You cannot keep on changing your strategy for every event that happens: Samit Vartak

"In new age companies like Nykaa it is very difficult to predict how they will evolve because there is no way you can predict how the competition will evolve given that they do not have that much of history," says Samit Vartak, Founding Partner & CIO, SageOne Investment Advisors LLP

I went through your last note where you did talk about how price to book is a more stable multiple than PE and you also mentioned that we have at least one bull market every five years assuming that we are in a bear market right now, is that also going to last five years or is it going to be short lived?
Right, bear markets are very difficult to predict. It also depends on whether the starting PE multiple or the price to book multiple was high. If you started in 2018, you have gone through almost five years of bear markets because you did not make any money and probably lost money. Same thing happened in 1992. So, how long bear markets last depends on your starting point and today the starting point is not that bad. Just look at the last 10 years. Our Indian market returns have not been anything to talk about – maybe somewhat in rupee terms but in dollar terms, they are way below our long-term average.

Look at the US returns, they are probably not the best but in the last 12-13 years, they have seen that. So, probably there are a lot of excesses in the US market in terms of the money which has been pushed into the economy, the level of interest rates, the leverage at consumer level, the leverage at government level and the leverage at state level.

I do not think that is the case with us. So I really do not think the bear market will last that long, given the starting point of the price to book. Of course, there are exceptions but name a company today which you think may go bankrupt. Even if we go into a recession, it’ll be very difficult to find such a company.

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In 2008, probably there would have been 100 such companies or in 2012-2013, there would have been dozens of such companies. Even in 2017-2018, there would have been many such companies, I do not see any of those today. You have to keep the backdrop in your mind and accordingly expect the worst-case scenario.

The biggest devil right now seems to be inflation. How does one make an inflation-proof portfolio ?
Every year, there will be different worries. It could be inflation, slow growth, any random war or trade war or any of such things. You cannot keep on changing your strategy for every event that plays out. The only thing which will stand in any kind of such disruptions is picking companies where they have significant competitive advantages and those are the ones which enable them to
have the pricing power.

If you have the pricing power, if your input cost goes up, typically they can pass on those prices. The question is whether the competitive advantages that you have evaluated, were short term in nature or sustainable in nature. The evaluation strategy of a company has not changed because inflation is a worry today. There would be chemical companies who do not have the passing power whereas there are certain specialty chemical companies or API companies or CRAMS companies which have a pretty formula. When input costs go up, they will be able to pass on the hikes.

There are certain converters in the steel sector who pass on whether the steel prices are at Rs 35 or Rs 70, it does not matter to them; they are able to pass on the price. I think the key is to stick to your strategy because this strategy must be something which works across different risk parameters and risk will keep on emerging, the world has become too volatile.

I was reading an interview of yours when you had said back in the day that you really liked Nykaa’s business. But you did not invest in the IPO or applied for the IPO because the valuations did not make sense to you. Since then, there have been opportunities to change the way the stock performed and the stock price came down. Did you buy Nykaa then?
No, when Nykaa got listed, it was at 3 times the price of what I thought was the fair value. It is not anywhere close and at the same time what happens is, after all it is about relative attractiveness. So, if Nykaa comes down by 50-60% there are many companies which become even more attractive and my rationale was, if I invest in regular conventional business which is much easier to predict and where I can see doubling of earnings in the next three years and accordingly if my starting PE multiple is reasonable, typically I can expect that I will double
my money in three years.

In new age companies like Nykaa, it is very difficult to predict how they will evolve because there is no way you can predict how the competition will evolve, given that they do not have that much of a history. My expectation of returns from such a company must be much higher. If I am expecting 25% return per year from a conventional business. I should expect much higher.

If I am expecting 2 times in three years or 2 times in four years, I should expect at least 3 times in three or four years from a company like Nykaa and even from today’s point of view, I do not see that happening at least relatively that outperformance is something which is very difficult to envision.

You have time and again talked about how you like to avoid PSUs. Would that also include a company like LIC which most fund managers say they must have in their portfolio?
There are certain reasons, so it depends on your strategy and what you are looking for. What we are looking for is doubling our earnings in three to four years. That is our basic requirement and secondly there must be pricing power, there must be management who is independent, a lot of those things do not exist in the PSUs.

First of all, it is very difficult to get the growth we are looking for, secondly you know the government has a lot of control and they may not think just from an economic viability perspective for a business and those kinds of things. PSUs for us become more of timing the market when they are really beaten down so you get in but you got to be getting out when things start looking pretty good and things start looking pretty positive and that is not our strategy.

So irrespective of how the business is – it can be extremely strong, it can be a leader – the problem is the management. Management in India is one of the most important factors, the execution, the control and how they strategize, these should not be controlled by someone else.