The period between June 2020 and September 2021 was one of the best for the Indian equity market but 2022 is turning out to be a gut-wrenching time. The liquidity/volumes in the market have fallen by half and correction in small- and midcaps in India is severe.   All the hyped growth stocks—even the likes of HDFC Bank, Asian Paints and Divis Labs—apart from cement and metal stocks are taking a beating. The sea (broad market indices like the Nifty and Sensex) appears calm but there’s an undertow lurking in both global markets and Indian mid- and small-cap stocks.   Nearly 50 percent of the stocks are down by roughly half from their 52-week highs. The average fall is around 38 percent from their all-time highs. In the US, the S&P 500 has seen one of the worst starts of the year and the NASDAQ is down by more than 20 percent (officially, this is said to be the start of a bear market) and the darlings of the COVID period like technology initial public offerings or IPOs, SPACs or special-purpose acquisition companies, cryptocurrency, etc. are down by 30-70 percent. So what went wrong?   Answer: Recency bias, or extrapolation based on recent events.   Not all growth is good   It was assumed that all the businesses that were growing at a good rate for the past decade or in the recent period would grow at this speed forever, and that led market participants to provide astronomical valuations to them. The most important thing for investors is to understand that not all growth is good. Sometimes growing beyond a certain rate actually kills a business.   If you look at Avenue Supermarts, HDFC Bank, Asian Paints and so on, you would conclude that all it takes to generate great returns in the equity market is consistent growth in revenues/operating profits and cash flows.   As the legendary investor Charlie Munger says, “Invert, always invert.” In this case, does this mean that every business that has grown revenues and profits has rewarded shareholders handsomely?   Let’s take an example of a company where revenue grew 174 percent, 123 percent and 106 percent in 2020, 2021 and 2022, respectively. Now, I want you to guess the return of this stock in the last one year. This stock is down 75 percent from its all-time high and down 44 percent in last one year alone. The name of the stock is Snowflake (Berkshire Hathaway also invested some portion of its portfolio into it).   Also see the fate of some IPOs in India like those of Paytm, Zomato, CarTrade, etc. Zomato is down 58 percent, Paytm 66 percent and CarTrade 65 percent. Again, any guesses on the growth rates of the above businesses? Revenue at CarTrade grew at a five-year compound annual growth rate (CAGR) of 32 percent, Zomato at 71 percent and Paytm at 44 percent.   Valuing the company right   A company’s valuation multiple is an outcome of the following:   1. Growth rates in profits and revenues2. Duration for which growth rate is greater than the economy can sustain (growth advantage period)3. Level of return on invested capital (ROIC)/return on equity (ROE)4. Duration for which such high returns can be maintained (competitive advantage period)5. Discount rates/opportunity cost of capital   If a business is growing at a fast rate with ROIC/ROE much lower than its discount rates, it actually reduces the valuation of the company. Let’s take an example.   Imagine you broke your fixed deposit, which was earning you 8 percent, to start a business. Now that business has earned on average 6 percent in the past five years. Would you put more money in this business to grow it or shut shop?   Practically, you have lost money at the rate of 2 percent per annum by starting this business. If you initially invested Rs 1 crore into this you lost Rs 1 crore x 2 percent per annum, or a total of Rs 10 lakh in five years. Now if you put another Rs 1 crore in this, will your losses increase or decrease? Assuming here that the health of the business remains the same, you will lose 2 percent on Rs 2 crore. A loss of Rs 4 lakh per annum, instead of Rs 2 lakh per annum. The increased losses will reduce your valuation. We know a lot of startups that operate this way. Well, that’s a topic for a different day.   When the bull run ends, analysts suddenly realise that a lot of businesses were like a pig with lipstick. They were growing with ROEs much below their opportunity cost, actually destroying the value of business rather than creating it.   Hence, not all growth businesses deserve high valuations. There are lot of other factors like competitive intensity changing (Asian Paints with the entry of Grasim and JSW in the segment), industry getting saturated (Colgate Palmolive in toothpastes) and so on that also support our thesis that just because a business has grown at a high rate in the past, it does not automatically deserve a high price-earnings multiple today.   How long might this correction last?   That is anybody’s guess. There have been multiple instances of sharp reversals when even after correcting by 20 percent the markets recovered within seven days (for example, in 1997, 1999, 2006 and 2012) and sometimes there are long periods of drawdowns where the market remained below the 20 percent correction level for more than a year (1992-1993, 1995, 2000-2003, 2008).   For investors willing to work hard, there are always investable ideas available in every kind of market. There are some sweet spots (growth plus reasonable valuations) like businesses related to data centres, capital goods segment, agro-chemicals space, defence, and so on.

India being a country of trust deficit, it has become a policy to micro analyse promoters' every move all in the name of looking out for the little guy, the shareholders.   There certainly isn’t any debate on shareholder interest against promoter interest but where do we draw the line? It is important to step into the shoes of the promoter to understand his afflictions. Let us explain how things could perhaps look on the other side of the fence. Skin in the Game A very common doubt amongst the investing community is if the company’s future growth is certain, then why wouldn’t the promoter increase their own stake? But there’s little empirical evidence of any correlation between the two. We can have ample example where the stock has performed extremely well inspite of promoters having reduced their stakes at regular interval. For example, Aarti Industries and in fact promoters of one of India’s biggest wealth creation stocks, Page Industries, have sold 1-2 percent of their stake in the company almost every year in the past 10 years! Reading promoter stake sale directly as a 'red flag' is a market cliché! The High Price of High Compensation All hell breaks loose when an analyst in the market sees promoter group/directors remuneration hitting the ceiling of 11 percent as permitted by Companies Act (although that even can be increased by passing a resolution). We should consider the base effects. Imagine a small-cap company with 50 crores of sales (at 2 times multiple a market cap of 100 crore) operating at 5 percent PAT margins leading to a PAT of 2.5 crore. Do you really expect the promoter to withdraw a salary of 5 percent of PAT i.e. 12.5 lakhs after creating a 100 crore company? Naïve right? Although this topic is debatable and we will go deeper into the issue some other time. The Family Tree People hate paying taxes and also there is “Lala” nature in terms of controlling the decision making. Hence to reduce tax paid on income they diversify the earnings among family members and include them into the board to control decision making. The Cash Trap vs Dividend Dilemma Sometimes business booms due to industry tailwind and the promoter decides to declare good dividends (which benefits even minority shareholders) to cash-in some money from his booming business. The analyst community would rip them apart stating it is a “no-growth” story. Funnily enough, if the promoters decide to do the exact opposite and start accumulating cash on the balance sheet, even then the promoter would be tagged as a `fool’ as it will reduce Return On Invested Capital and Return on Equity numbers!   The Related Party Loan Conundrum In small companies, this is a regular event by promoters to fund their liquidity positions. What’s the issue if business had surplus cash even after achieving sustainable growth rates and he is paying market level interest on the same? but sadly, the analyst community would still penalise them citing corporate governance issues!Till the time a promoter is not taking undue advantagea) by increasing his stake through amalgamations of private promoter owned entities at absurd valuations orb) by giving himself ridiculously cheap Employee Stock Ownership Plans to increase the stake, orc) by diverting funds out of the company for private purposes without interest payment and history of such loan write-offs, ord) by holding obscene amount of private assets on company balance sheet, ore) by owning private entities in similar lines of business that are actually performing better than the listed ones.Let other small things go. Else it becomes a perfect case of analysis-paralysis.Further, there can be multiple reasons for which a promoter might have to dilute his stake - Qualified Institutional Placements, SEBI regulation to bring shareholding to 75 percent, bringing a strategic buyer on the table which may provide key technology/asset, to release his pledged holdings, classification of shares in the non-promoter category due to family issues leading to reduction in promoter holding or transferring it to some Trust due to taxation purpose or, infact, his business in the lumpy in nature where he cannot predict cash flows so it's better to dilute equity than taking debt etc.   The main things to note that is forgotten by market participants isA) look at the track record of the promoter has he ever defaulted on paymentsB) how has the business performed during bad phases of business/industryC) did the promoter reduce his salary in bad phases of business andD) how much money has he raised by diluting equity and for what purpose.I will tell you from personal experience a bad promoter will latch on to the first opportunity he gets for raising money from the public without even having a clue where he will use that.I still remember a statement by Madhusudhan Kela in an interview when the insider trading case of one of the employees of Divi's Laboratories came into limelight - That boss look at the total equity of Divi's today. The promoter of Divi's has raised money from the public only once during IPO which today in front of total equity he has created is a drop in the ocean and he pays tax fully and such guys cannot be frauds.    

  Investment idea generation is no maths or science, it’s more of an art, an art that does not come with a breeze of luck! Most investors always talk about quantitative screens with filtration parameters like ROCE, ROE which can throw up a list of potential stock for your consideration. However, if everything in the investing world were as simple as picking stocks by running screens all while earning a market-beating return, then investment managers, like us, would most definitely be out of a job. Although, issues of running filtration screens is beyond the scope of this piece, be assured that this is a deeply flawed method solely due to the `garbage in, garbage out’ problem—what we mean is extraordinary items giving the illusion of better profits, return ratios and overall an excellent functioning business.   As investors, we all face a common constraint, time! There are tons of companies out there, and if we’d start digging into all, our entire life would pass by in a flash! Our time constraints force us to prioritize and so it’s only obvious for every investor to have a filtration criterion, of what passes for your precious time and what doesn’t.   Idea generation can have numerous strategies and we’ve only listed down only a few, but do remember that this is just the first step. It can only point you in the right direction, it tells you what deserves your time.   With that being said, the first source of idea generation can come from stories on capital expenditure, or capex. Keep an eye on sectors that are out of favour in the last 4-10 years. And if you happen to spot a company that announces capex, it’s time to start digging into this public display of capex bravado at a time when the entire sector is facing distress. Is it maintenance capex (necessary to continue operations in the current form) or growth capex (new assets or expansion of current capacity, intended to grow the business’ capacity)? You may just have discovered a gold mine if it’s a growth capex story.   Another possibility can also be that capex is undertaken by a company to reduce costs or integration with the supply-side to either gain control over raw materials expenses. Maybe the sector is undergoing consolidation, and although the sector isn’t doing well, there’s still a possibility of the company successfully stealing market share from other existing players. If so, again, there may be something bigger brewing here!   Do not mistake this for a scenario wherein the entire industry is at a turnaround juncture and that every company in the sector is investing in capex. Because that’s when it becomes overcrowded and everyone is looking at the same thing. A good management paying off its debt consistently can also be a powerful source of idea generation. It is perceived as one of the biggest signs of a turnaround in business, provided, if and only if it has done from the company’s available free cash flows, and not by raising more capital from the open market. And if the same management has plans in the pipeline since they foresee demand in the near future, it would be the icing on the cake.   Besides checking the company’s share pledging, investors should also monitor any change in the shareholding pattern of promoters or management. If the company’s promoters/ management are buying shares from the open market, in effect they are seizing the opportunity provided by the price corrections to consolidate holdings. It showcases their confidence in the business they have built or economic recovery and its benefit to the firm’s future plans.   IPOs make a great investment opportunity since the business is under-owned, mutual funds and other funds haven’t gotten a chance to participate yet and the small float can lead to large moves. If the stock is touching a new 52-week high almost every day, there’s something that has caught the market’s attention. A word of caution—evaluate the company carefully, especially in a bull market. Even poor businesses try to squeeze their way into getting listed.   A common theme around any investment idea generation strategy is voracious reading, from reading corporate announcements to financial reports, especially during the earnings results season, because this allows one to pick up ideas that may not be found using filtration screens. This, coupled with a close watch on any market updates, will help you connect the dots to make sense of the areas of disturbance in the market that may just be huge investment opportunities of tomorrow.

TTML or Tata Teleservices Maharashtra Services is a B2B provider of calling and internet services for clients in Maharashtra and Goa. The company is debt-laden and has been struggling with losses. It had a consumer telecom business that struggled and was sold off to Bharti Airtel. However, from its lows of about Rs 2 per share in March 2020, the stock has grown 75 times to around Rs 150 today. What’s happened here? There are good things happening in the company, but we think the cart is ahead of the horse here.   Some people we know told us about Tata Teleservices Maharashtra Ltd (TTML) a few months back. They made good money on the stock and recommended it to us. It was hitting upper circuits every day, and we were curious to see what’s the underlying story and did some research.   TTML or Tata Teleservices Maharashtra Services is a B2B provider of calling and internet services for clients in Maharashtra and Goa. The company is debt-laden and has been struggling with losses. It had a consumer telecom business that struggled and was sold off to Bharti Airtel. However, from its lows of about Rs 2 per share in March 2020, the stock has grown 75 times to around Rs 150 today. What’s happened here? This is a turnaround story and looks very compelling. TTML is transforming itself as a comprehensive digital transformation partner for India’s Small and Medium-Sized Businesses. Assume you are a small investment firm that caters to individual investors and have 30 employees. TTML will equip you with conducting business digitally. You would want an internet connection, voice calling solution for a call center, a cloud platform for sharing documents, a CRM for managing clients, video conferencing, live chat etc - TTML will provide all these solutions as a single provider. It’s transforming itself as the preferred SaaS+Connectivity platform for Indian MSMEs. Digital is the future and TTML is participating as a key enabler of this transformation. Its existing relationships and reach gives it an advantage. The Tata group is backing this company and assured investors that all debt obligations will be met. There is new focus on TTML and it can also be seen in the completely revamped annual report for FY21. There is also talk about TTML being a beneficiary of Tata’s SuperApp and 5G plans. What’s there to not like about the story!But we see four problems that make us cautious -   Firstly the impact of the new digital SaaS solutions is yet to come. TTML’s revenue has been consistently in the ~275 crore per quarter range since 2019. Given the investor optimism in the stock price, we would have expected to see some movement in numbers coming from the new solutions. So currently, a lot of future performance expectation is incorporated into the stock price.   Secondly, the question of TTML’s relationship with its parent company Tata Teleservices (TTSL) and the overall Tata group is important to consider. TTML’s operating territory seems to be restricted to only Mumbai, Maharashtra and Goa regions while the rest of the regions come under TTSL. Also, it is not clear whether TTML owns all the assets and IP related to the SaaS+Connectivity solutions or whether it will work as a distributor of the services. Some investors are hoping for TTML to be the spearhead of Tata’s SuperApp and 5G ambitions but it seems very unlikely that TTML will be the main vehicle for those initiatives. Thirdly, the valuations seem very expensive. TTML’s market cap today is worth 27,000 crore or $3.6 billion, which looks high and incorporates a lot of leap of faith assumptions in the future operating performance of the company. For comparison, Freshworks - a SaaS platform for ‘international’ small and large enterprises with a proven track record and $365mn revenue trades at a market cap of $7.5bn. If we take into account that TTML’s territory is restricted to only Maharashtra and Goa (not Pan India), then this valuation looks all the more expensive.The fourth and final point is the dynamics of how the company trades on the exchanges and narrative. Apart from promoters, TTML is almost completely held by retail investors and not any mutual funds or institutional investors. The stock trades on thin volumes and frequently hits 5 percent circuit levels. The company’s strong performance has probably created euphoria amongst investors. Search for TTML on YouTube and you will see lots of misleading videos pumping the stock and discussing every small news and stock price movement to keep the audience hooked. We worry that thin volumes can make the stock prone to lower circuits in the event of a drawdown and make any exit for investors difficult. There are good things happening in the company, but we think the cart is ahead of the horse here. The stock price has grown spectacularly (hitting 5 percent upper circuit regularly) while the signs of business growth are not visible in any numbers yet. The relationship between TTML and TTSL is another aspect we are not sure of. That’s why we decided not to invest and would be cautious on this stock.

Warren Buffet always used to look for a company’s moat while assessing potential investments. The Oracle of Omaha says that his success mantra is simply investing in businesses that have a definite moat around them. That is firms must possess a competitive advantage that allows them to maintain pricing power. But what most of us tend to overlook is the latter part of the moat strategy – even businesses with moats should be bought at a reasonable price.   Undoubtedly, these businesses are excellent contenders for portfolios focused in capital protection. But are they worthy of capital appreciation is the question that is left unanswered.   In reality, there are only two types of market corrections: price and time.   Price correction   To put it simply, a price correction is a reverse movement in a stock’s price from its peak. Investment in a business with moat means price correction is definitely taken care of, and your capital is protected. Why?   It’s simply because these businesses have emerged as the leaders in their segments, with their products generating way more cash that they burn. These moat businesses generate cash with certainty. So, they are also referred to as `Cash Cows.'   Every cash cow is a business with a moat. But not all business with moats become cash cows. Just look at Zomato’s money-losing, cash-burning business (without raising any questions about whether or not it holds immense potential)!   Booming markets surely wouldn’t leave behind the discovered businesses with moats, which leads to abnormal price rise and price-to-earnings (P/E) expansions. As a matter of fact, it’s almost impossible to find a business that has a moat and is available at a fair price in a bull-run!   Avoid buying businesses with moats in a bull market as stock prices would be at absurdly high levels. If you happen to do so, you are bound to be a victim of price corrections.   Time correction   Time correction is basically an extended period of no significant price movement, either upside or downside. And more often than not, the reason this happens is because of lack of growth.   If your moat business isn’t investing in its growth or, in other words, making an attempt to increase the free cash flows, then time correction would be taking a toll on your returns.   What happens with a moat businesses is that they keep growing, increasing sales, capturing more and more market share. But there eventually comes a time when growth stagnates. Although the sales and earnings numbers are huge, there’s no more room for any growth. The small fish has grown to now become a huge shark.   Take Infosys as an example. The company had turned into a huge cash cow in the early 2000s. It started trading at an unjustifiable P/E of around 100. So, the stock price did not move as much in the next five years. In times of rising inflation, when the stock does not perform, an investor is certainly destroying his or her wealth.   Cash cows are always going to be a profitable for the promoters, but this is not the case for retail investors. And that’s because our entry point will only be when we discover this cash cow, a very different one from the promoter. As retail investors, we’d want the stock price to keep increasing but the enormous free cash generated from its successful moat business has already been priced in.   To avoid stagnation, our shark has to chase growth and expand its business avenues, add capex and generate other streams of cash flow. Only if your cash cow moat business is chasing growth, is it fit for capital appreciation. If not, all that these excellent moats are doing for your portfolio is capital protection.

Just like the circle of life, businesses too are born, they grow and develop, reach maturity, they begin to decline, and finally (in many cases) they age and die. The life cycle shows the business’ progression in phases over time, which may impact its numbers. Let’s find out by understanding the business cycle.   Pilot stage: An idea is born, maybe to launch a new product or service. For instance, if one starts up a tiffin delivery service, the initial stage’s low demand visibility gives the business an added advantage of only incurring variable costs of vegetables, other ingredients. The absence of any fixed costs (FC) gives the business the ability to deliver all-time high gross profit (GP) and net profit (NP), profit margins and even the return on investment stands at the highest ever levels! Sadly, this doesn’t last very long!   Startup: This is where the conversion of a great business idea into a commercially viable product/service happens. But it also brings along with it enormous investments in fixed assets (FA) to cater to the projected growing demand in the coming years. Say industrial-grade cooking appliances for the tiffin business. Regrettably, 95% of businesses fail in this stage itself since they are unable to truly project the demand, FC and FA investments from the not-so-ever-lasting euphoric pilot stage! To gain distributor’s trust, credit sales are key! This in turn shoots up the cash conversion cycle (CCC), which only lowers once the business enters the successive phases. Due to high credit sales, low purchasing power and working capital needs to run daily operations, young businesses expect to see negative operating cash flows (OCF) during the initial stages. With growing investments in FA (low base but fast-growing) coupled with little revenues (increasing slow and steadily), the business’ asset turnover ratio (AT) and return on invested capital (ROIC) stands at its lowest here; again, gradually increasing in the coming stages.   High growth: Here, businesses will see extremely high revenue growth with some even managing to double their revenues (y-o-y) solely due to the initial stage’s extremely low base. However, GP and NP still remains high; albeit not as much as in the previous stages. CCC also remains high, but is comparatively lowering as credit is still king! With rapid sales growth and stabilized expenses, finally, there’s a chance for OCF to turn positive. As revenues are still unable to catch up with the growing asset base, AT and ROIC may remain low.   Slow growth: As these companies begin ageing, revenue growth tends to slow down since they are now building off of a bigger base of the early phases. In fact, given the humongous base from which it grows, even lower growth in sales is much more impressive now. Nevertheless, sales are at their peak level and ROIC is high. Profits may still grow but now at a much slower pace. OCF increases and manages to even exceed profits; making it the best time to invest in such proven businesses that have stood their ground in the face of aggressive competition and market saturation. Reputed businesses can even enjoy bargaining power from both, supplier and customer, further reducing CCC.   Maturity: As a company enters maturity, its revenues barely change from one year to the other. Here, GP will stagnate and NP will go down even further as diseconomies of scale set in. Business may not invest in themselves as much as they used to and as major capital spending isn’t a concern they may enjoy the highest-ever AT and ROIC. With negotiating power, now cash becomes king and so, CCC is at an all-time low. As per management’s decisions, companies can choose to pay large dividends, buyback stock often funded with debt pushing towards a high D/E ratio. In any case, if one’s business investment is approaching the maturity cycle’s end or about to enter the decline stage, it’s best to take your money and exit since what’s about to come next may just be a big disappointment!   Decline: In the final stage, revenues will shrink and cash flows too drop off since the business makes fewer profits. This is where one starts harvesting the business, dividend policy kicks in. Companies lose their competitive advantage, either accept their failure and call it quits or move onto other money-making avenues, thus extending the lifecycle. The business lifecycle busts myths of “safe large-cap, risky small-caps”. What’s far more important is being able to make a judgment as to where a company (regardless of capitalization) stands in the lifecycle.

Unarguably, prima facie, Suumaya Industries looks like an excellent company running an exceptional business. But we decided to take the company’s financial analysis just a notch higher by turning to the Cash Flow statement which indicated that when compared to the EBITDA, Suumaya Industries certainly isn’t converting its reported profits into any cash at all.   Being in the investment industry, analysts are bound to be surrounded by friends and family thirsting over their opinion about the overall market scenario or even any stock in particular. When one such particular eager friend with a heavy trading mindset enquired about our view on Suumaya Industries, claiming the company has reported marvelous top-line as well as bottom-line performance, we became curious.   A quick google search opened our eyes to a multi-bagger! Suumaya Industries was up 180.9 percent in six months, 848.6 percent in the past one year and since the last five years, the stock earned a whopping 2,690 percent returns for its investors. Now, that absolutely peaked our interest! We immediately turned to Screener; a simple, yet powerful online screening tool to analyse Indian stocks, for a quick glance at Suumaya Industries. The company’s mind-boggling reported numbers really could stupefy not just us but each and every investor out there. In the year ended March 2021, the company reported a stupendous 1,062 percent Year-On-Year (YoY) increase in sales, suggesting revenue was up 11 times. Profits exploded even more, almost 45 times increase from Rs 8 crore in March 2020 to Rs 358 crores in just a year! Thanks to the company’s operating leverage!As analysts, no one more than us could truly appreciate the beauty of the Return on Capital Employed’s (ROCE) deep J-curve! It started from 1 percent in 2015 and kept moving up in the following years to 2 percent, 3 percent, 9 percent, 15 percent, 22 percent and finally in the financial year 2020-21 ROCE stood at an exceptional level of 151 percent. What’s all the more fascinating was how close the ROCE and Return on Equity (ROE = 150 percent) are, implying there’s barely any debt! Some more brownie points for the company! The cash conversion cycle (CCC) was as short as 5.4 days, suggesting money invested in the business today can be converted into cash within six days. Wow! But the cherry on the cake (in the eyes of the retail investor of course) was that at the current price, the shares of Suumaya Industries trades at only 2.9 times its earnings, much lower than the industry Price-to-Earnings ratio (P/E) standing at 45.5 times.   Now bear in mind that with the stock price, P/E may too change every day, but the difference between the two may most certainly not vanish overnight at least.Unarguably, prima facie, Suumaya Industries looks like an excellent company running an exceptional business. But we decided to take the company’s financial analysis just a notch higher by turning to the Cash Flow statement — the biggest clue provider as to how a company is balancing its receivables and payables, paying for its growth, and overall managing its flow of funds. However, to our disappointment, the cash flow from operating activities or as popularly known CFO was Rs -10 crore, indicating that when compared to the operating profit (EBITDA), the company certainly isn’t converting its reported profits into any cash at all! This undesirable negative cash from operations made us question the earlier visited cash conversion cycle as well? The short cash conversion cycle implied that it would only take 5.4 days for the company to convert its investments in inventory and other resources into cash flows, then how was it possible for the company to be unable to convert any sales into cash?The answer was simple, CREDIT! Going back and forth, we noticed that the company did manage to keep its cash conversion cycle low, but at the cost of humongous trade receivables and payables. Both the days payables as well as days receivables stood in the range of 300-315, shortening the cash conversion!Simply put, a business has to manage 'credit' from both the supplier and the distributors’ side; the ability to buy something now and pay for it later. Sales to distributors or direct customers could be essentially 'put on their bill' rather than collecting cash. This 'put on the bill’ amount termed as trade receivables also works on the suppliers' side. Trade payables is money 'to be' paid or held back from the business’ suppliers, vendors, etc. and 'days payable/receivables' is simply the number of days the company takes to make or receive this 'on the bill’ payment in cash.In Suumaya Industries' case, looking at the bigger picture while analysing the cash conversion cycle, days payable and receivables altogether; there seems to be money stuck with receivables which may just be the reason why the company is further unable to pay up to its suppliers as well. In fact, when we scratched the surface just a little, we spotted the trade receivables number to be almost half the company’s reported total revenues, hinting at major credit sales!Now we aren’t saying that the company is a bad stock or a bad investment in any case. But what baffles us, are the numbers, as we don’t seem to make perfect sense out of them. What we came across just raise red flags, for us at least. Unlike popular opinion, red flags necessarily do not mean scams or fraudulent activities. Red flags just make us more cautious and all we try to do with every stock is play the devil’s advocate!And agreed, we haven’t yet read a single page of the company’s annual report neither have we dug deeper into its future growth prospects, but for us, the story ends here!

Some promising names, once the darlings' of yesteryears' bull market and who have now lost their charm, together are responsible for wiping out a whopping Rs 60,000 crore of shareholder wealth in just a matter of four years. This number is as big as Motherson Sumi’s entire market capitalisation or even about half of Zomato’s, as of today.   Despite riding the bullish wave amidst the entire Covid saga, when we look back in the rear-view mirror we come across a handful of promising names, once the 'darlings' of yesteryears' bull market, who lost their charm; leaving a sour taste in the investors' mouth. These fallen angels together are responsible for wiping out a whopping Rs 60,000 crore of shareholder wealth in just a matter of four years. This number is as big as Motherson Sumi’s entire market capitalisation or even about half of Zomato’s, as of today. Let that sink in!   These once magnanimous large, mid-caps are either already a penny stock trading in single digits or are on the brink of becoming one, except for Zee who was recently saved by the Sony merger! Now, bear in mind, that these are just a few names off the top of our heads. In reality, there could be a lot many names that could be added to this list of 'the biggest and most notable market failures', pushing the Rs 60,000 crore losses mark even higher.Surprisingly, all these businesses had one thing in common, they were the absolute darlings of the bull market and created all the buzz back in their days; for their respective prospects of course. In fact, not a single soul could have predicted that anything could go wrong with them. One just had to invest in one or even a basket of these dozen-or-so promising businesses, hold them for a few years and count the gains!But no one could have imagined what came next! When a business lists itself publicly, it sure can bring in an instant flood of capital, but we as investors fail to grasp that it also opens up the business to greater public scrutiny, airing out albeit not all but most of the company’s dirty laundry. And this becomes the duty of the investor to diligently study the company, its business and especially befriend its numbers which have the immense power to convey the honest truth, the real inside story, rather than the one being sold to them constantly by the media and company reports.The list is full of classic examples wherein investors fell for a story rather than an attractive quality business at a reasonable price.   Apart from the whispers of profit and loss, and balance sheet, fudging with practices of aggressively boosting revenues and conservative booking of bad debts; a few other commonalities we noticed with the majority of these dimmed stars were massive borrowings (debt), lofty promoter share pledges accompanied with a negative return on capital employed and cash flow from operating activities. We are barely scratching the surface here but as one may suspect, there’s also an independent crisis story unfolding behind each of these monster-sized setbacks. But we wouldn’t get deeper into that as most of us are well aware of these downfalls. But when we take a step back and look at these businesses collectively we notice that most of these stories show us the dangers of unmet and unrealistic expectations rooted more in hope than plausibility.With that as the backdrop, here’s a run-down of a few of the biggest and most notable market failures from the past four years. And even though we’re sure that the numbers may change going forward, but one thing we’re sure about is that it is unlikely that any of these stock flops will perform their way off of the list, at least anytime soon.Cox & Kings, once a household brand name in India and directly compared to Thomas Cook, got its name tarnished with the alleged accounting frauds. Losing over 99 percent of its value, the company is now in shambles!India’s largest fitness group, Talwalkars, which was considered to be a steady, conservative and successful enterprise also wound up shredding 99 percent of its value in the last four years. The fitness group borrowed massively along with pledging nearly three-fourths of the promoter shareholding.Analysts salivated at the prospects of the Adlabs Initial Public Offering (IPO) back in the day with newspapers covering articles like 'Top 5 reasons why Adlabs is good for long-term investors'. Adlabs Imagica once touted as the Disney Land of India also lost about 86.6 percent of its total market capitalisation.YES Bank’s technological prowess was supposed to be a strategic business enabler to build distinct competitive advantage as well as provide better products and services but immediately after its peak, it began lending to companies that were under stress, including the Anil Ambani Group, DHFC, and the Zee. Long story short, eventually the debts kept piling up leading to more and more non-performing assets. Ironically, the helping hand of YES Bank also got pulled down during this entire debacle to make its way to the list of dreadful market failures.Interestingly, about 40-50 percent of these companies’ holdings stood solely with retail investors. And as we already know promoter pledging was huge, proving they absolutely had no skin in the game whatsoever. What’s even more daunting is the fact that the majority of these pledged shares lay with government banks!Clearly, a lot can go wrong even with the biggies as they can quickly fall out of favour. So, go back and check again if you are sitting on today’s Adlabs, Talwalkars, perhaps Jet, or even RCom! Tread carefully, these are dangerous waters! Do not give in to tempered enthusiasm and always invest diligently; ensuring that occurrences like these do not run you off the road, but instead only remain mere speed bumps on your way to immense wealth creation!

  If you are a long-term investor, it is far more important for you to understand what drives a company’s value creation than its managerial competence, stock price and returns performance. In the long run, creating sustainable value is not just a function of only exceptional managerial skills. Competitive forces drive returns towards the cost of capital or expected returns. Two key determinants of evaluating the potential of a business for sustainable value creation are the industry it operates in and the opportunity size it holds.   To analyse how or whether a company can create value sustainably, the industry is the correct place to start with. Each and every investor should be able to easily estimate an industry’s annual growth and quantify the industry size at least 10 years from now.   For instance, let us consider the asset management company (AMC) business. India’s AMC industry has assets under management (AUM) of ₹35.15 trillion as of 2021. Say, that of the population of 139.58 crore in the country, the segment that can invest ranges from 20 to 50 years, that is, about 50% of the population. This means per capita AUM is about ₹50,000, i.e., India’s total AUM divided by its investible population.   Now, if we expect the industry to grow at a 15% annual rate over the next 10 years till 2030, the projected per capita AUM in that year is about ₹2 lakh.   Then, we proceed to understand the following: Will India’s population growth slow down substantially over the next decade? Will financial literacy increase the age of the investible population? With answers to these questions, one can easily project the industry’s opportunity size as well in 2030.   Once we have the industry’s estimated opportunity size, it is time to further study the industry’s growth drivers. With extremely poor financial literacy, the penetration of various financial products in India is much lower compared with the world average and other developed nations. According to some articles, while the AUM in the US is more than the country’s GDP at 103%, it is only 15% in India.   Moving on to the company, let us not forget that sustainable value creation is also largely a result of company-specific factors usually driven by the moat of a business or a competitive advantage such as their internal strategies for self-improvement. Irrespective of whether a company is the industry leader or not, this is important to determine a company’s growth potential within the respective industry in the years to come. Then ask yourself whether the market share of the company will increase, and by how much? With reference to moat and other opportunities in the industry, you can arrive at 2030 revenues, i.e. (industry’s size multiplied by the picked company’s market share).   Again, taking reference to the industry’s earnings before interest and tax margins (evaluated through operating, financing and combined leverage), we can easily calculate the company’s operating profit and deduct from it the projected capital expenditure required to sustain this growth or to increase market share in the industry. Finally, this brings us to free cash flow the business would earn in 2030, which when discounted back at the cost of capital (required rate of return of the business or long term average RoE), gives us the value of the business as of 2021.

We performed a detailed study on Nifty 50’s rolling returns data for the past 25 years. Imagine one invested ₹10 in the Nifty 50 index on 1 January 1996 and held on to it for a year, then did the same on 2, 3 January and so on for the next 25 years (2021). This will have a fair share of both, good (when the markets were low) as well as bad days (when markets were soaring high). Now, when we perform the same exercise to calculate the 2-, 3-, 4- and so on to the 15-year holding period (HP), we noticed that the gap between the maximum and minimum returns kept narrowing as the investor’s HP increased. In fact, in the seventh year, the investor’s minimum returns jumped out of the negative territory.   There has been no seven-year (7.3 years to be precise) period in the past 25 years in which one would have lost money in the index. We can pick any seven years in the past 25 years and the index would have earned at the very least 3-4% and a maximum of a whopping 28% return. This is proof enough that the markets are volatile only in the short term. It is this volatility that makes equities risky. But if one were to stay patient and remain invested for the long haul, the risk is eliminated! To calculate the probability of returns, we went back and counted the number of times an investor would have earned the respective returns for each HP. From a statistical viewpoint, with a 1-year HP, an investor stood a 70% chance of not losing even a single penny, a 58% chance of gaining a return of over 7% and the probability of earning a 10% return would be around 53%. Not bad, right? But what’s even more interesting is that as the holding period is increased to, say, over seven years, there’s no chance the investor would lose his/her money, turning index investing low risk in terms of probability. And earning a 7% and 10% return now becomes 90% and 63% probable, respectively. In fact, the study revealed that the odds of earning a good return keep magnifying with a longer time frame. Note, however, that while past returns are a guide to estimating probabilities, they are no guarantee of future returns. Probability of returns: Finally, with an over 14-year holding period, the investor would with high probability make a return of no less than 7% through the Nifty 50 index. Intriguingly, from all the 6,266 price data points, calculating the 15-year HP return gave us 2,516 returns data points, each one of which boasted a return greater than 9%. Simply put, if an investor were to hold on to his/her investment for 15 years, the returns have a good chance of shooting above 9%. Let’s say, for example, if we would have invested ₹1 crore and compounding it at 9% (CAGR), the end value would have been ₹3.64 crore after 15 years of holding. The real magic is all about being cool and patient. The best part? These are just the minimum returns earned through index investing, without even taking into consideration the effect of dividends. Historically, the average dividend yield hovers around 1.5% per annum. This means that even a conservative assumption of, say, 1% dividend yield takes the investor’s total return to 10% (from the 9% previous certainty for a 15-year HP). Furthermore, if the investor would have decided to reinvest this 1% dividend yield in, say, any financial instrument, his/her total return exceeded 10%. If one is willing to be patient, it is more than possible to profit from simply an index investing strategy. If past performance is any indication of the future, we can safely say that if you are in it for the long haul, index investing would make an excellent asset class wherein even a novice investor can earn superior returns, irrespective of investing in the market’s highs and lows. A diversified index balances itself as per the prospering sectors, sticks to its multibaggers and has a unique way of shredding its losers and rewarding the winners.