It is our view that for investors with a longer horizon, qualitative aspects need to be weighed very carefully as well to arrive at a meaningful analysis of a business.
We have written about the churn in the Indian equity markets and also about the divergent trends in stock price movements.
A lot is being said about the valuations of quality businesses with their P/E ratios being “high”. We will not go into the merits of this “high P/E” argument but suffice to say that the debate needs to be more nuanced.
The broader investment community continues to focus on the quantitative aspects of a business, with analysts extrapolating trends both on the downside and the upside.
It is our view that for investors with a longer horizon, the qualitative aspects need to be weighed carefully as well to arrive at a meaningful analysis of a business.
While in recent time the focus on governance and transparency as qualitative aspects has come to the fore, and rightly so, we believe that there are some common features that distinguish a great business. Here are the big four:
Transition from a founder-driven to a professionally driven business
Some of the best businesses in India have been able to make a seamless transition from being “promoter” driven to professionally run by bringing in outside talent to run and grow the business over time.
While in a lot of cases either the founder or the founding family continue to provide strategic direction and vision, the day-to-day operations are run by professionals, who when provided with the right environment, have been able to scale these businesses efficiently and meaningfully.
Relevance to customers
Many companies very often speak about “innovation” in their annual reports and commentaries. To our mind, the simplest definition of innovation is perhaps “being relevant”.
Over time, businesses that can adapt and remain relevant to their customers will continue to reap the benefits of longevity.
It is not a surprise therefore that we find listed business in India which have been there for a hundred years or more!
The ability to widen competitive advantages
A business is also gauged by the edge which it has or develops over time. These could be in the nature of brands, distribution or in recent times, technology.
Some of these businesses are efficient and strategically recognised these advantages. They have dedicated significant resources and management bandwidth to deepen and widen these moats.
Strong value framework
While heretofore strong ethical foundations and a commitment to behave responsibly towards all stakeholders were common features, more recently, the focus has been on sustainability and the role of businesses in the larger context of societies they operate in.
A look at the annual reports of some of the leading businesses in India reflects how this trend is evolving.
The recent experience in the US where the top 200 CEOs that make up the “Business Roundtable”, with JP Morgan Chase CEO Jamie Dimon as chairman, changed the definition of “the purpose of an organisation” is a pointer towards this new trend.
The equity markets will continue to gyrate in the short –term, driven as much by sentiment as by the focus on the near-term quantitative factors such as growth, margins, and P/E multiples.
However, in our view, the long-term compounding returns matter and these returns are provided by great businesses that have one or more of the attributes highlighted above.
The focus therefore on “high P/Es” in isolation ends up ignoring the qualities that go into building a great business that can navigate through trying times and end up delivering long term compounding returns for shareholders.
(The author is Founder & CIO–Bay Capital)Disclaimer: The views and investment tips expressed by investment experts on moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.LIVE NOW... Video series on How to Double Your Monthly Income... where Rahul Shah, Ex-Swiss Investment Banker and one of India's leading experts on wealth building, reveals his secret strategies for the first time ever. Register here to watch it for FREE.