Parag Parikh, Chairman, Parag Parikh Financial Advisory Services, talks about his investment style and ways to identify value stocks.
You have been an advocate of value investing. What exactly is this concept?
Value investing is buying the right business at the right price. Every individual would love to have a business, but all of us are not blessed enough to own one. Though you may not be able to start your own venture, you can always buy into other people’s businesses. Value investing is buying into a business which has a sustainable model, strong brand, good distribution network, entry barriers, pricing power and is managed by trustworthy people.
Investors often tend to buy stocks based on the hype created in the market. In behavioural terms, the most dangerous thing is the availability heuristic, that is, when people make a decision based on all the available information. This is usually imparted by the big guys who can spend on disseminating what they like and are able to drive decisions. A value investor is one who ignores this and does exactly the opposite of what the herd is doing. The price I pay for a stock is directly linked to the return that I earn. If I buy a stock for Rs 10, which pays Rs 2 as dividend, my return is 20%. Had I bought the stock for Rs 100, my return would have been 2%.
In the current market, where stock prices move up 20% in two days, do you think one needs to redefine investment strategies and exit at every opportunity?
Investing is a rather confusing subject and people tend to invest for different reasons. One could invest in large families or education in order to get a good job in the future, or in different asset classes and products such as stocks, bonds, real estate and gold. Then there are various investment procedures like buying and holding, selling short, etc. Many investors are advised to watch their stocks and trade constantly, which is clearly not investing; it is only a procedure. Most -people form speculative habits and think they are investing, even as intermediaries have turned it into a business. This is what an investor has to realise and stay away from.
The real definition of ‘investing’ is where preservation of capital is fundamental, where it offers a reasonable rate of return and where the investment has been made using your own funds. Buying a bond with borrowed money is not an investment, it is merely speculation.
An asset is something that creates income for the owner, whereas liability creates expense. A house, for instance, will be termed a liability if it has been bought through a mortgage; it belongs to the bank until you have paid off the loan. If you own a house but it is lying vacant, it is also a liability as you are still bearing expenses by way of society charges, etc.
Do you see value in the market right now? Which sectors should investors consider?
Yes, absolutely, there is value in the market right now. However, when you talk about the market, it is not correct to judge it only by the 30 stocks comprising the BSE Sensex or the 50 in the Nifty. If one changes the paradigm of search, there is a whole new universe. If you are a value investor, you should always have the urge to invest; today or tomorrow is not the criterion. You will find value even when the BSE Sensex is at 25,000.
When a person talks about the right sector to invest in, he is not looking at the business; he is more interested in the sector that is likely to make a quick buck. Take the power sector. Everyone is chasing power stocks right now. I, as a value investor, will be more than happy to give away my stocks. The sector does not have any pricing power and is heavily controlled by the government. Clearly, it is a market fancy and is hyped. Value investing is all about knowing this and avoiding it.
Real estate is another example. The sector may prove to be good over a period of time due to the rising property prices, lower interest rates, increase in the mortgage business, increase in affordability, etc. However, the business suffers from various issues, such as clearing titles and off-balance sheet transactions that are unaccounted for. As a value investor, I may not want to associate with these businesses as they do not represent the true picture.
There are various IPOs in the offing. Do you recommend investing in any of them?
Investment bankers are appointed by a company or a promoter to get the maximum price for the offering, and these are the people we listen to. Of the 7,000 stocks that are listed, you can buy any company. Why would you buy an IPO?
Also, IPOs are usually launched in bull markets, when investors are willing to pay any price for a stock. Why aren’t there any IPOs when the market is down? They would offer better value in a bear market and one could consider investing in them. Take Oil India. The stock was to be priced in the range of Rs 750-800, but with the markets moving up, this is no longer the case. Investing in oil may not be of much value considering that it is a controlled business and the government fiddles too much with its pricing.
Would you recommend structured products or derivatives to your clients?
The world economy tumbled thanks to structured products. It is nothing but a derivative product floated by a bank where a risk isn’t mitigated, it is only transferred. When the market went up, all the money managers were selling these products. Investors should refrain from these as they are not easily understood and are speculative in nature.
How can one identify a value stock?
An investor should look at a stock beyond the financial perspective. Consider the pharmaceutical industry. In all these years, the stress has been on curative medicines. In the past 20 years, we have had a revolution in miniaturisation, computerisation, digitalisation and nanotechnology. The ability of pharma firms to discover drugs has increased significantly. What took 10-12 years to work upon can now be done in just five-six years.
The focus of pharma companies is clearly shifting to preventive medicines rather than the curative ones., so one should look at stocks that offer preventive drugs, especially vaccines. In fact, in our portfolio, we have stocks like Aventis Pharma, Fulford or Glaxo Pharma, which can benefit from this revolution. Once you identify a business, look at the financial parameters such as profitability, valuation, etc. For a longer horizon, you may need technical analysis like Dupont analysis and cash flow analysis as PEs are driven by behaviour and sentiment.
Where do you prefer to invest?
I invest in my own company. I would also like to give something back to the society by spreading financial literacy through my books and writing.
MY INVESTMENT PRINCIPLES
Equities are the best long-term investment: Returns from fixed income options are capped at 6-7%. Real inflation would be 9-10%, so you lose when you invest in fixed income. Equities can give returns of 15-20% if you invest in properly managed businesses. If an 80-year-old had to invest, I would suggest allocation to equities. He could live up to the age of 95. In the 15-year period, his fixed income portfolio won’t offer him enough to survive. Equities will be the best hedge against inflation.
Invest for the long term: You cannot sow today and reap tomorrow. There are times when the market offers Rs 20 for a stock bought for Rs 10, a growth of 100%. This is capital appreciation, not returns. A stock is for its dividends, like bees for honey and chickens for eggs.
Be greedy when others are fearful: You don’t get value every day; in a bad market you get opportunities. You end up paying more when the herd is buying.
Don’t chase sectors: When the herd is chasing a stock, you end up paying a price that does not give you value. Ideally, go to an investment adviser who will listen to you.
Maintain a focused portfolio: Too much of diversification is admitting to mediocrity and does not reflect expertise. A portfolio should comprise 25-30 stocks that represent value.