Many a times I have been asked what to look for in a company before you decide to buy a share. Let me tell you what I was asked to do by an FII running an International Blue chip fund. Their definition of blue chip did change from market to market and the markets that we were covering had the following QUANTITATIVE criteria. I would not know the QUALITATIVE criteria, but you can take a guess. So to run a screen I had to use the following criteria:
1.Consistently increasing / constant earnings for 15 quarters: there was absolutely no argument for a fall in any quarter (I guess in case of say Nestle they may have allowed for something like a Maggi episode) but I could not bring an EiD parry into the argument. This meant they would not touch commodity, etc. but many (most) top pharma, financial companies, fmcg, and well diversified industrial consumable companies like Carborundum Universal would qualify. Coromandel International and Eid parry would not have qualified. So increasing CEPS was the consideration.
2.Increasing RoA over the past 5 years: the company had to get an increasing return on its assets and a good RoCe. The RoA cut off was real return (10 year gilt yield minus inflation). Except in some cases of very high capex or diversification, many companies would pass through this test without much hassle.
3.The Leverage had to be held constant or it had to be coming down: Actually if the d/e started off low, and it increased, I would argue that it was not a worry. Their argument was ‘we will never know whether the increased borrowing was because operations was sucking more money. So they were paranoid about debt. They loved companies which borrowed internationally (they felt international lenders did better due diligence). Companies which had a range of lenders, different maturities, different currencies were liked more. Of course this was possible only for companies with an international operation base.
4.How much of the asset growth was funded by internal accruals: again cash. So the importance of cash – did they grow with their own money or did they borrow too much?
5.How reckless with borrowing: they would do a sensitivity analysis seeing what impact on the bottom line if the interest rates went up say 50% in 3 years (remember the world is now numbed into a zero interest game). This was a brilliant eye opener for me. So many Indian companies would fail here – they would borrow for everything, and invest like crazy. One big agri company failed this test. I still hold that share, but of course I have not made money.
I stopped doing this work long back, and I wish I had kept some of the templates, so that I could run them again…
Source:Subramoney.com