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| The corner stone of our Investment Philosophy |
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The research process and structure could be explained in following stages:
Defining the Investment universe:
Our research team regularly scans the whole universe of stocks on certain well-defined objective criteria, such as |
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| Profitability ratios such as RoCE (Returns on Capital Employed), Return on Equity (ROE), incremental ROCE and ROE, dividend yield, return on market capital etc. |
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| Without any subjective judgment superimposed and having generated the screens, the investment team applies qualitative filters to arrive at final screens to be taken up for final evaluation. This is an ongoing process deployed to define the current investment universe. |
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Sector evaluation:
The next stage is evaluation of the size of addressable business opportunity of the stocks that have been selected. The size of an opportunity is a very critical criterion for us in context of the size of the company we are evaluating as well as the portfolio mandates under our management. This requires a comprehension of |
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| The concerned sector or industry and the future prospects. We prefer to participate in companies that represent a large opportunity size, rather then large companies operating in low growth situation. |
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| The long term growth expectations |
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| Sector specific risks - regulatory, competing products, shift in consumer preferences, demand supply equation in case of commodities etc |
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Business Characteristics:
We also lay an emphasis on the "inherent" characteristics of the business of the company. While the previous stage sensitizes an analyst to the current and potential size of opportunity, this stage instills an understanding of how "profitable" the opportunity can be. |
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| Micro evaluation of the business dynamics - |
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| Asset driven or cash generating? |
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| Nature of capital intensity? |
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| The ROCE potential of the business under normal and sustainable environment. This "normalized" RoCE should be superior to our benchmark cost of capital for the growth to be value creating. |
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Company specific evaluation:
This stage requires the evaluation of |
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| The strengths of the company in terms of experience as well as expertise |
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| Its management bandwidth and integrity |
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| Management depth is another key parameter. This pertains to a company's internal capabilities to provide leadership for long. |
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| Corporate governance track record and accounting policies |
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| Leverage policy, if there is a steady requirement of external capital |
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| Capital allocation policy and record |
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Valuation of the Security:
As explained earlier our approach to valuation is not just of pure value, or of growth but a blend of both. We have a proprietary method of evaluation, which takes into consideration the growth as well as value in the company. The valuation model passes through a rigorous cross checking across senior team members to remove any subjective biases. |
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| Discounted Cash Flow (DCF) is the most preferred approach and we use it to as many cases as possible. We discount the cash flows to the firm and derive the total value split across Cigar Butt (valuation assuming no growth in cash flow over the economic life of the business) and Growth Value (evaluating the growth component in the cash flows). |
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| Relative Valuation approach generally supplements our DCF in most of the cases. However, in cases where DCF is ineffective, this becomes the principal tool. We use this to see enterprise multiples and price multiples historically as well as for a peer comparison if comparables are strong. |
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| On this derived value, we impose the margin of safety with which we would be comfortable buying the company and at which we will be willing to sell it. |
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Setting up Buy/Sell Strategies:
The important criteria in setting up the buy/sell strategies include - valuation, size of the company in context of the size and nature of mandates at the portfolio level, the liquidity constraints due to market factors and the teams view on the macroeconomic undercurrent in the system. And the sequence of the investment approach mentioned above is sanctum sanctorum. |
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