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Why a Managing Director Told Us Not to Invest in His Company

Mar 22, 2016

In this issue:
» Why Rahul Gandhi is wrong on the small-savings scheme issue...
» SBI leads with 36% market share in mobile banking
» ...and more!
0.00
Devanshu Sampat, Research analyst

My colleague and I recently met with the senior management of a company. One of the tougher questions we asked was this: 'What is your take on comments about your company being a risky investment because it's a single-product business?'

The response was prompt and stern: 'I would simply say don't invest in the company.'


The MD continued with vigour:

  • This is the only concern analysts have for us. They assign company A and B [actual names avoided] multiples of 45x, and assign us a massive discount just because of this! And that too despite A and B operating in one business segment - a very similar profile to ours.
  • Being a focused player has allowed us to become the biggest brand in the space we operate in. We are a small company operating in a large sector. We have found one thing to do. And we want to do it well! In fact, this approach has now made us the largest marketer in this space. No one can match us when it comes to marketing spends backing a single product. And this is how we'll be able to retain, or even grow, our market share.
  • You must understand one thing...given our size, we would rather have few products with more resources backing each of them; rather than having more products with less money behind each.

His response reminded me of this quote by Warren Buffett:

Keep all your eggs in one basket, but watch that basket closely.

The debate on single-product businesses versus multiproduct businesses has been around forever. Certain investors prefer companies that 'de-risk' through diversification - be it across categories or sectors. Others prefer single-product, single-category companies.

What kind of businesses do we prefer? Well...our response would be only those that can allocate capital well.

Does it really matter whether the company has a well-diversified product or service basket? I don't think so... As long as it is able to grow its business (without losing considerable market share over long periods) and allocate capital profitably and sustainably, diversification is less of an issue.

Sure...risks such as product obsolescence and regulatory changes can arise...and can destroy companies entirely.

But I believe these kinds of risks can and should be taken care of at the portfolio level rather than at the company level. This means that an investor should handle this risk on his own. As you would agree, company level diversification can lead to a case of 'diworsification', where the probability of value destruction is quite high.

Over the years, we have met managements of companies with varied schools of thoughts. Many believe in dabbling in the 'flavours of the season' - the hot areas. The many conglomerates diving into the power and real estate sectors are recent and relevant examples. We are not saying that all of them have done badly. Or that avoiding such companies is the way to go.

But these moves bring about a lack of focus by the management. And for long-term investors, their wealth is largely determined by the fellow steering the ship. If they're able to find captains who want to stay on course - albeit at differing speeds - they'll be more likely to reach their destination.

What is your take on single-product businesses versus multiproduct businesses? Which do you prefer and why? Let us know your comments or share your views in the Equitymaster Club.


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2.50

Moving on to some news that have caused quite a stir at the macroeconomic level...the government recently slashed interest rates on small savings schemes. Interest rate have been cut in the range of 40 basis points to 130 basis points. Your favourite small-saving schemes, PPF (public provident fund), will now fetch an interest of 8.1% as against 8.7% earlier.

Of course, this is not good news for you and me. It is going to hurt our returns. Like every other issue, Rahul Gandhi was quick to take a jibe at the Modi government. He called the rate cut an 'assault by the Modi govt on the hard working middle class people'.

In a public discourse that is shaped by political rhetoric and foul cries, there is little room for rational discourse on any important topic.

So, is the rate cut on small-savings schemes really uncalled for? Did the Modi government make a big mistake here?

We don't think so...

Yesterday, Vivek Kaul penned a simple yet remarkable piece addressing this issue here: Rahul Gandhi Needs a Lesson in Inflation. I would highly recommend you read it.

We are not taking sides with political parties or their ideologies here. Our rationale is driven by an understanding of the very basics of economics - the link between interest rates and inflation. That's where we believe Rahul Gandhi errs.

By the way, the Ministry of Labour and Employment released the all-India consumer price index numbers for agricultural and rural labourers for February 2016. As per the data, retail price inflation for rural labourers, measured by the Consumer Price Index for Rural Labourers (CPI-RL), dropped to 5.3% in February 2016 from 5.7% in January 2016. Retail inflation for agricultural labourers, measured by the Consumer Price Index for Agricultural Labourers (CPI-AL), declined to 5.0% from 5.6% a month ago. Consumer price inflation for both the groups touched a three-month low in February 2016.

3:55 Chart of the day

A very important part of our research process at Equitymaster is this...to keenly identify and monitor key megatrends in the economy that could impact the business models and growth prospects of companies that we research on. Often, we see technological advances as the biggest disruptors and change catalysts.

How did you carry out your banking transactions before the advent of internet banking? I guess we all had to go to the nearest available bank branch...stand in a queue...wait for our turn...and then carry out the transaction. I'm sure many Indians still do that.

But there is a fast growing urban population that has embraced internet banking. In recent times, the advent of smartphones and mobile banking, has further accelerated the move to online banking.

We came across some interesting statistics on mobile banking in The Times of India. It turns out that the top five banks accounted for 92% of the total mobile banking transactions in December 2015. The five banks together reported transactions worth Rs 455 billion. India's leading public sector bank, State Bank of India, led the pack with 36% market share in value terms and 39% market share in volume terms. The remaining four banks are private sector banks.

Top 5 Banks Dominate Mobile Banking in India

4:40

Indians markets were trading flat today. The BSE Sensex was trading lower by 0.1% or 32 points at the time of writing. While stocks from the engineering and capital goods spaces were in favour, those from the FMCG and telecom packs were trading lower. Mid cap and small cap stocks were in demand today with their respective indices trading up by about 0.7% and 0.4% respectively.

4:50 Today's investing Mantra

"Abnormally good or abnormally bad conditions do not last forever. This is true not only of general business but of particular industries as well. Corrective forces are often set in motion which tend to restore profits where they have disappeared, or to reduce them where they are excessive in relation to capital." - Benjamin Graham

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat (Research Analyst) and Ankit Shah (Research Analyst).

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3 Responses to "Why a Managing Director Told Us Not to Invest in His Company"

Vivek

Mar 25, 2016

Obviously, there is no one simple answer! For every company which professes to "stick to the knitting" there are examples of well-diversified conglomerates/MNCs and others who have built profitable, well-diversified business empires by taking calculated decisions on diversifications. For investors too, the approach can well be to invest in companies that have demonstrated a consistently successful diversified approach (which many a times act as a hedge when one business can have headwinds while others may hold their ground.

All said & done, the article is indeed thought-provoking.

Like 

Subramaniam K V

Mar 22, 2016

A company Operating well with a single product is definitely good business. Diversification leading to diworsification is what one has to be wary about. You had featured an article about a company that ran into trouble due to diversification.

Like 

Balakrishnan R

Mar 22, 2016

Can you Concentrate on your timing Please!

Like 
  
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