One very important thing in equity research is ‘knowledge gathering’. Being an auditor (doing articles + a couple of years could be useful enough) is a very good place to start. The basic audit experience teaches you a lot of ‘hiding’ techniques, and the bank audits teach you ‘appraisal’ skills.
One important trait that FIIs taught us to look for is ‘core competence’ – a company should stick to its knitting. So a Colgate, Infy, TCS, Tata Steel, are really liked.
In the Murugappa group they have defined competence in a slightly broader sense – EiD Parry for e.g. is farm oriented. This is the reason why it is the holding company of Coromandel International – a fertiliser company. So it will not be surprising to see EiD Parry being in sugar, fertilizer, seeds, pesticides, and maybe branded ‘agricultural products’ at a later date. Makes sense.
However, some companies use their cash flows in one business to set up another business. MNCs do not do this much but Indian companies have done this quite a bit. Sometimes successfully, sometimes not so successfully. When Tube Investments invested in Cholamandalam General Insurance – you kept wondering why. When Cholamandalam Investments and Finance – core competence lending – set up a brokerage arm, mutual funds, distribution arm you wondered why. The market ruthlessly slashed its price earning ratio – the EPS fell because of a mis-allocation of funds. IF A COMPANY DOES NOT ALLOCATE MONEY to its core competence, it is misallocation.
The best thing in case of Cholamandalam is the management woke up and got rid of the mutual fund business, and pruned the lending at the bottom of the pyramid. The slashed the wage bill, and hey the p/e and price are back.
Ditto in case of Jain Irrigation.
Take the case of Tata Steel and Hindalco – leverage but core competence in its acquisition. The Jury is still out on the acquisitions.
2 companies which are PSUs masquerading as big private sector companies are ITC AND L&T. And they regularly allocate wrongly. Older investors should remember L&T’s foray into shipping and cement, and now finance (remember the famous statement ‘we want to be a global finance player in 7 years? 5 years are over!!).
The market has already reduced their price earning ratio….however since a big chunk is held by the INACTIVE investor a.k.a Ministry of Finance, the re-rating has not been so sharp….
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