Illustrating his theory with the historic price chart of
India, Mukherjea says if someone would have bought the stock each year for 10 years at its 52-week high from January 2011 till December 2020, the long-term investor would have pocketed a healthy compounded annual return of 18.6 per cent.
“Investing in consistent compounders takes the question of ‘when to buy’ completely out of the equation,” Mukherjea writes in his new book ‘
Diamonds in the Dust‘. Co-authored along with his Marcellus Investment Managers’ colleagues Rakshit Ranjan and Salil Desai, the book is published by Penguin Random House.
For investors looking to compound their wealth over the long term, Mukherjea says the low-risk route is to depend on consistent compounders, where earnings and cash flows grow at a steady and consistent pace. Such companies come with clean accounts, prudent capital allocation and strong competitive advantages.
The blue-collared fund manager gives the example of five such stocks — which are also part of Marcellus portfolios –
, HDFC Bank, , and Nestle India. He says if an investor would have identified these five stocks at the beginning of 2001 and invested an equal amount of money in each of them every year when the market was at its 52-week high, the portfolio would still have generated a healthy return of 27.4 per cent after 20 years.
“The same exercise, if done with the Sensex, would have yielded 12.6 per cent IRR. These numbers convey two crucial facets of investing: first, it is possible to do better than the broader market by investing in consistent compounders; and secondly, the time spent remaining invested is always more important than timing the market,” says the book.
Mukherjea, an alumnus of London School of Economics, argues that identifying the lowest point of a stock for executing your buys and identifying the highest points to sell them is practically impossible. Timing the overall market is not worth the effort, and surely not worth testing your luck, in getting each buy and sell timing right, says he.
P/E Valuations Matter?
Besides timing the market, the other dilemma for investors is the price of the stock. Should you buy a stock if its price-to-earnings (PE) multiple, Dalal Street’s favourite valuation metric, is low compared with its peers or the broader market?
Mukherjea says that comparison ignores a number of factors that drive the value of a business – the return on capital and the reinvestment rate being the chief among them. “It is like saying my plot of land should be valued at a certain price per acre, because my neighbouring plot of the same size was acquired by someone at the same price. What if the neighbouring plot had fruiting trees or an oil well while mine does not?” he asks.
Giving the example of Asian Paints, he says in March 1996 the stock was trading at a PE multiple of about 26 times while the corresponding PE for Sensex was about 13 times. As the stock was then quoting at a 100 per cent premium to the market, many investors would have found it expensive on a relative valuation basis and avoided it. However, calculations done by Marcellus shows that Asian Paints was actually quoting at a huge discount of over 30 per cent based on the company’s intrinsic value.
“Like in the Asian Paints example, a PE multiple that is large in the absolute sense is not necessarily expensive. Conversely, what might appear to be a ‘low’ PE stock might actually be expensive compared with its intrinsic value, if the business cannot support a return on capital higher than the cost of capital for a long period of time,” the author said, adding that trying to time buys and sells based on just the PE of a stock is a futile exercise.
So then how should you value a stock? Simply focus on consistent generation of free cash flow, Mukherjea insists.
