We are sharing the way we go about researching for a stock. We have developed our own set of detailed checklist that help us carry out research systematically and process complex information comprehensively.
Our research starts off from building a pool of potential investments by separating quality businesses from thousands of stocks out there. We use advanced screeners to filter out companies based on market cap, ROCE, growth, PE ratio, promoter holding, pledged shares etc. Once that is done, we run a preliminary valuation for these companies to figure out at what level the general market is willing to give them up.
Then we turn our heads to one of these companies and start with our established framework for research. Here, we try to give all our focus on the below mentioned broad characteristics of the business:
For us, the most important characteristic that will impact our returns and investment decisions is 'Business Quality'. We only want to buy quality businesses (at fair prices) and allocate not more than 15% of our portfolio to risky bets.
We then turn our attention to the management aspect of the business and remove those companies with bad management whose intent we do not think is in the favour of the shareholders. At last, we do final valuation incorporating the quality aspect of the business in our models. We decide a range at which we would make the purchase.
This is the most important characteristic for us to analyse while making investment decision. It is the business quality of a company which will determine our future returns. We have been trying to improve ourselves continuously to understand and analyse businesses in a better way. We believe a good investment is one which promises, one, high growth and second, high ROCE while protecting these returns from the competition.
Over the years, we have compiled down a comprehensive (yet not exhaustive) checklist of how to go about analysing business quality of a potential investment. When you actually go about researching about a stock, you realise that you don't have a proper structure of research which will help you cover all the important points related to the business.
We do agree that researching and investing is an art and not a science which cannot be compiled down to one checklist which will protect you from all the dangers of the investing world. But we do believe that researching with a proper structure and clear path in mind will help you attain more information in a better way as well as process it and understand it systematically.
In brief, we start with understanding the industry characteristics, whether its cyclical or defensive, monopoly or perfect competition, type of margins etc. Then we move on to company specific characteristics where we try to understand the core business, its competitors, expected growth rates, economic moats (if any) etc. If you wish to read further on business quality, please click here to gain access to our complete business quality checklist.
Checkout our detailed checklist about how to determine the quality of core business.
It's often said that assessing management quality is difficult. This aspect being purely qualitative and with no set method of study is more often than not neglected by a large part of the investing community. Not anymore. Over the years, after investing for multiple years, learning from successful investors and from our own experience in the markets, we have been developing a checklist on how to analyse the management aspect of the business.
Obviously, this is not a comprehensive list but we believe there are some aspects which are way more important than others which need to be checked and we have covered that. We have divided management quality into two parts - one, 'ability' and the other, 'intent'. Ability of the management refers to how the management is actually operating the business. Is it even capable of running this business?
Intent of the management measures how does the management behave with its shareholders and the company. It tries to capture the true intent of the management. Now, we really want to focus on the wealth destruction activities of the management and how it treats its minority shareholders.
Is it trying to steal from the company? Is the management trying to siphon off funds? Minor red flags that don't really affect the shareholders do not matter to us. After all, who doesn't love money right? If you wish to read more about management quality, please click here to view the complete checklist we use internally.
Click here to see our detailed process on how we determine the management quality.
We are big believers of risk management and paying the right price in order to buy a stock is of utmost importance to us. One of our established risk control measure is to buy the stock at a fair value which in a way protects our downside. No matter what, we don't want to invest in a company who is trading at exuberant valuation.
Think of it in this way. When we buy a stock, we expect to generate a return out of it. This return can be divided into fundamental return i.e. return generated from business performance and speculative return i.e. which we will face due to the whims and fancies of the market. By limiting our buy price to a fair value, we strongly bind ourselves to the business performance only leaving us further probability of earning a speculative return.
Our team has developed valuation control techniques that automatically highlight suspicious numbers in P&L, Balance Sheet and Cash Flow Statement. These red flags are then checked manually and we only move forward once satisfactory answers are achieved.
We believe it is our conservative approach and propriety valuation models that we use that really gives us an edge over the other players in the market. Our strategy is more or less focused on only buying quality companies at fair prices (which is available only during market crisis). If you wish to read more on how we try to value the company, please click here.