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Wednesday 23 December 2020

Highlights from 25th MOS Wealth Creation Study

There are two annual publications hat I eagerly await - Buffett's annual letter and Raamdeo Agarwal's (Motilal Oswal) Wealth Creation Study (MOSWCS). And to be fair, their quality has been going in divergent directions in the last few years. Buffett's letters have become increasingly boring and repetitive and the MOSWCS have come more and more elaborate and engaging. 

This year's study is a treat. Not only has the time horizon been increased from 5 years to 25 years for the base study but the focus on creating a detailed QGLP checklist is a great help to the investment community. As I have said many times, QGLP  is an primary investment framework that I use very often and think is one of the best and since I am also a checklist driven investor, it would help  me personally immensely. I also have 3 separate checklists and I would try to integrate all of them into 1 sometime.

My Highlights

- Stock returns are slaves of earnings power and growth. In the very long run, valuations matter less.
- Most businesses are cyclical in character. As is said, a rising tide lifts all boats. Most sectors do well when the economy is on the upswing. Thus, at the peak of the economic boom in 2007, 29 of 37 sectors recorded RoE>13%. However, for the last 7 years, that number is down to between 7 and 11.
- Only 3 sectors – Consumer/Retail, IT and Paints – maintained RoE>13% for each of the last 25 years.
- Corporate Profit to GDP has stagnated for the last 5 years. This is similar to 1999 to 2003, after which corporate profits took off for the next 5 years. 
- Permanent change in long-term interest rate band (from 12-14% to 6-8%) is leading to change in valuation expectations. Current valuations are supported by expected PAT revival after 5 years of stagnation and high liquidity led by low interest rates.
- Valuations are frothy with market cap around 100% of GDP. 
- Characteristics of wealth creators of last 5 years
○ Were small to mid in size in the base year 1995
○ Were consumer-facing, bestowing them a secular business model
○ Were very profitable (average base RoE was a robust 17%)
○ Grew to emerge as market leaders (among top 3) in their respective business
○ Had management with high integrity and competence. 

The QGLP Checklist

Q#1 What is the history of the company and management?
Q#2 Is the company’s business model understandable? How does it make money?
Q#3 Is the company profitable? If not, is it expected to emerge?
Q#4 Are the company’s terms of trade favorable? Is Cash flow healthy?
Q#5 What is the company’s cost and margin structure? How has it changed in the past?
Q#6 How’s the Du Pont Analysis for the company?
Q#7 What is the competitive landscape? What is the role of regulation in the business?
Q#8 Does the company enjoy an Economic Moat? What are its sources?

Q#9 What is the addressable market opportunity and its key drivers?
Q#10 What is the company's growth plan? How sustainable is the growth?

Q#11 Is the management high on Integrity & transparency?
Q#12 Is the management competent?
Q#13 Does the management have passion / growth mindset?
Q#14 Does the company have a rational capital allocation policy?
Q#15 Does the company have a suitable organization structure and depth of management?
Q#16 What is the organization culture?
Q#17 Does the company have a sound succession plan?
Q#18 Do the owners have enough skin in the game?
Q#19 Have the promoters pledged a large portion of their holding?

Q#20 Has the financial modeling been done with earnings estimates for at least 3 years?
Q#21 Is it a QGL stock?
Q#22 Is valuation reasonable?
Q#23 Is there enough Margin of Safety?
Q#24 Is the stock reasonably liquid?

Q#25 What can go wrong with the company narrative & numbers? 

I would strongly recommend all serious investors to read the checklist section of the MOSWCS - page 39 to 87 if they are short of time and can't go through the entire document.