This article was written by InvestKaar for their subscribers. You can visit them at www.investkaar.com
We at Investkaar believe in the practical application of our ideas more than the theory.
We know that talking just about investment approaches won’t make you money. So, we thought to present our growth stock picking framework to you – a set of guidelines that we follow to screen good stocks from the bad ones, eventually leading to finding the best growth stocks!
Get the story right and then believe in it
Pakistan, in its current state, needs exports and that too badly. Cognizant of that, the government has pushed the pedal hard on this and is doing everything to make life easier for exporters – TERF loans, weaker rupee (REER at 95.6 as of Oct 2021) and availability of cheap energy to textile exporters – to name a few.
All this makes us believe that there is a high chance that the export targets set by the government for FY22 and FY23 will be achieved.The two sectors that will stand out the most will be textiles and software companies, as they are already in the business and have all the channels set up already.
InvestKaar’s Comments: See, this is our story! You may agree or disagree with it, it’s your choice. But the reason to write all this is to tell you that you have to have a story behind the stock or the company you are looking to invest in. If you are new or don’t have a story yet, you can borrow the story from research reports or your brokers. But have a story.
Historical sales growth – the first thing to look at in a growth stock
With that story in mind, we will not go and blindly buy any company that exports textiles or software services. A proof of concept is always needed and where better to start from than looking at historical sales growth to know that the company was making sales even before all such incentives. If a company has survived in the bad times, it’s highly probable that it will thrive in good times.
InvestKaar’s Comments: Let’s start off by looking at sales growth for the last five years by different textile composites and software companies. See the chart below.
Out of a total of 26 companies listed in the textile composite space, 14 had been showing strong sales growth. So, the probability of increasing sales is higher for such companies – a high chance that they will thrive when incentivized. To come to a reasonable sales estimate for the next year, we will suggest growing the sales for the next year at their average growth numbers. For instance, they grew by 20% over the last 5 years, we will increase their last year sales by 20% to reach to next year’s sales number. This is a simplified example to show how to forecast sales for a company
Profitability – Look for consistently high or rising margin companies
What good a strong sales growth is if the company isn’t showing profits? Pakistani investors don’t have the patience to let a company grow without profits, gain the market share, slowly increase prices and then start to show massive profits. This is not Nasdaq!
InvestKaar’s Comments: Again, we will be needing proof of concept to know that they were profitable even when things were not that good. This way we will be comfortable to sit on our investments comfortably and let them grow! Also, profit means potential dividends and they can be very handy when the market isn’t performing like today! The best way to go about it is by taking a look at the net margins – the higher, the better. We don’t need long excel sheets to figure out every bit and piece about the company. We want to know how much they make as a percentage of sales they do. Historical numbers give you enough idea to make a reasonable estimate for that.
See the chart below.
Out of 14 shortlisted companies, the net margins for 8 companies are rising while 4 have been consistent. So we will move forward with these 12 companies. We will go ahead with these companies only to finalize ‘our example’ best picks from the sector.
Valuations / PE Multiples – know when to enter
The company should be worth our money. This means that it should be trading a such a multiple that we can put in money and expect it to give us returns. If it’s trading high vs other companies in the sector, it can mean either of the two things:
- the stock has already performed and hence the seller you are buying from will keep most of the returns, leaving fewer capital gains for you or
- the company is unique and has something like good management which other companies in the sector doesn’t have
- the stock is relatively more liquid – take the textile sector for example; most of the companies are illiquid (read the concept checker below) so any company which is freely traded will have a higher multiple.
InvestKaar’s Comments: We will accept that valuation is a subjective thing. Someone will tell you a stock is cheaper on DCF while others will use pricing multiples like price to earnings ratio or price to sales to arrive at a conclusion. These are all fancy ways of saying how cheap or expensive the stock is.
The most basic, easiest and useful is to look at the PE ratio. It’s easily the most used and every investor/trader follows it. Use it as general valuation guidance on the stocks you like.
CONCEPT CHECKER BOX
Some additional considerations!
- All the sectors will have different considerations. In textiles, the foremost is illiquidity. When you go indepth you also need to consider factors like new orders (if any), cotton prices etc
- Other sectors might have different considerations like for cements you need to follow international coal prices and local cement prices
- A true analysis requires, reading financial statements. Just open the latest and read their director’s report. You want to focus on company’s future prospects and the debt levels (Check this article if you want to know how to read a financial statement in an easy way)
- Management quality. Better the management quality, higher the value of the company! If you are new, ask you broker about the management and he will spill out everything
- Taking different perspectives! Once you have finalized the stock you want to buy, talk to people in your trading circle (broker/friends). You might find out a different story or a new angle worth considering to look at.
Conclusion – Final Screened Growth Stocks
We started off with 26 textile composite stocks and have reached a final 4. If we further have to choose two from the final four, they would be Interloop and Kohinoor Textile Mills. They have all the ingredients to qualify as growth stocks and are liquid enough.
How will this growth stock framework help you?
- It’s simple but effective. We don’t need to do a ton of financial analysis to take a decision – some key numbers help you keep on top. Follow these guidelines with whatever you want to buy or already own.
- Knowing the story with all your belief will let you hold on to the investment even when it’s not working. This is so much better than blindly following a tip and having no idea of what you are getting into.
- You don’t have to follow the steps on your own all the time. Listen to your broker with intent and see if he has a credible story to tell and that his numbers make sense. That works well too!
Disclaimer:
The stocks that we shortlisted should only be used as examples to explain the stock-picking framework clearly. They in no way should be considered as investment calls by InvestKaar. If you are one of those who really want to learn about investing strategies, subscribing to InvestKaar’s email list will bring your goal one step closer to you. Don’t forget to subscribe below. Pinky promise that you won’t be disappointed.
