Top 5 rules to handpick stocks which could turn out to be multibaggers: Ashish Chugh

Q) I know you won't talk about stocks in particular but if you can tell us the sectors you are bullish on & the investment themes you are working on currently?

A) My approach to stock picking is bottoms up & not top down. However, long-term potential of the sector surely is one of the considerations.

a) I have found out most of my multibaggers at times when the stocks were beaten well below their intrinsic worth and to abysmally low levels, on the back of certain short-term negatives.

b) One common characteristic of all stocks that have turned multibaggers is a significant growth in Sales. Growth is, therefore, a very important parameter - a value stock will otherwise remain a Value stock unless there is growth in the company.

c) I am on the lookout currently for companies where Capex is done in the last five years, the capex has not started yielding results because of factors like - not adequate demand or teething startup problems.

The profits would be lower today (compared to a scenario if they had not done any capex) because of higher depreciation & interest cost & hence lower Investor interest in the stocks. This enables me to buy the stock at lower levels.

However, my thesis is that as and when the demand pick up happens or the teething issues get resolved, revenues could go up & profitability could shoot up substantially due to operating leverage.

d) I am looking for stocks in sectors where the demand pick up can happen - ancillaries to Housing, Infrastructure, Building material & Rural plays etc. I am looking for select plays in Cement & E-commerce space, of course in the microcap segment.

e) I am also looking at few companies with great brand and brand recall, which were not doing well because of change in dynamics of their business - some of them may be restructuring and reinventing their business models. Am keeping an eye on such opportunities.

Q) Indian markets are at an all-time high and in many terms it as a liquidity driven rally, do you see foreign investors putting more money into the Indian markets?

A) India is undergoing a revolutionary change currently - something we have not witnessed since a very long time. Corruption, Black money, inefficiencies in the system had become an integral part of our lives & first time there has been a serious effort by any government to challenge the existing system and to change it.

Demonetisation & GST are steps which will change the way we transact and will bring in more transparency, reduce corruption and generation of black money and hopefully lead to increased efficiencies.

There are going to be teething problems on the way to this and this will take a few years to get fully streamlined though - so no quick fixes for our problems & changing the eco system which was built over decades.

I feel once the impact of these measures and many more changes that the government is envisaging starts coming, India could be one of the world's fastest growing economies.

India could, therefore, be a bright spot and the FII inflows can, not just sustain but accelerate in the coming years. Why just Foreign Money - with Real Estate & Gold in stagnation/ downturn and with FD Rates becoming unattractive, even flows from Resident Indians into Equities can also increase substantially in the future.

Q) I know you've been doing Microcap & smallcap investing all these years, What are the important things an investor should consider in microcap/smallcap investing?

A) First of all, it is important to understand ‘Who You Are’ & ‘What kind of Temperament’ do you have. You have to figure out whether you are cut out for microcap investing or not.

Microcap Investing & Multibaggers sounds fascinating; however, you have to figure out whether you can see your stock underperform the markets for years and whether at the back of this underperformance, can you develop the conviction to hold the stock.

How does your mind get swayed due to stock price movements? Microcaps are highly illiquid stocks with very high impact cost & in bear markets, you may have to see your stock trade even 50% lower than buying price - how would you react to such a scenario.

I have seen some of my stocks fall 30-40% from my buying price & then go up 5-10X times from there. I could have well sold out in panic, missing all the returns later.

In such a scenario, it is important to focus on the business and its direction rather than let your mind get swayed by stock price movements.

The other important thing is Risk Management - if you have learnt to manage your risk, 75% of the job well done. Remember, Equity Investing is all about Probabilities & Risk Management - no certainties here.

Focus on valuations is the key to risk management. Also, you can't work with target prices in microcap investing - here you have to focus on the process rather than the outcome.

One has to understand that Multibaggers are not there from Day 1, they evolve over a period of time – that’s why we call them "Potential" Multibaggers.

Also, it is prudent to invest in a basket of stocks - allocation of capital may depend upon conviction levels, visibility of earnings & Valuation parameters; however, the important thing is to diversify (and at the same time not over diversify).

Q) Management as we all know is a very important factors in any company. However, the fact is that most smallcap companies are run by managements where not much is known or written about in public domain? In such a scenario, how does one identify a good management?

A) Well, this is the tough part in microcap investing. You are right that these are mainly managements where not much information is available in public domain. However, if you go through the past of the company (not a few quarters but few years), you can get vital clues about the management.

The important thing to first understand is what constitutes a good management - I think this is one subject I believe is grossly misunderstood. I think in most cases (not all), it is nothing more than a perception which changes with the Stock price.

Most analysts link good managements to the stock prices of their companies - I am talking this from my experience of last many years. What I experienced is that when these stocks were trading at low valuations & low prices, there was not much interest of analysts and brokerages & these were brushed off as companies with management issues.

If everything else in the company looks OK & the management does not talk to the analyst or conduct Investor or Analyst concalls, such managements were labelled as being Investor unfriendly.

When the price moves up 5 to 10X from those levels, you start seeing analyst reports & suddenly the management quality would start looking good.

For me, a good management is one who is focussed on the business - Has skin in the game aka high promoters stake - allocates capital diligently - shares the wealth with Investors in the form of share buybacks & dividends.

Even companies which may not pay dividends (because of high Dividend distribution tax) but uses the earnings for regular Capex & scaling up a business without Equity dilutions. This too enhances shareholders value.

I think not making impressive investor presentations or not conducting Investor Meets and concalls are factors which are unimportant for judging a management as far as I am concerned.