Parag Parikh Flexi Cap Fund completed 10 years today. Here are some insights that Rajeev Thakkar, Chief Investment Officer at PPFAS Mutual Fund, has shared with us over the years.
On portfolio construction.
We are bottom-up stock pickers.
We start by eliminating companies where either the promoters / management do not have a track record or have a history of shareholder unfriendly actions in the past.
We also eliminate companies which have a very low return on capital and / or employ excessive amounts of leverage.
The remaining companies are allocated to our analysts to track on a sectoral basis and depending on the valuations and the business outlook, we choose individual companies to invest in.
Although there is no strict rule, we would typically not invest in companies with market cap of less than Rs 700 crores. This is on account of the fact that we may not be able to enter / exit stocks below that market cap without a high impact cost.
On preferred capital allocation of companies invested in.
- Re-invest in own or allied line of businesses
- Invest in a new line of business
- Undertake share buybacks
- Pay dividends
The last one, we don’t really prefer it anymore. Some of the companies that we own, do not pay dividends -- Alphabet, Facebook, Amazon -- and we are happy with that. We would be happier if some of our other investee companies, like HDFC Bank, eliminated dividends given that they have to periodically issue additional shares. It would be more efficient to retain the earnings and issue fewer shares.
A company earns a profit. It has to pay 30% tax + surcharge + cess. It then chooses to distribute the profits to its shareholders. Now it is forced to pay dividend distribution tax (DDT). A consequence of this tax policy is that the effective tax rate for a dividend paying company is higher than that of a company which retains the earnings to re-invest. We explicitly bump up the tax rate for dividend paying companies when we calculate the valuations of the companies that we own.
Now you cannot just value the company on the reported earnings per share (EPS) because there are taxes after the reported EPS, which is primarily DDT and, in some cases, additional tax.
If the dividend payment is zero, then that is real money without any leakage. So it’s of more value to shareholders than company paying out tax. When looking at earnings numbers of a dividend paying company, I would explicitly reduce DDT from the EPS to value the company.
On being overweight in IT.
We have two kinds of technology stocks. One kind is not related to IT services. For instance, Alphabet and Facebook are very different companies. They are advertising and media businesses rather than pure play IT. They have their own dynamics.
Is Amazon a technology company or a retailer? You can view Amazon as a retailer, but thanks to its seamless, frictionless transaction technology, among many other things, one can debate if it’s a technology company.
Is Apple a technology company or a consumer company? Tim Cook on CNBC explained that Warren Buffett probably views it as a consumer company. When asked for his take on that, he said: “We’re in the tech industry. But we work at that intersection of technology and the liberal arts and the humanities. We make products for people and the consumer is at the centre of what we do.”
Is Uber a technology company or a transportation company?
Is Netflix a technology company or a Media and Entertainment company?
Is Zomato or Swiggy or Uber Eats a technology company or a food company?
Is HDFC Bank a technology company or a Financial Services company? It provides services through its app. Just like Amazon. HDFC Bank has brick-and-mortar branches and staff that clear financial transactions. Amazon has football ground-sized warehouses that funnel merchandise and staff who organize delivery.
The point I am making is that you cannot paint with a broad brush all companies from Facebook to Amazon as being similar. I agree that all technology serves real human needs but both address a very different need. Both are very different companies. One way or the other, all of them use technology to address a need more efficiently, yet each address a diverse set of needs.
On the concept of value.
When Benjamin Graham started off, it was in the post-Depression era when businesses were available at throwaway prices, at less than cash on balance sheet. Picking up stocks based on the cheapness of the company worked well during that era of depressed prices.
Warren Buffett started off similarly but moved to a qualitative style of investing.
When academia defines value, they typically look at one measure of value - book-to-market, the reverse of the price-to-book ratio. They look for low PB stocks. But with inflation, book values have stopped being comparable. A company founded 50 years ago will have a different BV from one founded last year. Market values will be different too.
In a traditional, statistical, cheapness approach you are dependent on a catalyst to unlock value. This could come about due to shareholder activism, very common in the U.S.
Some businesses are asset light so the return of capital can be very high if they have a proper addressable market. On a small asset base, they can grow their businesses dramatically. Google, Microsoft. Asian Paints. These are some examples.
The concept of margin of safety and equity being the ownership of a business continues from Graham, but the main focus is now on cash flows and future earnings prospects rather than BV.
Cost of capital in today’s world is very different from the cost of capital many years back. The Discounted Cash Flow has a discounted rate for a bond or equity share. What is the cost of capital today? In the mid-90s, government bonds were trading at 14% per annum. It is now 6-7%. A big portion of sovereign bonds globally are giving negative yields today. 10-year U.S. Treasuries are somewhere around 0.7% levels. So we cannot go by past valuation metrics. Those PE ratios will be eliminated in a low capital cost world. While we must be aware of the environment that cost of capital is low, we must be careful not to buy into froth. So margin of safety and permanent loss of capital must be considered.
Source:
7 questions for PPFAS - September 2020
Why this investor doesn't care for dividend paying stocks - August 2019
Buying opportunities are rare in the current market - June 2018
Rajeev Thakkar on his go-anywhere fund - July 2016
