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Introduction

Dear Smart Money Secrets Subscriber,

Welcome and thank you for subscribing to Smart Money Secrets!

Youre in good company.

Kunal and I want you to feel at ease as soon as possible, and get the most benefit
from your Smart Money Secrets subscription.

Thats why we offer this Quick Start Guide.

It walks you step-by-step through everything you need to know in order to get started,
all the information regarding the service is available within these pages.

Its a comprehensive guide that you can turn to whenever you have any questions
about your subscription.

With that, Ill leave you to this Guide.

Warm Regards
Rohan Pinto and Kunal Thanvi.
(Research Analysts)

Introduction | 2
Imagine you got the chance to pick the best cricket players from around the world - a
World XI team of sorts, without being restricted to a single nationality.

Well, over the last year, Kunal and I have been studying, tracking, and in some cases,
meeting some of the worlds great super investors - the smart money.

We use three bits of publicly disclosed information to track the smart money in India:
the shareholdings of super investors, bulk and block deals, and promoter holdings.
These three bits of information have helped us unveil some valuable smart money
secrets.

We figured tracking smart money would only help us with our own stock
selection. However, successful stock pickers are still prone to mistakes.

So we went further and developed a system that can help us distinguish the
winners from losers, the wheat from chaff.

We created a system that combines the best practices of Indias super investors. Its
our equivalent to a World XI team.

Equitymaster's Smart Money Score

Equitymasters Smart Money Score (ESMS)TM is our proprietary system that can
help us select super stocks that have strong fundamentals and could become huge
multi baggers over the long run. The system also screens out potentially fraudulent
stocks. The system plays the dual role of capturing the upside and yet protecting the
downside.

3 | Smart Money Secrets: A Quick Start Guide

Let me explain these eight variables in further detail.

1. Smart Money Invested:

A gap is said to exist when the intrinsic value of the stock is greater than its current
market price. This makes owning the stock attractive since you expect the stock
price to increase going forward.

Professor Aswath Damodaran, an authority on valuations, is of the view that the

presence of big-name investors or smart money helps narrow the gap.

We can track this smart money in the following ways:

a. Public disclosures (companies are required to report their top ten

shareholders as well as who shareholding is greater than 1%)
b. Bulk and block deals
c. Promoters stakes

Depending on the role and stake size, we will assign a score to the company out of a
maximum score of ten. The idea here is to quantify the presence of smart money.

Smart Money Secrets: A Quick Start Guide | 4

 2. Business Quality

We look for businesses that have the capacity to suffer. Kenneth Andrade is always on
the lookout for businesses that outperform despite operating in a terrible industry.
The key is to look for inherent quality.

We evaluate businesses based on four criteria:

1. Return ratios
2. Long-term profit and sales growth
3. Sparing to moderate debt
4. Ability to convert profits into operating cash flow

These constraints are as follows:

a. Past five-year topline and bottom line compounded annual growth rate of
10%
b. Return on equity and return on capital employed greater than 15%
c. Debt to equity 1.0
d. The ratio of operating cash flow by profit after tax to be greater than 1.0

On the basis of these constraints, we will assign a score to the company out of a
maximum score of ten. The idea here is to quantify the quality and strength of the
business.

3. Competitive Advantage

No business operates alone. It is crucial to understand the competitive intensity of

any give industry.

Using Michael Porters theory on the five dominant forces that impact an industry, we
will further evaluate the strength of businesses.

5 | Smart Money Secrets: A Quick Start Guide

Porters Five Forces model:

a. Industry rivalry
b. Bargaining power of buyers
c. Bargaining power of suppliers
d. Threat of new entrants
e. Threat of substitutes

On the basis of the industry analysis, we will assign a score to the company out of a
maximum score of ten. The idea here is to quantify the competitive intensity of the
industry the and advantages the business enjoys among its peers.

4. Soul in the Game

Soul in the game refers promoters who hold substantial stakes in their company
while running the operations. The logic behind having soul in the game is simple.

They share both disproportionate upside rewards and downside risk due to their
decisions. A professional management, however, is incentivised by a fixed salary and
employee stock options and does not have much riding on their decisions.

Professor Bakshi is a firm believer in promoters who own and operate the business:

Owner-operators with soul in the game, statistically speaking, do far better than
professional managers who don't have ownership or managers of government-
owned companies.

We share this philosophy. Here are our criteria to evaluate managements:

a. Soul in the game or professionally managed

b. Compensation and employee stock options
c. Related party transactions
d. Auditors report

Depending on the stake of an owner-operator over the years and the above factors,

Smart Money Secrets: A Quick Start Guide | 6

we assign a maximum rating out of ten. The idea here is that we prefer owner-
operators with high integrity who are also reasonably compensated for their work.

5. Capital Allocation

A manager must be judged by his words and deeds. Analysing how the management
has employed the firms capital over the past five to ten years could provide crucial
information about the execution of the management.

We want to know both:

a. The sources of funds

b. The application of funds

The idea is to find stocks that use predominantly internal accruals to fund expansion
activities or distribute the funds to their shareholders in the form of dividends.

Both of these factors are weighed equally and we will assign a maximum rating of
ten. Management misallocation of capital will be penalised.

6. Earnings Quality

We believe the ability of any firm to convert its inventory into sales and sales into
cash is of interest. The long-term cash conversion cycle trend in any business is of
utmost importance.

Further, we assign a great deal of weightage to cash flow. Comparing the gross cash
flow from operations and net cash flow from operations helps us understand if the
profits are real or not.

Both these factors are weighed equally and we will assign a maximum rating of ten.
A high rating implies our trust in the reported earnings of the firm.

7. Scalability in the Business

Scalability, or the opportunity for a firm to continue to grow in the future, is an

7 | Smart Money Secrets: A Quick Start Guide

important factor affecting the valuation multiple of any company. We want companies
who can grow into the future.

I look for a scalable business. I look for a company that is doing well in its industry.
And the valuation needs to be attractive. - Kenneth Andrade

Depending on the ability of the firm to scale, we assign a maximum rating out of
ten. We are on the lookout for companies who can grow their topline at least 12%
compounded annually over the next ten years.

8. Market Leadership

We prefer companies that are market leaders in their segment. Market leadership
betrays a competitive advantage.

We will use Porters Five Forces model to understand industry rivalry and market
share.

We want a top three or top five player. Depending on the firms ranking, we assign a
maximum rating out of ten.

These eight parameters form a system that can help us distinguish the potential
winners from the losers, the proverbial wheat from chaff.

How Will We Be Tracking Smart Money

What, or who, is the 'smart money' in the Indian stock market?

In the investment world, Smart Money is defined as the cash invested by those who
are considered to be experienced, well-informed, and in-the-know investors.

These could be promoters, exceptional fund managers, or even individual investors

who have built a solid track record by identifying solid money-making opportunities
in the market.

Smart Money Secrets: A Quick Start Guide | 8

In other words, people like our Super Investors.

We believe these three indicators, combined, can help us track Indias super investors
in a unique and revealing way:

Tracking the shareholdings of super investors

Catching super investors early via bulk and block deals
Following promoter holdings

Let me take you through these three indicators:

1. Shareholding Patterns

As per regulation 31 of the Securities and Exchange Board of India Regulations 2015,
every company needs to disclose the names of shareholders holding 1% or more
than 1% of shares of the company.

Further, as per the Companies Act 2013, every company must list its top ten
shareholders in its annual report.

In other words, whenever our super investors buy more than 1% of a company or
become a top ten shareholder of any of the 7,000 listed companies, we can spot
them.

We believe our super investor list, close to 50, can do wonders with these indicators
when applied to the universe of 7,000 stocks.

Mind you, this is not as easy as it sounds. First, spotting this data out of such a huge
universe is very difficult. Second, by the time the super investor breaches the 1%
threshold, the stock may have already run up a lot, leaving no margin of safety.

2. Tracking Bulk and Block Deals

To catch these super investors early, we need to add another indicator: bulk and
block deals.

9 | The Secrets of India's Superinvestors

When a super investor enters a position, he generally prefers to buy in large quantities
to make sure he gets the right price.

Now, both the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE)
disclose all daily bulk and block deals for all listed companies.

But first, let me answer a question Im sure youre dying to know... What are bulk and
block deals?

Bulk Deal A company is required to disclose all transactions where total quantity
of shares brought/sold is more than 0.5% of the number of equity shares of the
company listed on the stock exchange.

Block Deal A trade, with a minimum quantity of 5,00,000 shares or minimum

value of Rs 5 crore executed through a single transaction on the stock exchange will
constitute a Block Deal.

There are countless bulk and block deals everyday - 95% of them are noise. However,
if you can identify the other 5%, you can find some solid unknown businesses.

Sifting the wheat from the chaff could be hugely rewarding.

Let me walk you through an example.

We have mentioned our interview with Akash Prakash, co-founder of Amansa Capital.

On 15 October 2008, Amansa bought a 0.56% stake in Eicher Motors for Rs 201. This
was a publicly disclosed bulk deal.

Date Client Name Deal Quantity Price

15-Oct-08 Amansa Capital Buy 156,727 201

Imagine if the fundamentals of Eicher Motors passed your earnings quality checks
and you invested in the company

Smart Money Secrets: A Quick Start Guide | 10

Every rupee would have multiplied 128 times by April 2017.

That's a compounded annual return of more than 77%.

Eicher Motors - The Compounding Machine

www.equitymaster.com Source: ACE Equity

Well, Amansa Capital stayed put and rode this multibagger the whole way.

According to the top-ten shareholder list published in the Eicher Motors 2016 annual
report, Amansa continued to hold around 0.73% of the company.

Now, there are plenty of other examples of how tracking bulk and block deals can
create huge wealth.

We are convinced catching the super investors early and off guard can help us find
great investment ideas.

3. Tracking Promoters Holding

The idea here was to track the smart money early. If we could do that, wed have an
edge.

This led us to our third indicator. And back to the important question: What or who is

11 | Smart Money Secrets: A Quick Start Guide

the 'smart money' in stock market?

Funds, smart stock pickers, FIIs, etc

But we were missing something: Promoters.

Promoters know everything about their company. When you see a promoter increase
their stake, it's a strong indication they believe in their business.

Fortunately, as per regulation 31 of SEBI regulations 2015, in addition to the mandatory

disclosure of 1% shareholding every company is required to disclose the increase/decrease
in the promoter holdings as well.

So we backtested the idea And the results were overwhelming.

Imagine a company with return ratios of around 9% and a debt-equity ratio above
two times. Add a declining EPS growth rate...and our screeners would never flag this
kind of company.

However, somewhere between these depressed numbers was something magical:

increasing promoter holdings.

The question here is: Why would the owner buy even more of a company with such
depressed numbers?

The reason is simple...yet ignored: The owner knows more about that company and
its prospects than anybody else.

Specifically, in this example, I am referring to an auto ancillary company, Steel Strips

Wheels Ltd.

The promoter group has been increasing its stake in the company. From 53.8% in
March 2013, it grew to 54.2% in June 2013 and continued inching upwards to 58.7%
in March 2017.

Smart Money Secrets: A Quick Start Guide | 12

Early Signs of Promoters Increasing the Stake

% of Shares Mar - 2013 Jun 2013 Mar - 2017

Total of Promoter and Promoter Group 53.82 54.21 58.77

Source: Ace Equity

The business fundamentals improved a lot over the same period. As of FY16, the
ROEs improved to 16% and the balance sheet got leaner with debt-to-equity at 1.6
times.

The stock's performance has been stellar, multiplying six times in the last four years
(a CAGR of 65%).

Stellar Stock Performance - Steel Strips Wheels Ltd.

www.equitymaster.com Source: ACE Equity

This is just one example. Rising promoter stakes often precede an improvement in
business fundamentals and stock price returns.

However, with a universe of 7,000 companies, these magical indicators often go

unnoticed, especially early on.

Kunal and I decided to solve this problem for our subscribers. We developed a tool
that tracks the positions of close to fifty Indian super investors. This tool uses our

13 | Smart Money Secrets: A Quick Start Guide

three indicators to track the smart money in India. We believe it can help us identify
multi-baggers at an early stage.

We have even developed a system that combines the best practices of India' super
investors.

This is our equivalent of having a best world XI team to help select the best stocks for
us.

Smart Money Secrets: A Quick Start Guide | 14

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