Wealth Creation Study 2006-2011

Blue Chip InvestingCreating wealth from dividends

By Raamdeo Agrawal

9 December 2011

16th

Annual Wealth Creation Study 2011

www.motilaloswal.com16th Annual Wealth Creation Study

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1017425877

135174

236246

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cr

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Two-minute salute

Asian PaintsDivd up 55x

MCap up 75x

NestleDivd up 51x

MCap up 82x


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Two-minute salute

Asian Paints, HUL, Nestle, Hero MotoCorp

Dividend up 75xMarket Cap up 70x

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Two-minute salute

Let’s take this opportunity to salute …

BLUE CHIPSThe Fountains Of Dividend !

As is rightly said – A stock is worth only what you can get out of it.

Even so spoke the old farmer to his son:

• A cow for her milk,• A hen for her eggs,• And a stock, by heck,

for her dividends.

— John Burr Williams


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Discussion Points

• 16th Wealth Creation Study

Findings

• Theme 2012: Blue Chip Investing Creating wealth from dividends

• Conclusions


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Wealth Creation Study Findings


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Concept of Wealth CreationThe process by which a company enhances

market value of the capital entrusted to it by

its shareholders

Net Wealth CreatedChange in Market Cap over the study

period adjusted for corporate actions

Wealth Creation Study Methodology


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Biggest Wealth CreatorsMinimum wealth created should be Rs 100 crores

over the previous five-year period. (This year, the

100th wealth creator created Rs 3,700 cr wealth)

Fastest Wealth CreatorsThe top 100 wealth creators are sorted by

fastest rise in their adjusted stock price

Most Consistent Wealth CreatorsBased on no. of times a company appeared

in the last 10 studies

Wealth Creation Study Methodology (contd)


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10 Biggest Wealth Creators

Rank,Company

NWC (Rs cr)

Price CAG

R

1. Reliance Inds

174,221

21

2. TCS137,92

820

3. SBI107,52

125

4. Infosys102,48

017

5. NMDC 83,304 31

Rank,Company

NWC (Rs cr)

Price CAGR

6. HDFC Bank

67,762 25

7. ITC 65,828 13

8. H D F C 63,582 21

9. L&T 62,275 22

10. ONGC 61,641 6Reliance largest wealth creator for 5th year in a row beating HUL

Total wealth created during 2006-11: Rs 22+ lakh crores

Last 8 years, top wealth creator has been from Oil & Gas: ONGC for first 3 years, Reliance in the next 5 years


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10 Fastest Wealth Creators

Rank,Company

Times

(x)

Price CAG

R

1. Sanwaria Agro 50 119

2. Adani Enter. 22 863. Bhushan Steel 12 64

4. Jindal Steel 11 62

5. Sterling Intl 10 59

Rank,Company

Times

(x)

Price CAG

R

6. Shriram Tran. 6 44

7. Coromandel 6 43

8. LIC HF 6 43

9. Exide Inds 6 4110. IndusInd Bk 6 41

Speed thrills … but also kills!

Some of these stocks are classic “transitory multi-baggers”

If they are not sold on time, investors are left not only with no gains, but most often, a permanent capital loss


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Consistent Wealth Creators

Rank,Company

Appeared

in WC Study (x)

10-Year Price CAGR

1. Kotak Mah Bk 10 47

2. Sun Pharma 10 33

3. Asian Paints 10 31

4. HDFC 10 29

5. HDFC Bank 10 29

Rank,Company

Appeared

in WC Study

(x)

10-Year Price CAGR

6. Reliance Inds 10 27

7. ACC 10 24

8. Infosys 10 24

9. ONGC 10 2310. Ambuja Cem 10 21

KMB, HDFC, HDFC Bank – Pvt sector financials emerging Blue Chips

Quality of mgmt a key factor behind consistent wealth creation


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Wealthex v/s Sensex (2006-2011)

Wealth Creators outperform markets as their earnings growth is typically higher than benchmark earnings growth

Mar-06 Mar-11 5-yr CAGR

BSE Sensex 11,280 19,445 12Wealthex (rebased) 11,280 26,095 18

Sensex EPS (Rs) 523 1,024 14Sensex P/E (x) 22 19 Wealthex EPS (Rs) 596 1,370 18Wealthex P/E (x) 19 19


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Wealth Creation by Industry

Industry(No of cos.)

WC(Rs cr)

2011 (%)

2006

(%)

Financials (21) 519,365 24 12Metals/Mining (12) 325,386 15 11

Oil & Gas (8) 304,293 14 27IT (7) 302,401 14 10FMCG / Retail (12) 170,856 8 6

Engineering (8) 153,982 7 11

Auto (8) 118,298 5 8

Industry(No of cos.)

WC(Rs cr)

2011 (%)

2006 (%)

Pharma (8) 90,176 4 5Ultility (3) 70,600 3 2Telecom (1) 57,429 3 1

Cement (5) 28,910 1 3

Others (7) 67,951 3 4

Total2,209,64

7100 100

For the first time ever, Financials has emerged the biggest wealth creating sector.

It is also the fastest with Price CAGR of 28% (average 18%)

Importance of Financials will increase further as insurance companies get listed, and new banking licenses get issued


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Wealth Creation by PAT growth

Markets can neither price hyper-growth or high quality growth, resulting in huge wealth creation at a rapid pace

Price CAGR (%)


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Wealth Creation by base ROE

3 above average performing groups:1. < 10% RoE – High risk, high return (start-ups, turnarounds)2. 15-20% RoE – Mainly financials (limited RoE, unllii3. > 40% RoE – BLUE CHIPS

Price CAGR (%)Average: 18%


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Wealth Creation by valuation

Base year P/E < 10x almost invariably delivers above average returns, but risk may be high

P/E of 20-30x are the reasonable valuation zone for BLUE CHIPS, which also deliver above average returns, but with low risk

P/E (x) No. of companie

s

% Wealth Created

Price CAGR %

<10 14 14 2510-20 29 34 1720-30 26 23 22>30 31 30 16Total 100 100 18


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Wealth Creation by valuation

Payback = Market cap divided by next 5 years’ profit

In every study, Payback ratio of less than 1x has proven to be the most reliable indicator of rapid wealth creation

Payback Ratio

No. of companie

s

% Wealth Created

Price CAGR %

< 1 23 21 301-2 38 38 192-3 23 14 15>3 16 11 13

Total 100 100 18


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Biggest Wealth Destroyers

The market can ruthlessly punish its own erstwhile darlings, if they disappoint on growth and particularly corporate governance

Company Wealth Destroyed Price Rs crores % Share CAGR (%)

Suzlon Energy 33,587 10 -30Reliance Communication 25,167 8 -19

Satyam Computer 23,228 7 -31M T N L 8,716 3 -24Bajaj Hindusthan 7,540 2 -32H F C L 6,708 2 -14Tata Communication 6,529 2 -13Videocon Industries 5,405 2 -15Punj Lloyd 5,185 2 -22Jet Airways 4,733 1 -15Total of Above 122,064 38 Total Wealth Destroyed 325,436 100


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Wealth Creation & Purchase Price

There is absolutely no substitute for paying right price.

In the Bible, it says that love covers a multitude of sins. Well, in the investing field, price covers a multitude of mistakes.

For human beings, there is no substitute for love.

For investing there is no substitute for paying right price – absolutely none.”

— Van Den Berg, OID, April 2004


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Theme 2012

Blue Chip Investing

Creating wealth from dividends


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Investing v/s Speculation

“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.

Operations not meeting these requirements are speculative.”

— Graham & Dodd in Security Analysis, 1934

Back to basics


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Investing v/s Speculation

“If he buys stocks, and buys as an investor, he holds for income; if as a speculator, for profit …

Wise investment requires that only such issues as are selling far below their true worth should be bought; then, as large income payments are received in subsequent years … a handsome return on the principal can be enjoyed.”

— John Burr Williams, Theory Of Investment Value, 1938

Back to basics


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Blue Chip Investing –Buying and selling ONLY Blue Chips,

at the right price

What are Blue Chips?Highly priced stocks, which typically tend to

enjoy premium valuations due to their high quality

The term “Blue Chip” comes from poker where the highest and most valued denomination chips are colored blue.

What is Blue Chip Investing


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Reason #1: QualityThe problem of poor quality: "The risk of paying too high a

price for good-quality stocks — while a real one — is not the

chief hazard confronting the average buyer of securities.

Observation over many years has taught us that the chief

losses to investors come from the purchase of low-quality

securities at times of favorable business conditions.”

— Benjamin Graham, The Intelligent Investor

The advantage of high quality: “Good quality

companies with strong dividend histories offer as much,

if not more,

investment growth potential than poor quality

companies; and they do so with far less risk.” — Geraldine

Weiss, The Dividend Connection

Why Blue Chip Investing


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Reason #2: Longevity

Power of compounding works best over long

term


US$ 10,000

US$ 40 billion

4 million times in 70 years.

Big number; but CAGR is only 24%

What is this? ?How Warren Buffet has compounded his initial

capital of US$ 10,000


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1st US$ tn

2nd US$ tn4 years

58 years

3rd US$ tn

4th US$ tn2 years

3.5 years

5th US$ tn1.5 years

Reason #3: Growth

India’s growth story far from over


The NTD journey is on …


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Reason #4: Low risk

High return but with significantly low risk


Mar

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8,000 BSE Sensex Blue Chip Index (both re-based to 100)

(Mkt Cap of Asian Paints, HUL, Hero, Nestle)


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Two Key Steps –

#1 Understanding Quality Business Performance

Financial Performance

Investment Performance

#2 Recognizing Value Buying stocks at reasonable price

Blue Chip Investing Process


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All listed companies

Screen #120 years of uninterrupted dividends

Screen #2Dividends raised in 5 of last 12 years

Screen #3Earnings growth in 7 of last 12 years

6-Screen Quality Filter

Screen #4Average 12-year RoE of 15%

Screen #5At least 5 million shares outstanding

Screen #6At least 80 institutional holders

3,000

133

106

68

76

68

48Blue Chips


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Screen-tested 48 Blue ChipsDescending Order of Total Return (2000-11)

Over same period: BSE Sensex CAGR: 13%

Median Total Return: 23%


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#1 LongevityMedian age of 48 Blue Chips: 57

Blue Chip Characteristics

No. of companies


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#2 Dominant Market Position44 out of 48 Blue Chips



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#3 Concentrated BusinessOut of 48 — 27 high, 7 Medium



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#4 Consumer-facing have an

edgeOut of 48 — 23 Consumer, 6

Financials



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#5 High quality of

managementReflected in above-average RoE,

Payout



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How To Overcome The High P/E Phobia

Understand the Payout-Yield Connection

Divd Yield = D(ividend) ÷ P(rice)

= D/E ÷ P/E (dividing both by E)

= Payout ÷ PE

So, PE = Payout ÷ Divd Yield

Even assuming higher end of Divd Yield band of say 3%,for an 80% payout company –

Floor P/E = 80 ÷ 3 = 27

The Valuation Dilemma


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How To Overcome The High P/E PhobiaTesting the “High Payout = High P/E” hypothesis

Back-to-basics investing math: Classical DDM

P = D k – g

Dividing both sides by E (for earnings)

P/E = D/E = Payout

k – g k – g

Thus, higher the payout, and higher the growth, higher should be the P/E



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Empirical EvidenceP/E distribution of all listed, profit-making companies by

payout range


Near perfect correlation between Payout & P/E

P/E (x)


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3 Company-level Case Studies

Case Study #1: Across sectorsInfosys v/s Asian Paints v/s HUL


HUL’s 5-year avg P/E higher than Asian Paints and Infosys, despite low growth

Only reason:

High Payout


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Case Study #2: Within sector (Non-financial)

Cement : ACC v/s Birla Corp


Both companies’ EPS CAGR is flat; Birla Corp’s RoE is much higher than that of ACC

Birla Corp’s Payout is 1/3rd of ACCP/E is also exactly 1/3rd


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Case Study #3: Within sector (Financial)HDFC v/s Shriram Transport


STF’s performance is superior on most counts – EPS CAGR, Divd CAGR, and RoE

But STF’s Payout is 2/3rd of HDFCP/E is also exactly 2/3rd


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Key points to note: P/Es are directly related to Payout and

Growth Dividend Yields are more structural and

homogenous

Blue Chips are unlikely to trade at throwaway prices, due to superior quality (high RoE, high Payout)

So, focus on buying at reasonable valuation, not necessarily cheap by conventional measures

“We try to invest in outstanding companies at sensible prices rather than in average companies at bargain prices.” — Warren Buffett

Blue Chips: When To Buy


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Back-tested two signals for last 5 years

Signal #1 Current Divd Yield higher than long-period median

yieldand at the same time

Current P/E lower than long-period median P/E

Signal #2 Current Divd Yield > 3%, irrespective of median

Blue Chips: When To Buy


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Top Blue Chips on Buy Signals

BLUE CHIP CMP Dividend Yield (%) P/E (x)

(INR) Current Median Delta Current Median Delta

Hero MotoCorp 2,003 5.2 3.3 2.0 19 17 1

Blue Star 178 3.9 2.5 1.5 24 17 7

Infosys 2,608 2.3 0.9 1.4 22 28 -6

Wipro 378 1.6 0.9 0.7 19 29 -10

Cummins India 356 3.0 2.4 0.6 18 21 -3

Tata Steel 385 3.1 2.6 0.5 5 7 -2Motherson Sumi 152 1.8 1.4 0.4 20 20 1

Ashok Leyland 25 4.1 3.6 0.4 11 13 -2

Bharat Forge 259 1.4 1.1 0.3 16 28 -12Exide Industries 116 1.3 1.0 0.2 20 22 -2


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Even the bluest of Blue Chips must be sold at extreme valuations, else they will significantly underperform for a long period

e.g. Infosys and Wipro since the dotcom boom of 2000

Blue Chips: When To Sell


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Potential Blue Chips

Catching ‘em earlyScreening criteria to identify potential Blue Chips

Quantitative Criteria Qualitative Criteria1. Uninterrupted dividends

for the last 5 years1. Dominant player in line

of business

2. EPS increase in at least 3 of last 5 years

2. Huge size of opportunity

3. Dividend increase in at least 2 of last 5 years

3. Competent management (prima facie corroborated by high minimum 15% RoE)4. RoE not less than 15%

in any of the last 5 years

5. 5-year PAT CAGR of at least 10%


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Recognized Blue Chips

Those with Mkt Cap > Rs 10,000 crores20 Recognized Blue Chips1. Axis Bank

2. B H E L3. Cadila Health.4. Canara Bank5. Castrol India6. Coal India7. Godrej Consumer8. HDFC Bank9. Jindal Steel10. Lupin

11. NMDC12. Oil India13. Petronet LNG14. Punjab National Bank15. REC16. Shriram Transport17. Sun Pharma18. Sun TV Network19. TCS20. UltraTech Cement


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Potential Blue Chips

Current Mkt Cap < Rs 10,000 crores28 Potential Blue Chips

1. BGR Energy2. Biocon3. Coromandel Inter4. Crompton

Greaves5. Deepak Fertilisers6. eClerx Services7. Emami8. GRUH Finance9. Guj Gas Company10.Hawkins Cookers

11. Indraprastha Gas12. Info Edge (India)13. Kansai Nerolac14. Karur Vysya Bank15. M & M Financial16. Mahindra Holiday17. Manappuram

Finance18. Opto Circuits19. Page Industries20. Rupa & Company

21.Shriram City Union22.Talwalkar23.TD Power Systems24.Thermax25.TTK Prestige26.Voltas27.VST Tillers

Tractors28.Zydus Wellness


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Floating the concept of MDOBringing back the long-term investor

Country Pay-out ratio (%)

Taiwan 76Malaysia 60Philippines 49Pakistan 49Thailand 45Germany 40Brazil 40UK – FTSE 39Nikkei 37Indonesia 36Singapore 31Hong Kong 31Korea 28China 26India – Sensex 23MSCI India 21Russia 12


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Financials have emerged as the largest wealth creating sector for the first time ever. Going forward, expect the sector to maintain its top slot led by existing and new pvt banks, and eventual listing of insurance companies.

Very fast growth in stock prices creates transitory multi-baggers. In most cases, what follows is prolonged and painful price and/or time correction.

Blue chips are fountains of dividend, and offer as much, if not more,investment growth potential than lesser quality companies, with far less risk.

In investing, there is no profitable substitute for quality. Understanding quality of the company doesn't stop at profits and profitability, it must extend to dividend payouts and longevity.

Most Blue Chips enjoy premium valuation. In deciding when to buy, one should focus not only on P/E, but also consider payout ratio, relative dividend yield, and earnings growth potential.

In India, over last 20 years, Blue Chips significantly outperformed benchmark indices with much lower risk.

In Conclusion


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Thank You !

&

Happy Blue Chip Investing !!

Wealth Creation Study 2006-2011

Business

Transcript of Wealth Creation Study 2006-2011