One of the biggest challenges for investors is to find a few valuable firms out of the 5000+ listed companies on the Indian stock exchanges.
This search is not easy; it cannot be done very fast; I would say it is a multi-year process.
Many great investors have suggested and used many criteria, but one simple important one I have is STABILITY.
What does this mean and how does an investor implement this in his portfolio?
Stability for me means a firm that:
- Shows a steady pattern
The firm should show a steady pattern on its key financials such as Revenues, EBITDA and Net Profits. This does not mean micro level steadiness such as quarter to quarter improvements. I would be more concerned about year to year steadiness, and a sense of expected things happening.
- Does not dilute its Equity Share Capital much
While 10-15% dilution every 3-4 years is ok, anything much more is a worry point. All dilutions affect older investors as EPS will fall to the extent of dilution. Dilutions by Rights issue are good for shareholders as they can participate in this corporate growth. Aggressive dilutions for new acquisitions or excessive ESOPs have to be assessed for stockholder benefits. PSUs typically have Share Capitals that do not change at all over the years. Banks are an exception to this rule as they are in the business of loans and the cheapest funds are available through equity dilutions.
- Has Low Debt
For a firm, an important source of funds is debt. It does not involve equity dilution. However if things are going badly for the firm, it excesses on Debt, or is unable to repay. Sectors in India like Insurance, Telecom and Infrastructure (that are at an early stage of growth) suck in cash and need a lot of debt to develop their operations and may over-leverage and have to pay high finance charges that depress profits. Check the Debt Equity ratio for your target firm. A ratio higher than 2.0 for Infrastructure firms and over 1.5 for other sectors is a Red Flag. Unless its a rare turnaround situation.
- No Pledging of Shares
Promoter stability is an essential to a good equity investment. A promoter that pledges his shares exposes his firm to a situation where a fall in share price (for any reason) will trigger a sale of his shares by the lender that will accelerate the fall of prices. The possibility of this happening may be low, but the consequences are bad, so investors should check the shareholding pattern of a firm before investing.
Remember as an investor, the advantage you have is you can walk away from a share investment if it does not meet your criteria. There are many fish in the sea. And Stability is an important concept in my search for great investment ideas.
Hope you liked the idea !!
Founder, JainMatrix Investments
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