Portfolio construction: Part 3

The second set of stocks - it is never enough!

Part 2 of my blog can be found in the link below, do give it a reading if you are seeing this for the first time.

When I started off writing these posts I thought I would more focus on the macros and the bigger picture. But, my mentor told me that everyone has an idea of things from a distance, its when you get close you lose the plot. Keeping this in mind, I thought it would make more sense to focus on the micro and come up with specific company names that perhaps would pique an investor’s/reader’s interest. So, here goes.

In my current set I’m going to relax my rules further and focus more on “growth”. Companies that have been able to grow beyond their pre-COVID levels in terms of sales. A lot of them would have compromised on the margins. The idea here is if we are able to pick companies that can sustain market share and control costs simultaneously in the future then we would’ve picked some winners for our portfolio.

The parameters being used here are as follows (Again these are non-BFSI):

1. 5 year sales CAGR of 10%+ - we are going to focus only on companies that have grown in size

2. Positive networth for the last 2 consecutive years - this would weed out businesses that would’ve started off recently, grown fast but would’ve burnt too much resources or would weed out businesses like Vodafone Idea that have accumulated losses.

3. 2 consecutive years of positive PAT - showing that the company does display some financial prudence even when it is pursuing growth

4. 5 yr total Operating cash flow > 0 - the business has been able to generate surplus cash after working capital requirements in spite of growing aggressively

5. EBITDA shrinkage of not more than (-50bps) p.a over the last 6 years - Though I’ve not used an EBITDA growth filter I’ve made sure that the growth in topline doesn’t come at tremendous cost to the profitability.

6. Operating Cash Flow/EBITDA > 0.5 for the 2 previous consecutive years - this tells if the business has been able to convert its accruals into cash or not.

7. Debt/Total Capital < 50% for the 2 previous consecutive years - this shows that the company is able to fund its growth predominantly from its internal accruals. speaks volumes of the capital allocation record of the company.

8. 5 Yr average RoE > 9% - This is a highly relaxed rule. We are ok with the company sacrificing on its capital efficiency a little bit for growth. I usually like to keep this measure ~12% but given that we are focusing on companies that are growing fast, 9% would do.

The names that popped up are:

A few observations:

1. ~30% of the companies are at least 10% away from their 3 year highs - seems pretty consistent

2. ~41% of the companies are less than 5% away from their 3 year highs - which seems to indicate the markets have rewarded growth

3. Only 13 stocks out of 36 have reduced debt which is fine because we are looking at companies that have been a bit aggressive

4. There are 5 companies who’s 5 year stock returns have been less than the growth in PAT and there are 12 companies that have delivered returns that are 10% at most higher than the growth in PAT. This measure is very important as this shows if the stock prices are running ahead of the fundamentals & vice versa

Considering all of these the list of stocks that seem interesting are:

1. Shree Cements

2. Natco Pharma

3. Eicher Motors

4. Alkem Laboratories

5. GAIL

6. Triveni Turbines

7. Indiamart intermesh

8. Varun Beverages

9. Fertilizers and Chemicals Travancore

10. Grindwell Norton

This is my second set and many companies in this set might not even feature in my portfolio for the next 5 years but my research on them would continue. This is because one great investor whom I regard highly told me that he made an investment in 2021 for which he had done his research in 2013. It left be flabbergasted! That’s how long term investing works.

Again, my effort here is to run this quant screener as much as possible till I have a list of 50 to 75 companies that would become my investment universe. These 50 to 75 companies will be tracked closely and be brought into the portfolio and taken out depending on how the valuations play out.

Stay Tuned for my next list!

Disclaimer : I am not a SEBI registered investment analyst; none of the securities discussed here are investment recommendations; the views expressed are my own and are not that of my employer or their associates; I can not endorse the veracity of the data that I have pulled out from databases