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Pune-based value investor Niteen S Dharmawat has earned his stripes on Dalal Street by being able to connect the dots. He has the knack of spotting companies that are on the cusp of a turnaround. One of the founders of Aurum Capital, this trait has helped him deliver robust returns to investors.

In the past few years, he has spotted many multibaggers. For instance, he bought integrated chemical player Atul Limited at Rs 180 in 2012 and later sold it with more than 1,000% return at Rs 2,000 in 2017. Likewise, shares like IPCA Labs, Godawari Power, KNR Construction and Finolex Cables, Sabero Organics, Vinati Organics also helped him in amassing wealth.

Dharmawat is also doing his bit in ensuring citizens are made aware about equity markets by giving free educational sessions on the stock market since 2008. In an interaction with Money9, he explained how investors have evolved over the years and how he has managed to spot outperformers.

Edited excerpts:

Q: How do you discover quality stocks?

Dharmawat: I usually invest in fundamentally strong midcap and smallcap stocks for the long term. Mostly, I like to enter into stocks and sectors which are underperforming and are on the cusp of a turnaround. However, I am sector agnostic.

I have experience of working in the industry for more than 20 years, including the likes of Crisil and L&T Group. This rich industry background helps me understand companies, complexities of business and tipping points that make or break a company. My approach is never limited to just number crunching but going beyond. I focus on the business, strategic direction, competitive landscape, governance process, the background of the promoters, turnarounds, to name a few. Often these are more critical items than just numbers. This has successfully helped me to tide over through multiple bear and bull market cycles.

Q: You have made good exits also. How do you decide to sell a stock?

Dharmawat: Exiting a stock is a tough call to make. The best is to focus on the valuations and take an exit. Secondly, in case of any corporate governance issue, we take a call to sell. In such a case taking an immediate exit is the best thing once you are sure that there is a certain corporate governance issue or the promoter has short-changed the minority shareholders.

Also, if we get a better opportunity compared to the existing one and our original investment thesis is not working then we take an exit call. But before taking the exit route, be sure that things are not going to change, be sure that the management is telling the same story quarter after quarter or maybe year after year.

Q: What investing lesson you would like to share with new investors?

Dharmawat: There are many lessons that I learn from the market. I often say that the market is the best teacher and one has to pay a tuition fee to learn lessons. The earlier the fee paid, the better it is. I am sighting two critical lessons:

a) The first one was, in 1992 – 93 when the Harshad Mehta scandal happened. As a young kid, I got fascinated by the stock market and started trading in ordinary, not so worthy stocks.

This allowed me to make paper money in no time and before I realised the bubble burst. It does not allow you to exit and you will remain in a fool’s paradise if you believe that the stock you invested in or traded will return to the levels you entered into; they will never. Particularly if the fundamentals are poor or if there are corporate governance issues in those companies. That is one hard lesson that I learnt.

b) The second one is more recent. It was about 7-8 years ago and it was an investment in MCX – Multi Commodity Exchange. I always believed in the long-term prospects of the company. But then NSEL, National Spot Exchange, fraud got reported.

I sensed the trouble in NSEL, because there were at least three to four brokers who approached me to invest in NSEL scheme. I questioned about the sustainability of the model and based on the offering, which was close to 13- 14%, for which the company will have to earn at least 20-25% return. This was difficult; if you remember, the economy was not doing so well during that period of 2012-13. It’s not impossible, of course, but very, very difficult to generate that kind of return. I asked them where this money will be invested, how they are going to make the returns. I could more or less sense the trouble in NSEL. But the problem was I didn’t link it with MCX. It could come to the doors of MCX. That is a mistake I made. Maybe because I might be biased towards MCX stock.

However, I continued to believe in the MCX story and I accumulated MCX during the downfall. But this drawdown could have been avoided too had I not been biased.

Q. What enthused you to enter stock market?

Dharmawat: I started my journey in 1992-93 and it was nothing to cheer about. It was a terrible start. But it surely gave a foundation to be conservative, contrarian, long term thinker and invest in quality companies. I took the stock market as a hobby in my initial years. However, it always fascinated me to study the businesses, how they operate, how do they achieve their goals, how transformations happen, how competition comes into the play, what makes some companies so successful while others not from the same sector even if they started at the same time with almost similar resources. What could have been a better place than the stock market to get the answers to all these while a constant opportunity to learn?

Q: You have always focused on corporate governance issues. What areas do you look at?

Dharmawat: Corporate governance is of utmost important to me. We cannot give the keys to the vault to a thief. There are instances where we caught the companies with corporate governance issues. Some of these are in public knowledge too.

There are basically two categories. One takes the advantage of a thin line of demarcation between legally right and morally wrong. Second, are outright frauds.

We need to be extremely careful of the first category. They are the real wolf in the clothes of sheep. The second category is easy to catch.

We just need 15-20 companies to invest in at any given point in time. In most cases, it is our greed that attracts us to the wolf. It is better to stay away from such wolves. We can’t be smarter than the fraudulent promoters.

Q: Can you suggest a few books to investors?

Dharmawat: The first book that I read was “The Intelligent Investor” and the second one was “Security Analysis”. These are all-time classic and have inspired me the most. The books written by Philip Fisher, “Common Stocks and Uncommon Profits”, by Charles Brandes, “Value Investing Today”, and by Andrew Kilpatrick “Of Permanent Value: the story of Warren Buffett” are worth reading.

Finally, we have “Value Investing And Behavioural Finance” by Parag Parikh is a great book with Indian examples. It provides very valuable guidance and a deep understanding of value investing and behavioural aspects.

Q: How do you rate this market amid rising uncertainty due to Covid-19? What kind of stocks and sectors are looking attractive at present?

Dharmawat: Covid is highly uncertain and has been terrible to our lives. If we have any subsequent strong wave in future then it would continue to impact negatively. Considering previous pandemics and present vaccinations, we might have seen the peak of this pandemic.

Among others, I like infrastructure, paper, and capital goods sectors. From a contrarian perspective, we should also keep an eye on tourism based companies and industries. This could include stocks from airlines, theatres, hotels, resorts, amusement parks etc. If the Covid wave is on a declining path and vaccination peaks up then we might see ‘revenge’ spending.

Q: What separates the new breed of investors with the old ones?

Dharmawat: I see new investors as more informed, learned, and investing with an objective of long term. Also, I see that they are not fearful when the markets are witnessing drawdowns. I also observe that they are open to take the help of professionals in building their portfolio and achieve long term aspirations. This is a great change.