Please find below our key excerpts from a investor memo published by Solidarity Investment managers around January 2021. This letter covers quality material on key parameters they look while investing in a company explained through live 4-5 case studies like Bharti Airtel, CAMS etc. this letter also has a wonderful small excerpt on comparison between gold and equity return on various time frames which might help investors with asset allocation guideline. (Emphasis Ours)
- 4/5th of global Investment grade Debt yields ~1% or less at present . Lower interest rates increase attractiveness of Equities relative to returns one can earn on Debt.
- Historical valuation benchmarks could be misleading at moments when Earnings growth can be non-linear. Moreover, lower interest rates can justify higher valuations for companies whose Earnings growth expectations remain unaffected.
- We continue to recommend an exposure to Gold. No one understands the side effects of this scale of money printing. When inflation returns, which we think is a high probability event, the same factors which are boosting Asset prices will act as head winds when interest rates rise. Conditions are perfect for Gold to do well and provide both diversification and protection to portfolios.
- In the short term, it is hard to separate the role of luck and liquidity. In the medium term, results from a good process dominate as luck averages out.
- One needs to recalibrate valuation approach a bit when estimating fair value for well-run companies.
- Lower interest rates justify higher valuations “for some franchises” due to lower discount rates. High quality companies (high, predictable earnings growth at high ROE) can trade at very high valuations as they become Bond proxies and are discounted at lower Cost of Capital, especially if their growth expectations are not altered.
- Listed Co. PAT to GDP is at 16 year lows
- Stock markets in the developed world are not reflecting confidence in Equities, but rather “relative” attractiveness vs poor return prospects in Debt. An uptick in inflation (not a concern at present) can suddenly reverse the euphoric sentiment if interest rates start rising. And the flood of liquidity into Emerging markets can start reversing.
- Recently listed SPAC traded at 20% above issue price implying investors were willing to pay a 20% premium just for cash on balance sheet.
- Low interest rates in India reflect surplus liquidity amidst low demand for Credit rather than structurally lower Cost of Capital.
- During periods of swiftly rising prices, risk is forgotten. “Successful investing is mostly a battle between our ears … the key is, how disciplined can you remain through the boom, bust, boom and bust?
- Growth, if backed with longevity and a strong competitive position, will correct any valuation mistakes if one has marginally over paid. The bigger risk is missing out because one keeps waiting for a correction.
- If one significantly over pays on the promise of growth, the odds are stacked against you, not only because of mean reversion, but also the probability that actual growth may be significantly lower than estimated.
- So when to wait for a better entry point, and when to risk over paying a bit? We look for whether competitive positions and/or growth trajectory is improving or are at status quo. We believe that for a vast range of FMCG/paint cos, the ROE/growth trajectory is as it was 5 years ago and the only lift to valuations is from a decline in interest rates; and this should reverse when interest rates rise.
- We are “perhaps” witnessing the start of a new housing cycle. There is clearly increased demand for home ownership prompted by the triple benefits of lower real estate prices, stamp duty cuts and lower interest rates.
- Intent to buy Life Insurance increased during the pandemic reflected in higher Google searches for Protection from April to July, but it hasn’t translated to numbers due to the inability to do medical tests. Millennials are buying Insurance earlier than the previous generation did and also buying higher ticket size longer tenure plans.
- Kotak, ICICI bank: Valuations in Banks are strongly correlated with Asset quality and consistency of reported profits. As the market gets more confidence on the cultural change at ICICI Bank, this will get reflected in a higher valuation multiple vs where the bank trades at present.
- Bharti Airtel: Telecom services today are akin to FMCG, as in the demand is secular and uncorrelated with the environment.
- A common critique of the Telecom industry is that it does not generate any FCF. That would be looking at the rear view mirror when the industry structure and conditions are very different at present than what they were a few years ago. Telecom will surprise immensely on profitability – Indians consume the most amount of data in the world while paying the least for it – an untenable position when the industry is not even earning its Cost of Capital. A revenue starved Govt. should have no objection to rising tariffs as it shores up revenue. Rising ARPU and lower unit costs over time should result in substantive margin expansion and FCF generation.
- Shaily Engineering: Most global procurement decisions are based on price and quality considerations. However, supply chain reliability is now getting as much prominence over price.
- Shaily has had issues in execution because of labour problems.
- Customers have kept faith in Shaily despite execution hiccups. That is reflected in continued new business wins. That is a huge vote of confidence on Shaily’s competencies and is key to gauge prospects for a B2B business.
- Gold: The Japanese Central Bank is creating money and using it to buy Equities – it is currently the larger holder of Equities in Japan and has a well communicated regular buying plan. The US Fed is at present buying bonds of barely profitable companies at any price by creating money. Over USD 3.2 Trillion has been created since the start of this year, most of which has gone in direct income support rather than productive investments like roads, airports and factories.
- If money printing could solve humanity’s problems, surely it would have been figured out much earlier.
- Gold has performed as well relative to Indian Equities over 5, 10 and 20 year periods and tends to do even better during very inflationary phases.
- CAMS: It is India’s largest Registrar and Transfer Agent (RTA) of mutual funds (MFs) with ~70% market share in a duopoly industry. This segment is ~87% of their revenues.
- Their core segment, RTA services to MFs, has strong entry barriers and high switching costs.
- A largely fixed cost model, its dominant scale provides a significant cost edge as the largest RTAs who have on boarded maximum Assets on their platform can offer lowest incremental price to all customers as the fixed costs are spread out over a large base.
- Switching costs are very high for customers - moving to another RTA is time-consuming and there is a high risk of business disruption and customer dissatisfaction.
- Limited competition, an Asset light business model, no threat from MFs bringing CAMS offerings inhouse results in CAMS earning high ROIC (>150%). The company will dividend out most of the cash generated as Cap ex requirements for growth are nominal. With Warburg Pincus as promoter and the HDFC Group having significant minority holding, there are no concerns around governance.
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or From their website: https://www.solidarity.in/