I had always desired to learn about all the companies listed in Indian stock market. This desire became stronger when I read about an interview of Warren Buffett with Adam Smith, the author of Supermoney. In the interview, Adam asked Warren about the advice that he would give to a younger Warren Buffett if he entered the markets today. This is what Warren replied:
Adam Smith: If a younger Warren Buffett were coming into the investment field today, what areas would you tell him to point himself in?
Warren Buffett: Well, if he were doing – if he were coming in and working with small sums of capital I’d tell him to do exactly what I did 40-odd years ago, which is to learn about every company in the United States that has publicly traded securities and that bank of knowledge will do him or her terrific good over time.
Smith: But there’s 27,000 public companies.
Buffett: Well, start with the A’s.
This one statement “Start with the A’s” had a profound impact on my thoughts. It highlighted that there is no alternative to the hard work of reading about each of the listed companies. At least one person, Warren, has done it earlier; so, it is not impossible.
Finally, I decided to put my plan to learn about all companies listed in Indian stock markets in action.
The Process that I followed to learn about Companies
Instead of Warren Buffett’s advice of “Starting with the A’s”, I decided to start with the company with the largest market capitalization (cap) and then came down the market cap ladder.
I decided to follow the simple steps. First, know about what a company does. It involved the following sources:
- Visit the page of the company on the Screener website and read the brief introduction about the company.
- Visit the website of the company and read the “About Us” and “Products & Services” pages.
The second step was to see the financial performance of every company over the last 10 years and decide whether the company is worth spending more time or not. For this step, the Screener website and its free feature “Export to Excel” proved priceless.
“Export to Excel” tool allows an investor to download the last 10-year financial data of any company to their computer at the click of a button. A user can then analyse this Excel file to draw inferences from this data.
One highly underappreciated feature of “Export to Excel” tool is that it allows the investor to customize the Excel file in any manner and then upload her customized template on Screener website. Thereafter, whenever an investor clicks on “Export to Excel” button for any company, then Screener website will provide her with the last 10-year financial data of the company in her customized format with her preferred dashboard of parameters.
An investor will appreciate that if she can see the 10-year financial data of any company in her preferred format with her favourite ratios on a single click of the mouse, then she can quickly make an initial opinion about the company and its business model. Based on her initial opinion, if she dislikes a company, then she may choose to reject the company straightway and move to the next company. Alternatively, if she likes the company, then she may add it to her watchlist so that she may study it in detail later.
I followed these two steps to learn about the companies i.e. know what the company does from the brief introduction on Screener website or the “About US” and “Products & Services” pages on the companies’ website. Thereafter, download the last 10-year financial data from Screener website using “Export to Excel” tool where I had uploaded my customized template.
I repeated this process for each of more than 2,800 companies with a market capitalization of more than ₹10 cr, listed on Indian stock markets. As per Screener, there are a little over 3,800 companies listed in Indian stock markets with a market capitalization of greater than zero. Out of these, about 1,000 companies have a market capitalization of less than ₹10 cr. For now, I skipped the companies having less than ₹10 cr market capitalization.
So, in a nutshell, I repeated the process of (i) know what the company does and (ii) look at its financial performance for last 10-years using “Export to Excel” customized file more than 2,800 times covering each of the companies listed in India having a market capitalization of more than ₹10 cr.
I prefer companies, which show fundamental strength in their business model by generating good steady profits, generate a lot of cash from their operations, use this cash to meet their capital expenditure requirement and thereafter, report surplus cash known as free cash flow (FCF). The company may choose to return this FCF to its shareholders by dividends or share buy-backs or it may keep it with itself as cash & investments.
To pick out such companies during my quest to learn about all the companies of Indian stock market, when I saw a company presenting the following picture, I added it to a watchlist so that I may read their annual reports and learn more about their business model in detail later. E.g. Pidilite Ltd whose consolidated financials showed that
- The company has never witnessed a decline in its sales and has increased its profits in nine out of the last 10 years. The first time it noticed a decline in its sales is in 12 months ending June 2020, which might be due to the lock-down following Coronavirus pandemic.
- The company reported cash flow from operations of ₹6,706 cr over the last 10 years, which is higher than its PAT of ₹6,687 cr for the last 10 years. It indicates that the company has kept its working capital under control.
- Moreover, the cash flow from operations proved more than sufficient for its capital expenditure of ₹2,128 in last 10 years leaving it a surplus of more than ₹4,500 cr. The company used this surplus to pay dividends of ₹2,000 cr, repaid its debt and has kept the remaining money as cash + investments of more than 1,800 cr.
- The company has a Self-Sustainable Growth Rate (SSGR) exceeding 35%, which indicates that it can easily fund its sales growth aspirations easily from its business profits.
On the contrary, if I saw that the company does not have fundamental strength in its financial numbers, then I simply rejected the company in one glance and moved over to the next company. E.g. Future Consumer Ltd, which showed that
- The company has never made any profits in the last 10 years.
- It has made operating losses in 6 out of the last 10 years and operating cash flow losses in 8 out of the last 10 years.
- Overall, the company has lost more than ₹800 cr in its operations over the last 10 years.
- It has done a capital expenditure of ₹971 cr in last 10 years and an investor would appreciate that if the company has not made any profits or cash flow from operations, then all the money for capital expenditure would have come from either incremental debt or equity dilution. The same is visible in terms of increase in total debt by ₹645 cr over the last 10 years and a significant increase in share capital.
- Therefore, if an investor is interested in investing in companies with strong fundamentals with cash flow strength, then she may simply ignore this company by just a single glance on the excel template without spending any more time on the company.
Therefore, with the help of Screener website, its free “Export to Excel” tool and our customized stock analysis Excel template, I could learn about the companies at a fast pace.
Now, after doing this exercise of knowing about more than 2,800 companies with a market capitalization of more than ₹10 cr and looking at the 10-year financial performance data (export to excel) of each one of them, I believe that I could do some justice to my desire of knowing about the companies listed on Indian stock markets.
The current article is an attempt to share with all the investors my key learning of this exercise.
Learning from analysing 2,800 companies listed in Indian Stock Market
1) There is a severe shortage of companies with a large market capitalization:
As mentioned earlier, instead of “Starting with the A’s”, I decided to start with the largest market capitalization company and then go my way down the market capitalization ladder until I reached ₹10 cr market capitalization and analysed 2,800 companies in the process.
An investor would know that in Indian stock markets, the number of companies above $100 billion market capitalization (i.e. ₹750,000 cr) is only TWO. Reliance Industries Ltd and Tata Consultancy Services (TCS).
Look at it from this perspective. If a multi-billion dollar fund wishes to invest $1 billion (₹7,500 cr) in an India listed company and wants to own less than 1% of the company so that it can exit whenever it wants without much impact on the stock price (called impact cost), then it has an option of only two companies. The fund needs to invest in companies with more than $100 billion market capitalization (₹750,000 cr) and currently, in Indian stock market, only Reliance Industries Ltd (₹1,380,000 cr) and TCS (₹845,000 cr) meet the criteria.
Now, assume that the multi-billion fund lowers its expectations and decides to invest in stocks above ₹100,000 cr market capitalization. After this adjustment also, the investable universe expands to 26 companies. Out of these 26 companies, the fund may face constraints like whether to invest in public sector companies like NTPC, SBI or only invest in a few finance companies because about 25% of these companies are finance companies.
Also, if the fund wishes to retain its target allocation of $1 billion (₹7,500 cr) per company, then it will end up owning 5-7% stake in these companies. This will limit its chances of easily exiting the company at will.
As a result, an investor will appreciate that for large multi-billion dollar funds, Indian stock market presents with only a few investable options.
In the light of this fact, an investor would notice that in Indian stock markets too much money chases too few large-cap companies, which leads to astronomical valuations of these few companies.
2) Most of the large-capitalization companies have astronomical valuations due to too much money chasing too few companies:
As discussed above, the Indian stock market has a severe shortage of options in the large-capitalization segment. As a result, most of the funds with large sums of money have only a handful of companies to invest their money. This leads to an increase in valuations of the stocks of these few companies.
When an investor looks at the valuations of some of the companies with a market capitalization over ₹100,000 cr, then she comes across companies like Hindustan Unilever Ltd (HUL) with the price to earnings ratio (PE ratio) of 75. On looking at the financial performance, an investor notices that the company had a growth rate of about 8% for its revenues and 13% for profits over last 10-years.
The moderate growth rate of HUL may be understandable due to multiple factors:
- There is hardly any region in India that is left unserved with HUL products. Even the tribal areas deep into forests, areas under constant violence like Naxalism are served by HUL. Therefore, any rapid expansion by entering unserved areas is unlikely.
- The competitors of HUL are companies with equally deep pockets and strong brand presence like P&G, Marico, ITC etc., which once again stresses that it is difficult to generate new untapped market to show a high business growth.
Nevertheless, despite a moderate business growth of 8% over last 10-years, HUL is trading at a PE ratio of 75. This primarily seems the result of a severe shortage of options for large multi-billion dollar funds to invest their money.
Another such instance is found in the case of Avenue Supermarts Ltd (ASL) running the stores under brand D-Mart. Currently, ASL seems to be the only retail stores’ company in the over ₹100,000 cr market capitalization segment unless Reliance Industries Ltd demerges its retail division.
Currently, ASL trades at a PE ratio of 143 based on July 2019-June 2020 earnings. There is hardly any option available for large multi-billion dollar funds to buy an India retail stores’ company if they wish to invest a large sum of money in this segment in Indian stock markets.
There is no surprise that to justify these high valuations, the research houses end up calculating earnings up to FY2029. See this section from the report of Goldman Sachs on ASL in Sept 2017, page 5:
…so we believe making a decision on near-term earnings could result in missing a long-term compounding opportunity. We base our 12-month target price of Rs1,586 on 28X FY29 discounted EPS…
An investor notices that brokerage houses go to innovative extents to justify the “scarcity” premium for the stocks in the large-cap segment.
An investor would appreciate that when the high valuations of companies are due to too much money chasing too few stocks, then when either the too much money becomes less or too few stocks become more, the “scarcity” premium goes away and the high PE ratios come down.
In the cases of such high valuations due to “scarcity” premium, any event like reduction in easy liquidity in western countries that drives FII investments in India can lead to a decline in valuations. Also, the change in the investment perception by only a few fund managers holding multi-billion dollar assets under management (AUM) can hit the “scarcity” premium and lead to a decline in valuations.
Further advised reading: 3 Principles to Decide the Ideal PE Ratio of a Stock for Value Investors
3) Instances of high valuations correcting themselves despite improving business performance of the companies:
When an investor analyses multiple companies that used to be at the peak of their valuations in the past, then she notices that many of these companies witnessed a decline in PE ratio despite improving business performance over the years.
Let’s look at the example of Just Dial Ltd. An investor notices that at one point of time, during FY2015, the company used to trade at a PE ratio of 65. The market was very positive about the future of the company.
However, soon thereafter, the company started facing competition from the local search services of Google and other industry-specific vertical players like Zomato, Swiggy, Practo, Urban Company (UrbanClap) etc. As a result, the company’s OPM and the average price per paid listing declined. The market share/customer mindshare of the company also declined and the investing community started to doubt the competitive advantages of Just Dial Ltd.
As a result, during FY2015-FY2020, the PE ratio of the company declined from 66 to 7.
This was despite an increase in sales of the company from ₹590 cr in FY2015 to ₹953 cr in FY2020 and an increase in net profit after tax from ₹139 cr in FY2015 to ₹272 cr in FY2020.
Moreover, during FY2015-FY2020, Just Dial Ltd generated a free cash flow of ₹788 cr and gave dividends of ₹14 cr and four buybacks of ₹688 cr in FY2016, FY2018, FY2019 and FY2021.
The shareholders of Just Dial Ltd experienced that an investment in the shares of the company at a high PE ratio of 66 did not generate a satisfactory return and the share price declined from ₹1,895 in August 2014 to about ₹380 in Sept 2020.
Over last 6 years (FY2014-2020), Just Dial Ltd has retained earnings of about ₹1,118 cr whereas its market capitalization has declined by about ₹8,537 cr, which indicates a decline in the market value of about ₹7.64 for every ₹1 retained by the company that was not distributed to shareholders.
Let us now look at another example, Gillette India Ltd. During FY2014 to FY2017, the company increased its profits by 5x from ₹51 cr to ₹253 cr. Its net profit margin (NPM) increased from 3% in FY2014 to 15% in FY2017.
However, during this period, the PE ratio of Gillette India Ltd witnessed a decline from 203 to 51.
An investor may see another case of Page Industries Ltd. During FY2017-FY2019, the profits of the company increased by about 50% from ₹266 cr to ₹394 cr. During this period, the sales of the company increased by about 34% from ₹2,129 cr to ₹2,852 cr and the operating profit margin (OPM) of the company increased from 19% in FY2017 to 22% in FY2019.
However, during the same period, the PE ratio of Page Industries Ltd declined from the levels of 100 in 2017 to about 50 in 2019.
An investor would appreciate that when the stock price of any company runs up too much ahead of its fundamentals, then even the good business performance may not keep the sky-high valuations intact.
Nevertheless, when an investor analyses companies in the higher market capitalization segment, then it is highly likely that if she looks at their business and financial performance, then she will be impressed.
4) Financial performance of large companies shows that they are large because of some reason:
When an investor analyses many large-capitalization companies, then she notices that the proportion of companies that impresses her with their good financial performance is far higher than the companies in lower market capitalization segment.
I noticed that in the segment with a market capitalization over ₹5,000 cr, about 75% of the companies have an impressive financial performance. If an investor ignores their valuation, then she would be tempted to have many of these companies in her portfolio.
On the contrary, this percentage of companies with impressive financial performance declines sharply when an investor comes down the market capitalization ladder.
In under ₹100 cr market capitalization segment, an investor may not find the financial performance of even 1% of the companies as impressive enough. She may have to analyse a far higher number of companies to find one such company that shows mouth-watering financial performance picture.
An investor may appreciate that large companies are large because of some reason. They have an established business model, a much larger reach to their customers, established sales & distribution set up and financial power to withstand the crisis. It was not a surprise that even during the challenging times of last 2-3 years, I noticed that a far higher number of large companies could sustain their sales & profit growth whereas most of the small companies witness either a decline in sales or a flat sales for the last 2-3 years.
It might be that the large companies took over the market share from their smaller counterparts during the last 2-3 years.
However, this is not to suggest that an investor should straightway jump and buy larger companies. Hard work and discretion by the investor is always needed. This is because, first, about 25% of the large companies are those, which earlier used to be even larger companies and are now facing declining business performance since many years. These companies are now on their way to becoming mid-cap and small-cap companies.
Second, the investor must focus on the key parameter of valuation. As mentioned above, if an investor overpays for a stock, then despite improving business performance and despite strong business model and brands, the valuation levels of stocks may correct and she may suffer negative surprises.
Nevertheless, when an investor analyses, the larger companies, then frequently she comes across companies with impressive financial performance. Large companies are large because of a reason.
5) Market rewards large companies with a “stable business” premium:
When an investor analyses many large companies in succession and keeps noting down their valuation levels, then she notices that very frequently, large companies with strong financial performance are valued higher than small companies with strong financial performance.
During this exercise, I noticed that once a company crossed ₹10,000 cr market capitalization barrier, the market gave it a premium of about 10-15 PE ratio. It means that if an investor finds a company with strong business growth backed by cash flow from operations and characterised by good free cash flow, which it used to reward the shareholders and the investor notices that it has a market capitalization of more than ₹10,000 cr, then the investor will find that its PE ratio will be about 10-15 PE more than another similar company with strong fundamental growth with free cash flow etc. but which has a lower market capitalization.
This trend of higher PE ratio to the large companies with good fundamentals seems to be the “stable business” premium that the market pays to such companies. As discussed above, these large companies have an established business model, a much larger reach to their customers, established sales & distribution set up and financial power to withstand the crisis. In addition, during challenging times, large companies take market share away from their smaller competitors.
In addition, it seems that when companies keep growing their business, then at some level, the market may think that the company has now surpassed the “existential threat”. It means that it is highly likely that the company would be able to survive the next crisis and come out of it alive without facing bankruptcy.
Relieving the market of “existential threat” seems to be an important barrier that large companies with good fundamentals seem to have crossed. As a result, market rewards these companies with a “stable business” premium of 10-15 PE ratio.
An investor may draw a few inferences from it. First, if she focuses on the segment of large companies with strong fundamental growth and convinces herself to pay a premium of 10-15 PE ratio to buy stocks of these companies, then she can avoid many negative surprises in her portfolio during a crisis or difficult times. This may bring peace to her investing journey.
On the other hand, the investor may infer that if she finds a small company with strong fundamental growth and stays with the company when it crosses barriers like ₹10,000 cr market capitalization, then the market, in general, will appreciate the company for its “stable business” and no “existential threat”. As a result, the market will then give this company a premium of 10-15 PE ratio, which will add a significant amount of return to her portfolio performance.
In addition, an investor may infer that this “stable business” or elimination of “existential threat” premium is nothing but the “scarcity” premium which institutional investors give to the large companies as these are the only few investable options they find to invest in Indian stock markets.
In any case, during this exercise, I found that the companies with strong fundamental business performance with a market capitalization over about ₹10,000 cr were trading at a premium of 10-15 PE ratio than the smaller companies with strong fundamental business growth.
6) Smaller companies had a slower growth over last 10-year in their business than larger companies:
As mentioned earlier, during my exercise, I started my analysis with the company with the largest market capitalization in India (Reliance Industries Ltd) and then made my way down the market capitalization ladder until I reached the level of ₹10 cr market capitalization.
During this exercise, I noticed that when I come down the market capitalization ladder, then the last 10-year business growth rate of smaller companies displayed a noticeable slower rate across the segment.
The companies with a market capitalization of less than ₹2,500 cr market capitalization had a slower growth rate in their business than the companies with a market capitalization of over ₹5,000 cr.
A far higher number of companies with a market capitalization less than ₹2,500 cr reported growth rates in single digits whereas a large number of companies with the market capitalization of more than ₹5,000 cr reported growth rates in double digits.
This was a noticeable observation in my exercise when I scanned over thousands of companies one after another. Many companies with more than ₹10,000 cr market capitalization kept on growing even during the crisis periods.
It goes with the prior stated inference that large companies are large because they have an established business model, a much larger reach to their customers, established sales & distribution set up and financial power to withstand a crisis. During subdued periods of the last decade, the large companies seem to have grown by taking over market share from their smaller competitors.
7) Many large companies keep rewarding shareholders by way of increase in stock market price despite nil or negative free cash flow:
During the analysis of many large companies, I noticed that the stock price of these companies had witnessed a significant increase over the last 10 years where these companies had nil or negative free cash flow. In many cases, these companies had resorted to funding this cash flow gap by taking additional debt. However, in almost all the cases, the debt raised was small and within easily serviceable limits.
One of the major parameters in such companies, which kept on reinvesting every rupee of their operating cash flow in their business was a consistent increase in book value. Companies that were growing their business (sales & profits) by 15-20% year on year over last 10-years and had invested their entire CFO and some debt in capital expenditure, reported small negative FCF; however, these companies increased their book values by almost 25-30% compounded annual growth rate (CAGR) over last 10 years. In many such cases, the share price of companies had increased at a CAGR of 20-25% over the last 10 years.
An investor may infer that if the business model of the company provides good reinvestment opportunities, then if the company invests all its CFO and even takes small debt to do capital expenditure and as a result, reports small negative free cash flow (FCF), then the company may present a good investment opportunity. These companies increase their book value at a fast pace and market seems to have rewarded these companies for the increase in the size of their business even though these companies have not returned any cash to their shareholders in the entire last 10 years by way of dividends or share buy-backs.
However, while analysing such companies, an investor should always be cautious that she should not confuse them with those companies with a poor business model who keep on growing with debt-funded growth and eventually head for bankruptcy.
8) Small cap segment is full of SMEs:
When an investor ventures into small capitalization (small cap) segment to find investment opportunities, then she expects to find the hidden gems, which can grow to become the next success stories. She aims to stumble upon next “Page Industries”, next “Bajaj Finance” etc. However, let me pause her in her dreams.
The small-cap segment is full of small & medium enterprises (SMEs) in sectors like:
- Small steel processing units,
- Auto ancillary units,
- Small textile mills,
- Small standalone paper factories,
- Small chemical & dye units,
- Small pharmaceutical manufacturers working on a job-contract basis,
- Computer parts & accessories traders,
- Small logistics operators,
- Small stockbrokers,
- Small NBFC and investment companies,
- Small commodity trading companies, and
- Small telecom equipment traders etc.
Therefore, it might be that if you look hard enough, then you may find a stockbroking firm that might be the next “Zerodha” or an NBFC that might be the next “Bajaj Finance” or an auto ancillary unit that might become the next “Motherson Sumi”. However, an investor needs to keep in her mind that such companies are going to be an infrequent find.
As mentioned earlier, in under ₹100 cr market capitalization segment, an investor may not find the financial performance of even 1% of the companies as impressive enough. She may have to analyse a far higher number of companies to find one such company that shows mouth-watering financial performance picture.
Now an investor may look at it from two perspectives. First, if she wants to find companies with strong financial performance easily, then she may focus on companies at higher market capitalization segment, where I noticed that about 75% of the companies with a market capitalization over ₹5,000 cr have an impressive financial performance. If an investor ignores the valuation, then she would be tempted to have many of these companies in her portfolio.
On the other hand, the investor may acknowledge that she would have to turn a lot of stones (in fact thousands of them) in the small/micro-cap segment to find one gem. As it is a very time-consuming exercise, therefore, naturally, a lot of investors may not follow this route and as a result, she may come across a promising small company at a very attractive valuation.
However, in the end, it is a trade-off between finding many financial strong companies easily, but trading at a rich valuation in larger companies or spending a lot of time scanning thousands of small companies to find that one company with strong financial performance and trading at an attractive valuation.
An investor may choose her option according to the availability of time and the effort that she can put in the stock selection.
9) Most of the small companies suffer from delayed receivables collection:
When I was scanning one company after another in the smaller companies section, then time and again, I noticed that so many small companies had their cash flow from operations (CFO) less than their net profit after tax for the last 10 years.
One of the prominent reasons for the cumulative CFO being less than cumulative PAT for the last 10 years is that the money of the company gets stuck in working capital, primarily the receivables.
Even though, the large companies also have instances of money getting stuck in the receivables; however, for the small companies, the problem was more obvious. Many of the small companies faced this issue.
One reason for sharply rising receivables over the years can be the delayed payments by the customers. Most of the times, small companies act as suppliers to larger companies and these large companies have a higher negotiating power over their suppliers. For every product, the large companies have many suppliers and as a result, many times, they resort to delaying payments to small suppliers to improve their own working capital position.
An investor may also come across instances where small suppliers went bankrupt as they could not recover their receivables from their larger customers.
The other reason for sharply rising receivables can be aggressive booking of sales by the company. It might be the case that the company has recognized revenue even before the customer has formally accepted the product/work as delivered. In such cases, the customer may be disputing the work/quality of the product and in turn, customer defers the payment to the company.
Another extreme case for a sharp increase in receivables can be accounting juggleries where a company may be booking fictitious sales. In such cases, the profit & loss statement (P&L) will show a very good picture with rising sales and profits; however, the cash flow statement will show low to negative CFO with continuously rising receivables that may never be received by the company.
Therefore, while analysing small companies with cumulative CFO for last 10 years less than the cumulative PAT for the last 10 years, an investor should be very cautious. She should increase the level of her due-diligence to satisfy herself that she is not investing in a company that either does not have any negotiating power over its customers or is indulging in financial juggleries.
10) The small companies segment has many companies with interesting business models with no competing listed peers:
While analysing small companies segment, an investor comes across companies with interesting businesses, which do not have many competing players listed on the stock exchanges. Look at the following examples:
- Radix Industries (India) Ltd: manufacturing of human hair products.
- Banka BioLoo Ltd: deals in bio-toilets, environmentally friendly products and services for the human waste management system.
- TAAL Enterprises Ltd: providing aircraft charter services.
- Global Vectra Helicorp Ltd: the largest private helicopter company in India, providing helicopter services.
- Banaras Beads Ltd: the business of handicraft items like glass beads necklaces, imitation jewellery.
- Hariyana Ship Breakers Limited, and VMS Industries Ltd: the business of ship breaking and recycling.
- Walchand Peoplefirst Ltd: acquired the franchise rights for training methods developed by Dale Carnegie Training & Associates, U.S.A.
- Tinna Rubber And Infrastructure Ltd: conversion of used tyres into crumb rubber and steel wires.
- Modern Insulators Ltd: manufactures porcelain insulators from 33KV to 1200 KV. These are the ceramic material looking coils on the high voltage power transmission lines.
However, if an investor thinks that these businesses would have generated significant returns for their shareholders, then she may be in for a surprise because none of them had super-normal profit performance with many of them suffering losses over the years.
11) Auto-ancillary companies have a predictable business performance:
When I analysed the financials of auto ancillary companies, then I noticed a common financial picture in most of the auto-ancillary companies. This was irrespective of the fact that the companies operated in such diverse segments like manufacturing steering wheels, suspensions, die-casting, locking system, fabrication etc.
- Most of the companies had an operating profit margin (OPM) in the range of 6-10%. In fact, 10% seemed to be the upper limit that original equipment manufacturers (OEMs) seemed to have set for their vendors. OPM of most of the auto-ancillary players used to peak at 10% and then again decline in the cyclical pattern characteristic of the auto industry.
- In almost all the cases, the CFO for the last 10 years for auto-ancillary players was significantly higher than PAT. This was primarily due to high depreciation and interest on debt on their balance sheet.
- In addition, almost in all the cases, the capital expenditure done by the auto-ancillary players was higher than their CFO, which led to a negative FCF. These players, in turn, had to raise more debt to meet the capital expenditure requirements.
Therefore, in my assessment of numerous auto-ancillary players, I noticed that most of them had fluctuating OPM within 7-10% range, negative FCF with capital expenditure funded by debt.
Though an investor would also find a few players that defy this trend with either higher OPM, low debt etc.; however, I noticed that it was an exception rather than a norm.
12) Companies acting as outsourced manufacturers for big brands give away profitability for assured business:
I came across many companies, which are engaged in the business of manufacturing goods for big brands. Look at the following companies:
- Amber Enterprises India Ltd: manufactures primarily air conditioners (AC) for big brands. However, it even produces microwave ovens, washing machines, and refrigerators etc. for them. You name any AC brand and you would notice that it is a customer of Amber: Daikin, Carrier, Hitachi, Blue Star, LG etc.
- Dixon Technologies (India) Ltd: a contract manufacturer of mobile phones, televisions, and other home appliances for Xiaomi, Samsung, Voltas, LG, Flipkart and Foxconn.
- Hindustan Foods Ltd (HFL): FMCG contract manufacturer for Hindustan Unilever, Reckitt Benckiser, Hush Puppies shoes, US Polo Association, Danone, Gabor etc. HFL is the company with the largest range of manufacturing items that I have ever seen. Its manufacturing range covers food, home care, personal care and leather goods. You name a product sold by FMCG companies and there is a high probability that HFL would be manufacturing it.
- Vishal Fabrics Ltd: manufactures clothes for numerous brands like Aditya Birla Group, Pantaloons, Lifestyle, Flipkart, Myntra, and Jack & Jones etc.
These companies manufacture products for many known and leading brands in their domain and as a result, they get assured visibility of the business. However, when an investor analyses their financial performance, then she notices that these contract manufacturers earn an OPM in the range of 6-10% and an NPM in the range of 2-4%.
It seems that these companies had to trade assured business with their profitability.
You may read our detailed analysis of Amber Enterprises India Ltd in the following article: Analysis: Amber Enterprises India Ltd
13) Most of the companies in some segments never report profits:
While analysing small companies, I noticed that many companies in certain business segments almost always reported losses. These segments are:
- Bollywood or film media companies
- Small unknown NBFCs
- Stock market small brokerage firms
Many companies in these segments have reported losses for most of the years of operations in the last 10 years.
If an investor wishes to extend the list of these segments, then she may add small construction companies (EPC etc.) in the same list where a significant number of players report losses year after year.
14) When a trend picks up, then share price of almost every company even remotely linked to the theme, goes up:
Investors would know that 2017 was a year of mid & small caps. During 2017, the share price of almost all the small-cap stocks zoomed ahead irrespective of the fundamental performance of the companies. Now, by 2020, the share price of almost all such companies have declined.
When an investor analyses the share price performance of small caps, then most frequently she sees this mountain structure where there is a sharp rise of share price during 2017 and then an equally sharp decline from 2018 onwards.
This is the story of many of the small-cap stocks where during 2017, the stock price increased 5-10 times and thereafter, the price has declined to pre-2017 levels.
Currently, in 2020, the theme is active pharmaceutical ingredients (API) due to ongoing tensions in India-China relationships. Indian pharmaceutical industry has been highly dependent on China for its API requirements. Now, in the current circumstances, there is stated requirement of India getting independent in the API production. As a result, almost every company, which has API as one of its business divisions, has seen its share price increase significantly.
It remains to be seen which all companies can capture the API boom in their financial performance and whether the current share price rally in the API manufacturers leaves the investors happy.
Looking at the history of such sharp up moves in the share price of companies, an investor remembers 2016 when share prices of most of the chemical companies had rallied when China tightened the environmental regulations in the country. Almost every chemical company witnessed its share price increase many folds due to anticipated growth in the business by capturing the market vacated by Chinese manufacturers. However, by now, the share price of most of the chemical companies have returned to pre-2016 levels.
And a person should never forget the recent share price movements of two cyclical industries that became very popular.
First one is graphite electrode manufacturers:
You may read the in-depth fundamental analysis of a graphite electrode manufacturer, HEG Ltd, in the following article: Analysis: HEG Ltd
And the second famous cyclical trend was seen in Calcined Pet Coke (CPC) and Coal Tar Pitch (CTP) manufacturers:
You may read the in-depth fundamental analysis of a CPC & CTP manufacturer, Rain Industries Ltd, in the following article: Analysis: Rain Industries Ltd
Looking at the above charts, an investor should always remember that when a theme or a trend picks up in the stock markets, then stock prices of almost all the companies even remotely linked to the trend increase. Many times, such prices may increase by 5-10 times as well. However, it is not certain that the wealth generated by these short spurts of thematic stock market rallies will sustain in the hands of shareholders.
The above instances indicate that in many such thematic rallies investors lose almost all the wealth generated during the up-market phases.
Therefore, an investor should always be cautious while she notices that the price of a company is rising as it is linked to a theme which is currently a hot favourite of market players.
15) Nostalgia: Old well-known brands now lying in small-cap segment:
In the small-cap space, I found many brands of past years, which used to be very famous in the past but are almost forgotten currently. Reading about these companies as a part of the exercise was nostalgic. In some cases, I was positively surprised to know that the companies still exist. Look at the following cases:
- Salora International Ltd: makes electronics under the once-famous brand of TVs “Salora”.
- Hipolin Ltd: it makes detergents under the once famous brand “Hipolin”.
- Dynavision Ltd: famous TV brand “Dyanora”
- Opal Luxury Time Products Ltd: famous brand of clocks & watches “Opal”
- Jindal Photo Ltd: sells consumer photo imaging products under the ‘Kodak’ brand, and medical x-ray under the ‘Fujifilm’ brand.
- Shalimar Paints Ltd: it is long since I heard of the “Shalimar” brand of paints in the media.
- MIRC Electronics Ltd: famous TV brand “Onida”
However, I noticed that many of these companies are barely surviving with losses in most of the recent years of business.
It was a nice experience to learn about these companies as a part of the exercise when I was analysing the last segment of the companies (small caps). It was a nice conclusion to the exercise that covered learning about 2,800 companies with over ₹10 cr market capitalization listed in Indian stock markets.
I do not know in how much depth Warren Buffett analysed thousands of American stocks when he read about all the businesses listed on American Stock Markets and how much information about each company that exercise gave him. I am not in any position to compare where my learning about these 2,800 Indian stocks stands in front of what Warren learned about American stocks.
However, it was an immense learning exercise, which in the end gives an investor the feeling that she has seen almost everything that the share market has to offer her as options. It is like going through the entire catalogue of a store or tasting all the food items on the menu of a restaurant.
In the end, when I reflect upon the role Screener website played in my exercise, then I can say that without Screener, this exercise would have been much more difficult. Probably, despite having the desire to learn about all the stocks in Indian stock markets for a long time, I could not achieve it in the past because tools like Screener did not exist and when it came into being, then I was not aware of it. Even when I started using Screener, then it took me a while to understand the real potential of its “Export to Excel” tool.
However, now, when I know about the screening tools and the “Export to Excel” feature of the Screener website, then the exercise of learning about all the listed stocks became very easy. All I had to do was:
- Put the screening criteria by market capitalization e.g. more than ₹10,000 cr,
- Sort the results by decreasing market capitalization,
- Click on the name of each of the companies to visit its page on Screener,
- Read the brief introduction about the company at the top of the page,
- Click on the link “Company Website” at the top section of the page,
- Visit the website of the company and read the “About Us” and “Product & Services” pages,
- Come back to Screener website, click on “Export to Excel” button and download the last 10-year financial data in my customized excel template,
- Click on the downloaded customized excel file and then see the dashboard of financial parameters to determine whether the company offers some fundamental financial strength to shortlist it for further analysis of annual reports and business model and if not, then leave the company, and
- Move over to the next company on the list.
- Repeat the above steps for each of the 2,800 companies.
I believe that any investor can follow the above steps to analyse any one or all the listed companies in the Indian stock markets. The only limiting factor is the time. However, nowadays, the information is available much more easily at the fingertips of the investor than what used to be the case about 75 years back when Warren Buffett analysed all the companies listed on American stock exchanges.
You would appreciate that the Screener website has played a very important role in this entire exercise. Moreover, none of the steps in the above exercise needs a premium subscription of Screener. I whole-heartedly thank Ayush Mittal and Pratyush Mittal for creating such a priceless tool for Indian investors.
In the end, just to rephrase my learning from the whole exercise:
- There is a severe shortage of companies with a large market capitalization.
- Most of the large-capitalization companies have astronomical valuations due to too much money chasing too few companies.
- Instances of high valuations correcting themselves despite improving business performance of the companies. E.g. Just Dial Ltd, Gillette India Ltd and Page Industries Ltd.
- Financial performance of large companies shows that they are large because of some reason. They have an established business model, a much larger reach to their customers, established sales & distribution set up and financial power to withstand a crisis. During the crisis, they take market share away from their smaller competitors.
- The market rewards large companies with a “stable business” premium. Once a company crossed ₹10,000 cr market capitalization barrier, the market gave it a premium of about 10-15 PE ratio.
- Smaller companies had a slower growth over the last 10-year in their business than larger companies. A far higher number of companies with a market capitalization less than ₹2,500 cr reported growth rates in single digits whereas a large number of companies with the market capitalization of more than ₹5,000 cr reported growth rates in double digits.
- Many large companies keep rewarding shareholders by way of increase in stock market price despite nil or negative free cash flow. They reinvest all the operating cash flow in their business and grow their book value at a significant pace.
- The small-cap segment is full of SMEs. Small steel processing units, Auto ancillary units, Small textile mills, Small standalone paper factories, Small chemical & dye units, Small pharmaceutical manufacturers working on a job-contract basis, Computer parts & accessories traders, Small logistics operators, Small stockbrokers, Small NBFC and investment companies, Small commodity trading companies, and Small telecom equipment traders etc. You may find a gem here; however, be ready to turn over more than a thousand stones to find it.
- Most of the small companies suffer from delayed receivables collection. Be ready to find out whether it is poor collecting ability, aggressive sales recognition or accounting juggleries.
- The small companies segment has many companies with interesting business models with no competing listed peer. However, a unique looking business does not ensure a higher return on investment.
- Auto-ancillary companies have a predictable business performance. Cyclical 6-10% OPM, negative FCF, increasing debt and cumulative CFO much higher than cumulative PAT over the last 10 years.
- Companies acting as outsourced manufacturers for big brands give away profitability for the assured business. They usually have an OPM in the range of 6-10% and an NPM in the range of 2-4%.
- Most of the companies in some segments never report profits. Bollywood or film media companies, unknown small NBFCs, small stock-market-brokerage firms and small construction companies.
- When a trend picks up, then share price of almost every company even remotely linked to the theme, goes up. However, more often than not, when the trend is over, then the share price returns to the levels previous to the thematic stock market rally.
- Nostalgia: Old well-known brands now lying in the small-cap segment. Most of these companies are barely surviving.
With this, I have come to the end of this article highlighting my learning from the exercise to read about most of the listed companies in Indian stock markets.
Request you to share your comments and feedback in the “comments” section below. In case, you have attempted any similar exercise, then it would be great if you can share your experiences with us. It would be great learning for the author as well as the readers of our website.
Dr Vijay Malik
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Registration status with SEBI:
I am registered with SEBI as a research analyst.
Details of financial interest in the Subject Company:
I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.