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Big Profits from Really Small Stocks

Jul 9, 2016

In this issue:
» SUTTI on the Block!
» Do Farmers Hold a Ton of Black Money?
» ...and more!
00:00
Rohan Pinto, Research analyst

Before recommending any small-cap stock in our Hidden Treasure service, we make it a point to meet the management. This is because managements have the biggest influence on the fate of young businesses. In our travels across the country, we've met many interesting leaders with varying management styles.

Some are aggressive. Some conservative.

Some are welcoming. Some reserved.

Some are talkative. Some stay on point.

Some are enthusiastic. Some seem bored.

We tend to discount most of this. We prefer substance over style. We give importance to what was said and try to ignore how it was said.

This approach serves us well. After all, these are all well-established firms. They have overcome early growth pangs. Their numbers are solid. If that were not the case, they would never have made it past our screening process.

So why should we bother about the promoter's enthusiasm or passion for his business? We already know that! That's why the company made it so far.

But like any good process, prioritizing 'what' over 'how' too has its limitations. These qualities matter a lot when the company is really small.

In her widely acclaimed book, Presence, Amy Cuddy shows why certain personal qualities of entrepreneurs are vital. One of her students, Lakshmi Balachandra, conducted an interesting study. She asked several venture capitalists (VCs) for feedback on entrepreneurs.

Why did they give huge amounts to some and not to others? What was so special about those few?

She studied videos of 185 VC presentations...and came to a surprising conclusion. The 'how' was more important than the 'what'.

The promoter's credentials and the business model were of secondary importance. What really mattered to the VCs were confidence, comfort level, and passionate enthusiasm.

But why? VCs are not fools. Why do they believe these traits are more important than the business model?

The reason is, at that point, the business model hasn't evolved yet. They have to trust the entrepreneur with the task of building it. They can trust him only if they believe he isn't faking it. These qualities are hard to fake. It's easy to identify someone who tries to.

Such qualities are not superficial. They signal how much the person truly believes in the value and integrity of his idea. As well as his ability to deliver on that belief when obstacles come his way...as they surely will.

So what is the takeaway here? Is there a point in the lifecycle of a business when we can ignore these qualities... and focus only on the numbers?

I don't think there is any one point.

We are always interested in good small caps. Some businesses we look at are really tiny. They haven't fully come out of adolescence. Their business models haven't matured. It's tough to recommend these stocks even if we like the business. Our Hidden Treasure subscribers are aware that our selection process is very strict, as it should be.

But we believe huge money can be made by going deeper in the small cap space. And that's where the quality of the management matters a lot. If such a stock can be bought at the right price, the long-term returns over its early lifecycle can be astronomical. Just ask the VCs!

Richa Aggarwal, editor of Hidden Treasure, tells me that she's on to something big here. She will spill the beans soon enough. Watch this space!

Do you agree that big profits can be made in tiny stocks? Let us know your comments or share your views on the Equitymaster Club.

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02:35 Chart of the Day

Having a consistent record of failure to meet disinvestment target, the Government has now resorted to Plan B. It has kick started the process to sell the equity investments of Specified Undertaking of the Unit Trust of India (SUUTI) over three years. One must note that there are 51 firms currently held through SUUTI (Specified Undertaking of the Unit Trust of India) holdings.

The Government's target for disinvestment in FY 17 is Rs 565 bn. If one considers SUUTI's key holdings - 11.9% in Axis Bank, 11.2% in ITC and 8.3% in L&T, these alone could meet the entire target at their current values. The Government has invited applications asking merchant bankers to come up with proposal on how to execute this plan. The mode could be offer for sale, block deals, bulk deals or regular sale through stock exchanges.

What this means for investors is that a lot of blue chips, including the likes of Hindustan Unilever, Ambuja Cements, Hero MotoCorp, Tech Mahindra, Tata Steel etc could be on offer. So, finally, the holdings that were lying as it is would be monetized and could help Government meet its target.

However, if one is inclined to buy when the Government sells, we believe one should keep in mind the valuations at which one buys the stocks. To know our view on some of these stocks and their valuations, please refer to the Stock Select service - our large cap recommendation service headed by Tanushree Banerjee.

How Much Will the Government Raise?


03.20

As India struggles to bring back millions and billions of black money stashed abroad, a bigger hoard back home is blissfully getting overlooked. And we are talking about rich landlords who are exempted from paying taxes thanks to a law that does not tax farm income. If the figure as per the Right to Information is to be believed, then citizens declared about USD$ 29 trillion worth of agricultural income in FY11 which is nearly 15 folds the country's present GDP. The number does look ludicrous. According to provisional data from the revenue department, the declared agricultural income in India stood at US$ 20 bn in the nine years through 2016. This is still no small amount by any means.

Large landowners have been milking the law meant to help poor, marginal farmers with land holdings of less than 2 acres who are barely are able to meet ends. And what's more, the waiver from taxes is availed by the large farmers over and above the benefits of fertiliser subsidy, minimum support price and cheap electricity. This gross tax evasion comes at a time when the government has been frantically making efforts to push up the share of tax revenues that fell to almost a decadal low value. Moreover, the host of measures for improved irrigation, crop insurance and better farming tend to benefit the well-equipped large farmers more than the small farmers.

The only way to plug the huge disparity and money laundering in agriculture is to bring the large, rich farmers under the tax bracket. But will the government be willing to bell the cat particularly as the affluent farmer community holds considerable political clout? At a time when public spending needs to be increased to boost the investment climate in the country, such largesse cannot be ill-afforded by the government we believe.

04.10

Stock markets in Brazil inched higher over the week as markets gave a thumbs up to the government's ambitious policy of curtailing primary deficit for 2017. The Brazilian Real also rallied as the prudent investors saw this initiative by the government as an encouraging sign.

After a huge rebound in the UK markets last week, the markets remained flat this week, the British pound continued to remain under pressure. The pound was trading under the $1.30 mark, recording its worst three weeks since the currency's 1992 crisis, when Britain fell out of the pre-euro Exchange Rate Mechanism. The stock markets in France and Germany ended the week on a lower note amidst an uncertain environment.

Chinese markets rallied higher as commodity prices rose and on hopes that the government will roll out more stimulus measures in future boosting industrial stocks. Singapore markets traded flat. The biggest loser for the week was the Japanese market. The markets declined by 3.7% over the week. Japan's wage growth was weaker than expected with the data for May showing a negative wage growth. Further the country also reported disappointing trade data, its current account surplus narrowed to $18billion, lower than street expectations.

Back home in India, the BSE Sensex ended the week slightly lower. Indian markets traded listlessly throughout the week. The shares of real estate companies inched higher as inventory levels were reportedly declined by 7% in the first half of the current year. This report compiled by Knight Frank India also suggested a revival in the buying appetite for the houses.

Performance During the Week Ended 8th July, 2016

04:50 Weekend Investing Mantra

"The universe I can't play in has become more attractive than the universe I can play in. I have to look for elephants. It may be that the elephants are not as attractive as the mosquitoes. But that is the universe I must live in." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rohan Pinto (Research Analyst).

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3 Responses to "Big Profits from Really Small Stocks"

Rajan

Jul 9, 2016

Agri-income is the real pot of fiscal gold which when tapped will solve all resource challenges in India. You are possibly one of the few who has even mentioned this.
I compliment you on this.
80% of our agri-land is held by 20% and it is this group which also dominates our politics. People like you and me are doomed to bear India's fiscal burden and also get lectured on the virtues of being honest tax payers by the Govt.
I doubt if I will see a govt in my time which will have the courage to tax agri-income. Let them at least set a data repository of land holdings linked to Aadhar so the subsidies paid to them are correctly attributed.
All our Govt's since independence have done is to jingoise the agriculturists and put them on a pedestal (Jai Kisan ) in order to fool the urban population to bear their economic burden.
Let them therefore at least tell the tax payers what is the cost of this political scam.

Like (1)

Satjit

Jul 9, 2016

Where has this figure of $29 trillipn of agricultural income being declared come from? I assume this is from taxpayers filing returns about income from non agriculture incomes, since 99% of farmers don't have enuff income to declare or requirement to pay taxes? So this shud have made huge headlines by now!!

Like (1)

mukesh

Jul 9, 2016

i agree with your point,small equity capital,debt free,increase in earnings.good business,in future......multibaggers

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