There isn't room for current market multiples to move up: Prashant Jain

HDFC AMC to 3P Investments: What's same, what’s changed

We have benefited from India’s strong macros and a very supportive global environment which is supporting faster growth in manufacturing and service exports. We continue to focus on strong businesses and focus on valuations. Our overweight positions in the power sector, utilities, select PSUs, some bottom-up individual picks and underweight positions in consumer staples and pharmaceuticals helped our outperformance last year. Our core investment philosophy of over three decades remains exactly the same. We only hope to make fewer mistakes because of our experience.

I think markets are pricing in the strong economic growth momentum. It is time to moderate one’s market returns expectations. It’s becoming harder to find value. By value I mean pockets where you can expect multiples to move up. One doesn’t see too many opportunities but I believe corporate earnings will continue to grow. Our endeavour is to buy businesses where you won’t run the risk of deratings. But returns of the last 3-4 years should not be extrapolated. That was largely because of the low base post the Covid-19 pandemic.  

Learning from experience: "Made mistakes in 2-3 areas"

Basically, when I look back, I find we made mistakes in two or three areas. First, wrong assessment of the business itself, where the business was weaker than what we thought. So, in such cases, over the years, we have learned and improved our judgement to distinguish or segregate between good and not-so-good businesses. When you invest in a weak business it is likely that the business will suffer on the performance at some point of time. This will cause permanent damage (to investment returns). So, we don’t succumb to the temptation of lower valuations if the quality is not there.

Second, here I think we have made fewer mistakes, we have moved out of excessively valued businesses in the past, whether it was the tech bubble or the 2007 infrastructure boom. While we have not made too many mistakes on this front, on the flip side, one has exited good businesses a bit prematurely. We have seen that good businesses can outperform one’s initial expectations. So, I think we would be a little more patient and a bit more tolerant of higher valuations for great businesses and target to hold them for longer periods.

The third type of mistake we’ve made is to succumb to pressure when a certain part of the market was doing exceedingly well and, not to a large extent but to a small extent, one may have participated in some of those companies just to hedge our performance. Again, we have seen over time, while that hedge may have worked for short periods, but in the end, it has eroded value. So, we hope to avoid that.

Now we are paying a lot more attention to size our bets a little more carefully. So, we try and size positions over time, depending on how the market behaves, and not go all in at one go. We hope to limit the extent of temporary underperformance to lower levels compared to earlier stints where, once in a while, the extent of underperformance was more because the bets were larger. Eventually, they worked out. But the pain they caused in the near-term was meaningful.   

Also read: MNCs selling stake is a very important signal: 3P Investment's Prashant Jain

Generating alpha: "Confidence to go against the tide"

Different businesses come in and go out of favour over time. But currently in this market, nothing seems to be meaningfully undervalued. It’s a phase of the market where most businesses are close to fair value or, I would say, in a few cases overvalued.    

Sometimes value is out there in the open. It is for the person to evaluate and, at times, bet against the momentum of the market. PSUs are a good example. Three years ago, at those P/E levels and dividend yields, it was a screaming buy. It was visible to everyone but very few wanted to buy because the momentum was against buyers and investors had suffered in the past. The market view was not to venture into this segment. So, it’s a lot about understanding these businesses well enough to have the confidence to go against the tide and the willingness to tolerate short-term pain.

Whether it was old economy stocks in 2000 or consumer FMCG companies in the post-Lehman era, they were deeply undervalued and very cheap. Some of these companies were around 10/15/20 multiples and later traded at 50/80 multiples.

You have to spend more time on investing, like understanding companies better, and limit the time one spends on non-investment related areas. This is critical. The more time you spend on reading, talking to experts or people who have a contrary opinion, and observing, the better are your chances of coming across some good companies.

Also, use your experience, judgement, and knowledge, built over the years, to understand a new or existing business model. One must focus on what’s changing in the environment. Mistakes will still happen, because ultimately in investing you are dealing with the future and there’s uncertainty. It is very difficult to forecast long-term business outcomes. But we hope the extent and the intensity of the mistakes will be lower.

Current market valuation: "Higher multiples are justified"

Our multiples are 10-20 percent higher today than the 10- and 15-year average. So, if you look at it from this lens, you can conclude, markets are overvalued. But we believe these higher multiples can be justified for three reasons. One, growth rate of the domestic economy is improving; we grew at 6 percent and we should grow at 7-8 percent. This is a meaningful improvement. Two, our cost of capital has dropped. Third, the volatility of markets has also reduced because local flows are pretty secular.

So, you can argue for lower risk premium for equity. I feel comfortable with these multiples in aggregate terms. At the same time, I don’t think there is room for these multiples to move and that’s why our expectations of future returns have to be very modest and realistic. In most cases, we expect returns to broadly track corporate earnings which should be around 12 percent CAGR in the long-term. One would expect similar returns from the broader market.