A short guide to stock idea generation
Premium- First source of idea generation can come from capacity expenditure or capex stories
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.
Koushik Mohan is fund manager & head of research at Moat Financials.
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