"Value investors do not talk or focus too much on growth"

Co-founder of Motilal Oswal Financial Services and value investor Raamdeo Agrawal’s annual Wealth Creation Study on finding 100X opportunities in 2014 was well received but it had a drawback. To improvise on that, the 2015 Wealth Creation Study was themed “Mid-to-Mega” which he considers far more robust and practical.

What led you to further dwell on the findings of the 100X study?

During the 100X Wealth Creation Study we learnt a lot of things. When we studied the 47 companies which went up at least 100x over 20 years, we learnt how companies grow from small to big and mini to mega. But later on we realised 100X is a rare phenomenon. Getting right some of the stocks like Infosys, HDFC, Lupin, which gave 100X return, happens rarely and that one should have the wisdom to buy at the right time and hold them. What i mean to say is that the probability is very low, like winning a lottery. You cannot consciously build a portfolio of 100X as the probability of finding such stocks frequently is very low.

What is the probability of finding 100X opportunities in the current market?

That is what our 2014 study left untouched. We realised that we still need to work and refine it further. Hence, we started working on the probability of getting a 100X idea. If you recall the 2014 study, we had coined the term “QGLP”, an abbreviation for quality, growth, longevity and price. The framework remains the same whether it is 100X or Mid-to-Mega, the 2015 study.

While variables like quality, longevity and price were thoroughly explored, the grey area in the framework was growth. The billion dollar question was: How to anticipate, calibrate and value growth? It is very obvious that growth is the biggest difference in the Infosys of 1995 compared to the Infosys of 2015. Infosys had a ₹100 crore market cap in 1995 and today has a market cap of around ₹250,000 crore.

The problem is that since growth cannot be reliably predicted, many value practitioners do not bother about growth. They buy cheap and if growth kicks in, they benefit from both. Most value practitioners are from the Benjamin Graham School: Buy cheap, the price should be so attractive that you do not have to bother about anything else. So, value investors traditionally do not talk about or focus too much on growth. When we value a business, which is nothing but the present value of future cash flows, how can we calculate it without estimating the future?    

This is where we thought; let us get deep into growth. Because of the previous study we already had the data. We took it further and probed under what circumstances did the growth occur?  What kind of businesses are they, how did the growth happen?

What are the attributes of extraordinary growth?

We identified two important things — one is value migration and the other is value creation. To put it in perspective, there was a huge value migration happening from fixed-line telecom service providers to wireless service providers as a result of which companies like Airtel and others grew at the cost of MTNL and other fixed-line service providers. In the case of value migration, you have a ready market. Another example is from PSU banks to private sector banks. Then, in IT we have a lot of opportunities coming from outsourcing because of the low cost. To my mind this is the world’s biggest value migration. This is why we believe that the spots where there is value migration, the growth is strong and powerful. If you can identify such spots there is a possibility that you might get good growth stories.    

The other important thing is value creation through a strong tailwind. For instance, look at the housing finance sector, which has been growing at 20-22% annually as a result of huge demand and an underpenetrated market. In such a case, you need to estimate the size of the opportunity. In the year 2000, of the $500-billion tech global outsourcing, India was doing $500 million. Today we are doing $100 billion of a $trillion-global tech outsourcing. By the year 2025, it is estimated that there will be close to $2-trillion global IT outsourcing and India will be doing $300-400 billion. If we get it right, a huge amount of money will be made by Indian companies.

We need that kind of uncontested very large opportunity. It may be domestic or global; the opportunity can come from anywhere. Needless to say, you need terrific management. In 1993 there were hundreds of companies, which opened shop and got listed but today very few are delivering growth. And the credit for this goes to the management. So there is no set growth formula. It is in fact a 'lollapalooza' effect where all the forces work together in your favour. When you get such an opportunity and understand how the story is going to play out, buy it.

You can read part two of the interview here