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Equitymaster portfolio - A review - Views on News from Equitymaster
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  • Dec 15, 2001

    Equitymaster portfolio - A review

    "Disinvestors lose as market falls -- but investors gain" - Warren Buffet in his annual shareholders letter 1997.

    Before making investment decisions, the importance of asset allocation cannot be understated. Investment avenues, on a broader basis, can be classified as equities, real estate, bonds, mutual funds, gold and fixed deposits. Depending on the risk profile of an investor, i.e. age profile and expected returns, proportion of each category of the total investment would vary. For instance, the risk appetite of a 25 old person would be higher when compared to a 40-year-old working executive. For the former, the equity component is likely to be on the higher side and for the later, the real estate, fixed deposits and cash component would be proportionately higher.

  • Click here for Your Asset Allocation Review

    Now, if a retail investor, after determining the asset allocation component, decides to invest in equities, the next question would be, where and which companies should I invest? Returns from equities, broadly speaking, are comparatively higher than all other investment avenues. And so are risks of investing in equities. Equities are generally subject to various risks like market risk, business risk, interest rate risks and so on. So depending on the risk profile, we have clubbed companies under three broad sub-divisions.

    These have been defined as stocks that can be held by investors across most age brackets and status. These stocks represent companies with very good management and strong financial performance over the years. One criterion that we applied to these stocks was how they fared in the recent downturn in economic activity. Other issues considered included - position in sector, prospects for the sector itself.

    Companies that have good managements, sound financial track record and good prospects but not without risks. These companies, to put it in a way, are not in the core list because there are certain issues that have made them more 'risky' than the core stocks that have been identified.

    This group represents stocks that have high risks associated with them. Nevertheless, they are in a situation where they can leverage on their present position (like national presence for ACC) to generate returns much in excess of their peers.

    The performance chart…
    (% gain/loss) 1-week 1-month 3-months 6-months 12-months Since Jan`00
    Core 4.5% 8.9% 6.4% 4.3% 4.3% -5.4%
    Stars 1.1% 1.3% -3.1% -3.6% -8.4% -15.2%
    Flyers 2.3% 6.7% 10.6% -10.1% -16.3% -27.4%
    Portfolio 2.4% 5.1% 3.9% -4.0% -8.3% -17.6%
    BSE-30 5.1% 11.8% 8.1% -1.5% -17.2% -34.7%
    CNX Nifty 4.7% 11.1% 7.9% -1.0% -15.1% -30.0%
    Nasdaq 4.6% 8.9% 17.5% -10.1% -31.7% -49.4%
    Dow 1.6% 3.3% 3.3% -9.6% -7.4% -9.3%

    We had deliberately entered the buy price as of January 1, 2000, the peak times during the tech rally to prove investors that even if one invests at high prices, investing in good companies with a long-term perspective can be fruitful. To put things in perspective, the buy price of Infosys as on that date was Rs 7,839 (Core), NIIT was trading at Rs 3,581 (Stars) and Zee was at Rs 1,180 levels.

    The number of companies in our portfolio comprising core, star and flyers are 48. Of this, there are 11 companies in our core list, 17 stocks in the stars category and 18 in flyers. We allocated Rs 1,000,000 in each stock thus resulting in equal weightage. Our basic approach towards selecting companies in our portfolio was a bottom-up approach because there are sectors like housing that continue to grow at a brisk rate despite a slowdown in the economy. The number of TMT companies in our portfolio are just 5 (Infosys, NIIT, VSNL, MTNL and Zee). The rest is spread between services (banking and financial institutions) and old economy companies from a bunch of sectors that includes FMCG, auto, commodities, hotels, energy and power. Before going any further, we look at the performance of the each category of our portfolio.

    This set is highly diversified with companies from both high growth areas like software and pharma to relatively stable performers from FMCG sector. Given the state of infrastructure in India, exposure to commodities also makes sense. If one were look at the sector-wise weightage, FMCG sector accounts for 27% value of investment. Cement and aluminium sector account for another 18%.

    Of the 11 companies in our core list, there are only four gainers (once again we would like to remind you that we are comparing with prices as on January 1, 2000). Asian Paints, BPCL, HDFC and Nestle are the ones that have outperformed every benchmark. The clear out performer in our core list is the housing finance major, HDFC. While all the global and domestic indices are down 35%, the stock has gained 124%.

    But all is not rosy in our core list of companies. HLL, Indian Hotels, Infosys and Gujarat Ambuja have fallen significantly in the last one-year. While Glaxo has come for criticism for not introducing new products in the Indian market, unfavorable economic environment and weaker sentiment affected valuations of the other companies. After all long-term investing is not just about a year. HLL's understanding of the Indian market, Gujarat Ambuja's low-cost competitive edge, Indian Hotel's unmatchable asset profile and Infosys's management cannot be doubted. In the long run, one can expect these companies to outperform the industry and its peers.

    Comparison with Mutual Funds…
    (% gain/loss) 1-week 1-month 3-months 6-months 12-months
    Core 4.5% 8.9% 6.4% 4.3% 4.3%
    Stars 1.1% 1.3% -3.1% -3.6% -8.4%
    Flyers 2.3% 6.7% 10.6% -10.1% -16.3%
    Portfolio 2.4% 5.1% 3.9% -4.0% -8.3%
    Pioneer ITI Bluechip (Growth) 3.6% 9.4% 15.2% -3.7% -17.9%
    Templeton India Growth 1.8% 10.1% 15.8% 3.3% -5.4%
    Zurich India (Growth) 0.9% 11.8% 23.9% 12.1% -3.2%

    Though this is a diversified portfolio, the proportion of pharma and auto companies is one on the higher side because of growth prospects. First let's look at the selection process. Domestic pharma majors like Dr. Reddy's, Cipla and Ranbaxy are in this category because they are relatively new to R&D and clinical trials. Though the growth prospects are promising, much depends on R&D efforts taken by these companies and so, to that extent the risk profile increases. Colgate, despite being investor friendly and having a committed parent company to boot, is largely a single product company. Similarly, Hero Honda faces the challenge of Honda's exit from the joint venture.

    Out of the 18 Star companies, just 4 companies are on the positive side. This includes BSES, EIH, Hero Honda and HDFC Bank. Hero Honda and HDFC Bank are up 106% and 29% respectively since January 2000. If you look at the performance of this lot in the last twelve months, the returns are mid-way between core and flyers category. This, in itself, puts forth the nature of the portfolio.

    This is a high risk-high return portfolio. Of the 17 companies in this list, there are only three gainers namely Tata Power, ICICI Bank and Reliance. Though ICICI Bank is aggressive on the retail front, its investments in various subsidiaries and technology ventures are one worrying aspect. Besides, the proposed reverse merger with the parent company (ICICI) is also a cause for concern. Similarly ITC's investment in hotels and greeting cards would have a negative impact on profits in the long run.

    If one were to look at the performance of this lot in the last 3 to 12 months horizon, there has been a sharp fall, as well as a sharp recovery in returns. While returns from this category are -16.3% in the last twelve months, when the markets recover, they are first ones to turn around (10.6% in the last three months).

    A re-look at our portfolio
    After more than a year and a half, we reviewed our companies recently and some changes were required. Not because they are not the flavour of the season anymore, but because of the fact that the company's management has failed to deliver, when situation demanded their best.

    Glaxo Smithkline and Indian Hotels, for instance, have been shifted from the core to the stars category. Glaxo's management is averse of introducing new drugs in India in absence of proper patent rights. Though they have a valid reason to do this, investors have lost almost 58% since January 2000. If Aventis Pharma (formerly Hoechst), operating in similar environment, has managed to introduce new drugs and managed to grow, so can Glaxo. Indian Hotel's management has failed to stem the slide in profits and at times displays lack of focus. Also competition has increased and the industry is reeling under pressure due to excess capacity in key markets.

    EIH, NIIT, Ranbaxy and VSNL also have been downgraded from stars to flyers. Ranbaxy's investments in stock markets have raised apprehensions about the focus of the company. NIIT, though a market leader in the software education business, has group companies competing in similar areas (HCL Technologies and HCL Infosys). This has forced us to rethink its risk profile. VSNL faces a double whammy. While on one front the government is preparing the ground for its divestment, on the other, opening up of the international long distance telephony has posed new challenges to the company. Thus the company is now showing stagnation in revenues and falling profits. But VSNL is now categorized as a Flyer on the hopes that disinvestment may bring in new growth avenues for the company.

    Reliance and ACC have been shifted from flyers to stars category. ACC initially was there in the flyers list because it was a tentative turnaround story (it may or might not happen). Now with Gujarat Ambuja raising its stake in the company, one can expect a consistent performance from the company in the coming years.

    We had included Reliance in the flyers category because of concerns about financial reporting standards. Though the concern still remains, the sheer scale of operations coupled with its project execution skills cannot be understated. Its global efficiency standards also have to be reckoned with.

    The also ran (Deletions)
    We have removed Novartis and TVS Motor Company (formerly TVS Suzuki) from our portfolio. Though TVS is backed by a management with high level of integrity, its product profile and lack of aggressiveness are expected to slow profit growth in the coming years. Novartis lacks a competitive edge in the otherwise highly competitive pharma sector. And there have been no positive developments to kick start growth also.

    The new ones
    We have included Wipro (Stars), GAIL (Stars) and HCL Tech (Flyers). The reason why Wipro was included in the Stars category and not in the Core portfolio is because the promoter holds 85% stake in the company and the management is yet to announce any succession plans. But the management team can be rated at par with that of Infosys (after all, Wipro has created more than 65 entrepreneurs).

    Gas Authority of India (GAIL) is the clear market leader in the gas transportation segment. The cross-country pipeline traverses a distance of 1,700 kilometers and with extensions measures up to 2,300 kilometers. But sales growth of the company continues to be dependent on gas availability. Therefore, GAIL does face a supply risk.

    "Our policy is to concentrate holdings. We try to avoid buying a little of this or that when we are only lukewarm about the business or its price. When we are convinced as to the attractiveness, we believe in buying worthwhile amounts." - Warren Buffet in his annual shareholders letter 1998

    In line with the Berkshire Hathway philosophy, we keep trying to pick the very best available on the Indian stock markets. We must admit that it's a constant learning process. Every now and then markets make a fool of everybody and we have been no exceptions. But in the long run, we are confident that it is not the flavour of the month or even the year that counts. What count is fundamentals, and that's what we bank on.



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