2022 belonged to auto and financial stocks: Ishmohit Arora

Asset opportunities are those businesses which are trading at a valuation which is less than the replacement cost so we have seen this theory playing out again and again in the cement sector when they are trading at a valuation which is less than the replacement cost says Ishmohit Arora, Founder/Teacher, SOIC.

While there are various parameters on which the stocks are classified could you tells us what are the common parameters in which you classify these stocks?
I will just give a standard disclaimer that there is nothing in this discussion will be a buy or sell recommendation because stocks can be basically classified into multiple categories and purpose is to teach you about them.

So broadly I will say you can classify businesses or stocks into nine categories. There is a very interesting classification given by Mr Peter Lynch in his book One Up On Wall Street and he has talked about stocks of being in six types and we have added three more on top of it.

So those nine types are; first is there are stocks which are slow growers. So what are slow growing stocks, basically these are companies whose growth rates are lesser than the GDP growth. If you look at the Indian GDP growth it is somewhere between 6% to 7% and these are companies which are growing their volumes at 2% to 3%. If you look at the lubricant sector over here in India as an example a company like Castrol is almost 99% penetrated so it ends up becoming a slow growing business. So this is one category of stock that you can look at and in this category always look at the penetration rate of the category.

Another example of a slow growing business or a category could be the toothpaste segment. All of us basically brush our teeth right and the penetration of toothpaste within India is more than 98-99% so again the growth rate falls to 2-3% normal growth rate. So this is an example of a slow growing category.

Second category of stocks are known as stalwart stocks. Basically these are businesses whose growth rates are plus minus 2-3% of the GDP point. Stalwart stocks are very established businesses but their growth rates will always be between 10 to 12% types. So whenever you are looking at stocks always try to recognise the growth rates of these businesses. So one example of stalwarts stock could be a Hindustan Unilever. It is a stalwart stock because the growth rates are between 10 to 12%. If you ex out the decline in tax rate in 2019 and this is considered to be a stalwart stock because the category is established it is the market leader but the growth rate is between 10% to 12%.

Then there are fast growing stocks. These are typically your businesses which are growing at a rate which is much faster than the GDP growth. So you will find such businesses growing at a rate of 15, 20, 25% and there are multiple of such businesses around. If you look at the business of Bajaj Finance it has always grown at some 25%-30% in the past and that throughout the last decade was an example of a fast grower. There are multiple such companies available in India today but whenever you are looking at stocks always categorise in terms of growth rates.

Then there are cyclical companies. This is a very very important concept for all the retail investors to understand as in cyclical businesses what ends up happening is that a lot of time your margins are very very volatile. If you look at the metal business, if you look at the sugar stocks, these are some of the cyclical businesses.

In 2018 we had a very good cycle in the graphite electrode stocks when the margins went from single digit to 30-40% but a lot of retail investors got trapped because they were not able to categorise it into a cyclical category. To get the cycle right always look at the margins of the last few years and keep asking yourself why the margins all of a sudden expanded because when the margins fell from 35-40% back to like minus 2-minus 3 a lot of investors lost wealth because they did not know how to categorise stocks into cyclicals.

Then we have the last two categories according to Mr Peter Lynch that is turnaround and asset opportunities. So turnarounds are those businesses which have been loss making for a long period of time then because of change in the industry fortunes they start reporting profits or because of selling some non-core businesses they start reporting profits.

Asset opportunities are those businesses which are trading at a valuation which is less than the replacement cost so we have seen this theory playing out again and again in the cement sector when they are trading at a valuation which is less than the replacement cost. So these are asset opportunities.

One of the last three types of stocks are the holding companies. You will find that in India there are lot of holding companies that are listed. Holding companies are entities which own listed subsidiaries. These are the promoter of listed subsidies and they own the equity over there but there are both problems and opportunities with holding companies.

First let us discuss the problems. These companies tend to trade at a discount. I will give you just two-three examples. Suppose if there is a Bajaj Holdings, there is a Maharashtra Scooters, there is a Kama Holdings. So Kama Holdings is the promoter of SRF and SRF's market capitalisation is close to Rs 68,000 crore whereas Kama Holdings trades at a market capitalisation of Rs 8000 crore. Kama Holdings owns 50% of SRF. So according to Kama Holdings, the holding valuation is close to 34000 crore because SRF’s market cap is Rs 68000 crore as Kama Holdings owns 50% of that but today’s Kama Holdings valuation is close to Rs 8000 crore. So there is a discount to the underlying holding of almost close to 75% to 80%. But generally this discount is seen across holding companies because market treats them as if that the holding company will never sell the underlying assets but sometime these discounts do narrow. So an idea for retail investors is to check the holding company discount to the underlying holding over the last five to 10 years and then look at the points where the discount has been maximum and how the discount got converged. So this is also one way to look at holding companies.

The eighth category of stocks that we have are known as conglomerates. The conglomerates basically have a lot of businesses in them. So if you look at the example of ITC you will find that ITC has many unrelated businesses within one entity. One business that they have is the tobacco business. Then they have the FMCG business, then they have the paper and boats business, then they also have an IT business and then they also have a hotel business. So this is an example of a conglomerate where you have multiple such businesses within one entity.

Generally it has been seen in Indian context that conglomerates all over the world actually trade at some discount to the underlying businesses. So in such businesses when you value them you have to use some of the parts valuations.
World’s most famous conglomerate is Berkshire Hathaway which is run by Mr Warren Buffett because Berkshire Hathaway has many underlying businesses so that ends up becoming an example of a conglomerate.

So in Indian context even Reliance Industries is a conglomerate because Reliance Industries has a petrochemical business, a telecommunication business, and also they have multiple other lines of business the retail business as well. So I think Reliance within itself might have more than 90 to 95 businesses. So these are example of conglomerates.

Coming to the last type of stocks, these are unique stocks or there is a skill set premium attached to them. So basically these are businesses where there is no competition in the listed space. It is the only stock listed in that particular category. One of the famous examples over here is of the highway tyre manufacturer by the name of Balkrishna Industries.


2022 belonged to which category of stock and going forward in 2023 which category of stock that investors should be looking out for? Which are the ones that look the most lucrative to you?
So what I basically think about it is that 2022 belonged to autos and financials. These are like typically your examples of cyclicals and turnarounds and I think given where we are in the credit cycle right now there is a possibility that a lot of financials which are also like cyclical stocks might keep doing well.

Indian market has actually been always a market of fast growers. So we have seen a lot of businesses within the beverages category or some other categories where they have grown really fast and they have always been given a premium. So Indian market is a growth market. If you are able to get a right mix of them then you can identify a lot of opportunities within the Indian context.

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