A Marketer's Approach to Business Analysis

While there is substantial attention garnered by large cap companies with coverage by both big financial institutions and Indian brokerage houses, there is hardly any cover for small and mid cap companies.

This blog is part of Congrolej's focused research on small and mid-sized companies. Our focus shall largely be on companies which we believe have the potential for explosive value creation. Yet often, we will cover companies with apparent value creation potential, but concealed pitfalls.   

An in-depth analysis by the author identified a few key trends amongst the companies which grew multiple-fold within a four-year period (our recommended investment horizon - less is too small for fundamental approach, more is too prone to natural selection, which anyway renders any research useless:

1. The list of the companies that grew more than ten-fold over the said period (58% IRR) was dominated by a few sectors in any given period. From 2001 to 2005, Steel and Capital Goods sector dominated the list, while Pharma, Textiles, and Auto Ancillary firms also registered presence (flavor of the times).  Similarly from 2005 to 2009, Real Estate and Infrastructure sector dominated the list with Beverages, Consumer Durables, and  Capital Goods also present in fair amount. 
2. The list had a much higher proportional representation from the companies in Rs100cr - Rs500cr market capitalization category. As a firm grows, it attracts attention of the institutional investors who bid up the prices. Firms with less than Rs 100cr market capitalization are too small with no critical mass and are often run unprofessionally.
3. A substantial proportion of firms in the subset had a higher free float (yet in most, promoters had a controlling stake), indicating promoter willingness to dilute their stake to grow in the past, which translated into a similar tendency in the future.  

The field of public equity fundamental research has traditionally been dominated by accountants, who often look at pro-forma, rather than on what is possible in varying contexts. Sadly that has been true for some of the private equity firms as well (even for some well known ones). So, we had blue-chip firms making a beeline for auto ancillary and textiles when they were past their prime.

Even some of the firms which rely on macroeconomic research err on this side, by taking a framework in which they project macroeconomic variables on a pro-forma basis rather than on any fundamental rationale. It is admittedly error-prone to build any independent dependable framework due to hitherto undiscovered linkages between macroeconomic variables, still we believe a common sense based approach to analyze the future will work much better than such macroeconomic analysis.

One approach we shall continuously follow is that of a marketer: using the intelligence of the masses to predict the future. We constantly interact with people at all levels in all spaces to gauge the current, collecting nuggets, and gleaning out noise. The author has sold us on a unique approach to value the brands, using a "Brand Debt-Brand Equity" framework, in which marketing research results get translated into a monetary value for a brand and a firm can be valued as a sum total of all the brands. The firm's perception in the eyes of the crowd was the governing factor that impacted its valuation.

Our team has converged on a set of beliefs about the future - next five years. The future will be dominated by agriculture, food, and healthcare. Against common beliefs, we believe Education sector is not expected to give any big winners. Educomp is already big and there is a cap to the size to which it can expand. Big foundations are entering the space with a capability to gulp the smaller players. The education sector has got a big push by salaried class from the private sector, who have seen their salaries stagnate in the last ten years, and are expected to remain stagnant in the next few as well. At the same time, there is substantial value in the Infrastructure ancillary sector with increasing government spends on roads and transport.

So broadly, our research shall be focused along these lines, however we will also focus on gems outside of our focused sectors and segment.

One pitfall, that everyone desirous of investing in this segment should be aware of, is related to promoter control of Indian companies. Unlike in West, promoters exercise far greater control here. There have been many incidences of merging together of two companies with benefits to the obvious class of shareholders, and of establishing subsidiary with  all investment coming from the parent, yet promoters getting a disproportionate stake. We will endeavor to raise the red flags on any such company.



Disclaimer: All information on this blog is for informational purpose only. During the course of our research, we make investments in companies which we have substantial belief in. As such, we do not disclaim ownership of minor stakes in any of the recommended companies.