We have witnessed a black swan event. We need to wait out the storm. We will not panic and sell unless we believe the fundamental 3-5 year prospects of a company have been significantly challenged. Selling now – just because there is short term uncertainty – will crystallize a temporary loss and make it permanent.
More than anything else, all of us need to control the weather in our heads. During present conditions, negativity pervades and time horizons shorten. We need to remind ourselves that we are playing the long game and things will normalize over time.
We need to be careful about how we interpret information. A lot of it at present is noise. For example, there have been newspaper articles citing declining Liquor sales in March and that sales of poultry have also declined due to the fear around Corona.
Companies are valued by discounting future cash flows. 1 Yr cash flow affects less than 10% of a company’s fair price. The true value resides in its terminal value. So even if a company experiences short term disruption; there is no reason to dump the stock if we believe in their growth prospects and competitive positions.
Partners are aware that we hold HDFC Bank in high regard. There are concerns on HDFC Bank’s succession issue and unsecured consumer loan exposures. The future is indeterminate, and there will always be a certain probability that HDFC Bank has lost its mojo. And there is no doubt the succession issue could have been better managed. But consider the following arguments if one is willing to look beyond short term uncertainty.
a) Good institutions are process-driven. While a single leader can destroy a Bank, it takes more than one leader to create a great one. There were similar concerns on leadership at Apple after Steve Jobs died but one can only be amazed at what Apple has delivered under Tim Cook
b) Banks are leveraged. So a slowing economy will impact them through rise in NPAs. However, well run Banks are also gaining market share from weaker competitors and enhancing their competitive positions. Market share of deposits of HDFC Bank, ICICI Bank and Axis Bank has risen to ~35% of incremental deposits from ~ 15% of incremental deposits in the last 3 years. Our hypothesis is that this number will further increase (please refer to our earlier blog)
c) Is the uncertainty in HDFC Bank not already being reflected in the valuation which is 2 Std. Dev below mean?
What matters is to the long term investor is
a) Not the short term earnings profile of a company but its long term competitive position (bulk of value resides in terminal value).
b) What expectations of long term earnings/cash growth that stock prices are reflecting
This is the time to act and deploy more Capital – traditional wisdom is to “buy when there is blood on the street”. But we would recommend this only if you will not be impacted by volatility and more markdowns in portfolios as no one can call the bottom or when sentiment will turn.