Why second best can be perfect

Buying business through the equity market can be overwhelming due to endless choices that are on offer. Common sense will tell us that one can just go with the market leader which guarantees past proven track record of growth and earnings. That it is a market leader allows for assumption that it is doing most of the things right and its safe to be with the leader. So , why not be lazy and just buy the likes of Reliance,L&T , Asian Paints , SBI , Maruti or an Infosys.

Except that it is just not that easy. Most of the names mentioned above are market leaders in their area of business but have delivered almost zero returns in past.Reliance in past 3 years has not managed to provide any positive returns to its share holders. A secure and simple bank FD would have delivered at-least 7 percent return.

But why will a great company not give great equity returns ? Simply because all the greatness is most likely been priced into the stock price and these companies trade a very high expensive PE(Price to earning ratio). The greatness you see comes for a price. These companies must then do extraordinarily well to command even higher valuations.

So what should an astute investor do ? How about looking for the second or the third best. Any market isn’t too small to be not able to accommodate a few good companies. The second or third best are usually not the most talked names on the incessantly noisy business channels and the Dalal street does rewards discoveries.

Finding a mid cap good to could be great company is indeed tough but some smart research can help. Here are few.

  1. Check for companies which have increased their sales more from a base year. good to have a 5 years data where available.
  2. Reducing or restructuring debt are usually good indicators of improving efficiency.
  3. Companies focusing on their core business and selling off non-core business
  4. Company is generating free cash. Remember net profit is not a great if there are no cash flow.

Happy Investing.