The power of conviction

In pursuit of excess returns compared to the index (popularly called 'alpha'), I used to take clues from a myriad of market participants. Very soon, I realised I was doing no better than the crowd, vacillating between greed and fear, between euphoria and disgust. I was reminded of a quote from Joan Rivers, the American actress: "Don't follow any advice, no matter how good, until you feel as deeply in your spirit as you think in your mind that the counsel is wise."

I wondered what that 'wise' thing was that would resonate with me? There must be some method to the madness. The words of Charlie Munger, a legendary investor, came to my help: "All intelligent investing is value investing - to acquire more than you are paying for. Investing is where you find a few great companies and then sit on your ass."

Finding a few great companies on which I will have the conviction to sit for a very long time became the motto in my investing career. Here is my mission statement in investing: to identify sustainable and durable businesses that are available at suitable valuations and are run by able managers with the ability to generate superior returns on equity (ROEs) over longer periods of time.

How I pick stocks
I look for the following aspects in a business:

Sustainable and durable business: This is ensured by some kind of distinct advantage, or moat, that the company may have, for instance, proprietary knowledge, access to critical raw materials, network effects, entry barriers, etc.

Able managers: The managers running the business should have high levels of integrity, friendly approach to minority investors, adequate financial disclosures, a spotless track record and a history of showing superior capital-allocation skills. They should be ambitious and motivated and able to identify high-return projects and deploy capital incrementally to back their ideas.

Superior ROEs: The business should yield a high return on equity, preferably above 18-20 per cent, which is more than the cost of capital of the company. Further, the high ROE should not be driven by a high debt on the company's books.

Long track record: The company should have a long track record of shareholder wealth creation, manifested through a healthy expansion of balance sheet (capacity expansion, high reliance on internal accruals, low dependence on debt) with no history of debt default or credit downgrade. All of this should have resulted in healthy year-on-year stock returns in the past.

Suitable valuations: I avoid picking stocks at steep P/E levels, even when there is a promise of high earnings growth in the future.