Monday, January 12, 2015

This Stock That is Not for All

I start with an interesting story of A drugs

While the company has grown its earnings and profits on a 5 year cagr basis by about 25% and eps by about 30%, it has not been a continuous increase. It had stunted growth for a few years and an occasional flat or slight negative growth. This reflects the nature of dealing with small caps while this may not reflect yet of an ‘arrived’ company or a very capable management. Small cap companies can exhibit in-consistent growth but can prove to be a multibagger over long run when the management matures and get their business into mainstream. 

If you look at A Drugs, say you invested Rs 100 a stock it remained in that range for 2 1/2 years until about June 2012, then it doubled its range and stayed at around 200 for many years until Jan 2014. As the bull market roared, it broke the range and climbed nonstop to 900 in about 10 months. Essentially an investor needed to have patience for 4 whole years seeing the money only flat or at best double and then for the wait he was rewarded 10 times in just 10 months.

A very good lesson while dealing with small caps. 

We need to identify businesses run by outstanding management with a high level of integrity and trust. What is the point in having a management that has incredible passion to success but are adopt wrong ways to grow, they will go down one day as we saw with Satyam. I would prioritize management Integrity as the top most trait for a successful stock.

Quality of business and growth in earnings come next. A capable management can grow companies even during times of adversity and we can see them in the ROE and ROCE over a historic time range.

Every time I prospect a business that has potential to grow and advise an investor, the only question invariably is how long one has to hold and how much will it multiply?

When we make an investment without understanding the underlying business or its prospects, we lack in conviction. How can we hold on to a stock when we lack in conviction? We will run out patience and finally out of luck. The only way out is to unlearn then learn and invest. Unfortunately I do not see institutions engaged in teaching how to invest in stocks. The few that offer, pass on tips or leads at best. The current state of the industry is bringing fatal damage to itself and the investors. Its a place of middlemen and gamblers.

An aware investor might say that stocks are not meant for him after he really understands what it entails to be successful. To me that is perfectly fine as it is a conscious and well informed decision.

A few enticing events attract our attention to the pharmaceutical industry, if you are interested in a copy of the same please email or