I have been writing this thread after trying out multiple mistake of mine in last one year. Different investment strategies I have tried in this year and to be honest all of them has been a mistake. Last year I have been able to gain 37% CAGR on my portfolio and this year it has struck me with 15% loss . It would have been much more unless I have already booked some losses and some profit this year. Well the loss booking was proven the rightest decision and few profit booking as well but the profit booking in D-Mart haunting me till date.
Well verbose enough let me categorize where I have made the mistake.
- Depending too much on the Macro and when things change like LTCG, Import ban etc the macro driven stock gets badly hurt.
- Depending on cyclicals like mining stock is my worst mistake this year although I haven’t even invest 2% of my portfolio in this so the loss is minimal in terms of money. In my life I will never try this again.
- Due to the rally in Mid & Small Cap segment last year which I was also a beneficiary I was over excited to invest in them instead of going for the market leader.
- What I have found that all the cyclicals , small caps , turnaround has fallen apart and only the few compounding machines like Avenue Supermart , Page, Asian Paints, HDFC bank, Gruh , Bajaj Finance, TCS, Titan has kept on going.
So I would like to open this thread on the quest of finding these Compounding Machine. Though each of them belongs to different sector and have distinctly different success stories but few things are common. So let me jot down the common factors :-
1. Consistent Sales Growth and Profit generation:-
This undoubtedly the first and foremost factor of any good business . If in one or two year it has generated exceptional sales growth / profit and in other years it is fluctuating then safely avoid them.
2. High ROE :-
High ROE along with controllable DE ratio [except for the financial sector] is very important along with high ROCE and ROA which will depict the efficiency of the management to run the business.
3. Less Working Capital requirement and high Cash Flow :-
Less Working Capital requirement [relative parameter would be working capital cycle ] is always good since it depict the liquidity of the business along with high operating cash flow. Even if free cash flow is less due to investment activity then it is fine try to discard the cash flow from financing activity.
4. Strong Distribution Network :-
To become the market leader a company has to have established strong, well penetrated , loyal distribution network. Like tie-ups, JVs, distribution strategies like selling incentives, profit sharing etc. Like LT foods have tie-up with big hotels & JV in foreign countries , HDFC Bank on it’s initial days becoming first banker with NSE [making all the broker to open an account with the bank] , Ajanta Pharma is having the highest number of sales force etc.
5. Sustainable Business Model :-
What the company is doing separately than it’s peers in terms of operation why is it so unique ? Like D-Mar owning and long term leasing strategy is giving it way ahead than it’s peers , Bajaj Finance using machine learning to judge customer credit record , HDFC venturing into retail and consumer financing in the day’s of industrial & wholesale financing and depend on CASA ratio highly for source of finance, Asset Light model of TCS.
6. Business Moat of the Company :-
Business Moat I believe is the derivative of above two factors although we can certainly distinguish it other ways like Having a niche business or not e.g. CNS drugs for Sun Pharma, Oncology for Natco Pharma , Operating African region as the source for critical drugs for Caplin , Long term agreement with distributer/customer and JVs with different producer like LT foods , Unique licencing like Page Industry with Jokey , Strong brand and distribution network like Hawkins, Maruti , Nestle [Maggi ], HUL, Titan etc.
7. Trusted Quality Management :-
Management quality is the most important thing in my opinion and generally it has been found that market used to give at least 1.5 times valuation to the management than it’s peers. Like Gruh gets high valuation for HDFC Management , Avenue Supermart always gets high valuation due to Damani.
8. Current and Proposed Market for the product :-
Few things we must calculate after finding all the other above factors i.e what is the current market size and expected growth rate ?, whether it is still under penetrated or not ? If the entry barrier in the Market is very low or high ? etc.
9. Secular Industry and Growth :-
If the industry is secular like Food, Apparel, Medicine, Banking & Finance etc or from some luxurious capital goods ,cars , travel , holiday , amusement, entertainment etc or from some cyclical like metal , mining , agree commodity etc or from some ancillary like auto parts , pharma API, IT etc . One should always go for the secular growth stories and avoid the rest but not always like IT and Auto ancillary industry is a massive wealth builder in Indian context . Also we need to check that if the replacement cycle for those product is short or not since if the replacement cycle is high then the stock will automatically become cyclical.
10. Risk associated with the Industry :-
Risk associated with the industry is prime factor as in the Pharma we have seen risk of ANDA approval, in the banking & finance we have seen NPA, Bad Loans, Credit Risk , Liquidity risk , unseasoned loan book etc. , in the food [like Maggi] we have seen food corporation and authority inspection risk which adhere to quality , in IT currency fluctuation risk so does for any other foreign currency/debt exposer business , commodity price fluctuation risk for food and fmcg etc, consumer demographic & trend changing risk for fmcg .
11. Trade off between valuation and growth :-
In case all the above points are met then it was quite obvious that you can not get tham at cheap valuation so you need to make a certain trade off between how much valuation you should give to them. You not only need to calculate PE,PB, EV/EBITDA or DCF valuation but you need to put proper weightage to the business quality , moat , management , risk , distribution network , brand etc … i.e. all the factor I have discussed . I will be soon publishing such valuation method in this thread itself .
Well to find out the compounding machine I believe the logic is simple a company having all the above-mentioned criteria and consistent 20-30% revenue and 40-50% PAT grower is the key to go. Requesting all the VP member to share their thoughts on this and if I am missing out on anything. Some companies like Natco,Supreme Industry I found still in a consolidation phase so might be a good opportunity to buy other non-tested stocks like Bandhan Bank, HDFC AMC [Will be trading from 6th August good read for AMC and Insurance story] seems good one to me, please share your thoughts on them also if any other you find is matching the criteria kindly mentioned them as well.