The large-cap stocks which we see today were all mid-cap stocks a decade ago. The driving factors for all these companies are said to be good governance, being competitive, presence in emerging sectors, consistent growth in revenue, attractive margins, leverage in technology, business ethics, and better regulatory compliances with Ministry of Corporate Affairs, Securities Exchange Board of India and Income Tax Authorities.
Reliance Industries, Tata Consultancy Services, Infosys Ltd, HDFC Bank Ltd, Hindustan Unilever Ltd, HDFC Ltd, ICICI Bank Ltd, Kotak Mahindra Bank, ITC and SBI are the top 10 companies by market capitalization as listed in Bombay Stock Exchange and National Stock Exchange. All these companies were mid-cap stocks two decades ago. As of now, if an investor needs to do research on any of the companies mentioned, the data availability is so easy that either of these companies’ names will appear as the headlines of the leading business newspaper, internet, television, and social media. But the same is not the case when it comes to mid-cap stocks.
An investor has to be fundamentally strong to identify the mid-cap stocks which can turn multi-baggers in the next ten years. For example, let us consider the business of HDFC Bank Ltd. The major driving factors of a bank are Credit Growth, Deposit Growth, CASA ratio, NII, Capital (Basel III Tier 1 and Tier 2), NPA, Provisioning and asset quality. Now the question is, how do you identify which bank would turn a multi-bagger stock. List out all the banks and compare the data points mentioned earlier. Apart from basic stock picking strategies which include P/E Ratio, YoY growth in profits, EPS, we need to focus on the parameters in which the banks stand out from others.
In this classic example, HDFC Bank Ltd stands out because of its significant credit exposure to the retail sector when compared to the other banks. The banks such as Yes Bank, IndusInd Bank, and ICICI Bank had more exposure to Corporate lending. That simply means if some corporates don’t keep momentum in their business growth, the problem gets spread to the bank’s credit portfolio. Of course, in a business cycle, there are ups and downs, but the problem would persist for a few years which we broadly call it a twin balance sheet problem. If you observe the P/E ratio, the valuations of Yes Bank and IndusInd Bank were found so attractive a few years ago. But, today, it’s altogether a different scenario.
To identify a multi-bagger stock, firstly an investor needs to understand a company’s business and its role in the economy which simply means the broad sector to which the company belongs to. An investor should only continue his research on identifying multi-bagger stock only if he understands the company’s business in detail. No matter whether the company had posted excellent profits or huge expansion in its business. What really matters is very simple, if you know the business invest else stay away. After all, an investor does not have a major role to play in the company’s business. This strategy would help the investor in the long run for the only reason that if the business does not continue to perform better, he can still exit the company with decent profits.
Secondly, what does the economy need at this point in time to achieve a higher growth rate? In the recent announcement made by the Finance Minister, the government laid out a blueprint on infrastructure by spending a massive amount of Rs.105 lakh Crores in the next five years. Here comes the opportunity, Infrastructure spending means demand for cement industries, construction materials, infrastructure companies, transport companies engaged with the infrastructure sector. Now, the job becomes easier to list out these companies which have the potential to grow more than 25-30% year on year business for the next five years. The recent changes in the corporate sector where the government had reduced the corporate tax significantly will provide more money in the hands of the companies. But, this will only help in the supply side of the economy. However, the government is also looking for the personal income tax cut in the upcoming budget which should increase the personal spending and provide a boost to the consumption sector.
Lastly, the developed countries, UN and developing countries are already in talks to reduce Carbon footprint & use of electric vehicles, here lies the opportunity in electric car manufacturing companies. This way, investors should make use of the fundamental factors and the unique driving factors of the company’s business strategy to identify potential multi-bagger stocks.