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The ‘greatness’ conundrum

18 March, 2013

Indian companies find it very hard to generate shareholder returns – over the last 20 years, 80 per cent of Indian companies have not been able to deliver real returns (i.e. returns better than the rate of inflation) to their shareholders. However, given that the country has grown at around 15 per cent per annum (in nominal terms) over this period, this means that the remaining 20 per cent of companies have delivered very significant real returns. So, how does one systematically identify these magical 20 per cent of companies? That was the homework exercise my colleague, Gaurav Mehta, and I set ourselves two years ago. 

Our research lead us to the ‘greatness’ framework i.e. a way of identifying companies which grow their businesses over long periods of time in a consistent and calibrated manner. What these ‘great’ companies do is very easy to describe – they invest systematically in their businesses, turn investment into revenues, revenues into profits, profits into cashflows and cashflows into further investment. The good news is that because the country is growing at roughly 15 per cent per annum, the ‘great’ companies are able to grow their toplines, bottomlines and assets at around 25 per cent per annum. High school maths tells us that if a company grows at 25 per cent per annum, it becomes a 10-bagger in 10 years (even without any P/E re-rating). 

The fact that only 10 per cent or so of the BSE500 companies are able to stick to the ‘greatness’ framework over a 5-6 year period does not surprise us – the negative political, social and economic influences prevalent in the country make consistent and calibrated development difficult for any Indian institution in almost any facet of Indian life. 

What does surprise us though is that very few large cap stocks are able to stick to the ‘greatness’ framework – the only Nifty stocks in our 40-stock ‘greatness’ portfolio for CY13 are ITC, Asian Paints and Lupin. So why is this? Why is it that the vast majority of the biggest companies in the country are not able to grow in a consistent and calibrated manner? This is a question which we are currently investigating. Answering this question is important as it could explain one of the other conundrums that had puzzled us – why is it that every 10 years the Nifty ‘churns’ by around 45-50 per cent, a much higher ratio than other major developed and developing markets. 

My current thinking is that large and successful Indian companies tend to hit at least one of the following roadblocks which brings them to a juddering halt:

  • Over the last decade India has created a dozen or so autonomous regulators. Whenever a sector becomes very large and very profitable, someone in Delhi decides that it is time to do some rent-seeking by setting up a regulator. Once created, the regulator seeks to lower the profitability of the sector. Classic example is our beleaguered telecom sector.
  • India has become a relatively open and competitive economy. Access to capital for local companies has become more democratic with the creation of a large private equity sector and with FDI norms being relentlessly eased, foreign capital is now able to enter relatively easily. So when entrepreneurs, Indian or foreign, see a large and profitable sector with juicy operating margins and ROCEs, they decide to join the party and thus disrupt the profitability of the incumbents. Classic example, our two wheeler sector which is currently being disrupted by Honda.
  • Indian companies, for all their claims to be relying on “professional management”, are still overwhelmingly dominated by and run by promoter families. These families are only human and once they decide to grow beyond the core business and the core territory that they know so well, they struggle. Expansion into new countries or new sectors by Indian companies are rarely successful. The finite nature of the promoter’s skill set puts a natural cap therefore on how far an Indian company can go. Classic example: plenty – so it would be unfair to single any one company out. 

So, how does one beat this trap? Look for Indian companies operating in niches which: (a) are unlikely to invite regulation or foreign competition; (b) have natural barriers to entry based on brand, distribution or technology; and (c) create a natural incentive to invest steadily (eg. the need into expand a new region). Examples: TTK Prestige, Bata, Whirlpool, Jagran Prakashan, Asian Paints, Carborundum, Cummins India and Balkrishna Industries. 

(Saurabh Mukherjea is the Head of Equities at Ambit Capital. The views expressed here are his own and not Ambit Capital’s.)

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1 Comment
Venu Madhav . 5 years ago

Counter argument on your stated road-blocks:

i. Would you be comfortable driving on roads with high density but without a traffic cop/signal. As the business volume increases either by bubble or by reality there needs to be a check on it so there is a real benefit to the society. It is the existing business model with the cost of deploying technology against the average revenue per user that is not helping the telecom business. Otherwise how tough it would be to scale a business when the market size is more than >500MM users; again the real achilles heel is the cost of commoditization in a service industry.

ii. May be from an investor standpoint few people may back disruptive/killer applications but from a customer standpoint every one of us will. It is a shame that none of the domestic players saw the inflection point coming and adjusted their strategy to it, even worse as they did not take the lead. If we do not welcome disruptive game plans we will still be driving in a newly released Pink-Ambassador.

iii. Indian Promoter based Managements have thrived during the license raj era and their sustainability is challenged by professionally managed companies because there are more responsible boards and questioning investors who will demand the right actions, which unfortunately cannot be challenged in fiefdom settings. Also the game plan for any type of Management should be win-win for all stakeholders and not “win” only centered for the promoter.

Rather than look out for companies that have a moat in the form of barriers, prudence will lie in identifying the “evolution strategy” of a company because it takes little time for Billion Dollar valued companies to bite the dust, if not always with the luxury of a decade, case in point: Kodak.

Also this exercise is not really novel if you look at the INSEAD index for Global best companies delivering value and also their global CEO index.

Finally, the point that really needs to be integral to the business DNA is how do you stay put on the path of growth by not compromising on values, strategy and the usability and increased value addition to customers.

The ‘greatness’ conundrum

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