CIO: Thank you for giving us this opportunity to be with you today. Could we start off by asking you what your overall investment philosophy is?

Raamdeo Agrawal: First, let me thank you for coming all the way here on a holiday and sparing the time to talk with me.

Investing has been a very enticing experience for me. Because of my passion for investment, I have been interacting very closely with the stock market. I first came to know about it in 1980. Since then I've been trying to gain as much knowledge about investing as possible.

Investment philosophy evolves as one learns and grows

The kind of ocean there is in terms of knowledge is amazing. One grows by learning and every day I'm learning new things. However, to be honest, I don't think I have learnt even one percent of what there is to be learnt. There is nobody who can talk about a perfect philosophy of investing. I believe that one's investment philosophy evolves as one learns and grows through such learning.

When I began my travails with the stock market, there was a strong desire to make big money. But I did not know how to go about doing so. Even to make a modest beginning, you needed some capital. Now, where does one get the first few thousand rupees to start with? I needed an idea that would enable me to begin without the comfort of adequate seed capital.

Broking is a great business

I first began investing in 1980 on behalf of my brother who had about a lakh of rupees. I used to go to my broker's office and there I saw some possibility of making money without actually investing in the stock market to start with. The idea was to start as a stockbroker, earn brokerage income and then invest the surpluses in the stock market.

In 1987, I started a small brokerage outfit that also provided round-the-clock advisory services. We didn't have much money of our own to invest, then. But the beauty of the brokerage business is that you receive your income every settlement. This income you can keep ploughing back into the market. Besides, our unique operations enabled us to have access to large float funds.

Our clients in Ahmedabad and Madras would generally be selling stocks while our clients here would be buying. There was always a time-gap between the receipt of funds from our clients here and our payments to our clients in Ahmedabad and Madras. Besides, as we normally sold more than we bought, we were always on the payout mode on the exchange. So, we were able to invest.

The entire process was very exciting. I started reading balance sheets in 1980. I used to sleep reading them in my apartment. I must have read over 500 balance sheets in the following three-four years. I began to think that I knew a lot about the stock market - much more than most of the guys on the street. I had a good grip on numbers and I wrote a book called "The Numbers Game".

For 15 years, I did not make any money

But for the first 15 years, I did not make any money. The value of my portfolio just did not grow. I came to know that only in 1995. We did not have a formal mechanism in place to review our portfolio on a regular basis. So, some year we may have earned a crore while in another year, we could have lost half a crore. We didn't really know and we were blissfully happy in that ignorance.

In 1992, following the bull-run led by Harshad Mehta, we suddenly saw our wealth growing disproportionately from about a crore of rupees to 8-9 crores. But once that euphoria died down, we were back to where we had started. In 1995-96, I took inventory of how much we had deployed in stock market investments in the last 10 years and how much we had earned.

I found, to my good fortune, that we had at least as much money as we had invested in the market. So, to tell you the truth, the money did not grow. But it was really satisfying to know that we had an ongoing business and that all our bills were paid out of its earnings. We had confidence that we would be able to grow it.

Then I came across Warren Buffett's principles

Then there was the first breakthrough - a ray of knowledge. I came across a book on Warren Buffett, "The Warren Buffett Way". Buffett was, I think, famous much before that. A lot of people who followed the stock markets - investors in the United States - had known of him and were regularly reading what he had to say. "The Money Masters" and some other book had interviewed him but I was not aware of that. This book was my first introduction to his views.

Focus on Return on Net Worth

I also happened to chance on some of his letters and I found them extremely interesting. I compiled the letters right from 1977 and went through all of them in 3-4 months. In one of his letters he said, "Don't focus on EPS, focus on return on net worth". As a chartered accountant, I had a rough idea of what it takes to make money. But it was then that I realised that the real foundation on which good investment is based is the return on net worth.

Though I had a little feel for this sort of thing - the return on my money - I had never focused much on that. I used to think that if a company was big, it got a high discounting. I had never really tried to figure out what drove P/E. Buffett's letter put things into perspective and I decided that I would never buy a stock that was not likely to earn 20-25 percent on its net worth going forward.

Companies that earn a 30-35 percent ROE are no doubt great, but the problem is that the whole market knows about such companies. The biggest opportunities can be found in a company that currently has low ROE but because of some inherent strength, it is likely to go up substantially. A company that has identified its biggest competence and is confident of driving up its ROE substantially because of this is surely going to become rich.

Follow a focused approach to investing

If you can identify such a company then you could make big money. How big, I don't know. My search for suitable companies to invest in has since been driven by this premise. I have always followed this as a rule and it has kept me in good shape. Another thing that I have followed is a focused approach to investing.

I remember that in 1996, I found that we had invested in about 225 stocks. Although all these investments were declared for income tax purposes, they were not even put in one place. That portfolio proved to be the biggest disappointment for everybody. About the time when communal trouble began in Mumbai that year, the power of focused investing was the hot topic of discussion.

It became clear to me that I had to bring down the number of stocks in my portfolio from 225 to about 20-25. In the following two years, we successfully brought down the number of stocks to 20. That was a most rewarding experience. I don't know whether I would have the guts to invest in just four or five stocks but I know that it is not possible for me to manage 100 stocks effectively. Even 20 stocks are too many. I think 10-12 stocks is a good number.

However, as the size of the average Indian company is small, a large fund cannot be suitably deployed in just 10-12 stocks. So, we chose to focus on 20-25 stocks. Now, companies keep falling out of favour and when you already own 20-25 stocks, adding another one can be quite painful.

Patience is an invaluable virtue

I found that it is better to invest within your own stocks provided of course that you have chosen them with care. Good businesses with sound management generally have a long life and their falling out of favour is normally a temporary phenomenon. In fact, such instances often give you a good investment opportunity.

All the stocks in your portfolio will never remain at the peak. There will be some stocks that are undervalued and some stocks that are fairly valued. You actually make money by sitting rather than by thinking. You have to allow a good company to run its own course before your investment begins to pay off. It takes time for a young tree to flower and bear fruit. You need to have patience.

CIO: What would be your portfolio turnover? How many times do you change its composition - about 20 percent change of portfolio once every five years?

Raamdeo Agrawal: There is no set pattern. If I like something and I believe that the company has potential, I continue to hold for relatively long periods. If I don't like something or if I believe that I have gone wrong in my study, then I don't hesitate to sell. Last year, I felt that the technology sector had peaked out. So, I sold a large portion of my tech allocation.

It had reached as high as 60-70 percent of my portfolio. The market had taken it from 20 percent to 70 percent and I was very clear that it would bring it back 70 percent to 20 percent. So, I booked profits and brought my tech allocation down to 40-50 percent. Although this was not to the extent that I would ideally have liked, nevertheless, it kept me in good shape.

My tech allocation is back again to 22 percent but at least half the fall has been because of my own doing. It was as a result of my cutting exposure to technology stocks that my turnover was high last year.

CIO: You say that it is buy and hold but don't buy and neglect.

Always be vigilant

Raamdeo Agrawal: Yes, you have to be constantly watching. In India, the economy as a whole is changing. Even in the larger economies, things are not stable. The whole environment is dynamic and as circumstances change, the prospects of the stocks you hold also change. Take for instance you hold shares of a company that manufactures pens. If the customs duty on raw material increases or if the import duty on finished pens falls, it could have an adverse impact on the company's profitability. If you do not keep a constant vigil on the businesses you have invested in, you could be caught on the wrong foot.

Look for the company's source of profits
Examine whether it is sustainable

Whenever I look at a business, I always try to find what the source of its profits is and how sustainable that source of profits is. Every company has a competitive advantage, a USP or a core competence. But I always try to pin point what is the fountain of profit in the company that allows it to make money in a sustained fashion. If a doctor is extremely good at treating cataract, it becomes his core competence and allows him to attract clients from all over the world. As long as these clients keep coming to him, he will continue to make money.

Every successful company has something great about it that enables it to earn that additional return. Whether this ability to earn higher returns would be sustained depends on how much demand there is for the company's product or service. If a company makes good matchboxes, demand is going to be limited but if it makes some product, which not only has a sizeable market but for which demand is also growing, then I think you have a winner.

Infosys, for instance, is able to provide quality IT services and the market for these services is really large. So how much of the market share it can pick up, how much business it can do is the concern rather than the demand part of it. At least that is what is being perceived right now.

CIO: You mentioned that you follow a focused strategy. You invest only in the few stocks that you know. But what about risk control? Do you look at market volatility?

Raamdeo Agrawal: What I am concerned with is business risk. I don't worry too much about the way the markets are behaving.

CIO: But right now we are witnessing tremendous volatility in the market. In such a scenario, wouldn't diversification help?

Focus on generating positive returns

Raamdeo Agrawal: I have always focused more on generating positive returns from my investments rather than on what the market index does. My basic philosophy has been very simple. Initially I used to think that we should double our money in two years. But now I am comfortable if we double our money in three years.

If I genuinely feel I have found a stock that will double in three years, I have no hesitation in picking it up. According to the Indian Income Tax Act, you have to pay 38.5 percent tax if you make a profit by selling stocks held for less than a year. If your holding period is more than a year, then you pay 11 percent tax. I just cannot afford to pay 40 percent tax. I mean I would pay if I had to but I always try to find a company that I could hold at least for one year.

I consider buying a stock with the intention to sell it within a year as speculation, which I don't want to indulge in. Not that six months or three months is a short period but it doesn't give me that tax break. So, anything with a holding period of less than a year is not of great interest to me. After one year, the decision to hold the stock is driven by whether or not I think that it meets my basic criterion - the possibility of doubling in three years.

Pick high quality companies

I generally invest in big companies. I somehow don't value very small cap companies as much as the large cap ones, unless a particular small cap company is really uniquely placed and has interesting ideas. I am not saying that I consider only those companies that have market caps of at least Rs 5,000 crores or Rs 10,000 crores. No, that's not the issue. The issue is that if it is not already large cap, the company should have the potential to become large cap.

I am basically concerned with picking very high quality companies for my portfolio. So long as I am confident of the quality of the businesses that I have invested in, market volatility is never an issue. If all my 20-22 stocks were affected by market volatility in the same manner and they all fell in line with or faster than the market indices, I would be deeply concerned.

However, I have never encountered such a position. It is always the poor quality stocks that are most affected by market volatility and you need to be extremely worried if your portfolio is made up of such stocks. Risk arising out of market volatility cannot be eliminated unless you go cash. So I'm not particularly concerned about market volatility so long as my portfolio is colorful.

CIO: Have you ever made money going short on any shares?

Follow a strategy that suits your temperament

Raamdeo Agrawal: No, I have never made money by going short. I did try once or twice and when I look back, I realise that those were very good decisions. I would have made a good fortune had I stuck to my positions. But I don't have the temperament to sit with a short position.

I am not comfortable even if my total short position is just one percent of my portfolio value. If you have the right temperament, however, going short could be a much better way of making money. Of course, I am assuming that the laws are conducive to short selling.

CIO: How much of investing do you think is an art and how much of it is a science?

Investing is the art of controlling emotions

Raamdeo Agrawal: I think investing is 99 percent art and 1 percent science. Well, let's not put too much importance into these numbers. What I mean is that investing is largely an art. Earlier I might have said that it is half art and half science. But as I learn and grow, I realise that it is more an art. In fact, I am almost tempted to say that investing is entirely an art.

You might know the right things. You might even preach the right things. But practicing what you preach is the biggest art, I would say. Information is no longer difficult to come by. Parameters such as ROE and ROCE of listed companies are easily available. You also know that you must not invest in companies with dubious managements. But you still get carried away by greed and fear. Controlling these sentiments is an art.

CIO: Extending the same art v/s science argument, which do you think is more important - projecting the EPS of a company accurately or arriving at the correct judgement of what P/E it would attract?

Raamdeo Agrawal: I think understanding EPS is more of a science. The historical EPS of a company is known to almost everybody. With a large number of analysts tracking each stock and with modern tools such as computers, even the two-three year forward EPS is no longer an issue. By and large projections of EPS by different analysts are similar as all of them have access to the available sources of information.

The real issue is knowing the P/E. Understanding where the P/E is going to be is completely an art. There are some basic tenets that drive P/E but none are perfect. For instance, just because a company generates a high return on equity, it need not enjoy a high P/E. High annual growth will again not guaranty you a high P/E. Let's say you are a Pentamedia or a Himachal that have really high EPS growth. But they currently enjoy a P/E between 1 and 2.

CIO: As you've just pointed out, understanding P/E is perhaps more important than projecting EPS. Could you tell us what are the conditions that enable a company to enjoy a high P/E?

Identifying a good business in not enough

Raamdeo Agrawal: Yes, some of these are necessary while others could be termed as sufficient conditions. Perhaps the most important factor that influences the discounting that a company gets on the bourses is the quality of its management. The more confidence that the investing community has in the management of a company, the higher is the P/E that it gets. Secondly, a business that yields consistent cash flows that are fairly predictable generally enjoys a high P/E. However, identifying a good business alone is not enough.

You also need to examine the quality of the management

You need to identify a good business that not only has stable profitability and profits but also good quality management. It is only when you have this combination that you get a predictable profits stream, which in turn leads to a higher P/E. If you are able to identify a company that satisfies the above criteria and is also perceived to be growing rapidly you would be even better off.

Market perception is also important

Perception is very important. Until three months ago, it was widely perceived that technology companies are not affected by business cycles and that they would continue to grow at the same rate. That perception led to high P/E for technology companies. Investors typically try to extrapolate current conditions into the future. Hence, if current conditions are good for an industry or a company, it tends to get a higher discounting. On the other hand, if current conditions are discouraging, you see a low P/E.

Find the good business that is currently out of favor

That's where one of the biggest opportunities lies for the seasoned investor. Warren Buffett's book says, "The good business, the good company but out of favor". When current unfavorable conditions, that are only temporary in nature, are extrapolated too long into the future and stocks are available at low P/E, it represents an opportunity to buy.

Take for instance, there is a drought in India in one season and the markets begin to perceive that this would last forever. In such a case, there might be an opportunity to buy. If there is a good monsoon in one year and people extrapolate the favorable conditions to the next five years, there could be an opportunity to sell and book profits.

CIO: You have laid a lot of stress on the quality of management. How do you go about assessing it?

Raamdeo Agrawal: Even before you've ever met the management of a company, you normally have some perception about it. This is formed out of what you've read, heard or seen in different media. I give a lot of importance to what a newspaper says. There's no smoke without fire. Such a perception is more or less right. I start with that.

When you go and personally meet the management, you notice the way they conduct themselves, what they share with you and what they don't, whether they come across as honest or deceptive. As you keep interacting with the management on a regular basis, say every three months, you are able to verify whether they deliver on their promises.

I am not so concerned when the management says that it expects a Rs 100 crore profit for the year and the figure actually turns out to be Rs 95 crores. But I am troubled when a company says that it will announce its quarterly results on April 15 and there is no sign of it even by April 25. I'd rather like they say April 25 and deliver by April 15.

Companies that generate good cash flows are safer

The managements of companies that borrow a lot are under tremendous pressure from financial institutions. They cannot be expected to act as they would ideally like to under such conditions. The problem is further compounded when there is a temporary slowdown in business and the company is hard pressed to meet its loan repayment obligations. I am not saying that there is no case for investing in such companies. Yes, there could be bargains found but one needs to be cautious. Companies that generate sufficient cash flows to meet their capital investment needs are generally safer bets.

CIO: In terms of quantitative measures would you say that high return on equity, low gearing are some of the...

Examine whether good performance has been sustained

Raamdeo Agrawal: It is possible that in a particular year a company might show extremely attractive financials. Profit & loss statements and balance sheet numbers can be suitably doctored to show a high return on equity. However, it is not possible to keep doing so in a sustained manner. If a company has been able to achieve high ROE and ROCE for the last five-six years in a sustained fashion, it is very unlikely that the management is not credible. A sustained high ROE, low gearing and a growing stream of profits is always associated with some unique business philosophy that has been guiding the company.

CIO: There is very little literature on what should determine one's exit from a company. How do you decide when to exit?

Raamdeo Agrawal: If you get into a stock because it is undervalued, by the same logic, you should get out when it is overvalued. Typically, however, you fall in love with a stock when it gets overvalued. Not so much for the profit it has made for you, but because there is so much of consensus that it is such a great stock. If it is widely agreed upon that Infosys is a great company and it occupies the front pages of not only the national business dailies but also the global headlines, then it becomes difficult to take a contrary stand and sell the stock. It is not easy to follow a disciplined approach to investing. I have also been guilty of breaking my own rules in the recent times. I am not a good enough artist.

CIO: Are there any other factors that could influence you to exit a stock?

If you make a mistake, admit it and get out

Raamdeo Agrawal: If a company is not behaving the way you thought it would, if your predictions about it's performance go wrong, you should consider exiting. Say you thought that steel prices are going to go up but global recession sets in and they actually fall. Then you need to sell the steel companies you had bought on the premise that prices would rise.

I bought Tisco because I believe that it will further reduce costs next year. The management has promised a three to five percent compounded cost reduction. Now, the inflation rate itself is around five percent. In this backdrop, the promise of a three to five percent reduction in cost by a large company like Tisco is really amazing. If the cost reduction happens, Tisco's operating margin will shoot up from 18 percent to over 30 percent.

However, if the management fails to deliver on its promise, I would have to reconsider my purchase decision. Normally, this is how one's thought process would be: If one had bought at Rs 108 and the stock had run up to Rs 120, one would comfortably get out. But if the stock had fallen to Rs 88, one would say, "Let me wait for the stock to go up to at least Rs 100." But the stock might never again see a price of Rs 100. So, wisdom is in getting rid of the stock at any price once you realize that your story has gone wrong.

CIO: Typically, what would be the valuation metrics that you would use as your entry criteria? Let's assume that the return on equity is good and the management is also good but then there has to be some valuation at which you'll buy the stock. You wouldn't buy it at any valuation.

Look for sufficient margin of safety

Raamdeo Agrawal: I look at two things. One is ROE, in combination with P/E and growth rate. The other, which is perhaps the more important of the two, is how much I would be paying for the company in absolute terms. It is not that I don't believe in P/E or the PEG ratio. But the future is uncertain and is not about a linear growth in anything. It is not necessary that the current business the company is in, will remain as good in the future.

The management has the option to diversify into an unrelated business. So, things could be good or even very good in the future but prudence demands that you have a sufficient margin of safety in the price that you pay for the company today. I am paying Rs 5,000 crores for Tisco's Rs 1,000 crores free cash flow. I am extremely comfortable with that. More so, given that most people do not think that the going will be as good for Tisco. They are extrapolating the current unfavourable conditions, which I believe are temporary, too far into the future. That, in turn, gives me further confidence that buying Tisco is the right decision.

CIO: Could you elaborate on the very principles that you talked about? How do you link ROE to P/E? How do you link growth to P/E? How do you arrive at the absolute value?

Raamdeo Agrawal: A company can grow its net worth only at a rate that is equivalent to its ROE. If you believe that its net worth would grow by 25 percent next year, its ROE for the year must be 25 percent. That is simple Mathematics. So, it is the sustainable ROE - rather, the sustainable ROE minus the payout - that will decide the rate at which networth will grow. The rate of growth of a company and its ROE are complimentary to each other. I don't think that in the long run, you can grow faster than the sustainable ROE because then you are perpetually into the borrowing mode, which is also not a good thing.

Let's say you identify a high growth company that has an ROE of 25 percent. You believe that this ROE is sustainable for at least the next 10 years. Then you should be comfortable buying the stock at a P/E of upto 25. However, if you were to apply this to a small company, your strategy may not work. That's because other investors may simply not take note of that company even after it has grown at a fantastic rate for the next three-four years. If it is a fairly large company, then the 25 percent growth will not go unnoticed.

Never count on making a good sale

I believe that if you identify about ten fast growing large companies and even if you go wrong on three-four of these, you could still get desirable returns on your portfolio. It has been my experience that the successful ones normally yield disproportionately high returns, which more than make up for the losses resulting from the failures. Besides, I always love to keep that margin of safety when I buy a stock because I can never count on making a good sale. As long as I am sufficiently prudent in deciding my purchase price, even a mediocre sale gives me a good return on investment or at least helps me to conserve my capital.

I strongly believe in Buffett's following two principles, "Rule 1: Never lose money. Rule 2: Never forget rule one." As somebody once said, "I walk very slowly but I never walk backwards." Even a slow and painful progress over time leads us forward. We never borrow - neither for our business nor for our portfolio. So long as we make good money we are not particularly concerned about the pace at which we do so.

CIO: You had recently talked about a slightly different or a new valuation tool, which you call the payback ratio. Could you discuss what this payback ratio is and how it works?

Raamdeo Agrawal: Yes, as part of our study on "Wealth Creation", we had talked about the payback ratio or the purchase price recovery ratio. The current P/E should reflect the future growth scenario for a company. But we find that one can't really figure out clearly how much growth is assumed. If the P/E is 5, does it mean that the company can grow at 5 percent? I don't think it is so. So, the P/E per se is not a very good indicator of growth.

The problem with PEG is that it takes into account the last two or three years that we include. It assumes a static condition for G going forward, which is not true. I mean it is coming to everybody's notice in the last three months that whatever we had assumed in December is no longer true. So, the stocks that we had found to be suitably priced based on PEG calculations then, appear expensive now. This is because G has fallen.

So we said let's take a more relevant measure. I think if you bought a company at a price that is less than the present value of its future cash flows, you'd have made a good investment. The issue here is how far into the future should one go? We assumed a five-year time frame and experimented with past data of recent multi-baggers to see if the theory worked.

We took their market capitalization as they stood in 1995 and added their profits for the next five years to see whether they "paid back" their market prices during that period. Infosys' payback ratio in 1995 was less than one. It could recover more than what it took to buy it in 1995 in the next five years. Today I have the benefit of saying this because I am looking back.

In 1995, you would have paid a price of Rs 380 crores for Infosys and in the next five years it would have earned Rs 500 crores. But had you bought it then, your wealth might have had multiplied by as much as 220 times. The rewards of identifying such companies at the right time can be truly great.

In our last two studies we found that the overwhelming majority of the companies that do well on the stock markets show an earnings growth of at least 25 percent over the last three-four years. This may not be a sufficient condition. There are companies that grow at 25 percent but even then they do not make money. However, companies that are not growing at 25 percent definitely don't make money. So, the condition that a company should be growing at 25 percent is a good starting point.

Unless I believe that a company's earnings will double in the next five years, I do not consider an investment in it. Zeroing in on a low payback ratio is basically about trying to see whether the company can grow its earnings by 25 percent on a consistent basis. If you are saying that 25 percent should be the earnings growth rate, 25 percent should be the ROE then your PEG ratio should be 1/2. So, if you pay 11-12 times current earnings for this kind of company and if your projections are right, it is unlikely that you will not make money.

How much money you finally make will depend on the euphoria that the company generates. In the last five years, Hero Honda has done better than many of the software companies on several parameters - whether it is free cash flow or earnings growth rate. But there has been no euphoria about any auto company. Thus, we saw that while Hero Honda's P/E fell from 35 to 8 during the period, it went up from 8 to over 250 for IT companies.

CIO: Would you look at earnings or would you look at free cash flow over here?

Look at Asset Turnover for growing companies

Raamdeo Agrawal: For a company in the rapid growth stage, it is virtually impossible to generate free cash flows. Although I do look at free cash flows, I find it more pertinent to look at the asset turnover in case of growing companies.

CIO: Can you use payback ratio at any time or is it only for times when the stock market has collapsed? You see, the valuations of IT companies might still not fit in this payback ratio. The payback ratio being very low, you would have to perhaps look for a large margin of safety.

Raamdeo Agrawal: There are two issues in that. First, what are your return criteria? The higher the returns you expect, the higher is the margin of safety that you need to look for. Simply put, you should buy cheaper. But if your competition does not allow the price of the stocks you are eyeing to fall to levels where you are comfortable buying them, you need to start looking at other stocks.

When I invest, it is with the intention of doubling my investments in three years. But my competitors, say for instance mutual funds, might be very happy with a four or five year doubling period. So, I don't necessarily have to look at an Infosys or a Wipro. I would be happy with Mukta Arts. I feel that it has a payback ratio of less than one and once I gain more knowledge about the business, I might find it matching my investment criteria.

CIO: So, is there a rule of thumb? If an investor is looking for a multi-bagger, what payback ratio should he look at? If he is looking for a steady 20-25 percent kind of return, then what payback ratio should he look at?

Valuation should come last in your evaluation process

Raamdeo Agrawal: I would be very comfortable with a payback ratio of less than one for a potential multi-bagger. When I say I expect my investments to double in three years, I don't mean that it is my starting point. That is my last point. I will always prefer investing in established large cap companies with good management. Valuations would come after I am satisfied with the business and its management. That sequence is very important. If you start with the valuation first, you could land yourself in serious trouble.

CIO: Given that there are 10,000 listed companies, what really determines your population of companies or your circle of competence? How do you go about determining what companies you would consider investing in? How many companies form the universe you would select from?

Raamdeo Agrawal: Most companies you can afford to completely ignore. There are just about 100-150 listed companies that are really worth even looking at.

CIO: But how do you come to that? Is it market cap driven?

Raamdeo Agrawal: It is definitely not market cap driven. Ideas could come from multiple sources. You could perhaps give me an interesting idea. I would explore that idea, discuss it with my analysts and try and get more insight into it. If after that I find that the idea is really worthwhile and I have conviction in it, I would invest in it. The idea could come from a newspaper or a journal or maybe some other media. Basically, I am not averse to exploring any idea.

But today I am very comfortable with FMCG and pharma. Whenever valuations in these sectors fall to levels that I consider cheap, I will invest more in them. When I see my pharma stocks falling, I know that they are going to make a comeback and I don't mind allocating more funds to them. Right now 33-35 percent of my portfolio is allocated to pharma. I sleep very well. I don't have any problems wherever the market goes. In my FMCG companies too, I have great faith.

Among Indian stocks, nothing is really out of my realm except PSU stocks. I am simply not comfortable investing in them.

CIO: How important is liquidity in your investment decision-making?

Raamdeo Agrawal: I give liquidity a lot of importance. In fact, I have let go of a number of good opportunities in the past because the stocks concerned were not listed. I am stuck with one of my largest investments because it is not listed. So I hate to invest in a company, which is not listed. But I am not averse to investing in stocks that are out of favor I just keep my tension levels low. I'm not looking for stocks that should have trading volumes of one or two million. I have patience to wait till volumes build up and they normally do if you choose correctly.

CIO: Having invested in a stock, how frequently do you update yourself?

Raamdeo Agrawal: In fact, I spend lot of time doing that. It's good you asked me that because I need to put it in perspective. I have my own research department and I kind of eat what I cook most of the time - 99 percent of the time. There is constant monitoring with the help of the respective squadron leaders. There is a practice of getting a valuation sheet organized value wise and business wise every day although I don't really look at it on a daily basis. But the records are maintained so that I am able to go through them whenever I feel that there is a need to do so. It is, nevertheless, a continuous process.

CIO: And between these broader thoughts of bottom-up investing and top-down investing have you by and large always been a bottom-up investor or you think that top-down investing has relevance to overall investment philosophy?

Raamdeo Agrawal: I have largely been a bottom-up investor, but in terms of risk management, top-down investing also has its own relevance. Say for instance, you get out of one overvalued IT stock and invest into another IT stock that you consider as undervalued at that point of time, you are actually not reducing your risk. Particularly the risk associated with that business.

When the IT sector peaked, I did reduce holdings in some IT stocks but I went back searching for alternative stocks within the sector. Hence the stock that I replaced my earlier investment with has also depreciated almost as much as the one that I sold. When you feel that a business has peaked out because of some bubble factor, it might be wise to go cash. In such a circumstance, even if you were to invest in some other sector, you may not be very much better off.

CIO: Because of the market conditions…

Raamdeo Agrawal: Yes.

CIO: Are you suggesting that an investor can actually time the market as well?

Raamdeo Agrawal: No, I am not suggesting that. Actually, I firmly believe that you should remain 100 percent invested both in good and bad times. But if you don't see a suitable investment opportunity, it is better sit on cash. It is like asking should you go to the river for taking a bath. There is no problem about it but if it is actually swollen or extraordinarily torrential, you'd better avoid going there. Situations like the 1992 boom or the recent tech boom are akin to the extraordinarily torrential river. In such times, you'd fare better if you remained out of the market.

CIO: Unfortunately, small investors typically enter the market at the wrong time. Could you tell us about the obvious indications that one could read into and hence avoid doing so?

When greed is pervasive, move out

Raamdeo Agrawal: I think that the most obvious indication that the market is ripe for a fall is the entry of a large number of lay investors. When people who do not know anything about the markets and who are not normally interested in them begin to invest passionately, the seasoned investor must start contemplating an exit. During such times you'd see that the pensioner, instead of trying to get half a percent more on his old-age provisions, starts speculating in highly volatile stocks. Trading volumes witness a massive increase and the market index shows no signs of falling. When you see that greed is pervasive, it is time to move out.

CIO: There have been very significant changes both in the global economy and the capital markets in the last 5-10 years. Has this impacted your way of investing?

Raamdeo Agrawal: Globalisation of the Indian economy has changed the entire landscape of the country. On the one hand, it led to destruction in many people's wealth. On the other, it brought new opportunities to grow wealthy. Businesses that thrived in a protected environment suddenly found that they could no longer survive in a highly competitive environment. A number of stock market favourites - companies belonging to the various Birla factions, for instance - have since lost heavily in terms of market capitalisation. Fortunately, I pared my portfolio from 225 stocks to 20 in 1995-96. In the process, a number of such companies were weeded out. But others who were not as fortunate saw their wealth shrink. Today, you cannot even find buyers for most of such companies.

The process of global integration has also been a source of tremendous opportunity if you look at the IT sector. Not only did it lead to the country being recognised as a provider of superior IT services, but also resulted in one of the biggest stock market booms in recent times. As a result of globalisation, superior management techniques, better business processes and more relevant legal procedures are being adopted. Companies in India have begun to behave almost like their counterparts abroad. Newer opportunities have arisen for them. Take for instance, Sterlite Optical. Its optical fiber unit was set up to cater to Indian needs and it did not do well. But it is now a 100 percent export oriented entity with global ambitions.

CIO: Who is your ideal in the investment world?

Raamdeo Agrawal: I have read several investment gurus and have benefited from them. However, the ones that stand out particularly are Graham, Fisher and Buffett. As I told you earlier, I think I have been most fortunate to read Warren Buffett. I have particularly benefited from the concept of "margin of safety". When I buy a stock, I look at it as buying a part of the company in question and not just as buying a share. I am conservative and I look for value.

Buffett has covered most of what Graham propounds - conservatism, margin of safety, focusing on value and the like. Fisher talks more about growth companies and is closer to technology. I like more of growth investing than looking for some kind of dead value. I find it difficult to absorb things like asset stripping in special situations. I have been most influenced by Buffett and partly by Fisher.

Although I have books on investing by several authors, I strongly feel that you must have only one guru. I consciously avoid getting deeper into investment techniques that I feel I do not have the temperament to follow. I think I don't have the capability to become a super doctor after meeting 10 doctors. But I am talkative and I like reading. So, I am listening to all these people.