Despite a 25% jump in the market, India’s macro backdrop remains unclear, and there is no evidence yet of the investment cycle turning any time soon. Therefore, while investors should look for exposure to any recovery in the investment cycle, when it does come, the best way to build in some caution is by maintaining strict quality discipline. The only way to strike a balance is to buy high-quality mid-cap names. In general terms, we’re now finding a better quality/value balance in mid-cap stocks, as many of the large cap ‘quality’ names look fully priced. (Institutional holdings decrease substantially with the decrease in a company’s market cap, especially in terms of foreign institutional holdings — and FII flows of $20 billion this year have been a major driver of the large cap names, hence the market. On an aggregate basis, FII holdings are 4 percentage points lower in mid-caps than large caps.)
One mid-cap stock we like is Persistent Systems, standing out as a scalable IT firm, with strong competitive positioning in the outsourced product development (OPD) segment, decent entry barriers and intellectual property (IP) giving it a cushion to sustain margins. It is also the only mid-cap IT company to have grown rapidly over the past 10 years organically (with only one small acquisition), with a 40% CAGR over 10 years from $10 million to $210 million. Another sign of a quality business is one that generates more cash than it consumes and Persistent’s cash generation (operating cash flow and free cash flow) is even better than some of the tier-I IT companies in India, with its operating cash flows as a percentage of operating profit at 88% over the last seven years.
On the fast track
The Pune-headquartered Persistent is the fastest-growing OPD company and ticks the boxes of a scalable OPD business