Wealth Creation Study 2003-2008

13th Annual Wealth Creation Study
2003-2008
By Raamdeo Agrawal
December 19, 2008

www.motilaloswal.com13th
Annual Wealth Creation Study 2
Discussion Points
• 13th
Wealth Creation Study Findings
• Theme 2009: Great, Good, Gruesome
• Market Outlook

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

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.

The 10 Biggest Wealth Creators
Rank Company Net 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

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

The Most Consistent Wealth Creators
Rank Company
Appeared 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

Wealthex v/s Sensex (2003-2008)
Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 CAGR
(%)
BSE Sensex 3,049 5,591 6,493 11,280 13,072 15,644 38.7
Yo Y (% ) 8 3. 4 1 6 . 1 7 3. 7 1 5. 9 1 9 . 7
Wealthex - rebased 3,049 6,470 8,019 13,724 15,680 22,987 49.8
Yo Y (% ) 1 1 2. 2 23. 9 7 1 . 1 1 4. 2 46 . 6
Sensex EPS (Rs) 272 348 450 523 718 833 25.1
Yo Y (% ) 27 . 9 29 . 3 1 6 . 2 37 . 4 1 6 . 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
Yo Y (% ) 26 . 3 31 . 6 1 2. 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

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

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 CAGRby Base YearMCap
2003 Market Cap Range (Rs crores)
Rapidly growing and deregulating Indian
economy will produce many young and
fast-growing enterprises

Wealth Creation by Earnings Growth
2003-08 Earnings Growth Range (%)
Price CAGRby Earnings Growth Range : Hig he r the be tte r
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 hypergrowth

Wealth Creation based on ROE
Price CAGRby 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 (%)

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

Price/Book
(x)
No. of
companies
% Wealth
Created
Price CAGR
%
<1 47 34 67
1-2 32 49 54
>2 21 17 30
Total 100 100 50
Price /Bookof less than 2x – 83% of wealth created

Watch out forPrice /Sales < 1
Price/Sales
(x)
No. of
companies
% 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

Paybackof less than 1x – 84% of wealth created
Payback
Ratio
No. of
companies
% 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

“There is absolutely no substitute forpaying 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.
Forhuman beings, there is no substitute forlove.
Forinvesting there is no substitute forpaying
right price – absolutely none.”
— VanDenBerg, OID, April 2004

Theme 2009

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

Great, Good, Gruesome – Graphical Representation

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

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

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

Great, Good, Gruesome – Typical Financial Profile
Nestle HDFC Bank Tata Tele
(Great) (Good) (Gruesome)
10-yearCAGR(%) -
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 NWeroded
10 years ago 36.4 26.4 -10.3
10-yearincr. RoE 230.0 14.0 Not 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

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

Key takeaways -
• Great companies are fountains of dividends
• Good companies are fountains of earnings
• Gruesome companies are bottomless pits
of capital consumption

Two Greats – See’s Candy vs Nestle India

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

Great investments are the result of huge
margin of safety at the time of purchase
Benjamin Grahamon 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

Great, Good, Gruesome – Investment Payoff Matrix
* Margin of safety
Nestle
Hero Honda
NoneSBI, IOC
HDFC Bank

Best investment strategy
• Buy good companies at great price, or
• Buy great companies at good price

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.

CharlierMungeron 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.

Market Outlook

Corporate SectorProfit Growth May TaperOff
Corporate Profits To GDP(%) : At alltim e hig hs
1.3
1.6 1.6
2.2
3.5 3.3
2.4 2.3
1.8 1.9 2.1 2.3
3.1
4.4
4.9
5.5
6.1
6.4
6.0
FY91
FY92
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09E
Mean: 3.3

Sensex EPS growth may flatten
81
129
181
250 266 291 278 280
216 236
272
348
450
523
718
833
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY93-98: 29% CAGR
FY98-03: -1% CAGR
FY03-08: 25% CAGR
FY93-08: 17% CAGR
Sensex EPS Growth: Re ve rsio n to m e an like ly

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 (%)

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

Earnings Yield to Bond Yield is comfortable
1.6
1.4
1.6
0.2
0.7
1.2
1.7
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
15 Year Avg is 0.73x

Market Cap as % to GDPis off its highs
28
23
43
54
85
109
55
37
19
44 26
26
85
51
34
43
24
54
0
20
40
60
80
100
120
FY91
FY92
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09E
Mean: 46

• 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

ThankYou & Happy Wealth Creating !!

Wealth Creation Study 2003-2008

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