India has seen several periods of booms and busts over the past thirty years. A key observation being that no bull market in India has lasted consecutively for more than 5 years. Each time, the crash or correction came in the form of an overvalued market. The triggers could be any, but the primary reason that brought the house down was that of an overpriced market. Is this time different? Noted economist Peter Berstein famously said “The history of markets is overreaction in both directions”. In recent times we have seen a market whose valuations bordered on irrationality. How then does one protect capital in this environment and grow it further?
In recent years, passive investing has seen significant growth in India, borrowing its success from Western markets. The concept of passive investing, especially through index funds like the Nifty 50, has proven effective for investors looking to gain exposure to mega-cap companies. The allure of passive investing lies in its simplicity, lower fees, and the ability to track broad market performance. Yet, the performance of this index-based investing has been 14% (pre-tax) over the past 10 years. Although, this is almost two times the risk-free return of 7%, it effectively means that capital doubles every six years (post tax). If one were to reduce inflation from this, the actual return comes to around 8-9%. Thus, we can conclude that passive investing while decent, does not produce meaningful wealth generating returns.
With that, is active investing the way to go? I believe so. However, to succeed in active investing, one must possess certain necessary ingredients. Patience, discipline, courage, an independent mind among others. As one can observe that most of these traits have more to do with temperament rather than intellect. Of course, knowledge of the fundamentals of a business along with basic accounting jargons are a must, they on their own do not produce high returns. Thus, the behaviour of the investor plays the most important role in generating market beating returns.
With these in place, what exactly should an investor look for while evaluating stocks? The concept of investing is to buy something which over a period of time becomes more valuable than it originally was. Here, the value being referred to is not the stock price but the value of the underlying business. One must thus be focused on where the business will go from today, till the time the investment should bear desired results.
Most of the well-known companies in the listed space are, to use the aphorism – over covered. There are, however, a major opportunity that lies outside this sphere: companies beyond the indexes, be it large, medium or small cap. The Indian market has over 5,000 companies outside of the indexes and they are largely overlooked by analysts, media, and investors alike. These companies, despite being outside of traditional indices, present an incredible opportunity for alpha generation—the potential to outperform the market. This vast pool of companies often gets extremely low media coverage, and their growth potential is largely ignored. Here, the investor can find hidden gems with untapped potential that may be overlooked simply because they don’t fit neatly into a predefined market category by the regulator. This is where active management becomes essential, as investing in such companies demands careful analysis and an understanding of each business’s underlying quality and the price one pays.
Instead of categorizing companies based on size, investors should evaluate businesses on their individual merits. Business fundamentals—such as revenue growth, profit margins, return on equity, and competitive advantage—should take precedence over the company’s market capitalization. A smaller
business that is well-run, with strong growth potential and stable cash flows, could very well be a better investment than a larger, but less efficient, company.
An alternative to Blue Chip and index investing is focusing on companies that dominate niche markets. These companies specialize in specific products or services, allowing them to maintain competitiveness and strong margins. Often overlooked by larger firms, these niche businesses thrive due to their specialization. Niche companies usually provide a product or service that large companies perceive as either beneath their need or noncore to their operations. Some examples like Nesco, Navneet Education, Control print.
Many leading small companies dominate their niche markets, often as the sole players in their fields. These companies have built strong barriers to entry, allowing them to maintain high operating margins despite fierce competition. They focus on value-added products and services, not commodities, and the limited size of their niches restricts competition. Successful niche businesses tend to respond to competition through innovation and quality improvements, rather than cost-cutting. As a result, some of these companies could become tomorrow’s blue chips, making them worthwhile opportunities for investors to watch closely.
