Wealth Creation Study 2003-2008

13th Annual Wealth Creation Study

2003-2008

By Raamdeo Agrawal

December 19, 2008

www.motilaloswal.com13th Annual Wealth Creation

Study2

Discussion Points

• 13th Wealth Creation Study Findings

• Theme 2009: Great, Good,

Gruesome

• Market Outlook


Study3

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


Study4

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.


Study5

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


Study6

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


Study7

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


Study8

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


Study9

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


Study10

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


Study11

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


Study12

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 (%)


Study13

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


Study14


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


Study15


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


Study16


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


Study17

“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



Study18

Theme 2009


Study19

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


Study20

Great, Good, Gruesome – Graphical Representation


Study21

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


Study22

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


Study23

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


Study24

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


Study25

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


Study26

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


Study27

Two Greats – See’s Candy vs Nestle India


Study28

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


Study29

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


Study30

Great, Good, Gruesome – Investment Payoff Matrix

* Margin of safety

Nestle

Hero Honda

NoneSBI, IOC

HDFC Bank


Study31


Best investment strategy

• Buy good companies at great price, or

• Buy great companies at good price


Study32


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.


Study33


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.


Study34

Market Outlook


Study35

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


Study36

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


Study37

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 (%)


Study38

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


Study39

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


Study40

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


Study41

• 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


Study42

Thank You & Happy Wealth Creating !!

Wealth Creation Study 2003-2008

Business

Transcript of Wealth Creation Study 2003-2008