, Saurabh Mukherjea of Marcellus Investment explains how you can choose right stocks for your portfolio

If you want to make money in the stock market, invest in companies that have healthy growth and generate good returns, regardless of their size, said Saurabh Mukherjea, founder and chief investment officer of Marcellus Investment Managers, in an exclusive interview with CNBCTV18.com. Mukherjea also said that these companies with a good track record will not fail you in an economic slowdown, and hence it is extremely important to research deeply for the long-term investment. Here are the edited excerpts from the interview:

You’ve been a big-time investor for years now. How do you dissect stocks on an all-time basis?

You make money in India by investing in companies that have healthy growth and generate good returns every year. So the first layer of investment analysis checks the company’s ten-year track record of sustainable revenue growth alongside return on capital being above the cost of capital. The reason why the return on capital to be above the cost of capital is important is that it indicates how much the company generates free cash flow.

, Saurabh Mukherjea of Marcellus Investment explains how you can choose right stocks for your portfolio

The second step is to understand the accounts of the company. You need to check if the company numbers are real or if it is making up its numbers. You can refer to my book ‘The Unusual Billionaires,’ where I have given a fairly extensive description of how you can detect accounting fraud. However, at the simplest level, you can use this technique such as comparing tax flow to operating profits over a long period of time for the company and its peers. Looking at the asset turnover for the company and its peers over a long period of time, looking at the growth in auditors’ fees and dividing that by growth in revenues. Now, if auditors’ fees are growing much faster than the revenues of the company then it means there’s a red flag.

The third step of the investment analysis process is to access if there are any barriers to entry, which the company has built and which will prevent other companies from entering and taking away the company’s profits. These could be licenses, patents, intellectual property, etc.

Hence, investment analysis is a very doable process and should be done every single day. It makes money consistent and one shouldn’t worry about the market cap of a company or which sector it belongs to. Those distinctions are not going to make you any money.

So how do you choose companies after this exhaustive analysis?

We start by crunching data of up to 2,000 companies and we look at ten years of data to check which companies have grown revenues at double-digit every single. Barely 15 companies pass this data crunch.

Step two is the forensic analysis. This involves looking at forensic ratios, ratios such as operating cash flow, operating profits, asset turnover, and others. In total, there are ten such forensic ratios and we crunch them in December. Forensic models tell us all those 15 companies which have believable numbers, around 12-13 companies survive the forensic data crunch process.

After this, we meet a lot of people who know the company very well. We spend about 6-12 months doing research on the overall company and then invest the money.

When you choose all these 12-15 stocks, do you normally invest in the long-term? Also, what do you do in times of economic slowdown?

The economic slowdown does not matter because the companies we invest in are not only the ones that will survive but will also thrive. In an economic slowdown, if you have a company in your portfolio that generates ten years of double-digit revenue then it is highly likely that it will grow revenues at double-digits every single year.

If you sell an essential product it doesn’t matter whether the economy is slowing down, the product will continue selling. You carry on grinding outgrowth which is in the mid to high teens.

In these 15 stocks in your portfolio, which is that ‘one’ sector that has the majority of stocks?

It is a mixture of various sectors. In our portfolio, we have got lenders, FMCG, building material, pharma, smallcap, midcap companies and many others. So there is no one sector which predominates. What does happen though is that sectors which require a very heavy capex say, real estate, power, and mining are the sectors with very heavy capex orientation do find it difficult to pass our 3-step process. Half of them fail at the first step, which is the 10-year data crunch and the remaining fail in the forensic accounting process. Therefore, sectors with heavy capex orientations struggle to make it to our portfolio.

In an interview, you said that this was the worst quarter. Do you expect this phase to continue in the near term? Do you really think that the economy will just boom based on good corporate earnings?

We have been in an economic slowdown for a long period of time now and the September quarter would be even worse than the June quarter in terms of GDP growth. It looks relatively clear that for the remainder of this fiscal we will be in an economic slowdown but that doesn’t get in the way of making money.

If you invest sensibly then even in an economic slowdown, you can make good money. For example, in the last 12 months, our portfolio is up 26 percent. Even this month, we expect 3.4 percent higher portfolio returns. So the point I am trying to convey is your ability to make money is not dependent on the macro. If you keep thinking that the macro will help you make money, you will continue to struggle to get anywhere in the Indian stock market.

What are your simple tips on ‘how to invest’?

Never invest on tips, whether I give you tips or some other CIO from a mutual fund gives you tips or a newspaper gives you tips never invest on tips, it is a road to ruin.

You have also outwardly spoken that the government should introduce more reforms. What kind of reforms were you talking there?

I am expecting the first logical reform to be land reform. Since the Finance Minister has said the companies who built new factories will get a 15 percent corporate tax rate. In that case, new factories will need land which requires an easy land acquisition process. Therefore it is logical to expect the amendment to the 2013 Land Acquisition Act sometime in the Winter Session or the Budget Session of the parliament.

Also, the government should expedite labour reforms through state government and since it is the BJP government at the Centre, the logical thing to expect would be that BJP states take the lead on labour reforms.

The third reform to expect is personal income tax. Given how the corporate tax rates have been cut, it would be very anomalous if the income tax rates are not cut. Therefore, I expect to see income tax rates come down, I reckon it will happen in the Budget. I won’t complain if it happens sooner.

If you see India’s five-year election cycle, two years where there are few elections, two years immediately after the general election and then you get busier three years running into general elections. So you get a two-year window from the general election to expedite reforms and my reckoning is this government will grab that window with both its hands.

In the Indian stock markets, 80 percent of returns are made in the two years immediately following general elections. The stock market typically gives you 27 percent compounded in the two years following general elections and that is driven entirely by this reform impetus that usually comes immediately after the general elections.

 

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