Strategising investments for high growth wealth creation

For long period investing strong compounding of Earnings per share is a must

Our country and its markets have evolved over some time. Different investing styles may be best suited to different periods of a nation's lifespan. In the early 90s, India was opening up and offered glorious growth opportunities as license Raj was rolled back and reform momentum was strong. However, businesses and business people all belonged to the older controlled regime. It was not certain who would do well in the new regime, which would progressively have lower protection.

At the same time, valuations in India were a fraction of valuations that existed globally, particularly in the US. In this context, growth at a reasonable price was a style that worked very well as while growth was there for the economy and industry, the longevity of growth for a company was not assured and many business groups did fall by the wayside.

As more time went by (2000-2007 period), the Indian market opened up and became the most competitive marketplace in the world. We had more telecom companies than any nation and practically all of the global auto majors set up shop in the country. Hypercompetition is a headwind for wealth creation. The richness of businesses suffered. Return on capital employed for businesses was low. In the early years corporate governance standards were very low.

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India offered many growth opportunities a plenty but many of these spaces did not offer a high Return on capital employed. For some time business continued to see growth on borrowed money or equity dilution. Easy money availability helped. This was a time when quality of business and quality of management came to the fore and became key differentiators between a successful business and an unsuccessful one. Investors like ourselves who followed theory and masters like Buffet did not take their eyes off corporate governance and the free cash flow generation of the firm is only growth. This helped us immensely in the next phase of the Indian economy.

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Prateek Agrawal

Executive Director - Business & Investment Strategy|Motilal Oswal AMC

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The next phase of the economy was the 2008 to 2021 period. This was a period which saw the Lehman crisis and the freezing of global financial markets. Indian banks started to recognize banking sector losses in 2015 and we had an ILFS crisis in 2018. In this period, businesses which depended on external capital for growth found going tough. Many of the businesses that grew strongly on external debt in the earlier phase, collapsed. This phase saw growth disruptions from necessary but difficult reforms like RERA and GST and ultimately COVID.

This was a period when growth was relatively lower than the pre-Lehman period. This was a phase when the lessons of quality of business and quality of management came to the fore. High-quality (high ROIC) businesses with managements who could allocate cash on the balance sheet judiciously (vs those who wasted it) to harness the growth potential did relatively much better than the broader market. Quality of business and management was the most important factor in this phase of the economy.

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From the COVID low, we have entered into the next phase of the Indian economy. The country is seeing a wave of supportive reform momentum. To some extent, the rollback of the wheels of globalization and China+1 sentiment globally has helped. Earnings growth has been strong. The disruptions of the previous era have helped spawn many Newer age businesses. Moreover, since the earlier era was an era when borrowing was very difficult, many of the businesses that are now coming to the market are high-quality, light balance sheet businesses with good PE-trained management.

As growth engines have again started to revive and are strong, it feels more like the 2002 to 2007 period of the Indian growth story versus the 2008 to 2021 period. In this period, strongly growing businesses could do very well. However, lessons learnt in the 2008 to 2021 period should not be forgotten. Growth should be sustainable through cash generated by the business alone or in combination with cash on the book. This is best done through the identification of themes which the country itself is focused on in its growth journey and has wide acceptance.

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While growth would benefit most businesses, many of the themes which would benefit from the next trillion dollar journey of the country, such as renewable energy, data centres, defence indigenisation, China+1 (Chemicals, EMS, textiles amongst others), health care infra, new tech, etc are new and are best played through relatively younger businesses.

We believe at this juncture of the Indian economy, high quality (of business and management) ensuring the sustainability of high growth should be able to capture investor attention. Businesses which have the tailwind of value migration, run by high-quality founders with fire in the belly and positioned to benefit from the next trillion-dollar growth opportunity of the country have a good chance of transitioning from mid-caps to mega caps.

Both as a firm and as an investor I benefited from laser-sharp focus and truly believe that less is more in investing.

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All along the growth journey of a country, while growth is what would entice most investors, value as an investing style can manifest itself from time to time as factors which result in sustained compression of value reverse (mostly temporarily). However, we believe for a long period investing in strong compounding of Earnings per share is a must and investors would find holding such portfolios, even through periods of relatively less performance (stock performance trailing EPS growth), easier with a lot of supporting data on long period correlation of earnings growth and stock price performance and truly benefit from the power of compounding.

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