Note: 1) I am using certain stocks as example to convey my thoughts. I have used these stocks because of my familiarity with these stocks. Request everyone, not to give too much emphasis to selection of stocks and letas not digress from main topic by starting debate on individual stocks, rather than thought process. 2) This thought process in mainly for Type C stocks, stocks with disproportionate growth.
I have not yet invested in any company following this process, but am trying to study various stocks with possibility of disproportionate growth in market cap over next 5-10 years.
One of the most important points to remember and understand that everystock CANNOT BE VALUED. Infact I would go one step ahead and say, valuation should be the last thing one should look into [By this I am not suggesting valuation are not important, but by initiating our thought process with valuation, we block our mind to see tremendous opportunity which lies ahead of the company or get too focussed on quantitative cheapness that we failed to see risks in the business model. Many investors ignore the risk of black swan events. I think black swan events in the last 10-20 years and occurring with frequent intervals and one just cannot ignore it completely]
**Ignore excel sheets, historical returns including ROE and ROCE and focus solely on BUSINESS MODEL AND SCALE OF OPPORTUNITY.**Again by no means I am suggesting historical ROE and ROCE are not important. But for many of such business when they are in their initial stage of high superlative growth, these ratios might be meaningless due to high expenses compared to current scale of operations, high investments in R&D etc. Read success story of Parag Milks here_http://forbesindia.com//article/big-bet/how-parag-milk-foods-got-it-right-with-cheese/35431/1_aIf he had gone about analysing this opportunity in a conventional wayalooking at the amount that would have to be invested, the return on that investment and so onahe would probably have decided it wasnat worth the risk. But he did what a classic entrepreneur wouldahe deleted the Excel sheets and took a gut call. aI realised it was now or never,a he says. He decided that there was an untapped opportunity in processed cheese and that Parag Milk Foods would ride the coming wavea
**Think like a venture capitalist:Have an investment horizon of 8-10 years and act as if you are investing in unlisted company and you will get exit opportunity only if company is ableto scale up its business model profitably.****If you think you will be comfortable in investing such business even if itas an unlisted company, then only invest else not.**Thinking in terms of decade will ensure that you eliminate companies where you suspect technological obsolesce, product obsolesce, regulatory changes or suspect management etc.
**Position size:**Again I think, mortality rate will be higher in such companies in initial stages when then is high possibility of superlative growth. Obviously superlative growth companies will be operating in innovative or untested field and there is very possibility that company may fail. So itas important to invest in such companies as a basket of 3-4 companies restricting position limit for each company to around 5%.