Q & A with Fund Manager – Swati Kulkarni

Question: You select companies based on their 'competitive franchise. What metrics do you use to evaluate the 'franchise'?

Answer: I believe competitive franchise is built over long period by companies that are fundamentally strong with well-managed capital structures reflected in low leverage, consistent revenue growth, focus on profitability as measured in terms of stable EBITDA margins, higher return on capital than cost of capital and consistent operating cash-flows generation. Such companies generate free cash flows for future expansion and avoid dilution of existing shareholders.

The other aspects that I consider are market dominance and the overall opportunity in the market place, product penetration levels, consolidation in the industry in which the company operates, brand and distribution strength etc. My belief is that these factors provide the companies pricing power which is crucial to sustain the competitive advantages. For businesses which do not have pricing power like the global cyclical sectors, I look for the cost and capital efficiencies.

The track record of management in terms of their conservative accounting, capital allocation decisions, willingness to rectify past capital allocation mistakes, ability to attract and retain talent, governance standards, investor communication and ability to conduct business efficiently across business cycles are some of the softer aspects besides the tangible fundamental aspects which go into stock selection.

Question: Is the GARP approach compatible with value? How do you blend both?

Answer: GARP amounts to buying companies at attractive valuations relative to the growth potential. Pure value approach on the other hand emphasizes on buying companies at discount to its intrinsic value.

I believe GARP is compatible with value to the extent that you are evaluating the underlying growth and how much you are willing to pay for that growth such that you buy companies having future earnings growth as well as valuation comfort.

With the combination of competitive franchise and GARP investing, I invest in companies where,

1. the market is underestimating the companies’ ability to sustain growth over much longer phase or the benefits of pricing power
2. the growth trajectory is improving through industry wide phenomenon like favorable demand cycle, consolidation, clearances of regulatory hurdles or through the company specific factors like cost competitiveness, prudent capacity expansion
3. the business is capital intensive but  the companies invest prudently, execute efficiently
4. the relative valuation within the sector is attractive

Question: In a large cap dominated strategy what do you think will be the sources of Alpha?

Answer: Large cap companies through their market dominant positions achieved through sustained competitive advantages can be very good compounding return stories over long term, defying the myth that multi baggers are discovered only when they are small. For e.g. large companies in Financials, Pharma and Auto have multiplied more than 6 times in last 11 years. Further, companies with strong governance standard tend to outperform over long period.

At different points of time, stocks and sectors tend to trade at extreme valuation as investors chase ‘what is in fashion’ and ignore ‘what is in distress valuation’. I believe GARP approach and sound investment process backed by investment professionals allows me to identify and hold on to the investment ideas to make money.

Question: What would you avoid in your portfolio?

Answer: I tend to avoid investing in,

1. Companies which are highly leveraged, have structurally low ROCE, inefficient capital allocation, and bloated cost structure
2. Companies where the fortunes are linked to occurrence of certain event
3. Companies having corporate governance lapses

ROCE - Return On Capital Employed

EBITDA - Earnings Before Interest Tax Depreciation and Amortisation

GARP - Growth At Reasonable Price