One can understand the attraction of growth to investors who are looking to beat recessionary forces in developed markets. However, in a blind chase for growth it is easy to forget that only the growth accompanied by economic profits creates value.
Perhaps we should review some of the once-celebrated, top-down investment ideas that did not live up to expectations and compare them to less exciting ideas that actually did deliver.
The infrastructure boom
Not long ago, India’s infrastructure companies were expected to multiply many times over in just a matter of years. It was hard to argue a few years ago with the need for better roads, more power (clearly needed considering the country’s recent massive power outage) and efficient ports in India. Public policy had also laid out ambitious plans to develop infrastructure.
Capital availability did not appear to be a major hurdle since many state-owned banks seemed willing to lend. Despite all the positive sentiments, however, negative shareholder returns were generated by some leading developers in the past five years—in sharp contrast to the top-line growth they achieved.
This should not have surprised bottom-up investors, given how frequently these companies diluted shareholders by issuing more stock to grow beyond what could be funded through internal cash generation or could realistically be borrowed. Accessing capital markets to fund growth in itself is not value destroying, but developers turned to markets too frequently and made unwise business moves such as overbidding for projects—a recipe for losses. Policy inaction by lawmakers and high interest rates, which the media love to blame, are actually only recent phenomena that have merely compounded an existing problem created by these firms.
Retail hyper growth
Another industry that was hyped a few years ago in India was that of organised retail, which is characterised by its larger scale, a network of stores and corporate ownership (such as supermarkets and hypermarkets). The premise was that the less organised ‘mom and pop’ stores did not offer the variety or the ambience expected by newly rich middle class.
There was some truth to this and more modern retailers did demonstrate extraordinary sales growth. But many were eventually punished by the market, with some nearly shutting down.
No doubt, the retailers offered a greater assortment of products and a better shopping environment, but they also found it hard to go up against less organised competitors who were selling the same products with minimal expenses.
Paying a reasonable price for growth is a good discipline to have. But it is easier said than done. First, there are certain well-run businesses in India that can remain expensive for a long time. This can lead investors to wonder if they are missing out on a good opportunity by being too value-conscious.
Such as…
One example is a leading private sector bank that has been able to deliver consistent results on growth and profitability in an ever-changing regulatory and macro environment. A closer look at the bank reveals that its ethos and work culture prepare it for coping in uncertain times, a competitive advantage not easily captured by regular valuation exercises. Investing in such companies can sometimes be less risky than investing in stocks that remain cheap for extended periods due to fundamental reasons of poor governance or weak business models.
No one can know the right price for a stock. In our experience, judging valuations is akin to estimating the height of a person from a distance. It is easier to compare height on a relative scale than to estimate in absolute terms. This is not to say that one should not attempt to ascertain absolute value.
However, often the best one could do at an absolute level is to judge someone as tall or short, or somewhere in between. Similarly, the value of a stock could at best be ascertained as expensive or cheap, or somewhere in between, depending upon whether aggressive, conservative or reasonable assumptions are priced into the stock.
In summary, making investment decisions based on a theme of top-line growth alone may not yield desired results in India. Bottom-up stock selection, on the other hand, is critical for growth investors in India to mitigate risks that may arise from such factors as weak business, inadequate governance and excessive valuations.
