This is such an excellent post. You have condensed the process of judging businesses in 6 simple questions (finding answers to them requires great lot of hard work). And if answers to above questions resonate with oneself, one can allocate more & more.
Thank you for setting the context as well. Our ultimate pursuit is to find strong, growing emerging businesses which will have enormous wealth creation & transformational effects on our lives. (Simply put in your own words from VP journey presentation many years ago - 20-25% to HDFC Bank bhi de raha hain, we need more!). This is the thing worth pursuing.
On above part, I strongly feel BQ/MQ has to be separate from potential growth in short/medium/long term. This helps me with clarity of 2/3 things -
- As growth falters, narrative changes from “what a great business/management this is” to “forensic investigation of smallest of things, disapproval/disappointment with management etc.”. If one has done proper work on BQ/MQ, one can manage this narrative change pretty well & hopefully to one’s advantage on valuation front.
- Many emerging/strong businesses can go through periods of business under-performance due to various reasons. It keeps me incentivized to keep tracking these businesses even in these times.
- Optimizing capital allocation. If one has list of 15-20-30 great emerging businesses, one can figure out may be 10 businesses which are better in terms of growth visibility or valuation & optimize capital allocation.
I can think of two examples - RACL GearTech & Axtel Industries. I am not sure if it makes sense to go into these businesses in this thread. But I will write in brief about these two businesses below. If you feel it is not appropriate, please moderate away.
RACL GearTech has been posting pretty good results for 3/4 quarters now DESPITE such bearish auto industry backdrop. The business seems differentiated (or has a niche) on two fronts - significant focus on export markets, manufacturing specialized parts for global high end two wheeler customers. Further, for such a small company, they have been smart to keep the end industries diversified so that headwinds in one industry does not stop them from growing. I had opportunity to observe & interact with them once recently & it seems that management has “growth mindset” & management capability to be a lot bigger than their current size.
BUT (Here comes the hard part, at least for me) is this growth sustainable? I am scared in back of my mind that - is this one off? What is driving this growth - new product introductions? new customers? Is there product/customer concentration? How will this company fare in terms upcoming EV disruption?
Basically, a lot more work is required (at least for me), to read about their customers, growth in their customers, understanding their products a lot better etc.
Axtel industries is what I would like to call is a “soft monopoly” (like Poly Medicure). The gap with nearest competitor in terms of capability/customers is quite large. The management seems like a technocrat management. There is clear cost advantage with global competitors like Buhler. It’s a different matter that Buhler is far ahead in terms of technical capability. The company has been doing projects for customers like Nestle/Hersheys/Mondelez/ITC/Amul etc. & some projects in export markets etc. Superficial tracking of end industries shows that - chocolate industry is growing at 15% CAGR & there is talk of CapEx. Nestle is talking about product introductions & CapEx. ITC is in perennial CapEx mode. Most snack players are in growth phase.
BUT will the trajectory of the business move from inherent 15% kind of growth to 25-30% type of growth that we seek? At least, I do not know! I will keep observing.
This is an attempt to demonstrate my central point - it is imperative to get the growth thesis right, to understand reasons for growth in granular manner, understand whether & why underlying growth trajectory can remain for 2/3/4/5/10 years without compromising on quality of growth & to figure out why & when growth will go down. This is pretty much an EDGE that we are all seeking.
This is not to say that we have not been doing this in BQ framework, we have been always doing it. It’s just that this aspect needs most attention post basic sanity checks & hopefully formalize it as much as we can. And to prevent us from throwing caution to the winds when story catches fancy & lowering our guard.
Disc - I have positions in both RACL Geartech & Axtel. This is not a buy or sell recommendation. I am not SEBI registered analysts. Please do your own due diligence.