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Motilal Oswal 21st Annual Wealth Creation Study Focus Investing – Power of allocation in Wealth Creation

Mumbai 09-Dec-2016


Motilal Oswal 21st Annual Wealth Creation Study 
Focus Investing – Power of allocation in Wealth Creation

TCS, Ajanta Pharma & Asian Paints – 
Biggest, Fastest & Most Consistent Wealth Creators

Mumbai, 9th December 2016: Motilal Oswal Financial Services Ltd. today announced the Motilal Oswal 21st Annual Wealth Creation Study,2016.
Every year for 21 years now, Mr. Raamdeo Agrawal, Joint Managing Director of Motilal Oswal Group, commissions an Annual Wealth Creation Study. 
The Motilal Oswal 21st Annual Wealth Creation Study has two parts 
1) Findings on Wealth Creation during the period 2011-16, and
2) Theme 2017: Focus Investing – Power of allocation in Wealth Creation

Key Conclusions of Motilal Oswal 21st Annual Wealth Creation Study
TCS, Ajanta Pharma & Asian Paints – Biggest, Fastest & Most Consistent Wealth Creator, respectively.

Consumer/Retail is the largest wealth creating sector for the second year in a row

State-owned companies have become marginalized in Wealth Creation with their share collapsing from 51% in 2005 to 4% in 2016.

Payback ratio (Mkt Cap ÷ 5-years forward PAT) < 1 remains the most reliable indicator of superior Wealth Creation across market cycles.

Stock allocation is a power tool for portfolio performance, but is under-researched vis-à-vis stock selection.

Focused Investing (i.e. investing in 15-20 stocks with asymmetric payoff and where investors have an edge over the market) is a sound strategy to exploit the power of allocation, and earn exceptional returns rather than acceptable returns.

The keys to Focused Investing are:  (1) Clear portfolio goal (2) Superior stock selection (3) Rational allocation and (4) Active monitoring.
Part 1) Wealth Creation Study findings
The 21st Wealth Creation Study analyzes the top 100 wealth creating companies during the period 2011-16. Wealth created is calculated as change in the market cap of companies between 2011 and 2016, duly adjusted for corporate events such as mergers, de-mergers, fresh issuance of capital, buyback, etc. The Study identifies the Fastest, Biggest and Most Consistent wealth creators. Further, it analyzes key trends in wealth creation, provides insights into winning companies and distills strategies for successful equity investing.

Study Highlights – Wealth Creation

Top 100 Wealth Creators created Rs 28.4 lakh crores wealth during 2011-16
This is the third highest ever quantum of Wealth Created. During 2011-16, Sensex CAGR was only 5%, but pace of Wealth Creation was healthy at 18% CAGR. This reinforces the point that Wealth Creation happens in all kinds of market conditions. So, investors are better off focusing on which stocks to invest in, rather than timing the markets.

TCS is the Biggest Wealth Creator for the fourth time in a row
TCS has emerged the biggest Wealth Creator for the period 2011-16, with Wealth Created in excess of Rs 2.6 lakh crores. HDFC Bank has inched up to No.2 after 3 years of remaining No.3.

Ajanta Pharma is the Fastest Wealth Creator for the second year in a row
Ajanta Pharma has emerged as the Fastest Wealth Creator for the second time in a row, with 2011-16 stock price multiple of 53x (121% CAGR). Eicher Motors is among the top 10 Fastest Wealth Creators for the last 5 studies.

Asian Paints is the Most Consistent Wealth Creator
Asian Paints is the Most Consistent Wealth Creator over the last 10-year period 2006-16, by virtue of – (1) Appearing among top 100 Wealth Creators in each of the last 10 studies; and (2) Highest 10-year Price CAGR at 30%, ahead of Kotak Mahindra Bank (26%) and Sun Pharma (25%).

 Other key takeaways

Wealth Creation Classification by Industry: Consumer/Retail has emerged as India’s biggest Wealth Creating sector for the second consecutive time, and the third time in the last four years. Deep cyclicals (Metals/Mining, Oil & Gas, Capital Goods) have significantly lost out to secular and quasi-secular sectors. Three of the top 5 Wealth Creating sectors – Financials, Technology and Healthcare – are beneficiaries of Value Migration i.e. flow of value from outmoded business designs to new business designs. In Financials, value is migrating from public sector banks to private banks. In Technology and Healthcare, value is migrating from developed world to emerging markets.
Wealth Creation by Ownership – PSU v/s Private: PSUs' (public sector undertakings) Wealth Creation performance continues to be dismal during 2011-16: (1) The number of PSUs in the top 100 Wealth Creators is only 7, and (2) Wealth Created by these 7 PSUs is only 4% of the total. The 7 Wealth Creating PSUs are BPCL, HPCL, Petronet LNG, Concor, LIC Housing, Bharat Electronics and Power Grid Corporation.
Wealth Creators by Valuation Parameters: Every study invariably suggests that the highest return is generated when payback ratio is less than 1x. Seven of the top 10 fastest Wealth Creators had payback ratio of less than 1x in the base year 2011. (Payback is a proprietary ratio of Motilal Oswal, defined as current market cap divided by estimated profits over the next five years. For 2011, we calculate this ratio based on the actual profits reported over the next five years).
Wealth Destroyers: The total Wealth Destroyed during 2011-16 is INR 15 trillion, 53% of the total Wealth Created by top 100 companies. 7 of the top 10 Wealth Destroyers are in the business of global commodities. The broader theme of Wealth Destruction is cyclical downturn. Metals / Mining is the biggest Wealth Destroying sector as was the case last year. This is followed by Banking & Finance, which mainly includes state-owned banks at the wrong end of the NPA cycle. Capital Goods and Construction / Real Estate also corroborate the cyclical downturn theme.




Investing in secular stocks and investing in cyclical stocks are best treated as two distinct investment styles. In both cases, When to Buy is important. However, when investing in cyclical stocks, When to Sell is as important if not more. Failure to sell at the peak of the cycle will most likely lead to a prolonged period of underperformance.

Part 2) Theme 2017: Focused Investing: Power of allocation in Wealth Creation

Backdrop
Two key aspects of equity investing are: (1) What to buy (i.e. stock selection), and (2) How much to buy (i.e. stock allocation or weightage in a given portfolio). Almost all of the past 20 Annual Wealth Creation Studies have covered various aspects of what to buy. In the 21st Study, we focus on how much to buy.

Kelly’s insights for investing - Look for asymmetric payoff, Create edge, Bet big
In the mid-1950s, John Larry Kelly Jr, a scientist with Bell Labs, developed a formula for an optimal bet size on a wager with given payoffs (i.e. odds) and win-loss probabilities. The formula is f = (bp – q) ÷ b, wheref is the fraction of the current bankroll to wager, b is the net odds (expressed as rupees to be won for every rupee bet) or win-loss ratio, p is the probability of winning, and q is the probability of losing.

Equity investing is starkly different from gambling. Hence, the precise math of Kelly’s Formula is not relevant here. Yet, it offers 3 clear insights for equity investing – 
1.Look for asymmetric payoff i.e. where upside is high and downside is low
2.Create edge i.e. have an informational or analytical advantage over the market and
3.When (1) and (2) coincide, bet big.

Opportunities to bet big come seldom. Focused Investing is a sound strategy to capitalize on them.

What is Focused Investing?
There are two contrasting styles of investing: (1) Diversified Investing and (2) Concentrated Investing. 

The underlying strategy in diversified investing is to hold a fairly large number of stocks across many sectors so that unexpected adversity in any stock or sector does not unduly hurt overall portfolio performance. This strategy typically leads to modest returns.

Propagated by a handful of investors like John Keynes, Warren Buffett, Charlie Munger and Phil Fisher, Concentrated Investing essentially involves choosing a handful of stocks (typically around 10) that are expected to produce above-average returns, allocating a bulk of the portfolio to these stocks, and holding them for the long term across market cycles and fluctuations. Concentrated investors indeed tend to outperform the market significantly over the long term, but with relatively high year-to-year volatility.

The study posits Focused Investing as the golden mean of the above two investment styles. Having a focused portfolio of 15-20 stock offers the best of both worlds – adequate risk diversification and meaningful return magnification.

Diversified v/s Focused Investing – The Indian scenario
The Indian mutual fund industry has about 286 schemes actively managing INR 4 trillion in equity assets. Diversified investing is clearly the dominant style. A high 56% of the schemes and an even higher 86% of 





assets are under portfolios with 41+ stocks. In contrast, only 13% of the schemes and 3% of the assets are under portfolios of 25 stocks or fewer.


Four keys to successful Focused Investing
There are 4 keys to successful Focused Investing:  
1. Clear portfolio goal, which sets a guidepost for both stock selection and allocation
2. Superior stock selection based on a time-tested investment philosophy or process
3. Rational allocation aligned with the risk-adjusted upside of stocks and
4. Active monitoring and improvement. 
Disciplined practice of these steps should lead to exceptional returns rather than acceptable returns.

Common mistakes of allocation are: Over-allocation, Under-allocation, Over-staying with winning stocks and Over-staying with losing stocks.
IMPORTANT DISCLAIMER
This study is primarily an analysis of economic data, company financials and stock prices.
The companies mentioned here should not be construed as our investment recommendations or opinions.

About Motilal Oswal Financial Services Limited.

Motilal Oswal Financial Services Ltd. is a financial services company. Its offerings include capital markets businesses (retail broking, institutional broking & investment banking), asset & wealth management (asset management, private equity & wealth management), housing finance & equity based treasury investments. Motilal Oswal Securities won the ‘Best Performing National Financial Advisor Equity Broker' award at the CNBC TV18 Financial Advisor Awards for the 5th time. It was ranked the Best in Events/Conferences, ranked amongst Top-2 for Overall Sales Services & Best Roadshows/Company Visits & amongst the Top-3 in Best Local Brokerage, Best Execution & Sales Trading Visits at the AsiaMoney Awards 2015. Motilal Oswal Private Equity won the ‘Best Growth Capital Investor-2012’ award at the Awards for PE Excellence 2013. Motilal Oswal Private Wealth Management won at the UTI-MF CNBC Financial Advisor Award in HNI Wealth Management category for 2015. Aspire Housing Finance was awarded ‘India’s Most Admired & Valuable Housing Finance Company’ at India Leadership Conclave 2015.

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