Mega-Caps, Large-Caps, Mid-Caps, Small-Caps, Micro-Caps, Nano-Caps… As if the business analysis wasn’t complicated enough, we have divided the universe based on size as well. But does size really matter? The answer will be a big yes if you are running a mutual fund, or some other regulated fund like a pension fund, which has to 1). Comply with SEBI guideline and stick to fund mandate by investing in the universe of stocks which comply with that and 2). Ensure enough liquidity so as to be able to enter and exit with minimal impact cost. But the same isn’t true for individual investors and in fact is their biggest advantage (See Jatin Khemani’s presentation on ‘Individual Investor’s Real Edge – TIA 28th Jan 2017’).
Generally speaking, large caps have been around for longer and hence are perceived to be less fragile than smaller companies, which has indeed some truth to it. But there are many small sized companies which are market leaders in their respective industries and in a better competitive position than many of the large organizations (in other industries). Yet they are small because their addressable market itself is small, though that could be growing fast. Some of these companies would fit all your checklist no matter how stringent they are in terms of return on capital employed, debt-free balance sheet, high cash flow generation, sensible capital allocation, high promoter holding without any pledge etc. To not consider them purely on the basis of their small size may not be prudent.
Though the opposite of this is also widespread- investors often pass on large-cap ideas no matter how attractive they look, thinking they are well discovered. There are so many examples of steady compounders from private banking, IT, pharma, FMCG etc. which despite being large cap and well-discovered have continued to compound at high teens for long periods of time.
Instead of classifying businesses based on market cap, internally we prefer to use following segmentation:
1. Established Businesses: These are companies which have been around for long and have been able to create a strong franchise. In these cases, one needs to focus a lot more on the strength and longevity of business than the key man like promoter or CEO. For example, in a business like Nestle or Asian Paints or Pidilite, it is okay if you don’t even know the name of the CEO, leave alone his personality, background etc. because the franchise is so strong that it will most likely continue to do well. Maggie’s quick comeback from that disaster is a perfect testimony to this. Perhaps these are the kind of businesses which Warren Buffet must be referring to while saying he likes businesses which even an idiot can run. Of course having a great leader adds further to that momentum and is a bonus. (See Anti-Fragile – 20 Companies that are century-old)
2. Emerging Businesses: These are companies that have come into existence only in the last two or three decades. In this case, besides conducting the usual business analysis, a significant time & effort goes into finding information about the key man, we usually prefer to back first-generation owner-operators in such cases. It is crucial to find out how ambitious the leader is because no matter how profitable and big the opportunity size is if the promoter is complacent, the opportunity may never get seized. When Infosys’ IPO came it was a bet on Mr Narayan Murthy much more than it was on IT business, similarly, it was more on Mr Chand Sehgal in case of Motherson Sumi than it was on the Auto Ancillary business. Whereas for those investing in these businesses today, it is much more about the business than the key man.
Stalwart Advisors’ Model Portfolio has 20 stocks currently and the majority of these are from 2nd category of emerging businesses, which is our focus area. We believe big money is made by investing in emerging businesses having the potential to graduate to the first category. Although being an institution, we pick stocks with adequate liquidity so as to minimize impact cost.
|Portfolio Characteristics||Current Portfolio|
|16 Market Leaders||20 Stocks in Model Portfolio|
|14 Owner-Operators||15 Stocks in Buying Range|
|14 Debt-Free||Deploy 75% Capital Immediately|
We rush to shopping street when there’s a sale, unfortunately, we often do the opposite when it comes to stock markets. One such sale is going on right now and we believe it is a good time to start deploying meaningful capital and also increase allocation to equity asset class. – Jatin Khemani