Where Can You Find Safe Quality Stocks in This Market? - The 5 Minute WrapUp by Equitymaster
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Where Can You Find Safe Quality Stocks in This Market?

Jul 13, 2018

Kunal Thanvi, Research analyst

The stock market in India continues to behave funny.

While the Sensex and Nifty are at life time highs, the correction in mid-small cap stocks is still gathering pace.

I hope you re-visited your portfolio, after the disappointment panda visited you last week.

It turns out it has visited many savvy investors of India as well.

Ever since, they believe this is the best time to re-visit their portfolios too.

The super investors of India are getting rid of companies with questionable corporate governance (cooked books, unethical managements, etc). But they are sticking with quality companies.

They believe, this is the time when protecting capital is far more important than finding multibaggers.

But when they say 'quality companies', what are they investing in exactly?

The answer: large-cap stocks.

Many mutual fund managers are trimming their exposure to small and mid-cap stocks and diverting funds to large-cap stocks.

These fund managers seem to believe... large caps = safety and quality.

Where are you Finding Quality Stocks?

This makes me uncomfortable.

I mean, I agree large caps are a relatively a safe space.

But is it right to conclude it is the only quality basket we have?

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Is it right to conclude the valuations in the large-cap space provides enough margin of safety?

Is it right to conclude large caps cannot fall as much as 30%?

Is it right to conclude there cannot be any frauds in the large cap space?

Remember Satyam? It was a large cap.

Punjab National Bank is a large cap.

PC Jewellers had a market cap of around Rs 240 billion recently.

In fact, Vakrangee had a market cap of Rs 500 billion!

While all these companies were classified large caps, they proved to destroy the wealth more than others.

So, what do we learn from this?

Market capitalisation cannot be the right metric to judge safety and quality.

The formula... large caps = safety and quality is incorrect.

We believe quality is market-cap agnostic.

It is the quality of the business (reflected in financials) and management (reflected in shareholder friendly behaviour) that defines the quality for us.

While we believe this is right time to have a re-look at your portfolio and take some tough decisions... at the same time investing blindly in the large-cap stocks cannot be your answer to safety and quality. (More on this in today's Chart of the Day).

When Smart Money Secrets was born, we were very conscious about the kind of quality we understand.

We devised our own proprietary tool 'Smart Money Score' that helps us reject companies with cooked books of accounts and questionable managements.

Now we may make mistakes. There may be times when we overestimate a company's competitive advantage.

But, our endeavour is to not go wrong as far as corporate governance and ethics of the management is concerned.

And that will ensure quality recommendations for our subscribers.

To find such quality companies, my calendar is booked for around 20 meetings over the next three months.

This is the time when companies hold their annual general meetings and I will attend many of them.

Also, starting early next month, I plan to meet many managements across the country to find safe and quality stocks for my Smart Money Secrets subscribers.

Till then, study your portfolio carefully and switch to quality companies across market caps.

Happy Quality Investing!

Chart of the Day

Talking about finding quality in large-cap stocks...

If history is to be believed, companies classified has large caps have also failed the test of 'quality'.

Surprisingly, the current mood in the market is to dump the entire mid and small cap space and buy large caps in the name of quality.

Many fund managers believe, in uncertain times like this, one should stick to quality large cap stocks.

Well, to an extent, I agree with them.

But for me... irrespective of market sentiment or market cap, sticking to quality stocks is the only mantra.

I mean look at the recent examples like Vakrangee, Punjab National Bank, PC Jeweller. If someone would have mistaken market cap for quality, he would have paid a hefty price.

This Was a Large Cap. But Was It Safe?

In January 2018, PC Jeweller's market cap was in north of Rs 200 billion.

So, if your metric for safety and quality was market capitalisation then this company may have qualified.

However, once the Vakrangee episode broke out and there were serious questions on PC Jewellers corporate governance practices, the frenzy was over.

It is a small cap now, just six months later, with a market cap of around Rs 50 billion. At Smart Money Secrets, we believe safety and quality is not a function of market capitalisation.

You should be market cap agnostic and look at metrics like long term ROEs, robust operating cash flows, lean balance sheets, managements credibility and transparency in the books of accounts etc to judge 'Safety & Quality'.

Regards,

Kunal Thanvi
Kunal Thanvi (Research Analyst)
Editor, Smart Money Secrets

PS: Kunal Thanvi is the Sherlock Holmes of investing. He is on a mission to reveal the top picks of India's best investors to you. For clean, high quality stocks that won't put your wealth in peril, subscribe to Kunal's Smart Money Secrets.

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