Business Quality: Refining our thinking on "Great Businesses"


(Donald Francis) #1

Delighted to present VP Business Quality Insights.

Something we promised when we made a good start with the VP Management Quality Insights presentation, last December. Capturing that ART form that we see imprinted in the refinements that senior investors bring to business quality thinking/dissection however,proved to be a tough ask - much tougher than we anticipated.

We struggled and laboured over this for over 2 months, sometimes making very little progress for days. But happy that we persisted as this made us think deeper about our businesses. As we sparred within VP core Team, the dissection Template started looking more well-rounded and holistic and added lot of value to each one of us.

Capturing that FEEL that senior investors bring to the table when they communicate simply in just a few sentences - where their favourite business is headed in next 2-3-5 years - was essential. Our challenge thus, was to keep it simple, crisp and usable.

Random sampling with a few lay non-investors has been very encouraging. This has now come to a shape where we feel confident of sharing this with with VP readership and the larger investment community.

Look forward to your active engagement and feedback to take this effort forward:

1). Do you find this simple and usable - by any passionate Learner, lay investor?

2). Do you get the FEEL why one business is special and some other, extra special??

3). Do you think you could perhaps transfer/communicate this feel or conviction to others - non-investors, your spouse???

Cheers

VP-Business-Quality-Insights.pdf (221 KB)


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(Donald Francis) #2

Thanks are due to Mr D and Mr M for their inspiration and guidance to seeing this through. Without their inspiration, this certainly couldn’t have seen the light of the day.

VP core Team and others like Vinod MS, Ananth Shenoy, Dhwanil who put their hands up - provided important inputs.

If you do find this BQ Dissection Template crisp and holistic - at the heart of that is an inspired exchange with “DeepInsight” VP member - who articulated the BQ Bottomline placeholders beautifully. Without those placeholders (those who have seen my previous attempts would be vigorously nodding) previous versions were nowhere half as effective :slight_smile:

Just another example of how alive and effective, collaborative effort within VP can do wonders.

But this is getting ahead of myself. Better wait to see the community reaction, first :slight_smile:


(Niranjan Shetty) #3

Thanks Donald and the entire VP team. Absolute delight to read. Amazing clarity of thought and presentation.

Cheers!

Niranjan


(Raj Panda) #4

Fantastic. I’ll take the liberty to use the format and come up with similar data for eicher & aia in next few days :slight_smile:

Regards

Raja


(Saji John) #5

Excellent presentation with great clarity. Even a novice like me could understand. Thanks Donald and all others who contributed. I hope you are working on other tracked stocks as well. Thanks once again…


(Donald Francis) #6

Thanks Niranjan, Raj Panda and Shaji John. I was getting worried that our presentation wasn’t upto mark. Glad that all of you like the communication clarity.

We were hoping that someone will also say that they want to use this framework for their favourite businesses, capture in these framework - and put it up for discussion/dissection. Thanks Raj Panda - a big thumbs up - all power to you. Will help you refine on AIA as I am familiar with the story.

I believe this is a very powerful tool to dissect threadbare any new ideas. Would love to see many others put their hands up and say I will do this for CCL, or Hester Bio, Tasty Byte. New investors and old hands - will both be surprised - at how much more thought can be brought to the table - on aspects we might not have even considered as significant.

If delved into with passion, this can speed up the learning curve real fast. And others can chip in and refine. The best part - this is not difficult to do - it just requires hard work to get all the info pieces in place. You have a head start - because you know what exactly you are looking for.

Let’s see more show of hands - for this exercise - VP discussions will be in a different league - if this takes off :slight_smile:

Cheers


(Vivek Gautam) #7

Superb.Template to be carefully noted down for a necessary checklist before buying any stock.


(Donald Francis) #8

Crucial feedback needed

Performance 5 years down the line will tell for sure. But do you get a FEEL for

A)From the examples shown, are you able to make out atleast one or two businesses that are a cut above the rest

B) Between Mayur & Astral - is it clear which is a superior business - on the face of it?

Am asking more from the point of gauging the effectiveness of the Template. It’s not about my opinion versus yours. It’s about ability of this Template ( and holistic inputs for the business) to be able to cut through all the clutter - and reach the heart of the matter - a la doodh ka doodh, paani ka paani. It’s effective if debate is sort of rendered unnecessary??


(Rajesh Rajput) #9

Great work VP team!

In times like these when stock picking has become more difficult, it’s a delight to see this kind of effort.

For Donald’s questions

A) the ratings of A+, A++ help as a summary in picking better businesses, and even without these the overall analysis is quite positively inclined towards highly rated businesses.

B) It comes out quite clearly that Astral is a superior business.

Once again - Great work!

Cheers

Rajesh


(Rajesh Rajput) #10

The other key question is how all this culminates into:

1). Near &Long term visibility

2). Stable PE range

As a standalone BQ measure, I doubt if one can say with any certianity that e.g. Mayur will double its business in 3-years. All it tells me is that their business will do **_far better _**than the industry…how much better is another story.

Cheers

Rajesh


(Varadharajan Ragunathan) #11

Donald

Great work - I am blessed to be a part of this forum and would like to request for an appretice ship under you to learn, contribute and have fun.

On a serious note, this is sort of a mental model I have been building for a while and a couple of things come to my mind :

1). We need to be able to define the floor and ceiling of RoE’s and RoCE’s and to that extent a mapping of the same for the universe of competitors for each of these companies help a lot. For eg., the RoE and RoCE movement in a fragmented market is much higher than it is is for an oligopolistic/monopolistic market. For eg., in your case it’s a function of EPA/sales ratios in the past. We could develop thumb rules similar to what banks use for Return on Assets.

2). One must remember that this is a snapshot, at a point in time. We must look at the sustainability of these metrices on the dash board over a longer time. IMHO, inflection points to be defined quantitatively for each of these businesses - this is a function of the EPA spread and the sustainability of the spread over long. One must remember that a lot of these businesses are still in early years (< 10-12 years of growth) and it’s only over 20-25 years can you identify the sustainability of the moat. for eg., for a business like astral, I would be worried if RoIC’s go below 25 %, market share dip of more than 5% in a year and EBITDA decline (just representative, not final). Even buffet, has 4-5 key operating metrices that he tracks weekly for each of his businesses - for eg., say underwriting losses in insurance, float growth or Same store sales in retail. In avanti’s case, I would track gross margin and asset turns.

3). The EPA spread and the sustainability of it answers the question about the superiority of the business. Like federer in tennis or tendulkar in cricket, it is a high average and consistency of average that indicates a great player.

My only request would be to find out the time dimension - both historical (time lapsed for the business and the time ahead, including key inflection points predicted). Whether in physics, sports or in life, it’s longevity that matters.


(Donald Francis) #12

Keep reactions flowing in. These can help clarify things for us as also others who want to take this forward.

@ Rajesh Rajput

1). Thanks for caring to provide the feedback upfront - about effectiveness of Template

2). This filled up BQ Sheet for a business - say Mayur or Astral - is a culmination of all the hardwork done in understanding the business, industry, competition. The time spent in scuttlebutt - meeting and talking to dealers, industry guys, Management and other stakeholders

3). Which means by the time you think you have done justice to the BQ sheet - you already understand the business well, have tracked it for a couple of years, seen the Management walk the talk - and therefore have a pretty decent idea/hypothesis on near-term and long-term visibility. Ultimately, performance on field will tell its story.

4). BUT, BQ sheet is equally effective for me - in thinking deeply about a business that is new to me. I get to form a hypothesis - before I even start on the scuttlebutt. But that’s a different story - will elaborate on that process, sometime later


(Donald Francis) #13

Continuing on above reactions:

BQ Sheet is like a verdict on the business -a snapshot, at a particular point of time)- at a higher abstracted level - to help us focus on our mission - make it easier for us in -separating the wheat from the chaff.

@ Varadharajan

Thanks Varadharajan - for bringing that out clearly for all of us. Snapshots, are meant to be revised and updated at regular intervals )- 6 monthly, yearly or as & when there is material change in variables in business/industry.

Good inputs and floors and ceilings for industry/individual business based on nature of industry. Need to think more on this - but my sense is - these are a matter of detail - and part of the quantitative work that goes in while understanding the business/industry

Inflection Points - might be a good placeholder to include (at what point would you start worrying). I can see the merit in that straightaway. That would be useful whenever you set to review the Snapshot on the business.

Will be delighted to collaborate with someone of your quality. VP was conceived as a collaborative research experiment. That it is thriving is because of folks like you participating meaningfully. The more we participate and share our hard work and insights, the more people seek you out - and teach you more, speed up your learning curve :slight_smile: That’s been the VP experience

Please keep writing in. Will share more on other reactions that have come in by email later


(Varadharajan Ragunathan) #14

@donald - thanks. I am just learning what I myself figured over the years.

The reason why I think floor is important is that it gives you a sense of the downside that’s possible - for eg., in e-commerce today, you can have your equity go to zero whereas in oriental carbon’s case, I can’t see RoE drop below 15 % - I see growth to be a bigger challenge for oriental carbon. Think of those as a car with an EBS + air bags + EBD vs a normal car.

Seth klarman keeps driving it in "eliminate the downside and look for an asymmetry of upside ". That’s why I get fussed about the floor - it could be just me

Inflection point : typically, I think 2 on PL side and 2 on the BS side is what works at a top down view level. For business like oriental carbon, revenue growth, forex exposure, and DSO would be the only things I would look at .

For a business like Avanti, I would be very worried if YoY revenue growth went below 10% (given that that could call for a much closer introspection of the on ground situation).

For a business like infosys, it would be revenue growth, forex gains/losses , EBITDA margins and DSO (because I know debt/investments into fixed assets and FCF are unlikely to be issues).

Again, I feel very happy to be a part of this forum. You guys are fantastic at moving the needle further


(Muthukumar) #15

Thanks Donald, VP Core team for sharing an excellent and easy to use template to share the unfolding story about the business via BQ insights with category grade + valuation mapping.

It will be great to have an example for a NBFC or BANK part of this template.

Regarding Avanti Feed (to learn again):

BQ category --Above average business, but Laborious: Category B ?

Stable PERange : 10 to 15

Perception/Expectation: It is broadly inline with perception/expectation as of now.


(biju john) #16

Thanks donald for sharing the template,the difficult one among them all is avanti feeds.

1.Lot of external factors affecting their performance over which they may have little control-global prices of shrimps,other markets recovering from diseases and staging a comeback,government policies(other countries providing subsidies etc).This looks to me like a commodity play and will undergo cycles of prosperity and gloom.If farmers are not making money or there is a glut what would the feedmaker make?There is no concept of minimum support price for the farmer.

2.regarding disproportionate future-i dont see shrimp replacing chicken/fish/meat in the daily diet of a non-vegetarian. Iam a non-vegetarian and i like to have it once a week ,not more whatever one says about its nutritional content.Just look at the costs atleast in the indian context shrimps 300 a kilo,maybe chicken 150 kg,the price differential exists and among fishes there are cheaper alternatives.

3.The main driver could be if they could get into the branded segment where they could get frozen stuff into the supermarkets like venkys or open their branded outlets serving shrimps and seafood,that would definitely increase the appeal of shrimps and take their valuations to another level.

Till then one has to be happy with moderate valuations(10 p/e),commodity type and pray for favourable conditions and markets.The comforting factor would be the management competency and their ability to deliver in terms of operational efficiency and return on invested capital.That deserves a slight premium on the valuation.

Some of the things mentioned in "what can go wrong’’ may be perception of lot of people and may not be true,but it still prevents this company in getting a fair valuation despite all metrics being right.


(Atul Garg) #17

Thats a holistic and very crisp format. Kudos…Donald and core team.

Another important aspect in addition to various BQ measures is if the business is facilitating a bigger trend that the world is undergoing.

Moving from unorganised to organised, outsourcing come to the top of mind.


(Donald Francis) #18

@ Muthukumar

Thanks for the Thumbs up

Re: Avanti - we are asking if there is GAP between Performance and the Perception/Expectation (which gets captured in PE). Response not clear from your post.

@ Biju

Avanti is a very interesting case to think deeper on subject.

Remember Perception (P/E) was 3-4 less than 6-9 months back despite the business going from 300 Cr to 600 Cr Sales to 1000 Cr plus. When it became clear Sales were going to near 2000 Cr (in AGM) Mr Market sat up and said okay lets give it 10 P/E, look at the margins, look at the RoCE!!

Despite all those multiple things that can go wrong, everything went in India and Avantis favour, and we know what happened. There is a case for things going smooth, is there?

Equally interesting to ponder where will this business be if it gets another 3 years of a free run? And if that scenario plays out, what may be the Performance vs Perception GAP??


(Donald Francis) #19

Some more food for thought …from Senior Investors

Few incremental thoughts from my side__

  1. On predictability, number of variables is fine to look at, and we are capturing it. A related angle of this dimension is out of numerous variables identified,how bad can the single biggest variable getfor prospects of the business.____
  2. To illustrate, USFDA for pharma is just one variable but it can be a killer for certain companies given their product & revenue mix. Withdrawal or non-renewal by Licensor like Lubrizol or key partner/technology supplier etc is one variable but can hugely erode the competitive edge when the going gets bad.____
  3. On the other hand, Mayur is laborious business alright, but there is no single variable that can kill this company which is a business plus. Variables on the table are all usual stuff : Chinese competition, export markets, currency management, capacity etc. In short, such business scores highly on predictability.____
  4. On Key monitorables over next 2-3 years,Market share in volume termsand its growth y-o-y remains the impact parameter which is not coming out forcefully in the template. I can imagine lack of reliable data here. That said, whatever yardstick or basis is used to formulate the initial investment hypothesis can be used to verify or validate it 2-3 years down the line.

(Donald Francis) #20

My reactions:

1). Yes in a business like Mayur perhaps nothing can go that wrong that horribly - that’s a great observation -the business has good chances of plodding along even if a few variables are amiss - Predictability is actually high!

Therefore we must have some Laborious greats in our Portfolio, along with some others where 1 single factor can go horribly wrong but ODDs are low and remote (like Astral-Lubrizol).That will mitigate single-factor risks at the Portfolio level.

2). While 1 factor may go horribly wrong, the ODDS of that kind of a risk coming to play need to be weighed. Besides how much of exposure the business has to this factor and is it getting increasing de-risked will weigh in. Valuations will also play the role (say Astral & mayur both become available at 20x 1 year down the line)

3). Yes, USFDA has a become a joker in the pack for Pharma companies with high exposure to developed markets… And the ODDS of things going wrong are maybe high at 50:50. So a Hitesh Patel will say you can still play this aggressively where USFDA has just finished inspection and they are clear - so next inspection is atleast 2 years away - the bogey is off your back :slight_smile: