[This is not an investment advice, just one approach to investing – your investment philosophy shall be based on your risk profile and financial goals]
I think everybody should have investment philosophy. Your investment philosophy drives your decisions at different levels. Here is an example of investment philosophy in equities.
To compound money at much higher rates than benchmark by investing in very quality growing companies.
My strategy is to build two portfolios
I keep a very strong check for my core portfolio but am okay to compromise some of these for my non-core portfolio. Here I want to list down my criteria for my core portfolio
How large can the company grow? Is the market size big enough or growing fast enough for company to grow bigger. One good thing about investing in India is that most of the markets are growing. One good example is housing finance market – even a large company like HDFC Bank has been growing 20% CAGR for last so many years.
Big market means nothing is management is not able to grow at market rate (ideally better than market size growth). Longer the track record, more conviction in the growth of the company. However, it is also important to look at recent growth numbers lest the company’s growth rate is falling. An example: Gruh Finance, a company in housing finance (growth company in growing market) has seen its profit grow at CAGR of 28%+ in last 10 years. Last 3 years growth is at 19%+, profits slowing down because of base effect but still growing strong.
ROCE and ROW are the best ways to measure the quality of management. The more management can extract return out, the more profits it can be invested back to grow faster. High growth company with high return on equity can be the best combination you can find. The problem is – these companies are usually available at very steep price. However, stock market keeps giving opportunity to buy such companies from time to time. Titan is an example of such company with high growth and high ROE – however recently being underperforming because of various reasons. On the other hand, there are high quality companies that are not growing very fast (e.g., Colgate – some investors do not mind owning such companies). I also usually do not like high leverage companies (high debt). I also evaluate competitive advantage of the company subjectively and the time frame for which companies can manage this advantage.
This becomes the biggest eliminating factor for most of the good companies. Market size if huge, company has been growing at very fast pace and quality of management is awesome. But guess what, everybody knows about this and hence such companies quote at very high price. This is also one of the most difficult factor to evaluate a company – how do you know that company is overvalued or undervalued. Unlike, growth rates or ROE, value cannot be figured out by a number (because it is very hard or impossible to predict how much profits a company would generate in future). P/E is used by lot of investors but in my opinion, it is a flawed tool – valuing a company based on its current year earnings does not tell much. Check out this company called “Page Industries” is quoting at PE of 64 (10Y CAGR of 37%, ROW of 58%). Is it expensive?
A company may be doing good on all fronts but there can be some red flags. I do not have an expertise in reading all red flags so I usually reject based on even minor hint of any problem with the stock. Sometimes just a simple Google search can help. Check out “Lycos Internet Ltd” – 10 year CAGR 78%, ROE 25%+ and PE of 3.3, however the cash flows have been lagging behind the reported profits.
Let me also list down companies that I do not look at for my core portfolio (again this is according to my philosophy, there is nothing right or wrong)
Disclaimer: None of the stocks discussed here are investment advice. This is just an example of investment philosophy.