Greetings from Carnelian
While the returns since inception encourage us, we continue to focus on our investment thesis (the “MCO” framework) instead of the scoreboard and will continue to look for new investment opportunities within this framework. The MCO framework enables us in identifying investment opportunities within 3 broad baskets “Magic”, “Compounder” and “Opportunistic”. Before we share our insights on the Magic Basket, we would like to share our thoughts on the current market scenario, which seems to be generating a lot of curiosity.
Our current thought on the Markets, Budget & Corona virus and Our Approach
Of late, markets are dealing with Budget falling short of expectations and global uncertainty on account of Corona epidemic. The Budget is behind us and we are sure that you must have read a lot about it. Our two bits - we are neither disappointed nor excited. There have been some things to be happy about and some disappointing. None of them are changing our view about the structural revival of the economy. We continue to remain a believer in the Indian recovery and growth. For the pace of recovery, we are watching only ONE VARIABLE which is critical for the revival of the economy i.e. CREDIT GROWTH.
We believe as it improves, economy will start getting better. We are very positive on its improvement. Another issue which can create a larger impact on the global markets, is the spread of Coronavirus. The severity of its impact will be unknown and uncertain for quite some time. It surely will have a negative impact on global trade, liquidity and risk, if it is not contained immediately. China which is almost 16% of the global trade will have a far reaching impact and its economic contagion will flow on to the western economies. In short term, it can turn anyways. It will be very hard to predict. We will monitor this closely to navigate the uncertainty.
The epidemic is unfortunate. However, this can create some good investment opportunities for investors. We can only say one thing for sure that this is not going to be permanent and hence any dislocation on account of this will be considered to build our long term portfolio. In fact we anticipate that as the epidemic recedes, all major economies including China will do growth stimulus which is good for overall markets. We will be willing buyers of good companies when most investors are selling because of bad short-term news/panic.
We recommend our clients to increase their Equity allocation over next 3-6 months in systemic way.
“The most common cause of low prices is pessimism…. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces” – Warren Buffet
Now let’s give you some insights into how we look at stocks in the Magic Basket, which contributes to our performance and alpha forming ~55-60% of our portfolio.
What is Magic? While the literal meaning of magic is having supernatural powers/qualities, however in the Carnelian world, Magic is the obvious change which is not yet priced in /deciphered by Mr. Market. Magic happens when Mr. Market starts recognizing the change leading to a P/E re-rating. We attempt to capture both Earning Growth and Valuation re-rating under this basket. We have identified various circumstances when this usually happens, some of them are mentioned below:
-Change in management
-Structural change of business cycle
-Change in business strategy
-Large Capex/Opex getting over, operating leverage to follow
-Clean up of past mess/ balance sheet repair
We have done a back testing of BSE 200 stocks in the magic category over the last 10 years. Out of the BSE 200 stocks, – stocks in magic category has delivered 29% returns from the magic event vs. BSE 200 returns of 9.32%.
Within the Carnelian portfolio, the Magic category has delivered 20.58% returns over the last 7 months.
Further elaborating on the above discussed magic category, we would like to illustrate the same with one of our Magic picks in Carnelian portfolio – ICICI Securities.
ICICI Securities had always been a well-established business & a brand with strong financials, uniquely positioned to benefit from the changing industry dynamics. However, lack of initiatives/aggression to respond to the changing industry dynamics, led to stagnation which we believe has now changed under the new able leadership of Mr. Vijay Chandok backed by the top leadership at ICICI Bank. Also, the markets clearly missed observing their growing distribution AUM, currently at INR 37500 crs with revenue yield of 63 bps in its portfolio (which has AMC like characteristics). An asset light business with high cash flow generation and dividend payout was available at lucrative valuations of ~ 15 P/E TTM and dividend yield of 4.5%. This coupled with a renewed management focus and new drivers meant a perfect recipe for re-rating once Mr. Market realized it’s potential. Our detailed work and analysis helped up build significant conviction around the idea.
Mr. Market has subsequently re-rated the stock to 30PE TTM.
Needless to mention, all stocks identified in the Magic Basket have to pass through the “Carnelian filter” & PIU scorecard before qualifying to be a part of the Carnelian portfolio (please refer November update for carnelian filter).
PIU entails detailing on various parameters mentioned below pertaining to Business, Management and Risk Reward of the company as described below.
We hope that we have been able to add to your understanding of the Carnelian world of investing. Please feel free to reach out to us, should you need any information or clarification.
We will be happy to receive your feedback, comments or suggestions.
Thanks
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