India is not the easiest place to get your head around. This book gives a value investor’s guide to investing in India

India has more than 6,000 listed companies, but formal research is available only for some hundred-odd companies. Therefore, the Indian market is rife with mis-pricing which value investors can take advantage of. At the same time, investors need to be careful and not fall into a value trap. A value investor, Rahul Saraogi, managing director at Atyant Capital Advisors, in his book titled Investing in India: A Value Investor’s Guide to the Biggest Untapped Opportunity in the World guides investors through case studies about how Indian companies are run and what investors should look for.

Saraogi explains how the Indian market is awash in amazing investment opportunities. However, he warns investors that they need to have an understanding of India’s history and culture before choosing to invest. Financial analysis should have weightage, but two critical factors that determine whether an investment will do well or not are: corporate governance and capital allocation.

He mentions that there are companies that understand capital allocation and compounding of capital, and there are those that don’t. Then there is a third category of companies which basically run Ponzi schemes. He gives the example of how Sahara operated the largest Ponzi scheme in the country. Therefore, it is important to be aware of such practices.

He explains a five-step framework to evaluate stocks and to separate value stocks. Each stock needs to go through one filter before going through the next. The five filters he explains are: corporate governance, capital allocation, business fundamentals, financial strength and relative opportunity.

When it comes to corporate governance, Saraogi says he looks for companies that treat minority shareholders like equal partners in the business and whether the company is run keeping in mind and safeguarding the interest of minority shareholders. He mentions that there are situations where dominant shareholders use companies like personal piggy banks or they use them to promote their own agendas; they’re not really safeguarding the interests of minority shareholders—unfavourable mergers, preferred dividends, etc. He further mentions that identifying poor corporate governance is subjective and no two investors will agree on what is forgivable and what is not.

The second most important filter is capital allocation. Most companies destroy the earnings that they retain with themselves, over time. After achieving a particular size or social standing, promoters no longer care about maximising returns on capital or growing real wealth. Instead, they get carried away by setting up offices and factories around the country and around the world. They expand the business for the sake of growth, but end up taking on significant debt and risk the long-term well-being of the company and its shareholders. They participate in competitive bids to acquire companies and, often, destroy value in the process. Few companies actually understand how capital grows and how it is compounded.

One such example he gives is of EID Parry, part of the Murugappa group from Chennai. Despite being in various cyclical businesses, he says that the Murugappas have an excellent track record of capital allocation and value creation. The flagship company, EID Parry is primarily into sugar manufacturing but the group has diversified into businesses like fertilisers, confectionery and ceramic bathroom fittings. These businesses have grown, with very little additional capital, to critical sizes; some of them were subsequently sold at attractive prices.

After a company passes through these two important filters—of corporate governance and capital allocation— one can then look at business fundamentals and financial strength. A high cash-generating business that is prudent in its capital allocation makes for a stock that is likely to be a winner. The last filter deals with the constant evaluation of potential stock investment ideas relative to stocks already in one’s portfolio. It is important to diversify one’s portfolio, but over-diversification can result in average returns.

The book gives an overview of the country’s history, government, politics and media practices. The author also delves into the banking system, financial infrastructure and real estate. It is really targeted at foreigners but is also a good refresher for an Indian investor. After all, Indian investors have stayed away from their own stockmarket and thereby missed the incredible value creating opportunity   over the last decade. Even today, they are ignorant about the opportunity ahead.