5 quantitative factors and 2 qualitative factors are used for stock selection
Quantitative Factors
High Return Ratios
The higher the returns on equity and capital employed over weighted average cost of capital (WACC), the higher
is the value addition by the company to its minority shareholders. Studies have indicated that companies with
superior return ratios outperform companies with poor or lower return ratios. Return ratios are averaged over a
5 year period to smoothen out lumpiness and volatility (if any).
Minimum Leverage
Investments will be made in those companies that can grow without leveraging the balance sheet. In a high
interest rate environment like the present one, interest outgo will pinch bottom line and therefore shareholder
wealth. Minimal debt for purpose of working capital is acceptable. Long term debt for the purpose of expansion,
Greenfield etc is avoided.
Market Cap Threshold
Will invest in companies with market cap of not less than 1000 crores which will avoid small companies with
lesser float, but at the same time will avoid investing in companies which are very large and themselves find it
difficult to grow.
Capital Light
Generally companies with very high fixed asset turnover ratios are preferred. Hence, asset heavy businesses are
discarded and entry barriers in these cases are mostly due to the company’s brands and the space it operates in.
Most companies that pass this filter will generate sufficient cash flows to fund their capex without external
borrowings.
High Operating Leverage
Companies that are in a better position to absorb rise in raw material prices and companies that are able to
easily cut its cost by increasing volumes are preferred especially in uncertain environments like the one we have
at present.
Qualitative Factors
Minority Shareholder Interest
Identifying managements that have generally kept in mind and have acted in the interest of minority
shareholders, do not frequent capital markets (for raising funds) and have been rational in their decisions.
Strong Brands & Market Presence
Brand pull will enable companies to pass on higher raw material costs to consumers. Brand pull will also ensure
that consumers continue to purchase the products with their reduced purchasing power in a high inflationary
environment.