The pride is in the framework of portfolio construction and the adherence to basic guidelines as an investment firm. Portfolio Manager is looking for well-managed, scalable business models, and the valuation framework within this is governed by intrinsic cash flow calculations.
It prefers not to use extended forecast based modeling for projections. Follows a basic checklist for businesses and risks it does not want to take in the portfolio. Finally, it’s important for the portfolio manager to evaluate the net free cash flow the business generates, net of reinvestment cost of capital.
The nature of businesses that are avoided matters and following is a guide to that :
• Siphoning of cash
• Poor returns on incremental capital (state-owned enterprises, conglomerates, airlines)
• Businesses with existential threats ( print media, wind energy businesses, etc.)
• Related party investments into other businesses
Basic assessment checklist that is followed :
• Too many related third party transactions
• Differing ownership in ‘ventures’
• Promoter pledged stocks
• Aggressive accounting policies – increasing accounts receivables with an increasing sales trendline
• Auditor change frequency
• Capitalizing expenses
What do we look for in growth?
The nature of the businesses that enter the growth portfolio bucket would need to demonstrate FCF growth of 10%+ over the last 5 years preferably with an increasing EBIT margin, and with growth coming in without adversely impacting the balance sheet in the form of additional debt. Such companies are rarely available cheap, but we do not mind paying a premium selectively depending on the industry nature, and if the ROCE > 20% ( For Banks, we would look at ROA as a measure).
When we look at companies, less than 10,000 Market cap, it’s important for us to expect a higher return profile as we are sacrificing on liquidity. If our estimate of return does not compensate us for the liquidity loss, we would be weary of investing in smaller market cap companies.