"Our preference remains more towards large-cap at this point of time"

Ankit Jain is a seasoned fund manager with over seven years of experience at Mirae Asset Management Company. He oversees four schemes (Mirae Asset Midcap, Mirae Asset Emerging Bluechip, Mirae Asset Great Consumer and Mirae Asset Multicap) within the company, with assets more than Rs 44,000 crore.

In our conversation with Jain, we delve into his stock selection mindset. He also shares his investment philosophy, approach to analysing stocks, and the key factors and criteria guiding his decision-making when establishing a position in a specific stock. Jain highlights a concise three-step framework for stock selection: business selection, management evaluation, and intrinsic valuation.

Here's an edited transcript of the interview:

Can you explain your investment philosophy and approach to managing equity portfolios?

There are three key parts of the investment philosophy. First is the business selection side, second is management evaluation, third is arriving at the intrinsic value of the business. On the business selection side, in India being a growing economy, the first priority is always about investing in growth-oriented businesses. That remains the first priority, and it is not only about top-line growth, but ultimately, that has to translate into profits, growth and cash flow. That is how, typically, we go about it. Also, business should have some sort of an entry barrier, because only then can it translate into the top-line, profits, and cash flow pool. We look at ROI as a metric. Let's say a company has generated a higher 10-year average ROI than the cost of capital throughout the cycle, which means the business has added value to the minority shareholders. That is another key aspect when it comes to business selection.

Secondly, management evaluation is about both qualitative as well as quantitative factors. Qualitative factors are thought leadership of the management, historical capital allocation, and how management has increased the addressable market historically because that is how we want to size it. The larger the opportunity size, the greater the longevity of growth. So, looking into the management, thought leadership becomes a key aspect, and then we try to look into the corporate governance side of it through various measures. Looking into the historical capital allocation and then looking into the board of directors, auditors, cash tax paid, historical cash flow conversion, some of these remain very important factors and more so in the case of mid and small-cap companies, doing a lot of primary checks has become even more important in terms of looking into businesses. We try to interact, wherever possible, with different stakeholders of the company, who are dealing with the company to get first-hand experience. These become key differentiators when it comes to getting full hang on to the management evaluation side.

The third is about the valuation, which is about building up a longer-term growth forecast for the company and then trying to discount future cash flows. These three remain the key tick box of processes when evaluating a business. When it comes to portfolio construction, ideally, all of those three parameters passing through the company come into the portfolio along with some subject to the underlying benchmark weights, particularly at a sectoral level.

What metrics do you analyse before investing in stocks in the mid-cap portfolios, and how is it different from looking at the large-cap stocks?

Start with business selection, management evaluation, and then arrive at the valuation side. The process remains the same at the business selection side. On the management evaluation side, in case of mid and small-cap, the ask rate for the growth has to be even higher. For instance, in case of any large-cap stock, if we are satisfied with 10 per cent growth potential, ideally the hurdle rate in case of mid and small-cap growth rate has to be higher, ideally 12 to 13 per cent, at least. Another differentiating factor is that we dwell a bit more deeper when it comes to the management evaluation side because typically, mid-cap, over time, has evolved and has become very sizeable. Still, when it comes to looking into small-cap stocks, in terms of management evaluation, we try to do a lot of primary checks, apart from our normal qualitative and quantitative analysis on the corporate governance side. It is because, at the end of the day, in the case of mid and small-cap stocks, we are taking bets on the particular management individual who is steering the organisation. So, to get more comfort around the management, the thought leadership side becomes even more important when selecting mid and small-cap stocks.

On the management side, when I spoke about primary checks, it is more about a lot of groundwork being involved. In this, wherever we get an opportunity, we meet different stakeholders of the businesses and then cross check around that and then try to get much more nuances of business as well as the management. The third is the valuation, so it is all about discounting future cash flows to arrive at the intrinsic value of the business.

The fund house has been an outlier in terms of having exposure to e-commerce companies in the last two years specifically. Why are you so upbeat on the new-age companies?

Most of these businesses fit into the investment framework of our business. Going to the business selection side, there is a long runway for growth in many of these businesses, and the addressable market is huge. Many of these businesses are market leaders in their respective sub-segments, with a proven track record and business model. Many of these businesses have very strong entry barriers. Even being a market leader itself seems like an entry barrier. Also, they have a good balance sheet, because they might have raised the capital very timely. A very strong cash on the balance sheet also acts as an entry barrier when many of their competitors struggle to raise cash in the private market.

In management evaluation, we try to look into many of these businesses' strong founders with impeccable track record. Many are technocrats with very strong board of directors and corporate governance. On the valuation side, it becomes quite tricky when valuing some of these businesses, because many of these companies are not profitable, at least, on a reported basis. Then, we further bifurcate that into their ability to generate cash flows. Many of these companies have already started becoming profitable. As and when scale goes up, we do the sensitivity analysis and then try to look into the discounted cash flow valuations. Most of these businesses fit in perfectly in our valuation framework. That is how we have been quite positive about this particular space and more so for the last couple of years.

The AMC has recently launched its multi-cap fund which is being managed by you. Given the current rich valuation in the market, which pockets attract you the most, and how do you plan to allocate that money?

Markets are quite euphoric, more so the mid and small-cap segment. We have been seeing quite a lot of euphoria getting built into underlying earnings. Momentums are great, macros are favourable, micros are also supportive, and quite a lot of things are playing their own part. So, the market is rewarding. Some of these things may be a bit more front loaded. So, on one-year forward earnings, the market will always look expensive, especially in the mid and small-cap markets.

As things stand today, our preference remains more towards large-cap at this point of time. We have levied to invest up to 45 to 50 per cent into the large cap and 25 per cent each in mid and small-cap. With that thought process, we have been deploying the money in terms of sectoral allocation, like financials, consumer discretionary pharmaceuticals, and new-age businesses. Some of these areas are looking quite interesting. I still think there is reasonable value across some of these pockets and that is how typically, we are going about deploying it. But having said that, we do remain quite constructive on the market from the longer term standpoint, trying to build a thought process to build a good diversified portfolio with good sectoral representation, typically avoiding very heavy active sector calls and, in that process, trying to minimise the risk.

When do you sell stocks, and what leads to the sell decision?

We do sell any position in three cases. One is if market value exceeds intrinsic value by a certain margin because we have bought sector specialists with price targets covering different sectors. So, if fair value is x and stock price is 1.2x, then we try to find out if there are better alternatives available. First preference remains within the same subsector; if there are better opportunities available, we try to sell it and then try to buy something else.

The second is about making genuine mistakes related to the forecast itself. So, clearly, the assessment value will also fall with time. In that case, we have to take a call. Within this bucket, in case any corporate governance issue or capital allocation issues crop up, we have to take a hard call and try to sell it.

In the third case, we might also sell it because, every six months, classification keeps changing from mid to large, small to mid, etc. So, at a given point of time, we have to maintain a minimum percentage across each of these buckets. In that case, sometimes we have to do a bit of a shuffling to be compliant with the overall mandate.