The Hindu Business Line : Spotting the wealth creating companies

Manish Shah, Associate Director, Motilal Oswal Financial Services talks about the key qualities that his group looks for, while selecting companies and stocks.

Successful investors have their own trade secrets which they use to build wealth. But a little observation and an astute eye can easily find out what they do. Others can repeat the actions to write their own success stories! And many of the so-called ‘secrets’ are simply common sense principles waiting to be applied!

We summarise a systematic approach in identifying wealth creating companies, drawing upon our group’s experience of over 20 years, in investing in the Indian capital markets.

Assess the entry barriers created by the company: It is important to observe the company’s business and note the entry barriers created by it. An entry barrier should be preferably intellectual in character — keep in mind that stock is nothing but an equity stake in the company’s business.

For example, a strong brand becomes an intellectual barrier that is also very long lasting, than a piece of land which is more a competitive advantage and a physical barrier that is not significant when a competitor acquires one as well.

As an investor, it is advisable to identify such investments early on, as they might not have been exploited by the business and the market would not have valued it in the company’s share price.

One must keep in mind, that while examining a company’s expansion plans, growth in the franchisee of the same business is likely to be rewarding in the future than growth from a totally new line of business.

Passionate and talented management teams: Identify companies that are led by an able and passionate management team. As passion drives wealth creation, these two qualities can work wonders. Wealth creators are driven by a passion for leadership in business.

Integrity is the cornerstone of success and is an antecedent to market attractiveness: Integrity is the most crucial quality that a company’s management brings to the company. Such companies not only run their businesses honestly but can also be trusted to be honest to all their business associates, even to the smallest retail stockholders. Without management integrity, no margin of safety can be high enough.

The above three characteristics must necessarily be present together, in the identified company.

Enter the stock at a low price: The price that you pay for a stock determines your rate of return and hence it is essential that the purchase price is optimal. While some companies come out on top with regard to the first three parameters, the returns falter when it comes to the purchase price.

Arriving at the correct purchase price is critical as it helps mitigate several other mistakes. Hence, estimate the expected value or the intrinsic value of the company and keep an adequate margin of safety in the purchase price. It is important to buy cheap than to sell dear.

Patience, although a rare commodity, is crucial: It truly is the mother of all virtues, and undoubtedly holds you in good stead in capital market investing.

After investing in a stock, it is imperative to look at its appreciation on a long-term basis instead of trying to make short-term gains. Investing is often driven by two emotions — greed and fear.

And patience is what one needs to save oneself from the staggering effects of these emotions. Patience makes the difference between investing and speculation, and once practised, ensures a safe route to wealth creation.

BL RESEARCH BUREAU

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