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'We like to ride a business as long as possible'

In this interview, Atul Bhole Fund Manager, DSP Equity Fund shares how he picks a stock, when he exits, and what sort of stocks he avoids

'We like to ride a business as long as possible'

In the interview below, Atul Bhole Fund Manager, DSP Equity Fund discusses the strategy the AMC uses in selecting stocks and selling stocks. He also elaborates on the fund's approach to valuations and why companies with valuations on the higher side feature in the portfolio.

How do you pick stocks for DSP Equity Fund?
For around 75-80 per cent of the fund, we try to select companies which have good businesses, competent management with high governance standards and decent growth of around 12-15 per cent at the least. We call it the BMG (business, management, growth) style. These parameters have overriding importance over valuations. We believe it pays to pay higher valuations, but taking risk on any part around business model or management is not worth it, particularly in these kind of volatile times. Within the BMG elements, we think management needs to be given the highest priority in stock selection.

For the remaining 20 per cent of the portfolio, we look at tactical opportunities like turnarounds, special situations, etc., but in such cases, establishing the margin of safety is crucial for us.

When do you exit a stock?
By and large, exits are few. We like to ride a business or stock as long as possible. Exits generally happen when we think a business has hit a rough patch in growth for an extended period of time. At such times, we move the money to other businesses with similar characteristics but with more visible growth. Just a rise in stock price itself is a very exceptional criteria for exiting a stock. We believe and have seen that if the three elements of BMG are present and fortifying, businesses and thereby stocks can scale unimaginable heights and we want to ride with such stories.

What sort of stocks do you avoid?
Generally, we tend to avoid businesses which are related to commodities or are capex-heavy and with high leverage. Also, as said earlier, management is the most important factor to select or avoid any stock, depending on its execution capabilities and governance standards. We also tend to avoid managements driving unrelated and aggressive diversifications as well as those which resort to frequent capital dilutions to drive growth.

How comfortable are you with the rich valuations of the stocks in your portfolio?
We think valuations need to be looked at holistically, especially in light of growth tailwinds and a business's readiness to capture those. We believe our investee companies are enjoying tremendous tailwinds in terms of huge growth opportunity and at the same time exceptionally weak competition, thereby driving superior growth. These companies are future-ready in terms of resources, management, technology and are at an altogether different level compared to the competitors. The virtuous cycle of growth, enabling further investments and resultant higher sales, is going very strong for such companies.

The valuations we are seeing are obviously on the higher side, but to some extent, they are only optical, given the underlying dynamics. Low global growth and interest rates act as further valuation enablers to drive the comfort. We have seen in the past that when starting point of any investment is cheap valuations, such investments don't pay off and often accidents happen in such endeavours. We want to save capital from such cheap but mediocre investments.

When do you see a recovery in mid and small caps? Are you planning to increase allocation to them?
We are definitely looking for good-quality and growing mid caps and will try to increase allocation but only marginally. At present, we also have a sizeable allocation to mid caps. As the macro situation begins to improve and normalcy returns to the financial system, mid caps have the potential to do well. However, it is essential to stick to quality mid caps as overall reforms-related volatility will be there in the system. It's better to be with sector leaders or winners in smaller sub-sectors of the economy.