India has many attractive features for the long-term investor, says Templeton
Lauren Templeton, founder & president, Templeton and Phillips Capital Management
With growth taking precedence over profit and new-age companies becoming the new poster boys of the stock markets, value investing has taken a back seat. Lauren Templeton, founder & president, Templeton and Phillips Capital Management, explains why the strategy can’t be written off. In an interview with Samie Modak, the great-grandniece of Sir John Templeton, pioneer of global value investing, shares her investment philosophy. She spoke to Business Standard during CFA Society India’s 12th India Investment Conference.
Edited excerpts:
Value investing is said to be going out of fashion, especially amid the liquidity gush caused by the stimulus measures. What is your take on it?
Value investing is inherently disciplined, and when monetary and more recently even fiscal stimulus overwhelm the financial system with liquidity, the surplus capital eventually finds its way into speculations that may generate large returns for the early buyers, yet always prove unsustainable and end in disaster. Value investors are motivated by discrepancies between fundamentals and their representation in current share prices, and in the case of speculative assets, value investors are conditioned to actively avoid situations where fundamentals (if there are any) are wildly over-represented in the asset/share price. Conversely, for those value investors willing to take a more aggressive stance, they could instead sell short in order to capitalise on wild or speculative mispricing. Sir John Templeton famously did this during the crash of the dot-com bubble in 2000. It is also important to recognise that value investing can take many forms and just because a low P/E strategy may not be working, it does not mean that a low-free-cash-yield perspective is not working. It is important to not conflate value investing with a few specific ratios.
What’s your view on the philosophy of growth at any cost?
That strikes me as a dangerous philosophy. There are some speculative buyers who may demonstrate skill in that practice but in my view, it is reckless to wilfully overpay for a stock in the hope it will continue to get bid higher. Looking at the situation today, even following the large corrections in tech stocks during the past few months, we still count approximately 670 stocks in the US market trading at a price-to-sales ratio greater than 20x. This implies that if these firms were able to remove all expenses and dividend 100 per cent of their sales without income taxes to the shareholder, the payback period is still twenty years. Similarly, there are great historical examples providing evidence against overpaying for growth. Consider Microsoft in 1998. Trading at 21.9x sales in 1998, it actually continued growing for the next two decades. Investors paying 21.9x sales in 1998 had to wait 17 years to generate a positive return on their shares.
How difficult is it to find the right stocks at the right prices at a time when valuations seem stretched across the board?
It is not too difficult if you are careful. It is important though to avoid what has been popular since the beginning of the pandemic — where valuations have become too stretched. It is important to remember that recovery from the pandemic has been very uneven, and remains largely incomplete.
What is the key to alpha generation?
The key to alpha generation is to avoid the consensus when it makes sense to do so. Sir John always said: “If you buy the same stocks as the crowd, you will get the same results. If you want to have better results than the crowd, you must do things differently from the crowd.” More often than not, this comes down to a long-term perspective and willingness to look for bargains where near-term share prices are too pessimistic. This is one of the reasons we tend to confine our purchases to panics, corrections, and bear markets. We have always found that our best returns come from these circumstances, and buying at exceptionally low prices can even cover your mistakes.
What are the key learnings from your great grand-uncle’s investment philosophy?
There were many important lessons but two that stuck out were his enthusiasm to locate bargains in places few people dared to follow and his constant search for new selection methods. You could probably distil behaviour into an endless curiosity and the intellectual humility to pursue answers. He was constantly learning and growing. He had a growth mindset. Since the markets are constantly evolving and becoming more sophisticated, it is important to be a lifelong learner.
Do you think the approach of Sir Templeton can be applied in the current environment?
Absolutely. It is important to note that his perspective on value adapted with the markets. When you look at his large investment in the US at the bottom of the bear market in the early 1980s, he was applying a discount to replacement value approach that gauged the effects of runaway inflation. When I worked for him, we were focused on P/E to growth metrics; P/Es were calculated on a 10-year earnings projection. He wanted to pay 2x or less for earnings 10 years in the future. He was very adept at finding the flaw in the consensus and then developing and applying the analytical tools to exploit it.
Would you be an investor in the US tech space? Do you think the tech biggies still have a long runway for growth?
We first bought shares in Google (Alphabet) in late 2014 and into 2015 when it sold off due to growth fears. At the time, the market thought that its growth was slowing and under threat from advertising at Facebook, which was growing rapidly. Likewise, the market thought Google’s margins were declining due to these competitive pressures, but in actuality, its margins were depressed due to its heavy investments at the time into YouTube, etc. and many other companies. The shares actually traded down to approximately 9x EV/EBITDA at the time, which was less than the S&P 500 multiple and in the bottom quartile of the market. We modelled significant upside in a DCF and bought the shares.
We have continued to hold the shares since then, but it is not as large of a position today, due somewhat to your question surrounding future growth. We still like the business very much, but its market cap of $1.8 trillion is in line with South Korea’s GDP, the tenth largest in the world. To double again would make it more valuable than the GDP of the UK (fifth largest economy). At some point these large numbers create obstacles to rapid growth, and it is reasonable to expect its growth to be slower in the future.
What is your view on investing in new-age companies or companies with no visible profitability track record?
We do not invest in firms with these profiles, but we do occasionally sell-short, and during that research we encounter these types of businesses and try to learn why they have become too popular in the markets. Sometimes we realize that under completely different pricing, they could be interesting investments. We are cognizant that many stocks could become bargains under the right conditions.
It should not be lost on anyone that Amazon fell over 94% during the dotcom bust and was obviously a great bargain trading at $5.97 per share in September 2001. So, while an investment in recently started businesses or loss-making businesses is highly unlikely (unless it is a cyclical firm experiencing a downturn), we recognize the importance of keeping an open mind and trying to understand the other side of the market. However, the one investment scenario we tend to avoid in nearly all circumstances are what we call binary outcomes. We do not want to invest in the hit or miss scenarios you might find in biotech stocks, etc.
You are an independent director of Fairfax Financial Holdings, which has made significant investments commitments to India? Are you bullish on India? Why?
Yes, I am bullish on India. India has many attractive features for the long-term investor; it combines: A low per capita income, a young population, and a heavier presence of high margin, asset-light firms in the technology sector. For example, India’s per capita income is $6,390 compared with China’s at $17,200. When countries experience economic growth from a low base, the creation of wealth among its citizens is transformative to the economy (much like China’s 20 years ago). We believe technology will continue to be a source of economic growth and productivity in the years to come, and the country has a strong foundation in this sector.
Which are the broader investment themes in India that you’d like to tap?
Consumer-driven themes and the development of the Indian consumer on a per capita basis over time provide a compelling long-term growth story. Banking and financial services are an obvious sector. Additionally, the capital markets should have decades of growth potential as increased wealth leads to new demand for financial services through savings and investments.
What are the key risks when it comes to India investing?
To generate excess returns versus the index, you need to invest in smaller, under-researched firms, and this presents governance risk to investors without local research and boots on the ground. The opportunities are large but so are the risks. While there are certainly managers doing this level of due diligence, many institutional investors are going to opt for the large, listed names and so part of the risk is that many investors will underperform the index since they resemble it but also charge fees.
What are your views on investing in China?
The changing regulatory environment in China has rattled many Western investors following their painful losses in the education listed stocks, de-listings, etc. However, we believe it would be a mistake to close the door to investing in China. The country still presents great opportunities for growth and it will be an economic force for years to come. We were invested in Alibaba following the crash from its IPO in 2015 until mid-2020, when we became unsure of the politics and sold. Alibaba’s shares, and several other Chinese tech shares are thoroughly unpopular today. We have not purchased any, but they have our attention as bargain hunters.
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