When we have to travel a short distance in our own city, we’re often confused about the mode of commute that would be optimal – should I drive my car ? should I take a cab ? should I take a metro ? should I board a city public transport bus or maybe take a rickshaw? Isn’t it? However, we’re never so confused while travelling from Delhi to Mumbai – We know, we’re going to board a flight. Similarly, short term trading decisions may involve mental bandwidth but really do not take us much far from where we stand.
Warren Buffet says, “never buy a company for even 10 minutes that you are not willing to hold for 10 years”. Wealth creation happens over long term. And, long term investment decisions are driven by fundamentals. Here we try and share some of the insights in this regard based on our learnings.
Observation 1: Choosing Good businesses
First of all, stick to the publicly listed equity space as it is much easier to get information here. Within listed space, look at companies which at least have a market cap of over Rs 100 crore. This surprisingly is a low barrier and throws a list of ~1,500 listed companies. Second, choose the time period for fundamental analysis as 10 years. Pick 2 yardsticks, Annualised revenue growth of 10% and return on capital employed (ROCE) of 15%, for every year for the past 10 years. ROCE can’t be applied on financial firms and so, for them, use return on equity (ROE) of 15% and loan growth of 15% every year. These filters result in a universe of stocks so small that can be counted on fingers, however the returns generated by these companies on long time basis is as high as 25-30% CAGR.
Observation 2: Retail facing businesses create a lot of value for shareholders
Strong retail facing companies work well for long term investments. Amongst these, look for those which make continues efforts to make products suitable for retail customers. Like Asian paints and Marico have adjusted their packaging to suit consumer needs. Page industries focused on individual distribution network to maintain uniformity of price throughout the nation. HDFC bank started as a corporate bank and its retail business got thrust only post 2000s, between 2000-08 their Branch growth CAGR was 27% and ATM growth CAGR was 43%. These efforts by the chosen companies to reach to the ultimate individual consumer have done a lot in creating shareholder wealth.
Observation 3: Professional management of functions
This is one of the most important qualitative features of the greatest companies. Look for those companies, that attract top talent and retain them for longer durations. Asian paints have a culture of hiring from top B-schools and training them to be leaders. Berger Paints even after going through a lot of ownership change has never curtailed professional style management at the top. HDFC Bank and Axis Bank (in the latest Avatar) has shown great affinity towards professional leadership.
Observation 4: Capital allocation
This is one of the most important internal factors for companies to gain significant advantage over the competitor. How judiciously a company allocates capital to its business segments is very essential to its success. HDFC bank while expanding its retail banking spent a lot of resources on developing technologies which gave a lot of power to the consumer and has been one of HDFC Bank’s greatest strengths. One can remember above simple observations when tempted to buy a stock for a short-term trade.
Observation 5: Debt Free Structure (for a non-financial company)
If a company’s Y-o-Y revenue growth is 10%, ROCE is 15%, why will a company need debt. Even if it wants to expand faster, look for those companies that rely on internal funds over raising debt. These companies are more agile and think more creatively without any burden. Even if it goes wrong, it can walk over the decision unlike a debt laden one which will have to serve the debt even after the wrong decision is over.
Observation 6: Promoters skin in the Game Leadership matters a lot.
And the topmost leader of a company are its promoters. A promoter may have many areas of interest to him and many businesses. Amongst all that, how much is promoters’ skin in the game in a business is important criteria while investing for long term. He/she is expected to be focused and spend 100% of his professional bandwidth to the company being considered for investing.
Observation 7: Clean Practices
No political connectivity | High corporate governance | Clean accounting | High Promoters integrity | Ethics never compromised | No related party transactions | No favours to relatives | No linkages to bureaucrats
The four most dangerous words in investing: ‘this time it’s different’ – Sir John Templeton
This is one of the most important quotes in investment history. Unfortunately, it’s often misunderstood. Of course, things are always different from one era to the next, but what does not change from era to era is human behaviour and the formation of market extremes.
Identifying extremes is easy in retrospect, but for most investors it’s very difficult in the moment. That’s because the natural human tendency is to chase performance, and the brighter the glow, the more average investors clamour to buy.
Here are a few things to consider regarding equity sector extremes. Timespan is important, extremes take years to develop; a year, two, or even three is typically not enough. The thing to look for is outperformance above the broad market for more than three years. Sectors in a classic bubble formation have usually outperformed for more than four years.