Bet on young companies

Allocation of our savings under different assets is crucial in wealth creation. Many people make mistake in choosing the right asset class for investment. An analysis by Morgan Stanley (see bottom) of post-tax income given by different asset classes gives several takeaways for us.

Equities are the best weapons to fight inflation and bank deposits are the worst;

Property is good, provided we are lucky with our choice. The above return is an ‘average’;

Gold is neither as good as it is touted to be nor as bad as it seems.

A return that measures the ‘average’ of a group or a set of products hides the real story.

We also have to factor in the point that the endpoints for these calculations were around December 2015. Thus, what the markets were at the beginning of the period have a lot to do with the answers.

There is one other interesting thing in these tables. The returns are ‘post tax’ returns. Now, given the fact that out of four asset classes covered above, three suffer income-tax, the pre-tax returns would tell a different story. Stock market gains are tax free if the holding period is more than one year. So, the pre tax and post tax returns would be the same (dividends excluded). However, there are different rates of taxation for different asset classes. Gold if bought as ETF would become a tax free return over long term, whereas physical gold would attract capital gains tax, identical to property. And in property, there are two choices.

The other thing is that you could invest '1,000 in the stock market or a gold ETF, but when it comes to properties, the minimum would be a greater number. If I look at the above table, to me it looks like the differences between various asset classes are so thin, it makes one wonder whether it is worth taking so much pain and effort behind deploying one’s money. To get the above returns in equities, you simply have to buy the index ETFs and sit back.

Most of us will spend our lives buying and selling stocks without any strategy. Luck will play a big role. Howe-ver, we can improve our luck with some rational approach. I would keep scanning for opportunities. Buy them in small quantities, with money I can write off and hold those stocks to eternity. If I can build a portfolio of around 15 such stocks, and I get lucky, one or two of them could multiply over a hundred times in 20 years.

I will, for sake of simplicity, divide business in to two segments:

B2B: These companies deal with other companies only. They supply some goods and services that go in to making some other produce for an end consumer. Could be an auto ancillary or a bulk drug making company etc. They should have some chance to grow at above the industry rate. A new entrant could start with a new product with one or two companies as his client and then expand his customer base. That would give the company an above industry growth.

B2C: These companies deal directly with consumers. They are subject to the whims and fancies of consumer preferences. It could be a bank or in fashion or technology providers.

We can pick up the companies when they are very young (say less than '100 crores sales and just two or three years young). If we make 15 such picks, after doing some basic hygiene checks (nothing negative about promoter, manageable debt, no complaints on social media about product or service etc) we increase our chances of success.

The key factor behind our stock picks is our belief that:

The product/service will attract demand and grow faster than industry over the next couple of decades;

If in B2B space, they have some niche which will help them get more clients and grow big;

If in B2C, they have a product or a brand in which one can see a long term winner; and

The promoter holding is strong (say over 60%).

These kinds of companies will have good times and bad times. We should not get shaken off because of one or two bad years.

Over 15 to 20 years, it is possible that one or at best two of the stocks could have become a serious wealth creator. The key thing to remember is that there is an equal or greater probability of losing a lot of money. If it bothers you, you should not take this route.

The writer is a veteran financial analyst. He can be contacted at balakrishnanr@gmail.com.