Widely read:
All it takes is one missing ingredient to ruin a dish. You can get everything right, down to the most minute details. But if you forget the salt, all your efforts are rendered mute.
The equity markets often work in similar ways. Take the example of these four companies with high quality scores: Bajaj Consumer Care , Castrol India , GM Breweries and Gillette India . Each of them has maintained a quality score of 10 (the highest score in our rating framework) consistently over the past five years. For the uninitiated, a high quality score implies that these companies have consistently displayed robust efficiency (high ROE and ROCE) and maintained a healthy balance sheet.
Bitter returns
Three of four companies gave negative returns despite high quality scores
| Company | Quality score | Growth score | Valuation score | 5Y returns (% pa) |
|---|---|---|---|---|
| Bajaj Consumer Care | 10 | 5 | 5 | -10.2 |
| Gillette India | 10 | 6 | 3 | -1.3 |
| GM Brewries | 10 | 6 | 6 | -1.4 |
| Castrol India | 10 | 5 | 6 | 2.9 |
In short, for the seekers of quality businesses, these are a jackpot. Yet, these businesses have failed to reward investors in the past five years. The reason is simple: a missing ingredient.
Here are the details.
| Company | Missing ingredients | Details |
|---|---|---|
| Bajaj Consumer Care | Growth |
It grew its PAT annually by a measly 3% in the past five years The lack of opportunities in its core hair oil segment restricted its earnings growth. |
| Castrol India | Growth |
Annual PAT growth was restricted to a meagre 3% in the past five years. Its reluctance to increase capacity and lack of reinvestment opportunities were the primary culprits. |
| GM Breweries | Growth | Its impressive 39% annual PAT growth rate between FY13-18 was largely due to margin expansion from better price realisation and lower raw material costs. Post FY18, rising raw material costs impacted its earnings growth. Its PAT grew by 6.5% annually in the past five years. |
| Gillette India |
Growth Valuation |
Its earnings growth has historically been driven by margin expansion rather than volume. Post 2018, its margins plateaued, leading to a slowdown in earnings (its PAT grew 9% annually between FY18-23). It hit an astronomically high P/E of 90 in 2018. |
Conclusion
The above exercise highlights why we assess every stock on three parameters in our rating methodology. Our three decades of experience analysing the equity market have taught us that robust quality, fair valuation and high growth are prerequisites for long-term wealth creation. But these three parameters are equally important. It's crucial for investors to exercise caution if a stock falls short in any of these areas.
We strongly advise our readers to give equal consideration to quality, valuation, and growth when using our ratings.
Also read: An emotionless system
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