A value portfolio should be a diversified portfolio with a bunch of 15-20 companies. To identify companies in a value portfolio the following steps are to be considered; spotting, analyzing, evaluating, positioning, and monitoring the companies on a regular basis.
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- Database Creation: To run screener-based standard parameters like Turnover analysis, Cashflow, and Leverage. The company should be under-leveraged (Net Debt to EBITDA is under control), have good cash flow generation, sustainably high ROE and ROCE, minimum working capital requirement, and good cash conversion cycle.
- Desk Research: After Spotting the bunch of companies the next and most important step is to analyze the company. For analyzing the company, one should look at all the fundamental aspects like the balance sheet, profit & loss, cash flow, and ratio analysis. Read at least 7-8 years of annual reports to understand product proposition, and competition and see if they are doing what they say, how are their disclosure while also doing channel checks i.e. feedback from suppliers, competitors, and distributors.
- Meeting with Companies: The next process is to meet with the management of the companies and understand their thought process, growth prospects of the company, and how efficiently they will manage cash flow for future growth. Capital allocation policy (dividend payout, capex plans & new product development). One should also try and understand the strategy adopted by the companies to gain market share without compromising profits on a long-term basis.
- Monitoring & Interaction: One should monitor the company regularly on at least quarterly basis by attending con-calls and AGMs of the companies and then apply all these parameters on financial modelling and update your projections.
- Allocation: Conviction is the most important aspect. If all our quality boxes are ticked and valuations are also attractive then right-sizing of the position in the portfolio is very critical. If every criteria is met then the size of the bet should also be proportionate in order to generate significant alpha in the portfolio.
Stick to your fundamentals during the company’s bad times and ignore short-term market volatility. Focus on the absolute return of the company rather than benchmark driven. Sometimes even after good results, the company won’t perform (stock prices) but in the long term if the performance of the company continues then rerating would be faster than the estimated one.
Diversify a portfolio with strong growth prospects, good management quality, and governance, buy a company at a significant discount to its intrinsic value, and hold and track it patiently and constantly. Hatching on to this process will offer opportunities for the investors to snipe a few multi-baggers and eventually see the companies transitioning from small to mid and eventually to large caps.
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After reviewing the company on a regular interval, do not hesitate to increase weightage if valuations are attractive considering the future growth prospects at that particular time. However, investors should prudently trim their positions in case the valuations are too expensive at that point of time.
Mistakes one should avoid:
- Bad management
- Highly leveraged companies
- High working capital leakage
- Don’t overpay even for a quality business (as the market always gives the opportunity to buy quality companies at a reasonable valuation if investors wait patiently. So don’t be a hurry to buy at any price)
