Investor confidence in Indian stock markets is shaky in the face of uncertainty on oil prices, GST collections and banking fears. Most indices have fallen significantly in the recent times, with the BSE Sensex tanking more than 10 percent from its all-time high on 29 January 2018 to 23 March. Albeit, the sentiment has somewhat improved of late on the hope of recovery in corporate earnings. Ambit Capital’s top brass explains how investors can maximise their chance of making money, and minimise risk of losing wealth, using what it calls the “Coffee Can Investing”. Ambit Capital’s CEO Saurabh Mukherjea, PMS fund manager Rakshit Ranjan, and products & advisory head Pranab Uniyal — the authors of the book ‘Coffee Can Investing — The Low Risk Road to Stupendous Wealth’ — tell Ashish Pandey of FE Online in a Q&A how the philosophy can help investors outperform the broader indices, especially when the markets are stressed.
What is Coffee Can investing strategy? What are the basic tenets of this strategy?
There are two basic tenets of the Coffee Can strategy:
- Buying high quality companies: Most good companies in India face disruptions which could be external disruptions (regulatory changes, competition intensifying, innovation, economic growth) or internal disruptions (capital misallocation, success planning, lack of systems and processes, change in senior management by way of retirement or resignation). However, there are a handful of companies in India which have the capability to deliver healthy fundamentals consistently for more than a decade, regardless of any type of disruption that they face. The Coffee Can Philosophy shows commitment to such high quality franchises that consistently sustain their competitive advantages over long periods of time despite being faced by challenges and disruptions at regular intervals. In order to filter out such stocks in the entire listed universe, we look at historical performance of a decade long period and select companies which have delivered revenue growth more than 10% each year (i.e. more than nominal GDP growth) and ROCE higher than 15% each year (i.e. more than Cost of Equity) for 10 year in a row.
- Holding on to companies for 10 years: Average holding period of a stock in such a portfolio is 10 years. Hence, the portfolio undergoes either zero or negligible churn.
How is Coffee Can investing different from other market strategies?
The following aspects of Ambit’s Coffee Can Philosophy help it outperform the broader markets by at least 500-700 bps per annum:
- Lower drawdowns during market crash: On average, the percentage fall in a Coffee Can Portfolio is less than half of the broader market during a market-wide crash. This is because Coffee Can Portfolio companies’ valuations are supported by robust fundamentals/earnings.
- Low churn in the portfolio: On average no more than 5% churn in a year compared to 40-50% churn for most mutual funds. As a result, the Coffee Can Portfolio incurs negligible brokerage costs, lower capital gains taxes and expense ratios, and thereby benefits the most from the ‘power of compounding’.
- Low cost structure: There are no entry loads/exits loads/other hidden charges for any investor. Moreover, there is an option choosing ZERO fixed annual fees where the investor pays only a proportion of profits above a certain hurdle rate. Low watermark is applicable on the hurdle rate.
- No need to time entry/exit from this portfolio: Given the ‘evergreen’ nature of the constituent companies’ fundamentals, an investor can generate healthy returns from the Coffee Can Philosophy regardless of bull/bear runs in the broader markets, regardless of whether the external economic environment is good or bad, and regardless of the number of years of since when the portfolio has been chosen by the investor.
What is the basic philosophy behind Coffee Can investing strategy? Is it aimed at rapid wealth multiplication, or sustained low-risk growth?
The basic philosophy is to help compounding of wealth at 20-25% CAGR with volatility in the return CAGR similar to that of a Government bond, for investment periods longer than 3 years.
When does Coffee Can investing mantra work best? During the times when markets are stretched or when down?
Coffee Can Investing tends to outperform both during good as well as bad phases of the broader stock market. However, the quantum of outperformance is higher during periods of market stress than during periods of market euphoria.
How does Coffee Can investing apply in the current market scenario?
Over the past 3 years (FY15-18), whilst Sensex’s returns have been entirely driven by an increase in its P/E multiple (there has been no earnings growth), performance of CCP stocks has been entirely driven by their earnings growth. Over the past three years (FY15-18E), Coffee Can PMS stocks (weighted by portfolio allocations) have delivered 18.1% earnings growth compared to -0.6% delivered by the Sensex over the same period. As a result, during the recent fall in the broader stock market (~10% or higher decline in most indices since 29th Jan 2018), Ambit’s Coffee Can PMS has shown remarkable resilience. Going forward, the stock market’s performance is likely to be driven by a combination of improving earnings growth momentum, partly offset by deflating P/E multiples. On the other hand, we expect the quantum of growth momentum of Coffee Can Portfolio companies to be 5-10% higher than that of the broader market, thereby justifying portfolio’s outperformance vs the broader market.
How did you come to write a book around this strategy?
We germinated this idea for Ambit’s Institutional equities clients in 2014 and the success of the institutional equities product made us write a book on the philosophy in 2016, called “The Unusual Billionaires”. Subsequently, we converted the institutional equities philosophy into an asset management product for HNIs and corporate treasuries in early 2017 when we launched the Coffee Can PMS. Thereafter, wrote our recent book using philosophy of Coffee Can Investing in the context of wealth management for an individual or a corporate, highlighting the various good and bad practices that investors use when they approach wealth management as a broader subject.
In the current scenario, what are the key upside and downside triggers for Indian stock markets?
The 12 month outlook for the Indian stock market over the Indian stock market hinges on three different triggers:
- GST collections: If the Government is to meet its budget deficit target for FY19, it will need to collect Rs 125,000 crores per month of GST revenues. The present run rate is around Rs 85,000 crores per month. If this run rate does not pick-up, we could see a further tightening of bond market conditions with adverse implications for the cost of capital in India.
- Oil prices: Oil is a familiar villain for the Indian market as it hits our economy via two different routes: it puts upward pressure on the fiscal deficit and it increases our current account deficit (which in turn weakens the currency and makes Indian stocks less attractive for FIIs). Over the past four years we had forgotten how painful high oil prices can be. If oil prices stay above $70 per barrel, it will start impacting the economy adversely.
- Fear in the banking system: Post the Nirav Modi scandal, the powers that be in New Delhi and Mumbai have woken up to the extent of malfeasance in the banking system. Not only has that put paid to the chances of the PSU bank recap, it has also resulted in bankers cutting working capital lines for companies. If this continues for another quarter, the economy will be adversely impacted.
This interview was originally published on 13 April 2018 on http://www.financialexpress.com