Warren Buffett is an enigma. That’s despite so much having been written about him, and his own crisp and humorous articulation of insightful quotes and interviews.
Buffett has donned various avatars since he started out in the investing world, making many suitable transitions along the way.
He has been blessed with a very sharp mind and memory, but to his credit, he has managed to understand the human psyche, including his own, better than most people. He has taken decisions that sometimes appeared outrageous, made large high-conviction bets, chosen the right businesses with sustainable competitive advantages by paying a price lower than the underlying value of the business, entrusted them with competent and well-incentivised managers, and demonstrated humongous patience. Most importantly, he has gotten very rich with a truly long-term horizon, unlike a lot of Wall Street bankers with unscrupulous compensation structures.
Despite everyone knowing what Buffett has done in the past six decades, why is there only one Warren Buffett? So much so that his long time friend, business partner and a man he highly respects, Charlie Munger (who also probably has all the traits above), has also not even a fraction of Buffett’s wealth. I have asked this question to myself and innumerable fans and followers of Buffett, and I don’t have any substantial answers yet and that’s the reason I call him an enigma.
He started out accumulating Ben Graham’s prescribed cigar-butts, participated in arbitrages, then tweaked his model to incorporate the value of intangibles, started allocating large parts of his portfolio into companies he truly understood rather well, raised stakes in such companies until he had stakes as large as a business owner, and then over time diversified into a gamut of businesses.
Let’s start with the key themes encapsulating his philosophy. Very simply, he likes capital efficient, scalable businesses with pricing power run by credible and competent management with interests aligned. The various industries across which his empire spans today broadly include FMCG, utilities, home builders/suppliers, media and BFSI. He has a few other relatively smaller businesses in certain other industries. All these domains were bought into at different time over the past many decades. Each time the motivation to invest in an industry may have been different but the broader framework was probably similar with certain suitable modifications, perhaps even exceptions.
Clearly there are plenty of Buffett followers across the globe, including in India. While many, many followers have made tonnes of money adopting his philosophy, there are also a bunch of them who have managed to rake in money thinking that they are following his philosophy, but actually are just speculating. Stocks of all his favourite sectors — FMCG, financials, and anything to do with a home (paints, ply, tiles, electricals et al) have pierced the sky and gone into space! So is Buffettology as understood by most common investors the magic wand to bulky returns for Indian investors?
Moats or goats?
Let’s start with consumer companies. India has always had a very large consumer base owing to its demographics but that base did not have enough purchasing power before the UPA came up with National Rural Employment Guarantee Act (NREGA). Since then, successive governments have been enamoured by the idea to barter doles-for-votes, the collateral benefit of which accrued to FMCG companies.
Within this space, there are a variety of companies that have the Buffett traits. Companies such as HUL, P&G, GSK, Colgate and Nestlé are businesses perhaps Buffett would approve of. However, he actually did not buy any of them. He has no legal restrictions on buying Indian stocks and there is enough free float in the large listed Indian FMCG space.
The reason could be that he already had exposure to these Indian listed stocks via their globally listed parents. But that does not make up for growth rates the Indian peers offer. And he did not even buy homegrown companies such as Marico, Godrej, Dabur, Britannia and Pidilite, which don’t have a global parent. These companies arguably did not have enough free float for him to buy into. The other stocks in the FMCG space in India are companies such as ITC and stocks from the UB stable. They probably don’t make the cut since they belong to the sin industry. Even otherwise, I doubt if he would have invested in either ITC or UB. The former has been poor with capital allocation, and the latter’s quality of books has been suspect.
However, all these stocks have done phenomenally well in India. Some for the right reasons, but others simply because there is the Law of Unintended Consequences.
I will simply illustrate how this has worked with some simple pointers. Let’s take two stalwarts of the FMCG sector, Nestlé and HUL. Suppose an investor entered the markets in 1999, got enamoured by Buffett, and bought these two stocks. The Graham in him would have been reluctant to buy, but someone who doesn’t even know Graham and knows Buffett somewhat would have jumped and bought regardless of the valuation, and held it ‘forever’. Fast forward 20 years. He would have made a killing making a 20% and 12% CAGR respectively, including dividends.
However, if we look deeper — remember we are in 1999 — these returns could have come only on the back of very fragile assumptions. That the monsoon shall be above average in most of the next two decades, the governments would spend ever more lavishly in rural doles throughout the two decades, there would be infinite pricing power in all product categories, competitive pressures would be non-existent, payouts shall be significant. And, the P/E expands further to the current 66x and 60x respectively. Now, if I were to moderate these assumptions and assume there was no P/E expansion (remained 42x and 46x respectively) then the returns diminish to 16.5% and 10.5% respectively. And finally, if the P/Ex decompress close to Intrinsic Value (say 30x), then the returns shrink to a pittance, 14.5% and 7.5% respectively. And these numbers match with the earnings growth since 1999 of these companies as well, 16% and 9% respectively. In other words, for 16% and 9% growth companies, it’s difficult to justify a 30x and 20x respectively, even though the 30 P/E taken for HUL still yields an FD return.
If we were to assume that the investor would be patient and wait for the valuations to be a little more reasonable, and bought in 2001, then also the return is enhanced by approximately 1-2% in both cases in the above scenarios. The point is, these are not earth-shattering returns and Buffettology seems to have worked in these stocks purely because of the multiple expansion without any sound fundamental basis to it.
Embrace the unloved
On another note, in one of the recent Berkshire Annual Meetings, someone raised a question which is very pertinent to 99% of investors in India. He asked Buffett and Munger how their strategy would change if they were managing $100 million instead of $100 billion. Without blinking an eyelid, the response was that they would be buying and selling stuff (much like what Buffett did during his Partnership days) and their favourite holding period need not be ‘forever’.
This gets me to the point that since most of us don’t have a problem of size (except few top mutual fund managers, of course), we would be missing a whole universe of opportunities that exist going by the Buffett stereotypes. It’s quite amusing to see most people trying to emulate Buffett of today even as their size is probably a millionth of his corpus.
A vast majority of stocks are thus neglected by most investors. Auto ancillaries, engineering companies, PSUs, paper stocks, fertiliser companies, chemical companies and the list goes on. And then, from time to time certain tough industries such as steel and textiles also give opportunities for investors. A lot of companies in these sectors undergo a period of stress. Some of them are unable to come out of the stress, but many of them do revive and subsequently thrive as well. Generally, when a sector is out-of-favour, the stock prices are beaten down mercilessly. Some of this is justified given the stress levels but, beyond a point, the stock prices tend to reach abysmally irrational levels. That’s a great opportunity for the contrarian value investor, which is what Buffett was when he was our size!
Yours truly has made outsized returns in stocks such as Chambal Fertilisers, a handful of PSU banks and south-based old private sector banks, a host of small niche PSU companies, a few construction companies, a textile company, a metal company, holding companies and so on. None of these investments would have qualified in the current check-list of Warren Buffett, but that surely doesn’t imply they were not great investments even by the classic definition of value by Buffett’s guru Benjamin Graham. Some were low risk, big bets and gave low returns (12-13%) in CAGR terms, while some gave as high as 35% even with low risk. Outliers delivered more than 100% CAGR. And the holding period varied between two years to more than a decade.
That brings me to the next point: most of us investors don’t run an insurance company that our holding period ought to be ‘forever’ to match the assets maturity with those of the liabilities. It’s a lot about asset-allocation. How well diversified is the risk in a portfolio. How many are ‘long-term holds’ and what weight is allocated to relatively shorter-term strategies such as cyclicals, arbitrages and turnarounds. How many are compounders and how many are cigar-butts. And most importantly, how much cash do you hold at any point given the economic circumstances such as the macro environment, policy, sectoral prospects, and very significantly, asset prices. You need to have Sehwag and Dravid alike in your team, along with specialist bowlers. Having 11 Viru’s make your team a disaster, even if such a team helps you win some matches!
But these are things that are often not talked about in most discourses on the great investor. To the naked eye, he made a poor return in IBM (discussed below) relative to his overall return till date, but he may have invested big in it to have some stability in his portfolio. After all, there is an ever-shrinking universe of big ($10 billion) opportunities. But most of us don’t have that problem. Therefore, implicitly we need not have an IBM in our portfolio nor should we remain invested in Coke, for that matter the Indian FMCG companies which appear to be in the same boat today in terms of valuation.
Buffett is no God. As with everyone else, Buffett has had his share of luck and lemons alike. He has made several errors of omission and commission. He has made a lot of money in Coke since he bought in the late 1980s. (Mind you, he drooled over the company for a long time but never bought until the stock price fell drastically for problems he comprehended to be temporary.) However, it was a mistake (one can say so only with the benefit of hindsight) not to sell it during the late 1990s boom when it was quoting at ostentatious multiples (P/E > 40x). Coke, mind you, has given zero capital gains for the past 20 years.
Back home, whoever may have invested in FMCG companies 20 years ago has made a handsome amount of money, but given the currently rich valuations of these companies, it’s hard to imagine making any meaningful returns going into the next decade.
Then again, though Buffett was right in avoiding the technology space altogether citing his lack of understanding of the sector, when he checked into IBM, it was late and he did not make a lot of money. (Though to put things in context, at the time he deployed his capital into IBM, he already had a problem of too much capital and an opportunity cost close to zero.) Buffett missed the commodities boom and invested in an oil company at what turned out to be the top of the cycle. Buffett’s foray into Tesco turned out to be chequered too. He didn’t make too much money on his bet on silver either. His latest (and big) bet on Heinz also seems to have gone awry. May be, it’s early days yet.
What I am trying to say is simple: ‘Nakal mein bhi akal chahiye’, unless one wants to ride one’s luck and believe in ‘Allah meherbaan to gadha pehalwan’. Let’s get real here. None of us are born in America, the ultimate consumer society along with the most efficiently functioning capitalist society. We don’t have the luxury of zero interest rates. Gone are the times when markets were relatively inefficient and one could buy a Coke at cheap valuations. None of us have either the ‘float’ or the incredible ability that Buffett has displayed to manage the ‘float’. We don’t have the superlative foresight Buffett has in various businesses either. We don’t have the discipline to not get sucked into areas we are not supremely competent in, we don’t have the patience to sit on cash for ‘as long as it takes’ (to get the fat pitch) and nor do we posses his unparalleled skill to not be riled even by the wildest of waves.
Some of us have some of these traits and skills, but I bet there is not even a single person on this planet who has all these skills. We can only praise him, but forget about emulating him in toto. One can try and emulate what he did when he was our size. That’s the best one can hope to achieve.