100x: The power of growth in wealth creation

"100x" refers to stock prices rising 100-fold over time i.e. "100-baggers" in stock market jargon. In 1972, a US-based columnist and analyst Thomas Phelps wrote a book "100 to 1 in the stock market" in which he refers to 365 stocks in the US which rose at least 100-fold in a 40-year time window. We applied a similar framework to the Indian stock market as part of the Motilal Oswal 19th Annual Wealth Creation study 2014. The findings were very insightful.

100x: The India experience

As of March 2014, the BSE Sensex stood at 22,400 levels. It was at 224-levels during FY84. Thus, Indian stock markets achieved 100x in about 30 years (17% price CAGR). Given such strong performance of the benchmark itself, smart investors should target to beat it and achieve 100x in 20 years at most (i.e. 26% CAGR).
During the 20 years 1994-2014, we identified 47 enduring 100x stocks i.e. companies which had meaningful size of operations and which did not fizzle out after achieving 100x. The top five 100x stocks are: Infosys 2,902x (1994, 49%), Lupin 1,170x (2002, 80%), Wipro 875x (1994, 40%), Motherson Sumi (775x (1999, 56%), and Shree Cement 644x (1998, 50%).

100x process: principle & elements

To make money in stocks you must have the vision to see them, the courage to buy them and the patience to hold them."

1 - Size
A potential 100x company should be small in size (based on sales and market cap) and relatively unknown. Small size enables high growth due to low-base effect. "Unknown-ness" leaves room for significant valuation re-rating.

2 - Quality
There are two aspects to Q in SQGLP – (1) Quality of business and (2) Quality of management.

3 - Growth
The two primary aspects of growth are (1) earnings growth and (2) valuation growth. The G in SQGLP addresses earnings growth, whereas the P (rice) determines valuation growth

4 - Longevity
Companies should have a sound strategy to maintain competitive advantage over peers. Likewise, value-enhancing acquisitions will help extend longevity of growth.

5 - Price
Arithmetically, 100x in stock price is achieved by the multiplicative combination of earnings growth and valuation growth (e.g. 25x earnings growth with 4x valuation growth). The best way to improve the odds of valuation growth is by ensuring favourable purchase price. A simple rule of favourable purchase price is single-digit P/E. However, in certain situations, low P/E may not be the sole determinant of favorable valuation (e.g. During bottom-of-cycle, earnings of cyclical stocks are depressed leading to high P/Es.

How investors can approach discovering 100x stocks
To discover 100x stocks, investors will need to put the mantra of SQGLP in action.

Size: A good starting point is companies with market cap of less than Rs 3,000 crore ($0.5 billion).

Quality of business: Sectors which offer play on value migration are the most suited for 100x – IT, pharma (in both cases value migrating from developed world to India), private banking (from public sector to private sector), and other select export-oriented industries.

Quality of management: While this is a highly subjective issue, some objective indicators of quality of
management are: (1) detailed and transparent annual report, (2) RoE consistently higher than 15% and also higher than competitors, and (3) dividend payout ratio of at least 15%.

Growth in earnings: To indicate earnings growth momentum, it would be good if profit growth in last two years is 25% or higher.

Price: Here, lower the P/E better are the chances of 100x. In any case, investors will be better off not paying higher than 1.5x market valuation of 16-17x P/E i.e. overall ceiling of 25x P/E.

The writer is joint MD, Motilal Oswal Financial Services Ltd