Executive Summary

Introduction: We believe it is fitting for us to focus on our commitment to adding value to clients’ processes in a manner that respects your time. While the number of ways we have seen clients use our products is highly diffuse, this paper will explain and identify the fastest way to source some of the highest probability names from our Core Rankings Model.

Conclusions:

  1. We find that one of the most efficient methods to use our Core Small & Mid Cap Rankings Model to source new idea flow is to place an extra level of emphasis on firms with extremely strong fundamentals (i.e., top quintile) relative to their price as captured in our Three Pillars of Valuation, Balance Sheet Quality and Earnings Quality. We call these stocks our “Fundamental Favorites.” Creating a portfolio exclusively from these Fundamental Favorites added over 50% to our Core Model’s historical annual excess return, improving it from an already strong +940bps per year to almost 1,500bps per year.

2. The availability of highly ranked firms that manage to get top quintile scores across all Three Pillars has declined sharply over the last two decades with the effect being most pronounced in the years since 2005. While this reduces the available pool of Fundamental Favorites stock ideas, it means the potential value of companies meeting the criteria of our Fundamental Favorites list is more valuable than in prior periods when they were more common. However, we note that the number of Fundamental Favorites over the last few months has been well above the 2.4 monthly average since 2005.

3. The primary mechanism that drives the excess returns of our Fundamental Favorites group is a meaningful improvement in batting averages over the already very strong batting averages in our Core Small & Mid Cap Model portfolio. While we do see a bit more dispersion in the winners and losers, the payoff structure is highly favorable as the improvement among the winners is nearly three times greater than the deterioration in underperformers’ relative performance. Combine the favorable asymmetrical payoff structure of our Fundamental Favorites with the higher batting averages, and you have among the most potent shopping lists ever created by Kailash Capital.

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Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.