You may want to explore possible substitutes in the same space in the developed markets.
In previous articles, we have articulated why Indian investors must explore investing in companies listed on foreign stock exchanges of developed markets such as the US, EU, UK, and Japan. Now the question is: How do you start understanding and pick potential companies as a part of your global investments?
There are highly structured ways, such as a scientific investing approach, of starting from the full investment universe and narrowing down to a low-risk, high-return investible set of companies with super-normal profit potential, using certain fundamental, financial criteria. We will cover these approaches in future articles.
However, in the current article, we will suggest a very simple way of getting familiar with global companies. Further, this approach allows for a relatively easy-to-understand way of doing a comparative analysis of the unfamiliar or less-familiar foreign company and the more familiar Indian company.
Let’s say you like a couple of footwear companies in the Indian markets. These are highly popular with the investors in Indian markets. However, let’s say they seem a little bit richly valued to you. You may want to explore possible substitutes in the same space in the developed markets.
You can go to a foreign stock screener, such as, the CNBC stock screener for the US markets. You will end up with 13 companies. Instead of just a couple of relevant companies in the Indian market, you will end up with more companies to explore.
Or consider the soft drinks space. While in India you would have only a handful of companies, you would come across nearly 40 companies listed in that space in the US (or North America) markets.
In food products space there would be 100 companies in the US that are listed as against 10-20 here.
Of course, bear in mind that all the above industries are being discussed only illustratively. A mention of any company, industry or sector doesn’t mean that it is being advised as an investment. For that you should do your own analysis (some suggestions are given below) or consult your investment advisor. You can choose any industry and do an exercise similar to the one suggested above. This will provide you a list of potential companies to explore further in the global markets.
Now you can start by choosing a company that already looks familiar to you, possibly a name you have heard as a consumer. The good thing about this approach is that you would probably be familiar with the product or services of that firm.
Even if you are not familiar with the firm, you can search for its profile in CNBC itself and start by reading the basic information about the company. If it looks interesting, then you can start exploring further.
Typically, these companies will have an investor presentation in which they provide the basic details about the company. You can then start reading the latest annual report with a focus on the consolidated balance sheet, income statement and cash flow. You can also focus on sections such as business overview, competition, and management discussion and analysis. In many cases, the earnings-call transcripts are also provided and can be quite useful in understanding the specific dynamics that are in flux for that company and sector.
Once you have an understanding of the business, you can start taking a more detailed look at its fundamentals. How much debt does the company have? What do the gross, operating and net margins look like? Does it have enough cash flows to service and repay debt? Are the revenues, earnings and cash flows increasing? What are the return on networth and return on capital? Is it creating value for the shareholders?
With this information, you are ready to do a comparative analysis of this company in terms of fundamentals with the Indian firm and also of the valuations at which both are available. Further, what is the future outlook, especially in terms of growth opportunities, for both the Indian and the global company?
Are the fundamentals, in terms of financial and other resources on the balance sheet, sufficient to support growth? Is there sufficient cash flow to aid growth or will outside capital be required?
Thus, you can start estimating whether the current valuation fully discounts the future prospects. Which of the two companies seem to be more undervalued?
Also, keep in mind that while at a macro level the Indian company will seemingly have higher growth opportunities, it makes sense to calculate the growth rates of revenues, earnings and EPS of the Indian company and also of the global company. In many cases, it will turn out that the global company is growing faster. Further, typically, the global company might also have Indian operations and operations in the US, EU/UK and also China and other emerging markets.
If it turns out that the global company provides better risk-adjusted rewards, then you might consider that for your portfolio rather than the Indian company. If you decide to retain the Indian firm, then at least you now have a better understanding of its positive points in terms of financial fundamentals or business dynamics.
We suggest that you start looking at global markets with these baby steps. In short, the suggestion is to understand the global investment universe with the Indian favourites as the starting point.
Go forth and multiply your wealth!