13th Annual Wealth Creation Study
2003-2008
By Raamdeo Agrawal
December 19, 2008
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Discussion Points
• 13th Wealth Creation Study Findings
• Theme 2009: Great, Good,
Gruesome
• Market Outlook
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13th Annual Wealth Creation Study
Concept of Wealth Creation:The process by which a company enhances
market value of the capital entrusted to it by its
shareholders
Net Wealth Created:Change in Market Cap over the study period
adjusted for corporate actions
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Wealth Creation Study - Methodology
Wealth Creators:Though Rs 100 crores of net wealth created is
the qualifying criteria, the top 100th wealth
creating company managed Rs 4,000 crores.
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The 10 Biggest Wealth Creators
Rank CompanyNet Wealth
Created Price Price PAT
Rs crores
% Share
Apprec. (x) CAGR (%)
CAGR (%)
1 Reliance Inds 307,727 12.1 10.1 58.7 36.5
2 ONGC 159,336 6.3 4.1 32.8 9.7
3 Bharti Airtel 150,478 5.9 29.2 96.4 L to P
4 NMDC 135,554 5.3 115.0 158.3 59.8
5 MMTC 108,409 4.3 193.9 186.8 51.6
6 BHEL 95,204 3.7 18.4 79.1 45.1
7 L&T 81,259 3.2 32.8 100.9 38.1
8 SAIL 72,674 2.9 21.0 83.8 L to P
9 State Bank 70,064 2.8 6.3 44.4 16.7
10 ITC 61,682 2.4 4.9 37.5 17.9
Total of above
1,242,387 48.9
Total of top 100
2,539,047 Dominance of commodities
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The 10 Fastest Wealth Creators
Rank Company Price Price Mkt Cap (Rs crores)
Apprec.
(x) CAGR (%) 2008 2003
1 Unitech 837 284 44,830 54
2 Jai Corp 316 216 9,186 28
3 MMTC 194 187 108,971 562
4 Financial Tech 164 177 7,359 36
5 BF Utilities 152 173 4,001 26
6 Aban Offshore 118 160 11,433 94
7 NMDC 115 158 136,743 1,189
8 Godrej Inds 108 155 8,294 70
9 Sesa Goa 102 152 12,321 121
10 REI Agro 99 150 7,078 44
Nothing is more profitable than investing in an early stage bubble
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The Most Consistent Wealth Creators
Rank CompanyAppeared in last 10
WC Studies (x)10 Yr Price CAGR (%)
1 Infosys Tech. 10 25.7
2 Hero Honda Motor 10 16.5
3 Ranbaxy Labs 10 8.7
4 Sun Pharma 9 46.0
5 Reliance Inds 9 40.5
6 HDFC 9 40.2
7 Cipla 9 21.8
8 Satyam Computer 9 19.2
9 Piramal Healthcare 9 16.6
10 ITC 9 13.9
Non-cyclicality of business is key for consistent wealth creation
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Wealthex v/s Sensex (2003-2008)
Mar-03Mar-
04Mar-
05Mar-
06Mar-
07Mar-
08 CAGR
(%)
BSE Sensex 3,049 5,591 6,493 11,280 13,072 15,644 38.7
YoY (%) 83.4 16.1 73.7 15.9 19.7
Wealthex - rebased 3,049 6,470 8,019 13,724 15,680 22,987 49.8
YoY (%) 112.2 23.9 71.1 14.2 46.6
Sensex EPS (Rs) 272 348 450 523 718 833 25.1
YoY (%) 27.9 29.3 16.2 37.4 16.0
Sensex PE (x) 11.2 16.1 14.4 21.6 18.2 18.8
Wealthex EPS (Rs) 386 487 641 719 977 1,228 26.1
YoY (%) 26.3 31.6 12.2 35.9 25.7
Wealthex PE (x) 7.9 13.3 12.5 19.1 16.0 18.7
Wealth Creators – higher EPS growth, lower P/E, higher appreciation
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Wealth Creation by Industry
Industry (No of cos.) Wealth Created (Rs
cr) Share (%)
Oil & Gas (8) 582,623 22.9
Metals (13) 441,617 17.4
Banking & Finance (15) 328,235 12.9
Engineering (10) 260,328 10.3
Telecom (2) 163,638 6.4
IT (5) 123,365 4.9
FMCG (6) 118,049 4.6
Pharma (8) 73,292 2.9
Auto (7) 68,033 2.7
Ultility (4) 63,519 2.5
Cement (4) 52,733 2.1
Construction / Real Estate (2) 49,076 1.9
Media (2) 14,657 0.6
Retail (2) 9,580 0.4
Others (12) 190,301 7.5
Total 2,539,047 100.0
Commodities may give way to users of commodities going forward
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165
103 99
74
51 57
3333
< 200 200-500 500-1,000 1,000-2,000
2,000-5,000
5,000-10,000
10,000-20,000
> 20,000
Avg Price CAGR: 50%
Wealth Creation by Mcap (Base Year)
Price CAGR by Base Year MCap
2003 Market Cap Range (Rs crores)
Rapidly growing and deregulating Indian economy will produce many young and fast-growing enterprises
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Wealth Creation by Earnings Growth
2003-08 Earnings Growth Range (%)
Price CAGR by Earnings Growth Range : Higher the better
27
49
67
108
98
43 45
0-10 10-20 20-30 30-40 40-50 50-70 >70
Avg Price CAGR: 50%
Markets are unable to fully price in hyper growth
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Wealth Creation based on ROE
Price CAGR by ROE in 2003
92
56
32
15
39 36
77
61
<5 5-10 10-15 15-20 20-25 25-30 30-40 >40
Avg Price CAGR: 50%
Bargains
Risk-reward balance
Bargains are found when markets are blind
to change
2003 ROE Range (%)
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Wealth Creation by Valuation Parameters
P/E (x)
No. of companies
% Wealth Created
Price CAGR %
<5 36 41 55
5-10 27 26 57
10-15 18 18 59
15-20 7 5 25
>20 12 11 37
Total 100 100 50
High margin of safety in single digit P/Es
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Wealth Creation by Valuation Parameters
Price/Book (x)
No. of compani
es% Wealth Created
Price CAGR %
<1 47 34 67
1-2 32 49 54
>2 21 17 30
Total 100 100 50
Price / Book of less than 2x – 83% of wealth created
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Wealth Creation by Valuation Parameters
Watch out for Price / Sales < 1
Price/Sales (x)
No. of companie
s% Wealth Created
Price CAGR %
<0.25 19 15 66
0.25-0.5 19 13 63
0.5-1.0 28 37 62
1-2 14 18 47
>2 20 17 30
Total 100 100 50
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Wealth Creation by Valuation Parameters
Payback of less than 1x – 84% of wealth created
Payback Ratio
No. of companie
s% Wealth Created
Price CAGR %
<0.25 22 18 116
0.25-0.5 28 19 59
0.5-1.0 32 48 50
1-2 9 10 38
>2 9 6 22
Total 100 100 50
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“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
Wealth Creation by Valuation Parameters
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Theme 2009
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Warren Buffett says –
“Think of three types of savings accounts. • The Great one pays an extraordinarily high
interest rate that will rise as the years pass. • The Good one pays an attractive rate of interest
that will be earned also on deposits that are
added. • Finally, the Gruesome account both pays an
inadequate interest rate and requires you to
keep adding money at those disappointing
returns.”
Great, Good, Gruesome – Definition
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Great, Good, Gruesome – Graphical Representation
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Great companies – • Require very little incremental capital for
growth• High and steadily rising RoE
Good companies – • “Put up more to earn more” phenomenon
Gruesome companies• Consume lot of capital• Earn little or no money
Great, Good, Gruesome – Key difference
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Great, Good, Gruesome – Characteristics
Criteria Great Good Gruesome
Competitive advantage
High and rising long-term competitive advantage from brand / low-cost production
Steady competitive advantage
Low or no competitive advantage
Nature of business
Stable business i.e. no rapid or continuous change
Subject to moderate change
Business likely to have rapid changes
Pricing power
High Moderate Absent
Management
Low dependence on greatness of management
Management, key success factor
High dependence on management
Growth Typically moderate growth; high growth rates a rarity
Moderate-to-high growth rate
High growth rates
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Great, Good, Gruesome – Characteristics (contd.)
Criteria Great Good Gruesome
Capital intensity
Low capital intensity; high level of intangible assets
Moderate-to-high capital intensity
Very high capital intensity
RoE Very high and rising RoE
Stable and attractive RoE
Low / falling RoE
Dividend payout
Typically high Moderate Low or no payout
Examples Hero Honda, Nestle, GSK Pharma, Infosys
HDFC Bank, L&T, BHEL, Tata Steel
Tata Tele (Mah), Jet Airways, Arvind
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Great, Good, Gruesome – Typical Financial Profile Nestle HDFC Bank Tata Tele
(Great) (Good) (Gruesome)
10-year CAGR (%) -
Sales 10.0 44.0 101.0
PAT 19.0 39.0 Loss to Loss
Capital Empd (Rs cr) -109 *11,158 1,742
RoE (%) -
Latest 102.5 17.7 NW eroded
10 years ago 36.4 26.4 -10.3
10-year incr. RoE 230.0 14.0Not
calculable
In last 10 years -
Cumulative PAT (Rs cr) 2,231 5,875 -2,670
Total Dividend (Rs cr) 1,818 1,205 0.0
Average Payout (%) 81.0 21.0 0.0* Net worth
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Great, Good, Gruesome – Typical Financial Profile
Nestle, HDFC Bank, Tata Tele (Mah) – ROE Trend
-120
-80
-40
0
40
80
120
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Net worth eroded from 2005
Tata Tele (Mah)
HDFC Bank
Nestle
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Key takeaways -
• Great companies are fountains of dividends • Good companies are fountains of earnings
• Gruesome companies are bottomless pits of capital consumption
Great, Good, Gruesome – Typical Financial Profile
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Two Greats – See’s Candy vs Nestle India
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Key takeaways - • Both have deployed very little incremental capital• Incremental PAT / Capital Employed is high for both• Both are proving to be huge cash machines• At 21.4%, Nestle’s return is same as 21.7% for See’s
• Main difference: In Nestle’s case, much of the return is by way of earnings growth, whereas in See’s it is by way of earnings yield (i.e. higher margin of safety)
Two Greats – See’s Candy vs Nestle India
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Great investments are the result of huge
margin of safety at the time of purchase
Benjamin Graham on margin of safety• “It is a favorable difference between price [paid] and indicated or appraised value.”• “The function of margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future.”• “Margin of safety lies in an expected earning power considerably above the going rate for bonds.”
Great companies need not be great investments
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Great, Good, Gruesome – Investment Payoff Matrix
* Margin of safety
Nestle
Hero Honda
NoneSBI, IOC
HDFC Bank
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Great, Good, Gruesome – Investment Payoff Matrix
Best investment strategy
• Buy good companies at great price, or
• Buy great companies at good price
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Great, Good, Gruesome – Investment Payoff Matrix
Benjamin Graham on good- and low-quality stocks
• The risk of paying too high a price for good-quality stocks is not the chief hazard …
• … chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.
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Great, Good, Gruesome – Investment Payoff Matrix
Charlier Munger on high- and low-quality businesses
• Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns.
• If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return – even if you originally buy it at a huge discount.
• Conversely, if a business earnings 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with one hell of a result.
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Market Outlook
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Corporate Sector Profit Growth May Taper Off
Corporate Profits To GDP (%) : At all time highs
1.31.6 1.6
2.2
3.5 3.3
2.4 2.31.8 1.9 2.1 2.3
3.1
4.44.9
5.56.1
6.46.0
FY
91
FY
92
FY
93
FY
94
FY
95
FY
96
FY
97
FY
98
FY
99
FY
00
FY
01
FY
02
FY
03
FY
04
FY
05
FY
06
FY
07
FY
08
FY
09E
Mean: 3.3
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Sensex EPS growth may flatten
81129
181250 266 291 278 280
216 236272
348
450
523
718
833
FY
93
FY
94
FY
95
FY
96
FY
97
FY
98
FY
99
FY
00
FY
01
FY
02
FY
03
FY
04
FY
05
FY
06
FY
07
FY
08
FY93-98: 29% CAGR
FY98-03: -1% CAGR
FY03-08: 25% CAGR
FY93-08: 17% CAGR
Sensex EPS Growth: Reversion to mean likely
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Interest rates are headed lower
14.0
5.6
7.9
2.1
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
Dec
-93
Dec
-94
Dec
-95
Dec
-96
Dec
-97
Dec
-98
Dec
-99
Dec
-00
Dec
-01
Dec
-02
Dec
-03
Dec
-04
Dec
-05
Dec
-06
Dec
-07
Dec
-08
10-Year India G-Sec Yield (%) 10 Year US G-Sec Yield (%)
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Market P/E is close to its all-time lows
11.5
1,700
6,700
11,700
16,700
21,700
Dec
-08
Dec
-07
Dec
-06
Dec
-05
Dec
-04
Dec
-03
Dec
-02
Dec
-01
Dec
-00
Dec
-99
Dec
-98
Dec
-97
Dec
-96
Dec
-95
Dec
-94
Dec
-93
0
10
20
30
40
Sensex P/E (LHS) Sensex (RHS)
15 Year Median P/E: 15.6x
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Earnings Yield to Bond Yield is comfortable
1.6
1.4
1.6
0.2
0.7
1.2
1.7
Dec-9
3
Dec-9
4
Dec-9
5
Dec-9
6
Dec-9
7
Dec-9
8
Dec-9
9
Dec-0
0
Dec-0
1
Dec-0
2
Dec-0
3
Dec-0
4
Dec-0
5
Dec-0
6
Dec-0
7
Dec-0
8
15 Year Avg is 0.73x
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Market Cap as % to GDP is off its highs
2823
43
54
85
109
55
37
19
44 26
26
85
51
3443
24
54
0
20
40
60
80
100
120
FY
91
FY
92
FY
93
FY
94
FY
95
FY
96
FY
97
FY
98
FY
99
FY
00
FY
01
FY
02
FY
03
FY
04
FY
05
FY
06
FY
07
FY
08
FY
09E
Mean: 46
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• Understanding of Great, Good and Gruesome companies is critical to investment success.
• Great time to buy Great companies (perpetual bonds) at reasonable prices, as interest rates are likely to remain low for quite some time.
• Gruesome companies are best avoided.
• Market is likely to see a sector churn – dominance of commodities will probably give way to users of commodities.
• Corporate profit boom of last five years is unlikely to continue. However, we have probably seen the market bottom at Sensex levels of 7,700.
In Conclusion
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Thank You & Happy Wealth Creating !!
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