Top fund manager Saurabh Mukherjea, who believes that taking a call on a smallcap company is akin to taking a call on the promoter, says smaller companies are, by and large, family-owned and family-operated businesses usually involving a single promoter or a few promoter family members who are at the helm of the affairs.
“For such companies, the promoter’s or group of promoters’ skills (technical, sales and/or managerial) becomes the defining competitive advantage of the company. Furthermore, the promoter’s strategic and capital allocation decisions shape the destiny of the company,” Mukherjea said.
The PMS fund manager, who handles assets worth over Rs 11,000 crore, has listed out four parameters to evaluate promoter’s involvement in smaller companies.
1. Shareholding
In a note to investors of Marcellus Investment Managers, Mukherjea said the higher the promoter’s stake in the company, the greater the likelihood that the promoter would think and behave in the best interests of the Company’s minority shareholders. Furthermore, how the promoter’s shareholding in the company has been evolving can also provide vital clues regarding her view of the company’s prospects.
2. Remuneration
The second yardstick to measure the promoter’s skin in the game is to find out the proportion of their remuneration which is variable (i.e. dependent on profitability) rather than fixed. “The higher the share of variable (versus fixed), the greater the promoter’s incentives to focus on profitability, the greater the alignment with the interests of minority shareholders,” Team Mukherjea said.
3. Dividends vs Reinvestments
Promoters have an option to either take out the profits of the company through dividends or reinvest it back in the business for growth. “Prioritising reinvestments over dividends is a sign that promoters are not driven by short term gratification but by long term value creation through fully exploring the business potential. The only caveat here is that reinvestment should not be return dilutive or below the opportunity cost of capital for the shareholders,” it said.
4. Business interests outside of the listed company
Significant business interests of promoters outside of the listed company, notwithstanding the high shareholding in the latter, raises question marks surrounding the time and focus that can be allotted to the company’s business. “This is particularly concerning where promoters are involved in an executive role in the listed company’s business as is the case with most smaller companies,” it said.
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