Thematic Study

19 December 2008

Great

Good

Gruesome

13TH ANNUAL WEALTH CREATION STUDY (2003 - 2008)

HIGHLIGHTS

Understanding of Great, Good and Gruesome companies is critical to investment success.

Great time to buy Great companies (perpetual bonds) at reasonable prices, as interest rates are

likely to remain low for quite some time.

Gruesome companies are best avoided.

Market is likely to see a sector churn - dominance of commodities will probably give way to users

of commodities.

Corporate profit boom of last five years is unlikely to continue. However, we have probably seen

the market bottom at Sensex levels of 7,700.

WEALTH CREAT

TOP 10 WEALTH CREATORS (2003 - 2008)

THE BIGGEST

Rank Company

1

2

3

4

5

6

7

8

9

10

Reliance Industries

ONGC

Bharti Airtel

NMDC

MMTC

BHEL

Larsen & Toubro

SAIL

State Bank of India

ITC

Wealth

Created

(Rs b)

3,077

1,593

1,505

1,356

1,084

952

813

727

701

617

THE FASTEST

Company

5-Y

5-Year

Price

CAGR (%)

284

216

187

177

173

160

158

155

152

150

THE MOST CONSISTENT

Company

Infosys

Hero Honda

Ranbaxy Labs

Sun Pharma

Reliance Industries

HDFC

Cipla

Satyam Computer

Piramal Healthcare

ITC

Appeared

in WC

Study (x)

10

10

10

9

9

9

9

9

9

9

10-Y

10-Year

Price

CAGR (%)

25.7

16.5

8.7

46.0

40.5

40.2

21.8

19.2

16.6

13.9

Unitech

Jai Corp

MMTC

Financial Technologies

BF Utilities

Aban Offshore

NMDC

Godrej Industries

Sesa Goa

REI Agro

Raamdeo Agrawal

(

Raamdeo@MotilalOswal.com

) /

Shrinath Mithanthaya (ShrinathM@MotilalOswal.com)

We thank Mr Dhruv Mehta (dhruvlmehta@gmail.com), Investment Consultant, for his invaluable contribution to this report.

Wealth Creation Study 2003-2008

Contents

Objective, Concept and Methodology

Wealth Creation Study 2003-2008: Findings

Theme 2009: The Great, the Good and the Gruesome

Market Outlook

Appendix I: MOSL 100 – Biggest Wealth Creators

Appendix II: MOSL 100 – Fastest Wealth Creators

Appendix III: MOSL 100 – Wealth Creators (alphabetical)

3

4-18

20-33

34-37

39-40

41-42

43-44

Abbreviations and Terms used in this report

ABBREVIATION / TERM

DESCRIPTION

2003, 2008, etc

Avg

CAGR

L to P / P to L

Price CAGR

RS 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 2003 to 2008

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.

19 December 2008

2

Wealth Creation Study 2003-2008

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 is compared

to the intrinsic value, the higher is the margin of safety. In this year’ study, we continue

s

our 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 How to Value a Business.

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 2003-2008. These companies have the distinction of having

added at least Rs1b to their market capitalization over this period of five years, after

adjusting for dilution. We have termed the group of Wealth Creators as the ‘

MOSL - 100’

.

The biggest and fastest Wealth Creators have been listed in Appendix I and II on page 39

and 41, 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 2009

Our Theme for 2009 is

The Great, the Good and the Gruesome,

discussion on

which starts from page 20.

* Capitaline database has been used for this study

19 December 2008

3

Wealth Creation Study 2003-2008

Findings

Wealth Creation

2003-2008

The 13

TH

Annual Study

Findings

19 December 2008

4

Wealth Creation Study 2003-2008

Findings

Wealth Creation

2003-2008

The Biggest Wealth Creators

Reliance Industries is No.1

Reliance is the biggest Wealth Creator for the second

year in a row. The company has steadily climbed

its way up the list of Motilal Oswal Biggest Wealth

Creators. It was ranked 4

th

in 2004, 3

rd

in 2005, 2

nd

in 2006 (behind ONGC) and 1

st

in 2007.

Wider participation in wealth creation

In 2003-08, top 10 wealth creating companies

accounted for 49% of wealth created compared to

76% during 1998-2003. The strong bull run in the

market has led to wider participation in the wealth

creation process.

TOP 10 BIGGEST WEALTH CREATORS

RANK COMPANY

NET WEALTH CREATED

RS B

% SHARE

PRICE

CAGR (%)

PAT

CAGR (%)

FY08

P/E (X)

FY03

1

2

3

4

5

6

7

8

9

10

Reliance Inds.

ONGC

Bharti Airtel

NMDC

MMTC

BHEL

Larsen & Toubro

SAIL

State Bank of India

ITC

3,077

1,593

1,505

1,356

1,084

952

813

727

701

617

12.1

6.3

5.9

5.3

4.3

3.7

3.2

2.9

2.8

2.4

58.7

32.8

96.4

158.3

186.8

79.1

100.9

83.8

44.4

37.5

36.5

9.7

L to P

59.8

51.6

45.1

38.1

L to P

16.7

17.9

16.9

12.6

24.5

42.1

543.6

35.2

40.7

10.1

15.0

24.9

9.4

4.8

L to P

3.8

22.4

12.3

10.6

L to P

4.6

11.4

DISTRIBUTION OF WEALTH CREATION BY RANK (%)

76

2008

2003

49

16

Key Finding

Commodities led by Oil & Gas had been the front

runners in 2003-08. But change of leadership is

almost certain going forward.

19 December 2008

5

11

10

4

7

3

5 2

41-50

4 2

51-60

3 1

61-70

2 1

71-80

2 0

81-90

2 0

91-100

1-10

11-20

21-30

31-40

Wealth Creation Study 2003-2008

Findings

Wealth Creation

2003-2008

The Fastest Wealth Creators

Unitech is No.1

Unitech is the Fastest Wealth Creator during 2003-

08, with a 5-year stock price CAGR of a whopping

284%. This is the highest ever in our 13 Wealth

Creation studies so far.

MMTC and NMDC enjoy the rare privilege of

featuring in both the biggest and fastest wealth

creators list.

Two dominant themes

(1) Real estate / Embedded value (Unitech, B F

Utilities, Godrej Industries, Jai Corp, Financial

Technologies) and (2) Commodities (MMTC,

NMDC, Sesa Goa and REI Agro).

Key Finding

At times, Fad Investing (e.g. Real estate) and

Momentum Investing (e.g. Commodities) can make

serious money in the stock markets over reasonably

long periods.

Nothing is more profitable than investing in an early

stage bubble.

19 December 2008

6

TOP 10 FASTEST WEALTH CREATORS

RANK COMPANY

PRICE

APPREN. (X)

PRICE

CAGR (%)

PAT

CAGR (%)

MCAP (RS B)

FY08

FY03

1

2

3

4

5

6

7

8

9

10

Unitech

Jai Corp

MMTC

Financial Tech.

BF Utilities

Aban Offshore

NMDC Ltd

Godrej Indus.

Sesa Goa

REI Agro

837

316

194

164

152

118

115

108

102

99

284

216

187

177

173

160

158

155

152

150

150

50

52

226

45

77

60

27

160

66

448

92

1090

74

40

114

1367

83

123

71

0.5

0.3

5.6

0.4

0.3

0.9

11.9

0.7

1.2

0.4

2003-08 PRICE APPRECIATION (X): UNITECH - FASTEST EVER WEALTH CREATOR

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

837 Unitech

665 B F Utilities

182 Matrix Labs

136 Matrix Labs

75 Matrix Labs

50 e-Serve

69 Wipro

66 Infosys

223 SSI

75

Satyam Computer

23

Satyam Computer

7

Cipla

30

Dr Reddy's Labs

Wealth Creation Study 2003-2008

Findings

Wealth Creation

2003-2008

Most Consistent Wealth Creators

TOP 10 CONSISTENT WEALTH CREATORS

Infosys is Most Consistent

Infosys, Hero Honda and Ranbaxy have all appeared

in all of the last 10 studies. Infosys is ranked as the

most consistent by virtue of its higher price CAGR.

Indian IT, which is truly global and stable in

character, is a new source of consistent wealth

creation.

RANK COMPANY

APPEARED IN LAST

10 WC STUDIES (X)

10-YR PRICE

CAGR (%)

PAT

CAGR (%)

P/E (X)

2008

2003

1

2

3

4

5

6

7

8

9

10

Infosys Tech.

Hero Honda Motor

Ranbaxy Labs.

Sun Pharma.

Reliance Inds.

HDFC

Cipla

Satyam Computer

Piramal Healthcare

ITC

10

10

10

9

9

9

9

9

9

9

25.7

16.5

8.7

46.0

40.5

40.2

21.8

19.2

16.6

13.9

36.1

10.8

-0.2

34.4

36.5

28.7

23.1

41.0

20.6

17.9

18.3

14.2

26.5

25.2

16.9

27.8

24.4

15.4

21.0

24.9

27.9

6.5

18.6

10.9

9.4

11.7

17.3

18.1

6.6

11.4

CONSUMER COMPANIES SCORE HIGH ON CONSISTENT WEALTH CREATION

Consistent Wealth Creators - 2005, 2006, 2007 & 2008

Consumer Facing

Pharma

?

Cipla

?

Dr Reddy's Lab

?

Piramal Healthcare

?

Piramal Healthcare

?

Ranbaxy Lab

?

Sun Pharma

FMCG

?

Asian Paints

?

ITC

Non-Consumer Facing

Others

?

Hero Honda

?

HDFC

IT

?

Infosys

?

Wipro

?

Satyam

?

Reliance Industries

Key Finding

FMCG, Pharma and IT companies dominate the list

of consistent wealth creators. Thus, non-cyclicality

of business is a key driver of consistent wealth

creation.

19 December 2008

7

Wealth Creation Study 2003-2008

Findings

Wealth Creators (Wealthex)

Comparative Performance

v/s BSE Sensex

Superior performance on all fronts

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. The Wealthex is superior to the Sensex

in all the three.

Market performance:

The Wealthex significantly

beat the Sensex in FY04, FY05 and FY08, and

matched it in FY06 and FY07. Over the five-year

period FY03-08, the Wealthex outperformed the

Sensex by 241%.

Earnings growth:

Five-year EPS CAGR for the

Wealthex is 26%, compared to 25% for the Sensex.

Valuation:

In spite of superior earnings

performance, the Wealthex traded cheaper than the

Sensex in each of the last six years.

Key Finding

Wealth creating companies were available in 2003

at superior valuation to Sensex, which led to their

outperformance.

19 December 2008

8

WEALTH CREATORS’ INDEX V/S BSE SENSEX (31.3.03 TO 31.3.08)

Wealthex - Rebased

32,000

Sensex

241% Outperformance

24,000

16,000

8,000

0

SENSEX V/S WEALTH CREATORS: HIGHER EARNINGS GROWTH, LOWER VALUATION

MAR-03 MAR-04 MAR-05 MAR-06 MAR-07 MAR-08

5-YEAR

CAGR (%)

BSE Sensex

YoY Performance (%)

Wealth Creators - based to Sensex

YoY Performance (%)

Sensex EPS

YoY Performance (%)

Sensex P/E (x)

Wealth Creators EPS

YoY Performance (%)

Wealth Creators P/E (x)

3,049

3,049

272

11.2

386

7.9

5,591

83.4

6,470

112.2

348

27.9

16.1

487

26.3

13.3

6,493

16.1

8,019

23.9

450

29.3

14.4

641

31.6

12.5

11,280

73.7

13,724

71.1

523

16.2

21.6

719

12.2

19.1

13,072

15.9

15,680

14.2

718

37.4

18.2

977

35.9

16.0

15,644

19.7

22,987

46.6

833

16.0

18.8

1228

25.7

18.7

38.7

49.8

25.1

26.1

Wealth Creation Study 2003-2008

Findings

(RS B)

PRICE

CAGR

(%)

PAT

CAGR

(%)

P/E (X)

2008

2003

Wealth Creators

Classification By

Industry

Size: The commodity factor

Oil & Gas (led by Reliance and ONGC) and Metals/

Mining (led by NMDC, MMTC and SAIL) dominate

the wealth created, with a combined share of 40%.

In 2003, their share was half this figure. In contrast,

IT which enjoyed 43% share in 2003, has a share

of only 5% in 2008.

Speed: The fad factor

Real estate and Retail emerged the fastest wealth

creators, as they were the “flavor-of-the-season”

sectors for investors in the Indian markets.

Metals/Mining, Engineering, Telecom: Best

of both worlds

Metals/Mining, Engineering and Telecom enjoyed

the best combination of size and speed.

Key Finding

Engineering and Telecom are the sectors to watch

out for in terms of huge wealth creation at a rapid

pace. Oil & Gas and Metals/Mining may lose out as

they are hit by the global slowdown, and collapse in

commodity prices.

19 December 2008

9

W E A L T H C R E A T ORS: C L A S S I F I C A T I O N B Y I N D U S T R Y

WEALTH

INDUSTRY

CREATED

(RS B)

SHARE OF WEALTH

CREATED (%)

2008

2003

Oil & Gas (8)

5,826

Metals/Mining (13)

4,416

Banking & Finance (15)

3,282

Engineering (10)

2,603

Telecom (2)

1,636

IT (5)

1,234

FMCG (6)

1,180

Pharma (8)

733

Auto (7)

680

Ultility (4)

635

Cement (4)

527

Construction/Real Estate (2) 491

Media (2)

147

Retail (2)

96

Others (12)

1,903

Total

25,390

22.9

17.4

12.9

10.3

6.4

4.9

4.6

2.9

2.7

2.5

2.1

1.9

0.6

0.4

7.5

100.0

17.0

2.0

12.0

2.0

0.0

43.0

2.0

15.0

2.0

0.0

1.0

0.0

0.0

0.0

4.0

100.0

41.5

83.3

54.1

78.3

87.8

24.4

25.9

35.1

45.2

52.5

50.7

253.4

42.4

107.8

91.3

49.8

15.9

62.7

21.5

40.2

63.4

35.6

12.5

24.2

32.7

10.7

49.6

116.5

28.4

73.4

33.5

26.2

14.2

16.8

16.3

34.0

25.6

17.7

27.6

23.1

16.1

25.9

11.2

40.4

47.1

41.2

35.4

18.7

5.2

9.2

5.0

10.2

12.8

27.3

15.8

15.2

10.3

5.2

10.8

3.5

28.1

16.7

5.9

7.9

NEW ECONOMY PERFORMANCE IN THE TOP 100 WEALTH CREATORS

No of Companies

% Wealth Created

10

5

1

2000-05

2001-06

20

11.9

10

10

1

2002-07

2003-08

Wealth Creation Study 2003-2008

Findings

Wealth Creators

Classification By

MNCs v/s Indian Companies

MNCs have underperformed Indian

companies

During the study period, MNCs sharply

underperformed Indian companies both in terms of

earnings CAGR and price CAGR. However, Indian

markets still believe in the long-term potential of

MNCs as indicated by their higher P/Es.

MNC dominance on the wane

The last 10 wealth creation studies clearly indicate

the waning dominance of MNCs in India. Over the

last 10 years, MNCs have lost significant share both

in terms of number of companies and amount of

wealth created.

Within MNCs, engineering and capital goods

companies like ABB, Siemens, Bosch and Cummins

are increasing their share of wealth created, relative

to consumer goods companies like Hindustan

Unilever and Colgate.

Key Finding

New Indian businesses and entrepreneurs have

eclipsed old MNC clout in wealth creation. New

MNCs like Nokia and Samsung do not seem keen

on listing themselves in India.

19 December 2008

10

WEALTH CREATORS: MNCs V/S INDIAN COMPANIES

2003-2008

MNC

INDIAN

Number of Wealth Creators

% Wealth Created

5-year Earnings CAGR (%)

5-year Price CAGR (%)

P/E (x) at the Beginning of Study Period

P/E (x) at the End of Study Period

10

6.8

20.1

31.4

15.5

24.3

90

93.2

26.6

52.2

7.3

18.4

MNCs ARE WANING IN WEALTH CREATION

80

50

60

43

40

20

0

15

21

Top Wealth Creating MNCs

30

23

3

16

10

8

2

Share of Wealth Created (%)

60.0

40.0

7

11

10

12

7

10

7

10

20.0

0.0

-20.0

19

1994-99 1995-00 1996-01 1997-02 1998-03 1999-04 2000-05 2001-06 2002-07 2003-08

Wealth Creation Study 2003-2008

Findings

Wealth Creators

Classification By

Ownership: State v/s Private

WEALTH CREATORS: STATE-OWNED V/S PRIVATELY-OWNED

During the study period, PSUs in aggregate

underperformed the Indian companies in terms of

earnings CAGR. However, led by commodity

companies such as ONGC, NMDC, MMTC and

SAIL, PSUs matched their private sector

counterparts in terms of price CAGR.

Value migration to the private sector has been

reversed in 2003-08. However, we believe this is

temporary as it is mainly led by commodity price

hikes, which have since corrected sharply.

2003-2008

STATE-OWNED

PRIVATE

No. of Wealth Creators in Top 100

Share of Wealth Created (%)

5-year Earnings CAGR (%)

5-year Price CAGR (%)

P/E (x) at the Beginning of Study Period

P/E (x) at the End of Study Period

25

34.6

17.0

49.9

4.6

15.9

75

65.4

35.7

49.7

12.6

20.6

DEREGULATION DIMINISHES ROLE OF STATE-OWNED COMPANIES IN WEALTH CREATED

48.5

50.6

35.9

No of PSUs

% Wealth Created

34.6

24.8

18.0

25.0

Key Finding

PSUs sometimes tend to be the handmaidens of

the government (eg. Gujarat state government has

mandated that all Gujarat state PSUs set aside 30%

of their PBT towards corporate social responsibility).

Hence, it is advisable to have a large weight for the

private sector in any portfolio. However, select PSUs

like SBI, BHEL and ONGC, which are dominant in

their respective sectors cannot be ignored.

19 December 2008

11

28.0

30.0

26.0

1999-2004

2000-2005

2001-2006

2002-2007

2003-2008

Wealth Creation Study 2003-2008

Findings

Wealth Creators

Classification By

Age Group

WEALTH CREATORS: CLASSIFICATION BY AGE-GROUP

Old companies for size, young for speed

The older companies tend to contribute higher share

of wealth created, while the newer companies have

speed in their favor, given their low base.

During 2003-08, companies in the age range of 21-

50 have contributed to 52% of the wealth created.

Companies less than 10 years old have recorded a

price CAGR of almost 150% over five years. The

price performance of all other age groups has been

closer to the average price CAGR of 50%.

NO. OF YEARS

NO. OF COS.

WEALTH CREATED (RS B)

% SHARE OF WC

PAT CAGR (%)

0-10

11-20

21-30

31-40

41-50

51-60

61-70

71-80

81-90

>90

Total

2

17

19

7

15

14

9

6

3

8

100

150

5,449

2,982

2,384

7,936

1,945

1,915

805

337

1,487

25,390

0.6

21.5

11.7

9.4

31.3

7.7

7.5

3.2

1.3

5.9

100.0

85.9

23.1

26.6

76.9

27.6

17.4

37.2

19.6

18.7

21.0

26.2

WEALTH CREATORS: PRICE CAGR BY AGE RANGE

Key Finding

Catch them young. Companies less than 10 years

old tend to report much higher PAT growth, given

their low base. High earnings growth leads to high

P/Es, which explains their outperformance to older

peers.

Example:

The 0-10 year-old high fliers in our study

are BF Utilities and United Spirits.

19 December 2008

12

149

81

52

45

57

49

39

Avg Price CAGR: 50%

50

25

43

0-10

11-20

21-30

31-40

41-50

51-60

Age Range (Years)

61-70

71-80

81-90

>90

Wealth Creation Study 2003-2008

Findings

Wealth Creators

Classification By

Size

Data indicates an inverse relationship between

MCap and speed of returns i.e. smaller the market

cap, larger the returns. Stocks which had less than

Rs2b MCap in 2003 have delivered a price CAGR

of 165%. On the other hand, large caps offered

33% returns, much lower than the average of 50%.

Rapidly growing and deregulating Indian economy

will produce many young and fast-growing

enterprises.

WEALTH CREATORS: BASE YEAR MARKET CAP

2003 MARKET CAP

RANGE (RS B)

NO. OF

COMPANIES

WEALTH CREATED SHARE OF WC

(RS B)

(%)

2008

MCAP (RS B)

2003

<2

2-5

5-10

10-20

20-50

50-100

100-200

>200

Total

17

13

14

14

24

9

4

5

100

1,707

1,222

2,956

2,572

5,068

4,467

1,705

5,694

25,390

7

5

12

10

20

18

7

22

100

1,878

1,307

3,266

2,787

6,126

5,493

2,482

7,335

30,675

15

38

106

177

793

574

595

1,772

4,068

WEALTH CREATORS: PRICE CAGR BY MARKET CAP RANGE IN 2003

165

Key Finding

Small- and mid-size companies with a large

business opportunity and ambitious, aggressive

management can prove to be kickers for superior

returns in any portfolio.

Example:

Some of the sub-Rs2b companies in our

2003-08 study include Unitech, Pantaloon, Aban

Offshore, Sesa Goa, Voltas and United Spirits.

19 December 2008

13

103

99

74

51

57

33

33

Avg Price CAGR: 50%

<2

2-5

5-10

10-20

20-50

50-100

2003 Market Cap Range (Rs b)

100-200

>200

Wealth Creation Study 2003-2008

Findings

Wealth Creators

Classification By

Sales and Earnings Growth

Sales growth: Higher the better

This is saying the obvious, but still saying it is

important. Typically, one would expect high sales

growth to be accompanied by high valuation

multiples. However, occasionally, the market throws

in bargains e.g. companies whose 2003-08 sales

CAGR was in the range of 40-50% were available

at a PE of 5x in FY03.

In the adjacent table, 40-50% sales growth

companies include cylicals such as Sterlite, Jindal

Steel and Hindustan Zinc. The >50% range includes

sunrise companies like Bharti Airtel, Financial

Technologies, Pantaloon Retail and TV18.

WEALTH CREATORS: CLASSIFICATION BY SALES GROWTH

SALES GR.

RANGE

(%)

NO. OF

COS.

SHARE

OF WC

(%)

PRICE

CAGR

(%)

PAT

CAGR

(%)

2008

2003

2008

2003

ROE (%)

P/E (X)

0-10

10-20

20-30

30-40

40-50

>50

Total

15

25

26

19

5

10

100

9.3

22.6

31.1

22.2

4.7

10.1

100.0

33.2

40.1

57.5

50.9

114.4

109.3

49.8

10.9

17.6

34.8

42.7

66.1

L to P

26.2

15.0

22.5

20.5

23.7

24.0

29.1

21.3

18.0

25.2

15.2

15.2

15.7

-1.6

19.4

19.4

12.3

20.6

27.8

17.8

24.2

18.7

7.7

5.1

9.5

21.0

5.0

N.A.

7.9

WEALTH CREATORS: PRICE CAGR BY 2003-08 EARNINGS GROWTH RANGE

108

98

Key Finding

Sunrise businesses (such as telecom, retail, media,

insurance) should continue to do well in the

foreseeable future. At the same time, the growing

Indian economy has resulted in a new dawn for many

traditional businesses such as engineering,

construction and financial services.

19 December 2008

14

Avg Price CAGR: 50%

49

43

27

45

67

0-10

10-20

20-30

30-40

40-50

Earnings Growth Range (%)

50-70

>70

Wealth Creation Study 2003-2008

Findings

Wealth Creators

Classification By

RoE

WEALTH CREATORS: PRICE CAGR BY ROE

Bargains are found when markets are blind to

change

When profitability of companies is good (i.e. high

RoE), it is tough to find them cheap. This causes a

paradox – companies which already have high RoE

do not tend to deliver high stock price returns.

Bargains are available when changing dynamics of

a company’ business is not known to the market

s

i.e. when current RoEs are low. However, such

investments also have attendant risks.

One way of balancing risk and return is to invest in

companies with moderate RoEs (10-20%), and

potential for growth.

92

Bargains

77

Risk-return balance

56

61

39

36

32

15

Avg Price CAGR: 50%

<5

5-10

10-15

15-20

20-25

25-30

30-40

>40

2003 RoE Range (%)

Key Finding

Anticipating change in profitability ahead of the

crowd is rewarded very well in the markets.

19 December 2008

15

Wealth Creation Study 2003-2008

Findings

Wealth Creators

Classification By

Valuation Parameters

WEALTH CREATORS: CLASSIFICATION BY VALUATION PARAMETERS (MARCH 2003)

Margin of safety in single digit PE

Two-thirds of wealth created, and two-thirds of the

top wealth creators had a PE of less than 10x in

2003. This suggests high margin of safety in single

digit PE multiples.

Price/Book of less than 1x works best!

47 out of the top 100 wealth creators were available

in 2003 at Price/Book of less than 1x. Their price

CAGR at 67% is significantly higher than the

average 50%.

NO. OF COS

% WEALTH CREATED

PRICE CAGR %

P/E (x)

<5

5-10

10-15

15-20

>20

Total

Price/Book (x)

<1

1-2

>2

Total

Price/Sales (x)

<0.25

0.25-0.50

0.50-1.00

1-2

>2

Total

36

27

18

7

12

100

41

26

18

5

11

100

55

57

59

25

37

50

47

32

21

100

34

49

17

100

67

54

30

50

Watch out for Price/Sales of 1x or less

66 of the top 100 wealth creators had Price/Sales

of 1x or less in 2003.

19

19

28

14

20

100

15

13

37

18

17

100

66

63

62

47

30

50

19 December 2008

16

Wealth Creation Study 2003-2008

Findings

Wealth Creators

Classification By

Valuation Parameters

(contd.)

WEALTH CREATORS: CLASSIFICATION BY VALUATION PARAMETERS (MARCH 2003)

Payback of less than 1x guarantees high

returns

Payback is the ratio of current market cap divided

by expected profits of the next five years.

When companies are in high growth phase, it is

difficult to value them using conventional measures.

Payback is based on empirical wisdom that markets

try and seek visibility of five years.

A high 82 of the top 100 wealth creators presented

a payback opportunity of less than 1x in 2003.

NO. OF COS

% WEALTH CREATED

PRICE CAGR %

Payback Ratio (x)

<0.25

0.25-0.50

0.50-1.00

1-2

>2

Total

22

28

32

9

9

100

18

19

48

10

6

100

116

59

50

38

22

50

MEDIAN VALUATIONS (X)

2003

SENSEX

WEALTH CREATORS

SENSEX

2008

WEALTH CREATORS

Median P/E

Median Price/Book

Median Price/Sales

13.1

1.9

1.3

6.7

1.0

0.7

20.4

4.1

3.6

22.1

4.6

3.5

Key Finding

The median valuations in 2003 clearly spell out the

sure shot formulas for multi-baggers –

?

PE of less than 10x

?

?

?

Price/Book of less than 1x

Price/Sales of 1x or less

Payback ratio of 1x or less

17

19 December 2008

Wealth Creation Study 2003-2008

Findings

Wealth Destroyers

TOP-10 WEALTH DESTROYERS (2003-2008)

COMPANY

RS B

WEALTH DESTROYED

% SHARE

PRICE

CAGR (%)

Wealth destroyed is 0.2% of wealth created

The stock market boom in 2003-08 is so widespread

that total wealth destroyed is only Rs59b. This is

barely 0.2% of the Rs25,390b wealth created by

the top 100 companies alone.

Among the top wealth destroyers, HPCL and TVS

Motor are the only prominent names.

HPCL

Vaibhav Gems

Media Matrix

Pan India Corporation

Rashel Agrotech

T. Spiritual

JIK Industries

Netvision Web

Ramco Systems

TVS Motor

Gufic BioScience

Total of above

Total Wealth Destroyed

WEALTH DESTRUCTION BY INDUSTRY

13

4

3

2

2

2

2

2

1

1

1

33

59

22

7

5

4

3

3

3

3

2

2

2

56

100

-3

25

-33

17

-59

-47

-54

-43

-19

-3

-16

Trading

Autos

Textiles

7%

6%

7%

Pharma

6%

Chemicals

4%

Finance

4%

Key Finding

Oil & Gas and Finance figure among top wealth

creating industries as well as top wealth destroying

industries. This suggests that wealth creation is

more dependent on company-specific – rather than

industry-level – factors.

19 December 2008

18

Others

17%

Media

7%

Oil & Gas

23%

IT

19%

Wealth Creation Study 2003-2008

THIS PAGE IS INTENTIONALLY LEFT BLANK

19 December 2008

19

Wealth Creation Study 2003-2008

Theme 2009

Wealth Creation

2003-2008

The 13

TH

Annual Study

Theme 2009

19 December 2008

20

Wealth Creation Study 2003-2008

Theme 2009

The Great, the Good and the Gruesome

Introduction

Every year, legendary investor Warren Buffett personally writes the Chairman’ annual

s

letter to shareholders of his diversified company, Berkshire Hathaway Inc.

His 2007 letter has a section on “Businesses – The Great, the Good and the Gruesome”,

where he discusses what kind of companies Berkshire likes and what it wishes to avoid.

We believe this section is a worthwhile “back-to-basics” exercise. We have applied our

understanding of the same to the Indian corporate sector.

Defining Great, Good and Gruesome companies

Buffett equates the Great, the Good and the Gruesome companies to three types of bank

savings accounts, where the interest rate is RoE (return on equity). He says, “Think of

three types of savings accounts. The Great one pays an extraordinarily high interest rate

that will rise as the years pass. The Good one pays an attractive rate of interest that will be

earned also on deposits that are added. Finally, the Gruesome account both pays an

inadequate interest rate and requires you to keep adding money at those disappointing

returns.”

Graphically, the Great, Good and Gruesome companies can be depicted as under.

DEFINING THE GREAT, THE GOOD, THE GRUESOME

High

Great Companies

Good Companies

Attractive

Gruesome Companies

Low/

Negative

Time/Equity Capital Employed

Source: MOSL

19 December 2008

21

Wealth Creation Study 2003-2008

Theme 2009

Understanding Great, Good, Gruesome companies

Great companies

Firstly, it must be mentioned that any country will have only a few Great companies. A

truly Great company

must

have an “enduring moat” (i.e. long-term competitive advantage)

that protects excellent returns on invested capital. This is possible only in either of two

cases –

1. It must be either a low-cost producer, or

2. It possesses powerful brand(s).

Great companies tend to grow slower than their Good and Gruesome counterparts. But

the key aspect of this growth is that it is achieved by consuming very little additional

capital. Over time, given the power of compounding, Great companies become significant

cash machines with high and steadily rising RoE, and high dividend payouts. Investors can

deploy these payouts to earn returns in other avenues.

To quote Buffett, “Long-term competitive advantage in a stable industry is what we seek

in a business.

If that comes with rapid organic growth, great. But even without

organic growth, such a business is rewarding.

We will simply take the lush earnings

of the business and use them to buy similar businesses elsewhere.”

Good companies

Good companies grow at healthy rates, but need large increases in capital to sustain growth.

Like Great companies, they too enjoy competitive advantage and make healthy profits.

However, they need to reinvest a significant proportion of these profits for growth.

Buffett calls this the “put-up-more-to-earn-more” phenomenon, which is true of most

companies across countries. Compared to great companies, return ratios will tend to be

much lower, as will dividend payouts.

Gruesome companies

Paradoxically, Gruesome companies tend to enjoy very high growth rates, which turns out

to be a trap. These companies require significant capital for such growth, and then earn

little or no money.

Buffett says, “Think airlines. Here a durable competitive advantage has proven elusive

since the days of the Wright brothers … The airline industry’ demand for capital ever

s

since that first flight has been insatiable. Investors have poured money into a bottomless

pit, attracted by growth when they should have been repelled by it.”

19 December 2008

22

Wealth Creation Study 2003-2008

Theme 2009

Characteristics of Great, Good and Gruesome companies

Return on equity is the financial differentiator of Great, Good and Gruesome companies.

However, numbers are lag indicators, and are the outcome of several qualitative

characteristics of the businesses. We summarize them below (for a fuller description of

the characteristics, see Annexure 1, page 28).

IDENTIFYING THE GREAT, THE GOOD AND THE GRUESOME

CRITERIA

GREAT

GOOD

GRUESOME

Nature of

Business

Competitive

Advantage

?

Stable business i.e. no

rapid or continuous change

High and rising long-term

competitive advantage from

brand / lowest-cost production

High pricing power

Low dependence on greatness

of management

Typically moderate growth;

high growth rates a rarity

Low capital intensity; high level

of intangible assets

Very high and rising RoE

Typically, high dividend

payout

Hero Honda, Nestle,

GSK Pharma, Infosys

?

Subject to moderate change

?

Business likely to have

rapid changes

Low or no competitive

advantage

?

?

Steady competitive advantage

?

Pricing Power

Management

?

?

?

?

Moderate pricing power

Management, key success

factor

Moderate-to-high growth rate

?

?

Pricing power absent

High dependence on

management

Typically high growth

rates

Very high capital

intensity

Low / falling RoE

Low or zero dividend

payout

Tata Tele, Jet Airways,

Arvind

Source: MOSL

Growth

?

?

?

Capital Intensity

?

?

Moderate-to-high capital

intensity

Stable and attractive RoE

Reasonable dividend payout

?

RoE

Dividend Payout

?

?

?

?

?

?

Examples

?

?

HDFC Bank, Larsen & Toubro,

BHEL, Tata Steel

?

The financial profile of a typical Great, Good and Gruesome company is as tabled below.

GREAT, GOOD AND GRUESOME: TYPICAL FINANCIAL PROFILE

NESTLE

(GREAT)

HDFC BANK

(GOOD)

TATA TELE (MAH)

(GRUESOME)

10-year CAGR (%)

Sales

PAT

Capital Employed

RoE (%)

Latest

10-years Ago

10-year Incremental RoE

In last 10 years

Cumulative PAT (Rs b)

Total Dividend (Rs b)

Average Payout (%)

22.3

18.2

81.0

58.7

12.0

21.0

-26.7

0.0

0.0

Source: MOSL

19 December 2008

102.5

36.4

230.0

17.7

26.4

14.0

Net Worth eroded

-10.3

Not calculable

10.0

19.0

-3.0

44.0

39.0

46.0

101.0

Loss to Loss

15.0

23

Wealth Creation Study 2003-2008

Theme 2009

Key takeaways:

?

Greatness is not dependent on growth.

Nestle has grown much slower than HDFC

Bank both in terms of sales and profit. Its cumulative PAT in the last 10 years too is

less than 40% of HDFC Bank. However, Nestle’ total dividend paid out is 1.5x that

s

of HDFC Bank.

?

Great companies are invariably asset light.

This means that they enjoy high and

rising RoE. In the last 10 years, Nestle’ capital employed actually declined 3% annually.

s

Its RoE was 36% 10 years ago, and its latest RoE is over 100%. Incremental RoE is

a high 230%.

?

Great companies are fountains of dividends.

Nestle’ average payout ratio is a

s

high 81%.

?

Good companies are fountains of earnings.

HDFC Bank has delivered high profits

at high growth rates.

?

Gruesome companies are bottomless pits of capital consumption.

Tata

Teleservices capital employed has grown at a compounded 15% for the last 10 years.

But it has not made profits even in a single year in the last 10 years.

See’ Candy v/s Nestle India: An interesting parallel

s

Warren Buffett cites the example of See’ Candy (owned by Berkshire Hathaway) as an

s

example of a great business.

SEE’ CANDY’ GREAT PERFORMANCE (US$ M)

S

S

1972

2007

CAGR %

Sales

PBT

PBT Margin (%)

PAT

Capital Employed (CE)

PAT / CE (%)

Incremental PAT / CE (%)

Cumulative PBT (35 Years)

Incremental Capital Deployed

Purchase Price

P/E (x)

Post-tax Earnings Yield (%)

Total return (Earnings Yield + PAT CAGR) *

30.0

5.0

16.7

3.4

8.0

41.9

383.0

82.0

21.4

54.9

40.0

137.4

161.2

1,350

32.0

7.5

8.3

8.3

4.7

25.0

7.5

13.4

21.7

* Over the long-term, expected return on stocks is equal to dividend yield + growth rates

The key points of the See’ case are as follows –

s

?

Berkshire acquired See’ in 1972 for US$25m.

s

?

PAT at the time of acquisition was ~US$3.4m, and the capital employed was US$8m,

i.e. PAT/CE of 42%.

?

In 35 years, candy volumes grew only 2% annually (16m pounds in 1972 to 31m

pounds in 2007), sales grew 7.5% and PBT grew 8.3%.

?

In 2007, See’ reported a PAT of ~US$55m, on capital employed of US$40m. Thus,

s

PAT/CE zoomed to 137%.

19 December 2008

24

Wealth Creation Study 2003-2008

Theme 2009

?

Over the 35 years, See’ delivered cumulative pre-tax profit of US$1.35b. This is 42

s

times the incremental investment of US$32m, and 54 times Berkshire’ investment

s

value of US$25m.

The Nestle parallel

We compare the See’ case with the last 15 years data of Nestle India. Like See’ Nestle

s

s,

has deployed very little capital employed relative to incremental earnings. As a result,

incremental PAT/CE is very high.

NESTLE INDIA'S RETURN IS THE SAME AS SEE’ CANDY (RS B)

S

1993

2007

CAGR %

Sales

PBT

PBT Margin (%)

PAT

Capital Employed (CE)

PAT / CE (%)

Incremental PAT / CE (%)

Cumulative PBT (15 Years)

Incremental Capital Deployed

Purchase Price (Mcap)

P/E (x)

Post-tax Earnings Yield (%)

Total Return (Earnings Yield + PAT CAGR)

5.4

0.5

9.8

0.4

2.6

13.3

35.0

6.3

17.9

4.1

4.2

98.3

239.9

37.6

1.6

14.3

19.3

19.3

3.4

16.6

47.3

2.1

21.4

At 21.4%, Nestle’ return is exactly comparable with 21.7% of See’ However, there is

s

s.

one key difference: In Nestle, much of the return is by way of earnings growth, whereas

in See’ it is by way of earnings yield (ie, higher margin of safety, discussed below).

s

Great companies need not be great investments

Great investments are the result of huge margin of safety at the time of purchase.

Margin of safety:

Given below are key quotes by Benjamin Graham on the concept of

margin of safety:

1. “The margin of safety is always dependent on the price paid.”

2. “It is a favorable difference between price [paid] on the one hand, and indicated or

appraised value on the other.”

3. “Margin of safety is available for absorbing the effect of miscalculations or worse

than average luck.”

4. “The function of margin of safety is, in essence, that of rendering unnecessary an

accurate estimate of the future.”

5. “In the ordinary common stock, bought for investment under normal conditions, the

margin of safety lies in an expected earning power considerably above the going rate

for bonds.”

19 December 2008

25

Wealth Creation Study 2003-2008

Theme 2009

Point 5 refers to comparing earnings yield of a stock to the risk-free treasury bond yield.

Higher the gap between the two, higher is the margin of safety. Obviously, if margin of

safety is high the price is great, if it is moderate then the price is good, and if it is low, then

the price is gruesome.

We present below the investment pay-off matrix for the various company-price

combinations.

GREAT, GOOD AND GRUESOME: INVESTMENT PAY-OFF MATRIX

Return:

Return:

High

Return:

Very High

Capital Safety:

High

Great

(High MoS*)

Speculative

Capital Safety:

Moderate

Capital Safety:

High

Return:

Return:

Moderate

Capital Safety:

Moderate

Return:

Moderate-to-High

Capital Safety:

High

Good

(Fair MoS*)

Low-to-Negative

Capital Safety:

Low

Return:

Negative

Return:

Low-to-Negative

Capital Safety:

Risk of Loss of

Capital

Return:

Low

Capital Safety:

High

Gruesome

(Low MoS*)

Capital Safety:

Permanent Loss

of Capital

Gruesome

Good

Company

Great

Great Option; but very rare

* MoS: Margin of Safety

Best Available Option

Avoid

Source: MOSL

Key takeaways

On Great companies:

?

Great companies do not necessarily mean great investments. If bought at gruesome

price, returns will be very low.

?

Great companies at great price are extremely rewarding, but extremely rare as well.

?

Over the long term, Great companies offer high safety of capital.

On Good companies:

?

In buying good companies, margin of safety needs to be higher than when buying

great companies.

19 December 2008

26

Wealth Creation Study 2003-2008

Theme 2009

On Gruesome companies:

?

Gruesome companies grow rapidly, require significant capital to engender the growth,

and then

earn little or no money.

Hence, such companies are best avoided at all

price levels, unless there is high possibility of turnarounds, corporate restructuring, etc.

Best investment strategy:

?

Buying good companies at great (bargain) price or buying great companies at

good (reasonable) price are the two options for investors at large.

Investment examples

Great company at good price: Hero Honda

?

Long-term competitive advantage: (1) 60% market share of Indian motorcycle market;

and (2) strong brand equity including a tie-up with Honda, the world’ leading two-

s

wheeler brand.

?

Reasonably large size of opportunity – motorcycle penetration of only 25% of Indian

households

?

High level of profitability – working on negative capital employed

?

Sensible price tag – TTM P/E of 14x for an expected earnings CAGR of 15-20%.

Good company at great price: State Bank of India

?

India’ largest banking franchise with 25% market share

s

?

High share of low-cost deposits due to large network of branches across India

?

Technology benefits and cost control to significantly expand profits

?

Embedded value of SBI Life, third biggest insurer in India

?

Sensible price tag – stock available at Price/Book of 1x.

Gruesome company that has turned around: Idea Cellular

?

Fourth largest GSM player in India with first mover advantage in many telecom circles

?

Mobility is the natural state of communication; India’ mobile penetration to increase

s

from 25% to 60% by 2012

?

Fastest growing among major wireless operators due to (1) entry into new circles

(Mumbai, Bihar, Tamil Nadu, Orissa, etc) and (2) acquisition of Spice Telecom (Punjab

and Karnataka)

?

Well-funded with equity placement to Telekom Malaysia International and stake sale

of tower subsidiary to private equity fund, Providence

?

Sensible price tag – stock available at P/E of 17x FY09.

In the final analysis, Century Management’ Arnold Van Dan Berg’ words are gospel for

s

s

investors: “There is absolutely no substitute for paying the right price. In the bible, it says

that love covers a multitude of sins. Well, in the investing field, price covers a multitude of

mistakes. For human beings, there is no substitute for love. For investing, there is no

substitute for paying the right price – absolutely none.”

(Outstanding

Investors Digest, April 2004).

19 December 2008

27

Wealth Creation Study 2003-2008

Theme 2009

Annexure 1: Characteristics of Great, Good and Gruesome companies

Great companies

We describe below the typical characteristics of Great businesses.

Stable business:

Companies with businesses that are prone to rapid and continuous

change rarely qualify as Great. “Creative destruction” in unstable businesses could lead to

redundancy of capital invested, adversely affecting cash flows and return on capital.

High and rising long-term competitive advantage:

There are only two sources of an

“enduring moat” (Buffettology for long-term competitive advantage) –

1. Low cost production; and

2. Powerful brand.

The enduring moat of Great companies is more likely to widen as the years pass by. For

instance, branded products (e.g. Colgate) are habit-forming with customers, and switching

costs are high. Such formidable entry barriers allow great companies to:

?

Enjoy pricing power; and

?

Maintain high return on invested capital.

Low dependence on greatness of management:

Buffett’ own words describe this

s

the best: “If a business

requires

a superstar to produce great results, the business itself

cannot be deemed great. A medical partnership led by your area’ premier brain surgeon

s

may enjoy outsized and growing earnings, but that tells little about its future. The partnership’

s

moat will go when the surgeon goes. You can count, though, on the moat of the Mayo

Clinic to endure, even though you can’ name its CEO.”

t

Modest growth rates:

Great companies seem to enjoy modest but stable growth. High

growth rates are a rarity because their businesses are stable, and have typically reached

mature phase.

Low capital intensity, very high RoE, high dividend payout:

For great companies, all

the financial attributes go hand-in-hand. Great companies require very little incremental

capital for growth (e.g. most FMCG and pharma companies outsource their production).

This leads to very high RoE. Free cash flow is also high which enables huge dividend

payouts. For instance, Colgate payout is 100%, Castrol ~95% and Nestle ~90%.

19 December 2008

28

Wealth Creation Study 2003-2008

Theme 2009

Good companies

We describe below the typical characteristics of Good companies.

Subject to moderate change:

Unlike Great companies, the businesses of Good companies

may be subject to moderate level of changes. For instance, banks have to deal with RBI

measures on CRR, repo rates, etc. Likewise, metals sector too is faced with volatility in

product prices.

Steady competitive advantage:

Good companies enjoy steady competitive advantage,

which typically arises from economies of scale (eg, State Bank of India in banking, L&T

in engineering).

Management, a key success factor:

Good companies have relatively weaker moats.

Hence, efficient execution of all major processes becomes a key success factor. Thus,

unlike great companies, good companies will tend to depend on their management’ character

s

and competence.

Moderate-to-high growth rates:

Good companies tend to enjoy growth rates higher

than great businesses. However, such growth requires additional capital, whether own or

from outside.

Moderate-to-high capital intensity, healthy RoE, reasonable dividend payout:

Businesses such as banking, steel and engineering need to plough back a sizeable proportion

of their earnings for fixed- and/or working capital requirements. As a result, though the

businesses are profitable, RoEs tend to be in the 15-25% band and dividend payout 20-

30%.

19 December 2008

29

Wealth Creation Study 2003-2008

Theme 2009

Gruesome companies

We describe below the typical characteristics of Gruesome companies.

Business most likely to have rapid changes:

The best example of this is the dotcom

boom and bust. Companies raised huge amounts of money to fund business models which

were subject to rapid and continuous change.

Low or no long-term competitive advantage:

Gruesome companies do not have an

established track record of long-term competitive advantage. This is mainly because the

business is either nascent and dynamic or extremely competitive (eg, the airlines sector

has been vitiated by the entry of several no-frill airlines).

Businesses with rapid growth due to huge size of opportunity:

Paradoxically,

gruesome companies enjoy great growth rates. This is because such businesses have a

huge size opportunity. For instance, Tata Teleservices sales growth in the last 10 years is

a high 101%. Yet it has not yet reported a profit in any single year.

High dependence on management:

Gruesome companies will be found to be led by

one of two kinds of management: (1) extremely passive and laid-back (eg chemicals) or

(2) extremely aggressive and ambitious (eg airlines, retailing).

Passive managements will be content with carrying on existing low-profit operations,

ploughing back a significant proportion of earnings. On the other hand, if current earnings

are inadequate for the growth plans, an aggressive and ambitious management is the only

hope of raising external funds for Gruesome companies. This typically leads to further

value destruction.

Very high capital intensity, low RoE/losses, low dividend payout:

The universal

example of a gruesome business is airlines. It is very highly capital intensive, leading to

losses in the worst case and low RoE in the best case, implying zero-to-low dividend

payout.

19 December 2008

30

Wealth Creation Study 2003-2008

Theme 2009

Annexure 2 – A mathematical framework for Great, Good and Gruesome

Mathematically, RoE is the starting point to differentiate between Great, Good and Gruesome

businesses. To assess the core operating RoE, the reported RoE can be adjusted to account

for surplus cash, if any, in the balance sheet.

For the purposes of our study, we used Adjusted RoE to shortlist the companies as follows:

Common steps:

1. Universe: Top Wealth Creators (100 companies)

2. Shortlist companies with a 10-year track record (95 companies)

3. Compute Adjusted RoEs for companies whose cash is in excess of debt:

(a) Deduct 7% of cash equivalents from PAT to get Adjusted PAT;

(b) Deduct excess cash from Net Worth to get Adjusted Net Worth;

(c) Compute Adjusted RoE as Adjusted PAT ÷ Adjusted Net Worth.

Classification criteria:

4. Great companies:

(a) 10-year average Adjusted RoE > 25%;

(b) Adjusted RoE not less than 15% in any of the last 10 years; and

(c) rising trend of RoEs (going by Warren Buffett’ definition of great companies).

s

5. Gruesome companies: 10-year average Adjusted RoE of less than 10%

6. Good companies: Companies which are neither Great nor Gruesome

Note:

The above methodology serves as a good first screen of companies. Beyond that

some element of subjectivity will need to be applied to finally decide whether a company

is Great, Good or Gruesome.

19 December 2008

31

Wealth Creation Study 2003-2008

Theme 2009

MOSL 100

–

Top Wealth Creators classified as Great, Good and Gruesome

(Note: All calculations based on consolidated financials wherever applicable)

GREAT COMPANIES

COMPANY

10-YR AVG.

ADJ. ROE %

ROE (%)

LATEST

10 YRS AGO

INCREMENTAL

ROE

ROCE (%)

LATEST

10 YRS AGO

INCREMENTAL

ROCE

DIVIDEND

PAYOUT (%)

Hero Honda Motor

Hind. Unilever

GlaxoSmith Pharma

NMDC Ltd

Nestle India

Infosys Tech.

Satyam Computer

Wipro

Dabur India

Container Corpn

Sun Pharma.

ITC

Asian Paints

394.0

158.5

105.0

101.9

85.1

67.6

53.8

41.5

37.4

36.5

34.2

32.6

32.2

32.4

127.0

39.7

39.2

98.9

33.8

23.3

28.1

54.1

23.2

29.8

25.8

41.7

40.4

47.6

26.8

16.9

31.2

23.5

43.6

27.3

19.2

30.0

22.2

28.8

25.2

31.5

Very high

43.6

41.7

230.2

34.2

22.8

28.1

79.7

22.0

30.2

25.2

49.0

45.3

145.8

58.3

59.7

149.4

38.9

26.0

24.1

55.6

29.0

30.2

37.5

50.0

46.0

57.3

37.6

20.7

31.6

27.6

25.0

21.4

15.1

37.6

19.0

33.5

23.6

45.2

Very high*

65.2

64.0

Very high*

39.4

26.1

24.3

192.2

27.2

31.1

39.0

67.4

45.7

73.9

49.8

18.8

78.6

31.7

16.6

26.1

40.9

21.6

16.2

34.5

45.1

* Very high because incremental capital employed is actually negative

GRUESOME COMPANIES

COMPANY

10-YR AVG.

ADJ. ROE %

ROE (%)

LATEST

10 YRS AGO

INCREMENTAL

ROE

ROCE (%)

LATEST

10 YRS AGO

INCREMENTAL

ROCE

DIVIDEND

PAYOUT (%)

Hind.Copper

HMT

Essar Oil

Aditya Birla Nuvo

Zee Entertainment

Pantaloon Retail

Jai Corp

IDBI Bank

TV 18 India

Reliance Infra

-135.9

-44.0

-0.3

2.6

6.8

6.9

7.8

8.8

8.8

9.4

27.4

-11.8

-1.2

1.5

13.4

-0.5

5.5

10.6

1.1

7.9

-45.5

N.M.

1.2

7.5

31.9

11.9

10.8

13.7

4.1

13.2

52.8

-2.0

-3.3

0.5

12.1

-0.7

5.1

24.8

1.0

7.0

32.6

2.2

-0.3

3.7

18.8

4.5

5.9

7.0

7.7

7.8

-7.8

11.6

0.6

11.2

35.8

16.6

13.2

11.3

11.8

14.4

78.4

-9.0

-0.8

2.7

17.4

4.4

5.4

2.4

7.6

6.6

0.0

0.0

0.0

32.3

18.9

19.9

2.5

20.2

31.4

15.5

GOOD COMPANIES

COMPANY

10-YR AVG.

ADJ. ROE %

ROE (%)

LATEST

10 YRS AGO

INCREMENTAL

ROE

ROCE (%)

LATEST

10 YRS AGO

INCREMENTAL

ROCE

DIVIDEND

PAYOUT (%)

Siemens

Bharat Electronics

Sesa Goa

Financial Tech

Hind.Zinc

Thermax

Unitech

Bosch

HCL Technologies

ABB

Glenmark Pharma

Tata Steel

Voltas

Ambuja Cements

GE Shipping

Jindal Steel

BHEL

SAIL

Natl. Aluminium

Indian Overseas

19 December 2008

82.7

75.7

75.0

69.6

60.5

46.8

46.1

40.1

39.7

36.0

35.6

32.5

29.3

28.7

27.8

26.7

26.5

25.8

24.9

24.9

37.9

25.1

52.4

57.9

37.1

38.3

46.0

23.8

25.2

30.5

41.6

42.4

35.9

38.0

33.7

33.3

26.5

32.6

18.4

25.5

-76.2

12.2

13.8

0.2

7.8

11.0

10.7

17.0

47.0

8.4

36.0

6.8

8.4

14.3

10.4

17.6

17.7

-22.5

8.8

10.2

42.7

27.0

55.7

58.1

39.7

61.2

47.1

25.1

24.0

39.1

41.8

48.5

45.9

44.5

42.8

34.5

30.1

56.3

22.9

27.4

53.9

35.6

78.4

61.5

50.7

59.9

16.8

30.6

28.3

48.0

31.2

23.6

48.5

55.1

23.6

16.9

41.1

43.6

28.5

7.3

0.0

25.1

12.6

3.5

15.5

15.1

12.2

26.0

50.0

12.6

40.7

7.4

16.4

14.4

9.9

18.5

29.7

1.4

10.4

7.9

68.9

37.8

88.2

61.7

54.2

101.1

16.9

31.6

27.1

62.5

31.0

25.5

83.6

79.6

29.5

16.8

46.0

Very high*

40.2

7.1

15.5

20.0

17.8

15.1

6.6

37.2

3.7

10.3

56.9

16.4

5.7

17.0

22.8

29.7

21.0

7.3

21.8

23.4

27.7

18.1

32

Wealth Creation Study 2003-2008

Theme 2009

GOOD COMPANIES (CONTD.)

COMPANY

10-YR AVG.

ADJ. ROE %

ROE (%)

LATEST

10 YRS AGO

INCREMENTAL

ROE

ROCE (%)

LATEST

10 YRS AGO

INCREMENTAL

ROCE

DIVIDEND

PAYOUT (%)

Jubilant Organosys

Titan Inds.

ONGC

Cipla

Piramal Health

Sterlite Inds.

Cummins India

ACC

M&M

GAIL

Ranbaxy Labs.

Grasim Inds

IOC

Shriram Trans.

Bharat Forge

Union Bank

Larsen & Toubro

Shipping Corpn.

Areva T&D

Reliance Inds.

Canara Bank

Adani Enterprises

BPCL

Punjab Natl Bank

Tata Motors

Welspun Guj.Stahl

Bank of India

Exide Inds

HDFC

Crompton Greaves

Tata Comm

HDFC Bank

Axis Bank

Hindalco Inds.

St Bk of India

Tata Chemicals

GMDC

Bank of Baroda

Neyveli Lignite

Godrej Inds

IVRCL Infra.

EIH

MRPL

Indian Hotels

Tata Power Co.

Reliance Capital

Essar Shipping

Aban Offshore

Kotak Mah. Bank

ICICI Bank

MMTC

Century Textiles

24.7

24.7

24.7

24.1

23.9

23.9

23.6

23.5

22.8

21.9

21.5

21.4

21.0

20.7

20.6

20.4

20.0

19.9

19.5

19.4

19.4

19.1

18.3

18.2

17.9

17.4

17.2

16.7

16.6

16.3

16.2

16.0

15.9

15.8

15.6

14.4

13.8

13.8

13.7

13.5

12.9

12.9

12.5

12.1

11.8

11.5

11.5

11.2

11.1

10.9

10.8

10.6

31.9

33.1

25.5

18.7

30.5

19.7

26.3

34.3

25.5

20.5

27.8

31.7

18.1

22.0

18.2

24.7

20.4

14.5

39.5

23.6

21.1

17.5

13.7

19.1

25.0

23.0

22.0

20.5

12.8

31.5

0.2

13.7

12.1

13.9

14.6

25.8

24.9

13.6

12.2

12.4

11.5

21.9

33.7

15.8

12.7

15.3

9.6

7.4

11.3

7.6

22.1

21.7

18.4

10.8

11.4

25.5

14.2

12.4

17.9

5.5

15.4

25.6

8.4

6.3

18.0

8.3

9.1

14.0

12.9

11.1

-6.7

18.2

9.9

24.2

23.2

23.8

2.6

-3.2

9.2

15.6

16.9

4.2

24.4

24.3

15.1

17.4

9.9

10.8

19.1

14.5

13.4

-12.9

22.3

13.8

1.1

13.4

10.0

8.0

4.8

5.9

3.7

20.5

2.9

-10.9

33.4

45.4

31.8

17.8

37.0

20.2

30.7

43.7

28.8

18.3

47.6

41.9

18.2

22.3

21.2

27.4

24.3

16.0

55.7

24.3

25.1

16.5

10.8

18.4

42.2

25.4

26.2

22.8

12.4

51.9

489.5

13.4

12.0

13.0

15.6

38.0

29.0

13.3

11.1

17.7

11.4

40.1

50.2

17.3

13.4

16.8

12.2

7.9

11.6

7.5

44.6

83.1

14.6

34.1

33.4

19.8

25.3

26.6

36.8

43.0

16.8

24.5

16.3

31.5

16.9

11.5

17.1

7.2

16.8

13.6

54.9

17.5

7.8

9.8

12.5

6.6

19.6

16.1

6.5

36.7

9.8

32.4

3.8

6.2

5.9

9.4

6.8

15.3

27.7

6.1

12.1

14.0

11.8

23.3

32.2

14.0

11.4

10.2

8.1

6.3

9.2

7.4

10.6

17.1

14.8

12.9

13.6

32.8

19.9

11.0

25.4

9.2

14.6

21.7

10.2

9.2

17.7

14.9

10.5

7.5

11.4

10.9

-0.4

12.1

7.6

18.5

24.6

7.9

7.4

1.0

7.1

14.9

13.9

9.6

35.3

9.0

9.2

20.2

7.7

12.5

32.0

8.0

13.5

5.6

21.5

12.5

7.5

16.6

12.2

8.9

5.4

14.2

13.3

7.9

4.3

4.8

14.6

236.0

44.0

18.1

27.0

28.0

42.8

81.2

17.2

26.1

18.5

41.8

16.7

11.4

19.1

7.1

19.0

16.5

75.3

18.5

7.8

9.2

10.3

6.2

26.1

17.5

6.2

63.3

9.2

63.9

-50.9

6.1

5.8

8.5

6.6

17.0

26.3

5.4

11.0

17.3

11.6

33.8

Very high*

13.5

11.3

10.5

9.4

6.2

9.1

7.4

12.3

405.3

9.5

23.9

36.0

22.4

33.0

6.1

38.4

28.0

20.7

31.1

48.3

14.5

25.9

29.0

27.3

19.0

25.8

27.7

22.2

12.4

16.5

6.2

23.5

13.8

31.2

7.2

16.8

27.1

34.5

22.9

67.3

20.0

20.7

11.1

12.7

35.8

18.3

19.8

26.3

32.6

9.1

33.4

30.4

32.8

23.0

17.1

0.0

24.8

6.1

33.6

26.2

20.7

* Very high because incremental capital employed is actually negative

19 December 2008

33

Wealth Creation Study 2003-2008

Wealth Creation

2003-2008

The 13

TH

Annual Study

Market Outlook

19 December 2008

34

Wealth Creation Study 2003-2008

Market Outlook

Market Outlook

India’ corporate profit to GDP is headed lower

s

In the last five years, India’ GDP grew 14% annually. Against this backdrop, corporate

s

profit CAGR was a robust 32%. As a result, corporate profit to GDP moved up from 3.1%

in FY03 to a high of 6.4% in FY08. Following the global slowdown, corporate profit to

GDP is likely to revert to 4.5-5% over the next three years.

Likewise, FY03-08 Sensex EPS CAGR is 25%, which is much higher than the long-term

CAGR of 15-17%. Overall, we are skeptical of profit growth over the medium term.

INDIA’ CORPORATE PROFIT TO GDP (%)

S

7.5

6.1

6.0

4.5

3.0

1.5

0.0

1.3

1.6 1.6

2.2

4.4

3.5

3.3

2.4 2.3

1.8

Mean: 3.3x

2.3

1.9 2.1

3.1

5.5

4.9

6.4

6.0

Source: MOSL

FY93 TO FY08 - SENSEX EPS PERFORMANCE (RS)

900

833

675

450

291

225

81

0

FY98-03: -1% C

AGR

272

Source: MOSL

19 December 2008

35

Wealth Creation Study 2003-2008

Market Outlook

Interest rates are headed down

Interest rates in India are clearly headed down in line with the global trend (eg, US 10-

year treasury yields are at an all-time low of 2.7%).

INTEREST RATES IN INDIA AND ELSEWHERE IN THE WORLD ARE FALLING

16.0

14.0

12.5

9.0

Diff of 840 bp

5.5

5.6

2.0

2.7

Diff of 390bp

6.6

10-Year India G-Sec Yield (%)

10 Year US G-Sec Yield (%)

Source: MOSL

Market is expecting earnings slowdown

Despite low interest rates, the BSE Sensex is currently trading at a trailing 12-month P/E

of 11x, close to its historic lows of March 2003 (the beginning of a five-year rally). Low

market P/E clearly suggests that the market currently anticipates a sharp fall in corporate

profits across the board.

MARKET P/E (TRAILING 12 MONTHS) IS CLOSE TO ALL-TIME LOWS

Sensex P/E ( LHS)

40

30

Sensex ( RHS )

21,700

16,700

15 Year Median P/E: 15.6x

20

10

11.0

0

1,700

11,700

6,700

Source: MOSL

Reasonable margin of safety at current levels

India’ market cap to GDP has corrected sharply from a high of 109% to 55% currently.

s

This is much closer to the long-term mean of 46%.

19 December 2008

36

Wealth Creation Study 2003-2008

Market Outlook

INDIA’ MARKET CAP TO GDP (%) HAS CORRECTED SHARPLY

S

120

109

90

60

30

19

0

24

54

44

43

43

34

37

28

26

26

23

51

54

43

M e an: 46

55

85

85

Source: MOSL

Most importantly, thanks to falling interest rates, earnings yield to bond yield is currently at

a comfortable 1.4x, close to its all-time high of 1.6x.

EARNINGS YIELD (TRAILING) TO BOND YIELD (X): COMFORTABLY HIGH

1.7

1.6

1.4

1.4

1.2

15 Year Avg is 0.73x

0.7

0.2

Source: MOSL

Moderate market cap to GDP and high earnings yield to bond yield suggest reasonable

margin of safety at current levels.

Conclusions

?

We have probably seen the market bottom at Sensex levels of 7,700.

?

We expect unprecedented reduction in interest rates.

?

We see distinct possibility of earnings decline over the next two years, contrary to

consensus estimates.

?

Earnings to bond yield is currently at 1.4x, which is an attractive zone. This sets the

stage for a sharp 30-40% recovery in the markets.

?

Sustenance of this recovery will be dependent on stability in corporate profit and its

subsequent revival.

19 December 2008

37

Wealth Creation Study 2003-2008

Wealth Creation

2003-2008

The 13

TH

Annual Study

Appendix

19 December 2008

38

Wealth Creation Study 2003-2008

MOSL 100

–

Biggest Wealth Creators

RANKED ACCORDING TO THE BIGGEST WEALTH CREATORS

RANK COMPANY

NO.

NAME

WEALTH CREATED

RS B

% SHARE

PRICE

CAGR (%)

PAT

SALES

ROE (%)

FY08

FY03

Appendix I

P/E (X)

FY08

FY03

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

32

33

34

35

36

37

38

39

40

41

42

43

44

45

46

47

48

49

50

Reliance Inds.

ONGC

Bharti Airtel

NMDC

MMTC

BHEL

Larsen & Toubro

SAIL

State Bank of India

ITC

HDFC

Infosys Tech.

ICICI Bank

Unitech

Tata Steel

Sterlite Inds.

HDFC Bank

Hind.Copper

Indian Oil

Wipro

Jindal Steel

GAIL

Reliance Capital

Natl. Aluminium

ABB

Essar Oil

Tata Power

Hind.Zinc

Sun Pharma.

Axis Bank

Reliance Infra.

Grasim

Satyam Computer

Siemens

Kotak Mah. Bank

Hind. Unilever

Tata Motors

M&M

Neyveli Lignite

Adani Enterprises

Tata Comm

Ambuja Cements

ACC

MRPL

Sesa Goa

Hindalco Inds.

Cipla

HCL Technologies

Glenmark Pharma

Pun. Natl. Bank

3,077

1,593

1,505

1,356

1,084

952

813

727

701

617

547

525

469

448

401

398

346

342

339

317

314

296

269

245

237

231

226

216

215

213

213

206

203

196

187

181

179

158

157

144

132

131

126

122

122

121

121

120

117

114

12.1

6.3

5.9

5.3

4.3

3.7

3.2

2.9

2.8

2.4

2.2

2.1

1.8

1.8

1.6

1.6

1.4

1.3

1.3

1.2

1.2

1.2

1.1

1.0

0.9

0.9

0.9

0.9

0.8

0.8

0.8

0.8

0.8

0.8

0.7

0.7

0.7

0.6

0.6

0.6

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.4

58.7

32.8

96.4

158.3

186.8

79.1

100.9

83.8

44.4

37.5

48.4

23.1

41.9

284.2

54.5

111.6

41.4

53.1

23.5

15.7

130.2

41.5

90.8

44.8

82.8

118.5

59.6

104.6

55.5

81.1

42.2

50.8

34.9

85.3

81.9

9.1

32.0

69.5

35.4

117.6

47.5

41.6

42.9

57.2

152.0

26.8

30.9

27.3

115.5

37.9

37

10

L to P

60

52

45

38

L to P

17

18

29

36

28

150

36

42

33

L to P

3

30

54

10

58

26

38

P to L

10

99

34

41

46

43

41

47

46

2

47

50

-1

29

-17

51

69

L to P

160

37

23

20

64

19

24

12

55

36

33

23

21

19

10

19

24

34

27

64

18

44

38

30

18

34

43

10

35

14

38

14

7

41

32

37

10

17

32

43

70

7

26

25

2

32

-6

27

19

32

55

32

23

40

35

14

25

24

30

39

19

27

23

33

14

26

20

33

9

48

21

7

14

27

17

27

33

20

17

18

31

-1

11

37

24

12

11

27

23

38

8

134

26

25

12

23

5

38

35

34

53

17

19

24

38

19

15

29

-6

19

4

9

12

-12

18

26

23

33

17

8

32

13

17

36

32

24

25

26

8

16

20

2

11

12

34

21

6

12

14

23

8

48

12

9

19

16

14

14

10

-41

5

9

23

14

23

23

17

13

25

42

544

35

41

10

15

25

28

18

21

43

11

53

29

147

8

20

26

14

29

18

51

N.A.

30

5

25

26

27

11

15

35

74

26

12

15

18

47

48

10

11

11

8

7

24

22

31

8

9

5

N.A.

4

22

12

11

N.A.

5

11

12

28

7

5

5

3

17

N.A.

3

35

3

4

6

9

13

7

4

4

11

5

18

8

18

11

21

18

17

8

4

3

3

11

23

N.A.

10

8

17

14

6

3

19 December 2008

39