Very interesting points. Let me try and add my thouhgts more to clarify my muddled thought process though penning it down.
“…not clear which business has the best economic characteristics” - how do you define what is the best economic characteristics, that I think is the question… Is it return ratios, asset turnover, margins, market share etc? Or does it inlcude possible market size and market share in the, say, next 10 years? If yes, then how do you measure that?
“…data that is being thrown up by members…about the quality of these excellent businesses…” - So, let us look at the numbers from one of these companies, say Mayur. (Let me pick Mayur as I have it has the highest capital investment and the second highest weigtage in my portfolio).
What does it tell us? That it has increased sales about 6 times over the last 5 yrs. Margins have doubled but has been in the same range for the last 3 years, not enough to conclusively prove that it has moved into a higher margin business or if its a cyclical upturn. ROIC has again gone up significantly in the last 3 years, but not enough to be sure if its a secular upmove or cyclical one.
All this tells you what happened over the last 5 years, with no real indication of how it happened and most importantly why it happened. The numbers tell you that it might end 2012 with a revenue of 300 odd crores. How do I know whether revenues can go up to 3,000 cr or 30,000 cr in the future? Can someone me what the net margins are likely to be in 2020? Will they be 15% as it has been for the last 3 years or will it be 8% like the 3 yrs previous to that, or any other number for that matter. I rest my case on this point.
“Assume all of these businesses are available ~7x 2013E earnings. Where will I put in my money - I think these numbers are a great way to start thinking more clearly on how much capital to allocate” - Great question. What I would do if I got say Mayur, BKT & Guj Reclaim all at the same valuation is I would have a 50:30:20 spread amongst them. The logic has nothing to do with numbers here but everything to do with “feel” and circle of competence and understanding of business risk. Mayur has a much higher potential market size and not too may competitors. Management seems sensible. Company is growing. BKT has a niche market which is difficult to replicate easily. Gujarat Reclaim is also a niche business but scalability is somewhat limited to my mind. It cannot increase its sales 10 times in the next 10 years even if it tried to. However, stock prices have a nasty way of misbehaving and making us look like fools. So, you might see Guj Rclm doing the best in the next few years!
Aonther way I have learnt to think (borrowed from Charlie Munger from his Art of Stock Picking) is if I have to start a business and have access to unlimited capital, what business would it be? And if I have to harm any business what could I do? Again, taking an example, would I buy Mayur as a whole company today (assuming they are willing to sell and I have unlimited capital)? If yes, why? If no, why not? Also, if I have to start a competitor for Mayur, what would I need to hurt Mayur? Can I take it out of business?
Net net, my thought process is more based on critical thinking and subjective analysis aided by core fundamentals, rather than the fundamentals itself.
P.S 1 : I take all published numbers with a pinch of salt. I am not sure if all the numbers that are published are 100% accurate. Not saying management is not 100% honest in all cases (which is certainly true in most cases). But other than actual cash numbers most are back calculated to a certain degree. So, use the numbers as a guide and not a roadmap.
P.S 2: Girish, free cashflow is an approximation in most financial statements as it is not directly reported. But to my mind it is one of the most important numbers that we should look at. Cash is king, you cannot dispute with it , unless of course you are holding Satyamshares:-)
Whew!! That ends my lengthy discourse, and now back into hibernation!!!