The secret to finding best growth stocks - The 5 Minute WrapUp by Equitymaster
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The secret to finding best growth stocks

Nov 22, 2014

In this issue:
» Is the banking sector plagued with NPA problem?
» A flashback to historical banking merger deals
» How have global indices fared over the week?
» ...and more!

The guys over at Oppenheimer Funds came out with a very interesting article recently. Given the kind of slowdown the Western world is experiencing searching for growth stocks in the new slow-growth world is like finding an Oasis in the desert. Also, in the case of India, while growth is much higher one has to be more selective and has to adjust his strategies to find companies that are set to ride the Golden Decade Megatrend.

Such companies typically fall in 3 categories and are all set to break new ground and succeed in today's market place. Be it from the developed or the developing world.

The 3 kind of companies which we are talking about are:-

  • Organic revenue generators
  • Efficiency vendors
  • Innovators
Organic revenue generators are companies that can grow at a brisk pace without much ado. They have to spend little on hiring or capex to grow. Nestle and Page Industries are prime examples here. They have big brands and thus ability to grow organically. Competition can do little harm because of brand loyalty. Capex needs are also low with minimal advertising or hiring needs. Such businesses have secular growth embedded in them.

Next comes efficiency vendors. They are a bit tricky to identify. Basically these companies sell efficiency or help in productivity improvements. Take the case of a small company called Honeywell Automation. It offers solutions to reduce operational cost; improve efficiency and reduce downtime for any particular business. In short, such companies help others get more value from their existing operations. We reckon opportunities in this space shall multiply as India's investment cycle picks up. Being specialised in nature companies that have first mover advantage here will be better placed than others.

The last classification pool is - Innovators. As the name suggests these companies innovate which helps them grab market share. It also gives them pricing power. Unfortunately, in the Indian context there are few innovators that come to our mind. However, healthcare and IT are two areas where we reckon India can find that silver lining.

In nut shell, companies belonging to any of these 3 categories are set to ride a Megatrend of sorts. In other words, they are secular growth stories. Upturn or downturn, their growth shall remain more or less intact. But it is very important for investors to take the right cues and keep an eye on the key triggers to identify them. The India Letter can certainly help you do this.

What kind of companies will you buy if you are on a look out for secular growth stories? Let us know your comments or share your views in the Equitymaster Club.

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Talking about identifying growth stories - is banking the right space to look at? Well, not really seeing the NPA problem the sector is facing. Fathom this. The current gross non performing loans (NPAs) in the banking sector stands at Rs 1.9 trillion! This is almost 5% of the total advances in the sector, one of the highest in the past decade. The recovery of bad debt too is not going to be a cakewalk. For the recourse to partially recover the loans via collaterals itself is weak.

In the case of top 20 NPAs that the banks are looking to recover, the collateral provided is just valued at a half of the loan amount! Moreover, there is a huge list of NPA cases under litigation. As reported by DNA, loans totaling to Rs 700 bn, or a third of total bad loans, is locked in a legal battles, If you thought the cases like Kingfisher Airlines and Deccan Chronicle were one offs with a consortium of banks waiting to recover money, the list is long. In the case of SBI alone, which had a bad debt of Rs 616 bn at the end of March 2014, 70% of the NPAs are locked in legal battles! Thus while the valuations of the PSU banks may no longer be reflecting the NPA woes, it is pertinent that investors stay cautious.

 Chart of the day
Sticking to the banking sector, the big news of late has been the merger between two corporate entities - Kotak Mahindra Bank and ING Vysya Bank. The way their respective stocks have reacted to this news indicates that the market has given a double thumbs up to the deal.

In fact, such a major merger in the sector comes after a gap of over four years. The last was between ICICI Bank and Bank of Rajasthan which took place in May 2010. Today's chart of the day shows the historical acquisition values of some of the major banking deals. As reported by the Economic Times, the acquisition value of the latest deal stands at Rs 151 bn which is the largest ever deal seen in the Indian banking space.

While the aim of the banks would be to gain a larger customer and deposit base, essentially the synergies would be gauged by combing a lot of other parameters such as the asset quality, increase in presence in terms of branches and network, amongst others. In case of the Kotak and ING merger, what is key over here is the fact that post the merger, Kotak Mahindra Bank gets a strong presence in the southern market; prior to the deal it had 80% of its branches in the north and western markets, while ING Vysya had about 65% of its branches based in southern India. Further even in terms of capital adequacy, margins and asset quality, the entities will together go on to make a relatively stronger bank.

M&A buzz in the banking space
OBC= Oriental Bank of Commerce; GTB = Global Trust Bank;
BoR = Bank of Rajasthan; CBoP = Centurion Bank of Punjab

Barring the stock markets in Hong Kong (down 2.7%) and Japan (down 0.8%) global indices ended week on a positive note. The Brazilian markets bounced back from last week's fall. The US markets ended the week higher by 1%. As the US markets enter the holiday season, there are growing concerns about the pace of the rally. The euphoria in the markets has taken the Dow Jones Industrial Average (DJIA) to record highs. The Chinese central bank made a surprise move to cut interest rates and the European Central bank (ECB) hinted that it was willing to step up its asset purchases to support the struggling European economy.

The European markets too were buoyant. The German Dax, the French CAC and the British FTSE ended the week higher by 5.2%, 3.4% and 1.5% respectively.

The Indian indices, buoyed by global sentiment, were up 1% for the week. Expectations are high from the upcoming winter session of parliament regarding the passage of key economic bills.

Performance during the week ended November 22, 2014
Source: Equitymaster & Yahoo Finance

 Weekend investing mantra
"I'm proud to be associated with the value system at Berkshire Hathaway; I think you'll make more money in the end with good ethics than bad.". - Charlie Munger

This edition of The 5 Minute WrapUp is authored by Jinesh Joshi.

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