What I Learnt from reading 80 pages of Motilal Oswal's 29th Wealth Creation Report

Concept of Wealth Creation

Motilal Oswal’s Wealth Creation report mainly focuses on studying Blue Chip stocks and to buy them lower than their intrinsic value, where the margin of profitability is highest while the margin of risk is lowest.

Blue Chips are one of the most attractive stocks in the market, they are hardly seen at any level lower than their intrinsic value in decades. They are usually the leaders in the sector hanging at a premium price, i.e. higher than their fair valuation. That’s not where we will be buying. We will be waiting for some circumstances to take place which causes the Blue Chips to get bruised to a level where they meet our requirements for Buying and Holding that particular stock.

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Assumptions and Methodology in the Report

• “we define Wealth Created as the difference in market capitalization over a period of last five years, duly adjusted for corporate events such as fresh equity issuance, dividends, share buybacks, mergers, etc.”

• The report’s conclusive results has been divided into 4 categories -

  • Biggest Wealth Creator ( in terms of INR )

  • Fastest Wealth Creator ( in terms of fastest compounding CAGR)

  • Most Consistent Wealth Creator ( highest number of years that a stock has outperformed the index for the last 5 years. If there are more than one stock with the highest number of years, the ranking is done based on the CAGR )

  • Best All-Round Wealth Creator ( it is decided on the summation of ranks, that are Biggest, Fastest and the most Consistent weal creator. If the scores are same for more than one of the stocks, the rank is done on the basis of CAGR )

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What are Blue Chips?

“Blue Chips as stocks with a reputation for quality, reliability, and the ability to operate profitably in both good and bad times.” — Wikipedia

Characteristics of a Blue Chip Stock —

• Track Record - Listing history of minimum 10 years

• Size - Top 50 companies by Market Cap

  If the company is not in top 50, it should qualify 2 criteria — should be in the top 250 and should give at least 20% ROE based on the last 10 year average.

• Leadership - Should be leader in their particular Sector

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What are Bruised Blue Chips?

“We have borrowed the phrase “Bruised Blue Chips” from a booklet titled, “How To Create Wealth Investing In Turnaround Stocks”. However, even the booklet does not specifically define the term “bruised”.“

“Bruised Blue Chip Stock”, here means a Blue Chip that has been facing bad times for a while now, the price of the share is declining that brings it back to it’s attractive valuation where we can spot a golden entry point.

Even though the companies are struggling, the mortality rate for them is very low as compared to their peers, due to the leadership quality and mainly because of the size of the organization. This moment where the stock price has fell a significant percentage allows us to build large positions in such reputable stocks and hold it for decades, as it’s very low probability that price of this stock will ever cross this level (the absolute low formed during the fall) again.

For this report, the stocks that have fell more than 50% than their 5 year high, are considered to be put in the watchlist, and are tracked closely for buying opportunities.

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What causes Blue Chips to get bruised?

The report has categorized the reasons into 2 key categories —

1. Stock Market Related

2. Company Related

   1. External Reasons

   2. Internal Reasons

Stock Market Related

Very Rarely, it’s seen that the prices of Blue Chips are declining due to the collapse in the stock market as a whole. Usually, a negative news about a sector or market as a whole doesn’t affect the prices of these companies, but some unforeseeable events in history like the Dotcom Bust, Economic Recession, Demonetization and COVID led to a decrease in the prices of these stocks too.

But, Due to the strong fundamentals and a good track record, they have built a trust among the investors, which help them to recover faster than any of their peers in the market after the event has been stabilized.

Company Related

External Reasons

1. Economic Recession - Marked by a substantial decrease in the private and government expenditures and investments.

2. Dynamic Competitive Landscape - A sector’s competitive landscape changes adversely when new players enter the arena, especially those with deep pockets.

3. Change in government regulations - Imposing of additional duties, or even increasing the rates of taxes, whether it’s for the entire economy or for the specific sector, it can all cause stock to get bruised.

4. Value Migration - A major shift in the sector when a new player enters or a new tech is imposed that better satisfies the needs of consumers, can lead the stock to collapse. If action is not taken on immediately, stock prices may never recover.

5. Global Events - Global events like wars, geopolitical instability, trade wars, pandemics, etc., can negatively impact international businesses, particularly for Blue Chips that rely on global markets and supply chains.

Internal Reasons

1. Capital Misallocation - Capital misallocation can affect the price of share in many forms but the most affecting one is the Merger and Acquisitions. A wrong M&A can set a company many years back that would make it very difficult to recover to it’s previous high state.

2. Weak or Outdated Business Strategy - In a dynamic environment where the tech and operations keeps changing on a regular basis faster than ever, no entity can afford to stick on just one strategy for operations for it’s entire lifetime.

3. Poor Corporate Governance - “Needless to say, this is a recipe for disaster.“

   This factor can even lead a stock to loose it’s Blue Chip Status.

4. Debt pile-up - Mega Acquisitions, especially global, due to the aggressive scaling objectives of the company can lead it to take up more and more debt, to the extent where the interest cost exceeds the profits, that is where the company not only gets bruised but also lashed.

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What causes Blue Chips to heal?

Like the reasons of Bruising, the report has categorized the reasons into 2 key categories —

1. Stock Market Related

2. Company Related

   1. External triggers

   2. Internal triggers

Stock Market Related

“When the stock market recovers from its sharp falls, so do prices of Blue Chips, delivering healthy returns in the process“.

Due to the strong fundamentals, they recover better and with a higher momentum are compared to their peers. They might also outperform other sectors with high volatility, like Banking, IT collectively.

Company Related

External triggers

1. Sector Tailwind - Lower interest rates, higher consumer spending, increase in government investments, etc. all counts under tailwinds that can lead to a stock recover faster.

2. Improve in competitive landscape - When peers of the company fell short of expectations, or are struggling to cope up with the industry average recover rate, it’s results better for the blue chip and leads to a faster recovery.

Internal triggers

1. Corporate Restructuring - After all the mess that management has made that led to decline in the shareholder’s wealth, management is now required to undo all that decisions and take corrective measures. These can include —

   1. Selling off Bad-Businesses

   2. Cutting Costs

   3. Focusing on Core Areas

   4. Changing how the company is organized

2. Change in Strategy - Management takes views from different perspectives to opt out better ways to achieve it’s objectives. The change in strategy can lead prices to recover faster.

3. New Product Launches - Successful new product launches can change the financial trajectory of a Bruised Blue Chip, causing it to heal.

4. Cost Control and Operational Efficiency - “Financially troubled Blue Chips many times resort to specific cost control and operational efficiency frameworks like Kaizen¹ and Six Sigma². If successfully executed, this restores the profitability of the Bruised Blue Chip, causing it to heal.“

5. Debt Restructuring - Usually the most common approach is to raise new and fresh equity to repay the debts in the company which would increase the profitability of the company eventually a faster recovery.

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Process of Investing in Blue Chips

1. Create a watchlist of Bruised Blue Chips

   A watchlist will help us taking appropriate actions according to the situation when healing starts.

2. Clearly Understand Reasons for Bruising

   “As discussed earlier, there are a wide variety of reasons for Blue Chips to get bruised. We need to clearly understand the reasons for the bruising. This is because, as also discussed earlier, Bruised Blue Chips heal only when what went wrong gets rectified.“

3. Wait till Healing Triggers are Visible

   Having understood the reasons for the bruising, we next need to await healing triggers. The most important ones to look for are sector tailwind (external) and change of management (internal).

4. Buy at an attractive valuation

   Bruising alone cannot be the sole reason for buying into a Blue Chip. Its prospects of profit and profitability need to be bright. Else, the Bruised Blue Chip will end up as a value trap.

1. Kaizen is a Japanese concept which states that one should make small but continuous improvements everyday

2. Six Sigma is a system to reduce mistakes and improve quality in the work process