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Identifying future large caps

There's no sure-shot way of identifying small caps that are future large caps but we can try

Identifying future large caps

The transformation of small companies into huge and successful ones is what a free market economy is all about. This is the heart of equity investing. Nothing makes investors happier and richer than being able to identify a small company, buy its stock, and then watch it grow and grow until it becomes a large cap that multiplies the original investment into serious wealth.

Of course, there's the flip side, too. In fact, there are two flip sides. One is identifying such companies too late. If you look at the early history of multibaggers like Eicher Motors, Bajaj Finance and a handful of others, the fact that they were destined for greatness is obvious only in hindsight. At that time, when they were small businesses, there was a lot of scepticism about them. In fact, they were just one among the many in their industries and it was not at all obvious that they had a great future ahead of them. Rather than being sceptical, most investors and analysts simply did not notice them or give them much attention or thought.

Today, the most common reaction of such investors or analysts is one of regret at not identifying these winners early enough. Reading about these companies later is a reminder of opportunities lost or foregone. After all, if I did not think of investing in Bajaj Finance till after the whole world and its uncle had thought of it, then I may just be irritated at being reminded of what a great investment the stock could have been had I not ignored it a decade ago.

However, that's not the way equity investment works. There's no investor in the world who does not have more misses (or ignores) than hits. Great investors like Warren Buffett and Charlie Munger have suffered such misses as badly as you and I. Earlier this year, in the annual shareholders' meet of Berkshire Hathaway, Buffett and Munger admitted that one of their great failures was not buying Google. Back in 2004 or so, their own insurance company benefited enormously out of the then new advertising service of Google. They observed this at that time, discussed it, recognised that Google was a business with tremendous potential, and yet never invested in it. "We just sat there sucking our thumbs," Munger said about failing to invest in Google.

Hindsight is 20/20, even for Buffett and Munger. However, what is important here is that instead of getting regretful or irritated at one's failure to identify great stocks early enough, one should try and see why that failure occurred and why some people succeeded. The reason for doing that is obvious - there are plenty of small caps today that are going to be large caps or giant caps in the future. That's inevitable, even though I cannot offer you any evidence of it. If we want to make sure that we don't miss tomorrow's Bajaj Finance and Eicher, then we need to figure out why we missed them out in the past. That's what Munger and Buffett are doing It's a learning experience, pure and simple.

And as for the second flip side of this story, that's about large caps which become small caps, but I'll keep that for another day.