How To Spot Asymmetry In Stocks With Earnings Catalyst, According To Samvitti Capital
The holding period for such a basket of stocks can be six to eight quarters.
Samvitti Capital Pvt. tries to spot an asymmetry in the stock or the sector and looks for a new catalyst that can materially change the earnings trajectory of the company, according to co-founder Prabhakar Kudva.
"Instead of taking a valuation-based approach of trying to find undervalued stock, what we look for is a neglected stock, where a new catalyst has entered, which can materially change the earnings trajectory of the company," he told NDTV Profit on The Portfolio Manager Show.
The holding period for such a basket of stocks can be six to eight quarters and research indicates most of the re-rating of a stock typically happens over that period, he said. "It is very much a bottoms-up approach."
The catalyst for change is earnings. The first step is to look for the "big delta change" in the quarterly earnings, and then figuring out why it happened and if it is sustainable for the next three to six quarters, he said.
"The second type of trigger is where we can anticipate an earnings improvement."
In his view, normally, the market tries to discount the next two to three quarters ahead, "but there are certain situations where the market really goes overboard and starts discounting the next two years".
When that happens, the fund house either looks at significantly trimming its position, or harvesting profit and getting into a newly neglected opportunity, Kudva said.
Watch the full conversation here:
Edited Excerpts From The Interview:
Talk to me Prabhakar about your investment philosophy?
Prabhakar Kudva: The investment philosophy is slightly different from what the street typically does. So, typically, what happens is that fund managers try to take a three- to five-year view of a particular stock or a sector. But what we do is slightly different. The core thesis for buying a stock is driven by valuations, or whether a stock is undervalued or overvalued. What we do is look at identifying if some sort of asymmetry is starting to appear in the stock or the sector. So, whenever we see something that has been neglected for a long time and suddenly a new catalyst emerges in the picture, which, we believe, can change the trajectory of the company.
We try to identify such stocks and build a basket of such bets, and instead of taking a three- to five-year view, typically our holding periods are relatively shorter, we look at a transition period of six to eight quarters, that is, anywhere between one-and-a-half and two-and-a-half years. Because, based on our research, we have realised that most of the re-rating of a stock typically happens over a six- to eight-quarter period, which is our average holding period.
But essentially, the key difference in philosophy is that instead of taking a valuation-based approach to trying to find undervalued stock, what we look for is neglected stock, where a new catalyst has entered that can materially change the earnings trajectory of the company. We have been doing that so far and have been quite successful.
Viewers would love to know how you actually go about identifying the stocks or sectors, but first up, is it fair to assume it's a bottom-up approach as opposed to a top-down approach when you're looking at stocks?
Prabhakar Kudva: It is very much a bottoms-up approach.
You said that you identify a catalyst, or you identify a company, on finding a catalyst, which could be the key driver or be responsible for re-rating. How do you identify the strength of this catalyst? What is that specific trigger that you watch out for, and how many quarters ahead of the curve would you jump into a stock?
Prabhakar Kudva: Typically, in 70–80% of the cases, the catalyst is earnings. We watch quarterly earnings very closely. We go through all the two-and-a-half thousand companies that are listed and that meet our liquidity criteria. And in them, we look for even larger changes in the earnings profile. Then we go back and figure out why this big delta has happened.
So the first step is to look for the big delta change in the quarterly earnings, and then go and figure out why this delta has happened. Why has this big change happened? Is it something that is sustainable over the next three to six quarters? Knowledge of the business certainly helps identify if it's a one-off quarter or if this is something that is likely to continue. There are also other triggers and other hints, like, typically, it will not be just one company that will be doing very well. In many cases, the entire sector starts to do well.
The second type of trigger is basically where we can anticipate an earnings improvement. So, the first one, like I said, is that we do it, post the quarterly earnings, and, in some cases, in some rare cases, we do anticipate an improvement in earnings and a change in the earnings perception. Then, we kind of go and bet on those companies.
Your current portfolio has a very clear bias towards broader market stocks. Is that an internal decision taken by the fund manager that you want to focus only on small and mid-cap names, or are you market-cap agnostic at this stage?
Prabhakar Kudva: No, the active Alpha PMS that we manage is a multi-cap scheme. So, it allows us to participate pretty much anywhere in the universe. That qualifies our liquidity criteria, but very clearly, like I said earlier, since we follow a bottom-up approach, the way the portfolio has evolved has been completely evolutionary, so to speak. So, there were no discussions about whether we would get into the sector or not get into those sectors. If you go back and study the earnings of these stocks six to eight quarters ago or five to six months ago, you will start seeing those delta changes in the earnings and the entire portfolio. We have been able to pick the sector because of some foresight, but it has been the outcome of the approach that we follow.
So, all of these names have come about very organically; there was no sectoral call taken; it is just that at times when you're constructing a portfolio, you might want to not go extremely overweight in a particular sector. To that extent, you might limit having more than x number of stocks in a certain sector, but all the stocks have emerged in a very organic fashion and not at all due to any sector-specific call.
In the multi-cap strategy, you have two strategies: active Alpha multicap and investor-savvy portfolio management. Is there an overlap in both of these portfolios? I mean, can you draw the difference between both the portfolios that you run?
Prabhakar Kudva: I think you have the name wrong—the other one is called a long-term growth scheme. So, typically, the approach remains the same: the approach remains to look for large changes in the earnings profile. But like I said, the active Alpha is a multi-cap approach, whereas the long-term growth is slightly biassed towards larger mid caps and large caps because, you know, we have different types of investors and different risk profiles. So some people are not very comfortable going into a majority mid-cap or small-cap portfolio. So, we have another scheme whereby the universe is slightly smaller and it comprises, let's say, a company with a market cap of more than 15–20,000 crore, and ideally, we don't do anything below that market cap.
In terms of strategy at this stage, I mean, there are pockets of investors who believe that the markets are looking very stretched. A correction could be around the corner; you've got a couple of key events as well. What is the allocation strategy at this stage? Are you sitting on any cash? Are you investing in a staggered manner? Are you still doing lump sums, and I am talking about fresh capital that your fund is attracting?
Prabhakar Kudva: I don't believe in cash calls because you've done a study. Also, I need to go back and look at situations where, let's say, you're taking a 20–25% or 30% cash call. Typically, the difference, and even if, let's say, you were able to sell at the top and buy back 15-20% lower after accounting for the transaction costs, the taxation and the impact cost, the net improvement at the portfolio level is not more than three or four percentage points.
So I strongly believe that to be able to maximise returns, one has to be able to sit through the drawdowns, which is why when we are very media shy, we do not have any big sales or distribution team, and all of that is because we work with a very closed set of customers, people who understand the markets, people who understand that this is a multi-year game, a three- to five-year game, and volatility and drawdowns are a feature. They're not a bug, so to speak. So drawdown management typically happens in the stock selection itself.
I've seen that when you're having a portfolio of stocks that are all enjoying earnings and tailwinds, then two things happen. One is that you fall relatively less than the market. So let's say now that if I have a bunch of mid and small caps, the initial fall will be similar; it will fall more or less as much as the initial or slightly more, but at some point buying emerges because these stocks have an earnings tailwind.
Giving example. It was FY22, which was a very tough year for the markets. But with this approach of buying earnings winners, we ended up again among the top two to three in FY22 because we ended up doing a 10-12% return, which in absolute terms is not great, but most of the market was negative in that year. So, when you construct a portfolio with earnings tailwinds, you have a little bit of a cushion whenever garden variety correction arrives. Having said that, if a correction like a Covid crisis or big macro crisis happens, then all bets are off, and those corrections, by definition, are not predictable. So, to that extent, we don't really take any large cash calls; we are always invested, and we like to take the corrections and drawdowns in stride.
Are you still accepting fresh money? What is the size of your assets that you're currently investing in? The reason I am asking you is to help us determine how nimble-footed you are in this market, especially with the kind of stocks that you hold. You would probably need to be nimble footed. Also, your largest sectoral exposure remains capital goods. Can you throw some light on these three questions?.
Prabhakar Kudva: Yes, we are accepting new capital. The AUM we are managing has two main products: PMS and AIFs. So, we also run a category-three alternative investment fund. Put together, both of these products were managing about Rs 1,500 crore of assets. To answer your third question about capital goods, these are the stocks that were picked up at least four to six quarters ago. It was driven by how these companies have started performing very well after a long period of lull. This, I think, was primarily due to the capex that the government spent, and now there are early signs of the private capex coming back. So I think we were able to get onto the bandwagon quite early, and these companies continue to give good results because, if you see that the last capex cycle, possibly, you know, ended in 2010.
For the last 10 years, we've not had any serious capex cycle. The new cycle was kicked off by the government after Covid, in my opinion, to support the overall economy, and they have done a great job of sustaining the economy until the private capex enters the market. So, I think going forward, with government capex still continuing and private capex also starting to pick up, both will continue to provide tailwinds to the stocks.
Your top holding in your model portfolios is HPL Power. This stock has had phenomenal returns over the last four years. However, it was an underperformer over the last decade or so. With policy continuity expected, the push and thrust towards railways in that sense have been the big reasons for this one being an outperformer, but the run-up is phenomenal. Do you still continue to hold HPL? Would you look to raise your allocation in a stock that you already own 6%?
Prabhakar Kudva: Sure. HPL has ended up at the top of the charts in terms of portfolio allocation. To set the record straight, we start off with the same allocation for all stocks, and it is very difficult for us to predict which stock will end up performing the best because all we're doing is looking for two main qualities in every stock that we buy.
One is that it has to be a relatively neglected stock. So when I say neglect, it means it has to be neglected in terms of price, in terms of the sector, and in terms of media coverage, among others. We look for a combination of such neglect, and, like I said, with the entry of a catalyst, the stock would shoot up. HPL Power was exactly that; like you said, it was a stock that was going nowhere, and suddenly multiple engines for HPL Power started to fire.
Of course, they had the battery division, but what really added the kicker was the implementation of Kawach, in which these people are involved in the railway signalling system. That led to the massive re-rating of the stock. So, yes, it was neglected at the entry of this catalyst, but the numbers started coming. If you look at the last two or three quarters, there has been significant improvement in the numbers, and the company is likely to continue to do well for the next several quarters. Yes, we continue to hold it, and at least as long as the numbers keep coming on a quarter-on-quarter basis, as long as they keep delivering, it will remain in the portfolio.
The selling decision typically happens in two situations. One is where I feel that this company has peaked out in terms of its ability to show acceleration in earnings. Second, the company, after a few good quarters, starts to peter out in terms of its earnings delivery. Unless those two scenarios are met, the stock will continue to remain in the portfolio.
Newland Pharma has shown phenomenal growth. It's been called a multi bagger. Margins look compelling, and returns on the stock have also been pretty good. Now at this price and this stake that you hold in Newland, what is going to be a trigger to sell or add more?
Prabhakar Kudva: Yes, like I said, typically, we don't add more. I would have bought Newland several quarters back. So, in terms of increasing the allocation, we would definitely not do that because a significant part of the re-rating has already happened. We will continue to hold it as long as it continues to deliver on the earnings front, and it has so many things going on in its pipeline in terms of its new drug delivery, among others. So, as long as those triggers play out and I see them in the earnings, I will continue to hold them. But there will come a point where the market will get ahead of what the company can eventually deliver.
So I'm very, very critical, trying to watch for that point, and sometimes that can be in terms of margins; some sort of peak margin trend can come in, which can give you extremely extraordinary earnings for the quarter, and that becomes kind of the talk in terms of the earnings for the next many quarters, or something like that or if the valuations start discounting the next three, four or five quarters ahead.
Those are the situations where I feel I will look to exit the stock. Typically, the market in a normal scenario tries to discount in the next two to three quarters ahead, but there are certain situations where the market really goes overboard and starts discounting in the next two years. When such scenarios happen, we either look at significantly trimming our position or, you know, harvesting that profit and, you know, getting into a new neglected opportunity.
We are almost at the end of the earning season. Have you identified anything exciting?
Prabhakar Kudva: This earning season has been quite boring, actually. Nothing new has come on the horizon. Of all the companies that we own, at least 80–90% of them have come out with good numbers. This will make me want to continue to hold them for the next one or two quarters. But in terms of new sectors or new categories, I do not see anything emerging in this earnings season.
This earnings season has very much been a story of not much top-line growth and a lot of margin expansion. You know, so nothing new except a couple of companies, if I can name them with a disclaimer. So, we added Shakti Pumps, which came out with very good numbers, again a very small startup position, because the numbers were very good, and that sector has a tailwind from the government in terms of installations and a push from the government for improving the investments in that sector.
Are you looking to add more to Titagarh or are you going to just hold on to what you have got? How much longer do you anticipate holding on to Titagarh?
Prabhakar Kudva: When I first got Titagarh, it was a very innocuous corporate announcement that we saw where Titagarh said that their order book was 10 times the revenue that they were doing in the previous year. That was what got me interested in that stock.
The market has recognised the stock, maybe from a one-year-forward point of view; it's already kind of priced to some extent. I am watching it, but I still feel that when you look at that large order book, you know, there is still a long way to go, but the stock definitely may go into consolidation because the markets are always wanting to be ahead of the curve. The markets will price it in the next two-three-four quarters, wherever they have certainty, and that may have been the case with Titagarh and several other railway stocks also.
I don't think that the story is yet over. But I think we have to brace ourselves for a bit of consolidation or a sideways movement, where for a period of time we may have no returns, before the next leg starts.
