- Wealth PMS (50L+)
If you were to ask us to condense our Focused Portfolio stock selection criteria into a single sentence, it would be:
‘We seek growth companies, ideally at a reasonable price, that have some sectoral tailwind, sound management, and a decent balance sheet.’
That’s the essence of it. Of course, this represents our ideal scenario. There may be instances where deviations are necessary, but generally, we strive to adhere to this framework. We choose a bunch of such companies—typically around 15-18 and form a portfolio.
Taking a broader view, it’s clear that rules for stock selection alone are not sufficient for portfolio management. So, to summarize our portfolio approach:
‘We adjust our positions based on near-term growth triggers, valuation, position sizing, and technicals, transitioning between equities and cash in response to market conditions.’
But there is one thing that we prioritize and consider a key driver for our stock selection and portfolio construction: Growth. Everything else is secondary.
In this post, let’s discuss our thoughts on the kind of growth we like and how we try to implement it in our Focused portfolio.
The market chases growth. No matter what your strategy is (Momentum, Value investing, Cyclical, Turnaround, etc.), the underlying thesis remains the same – to bet on the growth of a company, sector, country, etc.
But there is a caveat here. Not all growth is the same. When we identify a company with growth potential, we generally apply a mental framework to place it into one of the following categories. Let’s examine each of these and explore the growth qualities we like.
1) Secular Growth ✅
History shows that the biggest profits are often made in four major sectors: FMCG, IT, Banking, and Pharma. These sectors have delivered growth not just for years, but for decades, and continue to do so. They’ve demonstrated resilience across market cycles because they cater to basic human needs: Food, Clothing, Shelter, Internet, and Health. Everything else is essentially a variation of these.
Companies in these sectors offer visibility in the growth of revenue and earnings, maintain strong balance sheets, cash flows, and return ratios. The market often pays a premium for this consistency.
Generally, we like companies from these four sectors, especially when they show decent growth, about 18-20% in top-line growth and over 20-25% in bottom-line growth. We are happy to include them in our long-term portfolio.
These companies may not be cheap, but they serve as an anchor in our portfolio during volatile times.
For instance, VBL, ICICI Bank, NH, EMIL in our Focused Portfolio fall into this category. We strive to find and participate in the growth stories of these companies.
2) Hollow Growth 🚫
This refers to growth that appears secular but exhibits a cyclical nature. It can also mean companies fail to deliver quality growth due to excessive dilution or unnecessary expansion. For example:
Godrej Properties, though seemingly good on paper, bases its growth largely on constant dilution. In the last five years, the company raised 6700 Cr in equity but only delivered a cumulative PAT of 1300 Cr. They may be investing for the future, but we prefer to avoid such hollow growth companies where growth comes at a high cost.
Safari is another example. During 2019, they aggressively expanded by pushing sales through Exclusive Brand Outlets (EBOs) and Multi-Brand Outlets (MBOs). They offered relatively higher discounts than American Tourister and VIP for shelf space, which directly impacted their balance sheet. At one point, their receivables accounted for over 45% of their revenues. The cash conversion cycle was at 120 days, double that of VIP. This is on top of single-digit margins and debt. However, things improved in the last two years for the company.
Other examples include:
Such companies might show growth, but it’s shallow and doesn’t usually benefit the company or investors in the long run. We tend to avoid these kinds of hollow growth companies.
3) Cyclical Growth 🚫
While the biggest money is made in secular growth companies, the fastest money is often made in cyclical companies, in sectors like Metals, Infrastructure, Capital Goods, Power, Oil and gas, etc. These cycles are shorter, but growth can be exponential in terms of earnings and stock prices.
We are not very keen on participating in cyclical themes, as precise timing is crucial for both entry and exit strategies. Cyclical investing is a textbook example of buying into fear and selling into euphoria.
The strategy involves looking out for a stressed sector, finding the market leader with the financial strength to weather the downturn, and waiting for the cycle to turn upwards.
While navigating this downturn, the behavioral aspect is important, but one must also consider the opportunity cost, as down cycles can last several years before showing revival signs. Hence, we typically avoid cyclical plays unless the thesis or the company is compelling enough to warrant a bet.
4) Growth from Sectoral Tailwinds ✅
We like companies that are riding a tailwind. It’s like getting an extra push when you are already moving forward.
These tailwinds can come from different places, like:
These tailwinds usually last for a few years. During this time, the market leaders tend to grow faster than others. We like companies that have some underlying push from external forces.
Some of our holdings like Angel One, Divgi TTS and Data Patterns are examples of this group.
5) Emergence of New Sub-Sectors ✅
When a new sub-sector emerges from a matured sector, it typically tends to grow at a higher rate than the matured sector. For example:
It often begins with a mature company demerging its new business segment, leading to the formation of new companies that focus solely on this emerging area. We are interested in these growth themes and aim to participate in their growth.
Stocks like Kaynes and Syrma SGS in the ESDM sector (which is a sub-sector of the Electronics sector) are what we’re talking about.
6) Growth Coming Back to Quality ✅
When growth returns to a quality company, it gets our full attention. The growth can come from different reasons, like:
This type of growth is sustainable because the underlying company usually already possesses a healthy balance sheet and cash flows. What they need is growth. Once these companies achieve the required kicker, the market often re-rates them, and their premium valuation continues as long as the growth persists. We like such companies and are constantly on the lookout for such triggers.
So, when we say we like growth, we actually mean growth that stems from secular companies, sectoral tailwinds, emerging sectors, or a resurgence of growth in quality companies.
Q: I am a new investor in Capitalmind Focused portfolio. What should I buy now?
A: If you would like to follow this portfolio, you can purchase all the stocks in the model portfolio as per the recommended allocation for each stock. However, for experienced investors, custom stock picking is also an option, but we cannot track the performance of custom selections. We do not have “hold” positions, and all our positions are tracked as if they are buys.
Q: Can I skip investing in LiquidBees and park the cash in a savings account?
A: Yes, you can keep your cash in a savings account or any liquid fund of your choice. We park our cash in LiquidBees to keep track of NAV calculations. However, the decision to invest in LiquidBees or any other liquid fund is entirely up to you.
Q: How frequently is Capitalmind Focused portfolio rebalanced?
A: We closely monitor our portfolio companies and regularly review our portfolios. Whenever there is a significant change in any of our companies, we rebalance the portfolio and communicate this to Capitalmind premium subscribers via email.
Q: Do you follow technicals?
A: We consider both fundamentals and technicals to support entries, exits, or position sizing in the portfolio. However, the portfolio involves risk, and we may exit a position even in the short term if either price action or fundamentals dictate.
Q: What is the lot size of the portfolio?
A: We suggest a lot size of approximately INR 75k (including the cash component) for Capitalmind Focused. The idea is to get exposure to all the recommended stocks at the suggested position sizes. However, you are free to change the amounts as required, but this may result in different weightings.
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This post is for information and not a recommendation to buy or sell any stock. Investment in securities market are subject to market risks. Read all the related documents carefully before investing.