Listen to this article
An investment framework is a time-tested thought-funnel that can distil many winning investment ideas. And a robust investment process can overcome volatility and build a foundation of investment portfolio that can deliver consistent outperformance.
To discover importance of investment philosophy in the fund management business, Cafemutual hosted Navin Agarwal, MD & CEO, Motilal Oswal MF at Cafemutual Ideas Fest 2022 (CIF 22), who spoke about the power of framework in investing.
Giving an example of funnel, Navin said:
If you think of a funnel, quality of business and management comes at the top. Both are essential, impact wealth creation and are multiplicative.
Porter’s 5 forces come in handy to assess businesses. The threat of new entrants and the threat of substitute products/services determine how much value a particular sector can create. The bargaining power of suppliers, the bargaining power of buyers and rivalry amongst competitors will decide how that value will be shared in the value chain.
Going by Philip Fisher’s philosophy of evaluating a common stock, management constitutes 90% weightage. Industry and other factors follow next, with a weightage of 9% and 1% respectively. The longer you plan to stay invested, the more important is the management.
Growth in earnings forms the second filter.
By combining growth with quality, there can be far better wealth creation over the long term. Growth in earnings is reflected in volume growth, price growth, operating leverage, financial leverage, etc.
Next is longevity of both i.e. quality and growth.
And finally, comes price. There should be a high margin of safety and the valuations should be reasonable to quality and growth prospects. Payback ratio (Market Cap divided by Next 5 years PAT) and PEG (PE to Growth) ratio are important indicators. Lower the ratios the better.
Best investment strategy
There are three types of companies - great, good and gruesome.
Great companies need no capital and are fountains of dividends i.e. they pay regular dividends, which keep rising year after year. Buy great companies at a good (reasonable) price.
Good companies are fountains of earnings. They grow at healthy rates but need significant capital infusion from time to time to sustain growth. Buy such companies at a great (bargain) price.
Gruesome companies tend to enjoy a very high growth rate, which turns out to be a trap. They effectively are ‘bottomless pits of capital consumption’. Avoid such companies at any price.
