How does Windmill Capital avoid picking risky stocks?

Stock picking can be an extensive process and requires hours and months’ worth of research. At smallcase, our primary aim was to eliminate this process by letting experts do it for our retail investors. But how do the experts avoid stocks? What factors are taken into consideration while skipping stocks? Let’s find out!

With the recent brouhaha around Adani stocks, we discovered that the Windmill Capital team had avoided most Adani stocks across all their smallcases, except for Adani Ports and SEZ. This got us curious about why an expert would avoid a stock when the entire market was bullish on it. 

Here’s what we found out – 

The team at Windmill Capital believes in taking a conservative approach to investing while prioritising capital protection over capital appreciation (this is done to avoid taking too much risk for a bit of an upside). The belief lies in taking a more measured approach to give investors sustainable, long-term returns.

The Negative List: The Windmill Capital checklist to avoid frothy companies 

To avoid risky bets, the team at Windmill Capital uses a negative list to screen stocks before they are included in a smallcase. The list includes six testing parameters a stock must pass to be included in a smallcase: market capitalisation rank, promoter pledge, default probability, external investor holdings, ASM/GSM list and liquidity. Stocks that fail to meet these criteria are rejected and excluded from their smallcases.

Market Capitalization: Only top 750 companies chosen

Only the top 750 companies in terms of market capitalisation are included in their smallcases, out of more than 2000 companies that are listed on NSE. The top 750 stocks cover more than 90% of the marketcap of NSE.  

Promoter Pledge: Avoiding companies with high promoter pledge

Promoter pledge refers to promoters (read: owners) of a company taking a loan from banks by collateralising their shares in the company. This loan can be taken for any purpose, whether business specific or personal.   

In India, promoters own a majority share of their companies (approximately more than 50%). This is a peculiar case in the global context. Companies with high promoter pledges can pose a business risk and are viewed as a red flag; hence, the need to avoid such stocks. 

Default Probability: Avoiding companies with high SDP

The default probability is an indicator that tells you the likelihood of a company defaulting on its debt obligations. In other words, the probability of a company going bust.    

Companies with high default probability are usually deemed to be financially unhealthy and, hence, are skipped by the team at Windmill Capital.  

External Investor Holdings: Avoiding companies with low external validation 

When external investors (domestic mutual funds, foreign institutions) hold a substantial chunk of a stock, that is considered as a positive. Hence, the Windmill Capital process seamlessly integrates external validation by gauging such entities’ holdings into their investee companies and rejecting the ones with negligible external holdings. 

Stocks in the ASM/GSM List: Avoiding Erratic Movement

Windmill Capital also excludes stocks from our smallcases if they are on the ASM/GSM list. The ASM/GSM stock list is issued by exchanges when there is erratic price/volume movement in a particular stock and is a nudge to be careful with this stock.

Liquidity Filter

This proprietary filter checks how easily a stock can be bought or sold. Liquid stocks have lower transaction costs and investors can enter or exit positions without causing drastic price movements.

Besides all these measures, the team at Windmill Capital has another added caveat to test stocks before they’re included in a smallcase. Called the Fundamental Indicator, this proprietary algorithm is a fundamental score that is assigned to stocks based on certain pre-decided fundamental parameters.  

These were the key factors that helped Windmill Capital avoid stocks like Adani. However, one exception was Adani Ports and SEZ, which is present in a few of their smallcases. 

Picking stocks can be hard, and that’s why we believe in letting experts do it for us. And what is more reassuring than knowing that a smallcase Manager managed to avoid a risky stock while the rest of the market was bullish on it? 

Disclaimer: Investment in securities market are subject to market risks. Read all the related documents carefully before investing. The content in these posts/articles is for informational and educational purposes only and should not be construed as professional financial advice and nor to be construed as an offer to buy /sell or the solicitation of an offer to buy / sell any security or financial products.
Users must make their own investment decisions based on their specific investment objective and financial position and using such independent advisors as they believe necessary.

Windmill Capital Team

Windmill Capital Private Limited is a SEBI registered research analyst (Regn. No. INH200007645) based in Bengaluru at No 51 Le Parc Richmonde, Richmond Road, Shanthala Nagar, Bangalore, Karnataka – 560025 creating Thematic & Quantamental curated stock/ETF portfolios. Data analysis is the heart and soul behind our portfolio construction & with 50+ offerings, we have something for everyone. For more information and disclosures, visit our disclosures page here –https://windmillcapital.smallcase.com/#disclosures