Planning to invest? Remember these points!
Hitesh Patel posts some really good advice for investors on what to focus on while researching a new stock.
While analysing any company, especially for long-term holding, there are some basic criteria that need to be fulfilled. A little bit of leeway can be given here and there considering the Indian way of doing things and the jugaad entrepreneurs employ. (For the flavour of the season investments like a specific stock or sector which we want to ride for a short to medium term, these criteria are to be relaxed even further. )
The first and foremost criteria to consider according to me are :
1) Opportunity size:
The company should have a big enough and growing market for its products/services, in comparison to its size.
2) Scalability:
If the opportunity size is there to grow, the company should have the ability to grow fast. And this means it has the ability to deploy incremental capital, but this should be at a higher rate of returns. If the company which generates an ROE of 20% for say last 3 years plans to expand and expects ROE on expanded capacities to be 25%, it's always a good proposition provided they deliver.
3) Sustainability and Predictability:
There should be a clear runway for growth visible and business should not be lumpy. Companies with long periods of growth or promise of more than 20-25% CAGR for a few years will provide good returns even if you pay a higher price at the time of entry and hold it for long. (It should not be bought at exorbitant valuations of say 50-100 PE and grows only at 10-15%)
4) Balance sheet:
In growing companies, there can be some debt but it should not be out of proportion. Plus the return ratios once the growth engine starts chugging along should be above average. There can be a few years initially where free cash flow can be negative, but as long as the overall picture is good, it's okay.
5) Promoter holding and pledging:
Promoter holding should be sufficiently high to inspire confidence as an investor. Pledging should be negligible if at all. If it is high initially, over a period of time it should start going down.
6) Management:
Promoter-owned and run business is a good combination provided promoters know how to manage the companies Reasonably decent salary structure for promoter families is okay. Related party transactions within limits are also okay, as long as promoters do not feed their private ventures with money from publicly listed companies.
An example of fantastic management in the wrong business I encountered a few years back was in GRP, the erstwhile Gujarat Reclaim Rubber. They used to recycle waste rubber into recycled rubber. This was usually used in tyre manufacturing. Now tyre industry itself is a heavily cyclical industry and if your company is dependent on its fortunes, then it's a tough business and difficult to give consistent numbers. I met the management a couple of times during AGMs at Ankleshwar. Father and son duo is fantastic in their knowledge of the business and humility. And they provide superb food at the AGM. During my visit to the company, that was the only highlight. It's a tough business to run and in spite of top-notch management, has hardly provided multibagger returns for many years.
Above can be broad starting points to look at for long-term investments in terms of business quality and management quality. If these are satisfied, then one can do more digging and then take a call.
You can read One Up on Wall Street (I feel it's a book worth reading multiple times) and Pat Dorsey’s Five rules for successful investing. Try to digest and internalise these books (esp Lynch’s book) and look at the Indian way businesses are done (by going through annual reports of multibagger companies) and most of the queries at analysing companies will be gone.
Try to look at the company as a whole rather than bits and pieces. The idea should be to look at the big picture and avoid excessive analysis if the big picture is okay.