PERSONAL FINANCE

PERSONAL FINANCE: STOCK TALK
"I Buy or Sell, Never Hold"

Richard Overton, CEO, ITC Threadneedle Mutual Fund, reveals his strategic scrip(t)

Richard, how would you describe your investment philosophy, and how do you put it to practice in your Top 200 Fund, which invests in the BSE 200 stocks?

We have set the BSE 200 index as the benchmark for portfolio composition and performance measurement. We thought that the Bombay Stock Exchange (BSE) Sensitivity Index (Sensex), the 100-scrip National Index, or even the Nifty were either too restrictive, or did not give us a big enough universe of stocks to pick from. We found a very high proportion of foreign institutional investment in the BSE 200 stocks, and worked out our philosophy. That was two years ago. In the foreseeable future, I don't see any reason to be in stocks which the foreign institutional investors (FIIs) are not going to buy. There's lot of speculation in second-liners, but there is not much of net overseas investment in them.

I buy stocks which are intrinsically cheap. I buy them because I would expect someone else to come and recognise that they are cheap. What drives a stock up is not the fact that it is a cheap stock, but more buying and selling in it. We are looking for stocks which will be bought more than they will be sold. That, of course, is a truism; but then, that's the game.

If there is a stock two times its earnings, with more cash on the balance-sheet than market capitalisation, and it is the 1,000th-biggest company in India, no one is going to buy it because no one knows its story. It won't make a difference at all to the overall return.

But isn't it a disadvantage to be restricted to the BSE 200 scrips since you are unable to participate in any other stock? Don't you feel hamstrung when you see the markets make a rally, but in scrips that are outside your self-set purview?

I think there is very little appetite for equity products at the moment. And I don't expect that to improve until you have a sustained period of strong performance in the equity market -- maybe for as long as two years.

Yes, the BSE 200 index is a less comprehensive list, and it does restrict us. We haven't been able to buy Satyam Computers and Aptech -- stocks which have zoomed up. But the benefit of restricting ourselves to the BSE 200 is that people know we are not chasing cyclical stocks, and will not get stuck with them. What we are trying to do is to beat the market by adding value by picking the right stock.

Tell me, aren't you churning your portfolio a bit too often?

We are definitely not churning our portfolio. We have a relatively low turnover. I can't remember buying or selling more than three stocks in a quarter. You might say that that is a lot for a portfolio of 25 to 30 stocks. But in this context, you do buy two or three in a quarter.

Basically, every stock in our fund has to be a buy at every stage; for us, there is no such thing as hold. Every stock is either a buy or a sell. Once it is no longer a buy, we get out of it. We are an active manager. It is true that we are looking at stocks on a six- to nine-month basis. But, in two years, we will all be dead!

But doesn't that contradict your investment philosophy? Isn't yours a value-oriented, equity-selection investment strategy?

We do not define value as price to book value -- it's a whole load of things. Basically, what you are looking at when you are assessing a company's worth is how good the management and the business are. If you find a company that has an outstanding management and an outstandingly strong position in a growth industry, but there's no premium on its scrip in the stockmarket -- or the premium is insufficient -- that is what I would say is a cheap stock. And that is what I mean by value.

We probably apply the concept across the index. We are not looking only at high-growth companies like Infosys and Hindustan Lever. We are also looking at Bharat Earth Movers and Bharat Heavy Electricals Ltd (bhel).

When does a stock turn from a buy to a sell in your book?

That's a key question. Whenever we look at a stock and decide to buy it, we set a price target for selling it. This might be 20 per cent, 30 per cent, or even 100 per cent over the purchase price. A stock is not worth buying if we don't expect its price to appreciate by more than 20 per cent. When the target of 20 per cent, or 30 per cent, is met, we re-examine the stock, not just in the context of the stock movement, but also in the context of the movement of the market.

If the market is up 40 per cent, and the stock is up 40 per cent over the same period, all things being equal, we will hold the stock, but after that, it is market-relative performance. If the stock is up 20 per cent and market is down 20 per cent, we will re-examine the stock.

So, the first thing that we do when a stock has met its price target is to re-examine it. After the target is met, in normal circumstances, we would sell it. But we do re-examine it to see if the story is valid, or if it would be right to sell the stock. In the case of Infosys, for instance, we set successive price targets, and we met them every time.

We have a discipline: not more than 7.50 per cent of a fund will be put in a single stock. Or, the percentage will not exceed one-and-a-half times the weightage of the stock in the index. So, if Hindustan Lever has a weightage of 12 per cent in the BSE 200 index, and we are only 7.50 per cent in it, we would, by definition, be underperforming the market because of underweighting, if the stock does well. Since one-and-a-half times the 12 per cent weightage is 18 per cent, we can go up to 18 per cent in Hindustan Lever. So, in a way, we could benefit from overweighting in the stock.

That's great, but there must be underperformers in your portfolio too. What about them?

We have a number of stocks which have underperformed. TELCO (Tata Engineering & Locomotive Company) is one. We should not have bought it when we did. We bought the TELCO stock when the Top 200 Fund was set up in September, 1996, and we sold it in July, 1997 -- at no profit at all. In fact, we sold the last bit of the stock at a loss.

We are not interested in whether the stock has made a profit or loss when we decide to sell it. The most important question for us is: is it a buy today? Every day, the stock in our portfolio has to remain a buy. It has to have an upside greater than the market's upside.

Madras Cements is another stock which we shouldn't have bought in the first place. It has been a chronic underperformer. The thinking about that company when we bought it was: although it is horrible on marketability, it is the cheapest stock in the market. It is based in Tamil Nadu, where there was a shortage, and we did argue about whether there was a national market for cement And, at that time, it did look as though the cost of transporting cement would prohibit cost-effective sales by Gujarat Ambuja and other cement manufacturers. But then, that proved to be wrong. So, Madras Cements turned out to be a horrible underperformer. We sold it because if you look at the use of money, it made much more sense to sell it than to keep holding on to it. So, I have no qualms about selling Madras Cements. Our mistake was that we bought the stock in the first place.

The rupee could well be devalued over the next few months. Given that likelihood, are there any particular industries you would bet on?

I would not use the term ''devalued.'' We expect the authorities to allow the rupee to find its own level. Intervention will be used only to smoothen the extent of the short-term movements.

I do expect the rupee to fall over the coming months since it seems to us that it is slightly over-valued at present. Moreover, a fall in the value of the rupee is likely to present to the government the simplest way to raise revenues -- from higher Customs duties on imported goods, and from the stimulatory effect on our exports.

Hotels would present an interesting case in such an environment. You would expect them to benefit from a lower rupee. So they will -- at the margin. However, you have to look at India in the context of the larger region. A small fall in the rupee would still leave India very expensive compared with the South-East Asian countries.

I was in Sri Lanka a month ago, and I found it extremely cheap. That is, when I compared their hotel prices with ours. The people to whom I happened to mention this said they were all going to Thailand for a holiday this year. They would be staying at five-star hotels -- for just $10 a night! With offers like that available, it is hard to see tourists flocking to India this year. 

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