Real investing requires a lot of grit and stubbornness

Manish Sonthalia, CIO, and Director and Head Equities, PMS, Motilal Oswal AMC says, I look out for structural businesses as opposed to cyclicals and global cyclicals

Real investing requires a lot of grit and stubbornness

Can you tell us what brought you to the world of investing and what made you stay on?
In 1992, after clearing class 12, I began reading The Economic Times on a daily basis - I read stories of stocks soaring, the stories of money being made by certain individuals. This got me interested in stocks and stock markets. I tried to find the answers to a very basic question- what makes stocks move? This was the beginning of my investing journey.

You manage the India Zen Fund, which is a long only bottom up approach equity fund. Why the bottom up approach?
The India Zen Fund is now the Motilal Oswal India Fund (MOIF), which is the replica of the Next Trillion Dollar Opportunity PMS Strategy (NTDOP) on the offshore platform.

Over the last 25 years, I have understood quite well that only the long term approach to equity investing suits my temperament. I have tried out a whole lot of other things in the stock market, but I found that only this method works best.

Essentially, if you want to make money from stocks, you have to predict how much money a company will make over a long period of time. Essentially the stock price is nothing but the present value of future cash flows. Hence, the bottom up approach to equity investing. Can you take us through your stock-selection process?
Ideally, I look out for structural businesses as opposed to cyclicals and global cyclicals. These companies should have exhibited an ROCE (return on capital employed) of more than 15 per cent for some time period (15 percent, because the cost of capital in India on a thumb rule basis is about 14 to 15 percent). After that comes figuring out the growth that the company will exhibit in the future, keeping some margin of safety when it comes to paying the price for that growth and living through the entire company life cycle or product life cycle, as the case may be. I try to exit before the company is about to go through a difficult period.

What is distinctive about your investment philosophy?
I try to estimate the terminal value of businesses as precisely as possible. This takes a lot of effort, time, money and energy. It's not very easy. Predicting the longevity of growth correctly is the crux of wealth creation in stocks.

If you had to live on a desert island for the next 10 years and could only invest your life savings in three stocks, what would they be and why?
Page Industries, Hindustan Unilever and HDFC Bank. Their products will never become obsolete. They are the masters of their businesses and they are good at manoeuvering their business models to changing business environments to produce decent growth at all times.

As a fund manager, what are you doing that your competitors aren't doing yet?
We have a well documented philosophy and process and we stick to this philosophy irrespective of market conditions. This is the clear communication that we have for our clients. I don't think competition has so much discipline.

As a mid-cap stock expert, how do you measure the potential of an opportunity?
If one has to be successful in buying mid-cap stocks, essentially a few things have to be right.

One, the business in question should be a good business, which is to say that Rs 1 invested in that business should throw out more than Rs 1 of cash. Two, the size of the opportunity should be big. Three, the profit pool in the big opportunity should get shared among a very few players. Four, the company in focus shouldn't work for its bankers but for its shareholders, i.e., it must have minimum or zero leverage. Five, the company should double its profits every three to four years.

Take us through some of your biggest investment successes. How, why and when did they happen?
Page Industries, Voltas, Max Financial, Bosch, Eicher, Kotak Bank, City Union Bank, Emami are some of the successes that I have seen.

I think I was able to identify the competitive advantages in these companies quite early and just played the growth cycle in them.

Fund managers sometimes get it wrong. Can you share a few instances of where your judgement did not play out as well as you thought it would?
I have gone wrong many times when I got the management quality and cyclicality in a business wrong.

Have there been stock picks which made you wait for a very long time to deliver returns?
Yes, the stocks that I buy don't start to move the very next day. They take their own time. I buy only quality stocks and they don't ever come cheap.

One has to wait for the next round of growth in the company for the stock to deliver returns and that does take some time.

Competitive advantage, return on capital, growth, management and valuation are usually variables that investors use to screen stocks. How do you figure out the relative intensity of each of these factors? On which ones will you make a trade-off?
We practise QGLP. There can be no compromise on the quality - both business and the management. This comes first. Price comes last - we aren't too fixated about valuations. Everything else comes between these two things.

How do you form a definitive opinion about management quality? Since this is a qualitative exercise, how do you avoid assessment risks?
Assessing management quality is a tricky situation but it should be done diligently. We use both quantitative and qualitative techniques to figure this out. And, of course, our experience and vintage of over 25 years in the Indian stock markets does come in handy in precisely understanding which managements are good and capable of delivering and which are not.

Stiff formulas don't work in investing, but without a fixed process, results can suffer from a lack of stability. How do you strike a balance between science and art when it comes to investing?
Predicting two years of profits is a science. The whole world gets it right. Predicting ten years of growth is an art. The crux to creating wealth from stocks is precisely estimating how much money a company will make over a long period of time - and for this to be done correctly one has to understand the intricacies of how money is being made in that business. So, I focus on the competitive advantage and how long it will last. Markets are more often than not erroneous about the longevity of growth in companies.

How do you eliminate the possibility of a poor stock entering your portfolio?
Our well laid down philosophy and process prevents us from buying the wrong stocks in our portfolios.

When companies make announcements related to expansion, M&A and financial results, how do you view each of these and what do you look for in them?
I am focused only on the long term and for me, long term is a period of three years or more. Since a long term is made up of a number of short terms, quarterly, half-yearly or annual results - these tell us whether the company is on course to achieving the numbers that I want it to achieve. So, financial results are very important. Expansion and M&A are all about capital allocation. They give us an insight into how the management thinks and this is also very important.

If I were to ask you about the biggest lessons in course of your mid-cap investing career, what would they be?
Real investing is really a very boring thing. It requires a lot of grit and stubbornness to stay your course. It's a very lonely world out here and you have to defend your independence of thought on a daily basis. That's not easy.

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