Thematic Study

|

9 December 2011

16TH ANNUAL WEALTH CREATION STUDY (2006-2011)

Blue Chip Investing

Creating wealth from dividends

HIGHLIGHTS



Blue chips are fountains of dividend, and offer as much, if not more,

investment growth potential than lesser quality companies, but with far

less risk.

investing,

quality.

In investing , there is no profitable substitute for quality. Understanding

profitability,

quality of the company doesn't stop at profits and profitability, it must

longevity.

extend to dividend payouts and longevity.

buy,

Most Blue Chips enjoy premium valuation. In deciding when to buy, one

should focus not only on P/E, but also consider payout ratio, relative

dividend yield, and earnings growth potential.

In India, over last 20 years, Blue Chips have significantly outperformed

benchmark indices with much lower risk.







"The risk of paying too high a price for good-quality stocks — while a real one —

is not the chief hazard confronting the average buyer of securities. Observation

over many years has taught us that the chief losses to investors come from the

purchase of low-quality securities at times of favorable business conditions."

— Benjamin Graham,

The Intelligent Investor

TOP 10 WEALTH CREATORS (2006-2011)

WEALTH CREAT

THE BIGGEST

Rank

1

2

3

4

5

6

7

8

9

10

Company

Reliance Industries

TCS

State Bank of India

Infosys

NMDC

HDFC Bank

ITC

HDFC

Larsen & Toubro

ONGC

Wealth

Created

(INR b)

1,742

1,379

1,075

1,025

833

678

658

636

623

616

THE

FASTEST

5-Y

5-Year

Price

CAGR (%)

119

86

64

62

59

44

43

43

41

41

THE MOST CONSISTENT

Company

Appeared

in WC

Study (x)

10

10

10

10

10

10

10

10

10

10

10-Y

10-Year

Price

CAGR (%)

47

33

31

29

29

27

24

24

23

21

Company

Sanwaria Agro

Adani Enterprises

Bhushan Steel

Jindal Steel

Sterling Intl

Shriram Transport

Coromandel Inter

LIC Housing Finance

Exide Industries

IndusInd Bank

/

Kotak Mahindra Bank

Sun Pharma

Asian Paints

HDFC

HDFC Bank

Reliance Industries

ACC

Infosys

ONGC

Ambuja Cements

Raamdeo Agrawal

(

Raamdeo@MotilalOswal.com

)

Shrinath Mithanthaya

(ShrinathM@MotilalOswal.com)

We thank Mr Dhruv Mehta (Dhruv.Mehta@dhruvmehta.in), Investment Consultant, for his invaluable contribution to this report.

Wealth Creation Study 2006-2011

Contents

Objective, Concept and Methodology

........................................................................

1

Wealth Creation Study 2006-2011: Findings

.........................................................

2-15

Theme 2012: Blue Chip Investing

.......................................................................

16-37

Market Outlook

....................................................................................................

38-40

Appendix I: MOSL 100 – Biggest Wealth Creators

..........................................

41-42

Appendix II: MOSL 100 – Fastest Wealth Creators

.........................................

43-44

Appendix III: MOSL 100 – Wealth Creators (alphabetical).............................. 45-46

Abbreviations and Terms used in this report

ABBREVIATION / TERM

DESCRIPTION

2006, 2011, etc

Avg

CAGR

L to P / P to L

Price CAGR

INR b

WC

Wealth Created

Reference to years for India are financial year ending March, unless otherwise stated

Average

Compound Annual Growth Rate; All CAGR calculations are for 2005 to 2010

unless otherwise stated

Loss to Profit / Profit to Loss. In such cases, calculation of PAT CAGR is not possible

In the case of aggregates, Price CAGR refers to Market Cap CAGR

Indian Rupees in billion

Wealth Creation / Wealth Created

Increase in Market Capitalization over the last 5 years, duly adjusted for corporate

events such as fresh equity issuance, mergers, demergers, share buybacks, etc.

9 December 2011

2

Wealth Creation Study 2006-2011

Findings

Wealth Creation Study 2006-2011

Objective, Concept and Methodology

Objective

The foundation of Wealth Creation is in buying businesses at a price substantially lower than their

“intrinsic value” or “expected value”. The lower the market value compared to the intrinsic

value, the higher is the margin of safety. Every year for the past 15 years, we endeavor to cull out

the characteristics of businesses, which create value for their shareholders.

As Phil Fisher says, “It

seems logical that even before thinking of buying any common

stock, the first step is to see how money has been most successfully made in the past.”

Our

Wealth Creation studies are attempts to study the past as a guide to the future and gain insights

into the various dynamics of stock market investing.

Concept

Wealth Creation is the process by which a company enhances the market value of the capital

entrusted to it by its shareholders. It is a basic measure of success for any commercial venture.

Wealth Creation is achieved by the rational actions of a company in a sustained manner.

Methodology

For the purpose of our study*, we have identified the top 100 Wealth Creators in the Indian stock

market for the period 2006-2011. These companies have the distinction of having added at least

INR1b to their market capitalization over this period of five years, after adjusting for dilution. We

have termed the group of Wealth Creators as

‘MOSL-100’.

The biggest and fastest Wealth Creators have been listed in Appendix I and II on page 41 and 43,

respectively. Ranks have been accorded on the basis of Size and Speed of Wealth Creation

(speed is price CAGR during the period under study).

On the cover page, we have presented the top 10 companies in terms of Size of Wealth Creation

(called THE BIGGEST), the top 10 companies in terms of Speed of Wealth Creation (called

THE FASTEST), and the top 10 companies in terms of their frequency of appearance as wealth

creators in our Wealth Creation studies (called THE MOST CONSISTENT).

Theme 2012

Our Theme for 2012 is

Blue Chip Investing

(see page 16).

* Capitaline database has been used for this study

9 December 2011

1

Wealth Creation Study 2006-2011

Findings

Wealth Creation

2006-2011

The 16

TH

Annual Study

Findings

9 December 2011

2

Wealth Creation Study 2006-2011

Findings

#1

The Biggest Wealth Creators

Reliance Industries is the Biggest Wealth Creator



Reliance Industries

has emerged as the biggest wealth creator for the 5th time in a row

from 2007. This is a record - the first time that a company has emerged the biggest wealth

creator for 5 years in a row. The only other instance has been Hindustan Unilever (HUL)

which has also emerged the biggest wealth creator 5 times, of which only 4 were in a row

from 1996 to 1999.



Like HUL in 2001, probably Reliance has also seen its peak performance for the time-being.

Tech companies, mainly TCS and Infosys, are hot on its heels, and one of them is likely to

claim the top slot going forward.



Incidentally, Warren Buffet too is positive on the long term prospects of Energy and Technology

related businesses, his latest mega investment being 5% stake in IBM for USD10 billion.

Top 10 Biggest Wealth Creators

Rank Company

1

2

3

4

5

6

7

8

9

10

Reliance Inds.

TCS

St Bk of India

Infosys

NMDC

HDFC Bank

ITC

HDFC

Larsen & Toubro

ONGC

Total of above

Total of top 100

Net Wealth Created

(INR b)

% Share

1,742

1,379

1,075

1,025

833

678

658

636

623

616

9,265

22,096

8

6

5

5

4

3

3

3

3

3

42

100

Price

CAGR (%)

21

20

25

17

31

25

13

21

22

6

18

17

PAT

CAGR (%)

15

25

15

22

29

36

17

22

28

8

16

20

P/E (x)

FY11

18

25

16

27

17

27

28

28

23

11

21

16

FY06

12

31

9

33

16

28

32

25

26

12

18

17

Biggest wealth creators and wealth created (INR b):

Oil & Gas dominates

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

Reliance Inds 1,742

Reliance Inds 2,556

Reliance Inds 1,514

Reliance Inds 3,077

Reliance Inds 1,856

ONGC 1,678

ONGC 1,065

ONGC 1,030

245 Wipro

383 Wipro

377 Hind. Lever

Wipro 1,247

341 Hind. Lever

262 Hind. Lever

73 Hind. Lever

91 Hind. Lever

Share of Top 10 wealth creators in total

wealth creation steadily declining (%)

76

59

53

50

45

51

49

41

42

Key Finding #1

The contribution of the largest wealth creators has been declining steadily from 76% in 2003 to

42% in 2011 indicating a more widespread wealth creation.

9 December 2011

3

Wealth Creation Study 2006-2011

Findings

#2

The Fastest Wealth Creators

Sanwaria Agro is the Fastest Wealth Creator



Between FY06 and FY11,

Sanwaria Agro

emerged as a surprise fastest wealth creator,

adding INR43b to its market cap at a CAGR of 119% per annum.



As in the street, even on the Street, "Speed thrills … but also kills!" Most of the fastest

wealth creating companies have lost anywhere between 30 -98% of their peak value in next

3 years. Among all our fastest wealth creators to date, Cipla is the only exception.



Some of these stocks are classic "transitory multi-baggers", which are created by the

combination of cyclical nature of business and questionable quality of management. If they

are not sold on time, investors are left not only with no gains, but most often, a permanent

capital loss.

Top 10 Fastest Wealth Creators

Rank Company

1

2

3

4

5

6

7

8

9

10

Sanwaria Agro

Adani Enterprises

Bhushan Steel

Jindal Steel

Sterling Intl

Shriram Transport

Coromandel Inter

LIC Housing Fin.

Exide Inds.

IndusInd Bank

Price Appre-

ciation (x)

50

22

12

11

10

6

6

6

6

6

Price

PAT

CAGR (%) CAGR (%)

119

86

64

62

59

44

43

43

41

41

71

84

45

46

-33

54

49

36

45

73

Mcap (INR b)

FY11

FY06

43

764

93

653

66

180

81

107

121

123

1

14

8

58

5

20

12

16

20

14

P/E (x)

FY11

FY06

81

27

9

17

N.M.

15

12

11

18

21

24

10

5

10

114

14

13

8

19

37

N.M. - Not meaningful

History of Fastest Wealth Creator (Price Appreciation - X)

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

7

182 Matrix Labs

136 Matrix Labs

75 Matrix Labs

50 e-Serve

69 Wipro

66 Infosys

223 SSI

75 Satyam Computers

23 Satyam Computers

Cipla

30 Dr Reddy's Lab

665 B F Utilities

50 Sanw aria Agro

28 Unitech

54 Unitech

837 Unitech

Key Finding #2

Successful investments are those which prove to be enduring (not transitory) multi-baggers,

which are an outcome of high quality business and high quality management. Blue Chip Investing

is one such sound strategy (see page 17).

9 December 2011

4

Wealth Creation Study 2006-2011

Findings

#3

Most Consistent Wealth Creators

Kotak Mahindra Bank is the Most Consistent Wealth Creator



For the first time more than 10 companies have qualified for the title of Most Consistent

Wealth Creators, by featuring among the top 100 wealth creators in 10 consecutive studies.



In such a case, 10-year price CAGR is used as the tie-breaker, and Kotak Mahindra Bank

has emerged the fastest on that count.



HDFC and HDFC Bank also figure in the list of top 10 Most Consistent Wealth Creators.

Clearly, private sector financials are emerging as blue chip stocks with high, and more

importantly, consistent growth performance (e.g. HDFC Bank has delivered 30% PAT growth

for the last 38 consecutive quarters).

Top 10 Consistent Wealth Creators

Rank Company

1

2

3

4

5

6

7

8

9

10

Kotak Mahindra Bank

Sun Pharma

Asian Paints

HDFC

HDFC Bank

Reliance Industries

ACC

Infosys

ONGC

Ambuja Cements

Appeared In Last

10 WC Studies (X)

10

10

10

10

10

10

10

10

10

10

10-yr Price

CAGR (%)

47

33

31

29

29

27

24

24

23

21

5-Yr PAT

CAGR (%)

24

27

33

22

36

15

16

22

8

19

P/E (x)

2011

21

24

28

28

27

18

19

27

11

18

2006

16

28

29

25

28

12

28

33

12

26

Consumer facing companies score high on Consistent Wealth Creation

Consistent Wealth Creators - 2006 to 2011

Consumer Facing

Non-Consumer Facing

Healthcare

Consumer













Cipla (3)

Dr Reddy's Lab (2)

GSK Pharma (1)

Piramal Health. (3)

Ranbaxy Lab (3)

Sun Pharma (4)



Asian Paints (4)



ITC (4)



Nestle India (1)

Others

Technology









Hero MotoCorp (5)

HDFC (6)

HDFC Bank (3)

Kotak Mah. Bk (2)



Infosys (5)



Wipro (2)



Satyam (2)

Others











Reliance Inds (4)

Ambuja Cement (2)

Hind. Zinc (1)

O N G C (2)

ACC (1)

Number in brackets indicates times appeared within top 10 in last six years, 2006 to 2011

Key Finding #3

Quality of management is a key factor behind consistent wealth creation. The top 10 list also

features two cement majors - ACC and Ambuja (now, both owned by Holcim). Change in

management has significantly contributed to their consistent performance.

9 December 2011

5

Wealth Creation Study 2006-2011

Findings

#4

Wealth Creators (Wealthex) v/s BSE Sensex

Superior and more consistent performance over benchmark



We have compared the performance of Wealthex (top 100 Wealth Creators index) with the

BSE Sensex on three parameters - (1) market performance, (2) earnings growth, and

(3) valuation.



Market performance:

Over the last five years, wealth creating companies have delivered

point-to-point return CAGR of 18%, against 12% for the BSE Sensex.



Earnings growth:

Over the last five years, wealth creating companies clocked earnings

CAGR of 18% compared to benchmark earnings CAGR of 14%.



Valuation:

Wealth creating companies' aggregate P/E in March 2006 was at a discount to

the Sensex, whereas their P/E in March 2011 is in line with the Sensex at 19x. Superior

earnings growth combined with P/E re-rating have led to market outperformance.

Wealth Creators’ Index v/s BSE Sensex (31.3.06 To 31.3.11)

Wealthex - Rebased

28,000

23,000

18,000

59% Outperform ance

13,000

8,000

Sensex

Sensex v/s Wealth Creators: Higher earnings growth, lower valuation

Mar-06

BSE Sensex

YoY Performance (%)

Wealthex - based to Sensex

YoY Performance (%)

Sensex EPS (INR)

YoY Performance (%)

Sensex P/E (x)

Wealthex EPS (INR)

YoY Performance (%)

Wealthex PE (x)

11,280

523

22

596

19

11,280

Mar-07

13,072

16

12,825

14

718

37

18

810

36

16

Mar-08

15,644

20

17,457

36

833

16

19

1004

24

17

Mar-09

9,709

-38

11,868

-32

820

-2

12

1003

0

12

Mar-10

17528

81

22,964

94

834

2

21

1219

22

19

Mar-11

19445

11

26095

14

1024

23

19

1370

12

19

18

14

5-year

CAGR (%)

12

18

Key Finding #4

Wealth creating companies' earnings performance is superior to benchmark not only in terms

of higher 5-year CAGR but also lower volatility, with standard deviation of annual returns at 13%

compared to 16% for the Sensex.

9 December 2011

6

Wealth Creation Study 2006-2011

Findings

#5

Wealth Creation Classification by Industry

Financials - the new leader



For the first time ever, Financials have emerged the largest wealth creating sector. The new

leader has steadily increased its share of wealth from 12% in FY06 to 24% in FY11. At

INR5,194 billion, this is the second highest ever wealth created by any sector in a span of

five years, after Oil & Gas in the peak of commodity boom over 2003-08.



Importantly, size apart, Financials is also the fastest wealth creating sector with price (i.e.

market cap) CAGR of 28%, significantly higher than the average of 18%. This has been

made possible by two factors:

1. 5-year PAT CAGR of 25%, higher than the average of 20%, in turn, leading to

2. Lowering of valuation discount from 23% in FY06 to just 6% in FY11.



Going forward, importance of Financials will increase further as insurance companies get

listed, and new banking licenses get issued.

Wealth Creators: Classification by industry (INR b)

Wealth

Industry

Financials (21)

Metals / Mining (12)

Oil & Gas (8)

Technology (7)

Consumer / Retail (12)

Capital Goods (8)

Auto (8)

Healthcare (8)

Ultility (3)

Telecom (1)

Cement (5)

Others (7)

Total

Created

(INR b)

5,194

3,254

3,043

3,024

1,709

1,540

1,183

902

706

574

289

680

22,096

Share of Wealth

Created (%)

2011

2006

24

15

14

14

8

7

5

4

3

3

1

3

100

12

11

27

10

6

11

8

5

2

1

3

4

100

Price

CAGR

(%)

28

23

13

16

19

17

17

19

9

12

12

39

18

PAT

CAGR

(%)

25

20

12

24

22

27

26

25

12

23

23

31

20

P/E (x)

2011

15

12

14

24

30

22

13

24

16

23

15

24

16

2006

13

11

13

34

33

33

18

31

19

38

24

17

17

During FY06-11, Financials has created the second highest wealth ever by a sector in 5 years

INR b

5,826

4,949

3,891

2,723

2,126

5,194

1,839

2005

Oil & Gas

2006

Oil & Gas

2007

Oil & Gas

2008

Oil & Gas

2009

Oil & Gas

2010

Metals/Mining

2011

Financials

Wealth Creation Study Year / Top Wealth Creating Sector

Key Finding #5

Besides Financials, other consumer-facing sectors like Consumer Goods, Retail, Auto and

Healthcare are slowly rising up the pecking order, and are likely to regain their prominence in

Wealth Creation.

9 December 2011

7

Wealth Creation Study 2006-2011

Findings

#6

Wealth Creators by ownership: PSU v/s Private

PSU underperformance continues



PSUs' (public sector undertakings) share of wealth creation has increased marginally from

22% in our last study to 24% this year, thanks mainly to ONGC, NMDC and SBI.



However, on fundamental parameters, PSUs continue to underperform their private

counterparts: FY06-11 Sales CAGR of 16% (28% for private) and PAT CAGR of 14%

(24% for private).



PSUs' price CAGR is in line with PAT CAGR at 14%, well below 21% for the private sector.

The only consolation is that PSU P/E has held up at 13x, unlike the private sector which has

seen a de-rating from 22x in FY06 to 19x in FY11.

Wealth Creators: PSU v/s Privately-owned

2006-2011

PSU

Number of Wealth Creators

Share of Wealth Created (%)

5-year Sales CAGR (%)

5-year PAT CAGR (%)

5-year Price CAGR (%)

P/E - 2006 (x)

P/E - 2011 (x)

RoE - 2006 (%)

RoE - 2011 (%)

24

27

16

14

14

13

13

19

17

Private

76

73

28

24

21

22

19

24

17

PSU wealth creation by sector

Oil &

Gas

20%

Utilities

9%

Others

1%

Mining &

Metals

24%

Capital

Goods

9%

Finan-

cials

37%

Deregulation diminishes role of state-owned companies in Wealth Created

49

51

36

25

30

No of PSUs

% Wealth Created

35

27

30

27

28

26

18

25

16

22

24

Key Finding #6

PSU share of India's market capitalization is set to increase led by further divestments by

Government of India, listing of new PSUs (e.g. SJVN, erstwhile Satluj Jal Vidyut Nigam), and

re-capitalization of PSU banks.

9 December 2011

8

Wealth Creation Study 2006-2011

Findings

#7

Wealth Creators by Age Group and Market Cap

Age no barrier to wealth creation, but smaller is still beautiful



At first glance, younger companies (0-10 years) seem to have an edge in wealth creation -

highest Price CAGR on the back of highest PAT CAGR. But the size of wealth created will

always be small, with 6 companies accounting for only 2% of the wealth created.



In contrast, 8 companies above 90 years of age generated a substantial 8% of the Wealth

Created. And that too with in-line with average Price and PAT CAGR.



Interestingly, of the 11 companies above 80 years of age, 7 companies are public sector

banks. This re-affirms the longevity and earnings power of the Financials sector. The other

4 are GSK Pharma, ITC, Tata Steel and Tata Power, the first three of who feature in our

Blue Chip list (see page 23).



In terms of market cap, companies with base year market cap less than INR10b continue to

have the edge in terms of speed of wealth creation but with higher risk, whereas the larger

ones create wealth a bit slowly, but with low level of risk.

Wealth Creators: Classification by age-group

No. of

Years

0-10

11-20

21-30

31-40

41-50

51-60

61-70

71-80

81-90

>90

Total

No. of

Cos.

6

25

19

9

14

7

8

1

3

8

100

Wealth Created

(INR b)

440

5,934

4,077

3,555

2,530

2,070

1,394

45

339

1,711

22,096

% Share

of WC

2

27

18

16

11

9

6

0

2

8

100

PAT

CAGR (%)

36

19

21

15

21

18

27

10

21

22

20

Price

CAGR (%)

26

18

21

19

16

22

14

5

18

18

18

Price CAGR and PAT CAGR by base market cap range

36

Price CAGR (%)

PAT CAGR (%)

27

19

21

15

26

18

21

19

22

16

14

5

0-10

11-20

21-30

31-40

41-50

51-60

61-70

Base Market Cap Range (INR b)

71-80

81-90

>90

10

18

18

21

18

21

22

Avg Price CAGR: 18%

Avg PAT CAGR: 20%

Key Finding #7

An interesting strategy to balance quality, return and risk is to try and identify Potential Blue

Chips, as covered in our theme section on Blue Chip Investing.

9 December 2011

9

Wealth Creation Study 2006-2011

Findings

#8

Wealth Creators by Sales and Earnings Growth

Markets are slaves of earnings power



Pace of wealth creation is almost singularly decided by quantum of earnings growth, at least

in the short- and medium term. Earnings growth, in turn, has a very high correlation with

Sales growth, as margin expansion is not sustainable over long periods.



Consider the table showing classification of Wealth Creators by PAT growth. Interestingly,

companies in the higher PAT growth buckets have seen a sharp de-rating in terms of P/E

multiples. The main reason is this - super-normal growth rates (say, in excess of 30%), are

usually possibly only in the upward phase of cyclical businesses. Thus, the high PAT growth

companies include cyclical names like Sesa Goa, Jindal Steel, Bhushan Steel, Tata Motors,

UltraTech, Shree Cement, etc, which enjoy low multiples in their upcycle and vice versa.



Over the longer term, however, it is the quality of earnings which decides their sustenance,

translating into premium valuations. Two indicators of earnings quality are RoE and Dividend

Payout. This is also discussed in our theme study on Blue Chip Investing.

Price CAGR (%) by 2006-11 PAT growth range

57

38

28

18

7

19

43

Classification by PAT growth

PAT Gr.

No. of

Range (%)

Cos

0-10

10-20

20-30

30-40

40-50

50-60

10

19

36

16

10

3

6

100

Price

CAGR (%)

7

18

19

28

38

43

57

18

P/E (x)

2011

2006

14

16

18

15

14

20

26

16

14

14

23

21

19

30

86

17

0-10

10-20 20-30 30-40 40-50 50-60

PAT Growth Range (%)

>60

>60

Total

Wealth Creators: Classification by Sales Growth

Sales Gr.

Range

(%)

0-10

10-20

20-30

30-40

40-50

>50

Total

No.

of

Cos.

7

25

40

19

5

4

100

Share

of WC

(%)

4

25

48

17

5

1

100

Price

CAGR

(%)

14

13

20

26

21

32

18

PAT

CAGR

(%)

5

14

23

35

20

82

20

RoE (%)

2011

14

15

20

20

14

16

17

2006

30

19

22

23

25

3

21

P/E (x)

2011

19

15

18

16

13

19

16

2006

13

16

20

23

13

97

17

Key Finding #8

Markets are unable to appropriately price both, hyper-growth and high quality growth, resulting

in huge wealth creation.

9 December 2011

10

Wealth Creation Study 2006-2011

Findings

#9

Wealth Creators Classification By RoE

The first test of ''Blue Chip-ness''

Considering base RoE in FY06, three groups stand out in terms of above-average PAT and Price

performance - (1) Base RoE < 10%, (2) 15-20%, and (3) > 40%.

(1) Base RoE < 10%:

This is the high-risk-high-return group, and typically includes start-ups

(e.g. Yes Bank), turnaround cases (e.g. Essar Oil, IndusInd Bank), and bottom-of-cycle

stocks (e.g. Shree Cement). If things turn out to be favorable, these stocks can deliver very

high earnings growth and stock price returns. But there is an equal chance, if not more, of

things turning adverse, in which case there will most likely be permanent loss of capital.

(2) Base RoE of 15-20%:

13 of the 22 companies in this group are Financials, a business

which cannot deliver supernormal RoEs but can deploy almost unlimited capital and earn

risk-adjusted returns well above cost of capital.

(3) RoE > 40%:

This is the group of Blue Chips, usually associated with modest earnings and

price performance. However, in an enabling growth environment such as in India, even large

Blue Chips can deliver robust earnings growth (27% CAGR), which gets highly reward by

the markets.

Wealth Creators: Classification by RoE

2006 RoE

Range

(%)

<5

5-10

10-15

15-20

20-25

25-30

30-40

>40

Total

No.

of

Cos.

3

7

9

22

22

8

15

14

100

Share

of WC

(%)

1

2

8

22

18

14

17

17

100

Price

CAGR

(%)

23

19

15

25

19

12

18

22

18

PAT

CAGR

(%)

36

28

19

21

18

15

20

27

20

RoE (%)

2011

12

15

11

14

16

21

21

33

17

2006

5

8

12

16

22

27

34

49

21

P/E (x)

2011

18

16

15

15

17

15

16

20

16

2006

29

24

18

13

17

17

18

24

17

Wealth Creators: Price CAGR by RoE

25

19

15

12

19

Avg Price CAGR: 18%

22

18

23

<5

5-10

10-15

15-20

20-25

2006 RoE Range (%)

25-30

30-40

>40

Key Finding #9

Blue Chips, by virtue of their dominant position in their respective businesses, are able to

deliver quality earnings growth (i.e. with high RoE), leading to huge size and high speed of

wealth creation.

9 December 2011

11

Wealth Creation Study 2006-2011

Findings

#10

Wealth Creators by Valuation Parameters

Payback ratio of less than 1x continues to guarantee highest returns



In almost every single of our past Wealth Creation Studies, the key valuation indicators for

multi-baggers are -

1. P/E of less than 10x

2. Price/Book of less than 1x

3. Price/Sales of 1x or less

4. Payback Ratio of less than 1x

(Payback is a proprietary ratio of Motilal Oswal, defined as current market cap divided by

estimated profits over the next five years. We back-test this in 2006, based on the actual

profits reported over the next five years.)

For the FY06-11 period, all of the above indicators worked according to form, but the Payback

Ratio continues to deliver the highest level of returns to the largest number of companies (23

companies had Payback ratio of < 1 in 2006).



Wealth Creators: Classification by Valuation Parameters (March 2006)

No. of

Cos

P/E (x)

<5

5-10

10-15

15-20

20-25

25-30

>30

Total

3

11

15

14

16

10

31

100

1

13

22

12

12

10

30

100

35

24

17

16

21

24

16

18

% Wealth

Created

Price

CAGR (%)

Price/Sales (x)

<0.5

0.5-1.0

1.0-1.5

1.5-2.0

2.0-3.0

3.0-5.0

5.0-7.0

>7.0

Total

7

4

16

7

18

21

13

14

100

3

2

22

6

15

15

10

27

100

18

33

24

17

16

15

16

19

18

No. of

Cos

% Wealth

Created

Price

CAGR (%)

Price/Book (x)

<1.5

1.5-2.0

2-3

3-4

4-5

5-10

>10

Total

12

7

13

10

10

28

20

100

10

4

21

10

10

23

22

100

27

33

17

13

23

19

16

18

Payback Ratio(x)

<0.5

0.5-1.0

1-1.5

1.5-2.0

2.0-2.5

2.5-3.0

>3.0

Total

6

17

19

19

13

10

16

100

6

15

21

17

14

0

11

100

62

25

24

15

13

17

13

18

Median valuations (x)

Sensex

Median P/E

Median P/B

Media P/S

15.3

3.2

2.5

2006

Wealth Creators

16.9

3.1

1.9

Sensex

21.4

3.5

3.2

2011

Wealth Creators

22.0

4.1

3.3

9 December 2011

12

Wealth Creation Study 2006-2011

Findings

#11

Wealth Destroyers

Wealth destroyed is 15% of wealth created



During FY06-11, total wealth destroyed at INR3,254b is about 15% of the total wealth

created of ~INR22,000b. This reflects the significant deterioration of the Indian market over

FY10. In our last study covering FY05-10, wealth destroyed was a mere 2% of the wealth

created. The number of wealth destroying companies has also significantly increased to

1,036 from 650 in the previous study.



Four sectors - Capital Goods, Telecom, Technology, Construction/Real Estate - account for

56% of the wealth destroyed.



Most interestingly, just 3 companies - Suzlon, RCom and Satyam Computers - account for a

whopping 25% of the total wealth destroyed.

Top-10 Wealth Destroyers (2006-2011)

Company

(INR b)

Suzlon Energy

Rel. Comm.

Satyam Computer

MTNL

Bajaj Hindusthan

HFCL

Tata Comm

Videocon Inds.

Punj Lloyd

Jet Airways

Total of Above

Total Wealth Destroyed

336

252

232

87

75

67

65

54

52

47

1,221

3,254

Wealth Destroyed

% Share

10

8

7

3

2

2

2

2

2

1

38

100

Price

CAGR (%)

-30

-19

-31

-24

-32

-14

-13

-15

-22

-15

Wealth Destruction by Industry (%)

Sector

Capital Goods

Telecom

Technology

Construction / Real Estate

Sugar

Textiles

Auto

Media

Metals

Healthcare

Utilities

Financials

Airlines

Chemicals & Fertilizers

Others

Total

No of

Cos

99

17

108

47

33

131

63

38

54

52

6

65

3

66

254

1,036

(INR b)

544

517

423

327

182

178

154

91

86

86

80

54

53

49

430

3,254

Wealth Destroyed

% Share

17

16

13

10

6

5

5

3

3

3

2

2

2

2

13

100

Key Finding #11

Markets can severely punish its own erstwhile darlings severely, on various grounds, particularly

proven or suspected corporate governance issues. Even Blue Chips - which typically have no

management issues - can destroy significant wealth from their peak price levels. Hence, it is

important to sell Blue Chips at extreme valuations (see page 33).

9 December 2011

13

Wealth Creation Study 2006-2011

Findings

#12

Wealth Creators & dividends

Our study on Blue Chip Investing has revealed to us the power of dividend in wealth creation,

especially over very long periods of time across economic and business cycles. The time horizon

of our Wealth Creation Studies is much shorter i.e. 5 years; and yet, a few linkages of dividend

are evident e.g.



PEs have a very high and positive correlation with payouts;



Payouts have a very high and positive correlation with RoEs;



High payouts coupled with growth is a potent combination for wealth creation as it reflects

several things:

(1) The company's business is intrinsically highly profitable, and it needs to retain very little of

its annual profit to fund future growth;

(2) The management has an attitude of sharing economic benefits with minority shareholders;

(3) Low risk of misallocation of retained earnings in unrelated diversifications, risky overseas

acquisitions, etc.



Structural rise in payout ratios is a potential source of PE re-rating over the next few years;



Dividends yields are highly homogenous across companies e.g. 66% of the top 100 wealth

creators had a base FY06 dividend yield below 1.5%.

A few key charts on dividends and payouts based on the FY06-11 study are presented below.

Expect a lot more on this subject in the studies to come.

Strong correlation between payout and P/E

across 2,100 listed companies …

28

… partly evident among top 100 wealth

creators as well

27

24

17

12

10

9

14

17

18

15

15

<10

10-20

20-30

30-40

40-50

>50

<10

10-20

20-30

30-40

40-70

>70

Payout Range (%)

Payout Range (%)

Wealth Creators: Classification by Payout

Payout Range

No. of

Companies

>70

>40-70

>30-40

>20-30

>10-20

<10

Total

4

6

13

24

34

19

100

Share of

WC (%)

2

4

24

16

37

16

100

Price

CAGR (%)

19

15

14

14

25

23

18

PAT

CAGR (%)

18

17

14

21

21

27

20

RoE (%)

2011

2006

77

31

15

21

17

16

17

52

27

21

20

20

23

21

P/E (x)

2011

2006

24

27

18

15

15

17

16

24

30

19

20

13

20

17

9 December 2011

14

Wealth Creation Study 2006-2011

Findings

#12 Wealth Creators & dividends (contd)

Top 10 dividend paying companies

FY06 to FY11

INR b

ONGC

NTPC

ITC

TCS

Reliance Inds

IOCL

Infosys

State Bank of India

SAIL

ICICI Bank

Total

Dividend

413

171

121

112

108

107

100

85

71

71

Avg Payout

(%)

35

37

58

33

11

25

33

15

20

31

Top 10 dividend payout ratio companies

FY06 to FY11

Castrol India

Colgate-Palmolive

Nestle India

Hero MotoCorp

ITC

Engineers India

GSK Pharma

Godrej Consumer

Cummins India

GSK Consumer

Avg Payout

(%)

76

72

71

71

58

57

53

45

44

43

Dividend

(INR b)

13

12

22

58

121

10

17

6

10

5

Top 10 companies with change in dividend

FY11 over FY06

INR b

ITC

Infosys

TCS

Hero MotoCorp

BHEL

State Bank of India

ONGC

Reliance Inds

NMDC

ICICI Bank

Delta

Dividend

24

22

21

17

12

12

11

10

9

9

Delta

Payout (%)

25

0

8

68

4

4

-9

-2

0

-6

Top 10 companies with change in payout ratio

FY11 over FY06

Hero MotoCorp

ABB

Hind.Copper

GSK Consumer

UCO Bank

ITC

ACC

Petronet LNG

BPCL

IndusInd Bank

Delta

Payout (%)

68

52

41

39

32

25

25

24

16

16

Delta

Divd (INR b)

17

0

1

2

3

24

4

2

4

1

9 December 2011

15

Wealth Creation Study 2006-2011

Theme 2012

Wealth Creation

2006-2011

The 16

TH

Annual Study

Theme 2012

9 December 2011

16

Wealth Creation Study 2006-2011

Theme 2012

Blue Chip Investing

Creating wealth from dividends

A stock is worth only what you can get out of it. Even so spoke the old farmer to his son:

A cow for her milk,

A hen for her eggs,

And a stock, by heck,

For her dividends.

— John Burr Williams in his book,

The Theory Of Investment Value

1. Introduction: Back to basics

When in doubt, get back to basics. Thus, in the current, highly uncertain investment climate, it

may be useful to get back to the basics of investment, including its very definition. As far back

as 1934, Benjamin Graham and David Dodd wrote in their classic text book,

Security Analysis,

"An investment operation is one which, upon thorough analysis,

promises safety of principal

and an adequate return.

Operations not meeting these requirements are speculative."

In 1938, John Burr Williams wrote in

The Theory Of Investment Value,

"If

he does buy stocks,

and buy as an investor, he holds for income; if as a speculator, for profit

… Wise investment

requires that only such issues as are selling far below their true worth should be bought; then, as

large income payments are received in subsequent years … a handsome return on the principal

can be enjoyed."

Currently, there are several styles of investing which prevail - Value Investing, Growth Investing,

Momentum Investing, Common-sense Investing, Distress Investing, even UU Investing (Unknown

& Unknowable,

Wealth Creation Study 2010).

However, going strictly by the perspective of

Graham & Dodd and Burr Williams, more often than not, it is only Blue Chip Investing which is

truly an "investment operation", and only Blue Chips qualify to be called "wise investments".

2. What is Blue Chip Investing?

Simply put,

Blue Chip Investing involves buying and selling Blue Chips (i.e. high quality

stocks) at the right price.

The term "Blue Chip" comes from poker where the highest and

most valued denomination chips are colored blue. Thus, "Blue Chip stocks" is a common term

used for highly priced stocks, which typically tend to enjoy premium valuations due to their high

quality. They are also sometimes referred to as bellwether stocks.

Blue Chips are described variously (see box on page 18), because the parameters for a blue chip

are relatively subjective. Like beauty, "Blue Chip-ness" lies in the eyes of the beholder. Thus,

an appropriate phrase relevant for a Blue Chip may well be, "I can't explain it but I

know it when I see it."

9 December 2011

17

Wealth Creation Study 2006-2011

Theme 2012

At best, professional investors agree upon a few features common across most Blue Chips -



High priced stocks,

both in terms of premium valuation and also absolute ticket price

(unlike penny stocks)



Frontline stocks,

many of which tend to be constituents of the leading benchmark stock

market indices



Large-sized companies

in terms of revenue and market capitalization, usually whose

products or services offered are well known to the public at large, and not just to the investment

community



A long record of strong financial performance,

resulting in uninterrupted dividend payments

across business cycles



Widely tracked and researched stocks,

with a significant holding of institutional investors



Ease of entry and exit

due to large floating stock and huge traded volumes.

Blue Chips are …



"… stocks of well-established and financially sound companies that have demonstrated its

ability to pay dividends in both good and bad times."

"… stocks of companies that are thought to be safe, in excellent financial shape and firmly

entrenched as leaders in their field, generally paying high dividends, and favorably regarded

by investors."

"… the crème de la crème of the stock market - solid, dependable stocks that will deliver

good returns year after year to investors."





3. Why Blue Chip Investing

Geraldine Weiss, in her book,

The Dividend Connection,

says, "good

quality companies with

strong dividend histories offer as much, if not more, investment growth potential than

poor quality companies; and they do so with far less risk."

Key words here succinctly

capture why Blue Chip Investing is an excellent strategy to create wealth in the stock markets -

3.1. "Good quality companies"

The essence of Blue Chip Investing is to invest

only

in high quality companies. This alone plays

a huge role in ensuring "safety of principal", as suggested by Graham & Dodd. Or as Warren

Buffett famously puts it, "Rule No.1: Never lose money. Rule No.2: Never forget Rule No.1."

These two rules can effectively be practiced by investing only in high quality companies. Given

their strong business and financial track record, the risk of permanent capital loss is virtually

zero. Worst case, investors may suffer quotational loss, if they happen to buy into Blue Chips

when they are grossly overvalued.

3.2. "Strong dividend histories"

If good quality companies are the root of Blue Chip Investing, strong dividends are the fruit. Blue

Chips manage highly profitable businesses, and in most cases, have attained critical mass of

scale. Thus, they generate enough resources not only to fund their own growth, but also distribute

surpluses by way of generous dividends. Over time, Blue Chips prove to be fountains of dividend

across economic and stock market cycles, which in turn, ensures "handsome return on the principal",

to recollect Burr Williams' words.

9 December 2011

18

Wealth Creation Study 2006-2011

Theme 2012

Asian Paints: Dividend up 55x, Mkt Cap up 75x

3,600

2,700

Divd (INR m)

Mkt Cap (INR b, RHS)

225

300

HUL: Dividend up 36x, Mkt Cap up 47x

20,000

15,000

10,000

5,000

0

Divd (INR m)

Mkt Cap (INR b, RHS)

700

525

350

175

0

1,800

900

0

150

75

0

Nestle: Dividend up 51x, Mkt Cap up 82x

5,000

3,750

2,500

1,250

0

Divd (INR m)

Mkt Cap (INR b, RHS)

400

300

200

100

0

Total of Asian Paints, HUL, Nestle, Hero MotoCorp

48

36

24

12

0

Divd (INR b)

Mkt Cap (INR b, RHS)

Dividend up 75x;

Mkt Cap up 70x

1,800

1,350

900

450

0

3.3. "As much, if not more, investment growth potential than poor quality

companies"

The most common investment activity in stock markets, even among seasoned professionals, is

the search for the next Blue Chip - "the next Unilever, the next Infosys, the next Bharti, the next

HDFC Bank." This is due widespread (mis)perception that Blue Chips are "boring, stodgy and

over-researched stocks", unlikely to outperform the broader market and the aggressive upstarts.

Whereas actual experience across stock markets - whether US or India - suggests exactly what

Geraldine Weiss says i.e. Blue Chips offer "as much, if not more, investment growth potential

than poor quality companies."

Consider the following table. Four Blue Chips - Asian Paints, Hero Honda, Hindustan Unilever

and Nestle - have together delivered an average return (including dividends) of 24% compounded

over the last 20 years, significantly higher than the Sensex CAGR of 15% (16-17% including

dividends).

Blue Chips Total Return: The power of longevity & compounding (INR)

Company

Adj. Price

1991

2011

P/E (x)

Capital

1991

2011

Gain

20

7

21

26

15

33

17

32

64

19

2,493

1,579

275

3,714

Total

Divd

173

372

74

349

Divd %

of PP*

514

5,041

765

432

Total

Value

2,666

1,951

349

4,063

Appreciation

CAGR, % Times, x

24

32

20

22

24

15

79

264

36

50

107

17

Asian Paints

34 2,527

Hero MotoCorp

7 1,587

Hind Unilever

10

285

Nestle India

81 3,795

Average of above

BSE Sensex

1,168 19,445

* PP — Purchase Price

9 December 2011

19

Wealth Creation Study 2006-2011

Theme 2012

3.4. "Far less risk"

Even as it attempts to maximize return, a true investment operation seeks to minimize risk. This

is very naturally possible only in Blue Chips, where (1) chances of permanent loss of capital is

virtually zero, (2) quotational losses get recouped over time, and (3) at all times, steadily rising

dividend cheques get delivered home. Thus, statistically speaking, Blue Chips deliver above-

average return, with below-average standard deviation as shown below.

Blue Chip Index has handsomely outperformed the Sensex with low standard deviation

8,000

6,000

4,000

2,000

0

%

20-year CAGR

Standard deviation

Co-efficient of variation

BSE Sensex

Sensex

15

68

251

Blue Chip Index

Blue Chips

24

34

124

(both re-based to 100)

4. The Process of Blue Chip Investing

There are two key steps in the process of Blue Chip Investing: (1) Understanding quality, and (2)

Recognizing value.

4.1. Understanding quality

Quality is a subjective concept. But in the case of a company, its quality gets objectively reflected

in its performance at three levels -

1. Business performance:

Large business opportunity, strong competitive position with distinctly

differentiated offerings or low cost relative to peers, excellent track record of R&D and

launch of new products & services, and high quality management in terms of competence,

character, stakeholder consciousness.

2. Financial performance:

Long-term track record of healthy sales and profit growth,

uninterrupted and rising dividend payouts, robust return on capital, low debt-equity, and prudent

capital allocation.

3. Stock performance:

Rewarding total return to investors (dividend + capital appreciation)

over a long period, high institutional holding and interest in the stock, inclusion in benchmark

indices, etc.

Of the above quality-reflecting criteria, some objective ones can be effectively used as an initial

screen to identify Blue Chips (see

Section 5,

page 22).

4.2. Recognizing value

Precisely because Blue Chips demonstrate sustained high quality of business and financial

performance, they enjoy a significant valuation premium over stocks of lower quality. Hence,

one cannot buy Blue Chips at any price and still hope for significant total return. In most cases,

9 December 2011

20

Wealth Creation Study 2006-2011

Theme 2012

their high valuation does not leave very high margin of safety; in other words, there is not much

room for investor disappointment in one or more of their bellwether criteria e.g. lower earnings

growth, cut in dividend payouts, misallocation of capital, etc.

Consider the classic – yet, extreme – examples of two undisputed Indian Blue Chips, Hindustan

Unilever and Infosys. If bought at the peak of dotcom boom in year 2000, both would have

significantly underperformed the market from then to date. Over the next 11 years, HUL stock

price is up 1.6x and Infosys 2.3x, much lower than the Sensex which is up 3.2x over the same

period.

If purchased at the wrong price, even Blue Chips can underperform for a very long period

Sensex

450

360

270

180

90

0

HUL

Infosys

Our view

We believe successful Blue Chip Investing involves the following three steps -

(1) Making sense of Blue Chip valuations by observing their earnings growth, dividend payout

ratios and P/Es (see

Section 7,

page 27),

(2) Buying them based on valuation signals, which have back-tested evidence (Section

8,

page

30), and

(3) Following a "buy-and-hold" strategy to enjoy the long-term rewards of dividends and capital

gains.

5. Understanding quality: The 6-screen filter for Blue Chips

As stated earlier, the somewhat intangible feature of Blue Chip quality gets reflected in select

tangible criteria across business, financial and stock market performance. We have applied six

Blue Chip screening criteria to the universe of listed stocks in India. These criteria effectively

capture longevity of dividend payouts, earnings and dividends growth trend, earnings quality, and

stock liquidity and popularity.

9 December 2011

21

Wealth Creation Study 2006-2011

Theme 2012

6-screen filter to shortlist Blue Chips

No.

#1

#2

#3

#4

#5

#6

Criteria

20 years of uninterrupted dividend payouts

Dividends raised in at least 5 out of last 12 years

Earnings growth in at least 7 out of last 12 years

Average RoE of at least 15% for the last 12 years

At least 5 million shares outstanding

Should be owned by at least 80 institutional investors

What it captures

Longevity

Dividends growth trend

Earnings growth trend

Earnings quality across cycles

Liquidity and trading volume

Wide stock market popularity

Note:

Core criteria as suggested by Geraldine Weiss in

The Dividend Connection,

and also in her newsletter,

Investment Quarterly Trends,

suitably adapted to Indian conditions.

3,000

listed companies

5.1. How the 6 screens capture "Blue Chip-ness"

We applied the above 6-screen quality filter on the entire list of 3,000+ listed companies. We

briefly describe each of the 6 quality filter screens, and the number of companies that emerged

from each filter in our Blue Chip shortlisting process.

133

with 20 years of

uninterrupted dividend

Screen #1: 20 years of uninterrupted dividend payouts

It is said that dividend is the only transaction for which a company necessarily needs to write a

cheque. An extreme interpretation of this is that from the minority shareholders' perspective, a

company's financial statements are an accounting fiction (e.g. Satyam Computers), while the

dividend cheque received (assuming it is cashed!) is the only financial reality.

We believe a company's dividend payouts are a strong reflection of (1) the inherent profitable

nature of the company's business, and (2) the management's attitude of sharing profits with

minority shareholders. A very long track record of uninterrupted dividends lends very high level

of confidence on both these counts.

106

raised dividend in at

least 5 of last 12 years

Screen #2: Dividends raised in at least 5 out of last 12 years

Long dividend track record apart, growth in dividends is also a hallmark of blue chip quality.

Thus, though 20 years of dividend payments is a must, what is also important is a company's

more recent track record of dividend growth. Dividends raised in at least 5 out of last 12 years

acknowledges that dividend step-ups need not necessarily happen every year, given considerations

of growth capex, debt repayment, etc.

76

grew earnings in at least

7 out of last 12 years

Screen #3: Earnings growth in at least 7 out of last 12 years

The only source of uninterrupted growing dividends is high quality of underlying earnings and its

steady growth. At least 7 years of earnings growth in the last 12 years suggest very few years of

earnings de-growth, which actually gets severely punished in the stock markets.

68

had 12-year avg RoE

of at least 15%

9 December 2011

Screen #4: Average RoE of at least 15% for the last 12 years

To enjoy steady earnings growth, the company's business needs to be profitable i.e. deliver a

reasonable return on capital. 12-year average RoE of at least 15% ensures that the company

recovers at least the cost of equity in India across business cycles. (Benchmark stock indices in

India have delivered long-period return of 15%, which can be deemed to be cost of equity here.)

22

Wealth Creation Study 2006-2011

Theme 2012

68

all qualified with at least

5m shares

Screen #5: At least 5 million shares

This is to ensure there is high liquidity in the stock, including entry and exit of large institutional

investors with low impact cost.

20

just missed due to lower

institutional holding

Screen #6: Should be owned by at least 80 institutional investors

High interest of institutional investors - domestic and foreign mutual funds, insurance companies,

etc - is an indicator of the stock's popularity in the markets, an essential Blue Chip trait.

Blue Chips which missed out only on the institutional holding criteria

Alfa Laval (22)

Balkrishna Inds (52)

Berger Paints (69)

Carborundum Univ. (63)

Elgi Equipment (43)

Fag Bearings (73)

FDC (41)

Godfrey Phillips (55)

Grindwell Norton (40)

GRUH Finance (43)

Kansai Nerolac (31)

Lakshmi Machine (73)

Navneet Publications (40)

State Bank of Travancore (45)

State Bank of Mysore (12)

Sundram Fasteners (70)

Supreme Inds (64)

Tata Investment Corp (60)

Unichem Labs (62)

Wyeth (45)

48

BLUE CHIPS

5.2. Our 48 Blue Chips

Applying the above six screens to all stocks listed on the Mumbai Stock Exchange, we arrived at

a list of 48 Blue Chips. This is just 1.5% of the 3,000+ actively traded stocks. The Blue Chips are

listed below in their alphabetical order and in descending order of their total return over the last

12 years.

Next, we analyze some key qualitative and quantitative characteristics of blue chips, some of

which we later apply for early identification of potential Blue Chips (Section

10,

page 33).

Blue Chips (alphabetical order)

Blue Chip

ABB

ACC

Adani Enterprises

Ambuja Cements

Ashok Leyland

Asian Paints

Bajaj Auto

Bharat Electronics

Bharat Forge

Blue Star

Bosch

Britannia Inds

Cipla

Colgate-Palmolive

Container Corpn

CRISIL

12-yr Total Return

(x)

16

8

17

6

10

15

8

30

13

22

13

3

4

6

17

16

CAGR (%)

29

21

30

18

23

28

21

36

26

32

26

11

13

18

29

28

Cummins India

Dabur India

Dewan Housing

Exide Inds

Federal Bank

GAIL (India)

GE Shipping Co

Grasim Inds

GSK Consumer

GSK Pharma

Havells India

HDFC

Hero MotoCorp

Hind. Unilever

Hindalco Inds

Infosys

Blue Chip

12-yr Total Return

(x)

9

7

12

25

32

14

20

9

5

4

51

19

10

2

4

3

CAGR (%)

22

20

25

34

37

27

31

22

15

12

43

31

23

4

12

11

IOC

Ipca Labs

ITC

Larsen & Toubro

LIC Housing Finance

M&M

Motherson Sumi

Nestle India

Pfizer

Pidilite Inds

Reliance Inds

Sesa Goa

State Bank of India

Tata Steel

Titan Inds

Wipro

Blue Chip

12-yr Total Return

(x)

6

21

8

24

37

9

63

9

3

9

9

185

15

10

44

1

CAGR (%)

19

32

21

33

39

22

46

23

9

23

22

61

28

24

41

-1

Note:

Over the last 12 years, BSE Sensex is up 7x or 13% CAGR

9 December 2011

23

Wealth Creation Study 2006-2011

Theme 2012

Blue Chips: In descending order of Total Return (dividend + capital gains) over FY00 to FY11

Blue Chip

Stock price (INR)*

Mar-00

Sesa Goa

Motherson Sumi

Havells India

Titan Inds

LIC Housing Finance

Federal Bank

Bharat Electronics

Exide Inds

Larsen & Toubro

Blue Star

Ipca Labs

GE Shipping Co

HDFC

Adani Enterprises

Container Corpn

ABB

CRISIL

State Bank of India

Asian Paints

GAIL (India)

Bosch

Bharat Forge

Dewan Housing

Tata Steel

Ashok Leyland

Hero MotoCorp

Nestle India

Pidilite Inds

Cummins India

M&M

Grasim Inds

Reliance Inds

ACC

Bajaj Auto

ITC

Dabur India

IOC

Colgate-Palmolive

Ambuja Cements

GSK Consumer

Cipla

Hindalco Inds

GSK Pharma

Britannia Inds

Infosys

Pfizer

Hind. Unilever

Wipro

2

4

7

4

7

14

60

6

72

19

15

17

38

38

76

50

40

190

177

38

500

29

24

68

3

194

430

17

57

81

303

128

140

192

25

14

63

145

26

518

90

63

731

124

1,113

507

225

549

Return over investment (INR)

Divd* % share

13

8

7

2

16

27

131

4

59

37

14

79

41

3

91

17

27

152

127

58

138

20

24

95

5

266

273

7

35

41

200

42

108

129

15

6

73

98

16

103

14

15

223

33

146

122

60

21

4

4

2

1

7

6

7

3

4

10

5

24

6

1

7

2

5

6

5

12

2

6

9

15

17

16

8

5

8

6

8

4

10

37

9

7

21

13

12

5

6

9

12

12

6

14

50

-

% of PP

816

232

99

55

243

194

219

67

82

196

93

461

106

8

119

34

68

80

72

152

28

69

99

139

149

137

63

40

62

51

66

32

77

67

60

42

116

67

62

20

15

24

30

27

13

24

26

4

Value

of Invt

(INR)

304

223

379

193

241

446

1,810

147

1,713

409

316

342

739

664

1,303

809

622

2,920

2,654

523

6,457

366

292

715

34

1,853

4,068

156

524

740

2,661

1,089

1,184

1,589

196

102

407

913

159

2,416

335

224

2,565

404

3,382

1,346

344

499

Appreciation

(x) CAGR (%)

185

63

51

44

37

32

30

25

24

22

21

20

19

17

17

16

16

15

15

14

13

13

12

10

10

10

9

9

9

9

9

9

8

8

8

7

6

6

6

5

4

4

4

3

3

3

2

1

61

46

43

41

39

37

36

34

33

32

32

31

31

30

29

29

28

28

28

27

26

26

25

24

23

23

23

23

22

22

22

22

21

21

21

20

19

18

18

15

13

12

12

11

11

9

4

-1

23

13

EPS

CAGR

(%)

49

36

44

31

18

49

26

23

26

18

22

14

22

25

16

5

23

20

23

12

26

17

18

26

45

26

19

19

19

20

22

19

26

13

18

24

11

20

17

12

19

6

15

12

38

18

7

32

20

13

Divd

CAGR

(%)

40

33

22

21

16

34

22

20

20

14

17

12

28

31

17

6

36

19

21

10

27

13

8

15

28

42

18

21

28

19

19

14

31

13

30

24

50

18

16

21

25

9

9

20

13

16

9

56

20

-

Mar-11 Cap. Gain

290

214

371

191

225

419

1,679

143

1,653

372

302

263

699

661

1,212

792

595

2,768

2,527

465

6,319

346

268

621

28

1,587

3,795

149

489

699

2,461

1,048

1,076

1,460

181

96

334

815

143

2,313

321

209

2,343

371

3,237

1,225

285

478

289

211

364

186

219

405

1,619

137

1,581

353

287

246

661

623

1,136

742

555

2,578

2,350

427

5,819

317

244

552

25

1,393

3,365

133

432

618

2,158

920

935

1,268

157

82

271

670

117

1,795

231

146

1,612

247

2,124

718

60

-71

Median of above

-

-

7

67

-

10

BSE Sensex

5,001

19,445

-

-

-

-

-

4

* Stock price and dividends adjusted for bonus issues, stock splits, rights, etc

% share stands for Dividend share in total return; % of PP stands for Dividends as % of Purchase Price

9 December 2011

24

Wealth Creation Study 2006-2011

Theme 2012

6. Characteristics of Blue Chips

The 6-screen filter used for shortlisting Blue Chips is heavily weighted towards earnings and

dividends growth and quality. However, most of the companies which the filter threw up also

confirmed several other qualitative and quantitative traits of high quality stocks.

6.1. Business performance traits of Blue Chips

Blue Chips tend to comply with two of Warren Buffett's key stock selection criteria: (1) Favorable

long-term economics, and (2) Able and trustworthy management.



Longevity:

One of the first findings of the study is the longevity of companies. The median

age of our 48 Blue Chips is 57 years. 40 of 48 companies are above 30 years old, and 30

companies are more than 50 years old. Thus, most Blue Chips are built to last i.e. their

businesses are relevant almost forever, and the companies have developed some form of

sustainable competitive advantage. The rare Blue Chips whose businesses become irrelevant

end up as Fading or Faded Blue Chips.



Dominant market position:

This seems by far the most necessary condition for a Blue

Chip. 44 of the 48 Blue Chips are among the top 3 players in their respective business.



Concentrated business:

34 of the 48 Blue Chips (i.e. 70%) are from industries with high-

to-medium market concentration. (Market concentration measures the extent to which top

firms in any industry account for a high market share. Thus, high concentration implies the

top players account for a major share of the market.)



Consumer-facing businesses have an edge:

29 of 48 Blue Chips (i.e. 60%) are from

consumer-facing businesses, including financial services. Still, overall, Blue Chips seem to be

fairly industry agnostic considering that there are Blue Chips from several non-consumer

facing industries as well - from Oil & Gas (Reliance, IOC, GAIL) to Engineering (L&T,

ABB, Cummins, Blue Star) to Cement (ACC, Grasim) to even Shipping/Logistics (Container

Corporation, GE Shipping, Adani Enterprises).



Character and competence of management:

Management quality is an intangible trait;

but we believe two tangible indicators come closest to capturing it: (1) RoE, which shows

whether the management has ensured that it has consistently earned returns on shareholders'

funds higher than cost of equity, and (2) Dividend payout ratio, which reflects the

management's sharing attitude towards minority shareholders. On both these counts, Blue

Chips score higher than benchmark indices, and even more so, over benchmarks ex Blue

Chips (see table under

Section 6.2).

30 of 48 blue chips are over 50 years old

Blue Chips tend to be dominant consumer-

facing companies

22

4

14

10

8

8

44

27

< 30

30-50

50-75

Age range (years)

> 75

Dominance

Concentration

19

Industrial

Client Profile

7

6

Financials

23

Consumer

9 December 2011

25

Wealth Creation Study 2006-2011

Theme 2012

Sector mix of Blue Chips:

Fairly sector agnostic

Logistics,

3

Oil & Gas,

3

Metals, 3

Cement, 3

Auto, 8

Healthcar

e, 4

Engi-

neering, 6

Financials

,6

Superior RoE & payout reflect Blue Chips'

management quality

Blue Chips

Consumer

, 10

35

32

25

25

20

20

BSE 500

BSE Midcap

Tech-

nology, 2

Payout

RoE

6.2 Financial & Stock performance traits of Blue Chips

We compared our Blue Chips with major benchmark indices on seven key financial and stock

performance criteria as tabled below. Blue Chips' performance on all the counts is distinctively

superior.



FY07-11 PAT CAGR is line with benchmarks, but dividend CAGR is distinctly higher, led by

higher payout



Average RoE is significantly higher than benchmarks.



Market cap performance and valuation of Blue Chips are also higher. The gap widens as

quality of stock group declines.



Interestingly, Average Dividend Yield is much more homogenous across stock groups, with

co-efficient of variation one-third that of P/Es. This clearly establishes that, in the ultimate

analysis, medium- and long-term dividends influence stock prices more than just earnings

(detailed discussion under

Section 7,

page 27).

Blue Chips v/s Other Indices

Stock Group / Index

No. of stocks

FY07-11 CAGR (%)

PAT

Dividend

Market Cap

FY07-11 Average (%)

Payout

RoE

P/E (x)

Dividend Yield

Blue Chips NSE Nifty BSE 500 BSE Midcap

48

14

18

19

35

32

19

1.5

50

12

14

18

30

23

19

1.5

500

13

15

19

25

20

17

1.4

270

13

14

16

25

20

14

1.5

13

15

18

29

24

17

1.5

Mean

Std

Co-eff. Of

Deviation Variation (%)

1

2

2

5

6

2

0.1

7

13

10

17

24

12

4

9 December 2011

26

Wealth Creation Study 2006-2011

Theme 2012

7. Valuation dilemma: Why are Blue Chips always expensive?

A common refrain of many investment practitioners is this - "Identifying a Blue Chip is relatively

simple. The tough part is deciding when to buy, because they always are so expensive." This

concern has been heightened given several cases of underperformance by Blue Chips even

when held for a very long period (e.g. HUL and Infosys discussed earlier).

We believe the approach to resolving this quality-valuation dilemma is two-pronged -

1. Understanding the connection between payout and P/E; and

2. Using the right valuation signals to judiciously buy into Blue Chips (see Section 8, page 30).

7.1. The connection between payout and P/E

Here again, we go back to the very basics of valuation for any asset, not just stocks –

The intrinsic value of an asset is the present value of its lifetime cash flows.

For a long-term buy-and-hold investor, the real cash flow from a stock is dividend income over its

lifetime. The value in this can be derived using the dividend discount model (DDM, also called

Gordon Growth Model, propagated by one M J Gordon in 1959 -

D

P=

(k-g)

where

For the academically and mathematically inclined, the

derivation of Gordon model is presented on page 37

P = Price of the stock; D = Next expected dividend;

g = Dividend growth rate to perpetuity; k = Required rate of return (technically, Cost of equity)

P and D are absolute in INR; k and g are expressed in decimals (i.e. 10% growth = 0.1)

A small mathematical operation to the DDM is highly insightful -

P =

D

Dividing both sides by E (earnings), we get -

(k-g)

(D/E)

(k-g)

i.e P/E = Payout

(k-g)

................................................................................. (1)

P/E =

In (1), if k-g = 0.01 (i.e. 1%), PE = Payout (i.e. Payout in decimals

x

100)

.............. (2)

Thus, PE is a positive function of growth and payout. If two stocks have similar growth rates, the

one with higher payout ratio merits a higher PE. As Blue Chips, especially asset-light ones, have

very high payout ratios, their PEs always tend to remain high.

Strong correlation between payout and P/E

across 2,100 listed companies …

28

… partly evident among top 100 wealth

creators as well

27

24

17

12

10

9

14

17

18

15

15

<10

10-20

20-30

30-40

40-50

>50

<10

10-20

20-30

30-40

40-70

>70

Payout Range (%)

Payout Range (%)

9 December 2011

27

Wealth Creation Study 2006-2011

Theme 2012

The Dividend-Yield angle:

The reason high payout companies enjoy high PEs is because of

the dividend yield angle, which can be analyzed as follows -

D/P =

D/E

P/E

i.e. Dividend Yield =

Payout

.................................................................. (3)

P/E

Thus, if the PE for a high payout company drops (i.e. lower denominator equation (3) above),

Dividend Yield becomes very attractive. Consider a company with a payout of 80% (such as

Hindustan Unilever) i.e. if EPS is INR100, Dividend Per Share is INR80. Now, if the P/E were

to be 15x (i.e. stock price of INR1,500), the Dividend Yield works out to an attractive 5.3% (80

÷ 1,500), compared to the typical yield range of 1-3%.

Thus, even assuming the upper end of the yield band, for an 80% payout company, 27 (i.e. 80 ÷

3) virtually becomes the floor P/E.

Again using (1), we get k-g = Payout

PE

............................................................................. (4)

Combining (3) and (4), we have k-g = Dividend Yield or k = g + Dividend Yield ………… (5)

Thus, return is a positive function of growth and dividend yield.

The RoE angle:

Finally, there is the RoE angle. It is wide acknowledged that companies with

high RoE's merit high PE's, but the mathematical link is relatively less known -

Price/Book Value (or MCap/NW) = MCap/PAT (i.e. PE)

x

PAT/NW (i.e. RoE) ……….. (6)

Thus, if two stocks have similar earnings growth, the one with higher RoE should merit a higher

PE multiple, else it becomes more attractive on a Price/Book basis.

Based on (1) to (6), the inferences are -



Price and PE are positive functions of growth, dividend payout, and RoE.



If Required rate of return (k) is less than or more or less equal to Expected actual rate of

return (growth + yield), the stock can be bought at prevailing price levels.



If Required rate of return is meaningfully more than expected rate of return, then the P/E

or price paid will need to be much lower than that prevailing.

7.2. Case studies: How payouts influence P/Es

We studied 3 cases to examine our hypothesis that higher payouts typically mean higher P/Es.

The case studies were done both across sectors and within sectors as follows -

#1 - Infosys v/s Asian Paints and Hindustan Unilever

#2 - ACC v/s Birla Corporation (both from Cement sector)

#3 - HDFC v/s Shriram Transport Finance (both Non-Banking Financials)

The hypothesis holds true in all the three cases.

7.2.1 Case Study #1: Infosys v/s Asian Paints and HUL

We compared the last five years' payout ratios and P/Es of Infosys with Asian Paints and

Hindustan Unilever to test the hypothesis that higher payouts typically mean higher P/Es. Asian

Paints' average payout is 39% v/s 31% for Infosys, and average P/E is 26x v/s 22x for Infosys.

However, here, it may be argued that Asian Paints' higher PAT CAGR of 31% v/s 15% for

Infosys is the main reason for P/E differential.

9 December 2011

28