Buffettology for India

Warren Buffett is the last word in the stock market. Or is he? There is no denying his investing principles. Yet, these seem difficult, and often irrelevant, when put into practice. Why?

Consider Buffettology's first rule: Hold for the long term. So what would have happened if you had held some blue chips forever? In the past 18 months, you would have seen Reliance and L & T crack to 30% of their peaks, DLF and Tata Steel to 15% and Bharti Airtel to under 50%. Inaction in the face of gross overvaluation is sinful; anyone who did not see the big correction coming in Indian equities was obviously blind to the high valuations across sectors.

As it turned out, no one did. The antidote is to heed valuation norms and seek a margin of safety, especially when sane valuations are crossed. This, too, is part of Buffett's investing axioms. The fine print of a rule is as important as the rule itself.

Reading the macro signs right would have paid off in India, irrespective of the stocks you punted on. Those who called the growth and investment cycle as early as 2003 (interest rates coming off multi-year highs, sentiment was rock-bottom, private and public capex had all but stalled) were rewarded with four years of appreciation. India is a little different from the country that Buffett has lived in.

So we need to temper his methods to fit in with the desi scheme of things. No amount of RoCE or DuPont analysis of Bhel and SBI would have tempted you to buy them when they were poised for multi-bagger growth. They were just mountains of promise staring into an ocean of opportunity.

Another favourite theme of Buffettologists is to look for competitive 'moats' or entry barriers that companies build around their businesses. To me, the only meaningful moat that Reliance has built is the ability to 'manage' the government getting the regulatory and administrative regime tailored to suit it. Otherwise, who would pay close to 15 times the forward earnings on a refiner with (increasingly visible) upstream assets?

Our fair value sum-of-the-parts valuation for Reliance is about Rs 1,700, after making some benevolent assumptions. Tell this to the guys who bought it recently for over Rs 1,900 (or those who took it up to over Rs 3,000 in the frenzy of 2007-8).

Free cash flow is another mantra of the Buffett fan club. There is no substitute for this vital part of value creation, but sometimes growth overshadows everything. When a company is growing at 40-60% year on year and has to reinvest in the business, you should not complain about the lack of cash flow. We need to read the micro cycle of a company's life, pour capital for a few years to take it to a steady state, and wait for the stock market to do its tricks.

An example is Pantaloons, which earned 70.64% annualised return for its shareholders in 2004-8. It was virtually creating the organised retail sector in India, changing every rule in the game and guzzling capital even as its revenues grew from Rs 655 crore in 2003-4 to Rs 5,296 crore in 2007-8.

Of course, the cycle turned and Buffett's principles prevailed. The important thing is not to let an ill-fitted version of his principles to come in the way of recognising genuine investing opportunities. Buffett's principles are not irrelevant or dated. They just need to be applied appropriately in India.