The Buffett of Bombay

There has been a great deal of hype surrounding India recently – some good, some bad. But as the saying goes, "Value without growth isn’t value." We sent our small-cap sleuth, James Boric, to Mumbai to get the real story.

Amid the squalor in Mumbai lies a golden gem. And for the uninitiated small-cap investor stateside, it is – quite possibly – a buried treasure. I have to say that meeting Mr. Bharat Shah, CEO and Managing Partner at ASK Raymond James, here in Bombay, was the highlight of my trip to India. The "Buffett of Bombay," Mr. Shah makes his living by scouring the market for true value stocks – companies with both a margin of safety and a growing business model. He has a history of being right. From the interior of Mr. Shah’s office, even a brain surgeon could tell that Mr. Shah was a very successful investor.

Before he became the CEO of ASK Raymond James, Mr. Shah managed $1.2 billion in assets. And at ASK R.J., he manages nearly $50 million or – as they say here in India – Rs. 250 crore.

There is no doubt that this man knows what he is doing. And he knows how to spot value in the market. With that in mind, my first question was:

"Do you think the Indian market is overvalued, undervalued or properly priced?"

Bharat Shah: Slightly Undervalued

He told me that, as a whole, he felt the Indian market was slightly undervalued – not much, mind you. But with stocks trading for around 11-times earnings, Indian businesses certainly aren’t expensive.

Mr. Shah isn’t concerned with the price of a company. He determines value by looking at how well a company manages its capital, how well the managers run the business and how the company is valued based on EBITDA and cash flow.

"Look at technology services, business services, pharma and specialty manufacturing industries," says Shah, "These are the areas that will continue to grow as the Indian economy gets stronger. And as more and more government money is spent on improving India’s infrastructure, investors should keep an eye on the telecom and construction sectors, as well as the auto business."

The government is spending money like a drunken sailor – roads, ports, railways and social infrastructure (education, health care and drinking water)…you name it, the government is involved. A one-rupee tax was recently added onto every liter of gasoline sold at the pump – which will be used to build new roads. India is remarkably underdeveloped and every road built here will be a huge help. Not only will it encourage more business (by supplying construction jobs and allowing people to travel further to find work), it will also help transport food to the poorer regions of the country where food is currently in short supply.

Bharat Shah: Opening up the Retail Sector

Despite a spate of privatization, the retail sector remains one of the last government-run sectors in India. But look for the new government to open up the sector to both foreign and domestic competition in the next few years. When it does, goods will get cheaper. More jobs will be created (although mom and pop shops will likely suffer) and consumer spending will skyrocket. Right now, India’s savings rate is north of 20% and there are over $150 billion sitting in domestic bank accounts.

With the opening of the retail sector, that money will be tapped – sparking a chain reaction in the Indian economy. But before the retail sector is opened up, something has to be done about the enormous taxation the government levies on retail goods. Open any newspaper, and you’ll read about the value-added-tax on goods. The idea is to lower taxes. This, the thinking goes, should encourage Indian consumers to be more like American consumers in their buying habits, but with one huge difference – there doesn’t appear to be a credit bubble here in India because, at the moment, the only lenders are the banks. Indians, themselves, are net savers.

There’s something in the air, here in Mumbai, and it’s not just the sweet smell of curry. Indians are optimistic. "They know they sit on the cusp of becoming a developed nation. They’ve simply come too far to slip backwards again," said Mr. Shah.

Bharat Shah: Indian Small-Caps

This was great. But what the Buffett of Bombay said next brought a smile to your faithful editor’s face.

"If you really want to find value in India right now," Mr. Shah told me, "you shouldn’t look to the large blue chip companies – those trading on the Sensex and Nifty (the equivalent of the Dow and the S&P in the States). Rather, the real gems are hiding in the mid and small-cap markets."

There are many smaller Indian companies with cash, growing businesses and competent managers, which are flying under the radar screen. These are the companies you should be looking at.

Eureka! These are the same companies that I have dedicated my career to.

Mr. Shah had confirmed the very reason I boarded the plane for Mumbai in the first place…small-cap Indian stocks provide investors with the best chance to get both value and growth in this market. And then he made a point that really resonated with me…

"Value without growth isn’t value."

That seems so obvious in retrospect. But it is a lesson lost on most investors in America. If a company isn’t growing its business, it isn’t worth owning. It made me think…

Had investors followed this kind of logic in the 90s, no one would have lost a dime in the dot-com blowout.

What a trip.


James Boric
for the Daily Reckoning
June 22, 2004

Editor’s note: When James departed to India, he only had two small telecom stocks in mind. But having been to Mumbai, and having seen India’s promise with his own eyes, he thinks that these two telecom stocks are the only two stocks you need to own for the next 15 years. They are the crème de la crème de la crème.

Qui solvo?

Thus, at last night’s MoneyWeek Roundtable, were the great issues facing investors and economists in the year 2004 reduced to a single two-word question. Who pays? We put it into bad Latin to make it seem even more important. Timeless, even.

One way or another, all debts are settled…reckoned with…either the debtor pays, or the creditor does. Today, Americans owe more money to more people than any race ever did. Mr. Greenspan made credit exceptionally cheap and easy. This EZ money caused a boom in stocks…then a bubble in stocks. When the bubble began to lose air, the Fed chairman pumped even harder…causing new bubbles in mortgage debt, and housing. So impressed were homeowners with the ‘pseudo-wealth’ they had gained in their inflated houses, they rushed to spend the money – causing yet more bubbles in imports (record breaking trade deficits)…and Chinese capital spending (trying to keep up with orders from Wal-Mart.)

The debts have grown so big that the borrowers will not be able to pay them back. "Orderly deleveraging is now impossible," writes Kurt Richebächer. Most homebuyers, for example, have no intention of ever paying off their mortgages. Nor does the Federal government ever intend to pay off its debt.

Of course, as long as nothing happens, debtors will be able to continue servicing their loans forever. Nothing is fine for the lumpen. But the smart money knows that nothing won’t happen forever. Even failing to borrow more would be something. Today’s consumer spending requires more and more borrowing. And yet, the more they borrow, the harder it is for the debtors to keep up with the interest payments.

How, then, will all this debt be settled? Will it be inflated away? Or deflated by defaults and bankruptcies?

"The whole inflation/deflation discussion," began James Ferguson, "asks the wrong question. Will we have inflation or deflation? The answer is yes. We will have both of them. Because the real balance in an economic system is not between rising prices and falling ones…it’s between stable prices and unstable ones. When an economic system is healthy, prices move up and down…but in a state of balance. When the system becomes unbalanced – which is especially the case in America now – prices can runaway in either direction and usually both.

"What you might expect is an interest rate shock – which is what it looks like we’re getting in Britain…rising rates that pop the real estate bubble. Then, consumers stop borrowing against the rising value of their property. They stop spending so much. And all of a sudden, you have not an inflationary environment, but a Japan-like deflationary one."

Look out for "savage deflation for the asset markets," writes Kurt Richebacher, "but stagflation for the economy. It is so obvious that no one can see it."

In a stable, healthy economy debtors pay their debts. In an unstable one, it is the creditor who bears the loss. Either the debtor pays him back in inflated currency…or he goes bust and can’t pay.

Be not a long-term lender at today’s rates, dear reader; it is likely to be a losing proposition.

But what about Treasuries? There, you have no risk of default or bankruptcy. The U.S. government will pay you back. Deflation would make them more valuable, not less.

Your only risk is that the money you get back won’t be worth as much as the money you lent.

"That is still a very large risk," said fund manager Arild Eide of RAB Capital. "The U.S. can not allow millions of consumers and homeowners to go broke. It is not politically possible in a social democracy. Besides, [Fed governor Ben] Bernanke has already outlined for us the steps they will take to make sure inflation eases Americans’ debt load."

Okay, let’s get this straight. What to expect, we mean. Rising inflation brings rising interest rates that pop the debt bubbles. Then, the economy slumps…with falling prices for almost everything, especially financial assets. But the authorities can’t stomach the sight of millions of voters trapped by their own recklessness…so they take action. What do they do?

"Whatever they need to do," came the answer from the Roundtable.

We do not doubt the logic. Or the will. What we doubt is the ability. But we will see. We will see.

Here’s Eric with the latest from Wall Street…


Eric Fry, from the City that never sleeps…

– Fortune smiled on very few investors yesterday, as the price of almost everything fell – stocks, crude oil and gold all declined. Only bonds managed to eke out a small gain, which was small solace to long-suffering bond investors.

– Crude oil for July delivery fell $1.12 yesterday to $37.63 a barrel, as Iraq resumed partial exports through one of the two pipelines shut down after last week’s terrorist attack. The gold price followed oil lower, slipping $1.20 to $393.65 an ounce. Long-term interest rates also retreated a bit, as the yield on 10-year Treasury notes fell to 4.68% from 4.71% Friday.

– But despite this trio of good news for stocks, the Dow Jones Industrial Average failed to advance. Repeated rally attempts fell short throughout the day, as the Dow fell 45 points to 10,371 and the Nasdaq slipped 12 to 1,974. Many investors continue to declare their faith in "stocks for the long haul," but few are rushing to buy. On the other hand, the bears don’t seem particularly eager to sell…and so, we dispassionate observers in the media, wait for something – anything – to happen to shake the market from its torpor.

– According to the finest minds on Wall Street, crude oil, gold and interest rates are trespassing – wandering into locales where they do not belong. Crude oil has no right to tip-toe past $40 a barrel, say the experts, and gold has no business whatsoever loitering around $400 an ounce…And the audacity of interest rates!…to encroach so far into forbidden territory that the 10-year Treasury note yields nearly 5%.

– But soon, the experts assure us, the rightful order will be restored and these three troublemakers will be booted back to where they came from. Indeed, say the experts, were it not for the incessant meddling of real-world events, crude oil would sell for $20 a barrel already, gold would be lucky to trade for $300 an ounce and the 10-year Treasury would yield less than 4%.

– Maybe it’s true. Maybe oil, gold and interest rates are trespassing, and maybe their simultaneous ascents are a complete fluke. On the other hand, maybe the experts are mistaken. Perhaps crude oil, gold and interest rates are pursuing a kind of Manifest Destiny, preordained by the easy-money policies of Alan Greenspan and by the spendthrift ways of America, both public and private.

– Maybe the stock market is the financial trespasser…After all, a stock market selling for more than 30 times earnings would seem to have lost its way, especially when the prices of crude oil and gold are rising in harmony with rising interest rates.

– A Google search for the words "terrorism" and "oil" produces a whopping 2,920,000 results. Refining the search to "Islamic terrorism" and "oil" still yields 749,000 results. Who doubts that these words will remain linked for many years to come? When might the sort of normalcy and tranquility return to the Middle East that produces $25 oil? Never, is one possibility.

– We would not be surprised if the next catalyst for dramatic action in the stock market comes from the oil market. We don’t know where the price of crude oil is heading, of course, but we expect the crude oil market to display more pyrotechnics than Manhattan on the Fourth of July…or Paris on the 14th.

– Two weeks ago, the Washington Post reported, "Saudi officials scornfully dismiss the suggestion that terrorism could block the flow of oil. It’s one thing to blow up a housing compound…but quite another to obliterate a facility that pumps, transports or loads oil. The latter, they insist, is virtually impossible. Wrapped in layers of fencing, barbed wire and hydraulic barriers, watched with cameras and night-vision goggles, Aramco’s oil facilities are monitored by more than 5,000 guards."

– A few days later, terrorists knocked out two Iraqi pipelines that "pump, transport [and] load oil." It’s true that Iraq is not Saudi Arabia, but oil is oil. If terrorism can interfere with supplies anywhere on the globe, and do so regularly, the oil market will become as volatile and unpredictable as an ex-wife.

– Curiously, despite the explosive conditions in the oil market, investors value semiconductor stocks nearly three times higher than oil stocks. The semis seem to be levitating on the legacy of rapid earnings growth, while oil shares seem to be laboring under the opposite legacy. But times have changed, and therefore, the valuation disparity between semiconductor shares and oil shares might be seen as a curious and incongruous juxtaposition.

– "With oil prices just a smidge below $40 a barrel," Barron’s notes, "and one ugly international incident away from a new record, you’d think these would be good times to be invested in the big oil companies. But in truth, the benefit to the stocks from higher crude prices has been modest. For the year to date, Exxon Mobile shares have gained about 6%. BP is up 8%; Chevron Texaco, 5%. Not terrible performances, but hardly windfalls given the spike in oil prices. The result is that the big oil shares trade significantly below the multiple on the S&P 500 – 11 times projected 2004 earnings for Chevron Texaco, 14 times for BP, 15 times for Exxon Mobil."

– Barron’s also notes that Saudi Arabia produces about 12% of the world’s oil. "Any disruption in Saudi production could make $40 oil look cheap," says Barron’s. "Put it all together…and the future for the integrated oils looks extremely bright."


Bill Bonner, back in London…

*** Blond-haired, blue-eyed, Arild Eide is from Norway.

"It’s a great place to go for a vacation," he said. "But living there…the whole population numbers less than the city of London…"

"Maybe it’s like Geneva," commented a Swiss friend. "I can spend a day or two there, but it’s so boring…if I stay longer than that, I feel like going into the woods and hanging myself."

*** "It was lovely…" Merryn Somerset Webb described last weekend’s trip to Scandinavia. "We sailed around the islands off the coast of Sweden. There are beautiful houses all along the coast…nestled in the trees on the islands. The food was great. It was a great vacation."

Are they expensive, we wanted to know.

"When you’re from London everything seems cheap," explained James Ferguson. "What we find very difficult to understand is that our point of reference is so far out of the ordinary that it is no help at all. I have friends who bought places in France. They bought one for almost nothing. And then someone gave them another little house for nothing. It’s hard to imagine that houses could be worth less than nothing – I mean, the owner just wanted to get rid of the hassle of owning the place – but they are."

Houses can’t go too high – because people have to be able to afford to live in them. And they can’t go too low either…because people want to live in them. But sometimes, people stop wanting to live in them…and property sinks to below zero in value. That has apparently happened in some areas of France – where little towns have been abandoned. And it happened in Baltimore. Whole blocks were boarded up as the city’s population fell over the last 40 years.

Will people drive away from America’s suburbs one day? Will house prices fall…maybe sinking to less than zero?

Yes, dear reader…they will.

*** Our man in Bombay is no more. James Boric has just returned from India. From his sixth-floor vista in the Taj Mahal Hotel, Boric had a perfect view of the most expensive real estate in Mumbai.

"Mumbai property is surprisingly expensive," James recalls, "With all the politicians, Bollywood film stars and cricket legends in the area, a two-bedroom apartment can sell for over a million dollars while, at the same time, overlooking some of the poorest neighborhoods I have ever seen. Dubbed mini-Manhattan, the Malabar Hill area of Mumbai rivals London’s property prices."

The Daily Reckoning