Transcription
People's portfolios in small and midcaps are literally bleeding, right? Why should one be looking at investing in the micro cap space right now?
Small caps. Small cap investors are reassessing their approach. Should they stay the course, rebalance or adopt a more cautious stance?
Let's look at 20-year data. Nifty is probably given you about 13-14% compounding. Midcaps have given you 16-17%. Micro cap's the one which is closer to about 18%.
Hey guys, welcome to the money mindset. I have with me Pavan Baradyia who's the CIO of Equity Capital. In the last 6 years, their PMS has given returns of over 40%.
Can you identify a couple of big themes? For example, auto. Despite auto being a 70-year-old industry in India, we still end up importing close to about 20 billion worth of auto components every year. Even after 70 years, we still don't have self-sufficiency in auto components.
Why do you think that is?
This is interesting. Actually, we heard the prime minister talking about use of solar pumps. Probably India has close to about 1 crore diesel pumps yet to be moved on solar pumps and that's like roughly about 2.5 lakh crore opportunity.
Are there any peers which look exciting enough?
There are a couple of other companies. Gre has got into Ital Pumps, which is a small company called GK Energy.
You have identified as Aarti Industries. You entered around 95 rupee level and the exit was almost at 800.
Around 800 level.
How did you decide when to enter, when to exit?
So, Aarti, we invested.
Hey guys, welcome to the money mindset. Today we are going to talk about a topic that scares a lot of investors, actually. Micro cap investing, which is investing in companies that are small in size but have huge growth opportunity. It's a skill set that a lot of us don't have. So today, we're going to try and understand and do a deep dive into this particular space. I have with me Pavan Baradyia, who's uh the CIO of Equity Capital. It is an AMC that was founded in 2012. They are SEBI-registered PMS advisers as well. And Pavan himself has over 25 years of experience in investing and in the equity markets in India. I was going through some of their uh fund returns, their portfolio returns, and it's been quite phenomenal to say the least. In the last six years, their PMS has given returns of uh compounded growth returns of over 40%. And a lot of their portfolio is concentrated in the small cap and micro cap space. So it's, it's a very interesting space because I have never been able to crack it. But Pavan is here with me. Pavan, thank you so much for being on the show.
Thank you so much, Sonia. It's a pleasure to be here. You know, it's an interesting time to have this discussion because people's portfolios in small and midcaps are literally bleeding, right? If you look at the last one year, 18 months, um, there have been huge drawdowns in portfolios. So, you know, what is the use case or I mean, you know, why should one be looking at investing in the micro cap space right now?
In fact, these drawdowns actually make it the perfect case to be looking at investing into small caps. So if you look at uh numbers uh statistically over a longer period of time, and we're talking only of the last 18 months where, of course, small caps have taken a lot of beating. But if you look at the last 5 years, or last 5 years, probably is COVID lows. Let's look at 10-year data, or let's look at 20-year data. Nifty is probably given you about 13-14% compounding. Midcaps have given you close to about 17 or 16-17% compounding. The micro cap universe is the one which is closer to about 18% compounding. And in fact, most of today's uh big uh companies or or the so-called large cap stocks, they started their journey of small caps or micro caps at some point in time, right? Uh, and and that's where the wealth creation actually happens.
So, you know, it's also a very high-risk, high-reward space, right? I mean, it's hard to identify and then it's hard to stick with companies through upcycles and down cycles. So if you pick, say, a TCS, and it's just psychological. I mean, you know that, okay, the company may not do much, but you will not lose your money. But in small caps, micro caps, the problem is the drawdowns are like 30%, 40% in a bear market. So in your um, you know, in your wisdom of so many years of investing, uh, what is a way to kind of balance that? I mean, how do you uh, you know, wade through periods when there is significant downside in your portfolio, especially in mid and small caps?
See, from our perspective, the way we look at investing into this genre is not really looking at the stock price. Because if you look at the stock price, uh, the behavior can be very erratic. And uh, if the decisions are led by stock price, invariably, you'll end up making a wrong decision. The way to look at investing into this segment or this genre is to more be more like a business investor. You mentioned about TCS, right? U now, while people follow TCS as a large company and hopefully a safe haven to invest into, how many people really understand the intricacies of what TCS does, where the revenues are coming, which segments are they growing, which segments are they getting into, and you know, where the growth is going to come from? If you have answers to those questions, that's where you start changing from being a stock price investor to becoming a business investor. And that's a huge differentiating factor when you have to invest into these micro cap and small cap companies. In fact, from our perspective, we look to buy into businesses which have been in existence for at least two decades. Now, there itself, that whole uh segment of companies which have survived themselves for two decades, that itself reduces uh chances of errors.
Okay. So when you do investing, do you look at it top-down? Do you identify the sector first, or is it like a bottom-up approach from your end?
It's a combination of both. So there are certain themes that we look for, which we believe is um, probably getting played out over the next decade. And at that then you start being a micro investor. So essentially, maybe it's 25% macro, but 75% of the times, it is actually ground-up investing. That's the only way that you can invest into this genre.
So if you had to look at a couple of big themes, right? For the over the next 12 to 18 months, or say over the next um, because you have a time horizon, I think, in excess of five, seven years that you stick with a stock. So let's look at say, 5 to 7 years, right? For the Indian markets. Can you identify a couple of big themes, and then we'll sort of drill it down to specific companies and how you look at what your investment philosophy is?
Sure. So uh, if you look at themes like energy, uh, if you look at themes like water, uh, if you look at themes like uh, uh, Indian manufacturing gaining share in the global market space in terms of uh, global merchandise import substitution. And this is across a diverse uh range of companies. Uh, for example, auto. Despite auto being a 70-year-old industry in India, we still end up importing close to about 20 billion worth of auto components every year. Now, you imagine, even after 70 years, we still don't have self-sufficiency in auto components.
Why do you think that is?
This is interesting, actually. So if you look back 20 years, Indian entrepreneurs' mindset was very different. People would not care as much about giving a great value product or or great uh quality product, so to speak, right? The idea was basically to make money from wherever you could fleece, and that used to be the profits. So only a handful of entrepreneurs had the mindset to really think of creating a great value product and, you know, giving up with a good quality product. That mindset is changing today.
I guess it also happens when countries move from a survival mode to growth mode, right? As the per capita GDP goes.
Absolutely. Apart from that, lot of uh, you know, the measures that government took in terms of digitization of the economy and everything else, that's plugged in a lot of these kind of holes. Now, today, this breed of entrepreneurs realize that if we have to survive, either we come up with a great quality product or do something which is different. And that's where the mindset is changing. And also because, I mean, the generation is changing, right? So even in our uh, socioeconomic uh, surroundings that you look at, uh, with this whole digitization of uh, money and everything else, the new generation doesn't even want to touch cash right now. If you come to think of it, the ways of doing business 20 years back, if they were to continue even today, the new generation doesn't relate to it.
But as far as the domestic manufacturing theme is concerned, you said energy, water, manufacturing overall, right? Auto ancillaries. Do you think a lot more needs to be done from the Indian entrepreneur or businessman? Because I'm, I mean, top of mind, right? Recently there was this whole article about how billionaires in India are still investing in spaces like ice creams, for example, while we have the Metas of the world, the uh, you know, Google's Alphabets, high-tech is happening, AI high-tech is happening only in the West. So why do you think that still is? And do you think there's still a long way to go before India gets there?
So like, I think Manish Khani had mentioned this thing that uh, India has multiple uh, fists to it, right? Probably we have five different countries in the same bucket. So there's a space for everything. When you talk of high-tech, uh, we've proven our uh, strength in terms of space technologies and everything else. AI is something that probably, yes, we're still not right up there, uh, or anywhere close to what Meta is or, you know, some of the other companies are. Manufacturing, we are yet to get there. That's what the whole import substitution thing is all about. And we've seen that happening in certain segments. If you look at in electronics, the way things have happened. You look at uh, the way chemicals has changed. You look at pharma. I mean, COVID happened. India was probably amongst the few companies globally to come up with a vaccine. So we've been showing our progress. Defense exports in the last 5 years, defense exports have been growing at a CAGR of about 35%. I mean, from being net importers of defense equipment, the the scenario is changing. So there is this breed of entrepreneurs which is rising up to the occasion. And while ice creams will still sell because uh, India still remains an aspirational market and investment in ice cream probably will still do well. But at the same time, uh, there are these kind of things which are also being done. So, uh, it's a combination of both and and we're seeing that across the board.
So if I look at your list of companies where, you know, the I think your expertise is in identifying companies in in the very nascent stage and then holding them through, right? Whether it's Aarti Industries, Shakti Pumps, HBL, and a whole long list of stocks. Um, so I want to go one by one because I want to just understand, take examples and understand how do you identify such multibaggers? Now, if you look at the specialty chemical space, one of the companies that you have identified is Aarti Industries. As per your own fact sheet, you entered around that 90-95 rupee level and the exit was almost at around what? 800?
Around 800 levels.
Around 800 rupees. Okay. Now, that's that's a huge, that's a multibagger, right? So, at what was the thesis for entering and what was the thesis for exiting? Because currently, I think the stock has gone down quite a bit. It's all, it's at 460 or so. So you...
This is 460 adjusted to the bonuses and the stock splits.
Correct. Correct. Correct. So you managed to uh, you know, ride out a large part of the upside in the stock. But just take me through the rationale and how did you decide when to enter, when to exit? What were the green flags?
So, Aarti, we invested back in 2012, uh, just about when we set up Equity. And uh, one of the things, or rather few things that we saw in Aarti back then was that despite being a small company, I mean, those days, Aarti's profit numbers was just about 100 odd crores. And at that size, they were competing with the largest of specialty chemical companies globally. And some of the product segments that they were into, they were directly competing with the likes of Dow Chemicals and a couple of other large companies. Somebody from India at that size competing with the global majors, that itself was a big, big driving factor for us. When we looked up through the balance sheets and everything else, we realized that Aarti was actually writing off, you know, this whole investment that they were doing on environmental engineering. 2012 was just around the time when uh, India rose to this environmental engineering concept and investments were required to be done on pollutions and everything else. This was one of the few companies which was actually writing it off. Uh, now, that to us meant that the profits were actually being underreported.
Okay.
Now, and and this is, you know, uh, the best way to look at, you know, how the cash flows and the profits are being reported and what are the P&L items when you slice it down, that's where you get these kind of details. So we thought that here is a management which is very conservative because environmental engineering is not really value accretive, or it's not directly contributing to your revenues and otherwise. So they were writing it off, and that again was uh, something that we really got very excited about. And then, those days, markets were not uh, in in the best of uh, the valuations. So the valuation was about 600 crores. So we're buying this thing at six times. When we spoke to the management, we realized that they were working on some very cutting-edge solutions. So they were essentially a benzene-focused company working on multiple applications for surface technologies and other things that they were into. And these are very high specialized areas to be in where entry barriers are really high. So all of these factors put together drove us to buying into Aarti.
So, have you exited completely?
We exited. So again, from our perspective, or rather from a micro cap or small cap genre, it's extremely important to be disciplined on the exit side. And sometimes we get it right, sometimes we probably end up selling early. So Aarti was one of those where we actually sold out a little early, I would say. So we did sell at 800 levels, and then the stock went all the way to 4,000.
And today, adjusted to the bonuses and everything else, what we see at 460 essentially is close to about 1700-1800 levels. So why did you exit at 800?
So the way we look at our exit is, you know, defining by the PEG, which is price to earnings growth ratio. And the minute we see PEG crossing two, we generally look to press the sell button. So at around those levels, Aarti's PEG was a little over two, and that's that's the only reason that we know we took that uh, sell call.
But you then missed out on a big chunk of the...
We did, uh, but in our experience in the last 13 years, Sonia, uh, probably two out of 10 times, we would have missed the upside.
Of course, I mean, you can't...
Eight out of 10 times, that discipline actually helped us to protect our profits.
Okay. Okay. And is there any time frame for which you hold stocks? Is it like 7 years, 8 years, or beyond 8 years, you don't hold it at all? I mean, do you go by that analogy?
Not really. It's, it's classically, you know, being that business investor. And so long as the growth continues in the business. Uh, so essentially, we look at businesses which can compound at 20-25%. And and that automatically becomes our bare minimum threshold in terms of the return expectation.
So when you say compound, is what?
Profits compound. Profit compound.
Profits compounding.
Okay. Okay. So, so long as that compounding continues, we are happy to be invested. And the longer the compounding continues, the better off we are.
And how many years' profits do you look at on an average? Like suppose you identify a company, do you look at the three preceding years, or do you...
It's not the preceding. We're looking at the future. So if we are buying any business today, what we are looking at is the capability of the business to deliver a 20-25% compounding during our holding period, which could be 5 years, which could be 3, 7 years, for as long as the compounding continues.
No, fair, fair. That is the forward-looking the guidance, right? But I'm saying, when you identify a company, uh, do you, do you stay away from loss-making companies? I'm asking because, see, a lot of new-age businesses, for example, platform businesses, start off loss-making, but then there's, you know, huge profit expectations. So do you have any mandate that you don't look at loss?
Generally, yes. So probably we come from that old school of thought where, uh, I, I grew up in a Marwari family, and cash was the profit. That's how, you know, we grew up. So we still continue with the same mindset that we don't buy into businesses which are loss-making. For us, it's essential that businesses are making profits because, and not just making profits, but resulting into extremely high internal cash generation. It's that cash flow which gives us the visibility and confidence that a business can invest on a continuous basis and keep delivering the growth.
Correct. Okay. Fair enough. So you're saying the PEG growth ratio, has once it crosses two, then you, you decide that, okay, ex, this is time to exit.
Okay. And you look at businesses that have a 20 to 25% compounding profit expectation going forward, right? And you don't buy into loss-making companies. Fair enough. Uh, another stock that you held for eight long years and made a lot of money on is Shakti Pumps. It is a big growth story for you. Identified at 25 rupees, and I think sold at 530 or so.
Or you're still holding on to it.
You're still holding.
Oh, you still hold Shakti. Okay, great.
That's interesting to me because in the last one year, there was a big drawdown in that stock. Great business, amazing management in a high-growth sector, but the stock is down 40% in one year. What do you do at a time like this? Now, imagine a retail investor who has identified this company, put money to work, and seen it down 40%. At what stage, you know, does your patience run out in a bear market?
And so this is where, you know, understanding of the business is extremely important. I mean, in that journey from 25 to today, whatever 530, and we have seen 1300 also, uh, in that journey, we have seen Shakti getting corrected by 40% at least about three to four times. So it's not something new that we're experiencing for the first time. And each time, I mean, the way we look at things is, we keep assessing the business quality. That if the business performance has got impacted, uh, is it more to do because of the external business environment, or is it more to do with the promoter's inability to execute? In each of those instances, including uh, right now, where we are, this has been driven more by the external environment factors, not as much because of the promoter's inability to execute.
How do you know that? I mean, how do you decide that?
Well, that's probably, um, I would say that's where the understanding of the business comes in. So in case of Shakti, for example, right now, uh, last two quarters, Shakti got embroiled in the receivable cycles. So the market looked at it classically, of any B2G business. The thought was that here is another B2G business which will get sucked into on receivables, and the numbers were large. I mean, Shakti, uh, in December quarter, they reported almost about 1,700 crores of receivables, which was huge. We knew that this is not a business segment where the receivables get stuck. One, because money is put into escrow upfront before the orders are released to the companies. Uh, two, because here, this was not a case of a new allocation required from the budget, because the way the scheme is designed, whatever subsidies state governments are otherwise offering, that subsidy money is just being rerouted for the solar pump category. So it's no incremental burden. Third, because there's a direct commercial interest of the government. It's a direct P&L impact because you're spending close to about 1.5 lakh rupee every farm connection, every year in revenue, as against that, you end up giving the same amount in subsidy, and you free up your cash flows for the next 15-20 years. So we know, we knew that, you know, money doesn't get stuck in this case. Unfortunate that because of the extended rainfall and because of uh, other bureaucratic delays, Maharashtra had its own uh, BMC elections and other municipal elections, followed by death of uh, the ex-deputy chief minister, and money got stuck here. As we speak, Shakti did cash collections of almost about 1,200 crores in the last quarter.
But it's also an opportunity cost, right? I mean, if a stock is down 40% in a year, I agree that you caught it early. But then if you had exited, then you could have sort of...
That's a hindsight conversation, right? Uh, I mean, we did trim some bit of our positions at about 1250 levels, uh, primarily just to make our uh, allocations a little more reasonable, more than anything else. And we held on to cash. So again, it's also, you know, taking those kind of calls and understanding, you know, where to trim positions and how we sat on the cash, and we've been redeploying that again, because this remains a multi-year opportunity. I mean, we heard the prime minister talking about use of solar pumps just a couple of days back. And uh, if you look at probably India has close to about 1 crore diesel pumps yet to be moved on solar pumps, and that's like roughly about 2.5 lakh crore opportunity. So for someone who's missed out on the Shakti Pumps rally, you think that after this correction that we've seen, there's still a long runway as far as the fundamentals as well as the overarching theme of, you know, the growth in the solar pump story.
Let me put a disclaimer. I mean, like I mentioned, we are invested into Shakti. So take it with a pinch of salt. Uh, this is not a recommendation to buy. But uh, yes, from our perspective, it does remain a multi-year opportunity. Solar pumps is one of the things that Shakti does. They've got into doing uh, rooftop solar. They've got into doing uh, uh, controllers for EVs. Uh, Shakti probably is the only company in India which has gone abroad. Uh, they've done a $30 million project in Uganda, which is one of its kind of a project done where they've actually irrigated entire villages using the solar technology. Now, that was a pilot project which they did. And mind you, this is a $30 million pilot project. The opportunity in Africa is probably 10 times bigger than what we have in India. Now, whether they can deliver, whether they can execute, and when does this opportunity opens up, probably it's anybody's guess. But theoretically, that potential does exist. And in this space, uh, in this solar pumps, uh, space, are there any uh, peers? I mean...
There are, which look exciting enough and and have sort of credible managements, not very high debt, good businesses.
There are a couple of other companies which have got listed over the last few years, and each one of them will do equally well because if you think of the market opportunity, we're talking of 2.5 lakh crore just for replacement of the existing diesel pumps, forget the new connections that we're talking about. I mean, if you add up all together, probably it's a 5 lakh crore opportunity. It's not practical for any one company to cater to this kind of a market opportunity. So there are a lot of companies which are there, and my sense is that probably everybody will have their due share in the whole thing.
Got it. So once you've identified a sector, say solar pumps, right? Which we're talking about, and you identify some companies, uh, what are the red flags to look for to eliminate the ones that should not be in your portfolio?
There are lots, in fact, especially if you want to invest into micro caps, there are more red flags. In fact, our rejection rates are close to about 90%. So in the last 13 years, would have met maybe about 650 companies, and u all put together, we've invested in only 42 companies. So that's the kind of rejection rates that we have. See, I mean, all of us know that micro caps, uh, are plagued with all kinds of corporate governance, uh, market manipulations, pump and dump, that's what we keep hearing about. If you go through good three, four, five years of balance sheets of these companies, you'll probably be able to pick enough and more holes, and and there are glaring holes in the balance sheets.
Like what?
I mean, for example, uh, we were looking at one of the businesses, and uh, the promoter was talking of, you know, very fast, massive expansions. Now, when you are doing this kind of expansions, it's as logical as what one can get, that your electricity cost has to go up. We just tied up their electricity cost with the expansion, and we realized that it did not show up any growth. That's just impractical for anybody to do expansion without his electricity cost going up, and that itself was a red flag. Uh, there are a lot of red flags in working capital. So, like I said, we understand cash flows and cash profits, not the reported profits. There are enough and more businesses which end up reporting large profits, but when you look at their operating cash flows, there's barely anything to look at.
Forget one year, even if you look at that 2 years, 3 years, and probably you will not find anything coming out from the operating cash flows.
So you're saying operating cash flow has to be positive two, three, look at the last 2, 3 years, and if there's like dwindling operating cash flow, then there's a problem.
There is definitely a problem because then somebody's just reporting book profits, right? Uh, we've gone to the extent of uh, some businesses that we were looking at, and this was supposed to be high-tech businesses. Promoter claimed that he has, uh, some 30 odd patents across multiple countries. We scanned through their five, six years of annual reports. There was barely any legal cost. There was barely any R&D cost. Now, it beats me that, you know, how does anybody have 30 patents without incurring any legal cost, unless you are going to some obscure, you know, Ethiopian country and taking a patent or something similar to that, right? Which probably is not even worth it. So the stories may sound very alluring, but when you get into the details, where the stories are coming from, and you know, why, that's where you find. Like they say, the devil is in the details.
Absolutely. And more so in these micro caps, right?
Absolutely.
There's not as much information available to shareholders as much as in the large caps, and it's not as researched also.
Yes. It's not as researched. So that makes, you know, uh, more effort on somebody's uh, end to do, because you have to go through these annual reports, see through the transcripts, if they are doing IR. So we are not in that segment where we are buying in sub-500 crore companies. So we essentially look to buy between 1,000 to 5,000 crore market cap companies. There, the level of disclosures are fairly reasonable, and most of these have an IR function. So it's much more easier to get access to these managements, understand, talk to them, shop floor visits. I mean, you will be surprised. We have been at a lot of shop floors where the team has probably just come in one year back. Now, if a promoter is talking of scaling up from 100 to 500 over the next 3-4 years, and the team is relatively so young, it beats me that how the team will end up delivering, because it takes time for the team to sink in. Give them the space and freedom to deliver what they have to deliver. Sometimes you end up seeing plants which are like really age-old plants, completely depreciated, probably, and I don't know for how long they can continue that ways. The level of automation which is there on the plant. These are finer nuances which tells you the execution capabilities of the businesses that you're investing into.
Okay. So just to close this, uh, you know, discussion on solar pumps. You said this is a space where there's huge opportunity, and lots of work is being done in India, especially with, you know, private players, and now the government also, you know, increasing its focus on solar pumps and solar energy in general. Right. You want to just help us with some names, or you want to stay away from the other guys that interest you in this space, and of course, standard disclaimers that these are not recommendations, but just to understand.
There are quite a few companies. I mean, Captain Greas has got into it. You have Osw Pumps, which is another leading player into this thing. There's a small company called GK Energy. So there's a lot of, uh, enough and more players now in the system who are working in the same space and segment.
Okay, great. Another space which is very interesting to me is building materials and in general, like home improvement, right? Because everywhere you look, India, there's massive urbanization. Real estate is just like booming everywhere. Tier 2, Tier 3 metros. I mean, there's no space left now. In fact, um, so once stock that you guys identified was Stylam, and you bought it at 90, and you exited at 2300. That's a 25x return on your portfolio, right? And this is a company that makes laminates and is into exports as well. Uh, I was going through their financials, and the financials look decent. I mean, it's, it's not like a, you know, path-breaking growth, but like 500 crore was their revenue about in 2021, and today it's at about 1,000 crores, 30 crores. Profits also 55 crores in 2021. Today it's 122 crores. So not such a big jump, but the stock has had disproportionate returns. So this is what, you know, micro cap investing does, right? I spoke about 20% compounded returns. If you look at Stylam, that's one of the businesses which has delivered those kind of compounding, and then if a rerating happens, that's where the value discovery happens. So Stylam, when we bought, nobody knew about Stylam. I mean, this was a small Chandigarh-based company doing their own things. It was 100% EOU back then, but they were focused on doing larger with laminates for European and American markets. Now, like in case of Aarti, it was a similar thought process that a small company based out of Chandigarh, if they can take global competition head-on and be relevant in a European and American market, they got to be doing something relevant. We looked at the balance sheet, the balance sheet was debt-free. They were cash back then, expanding in their capacities, getting into newer products. So, Stylam, even recently, Stylam is one of the first companies which has launched, um, surface finishes for kitchen platforms, which otherwise remains like an import substitute. And that's a, so this is what I was talking about, right? Import substitution. It takes time. It takes time for a domestic brand to build that market and reputation and everything else. But once you prove the concept, then you have a geometrical growth.
So in this building materials space, is is there still a lot of potential, you think, or is it kind of bit saturated in terms of...
Last few years, we have seen a bit of a saturation. Growth has not been coming about, and that's also because it's become very, very...
Price conscious.
Price conscious, very uh, diversified kind of players and market and options. So while overall, we see a lot of construction and a lot of spend being done, but I guess it's getting distributed across so many players. So there's not been a single consolidator to really show that kind of a growth.
And I think entry barriers are also low, right?
Entry barriers are low. So I mean, if you have to get a kitchen done, for example, you'll probably have options running from three lakhs to going up to 25 lakhs, right? So that's the kind of dispersion which is there in the market. So there's no one consolidator who can stand up and say that here is what, you know, I'm the largest market share and I can keep growing on that thing. So that's a challenge. But yes, uh, companies like Stylam. Now, again, the other part is again, I go back on that 20-25% compounding, and why we look at the micro cap segment. Whether it is Stylam or whether it is anybody else, statistically, about 4,000 companies are listed, and you'll be surprised that just about 2 to 3% of these are businesses which have delivered a 20% compounding over a 10-year period. You bring this down to 7 years, and probably the number will be between 6 to 8%. That's all. So if you're talking of a 4,000 listed company with a 10-year track record, you have only about 6%, which is about 400 companies, who can deliver this kind of return growth. Right? Now, that's where the crux is. So a smaller company, given their smaller base, a 1,000 crore company can potentially give you a 20% compounding over a longer period of time as against a 50,000 crore topline company, for the sheer size, it will not be able to deliver. So, uh, for coming back to Stylam, you guys have exited, right? The stock...
We have exited. Again.
Okay. Again, it was the...
The PEG. Okay.
It's the same PEG. So that discipline is extremely important to protect value.
Fair, fair. Okay. Um, so we coming back to some of the sectors, right? You said water is a big sector that you're looking at going forward, where you see a lot of growth. Can you just dive a little deeper into that?
Well, in a country like India, uh, I mean, if you come to think of it from a macro perspective, anything which is required to ensure uh, sustainability and complete dependence, you need water for drinking, right? And globally, that's barely a very small percentage of portable water which is available. So definitely, water has to be one essential uh, requirement. Now, companies which are catering to the water segment or water treatment, in any of these kind of segments, they have to do well, essentially. In fact, when we did Shakti, that again was the basic premise that food sufficiency has to be there. For food sufficiency, you need farm productivity to increase. Now, how does you, how does anybody increase farm productivity? Irrigation is the biggest thing. Now, unfortunately, farmers used to get diesel subsidized diesel, as and when the government can provide it, or wherever you have wired connection, the connection is available, electricity is available at 3:00 in the morning, at that wee hours. So farmers would leave the pump on and end up having flood irrigation, which reduces productivity. So the macro thought was that if solar pump can solve that problem, and the farmer can see a 25% increase in productivity, that has to be sustainable.
Right. So likewise, when you talk of water, likewise, when you talk of any other segment, that's the way we look at longevity of a particular business segment. I mean, defense exports, for example, defense as a segment.
So wait, before I come to defense, in within water, right? I mean, all of us know those traditional companies, say like a VA Tech names like that, right? But you, any um, any list of companies where you, you think even valuations are reasonable and growth opportunities large?
We are working on a couple of opportunities. I would refrain from taking names because those are still uh, work in progress for us. But there are very interesting opportunities in the segment.
So, this, not the names, but at least like the categories. Like you spoke about pumps. What else in the water treatment? It could be equipment suppliers, it could be chemical suppliers, because you'll require a lot of water chemicals uh, in the treatment and otherwise. And and those are very, very interesting segments to look at. Again, if you look at it, it's not just India opportunity for them. I mean, these guys can become global.
But on globally, is it just on the cost front where India wins, or is it really on technology as well?
Now, it's both. Now, it's both. That's where again, I go back to that this breed of entrepreneurs which has moved up the value chain, where these people are doing top-quality products at a cost-competitive prices.
So competing on technology even with like countries like China?
Yes. M in fact, so here's the new thing that is happening in the Indian corporate arena, right? That a lot of these companies, even the smaller ones, are going out and buying European and American front ends, which is changing their scope and their addressable market opportunities overnight. The smaller companies which are going and buying European front ends, which gives them, you know, the required approvals or regulatory, you know, inroads to be able to participate into a lot of these kind of projects.
It's interesting you say that because the narrative is always the other way around, right? That India is not competing with a lot of global players. So just to, you know, kind of, um, bust those myths, from your assessment, which are the sectors where India is competitive, both on a price and a technology front, say with countries like China?
See, again, I would not want to paint the whole industry with the same brush. There are specific business segments. So, for example, let's talk of apparel. Now, apparel, until a few years back, China used to have 50% global market share. Business moved from China to Vietnam, Bangladesh, Indonesia. Today, China is down at about 37-38%. And these Asian countries were the beneficiaries. India did not get as much. Today, uh, thanks to this whole FTAs and everything else, and the quality consciousness that we're talking about, right? There are a lot of Indian companies which are rising up to the occasion, and they are gaining market share. They are cost-competitive as against the Chinese guys. You talk of technology, uh, we have another company in the portfolio which is in the casting segment. Now, certain category of products that they do, they are probably the only supplier in the world other than Europe and China, right? So despite all the tariff issues, despite all the raw material issues and everything else, and this is very interesting, at about a 47% capacity utilization, these guys end up working at 29% EBITDA margins.
Wow.
That's unheard of for a casting company.
For any, any industry, actually. For any industry, right? I haven't heard 30% margin. That's where the combination of technology and cost both comes in, where they are extremely cost-competitive vis-à-vis the Chinese guys, and right up there in terms of the technology, where they're taking the European guys head-on.
So apparel is one space. Any other industries that you're looking at?
Like I said, it's a very ground-up thing. I, I give you another example of castings.
Yeah, castings.
Which, I mean, there are many casting companies in India, but extremely rare there and few of these kinds who can do this thing.
Wow. Interesting. Okay. Uh, defense is a space that we spoke about, we uh, touched upon, but I want to get into that because one sector that you've identified, or one stock rather, is HBL Engineering, right? It's into batteries, into the defense space overall, and I think 20 rupees is when you identified that.
And today the stock is what? 800?
800.
Okay. Wow. Terrific story there. You held on. You're still holding on to it?
We're still holding on to it.
Okay. For like seven, eight years now?
About seven years. Okay. Phenomenal. Was that like, how did you identify that, and how did you hold on? Because at some point, even position sizing is something that you need to do if you want to make sizable returns. There's no point just identifying a story and...
Absolutely. In fact, there is no point in doing this genre of investing if you're not doing the right position sizing.
What's a great point in getting a 40x and, you know, having a very small amount invested into it. It has to lead to complete financial freedom. That's, that's the way we think. And you are right that, you know, the journey is not so easy. So HBL, when we bought at 20 rupees, we knew what the capabilities are. They were working on Kavach. I'm sure you would be familiar with the Kavach implementation that's an anti-collision device that India is implementing right now. I think just yesterday, the railway minister said that he wants to see railway network working at 250 km per hour. Now, for you to be able to do that, the engines have to talk to each other and auto-stop, because otherwise, you expect a head-on collision all the time. And that's what Kavach is all about. When we were buying into HBL, they were primarily, historically, they were known as a battery company, doing uh, telecom batteries and other industrial batteries. Moving into power electronics, where Kavach was just one of the products. And we knew that they are ready with the product. They were already approved. Commercial orders had not yet started because the competition was not ready. It took us four years before we saw the first jump. And and that's where the patience gets tested. That's where the conviction gets tested. The stock barely moved or was in just in the same range between 20 to 50 rupees. So optically, what people saw that there was stagnation. What a lot of people missed out was that during those four years, they became completely debt-free. They used to have 450 crores of debt back then.
So, why did the stock not move for 4 years?
Because optically, what market participants saw was stagnation. They were at about 1100 crore topline, and the same topline maintained. What got missed was the capabilities which were getting built, the balance sheet which was getting strengthened, the fact that external environment was not ready. And when they got ready, and when the orders came through, in one year, the stock moved from 50 to 250.
Wow. And then...
And then of course, then the journey began.
Because we knew that the addressable market opportunity is very large.
I want to talk about that because now, with the way the geopolitical situation is very precarious right now globally, how is India positioned, according to you? Are we ready? Uh, what is the work that India is doing in the defense space? And from an investor POV, where do you see the biggest opportunity now?
This is across the board, so far as defense is concerned, because I think, uh, with the kind of neighbors that we have, and with the all kind of geopolitical situations which is there globally, uh, defense investment will only keep continuing. And this government has been more focused on indigenization. So whether it is, uh, for example, HBL is probably one of the few companies in India, probably the only three companies in India, which is certified for electric fuse.
Electric?
Fuse. Fuse.
These are fuses which are used for short-range...
Ammunition for missiles, for grenades, and multiple other things. Now, like what we waited for Kavach for a good very long years, we have been waiting for commercial orders to come in. But we know that this has to happen. And this electronic fuses, probably India ends up sourcing close to about 10,000 crores every year. So that's the kind of market opportunity we're talking about.
India was importing it earlier.
So if indigenization has to happen, orders have to be issued at some point in time. It's a matter of time. When does that happen?
So, which are the other spaces within defense where the import substitution theme is...
This will be across the board. I mean, whether you talk of drones, whether you talk of submarines, whether you talk of missiles. So companies like Astro Microwave, Premier Explosives, they're all right up there. So there's huge impetus on import substitution. Uh, and this is very, very diversified.
But names like Astra, Micro, Premier Exclusives...
Premier Explosives.
All of that are well discovered stories, right? So the problem in defense is that it's hard to find stocks with cheap valuations right now. Growth stories are there.
If it were so easy to find uh you know undiscovered ideas then probably everybody would be rich, right? That's where the effort goes. So while Astra Premier have now become very discovered and known ideas, there are many lesserknown companies which are doing cutting edge work. Well, there's a very small company that we are working on right now which is in the ship building space where they're working on the defense side. They're working on commercial ships doing some very very interesting and exciting work. Again, given the small base, they are growing at almost about 40 50% kaga and can potentially continue to deliver this kind of a growth for at least next four five years basis the kind of visibility we are seeing. It's a relatively lesser known name. Now that's where the wealth creation actually happens.
A fair point. Yeah. I mean identifying stories is the real skill set. But given the way the market is going uh right now, do you think this is the right time for people to be investing in mid and small caps from your lens? What is your you know market view right now?
Absolutely. In fact, like they say, right, the best time to make investment in the market is in midst of all the um negativity and you know anxieties and and probably we are at the prime of this anxieties.
But do you think you can get better levels over the next couple of months or so?
It's difficult to assess right uh if we hear a petrol price hike coming up next week. Uh probably we may see good decent correction coming about and that may lead to inflation and other worries and so on and so forth. So yeah, maybe one or two quarters can be bad. But if you are looking to play momentum, then you would be worried. If I'm buying a business from the next five year perspective, I may do my position sizing in a right manner. I may start taking some small positions right now. See, you know, how the market behaves and reacts and if I get to buy the same thing 10% cheaper or 15% cheaper, I'll be more happy to buy because my horizon is next five years. I'm not looking at next two quarters. These issues they keep playing out. I mean it's been 25 27 years that I've been investing. Not one year has gone by where we have not had some of the other anxieties playing out. Right? And there is always going to be something or the other. In fact, we keep talking about it u where we are right now probably next two years we will be entertained with all kinds of things and the volatility will continue. But businesses have their own path right and they have their own cycles.
Absolutely. Yeah. It was a it was really interesting conversation actually and we've run out of time but not out of questions but I want to end by just asking you about you know you started your journey at Morgan Stanley you were telling me and today you are you know sitting with of SEBI registered PMS advisory and you're kind of generating these huge returns in your 20 25 year journey 25 30 years I don't know how much it has been what what have the biggest learnings been for you to become and to you know to stay consistent consistent as a successful investor is hard right to build a brand is easy but to keep that brand going consistently for 25 30 years is tough so what are have your biggest learnings been
Stick to the core disciplines I think that is the biggest differentiating factor especially if you're doing listed markets there is so much of noise there's so much of clutter every day you get pushed with another 10 new ideas now in midst of that to be able to sit on an investment for good 7 years 8 years allow the businesses to compound and during that phase go through you know certain periods of challenges and downsides and so on so forth. It requires a lot of discipline and and that's what we've tried to do over the last 13 years. We've tried to perfect our systems processes uh and probably uh being lazy helps. So uh that's that's the kind of investing that we like to do that you know we spend a lot of time before we get into a business. Once we have got into then it's it's basically monitoring the business and sticking to the core disciplines.
And for people who say that micro cap investing is very high risk, it involves a lot of scams, there's a lot of missselling, there's a lot of pump and dump. What would you want to say to them? Because that is a real fear, right? Especially in today's day and age where there are so many avenues where you can reach retail investors. Earlier there was just television.
That's it. Now
It's much more easy. You're absolutely right. WhatsApp groups and too easy to pump and dump.
You are absolutely right and all of it does happen. Uh and which is why it is important to not follow the stock price. There are a lot of times when the stock prices probably would run up way ahead of the fundamentals in the business and that's why it is important to understand the business that you're buying and not really look at the stock price as your decision making. So we don't get exuberant to see a stock price 50% up and neither do we get into a despair if we see it down 20%. We always look at you know how the business is behaving whether my balance sheet is intact or do I see deterioration in the balance sheet those are the kind of things that we keep questioning and and probably look at you know rather than looking at the stock price in the short term.
H okay Pan we have to do a part two of this because we have many more sectors to discuss whether it is energy transition whether it's autos we have to touch upon that as well but thank you so much for being with us on the money mindset and hopefully we'll get to chat with you a lot more in the due course
Sure my pleasure thank you thank you for having me over
And thank you to all of you for watching