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It is not very difficult to pick a winning business to pick the right stocks Getting the big picture right is perhaps the most important thing, so far as identifying aninvestment opportunity is concerned. Once we have that right, the other things are not asimportant in analysis. I will illustrate this with a simple example. For instance, I am in the business of growingvegetables. Each one of us is a consumer of vegetables. And, I think that for the next fewdecades, people will still continue to eat vegetables. So, I think that growing vegetables isa good business.Then comes the issue of how do the vegetables get delivered from the farmer to theconsumer. Is it that the farmer delivers the vegetables directly to the consumer? This isunlikely. Will the consumer go to the farm and buy these vegetables every day? Again,unlikely. Hence, there is a need for someone to fill the gap: someone who can collect thevegetables from the farmer and deliver them to the consumer. Multiple StagesI find that this process involves multiple stages and, in the traditional or existing supplychain, there is no valueaddition, except some kind of sorting, before it is offered to theendconsumer. If a new business were to emerge that aggregates directly from the farmer,does a lot of valueaddition in terms of cleaning, sorting, grading and packing thevegetables in a hygienic manner, there would be a demand for the products. If we thinkthis is a business that is here to stay, we have identified a place to invest.

Moneylife » Investing » Learning » Get the Big Picture Right

Get the Big Picture Right

R BALAKRISHNAN | 05/05/2015 10:22 AM |

PERSONAL FINANCE INVESTING COMPANIES & SECTORS ECONOMY & NATION LIFE

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Extending it further, let us look at someone who has set up a chain of retail stores to sellthe vegetables. Is this business here to stay? As an industry, the answer is ‘yes’. As abusiness, there might not be a sure answer. There is competition from stores that come upin the neighbourhood, someone else with lower rentals and overheads, someone whooffers delivery at consumers’ homes, some online portal which lets consumers buy forhomedelivery or some mobile van which visits every neighbourhood… Yes, selling ofvegetables cannot disappear; but the way it reaches the consumer can keep changing. Thus, we can say that the logistics business is an attractive one. It is merely the link thattransports the product irrespective of size, shape, etc. We maintain that goods havealways to be moved and, hence, someone providing this service is here to stay. One oldstory has it that the most money during the Arizona Gold Rush was made by Levis Strauss—providing material for the tents and hardy trousers for the prospectors. No gold minerperhaps had so much of predictable earnings as Levi had! Now, one can perhaps understand why apparently simple businesses, like Gillette, do sowell—whether today’s Mach3 gives a better shave than the cutthroat razor of a couple ofcenturies ago. Each year, Gillette seems to admit that it is yet to find a perfect shavingsolution (since every model claims to be ‘new and improved’), but it continues to enjoysupernormal returns and market share; the power of a brand that has been built up overyears. Apple, for instance, is a brand that stands out in a commodity business of selling afew electronic products. Or take CocaCola. These are brilliant consumer franchise modelsthat are exploited to get great returns. In a high growth economy that is emerging frompoverty to riches, there will be a lot of shooting stars: businesses with apparent neartermgrowth but which are fundamentally not attractive businesses. Like the company thatbuilds houses or makes roads: a big business opportunity for a limited period of time. Secular DemandThe key is to pick the right space. For instance, we know that houses are needed urgently.However, if we look at the building industry, we are not happy with the quality ofbuildings and the lack of transparency. Stretching a bit, we also know that, today, mosthouses are sold to people who finance them with a housing loan. So, if I am bullish onhousing, why not choose the person who finances the purchase of a house? Unlike a housebuilder, a home loan provider will have longevity. Builders may come and go. But a homeloan will last its tenure. Maybe, the company gets acquired or merged. But the business isstill there. Tomorrow, a builder may just close down. He may get into a mess. While theindustry is set for growth, there is no guarantee that a particular builder will thrive.Hence, let us pick the home loan provider. We can see from our markets that there are companies like Asian Paints, HDFC Ltd, etc,that are primarily beneficiaries of the building boom. And these companies have beenaround for long, have a solid reputation and have high profitability and growth. Surely, abetter pick than a DLF or a Unitech! If everyone is going to buy more clothes, should we pick the company that makes clothes?Once we get in, we see that there are too many sellers competing. No single maker ofclothes may be a good bet. So, why not choose someone who is just a ‘seller’? He stocksevery brand and if one brand goes out, another is in. So a retailer may be a better bet inthis space.

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Thus, it is not very difficult to pick a winningbusiness. Certainly, it is not as difficult as it ismade out to be by analysts and media persons.In fact, if you read any research report on acompany, you would think that analysts think itis below their dignity to give a simplebackground note on what the company doesdifferently and who owns/runs it and how.

Promoter’s Quality Once we know the businesses that are good, the next thing to figure out is the quality ofthe promoter. This has to be done through contacts, media and, of course, Google.Ultimately, buying a share is akin to owning a piece of the company. It is important toknow what kind of a person the promoter is. Here, my view is that I cannot expect a lilywhite report on any promoter. Honesty, often, becomes a relative rather than an absolute value. One test is theconsistency of the return on equity (RoE)—profit after tax (PAT) divided by the totalshareholder funds or earnings per share (EPS) divided by the book value—and asufficiently high number. I also like managements that pay dividend regularly, do not siton cash balances and do not diversify wantonly. I do not give any weight to ‘independent’directors, etc. In the real world, no owner will take on board a truly ‘independent’director. In quality checks, I find that multinational companies (MNCs) score better than amajority of the Indian companies. The small list of Indian companies would includenames like Bajaj Auto, Hero Motors, Sundaram Finance, Mahindra, HDFC, Infosys, etc. Ifyou have a high hurdle rate on RoE, just a handful of Indian companies clear it. This hasled me to believe that the Indian promoter has a separate return on his equity which is notavailable to the nonpromoter shareholder. I do not hold a torch for the MNCs, but findtheir RoE numbers healthier. And MNCs also have a better dividend payout policy. Indianpromoters tend to sit on cash balances and to use it for unrelated diversifications.

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Akshat Agarwal 4 days ago

I didn't understand the Gillette India case. Most of the returns appear to havecome recently after May 2014. Am I reading something incorrectly here ?

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