Private equity has been experiencing impressive growth. Over the last decade, the number of private equity backed companies in the US has grown from 4000 to 8000. This spectacular growth is even more stunning, when we compare it to the public markets, where the number of listed firms fell by almost 50% since the late 1990s.
In order to understand how these professional private equity investors evaluate investments, and what lessons might be applicable to the broader investor community, we sat down with Ankit Kumar, one of the most well-known emerging leaders in private equity. During his fifteen year career, Mr. Kumar has served as an investor, board director, and executive for several successful companies. Known for his sharp intellect, business acumen, and unpretentious manner, we wanted to understand what makes Ankit tick and his investment philosophy.
California Herald: To begin, could you tell our readers how you evaluate businesses. What kinds of businesses do you like?
Ankit Kumar: I like to keep things simple. There are two key things I focus on when I look at a business. First, how differentiated is it when compared to its competitors, and second, its capital efficiency – whether it can grow without requiring enormous amounts of additional capital.
The best businesses are those whose products or services are in high demand by customers who perceive them as highly differentiated when compared with competitive offerings, and which do not need a ton of capital infusion to grow. Many of the good software businesses and strong consumer brands fall in this category.
The businesses you absolutely need to stay away from are the commodity businesses which are also capital intensive. These businesses are seldom profitable unless there is a supply constraint and it is almost impossible to get a return on capital expenditures as all your competitors will make the same investments and then give up price to capture volumes. It is very common to see such attributes in many of the oil and gas focused businesses and commodity chemical manufacturers.
California Herald: That is great insight. Could you help our readers understand how you decide to make an investment if you like a business? Do you ever not invest even if you find an amazing business?
Ankit Kumar: All the time. The key is to always have a margin of safety. Even the best businesses won’t make good investments if we overpay for them.
I am always looking out for situations where the market has overreacted to some negative news and the price for a business as a result of the market’s psychology is much below its intrinsic value.
While this goes against the efficient market theory underlying modern finance, I believe the markets are efficient in incorporating all existing information into the consensus view. However, this does not necessarily mean the consensus view is correct. Psychology can often result in large deviations between market price and the fundamental underlying value of a business.
California Herald: Great. Are there any other key areas you focus on when deciding on an investment?
Ankit Kumar: Once I find a good business at a good price, the third important thing for me is to understand the seller’s motivation.
I like situations where the seller has some attachment to the business and is looking for the right next home. In these situations it is also very likely that the seller has taken care of the business, their accounting books are in good order, and there is good employee morale.
In addition, the seller is also going to appreciate the unique value I, as a buyer,ambringing to the business, through industry knowledge, new ideas to grow earnings, or the ability to hire managers to scale the business. This also increases the potential that a deal will actually get done.
California Herald: Any final thoughts for our readers?
Ankit Kumar: One thing I have realized with experience is that the emotional part of investing is even harder than the technical part. In most good investments, we are taking a contrarian view, and it is hard to have the conviction to do that unless we have absolutely dotted our i’s and crossed our t’s. In addition, there is also the pressure to make a deal work. It becomes really important to maintain discipline, especially once we have invested significant time chasing a prospective deal.