Stocks that can make you a millionaire

Identify stocks Motilal Oswal Securities Ltd. has been studying wealth creators in the Indian equity markets for over a decade. Every year its Wealth Creation Study looks at the capital markets over the past 5 years to discover trends in wealth creation. Here are some interesting insights, gleaned from these studies.

Qualitative and quantitative aspects of wealth creators (1991-1996 study I) The first study explains that wealth-creating companies have a substantially high ROE (Return on Earning) and ROCE (Return on Capital Employed). Wealth creators display a high correlation between ROEs and P/Es (Price-Earning ratio). It advises that there is an inherent margin of safety in buying a stock at a P/E ratio substantially lower than its sustainable ROE. Amongst other things, it reveals that mid-cap stocks have the propensity to create wealth faster than heavyweight blue chips but the surety of wealth creation is greater for large-cap stocks.

Good businesses, which get better (1992-97 study II) This study states that “The principle one must bear in mind while identifying a right business is that the business economics must not only be distinctly superior but should get better with time”. It further recommends picking market leaders in various business segments since wealth creators are driven by a passion for
leadership in business.
Competitive strengths of wealth creators (1993-98 study III) This study, like the previous two (1991-96 and 1992-97), observes that focussed business activities are the stepping-stone to wealth creation. In addition, it points out that superior technology and strong brands are key competitive strengths of Wealth Creators.

Characteristics of growth and valuation of growth (1994-1999 study IV) The study advises us that consistency, profitability and sustainability are the key drivers to the valuation of growth. It also highlights the magic of compounding. What makes growth valuable is its power to compound returns over a period of time.

Outstanding management (1995-2000 study V) The quality of the company’s management plays a vital role in creation of wealth. The management should have important attributes such as: Depth to sustain the competitive edge. A long-range profit outlook. Unquestionable integrity to achieve better visibility of earnings and better valuation.

three components of value (1996-2001 study VI) This study points out that value investing starts with having a better understanding of the intrinsic value of the company than the rest of the market. We can divide a company’s intrinsic value into three parts: 1. Asset Replacement Value: This is the current value of a company’s assets. The basic value of a business with no competitive advantage is the replacement cost of its assets. Any new entrant can get these assets by paying the current price. 2. Earning Power Value: This is the ability of a company to earn returns. A competitive advantage or some kind of entry barrier allows companies to earn higher returns than the cost of capital. 3. Growth Value: This is the ability of a company to benefit from growth. Amongst other things, new lines of business without competitive advantage are unlikely to earn attractive returns on additional capital for a meaningful period of time.

Value of a stock (1997-2002 study VII) This study underlines two factors, which are critical to determining the value of a stock - dividends (which are dependent on long-term earning power of the company) and discount rate (the rate at which future dividends are discounted to the present value). It also makes an interesting point about value: There is no such thing as absolute value in this world. You can only estimate what the thing is worth to you”.

Transitory or enduring wealth creators (1998-2003 study VIII) Multi-baggers are super stocks that multiply in value over a period of time. These are created by a combination of the nature of the business they belong to and the quality of their management.

Multi-baggers are of two types: transitory and enduring Transitory multibaggers attract a lot of crowd and media attention, but they always give nasty end-results - their financials do not support their value or worth at the peak. Enduring multi-baggers, on the other hand, are those companies, whose wealth creation is long lasting

Business cycles in commodity businesses (1999-2004 study IX) When demand is high and capacities are being fully or near fully utilized, prices and profits rise. This attracts more investment into capacity creation, which eventually leads to over-capacity in the industry and finally, a glut situation (excess supply). This is a typical feature of commodity companies, which have a boom and trough every few years. Understanding these cycles could help you time your investment in such stocks.

Understanding price and value (2000-2005 study X) This study examines the dilemma of what price you should pay for wealth creating stocks if you aim to augment your wealth through investment in these. It explains the need to understand that price is what you pay and value is what you get or you expect to get in future. Earnings, dividends, assets and sentiment all have an effect on price determination. The study reminds us that consistent wealth creators (like any other stock) have to be bought cheap and sold when they are dear.