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100x: The power of growth in Wealth Creation

BACK

Mr. Raamdeo Agrawal

Chairman, Motilal Oswal AMC
100x refers to stock prices rising 100-fold over time i.e. 100-baggers in stock market jargon. A 1972 study in the US revealed that 365 US stocks rose at least
100-fold in a 40-year time window. We applied a similar framework to the Indian stock market as part of the Motilal Oswal 19th Annual Wealth Creation Study 2014.
The ndings were very insightful.

100x: The India experience

As of March 2014, the BSE Sensex stood at 22,400 levels. It was at 224-levels during FY84. Thus, Indian stock markets achieve 100x in about 30 years (17% price
CAGR). Given such strong performance of the benchmark itself, smart investors should target to beat it and achieve 100x in 20 years at most (i.e. 26% CAGR).

During the 20 years 1994-2014, the Wealth Creation Study identied 47 enduring 100x stocks i.e. companies which had meaningful size of operations and which did
not zzle out after achieving 100x. The top ve 100x stocks are (year of purchase and price CAGR in brackets): Infosys 2,902x (1994, 49%), Lupin 1,170x (2002, 80%),
Wipro 875x (1994, 40%), Motherson Sumi (775x (1999, 56%), and Shree Cement 644x (1998, 50%). The average price CAGR of the 47 stocks works out to 47% i.e.
100x in 12 years. (Note: The multiples are based on stocks being purchased at the lowest prices for the respective year, and held on to 31st March 2014).

100x Process: Principle & elements

The key principle for achieving 100x is best articulated in the 1972 US study referred to above To make money in stocks you must have the vision to see them, the
courage to buy them and the patience to hold them. We believe that a favourable situation for 100x can be created if small companies (in terms of sales and/or
market cap) are screened on our investment philosophy QGLP (Quality, Growth, Longevity and Price).

100x First step Small-size company

A potential 100x company should be small in size (based on sales and market cap) and relatively unknown. Small size enables high growth due to low-base effect.
Unknown-ness leaves room for signicant valuation re-rating.

100x QGLP Screener #1 - Quality

There are two aspects to Q in QGLP (1) Quality of business and (2) Quality of management. Quality of business needs to be assessed for factors like size of prot

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pool for the industry (and hence the company), opportunity for value migration, competitive landscape, potential for sustained above cost-of-capital return on
investment, etc. The toughest part of QGLP is quality of management, as it is subjective, non-quantiable, and hence more of an art than science. We suggest 3
aspects of management quality: (1) Integrity, (2) Competence and (3) Growth mindset.

100x QGLP Screener #2 - Growth

In 100x investing, upon the foundation of small size and quality comes the superstructure of sustained high growth. The two primary aspects of this growth are (1)
Earnings growth and (2) Valuation growth. The G in QGLP addresses earnings growth, whereas the P(rice) determines valuation growth Earnings growth has three
multiplicative dimensions: (1) Sales volume, (2) Sales realisation, and (3) Net prot margin. Volume growth is a function of demand growth matched by companys
capacity to supply. Realisation growth is inuenced by the companys pricing power and/or product mix change. Finally, Net prot margin growth depends on cost
structure (which decides EBIT) and also structure (which decides interest cost and hence PBT).

100x QGLP Screener #3 - Longevity

Having established a companys quality and rate of growth, the next challenge is assessing how long it can sustain both quality and growth. Companies should have
a sound strategy to maintain competitive advantage over peers. Likewise, value-enhancing acquisitions will help extend longevity of growth.

100x QGLP Screener #4 - Price

Arithmetically, 100x in stock price is achieved by the multiplicative combination of earnings growth and valuation growth (e.g. 25x earnings growth with 4x valuation
growth). The best way to improve the odds of valuation growth is by ensuring favourable purchase price. A simple rule of favourable purchase price is single-digit
P/E. However, in certain situations, low P/E may not be the sole determinant of favorable valuation (e.g. During bottom-of-cycle, earnings of cyclical stocks are
depressed leading to high P/Es. Likewise, where companies are expected to turn from loss to prot, current P/E cannot be calculated.)

India: Fertile hunting ground for 100x stocks

It took India over 60 years post independence to generate GDP of US$ 1 trillion in FY08. However, on this high base, India is adding every successive next trillion
dollar (NTD) in shorter time (e.g. the second trillion dollar of GDP has taken only 7 years from FY08 to FY15). This linear growth in GDP spells exponential
opportunity for many businesses. Apart from a large domestic market with favourable demographics, India also enjoys global competitive advantage in some
sectors like IT, pharma, two-wheelers, etc. A new government at the helm is expected to lead a new phase of reform-led growth. All of this makes India a fertile
hunting ground for many 100x stocks to emerge on a sustained basis.

How investors can approach discovering 100x stocks

To discover 100x stocks, investors will need to put the mantra of QGLP in action. Thus, stocks which fulll the following criteria should be shortlisted for investment
consideration

Size: A good starting point is companies with market cap of less than Rs 3,000 crores (US$ 0.5 billion).

Quality of business: Sectors which offer play on value migration are the most suited for 100x IT, pharma (in both cases value migrating from developed world to
India), private banking (from public sector to private sector), and other select export-oriented industries.

Quality of management: While this is a highly subjective issue, some objective indicators of quality of management are: (1) Detailed and transparent annual
report, (2) RoE consistently higher than 15% and also higher than competitors, and (3) Dividend payout ratio of at least 15%.

Growth in earnings: To indicate earnings growth momentum, it would be good if prot growth in last two years is 25% or higher.

Longevity: Investors need to assess how long the company will be able to sustain its quality and growth, depending on size of opportunity e.g. IT, pharma,
banking and consumer goods (including durables) seem to be large, secular markets.

Price: Here, lower the P/E better are the chances of 100x. In any case, investors will be better off not paying higher than 1.5x market valuation of 16-17x P/E i.e.
overall ceiling of 25x P/E.

Source: Motilal Oswal 19th Wealth creation Study 2014. Data as on: March 31, 2014.
The Stocks and sectors mentioned above are used to explain the concept and is for illustration and comparison purpose only and should not be used for development or implementation of an
investment strategy. It should not be construed as investment advice to any party. The stocks may or may not be part of our portfolio/strategy/ schemes. Past performance may or may not be
sustained in future.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully

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Raamdeo Agrawal - Mr.Aashish Somaiyaa -

Chairman MD & CEO

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Gautam Sinha Roy - Siddharth Bothra-

Fund Manager, MF Fund Manager, MF

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