It's probably going to be in sectors which are going to be in an economic recovery.
So, your banking sector, capital goods, metals which are probably a lot cheaper valuations, then you're paying 60-70 times for safety. And safety for the right reasons and safety in terms of revenue growth, profitability, cash flows, everything else. But they might not be the market performers of 2021. That might now fall to the next set of sectors, which are there for the economic recovery. And those would be the beneficiaries of that. And obviously, evaluations would be more appealing, because everyone's going to have shunned away from them in the short term, to all find safety in going through what we've been going through in the last six months.
GE: How long is the game? The stocks are good, the prices are all right. The management is of good quality, the global trends are more or less in sync. But if I invest today, when should I start expecting a return? What should my horizon be?
AH: For equity investments, my time horizon is on the long side. It is more three to five years. Now it depends on what I'm thinking, right? I would have a price target for at least the immediate term, which is one year, because one year you can have a good guess at what you think will happen. Five years out, a lot of things can change, right? But at least I'll know what my price target is in the first year. Now, it depends if you meet that price target. If you meet it towards the end of the year, then you ask yourself, do I need to revise that price target? Is there anything else that I need to kind of think about which would keep me wanting to hold that stock compared to another stock? And again, it all goes back to asking that same question. What's the opportunity cost of me holding A versus B in the same sector, or this one sector versus the other sector?
So, you've got to be looking at your portfolio on a consistent basis, not necessarily churning it. But let's say where's the opportunity? Do I need to kind of diversify from where I am today to the trends which I see in the future? So, whilst it's always good to hold stocks with three to five-year period, you might find, for example, it could be just, you know, disruption in the auto sector. And because of electrical vehicles, then what do you? Do you stick with the old regime of companies? Or do you look towards the new ones?
You've seen that very well in the auto industry in US where Tesla is now the leading company globally. Whereas who would have thought that five years ago? So, what I'm saying is that the trends for auto ownership might still bode well for a Ford or a GM. But obviously, this has been disruption and something's changed it where you need to change your thinking as well. So yes, in the three-to-five-year time horizon, but continue to look on a regular basis of what the trends and what you're seeing going forward.
GE: Are equities something that you would always recommend to others over time?
AH: I was brought up with the kind of the debt to equity minus your age type of thing. So, obviously, for younger people, you would want to have equity. Unfortunately, now, for many years, we've had the SIP, which is a great way of investing, you buy at the bottom and buy in the middle and buy at the top. But over the years, your money will grow. I think the thing I would say in terms of equity investing is that there's a lot of moving parts at the moment. And I think one of the things that I would suggest that people look at more and more is ESG (Environmentally Sustainable Goals). It might not be a big thing in India at the moment, but it's a very big thing globally. And this will shape the way we're thinking about investing for many different reasons.
So, if you look at the performance in the US of oil companies versus renewables, it's just a huge stark difference. Renewable share price has gone like that, oil companies share price have gone like that. If you did a very simple chart of Hindustan Unilever versus ITC, you'll see Unilever going this way and ITC going that way. I'm not saying that's all to do with ESG issues, but it's becoming more and more where, you know, foreign investors, and we're talking, you know, $30 trillion of money now will not invest in tobacco companies. And it obviously has an impact over time.
So those are the kind of new trends which are also going to be played through. So, I'm just asking potential investors when looking at when looking at companies to add this new dimension. Because companies will be forced to kind of change or just be abandoned. I think what got me first interested in ESG, many, many years back was a BBC documentary on a tea company in India, where they showed under age workers working on the plantations. The next day, apart from the share price falling, most of the companies who globally bought from this company, took their orders away day one. That was it. Finished. And it's taken years for this company to get back to some kind of credibility with the global buyers.
GE: Over the years, tell us about the one rookie mistake that you've made from what you've learned, and the one strategy that has really paid off for you.
AH: I've made many mistakes. Not more recently, but it's a hopefully, it's a reasonably funny one. It's not listening to other people. I was told many years ago, you must buy this stock. And so, I did blindly thinking it was fine. And I was watching the news that night and I saw that the company's oil rig was on fire. Oh my god I bought a company where the oil rigs on fire! So, the next day I found out that the person who gave me this idea and said what are you doing? What is this oil rig on fire? He said, "No, no, we bought it because some guy called Boots Hansen is going to come over from America and put it out. And that's the reason I bought it apparently. So, don't listen, do your own homework.
A lot of it's very simple, right? We all know, the story of Apple, we all love the phone. You know, some of it's easy. If you've got children, you love Walt Disney, they love Mickey Mouse. So very simple kind of stocks, which you can look at. So that's one of the big mistakes I've made. And in terms of the successes, I think, because we run a hedge fund, is thinking what are the risks to the downside. I'm always thinking what can make the share price fall? And also, that when you think share price should be going higher, and for some reason it keeps going down, is that the market is trying to tell you that there's something wrong. So, don't stick to your "Oh my fundamentals are right." You're missing something, go back and do your homework again. So those are the things which have helped me out a number of stocks which I thought initially were great, but then found out that it was something I missed.
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