Let’s admit it. Most of us don’t invest in stocks to ‘beat inflation.’
We do it to create wealth on an epic scale. The secret wish of every stock market investor is to unearth that gem of a stock that goes up fifty or hundred-fold in 10 years, and helps him bid goodbye to his day job.
So, what are your chances of hitting upon such a stock? Is there any science to it?
The odds aren’t high First, banish the thought that buying and holding any old stock will deliver untold riches to your bank account. In the last 10 years (from December 2005 to December 2015), finding multi-baggers has been an uphill task for an Indian investor. This was a period in which the Nifty 50 delivered only a 10.8 per cent CAGR (compounded annual growth rate).
Mid and small-cap stocks didn’t fare much better. The Nifty Next50 (formerly Junior Nifty) clocked 13.6 per cent and the Nifty Midcap100 earned 12.7 per cent.
But if you were shooting for a 26 per cent return (that is, doubling your money every three years) 60 of the 788 stocks made the cut. That’s an eight in 100 chance of unearthing them.
Take the top wealth creator Ajanta Pharma. Had you plonked ₹1 lakh on it in 2005, you would today be a crorepati. Eicher Motors (up 73 times), Amara Raja Batteries (67 times) and Indo Count Industries (40 times) were a few other toppers. (All stock returns in this analysis are adjusted for bonus and stock splits, and don’t include dividends).
Consumer isn’t king There’s a misconception among investors that consumer firms are the kingpins of wealth creation, while industrial stocks are washouts. Is it not consumer companies that have a strong ‘moat’ by way of their brands, pricing power and high return on equity?
That may be true, but our list of top twenty wealth-creators features more B2B companies than B2C ones. There are four pharma companies (Ajanta Pharma, Lupin, Aurobindo and Natco Pharma), two auto ancillary firms (Amara Raja Batteries, Motherson Sumi) and even industrial plays like Somany and Kajaria Ceramics, Indo Count Industries (textiles), Shree Cement and Supreme Industries (plastic products).
The only true-blue consumer firms were consumer durable makers like TTK Prestige, IFB Industries and Hitachi Home.
In fact, the top 20 featured so many different businesses that one cannot pick any single sector that yielded sure-shot winners. Who would have thought to bet on a textile or ceramic tile maker in 2005?
In contrast, the losers list did feature one sector prominently — information technology. Eight of the 20 wealth-destroyer stocks which crashed 90 per cent-plus in a decade are from the software space.
Though the dotcom boom cracked in 2001, many tech stocks remained overheated for the next few years.
Investors who bet on 3i Infotech, Subex, Helios and Matheson at PEs of 16 to 33 times in 2005 saw both their earnings and PE multiple compress drastically, decimating wealth. Firms that turned out winners didn’t just get there by being in a fancied sector. They got there by focussing on their core business, scaling up steadily and avoiding hubris — no unrelated forays along the way.
The takeaway for investors is that to home in on real wealth-creators, you need to focus mainly on the company.
Hoping to make big bucks from identifying the next big ‘sunrise’ sector is a pipe dream.
Fundamentals do matter Many Indian investors believe that the link between stock price performance and corporate earnings is tenuous. Doesn’t the Sensex sway daily to FPI flows? But experience from the multi-baggers shows that stock prices over the long term only respond to company earnings.
If the top 20 money-spinners delivered a 39 per cent CAGR in their stock prices over 10 years, they also managed a strong 32 per cent CAGR in their net profits over the same period. Don’t forget that this was a very challenging decade for the Indian economy, marked by two distinct downturns (2008-09 and 2012-13). Yet, profit growth for these firms ranged from 14 to 57 per cent, while their revenue run rates were 6 to 30 per cent.
Take the case of Ajanta Pharma. In 2005-06, this company was a pharma midget clocking profits of ₹10 crore on revenues of ₹205 crore, mainly from its bulk drugs business. Over the next decade, it proceeded to build up a basket of nearly 200 branded formulations in the domestic market and expanded aggressively into export markets such as Africa and Asia.
By 2014-15, its sales had scaled up six-fold to ₹1,300 crore, and profits 30-fold to over ₹300 crore.
Amara Raja Batteries, an automotive battery maker, clocked net profits of ₹24 crore on sales of ₹363 crore and was one-fourth the size of market leader Exide Industries in 2005-06.
Over the next 10 years, it scaled up to ₹413 crore in profit (75 per cent of Exide’s level) while managing to top its rival’s return on equity. This also saw its PE multiple expand threefold to 33 times.
In fact, for most 10-year winners, the mind-boggling returns have not come about steadily through the decade.
They have come about in a short burst within three-four years when the stock got re-rated. For many firms, even as earnings steadily improved, stock prices remained stuck in a rut for many years. But once the markets started taking note, their PEs were quickly re-rated and they turned multi-baggers.
Eicher Motors, for instance, was an under-the-radar auto stock until 2008. Between December 2005 and March 2008, the stock had inched up from ₹229 to ₹249; but as the LCV market took off, the stock took the elevator to zoom to ₹16,855 by 2015.
The lesson here is that, if a company is delivering decent earnings growth but the stock isn’t budging, you shouldn’t dump it in haste. You never know when the markets will take a shine to the business, no matter how unglamorous it may appear to be!
But the bad news is, the link between stock price returns and earnings has been equally strong for the wealth-destroyers too. It is not a coincidence that all of the bottom 20 stocks that have wiped out 95 per cent of their investors’ money have gone from profits to losses in the last 10 years.
Bargains may not deliver While selecting stocks for your portfolio, don’t assume the cheapest stocks in the sector are the best bets. Quite a few of the top wealth creators weren’t the biggest bargains in their sector ten years ago. With TTK Prestige at 20 times, Somany Ceramics at 19 times, Shree Cement at 18 times, Gruh Finance at 10 times, none of them was the most inexpensive in its sector.
The losers list, in contrast does feature stocks that appeared to be “value buys” in 2005. Surya Pharma (at eight times), Todays’ Writing Instruments (eight times) and Malwa Cotton (four times) started out with a low PE. But as their subsequent financial performance shows, the market wasn’t really under-valuing their prospects.
This argues against using purely quantitative filters such as low PE or low price-to-book value, to select stocks for your portfolio.
PSUs aren’t safe-havens
Hard as it is to find a unifying theme across all the multi-baggers, one does stand out — public sector firms are nowhere in the picture. For investors who think of government-owned firms as safe havens, it should be an eye-opener that the top wealth creator among PSUs (Bharat Electronics) barely delivered a 15 per cent CAGR and ranked a lowly 166{+t}{+h} in the listing. BPCL and Petronet LNG, also barely made the bar of 15 per cent.
But many PSUs — BEML, NTPC, BHEL, ONGC and PNB — fared worse. They barely matched your savings bank account, with a 2-5 per cent CAGR in 10 years. Some PSUs have lost big money too — MTNL (down 85 per cent), IOB (down 67 per cent) and HMT (down 48 per cent since 2005).
That a large number of PSUs operate in commodity sectors that are down and out today could be one reason for this.
But another reason certainly is policy intervention in every aspect of PSUs’ operations, which curtails their profitability and makes these firms unable to compete with their niftier private sector peers. If you’ve been a regular bidder in PSU divestment, think twice about weighing down your portfolio with too many of them.
Overall, all this analysis suggests that there’s only one secret sauce to finding multi-baggers — identify businesses that can consistently grow their profits over a decade. Whether the stock belongs to a fancied sector, whether it’s a value stock or a growth one, whether it is a B2C business or B2B — it doesn’t matter all that much!