OF LONG-TERM VALUE & WEALTH CREATION FROM EQUITY INVESTING OBSERVATIONS, IDEAS & REFLECTIONS BHARAT SHAHACKNOWLEDGEMENT Quest for value and wealth creation, through investing, is an eternal one. This search, unlike Physics, is not entirely intuitive or contemplative. Pure Physics (or theoretical one), unlike applied Physics, is very abstract and conceptual. Empirical evidence, usually, comes much later. Take, for example, Higgs Boson or Theory of Relativity. Theory was formulated, in each case, much before it was possible to validate the theory with an observation or an experiment. Fortunately, good investing does not call for such high skills. Also, a body of recorded evidence and a set of observations help in formulating many investment principles unlike the other way round. Some level of intuitive skills is also called for in investing which makesita blend ofartand science. In the enclosed study, covering a period of a decade, an attempt has been made to cull out some investment principles. They have been sought to be affirmed from the observed data in the Indian context. The investment principles have always existed for quite some time. The study has largely focused on validation of the same. Ithas benefited from all the prior good work. The study efforts have spanned well over six months. It has been a tremendous team effort to make it happen. While many have helped, directly or indirectly, some individuals stand out. Sudhir Kedia and ‘Sumit Jain have made enormous contribution with their outstanding data crunching efforts as welll as by being, generally speaking, critical sounding board, in crafting and shaping many thoughts. So much of data has been looked at and appropriately layered. None of that would have been possible without their invaluable efforts, Rajdeep Singh and Darshit Sheth have worked tirelessly at all the stages. Right from the stage of encapsulating of the thoughts, converting them into clean readable copies, formulating them and reformulating them, both Rajdeep and Darshit have played stellar role. They have been actually human machines! Parth Trivedi has also chipped in with a lot of support from Without any over-statement, this study would not have seen the light of day, without the support, help, ‘thoughts and perseverance of al of them. And there have been others who have generally encouraged, cheered and egged on to carry ahead, when the efforts started looking more like workand when often, it became over whelmin ie to time. Hope you enjoyitas much asitwasajoyincreatingit. BHARATSHAH February 08,2013Table of Contents INTRODUCTION 1 SIZEOF OPPORTUNITY + Size of Opportunity isa Foundation for Continual Growth (of profits) and Creating a Compounding Machine: Foundation on which Large Value Creation Rests. It is Less about How Large itis and More about whatiitCan Be, 5 + While Size Helps, What Matters More is the Character. Also, More than the Present Size, What it willbecomeis More Critical. 8 \ + The Debate between Large-Cap and Mid-Cap is Largely an Artificial One, Debate is really between Quality and Lack oft. Debates really about Future Size rather than the Present One, 8 EARNINGS GROWTH: QUANTUM, CONSISTENCY, PREDICTABILITY, DURABILITY | + Priceisa stave of earnings growth 10 + When Growth goes away, Equities reduce to.a Bond. Itwill be Treated like a Bond for a while. ifthe Picture Deteriorates Further, then it will be Treated Worse than a Bond, “4 | + When the Character of the Market is a Growth Market, the Focus has to be on Growth and not Cigar Butt. 15 + Growth has @ Way of Covering Valuation Mistakes and Fighting with Prolonged Period of Market Machinations. 15 ' + For a Same Rupee of Profit, (Capital) Dilutive Growth Results in Lower Relative Value Compounding compared to Non-Dilutive Growth. 35 + Significant Capital Expenditure Projects or Significant Dilution in Comparison to the Existing Scale of Operations or Value of a Firm will almost Invariably end up in Tears. Even more so, when the Time taken for the Fructification of Projectsis very Long and Project Economics is Uncertain. 7 | + Acquisitive Growth vis-a-vis Organic Growth: Market does not Reward Acquisitive Growth in the same way as Organic Growth. In other words, Per Unit Market Returns for a Unit Growth of Profits Is Less or Acquisitive Growth, than for Organic Growth, 18 + Focused and Diversified Growth 19 + Banking and Finance: A Special Compounding Machine. 20 QUALITY OF BUSINESS: CAPITAL INTENSITY AND CAPITAL EFFICIENCY + Quality of Business Ey + TwoVital Tests for Quality are Capital intensity and Capital ficiency. mu + Persistent and Superior Capital Efficiency s the Single Most Important Evidence of Quality 6 + Eamings Growthis Necessary butnota Sufficient Condition for Value Creation 6 + Hygiene of ROCE gets Reflected much more Vividly in Balance Sheet rather than Profit and Loss Statement. 26 * Growth and Quality of Growth are not Co-incidental for Creating Value but they actually cohabit to doso. 27