Saurabh Mukherjea on 3 qualities to look for while buying stocks

What will give you prosperity is a combination of clean promoters, essentiality and dominance. If you get all three right, you will be in good shape through this exigency. But if you compromise, life will stay very difficult for you, says the Founder of Marcellus Investment Managers.

We are seeing declines coming in across all asset classes. What do you attribute it to?
The various factors at play are the fears around the second wave of Covid-19 infection, apprehensions around the US elections and so on, but as investors, we quite relish these sorts of corrections. We look for opportunities where complacency and unnatural optimism had set in and which are getting challenged. In the last 30 days, the market has given up some 6% odd and we love these sorts of opportunities because it allows sensible investors to cherry-pick really high quality franchises.

We have seen throughout the coronavirus episode that well run strong franchises are constantly consolidating their position. Royal Enfield’s dominance in the motorbike and Harley’s exit exemplifies this phenomenon. Royal Enfield has said consistently over the last three months that footfalls to their showrooms have normalised while an American company exited India. We have seen this phenomenon play out across several sectors where strong companies are doing really well through the June, July, August, September unlock and consolidating the position.

This sort of correction gives everybody out there a chance perhaps to buy dominant franchises with powerful financial positions in a pullback. As we head towards winter which might lead to a resurgence in corona cases, it is unlikely that on the other side of the tailwind, you get this degree of jitteriness as on the other side of winter, you have the vaccine, you have a new US president perhaps and you have another gush of liquidity.

So for the discerning stock pickers, the theme of the last six months is that strong are getting stronger in the economy, dominant franchises are pulling in more market share and this pullback gives us a good opportunity to buy high quality franchises, several of which have corrected 6%, a case in point being TCS and Bajaj Finance -- two stocks in some of our portfolios.

Are you seeing it as a crisis that separates the boys from the men? Is this a technical correction with plenty of good news still to come?
This is nothing like March. In January, February March mayhem, the market gave up 35%. You had well run strong franchises like Bajaj Finance falling 70%, you had market leading banks like HDFC Bank, Kotak Bank giving up 40-50%. So for a very good reason, it is not nothing as bad as the January, February, March mayhem primarily because everybody across the world has figured out that coronavirus is a very controllable event. In India, the death rates that are being reported are well below 2% while three months ago, it was 6%. Yes the cases are rising as we do more testing as a civilised nation should do and as are reporting more cases.


But with the death rates having gone down, you are seeing economic normalcy return to several parts of the economy, be it well known names such as ITC, Marico-- the FMCG companies or auto giants like Maruti, Bajaj Auto, Hero MotoCorp, or multitude of tech companies like TCS, Infosys. Through June, July, August, business has returned to 80-90% of pre-Covid level. That in turn is emboldening people alongside the low death rates to start getting back to business as usual and therefore my reckoning is this correction will be more modest than the mayhem in Jan, Feb, March.

What in your opinion will be the pockets of strength from here on?
I would prefer to look beyond the sector specific story. I will give you names of several companies which are in our portfolios so you will have to bear with me because these are the companies I understand the best. If you look at FMCG, a company like Nestle has 95-96% share in infant milk powder. It really has no competition whether it is in noodles or in milk powder, Nestle has done immensely well through this whole last eight-nine months period. I reckon it will carry on dominating these categories where it is almost a monopoly.

Similarly, if you look at Asian Paints and Pidilite, again two dominant franchises in paints and adhesives respectively, the commentary from them over the last three-four months has been businesses heading towards normalisation. In Asian Paints’ case, the business is laterally growing 10-15% year-on-year. The longer the corona onslaught continues, the more Asian Paints’ competitors lose out to this dominant company.

Among Indian IT companies, all the top four have reported very healthy progress in their order books. TCS is the one we have but I can also see a broader story building up around IT as the western giants invest more in digital due to the impact of the corona on the western companies.

Finally, coming to the banking sector, it has suffered the most through the last eight to nine months. HDFC Bank, Kotak Bank, Bajaj Finance are still trading around 20-30% below where they were at the beginning of the year. You are not going to get too many chances to buy franchises of this quality at these valuations. So we are making the most of it by enthusiastically buying the high quality lenders, the best run banks, the best run NBFCs because we can see weaker banks and weaker NBFCs will be in deep trouble over the next couple of years and therefore the stronger banks and NBFCs will gain share.

The theme is look for dominant franchises across sectors make sure you do some homework on the fact that the promoter is clean, does not steal money and if you can find dominant franchises which have done well over the last six-seven months, having got a degree of comfort in the promoters’ integrity, it is worth thinking about investing through this correction.

Is this the time to stay away from smallcaps, midcaps and remain only with the bluechips?
There is no such thing as blue chips, smallcap, midcap -- this distinction is a specious and very damaging distinction. Across market caps and across sectors, look for a)clean promoters, honest high integrity business people; b)companies selling products and services which are essential for day-to-day life in India and c)dominant franchises. You can find them in smallcaps. There is a company called Ultramarine which is a small company and sits in our smallcap portfolio. It is the largest producer of the said product ultramarine in Asia, it is a dominant franchise in its category but it is a smallcap company.

At the other end of the spectrum there is HDFC Bank It is a $100-billion market cap money machine and has a mere 6% share in the banking sector. It has a market cap per se which will not give you prosperity or pain. What will give you prosperity is this combination of cleanliness, essentiality and dominance. If you get all three right you will be in good shape through this exigency which has hit the planet. If you compromise in these three, you can buy as much largecap as you want, life will stay very difficult for you.