The Unusual Billionaires — An Update
I first read The Unusual Billionaires in December of 2016, just a few months after its release. It felt like early morning rain of investment rationale and I remember meeting my CFA classmates that same evening and showing off my new-found knowledge of using ROCE and Revenue CAGR as a filter.
Having picked up the book again, a good 3½ years later in June of 2020 made me realise, what was once an early morning rain was now a torrential downpour. Partly because in the period that went by, I had cleared several national and international finance exams, cracked the CAT to graduate from a top BSchool in India and was somewhere better equipped with the technical know-how of a wide variety of subjects beyond finance which would allow me to understand this book in a far deeper sense.
For the uninitiated, The Unusual Billionaires is a book written by Saurabh Mukherjea that goes on to break down perhaps the most simplified approach to long term investing. It filters out eight businesses in India that went to create a brand for themselves while also generating enormous shareholder wealth. And once I finished the book, I asked myself:
Question 1: What if one had invested in all the 8 companies listed in the book back in December of 2016…where would the portfolio stand?
Question 2: What would the Coffee Can portfolio comprise of today?
This post is all about answering the above.
But first, the Coffee Can Portfolio. This is a set of those companies that have been screened through a simple set of clear and straight forward parameters:
a. Market Capitalization of more than ₹100 crores: There are over 5000 companies in the listed universe of public equities in India and choosing anyone below a market cap of ₹100 crores can lead to the unreliability of data. Not that those with market caps above ₹100 crores any saints, they are just a little less of a suspect. With this, the number comes down to 1500
b. For non-financial services companies: Revenue growth of 10% & ROCE of 15% every year for 10 years. Firstly, a decade is chosen to not unfairly penalize cyclical companies, nor unfairly advantage companies in more steady sectors, given how a decade usually covers, more or less, an entire economic cycle. And then, Revenue CAGR and ROCE are taken because they are essentially the two line-items that define the well-being of any business at a very basic level. A business with a positive Revenue CAGR and a ROCE only means that it's both profitable and growing.
The reason behind taking 10% as the Revenue CAGR threshold is simple: India’s nominal GDP growth rate has averaged 14.5% over the 10 years preceding the release of this book (FY06-FY15). A firm operating in India should have, therefore, delivered sales growth of at least 14.5% per annum during the same time frame. However, since only 9/1500 showcased this kind of revenue growth, the filter was lowered to 10%.
ROCE, defined as the Return on Capital Employed where capital employed is the sum of the fixed assets used by the business and the working capital used to finance the business, is chosen because the return generated on the capital employed by any business is usually also the annual return one is likely to get from holding its stock. The return on capital employed, however, has to be at least as much as the cost of capital employed. This cost is nothing but the WACC — the weighted sum of the cost of equity and the after-tax cost of debt. The WACC for any India investment is around 15% — calculated as the sum of GoI 10 year bond of 8% and the equity risk premium of 7%. It is also the return CAGR which Sensex has delivered for the same time frame further validating this threshold
Note: A detailed paper on calculating WACC can be found here. It’s co-authored by one of my favourite writers, Michael Mauboussin
c. For financial services companies: ROE of 15% & loan book growth of 15% every year for 10 years. Companies in the banking and financial services industry (BFSI) have neither revenues nor ROCE, since they borrow and lend money, and earn interest and investment income on these operations. ROE and Loan Book CAGR are good proxies and the stated thresholds help filter out just about the right set of financial services companies, for about the same reasons stated in the previous point
The first screening was for financial years FY1991 to FY2000 and there were five companies that met these requirements — NIIT, Cipla, Hero Moto, Swaraj Engines, and HDFC Limited. This set of five companies make Coffee Can Portfolio 2000 (CCP 2000). The stock price performance of CCP 2000 is then tracked for the next ten years (i.e. from 30 June 2000 to 30 June 2010). Similarly, running the screen from FY92 to FY01 gives the Coffee Can Portfolio 2001 (CCP 2001), the stock price performance of which is tracked for the subsequent ten-year period (i.e. from 30 June 2001 to 30 June 2011). Given that each time bucket is ten years, there were six fully completed Coffee Can Portfolios at the release of this book:
1. CCP 2000: FY1991–2000
2. CCP 2001: FY1992–2001
3. CCP 2002: FY1993–2002
4. CCP 2003: FY1994–2003
5. CCP 2004: FY1995–2004
6. CCP 2005: FY1996–2005
And there were 10 incomplete Coffee Can Portfolios which had not completed their 10 years of stock performance:
7. CCP 2006: FY1997–2006
8. CCP 2007: FY1996–2007
9. CCP 2008: FY1996–2008
10. CCP 2009: FY1996–2009
11. CCP 2010: FY1996–2010
12. CCP 2011: FY1996–2011
13. CCP 2012: FY1996–2012
14. CCP 2013: FY1996–2013
15. CCP 2014: FY1996–2014
16. CCP 2015: FY1996–2015
Quoting the book, “The results can be summarized in one sentence: Each of the sixteen CCPs has outperformed the benchmark large-cap index in India, the Sensex. In fact, the outperformance of the CCP to the Sensex is almost always in excess of 4 percentage points per annum.”
The book describes in great detail those businesses which showed up in these 16 CCPs more than thrice and did not have any hiccups in financial performance in the preceding three years (FY13–FY15).
The ones to make it were:
- Asian Paints
- Astral Poly
- Berger Paints
- ITC
- Marico
- Page Industries
- HDFC Bank
- Axis Bank
The author calls them ‘primus inter pares’ which in Latin means ‘first among equals’. The ones that stand out even among peers.
Question 1: What if one had invested in all the 8 companies listed in the book back in December of 2016…where would the portfolio stand today?
Answer: Let us run a simple paper-portfolio test with these eight stocks. And since I read this book in the last week of December 2016, let’s take the first trading day of 2017 as the day of entry when the investment would have practically been made with the closing price of these stocks on that day as the price of entry. With an investment corpus of ₹10,00,000/- the weights of the individual stocks can be calculated by their free-float market cap, or an equal-weighted portfolio can be used. For our study, let us check both.
Note: A free-float market cap (FF Mcap) weighted portfolio has an inherent issue of overweighing large-cap stocks and underweighting small-cap stocks.
The first trading day of 2017, the entry day, was Monday, the 2nd of January. And for simplicity's sake, I’ve used the exit day as Tuesday 30th June 2020. Closing prices were taken for both days. The Freefloat was calculated using shareholding available in FY17 reports given the lack of CY16 year-end data. The investment period is 3½ years and the same is used for calculating ROI CAGR.
The Results:
How did Sensex fair?
As pointed earlier Free Float Mcap weighing has a large-cap bias as is evident with its heavy weighting of ITC and HDFC (the heaviest two back then). Instead, had you and I invested equal amounts (big enough to buy large-sum stocks like Page Industries), we would have made a 16.13% YoY return over a 3½ year period. Compare that with the Sensex return of 8.09% per annum over the same period. The alpha clocked at over 800 bps or in other words 100% of the benchmark at least. (Why “at least”? Because some of these stocks gave hefty dividends as well. But then the benchmark may have had a dividend yield too and I am choosing to not account the same for both, like how I’m not factoring in fees and taxes).
So did we miss the bus? Yes and no. Yes, now that we look back. But then everyone’s a genius in hindsight. We could have invested in every single opportunity that now seems to have been right before our eyes, but was it really? And so no, we did not miss anything because the markets are full of opportunities and while history may not repeat, it sure is bound to rhyme.
This, therefore, leads us to the last bit of this article.
Question 2: What would the Coffee Can portfolio comprise of today?
Answer: The author cherry-picked 8 out of the 14 businesses whose names repeated in the 16 CCPs. We’ll simply draw from the exercise:
Step 1: Build CCP 2016, CCP 2017, CCP 2018, and CCP 2019.
Step 2: Find the names that repeat in all the 20 CCPs
Step 3: Log in to Zerodha.
Building CCP 2016 till 2019
The first challenge towards building a coffee can portfolio is with deciding the floor for the revenue growth. The author chose a 10% CAGR in contrast to conservatism from the 15% average rate that the GDP had grown over the decade preceding the book launch. Should we follow the same principle now, the average GDP rate comes to 8.14% over FY10–FY19.
The next task at hand is to figure the ROCE which would match the WACC using the Build-up Approach. At the time of writing this article, the 10 year India bond yield is 5.836%. Added to this is the Equity Risk Premium adjusted for Country Risk which is 9.49%, totaling to 15.32%.
We stick to the 10% revenue CAGR and 15% ROCE as our floor and end up with the following in our CCPs:
Of these, the businesses common across all 20 CCPs are the ones we would call our First Among Equals:
1
2
3
4
5
6
But should we deploy capital into these? No. Not just yet.
