Better disclosure norms will give shareholders equal access bottomline-impacting information, and without having to read between the lines.

IN HIS book One Up On Wall Street, legendary fund manager Peter Lynch, who has averaged over 35 per cent return on investments for over 10 years and consistently outperformed the market, offers interesting insights into his working style. The man who managed the Magellan Fund–the single largest mutual fund, with over $50 billion in assets (that’s about thrice as big as UTI)–says he spoke with the top managements of numerous companies every day and made factory visits several times a year.

Inspired, I called a company I was invested in, but I barely got a minute with the secretary before the phone was banged down on me. As someone who held just 100 shares, I hadn’t a chance of getting through to the management, unlike top fund managers who hold large stakes and have easy access.

The spirit of full disclosure addresses precisely this issue: is it fair that fund managers and those close to the management have better access to information than small shareholders like you and I?

Any attempt to ensure a level playing field must address three issues:

1. relevant information must be easily available to all investors;

2. information that significantly affects a company’s financials (and, in turn, the stock price) should be made public without delay;

3. companies must standardise the accounting information they furnish, so that annual reports of companies can be compared using the same yardstick.

In recent years, the Indian accounting system has done much to ensure fair disclosure. The stipulation that companies must announce quarterly result is a significant step. Other recent moves–the consolidation of accounts and stipulations governing treatment of deferred taxes–should also bridge the disclosure gap. But much more needs to be done.

Access to information. In the US, all companies have mandatorily to file certain information with the SEC (the Securities Exchange Commission, similar to our Sebi) and that information is put out on a government-maintained website. Anyone who wants to check the latest quarterly financials or the annual report or whatever merely has to log on to www.sec.gov or www.freeedgar.com.

Moves are afoot to get rid of inequities that exist at other levels too. There are times when companies meet analysts or large investors in private and give them market-impacting information. And even if you’re unable to attend an annual general meeting of a company–simply because it’s being held in another town–your rights as a shareholder are eroded.

But it is now mandatory for US companies to give out such information only in public forums and to make details of such conferences available on the Net. Increasingly, companies are hosting such conference calls on their websites: to listen to Bill Gates discuss his company’s prospects and future IT trends, check out  www.microsoft.com/msft/speech/archiveanalystmtg2001.htm). For smaller companies that can’t afford to do this on their own, sites like www.companyboardroom.com offer a platform.

Indian companies that have gone in for ADRs routinely disseminate such information. Wipro puts out a soundcast and the complete text of the conference call on its website (http://www.wipro.com/investors/whatshot.htm). In a few years, you can expect to log on to, say, the HDFC website and listen to Deepak Parekh discuss the company’s performance and future prospects.

Relevant information. If you’ve contacts in a company’s top management or even in the finance department, you could be privy to financial results before they’re made public. Often, you’ll see large price movements, backed by large volumes, about 2-3 days prior to the announcement of results.

In many markets, it is mandatory for companies to make public any information that may impact on its fundamentals, as soon as the company is aware of it. Auto companies in India disclose unit volume numbers every month. A retail company in the US (www.dollargeneral.com) gives out weekly sales data.

Of course, deciding what is material information and what isn’t is a bit tricky. For starters, it would help to make it mandatory for a company to disclose an insider’s intent to sell or purchase shares of that company. If I notice the top management investing a large portion of their wealth in their company, I would be reassured.

Standardised information. Additionally, companies’ annual reports should carry the following information, which would conform to prevailing US standards:

‘Segmental data’ of sales, operating profits and assets employed in the different segments, particularly in diversified companies.

If a single customer accounts for more than 10 per cent of a company’s sales, it is important that investors are aware of the risks involved.

Many good companies provide financial history (summary of balance sheet and profit and loss accounts) relating to the previous five or 10 years. This provides a long-term perspective to one’s investments. Making this provision mandatory would be in the shareholders’ interests.

Globalisation is all very well, but there are some fundamental differences between the Indian market and the developed world.

THE PAST couple of years have seen a very strange change in the behaviour of equity investors in the country. Many professional stock market analysts spend their nights avidly watching TV, following each move in the US markets. In the morning, hour before the stock markets opens, it is not uncommon to hear conversations on how the Nasdaq or Dow has performed the previous day. Trades in India are accordingly put through. This is strange.

Agreed, the technology boom and the increasing exposure of the Indian markets to globalisation could lead to a degree of correlation with the international markets. Short-term money flows are often influenced by markets elsewhere, so it’s certainly important to follow global events.

Having said that, it’s important to understand that there are some fundamental differences between the Indian market and the US. I believe there are three reasons why you should refrain from basing your investment decisions solely on what happens in the US market.

India posed for a boom
The US market is now coming out of one of its longest periods of economic boom (along with a corresponding stock market boom). The boom technically lasted almost 20 years. In the 10 years between 1985 and 1995, the S&P 500′s average PER (price:earnings ratio) stayed between 16 and 17–and shot up to 28 in 2000 (it’s currently around 23-24).

Conventional wisdom has it that such a long bull phase would be followed by a reasonable period of correction. The average S&P 500 earnings are expected to fall from about $50 to about $40 this year. Chances are that we could see the market correct another 30 per cent before the US market stabilises-leave alone a bear phase.

In contrast, the Indian economy has seen relatively slow growth over the past decade, and the market has stayed almost flat. The market’s PER is currently around 12, down from a high of over 25. Chances are that we should see a correction upwards. Especially, with a fall in interest rates, the market’s average multiples should rise-so, the market should do better over the next decade.

Falling interest rates
Over the past two decades, US interest rates have fallen from over 12 per cent to the current 4.5 per cent. The US economic boom in the 1940s was led by widespread road construction. The recent economic expansion was led by housing (the US currently has 120 million houses for a population of 260 million).

This correlation between low interest rates and growing economic activity is a well-proven fact. Take the Mumbai-Pune expressway project, for instance. At an interest rate of 13 per cent, the project would require a daily traffic of 60,000 vehicles. If interest rates fall to 5 per cent, the project’s financing becomes so cheap that it needs just 25,000 vehicles a
day to be viable. India is on the right path for an economic boom, as interest rates are falling from abnormally high levels. That will make a huge number of pending projects viable.

Falling interest rates will also spur a growth in housing. The EMI (equated monthly instalment) per Rs 1 lakh (for a 15-year loan) has fallen to the current Rs 1,200, from Rs 1,500 a couple of years back. Very soon, housing loans will become so cheap that funding your own house through a loan would seem a smarter option that living in a rented house.

Let me illustrate. The rent on a Rs 10-lakh house would be around Rs 5,500 or thereabouts. If you were to buy that same house with your savings (say, Rs 2 lakh) and a Rs 8 lakh loan, your EMI would work out to Rs 9,000. You would also get a tax benefit to the extent of Rs 2,000, in effect dropping your monthly cost to Rs 7,000. Many would rather buy their own house at Rs 7,000 per month rather than pay someone a rent of Rs 5,500. Imagine the housing boom that could happen in such a situation.

The US market has already been there, done that. That market is not about to see such a boom anytime soon.

Market width
Many analysts can’t stop touting the market’s depth. With 6,000 listed stocks, they say, the Indian market’s depth is far better than that of many other developing markets. On the other hand, the market lacks representation by industries that account for a vast chunk of the GDP. End-user food sales, for instance, add up to over Rs 300,000 crore every year, but the food sector’s representation in the stock market is marginal.

Retail, apparel and insurance are some other sectors that are well-represented in the stock markets of developed economies, but lack such a presence on Indian bourses. (I especially like retail because that sector accounts for five out of the top 10 performing US stocks over the past 20 years.) Then there’s telecom (there is a cellular phone boom going on and there is no way of getting a stock market exposure!). These areas have a huge market capitalisation across the world, but they are sadly missing in Indian bourses. This will change, sooner or later.

Rough estimates of the enormity of many sectors are staggering. It does look like India is poised to perform a lot better than many international markets. Blindly following the West is one sure way to miss the new boom.

You can make exceptional returns over a time-frame of three to five years by investing in companies that are increasing market share within their industry.

RECENTLY, A friend of mine, who is a portfolio manager by profession, posed an interesting problem to me. He had this new client, who wanted investment advice on his portfolio. Infosys alone accounted for 85 per cent of the client’s portfolio, while 12 per cent of it was invested in Hindustan Lever. Over 30 stocks made up the balance 3 per cent. Apparently, the client had bought Infosys and Lever at the time of their respective IPOs (initial public offerings), and simply held on to them. His investment in Infosys had appreciated 2,000 times. Now, he wanted to know what to do with his portfolio?

My friendly advice to my friend was to give his money to his client to manage. The client seemed to have taken a smarter decision than any portfolio manager I have seen: he placed most of his chips on one potentially good stock, and patiently watched it appreciate steadily over a period of time.

Sounds simple: invest Rs 10,000 in one stock, and see it go through the roof over the next decade.

Infosys might be an extreme example. Still, fact remains, the stock market does throw up such opportunities time and again. Lever, Hero Honda, Punjab Tractors, Castrol, Wipro, Zee are some illustrious names that have given phenomenal returns over the past decade. Such outperformers exist in every market, even mature ones like the US. There, stocks like Dell, EMC, Wal-Mart, Home Depot have also done extremely well over the past decade or so.

So, just what is common to all these stocks? How does one identify such stocks? Well, here are some pointers:

The company should be gaining market share. Probably, the first important sign of an excellent performer is that the company constantly proves its ability to increase market share. So, when the industry in which it operates is growing at around, say, 10 per cent, our company grows at over 25 per cent. As a rule of thumb, look for companies that beat their average industry growth by at least 10-20 percentage points.

This happened with two-wheeler major Hero Honda. Around a decade ago, it had a market share of less than 10 per cent — in other words, potentially, it had plenty of opportunity to grow. And it did. For many years, it consistently grew at an annual rate of over 25 per cent. Today, its market share is close to 50 per cent, and its becoming more difficult for it to add incremental market share. And though it still throws up growth rates in excess of 40 per cent in a market growing at less than 15 per cent, I can’t see the company sustaining this above-par performance.

Stocks of companies on the fast path in the market share sweepstakes exhibit some standard patterns. The best time to buy such stocks is when the company’s market share is in the region of 1-4 per cent. During this phase, the company would have shown sufficient proof of its ability to grow at a pace faster than the industry. In other words, you are making more than an informed guess. At the same time, the valuation given by the market to the stock would be reasonable – so, the appreciation potential is immense.

Stress starts to develop in a stock when the company’s market share nears the 20 per cent (in some industries, 35 per cent) level. Castrol and Punjab Tractors were excellent performers, with steady growth, till about the time they hit a market share of about 20 per cent. That’s when the stock started to peter out. Globally too, high-growth companies have shown similar trends. EMC, for instance, started moving down when its market share approached 35 per cent.

As a corollary, any company whose market share is in excess of 50 per cent will face serious resistance. It happened to Colgate over the past decade. The company lost market share, from being in excess of 65 per cent to below 50 per cent. It’s difficult for companies to sustain market share well over this threshold level in a free market, as competition eventually tends to find ways to breach your defences (unless they are a utility or a monopoly).

The company should operate in a reasonably fragmented market. A fragmented market makes it easier for a company to increase market share. Ideally, the combined market share of the top five players should not exceed 60 per cent. Such industries enable a company to increase market share without seriously affecting industry dynamics.

This happened to PC (personal computers) manufacturer Dell in the US. The company has increased its market share from below 3 per cent a decade ago to around 15 per cent today in the PC industry (an extremely fragmented industry). However, don’t expect serious changes in market share in an industry like oil refining in India, which is dominated by essentially three players.

The market for the company’s product(s) should be growing at a decent clip. Besides being fragmented, the market itself should be growing at a reasonable pace. Multi-baggers abound when the underlying market itself is growing at an extraordinary pace. Like Nokia in mobile telephony devices. The company has gained market share steadily over the past decade, to around 35 per cent today – the stock’s performance too has been exceptional. At the same time, the market for mobile devices has grown at a brisk pace, much better than the average growth rates in most other industries.

The ability to log above-industry average growth is one of the reasons I like Infosys. The company has consistently grown at a pace faster than the average industry rate. Its share in the Indian IT industry is less than 8 per cent. The IT industry is still growing at a healthy rate. Given the above hypothesis, Infosys still has a few years of above-average growth to show before stress starts developing.

Single-product companies offer high returns, but keep a look out for multi product companies. When it comes to growth, single-product companies and multi-product companies have different risk-reward equations. A fast-growing single-product company will give better stock performance, as it is not weighed down by slow-growth products. But the risk associated with it is higher, as everything depends on that one single product.

For lower risk, look at multi-product companies that have many sub-product categories gaining market share.

Take Lever. Over the past decade, it has held on to its dominant position in the soap segment, while increasing market share at a dramatic pace in various other product categories like shampoo, toothpaste and other personal product niches. It is also trying to replicate the same magic in the foods segment in the coming years.

The company should be available at a reasonable valuation. I have high regard for a pure value-driven approach to investing. One major problem with this approach (of buying companies very cheap), though, is that many of the exceptional-performing stocks over long periods of time will be missed, for chances are you will never really get them at rock-bottom prices attractive to value investors. Home Depot is one such example. It has increased its market share from scratch to about 15 per cent in the past 15 years. At no point during this time has the stock been available at a PE (price-to-earnings) ratio of less than 22 – valuation levels that just don’t entice value investors.

The best measure to buy into these companies is the PEG (PE to projected earnings growth) ratio. To explain, if a company is growing at 25 per cent and you get it at a PE of 25, then its PEG ratio is 1. A PEG ratio of less than 0.7 is ideal to buy into growing companies – in other words, a company whose earnings are growing at 20 per cent a year can be bought at a PE of less than 14. So, assuming Infosys can grow at over 30 per cent a year, the best price to buy it would be at a PE of around 22.

Get into the practice of finding out market shares. As an equity investor, it is probably most important to get into the habit of finding out the total addressable market opportunity. Even a rough estimate should help you go a long way, and save you from making major errors. It helps to find out whether the industry is at a nascent stage, or whether most of the growth opportunity is over?

So long as you stick with companies that are increasing market share within their respective industries, chances of you making exceptional returns over a time-frame of three to five years are high.

Companies that tweak their products to suit regional tastes are likely to do far better than those that rest on their existing portfolios.

PROBABLY THE single biggest change in corporate circles over the past decade has been the shift in focus from ‘globalisation’ of products to ‘regionalisation’ of products.

You may recall what happened in that seemingly long-ago time (but actually only a decade ago) when Coca-Cola bought out Thums Up in India. The purpose of Coca-Cola’s purchase was purely to use Thums Up’s distribution network for its own use–something that seemed to be common sense at that point in time. It completely stopped promoting Thums Up and tried to push Coke. But over the next few years, Coca-Cola found that this was one time when the phoren label wasn’t going to win hands down and that Indian customers actually wanted Thums Up back. In the interest of profits, Coke was forced to focus on Thums Up. Which is why we see today Salman Khan hopping from town to town in those whirlybirds and asking giggly teenagers to “grow up to Thums Up”. And which is why Thums Up is the No. 2 brand in its category. If Coke had promoted Thums Up in those initial years, the chances of Pepsi being No. 1 might have been remote. (By the
way, India is the only large market where Pepsi is larger than Coke.)

A similar story happened with P&G and Godrej. Godrej was drawn into thinking P&G would lead its products, but unfortunately, most of its brands, except perhaps for Cinthol, were completely killed. P&G, in the meantime, decided to wash its hands of soaps in India. Its leading brands today, like Vicks, are all home-grown products, so to speak. If only it had supported the Godrej brands, P&G would today have been a strong contender in the soaps market.

This story is not restricted to brands. When MTV was launched, it had a staple diet of English songs–and about 300 visuals a minute for those with short attention spans. But then it found that its viewer ratings were simply not picking up. Now, that self-same channel actively supports the rapidly growing Indi-pop industry. The same has happened with the automobiles market, where almost every contender has been forced to introduce vehicles that are better suited to weather the rough Indian terrain.

The point I am trying to make is that corporate success depends upon how well companies manage to deliver what the customer wants rather than thrust down their throats what they don’t need.

The debate is probably most intense in the packaged food industry. Britannia is actively trying to convince customers that cheese is good for them; but most Indians consume milk in the form of paneer, milk and curd. In Switzerland, however, cheese is almost a staple. The Indian cheese market is less than Rs 200 crore, while the milk market is probably about Rs 30,000 crore.

I assume that companies such as Amul and Nestle will enjoy better growth opportunities from packaged milk and curd than by trying to convince people to eat cheese. In fact, it looks like Hindustan Lever has read the writing on the wall and plans to enter the paneer segment. Another example from the food sector: the market for packaged atta is growing at a rapid pace–and is supposedly much larger than the market for sauces.

The readymade garments industry is also facing a similar dilemma. While men’s wear (the Louie Philippe variety) is doing well, the women’s wear segment is struggling. The problem seems to lie in the fact that the vast majority of Indian women prefer the salwar kameez to Western outfits.

The bottomline is that over the last decade, companies have found to their cost that Indian consumers do not accept just about any product that has worked abroad. The products need to be fined-tuned to suit Indian conditions and tastes. This trend is most likely to intensify over the next decade and those companies that fine-tune their products to the Indian palate are bound to do well–and become great investment opportunities.

Personally, I’m looking forward to a time when the regionalisation of products makes available a range of interesting products–and I’m not talking here merely of investment avenues. The bowling alleys that you see all over our metro landscape don’t fascinate me one bit. What I would like to see are batting alleys: I’d love to be able to face a computer-simulated Glenn McGrath special delivery and see if I can score a boundary off him. Yes, I’d love that!

HAVING TAKEN up investing as a career, I often meet great investors so that I may pick up some nuggets of wisdom to make me a better investor. Why reinvent the wheel?

I met one such investing guru some five years ago. You could call him an investor or a market operator, and you would get a big yes from numerous individuals from two completely different quarters. When I finally managed to meet him, I asked him the standard question, ‘How do you choose companies to invest?’. Which I presume is reasonable – after all, the biggest part of investing is choosing the right companies to buy. His answer surprised me: “The company should be paying taxes’. I have to admit I was a bit disappointed, a bit like the guy who climbs the Himalayas to ask a rishi the secret of happiness, only to hear something like ‘Sleep well’. (I was later told that this investor was one of the highest individual taxpayers in India.)

The best performers pay taxes…As with all great truths, it was only later that this one’s import sunk in. Some of the best investments of the past decade — Hindustan Lever, Hero Honda, Castrol — all pay taxes at higher rates than their respective sector’s average. Look at lists of the best-performing stocks over any 5-year period, and you will find them packed with companies that have a high tax outgo. (Infosys and Wipro are of course exceptions to the rule, as their export incomes do not attract tax — but that advantage is to go away over the next five years.)This criterion for great stock picks is quite simple in essence: as long as a company is paying taxes, you can be certain it is making profits. (Though there are exceptions — we have all heard of companies that doctor their numbers to show profits on their books, usually just before they want to raise money through public issues. With all due regards to auditors, this seems common.)

…skimping on taxes hits valuations

One corollary of that principle is that relative valuations of companies are directly proportional to their tax outgo. For instance, take the PER (price to earnings ratio), a simple and at the same time a reasonably good measure of valuation. One qualification: the PER criterion is useful only when a company is operating at its optimal level of profitability. The best way to ascertain this is to check if the return on equity (RoE) is consistent with its historic levels.

As a general rule, companies paying high taxes consistently get high valuations on the bourses. On the other hand, companies that have a low rate of taxation get a low PER. Take Zodiac Clothing – the stock has a great record of RoE and profit growth, but its tax outgo has always been below 6 per cent of pre-tax profits. Investor are evidently rather  skeptical of such companies; why else is the company’s PER stuck between 4 and 6?

The right PERStock prices are a reflection of the market’s perception of their companies’ earning potential. Many companies can at times delay paying taxes by either setting up new capacities or making use of tax sops. But ultimately, taxes are inevitable. Moreover, companies that pay taxes seem to command similar valuations to companies that make higher profits but pay no taxes. Some examples of such companies are Marico, Dabur and Nirma, which pay taxes of less than 20 per cent of pre-tax profits, despite being consumer product companies. Their MNC counterparts (such as Colgate and HLL), on the other hand, pay considerably higher taxes.

This may well be a result of some smart tax-planning, but the market does not seem impressed – take a look at their valuations. Evidently, the markets value them on a peer-to-peer basis at the pre-tax levels. Still not convinced? Check out the tax rates of the dogs in your portfolio.