How to Move Beyond Good Companies and Spot the Great - The 5 Minute WrapUp by Equitymaster
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How to Move Beyond Good Companies and Spot the Great

Jan 22, 2016
In this issue:
» Have the valuations of Start up firms peaked?
» India's debt position riskier than its peers
» ....and more!
00.00
Bhavita Nagrani, Research analyst

One factor can make or mar the fortunes of any company.

Management.

Philip Fisher, renowned investor and author of one of the all-time best investing books, Common Stocks and Uncommon Profits, taught that an able management is essential to a good business.

Fisher, a growth investor, classifies growth companies into two groups - 'fortunate and able' and 'fortunate because they are able'.

What's the difference?

Let me explain with an example from the pharma industry.

The chart below highlights the historical growth of select pharma companies.

Select pharma companies sales growth during 2009-14

As you can see, these companies experienced healthy growth in the US from 2009 to 2014.

What drove this robust growth?

Well, several blockbuster drug patents in the US were due to expire. As the drugs lost patent protection, a number of Indian companies with a strong presence in the US jumped on the opportunity.

So make no mistake. This growth was not luck. Not all Indian pharmas in the US did this well. Only the companies whose management anticipated the opportunity and took the appropriate measures to capitalise on it saw spectacular growth during this period.

Fisher would call these companies 'fortunate and able'.

They were fortunate to be operating in in the right place at the right time, and the expiring patents provided a fortunate opportunity. But only the 'able' companies managed to capitalise on the fortunate circumstances.

Later, riding their success, these companies shifted their focus to other segments. But here again, only a few were able to take their business to the next level. Sun Pharma is one such example.

Along with tapping blockbuster drug opportunity, Sun Pharma's management decided to focus on opportunities in low-competition niche therapies. By the time the blockbuster opportunity began to fade, Sun Pharma was already the market leader in some of these therapies.

And that, according to Fisher, makes Sun Pharma 'fortunate because it is able'.

Whether 'fortune and able' or 'fortunate because they are able', superior management ability is a feature of both groups.

But it's a rare talent to look beyond the macro opportunities and stay ahead of the curve. Making the most of broader economic tailwinds is one thing, but it's quite another to make your own luck.

Our Hidden Treasure, Stock Select, and India Letter teams are always looking out for companies and managements that are not only 'fortunate and able' but 'fortunate because they are able'. Apart from financials, the teams monitor numerous indicators that help spot such stocks ahead of time.

Is the company's focus long or short term? Does the company stand out among its peers? What is the company's outlook towards the margins? Is the company overly focused on topline (volume) growth, or does it look forward to profits too?

Does the company make its own luck?

These are some of the key questions we try to answer as we travel from Delhi to Chennai to meet with company managements. The answers help us identify not only good Indian companies but the best the country has to offer.

What do you look for in a management? Let us know your comments or share your views in the Equitymaster Club.


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2.50 Chart of the day

India's public debt to GDP ratio has never been a real worry. Compared to the 100% plus number for developed economies, India's number stood benign at 65% in FY14. As per Mint, the ratio moved up to 67% in FY15 and is currently higher than that of Russia, China and South Africa.

While so far there is nothing alarming, the chances of the ratio going up further and creating trouble in the event of major macro crisis is a worry. This risk is worth worrying about because macro shocks in the form of lower than expected growth, another bout of disinflation and higher interest rates can easily arise. So it is important for the government to realize that while public spending is necessary, some fiscal reforms are pertinent to finance that extra spending. Whether it may be via selling stakes in PSUs, fiscal reforms like rationalisation of subsidies or higher direct taxes, the government must look for options other than borrowing. Only then will it get onto the virtuous cycle of higher growth and macro stability.

India's govt debt to GDP ratio riskier than peers

3.30

Start-ups have been one of the hottest investment stories ruling Venture Capitalists' kitties since some time. As these VCs saw big upside potential, they pumped tons of money. Among these, the internet start-ups have received immense positive response. We see this reflected in the insane valuations many of them command. The amount of money that has been poured into firms like Flipkart, Snapdeal and others is mind-boggling. This is despite the fact that these firms are years away from profitability.

In fact, just a couple of months back, my college Devanshu Sampat had discussed about the key challenges start-up firms are likely to face .

It seems that VCs too are now getting realistic about their expectations. As reported in Business Standard, the VC investments have halved to US$ 1.5 billion during the December quarter, as compared to the July-September period. Given the macro challenges on one hand and poor financials of these start-ups, we will not be surprised to see, many of them getting wiped out.

4.30

After opening on a firm footing, Indian markets continued to surge in the subsequent hours. At the time of writing, the BSE Sensex was trading higher by about 419 points. Barring stocks from the telecom sector, all major indices are trading in the green. Both mid cap and small cap indices are finding favour too, with each trading higher by around 1.8%.

4.50 Investing mantra

"When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is usually the reputation of the business that remains intact." - Warren Buffett

Editor's note: There will be no issue of The 5 Minute Wrapup tomorrow. Hoping to see you at the Equitymaster Conference!

This edition of The 5 Minute WrapUp is authored by Bhavita Nagrani (Research Analyst) and Tanushree Banerjee (Research Analyst).

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