Look for new themes to achieve 8% growth

In the early 1990s, the chairman of a small service company (which had posted 100% yoy growth in revenue for two consecutive years with revenue of about Rs 300 crore) declared that his company would continue to grow 100% yoy for the next 10 years without realising the beauty of "base effect".

Had it grown its revenue at 100% every year, this company's revenue would have grown close to one-fifth of India's GDP of that base year! Even today it is struggling to touch Rs 1,000 crore mark!

HDFC Bank, has posted 20.1% yoy growth in net profit in September 2014 quarter – this is the 5th consecutive quarter that the bank has posted net profit that is below its trend growth of 30%. Till Q1FY2014, for 52 quarters HDFC Bank posted about 30% yoy growth in net profits.

Of course, the profit growth tapered off partly due to the slowdown in the economy. However, it is also due to steep increase in the base of its business parameters. Ten years ago, HDFC Bank could grow its advances by 51% in FY2004 to Rs 17,745 crore. However, in FY2014, it could grow its advances only by 26.7% yoy to Rs 3.03 lakh crore!

HDFC Bank's credit base has gone up 17 fold during this period. Ten years ago, the entire banking industry's credit could grow over 20% yoy – now it is growing around 10% as the industry's credit base has grown from mere Rs 8.4 lakh crore in 2004 to over Rs 61 lakh crore (8-fold jump) now!

Similar is the case with Infosys which reported 47% yoy growth in revenue and 52% yoy growth in net profit in FY2004, but in the first half of FY2015, it just posted 8% yoy growth in revenue and 25% yoy growth in net profit. In the last ten years, its revenue base has grown 7-fold to over Rs 50,000 crore now!

Compounding of wealth is much faster at the initial stage when the companies grow from small base to large base. Infosys used to enjoy 30 to as high as 150 PE when its revenue base was too small compared to the present size.

It is almost impossible for China for the same reason to go back to 10% annual growth – its GDP has gone up little more than 5-fold to over $9 trillion now as compared to close to $2 trillion in 2004. India's GDP (at current prices) has also gone up 4-fold in the last 10 years to about Rs 105 lakh crore in FY2014 from Rs 26 lakh crore in FY2004. We often hear from some analysts that if the government decides, we can get even 10% GDP growth – it is almost impossible partly due to the base effect! Moreover, in the last 20 years, we had IT and telecom (mobile) themes, which together pushed up both the service activities and job opportunities substantially – they helped the service sector increase its share in the country's total GDP to over 60%.

Today both the government and the investors need to look for new themes. For the government, new theme (s) could be in retail or low-cost / innovative manufacturing to get us even 8% growth
as the growth and penetration respectively in the IT and telecom sectors have tapered off.

Similarly, the investors need to identify emerging themes well in advance to create significant wealth during the initial pace of low base to high base. However, it doesn't mean that they have to shun the companies (leaders) with large business base. Banking on them to some extent normally becomes defensive bets and provides risk mitigation to the equity portfolios in this highly volatile market.