In an article in ET, Dr Vikas V Gupta has explained the rigorous filter that he put the stocks through to identify the value stocks:
Step 1: Filter out all companies with sales less than Rs 250 cr. Companies with sales lower than this are very small companies and might not have the business stability and access to finance that is required for a safe investment. This eliminates the basic business risk.
Step 2: Filter out all companies with debt to equity greater than 30%. Companies with low leverage are safer.
Step 3: Filter out all companies with interest coverage ratio of less than 4. Companies with high interest coverage ratio have a highly reduced bankruptcy risk.
Step 4: Filter out all companies with ROE less than 15% since they are earning less than their cost of capital. High ROE companies have a robust business model, which generates increased earnings for the company typically.
Step 5: Filter out all companies with PE ratio greater than 25 since they are too expensive even for a high-quality company. This enables us to pick companies which are relatively cheaper as against their actual value.
He points out that applying these filters enables us to reduce and even eliminate a lot of fundamental risks while ensuring a robust business model, strong earning potential and a good buying price.
After a detailed explanation of the entire methodology, Dr Vikas V Gupta explains that applying the strategy since 2003 delivered astounding returns with a CAGR of 29.1% and the money growing 20 times in 11 years!
The 10 stocks that qualify under the Graham-Buffett formula are Zensar Technologies, Coal India Ltd, NMDC Ltd, Cairn India Ltd, V.S.T. Tillers Tractors Ltd, Tech Mahindra, Hexaware, Indraprastha Gas Ltd, Infosys Ltd, Engineers India Ltd
Dr Vikas V Gupta explains that these 10 stocks illustrate that high quality companies with strong balance sheets also withstand the stringent Graham-Buffet screening process. He recommends that investors progressively form a portfolio having exposures to a few of these stocks for the current month after due diligence and having discussions with their trusted financial advisors.
He has also recommended a maximum ceiling allocation of 5 per cent for any stock. An ideal portfolio should constitute about 20 stocks and not less than 10 stocks, he advices.