A famous adage you see pinned up in many investors’ offices is, “In God we trust, all else must bring data.” This adds to the pop culture visual of investment analysts being number crunching, excel wiz kids.
While that may be the case for some, investing outside of the large-cap universe, or rather companies that haven’t hit maturity, is more guided by intuition or feeling rather than by calculations alone. This is a consequence of two realities.
First, what can be measured is usually already in the price. There is no such thing as an information edge for a common, minority investor. What minimal opportunity can be created based on data points that can be measured are in times of extreme fear or greed, where liquidity or the lack of it results in mispricing of assets. Such arbitrage opportunities cannot last long. One, therefore, cannot have a strategy solely based on this. Not at scale anyway.
Second, what can be measured is in the past, and stock markets are a future discounting machine. Investing in small and midcaps (or emerging companies) based only on the past is akin to driving a supercar by looking at the rearview only. Accidents are bound to happen. Feeling, instead of measuring, is what is required to gauge structural tailwinds that create the multibaggers your investment returns demand of you.
Investing in Eicher Motors in 2010 would have required believing in the pursuit of biking as a hobby, and therefore a world-class cruiser finding its feet with an aspiring young population; and in the vision of the then MD, Siddharth Lal, to pull it off. No data points, no numbers suggested that anything of that order had happened in India before.
a) Sectors- Is the company already in or expanding into sectors where there are significant tailwinds? Do these sectors have a long runway in India or for Indian companies? Customers spends only have visibility for one or two years. Nothing is given beyond that. There would have to be some form of leap of faith on the part of the investor to believe that these tailwinds sustain. Informed guesstimate but a guess nonetheless.
b) Mindset- Does the promoter have the mindset to scale it to ₹1,000 crore? Zero to one and one to a hundred require fundamentally different mindsets. Some evolve with time, but most don’t. Zero to one requires scrappy management, while one to one hundred requires institutionalising processes for scaling up. Even within those phases, there are multiple steps of evolution for a company. In his vision, from ₹300 to ₹1,000 crore, is he still thinking local? Is he looking to cater to emerging demand in India and benefit from PLI schemes? Is he thinking of competing at a global scale and selling to the top two battery manufacturers globally and then entering India at the top of the value chain? Is he thinking in blocks of ₹20-30 crore or ₹200-300 crore now?
c) Execution- It goes without saying that this mindset, without being married to execution, would be fruitless. In evaluating whether there is execution capability to marry the mindset and capitalise on the tailwind, there is a fair bit of measuring involved. A great starting point to judge execution is by looking at what has been delivered in the past. It still requires some amount of instinct to judge whether they would manage well at scale, but at least measuring gives a starting point.
In judging whether a small/ mid/ emerging company can grow and continue doing so for a long time, it is this SME framework that comes in handy. Unfortunately, measuring only covers a part of execution. It is the investor’s gut call on the other two that matter most, and that develops only with time and a dose of luck. Measuring alone and relying simply on financial models can lead us to a point of being precisely wrong when all you need for a great investment is to be directionally right.
(Disclaimer: This article is by Harini Dedhia, head of research, Tamohra Investment Managers. Views are her own.)
