The concept of model portfolio has been prevalent in the investing world for a long time. It started from Harry Markowitz’s famous Modern Portfolio theory (1952) to factor-based investing to motif investing, and many more. Well broadly, the end purpose of all these concepts have been to provide investors with a portfolio that suits their style and risk profile.
You see, for any portfolio to work, it is necessary that it ensures capital protection. Followed by capital appreciation. For this to happen, the portfolio manager needs to amalgamate a set of relevant criteria/factors that will help her land that right portfolio.
Against this backdrop, let us take a look at the way we run and manage – Straight Flush smallcase.
Straight Flush is a model smallcase that depends on a set of criteria, which we will refer to as model criteria. These model criteria are a mix of market factors in order to make the smallcase investable for one who is comfortable with additional risk.
For the benefit of your understanding, I shall divide these criteria into four major categories – Growth, Quality, and Valuations.
Before jumping on to the criteria, please note that the smallcase only chooses companies from the smallcap universe.
For growth, we check –
- Earnings Per Share – The forward growth rates for EPS help us gauge the future profitability prospects of the companies under study.
To take pulse of the company’s quality, we take into account 2 parameters –
- Gearing Ratios – Gearing ratios are a bunch of financial ratios that measure the financial leverage of a company. Extreme business leverage is a red flag for us.
- Free Cash Flow – This is an indicator of how much cash a business is generating, post expenses, which is a good indication of business performance.
- Return on Equity – This gives us an idea of management effectiveness in generating profitability.
To get a sense of valuations, we look at –
- Price to Earnings – We tend to be cautious around valuations and do not wish to fall into the value trap, especially given it’s a smallcap universe. For the valuation parameter to be actionable, we compare the company P/E with the industry median.
To sum it up, the smallcase simply looks to pick smallcap companies that are growing their business efficiently, demonstrating good earnings growth, and are expected to be consistent. Moreover, the companies should also generate free cash flow, have low debt, and generate a high return on equity.