Musings with Analyst, March 2024

| Process, Process, Process ft. Windmill Capital

‘Process is more important than results’ ~ Mahendra Singh Dhoni.

These words couldn’t get any wiser. At Windmill Capital, we share this ethos as we have an extremely process oriented mindset. Everything we do from ideating new smallcases to rebalancing and managing existing ones, we have a set process for all the tasks.

With time we have realized that process is one of the most important facets in the investing space. The reason being that if you come to think of it, the only controllables while investing are process and discipline. Returns, risk, market cycles all these are out of our control. 

What is the framework one can use to make decisions? In a widely renowned book, Winning Decision, the authors came up with a simple and incredibly powerful matrix.

Each one of us would want to be in the upper left box, wherein we follow a good process and get a good outcome. Contrastingly, in real life, one dumb luck moment fools us into believing that whatever we do will lead to a good outcome. This especially happens when things are going great, for instance the post COVID-19 pick up rally. That’s why H. Neill’s famous line, ‘Don’t confuse brains with a bull market.’  

Let’s talk about the processes, shall we?

1. Defining the stock universe: The Starting Point

 There are more than 5000 stocks listed in India and it’s not practically possible for us to consider all of them when it comes to managing smallcases. Hence, we have a fixed stock universe wherein we only consider the top 750 companies by market cap rank, listed on NSE.. This universe covers more than 90% of the market capitalization of NSE. 

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

To avoid risky bets, we use a negative list to screen stocks before they are included in a smallcase. The list includes five testing parameters a stock must pass to be included in a smallcase: promoter pledge, default probability, external validation, ASM/GSM list and liquidity criterion. Stocks that fail to meet these criteria are rejected and excluded from our smallcases.

Promoter Pledge: Avoiding companies with high promoter pledge

Promoter pledge refers to promoters (read: owners) of a company taking a loan by collateralizing their shares in the company. This loan can be taken for any purpose, whether business specific or personal. If the value of the pledged shares declines significantly due to market volatility or adverse business conditions, lenders may demand additional collateral or sell off the pledged shares to recover their loans. This can lead to a downward spiral where forced selling of shares exacerbates the decline in share prices, further eroding the value of the pledged collateral. In extreme situations, promoters might also lose control of their company when pledged shares are sold in the open market.

Default Probability: Avoiding companies with high SDP

The Starmine Default Probability (SDP) is an indicator that tells you the likelihood of a company defaulting on its debt obligations.. Companies with high default probability are usually deemed to be financially unhealthy and, hence, we do not consider them for inclusion. 

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 low or negligible external holdings. 

Stocks in the ASM/GSM List: Avoiding Erratic Movement

We also exclude 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, price manipulation, or other irregularities in a particular stock and is a nudge to be careful with this stock.

Liquidity

 Liquidity is one of the most important metrics when it comes to stock investing. Irrespective of how good the fundamentals are of a company, if there are liquidity issues with the company, it becomes difficult for you to enter and exit the stock properly. Windmill Capital’s proprietary liquidity check helps weed out illiquid stocks and ensures that only the most liquid stocks are considered for inclusion into Windmill Capital smallcases.

All these measures have allowed us to always protect investor wealth and keep things simple.

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_{Windmill Capital TeamWindmill 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. CIN of the company is U74999KA2020PTC132398. For more information and disclosures, visit our disclosures page here.}