If you ask Rakesh Jhunjhunwala, the Badshah of Dalal Street, the reasons for his spectacular success on the stock market (he is presently worth $2 Billion or Rs. 13,000 crore), he will unhesitatingly credit the three stars in his advisory team – Utpal Sheth, Atul Suri and Amit Goela – for providing him with timely strategic inputs and advice.
The credit is not misplaced because each of the three is a brilliant stock picker and strategist in his own right.
We can get a glimpse of Utpal Sheth’s mastery in stock picking from the old transcript of his interview with Chetan Parikh of capitalideasonline.com. In the interview, Utpal Sheth explained his investment strategy at great length. He pointed out that he essentially looks for stocks which fulfil the following criteria:
(i) The underlying business has to be inherently attractive;
(ii) The company must be able to achieve a sustainable competitive advantage in the foreseeable business;
(iii) The management must be of top quality and trustworthy;
(iv) The company must be able to earn high rates of return on capital.
In the old interview, Utpal Sheth was not content with talking about theory. He identified two stocks, Colgate and United Spirits, as an example of what he meant. Needless to say, both stocks are multi-baggers today.
In his latest interview with Ramesh Damani for the Wizards of Dalal Street series, Utpal Sheth has further elaborated on his investment methodology in the context of four of his stock picks which have become super-duper multibaggers – Pantaloons Fashion, Titan, Crisil and Shree Cement.
Utpal Sheth says that there are a few factors necessary for a stock to become a winner stock, and for us to become successful investors. These are:
(i) Structural change and leadership attributes: Look for companies pursuing structural change and showing leadership attributes. A confluence of these two factors results in the creation of the greatest opportunities. These two factors influence both the earnings per share (EPS) and the PE. The key parameters of such companies is great scalability, great return on capital employed and cash flow profile;
(ii) Capital allocation and structure: The most important factor is capital allocation and capital structure. These are the biggest drivers of value creation. How a company deploys its cash that it earns is very important. Mathematically, how the return on incremental capital behaves is very important to the future return on capital employed;
(iii) Serial Diluters: Avoid companies that constantly need external funding, whether in the form of equity or debt. Such companies will never generate high rates of return of capital;
(iv) High Debt: Avoid companies that are highly indebted. Also avoid debt in your personal life. Debt is the enemy of compounding everywhere, be it in a company or be it for the investor;
(v) Magic of compounding: Don’t obsess with finding overnight multi-baggers. Instead, focus on stocks that can give long-term compounding. The magic of long-term compounding is very powerful. Though we have all learnt and read about this, most of us don’t practice it enough;
(vi) Risk management: Risk management and financial discipline are very important for an investor.
Interestingly, Utpal Sheth pointed out that the non-adherence by him and Rakesh Jhunjhunwala to the above principles had led to two miserable flop stock picks, A2Z and Bilcare. He explained that poor capital allocation and poor capital structure created a vicious circle which led to the doom of these companies. The return on capital employed being generated out of the business was poor and so, though there was growth, the free cash flow generation and ROCE was poor.
So, “return on capital employed and scalability are two big mantras for long-term valuation creation for the company and wealth creation for the investors” Utpal Sheth said with a big smile on his face.
Now, the million dollar question is whether there are any stocks around with “high return of capital” and “scalability” for us to pick and make mega bucks?