Ambit Capital - Strategy - Can 'Value' Investors Make Money in India (Thematic) PDF

STRATEGY
April 2015
Can value investors make money in India?

Analysts:
Gaurav Mehta, CFA
gauravmehta@ambitcapital.com
Tel: +91 22 3043 3255
M
T
E
O
Karan Khanna
karankhanna@ambitcapital.com
Tel: +91 22 3043 3251
M A
D
E
Strategy
CONTENTS
Can value" investors make money in India?................................................ 3
Value versus quality................................................................................. 4
Value delivers over shorter time-frames. 5
The value premium dissipates over longer horizons 7
Decomposition of the value premium. 8
Are value and quality mutually exclusive? .10
Why long term?......................................................................................... 12
April 29, 2015
Ambit Capital Pvt. Ltd.
Page 2
Strategy
THEMATIC
April 29, 2015
Can value investors make money in India?

In this note we address the age-old debate on value vs quality. Whilst
value delivers over shorter time frames (a year or less), the value
premium tends towards zero over longer time frames, say 10 years. This
is because whilst valuations dominate short-term performance, earnings
growth dominates over longer time frames. Earnings growth, in turn, is
the weakest for the cheapest stocks. Further, value and quality are not
mutually exclusive; we highlight a few high-quality companies trading
at reasonable valuations from our Coffee Can Portfolio (CCP) and tenbagger portfolios.
The value vs quality debate
Our investment approach centers on investing in quality businesses for the long
term; our Ten-bagger and Coffee Can portfolios are both modeled on this
philosophy. Further, we have tilted towards being agnostic to valuations in these
portfolios, as we believe that after screening for quality, adding a further
valuation filter does not enhance performance. Yet at the same time, the
existence of a value premium has been well documented, especially in the
Western context. In this note, we address this disconnect between the two
approaches: value and quality.
Value delivers over shorter time frames of around a year
Analysing the performance of quintiles based on P/E suggests that low P/E
works well, thus supporting the existence of value premium. The performance of
value is best over a one-year holding horizon and the premium dissipates as
the holding horizons increase. Moreover, earnings growth remains weak for the
cheaper quintiles, suggesting that it is a rerating in valuation multiples that
drives the near-term outperformance for value stocks.
and the value premium dissipates over longer-term horizons
The link between beginning period valuations and stock returns becomes
weaker over long time frames and approaches zero on a ten-year basis. Thus,
whilst valuations play an important role in driving stock returns in the near term,
in the long run it is the underlying trajectory of fundamentals that drives returns,
with valuations tending towards irrelevance. Thus, value stocks, with poor
earnings growth, do not deliver over longer holding horizons.
However, value and quality are not mutually exclusive
Stocks become expensive for several reasons such as investors betting on a
revival. Similarly, good companies may go out of favour due to near-term
concerns and may become cheap. Thus, quality and value should not be seen as
mutually exclusive groups. In fact, a distribution of firms with RoCEs of >15%
suggests that such firms are uniformly distributed across P/E quintiles (like the
distribution of our Ten-bagger and Coffee Can firms too). Combining value and
quality, on the other hand, should thus improve returns further.
High-quality companies from our

model
portfolios
trading
at
reasonable valuations
Ticker
Company
name
Trailing Part of which

P/E portfolio?
TCS IN
TCS
24.5 Ten-baggers
ITC IN
ITC
28.6
Coffee-can;
Ten-baggers
HDFCB IN HDFC Bank
24.0 Coffee-can
COAL IN
Coal India
17.4 Ten-baggers
TTMT IN
Tata Motors
10.3 Ten-baggers
HCLT IN
HCL Tech
17.2
AXSB IN
Axis Bank
18.1 Coffee-can
IDEA IN
TRP IN
Idea
Cellular
Torrent
Pharma.
Coffee-can;
Ten-baggers
22.6 Ten-baggers
23.8 Ten-baggers
MRF IN
MRF
14.1 Ten-baggers
MTCL IN
Mindtree
19.4 Ten-baggers
IPCA IN
Ipca Labs.
21.7
BIL IN
CUBK IN
PSYS IN
ECLX IN
FNXC IN
SF IN
GDPL IN
Balkrishna
Inds.
City Union
Bank
Persistent
Sys
eClerx
Services
Finolex
Cables
Sundram
Fasten.
Gateway
Distr.
Coffee-can;
Ten-baggers
15.1 Coffee-can
13.1 Coffee-can
19.1 Ten-baggers
19.8
Coffee-can;
Ten-baggers
19.3 Ten-baggers
27.2 Ten-baggers
22.2 Ten-baggers
VST IN
VST Inds.
17.3 Ten-baggers
MUNI IN
Mayur
Uniquoters
22.4
Coffee-can
Source: Bloomberg, Ambit Capital research.

Note: These are stocks from our model tenbaggers and Coffee Can portfolios that fall in
Q3, Q4 or Q5 on trailing P/E
The value premium dissipates in India as holding horizons increase

6.0%
4.0%
Analyst Details
2.0%
0.0%
-2.0%
1-yr
2-yr
3-yr
4-yr
5-yr
10-yr
Gaurav Mehta, CFA

+91 22 3043 3255
-4.0%
-6.0%
Karan Khanna
Value premium
+91 22 3043 3251

Source: Company, Ambit Capital research. Note: Value premium is the excess returns for the cheapest
quintile on trailing P/E vs the average returns for the remaining four quintiles
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Strategy
Value vs quality
The debate on what matters more, value or quality, has always been a hotly
contested one, and has gained more prominence recently, given the sharp share
price correction in many of the expensive, good-quality names.
Our preferred investment approach traditionally has been to invest in Good & Clean In this note we address the age-old
companies, which implies investing in firms with high corporate governance debate on value vs quality
standards and an efficient capital allocation track record. Our Coffee Can and tenbagger
portfolios
have
been
modeled
on
this
approach
(click here for our 17 November 2014 note on the Coffee Can Portfolio and here
for our 5 January 2015 note on Tenbaggers 4.0). In creating these portfolios, we
have been agnostic to valuations, as beginning period valuations do not stay as Note 1: But for stocks where beginning
relevant in shaping long-term returns, after having been already screened for quality. valuation are so high that even in blue
sky scenario, returns for next 10 years
In our 20 November 2014 note, Role of valuations in long-term investment success, basis is below 10% should be avoided
we had shown that the five Coffee Can portfolios from 2000 to 2004 had gone on to
beat the Sensex over the subsequent ten years in spite of higher beginning P/Es.
Exhibit 1: Coffee Can portfolios beat the Sensex in spite of higher beginning period
valuations
CAGR returns for ten-year
period starting
CCP All-cap
returns
Sensex Beginning-period Beginning-period

returns
Sensex P/E
CCP P/E
30 June 2000 30 June 2010
16.7%
14.1%
22.7
31.8
29 June 2001 30 June 2011
21.7%
18.5%
16.9
20.1
28 June 2002 29 June 2012
19.0%
18.3%
14.2
16.0
30 June 2003 28 June 2013
25.1%
18.3%
11.7
12.9
30 June 2004 30 June 2014
31.6%
18.1%
12.5
13.5
Source: Bloomberg, Ambit Capital research
Another plot that we have often used to illustrate this point on valuations is displayed
in Exhibit 2 below. This exhibit plots FY04 valuations as measured by P/E vs ten-year
relative returns over FY04-14 for the BSE200 universe of firms.
The value of the R-squared makes the story self-explanatory. A zero for this value See note 1
indicates that the beginning-period valuations do not play any meaningful role in
explaining stock returns over the next ten years.
Exhibit 2: Data over FY04-14 suggests beginning period valuations do not materially
influence investment returns over longer time frames
FY04-FY14 share price CAGR
40%
R = 0.0025
30%
20%
10%
0%
-10% -
20.0
40.0
60.0
80.0
100.0
-20%
-30%
-40%
-50%
FY04 price to earnings
Source: Ambit Capital research; Note: FY04-14 returns here are stock returns relative to Sensex. Trailing P/E has
been restricted to 100.
Whilst our approach of sticking to quality irrespective of valuations has worked so far
(in both back-tested and live portfolio performances), there is ample literature
available, especially in the developed world context, to suggest that value investing
does deliver outperformance. Thus, in this note, we address this disconnect between
the two approaches: value and quality.
April 29, 2015
See note 1 plus higher the valuation,

lower the subsequent returns holds
true. But sticking to quality ensures
that there is no permanent loss of
capital....One might needs to lower
his hurdle rate to stick to quality....
Page 4
Strategy
Value delivers over shorter time frames

To test the performance of value investing in India historically, we begin by defining
value as stocks trading at cheap valuations (as measured by trailing P/E). The market
(i.e. BSE200 Index) is divided into five quintiles based on the trailing P/E multiple, and
performance is measured over the subsequent year with an annual rebalance of the
portfolio over the last 15 years. (The portfolio rebalance is done as of the end of
March every year with the prevailing share price on that day and the preceding
Financial Years earnings.)
The rolling one-year returns for quintiles constructed using beginning period P/E
suggests that a low P/E strategy indeed works very well over shorter time frames.
Using average returns, whilst the most-expensive quintile (i.e. Q1) has delivered
CAGR returns of 10% over the last 15 years, the cheapest quintile on P/E (i.e. Q5)
has managed to deliver CAGR returns of ~22%. We see this as strong evidence in
favour of the existence of a value premium.
Rolling one-year returns for

quintiles constructed using trailing
P/E suggests value delivers over
time frames such as a year
Exhibit 3: Rolling one-year performance of P/E quintiles (with Q5 being the cheapest
quintile) over the last 15 years (average basis)*
2,000
Frequent churning improves returns

drastically in cheap quality stocks and
reduces return drastically in high quality
stocks. Buy & Hold works for high quality,
whereas for cheap quality one needs to get
both entry and exit right.
CAGR
1,600
Q5
22%
1,200
Q4
20%
Q3
17%
800
14%
Q2
400
10%
Q1
Apr-15
May-11
May-12
May-13
May-14
May-08
May-09
May-10
May-05
May-06
May-07
May-01
May-02
May-03
May-04
May-00
Source: Bloomberg, Ambit Capital research. Note: The portfolio rebalance is done on 31st May every year. Stocks
with trailing P/Es above 100 have been excluded from the universe. Performance for the latest year has been
updated till 27 April 2015.
The premium continues to exist even if we use median returns instead of average
returns, suggesting this value premium is not the result of a few outliers. On a
median basis, whilst the cheapest quintile has delivered CAGR returns of ~14%, the
most expensive quintile has delivered CAGR returns of ~6%. This translates into a
performance differential of ~8% for Q5 vs Q1 on a CAGR basis.
Exhibit 4: Rolling one-year performance of P/E quintiles over the last 15 years
(median basis) *
1,200
1,000
CAGR
800
600
400
200
Q5
14%
Q2
11%
Q4
10%
Q3
9%
Q1
6%
Apr-15
May-14
May-13
May-12
May-11
May-10
May-09
May-08
May-07
May-06
May-05
May-04
May-03
May-02
May-01
May-00
Source: Bloomberg, Ambit Capital research. Note: The portfolio rebalance is done on 31st May every year. Stocks
with trailing P/Es above 100 have been excluded from the universe. Performance for the latest year has been
updated till 27 April 2015.
April 29, 2015
Page 5
Strategy
Thus, it is evident from the discussion above that over shorter time frames, a valueoriented strategy seems to have worked well historically. However, as can also be
seen very clearly from these two exhibits, performance of value has a degree of
cyclicality to it. In the past four years, the Q5 worm seems to have stagnated even as
Q1 has continued to rise. This is in line with our previous work on the subject (see
here) that value delivers in periods of conducive macro but does not when the
macro turns challenging.
The idea of the current work, however, is to assess the performance of value on a
very long-term, cross-cyclical basis. In that context, at least over a one-year holding
horizon, value has delivered in the past 15 years. Whether or not does the value
premium continue to exist for longer holding periods (say 3, 5 and 10 years) is what
we address in the next section.
April 29, 2015
Page 6
Strategy
The value premium

longer horizons
dissipates
over
As discussed in the previous section, there seems to be evidence of the existence of a

significant value premium on a one-year basis. In this section of the note we analyse
whether or not the value premium remains over longer time frames as well.
Exhibit 5 below shows the average returns for the quintiles constructed using
beginning period valuations over different time horizons for the last 15 years.
Exhibit 5: Performance of value over different time horizons
Quintiles based on
beginning P/E
Q1
Highest PE
Subsequent returns
1-yr
2-yr
3-yr
4-yr
5-yr
10-yr
8.3%
10.5%
12.5%
13.2%
13.6%
13.3%
Q2
14.4%
14.5%
15.4%
16.7%
17.7%
17.1%
Q3
12.7%
13.6%
15.3%
15.2%
15.8%
13.3%
13.0%
12.3%
12.6%
13.6%
13.5%
11.4%
16.8%
16.3%
15.9%
15.0%
14.1%
9.4%
Q4
Q5
Lowest PE
average (Q1-Q4)
12.1%
12.7%
14.0%
14.7%
15.2%
13.8%
Value premium (Q5
4.7%
3.5%
2.0%
0.3%
-1.0%
-4.4%
minus average)
Source: Bloomberg, Ambit Capital research. Note: stock returns for a quintile at any point in time are on a
median basis; quintiles returns have then been averaged over time. Stocks with trailing P/Es above 100 have
been excluded from the universe.
An analysis of the returns for these quintiles over longer time frames suggests that
whilst the value quintile continues to outperform, as can also be seen in Exhibit 6
below, the value premium dissipates over longer holding horizons.
The value premium dissipates over

longer holding horizons
Exhibit 6: The value premium dissipates as holding horizons increase

6.0%
4.0%
2.0%
0.0%
-2.0%
1-yr
2-yr
3-yr
4-yr
5-yr
10-yr
-4.0%
-6.0%
Value premium
Source: Bloomberg, Ambit Capital research. Note: stock returns for a quintile at any point in time are on a
median basis; quintiles returns have then been averaged over time. Stocks with trailing P/Es above 100 have
been excluded from the universe.
Thus, whilst value works well over shorter time frames, the link between beginning
period valuations and stock returns gets weaker over long time frames and
approaches zero on a ten-year basis. This also explains the zero R-Squared thrown
up by a regression of beginning valuations and the subsequent ten-year returns in
Exhibit 2 (page 4).
One direct conclusion from this analysis is that whilst valuations play an important
role (P/E in this case) in driving stock returns in the near term, it is the underlying
trajectory of fundamentals (earnings in this case) that drives returns in the long run,
with valuations tending towards irrelevance. We explore this point in the next section.
April 29, 2015
Page 7
Strategy
Decomposition of the value premium

That returns are significantly affected by valuations in the near term but are driven by
fundamental performance in the long term seems to the key learning from the
findings of the previous section. We will shortly demonstrate this with actual numbers
at the stock level for the five P/E-based quintiles, but before that going through a
deconstruction of returns at the index level into these two components - valuation
change and earnings growth - is equally enlightening.
As is evident from Exhibit 7 below, on a YoY basis, valuation rerating has been the
single biggest driver of Sensex returns. In contrast, over longer time horizons, Sensex
returns have largely been driven by earnings compounding. The 15% CAGR returns
delivered by Sensex has broadly mirrored its earnings growth over the same time
horizon (see Exhibit 8 below).
Exhibit 7: Whilst P/E seems to be a bigger driver of Sensex
returns over shorter time frames
3,200
R = 0.7912
80.0
2,800
60.0
2,400
1,600
20.0
1,200
(10.0)
(20.0)
40.0
800
90.0
400
Source: Ace Equity, Ambit Capital research. Note: Both Sensex returns and
change in P/E have been calculated on a yearly basis starting from Dec 90.
Jan-15
Jan-13
Jan-11
Jan-09
Jan-07
Jan-05
Jan-03
Jan-01
Jan-99
Jan-97
Jan-91
change in trailing P/E (%)
Jan-95
(40.0)
(60.0)
15%
14%
2,000
40.0
(60.0)
Sensex
Sensex EPS
Jan-93
Sensex returns (%)
100.0
Exhibit 8: Sensex returns have mirrored EPS growth over

long periods
Source: Ace Equity, Ambit Capital research. Note: Both Sensex and Sensex
EPS have been rebased to 100 at the beginning of Jan 91.
Thus, over the long term, returns mirror earnings growth even as they are primarily
driven by valuation changes in the shorter term, at the index level.
Coming back to stocks, a decomposition of returns of the P/E quintiles is shown in Whilst returns are primarily driven
Exhibits 9 and 10 below. Even as earnings growth stays weakest for Q5 and strongest by valuation changes over shorter
for Q1, Q5 still manages to outperform over shorter time frames primarily owing to a time frames
valuation rerating (vs a derating for Q1) over shorter time frames.
Over longer time horizons, however, the valuation rerating that explains the value
premium becomes much smaller in magnitude in comparison to earnings growth.
Further, earnings that become much more important over longer time horizons are
significantly inferior for the value quintile vs the other quintiles (see Exhibit 9 below).
As a result, the premium that value enjoys on a one-year basis gradually tapers off
over time.
earnings become much more

important over longer time
horizons
Exhibit 9: Even as earnings growth is weakest for Q5 and strongest for Q1

Quintiles based on beg.
P/E
Subsequent earnings growth

1-yr
2-yr
3-yr
4-yr
5-yr
10-yr
34.7%
27.7%
25.5%
23.3%
21.3%
17.6%
Q2
21.1%
18.6%
17.7%
17.6%
17.5%
16.4%
Q3
12.0%
11.6%
12.7%
12.5%
12.5%
12.0%
Q1
Highest
Q4
Q5
Lowest
average (Q1-Q4)
Q5 minus average
2.7%
6.4%
6.8%
9.4%
9.9%
12.7%
-1.5%
3.0%
5.6%
6.4%
6.9%
7.0%
17.6%
16.1%
15.7%
15.7%
15.3%
14.7%
-19.2%
-13.1%
-10.1%
-9.3%
-8.4%
-7.7%
April 29, 2015
Page 8
Strategy
Exhibit 10: valuation changes ensure better returns for Q5 over shorter time frames
Quintiles based on beg.
P/E
Subsequent earnings multiple change

1-yr
2-yr
3-yr
4-yr
5-yr
10-yr
Q1
-18.4%
-13.7%
-10.0%
-7.3%
-4.5%
-1.0%
Q2
-7.7%
-2.1%
-1.5%
0.2%
1.3%
2.1%
Q3
1.0%
3.6%
3.9%
4.8%
4.6%
3.4%
Q4
16.6%
12.1%
12.1%
9.9%
8.9%
3.8%
Q5
23.9%
18.9%
16.1%
14.4%
13.6%
6.9%
average (Q1-Q4)
-2.1%
0.0%
1.1%
1.9%
2.5%
2.1%
26.1%
18.9%
15.0%
12.5%
11.1%
4.9%
Q5 minus average
Source: Bloomberg, Ambit Capital research.
Given that investing in high-quality franchises with strong longer-term outlooks has
traditionally been the cornerstone of our investment philosophy, it is encouraging to
see that earnings growth - and not valuations - is a more important driver of
investment returns over the long term.
A backtest of the returns from our Coffee Can Portfolios corroborates this finding. As
is evident from Exhibit 11 below, the ten-year returns of these portfolios have more or
less converged to the earnings growth over the period with valuations (i.e. P/E
expansion) becoming almost irrelevant.
Exhibit 11: CCP return decomposition shows that earnings growth is the biggest driver
of portfolio returns
Iteration
Run-period
Total returns
P/E expansion
Earnings growth
2000
30 June 2000 30 June 2010
16.7%
-5.7%
23.7%
2001
29 June 2001 30 June 2011
21.7%
2.7%
18.6%
2002
28 June 2002 29 June 2012
19.0%
0.7%
18.2%
2003
30 June 2003 28 June 2013
25.1%
3.5%
20.9%
2004
30 June 2004 30 June 2014
31.6%
3.9%
26.6%
22.8%
1.0%
21.6%
Average
However, before we conclude this discussion, there are two points that need to be
elaborated upon.
a) Are value and quality mutually exclusive?
Whilst everything boils down to earnings growth in the long term, does value
working over shorter time frames in turn imply that quality does not deliver over
such horizons?
b) Why long term?
Why do we place so much emphasis on long-term investing? After all, as Keynes
famously said, in the long term we are all dead.
April 29, 2015
Page 9
Strategy
Are value and quality mutually exclusive?

Given that value works well over intermediate time frames, one could conclude that
quality does not over such time frames. More generally, there is a tendency to equate
value with low quality and vice versa.
This view gets further enforcement from the fact that forward-looking earnings
growth for Q5 stays much weaker vs Q1, suggesting that Q5 indeed comprises lowquality stocks. However, it is important to note that growth in accounting earnings is
not in itself a conclusive evidence of quality (a company like Arshiya for example
showed stellar EPS growth of ~35% over FY07-12; however, Arshiya does not qualify
on Ambits Good & Clean criteria by any stretch of the imagination).
Using RoCE as another dimension of quality, we tabulate the distribution of firms with
RoCEs of more than 15% across the five P/E quintiles in Exhibit 12. First, contrasting
the performance of firms in these quintiles with RoCEs of more than 15% with that of
the full quintile clearly suggests that superior RoCE leads to superior performance.
More importantly, the distribution of quality (defined as firms with RoCE greater than
15%) across the five quintiles is more or less uniform, with concentration in Q1 not
being materially higher versus other quintiles.
Distribution of high RoCE firms

across the five quintiles is more or
less uniform
Exhibit 12: RoCE distribution in the P/E quintiles

% of firms
with
RoCE>15%
Median returns
[over May 00-May 15]
for all firms in the quintile
Median returns
[May 00-May 15]
for firms with RoCE>15%
55%
4.9%
9.8%
Q2
68%
12.4%
13.3%
Q3
64%
8.0%
10.6%
Q4
62%
8.7%
10.8%
62%
14.0%
17.4%
Q1
Q5
Highest PE
Lowest PE
Bad quality companies generally have

lower PE, but all low PE companies
are not bad. Same for high PE...
Even in low PE multiple, quality
[ROCE > 15%] wins...
Source: Bloomberg, Ambit Capital research. Note: Universe is BSE200 index rebalanced annually. Performance
has been measured over May 00 May 15.
Similarly, a distribution of our ten-bagger and CCP firms across the five quintiles has
been displayed in Exhibit 13 below. Given the stringent quality filters that we use to
construct these portfolios, one would expect these stocks to be trading at expensive
valuations (and hence dominate Q1), especially given that quality has performed so
well over the last few years.
Yet, what is evident from the exhibit below is that these portfolios are again uniformly
spread across the first four P/E quintiles (very few of these firms lie in Q5, the lowest
P/E quintile).
Even our ten-bagger and CCP firms

are uniformly spread across the
first four P/E quintiles
Exhibit 13: Distribution of our ten-bagger and CCP firms across the five P/E quintiles
Q1
Q2
Q3
Q4
Q5
Total
Ten-baggers
23%
23%
37%
13%
3%
100%
Coffee-can portfolio
25%
19%
31%
25%
0%
100%
Source: Bloomberg, Ambit Capital research. Note: This is the distribution of our Ten-baggers 4.0 portfolio
published on 05 January 2015 and our Coffee-can portfolio published on 17 November 2015 using trailing P/E
as on 23 April 2015.
Similarly the distribution of our first three ten-bagger portfolios, published once every
year for the last three years, across the five P/E quintiles (basis the trailing multiples
at the time of publication of the respective portfolios) is shown in Exhibit 14 below.
Here too the distribution is relatively uniform, especially in the first four quintiles,
suggesting there is no undue concentration of these stocks in Q1.
April 29, 2015
Page 10
Strategy
Exhibit 14: Distribution of our first three ten-bagger portfolios across the five P/E
Highest PE
Lowest PE
quintiles
Q1
Q2
Q3
Q4
Q5
Total
Ten-baggers 1.0*
25%
38%
25%
8%
4%
100%
Ten-baggers 2.0
30%
30%
23%
10%
7%
100%
Ten-baggers 3.0
33%
23%
30%
10%
3%
100%
Higher PE Is not equal to quality

always, but vice-versa is true in LT
Source: Bloomberg, Ambit Capital research. Note: This is the distribution of the first three iterations of our Tenbaggers portfolio published on 19 January 2012, 14 January 2013 and 26 November 2013 using trailing P/E as
on date of publication. *excludes Tata Power as the company made losses on a trailing twelve month basis.
In conclusion, stocks may become expensive for several reasons like investors betting
on a revival in the economy in general or a turnaround for a company in particular.
Similarly good-quality companies may go out of favour due to near-term concerns
and may become cheap. Therefore, quality and value should not be seen as mutually
exclusive groups. This also helps reconcile why our ten-bagger portfolios have
continued to deliver each year even as the findings of this research piece suggest that
value works well over time frames such as a year. Combining value and quality, on
the other hand, wherever possible, should improve returns further.
Combining value with quality

should help improve returns further
In that context, several quality companies that comprise our Coffee Can and tenbagger 4.0 portfolios are also trading at reasonable valuations. This short list of (CCP
and ten-bagger) firms that fall in Q3, Q4 or Q5 on trailing P/E currently is shown in
Exhibit 15 below.
Exhibit 15: High-quality companies from our model portfolios trading at reasonable valuations
Mcap
(US$ mn)
6M ADV
(US$ mn)
TCS
77,309
51.9
24.5
Q3
Ten-baggers
ITC IN
ITC
42,801
53.6
28.6
Q3
Coffee-can; Ten-baggers
HDFCB IN
HDFC Bank
39,831
32.6
24
Q3
Coffee-can
COAL IN
Coal India
37,210
26.0
17.4
Q4
Ten-baggers
TTMT IN
Tata Motors
26,418
42.7
10.3
Q5
Ten-baggers
HCLT IN
HCL Tech
19,357
36.8
17.2
Q4
AXSB IN
Axis Bank
20,074
51.0
18.1
Q4
Coffee-can
IDEA IN
Idea Cellular
10,919
16.6
22.6
Q3
Ten-baggers
TRP IN
Torrent Pharma.
3,188
1.8
23.8
Q3
Ten-baggers
MRF IN
MRF
2,504
9.8
14.1
Q4
Ten-baggers
MTCL IN
Mindtree
1,551
4.4
19.4
Q3
Ten-baggers
IPCA IN
Ipca Labs.
1,277
4.3
21.7
Q3
BIL IN
Balkrishna Inds.
1,130
2.0
15.1
Q4
Coffee-can
CUBK IN
City Union Bank
869
1.4
13.1
Q4
Coffee-can
PSYS IN
Persistent Sys
894
2.5
19.1
Q3
Ten-baggers
ECLX IN
eClerx Services
760
1.3
19.8
Q3
FNXC IN
Finolex Cables
666
1.4
19.3
Q3
Ten-baggers
SF IN
Sundram Fasten.
595
0.7
27.2
Q3
Ten-baggers
GDPL IN
Gateway Distr.
622
2.2
22.2
Q3
Ten-baggers
VST IN
VST Inds.
408
0.2
17.3
Q4
Ten-baggers
MUNI IN
Mayur Uniquoters
299
0.5
22.4
Q3
Coffee-can
Ticker
Company name
TCS IN
Trailing
Quintile on
P/E trailing earnings
Features in which
Ambit portfolio?
Source: Bloomberg, Ambit Capital research. Note: Universe for the purpose of arriving at the quintile on trailing valuations is BSE500 index as of Oct 14.
April 29, 2015
Page 11
Strategy
Why long term?

Equities, given the inherent volatility, are usually touted as a long-term asset class.
This makes sense at an intuitive level - whilst the Sensex has returned over 15%
CAGR returns over the last 25 years, there have been intermittent periods of
unusually high drawdowns. For example, in 2007, an investor entering the market
near the market peak would have lost over 60% of value in less than twelve months
of investing. Thus, whilst over longer time horizons, the odds of profiting from equity
investments are very high, the same cannot be said of shorter time frames.
In his book, More than you know, Michael Mauboussin illustrates this concept using
simple math in the context of US equities. We use that illustration and apply it in the
context of Indian equities here.
We note that the Sensexs returns over the past 30 years have been 16% on a CAGR
basis, whilst the standard deviation of returns has been ~29%. Now using these
values of returns and standard deviation and assuming a normal distribution of
returns (a simplifying assumption), the probability of generating positive returns over
a one-day time horizon works out to ~51.2%.
As the time horizon increases, the probability of generating positive returns goes up.
The probability of generating positive returns goes up to ~70% if the time horizon
increases to one year; the probability tends towards 100% if the time horizon is
increased to 10 years (see Exhibit 16 below).
Exhibit 16: Probability of gains from equity investing
disproportionately with increase in holding horizons
in
India
increase
The probability of generating

positive returns increases
disproportionately with increase in
holding horizons
Probability of gains
100%
90%
80%
70%
60%
50%
1 Hour
1 Day
1 Week
1 Month
1 Year
10 Year 100 Years
Years
Source: Bloomberg, Ambit Capital research. Note: This chart has been inspired by similar work done by Michael
Mauboussin in the Western context.
In addition to a disproportionately higher probability of profit, three other factors

work in favour of longer investment horizons at the portfolio level:
(a) No churn: By holding a portfolio of stocks for over ten years, the investor resists
the temptation to buy/sell in the short term. With no churn, this approach reduces
transaction costs which add to the overall portfolio performance over the long
term.
(b) Power of compounding: Holding a stock for long periods allows the power of
compounding to play out. As a result, winning stocks gain disproportionately and
start dominating portfolio returns while losing stocks fade away to irrelevance.
Thus, even with modest strike rates, investors improve their portfolio returns by
holding stocks for the long term.
(c) Neutralising the negatives of noise: Investing over longer time horizons is
also an effective way of killing noise that interferes with the investment process.
Consider for example, how over the long term Lupins investors have had to
withstand short-term disappointments to eventually compound at an impressive
33% CAGR since Jan 04 (see Exhibit 17 below).
April 29, 2015
No Churn once quality bought at fair

price, unless even in blue sky
scenario returns less than 10%
No churn, power of compounding

and neutralising the negatives of
noise are other factors that work
in favour of longer investment
horizons
Page 12
Strategy
Exhibit 17: Lupins stock price has compounded at an impressive 33% CAGR since Jan
04
2,500
2,000
1,500
1,000
500
Jan-15
Jan-14
Jan-13
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Lupin's share price

The chart shown above highlights that over the past 11 years, there are several
extended time periods when Lupins share price has not gone anywhere such as
from Jan 04 to Mar08 and from Jun10 to Jan12. In spite of remaining flat over
these periods, Lupin has performed so well in the remaining six years that the 11year CAGR of the share price is 33%. At its simplest, this is why the concept of
investing for longer time horizons works once you have identified a great franchise
and you have the ability to hold on it for a long period time, there is no point trying
to be too precise about timing your entry or your exit. As soon as we try to time that
entry/exit, we run the risk of noise rather than fundamentals driving our investment
decisions.
April 29, 2015
Page 13
Strategy
Institutional Equities Team

Saurabh Mukherjea, CFA
CEO, Institutional Equities
(022) 30433174
saurabhmukherjea@ambitcapital.com
Research
Analysts
Industry Sectors
Nitin Bhasin - Head of Research
E&C / Infra / Cement / Industrials
(022) 30433241
Desk-Phone E-mail
nitinbhasin@ambitcapital.com
Aadesh Mehta, CFA
Banking / Financial Services
(022) 30433239
aadeshmehta@ambitcapital.com
Achint Bhagat
Cement / Infrastructure
(022) 30433178
achintbhagat@ambitcapital.com
Aditya Bagul
Consumer
(022) 30433264
adityabagul@ambitcapital.com
Aditya Khemka
Healthcare
(022) 30433272
adityakhemka@ambitcapital.com
Ashvin Shetty, CFA
Automobile
(022) 30433285
ashvinshetty@ambitcapital.com
Bhargav Buddhadev
Power Utilities / Capital Goods
(022) 30433252
bhargavbuddhadev@ambitcapital.com
Deepesh Agarwal
Power Utilities / Capital Goods
(022) 30433275
deepeshagarwal@ambitcapital.com
Gaurav Mehta, CFA
Strategy / Derivatives Research
(022) 30433255
Karan Khanna
Strategy
(022) 30433251
Krishnan ASV
Real Estate
(022) 30433205
vkrishnan@ambitcapital.com
Pankaj Agarwal, CFA
(022) 30433206
pankajagarwal@ambitcapital.com
Paresh Dave, CFA
Healthcare
(022) 30433212
pareshdave@ambitcapital.com
Parita Ashar
Metals & Mining / Oil & Gas
(022) 30433223
paritaashar@ambitcapital.com
Prashant Mittal, CFA
Derivatives
(022) 30433218
prashantmittal@ambitcapital.com
Rakshit Ranjan, CFA
Consumer / Retail
(022) 30433201
rakshitranjan@ambitcapital.com
Ravi Singh
(022) 30433181
ravisingh@ambitcapital.com
Ritesh Gupta, CFA
Midcaps Chemical / Retail
(022) 30433242
riteshgupta@ambitcapital.com
Ritesh Vaidya
Consumer
(022) 30433246
riteshvaidya@ambitcapital.com
Ritika Mankar Mukherjee, CFA
Economy / Strategy
(022) 30433175
ritikamankar@ambitcapital.com
Ritu Modi
Automobile
(022) 30433292
ritumodi@ambitcapital.com
Sagar Rastogi
Technology
(022) 30433291
sagarrastogi@ambitcapital.com
Sumit Shekhar
Economy / Strategy
(022) 30433229
sumitshekhar@ambitcapital.com
Sandeep Gupta
Media / Midcaps
(022) 30433211
sandeepgupta@ambitcapital.com
Tanuj Mukhija, CFA
E&C / Infra / Industrials
(022) 30433203
tanujmukhija@ambitcapital.com
Utsav Mehta, CFA
Technology
(022) 30433209
utsavmehta@ambitcapital.com
Sales
Name
Regions
Sarojini Ramachandran - Head of Sales
UK
Desk-Phone E-mail
Dharmen Shah
India / Asia
(022) 30433289
dharmenshah@ambitcapital.com
Dipti Mehta
India / USA
(022) 30433053
diptimehta@ambitcapital.com
Hitakshi Mehra
India
(022) 30433204
hitakshimehra@ambitcapital.com
Krishnan V
India / Asia
(022) 30433295
krishnanv@ambitcapital.com
Nityam Shah, CFA
USA / Europe
(022) 30433259
nityamshah@ambitcapital.com
Parees Purohit, CFA
UK / USA
(022) 30433169
pareespurohit@ambitcapital.com
Praveena Pattabiraman
India / Asia
(022) 30433268
praveenapattabiraman@ambitcapital.com
Shaleen Silori
India
(022) 30433256
shaleensilori@ambitcapital.com
+44 (0) 20 7614 8374 sarojini@panmure.com
USA / Canada
Ravilochan Pola - CEO
Americas
+1(646) 361 3107
ravipola@ambitpte.com
Production
Sajid Merchant
Production
(022) 30433247
sajidmerchant@ambitcapital.com
Sharoz G Hussain
Production
(022) 30433183
sharozghussain@ambitcapital.com
Joel Pereira
Editor
(022) 30433284
joelpereira@ambitcapital.com
Nikhil Pillai
Database
(022) 30433265
nikhilpillai@ambitcapital.com
E&C = Engineering & Construction
April 29, 2015
Page 14
Strategy
Explanation of Investment Rating
Investment Rating
Expected return (over 12-month)
BUY
>10%
SELL
<10%
NO STANCE
We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation
UNDER REVIEW
We will revisit our recommendation, valuation and estimates on the stock following recent events
NOT RATED
We do not have any forward looking estimates, valuation or recommendation for the stock
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STRATEGY

Can value investors make money in India?

April 29, 2015

Ambit Capital Pvt. Ltd.

April 29, 2015

Can value investors make money in India?

High-quality companies from our

Trailing Part of which

HDFCB IN HDFC Bank

Source: Bloomberg, Ambit Capital research.

The value premium dissipates in India as holding horizons increase

Gaurav Mehta, CFA

+91 22 3043 3251

Sensex Beginning-period Beginning-period

30 June 2000 30 June 2010

29 June 2001 30 June 2011

28 June 2002 29 June 2012

30 June 2003 28 June 2013

30 June 2004 30 June 2014

Source: Bloomberg, Ambit Capital research

FY04-FY14 share price CAGR

FY04 price to earnings

April 29, 2015

Ambit Capital Pvt. Ltd.

See note 1 plus higher the valuation,

Value delivers over shorter time frames

Rolling one-year returns for

Frequent churning improves returns

April 29, 2015

Ambit Capital Pvt. Ltd.

April 29, 2015

Ambit Capital Pvt. Ltd.

The value premium

As discussed in the previous section, there seems to be evidence of the existence of a

The value premium dissipates over

Exhibit 6: The value premium dissipates as holding horizons increase

April 29, 2015

Ambit Capital Pvt. Ltd.

Decomposition of the value premium

change in trailing P/E (%)

Sensex returns (%)

Exhibit 8: Sensex returns have mirrored EPS growth over

earnings become much more

Exhibit 9: Even as earnings growth is weakest for Q5 and strongest for Q1

Subsequent earnings growth

Source: Bloomberg, Ambit Capital research

April 29, 2015

Ambit Capital Pvt. Ltd.

Subsequent earnings multiple change

Source: Bloomberg, Ambit Capital research.

30 June 2000 30 June 2010

29 June 2001 30 June 2011

28 June 2002 29 June 2012

30 June 2003 28 June 2013

30 June 2004 30 June 2014

April 29, 2015

Ambit Capital Pvt. Ltd.

Are value and quality mutually exclusive?

Distribution of high RoCE firms

Exhibit 12: RoCE distribution in the P/E quintiles

Bad quality companies generally have

Even our ten-bagger and CCP firms