We have written about the ongoing catharsis in the Indian equity markets earlier and about the divergent trends that are being displayed in stock price movements. There has been recent commentary also about the valuations of quality businesses with their P/E ratios being “high”. We will not go into the debate about the merits of this “high P/E” argument but suffice to say that the debate in or view needs to be more nuanced.
While a large part of the focus of the broader investment community continues to be on the quantitative aspects of a business with analysts extrapolating trends both on the down side and the upside, it is our view that for investors with a longer horizon, the qualitative aspects need to be weighed very carefully as well to arrive at a meaningful analysis of a business. In recent times while the focus on governance and transparency as qualitative aspects has come to the fore (rightly so), it is our view that there are some common features that distinguish a great business and these are displayed if one were to take a closer and deeper look:
The transition from a founder driven business to a professionally driven one
Some of the best businesses in India (in our view) have been able to make the seamless transition from being “promoter” driven to professionally run by bringing in outside talent to run and grow the business over time. While in a lot of cases either the founder or the founding family continue to provide strategic direction and vision, the day to day operations are run by professionals who, when provided with the right environment, have been able to scale these businesses very efficiently and meaningfully.
Relevance to customers
Many companies very often speak about “innovation” in their annual reports and commentaries. To our mind, the most simple definition of innovation is perhaps “being relevant”. Over time, businesses which can adapt and continue to remain relevant to their customers will continue to reap the benefits of longevity. It is not a surprise therefore that we find listed business in India which have been in existence for a hundred years or more!
The ability to widen their competitive advantages over time
A business is also gauged by the edge which it has or develops over time. These could be in the nature of brands, distribution or in recent times- technology. Some of these business have very efficiently and very strategically recognised these advantages and have dedicated significant resources and management band-width to deepen and widen these moats.
Strong value framework
While heretofore, strong ethical foundations and a commitment to behave responsibly towards all stakeholders were common features, more recently, the focus on sustainability and the role of businesses in the context of the larger societies that they operate in have started to take root very strongly indeed. A look at the annual reports of some of the leading businesses in India will provide a mirror into how this trend in evolving. The recent experience in the US where the top 200 CEO’s that make up the “Business Roundtable” (with Jamie Dimon as Chairman) changed the definition of “the purpose of an organisation” is a pointer towards this new trend.
The equity markets will continue to gyrate in the short term driven as much by sentiment as by the focus on near term quantitative factors such as growth, margins and P/E multiples. However, in our view, long term compounding returns are what matter and these returns are provided by great businesses which have one or more of the attributes highlighted above. The focus therefore on “High P/E’s” in isolation ends up ignoring the qualities that go into building a great business which can navigate through trying times and end up delivering long term compounding returns for shareholders.
This article first appeared on www.moneycontrol.com and can be read here
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