The growth expectations from such stocks are quite high even today: Swati Kulkarni, UTI AMC

Investment style revolves around looking for stocks with a strong moat or competitive franchise. In today’s market, with a consumption slowdown, look for companies that offer competitive advantage and also growth at a reasonable price. Despite the slowdown, there are opportunities within consumption where there is a long growth runway with low penetration levels, those that can benefit from formalisation of the economy, a shift from the unorganised to organised sector and so on. Now the question is how much of this is in the price. High valuations do rule out some of the consumer categories today, but hold positions in consumer discretionary stocks with strong drivers.

As Pat Dorsey has said, it is important to differentiate between temporary competitive advantages and durable competitive advantages. If you overpay for a temporary moat, you will suffer value destruction. The assessment of moat or competitive advantage differs for different businesses. In capital-intensive or B2B businesses, you judge a company’s moat by its cost efficiency.

The buyer is a hard negotiator too and you won’t get pricing power. You can look at fixed costs per unit of capacity compared to peers, whether the company is moving up the value chain, its R&D efforts, and its de-risking strategy and so on. In B2C businesses, you assess pricing power. Often, people talk of brand value or market share, but these to be transitory. A brand can lose recall and a company can lose market share. So, unless the company is able to charge a pricing premium on the basis of its brand, the moat isn’t durable. One way to assess the moat is to see if the company’s profit margins remain within a tight band. This is indicative of its ability to pass on input costs. If a company manages growth while rarely diluting equity, this adds to return ratios. These are the key numbers I would look at to assess moat.

If you see in the Nifty500, the top ten stocks have a 43 per cent weight in the index and contributed 40 per cent of the returns from January 2018 to October 2019. Whereas if you see the bottom 250 stocks, they have delivered negative returns. So, there is polarisation.

The market prefers the handful of companies because of the dearth of growth elsewhere. Even today, growth managers vouch for the compounding characteristics of companies such as HDFC or a Hindustan Unilever. So, GARP (growth at a reasonable price) gives a framework to spot opportunities that balance both. While doing some Nifty companies that have delivered returns, balance it out with positions in sectors such as two-wheelers quoting at low valuations. At the headline level, compared to December 2017 when mid and small-cap indices were trading at a 30 per cent premium to the large-cap indices. But today the valuations have reverted to a normal 20 per cent discount. To that extent, we have been increasing mid cap allocation within scheme mandates. But indices often don’t tell the full story. We find that there are only a few mid-cap stocks that meet our frameworks on returns and cash flow generation. The growth expectations from such stocks are quite high even today. Even large-cap companies in the Nifty have been struggling to deliver on growth expectations and we are seeing earnings estimates being repeatedly downgraded for the last 5-6 years.

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