TCS biggest wealth creator in 2012-17, Ajanta Pharma the fastest: Wealth Creation Study

Referring to one of the interactions of media with billionaire investors Peter Lynch about his investing carrier – Lynch replied saying he sold all his stocks too soon.

Investors can make big money by investing in great companies that have the potential to deliver compounding growth year after year. “Great companies, and there but are just handful of them right now – live much longer then what investors’ think and they create big money compared to so-called stocks which double in quick time,” said Agrawal.

Explaining the concept of compounding, Agrawal said it makes sense for investors to stay with the company for a long period of time to create wealth.

To identify wealth creators investors should first understand industry structure and then study the product offering by the company in that particular sector.

Commenting on the PSU space, Agrawal said there could be a turnaround in this space. If you remember, from the year 1996 to about 2003, every year, 50 percent of the wealth was created by PSUs. But, then they started sliding thereafter.

Three years ago only 2 companies came in the list. In other words, only 2 percent wealth got created. Now, because of government efforts in term of taking subsidy burden off, we are seeing some revival in the oil & gas space.

But, things couldn’t have been worse than what it was. In other words, things can only get better from here, explained Agrawal.

Below is the verbatim transcript of the interview.

Latha: What is the incremental lesson that you have got as you and your group look for value, what is that incremental value in the 22nd study and what is the combined wisdom that you have got?

A: This is after two and a half months kind of study, so, one of the things about investing and making a lot of money in the market is that you need compounders and India produces a lot of compounders like HDFC Bank, HDFC, Infosys. Peter Lynch was asked what is your biggest learning of your investing career, and he said one of the biggest mistake he committed was that he sold all his stocks too soon. He bought Home Depot when they were four stores and he sold it the moment it tripled. After that it went almost 100 times more. So, great companies, let us be very clear, and there are very few of them, great companies they live much longer than what the investor thinks and they create much bigger money than the so called quick double top or whatever – quickly you sell because it has doubled or something like that. So there is a lot of money to be made.

In compounding what happens is – I will just try to give you a simple example, at 25 percent a rupee doubles in three years and goes 10 times in 10 years. So you bought at Rs 1 something, and that Rs 1 goes to Rs 10 in 10 years, so you have added Rs 9. However, in next 10 years that same Rs 10 becomes Rs 100 – 10*10, then it adds Rs 90. Then the third 10, means like 21 to 30, then it goes to Rs 1,000 and at that time it adds Rs 900. So, it is still called 25 percent, but if a company you have bought, your purchase price is frozen at Rs 1 and if it keeps growing at 25 percent for 30 years, what it does, your Rs 1 becomes Rs 1,000. So longevity of these compounding machines are very important characteristics and it is not written on the face of any company.

Latha: Is it written on the face of bitcoin?

A: Very tough subject and it is the hottest subject right now. However, I have zero knowledge on that.

Anuj: Let us talk about Indian context, let us take for example Maruti Suzuki and I know you have liked it in the past, it has been one of the biggest wealth creators and we were just discussing it, issue price was Rs 125 and we are now talking about Rs 10,000 almost on the stock. It has truly been a great company but do you have the visibility for the next 10-15 years that some of these great companies will continue to remain great because that is the big one, hindsight it is 2020 but to predict the next 10-15 years?

A: Yes, that is where this framework – it will look slightly technical, FFHH, so you got to get into this thing, but basically you have to look at the industry character. First thing is whether there is going to be need for the car at all. The concept of car which is 100 years old, is it going to be lasting for next 100 years? That you have to make a call. So, if that is going to be so, if the car is needed for the basic transportation of the masses, in that case, who is going to provide this car?

India today does 3 million, China does 24 million; 10 years back China was also doing 3 million. I am not saying that we will do 24 million, but even if you do half of it, say 10-12 million, who is going to provide that car. Today out of two cars, one car is coming from Maruti. So you have to look at the industry structure; there is no rivalry, he is 51 percent, the second guy is 15 percent, there is no third, and this country needs so many millions of cars, what do you do? So industry structure has to be understood before passing a judgment.

Anuj: Infrastructure wise are we ready?

A: You have the cars, roads will come. The guy who is buying he does not care; if you have a car and I am a young guy with a new wife and family, what do I do, I go and buy the car. It is for the government to provide the roads.

Sonia: We always talk about sectors that create wealth, but one sector that has almost never created wealth is PSUs and you write very beautifully in your report about how there could be a turnaround in the PSUs because of what the government is doing. Would you bet on this space?

A: No, turnaround we are saying because from literally 50 companies --see till about 2002-2003 of our wealth creation study, we started study in 1996 from 1996 till 2003 every year 50 percent of wealth was created by PSUs. It was really commanding heights of Indian economy and then it starting sliding one-by-one. Three years back, only two companies came in the list and 2 percent of the wealth was created, so, literally lights were out in PSU entire culture.

Now because of this oil revival, the subsidy going and HPCL, IOC coming through, Petronet LNG coming through, some revival has come. However, things couldn't have been worse than what it was -- I mean literally zero, so, from zero it can only be better. Maybe there will be privatisation, maybe there will be some sell-off, maybe they will tighten the management, but as the competition increases in the economy and various sector where PSUs are operating, it will become even tougher for the PSUs to compete.

Latha: Your page 31 that was very interesting, I mean where you have the confluence of your competitive advantaged companies and the growth advantaged companies. I might give you that summary. They have looked at companies which have a competitive advantage because it is difficult to get competition, because suppliers don't call the tune on various parameters as well as those that have continuous growth advantage. The confluence has actually two housing finance companies, you have Dewan Housing Finance (DHFL) and LIC Housing. Is not that a sector where you can get competition easily and where margins are genuinely thin?

A: Yes, but competition was always there, there were banks who were already providing, but just the size of the opportunity is so big right now, of course the competition has come, it will dent the spreads which you have, but all the lending companies, one of the biggest problem world over, they go under, not because of the expenses or the low risk margin, but because of the bad underwriting. When you give loan to somebody who doesn't return it back, then you are in trouble. All the PSU banks are in trouble because money is not coming back, not that their expenses are more or anything like that.

Housing finance is one thing where at least at this stage of India where houses are literally not there, so what happens is that if collateral is there, you will have delay in payments but loan loss will not be there finally. Money will come back because the collateral is solid. So, you have to just avoid the fraudulent cases, but if you have good underwriting skills and collaterals are there, with delay also money comes back.

Anuj: It is interesting we have been talking about a bear market for pharmaceutical but for last three years it is a pharmaceutical company which have been the fastest wealth creator, Ajanta Pharma. In the past also we have seen couple of pharmaceutical companies do that. So do you think Indian pharmaceutical will still keep finding these stories which will keep generating wealth despite the kind of negative headwinds that we have right now?

A: Pharmaceutical and IT both, where India has a huge prowess and opportunities global, but since it was very America centric pharmaceutical kind of exports were building up and they had become very large globally, but a lot of profits were coming from US. There is a structural change in the US, the way US is buying generic pharmaceutical, I think there is a consolidation at the distributor level and the competition among the Indian players also for the same molecule had also increased. So, world has to consume a lot of generics as it edges and the population grows, and nobody can produce the quality and the price at which Indians can produce. So the business belongs to India.

Now who strategises in such a way that they are able to make money out of that; they are still making money, they are not making as filthy money as they were making three years back. So there is a reset of the profit level. I think they will find smarter ways. There is biosimilar now, you saw Biocon, so, they will enter newer phase of it and they are the first. Dr Reddy did in 1995 the first first-to-file, now this is the first in biosimilar. So there will be many more riches but finally India will be there in generic space.

Latha: Actually you have many more as well, to be fair Cadila Healthcare 33 percent profit growth every year, compounded annual for the last five years and 31 percent price growth continually for the past five years and likewise for GSK Pharma you have very high rate of growth, Divis Laboratories?

A: Actually, one of thing is that of the competitive advantage period (CAP) and growth advantage period (GAP). CAP is a well discussed subject. It is already there, if you Google, you will find lot of literature on competitive advantage period, for how long profits remain intact in the companies. There is no birth right that Coco Cola will keep making money. Someday the companies mature and they die out. Like Century Textile, in 80's and 90's they were making huge amount of money, now they are struggling. So, there is always a lifecycle of the company.

So, in that, you have the competitive advantage period when you actually make huge profits, you are at pink of your health and then growth advantage period. The growth advantage period is a new concept written first time by us. So, what happens is, we have observed, when we studied the lifecycle of the companies, we find that companies, they start growing at some age, say after five years, seven years -- when everything is fit and the tailwind is there, companies start growing for various reasons. Once they start growing, they keep growing for five years, 10 years, or 20 years.

Like HDFC Limited, we have covered HDFC extensively here, so they started in 1978 with Rs 10 crore and I think they got listed around that time. In 1981, if I am not wrong they made first Rs 60 lakhs profits and then they made Rs 1 crore profit and since then last year they made Rs 11,000 crore profit. This year they will make more than Rs 13,000 crore. So if you bought 100 shares then for Rs 100 -- till about 1987 I remember it used to be trading for -- Rs 100 share used to be trading for Rs 130-140. It used to trade on yield of 8-9 percent.

Sonia: That is a about growth advantage but coming in to competitive advantage I wanted to ask you how do you realise when a company has reached its peak as far as competitive advantage is concerned? For example Titan, we are going to profile the company now, it has gone through a lot of ups and downs, what gives you conviction?

A: So again coming back to the industrial structure, how exactly they are beating the competition quarter after quarter? So if you look at the industrial structure, first you have to see how once the company starts making money, can the new guys come and spoil the party. That is what really happens in capitalism. The moment you start making money 10 more guys will come in and then they will spoil the party because nobody wants you only to make money. So, is there any barrier? Say Titan, in Titan it is open for all, you can open a jewellery shop, I can open a jewellery shop nobody can stop. However, can I compete the way Titan can compete because there are so many jewellery shops, but there is only one Tata on which name there is a trust.

Then once you go there with a trust they are not going to buy just because Tata name is there, designs has to be there, customer service has to be very good, and there are whole lot of things that they do. So, Titan started selling jewellery in early 2000-2001 otherwise it was a watch company. So watch itself, the Titan brand, was fantastic. Then they created Tanishq and they have attacked to one of the largest segment of India where jewellery is such an integral part of everybody's life here. Ladies they love to splurge on jewellery. Now there are segments of office going jewellery, marriage jewellery, so it is a very large segment.

Titan is not a number one jeweller in any of the cities. They are number three, number four. There is always a local jeweller. So, there is a long way to go for them to gain some kind of a share. Now with GST and demonetisation, not cash dealing coming through, now the quality advantage people had, in the sense that the competition used to say 18 karat but actually it used to be 15 karat. Now that will go away. So, all the advantages of unorganised, will go away and Titan will have a good time.

Anuj: 70-80 percent of these companies are in some sense consumption companies, they are catering to consumers and that has been global trend as well. Is that likely to remain the big theme, you got to catch these companies?

A: That is going to remain the biggest theme because one thing you can be guaranteed as the economy grows, the consumption will grow and on the back of consumption only the whole show is going to happen. Human beings consumption is very predictable, you will eat 400-500 grams every meal and in the meal also you will have curd, or this or that. So you can actually predict how 1.3 billion people will consume and with data analytics, you can see even more so what exactly is going to happen.

Consumer is one thing around which the whole circus happens in the economy and it is the most predictable. Now the issue is that companies are smart in creating barriers. You want to buy coffee but there will be only three players. Like car, it is open to everybody, there is no licence, but one out of two cars can you believe this, what a situation it is, nowhere in the world it is there.