Over the years, India has emerged as one of the fastest-growing economies in the world and an attractive investment destination driven by economic reforms and a large consumption base. India’s gross domestic product (GDP) at current prices stood at Rs. 55.54 lakh crore (US$ 743.34 billion) in the second quarter of FY22, as per the provisional estimates of gross domestic product for the second quarter of 2021-22. Indians are likely to save more and spend less on discretionary items in 2022, according to a ‘Consumer spending Outlook 2022’ report by community platform LocalCircles. While 40% of those surveyed were likely to invest in equity and mutual funds, 15% were likely to spend on property, car, and jewellery in 2022. The significant growing interest of Indians in the investment sector, there has been many approaches to theorise how one should invest their money for wealth creation. But the best teacher in investing is the experience in the market. Dalal Street’s top money manager, Satwik Jain, has come out with a simple three-step formula to find stocks that can generate 10x returns in the next 10 years.
The founder of multi-family office, Generational Capital, & fund manager of RH Perennial Fund says one should look out for sectors with consolidating profit pools, companies with clean accounting & promoters willingness to share profits with minority shareholders with top notch capital allocation, competitive advantages with huge & growing addressable markets & reinvestment moats leading to portfolio doubling its earnings and cash flows in 3-4 years irrespective of macroeconomic environment with valuation rerating potential. Satwik states, “Our job is to look at sectors where demand from customers is very strong & secular but supply side is broken as weaker players are finding it tough to compete due to formalisation of the economy with advent of GST, demonetisation, RERA, Jio moment, etc. The leaders and challengers in these sectors have very little competition & their ROCEs (return on capital employed) are high using technology as an enabler & hyper scaling decimating the competition. Our portfolio level ROCEs are more than 25%, implying high operating & free cash flows and reinvestment rates upwards of 40%.
Here’s Jain’s formula to identify perennial compounders to build generational wealth:
1) Identify consolidating profit pools- In most sectors globally as well as India, profit pools are getting concentrated in the hands of a few champion franchises. For instance, despite the presence of networking social media like LinkedIn or a multi-billion-dollar enterprise like Monster, Info Edge’s Naukri.com has built a strong monopoly in the field of Job search. It now boasts of 80% of revenue share and about 110% of profitability in this space, as other businesses are loss-making, at an aggregate level. In the global digital advertising market, out of every dollar spent, approximately 70% goes to Alphabet & Facebook. This leads the team to narrowing down their research to sectors like cables & wires, pipes, jewellery, paints, IT services, job search,, labware, dental healthcare, domestic branded pharmaceuticals , diagnostics, , music streaming, paints, dominant lenders among others
2) Identify clean accounts & promoters willingness to share wealth with minority shareholders using forensic accounting & fraud search toolkit- A 2x entrepreneur, Satwik Jain uses a war chest of 20 forensic ratios marrying the balance sheet, cash flow & P&L statement to see whether the businesses are cooking up their books to please analysts & shareholders. “Most investors are focused on only the quarterly Sales & profit growth. The promoters who have built multimillion businesses know that well. We need to get into the promoters’ shoes to see accounting mockery” Satwik mentioned.
Post the quantitative analysis, it is of utmost importance to get into the qualitative analysis for which Satwik runs through a 150 keyword fraud search of over 100 man hours to check the intent & vision of the promoters. “The key here is to see whether the promoter is not buying a football club from the company cash flows, renovating golf courses from CSR expenses, whether any serious criminal cases & litigations have been filed against them by their lessors, customers or suppliers. Some favourites of the current bull run in diagnostics, FMCD, QSR did not clear our frameworks” Jain says.
3) Identify competitive advantages, huge addressable markets & potential hyper scaling-
“All information is in the past; all wealth will be created in the future” Satwik states. Businesses with sustainable competitive advantages tend to make outsized profits relative to peers and therefore by extension deliver outsized returns to shareholders. He identifies moats as network effects in case of platform businesses like Naukri.com, Alphabet, Amazon, high switching costs in case of healthcare & consumer companies like Syngene, Thermo Fisher, Hindustan Foods, low cost producer for high quality retailers like Dmart, Trent, Zara, Walmart & intangible assets in case of high quality franchises like Titan, Tiffany’s.
Post this, the company should be in the growth stage of its life cycle where either it is embarking on a mega capex plan like Polycab, KEI Industries, Tarsons Products, PrevestDenpro or there is potential of operating leverage kicking in since capex has been done like in case of Syngene. Satwik also mentions he stays away from sectors with weak economics & B2G businesses like infrastructure, airlines, and hospitality, sugar, metals, APIs & cautions investors also. Stating the reason, he said, “It is okay to be in shallow cyclicals but most of the businesses in these sectors are heavy cyclicals where we have to enter and exit with perfection leading to low stress adjusted returns”.