Value Vs Growth: Ravi Dharamshi Dispels Myth Behind Expensive Stocks

Ravi Dharamshi: So, see, I don't think the concept of value has changed, but what happens is, as markets evolve, everybody tries to bucket themselves, and I'm a value investor, I'm a growth investor, and I think that is what creates confusion. I mean every type of investing is value investing, and that is what Warren and Charlie have said over a period of time and I had tweeted a particular video of Warren speaking about it also. I think value and growth are not mutually exclusive concepts.

Growth is very much a part of the value equation. If you want to estimate the value of a company, you have to know what the future growth is going to be. If there are certain people who are completely shunned away from doing any kind of forecast and say, I will buy when the intrinsic value of the company is, you know, much higher than what the current quote of the company is. It is absolutely a wonderful thing. But those kinds of cigar butt investing opportunities come very, very rarely, like once in two decades, maybe where there is a crisis of sorts, where asset prices fall so much that they become very, very attractive in relation to their own intrinsic value.

In a regular course of business, and especially in a market like India, which is a growth market, you will be hard pressed to find opportunities which fit into this particular traditional definition of value. So the value of an asset in simple terms, if you take the formula is the discounting of all future cash flows. By definition, it is all future cash flows. So you have to know what the future cash flows are going to be.

Now, if you figure out that the future cash flows are going to be much higher than what they are at present, because there are certain aspects about business which are panning out now, then you suddenly realise that there is very apparent value, even though in the traditional P/E format it might not fit. That is what I have been trying to dispel that myth that just because on a TTM P/E basis, or a last year P/E basis, a stock looks expensive does not mean it is actually expensive. There is a fine logic why there is a lot of value in it.

Ravi Dharamshi: I think there's a very simple way. Of course, it entails that you do some scenario analysis on what's going to pan out in the 10–20-year time frame. Often enough, even in the bottom of you know, right after 9/11 when, you know, the stock prices were dirt cheap at that point of time, in September 2001 you know, you would have found that Asian Paints was still expensive. vis-a-vis the market, Titan was still expensive. vis-a-vis the market.

Now, at that point of time, you could have said that, you know, these are expensive. Let me buy a 5 P/E multiple company. Sure, you would have bought a 5 P/E multiple company and made some money on it, not denying that, but you completely missed the point, if you just focus on historical valuation, what about understanding the business? What about understanding the management? What about understanding the prospects of the business five, 10, 20 years out. If you would have understood that, then you would have realised that those seemingly expensive stocks were actually the cheaper ones, and those seemingly cheap stocks were actually the expensive ones, because you lost out on an opportunity.

You did not understand the prospect of that business. So, if you can say that I will take that example of Titan again. Now it's not like everybody has a clear picture of what's going to happen, but if you could foresee that, there's a large jewellery market out there, Tata has a trusted brand name, and there is a management in place that has focused on creating that value, then you it would have become very, very clear that it's okay if the traditional metric of P/E and price to book might say that this is an expensive stock, but this is a long runway.

There is a lot of predictability to it, and you can say that the probability of a Titan becoming a much bigger company was much higher than, let's say, some XYZ company becoming that too large. So focus on identifying that predictable growth over a long period of time, and where markets are actually probably underestimating the kind of growth that can happen. That is where the value lies. I mean, I hope I've been able to explain, but honestly, I'm not very good at articulating as maybe some of the other valuation experts are. 

Ravi Dharamshi: See today, no doubt about it, they are factoring in a lot of the future. So, there is a risk to the extent that the future is different than what the stock price was suggesting. However, I'll just give you a framework on how we think about it and how we attach probabilities to the outcome, and that might give you some sense and how to evaluate this.

So, two, three years back when this sector was actually getting born, and you know where new companies were getting listed at that point of time, this valuation concern was actually totally not required. Why, because we tend to track a lot of these trends on our 10-20 year horizon, but only when they cross a particular inflection point that would bring it on our radar or make it part of our investable universe is that the growth is going to pan out in the next five, seven year, and not in some 10-20 year horizon, which might not be my investment horizon to begin with.

So when you know, the government in 2014-15 started talking about Make in India and then they focused and they came out with a policy for electronic manufacturing. We knew that this is the beginning of a particular megatrend. However, we waited until, you know, Samsung came here. Apple came here. Once the OEMs started coming here and of course, we all started with low end assembly work, and then the ecosystem around it started developing. That's when you keep your eyes out for companies where there is some differentiation, where they are showing some signs of who these large OEMs are beginning to work with? Those are the companies that you should be focused on and then you have a reference point on how this particular thing has panned out, whether in China, whether in Taiwan, and will, someday we will have our own Pegatron, Wistron and Foxconn out of India.

Yes, there is all possibility and likelihood that we will have because the government has created that required ecosystem, and the required ingredients from where the entrepreneurs can actually start charting their own path. So that is what tells you that, give or take, a couple of years, this story is going to pan out, and in that kind of a scenario, you don't try to value those companies on what the current year's earnings multiple is, but you try and build scenarios what kind of size this company can become, what kind of profits this company can make in a three, five year horizon and then see vis-a-vis with that scenario, is the stock still, you know, very attractively valued, or very cheaply valued, and in that also, you don't have to make extravagant predictions or forecasts to justify your position.

Even in a basic case scenario, if it is attractive enough, then you can let the upside, you know, surprise yourself. That's how we think about these things.

Ravi Dharamshi: So, when you say power, am I assuming you're talking about power equipment companies? 

Ravi Dharamshi: Again, it is the same thing. What is the size of the opportunity? How soon will this opportunity pan out? See, we don't like to talk in terms of 10-20 years. We like to talk in terms of five, seven years and is that opportunity going to pan out in that five, seven years.

Basically, will the government be forced to spend money on building power transmission infrastructure or even the private sector will have to spend that money. If you see today, for example, for all the renewable generation that is coming up, the single biggest factor that is impeding that growth is the connectivity to the grid. So basically, you need to put those transmission lines in place today if you want the entire energy transition to succeed. Otherwise, we would have failed. It's like paving the road before selling cars. You cannot sell cars if there are no roads available to drive. So first you have to pave the roads. So, Power equipment companies are essentially catering to that opportunity of paving the roads for energy transition, and that spend needs to happen in the next five, seven, 10, years and because of that, the delta is huge in terms of spend.

If x was being spent two years back in the annual number for that x will become three to 5x in the next five year horizon. That's a huge delta and then there are very few companies who are catering to that kind of an opportunity. So there is a huge delta into the opportunity, and now there is a right to win of certain companies, which is where the stock prices are running, probably slightly ahead of even ordering.

We saw the same thing in Defence as well. Way before the orders started coming, the stock prices started moving and with every order, the stock prices have been going up. So this is how usually a cycle plays out. Now, of course, probably I can say Defence has reached a point where ordering has kind of reached a kind of a peak level, and now you're carrying the entire execution risk ahead of yourself. Now that not to say the opportunity would pan out, but now the risk reward might not be that favourable from the next five years perspective.

Ravi Dharamshi: Thanks for that question. Niraj. So, first of all, the way we look at this is that energy transition is not new. We've been moving from various forms of energy. There was a point in time where coal was a big percentage, then oil took over, and now oil is being replaced by renewable What is different about this particular energy transition is it is being driven not by natural resources which are to be dug up from the ground, but it is being driven by technology which is made in factories. So there is a learning curve involved over here. These technologies tend to keep improving as you produce more and more of it at scale, they become cheaper, they become more efficient, and they are able to extract more. So that is the main difference between this particular energy transition as against the previous one.

Another thing that's different about this particular energy transition is that there is a time bound nature to it. It's not like it will take its own new course. We have to achieve a certain level of carbon emissions, and to achieve that, we basically to reduce that carbon emission, we need to achieve some level of renewable penetration for those carbon emission norms to be achieved. So there is a timeline to it as well and we always prefer opportunities that come with a timeline that has to be done in the next 30 years, if this has to happen in the next 10 years, that is when opportunities become real. So that is the point.

Now, the backbone of this entire energy transition, in my opinion, is going to be Solar. Why solar? Why not Nuclear is because there are three things that are needed for a particular technology to be adopted at a mass level. Cost, basically, which means affordability, accessibility and acceptability. So nuclear cost is an issue, with nuclear accessibility being an issue, because, you know, there is something called the NIMBY effect, not in my backyard. If you were to put up a nuclear plant, let's say 10 kilometres away from Bombay, I don't think the entire city is going to agree to that plan today, as of now. So basically, you will have to go to a remote location, which might probably increase the cost even further of evacuation and everything. So technology can become mass only when it is accessible, affordable, and it has reached that mass adoption level. So those are the points that we want to make.

Now, this energy transition as a theme transcends many, many sectors. Okay, on the generation side, on the transmission side, on the consumption side, on the new technology side, on the financing side. So from time to time over the 30 year period, some sub sectors from the energy transition will end up being a beneficiary. I'll give you an analogy of, you know, the internet. The entire pipelines for the Internet were laid in the late 90s, early 2000. However, the eventual winners of that pipeline probably are being discovered today. You know, Google, Apple, Microsoft, AI. Those are the beneficiaries of the pipelines that were laid 20 years back. So think of this energy transition also as a pipeline exercise that is going on for renewables.

At some point of time, 20 years down the line, we'll see that new business models have suddenly cropped up, which leverage on this particular thing. I'll just give you one example that I can think of right now is heavy manufacturing industries where the power cost is very, very high. We are already witnessing that the power costs are falling to zero, or it is actually power is becoming a source of revenue, rather than a source of cost. For example, let's say spinning in textile is a very power intensive business, but if you have your own solar plant, you're actually making money. You're supplying power to the grid and your competitor now has no choice but to actually install the solar plant on its own, because otherwise they will not be able to compete with you at all.