Q & A with Fund Manager – V.Srivatsa
Question: How do you define value? Which are your preferred metrics of value?
Answer: I define value as being present when valuations of a company are below its long term averages or when it is cheap relative to market aggregates. The preferred valuation metric could vary across sectors – in some it is earnings led such as *EV/EBITDA or **P/E or and in others it could be Price to Book Value or Asset value led. There is no one single metric that is more important than the others. The choice of appropriate metric is largely driven by the nature of the business – its capital intensity and cyclicality. All industries go through cycles- the length and depth of the cycle is unknown; buying when valuations are cheap provides you with a margin of safety. Plus you may get to ride the up-cycle.
Question: What is your selling discipline? Do you sell when a stock when it achieves fair value?
Answer: Since I have a value approach, there would be rotation of value ideas on every time frame as stocks or sectors would get into value zone over a period of time. I would evaluate switching out of stocks and sectors when the comparative valuations becomes less favorable and other value can be found elsewhere. Also in cyclicals I would look for valuations being in an attractive zone especially on price to book basis or asset value as earnings led valuation would mislead. In cyclical business valuations are very cheap on earnings at the top of the cycle and forecasts also tend to rosy at the top of the cycle. Apart from valuations, change in business dynamics or regulatory environment or management behavior would be the key reasons for the sell call. The target or intended weight also plays a role in selling decisions - if the stock outperforms and crosses the intended weight, I would sell the excess weight
Question: You are quite partial to small caps, How do you manage risk there?
Answer: In terms of selecting stocks the first thing we would look at is their long term track record. The level of diligence needs to be more rigorous and management evaluation plays a key role. Further, risk is managed by limiting position size- often to below one percent of the fund. in the case of mid cap stocks, my focus would be on sectors where I see changes in the business environment either in terms of demand outlook improving or supply side constraints which would lead to improved profitability and return ratios. I would also look out for signs for change of management behavior in stocks which can lead to improved profitability and return ratios.
Question: How do realize value from investing in conglomerates? Are these value traps
Answer: Conglomerates typically trade at a valuation discount to pure plays. Buying on merely a hope that the discount vanishes is pointless as history suggests that the discount tends to persist. In the case of conglomerates the key is to be comfortable with the flagship business. Typically this business is the cash cow for the conglomerate and it dominates the cash flow generation. What is critical in conglomerates is the Long term capital allocation track record and the willingness to recognize and correct poor capital allocation decisions. Often the intention to monetize businesses by selling, splitting and/or listing individual businesses separately is the key driver of the unlocking of value.
*EV/EBITDA : Enterprise value / Earnings before Interest tax depreciation and amortisation
**P/E : Price to earning ratio