Profitable screenings from DSIJ: Asset-light company stock selection made easy
Analysts and investors often use this screening technique for long-term wealth creation and profit.
Stock screens can range from simple forms, like 'companies in the pharmaceuticals industry' or 'companies with ROI exceeding 20 per cent,' to more complex criteria. However, these simple screens lack a distinctive edge, as they are easily accessible to most investors.
To refine stock selection, such screens must be complemented with other parameters. For instance, after identifying pharmaceutical stocks with an ROI over 20 per cent, it's essential to assess if they are reasonably priced with potential for appreciation and whether industry trends support sales growth at existing profit margins.
Past events, like the impact of strict import regulations post-President Donald Trump's inauguration in 2017, emphasise the need for caution. Many Indian pharma companies, once benefiting from US exports, saw declines in sales and profits, leading to significant drops in stock valuation.
Relying solely on a single stock screen or even a complex one incorporating multiple parameters (industry, profitability, dividend yield, PE ratio, return on capital, etc.) may not be prudent. Stock screens should be viewed as the initial step in a thoughtful investing journey, not the final destination. Long-term investors, prioritising minimal trades and eschewing immediate gains, find stock screens to be a valuable starting point.
Why Screen Asset-light Companies?
One of our favourite financial parameters is small balance sheet companies. Here smallness of the balance sheet is measured not in rupees crore but with the company’s turnover or profits.
For example, company A has a turnover of Rs 1,000 crore, with an EBITDA margin of 35 per cent, and its total assets are Rs 700 crore. Then its EBITDA/Assets ratio is per cent i.e. (350/700). Company B has a turnover of Rs 1,500 core, its EBITDA margin is 40 per cent and total assets are Rs 2,000 crore. Its EBITDA/Assets ratio will be 30 per cent i.e (600/2000).
All other things, including growth potential being equal, which company is better from an investment point of view? The answer is – Company A. The reason: To create every Rs 1 crore of future EBITDA, Company A will need to invest Rs 2 crore (reverse calculating EBITDA/Assets ratio of 50 per cent), while Company B will need to invest Rs 3.33 crore (EBITDA/Assets ratio of 30 per cent). Thus, in the race to increase profits, Company A will have to seek lower equity and Debt Funds compared to Company B.
Analysing the DSIJ Asset-light Companies Screen
The screen defines “asset-light” businesses as those generating at least 25 per cent EBITDA over total assets. On November 30, 2023, the screen returned 334 companies, of which there were 126 Small-Cap companies, 113 Mid-Cap companies and 95 Large-Cap companies.
In the steps below, we are proposing a method of generating a short list of approx. 15-20 best companies from which we can pick a few stocks for investing.
- The list of 334 is fairly large. It can be reduced, if we sort all companies to select the most favourable values for EBITDA/Total Assets, ROE, price to earnings ratio and so on. The DSIJ screener provides us with the facility to do so.
- To shorten the list of 334 to approx. 45 companies, the three segments, namely large cap, mid-cap and small cap are separated and only the companies having EBITDA/Total Assets ratio of 45 per cent and more are selected.
- Thereafter, the companies are sorted by the lowest valuation ratios and the highest profitability ratios reflecting the current market valuations and the latest financial results of the companies. This process will give us a further refined list of 15+ companies.
Thus, further shortlisting is based on:
The companies that satisfy one or more of these criteria have been highlighted in the following tables.
It is important to note that the short-listing criteria used here is objective as far as possible, yet it reflects the personal approach of the user/ investor. Different investors are likely to develop different selection approaches.
Given below are two stocks to consider in each of the three segments.
Small Cap Finds
The table below highlights the highest short-listed values for EBITDA margin, ROE and EBITDA/Total Asset and the lowest short-listed values for P/E ratio and price/book value ratio. Some interesting findings in this table is as follows:
West Coast Paper Mills, is a fairly old and established company with a P/E ratio of just 3.86 and a high EBITDA margin of 35.2 per cent. Paper is a fairly steady business, with sales growing by 40 per cent in the past four years.
Accelya Solutions, which is in the IT industry, is also valued relatively reasonably at a P/E ratio of just above 16 and its price is close to its 200DMA of Rs 1,372. It has consistently performed well in Quarterly Results, too.
Mid-Cap Finds
Chennai Petrochemicals, which has shot up by over 2 times in the last 12 months after reporting excellent quarters still shows a P/E of 3.3 only.
While on this subject, investors would do well to consider Chennai Petro’s peer group stocks, such as MRPL and BPCL. While these are not in the mid-cap segment (and also not in our large-cap short-list below), these are very attractively valued despite recent bullish moves.
Another mid-cap company that looks good is the chemicals sector multinational BASF. It is attractive due to its global strength and long-term sector growth. It is available at a comparatively reasonable valuation of P/E 36 with an ROE of 42%. In the last 4 years, it has more than doubled its sales and it has reported several excellent quarters.
Large Cap Finds
An obvious large-cap find is TCS, which is undergoing a buy-back at Rs 4,150, while the stock price is Rs 3,506. From the point of view of long-term investing, one need not get into the details of quarter-to-quarter analytics of industry leaders like TCS simply because of its strong global competencies and unassailable business model, which generates 49.5 per cent ROE and it is available at P/E of 28.3.
Investors could also consider Infosys from this list for the same reasons, as well as other leading IT shares that do not find a place in our shortlist here.
Another eye-catcher here is Hindustan Zinc, for its very high EBITDA margin of nearly 50 per cent on sales, good results and low valuation at a P/E of 15. It is one of the few quality large-cap stocks trading just above its 12-month low.
We hope this analysis demonstrates to our readers an approach to using the DSIJ screener and helps them develop their own individualised methods to perform the research and stock picking using all available features offered by us.
For more information, please visit: DSIJ Screeners