Motilal Oswal Wealth Creation Studies - 1994 to 2022

Tanishk_Ojha · 2023-09-24T15:31:45+00:00

Google Drive Link As Phil Fisher says, “It seems logical that even before thinking of buying any common stock, the first step is to see how money has been...

Tanishk_Ojha

1995-2000

Fastest wealth creators - again IT.
86% of the wealth created by multi-baggers has been due to P/E re-rating.
80% of the wealth created by MOSt -Inquire 100 has been made in 1999-2000. In the first two years of the period, it lost 16% of the purchase price.
Again, Phil Fisher very appropriately says “if big profits are to be made out of investment, one needs patience, for it is easier to tell what will happen to the price of a stock than how much time will elapse before it happens".

All successful Wealth Creating companies have erected high entry barriers through technological advantage or strong brand-building.
As per Michael J. Mauboussin and Alexander Schay, the period of excess return for an individual company, which is known as “Competitive Advantage Period”(CAP), is shortening due to rapid pace of innovation. In plain language, this means that the valuation of fast changing industries should be lower, all things being equal, than the more stable industries. But here is the twist. We see knowledge-based market leaders achieving higher- than-ever economic returns. This substantiates their higher valuation.
The speed at which the stock market recognises business success is increasing everyday.
Favourable external environment should continue for a long period of time.
Size of the business opportunity has to be very big.
A company should be purchased when it is out of favour and later on, it should come into limelight.
If the return on the stock has to be anywhere near 100% every year, the base value has to be modest. Otherwise it will become a mathematical impossibility for a stock cannot keep growing at such a pace for a long time.
Focus should be on 'price of companies' rather than on 'price of shares'.

Focus on Payback Ratio.

Tanishk_Ojha

1996-2001

High RoE (well above cost of capital) is the foundation of wealth creation.
Growth in the same business franchise is likely to be more rewarding in the future than from a totally new line of business.
The foundation of Wealth Creation is in buying businesses at a price substantially lower than their intrinsic value.
Lower the market value than the intrinsic value, higher is the margin of safety.
Major wealth created by IT, FMCG And Pharma. (Consumer products + Service-oriented businesses)
The speed of Wealth Creation is directly correlated to the size of market capitalisation.Thus, if one wants speed in Wealth Creation, then it is imperative for investors to buy companies with relatively small market capitalisations and whose businesses have the potential to create value for shareholders on a consistent basis.

Never count on making a good sale. Make the purchase price so attractive, that even a mediocre sale gives an attractive return.

Tanishk_Ojha

1997-2002

A consistent finding of our Wealth Creation Studies, including the current one, is that most of the Wealth has been Created by companies that have seen their earnings grow faster than 25% annually.
Most of the Wealth has been Created by relatively young companies.

Once the bull market gets under way and once you reach the point where everybody has made money, no matter what system he or she follows, a crowd is attracted into the game that is not responding to interest rates and profits but simply to the fact that it appears to be a mistake to be out of stocks.

Tanishk_Ojha

1998-2003

Multibaggers could be of two types: transitory and enduring. Transitory multibaggers are created by the combination of cyclical nature of business and questionable quality of management.
Only good quality managements can deliver enduring multibaggers. Market folly contributes enormously to the creation of mega multibaggers.
A wide ‘margin of safety’ at the time of purchase is non-negotiable for the creation of multibaggers.

Though the relative attractiveness (read value) of equities improved in FY03, investors stayed away from the stock market. They decided to put their money in bonds because bond prices were going up whereas stock prices were falling. Now that the bond rally is arguably over, investors will flock back to stocks.
We took a close look at the 115 stocks that had more than trebled during the period 1998-2000. We assumed that the purchase was made on 1 April 1998 and the sale on 31 December 2003. The results were hardly surprising; most of these stocks turned out to be transitory multibaggers. They ended up destroying as much wealth in their journey downwards as they had created during their journey upwards.
Improvement in business conditions leads to a change in the earnings trend. That is typically the starting point of the dismantling of pessimism on a stock. Hence a positive change in business conditions is a must for the creation of a multibagger.
For the creation of enduring multibaggers, the combination of a good business and a good management is necessary. In cyclicals, despite the fact that poor business conditions are temporary in nature, the best results over a long period of time are achieved when the best management leads the company. Therefore, in our quest for enduring multibaggers, we must look for improvement in business environment combined with good management. When a weak management makes way for a strong management in a good business, it could lead to the emergence of a potential enduring multibagger.

Tanishk_Ojha

1999-2004 (Commodity Primer)

We had not expected commodity companies to create much wealth, but they account for more than 60% of the total wealth created in the current study
Commodity companies make money only when there is a sustained demand-supply gap.
Purchase price discipline, that is, huge margin of safety at the time of purchase, is paramount because it covers a multitude of errors committed while investing.
Institutional imperative is to back more steady larger companies, where speed is sacrificed for the size of Wealth Created.
High earnings growth need not be associated with high sales growth. High earnings growth companies have been the fastest and biggest Wealth Creators.
Despite superior earnings growth by new economy companies, their market cap growth has been pulled down by the handicap of high purchase price.

Typically, all commodities are investment/asset intensive. If adequate investments have not been made in these industries for long periods of time, there is likelihood of supply growing at a limited pace during the period of fresh capacity creation. It would mean that the ratio of supply growth to demand growth would remain less than 1. This leads to a sustained squeeze and further price rises lead to a situation where profitability becomes so high that disproportionate investments are attracted in either creating new capacities or creating cheaper substitutes. This alters the ratio of supply growth to demand growth to well above 1, which ends the squeeze.
A more accurate way to value a commodity business would be to add the total profits during the period of exponential earnings growth and the residual value of business. This is typically reflected in private buyer transactions of the businesses. For instance, in the hotel business, the estimate of next three years’profits and the eventual selling price of the hotel property would give a good understanding of what the value should be.
Stock prices are altered by a change in business outlook.

Tanishk_Ojha

2000-2005 (Consistent Wealth Creators)

While one would always like to have fast wealth creators, these are difficult to find in their early stages. In fact, several consistent wealth creators have been fast wealth creators at some point of time. The speed of wealth creation is typically dependent on two factors: (1) the earnings growth rate, and (2) the margin of safety at the time of purchase.
Consistent wealth creators are known for their demonstrated earnings power over a long period of time. Typically, the demonstrated earnings power continues well into the future. The future, though uncertain, is usually not vastly different from the immediate past. Keeping this fact in mind, it is assumed that these companies will maintain their high earnings power well into the future.
The first benefit of investing in consistent wealth creators is that the investor is looking at a very small number of companies, at a given point of time. Secondly, these are established large companies and leaders in their own fields. Safety of capital invested in them would be very high. The problem is identifying when or at what price to buy.
Consistent wealth creators (like any other stock) have also to be bought cheap and sold when they are dear. One cannot buy some thing cheap or sell something dear unless one knows what cheap is and what dear is.
By investing in consistent wealth creators below their median valuation, you have an almost 100% chance of beating the Sensex.

Tanishk_Ojha

2001-2006 (Terms of Trade)

Only corporate earnings growth is not sufficient for markets to rise to higher levels. Growth expectations and change in risk free interest rate may come in the way of the 4th year of bull run.
Large unpopular companies have not only been the source of bulk of wealth creation, but also the speed of wealth creation.
Corporate earnings grew by 58% during the two-year period 2001-2003, but the Sensex fell by almost 15% – stock prices can fall despite strong earnings growth
In 2006, the Sensex P/E was 21.6x, around the same level as in 2001, indicating that most of the appreciation in the market index has been driven by earnings growth.
Sugar, Autos, Textiles and Engineering, which the markets ignored in 2001, have given stellar performance during the period of study. Oil & Gas, Banks, Metals and Engineering companies account for most of the wealth created during 2001-2006.
To create wealth fast by investing in large companies, one must buy when they are unpopular.
Wealth creators are usually the leaders (No. 1 or No. 2) in their businesses. Even if the leaders are expensive, it pays to be invested in them.
New economy companies are still suffering from high valuations vis-à-vis old economy companies. The superior and consistent growth of IT companies will help them to create wealth in the future, but old economy companies will still beat them in terms of pace of wealth creation.
Buy a growth stock, but don’t pay for growth.
To enhance its RoCE, a business entity must do one of the following:
-->Increase profit without a corresponding increase in capital employed.
-->Increase / maintain profit together with a decrease in capital employed.
Now, there is usually very little that a company can do about its fixed capital but better ‘terms of trade’could help lower working capital requirements. ‘Terms of trade’refers to the ratio of debtors to creditors – the lower the ratio, the better. While favorable ‘terms of trade’could result in zero or even negative working capital, adverse ‘terms of trade' could mean very high working capital requirements, rendering the business unprofitable.

The greatest situation for a company to be in is when customers are prepaid and there is a credit cycle from the suppliers. In such a scenario, the company’s working capital is negative, and these funds can be channeled to financing fixed capital requirements. Such a business usually enjoys good profit margins, too. As its capital requirements are largely taken care of, it yields high cash flows and rewards shareholders handsomely.

Tanishk_Ojha

2002-2007

Bargains are found when markets are blind to large business opportunity, positive changes or sustained growth; losses are guaranteed when one grossly overpays.
Large, unpopular (even loss-making) companies are potential multi-baggers with high margin of safety. Example: Bharti and SAIL are large companies, but were unpopular in 2002 due to lack of profits. Low visibility of profits laid the foundation for huge wealth creation at rapid pace.
Companies less than 10 years old tend to report higher PAT growth, given their low base. High earnings growth leads to high P/Es, which explains their outperformance to older peers.
Bulk of the wealth created (61%) is by stocks bought at a PE of less than 10x. The price CAGR in these stocks is also much higher than average. To create wealth, focus on growth but be ahead of the crowd.
45 out of the top 100 wealth creators were available in 2002 at Price/Book of less than 1x. Needless to add, their price CAGR is also significantly high.
57 of the top 100 wealth creators had Price/Sales of 1x or less in 2002.

Tanishk_Ojha

2003-2008

At times, Fad Investing (e.g. Real estate) and Momentum Investing (e.g. Commodities) can make serious money in the stock markets over reasonably long periods. Nothing is more profitable than investing in an early stage bubble.
Small- and mid-size companies with a large business opportunity and ambitious, aggressive management can prove to be kickers for superior returns in any portfolio.
Anticipating change in profitability ahead of the crowd is rewarded very well in the markets.

Great companies become significant cash machines with high and steadily rising RoE, and high dividend payouts. Investors can deploy these payouts to earn returns in other avenues. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding.
We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere.

The enduring moat of Great companies is more likely to widen as the years pass by. For instance, branded products (e.g. Colgate) are habit-forming with customers, and switching costs are high.
Good companies have relatively weaker moats. Hence, efficient execution of all major processes becomes a key success factor. Thus, unlike great companies, good companies will tend to depend on their management’s character and competence.

Tanishk_Ojha

2004-2009

PAT CAGR of MNCs is typically lower than that of Indian companies. However, they still enjoy premium valuations. The main reasons are higher RoE and healthy dividend payout (still valid though?).
Typically, high growth is accompanied by somewhat premium market valuations. However, this should not be a deterrent to buying these stocks.
Of the top 100 Wealth Creators, 66 had strong Entry Barriers. Even more interestingly, they accounted for a disproportionate 86% share of the wealth created. Our study shows that companies with Entry Barriers enjoy exponential growth in profits. When bought at reasonable valuation, they create significant wealth over the long term.

"We are partial to putting out large amounts of money where we won't have to make another decision. If you buy something because it's undervalued, then you have to think about selling it when it approaches your calculation of its intrinsic value. That's hard. But, if you can buy a few great companies, then you can sit on your ass. That's a good thing."- Charlie Munger

Tanishk_Ojha

According to me - this report is the best so far. Makes perfect sense too.

READ THE COMPLETE REPORT.

2005-2010

FY05-10 data suggests that companies with RoE of less than 10% in FY05 delivered significantly superior returns over the next five years. This is counter-intuitive as RoE is supposed to be a key indicator of the quality of company’s earnings. But typically, RoEs are low when the companies are in the investment mode, or are faced with a cyclical downturn. At these times, even P/Es look very high. However, from such a low base, the companies are able to deliver very high earnings growth over the medium term at least.

Empirical evidence suggests that in normal life, most massive gains (or losses) are the outcome of positive (or negative) UU events. For instance, positive UU events could include an unexpected lucrative job, or a low-value real estate holding exploding in value, sharp surge in the value of gold accumulated over time, or even a lottery jackpot.

Behavioral economics suggests people tend to think they know much more about unknowable quantities than they do. This can prove to be a dangerous tendency when coupled with the temptation of high payoffs in UU investing. Zeckhauser puts it aptly, “If you lack Buffett capabilities, you will get chewed up as a bold stock picker.”
By definition, UU investing involves taking calculated bets in situations where knowledge is scanty. If such investment(s) were to incur significant loss, the investment would be criticized in hindsight as foolish by all but the most sophisticated. Investors who are prone to get affected by such hindsight criticism – technically termed Monday Morning Quarterback risk – need to refrain from the UU investing approach.
One might be blamed for a poor outcome if one invests in ignorance when, in fact, it was a good decision that got a bad outcome.

Tanishk_Ojha

2006-2011

Successful investments are those which prove to be enduring (not transitory) multi-baggers, which are an outcome of high quality business and high quality management. Blue Chip Investing is one such sound strategy.
Quality of management is a key factor behind consistent wealth creation.
Two indicators of earnings quality are RoE and Dividend Payout.
Markets are unable to appropriately price both, hyper-growth and high quality growth, resulting in huge wealth creation.

Blue Chips, by virtue of their dominant position in their respective businesses, are able to deliver quality earnings growth (i.e. with high RoE), leading to huge size and high speed of wealth creation.
In almost every single of our past Wealth Creation Studies, the key valuation indicators for multi-baggers are -
- P/E of less than 10x
- Price/Book of less than 1x
- Price/Sales of 1x or less
- Payback Ratio of less than 1x
  
  (Payback is a proprietary ratio of Motilal Oswal, defined as current market cap divided by estimated profits over the next five years.)
Structural rise in payout ratios is a potential source of PE re-rating over the next few years.
Dividends yields are highly homogenous across companies e.g. 66% of the top 100 wealth creators had a base FY06 dividend yield below 1.5%. (Less Dividend ==> More capital towards growth?)
Benjamin Graham and David Dodd wrote in their classic text book, Security Analysis, An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.
Dominant market position: This seems by far the most necessary condition for a Blue Chip. 44 of the 48 Blue Chips are among the top 3 players in their respective business.

Tanishk_Ojha

2007-2012

Consumer goods companies are generally considered to be steady growth businesses, and deemed unlikely to generate high returns.
Given low cyclicality, consumer facing companies (both goods and services) are better placed to appear in the list of Most Consistent Wealth Creators. Notable exceptions are Holcim Group companies, ACC and Ambuja Cements, which appear in the top 10 list both this year and last. Clearly, Holcim's presence has made the behavior of these companies more predictable to investors, leading to better and stable valuations.
Quality of management is a key factor behind consistent wealth creation. This is further amplified by the role of management strategy in creating and/or defending a company's Economic Moat which protects its profitability from being eroded by competitive forces.
Economic Moat Cos are those who enjoy a sustainable competitive advantage in their respective industry, which helps them earn superior profits and deliver higher shareholder value.
Younger companies start off on a low base and manage to deliver high rates of growth. However, markets are reasonably efficient in pricing these growth rates upfront.
Long-term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding.
Interestingly, since markets are efficient, in most cases, quality of an Economic Moat is priced in. Given this, it is the deepening or the narrowing of the moat (i.e. delta or incremental RoE) that influences stock prices more than the absolute levels.
- The above is confirmed in this year's study as well. Companies with RoEs in excess of 35% have underperformed the benchmark return of 20%.

Bargaining power with customers : This affects an industry's terms of trade on the revenue side such as product prices, volume discounts, credit period to customers, ability to pass on cost hikes, finished goods inventory levels, etc. Industries which supply to large, consolidated or well-informed buyers are adversely placed and vice versa. Likewise, if an industry's products can be easily substituted by buyers, it is adversely placed and vica-versa.
Bargaining power with suppliers: This affects an industry's terms of trade on the cost side such as cost of raw materials, credit period from suppliers, ability to defer cost hikes, raw material inventory levels, wage negotiations with labor, etc. Industries with large and consolidated suppliers (including strong worker unions) are unfavorably placed and vice versa.
Entry barriers: Ease of entry decides how quickly supernormal profits can be leveled off in an industry due to emergence of players. Some of the entry barriers to an industry include high capital cost, access to distribution network, government regulations (e.g. on imports, on safety and environment norms, etc).
Rapid changes in business environment: Industries which are vulnerable to rapid and far-reaching changes in business environment are unfavorably placed vis-à-vis more stable industries. For instance, companies in dynamic businesses face overnight obsolescence if a better substitute product or service emerges e.g. audio/video cassettes, film-based photography, pagers, etc. This phenomenon is particularly true in businesses involving high R&D spend such as healthcare and technology.

Tanishk_Ojha

2008-2013

Uncommon Profits in companies = Uncommon Wealth Creation in stock markets.
Successful Emergence of Value Creators is very rare; a strong corporate-parent in a non-cyclical business significantly increases the probability.
Endurance of Value Creators is mainly threatened by disruptive innovation/competition, major regulatory changes, and capital misallocation.
Mid- and small-cap companies with the right business model, able management and bought at reasonable valuation deliver handsome returns irrespective of economic and stock market conditions.
Wealth Creators defy the commonly heard maxim in equity markets - "High return, high risk". At the time of purchase, Wealth Creators' P/E is lower than benchmark (i.e. lower risk), and yet returns are higher.
Wealth migration follows Value Migration. Over the years, value has migrated from PSUs to private companies across sectors - Banking, Telecom, Oil & Gas, Metals & Mining, Utilities, Capital Goods etc. This arguably lends further support to the maxim, "The government has no business to be in business."
There is a widely-held belief that Value Creators are mainly Consumer stocks. However, Value Creators are found across sectors and significantly outperform the markets irrespective of economy and market conditions.

The competitive landscape of the industry is a major determinant of incumbent companies' ability to sustain Uncommon Profits. Clearly, lower the competitive intensity, higher the chances of Value Creators emerging and vice versa.
One metric of an industry's opportunity size is Profit Pool i.e. the absolute level of profit of all players in an industry put together. If an industry has a high profit pool, a company with the right value proposition/strategy can claim a rising share of this pool and emerge a Value Creator over time. In contrast, Value Creators are unlikely to emerge from industries that have a small profit pool in the first place.
Value migrates from outmoded business designs to new ones that are better able to satisfy customers' most important priorities. In effect, Value Migration results in a gradual yet major shift in the way the profit pool in an industry is shared. Seen this way, Value Migration is one of the most potent sources of Emergent Value Creators.
Common feature across most Value Creators is that they come from industries which are stable. An industry may be deemed to be stable if it is less prone to de-stabilizing factors -
- High cyclicality of demand and/or supply, leading to volatility in product pricing
- High level of product innovation, resulting in rapid changes in player market shares
- Rapid and unexpected changes in government regulation
Many companies in their initial years show steady improvement in their profitability and profits, suggesting they are most likely to breach the CoE threshold in the next couple of years. Investors are prone to invest in such companies early, expecting to earn superlative returns. However, actual data suggests that in most cases, there is no significant gain in pre-empting emergence.

Tanishk_Ojha

2009-2014

100x stocks are few. Finding them requires vision to see, courage to buy, and the patience to hold.
Quality does not guarantee growth, and in turn, rapid long-term Wealth Creation.
Very few investors even conceptualize their equity investment multiplying 100 times. Even fewer actually experience a 100-fold rise in the price of their stock(s). This is because such 100- fold rise may take longer than 3, 5, or even 10 years' time. And holding on to stocks beyond that period requires patience which “is the rarest of the three” qualities, the other two being vision and courage.

Most of the niche companies seem to go through several rounds of trial and error (e.g. TTK Prestige is established in 1955, but has been a mediocre company till as recent as FY09). Hence, it may be prudent to buy into such companies only after they have secured their business model.
Even in a consolidated market, the leader tends to gradually gain market share, ensuring that it grows faster than the market; and The dominant player tends to enjoy pricing power which ensures profitability.

High-Quality-Low-Growth: Such companies may prove to be Quality Traps. The high quality in these companies blinds investors to the possibility that these companies may not be able to grow their earnings at a healthy pace due to low underlying base rate (e.g. Castrol in lubricants, Colgate in oral care, Hindustan Unilever in soaps & detergents, etc). High RoE, high free cash flow and high dividend payouts ensure that these stocks enjoy (and indeed merit) rich valuations. So, they can be bought only when they trade at significant discount to their long-period valuations (e.g. during extreme pessimism in the broader market or in the specific stock).