Never miss the forest for the trees
Bajaj Finance has been a classic case of what I feel people forgetting the big picture and missing the overall big picture apart from the fact that trees don’t grow to skies (pun intended).
The big picture in itself has been enormously high amount of profits along with enormous growth in many financial firms. While investors dealing in companies in diverse sectors such as chemicals, manufacturing used to get all juiced up by just thoughts of incremental revenues of few hundreds of crores (which can possibly re-rate such companies by more than 50% in many cases), when it came to even a small-cap financials the incremental profits in itself used to range in a different stratosphere. How financials got more than 40% weightage in NIFTY even when none of them are monopolies, have considerable amount of existing regulation and future regulatory risk and where threats from technology exists more than ever is a case study in itself. The reason was very simple - the market is huge because everyone wants credit and hence runway is very long and hence lets just extrapolate the last few years into eternity and give crazy multiples - even though the example of high RoE and high growth over 2 decades or more is just one in the entire space (even Kotak suffers from low sub 15% RoE) - which means that most of the growth is non value acretive. Infact in India, most value in book value terms has been created by raising funds right at the peak to mathematically increase the Book value per share by smart managers of financial firms rather than through lending operations.
Can many such financials continue to post 30-50% profit growth easily while GDP and core firms are struggling to grow in single digits just on account of penetration argument forever. Or there are risks which are being more than usual which are not accounted in these high profits - I certainly don’t see how many such firms like IndusInd (1800 to 350), RBL Bank (650 to 100) and many others have crashed only because of Covid.
When one lends, as Rajeev himself said in an interview, all the profits reside in the last EMI being paid. That is one risk to the earnings which is not captured in the financials under the accounting systems, especially for the organizations where the growth is high, loan tenure is short and most book is new. The only way to do the lending right is to be right just like a stock market investor - rapidly increasing the pace of lending when the times are bad and when great book can be built at decent rates as others are not lending and vice-versa. However in the pressures of market make most succumb to chasing highest amount of growth possible at precisely the wrong time - most firms end up choosing efficiency over sustainability which hampers them badly when the macros take turn for the worse.
Bajaj Finance in itself did not suffer from most of what I have written which probably is more true for most others. The credibility of the management is definitely high. What however they still suffered from was the way market extrapolated their profits like a simple excel model. If that would have continued for 5 more years for few of such firms, I am pretty sure their weight-age in NIFTY would have been maybe 60% of NIFTY and thinking in such big picture terms helped. Can 60% of all value cretaed in India come from just one sector. Currently there is one more gentleman in the markets falling under the trap of extrpolating last few years into eternity to think that 80-90% of India’s profits can be generated by just 10-15 firms (although none of these 10-15 firms are into technological innovation as such which is a data point completely different from USA if one has to look at global example). Yes sir, in which India will be no better in governance than many of African countries and will be a banana republic in which case one should possibly review the thesis of investing in our country itself.
Although brilliant Keynes have said that markets can remain irrational for more time than one can remain solvent, market is but a place for fair price discovery. Market exists for a reason and that is fair price discovery. In its search for the sole purpose of its existence, events that happen are only a reason to take things to their logical outcome rather than outcomes being dependent on the event itself. Market may have now (almost !!) permanently re-rated the leveraged financial firms to a new normal while on its way to also induce a massive time correction on low leveraged-low growth but exorbitant high valuation firms.
The current scenario is unprecedented, no one knows the impact on credit costs - one is still working with several assumptions like (almost) similar consumer attraction towards leverage and high ticket items post covid, no second waves, economy mostly back to normal by 4Q21 etc etc but then there is no surety about any of the above. When I read about gas leakage accident in Vizag and then plane crash in Pakistan today, I can think of some correlation. Its the same thing which happens to sports person on a game of football. It pains only when the game is over not in the heat of the moment. Complex systems unlike ceiling fans don’t start as soon and as well as before when switched on after it is switched off.
Bottomline is when the things are going great for any stock, investors tend to take things to extreme - all potential good things are priced in and all risks are shrugged off. As an intelligent and contrarian investor one has to always take into account both. Only then can a fair price emerge. Now when we have seen so many risks, I think one thing one must not do is to compare the Bajaj Finance today to its past either in financials metrics or in valuations metrics. People should also forget that it made a high of almost 5000 bucks and it grew 6x from demo to covid.
MARKETS DON’T LET YOU MAKE SERIOUS MONEY UNLESS YOU ARE GREAT TRADER OR A GREAT CONTRARIAN INVESTORS. A lot of great traders I know got stopped out of their positions by 4200 or above levels and a lot of good investors either entered pretty early at much lower levels than current price or sold out early enough. The remaining big chunk of people left were either momentum chasers without thorough discipline or or PMS fund managers making clients feel that it is so easy to make money in stock markets through them by only investing in firms showing highest growth. Many such managers even started to speak about financial firm valuations in terms of P/E although E can be highly volatile and of less meaning for a financial firm than the more conservative and cross cycle appropriate P/B which obviously looked far and far unusual for some such firms.
Independent, unbiased conservative and practical thinking is required where the big picture of current reality is not lost to take a call to buy or sell. If you don’t understand any of the above, understand just one thing - it is seriously very very hard to be a long term investor and to sit on a stock trading down or side-ways. Be sure of yourself before investing in some of these fallen angels.
All the best.
Regards,
Sarvesh Gupta
PS - I run a SEBI registered advisory firm. No current holding in Bajaj Finance. No trades in past month for myself or clients.