Can buying quality shares regularly be more rewarding than mutual fund SIPs?

Vinayak Savanur

Rahul studied the account statement of his mutual fund investment with a sinking heart. He had started an SIP investment in a multi-cap fund 10 years ago to save up for his daughter’s education. The account statement showed the current value of his investment at ₹ 86.92 lakh. The US-based university in which his daughter had received admission had sent Rahul the request to pay up $ 1,36,318 (₹ 1 Crore). He had a gap of ₹ 13.08 lakh. Where would he get the money from? Would his daughter have to sacrifice her education because he had not been able to accumulate sufficient funds? Rahul computed the CAGR returns over the last 10 years of the multi-cap fund and found that it had generated a modest 8 per cent while the Nifty 500 benchmark index had generated 10 per cent during the same period.

Rahul managed to take a loan to meet his daughter’s education fees. Rahul then decided to do his own research on SIP investing, which revealed some surprising facts.

SIP, or Systematic Investment Plan in a mutual fund is done irrespective of where the stock markets are headed (up or down). As a result, over the long term, your investment cost averages downward.

SIP investing can be done in direct equity shares too. The concept remains the same as SIP in mutual funds. However, SIP in equity offers the following benefits.

Advantages of equity SIPs

-More control over your portfolio in terms of stock selection, purchase cost, exit price, percentage of each stock in the overall portfolio, sector allocation, etc.

-Possible to change allocation across stocks and sectors at any time depending on market movement and your preferences.

-You can continue to hold winners and exit losers.

-You receive dividends directly from companies whose stocks you own.

-You can avoid over-diversification, which some mutual funds tend to do.

-You don’t have to pay management fee that is levied by mutual funds.

-You enjoy high liquidity; you can sell stocks at any time if you need cash.

While Rahul was convinced, he had a concern. He didn’t have the skills or the time to select and monitor individual stocks. How would he overcome this? On digging deeper, he found the concepts of ‘Buy what you see’ and ‘Quality’ investing.

‘Buy what you see’ is a simple concept. It implies that you invest in stocks of companies whose products you use and see a lot of other people using.

Quality investing

‘Quality investing’ implies investing in fundamentally strong companies that meet the following 10 parameters.

-Market capitalization of over   ₹ 1,000 crore (Market capitalization = number of shares outstanding multiplied by market price per share).

-The company should have been in existence for at least 10 years.

-The company should have delivered Revenue/Sales growth of at least 10 per cent and Return on Capital Employed (ROCE) of at least 14 per cent consistently over the last 10 years.

-Competent and visionary management; the company should be a frontrunner to adopting new technologies to make its business more efficient and improve its offerings to its customers.

-Part of sector that is on the threshold of sustained exponential growth.

-The company should successfully move through these value migration stages while maintaining its leadership. For instance, with respect to commuting, moving from cycles to cars, and now, to driverless cars.

-Should be a ‘quality’ company in the B2C (Business to Consumer) market segment, which facilitates building brands, customer loyalty, expanding across geographies and products, etc. thereby increasing the company’s equity valuations.

-Look for quality companies you are familiar with based on brands, quality, service, loyalty, etc. – a product or service that you use and like.

-Quality companies usually offer products across the price spectrum, thereby increasing their consumer base. For instance, a company manufacturing brown goods (refrigerators, air conditioners, etc.) can offer products at different price points.

-It’s best to avoid PSU stocks and cyclical companies in sectors such as Infrastructure, and capital goods.

Searching for examples

Rahul decided to look for an example. He looked at the tube of toothpaste lying on the bathroom counter. He read the label ‘Colgate’. He then thought about the company manufacturing this toothpaste and realized that most people he knew used Colgate toothpaste just like him. He then sought information about Colgate Palmolive (India).

-The company’s market capitalization (number of shares multiplied by the market price per share) was nearly Rs 40,000 crore.

-The company belonged to the personal care/FMCG sector. It has been in existence for more than a hundred years.

-The company is run by credible and competent management; it has had strong financials over the last 10 years (consistently high Return on capital employed (ROCE) of above 14 per cent, sustainably high profit margins of over 10 per cent, healthy free cash flow (FCF), strong balance sheet, Zero debt, etc.)

-The company’s business was non-cyclical, i.e., it was not significantly impacted by economic cycles and it was a market leader in the mouth wash/care market.

-The company is constantly innovating by introducing different kinds of toothpastes.

-The company is also a leader in the toothbrush and mouthwash segments offering innovative products - 360 degree Charcoal Gold, 360 degree Whole Mouth Clean, 360 degree Visible White and 360 degree Floss-Tip, Colgate ZigZag Black Toothbrush, etc.

-The company enjoys customer loyalty. It has an extensive distribution network and is strongly recommended by dentists. In fact, ‘Colgate’ satisfied all the parameters of a ‘quality’ stock.

Using the SIP investment strategy in ‘Buy what you see’/quality companies such as Colgate has the potential to generate consistent and robust returns over the long term, with low risk.

Rahul also discovered that over the past 10 years, while multi-cap funds have generated CAGR returns in the range of 7 to 12.5 per cent, a ‘quality’ portfolio has generated CAGR returns of about 19 per cent (Excluding dividends & Bonus Issues, etc.,). Against this, the Nifty 500 index (which constitutes most stocks that form part of multi-cap funds’ portfolios and ‘quality’ portfolio) has generated CAGR returns of about 10 per cent.

Rahul decided to build a portfolio through SIP investing in 10-12 such quality stocks with allocation of not more than 10 per cent of the portfolio in each stock. Rahul was on his way to build his personal wealth.

Disclaimer: The above stock example is just for illustration and is not a recommendation.

(The writer is the founder & CIO at Sukhanidhi Investment Advisors, a SEBI registered equity investment advisory firm, based in Hubballi-Dharwad)